Carpenter Technology Corp (CRS) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2007 Carpenter Technology earnings conference call. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session toward the end of today's conference. At that time, if you wish to ask a question, (OPERATOR INSTRUCTIONS). As a reminder, ladies and gentlemen, this conference is being recorded.

I would now like to turn the presentation over to your host for today's conference, Vice President and Treasurer, Mr. Jaime Vasquez. Please proceed.

Good morning. Welcome to our conference call for the period ended September 30, 2006, the first quarter of Carpenter's fiscal year. This call is also being broadcast over the Internet. With me today are Bob Torcolini, Chairman, President and Chief Executive Officer; Dave Kornblatt, Senior Vice President Finance and Chief Financial Officer; and Rick Symons, Vice President and Corporate Controller.

Some of Carpenter's statements will be forward-looking statements which are based on current expectations. Risk factors that could cause actual results to differ materially from these forward-looking statements can be found in Carpenter's recent SEC filings including the Company's June 30, 2006, 10-K in the exhibits attached to those filings. I will now turn the call over to Bob, who will start with a brief overview.

Thank you, Jaime and good morning, everyone. As you read in this morning's news release, we reported record first quarter net income. It was the third highest level of quarterly net income in Carpenter's 117 year history. The record performance was achieved despite significantly higher raw material costs. We estimate the impact primarily from the rise of the cost that nickel added $26 million to our cost of goods sold.

Our performance highlights the benefits of our continued focus on operational excellence through lean and variation reduction and the elimination of marginally profitable products. These actions are the cornerstone of an operating model that will generate returns in excess of our cost of capital through all phases of the cycle.

Now, let me provide you with some detail on Carpenter's consolidated first quarter sales, which increased 17% from a year ago. All references that I make to changes in sales will be based on year-over-year comparisons.

The quarter included a significant increase in surcharge revenue as a result of a rapid escalation in raw material prices. Dave will talk about the impact on margins in a few minutes. Excluding surcharge revenues, sales increased 10%. This level of growth is particularly satisfying, given the strong demand for our materials that we experienced a year ago.

Sales to the aerospace market increased 34% to $158 million, a first quarter record and the third highest level of quarterly sales to that market. We experienced solid demand for our titanium, specialty alloys and ceramic materials, which reflects the projected increase in commercial aircraft deliveries.

Demand for titanium material used in the manufacture of structural fasteners for commercial and military aircraft was particularly robust during the quarter. Shipments to this market were a first quarter record and were primarily responsible for a 33% increase in total titanium sales.

We saw solid demand for our specialty alloys used in the manufacture of aircraft engines and airframe structural components. Sales of our ceramic cores used in the casting of turbine blades for aircraft engines also increased, and was a primary contributor to a 7% growth in first quarter ceramic sales.

There has been a significant step up in our sales to the aerospace market. Over the last four quarters, aerospace revenues totaled nearly $660 million or 40% of total revenues. Our sales to the automotive and truck market increased 23% to $52 million. Sales to this market were near record levels and more importantly, reflect a richer mix of products than in prior years.

Demand for high temperature alloys used in automotive engine components and specialty alloys in stainless steels used in automotive safety devices such as airbag sensors contributed to the increased. Industrial market sales increased 13% to $88 million. Beginning with this quarter, sales to the oil and gas sector are no longer included in industrial market sales. These sales are included in a new category for Carpenter titled Energy, which will also include sales from the Power Generation sector. We are segregating sales in this manner because of our increased focus on the energy market.

Industrial market sales benefited from increased capital expenditures made by manufacturers. The strength of the industrial market was the primary reason for the 13% increase of our stainless steel sales.

Consumer market sales increased 2% to $48 million as a result of higher base prices in surcharges which offset reduced sales to the sporting goods sector. Sales to the energy market of $29 million were relatively flat with a year ago. Our focus on the oil and gas sector helped increase sales by 67% in the recent first quarter from a year ago.

We are excited about the opportunities we are finding among oilfield service companies and the growth we are enjoying with key energy customers. The growth in the oil and gas sector was offset by reduced demand from the power generation sector due to the timing of some shipments to customers.

Medical market sales decreased 7% to $30 million in the first quarter from a year ago. Although the strong growth fundamentals in this market remain unchanged, demand declined due to inventory adjustments taking place within the supply chain.

International sales increased 20% to $123 million or 30% of total sales. International sales benefited from increased sales to the aerospace market.

