ATI Inc (ATI) 2007 Q4 法說會逐字稿

Good day and welcome to today's Ladish Co., Inc., 4th Quarter Year End 2007 conference call. (OPERATOR INSTRUCTIONS) At this time, I would like to turn the call over to Mr. Wayne Larsen, Vice President of Law and Finance, please go ahead sir.

Thank you. Good morning, everyone. Welcome to the fourth quarter call for Ladish in year end for 2007. Glad everybody could dial in this morning. We will get right into it and get everybody's day moving along. We will obviously follow this up with questions after my presentation and we will move from there.

First off, I will obviously give you my standard proviso that there is going to probably be comments made that are going to reflect management's opinion and forecast as far as outlook for 2008 and beyond. As a result of which, obviously, those are clearly forecasted opinions and are meant to be a statement of fact at this point of time.

Jumping right into the year, let's talk about the fourth quarter first. Fourth quarter came back pretty strong for us. We were pleased with how the fourth quarter ended up after somewhat of a challenging third quarter.

All of our operations came back fairly strong in the fourth quarter with ending up a $108 million of sales, 16% pick-up over the fourth quarter of last year and about a 3% to 4% pick-up over the third quarter. More importantly, obviously, we did a much better job of realizing the results on those sales. We ended up with net income of about $9.3 million at about an 8.6% run rate. A significant improvement over last year in the fourth quarter with a 6.4% run rate and obviously that is a big improvement over the third quarter.

Going down the financial statement in the fourth quarter, obviously gross profit came in at $18.3 million at about 16.9%. A little better than in the last year, where in the fourth when we were about 16.4% and certainly an improvement over the third quarter. It's back more to a much more normalized run rate for us when things are perking and going right in this business and we aren't faced with some of the challenges we faced in the first and third quarter of the year. That ended up with an operating income of 12.7% and that is a big step over last year when we were running at about 11.6% rate and another reflection of we got there with continue focus on SG&A in the quarter. It was a little higher than what we had been for the year. We came in with SG&A at about 4.2% of the sales for the quarter. A little higher than our 3.9% to 4.0% run rate for the year, but just a reflection of the quarter came in a little stronger than we had initially anticipated. The year ended up a little better and quite candidly, we had to make some additional provisions for profit sharing throughout the company.

Everyone of our operating units hit their profit sharing goals, so all the employees benefited from that and ended up being a good year for everybody at Ladish. That drove the SG&A up just a tad obviously in the fourth quarter, but still at a respectable 4.2% and didn't really hurt us on an overall rate for the entire year. We got it down to pre-tax income of $13.3 million or 12.3%. Again, another nice step up over last year and again over the third quarter this year.

We clearly benefited in the fourth quarter from a little lower than expected tax rate. Lower than expected tax rates really are a reflection of some advantages we picked up particularly in Poland with our Polish subsidiary, ZKM. When we bought ZKM in the end of 2005, they had built up a number of net operating loss carry forwards that obviously we were able to inherit when we purchased the stock in the company. Up until this point, we had a valuation reserve on those net operating loss carry forwards. We reversed that in the fourth quarter based on ZKM's continued strong financial performance. They have been effectively profitable now for over 2.5 years. Clearly, their forecast going forward is for continued profitability. We thought it prudent to reverse that valuation allowance and obviously we picked up an advantage there.

So, we lowered our fourth quarter tax rate to about a little over 30% from our normal run rate of about 37%. So, obviously, we have picked about $.04 or $.05 to the bottom line as far as EPS on that. Without that benefit, EPS probably would have come in around 58%, 59%. The result of which with the tax benefit we came in at 64%, which was obviously a little higher than any of us had anticipated, but certainly nothing anyone was complaining about.

