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Executives

Richard Leone - Director, Investor Relations

Dawne Hickton - Vice Chairman, President and CEO

Bill Hull - SVP and CFO

Bill Strome - SVP, Finance and Administration

Analysts

Kuni Chen - Bank of America

Luke Folta - Longbow Research

Edward Marshall - Sidoti and Company

Chris Olin - Cleveland Research

Avinash Kant - D. A. Davidson & Co

Patrick McCarthy - FBR Capital Markets

Gautam Khanna - Cowen and Company

Frank Haflich - AMM

Robert Chapman - Chapman Capital

RTI International Metals, Inc (RTI) Q4 2009 Earnings Call February 4, 2010 10:00 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to the RTI International 2009 results conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Richard Leone. Mr. Leone you may begin.

Richard Leone

Good morning everyone. Welcome and thank you for joining us today for RTI’s fourth quarter and year end 2009 financial result conference call. Today's call will be led by Dawne Hickton, Vice Chairman, President and Chief Executive Officer of RTI.

In addition to Dawne, Bill Hull, Senior Vice President and CFO and Bill Strome, Senior Vice President of Finance and Administration will be available for your questions at the conclusion of Dawne's prepared remarks. As always, elements in this presentation are forward-looking and based on our best view of the business as we see it today. Please refer to our detailed disclaimer included in today's press release.

Now let me introduce Dawne Hickton. Dawne?

Dawne Hickton

Thanks, Rich. Good morning, everyone and thanks for joining us on our call. As Rich mentioned I will review RTI’s fourth quarter results as well as our 2009 [business] results. It should not come as a surprise to hear me say that 2009 was an extremely challenging year for the titanium industry as a whole and for RTI in particular. Between the global economic recession that began in the latter part of 2008 and continued throughout 2009 to the extended delays for the Boeing 787 program along with the difficulties that Airbus is a still facing with their A400 Military Transport program and not to forget the unprecedented inventory buildup of Titanium mill products.

2009 is one we hope not to be repeated anytime soon. One of the bright spots for RTI, the Joint Strike Fighter program received strong support from Defense Secretary Gates, during the summer and fall of 2009, came under budget scrutiny in the last few weeks.

The good news, it has survived that scrutiny and that program is still on track with our forecast. Nonetheless, RTI continued to manage through the downturn, we exceeded our cost reduction target, we took out over $36 million in cost and we raised capital to leave us with a strong balance sheet with over $121 million in cash and short-term investments at year end.

We are well prepared to continue to face the challenges that we believe lay ahead in 2010 and we look to an industry recovery in 2011. Let me recap the financial performance for the quarter and the year. Before highlighting the results, let me point out by stating that during the fourth quarter, we did announce the indefinite idling of the Mississippi sponge production plant. Based upon current and foreseeable market conditions, we do not foresee a need for sponge from this facility.

Consequently we have impaired assets that represent a charge of $68.9 million. In addition to this impairment, our results were also impacted in the fourth quarter by fines and penalties assessment coming from customs on the pre-2007 duty drawback claim. This was in the amount of $1.7 million.

Lastly, due to the competitive challenges in the energy markets, we experienced a write-off and goodwill for our energy unit of $8.7 million.\

Now let me address the quarterly results. For the fourth quarter, RTI recorded a net loss of $57.3 million or $1.91 per diluted share compared to a net income of $3.6 million or $0.16 per diluted share in the same period a year ago. Absent the above [benefit] of write-downs, the operating loss would have been $7.6 million.

Net sales for the quarter were $97.3 million, down about 35% as compared to $148.8 million for the comparable quarter last year. For the full year, net income, a loss of $67.2 million or $2.67 per share, net sales of $408.8 million.

These results compared to net income of $55.7 million or $2.41 a share on sales on $609.9 million to the previous year. A significant matter that impacted 2009 was the fact that Airbus did not take all of the volume they were contractually required to take under our supply agreement. Under the agreement, Airbus is responsible for the value of the missing volume. The parties are discussing the value of the shortfall and we would expect to resolve that issue sometime during the first half of the year.

The magnitude of the shortfall was approximately 1 million pounds with the value that we have calculated using lower priced products at about $17.9 million. Even with these economic challenges and the Airbus shortfall, we were still able to shift 10 million pounds of mill products during 2009.

Although we still face challenges throughout 2010, we continue to be in a strong position as a supplier of choice for key titanium intensive projects. These projects will not only drive demand for our mill products, but they support the long-term strategy of RTI where demand is continuing to grow for our fabricated and machined titanium products.

Over the past three years, we have expended over $150 million in capital expansion projects that are now in place to support the growth as we move into this decade. One half of the expansions are in the Titanium group and they support the Lockheed Martin contract as well as the ultimate ramp up for the Airbus contract and some other long-term agreements we have from products.

And the balance of expansion are in our fabrication business including not only our Montreal machining center which is starting to experience a ramp up of the Dreamliner, but in December, we commenced operation of a new machining facility in the United Kingdom which supports not only our Howitzer program, Airbus opportunities, but also the Joint Strike Fighter products we supply to the Lockheed’s partner BAE Systems.

In addition during 2009 we signed two long-term sponge supply agreement with long-term fixed pricing that will support the forecasted demand for sponge under our mill product supply contract. And of course as I did mention above, now that we have seen the first flight of the Dreamliner, we are starting to experience the ramp up albeit slowly of the fabricated and machine parts we provide to that program.

