Haynes International Inc (HAYN) 2007 Q3 法說會逐字稿

Greetings and welcome to the Haynes International third-quarter 2007 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your hosts, Mr. Marcel Martin, CFO; Ms. Stacy Kilian, General Counsel; Mr. Dan Maudlin, Chief Accounting Officer; and Mr. Francis Petro, President and CEO for Haynes International. Thank you, Mr. Petro. You may begin.

Thank you very much, and thank you all for joining us this morning. I am going to discuss the third quarter and nine months. I will focus mainly on the aspects of the business from CapEx to operational issues to our markets. And then Marcel Martin, our Chief Financial Officer, will summarize the financial results. And then we will make sure that we leave sufficient time for questions, because we anticipate, with the volatile markets and the price of nickel going up and down and changing rapidly, that there will probably be several questions from all of you, and we want to make sure that we have an opportunity to answer as many of those questions as possible.

First of all, I am pleased that we continue our path of consistent, positive progress, which is where we have always been and always are focused. We successfully completed our negotiations with the United Steelworkers of America, and we are very pleased with that. We have a very responsible union and workforce, and we were glad that we finally reached that agreement.

Part of that agreement closes off the defined pension plan, which we had already done for the salaried people. And that was something that was high up on our list to start to limit and fix our liabilities as we go forward.

I was also pleased that the markets continue to be strong. A lot of people watch the price of nickel and they think that is a reflection of the market. Well, that is half-true. It is a reflection of the stainless steel market mainly. If you remember, high-performance alloys are 0.6% of the world metal production. The vast majority of where nickel is consumed and what drives the demand that drives the price of nickel is stainless steel, not nickel alloy or super alloy or high-performance alloys.

Our aerospace market, land-based gas turbine and chemical markets remain very good. In addition to that, our other markets are -- we are starting to see some grow in our FGD. Certainly Europe is performing very well. China continues to expand. India expands rapidly.

And the new light on the horizon is Russia. We have seen in the last couple months more activity and requests for quotations and involvement in Russia than we have seen in the last 10 years. Russia is in the process of rapidly changing their aerospace and land-based gas turbine, and in some cases their chemical business, to Western specifications. And consequently, there is a tremendous amount of activity there, and we are participating in that in all aspects of the market.

We continue to make progress with our CapEx projects. As you know, from day one, when we started and we came out of our reorganization, that we had a substantial amount of not only recapitalization, but recapitalization with the understanding that we would do everything we could, and are, to improve the quality, the capacity, the efficiency of our equipment.

We have successfully now completed the ESRs and the second phase of the MKW-100. We are in the process of completing the Drever furnace. We took that down about six weeks ago. It will come back online the end of this month. In the meantime, we are operating with the electric furnace. When the Drever comes back online, then we go into the extensive rebuild of the electric furnace.

Both of these projects then tie exactly in with our flat-rolled capability and the extended capacity and improved capacity of our MKW-100 and are going to allow us to continue to expand our volumes.

Our volumes do continue to expand. Our backlog, if you look at our order backlog, is very good and very strong. And if you remember, if you look at our backlog, it generally takes -- our backlog represents about four to six months of what we will ship. So it is fairly easy to predict what is going to happen in the next three months.

The other aspect of our business which I was very pleased is our safety performance year to date continues to be improved over last year. And last year's safety performance was a record for our Company. So the reason I mentioned -- certainly I mentioned it because safety is extremely important -- but I also mention it because it is important that during a period of contract negotiation and everything else and revitalizing equipment and working around all the things that we're doing and simultaneously conducting negotiations, that our employees, in spite of all that stuff going on around them, stay clearly, clearly focused on how safely and effectively we run our operations. And I think that speaks highly -- that people can have the anxiety, which there always is when you negotiate a contract, and all these things are going on, and yet people continue to stay very, very focused and perform extremely well.

So in summary, our markets remain good. We continue our planning for how we are going to handle the growth in India. We continue to look at expanding our value-added operations in our service centers. That continues to grow, and it is becoming a very substantial part of our business, particularly the core of our business, which is our flat products, which make up 70% to 75% of everything we do.

So at this point in time, I would like to turn the discussion over to Marcel Martin and have him walk you through the financial results. And then as I promised, we will reserve time for your questions. Thank you.

Thank you, Francis. Good morning, everyone. The first thing I would like to do is just reflect a little bit or comment on our 10-Q that we've just published. One of the things that we have done in response to questions and requests by our constituencies is to add some additional information in the Q. We have done that (inaudible) by the additional information related to backlog, primarily the information related to our markets.

Again, people were looking for an opportunity to establish an ability to measure trends. And that is what we wanted to provide, particular markets in the form of revenues, pounds and average selling prices. And so I think it will help people. It's an education process. We are relatively new at this, and we are endeavoring to make sure that we continue the education process so that people can get a good sense of what the business is all about. So those are the issues that we have dealt with relative to that -- just added some additional information.

The first thing that I would like to just comment on on the balance sheet is the inventory. We have had a substantial increase in inventory from the beginning of the year, almost $100 million, and from the end of last quarter to the end of this quarter, approximately $50 million. If you go back to the beginning of the year, it is approximately a 58% increase in inventory, really broken down between a volume increase of approximately 10% and a raw material increase of approximately 43%. Again, the increase in volumes are associated with the selling at a higher level and safety stock that we have had to put on the ground in order to work through some of these planned outages.

The primary increase, though, goes back to raw materials, primarily nickel. If you look at the LME and you use that as a benchmark, the nickel cost from the end of September to the end of June has gone up approximately 40%. And then also, we have had chrome, moly and cobalt increase during this time period.

And particularly when you look at from the end of March to the end of June, inventories went up about $50 million, approximately 21%, and that was essentially all costs primarily related to nickel just in that second quarter. Our second quarter compared to our third quarter, nickel went up from quarter to quarter approximately 21%, if you are using the LME, and that is essentially the main driver in the inventory increase.