So, on an overall basis quarter-to-quarter over last year, significant pick-up $0.64 of the EPS versus $0.42 last year and $0.45 in the third quarter this year, nice overall improvement. Some of the things that happened in the fourth quarter that really drove that was really better operating efficiency. We got back to a more normalized run rate as far as our byproduct sales, as far as coming back to credit our cost of goods. We also benefit in the fourth quarter from some tool and dye sales that again come back to reduce cost of goods not to the top line. We talked about that at the end of the third quarter, but sometimes either the, particularly the tooling sales, can be a little lumpy. We incurred the costs as we go along, whether it is in the tooling material or in the labor. Actually making the tools and getting them ready. We do not recognize the revenue until the tools are ready and we have run first article approvals and the customer has accepted the tooling's qualified. We can have occasionally a little lumpiness with that and certainly that happened between the third and fourth quarter, but it obviously benefited and helped the fourth quarter be as strong as it was.

Looking into (inaudible) with full sight for the full year, again came in as a great year for Ladish with $424 million in sales, 15% improvement over 2006. Generally, just a nice pick-up across the board as far as where we went. All of our business units came in effectively beating plan or over plan. They and everyone pretty well performed to our expectations. No real disappointments on an annualized basis.

We have talked about before on these calls, we really run Ladish from an annualized perspective. The nature of the business is such that usually things happen and we do get the lumpiness from quarter to quarter as demonstrated -- 2007 was a prime example with the issues we had in the first quarter of 2007 with the equipment issues and then, again, the issues we had in the third quarter with the raw materials, whether it was byproduct or unavailability of some of our starting material. Following both quarters, obviously a nice recovery. What happened in the second quarter this year reflected due to the pick-up is we got back on steam with equipment up. We recovered in the second quarter and again in the fourth quarter recovering from the third. So, on an overall basis, we were fairly pleased with where the year came in and met generally our expectations of where we thought the year could be. A reflection of how this business operates. As you look over the course of the year, that is really how we judge the business, how we operate it and how we judge our operating units, not on a quarter-by-quarter basis.

Back to 2007, again, it was a strong gross profit of 16.3%, $69 million, down a little as a percentage from last year when we ended up at about $18 million. That is really just a reflection of the raw material price increases we saw in 2007 as the raw materials continued to creep up as the bigger percentage of our cost of sales. Obviously, it hits that gross margin line as a percentage. That is really the driving factor between those two numbers above anything else aside from what could offset. Again, one of the positives in 2007 versus 2006, for the year 2007 came in with about $16.7 million of SG&A versus $18.2 million last year on significantly higher sales that resulted in SG&A for the year being at about 3.9% of sales versus last year we were a full 100 basis points higher at 4.9%. A reflection of attention to detail here, a better focus on how we're handling international sales and just an overall attentiveness to detail that kind of runs throughout the company to try to manage our costs and keep ourselves under control.

Resulted in operating income of $52.3 million up from last year at $48.9 million, again down about half a percentage point just as with the gross profit, just a reflection of not being able, even with the SG&A improvement, to totally make up for the difference in the raw materials price escalation throughout the year.

Another positive for the year is we ended up with interest at about $2.5 million versus $3.5 million last year. The reduction in interest is two fold. One, it was less debt in 2007 that we serviced in 2006 and it was also a reflection with our capital expenditure budget, how much of the interest is being capitalized as part of those capital projects. But again, a positive on both ends of it.

That gets us down to pre-tax income of $50.2 versus $44.7 last year. Again, on a percentage basis, we have gotten it down to about 11.9% versus 12.1%. As a percentage, it's really balanced out and is reflecting similar performance, even with the raw material impact.

Taxes for the year, we ended up at $17.8, which for the full year ended up at about a 35.5% rate. Compared to the last year, we were at about a 35.9%, so not a material distinction between those. Again, a reflection of what brought down the entire rate for 2007 was at large part, the benefit of the tax credit we had in Poland for ZKM.

Results in the year ending up with $32.3 million in net income versus $28.5 last year, a little over a 13% improvement year-over-year, we were pleased with that. Obviously, we would have liked for it to have been a little higher, but given the escalating raw material impact, we were happy with where that came in. Ultimately resulting in a year-over-year EPS growth to $2.22 versus $2.01 last year, again a nice double digit pick up for us on the EPS side.

