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Industrials - Manufacturing - Metal Fabrication - NASDAQ - US
$ 60.93
0.511 %
$ 779 M
Market Cap
21.01
P/E
EARNINGS CALL TRANSCRIPT
EARNINGS CALL TRANSCRIPT 2015 - Q4
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Executives

David Van Bibber - Controller and Chief Accounting Officer Mark M. Comerford - President and Chief Executive Officer Daniel W. Maudlin - Vice President of Finance; Chief Financial Officer.

Analysts

Edward Marshall - Sidoti & Company, LLC. Michael Gambardella - JPMorgan Chase & Co. Philip Gibbs - KeyBanc Capital Markets Inc Lisa Springer - Singular Research.

Operator

Greetings and welcome to the Haynes International’s Fourth Quarter and fiscal year 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation [Operating instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host David Van Bibber, Controller and Chief Accounting Officer for Haynes International. Please go ahead sir..

David Van Bibber Controller & Chief Accounting Officer

Thank you very much for joining us today. With me today are Mark Comerford, 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 assurance that such plans, intentions or expectations will be achieved.

Many of these risks are discussed in detail in the Company’s filings with the Securities and Exchange Commission, in particular Form 10-K for the fiscal year ended September 30, 2015. 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 Mark..

Mark M. Comerford

Thank you, Dave. Good morning, everyone and thanks for joining us today. Hopefully, you have all seen the press release and had a chance to review it. We will follow our standard agenda in today’s call. I’ll open with comments about the business and our end-markets and then Dan will give you greater detail on the financial results.

Fiscal year 2015 was a year of contrast here at Haynes, we saw record volumes shift into our aerospace market and record volume produced in our quarter coil and sheet operations. Principally driven by the aerospace market which by the way means it was a very complex mix as well.

We also purchased and integrated the assets of Leveltek LaPorte which we call LaPorte Custom Metal Processing and we had significant success during the year in executing our strategy and developing new special key applications and projects. This highlight the core strength of Haynes and is the key part of our strategy.

In fact I think this is probably Haynes’ best year in development of new projects and winning new applications.

During the year, we picked up new applications or projects and everything from the electronics industry to welding to gasification and refining to co-generation to new aerospace platforms and to start contrast for these positive results, I think our industry is experiencing one of its most tumultuous periods since the 2008, 2009 downturn.

Nickel pricing is about half if not less than half of where it was 12-months to 18-months ago, the oil and gas industries has been decimated by slowdowns in demand as industrial demand worldwide pulled back as global economies have slowed. This slowing in industrial activity and having a dramatic impact on our business in the Asia Pacific region.

In fact, I think last call I think I just gotten back from Asia and we talked about how slow things appear to be over there and to be honest with you, I think if anything its gotten progressively worse on the industrial side and I think was even slower than I saw it when I was over there.

More specific to Haynes, I can’t remember a slower time in the chemical process industry. I believe our backlog today in the chemical process industry is the lowest I have seen it in my seven plus years at Haynes.

Strong backlogs in other areas, but in the CPI industry in particular it’s very slow, but I will elaborate on those comments in contrast as I get into the specifics of our core markets. First, let go through the results for the year.

Taking a look at fiscal 2015, the year finished with net revenue of $487.6 million up 7.1% from last year’s $455.4 million. Net income in fiscal 2015 was $30.5 million up over 700% from last year’s $3.8 million. Volume shipped this past year declined 6.5% to 20.3 million pounds against last year’s 21.7 million pounds.

Freighting during the year was positively impacted by our strong product mix, finishing at an average of $24.07 per pound inclusive of our other revenue, which is primarily the tolling business and that pricing level was up 14.5% versus the $21.02 per pound we saw in fiscal 2014.

Again, the strong mix of aerospace, special projects and tolling clearly offset the weaknesses we saw in commodity pricing, primarily nickel and softness we experienced in our gas turbine and chemical process markets.

As I typically do at the end of our fiscal year, I met with about 50 or so customers over the last few weeks to discuss the upcoming year. In general, the sentiment matched up pretty well with what I said so far.

Those involved in aerospace are very bullish on the upcoming year and the new engine platforms along with increased production levels announced on the commercial side of the business.

In fact, I had more than one discussion with customers and they mentioned that they are excited about moving into the ramp up stage and getting away from the readiness on it that we have all been going through for the last four years or so.

The gas turbine customers I met with were surprisingly more bullish than I expected them to be, but they feel we are nearing the bottom economically in several areas and they expect 2016 to be at levels similar to 2015 or slightly above.

CPI accounts still reports slow conditions, especially our international account, but domestically several reports based on the quota activity they feel is being driven by the national gas build out occurring on the Gulf Coast and in Shale regions. In my opinion, the next two quarters may be difficult for the industry including Haynes.

We expect our aerospace and tolling business to remain solid, our gas turbine backlog picked up, so we are expecting a little bit better results there, but we are seeing a low in our special projects.

Right now, we are processing some special projects through the mill, but we expect the invoicing level to be low this quarter or I should say lower than in previous quarters. And I think that will drag down into second quarter as well. So the next six months I think are going to be a bit of grind.

Our other market areas is down slightly right now, but a lot of that has to do with timing of orders as they come through specifically on some of the new applications we won and we do expect that to pick up in volume as we enter the calendar year.

Again in mind, this adds up to a challenging beginning to the new fiscal year, but we still feel very good about where we are positioned and longer term demand we expect from our core end-use markets and our focus is especially on special project development.

