Carpenter Technology Corp (CRS) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2013 Carpenter Technology earnings conference call. My name is Darcelle and I will be your operator for today. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions). I would now like to turn the conference over to your host for today, Mr. Mike Hajost, Vice President of Investor Relations and Treasurer. Please proceed.

Thank you, Darcelle. Good morning, everyone, and welcome to Carpenter's earnings conference call for the second quarter ended December 31, 2012. 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, [Tony Tan], Senior Vice President and incoming 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, 2012 10-K, September 30, 2012 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. I know you may have some questions about the business following our January 15 press release, so I'm going to be brief with my prepared comments this morning which will leave more time for your questions. In addition, I've asked Doug to provide more clarity on our second-quarter one-time events and our forward outlook.

In our second quarter, Carpenter achieved strong year-over-year volume and earnings growth. Sales ex-surcharge were up 30% on 28% higher volume. This was driven by the Latrobe acquisition, strong demand for our Premium and Ultra-Premium products, primarily in the Aerospace & Energy market, solid growth in Europe and Asia-Pacific, and continued Omega West sales growth in the context of a 10% drop in the rate count.

From an earnings perspective, we increased operating income and EPS by about 20% versus the same period in the prior year. This growth was driven by the addition of Latrobe which is realizing about double the expected synergies. Note, year-to-date the Latrobe manufacturing operation is running at about 17% operating margins.

In addition, strong mix has helped to improve our profit per pound within our SAO business. At the same time, as we described in our January 15 press release, during the second quarter we saw the impact of destocking in the titanium medical supply chain, reduced demand for value products at Latrobe and our power operations, and we reduced overhead absorption in our Specialty Alloy Operations as we began to reduce inventory.

As we look to the remainder of fiscal year '13, we continue to expect our full-year operating income improvement of 20% to 30% versus last year with strong second-half revenue and earnings. The reason for this range is because of the continued short-term demand uncertainty with some of our value products. Note that at the same time, we are continuing to see strong demand for our Premium and Ultra-Premium products especially in Aerospace & Energy.

In addition, we are still planning a debt refinancing in the sale of our distribution business, which will further strengthen our cash and liquidity position. Doug will speak in detail about these actions and their impact.

So in summary, we feel great about our business mix, we feel great about Latrobe and about our projected 20% to 30% profit improvement year over year. The prospects for our business remain extremely positive. Our new Athens facility will be operational in just over a year. This capacity will enable us to accelerate our growth as current demand exceeds our supply capabilities and our targeted Ultra-Premium and Premium markets. In addition, we continue to make solid progress commercializing new and differentiated technologies as was evidenced by yesterday's announcement about our collaboration agreement with US Steel to lightweight our automotive applications.

So, based on all of these factors we remain confident that our strategic actions will enable us to achieve our mid-decade EBITDA target of $550 million to $580 million.

With that, I'll now turn over the call to Doug who will provide more detail on our key initiatives and results.

Thanks, Bill. I would like to supplement Bill's comments with some more specifics on our second-quarter results, fiscal year earnings and cash flow outlook and some of the special items that we are calling out.

For the second quarter, let's start with the topline. Revenue in the quarter was $533 million. Excluding surcharge, revenue was up 30% versus the year ago period and about the same level as we reported in the first quarter. Excluding the impact of the Latrobe acquisition our Q2 revenue ex-surcharge was up 5% on volume that was up 2%. On the bottom line we delivered Q2 EPS of $0.62 which is up 19% versus the $0.52 we reported in the year ago period and below the $0.74 we reported in Q1.

Bill has already commented on the strong earnings growth versus year ago which we feel good about in the current market environment. The lower sequential earnings performance versus Q1 was due to the following factors.

Operating income in the PEP segment was $2.6 million lower than the prior quarter level. Our powder revenue and earnings were down due to continued weakness in Europe and other lower value parts of the portfolio. Revenue and earnings were also off in the Dynamet titanium business with aerospace fasteners continuing to grow but more than offset by very weak near-term shipments in the medical supply chain. Note that revenue and earnings in the Omega West energy business increased versus the first quarter, so that business continues to perform well in a market where overall rate counts are off by about 10% versus year ago.

Latrobe revenue and profit were down from the first quarter due to weakness in the order rate for lower value products. We are compensating for that by continuing to exceed our plan for synergies and the overall deal economics.

That leaves the SAO segment. First, on the positive side, overall volume and revenue were up slightly from the first-quarter level with continued improvements in our product mix. However, our manufacturing costs were higher in the second quarter as we melted less material in Q2 versus Q1 which resulted in lower cost absorption. The reductions in plan production levels were made to avoid building excess inventory on lower value products where demand remains weak, and also to begin implement changes that will allow us to manage to lower inventory targets going forward, consistent with recommendations from the consulting report that we have previously referenced. We collectively referred to this as production balancing in our January 15 press release which I know some of you found unclear.

