ATI Inc (ATI) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the 2005 third quarter Allegheny Technologies earnings conference call. My name is Minoshia, and I will be your coordinator for today. [OPERATOR INSTRUCTIONS.] I would now like to turn the presentation over to your host for today's call, Mr. Dan Greenfield, Director of Investor Relations. Sir, you may proceed.

Thank you, Minoshia, and good afternoon, and welcome to Allegheny Technologies' earnings conference call for the third quarter 2005. This conference call is being broadcast live on our website at alleghenytechnologies.com and 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, and welcome, everyone. I'm pleased to report today on the progress, results, and rate of changes at ATI. We will report on a excellent third quarter and give some guidance for continued performance in the fourth quarter. You will see that our sights are really set on ATI's future growth in 2006 and beyond. Year to date 2005 we've grown sales 35%, compared to the first nine months of 2004, with revenues of $2.6 billion, and an operating profit approaching 390 million.

What's driving this performance? First of all, revenues from the aerospace market accounted for 24% of total sales, a $300 million increase over the same period last year. Chemical process industry, as well as oil and gas revenues grew to 16% of total sales, a $200 million increase over the first nine months of 2004. Revenues from the electrical energy market, that is, power gen and distribution, have grown to 10% of total sales, a more than $100 million increase over the same period last year. These markets now represent 50% of ATI's total revenue. ATI's cost savings stand at $100 million year-to-date, achieving our 2005 annual goal in the first nine months.

And, lastly, the High Performance and Engineered segments recorded all-time record operating profits, while the Flat-Rolled Products segment achieved a respectable 7.6% return on sales in the third quarter in a difficult stainless commodity market. We are seeing a global infrastructure build and rebuild that require our technology and our products. And we are positioning ATI through cost reduction and new investments in R&D, products, and facilities to maximize our opportunities in these markets over the next several years. We believe the aerospace, chemical processing, oil and gas, and electrical energy markets, coupled with our current capabilities and recently-announced expansion products -- projects bring extraordinary global growth opportunities to ATI Companies in 2006 and beyond.

Now turning to the third quarter, our results demonstrated both growth and the transformation of ATI. First, our Flat-Rolled Products segment recorded a operating profit of $33 million, even with commodity shipments at the lowest level since the first quarter of 2004. Our high-value product mix continued to be strong. This quarter demonstrates that ATI can be profitable in this segment, even in a difficult commodity stainless environment. Second, our operating profit in our High Performance Metals segment was over 27% of sales, a new record in performance. And third, our Engineered Products segment had another strong quarter. Sales were near record levels set during the second quarter of 2005, and operating profits set a new record high at nearly 13% of sales.

Bottom-line results for the third quarter -- sales, 862 million; net income, 88 million, or $0.88 a share; operating profit, 134 million; segment operating profit nearly 16% of sales; net debt to total capitalization improved to 21%; cash flow from operations at $135 million; and cash on hand at the end of the quarter, 372 million.

Now some of the significant milestones in this journey. Our High Performance segment continues to set new records for sales, operating profit, and operating margins as a percent of sales. We are still in the early stages of what appears to be a strong aerospace cycle. Keep in mind, we are shipping our materials for the current engine and airplane build rate, as well as engine spare parts. Very little of our titanium alloys, nickel-based superalloys, or specialty alloys currently being shipped are destined for new models, such as the Airbus A380 and 350 or the Boeing 787. So we are optimistic about continuing growth prospects for our High Performance Metals segment, as the new airplane builds gain traction, which utilize more of our materials.

In addition we are benefiting from an improved productively and throughput in our newly upgraded and ultra-modern Richburg, South Carolina long products mill. And through new capital investments, and the ATI business system efforts, we have significantly improved capacity, as well as productivity, at our facilities for titanium and nickel-based superalloy products. We are now well underway in expanding our Oregon titanium sponge facility, with capacity coming on stream beginning in the second quarter of 2006.

Lastly, our exotic metals business turned in another good quarter. Demand was strong from government, aerospace, chemical processing markets on a global basis. I'm enthusiastic and excited about the further ramping up of our High Performance Metals segment in 2006, with full effect in 2007. Bottom line, we're early in this segment's growth and profit potential.

Now let's turn to Flat-Rolled Products. I'm also pleased with the performance of the Flat-Rolled Products group. Why would I say that? Third quarter operating profit was $33 million, on sales of 439 million. This demonstrates the benefits of the J&L consolidation and the transformation of our stainless steel business. Bottom line, product mix has improved, cost structure is better.

