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Precision Castparts Corp. (NYSE:PCP)

F2Q10 Earnings Call

October 20, 2009; 10:00 am ET

Executives

Mark Donegan - Chairman & Chief Executive Officer

Shawn Hagel - Chief Financial Officer & Principal Accounting Officer

Analysts

Joe Nadol - JP Morgan

Peter Arment - Broadpoint

J.B. Groh - D.A. Davidson

Robert Spingarn - Credit Suisse

Cai von Rumohr - Cowen & Co.

David Strauss - UBS

Sam Rothstein - Wells Fargo Securities

Eric Hugel - Stephens

Noah Poponak - Goldman Sachs

Peter Grondin - OSS capital

Operator

Good morning and welcome to the Precision Castparts, webcast and conference call to discuss its second quarter earnings for fiscal 2010. As a reminder you may listen to this morning’s presentation and view the accompanying slides in real time by going to do Precision Castparts company website at www.precast.com and clicking on the link provided by the corporate presentation section of the PCC corporate center.

Additionally this event is being recorded and will be available on the PCCs company website shortly after the conclusion of the presentation and discussion. Following remarks by members of the PCCs Management, the dial in access lines will be open for questions. (Operator Instructions)

Now, I will turn the floor over to Mr. Mark Donegan, Chairman and Chief Executive Officer of Precision Castparts. Please go ahead.

Mark Donegan

Thank you, operator. I’m sure you’re all familiar with our forward-looking statements, and you need to take consideration when you’re analyzing the following presentation. If I sit back and look at where we were looking at the year and then kind of where we were at the end of Q1 certainly there’s no doubt that we saw Q2 as our most significant challenge, kind of both by the aerospace destocking and the normal Q2 events in our forging.

Having said that, I think we’ll go through a number of opportunities that we were able to accomplish in the following pages, but kind of looking at the company as a whole sales declined 28% year-on-year going from just under $1.8 billion last year to $1.3 billion this year and on that sale decrease operating income decreased by 17% going from $404 million last year to $337 million this year.

Again kind of some we continue to focus on even in the toughest quarter I think we’ll have we saw margins increase from 22.5% last year to 25.9% this year. We were able to stay in the range of Q1 given kind of the head on pressure of our Q2 forging outages and all this generating EPS going from $1.88 last year to $1.54 this year from continuing operations.

If we look at the key drivers for the company, on the sales kind of looking at an apples-to-apples comparison, of the $496 million reduction roughly $128 million or 26% was a result of currency, lower material, contractual material pass through and lower external material prices at three primary mills driven by lower elementals.

Certainly from there and by far the most significant contributor to our sales drop was continued accelerated destocking across all of our aerospace operations and again we kind of saw this even more significantly than we saw in Q2 in a kind of a delta to the bill rates. What I want to do is just give you a snapshot of what these are sort of put some substance to, if you look at construction castings we have a really very, very clean line of sight into how they match up so one structural casting goes into one engine, one engine goes on to a winning and so on and we have almost know after market.

You can see the impact for the delta between our queue demands and kind of the bill rates and narrow bodies our customers were asking for roughly 50% below the current bill rates and on wide bodes we kind looking at 25% delta from the bill rates. So, in kind of see the impact, this kind of carries still we’ll go through this in the balance of our presentation, but this carries through kind of all our particular segments, but again I think structural castings gives us the clean nest line of sight to kind of the impact of what we are seeing.

Moving beyond the aerospace and kind of going to general industrial, I think Q2 certainly appears to have been the bottom where we did see a roughly at 30% decline from last year, but again, seems like Q3 and Q4 kind of go up from here and we will certainly talk about those as we move through the various segments.

Moving from sales on operating income and again kind of putting us on an apples-to-apples comparison, for the company the negative effect of currency versus last quarter was roughly $6 million and from there again as you can imagine the most significant driver certainly was the decrease in the volume across our assets in the aerospace and then to that in Q2 we obviously had the additional loss absorption from our forging outage.

I will breakout as we go through this kind of segment the following pages as kind of what the magnitude were, so I’m going to try and provide at least kind of the elements and some of the clarity, but just as an overall that’s kind of what we’re looking at and then to that we also had besides the last level. We also had roughly $8 million of related expense to kind of yearly planned outages and the holidays.

Have been said, all this I think that I clearly understand as do all of our employees kind of what our job is given this environment. It’s to focus on those opportunities that we have to drive the cost structure and to stay focused on this in an unrelenting process and kind of fight our way through this destocking.

To after a large degree, I think we’ve been able to come up with a significant amount of improvements. We’re kind of looking at record productivities and most of our factories. We’ve seen a significant increase in our revert utilization. We have unprecedented fixed cost levels.

So I think that we’ve been able to focus the operation on those areas of opportunity rather than kind of sit back and be victims of what’s kind of going on with the destocking, but again it is a minute, hour, daily kind of a drumbeat and again I think we’ll go through, what those kind of results were.

Taking a quick look kind of at the sales breakout in Q2, aerospace remained constant at roughly 52%, power generation grew from 23% last year to 20% this year, kind of as we covered general industrial went from 25% of total last year to 20% this year. So kind of delving now into each one of the segments beginning with investment cash, investment cash saw sales decline of roughly 27% versus last year going from $156 million to $130 million this year.

We saw a 13% decrease in operating income going from $156 million last year to $136 million, but again we continue to see solid margin expansion going from 25.5% last year to 30.4% this year and we were able to in casting to go see a continued margin expansion sequentially over Q1 on lower sales. So again I think we try to continue to find ways to kind of extract value out of this business.

If I look at the key drivers on a sales basis and again comparing apples-to-apples lower material pass through had a negative impact of $22 million versus last year. From there, again by far in this segment they weren’t taken head on that aerospace destocking and besides the casting side of our business, if I flip over into Cannon, which again falls in this particular segment, we saw additional impact of destocking, where Cannon supplies quite a bit of material to the outside world, where they roughly saw 25% reduction in supply versus last year.

