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Executives

David Sean Van Bibber - Chief Accounting Officer,Controller

Mark M. Comerford - Chief Executive Officer, President and Director

Daniel W. Maudlin - Chief Financial Officer, Vice President of Finance and Treasurer

Analysts

Daniel M. Whalen - Topeka Capital Markets Inc., Research Division

Timothy P. Hayes - Davenport & Company, LLC, Research Division

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Alan Brochstein

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

Haynes International (HAYN) Q1 2013 Earnings Call February 1, 2013 9:00 AM ET

Operator

Greetings, and welcome to the Haynes International Incorporated First Quarter Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Van Bibber, Controlling (sic) [Controller] and Chief Accounting Officer. Thank you, sir. You may begin.

David Sean Van Bibber

Thank you very much for joining us today. With me today are Mark Comerford, President and CEO of Haynes International; and Dan Maudlin, Vice President and Chief Financial Officer.

Before we get started, 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 of 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 such 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 the fiscal year ended September 30, 2012. The company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Thank you very much for listening. And now, let me turn the call over to Mark.

Mark M. Comerford

Thank you, Dave. Good morning, everyone, and thanks for joining us today. By the way, did want to introduce Dave Van Bibber to you. Dave joined us in December of last year. He's filling the position that Dan Maudlin vacated when Dan moved up to the Chief Financial Officer. So you'll hear more from Dave in the future. And I know many of you have calls scheduled later today and you'll have a chance to talk to Dave a little bit.

Hopefully, you've all seen the press release and have a chance to review it. We'll follow our standard agenda in today's call. I'll open with comments about the business and our end markets. And then Dan Maudlin will give you greater detail on the financial results.

Our first quarter results were negatively impacted by lower demand as customers continue to reduce inventory in their supply chains in response to global economic concerns. Net revenues came in at $114.3 million in the quarter, down 11.3% from last year's $128.9 million. Net income in the quarter was $5.8 million, down 30.9% from fiscal '12's $8.4 million.

As we look beyond these short-term headwinds, we remain very optimistic about Haynes long-term growth opportunities and the growth expectations of our core markets. Recent reports from the aero engine manufacturers showed excellent activity. We saw an increase in our backlog during the quarter for our chemical process market area, including winning a significant large project that we've been working on for well over 1 year. And whereas land-based gas turbine market is still slow and very transactional in nature, we believe that as economic activity rebounds globally and power demands increase, we'll see a rebound in the gas turbine market.

Internally, we continue to focus on the cost structure of the company. And as you know, it's an ongoing process at Haynes. Over the past few years, we've consolidated operations in China, closing our Shanghai sales office downtown and relocating those operations to our Waigaiqiao distribution facility outside Shanghai. We also closed the back end of our distribution operations in France outside Paris, relocating the equipment and materials to our locations in Switzerland and England, while maintaining our sales, service and technical presence in France.

We've adopted Six Sigma and Lean methodologies to improve productivity and capacities and reduce operating cost throughout our manufacturing operations, while always staying focused on maintaining and improving our service capabilities to our customers. We'll continue to drive waste out of our processes and operations, while also continuing to invest in the future of our business. We have a number of key capital projects that we're working on to further improve the company.

On our flat roll capacity expansion, we received the necessary permits to start construction and install the furnaces. Our upcoming quarter will be very busy as we build-out those areas and start the furnace installations. Running parallel to that process, we're also finalizing the plans on some of the support and finishing equipment, as well as the floor plan installations.

On our tubular product expansion, all the permits are in place and completed. 2 structural editions are part of this expansion. One of them being the finishing area, engineering work is completed on that structure and the materials have been ordered. The second structure will be in the heat treatment or annealing area of the operations down in Arcadia. That's in the final engineering approval stage.

With respect to the equipment, we've completed all the engineering work for the new equipment. We've sent them up for bid. We've actually rebid some of the equipment. All of that equipment has now been specified and ordered.

And by the way, on both of these projects, we've done some floor plan work with some -- a consulting firm we use on the outside for Lean. I'm very excited that they're going to improve the process flow in both of these areas. And as many of you know, we have -- the facilities we have are pretty old. And so the new floor plans are -- we're excited about the flow will give us personally and I know everybody in the plant also very excited because we're looking at them from the point of view of safety as well. And think they're just going to give us a better operating environment all the way around.

