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Executives

Richard E. Leone - Director of Investor Relations

Dawne S. Hickton - Vice Chairman, Chief Executive Officer, President and Member of Executive Committee

William T. Hull - Chief Financial Officer, Chief Accounting Officer and Senior Vice President

James L. McCarley - Executive Vice President of Operations

Analysts

Arun S. Viswanathan - Longbow Research LLC

Kuni M. Chen - CRT Capital Group LLC, Research Division

Christopher Brown - BofA Merrill Lynch Petrie Divestiture Advisors

Gautam Khanna - Cowen and Company, LLC, Research Division

Stephen E. Levenson - Stifel, Nicolaus & Co., Inc., Research Division

Jonathan Sullivan - Citigroup Inc, Research Division

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Taryn Kuida - D.A. Davidson & Co., Research Division

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Patrick J. McCarthy - FBR Capital Markets & Co., Research Division

Frank Haflich

RTI International Metals (RTI) Q3 2012 Earnings Call October 31, 2012 10:00 AM ET

Operator

Welcome to the RTI Third Quarter 2012 Results Conference Call. My name is Dawn, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Richard Leone. Richard Leone, you may begin.

Richard E. Leone

Good morning, everyone. Welcome, and thank you for joining us today for RTI's Third Quarter 2012 Financial Results Conference Call. Today's call will be led by Dawne Hickton, Vice Chair, President and CEO of RTI. In addition to Dawne, Jim McCarley, Executive Vice President of Operations; Bill Strome, Senior Vice President of Finance and Administration; and Bill Hull, Senior Vice President and CFO, 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 disclaimers included in today's press release.

Now let me introduce Dawne Hickton. Dawne, please go ahead.

Dawne S. Hickton

Thanks, Rich. Good morning, everyone, and let me start off, I'd like to offer those of you on the phone who are calling in from the Northeast areas that have been impacted by the recent pretty horrific storm, we certainly hope you and your families are safe, and we wish you well in the cleanup efforts over the next few days and the next few weeks.

But let me start on this Halloween morning by stating it's a treat, and I think well worth noting that the third quarter for 2012 was RTI's eighth profitable quarter in a row and the seventh out of the past 8 quarters that our company has reported earnings growth on a quarter-to-quarter basis. Our numbers today reflect recovery, and it's not a trick, it's a recovery both in our industry and globally from the bottom of the financial crisis that has impacted us this past few years. I also think RTI's performance reflects that our strategy of supply chain integration and market diversification is working. I can't say for sure that we've broken the back of cyclicality, but I certainly do see that we've made progress toward of that goal.

A few of the highlights of our financial results. Our third quarter net sales were $189.1 million, and that compares to $143.7 million for last year's third quarter, a 32% increase year-over-year. And our operating income increased 68% to $12.9 million this quarter versus $7.7 million for the same period in 2011. We're reporting earnings per share of $0.19 against $0.07 last year in the third quarter. Our mill product shipments totaled 4.2 million pounds as compared with 4.3 million pounds for the same period in 2011, and our backlog at the end of the third quarter is at $582 million, and that compares with a backlog of $454 million last year. But I would note that some of the increase in that backlog does reflect the fact that we have the acquisitions of Advanced Forming and Remmele included, as well as the increasing backlog in our energy markets.

Bill Hull, our Chief Financial Officer, as usual, will provide details on each of our business segments a little bit later on the call. After he talks, I'll discuss our outlook for the rest of year and I will give some preliminary guidance for 2013. But I'd like to say at the outset that our Fabrication Group is gaining traction and this traction is about not only the performance of our 2 acquisitions but also improvements in our defense and energy markets this past quarter.

