Carpenter Technology Corp (CRS) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by for our conference call this morning. Welcome to the third-quarter 2008 Carpenter Technology earnings conference call. My name is Jackie and I will be your operator for today's conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Mr. Dave Christiansen, Vice President of Investor Relations and Business Development. You may proceed, sir.

Thank you, Jackie. Good morning, everyone. Welcome to Carpenter's earnings conference call for the third fiscal quarter ended March 31, 2008. 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 and Chief Financial Officer; Tom Cramsey, Vice President and Chief Accounting Officer; and from our operations, we have Mike Shor, Senior Vice President of our Premium Alloys Operations, and Mark Kamon, Senior Vice President of our Advanced Metals Operations, as well as other members of the management team.

Statements made by management during this conference call that are forward-looking statements 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 most recent SEC filings, including the Company's June 30, 2007, 10-K, our subsequent 10-Qs and the exhibits attached to those filings.

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

Thank you Dave, and good morning, everyone. Before we get into the quarterly review, I want to note a few changes within the Finance Group. We are pleased to announce that Tom Cramsey has been promoted to Vice President and Chief Accounting Officer. Tom has more than 20 years experience with Carpenter in various accounting and finance roles. Tom takes over the accounting responsibilities from Rick Simons, who recently left Carpenter to become chief operating officer of another manufacturing company.

As many of you probably already know, our Vice President and Treasurer, Jaime Vasquez, has been promoted to President of our Asia-Pacific operation and will be relocating to Shanghai later this year. Jaime will be responsible for expanding our operations and footprint in the Asia-Pacific region. Dave Christiansen, who has been with Carpenter for 15 years, has taken on Jaime's responsibility for investor relations. Dave is also responsible for business development at Carpenter. Having served as Carpenter's Corporate Counsel, Dave comes to the IR function with a firm understanding of our business.

As we reflect flat on our third quarter performance, the results we achieve in our continuing operations for the third quarter were not where we wanted to be. As we mentioned on our last call, we knew it would be a challenge to surpass the exceptionally strong results of the third quarter a year ago.

In 2007, the third quarter represented the highest operating income of any quarter in Carpenter's history. We did experience strong sales this quarter in energy and in aerospace, both domestically and internationally, just as we expected we would with sales to our economically sensitive domestic markets -- automotive, industrial and consumer -- weakened at a rate we had not anticipated. In addition, there were a variety of items that negatively impacted our performance in the third quarter. These items include implementation of new planning processes and production disciplines to streamline product flow and reduce inventories and production inefficiencies related to the processing of new products. At the end of the day, though, these are necessary investments in improving operating systems for the Company, investments that we are confident will deliver future benefits to the business.

Looking ahead, we expect current favorable trends in energy and aerospace to continue through the fourth quarter and beyond. However, we anticipate that automotive and industrial may have some weak soft spots in the U.S. market. On balance, we believe our fourth-quarter results should meet or exceed the third quarter. For the 2008 fiscal year, we expect to report record results for the fourth consecutive year.

Next I will review our end-use markets and then Doug will cover the financial highlights. After that, we will take your questions. To provide some insight into our performance, the year over year comparisons exclude surcharge revenue.

Aerospace sales were $142.9 million, a 6% increase over a year ago. The aerospace sales momentum, the improvement, came from higher sales of specialty alloys used in jet engines and fasteners, as well as titanium coil used in fasteners. We are seeing the rebound in our shipments to both the U.S. and European aerospace markets that we had expected to see during the second half of our fiscal year.

Our aerospace volume grew at a double-digit rate this quarter and should continue to grow at least at the rate of airline builds going forward.

Energy market sales were $42.5 million, up 38% from last year. The growth in energy reflects strong demand for specialty alloys used in industrial gas turbines for power generation. We again saw increased global demand for high-strength corrosion-resistant material in the oil and gas market. The exploration for oil and gas and an evermore difficult drilling environment is driving this demand.

Medical market sales increased 3% over a year ago to $29.4 million. The slight improvement in medical occurs at a time when orders for titanium by both medical OEMs and by distributors to the medical market are beginning to show signs of returning to more normal buying patterns.

Now turning to the economically sensitive end markets, Carpenter's sales to the industrial market were $70.7 million, a decline of 16% compared with the third quarter last year. Most of the decline in industrial was due to lower domestic demand for materials used in capital goods and valves and fittings. Automotive and truck market sales were down 12% to $38.3 million. The decline reflects the general slowdown in the domestic automotive industry, a trend over the past several quarters. On the other hand, we are benefiting from a more positive product mix in automotive and from stronger sales outside the U.S.

