Carpenter Technology Corp (CRS) 2011 Q1 法說會逐字稿

Good morning and welcome to Carpenter Technology's first-quarter earnings conference call. My name is Angela and I will be your coordinator for today. At this time, all participants will be in a listen-only mode. After the speakers' remarks, you will be invited to participate in a question-and-answer session towards the end of this conference call. (Operator Instructions).

I would now like to turn the call over to your host for today, Mr. Mike Hajost, Vice President and Treasurer. Please proceed.

Thank you, Angela. Good morning, everyone, and welcome to Carpenter's earnings conference call for the first quarter ended September 30, 2010. This call is also being broadcast over the Internet.

With us today are Bill Wulfsohn, President and Chief Executive Officer; Doug Ralph, Senior Vice President and Chief Financial Officer, as well as other members of the management team.

Statements made by management during this conference call that are forward-looking statements are based on current expectations. Risk factors that could cause actual results to differ materially from these forward-looking statements can be found in Carpenter's most recent SEC filings, including the Company's June 30, 2010 10-K and the exhibits attached to that filing.

I will now turn the call over to Bill.

Good morning, everyone, and thank you for joining us on our fiscal 2011 Q1 earnings call. What a difference a year makes. One year ago, our sales volume was at a cyclical low. Today, we are pleased to see dramatic year-over-year growth in volume, revenue, and profitability. Overall, the year is shaping up to be in line with our expectations.

While Doug will walk you through the numbers shortly, I want to take a few moments to briefly describe some of my initial thoughts on the business and what I believe should be several of our core focus areas.

As most of you know, I started in the role of President and CEO on July 1 of this year. While I was engaged as a Board member for over a year prior to July, as you would expect, I have spent the last couple of months digging deep to increase my understanding of how the business is operating and how we are positioned for future growth. From these efforts, I've identified three core areas for my initial forward focus.

One, enhancing our already strong operational excellence; two, improving our product mix; and three, accelerating growth in the business. While these are not new areas for Carpenter, I believe they are important emphasis areas that will drive shareholder value.

Our first priority focus begins with the customer. For several years now, Carpenter has prioritized operational excellence and there is much to show on these efforts, particularly with respect to safety results, quality programs, and cost savings. Now, in response to rapidly growing demand, I believe we need to increase the focus of our operational excellence efforts to sustain high levels of customer satisfaction. Specifically, to distinguish ourselves from the competition, we will seek to enhance our responsiveness and reduce our lead-times.

Our second core priority focus is to improve our product mix. During the downturn, we did a great job of filling excess capacity by taking on some lower value of profitable business. We recognize that the business cycle has now changed and demand is returning for higher-value product lines. Thus it is important for us to carefully steer our capacity towards a richer product mix. This will help ensure we can build the same level of momentum on the bottom-line as we are seeing on the top-line.

And finally, I have focused on ways to accelerate Carpenter's growth. I would categorize our growth opportunities into the following four specific buckets -- one, building upon our key customer relationships to remain well-positioned in attractive end markets; two, investing in new capacity and technology to support growth; three, leveraging industry trends that are driving rapid growth in the use of the advanced performance materials we sell; and fourth, augmenting organic growth with acquisitions and joint ventures.

First, with respect to our position in attractive end markets. We view our diversity of sales across six end markets as one of our core strengths. Within these end markets, we are particularly pleased with how rapidly demand is growing in our Aerospace and our Energy segments. The projected growth in aircraft builds and the shift to models that require more of our materials continues to make aerospace a very attractive growth market for Carpenter.

Our engine business is stronger than ever and we continue to expect a pickup in fastener demand in the second half of our fiscal year. We are also evaluating opportunities for increased participation in aerospace structural applications, an area where our share is low. Energy also remains a significant source of growth for us.

We are pleased with the return of directional drill rig activity and the related increase in demand for our non-magnetic drill collars. Augmenting this growth is our early success expanding our oil and gas business into completion applications. Finally, while we have a good position in isolation collars, there are even larger opportunities in the markets for housings and stabilizers.

With respect to power generation, we have seen an improved demand from materials used in large industrial gas turbines as global electricity consumption increases. All of these developments further support our view that the energy market has the potential to create the most new growth to Carpenter, particularly in international markets.

Second, with respect to our production capacity, increased order activity for our high value products is increasingly consuming our premium melt capacity, which is good. At the same time, we are becoming tighter in some of our downstream processes, including our hot working operations. With demand returning, we have been hiring new employees to better utilize available production capacity; taking pricing actions to increase the profitability of transactional business; and making management decisions to ensure we are prioritizing the right pieces of business.

These short-term actions are all geared towards improving profitability and creating additional flex capacity for attractive incremental volume. Beyond these short-term actions, we are also carefully evaluating the need to expand our hot working operations and other strategic assets to ensure we can meet the growing global customer demand and provide excellent customer service into the future.

Our third growth focus relates to our leveraging trends and material requirements. Across our end markets, customers increasingly need materials that have greater strength to weight ratios; are tougher; are more corrosion-resistant; can perform at hotter temperatures or higher pressures; and that last longer. That is why our R&D program is a major element to Carpenter's strategic growth plans.

Our recent development in powder metals are evidence that this program is working well. We believe that powder metal technology will become increasingly important in the future for use in aerospace, energy, and other high performance applications. In specific applications, powder metals offer better performance as a result of more homogeneous green structure and improved manufacturing yields.