Moving beyond sales into operating income, certainly most significant headwind in this was the kind of effects of the volume, but over that we have currency impact of $2 million roughly a $3 million impact from the shutdown and holiday. I think that again finding those areas that we can attack the cost structure as a key and each one kind of has their own nuances to it.

If I look at investment cast certainly by far, labor is the most significant component of cost. I think at this point in time, we’ve really attacked that on a very aggressive trend. We’ve been able to see record productivity pretty much across the board and again you’d expect to see some of these. We end up with a very well seasoned cross trained workforce. Certainly our training is at zero pretty much right now. So again you end up with a workforce that should be able to drive productivities.

I think we’ve seen very solid improvements in material efficiencies. Our scrap and rework are near or at all time lows. So I think we were able to focus the operation in those areas of opportunity. What I wanted to do though was come up with kind of someway of put a value or a magnitude to kind of what we’re seeing. What I did is, I kind of took a run rate that we’ve been at and if you look at the last four, five years we’ve certainly been seeing on average incremental margins on increasing volume of roughly 30% to 35%.

We had some areas that, we had some quarters that were above average, some below that below but for a four to five year run that’s probably been a pretty good average. There is a number of you that a number of conversations have said, what we should expect to see the same type of decremental margins as the volume falls off. So what I try to do is to take kind of health care process and say, okay, on those type of deleveraging 30% and 35%, what would the impact be and I’ve kind of done this on all the operations.

If I look at the net 23% lower sales in castings that math would have worked out to be kind of an operating income decrease of roughly $43 million to $50 million. With everything that we did and all the areas really went attacked and all the improvements we got, we saw that $43 million to $50 million go to $18 million. So we’ve been able to kind of extract or create incremental value out of our cost structure to the tune of roughly 25 plus million dollars.

So again I think it’s that focus on where are our opportunities and what can we do that we want to make sure that we stayed focused on. We’ve mitigate way outside the box, so if I look at what traditionally done, we’ve gone well beyond that. We’ve look that the way we manufacture, we look at where we’re manufacturing, we’ve consolidated where possible operations. So again I think that we continued to challenge what the box looks like and how to get outside of that box.

Again, you’re going to hear this as a constant theme as we go through, I think that as a general rule we have established a new cost structure that we certainly intend to hold on to and move incremental volume across it as kind of the destocking recovers. If I move from investment casts on to forging, as with every Q2 forging certainly provides us with the most challenging environment of the year and this one certainly provided all the challenges we wanted.

On the sales front, we saw 34% reduction year-on-year with sales going from $781 million last year to $516 million this year. We saw an operating income declined by 22% going from $153 million last year to $120 million this year, but again as we saw our castings, we did see substantially year-on-year improvements in our margins going from $19.6 million last year to $23.2 million this year.

If I kind of look at the primary drivers now in the forge segment, on the sales again starting again with a constant basis between currency, lower contractual material pass through and lower external prices that’s roughly $95 million of the decrease. From there without a doubt as with castings the most significant contributor to the decrease was to disconnect between our aerospace demand and our current build rates; and that was roughly 20%, kind of across the components that go directly into the aerospace world.

On top of that, as with Cannon, we do have parts of our businesses in the forge itself to the outside world and again we saw the destocking kind of having impact in our external alloy sales and now with somewhere in the range of 35%. To the headwinds of kind of destocking, we also had the lost output from our forging out of outages. This is again something we do every single Q2, it’s there, and it was certainly in our Q2 of this year.

To this, we also saw kind of the general industrial fall off and again we talked about that on the front page and again I think at this point in time, we kind of saw the bottom and as I look forward, we’ll go through this as we looked at the balance of the year. We do see kind of a controlled recovery.

On the operating income line, obviously the most significant challenge in this is the absorption impact from the destocking and then to that we had the loss of absorption from the outages. We also saw $2 million in currency and roughly $3 million in expenses on top of the absorption due to the outages, but as with castings, our goal remained clear, to find those areas of opportunity that we could kind of drive and mitigate this effect.

By far the most significant challenge we face with falling volume is in the forging world and in that kind of looking at the opportunities the most significant component is materials. So for us the goal was clear, focus on every pound, on every any part, anywhere our operations and capitalize on what could we see and what could we gain from that.

I think we’ve been able to get greater revert amounts. We’re able to get greater access to them and in some cases we’re able get something and convert it to a revert stream that is more valuable to us than another one. I think we’ve been able to capture more significantly than ever that we closed off our revert streams and so we’ve really tightened that closed loop, dust, sludge, everything has value to us right now and again capturing that and processing that is key for us.

I think we’ve done a reasonable job of aligning our workforce to the required manning levels and even in forgings, productivity is key so attacking those productivities has been a key part of the puzzle. Doing the same math that I did for castings and again you could certainly make the case that in a fixed asset like our forging that 30% or 35% would certainly be a tougher task, but for the purpose of the math I use the same average of the company of 30% to 35% and kind of applied that the same way.

If I look at that 30% to 35% applied against a net sales decrease of 23%, we would have expected to see a decrease in operating income of roughly $50 million to $60 million. Again, instead of buy attacking areas above we saw roughly a $31 million drop and again we kind of lowered our cost structure by that $20 million to $30 million. So again the key was to identify, where we have opportunities and kind of drive those home.

As we look forward certainly in on the flip side in this segment holding on to that cost structure and driving that volume across it place a very key role for us and we completely understand it, we are firmly focused on it and we get it. So certainly we all understand the challenge that’s to us.

Finally moving on to fasteners, we saw a 17% reduction in sales going from $405 million last year to $338 million this year. On that sales drop we saw an operating income decrease of 7% going from $118 million last year to just under $110 million this year, but again as with all the others, we saw margin expansion from 29.2% last year to 32.5% this year and sequentially albeit small we did see our margins expand up from Q1 again on less sales.

Looking at the key drivers on sales again an apples-to-apples comparison currency negative impact of roughly $10 million versus last year and then from there aerospace destocking certainly was the primary driver, where we saw a 10% year-on-year decrease. I think that the destocking kind of on its own certainly wanted to be more severe.

