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Haynes International, Inc. (NASDAQ:HAYN)

F1Q09 (Qtr End 12/31/08) Earnings Call

February 10, 2009 09:00 AM ET

Executives

Stacy S. Kilian - Vice President - General Counsel & Corporate Secretary

Mark M. Comerford - President and Chief Executive Officer

Marcel Martin - Vice President - Finance and Chief Financial Officer

Analysts

Mark Parr - Keybanc Capital Markets

Luke Folta - Longbow Research

Edward Marshall - Sidoti & Company

Nat Kellogg - Next Generation Equity Research

Operator

Greetings and welcome to the Haynes International Inc. First Quarter 2009 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator instructions). As a reminder this conference is being recorded.

It is now my pleasure to introduce your host, Miss Stacy Kilian, Vice President and General Counsel for Haynes International. Thank you, Miss Kilian. You may begin.

Stacy S. Kilian

Thank you, Claudia. Good morning. Welcome to the Haynes International Inc. earnings conference call for the fiscal quarter ended December 31, 2008. This call is also being broadcast over the Internet.

With me today are Mark Comerford, President and Chief Executive Officer of Haynes International and Marcel Martin, 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 could contain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. The words believe, anticipates, expects, plan, and similar expressions are intended to identify forward-looking statements.

Although we believe our plans, intentions, and expectations reflected or suggested by such forward-looking statements are reasonable, such forward-looking 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 filing with the Securities and Exchange Commission, in particular, in its Form 10-K for the fiscal year ending September 30, 2008.

The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of the new information, future events or otherwise. Thank you.

And I will now turn the call over to Mark.

Mark M. Comerford

Thank you, Stacy. Good morning everyone and thank you for joining us. I'll recap our financial performance for the first quarter and discuss some of the issues within our key markets. I'll then turn the call over to Marcel, who'll give you greater detail about our financial results and we'll finish up with your questions.

Hopefully, you've all had a chance to review the information in our press release and quarterly report. Our first quarter results were disappointing and indicative of the economic environment and market conditions which began deteriorating in the August-September timeframe and have since continued to worsen.

The economic outlook remains very cloudy. Our key customers report the same, and the credit crisis and economic downturn appears to be putting many capital projects into question. In the first quarter, we recorded $4.5 million of net income or $0.38 per diluted share, compared to $13.8 million in net income or $1.16 per diluted share for the... first quarter of 2008.

During the quarter, we saw several issues affect our business, first, the economic down turn resulted in a more competitive environment and lower volume. Second, we saw a rapid decline in raw material prices from the commodity exchanges, triggering dramatic price changes in the market place. This factor combined with our high cost inventory in our system resulting compression of our gross profit margins. We expect this compression to continue through the next few quarters, as we flush out our higher cost FIFO inventories, and expect to achieve levels more in line with current commodity price levels, and current market prices provided that such pricing stabilizes.

We have taken actions below our cost structure to adjust to this new demand level, most significantly, we've reduced our workforce by over 10% in the quarter, and we're continuing to sharply cut our costs and spending. However, we are continuing to reinvest in the business. For example, several key CapEx projects will enable us to improve our reliability and quality which we believe will make us a better partner to several key accounts. And I think you've heard me talk on the prior calls that, in meeting with customers, quality and reliability are absolutely critical, without fail our customers talk to us about, if we were more reliable they'd be able to place more business with us.

Likewise, we continue to pursue broadening our application development and marketing efforts. While we believe we can maintain profitability for the fiscal year, due to the conditions I described above, the base economy, our volume and cost of inventories flowing through, we expect our results will be well below those seen in recent years and we'll have a substantial impact on the company's profitability in the second quarter.

Turning to our key markets. In aerospace, first quarter '09 revenue was $49.7 million, a 16.4% reduction compared to the $59.4 million in the first quarter of last year. Volume was up 23.3%, but partially offset by 9% higher average selling price. The volume reduction is due to fabricators in the supply chain leaning out our inventories, along with the disruption due to the Boeing strike. We expect at least the next several quarters to continue to be at lower levels than seen in fiscal 2008.

Sales of the chemical processing industry were $30.9 million in the first quarter, compared to $40.8 million a year ago. This is a 24.3% reduction in revenue and a volume reduction of 27.8%. Higher average selling prices reflecting a higher mix of specialty product helped offset the volume reduction. Several key projects in this industry will close out in 2009 and funding in this industry for new projects remain unclear due to the credit crises and falling demand in some areas of the chemical industry. Furthermore, MRO business in this market can be negatively impacted in times of financial distress, as operators use cheaper materials which must be replaced more frequently in order to preserve short-term cash.

