Haynes International Inc (HAYN) 2012 Q3 法說會逐字稿

Greetings and welcome to the Haynes International third-quarter fiscal year 2012 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 host, Mr. Dan Maudlin, Controller and Chief Accounting Officer. Thank you. You may begin.

Thank you very much for joining us today. With me today as normal are Mark Comerford, President and CEO of Haynes International and Marcel Martin, Vice President and Chief Financial Officer.

Before we get started, as always, I would like to read a brief cautionary note regarding forward-looking statements. This conference call could contain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1933 and Section 21E of the Securities and Exchange Act 1934. The words believe, anticipate, plan and similar expressions are intended to identify forward-looking statements. Although we believe our plans, intentions and expectations regarding or suggested by forward-looking statements are reasonable, such statements are subject to a number of risks and uncertainties and we can provide no assurance that such plans, intentions or expectations will be achieved.

Many of these risks are discussed in detail in the Company's filings with the Securities and Exchange Commission, in particular Form 10-K for fiscal year ended September 30, 2011. The Company undertakes no obligation to publicly update or revise any forward-looking statement whether as a result of new information, future events or otherwise. Thank you very much for listening and now I will turn the call over to Mark.

Thank you, Dan. Good morning, everyone and thanks for joining us today. Hopefully, you have all seen the press release and had a chance to review it. We will deviate just a bit from our normal agenda today. I want to spend a couple of minutes discussing the capital investments we announced in June and give you some insight into the whys and whats we expect from those investments and Marcel will then provide detail on the financial results.

Quickly, I am pleased with the work we have done to manage our mix over the past year or so and we have utilized our capacity for higher value products. I believe our results with expanding gross margins bear out the fact that we have had success managing that mix. We are manufacturing more lighter gauge products, processing more difficult materials with more stringent property and test requirements and we are continuing to convert our account base to more value-added products. The result of this combination of mix management and process improvement initiatives has resulted in our net income per pound shipped in the quarter being 76% higher than in the third quarter of fiscal '11 and year-to-date comparisons are similar on that measure.

As I am sure you are aware, a lot of work has gone into achieving this and there are a lot of moving pieces as we reengineer some of our processes, utilizing the upgraded equipment, convert more applications to value-added products and continually manage both the service and manufacturing sides of the business. We still have quite a bit more opportunity to get better, but thus far, we are pleased with the results we have had to date and the continuous improvement direction we are taking in all aspects of our business.

In June, we announced $61 million in capital expansion projects. Unlike several of our prior capital projects, which were targeted at upgrading existing facilities or equipment, these projects are targeted at growing our business. Specifically, we are committing $37 million in new equipment and upgrades to our Louisiana high-performance tubular products facility to meet the need for capacity to support requirements in the aerospace, energy and corrosion markets.

The Arcadia facility continues to operate today as we told you previously at very near to full capacity. Our expectation from the process enhancements that we have already made is that Arcadia's output this year will surpass the levels of the prior peaks of the 2006-2008 period. So in order to meet anticipated demand, we need to invest in greater output capabilities.

Our existing core markets and existing customers will necessitate the expansion as several of the new alloys and new applications we have developed over the past three plus years add to the need for this expansion. Almost all of these products are at the premium level of our product offering, so we expect a 60% expansion in capacity to provide excellent margin enhancements and returns when we are fully operational in fiscal '15 and we expect these projects to begin contributing to our business in fiscal '14.

In addition, we announced $24 million in growth capital to be committed to our Kokomo operations for additional flat-roll capacity. And by flat-roll, I am referring to sheet, coil and plate products. Like the tubing project, we expect this to be fully operational in fiscal '15. However, we expect some of the benefit from this expansion to start next year in fiscal '13, late in the year.

If you'll recall, Haynes invested roughly $30 million a few years back to upgrade and replace cold-finishing operations for sheet products, specifically upgrading cold-rolling and annealing operations. The result increased capacity of those operations from a little bit less than 9 million pounds per year to 12 million pounds per year. With those upgrades and several process improvement projects completed by our people in the plant, we have already exceeded that 12 million pounds per year and in fact, as I mentioned earlier, we are processing lighter gauge and more difficult alloys. So if you look at this from the perspective of number of linear feet through the mill, the process engineering group and the production people in the mills have done a great job in getting the most out of this equipment.