In addition, our reputation as a producer of quality machined titanium parts is now reflected in the interest we are receiving from Lockheed Martin on our capabilities to support them on fabrication for the Joint Strike Fighter that go beyond the mill product supply.

Also with Boeing, on their 747-8 program and also from Bombardier on the new CSeries. We are also seeing interest in our fabrication capabilities in China with the aerospace manufacturers. More recently we’ve had an opportunity to work with Gulfstream on machining parts for the new 650 as we start to see life begin in the business jet market. Let me turn it over to Bill Hull, our Chief Financial Officer and he will give the segment reports. Bill?

Bill Hull

Thank you, Dawne. Starting with the Ti Group, for the fourth quarter of 2009, excluding the $68.9 million sponge plant impairment and the $1.7 million duty drawback related charge, this group reported an operating loss of $4.8 million on sales of $48.4 million including intersegment sales of $27 million.

During the same period in 2008, this group had operating income of $3 million on sales of $70.5 million including intersegment sales of $25.3 million. Mill products shipments for the fourth quarter were 2.2 million pounds and an average realized price of $20.86 per pound compared to mill product shipments of 3 million pounds in the fourth quarter 2008 and an average realized price of $22.04 per pound.

Reduction in the Titanium Group's net sales continue to reflect a difficult titanium market that has been impacted by the inventory buildup in the commercial aerospace supply chain.

Turning to the Fab Group. Net sales declined 34% during fourth quarter of 2009 to $26.3 million versus $40 million for the same period a year ago. The group's operating loss, net of goodwill impairment of $8.7 million was $3.5 million compared to an operating loss of $1.4 million in the fourth quarter 2008.

The decrease in revenue is a result of both the general downturn in the commercial aerospace market and a slowdown in energy exploration and development which has led to the delays and orders from our energy market customers and finally, net sales for the Distribution Group of $49.6 million compared to $63.6 million for the same period a year ago, a decline of 22%.

Operating income was $750,000, compared to $3.7 million in the fourth quarter of 2008. The decrease in the Distribution Group net sales are a function of the global economic downturn and a slowdown in the commercial aerospace market.

Starting in fourth quarter, pricing for titanium products appear to stabilize while nickel-bearing alloys increased modestly. Now back to Dawne.

Dawne Hickton

Thanks, Bill. At this point let me start out by providing a very brief update on our Virginia forging and rolling expansion and talk about our capital expansion plans for the year. We're more than 50% complete with the Virginia project and we're still on track to have this facility fully certified and operational in time to support the ramp up on our contracts, particularly the Lockheed Martin and Airbus contracts as we move into 2011.

We have spent approximately 50% of the estimated $100 million cost for the project and the balance will be spread out over the course of 2010 and into the first half of 2011. Along with our Virginia mill and our normal maintenance projects, we expect our total capital spending during 2010 to be between $50 million and $60 million.

With respect to the full year 2010, as I mentioned earlier, we have been advised by Airbus that they do not have a current need for the full 5 million pounds required under our supply agreement for the year 2010. As I mentioned on our last call, the delays in their A400 program and the A380 schedule have impacted their near-term requirement.

Because of their expected shortfall in 2010, right now we expect our total mill product shipments to approximate 7.5 million pounds for the full year 2010. We are in discussions with Airbus regarding their requirements not only for ‘10, but also for ‘11. We are in discussions and working with them toward cascading a solution to their dilemma that could be beneficial to us, but absent any additional value added opportunity, that’s considerations to the lost volume, we would fully expect the contract to be honored by its terms.

As part of those discussions however, Airbus may determine during course of this year to either order the additional pounds, they order that additional pounds of material, that would mean the full 5 million minimum or alternatively they could pay the reduced volumes as turned out to be the case for 2009.

At this point, discussions regarding production, product mix and scheduling are ongoing. However to the extent required minimums would not be produced during 2010, the impact of required payments under the contract may not be recognized in 2010, but could be recognized in 2011.

Regarding 2010, with the uncertainties in the marketplace particularly for us concerning the Airbus production schedule, we do not have the visibility to provide definitive guidance for the full year. What we do now is with our current backlog which is growing, and with our contracted business, we have visibility to the 7.5 million pounds of mill products for the Titanium Group. This assumes that Airbus would only take half of the required minimum. As our discussions are completed that maybe adjusted.

On the other hand, this volume does include the current schedule for the Joint Strike Fighter where our shipments in 2009 were slightly less than 1 million pound and we will see a modest increase to that volume in 2010 growing to 2 million pounds by 2011 and those schedules have been confirmed by our discussions with Lockheed.

In addition, a strong backlog and the recent orders for the Howitzers are in place and this continues to be a great program for our company, the Howitzer program highlights our integration strategy as we make product across our value chain from our TI Group to our fabrication businesses.

Whether any additional businesses booked for 2010 remains to be seen as we move throughout the year. We anticipate our average realized pricing will be down from 2009 by about 7% depending upon product mix. This reflects the reduced pricing on our LTAs that are tied to the annual indices and the impacts of 2009 overall pricing.

And in addition as we previously reported, our purchased sponge cost will be down from 2009 levels by about 15%. In our fabrication side of the business, we expect to ship close to 30 equivalent ships during 2010 for the 787 Dreamliner program and we expect that to ramp to over 60 ship sets in 2011. Actual shipments over the course of the year will be driven by Boeing’s production schedule.

Finally, we do continue to be presented with opportunities to participate in the supply chain as a fabricator of parts for new programs such as the Joint Strike Fighter, the Bombardier CSeries as I mentioned and the Boeing 747-8 along with additional opportunities on the 787 as well as the A350.

