ATI Inc (ATI) 2008 Q1 法說會逐字稿

Good day, everyone, and welcome to today's Ladish Co., Inc., First Quarter 2008 conference call. (Operator instructions) At this time I'd like to turn the call over to Mr. Wayne Larsen, Vice President of Law and Finance. Please go ahead, sir.

Thank you. Welcome, everybody, to the Ladish first quarter conference call. We'll jump right in and get going. Before I do, obviously, I'll give my proviso that there's probably forward-looking statements today. Although we won't be giving forecasts, we will be talking about the future and management's assessment of where the company goes from here. And as such, those are forward-looking statements protected under the Securities Litigation Reform Act of '95. And with that said, we'll skip forward.

I guess I'll start off saying, obviously it was a good quarter for us sales-wise, but as we kind of characterized going into this year at the end of '07, this was going to be a transition year for Ladish, and certainly the first quarter has proved so. As I said, a nice pick-up on the sales side with a 20% growth, but obviously the earnings didn't come in where we had expected and where certainly we want them to be.

The interesting thing on the 20% growth on the sales was the sales didn't exactly come in with the mix where we had at end of the year of what we had planned. Obviously the 787 push-out has had an impact on us already in this year. We were seeing the push-out throughout the first quarter. While Boeing didn't specifically come out and say anything, obviously the engine manufacturers had reacted accordingly, and Rolls Royce and GE adjusted their schedules starting at the beginning of the quarter, and have continued to do so.

So the mix for the quarter wasn't exactly where we expected it to be. Interestingly, with the growth, our engine side of our business is actually off 4% from the levels of '07, and certainly is less than where we had projected it was going to be for the first quarter of '08. Offsetting that was our aerospace side of our business -- was up over 75%, and the industrial side of the business is up over 40%.

So while obviously sales picked up and a number of parts and product we put out was significantly higher than last year and where it was along the lines of where we expected, the mix wasn't what we wanted it to be. That obviously had an impact on earnings from a variety of perspectives, both on profitability of the initial jobs themselves, but it flows on through our business all the way down through an impact area such as byproduct sale and tooling also, because, obviously, what kind of products getting out of here impacts those other areas.

So that was really kind of underlying what happened in the quarter. There's obviously other positives that happened in the quarter. As you saw in Kerry's press release, another excellent quarter for order receipts. We booked over $133 million of new orders for the quarter. Again, our booked-to-build remains quite positive, which helped drive our backlog to another all-time record high of over $630 million as of the end of the first quarter. So again, we were really pleased with that.

As we look across the board of what really happened, some of the other positives that we saw in the quarter -- again, as we look down through the P&L, SG&A came in for the quarter down to 3.8% of sales, down a little from last year in the first quarter; we were running about 4%. So we're pleased we were able to continue to maintain that area as we went forward. Obviously, underlying gross profits were certainly less than where we wanted it to be, coming in at 12.6%.

Really what impacted the gross profits in the first quarter were a number of factors. Probably first and foremost is material content continues to creep up on us in the first quarter of '08. We ended up at about 48% of material content, versus last year in the first quarter we were about 44%. 400 basis point pick-up obviously had a huge swing in the difference. But for that, we would've been obviously a lot closer into the 16%, mid-16s as far as the gross profit range just on the raw material issue alone. Obviously, as always, those costs have been passed on to the customers, but it certainly does continue to impact the percentage.

We're probably going to see some more of that in the second quarter when we look at year-over-year comparisons, going into the second quarter. And then for the second half of the year, I think it'll balance out because if you look -- most of you probably recall by the second half of last year, the raw materials crept into the high 40s already, so it's just continuing on. It's not the raw materials continuing to increase; it's just that year-over-year comparison that we're seeing at this point.

One of the other costs which was a big issue for us -- and, again, Kerry alluded to it in his press release -- was employment cost. To support the growth that we're seeing -- I know most of you have heard before, for the last couple of years we've been running about as lean as we could run with people. And we're really to the point that to continue to grow this business and to have the pick-up that we need both -- particularly on the forging and on the casting side -- with the expansions that we're doing, we haven't had any option, but we've had to add people. And of course, in the year-over-year first quarter we're up about a hundred people in total.

So we're up from about 1,900 to 2,000, and while that probably doesn't seem like a huge proportionate gain, the way things are going right now both in Wisconsin and in Oregon as far as the skilled manufacturing people, they really just aren't available. What we've been forced to do is been forced to hire a lot of new people, a lot of unskilled people, and had a lot of people in training programs. At last count, we had almost 50 people that were in various apprenticeship and skill learning programs, and while we're encouraged these people will be excellent long-term employees and they're moving through their training programs, right now they are not the greatest as far as from a productivity perspective. And not only is it somewhat of a drag to those people as they're being trained, it doesn't necessarily help with the people who are training them. So overall, it was certainly a challenge in the first quarter, and we ended up with -- our employment costs year over year were about $3 million higher, so, again, that was an issue.

The overwhelming portion of that is flowing through our cost of goods. Again, as I indicated, it's not really any SG&A. These are by and large direct people that are touching the product that we've hired, but, again, that's one of the issues that certainly was a detriment to gross profits in the first quarter.