In short, the capital project from the 2007-2008 period was a clear winner for Haynes. The new project will increase our capacity for both plate and sheet products and we have seen an approximate increase of 20% to our total flat roll. Again, by flat roll, I am now including plate products in addition to sheet and coil. So our expectation is that, upon completion, we will have another roughly 3 million to 4 million pounds of flat-roll capacity available.

As you have heard us in prior calls, sheet and plate are the core of what Haynes does. It's about 70% of our business and these products are excellent contributors to our business. You have heard us refer to them previously as real good absorption products for our business. Our end markets are expanding and we are constantly introducing new alloys and value-added capabilities. These investments will allow us to grow with our end markets and add more new applications to our mix.

Finally, I would be remiss if I didn't address the current macroeconomic issues surrounding us. From the fiscal cliff to the European financial crisis to the slowdown in China, we are facing a period of very limited short-term visibility. I spent a lot of time in the last six months with our employees around the world and visiting customers. I returned last week from a trip to both Europe and Asia where I visited all of our facilities and met with a couple of customers as well.

Yes, there is a short-term softening most apparent in our chemical processing and other markets categories. Marcel will give you greater detail on this as he discusses backlogs. But a key thing is aerospace remained very strong as evidenced by Boeing and Airbus backlogs and deliveries. Demand for more efficient aero engines is growing as new generations of more efficient commercial aircraft take hold in the industry. Our energy and land-based gas turbine markets are still strong and in several areas, especially the OEM side of land-based gas turbines, we are seeing improvement.

And finally, the discussions I have had with the weaker areas of our market mix right now -- chemical processing, flue gas desulfurization and industrial heat-treating -- indicate that they see project work out in the future that they are actively quoting today, but clearly they have also said that some of these projects have been delayed by the current economic situation.

Three key points that they have relayed to me are, one, things are wearing out and they are going to need to be replaced. Two, new projects are on the horizon and capacity will tighten as world economies recover and three, when they get the orders, Haynes will get the orders. With that, let me turn it over to Marcel for details about our financial results.

Thanks, Mark. I will start with the year-over-year quarterly comparison of sales and an update of market backlog changes for the quarter. Our third quarter of fiscal 2012 closed with net revenues of $141.6 million, down 1.1% from the third quarter of fiscal 2011. However, net income was up 63.5% to $13.7 million or $1.11 per share. Backlog at the end of the quarter was $241.2 million, a decline of $23.1 million from the beginning of the quarter.

On a year-to-date basis, backlog has declined by $32.2 million or 11.8%, primarily due to a reduction in pounds caused by slowing order entry for project business in the CPI and other market categories.

Looking at our [prime housing] in our four primary markets, net revenue in the aerospace market in the third quarter of 2012 was $55.9 million, up 4.3% over the third quarter of 2011. Aerospace accounted for approximately 40.8% of our revenue during the quarter. Through the entire fiscal year, the aerospace market has continued to perform well as demand for engine materials and hydraulic tubing are being driven by new plane builds and MRO work. Both Boeing and Airbus backlogs continue to grow their combined backlogs after of the Farnborough airshow now exceeding 8000 planes. Also, as stated on prior calls, our new alloys and applications for these (inaudible) continue to make an increasing contribution to both the revenue and margin lines.

Aerospace backlog was down only 2.6% for the quarter due to a combination of robust order entry and sales. The combination of this year's sales pounds supported by our order entry could provide a record level of pounds shipped in this market category.

In our chemical processing market, net revenue for the third quarter was $32.6 million, down 29.3% from last year. CPI accounted for approximately 24% of our total revenue in the quarter. Business in this market for both transactional and project applications remains very competitive. Our current results reflect higher selling prices at lower volumes compared to a year ago. (technical difficulty) the prior year period included a key high-volume project, which (technical difficulty) repeated. However, transactional MRO business for this year continues to perform well.