The thing to keep in mind in conjunction with the CapEx programs that we've been working on, and a significant number of which are coming to fruition in this quarter and through the first two quarters of next year, we are going to have a favorable effect. There will be a favorable effect on inventory, if for no other reason, with the drop in raw material costs that we are experiencing -- again, that will certainly impact our inventories favorably -- but we'll also begin to see a favorable effect relative to the improvement relative to our ability to manage inventory through our various operations, our queues.

Again, one of the things that we have highlighted through this process with these CapEx programs is our ability to improve working capital management. And we will begin to see favorable effects of that over the upcoming year, if for no other reason than the removal of safety stock from the process, but also just improved efficiencies, increased capacities, improved run speed. So we will begin to see that effect over the upcoming year.

Through the course of -- one of the things that we have continued to do is improve our revenues. The volumes is the important thing for us. We have laid out and we have told the world what our plan is. Although we don't provide quarterly guidance, we do provide what I believe is a more important guidance, and that is where the direction of the business is going.

One of the things that we have set out for people is the goal that we have established for ourselves of achieving our 23.5 million pound high-performance alloy volume sometime between 2009 and 2011, and that is a goal that we are working toward. If you look nine months to nine months of this year, we're up 9% in high-performance alloy volumes from last year.

And one of the key areas -- what we are looking to do is obviously improve the volumes in our traditional markets, but in addition to that, look to expand our volumes in other markets where we know we have opportunities. And you'll notice that the other category has improved substantially from quarter to quarter, year to year. And that is primarily driven by specifically FGD, flue gas desulfurization products or opportunities.

It is a very large market. And with the improvement in our capacity, with the completion of the Drever, the electric furnace, through the first half of next year, we will be able to move our volumes for sheet product from that historically -- that 9 million pound level up to 14 million pounds.

In addition to that, we will improve the cost structure of our products. So we will be able to compete more vigorously in that particular market and we would expect to continue growing the volumes within that market. In addition, we're looking to grow the volumes in the automotive market in the other category. So again, we have made progress from that perspective.

In addition, the backlog, from quarter to quarter, is up $21 million. It's about 9%, 1% of which is volume and 8% of which is increase in the average selling price. It is interesting -- we work very hard to do that. Through the course of the quarter and actually through the course of the first nine months of this year, as everyone recognizes, raw material costs, nickel, including the other costs, have gone up substantially, from approximately $13.50 at the beginning of the year, where June ended about -- almost $19 on the LME.

In that type of market, we got a lot of resistance relative to customers. It seems to be -- it's very typical -- when raw material costs are going up, product costs are going up, customers want to wait as long as possible to place orders. When it is dropping, they want to wait as long as possible to place orders. In that environment, in that kind of volatility, we were able to continue to expand our sales.

In addition, we expanded our backlog. So I think it was noteworthy to look at that in the context of probably some of the things that -- a portion of that additional backlog clearly is FDG oriented or related. Again, with the increase in that level of activity in our sales, we're seeing a corresponding increase in the backlog related to that also.

I want to speak to the next area -- will be just looking at the overall quarterly performance primarily as it relates to our gross margin. One of the things that, if you look three months to three months, and more importantly, nine months last year compared to nine months this year, we've improved our gross margin percentage approximately 3% in a relatively challenging environment relative to raw materials.

I think what is more important is what we were able to do quarter to quarter, our second quarter compared to our third quarter. And if you look at the -- if you just measure the increase in nickel through that time period, nickel went from approximately $15 at the end of December to $19 at the end of June, peaking in May at approximately $24 on the LME.

One of the things that, if you look at the gross margin percent and you look at the gross margin dollars, and if you just compare second quarter to third quarter, you will see that our gross margin dollars were down approximately $3.3 million -- $40.3 million for the second quarter compared to $37 million for the third quarter. And that is approximately a 29.4% gross margin compared to a 26.2 gross margin percentage.

There were two things that occurred during this third quarter. There was the bargaining unit agreement. And part of that agreement, we had a signing bonus that we provided to the bargaining unit, and that had a cost of $2.2 million.

In addition to that, we do a deferred revenue analysis at the end of every quarter. And historically, that deferred revenue analysis has been averaging between $2.5 million to $3 million. That was the adjustment we booked. At the end of this past quarter, because of the increased export sales, particularly to China, we had a substantial amount of additional or a large deferred revenue entry we were required to make because products had not yet cleared the port and title passed. And that was approximately $2.2 million difference from what we had prior -- historically experienced. That equated to an approximate additional reduction in gross margin dollars of $1.1 million.

So if you start with the $37 million of gross margin dollars for the quarter and you add back the $2.2 million of the bargaining unit and the $1.1 million for the deferred revenue, the effect on the margin, your adjusted gross margin is about $40.3 million, equivalent to what we had in the second quarter.

Although the percentage was about 1% lower, 28.4% versus 29.4%, I still believe that that is a relatively good performance -- no, that is a very good performance for this past quarter, based on the volatility -- and it is all volatility relative to raw material costs. So we did, I believe, a very good job of managing our gross margin percent.

And ultimately, what I am looking to see is a fourth quarter that probably behaves much like the second and third quarter from a performance perspective. And the reason I highlight that is because of the way we match up our revenues with our cost of goods sold. We're on FIFO. What we will do is through the fourth quarter of this year, it is not likely that we will see any benefit in the fourth quarter, which is July/August/September for us, of the decline in raw material costs. Where we will begin to see, I believe, a benefit relative to the decline in raw material costs, particularly as it relates to nickel, is in the first quarter of our fiscal 2008.

And the reason I say that is because obviously nickel has come off its highs. In addition to that, what we have is the effect of our projects being completed. And this will work through in the fourth quarter -- we will work through the costs that we have incurred relative to raw materials, which is supported by higher average selling prices related to the backlog.

