Carpenter Technology Corp (CRS) 2009 Q3 法說會逐字稿

Good morning and welcome to Carpenter Technology's third quarter 2009 earnings conference call. My name is Kamisha, and I will be your coordinator for today. (Operator Instructions). I would now like to turn the call over to your host for today, Mr. Dave Christiansen, Vice President for Investor Relations and Business Development. Please proceed.

Thank you Kamisha. Good morning everyone. Welcome to Carpenter's earnings conference call for the third fiscal quarter ended March 31, 2009. 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; and Mike Shor, Executive Vice President, AMO and our PAO 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, 2008 10-K, its September 30, 2008 and December 31, 2008 10-Qs, and the exhibits attached to those filings.

I will now turn the call over to Anne.

Thank you Dave. Good morning everyone. As you can see from the press release, our third-quarter results reflect the continuing difficult market conditions that we operate in today. We mentioned on our last call that we expected our business to be 20% to 25% lower versus the prior year. That is where we ended up this quarter.

And not surprisingly there has been no significant improvement in the condition of our market since we spoke last quarter. In fact, the fastener segment of our aerospace market has begun to slow this quarter. I can't say when our markets are expected to improve. I certainly see no short-term relief in sight. We expect weak demand in most of our global markets to continue through the calendar year.

In light of these conditions we are taking aggressive steps to manage our business through this downturn. We are attacking all of our costs, both fixed and variable. We have reduced production hours by 30% to 40%. We have cut labor rolls by nearly 300 positions. We have slashed SG&A spending, and we are closing our UK metal strip manufacturing facility.

At the same time we will be prepared to take advantage of the recovery when it comes. We are completing the capacity expansion of our premium melt program. We are investing more heavily in new products and R&D. We have new marketing programs that will grow our customer base. We are investing resources in China and other international markets. And we will continue to improve manufacturing efficiencies through our lean initiatives and waste reduction efforts. These actions by our leadership team will optimize the company's performance during and after the recovery.

Carpenter is a financially strong company with tremendous growth potential. We will stay strong through this downturn, and we remain committed to our goals of positive free cash flow and a strong balance sheet.

Now I'll review our end-use markets and then Doug will cover the financial highlights. To provide better insight into our performance, quarterly sales numbers and the year-over-year revenue comparisons exclude surcharges.

Aerospace sales were $117 million, a 17% decline over a year ago. Shipment volumes also were down 17% from last year, reflecting the continued impact of a reduced airplane build schedule, lower overall passenger miles, and excess inventory in the jet engine market. Although we continue to strengthen our market position with engine customers, we do not expect to see improvement in this sector until late fiscal 2010.

This quarter also saw for the first time a weakening in demand for materials for aerospace fasteners. Backlogs at fastener manufacturers that used to be about 50 weeks are now less than half of that as orders for finished fasteners are pushed out. Fastener demand is likely to weaken further.

Carpenter's sales to industrial market were $63 million, a decline of 15% compared with the third quarter last year on 27% less volume. In general there was lower demand for materials used in valves and fittings, fasteners, and general industrial applications. We also experienced volume losses in commodity type products where pricing has been very competitive. Industrial production indices do not show recovery until well into our fiscal 2010.

Demand in the energy market has abruptly weakened. Our energy market sales were $30 million, down 27% on 43% lower volumes. Oil and gas exploration activities remained slow in the face of reduced demand for oil as the recession deepened. Drilling rig activity continues to decline and there is substantial excess inventory in the supply chain.

These conditions combined with the forecast of low oil prices into fiscal 2010 lead us to believe this market will not improve over the next year.

Declining market demand and high customer inventory are also beginning to affect sales to the power generation market. Power gen users are continuing to struggle with financing these large pieces of equipment in the current credit market.

The medical market continues to be resilient, driven primarily by steady increases in the number of medical joint implant procedures in North America, Japan, and the EU. On 5% higher volumes our medical market sales in the third quarter were $24 million, a decrease of 15% compared with the third quarter of fiscal 2008.

The increase in medical shipments reflect higher demand in orthopedic implant and medical instrument applications. The revenue decline in medical came from the pass-through of lower titanium costs and a leaner mix of products. Based on long-term demographics, we expect the medical market will continue to grow during our fiscal 2010.

Carpenter's sales to the consumer market were $17 million, down 45% from last year on 39% lower volumes. Consumers continue to be extremely cautious in today's environment of tighter credit and higher unemployment.