Dropping down to the balance sheet, we end the year with about $6 million in cash versus about $3 million, $4 million last year, a reflection of a little stronger collections at the end of the year. Receivables we had a little growth in the course of the year as sales continue to escalate to about $75 million from $69 million, so about a $6 million growth in receivables. Given the growth in sales of 15%, I didn't feel a 6% growth in receivables was out of line. Day sales outstanding still remain relatively constant, so I think our guys are doing a pretty good job of managing that side of the balance sheet.

Inventory, we had a little growth also to $118 million from $106 last year. Again, a lot of reflection of raw material price increases year-over-year. The actual pounds of materials on hand and pieces still stayed relatively flat, as has our inventory current. So, our guys are trying to manage that side of the business and I think doing a pretty good job.

Overall debt was down slightly for the year for $54.1 in 2006 to $53.5 in 2007. Really a reflection of what we have been doing with our cash. It was a very strong cash generation year. Operating cash flow came in at about $39.8 million. Up significantly over last year, in 2006 because of balance sheet and work in capital demands where we actually had negative operating cash flow in 2006. 2007 really reflecting, once again, the kind of cash flow that Ladish generally can generate and does generate. We considered that a positive. Obviously, what happened that cash flow, I'll jump further down --- where we spent the money in 2007 is in large part on capital expenditures.

The capital expenditure budget ended up the year at about $38.1 million, significant increase over the $16 million we spent in 2006. That is really being driven in large part by the new isothermal press here in Wisconsin in the Radish's forging operation and along with the getting started at some of the other operating units be at Pacific Cast with their plant expansion and new furnace to a new machine center at ZKM and additional new machine tools at Stowe and Valley Machine here in the States also; a big year obviously in CapEx.

Going on down, I guess, again one of the real highlights for the year was the order activity and really gives us some confidence going forward for 2008. Just for the fourth quarter alone, new order activity was about 142 million, when you balance out all the schedule shift and what happened. A very positive Ladish quarter for us for order activity. We ended the year with about 535 million in new orders. That compares to about 415 for 2006, which ultimately culminated in, once again, Ladish reaching a new record on backlog of almost $611 million when compared before we entered last year at about $500 million. Pretty strong order activity, significant demand out there, really giving us a lot of confidence going forward as far as where we end up.

Couple other highlights over the course of the year, a couple points to make, is I need you to sit back and look at the year. Were there any significant shifts? One of the shifts we did see is our military presence crept up a little in 2007. Military business crept up to about 25% of our business, up from about 22% in 2006. That is really being driven in large part by demand on the helicopter side, both on new builds for helicopters and spares, along with the rotating engines with driving those helicopters. They are a very strong part of the business and we expect that to continue for the foreseeable future.

I guess looking out from there into 2008 and beyond where we see things going. Obviously, with the backlog growth that we have, the demand that is out there, 2008 is going to be a balancing year in large part for us. On one side, it is going to be balancing servicing the demands our customers add. We will increase sales at every one of our operating units, which we're certainly stepping up to. Along with that, we're obviously focused on adding to our organic growth with the capacity expansion we've got going on throughout the company. The new isothermal press here in Wisconsin is on schedule. We fully expect that to be installed by the end of the second quarter this year. We will be doing the testing and qualification in the third. We expect it certainly into operation making parts in the fourth.

On an annualized basis, that new press is going to give us somewhere between $50 to $60 million of additional capacity. Don't assume that's all going to happen in the fourth quarter as we get that press loaded up. But as we head on in to 2009, 2010 and beyond and as some of the new programs come on, therefore significant demands are going to be on that press. Whether it's 787 with Boeing or the redesigned 350 with Airbus, we think there is going to be plenty of work for that press going into the future.

Out at Pacific Cast, they are diligently at work with their plant expansion and installing their new melting furnace. It is going to be definite plus for them. When that is completed by the end of 2008 and heading into 2009 that should give them the opportunity for an additional $20 to $30 million of plant capacity out there.

ZKM's machining facility that I referenced is underway. Where, as always in Poland, dealing with some of the regulatory licensing agencies and we're in the permitting process right now, which is really the pacing item over there. We fully expect their operation with the new machining facility to be up by the end of the year also. That should give ZKM, at a bare minimum another $5 million opportunity. ZKM continues to see additional aerospace opportunities, as far as they continue to expand and bring aerospace business in.

