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Edited Transcript of HAYN earnings conference call or presentation 15-Nov-19 2:00pm GMT

Q4 2019 Haynes International Inc Earnings Call

KOKOMO Nov 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Haynes International Inc earnings conference call or presentation Friday, November 15, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel W. Maudlin

Haynes International, Inc. - VP of Finance, Treasurer & CFO

* David Sean Van Bibber

Haynes International, Inc. - Controller & CAO

* Michael L. Shor

Haynes International, Inc. - President, CEO & Director

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Conference Call Participants

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* Christopher David Olin

Longbow Research LLC - Analyst

* Edward James Marshall

Sidoti & Company, LLC - Senior Equity Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, good day. And thank you all for joining this Haynes International, Inc. Fourth Quarter Fiscal 2019 Earnings Conference Call. (Operator Instructions)

And now for opening remarks and introductions, I am pleased to turn the floor over to Controller and Chief Accounting Officer, Mr. David Van Bibber. Please go ahead, sir.

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David Sean Van Bibber, Haynes International, Inc. - Controller & CAO [2]

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Thank you very much for joining us today. With me today are Mike Shor, President and CEO of Haynes International; and Dan Maudlin, Vice President and Chief Financial Officer.

Before we get started, I'd 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 and Reform Act of 1995 and Section 21E of the Securities and Exchange Act of 1934. The words believe, anticipate, plan and similar expressions are intended to identify forward-looking statements.

Although we believe our plans, intentions and expectations regarding or suggested by such forward-looking statements are reasonable, such statements are subject to a number of risks and uncertainties, and we can provide no assurances such plans, intentions or expectations will be achieved. Many of these risks are discussed in detail in the company's filings with the Securities and Exchange Commission, in particular Form 10-K for the fiscal year ended September 30, 2019. 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.

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [3]

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Good morning, everyone. With the close of fiscal '19, I'm pleased to say that we've moved from words to actions and from plans to results. While we have so much more that we believe we can do with volumes, costs, pricing, cash generation and margins, I'm very proud of our team and all that they have accomplished in fiscal '19. We've gained significant momentum over the past year. Our employees' focus on our monthly metrics and the actions required to change this business have been excellent.

A few highlights related to both Q4 and fiscal '19. The depth of thinking and the actions underway to implement proactive safety initiatives throughout the entire company have been excellent. We must continue to improve our safety performance, and our employees' actions are a significant step in the right direction. Our cash flow has been positive for 8 of the last 12 months. We increased cash over $21 million in fiscal '19, of which $9 million was from Q4. Inventory was reduced by $10.3 million in Q4. Our fourth quarter gross margin finished at 16.4%. This much-improved result is despite the well-documented cobalt price collapse and the cost and yield issues associated with the planned furnace rebuild, both of which are now behind us. These numbers are also beyond anything we've seen in recent years.

As I stated last quarter, our goal is to move from worst to first in gross margin percent in our slice of the industry. We continue to make progress towards that goal. Our gross margin percentage increased in each quarter of fiscal '19 from 10.6% in Q1 to 11.5% in Q2, 14.4% in Q3, and as just noted, 16.4% in Q4.

Our pricing actions and cost reductions are real and have had a significant impact on our bottom line. Our price increases (technical difficulty) therefore, contributing to our improving margins. On the cost reduction side, very positive results are being seen across all of our manufacturing locations. Our efforts to create competitive advantage within -- via the supply chain -- excuse me, our efforts to create competitive advantage via the supply of high-value differentiated product has great focus and emphasis. First, in our R&D labs through alloy development; next, with our sales, marketing and application staff who work closely with our customers to look for solutions to their materials-related issues; and finally, in our distribution facilities, where we continue to grow our cut part business.