As I previously noted on the prior call, there was a major new application last year that has not repeated this year, but could in the future. However, our application, engineering and marketing groups have done an excellent job this year filling the gap created by a reduced level of large project business. CPI backlog for the quarter is down by 18.6% and reflects the reduced level of project business currently being booked. Based on our discussions with customers, (inaudible) project work (inaudible) canceling projects.

For the land-based gas turbine market, our net revenues totaled $28 million for the quarter, up approximately 32.8% from last year and represents 21.6% of our total revenues for the quarter. End users continue to be confident about achieving their shipping targets in this market, especially in the US where natural gas prices remain at near multi-year lows. Quote activity is rising with OEMs and we are having success booking orders with non-US manufacturers, as well as US-based manufacturers.

In addition, we are seeing increases in long-term forecast build rates and increasing amount of MRO business. Similar to aerospace, land-based gas turbine backlog declined by only 3.1% for the quarter and as with aerospace, there is a good possibility that sales pounds for fiscal 2012 could reach a record pound level.

Lastly, our other market category had net revenue of $21.3 million in the quarter, up 10.6% from the third quarter of fiscal 2011. Examples of the markets within this category include, but are not limited to, oil and gas, flue gas desulfurization, heat-treat and solar. This market category accounted for about 13.7% of our total revenue in the quarter.

As we said previously, this market is probably the most project timing-dependent and as previously noted, project business has slowed, which is why this market category has had the largest decline in backlog equaling 28.7% for the quarter. Although large capital projects are currently being postponed in this category, customers are indicating that project business for [related] industries should return in fiscal 2013.

A comment on July's backlog. Our book-to-bill in July was essentially 1, the backlog today at $239.8 million, 8 million pounds at an average selling price of $30.10. Although the backlog has declined during the year due to reduced project business, particularly for CPI and other market categories, the backlog continues to represent a solid order book representative of good margin product.

The combination of the noted revenue and cost changes between last year's and this year's third quarters as discussed in the 10-Q and press release resulted in a gross profit margin in the third quarter of fiscal 2012 of $32.4 million compared to $25.3 million in the same quarter a year ago, an improvement of $7.1 million or 27.9% between periods. The improvement in product pricing of $1.59 per pound netted against an unchanged product cost per pound between periods contributed $9 million to gross margin improvement, which was partially offset by an unfavorable volume effect to gross margin of $1.9 million.

The result was that the gross profit margin as a percentage of net revenues was 22.9% in the current quarter compared to 17.7% in the comparable period a year ago. As noted above, the most significant contributor to the gross margin improvement for the third quarter of this year compared to last year was the increase in average selling price between periods of $1.59 per pound, which essentially all fell to the gross margin line. Last fiscal year's third-quarter gross margin per pound was $4.10 and this year's third-quarter gross margin per pound is $5.68, a 38.5% increase between years.

The year-over-year improvement in performance in the third fiscal quarter reflects the improved economic environment, which thus far as favorably impacted the markets we serve us. It also highlights the effect of continuing to improve product mix by managing what markets we sell into, what forms we sell, what alloys we sell, and our continuing effort to improve the manufacturing cost structure through capital spending.

The gross margin percent in the third quarter fiscal quarter of this year was 22.9% compared to 21.7% in the second fiscal quarter of this year. The 1.2% higher rate from second to third quarter is due to a higher average selling price per pound combined with a lower cost of goods sold per pound quarter to quarter, resulting in a gross margin per pound of $5.68 per pound in the third quarter compared to $5.33 in the second quarter.

The $2.1 million reduction in gross margin from the second to third quarter of this fiscal year is attributable to the carryover dollars in revenue from the first to second quarter which has been described in both the second and third quarter Form 10-Qs. The carryover revenue added $2.1 million in gross margin to the second quarter, which, when adjusted for, makes the gross margin dollars between the second and the third quarters comparable.

SG&A, including R&T, for the current quarter was $11.2 million, an increase of $200,000, or 2%, compared to the prior year's third quarter. Factors contributing to higher SG&A costs in the third quarter of fiscal 2012 included additional headcount, salary increases, and increased marketing costs as the increasing level of activity. From last year's third quarter to this year's third quarter SG&A plus R&T, as a percentage of sales, improved slightly from 8% to 7.9%.

