Carpenter Technology Corp (CRS) 2013 Q3 法說會逐字稿

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

(Operator Instructions) I would now like to turn the call over to your host for today, Mr. Mike Hajost, Vice President of Investor Relations and Treasurer. Please proceed, sir.

Thank you, Steve. Good morning, everyone, and welcome to Carpenter's earnings conference call for the third quarter ended March 31, 2013. This call is also being broadcast over the Internet along with presentation slides. Please note, for those of you listening by phone you may experience a time delay in slide movement. With us today are Bill Wulfsohn, President and Chief Executive Officer; and Tony Thene, Senior Vice President and Chief Financial Officer, as well as other members of the management team.

Statements made by the management during this earnings presentation 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 and December 31, 2012 10-Qs and the exhibits attached to those filings. I will now turn the call over to Bill.

Thank you, Mike, and good morning, everyone. Thank you for participating in our Q3 fiscal year '13 webcast. We are pleased to have a new member of the Carpenter team with us on the call. We welcome Tony Thene who joined us from Alcoa on February 1 and is our new CFO.

As you will notice, we have adopted a new approach by condensing our press release and augmenting it with more detail in our webcast presentation materials. We will begin this morning's discussion with a high level summary of the quarter. I will then turn the call over to Tony who will discuss our financial results. I will then provide more information on our reporting segments and markets, and we'll finish with Q&A.

Moving to page 4, in summary, for the third quarter, while we felt good about the underlying growth dynamics in our core markets and the progress we are making versus our strategic initiatives, we need to begin this discussion by noting that market conditions changed significantly during the third quarter. More specifically, we saw increased customer deferrals. In fact, January deferrals and cancellations increased by 40% over their recent historical run rate. Also, weak sales to distribution customers and defense-related mix impacted our overall profitability. Thus, we achieved lower sales and earnings in Q3 than expected in January. While we have seen a reduction in orders and the decline in deferrals, Q3 results combined with uncertainty in Q4 has led to us revise down our full fiscal year '13 earnings outlook.

That said, in this challenging context we have made some important and solid gains. More specifically, we have achieved sequential sales and EPS growth. We saw solid demand for our Premium and Ultra-Premium products sold to the aerospace and energy markets. We realized above plan Latrobe synergies and have completed our integration with synergies running roughly double our targeted $25 million rate. We've also strengthened our capital structure and liquidity while improving our pension funding status, and Tony will speak to that.

With the recent operating improvements, we now have the capacity to grow our sales and realize margin expansion. This is important. You may recall that during recent communications we've highlighted that we were capacity constrained. Now with the addition of Latrobe and key bottlenecking improvement initiatives we have roughly 10,000 tons of new available capacity to support growth as demand recovers. Beyond volume-related income growth, we now have additional margin expansion opportunities as additional volume will run through our existing assets. With that, I will turn the discussion over to Tony who will walk through our financial results for the quarter.

Well, thank you, Bill, and good morning to everyone. I'm happy to be here. I look forward to meeting many of you in the near future and developing a good working relationship going forward. So let's get started with slide 6.

I'll give you a financial overview of the quarter, and then we can get into some of the details. Net income was $32.9 million, or $0.62 per share. If you exclude the impact of restructuring and special items, net income was $36.7 million, or $0.69 a share. In March, the first comparable month, Latrobe manufacturing achieved year-over-year improvement driven by stronger than expected synergies. In February, we successfully completed the $300 million 10-year bond issuance with an impressive 4.45% coupon. This issuance provides us flexibility to make discretionary pension contributions and allows us to repay the $100 million 6.625% note maturing in May. Once we pay off the $100 million note next month, we do it not have a scheduled debt payment until 2018. That, combined with the fact that we don't anticipate the need to make any significant required pension contributions until fiscal year 2017, and the fact that the Athens spend will be winding down in FY '14, it puts us in an enviable position in terms of capital structure and liquidity. Moving along, we achieved strong cash flow from operations of $105 million excluding the discretionary pension contribution. And lastly, our total liquidity of $638 million is $85 million higher than where we ended fiscal year 2012.