In terms of sales by product line, sales of titanium materials experienced the largest year-over-year increase. As I mentioned, sales increased 33% to $48 million. Robust demand from the aerospace market was partially offset by reduced demand from the medical market. Sales of our specialty alloys increased 20% to $172 million. Solid demand from aerospace, automotive, and oil and gas markets were the primary contributors to the increase.

Our stainless steel sales increased 13% to $144 million. Solid automotive and industrial market demand resulted in the second highest level of quarterly sales in more than six years. More importantly, our stainless steel sales contain a much greater proportion of higher value materials as a result of our focus on reducing marginally profitable products.

Ceramic sales increased 7% to $27 million in the first quarter compared with a year ago. Strong demand from the aerospace markets benefited sales.

Now I would like to turn the call over to Dave.

Thank you, Bob. As Bob mentioned, sales in the first quarter were up 17% to a first quarter record $404.5 million. Excluding surcharge, sales increased 10% from a year ago due to higher base prices, increased sales of higher value products, and increased shipments.

Gross profit in the first quarter increased by 13% to $103.9 million from $91.7 million a year ago. This was a first quarter record for gross profit. Gross margins, however, declined by 80 basis points to 25.7% of sales from 26.5% a year ago. The decline was directly attributable to the significant increase in surcharge revenue collected. The increase in surcharge revenue primarily reflected the change in nickel prices, which were 100% higher on average compared to a year ago and had a dilutive effect of 120 basis points on gross margin.

Cost of sales in the first quarter of fiscal 2006 included a charge of $26.2 million to value inventories using LIFO method of accounting due primarily to rising nickel cost. In the first quarter a year ago, cost of sales included a $3.7 million credit to value inventories using LIFO.

Selling and administrative expenses in the recent first quarter were $30.8 million or 7.6% of sales compared to $28 million or 8.1% of sales in the same quarter a year ago. The increase in selling and administrative expenses reflected $1.6 million of costs associated with due diligence expenses of a potential acquisition and $800,000 of recruitment fees.

Despite the significant rise in raw material costs and marginally higher selling and administrative expenses, operating income increased to $73.1 million or 15% more than a year ago. Other income in the quarter was $5.9 million compared to $3 million in last year's first quarter. The increase in other income is primarily due to increased interest income from higher balances of invested cash.

The tax provision in the recent first quarter was $22 million or 30.1% of pre-tax income versus $20.6 million or 33.9% in the same quarter a year ago. Our tax provision in the recent first quarter reflected the reversal of certain deferred tax valuation allowances due to change in specific state tax laws and an improved outlook regarding the ability to use those benefits.

As a result of the strong operating performance, Carpenter generated record first quarter net income. For the quarter, net income was $51.2 million or $1.94 per diluted share as compared to net income of $40.1 million or $1.54 per diluted share in the quarter a year ago.

Turning to the balance sheet, accounts receivable were $41.1 million higher than a year ago due primarily to increased sales. However, day sales outstanding were reduced to 48 days from 49 days at the end of the first quarter a year ago.

Inventories of $233.7 million were $20.6 million lower than last year. For the quarter, free cash flow was $50.8 million versus $0.7 million in the quarter a year ago. In addition to $11.1 million in higher earnings, free cash flow benefited from improved working capital.

Capital expenditures in the quarter totaled $7.3 million as compared to $5.7 million in the previous year's first quarter. We anticipate that total fiscal 2007 capital expenditures will be in the range of $35 million to $45 million. Based on our expectations for steady earnings growth and further working capital improvements, we remain comfortable that our free cash flow will be in excess of $200 million for fiscal 2007, as previously announced. I will now turn the call back to Bob.

Thank you, Dave. Let me close by saying that Carpenter is in the best position in its history to capitalize on new market opportunities and to continue increasing shareholder value. As many of you know, I announced in June my plans to retire. Carpenter's Board has elected Ann Stevens to succeed me on November the first, as we announced last week.

Ann has the depth of skills and experience that will be invaluable to Carpenter as it moves through its next stages of growth. Ann and I share many of the same continuous improvement philosophies including a strong belief in the value of lien and variation reduction. I am extremely optimistic about Carpenter's future and I'm certain that the Carpenter team will continue rewarding shareholders with exceptional returns. [Operator], we will now open the call to questions.

(OPERATOR INSTRUCTIONS). Michael Gambardella, JPMorgan.

Good morning. I have a question in regards to the LIFO hit took in the quarter. It's an extremely large number -- about $0.65 per share. So it's very large on an absolute basis. But if you look at it compared to say Allegheny, which reported yesterday, your LIFO is relatively large to theirs. I looked at it on a pre-LIFO basis and then looked at the LIFO charge as a percent of that pre-LIFO number. And you are quite a bit higher as a percentage there. Is there any reason for that relatively higher LIFO charge?