Before I turn it over to Bill, I do want to comment on a couple of matters that took place in the past quarter. This includes the International Titanium Conference, our new Martinsville plant inauguration ceremony, and some brief spotlights on our medical and energy markets. Let me touch briefly on our recent experience at this year's annual meeting of the International Titanium Association that was held in Atlanta, again, a conference that drew over 1,000 attendees earlier this month. It was productive for RTI in a number of ways. First, in big picture terms, I'm happy to report that executives from our key customers with whom we met, including Boeing, Airbus, UTC and some others, continue to see long-term ramp of commercial aerospace production is intact and on track. They do expect a relatively modest but still strong 2013, with productions accelerating in the years following to deliver their more than 8,000 commercial aircraft that are in the current backlog, the largest in the history of the commercial aerospace industry. Second, is as our custom during this Titanium conference, we met with our sponge suppliers and finalized negotiations for next year's requirements. Based upon the outcome of these meetings, we expect our overall raw material cost for next year to be relatively flat to this year's costs. And third, we continue to make progress in discussions for new opportunities in the engine markets. Specifically, we finalized negotiations with a major engine OEM for a long-term supply agreement that will be the anchor customer for the qualification process for our new EB furnace. Such furnace we expect to commence melting product by the end of the year. Once this contract is signed, which I would also expect to take place before year end, we will be in a position to more fully disclose its timeframe and scope. Suffice it to say, I'm confident in our decision to move forward with the EB furnace.

Now immediately following the ITA conference, we celebrated the start of commercial operations at our state-of-the-art forging and hot grinding facility in Martinsville, Virginia. That plant is an important new link in our integrated supply chain, adding the capacity to meet the needs of the coming accelerated aerospace production ramp. We welcomed top procurement executives from Toulouse, France to our launch ceremony, and much of the plant's first output will be to ship for to Airbus for use on the A350 Extra Wide Body. And a week after Martinsville, I was pleased to lead RTI's team back to Toulouse, France to mark the Airbus' celebration of the company's first assembly line for the A350. These ceremonies provide experiential evidence of the continued strengthening of the Airbus and RTI's strategic relationship and the progress of the aerospace ramp.

Another highlight of the quarter, we met with the head of the Medical Device division of one of the world's largest healthcare companies. This is the highest-ranking executive to visit our operations, and she came to see firsthand the breadth and depth of our highly automated engineering, design and advanced production capabilities. During this meeting we were able to develop a number of opportunities and ideas on how to expand our relationship with this key customer, and we are working to grow a strategic relationship that will support the customer's growth needs. In support of these efforts, and while we're on the subject of Remmele, the integration of the Remmele acquisition is proceeding on track and as expected.

And then another highlight of the quarter and now I know I'm starting to sound a bit like a travelogue, but we did have a series of meetings in Houston with executives of BP, Shell, Anadarko, and other energy market customers. Their message was clear, and it provides clear opportunity for RTI. We're growing fast, we've got a lot of business to do, and we want to make sure that RTI has the capacity to meet our needs. Much of that discussion focus on offshore oil and gas production. This is an area we've been suggesting for some time holds great potential for RTI. And it's because offshore oil and gas production at depths that exceed more than 40,000 feet under the ocean surface make titanium risers, stress joints, downhole casing, tubing and other specialized equipment increasingly cost-effective when compared with steel and other components

The weight, heat, pressure and corrosion resistance properties of titanium give us special advantages in the extraordinarily hostile environments of deep ocean exploration. We're listening to our customers, and we're working to make sure that we have the capability and capacity to meet demand growth in our energy business, whether it be through expansions, acquisitions or a combination of the 2.

Now, while I've outlined a lot of positive activity during the quarter, there are, of course, a number of familiar uncertainties that could affect our expectations going forward. The most current potential negative is the threat of sequestration in the U.S. and the impact it could have on our global economy. Most important for companies such as RTI is how the mandatory defense spending cuts could hurt our business. But as the those of you, who follow RTI know, we've been planning for changes in defense spending for some time and we've prepared for the contingencies. This has included plans to deal with cuts and spending, but also including the bufferings of some material so that in the event sequestration is deferred, we will have enough product to meet demands for the Joint Strike Fighter no matter how the schedule is impacted. And as to specific financial impacts to RTI, I can tell you today that a deep dive into the numbers shows us that, should sequestration occur as currently mandated, the worst case impact to RTI's top line revenues would be a decrease of up to $15 million of revenue. These calculations are based on our recent meetings with the Pentagon and a program by program review with defense officials of all spending cut recommendations being prepared to comply with sequestration law.

Consequently, borrowing unforeseen circumstances in the next few months and based upon the steps we've already taken to minimize the impact of these defense cuts such diversification of the markets, we believe the immediate impact to us would not be material.

So let me sum up before I turn it over to Bill. The third quarter financial performance shows continuing strength and profitability for RTI, the fundamental trends driving demand for our products and services remain favorable and we continue to strengthen our existing customer relationships and develop new opportunities to promote and advance our growth.