Moving to slide 7 and the income statement summary. Revenue in the quarter was $581 million. Excluding surcharge, revenue was $471 million, up 9.4% sequentially and 12.5% versus the year-ago quarter. If you exclude the impact of Latrobe, our third quarter revenue, excluding surcharge, was $375 million, up 7.7% sequentially and down 2.2% versus the year-ago quarter. SG&A was $48 million in the quarter as we drove our percent to sales, excluding surcharge, from 11.6% in the sequential quarter, to 10.2%. SG&A increased approximately $7 million versus the year-ago quarter and, obviously, the majority of this was driven by the Latrobe acquisition. Operating income, excluding pension EID, was $61 million in the quarter which is slightly higher on a sequential and year-over-year basis. Our margin of 12.9% in the quarter was lower on a sequential and year-over-year basis, driven primarily by a weaker mix, as Bill mentioned in his opening comments. The effective tax rate for the quarter was 33.1%. This does include the tax rate impact of our planned discretionary pension contributions and the R&D credit extension. For the fourth quarter and for fiscal year 2014, you should use an all-inclusive tax rate of 34%. As I mentioned earlier, net income for the quarter was $32.9 million, or $0.62 per share, and $0.69 per share excluding special items.

So now let's turn to slide 8 and discuss in detail those special items. First, let me acknowledge that the quarter was a little messy, as we've previously made mention of many items. Going forward, I intend to limit the special items discussion to restructuring and discrete tax matters. This will make it much easier for both of us. The first item on the table is the inventory initiative worth $0.01. This is the cost of the inventory consultants we engaged in connection with the Latrobe acquisition to reduce inventory levels across the integrated mill system. This consulting project has now ended, and we will not have this expense going forward. The second item is restructuring-related items worth $0.02, mostly related to headcount reduction, asset write-offs, and costs associated with a few footprint optimization opportunities. The next item is the additional interest incurred due to the $300 million debt offering that was executed this quarter. In order to eliminate this item as a special item for next quarter, please use $5.8 million for interest expense in the fourth quarter.

The fourth item is the tax impact of the pension contribution. Pension contributions lower our taxable income. When taxable income is lower, we reduce the domestic manufacturing deduction on the delta. The impact this quarter is roughly three-fourths of the total impact for the year. The remainder will hit the fourth quarter. The tax rate guidance I just gave you of 34% for the fourth quarter accounts for this. So if you use this given rate, this item drops off the special items table. The last item is the R&D tax credit extension, the only item on the list that was not a charge to earnings. This credit expired at the end of calendar year 2011. In the quarter, the credit was extended on a retroactive basis and $0.03 is equal to the catch-up. Going forward, the impact of the credit is included in my effective tax rate guidance. If you choose to net out the items op this table, earnings per share for the quarter were $0.69.

Let me make three important points before leaving the slide. One, the Athens-related start-up expense was $1.4 million in the quarter and was not called out as a special item. For fourth quarter, I would expect Athens-related expense to be $1.7 million. Two, given the current environment, further restructuring is currently under consideration for the fourth quarter. It's important to note that any restructuring actions would be accretive to earnings by year two. And, three, if the distribution sale closes in the fourth quarter as expected, it is probable that we would take a significant non-cash charge to earnings. Again, it's important to note that such a charge would be booked in discontinued operations.

Now let's turn to slide 9 and the free cash flow summary. Certainly, free cash flow in fiscal year 2013 has been impacted by our Athens expenditures. However, when you look inside the detail of the third quarter you see solid performance. Net cash from operations excluding the discretionary pension contribution was $105 million, the highest quarter this fiscal year. The main driver was the $47 million inventory reduction as our manufacturing team implements efficiencies throughout the integrated mill system. If I exclude any discretionary pension contributions, I expect the fourth quarter free cash flow to be positive, even without the proceeds of the sale from the distribution business. With that, let me turn it back to Bill.

Thank you, Tony. I will now go into greater detail regarding our end markets and reporting segments. On page 11, we profile our sales by end market segment as they compare to prior year quarter 3 and sequentially versus prior quarter. We saw strong growth in our largest end market, aerospace and defense, which represents 49% of our overall sales. Sales were up 20% versus prior year and 10% versus the prior quarter. Our sales versus prior year clearly reflect increased OEM builds, the addition of Latrobe, and increased content on new platform. We saw no noticeable impact of the 787 issues. However, within the segment, we had a significant mix shift. While defense represents less than 5% of our sales, we saw a 50% drop in several Ultra-Premium products sold for such applications as missiles and military landing gear.