Our backlog will flow through in the fourth and first quarter of next year. And that will be matched up with the costs we have incurred, and we will probably begin to see some amount of benefit because, as Francis noted, the raw material costs decline that we are experiencing currently is tied to the stainless market and not the markets that we serve. So ultimately, we will probably have to give back some of the margin or some of the dollars, but we will retain some of that margin with the drop in the raw material costs.

The last item I would like to speak to very briefly is just our tax rate. We had, in the third quarter, approximately $2.9 million in tax benefit or tax credits recorded relative to amended returns that we filed relative to extraterritorial credits, primarily for costs incurred overseas for U.S. shipments. And that is not a cost we would anticipate to experience on a prospective basis. Historically our tax rate has been approximately 40%. And we would anticipate that tax rate to continue at that level into the future on a prospective basis.

So again, I want to summarize -- I appreciate your time. I wanted to hit the highlights for everyone. But I would like to open the floor, turn it back over to Francis, and we can open the floor for questions. Thank you.

(OPERATOR INSTRUCTIONS). Mr. Starke, Weeden & Company.

Marcel, just to put a finer point on what I think you just said, are you generally indicating that average selling prices are probably not going to come down, even as nickel comes down?

In the fourth quarter, probably not, because remember, we have a backlog of approximately $250-some-plus million, and that backlog is going to flow through in our fourth and first quarter of fiscal 2008.

Right, but I guess what I should really ask is -- but on new bookings, would you expect the ASP to come down (inaudible) nickel?

Not as much as the drop in nickel might indicate. You've got to remember, our markets remain and continue to be very strong. And so although we get significant pressure from our customers to drop the selling price, we resist that very strenuously.

There is obviously a big difference in ASP between the other markets category and chemical processing. And chemical processing was a little lighter this quarter than in other quarters. Does that translate into gross margin, is my first question.

And my second question is, can you explain the difference in the selling prices there?

And then three, would you expect them to converge over time?

Marcel will answer that question, but I wanted to add something to his answer to your first question. Remember something about the pricing of our products. It isn't just the price of nickel. Our markets remain strong. And the types of processes that we have to produce these, it makes a big difference whether something is vacuum-melted or air-melted. Vacuum melting in this country is sold out. And regardless of what anybody wants, it is 24 to 26 weeks' delivery.

And when you are selling something with a demand where you get 24 to 26 weeks' delivery, the guy can't argue about the price of it relative to the price of nickel for too long before he finds out he can't get the material. So it is not just the price of nickel. It is the fact that the demand for these materials is strong and the demand on the specific types of equipment it takes to make certain alloys is very strong. And the leadtimes are still very long. And so customers still are concerned about making sure that they get the material that they need.

So Marcel, do you want to--?

To your first question, on the issue of gross margins, our gross margins for all our products were relatively close. There is a very tight range on our gross margins. And you would expect that because of the fact that we are using the same raw materials on the same equipment by the same people with the same distribution process. So again, I think that gross margins are relatively tight.

To your second question, the reason why the average selling price for the other category is lower than the other traditional categories is because that includes the stainless wire. I believe if you take the stainless wire out of that category, the other category, the average selling price for the other category will be commensurate with our more traditional -- it will be right in that same range.

And if you remember, we are phasing that product out. Every quarter, we make less and less stainless wire and more and more nickel alloy wire at our wire operation, which is part of the -- that was our plan from the day we bought that facility.

Mr. Levy, Jefferies & Company.

Two questions. First off, you guys did provide an awful lot more information, and thank you for that. Is there any way we could get a sense as to the backlog by industry?

By market?

Yes, by end market.

Well, I think what we will do over time is see how many requests we get like that. And if we get enough requests like that, we may in fact do that. Again, it is just a matter of seeing how much more we can provide and ultimately how meaningful it becomes. Good question, good request, and that is why we have got the expanded disclosures, because of those kinds of requests. So we will certainly consider that.

But I guess without disclosing too much more, does it look dramatically different than the distribution by industry of the current--?

It doesn't really, not much.

That is kind of what I was getting at.

And them the second thing is there has historically been somewhat of a seasonal lull in the fourth quarter. It used to be attributed to vacation days in Europe or something like that.

Well, that has a lot to do with it.

And yet, your backlog's continuing to rise. Can you talk a little bit about whether or not you think that this summer will be similar to previous summers in terms of that seasonal lull?

I think what is happening, Brett, is that the world markets -- we are becoming more globally oriented. And I think what is happening is that traditionally, the reason why this fourth quarter had historically been a noticeably weaker quarter was a lack of activity in Europe.

That certainly isn't the same anymore. So I still think a little bit of that exists. We will see that during the summer. However, I don't believe that is quite as strong, or it doesn't have as much influence. So you may see something, but I wouldn't think it's going to be significant. And as I indicated, I expect to see a fourth quarter much like the second and third quarters.

I think the other thing -- when you watch Europe, the business in the United Kingdom is very strong. The business in Germany is very strong. France will still take half the month off or three-quarters of the month off and Italy will do whatever Italy does. But the rest of Europe is still very, very active.

When we talk about our historical trends, and you could predict that the fourth quarter would be down, we didn't have the volume of business with China and India that we have today. Those markets are still very, very active and the market in North America is very, very active.

One of the reasons that we provided the backlog information was to give a strong indication of what the next-quarter performance might look like. The fact that we had the pickup in the backlog during our third quarter clearly leads to the fact that we would not expect to see a dip in the fourth quarter like we have historically seen.

Mr. Rizzuto, Bear, Stearns.

I've got a couple questions here. First of all, thanks very much for that clarity on the backlog. I find it very helpful. I've got a first question on the alloy development -- on your Haynes 282, what is required, gentlemen, to get a green light? And can you provide some idea of the potential demand in margins that you would see versus your existing alloys, or would it be more of a cannibalization type of effect?