I know I've talked before because all the capital improvements we've done -- I told you at the end of the year, we expect that depreciation was going to be up $2 to $3 million for the year, and we're still on that pace. In the first quarter, depreciation was about $600,000 higher than it was in the first quarter of '07. Again, that's primarily flowing through cost of goods also.

One of the other issues, again, Kerry alluded to in his press release was that we had a fairly nasty winter here in Wisconsin, and I would like to tell you it's over, but I got up and this morning it was still about 32 degrees. But we are getting there, and we are -- as most of you who have been here before know, we've had to tend to throttle down the heat in this place. But throughout the first quarter, it was a bitter winter, and our energy usage was up significantly. Admittedly, partially of that is due to increased production, but the heating cost was significantly higher, and we ended up burning well over $1 million more of natural gas in the first quarter of '08 than we did in '07. So another drag as far as to the gross profit line.

I guess one of the other issues we dealt with throughout the course of '07, and I somewhat was suggesting to it earlier with my comment about the product mix -- the product mix was we shift from engine product to aerospace and into industrial. Because of the materials involved, they don't all generate the same amount of byproduct opportunity, with the byproduct market still being somewhat depressed as far as pricing. But we ended up with well over $1.5 million less of byproduct sales in '08 versus '07, another yield that would've been obviously a direct credit to cost of goods.

So we expect that to improve as the year goes by, as we expect the mix to shift back a little with getting a little better schedules as far as on the engine side. We expect the engine side to come back. That'll certainly help on the byproduct.

And the other area where we were somewhat off in the first quarter was our tooling revenue. Again, not hitting sales, but certainly impacting earnings by not getting the credit for our tooling revenue. Again, it's, as always around here, somewhat of a timing issue, and it just didn't happen. We were down significantly from the fourth quarter of last year's tooling level and the first quarter of '07's tooling level. The tooling demand is still strong. We expect that to pick up in the second and third and fourth quarters of this year, so we expect, obviously, a positive from that.

Looking over on the balance sheet side of the equation, we entered the quarter with about $7 million in cash, which was up significantly from where we were at last year. Business continues to generate cash from an operating perspective, but as I will also obviously tell you, with all the CapEx going on, we're continuing to by and large spend it as we're going forward.

CapEx for the quarter was about $4.6 million, down a little from last year in the first quarter. That's really just a reflection of when some of the progress payments have to be made on the new isothermal press and with the new furnace and melting capacity we're adding out in Oregon.

Both projects are on schedule and are moving forward. We fully expect them to stay on schedule. The isothermal press should be installed by the end of this quarter, and we expect it to be proving out and doing all the testing on it in the third quarter, and hopefully it's pulled into production in the fourth. And the casting facility expansion should be done by the end of year, as we expected.

The expansion over in Poland with our adding a machining facility is on schedule, too. Kerry was over there with them last week. That's progressing along. ZKM continues to see more aerospace opportunities that we're taking advantage of, so we think that '09's going to be another nice transition here for ZKM as they continue to add to their aerospace business nicely over in that part of the world.

So all in all, as I said, it was a transition quarter. Part of this year is -- again, this year, as always, we're running on an annual basis. We're still really optimistic about where this year comes in at a total. We think we've got a lot of opportunities, particularly in the second half of the year. Some of the schedules firm up in the second half that were a little softer in the first. But the sales growth we think is there is going to continue, and it's going to go nicely with where we're at as far as the capacity.

So obviously, we've had to deal with some challenges with the rest of the industry with the 787 push-outs. The A380 is coming back -- not as fast as we would like it, but it is coming back -- and the 787 is ultimately going to fill in. If we don't end up seeing it where we want it to be in the second half of this year, it's going to come back for '09.

Our backlog is, again, at a record high. It's supporting the gross where we're at, and we're encouraged by that. We've got, obviously, as I indicated, a lot of new employees in training. We're expecting by the second half of the year these new employees -- most of them will be through their training -- will become a lot more productive. And we're obviously also expecting our energy costs should be down for the remainder of '08.

So all things considered, we've got a lot of opportunity for the rest of the year, and we expect the rest of the year to continue to improve as we go forward. We're continuing, obviously, with our [Annic] expansion and growth opportunities. We're also beginning to see, I think, more opportunities externally for some of the areas we look for. We think, if nothing else, probably some of the trending, people's getting the perspective that the potential future tax changes that may be coming down the line or giving some private owners a little more impetus to start thinking about maybe it's time to transition out of their business. So we still remain optimistic that we're going to have some opportunities to grow externally yet this year.

So I know that's a lot to digest, but that's kind of the summary of where we're at at this point in time. So if people have questions, I will do my best to answer.

(Operator instructions.) We'll go first to Tyler Hojo with Sidoti & Company.

Hey, good morning, Wayne. How are you?

Hi, Tyler.

You mentioned both in your prepared remarks and also in the press release, I guess, where you mentioned an awful lot of cost pressures, and I was just wondering if you wouldn't mind kind of going down the list just in terms of order of magnitude on how much those actually impacted you in the quarter.

Well, as far as cost pressures, certainly as I indicated, employment costs were up about $3 million year over year. Depreciation was up about $600,000 year over year. Energy was up about $1.25 million year over year. And byproduct was down about $1.5 million year over year.

