ATI Inc (ATI) 2004 Q3 法說會逐字稿

Welcome to the Q3 2004 Allegheny Technologies earnings conference call. At this time, all participants are in a listen-only mode. We will, however, be facilitating a question-and-answer session at the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to your host for today's presentation, Mr. Dan Greenfield, Director of Investor Relations of Allegheny Technologies.

Thank you. Good afternoon and welcome to Allegheny Technologies' earnings conference call for the third quarter 2004. This conference call is being broadcast live on our website at AlleghenyTechnologies.com and on CCBN.com. Members of the media have been invited to listen to this call.

Participating in the conference call today are Pat Hassey, Chairman, President and Chief Executive Officer, and Rich Harshman, Executive Vice President Finance and Chief Financial Officer. After some initial comments, we will ask for questions. Please note that all forward-looking statements made this afternoon are subject to various assumptions and caveats, as noted in the earnings release. Actual results may differ materially. Here is Pat Hassey.

Thanks, Dan, and good afternoon. Thanks everyone for joining us today. I would like to begin this session with a few summary statements about our position -- our current position of ATI.

Number one, our optimism for 2005 continues. Number two, our 2004 transition to profitability is on track and on schedule. Three, our third-quarter results demonstrate that our strategies are working. Four, we continue taking the necessary actions to transition ATI to profitability. And lastly, our markets continue to recover.

In the third quarter, sales increased over 50 percent compared to the same period last year. Operating profit increased to $53 million with a year-to-date number of 92 million. Retirement benefit expense was considerably lower as a result of the actions taken in the second quarter to control certain retiree medical expenses. Net income was over $8 million, or 9 cents a share. It's worthy to note that the year-to-date sales of nearly $2 billion already exceed the total sales of 2003.

Some highlights for the quarter. Our flat-rolled product segment continued to improve during the third quarter. Sales increased by 80 percent compared to the third quarter of 2003. Shipments of over 170,000 tons set an all-time record for ATI. Operating profit reached 26 million in the flat-rolled product segment. This was accomplished without any operating profit benefit from inventory purchased in the J&L acquisition, since the acquisition was accounted for as a purchase. The integration of the J&L assets into Midland, Pennsylvania and Louisville, Ohio with ATI Allegheny Ludlum is progressing very well, and the new capabilities exceed our expectations.

The second new and efficient electric arc furnace at our Brackenridge, Pennsylvania melt shop started up and is ahead of schedule. The first group of retirements under the new Allegheny Ludlum labor agreement occurred in the third quarter. In our high-performance metal segment, sales increased 19 percent and operating profit reached $21 million. Operating profit as a percent of sales reached 11 percent. Importantly, we see further indications that we are at the beginning of a recovery in the commercial aerospace cycle. Demand for our high-performance metals was strong for spare parts and improved from the OEM market during the quarter. Looking ahead, we are encouraged by the OEM build forecast in terms of the number and size of the aircraft, as well as the increased high-performance metals content of the aircraft.

Our exotic alloys business continued to perform well. Demand remains strong from the government and medical markets and from corrosion markets, particularly in Asia. Sales in our engineered products segment increased as a result of strong demand from several key markets such as oil and gas, mining and transportation, especially Class 8 trucks, train locomotives and off-road construction, including mining equipment. Demand was also strong from the wind energy market as well as from an overall pickup in manufacturing demand.

The effects of the ATI business system and our ongoing cost reductions were apparent in the third quarter. Employees throughout ATI deserve a lot of credit for these accomplishments. Operating profit as a percentage of sales improved over 7 percent. This was achieved even with the negative impact of LIFO inventory valuation reserve charges. Managed working capital as a percent of annualized sales improved to just over 26 percent at the end of the quarter compared to nearly 31 percent at the end of 2003, which was an improvement, as you know, over 2002. This improvement demonstrates the value of the ATI business system.

We saw faster flow times with simplified flow paths, with people improving and connecting our systems throughout the business. We have achieved $103 million of cost reductions before the effects of inflation in the first nine months of this year. We have already nearly reached our $104 million goal for the full year. In addition, we began to make progress toward achieving our $200 million cost structure improvements and synergies for the J&L asset acquisition and the new Allegheny Ludlum labor agreement. We expect the majority of these savings to impact our results beginning in 2005.

We improved our balance sheet during the third quarter. We received cash proceeds of $230 million from our public offering. We made a $50 million voluntary cash contribution to our U.S. pension plan to improve the plan's funded position. Cash on hand at the end of the quarter was $263 million. And we continue to have no cash borrowings under our secured domestic credit facility.

I now want to focus on three issues of interest. First, we are in an environment of unusually volatile raw material prices. Secondly, alloy substitution to lower nickel-bearing alloys is expanding in our stainless steel business. And lastly, our business in China and Asia is doing very well. First we will discuss the raw material prices and its impact on our LIFO accounting methodology.

As a result of the unprecedented rise in raw material costs this year of over 85 percent from the 2003 average, we have reported an $83 million LIFO valuation reserve charge during the first nine months of 2004. As a point of emphasis, the LIFO charge reduced our nine-month operating profit by $83 million. And if you recall, I mentioned the year-to-date profit is at 92; this reduced it by 83 million.

We expect additional LIFO charges in the fourth quarter based on current raw material prices, yet this forecast is very difficult. You know the price of iron. Scrap is at an all-time high of $415 a ton. We also know the LME nickel price has been extremely volatile in October. LME cash nickel traded as high as $7.53 per pound this month. Today's price is 602. In the case of nickel, the monthly average is what matters for us. That number today is $6.78 a pound. We used the October LME cash monthly average to determine our cost of nickel purchased in November, and to calculate our December surcharge in our stainless steel business.