Our company also made it back to the long talked about 20 million pounds in fiscal '19, despite the loss of 3 million pounds of large frame IGT business from our 2012 peak. As far as our backlog, it did decrease this quarter, but we ended fiscal year '19 $19.2 million greater than at the beginning of our fiscal year. We believe that there is some minor rebalancing of inventories occurring in some segments of the supply chain. We all look forward to the 737 MAX issues being resolved. We expect demand to strengthen once the build schedules are increased. Also impacting the backlog during the quarter are typically lighter bookings in the summer months along with shipments of some specialty application projects into the chemical processing market, which were booked in prior quarters.

As for the details of the quarter. Volume shipped in the quarter was 5.4 million pounds, our highest quarterly volume in 4.5 years. The strong quarterly shipment performance put volume for fiscal '19 at 20 million pounds, alleviating the margin headwinds associated with lower volumes. The prior 3 years volumes were at lower levels, with each year being between 18 million pounds to 18.4 million pounds. Net revenues were $129.6 million in the fourth quarter of fiscal '19 and $490.2 million for the year. Net revenue for fiscal '19 was 12.6% higher than fiscal '18. Each of our 3 major markets of aerospace, chemical processing and industrial gas turbines had revenue increases of greater than 13% each. Average selling price in fiscal '19 was $24.46 per pound, inclusive of our other revenue, up about 3.4% over last year's $23.66 per pound. This average selling price increase was led by the aerospace market, where the average selling price increased 8.9% in fiscal '19 as compared to fiscal '18.

With that, let me move to our key markets. Sales to the aerospace market accounted for 53% of our revenue at $68.3 million in the fourth quarter of fiscal '19. This represents an increase of 11.3% from $61.4 million in the same period last year due to a 5.9% increase in the average selling price per pound, combined with a 5.1% increase in volume. We successfully initiated price increases in the aerospace market for both transactional business and with renewed customer agreements.

Looking at the full fiscal year, volume and net revenue shipped into the aerospace market during fiscal year '19 was 10.3 million pounds and $258.1 million, the highest in the company's history. Backlog in aerospace decreased sequentially from Q3 to Q4 by 6.1%, however, aerospace backlog over the fiscal year is up 10.6%.

Sales to the chemical processing market accounted for 21% of our revenue at $27.8 million in the fourth quarter. This represents a solid increase of 19.2% from $23.3 million in the same period last year due to a 14.3% increase in volume, combined with a 4.2% increase in the average selling price per pound. We've improved shipments of specialty application projects as well as better base business shipments. Our backlog dollars in CPI decreased sequentially from Q3 to Q4 by 32.2% primarily due to the shipment of special project orders from our backlog.

Sales to the industrial gas turbine market accounted for 12% of revenue at $15.8 million in the fourth quarter of fiscal '19. This represents an increase of 3.2% from $15.3 million for the same period of last year due to an increase in volume of 29.9%, nearly offset by a decrease in average selling price per pound of 20.6%. The decrease in average selling price is mix related. The increase in volume is primarily attributed both to an increase in small and medium frame engine builds, combined with a resupply of material into the supply chain. Demand for the large frame turbines in the energy market continues to be weak. Our backlog dollars in industrial gas turbines decreased sequentially from Q3 to Q4 by 2.9%. However, for the year, the backlog has increased 32.9%, coming off of very low levels.

During the last quarter call, I mentioned that we do see meaningful potential opportunities for market share growth for Haynes in our IGT market. I'm pleased to report that we recently received an order in November, for roughly 100,000 pounds in the IGT market, representing the start of market share growth for us.

Finally, our other markets and other revenue accounted for 14% of revenue at $17.7 million in the fourth quarter of fiscal '19. This represents a decrease of 20.4% from $22.3 million in the same period of fiscal '18. However, looking at the full fiscal year, revenue has increased 8%, primarily from an 11.5% increase in other markets pounds sold compared to fiscal '18. Our backlog dollars in other markets increased sequentially from Q3 to Q4 by 14.4% during the quarter.

With that detail on the markets, let me now turn it over to Dan for more details on our financials.