Okay, great. And I guess, as well, last conference call you provided us with a little bit of forward-looking commentary just in terms of what your expectations were in terms of top-line growth, and I think you also mentioned that maybe there'd be a little bit of maybe nominal margin improvement in 2008. Obviously, it seems like the top line's there, but with the start to the year that we've seen just from a margin perspective, do you still think it's realistic that margins will break even or maybe improve a little bit?

Well, I certainly think we had every expectation in the world that margins are going to improve certainly from the first quarter, Tyler. Kerry wasn't happy in the first quarter -- obviously, neither was I -- with where margins came in at. Obviously, as we just went down the list, there were a lot of moving pieces, a lot of things happened, but that's not satisfactory performance for the company from our perspective, and we're obviously working on these issues.

I think I told people at the end of last year that we expected somewhere in the neighborhood of 10% sales and earnings growth totally. Obviously, the sales is running well ahead of that. Earnings isn't there. Can we totally make up for the shortfall in the first quarter throughout the year? That's going to be challenge, but I certainly expect the next few quarters to get back to where we want them to be.

Okay, so maybe with sales running a little bit ahead, that'll provide a little bit of catch-up for the bottom line.

Well, certainly it will help if we can get our mix a little better situated going forward, and that starts helping, as I indicated, a number of areas from both sales profitability down to byproduct, and it also impacts tooling. Our tooling tends to be targeted with specific product, and if we're not shipping jet engine product, it generally doesn't tend to help our tooling either. So all of those things tend to go hand in hand, so we're expecting better -- certainly much stronger second half of the year, and we're expecting better performance in the second quarter, too.

Okay. And just one more before I hop in the queue. Historically, 2Q's been really good for you guys, and based on some of these cost pressures coming on-line, it seems like -- is the read maybe that 2Q's a little bit better than 1Q and then you just see a really strong ramp in the back half?

Well, I certainly think Q2's going to be better than Q1. We had a phenomenal second quarter last year with a lot of things going right, but one thing is -- I mentioned earlier, we still are going to be wrestling in the second quarter with a year-over-year comparison with higher material costs as a percentage of sales. We were up 400 basis points in the first quarter. I expect the difference to be similar in the second. But we got to be in that high 40s in the second quarter for the remainder of the year. And actually, when we get to the second quarter -- in the second half of the year it'll give us a much better apples-to-apples comparison.

Yeah, right. Okay. Great. Thanks a lot, Wayne.

And we'll take our next question from Steve Levenson of Stifel Nicolaus.

Thanks. Good morning, Wayne.

Good morning, Steve.

I guess you answered the gross margin question. In terms of materials, where you had shortages, it looked like you had things pretty much licked in the fourth quarter. How's that going, and how's it looking going forward?

Performance, particularly on the powdered metal side, has been pretty consistent with the fourth quarter. They're still not entirely where we'd like them to be, but much better than where they were in the first three quarters of last year. Clearly, they are trying to improve their performance. In fairness, if there's any solace in the bad news of, obviously, Boeing pushing out the 787, it has given the supply chain a chance to try to catch up and get themselves in better order going forward. So it's given both special metals obviously a chance to catch up, and it's also obviously given other people the work on their supply also. We think that probably is working itself out and will continue to do so.

Okay, thanks. On the increase in aerospace-related sales other than jet engines, can you tell us how that breaks out? Is it mostly helicopters?

Big deal are helicopters. Some landing gear, but probably helicopters a big driver there.

And do you see that continuing?

Yes, absolutely. The demand there is pretty robust.

And how about at ZKM? Do they have any opportunity on helicopters?

They're going to. Right now Sikorsky has moved an assembly line over there. Right now they're not doing anything that ZKM is going to be able to help with immediately, but that's certainly a long-term opportunity for ZKM. They are trying to work with Sikorsky on, prospectively, more of some of the gearing and some of the things of that nature, which obviously goes to why, again, we're trying to add some machining capacity and other items over there. Also, obviously, ZKM's working with -- got a lot of guys in the [Sapling] group that's supporting Airbus, so there's plenty of opportunity over there for ZKM.

Okay. Thanks very much.

We'll take our next question from Eric Hugel with Stephens.

Good morning, Wayne.

Hi, Eric.

Can you talk about sort of the rocket work that you guys do? I guess when we talked last quarter on the conference call, you thought that this year -- I guess last year you had a big lump of work in the second quarter, and you thought this year would be more consistent. It would be I guess 1.5 to 2 times the size and more consistent throughout the year. Can you sort of update us on where you see that coming in?

Right now, Eric, we had a little in the first quarter. It looks we're going to have a little in the second. It's probably going to unfortunately drift more into the second half again. Without naming names, a couple of our customers are -- let's just say they're not getting along right now. Our scheduling is being negatively impacted by some squabbling a step above the supply chain from us. And we're trying to work with them to get some issues resolved, but so far it hasn't had a positive impact on us, but we're still cranking along. We expect the product is going to go throughout the year, but it's probably really going to have a stronger impact on us in the second half.

