Carpenter Technology Corp (CRS) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2007 Carpenter Technology earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session at the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Mr. Jaime Vasquez, Vice President and Treasurer. Please proceed, sir.

Thank you. Good morning. Welcome to our conference call for the fourth quarter and fiscal year ended June 30, 2007. This call is also being broadcast over the Internet.

With me today are Anne Stevens, Chairman, President and Chief Executive Officer; Doug Ralph, Senior Vice President, Finance and Chief Financial Officer; Rick Simons, Vice President and Corporate Controller; and, from our operations, Mike Shor and Mark Kamon, as well as other members of the management team.

Some of Carpenter's statements will be forward-looking statements, which are based on current expectations. Risk factors that can 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, subsequent Form 10-Q and the exhibits attached to those filings.

I would like to now turn the call over to Anne, who will start with a brief overview.

Thank you, Jaime. Good morning, everyone.

Before we get started, I want to take a moment to introduce Doug Ralph, who joined us on July 9th as CFO. Doug joins us from Foamex International, where he was Executive Vice President and Chief Financial Officer. Prior to joining Foamex in 2003, Doug spent more than 20 years in various financial position for Procter & Gamble. Doug brings to Carpenter extensive financial experience at both the corporate and operating level, including Europe. His wide perspective on the global market and financial management allow him to play a key role in the expansion of Carpenter into new markets.

Let me turn the microphone over for a few comments from Doug.

Thank you, Anne, and good morning, everyone. I'm excited about joining Carpenter, especially given all of the growth opportunities in front of us, both in terms of deepening our penetration of existing markets and expanding into new markets. In the brief time I have been on board, I have been impressed with the capability and dedication of the people who work here, as well as the many strengths in the Company's operations. A lot of work is being done to look at ways to capture the opportunities available to this company in a global market, so I'm joining at a very exciting time.

I do hope to meet many of you personally in the months ahead. Now let me turn things back to Anne.

I want to now turn to the operating results, after which I will ask Rick to run through the financial review.

Carpenter had a strong fourth quarter and its third consecutive year of record earnings. Fourth-quarter sales were 24% above the fourth quarter a year ago. This performance was achieved despite challenges presented by historically high nickel prices and supply chain adjustments.

The hard work of our employees, combined with the strength of our product portfolio and our business operating model, allowed us to optimize results. This was most evident in the recent fourth quarter, when we faced challenges in our aerospace and medical end-use markets, along with record high nickel prices. However, our execution was good and we were able to generate record fourth-quarter operating income despite these adverse factors.

Strategically, we are focused on the right end markets. While some markets were soft in the fourth quarter, we enjoyed phenomenal growth in the energy market, where sales excluding surcharge increased 89% from a year ago to $55 million and accounted for almost 15% of total sales. We expect the momentum and energy to continue in the months ahead. Included in our energy sales is the oil and gas sector, a market to which we began dedicating more resources only recently. Our success in oil and gas is the result of a product portfolio that provides solutions to demanding problems, such as directional drilling for oil and drilling deeper into harsher environments.

Now let me summarize our fourth-quarter sales by end-use market. To help make the end-use market sales comparisons more meaningful, all of the sales references will be exclusive of surcharge and measured against the fourth quarter a year ago. Let me begin with our largest end-use market, aerospace.

The temporary pause in aerospace that we talked about at the end of our third fiscal quarter continued into the fourth. Sales to the aerospace market declined 21% from last year's record level to $139 million. The decline reflected a 19% decrease in pounds shipped. This recent fourth quarter compares to last year's fourth quarter, when there was unprecedented demand for materials from the aerospace sector.

Sales of nickel-based alloys and titanium coil were impacted throughout most of fiscal 2007, as a result of robust buying activity that took place in the latter part of fiscal 2006. Also, record high nickel prices throughout most of the fiscal year altered purchasing habits.

Now, we believe that most of the aerospace inventory adjustments will be worked through by the end of this calendar year. The fundamentals within the aerospace market remain strong. The July 2007 Airline Monitor, which forecasts commercial aircraft deliveries, reinforced the double-digit growth rates that we expect to see over the next several years. We expect that titanium sales will begin to benefit more significantly in the second half of our fiscal year, due to commercial production of Boeing 787, while our nickel-based alloys should benefit from the 10% increase in expected deliveries in calendar year 2008.

Offsetting the decline in aerospace sales was the significant jump in sales to the energy market. Energy sales increased 89% to $55 million, as pounds shipped more than doubled compared to a year ago.

Sales to the oil and gas sector were up 100%, as we continued to gain strong acceptance for our high-strength and corrosion-resistant materials in the marketplace. We also benefited from the growth of key customers and from the successful introduction of new Carpenter products.

We experienced a surge in sales to the power generation sector during the quarter. Power generation sales increased 78% to $27 million, due to a solid pickup in demand for industrial gas turbines, especially from the Middle East. We expect sales of our ceramic and nickel-based alloys to the power generation sector to remain strong in fiscal 2008.