Mike, I think we've got two big drivers in there. I mentioned nickel, that's a pretty good one, and also we have titanium in there as well.

I know, but Allegheny has the same thing. I don't know if it's exactly the same, but certainly in the stainless they have the nickel and superalloys of nickel and they have titanium as well. Could you explain any reason why it would be relatively higher than Allegheny's LIFO charge?

Dave, do you have any comment on that?

I believe the portion of our business that would be nickel-based alloys would be a higher percent than maybe ATI would have. I think that in percentage terms, I think they're titanium business is larger than ours and that's not where the larger increases were for us this quarter.

And on the timing of the surcharge mechanism, could you just go through that, how you realized the higher cost in nickel and your surcharge on pricing?

Well, as you know, on LIFO, we expense the cost of those materials as soon as we procure them. And in terms of the recovery, surcharges typically have a lag. That lag is generally a one month lag. So we won't recover -- depending on the timing of it, we may not recover, fully recover that until that period ends.

And then last question. Just on the potential acquisition, how do you -- can you give us any status on the potential acquisition and also how do you handle a potential acquisition when you're retiring and a new CEO is taking over?

Well, Mike, we really would not make a practice of commenting on any acquisition activities that we might have underway, but the charge that's related in the quarter, it relates to an acquisition that doesn't seem certain to materialize. And I guess I would emphasize the word certain because I think its strict interpretation of the accounting rules would say unless you have certainty, the conservative treatment would be to expense that and that's what we've done. So it's just the degree of certainty.

So that's something that you're probably not going to consider going forward?

Yes, all I said is that it's just a degree of certainty to materialize. It's not to say that it won't or can't. It's just the way that we've accounted for it.

And can you make any comment on volumes in terms of your volume activity on the shipment side, just sequentially in the quarter.

I don't think we really look at that sequentially. We really looked at it on more of a year-over-year basis and it's up slightly. About 4%.

Did you have any outages in the quarter?

We had a few. As you know, we have our major plant shutdown in our largest business unit in SAO, especially alloy operations, and we had a pretty extended shutdown in our arc melting area. We had a foundation problem with our 40 Ton AOD, so we were down in that shutdown for almost five weeks. We also have a couple of unplanned outages, one on our [Rotarage Forage] and one on our large vacuum induction melting furnace.

So those happen within the quarter and they had some impact, but there will be recovery on that.

Can you quantify that?

Not really, no. We haven't really disclosed that and don't care to.

Chris Olin, Cleveland Research.

Could you talk a little bit more about the shipment delays to the energy sector or the energy customer, what's going on there and just help me out a little bit with why medical sales are weaker than expected.

On the energy sector, we mentioned that it's really due to the timing. And that means that in some cases, we have heavy shipments, particularly into the power generation sector and then it kind of slows and then it comes in surges. So I think one of the things we're seeing is really the timing of those shipments, particularly to the power gen side.

On a routine basis, we normally see this in the 15 to 20 million per quarter. And that would be on a more normalized level that we would be seeing. The first quarter was really down at about the 11 range. So, on the medical side, in prior calls, one of the things that you heard me talk about was erratic supply chain behavior and I think this is really manifesting itself pretty heavily now on the medical side. And what that's all about, you heard me say that when you have rapidly escalating material costs, and that certainly was true on the titanium side, and you have shortages of material, which obviously occurred in the prior quarters on titanium, you have erratic buying behavior because people are really concerned about not having the materials to make the devices. And I think in the medical world, in order to make sure that there's adequate material to support product launches, it's not uncommon for people to really buy forward.

And so that kind of erratic supply chain behavior, we believe, is what we've seen in the this recent quarter, in this particular quarter, because it's really primarily on the titanium side, we also make chrome cobalt Molly and it's not as pronounced on that side as it has been on the titanium side.

Can I assume that the fourth quarter will be a little bit better than expected on the shipment level because of the delayed orders?

You mean our second quarter? I guess in our second quarter, again, I don't really speculate on what's going to happen in the quarter ahead. The one thing I can say is that the reason that we're seeing the decline, the 7% decline, is primarily the burnoff of inventory at some of the major medical accounts.

Are there any Airbus issues that might have impacted the quarter?

I would say no. I would say that the things that we talked about previously with the A380 and the new delay on the A380, I think a lot of those things had already been reflected, and the aerospace shipments were continually very strong through that quarter.