Okay. Maybe from the standpoint of looking at the various headwinds -- I guess last quarter when you had said, look, we think we can do a little better than the 16.3% gross margin that you did last year. You must've anticipated adding employment. I guess what I'm trying to figure out is what was incrementally worse -- I mean, obviously, weather and stuff like that, but what was incrementally worse that you're actually experienced, that you're expecting to see now, than what you expected last quarter?

Well, we certainly had anticipation, Eric, that we were going to be adding to the head count, I guess. We added to the head count a little more rapidly than I had anticipated we were going to. Our operating guys -- I won't say they got ahead of themselves, but they certainly -- when I look at things, I tend to try to factor a little -- smooth it a little more evenly over the course of the year. And sometimes we don't operate quite as smoothly as when I'm sitting in my office trying to figure out how this is all going to flow through.

So part of those costs got accelerated into the first quarter that I thought would've been a little more spread across the year on the employment side. So that was obviously a bit of a surprise. Clearly, the product mix was not what we had anticipated going into the year. So obviously, as I indicated, that has impacts both on profitability of the product and it impacted us on byproduct, it impacted us on tooling. It's all of those issues rolled in, too. Obviously, as I indicated, we're kind of happy with the 12.5% gross profit run rate, and we think it ought to get back into the 16s and we're obviously pushing, trying to get it back into there.

Right. It's kind of odd in terms of your product mix where you're looking at engines down 4%. That would imply that it's much more than just 787.

Yes, the 380 hasn't came back as fast as it should have, as we had anticipated, and when they're back to making 380s, the one issue that we had going into that when we knew they were trying to ramp the program up was just how much inventory in particular Rolls-Royce was sitting on. Before they pushed the 380 out, obviously they've been buying product and we've been shipping them.

We were never entirely in the loop of where they are with -- as how much inventory do they have, how many parts do they have, particularly with a start-up program because of the qualification and how many parts were they actually yielding out of what we provide them. So that didn't ramp up as fast as we thought it was going to.

We're also seeing it on the engine side with -- which that impacts the casting side also, because we're not seeing -- some of the case work that we do out at Pacific Cast didn't pick up as fast in the first quarter as we would've thought, and that flows through the engine side also. So all of those things came together, Eric, and that's why engine sales were down from where they were.

But on an overall standpoint, we shouldn't draw the conclusion that there's something sort of going on in your engine business -- it's just the back of the year is going to be much more heavily weighted towards engines.

Right. Yes, that's what's going on. Yes, there's a number of engine programs that are strong right now. Engines -- the 700 that's supporting the A330 is a strong program right now. We continue to do well supporting GE and the T-700. It's the engine that flies the Blackhawk. There's a number of engine programs that are strong right now, and we're actually beginning to pick up some additional isothermal share of a few engine programs. But on an overall basis, it was down from where we planned and where we expected it to be.

Right. With regards to the new capacity coming on-line, a lot of this -- I'm assuming that your intention was -- it was to support the 787 ramp-up, which is now several years out. And as you add this capacity, are you -- as you go into next year, you're going to be adding -- obviously, you're going to be ramping it up and you're not going to flip the switch. But are we going to be in a situation where next year and into 2010, where you have some volumes that are going to be coming through, but you're going to be pretty over-capacitized with regards to having all this new capacity, because 787 is coming on at a much slower rate than originally anticipated?

There may be a little bit of a disconnect, Eric. At this point in time we don't know. We may be a little ahead of the curve at this point, but the overall demand for there is pretty robust, as I indicated. We have been getting additional pickup for additional isothermal work for other programs, so we're not kicking ourselves right now for putting in the new isothermal press. We think it's going to have plenty of opportunity to make parts. The other thing -- along with 787, we know it's still out a few more years. But the redesigned 350 is all going to have to run across that isothermal press, too.

But that's out in middle of 2014, 2015 before you get any volume, right?

Right. Yes, we're doing the development work on it right now. Yes, but as far as major production volumes, it's going to be out '14, '15, which admittedly is a ways out. But you have to have the capacity and you have to be there, and obviously, it takes us a few years to get this kind of capacity up and running. There may be a little bit of a disconnect between immediate demand, but it's ultimately going to be utilized.

So Wayne, with regards to what we should be thinking -- 'cause some of the things that you're talking about when you're talking about gross margins, like your material cost pass-through -- yes, it affects gross margins, but it has no impact on your earnings dollars. Can you sort of walk us through -- again, you talked about, I believe, on the last quarter, low-teen revenue and earnings growth. Would you expect to see earnings growth this year, period, given some of these pressures that we're seeing? Or are we not going to really see earnings growth until next year?

We're certainly anticipating -- as I said, second quarter -- to have a better quarter-over-quarter second quarter than we had last year, it's going to be a remarkable challenge. The other factor to keep in mind -- you've got running through there -- you've got some difference in tax implications, too, from this year to last year. Obviously, we're running at a higher tax rate than we had last year, so second quarter to do better is going to be a challenge. It's not going to be a challenge to do better than the first quarter.

Doing better is one thing, but will it be -- do you think it'll be in the ballpark as to -- obviously, not better, but are we talking -- better than this quarter, you could be talking a $0.50 number. Sort of order of magnitude -- not better, but are we talking sort of off the cliff like this quarter was? How should we be -- I know the business is lumpy. I'm just trying to get an understanding of how some of these things will flow.