Moving to our end markets, net revenue in the aerospace market for fiscal 2015 was $215.1 million up 10.2% from last year’s $195.2 million. Volume in this market was a record 9.2 million pounds up 4.7% from last year’s 8.8 million pounds.

By the way, Haynes’ prior records for shipments in the aerospace was 8.9 million pounds and that occurred both in 2008 and 2012. In fiscal 2015 aerospace accounted for 44.1% of revenue that’s also a record for Haynes.

Backlog during the quarter decreased slightly by 1.3% due to timing of some order placement on the aerospace tubing side and by the way those replacement orders have since been entered. In spite of declining echo and our record shipping levels in fiscal 2015 the backlog in dollars in our aerospace market grows slightly during the year by about 2%.

I think most of you know the story in the aerospace market, activity at the demand end of the supply chain has been excellent as reported by Boeing Airbus.

They have dramatically increased shipments of commercial aircraft over the past four to five years and they expect to further increased production rates particularly notable on the increases on single aisle aircraft.

At the engine line and the sub tier supplying into the engine manufacturers were starting to see increased demand for the new materials, for their new platforms, specifically related to GE Leap and the Pratt 1000 Series engine programs.

We expect demands for these components to increase as we move through 2016 and into 2017 and by the way this was an area when I was meeting with customers, they were talking about the ramp levels that they have been discussing with the engine manufacturers and again it appears that this is finally occurring.

And by the way, I think most of you know, we've got Haynes 282 specified into the Pratt 1000 series and we're finally crossing some critical thresholds and demand there and really starting to position material for that supply chain. So we're excited about where that business is moving.

We completed our expansion, the capital expansion in our tubular products area and we're ramping up that production which contributed to our record shipments this year and has allowed us to the family improve our performance in meeting our customers' requirement.

With the investments we've made in our tubular products area and the investments we've made and are making in providing better products and service in our coil and sheet products. We feel very confident about where we have Haynes positioned for the increase demand we expect in the commercial aerospace market.

As we mentioned in the press release, we're booked heavily on our coil, sheet and tubular products servicing aerospace market well into 2016. So part of our focus in 2016 in the upcoming year is going to be on eliminating the bottlenecks in our processing ensure we meet our customers need as we move into 2016 and 2017.

In our chemical processing market, net revenue for fiscal 2015 was $111.6 million down 1.6% from last year's $113.4 million. Volume in this market fell 18% during the year to 4.3 million pounds from 5.2 million pounds in fiscal 2014.

This area accounts for quite a few for our special projects during the year resulted in average selling prices being up 20% in fiscal 2015 to $25.97 per pound as compared to last year's $21.63 per pound. CPI was approximately 22.9% of our total revenue.

I would like to remind you that not only do we have a strong year in special projects in this market area, but this was also an extremely slow year for high volumes typically lower price commodity applications. That combination helped in the growth of the overall average selling price for the year.

Obviously we're pleased with our performance in developing new applications in special projects, but I think we've talked about in the last call and I'll reiterate it.

We're also very concerned about the dramatic softness in the core higher volumes side of this business and I think several of peers really saw the impact of that slow down in the core side of CPI business.

Our backlog in this area is down about 33.5% from last quarter as we continue to shift several projects, but more dramatically its down 71.4% from the beginning of the year. Again, I think I need to qualify that a little bit.

At the beginning of fiscal 2015, we had one of our highest backlogs in our history for this market, especially with all of the special projects we had coming into the year and today we have the lowest backlog that I can remember since I joined Haynes, seven plus years ago.

As I said earlier, some very start contracts occurred during the year and as we said on the call last time, a lot of concerns right now about the depth of the softness we're seeing in the core applications of this market.

Again, some of the discussions I had with customers over the last few weeks was some of them feel that with some of the natural gas boom that’s coming online and some facilities that are being built. That some of the MRO money is being held back a little bit and so we see how some of that plays out. Again, strictly qualitative discussions there.

But one of the positive areas that we've taken away, I mean now that I have sufficiently frightened you with how deep the backlog has declined, one of the positives is the growth in these areas, the shale areas, the area in Gulf Coast region.

It was funny as recently at an Investor meeting and some of the guys in the aggregate areas said “yes those projects are moving ahead and they seem to be doing quite well.

So, we will typically follow someone in that area, in construction of these big projects.” Also things like the automotive industry and construction industries seems to be doing well, those are also typically lead indicators for the chemical processing industry.

So, right now we're at a very deep point as far as the backlog and where this industry stands with respect to its core applications, but I think there are some good indicators out there that this will come back for us.

Also just want to remind you, you know we always have special projects, cooking and working in the incubator and it’s no different right now.

We do still have some special projects going on, it’s just the timing of those project and such that I think the next six months as far as invoicing, there won't be as many special projects in the next six months invoicing. They are processing through the mill, but invoicing as we did last year this time.

Moving to land-based gas turbine, our sales into land-based gas turbine market total $74.5 million in fiscal 2015 down 14.2% from last year's $86.7 million. Volume was up 21.9% to 4.7 million pounds from 2014's 5.9 million pounds.

The level of shipments was whip off our peak levels of 2012 and whip 13 of 6.5 million pounds and 6.1 million pounds respectively and it reflects roughly a two-year correction in the supply chain in this market.

This market accounted for 15.3% of our net revenue in the year, during the quarter we saw the backlog in this area increase to 16.5% and over the year that backlog was up over 40%. The customers I met with recently expressed the optimism as I have mentioned. However, the backlog increase as I just cited for you are at very low levels.