Compared with the third quarter a year ago, Carpenter's sales to the consumer market were down 4% to $31.9 million. Again, the factors were the same as in recent quarters -- lower demand for materials from the housing and from the consumer durables sectors and the weakening domestic economy. Some of the decline in consumer sales was offset by increases in the sports and electronics segment and by a richer product mix.

Including surcharge, Carpenter's international sales in the third quarter reached a record $178.6 million. That's an 18% increase over the 2007 third quarter. Most of the gains were in Europe, which was up 26% over a year ago. Overall international sales represented 35% of total sales during the quarter. We are seeing some benefit from the weak dollar, particularly with strip and wire products sold into Europe and Asia.

At the end of the third quarter, we closed on the sale of our ceramics businesses to Morgan Crucible. These were strong businesses, but not strategic to Carpenter's future growth. Having sold them for $145 million, it will enable us to further concentrate our focus on core operations. Last quarter we also made a small acquisition, but one that is strategic to Carpenter's growth plan. Our Carpenter Powder Products a subsidiary acquired UltraFine Powder Technology, a small facility in Rhode Island. UltraFine manufactures and sells fine gas atomized powders for metal injection molding and other specialty markets. Carpenter remains well positioned in the right end-use markets. The outlook for our global aerospace and energy businesses remain strong, and we expect energy and aerospace volume to continue to build in the fourth quarter and the next fiscal year. We also expect that our international growth will continue to outpace our overall growth.

No Doug will walk us through the third quarter financial highlights.

Thanks, Anne, and good morning, everyone. I will now provide some additional perspective on our third quarter financial results. Please note that all income statement comparisons are for continuing operations excluding ceramics.

Net sales in the quarter were $509.8 million or 1% below a year ago. Backing out the surcharge, sales from continuing operations were essentially flat. Results reflect lower overall volume of 7%, offset by a higher value sales mix.

You have heard us talk about the exceptionally strong third quarter comparison from last year. For perspective, we shipped almost 64 million pounds in the third quarter of 2007, which was 13% higher than any other quarter last year. In this year's third quarter, we shipped a little over 59 million pounds, which is almost 20% above our first-half run rate, but still 7% below last year. So we feel our business has good top-line momentum that does not fully show up to do the tough third quarter comparison.

As further evidence of the momentum in the more strategic parts of our portfolio, our premium alloys operations, which is about 90% aerospace and energy, increased pounds shipped by 12% in the quarter. This was offset by a 9% decline in pounds shipped by our advanced metals operations, which contains the more economically sensitive parts of the business.

Returning back to the sales line, I would also point out that our third quarter sales, excluding surcharge, on specialty alloy products were up 8% from last year, titanium products were up 6%, and stainless steel products experienced [all the] decline at minus 8%.

Continuing down the income statement, third quarter gross profit was $109.3 million compared with $122.4 million a year ago. The decrease in gross profit primarily reflected lower volume as well as higher operating costs in the quarter, as Anne has already covered. These areas were partially offset by continued favorable mix improvement.

Our second half inventory reduction also has an unusually high impact on the third quarter profit comparison due to the difference in nickel price trends between this year and last. In both years, our inventory pattern was similar, with a build in the first half and reductions in the second half. However, this fiscal, nickel prices have declined from over $18 a pound at the beginning of the year to about $13 a pound currently, while in fiscal 2007, prices climbed from about $10 a pound at the beginning of the year to well over $20 a pound by the second half. Normally, our inventory pattern during the year would not have a significant impact on the bottom line. But, in combination with the difference in nickel price trends, the negative year-to-year profit impact in the third quarter this year amounted to just under $11 million. Note that there will be a similarly large negative impact on our fourth-quarter profit comparison. However, our expected fourth-quarter inventory reduction plans will result in a partially offsetting $6 million benefit from the liquidation of LIFO inventory layers.

Overall, third quarter gross margin was 21.4% compared to 23.7% in the third quarter last year. Adjusted for the dilutive impact of the surcharge, the year-to-year difference in the lag affect in our surcharge mechanism and the inventory effect we just discussed, gross margin on a comparable basis would have been an estimated 32.6% in the third quarter versus an estimated 34.3% in the same quarter a year ago.

Operating income was a $75.3 million compared with $92.5 million in the 2007 third quarter. The decrease in operating income is a function of lower gross profit and $4.1 million in higher selling, general and administrative expenses. At discussed in prior quarters, the higher SG&A expenses this year are largely capability-building investments in systems and resources needed to drive our future growth initiatives.