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Daniel W. Maudlin, Haynes International, Inc. - VP of Finance, Treasurer & CFO [4]

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Thank you, Mike. Fiscal year 2019 was a positive year financially, ending the year with our highest quarterly volume shipped in 4.5 years as well as our highest quarterly gross margin percentage in 3 years. Overall volume shipped in fiscal 2019 increased 8.9% over last year. Net revenues increased 12.6% and gross margin dollars increased 17.3% in spite of 2 significant margin headwinds. The 2 I'm referring to are the fall in the market price of cobalt, which had a significant margin compression in the third and fourth quarters; and second, the impact from the cold-finishing outage and upgrade. Both of these headwinds are expected to be alleviated moving into fiscal 2020.

Positive impacts on gross margin dollars in fiscal '19 include: one, higher overall volume shipped, achieving our goal of 20 million pounds; two, price increases beyond raw material changes, primarily in the aerospace market; and three, cost reductions that include improved productivity, better scrap management, reduced melt cost and many other manufacturing cost reduction initiatives; and number four, improved sales levels of the specialty application projects, which were $9.6 million in the fourth quarter, increasing from the $5.5 million in the third quarter of fiscal 2019.

Our focus on increasing volumes, improving profitability has gained traction and positively impacted results with gross margins improving each quarter sequentially over fiscal 2019 despite headwinds. The fourth quarter gross margin as a percentage of sales was 16.4%. These efforts are continuous, and we expect to keep pushing our performance higher.

Moving down the P&L, SG&A, including research and technical costs, were $12.5 million in the fourth quarter of fiscal 2019. This is $1.2 million higher than the same period of last year, which related to incentive compensation that included a prior year expense reversal from stock comp forfeitures, and it's also related to foreign currency changes. We expect SG&A, including research and technical costs in fiscal 2020 to be approximately $49 million to $51 million.

Nonoperating retirement benefit expense in the P&L was $879,000 compared to last year's Q4 of $1.9 million, driven by the prior year favorable valuation at 9/30/2018. As I mentioned last quarter, we were concerned about the lower discount rates to be used in the valuation of 9/30/2019, which determines the 2020 expense levels. This concern was warranted as the discount rate declined, which significantly increased our liability on the 9/30/2019 balance sheet and is expected to increase fiscal 2020's expense by $4.8 million as compared to fiscal 2019. Approximately $3.4 million of this increase is expected to be reflected in nonoperating retirement benefit expense in the P&L and the remaining $1.4 million increase is expected to impact the cost of sales.

While on the subject of fiscal 2020 expense, let me also mention another significant item that is expected to increase. The market for property insurance has tightened dramatically. There is much less capacity available, which is resulting in an additional amount of expense of $2 million on less coverage and is expected to be recognized primarily in cost of sales in fiscal 2020.

Now back to fiscal 2019. Our effective tax rate for this quarter was 22.1%, which is lower than last quarter, primarily due to reversing valuation adjustments on foreign tax credits, partially offset by the tax impact of certain types of stock compensation forfeitures that occurred in Q4 and adjustments to our accrual for global intangible low-taxed income or GILTI tax.

Last year, we incurred several tax adjustments stemming from the Tax Reform Act and the tax impact from special items. To see these details, I refer you to the reconciliation of non-GAAP measures table in the back of the press release.

And to finish off the P&L, net income this quarter was $6 million or $0.48 per diluted share and the full year fiscal 2019 net income was $9.7 million or $0.78 per diluted share. Backlog decreased 7.7% over the fourth quarter, coming off the June 30, 2019 levels that were the highest levels since 2012. Over the fiscal year, backlog increased 8.9% to $235.2 million at September 30, 2019. This is the highest fiscal year-end backlog since September 30, 2011.