We recently received our first large commercial order for NeutroSorb, an innovative, borated, stainless steel powder material that absorbs neutrons in nuclear reactors. We are also seeing positive initial results in the use of our super alloy powder and land-based gas turbine applications.

Beyond these developments, there are several large R&D projects we are currently working on to develop proprietary materials. These projects take time to fully materialize, but we would expect to see increasing evidence of results from our investments over time.

Finally, we continue to believe that our organic growth opportunities can be accelerated with strategic acquisitions and joint ventures. Our recent announcement outlining two new joint ventures with Sandvik as a good example of how we can augment our portfolio of high-value differentiated products. We believe these new JVs will further strengthen our leadership position in high-performance powder metals with specific focus on rapidly-growing demand for near-net shape or pre-shaped products.

Through these JVs, Carpenter will be able to provide material that is closer to the final product and thus help customers gain manufacturing efficiencies and improve their yields. We'll continue to look for joint venture opportunities while also evaluating strategic acquisitions that could allow us to expand our high-value product offerings, increase our capacity, or grow geographically.

We can only realize the full potential of these growth opportunities if we have the right management team in place. Our leadership team has over 140 years of Carpenter Technology experience. This team also has meaningful experiences from other highly-respected companies and industries, all of which contribute to our use of best practices. I'm very pleased with how the team is coming together to address the opportunities in front of us.

Switching gears, I will now review the status of our end markets and the orders of their contribution to net sales.

Our aerospace sales were $146.1 million in the first quarter. Excluding surcharge revenue, aerospace sales were up 32% on 29% higher volume. Aerospace results reflect the fourth consecutive quarter of strong demand for engine components and the impact of our share gain.

We are also seeing the beginning stages of improved fastener order activity. OEMs continue to increase production rates for single-aisle aircraft, and backlogs are increasing. There are also early signs that the supply chain is gearing up to supply Boeing 787 builds. We continue to see our fastener customers making channel checks to verify supplier capacity and readiness. This supports our view that fastener demand will strengthen in the second half of our fiscal year.

Sales to the industrial market were $83.0 million in the first quarter. Excluding surcharge revenue, industrial sales increased 46% on 36% higher volume. The year-over-year result reflects increased overall demand for industrial products that outpace general market growth rates. There was also a positive mix shift to higher-value fittings and semiconductor applications.

Activity in the manufacturing sector has expanded for the 14th straight month and utilization rates continue to rise, outpacing the general economic recovery. As stimulus effects continue to dissipate and restocking comes to an end, we would expect demand in the sector to better match the GDP growth rate.

Consumer market sales were $33.7 million in the first quarter. Excluding surcharge revenues, sales increased 36% on 38% higher volume. Increases in volumes and revenue are due to supply chain inventory restocking, and demand growth from Asia for fasteners and electronic components used within the housing and appliance applications. Although the majority of our sales are made to the US-based customers, they are distributed globally, reducing some of the impact from the slow US housing market.

Automotive market sales were $30.3 million in the first quarter. Excluding surcharge revenue, automotive sales rose 36%, as volumes increased 46%. The year-over-year volume increase partly reflects demand growth for high-value turbocharger products and our expanded participation in the growing, high-value segment of fuel system components.

Overall, mix was adversely impacted by growth within the lower-value automotive products. Currently, automotive production is outpacing sales and is likely to result in growing inventory. Inventory correction, expected in the first half of calendar 2011, will slow production during this time. Demand is expected to rebound during the second half of calendar year 2011, boosting annualized production to 12.8 million units, up from 11.6 million unit rate in calendar 2010.

As previously mentioned, our objective in the short-term remains to shift our mix towards higher-value applications. Longer-term, we remain confident that Carpenter is well-positioned to participate in the transportation industry's continual push for fuel efficiency and performance.

Energy market sales were $29.9 million in the first quarter. Excluding surcharge revenue, energy market sales increased 156% on 149% higher volume. The year-over-year increase reflects sharply higher demand for materials used in oil and gas applications and recovering demand for high-value materials used in industrial gas turbines off a low comparative base.

Directional drilling activity has picked up considerably, as evidenced by drill rig counts above the prior peak levels. Contributing to this increase is the further adoption of horizontal drilling techniques beyond gas and into oil wells. We have also expanded our participation into completion applications that utilize higher-value products. Low natural gas prices, newly available financing, and growth in electricity consumption are all contributing to demand recovery for material used in industrial gas turbines.

These developments increase our confidence that energy has the potential to be our fastest growing market overall and will have a positive impact on our international business.

Sales to the medical market were $28.7 million in the first quarter. Excluding surcharge revenue, medical market sales increased 16% on 9% higher volume. The year-over-year change reflects increased demand and restocking of titanium products. Major OEMs have been driving down inventory to reduce overall costs and adjusting for temporary sluggish elective procedure growth. However, we are now seeing a supply-chain restock select materials in advance of expected near-term OEM reordering.

Orthopedic procedures are projected to continue their 5% growth rate with material demand fluctuating with stock, and stocking and destocking trends.