The forecast for fiscal 2012 SG&A, including R&T, continues to be approximately $45.2 million for the year. For the third quarter of this fiscal year pretax income was $21.2 million compared to pretax income of $13.9 million in the third quarter of fiscal 2011. For the third quarter of fiscal 2012 there was tax expense of $7.5 million versus a tax expense of $5.5 million in the third quarter of fiscal 2011.

The effective tax rate for the third quarter of fiscal 2012 was 35.3% compared to 39.7% in the comparable period of last year. The rate from last year was higher primarily due to reduced state tax rates, which required recognition of an estimate for the decrease in deferred tax assets due to the lower state tax rates. It is anticipated that the rate for fiscal 2012 will be approximately 34.5%.

Net income for the third quarter of fiscal 2012 was $13.7 million, $1.11 per diluted share, compared to net income of $8.4 million, or $0.69 per diluted share, in last year's fiscal third quarter. The Company continues to focus on improving working capital management with an emphasis on inventory through capital improvements and initiation of employing lean manufacturing techniques.

Inventory increased by approximately 17.3 million during the third quarter in order to support project business scheduled to ship in the fourth quarter and developing of extra material in the third quarter will offset maintenance outages of (inaudible) and equipment scheduled for the fourth quarter of this year. It is anticipated that through the fourth quarter the project business shipments and reduced [smelting] inventory will decline and turns will improve at approximately a turn rate equal to the rate at the end of last fiscal year.

In the first three quarters of fiscal 2012 the Company spent $17.1 million on capital projects, including the continuation of work on the four-high Steckel rolling mill, installation of an additional electroslag remelting furnace, upgrades of the vacuum melt furnace processing systems and instrumentation, upgrades to the research and technology laboratory equipment, and the upgrade of the information technology system. Also, as noted by market, the Company has initiated two additional capital projects which will total approximately $61 million in spending over the next two fiscal years with initial spending for these two projects totaling $7.4 million fourth quarter.

Capital spending in the fourth quarter is expected to total $12.7 million, bringing the total of spending for fiscal 2012 to $29.8 million on capital projects. In addition to the cash available of $51.3 million at June 30, 2012, the Company has a working capital facility of $120 million which can be increased to $170 million at the Company's option. This provides total liquidity of $220 million, which is expected to enable the Company to continue to take advantage of the improving economic environment and any other growth opportunities that become available.

Net income in the fourth quarter of fiscal 2012 is expected to approximate net income of the third quarter fiscal 2012. However, net income may exceed this level if improvement occurs in transactional business during the fourth quarter.

Even though the economic environment continues to be uncertain, the Company's performance continues to improve. The Company's balance sheet is solid with no debt and liquidity expected to be sufficient to fund our obligations and support the growth of the business on a prospective basis. We have a business plan and continue to perform to that plan. Lastly, the backlog represents a strong starting point for the remainder of fiscal 2012.

With that let me turn things back to Mark now.

Thanks, Marcel. Our balance sheet remains strong and we intend to keep it that way. We have significant inventory on the ground as of June 30. However, we are reducing that as we progress through a planned maintenance shutdown in our melt shop in the fourth quarter.

We are managing our mix well and migrating further into value-added services. Our plants are responding well and our people are committed to meeting the needs of our customers.

Our core markets of aerospace, land-based gas turbines, and chemical processing al have excellent longer-term growth opportunities. We have always been very conservative in our assessments of the market and aggressive in our pursuit of new applications in driving waste of our processes. We will continue to manage the business in this manner.

Everyone at Haynes is excited and, by the way, too, several of our key accounts that rely heavily on Haynes for supply of products are also very excited about the growth capital we are now committing. And we are all fully aware that the real work of converting that growth plan into reality starts now.

Finally, I also want to recognize and welcome Mike Shor to Haynes. Mike joined our Board of Directors on Wednesday and, as many of you know, he has a great background in our industry and a deep knowledge of manufacturing and operations. Mike recently retired from a long career at Carpenter Technology and I can you I am very pleased to have Mike join us.

