ATI Inc.
Q3 2009 Earnings Call Transcript

Published: 22 Oct 2009

[Operator:]

Good day ladies and gentlemen, and welcome to the third-quarter 2009 Allegheny Technologies earnings conference call. My name is Kesha and I will be your operator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) I would now like to turn the call over to Mr. Dan Greenfield, Director of Investor Relations and Corporate Communications; please proceed sir.

[Dan Greenfield:]

Thank you, Kesha. Good afternoon and welcome to Allegheny Technologies earnings conference call for the third quarter 2009. This conference call is being broadcast on our website at www.alleghenytechnologies.com. Members of the media have been invited to listen to this call. Participating on the call today are Pat Hassey, Chairman, President and Chief Executive Officer; and Rich Harshman, Executive Vice President of finance and Chief Financial Officer. All references to net income and earnings in this conference call mean net income and earnings attributable to ATI common stockholders. After some initial comments, we will ask for questions. During the question-and-answer session, please limit yourself to two questions to be considerate of others on the line. Please note that all forward-looking statements this afternoon are subject to various assumptions and caveats, as noted in the earnings release. Actual results may differ materially. Here is Pat Hassey.

[Pat Hassey:]

Thanks Dan, and thank you to everyone listening on today’s call. Our markets are showing signs of improvement, and the worst appears to be behind us. We are seeing some positive data points in some markets, yet in the short term our customers continue to be cautious and most are keeping their inventories low. Looking at and comparing our third quarter performance to a more normal period, we’ll like ATI’s upside potential when our markets recover, and our shipment volumes improve. In the third quarter we were EPS positive and earned segment operating profit of $54 million. This was accomplished under difficult circumstances. First of all, overall utilization rates of about 50% to 60% crossed our operation; a reduction in operating profit of nearly $19 million due to idle facility costs, further severance costs and new facility start-up costs. A LIFO catch-up of $22.5 million due to rising raw material costs; and while our US-defined pension plan is fully funded, we recorded $20 million of pension expense, primarily due to the significant negative investment returns in 2008; these amounts are all pre tax. We ended the quarter with $826 million of cash on hand. We continue to self fund our capital investments and our balance sheet remains solid, giving us financial flexibility. We remain focused on continuing to improve our cost structure. Gross cost reductions in the first nine months of 2009 were over $121 million. We expect to exceed our 2009 cost reduction target of $150 million, and expect 2009 cost reductions to be the highest in ATI’s history. Our strategic focus on high value products continues. Year-to-date sales of our high-value products were over 79% of total 2009 sales. Now, first turning to the markets; 75% of 2009 sales through the third quarter were to our core global markets. We remain confident in the intermediate and long term growth potential of these global markets. Aerospace and defense accounted for 32% of nine months 2009 sales; electrical energy was 20% of year-to-date sales; the chemical process industry, oil and gas markets, accounted for 19% of sales; and the medical market accounted for over 4% total sales. Today ATI is more globally focused than at any time in our history. Direct international sales reached nearly 31% of sales through the third quarter of 2009. For a comparison, direct sales, international sales were 28% of total sales for the full year 2008. We expect this trend to continue as a result of our focused sales and marketing efforts, which we expect to be further aided by the weaker dollar in 2010. Turning to the individual business segments, and the high performance metals segment, compared to the second quarter of 2009, shipments of our titanium based alloys and nickel based super alloys declined 18% and 20% respectively, due to the ongoing inventory correction in the aerospace supply chain. For us, that is mostly the jet engine segment of the market. We expect the jet engine segment forecast to be finalized in balance with the current airframe forecast before year’s end. Shipments of our nuclear grade zirconium alloys to the nuclear energy market remain solid; however, total shipments of our exotic alloys was at 23% in the third quarter of 2009, compared to the second quarter of 2009, due to the timing of new projects for chemical processing plant construction, which uses our industrial grade zirconium alloys. In the flat-rolled products, third quarter 2009 shipments of our high value, flat rolled products increased 8% compared to the second quarter. Some highlights

[Operator:]

(Operator Instructions) Your first question comes from Timna Tanners - UBS.