I think that we continue to find areas of opportunity in this particular fasteners segment is to kind of offset some of that destocking and again this segment tends to have more exposure to the biz jet and regional jet and where we basically saw little to no demand in that particular market.

To the aerospace, we saw a 20% decrease versus last year in our general industrial, primary driver’s were pulp and paper, kind of a housing world with E/One and the automotive comparisons to Q2 as you can well imagine were abysmal. So, those all totaled 20%, on the operating income side besides the impact of the volume reduction currency and shutdowns impacted the segment by roughly $4 million, but as with the other two segments our task was abundantly clear to exploit any areas we had to attack that cost structure.

This is kind of a blend. So, I think we had a number of opportunities certainly productivity to the key piece of the puzzle. We’ve been outsourcing quite a bit we could pull a lot of that outsourcing in. We have the ability to right size our Southern California operation. So, again defining what the box looks like, breaking the walls down and moving to some unprecedented way of looking at our manufacturing operations has been and will continue to be kind of thus the way we look at these businesses during these times.

It begin if I kind of finalizes and look at the value using the same particular math of that 30 to 35 and applying that against the 14% drop in net sales we would have expect to do is he a $17 to $20 million dropping operating profit instead we saw roughly a seven. So we are able to see kind of a pretty significant impact in this particular segment of attacking that cost structure.

In that segment as I look forward, they again are seeing some additional opportunities I think we’ve been able to capture some of the 787 both in terms of short term need and long term need so even in this environment we are seeing something on that 787 and again we’re seeing relatively no demand in the biz jet, but any as I open up the manufacturing facilities and start making plane one, plane two that should be able to kind of get momentum going from that standpoint.

So, I certainly understood clearly that Q2 was going to be a gut check time. We saw when we laid the year out certainly saw it as we said here 13 weeks ago and I think that certainly it was gut check time. Our goal was clear focus on those areas of opportunity. You are never satisfied with where you are and this is again the same case, I do not think we are at the end, but I think we established a very solid cost structure of which we can build off in the future.

Moving beyond the segments now and looking at our cash position, we ended quarter with roughly $743 million cash on hand and debt of $259 after a Q2 kind of a double tax payment of roughly $200 million. So, I think we’re positioned extremely well to close the current transaction where we were looking roughly in the area of $350 million worth of commercial paper to kind of complete the transaction, so if you look at $350 million I think we are positioned very well to pay that down in a very reasonable period of time.

So in summary, kind of recapping Q2 I think we continue to see accelerated stocking in Q2. The forging outages provided us with additional challenges not only in the sales line, but also adding to the lower absorption and certainly we deal with the extended four week holiday period of time in the European operations and kind of talked about the impact of the lower fixed absorption and again our challenge was clear.

We refuse to be the victim that’s just not what you pay us to do and we get it. I think we attack the areas of operational opportunities that we had to kind of mitigate the volume effects and again I think we established a new baseline to build off of. If I kind of look at what that looks like and kind of look at the value in Q2 in totaling kind of that same 30% to 35% incremental thought process if I take that and apply it against the overall 20%.

We would have expected the downward pressure to decline those operating income by roughly $112 million to $130 million, but by going after the opportunity kind of cut those in half to $56 million in the quarter. So, I think that we certainly made some progress but had a lot more to do and a challenge for us was abundantly clear we’re going to find like hell to hold on to that. I have no intentions of giving back any grounds that we made and as we look to the rest of the year certainly as the destocking tends to subside that can play a significant role for us.

So if I’m look at the rest of the year, moving into Q3, again I think that we kind of hit the bottom and we begin closing the gap in the aerospace side, we’ve been closing the gap on the schedules to the current bill rates. I will say that there’s a significant amount of pressure to hold off that closing of the gap as long as possible as a lot of our customers year end come in this quarter. So there’s no doubt about that it we’re seeing a tremendous amount of pressure to not let that gap close probably as quickly as it would like to do and I think as we look at the balance in the aerospace we’re seeing no real recovery in the biz jet in our Q3.

The general industrial, again I think Q2 certainly was the bottom. I think we’re looking at a gradual controlled recovery, not some exponential line, but certainly a consistent volume coming back and I’ll take that any day, what was gone through the last two quarters in terms of opportunity. Operationally in Q3, we have five fewer manufacturing days, same as every previous Q3. So you need to make sure you take that into consideration.

Carlton, we did close two, three days after the quarter. Carlton had planned in this quarter, our Q3 a major outage. We’re going to let them take it right now. The supplies have been ordered. It’s already set up. We will obviously in the future move that to our Q2, but we are going to let them take that outage, it pretty much runs before Thanksgiving through Christmas, but again we’ll move them onto our Q2 from that point forward. I think that the margins in Q3, we can begin to certainly move those forward and we have every intention to be able to do that.

Moving into Q4, again I think we continue to close the gap on that destocking. I think it moves its way through, so through January and February and we kind of get to March before we see kind of that real closure and kind of Q1 is where the quarter is starts kind of matching up fairly well to where the build rates are and I think that will start to see something coming out of the biz jet/regional. It’s not going to be some kind of McBride, but at least there will be something over and above what we had today.

Again in general industrial, I think it continues its upward trends in a controlled manner and the primary driver as far as to several oil, gas and chemical processing. Q4 has in it, and they will be the first full quarter of com again the maintenance will be inanest, precise will be inanest. Certainly, Steve and his team are clearly identified in the integration process. There’s a substantial team down there involved in that and certainly I think the Carlton team is really kind of grabbing onto the value what have we wanted to.

Operationally, we have a full complement of working days. Certainly, our task is abundantly clear is to stay focused on incremental volume and drop that through and we get it. We get it abundantly clear. To look at beyond that, so going into Q1, Q2, again we are not going retried from operational improvements. We’re going to hold on to those and drive those incremental volumes to.