No -- well, let me answer that. First of all, 282 is probably -- there is more activity in that new alloy than probably any new alloy we have ever developed in the last 20 years. The sequence that you'll see unfold is it's much quicker and people are already putting this material in various parts of the combustors of land-based gas turbines, because the certification process for something that doesn't leave the ground is a lot faster than for a turbine that flies in a plane.

So the process -- now, every single aircraft manufacturer, aircraft engine manufacturer, is testing, experimenting and working with and looking at 282. There is no doubt that it will be specified in some of the new engines. Rolls-Royce is already working with us. But the first phase will be a tremendous impact on the application of that alloy to the land-based gas turbines, relative to margins and stuff like that.

This is a proprietary alloy. And this alloy, in many cases, it can and will replace some alloys. It could replace Waspaloy. It could replace Rene. Depending on the uniqueness of the design, it could replace 718 and some other alloys.

But remember something -- part of our heritage is we continue to develop proprietary alloys. And the margins on those alloys historically are very, very good. And even if they do supplant an alloy, the alloys that they would supplant, 718, are no longer under patent to anybody. So the future of this alloy, both from a growth standpoint and from a margin standpoint, is very, very strong.

Now, can I predict the exact date and everything else on these? No, I can't, because I don't know how many of you have ever dealt with some of these, but some of these things take a while to get them spec'ed in. But I can tell you this -- we are now receiving production commercial orders for 282 for certain applications in land-based gas turbines. I can tell you that.

Thank you, Francis. And I have another question, too. And I was wondering, on the P&L, on the other revenue line, should we infer that the bulk of the $1.3 million increase year over year was due to toll conversion related to the TIMET agreement? And if so, is it reasonable to assume this as more of a fixed fee arrangement as we look at our model and try to model that going forward?

I think it is probably a more fixed structure, although there are accommodations to increase the pricing year to year as a function of the CPI. Again, it's --

And the volumes. (multiple speakers)

There is some variability to it.

But that would be adjusted on a calendar-year basis or on your fiscal year?

Calendar year. It would be on a -- actually, it would be our fiscal year.

Typically is what we hear -- it would be escalators and things of that nature and --

Yes.

But the volume that we're doing for them continues to grow, so the revenues will grow.

All right. That is what I wanted to get at. And I was wondering where you are in terms of that initial phase of the contract. I know that can be expanded.

The original contract was a guarantee to provide 10 million pounds with the probability or at least the accessibility that they could expand that to 20 million pounds over the life of the contract.

With some -- obviously some expansion, and they would contribute to that.

Right. (multiple speakers) have to expand some furnaces and stuff for the four-high Steckel mill. Correct.

Are you guys currently at the 10 million pound annualized rate?

We are not at that level yet.

Not yet, but we are moving in that direction pretty rapidly.

That's very helpful. I appreciate it.

Mr. [Flanagan], [Fundamental Equities].

Marcel, could you comment on the current trends in your commercial aerospace customers, whether demand there remains strong? And can you comment on your position on the 787 specifically?

I think to the extent that -- if you look at the overall order book, you look at The Airline Monitor as of just this month, and between Boeing and Airbus for the next 2007, '08, '09 and '10, they are forecasting over 10,000 engines to be built during this time period. So I think in that context, that is a pretty strong backlog from their perspective. And it obviously plays into our order book also.

As to the 787, I think that we'll certainly participate in that process, as we will with any engine, because our customers are the people who make engines, that being GE, Rolls-Royce, Snecma, Pratt & Whitney. And we certainly provide product to all those people.

I think the interesting aspect is, one of the comments that I have gotten is -- or one of the questions I have gotten periodically is with the push-out on the Airbus, the 380/350, what effect might that have had on us.

And it is interesting -- when you look at their backlogs, you look at their order books, even though some of these planes did get pushed out, what has happened is the orders got backfilled with other engine requirements because people are in fact looking for opportunities to fill a void when it is created just because of the capacity limitations that the producers are having with their engines.

I think what we will see at some point in the future -- we are all familiar with what has happened in the past with Boeing and Airbus, the reluctance to increase capacity. But I believe -- it is a belief, not a fact, a belief -- that these producers will find ways over the next three to four years to continue to find ways to expand their current production capacity, which just bodes well for the industry.

And I think one other thing that you should remember is we are also a significant player in titanium hydraulic tubing. With the 787 and these other planes, that market for us is also a growing market. And as we've previously announced, we are increasing the capacity of our Arcadia pipe and tube facility mainly because of the requirements for hydraulic titanium tubing for aircraft. So that is another aspect of that aircraft market that we also participate in.

Is that a meaningful amount per airplane?

Titanium tubing?

Yes.

I think from our perspective, the titanium tubing is an ancillary product. It is a very profitable product. It is not a significant volume, but again, as compared to our total revenues, again it is not a significant number, although it is meaningful relative to the margins it generates. It's part of that package we provide to the customer for the aerospace business.

It is important we continue to participate because it is a point of contact. Again, we are a supplier that provides not only flat product for the hot spots or hot combustor parts of engines, but also titanium tubing. Again, it is one of those ancillary products that -- it is not our core product, but it is clearly complementary to our product line and it is a point of contact with specific markets.

Mr. Parr, KeyBanc.

I was wondering, Francis, the orders you're getting for 282, are these flat-rolled orders?

Yes. Well, they are both flat-rolled and in some cases they are some forging billet for certain types of ring applications.

Based on what you know right now, is this material -- I'm trying to get a sense of how big this could become in the context of your overall shipment mix. Is this a product that could be more than 20% of your total shipments at some point?

That is something that --

We don't know.