Our business in China is heavily tight in this segment today and we've seen this market fall off precipitously since November. However, the Chinese stimulus program appears to have freed up some money and we're starting to see some releases of orders that have been on hold. We do expect this will continue to be a very challenging market through the fiscal year.

Our revenue of land-based gas turbines increased 26% year-over-year to $32.1 million, an increased volume of 42.2%. A lower price product mix as well as increased competition resulted in 11.3% reduction in the selling prices of this market. The increased volume comparison year-over-year is also reflective of the timing issue which lowered shipments in the first quarter of 2008. However we feel this market is holding up relatively well with current volumes similar to average quarterly volumes seen in fiscal 2008. Our key MRO accounts report very strong, steady backlogs, but we do feel OEM activity is slowing as OEMs are looking at their supply chains and proactively positioning their inventories in the events of cancellation or delays of capital projects.

Our sales into other markets such as flue gas desulfurization, alternative energy and industrial heating grew 1.5% to $19.2 million on a corresponding 1.5% growth in volume.

Finally, we are continuing to see improvements in our delivery performance metrics and velocity, meaning shorter lead times through our plants, which allows our customers greater flexibility in their order entry patterns. Faster, more reliable throughputs, reduced our backlogs, as we no longer require our customers to order so far in advance and it therefore helps the entire supply chain to be more flexible and cost efficient.

We are continuing to forge ahead with our new (inaudible) promotions and specification work, as this will continue to create more niches for our products into the future. This is the life blood of Haynes and we're committed to expanding our presence in our core markets and creating better penetration in some of the smaller new market areas that we have in development.

We continue to meet the commercial and technical needs of our customers and build a global foundation on the world map. And almost 40% of our revenue is from outside North America. Our model of service, innovation and reliability has allowed us to grow to this level and we're continuing to develop new geographies and new avenues to broaden our global footprint.

Finally, we're weathering a storm right now as we push through higher cost inventories. Haynes ability to absorb this blow and keep moving forward due to the strength of the balance sheet we've built over the past few years. We are committed to managing our cost structure and meet the needs of our customers and the expectations of our shareholders in this difficult period.

I'll now turn the call over to Marcel.

Marcel Martin

Thank you, Mark. I will first speak the comparison of the first quarter of '08 compared to the first quarter of '09, then comment on the fourth quarter of '08 compared to the first quarter of '09, with emphasis in both comparisons, the thing the contributing factors for the decline in gross margin dollars between periods, and finish with several comments on our cash flow, working capital and backlog.

First, the gross margin for the first quarter of '09 was lower by 15.4 million compared to last year's first quarter. There were four primary contributing reasons for this decline with each cause having approximately the same effect on net gross margin reduction. When you look to the first quarter, the revenues were down by $11.8 million with a volume reduction of half a million pounds, primarily due to the global recession, a tight competition, and the volume competition that we experienced in the quarter. That contributed about a quarter of our reduction in gross margin.

Second item, last year's first quarter was reduced... cost was reduced by $3.7 million for a favorable pension adjustment due to the salary secession of the accrual for benefits in that quarter. That was about a quarter of the reduction in net gross margin. The third item contributing to the reduction and gross margin for the quarter was unfavorable spending to reduce absorption, a higher cost structure year-over-year due to additional personnel and wage increases, fringe costs going up, and a mixed change to a higher cost production product. And lastly, it was increased raw material costs due to mix changes, especially type alloys, primarily cobalt and moly related.

From a SG&A perspective, the cost per quarter went up approximately $0.5 million from $10.9 million in SG&A cost last year in the first quarter compared to 11.4 million in this quarter. SG&A going from 7.5% of revenues to 8.5%, that primarily due to the reduction of overall revenues.

Interest was down slightly quarter-to-quarter due to the lower average debt balance. Tax expense was down by $6.5 million due to lower pre-tax income compared to the prior year, at a rate of about 35% due to some amended returns filed in the quarter. On a go forward basis, the tax rate would probably average between 36 to 37% over the balance of the year. That resulted in net income of $4.5 million compared to 13.8 million in the prior year.