I think then the schedules match up well to the bill rates. So kind of this three quarter, severe pain we’ve been threw certainly goes away. I think we have the ability to generate. I’ve talked about that suite spot in a controlled environment given our cost structure. I think we have the opportunity to deliver solid incremental margins and then as we move into next fiscal year, we will start seeing kind of the effects of the 787 moving into some sort of production rate. Again we go to back off six to nine months in the F-35, which we’ve kind of taken the F-22 out and no F-35, so that’s kind of a benefit for us.

With that, I’ll open it up. I’m sure you all have a lot of questions and we can go from there.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Joe Nadol - JP Morgan.

Joe Nadol - JP Morgan

Mark, first of all, thanks for that math on the decremental margins plus the structural cost take out. Just a couple questions around that, first if you look at the forged segment and you look at it sequentially rather than year-over-year it’s 100% reduction in drop through of sales to earnings and interestingly the same thing or close to it happened last year as well from Q1 to Q2. Can you talk about that segment specifically?

Mark Donegan

Yes, the biggest delta we face there is that the outages, so big, there’s a lot, there’s a misconception that the sales line is actually the biggest impact from the outage. A lot of times we will build up an inventory position and ship that out, because we have to make sure that we satisfy our customer needs.

The biggest impact and we have some of our large probably four out of our five largest factories were seeing outages or downtime of roughly four weeks. So, you just have the lack of volume going over those assets that you can’t overcome. You still have the people in play we still have the cost, but we just don’t have the volume going across it, so the reason why you see that more of a drop through and then it bounces its way back up in Q3 is because we just don’t have the absorption across that asset based.

Joe Nadol - JP Morgan

So, would you characterize as we look forward and think about your seasonality you would characterize Q1 as a very high margin quarter going forward in forged and then that big sort of multi-100 point drop sequentially is probably something we should expect on an ongoing basis.

Mark Donegan

Yes, and again there’s certain if you look kind of where we were last year with the volume coming at us at a rate we couldn’t handle I think so we kind of limit our way along in terms of the press outages whereas certainly this year we are able take them down. So, but as a general rule, yes, I think you see Q1 tends to be a full quarter, full operational, full days.

You get a real good utilization of your assets. We come into Q2 that the forging world, you take scrawl on the chin shutting those forging presses down, and the other thing I would add, too, we continue to add to that where in the past there was just Wyman-Gordon’s now you have Carlton, it is the Jiffy Lube that do the repairs or you have a significant kind of traffic failure.

So, we have to make sure we do that and than I think you say Q3 moves up but you have Forge Works effecting days and then Q4 gives you again a full complement. You see Q4, Q1 should be really solid margin performance, Q2 you got the press outages, Q3 you should see an improvement, but it has the Forge Works manufacturing days and that should have more of a repeatable pattern in that world.

Joe Nadol - JP Morgan

T0hen thinking about your capacity maybe a different way your sales quarterly sales peaked out at about $1.8 billion right then your $1.3 billion here which you say is you think is the bottom. You’ve talked about a sweet spot in the incremental as you come back up off the bottom as you layer in more volume without adding heads. Given the headcount you’ve taken out, though where in between the $1.8 and the $1.3 would you say you can get to without adding significant headcount where you are effect…

Mark Donegan

Just let me say that in apples-to-apples the $1.8 was kind of brought back by roughly $126 million between currency and all that. So you are looking at something that’s probably 1.68 or something like that. I think rather than saying the 1.68 or a number it’s really the rate of the recovery. So, right now as its coming in if it comes in any more linear fashion we can control the hiring we can control the cost structure.

So, I would say that you could get back to 1.68 to 1.7 and drop through quite a bit of margin as long as we could manufacture it in a controlled manner and I think so that’s the key so I wouldn’t say it necessarily a hard number, but it’s kind of the rate at which we recover.

Right now what it feels like is that, again, we’re seeing a lot of pressure to keep Q3 out we may choose the manufacture in a more equal process. So I certainly think that for the next three is type of quarter the way it looks like today, we should be kind of moving into that sweet spot. I think Q4 and Q1 certainly are in that range.

Joe Nadol - JP Morgan

Then just one more angle on this, a lot of companies have talked about permanent cost take out through this downturn, but also an element of temporary cost take out, no employee travel or reduced employee travel and all kinds of things like that. How much, if any would you characterize of the structural take out that you is temporary?

Mark Donegan

We take a different point of view. I’m not saying, what’s right or what’s wrong. What I feel is though we need to adjust the cost structure appropriately to where it is and then its business as normal. So our people kept traveling. We gave raises, where bonuses were earned, we paid bonuses. I just think that you have to make sure you keep everything, what I don’t want to do is have to overcome a certain amount of money that I took a one time hit then next year, or next quarter whatever it is I can’t, it’s not as sustainable.

So, I would say that, 98% of what we did was sustainable and should be a lower cost structure moving forward. So, I mean certainly if there was three people we’re to go over to a customer in Europe, maybe there was two, but if they had to go over and see the customer, they went over and saw the customer. I can say, we’ve not suspended pay raises, where bonuses were earned, we’ve not suspended bonuses.

Joe Nadol - JP Morgan

From management comp and employee comp, it is no headwind there?

Mark Donegan

No, we’re going to keep paying up. They are down from where they were, but further down proportionately to what the operating income is down.

Operator

Your next question comes from Peter Arment - Broadpoint.

Peter Arment - Broadpoint

Just quickly, you’ve given us a lot of information here on the slides. Talking about revert streams, how do you do where you are now as particularly when you fold in Carlton, I guess that’s an overall percentage of what you were going after?

Mark Donegan

I think that, let me break it out pre-Carlton, and then I’ll tell you Carlton. I think pre-Carlton were probably 75ish percent of where I’d like to be. Now I answer that with a caveat, I think we’ve gotten smarter in how we can extract alloys out of streams we never thought we could get it before, powder, dust, sludge, we have the capability with the volume level, we’re running at now.

We may be able to run a kind of a consolidation heat and extracts the particular only one extract. So, I think from that standpoint, we’re probably 75%. I think Carlton, certainly, opens up additional, so if I would add that in, I think probably overall access us back down to 65.