2008 is going to be another year of, I wouldn't say qualification orders, but they're really initial trial orders as we're continuing to get opportunities with some of the air frame people, particularly servicing some of the programs that are going into Airbus for programs like the 319 and 320. So, it's a gradual build up again in 2008, but we really expect 2009 to be another positive year for ZKM on the aerospace side because there is going to be a number of long term agreements that are going to come on line by 2009. It would be an opportunity for ZKM to gain some significant material share so they can start shifting their product mix.

Our new recently announced expansion down in Mexico with the new titanium investment casting facility is progressing as we move along; we are still in negotiations on the site selection with the various local states to make sure we get the best possible incentive package going forward. But, we're relatively confident obviously that we'll have that plant up and running later into 2009. Again, that will be another opportunity to add some significant titanium investment cast capacities on that side of the business.

So, overall obviously, a lot of things going on, a lot of balls in the air, but we're pretty encouraged. It's got pretty much the entire organization excited and moving forward about all these opportunities. Looking out at the industry, obviously, there's been some issues as far as the start and stops with Boeing on the 787. We haven't seen any immediate impact of 787 our guys have taken kind of a cautious outlook toward it and not being overly optimistic as far as when the real ramp up demand, it's actually probably going to work much better for us with when the real opportunities come with new isothermal press here in Wisconsin. But, there's plenty of other significant demand out there. The 380 is coming back online, so we have plenty of work to fill in if the 787 falters for a while. We don't expect that to be a long term problem. It really appears to be a supply chain problem and not a supply chain problem on our end.

The ongoing question, I know people are probably curious as what the material situation as far as raw material supply. By and large across the board, it seems to be relatively stable. Prices are not dropping but they're not rapidly accelerating at this point. The time that they are staying at a relatively high level. As far as the availability of supply, particularly on the nickel based powder that we get from Special Metals Corporation, it certainly improved in the fourth quarter. I know a number of you have asked and I know I alluded to it at the end of the third quarter that we were seeing better performances in October. We saw that again in November and in December. Certainly in those three months is starting to set a trend that they're beginning to do a better job of operating that company and producing a more reliable quality product melt after melt. We're somewhat encouraged by that. They are in the process. They do intend to expand that facility to meet the future demands coming with the demands particularly out of Rolls Royce for their material, for the 787 and the redesigned 350. So, we're obviously working closely with them on that and encouraged that they're going to be able to step up and meet our demands.

So, overall basis, obviously, we're pretty pleased with where 2007 came in. Again, a reflected a nice 15% year-over-year growth. Really looking out for 2008 over 2007, we're again looking somewhere probably in the low teens again as far as percentage growth year-over-year and expect the profitability would follow correspondingly. We're pretty encouraged by our opportunity of where 2008 can be. We think 2008, in large part, is going to be -- we think it's going to be another strong year. We think it's going to be a nice staging year as we work on adding to our capacity going forward. I guess with that, that's pretty much in a nutshell pretty much sums up where the quarter and the year ended up and where we see 2008 and 2009 in the future headed. I thought about, before we came in here, do we have any major concerns or anything right now? Once again, short of some kind of international economic malaise and people stop flying and/or the military stops absolutely buying the supporting programs like the Blackhawk, we are not terribly concerned about the future right now. In fact, we're pretty excited about the future. So, with that, if there is any questions, I'll do my best to answer them.

Thank you. The question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) Our first question will come from Eric Hugel from Stephens, Inc.

Hey, good morning, Wayne.

Hey, Eric.

About the quarter, can you give us sort of maybe a little more of an update on the trajectory? You talk about powdered nickel alloy shipments improving. I guess if you think about now, where are they versus where they need be to support your demand? Can you sort of talk about where they are and sort of how quickly they need to catch up trajectory wise? Have they also been sort of improving over the quarter and continuing to improve as we go into January? Or, are we still sort of stepped up and stable?