Industrial sales in the recent fourth quarter were $83 million or 33% higher than a year ago. A 10% decline in pounds shipped was more than offset by increased sales of higher-value materials. Sales to the industrial market also gained from increased shipments of higher-value materials used in capital equipment and in the manufacture of valves and fittings for chemical and food processing facilities.

Partially offsetting this sale of higher-value materials was a reduction in sales of products sold through the distribution channel. As we stated last quarter, we expect that sales growth rates to the industrial market will moderate from the robust levels experienced in fiscal 2007.

Consumer market sales were $36 million for the fourth quarter or 3% lower than a year ago, due to a 14% decline in pounds shipped. Reduced demand for materials sold into consumer electronics and sporting good market were the primary contributors to the decline. We do expect sales to the consumer market to grow in fiscal 2008, based on increasing sales to the sporting good markets and to growth in Asia.

Sales to the medical market were down 17% to $29 million, primarily as a result of a 13% decline in pounds shipped from a year ago. The lower medical sales reflected reduced demand of titanium and specialty alloys, as the supply chain continued to work down inventory. We expect that the inventory correction now taking place within the medical supply chain will persist through the balance of calendar year 2007.

Sales to the automotive market declined 8% to $41 million from a year ago, due primarily to a 22% decline in pounds shipped. Lower production rates in the US and Europe were the main contributors to the decline. We continued to focus on customers with unique requirements that leverage our metallurgical expertise in product performance.

Finally, Carpenter's sales outside the United States increased to $169 million in the fourth quarter, compared to $147 million a year ago, inclusive of surcharge. Increased shipments to the energy, medical and industrial markets were partially offset by reduced shipments to the aerospace and automotive markets.

Geographically, our rapid growth continued in the quarter, as sales increased 34% from a year ago to $31 million. Asia sales were almost $100 million in fiscal 2007, and we expect this growth to continue in fiscal 2008.

Now let me turn things over to Rick, who will review the financial performance.

Thank you, Anne, and good morning. As Anne noted, we had a strong fourth quarter and fiscal year, despite the impact of record nickel prices and inventory adjustments that took place in our key markets. Fourth-quarter sales were up 24% to $560.5 million. Excluding surcharge, sales were essentially flat with a year ago, as a better product mix was offset by a 9% decrease in pounds shipped.

Gross profit for the fourth quarter improved to a quarterly record of $128.8 million or 23% of sales. That compares to a gross profit of $126.6 million or 28.1% of sales in the same quarter a year ago. The increased gross profit was achieved despite the negative impact from record high nickel prices throughout most of the quarter.

Nickel on the LME he averaged about $21.80 per pound in the recent fourth quarter versus $9.04 per pound a year ago. As a result, our surcharge revenue increased to approximately $177 million in the recent fourth quarter versus approximately $66 million a year ago. Customer surcharges during the full year of 2007 totaled almost $500 million, up from $200 million in the previous year.

As we've stated in the past, our surcharge mechanism is structured to recover changes in raw material costs. While the surcharge protects the absolute gross profit dollars, it does have a dilutive effect on gross margin when raw material prices increase. In the recent fourth quarter, the dilutive effect of the increased surcharge on gross margin was approximately 570 basis points. The escalation in nickel prices also negatively impacted gross margins by approximately 40 basis points, as a result of the lag effect that is inherent in the structure of our surcharge mechanism.

Adjusted for the dilutive effect of the surcharge and the negative lag impact, the gross margin would have improved by approximately 100 basis points in the recent fourth quarter from a year ago. This underlying improvement was largely driven by a better product mix and ongoing cost controls.

We recorded a LIFO inventory expense of $79 million in the fourth quarter. In the fourth quarter a year earlier, the Company reported LIFO expense of $20 million. As we discussed before, most of the LIFO expense is captured through surcharge revenue, and thus has little impact on operating income. The increase in LIFO inventory expense from the third quarter of this fiscal year primarily reflected the continued escalation in nickel prices in April, May and the first half of June and higher year-end inventory balances.

The decline in nickel prices during the last two weeks of the quarter had virtually no impact on our results. If nickel prices were to stay at or below the current midteens level, we would expect to report LIFO income in fiscal 2008. However, again, this will be offset by reduced surcharge revenue, thus having little or no impact on operating income.

Operating income of $92.4 million or 16.5% of sales was a fourth-quarter record, and compared to $90.9 million or 20.2% of sales a year ago. Despite significantly higher raw material costs and reduced volumes, we were able to achieve this record level of operating income as a result of a richer mix and ongoing cost controls through operational excellence.

The tax provision in the recent fourth quarter was $31.8 million or 34.2% of pre-tax income versus $23.4 million or 25.6% in the quarter a year ago. Last year's fourth quarter benefited from a $5 million reduction in valuation allowances related to state tax operating loss carryforwards and additional US export incentives.

We expect the fiscal 2008 tax rate to be around 35%. The anticipated rate is higher, since many of the positive impacts that we have experienced in the past two years will not repeat in 2008.