Adjusted for the impact of surcharge revenue, the lag in the surcharge and the year-to-year inventory effect, our estimated operating margin on a comparable basis would have been 23.1% in the third quarter compared to 25.9% a year ago. Other income in the quarter was $3.7 million compared to $6 million in last year's third quarter. This primarily reflects lower interest income on our invested cash as a result of lower interest rates.

Our income tax provision on continuing operations was $23.1 million or 31.3% versus $28.5 million or 30.7% for the third quarter last year. We expect an effective income tax rate for the full year of about 33%.

Third quarter net income from continuing operations was $50.8 million or $1.05 per diluted share. The record third quarter a year ago had comparable net income of $64.3 million or $1.22 per diluted share. We continue to expect that free cash flow for the fiscal year, excluding the cash associated with our third quarter acquisition and divestitures, will be about $100 million. Within this, our estimated capital spending for the year remains at $125 million.

On our March ending balance sheet, we had a cash and marketable securities balance of $600.6 million, which includes the ceramics sale proceeds. Our priority for deploying this cash remain the same as we had previously communicated.

Now I will turn it over to Anne for some closing thoughts.

Thank you, Doug. Before we turn to your questions, I want to briefly comment on how our business is changing. One of the key drivers in Carpenter's growth plan is the pursuit of global growth. We are continuing to strengthen our relationship with strategic customers. In addition, we are following the migration of our customers overseas and we are reaching out to new customers as well. I have been spending a considerable amount of time visiting with current and potential customers overseas, particularly in Europe and Asia. These visits are to ensure that we better understand their needs. I am also here to let them know how Carpenter is able to support them.

Our capabilities in technology leadership represent quality sourcing for our customers and good growth opportunities for Carpenter. We are committing more capital and human resources to promote our growth throughout the world. A good example is what we are doing in China to further our growth deals and provide additional technical support to our customers.

Carpenter has devoted much time and effort in the past to improving our agility and lowering our fixed cost structure. Moving forward, we are taking the next steps to streamline both our business practices and our manufacturing techniques. We are maintaining our focus on strengthening and growing our core businesses. We have been shedding noncore operations to better utilize our assets and to reduce complexity. And we will continue to invest in a lean manufacturing environment, adding people only where necessary and improving systems and processes. I can tell you that the management team understands what is required to grow and understands to continuously improve our processes to achieve operational excellence.

Now with that in hand, I would like to open the line to take your questions.

(Operator Instructions). [Fez Olin], Citi Research.

I guess that's me. It's Chris Olin from, Cleveland Research.

Oh, you changed your name.

Let me start off with some maintenance questions here. I guess first, what is the other materials component in your segment breakdown that you are listing now? And I guess are you benefiting from the TIMET that relationship? Is that anywhere in those numbers?

Yes, the TIMET relationship is going well. That was an agreement where we purchased ingot and we process for them. So we are really satisfied. That is a good agreement for us.

Just in terms of new products, some of these products are developmental products. Some of them are different ingots that the team had not processed before. And along with that, the lineups that we have put out in the plant were not as efficient as we expected them to be. The problems are behind us and we have learned from the experiences.

Chris, that other segment is a small business that in Massachusetts, the Rathbone business.

So you are processing titanium volumes despite, I guess, the issues with the 787, etc.?

Yes, a small amount.

Can you quantify what the impact has been?

No. At this particular point in time, I couldn't do that, Chris, but it's a small amount.

Changing gears, then, a little bit, help me understand what your thoughts are on the nickel alloy supply out in the marketplace. Are we concerned that maybe there is too much melting capacity out there? And I guess I get concerned that a lot of it may be targeting the energy market going forward. Can you help me with this?

Yes. When we made the decision on the capacity expansion, we looked at putting that in, taking into account that there could be some additions in capacity. But overwhelmingly when we looked out through the cycle, the growth in both energy and aerospace supported the capacity growth. There are some weaknesses in some of the other markets, but that does not change our feeling right now that there is not significant excess capacity out there.

So you still feel pretty good about the aerospace growth numbers, despite some of the --

Yes. The aerospace and the energy growth, and if you look at the results we've had a lot of good top-line momentum. The volumes are actually up 20% from the first half run rate, and we expect that momentum to continue, not only into quarter four, but the next fiscal year.

Michael Gambardella, JP Morgan.

Could you give us to some color around your share repurchase program? You were active in it, in this past quarter. How much is left and what was the average price of what you bought back in the previous quarter?