With respect to distribution, we're constantly looking at our capabilities and the needs of our customers around the world. We've added some cutting capabilities. And as we've mentioned with China and France, we've also moved some capabilities from one location to another and we're to optimize production efficiencies and service capabilities. Specifically, what I'm talking about there is in some instances, we've found that we were going to have to buy some equipment in one of our facilities and another piece of equipment in another facility was underutilized. So rather than go out and buy the equipment, we've relocated some and now we have some operations that we're running maybe 5 shifts or 3 shifts a week. We've moved into another facility and we're operating those facilities now around-the-clock. And what we're doing is using dedicated logistics to get the product to customers more quickly. But it's a better operating atmosphere for us that we're running these facilities around the clock in some areas.

As part of this project and distribution, we're also taking a closer look at the migration of our business toward more value added cut parts and what that means for our internal needs. We'll be continuing to refine our distribution system and we're currently looking at the service needs of our customers in North America and the current capabilities of our North American service centers.

On our IT project, we went live with our European operations on January 1. We had the usual headaches as with the startup of any system, but we're getting material received, assigned orders, shipped and invoiced. So we're getting the system to work the way we want it to. The workload's very high. There's lots of sleepless nights on both sides of the Atlantic, a lot of people putting in a lot of time of getting these systems up and operating. But the good news is we're very upbeat.

I think, as many of you know, before we made investments in this IT system, we had a 6-week session, where we had our people going through the mock work with these systems, and our people were very excited that -- in fact, our people were, I guess, were very excited that we're going to make this investment. And now that we've put it in, they're doing just a great job, getting it to work the way we want it to.

At this time, on all of these projects, we feel very good about the way we're executing on them. Also, and perhaps more importantly, I think our customers are excited to see that Haynes is investing in the future for our business. And I know our employees are thrilled to see the investments we're making. These projects are going to help us to grow the business. They're going to help us improve our quality of our products and our service, and they're going to help us lower cost.

Taking over to the commercial side of the business, at this point, short-term visibility is very poor. I think in specialty alloys, this view has been a pretty common theme over the last 3 months and even looking forward into the next 3 to 6 months.

As we look at each market, our net revenue in the aerospace market for the first quarter of fiscal 2013 was $52.3 million, roughly flat with the first quarter of 2012's net revenue of $52.7 million. Aerospace accounted for 45.7% of our total revenue in the quarter. Order entry in Aerospace fell during the quarter, resulting in a backlog reduction of about 13%.

However, with the reported deliveries of Boeing and Airbus and at the engine manufacturers, GE, Brett [ph], Rolls-Royce, et cetera, still strong. We expect this market to rebound as the year progresses.

Also on our HAYNES 282 alloy, I put a target in front of our market group last year entering the year to double the sales of 282. They beat that target by 50%. A number of defense applications came in good for us. Perhaps, more importantly, some of the newer engine platforms, a lot of prototype work going on. Nothing on the production side yet. I don't think we'll see that until these engines get further into production, things like the -- for the A320 and things like that, we're expecting in-service dates probably in the 2014 and, for the A320, like 2015. So we won't see production material really starting to ramp up, I don't think, until we get further into 2013 and into 2014. But a real good year for 282 for development projects.

Also on 282, by the way, if you don't mind me making an aside, the -- I mentioned probably about 1 year ago that there was a very good paper done by the Energy Power Research Institute on 282 for steam turbines. There was a follow-up article on this month's edition of Advanced Materials & Processes, which is kind of a Sports Illustrated for metallurgists, called new materials enable unprecedented improvement in turbine performance. And some real good information there about 282.

And the reason I bring that up is one of the melting procedures on 282 for those materials in that qualification was triple melt, then ESR VAR. And as many of you know, we do not have VAR capabilities. What we've done is we've entered into licensing arrangement with one of the turbine manufacturers. And they're having that material then processed at another company. But again, Haynes not being in a rotating components business, this is still good news for Haynes that one of our alloys is getting some good press and showing some pretty good performance in another area.

With respect to our chemical processing market. Net revenue for the first quarter was $26.3 million, down 11.5% from the $29.7 million we did in the first quarter of '12. CPI accounted for 23% of our total revenue for the quarter.

As we've discussed, this market has experienced softness over the past few quarters, as large project-related business went on hold. Quotation activity is strong in this area. We did manage to pick up a large order for a heat exchanger application that we've been working on for well over 1 year. This market is expected to remain very project timing-dependent as we progress through 2013. So being in front of design engineers and the fabricators are going to be very critical.

By the way, our backlog in this area increased over 31% during the quarter, as our local inventories took advantage of transactional nature of the business. And as mentioned, we finally, saw some letting of some project business.

We expect this market to remain very competitive throughout 2013. In the last -- in land-based gas turbine business, our market totaled $22.6 million in net revenue in the first quarter, down almost 25% from the first quarter of last year. As we've mentioned in our last call, we shipped a record level of product in fiscal '12, and we believe we're seeing customers now work through that material.