Yes, we haven't jumped off any cliffs yet. The lemmings are still here. Winter quarter it's going to come in at -- Eric, at this point in time, we're still in April. I'm not 100% for sure. I'd love to be a lot more specific for you right now, but obviously I can't be.

Some of the issues that obviously we experienced in the first quarter are going to drift into the second. The material issue is going to continue to drift through into the second quarter. The employment is going to be somewhat of an issue, but hopefully we're starting to see a little productivity pick-up in the second quarter, and most of that is going to flow into third and fourth.

Well, the $3 million employment cost that you're talking -- is that just sheerly paying these people, or is that reflecting the lack of productivity?

It's dollars out of pocket. It's what we're paying people. It's benefit increases.

But if these people are less efficient, your [scraps] would be higher because you're investing stuff, and if the casting isn't exactly right, that to me is -- in terms of efficiency impact, what you're going to pay these people is what you're going to pay them. But if they're doing things wrong the first time, you got to rework it. That really is efficiency. I would assume that you're seeing that, too.

Yes, we are. We did see that in the first quarter.

So that would be on top of the $3 million -- that sort of efficiency impact that should --

Yes. Production's so -- it's just hard to put a number on that.

Yes, yes, I know. I understand that.

But clearly, if they're not as productive -- the other thing you can't put -- which I talked about earlier -- I have a hard time putting a dollar value on is -- clearly, when you've got a guy out there in a learnership program, somebody's teaching him, and that guy teaching him isn't as productive as he is if he's just out there working by himself. But given the demand for where we're trying to go with the business as far as growth, along with the fact that we, up until this point, have got a fairly aged workforce, we've got to -- we don't have much choice. We've got to bring new people on. It's an expensive cost of doing business these days, but it's really one that we've got to face to go forward.

How much new hiring do you still have in front of you?

There's some to do but not as much as we have done to date. We're over probably a big piece of the hurdle as far as bringing people on, both here and in Oregon.

So maybe another -- you hired 100, maybe another net 50 or so?

I hope not quite that many. It should be less than that.

And finally, you sort of did a good job of sort of quantifying all the impact. You didn't talk about what the impact from the tool and die was.

Quarter over quarter, the differentiation was probably somewhere in the neighborhood of $0.5 million.

And can you sort of maybe give us a measuring as what it was maybe versus last quarter and the fourth quarter?

The difference between the fourth quarter and the last quarter is probably $0.5 to $0.75 million differentiation.

Great. Thanks a lot, Wayne.

We'll go next to Rob Damron with 21st Century.

Hi, Wayne.

Good morning, Rob.

Let's see, a couple questions. Could you just update us on what you expect for your CapEx in '08, and then where that might go in '09? And then this '08 CapEx -- how much additional revenue annually would you expect to generate from these new CapEx projects?

Okay. Total CapEx for the year, I think -- we're still sticking with -- it's probably going to be in the low to mid $30 millions for '08. And where that ends up as far as what's that going to do as far as additional capacity, we've said that the new isothermal press on an annualized basis ought to be $50 million to $60 million additional capacity. The new melting capacity out at Oregon ought to be at least another $20 million capacity, and probably somewhere in the neighborhood of $5 million plus of machining capacity in Poland.

And where do you think that CapEx budget goes in '09? Does it go down at that point?

At least by half. My guess is we go back somewhere in probably the high teens.

Okay, and then just a couple other questions. What would you say your capacity utilization was during the first quarter?

Capacity utilization was -- I think it was somewhere in the mid 80s, Rob. It's just hard to say. Again, being the job shop, as parts move around, some areas had less demand than we anticipate. Others had much higher demand in the first quarter because of the mix that we had flowing through here.

Okay, and then just my last question, just to get a little more clarity on the backlog. What percent of the backlog is represented by the 787? And then is there any single aircraft or project that represents a large portion of the backlog?

There isn't any one program that's disproportionate amount of the backlog. On more of a macro sense, obviously the Trent family with Rolls is an inordinate amount of our backlog, but that's beating across obviously a multitude of platforms. And, again, that's reflective of Rolls being 25% of our total business. But that's obviously spread from the Trent 700 to the Trent 1000 to the Trent 500 to all the programs that flow across there. So there's not one program that's really disproportionate amount of our backlog.

Okay, and then just specifically with the 787, what would you say that represents as a percent of the backlog?

I don't know off the top of my head, Rob, to be quite candid. Like anything else, it's an important program to us, but it's not 10% of our backlog.

Okay.

No one program is 10% of our backlog.

Okay, that's all I have. Thanks.

We'll take our next question from Vince Damasco with the Colony Group.

My questions have been answered. Thank you.

And we'll go next to J.B. Groh with D.A. Davidson.

Hi, Wayne, it's J.B.

Hey, J.B.

How you doing? I had a question on the backlog. Could you maybe talk about the sort of implied margins within that backlog? Is the business you're turning out more profitable than what you had in the past just on a pricing standpoint?

I would say, from a macro perspective, yes.

Okay. And then maybe you could update us on your Mexico project. I know it's early in that process, but sort of give us an update of where you are on that and the timeline.