Doug has the data in front of him. I'm going to ask him to comment on that.

Just a couple of questions here, Michael, that I think will clarify what we are doing on the share buyback. Up until this recent blackout period, we had a 10b5-1 program in place that directed our share buyback activities. So during the third quarter we deployed $25 million of capital against share buyback, $29 million in total. If you look at the start of the new program, and the average price that we paid, which was at the beginning of the quarter, was just under $70 a share on that small allotment of capital. I don't know if that answers your question or --

And how much is left?

What we have left is about $220 million as of the end of the third quarter against the new authorization from the Board back in December.

Okay. And when does the blackout period end after today's release?

Basically 48 hours after the release.

Gautam Khanna, Cowen & Company.

I just wanted to ask on the margin side, what is your expectation going forward beyond Q4? It sounds like some of these kind of onetime-ish issues are going to persist for the quarter. But looking at fiscal '09, where do you see margins at premium and advanced heading. Are we going to be moving up or are we going to be moving down on a year-over-year basis?

Margins, as I think you know, is a complicated subject because of the mix component of the margins. But generally, the mix on our business has been positive. Certainly in the short-term, some of the increases in our operating costs have hit us from a margin standpoint. But going forward, margins -- there are positive elements in margins and other things that may pull down on margins. And as it relates to mix, one of the things that we would just make clear is that we are not going to walk away from good business opportunities that are right to do even though they may have a negative effect on margins. So at one time in the Company's history, you could maximize them and we could certainty that today, maximize the margin by reducing 30% of the product portfolio. But there are opportunities that are growth opportunities that could have a negative effect on our margin, and we are more and more inclined going forward to look at our business in terms of growth in dollars of operating income versus operating margin, although we would still, saying that, expect our margins to remain at a high level.

May I ask it a different way? I think you have now got guided Q4 to be at or above Q3. And I don't know if this is a nuanced point, but I thought previously you said it would exceed Q3. Is there any reason why, heading into the next fiscal year, we are going to see year-over-year compares coming down? Is there anything is that gives you pause -- I mean, you were talking about the economically sensitive businesses, which you made us aware of for a while. Now you have some operating issues. The question I have is when you're talking about operating income, let's talk about operating income. Is operating income going to be growing in fiscal '09. We know the share counts is shrinking on a year over year basis, but I'm trying to get an earnings growth.

What I would say there, without providing specific earnings guidance, which is something that we don't intend to do, but as it relates to operating income we expect our fourth-quarter operating income to be above our third quarter operating income, and we've got good top-line momentum in the business, and we also expect that to carry through on the bottom line. I have been clear and transparent about the toughest thing to predict, honestly, in our fourth-quarter results is the ending inventory position and the impact that has on the LIFO inventory balance. Right now we are expecting a reduction in total pounds at the end of this year versus the end of last, which would cut into a LIFO layer and generate about $6 million of positive profit in the fourth quarter. We feel good, as Anne had mentioned, about the top-line growth momentum that we have in the business carried to fiscal 2009, and particularly on our strategic parts of our portfolio, aerospace and energy. So hopefully, that gives you enough to characterize how we feel going into the fourth quarter and then continuing on into fiscal 2009.

And last question, housekeeping -- excluding the surcharge, what were the power gen sales and what were the oil and gas sales within Energy?

Excluding the surcharge, power gen was up in sales terms in the third quarter 63%, $15 million. And oil and gas, excluding surcharge, was $27.5 million and up 28% versus the prior third quarter.

Mark Parr, KeyBanc Capital.

I have a couple of questions. First, in your commentary, you talk about your free cash flow outlook for the year of continuing to be more than $100 million, I believe. Is that including or excluding the cash input from the sale of the ceramics business?

Excluding, Mark.

So then you would look at $100 million in free cash flow, plus about $100 million or whatever of booked gains on the ceramics business?

That is right.

Terrific. It's good that even in the economic slowdown you're seeing in part of your business that your free cash flow outlook is being maintained. I think that's very critical and very important from a value creation standpoint.

A couple of other questions, if I could, just regarding current business conditions. As far as the VIM furnace is concerned, the new furnace, could you talk a little bit about the -- give us an update on the timing of the start of that furnace? And also, could you talk a little bit about the amount of P&L expense that you are incurring from that furnace and when you expect it to peak?

First, I will comment. Obviously, an investment this large is something that the full team reviews. We just had a deep review of the project about a week ago, and I'm extremely pleased with the work the team has done. But I'll ask Mike Shor, since he is close to it on a day-to-day basis, to give you a bit more specifics and color to the project.