It is critical for us to highlight that on a cash basis, raw material costs are mostly neutralized by our raw material surcharge and index pricing mechanisms. Reasoning together, as raw material costs stabilize, LIFO charges will have a less impact on operating profit. In addition, when raw material costs decline, year-over-year LIFO income results in an operating profit to the business.

Volatile nickel prices in 2004 have created some opportunities for ATI, especially Allegheny Ludlum, to leverage its broad array of alloys and technical capabilities. Our technical marketing group meets with customers to help with optimum alloy selection. Many of our customers have moved to alloys that contain less nickel. For example, Allegheny Ludlum's type 201 shipments have increased significantly year-to-year in 2004 compared to the same period in 2003. Many more customers are considering alloys substitutions to lower nickel-bearing alloys in 2005. We expect this trend to continue.

In the case that we make for substituting the 3.5 to 4 percent nickel type 201 alloy for the 8 to 10 percent nickel type 304 alloy stresses that customers can reduce their cost and reduce the price volatility of nickel. For example, the October type 201 surcharge is at 20 cents per pound -- is 20 cents per pound lower than the surcharge for type 304. Alloy substitution is accomplished in many applications without major trade-offs in corrosion, resistance, formability or strength performance.

The final point in our business -- in this section is our business in China and Asia. Our stall precision rolled strip products operation in Shanghai has set another record for shipments in the third quarter of 2004. This facility remains booked solid. Its end-use markets are electronics and electronic components. In addition, the business we book through our Asian sales office remains very strong. These offices sell many of our higher value products such as super stainless steels, nickel alloys, titanium and zirconium products, to power generation, corrosion and the aerospace markets.

If I could just now summarize where we think we stand today. We've made important strides in the third quarter in transitioning ATI to profitability. We were profitable in the third quarter after three very difficult years. The J&L acquisition integration is progressing very well and the equipment is performing better than expected. We are beginning to transition to the new progressive labor agreement in our stainless stainless steel business, and the benefits will be coming in 2005 and beyond.

We see indications that we are at the beginning of an aerospace cycle recovery. We are encouraged by the OEM build forecast, especially the new titanium usage. We see significantly improved improvements to our balance sheet. We see 2004 as a year in which we accomplish a transition to -- we have accomplished a transition to profitability. We believe the strategies that we put in place in 2004 are working and have positioned ATI for significantly better earnings performance in 2005.

Our optimism for 2005 continues very strong. First, our markets are recovering. We expect a significant positive impact from the $200 million of cost structure improvements and synergies from the J&L asset acquisition and the new Allegheny Ludlum labor agreement next year. And lastly, approximately 40 percent of our consolidated sales in 2004 are under priced contracts. We are negotiating new contracts now, and expect 2005 contract prices to reflect the price restoration actions we have put in place in 2004, with even stronger markets coming forth in 2005.

This concludes my opening remarks and we would ask the operator now to please open the call for any questions.

(OPERATOR INSTRUCTIONS). Robert LaGaipa, CIBC World Markets.

Pat or Richard, maybe you can help me out in terms of your last comment, in terms of the contract business. Obviously we saw a significant increase in margin in the high-performance metals business. Maybe you can provide a little bit more color there. More importantly, maybe you can give us a sense of magnitude in terms of the contract increases or your progress in the contract business on the aerospace side for next year?

Just a couple of comments, Bob. First of all, if you look at our basic price increases -- this does not include standards and extras and other things -- but our basic price increase through the year-to-date timeframe have averaged about 25 percent. Now, as we're talking about prices that were fixed under contract, of course those products have not seen any of those price increases. And in addition to that, we have size extras, we have other indications as the supply demand tightens for these kind of products that we are able to look at different kinds of negotiations moving into this next aerospace cycle. But these price negotiations are on the aerospace side. They're also on our engineering strength (ph) and on our precision strip products. They're also on our titanium product, they're also on our exotic metals. The markets are strong and those products that we have had under a fixed basis will see the price restoration next year.

So when you look at where we have been, we have been moving prices and restoring prices throughout the year. But the effect of those price increases, of course, have rolled in during the month in which they were implemented or at a future date. So we haven't seen the full impact of those under a full-year basis yet, plus we have new prices coming in under different contracts.

So what would you say would be the major contributor sequentially from kind of the 6 percent margin range to the 11 percent margin range in high-performance metals?

I think we have just a better mix for one thing. We're selling and moving product out with some better mix to it. We've had some spot business that's come in that has enhanced that particular business.

Second question if I might. Just in terms of the cash flow, obviously now you have $263 million in cash on the balance sheet. You made the pension contribution. Now I would think at some point some of the charges that you have taken over the last couple of years will come back on the balance sheet in terms of the pension charge that you took two years ago, the valuation allowance. What is going to be your use of cash flow on a go-forward basis, this $260 million? And Rich, maybe if you can kind of provide a little bit more color as to when and if some of those charges that were taken out of equities the last couple of years might come back on the balance sheet.

I will let Rich handle this question.

Bob, let me start with the last part of your question first. The two charges, the pension charge that we took where we wrote off our pension asset -- our measurement base as you know is at the end of November of each year, so obviously at that point we will look at where the assets are, not only in terms of what the performance and returns are on the assets, but also the impact of the $50 million contribution. Compare that to where the liabilities are and determine whether or not the assets are above the liabilities. At the end of November of 2003 they were not. And the determination of the liabilities are largely driven by what discount rate assumptions you use. We used the 6.5 percent assumption in 2003. Obviously, we will be looking at that as we enter in the end of 2004 to determine what appropriate discount rate we should use based upon the high-grade corporate debt yield.