With that let's open the call to your questions.

(Operator Instructions) Edward Marshall, Sidoti & Company.

Good morning, everyone. So a point of clarification. As a look at some of the commentary around short-term visibility and words like transactional, it sounds to me like there is a lack of urgency from, say, the customer base and they don't really want to extend the inventory on themselves.

Is that what you are saying? It doesn't really sound from the commentary from customers or from other peers that there is any deterioration, so to speak, in the end markets?

I think it is market dependent, Ed, and also I think everything is relative. I think one of the things you have to take a look at is last year six of the first seven months of the year we recorded record quarter entry clearly. And as we stated at a time there was a replenishment of supply pipelines going on throughout the industry. Now what we are seeing is people are operating now and supplying jet engines, flue gas desulfurization, wallpaper, all of those things through to their customer base right now.

As you look market to market, and as Marcel talked about in the backlog situation, you can see that the aerospace and land-based gas turbine the data (inaudible), look, it has flattened out at a very nice level. It is holding up well and if you look at the end markets all the way down at the end Boeing is shipping or delivering almost -- well, I think they are 330 planes now through July. There is going to continue to be very good pull on the supply chain moving into the future years.

As you look at things like the CPI, chemical processing industry, FGD, industrial heat treating, some of those what happened is you are not seeing the large projects get left lately and I think that is consistent through the industry that people are seeing that type of thing. So what is happening is you are seeing people come in for MRO things.

One of the things we do is we do commit to inventory so that we can meet those quick transactional requirements. But whereas a year ago people were saying go ahead and let's replenish the pipeline and supply us, we will put it on the ground and go out and compete for projects. Now a lot more of that is coming back into the supplier.

More importantly, at the end-user side of things a lot of these big projects it is quote, re-quote, quote again, and they are just now getting the money left to our customers to go ahead and initiate a lot of these big projects. Did I answer your question?

Yes. So it is timing is what I hear?

That is what is being relayed to us. As I said, I met with a bunch of these guys especially in the last quarter and a lot of it was, yes, these things are wearing out.

Trust me, when we get it you will get it, because I am kind of pushing them a little bit on these things. Especially with where nickel is right now, it is a good time for some of these guys to be buying. By the way, too from a macro level I think that nickel number is telling you something and we all see it right now.

So it is a short-term visibility issue right now. I think things are still looking very good, especially as we look at 2013 and 2014, but I think you just had a situation right now, especially with what is going on in the macro environment, be it China, be it Europe, or even the situation here with the fiscal cliff, a lot of people are sitting on their wallet right now.

You were certainly ahead it. I recall you mentioning the nickel situation I think last quarter. So it was surprising to see the inventory build in the quarter being ahead of it, but I think you said it was for safety stock, perhaps for the shutdown that you have coming out in the next quarter. Is that right?

Yes, we are going to bleed the inventory down this quarter as we had some planned shutdowns. I mean, you know the drill. What happens is you end up with a lot of revert coming through and you pull heaps out of the melt schedule to match the order book, so I am sure we will see some increase in things like raw materials and stuff like that.

But what we expect to see is the things like [whip] and semi-finished and even finished goods get pulled down during the quarter. That is the plan.

So looking at the margin and the business across the whole, I mean this was I guess a testament to what kind of tweaking you did to the equipment, because when sales fell in the previous cycle I mean you saw a quick deterioration in the margin profile. That hasn't happened and I can't help but think if volume returns what kind of leverage you can get off this new model.

I know you mentioned pricing and lower COGS, I guess due to raw materials, but can you also maybe talk about some of the efficiencies and what that did to the margin structure of the business?

I will let Marcel touch on this, but I also just want to keep forefront in your mind too that we have done a lot of great cost reduction work, and I think we are seeing a lot of the benefit. A lot of it being the CapEx upgrades.

Like when Haynes redid the furnaces and the cold rolling mill that really helped throughput, and throughput is great at a place like this. When you are running 12-plus-million pounds a year of sheet as opposed to 8 million or 9 million, that is great absorption for the business and those are great volume items for the business. So that is fantastic on the cost side.