That is something I am not sure --

It is going to be -- I don't think anybody knows yet. What we do know is this material has better workability. It can operate at higher temperatures. So it is up to the design and where all these engineering people take this.

It is very difficult to predict other than we know it is a better alloy and we know there is a tremendous amount of interest. But we are in no position to even guess yet what it is going to be other than we know it is going to be very good.

From a production standpoint, are there any significant bottlenecks that you may have to address in terms of potential differences and how you need to make this material?

No, ironically, it is easier to make than some of the materials it may replace. It is easier to make than Waspaloy; it is easier to make than Rene. It is very seldom we invent something that is this hard that can work this well that is easy to make. So maybe this is -- it is interesting.

But actually, a couple of the alloys it would replace, it is much easier to make. And it is not any harder to make than, for us, from the standpoint of our operations, than 718, for example, which is a high-volume aerospace alloy.

That is really helpful. If I could just ask a housekeeping question to Marcel, it looks like your nine-month tax rate was a little under 36%. I think that is right, or around 36%.

That is right.

Is that the number that we should be using for the fourth quarter?

On a prospective basis, I think you need to stick with the 40%. That is our traditional rate. That will be our effective tax rate.

And are there any -- if you are looking at the fourth quarter at this point, do you have any unusual items that might emerge that you want to discuss up front?

I think from our perspective, as I indicated, we expect to see a quarter much like we did in the second and third quarters. I think the backlog is reflective of that support for the fourth quarter.

As Francis indicated, we have a number of capital projects coming to fruition during this quarter. So I think that is something for us to be sensitive to. Although we have always been very successful managing those projects, again, there is quite a few this quarter -- there's three major ones, as Francis indicated -- the remelt furnaces, the MKW-100, and the Drever, our annealing line.

So we just have to be careful. But again, we have always done this very well. So on one hand, I caution you, but on the other hand, we have been very successful managing these projects.

And then if I could just ask one question prospectively, all these capital upgrade programs, in addition to the increased capacity that they will give you, they also offer significant cost reductions. And I think in going back and looking at some of your preliminary materials that were distributed in your offering process, I think the magnitude of those savings was somewhere around $9 million or $10 million annually. I think that is the right number.

Could you talk a little bit about how you might expect those productivity enhancements to flow through to the income statement over fiscal '08 and '09?

I am not quite sure how we quantified that.

I think it was in terms of, like, cents per pound of cost savings.

First of all, the fact is that these will have a favorable effect on the bottom line. The effect will be favorable. To the extent that we quantify them is a bit more challenging.

However, what we can say is that we will begin -- we have seen up to this point some positive effect relative to the CapEx projects because of this, our CapEx projects have been touching a lot of different parts of the business, from melting through the finishing operations.

But I believe the most significant impact will come with the completion of these annealing lines in the MKW-100, because again, those are the areas through which the bulk of our product flows. Again, from a sheet perspective, 50% of our product flows through the finishing operations are our rolling lines and our annealing lines. And with the increase in the capacity, that is going to up that percentage probably to 55% or 60%.

So that is where the biggest bang for the buck is going to come. It certainly will be favorable. Again, I am reluctant to quantify it except to say it is going to be favorable. We will begin to see that clearly in the second half of next year with the completion of the electric annealing lines in probably February or March.

Terrific. Congratulations on a great quarter. And it looks like you've got some really good volume momentum, new product momentum, productivity momentum, and look forward to next quarter's update. Thank you.

Mr. Gambardella, JPMorgan.

Thanks a lot for all the additional information in the Q. A couple of questions. One, in terms of the service center business that you have, where are you in terms of selling parts to some of your customers as opposed to just selling sheets or coils of the material?

That is a good question, because that is one of the other areas we have made significant progress. And as I mentioned in the beginning, that we continue to enhance our value-added business. If you look at the business we do with Snecma and Rolls-Royce in Europe, 100% of everything we do with both of them is now laser-cut parts and water-jet-cut parts. We don't supply any just sheet material.

We have made significant progress in the United States with our laser. As a matter of fact, we believe we are already running out of capacity. And our goal is constantly to provide services and differentiate ourselves from our competitor with our value-added services, be it laser-cutting, water-jet-cutting, or, for example, the way we do business with Rolls-Royce in the UK to some of their fabricators is we actually have these large wooden boxes that they call kits. And every week we deliver these boxes with all the parts, and we pick up an empty box that has a piece of paper in it, and it says, make 11 of these, 14 of this, 28 of that. And we bring that box back and that is what we make to deliver the next week. And this is how close that we are getting to the manufacturing process of several of our people. We are also making tremendous progress with laser-cut parts with land-based gas turbine manufacturers.

But remember, a lot of the stuff that these people do, they do through a fabricator. And so a lot of the work that we have in place and that we are growing and expanding all the time is our capability to supply the laser-cut parts to the people that fabricate various things that then go to somebody for final assembly.

But that business is growing and growing very, very rapidly, and it is a very, very key part of our focus. And we have very excellent people that are full time devoted to nothing but enhancing this aspect of our business.

Could you give us an idea of what percentage of the business it is today and where it may go in the future?

That is a very difficult question. I guess I am going to have to pass on that one. And again, I think that is much like the requests that we have been getting to maybe augment the information we provide. It is a fair question. I don't have a good answer for you today.

Let me ask one more question about it, though. When you go into, say, Rolls-Royce in the UK, are you the only one doing this for them? Or are some of your other competitors now trying to do the same thing or are doing the same thing?

We have no -- what is really happening, and this was a very insightful question -- what is really happening is historically, people look at us and they think our competitors are always Carpenter, Allegheny Technology, Special Metals, PCP, VDM -- that is the spectrum of how they look at us.

If you look at what we do and that now, over -- in the last nine years, our service center business sales has grown from 30-some percent of our business to over 60% and our strategic goal right now, our objective, is to get it to at least 70%, and we are over 60% now.