Peter Arment - Broadpoint

You mentioned a lot of destocking, do you view it any differently than the last cycles or is this kind of similar to what you’ve seen, have the OEMs gotten smarter or is it just happening at a faster pace?

Mark Donegan

No, I think that we kind of believe when I did the math going back over a year. So if you look at the build rates, again, we had to. We certainly saw that last year at this time, we were over building what the build rates, but again we’re heading into again if you back off for a six to nine months, we had to be building April, May, June to support what was going to be a 10% to 12% increase this year.

So I think what happened is when that dried up not only did they bring us back to the build rates we also kind of got the whack of the over build. So we had to take the over 12 that never occurred and kind of belly out. So, I don’t think that they got any worse. I think that we just were expecting and we had schedule lying on top of us that we’re requiring a higher demand than the build rates were last year. I think that there certainly were sometimes during the economic meltdown where people just said, I just have got to extract every ounce of cash I can possibly get.

I think it’s a combination of those two. I don’t think it was necessarily the supply chain being sloppy. I mean, it was like we’re over building, the rates didn’t come. The economic hit and then it just kind of throttled everything back.

Operator

Your next question comes from J.B. Groh - D.A. Davidson.

J.B. Groh - D.A. Davidson

In looking at this cost savings that you laid out for us which is pretty helpful I mean annualize numbers, mid point $260 million. Can you give us some kind of three concrete examples what have exactly it is that you are doing, I mean it’s a pretty big number and it’s fairly impressive I’m just curious it is just headcount reduction, is it in new equipment or is there any other thing that we should look at as being really the driver of that number.

Mark Donegan

Let me try to answer the best I can without necessarily giving away some of the special sauce. Certainly we adjusted our man force accordingly. So, I’d say probably 35% to 40% was kind of just adjusting the man power. From there you can’t get all the way. Then we start looking at the man power add where can we go with tech. We’ve talked about some of these in the past.

In the casting world variable is 45% to 50% of the cost and labor is by far the most significant component. When we were growing our productivities were flat. For a pretty long extended period of time and again in an environment we are bringing 25% to 30% people on flat has proven to be a challenge all of itself. We have a model that also says when that flips, when we stop training.

What are the expectations in terms of a productivity gain and they tend to run well into the double digit range. So, we could then take that manning model and it’s a math model because you can look at your population and 25% or 15% productivity and 25% or 50% and so on down the road so you can run a model and say when those people are gone you should expect to see productivity jump.

So we lay that out there and that become the base line to kind of go attack. We measure that manning model on a 16 week rolling forward average every single solitary week. So we kind of make sure that we are adjusting in enough time to the proper manning model. So that’s one example. Another example is we were going outside on a lot of operations.

It usually costs you more to go outside we could pull all those operations back in hand. We have an operation in Mexico. We could fully utilize our operation in Mexico to finish product. We some cases if you look at the vicinity of some of our operations where instead of having a heat treat operation running a third full, another one third full, you can one down and maximize one layout, X ray.

So, that’s kind of labor productivity side of it. Material utilization, there’s a reason why we bought California and it was to go get our ten or goes out of far as out as we can get like a squid and pull everything back that we can get. So getting access to that and then looking at what could we do with it, could we melted, could we get some, could extract a certainly alloy and then the teams have been very successful in finding ways of getting the metallic out of things at least paid and disposed of in lands filling. So those are the types of things we’ve gone after.

J.B. Groh - D.A. Davidson

So, its basic blocking and tackling and then I guess if we do see the headcount ramp up there would be a little bit of headwind in terms of productivity, but you are saying most of the stuff is sustainable?

Mark Donegan

What you are going to get J.B. is there is a population and so with everybody that went we have a percentage of our population that was laid off that they were at 85%, 90% productivity. So, depending on the rate as you eat back into that calling people back you’re still going to a fairly well trained piece until you get back to the levels we were last year at the time, which again we aren’t going to give up these gains. We’ve structurally changed the way we do business. So, again I think again that the rate of growth or the rate of recovery for us is probably the most significant component of how do we drop it through.

J.B. Groh - D.A. Davidson

Just a couple of housekeeping item, you guys gave the pass through number on the forged product. You gave the decrease but you didn’t give the number from last year. Do you have that handy? It was down $83 million but I don’t know what the starting number was for Q2 of fiscal ‘09.

Mark Donegan

Hold on.

J.B. Groh - D.A. Davidson

Then while you are getting that, looking at the corporate expense that nudged up a little bit sequentially, is there any sort of pre-deal Carlton cost in there thing that are extraordinary in this particular quarter or what should we think of as a run rate there.

Mark Donegan

There are legal expenses that are in there, that are different from what we’ve done in the past. So yes, to answer your question, there are legal fees in there for deals. The number of last year it was $78 million, J.B.

J.B. Groh - D.A. Davidson

$78 million and it was $83 million lower this year.

Shawn Hagel

That’s a combination of pass through as well as the metal costs. So the $78 million is the material pass through primarily on our Wyman-Gordon facilities, compared to a drop of about $57 million this year. The rest of it is the metal pricing that the metal pricing drops in our primary mills. So it’s a combination of those two things.

J.B. Groh - D.A. Davidson

What I’m trying to get at is sort of the pure margin improvement taking out the pass through from forged from last year and if it was $83 million lower at this…?

Mark Donegan

Do you have the combined? I don’t have the press release from last year, but do you have the combined, J. B., that’s the delta of the three, which is contractual material pass through, which basically could be Wyman-Gordon and the elemental price change in special metals, that’s the delta change from last year to this year. So if you want to take the sales dollar and put them on a comparable basis that’s the delta.

Operator

Your next question comes from Robert Spingarn - Credit Suisse.

Robert Spingarn - Credit Suisse

Some couple of thing Mark, while we’re on that topic, so what did the nickel do in the quarter, it went up, right?

Mark Donegan

Again, nickel on the LME went up during the quarter, it went from probably $7 million to a high of $9.25 million and then started working its way back down. Again, that is not necessarily, you realize we have overlays all the way out for a year. So the actual price per se didn’t necessarily get in our operations because we have hedges that are three months, six months and so on down the road.