[Timna Tanners:]

I wanted to ask you about the jet engine destocking, and if you can give us whatever color you might have. I know you and also some of your peers are also talking about this, but what gives you the conviction that this destocking is near an end? What can you tell us more in detail about that?

[Pat Hassey:]

Just some anecdotal kind of things. I think that there has been some disconnect between the airframe build for 2010, and what might be the conjecture of some prime suppliers as to the number of aircraft that’ll be built next year, so two things are happening. One is that Boeing again today reiterated that the 2010 build rates are unchanged and firm for the single aisle, which is a major factor, and also that their schedule for the 777 is on schedule. They’ve also confirmed that the 787 should fly before the end of the year. Those are all very good things, because as you get down to normal lead time changes, these kinds of things have to be set and schedules have to be concurrent, I would say before the end of the year. So we know there’s been some disconnects in what should I stock, how much should I be buying, what are really going to be build rates, and I think those rates are coming to an end, and the jet engine makers will see a firm schedule, and we’ll get a concurrent schedule. Once they get that in place, then you’ll look at the lead times that are being offered in the industry and also the amount of material on the shelf; that’s one point. Second point I think is, that we’ve seen some outages. We’ve seen customers coming to us and asking for some relatively short deliveries to fill in holes, where they have seen some changes or have taken the inventories down too far. So I think two things are happening, those two things. In response to those two things, we are putting inventories in forward positions to be ready to respond to this market, and we would say that we don’t see that this thing is certainly going to end in the fourth quarter, but as we move into the first quarter, we see improving shipments and then we see growing shipments throughout the rest of the year.

[Timna Tanners:]

What are you looking for to see signs that stainless volumes pick up as well?

[Pat Hassey:]

I think it’s very clear stainless volumes are ticking up. The 63,000 tons was the best quarter that we’ve had this year. We’ve had the three price increases in the market; they’ve all held. I think we have an interesting couple months ahead of us, because as you come to the end of the fourth quarter we have lower surcharges in the November timeframe than in December, so we’re probably going to see a very good pull for the product through the November timeframe. So I don’t think we’re going to get into the position of people delaying shipments towards the end of the year, because they’d rather take the material early to avoid the higher charges. Now all of that being said, our schedules are full through November, so we’re seeing that pull and we’d like to see how December fills, but the real test is going to be what we see going into the first quarter. The consensus across most people, what we hear from our distributors is that we’re seeing demand firming, everybody is cautious, we are not going to put a lot of inventory in right now, we can operate this way because the mills are keeping good product toward the end of the supply chain in some cases in finished form, so they’re going to use the mills inventories for a period of time. At some point if demand stays there and we’re going to see that move, and we’re going to see that lot less caution, I would think as we move past the end of the year and into the next fiscal year.

[Timna Tanners:]

And you’re still looking to 300,000, 350,000 tons to be able to kind of get that sweet spot in terms of leveraging fixed costs?

[Pat Hassey:]

Absolutely.

[Timna Tanners:]

Final question from me, going forward in CapEx, can you give us an idea about what you might be targeting run rate into 2010?

[Pat Hassey:]

The CapEx is going to change; it’s going to come down. The major projects we’ll be finishing up will be our melt shop consolidation which I mentioned. We also have to finish up some expansion in our exotic metals, we’ll be bringing through the start-up cost of the new sponge facilities and super forge facilities, but the major expense is going to be the new hot rolling facility which will begin construction. So the number is going to be beginning with the three, not a four.

[Operator:]

Your next question comes from Stephen Levenson - Stifel Nicolaus.

[Stephen Levenson:]

In relation to the acquisition of Crucible and your long term agreement with Rolls-Royce are the powdered metals covered in that agreement?

[Pat Hassey:]

We didn’t have powdered metals when they made that agreement, but we have an overarching arrangement with Rolls-Royce as their strategic suppliers. So I think the development of the powder alloy business and also any new products that we would be developing for aero engine alloys could well fit into addendums.

[Stephen Levenson:]

And that would be on that top of the amounts that you discussed or is…?

[Pat Hassey:]

Oh, yes. On top of the amounts we’ve talked about.

[Stephen Levenson:]

What do you think it takes for titanium pricing to move higher, and how does that tie in with the reduction of shipments from the Russian and Cossack operators?