Now, having said that, certainly when you look at the forecast, the build of airplanes, of A380 airplanes through 2010, there is a change there that may have a moderating effect on growth of the industry as a whole, but there's still a lot of underlying growth there.

I guess and lastly, just looking at your stock price reaction today, is it time to maybe consider giving a little more earnings guidance, given the kind of volatility that you're seeing from order to order and maybe it would help in terms of investor reaction?

I think we're very proud of this quarter's results. This is the third best quarter in the Company's history and a very, very strong first quarter. You're aware of the seasonality that we typically have in our business because we typically make between 55% and 60% of our earnings in the second half of the fiscal year. So we are pretty pleased with this result.

Mark Parr, KeyBanc Capital Markets.

You guys keep knocking the cover off the ball. Great quarter. And Bob, we're going to miss your comments every quarter. Again, I think I said this last time, but I'll just say it again for repeat. You've done just one hell of a job charting a great course for this Company over the last 10 years. So, best wishes to you. I can't wait to figure out what you do next.

I wanted to just kind of pile on with what Chris said. I think that -- this is my opinion. You're probably doing better than any other specialty metals company in the market and you're not getting the equity value that a lot of these other companies are getting. And I know that you don't feel compelled or comfortable with quarterly earnings guidance. But, I think that the price that you pay for that is a lower equity valuation in the market. And just as a way of enhancing shareholder value, I would say that, given the very strong performance you have and the strong outlook that you have achieved and the great positioning that you have, probably one of the best things that you could do for the stock is to be a little more helpful on where you think the quarterly earnings are going to be. Look, I know that we have a philosophical disagreement with that, but I just want to put it out in a public form one last time if I could.

Okay, Mark. So noted.

Anyway, congratulations and we'll look forward to continued good performance from Carpenter.

Matt McGeary, Sentinel Asset Management.

Is there any regulatory or legal reason why you couldn't give your new repurchase program a test drive this morning?

I'm sorry, I'm not sure I heard the question correctly.

Is there any reason why you couldn't be buying back stock this morning from a legal or regulatory reason?

We're subject to the same windows, so we don't -- I think we wouldn't be in the market until Monday.

What is that, 48 hours, is that how that works?

Yes.

Just on the M&A front, it sounds like that deal may or may not happen. Just sort of curious what you're seeing on that front out there -- more or less encouraged than you've been in recent quarters, sort of what you're seeing on valuations, other opportunities there?

I think previously we commented that there are a lot of metals materials companies right now on the market because there are pretty strong market prospects for metals and materials companies, so the valuations typically reflect the strength in the markets. But I'd say that we believe that we can find acquisitions that meet our financial criteria even in these markets. So, if you forward, the markets are strong. So the right acquisition with the right product and market exposures would still be attractive.

Are there any capacity issues right now that maybe affecting the volumes you're getting out the door or is it just sort of seasonality and general market dynamics?

I would say the latter.

Don Brown, Principal Global Investors.

On the LIFO reserve charge, I have 26.1 million shares outstanding, you have 26 million. If titanium prices flatten out and nickel prices flatten out, will you guys regroup this 26 million through price increases?

I think if your question is in a stable commodity environment, would we be able to improve margins going forward, I guess I'd say yes.

And on the share repurchase plan, can you give me some color on when do you plan to buy stock? Do you plan on doing it quarterly? Do you plan on doing it opportunistically? What do you plan to do there?

I think the best answer to that is really contained in our press release that was issued, I believe, on the 21st of September which talked about our strategic initiatives, and it referenced those shareholder actions of both dividend and share repurchase. It looked at all of the uses of cash including capital expenditures for organic growth and also the acquisitions, as well. So it will be a balanced approach, I think.

No particular timing? I mean, I've invested in metal companies all my life and I see a lot of unfunded stock repurchase announcements. So, if you could give some more color on that, that would be appreciated. That's kind of open-ended. Thank you.

Andrew O'Connor, Wells Capital Management.

I wanted to know, can you guys elaborate on the plans announced on September 21st to invest $200 million in CapEx over the next four years, of which you'll spend $35 million to $45 million in 2007? Where is the money going and what are your priorities for this year? Thanks so much.

Well, of the $200 million, one of the things that the biggest chunk of that is really going to probably be in the primary melting side of the business, particularly in what we call premium melting. And so premium melting is really directed at the high-value products. And that would include things like vacuum induction melting, vacuum arc remelting, electroslag remelting and even hearth melting.