Outlook for next quarter. As we look into fiscal year 2020, we see strong momentum stemming from the continued implementation of our focus initiatives. We are optimistic about improved results in the long term. This optimism remains in spite of the uncertainty related to the 737 MAX and global trade tensions as well as expected higher pension costs due to low interest rates and higher cost of property insurance. The first fiscal quarter of the year is typically seasonally impacted by holidays, planned maintenance outages and customers managing their calendar year-end balance sheets. Based on that, we expect revenues and earnings in the first quarter of fiscal 2020 to be lower than the fourth quarter of fiscal 2019. However, revenue and earnings in the first quarter of fiscal 2020 are expected to be better than the prior year first quarter of fiscal 2019.

Moving on to liquidity. We have 0 borrowings on our credit facility at September 30, 2019, and cash was $31 million, representing a $21 million increase over fiscal year -- over the fiscal year. Net cash provided by operating activities was $43 million in fiscal 2019, driven by stronger profitability, combined with lower costs and inventory in a period of rising sales volumes. Normally, rising volumes would increase inventory and consume cash. Thus, I believe it is a notable point that we generated cash this fiscal year. Also contributing to cash generation was controlling capital expenditures. Capital spending was $10 million in fiscal 2019 as compared to our depreciation level of $18.9 million. The forecast for capital spending in fiscal 2020 is $12 million.

In conclusion, we remain committed to continuing to push profitability higher as we focus on the execution of our strategic improvement initiatives. New headwinds are expected in fiscal 2020 as noted earlier, but also new opportunities are expected to further implement these initiatives focused on improving volume, product mix, pricing and costs.

Mike, with that, I will now turn the discussion back over to you.

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [5]

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Thanks, Dan. It has been an exciting year as we have launched and implemented our series of focused initiatives designed to unlock the potential of our company. Our goal is to grow this business by increasing revenues, profitability and cash flow, while continuing to be our customers' provider of choice for high-performance alloys, technical support and value-added processes.

With that, Jim, let's open the call up to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll hear first this morning from Edward Marshall with Sidoti & Company.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [2]

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So I wanted to first touch on the MAX. Some of the engine suppliers are talking about finally ramping down to 42 from 52. I know it's hard for you guys to see that in your volumes. As I look at backlog, as I think about kind of the performance you've had in aerospace, do you think that at least, for the first quarter or 2, you'll start to see that impact in your material pull or any comments around aero?

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [3]

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Sure. Ed, as you know, we spent a lot of time on discussing the 737 MAX. We spent a lot of time with our customers going through it. You know the recertification process continues to move along. We all know that if there is not good news, that is a significant issue for the supply chain as we move forward. But with that said, honestly, we've not seen a significant change in our order book related to the 737 MAX situation. This was emphasized. I had a series of customer meetings, both airframe and engine in late October and the conversations continue to be very positive and the conversations continue to be about making sure we continue to supply.

With that said, obviously, if there is news in the industry, which is going to either keep it low or even reduce it further, that's something we're all going to have to deal with, but we're not dealing with that right now. We feel good about where we are. The backlog -- we typically, when you look at our Q4 versus our Q3, we've looked at the last 5 years. And in each of those 5 years, we've reduced our backlog. So don't look at that as unusual and continue to get comments from customers that -- in the current state of events, they want us to keep pushing forward.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [4]

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And staying on the aerospace for a second, I think in your prepared remarks, you talked about pricing above base raw material pricing. And I'm curious if you can attribute any of that to the freed-up capacity within your aerospace cold finish.

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [5]

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Yes. I think part of it's that, but I really believe that from the aerospace perspective, Haynes provides a high-value differentiated product. That's in the technical support, that's in the inventory we supply, that's in the small quantities that we're able to deliver, it's even in the cut parts. So I think a big part of our ability to get prices, we truly believe in aerospace, which, as you know, is 53% of our mix, that we have a high-value differentiated product, and we feel very strongly we need to be paid for that. And we're very comfortable in talking to our customers about that. So that's a big part of it. I also look forward to when the MAX does come back and there is a pull, transactional pull that, hopefully, we can continue to drive our lead times down and take advantage of that, not only from the volume standpoint but from a pricing standpoint.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [6]

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So just if I understand you correctly, it sounded like it was more about the initiatives that you set to price the product appropriately as opposed to maybe just having the available capacity. Is that what you said?