The decline in revenue was led by housing and electronics. US housing starts continued to decline in the third quarter of fiscal 2009 while consumer discretionary spending on electronics and sporting goods also fell. Some economists are projecting improved consumer spending in the latter portion of this calendar year.

The automotive market remains depressed. Our sales were down 56% to $17 million on 57% lower volume. The significant slowdown in consumer spending and tighter credit continued to suppress auto sales during the quarter.

Including surcharge, Carpenter's international sales in the third quarter were $112 million, a 37% decrease over the 2008 third quarter. International sales were 34% of our total volumes in the third quarter. The decline in international sales was primarily related to lower demand in Europe for aerospace, energy, and automotive. Demand in Canada for oil and gas applications was also a factor. Our China business has seen strong growth, and we are adding new customers in that region.

At this point, let me turn the call over to Doug so he can walk you through our financial results.

Thanks Anne.

Our primary financial objective during this downturn is to deliver positive free cash flow and maintain our strong balance sheet. Through the first nine months of this fiscal year, we are at $60 million negative free cash flow due largely to the significant buildup in our inventories in the first half of the year. We made great progress the third quarter by reducing inventory by $55 million, and we expect to achieve a further significant reduction in the fourth quarter.

In addition we have scaled back on some lower priority capital projects and expect to finish the year at about $110 million of cap ex.

Our team is also doing a very good job managing our customer receivables exposure in the current environment. We achieved positive free cash flow for the third quarter and are still targeting to be positive for the full year. We expect this to be very close.

Positive free cash flow is also our top financial goal for next year. Due to current business conditions we expect capital spending next fiscal of about $50 million.

Let me now move to our third-quarter income statement. Net sales in the quarter were $330 million or 35% below a year ago. Excluding raw material surcharge, sales were down 24%. Overall tonnage volume decreased 31% in the quarter with special alloy products down 22%, titanium products off 24%, and stainless steel products down 35%.

Third-quarter gross profit was $49.2 million compared with $108.5 million a year ago. Excluding surcharge revenue, our gross margin in the period was 18.4% versus 30.8% last year.

Our SG&A expenses decreased 8% year-over-year and are down 12% if you adjust out the impact of higher, non-cash pension expense. This is the result of actions we have taken to reduce headcount and spending.

We have $2.1 million of expenses in the quarter from the announced closure of our Crawley, UK strip facility and expect a total income statement impact of about $9 million for the fiscal year. The net cash outlay associated with this closure is about $2 million with an ongoing operating profit improvement of $2 million per year.

Overall operating income for the quarter was $16.1 million compared with $74.7 million in last year's third quarter.

Our operating margin excluding surcharge and restructuring costs was 6.8% for the quarter, down from 21.2% last year. Our margins are being negatively impacted in the second half by a confluence of factors. First, demand is down significantly. This, coupled with our major reductions in inventory, puts increased downward pressure on our production levels and results in negative fixed cost impacts.

We have worked very hard to reduce labor costs in line with the lower production levels, and as of this moment we have cut our labor rolls by nearly 300 people -- one third temporaries, one third through voluntary short-term furloughs, and one third by a layoff.

Further we are buying much less nickel and other raw materials now when prices are lower, which also has a negative effect on margins in the second half.

We calculate that the combined LIFO accounting impacts from the inventory reduction and our raw material purchase patterns reduced third-quarter profit by about $11 million. All of this otherwise overshadowed a pretty good order of operating cost performance in the period.

Continuing down the income statement, other income for the quarter was $2.7 million compared to $3.7 million last year.

We had a lot of activity on the tax line this quarter. Our third-quarter tax provision was $1.8 million or 12.1% versus $22.8 million or 31.1% in the same period last year. The lower tax rate primarily results from applying R&D credits to our lower taxable income level and the reversal of certain reserves recorded for a prior tax year. These items were partially offset by a value a valuation reserve against certain deferred state tax assets. Our full-year effective tax rate is expected to be about 25%.

Third-quarter net income was $13.1 million or $0.30 per diluted share versus comparable income from continuing operations of $50.5 million or $1.05 per diluted share from a year ago.

We continue to maintain a strong and conservative balance sheet. This is a fundamental advantage we have versus the last cyclical business downturn in 2002. We have plenty of liquidity and headroom within our facility covenants. We are also closely monitoring our accounts receivable and other financial exposures and have had no significant issues with these.