Robert Spingarn - Credit Suisse

So it’s more complex than just thinking about the one quarter?

Mark Donegan

Yes, we probably have at any point in time six to seven different hedges. We still have some hedges as low as $4.50 million, some as high as $12 million.

Robert Spingarn - Credit Suisse

So would be incorrect for me to simply just conclude, maybe this is for Shawn that you would the LIFO reserve would have gone up, which would have been an unfavorable move in the quarter?

Shawn Hagel

LIFO reserve, there’s not an easy answer for that because our operations really do get impacted on various, depending on what their metal costs were, so it did go both directions, but relative to an impact of the quarter it really wasn’t all that significant at all.

Mark Donegan

Rob, somewhere we’re all along, I’m very happy to show you kind of as an example what the hedge overlays look like.

Robert Spingarn - Credit Suisse

Maybe as a future thought, since this gets asked every quarter, maybe there’s some level of detail and calculus you can include here?

Mark Donegan

I’ll give it some thought. That’s a good point, that’s a good observation.

Robert Spingarn - Credit Suisse

On the fastener destocking, you talked about that being 10%, there’s some offsets within that. What would the raw fastener destocking look like?

Mark Donegan

I think that kind of as a general rule, the raw destocking probably would be 30% to 35%. So that would be consistent with the numbers we’re seeing from some of the distributors. Yes, absolutely. If we were not having opportunities or share opportunities, there’s no doubt about it what the distributor are telling you we would have seen hit of slow entity.

Robert Spingarn - Credit Suisse

Then just finally on the quarter on Q3, you’ve talked about the difference in the number of workdays and the fact that we’ve bottomed at least in certain areas of the business in Q2. On a revenue basis in Q3, should we be back to Q1 levels or we still short.

Mark Donegan

No, you’ll not be back to Q1.

Operator

Your next question comes from Cai von Rumohr - Cowen & Co.

Cai von Rumohr - Cowen & Co.

Mark, Carlton you mentioned that you’re going to have planned maintenance. Could you tell us, how long is that planned maintenance, did they have any inventory going and in kind of maybe give us some sense of the annualized, normalized revenue run rate we should be looking for?

Mark Donegan

I can’t tell you the run rate, but that’s okay, it was a good try. What, Cai, you are probably looking at a six type of would go outage of the type of rework, the type of maintenance there’s one you have to get into it to see what you’re dealing with. You’ve asked couple more question, I know you asked Dwight a couple times, I am going to try at the next conference I will try to as we get a little more underneath our belt I will give more color to the type of things we expect to see in terms of where we looking for, what type of synergies we think we can get, kind of what’s out there.

So, I will do that I think the next one is December, so I will kind of do it at that December stop. So, it’s not as over try to avoid you at all, I just want to make sure I get a clean line of sight at it when we are in it. Steve is down there, we have roughly 12 people down the integration team so we are laying that out right now, but you probably look at a six week type of outage.

Cai von Rumohr - Cowen & Co.

Did they also like your forging operations billed inventory for bill?

Mark Donegan

One income prompt to date has a little different recipe than we do and again they deliver very well. So they have some inventory in play for either this or other reasons answer your question, yes, they get inventory in play from a standpoint of sales, but again they are going to take squarely that will lack of absorption.

Cai von Rumohr - Cowen & Co.

Given that they are relatively large this is a larger maintenance downtime than you guys experience. When we overlay them I mean should we expect that the forge margins may be relatively flat in the third quarter versus the seconds?

Mark Donegan

I think that with Carlton rolled in given that’s probably a pretty reasonable assumption and as we get Carlton into a full quarter with not overcoming that I think you moving into Q4 that tends to be probably more representative quarter of what will look like.

Cai von Rumohr - Cowen & Co.

Well, because of the extra leverage you have in the forge business I would think that in the fourth quarter when you get the seasonal up tick but you really should have a very good, so the third quarter will look more like the second and the fourth should be considerably better.

Mark Donegan

Yes, I would agree with that logic.

Cai von Rumohr - Cowen & Co.

Your balance sheet still is in good shape. Tell us a little bit about kind of how you think of M&A at this point? Would you go something just having just on Carlton or how do you think about that?

Mark Donegan

Absolutely, again, our pipeline typically does not be one just one particular thing. Usually at any point time we have two to three ideas at varying points. The advantage of Carlton, unlike, let’s say SPS as an example, we bought SPS we had to pick up 23 operations. So, it certainly took sometime to digest that and put the systems in play and all that.

The advantage of a Carlton is its one plant, with our two, but I mean they’re very reasonably located. So for Steve and his team, it’s kind of a full time blitz. They are down, they are living, they are in the facility and they are moving with the Carlton team. So I look at it more from a dilution of where the resources and what can they do, so would I do another one?

Again, at the right price, at the right value, at the right multiple I would so, but if Carlton had been 23 plants I would you have probably said, what to do all the shareholders the proper justification I need to wait six to nine months. I think we actually said that at the SPS transaction that we want to do wait a period of time to make sure that we didn’t, I don’t want reduce I do not want to dilute our integration and we make sure we stay focused on that.

Cai von Rumohr - Cowen & Co.

You told us oil and gas maybe bottoming out and kind of still seeing some push outs in aerospace. Can you give us just some color, I mean was September a better quarter? What are you seeing in the early weeks of October just in terms of general color, what businesses is getting better, what still maybe looking week?

Mark Donegan

Well, I think we went into Q2 in that general industrial world probably booked 25%, 30%. So we were scrambling and pushing and clawing and fighting all the way through in that general industrial world. I think what we’ve seen is certainly our bookings are coming in much stronger and better than they were, but I think from an output everything is a matter of perspective I mean if you gone back a year ago and you told me we would see 1% to 2% growth I would have said that’s a rounding error.

Now, that’s good, I’ll take it. So, I think what we’re seeing is, we’re seeing bookings pick up. We’re seeing income longer range projects starting to come into play that were certainly put on hold. Again we’re seeing a controlled rate, so we’re sitting better from a bookings standpoint than we’ve been in the last two quarters, probably.