You know, I haven't seen statistics yet for January, Eric, but I haven't heard any particular complaints. One of the things I obviously watch that I'm able to see is since I sign the checks; I do see quite a bit that we've been paying that operation. That's gone up geometrically due to the fourth quarter and continued through January, which is obviously an indication we're getting a lot more material. Are they still where we would like them to be? Probably not. Performance still isn't quite what it was pre-acquisition, but it's improving. I think they've made a commitment. They are working with it to improve. The OEMs have certainly gotten involved both Rolls Royce and GE encouraging them to improve. There is a full fledged effort throughout industry trying to make sure that plant puts out a sufficient amount of material. As I indicated, they do have expansion projects going away to step up their capacity so they can produce at the levels where the industry is going to need to be.

Can you talk about your rocket work? I guess you've talked about that work I guess with ATK kicking in this year on a much more consistent basis? I guess you had a big slug of work that hit in Q2 of last year at a high margin. Is that sort of the way we should continue to think about real inconsistent, really start it again up in Q1 and we're going to see that more consistent through the year? Can you sort of give us sort of a bracket in terms of how much you would expect for the year?

Yes, I think it is going to be, hopefully, a little more consistent this year as we're continuing to move forward with the programs for the Orion and Aries program. So, I think it's hopefully going to move forward on a little more consistent basis. Instead of all landing in one quarter, the way it did here in 2007. I am not anticipating looking at what are guys are working at now, that it's going to have a big impact on Q1. It's probably going to be Q2, Q3 and probably throughout the year.

As far as volume, again that isn't, total dollar wise it's not a huge piece of business for us. But, it's certainly for a profit perspective, it does certainly help. It should be hopefully 1.5 to 2 times what it was in 2007.

Can you remind us what it was in 2007?

Not precisely.

In the $1.5 to $2 million range. Is that sort of a good guess?

It's a little more than that.

Can you also talk to us about, I guess, with regards to the NOL, does that affect your -- where should we think about you're tax rate being going into 2008?

I think 36%, 37% again. We recognize that asset. The benefit of that has been realized.

I guess, also, one final question with regards to a comment being made in the press release that with new titanium casting capacity increasing in '08, my understanding was that the Albany facility wasn't going to be really up and running -- that new furnace -- until right at the end of '08, really into '09. Are you referring more to really A380 kicking in. I remember when we were up in Albany you had a whole sort of dipping room that was just sort of vacant waiting for A380 to start, is that really more what you're referring to?

Yes. We expect that business on an overall basis is going to pick up this year, Eric. You're absolutely right the new capacity won't be online until the end of the year. So, it isn't going to particularly help. But, you know the Trent 9000 engine that Pacific Cast has the cases for is kicking back on which it's on the 380. We expect an overall pick up in that business this year, just because of the demand on that business. They do have capacity to grow aside from the additional capacity we're adding. They weren't quite maxed out yet. That business is going to grow this year.

How much do we think about that A380, it's sort of slowly trickling in in Q1 and accelerate or did Airbus just sort of flicked the switch and you started producing at a nice rate?

Well, on the casting side it's going to be more the second half of the year. Because they get them ramped --- it's starting, stopping, starting, stopping, particularly with the casting, the lead times of getting going on that. You know on the forging side, I think it's going to be more smooth as it works it's way throughout the year. Again, that's one of the reasons why we're looking at the growth that we are for '08.

Thanks, Wayne.

Our next question comes from Rob Dameron from 21st Equity Research.

Wanted to dig down a little deeper on the gross margin side and certainly the gross margin improved. You touched on a few reasons why, but maybe you could go through what was the biggest variance in the gross margin improvement. If you look at it versus Q3 or if you prefer to look at it versus a Q4 last year, just kind of give us a little more color there.

Probably the biggest variance between Q3 '07 and Q4 '07 Rob was the benefit we picked up from improved byproduct sales and the additional tooling revenue we had. Both of which, obviously, reduce cost of goods as a result of what you would drive up gross margins, obviously, and go right to the bottom line. That's why you saw the bottom line improvement. It improved almost as much as the sales improved quarter-over-quarter.