So those are areas of premium melting that we would be anticipating capital spending over the next few years. In addition to that, there are some select other capabilities, again, primarily directed at high-end products that are serving the aerospace, medical energy, and high-end automotive markets.

I said previously we've got lots of finishing capacity because of having redirected a lot of our stainless capacity away from these marginally profitable products, so our real augmentation and technological investments are really going to happen primarily on those premium products side.

In the $35 million to $45 million, we've already -- what we were referring to there is we have a capital approval process where we valuate projects, approve projects; depending on their size, they could be approved by the Board or approved by myself as the CEO. A lot of those projects have been approved, so the cash will flow in fiscal '07 and that's what we'll be seeing in fiscal '07 is the result of some of the approved projects and some projects that have yet to be approved.

So the addition to premium melt capacity, would that begin this year -- fiscal '07?

Yes, we already have made an investment in two additional VAR furnaces. That was detailed in the September 21st release, so we currently run 17. We'll have 19 by December. And we also retrofitted two idle ESR furnaces, so we modernized and computerized those.

So we've really brought four remelt furnaces on in the past year and what we will be needing to do is to augment that capacity based on market projections for the future.

So of the $200 million, like what dollar amount then would go to premium melt?

I don't think we've really carved that out yet and because we're still in sort of the preliminary engineering phases, it would be premature to really cut that out, to really specify that.

And then secondly, there have been some questions asked about the share repurchase program. I wanted to know, can you more explicitly review your priorities for the use of more than $200 million in free cash flow this year fiscal '07? Thanks again.

Detailed in that press release is that we see those organic growth opportunities totaling as much as $500 million over the next four years. We want to be certain that as those growth opportunities materialize, that we are prepared in advance of that, so that's the organic growth piece in the capital. And then the second thing, obviously, is we believe there could be some very good strategic acquisition opportunities for us. So that would be our priority right there. And then balancing that, the capital and the acquisition would be a very measured, considerate dividend practice.

As you know, last quarter increased our dividend by about 50% and we look at that as pretty much a one-way street. We want to do it on a certain basis so that we will not have to do what we had to do a few years ago. And then lastly will be a share buyback considerate of all the factors including what our cash position will be after some of these other things are done.

Tony Rizzuto, Bear Stearns.

I've got several questions here. First, I'm a little bit unclear on the acquisition strategy a little bit. I wanted to make sure that I understand the comments that you said earlier. Are you still involved in negotiations as of this moment?

We wouldn't really comment on that. All I can say is that the accounting treatment of this, you have to have a very high degree of certainty and if that certainty isn't there, then we took a conservative approach to book this.

Now, with some sensitivity to that, I was wondering, can you elaborate maybe as to why it sounds like this is not going forward, maybe these negotiations or discussions you were having -- was it simply a price thing? Was it a cultural difference type thing? Can you elaborate a little bit?

I think it's probably a very simple answer -- valuation.

And then I guess along with the 921 release on strategic initiatives, should we read that Cartech will take a more restrained view of looking at acquisitions smaller in nature? Is that the proper way to look at it?

I would say that our interest in acquisitions are really those that are going to be meaningful from an earnings and revenue standpoint. We have a history in the '90s of having acquired some relatively small not-material businesses and we really are looking for things that are more meaningful and more material.

I've got a couple of other questions if I may, one on the share buyback. I hate to beat a dead horse, but let me ask it this way. Is there anything that would preclude you guys from buying back your stock 48 hours from now?

I think the reason for the authorization was to have the flexibility to do that.

But obviously, if there's something going on, it would preclude you from buying any of your stock. Is that correct?

Meaning if we have a blackout in place?

Exactly.

I guess I'm going to defer not to comment on that, if I could.

The last question I have is on [Airbus]. If you could give me some sense of where your current exposure is now if you look at exposure overall and in terms of all the segments that obviously serve that market, Boeing versus Airbus, and given how contracts may change, where you see that changing, Bob, over the next two or three years, that relative exposure.

We've said that in the past, we're pretty evenly balanced, if you will, between where our aerospace products are really headed, be they Boeing or Airbus. And I would say that has not changed. So whereas the A380 delays will have an impact on the business, conversely, the 787 success is going to also have some impact on the business.

So I think we've strategically intended to be able to have a very balanced exposure to both Airbus and Boeing on the commercial side; that is where so much of the growth is. We all read the projections for 2025 and how many airplanes are going to be delivered in that period. It's a lot -- 27,000 airplanes. So we want to make sure that as that market grows and as both Boeing and Airbus grow in that market, we want to be right there with them and we are comfortably positioned right -- very, very well with both end markets.