To date, we have spent a little over $50 million on our premium products expansion project. We actually have hot metal running through our first furnace. The first of our four new VAR furnaces is operating and has been operating since March. We have two ESR furnaces which are coming online. The first one will be in August. And the cornerstone of the project, which is our new 20-ton VIM, will be melting by the end of the calendar year. We feel good about all the markets and the products that go into that furnace, but on the aero and energy side, where we are seeing double-digit growth, we feel really good about that furnace coming in and what we are going to be doing with it.

Okay. I guess I was just curious about P&L impact of the commissioning of these new assets. And I am guessing that while you're capitalizing most of that $50 million, if not all of it, there has also been a P&L impact. Could you talk a little bit about how much that is affecting current reported earnings and when you would expect the negative effects of the commissioning process to begin easing off and -- as the productivity of these new asset begins ramping up?

It's tough to dimensionalize in specific terms -- Mark, this is Doug. The $50 million, as you say, is being capitalized. I think it's inevitable when you take on a project of this scale that there are some inefficiencies that are created throughout the balance of the operation, but --

Absolutely. I'm just trying to get some clarity around that, that's all.

We don't believe that it has been material to our results. Otherwise, we would have identified that as such. But it's inevitable that there are some of those spillover inefficiencies.

If I could just go on and ask a couple of other questions. It looks like the vast majority of your demand weakness is on the stainless steel side based on your commentary. Is that correct?

That is correct.

Could you talk a little bit about what has been happening with stainless leadtimes and backlog? You think things are stabilizing here? Do you think that there is an operating -- based on what you're seeing, is there a potential for some worsening of the stainless business in the next six months?

I will comment on a high level and if we are at the bottom or not, I don't know. As I gave my statement, I am not going to say bullishly we are at the bottom and it's over with, because I still believe that the domestic economy is soft and the sensitive markets like the industrial and the consumer, particularly when you look at things like housing, is soft and I can't see it strengthening the next quarter to any significant level. But the guy that is responsible for a lot of the products is Mark Kamon, and I know he has a couple of additional comments he would like to share with you.

The one comment I would make is, when we compare year over year, as Doug mentioned earlier, we had a very strong third quarter last year. You look at how the stainless business is evolving, over the first half of the year, inventories in most of our supply chains had been leaned out by customers that we deal with in response to the nickel volatility that occurred earlier in 2007. So we've actually seen growth in our stainless business from second quarter to third quarter, and frankly we see stability going forward because inventories are in pretty good shape within the supply chains.

I've heard similar kinds of commentary from ATI, which is on the flat rolled side. I think they had indicated that their stainless business looked like it had -- they did not say much as far as the demand was concerned, but this supply chain issue as far as the excess inventories that needed to be worked out of the system and probably actually got overdone on the downside. Would you say that a similar thing -- would you say that inventories at your customers are below normal in stainless right now, or normal, or how would you characterize them?

I think there's a lot of market uncertainty right now, but I think where -- the customers have their inventories where they want them to be, and I don't think in enjoyed movement within the supply chains is going to be a major factor (multiple speakers) how the economy developments and how we go forward.

So at least you won't have the inventory destocking issue. You will have the economic issue, but the inventory destocking issue appears to be behind you for the time being. Is that fair?

Some of the checkpoints that we have done and from the conversations that we have had with customers, that is how we feel right now. However, there are some consumer segments that are weak, and domestic auto remains weak.

Absolutely. If I could just ask one more question. Could you talk a little bit about lead times and backlog momentum in your nickel alloy and the titanium business? And then I'll pass it on. Thanks very much for all the color.

We don't really look at our backlog in terms of projecting the health of the next quarter, but I can give you a general comment that the backlog is up over 12 -- over 10% from where it was last year.

That's terrific. Thanks very much, Anne.

Brian Yu, Citigroup.

Anne, I think if I recall correctly earlier you said that aerospace volumes were up about double-digits year on year.

Yes, aerospace volumes were up 15% in quarter three.

Okay, but then the core revenues, ex surcharges, only up 6% -- is this a mix issue, or are you seeing greater competition in the aerospace industry?

It would be mix, Brian.

And you would expect that to -- so you would expect core revenue growth to better track volume growth going forward, or are we going to see this type of lag for a bit longer?

Again, this is one of these complicated areas, but a nine-point spread, I would just comment, is unusually high in terms of a mix affect. And so we would expect to see closer relationships going forward.