Okay and then I think you mentioned in Q3 that one of the things that negatively impacted the margin was the product mix. Did you have a better product mix in Q4 than you did in Q3?

The mix was a little better in Q4 than in Q3 also. You're absolutely right.

Then I also wanted to talk about your capacity. You're obviously bringing on quite a bit of additional capacity later this year and into '09, but you have a large order backlog. Do you have the capacity over the next three quarters to meet the demand that you see reflected in your backlog?

Yes, I think we do. We're obviously (inaudible). We're obviously working a lot of time, if January is going to be any indication how this year is going. I think we'll meet the demand. It's just we're going to be doing what we can to effectively create capacity until further new capacity comes online.

Ok, and just last question, what is the CapEx expected number for '08?

It's going to be big. It really depends -- the real driver is how fast the project in Mexico comes online. It will certainly probably be every bit of what '07 was, if not more so. It's really going to be a timing issue on how fast we can get a few of these projects done. But, it's going to be another big year of capital dollars from Ladish.

Okay. That's helpful, thank you.

Our next question will come from J.B. Groh from D.A. Davidson.

Good morning, Wayne.

Hey, J.B.

I think you mentioned that sales will be up for the low teens and I think you said corresponding gross margin. Does that mean you expect that gross margin to go down in 2008? Or it should it stay?

No, I mean total earnings.

Ok, good.

Gross margin is going to be a challenge again in '08. Raw material is not getting any cheaper and our initial outlook right now would tell you that raw materials as a percentage of total sales is going creep up a little because of the product mix. Total profitability, we think we're still going to be able to show similar growth and total profitability as in sales.

Okay. So, don't look for huge improvements in gross margin next year, it's going to be more sales driven.

Right, it's truly going to be, because we're still wrestling with the raw material demon that's out there. So, we're doing everything we can obviously from a productivity and incremental sales perspective to try to offset that. But, it's a constant battle as that raw material guy keeps creeping up from the low 40s into the high 40s trying to get to 50.

You're Q4 SG&A was up a little bit, was that just typical year end audit expenses and sort of thing? What was their . . .

It was really the year that came in a little stronger than we had initially anticipated and that drives our profit sharing at everyone of our operating units. We were a little under reserved on the profit sharing. It's (inaudible) side of the business, so we had to increase our reserves a little and cover those payments. We were actually please that everyone of our operating units did beat they're goals as far as what they needed to do for profit sharing so everybody participated.

Maybe you could talk about your appetite for acquisitions. Obviously, the balance sheet is in pretty good shape.

We certainly got an appetite for acquisitions. We're continuing to look. We're looking at some opportunities as we speak. Again, these are not going to be company changing acquisitions. Kerry and I's focus are typically on trying to find smaller niche businesses that compliment what we're doing. Fill in where we perceive there to be perspective holes and our supply, our total product line. We are looking at a couple opportunities now which we think will, if they come to pass, we think they'll be a nice opportunity for the company. But, it's not going to be something that's suddenly is going to shake the Aerospace industry. That's just not what we do.

[Inaudible question -- background noise] in the ZKM type size or would you consider that big?

No, with ZKM or smaller, we typically look at business candidly as far as sales wise that are generally in the $10 to $100 million in sales is generally the category we look at. It tends to be more of our appetite. We also tend to be much more successful, when with opportunities that we can specifically identify and transactions we can get done that aren't per se out in this public arena. We don't do real well on auction. We tend to be a little to frugal to do well at auctions. We do better when we can find opportunities and convince people that they are better off as a part of Ladish. Similar to what we did with ZKM, Valley and Stowe. With the exception of PCT, all the acquisitions we've done have all been pretty much privately done. We think that perhaps that works better.

Okay, hey, thanks for your time and congratulations on the quarter.

Thanks, J.B.

Our next question will come from Karl Oehlschlaeger from Banc of America.

Good morning, Wayne. Congratulations for the quarter again.

Thank you.

Talk a little bit more about how we should be thinking about margins in 2008. It sounds like you're looking to maybe, given the raw material issues, kind of keep that to where it was in '07? As we look at '07, is it the full year 2007, like a 16.3 number, make more sense than the 16.9 you did in the fourth quarter given that you had the benefits from the tool sales lumpiness?