Taking a closer look, operating margins in the Flat-Rolled Products segment were just under 8% of sales. As we have said, our goal is to achieve operating margin in the Flat-Rolled Products segment in the range of 8 to 12% of sales. Considering the third quarter's difficult commodity stainless market and the segment's higher energy costs of $8 million, net of the benefits of our natural gas hedges, this quarter's performance is acceptable. Remember, when our stainless steel business used to be in the -- remember where our stainless steel business used to be in periods of soft demand. ATI, Allegheny Ludlum now has a solid future, with plenty of upside based on an 8% return on sales in the low cycle.

Further, in September we announced an energy component to our Flat-Rolled Products surcharge mechanism that covers natural gas. This energy surcharge goes into effect with shipments beginning November 1st, 2005, and it is -- and it is intended to protect our earnings from rising natural gas costs. Commodity flat-rolled shipments were less than the second quarter, due to ongoing service center and supply chain inventory management actions.

Approximately 10% of ATI's sales in the third quarter were commodity stainless steel coil products to service centers. We consider commodity stainless as a base load. We can now compete with anybody and make money in commodity products. July marked the low point in our commodities stainless shipments. August and September were better. October shipments order entry are even better.

The U.S. stainless markets are fairly good. We are seeing increased orders, as service centers continue to bring their inventories better in line with demand. Our high-value Flat-Rolled Product mix was particularly strong, due to demand for our flat-rolled nickel-based alloys, specialty stainless steels, and titanium products.

A few points on the rapid change in markets from our high-value Flat-Rolled Products during the first nine months. The chemical process industry and oil and gas grew to 19% of Flat-Rolled sales, a $160 million increase over the same period last year. Electrical energy has grown to 14% of Flat-Rolled sales, a $90 million increase over the third quarter 2004. And aerospace accounted for 5% of Flat-Rolled sales, more than double last year. The average price for our high-value Flat-Rolled Products was approximately $6,100 a ton in the third quarter, or about $3.05 a pound.

Year to date we have shipped over 33 million pounds of just flat-rolled product nickel-based alloys and specialty stainless steels, and over 3 million pounds of flat-rolled titanium products. This does not include the shipments from our Uniti titanium joint venture, which, by itself, is now one of the world's largest producers of industrial titanium products. Add these flat rolls, nickel alloy, and titanium products shipments to our High Performance Metals segment and you can see that we are a big supplier of high-value products. In fact, our current estimate is that ATI Companies, plus our JV Company, called Uniti could represent as much as 30% of the worldwide titanium mill products produced in 2005.

Even in a period of strong earnings growth, we remain focused -- excuse me. Sorry. Turning to our -- sorry, missed a section here. Turning to our Engineered Products segment, we're near the record levels set in the fourth -- in the second quarter of 2005. But operating profits hit a new all-time high. Demand from -- was strong from our oil and gas drilling, transportation, construction and mining, aerospace, and electrical energy markets.

A little bit on our ATI business system efforts. We recorded further positive results. Employees throughout the Company are continuing to improve the profitability of ATI in an exceptional manner. In safety, ATI employees achieved a lost time case rate of 0.69 for 200,000 hours worked, a 40% improvement over the previous three-year base comparison.

Even in an period of strong earnings growth, we remain focused on cost reductions. We have already achieved $100 million of cost reductions, before the effects of inflation in the first nine months of 2005. So we have, again, exceeded our annual cost reduction target of $100 million. Managed working capital as a percent of sales in the third quarter was an efficient 31%, demonstrating our flow of material through operations.

Now, looking at the fourth quarter, demand for our High Performance Metals segments' products is expected to remain robust, and demand for our Engineered Products is expected to remain strong. In our Flat-Rolled Products segment, we continue -- we see continued strength in demand for our high-value products. In addition, we are seeing increased orders, as service centers continue to bring their inventories better in line with demand. We believe our fourth quarter 2005 operating profit will be similar to the third quarter 2005 performance, and we expect good cash flow from operations.

We are considering making a voluntary cash contribution to our U.S. defined pension benefit plan of at least $75 million. We remain confident about the prospects for ATI and can now pick up the pace in building the foundation for further growth.

In our direction and strategy in going forward, we are committed to grow the high values -- high-value metals business. For nine months 2005, sales of our high-performance high-value products reached 66% of ATI's sales, compared to 62% of sales during the first nine months of 2004. That's an increase of more than $500 million.