All of this is part of our plan to become integrated supplier of titanium and specialty metal parts and components. Looking into the future, I am convinced that the long-term demand dynamics for titanium are compelling. They're driven largely by commercial aerospace market that despite the challenge of the last two years is still fundamentally strong and our long-term contracts are secure and in place to support this demand growth. At this point we're happy to take any questions. John?

Question-and-Answer Session

(Operator Instructions). Our first question comes from Kuni Chen from Bank of America.

Kuni Chen - Bank of America

Just to start off on the contract dispute and the fact that there was a million pounds that did not ship in the fourth quarter, pretty material events, can you let us know when you first knew about this and why you chose not to publicly disclose that to investors?

Dawne Hickton

Kuni, I will start right off by telling you, I am not sure why you use the word dispute. We have the contract, it’s 5 million pound over the course of the year. As indicated on the last call, it was a question as to what actual volumes would be and you’ll recall under these contracts, Airbus is not buying directly from us. They are buying through their naval suppliers. As you get to year end, and into January what is taking place now is really the true-up on what volume was not taken under the contract.

Within the last literally week or so, the parties have been in discussions, focused on that actual volume that was not taken under the contract and under the contract what is the value of that volume and as you’ll note from previous take or pay experience if you look back several years ago when we had a similar experience with one of our OEM, the payments that are made are then booked when received. So that will be something as we receive the payments when the value is trued up, we will see those coming up in the first half.

Kuni Chen - Bank of America

Is this largely on the A400 A380 programs? Is there something else going on within the supply? Do you have a view on how much excess material Airbus may have in their supply chain?

Dawne Hickton

From our standpoint when this contract was entered into, and we were basing it upon forecast back two or three years ago, there were minimum forecast to requirements that they had and their contract with us to supply the 5 million. We had put in place additional melting capacity, all of that to support that 5 million pound contract. As they moved out with all of the events that had taken place globally in the last couple of years and then looking at what’s going on which you know yourself reading in the paper of their A400, there was a little bit of push out on their current requirements.

So we are really talking about is current requirements and where that adjusts. I am not aware of anything other than that.

Operator

Our next question comes from Luke Folta from Longbow Research.

Luke Folta - Longbow Research

If you look at the costs, both within the TI Group and in Fab sequentially adjusting for the charges that you had mentioned, seems like there were some costs higher sequentially, I want to understand is this mostly due to the fixed cost absorption or there are some other issues in that that were a problem for you guys?

Dawne Hickton

Predominantly you are dealing with some fixed cost absorption, but Bill, I don't know if you wanted to add additional color to that.

Bill Hull

That’s the basic reason. We are fixed cost because of the volume we were producing, we weren’t able to absorb all of that. So that is the main driver.

Luke Folta - Longbow Research

The million tons that was a short fall for the Airbus contract, that was not all on the fourth quarter?

Bill Hull

That was throughout the year.

Dawne Hickton

That is really as they are ordering the material throughout the year, as we mentioned in our last call, it looked like they were looking at some lack of need for their full requirements. What you really have is just at the year end is you true up what was not purchased under the contract.

Luke Folta - Longbow Research

On your sponge contract, I heard you say that those were fixed price. Is that one price through the entire agreement or is that fixed annual price that steps up or steps down?

Dawne Hickton

The new contracts, the new ones that start when we get past 2012, the two new contracts were announced, those are fixed price over the term of the contract. They do have some manual adjustments for actual cost.

Operator

Our next question comes from Edward Marshall from Sidoti and Company.

Edward Marshall - Sidoti and Company

Hitting on the Airbus comments which you have already made, out of the particular scenario, you’ve had history with this before with other suppliers. I believe, you recovered those costs? Going from that is a potential that could you just see the operating income as a potential payment?

And maybe not necessarily the sales profit? Is that possible coming back from your negotiations or is that something that you go after?

Dawne Hickton

Under the contract, if this is a take or pay, they take the material or they pay, Now whether, what I will say to you is keep in mind this is a long-term partner relationship. We have been a supplier to Airbus for literally decades. The whole point of entering into this contract was to recognize that relationship, to recognize that this is a cyclical industry and during the downturn, we are going to need some support on the contract and certainly long-term they are going to need some support.

Having recognized that, if there is some opportunity in discussions with them with respect to 2010, and they're missing volume, I think that would support shareholder value that we secured in this contract, but maybe provide something that gives even greater value longer term to our shareholders. I could see something like that coming out of it.

Example, trading some additional value added opportunities on the A350, but short of that, we are open to discussion. We are really looking at how do we follow the contract for 2010, recognize the volumes and support Airbus in the long term.

Edward Marshall - Sidoti and Company

The recent supply agreements, I want to circle back to some of the comments made, but also does that change any of the old supply minimum requirements that you had to take?

Dawne Hickton

There are no changes to our current supply agreement with Osaka, no.

Edward Marshall - Sidoti and Company

So you are still taking the required minimums at this point?

Dawne Hickton

Yes.

Operator

The next question comes from Chris Olin from Cleveland Research.

Chris Olin - Cleveland Research

I want to just make sure I understand exactly what’s going on with the Airbus because it seems to me the problems within that channel originated in like May of 2006 with the A380 going through all the problems.

That created this big channel fill that was being worked down. I'm confused on exactly what has changed and now when you look at 2010 and 2011 because if you look at the A380, they're always talking about 10 jets and then there wasn’t a whole lot of metal go into the transport, what are you seeing within that that’s creating concern looking outward?