Of note, our manufacturing performance metrics, including things like melt deficiency, continue to be strong in the quarter. Also our spending is running below plan levels, so that is not the issue, rather it is the activity or absorption level with the mill operation due to lower production.

The transition of reducing plan production levels to enable better forward inventory turns will also have a negative impact on manufacturing cost absorption in the third quarter. After that, we expect to be back in balance by Q4 and our plan is to keep overall mill inventory relatively flat as we bring on Athens, which will achieve our turns improvement objective.

All of this is reflected in our current expectation for full-year operating income improvement of 20% to 30% versus a year ago. To be a little more specific on this, if we meet the criteria for reclassifying the distribution business into discontinued operations, the base earnings we are comparing against in fiscal year '12 in terms of operating income excluding pension EID will change from $237 million to $233 million.

Growth of 20% to 30% from that new base would therefore imply an operating income improvement of about $50 million to $70 million. As a reminder, this is on top of operating income improvements of $102 million in fiscal year '12 and $85 million in fiscal year '11.

As outlined in today's press release our operating income growth projections exclude two items. Expected one-time impacts of about $3 million this fiscal year for various footprint restructuring opportunities as a result of the Latrobe acquisition. These include the announced closure of our fine wire facility in Orangeburg, South Carolina in Q1, the consolidation of our two UK warehouses into one that we are recording in this quarter, and a few additional items that will mostly fall in the third quarter. We will continue to include a schedule to our press release that reports the amounts we incur for footprint restructuring projects which totals $300,000 through the first half.

In addition, we previously mentioned that we will incur third-party consulting cost of about $3 million associated with developing our inventory reduction strategy. There are other negative cost impacts associated with making this transition, as you have seen, but the consulting fees are the only thing we are calling out as a special item and the rest is reflected in our 20% to 30% growth target. We've incurred $1.6 million of cost for this item in our first-half results.

To be clear, the $6 million of startup costs we expect to incur on our Athens facility this fiscal year is also already factored into our 20% to 30% earnings guidance since this was in our plan from the start. That hopefully provides you with good clarity on our expectations.

If you do the math, that would imply that second-half operating income, excluding the exceptional items, will grow in excess of 20% versus the first half. Beyond this, there will be some other EPS impacts as we outlined in our press release. The debt refinancing and discretionary pension contribution would result in a negative earnings impact of about $0.13 per share from higher interest in income tax expense.

Our plans in this area have positive cash flow and EPS impacts beyond this year so we are confident this is the right thing to do, given current attractive credit markets. There will also be EPS impacts associated with the sale of the distribution business, but these will mostly fall to discontinued operations. On the other side of the ledger, we will benefit by about $0.04 from the recent retroactive extension of the R&D tax credit.

Finally, I'd like to elaborate on our multiyear plan to maintain a strong cash and liquidity position on the business as we simultaneously fund our Athens greenfield expansion project. More specifically, based on our debt plans, inventory reduction initiative and expected distribution sale, we now expect to end fiscal year '13 with a cash and liquidity position around the same level as our beginning fiscal year position despite $350 million of total CapEx investment, about two thirds of which is going toward Athens. Previously we expected a negative cash impact of about $125 million this fiscal year.

In fiscal year '14, we are also targeting relatively neutral cash flow while spending about $325 million of CapEx with most of this related to completing our Athens investment. And beginning in fiscal year '15 and for the balance of the decade we expect to have very strong positive cash flow on the business with the contribution from the Athens tons.

With that, let me now turn things back to Bill.

Thanks Doug. To wrap up, I just want to make a few closing comments about our business. We had record Q2 EBITDA, the strongest in our history. We had a solid first half of our fiscal year, with our first half earnings per share up $0.30 or 29% versus prior year, and operating income was up $31 million as we achieved higher average operating margins.

Looking forward, we feel great about our fiscal year 20% to 30% operating income growth target, which is driven primarily by our mix management actions and Latrobe, and it's above plan synergies. As Doug mentioned, we are also taking actions to improve our cash and liquidity position while still making a sizable investment in our Athens facility. These actions will enable us to maintain our strong balance sheet and provide us more flexibility to take advantage of business development opportunities.

And last but not least, we are excited -- as excited as ever -- about our new product development efforts to meet customers' evolving needs, including continued progress with [Pyromet] and Temper Tough as we just announced yesterday, and further positive developments related to our stainless steel Landing Gear commercialization. Altogether, while we have some near-term concerns about demand in some of our value areas of our portfolio, we remain very excited about our growth prospects this year and beyond.

With that let me now turn it back to the operator so we can open the line for your questions. Thank you.

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

Good morning. So you mentioned the fastener material, in particular, I think you mentioned as it relates to Dynamet. I am curious if you could kind of look at leadtimes and tell me what maybe the leadtimes look from either the last six months and the last year if you could do that, in both say the nickel as well as the titanium fasteners.

To answer that I'm going to turn the question over to Andy Ziolkowski, who is our Senior Vice President of Commercial Operations with our sale business and has also been overseeing our Latrobe operations and integrations over the last year.

