Carpenter Technology Corp (CRS) 2014 Q1 法說會逐字稿

Ladies and gentlemen your conference will begin shortly, in the meantime we will continue to play music.

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

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.

Thank you, Carolyn. Good morning everyone and welcome to Carpenter's earnings conference call for the first quarter ended September 30, 2013. This call is also be broadcast over the Internet along with presentation slides. Please note, for those of you listening at home you may experience a time delay in slide movement.

Speakers on the call today are Bill Wulfsohn, President and Chief Executive Officer; Tony Thene, Senior Vice President Chief Financial Officer; Andy Ziolkowski, Senior Vice President Commercial, Specialty Alloy Operations; and Gary Heasley, Senior Vice President, Performance Engineered Products. Also the room are David Strobel, Senior Vice President of Global Operations -- as well as other management team.

Statements made during this presentation better 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 10K and the exhibits attached to that filing.

I will now turn the call over to Bill.

Thank you, Mike. Thank you for joining us for our fiscal year 2014 Q1 earnings call. From an earnings perspective, we met our expectations in a very challenging environment. As we anticipated, market demand remained soft in the quarter. We believe market conditions suffered as raw material and scrap prices remained low, lead times remained soft, and economic uncertainty remained high.

In this context, I believe the Carpenter team responded aggressively, showed agility, and demonstrated strong execution. Within our specialty alloy operations, or SAO as we call it, the commercial team did a great job of offsetting market weakness by bringing in new value to product sales. As a result, while revenues declined, we achieved 1% volume increase in the quarter. This volume helped keep our operations busy and drove strong overhead absorption.

Our operations performed at a high level of the quarter. They did a great job of reducing cost per ton by improving yields, expanding scrap management practices, and by aggressively controlling costs. They also completed our planned forage overhaul ahead of schedule and below budget.

Our performance engineered products, or PEP business, showed sequential improvement in the quarter. There is much work to get done to get this segment back to targeted levels of profitability. Gary Heasley, our Senior Vice President, PEP, will outline developments and actions plans in a couple of minutes.

All of Carpenter benefited from the restructuring actions we executed at the end of fiscal year 2013. Overhead was down sequentially and flat versus prior year. In total, this team showed the agility to respond to a rapidly changing environment. In a down market environment we are able to sustain our sales volume and maintain our operating income margins.

We would also like to note that while cash flow was negative in the quarter, strong cash from operations helped to substantially offset our largest quarterly Athens CAPEX to date. Projects, capital spending will decline from here. Post Athens, -- we expect CAPEX to drop to $120 million or less annually. This is key as we seek to drive strong cash flow in the future.

On the strategic front, we have made some important gains. To advance our position in aerospace, within ultra-premium products, we negotiated several key customer long-term agreements and we obtained a license from Pratt Whitney enabling Carpenter to enter the rapidly growing super alloy powder market.

We also made substantial progress in finishing the construction of our new Athens facility. I will discuss Athens in more detail later, but want to emphasize that Athens is nearing completion and is on-time and on-budget. These are difficult times from a market-demand perspective. In this environment, the Carpenter team executed well against our stated goals and strategy.

Moving to page 5, I will discuss our end markets. You see we had a down quarter in terms of sales revenue; however, from the take-away at the bottom of the page, you can also see that we actually increased our sales [tons]. Let me explain.

Aerospace was down substantially. We believe this decline was largely driven by customer de-stocking. Why? Because the number of aircraft being built by Airbus and Boeing increased 9% over last year and is expected to grow by another 8% in 2014. Our demand decline does not match OEM build growth. This can only last for so long.

In the energy market, our demand was impacted by two factors. In oil and gas, the North American rig count was down by 1%. At the same time, we have seen a customer trend away from chasing drill collars to, instead, renting them. This dynamic is not necessarily bad for Carpenter, while it lowers sales revenue, it increases our profitability.

In the power generation arena, [G] announced during our most recent call that industrial gas turbines sales were down 7% versus the prior year. With the low price of natural gas and the newly proposed taxes on coal generation -- power generation --coal power generation, we believe this market is poised for a recovery from a cyclical low.

In transportation, European auto sales were down 4% year-over-year. This decline impacted our sales as Carpenter has significant content on European vehicles, due to their advanced fuel delivery systems and extensive use of turbo chargers.

With demand down in our premium markets, the commercial team responded by increasing our value product sales to transportation, industrial, and the consumer market. All together, revenue was down, but our volume was up 1% in the quarter versus last year.

Note that while our strategy is to increase sales into more premium segments, I think our team did a great job in bringing volume into offset weak demand. These actions helped drive higher levels of manufacturing absorption which helped us maintain our operating margins.

I will now turn to the call over to Tony who will walk you through our financial results for the quarter.

Thank you Bill, and good morning everyone. Let's start on slide 7 with the financial overview of the quarter, and then we can get into some of the details.

Overall, we have a very clean quarter with no special items and the results were in line with our expectations. Net income was $34.6 million, or $0.65 per share. Net sales, excluding surcharge was $412 million. Importantly, two of our key end-use market, aerospace and energy, accounted for 59% very total sales, as we further strengthened our position in these markets.