Certainly, we're still in the exploratory phase with that, J.B. I guess two points I would make. One, we're committed to the model that we've got for growing out that piece of the business, and adding an additional titanium investment casting facility makes sense. It certainly meets all of our parameters. That, I think, is pretty much of a given.

Where it ultimately ends up being located -- we're still working on that subject. The negotiations on some issues haven't gone as smoothly as one would've hoped and, maybe naively on our part, would've hoped that they would've went in Mexico, that we're not necessarily ruling out other prospective locations for that. We are going to go forward with the project. Location still seems to be somewhat up in the air. We've got a board of directors meeting next week. We'll be talking about that then.

Do you mean someplace other than Mexico, or different places within Mexico?

Both.

Okay. And the thought there is to do smaller titanium parts that don't have the same sort of profitability when you're producing them with Oregon-type labor costs?

It's both the Oregon-type labor costs and the Oregon total overall cost structure with all the engineering talent and everything else that goes into what happens at the Albany, Oregon, facility. The idea here is to set up a dedicated facility that's more committed to part families and, to your point, to smaller, less complicated parts that we could live off of the technology base that we have in Oregon. The theory is not totally dissimilar to what we've done with ZKM in Poland, living off of part of the technology out of Wisconsin, so it's kind of a similar thought process.

Got you. Okay, thanks for your time, Wayne.

Thank you.

And we'll take our next question from Scott Blumenthal with Emerald Advisers.

It's Scott Blumenthal. Good morning, Wayne.

Hi, Scott.

Wayne, can you tell us if the Mexican, or wherever it's going to be, facility -- or if it does fall into your CapEx plans -- is there any of that in 2009?

Very minimal in our CapEx plans at this point, Scott, because quite candidly, we're still wrestling with where it's going to be and what we're going to do with it. Are we going to own the facility? Are we going to lease? What we're going to do, so that's not really reflected in the numbers I was talking about earlier.

Okay, but you do plan on doing something with that in 2009, and therefore CapEx could be a little bit higher than those high teens that you mentioned?

Could be, but it just depends on where we end up and how we go about doing this. I don't mean to be elusive, Scott, but we just don't definitively know right now.

Understood.

We know what we want to do; we're just not for sure where.

Sure. Sure. Completely understandable. Wayne, can you talk about what happened in ZKM during the quarter, whether that performed to your expectations, capacity utilization over there, and what the opportunities are for leveraging that business?

Yes, they had a good quarter. They performed pretty much as we expected. Certainly their improvement was -- it was a better quarter for them, '08 over '07. Certainly they had a better first quarter. They are getting some of their first aerospace product. It's just now beginning to come out and be shipped, so that's definitely a positive for them.

They have the disfortune of being over there, having to wrestle with some currency fluctuations. That's a bit more of a challenge for them, particularly trying to sell into the aerospace market where everybody sells in dollars. While it's great for us, it's a bit more of a challenge for them going from the zloty to the euro to the dollar. But on an overall basis, certainly the operating performance over there is -- they're doing quite well. We're pleased with how they're proceeding.

With regard to the backlog -- and can you give us any idea if any of that applies to ZKM, because you did mention I believe to J.B. that the profitability of what you have in backlog is looking better. Does that apply to ZKM as well?

Yes, it has. That backlog number does include ZKM. We don't break out individually for where they're at, but ZKM's backlog is growing nicely.

Okay. And I don't know if I heard this or not. Did you give us a number as to how much of the backlog you think is going to be deliverable in the next 12 months or so?

12 months? It's about an 18-month backlog, so you can probably --

Divide by two thirds?

Yes, and it's probably a little higher than that. And the other thing you have to keep in mind is certainly a lot of our industrial work -- it's not in that backlog. We're probably only booked out into the third quarter on industrial with people like Caterpillar. You don't even see Cat's fourth quarter demands in that backlog number.

Okay. So is most of the backlog, then, is aerospace?

Yes, it's primarily aerospace and engine. There's probably three to six months of industrial backlog in there, but it's obviously overwhelmingly driven by aerospace and engine demand.

And would it be possible for you to give us some idea how this quarter compared to maybe Q4 with regard to volume and/or sales dollars in the engine, aerospace, industrial, and tooling kind of businesses that you're all involved in?

Well, volumes were up significantly as far as pure part number; that I know -- obviously, along with the dollar numbers. The engine business I would guess was down -- my other comment about year-over-year comparison probably wouldn't vary that much from first quarter over fourth quarter comparison, but I don't have those numbers right in front of me right now, Scott. I'm sorry.

Okay. Maybe I can follow up with a call later.

That would be fine.

And just one last one. What are you doing -- and is there anything that you can do right now from an operational perspective to combat some of these energy costs and employee inefficiency, so on and so forth, that you're dealing with?

Yes. The energy cost -- obviously, part of the biggest couple issues we've done, and we have been doing, obviously, is continuing to update the facilities, particularly in the heat treatment area for some of those items as far as putting in more efficient boilers, more efficient burners, combustion units obviously where a lot of the natural gas gets consumed. And certainly on the electrical side, one of the big projects we did was we switched out a lot of large air compressors and put in smaller ones. But some of that is an ongoing demand, and obviously because energy is such a big expense for us, it's something that we're constantly trying to deal with. But for those of you who have been here -- particularly here in Wisconsin -- know we've got way too big of a facility, and it is an energy beast, particularly when you have a first quarter like we had with below average temperatures every month.