Backlog also fell about 6% during the quarter. This market was 19.8% of our total revenues in the quarter. We do expect this market to strengthen in 2013. However, as we mentioned in our last call, coming off record volume performance in 2012 in what was clearly not a record year for the end producers in this industry, we're cautious about inventory levels in the short-term supply chain. We do expect this market to remain very competitive and service-dependent through 2013. Our distribution and manufacturing operations have done a great job responding to the demand changes in this market over the past 12-plus months.

Finally, in our other markets, we have net revenues of $10.6 million in the quarter, down 16.5% from the first quarter of fiscal '12. This market accounted for 9.3% of our net revenues during the quarter.

Industrial heat treating, flue gas desulfurization, activity remained very slow at this time. We've also seen a slowdown in some of the alternative energy applications we've developed, as funding has been delayed. Specifically on the solar side of our Energy business, one major project for which we've been qualified has been on hold as that funding has been delayed. I did see recently though that there are some approvals and we do expect to see some funding come through in 2013. I wouldn't expect orders for the material, though, to come through until probably fiscal 2014. But again, that was just this week that I saw some information on that.

Finally, our HASTELLOY C-22HS material for large oil and gas project is still in production testing. As we mentioned on our last call, we do not expect to ship any significant levels of material into this application in fiscal '13. But we're still pushing for favorable results in the production testing on this application, along with some prototype materials we're working and smaller application test in the other oil and gas applications.

With that, let me turn it over to Dan for more details on our financials.

Daniel W. Maudlin

Thank you, Mark. I will begin with a year-over-year comparisons of the first quarter fiscal '13 compared to the first quarter of fiscal '12. As we mentioned in our pre release announcement, net revenues were lower-than-expected, coming in at $114.3 million, which is an 11.3% decrease from the first quarter of last year. This represents a decrease of $14.6 million, of which $11.2 million can be attributed to volume, with pounds sold decreasing 8.7%. Therefore, volume accounted for a majority of the decrease.

The remaining 3.4% can be attributed to the price, which a 2.8% decrease in average selling price occurred in the quarter. Net revenues were down across each market compared to Q1 of last year. Generally, the lower net sales were a result of customers exercising increased caution in making purchases, which we attribute to ongoing uncertain conditions and customers' reduction of inventory levels throughout the supply chain.

The level of transactional business declined this quarter after remaining relatively consistent throughout 2012. Intermediate and large-sized, project-based orders continued at relatively low levels in the first quarter of fiscal '13, as experienced during fiscal '12.

Pricing competition increased in the first quarter, especially in the commodity type alloys, as mill direct lead times decreased in the industry. Cost of goods sold was $95.5 million, a 9.3% decrease from the same quarter 1 year ago. In dollars, it's a $9.8 million decrease. A majority of the decrease is attributed to volume.

One item hitting cost of goods sold was the upfront payment resulting from the ratification of the collective bargaining agreement in Arcadia, Louisiana operation, which impacted cost of goods sold by approximately $325,000, including payroll taxes.

Gross profit margins and gross profit margin percentages declined in the first quarter of fiscal '13 compared to the first quarter of '12, due to a combination of lower volumes and weaker pricing, primarily in the commodity alloys. Gross profit margin, as a percentage of net revenues, was 16.4% in the current quarter, compared to 18.2% a year ago. Our cost structure is highly fixed, which can cause margin percentages to compress when volumes decline and expand when volumes rise.

SG&A cost, including research and technical for the current quarter, were $10.7 million, which represent only a slight increase compared to the prior year first quarter. Inflationary items that increased SG&A were, for the most part, offset by variable cost items decreasing, such as sales commissions. SG&A, as a percentage of sales, increased from 8.2% to 9.4% compared to a year ago, due to the lower net revenues.

Looking forward, the full year fiscal '13 SG&A is forecasted at approximately $45.2 million for this year. Tax expense in the first quarter of fiscal '13 was $2.3 million or an effective tax rate of 28.1% versus $4.5 million or 34.8% in the first quarter of fiscal '12. The decrease in the effective tax rate was due to a change in the California tax law related to apportionment that took effect in November with the election, which raised our state tax rate.

This higher tax rate caused a onetime increase to the deferred tax asset and lowered tax expense for the first quarter fiscal '13 by $525,000, a favorable adjustment. The effective tax rate for the full year is anticipated to be 34% to 34.5%. Our net income in the first quarter fiscal '13 was $5.8 million, or $0.47 per diluted share, compared to the net income of $8.4 million or $0.68 per diluted share in last year's first quarter.