If you remember a year-ago we were kind of in the land-based gas turbine backlog levels where we are today with the CPI levels, not as dramatic as where we are today with the CPI, but you probably remember about a year ago I was telling you how low these land-based gas turbine backlogs were.

They are much stronger right now, but I still wouldn't say that they are back to good or excellent levels. I think they are getting to good.

The customers I met with again as I said, expressed a lot of optimism moving from 2015 into 2016 and then further into 2017, but for me right now and for us we're still in a wait and see mode to see if this market can return its strength. Pricing in fiscal 2015 held at pretty in the phase of falling nickel and the strengthening U.S.

at 15.99 a pound for the year up 8.5% from last year's average of 14.74. We attribute most of the change to mix, we saw fewer orders for large heavy section lower priced applications that there by skewed the mix to the more of the MRO applications, transitions cut part, et cetera.

Looking forward, I really I would say I see a catalyst out there to drive this market up quickly, other than that it appears a lot of the supply chain direction, there is two years of destocking we seem to have gone through.

It appears to be nearing completion until, global industrial demand and economies improve and demand for oil and gas increases specifically for small turbines that for pipelines, et cetera. I think it's fair to say that this market is going to remain very choppy.

Finally, our other markets and other revenue accounted for $86.5 million in net revenue in the fiscal 2015, up 44% from over fiscal 2014 to $60.1 million. This accounted for 17.8% of our revenue for the year. We won several applications during the year and we saw solid benefits from the addition of LaPorte into our company.

This area was hit very hard over the past three years from the [indiscernible] and specifically flue-gas desulfurization, pollution control applications, which used to be a large part of this market area for Haynes. However, we continue to develop welding, grazing, heat treatment, consumer applications, et cetera to rebuild this area.

Looking ahead, the backlog is off about 20% from last year at this time excluding our tolling business, the tolling business as most of know comes in and goes out in the same month.

So it's a not a real fair indicator in the backlog numbers, but about 50% of the drop that we've seen is timing from new orders and new applications, so we're comfortable that we'll be able to fill that gap.

Some of the more common welding applications are under attack right now by lower priced alternatives and just a general slowdown in the oil and gas industry, but again we feel when this industry regains its footing, we have some excellent value added applications that we think will win business.

On our operating side, we are continuing to invest in our process engineering modification and we're modifying our processing equipment as well to upgrade our capabilities to meet our customer needs.

I mentioned earlier that we shipped record levels into our aerospace market and subsequently we had record production from our coil and sheet processing facility.

And just taking you back a little bit, if you remember back in 2007, 2008, Haynes took on the capital expansion upgrade project that increased the shipment capacity of our core coil and sheet products about 50%.

Hopefully, also if you remember we stilled that capacity by 2012 in fact in 2012 we set a production record for the Company in that product areas of the coil and sheet area. We since increased that capacity again about another 10% or 15% just through add-on projects and process engineering projects in our flat roll area.

And this year, we've been bumping up against this new rated capacity level you might say. And again, with the complexity of the mix, it's dramatic increase in the volume we're processing through the plant.

For those of you who have may not seen our operations we largely used the same equipment for manufacturing products that we supply into all of our end markets.

However, speaking very broadly the complexity and manufacturing aerospace alloys requires more processing steps and more processing times on that equipment than does the processing of say a higher volume, more commodity related chemical processing corrosion alloy.

So the type of mix we've been processing through the plant is a more complex mix and we are bumping up against much higher capacity levels.

Our objective is we will continue to debottleneck those specific process steps to help us meet the projected growth that we anticipate in the aerospace market and meet the needs of our other core markets when their volumes return.

We will be committing about $16 million to $17 million in capital over the next year or so to further upgrade these facilities to achieve these objectives.

Mainly the modification of existing equipment and upgrading some equipment that we've had for years that things like the electronic systems, the bearing systems those things need to be upgraded to become better contributors to the processing of our materials.

Our manufacturing and engineering teams have done an excellent job over the past 18-months of meeting demands and we will be giving them better tools and better capabilities ready ourselves for the next upside. LaPorte Custom Metal Processing, our acquisition in early 2015, also adds to these capabilities.

LCMP gives us the capabilities we had outsourced previously and access to a market that we feel has a growth potential with limited capital requirement.

We feel this acquisition will further allows us to be a better partner to target accounts where we provide value-added processing, in particular allowing us better shape control for our expanding value-added cuts parts business.

And again just to remind you, when I talk about aerospace volumes and our aerospace business, remember that is probably our most intensively cut parts business or market segment. So we are constantly doing more and more cut parts servicing in the aerospace market. We are doing quite a bit now on the land-based gas turbine side too.

So all of these adding into kind of differentiating ourselves along with the work we do to develop specialty applications and specialty projects. A lot of that occurring in the corrosion area. Finally, we have entered into the production stage of our IT platform upgrade.

So far, we have been able to run parallel systems and integrate new production orders on the new system while closing out existing orders on our legacy systems. I'm sure those of you who have done an IT implementation can appreciate the complexity of such an endeavor.

So far, production implementation at our tubular products facility down in Louisiana is going well. We expect to start implementation at our Kokomo operations in calendar 2016 using what we have learned at the two facilities to help us with the implementation here. I have kind of given you a lot now.

Let me turn it over to Dan, so he can walk you through the financials..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Thank you Mark. Business conditions became more challenging as the fourth quarter progressed with falling nickel prices and continued headwinds related to the strong U.S. dollar and to lower oil and gas demand creating a spillover impact on our chemical processing business.