And Doug, I think historically, you guys have always broken out the gross margin impact. As a result, the surcharge lagged by itself. And I'd notice this time around it was lumped in. Do you have that number available, or is it not material?

The lag affect itself difference quarter to quarter was about $3 million. So you can do the math there. But if you just look at that piece in specific, the difference from quarter to quarter was $3 million.

$3 million, okay.

Positive to this year's third quarter versus last year's third quarter.

Got it. And then the production inefficiencies, Anne, I think you said that this is pretty much behind the Company now. Any way you could try to quantify the impact in the third quarter as a result of these production inefficiencies so we can try to figure out where more normalized operating EPS might be?

The answer to your question is, I can basically tell you in every penny. Trust me. I was just talking to the team about this, this morning. I will let Doug comment on the amount. What I will comment on is the efficiencies that we had experienced -- the bulk of them are behind us. The type of things that are still out there, to a smaller effect, are some of the investments that we are making in the lean manufacturing area, as well as some additions of people that we have and the training associated with them for growth. So there are still some of these investments that will carry forward, but the bulk of the inefficiency due to lower yield and processing issues are behind us.

The only other thing I guess I would add is that we had a better March than we did January and February, and so if that's any indication that a number of those areas are being addressed.

Sanil Daptardar, Sentinel Asset Management.

On the titanium side, could you just give us some [clear] on how your product pricing is basically? Is it linked to a certain kind of an index, or it's basically on a contract basis?

This is Mark Kamon. The titanium, about 65%, 70% of our business is linked to formulas, and the remainder is sold through distribution on a spot basis. As you know, spot prices in titanium over the last year have declined. That's what I would comment on (inaudible).

And that 65% to 70% on the formula is based on cost plus kind of thing, or it's basically again, devoted to that index partially?

Well, it's really tied to material movements, so the material movements are neutral.

On that inventory destocking question, basically the previous one you talked about, are you seeing that your distributor chain or the supply chain looking to restock, or there is any kind of signs that they might be willing to restock with the inventories coming down now, the destocking over? Or, you see that may not happen with the soft economics?

I will give you my view. My view is, the inventory levels are where the distributors want them to be. And they will be restocking as demand pulls material. I do not see, based on the conversations that I've had, that there is movement out there to stock at a significant level above where they are.

On the international markets, you talked about Europe grew 26% year over year. In fact, Europe generally lagged the U.S. in terms of the economic softness. Are you seeing any kind of early signs that the demand might start to weaken in the European market and possibly spill over into Asian markets and aerospace?

No. At this point and from all the conversations and traveling that I have done, I see no signs in the markets that we participate in.

If I may just ask the last question on the fiscal '09, do you think that the aerospace and the energy market strength in terms of the volumes may be able to offset any kind of demand softness, continued demand softness in industrial autos and consumers?

I think what we have said there in general is that energy and aerospace are our two most strategic markets, that we would expect the growth rate on both of those to be in the high single-digits going forward, and that we would expect the balance of the business is to model a GDP type growth rate, which is impacted right now by recession. But aerospace and energy, you've got 50% of our total business mix there between those two markets, and the balance is 50%. So the wild-card is really what happens in the general economy, but we do expect to see strong growth in aerospace and energy.

And the high single digits is in revenue terms, right? It's not in volumes? The volumes might be much more than that?

Correct.

Tim Hayes, Davenport.

Just some numbers questions. I missed the aerospace sales ex surcharge. What was that figure again, please?

It was up 6%.

And what is the level of that?

I am sorry?

The level of sales?

The total dollar sales -- just a second.

We are flipping back to give you the exact number.

$143 million.

And you gave the year-over-year change in volume for aerospace. Could you also run through each of the other five key end markets?

Sure. We were up 29% in energy, up 18% in medical, and then on the economically sensitive businesses as you would expect, down 15% in industrial, down 23% in automotive and down 24% consumer.

And my last question is on this LIFO layer benefit of $6 million that you expect in Q4, is that embedded into your guidance that you see Q4 at or above Q3 levels?

Sure, because that is consistent with how we are managing the inventories. What's also embedded in there is the year to year effect from this confluence of inventory build/debuild and the nickel price trends between the year, which is of the magnitude that we saw in the third quarter or $11 million, so that is also in there as a negative.

And the LIFO liquidating, the $6 million, that is a pretax figure?

Yes.

Bob Fetch, Lord Abbett.