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [7]

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I think Part 1 is pricing for value; part 2 is, as we've expanded our tube and our cold-finished flat and our plate capacity, it's allowed us to secure more. So yes, a combination, Ed.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [8]

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Got it. The R&D swell in the quarter. I mean is there something unique that's going on in this particular quarter? I mean it was up, it looks like 25% or so, sequentially.

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [9]

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It's funny. We spent a lot of time talking about cost reduction and what we need to do, but I'm much more interested, and we're much more interested in variable cost reduction. Over the last couple years in research and development, we've lost a couple of our high-end engineers, and quite frankly, some of our technicians. And the drop that has occurred in the past has been because of the loss of those people, and our drive has been to pull that number back up. So what you're seeing now is approaching what should be more typical for us. I have been amazed, both as an outsider, now as an insider, by the technical development capabilities of this company. It's the backbone of what we do. And this is one area I want to spend more than less and continue to do that.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [10]

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That sounds good. Could you quantify the impact may be from cobalt and the higher production costs in the quarter? And does higher cobalt -- or the change -- I'm sorry, the change in cobalt also impact your volumes as well as customers kind of assess?

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Daniel W. Maudlin, Haynes International, Inc. - VP of Finance, Treasurer & CFO [11]

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Yes, I can start with the first part of that. I mean the -- it's a bit of a difficult number to quantify. So what we would say is really roughly 1% of an impact on our margin. And that's the combination of both cobalt and the Drever higher costs impacting the fourth quarter. So we would say roughly 1%, maybe slightly higher, but right around that range.

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [12]

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And I don't think the cobalt pricing drop impacted volume. I think these are items our customers need. So I really don't think there's any material change to volume requirements.

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Daniel W. Maudlin, Haynes International, Inc. - VP of Finance, Treasurer & CFO [13]

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And as I mentioned, going into 2020, this headwind really alleviates. Everything seems to be more neutral on cobalt and the costs that we see from the Drever outage, those are pretty much flushed through the system. So those headwinds alleviate. We have new headwinds coming up that I outlined, but moving on to 2020.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [14]

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And if I do the math quickly, I mean it looks like the new costs offset by the absence of these 2 impacts in Q4?

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Daniel W. Maudlin, Haynes International, Inc. - VP of Finance, Treasurer & CFO [15]

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Roughly, roughly. I mean the insurance will be mostly on cost of sales, which is a $2 million increase over the whole year. So just a quarter of that, if you're looking at a quarter, but also the pension and post retirement, most of that is below operating income, but there is a portion that is above that will squeeze the margin a bit.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [16]

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Right. Final one for me is just kind of what you -- as the operations improve, you're obviously generating more cash, you had pretty good comments about that. There's not a lot of need for major CapEx. I'm curious what's the focus of the balance sheet now as you're starting to kind of put that cash back on the balance sheet in a pretty decent sum?

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Daniel W. Maudlin, Haynes International, Inc. - VP of Finance, Treasurer & CFO [17]

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Well, as far as capital allocation, we're always talking about that at the Board level. So we certainly think about improving gross margins and generating more cash. And then what we do with that, we certainly continue to fund our pension plan. And we think about what other capital allocation opportunities are out there. So really the table -- everything is on the table as far as options at the Board level.

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [18]

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I'm thrilled we're generating cash. I'm thrilled net income is leading to cash generation, makes a lot of sense. And then from that point forward, we'll do whatever makes the most sense for shareholder value.

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Operator [19]

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(Operator Instructions) We'll move next to Chris Olin with Longbow Research.