Net income of $61.3 million or $2.33 per share compares to net income of $68 million or $2.58 per share in last year's fourth quarter. The reduction is entirely due to the higher tax rate in this year's fourth quarter, as pre-tax income was higher than last year. Net income of $227.2 million or $8.63 for the full year of fiscal 2007 compares to net income of $211.8 million or $8.08 for the previous year, reflecting a 7% increase on the bottom line.

For the quarter, free cash flow was $101 million versus $107 million a year ago. For the full year, free cash flow was $202 million, or about the same as the previous fiscal year. The impact of higher nickel prices was evident by the increase in our accounts receivable balance, which increased $64 million, driven primarily by the amount of surcharge and receivables. Offsetting this was a higher accounts payable balance, which increased $78 million from a year ago, driven by purchases of higher-cost raw materials.

We ended the year with cash and marketable securities of $674 million on the balance sheet. As we've previously stated, our first priority for this cash is to fund organic growth. For fiscal 2008, capital expenditures are expected to be in the range of $140 million to $160 million, with more than half of that being invested in growth initiatives. Additionally, we wanted to maintain the financial flexibility to make acquisitions and enhance existing market positions or extend us into new markets that leverage our metallurgical and manufacturing expertise.

Finally, we are committed to completing the remaining $220 million of our share repurchase program, subject to market conditions. During the fourth quarter, Carpenter purchased 115,000 shares of common stock for $15 million. In total to date, we have purchased 235,000 shares of our common stock for approximately $29 million.

I will now turn the call back over to Anne.

Thank you, Rick. With fiscal 2008 underway, we expect another year of record earnings. We are beginning the year facing some headwinds, as the aerospace and medical supply chains work through their inventory adjustments. However, the fundamentals remain exceptionally strong in these markets, and we're seeing some very positive trends in the operating environment.

Now, for one, nickel prices continue so far to back off from their historical peaks. It's still early, and we believe customers for some special alloy products may continue to hold off a bit longer on restocking, to see how far nickel prices decline.

Another bright spot is the gradual clearing of supply chain issues, particularly in aerospace. Based on discussions with customers and the anticipated production schedule, the indications are that the demand among aerospace customers will increase gradually from here, with momentum building throughout the year. As I said earlier, the energy market is already strong and continuing to build, led by power generation and by increasing demand for more specialized products in the oil and gas industry.

The industrial market will continue to be a strong growth area this year, but clearly we're not expecting this year to sustain the record growth seen in fiscal 2007. Automotive and truck will most likely do very well on a global basis. But we anticipate international sales will be stronger than US sales.

Beyond this, we're putting a lot of time and effort into three key internal initiatives. The first is operational excellence at all levels. The focus on efficiency enabled us to build core operating margins last year, despite significant increases in raw material costs, especially nickel, and despite a slowdown in some key markets. That is a tribute to the employees of Carpenter.

Secondly, we are increasing our efforts in developing products and methods that meet the needs of our customers today and we anticipate their needs for tomorrow. We're stepping up our investment in new product development and modernizing internal control systems as part of our capacity expansion. Our recently appointed Senior Vice President and Chief Technology Officer, Dr. Sunil Widge, is charged with making sure Carpenter's R&D produces the value-added innovation necessary to sustain and propel growth.

Our third key initiative is to carefully and thoroughly explore new market opportunities for Carpenter's products and expertise, especially including the United States and outside the United States. We can and we will do more to capture share wherever sophisticated science and engineering require advanced metal technology. We had a very strong early success with this approach in our energy markets, where Carpenter is positioned to provide customers with exceptional heat and corrosion-resistant products for exploration and production in ever more difficult field conditions around the world.

An essential part of successful execution is putting together the right team. In addition to Dr. Sunil Widge, the appointment of Doug Ralph as Chief Financial Officer will bring a broader, more international perspective to the management team. To complete this team going forward, Senior Vice Presidents Mike Shor and Mark Kamon will lead our operating units. We will also put an enhanced focus on market sectors, with Mike Shor responsible for aerospace, energy and defense sectors going forward and Mark Kamon responsible for medical, automotive, commercial and industrial segments. Senior Vice President Denny Oates has left the Company.

The leadership team will more precisely and efficiency fit the needs of our existing and future customers with Carpenter's metallurgical and processing expertise. We will increase customer satisfaction, enable Carpenter to expand in adjacent end-use markets and further enhance operational excellence. I'm excited about the new opportunities we are finding in our end-use markets such as energy and in Carpenter's new product introductions, such as our Custom 465 and 718 for oil and gas applications. We continue to explore new market opportunities that will leverage Carpenter's portfolio of proprietary alloys.

I'd like to close this by first thanking our customers and our shareholders and our employees for Carpenter's success. Operator, we will now open the call to questions.

(OPERATOR INSTRUCTIONS). Matt McGeary, Sentinel Asset Management.

Talking about all the inventory sort of back-ups in the supply chain, do you feel like you have better visibility on the aerospace side than you do on the healthcare side of the business or the medical side of the business?