Dawne Hickton

Again, Chris, I guess it’s the wording of the concern. We don’t have any concerns. We have a contract, under the contract, it was entered into a long-term basis to support long-term requirements and additional consideration where we built out our plans to support that long term.

Airbus agreed to provide as with 5 million pound minimum to support that over the long term. In the event, they don't take the 5 million, there are provisions of the contract where they pay for it, that mechanism is working.

What has happened globally has indicated that at the moment, they did not need all of that 5 million pounds in 2009. In 2010 they have advised us they do not need all of that 5 million pounds. Whether they choose to take it as we have seen other OEMs do under their supply agreements and stockpile it or whether they choose to pay for it, is the decision that is really in Airbus’s court.

We are certainly willing to discuss with them options surrounding that which is really why today we are in the discussions, what is that product mix going to be, what will the production schedule be? Will it be the 2.5 million they believe they need right now or will it grow to that 5 million pound. And we expect to finish those discussions when we finalize that. We will have more to say about what we expect our production to be for the full year.

Chris Olin - Cleveland Research

You made some reference that maybe they would not be the material in 2011, too though, did I understand that correctly?

Dawne Hickton

What they have told us for 2010 is that their current needs are less than the 5 million pounds. Depending upon what happens with 2010 and how much they take may impact what their requirements will be in 2011.

Chris Olin - Cleveland Research

Is there something you can say to make people feel a little less nervous about the Joint Strike Fighter. You said that you’re talking about supplying 2 million pounds I think it was 2011. There's a talk with all these revising schedules and it does not seem it has the full support that it used to have.

Are we concerned longer-term about how many they are going to produce?

Dawne Hickton

I am not concerned longer term. We have been in very frequent communication with Lockheed. I personally was involved in discussions where this surfaced a couple of weeks ago at the Pentagon.

I think there is very strong support for that program. I do think there's a lot of concern for the cost of the program going forward and I believe all I can tell you is that I'm sure there is lots of discussion going on how to address some of that costs. Recently there’s a lot of activities, payments will not be forwarded to Lockheed as I understand, about a $600 million payment, but overall the production schedules that we are receiving from Lockheed supports the forecast as we put it into our order book for the next couple years. There has been no indication whatsoever that the long term 2400 purchases on the domestic side are at risk. So that’s about all I can say.

Operator

Our next question comes from Avinash Kant from D. A. Davidson & Company.

Avinash Kant - D. A. Davidson & Co

As you are talking about Airbus’s requirement being half of what the minimum is in 2010, does that mean that you’ve already agreed to this kind of shipment level for ‘010 with them?

Dawne Hickton

That agreement has not yet taken place. Under the contract, they have a requirement for 5 million pounds. They can either take that or they can pay a value for it. As of right now, and normally in the December-January timeframe, we wouldn’t be receiving our forecast from our main customers, projecting at our projection levels for the year. In this particular case, the early indications from Airbus had been that they are not going to require in 2010 the full 5 million pounds. So we are in discussions right now on what that ultimate level will be during the year.

Avinash Kant - D. A. Davidson & Co

So basically the discussions are going on two fronts, one is almost $18 million of shipment that did not take in ’09 and also the ‘010 that they are talking to you about that has not been agreed upon yet, right?

Dawne Hickton

I would say it a little bit differently. 2009 is behind its. The only discussion related to 2009 is calculating the value and that’s really just kind of a true up of what the missing volume and what is the value of that missing volume. That’s 2009, 2009 is over. 2010 is really a production issue. Yes, those discussions are also going on.

Operator

Our next question comes from Patrick McCarthy from FBR Capital Markets.

Patrick McCarthy - FBR Capital Markets

I was hoping that you could comment on gross margins during the quarter, clearly some puts and takes in there, if you’re looking at a core gross margin for the quarter, do you have a sense as to what that would have been

Bill Hull

Let me give it to you by product group. The TI Group was basically a 0.6% gross margin on net sales. Fab was 9.8% and distribution was 14.5%.

Patrick McCarthy - FBR Capital Markets

Then you mentioned the cost situation, the cost taken out of the business in 2009, do you have expectations on what might come out of the business in 2010 or you feel you are where you should be?

Dawne Hickton

At the moment, our focus in 2010 is going to be on cash and cash management, not so much on further cost reductions. We are starting to see the ramp up on the 787. So one of the issues we have is we have to balance any further cost reductions against our ability to ramp up when the market starts to pick up.

We are starting to see with the 787 net pick up and also ultimately, as we get toward the end of the year, you are going to start to see some activity on the mill product side. So in both cases, we need to balance, really I wouldn’t see any further cost reductions, but we are going to keep a very close eye on our cash management this year.

Operator

Our next question comes from Adam Wilson from Citi.

Unidentified Analyst

Has there been any talk about deferrals related to the $1.1 billion contract with Airbus that’s scheduled to pick up in 2010?

Dawne Hickton

The only discussions are really with the short term, what we are looking at in the needs for 2010 and how that may impact 2011.

Operator

Our next question comes from Gautam Khanna from Cowen and Company.

Gautam Khanna - Cowen and Company

I wanted to understand a little better on the Airbus agreement, are you totally indifferent as to whether it’s a take or a pay, does it true up to your operating profit contributions, they just write you a check or is there some other benefit to actually producing the mill?

Dawne Hickton

Certainly we are in the business to make the metal and we would rather be producing titanium and that’s in the best interest long term for the customer that we supply them the product they require. Short term, it’s actually beneficial to us for the payment. In other words it’s higher than the operating margin.