We are also committed to continue to grow as an international and a global specialty metals Company. ATI sales outside the United States for the nine months 2005 reached nearly 640 million, or 24% of sales. Of that number, 40% of our sales outside the U.S. are Flat-Rolled Products. We have an extensive global sales and distribution system. We plan to expand this global approach, and expect to continue to see strong demand for our high-value specialty products from the Asian and European markets. Looking ahead, we believe that ATI products are a necessary element and contribute to building the new economies of the world and modernizing the old ones.

In summary, again, we are on track, ahead of schedule, committed, technologically focused on achieving our strategy and growth objectives in an systematic, effective, profitable, and rapid way. The growth potential and transformation of ATI were demonstrated in the third quarter 2005, are on a rapid rate of change. ATI is recording its best year in history, and is now generating the cash for profitable growth. This is enabling a self-funded growth strategy for 2006 and beyond, with a disciplined plan and vision to build the world's best specialty metals Company.

This concludes my comments for this meeting. And at this point, we will open the call for questions. Operator, please open the lines.

Thank you, sir. [OPERATOR INSTRUCTIONS.] Your first question comes from the line of Tony Rizzuto of Bear, Stearns. Sir, you may proceed.

Hi. Thanks, very much. Congratulations on the excellent strides the Company has made.

Thanks, Tony.

You're welcome, Pat. Just got a couple questions, here. First of all, just regarding the contracts in the HPM segment, and generally, could you give us a idea what percentage of your contracts are being repriced for calendar '06? And if there's anyway you can kind of guide us a level of magnitude? That type of thing would be helpful. And, also, are you able to pass through these high raw materials and energy via surcharges and/or index price mechanisms on these contracts?

Yes. The answer is yes and yes, Tony. Let's, first of all, go back to our strategy in filling our 2006 schedules in the High Performance Metals and high-value products area. First of all, the schedules were open to those customers, those long-term customers and committed customers of ours that wanted a long-term arrangement with us, meaning that they would be willing to step up to a longer-term contract -- longer than one year -- and also willing to step up to the issues that we deal with in inflation and deal with in the uncertainties of raw materials. So the first schedules were opened to contracts that would average about three years. The second opening of the schedules were to those customers that wanted an annual contract to us -- with us. And those schedules were opened under the same circumstances.

We're currently filling the balance of the schedules with order business. And those schedules will easily fill to 85% of capacity in the next few weeks. So we are protected with raw materials, surcharges, inflation mechanisms. We're protecting pricing in longer-term arrangements, with those customers that we wanted to protect from a supply standpoint. And we also are continuing our program of hedging natural gas, and, of course, on the flat-rolled side, we have instituted a surcharge for natural gas in those products today, beginning November 1.

Okay. Excellent. And I also noticed that, obviously, your cost reduction goals, that you've attained your 2005 goal already through nine months. Do you have an update for us on that? And also, will we see a similar initiative for 2006?

Well, we're going to have a similar initiative in 2006, because I think part of a good Company is continuing their focus on cost reduction and efficiency, even in these markets where we have am excelling market to buy our products. I would expect the fourth quarter should be, I think, what I would say, I'd be disappointed if the fourth quarter doesn't average the first three quarters.

Okay. And just one question on the EPS guidance for the fourth quarter being similar. You, obviously, had a little bit of a benefit in there from a tax rate standpoint. What tax rate assumption should we be using in the fourth quarter?

I think we've got some issues that we need to deal with and a lot of things around tax rates. I don't really want to comment exactly when we bridge that gap. But let me just say something about the fourth quarter and our projection for the fourth quarter. First of all, the fourth quarter does have in it the average projections for LIFO charges. You can take the first three quarters and for projecting LIFO, you'll find that we have a LIFO projection charge of about $15 million in the fourth quarter due to titanium scrap prices and tungsten APT kind of issues. It is certainly not driven by the nickel side. So people are adding to our fourth quarter a LIFO pickup, we are not projecting that.

Okay.

Okay? So, also, in that quarter we have less working days than we do in the third quarter, with the holidays and -- over the Thanksgiving period and the Christmas period. We have already said that in the third quarter, we had very good, strong performance, strong bookings for our high-value products. And we would think that that's going to happen in the fourth quarter. In fact, they're booked into the fourth quarter. So the pickup comes in commodity products, if you're talking stainless.

I see.