I just want to extend my congratulations to you two also and wish you all the best in your future endeavors and also, your congrats on riding the ship.

Thanks, Tony. I appreciate it.

Dan Whalon, Bear Stearns.

Just in regards to your efforts to reduce the marginally profitable sales, I know you've already made a lot of progress on this front. Just wondering if you could give us a sense of how much more room there is to go and -- or maybe a bit more specifically, what percentage of sales kind of fall into this general category?

Dan, we've talked about this in the past and I'll say that what we have done is we've done a lot of the heavy lifting on the marginally profitable business, but there is a portion of our business that we continually revisit. A part of our portfolio that is, let's call it on the bubble, that based on different market conditions, we are opportunistically looking at what do we participate in? What don't we participate in? So I would say that the majority of the reduction or the elimination, let's say, of some of these products, that's behind us and now what we really look to do is to judge whether or not the returns that we could get from those products are really attractive to us at any point in time.

And some of that could be market and some of that can be that we successfully reduce the cost of our making the product and reintroduce ourselves into the business. So I would say that that's an ongoing thing. I've been asked in the past how much of our business would we consider to be more of a commodity and that would really be in the area of the stainless bar business. We make some stainless bar that is sold through independent distribution and it represents right about 10% of our sales.

[William Volvo, CRT OOC]

Again, superb performance. I, like the other folks as you can surmise from the call, are just hoping that you might be able to give us a little bit of an anchor to [WinWord] on visibility on LIFO. And maybe it's more of a request than a question.

If you were to just formulate an equation which took last year's mechanically and historical and highly sterile average price for nickel during what is going to be your second quarter and looked simply at what you saw the run rate of purchases and costs for the upcoming quarter, and then turned the crank, and just gave folks a sense, and I know that there are moving targets and depending upon what your levels are, but if there was just a range given, and you wouldn't even have to give specific guidance on EPS, but you could at least help folks have a sense of whether or not there's a rock in the harbor. And if you want to respond to that, that's fine.

But I also share the sentiment that you all are winning the battle in terms of executing your business, but the folks in the equity market just -- it's all about fear and greed and I think they've got more fear than they should over the fact that this is a fine company that really is -- warrants a much higher multiple, particularly on a day like today where you all have put your heart and soul into executing so well.

I appreciate those comments. I can only say this, is that looking forward, I can't tell you that I have any great insight into what's going to happen in some of these commodity markets. I don't think anyone would have anticipated the rapid rise in nickel prices, and as you well know, there's so much financial hedge fund intervention in nickel, so it's not really just supply, demand and producer pricing.

It's really driven by a lot of financial intervention. So it's very difficult for us to predict on a going forward basis what's going to happen with these prices and therefore how it's going to affect the valuation reserves that we need to take. The most important thing for our business, however, is that we do not expose Carpenter to the fluctuations in those raw materials. I think that we've been very successful through surcharge mechanisms and other means to be able to pass those along because these are globally traded commodities and we just don't have any control over that. So I think that's the best I can tell you in terms of our ability to look forward.

So what is the interplay between a non-cash LIFO reserve and your -- on a good forward basis, being able -- you mentioned earlier in the call a one-month lag. To what extent will you now have a one-month lag to step up the charges to your customers that are implied by the LIFO step up that you had to take on your own inventory?

Let's answer that by just taking a theoretical. Let's say that nickel prices today are roughly $15 a pound. And if suddenly they were magically to go down to $10 a pound, next month we'd be surcharging at $15. So, there would be a recovery, if you will, if there was a rapid reduction. But on the way up, obviously, it's a drag.

But in terms of on the customer side, when it goes from $10 to $15 on the customer side, you have an escalator, do you not?

When it goes to $10 to $15, correct, but we don't collect it immediately.

Right. But I guess that's my question. Is it too much lost in the complexity of all of the different pricing mechanisms and charts that you have in terms of leaps and lags? Is it something where over the course of one quarter lag, you would more or less recover the -- let's just say the prices are sustained?

Generally, if they were to stabilize right now, then the short answer is yes.

Over what interval?

Certainly, you said within the quarter. Yes. Without a doubt.

Chris Olin, Cleveland Research.

Can you talk a little bit about how much upside you guys see in the titanium fabrication business? Still looking at strong volumes for '07? And also, just want to touch upon this conversation we had at the titanium conference which suggested that the early preview for the Next Generation 737 design would have a composite wing. Now, I guess that would assume some pretty good faster demand on a longer-term basis as well.