I'd like to talk a little bit about the fourth quarter comparison of '08 to the first quarter of this year, which I think is probably a bit more pertinence to the process that we find ourselves in and having to remedy that situation. Gross margin for the first quarter of '09 was lower by $15.6 million compared to the last year's fourth quarter. There are three primary contributing reasons for this decline with each cost contributing approximately one-third of the decline in gross margin of $15.6 million.

The first was obviously the continued issue of the competitive environment of global recession. Our volume was down by 1 million pounds quarter-to-quarter with revenues being off by $26.5 million. That contributed approximately a third of that decline in gross margin. The second item was unfavorable spending due to other absorption, primarily because of the million pound reduction, also contributing to that was the... then cost structure being higher year-to-year and again a product mix shift to a higher process cost product. We had a significant shift in the first quarter as compared to that fourth quarter of this product or a specialty type product, typically this runs in at about 18% mix to our product. The product mix in this quarter went up to 25% of our overall mix was substantial.

The third contributing item to this reduction in gross margin between quarters, fourth to first, was a material mismatch which is having higher cost raw material already an inventory of reduced products for sale that are priced at current raw material costs, the another of the three contributing factors to the overall decline in our gross margin fourth quarter to first quarter.

Relative to solutions for our challenges related to these reductions, first of all, the competitive environment. There is very little we can do about the competitive environment, except to stay focused on customers, in markets and continue to look for opportunities, and real change will come with the market improvement.

The cost structure, Mark has mentioned that during this last... during January, we announced a reduction in headcount that was about 12% of our total worldwide staff, it was 130 people and this reduction of staff equates to almost $1 million per month in cost reductions. In addition to that, we have taken steps across our footprint to reduce cost wherever we can. We're looking at everything we are doing. We are being aggressive going back to our suppliers, looking for rate reductions through the process, looking to manage our cost better and consolidate our efforts where we can. So this is the process that we'll undertake and I think have taken aggressive steps already relative to the headcount and we'll do things in the future required to make sure we bring our cost structure back in line.

The last item, the material mismatch. We are working through that process. It could be back in balance, selling price match to product cost or material cost by the end of the third quarter depending on what happens with sales, volumes, cost and pricing. Again, this is a structural issue which we are working through and we think will be remedy... we'll have a remedy to be back and bounce by the end of third quarter.

Some comments on working capital. One other things that we're focusing on, or have been focusing on is the initiative to reduce inventory, operate more affectively and the challenge put to us over the last quarter is a synchronized customer requirements with production. This presents a challenging situation which we've been making a progress on.

Over the course of the balance of the year we hope to reduce our inventories by another 50 to 75 million pounds. Those reductions will be split between a lower material cost in a pound reduction. Mark commented on the CapEx program. Our program for this year is an approximate $15 million. We are looking to continue to do those projects which provide benefit to the company in the short-term and more importantly in the long-term for both Haynes and for our customers.

I want to talk a little bit about the cash flow or cash flow operations for the first quarter. It was $13.8 million for the quarter and that was reduced by a tax payment of $15 million during the quarter for the time that money we received two years ago, the $50 million payment. We made debt tax payment this last quarter. So if you adjust with that, we had substantial cash from operations in the first quarter. The primary contributor to that was our AR reduction of $18 million, a source of fund.

If you look quarter-to-quarter, our sales were down 16% and our AR was down 27%. DSOs went from 56 days in the fourth quarter '08 to 52 in the first quarter of '09. That's primarily due to... obviously we continue, particularly in these times, to focus on collections. We are very aggressive from that perspective on our credit policies. In addition, there was a slight shift to domestic, as a large percentage of the mix versus export with domestics having terms typically in that 30 to 45 days, and with exports typically in the 45 to 60 days. So that contributed partially to that.

As far as the liquidity and this is the thing that we feel is the most important thing for us going forward, we've prepared ourselves well, our debt is down to zero. We've had cash at the end of December of $5 million. We look to improve upon this position over the balance of the year depending on the environment, from inventory and cost reduction efforts.

We've put ourselves in good position, we've renewed our revolver during the last quarter. We've got a 120, we've got an asset base level with the $120 million of availability on that loan. We've got limited covenants, actually only one covenant, a fixed charge covered ratio and that only comes into play if availability falls under $25 million. So, I think we've positioned ourselves well with the CapEx programs over the last several years, with the liquidity position we find ourselves in right now and with the aggressive approach for taking to manage... managing and improving upon our cost structure.

Thank you. Mark?

