David Van Bibber - Controller & CAO Michael Shor - Chairman, Interim CEO & President Daniel Maudlin - VP, Finance, Treasurer & CFO.

Edward Marshall - Sidoti & Company Philip Gibbs - KeyBanc Capital Markets.

Greetings, and welcome to the Haynes International Third Quarter Fiscal 2018 Earnings Conference Call. [Operator 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. Thank you. You may begin..

Thank you very much for joining us today. With me today are Mike Shor, Chairman, 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 could 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, 2017. 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..

innovation, customer service, manufacturing excellence and financial strength. When we execute well on all of the actions just noted, all in support of these principles, we will increase shareholder value. Our team is committed to the relentless pursuit of this goal.

As far as our search for our President and CEO, the board has requested that the governance committee begin the process of identifying characteristics deemed important in a selection of the next CEO for the company. That process is underway. We will update you as appropriate. Now moving on to the results of the third quarter.

The favorable backlog trend has continued this quarter, with backlog increasing $8.3 million or 3.9% in the third quarter compared to the second quarter of our fiscal year. This occurred while sales also increased sequentially $2.9 million or 2.6%.

We are seeing continued strength in shipments into the aerospace market and the continued recovery of shipments into the chemical processing market. However, both are nearly being offset by weakness in shipments into the industrial gas turbine market.

To illustrate this, looking at the pound shipped in the first 9 months of this fiscal year compared to same period last year, aerospace volume is up nearly 11% despite, in my mind, very long lead times in our cold finish products. Chemical processing volume is up 21%, and other markets volume is up 12%.

Solid increases, but they are completely offset by a dramatic 38% reduction in industrial gas turbine volume, causing year-to-date volume nearly equal to last year's 9-month volumes. Specific to the overall third quarter. Net revenue was $113.1 million, up 15.4% from last year's $98 million.

Volume in the quarter was 4.8 million pounds, up 4.5% from last year's 4.6 million pounds. Average selling prices in the quarter were $23.65 per pound, inclusive of our other revenue to about -- up about 10.5% over last year's $21.41 per pound. With that, let me move to our key markets.

Net revenue in the aerospace market for the quarter was $59.6 million, representing approximately 52.7% of our total revenue. Sales were up about 27.2% from last year's $46.9 million. Volume shipped in this market was 2.6 million pounds, up 19.8% over last year's 2.2 million pounds.

Average selling price was up 6.1% to $22.55 per pound from last year's $21.25 per pound. We saw backlog in aerospace increase sequentially from Q2 to Q3 by 5.4%. The strength in this market is primarily driven by increasing shipments of new engine platform sales, combined with our enhanced capacity from our capital investments.

We've continued to make progress ramping up production levels in our cold finish strip and sheet area in Kokomo, Indiana; our tubular products area in Arcadia, Louisiana; and our primary distribution and finishing operations in LaPorte, Indiana, with further performance and volume upside possible in all of these areas.

While we've all heard the specific risks associated with jet engine OEMs potentially not hitting expected higher production rates on new platforms, overall volumes are currently still healthy, and we currently remain optimistic about continued growth for Haynes, for Haynes products in this market.

In our chemical processing market, net revenue for the quarter was $21.4 million, up 42.3% from last year's $15 million. CPI accounted for 18.9% of our revenue. Volume was 1 million pounds, up 18.6% from last year's 858,000 pounds. Average selling price was $20.99 per pound, up 19.9% from last year's $17.50 a pound.

Backlog in CPI increased 12.7% sequentially over the quarter. We are seeing better levels of specialty application project shipments that utilize our proprietary and specialty materials compared to last year. As I mentioned earlier, I am pleased with our pipeline of opportunities in specialty application projects.

On our base business side of chemical processing, we have some work to do to improve volumes. We see optimism in the market, and it was good to see overall volume again over 1 million pounds for the quarter. But our potential is definitely higher.

As we implement strategies to more effectively utilize open capacity on major assets, as I mentioned earlier, we expect to see improvement in base business volumes in this market. Moving to the industrial gas turbine market. Our sales in the quarter totaled $11.9 million, down 19.4% from last year's $14.7 million.

IGT accounted for roughly 10.5% of sales during the quarter. Volume shipped in this market was down 38.5% to 622,000 pounds from last year's 1 million pounds. Average selling price per pound in the quarter was $19.08 per pound, up 31% from last year's $14.57 per pound. Backlog in industrial gas turbine decreased 8.8% in the quarter.

As was discussed on previous calls, the restructuring announcements from the large OEMs highlight the weak demand in the large- and medium-frame turbine markets. We clearly see this weakness in our shipping levels. Our customers continue to suggest that weakness could remain through calendar 2018.

Smaller-frame applications could see a pickup as investment in oil and gas applications start to increase. But the overhang in the large- and medium-frame applications will likely continue to dampen this industry in the next few quarters.