Operator

Your next question comes from David Strauss - UBS.

David Strauss - UBS

Just want to tack this destocking issue from another angle. Your aerospace space business it looks like, last year I guess even in ‘08, it was about $3.8 billion business. Last year it was about $3.6 million, but it include the Boeing strike, that is the right way to think about that business is running at about $3 billion run rate this year including impacting of destocking, if it they work for destalking, it would be more of a 3.4 hard business?

Mark Donegan

I think that your numbers are pretty close, yes.

David Strauss - UBS

So as we think about the next year it’s a 3.4 business without any further production costs and $787 million?

Mark Donegan

David, you cut out on me. You’re kind of coming and going. Let me try to at least answer what I thought I heard you say. As we move into next year, I think that kind of that bass rate you were using, we kind of get back to that level and then depending on what happens in the 787 and JSF that would be kind of an accelerator to that or if there were ever was a change in the build rates.

So, would kind of be on that, but I think on the aerospace side, we’ve kind of shown you what we’ve looked like at let’s say at least the 20% drop in build rates, you’re kind of seeing what we look like. If we just match up and there are no decreases, it’s a nice number for us. I don’t know if you’re still there. Are you still there?

David Strauss - UBS

No.

Mark Donegan

So I think we should move on to...

Operator

Your next question comes from Sam Rothstein - Wells Fargo Securities.

Sam Rothstein - Wells Fargo Securities

Just following up on something Cai asked about general and industrial. If you actually look at where you’ve given up percentage of sales by the quarter, actually it looks like it grew 10% or 11% since the second quarter I guess sequentially. Am I reading that right and really what were the drivers?

Mark Donegan

No, they were down year-over-year, I think you said year-over-year, so they were down Q2 versus last year, roughly I think 25%, 30% is what that general industrial world was down.

Sam Rothstein - Wells Fargo Securities

I was actually looking at it sequentially where it looked like it ticked up, yes, year over year down, but it looked like it ticked up at last.

Mark Donegan

Sequentially again was down, not significant, but it was down.

Sam Rothstein - Wells Fargo Securities

Then I guess I don’t want to be flip about this, but I guess I look at this $55 million to $73 million worth of cost structure that you’ve reduced. I guess a question is why does it happen now, why wouldn’t it have happened last quarter or last year? What set it up now?

Mark Donegan

I guess what I would tell you is it did happen. We carried Q1, so those numbers we’re looking at Q2 to Q2. So I could run the same math Q1 to Q1 and it would you have showed you sum we continued to build on it. So that was kind of the delta change Q2 to Q2 of which, some came in Q4, some came in Q1, one more came in Q1. If I look at probably the bulk of it came in Q1 and Q2, but it didn’t come all in Q2.

Again that math was looking at the volume drop Q2 to Q2, and if we had done nothing between last Q2 and now, it would have been the impact of X. In fact that we did do things Q1, Q2, made that delta smaller.

Sam Rothstein - Wells Fargo Securities

Okay and then trying to just think through in terms of the future quarters what you’re saying about Q3 and Q4, so if I’m reading that right even with acquisitions if it sounds like you’re still not positive in terms of top line comparisons in December or in the March quarter. Is that...?

Mark Donegan

Till when?

Sam Rothstein - Wells Fargo Securities

Year-over-year.

Mark Donegan

Yes correct, year-over-year.

Sam Rothstein - Wells Fargo Securities

So even with the impact of Carlton, we should still be flat to down in either of those quarters?

Mark Donegan

I haven’t looked at Q3. I would answer yes. Q4, you are probably taking into account metal, and all that you are probably going to be more close. Again, there’s going to be a metal change in there, but you’re going to be a lot closer.

Sam Rothstein - Wells Fargo Securities

I think you did your test for goodwill for some of the prior acquisitions and just given the destocking and what’s happened to some of the businesses, I didn’t know if that affected any of the values?

Mark Donegan

We went through the testing and everything was okay. We weathered the knockout punch and moved on.

Operator

Your next question comes from Eric Hugel - Stephens.

Eric Hugel - Stephens

You gave us really good color sort of how things work in aerospace as we go through and industrials go through Q3, Q4 and into next year. Can you talk about industrial gas turbine and maybe you can add some color, one of the comments on GES call, the other day is they’re starting to see the second sort of maintenance cycle come through on their F class turbines. Can you talk about a much more substantial for after market upgrades than the first maintenance wave. Can you talk about for how that works for you and sort of how we look going forward?

Mark Donegan

Basically year-on-year, all of our work everything has held us flat. So all additional market share and everything we’ve done has held us flat. We’ve seen a lot of volatility, up down over the course of the last three to four months in terms of kind of what the customers are looking for.

As they enter in the second wave, yes, I would expect there’s a breakdown typically as you move into the second wave here. The number of replacement parts goes up. We have not seen that yet and we obviously have nothing in our schedules yet, so kind of what that would be additive for us. The only thing to-date our new share, our new customer base, the after market has held us flat year-to-year.

Eric Hugel - Stephens

Nothing in terms of talking to GE with regards to sort of capacitizing for were you’ve a capacity?

Mark Donegan

We have plenty of capacity.

Eric Hugel - Stephens

Just to clarify, I think one of the previous questions asked was in Q3 sort of could you get back to Q1 sort of sales levels?

Mark Donegan

No.

Eric Hugel - Stephens

You said no, but is that sort of just Ex Carlton. If you included Carlton would you be above that?

Mark Donegan

Again, the reason of problem is kind of as we’re going to lose almost half the quarter in outages and again they’re probably going through the same thing that we’re seeing in.

Eric Hugel - Stephens

I thought with Carlton that was more of a margin, they have inventory that they’re going to sell?

Mark Donegan

I apologize. Yes, the answer to your question, we’ll be reasonably close to Q1.

Operator

Your next question comes from Noah Poponak - Goldman Sachs.