Yes, I really believe that we do. Again, as every day goes by, we are getting more visibility and a greater understanding. When I look at the medical market, number one, the medical market does react to the demand coming from the aerospace products, particularly in the titanium sector of the business. So what we saw in medical and what has impacted this quarter was the overbuy that happened a year ago on titanium, when titanium was short in supply. With the supply/demand balancing on titanium now, the medical supply chain is adjusting and taking down the inventories.

In addition to that one, the other thing that we're seeing, as consumers' healthcare costs are spiraling out of control, and having been really active in Lean Manufacturing all of my career, I am seeing more and more hospitals and suppliers to the medical field, the Tier 1 suppliers, really implementing Lean Manufacturing procedures, which is they're asking for shorter inventories and shorter lead times, so that they can respond to the pressure frankly all of us are putting on healthcare costs.

So there's two factors. First was the overbuying when there was concern about supply of titanium, and then the second is the reaction to increasing healthcare costs and the implementation of Lean Manufacturing principles, both at hospitals and Tier 1 suppliers.

Just a couple of quick follow-ups. One, could you just walk us through potential things we should look for as your next fiscal year progresses in terms of adding your capacity, sort of what kind of data points we should look for to gauge your success in terms of timing there? I also just wondered if you would comment briefly on potential M&A, your thoughts generally there and what the environment looks like for you.

Let me just respond to that probably, and then I will ask some of the tam to give you a bit more specifics. With respect to M&A and our overall cash deployment strategy, clearly, the announcement of the premium melt capacity addition was the confidence in the markets that we have plus our commitment to organic growth.

In terms of acquisitions, when I joined the Company, the top priority was what is the growth strategy for our Company? It has been my top priority. Some good work is being done, has been done over the past couple of months, and I'm really committed to try to complete that work and really announce a bit more of our intent of end of this year.

So today, what I can say is I understand the question. They are my questions as well, and we are in the process of developing some good answers of how we're going to return back to the customer growth in earnings.

Now, what I'd like to do at this point in time is ask Mike Shor to comment on the status of premium melt, a project that I have been really excited about.

Two major projects that we have announced. One deals with one of our hot-rolling mills, and it's a mill control system upgrade which will significantly improve the quality and productivity through that facility.

Then the cornerstone capital that we have announced is the premium melt project. Our highest-value products go through multiple steps in melting. The first step is vacuum induction melting. That investment has been announced. The installation is scheduled to be complete towards the end of calendar year 2008, with startup later in the second half of fiscal year 2009. What we've said is we feel very good that first full year in operation we would have at least $150 million of new sales there, and of course, the products going through here are the products with our highest margin.

Lloyd O'Carroll, Davenport.

A couple of inventory questions. Your own inventory was up, and I'd like to get some idea of was it finished goods, in-process or raw materials inventory? So just get a better feel for balance sheet.

On the balance sheet, the inventory increase was primarily in the work-in-process area. I don't have the specific breakout here with me, but it was primarily in work-in-process.

Then in terms of guidance, what kind of working capital change assumption is in your CFO guidance?

Well, we don't break out that cash from operations guidance between operating income and working capital, because obviously, they're inter-reactive. If one goes up, it's usually as a result of the other going up. So we don't break that out, but we feel comfortable with the guidance that we had in the press release.

Back to your own inventory, was inventory up Q3 to Q4 or just year over year?

It was down slightly from Q3.

Luke Folta, Longbow Research.

Last quarter, you talked a little bit about titanium ingot prices. I was wondering if you can give us an update on what you have seen this past quarter.

Titanium ingot prices continue to drift lower, and I would say we're seeing a range around the $20 mark now, plus or minus.

On your nickel-based alloy sales, you said that you saw a reduction in volumes to jet engine manufacturers. A competitor of yours yesterday released pretty strong volumes in that product line. I was just wondering if you can kind of go over what the differences may be there, and what they're seeing versus what you're reporting?

Obviously, we study the competitive results as well as our own. The one thing that you just have to look at, or one thing I look at really closely, is where you participate in the supply and the value chain. Then the second thing that we look at, clearly, is not only the metals that we are supplying but the final form that we're supplying, and who are the prime end-use customers. Clearly, there are differences amongst ourselves as well as the competitors.

One thing that does impact us is the distribution of our customers between Boeing and Airbus. As we all know, the Airbus A380 was delayed, and to react to the change that that did to the financial performance, Airbus started a Power 8 initiative, which was clearly a form of a Lean Initiative that they used to reduce inventory not only in their facilities but in the supply chain.

The last thing that has impacted us was what we see is the instability in the price of nickel. I know we had spoken to many of you about if we had a wish, what would we do for nickel pricing? We basically said that the best thing that could happen was a gradual decline in nickel price versus the stepwise down change. With the stepwise down change that we experienced in nickel pricing, what we are seeing and what some of our customers are telling us is, well, I'm going to hold back, not put in the order until we see what nickel is doing.