As announced last week, we maintained a constant dividend payment for this quarter. Future dividend payouts will be aligned with our foreword cash flow projections and cash deployment priorities.

Looking ahead, our overall volume level will be lower next quarter and will probably hit bottom in the first quarter of next fiscal year based on current estimates. In addition our volumes with key aerospace and energy customers are expected to be weaker over the next few quarters due to the conditions that Anne has described in these markets, which is negative from a mix standpoint. This will result in a loss for the fourth quarter.

Additionally in the fourth quarter, we expect a further earnings impact of about $7 million from the Crawley closure and another $20 million of negative LIFO and raw material impacts due to declining demand and the significant second-half inventory reductions.

The pressure from lower volume and weaker mix will extend into the first half of next year. We will also likely face another significant increase in non-cash pension expense in fiscal 2010.

Again our top financial objective is to manage through this downturn by delivering positive free cash flow, which will preserve the company's strong financial position.

With that, let me now turn things back to Anne for some closing comments.

Thank you Doug. As we have already indicated, we do not expect to see the beginning signs of recovery for the balance of the calendar year. All indications are that end market conditions will remain soft for some time.

Now while everyone hopes for a quick end to this recession, we have to work on the assumption that the anticipated recovery is likely to be gradual. Therefore, as we head into next year we must continue to do more of what we are already doing -- cut costs, and reduce headcount, manage working capital, and keep inventory more level in order to avoid the swings seen in each of the last few years, reduce our capital expenditures, and take other actions necessary to generate positive free cash flow and maintain our strong balance sheet.

We continue to make progress in manufacturing efficiency, and we will complete our new premium melt facilities in advance of need. The tangible results of much of the work we are doing now will show itself when end market demand improves.

Equally important we will remain close to our customers and proactive in our new products and global marketing programs.

We have established a greater presence in the long-term growth markets of Asia and Eastern Europe. Our China business is responding well to the recent investments that we've made there, end we are continuing to add new customers in that region.

All these actions position Carpenter Technology for stronger long-term growth when general economic conditions improve.

With that we will now open the lines for your questions.

(Operator Instructions). Edward Marshall, Sidoti & Company.

I was -- my first question -- I just was curious. We talked about inventories coming down and reducing. Is there any kind of outlook that you could provide as far as 2010 or fiscal 2010 as far as these -- as far as a reduction in inventory and how low can it get? With respect to the fact that I know it's kind of hard to predict given the demand situation.

We certainly next year are going to manage to a more level inventory pattern than we've seen over the last couple of years. So I don't know that there are significant further reduction potentials versus where we will end up this year. We've got a lot of work to do in the fourth quarter, but as we deliver the level at the end of this year I think you can expect just a more level inventory pattern across the next fiscal year.

And then from a backlog perspective, I don't think you break it out on a quarterly basis, but if you could kind of give us an indication as to your book to bill in the individual segments and what that is doing. Are you dipping into backlog here?

The backlog numbers aren't fully indicative of our results, but we've got backlog numbers at the end of the quarter that are probably running order of magnitude 40% or so below the same period last year.

Gautam Khanna, Cowen and Company.

Doug, could you talk about the cash impact on the pension next year, fiscal '10?.

For fiscal '10 -- so based on where our asset values ended up at the end of last calendar year, we right now would continue to project a cash investment need of about $20 million, and that would be in September of 2010 for the 2009 plan year. And depending on where we are at at the end of this calendar year, we would potentially then need to start estimated payments beginning in April 2010 for our 2010 plan year. Those are of an undetermined magnitude because we don't know where the assets are going to be at the end of the calendar year.

So very little of that that would affect our fiscal 2010 cash flow.

Right. And you mentioned some of the dynamics in the fastener market. Are you seeing this both at Precision Castparts and Alcoa? And do you think there is any element here where it's not just demand but also perhaps share loss? If you could just comment on the dynamics you are seeing there?.

This is Mike Shor. I will comment. It is not share loss. Obviously fasteners are tied to the plane builds, and what we see is the fastener materials purchased about six months before plane assembly versus the 12 months for the engines, so we see that now coming on.

We've seen our customers backlogs shrink probably by about 50%. So we are really just beginning to see a decrease in fastener demand, and we feel it will continue as we move forward. (multiple speakers)

And you've seen (multiple speakers)

It is not indicative of share loss.

And you're seeing it at both of the major fastener manufacturers? Or is it just that one?