Moving to energy, the North American rig count was down 6% versus prior year, and industrial gas turbine builds remained at cyclical low levels. In this context, we saw a strong year-over-year and solid sequential volume growth primarily due to increased Amega West share gains and further penetrations into completions. Moving to medical, versus prior year, we saw a substantial volume decline as low titanium scrap prices, high inventories and industry consolidation downstream drove destocking. We have seen a mild recovery versus Q2 and are optimistic this trend will accelerate through the remainder of the calendar year. You will note that transportation and consumer and industrial were our fastest growing segments in the quarter versus quarter 2. While we value this business, it is at a lower end of our profit per pound and thus dilutive to our overall profitability.

Before I leave this page, I think it's important to mention that over the last quarter I have spent a significant amount of time with customers, and my observations are that there is a general feeling of cautious optimism about the future based upon the underlying market growth rates in our industries and related consumption. Most of our customers appear to be working down inventory due to the availability of material on short lead times and general market uncertainty. And finally, our relationships with our key customers, I believe, are stronger than ever.

Moving to page 12, we'll look specifically at our SAO segment. What you will first note, is that we did see a solid increase in overall pounds sold versus Q2. But I have to note that this gain was still down roughly 3,000 tons versus what we had forecasted in January. The growth we realized sequentially was driven by aero engine-related sales and oil and gas completions. Unfortunately, even with this additional volume, our operating income dropped. This is because of the previously described dynamics related to reduced sales of high-value materials to defense and increased sales of industrial, consumer, and transportation. In addition, we had less volume running through our system than anticipated which did affect overhead absorption. I would like to note that our variable cost per ton was actually down in the quarter as we worked effectively to reduce costs in a difficult context. Looking forward, order uptake is up 40% over the last three months versus the previous three months, and deferrals are down during the same period by roughly 33%. Aerospace and energy demand is strong, but I must emphasize it's too early to call the recent uptick a true trend. That said, we have the capacity to grow and achieve margin expansion from an already healthy 16% margin when demand recovers.

Moving to page 13, we'll focus on Latrobe. Very similar to the dynamic we've seen in SAO, you can see that there was an uptick, primarily seasonal, from Q2 to Q3, but overall we saw a weak mix. We expect steady sales profile with a clear potential for demand recovery as we complete this calendar year. To me, the key highlight for Latrobe is that we have now completed our full first year of owning and integrating Latrobe. As expected, the acquisition has been strongly accretive. Results to date are over our original plan as synergies are running at roughly double the expected levels. We see lots more upside as we complete the qualification of Latrobe's assets for Premium aerospace and energy applications. I would like to congratulate the legacy Carpenter and legacy Latrobe teams for working well together and executing at a high level. We look forward to celebrating Latrobe's 100-year anniversary this spring.

Now moving to page 14, we profile our PEP businesses. To describe these businesses, we must go through one by one as you will note there are very different business dynamics occurring within the segment. Our Dynamet business is growing rapidly as wire sales to the aerospace industry are roughly 20% up over prior year. This growth is partially offset by weak demand to medical as a result of the previously described customer destocking. Amega West saw an increase in earnings on weaker sales as uncertainty drove customers to rent as opposed to buying drill collars. Ultimately, that's good for us on the bottom line, and our earnings were up despite rig count being down. Finally, our powdered products business has some specialty areas which are showing strong contribution, but we do see challenges in the air melt portion of our business which serves the tool steel market. This is an area which we will focus on for operational improvement and cost reductions as we move forward. In summary, with these puts and takes, the PEP business was relatively flat in the quarter.

Moving to page 15, we'll discuss some exciting developments in the area of technology and innovation. We're pleased to announce a new agreement with Rolls Royce to supply advanced material for jet engine components. It's a five-year agreement valued at roughly $75 million, and we will target production for this contract out of Athens. Most importantly, it formalizes an expanding relationship with a key customer. Moving to stainless steel landing gear, progress continues to be made as we've already made the fittings for nine units that ultimately will be used for flight, which is planned in 2014. Finally, as you will recall, last quarter we announced a joint development agreement with US Steel to develop Carpenter's proprietary Temper Tough materials to enable light weighting of vehicles. Temper Tough is stronger with superior fatigue resistance allowing thinner and lighter-gauge materials to be used. Since the announcement, much progress has been made as we've melted, cast, and rolled product. We have also made prototype rocker panels that show a 10% productivity improvement possible by eliminating welds along with thinner-gauge material to result in material savings. We believe these are exciting developments, and they have a bright future.