Gautam Khanna - Cowen and Company

Can you walk me through your calculation of the $17 million or 18 million that you would expect, is that what the sales will be and with no associated costs and that’s why it would be all through the bottom line?

Dawne Hickton

That is correct. There’s approximately roughly a million pounds that was not taken into the 5 million. Under the pay provisions, we trued that up based upon an estimate looking at the lower priced product and it’s totally straight to the bottom line.

Gautam Khanna - Cowen and Company

Do you have sense for, if Airbus does not take that million and then takes 2 million instead of five next year, at what point their inventories would actually be in balance, at what point in time? But there could be a positive obviously as they destock and write you a check in the interim.

Dawne Hickton

I am not sure I followed your last comment there. From a certain standpoint, you can look at, I don't think it does the industry any good for people to order any material and let it sit in inventory. Certainly we saw the impact of that over the last two years. So I think the best approach obviously is to balance the demand against the growth that’s expected in the next couple years.

I really can’t say more than that because frankly those are the discussions that are taking place right now. As Airbus is looking after a forecasted demand and truing that up against what their true needs are under their program.

Gautam Khanna - Cowen and Company

Do you have a sense from the Airbus suppliers who probably in some cases supplied Boeing as well, are they allowed to use the Boeing products that has been bought above the current needs instead of the Airbus stuff? Is that what actually is causing this pressure, was it specifically in the Airbus supply chain?

Dawne Hickton

I don't know that I can give you the answer you want on that. Our sense and what we know is strictly the Airbus supply chain.

Operator

Our next question comes from Frank Haflich from AMM.

Frank Haflich - AMM

Can you go over again what you said you will ship for the JSF, did you say what you ship was for this year and next year?

Dawne Hickton

For 2009, we were slightly under million pounds. In 2010 we are going to see that grow by maybe a couple hundred thousand more pounds, it will be a little bit over a million pounds. When we get to 2011, we expect that to be around 2 million pounds annually.

Frank Haflich - AMM

Also did you say at any point this morning that indications are Airbus needs only half of that 5 million pounds in 2010?

Dawne Hickton

What I had said is we have been advised by Airbus that their requirements for 2010 under their forecast that indicate that they need less than the 5 million pounds and it’s approximately half is what their 2010 requirements look like. We are in discussions right now with respect to our own production schedule on how much of that they are actually going to take and how that will play out.

Operator

Our next question comes from Robert Chapman from Chapman Capital. Please go ahead.

Robert Chapman - Chapman Capital

Dawne, could you just give us some of the key limitations that any customer has regarding take or pay when they do take rather than just paying in terms of marketing the product that they have inventoried, what exactly are they prohibited from doing with that inventory in the way of putting that back out into the channel of sorts to sell it to another party?

Dawne Hickton

There actually are different requirements with different customers. We do have a couple of other smaller take or pays where our customers are not permitted to sell the material in the marketplace before offering it back to us first.

Robert Chapman - Chapman Capital

Talk about the big cuts.

Dawne Hickton

On Airbus, that is there is no limitation.

Robert Chapman - Chapman Capital

So if they had a means and desire, they actually could increase the channel with inventory they wanted to reduce their own?

Dawne Hickton

Well they could, yes. There’s no limitation once they buy the material from us.

Robert Chapman - Chapman Capital

How practical is that in your view and have you seen it in the past?

Dawne Hickton

How practical is it. Well all I'm going to say is that one of the issues that was a major impact that was negative to this industry for the last two years was the fact that you had a very large inventory build of materials that was fitting out there on a take or pay contract. Frankly, our view is it’s not necessarily beneficial to the industry to stockpile a lot of the materials, it maybe beneficial to the customer.

Robert Chapman - Chapman Capital

No, I understand that, what I am trying to get a sense for is two options, you can stockpile and just stare at it or you can actually go out and try to market it and take it off your books which of course is not good for those who are in the business of selling the products by yourself. How practical is the second alternative? Is it difficult to develop the distribution to actually put that back out there into the market?

Dawne Hickton

I would say it’s relatively difficult only because if the demand is not there, the demand is not there. Plus you also keep in mind a lot of this depends on the mix of the products you are making and some of this you are making to a specific spec for a specific program.

If it is a military spec and military program, you are not going to be able to buy it up and stockpile it if you are a distributor, but there could be some of that going on and it’s happened in the past. The end of the day, if the demand’s not there, I am not sure somebody wants to spend millions to stockpile that for an indefinite period of time.

Operator

Our next question comes from Kuni Chen from Bank of America.

Unidentified Analyst

This is [Chris Brown] falling in for Kuni Chen. Is there any potential of silver lining for the Airbus contract issue and that you maybe able to substitute your sponge instead of using Airbus’s materials?

Dawne Hickton

Under the agreement, that is, we are responsible for the sponge after 2012. So Airbus supplied the sponge up until that period of time, after 2012 that’s our responsibility. That is within our planning with the new LTAs we put in place that commence in 2012 and beyond.

Unidentified Analyst

Assuming the 787 program stays on its current schedule, can the Fab business still be profitable in the second half of this year?

Dawne Hickton

You are going to see 2011 is the year when we turn the corner on Fab.

Operator

Our next question comes from Luke Folta from Longbow Research.

Luke Folta - Longbow Research

Did you say earlier that the value of the pay option is the same as what the value would be if you ship the material to Airbus?

Dawne Hickton

The value of the missing volume that we have calculated is at $17.9 million, we based it upon lower-priced product. One would assume had they taken a product it would have been a different mix.