And you can -- remember we said, we're only, today, getting 10% of our total revenue from commodity coil in the distribution market. So if you wanted to project what you think that profit will be to us as those markets recover, go ahead.

Okay.

So that's why we have a similar projection into the fourth quarter. Make sense?

All right. I appreciate that. I'm going to go back in queue, then. I'm sure there are a lot of other questions.

I think we should -- we should probably let Rich talk a little bit about this tax issue that we're dealing with.

I think that would be helpful.

Yes, hi, Tony. As we've said in our news release, we talked about the valuation allowance, and our analysis that we will undertake in the fourth quarter dealing with the valuation allowance that remains at that point in time. So I think it's premature for us to discuss that issue. But setting that aside, if you just take the year-to-date tax provision through three quarters, which is $4 million, in accordance with GAAP, basically, you can conclude that that averages a little over $1 million a quarter, and that, on a normalized basis, would be approximately the normal -- the tax provision that we would be expecting in the fourth quarter, setting aside the valuation allowance issue.

All right. I guess it would be ultraconservative to use a full tax rate in '06, then, if we're thinking about it from that regard, just a little bit sticky in trying to -- ?

Well, we have said in prior calls that, once again, setting aside the valuation allowance issue, which is a more complex issue, but setting that aside, we would expect in 2006 an effective tax rate in the range of between 36 and 37%.

Okay. That's --

So that is what we have said before.

All right. Great. Thanks very much, Rich.

Thanks, Tony.

Thanks, Pat.

And your next question comes from the line of Michael Gambardella of JPMorgan. You may proceed.

Yes, good afternoon.

Hi, Mike.

Hi. I have a question going back to your contracts that are coming up at the end of this year. Where do you see the most upside potential in terms of product category or end market for new contracts? This year, earlier in the year, it was aerospace. Where do you think the most potential is for you for '06?

I think the aerospace business is certainly the major market segment that's driving, but it does flow into some of the other market segments, including oil and gas, chemical processing. In fact, I think suppliers of high-value materials, especially in the titanium side of the business, and also in the high-nickel-based corrosion-resistant stainless side of the business have great opportunities to do project work on a global basis. And it's really a matter of matching your capabilities, delivery schedules, and prices with the final need of the market. There's just -- in these kind of products, beginning with titanium and moving through the high-value metals products, there's just a lot of demand out there that is being sorted through. And I think customers are looking for exactly where they're going to get the materials, when they're going to be delivered, and in what form, including substitution.

So these are the areas. It's the markets that we talked about. It's the aerospace market, oil and gas, chemical processing. And don't discount the electrical energy side of the business today, especially in distribution, or, in our case, grain-oriented silicon.

Okay. And you've done a great job at deleveraging the balance sheet. I think, when I looked at the numbers this morning, it looked like in the last five quarters you've taken down net debt by about 63%, I think it was. Can you go through the priorities for cash going forward? And, also, if you could talk about, maybe, working capital issues going forward and how they affect cash flow?

I think Rich and I will balance this one together. But let me just first of all say that when we look at the working capital, I am hoping that we have now funded this business at the levels that we need to be at for working capital. The only other major thing we're looking at in working capital is as we grow the titanium business and bring back the sponge production beginning in the second quarter of 2006, we will have some -- obviously, some materials going into that new -- that new production. As we begin to bring on the new capital projects, moving forward, the cash that we put into that operation will be more of a offset, much more of a offset with the new revenues and new business that we will be shipping from those capacities.

So this a double answer to your question. One is we hope that there's no major movement in working capital other than our planned sponge plant. Two, we have already announced $130 million of new capital plans beginning -- in fact, they're underway now and moving into 2006. We will spend somewhere in the range of 100 million this year, and with 130 million already announced for projects in 2006 to be effective in 2007, you can see a expanded use of cash on facilities and new capital going forward. We've already also said that we plan to put at least a $75 million contribution into our pension fund during the fourth quarter.

And with that, Rich, if you have anything to add?

Yes. I think the only other thing, Mike, is, as you think about moving forward, we will eventually fully realize our NOL carry forward and become a taxpayer. And, obviously, as you look at 2006, we expect that we will be a taxpayer in 2006. So that's a use of cash that we haven't had to deal with here in the past couple years, but that's a good thing. And I think the rest of it is, as we continue to -- we're very confident in terms of our ability to generate very good, positive cash flow going forward. And it then becomes just a prioritization in terms of what creates the greatest shareholder value over the long-term.