So the answer to that question is that before you can put the asset back on, your assets have to be at your measurement date above your liability. And it's really just premature to say when that will be. There's just a number of factors that drive that. On the deferred tax valuation allowance that we recorded in the fourth quarter of last year, as we have said in our public filings and on previous calls, under FAS 109, the ability to reverse that charge is really dependent upon a consistent time period of profitability on a GAAP basis. And I would suggest that it's more than one or two quarters. I think the earliest that that would be an issue is sometime in late 2005 at the very earliest, before that valuation allowance could be in a position to be reversed.

And in terms of the cash flow, the use of the $260 million on a go-forward basis?

That is consistent in terms of what we said during our equity offering. We really had three components of that. One was to provide the financial flexibility to make important strategic investments either internal or external, and we will continue to look at that, obviously, as part of our 2005 planning process in terms of what our capital expenditure profile would be. And the second third pieces were really earnings improvements from the standpoint of reductions and outstanding debt, and therefore, interest expense. And what we have said on the debt reduction side is that we would be focused on opportunistic cost efficient repurchases of our public debt. And then finally is improving the pension funding side which we have done at least initially with the $50 million contribution here in the third quarter.

If I could sneak one more in. Pat, maybe if you could just give us an update in terms of what you are seeing in the marketplace across -- I know you have pretty broad end-market exposure; maybe you can kind of outline or not if there's any weakness, any specific strength. Obviously, aerospace looks like it's going to be strong into next year, and also judging by the price increases. But any changes incrementally in any of your other end-markets?

I think the only change that we would say that we've looked at or will experience in the fourth quarter -- we have distributors on that section of the business that will be doing some inventory level adjustments toward the end of the year. We also have some customers that want to be taking Christmas outages and those types of things toward the end of the year. That reflects that quarter, maybe a little similar to them, the third quarter. But in the days that we're operating, probably stronger. And moving toward 2005, I think all of the markets were still very optimistic about 2005. We're holding very steady around our optimism for what we see going forward. Many of our particular product lines are at or near capacity moving into 2005, with schedules going forward. We still are under controlled order entry for products. We are able to move price restoration actions in place without compromising that. So I feel very confident about where the markets are headed. I think the only issue that we have is to see how the overall economy stays where it is.

Alex Glatzer (ph) Merrill Lynch.

I had a question, Pat, on your comments regarding the J&L assets. You mentioned they are performing slightly better than expected so far, and I was just wondering if you would elaborate just a little bit on what you're seeing there?

We're really talking about our experience with the continuous automated finishing line coupled with our high-quality hot melt products. Just to give you an anecdotal story. In terms of our upgrading the products coming off that line into full distribution line products, that line for us produced more product in the month of September in what we call standard distribution coil 304 two side bright coil in one 30-day period than what J&L produced (indiscernible) those particular products in the entire year of 2003. So we think that's very good for us. Our recoveries are very good. Comments that we're getting back from the marketplace in terms of the strip quality, it is the best strip that we've produced in many cases. So we are very happy with that finishing line, we're very happy with our ability to run a virtual operation with unitrain (ph) moving product from our Brackenridge hot mill to the line, and we're very happy with the J&L workforce and the new work rules him and the training going on, the flexibility that we're finding under the new arrangement, the arrangement of integration between the two companies. And we will have a complete system switchover here coming up shortly that there will be -- none of the J&L systems will be left. We'll be completely on the Allegheny Ludlum systems across all the manufacturing facilities. All the specs, all the quality issues under one system here in the early November timeframe, which is 120 days into the integration to have the entire workforce, the entire IT systems, order entry systems, cash-to-order systems, all under the Allegheny system within four months. So from a systems standpoint, customer acceptance of the products, the products that we want to run on that line, the workability of our hot strip mill to J&L's finishing facilities -- we're actually very, very happy, and I would say we are ahead of schedule.

That is very positive. I had a question also on some of the substitution you were discussing. It's interesting, I had heard that perhaps the Chinese had over-engineered, used the 300 series when in fact they could have used some more 200 series. Then I've heard other comments that some of the railings on the boats and some of the other exposed 200 stainless on the ocean side of the country were actually corroding somewhat sooner than they expected on the lower quality series. So the risk I guess is if the product is not engineered or specified properly, people or engineers might be mistaken and not use the product going forward, or the right product. When you see substitution, are you seeing it being engineered out or are these just sort of flexible? Over what time period can these -- if nickel prices abate some, can these applications return to the higher value nickel-bearing stainless steels?

Let me just start back a couple of years. ATI was the pioneer in developing the 200 series alloys. We have actually redirected some of our technical time and energy now. And led by Dr. Jack Schilling, back to the businesses, looking at specific applications with our customers, going out to the customers, talking to them about what the end-users are, and engineering the alloys to meet their end uses. We're not advocating that we would put a substitute alloy into something that would not work. What we're saying is the 201 series will work on many applications and work very well and perform for 50-use applications without any difficulties. The interesting part of course for the customer is in the month of October that's 20 cents less. In the nickel charge or the surcharge the nickel mechanism then is smooth from the volatility of nickel. And secondly, as far as we are concerned, the margins on 200 series or 300 series are just -- even for us. So from our conversion standpoint whether we're running 300 or 200, we're perfectly happy, and the applications seem to be moving toward the 200 series. Just to give you some basic numbers for us, I'm going to give you some percentages. (indiscernible) but from 2002 to 2003 -- excuse me, I'll start again. From 2003 to 2004, the usage of our 200 series at Allegheny Ludlum were up 50 percent. When you compare that same usage from 2002 to 2004, it's up 75 percent.

That's pretty incredible increases. I appreciate you putting that in perspective for me. I'll get back in queue. Thanks.

John Tumazos, Prudential.