Luke Folta - Longbow Research

There is some incentive, I understand. If it is the same price then why wouldn’t they just take it and even scrap it, sell it whatever they can get it for. That makes more sense now. And then secondly any pickup in spot market fundamentals. I know price is going to be stabilizing, have you seen any order flow from anywhere?

Dawne Hickton

We are starting to get a lot more inquiries, we are starting to see some activity. I think it’s a little too early in the year for me to be confident to say that we have completely turned the corner and things will get moving rapidly.

Having said that, I do think we have seen the stabilization, we’re starting to see the scrap pricing go up and we’re starting to get more inquiries, so I think that is all good news.

Luke Folta - Longbow Research

Can you give us the tax consequences from the charges in the quarter just so that we can come to an adjusted met number?

Bill Hull

The way I look at this is if you back out the sponge plants and the goodwill impairments, you end up with about a 25% tax rate on which we call normalized earnings. We arrived at that basically by applying the appropriate rates to those specific items which is around 36%.

Operator

Next question comes from Avinash Kant from D. A. Davidson & Co.

Avinash Kant - D. A. Davidson & Co

So the 25% tax rate is a tax gain at this point, right because you had losses?

Bill Hull

It’s a benefit because we had losses. So it’s a benefit of 25% on the $7.6 million adjusted operating loss.

Avinash Kant - D. A. Davidson & Co

Dawne talked about shipping ship sets in 2010. Did you give out the numbers of ship sets you did ’09?

Dawne Hickton

We have not, and what I am giving out is an equivalent value of the ship set and by that, we ship multiple parts and the value of one complete ship set is about $1.6 million under the program. So this year we expect it to be 30. Over the past 2.5 years, we have shipped a total of about 36 equivalent ship sets and we have not broken that down during the value specifically for 2009, frankly just because the manner in which the shipping occurred reflected aircraft from one all the way up to a 100.

Avinash Kant - D. A. Davidson & Co

If we knew what was in ’09, then it will help us model the ‘010.

Dawne Hickton

It was approximately, when you look at the equivalent value, about half of those prior shipment.

Avinash Kant - D. A. Davidson & Co

Less than 18?

Dawne Hickton

Right.

Operator

Our next question comes from Patrick McCarthy from FBR Capital Markets.

Patrick McCarthy - FBR Capital Markets

Does this end the drawback situation once and for all?

Dawne Hickton

I wish I could say it did. It does from this standpoint. We have filed, we’ve paid everything that has to be paid, anything that was challenged is behind us. We have now incurred the fines and penalties on all those claims and the only thing remaining is we have appealed, a very small portion are under appeal and if we lose that appeal, then that will be the end, but we have already accrued for that number, just a couple of millions.

The only other thing I will say to you is we have filed new recoveries as business has gone forward. We have not recorded any of that, we will not record those until we actually receive payment on the claims. And today it does about 11 million, we got about $11 million in reimbursements pending.

Patrick McCarthy - FBR Capital Markets

In the energy business, obviously you had the write-off in this quarter, how are you thinking about the business for next year, is it down 50%?. How can we model that?

Dawne Hickton

What we're looking at for the business is really equivalent this year to what we saw last year. We had a lot of pushouts at the end. So we don't think we are going to see a big pickup yet in 2010. Bill Strome, you want to add color to that?

Bill Strome

Patrick, we are seeing a pickup in [quoting] activity particularly for the clouding part of the business, but of course those are nice margins products, but not big revenue generators. Over all, the business might grow modestly in ‘10 based on what we see today.

Patrick McCarthy - FBR Capital Markets

You are expecting a significant deterioration from here?

Dawne Hickton

No, no expecting deterioration, just not expecting a lot of boost.

Operator

Our next question comes from Chris Olin from Cleveland Research.

Chris Olin - Cleveland Research

Do you have some contracts that on [occasion] rollover in January, I always prefer to have like annual deals. Can you provide us with any help on where those are being priced now or any kind of realization outlook for the mills?

Dawne Hickton

I think what we saw overall Chris is that right now keep in mind that $7.5 million, the overwhelming majority of that is that small contracts plus the Airbus. Other than the Airbus all those have the end of season them and what we are seeing is our overall pricing for the year is going to be down about 7%.

Chris Olin - Cleveland Research

I saw some are gaining maybe was, when your competitors was announcing spot increases if you will. Are you seeing anything like that holding in the marketplace?

Dawne Hickton

They are putting charges out, what we are seeing is some increased interest, I think it’s too soon to say any thing is holding in terms of continuing to grow in the increasing side. Scrap is rising though, that is good news.

Operator

Our next question comes from Edward Marshall for Sidoti and Company.

Edward Marshall - Sidoti and Company

I want to see if I understand what you're saying correctly. Other than the obligation or the lower obligation of the product mix that you have put out, the expectation or the timing of the stream of income really hasn’t changed. It’s the only thing that’s really changed here.

Dawne Hickton

Talking about Airbus?

Edward Marshall - Sidoti and Company

Yes, you expect to get paid. It’s just a matter of what time when you get paid, the only difference here is that the product mix changes, is that really the only difference?

Dawne Hickton

I guess I would look at this historically, go back a couple years and look at the Boeing take or pay arrangement we had. During the course of the year, you have minimum volumes.

You get to the end of the year, if they haven’t taken the volumes and you don’t have any other provision to try to adjust for that, maybe some quick year end shipment. Then at the end of the day, in January, you are truing up what’s missing and the way that it is accounted for is when we receive the payments under the contract. So here we have about a million pounds missing. We are working out the value, we believe it’s approximately $17.9 million.