However, we were able to mitigate a portion of these headwinds in the fourth quarter with some continued specialty application projects that shipped during the quarter. This favorable mix helps support the gross margin in the quarter and partially offset the compression from the noted headwind.

Over the course of fiscal 2015, these high value specialty application projects provided an offset to the sluggishness in the highly competitive commodity base side of the chemical processing market.

Last year, the intense competitive environment in that market required the company to aggressively price orders unfavorably impacting gross profit margin and net income in fiscal 2014.

The improved circumstances this year contributed to an average selling price increase per product sale of $2.45 per pound sold in fiscal 2015 a 12.1% increase over fiscal 2014, this improvement occurred in an environment where nickel declined 45% over the course of fiscal 2015. This performance is favorable.

However, looking forward we expect to have less specialty application project business in the upcoming first quarter. While our technical applications development efforts are continuing and are a key part of our strategy, these special projects are by nature sporadic and sometimes inconsistent quarter-to-quarter.

Our base business volumes were relatively stable in the fourth quarter except for chemical processing, which was down in the past two quarters and our backlog has declined. As previously mentioned, the market price of nickel has been declining dramatically.

The average LME price for the 30-days ending September 30, 2015 was $4.49 per pound, which is a 45% decline in the same period at the end of fiscal 2014 of $8.20 per pound.

Falling nickel prices creates compression on gross margin due to pressure on selling prices with lower nickel, combined with higher cost of sales as we sell off the higher cost inventory acquired in prior periods with higher nickel prices.

This compression occurred in the third and fourth quarter and will likely continue to negatively impact gross profit margins in fiscal 2016.

We estimate that margin was compressed by approximately $1.5 million to $2 million in Q4 due to declining nickel and we are expecting more significant compression to margin from declining nickel in our upcoming first quarter estimated in the range of $2 million to $2.5 million pretax.

Our gross profit margin percentage this quarter was 18.3% down from Q3 of 19.9% and up compared to Q4 of last year of 15.8%. SG&A cost combined with research and technical cost were $11.7 million for the quarter and $46.2 million for fiscal year 2015, which is 9.5% of net revenue compared to fiscal year 2014 of 9.3%.

The increase is driven by higher commissions paid to agents related to the special projects and higher incentive compensation accruals. Net income was $5.8 million for this quarter compared to Q4 of last year of $6.4 million and was $30.5 million for the full fiscal year 2015 compared to only $3.8 million for fiscal year 2014.

Outlook for the next quarter. We expect lower nickel market prices to unfavorably impact our product selling prices reducing our revenue and compressing our gross margins in the first quarter of fiscal 2016.

In addition, the mix of shipments is expected to be less favorable with lower levels of project related specialty application shipments than in recent quarters.

These factors along with the typical first quarter actions of customers managing their calendar and balance sheet and our holiday and maintenance shutdown scheduled are expected to contribute to lower results in the first quarter of 2016.

We expect our revenues and gross margin percentage in the first quarter of fiscal 2016 to be lower compared to the first quarter of fiscal 2015. We anticipate that earnings will be low, but remain positive. Backlog was $185.8 million at September 30, 2015 a decrease of $7.1 million or 3.7% from the $192.9 million at June 30.

Mark provided commentary on the backlog already, but I wanted to update the number to a more current date. The backlog on November 15, 2015 increased $5 million since year-end to $190.8 million. Capital spending and acquisitions in fiscal 2015 was $33.1 million and forecast for capital spending in fiscal 2016 is $35 million.

The $35 million includes $16.6 million to increase sheet manufacturing capacity in Kokomo operations which is expected to help the company to keep pace with the anticipated growth in the aerospace demand.

As Mark mentioned, during fiscal 2015 the company was capacity constrained on sheet production and hit record level of sheet and coil production level this year.

Remaining $18.4 million of capital spending and includes $1.7 million for the manufacturing phase of the IT systems upgrade with the remaining $16.7 million for continued upgrades throughout the manufacturer facilities which is considers a maintenance level of CapEx spending.

Net cash provided by operating activities was $48.4 million in fiscal 2015, which is nearly 80% better than last year driven by stronger net income.

Inventory favorably decreased to $6.2 million, but was more than offset by the used of cash from the decreased in account stable of $9.2 million and then increase in accounts receivable of $3.2 million, causing controllable working capitals to increase $6.2 million to $277.5 million at September 30, 2015.

Our revolver balance remains at zero borrowings. Our credit facilities expires in July of 2016 and we're in the process of gathering and evaluating information for that renewal. Our cash balance increased in fiscal 2015 to $49 million from $45.9 million last year.

The year-end’s pension plan valuation resulted in a $35 million increase in our net liability for two primary reasons. First, it required actuarial change to higher mortality assumptions required a new mortality tables to be used, which was the main reason for a $22 million actuarial loss that increased the liability.

And second a market drop in the plan assets and near the end of the fiscal year reduced the plan assets $13 million, some of which has been since recovered in the market in October and November. These combined resulted in an increase to our net liability and the pension plan to $106 million versus last year's $71 million.

To put the $106 million net liability in perspective, excluding this year's mortality table change, the actuarial losses from 2009 to 2014 primarily due to falling interest rate equaled about $100 million. This year discount rates remains low, although we were hoping for an increase.

The mortality assumptions also impacted the retiree healthcare plan, which increased the liability $5.1 million to $110.5 million up from $105.4 million last year. And keep in mind the Retiree Healthcare Plan has no plan assets and is a pay as you go plan with a cap of $5 million annually.