Your first -- you've said titanium fabrication? Is that what I heard you say? Is that what you meant?

Yes, I did.

Fabrication. Well, I just want to say that our titanium in aerospace is primarily wire products that are being converted by others into fasteners. And those fasteners are primarily driven by the builds of new airplanes. So just to level set that. So clearly, if you look at the airline monitor numbers for 2007 and 2008, the most recent July numbers, they had numbers in '07 of roughly 900 planes delivered and in '08 about 1,000.

You really need to back out the A380 numbers now, but that still leaves the 910 down to about 880 and the 1,000 down to about 960. So there's still a lot of airplanes that are going to be constructed and if you look at the mix of those planes, 61% of the future plane builds are projected to be single aisle. 23% are the twin aisle and only 3% are the big ones, the 737, 747's and the A380's.

So there's still a lot of aircraft activity out there that's going to be occurring within the next three to four years and even beyond that. So that's why when so many people ask questions about the aerospace side, the commercial aviation side, I'm sure that these events like the A380 are definitely going to be felt within the supply chain, but there's so much other activity out there that that's what's different, I think, about this particular period than in prior periods.

You asked about the 737. I would say that since the single aisle is 61% of these new planes that they are projecting for the future, they are just going to have to be operating at a completely different level of efficiency. And the way to do that is to get the weight of the airplane down and get the fuel efficiencies and engine efficiencies up.

That's going to drive development, both on the engine side and on the airframe side. So I would say that when you start seeing more composites, and there's already not an insignificant amount of composites even on some of these single aisle aircrafts, but you're going to see even more. And as they fit more airplanes with composites, you're going to see more and more titanium. Not only titanium structural members, but titanium fasteners because of the compatibility with the composite materials. So that's a very good trend. You're still going to see a lot of single aisle and the regular twin aisle airplanes, and they're going to use more composites and that's going to bode well for titanium fasteners and otherwise.

And then lastly, I just want to touch a little bit. Can you just -- I'm not sure if anybody's asked you yet, but can you discuss your nickel-based alloys backlog -- maybe where you stand versus the last quarter? I get the sense that there might have been a surge in demand, if you will, in the second half and that might be favorable outlook in next quarter and then going forward?

We haven't broken out anything regarding nickel-based alloy backlog. We talked generally in a file in our 10-K what our backlog is and our backlog has remained pretty stable. So, I mean, as far as nickel-based alloys, this has been a robust period and it continues to be. Does that answer the question?

Sir, his line has disconnected. He may have accidentally -- Did you want to take the next question?

Sure.

Eric Mintz, Eagle Asset.

I was wondering, could you just comment in terms of both near and long-term behavior patterns from your customers, what $15 nickel prices is doing -- what you're seeing out there?

I answered a question earlier regarding the medical market and really we talked about titanium. I would say the same kind of behaviors are happening when you have nickel going to $15. Because people really are taking a hard look at -- particularly people who are buying alloys that have 50% to 70% nickel -- they're really taking a look at this rapid escalation and then that causes them to say do we believe that it's going to stay at these prices? What is my inventory position right now? Could I sit out a month's worth of procurement and burn down my inventory on the chance that nickel prices are going to come down? I would think that kind behavior is not uncharacteristic when you see this kind of unprecedented level of nickel buying.

The other question we've received in the past has been do you see substitution? And I've answered it by saying if we're talking about stainless steel on barbecue grills, you might see substitution. If you're talking about a nickel-based alloy in the hot section of a jet engine, it doesn't happen.

So, there's not going to be substitution on the very, very high-end applications which is where we're focused, but you can be sure that people are very concerned when they're purchasing large, large quantities of these materials, when you see a doubling of nickel price and you have half of the raw material cost that is nickel. So there is some of that where people are looking, holding off and then saying, well, gee, if it doesn't come down, I have to order anyway and so that causes some of that erratic supply chain behavior.

Is it possible to say then that some of your customers' inventories might be low in light of that behavior right now?

If you think back to the last, probably 12 to 18 months, availability has been an issue. So, customers had been operating freely lean on inventory, but they always also try to make sure that they have some buffer stock and when that buffer stock enables them to be more flexible with their purchases, they'll do that.

I wouldn't speculate on where inventories are, in the supply chain it differs by company. You see some companies that are heavy on inventories, others that operate freely lean. So it runs the gamut.

Gregory Macosko, Lord, Abbett & Co.