We have seen higher levels of development activity related to new engine designs, pursuing greater engine efficiency, which would equate to better future demand for air types of advanced materials. Finally, our other markets and other revenue accounted for $20.2 million during the quarter, down 5.1% from last year's $21.3 million.

This area was roughly 17.9% of our revenue. The decrease in sales from last year relates to toll processing of other companies' materials, which can vary quarter-to-quarter. Operationally, we are pushing hard to increase volume levels while seeking efficiencies to reduce costs.

Our initiatives to continue to ramp up production in our cold finishing equipment has increased our production of these products 17% this year versus last year's 9 months.

Also, our initiatives to pursue the higher-volume plate opportunities previously mentioned is expected to be the catalyst to push us over that 5 million pound per quarter shipping threshold, which we have previously mentioned as being critical to getting us back to solid profitability. We are pushing to get to that next level.

Finally, I'm very proud of the work done related to negotiating and ratifying a new 5-year collective bargaining unit agreement that covers 482 employees in Kokomo, Indiana.

This agreement between Haynes and the USW represents a strong statement that both the company and the USW are making a long-term commitment to our employees, customers and shareholders.

I was pleased that our employees voted their support for the agreement as it represents a true effort to address the needs of the employees while also addressing the efficiency and manufacturing process improvements that our company needs in order to be competitive in our challenging market conditions.

With that, let me turn the call over to Dan for more addition -- for more details on our financials..

first, the costs recorded for the attempted strategic acquisition of $1.5 million, which included legal fees and due diligence costs for the financial, environmental and tax diligence that reached late-stage negotiations but ultimately did not result in an executed purchase agreement; second, costs for the CEO transition of $1.1 million related to the retirement of the company's Chief Executive Officer.

These two events are considered onetime special events included in SG&A this quarter. Foreign currency impacts on SG&A is something you've heard us mention in the past. We implemented a foreign currency hedging program at the beginning of this quarter to reduce SG&A volatility resulting from U.S.

dollars on the balance sheets of our foreign subsidiaries. These contracts are designed so that there are no currency exchange contracts remaining unsettled at quarter end. In the third quarter, this program was 91% effective in offsetting our overall foreign currency impact. I guess the unfortunate part is it was offsetting a gain.

However, I expect in the future, currency losses would also be offset. Keep in mind, the purpose of the program is to reduce volatility. This quarter included favorable tax adjustments of approximately $1.8 million related primarily to an increase in the year-to-date effective tax rate. Our current effective tax rate is now 33%.

Beyond fiscal 2018, assuming normalized market conditions and a solid income environment, our effective tax rate is expected to be in the mid-20% level. Net income for the quarter was $713,000, good to see a positive number which we have not seen in 7 quarters.

As we progress further into the cycle and we implement the initiatives Mike outlined in his comments, further growth and profitability is expected. Turning to backlog.

Backlog at June 30, 2018, was $220 million -- $220.6 million, excuse me, an increase of 3.9% over the quarter and a significant increase over the first 9 months of fiscal 2018, which increased $43.3 million or over 24% from the $177.3 million at September 30, 2017.

This backlog strength underlines our optimism for continued increasing revenue and profitability as we move forward. Beyond the quarter end, backlog continued to increase with the July 31, 2018 backlog at $229.2 million, a solid increase of $8.6 million for the month of July. Outlook for the next quarter.

Given the continued positive trends in order entry rates, backlog and pricing, combined with our focused initiatives to increase volumes and profitability, we expect fourth quarter revenue and operating income to be better than those of the third quarter of fiscal 2018. Liquidity.

Working capital increased in conjunction with backlog increasing, corresponding increased production levels. As I just highlighted, backlog increased $43.2 million or 24.4% year-to-date as compared to the controllable working capital increase, $25.5 million or 9.8% to $284.7 million at June 30, 2018.

This increase was primarily driven by inventory increasing $27.2 million. This resulted in a decrease in cash of $31.7 million over the first 9 months of fiscal 2018.

As cash collections increased in the -- with the higher third quarter sales and our initiatives to reduce inventory, cash balances are expected to improve over the fourth quarter of fiscal 2018. Our revolver balance remains at 0, with the size of the untapped credit facility at $120 million with an accordion feature to $170 million.

Our capital spending in the first 9 months of this fiscal year was $9.8 million, and total for the full year is expected to be $12 million. An important project that is planned for the first quarter of our fiscal year 2019, that's the quarter ending December 2018, is the Drever outage.

This is one of the bright annealing lines in our cold finishing department. We have had this plan for some time, and much of the equipment is already purchased and paid for, but we needed the new cap line to begin performing well before it made sense to take the planned outage.