As a result of these valuation issues the pension and retiree healthcare expense for next year is expected to increase an additional $6.4 million in fiscal 2015 to $19 million as compared to fiscal year 2015 at $12.6 million.

And in summary, as we continue to navigate this challenging environment, we will stay focused on the things that differentiate and create shareholder value, including technical application development for special projects, a deeper integration of our cut parts program and our new alloys, continued management of cost and manufacturing efficiency and the focus on capital allocations yielding a value creating return on investments.

And with that I'll turn the call back over to Mark..

Mark M. Comerford

Thanks Dan. We mentioned last year that we saw fiscal 2015 will be a transition year. I think that occurred, as I mentioned earlier, it’s also a year of contrast. We executed extremely well I think in taking advantage of our new alloys and new applications in the form of new projects.

And by the way, just so say you are aware quite often we will go into these specialty projects and we will be developing application with the customer and a lot of times its for an existing alloy and alloy that's in production not patented type of material, sometime they are just to more complex alloy to manufacture or there is issues with welding or things like along that nature.

But so they are not always for patented alloys and higher priced, higher margin alloys, but we do kind of get phone call on a lot of times for any time somebody is coming up with a new idea and new technology or a new specialty project application, which works well for us that's what we like to do.

I think we also added the capabilities especially with the addition of LCMP in the last year. We also managed our mix to insure that we could maximize our participation in the aerospace market, especially with our coil and sheet products. In addition to our value added products.

We also saw the gas turbine business continue to struggle, although the backlog is starting to build a little bit, especially on the OEM applications it’s been struggling and the small drive systems as I mentioned the turbine, the dry pipeline, et cetera.

And we really experienced a dramatic fall off in the core high volume side of the chemical process market. Overall, we see some cloudiness over the six months as I mentioned and Dan had mentioned. We expect the aerospace to remain strong and we expect our tolling business to remain strong.

We expect a little bit better activity out of the gas turbine market when we take a look at where we are with our backlog right now.

We also expect that high volume chemical business will remain soft and whereas we still have quite a few projects in the pipeline and we have some projects right now that are running through the mill, but we just don’t expect a strong invoicing level of project activity as we did in the first and second quarters of last year.

It just won’t be as strong on the annual side. And as Dan mentioned, I mentioned, these projects are sporadic. As we look longer term at the business through late 2016 and into 2017 we feel very good about where we are positioned.

We feel real good about the actions we took in 2015, we feel good about having the record levels in aerospace doing a lot more cut parts, LCMP is fitting nicely in case of the footprint we are looking forward as we go into the future.

It gives us a lot of the capabilities we are looking for as we go into the future to provide better quality, better turnaround especially in the aerospace market. We feel pretty good that we are becoming a technical resource for our customers seeking to develop new application.

Again, we feel good about what happened in aerospace business this year as an indicator of we are pretty solid, pretty strong on platform business and the kind of business you get specked in and constantly returns and constantly comes back every year.

And we also had a very good year and we are continuing to develop new applications, but very good year on the project application side of the business, but I’m not sure a lot of the other metals mills, metals manufacturing guys do the way we do, which is I think it’s a big differentiator for Haynes as our participation in the specialty project related applications.

So again with that let’s open up the call to your questions..

Operator

Thank you. We will now be conducting a question-and-answer session [Operator Instructions] Our first question today is coming from Ed Marshall from Sidoti & Company. Please proceed with your question..

Edward Marshall

Good morning Mark, Dan, how are you today?.

Mark M. Comerford

Good morning Ed..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Good morning..

Edward Marshall

So I guess the first question and I guess it may be a comment, but when I look at the gross margin this year I mean the stability that you’ve been able to show in kind of very volatile nickel environment especially lately.

I’m kind of curious as to is this a result of your capital upgrades or is this a change in the business, are you kind of at a base level.

I mean I know you’re on FIFO, so are you in a base level of kind of nickel where the changes aren’t hurting the margin as much? Kind of what can you add there to kind of talk about what is happening on that line?.

Mark M. Comerford

I will tell you Ed if you think of where we were strong this year okay, take a look at the aerospace, take a look at the tolling, take a look at the special projects, I can’t think of three more value-added excellent areas for us to have a strong year. Those are by far our best I will say selling price types of application.

We are also very process intensive, but those are pretty much “boy if I could have a mill that only did that stuff and there was sufficient volume in all that stuff” that would be the way to run. And so you have to get into a mix management. So that’s a lot of it.

Now our ability to get out especially if you think of the aerospace, our ability to get out as much product as we did in aerospace, and by the way when I say we are booked heavily into 2016, a lot of those orders are kind of on or before. So we are still pretty clogged in some of the areas, we've got to debottleneck some areas.

That gets back to your question about is some of this the investment in the CapEx. Had we not done the work in 2008 there is no way we get this volume. I think about our volume today in the coil and sheet area is about 60% to 70% higher than it was in say 2006 type of timeframe.

In a year like this a lot of that was aerospace which again is a much more difficult product to manufacture. So the capital upgrades we have done are the only way we would be able to get these types of numbers out to be a good rate.

But as for margin point of view, in my opinion as I look at it and go through it, I think the mix we had this year was extremely strong and extremely good for us to be - think about it, nickel was 8.50 16-months, 17-months ago and think of where nickel is today.

Nickel today if you look back at 2008 when the world fell apart, nickel I think was down in the average in December of 2008 it was like 4.39 and it kind of lingered through that level through March 2008, December 2008. Having lingered through that level through March of 2009 when there was so much uncertainty and nickel is below today.