When we get the payments for that, it will occur sometime in 2010. What we wanted to point out is if they don't take the full volume in 2010, you will see that same shifting into 2011 on whatever the payment is to cover the difference.

Edward Marshall - Sidoti and Company

Just remind me or refresh my memory, on the second Airbus contract that was signed, I believe there were some parameters that may have changed the original take or pay? When does that expire?

Dawne Hickton

That is not accurate. Under the first agreement, it is a flat 5 million pounds. Under the second agreement, it shifts to in later years to a percentage of their requirements, but within that percentage of the requirement, there is still a minimum volume requirement. It starts to grow from the 5 million pounds in later years.

Operator

And next question comes from Robert Chapman from Chapman Capital.

Robert Chapman - Chapman Capital

I am going continue on my last train of thought because I did not quite get the answer and I think Dawne wasn’t being clear. The gentleman who was announced as being promoted in October, either Richard Leone or (inaudible).

My concern is not so much this year or next year, the stock is trading off the concept of when the demand come back to absorb supply. That’s pretty much why your stock is down $3 today and why it was up $29 earlier and people are making guesses on when that’s going to occur. In past periods of massive overcapacity, whether it be commercial real estate, will the sublease market absorb new demand that comes into the recovery or telecommunications equipments where new demand is absorbed by people selling their servers and switches that they bought and did not need whether (inaudible) or otherwise.

That has dented and delayed the recovery for the primary manufacturers of objects of supply. So my concern is and if one of these three gentlemen can maybe answer, in your expertise, in your experience, is there a real risk that those who take product and stockpile could satisfy the demand that comes to the future not now, Dawne, but in the future and thus delayed RTI’s own ability to profit from the recovery by a certain amount of time, would it be months or years?

Dawne Hickton

I suppose theoretically if somebody wanted to take those investments and pay millions of dollars and stockpile the titanium, they are willing to take that risk, that would probably happen. I would be surprised particularly since the product line is spec to particular program and it would be very difficult when you are already have a contract with the OEMs to directly supply under those programs and they have requirements to meet those particular specs.

For instance, your concern would be why doesn’t Airbus take it and stockpile or sell it to somebody else, stockpile it and sell it back then to Airbus. The problem with that theory is that we have a contract with Airbus that grows as a percentage of their requirement. So you would find that party that might want to take that risk facing an inability to sell the product in the future.

Robert Chapman - Chapman Capital

There's no commodity aspect that any significant percentage of business without any risk?

Dawne Hickton

Not to our product line, no.

Operator

And our next question comes from Gautam Khanna from Cowen and Company.

Gautam Khanna - Cowen and Company

Just a follow-up quickly on the Airbus discussion, do you have to take the [cassock] sponge, the 8 million pounds where you obviously have to buy every year just to melt 5 million of mill product, but are you still obligated to take that full amount pay?

Dawne Hickton

No, the [cassock] sponge of tax out of it, and we're only taking the sponge from Airbus that will be required to make whatever product Airbus requires.

Robert Chapman - Chapman Capital

So through the year, did you presumably took 8 million pounds of sponge?

Dawne Hickton

No, our orders for [cassock] sponge will match whatever the ultimate request for mill product is to Airbus. We won't be sitting on extra inventory for that particular deal.

Robert Chapman - Chapman Capital

If they pay you rather than take, it is a plus for the near term, but obviously doesn’t lead with overstocking and there is no cost incurred, incremental cost occurred?

Dawne Hickton

It's obviously a plus if somebody just decides to pay under a contract. We don't produce, we don't incur the cost, we don't have to worry about the order of sponge. We are not in the business for the short-term. The purpose of the contract was to balance the party's needs short term and this contract frankly is showing exactly why that’s the value of the contract, but the value of the partnership would be for us to work with Airbus because there are some additional growth opportunities for our fabrication business.

So certainly as we move forward, we would like to partner with them in higher value products. So there's always that opportunity in the future, but short term absolutely, this is beneficial to us.

Robert Chapman - Chapman Capital

The new contracts with the (inaudible), with the price of sponge negotiated, is that approximately what you're paying (inaudible) now, and in the fab business, the quarter was pretty light from an operating profit perspective, was there any lingering overhang from the two contracts from the first half?

I think one went away in RTI Energy in August, the other one was the product shipment that were delayed. Was that the (inaudible) explanation that you can provide us to why the quarter was soft? That's all.

Dawne Hickton

I think what you're referring to in the first half we had those production problems deterred us in the first half, now those are behind us. What you saw though is the third quarter was strong as we sort of caught up from some of those production problems and then it kind of smoothed out and the other issue we had in the fourth quarter is we're starting to ramp up on the 787, they were incurring some of those costs without the shipment affected at the end of 2009. You just are not going to see those getting out until get into 2010. That’s really quite frankly a timing issue.

And the earlier questions you asked about the sponge, I really can't correlate the order sponge against the new contract. The new contract are based on an entirely different approach, it’s long-term fixed-price, our view when we get into those was really more on a decision whether we buy or build, so we price those based upon protecting our margins on the Airbus and the Joint Strike Fighter contract longer term. We are neutral on the sponge cost in the early years of Airbus because that's just the pass-through.

Operator

Your next question comes from Frank Haflich from AMM.

Frank Haflich - AMM

What you're seeing now for the bulk weldable scrap? What type is at the end of the last year, and is that related in any case to the ferrous titanium demand and the second question is when you talk about cooling it up for the lower price product, do you mean (inaudible)?