With respect to our international business, Carpenter sales outside the United States in the first quarter were $109.8 million, an increase of 53% over the first quarter a year ago. Overall international experienced strong growth this quarter, particularly in our key target markets of aerospace and energy. We saw continued momentum related to our Asia-Pacific strategy, as revenues increased 63% in that region on 45% higher volume. This was driven by significant broad-based growth in most markets.

Sales in Europe were up 42% on 36% higher volume, driven mainly by increased demand in aerospace and energy. International sales in the 2011 first-quarter represented 31% of total sales, unchanged from the prior year. We are focused on taking our international business to the next level. Having just returned from Europe, I was able to see firsthand the opportunities we have there and I'll soon be visiting Asia to review our growth plans in that region.

Our initial investment in Asia-Pacific is proving to be very successful and we feel we are now better positioned to capture more growth in that region. Our expansion into broader oil and gas applications, such as completions, should also drive considerable international growth as global activity increases. We continue to believe that international growth will outpace overall Company growth in the coming years.

I will now turn the discussion over to Doug, who will walk us through the financial results.

Thanks, Bill. Overall, first quarter results were in line with our expectations. As we communicated on our last call, volume was slightly lower than the level we were running at in the second half of last fiscal, but we maintained a consistent operating margin of about 9%, as good cost performance and a slightly better quarter-to-quarter product mix offset the lower volume.

Our absolute level of operating income was also higher than either quarter at the end of last year and certainly better than the year-ago period, which was the bottom of the downturn.

Looking forward, as our business continues to strengthen, we are taking actions to improve profitability through pricing and other mix management actions. The pricing, which began in the fourth quarter of last fiscal and include those we announced in recent weeks, will still take another quarter to impact the bottom-line, due to current lead-times on our transactional business and the amount of capacity devoted to long-term agreements.

We also expect our cost performance to continue to improve due to volume efficiencies, and since we are incurring some higher costs in the short-term, to bring new employees up to target proficiency. We expect the net result of all this will be improving revenue and profit performance across the year. Looking even further ahead, our objective is still to get back to and beyond our prior peak level of financial performance of about $350 million in EBITDA.

With that, let me now take you through our income statement and other results for the quarter.

Net sales in the quarter were $352 million, or 50% above a year ago. Excluding raw materials surcharge, sales were up 40%. Overall pounds shipped increased 39% from a year ago, with special alloy, titanium, and stainless steel products all growing at about the same rate.

Gross profit was $49.8 million compared with $19.2 million in last year's first quarter. The higher gross profit level is driven by significantly higher volumes and better overall cost performance, partially offset by a slightly weaker product mix compared to last year.

The story on product mix deserves some further explanation. While our aerospace engine business is stronger than it's ever been, which is a positive, other high-value businesses like aerospace fasteners are not yet operating at normal shipment levels. In addition, we made decisions to take on other lower-value product lines when we had excess capacity, which will either lead to higher-value opportunities with these customers or be the kind of products we reevaluate, as mix management becomes more important in the current tight capacity and situation.

Over time, we expect the growth of our premium melted aerospace and energy products and other high-value product lines will result in a positive financial impact from product mix.

Reported SG&A expenses in the first quarter were $35.7 million compared to $32.5 million in the prior year. The increase is primarily due to a more normalized level of variable compensation accruals versus the prior period. Our accruals for these programs assume we will be successful achieving our targets for this fiscal year, while we were losing money in the first quarter last fiscal, and had lesser accruals as a result. Beyond this, we are making some resource investments to drive our strategic growth initiatives, as we have been talking about for awhile.

For the year, SG&A costs is expected to increase about 8%, which is consistent with our goal to resource our strategies while limiting the SG&A increase to less than half of the rate of revenue growth.

Returning to the income statement, we had operating income of $14.1 million for the quarter compared with a loss of $13.3 million in last year's first quarter. Sequentially, operating income was up from the $10.2 million achieved in the fourth quarter last year.

Our operating margin, excluding surcharge and pension, interest, earnings, and deferrals, or EID, as we always quote it, was 8.7%. This is up from a negative 2% in last year's first quarter and is in line with the operating margin level achieved in the second half of last fiscal. As noted in our press release, there is little in the way of LIFO or other business model effects that impacted our results this quarter.

Finishing up the income statement, other income of $1.6 million was flat from last year's level. The income tax provision for the quarter was $3.9 million, or 34% of pretax income, compared with an income tax benefit of $6.8 million or 42% of pretax loss a year ago. There was a tax charge related to our Mexican operation, which impacted the first quarter rate. For the full year, we expect our tax rate to be about 28%.

Net income was $7.6 million or $0.17 per diluted share compared with the first quarter net loss of $9.3 million or $0.21 per diluted share in 2010. Free cash flow for the quarter was a negative $46.5 million due almost entirely to higher inventory levels. The bulk of the increased inventory is in the WIP, or work in process stage, so this is for customer orders that we have melted and the material is working its way through the rest of the processing steps.

As our business continues to be strong, and we take appropriate actions to meet this demand and replenish customer inventory programs, we expect inventory levels to continue to be high in the first half of the year before reducing somewhat in the second half. We still plan to deliver overall free cash flow performance of about neutral for the full year, in line with previous guidance, although our priority is on supporting the strong consumer demand and there are wildcards like the impact of raw material prices on our year-end accounts receivable. We also still expect to spend about $70 million in CapEx this fiscal, as growth-related project activity picks up during the year.