Thank you Bill, and, Edward, I'll speak specifically to the nickel and Sanjay Guglani can help us out with the titanium. But on the nickel side in terms of our leadtimes, our leadtimes have been improving. So specifically in this area we've seen about a 10 week improvement in leadtimes in the products in the nickel products that go into the fastener materials. So very similar to the comments that were made for the titanium demand, we are seeing a similar demand on the nickel side.

So just to be clear, that market is tightening up then for you quite a bit. I think it was six weeks last quarter. Are you saying you're at 16 now?

I'm not sure we are following. I think what we are suggesting is we are improving. The market has signs of improving, and we see a lot of hope there.

But we have been working in fact throughout our operations to reduce our leadtimes, so in that area and specifically I think Andy was referring to the nickel-based fasteners, we've seen our leadtimes actually come down, which is what we have been targeting so we can have better responsiveness for our customers.

Ed, this is Sanjay Guglani. For the titanium fasteners, the leadtime stays what it was previously, 12 to 14 weeks out. And we are seeing increased demand for titanium fastener wire and we are making operation improvements to accommodate that so that we can maintain the same leadtime.

So I would also just to conclude on this, just point to the press release that we had before, which stated that the nickel and stainless fastener material increased year over year for the 10th consecutive quarter, and shipments of titanium fastener materials set a new second quarter record up from a year ago. So, continued very positive trends in that area even as we've been able to bring in our leadtimes.

When I look at the quarter itself, and I know you mentioned a little bit of destocking in some of your markets, the revenue on a sequential basis and seasonally weak December being that seemed to hold in there pretty well, I would say. When I look December to September. There seems to be more of kind of is it the fixed cost absorption, and I think you alluded to that in your prepared remarks. But is that really what say the pressure on earnings had been for this particular quarter? And not necessarily something on the revenue side that's from the demand? I guess they are related.

Sure. To break into the three business segments that we report, the SAO side, the legacy Carpenter mill products area, we actually saw a very similar demand from a ton standpoint Q1 to Q2. And our contribution per pound, which we look at internally, was very consistent with what we have had in Q1 to Q2. We did see more overhead, so between the direct contribution and the bottom line we saw an increased overhead, and that was really a result of we melted less material. And as we melted less material, even though we took some cost out, we had less absorption. So it went to the bottom line.

In the Latrobe area, we saw very similar demand from a manufacturing standpoint or the manufacturing side of the business between Q1 and Q2. But then finally in the PEP business we did see a sequential reduction and that was primarily in the CPP area or powder business, and also the Dynamet business and I think we have referenced the two reasons for those.

Gautam Khanna, Cowen and Company.

Thanks. Perhaps for Andy first, on the production balancing. Could you give us some color on when it began when you started to take down utilization levels? And how we should think about whether -- kind of what we saw in the quarter was just a partial effect of what we're going to see in Q3 and Q4 because you're going to continue at lower levels? And when did you guys -- when did it begin in the quarter, and how does it extend beyond the calendar Q4? That's the first question, and then I have some follow-ups.

I'll begin with the answer here. It's Bill. We had explained and had begun work really at the start of this fiscal year to look at ways that we could optimize our inventory investment while still providing the same or even higher levels of service to our customers. We essentially got the feedback from the work that we had commissioned at the very end of October, very beginning of November, and we took action virtually immediately thereafter.

So we began to melt less material. Specifically in December was really where we focused that energy. And we expect that we will melt more than we did in Q2, but we have taken down our projections from melt in Q3 versus what we had initially anticipated at the start of the year. And we believe that that will, as Doug mentioned, bring the system back into balance versus our targets. And as Doug also mentioned, the impact of that is reflected in our full year forecast and we will see a greater impact of this effort in Q3 and Q4 we will be back -- what we expect will be above Q1 type of melt rates. So we are just working that through and, again, it doesn't affect our overall forecast.

Okay. I guess what I wonder, you're saying it does not affect your overall new forecast. But can we talk about sort of what were the one off dis-synergies in doing this versus -- obviously you can always optimize inventory better and that's the basis for the consultants' conclusions of what you're doing. So I understand that you're going to get a lower level of inventory going forward.

But what were sort of the one-off items in the quarter? Because we saw a reduction of whatever it was, $5 million of EBIT sequentially at SAO, and I just wondered how much is actually contained to that quarter due to dis-synergies and starting the process? That won't recur?

Yes, the one-off item was entirely the lower cost absorption from reducing our production levels.

Which was how much?

Our production levels were down something like 20% versus the first-quarter level in the second quarter.

Does that explain all of the $5 million decline in EBIT sequentially at SAO?

It does.

And again, since you are now at that lower level, how much of that -- we shouldn't just assume it's a $15 million hit or a $10 million incremental hit in the first calendar quarter, is that right? It will be less than that?