Could you explain specifically what are the limiting factors in your flat-rolled tonnage output, why you produced at a 170,000 ton rather than a 200,000 ton rate? And could you, just for some of us that are not as fresh in our metallurgy, explain the exact composition of alloy 201?

We're going to let Dr. Schilling do that in a minute. He's here with us. We have it. It's basically 4 percent versus 8 percent in nickel. Let me start with your first question. 170,000 tons are tons out the door, pounds out the door. We're interested in enriching the mix and enriching the -- utilizing our facilities for the most profitable mix to meet our customers' needs. When you look at our business, you'll find that we're looking at products that are lighter in gauge, narrower in width, in some cases precision-stripped. We're also rolling titanium. We're rolling stainless steels that are of different gauges and widths. So a lot of this simply depends on the mix that we're booking, and we're booking a mix to optimize the profitability and that best fits our operation. So that number could be -- for giving you some ranges -- on an annual basis, our numbers could be between 680 and 780,000 tons.

What is the limiting factor? The electric furnaces, the caster, the hot strip mill?

I guess in the end it's our wide coal rolling path would be our limiting path.

Thank you. And the alloy 201 formula?

Jack Schilling. How are you? John, real briefly. The 201 has about 4 percent nickel, which is half of what 304 has. And that's where the big advantage is. It has around the same chromium, which is where the corrosion resistance comes from. So it has not only the same chrome but half the nickel. One of the confusions, back to the other issue, that exists out in the marketplace is if you go around the world, particularly into India, you will find a lot of different 200 series alloys, some of which have very -- have a lower chromium level. So when we talk about 201, we're talking about a very mature alloy that we have a fair amount of experience in a lot of different applications, and it has approximately the same chromium level.

How does the 4 percent that is not nickel breakout between moly, manganese and iron?

It's mostly going to be iron. The manganese is a little bit higher. But I mean, basically it's going to be iron.

What is the moly and the manganese content.

The moly is going to be very similar. I don't even have the moly, because it's not an intentional add to those alloys, either one of them, 304 or 201. Manganese is approximately 6 percent, which is higher than 304 where it's just about 2 percent.

Michael Morrisroe, Bear Stearns.

Just regarding that last question on the tonnage and the flat-rolled area, I know that one of the initiatives of doing the transaction was to increase the value-add and free up some capacity at (indiscernible). But if we look at second quarter to third quarter on the higher value product, the year-over-year change doesn't seem to be too much different. In other words there's about 23 percent in the second quarter and then 24 percent in the third quarter. I'm just wondering will that be picking up? It just doesn't seem that you gained much more value-add in the quarter. Is that accurate?

It's just of the total number. You have to look at 24 percent of 107,000 tons versus 24 percent of a much lower number.

So we should look for that higher value-add to increase significantly?

Yes. We are going to move the commodity products that we run. The path is the Midland melt shop, Brackenridge hot mill to the continuous automated finishing line or Newcastle kind of operations we have. When we do that, that frees up our capacity in our higher-value rolling mills in the Northeast and also here in Vandergrift, Pennsylvania.

Secondly, on the pricing issue. I know another major initiative has been to kind of go with the decoupling method and do your own discipline basically. But we haven't seen any price increases in a good number of months. Is that indicative of the market has slowed? Or can you just give us -- should we expect some price increases again?

What you have seen is not price increases in the base price of 304. We have had several price increases moving through in widths and in (indiscernible) steel and plate in various sizes. Price increases that we do not announce are not announced price increases in our aerospace products. And so, I think where we stand today on the base price of the standard products, we'll have to see how the market reacts to where we are. But in terms of our ability to move those prices, they are up 25 percent year on year. And we want to make sure that we're also considering this in a global perspective, also watching the imports coming into the U.S., and also the monetary issues that we deal with in Europe, China and here. So it's a little bit more complex as you look at price restoration for commodity products that many people can make. The market is strong. So far we have been able to move the prices to restore those levels that we need to, and certainly those products that have a high demand or high technical capabilities to make -- specialized equipment, quantities with purposes, edges, those kinds of things have -- those prices are up on a significant basis. And I'm going to reemphasize again that we are in the current period of contract negotiation on 40 percent of our tonnage coming out of these plants for the 2005 period. And those prices are on more of the specialty products and specialty commodity products.

Is it just fair to say then that you're receiving more pushback from the customers than in the first half of the year when you had instituted -- and this is on commodity grade stainless steel when you instituted the five price increases?

We just haven't felt that -- this is a decision that we're looking at. Let me just go back and say that we know that the commodity stainless steel market is a global market. We know what the prices are in Western Europe, we know what the prices are in Asia, and we know what the prices are in the United States. We know what the prices are among the various competitors in the United States. But when we're in that kind of a mode, we're making rationally good decisions as to what we do with our pricing, especially for the customers that we're serving.

John Hill, Citigroup.

Congratulations on a good quarter, everyone. I was wondering if we could revisit the subject of the opportunity cost of selling the purchased J&L inventory. Obviously that marked up to market through the P&L, and finding expression in the fact that volumes were up with margins flat. Could you just walk us through what that opportunity cost was in millions of dollars, and what -- and let's just call it a normalized type of quarter with these volumes, what we would have seen for margins in that piece of the business?

This is Rich. As we have said, the inventory purchased as part of the J&L asset acquisition under purchase accounting -- and we have disclosed that number in our SEC filings -- the preliminary number subject to final resolution of the net working capital calculation was just under $58 million at June 1st. That's the value of the inventory that we purchased. That inventory is valued at fair market value plus any additional cost to complete the inventory, for example, on work in process, less than nominal selling expense. So basically what purchase accounting requires you to do is to value that inventory at its fair market value less the cost to complete and sell, and therefore, the operating profit on that inventory is essentially zero as you flow it through the income statement. And for the most part, most of that inventory was completed and shipped. There's still probably a little bit left in terms of shipping it into the fourth quarter, but not a significant amount. So most of that inventory float was shipped and flowed through the income statement as zero operating profit in the third quarter.