Dawne Hickton

Last time, I was looking and focusing on the bulk weldable was back in the last quarter, so I don't have a year end number for you, but last quarter was around $0.45 and most recently we saw it at $3 a pound, but the bulk weldable spot is moving up pretty significantly.

The [ferro tis] just slightly doubled, now you're seeing some strength in that, and recently the ferro ti ships are moving out, so yeah you're seeing some movement there in the steel industry side, and you're seeing movement in some scrap, which is a good sign for us.

Operator

Our next question comes from Edward Marshall from Sidoti & Company.

Edward Marshall - Sidoti & Company

So when I think about this, your mill is going to be running at about 25% less the volume that you ran this year, if your guidance holds true, you're going to see a 7% decline in pricing. So based on kind of look from the fourth quarter and carrying that forward, you expect the mill would be profitable in 2010?

Dawne Hickton

Right now it's all going to depend on where we end up with our Airbus discussions, which is why we're not in a position to provide a full-year guidance. What we know it’s 7.5 today. That could increase if spot spec does start to pick up and we see some of the movements that people are talking about. And so at this point, I really can’t give you any more information longer term than what we have already said.

Edward Marshall - Sidoti & Company

Clearly at 7.5 million pounds, you are running at less of a optimal level and you're going to see that pressure on margin.

Dawne Hickton

Absolutely.

Operator

Our next question comes from Gautam Khanna from Cowen and Company.

Gautam Khanna - Cowen and Company

Dawne just to explore your comment, your observations on scrap prices, in the last cycle there was a shortage of sponge, where it was [vastly] inflated rand the scrap rate is above sponge in terms of stock market pricing.

If this go around it looks like currently the sponge producers are operating at two thirds or less of utilization. Do you expect scrap prices to actually exceed the marginal cost of sponge, is it cycle or do you think there's a limit to where bulk weldable and the various chips can go and that they will always trade below the cost of sponge.

Dawne Hickton

In the near term in this market, I think your observations are valid. I don't think you are going to see the run up in sponge that you saw back in the 2005 timeframe, but a very reason, you said Gautam. I think you'll see some activity, I think you’ll see some movement and it really depends on how quickly the market moves.

Gautam Khanna - Cowen and Company

As a producer of mill products, you would always prefer sponge over scrap, right? Specially if the costs were about equivalent?

Dawne Hickton

If you are talking equal cost, the sponge is from a production standpoint favorable, but at the end of the day we put in the different hot furnaces over in our [Kent] facility so that we can manage through this and have maximum flexibility. So, the flexibility at the end of the day is really what’s driving our ability to use that, flexibility and the cost of it.

Operator

The next question comes from Frank Haflich from AMM. Please go ahead.

Frank Haflich - AMM

When you noticed that ferro-ti doubled, was that in price or in volume and second of all, my question was when you true up to lower price products, ingot?

Dawne Hickton

It’s both, the ferro-ti number I gave you doubling was price. Slightly more than double. Were you asking about the Airbus contract?

Frank Haflich - AMM

You are talking about to the lower price products.

Dawne Hickton

Right, I’m talking about the Airbus missing volume.

Frank Haflich - AMM

That’s what I meant.

Dawne Hickton

We calculated the $7.9 million making an assumption on product mix that was lower priced product, but not ingot. We don't supply ingot.

Frank Haflich - AMM

So you would be down the line like plate or sheet or billet?

Dawne Hickton

I am not in a position to give you anymore information, I have already given you for proprietary reasons but under the contract, that’s the value we provided.

Operator

Our next question from Luke Folta from Longbow Research.

Luke Folta - Longbow Research

Just regarding your shipment guidance for next year, the 7.5 million, does that include 5 million Airbus pounds?

Dawne Hickton

No, it does not include. It only includes about half of the Airbus. It includes the preliminary estimate of their 2010 requirement, whether they determined to take the full 5 million is still under discussion.

Luke Folta - Longbow Research

Regarding charges related to the sponge project, is that completely behind us and what you are expecting for Tronox, anything new there?

Dawne Hickton

We have taken the write-down on the sponge plants, that’s behind us, there could be some modest adjustments right now going forward but mostly we have got some equipment that we will be disposing off in the short-term. In terms of Tronox that matter is pending, we have filed a complaint pending in the bankruptcy court.

Operator

Our last question comes from Gautam Khanna from Cowen And Company.

Gautam Khanna - Cowen and Company

What do you anticipate or believe today the cost of sponge would in the stock market for aerospace grade application?

Dawne Hickton

I actually haven’t looked at that. Since we have got so much [things] sitting under our contract right now and we have s lot of inventory. Gautam, I don't know if you guys have looked at it. We haven’t even looked at it, we are not out in the market buying sponge.

Gautam Khanna - Cowen and Company

It looks like the contract is priced somewhere in those $6 range, but actually one of the spot market given it a low utilization, if you can get it for like five. Is that fair?

Dawne Hickton

I can’t respond to that. I am not in the market to buy sponge right now.

Operator

That was our last question.

Richard Leone

Thank you for joining us on today's call. The operator will now give you replay information. John, please go ahead to.

Operator

Thank you ladies and gentlemen. A replay of this call will be available in one hour and remain until February 16, 2010 using playback numbers 888-843-8996 for USA and Canada or International at 630-652-3044 and your pass code of 26181318. Thank you for participating. You may now disconnect.

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Source: RTI International Metals, Inc Q4 2009 Earnings Call Transcript
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