Our balance sheet remains strong, as we ended the quarter with $327 million of cash and net cash of $67 million. This cash and balance sheet position allows us to fund growth initiatives, both organic and external. We will do this while maintaining an appropriately conservative financial structure given the inherent cyclicality of our industry.

We did have a $100 million note go current in the quarter, as it matures in August of 2011. We plan to refinance that note upon maturity, and we have begun to hedge the risk of rates rising between now and the refinancing date.

In closing, I'll confirm that we remain on track to achieve the fiscal year goals we outlined on our last call. To briefly recap, we expect strong mid to high teen topline growth for the year with positive comparisons versus all year-ago periods. Our operating income, operating margin, and earnings per share should all be on an improving trend, as we grow volume, improve our product mix, continue to drive cost savings, and realize the benefit from announced price increases.

Operating margin is expected to remain around the current level in the second quarter and should then improve in the second half of the fiscal when we have all four elements -- volume growth, mix improvement, cost savings, and pricing working to our favor. As a reminder, we will not see the CDSOA income in our second quarter this year, which had been running $5 million to $6 million over the last several years, as this program has expired.

With that, I will now turn it back to the Operator so we can open the line for your questions.

(Operator Instructions). Edward Marshall, Sidoti and Company.

Thanks for taking my call. You talked about in the press release and I think you mentioned it in your prepared remarks as well, about other energy markets. And I'm wondering if you would elaborate a little bit. I think you mentioned completion, but could you kind of elaborate on what the potential is there and what markets you're targeting?

Okay, there are actually 12 additional Energy segments that we're focusing on. On the three that are really in our first wave at this point are the oil and gas completions, expansion of our portfolio in terms of adding more to the products that we provide for gas turbine components, and also nuclear opportunities.

So those would be the primary focus areas. And as we've mentioned, we are optimistic that this will be the fastest-growing area for us, and it will be based upon, of course, the momentum in the current business, but also focused on those three areas.

I'm assuming this will be in conjunction with an international growth story as well?

Absolutely. So much of the -- as we know, the nuclear activity will be overseas and, for that matter, the oil and gas as well, so.

Great. Aerospace materials -- and you commented on this briefly as well, but -- aerospace was flat to slightly down quarter-over-quarter. I would have expected at this point in the cycle that -- and especially what we're hearing with the OEs about a strength in the engine demand, your material would have been up. Can you talk about what happened there?

Yes, the numbers of that sequentially were about 9% down in both volume and sales terms versus our fourth quarter. And that's really a function of the seasonality that we talked about in our business -- normal seasonality of both the customer plant shutdowns as well as our plant shutdowns during the summer period.

Okay. And do you have a utilization rate that we can talk about on the premium alloy level?

Sure. Actually, Dave Strobel, who is our Senior Vice President of Operations, is here with us and he can speak to that.

Sure. Good morning. As Bill mentioned, our demand has really come back very rapidly and strong in some of the areas and it's flowing through our processes right now. Last quarter, we had talked about the lean forward strategy and the fact that we were bringing in people to support that ramp-up.

On the high temp side of the business, we're running at about 80% of our VIM capacity with the new furnace that we have online, and that's been running very efficiently and effectively for us. When you take a look at that in conjunction with the downstream operations, I'd say we were about an 80% level there; downstream operations are very busy.

Just to complete the utilization, on the stainless side of the business, we've added crews to our static shop as well as the castor. We talked about that last quarter. We're running about an 85% to 90% utilization in those areas.

Thank you very much.

Sanil Daptardar, Sentinel Investments.

Could you talk about in certain of the markets you've got some price, better pricing, basically excluding the surcharges. Is it mainly driven by the product mix? Or you had an increase in the base prices?

We have been very active, as we have mentioned and have issued press releases, raising prices on our transactional business. About 50% of our volume is transactional. And we've had two announced increases over the last roughly eight months. It takes a little while for them to work their way through the systems because of orders in the system, but we'd expect for those to be having an impact as we move into next calendar year.

And 50% of our business is essentially tied to long-term agreements. And there are, of course, price escalator clauses as well as some inflationary clauses. So we'll see some general benefit as we move into the next calendar year as well. So pricing is a big part of our story. As you can see from a volume versus revenue standpoint, revenue increased more rapidly in the aerospace and industrial markets. And that's primarily because of the mix component at this point in time.

Okay. Just an extension on those. If you have price increases on the transactional business, do you feel that there might be a market share loss? Or you think that the demand is so high that consumers will continue to buy products from you?

Well, right now, our lead-times are fairly lengthy from a demand standpoint. And so with that, as we raise prices, we haven't seen business and demand fading away. But, of course, on the lower margin area, if some of that does fall away, that's okay; that's a risk we're willing to take.

Okay. Second question on the inventory part. In certain areas, you've talked about restocking and restocking coming to an end. Do you think there in automotive and in other areas, I think, in the consumer market the demand would remain very medium and soft, right, in the second half of 2011 of your fiscal? Do you think that beyond that, there might be in certain the demand or do you think that you're looking for a soft pattern continuing throughout the first half of fiscal 2012?

Well, we -- just the converse of that is that in the aerospace fastener side of the market, which is strategically and financially very important for us, that's a market where excess supplies in the marketplace have actually artificially kept demand down by as much as 20%. So we see the demand in that area coming up.

There may be slightly lower demand in some of the automotive markets as well as some of the consumer markets based upon inventory, but net-net, we don't see a big shift in terms of our volume because of inventory stocking or destocking at this time.

Okay. Great. Thank you.

Steve Levenson, Stifel.

Just a question -- you recently raised base prices -- and forgive me, I've been going back-and-forth between two other calls -- but what's the mechanism that drives that? And is there potential for additional base price increases over the next year or so?

The mechanism that drives that is simply price increases that we implement to our customers. We did announce an average increase of about 5% last May and then additional increases of another 3% to 8% earlier in October.

And the second part of your question, Steve?

Just do you think that can happen again on base prices as opposed to surcharges during the next 12 months?

Yes, I think we're focused on making maximum profitable use of our available capacity. So, as a function of that, we'll continue to take price increases where it's appropriate in that regard.

Okay, thanks. And last, are you working on any new alloys or are you finding competition from any recently introduced alloys from some of your peers?

Well, we have increased dramatically, over the last several years, our investment in research and development. And on that basis, we have a number of innovations to our existing alloys and improvements, but in addition, some what we think are really exciting developments for the future. So we're very bullish and we believe that continuing to innovate and commercialize new alloys is essential to our overall success, and, of course, getting premium margins, which are also important for us.

From a competitive threat standpoint, we are always on the look-out. We've got some very capable competitors out there who are also making investments, but there is nothing that is, if you will, on the immediate horizon that we feel unduly threatened by.

Great. Thank you very much.

Brian Yu, Citi.

First off, just going back to the fastener side, can you give us a sense of where your shipments are running now and perhaps where you expect it to go, once it begins to recover in the back half of your fiscal year, on a run rate basis?

Sure. Right now, it's really as expected. We didn't anticipate a pickup before the first quarter of the calendar year, next year. We're beginning to see signs of that not only through the channel checks that are being taken by the OEMs, but also some of our customers have begun to increase their orders in this area. And so with that in mind, we are confident and cautiously optimistic that we'll see roughly a 20% increase as we move into next year in the fastener area.

Okay.

And I think, as you know, Brian, when we've talked about our aerospace revenue before, fasteners in total would be roughly 40% to 45% of our total aerospace revenue.

Okay. Is that where it is now or where you expect it to be once it improves?

On a normalized basis, that's what it would run.

On a normalized basis, okay. And then just if you could refresh my memory, with these fasteners, are they requirements-type contracts or there were take-or-pay minimums associated with it?

They are mostly built on target percentages of customer market shares. And in some cases, we would hedge those to lock in the raw material price, but for the most part, they would operate off of our standard surcharge mechanisms.

Okay. And on the nickel side, you mentioned you had announced a couple of base price increases. Can you give us a sense of what the lead-times are just specifically? Maybe it's six months, so we can try to calculate when these base price increases are going to flow through. And I also get the sense that these price increases are sticking, right? They're --?

Yes, they are sticking. And I think in terms of effectiveness on our bottom-line, it's something that we expect in the second half of our fiscal year, as Bill mentioned. And the reason for that is that you've got about 50% of our business that's in long-term agreements, the pricing on those long-term agreements has been stable and was stable through the downturn period.

And so really the target for the pricing actions is on the transactional business. And with the current lead-times, order lead-times that we're running against, it takes a number of months for that to work through and hit the bottom-line.

Okay. Thank you.

Gautam Khanna, Cowen.

Doug, just a quick question on what you mentioned earlier with respect to hiring staff and the margin progression through the year. Since you're hiring staff, I mean, should we expect premium alloys margins to dip sequentially at any point during the year, as those people are trained and brought back up to speed? And if you could just remind us about whatever seasonal factors exist in the December quarter with respect to holiday-related shutdowns and managing around that?

Sure. We are going through some inefficiencies currently as we bring on new employees and train them up to a level of proficiency; nothing that has a material impact on the bottom-line. And in fact, our overall cost results, when you factor that in, continue to be directionally positive.

So, therefore, I would not expect any noticeable impact on our margins. In fact, if you look at our PAO margins, our premium alloy margins reporting 32% for this quarter, we were running 33%, 34% in the middle of last year. So I think you've seen stability on those margins.

And I'm sorry, the second part of your question, Gautam?

If you could remind us as to whether there is some seasonal factors in the December quarter with respect to vacations and what-have-you around the holidays and how you're managing around that. Should we expect shipment levels to rise sequentially in the (multiple speakers) --?

Yes, there are seasonal factors associated with, again, our plant shutdowns and customer plant shutdowns over the holiday period. They're typically less so than what we would see over the summer period, so we would expect some bump-up in volume second quarter to first quarter.

Okay. And if you could just remind us on the AMO side, it sounds like you'd had some lower-value shipments out of the auto side, that what you had in the backlog and -- I presume you're not booking that type of business today.

And when do we expect sort of the low-value mix to peter out at AMO and start to see again the margin pickup to the high single digits? Is that going to happen in the second quarter or do you think that's more second half of the year?

Yes, it certainly doesn't happen overnight, because behind that, you've got important customer commitments. And with our lead-times out, that business has been booked with promise shipments for awhile. So I would expect that we would see more evidence of that toward the latter end of the fiscal year and certainly not in the second quarter.

Could you provide the ex-surcharge sales by end markets? I may have missed it if you did.

The total dollar amounts?

Correct, ex-surcharge.

So aerospace would have been $107.6 million for the quarter; industrial, $60.1 million for the quarter; automotive, $22.1 million; medical, $24.8 million; our energy business, $24.3 million; and our consumer business, $24.8 million. All should add up to $263.7 million for the quarter.

Perfect. And just another one. We've heard one of your customers talk about in-sourcing material as of January 1 and I've brought it up on several calls, but could you just talk through here some of the offsetting points you had -- I mean, you guys have been pretty clear about not -- the likelihood of that showing up in the numbers being pretty remote.

Is there -- can you talk about some other long-term agreements that you have signed? Could you talk about how long your lead-times extend, so how possible that really is, first to take away business from you guys on January 1? Can you just talk about some of the offsetting factors you guys have lined up?

Yes, and I think you're referring to the statement you put in your release about Carlton. Carlton, or PCC, is a very important customer to us. We do value the business we have with them and, of course, we try to be a good supplier to them.

They have made the statement that they're bringing some more material inside. This is not a new trend. This is something that they have been working on for several years, and actually, a majority of -- or a significant portion of what they've brought in has been brought in over the course of the last couple of years.

We have lead-times right now on our high temp area that's as much as 20 weeks long. We have been working over the last several years on share shift and we believe we've gotten considerable share shift, positive share shift in this area, which is one of the reasons our backlogs are so long at this point. We continue to work and develop new business.

So, at this point, we are having a greater challenge, if you will, just keeping the production capacity expanding to meet with demand. And we certainly want to be a long-term and good supplier to Carlton, but if they choose to bring more material in through 2011, we think we'll be fine from a volume and throughput standpoint.

And guys, could you give us some color? I know you talked about your Q1 being on plan, and when you say on plan, I mean, what is your expectation for operating income growth --?

On plan is in the context that we had talked about a operating margin level that was level versus what we achieved in the second half of last fiscal year, and on plan being that we identified that we would see a seasonal dip in our volume performance.

Our expectations for the full year are really unchanged versus what we have talked about previously, which is on the top-line, that we would see revenue growth in the mid to high teens level, with each quarter being -- having good numbers versus a year ago from a comparison standpoint, and that generally, our profitability.

By profitability, we'd be talking about absolute levels of operating income, our operating margin and earnings per share are going to be on an improving trend during the year. As volume improves, we see improvements in our product mix, we continue to drive cost savings and see the benefits from the pricing actions.

Got it. Thanks a lot, guys.

John Tumazos, Tumazos Independent Research.

Could you explain the acquisition comments you made in your prepared remarks, specifically what might be the largest dollar size? What is your philosophy toward paying a premium for businesses? And how far from your existing product lines you might stray?

Okay. Well, I'll answer it in a qualitative manner and ask for some more specific comments from Doug as well. But as you can tell and as you can see, we have a, we think, a good range of financial flexibility based upon our untapped revolver, our excess cash position.

And I would say that we want to ensure that we remain investment-grade, so we would not be looking to take on more debt than that would allow. That still gives us a lot of room and opportunity to grow. So we would be looking at items or opportunities which are close to our core. We're not looking to -- I mentioned the areas we were focused on, if we can expand our product line or our geography, hope to move us in with products in our targeted market segments, that would be great, but we're not looking to take on, if you will, a new dimension or new growth leg for the Company.

In terms of premiums, that's always the toughest question, especially in this economic environment where businesses are recovering. And so we know that that will be market-driven, but I can tell you that it will really be based upon whether or not we can get a proper return for our shareholders on the investment that we would make. And if the premiums are -- the market premiums are too high, then I think, of course, we would pass.

So we're aggressive and ambitious, but we are not blind in our efforts here. We want to be very responsible and prudent.

Bill, I have a couple of shares of your stock, and I just want to comment that you can buy your stock any business day without paying any premium. And I sure hope your friends on the Board take a very conservative view toward acquisitions.

And I think you've seen that our history has been one such that we have not jumped into acquisitions that didn't make sense for the Company, and really have taken a pretty conservative position, so (multiple speakers) [and I appreciate you] --

I hope you're in place a good five years and learn the Company well on a day-to-day basis, visit all the customers and really proceed slowly on acquisitions.

Okay, well, thank you. And I agree, I hope I'm around for awhile myself. And with that, I am, I think, for the people who work with me, somewhat of a front-line type of individual. I believe you've got to get the full understanding of the business by working with the customers and working with the people in the business; obviously working with investors and I've spent a lot of time over the last few months doing that. And I have a lot more that I can learn. So I'll be working on it.

Thank you. Good luck.

Dan Whalen, CapStone Investments.

Just a quick question on nickel here. Just given the volatility we've seen in the price of nickel, can you just comment or add any color in terms of any potential impact it's had on order patterns or things of that nature? And secondarily, just any color you can provide in terms of your expectations for the price of nickel going forward?

Sure, I can make a couple of comments that, as you know, the [Valet] strike was settled recently, and production and the volume associated with that is now returning into the business stream and the business mix. At this point, the LME has had a run-up in price. We attribute that to the weaker dollar and of general bullish conditions for some other alloys, but we're hoping that will be, if you will, softened by the increased production that's coming online.

Our contracts with major suppliers are nearly complete, so we feel very good about our supply as we move into next year. So, in general, as you know, a significant portion of our business has a surcharge mechanism associated with it so we have some degree of insulation from movements in the price. But in general, because the prices haven't moved that greatly and there hasn't been that high of level of volatility, we haven't seen large changes in order demand patterns as a result of, if you will, downstream customers positioning to take advantage of those pricing dynamics.

Great. So it sounds like you may be expecting a little softer nickel price going forward? Is that a fair characterization there?

Well, I think it's difficult to say. Logic would say with the additional production coming on, [Valet] production, that you should see some loosening of supply. At the same point, we have seen a tremendous increase in demand, and depending upon what you're hearing from other folks as you complete these calls this earnings season, there obviously may be some increase in demand on them as well to offset that. But we don't see a great shortage or a great excess.

Okay, great. And then just on the energy side, you did some pretty constructive commentary in there that's very encouraging to hear. Just trying to get a little more granularity -- are you seeing a market pickup in requests for quotes or orders? Or is this actually translating into near-term orders?

Well, it's definitely turning into near-term orders. In the directional drilling area, the peak number of directional drilling rigs was about 1,300 in 2008, September 2008; it bottomed out at about 830 in May 2009; is now at 140. So, there's definitely a true core demand that's associated with that.

In terms of gas turbines, we've seen -- and GE just announced their earnings a week or so ago and had some direct comments. They saw the market as flat overall but they saw that shipments were increasing year-over-year. And they expect that overall shipments this year will be down because of weaker activity in the first half of the year, but picking up as the second half of the year goes on. So we expect that market, I'd say more on a prospective basis, will be increasing from a demand standpoint.

Okay. So this is just customers testing the water and seeing what the quotes are. There's real translation into revenue here, then.

Oh, without question. That's -- in the gas turbine area, that's actually been part of our backlog that's built up from a demand standpoint.

Great. And then just lastly, in terms of the acquisitions, can you just update us in terms of your latest thoughts in terms of target markets? Is it energy or aerospace-related -- any comments on that?

Well, yes, if we break it into the several dimensions that we've talked about, we've said that our core market segments of focus are aerospace, energy, and medical. So those would be three areas that we might logically look at. In addition to that, we recognize that, from a geographical standpoint, there's great opportunities for growth in Asia-Pacific and India; again, more potentially from a venture standpoint than an acquisition.

And then there are also some products which we are very deep in, and other adjacent products that we supply to those markets which we have less production capability. And if we could bring on some capabilities or capacity that would augment our product offerings and our alloy offerings, those would be the target areas that we would say are of interest. Things that get further from the core are things that would have less interest for us.

Okay, great. Thank you very much. That's very helpful.

Tim Hayes, Davenport and Company.

Just one question. Could you run through the sequential volume changes by your six end markets, please?

Sure. This is all versus the fourth quarter -- aerospace down 9% -- and you can see the seasonality reflected in all these numbers -- but aerospace down 9%, fourth quarter to our first quarter; the medical business down 13%; industrial business down 10%; our automotive business down 6%; our consumer business down 8%. And the one exception -- and really because it's a business that we're coming off of such a low base -- is the energy business, which was up 19% fourth quarter to first quarter. So overall volume was down 7% fourth quarter to first quarter.

Very good. Thank you.

Phil Gibbs, KeyBanc.

I had a question about the volume guidance. And Doug, did you say that that was maintained at mid-teens levels for fiscal '11 year-over-year?

Yes, mid to high teens is what we said in our last call. And we have revised that upward, if you remember in our last call, from something that we were viewing as more mid-teens. So we continue to get more and more bullish about the strength of the customer demand out there.

Is most of that confidence or incremental -- it seems like incremental positivity I think right now on the energy side; I don't think we were looking for IGT to see very much support yet in the marketplace, but it seems as though you're seeing that maybe a little bit earlier than anticipated?

Yes, I think that's fair. And keep in mind, it was from such a low base last year. It's good to see that some momentum is building, but there's still a recovery to take place in that market.

Hey, man, I think a lot of that would mostly be driven by the low natural gas prices and it's interesting that you mentioned financing improving. I think that's very important right now. And that's something that we necessarily haven't heard on a lot of these calls.

(multiple speakers) Go ahead, I'm sorry.

I was just going to say, the other market for us, which as we mentioned before, is key to the increasing demand as we go through the year, as the aerospace fastener market.

Perfect. And then just lastly, guys, on the backlogs, can you provide any color on sequential backlog in 1Q versus 4Q in your various end markets and whether -- and where you've seen the backlog possibly pick up and where you've seen it stabilize by end market?

This is Dave. From a -- we typically look at those backlogs by the lead-times. And from Q4 to Q1, again, we were planning on the lead forward and gearing up, but honestly, those lead-times continued to grow on us during that timeframe. And we're starting to kind of get a handle on them, but I'd say we'd had a 30% increase as far as our lead-times, 30% to 50% in some cases.

30% to 50% increase in backlog? Is that what you're saying, just in the last three months on lead-time?

We do track backlogs as well, it's not a measure that we view as 100% reliable, but it's a decent indicator. And those are up marginally at the end of the first quarter versus what they were at the end of the fourth quarter.

You're saying the backlogs are up marginally but the lead-times are certainly pushed out?

Yes.

Okay. Perfect. Thanks a lot, guys.

Gautam Khanna, Cowen.

Yes, just a quick follow-up. When you talk about the fastener demand pickup, are you -- this obviously ships out of AMO, correct?

That's right, yes.

Okay. It's out of AMO. So, I mean, presumably it's very mix-additive, so I'd asked the question earlier about AMO margins trending up towards the high single-digit by year-end. Is there a reason given that mix, positive in the second half of the year, that we wouldn't get there? Or is there something else that we should be mindful of?

No, I think our AMO margins, as you know, have been kind of at this four-percent-ish level now for three or four quarters. And fasteners is a important upward lever there that we would expect to see evidence of in the second half of our year.

Is it reasonable to assume the fastener margins are incremental margins and comparable to that of the PAO and to nickel margins?

Certainly in that direction.

Okay. And you mentioned earlier, I think that capacity utilization at PAO was running around 80%. If that's so, A, did I understand that correctly? And B, could you give us a sense for how that compares with prior peak capacity utilization at PAO? I know you have more capacity now. If you could give the framework for that.

Yes, we've -- that 80% refers to our VIM tons. And when you look at what we've basically put in from an equipment standpoint over the last several years, put a new VIM furnace in, that's a 20,000 to 25,000 ton furnace. We also installed four VAR furnaces, two additional ECR furnaces, and we had the press and the Forge.

So we installed more VIM capacity than what we had downstream additions to take away. And we're very pleased that the downstream capacity that we did add with this additional VAR and ESR furnaces is very, very busy. The same thing with the press and the Forge, those are very busy operations as well.

I guess what I'm trying to get a sense for if we were to scale up to, say, 90% utilization x-price increases assuming comparable mix, what would we be doing in terms of annualized operating profit? And then from that -- I see the AMO business is severely under-utilized right now and that's sort of the big swing item to the earnings but at PAO, I'm trying to figure out how much room do you still have left before you run out of capacity. If you could talk to that.

Well, and another factor I'd bring up just for consideration is, as you saw in the financial tables, during the quarter, we also had a considerable inventory build. That's something which we did in anticipation of greater demand and staging inventory to fill customer orders. But of course, over time, we would seek to either keep that at a steady state or bring it back down. So with that in mind, that production capacity would actually go towards sales as opposed to towards inventory build.

So if you're comparing our current utilization versus our sales, I'd suggest you factor both of those two things in.

When you look out over the next year, currently it seems like there is demand above the rate of underlying consumption on the engine side due to the massive destock that happened in calendar '09. I mean do you anticipate at any point we're going to see a dip over the next four to six quarters in terms of engine-related shipments? I know we're having OE rates moving up, the aftermarket has obviously picked up considerably, but do you anticipate that since we're kind of above trend, we're actually going to drop below at some point? Or do you think this is sort of slow and steady progression --?

It certainly could be, but the spare market, as you indicated, is picking up, the overall builds of aircrafts are picking up and we could go through that, I'm sure you have that profile.

At this point, we have more requests for business than we can accommodate in our backlog or guaranty lead-times on. So we're being more selective, obviously, working with our long-term agreement customers. And based upon that, we have still quite a long backlog.

So is it possible that demand could decline precipitously? I suppose it could, but there are no indications from our side that that's the trend at this point. In fact, just the opposite. We are working to get the capacity utilization up and to improve our operating efficiencies so we can get greater levels of output to meet the demand that's out there. We're much more focused on that than anticipating some store markets coming our way.

And then lastly, we've talked about a number of areas where prices are rising. Are there any areas where prices are falling or likely to fall come calendar Q1 or can you can talk about any downers to the numbers?

There's nothing that I'm aware of from a pricing trend standpoint that would be moving downward. And again, part of what our big challenge right now is, is not just pricing up but also managing mix. So if there was tremendous downward pricing pressure, there might be some self-selection in terms of business that we would continue to support.

Thank you, guys. Appreciate it.

Brian Yu, Citi.

There's been a lot of headlines lately about China and Rare Earth, and I must confess it's not an area that I'm familiar with. Do you use any of this product and if so, are you seeing any kind of impact from those restrictions?

We use some very small quantities and we typically have -- and, in fact, in this case, have a supply, if you will, in-house here. So we don't see any issue at all at this point in time and don't anticipate even if there's an embargo that that would impact us for quite awhile here.

Would you be able to give us a sense of what the long supply and quite awhile means? Is it like six months to a year? Or are we talking about longer than that?

Yes, I mean, of course, it could be a function of the specific material, but in general, we feel as though we have about a year's worth of supply.

Okay. Thank you.

And gentlemen, at this time, I show no further questions within the queue. I would like to turn the call back over to management for any closing comments.

Well, thanks for participating in our call this morning. As you can tell, we are excited about the prospects for the business as our end markets return. And our goal is to reach and then exceed prior peak earnings.

We remain committed to enhancing our operational excellence, to make sure that we're a great supplier to our customers; optimizing our mix and translating the growth to the bottom line; and driving for opportunities to accelerate the growth of our business. So, thank you again for your continued interest and support of Carpenter Technology. We look forward to speaking with you again next quarter. Goodbye.

Ladies and gentlemen, we thank you for your participation in today's conference. This does conclude your presentation and you may now disconnect. Have a wonderful day.