Now shifting to a comparison of gross margin from the fourth quarter of '12 compared to the first quarter of '13 sequential quarters. Gross profit margin declined by $11.7 million to the 16.4%, compared to 20.2% in the fourth quarter of fiscal '12. A reduction in gross margin in these quarters was expected, as our first quarter typically has reduced absorption of fixed manufacturing cost that do not decrease in proportion to the decreased production levels.

Production levels decreased in the first quarter due to the company's observance of seasonal holidays and vacations, as well as planned equipment downtime for capital upgrades and maintenance projects, with the result of fewer production days. However, the reduction in gross profit and net income was more than we anticipated due to the reasons noted earlier.

Backlog was $211.7 million at December 31, 2012, a decrease of approximately $11.1 million or 5% from the backlog at September 30, 2012, of $222.9 million. Order entry volumes in pounds were low, but were comparable to the low sales volumes in the first quarter, causing a slight increase in the backlog pounds.

However, backlog dollars declined during the first quarter fiscal '13 due to a 5.5% decrease in the average selling price, resulted from reduced order entry pricing and a slightly lower valued mix of products in the backlog.

Just to comment on the January backlog. While today's the first day of February, the final numbers are still coming in. But it looks like the January backlog is similar to that of the end of December. And the order entry rate for January was similar to that of the past few months.

Moving on to the balance sheet and cash flow. The company's cash balance increased $18.7 million to $65.5 million, with cash flow from operations of $29.5 million in the first quarter. Cash collections from accounts receivable was strong at $28.3 million from the high levels of accounts receivable we had at the end of our fiscal year September 30, 2012, that was collected in the first quarter of this year.

However, inventory increased, causing a usage of cash of $12.1 million. The finished goods inventory increased due to lower-than-expected sales this quarter. And scrap inventory increased due to the unfavorable scrap utilization due to lower levels of production and melting that would normally utilize that scrap.

The company continues to focus on improving working capital management with the emphasis on inventory management through initiation of lean manufacturing techniques, plus capital improvements, especially our investments being made in the IT system.

Controllable working capital, which includes accounts receivable, inventory accounts payable and accrued expenses, was $287.7 million at December 31, 2012, a decrease of $23.5 million or 7.6% from the $311.2 million at September 30, 2012. Working capital, as a percentage of net revenue, unfavorably increased from the end of fiscal 2012, but is anticipated to improve over the year with higher sales.

Management continues to believe in the long-term growth potential of our markets. Therefore, we are continuing to implement the previously announced capital spending projects.

Capital spending in the first quarter of fiscal '13 was $9 million and the forecast for capital spending for fiscals '13 and '14 are approximately $70 million and $39 million, respectively. The 3-year capital investment program for fiscals '12, '13 and '14 approximates $135 million and is expected to allow the company to increase capacity in certain product forms, enhance product quality, reduce cost and improve profitability, and improve our working capital management. The proper execution of these capital projects is a major focus area for the management team.

Our liquidity remained strong with a 0 balance on our revolver. In addition to the $65 million cash on our balance sheet that's available, the company has a credit facility of $120 million, which can be increased to $170 million at the company's option. This, combined with cash on hand, provides total liquidity of over $235 million, which is expected to enable the company to fund the future capital program, as well as take advantage of a future economic recovery and any other growth opportunities that become available.

The outlook for the second quarter of fiscal '13. Net income for the second quarter fiscal '13 is expected to exceed the net income of the first quarter of fiscal '13, but is expected to continue to be unfavorably impacted by the lower volumes and the weaker pricing, similar to that experienced during the first quarter. Due to the continued uncertainty of the economic environment, the lack of visibility and the continued lower level of order entry, management does not anticipate a recovery in the second quarter.

However, certain macroeconomic trends may suggest a potential improvement in the second half of 2013. Management expects net income for fiscal '13 to be below net income of fiscal '12 due to the slow start in the first quarter and the uncertainty of when a recovery may begin to materialize.

And in summary, we believe this period of uncertainty and low order entry in sales activity is temporary. Management continues to believe in the long-term growth potential of our markets, the quality of our products and the innovation that the Haynes technical team providing superior customer service to our customers. The financial strength of Haynes International is intact, and we are well-positioned to capitalize on future opportunities.

With that, let me now turn his discussion back over to Mark.

Mark M. Comerford

Thanks, Dan. As Dan had mentioned, too, market conditions are very competitive right now. Some of the things Dan highlighted on pricing underscore the -- we're still in a period of inventory corrections and market uncertainty. At this point, I think it's fair to say we do not currently expect to see activity increase appreciably until the second half of fiscal 2013, or even the second half of calendar '13 seems to be the theme we're hearing, not just within our industry, but we're hearing quite a bit of that from some of the chemical producers as well. So just in general in the industry.