Yes, you know part of the issue though you have to keep in mind for the full year --- you have to keep in my mind in what we did in Q1 and Q3. We had a phenomenally strong Q2 and obviously a nice bounce back in Q4. I like that we're striving to do better than the 16.3. It's certainly one of our goals as continues to try to push that number forward. Again, we do wrestle with the raw material issue. Barring the kind of unforeseen issues that we ran into in 2007 with the equipment down time and without another major material issue, we're certainly going to pushing to try and do a little better. We're not quite satisfied at 16.3.

When you're talking about the raw material issues and how that's been a challenge and creeping up, to a certain extent you have for the most part passed through pricing contracts that help offset the impact there so it would affect margins, but it's also going to affect the top line growth I would think. Maybe talk about that a little bit.

It obviously helps the top line growth.

When you say low teens, what sort of expectations are you figuring in for raw material price increases and the comments you've given on margins?

We're really hoping that we can maintain raw materials in the general area of what it is right now. So, we're not looking for a lot of raw material price increase to really benefit '08. The challenge for us is we're seeing product mix shift and the product mix shift is really at this point and time just driving the raw materials as far as a higher percentage of our cost of sales.

Okay.

You're absolutely right. We do have the opportunity the pass through price increases and we have passed through price increases, but that doesn't negate the impact on margin.

Sure. Thinking about that low-teen number you talked about for '08. To kind of get an idea of what your makeup is if you were to assume that these capacity expansion projects that you talk about aren't included in your '08 number, what would that growth rate look like?

Those aren't included in my '08.

There's none of that. So, we might see some of those capacity expansion programs benefit in like the fourth quarter, but at this point that doesn't include any of it.

Right. We are not banking on the capacity expansion really helping in '08. That's going to be '09 and '010.

Right, okay. Thank you.

(Operator Instructions). Next question will come from Tyler Hojo from Sidoti & Co.

Hey, Wayne. Just wanted to touch on that gross margin topic from the last questioner a little bit more here. I guess if we look at 2008, do you expect to see the same sort of lumpiness that we saw in the first and the third quarter? Or, would you expect it to be a bit smoother here? I'm just trying to get a better feeling of how we should be looking at some of these quarterly issues.

Well, we're certainly hoping for a smoother year, Tyler. So far, we're into February and we haven't had a major equipment failure that we had in the first quarter of last year. This business is always somewhat lumpy and that's why I opened my monologue this morning by making a comment to look at us on an annualized basis. But, I hope we're not going to have the lumpiness that we had last year. It should be a lot smoother based on what we see as far as demand and without anything untoward happening that's basically out of our control -- equipment failure or something happening with a major customer or something. So, we're looking for the business to be a little evener this year. With that said I'll continue the proviso, the second quarter year-over-year is historically is generally always going to be Ladish's best quarter. We've got more working days. The weather's warmed up. The utility usage is down. There's just a lot of things that go right for us in the second quarter. Again, we're not anticipating you're going to see the dramatic swing quarter-to-quarter that we saw this year from the first to the second and the third to the fourth. I think it will be a little more smooth.

Okay, good. My last question just relates to the backlog. Saw some pretty nice sequential increases there, what drove that? Did raw material have any impact in the growth of the backlog or what was that?

Not significantly. It's legitimate demand. It's our customers have a demand out there across the board at all of our operating units and our guys have done a pretty good job stepping up to it and trying to be the supplier of choice.

Okay, good. I guess a follow up to that. This is going back to the beginning of the year. One of the earnings conference calls that you held, I remember you indicating the backlog had basically peaked and the focus for Ladish going forward was going to essentially be executing upon that backlog. I guess my question is what's changed? Are we talking about a backlog that's stretched a little bit further? Or, what's going on there?