So in the third quarter, we will still be impacted by a reduction in production levels versus our originally planned levels. As Bill mentioned, we will be -- very clear -- that when we look at the contribution the direct contribution coming from the business, the first quarter and second quarter were virtually identical in our SAO operation so it really was related to this absorption activity which falls below that direct contribution line.

How does this not change your mid-decade targets? I guess I am just trying to understand what is sort of an enduring cost -- a stranded cost or unabsorbed cost going forward, because presumably you're going to operate your melt facilities at just a lower level of utilization because you are able to keep the lead times and what have you. So I just wonder why doesn't this affect our mid decade and end of decade targets?

The reason why it doesn't is because we are making, if you will, a correction to our inventory levels with our activity that we have going through the mill. Once we've made that adjustment we intend to continue to try to drive with greater efficiency, but we will be expanding our production as we expand our sales activity, and so really net-net, we shouldn't expect that there will be less production going forward as a result of this adjustment activity.

And actually having gone through this on the cash side of things it enhances our cash outlook through the mid-decade projections as I had outlines.

That makes sense. Just skipping around here, you mentioned I think in the press release something about shipping already on some of the next generation engines. I was wondered if you could elaborate on that because of a lot of other folks are seeing weaker engine demand, and I was curious to see why you are not. If you could elaborate on that.

So, this is Andy. I'll just kind of refer you back to the communications we did during the investor conference and we think we are well positioned on some of the new engine platforms, particularly on the single aisle in the A-320 and the new variants of that platform as they come forward, and we are starting to see some of the early signs of that.

Okay. And what are you guys expecting on the IGT front? When we look at GE's original equipment IGT turbine orders and they were down 19% last year versus the year before. It looks like they are guiding shipments down and how do we square that with what you're seeing, what you were expecting? Which sounds like growth.

I think we've actually very consistent. Our business tends to track more to the OEMs, so the guidance by GE is something we look at. We tend to ship into the larger forgers, and we are consistent with their build schedules. We are seeing a little bit of increase in demand right now, so we will participate in that increase in demand and the mix of turbines that they are doing.

So we are seeing that and we are booking activities filling into the second half of the year.

That's actually an area we've seen a bit of an uptick on since the first of the year.

Great. Last one and I'll get back in the queue. If you could just comment on any encouragement you're seeing from new competitor entry on the aerospace fastener metals side, be it [VSNTO] or ATI, or it seems to be a focus of ATI's conference call. Are you seeing any market penetration size there?

We've referenced this in our earnings release that we've really seen strong demand growth across all the range of our fastener products. The consumption of fastener material is clearly going up, and we are not seeing any impact of if you will competitive incursion in that area. The majority of our business is at least in the titanium area would be related to the wire, and so I don't know specifically what others have referenced. A smaller portion is the bar that might be where the focus is, but we see record demand right now.

We have a number of long-term agreements that we've put in place that we've extended and we think give us a very strong position going forward. And while there are capable companies out there that with the right effort can always make progress, this is an area that takes -- it takes some time to get into the market.

So we are not seeing it today in a material way, and don't expect that it will have any significant impact in the near future on us.

Sal Tharani, Goldman.

Thank you. How are you? I have a very quick question, Doug. The pension payment you plan to do $165 million later this year. What would that -- how would that drive your pension cost which was I believe $0.21 or $19 million in the quarter? Where do you think it will go to -- will it make impact that?

We would expect next year the combination of that plus the additional interest from the debt would be somewhere around a net positive $0.08 or $0.09 beginning next fiscal year. That's holding every other variable constant.

Steve Levenson, Stifel.

Good morning, everybody. Can we talk a little bit about the deal you announced with US steel for the new alloy? Is that something that you will actually be manufacturing or is it something you'll be developing and then receive either one-time payment or royalty?

We are very excited about that announcement and are optimistic that it could play a significant part in our future. So we are excited about it. That being said, as I think you are aware, we really focused on, if you will, lower volume, higher value niche opportunities; and our production capabilities are wrapped around that. And so we still see great growth opportunities in that respect, if you will, in our core business.

What US Steel brings, should this project move forward, as we hope it will, is obviously they have the ability to look at a much larger and broader market that would produce volumes that are not within our capabilities, and they also have a route to market and established connections which are clearly ones which are very strong and advantageous.

So we would see continued growth in our efforts, our internal efforts, and the Temper Tough and Prima Met areas or Prima Met and Temper Tough -- excuse me, and this is upside to our internal projections. And I think it's just further confirmation that our efforts to develop and commercialize new technology are beginning to yield dividends.

We would see the benefit, should this move forward, the work with US ex to bring in royalties down the road, that would be the primary way that we would benefit per our expectation. And when you look at this it really is a great opportunity with the need -- the Cap A standards going out, the needs to reduce about 500 -- 500 pounds per vehicle on average, and we see that the ability to achieve roughly the same strength with around 20%, 20% to 25% less weight, you can do the math. This could be a strongly enabling material.