So what is happening is now what we see is our competitors become at a place where you specifically asked, like a Rolls-Royce, become people with the capability of a Rolled Alloys -- not Allegheny and other people like that. Now, Allegheny may supply the material to Rolled Alloys, but in essence, who's Haynes' real competitors is changing. And it's changing to people like Rolled Alloys. In the chemical business, it will be people like Corrosion Materials. Now it will be people like O'Neill, which is consolidating a lot of service centers and trying to do some value-added business.

But remember something -- once you get a contract for somebody, you don't sign a contract for these parts for a year, because first of all, once people give you all the drawings and you start doing this, and you get certified and you meet these specifications, regardless of the capability of anybody to do that, and there are people that can do it -- Rolled Alloys can do it -- for them to switch from one company to another is a very difficult, time-consuming process.

So where you will face the main competition is going head-to-head to get the original contract in the first place, not so much on a year-to-year basis of worrying about losing the contract. The contract with Snecma, for instance, was a five-year contract. And I'm not exactly sure -- I know that Rolls-Royce runs a multi-year -- I don't remember if it is three years or five years. But whatever it is, it is not a one-year-type thing.

And none of these types of contracts are short-term contracts because of the complexity and the time that is involved in these. And even if somebody came in tomorrow and said, I will sell you that part cheaper, whatever that might be, can you imagine the transition of the certification of the parts and everything?

So the competition will be getting the original business with each fabricator. However, it is going to go into whatever turbine it is going to go into or whatever part it is going to be. But that is a very good question.

Last question on this -- the pricing for these kind of multi-year contracts -- are you locking in some type of conversion spread on the business?

Yes. And we also -- we are very careful how we do this because they also have raw material adjusters. Even though we are not supplying them sheet and everything else, it is our sheet and it has a value. And so there are adjustments in there for raw materials and other significant things that may change, like our labor contract or energy -- places, things like that. Yes, there are.

Mr. Jelisavcic, Longacre.

Again, thank you for the enhanced disclosure in the June Q. Just a couple questions. First, not trying to belabor it, but just regarding the 282 alloy, can you just give us a sense of what the potential growth is in terms of revenues and how you -- over what period of time you see that ramping up?

Well, we don't know. We know that everybody is experimenting. Everybody is looking at it. Every major aircraft engine manufacturer and every significant land-based turbine supplier is running trials and everything else. It is too early to tell, and it is too early to tell what strategy they will take with their designs.

I will give you a good example. A couple years ago, a customer of ours decided he was going to -- we were supplying a very specific alloy to him. And he decided to buy a different alloy, which was cheaper, from somebody else. And he put that alloy in a couple turbines and they didn't last half as long. So then he went through the process of redesigning that and changing back to the other alloy. It's our alloy.

I can't predict all those things. All I know is this alloy -- the uniqueness of this alloy is excellent. I mean, the fact that it is more workable, it is much easier to weld and it can withstand higher temperatures -- these people are smart. They are very smart. And they will figure it out. In what time frame and to what extent, I can't even -- anything I would say, I just would feel uncomfortable, because that is not my nature to say something. I can just tell you this -- it will have a very, very positive impact on this Company.

Understood. I appreciate that, Francis. Just turning to more concrete matters, can you give us an idea of what percentage of your revenues comes from maintenance/repair/overhaul as opposed to newbuild?

Generally, as hard as we try, and we try very, very hard because the maintenance and repair business is a big, important part of us, because that is one of the upsides of our service center. When somebody wants to buy something for a repair, they don't want a 22-week delivery when they've got the turbine sitting on the floor. So they call a service center and they want the material today. We estimate -- and the other good thing is as you build more and more turbines, the maintenance business automatically grows.

Right. So it is a wonderful multiplier effect.

Right. So we have always kind of as a yardstick guessed that -- because we don't know when somebody orders something, because there's people that fabricate parts and turbines for OEMs and there's people that do it -- same people will order materials to repair one. And our guess is it's around 50%. That is kind of a ballpark -- which is a high number.

Right. Would you generally -- it is a very high number -- would you generally expect that to kind of grow over time as last year's -- let's say aircraft turbines is typically four-year lag between new sale and the first D check overhaul. Do you think that is going to grow as a percentage or --

Big picture, you will probably see -- right now we are probably leaning toward a higher percentage of product being OEM-oriented, between 50% to 60%. I think right now the other direction is 50% to 40% for the maintenance-type business.

As time moves forward, with the increased numbers of engines in service, the additional CPI-type plants -- land-based gas turbines are coming into play, you would expect at some point in time in the future for that to be 50%, 60% maintenance, with the OEM being the smaller percentage.

Right. When the business really matures --

Exactly.

I think the important thing is that both over the next three to four years, for sure, with the demand -- you know what the demand for aircraft engines is, and now the demand for land-based gas turbines is growing rapidly -- that you're going to see, wherever it is, whether it is 40% or 50%, it is going to be 50% of a bigger number. I think that is what is important, that the revenues are going to expand.

Right. I appreciate the clarification. Speaking of land-based turbines, would you say in percentage terms that's your fastest-growing end market right now?

The fastest-growing end market right now is still aircraft.

I think that is somewhat of a --

Percentage change.

I think the key thing to recognize is that -- I'm not sure that is the right way to look at it, only in this context -- we are capacity constrained. When we are endeavoring to do is work through the process to open up our sheet production capability. And part of what we are endeavoring to do today also is penetrate new markets. So I don't know if there is a fastest-growing market. If you wanted to say --

They are all strong.

They are all strong. I mean, the fact is a year ago, we had relatively small amounts of FGD. This year, we have a substantial amount of FGD product. If you wanted to label something fastest-growing, that would be it. I think that is inappropriate, only because we have three traditional markets. We are going to continue to grow and support those markets. So I guess it is just a matter of where we want to place our product to get the best possible bang for the buck.