[Pat Hassey:]

That’s a big question. As you know, the Cossacks are committed to Airbus and a large extent to their supply chain, and the SMPO is committed to a large extent to the Boeing supply chain. Both for companies like ourselves and some others, we provide the enabling part of that equation. In short, we are a company that ships what we ship on time with the kind of quality that the aerospace customers need in qualifications. We have capacities to expand and so we’re an enabling supplier and a large supplier; maybe in the second position, maybe not the primary position, but a second position that allows us to grow. So we think that those kind of strategic moves have already been put in place, and those kinds of agreements have already been laid out. So what it takes for that side of the business to improve is for these new aero plane programs to get up and running; they have to get up and running. Another thing that’s been very interesting to me is the recent announcement from Comac of the C919, and the recent announcement from the Russians that they’re going to be building their own large single-aisle aircraft and putting those aircrafts into play by mid next decade. I think that changes the game, and changes the world, and changes the requirements that may be coming from the two major builders, as they look at how are they going to compete in the single-aisle families. I don’t believe that either one of those major players are going to easily concede any market share to anyone that’s coming into those timeframes with a newer aircraft, so their aircraft has to be upgraded or a new one designed. I think that’s a big opportunity for titanium in either event. The third thing that has to happen is that the infrastructure builds, oil and gas, financial markets, have to break loose, some of these projects that are sitting in the wings waiting to happen, and as the global economy moves forward; I’m talking global, not just United States, but say 9% or 10% in China, 7% in India, 5% in Brazil, plus 3% in the United States, 3%, 3.5% in Europe, those things happen. When the infrastructure markets come in, the industrial markets start to move, and when that happens, we start to see the pull on the titanium supply, the scrap that’s out there, and the prices change.

[Stephen Levenson:]

And the last item, you mentioned some positive data points, can you give us any additional details on what those were?

[Pat Hassey:]

They’re certain markets. We certainly see some stabilization in growth now in oil and gas, and that was stalled for a good part of the timeframe. We did have some spurts in the automotive market, but basically it now looks pretty stable and continuing at a lower level, but not at the levels that we had in the first half of the year, which were nothing, so that looks good. We’re waiting for the stimulus package to be finalized on appliances. This $300 million plus stimulus package in the US for appliances is going to give everybody in the stainless steel business a little burst in the appliance area. I think there’s some growth that is going to come from other projects that have been either on the drawing board or being worked out, and some of the stimulus money for such things as electrical grid and electrical steel. We do have some stabilization now, at least in the new builds of the housing market, and as people keep their jobs, not the 10% that are unemployed in this country, but if people keep their jobs and maybe decide they’re not going to be able to finance a new home, they’re going to keep the one they have, we should see some further movement in our building materials side of the business in appliances and building materials as people upgrade the homes that they’re living in, those 90% that have a job. So I think this thing stabilizes and starts to move forwards. We’ve seen just better bookings is what I would say. We’ve seen better bookings out of Asia, better bookings out of Europe, better bookings coming into the fourth quarter, new orders and new bookings than what we had in the third quarter.

[Operator:]

Your next comes from John Tumazo - John Tumazo’s Very Independent Research.

[John Tumazo:]

As Rowley, Utah ramps up, could you give us a flavor for what the quarterly dollars of depreciation will be? What operating rate is necessary for it to breakeven? What you expect the learning curve would be? We want to see the $600 million bearing fruits soon.

[Pat Hassey:]

It’s $500 million, but okay. Rich, why don’t you just start with this one and I’ll add anything I’d like to.

[Rich Harshman:]

The depreciation run rate on average, on a quarterly basis will be between $4 million and $5 million for the Rowley facility. I mean obviously as we’re ramping up, some of that will be absorbed into the inventory carrying costs, so you may not see that. Especially beginning in 2010 as we start producing products that we expect to use in mill products and sell, it’ll be absorbed in there, but on an ongoing basis the run rates between $4 million and $5 million.

[John Tumazo:]

What do you think the peak quarter for start-up loss is going to be, and how much might that be?

[Rich Harshman:]

Certainly we saw some of that here in the third quarter. It was a relatively modest amount, but I think the fourth quarter of this year and the first quarter of next year would be the peak quarters for our start-up costs flowing directly to P&L as a period cost.