In discussions I've had with customers, the general tone is that they're working through inventory and they expect to pick up in the late spring or early summer. As we've said, before, longer term, we're confident that our end markets will return to a strong growth trajectory. We've deployed the capital necessary to meet these needs in a very targeted and disciplined manner. We continue to invest in alloy development, technical service and developing Lean and Six Sigma methodologies in our operations to drive out waste. On the service side, we're staying very close to customers. We're solving the technical and logistical issues that allow us to add value in their supply chains. Our challenge is to make sure that we're prepared when the destocking ends and the upturn arrives and gains momentum.

With that, I'll let the operator open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Daniel Whalen of Topeka Capital Markets.

Daniel M. Whalen - Topeka Capital Markets Inc., Research Division

So I'm just -- I understand and I can appreciate the guidance and kind of the way it's been framed up. I'm just trying to match it up a little here in terms of certainly a sequential increase, but not really a recovery in the second quarter. So that's kind of -- what I'm translating that it sounds like you may get first quarter seasonally softer. So you maybe get a little bit of a seasonal uptick. But it sounds pretty, like a modest sequential improvement. Is that kind of fair to say?

Daniel W. Maudlin

Yes, I think it is fair to say, Dan. It's -- our first quarter is typically with a lower production days, a softer quarter for us. So seasonally, the second quarter is better. But clearly, we're going to be, continue to be impacted by the unfavorable trends that we've been talking about.

Daniel M. Whalen - Topeka Capital Markets Inc., Research Division

All right. So -- I mean certainly better than this year's first quarter, but probably below last year's first quarters is, I mean, last year's quarter, it was $0.68, $0.69. I would imagine probably somewhere in that range we're going to try and book end it a little bit.

Mark M. Comerford

Well, that's what's a little bit hard to tell. I mean, as we mentioned, limited visibility and the uncertainty that's still out there. It makes forecasting, especially that transactional business, very difficult. So I think that's -- it's tough to say.

Daniel M. Whalen - Topeka Capital Markets Inc., Research Division

Okay. Great. And then the chemical project that you were awarded. That's great. Was that in the first quarter or is that something that's going to flow through onto the second quarter?

Mark M. Comerford

That should ship in the second quarter, just to give you -- to me also, Tim (sic) [Daniel], if you think what was very encouraging was the chemical process industry, we saw the backlog increase over 30% in the quarter. Just to give you an idea. This large chemical project that I talked about, I'll characterize it as a heat exchanger just to make it easy. My marketing guys will probably want to kill me for saying that. But that project was 20% of that increase in the backlog. So it wasn't -- it's not the entire increase in the backlog. It was only 20% of the increase in the backlog. So we saw a number of small -- and by the way, too, what's a large project to us, some of the other people in the industry would -- it'd be a rounding error for them. So it's a large project that we've been working on and it's a great project for us. I tend to think some of the larger companies might not even notice it or call it a large project. But more importantly, to someone like me, we saw the backlog and CPI increase 30%. And this single project was only, I'll say, 6 points of that 30% or 20% of that 30% increase.

Daniel M. Whalen - Topeka Capital Markets Inc., Research Division

Okay, great. And then one last one, if I may. Just in terms of your success here in the 282 alloy. Is that all incremental or is there some cannibalization there in terms of the existing business?

Mark M. Comerford

Yes, if you think about it, more often than not, what it's -- it's displacing some of the higher-temperature materials and some applications. Maybe the performance is a bit better than the 718. And again, it depends on the operating temperature you're working at, what kind of strength level you're looking for. So it might be displacing some 718. Some of that 718 might be ours, some of it's other people's. And it might be at a lower range maybe or, I'll say, more from a fabric ability or weld ability and might be some displacing lost boy [ph] and some Internet [ph] applications. But again, it's cannibalizing some of our existing sales. But it's also, there are some areas where we're sharing that business with other people and now, because we have a patented alloy, won't we shared.

Daniel M. Whalen - Topeka Capital Markets Inc., Research Division

Got you. And I would imagine certainly a higher margin business versus the 718.

Mark M. Comerford

It's a nice product.

Operator

Our next question comes from Tim Hayes of Davenport & Company.

Timothy P. Hayes - Davenport & Company, LLC, Research Division

A couple of questions on the -- your sales in the power generator, your land-based gas turbine market. How much of that is international for you all?

Mark M. Comerford

Yes, let me think of the top of my head on something like, Tim. I don't have right immediately, but a pretty fair amount. If you think of our European operations with sales into Siemens and Alstom, it's quite a bit. And it's interesting even here in the States right now, there's some transplant business that we're doing year where maybe the materials being purchased and some of the parts prefabricated. But then it's been shipped over to Europe or to Asia. So it's getting a little more difficult to characterize. But I'd say it's probably pretty close to what we say our normal distribution, which is 40% is international. Maybe a little bit less than 4%, but something along those lines. Dan, do you...