Could we just go back to the capital expenditures that we were talking about earlier? Would you describe the $200 million that you want to spend as debottlenecking so that we wouldn't expect to add capacity? Or will there be a reasonable amount of capacity added as a result of the spending?

The real simple answer is that it is adding capacity in response to growth. So, as we see the growth and just think of the numbers that I just talked about earlier with regard to the aerospace -- the commercial aviation -- 27,000 airplanes is going to drive a lot more demand for things like nickel-based alloys, titanium, high performance stainless material. So we need to make sure that as that growth is going to be materialized, we're prepared in advance of that growth so that we can respond to it.

So, it's looking at growth, and yes, there's also a technological component that we want to make sure that we're modernizing and keeping our facilities technologically current. So it's not just a debottlenecking, per se, it's more of a adding capacity in response to market growth that we see in many of those sectors I mentioned earlier.

How much do you figure over that -- with that money that you're going to spend (indiscernible) in terms of capacity?

Well, from a revenue perspective, we see the opportunity for $500 million worth of additional revenue over that four your period.

So just on a normalized basis, that would relate to the capacity as well, that $500 million, then?

Yes.

And so I guess going back to another question with regard to the shifting of products from sort of lower end to higher end product, I guess that kind of answers that question, that there's relatively little low profitability remaining at this point relative to the capacity issue that you're talking about.

Yes, in fact, what really has happened there is that as we decreased our participation in those marginal products, it literally, on the finishing end, frees up the capacity to do more of the more high-end, high margin. They do process at a much slower rate, so it's not one pound for one pound, but it does free up considerable capacity, and that's, as I mentioned earlier, very much behind us, so we've got plenty of finishing capacity, plenty of rolling capacity, plenty of heat treating capacity, and where we just see the need for augmentation (inaudible).

And then finally, do you feel that the others in the industry are taking a similar tack and so that we may see quite a bit of additional capacity coming on over the next year or two?

Well, much publicized has been the addition of titanium and titanium sponge capacity globally. So, but again, there's also a projected doubling of the requirements of titanium in the years ahead. So I think that the answer would probably be very much along the lines of what I've said, is you've got to be somewhat proactive to anticipate the demand curve before it's upon you.

Matt McGeary, Sentinel Asset Management.

Just piggybacking on that last series of questions, is it possible to think about when you are considering this CapEx program, this increasing capacity, is it possible to think about sort of how much you are increasing your kind of fixed costs? So looking out sort of over the longer-term, what is your cost structure? Is it possible to sort of think about things that way? In terms of your fixed cost structure that you're adding?

Yes. I would say that there's not a day goes by that I don't think about things that way, because if you look back the 30 years I've been at Carpenter, one of the things that we have to be very careful about is overinvesting in the business. Because if you add too much capacity at a time when there isn't really very much demand, that you don't really get a very good return on that invested capital.

So, we need to be very pragmatic about the strength of the markets and determining whether or not we can incrementally add that capacity as opposed to putting it in a very big quantum leap. But we always look at the assets that we're adding, the cost of those assets and the returns that we expect to get on them. We are very much of a performance focused company, both profit and return on net assets. So by adding to the PP&E, if we were not to get a return on that, we would not be earning our cost of capital. So we're very much aware of and focused on that point.

And just lastly, does Ann have a start date?

Yes, I mentioned in the call, it's November the first.

So, how does it work than? In terms of -- think someone mentioned earlier maybe, I missed the answer, but in terms of things like the buyback, in terms of things like potential M&A, do we assume that those sort of things maybe get throttled back a little bit as we let the new CEO get her feet wet and understand what's going on? How do we think about that?

Well, one of the things that was said in the press release was that both the Board and myself are very committed to an orderly transition so my retirement is actually going to be in January of 2007. So we'll be working together. Ann will be the CEO and Chairman and President of the Company, but we will be working together to ensure that things that we have underway are very smoothly transitioned.

And I also need to mention that we've got a very, very strong operating management team here that is very much capable of continuing the initiative that we have underway.

I have no further questions in the queue at this time, sir.

Okay. So if there are no further questions, I'm going to turn the call over to Dave.

Before we close, the management team would like to recognize Bob for his countless contributions in making Carpenter one of the best performing companies in our industry. Bob has instilled a culture of performance and unending drive to maximize opportunities, which we will carry forward. Bob, we thank you and we wish you the best. We'd like to thank all of those on the call today and we look forward to talking with you at our next quarterly conference call.

Thank you for your participation, ladies and gentlemen. You may now disconnect. Have a great day.