I will also say, too, right now the mix is very good. These tubular products or some of these -- the new, the C-22HS that we have gotten into some new applications. Some of the cobalt-based alloys came back pretty strong this year for aerospace.

So the mix right now -- we talk a lot about mix management, and there is a lot that goes on as far us picking and selecting which orders we really want to be competitive on versus which -- you have to let go sometimes when you are full on certain pieces of equipment. But the mix has been very good and we have been the beneficiaries of a very good market in some key areas where it allows us to manage the mix that way.

Marcel, anything to add on the cost side?

Just to reiterate I think, Mark, and you have alluded to it, we have been spending CapEx now at a very good clip, and increasing clip since 2007 after the restructuring -- or the 2005, and it has always been about just improving the process from the beginning to the end. We talk a lot about the sheet area where we spent money on the finishing operations for the cold rolling mills, the kneeling lines and so forth, increased capacities and reduced operating costs. But it's also been done at the -- really, literally through the entire facility starting at the air melt.

We spent money upgrading the air-melt operations, increasing capacities, reducing operating costs on the vacuum side. We have upgraded all our ESRs over the last several years, completed that project. We have added equipment periodically to fill gaps. So this is just a process that continued -- or started 5, 7 years ago, and we continue to work on it. And what you see coming with the $61 million is a combination of both a capacity add but also of just an operating improvement that it's applicable to all of the product we make in Arcadia. It's all the flat product we make here in Kokomo.

And if I can add to that too, any time we talk about Arcadia being full, those are very good products. That means the world of acetic acid is picking up either MRO or new business, the aerospace businesses going strong. And some high-end corrosion applications like I said with the acetic acid, those are going pretty well.

And I think you are aware and we have discussed it before, in the new application work that we've done, a lot of that has found its way into Arcadia and that has been very good for the Company.

Just to focus on that particular point in Arcadia, Arcadia is a specialty type operation, not a lot of pounds. So we look at that operation from a tubular perspective. It's representing about 14% of our business from a revenue perspective. That's how you have to really look at that business; it's the high end for us, very good margin product, very high-end product.

Marcel, while I have you, last question. SG&A you said $45 million for the year. I am assuming that includes R&D?

Yes, it does.

Okay, good. Thank you.

Tim Hayes, Davenport & Company.

Good morning. With the expansion here on finishing the rolling side, does that put any constraints on the melting side? Or with your investments from a few years ago, do you have plenty of room on the melting side?

You know we are adding some remelt capability that we should have in place probably toward the end of this calendar. That is going to help us out quite a bit. On the air-melt side, I will say there are no constraints. On the vacuum, our premium side of the business, we are definitely up against some hurdles there. So that is part of the managing mix equation.

Any thought to adding the melt in that area?

We are looking at a number of options right now, Tim.

All right, that's all my questions. Thanks.

Alan Brochstein, AB Analytical Services.

Congratulations on continued margin improvement, great to see. I had a few questions. First of all, can you update us on the CFO search?

Yes, we have contracted an outside firm and we are interviewing both inside and outside candidates, and it is going very well.

So when do you expect to announce a hiring?

Probably toward the end of the fiscal.

And then thanks for the detail on the capital projects; it's very exciting. And I guess maybe I could parse it together, but can you somehow describe in an overall sense for your total business what the total additions would be? I guess what I'm trying to figure out is compared to your prior capacity in 2007, how much more capacity in pounds will you have now?

We will break it down into two pieces. We talked about Arcadia, that's our tubular facility. That currently represents about 14% of our business right now. So we are taking that 14%; we are going to expand it by over 60%. So that's that element of it, and that's essentially via additional [pillagering] equipment. We've got seven [pillager] operations down there. We are going to add two more. We are adding in a third kneeling furnace.

We are adding a significant amount of new equipment replacing old equipment. So from an operating cost perspective, you know, are reducing the cost substantially through better yield improvement, better processing.

On the flat product side, as Mark noted, we are adding probably 4 million pounds of product on that side of the operations. And that typically sells -- our average selling price is about $24, $25 a pound, so I think you can see the add-on relative to that.