This is expected to slow down our cold finish flat production in Q1, but it should enable higher production levels later in the fiscal year. This is a significant step needed as we push towards achieving the 12 million pound production level Mike was referring to earlier.

In conclusion, the CapEx investments we've made over the past few years provide upside for improving operating leverage to be realized on higher volume levels going forward. Our focused initiatives to increase volumes is expected to help begin to unlock this value going forward. Mike, I will now turn the discussion back over to you..

Thanks, Dan. The third quarter volume, revenue and margins increased sequentially and increased above last year's third quarter. In addition, we moved back to profitability this quarter. While these trends are pointing in the right direction, continued focus on accelerating improvement is our priority.

The initiatives that I just outlined in my introduction have been launched and are focused on increasing volumes, enhancing price, reducing costs and improving our working capital management. Our focus is to gain momentum to meaningfully accelerate improvement in each of these areas. With that, Donna, let's open the call to questions..

[Operator Instructions]. Our first question is coming from Edward Marshall of Sidoti & Company..

Mike, welcome to the call. So I wanted to ask, the 5 million pound mark, you said it's critical to offset unfavorable fixed absorption. I'm curious if you can try to share with us maybe the incremental margin change that would occur at that 5 million pound mark..

Let me just start in general with that, Ed. When you look at our history, it's really clear. When we do not clear 5 million pounds a quarter, we struggle to make money. And when we do clear it, for the most part, this is a very profitable enterprise. So our goal with this is to say, okay, we've got ITT issues, we know that.

We've got special projects, which are terrific, but they're lumpy. And so our goal is to find a way to achieve 5 million pounds without hoping that those come back -- without assuming that they come back. And when they come back, they will be [indiscernible].

So our goal and what we're going to do is go after cold finish flat business, which we are at capacity and at extended lead times now. As we get the Drever up and running, as Dan talked about, so that'll take us from the current 14.5 million pounds to 18 million pounds, a very profitable business.

We want to expand our wire volume, which we have relatively low use of capacity in some very profitable products to that, and go after plate, which I would say the plate would be below average margin, but the other 2 would be above..

And we would think about this on the corrosion plates that Mike's mentioning. We'd look at it more from a bit of a contribution margin point of view, but it would be a strong positive contribution margin to help offset some of the fixed costs.

And if you think about it, if we -- the 5 million pound per quarter level, 20 million pounds for the year, the last time we were over 20 million pounds back in 2015, just quoting margins there, it was 19.2% margin. When we're over that 20 million pound mark, we definitely can get some leverage on that margin percentage, and that's our goal..

Great. That adds some color. I'm curious, you talked about the backlog at the end of July 31.

Are any of the initiatives that you talked about within CPI the base volume? And I guess maybe it's too early for plate, but did that start to show up in the July 31 backlog component?.

I'd say the answer is yes for two reasons. This year versus last year, cold finish flats, even though they're still constrained and we have a long way to go, they're up 17% year-on-year. So that is being loaded in. Again, not to the volume we would like, but it's being loaded in.

Secondly, plate, we started that initiative just about the time that I arrived. And we've had 2 months under our belt, and we've had some fairly significant orders come in and success with that. So they're both beginning. They both have significant upside, but yes, it is beginning to show in the backlog..

Got it. And having a mixed voice on the board as well as at the operational level, I'm curious what -- when we look at the acquisitions that you're talking about, I'm curious to the extent of -- maybe a thirst for need for both -- and confidence that you have about the long term.

I think it might be helpful to understand whether you are either outfit for the asset or you walked away because the price was too high..

First, we really cannot disclose any further detail related to the nondisclosure, so we're not going to go there on that one, Ed. But I would tell you, the board and our management team is focused on ways to increase shareholder value. And there's two obvious ways to get after that. And the first is to improve operationally everything we do.

That's on the price side, the margin side, the cost side, working capital and getting volume in. So we're focused on that to increase shareholder value, but I think we have an obligation to also continue to look at what is out there, where could there be potential synergies and we'll continue to pursue that as they come up..

Got it. And the last one just for me, just on that same line. In the press release, you talked about pursuing alternative strategies to strengthen. Can you elaborate on that? I mean, is that language that we should interpret as obviously seeking potential sale of the business? Just curious what your thoughts are..

Yes. I think that's included in there talking about even though this acquisition did not result in a purchase agreement, we're not turning away from the strategy. We're certainly looking at opportunities out there to expand and grow shareholder value, whether that be capabilities in our mill or further penetration into our customers' supply chains.

So the door is not shut on acquisitions just because this one did not end the way we wanted it to..

Our focus is to grow profitably, Ed, and there's multiple ways we can do that. We can take advantage of significantly increased internal capacity that's either here coming with the capital we spend, and it's also looking at where we can grow this business should an opportunity come up through acquisition.

And just because this did not work out, does not mean we won't pursue in the future..

Maybe you misunderstood the question.