Daniel W. Maudlin

No, 60% U.S., 40% export. And I would agree, land-based gas turbines probably follows that same pattern.

Timothy P. Hayes - Davenport & Company, LLC, Research Division

Is there any difference in trends for that specific end market? Is the international stronger than the U.S. market or vice versa?

Mark M. Comerford

The trends, what I really saw. And again, if you think about it -- and I have difficulty. Yes, we do state what our international business versus domestic business, but I always try to get people to talk more -- when you talk about Haynes, you talk more about end markets and where things go. Because these largely are fabricators, et cetera. It's just -- it moves around all throughout the world. The real drivers are the end markets that drive these things. With respect to this market, is one better than the other? I mean, for instance, we all know the situation from Japan with Fukushima. And the number of turbines that are anticipated, expected. But then there's a number of infrastructure projects that have to occur to allow those turbines to go into service. So the tendency might be to think that there's real strong demand there. But the other thing I'd really say too is within what we call the land-based gas turbine market, there's a number of submarkets within that. Be it the mechanical drivers, the pumping systems, the items that go on, the smaller turbines that go on offshore rigs, things like that. That's where we see the real difference is in end markets versus utility, energy or things like that. That's where we see more of the changes within that market seem to occur within the submarkets. Did I help you at all?

Timothy P. Hayes - Davenport & Company, LLC, Research Division

It did. And the -- one next question. On the -- you mentioned some regulatory concerns that was affecting the sales to the gas desulfurization, gas flue desulfurization area. Is that strictly on the coal side or is it more -- or is that a different regulatory impact?

Mark M. Comerford

That's really -- when we're talking about it, I mean, that's the one that's the biggest impact. Now the FGD business is about 5% of our business. But we're definitely seeing some of the coal-fired power plants. I don't want to say decommissioning. But there's a lack of visibility on that side of the business. We anticipated a very good shutdown season in autumn of last year, and we mentioned this in our last call. We didn't get it. The power outages, the maintenance season that usually occurs in the autumn of last year just really didn't happen. So is that going to be pushed out into spring? We don't know. And as we talk to people, they're not sure what's going to happen, what kind of money will be left for these projects as we go into spring. The big shutdowns from the big utilities, usually the coal fire. What's kind of neat as we talk to more of these guys is, they're branching more out. They're starting to say, well, instead of just going to utilities and looking at the coal-fired plants, they're starting to go more to -- is the rebuild work that can occur in chemical plants. And those types of things. So it's kind of the evolution of the business. I think, we'll see in the next couple of years.

Timothy P. Hayes - Davenport & Company, LLC, Research Division

And one last one. Just a clarification. You gave backlog, changes in backlogs by end market for it -- for example, the aerospace backlogs declined 13%. Was that sequential or from 1 year ago?

Daniel W. Maudlin

Sequential.

Mark M. Comerford

That's sequential compared to our value.

Operator

Our next question comes from Phil Gibbs of KeyBanc Capital Markets.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Can you talk a little bit about the growth in value added services and cut parts and how you're differentiating your business? I find this progression really interesting.

Mark M. Comerford

Yes, it's something that Haynes engaged in, I'll say, 8 years ago. And that side of the business has more than doubled. And if you think of what's going on in the industry, there is a lot of vertical integration in the industry. And we're not huge players like a lot of the other guys out with forgers, as well as melters and things. But our value stream, so to speak, has been more towards adding value at that part side. And the cutting of parts, keeping the scrap for ourself rather than forcing your customer to have to deal with the scrap deal and the parts manufacturer and things like that. So it's become a much more important part of the business for us. And it's funny, when I talk to people and they say, "Oh, Haynes has a distribution business." And I always lead them, "Well, it's more of a service center business." And I always tell people, it's actually -- it's evolving almost into a little bit of a light manufacturing business with the lasers, the water jets and some of the other cutting capabilities we have. But it's definitely -- it's an area that we focused on and we keep pushing the business down more into that area. And I shouldn't say we're really pushing. We're getting a lot of pull from customers into that area as well. Just over in the U.K., a couple of months back, and one of our large customers over there is asking our service center to cut parts out of other people's material, which I was very pleased. It was very complementary. It's not an alloy we produce, by the way. But they've asked us to start cutting these parts out of other people's materials. So it's an area where we would -- either they would buy the material or would buy the material from somebody else, bring it in and cut the parts for them.