The rest of your question in terms of what's the normalized, if you will, operating profit going forward -- w0e haven't broken out the individual components of profitability of each product that we make, but suffice it to say that we would expect normally to have operating profit when we sell inventory that had a value of close to $60 million.

Right. I guess my question was what was the tonnage of this inventory that was shipped? And let's say that if you had shipped an identical amount of your own product, what would the margins have been. You must have a feel for that.

We have a feel for it, but the margins were -- on the segment basis, you obviously see what our operating profit margin is in the quarter. That would have had on a tonnage basis about 30,000 tons of the 170,000 that we shipped in the quarter that had very little operating profit on it. So I am sure you could look at the information that's in our earnings release and come up with what you think is a reasonable going forward rate in terms of operating profit.

Great. Switching over to the synergies and savings column. You mentioned 103 million or so delivered, and then there was some language about inflation offsets. And we just observe that really the metals universe is filled with many companies that we'll leave nameless with perpetually successful $1 billion cost-cutting exercises, yet where the cost of goods sold line always goes up on the income statement. We all know the reason why, because the cost to inputs and everything else goes up when the outputs do. But my real question is -- and my point is not to be critical -- but to just ask, as you view these synergies here and the savings going forward, the additional 200 million. On a rough basis, how much of that do you think you can drop to the bottom line? At most other companies we see a maximum of about 25 to 30 percent. In the past you've indicated a much higher level, yet now were hearing about inflation offsets. So I was just hoping you could walk us through that, understanding a lot of it is tied to $50 oil and all the rest?

Let me just go back, John, a little bit. First of all, the way the Company has always reported their cost savings is net of any inflation here. Also, recognizing that all of the inflation that we can pass on to customers that we are experiencing in the raw materials are coming through in surcharges. Also, we are passing along surcharges for fuel premiums in transportation today. So those kinds of inflation levels we're really not talking about. Part of the issue that we have in this purchase accounting that we're talking about, as Rich points out, is that we have moved basically three months worth of production -- which, I don't know, of the 30,000 ton number, I think there's maybe a little (indiscernible) could be 30 to 50,000 tons moved out of J&L at purchase accounting at this point in time. But when we look at this whole issue of cost savings, as you do the cost system that Allegheny Ludlum runs, and we look at costs moving through our inventory, you have to remember that as we take -- we're taking -- as we are moving with the transition to the new labor agreement, we're taking people out. We're also experiencing today training costs as those people are trained to take the people's jobs that are leaving. So as those 125 people left J&L, the operating people, that just occurred at the beginning of November. Basically it's going to occur end of September up to the end of October. Those new costs go into the products that they are making. Right? And those new product costs are carried in the normal terms of the year. So we have about a quarter delay before we start to see those costs coming back to us, which will put us close to the first of the year that we will be seeing those synergies that we're talking about beginning to show up on the bottom line. And I think you will see a large percentage of those costs affecting our overall profitability in this company.

Just wanted to clarify. You had indicated 103 million in cost savings before the effects of inflation. Well, what were the effects of inflation and what was the magnitude of the offset there?

John, this as rich. Let me -- we have consistently said that the reason why we describe it as growth cost reductions is because it is before the effects of inflation, the effects of all inflation, excluding raw material costs. Because on the raw material cost side, on a FIFO basis on the raw material cost side, that's where the surcharges and the indices come in. So generally speaking, when we target a growth cost reduction, and let's just use round numbers of $100 million, we are targeting that to be twice the rate of expected inflation. And that's expected inflation in terms of higher health-care costs, higher wage expenses, higher natural gas costs, higher cost of power, any higher cost of any other operating supplies, etcetera. So that in normal type markets, or hopefully strong markets, if we achieve that, then $50 million should drop to the bottom line.

When you look at the third quarter of 2004, and specifically all of 2004, quite frankly there is significant earnings improvement in ATI. And that's partly driven by higher volumes as end-markets improve, higher prices -- base prices -- because of price restoration, and the impact of $103 million of gross cost reduction offset by inflation of $50 million. But the reason why you're not seeing all of that drop to the earnings per share is because of an $83 million LIFO hit. So we're sensitive to your comment about the reporting of cost reductions and where is it on the income statement, where does it appear on the income statement. As we've discussed with the investment community in the past, the last three years, what it enabled us to do was to significantly minimize losses because all of that was given back to the market through lower prices and lower volume.

On the $200 million issue, that $200 million is really a different issue because it's looking at the pre-acquisition J&L and Allegheny Ludlum cost structure, the flat-rolled stainless business, and the 200 million is taking $200 million of costs out of the combined cost structure for all of the flat-rolled products business. So that's the J&L standalone cost structure, the Allegheny Ludlum standalone cost structure. You put the these two businesses together, significant operating synergies -- number one. Number two, a much different labor agreement, allowing for labor flexibility, lower hourly headcount requirements, a different fringe benefits program, especially retiree health-care. Those all add up to the $200 million that we were very descriptive on in terms of our prospective supplement to our public stock offering as well as the roadshow.

Thanks for that very succinct response, and congrats as well on a great quarter.

Aldo Mazzaferro, Goldman Sachs.

Rich, I really appreciate the accounting explanations you give us. I'm wondering on your pension contribution, how soon are you going to see a benefit from that in your expense line in the income statement?