Touching base on the industrial, who are your principal customers' end markets there? When you are talking capital goods in valves and fittings and so forth there, are we talking products that are housing related there or not? Because otherwise many companies in related areas have been doing particularly well, partly due to strong exports?

Our industrial products are spread across a myriad of customers. And I would say, certainly our international business is strong. When you look at the year to year comparison versus last year, we had some very unusual sales in the third quarter of last year, which were not duplicated this year. So the comparison year over year is a little distorted. But our experience from the standpoint exports has been very good overall, as our numbers would indicate.

So those very unusual sales, were they to a customer or two who you no longer have, or what?

No. Obviously, we can't say anything specifically about a customer. But we did have a customer position for international growth that did build some stock last year. And when we look at a year-over-year comparison, some of that's reflected in the numbers.

And maybe what might be worth providing for a perspective here is, if you look at last year's third quarter and the dynamics of what was going on in the nickel market, the reason it was such an exceptionally strong overall volume quarter is because nickel was trending significantly up at that time. And so you had motives in our customers to buy in anticipation of what they were seeing going on in nickel at that time. So there are several customers in industrial, but also in other parts of our business, where the numbers in last year's third quarter were very high because of that nickel impact.

So the comments you made earlier are consist in the industrial area. Did you see growth quarter to quarter from second to third quarter then, then destocking kind of behind you?

Yes.

Okay. In the automotive, is that more heavy-duty truck sensitive as opposed to automotive or not?

No, it's just the overall domestic automotive.

The run rates in build in the U.S. auto producers have continued to decline and are forecast be $15 million or less at this point for this year. So that's a pretty substantial reduction in run rate. You have the interferences of the noise in the auto strikes and the labor situations that are causing people to be very sensitive about their inventory positions.

And is that more Tier 1 suppliers here you are supplying, and which particular product types are you the most exposed to?

I would say it's all customers are very sensitive right now. And it's probably the area where there is the most uncertainty in inventory projecting, so I would leave it at that.

Do you know what extent it's a mix issue, and you have more or less exposure to SUVs?

No, I think it's fairly balanced.

In the medical area, can you tell us what you think the inventories are at your customers there and whether you've picked up any new customers or have penetrated some new product categories?

With the medical pull, we are beginning to see what we think is that the inventory correction overall is more in balance than it was last year. So I think both from the OEMs and the distributors, we are returning to more normal buying patterns. We all know that the medical industry is under pressure, so to say it's over with or not, we are seeing signs that it is. Beyond that, I can't comment. In terms of specifics customers, I can't comment on that one either.

How about products?

I guess I would say, we are seeing a return to something more normal on the titanium side. And the nickel-based side, I would say is stable to up a little bit relative to returning to more normal buying patterns.

So would you expect then, based on those comments, that your sales should improve from the low single digit level?

I would say in general, things will continue to improve as the destocking activities that have taken place over the last year so continue to get more in balance.

And in regards to the conversation on international, which end markets would you say that at this point in time are closest in view that you might be supporting and the principal applications that are being targeted that are closer at hand?

Aerospace and energy are the two main markets of growth in international, although we participate in all the products. Those are the two big ones.

And is that at this time, then, principally following existing customers?

Existing customers, plus we've got a lot of contacts with new and strategic customers as well.

So as you look out the next, say, two to three years, if you could prioritize the two or three principal areas you would expect to get the best incremental growth from?

Mike has been doing a lot of work in this area, so I will ask Mike to comment with a bit more color.

Two areas that we continue to feel will lead to significant growth for us are aerospace, and that's not only the engine and the structural side, but the fastener side. And also energy, and energy is both power generation and oil exploration. And we have seen both ourselves and our customers move more to an international footprint, hitting new geographies with some of these products. So we feel very, very good about both of them.

And on energy, what is the mix between power gen and other energy-related products?

Strong growth on both. I gave the numbers earlier in the call. Do you want me to repeat those?

I think in energy, you had us up like 25%, was it?

Overall on sales terms, we were up 38% in the third quarter, and big numbers on both oil and gas and power gen.

And then lastly, how important are the titanium fasteners at this stage? We have been, hearing that has been one of the bottlenecks all along for the use of composites in some of these obviously big backlogs for these very wide aisle --

There is no constraint on our part. We've got the ability to meet all the demand from Boeing and aerospace for titanium fasteners.

And what is the current run rate about today?

What do you mean run rate?

Say sales in that division?

We don't break out sales, anything below our -- the end market or the reportable segments that we provide.

Leo Larkin, Standard & Poor's.

Could you give us any preliminary guidance for CapEx and DD&A for fiscal '09?