Mark M. Comerford

We'll turn it over for questions, if you'd like now.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen we'll now be conducting the question-and-answer session. (Operator instructions). Our first question is coming from Mark Parr, of Keybanc Capital. Please state your question.

Mark Parr - Keybanc Capital Markets

Hey, thanks a lot. Hey good morning everybody.

Mark Comerford

Good morning Mark.

Marcel Martin

Good morning.

Mark Parr - Keybanc Capital Markets

Hay, one thing, just for clarification, Marcel. When you talked about your inventory reduction plans for '09, were you talking about pounds or dollars? I thought you said pounds.

Marcel Martin

I was talking about dollars.

Mark Parr - Keybanc Capital Markets

Okay.

Marcel Martin

When I... I may have misspoken. When I was talking about... I mentioned that we've looked to reduce our inventories over the balance of the year between $50 to $75 million.

Mark Parr - Keybanc Capital Markets

Okay. Alright. Any, Mark, you talked about the improvements in the manufacturing process allowing you to move material through the backlog more quickly. Could you talk about what we might be able to expect or what we ought to be looking for as far as say weeks of sales in the backlog, say looking at fiscal '08 versus fiscal '09 versus fiscal 2010 in terms of what you would anticipate the weeks of fails in the backlog to represent?

Mark Comerford

Yeah, it's kind of tough one Mark. When I think about backlog and I think of essential lead times, queue time plus the actual manufacturing context times, if you go back a year or so, and just quoting somewhere around the order of 22-26 weeks and then the reliability also comes into play as well. How reliable are you to that metric, of hitting that 22 or 26 weeks?

What we've seen in the past x number of months, a lot of the investments that we've made in the equipments, the furnaces and things like that that you know about as well as some help we've been getting in some of the techniques that we're doing for measurements out in the plants. And frankly, also through the effort of the people in the plants, has one cut lead times now? So, we are not quoting on the area of some of the more common alloys that go through the plants, or somewhere around 12 weeks, occasionally less depending on the product form, as well as some of the more complex alloys, we're in the area of 16 weeks. So when I sit back and sort of look at targets for working capital, and inventory and process in the plants, I immediately just start subtracting weaker metal that I see going through the plants.

And I think you can almost extrapolate that into the backlog as well, if you are quoting 22 or 26 or 27 weeks and you might have a couple of weeks of shipping time in there, your backlog better be roughly half a year sales, essentially between queue time and the contract time. But when you have the flexibility now to quote something like a 12 weeks, you're going to see more of a transactional environment, items coming in and shipping right out. And so your backlog, I mean backlog goes, and it's a nice thing to have there built up. But the real capability, or the real benefit someone like us gets or someone like our customers gets, is in that velocity through the melt (ph) the speed with which we can react and get product out now.

Mark Parr - Keybanc Capital Markets

Okay. I had another question again just on some of the language in the release. You talked... when you talk in the release about the headcount reductions in terms of what they will say. You talked about net of severance. Does that mean that the reduction in expenses, that expenses for the headcount will still be down even including severance or is this excluding severance?

Marcel Martin

Just to clarify, and to the extent I am talking about almost $1 million a month in reduced cost on an annualized basis.

Mark Parr - Keybanc Capital Markets

Yeah.

Marcel Martin

That's not a go forward basis. In January, when we released, we talked about savings for the balance of the year, that was reduced by the severance cost we paid in January for those individuals.

Mark Parr - Keybanc Capital Markets

Okay. So, the say the $0.30 improvement that you talked about in January and that is after severance is included in the equation?

Marcel Martin

Yes, after severance.

Mark Parr - Keybanc Capital Markets

Okay. Can you quantify what the level of severance charges that we're taking in the March or in the December quarter or what you would expect to take in March quarter?

Marcel Martin

Well in this quarter, the total severance cost in the aggregate was approximately $700,000, those are the charges that we took in, they have already been reflected.

Mark Parr - Keybanc Capital Markets

And the... the $700,000, that was the December quarter or?

Marcel Martin

No. That was this quarter.

Mark Parr - Keybanc Capital Markets

That's for the March quarter.

Marcel Martin

The March quarter, yes.

Mark Parr - Keybanc Capital Markets

Okay. Alright. So, you're not taking any expenses related to pension or anything like that?

Marcel Martin

We're not.

Mark Parr - Keybanc Capital Markets

Okay.

Marcel Martin

There were no curtailments there.