With that, I'll turn it over to you, Bill.

William T. Hull

Thanks, Dawne. Let me begin with our Titanium group. For the third quarter of 2012, this group posted operating income of $2 million on sales of $85.8 million, including intersegment sales of $43 million. During the same period in 2011, this group had operating income of $4.9 million on sales of $87.7 million, including intersegment sales of $42.7 million.

Gross margin on net sales for the quarter was 21% compared to 22.2% for the same period last year. For operating margin, the year-over-year decrease was due to a $2.4 million charge related to an electrical transformer fire at our Canton facility, as well as higher raw material cost than previous period. New product shipments for the third quarter were 4.2 million pounds at an average realized price of $19.01 per pound. That compares to mill product shipments of 4.3 million pounds in the third quarter of 2011 at an average realized price of $18.99 per pound.

For the third quarter of 2012, the Fabrication Group generated operating income of $76.1 million on net sales of $87.9 million. For the same period in 2011, this group had an operating loss of $1.5 million on net sales of $40.2 million. Gross margin on net sales for the quarter was 21.5% compared to 12.4% for the same period last year. The improvement in the group's results reflect the impact of the Remmele and Advanced Forming acquisitions and a strong contribution from RTI's energy market projects. Additionally, costs associated with the 787 Pi-Box program were lower sequentially, as well as compared to the same period in 2011.

For the third quarter 2012, the Distribution Group reported operating income of $4.8 million on net sales of $58.3 million. These results were very consistent with the prior period where in 2011 we had operating income of $4.3 million on net sales of $58.4 million. Gross margin on net sales were 17.1% for both quarters. Compared to the prior year, these results reflect increased demand for the group's titanium products, both in commercial and military markets, offset by lower demand for non-titanium products.

For the full year 2012, we expect our tax rate to be approximately 35%. Our interest expense for the year is still forecasted at $18.5 million. And finally, we contributed $18.1 million to our pension fund this year.

Dawne?

Dawne S. Hickton

Okay. Thanks, Bill. Looking ahead, we're confident about the outlook for the balance of 2012. We do expect we will meet the annual guidance we gave of reaching and possibly exceeding the 60 million pounds of titanium mill product shipped, and we expect our operating income to approach the high end of the range we gave up $45million to $50 million.

Now in terms of preliminary guidance for 2013, we do anticipate that mill product shipments will be similar to the current year and raw material prices will remain largely flat. I would expect that improvements in our Fabrication Group would continue as we move from roughly 43 ship sets on the 787 Dreamliner this year to over 65 ship sets next year, as well as we expect to see continuing improvement in our energy and medical markets.

We're expecting our CapEx to be down slightly next year from this year where we're in the range of right around $65 million to $70 million. Next year were expect it to be approximately $50 million at this point. This is mostly due to the fact that the majority of the spend for our titanium group is now behind us, and we would expect that any spend next year may occur more likely in our Fabrication Group. But a word of caution: It's very important to note that for the reasons we are all intimately aware in this call, China, Europe, sequestration, next week's election, there's a lot of uncertainty. So although we're pleased with the progress that the company has made, I'm not expecting 2013 to be a breakout year. And there's a little too much uncertainty today to be able to forecast when the acceleration in our business will occur. But we do look forward to providing more detailed guidance for 2013 when we get into next February as we usually do.

So in conclusion, 2012 year-to-date's been a good one for RTI and we expect to finish strong. We continue to see alignment of our strategy and our competitive positioning with market trends and opportunities, and we believe the outcome will produce continued advancing growth for RTI.

With that, we'll turn it back to you Dawn to take your questions or Rich.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Arun Viswanathan from Longbow Research.

Arun S. Viswanathan - Longbow Research LLC

I guess the first question had to do with fabrication, the results were better than I expected, and I guess a lot of folks expected. So congrats on the positive momentum there. Have you guys reached some kind of a more representative level of the earnings power of the segment by this time?

Dawne S. Hickton

Well let me say this. First, thanks for the congratulations; second, we did get a big boost from energy, and these are a lot of project-based opportunities. Can't -- I don't want to guarantee there's going to be a smooth boost going forward, maybe Jim, you may want to comment a little bit on that.