Noah Poponak - Goldman Sachs

Mark, you talked about the past three to five years, you had the consistent 30% to 35% incremental and in better revenue environments that drives several hundred basis points of improvement in a given year. As we look much longer term three to years out, when we’re back into a better revenue environment, is there still that kind of upside to the profitability for PCP longer term?

Mark Donegan

Yes, on average longer term, yes, again, we’re not at the end of this road. I mean there’s not a single facility, I can tell you that I walk in and say, great job you’ve done and I’m moving on. So that is kind of the cadence and the drumbeat. I think what eats into that more than anything is a rate of acceleration. If we can have a controlled recovery in any environment, we can manage our ways through it pretty well.

If we see rapid acceleration, significant delinquencies, tremendous pressure that for build rates we tend to become more inefficient and those probably could drop to 20, but in a controlled environment over the long haul, that’s why I think the way we did, we went through previous to this destocking debacle we’re in right now. The controlled environment in which the industry was growing was great for us. So even though we didn’t deliver the productivity I thought we should get, we still didn’t have to go berserk and become horribly inefficient.

So again the rate of acceleration as we get through the next point, if we were going to go for a rate of two so we take an extreme case a rate of two to rate of 10 over two quarters in the 787 that would be a problem, but if we went two, three, four, five, six, over a sixteen month period of time we can digest that in a very reason reasonable. So again, the rate of acceleration is probably more significant than necessarily the upper ends.

Noah Poponak - Goldman Sachs

So in that more favorable backdrop and a better revenue environment, here is no reason to think that this can’t be a 30% to 35% total margin company.

Mark Donegan

That’s right and I’m not going spend there. Again, I use the incremental drop through, I think using incremental drop through and 30 to 35 in the long haul, it’s a good you may see some quarters that are higher, you may see some quarters that are lower. Depending on what your sumps are that’s they ketch you to wherever a point you want to be to.

Noah Poponak - Goldman Sachs

You mentioned that, I think if I heard you correctly you mentioned that the destocking relative to the actual build rate is much greater on narrow body than on wide body. Can you just address why that is given that we’ve seen a cut on wide body and not on narrow body?

Mark Donegan

I don’t know per say. I think that we see a lot more of the partners involved in the narrow body. So you get a lot more arms in it and what I mean by that is it goes from us to somebody to somebody and ends up going to the OEM and ends up going into the two air framers. As we were building up, I think everybody had 12% growth, 12% growth, 12% growth. So, I think that they were just a lot more proliferation of the players that were involved in the narrow body and there just seemed to give us a more of a impact from the destocking.

Noah Poponak - Goldman Sachs

One last one, what do you expect the first full year revenue contribution to be from Carlton?

Mark Donegan

We haven’t said yet.

Noah Poponak - Goldman Sachs

Not willing to share that with us today?

Mark Donegan

Not yet. Like I say, we’ll start, typically what we do, we’re not trying to be coy, if you look at SPS, and the SMC, what we’ve done. We get a quarter underneath our belt. We lay our strategy in place. We then start sharing kind of what we see in the next six, nine, 12 months and then we get another six months we’ll come out with another one. That’s kind of a pattern and I want to stick with in Carlton, too.

I just don’t like giving quick off-the-cuff. I want to make sure, we digest and understand and what we give you is kind of a realistic profile.

Operator

Your final question comes from Peter Grondin - OSS capital.

Peter Grondin - OSS capital

One of the callers earlier had sort of touched on this. Is it fair to say that there is a reset level of basically $1 per share in terms of earnings power of this company on an upward volume situation? The way I got there is just rough math color $240 million annualized multiplied by you’re the minus tax rate and divide by a 140.

Mark Donegan

I’d be lying if I told you I could do that math on the top of my head, but...

Peter Grondin - OSS capital

A much even qualitatively is that the way to think about it?

Mark Donegan

Ask your question, when we saw there answer to you question one more time…

Peter Grondin - OSS capital

I’m saying roughly you had that range 53 to 75 or whatever and that was for the Q2 so I’m just saying...

Mark Donegan

Okay, yes, if you go on out in the future as on ongoing run rate you’re going to have a sweet spot where you maintain that. Somewhere along the way you’ll start giving some of that back.

As you hire and bring your fixed cost back, but yes there is a sweet spot again depending on the rate of growth that we can sustain that for two, three, four quarters and then we’re going to start giving some of it back. Revert streams will start drying up as build rates increase, revert goes away, but again you will hit a sweets spot and then you give some of that back. Does that answer your question?

Peter Grondin - OSS capital

Second thing is, in terms of you constantly sort of as you said beating the drum take costs out, are there any other areas that really haven’t been touched yet in your plants that you think can really stuff on and I’m not talking about efficiencies on the margin but, for instance, if you look at the, on the casting side the wax as a big component and I think maybe some of that you really don’t sort of capture that or recycle that that much. I mean is there in area that you could potentially gain some benefit?

Mark Donegan

Using that as an example we actually do recycle wax, but I don’t think to dated there’s anything that we don’t know or haven’t touched. Now our success rate varies. So I mean again if you look at some examples we have some operations that are 90% using, we have operations that are using 65.

So how do we get qualified, how do we get those through, how do we capture those, that’s an opportunity. We’ve talked about some of the consolidation. We still have other facilities that are remotely kind of within the what I consider a reason that you could continue to shutdown additional furnaces and that and get more utilization of one. That is a whole cascading effect, you got energy that goes away.

So right now let’s say we have two facilities that are three miles way each other and they get six furnaces each running a third, a third, a third full, you could shutdown two, bring them over to the other one, you pay a little more in transportation, but then you start getting benefit of efficiencies across the existing asset based less energy. So, I don’t think there is the next great thing in life, but I think there is a huge amount of stuff that we still are not hitting effectively and doing well in all of our operations.

Operator

On behalf of the Precision Castparts, Mr. Donegan and PCC Management I would like to thank you for joining the call today. As a reminder the webcast and call has been recorded and will be available on Precision Castparts website at www.precast.com for approximately 30 days. This concludes today’s meeting.

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Source: Precision Castparts Corp. F2Q10 (Qtr End 27/09/09) Earnings Call Transcript
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