It's pretty much across the board.

Kevin Money, Cleveland Research.

Just looking at the markets that you serve, what is the long-term supply outlook there? And is there too much capacity out there? And just what do you see from a global perspective?

Well, let me start and talk about aerospace and about the demand. What we -- we look at a couple of indicators to see what's going on. One publication that we subscribe to and look at closely is Airline Monitor. And in effect what you see when you look out over the next five-plus years, you see strong demand, but the demand -- it seems like every six months the demand is pushed out, so when you look at Airline Monitor, primarily what we look at is Airbus and Boeing. Even though we supply product that goes into the smaller plane market, the bulk of them of the material that we take are from those two, and we look at the numbers that Airline Monitor publishes.

So if you look mid- and long-term, it's still a strong, growing market. I don't think either Boeing or Airbus is over facilitized. I know both of them have been very cautious in terms of how much capacity they have put in. I believe it's just the general dynamics of demand on airplane travel plus the tightening of the financial credit markets.

So the answer is, I don't believe they are over capacity. I do believe demand will come back because the mid- and long-term demand is there. It's just a matter of the push-out of timing.

When I look at other markets like energy, energy obviously is linked to a lot of things. The sectors that we participate in -- oil and gas exploration, which is down -- drilling activity is down, so that impacts our volume there.

The other is the power generation sector. We participate in the bigger turbine end of that market. That's down for some of the same factors as aerospace -- the credit markets, plus the price of oil is down.

So long term we're linked heavily to oil, and that demand will come back over the long term. It's just not there now.

In addition to that, we have increased our participation in getting involved in the newer energy forms. But when you compare the volume, yes, it's growing. The growth rate is more rapid than oil and gas, but the volumes are low.

And you know then if you break into the other sectors -- automotive, consumer, that demand is down, linked to financial. I'm not sure when the demand comes back. The one economy that seems to be strengthening is China, but even the rate of sales in China automotive has gone down. I think that will be down for a while.

Then industrial, the pieces of that we participate in are linked to construction of chemical, food processing, and electronic plants. And with the capital crunch and people cutting back on spending, that market is down.

Leo Larkin, Standard & Poor's - Equity Research.

Could you give us guidance for DD&A for 2010? You gave us CapEx.

Yes, for 2010 we would expect to be somewhere around $58 million.

John Tumazos, John Tumazos Very Independent Research.

In terms of the US consumer I guess taxes are probably going to be the next shoe to drop. And the heavy sectors clearly take a little while to get going again after a recession. Are you looking at overseas consumer end markets as ways to redeploy your sales efforts or investment focus? And could you talk to what consumer markets you think are going to lead to global recovery?

Yes I can. That is something -- fortunately we have a very strong presence in Europe, and so we already have customers overseas. What we did is our main office is in Brussels. And what we did starting last year is put a focus on Eastern Europe because that's a developing section of Europe, and we did hire a technical salesperson to cover that region, and we are beginning to see sales come in as that market continues to develop and the economy rebounds.

In addition to that we have a sales office in Singapore that has been there for quite a few years with a lot of contacts and customers in Asia Pacific. But with the growing economies in China and India. we did put a President of Asia Operations, and we are putting in distribution in China so that we have more coverage to develop the markets there. And we are already seeing new customers come in.

In addition to that, we have strengthened our presence in Canada because Canada, even though the market is down now, it's very strong with respect to energy growth, both traditional and nontraditional forms of energy, and we've put some additional resource into western Canada and redeployed some resource there. Plus we have a strong operation in Mexico, which also covers the growing region of Brazil.

Brian Yu, Citi.

My question is on the energy markets. Can you provide some sort of breakdown between your exposure to down-hole drilling versus the big turbine market? And then also with a slowdown in turbine, is that financing-related so projects are being delayed, and once financing and credit markets unfreeze, those projects can restart relatively quickly?

Yes. Our split is 60/40 approximately with those markets. In terms of the down-hole drilling, where we sell product into that market, the exploration is the non-mag drill collars, and that is a very highly specialized piece of metal that protects the big investment that drilling rigs have, particularly directional drilling rigs, in the censors and the electronic equipment that goes down the hole. So obviously one of the indicators that we look at in that market is how many directional drilling rigs are out there and how many are being built? We have seen a significant decrease in that one.