Sounds great, thanks a lot for the detail. Another question is there's been a lot of talk and a lot of activity around additive manufacturing including General Electric buying a few 3-D printing companies. How does your powder metal business fit in to that, what are your objectives there?

So we are continuing to develop and refine our powder strategy. We are excited about the potential that the additive manufacturing could bring as an additional dimension from a technology and market growth perspective. And we are again working through and assessing our powder business, how we can best, if you will, realign it to capture some of those opportunities.

That being said, the additive manufacturing growth and opportunity is a longer term potential or prospect, and we would not see that having a significant impact in the next several years. But it does fit very well with our Premium and Ultra-Premium strategy. And we do have good working relationships with those parties that are working and developing this technology for practical applications.

So I would say this is an area where we will have some more commentary to come in the future.

Thank you very much.

Arun Viswanathan, Longbow Research.

Thanks for taking my question. Just wondering, can you help us understand on the guidance for the year, given what you've, I guess, undergone in the last quarter on the destocking side, what would kind of get you at the lower end of that 20% or -- and what would get you at the upper end of the 30% operating income? Thanks.

Sure. We are working internally to achieve the upper end, and we see a path to get there. That being said, we do see some uncertainty. There is some volume, which we will need to book in the fourth quarter, and given the uncertainty in those markets, we think that that is primarily the difference between the 20% to 30%. So it's really primarily in the value area how well the order intake pattern solidifies.

One of the advantages we have with our shorter leadtimes is that we are able to respond better to our customers, and we are also able to bring in some transactional business which is very positive. The other side of it is when you are not booked out nine or 12 months, then you can't see with as much clarity when you begin getting out towards what we are talking about, six months or so from now. And that's why we call out some risk as it relates to this.

And, I'm sorry, are you expecting -- so the only risk is in the fiscal fourth quarter? Is that right?

Well, I think we feel that we are well booked through the third quarter and we feel we have good visibility on that. You always run the risk that customers can delay taking orders, even though they are produced per schedule. But we are not seeing that now, in fact we are seeing strong early shipments and good demand. So that's not what we are seeing today.

So really it comes down to in our view more of how will the order book fill in for the latter part of the fourth quarter? And again, our order intake rate has been good since the start of the year so we don't see any issues there. But we are trying to be responsible by sharing that there is some degree of uncertainty out there and that can affect the results as we've described.

So you think that you've kind of weathered all the destocking in the value area for the near term, or is it still going on?

We are -- as we mentioned we've taken down our melt production versus our original plans, it will be up over what we did in Q2, but we expect in Q3 it will be below what we had anticipated, maybe six to nine months ago. And that is reflected in the guidance that we have provided, the numbers going forward. So we'll see a stronger impact of that in Q3, but again it's within our numbers and then, I think, by the time we get to Q4 there should be a subject that we really won't need to reference much again.

Thanks. Just a clarification, you said the pension, once that's done, the net positive after the increased interest expense is going to be $0.80 to $0.09 a quarter? Is that right?

$0.08 to $0.09 for next fiscal year.

Next fiscal year.

And then obviously a cash benefit, because any money we put in now, our expectation is that that would alleviate the need for about four years' worth of required cash contribution. So it would be cash neutral over that period.

So is the $0.08 to $0.09 an annual savings every year?

Yes.

Okay. And it's not going to grow any larger or you don't make -- don't expect to make any other investments in the pension fund to reduce the expense even further?

I won't comment on that. That's to be determined in the future, but just based on the action we would put in place this fiscal year would have in the $0.08 or $0.09 benefit on next year's EPS.

[Seth Saffron], Buckingham Research.

Good morning. I just have one question. I apologize if this was asked before, I was disconnected from the call and I was off for a bit. I just wanted to ask you about Latrobe, and I was very interested in your comments about better-than-expected dis-synergies, I think I heard you say double.

So I wanted to know if you could give an update on the targets you set previously in October, I think they were like $25 million net synergies in year three. Two thirds run rate by the end of fiscal '13. I would have to think that you're now going to be meaningfully above that.

Seth, this is Andy, I'll take that one. Direct operating responsibility for Latrobe, so the guidance we gave was $25 million and thus far we are running about two times that rate. So I think you can stick with that. This has, however, somewhat helped offset some of the value discussion we've been having. So it has helped offset if you will some of the softness that we've seen in the value segment. So when that returns we believe there is some upside potential.

Mark Parr, KeyBanc.

Thank you. Good morning, guys. A couple of questions. First, I guess is that -- if you look at your full year growth expectation, I guess I'm wondering how much of that growth is going to come from the legacy business as opposed to Latrobe. Can you help give some color on that?

Sure. From a volume standpoint I think majority of our growth would be coming from the addition of Latrobe to Carpenter. We, within the SAO business, have really been focusing more, as you are aware, on trying to optimize our mix, trying to continue to provide more Premium and Ultra-Premium products, so as we gain opportunities in that area we've been exiting some other more value-oriented areas.