James L. McCarley

Yes. This is Jim McCarley. I think the better way to characterize the Fabrication Group is that as we deliver in some of the energy projects, we're going to see sort of peaks and valleys that show up. So I'd really recommend that you sort of look over the last 3 quarters, and you can pick up some trends that are happening there. And I think balancing out that way, you -- really look at any one individual quarter and try picking that off from a net change to the prior quarter given the cyclicality of the energy deliveries. It's probably safer to smooth that over at least a 6-month period.

Dawne S. Hickton

But overall, we are seeing the improvements in our Fabrication Group operationally. So yes, good quarter.

Arun S. Viswanathan - Longbow Research LLC

Yes, and just a follow-up, you mentioned that your backlog was up to $582 million last quarter from $450 million a year ago. And you mentioned that, that was mostly downstream and energy like Remmele. And so is that -- would that, I guess, portend continued strong results in fabrication? Is that where most of the backlog is headed?

Dawne S. Hickton

Well, I don't want to say it was only those. I just wanted to highlight that the large jump from $480 million to all the way over to $582 million included the -- not to forget that we had to the acquisition in there, having said that, we're seeing strength across our entire backlog but yes, we've got some energy strength in there and yes, fabrication strength.

Arun S. Viswanathan - Longbow Research LLC

Okay. And then the other question I had was again on distribution. Similarly the margins there were a little bit better than expected. Any comment on what's driving that business? Was there some inventory reduction or was this quarter unusual in any way?

Dawne S. Hickton

Not particularly unusual. You're really just -- we're looking at a mix of the product. It was higher titanium product than some of our other inventory that we had there.

Operator

Our next question comes Kuni Chen from CRT Capital Group.

Kuni M. Chen - CRT Capital Group LLC, Research Division

I guess, just first off, on the raw materials side, with your annual negotiations for sponge. I know your overall comments talk about your whole raw material baskets, and what's in inventory, and what's purchased under longer term agreements and whatnot. But just for the annually priced piece, can you give us a little bit of additional color on that? Maybe a percentage range for how that moves up next year?

Dawne S. Hickton

Yes. Kuni, we're just going to leave it as kind of looking at the total mix because as we -- right now, it's a little premature for us to determine exactly where all of our mix is going to come from. We're seeing scrap pricing coming down. So it really is just going to depend on how we play on it in the next year. But right now as we look at it, all we're willing to say is that we expect our total raw material cost across the year to be pretty flat to this year.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Okay, right. Fair enough. Let's see, I guess, just on the fab side of the equation, I think you said for this year you're looking at 43 ship sets.

Dawne S. Hickton

Right.

Kuni M. Chen - CRT Capital Group LLC, Research Division

So that's -- what did you do in the third quarter and kind of what's left for the fourth quarter?

Dawne S. Hickton

Yes. Well, if you look at the first half of the year, we did approximately 17 equivalent ship sets, and we're starting to see that ramp up and we got through about 13 equivalent ship sets in this quarter. But we're smoothing it out, so we would expect the fourth to be right around that 13 again. And then we'll start to see a pickup as we move into the first half of next year.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Right, okay. And then one last quick one, I think there was $1.6 million of asset charges. Can you just give us some more detail on that?

William T. Hull

Yes. Kuni, that was related to the Canton fire that we had. Those are -- that was the asset impairment related to that fire. So you had $1.6 million in asset-related charges net you had about $800,000 in other costs related to production absorption that was in cost of sales.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Okay, so the 1.6 was part of that overall 2.4?

William T. Hull

Exactly.

Operator

Our next question comes from Chris Brown from Bank of America Merrill Lynch.

Christopher Brown - BofA Merrill Lynch Petrie Divestiture Advisors

I just wanted to start off on the flat sort of volume guidance for 2013 for the titanium group. I guess, sort if given the production ramp expected at Airbus and the other titanium consumers out there. I guess, what are some of the moving parts if you're doing 5, 6 million pounds this year? Is that being sort of offset by lower defense demand, I guess, or could you sort of walk us through that?