For fiscal 2009, no, other then this year we would expect to spend about $125 million in CapEx, as I mentioned. And next year, we anticipate a continued healthy level of CapEx, just given the needs of the business. So I would not be any more specific than that. In terms of D&A, we were at $37 million through nine months. We would estimate this fiscal year at about $50 million. It will be a little higher than that next year because you will begin to have some of the depreciation on the major premium melt expansion project.

Would $125 million be safe to model in as just tentatively speaking for 2009?

This is a period of the year where we are right in the throes of all of our specific planning for next year. So I don't have a specific number to give you next year, other than we expect that the business still has some healthy CapEx needs looking forward.

Gene Fox, Cardinal Capital Management.

Just a couple of questions. Anne, the $4.1 million of incremental spending that you referenced in Q3, could you talk about -- is this a run rate we should expect going forward, and when should we start to see the benefits from that?

There are two pieces of the spending. I can give you -- the one piece of the spending is investment in technology, marketing and customer support. That's a little hard to see when you get the benefit from it. Obviously, there is a time lag on both. So that one is a bit more difficult to quantify the when.

In terms of the other investments that we are making in lean manufacturing, typically -- and this is something I've spent a lot of time on over the years -- typically, you make the investments and you start seeing the benefit in three to five years. We may start seeing a little benefit before then, but the significant benefit is a couple years out. And in terms of the lean investment, we are just finishing up the beginning of the first year.

So it's really fair to think about those for the time being as just incremental ongoing expenses that we should model in, but where we will ultimately get some payback on?

Yes, because of course any time you drive a lot of change in an organization like we are in these areas, some of it are the things that I talked about. But some of the investments that we are making is recovering some of the things from the cost cutbacks that the Company needed to do from a four- to five-year period. And an area where you will see quicker benefit is obviously investments that we have made in systems. So efficiency and effectiveness, you're going to see from that. But just overall, we're continuing to invest where we see it's appropriate to drive the business for growth in the future.

A couple of other questions. When I look at a high level of your Q3 versus your Q4, on the positive side I think you outlined this LIFO benefit that you put at about $6 million as well as the absence of an unquantified production inefficiency in Q3 that is not going to be there in Q4. On the minus side, we are really talking about macroeconomic issues and whatever conservatism you want to build into your forecast for your economically sensitive businesses. Is there something else that I am missing when I think about how you are thinking about the business, at least as to Q4?

No, I think that's a fair characterization. I guess one of the other areas that's missing in that macro construction that one of the other previous callers asked about was just the impact of some of the difference in the lack effect, so to speak, one quarter to another. In the fourth quarter, if you look at what was happening in nickel at that point in time, prices were trending down in the fourth quarter. And so I think there will be some negative comparison in the fourth quarter due to that lag effect, but otherwise I think you've got the construct right.

And you are talking about that relative to Q3?

I am talking about that both relative to Q3, yes, and relative to last year.

How should be think about that impact separate from the $11 million number that you discussed that will impact both Q3 and Q4?

The numbers on the lag affect are just not big numbers. So they are not comparable to the $11 million; the $11 million is the big number.

In terms of the $11 million, is there some, as well as the LIFO charges, is there any way to think about how those would impact '09 going forward? Is there something structurally that would make them relevant to your business in 2009?

Yes. I think as you would look ahead on that, there's just a confluence of events that are affecting this third quarter and the fourth quarter as it relates to inventory patterns and nickel patterns that just aren't normal. So looking forward, but also looking backward, there was some volatility in nickel pricing that has been unusual over the last 15 or 18 months. And so I guess what I would say as it relates to any period looking ahead, including fiscal '09, inventory is constant. There would be no impact from what I just talked about regardless of what happens to nickel prices. If nickel prices are constant, there would be no impact from any changes in the inventory levels. It's really when you're dealing with the combination of the two in a different way across the fiscal years that you get any numbers that are anything like that magnitude. So looking ahead, I think things remain as a stable as they have been, it should be a nonevent.

So, to rephrase what you said, the $11 million should not be something we should necessarily build into our models going forward?

Right. We have highlighted the third-quarter affect and there will be a similar fourth quarter effect. But beyond that, it would not be something that we would anticipate.

And at this time, we have no further questions. I would like to turn the call back to Dave for closing remarks.

Thank you very much. I want to thank all of you for joining us on the call today, and we look forward to talking with all of you next quarter.

Thank you, ladies and gentlemen, for your participation in today's presentation. You may now disconnect, and have a wonderful day.