So it's a couple impact where we participate, with respect to adding value to the end-use customers, both in the Boeing and the Airbus supply chain, the rapid change in the nickel pricing and our distribution of Boeing versus Airbus customers.

Finally, just on your oil and gas end markets, you put up a really impressive number this quarter. Can you talk about how we're likely to see shipments to that end market grow over the next couple of years, kind of looking out?

On that one, I just remain optimistic as I've gone around speaking to the customers, on one hand, and on the other hand just the confidence that I have in our Chief Technology Officer, Dr. Widge, and the products that we have introduced into that market and the work internally that we have going on. So right now, I basically see that market as red hot, and from indicators that we look at, I think the strength in that market is going to continue.

So my confidence in that one really was just recently reinforced by what GE recently had announced -- basically, 170 gas turbines this year, which is up from a previous high of 124. Most of this is coming from the growth of the developing markets that are going on out there.

So overall, I'm confident in the market. Part of our decision to add the capacity in premium melt was based on not only aerospace but our confidence in participating in this market, with the strength of our products and the growth in customers that we've got some very strong relationships with.

Sanil Daptardar, Sentinel Asset Management.

Just a few housekeeping questions. First, on the tax rate, you talked about some positive effect that you saw both in the previous two -- in 2005, and that's going to flow through again in 2008. Could you just refresh that, what were the positive effects?

We had a positive impact in the fourth quarter of fiscal 2006 of about $5 million. There was no specific impact in the fourth quarter of 2007. On the other hand, year on year, the tax rate was actually very, very close because there were full-year benefits in both years. In fiscal 2008, we don't see having some of those same sort of benefits, and so we're looking at a tax rate closer to the 35% rate.

If you look at the first three quarters of 2007, your tax rate was more closer to around 31%. So it's didn't have any kind of positive impact out there, so why you are expecting tax rate to jump almost 300 to 400 basis points, in that case?

Right. Again, earlier in fiscal 2007, in the third quarter and I believe in the first quarter, we had some benefits that were booked that were one-time benefits -- specifically, tax law changes in Pennsylvania relative to net operating loss carryforwards and the ability to use more of those, and then some adjustments to reserves that we had against audits that we were able to settle more favorably than what we had reserved for.

So if you look at the full-year tax rate for 2007, it was in that 31-point-something range -- I don't have that in front of me -- which was very similar to the full year of last year. Then as we look towards fiscal 2008, right now we don't anticipate reversing any more reserves. There are no other audits that we have outstanding. Tax law changes, obviously, we can't forecast. We know of none right now that would benefit us going forward, so we certainly wouldn't forecast those.

On the surcharges, generally there's a lag effect. How much would be the flow-through effect in 2008 on the surcharges?

That's all going to depend on, obviously, what nickel does and how rapidly it reduces. We have talked about the lag effect in the past. As you know, during the course of fiscal 2007, nickel was increasing month after month, and so we were having a negative impact month after month as we surcharge off of the previous month, but buy nickel in the current month's prices.

We have had this sudden drop from the end of June until now, to the midteens, which obviously will give us a benefit in the month of July. I have to say, when it came down that suddenly, that rapidly, we will only have the one-month benefit. If it were to stay at the rate it's at now for the rest of the year, we'd have the one-month benefit, and that is all.

Then secondly, truthfully, July and August, as you all know, July, August and September is one of our lower quarters. So the fact that we're shipping less because our customer shutdowns and so on in the summer months, we will have less of an opportunity to take advantage of that than we might have during a higher-shipment month.

So in that case, we should assume your gross margins to get effective in that case?

Certainly, the gross margins will, because the surcharge number is going down. As we've explained, that's a mathematical calculation, where the surcharge in the sales effects the margin percentages. So yes, we will have improvements in the gross margin percentages. I think the most important thing that I will say is that, as we have done this year, and given we've provided transparency as to the impact of those things, both the lag and the mathematical calculation on sales of surcharge, going forward in fiscal 2008 we will continue to give that transparency, so that you can understand more clearly what the true operational results are underneath.

On the aerospace side, you had mentioned last quarter that there was one customer who shifted to their in-house manufacturing unit to buy products. If I exclude that, your aerospace would have been up year over versus year-ago period?

No, the aerospace sales would not have been up, because of some of the factors that I had quoted previously -- the Boeing, the Airbus, the difference in our customer base, where we participate in the value stream and the Airbus inventory corrections with their Power 8 program.

Now, the one thing that I will say is I have met, as well as the leadership team, with most of these customers. Clearly, for us, it is not a market share issue, other than the one that we have spoken about. The demands will come back, once the inventory is corrected, and we expect to participate in the growth of these markets going forward.

If I just look at the next two quarters -- of course, the long-term is pretty good outlook here. But if I just look at the next two quarters, can your stronger sales in oil and gas and power gen could offset the weakness in the aerospace and the medical side, or it won't be sufficient to offset the weakness?

We are anticipating that it will offset.

Mark Parr, KeyBanc Capital Markets.