Dawne S. Hickton

Sure, what we're looking at right now is the real -- no, let me start over. Let me focus on Airbus for a moment. The key with Airbus is they have done a very good job of managing their inventory levels and not kind of getting out too far ahead of themselves. So what you're seeing is this year and next is a very modest ramp before they start to hit their full production needs as you move into '14 and beyond. So they've been managing that inventory pretty well. So I think we'll see where we are today and where we are next year will be pretty consistent with what their requirements are. JSF, obviously, we're looking at a little under 2 million pounds this year and we're not projecting much more than that next year. That will wait and see how that all plays out. And then because you still have a little bit of the inventory overhang on the other side of the ocean across the market, you're not seeing a lot of pickup in the spot yet. So what we're seeing right now is a solid base of our business and that's what we're projecting for next year.

Christopher Brown - BofA Merrill Lynch Petrie Divestiture Advisors

Okay, and then other than the Joint Strike Fighter, what other sort of defense programs should we be sort of watching for when sequestration potentially happens? Are there any sort of specific programs that you guys are tied to more than others?

Dawne S. Hickton

No, I mean, really, what I've told you is the impact we see. We've got a little bit on multiple programs. We're supplying to, with the reduction in the JSF, there's been a pickup in some of the other fighter planes, and then you've got like the C-17. So we're supplying across the supply chain there. But the real question with sequestration is they're going to balance this across the program. So we don't see the ones we're working on as programs that will get hit more than what we have indicated. Plus, overall, from a diversification standpoint, we've continued to reduce our overall profile as a company. A couple of years ago, we were almost 40% defense. Last couple of years we were in the high 20s. We're coming down from that. So the impact on us will be less. But the big program for us is really JSF.

Operator

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

Gautam Khanna - Cowen and Company, LLC, Research Division

I was wondering if you could comment a little bit more on the 787 learning curve you've experienced and whether it's profitable now, and if not, how we should think of that changing over 2013?

Dawne S. Hickton

Well I think as we've said previously, that doesn't -- the profitability hits when you get above 6 ship sets a month, and we're not quite there. So while we're doing well in that program compared to where we've been in the past, and we're making a lot of improvements, the second half of the year we're at 26 ship sets over 6 months. Next year, we expect to ramp that up. So I think as you move into next year, you'll start to see us towards the second half of the year, into the third, maybe the third even the fourth quarter, you'll start to see profitability in that program for us. I don't know, Jim, if you have any other learning curve comments you want to make?

James L. McCarley

Well, Gautam, I think it safe to say that we're 9% through the learning curve. We continue to have a few issues around our welding operation that we continue to work with the entire team on. And we've got a few more of those types of items that we need to wrap up and put behind us. But the bulk of our issues as far as the learning curve I think are in our rearview mirror at this point.

Dawne S. Hickton

But the one add I'll make, Gautam, and you really haven't asked this, but for the Montréal operations individually, that's just a part of our 787 program. But in Claro itself, we've been able to do some diversification there. We now have -- we're growing other customer opportunities there, including the Airbus machining opportunities.

Gautam Khanna - Cowen and Company, LLC, Research Division

And maybe just to put some nuance on the question, are you -- do you feel like you're profitable on a kind of gross margin basis? I understand there's the absorption impact of having overhead and what have you that's not fully absorbed, but do you think that you're actually making money on a kind of -- on a unit basis, x the SG&A piece that's unabsorbed?

William T. Hull

Gautam, we're not there yet. We're within maybe a couple more ship sets from getting to that point. And it really has to do with -- the last 10% of the learning curve does have a pretty significant cost component into it. There's items we're able to use but we're reworking, and so from that standpoint, that's a much bigger drag. Until we get that solved, I don't think we can get to a profitable gross profit level so -- without the higher volume.

Gautam Khanna - Cowen and Company, LLC, Research Division

Okay. And that's a volume dependent factor in your view, okay. Also maybe could you comment -- I remember at ITA, Dawne, I don't if you saw the Airbus presentation showed 20%. I think it was consumption growth of titanium in 2013. It wasn't clear from the slide. But how do I square that with kind of your guidance for flat shipments overall in terms of the time mill next year?

Dawne S. Hickton

Well, remember we have -- our market share of their requirement is on the 30% to 35% range. So if you look at where we are at around that $6 million that's right around the 30 -- that's certainly 30% of that, an opportunity for more. So I think that's actually consistent with where they are.