Moving to page 16, from an operational perspective, some great project is being made on some exciting initiatives. We'll begin with our biggest and most exciting project, that is the construction of our new Athens facility, and like to highlight that this project is on time, under budget, and will start up on or before April 2014. I would also like to note that, as Tony described, we are incurring some overhead this year associated with the construction and start-up of that operation, and we see it increasing, but by roughly $4 million in fiscal year '14 before actually coming down in fiscal '15 year and beyond. So you won't see a major impact of costs related to Athens as we move into fiscal year '14 or '15. We are trying to accelerate the construction and commissioning of this facility because we are still overtaxing some of our existing assets and are constrained in our press. In addition, the Athens facility will give us a chance to lower production costs on some key products, and we believe in the underlying growth in our core markets and want to be ready with approvals as that demand comes to fruition.

Moving to Dynamet, as I described, year-over-year titanium wire sales have expanded dramatically. To support this growth and expected future growth, we will be commissioning two lines in our Florida facility, and that will represent roughly a 22% increase in total capacity. Customer demand for this product has been very high, and we are quickly booking that capacity. In fact, we are considering additional investment to expand our wire capacity further.

And finally, our China expansion, which will focus on bar finishing, is moving forward. We have a site. We've ordered equipment. We expect that our capital investment will be roughly $20 million and our first commercial sales from that facility will begin in fiscal year '14, which is great, because we just had our largest sales month ever in China in March.

So moving to page 17, in summary, market conditions changed significantly during Q3. We expected greater sales and a stronger mix, and results were below our expectations. That said, we achieved sequential sales and EPS growth. We continue to see strong demand for our Premium and Ultra-Premium aerospace and energy products. We completed our Latrobe integration with synergies above plan, and we strengthened our capital structure and liquidity while improving our pension funded status. Looking forward, we have seen a recent uptick in orders and a reduction in deferrals. We've also seen that volume pickup should help to improve absorption but recognize that risks remain in Q4 that the dynamics we experienced in Q3 will continue.

In conclusion, while we're not happy with our Q3 results, and the markets remain a bit uncertain, we feel good about the financial progress we have made over time, the underlying position and dynamics in our core markets, and the strong upside we have as the markets recover. Remember, we have now roughly 10,000 tons of capacity to leverage in our legacy Latrobe and SAO assets, 22% wire expansion, and ultimately our Athens operations which will help debottleneck our hot working operations and will give us the needed capacity for growth with our Premium and Ultra-Premium products. With that, I will turn the call over to the operator to take your questions.

Thank you.

(Operator Instructions)

And your first question comes from the line of Gautam Khanna from Cowen and Company. Please go ahead.

Yes, thank you. Bill, can you update us on your mid-decade EBITDA targets? Should we still rely on the $550 million to $580 million guidance you provided in September? Then I have a second.

We remain confident in the projections that we put forward. We see at this point a current weakness and uncertainty in demand, but we believe that is, if you will, a mid-cycle dynamic, and that ultimately, the aerospace builds will continue as we had forecasted earlier. The dynamics in our energy market will be strong, so while we're disappointed with our Q3 results, we still believe strongly in our mid-decade targets.

Okay. And if you could just talk a little bit more about the phase-in of the Athens facility, you mentioned in the slides the $9.5 million of overhead. Could you give us the other moving pieces? Depreciation, how big that will be in fiscal '14 incrementally, and do we actually see a step-down, or a GAAP EPS dilution as it's brought online, and sort of the phase-in, if you could give us any granularity? Thank you.

I can take on the depreciation question. As it stands right now, assuming an April start-up, depreciation for FY '14 for Athens will be approximately $1.5 million.

With that in mind, our objective, as we've stated before, is to commission and sell sufficient products to enable us have this facility be accretive to earnings in its first full year of operations.

Thank you.

And your next question is from the line of Steve Levenson from Stifel. Please go ahead, Steve.

Thanks, good morning, everybody.

Good morning.

Good morning.

Can you tell us a little bit more about your LTA with Rolls Royce, which materials it covers and which engine or engines?

Well, I believe that at this point it's appropriate for us to leave the description as we've shared it with you, and we will be able to communicate more information as time moves on, but I would like to leave the commentary to the way we've described it. It is an important development for us. I think that our value added products will help enable some of the Rolls Royce objectives for improving and enhancing their supply chain and their future engine designs, so we are looking at this as really the start of longer-term partnership.