So I think it's fair to say that a very significant majority of our growth from a pure volume standpoint is directly related to Latrobe.

Okay. Along those lines, it looks like your production momentum came down pretty meaningfully in the December quarter from the September quarter. And I was wondering if you could provide some more color behind that. Was there a need to really build inventory early in the year, or is this really the pullback? Is this all a function of some of the downdraft you're seeing in the value business and kind of slower growth environment for the end markets?

I think it's really both of those items. We are targeting over the next we will say 18 to 24 months to see roughly a half turn improvement on our inventory, which as you know in our business would be very significant. So we've begun efforts as it relates to that. But there's no question that we also, as we saw some weakness in the value area, rather than build up and carry a lot of extra inventory kind of going into this calendar year, thought that that would be the best and most appropriate place to slow our production down. So it's really a combination of the two.

Okay. All right. Thanks much and good luck in the March quarter.

Lloyd [Carol], Davenport.

Yes, three items. First, a specific end-use on -- how was power gen year over year in the quarter? You referenced soft, but can you quantify that?

Why don't you go onto question two (multiple speakers) looking through our notes here. Just a factoid for you if you will.

As I interpret what you're doing is that value has slowed somewhat, you've got some destocking, but the major impact was from taking out working capital on a permanent basis, and in order to do that you had to melt substantially less product in the quarter, and to some degree in the current quarter as well in order to achieve that. Hence, cost absorption issues, margins down. That -- I interpret that as an operation -- a one-time operations that has no implications for the future other than you will be operating with lower inventory going forward, and therefore be more efficient.

Is that the proper interpretation?

Thank you. You said it very succinctly and I think very accurately.

Okay. And -- yes. This is something that all metals companies need to do, and some others have done a pretty decent job. And --

I'm sorry, the only other items that I would not -- not item, but -- we intend to continue to work after the Q3 to improve our inventory turns, but as we grow the business we will simply be trying to continue and support the growth with, if you will, similar levels of inventories as opposed to just growing that by our turns ratio. So we do plan to continue to make improvements beyond Q3, but it won't be impactful as you've described in Q2 and Q3. It won't be that kind of situation.

This is a major -- a major operation, and then you'll just be in a continuous improvement mode going forward.

Well said.

Okay. Near term, can you give us some rough quantification of order rates in January versus how they compare to the average month of -- for the December quarter?

So the early intake rate would be consistent with our production rate, if you will, so we don't see substantial increase in backlog, or a substantial decrease since the first of the year. It's kind of continuing in what appears to be a pretty balanced way. That can change pretty quickly, but that's what we've seen thus far.

And so if you find the power gen number.

We do have some information on that, so thank you for the three questions, it helped us pull that up.

Thanks for buying us some time. Overall volume in the power gen area was down about 6% in the second quarter versus the prior year.

Okay, and it looks like you'll see improvement in the rest of the fiscal year because of build schedules and --

That's correct.

Thank you.

We've already begun to see that in some orders that are moving into the system.

Josh Sullivan, Sterne Agee.

Good morning, Bill. Welcome, Tony. I have one more inventory question here for you. Of the inventory on hand, can you roughly quantify how much is the lower value alloy versus prepositioning for the aerospace build rate increases we are looking at?

I think that would be a difficult one to break out, at least, if you will, on this call. We have to do a little work behind the scenes on that one. But I would say that what we have done is we have built some materials over the course of last year, so kind of in the middle of our process so we could be more responsive. And I think that's valued or the amount of it will be proportional to our business activity within those relative segments.

So yes, we did bring down, in some of our value melting activities we brought some of that down based upon activity and that's kind of our first target. But I think our inventory is pretty balanced across our portfolio at this point in time.

And then just historically, with the medical end market, how long can the destocking last, or when do you see a rebuild?

Sure. We believe that it's going to be six to 12 months before we'll see a real recovery in that area. Inventories were built up and right now, you still see following titanium scrap prices, and so, there's not a great incentive for the distributors to bulk up, if you will, on materials. Hopefully, in a little period of time that inventory will have been depleted and we'll begin to see the titanium prices rise. And with that, we would expect to see then our products becoming greater demand for that segment.

And just one last one on the sale of the distribution business. Do you guys have a timing for that, and then just secondly, M&A targets. Are you still targeting the PEP area of -- Amega West type operations is what you're looking at?

So we are moving forward, as we had planned, and without any change in what we had anticipated with the sale of the distribution. We think that could happen possibly in Q3, could be Q4. But that would be the logical timing. It would be -- and then we are active when looking at opportunities in the PEP area, and specifically in the Ultra-Premium, Premium area there are a couple of opportunities that are of interest.

As you know we've tried to be very disciplined about moving forward, making sure that it has not only good strategic value but strong earnings benefit to us. So we are working that, and it takes two to tango, but we have some ideas and we are working on them.

Gautam Khanna, Cowen and Company.