Okay. Thank you, very much.

Thanks, Mike.

Your next question comes from the line of John Tumazos of Prudential. You may proceed.

Congratulations on the tremendous results.

Hey, John, thanks. Appreciate you sharing that.

I was looking at that $220.5 million of non-cash working capital consumption of cash that, I guess, kept your cash balances from being 600 million on September 30th. And I know that must make you mad as [expletive].

Well --

And I also noticed that nickel was $5.26 yesterday.

Yes.

So I should, I guess, assume that that non-cash working capital consumption at year end is closer to 100 million than 220 because you got to put so much money into titanium scrap and tungsten? And it'd be near 0, given how nickel's just gone down and down and down?

Well, we're projecting, of course, LIFO for the end of the year. So, we certainly are considering what's going on in the nickel market. But it will be our average for September, October, November, not necessarily exactly the December numbers on the nickel side. So you can project where that might have been and what our projection was prior to that. So that's the one side.

The other side is that we continue to see titanium prices as high as $12 a pound for scrap, and we continue to spend in the range of between 280 and $300 a ton for APT on the tungsten side, which is a major increase for our engineered products business. We've been able to recover those kinds of prices in the marketplace, but we do have LIFO reserve charges to take as we see those in our inventory. Your point is well taken, that if, I'm correct, that we will eventually, now at the end of the year, these things stabilize, we can take our year-to-date 195 plus the other 220 and look at about a $350 million operations cash flow, excluding what's gone into working capital from operations. And if those things balance out, you start to get the flavor for the potential cash generation of the business next year.

If I can ask another question? In the Inco minutiae yesterday, they seemed to sell nickel for $0.17 under the LME in the third quarter. And, of course, they said that was just due to some minor timing issues, of course, they don't discount. But I know your Company has a great tradition of buying scrap wisely. As Inco expands Boise's bay output, they're going to buy less ore from these little independent mines in Canada and Australia to run through their metallurgical complex. Have you looked at buying raw ore from isolated mines and then having those big nickel companies toll process it for you? You know how sometimes steel distributors, when steel's $100 a ton for slabs and $200 for hot rolled, will ask the mills to toll roll it for $30 and get it even cheaper. I know you're very creative with materials.

We've been creative with scrap and how we buy and how we mix in our new electric arc furnaces and all that. We really haven't considered moving upstream into the raw materials purchases. We have good suppliers. And as long as we have a surcharge mechanism going out there, we haven't gotten into that side of the risk equation. Remember, also, that we're -- we need a base load, as you understand very well, John, in our melt shops and in our hot mill.

But we're not out chasing tons. We're chasing that base load that we can find it at one- and two-tier kind of people, with our position being a secondary position to, maybe, their primary producer. Once we have that base load, we're chasing the higher-value products on a global basis. And remember, going back to the amount of revenue that we're now bringing in from overseas, over $640 millions, or 40% of that is coming out of Flat-Rolled Products.

So we are producing a lot of products on a global basis today that are well-priced and paying for themselves. And we hope to continue to grow that, become a larger global presence and concentrate on the high-value products that can pay us. So we haven't really moved upstream.

If I can ask one more question? When you buy prime nickel from one of those nickel companies, what's the usual discount to LME that you get?

Don't want to comment today on that.

Thank you.

Okay. Thanks, John.

Minoshia, could we have the next question, please? Hello?

Your next question comes from John Hill of Citigroup. Sir, you may proceed.

Good afternoon, everyone. And congratulations on a great result.

Hey, John, how are you?

Just fine, thank you. A couple quick questions on the High Performance Metals pricing arena, as Mr. Tumazos has pointed out, nickel price has fallen during the quarter. Yet, your nickel realization is up from 11.30 to 11.71. Was there a base increase in there?

Sure. Absolutely. And the other thing that we do, of course, is in our high-value products, a lot of times it's on a longer term LTA. It's up to the customer whether they would allow us, or elect for us, to hedge the nickel at a particular time in the marketplace, and those prices get fixed into the charge, or they can go with the price in effect at time of shipment, where we're charging the prices for the raw materials when the product is actually made. So the increases that you're seeing with our margin sales at 27% today, 25% the quarter before, and my earlier comments on longer-term contracts and how we feel 2006 and beyond, yes, base prices are going up.

Right. And, then, if we turn to the exotic metals prices going 38 to 43, are there any unusually, sort of, lumpy contracts, deliveries, or mix issues we need to be aware of in there? Or is that pretty transparent?