And I always say to you guys and nickel is telling you something, it is a real difficult time for certain sectors in the industry, aerospace holding up and we were able to manage the mix to get as much aerospace out possibly could.

But again getting back to your original question, a lot of that a lot of the execution this year is because of the upgrades to equipment and some of the additional capabilities like LCMP that really contributed to us getting a better product.

I'll let Dan talk a little bit now about specifics on margins, but that's kind of if I’m giving you a qualitative overview that's really it this year..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Yes definitely, we certainly felt the effects of nickel, we just had this other things offsetting it, so nickel as I mentioned in the fourth quarter was about a $1.5 million to $2 million impact, so that was clearly a compression on margin that was just offset by some very good specialty applications.

And as we kind of move into Q1, I mentioned the nickel has fallen since Q4 or Q3, so that number goes up to $2 million to $2.5 million impact on our margins. So a delta there from Q4 to Q1 of probably $1 million that will impact our margin, and in Q1 we don’t quite have that mix that we mentioned.

So we won't have that offset, so we will feel the effects quite a bit more significantly on our margin..

Mark M. Comerford

And if I could add to it too and maybe I should give you this clarity as well. If you think about when I say we are soft in the CPI, I don't want you think that it’s strictly coil and sheet product.

When we were soft in CPI a lot of that is billet, forgings, heavy plate areas where we have capacity available to today and expecting when it was a year of contrast, we are just booked very tight, very solid in the coil and sheet areas the most complex product and the core product.

I mean you guys know 70% of our volume of the company is coil and sheet. But areas like billet and plate and ingot, they are still doing okay as far as aerospace still doing okay as far as land-based gas turbine, not up to normal land-based gas turbine area, but where they really suffered in the last year as in the CPI industry.

So we have been able to move ships out, move people over into the coil and sheet processing area, but if you ask me like capacity today we are running pretty slow in like the forging area, the billet area, the heavy sections.

And I mentioned it in my script, but that's what I say when I say we didn't see a lot of activity in the heavy section side of the chemical process business this year..

Edward Marshall

Big testament, big change from some of the gross losses we've seen in future, the prior years when nickel had this kind of volatility so that’s a complement. When I look at your sheet capacity that you are adding and I’m curious I mean you are adding it I guess you mentioned for aerospace in general.

I know that equipment is also transferable, are you kind of anticipating that you might see a pickup in other end markets next year, I mean how much capacity you are adding how much capacity do you need and what is the cost of that capacity?.

Mark M. Comerford

Yes just from a general market side, I think we're still at the frontend of the aerospace cycle, in just my opinion. Again, when I talk to customers, there is still some I'll say reluctance not on playing orders per se, but there is still a little bit of movement or migration from legacy systems into the new platforms.

So I guess the best way to put it is people are still very careful on placement of any kind of business that support legacy systems. So we had a real good year in aerospace in my opinion and we had a record volume year in aerospace.

And I don't think the aerospace business is really kicked in yet and I can you tell you from my indicator, which would be sales of HAYNES 282, it's finally kicking up a little bit, but it's nowhere near where people are telling it's going to be, which is my indicator for okay the new platforms.

We are starting to see some volume come through, but we're going to need some capability if we are kind of bumping up against some capacity restrictions where we are today.

Now you can always manage the mix further, right, you can always eliminate a little bit more of some of the other markets, other products that you are running through the mill to reserve that space for aerospace.

But we still need some additional capabilities, upgrading some of this old equipment, because if we do see some pop-in land-based gas turbine and chemical again and a lot of these specialty applications we've developed this year and we've worked on this year were, I'll say chemical related refining for thin gases and coal generation and gas.

You guys remember a couple of years ago we had some applications in solar that they come back sporadically we have to debottleneck some of that coil and sheet capability. And if you think about it too especially because a lot of that coil and sheet capability in our mill is now kind of I'll say setting up beautifully.

It's fleeting in up this cut parts and value-added capability that we have that I think is a big differentiator for us and we need to keep feeding that beast as we go forward, it's kind of our version. A lot of the guys on the long product sides have integrated themselves into the big forging area.

We're not really a long product manufacturer, so if we're going to integrate ourselves in the supply chain and then view ourselves through the customer base, we keep integrating further into the part side of the business and so we'll need that coil and sheet capability to continue to feed that value-added differentiator that we have..

Edward Marshall

Got you. Last one from me, when I was listening your CPI comments and if I compare that maybe to some of your competitors, your peers I think their outlook might be a little bit stronger. And I guess it's more anecdotal at this time, I think there has been some orders, but I know competitions part of equation.

Are you planning that prices are what's kind of leading into kind of some in your comments relatives to those, I mean are you getting priced out of the market, also I guess a lot of your CPI is based in Europe, so is the dollar strength affecting your competitiveness at all?.

Mark M. Comerford

If you think about it Ed, I wish it was just one thing, but if you think about it, we talked about nickel, strong dollar clearly relates into that.

Talked about the weakness in just the Asia Pacific market, if you ask me what the real difficulty right now in the CPI market, to me anyway to team is this dramatic fall off weakness we saw in the Asia Pacific markets.

If you take a look at our revenues numbers for the quarter, I spoke to you guys last quarter, which was at the end of September or something like that or it will June, July - August I guess it was. When I just gotten back from China, September I think it was, our shipments out of our service center in China were off 90%.