I just wanted to get an update on the Alabama facility and your expectations for how that capacity utilization will ramp, given whatever dynamics you are seeing on demand and sort of your management actions. With Latrobe, do you still have the same high hopes for it operating at least breakeven as it's brought online in late fiscal '14, or does any of the recent dynamics change that view?

We are continuing with the project as planned and are clearly on our schedule. We are even pushing if we can to try to move the schedule up a little bit. We are still constrained specifically in the hot working area, and we see opportunities out there that are over and above our capacity today in that area. So yes, we feel very good about that investment and we don't see any deviation at this time from what our initial expectations were with that facility. And obviously this is in the context of in general not the most robust economic environment.

And just back to what we've described before, the types of things where we have seen the weakening have really been in the value areas which wouldn't per se necessarily go through the Athens operations. They are really through some of the more legacy assets.

Okay. Maybe just if we could step back at a higher level, when we think about some of the longer term growth, the airplane production rates effectively plateau at some time next year, second half next year ex the A-350. And so that's assuming Boeing and Airbus can execute to get there.

And I would assume we back Carpenter and other alloy suppliers up six months perhaps, 12 months and their inventory corrections and what have you along the way.

But I guess what I wonder is how should we think about sort of SAOs post-fiscal -- second half of fiscal '14 growth rate. Does it start to slow down because you will already be sort of operating at that peak level with respect to engine builds and the like, or do you have a lot more chair on the A-350 or a lot more share on the next generation engines that's going to continue the robust growth you are putting up this year, at SAO, for example?

On the aerospace side, we see that there will be a change mix to widebody aircraft, which inherently draws significantly more material, the types that we provide. In addition, on the new aircraft design, once again we see increased participation on those new aircraft, the new A-320 and 737. In addition to that, the energy market is continuing to grow and our position within that is growing.

And there are a number of other areas that we have historically not necessarily been able to support, and we will have a greater opportunity for going after and participating in those market areas in the future. So we feel very good about the projectile or demand profile that will come forward as a result of having the capacity.

The other issue, when you look at the overall growth of demand, and then you look at the number of parties that are able to supply that marketplace and their relative capacity or availability of additional capacity, you begin to see that, at least from our view, that there is an industry need for this capacity, and as such we are hoping that will be able to absorb a significant part of that overall growth.

Okay. Just one higher-level question. On the PCP acquisition of Timet, I know you do some outside conversion for Timet already. How secure do you think that business is, PCP has talked about downstream conversion being insular, and what have you. I just wonder, a, what is your exposure there. And what contractual protections or other protections do you have that would maybe limit the ability for them to take that in house?

And just looking more broadly, you are one of the few kind of unintegrated alloy manufacturers and aerospace. Now if you look at PCC, you look at ATI, and there's others, VSFDO and what have you. Does this worry you? Do you feel like this is still the right business model?

Looking out five years I understand that it is perhaps during the duration of the contracts you already have, but on the next go round do you worry about your position? Thanks.

So just to cover that, that's a pretty broad area. And first of all, I think -- PCC, what a great move they made and congratulate them for being able to make the transaction happen, and I'm sure it will show great value for them as they move forward.

Interestingly enough, you know that PCC is a major customer for Carpenter. We focused intensively on trying to be their best external supplier, we continue to make efforts to hopefully position ourselves in a better and stronger way with them. The purchase of Timet has a couple of interactions, if you will, with us. One as we are now a customer for PCC, because we buy a lot of our titanium from Timet and we have a long-term agreement as it relates to that.

So there's a chance that we might be able to buy more and become a more significant customer for them, which would be good. The conversion contracts we have are also long-term agreements. When we say long-term these are multi-decade agreements that were established several years back. And PCC will have the ability to move some of that material logically if they want to within their own operations, but there are minimums. And I would say that as we've seen with other acquisitions that PCC has made, that if we can be a good dependable effective supplier for them, we are optimistic that as they win in the marketplace hopefully that will have a trickle-down effect to us.

From a strategic standpoint, we do feel very good about the relative degree of independence that we have, and that we see opportunities to draw some closer supply connection points and that will help to give us, if you will, a more sustainable and robust position. We talked briefly about the US Steel. If that works there is a dimension or a type of alignment which could be beneficial.

But we don't feel the need to move downstream and we are not interested in being competitors with our customers. If it turns out that the others downstream -- or the others in our space consume more and more, if you will come, downstream customers, the first question is will they have the capacity to support that? Again, there's kind of an aggregate amount of capacity in the industry, so that doesn't change regardless of who owns the [4 gen] house or whatever. But beyond that, as you've seen, if we continue to be good suppliers to those customers, we think we can grow, and if we needed to we will have the financial flexibility as we go towards the latter half of this decade to look at making moves of our own in that area.

But I'll tell you that that is not our intention, that we prefer and think there are good advantages for the approach that we have taken. So we have the flexibility, but that's not our intention.