Mark Parr - Keybanc Capital Markets

Alright. Other thing, I'm just curious Marcel, if you have any sense what you... how you would bracket potential mark-to-market charges on inventories that you have on the ground right now?

Marcel Martin

Well I think the issue is, I talked... we talked about the first quarter, we bracket... I spoke to packages mismatch that we approximately accounts for about a third of our reduction in gross margin. On a prospective basis, again that's very difficult to do just because of all the things it impacts that calculation, again it's a matter of volumes, selling prices, the cost of the commodity and so that's really very difficult a our number to come up with, or estimate. We can say though, is knowing how our product flows and how it's currently flowing, we clearly look to see being up from under this mismatch by the third quarter. All things, other things being equal that should be when we'll move out of that problem.

Mark Parr - Keybanc Capital Markets

Okay. So you had about $5 million... does that represented a third of the deterioration here, it's a 5 to $6 million or 4 to $6 million kind of raw material?

Marcel Martin

That's exactly right, Mark.

Mark Parr - Keybanc Capital Markets

So, you look for another couple of quarters. I mean would you expect that to increase in the margin? It probably increases in the March quarter or maybe comes back down a little bit in June by the time it finishes up?

Marcel Martin

That's a fair representation and knowing that this problem started in the first quarter and knowing that our product moves through and flushes out within a six month period, you'd expect to see the bulk of it in the second quarter, with running out in the third quarter.

Mark Parr - Keybanc Capital Markets

Okay. Alright. So, as far as this quarter's actual charges or things you are going to identify separately, I mean you are basically taking all this into the P&L on an asset incurred basis?

Marcel Martin

This is a situation where we are just recognizing cost of sales as we go.

Mark Parr - Keybanc Capital Markets

Okay, alright. Okay, terrific. Thanks for that incremental color. That's very helpful.

Operator

Our next question is coming from Luke Folta with Longbow Research. Please state your question.

Luke Folta - Longbow Research

Hi, good morning.

Mark Comerford

Good morning.

Marcel Martin

Good morning.

Luke Folta - Longbow Research

Hay, just first of all, thanks for all the details you gave in this morning's presentation, that's really helpful. And my first question was regarding the current competitive environment we spoke of. Can you give us kind of an idea how this is impacting base prices and what your expectations are there going forward?

Mark Comerford

Yeah Luke. Essentially, what we are seeing right now, we are seeing a lot of... I think by base you mean essentially net of metal value?

Luke Folta - Longbow Research

Correct.

Mark Comerford

What we really saw in the fourth quarter is a dramatic decline in metal value, and really essentially prices resetting in the marketplace based on the metal value type with number. Where someone like Haynes is hurt, is that we have the high cost metal flowing through the system, that Marcel mentioned. So, we've got this higher cost material flowing through and then faces a lot of crisis, contract crisis and things like that. More importantly market competitive crisis, reset based on the new metal value. And the steep decline and the timing of the decline, it was a very quick decline, as well as very steep decline, and to adjust to those prices very dramatically, very quickly. So, competitors and competition then goes out to those new price levels and that's where you get hurt tremendously.

The base price level change has more to do with the volume. We did surrender a little bit of volume in that first quarter as Marcel said. About 4.8 million pounds versus 5.2 million pounds in first quarter of last year but a lot it being timed to a large project that didn't continue. But that's really where we'll see those types of differentials. We're committed to maintaining our market share and looking for avenues where we can grow it. So, we're going to be aggressive in going after these things. We are seeing some base price deterioration, but the real situation out there right now is adjusting to these new metals values that are out.

Luke Folta - Longbow Research

Okay. And on the kind of the more commodity and I know you guys both do commodity side products. But the... on the less complex price dropping that you have, are you seeing more competition from imports or?

Mark Comerford

Yeah, a little bit. I think we have a major competitor on that commodity end or it's commodity for us, it's specialty for other people. And as a lot of the larger mills we've seen, their stainless products go out. Yeah, there is a large competitor in Europe that is benefiting through their economies, but they are also benefiting through the change in the price of the Euro, the strength of the Dollar in comparative terms, and they do have a capability.

Do I think that's a very, very significant part of the competition that we're seeing? If you ask me in Asia, I'd say yes. If you ask me, in North America? I'd say no.

Luke Folta - Longbow Research

Okay. Just one, final one, on your... you renewed your credit facility in November and I know it's allowing for dividends and share repurchases. Should we consider that pretty much off the table, at least for the next few quarters?