I remember coming back and talking to you guys and saying I went to China, boy it is weak I can remember since the Asian financial crises. And I come back and sure enough it was off 90% in one month, 80% in the other from our my plan levels and that the pretty dramatic kicks.

So China to me is the biggest kick in CPI, I defiantly think there is some strong dollar impact where we sit and talk with our customers and the lot of them are fabricators and we still got their business.

But it wouldn’t surprise me and some of the fabricators in Europe and in other areas might be filling up a little bit more based on what is happening with the dollar. I’m a manufacture, I don’t like the strong dollar and my customer are manufactures especially in North America, they don’t like a strong dollar.

So there is defiantly some of that impact..

Edward Marshall

Okay. thanks guys. Thanks for your comments, I appreciate it..

Mark M. Comerford

Thanks..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Thank you, Ed..

Operator

Thank you. Our next question today is coming from Michael Gambardella form JP Morgan. Please proceed with your question..

Michael Gambardella

Good morning..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Good Morning..

Mark M. Comerford

Good Morning Mike..

Michael Gambardella

Two questions.

First, what percentage of your sales are kind of parts you do? High value-added parts?.

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Yes. We don’t tell people on that Mike. I do think that a couple of years-ago or it might have been last year at this time.

I remember I gave you guy a little bit of an indicator you know, eight years-ago or so in one of our facilities we were doing something like 8,000 to 10,000 cuts parts per months and we are doing in excess of 40,000 cuts parts per month. So it gives you a little bit an indicator of how it's growing, we don’t tell people what the percentage is..

Michael Gambardella

Okay. And then second question going back to the nickel issue.

Can you talk about how you protect yourself against fluctuation in nickel in terms of what percentage of your exposure do you kind of hedge with financial instruments, what percent you hedge price is doing a tolling process or such as formula in your pricing for nickel?.

Mark M. Comerford

Right, we have many different kind of customer agreements and most of those will have escalator or decelerator for nickel. So just it’s a matter of what time frame each one of those have. Some are a three month adjusters, so it will adjust every quarter, based on nickel some are six month and some even go out of year.

No if we go out a year we are fixing the cost of nickel with our suppler to protect the margin in that case. So really depends on how much nickel goes up or down in a particular period.

When we try a measure the impact of nickel, I would look at the volume and say about a third of our business is a bit susceptible to fluctuations in the price of nickels. So when look at nickel, it will be about 33% of the volume and nickel is about 50% of our volume in our products.

So kind of formula works out to be this period it was about a $1.5 million to $2 million in Q4 and going forward it will be more significant to 2$ million to $2.5 million.

Does that helps?.

Michael Gambardella

The example you gave about the annual - is there an annual fixed price contract..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Yes we have some fixed price customer agreements, but in no cases we go to our suppler of nickel and fix the cost, so the margin is protected over that full-year.

anything shorter than that is a bit susceptible to commodity price risk, but it's depends on if it’s a mill direct type item we will accept the price of the products, as a point of order entry and we will melt it right about that same time.

So we are protected in that cases, if the things that come maybe out of the service center that maybe a spot type business that we melted maybe two or three or maybe in four quarter ago. So it's that lower nickel out of the service center and that order coming out of the service center versus the cost two or three quarters ago..

Mark M. Comerford

Yes Mike, to give you a good idea, let's say for an aerospace accounts, we might have a three year LTA with the customer right. And what we do is okay for let's say for next year for 2016, calendar 2016. That customers says, hey its part of the LTA, we want a firm price for calendar 2016.

We say fantastic, we call our nickel suppliers and say give us a nickel number for 2016 based on these volumes. They give it to us, we go back to the customer and say, okay we got our nickel number, here is what your price adds up so that's what it’s going to be for 2016. And they say yes.

And so we actually then enter into that agreement with the customer and with our supplier for that firm nickel for that LTA.

And then if it’s a three year LTA, next year we will do the same thing, year after that we will do the same thing and then when we renegotiating LTA its usually you are just renegotiating fab prices, escalator based on consumer price index, blah, blah, blah those types of things. Okay..

Michael Gambardella

Okay. So overall about a third of your sales is close to nickel fluctuations? Would that be more service center type of business.

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Yes, the best way to think about it Mike on the service center side is we might melted five months ago for demand, we anticipate that will come in, we call a transactional business out of the service center.

And so that's where we are taking a risk and that's where if you think about it today we've got $6 nickel going through the service center that we are selling for $4.10, if it's a transactional buy right now. Yes, that's a part of the killer right now..

Michael Gambardella

Okay. All right. Thanks..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Yes..

Operator

Thank you. Our next question today is coming from Phil Gibbs from KeyBanc. Please proceed with your question..

Philip Gibbs

Hey, good morning..

Mark M. Comerford

Good morning Phil..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Good Morning Phil..

Philip Gibbs

You talked about the nickel mismatch being about $1 million incremental hit versus Q4. Is the mix impact in Q1 versus Q4, greater than that million, just trying to get gauge based on your comments..

Mark M. Comerford

Yes, I would estimate kind of the mix to be if you looking at a compression on margin it’s probably going to be a compression of one percentage point to two percentage points, is my estimates of the mix change.

So that's going to be pretty substantial and another item I would throw in and we've talked about nickel, we talked about specialty applications and other one I would throw in would be the pension..

Philip Gibbs

Yes, pension seven times or something like that right?.

Mark M. Comerford

Yes, it's going to increase over the year $6.4 million. So over a quarter, that's going to be about $1.6 million over a quarter, now some of that’s SG&A, but probably about 70% of that's going to be cost to sales. So if you look at that that’s going to have maybe a margin compression of about a point as well.