Daniel W. Maudlin

And I would add to that. The investment that we have in this side of the business. Mark just mentioned being in the U.K., we are investing in that service center and expanding the footprint of that. [indiscernible] is going through the number of cut parts that they are cutting is growing. So that's an area of our business that is clearly growing. And it has an interesting impact on if you're looking just the sales pounds, when we're selling cut parts, as Mark mentioned, we manage the scrap ourselves. So our pounds sold actually decreases somewhat. So you kind of have to take that into account when you're looking at our volumes. The more we get into cut parts, that trims back a little bit of the actual pounds that are sold into the markets. It's a good business for us.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Okay. And then just -- if you could refresh our memory here on your gross profit margin targets. Assuming that these 2 growth projects ramp-up and you have end demand that caught more normalized levels, can you give us a sense of where we should see gross margins in the next, call it, 2 to 4 years?

Mark M. Comerford

Yes, the big CapEx projects that we talk about, the $60 million in the Arcadia tubular product area. And in the flat product area, we disclosed that, that would add about 2 to 4 points to our margin. And I think you're making a good point that with normalized volumes, I think in a period of time where our volumes are decreasing, that may dilute that somewhat. But we expect that to be temporary once volumes get back up to normal on that long-term timeframe that you just mentioned, 2 to 4 points on the margin is, I think, very doable with many different improvement that I think were going to get from these projects, not just on the margin, but on inventory management and other efficiencies as well. So we're pretty excited about it.

Mark M. Comerford

Yes, and if I can add to that, too. Just to add a little more color. The tubular product area, if you think about it, the expansion is largely going to the titanium or hydraulic, aerospace hydraulics value stream that we have down there. And as I've mentioned before, and just sort of everybody's well aware, that's still at capacity. So that's -- it's very necessary that we get that capacity brought in and put online. The tubular product side that is the HASTELLOY or the nickel-based materials, more so than anything, some capacity has opened up in that. So we're getting more competitive and lead times have dropped in that area, whereas the titanium tubing, where the investment is going in, is still very, very busy. Same thing on the flat roll side of the business. Right now, some capacity exists in that area, as we've seen the order-entry levels drop off. But staying cognizant that in 2008 and in 2012, 2011, 2012, that area was pretty much sold out. So we're very pleased with the investment side. And this is what I mean when I talk about the targeted investments that we're making. We're very pleased that we're bringing these capacities on and we think we're going to need these capacities, especially if things like aero engine requirements increase.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Mark, where is that HASTELLOY tubing going as far as end market?

Mark M. Comerford

Typically heat exchanger applications, big chemical plants. There's a number of applications. But if you ask me what the big one is, I'd say that's it.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

And then just lastly, just for clarification. You talked about 200 and 400 basis points on the gross margin. Is that relative to your fiscal '12 base?

Daniel W. Maudlin

Yes, I think it would be. Yes, that's when we disclose that. So that's the base that we were going from.

Operator

Our next question comes from Alan Brochstein of AB Analytical Services.

Alan Brochstein

I just had 2 quick ones. First of all, does the slowness help on these capacity projects? I know you have some scheduled downtime but the fact that things are a little bit soft. Is that -- is there a silver lining there at all?

Mark M. Comerford

As much at it can be considered a silver lining. I mean, we would much prefer to have the busier business levels. But it does -- it helps you catch up on some things. And it also -- there is quite a bit of work going on right now throughout various locations within the company. Now when we plan these things out. That's one of the things we want to do, is make sure that nobody was overtaxed. That's why we've got some of these projects spread out the way they are. One down in Louisiana. One up here in Kokomo. One on the IT side and then one occurring at the various distribution outlets throughout the world. We didn't just come in and decide to overload Kokomo with a myriad of new things. So it does help a little bit with the workload. To be honest with you too, some of the slower times help with the availability of contractors and getting them in to do some of the work as well.

Alan Brochstein

Got it. Okay. And then one other question. I know this probably isn't a risk right now, based on the news. But, obviously, the Boeing 787 problem is a little bit of a question mark. And if they were to slow down their production, can you just talk a little bit about your exposure to that program?

Mark M. Comerford

To us, Alan, we're not really big structural guys. I mean, we do the hydraulic tubing. But just so you're aware, I mean, there's -- there's the 737, 777. And as I've mentioned, our titanium tubing level is pretty much at capacity. So we're not -- we don't see much of a change. And with respect to the rest of the 787, and really our core business being jet engine, it's 2 engines. It's -- they're great engines. The Trent 1,000 -- and we do have material. But for the most part, we won't be impacted the way the guys are who were in the fastener business or the airframe business or anything like that.

Alan Brochstein

So you call it modest, it sounds like?