[Pat Hassey:]

One project balance is up and the other one comes on stronger. We have Rowley coming on stronger, while the new forge facility levels out.

[John Tumazo:]

How many pounds per month does Rowley need to make to break even?

[Rich Harshman:]

Well, I think the large part of that quite frankly depends on the macro market for titanium, and the pricing for titanium mill products. I think from a minimum operating efficiency standpoint, the numbers that that facility is initially targeted at this stage for 24 million pounds a year of premium grade sponge. There is a pretty healthy qualification process that has to happen, that will take a while for the premium rotating part applications, so whatever we make there will be more standard grade initially for the non-rotating market, but I think as we look at that facility, an annual rate of around 15 million pounds would be something that we would be comfortable with from a cost structure standpoint.

[John Tumazo:]

Is that industrial or premium?

[Rich Harshman:]

It wouldn’t matter.

[Operator:]

Your next question comes from Dave Martin - Deutsche Bank

[Dave Martin:]

I had two questions on the flat-rolled business if you would. The first is your high value shipments increased sequentially from the second quarter of this year; was that all precision-rolled strip or is there something else driving that? Then secondly on electrical steels, I think back in July you had said your electrical steel volumes will approximate 95,000 to 100,000 tons this year, is that still true?

[Pat Hassey:]

Okay, I’ll start with the second question, and yes, that’s still true, we’re going to be around 95,000 to 100,000 tons on the electrical steel side, so those volumes actually are down as we had worked with some customers, down from 2008. So we’ve worked with some of those customers to put some of that volume out into 2010. So nothing’s been cancelled. The volume has moved out because the market leads just have been delayed. So that’s still a very strong business for us. I think the volumes are relatively good compared to others we have, where our long term arrangements have a very high market share today, and those tons should go out. I would expect that our shipments in the fourth quarter look a little bit better than what we did in the third quarter for electrical steel. Now on the 8% number, basically that includes our nickel based alloys, where we saw improvement, and it is somewhat down on the electrical steel. It includes precision rolled strip, but we did pick something up on the automotive side, and it includes our titanium shipments which were down. So you put all that together, and the overall levels are up, but it’s a mixed bag of products. I would say that our backlogs for our strong alloys, the nickel based alloys, that side of the business, the backlogs moving into the fourth quarter picked up substantially over what we had at the end of the second quarter, moving into the third quarter.

[Operator:]

Your next question comes from Michael Gambardella - JP Morgan.

[Michael Gambardella:]

Rich, I’ve got just a dumber question first. On the quarter you had net interest expense of about $8 million in the quarter, how much interest did you capitalize in the quarter?

[Rich Harshman:]

Hold on one second, because I don’t want to give you a bad number. It was about $10 million roughly, and obviously on that point, the interest capitalization rules are such that it’s a capital project that’s over a fiscal period, so more than one year, and how much of the amount remains in construction and progress before you begin to enter it into production and depreciate it. So if you think about that, in the third quarter the two big projects that affected that were the super alloy facility which was just beginning production here in September, and then the Rowley titanium sponge facility, which won’t begin production until the fourth quarter. So as we look at the fourth quarter, the super alloy facility kind of drops off that equation, because we begin depreciating that. Rowley really doesn’t until some time in December, so that will still impact the capitalization requirement, and then in the beginning in the first quarter of next year that drops off, and then really the big project that will affect the capitalization rules throughout 2010 and beyond, through 2012 is the hot mill. When you think about the hot mill in terms of roughly a $1.2 billion project, some CapEx incurred this year, modest by the percent of the total project, and then fairly evenly split between 2010 into 2013. So that capitalization will grow throughout that period.

[Michael Gambardella:]

So in the quarter you had $8 million of interest expense, but also an additional $10 million of capitalized interest. Even though the CapEx program for 2010 will decrease, what you normally think about the capitalized interest would therefore roll off and decrease, you’re saying it is going to go up next year?

[Rich Harshman:]

No, I don’t think it’ll go up. I mean, when you look at total growth interest expenses, it’s around $60 million a year and a little bit higher, so a smaller part of that in 2010 will be capitalized versus 2009, but then a larger part of that in ‘11 and ‘12 gets capitalized as the capital spend base for the hot mill takes hold.