Okay, I understand, thank you. In terms of fastener demand, can you talk a little bit about titanium availability, pricing and lead times? Is it still pretty much of a glut out there? You can get material that you need, and are you adding to stock advantageously right now?

We have availability of the titanium materials which are required to produce our fastener wire. That has not been a challenge or a difficulty for us. And we are currently using our assets to produce that titanium wire completely, and that output is going to customers. We are not building inventory in the segment, and, in fact, that's why we're bringing on additional capacity, because there is additional demand that currently we're having difficulty supporting, and thus, the new capacity, which will come on board over the course of the next couple of months.

Okay, thanks. And last one on the powder metals. Are you seeing any impact at all, or do you expect an impact in the next year or so related to additive manufacturing, 3-D printing, or is that something that's still a future story?

It's clearly a future story. We are well positioned in that area and we are seeing increases in demand for that product, but from a volume standpoint, it is relatively small compared to the product sold to other parts of our, if you will, sales mix. And with that in mind, it will be several years before we would say that that would have a very large influence on our overall sales growth in the powder area.

Got it. Thank you very much.

Thank you.

And your next question comes from the line of [John Jumasos] with [Berry Independent Research]. Please go ahead, John. John, your line is open, you may go ahead.

Thank you. Back in the '80s, Carpenter did a really good restructuring going from two plants to one, closing Bridgeport and having economies of scale in Reading. As you are growing to four plants, including the old Talley plant in the Carolinas, Alabama and Latrobe, how are you maintaining your efficiencies, and would it make sense to go from four plants to three plants or two plants, particularly as the market is poor?

First of all, we, of course, with the addition of Latrobe and the operation there brought on the incremental sales that were related to that core business, and actually in that case we view the opportunity to leverage the capabilities and have invested to expand our output and productive capacity. And, of course, the addition of Athens is meant to support what we believe will be strong industry demand and growth for the products that we provide in the Premium and Ultra-Premium area.

So we are clearly to focused on trying to run our combined system as efficiently as possible. We do make some specific consolidations to bring specific equipment up to high levels of utilization. In fact, Dave Strobel, our Senior Vice President of Operations, would like to make a comment about that.

Good morning, folks. Just to add on to what Bill has talked about, one of the strategies that we had undertaken in the '80s, with the closing of the Bridgeport operation, was really to kind of upgrade our mix, and we had the ability with that strategy in place to really pull in a lot of those operations into our Reading operations, and we moved some equipment in. Our strategy today, we're looking at -- focused on centers of excellence with our operations, and as you can see from the standpoint of the synergies that we've gained as we've begun to work with the fine folks out at Latrobe, we've really been able to adopt our operating practices and really get much more out of the operations. That's really our strategy going forward. We believe the long-term demand is there and our operations will be geared up to support that efficiently.

Thank you.

And your next question is from the line of Sal Tharani from Goldman Sachs. Please go ahead, Sal.

Hi, Bill and Tony.

Good morning.

Good morning. Can you give us some more color on the deferrals? Where are you seeing the improvement? Are these the OEMs, or their agents, and also, are these deferrals also on the LTAs they are just deferring?

Yes, just to provide a quick profile, roughly 60% of what we sell from our SAO organization is for mill orders, and 40% are from stock. So when we talk about deferrals, they're really on the mill-based orders. The deferrals were by and large across all markets. Some of those deferrals moved into Q4, and some moved out further. The deferral levels peaked in January and have been declining since. So I hope that answers your question there.

Okay. And next, you mentioned shorter lead times. Can you give us an idea what the lead times are right now in your couple of products, [min] products and what they were last year at this time?

Sure. The lead times are down substantially, and really that's the result of; one, the demand levels are lower; but, two, we've had a significant focus to bring our lead times down. We focused extensively on improving the flow within our operations so that we could not only achieve shorter lead times, but our goal is to sustain those regardless of where we are in the cycle. Overall, you would see that our lead times are between 8 and 14 weeks, and if you go back, perhaps, 1.5 years ago, they would have been as long as six months. But, again, that was a result of not only demand but also our production process.

Great. Thank you very much.

Thank you. And your next question is from the line of Josh Sullivan of Sterne Agee. Please go ahead, Josh.

Good morning, Bill and Tony.