Okay, I will work through that. I guess you were kind enough a year or so ago to kind of answer a question which I think was on a lot of investors' minds, which is given the pricing that was really high up back at the last peak but from the capacity expansions that you were making and now with these, would it be possible to exceed your prior peak EPS; and your answer was yes at the time.

I was just wondering if you could quantify that with these new capital additions. And I guess more importantly, given the third variable would be just your mix change. So I guess can you quantify how much more you might be able to exceed it? I know you don't want to be locked into a number, but at capacity?

I think, again, it's -- maybe I will give you the parameters to work within. We talked about what the add-on would be relative to the tubular facility from a revenue perspective. We have talked about or even noted the pound adds for the flat product side, so that should give you pretty good revenue numbers. And then you need to think in terms of how we look at it is because of these new projects, again, we are talking about capacity. That is one way to look at it. There are additional revenues; we've talked about that.

But then I think you need to just think in terms of what will these things do to our gross margin percentage. And if you think about these projects, essentially what we are adding, the operating cost adds here are related to depreciation expense and to raw material variable cost. Other than that, the costs are relatively a small add-on. They are very variable in that respect. And these projects impact all of the products that we make within the flat area and the tubular area.

Well, I am trying to paint a little picture here for you. Then you think in terms of what might the margin percentage effect be. You know, we've talked about this, and probably next year and towards the latter part of the year, will we really have any effect on the margin percentage.

However, in 2013, we would expect to see something in the area of 1% to 2% of additional gross margin percentage add-on, and then in 2015, probably another 1% to 2%. So you are looking out at the end of these projects with completion of something probably between 2% to 4% of additional gross margin add-on. Does that help?

Yes, it really does. Thanks. That is all the questions I have right now.

(Operator Instructions) Mark Parr, KeyBanc.

Thanks very much. Good morning. One thing, Marcel, I appreciate the color again on the backlog for July. Can you detect any shift in the mix from an end-market perspective compared to what you have been seeing over prior months?

No, it is very consistent, and I think it has to be for us to start the year on the aerospace side, for example. We talked about this past quarter there being about a 3% drop. But if you look year-over-year beginning of the year to the end of June, the backlog was flat for aerospace, and we have had a very robust sales year. We are approaching potentially hitting a record sales pound shipment level.

We essentially had the same situation with the land-based gas turbines, and so that 60% of our market has been very consistent at a relatively high level, at least compared to 7 and 8, and really haven't detected any changes at this point. I really can't see any.

Okay, I appreciate that. One other question, I don't know if -- you may have mentioned this before, but in terms of the inventory build did you talk about how many pounds of material you built?

We really haven't talked about that. I think we'll just at this point stay with the dollar. It's always a moving target. But we did add probably in the quarter about $17 million. But if you look at it as compared to the beginning of the year, we've added about $50 million.

But the primary driver was we have some melding equipment outages through the course of this quarter, and we had to take steps to build inventory on the finished goods side, primarily in our foreign operations. Because if you think about the fact that it takes four weeks to get material from here to our foreign operation. So you really have to start that process early in the second quarter. You really can't wait till the third quarter. You start melding, you start building.

So what you're seeing now at the end of the third quarter is an increase in our finished goods in our foreign operations, which will be metered out over the balance of this quarter. In the US the finished goods add was essentially -- was flat. We didn't really add anything in the US ops.

Where we did have some adds was on the work-in-process side, and we're taking out through the course of this quarter that will be run down with the lack of melding operations. We will see a little blip through the quarter and probably we'll get that worked out by the end of the quarter in our revert material. When you don't melt, you build revert. So that is just a natural process. We will work that out, but I think again we are working the inventory down, and I don't think we will have any issues by the end of the quarter.

Okay, I appreciate that. If I could ask just one last question. One of the things that is important to your business has been -- that you have talked about over the years -- has been the ability to ship quickly and to provide a superior customer service.