[Michael Gambardella:]

Then second question, I know in the release you categorized 2010 in terms of the earnings as a transitional year, but right now and I guess third quarter you guiding pretty much the same for the fourth quarter, your EBITDA on a quarterly basis is a little over $40 million. If you look at the consensus EPS for next year it equates on an EBITDA basis about $100 million a quarter or about 2.5 times the earnings growth that you currently have. Is that consensus out there reasonable?

[Dan Greenfield:]

Well, we’re not giving guidance in 2010. I think that the consensus is an interesting number. As you know, everybody has their own views of life. We have some analyst, who for example have zero pension expense in 2010, and that affects the consensus. So I think as what we said in the earnings release, we along with I think most people aren’t expecting a V-shaped recovery in the global economy in 2010. We think it’ll be on balance or a modest recovery, if that represents a GDP growth of around 3%. We believe in the markets that we serve for all of the reasons that Pat has articulated, that 2010 with all of the things that we have done will see a much better performance than that kind of a global GDP growth, and it will continue to improve as the markets improve throughout the year.

[Operator:]

Your next question comes from Luke Folta - Longbow Research.

[Luke Folta:]

Just a couple of questions; firstly, on your high performance metals business, we saw revenues come down about $40 million quarter-over-quarter, but there was an improvement in EBIT, but even if you pull out the LIFO, if you exclude that, you’re still even with last quarter. So I’m curious to know what the improvement was there?

[Pat Hassey:]

I think the improvement was basically in the mix of products that we sold and our performance. We are taking costs out of the business, we did get some benefits from these inventories; high-priced inventories and metals finally working their way through from the first half of the year which we talked about in previous quarters, that when you’re in the kind of business that we’re in, it takes a while to wash through that higher priced metal. So as that metal prices washed through I would say it this way that maybe some of our margins were depressed from paying for some higher priced metal in the earlier part of the year, and catching up with what the current market performance should be.

[Luke Folta:]

Just regarding your guidance for the fourth quarter, it’s regarding the distribution of earnings across the segments. Would you expect any kind of meaningful change from 3Q, and can you give us your LIFO expectations for the remainder of the year?

[Rich Harshman:]

Yes, I think obviously LIFO does impact the segments. When you look at the biggest benefit in the fourth quarter compared to the third quarter, it’s in the flat-rolled products segment, because we took a LIFO expense because of a catch-up in the third quarter in flat rolled products of just under $7 million. So that positions us year-to-date in that segment of $45 million LIFO income or benefit, which would mean that in the fourth quarter, assuming the same, our assumptions are consistent with what reality is in terms of raw material costs and inventory mix, and everything else which we’ll see. That would equate to a $15 million LIFO benefit in the fourth quarter, versus a $7 million LIFO charge in that segment in the third quarter. Conversely the high performance metals segment, actually had a LIFO benefit in the third quarter of $10 million, which was a catch-up provision, because we had to be 75% booked of where we think the full year will be, so that $10 million benefit in the third quarter will actually become only a $3 million benefit in the fourth quarter. So both of those things impact those two segments, and then everything else is just fundamental in terms of where the volumes are, and what the shipment expectations are, and Pat’s already talked about that from a product and an end market standpoint.

[Luke Folta:]

And just a quick follow-up; the idle facility costs, was that a one timer this quarter or is that going to be recurring?

[Rich Harshman:]

No, idle facility costs, first of all what the number was $18.9 million. It’s a combination of severance costs, start-up costs and idle facility costs. Severance costs are unique in terms of what actions we’re taking to right size the businesses. We’ve been doing impacted really through the entire year on all of these issues, but the biggest impact certainly was in the third quarter, relative to a comparison to either the first or second quarter. I think we continue to look at the cost structure of these businesses in light of what we believe the underlying fundamentals will be, so we will continue to have some modest severance costs impacting our third quarter, but I think the biggest impact in Q4 will continue to be start-up costs that we’ve talked about here briefly, and by far it’s the idle facility costs. When you’re operating at 50% to 60% of capacity, under the accounting rules some of those fixed costs flow through as period expenses, and to the extent that we continue to operate at that level we’ll continue to have those costs. As we improve utilization, which is our expectation, beginning in 2010 and beyond, that creates some of the earnings leverage, plus just the additional volume that we see heading into 2010.