On the gas turbine section of the market, our materials go into the big turbines, the 9F's, and that is the area where we're seeing two factors. One, customers that had ordered that particular equipment can't finance it, so we're seeing some cancellations of those orders, plus we have seen customers move to smaller turbines. And that's not where we sell our material.

All right. And then a broader question on just competitive pressures which you have cited, since some of your other competitors who've reported earlier are saying that they're kind of taking market share -- I know earlier you said you're not losing market share, yet your volumes are down significantly. I'm wondering can you just elaborate on that a little bit? And then how do you think about going toe to toe with your other competitors out there as you bring online these premium melt (inaudible - background noise) so that (multiple speakers) positioned for that recovery?

Our competitors play in different segments. Some of the segments obviously we cross, but many of the segments we don't participate in. For example, we are all long products, so we have no flat rolled product. So obviously that's not one we plan. And the other is in the titanium sector. Where we play is in the titanium fastener and also the titanium medical -- primarily, although we have some bar that goes through distributors.

So if you look at what's sectors they play in -- and even with alloy type they have different types, so you know, where we don't talk about share, but I can tell you when we made the decision to put in the premium melt facilities, we had a very focused effort to build relationships and grow the long-term arrangements that we have in products that go into that sector. So the sectors that we have focused on, we are growing.

Now there are some sectors that competitors are reporting share growth that we don't participate in. And frankly, there are some sectors that we have chosen to hold our prices rather than chase volume. And that tends to be in areas that we would say is high end of the commodity.

That's helpful. Thank you.

Mark Parr, Keybanc Capital Markets.

Just to try to summarize what I think you were trying allude to, I mean I guess first of all regarding the fourth quarter, due to the reduction in volume and weak mix, based on those two issues alone, are you saying you expect an operating loss for the quarter?

Yes, that's right Mark.

Then on top of that we are looking at what, you said about $20 million worth of LIFO expense and $7 million of plant closing costs?

That's right.

Okay. So I just wanted to make sure that I was hearing that correctly.

And then, given the fact that I think you said you expect your shipping momentum to bottom in the September quarter, would that an imply then that we could expect a further downward momentum in earnings through the September quarter, reaching a bottom there, and then perhaps either leveling off or beginning to move up off of that?

I'm not sure, you know, our revenues we -- based on current estimates we certainly expect to bottom in the first quarter of next year. On the operating margin line with volumes down and mix weak, those will create pressures. One of the things that I would point out as a mitigating factor there is that because of the changes to our production schedule in the second half, which are much more significant than what we're seeing on the volume line because of the drawdown in our inventories, that's created some significant cost inefficiencies in the operation, even as hard as we've worked to reduce production labor costs in line with the lower demand. So that will mitigate somewhat in the first quarter. But yes, the tough conditions will continue into the first quarter and first half of next year.

And then if I was going to try to get some additional color here around that, what areas would you expect to kind of lead the way for somewhat improving momentum, whether -- is it a mix that's going to pick back up again? Or I know, Anne, you had said you thought the medical markets were going to show strength next year. But is there some way you could give us a little more color on how you would expect the earnings environment to begin to show stability? Now, maybe it's just a production situation or the cost cuts that you've done or you know getting the working capital in line and getting the inventories down, but is there anything on the top line that might help to drive the upside beyond the first quarter?

I think there is still a lot of uncertainty in the end market conditions, based on the leading indicators, many of which Anne has just described. Those would indicate that we would see a pickup in our business in the second half of next fiscal year. And in addition to that, some of the very difficult changes that we've had to make to our production schedule because of lower demand and because of the inventory reductions will mitigate in the first part of next year and should get progressively better, as well as, as we are successful in managing to a more level inventory, we won't be subject to the same kind of LIFO impacts that we've had over the last couple of fiscal years.

Just to repeat here, your goal for fiscal '09 is to achieve free cash -- a positive free cash flow, but I think you said it was going to be close and it will depend on inventory. Is that right?

Yes, that's right. We are $60 million negative through the end of the third order even though we made very good progress in our third quarter alone, and we are planning on significant further progress on our inventories in the fourth quarter, and there's a lot of ground to make up. But we're -- we've got the whole organization focused on the actions that we need to take to drive continuing positive cash flow.

And then as far as 2010 is concerned, you look for free cash flow to also be present in that year as well?

Right. That's our top financial objective is managing through the downturn and being able to generate positive free cash flow.

But given the magnitude of the downside that we are seeing, being able to preserve and protect your balance sheet is a hell of an a accomplishment. So I'm encouraged to hear you say that that's a realistic objective for you. And good luck managing through the process.