Gautam Khanna - Cowen and Company, LLC, Research Division

Okay, and then the last one, if you wouldn't mind, what was the actual free cash flow in the quarter and what was the CapEx spend year-to-date? I couldn't tell from the cash flow summary you provided.

William T. Hull

Yes. Gautam, the CapEx spend year-to-date is about $48 million.

Operator

Our next question comes from Steve Levenson from Stifel, Nicolaus.

Stephen E. Levenson - Stifel, Nicolaus & Co., Inc., Research Division

Just a little bit more on the ITA conference. Boeing indicated that their over-inventory situation should be resolved in 2014, and given the lead times that you have now, and maybe you could give us some details on that and lead times that you expect, when do you think you'll begin to see the pickups in orders even if you don't yet have the pickup in shipments next year?

Dawne S. Hickton

Okay, I'm not sure I understand your question. Let me just backup. Your -- what the Boeing individual executive said at the ITA is consistent with what we've been hearing in the marketplace but I mean that's really Boeing and their inventory levels on mill products. But that is consistent. End of '13 or into '14 before they level off their inventories. But in terms of our shipments, keep in mind on these programs, we are not the contracted supplier of mill product to Boeing for the 787. So that really doesn't impact us directly. The indirect impact of that is so long as you have a lot of inventory out in the marketplace...

Stephen E. Levenson - Stifel, Nicolaus & Co., Inc., Research Division

Right. That's what I was concerned with.

Dawne S. Hickton

Yes. It puts a damper on the spot market, opportunities out there that may surface when people draw down that inventory. So I do -- I think there's an opportunity maybe as you get into second half of 2013. You might see the spot market pick up. But quite candidly at this point that's too far out for us to forecast that. So we're really sticking to our base solid business that we know we're going to be able to ship.

Operator

Our next question comes from Jonathan Sullivan from Citi.

Jonathan Sullivan - Citigroup Inc, Research Division

I have a question on the Distribution Group. I was wondering what drove the year-on-year increase in sales of titanium products within the Distribution Group? Is that an Airbus issue or what was behind that?

Dawne S. Hickton

Airbus is a large component of it, but a lot of it is across-the-board. And you've seen the overall pickup as we come out of this recession.

Jonathan Sullivan - Citigroup Inc, Research Division

And then in terms of -- on the titanium group, the fact that the pricing was essentially flat year-on-year, despite some declines in ingot and some of the input cost, was there anything there from a mix management perspective or does that really just have to do with the fixed pricing contract?

Dawne S. Hickton

It has much more to do with our long-term agreements and our ability to smooth out that cyclicality for good or bad. So in the down market, it benefits us.

Operator

[Operator Instructions] Our next question comes from Sohail Tharani from Goldman Sachs.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Of the 16 plus million tons of titanium you're going to ship this year, how much is going to the nondefense applications? Do you have any idea?

Dawne S. Hickton

16 million pounds, not tons.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Oh. I'm sorry, pounds, yes.

Dawne S. Hickton

I'd love for it to be in tons but I think that would put us over the top. The majority is commercial aerospace, so we've got probably -- we've got at least roughly 2 for the Joint Strike Fighter and then under another million on another program is not even...

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Is there any industrial application you're shipping out to also?

Dawne S. Hickton

Well, 2 comments. From a pure industrial market standpoint, we're not a producer of CP titanium. So we don't ship into those markets out of the mill. But we characterize within our industrial, our energy markets, and there is some modest shipments in terms of pounds into the energy markets, and medical for that matter, outside of commercial aerospace.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Got you. Also another question on sponge. You mentioned flattish pricing. Does it mean that it doesn't include any of the salvages on ground or is it actually a flattish price for what you're going to be buying in the year?

Dawne S. Hickton

What I've spoke to with respect to flat costs of our raw materials going into next year is our total raw material cost. As you know, the single largest component in the manufacturing of titanium is the raw material cost. So combination of inventory purchased sponge, purchased alloys, purchased scrap. Across-the-board we're expecting it to be flat to this year in total cost.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

And if we look out beyond that, because the whole titanium got sell all the price are down, that could be some, even relief in 2014, you guys would think?

Dawne S. Hickton

I think that's a fair assumption for the future.

Operator

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

Taryn Kuida - D.A. Davidson & Co., Research Division

This is Taryn Kuida filling in for Avinash. Most of my questions have been answered, but just a couple of housekeeping items. I was just wondering what your D&A was for year-to-date.