Marcel Martin

I would like to think that our emphasis needs to be on just managing the business like everyone else is facing it right now. Because there is still a significant amount of uncertainty going forward. I would put ourselves in a good position. We want to retain that flexibility to do all the things we need to do. We are dealing with any unforeseen challenges that come down the road. So I think in the short term, we're about making sure we do all the things to protect the business and prepare ourselves for growth in the future.

Luke Folta - Longbow Research

Alright, great. Good luck. Thank you.

Marcel Martin

Thank you.

Operator

(Operator Instructions) Our next question is coming from Edward Marshall with Sidoti & Company. Please state your question.

Edward Marshall - Sidoti & Company

Good morning.

Marcel Martin

Hi, good morning.

Mark Comerford

Good morning.

Edward Marshall - Sidoti & Company

My first question is centered around pricing. When do you guys... pricing reminds me, do you set the prices at the order entry or do you set it at when you know at melt the material?

Marcel Martin

Typically our pricing is set when we take the order, order entry. We have multiple ways we take orders and that we have contracts and those contracts have adjusters. We take spot orders, right out of the service centre at that time. And then we have POs or purchase orders which fall in between the spot order and the longer term contracts which maybe are three to six months but in that case even those are set when we take the order.

Edward Marshall - Sidoti & Company

And how much is spot a percent of your business?

Marcel Martin

Probably about a third.

Edward Marshall - Sidoti & Company

Okay, so I can assume, I can understand how if we are setting prices at that point, I can see how the margin on the spot if we get... on the spot business I can see the margin compression. But did you have an excess build of inventory here of raw material inventory that wasn't claimed to any particular contract?

Marcel Martin

Not really, and we have been kind of manage our inventory down over the course of the last six months. Remember, we finished our annealing project at the end of, in that third quarter of '08 and we have some additional work due to the quarter, the fourth quarter and little bit into the first quarter of last year. We have been endeavoring to bring the inventories down. We had a very, very good fourth quarter. I mean we had a... that was a pretty healthy quarter from a shipment perspective. I believe it was approximately, I want to say, 5.8 million pounds in that fourth quarter, that's pretty healthy quarter for us.

So, I think and we had a good solid backlog. What we probably didn't anticipate much like everyone else in the world was what happened in the first quarter, our first quarter, just the economic downturn. So, it wasn't anything specific that we were caught off guard or built inventory for, it was just the rapidity of the downturn, how quickly it happened.

Edward Marshall - Sidoti & Company

Right. But I am looking at the mismatch and I would assume that you are buying raw materials to fill certain contracts and if you are filing that contracts with specific price at order entry, I would imagine that somewhat, it would be mitigated through the...

Marcel Martin

And in fact it was, I mean the fact that we have backlog and we have material on the ground for that backlog. This mismatch only applies to the certain portion and it relates to this spot order type of business.

Edward Marshall - Sidoti & Company

So, in front of (ph) your business basically, is where the impact came?

Marcel Martin

Right.

Edward Marshall - Sidoti & Company

Now, when prices mix... when prices and materials are back and lock and step up. What should we expect as margin that you guys could put up from a gross margin perspective?

Marcel Martin

I think the challenge there is, not knowing exactly what is going to happen over the balance of the next six to nine months. I mean we're seeing pricing changing all the time, there is the pricing in that competitive environment, there is the cost of the raw materials. What we're able to do and what I try to do at least identify those things that impacted our fourth... the first quarter, quantify those or at least compartmentalize them and indicate what we're doing to address those things as those won't be issues going forward. As to what the margins will look like in the third or fourth quarter? Again, that's, just significant uncertainty is there. So, again that's not a guidance I think anyone can provide at this point.

Edward Marshall - Sidoti & Company

Okay. Switching gears a little bit on the inventory. You mentioned 50 to 70 million. That's not new. We've discussed that before. Or is that incremental on top of what we already saw in the first quarter?

Marcel Martin

No, I think, well on top of what you've seen in the first quarter, I think our inventory at the end of December was 294 million... 291 million.

Edward Marshall - Sidoti & Company

Right.

Marcel Martin

And we're talking about reduction from that point.

Edward Marshall - Sidoti & Company

So another 50 to 70 from 291?

Marcel Martin

Yes.

Edward Marshall - Sidoti & Company

Okay. You also mentioned the DSOs in the quarter were relatively strong. Is there seasonality however in the December quarter that you see with some improvements in DSOs?