And congratulations on the March quarter. All things considered, things could have been a whole heck of a lot worse for you guys.

Thanks Mark. The whole organization is committed to protect that balance sheet. This company has worked hard a lot of years to have a strong balance sheet. This is a team that's going to protect it and grow it.

Bentley Offutt, Offutt Securities.

I thought maybe we would move over to something perhaps that's more optimistic than the short term. I'm very interested in what's going on in the far east and your efforts in China, mainly in China. And also, to learn more about the type of model you are using over in China to get close to those customers relative to the domestic model.

So I thought maybe you could talk about the growing sales force you're hiring of engineers to support the customers in China, and what type of opportunities do you see? I know that historically your sales have been somewhere in the order of $40 million out of your Singapore office. What opportunities do you see in China?

Good questions. Many of you on the line know Jamie Vasquez. Jamie was prior Vice President of Investor Relations, and Jamie was Treasurer for Carpenter. So Jamie is the person that I selected and the Board supported to send to China, residing in Shanghai as President of the Asia-Pacific operations, and he has the Singapore office reporting in to him.

Along with Jamie, what we really felt was important is to send to someone with technical expertise and market development expertise. And we sent a gentleman that had spent time in Asia-Pacific previously and that had come back to Reading. He had worked through the Singapore office in the past and other places. So he was also sent along with China, so there are two ex-pats there. So that's part of it.

In terms of the business model, we do have -- we have had business in the past through some agents. We still have the agents there, but we are beginning to hire in local, domestic talent both in sales and as regional reps. So the model that we use to support the customers is sales and technical service through the regional reps. Now supporting that -- and we are just in the process of hiring that -- of hiring it, but we do have training for the people that we are hiring in. Obviously they will need to be bilingual, and that's the model that we are hiring. But we have also in addition to just having the presence there had worked really closely with many of our customers that have locations in China and along with existing customers have worked through what can we do to support their business model and their strategy for growth.

So in effect, bottom line, it's multifaceted. Number one, it's having the head of the Asia-Pacific operations that is financially astute and business pragmatic, which is why I selected Jamie. Balancing it with someone that has a lot of business development and technical expertise. Hiring local talent, and then training the talent in the Carpenter business model, and then reinforcing it with some quicker growth in supporting existing customers.

Now, we are -- before the end of this fiscal year -- and things in China, sometimes they don't go according to the timing plan that we set up, but we will be putting a distribution warehouse there, and the products that will be going into that warehouse -- number-one, priority is to support existing customers, but then number-two, the team is working with Sanjay in terms of business development to make some decisions on what other material to put there.

Now, overall the business in China this fiscal year is showing some positive growth as you compare it to the other markets. And the other thing is, even with the team there that is not fully staffed, we have added new customers during this year and we are seeing a lot of opportunity to grow.

In terms of how much growth, it's a little too soon for us to tell. Obviously we are just in the process now of developing the next cycle of our three-year business plan. So as we understand the markets, I will have a better forward view of just how much growth is there. But we are really excited about the initial results that we are seeing. And the other thing that we are excited about is the availability of some very good talent to support our strategy and growth.

Edward Marshall, Sidoti & Company.

I just wanted to clarify on the comments about aerospace and energy. You had said that engines had slowed down on the aerospace side and now you're starting to see fasteners slow down as well. Is that indicating that this -- the degradation is accelerating or is it already reached a low on the engines and now it's just going to stay constant with the additional weakness in fasteners? And then the same thing on the energy side with oil rigs and power gen?

Okay. Let me talk first about aerospace. When we look at engine components, there's a couple of factors there. The one factor is the time difference between material that we produce that will flow through to the OEM is different. The time for a fastener is six months, plus/minus. The time for an engine is 12 months plus/minus. So there is a time difference which also impacts.

The second thing that impacts in there, the faster manufacturers were in a catch-up mode because there was a difficult launch with the 787, and so they were behind schedule. So there was catch-up plus filling the inventory. That was a second factor that caused a defense in timing with fasteners.

The other factor that plays in here is when you look at revenue passenger miles, which have been down, and you look at engine replacement parts, typically engine replacement parts is about 25% of the material demand versus fasteners is only about 10%. So there is a lot of different factors in there, along with what I have said before, the Airline Monitor has reflected the pull-down in builds of both Boeing and Airbus. And then again there is the other push-out of the 787. So that's the fact -- the additional comments on the aerospace side of it.