William T. Hull

We're about $30 million year-to-date.

Taryn Kuida - D.A. Davidson & Co., Research Division

$30 million?

William T. Hull

Yes. I say we're going to do $40 million this year.

Taryn Kuida - D.A. Davidson & Co., Research Division

Okay, and then your tax rate for next fiscal year, what do you expect?

William T. Hull

Well, it's -- I would say it's a little bit early for us to finalize that, but it's going to be in the 35%, 37.5%. That's what we would look for.

Taryn Kuida - D.A. Davidson & Co., Research Division

Perfect. And one more, if I may, for the titanium group, I understand that there was a higher than anticipated impact from the power outage, but once this quarter is past, how should we think about the margins going forward?

Dawne S. Hickton

I think they'll smooth back up to where you saw previously. I mean I think you can look back -- check my notes here. But -- yes, I mean, I think you can look back a quarter or 2 and kind of smooth it out.

Operator

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

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

A question on the medical market. How big is that piece of your business right now overall, and what opportunities are you seeing there?

Dawne S. Hickton

It's relatively small today. That was part of the -- almost half of the Remmele acquisition was the medical side of it. So it's less than 10% of our total revenue. But having said that, we see some pretty significant growth opportunities that's being driven by a lot of what's going on in the marketplace, just aging population, and where we sit is in the medical device market. We have relationships with the largest OEMs in that market and just a lot of really strong opportunity for growth.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Has that piece of the business grown year-to-date from a top line perspective?

Dawne S. Hickton

Yes. It's already grown about 5% to 7% year-to-date. We see continuing opportunities to grow it. And we think it's a really nice market for us.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

And then just a follow-up if I could on Martinsville, how should we be thinking about the ramp there into next year? I apologize if you already commented on that.

Dawne S. Hickton

Yes. I'm going to let Jim speak to that.

James L. McCarley

Well, the key to Martinsville is really we're displacing what work we used to send outside, and we're bringing that work back into our own organization so from a cost standpoint, it's really -- we're going to be on par with what we were doing before. It really helps us on sort of the other side of the equation, which is our cycle time and inventory reduction type of opportunity.

Operator

Our next question comes from Patrick McCarthy from FBR.

Patrick J. McCarthy - FBR Capital Markets & Co., Research Division

My question was on the EB furnace contract that you had mentioned. I know it hasn't been signed yet, but I was wondering if could give us a little bit of a flavor on it. I mean are you a lead supplier or a secondary supplier, safety supplier? Is there anything you can kind of give us on the details side?

Dawne S. Hickton

All right. Let me just say -- there's not a lot I can say until we sign that and make it public. This is an opportunity we've had. We finalized the negotiations. It will be the anchor for EB furnace, and it's really a key customer relationship for us. We will not be the major supplier to that particular engine OEM. But we will be a key supplier going forward in the future.

Operator

Our next question comes from Jonathan Sullivan from Citi.

Jonathan Sullivan - Citigroup Inc, Research Division

So okay. I just had one follow-up question on the fabrication comment before. I believe the comment was made that in terms of looking at sort of a more normalized run rate, that we should look at the last couple of quarters. Is that from an operating margin perspective that the 3Q operating margin would be higher than sort of an expected run rate? Is that the way to interpret that comment?

William T. Hull

Yes. My answer would be yes. We saw some things in Q3, which was some work that could have shipped in Q2 and other work that might have shipped out in Q4. It really depends on -- really, these projects are very technical and as you work through the details of them, in some cases, you're able to accelerate the plan and others, you see sort of things that hang in the right at the end of the line. So I would not bridge Q2 to Q3 and move that trajectory going forward as a baseline.

Dawne S. Hickton

And if you look at the numbers over the last 3 quarters, you're seeing continued positive momentum. We just don't want you to get out ahead of us. I would look at those 3 quarters and more, normalize them.

Jonathan Sullivan - Citigroup Inc, Research Division

Normalized them from a profitably standpoint.

Dawne S. Hickton

Right.

William T. Hull

Right.

Operator

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

Gautam Khanna - Cowen and Company, LLC, Research Division

Yes. I know you're going to put this in the queue, but could you give us the gross margin by each segment first? And then I have a follow-up.