Right. Okay, well, thank you, Wayne.

We'll take our next question from Robert Hoffman with Princeton Capital Management.

Good morning. A couple questions. At ZKM, is it possible to kind of give us a breakdown of kind of the old business that they brought with them as well as the new aerospace business on a percentage basis?

We don't break that down for our individual operating units into that kind of segment reporting. Certainly their business right now -- they're in a transition mode, as we've indicated. When we originally got them, they were 100% industrial. Certainly our long-term drive is to get them to be about 50/50 industrial and aerospace. But obviously, we're a long way from there at this point in time.

And that's really the percentage that I was looking for, and have they retained all of their other business? The point you had made in past calls was that they had just a huge amount of capacity utilization or a capacity availability so that they could keep what they were doing, and then everything you did on the aerospace side would be incremental. Is that correct?

Yes, they certainly kept their general industrial base. One thing we did when we got them -- we continue to make sure that they do is -- to focus on is that they have the right general industrial work, because when we first purchased them, they had a lot of work that, candidly, we'd just as soon them not have. It was jobs they were never going to make money on. So they've done a nice job of transitioning out of that kind of work and try to focus on those areas where they can make a zloty. So they've done a much better job of focusing on getting the right work, and obviously they do have the capacity to maintain their industrial work as they add the aerospace work to it.

Okay. Switching gears -- when the new isothermal press comes on -- you mentioned that you're hoping to be around $50 to $60 million in annualized incremental revenue. How do you price that type of product? It's a very unique machine. Should you be getting better margins on stuff that comes out of there?

We tend to think where there's obviously less competition and more demand that we ought to be paid accordingly.

Okay, so you really are on a demand-driven pricing as opposed to -- I think a number of years ago, you said you were mostly on a cost-plus mentality. So you've moved to more of a -- well, what can we get for this piece of -- what will the market pay us for this product, because market can't get it anywhere else?

Our guys certainly try to price the product accordingly when they know they have an opportunity to do so.

All right. And then, finally, not a major deal but I was just curious, and I'm not an accountant with real training, but I noticed that your shareholder equity went up about -- I don't have it in front of me now -- about $10 million, whereas your earnings were only up around $6 million. Is there one thing that I'm missing there as to why that would happen in a one-quarter basis?

Not off the top of my head. One of the things that does impact that -- one of the negative things that we were hit with a couple of years ago -- when we had to translate pension adjustments that it tends to go down. That was a drag because of under-funded pensions. We're trying to get our pensions back in a better status from that perspective, so there's a number of items that flow through there, and without digging into it right now, I don't know --

All right. So when you revalue pensions, that kind of bumps it up and down without flowing through the income statement?

Yes, it certainly can.

Okay. Good enough. Thank you.

And we do have a follow-up question. Comes from Eric Hugel with Stephens.

Hey, Wayne. Two questions. One, you're seeing the effect right now of metal prices come down in terms of the scrap. I mean, titanium and nickel prices have come down pretty dramatically, but we're not seeing it yet on the top line as well as in the gross margins. I realize some of that is reflective of mix, although I scratched my head at this quarter when pricing went up as a percentage, yet your mix was heavily weighted to industrial and aerospace and not to engine. So I guess, can you sort of maybe reconcile that and sort of when should we expect to see sort of the metal prices come down, as they have in terms of spot prices?

Yes, well, a couple things you got to keep in mind with that question, Eric, is, one, steel's going through the roof. So steel prices went up significantly, and obviously that's impacting the industrial side.

The other thing you have to remember is, although you see spot market bouncing around for nickel and titanium, keep in mind, Boeing and the OEMs, the engine guys, have all locked in long-term pricing that's higher than the spot market, and we're forced to deal with that. And therefore, obviously it passes through to them, but it stays up. We could be out buying material right now at less pricing than we are, but we're committed because of the OEMs to pay the price where they've set the market. They set the market artificially high.

Okay. That makes sense then. And I guess, finally, with regards to 787, I assume at some point, whether it's going to be second quarter or third quarter -- similar to what we saw when the A380s got pushed out, you went through a process of having to de-book orders that slipped out beyond your 18-month time horizon. Did we see any of that in the quarter? And if not, when would you expect to sort of see that? What's sort of the time frame that you would expect to get revised build schedules from the engine OEMs?

We haven't gotten anything to date that's pushed anything out of our window, as far as our backlog window. If it does happen, it will remain to be seen, but the engine guys have not pushed us out beyond that. We were seeing -- and, again, keep in mind -- we were seeing softness pretty much from the beginning of the quarter on, as I indicated. They didn't wait for Boeing to come out with their latest announcement.