We set our measurements, as we've said, at the end of November of each year. That measurement date really drives the next year's FAS 87 calculation. So to the extent that we made the contribution before November, the assets are $50 million higher than they otherwise would have been. So we will see the benefits of that in the 2005 estimated pension expense.

In terms of offsetting, I can read your comments in the press release about the operating income being roughly flat and then a little bit higher LIFO charge. In terms of the other potential offsets there. is there anything in your corporate expense line that was unusual this quarter? And I would assume your interest expense would drop next quarter too, with the new cash on the balance sheet, right?

A little bit, but as you know, we're taking a very conservative approach in terms of how we invest that cash. So you're not earning a lot of money on invested cash at this point. I think the interest expense will be relatively similar in the fourth quarter to the third quarter, because we don't -- unless we do something in terms of reducing debt, that would change that. But I don't really see that being much different quarter over quarter. On the corporate expense side, we did have -- the increases we said was primarily due to the incentive compensation programs. And a large piece of that is really the equity base instead of compensation program under our TSRP, which is described in our proxy. And that is under accounting rules as a marked-to-market calculation. So that really depends upon where our total share (indiscernible) return performance against all the companies in the peer group stand at the end of the quarter, and then we'll determine whether or not there's an adjustment to that accrual either up or down at the end of the fourth quarter.

I get it. Finally, Rich, can you give us an actual headcount for the quarter, either -- any way that's the easiest for you, either total hourly for the Company, or maybe just for the Ludlum division? And what you expect kind of as a progression through 2005 on headcount?

That's a good question. That's something I don't have off the top of my head, other than round numbers of probably about -- in total at ATI, we have got just under 9000 employees worldwide. We are driving. We've got the taps that have been put in place under the new labor agreement. I think Pat's already commented on that. As we have said, looking at the 650 taps under the new Allegheny Ludlum agreement, 40 percent of those will have been accomplished by the end of this year. And we've got maybe about 75 percent of that done through the third quarter, with the rest happening here in the fourth quarter. And then, at the former J&L operations, or Midland and Louisville, there were 125 taps there. And most of those, the majority of those were put in place at the end of September. So in total, we will have as part of the taps, the cumulative taps program, we'll have about 400 heads out by the end of the year.

That's helpful. In terms of accruing the expense for those departed employees, is that an immediate change in your expense, or is there some carryover affect that might delay the phasing?

The impact of the taps and any other severance-related expenses were recorded in our second quarter. That was part of the net special charge in the second quarter.

Chris Olin, Longbow Research.

Most of my questions have been answered, but I wanted to ask on titanium. One of your key competitors continues to have issues with their labor, as well as some production limitations. Are you seeing any positive benefits from customers coming to (indiscernible) to assure supply in maybe the fourth quarter and '05, or was that a potential benefit in the previous quarter?

I think just the strength of the market, Chris, has benefited all titanium suppliers. I don't think -- we're not aggressively seeking anybody else's customers. One thing that I think is helpful with the titanium -- the strong market for the titanium products -- as we requote some of these longer-term arrangements onto the aerospace and power generation type of packages, we are able to package the titanium with the super Al Lloyd nickel products and create a very nice package for the customer and also for us. So it's our ability to produce all these products at Allvac and other portions of our companies allow us to package these together in a very competitive way, and produce a value package for the market that brings business to us.

Interesting. Also, can you give us a quick update on Uniti, the, what, VSMPO joint venture. How are the business conditions in that with that business? How has the market acceptance been? And also, have there been any problems with VSMPO's supply? I though I've heard some rumors that they were having some production issues.

The issue that we have is between the two partners. The market is robust. The market for petrochemical and corrosive applications, including everything from desalinization to highly acidic environments to petrochemical has been very, very strong. And when you look at the entire markets, including the recovery of the aerospace market, the two partners, VSMPO and ATI need to decide how many -- how much business that Uniti is going to take out of that entire market. So what we have today is the situation that we can sell everything that we can make. So the question is is the allocation of the raw material supply to the joint venture versus other applications between the partners within the company. So we have had a supply, a very tight supply on the titanium side, and we will meet those commitments that we've given to our customers and watch very carefully what we're committing in 2005.

So the aerospace business is just as strong as the non-aerospace titanium business today?

Yes. You know, if you look at the leadtimes, Chris, as I have read much of your reports -- and as you know, the longest leadtime item coming into the engine and airframe build is the titanium products. So if you believe the increased build rates moving into 2006, you can see that we're right at the beginning of that cycle for orders for the titanium product mix. So the titanium business recovery, the 2006 build rate is underway today.

Mark Parr, KeyBanc Capital Markets.

It's a good conference call. Thanks for all the disclosure. I was curious in looking at your stainless business, your flat-rolled business, could you give us a sense of what the apples-to-apples year-over-year volume comparison was for flat-rolled stainless in the third quarter?

I think we might have that someplace here. It's up considerably. Let's start there.

Mark, this is Rich. Are you talking about ATI's flat-rolled shipments?

Now that you have got the two organizations combined shipments for the third quarter of 170,000 tons, how does that compare to a theoretical or a pro forma combined shipment number for the third quarter of '03?

Including what J&L was doing?

Yes.

WE really don't have that information. The -- as 2003 progressed, obviously, as it was becoming closer to the end of the year and closer to the end of the third quarter, there were different operating approaches that were being taken at J&L. So we really don't have the historical J&L shipments right in front of us.

I think it's fair to say that when you look at the apparent domestic consumption statistics that are publicly available through SSI&A (ph), year-to-date, cold-rolled sheet and strip is up 12 percent. Stainless steel sheet and strip is up -- fair domestic consumption is up 12 percent through July. And annualized that would be -- the consumption annualized in 2004 would be about 1.8 million tons, which is very close to the historic high of about 1.9 million tons that I think was achieved in 2000.