Good morning.

Can you talk about the timeline for the Alabama facility? You mentioned the possibility of opening earlier than April. Can you just expand on that? And then, can you also talk about how bookings are progressing for the facility? I think you had given some metrics out at the analyst day.

This is Dave again. I will take the first part of that question. What was announced was an April 2014 start-up, and from an operations side, we're always pushing for faster, better, and under budget, and we believe that we have the potential to take some time out of that schedule, if everything goes according to how we see it today. There's a lot of room for some issues to happen. That's part of operations, but that's what we're gearing for is to bring that on line much sooner.

And as we look at the overall demand that we have within our system, and how we'll operate, we will operate that system, or Athens, as part of an integrated whole, which is how we are also operating with Latrobe. So what we are looking to do is expand our overall sales base. We'll be moving products between Athens, Latrobe, and Reading, based upon where the approvals are achieved, and where the economics of production are strongest. Right now we are constrained in our hot working press which is for materials that is in support of aerospace engines and structural components, and once we have the new capacity on board, while it will take time to qualify for those applications, we will move other materials from Reading and Latrobe into the Athens facility, which will enable to us produce more of the engine and structural materials there and support customer needs.

Okay. And then, just on the guidance for 2013, can you just remind us what the comparable for the double-digit growth is?

The double-digit growth would be based upon, as we've communicated, the fiscal year '13 number which is adjusted for the one-time related expenses associated with, for example, the acquisition of Latrobe, and right now that would be a $237 million operating income level, and if we were to complete the divestiture of distribution, the comparable would be approximately $233 million.

Thanks.

Thank you. And your next question is from the line of Dan Whalen from Topeka Capital Markets. Please go ahead, Dan.

Great, thanks. Hello, everyone. Just a follow-up question in terms of the deferrals. Just wanted to make sure there weren't any meaningful cancellations. This is just sheerly a push-out of demand. Is that correct?

Yes, we actually track separately cancellations and deferrals, and we always have, in any month, we have some cancellations, but the level of those cancellations did not fundamentally change. The spike was really in deferrals, and that, as I mentioned, has been coming down consistently since January.

Great. And then, any additional commentary you can provide for the after market aerospace engines? What are you guys seeing in that market?

It's difficult for us to have the transparency that -- or understanding that some of, we'll say our peers or competitors have, because of their degree of vertical integration versus ours. We sell, of course, to the forgers who then sell either to the OEM or after market. What I can share is just the feedback that we have gotten which is directionally that the spares market has been slow as the life of the parts, if you will, have been extended, and that that is something that will not sustain itself for an extended period.

Okay. Great. And then just given all the actions that you guys have been taking from a capital structure and some of the plans that you have in place, in this quarter you had, I think, a $0.21 headwind from post-retirement benefit plans. How should we be think about that for next year? Is that going to be a headwind or a tailwind versus current conditions?

So the good news is with the discretionary payment to the pension, that should substantially reduce the headwinds that we're facing. Tony, maybe you can give more direction.

Yes, if we make the full, as we expect, the full discretionary pension contribution, that will be about a $0.14 positive for us in FY '14 versus FY '13.

Great, $0.14. Great. Thanks a lot.

Thank you. And your next question is from the line of Richard Safran from Buckingham Research Group. Please go ahead.

Hi, good morning.

Good morning.

And I had a general question for you on defense and some of the comments that you made today and in the release on sequestration. We've had some rather stellar earnings from the defense companies thus far, and while they've maintained guidance and they've blown away numbers this quarter, so I wanted to know if you could comment on, in general, the uncertainties that you are seeing associated with sequestration. Do you think that that's like more of a very short-term/near-term phenomena, or do you think that's more maybe long term and more general and something that might impact defense companies later on this year?

What we can share is what we see, and that is some specific materials for specific applications that go through specific customers. We've seen a significant reduction in demand, as I mentioned. This would not be related, as we believe, to any sort of a share shift or anything related to that. As you can imagine, these materials typically are [well-speced] into the design of the equipment or aircraft. And so in our belief, over time, there will be a need for replacing the landing gear, for example, and the builds of, say, the joint strike fighter will increase over time, but we do see a reduction in demand that has sustained itself, as we've entered into the fourth quarter in this area. And so I think it would be, probably the earliest would be the latter half of this calendar year before we'd see a true recovery in this area. But to us, there's nothing that is apparent that is structural.