No, I understand that, Wayne. But if you just do the math and you have an 18-month backlog, and then Boeing under the prior plan was going to deliver 109 of these aircraft by the end of 2009. Now they're going to do something like 25 and something not that much greater in 2010. The implication being there's a lot of potential backlog there that is going to slip out -- not go away but slip out -- beyond sort of your 18-month time horizon, 'cause right now pretty much the end of 2009 is sort of your 18-month sort of window. So if we're just sort of looking at that window and you're going from 109 aircraft to 25, that sort of pushing out has got to have an impact to your backlog.

Right. I don't argue with you, Eric. I just don't know what the number is, and we haven't seen it yet. As I indicated, there's still nothing in our backlog, including the 87, that's anywhere near 10% of our backlog as far as one program. So it's not like we're going to see a $50 million hit to our backlog.

And would you have any idea of with regards to -- 'cause you're doing product for both the Genex as well as the Trent engine for the 787. Any idea of how many ship sets that you have delivered to date so we can get an idea of what's sort of in the chain already?

No. I wish I could tell you, Eric. It's kind of like the same situation we've had with the 380. We deliver a product, but on the front end of the programs, we're never for sure how many that turns into as far as being actual engines or actually end up being cut up, going into spin tests or otherwise. So I can't tell you how many engine sets that are out there right now.

Would you get the sense -- maybe you just don't know, but would you get the sense that you've been producing sort of to the point that now there's a sizable quantity of inventory, and that Rolls and GE are basically going to tell you guys, stop, don't produce anything for the next two years?

I don't think so.

You would expect to be producing 787 equipment over the next couple of years, but just at a lower rate than you were previously?

That's our guess right now. We certainly don't think we're going to be put on hold for two years by any stretch.

And how would that work in terms of any metal that you've gone out and bought to the prior build rates? Is that something that -- similar to the A380 where you guys got compensated for that?

We certainly hope so. We're not interested in being out here and being a warehouse for GE or Rolls-Royce or Boeing either, for that matter. So far no one has indicated that that's what they're going to do.

And you don't really have any visibility as to when you're going to get any visibility with regards to this.

Not yet, but keep in mind a lot of the material going into the 787 program is a lot of powdered material, Eric, so there's not a surplus of that floating around. So it's not like we're sitting on ingots and ingots of titanium. It's a matter of getting the product as opposed to having way too much of it.

And I guess that's a positive from the standpoint of what's likely in the supply chain is likely below what they would like to see also.

Right. Exactly. I mentioned that earlier. If there's a silver lining to the dark cloud of the 787 drifting out, it gives the supply chain a chance to get better caught up and better situated to support the program going forward.

Okay, great. Thanks, Wayne.

And we do have a follow-up question from J.B. Groh with D.A. Davidson.

Yes, Wayne. On the 787 -- this has also kind of helped you out in this CapEx plan that you have. It takes a little bit of pressure off this big isothermal build. If that were to slip in any way, you're probably not under the same pressure as the old schedule, correct?

Well, it certainly gives a lot more time to get programs certified, J.B. The people won't be perhaps as crazed as they might've been. So yeah, it certainly gives that opportunity and gives an opportunity to get things tweaked out of the system before you feel like you have to suddenly start throwing product through it faster than you might want to. That's an opportunity to have a more efficient production process.

So if you're testing in Q3 and you think you can start producing parts in '04 [sic-press release], with the delay do you think you have a chance at being more profitable out of the gate, or is there still going to be kind of a learning curve ramp there?

Yes, there's still going to be a learning curve ramp. That's just what happens with a new process of this complexity, but we're still confident that the process is going to go forward, the press is going to be utilized, and, again, it may not be as robust in '09 as we had originally thought, but the long-term demand is certainly there.

But by middle of '09, things should be running at a pretty good clip, correct?

Oh, absolutely.

Okay. And then if you could help us remember how you kind of managed gas prices -- you try and buy forward a little bit, don't you? And maybe you could talk about sort of what your embedded costs are for the rest of the year, if you know that.

Sure. Well, we clearly do buy forward, and we try to buy forward and cover ourselves somewhere in the neighborhood of around 70%, 75% of what we perceive to be our projected demand. We don't try to buy more than that, because sometimes things happen. 9/11 was a prime example. When we bought forward a little more than we had and 9/11 happened, the market and the industry demand fell off 40%, and we had more natural gas than we knew what to do with and took a bath over it.

So we don't try to buy forward any more than about 75% of projected demand. What happened to us in the first quarter was, obviously, demand came in a little higher than projected, and the weather with the heating season was significantly more than what we had projected. We project out based on what our typical average demand is going to be for a heating season, and this year because of the weather was significantly higher. So that had us filling in in the spot market, and the spot market -- obviously, because of it being so cold, the spot market was up along with our demand being up, so we got it on both sides.

So your forward price is in maybe $6 to $8 range, and then the fill-in for the excess demand was in the $9, $10, $11 range.

Yes.

Okay. That makes sense. Thank you.

And Mr. Larsen, there are no further questions in the queue. I'll turn the call back over to you for any closing remarks.

Okay. Well, if there aren't any further questions, I appreciate everybody dialing in this morning and listening. As always, if anybody has anything else that dawns on them later, don't hesitate to give me a call. We'll continue to try to push forward, and I look forward to talking to you in July with hopefully some happier news. So thanks for calling in, everybody.

This does conclude today's conference call. We appreciate your participation.