It's really just how the quarter came out with the mix that we were running. Our pricing there has been strong and continues to be strong. But as we move from some of these exotic materials, it's different to run a zirconium than maybe a titanium job or hafnium kind of shipment, or a combination of those. So it's just simply a mix issue, but it really won't be significant.

Right. And, then, just a final question. Coming back to our friendly, local Canadian nickel miners that were mentioned. A company yesterday stopped short, and just barely short of pounding the table, for an inflexion in nickel markets. Their view was that, essentially, global stainless steel inventory adjustment was in the process of dramatically overshooting to the down side, and that melt shop production was going to come up. That also seemingly echoed by an data point out of the International Nickel Study Group this morning. Is that what you're seeing as well? Would you validate that view? Or do you have a different perspective?

I would -- I would say that we're going to follow a pattern very -- I think stainless will follow a pattern very similar to carbon, where you might have seen some over reduction -- over inventorying and then a reduction and then moving too far and then coming back. I think, personally, my projection is that we'll see a strong recovery in stainless usage in the first, second quarter of next year.

Great. Thank you, very much.

Your next question comes from Scott Bloomingthal of Emerald Advisors. You may proceed.

Thank you for a terrific quarter.

Hey, Scott. How are you?

Fine. Thank you. Pat, could you talk a little bit about capacity utilization? And, also, with spot and long-term contracts and orders coming in, how you kind of balance this -- we're well schooled in the flexibility of ATI productive assets. Can you kind of tell us how you're balancing that? We understand that you're trying to move toward a high-value product and kind of away from the flat-rolled. But since we have contracts and orders, how's that all working through?

Well, let me just -- let me just say this, that we're running full out in our melt furnaces in the High Performance Metals portion of the business. And you can see the revenue's well over $300 million for the quarter. And you can kind of multiply that times four when you're looking forward. And you can see that that business is somewhere now between 1.2 billion and $1.5 billion.

And, so, we're running full out, with new equipment coming on stream in 2006. So we're making, and trying to make every pound that we can make. And at the same time, I'm happy to report that our reliability and our performance is good in that side of the business. We've had an exceptionally good performance out of our Allvac units. And I'm very proud of what they've been able to do in servicing the market, servicing their customers. They're a great supplier.

When we come to the Flat-Rolled side of the business, we're now running two separate melt shops, one is geared at many times to the specialty products that we've talked about. And the other is geared to the commodity products that we've talked about. So we also have seen a great increase in our electrical steel silicon business. So we're able to operate schedules that appear to be effective to us, appear to help us with avoiding some of the premium rates on electricity and still getting the tonnage we want without too much of a problem in terms of absorption. So I give a lot of credit to the creativity of the Allegheny Technologies Ludlum schedulers and production people to balance these schedules, move the products to the right places and achieve an efficient operation.

Fair enough. Thank you.

Thanks.

Your next question comes from Robert LaGaipa of CIBC World Markets. Sir, you may proceed.

Thank you. Good afternoon.

Hi, Bob.

Just had a few questions. One time, maybe if you could just help us with the Flat-Rolled division. I mean, we're all aware, I think, of the inventory overhang the last couple quarters. Looking at it sequentially, in terms of the volume declines, 14% decline the second quarter, 14% decline the third quarter. And I was hoping you might be able to provide us a little color as to whether this inventory overhang is completed, kind of where we stand there? Because, even if we look at the value-added products, and I recognize most of the decline's been on the commodity end.

Right.

But even on the value-added part of that business, it was 11% sequential decline the second quarter, 5% in the third quarter. Is that something where, you're just -- related to your price decoupling strategy and, kind of, focusing in on the most profitable products? Is it partly due to that? Is it related to the market? And I was just curious as to what your volume expectations are moving into next quarter?

Well, okay. Very good. We are out on the high-value products, chasing those products under a strategic renewal process in that business that best fit us and best fit our equipment and give us the most contribution margin that we can make. As we do that, we continue to change that mix. And I especially noted in my comments that we produce 3 million pounds of our titanium in our Flat-Rolled Products business. These are lighter gauges, this is titanium sheet that takes rolling time in the business. I would say that it's our choice, maybe, to produce a few less tons in some of those products and select the mix that we want, although I think that the standard precision strip mix we've elected to back off of a little bit with the automotive business when it went through that cycle during the third quarter, picking up again now.