And along those lines I'm just wondering as you go forward with these new expansion projects and you see recovery of the end markets, what is the ideal level of backlog for you guys? I mean where the backlog is now, is this a good level or would you like to see it higher, or would you like to see it lower as these end markets unfold over the next couple years?

Our objective, Mark, just to give you an idea, is to keep improving the turns that we have in our inventory and all the way through, which gets back to the backlog level. So if you think of really what that is is more so than anything, at least in my opinion, is it gets down to the cycle time and the velocity through the plants. Things like shipping time, we have difficulty controlling that.

Also at the finished goods side of it, just to give you an idea, one of our operations three years ago used to make about 14,000 cut parts a month. They're now up -- last month they did over 50,000 cut parts. So there is an inventory support level required to meet that.

And by the way, cut parts is one of the reasons that you see our average selling prices increasing even in the face of lower nickel prices. So I'm giving you kind of a long answer, but I will let Marcel talk more about it. But really what we are constantly striving to do is create better velocity through the plants and, therefore, really drive our turns to a much better level. So trying to manage the business better on less inventory per dollar of sales.

Exactly what Mark said. If all things remain equal and with these capital adds both in Arcadia and here in Kokomo, what you would see are two things -- inventories would decline because of improved turns at the same level of sales, and we would probably have a downtick in the backlog because we would just be producing -- we would be servicing our customers quicker. That's if all things remained equal.

Does that answer your question, Mark?

Yes, it sure does, Marcel and Mark. Thanks and congratulations on the results. Good luck in the September quarter.

Thank you very much, Mark.

Edward Marshall, Sidoti & Company.

Just two quick follow-ups. I don't know if you can have a perspective on aerospace and your split between OEM and spare engine platforms. I know spare seems to be a little bit weaker than OEM, and I know you have tried to parse it out before, but do you have a better answer for us at this point?

I can tell you that when I talk to the marketing guys and it is like you said, Ed, if you think about where we sell, a lot of the fabricators that we sell to are supplying both into the OEM market as well as to the spares market. So it is tough to parse this out. I think as you get further down the supply chain, you get better clarity on that.

But essentially what our people say is essentially we are probably running about 40%, 45% OEM. And the MRO business runs anywhere 55% to 60%, so it's almost a one-to-one breakout the way our people assess the market.

So more MRO than OEM, slightly. And then finally the pricing perspective and with the capacity additions. I know you guys are conservative, so when you put in new facilities, you need it. What do you think that does to pricing in the marketplace in general as you kind of roll out additional capacity?

I think you have to be very selective in where you add the capacity. Somebody asked the question earlier about melting capacity. There seems to be quite a bit of melting capacity that has been added into the marketplace in the last X number of years. So maybe we can strike an alliance somewhere and help people out there or purchase some of that capacity. So we don't know.

Typically, the equation is as capacity is added, prices go down. I think that is why we have to be very selective in where we do it. A lot of what is driving our capacity additions are growth in the core markets that we have. Strategically, we expect pricing to hold up in those areas as we meet the increased demand from what is out there.

The same thing as we develop new applications, some of the capacity additions that we are talking about are new application related. And some of the strains we are having on capacity right now are because of the new applications we have created. Things like HAYNES 282, we are going to sell about four times more HAYNES 282 this year than we did two years ago. So there is a new alloy, high-temperature alloy, that is clearly gaining traction.

C-22HS, the numbers would astound you. Five years ago that was close to nothing in revenue, and I will tell you now it is one of our top 20 alloys in sales. So, again, as we develop new applications, you have a bit more pricing leverage. And that is our intention is to keep managing the mix and driving the Company towards more value add.

Excellent.

There are no further questions at this time. I would like to hand the call back over to management for closing comments.

Thanks very much, everybody. We appreciate your time today. As we had mentioned, the short-term visibility is very cloudy right now. Long-term we think we are in great markets with great products, and our people have really stepped up on the production side especially, but also on the commercial side.

A lot of challenges out there right now, a lot of moving parts, but I think that we are positioning ourselves extremely well with our account base and positioning ourselves extremely well with new applications with our new materials. So, again, thanks for your time, your interest and your support of Haynes, and we will look forward to talking to you next quarter.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.