William T. Hull

Sure, Gautam. The titanium group was 21% for the quarter. The Fab group was 21.5% for the quarter, and Distribution was 17.1%.

Gautam Khanna - Cowen and Company, LLC, Research Division

Okay. And Bill, maybe you could -- now that we're turning the corner here on profitability, can you remind us about the convert accounting and when that actually gets fully diluted to 6 million shares? At what level of earnings is it -- gradual [ph] tax income?

William T. Hull

Yes. I would tell you that it's not going to happen this year. It's not going to happen next year. So I mean that's about all I can say at this point, really.

Gautam Khanna - Cowen and Company, LLC, Research Division

Okay. it happens gradually, right? It doesn't -- it's not an all or nothing...

William T. Hull

Right, it's not a cliff. It will -- it moves up variably as you become more profitable.

Gautam Khanna - Cowen and Company, LLC, Research Division

Got it, and I think you mentioned Remmele's sales contribution in the quarter, but could you talk about the operating income of benefit as well? Contribution from that?

William T. Hull

Yes, it was about $1.9 million operating margin, all they contributed.

Gautam Khanna - Cowen and Company, LLC, Research Division

Could you repeat that?

William T. Hull

$1.9 million.

Gautam Khanna - Cowen and Company, LLC, Research Division

$1.9 million, and what about Aeromet?

William T. Hull

That was about $400,000. These are all after purchase accounting adjustments.

Gautam Khanna - Cowen and Company, LLC, Research Division

Which is still going on, is that fair?

William T. Hull

Oh, yes.

Gautam Khanna - Cowen and Company, LLC, Research Division

When does that actually roll off?

William T. Hull

Well, I mean, that's going to be with us for a while because we had to fair value a lot of the assets, and so you're depreciation steps up. But things like the inventory valuation we did, those have rolled off already. So there's no impact there.

Gautam Khanna - Cowen and Company, LLC, Research Division

Okay. Understand. So you mean -- by purchase accounting, you mean like amortization and things of that nature.

William T. Hull

Yes. Depreciation, amortization, intangibles -- exactly.

Gautam Khanna - Cowen and Company, LLC, Research Division

Fair enough. And then can I ask when do you anticipate being at 10 a month on the 787? I mean, given -- it looks like Boeing is going to do it early '14, late 2013, something like that. And you're going to be shipping 60 somewhat next year. When do you actually step up to 110?

Dawne S. Hickton

Yes. Well, keep in mind, Gautam, I mean, we've already shipped past like aircraft 140. So we are already -- we're head of the game here. So I don't think you'll see it at a 10 until you get into 2014.

Gautam Khanna - Cowen and Company, LLC, Research Division

But will you be at 10 in 2014? Do you think at some point?

William T. Hull

Based on the way the schedule lays out today, that answer's yes.

Dawne S. Hickton

Barring whatever going to happen the next 24 months, sure looks like it.

Operator

Our last question comes from Frank Haflich from AMM.

Frank Haflich

I apologize if you've answered this before but what's the titanium group's capacity utilization? And can you give us an update on qualifications at Martinsville?

Dawne S. Hickton

Well, based upon -- until Martinsville came online, our capacity in the titanium group was close to maximum capacity utilization when you look at it from a mix standpoint, Frank. By bringing Martinsville on, which we now have done, that takes our full capacity up to about 24 million pounds of what I would call a normalized mix rate. So the normalized mix capacity right now with Martinsville, which is online, is about 24 million. And in terms of the certification process, our inauguration -- we went through a ceremonial event and have now officially certified the biggest customer using that facility, which is Airbus. There'll be a few more customers that will go through the process, but for the most part, we're up, we're running and we're moving forward.

Frank Haflich

Is there any additional qualifications that you have to go through, or is that pretty much it?

Dawne S. Hickton

Well, I mean there's individual customers as they want to use product off that will have to go through their own certification. And most of that's in process. But the biggest hurdle, if you will, was getting Airbus certified, and that's behind us.

Richard E. Leone

Thank you for joining us on today's call. The operator will now give you replay information. Dawn, please proceed.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. A replay of this call will be available in an hour and remain through November 14, 2012, using playback number (888) 843-7419 for USA and Canada, or international at (630) 652-3042, and your passcode of 33575679. Thank you for participating. You may now disconnect.

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