[Pat Hassey:]

Year end is always an interesting time when all of our customers are looking at how their books are closing, and where their inventories are, and you always deal with the fact that you could do a lot of shipments on January 5, that you would have liked to have shipped on December 28.

[Rich Harshman:]

Correct.

[Operator:]

Your next question comes from Kuni Chen - Banc of America-Merrill Lynch.

[Kuni Chen:]

I guess just first off on electrical steel, can you give us a little bit more of a forward view there and provide some color on what you’re hearing from your customers as far as the outlook on 2010? Have you started some of the negotiation process yet? I just hope to get some more details.

[Pat Hassey:]

As I mentioned Kuni, and we look out through he rest of the year. We are working with our customers to make sure that we’re doing the best that we can with them in the market conditions. Our shipments at these levels this year are due to our long term arrangements and our partnerships with some of these customers that put us into the business and moved some of these arrangements then into 2010. So I think we’re going to be well positioned in 2010 to continue with about what we’re doing in the second half of 2009.

[Kuni Chen:]

Then just as a follow up, on the titanium side of the equation if I just look at high performance metals you did about 5.5 million pounds in the quarter. Would you consider that to be your minimum baseline volume or could that potentially even go lower in the destocking scenario?

[Pat Hassey:]

I think that’s the absolute bottom quarter.

[Kuni Chen:]

Okay. So kind of given a view that perhaps there’s some excess material out there in the supply chain; perhaps, I guess where would you see upside to that quarterly run rate for next year?

[Pat Hassey:]

I think we’ll you have to look at our business in a different way, because we have the high-performance side, we have the flat-rolled side, we have our joint venture partner in Unity, so we’re servicing global markets. A good portion of our business is offshore. It isn’t all aerospace and defense. So when you’re looking on the aerospace side that is what you’re seeing on the 5.5 million in high performance, maybe oil and gas in there. So what we’ve said is that we see a destocking for the balance of 2009. I think that we have a good possibility that that’s going to reverse itself beginning late in the first quarter, but at the latest, certainly in the second half of next year we’re going to see some different numbers coming through; you just basically run out of material, and the build rates are going to hold on the single aisles on that side of the business. I think we’re making some good progress on the defense side of our business, and we certainly are waiting for some global infrastructure to come back to more normal levels. So all those things bode that the third quarter is probably the worst quarter we’re going to have.

[Operator:]

Your next question comes from Mark Parr - KeyBanc Capital Markets.

[Mark Parr:]

Do you have any idea what pension expense might be for 2010 at this point?

[Rich Harshman:]

No, we really don’t Mark. We’re pretty comfortable, especially if the equity markets and the fixed income markets hang in there with where our asset level will be. The question is what’s the discount rate, what is the Moody’s AA bond yield at the point in time of 12/31, which is the FASB or the accounting standard requires you to use, and then apply that to the bond models, the actuaries run, and the whole thing is going to be driven, I think largely influenced by what happens with that interest rate which is the discount rate used to value our liabilities. I’m not as concerned quite frankly about the asset side at this point; concerned isn’t the right word - just we have to wait and see where the interest rate comes down.

[Mark Parr:]

Another thing, I was just curious about this, I don’t mean to like pick at stuff, but on the corporate expense side which was up, is there something that’s new and different about incentive based compensation that I’m missing, that could create some more expenses as your earnings recover next year?

[Rich Harshman:]

No, not really. We have various incentive-based plans that are both equity driven, as well as cash driven; there’s short term, as well as long term. We look at the facts and the circumstances every quarter. It’s a balanced score card approach, it’s not just driven necessarily by one factor, so we look at all of those in term of where the accruals are at the end of every quarter. The second quarter benefited from some favorable adjustments downwards to those accruals, which were not there in the third quarter, and then the third quarter was also impacted as you looked at the facts and circumstances by the elements affecting long term incentive compensation awards, and the adjustment required for those accruals. So I think on balance, the annual programs are not the biggest driver. If there is some volatility, it’s more in the equity based programs, as well as the long term cash incentive programs that we were on.

[Mark Parr:]

And just if I could, one last question. Pat, I wonder if you could handicap for us the probability of rising base prices in grain oriented and electrical steel for 2010?