Terrific. Thank you very much.

Thank you. And your next question is from the line of Gautam Khanna from Cowen and Company. Please go ahead.

Yes, Bill, can you just talk about any changes to the relationship with Precision Castparts since the time of that merger, perhaps, on the conversion side?

We haven't seen any, as I think you appreciate, we respect PCC a lot. They're an important customer to us. Now they're an important supplier to us with Timet. We're working hard to be their best external supplier and the relationship that we have in terms of titanium from Timet being supplied to us and conversion of titanium that runs through our facility. As of this point, we have not seen any sort of a decline. So we're not anticipating that at the moment, and our relationship, we believe, remains strong.

They have mentioned an interest in buying or, perhaps, building titanium fastener stock capability. I just wonder, if they were to buy your larger competitor, in that market, in the titanium market, what protections would you have to kind of guard against share loss in terms of contracts or what have you?

I think there are a couple of aspects to that. First of all, maybe you have some indication that that's going to occur. We haven't gotten any indication that that would occur. We've seen our relationship actually, I believe, get stronger in the fastener area since the purchase of Timet, which is fairly logical, because we are not reverse integrated into the manufacturing of titanium, so there's no conflict, if you will, on that front.

But if they were to make that as a strategic action, I think the answer would be that would you have to take a look at the overall market, and our sales to them and the relative size of the total market. To the extent they would, over time, and I say over time because in many cases it couldn't be or wouldn't be overnight to qualify and move to a different supply, but if they were to take that trend, because they purchased or built competitive capabilities, our thought is while we would miss that business, there would be other companies that are in the space that we currently supply to who would probably have a greater interest in purchasing from us, just because that other source of supply would then be their competitor. So we're not looking for that to happen. We wouldn't be excited about hearing that in the news, but we don't feel as though, if it were to occur, that that would fundamentally shift our business profile.

Okay, lastly, M&A target, you guys, where are you looking to deploy capital? Which end markets? And do you expect any deals to be transacted over the next 12 months?

We believe we have the financial flexibility to move forward. We, I think, have shown pretty good discipline in terms of going after [only] opportunities where there are strong synergies, and we can add value in an area that mirrors, if you will, our focus on Premium and Ultra-Premium products. We are actively looking at opportunities that in space. We've talked before, it takes two to tango, if you will. We're it not going to rush out and overpay for something, and use the big strategic word around it. So we are active, and we're optimistic that you will be seeing and reading some developments in this area over the course of the next year.

Thanks.

Thank you. And your next question is from the line of Edward Marshall from Sidoti & Company. Please go ahead, Edward.

Good morning. You mentioned lead times and how they're coming in just a bit. And I was curious if you could kind of parse through what is -- is it possible to look at it from how much of is it destocking and slowing of demand and how much of it is the efficiencies? If you can kind of weight that, I imagine that's pretty difficult to do.

It is difficult to do, because there's a little bit of chicken and the egg syndrome, if you will excuse the expression, because we have general availability and our lead times are short, I think it gives customers the opportunity to layer in orders closer to when they actually need the product, which makes sense, because they then carry less inventory and have greater certainty as to the demand profile. And we have focused, and will continue to focus, on keeping our lead times short. Our goal is to sell an extra 10,000 tons out of our existing assets and to leverage our new Athens capacity, and not see an increase in our overall lead time, at least, not a significant one. We've gotten that feedback from our customers, that they need short lead times because the, if you will, the certainty in their business, the predictability of their customer demand downstream is not always difficult to see, and we've really focused on trying to improve, if you will, customer satisfaction, customer-related performance, and we believe this is an important component. But it feeds upon itself. If lead times started extending because of difficulties with capacity, I think you would begin to see an effect which would layer upon itself as people would get in line faster to make sure they would have access to that capacity.

Does that shorten your visibility at all in the long run, with customers and movements in the markets, and also, does that increase maybe your pricing risk to your own model?

I don't know that it increases our pricing risk, because so much of our materials are sold either on long-term contracts or with pretty well established, but there's no question, and I think we saw that this quarter, that the short lead times do affect our visibility. As we enter a quarter, a certain portion now of our business we are booking within the quarter, and while we can assess based upon recent trends what we expect those bookings will be, there is now some variability, depending upon the certainty or uncertainty that our customers have and how they feel they need to layer in their inventory. So, yes, I would say that that is creating more uncertainty in our market.