Congratulations on record results. I was expecting only $50 million in LIFO charges in the fourth quarter, which I'm assuming the Street was probably close to that. So if you look at your actual LIFO charge, your FIFO numbers were enormous in the quarter, and I think the apples-to-apples comp was over $3 a share for you guys. So, with all these supply chain issues and with all these delays in momentum, you guys should be congratulated on having tremendous positive momentum in these kinds of market conditions.

I appreciate your comments. I just want to make sure everyone on the line understands, when you look at that LIFO expense, again, if you're trying to compare us to a FIFO company, I think what you are doing is fine. But realistically, that LIFO expense does get recaptured for us under our surcharge mechanism, and LIFO is representing the most recent purchases of inventory and, obviously, the surcharge represents or gets passed through (multiple speakers).

Last month, yes.

-- cost. But it's a one-month lag, and the $79 million is not -- again, that gets offset to a great degree by the surcharge mechanism.

Yes. No, I understand that. That's what we are -- this LIFO can create these anomalies in reported results, but they are not indicative of how the business is performing, I guess, is all I was trying to say.

That's correct, if you're comparing us to a FIFO company.

I appreciate that, because with a fourth-quarter operating profit of $92 million, there's a 100 basis point improvement in core operating margin, even excluding the impact of LIFO in the surcharge. In spite the increase in nickel prices and the inventory issues and I talked about, the team has really work very hard delivering the margins through how we operate and the focus on efficiencies and the business model.

I think we had this discussion, to a certain extent, and I will just reiterate it very briefly on the call. But if you had been able to -- I realize what the LIFO number was might have been not transparent to you until you had some of the year-end consolidations done. But to the extent that you could have given us a little more transparency in front of the release, I don't think your stock would be down quite as much today. This is something that has happened on numerous occasions where you've seen the stock really out of line with what is actually happening within the Company. It's too bad, because your stock shouldn't be down whatever it is, 14 or 15 points today. It's like ridiculous.

I did have a question, just to try to challenge you a little bit on the aerospace side, because you did have this one customer issue. If you're looking for aerospace shipments up about 10% in 2008, calendar 2008, do you have a sense of what Carpenter's aerospace-related volume ought to be, or what sort of volume number you would expect in a 10% shipment growth environment?

The bottom line is, as we look at the fundamentals within the aerospace business, we obviously have dealt with some inventory reductions. We've dealt with the customer issue that has been well versed. But we see, especially when looking at the airline monitor, that 10% growth, and we feel very good across all of our products that we will see that moving forward.

If their shipment momentum is up 10%, would you expect to be up more than 10% or less than 10% or at 10%? That was my question.

I would say, on the titanium side, as we've talked about in the past, with the utilization of composites on the airframes, we would grow faster in titanium than we would in the others. The others, I would say, would be fairly close to that growth rate.

Terrific. That's really helpful, thank you. Congratulations on the progress and I look forward to continued good news.

Tony Rizzuto, Bear Stearns.

First of all, you spent a lot of time talking about the energy markets and [at present are] about 10% of revenues. Are you looking, Anne, to actively grow via acquisitions in this area?

I'm not going to give any specifics on where we are looking to specifically grow right now. What I can say is we've been really clear about the markets that we're focusing in, and energy is one of the markets that we've got resources dedicated to studying how we're going to grow in that market.

Could you describe the relative margin differences between your materials that you sell into the energy markets versus, say, aerospace?

Energy is a very strong market with very strong margins, just as aerospace is.

As strong as aerospace?

Yes.

They are in the upper quartile of profitability, yes.

What would be your vision as to what component, if you looked at -- obviously, I've heard you describe for this group in terms of which markets you're focusing on. What is your vision of how big energy should be as a component of the total Company?

That's something that we're looking at. As I look at the pie charts of how we're distributed today, both in terms of materials, the geographic locations and the specific markets -- and I've got a few scenarios that I'm looking at, at the future. So right now, there's a couple of them, and we have not finished the analysis to say yet which way we're going to grow. As soon as we have concluded that, I'm very confident that I'll be out saying more by the end of the year.

I wonder, regarding aerospace, can you give us an idea of what your relative mix is between Boeing and Airbus at this juncture, and how that's going to change this fiscal year?

It's about 50/50.

Is that going to meaningfully change at all as you look at this year or perhaps fiscal 2009, as you look out a little bit further?

I don't think so.

Let me ask you this -- how comfortable are you that you're going to be able to replace the lost business? Obviously, with a key customer, you've got a nickel melt expansion for the premium nickel melt alloys. How confident are you? Can you give us some examples of some of the wins that you've had, so we can better track this as you continue to move forward and hopefully have, certainly, improved results with aerospace as the market continues to be very good?

Okay, I am extremely confident. If I was not extremely confident, I wouldn't have gone to the Board of Directors with the capacity expansion. So I'm extremely confident in aerospace as well as energy, as I just painted out.

In terms of giving more specifics on that one, there's just a lot of confidential negotiations, commercial negotiations going on right now, and so it's really inappropriate to discuss it in the call. I think it's a great question, but it's not one that I can answer.