[Pat Hassey:]

Well, I don’t think that the market is going to do anything outside of what contracts are there, so I would guess that any spot businesses prices are going to be lower based on the competitive nature of the actual demand out there. We sell about 25% of our product outside of the United States, so you have to look a little differently than just the US market that is so depressed, but we are in pretty good shape with longer term arrangements that we made in the last three years, that we have renegotiated the time frames for delivery of some of those products as the markets changed. So I think in general if I was going to characterize the market, I’d handicap it as probably more competitive next year. When you look at individual players or suppliers within that market, it depends on where their contracts are.

[Operator:]

Your next question comes from Gautam Khanna - Cowen & Co.

[Gautam Khanna:]

Rich, you’ve been very kind in the last couple quarters to call out the price and cost inventory mismatch at high performance, $18 million in Q1, $5 million in Q2, and the profitability. To follow up to Luke’s question, it was pretty strong in Q3; was there a positive variance this quarter, and if so how large?

[Rich Harshman:]

I don’t think there was a negative variance. I think to the extent that there was a positive variance; it’s in the noise factor in term offer what the quarter was.

[Gautam Khanna:]

Okay, so under $5 million?

[Rich Harshman:]

Yes, I think that’s fair; certainly under $5 million. If it would have been a major driver, we would’ve said something in the earnings release. It’s certainly pale in comparison to the negative impact on a quarter-on-quarter basis to the LIFO benefit, which was only $5 million in the third quarter, and had been running $26.5 million in each of the first and second quarters. So it was pretty much a non-event in the third quarter.

[Gautam Khanna:]

Well, since we last had an update from you guys last quarter, Boeing has put out a new schedule for the 787, which delayed the full rate by about a year, and how should we think about titanium mill volume out of the high-performance segment in ‘10, assuming the schedule holds?

[Pat Hassey:]

We’ve had a minimum take-or-pay level with Boeing, so we have minimums targets, maximums as we’ve said. I really don’t see the trend changing at shipping at those minimum levels, until later in 2010, maybe 2011. Those programs are going to ramp up, and the best way to look at that is when we’re kind of early, we need to get the plane up and flying and it needs to be certified, but as you look up the ramp-up schedules for that aircraft, you can back up those deliveries by about 12 months as to when you’ll see the material supply ramp up ahead of that.

[Gautam Khanna:]

To that point, you also made the point that the engine destocking’s been pretty aggressive recently. So when we think of aggregate titanium mill volume and each of them next year, if the Boeing business is relatively flat, should the aggregate shipments out of that area increase just from the destocking abating on the jet engine side? In other words, should we look for an increase, and if so, can you characterize on the size of that increase?

[Pat Hassey:]

We’re not going to characterize the size, but I would say that generally speaking your thinking is right. I think that the airframe side of it will be pretty much to what the contract volumes were. I think on the jet engine side there’s been significant destocking in the second half of the year. I think there was speculation around whether the build rate schedules would hold for 2010, and I think that the procurement people on those sides of the business now have to assess where they are in that supply chain, as compared to not only what 2010 will look like, but also as moving into 2011. So you have some speculation as the 787, the A350-type programs, the A380 programs, on the military side the Joint Strike Fighter, and the tanker program, all that comes into play, because most of the materials that we sell are fungible to these people and they can move them around to different program levels. So I think generally speaking, 2010 rates going to be firm and then the question is what units are going to be built in 2011, and then as you get into 2012 and the newer planes ramp up it’s good news for the titanium side, because the newer planes use more titanium than the older planes. So I think generally speaking, I think it’s a better year than this year; probably geared more toward the second half than the first half.

[Gautam Khanna:]

In terms of an ASP it was down sequentially, perhaps because of the weaker mix with engines being off most, is this the bottom in terms of ASP in your estimation, assuming a normalized mix going forward?