Mark M. Comerford

Yes, I'd say we're probably impacted less than just about anything else in the specialty metals area, by any changes in the [indiscernible]. And that's same thing on the upside. When that thing gets ramping up to us, it's pretty much 2 engines per plane. Whereas the other guys, the titanium guys, et cetera, that's going to be a real windfall for some of those people once that thing gets going the way it should be going.

Alan Brochstein

Okay. And then my last question is most of the recent quarters you guys have had mixed shift really benefit you. If I'm understanding it correctly, that didn't go that way this quarter. Is that accurate?

Mark M. Comerford

Yes, that is somewhat accurate. I mean, with the slowdown typically, and weaker prices that we mentioned, it does impact of the commodity alloy somewhat. So that inherently means your mix is a little bit richer but we really didn't see a great impact from that on the margin at all. So yes, the favorable mix shift that we were seeing in some of the prior quarters of fiscal '12 really didn't see a change in the first quarter related to mix.

Mark M. Comerford

And I think, you know, Alan, too, volume is really a big thing in this business. When you see dropping volumes, absorptions drop and that's when you get some margin pressure.

Daniel W. Maudlin

Right.

Alan Brochstein

Okay. So the mix -- any sort of slowdown in that improving mix was really not the main issue. Volume was the predominant issue?

Mark M. Comerford

Yes.

Operator

Our next question comes from Mark Parr of KeyBanc.

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

Just a question on working capital. As you go into this flat rolled upgrade, how much impact on working process or inventory levels do you expect to see? And how long will it take to restore inventories back to normal? When do you see that happening?

Daniel W. Maudlin

Well, let me take the last one there first. When we expected to get back to normal. I think it's -- we're already adjusting to the sales volumes. We manage our melt based on the orders that we see coming in and we can adjust that melt quite quickly. And we've already adjusted our melt pounds down 25% or so even -- in response to the lower sales volumes. But a metals company like ours takes a bit to kind of turn the ship. When you slow down the melt, that means you're utilizing less scrap, you're utilizing less raw materials that you may have already committed to. So your raw on scrap sometimes will increase. And it takes a while to kind of flow all that metal through the system. So I do expect inventory levels to balance better with sales over the next quarter or 2. So I expect that working capital as a percentage of sales to improve. The way we calculate working capital as a percentage of sales is really based on the current quarter annualized. So taking this current quarter annualized is makes that working capital a percentage of sales quite high. So I expect that to improve. To your second question, related to these CapEx projects. I think the biggest impact will be on the flat rolled side and especially on the plate side of things, which is an area that we want to increase some capacity on. The actual number of pounds that we expect inventory to go down by, we're not sure it really depends on inventory levels or sales levels. With this increase in production, we're hoping to ramp up our sales as well. So in general, when we're ramping up sales, inventory is going to go up along with it. So we think it'll be more efficient in less inventory, but can't quite put a pound number to it because we're expecting sales to go up along with it.

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

Yes, it does. If I could just ask one follow-up. I know Phil had guided -- just to renew the profit enhancement opportunity associated with the capital projects. I was wondering if you could maybe provide a little more color in terms of, what -- particularly on the flat rolled upgrade, I mean, what's going to happen to drive improved profitability on its Steckel mill?

Daniel W. Maudlin

Well, one of the things is that some of the outside processes that we have were things like plate finishing, we'll be able to do a lot more efficiently and reduce our cost. So I think that's one area that's going to drive better efficiency. And just getting things more, you might say, integrated within the flat rolled side of things. So that's one of the main places where we feel that we're going to gain some efficiencies and improve that margin percentage.

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

You're talking about less outsourcing or is it...

Mark M. Comerford

Yes, I don't know if you're aware of it, Mark. But we do quite a bit of conversion work on a number of the products we manufacture. Plate being one of them. And some of the processes that we currently do outside, we're planning to do bring some of that in-house, which will help. Also just to give you an idea too. Frequently on the furnace side and preheat furnaces and things like that, sometimes the Steckel mill is waiting for a load to heat up. And I know that sounds pretty odd, but we got a Steckel mill that is -- it's got more capability and capacity than -- God bless Cabot when they put it in 1982. It's got more capability and capacity that we've needed here 30 years later. And I'm not kidding you, that sometimes the Steckel mill is waiting for pre material to come through. So this will help us on that side of the business as well, as far as having available furnaces to essentially increase the cycle time through the for-hire mills. So there's a number of good things going on in this area.

Operator

[Operator Instructions] It appears we have no further questions at this time. I would now like to pass the floor back to management for closing comments.

Mark M. Comerford

Thank you very much for your time today, everybody, and thank you very much for your interest and support of Haynes. We'll forward to updating you again next quarter. Thanks again. Bye-bye.

Operator

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

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