No. It's the same period of time. It's still at 18 month backlog. Couple things have happened to us obviously. We've booked new orders for some new programs. We've got a lot of new tooling jobs and a lot of new programs that are going both at the forging operation and in the casting operation. So, their demand there that's picked up. Obviously, we're trying to focus on what we can do and where we can grow the business. You've had a little price escalation. You have had a little raw material escalation over the total course of time. But, it's really just a reflection of the total demand for the business and Ladish being perceived as the supplier of choice at this point.

Thanks so much, Wayne.

We have a follow up question from Eric Hugel with Stephens, Inc.

Hey, Wayne. Can you talk a little bit more -- you talk about benefiting in Q4 from sort of these tool and dye -- and is that more a reflection of getting paid or is it more of a reflection of just doing less work?

It's more a reflection of being able to build the tooling, Eric. Because of the cycle of how the tooling gets built, you incur the cost when you buy the tool material. You incur the cost when you're doing the actual sinking and preparation of the tool. You don't recognize the revenue until you can bill the tools, which is when the tools have been tried out. So, it's really a recognition of the revenue that have benefited in the fourth quarter and that should be more balanced going forward. One of the things that happened to us the third quarter was we were really starting to see already in the third quarter some of the pick up and demand for a lot of new jobs. We have a lot of new tools that work and we're incurring a lot of cost and expense without corresponding revenue. We started picking up on the revenue in the fourth quarter and that should be more balanced going forward in '08.

That's what I was sort of getting to. Q3 was unusual negative, is Q4 an unusual positive? It seems like Q4 is more of steady state that we should think about what that does to gross margin, correct?

There was probably a little bit in order to pick up in Q4, but it's closer to a steady state certainly than Q3. Q3 was the anomaly.

Okay. So, we should see improved tool and dye and, hopefully, knock on wood, we should see continued improved mix in terms powdered nickel alloy coming in, because that should be a positive vote to the top line as well as margins, correct?

Correct.

I guess my last question; you talked about rising raw material costs. You talk about your revenues and your profitability earnings sort of rising at sort of equal levels, but I scratched my head considering we look at last year you had first quarter, the press went down. That was sort of a big hole and then Q3, some pretty easy comps here. Then, you talked about material costs going up, but when we've always talked about material costs, yes it impacts margins, but it doesn't impact EPS dollars. Can you sort of reconcile that?

Well, I think it's reflective of where we ended up this year with '07 over '06. Total sales ended up going up at about 15%. Net income went up at about 13.5%. It lagged a little and, again, that lag was just a reflection of the raw material portion of our cost of sales being that much higher in '07 versus '06. We're going to be wrestling with that in '07 over '08. Not as much so, because of the continued raw material price increase, as we think those hopefully are going to stay relatively stable but at a higher rate. With the mix that's shifting, it is going to have a tendency based on our outlook right now that it's going to continue to be a challenge driving raw material to a higher percentage of our costs of sales.

Alright. Thanks a lot, Wayne.

We have another follow up question from Karl Oehlschlaeger from Banc of America.

Hey, Wayne. One more thing on the raw materials. Can you talk in a little bit more detail about the scrap side of the business, the byproduct sales? It sounded like that has sort of improved versus what you saw in the third quarter. But, when I look at some of the data for some of the scrap materials, the fourth quarter was I thought pretty weak. Again, maybe can you talk about what you guys actually saw?

Yes. We clearly saw an improvement in the fourth quarter over the third. Probably, driven as much as by anything by the mix of what those byproducts that we were selling. We had some higher value material that we were able to move into the byproduct market in the fourth quarter as opposed to the third. We did see some stabilization. It will continue to be a challenge in '08, but obviously, our guys are trying to maximize their opportunities and we'll continue to move forward. We don't think we're going to see the swing that we saw certainly in the third quarter. We think it's going to be a little more constant in the fourth. Probably not at the levels that we saw in the first half of 2007, but it should be more evenly paced based on what we're seeing in the market at the moment.

Okay, thank you.

We have no further questions.

Alright, great. Well, I thank everybody for dialing in. Obviously, if anybody has any follow up questions, don't hesitate to give me a call. We'll continue to push the company forward and we'll talk to you again probably in the month of April. Thank you.

This concludes today's teleconference. We thank you for your participation. Have a great day.