I just have one quick just follow-up on the cash flow guidance, the $300 million. Obviously, working capital -- big use of cash in 2007. Can you help us out of a little bit in terms of understanding how you're looking at that, in terms of the magnitude of use of cash in fiscal 2008? I would assume another use, obviously, with sales activity improving.

But can you just help us out to try to flesh that out a little bit better? It would seem like that guidance is awfully conservative. But maybe not so, but how do you feel about that number itself? Is it a conservative number, in your view?

I'll give you a higher-order comment, and then I'll ask Jaime to give us a bit more. But in terms of use of our cash, the first priority is for organic growth. As we look at cash expenditures in fiscal 2008, some of the cash will be deployed to organic growth.

With respect to cash overall that we have invested in inventory, raw material, in-process and finished inventory, when I talk about the efforts that we have in operational excellence, that is clearly one thing that we look at. We look at the use of cash to deliver returns to the shareholders. So everything coming in, sitting in the plant and going out to satisfy customer orders is on the table for what is the best investment and where we invest the cash sitting in inventory. Internally, I'm not prepare to comment on specifics, but internally the team has some great pilots going on, to be sure that we're investing that cash in the right places.

Doug would like to give (multiple speakers).

As it relates to guidance that we put in our release, there's nothing noteworthy that we want to call out on working capital. But we would emphasize that we expect the overall cash flow from operations of to approach $300 million, and expect as part of that that capital spending is going to be in the $140 million to $160 million range, and that our free cash flow is going to be around $100 million.

The DD&A -- should we be assuming somewhere around $50 million? Is that a fair number to use?

It's going to be around $52 million.

Chris Olin, Cleveland Research.

Can you help me better understand the long-term upside for the titanium fabrication business, represented by the increased Boeing 787 production schedules? What I'm most interested in would be how much incremental demand you expect to be generated by aerospace, toward the end of this year or early next year? Where is your current capacity utilization number? I'm wondering if you need to expand the service market, especially when you consider the potential at the Airbus side.

Yes, I'll give some comments, and then I'll ask Mark Kamon to give a bit more. We have done a lot of analytics on basically projecting for ourselves what the demand is going to be. We will be investing more capacity, particularly on the finishing product end of the business to support those markets, which will grow.

I would also add that, as you know, the A380 is about to restart production of new models. The 787 is ramping up. Both of those new aircraft are very heavily weighted to titanium fasteners that our products support. So we anticipate, as they ramp up, we will see significant growth opportunities.

As we, overall, think about capacity, we've increased our capacity to finish and produce for our customers by about 60% to date, and that has come through some hard asset investment, but also some operational excellence and effectiveness measures that have increased our throughput. So we are very pleased that we're maintaining a pace out in front of our customers to supply the market what they need. So we are feeling very good about where we are.

We're prepare to invest to support our customers in this area.

Is it safe to use the number of 10 times more fasteners stock in these next-generation aircraft, or has that engineering changed at all?

That's probably an overstatement at 10X. The larger aircraft, by definition, are going to use more fasteners. Just look at the size of an A380 compared to an A320 or a 737. But the composite technology that's being used in aircraft is very compatible with the use of titanium, from the standpoint of thermal expansion. So we see the growth in new aircraft and the use of composites driving titanium usage.

You are definitely moving in the right direction by offering volumes. I'm just wondering if it makes sense to maybe break out the volumes by product category, so maybe we can get a better view into the upside on the titanium side. Or is there a reason why you're unwilling to go further on the volume breakdown?

We're continuing to look at that, and you can expect to see more changes as time goes on. I know you have asked for more detail. I have listened, and as we can provide more, we will. As you can imagine, what is influencing what we will provide is clearly strategy. But we have listened, and we will continually provide more.

Fair enough.

Seth Glickenhaus, Glickenhaus & Co.

Most of my questions have been answered. However, I do want to congratulate you. I do think, considering the difficulties you had with the price of nickel and the problems with the air space where they had overbought originally and canceled a couple of planes, why, you did well.

However, I would just like a little more detail on the growth potential in the energy field. In other words, you mentioned things are very hot and you're studying it and so forth. But do you look for continued expansion of the sorts you've had, or are we apt to have more of a stable picture there?

Well, you know, the market is hot now. When we take indicators like GE had given us with respect to the gas turbines, that's one of the trend indicators that we look at. But I think the other thing that I can say, as I've gone out and I've met with the customers, the drilling environments are getting harsher. What they are asking for consistently is higher-performing materials, because these environments are requiring materials with higher strength and even more corrosion resistance than they have today.

So, as the exploration and the extraction environments become more aggressive, then there will be even increasingly more use of our materials. We have focused incremental resources on product development in that area.

Okay, that's mildly helpful. Thank you very much.

Greg Macosko, Lord Abbett.

Lloyd O'Carroll, Davenport.

It's actually Tim Hayes. I just wanted to get some precision on the surcharge. This is a one-month lag on the LME cash; is that correct?

That's correct. Well, it's a one-month lag, both on the cash as well as, obviously, the profitability, because we're under LIFO method.