On the commodities side, we probably could have made more. We were not chasing tons, and we were not in the business of lowering our prices. So we did let some tons go once we got to the base loads that we thought were necessary for the business. I think, as the market improves, I think we did say that July was certainly the bottom of that market, August and September improving, and we're more encouraged with the October time frames. But I really believe that we will continue to see a gradual improvement and then back to more normal levels, maybe even some growth. And if anybody has overadjusted to inventories, and with the nickel prices coming down, and we start to see people believing that nickel has leveled out at some place and ready to restock or divide their commitments in 2006, we're going to see those -- that commodity side of the business pick up, and hopefully at the revenues and contribution margins that we would like to see.

Terrific. The follow-up question, if I could, just on the High Performance Metals business. In light of these new projects, the titanium expansion, the nickel-based alloy expansion, I was hoping -- and I recognize this is early in the process -- but maybe if you can kind of give us an update as to where you stand with regard to these upgrades? And I guess a related question to that is, from a margin perspective, I'm not sure that -- you've thought in the past that, maybe, you can get to 27% operating margins, if we look last year, a couple years ago, whether that was possible or not. And just looking longer term, do these upgrades change your perspective on what margin levels might be achievable in this business?

Well, I think I kind of alluded to earlier in my comments that I think the levels we have today or better are in our future now. And those are secured in contracts and other mechanisms that we have. The expansion of our titanium sponge facility, or re-start and modernization of that facility in Albany, Oregon is going quite well. We would expect that we would begin do bring furnaces online toward the end of the first quarter and ramping up throughout the second quarter with full production of that segment of the plant that we announced, the 7.5 million pounds in full production in the second half of 2006.

In conjunction with that same announcement of expansion we have placed several pieces of equipment on order, and at the same time, we said we would expand our titanium melting facilities in Bakers, North Carolina. That ground is broken. The building is under construction. The equipment's on order. And we hope to start seeing some benefits of that estimated $300 million increase in revenue in 2007, beginning in the second half of next year.

Terrific. And if I can just sneak one last one in, and this one's a quick one. In light of Boeing's announcement today, talking about how they -- because of the strike, they weren't able to deliver 30 planes, they didn't change their forecast moving forward, did you see any effects of that in terms of your production levels? And I recognize you have some significant visible and lead time, so I'm not sure that you would. But I was just curious as to if you saw any effects of that this year.

I'm just going to give you a couple comments from major customers and first-tier suppliers and so forth. This is a chance to catch up. This is a chance that we can get our inventories in better shape for these build rates. This is a chance to prepare for the 2006 build rates. None of our customers, including any of the OEM's or any first-tier customers at all, slowed up any material that we were producing during the Boeing strike. And I don't see that impacting our shipments in the fourth quarter or beyond.

Terrific. Thank you, very much. Good quarter. Thanks, Pat.

Thank you.

Your next question comes from Chris Olin of Longbow Research.

Afternoon.

Hi, Chris.

Hey, I was just curious. I'm a little bit surprised by the level of -- or the pricing for titanium scrap at this point in the cycle. When do you expect to see some type of benefit from, I guess, more scrap supply coming back in from the airline producers that will eventually help the pricing environment for you?

I was hoping you'd tell me. But I think that we have such a rapid growth in that business, and it's not just the -- just from the aerospace or the aerotransportation engines or airframe kind of the business, but the world infrastructure builds are such today that, as we see the metals being made available, if you have melting capacity and fabricating capacity to put a project into the schedule, it seems to get filled, Chris. So I really don't know.

I think, for us, the good news is that, as people need the materials for various kinds of projects, and, also, their ongoing needs, we've been able to find a way to satisfy that need at an acceptable price to the end customer. And we have bought scrap in the open market and made other arrangements to increase our production. And it isn't inexpensive these days.

What about on the sponge side? Do you have any thoughts on sponge costs for next year? Will they be up significantly?

I think it depends on what kind of commercial arrangements that you've made in the past and your arrangements with your supply base. But I definitely think that if you're buying sponge on an spot market basis, or if you're incrementally increasing your sponge usage, you're going to pay the current market price for that. I think our own facility coming online will be right at that competitive level.

Is there still a lot of demand from the steel industry for a lot of the titanium units?

Yes. I think as the business picks back up, you're going to see that side, again, come back into usage. I think those suppliers would prefer to sell it differently, but that's how it is.

Thanks a lot, Pat.

Thanks, Chris.