[Rich Harshman:]

I think we’d answered that, yes. Obviously a part of the transaction price that you’re seeing has two pieces, right; it has a base price and then it has a raw material index price. so when you look at where scrap prices are, scrap prices have actually come up a little bit in the last 60 days for titanium, primarily in our view, driven by the fact that the carbon steel industry has increased their utilization of ferro titanium, and that pretty much forms the bottom in our view, for scrap prices. I think the ASPs and the disclosures that we make as you know are at a high level and are mix sensitive, and as we have said many times, leaving the Boeing contract aside, which has minimum take-or-pay volume regardless of what that product mix is, the rest of the market is influenced by where you are in the cycle, and I think it’s fair to characterize the titanium market this year, with the aero-engine correction going on. It’s that ingot becomes a much bigger piece of the shipment equation for milled product producers, than value-added products like billet and bar. One could see a flat volume, or actually slightly lower, that’s actually better for a mill product producer, because you’re selling product that’s a more value-added product, like a billet or bar or a shape or a rectangle or a wire, and we would obviously much rather do that than just sell ingot. So you can’t focus as we have said for many times, just on volume. It’s really all about the mix, we like a richer mix; and how that all plays out in 2010, that remains to be seen, but I think our view is that the titanium market will gradually improve throughout 2010.

[Operator:]

Your next question comes from Peter Jacobs - Ragen MacKenzie.

[Peter Jacobs:]

I apologize if you have already talked about this, but what do you have on kind of in the budget for CapEx spending for 2009, and then for 2010? Secondly, could you talk a little bit about the engineered products business? That’s currently running at a loss, and what would it take at these demand levels now to have that be a break-even or modestly profitable, or is that just out of the question that it is going to take a lift in the top line to get that back to be a profit contributor?

[Pat Hassey:]

Yes, a couple of answers. Again on the capital side, we think that we’ll be more in the $300 million plus range, than we are in the $400 million plus range in the next two years. The major capital spend is on the primary side of the business for titanium and the high performance forging assets will be completed. We have another molding asset that will be completed early in the year, so the big project is the hot-rolling facility, which is the project that’ll be spread over 39, 42 months, something like that. So we’re looking at $300 million to $400 million, $300 plus million.

[Peter Jacobs:]

Would that be for then ‘10 and ‘11 do you think?

[Pat Hassey:]

Yes, and on the engineered product side, this is a business that has just been influenced. It’s very much related to the general economy, and when you take 50% of the business away from it, it’s very difficult. You look at people that are in that business, none of them are profitable today. If you’re looking at our engineered products and you’re looking at castings, forgings, and tooling, and tungsten-type tooling, I think if you look at the Kennametal’s of the world, Sanpex of the world, you’ve seen the story. So the real question is, how do you position yourself to move forward with a base load of business that allows you to make some money, and we’ve been making some very good progress, some very good strategic arrangements with key volume customers that we think will help us to build a base load of business, that we can have a platform to grow from. So we’re doing that today and we expect better performance out of that business unit, actually beginning next quarter.

[Operator:]

Your final question comes from Brian Yu - Citi.

[Brian Yu:]

Earlier you mentioned your order entry rates had picked up, did you mention if this is high performance or flat-rolled related?

[Pat Hassey:]

It’s more flat-rolled related today on the early cycle, and also in some engineered products. On the oil and gas side we’ve seen some things, but I think on the high performance we’ve seen spot business that we didn’t expect; spot business that’s coming in, where people have had some holes in their schedules from running out of material or needing something earlier and we’re able to offer the lead times and the product mix to fill those in. So we’re not really expecting high-performance metals to pick up in the fourth quarter. We’re really looking for next year, and that transition year for that business segment.

[Brian Yu:]

Then my second question, it’s a bit more conceptual related to high performance metals, and we’ve seen the high and low watermarks in terms of margins from the last cycle. As you kind of look out, without making assumptions about pricing problems, if you can just get utilization rates back to 80% to 90%, what do you think is a realistic margin expectation for that segment?

[Pat Hassey:]

We had utilization rates of 80% to 90%. We could have margins easily above 25%. Our target for that whole segment including exotic alloys, we think in a normally and reasonable year should be 30%. I would say over 25% overall, and I’m talking about the titaniums, the zirconiums, the high end nickels, everything put together. That is a reasonable margin for that business running at 75% to 80% volume level.

[Dan Greenfield:]

Thank you for joining us today. That concludes our call and the conference call is available on our website. Thank you very much.

[Pat Hassey:]

Thank you, guys.

[Operator:]

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.