Would Haynes potentially be for sale? Is that part of the language of what you're trying to tell us?.

No..

That is not the intent of that language, no..

[Operator Instructions]. Our next question is coming from Phil Gibbs of KeyBanc Capital Markets..

I have a question just about the strategy that you're outlining for volume growth. I would have thought given the investments that you all made in cold finish capacity that you already would be sort of donning for volume growth to the extent that, that opportunity was available.

And then also, on the plate side, I can appreciate the markets coming back from CPI and maybe some orders being more available and you're pushing the envelope there.

But how do you balance that thirst for volume and also trying to maintain this other side of the equation on pricing integrity?.

Phil, thanks for the question. On cold finish flats, we've spent obviously a fair amount of money, but there are multiple pieces to this puzzle. And we had to get what Dan referenced as the cap line, one of our annealing furnaces, up and running to be able to take down one of our older furnaces, which is called the Drever.

That furnace is now -- as Dan mentioned, is going to go down at some point in October. So we have, with the cap line, as the Drever is beginning to come down, expanded our capacity from 13 million to 14.5 million pound. But what's key with that, our lead times continue to go up and demand continues to rise despite us raising prices in that area.

So the big piece for us there is to get the Drever down, get it back up successfully and then be able to move towards rapidly this 18 million pounds. So a significant opportunity for growth there. And as the CPI business comes back, we -- and where the pricing is, we understand where the margins are.

We have open capacity, and it's excellent for our bottom line because of the way it absorbs assets..

I just want to be on the same page with the cold finish capacity.

So you have about current capacity to be around 14 million, 15 million pounds, and you need to take the Drever outage to tap the higher end of that 15 million pound goal?.

We are maxed out with something that drives, not just extended lead times. Maxed out there. Customers want more at about 14.5 million pounds. Mix plates are rolling up but about that. When the Drever comes back and we have all equipment running, we have 18 million pounds of capability. We do not have that today..

And as we mentioned, we're at around the 14.5 million, pushing 15 million pound level now. But it's a little sporadic, a little volatile. So with this Drever outage, we will, I think, get more consistent and be able to push up to those 18 million pounds. It was all -- as I mentioned, we've had this plan for a while.

So it's always part of the plan, we just didn't know when would be the right time to take the outage. And we certainly see it, the cap line doing much better and up and running. So the time is in the first quarter..

Can you give just some more color around the outage? I think, Dan, you talked about CapEx being what it will be in Q4. But Dan, as you look into Q1, is it a Q1 absorption issue that you'll take in the P&L and the CapEx spend that you have to make? I'm just trying to think about that. And then a question for Mike, subpart of that.

Where does all this cold-finished plate -- not plate, but sheeting part business going in terms of end market momentum?.

Okay, I'll take the last one first. It's -- our cold finish flat nickel-based super alloys are going into the aerospace market. The market is very strong. We can tell, by the way, that there's not much inventory in the supply chain because as our lead times go out, we really get our customers' attention on that.

So we know there's not a lot of buffer in the supply chain. But it's an aerospace play, and that expansion is also an aerospace play. As far as the outage, the good news is we've invested in this so-called cap line, which is up and running. And so that will offset some of this.

What we're seeing is that our Q1 production will be lower by about 450,000 pounds, equating to sheet coil available sales lower by about 360,000 pounds or about $8 million in sales. We do not believe, and we hope, the revenue will not be impacted in the quarter by that much as we draw down inventory, and so as best we can, other product forms.

The good news is offsetting that impact is over the balance of the year, especially Q4, we will see higher amounts, and the net impact we're hoping for the year to be 0.

And then, of course, the good news for us is moving from that 14.5 million we've talked about up to about 18 million once we have all of our new equipment and modified equipment in place..

And keep in mind, this is planned around our normal kind of holiday outage time frame in which we typically do planned outages. So we kind of put it all in concert with that to have the impact as minimal as possible. And as Mike said, for the year, we hope to not have the impact to be there at all. In fact, those higher operating levels we can achieve.

After the Drever is upgraded, I think will be very beneficial for us..

Now is there a CapEx impact in Q1? Or did you just frame it kind of -- I mean, Mike, you framed it up, obviously, in terms of the volume and the revenue and the momentum there. But is there a CapEx spend? I didn't quite understand if there will be for Q1..

Yes, to a degree, there will be probably -- this outage will probably be in the neighborhood of $3 million, but it was all part of the plan that we had originally set out. So around $3 million..

At this time, I'd like to turn the floor back over to Mr. Shor for closing comments..

Thanks, everyone, for your time today. Thank you for your interest and support of Haynes. We look forward to updating you again next quarter. Take care, everybody..

Ladies and gentlemen, thank you for your participation. This concludes today's conference. You may disconnect your lines at this time, and have a wonderful day..