Your next question comes from the line of Daniel Roling of Merrill Lynch. You may proceed. Mr. Roling, if you would like to ask a question, please press star, 1. Okay. [OPERATOR INSTRUCTIONS.] Gentlemen, you have no further questions at this time.

Okay. Well, it's been great to be with you. I think you can all see the excitement that we have here at ATI about the future potential of the Company, plans that we put in place to grow the Company, the equipment that we're bringing online, the markets that we're concentrating on, the focus to those few specific markets that are really growing in the world today, and our nice fit with those. So I'd like to thank everybody for joining us today and thank you for your continuing interest in ATI.

Looks like we have one additional question.

Minoshia, is there somebody in the queue now who maybe wanted to ask another question?

Yes, sir. We have Alex Latzer of Merrill Lynch.

Thank you.

Actually, Pat, it's Dan.

Okay. Dan, we lost you. We didn't know where you were, but we're glad to talk with you.

Dumb me hit the speaker button instead of the mute and disconnected myself. We heard all this good demand story for aerospace and the outlook for titanium. And it's all great. But the question I have is -- Have we seen any significant pickup in industrial gas turbines? Because we haven't heard much about that lately. And, also, what's the outlook for scrubbers? We hear about all the scrubbers being built. But are you seeing any demand or any pickup in order from the utilities?

Certainly the oil and gas business and the electrical energy business is picking up. We're now at 10% of our total sales. A lot of that for the -- is coming into the scrubbers. We also have, of course, in that same segment, wind energy and natural gas projects that are coming on stream. I don't really know that we -- I don't think we could really tell you that we've seen a major pickup in land-based turbines for our business, other than the fact that it's better than it was, and we would be hoping that this is going to come on stream a little bit heavier from a standpoint of a major maintenance market.

I'm not sure how many people are putting land-based turbines in when gas is under question. So we haven't seen a great drive there. But I do know that those build rates of back in the 1999, 2000, even into 2001 time frames, you run those turbines heavy for 60,000-plus hours, you're going to do some rebuild on them.

And when should we start seeing that? Next year, maybe?

I think so. I think so.

Thank you for getting me back in.

Thanks, Dan. I guess we have two more questions.

Yes, sir. You have a follow-up question from John Tumazos.

You said something in your prepared remarks about energy escalation as it relates to gas hedges. And I'm not sure I got it right. How much was the benefit or cost avoided or profit from the gas hedges in the third quarter? And could you review the amount hedged and the average cost for the subsequent periods?

Well, let me just say this, John. We've had a strategy in place to come into an quarter at least 80% hedged. And as you're hedging, of course, under these markets, the price that you're getting is under is being laid in as you go. We have said that third quarter costs of $8 million more than the same quarter last year.

Costs were more?

Cost us more, net-net, $8 million. So we have seen that. The -- I think the good news for our major gas consuming Flat-Rolled Products business is that we do have a surcharge in place beginning November 1st that will be a part of our surcharge mechanism and normal pricing. Many other areas that we have -- we've had gas supplies at prices that we're also surcharging out in the form of either a base price increase or in inflation.

Let me ask this a different way, maybe you'll answer it this way. Did the profit on your gas hedges contribute to the above-expectation third quarter that you revised upward in mid-September? And is the absence of that profit part of the reason why you're only suggesting a flat fourth quarter, even though nickel's fallen out of bed for a month or two you benefit from that?

I'm going to let Rich answer your question.

Yes, John, I would say that the answer to the two questions on the third and the fourth quarter are, no. We -- our strategy on natural gas hedging has been in place for at least three years. We try to enter a quarter, as Pat said, 80% of our requirements hedged. That would be done on a dollar-cost averaging basis over the prior three quarters. So we have a fairly good idea.

And we do not disclose what the real -- what the impact of that is or where we're hedged at. So -- and I don't think we want to do that. But, obviously, when you look, certainly post-hurricanes, where natural gas is at any point on the futures curve, you can't hedge below 11 or $12. So that's really not a very cost-efficient place to hedge. But it did not have anything to do, really, with our pre-announcement or our guidance as we look at the fourth quarter.

Okay. Well, again, maybe we'll try to wrap this up one more time. Thanks, again, for being with us. We are excited and enthusiastic about the prospects of the Company. We're enthusiastic about the markets and the customers we're serving. The strategies are on track, on -- ahead of schedule, and are focused to the technology of the Company. So, again, we thank you for joining us today and for your continuing interest in the ATI Company.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Everyone, have a great day.