So that's going to be something else that compresses margins going into 2016..

Philip Gibbs

Okay and have you outlined what your cash contributions are, I think last year on the pension side, it was pretty de minims if I remember correctly and do you have any thoughts on what that tool look like this year?.

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Yes, this year we contributed $1.5 million so it was small and we are under discussions now with the Board to terminal funding level will be next year. We haven't decided exactly what that would be. So we'll have to get back to you on what we end up agreeing to you there..

Philip Gibbs

Okay. And then on the $16 million to $17 million debottlenecking CapEx, it sounds like it’s always at Kokomo.

Is that because you are seeing demand on the aerospace side better than you saw or is that because you don't have some current capabilities that customers are asking for getting change in technologies and mix and right now you hammered a lot on complexities.

So I guess I'm just trying to understand that this $16 million surprised you in terms of the demand..

Mark M. Comerford

No, it is demand, it’s a little bit of both honestly Phil. Its primarily demand though, we've got some equipment that will take god bless [Cabot] (ph) corporation, they left some good bones, some good skeletal structure when they put equipment in here 35-years ago, 33-years ago.

And this is one of those pieces of equipment that like I said, you need to upgrade the bearings, you need to upgrade the some of the housing, the electronic the automatic gauge control, these are things we need to do to get better quality products, but it's can give us more capability and more capacity.

We're also doing something on the heat treatment side, on the [indiscernible] side that will also allow us to make a higher quality product for some certain specific applications where we don't participate today or every time we participate in it. We kind of have some trouble in giving customers the quality they want.

And there are some good customers, good partners that we work with that they really want us to produce this products for them, but they need us to provide them better quality product than we have in the past. So we're modifying equipment, we have out there that's going to give us that capability for that.

So that's really the big changes on the CapEx there..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

And we are estimating of the sheet and coil that goes through that areas that this CapEx will increase capacity over 35%. That will be a return on investment on even - through the ramp up would be 27% or better..

Philip Gibbs

Okay. That's very helpful and then just lastly, how do your internal inventories feel to you right now and how are those placed in terms of this specific end-markets of products, do you feel having certain inventory levels, do you feel like they are just right? How are you thinking about the networking capital and that’s all I have [indiscernible]..

Mark M. Comerford

Yes I think in general, if you ask me I think we feel pretty heavy in inventory, but think of where we are in the year right now and also think about the first quarter. All right first quarter is coming up, you know we are going to be cutting back in mountain, we always do.

We are going to be cutting back in some of the operations to do some maintenance. So we do the usual thing where we melt pretty heavy in the September, October timeframe, we starting cutting it back, holidays et cetera.

So heavy in inventory right now, we do expect to believe some of that or a lot of that’s going to depend on the transactional activity kind of getting back to Mike Gambardella’s question, if transactional activity is heavy and it picks up to 40% or 50% of revenue then we should be able to cut the inventory pretty quickly.

I had a good discussion with production yesterday, I said “boy we are really light on the billet or the things that feed into the forging industry” and he came back to me and said “we just shipped our heaviest forging orders of the year last month” and he is right we did.

So having some of that and this is what we do for a living with the service center, we take advantage of those transactional opportunities when they come up.

It’s like how many times have I said to you guys in the last two years that we might had a half decent quarter in land-based gas turbine and it was because somebody quoted a quick turnaround, quick delivery applications, one of our customers and came to us, because they needed the billet or they needed a sheet or the plate.

So yes, we are little bit heavy in some of those inventory areas, but it’s historically anyway, especially when we are coming out of these tough periods, I mean people get busy again it pays off for us and we have that metal ready to go.

So like I said, you know where are right now going into first quarter and into the holiday season, we will be cutting back on our manufacturing operation. So we are definitely heavier in inventory right now than we would like to be, but this is kind of standard for us when we enter this period of the year..

Philip Gibbs

Thanks gents..

Mark M. Comerford

You bet..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Thank you..

Operator

[Operator Instructions] Our next question is coming from Lisa Springer from Singular Research. Please proceed with your question..

Lisa Springer

Good morning. My question concerns to the effective tax rate for the fourth quarter, which was affected by the geographic mix of earnings.

In terms of modeling, should we look for that higher effective tax rate going into 2016 as well?.

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

No that was more of - when you do the yearend tax provision it’s a lot more comprehensive, so when we look at our taxable income by tax jurisdictions versus our estimates the actually we had more taxable income really in the U.S. the higher tax rate than we did in some lower tax rates especially like the UK.

So that maybe effective tax rate for Q4 about 38%. For the full-year we were at 35.4%, but the number a few quarters we had a discrete item related to the State of Indiana where they had a change to the throw back rule so that effectively will change the rate going forward in the future.

But with a deferred tax asset we had to devalue that deferred tax asset that was about $1.2 million, but if you take that out the effective tax rate for the year was about $32.8 million. So going forward, I would think of 33% to 34% rate would be probably the proper rate for us..

Lisa Springer

Okay. Thank you. That’s helpful..

Daniel W. Maudlin Vice President of Finance, Treasurer & Chief Financial Officer

Yes..

Operator

Thank you. We have reached end of our question-and-answer session. I would like to turn the floor back over to management for any further or closing comment..

Mark M. Comerford

Thanks very much Kevin. Everybody thank you very much for your time today and thank you for your interest and support of Haynes. Please be safe over the holidays and we will look forward to updating you again next quarter..

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