Marcel Martin

Not really. Now we just... I think we've always been very sensitive to collections here, annually, very aggressive and very aggressive side, credit policy sometimes to the decrement of our sales people. However, we stand by that policy. I think it's served us well. What's happened with, the things that began to happen in the last quarter, what we saw in our first quarter, we got very aggressive from a credit perspective. So I think that focus and additional focus by everyone I think helped us a bit. But we also had a bit of a shift to domestic versus export and that also helped our DSOs.

Edward Marshall - Sidoti & Company

And last question, kind of a follow up to Luke's question a few minutes ago. I think it was Luke's. The dividend reduction of or the elimination of the dividend covenant in the revolver. I know it was, I was wondering though, if that was something that you guys actually pushed for, or is it something that was just kind of going in as part of the deal?

Marcel Martin

Well I think in the context of negotiating any agreement, you try to get the best agreements you can. You try to eliminate any kind of restrictions and I think in more in the context of covenants, we've worked hard to make sure we minimized the covenants, eliminating the dividend restriction was just that no one was sitting down and saying that we want the flexibility to do everything we want at some point in the future. So, that was why, that's why its down, it's just a matter of giving us flexibility to do the things that we need to do in some point in the future.

Edward Marshall - Sidoti & Company

Okay. I guess extending that a little bit further, I mean, did the inventory reduction loan should help you generate depending on certain measures going into the cash flow statement, but should give you some pretty good cash flow in the year. But can you kind of pinpoint 1,2,3 what you will be using for, what your order of priority would be for cash?

Marcel Martin

I think in the short term it's about just making sure we have an insurance policy to make sure we can deal with anything that might come up that's unforeseen and we still got to continue to operate in the business and buy inventory for operations. We still have a CapEx program that we want to continue to fund because again that has to be done to continue to pay benefits for us in the short term and our customers in the long term. Again, it is the same issues, working capital, CapEx, again those are the short term requirements and I think we'll get the focus.

Edward Marshall - Sidoti & Company

Okay. Thank you guys very much.

Marcel Martin

Thank you.

Operator

Our next question is coming from Nat Kellogg with Next Generation Equity. Please state your question.

Nat Kellogg - Next Generation Equity Research

Hi guys, how are you doing this morning?

Marcel Martin

Good.

Mark Comerford

Good morning Nat.

Nat Kellogg - Next Generation Equity Research

Just a little bit going through the last callers question, but I guess we talked about, you guys talked before about a third of the business is contract and a third is sort of PO a third of spot. And I guess, just trying to I guess drilling down a little bit more. I mean are you... were you seeing any price segredation on sort of the contracts or PO business that you would expect, historically you match up the raw materials with the pricing when you get the order in and so that you shouldn't see much margin compression on that down the line as raw material costs have changed? And have you guys had to give back any price on sort of that two thirds of the business or is this really from the spot side?

Mark Comerford

We do have escalators in the number of the contract business that we have.

Nat Kellogg - Next Generation Equity Research

Okay.

Mark Comerford

Some of them are built in, so you do make some adjustments on price as Marcel said. Pricing is at essentially date board (ph) entry but it is limited. Essentially, that price level might be limited for a 12 to 13 week period as we see what's going to happen. So, we have various types of contract that are out there. And as Marcel had mentioned, one of the key things that we saw in the quarter and we will continue to see going forward is this change in the mismatch so to speak of the metal value that we have in products that are flowing through our operations right now, compared with the metal value that's being priced into either contract or transactional spot price, things like that, the current metal value that is out in the competitive marketplace.

Nat Kellogg - Next Generation Equity Research

Great. That's helpful. And then on CapEx I think you really said about 15 million for this year but it sounded like you... in the press release that maybe that was up for negotiation. I am just sort of curious whether just sort of an update or 15 or so make sense or whether you would like to do a little bit less than that or where that sort of... it looks like it might shake out.

Marcel Martin

I think it's versatile, and we evaluate that. We do that with any CapEx program. But I think if you just say in the terms with that $15 million. That's still a relatively modest CapEx expenditure amount for a company of our size. We have some key projects that we need to do, either beneficial for us and for our customers, they are quality related, they are capacity related. Again, we'll probably do something in that vein (ph), it's not a... we may do a little bit less, we might do a little bit more. It's just... if we find something that we get a benefit much quicker from, we might choose to do. Again, so fifteen is what we start out and we can go up or down, I mean it's a relatively a flexible process for us, so I could expect this then something close to that this year.