Bill, would you mind ballparking and for us what the long product conversion exposure is that you have with Timet? I recognize it's not all going to go away, and it may take many years for any of it to go away. But can you just ballpark it so we can have sort of a rough framework of how to think about --?

I believe that it would be fair to say, and we'll be seeing you shortly so I can try to provide a better number, but to say that it would be less than 2% of our kind of Premium production that is potentially in play, I think, would be a reasonable ballpark. But that's -- I prefer to give you a more button-down number on that. But it's not 25% of what we do or something like that; it is a much smaller part of our overall activity area.

And it's also conversion work. It's not our highest contributing product line area, if you will, either. It's a conversion.

And one last one. Some of your competitors have made reference to new alloys they have developed for aerospace applications, be it 718 plus or -- there's a laundry list. I just wondered if you could give us some color on what you guys have developed, maybe not as talked about as broadly, but what have you developed and how does that translate sort of on the next generation engines, and your prospective market share? Thanks.

Sure. The good news is that I think just triangulating when a number of folks say they see their business growing, they are probably all telling the truth, because the marketplace is growing, and as the engines increase their size with widebody and have more rigorous requirements in the hot section of the engine it creates more opportunities, not just for us but for others in the industry. We have mapped and for our internal purposes kind of part for part and that's the basis by which we talk about our growth on new platforms. It's not a kind of thumb in the air, it's an assessment.

I think you've heard us talk pretty considerably about the impacts that custom 465 is having in the marketplace right now. That's not our newest alloy, it is a proprietary alloy and I think that's actually a good example where a new product that comes out today is really not necessarily adopted four or five or 10 years, and it takes a while to get involved in the design. We continue to invest in other differential alloys, some of which we talked about in our investor day. And we could actually make that part of our forward communications -- I don't know that time really permits us right now to go into them, but we believe we are investing as the percentages sales, the highest in the industry as it relates to new product development. And we believe we are seeing an impact of that in our overall sales mix.

So why don't we leave it at that just because of the time issues, and again, we know we will have the opportunity to catch up down the road. We will try to share a little more granularity on that with you.

Jonathan Sullivan, Citigroup.

Good morning. I just had a quick one on Latrobe. In terms of the sequential profit comparison, was that at all driven by the inventory management actions, or was that really just due to lower demand on the value commodity type products?

I would characterize it as the latter. It's really the lower demand on the value proposition.

Okay. And one other one, back in inventories it seemed like in terms of balance sheet inventories that you are more or less flat in the second quarter. Based on the profits process you're undergoing overlaid with typical seasonality, should we expect those to decline in the second half of the year or what is the expectation there?

Our goal is to bring our inventories down from where they are or where they were in the second quarter, and our target it's inventories is tough to kind of dial into the dollar -- specific dollar. Our goal is to be very close and very similar to where we started the year. And we were up -- in the first quarter, I believe, we are of close to $60 million in inventory. So that gives you roughly the size of the target that we are working towards.

Sal Tharani, Goldman Sachs.

The nickel prices moved up a lot over the last couple of weeks, year-to-date up 8% and I think 6% just in the last week. And I know for stainless industry it has been always a pass-through. But just wondering if this quick change in nickel impacts you in terms of time lag positive or negative in the near term.

That's a good question, because as you know our model is one which we don't say we profit or suffer, based upon the relative price of nickel, but that's really over the course of if you will a year or so you can have some short-term impacts because of the timing, kind of the lagging surcharge. I believe that it would be fair to say that when nickel prices are going up, that you tend to see a more positive effect if there were a lag effect than when they are going down.

So I don't believe that this would be something that we would anticipate would hurt us. But once again, we wouldn't be looking at this as a material event for us one way or the other.

Mark Parr, KeyBanc.

Thanks. It's just a follow-up on -- I didn't -- I was hoping you could just repeat the commentary you made about January orders compared to December. And also, I don't know if you did this, but if you could add some color on how strong December was or how weak it was and how the January momentum would compared to your run rate business over the last several quarters.

Sure. The December month is always a difficult one just because of the timing of holidays, whether people shut down for three days or a week, and I would say that December was not a very robust month for us. It wasn't a catastrophe either, as we mentioned, in SAO, as an example, our volumes quarter-over-quarter, first quarter second quarter, were pretty equivalent. So that's what I would say about December.

January is clearly a stronger month than December was, and again the related orders are pretty much in line with our overall shipments.

Was it January '13, was that up over January of '12?

You're talking about orders or shipments?

Orders.

I don't have that information, and of course we are not quite through the month now. So -- and it's not good to speculate. But if I recall, at this time last year, there was still kind of a growing backlog, and so at this point we are beginning to see kind of a more consistent level, so that is the only color I can provide on that, but again we haven't even close the month so I can't speak to specifically to that.

Thanks for the additional color though, Bill. Appreciate it.

There are no further questions at this time.

Thank you. Thank you, again, for participating on today's call. We look forward to speaking with you again next quarter. Thank you and goodbye.

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