What I was trying to get at was to see if the combined entities in the third quarter were growing faster or slower than the underlying total market. And I guess if we don't have the third quarter number for J&L, it's kind of hard to get into that. But that's something maybe I can try to dig into someplace else. One other question that I had, looking -- I wanted to say congratulations on your efforts to optimize customer mix and to be flexible and proactive in this very unusual alloy environment. But I did notice that at least on a revenue-per-ton basis sequentially, the third quarter appears to be a bit lower on a revenue-per-ton shipped than in the second quarter. I was wondering if that may be a shift in mix away from some of the flat-rolled titanium, or if there was perhaps some other mix issues associated with bringing on J&L business that contributed to that? If you could give some color on that I would appreciate it.

I think your second part of your answer to your question is the answer. The J&L business that we brought on, especially emission control, which is a lower-cost product in total, and less nickel and so on --

So that's -- J&L had a higher mix of 400 series?

Absolutely.

Congratulations on a solid quarter.

Naomi Dishens (ph), TCW.

I'd like to know at which level you would like to see operating margins in the next two years?

That's a very good question. We are improving operating margins on a significant basis as you go forward. I don't think I want to answer that question exactly on what our strategy is on operating margins. But the overall profitability of the Company needs to be at to return to capital cost, cost of new capital.

Mark Bishop (ph), The Boston Company.

I just have a few questions. Just along that same line, do you have any kind of targets for peak operating margins or EBITDA margins? Or can you put it in perspective historically? I know it's hard to look at the history because your business has changed a bit.

Mark, there's two things happening. One is that we are up 25 percent on the base price for standard products. Remember that we haven't had a full year impact of that, and we also had a full quarter of purchase accounting at the J&L business. So when we look at those products there, they're not approaching the historic highs of the stainless steel standard product business. All that said, when you look at our cost competitive path now for the commodity Midland smelt shop, which is specializing in the commodity side of our business, coupled with internal hot mill path and an automated finishing line that finishes those products, our cost structure is much lower. So they don't necessarily have to be at the historic levels to create the same margins that they once created at those levels, if you're following what I'm saying. So we have to see where those market prices settle out in the United States with the three remaining competitors, and that has to do with the demand for those products, and it will also have to do with the prices for those same products in Asia and in Europe. All that said though, because we have these assets in place now and this automated finishing line, and the virtual footprint that we're running here in the Western Pennsylvania area, we have a cost-competitive path as good as anyone's in the world.

I was just wondering what you would say your margins were historically at the peak on some basis that's a reasonable comparison with your go-forward business, and whether you think you can get there again or exceed that? What numbers are those?

I think our current flat-rolled product segment is running about 4 to 5 percent. We would certainly be -- 5.7, I guess, is the number. We need to get closer to 10.

10 percent what?

Return on sales.

What kind of return? Is that EBIT before pension and before corporate expense?

Yes. It's operating profit type of returns. The full-out cost of the business.

So you need to get to 10 percent? That's before pension and corporate expense?

Yes.

Is that as far as it got historically, or is that like an average that you need over the cycle?

I think it's been higher than that on a historic basis, but I'm not sure that the profitability levels would be any different.

What does that mean?

We have a lower-cost path.

Are you expecting 10 percent would be a median over the cycle, or 10 percent would be like the peak you might achieve and then it goes down again?

I think it's a target to achieve as the average over a cycle.

Target average. Okay, that's great. I'm getting to my main questions, which first of all on the J&L thing, you're talking about $200 million of synergies and savings. Does that start at operating profit of zero for J&L, or does J&L come in at a negative and then you add 200 million of synergy savings?

Mark, this is Rich Harshman. I don't think it makes sense to talk about J&L, because J&L doesn't exist anymore. Right? So what we have done is we've taken two of the substantial players in the U.S. market for flat-rolled stainless, J&L's operations and ours, combined them together. We have said that in total that gives us the capability of producing between 700 and 800,000 tons of flat-rolled products. Now that's more than commodity stainless steel. That's all the things that we make. And when you look at that business combined and you take the pre-existing separate cost structures and put them together, we have identified $200 million of synergies and cost savings in that combined business. So starting J&L at zero or a negative or whatever is really not relevant in terms of how we have viewed that equation.

Okay. But if you have the results of Allegheny to start with, now you acquire J&L which is great and you're going to take $200 million out, or in total add that to the returns. The thing is you started with Allegheny. Now you're adding J&L and you're adding these synergies. Does the J&L take away some of the 200, so that in total what does the proposition of adding J&L add potentially according to your plan to the EBIT line?

We had an 8-K filing where we provided the reconciliation of the J&L audit financial statements pre-acquisition, and provided relevant information in terms of taking J&L's stand-alone P&L and correlating that to the post-acquisition operation. So when you look at it that way, those audited financial statements showed J&L in 2003, I think, with a modest loss. Recognizing that that was in 2003 at the trough of the stainless steel market in the U.S. So, my point is that to look at the history even in the third or fourth quarter of J&L stand-alone operations and try to take that going forward, I don't know exactly what you are accomplishing, because the market conditions are different, pricing is different. Suffice it to say, I think when you look at 700 to 800,000 tons of stainless steel, what is public, obviously, is the historical operating performance over the past several years of Allegheny Ludlum, which is our flat-rolled products segment, or at least the vast majority of it. And a $200 million synergy, taking the cost structure out to produce 7 to 800,000 tons, is a significant reduction in cost when you combine it with price restoration actions and different market conditions. And that's really about as far as we can go because we haven't commented public on any other aspect of it.