I just noticed I think some of the flat-rolled stainless producers use a two-month on the LME cash. Is there a reason why it's different from -- maybe it's because you are doing long product versus flat-rolled? Or any idea on that?

The attempt was to try as best we can to match the surcharge up with the most recent price, and one month versus two months does accomplish that.

Right. Has it been one-month lag all along, or has been changed?

It has been one month all along.

Finally, just to clarify on the movement of nickel prices, on the LME cash, I show that it peaked in mid-May. You mentioned that it didn't really start to peak or come down until the second half of June. Are you looking at maybe a US price of nickel versus the LME cash, or a different number than the LME cash?

No, I agree with you. It did peak in May, but then after that it went down a couple dollars. It wasn't until mid-June when it really plummeted down into the teens. So I was referring more to that significant drop that happened in mid-June. That's the one where it was really a meaningful change.

Shyamli Saigal, Perennial Investments.

Yes, this is Chris Heintz. Could you give us a sense for what you think the long-term capital structure would be appropriate for the Company?

We always say we target that 35% debt to cap, and that's just total debt, not net of cash. So we recognize now that we're underleveraged, and a lot of the strategies that we're developing will encompass what the appropriate capital structure should have.

How do you devise that figure?

Divide it in terms of --?

No, no, sorry. How did you come up with that figure, as opposed to some other figure?

Well, 35% is a level that we feel comfortable with. Obviously, this is very subjective from company to company. But it's a level that we feel comfortable with, that provides us enough flexibility to take advantage of opportunities more in a down cycle than in an up cycle. As you know, historically, the industry has some severe cyclicality to it. That's where we can best find opportunities.

Switching gears for a moment, could you give us a little sense or a sense for the return on investment that you anticipate from your capital expenditure program, say in 2008?

Yes. I'm going to answer that more broadly. We have embedded in our culture earning our cost of capital, economic profit. So everything that we look at has to earn its cost of capital. Each project, even each business unit, has their own particular cost of capital. They are measured performance-wise based upon achieving something in excess of that cost of capital.

Certainly, I would add the large projects we have now are anticipated to earn well in excess of our cost of capital.

Could you provide me with a sense for the kinds of projects? Forgive me if you've already outlined that, but kind of go through some of the catalog of things you are doing with that money.

Yes. The first thing that we had announced back in January was a 40% expansion in our premium melting capacity. These are primarily nickel-based alloys that serve many sectors. The two that we have spoken about in this call was the aerospace and energy. But there are products also servicing other markets.

The second thing is upgrading the control systems in some of our high-priority processing units. So growth and efficiency and effectiveness are the projects that we have announced.

Greg Coolis, [Brentcourt Advisors].

When you talk about your orders for aerospace and looking at what they looked like this quarter, I'm curious if the buildout for the 787, for example, which tend to start 15 to 18 months before production, if you expect to see those. You had mentioned the second half of your fiscal 2008. But won't you start seeing some of those orders pick up pretty meaningfully in the calendar fourth quarter? Wondering if you're seeing anything differently, because a few of your competitors have spoken to what they see in the back half of this calendar year in aerospace order pickups.

We are seeing a pickup on the orders, so I would confirm with some of the comments that have been stated by our competitors.

Sanil Daptardar, Sentinel Asset Management.

Just on nickel supplies, basically, nickel having come down to $14, $15 range right now, do you intend to enter into a hedging program to lock in the prices, or you just remain unhedged on that, on your supplies?

The only time we lock in on nickel is when we have a firm commitment from the customer; then it becomes a take-or-pay. Otherwise, the surcharge essentially acts as the natural hedge for us. So we will not take any speculative positions on nickel.

Adam Scotch, JANA Partners.

Someone already asked the question about appropriate capital structure, and I appreciate the answer. In light of the fact the stock is down $20 today and you still, with all the CapEx spending that you are planning for next year, and what could be or I hope is a conservative outlook, you still plan to be free cash flow positive. When you are considering all the return requirements of the CapEx you're spending, I would challenge the Company to come back to investors and tell us why buying back your own stock, given the outlook for the Company and its end markets, is not one of the highest and best uses of capital. The current buyback that has been executed thus far and announced is pretty paltry, frankly, given the balance sheet and how unlevered it is.

Also, given the fact that the Company has undergone a significant restructuring under the prior CEO, where it's my understanding that a lot of the SG&A and fixed costs has been removed such that the next down cycle for the Company, all else equal, shouldn't be quite as severe as the last one. So I would think that that gives the Company more confidence to take a slightly more aggressive capital structure, particularly given how sort of unaggressive and, frankly, inappropriate the current one is. That's all. Thanks.

Operator, any further questions?,

No, sir. That looks like that is our last question for today.

Okay. In closing, I would like to thank all of you who called in today for the great questions that you asked, and we look forward to talking with you at our next quarterly conference call. I'm sure I'll be seeing some of you in the interim. So thank you very much and have a good weekend.

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may now disconnect. Have a wonderful day.