Nat Kellogg - Next Generation Equity Research

Okay. And then you guys, I think you're looking at about 300 to 400 million bucks a quarter in sort of pension expense, is that right?

Marcel Martin

The pension expense is probably about a million and a quarter, the cash funding is about... I think it's about 3 million a quarter.

Nat Kellogg - Next Generation Equity Research

Right, that's asset for a month, cash flow side (ph), because I guess my question is, you got the CapEx you talked about, then obviously the cash funding and the pension. Those are sort the two biggest expenses that you guys will have on a cash basis for rest of the year going forward, correct?

Marcel Martin

Yeah, I mean those are the amount you've spoken to from... the CapEx program and the cash funding for the pension plan.

Nat Kellogg - Next Generation Equity Research

Okay, that's helpful. And then, I know, trying to get a sense of the seasonality. I know it's a little tricky with their business, just because, depending upon when orders are set and when not. But obviously I would say back the last couple of years I mean. Q1 does seem to a be a little bit seasonal, your prices (ph) for the first quarter to fourth quarter of the year, just so people get shutdown at the end of the year and I mean. I know that with the way the economy is sort of unfolding, that makes it challenging, but I mean would you still expect that were Q1? Do you still feel like there was some slowness seasonality-wise in your equity, you can just report it or because of the way things are holding in a broader world that sort of all bets are off as far as what normal seasonal patterns look like.

Mark Comerford

If you look at our business, we're very heavily project related. And we had a pretty strong Q1 as far as volume holding up pretty well, we made some real nice inroads into cutting back our past dues in the plants. So Q1 was a fairly strong at 4.8 million pounds, it was fairly strong as far as the volume flowing through. I understand what you are coming through, some of the... normally you think of that fourth quarter of the calendar year just being naturally fewer shipping days.

Nat Kellogg - Next Generation Equity Research

Yeah.

Mark Comerford

Like the first quarter of the calendar year, with the lunar New Year is obviously slower in the Asia Pacific region. But, I think the real wild cards that are out there right now are definitely the economy and timing of the projects. There is a lot of just unclear and almost conflicting information coming out of the aerospace segment, between here are the backlogs and here is what they stand for. And then I don't know if you saw it, at Saturday night there was a nice article in the Seattle Times talking about the leasing companies and what they think the demand will be this year, which is a little bit in conflict with the stability of some of the prior information, that's critical, we mentioned things like the chemical process industry and dropping chemical commodity prices and what you are seeing in the chemical industry and the timing of projects there and what will happen going forward. And the land-based gas turbine business for us, again you get conflicting reports, some people had good quarters, we had very good quarters shipping into land-based gas turbines and some other people mentioned that they did not have a very strong quarter shipping into that. A lot of it too when you go out and talk to your customers, it's the difference between the OEM and the MRO business.

The MRO guys seems to be doing extremely well with strong, steady backlogs. The OEM guys are still going pretty well, but they speak to you a little more cautiously. So, I'm kind of giving you a long answer to Nat, but I think really when you think of our business, going forward at least this year, I think it's critical to think coming from a project point of view, capital projects that are out there and just the basic, the timing of the economy that's out there. A lot of caution as we go forward.

Nat Kellogg - Next Generation Equity Research

Yeah, absolutely.

Mark Comerford

Turbine is holding up pretty well though. I mean we're very pleased with where the volume was in the first quarter.

Nat Kellogg - Next Generation Equity Research

Yeah. I know I mean in the case of oil and (ph) gas turbines, you just already hold up particularly well. Thanks both for you guys. So, listen guys, I appreciate the color in those. Thanks for taking my questions. And that's all I got for now.

Mark Comerford

Thank you. Again everybody thank you very much for your support of Haynes. It's a very cloudy environment that we are all dealing with and you're seeing I think across everybody in industry these days. We're staying very aggressive out there. We're out in front of customers. We're doing a lot of great things in the plants too, the group in the plants are doing a great job, as far as velocity, as well as getting on time delivery numbers up. It's very impressive. So, a lot of good things to talk about. But as we've mentioned, we wanted to make sure in this call that we gave you a very strong indication of what the challenges are that are going to face in the upcoming quarters. So, again thank you very much, we appreciate it, and we look forward to talking to you again.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.

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Source: Haynes International F1Q09 (Qtr End 12/31/08) Earnings Call Transcript
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