On the energy side of it, just the rigs that I was talking about, the directional drilling rigs, the number of rigs out there is still declining. So that's still in decline. And inventory was and continues to be very high.

So bottom line, in aerospace they are still building a lot of planes. The growth is still projected out there. Basically what we are seeing from some external reports that we've looked at, there was a recent survey by UBS Investment Research that pretty much said that there are likely deferrals of aircraft orders, but there is a similar percentage of pull-aheads. So bottom line on that is we believe the build schedule at the lower rate for this year and next year it is stable. But there still is excess inventory.

Yes, the one other thing I would call to your attention on aerospace is that if you go back and look at the first half of the year, our business was flat in aerospace, which is certainly better than what the overall market was doing at that time, and I think that reflects the fact that we are well positioned in the market and that fasteners took longer than the engine products to show softness, and so what we're seeing was 17% down in the third quarter here as the fasteners starting to kick in in addition to the engine parts.

The bottom line is that across those markets, we still see the long term as key for our business, and we still see them as attractive. In the nearer term, yes, we have seen some decreases in demand; yes, we have seen some customers reducing inventories. But we still expect the markets to grow, and we still expect to grow faster in the markets.

And then from a mix perspective, I guess am I right in assuming because of the way they are melted that these are higher-margin businesses, the aerospace and energy?

Yes they are.

Gautam Khanna, Cowen and Company.

Could you walk me through some of the puts and takes on the cash flow statement fiscal 2010? And also comment -- I think earlier you mentioned inventories or rather receivables you are watching carefully. Are you seeing any sort of stretch-out? Are you going to have to finance your customers a little more than you have in the past? If you could just walk us through some of the issues there in cash flow. Thanks.

Our receivables management and past-due receivables statistics are all looking remarkably level, due to the strong efforts of our organization in that area. We've seen flip-ups in some parts of the world like Asia, but on balance the group has done a terrific job in very difficult economic circumstances in managing our customer collections.

In terms of the puts and calls, fiscal 2010, for cash flow, we talked about CapEx, which will reduce to $50 million next year. We expect next year that on the revenue side our first quarter is going to be below our fourth quarter of this year, and given the relevant strength that we had in the first half of this year, I think inevitably revenues will be lower in fiscal 2010 than in fiscal 2009, so that will be on the puts side.

Right. But I guess if we go back over the last look years, the first have inventory as a cash use. But given the dynamics now it sounds like inventories, you're not going to be stocking inventories. So should we think of inventory as sort of a cash plus through the year? And if so, how big could that be?

Yes, I wouldn't expect any big number there on inventory. Our inventory levels are going to tend to flow with the volume level of the business. I think we are working very hard to get right as of the end of the fiscal year, and we are committed to manage that on a more level basis into fiscal '10. I don't think all of that results in a major improvement in our inventory levels next year.

Okay. And you said again there's a $20 million cash hit on pension early in the year, but then again in April we could see another one, right? And could it be bigger? Is that sort of what your view is? It could be bigger, given where the plan is today?

Well, the -- so we've got to separate out cash effects from earnings effects here on the pension line, so what I had talked about earlier was on the cash side, the $20 million funding -- and oh, by the way, that would be the first time the company has had to put cash into the pension plan since 1986. That wouldn't come until September of 2010. So that falls out of next fiscal year.

And then depending on where our asset balances are at the end of this December, for the 2010 plan year we could -- that could require us to have to begin making estimated cash payments beginning in April of 2010. So all of that would say that there's going to be very little cash impact from pension that's going to fall into our fiscal '10.

Now, on the earnings side that's something different, and again, this all depends on where asset values end up this fiscal year and actuarial analyses and assumptions on discount rate and all those kind of things, but where pension asset levels are right now, we'll probably see a further significant increase in non-cash pension expense next year.

And if I were to bracket that right now, understanding that you still have a couple of months to go on equity values, they could impact this. Potentially that's another $0.50 to $0.70 a share on top of the $0.28 a share that we saw between our fiscal '09 and fiscal '08 on the pension line. That's not cash pension expense.

There are no additional questions in queue. I will now turn the call over to Ms. Anne Stevens for closing remarks.

Thank you very much. I appreciate it.

And to all participants, thank you for your interest in Carpenter, and we look forward to talking with you again for our fourth quarter conference call. Thank you.

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. And have a wonderful day.