It is still aerospace?

Yes.

Just really quickly, you touched on capacity constraints. Can you give us an idea of what your capacity utilization is?

I think if you think in the context of -- you have three parts of the facility -- you've got your melding operations, your hot-rolling and your cold-rolling or finishing operations. And that is where we are currently constrained.

Historically we have been capped out at about 9 million pounds. The things that we have talked about, all the work we are going through right now, primarily is focused on expanding that from 9 to 14 million pounds. So right now, in that context, you would say we were pretty much bumping up against capacity relative to the finishing operations to take a step up once we can finish the finishing operations.

So if you back up from that, that means that we still have substantial capacity in the hot-rolling and in the melts to provide that additional 5 million pounds. So what we will have is a significantly higher utilization of the melting operations. We will have significantly higher utilization of the hot-rolling operations and we will be utilizing probably 90%, from a practical perspective, of our finishing operations.

Right. Because what we're doing -- if you look at all these projects, they are essentially matching our flat-rolling and finishing flat product capability with our capability to melt and hot-form the material -- mainly the Steckel mill. And those have excess capacity.

Could you just quantify, is it about 90%, Francis, for finishing, and what's the ballpark percentage for hot-rolling and melt?

From a melt perspective, currently we are probably running at the maybe 70% level.

Yes, 70%.

From capacity utilization.

And hot-rolling is probably -- the Steckel mill is probably 75% -- 72% to 75%.

You have got some expansion potential there.

Sure. That is the whole point of the --

That is one of the reasons we agreed to do conversion for TIMET, because we do have that capacity. And we will have that capacity even when we free up our own flat-rolling, we still would have capacity on the Steckel mill.

I'm impressed that you guys can maintain big margins when the capacity for hot-roll and melt -- and I realize there are different kinds of melts -- you talked about air versus vacuum, but it's still pretty impressive you guys can maintain margins with --

Well, our vacuum melt is at 100% of capacity.

Understood. Last question and I will turn it over to my colleagues. Because all your production is in the U.S., and I guess your costs are predominantly in U.S. dollars so that your labor is almost all in U.S. dollars, with the decline in the U.S. currency, do you have more pricing power? Are there opportunities to raise prices in dollar terms to foreign buyers?

Well, we certainly benefit from the fact that the euro is $1.37 or $1.38 or whatever it is today -- I don't know. Those things certainly benefit us in the marketplace.

But what you find out when you look at these kinds of materials, these materials are only made in a couple countries. A very nominal amount is made in the UK and Germany, and quite a bit in Germany, but the rest is all made in the United States. The benefit we get from currencies is from the competition of somebody like VDM, which manufactures in Germany. But the real benefit is in the selling of the material in various countries in the world and how you compete.

Just an announcement -- we have 30 minutes left for the Q&A. Again, we have only 30 minutes left for the Q&A.

Mr. [Patterson, ECT].

In the vacuum melt area, you mentioned your backlog is going to run basically half -- to half a year. Given the volatility of the price of nickel, how do you price these contracts? And can you hedge in the nickel market?

We do buy nickel forward, and I will have Marcel explain that whole process to how we do that, because we have a very specific policy and procedure that we follow and monitor relative to how we would purchase anything forward.

All our contracts have raw material price adjusters. And some of them have price adjusters for other aspects of energy and other things, which generally operate on a quarterly basis.

And even like, for example, like now the price of nickel -- I will give you an example -- the price of nickel is going down. But the price adjusters for the contracts, because the price of nickel was so high in the last quarter and it is based on the trailing average, will actually go up. And the people won't benefit from that until the next quarter. But we don't have any major supply contracts with any customers that don't have adjusters in them for raw material.

Marcel, why don't you take a minute, just explain exactly how we buy the nickel?

I think Francis hit on the issue. It is a matter of managing the raw material costs. The fact that it's -- the managing of that cost is done in a number of different ways. One of the ways we manage cost, and it's really not managing the cost so much as it is decoupling it from what we do from that raw material cost.

We've got a very dynamic pricing model. So what we endeavor to do is, for example, we will reprice products every single day relative to changes in raw material costs, so that any product that we sell today under any set of circumstances will reflect the current pricing, except for contracts, obviously. But those products we sell on spot, out of the service centers, will be priced as aggressively as we can relative to what is happening in the marketplace today.

Francis mentioned that we have contracts with escalators. That is clearly part of our process.

We also buy a portion of our raw material requirements forward on 90-day contracts. We manage that process from the perspective of looking at a 90-day contract, and if there is any backwardation or not. To the extent there is backwardation, we will go ahead and commit some portion. However, to the extent that the backwardation is neutral or going contango, we're not going to do that. So we are sensitive to that every single day and we manage that process.

And then there is the kind of stuff that -- we are, in fact, long in nickel. So we leave a portion uncovered just because we are long in nickel. So again, I think those are some of the key aspects of how we look at raw material. It really all gets back to how you price your product.

Mr. Whalen , Bear, Stearns.

Most of my questions have been answered. But you mentioned in the 10-Q that you are evaluating the possibility of opening a second service center in China and also opening one in India.

That is correct.

I was wondering where we are in terms of the process and how far we are from a potential decision, and then once that decision is made, when the facilities would be open and running?

That is just a process that we have undertaken. We have just started examining those opportunities. We talk to the level of business that we have in China right now -- that certainly has grown, and part of that is a result of our service center there. But China is a big place and it has got a lot of different industries developing. And I think part of the reason why -- one reason is just the level of activity, but another reason is just the specificity of the industry we want to serve.

And the location.

And the location, which is oriented toward either CPI or oriented toward aerospace. So that is, again, part of the reason why we look to take advantage of just the robustness of the economy and look for an opportunity to create that point of contact with the customer.