It's great. I'm not -- I think it's all very positive. I'm not suggesting anything else. I'm just wondering when you talk about 200 million of savings, I'm not sure what exactly, what to plug into my model. And when you say well, so -- it sounded like you just said that J&L started at a modest loss, so it's relatively close to zero. So your operating -- your EBIT ought to benefit by more than $200 million from this J&L thing, because you're also going to -- in addition to the synergies and cost savings at J&L, you would get the benefit of the price improvement as it affects the J&L tonnage, or is that all included as part of the 200 million?

There's no price action or volume assumptions or revenue assumptions made in the 200 million. The 200 million -- we have disclosed publicly what the components of the $200 million are, and it's a result of the combination and the new collective bargaining agreement at both J&L -- at the J&L operations as well as Allegheny Ludlum's operations.

This is Danny. I'm afraid the call is getting long and we still have a few people in queue, so we would like to go on to the next person now. If you have any follow-up questions you can get back in the queue or we can talk later.

Alan Fournier (ph), Tenant (ph) Capital.

Two questions on the end markets. First, could you help me understand aerospace as it relates to overall sales, both in terms of the sales and profits? Have you provided that kind of a breakdown?

We can tell you that our aerospace business is our largest marketing segment. It's 18 to 20 percent of the entire company. It's a much larger portion of the business at our Allvac operations.

Is that revenues, that 20 percent?

Yes.

So should we assume profitability is significantly higher than that?

We can assume that it's one of our most profitable segments of operation. When we talk about aerospace, really it's being driven by aero engine mainly, and then secondly now by airframe.

How would you break that down between commercial and defense?

Mostly commercial. Maybe it's out of that number 25 percent defense, 75 percent commercial. But spare parts are kind of hard to put out across the board because, of course, our first tier suppliers to them can use many of these materials either way.

I see. So I would imagine demand here historically has responded to the customer environment with a lag?

I don't understand your question. Help me a little bit more on that.

Obviously, this market was very difficult after 9/11, and then improved. And now the build rate is improving with a lag.

What happens is that the material suppliers are on the front side of that build-up. So as we've talked about earlier in the call, if you are talking a titanium product it's probably a 14-month, 16-month leadtime getting the finished part to the end product to the aircraft. If you're talking specialty steels or products like that, the ordering would begin in about a 9 to 12-month period prior to the need. So when we're looking at 2005, when we're looking at fourth quarter in 2005, we're really talking about end build rates that are being reported for the 2006 and later cycles.

I'm trying to reconcile trends in commercial aerospace with an industry that is on the verge of bankruptcy.

Are you talking about the U.S. airlines?

Yes.

What we're talking about -- much of this demand that we're talking about are for carriers outside of the U.S. carriers. We're talking about demand for transatlantic, transpacific, foreign countries. We're talking about turning in aircraft, moving from older aircraft to commuter-type aircraft that are replacing some of the single (indiscernible) older single (indiscernible) planes that are flying. But the demand for aircraft is on a global basis, and frankly when you look at the low-cost carriers in the U.S. they are driving the demand in the domestic market today. And that would be year Jet Blues, your AirTran, your Southwest Airlines and other start-ups versus the mainline carriers? So you can't just look at mainline carriers and think that there's not the ability to move this forward. The aircraft also in Europe, you're talking about EasyJet, you're talking about Ryan growing faster than the older airlines there. But it's a global market. I don't think the two main airframe builders are counting on a recovery from domestic carriers, mainline domestic carriers.

Great. One other quick question. In terms of service centers, what percentage of your overall revenue now goes to service centers?

I would say that on the commodity side of our business it's the majority user, but basically it's probably 30 percent of our business, 25 to 30 percent of the business.

How would you characterize service center inventory levels at this point?

I think what we're going to find is service centers doing what they need to do to -- for their own business purposes. That may be reflected in some inventory balancing for the fourth quarter, in terms of making sure that the turns that they need are there. And the turns are measured in dollars and cash flow. But we are expecting once that adjustment is over to come back very strong.

Aldo Mazzaferro.

Pat, sorry about another follow-up. I was just wondering about your views on the stainless pricing in China. I know you probably are a buyer in that region, and I'm wondering what you're seeing recently in the stainless price there.

The stainless price is certainly lower than the U.S. or in Europe. Remember that the net domestic market in China is still a major importer of stainless products. So how we are participating in our particular business is in the high end of that product market, so it's really quite a different market for us. We have not experienced any price declines, anything other than what we would sell in the U.S. On the other hand though, those prices are drifting up. They are moving up on a gradual basis as this demand is -- and the world price is affecting the global markets across the board. If you take a look at the three markets, the U.S. market, the European market are very similar; the Chinese market is somewhat down from that maybe 5 to 8 percent.

And I know there's some capacity scheduled there. Is that a near-term event that's something that they're offering you tonnage at this point from the new capacity, or is it still pretty far out?

I don't understand. Somebody offering us capacity? I don't understand what you mean.

The Chinese are planning to add, I think, about 3 million tons of stainless capacity, but I know it's a pretty long-term proposition. I'm wondering if that's near-term enough that you are entertaining any offers of contract purchases from those mills or anything?

No. Actually, we look at that market and don't expect that market to be in balance until the end of 2007 into 2008. And the question is whether all of the planned capacity will come on as exactly scheduled or be delayed or come on at different times. My own personal opinion is that capacity comes on to meet the domestic demand in China.

Thank you, ladies and gentlemen. That just concluded our Q&A session. I'd like to turn it over to our speakers for closing remarks.

Just let me say thanks to everyone for joining us today. We really appreciate your interest in ATI. We appreciate your very good questions today. We are happy with the third quarter. We are on track. We're moving on our objective of transitioning the Company and optimistic about its future, especially moving into next year. Thanks so much for being with us.

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect.