Carpenter Technology Corp (CRS) 2012 Q3 法說會逐字稿

Good morning, and welcome to Carpenter's Technology third-quarter earnings conference call. My name is Chris and I will be your moderator for today. (Operator Instructions). At this time I would now like to turn the call over to your host for today, Mr. Mike Hajost, Vice President of Investor Relations and Treasurer. Sir, you may proceed.

Thank you, Chris. Good morning, everyone, and welcome to Carpenter's earnings conference call for the third quarter ended March 31 of 2012. This call is also being broadcast over the Internet.

With us today are Bill Wulfsohn, President and Chief Executive Officer; and Doug Ralph, Senior Vice President and Chief Financial Officer. Also participating on the call are Dave Strobel, Senior Vice President of Global Operations; Mark Kamon, Senior Vice President of Specialty Alloy Operations; Andy Ziolkowski, Senior Vice President of Latrobe Operations; Sanjay Guglani, Vice President of Performance Engineered Products, 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, 2011, 10-K September 30 and December 31, 2011, 10-Q and the exhibits attached to those filings. I will now turn the call over to Bill.

Thank you, Mike, and good morning, everyone. This is a very exciting time here at Carpenter, and I'm very proud of what the team has accomplished this quarter.

In summary, we've posted another quarter of strong results. We also closed on the Latrobe transaction, and we took steps to increase production capacity, which will enable near- and long-term growth.

Before Doug gives you details about our operating results I would like to take a few moments to comment on each of these three areas.

Let me start with the results of our legacy Carpenter business. In summary, our end market demand remains strong. Within aerospace we are experiencing continued strong demand for super alloys used in aerospace engines, significantly increased demand for our titanium, nickel, and stainless materials used for fasteners, and we are seeing increased participation in aerospace structural applications. More specifically, we are seeing higher adoption of our proprietary custom series of stainless materials for slat track, engine mount, landing gear components on new platforms such as the A380, the A350, 747-8, 787, and the future 737 MAX.

In addition, Latrobe's portfolio broadens our participation in complementary aerospace applications such as commercial landing gear and bearing steel.

Within energy there remains strong demand for our materials used in oil and gas exploration as directional drill rig activity remains high. And it is now shifting from natural gas to oil exploration. We also see increased demand and materials for industrial gas turbines.

And finally, as we've discussed in past calls, we're diversifying our product offerings within the energy market. Note we are also seeing good growth and movement towards higher value product opportunities in other strategic areas such as transportation. Thus, in the aggregate, the demand for our premium product has enabled us to sustain a very strong backlog.

In addition to our strong end market demand we are continuing to see positive impact from our pricing and mix management actions. These actions have resulted in higher average profit per pound, greater overall profitability, and we've seen revenue growth in the quarter has once again outpaced volume growth.

In summary, we are progressing rapidly to meet our commitment to return to our prior peak level of EBITDA, excluding any Latrobe contribution.

Switching gears, February 29 was a very exciting day in the history of Carpenter as we closed on the Latrobe transaction. While the antitrust approval process was long, it gave us time to prepare for integration, which enabled us to hit the ground running after close. I am pleased to report that the integration process is going well. The Latrobe's operating results are already accretive to earnings excluding acquisition-related costs. And we are even more encouraged by the synergy (technical difficulty) long-term growth objectives. As previously discussed we have seen rapid demand growth for our premium products.

This is good news, but has also taxed our available supply. To address this opportunity, in the near term, we have taken actions to add remelt capacity and address constraint in our Reading operation. And immediately after closing on Latrobe we moved forward with an investment to add three additional VAR furnaces at that location.

The impact of these investments should result in an incremental 4,000 tons of premium capacity over each of the next two years.

We are also well underway to doubling our capacity to produce titanium wire used in aerospace fasteners and expand our powder metal production capacity.

Every market indicator combined with our customer discussions solidifies our belief that we are in the early stages of a strong growth cycle in the aerospace and energy markets. Thus, to support further market demand growth over the long term, we just broke ground on our new Alabama facility that will be capable of producing 27,000 tons of premium product. This facility is scheduled to begin operation in April 2014.

This investment will enable us to accommodate more customer demand and offer the market shorter lead times and improved stocking programs. We also believe this investment will improve the company's earnings growth power. It is important to note that key customers have demonstrated a willingness to commit along with us by entering into long-term agreements to meet their growing material needs.

To emphasize this point, I want to point out that approximately two-thirds of our top engine and fastener customers have worked with us to establish long-term agreements that extend beyond the start of the Alabama facility in 2014.

In addition, beyond meeting these long-term agreement commitments, the additional premium capacity we will build will allow us to capture profitable transactional volume opportunity.

We also believe this project has limited downside risk. More specifically, we expect we will be adding less than $10 million of additional fixed costs at the Alabama facility by the startup in fiscal year '15, excluding non-cash depreciation. And note that it takes a relatively small amount of volume to offset the impact of these additional fixed costs. And we could be selling significantly more premium products today if we had more capacity available, and that situation is likely to expand in the future. This facility will also generate cost savings on existing volume due to newer technology and better product flow. Finally, we are funding this investment largely through existing cash and operating cash flow.

So in summary, Carpenter is on a good path with strong momentum in the core business; Latrobe will have a significant positive impact on our earnings growth profile; and we are taking required steps to grow our premium capacity for both the near and long term, so we can better support our customers and we believe will also lead to sustained strong and profitable growth and value creation for our shareholders. I'll now turn the call over to Doug, who will cover our financial results.

Thanks, Bill. We had another good quarter of results. We've included a chart and exhibit in our press release that hopefully will help you follow the pluses and minuses this quarter and also going forward.

Overall, we've delivered earnings per share of $0.69, which included a total of $0.15 from final Latrobe transaction costs and a fair value cost adjustment on beginning inventory that we'll experience this quarter and next quarter. Excluding these impacts we would have been at $0.84.

The Latrobe business delivered about $5 million or $0.07 per share from operating results, and the impact from share dilution was $0.04, so Latrobe is accretive on an operating basis right from the start as we expected.

Before I get deeper into Latrobe I want to highlight our strong performance on the legacy Carpenter business. This is the fifth quarter in a row that we saw a strong positive spread between our revenue growth rate and volume growth rate and an improvement in our average SAO profit per pound. This reflects good execution of our strategies to drive premium products growth and improve our pricing and product mix. Our average SAO or mill profit per pound is up over 50% from the past year, which was our internal goal and increased by another $0.12 from the second quarter. Overall operating income on the legacy Carpenter business is still tracking to exceed the 50% improvement goal that we set at the beginning of the year.

And our trailing 12 months EBITDA of about $310 million excluding Latrobe, using the definition that we've communicated of operating income (technical difficulty) amortization, plus non-cash pension expense continues on a pace to achieve our goal of returning to our prior peak level of EBITDA on the early end of our communicated two- to three-year target.

We are also now off to a good start with Latrobe. It is immediately accretive from an operating perspective, and we would like to achieve a goal of overall EPS accretion over the first full year of ownership, including offsetting our total transaction-related costs, going back to the beginning of the deal last June. This would mean that Latrobe is at least 10% accretive to EPS in fiscal year 2013.

We will have a further fair value cost adjustment on inventory of about $9 million in the fourth quarter. Excluding this we will again be modestly accretive on Latrobe operating results after share dilution in Q4. Note that there are other purchase accounting adjustments for Latrobe that we are absorbing in our operating results, namely the amortization of asset and intangible writeups, which add about $16 million of non-cash expense in the early years on top of base depreciation at Latrobe of about $10 million.

The fair value inventory cost adjustment is currently expected to end after the fourth quarter.

As we work with Latrobe we continue to be confident in delivering net pretax synergies of at least $25 million by year three. This is beyond the immediate interest expense savings and lower tax rate we will realize from the integration of the companies. We expect these synergies to start to show up in our results by this fall with most of the value being achieved within 18 to 24 months.

Most of the $25 million in net synergies comes from operations. And the largest single opportunity is for additional premium tons capacity from the existing Latrobe assets as well as three additional vacuum remelt furnaces that we provided for in the deal economics and are ready to move forward with. This provides a critical bridge to meet strong customer demand for premium aerospace and energy product between now and the startup of our Alabama facility.

Note that much of the value for this will show up in our SAO segment results based on where the shipments occur.

Beyond this there are other opportunities to improve output and reduce (technical difficulty) across the Latrobe business and total mill operating system. In addition, there are cost savings from purchasing and combining things like insurance coverage and professional fee contracts.

Additional synergies from potential footprint overlap will take the longest to analyze and achieve, which is why we have the three-year timeframe.

And we would expect to make steady progress improving the average profit per pound across the Latrobe assets and overall mill system as we have successfully done on the Carpenter business.

On the other side we do have some near-term cost synergies from items like IT integration and strategic studies we will undertake to optimize the integration of the two systems. These were all anticipated in our deal economics, which were conservatively developed. And last, we have a list of other icing on the cake opportunities beyond this that we will pursue in due course.

Next, we are confident in achieving at least our communicated level of synergies on the deal with some part of this realized during the course of fiscal year 2013.

With all that as background let me now to take you through our third-quarter results.

Net sales in the quarter were $540 million or 16% above a year ago. Excluding raw material surcharge, sales were up 24% on 10% higher volume. Without Latrobe, sales ex-surcharge were up 13% on flat overall volumes.

By product class, and excluding surcharge, special alloy sales increased 13% on 6% higher volumes and stainless steel product sales increased 17% on 2% higher volumes which (technical difficulty) with our focus on premium tons output and product mix management.

Titanium product sales increased 11% on 1% lower volume while powder metal sales decreased 8% on 16% lower volume due to the European portion of that business. And finally, alloy and tool steel sales and volume both increased over 200% due to the addition of Latrobe.

Continuing down the income statement, gross profit was $105 million compared with $73 million in last year's third quarter. The higher gross profit level was driven by a significantly higher profit per pound due to an improved product mix and higher price and the inclusion of Latrobe.

SG&A expenses for the quarter were $41.5 million or 9.9% of revenue excluding surcharge compared to $37.9 million or 11.2% last year. This 1.3% reduction in SG&A is consistent with our strategy to control overhead cost growth to well below the rate of revenue growth. The higher spending mostly reflects the addition of the Latrobe overhead costs.

We had $7.9 million of Latrobe transaction costs in the quarter, which we were showing as a separate line item on the income statement. This relates to final legal and investment banking costs and a $5 million liability related to the agreed FTC remedy to transfer assets and purchase equipment for Eramet to produce two specific alloys.

Operating income for the quarter was $55.7 million compared with $35.2 million in last year's third quarter. Our operating margin excluding surcharge and pension EID as we always quoted was 14.2% or 16.8% excluding the Latrobe acquisition-related costs. This compares to 13% in last year's third quarter.

Interest expense in the quarter was $5.6 million compared to $4.4 million in the year-ago period. This reflects the net income -- the net impact of an incremental $150 million of debt from our financing actions last June at a lower overall average interest rate. We fully paid off Latrobe's debt at closing, so we will have no increase in interest expense from the transaction.

Finishing up the income statement, other income of $1.7 million for the quarter compared to $1.1 million last year. The provision for income tax was $18.8 million or 36.3% of pretax income. This compares to an unusually low $3.1 million or 9.7% of pretax income in last year's third quarter.

The tax rate this quarter reflects the non-deductibility of some Latrobe transaction costs and the state tax provision. We expect our full-year book tax rate will be about 36% and our cash tax rate on the other hand is only 11%.

Overall reported net income was $33 million or $0.69 per share. As previously discussed, this consists of $0.84 per share from the continuing business, partially offset by $0.15 of Latrobe acquisition-related costs.

Net income in the third quarter last year was $28.6 million or $0.64 per share.

Looking at the segments on an ex-surcharge basis, specialty alloy operations or SAO sales increased 12% on 1% lower volumes, with operating income of $66.7 million and a 21.5% segment operating margin.

Performance Engineered Products or PEP sales increased 21% on 8% lower volume with operating income of $9.8 million and an 11.6% operating margin.

Latrobe reported segment operating income of $2.9 million for the month of March and a 5.8% operating margin that adjusted for the inventory fair value cost adjustment and other items. Adjusted operating profit was $5.1 million with a 10% operating margin.

Free cash flow for the quarter was positive $9.6 million, which included $11.5 million for the Latrobe transaction. We still expect positive free cash flow in the fourth quarter and modestly negative overall free cash flow for the full fiscal year. We have been reducing our inventory level and have made good progress in some areas, but it is a higher business priority right now to maximize our output in the near-term to accommodate more customer demand and enhance our stocking programs to reduce customer leadtimes. We still expect to see a further reduction in inventory in the fourth quarter and believe inventory reduction between the Carpenter and Latrobe systems is an opportunity area that we will put focus on as part of the integration process.

We still expect total capital spending for the fiscal year between $175 million to $185 million. For the next two years this will increase to about $300 million a year, due primarily to the investment in our new Alabama facility. As we've said previously our CapEx investments and intensive funding obligations over the next two years will result in overall modest negative free cash flow.

(technical difficulty) our (technical difficulty) expansion investment are an essential response to the strong market demand from our customers. We anticipated this level of near-term aspect of investments in our financing actions last year and our growth plan is self-funding with no external credit market risk. Once we are past this peak investment phase, the company should return to being a strong cash generator over the balance of the decade.

In terms of our balance sheet we continue to have sufficient liquidity and anticipate very little if any need to tap our $350 million revolver. Our other balance sheet metrics have strengthened with the addition of Latrobe's EBITDA and no incremental debt.

We currently intend to pay off $100 million of debt that matures next May and did an upsized bond offering last June in anticipation of that.

Finally, I'll end with two comments on our outlook for earnings next fiscal year. As we close out fiscal year 2012 we are on track to grow our operating income, excluding non-cash pension EID, by (technical difficulty) million dollars or over 70%, including the addition of Latrobe.

For fiscal year 2013, our early look is that we believe we can achieve a further increase in operating income ex-pension EID of at least 30% and an additional $70 million. Latrobe on its own will be about 10% accretive to EPS, even considering the $16 million in additional non-cash expense due to purchase accounting impact on asset and intangible depreciation and amortization.

We are currently using $59 million or $0.76 per share as our estimate for pension expense including Latrobe next year with about $22 million of this on the pension EID line. The (technical difficulty) locked in until the asset value and interest rate assumptions at the end of June, so we'll continue to keep you updated on these estimates.

And we are estimating a combined fiscal year 2013 tax rate of 34%. Beyond this we are taking actions, including creating more near-term premium products capacity, to continue the strong earnings progress into fiscal year 2014. And then we have the Alabama facility capacity kicking in beginning in fiscal year 2015.

Taken altogether, we are bullish that we can sustain strong revenue and profit growth through the rest of the decade with our core business growth opportunities, the Latrobe acquisition and synergies, the additional Alabama capacity, and other growth strategies including new product initiatives.

We are planning an investment day in New York City on the morning of September 7 when the management team can take you through all of this in more detail.

And with that, let me now turn it back to the operator so we can open the line for your questions.

(Operator Instructions). Steve Levenson, Stifel.

Good morning, everybody. Could you talk a little bit about how pricing on nickel-based super alloys works relative to capacity, and what if any relationship it really has with LME nickel prices?

This is Mark Kamon. Pricing on nickel alloys for our business occurs in two different ways. Primarily, we have transactional business, and we have what we'll call annual contracts or long-term agreements where we have price arrangements. So, on our transactional business, and on our LTA business, we have hedging and/or what's called a raw material surcharge strategy that moves with nickel. So as nickel moves up and down, that responding action moves up and down. So we think over time we are neutral as nickel moves.

Okay, thanks. And then in relation to the transactional business, not subject to long-term agreements, I guess, what, as you continue to use up the capacity you're able to raise those prices.

Sure, that's the, you know -- there is supply/demand that enters in on transactional business, but we also are looking to grow our new products and use our capacity to enhance our customers' ability to compete and succeed as well.

Got it. Thank you very much.

Gautam Khanna, Cowen and Company.

Great results, guys. So could you talk about a couple things. First, I think you were doing a study on the fasteners side of the business to see what actually is going on. So could you clarify what you're seeing with respect to nickel, stainless and titanium fasteners? A. And then I have a couple follow-ups.

This is a Sanjay Guglani. For the titanium fasteners, we are seeing increased demand from most supply chains. There are some isolated sections of the supply chain where the take-up is not that fast. And I would say that is true for both nickel and titanium.

Could you comment maybe on the differences between Boeing and Airbus?

So our perception is that the Airbus supply chain is pulling materials on a consistent basis. It seems that on the Boeing supply chain there might be isolated incidents of burning down of excess inventory from previous buildups on titanium side.

On the nickel side --

So, on the nickel side of the business -- this is Mark again. On the nickel side of the business as we've reported over the last few quarters, we've seen significant double-digit increases in fastener demand. And that continues through the third quarter and as we've just experienced.

I would comment in general that when you think about fasteners, the fastener demand is really a function of the number of planes that are rolling off the end of the assembly line over a long period of time. So the number of planes is growing, and the size of those planes is growing, so we should see consistent fastener growth, consistent with the airplane builds. And we'll see from time to time some quarters that are higher in demand and some quarters that are a little lower, but growing steadily further as we go through the decade.

Are you -- Mark I mean to follow up on that are you seeing any differences between the major faster OEMs? I mean because obviously Boeing went to these long-term agreements January 1 and presumably shifted share along the way. And I'm just wondering if you are seeing any notable differences between the three major --?

I wouldn't -- couldn't comment on the nature of their business because I don't know the details internally, but suffice it to say our overall fastener demand, when we participate with the entire fastener community, continues (technical difficulty)

Okay. The other thing, Doug, you mentioned the inventory I think -- the step up goes away in the September quarter, so, is that a zero? I thought it was going to be over six months. Did I hear you right?

Yes, we are anticipating beyond the charges that we book this quarter a similar $3 million a month in the $9 million-ish type of charge in the fourth quarter, and really, then, it becomes a function of -- this is part of our LIFO nickel pool. And when we are reducing inventory we'll have these kind of cost impacts, but if inventory is level to increase and we wouldn't and right now we would not anticipate having any carryover of the inventory cost adjustment into our fiscal year 2013 or that September quarter.

Okay. Could you also explain for us -- you mentioned 4,000 tons of incremental capacity. Does that relate apples to apples to 40,000 tons that you currently have? Could you just talk about what specifically your premium melt capacity will rise by first ex-Latrobe and then with Latrobe?

This is Dave Strobel. If you take a look at our premium melt capacity, the key area that has -- the two areas that have been inhibiting our growth there has been the remelt capacity as well as the hot (technical difficulty).

We've taken some actions within Reading operation to improve that with two ESR furnaces. The first is started up. The second is starting up the second quarter, and the addition of three VAR's out of the Latrobe operations. So that will help from a remelt capacity.

The hot work capacity, long term, obviously will be the focus facility in Alabama. Short term we're making some changes with the products between Reading and Latrobe to open up additional hot work capacity, so between the two operations, we feel very comfortable with the 4,000 tons FY 2013 and another 4,000 tons over FY 2014.

Okay. And then lastly just a general one, maybe, if you could talk about any areas of the portfolio that are actually softening.

Well, this is Bill Wulfsohn. And I would say that it's not that we are seeing softening per se but there are some areas as we've discussed in previous calls where strategically we have made the decision that we needed to either get more price or exit certain parts of our business that would be kind of lowering our overall profitability and mix and yet going through constrained operations. And so you see that in parts of our operations, part of our SAO business.

Maybe would comment that in Europe we are seeing a little bit of softness on the powder side in the marketplace, so that would be one specific case. But beyond that, we are seeing in general strong and robust demand.

Chris Olin, Cleveland Research.

I wanted to just make sure I am clear on the 2013 guidance. The incremental $70 million, that does include Latrobe?

Yes, it does.

Okay. In terms of the nickel-based alloys market, is there going to be a time where you could see some type of benefit from contract rollovers or the favorable pricing that seems to be in the market today?

Yes, this is Bill Wulfsohn. I would say a couple things.

I mean certainly the dynamics at this point in time have been reasonable for having new contracts and extending contracts. But what I really try to emphasize, that is, what we are trying to establish is long-term supplier relationships with our customers. So, there probably is some spot opportunity if you were to take things from more of a transactional viewpoint to push price even harder, but those could have long-term implications and consequences in terms of our supply relationship to those customers. So what we've been focused on is trying to find what we think are very good returns for our shareholders and very sustainable pricing positions for our customers and trying to strike that balance accordingly. And I think you're seeing that reflected in our results.

Last question -- I have two back to that 2013 guidance. Does that include the potential impact from the new incremental capacity that you talked about hitting the market?

Yes, it would. But obviously not the focus facility because of the timing that that will come online.

Okay. Thanks.

Josh Sullivan, Sterne, Agee.

Good morning. Great quarter. I know you said that cash flows are going to be slightly negative as you invest in the new facilities, but kind of in a similar vein to how you expect to exceed your previous EBITDA targets. Do you expect cash flows to return to that kind of 100% net income level once the facilities are up and running long term?

We will have made the structural investments that we believe will give us significant capacity to meet the demand. The cost of adding for example in the nickel area -- incremental capacity -- will be structurally much lower because the base investment we're making now will not only give us capacity gains but will set the means for further growth. We can't predict what kind of acquisition opportunities might be out there or what other types of growth opportunities we would want to pursue, but we believe that from an operating cash flow we are making the structural investments right now to get the capacity and capabilities we're looking for. And so, barring any of those other caveats, we should see very strong cash flow coming off the business after those investments are completed.

Thanks. And then just kind of that M&A outlook, are you looking more kind of on the energy side in the PEP segment or where might that be targeted?

I think the PEP segment would be the very logical area to extend ourselves. We're very excited. Feel very good about our momentum, but have of course an execution agenda on the SAO portion of the business with integrating Latrobe and expanding our capacity. The PEP business is -- and that's one of the reasons why we structured it in a separate operating group -- it doesn't have some of those execution agenda challenges that the SAO business is faced with, so that's an area that would be very logical for incremental and additional acquisitions.

Great, thanks. I'll get back in the queue.

Dan Whalen, Auriga USA.

Thank you. First of all congratulations on the quarter and the acquisition completion.

So, on the titanium fastener side we've exceeded prior peaks. Where do we sit in terms of the nickel and the stainless? If we were to look at the face of the clock where do those fasteners sit in terms of the cycle?

Well, I would say there is a difference in tie and the nickel driven by the aircraft. So if you think about Boeing starting the 787 production, the 777 increasing, some of the larger aircraft, the tie content is much higher, which is why you're seeing tie respond faster. So we've seen significant growth on the nickel side.

We're not quite back to peak, but frankly it continues to come as I said with double-digit growth, significant double-digit growth quarter after quarter for the last four. And we would expect that momentum to continue for some period of time.

And what about the stainless?

My comments pertain to both nickel-based and stainless, but stainless is a smaller piece of the total asset.

Right, okay, which as a follow-up, I mean if we were to congregate the titanium nickel and stainless, can you give us a rough estimate in terms of the contribution in terms of total fasteners?

I'm not sure contribution -- this is Doug -- contribution in what terms, but we've --

Well (multiple speakers) yes. If we were to take a look at your total fasteners business, how much is titanium, how much is nickel, and how much is stainless?

We've talked about them altogether. Aerospace as you know is our largest business, representing about 43% of our total revenue, and within that fasteners is about 35% to 40% of that. And we have a strong position with -- majority market share positions in all three types of fasteners there. And we have haven't really broken down that individually other than what you can infer out of looking at our titanium product sales that we report.

Right. Okay, fair enough. And then post-Latrobe can you remind us what your spot versus contract long-term agreement is, in terms of pricing?

On the -- what we'll call the legacy Carpenter business it's about 50-50 LPA and transactional. And on the Latrobe side, the long-term agreement would be a -- quite a bit of a smaller percentage.

Okay. So your spot business went up -- on a combined basis.

That's correct.

All right. And then lastly, this is maybe in your filings, but I may ask one more, but can you just remind us what -- for Latrobe what the peak EBITDA levels were?

You would have to refer to Latrobe's filings including their S-1's. They were a private company, as you know, in that timeframe. So, any information on that would be in their previous filings.

Okay. Okay, well thank you for the color.

Phil Gibbs, KeyBanc Capital Markets.

Doug, just wanted -- for clarity purposes, the guidance that you've provided for operating income excluding EID pension, is that on a GAAP basis?

Yes. Between our operating income that we report on our GAAP statements and add the pension EID and that's the number that we are referencing.

Okay. So for our fiscal 2011 base level, is that $132 million then?

That's correct.

Okay. Perfect. And then over the last couple calls we've thought that inventories were going to come down a little bit. In the back half of the year, that would, I think with declining nickel, create some sort of LIFO charge. And, just looking to see the outlook on that, I know you mentioned it a little bit, but did we have a modest benefit in this quarter?

We had about a $1 million negative; I mean inventories did come down some. And we would expect as inventories come down in the fourth quarter to have a little bit more of a negative impact, if that's your question.

Yes. Okay. And then last question here, for Bill. The PEP sales have largely leveled out here over the last three quarters. Is that largely because of the powder business?

That would probably relate more specifically to the comment I made a little earlier that powder weakness (technical difficulty) specifically in Europe. The business here in North America has been very strong.

Okay. Thanks, gentlemen.

Doug Thomas, JET Research.

Outstanding results and I very much applaud the efforts. Quick question -- I think it was Doug who talked about the -- your efforts to try to incorporate your customers' views and outlooks in terms of the Alabama facility and so forth. And whether it's Bill or Doug, I guess my question is, is going forward, you've clearly got much more of a customer-facing approach to building this business than at any time I think probably I can recall. I'm just wondering how that plays out.

How much do your customers have an interest in involving themselves in the planning for the new capacity? And how much of a -- over the long term what sort of benefits will that accrue?

Absolutely. I appreciate your question and the theme you picked up on.

We've looked at it very carefully and we've assessed from a kind of macro trend standpoint what we believe will be the aggregate needs in the marketplace versus the aggregate path to the unavailability. So we're trying to be proactive to make sure that we not only have the needed capacity but also that we have the flexibility to meet if you will certain peaks that come with demand without having to extend leadtimes. In fact, our goal is to dramatically shorten leadtimes by putting in much, much more lean production processes.

And in terms of aligning the capabilities with our customers we actually are going through a process by which we are spending a lot of time with our specific customers, sharing with them the details of what it is we're doing and getting feedback from them as to, if there are specific enhancements, nuances, that could be beneficial from their perspective. So, we want to be the best supplier to the industry.

And then I guess, secondarily, I know we're just coming off the third quarter and I'm -- people are looking at the fourth and next year. But Bill, again, I know that the approach -- and not a lot of people talk about it -- but the approach towards aligning management compensation with performance you're not going to have a meeting until September by which time there will be another -- there will be the proxy out for this year and so forth. But, can you give a sort of a state of the nation sort of just view of how things are working out in terms of the alignment that you've put in place there in the last couple years and what you're expecting as we head towards next year?

Sure. Well, I think first of all we have an excellent team and we've rallied around the opportunities we have. We work well together, but each individual understands their specific contribution to the core success.

From an incentive compensation standpoint, in our short-term compensation, and you can find us this in our CD&A, that we are primarily focused around what we deliver in terms of operating income, so very aligned with the shareholders. We have customer performance and safety performance as part of what's important for us to deliver. And clearly our long-term incentive compensations are very much aligned to total shareholder return and stock appreciation.

As we look forward to next year, while this is ultimately up to the board to make the final decision, we are not looking for a fundamental redesign in terms of our compensation program. We believe that they are well aligned with the business interests and the shareholder objective.

Okay. I apologize, just briefly, you mentioned about there is not really a clear path I guess in the near term to acquisitions or things that you find compelling enough to do here until you have integrated -- made some -- the integration of Latrobe and also new capacity and so forth. Can you talk about pricing as -- and additional consolidation outside of Carpenter? As -- are there some deals out there? What's going on in terms of pricing of potential M&A?

I want to be clear -- and maybe I wasn't before -- that we are very interested and are active and will pursue acquisition opportunities. Sometimes that can be opportunistic because others choose to make transactions available, whether it's on your schedule or not. But from a cultivation standpoint, we are really focused more on acquisitions as it relates to the PEP business. And I say that just because of the strong execution focus that we have in the SAO business at this time.

In terms of valuations and pricing of potential deals that are out there, I would only comment that it's not surprising that given the general momentum in earnings growth and the fairly bullish sentiment around some of the segments that we would be focusing on, like energy and aerospace and medical, that people are looking to not just get their current value and historical value, but also what they perceive as the future value of their businesses. So, it's not inexpensive.

Okay, well said. Listen, thank you very much. Congratulations, again. I appreciate it.

Mark Parr, KeyBanc.

That was a very nice quarter. Congratulations. I am delighted just to see the progress.

My one -- most of my questions have been answered and I had one longer-term question. And it would relate to the new facility in Alabama; and once you get that -- once you begin commissioning, there would seem like there would be an opportunity to perhaps move non-premium, non-super premium material from Reading into that operation and give you another boost to super premium in your existing operations of Latrobe and Reading. Is there any way that you could quantify that for us in terms of what sort of incremental capacity that might create for the high-end products?

Good morning, Mark. This is Dave.

Hey, Dave.

You're absolutely correct in that a lot of the product that we hope to eventually have down at the Alabama facility going through there will require vendor qualifications that can take two or more years. And obviously to get that operation up and running, our plan would be to move product that does not have stringent qualifications. So you get turned on very quickly down there and allow us to get operating and free up the capacity then within Reading and Latrobe operations to make more of the vendor group processes, while we are going through the qualification now with them.

So we feel very confident that as we start up that first fiscal year, and we're looking at 10,000 tons plus and being able to grow that over four years up to the 27,000 tons. Does that answer your question?

Yes; thank you very much. And good luck on the June quarter.

This is Bill. I would only just add -- and we will see indeed versus the [words], but in interactions with customers, given the relative limitations on supply today and the relatively long leadtimes, we've found that customers are expressing a willingness to move in terms of qualification and in a very productive/constructive manner with us. So we are hoping -- and especially when the leadtimes that we are looking to offer out of this facility based upon the lean approach, we think there's going to be some very good incentive for customers to move that process forward in what we hope will be of course a responsible but a fairly quick time frame.

Thanks, again.

Chris Olin, Cleveland Research.

I just wanted to follow up on the 2013 guidance once again just to make sure I understand where you're coming from. If I take the SAO EBIT number of $66 million annualized, let's just say $70 million, I get $280 million in 2013, so that's incremental about $45 million, and presumably Latrobe I'll just say $30 million to $40 million; that's $70 million incremental there. And that's just considering all the numbers hold relatively flat.

Am I missing something? Are you expecting some type of margin erosion next year? Is there something in the numbers that would suggest it should be that conservative?

You're going a little too quick for me there on the math and the different pieces there. But the direct answer do we expect erosion in any of the pieces, no, we would expect continued progress on our SAO business, on our PEP businesses and with Latrobe. So I would have to spend some more time in the way that you've kind of laid it out -- laid out your construct. But the goals that we've established there would represent progress on all three fronts.

Have you -- did you provide what the average mill lead time is right now versus the fourth quarter?

We're actually looking some quarters out into the end of the calendar year at this point, so we remain very strong as far as the demand. Again, as we free up the capacity, through the integration efforts that we have we'll be able to provide some additional transactional business as we work our way through the calendar year as well.

Okay, thanks.

Gautam Khanna, Cowen and Company.

I just want to follow up on the guidance questions. So I just want to be clear, in Q4 -- we're estimating -- you've done $1.74 year to date. The implied guidance is somewhere around $2.80 million. So, is Q4 on a GAAP basis somewhere north of $1.00? I just want to make sure we're talking the same language.

I'm not sure how to respond to your question, Gautam. The (technical difficulty) and the math for Q4, but --

Maybe we could just talk about some of the items. So, interest expense in Q4 will be comparable to Q3. Is that fair, around $6 million?

We are not adding any debt so our interest expense is constant currency.

Is there anything with respect to margins? We saw the PEP margins step down a bit; could those rebound? Or is there any one-time effect in the March quarter?

I don't want to get deeply into providing specific guidance in the fourth quarter. I will point out on Latrobe that we do have what we estimate to be $9 million of further inventory costs that affected purchase accounting on Latrobe, so that's got to be factored into the equation. And, share dilution alone in the quarter is probably about $0.12, so between those two effects you've got a say $0.23, $0.24 headwind that we need to compensate for with the Latrobe operating results and the progress on the legacy Carpenter business.

Okay. Could you talk about kind of -- you mentioned being capacity constrained. In terms of spot business you were unable to fulfill so far this year, can you quantify that for us?

We -- obviously we've been expanding our premium capacity output. And I think that's a message I just want to emphasize is, yes, there are constraints but we are expanding our output in the premium area. Some of that is through mix management and some of it's through the capacity investments that we're making and the synergies coming from Latrobe, and we expect that to continue. We've tried to highlight that.

Clearly, if we had the 27,000 tons that were at the premium facility available today, we think that we would be well utilizing a significant portion of what we have set as our first-year target for that facility. It would be wonderful to have it here today, but, as a result we're -- we've deferred and had to if you will extend out to leadtimes on some of that business.

Okay. And then, Doug, could you talk about kind of the cash pension requirements next year -- fiscal 2013?

I think we're looking at -- roughly -- it will be in our SEC filings -- but we are looking at roughly a $55 million -- $55 million on legacy Carpenter and then probably another $15 million on Latrobe, so $70 million in total.

Thank you.

Alex Cook, Voyant Advisors.

Good morning. Could you speak about the drivers of the increase in inventory?

Sure. Actually, we have been working on progressively bringing inventory down, and we expect to continue that through the fourth quarter through just overall management. But what we have done over time is we've specifically built up some of our stock programs, some of our intermediate materials, so that we can try to have the flexibility to provide responsiveness back to our customers, given that we have relatively longer leadtimes.

In addition to that we've had almost $25 million worth of increase in the value of our inventory, just as a result of the fact that there is a richer mix of products that we are selling at this point in time. So both of those factors are contributing to the build up between the first half of this year and now we're working to bring that down. But again, responsiveness is the priority right now.

And then how much of that is related to the Latrobe acquisition?

Well, there's really been I would say very, very little as a result of the Latrobe acquisition. Now that we are working together after the close we are obviously running some qualification runs of their product at the Reading facility and vice versa. So there might be some incremental effect, but we wouldn't point to that as a major driver.

(Operator Instructions). Tim Hayes, Davenport & Company.

Just to clarify, again, back on Latrobe and the impact from the inventory write-up, the reported operating income was $2.9 million. And how much of the inventory was there from the inventory writeup in that $2.9 million?

There was -- it's the same number, Tim -- $2.9 million. If you look at one of the back schedules in our press release, it breaks out getting from a $2.9 million Latrobe segment operating profit, backing out the $2.9 million that's due to the inventory writeup, and then some other adjustments and getting to the, a little over $5 million of Latrobe operating results contribution in the -- well what effectively amounts to a month.

Okay. So that's the overall and there is a $2.2 million adjustment?

Right. Of which $2.9 million is the inventory item.

Got it. Okay. Thank you.

And we have no further questions at this time. I would now like to turn the call back over to the speakers for any closing remarks.

This is Mike Hajost. Thank you, again, for participating on today's call. We look forward to speaking with you again next quarter. Thank you and good bye.

Ladies and gentlemen, that concludes today's conference. Thank you so much for your participation. You may now disconnect. Have a great day.