So I think that is what is driving the process. We have started it. We are beginning to put economics together. It's going to take some time do that. We want to begin to make sure we understand the markets, the potential, because really, it is a function of the tradeoff between having a service center on the ground, making that investment, and what can we do from a direct sales perspective.

Essentially, the primary way we service the Chinese market is mill direct. We've got a very robust, I think, salesforce working very diligently in China. And so what we need to do is measure the economics, the benefit of the service center versus continuing that mill direct process.

Same situation in India -- we're starting --

In India we are much farther ahead.

Where we're looking to do somewhat the same thing in India. We want to -- since we don't have any service centers there at all, it is a matter of just putting a business plan together. Ultimately, it's like any other investment. We want to put a business plan together. We want to measure the economics. We want to do projections into the future, how we anticipate these markets to grow, so that we can assure ourselves that when we make the investment, it's going to have the appropriate return.

So again, it is something we're looking at in both cases. As to a specific timeline, that is not something I think we can really comment on at this time.

We do have a sales office in India running. And we have a tremendous amount of information. And we know that we will have a service center in India. It is a question of time. And Marcel has laid out the parameters of all of that.

In China, which is huge, ultimately, for two reasons -- not only the location of where they do all this fabrication is hundreds of miles from Shanghai, where our other service center is, is number one.

But as you look, if you think out long term in China, ultimately we're going to have to have a service center there anyway to service the maintenance aspect of these businesses, which isn't a big thing yet because they're building so many new ones they haven't worn them all out and wrecked them all yet. But they will. And then it will be a matter of time. But that will change in time. But there is no question that these things will happen.

Right. It seems like you have such tremendous opportunities over there, and they only seem to be getting stronger. Is it fair that over time that we assume that your tax rate gradually trends down, just given the international opportunities and the lower tax rates in the regions?

I think over time it will trend down. I don't have a specific timeline relative to that, but typically because the foreign operations do have lower tax rates, you would expect it to come down.

Thanks a lot for all the input and the added color in the Q there.

Mr. [Reiner], Searock.

Congrats, guys, on good numbers and everything. Can you talk when we might see any kind of stock split or anything from that point of view? It is something we have discussed a little bit before, and just in terms of some of the opportunities regarding that?

This is Stacy Kilian. I'm General Counsel for the Company. And Marcel just asked me to address that. Obviously, we are committed to taking actions that are going to increase shareholder value.

We are not obviously going to rule out the possibility of a future stock split, but only four months have passed since the public offering. We are in the middle of an extensive CapEx program. Obviously, the growth in the share price has been steep since the IPO, but we continue to have what we think is an acceptable level of trading volume and (inaudible) at prices that aren't particularly inflated as compared to our peers.

Plus we feel right now that it is very important to stay focused on the business and our growth strategy. So at this time, we aren't contemplating a split. But obviously, if it made sense as we go forward, it would certainly be something that we would consider.

Mr. Folta, Longbow Research.

Most of my questions have been answered. I noticed that you guys quoted a pretty strong uptick in sequential shipments to the aerospace end market. And I was wondering if you could talk about if any of that has to do with the 787 engine programs and to what extent we can see that number grow over the next few quarters?

Well, there is no question that we are involved in those. We are involved in every engine design for every major aircraft that has come along. It is a question of who is fabricating what for what engine, and at what time they release the orders. We respond to that accordingly. And because most of these things are all contracts, with specific release times over the course of a year, which is based on their ability to supply the fabricated material to the actual guy that is going to assemble the whole engine -- so it all works in that thing.

So the natural thing that you would expect is that the more orders they get, the more you're going to see that filter to us, because generally -- historically, the leadtime used to be 18 months to two years that they would have to give an order to us. Now it's like 12 to 18 months. So whatever we're doing supplying to somebody today in the next 12 to 18 months will be in an engine, in general, rule of thumb. So as those go up, it's just a function of the demand.

Mr. Rizzuto, Bear, Stearns.

All my questions have been answered. I appreciate it.

Thank you. There are no further questions at this time. Mr. Petro, I would like to turn the floor back over to you for closing comments.

Well, thank you very much. We appreciate all the questions. And more importantly, we appreciate the interest that all of you have shown. We are getting, since we did our secondary offering and went on the road, we have gotten a tremendous amount of interest and questions.

And I know both Marcel and I are going to participate in some other meetings where we communicate with potential investors or analysts. And we're trying very hard as we go along to learn how to provide appropriately the best information we can and to be as candid with you as we can, and I think we have been, about what our vision is, how we operate the business, where we are at with our facilities and our equipment.

And I think for those of you who were with us in the beginning, when we had a lot of equipment problems a couple years ago, we were very candid about the extent of those problems and what we had to do, and that we expected consistent, positive progress and that we had a workforce and people that were capable of managing and fighting their way through this.

The fact of the matter is, we have made consistent, positive progress. We have not deviated from that plan one iota, nor will we. We stay clearly focused on differentiating ourselves from our competitor, supplying value-added material in every opportunity, to continue to develop new alloys quicker than anyone, and to develop our capacity in our core product, which is our flat products, and in particular our very specialized flat products for the aerospace/land-based gas turbine business. And we won't deviate from that focus.

Finally, we are bringing some of these projects, which are going to have a lot of benefit for us, to conclusion. We still have a major one which is the rebuild of the electric furnace, to go through once we get the Drever back on line this month.

But these are significant steps forward for Haynes to get us to the plan that we have talked about from the time we went on the road to the 23.5 million pound volume, which kind of puts our capacity that you people -- several of you have asked, between our melting, our hot capability and our cold-rolled flat capability.

We continue on that path. And we continue to make consistent, positive progress. And there is no doubt in my mind that we will continue on that path and we will continue to make consistent, positive progress. And without question, we will do what we say, to the best of our ability.

So thank you very much for joining us. I sincerely appreciate it. And I look forward to the next call. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.