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Christopher David Olin, Longbow Research LLC - Analyst [20]

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A little bit of -- I guess my first question is on the contracts and the transactional pricing increases that you talked about. I was wondering if you could put a little bit more color around that, maybe in terms of what type of realizations you guys are getting? And maybe how much of the aerospace business is going to be reset for 2020?

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [21]

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As far as pricing, we feel very strongly that the overwhelming majority of the product that goes in aerospace is our high-value differentiated product. We started last year. And if we're 53%, that's roughly 10 million pounds. And we're going after all of that as the contracts mature, both last year and this year to increase their price. But again, my point of emphasis here is we're talking about price increases beyond raw material pushes. These are pure bottom line increases. We also, on the transactional side, are doing the same thing and are pushing that and continue to push that. We've had some cost pushes, for example, refractories and molds. And our goal is not only to offset those through transactional and contract price increases, but to go beyond just offsetting them.

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Christopher David Olin, Longbow Research LLC - Analyst [22]

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Is the component of the transactional business moving higher?

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Daniel W. Maudlin, Haynes International, Inc. - VP of Finance, Treasurer & CFO [23]

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Well, when we do measure, what we consider transactional is we get an order and we can ship that order within a month or 2. So it's less than a mill lead time. So I would not say it's moving higher. We do track that. It was about $23 million this quarter, which is around 18% or so, approximately 18%. So it's been holding pretty steady across the year. If you look back a few years ago, that was a higher number. So we have shifted a bit more into the LTA and nontransactional, but it's holding pretty steady this year.

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [24]

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Chris, Marty Losch and his team over the last couple of years, just following up to what Dan said, have looked to tie up more and more business in LTAs. And so that's why the number is down from where it was. But I really think if we do see the 737 MAX come back and start to approach 57, that we'll have the opportunity for more transactional business. And my mantra here is the shorter the lead time the higher the price can go. So it can be good for us.

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Christopher David Olin, Longbow Research LLC - Analyst [25]

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Okay. Good. You guys did a pretty good job talking about the MAX net risk or impact. Is there any overlap with the 787 or maybe the 777X. I was thinking maybe there's some issues with Arcadia or any kind of tubing pushback?

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [26]

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No. We -- right now, we have fairly steady demand. There's obviously puts and takes in the industry. I will tell you that Arcadia on the titanium side, their lead times, much to my chagrin, are continuing to push out, which means demand is extremely strong for titanium, which is all airframe. And so that's going well, and we've seen no pullback whatsoever as far as the demand for titanium tubing for us.

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Christopher David Olin, Longbow Research LLC - Analyst [27]

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Okay. And my last question, just -- and I realize it's not a one-to-one relationship, but we've been watching the rig count fall now for a number of months. And I'm wondering if that has any type of impact or any -- does that change your visibility at all in terms like the CPI business?

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Daniel W. Maudlin, Haynes International, Inc. - VP of Finance, Treasurer & CFO [28]

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Well, we are somewhat tied to kind of an indirect connection to the oil industry. So that could have an impact on chemical companies, if they see rig counts going down and the oil price is weakening. We did have that impact us a few years ago when the oil market collapsed. And that had a -- we called it a spillover impact on our CPI business. So it's not direct, and it's not significant at this point even with the rig count going down slightly.

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [29]

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And Chris, what tends to move the needle for us in CPIs are special projects. And we're anticipating continued growth this year in our special project business.

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Operator [30]

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(Operator Instructions) And we have no signals coming from the phones. I'll turn it back to our leadership team and Mr. Shor for any additional or closing remarks.

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Michael L. Shor, Haynes International, Inc. - President, CEO & Director [31]

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Thanks, Jim. Thank you, everyone, for your time today, and thank you for your interest and support of Haynes. We look forward to updating you again next quarter. Happy Thanksgiving.

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Operator [32]

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Ladies and gentlemen, this does conclude today's earnings conference, and we do thank you all for your participation. You may now disconnect your lines, and we hope that you enjoy your weekend.