If you go back a year ago, and we weren't happy with six-month lead times, nor were our customers, but there was pretty good certainty as to what we were going to sell in the upcoming quarter when you were booked six months out. And so that is something, and that affected the clarity of how we saw things in our January forecast versus how the results came in. And that's why, while we see some positive directional trends in our order rate, we still are putting out some cautionary words because you don't like it when the results come in different than expected, nor do we. So we want to communicate that this is a dynamic that we are now trying to work with and work through.

Also on the order intake, it was up 40%, I think, is what you mentioned. I was curious, if you said, I missed, if any market in particular was driving that, and is it related to the industrial consumer where you've seen the strength recently, and thus we should assume a weaker mix going forward, at least temporarily, or could you kind of walk through that order intake rate?

Sure. The order intake rate has picked up, and I would say it's really across all of our markets. We did see in Q3, as we mentioned, really a couple of factors that affected our overall mix. One was the reduction or change in the defense-related mix, and the other was the increase in overall balance in consumer, industrial, and transportation. And I think it's fair to assume that a similar dynamic will continue at least into Q4 here. Over time, as we mentioned, the defense-related activities will pick back up, and we think that some of the aerospace dynamics, where you're seeing some degree of inventory management will, if you will, the line will get taut, and that will come back into greater balance.

Also, in the area of automotive and industrial, those really have multiple sub-categories, if will you. We are expanding our sales of materials, high-value materials, for fuel injectors in automotive which should help our mix. That's something that will take time to see a full manifestation of it. Also in our industrial realm, we have that as a fairly broad definition, but a big part of our sales and an important part of our sales are for industrial fittings, high-value industrial fittings, and we have seen an increase in orders and demand related to that portion of the business. So we believe there will be a recovery, but, again, there's caution in saying that we're not saying that you will see an immediate bounce-back here in Q4.

And finally, if you could, just a little bit of bookkeeping, net sales including the surcharge for the quarter, I think there was $110 million of surcharge, if it's easier to give the full number or if it's easier to give just the surcharge per segment -- or end market, I'd appreciate it.

Okay, I don't have that handy with me right now but I can get that number for you.

Okay, thanks, guys.

Thank you. And your next question is from the line of Jonathan Sullivan of Citigroup. Please go ahead, Jonathan.

Thank you. I just had a quick one to follow up on the guidance. So for the double-digit -- low-double-digit growth this year, would that include restructuring charges and inventory consulting fees, or would it just be an operating income ex-pension EID?

It's the latter. We don't want to further confuse the issue by introducing those in the directionality of our business. As Tony said, we are going to try to reduce the impact and number of those things that we call out as we move forward. But especially last year, as will you recall, there were some significant costs that were associated with the acquisition of Latrobe, and we're not including that as a benefit that we would call out an improvement over. So it's really the latter. It's the underlying business itself.

Got it. Thanks. And just one more, if I could. Did the weaker mix on the quarter, did that include any sales of commodity stainless, or would that be still a product that you're not -- or a market that you're not engaging in currently?

Well, we define and have discussed kind of Premium, Ultra-Premium, and value products. The value would be the closer to commodity grades, but I still wouldn't describe those as true commodities, and I think, as you reference us versus some other companies that have a strong stainless commodity portfolio, we typically don't compete in those portions of the business. We're not in flat rolled product that might go for appliance and other applications, and other things like that, that you might be referencing or thinking.

Great. Thanks a lot.

Thank you. And your next question comes from the line of Gautam Khanna of Cowen and Company. Please go ahead.

Just to understand the comparability issue, if you were to exclude the distribution business in Q4, disco it, what is the impact to current year?

We have not disclosed the actual EBIT that is associated with that business right now, and I know you'd like to have that number, but I think it would be difficult for us to convey that until we've completed the divestiture. So I'm not trying to avoid your question. It's probably not appropriate for me to speak specifically to that.

Okay, maybe can you ballpark it? You've given us, I think, it was $14 million or $15 million of EBITDA.

Right. And we -- that was essentially our target for the year, and so we see the business performing in that range. There's been some market softness, but in that range. So it also depends upon the timing of the divestiture, of course.

Thank you. You have no further questions.

(Operator Instructions)

That concludes the question-and-answer portion of today's call. Now let me turn it over to Mr. Mike Hajost for closing remarks. Please go ahead, sir.

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