Operating margins improved sequentially by 20 basis points. We generated free cash flow from operations of $64 million and free cash flow was a negative $61 million. Capital expenditures for the quarter were $115 million. And lastly, our total liquidity stands at $693 million with $201 million of cash on hand.

Now let's turn to the next couple of slides and I will give you more color on the results. First, the income statement. Revenue in the quarter was $499 million or $412 million excluding surcharge. Although sales declined sequentially, and year-over-year, it's important to emphasize that this decline was macro-related. In fact, our market position in our key markets has been enhanced. Overall, the long-term market fundamentals remain solid and we are well-positioned to capitalize on growth opportunities.

SG&A was $48 million in the quarter, a $7 million sequential decrease and back in line with what we view as a normal run rate. If you remember, our fourth quarter fiscal year 2013 SG&A was driven up by the restructuring activities, and a normal year-end variable compensation adjustments. Our internal emphasis has been at a minimum to hold SG&A cost flat versus year-over-year, and we are achieving that objective.

Operating income excluding pension EID was $61.8 million in the quarter. It is important to note that our operating margins improved sequentially 20 basis points to 15% verses 14.8% in a very challenging market. This was driven primarily by manufacturing efficiencies and fixed cost control. The effective tax rate for the quarter was 32.8%. However, for the remainder of FY '14 you should use an all-inclusive rate of 34%. Lastly, as I mentioned earlier, net income for the quarter was $34.6 million, or $0.65 per share.

Now, let's turn to slide 9 and the free cash flow summary. Net cash flows provided from operations was $64 million, our fourth quarter in a row of positive net cash from operations. In the first quarter of each year, we usually see an increase in net working capital. As you can see we manage net working capital, particularly our inventory levels, much tighter this quarter compared to the year ago quarter.

In addition, our required pension contributions were significantly lower as a result of the strategic discretionary pension contribution we made in the third quarter of fiscal year 2013. The result was $101 million year-over-year improvement in net cash from operating activities.

For the quarter, we continue to have elevated capital expenditures driven by the Athens project which is $94 million or 82% of total capital expenditures in the quarter. In the second quarter fiscal year 2014, I expect capital expenditures to be slightly lower than quarter one, however, I do expect free cash flow to be negative in the second quarter due to the Athens spend.

In the third and fourth quarters of this year, I expect lower levels of CAPEX as the Athens spending winds down. Accordingly, I anticipate the second half of fiscal year 2014 to be positive cash flow. As the Athens project nears completion and with minimal near-term required pension contributions and debt payments due, we believe the Carpenter has the ability to generate significant free cash flows going forward.

With that, let me turn it over to Andy.

I will now cover the SAO segment. Compared to the year ago, quarter one experienced slightly higher operating margins due mainly to continued solid operating performance and focused cost control efforts.

Quarter one experienced a weaker sales mix resulting from lower volumes of aerospace and power generation materials and higher volumes of more value-oriented materials used in the transportation, industrial, and consumer markets. Volumes in the period were actually higher than a year ago and a thorough analysis of our portfolio indicated that pricing levels were similar to prior period levels.

Inventory adjustments in the aerospace supply chain continue to have a destabilizing effect on current demand, with higher levels of deferrals and cancellation activities than the same period a year ago. Moving forward, we believe the longer-term perspective in many of our core markets is positive, particularly for aerospace. In the near-term, the markets will remain challenging and we expect supply chain adjustments to continue. To that end, sales mix and production activity levels are likely to be weaker than we saw in quarter one.

I will now turn the discussion over to Gary Heasley to cover the PEP segment.

Thank you, Andy, and good morning everyone. Our PEP segment is made up of a group of four differentiated businesses. Each of these businesses has experiences unique market in the first quarter that resulted in PEP reporting increased operating income for Q1 versus Q4 while sales were down 11%.

Operating income improved as a result of an improved product mix and cost savings in our powder business, increased drill [collar] rentals, and improved profitability in our distribution businesses, among other factors The decline in revenue was driven by softness in demand for Dynamet's titanium products in the medical and distribution markets, decreased powder shipments, and seasonal softness for some products.

Looking forward, PEP's performance is expected to be effected by solid demand for aerospace, titanium fastener wire for Dynamet with some seasonal softness in other markets that Dynamet serves. Soft demand for power tools deals in Europe and America, resulting week powder sales, and continued improvement in tool rental at Omega West.

As we look to the second quarter, we again expect varied results from the PEP businesses that will make it a more challenging quarter for PEP. To improve performance in the PEP group, we're working to complete the installation of additional wire capacity to serve anticipated growth in demand for titanium fastener wire in the aerospace market.

To identify and implement cost savings opportunities in our powder operations as we work to improve execution in that business. To improve efficiency at Omega West to capitalize on the growth we have seen in that business over the last couple of years, and to better leverage our distribution businesses by more closely integrate them into a Carpenter business units.

The PEP businesses are facing markets that range from steady to soft over the next quarter, but we see market opportunities that we will capitalize on and opportunities for cost savings and operational improvements that we will be implementing to drive results. Bill?

Thank you, Gary. Moving to page 15, I would like to highlight some strategic developments which we believe will enhance our growth.

As previously mentioned, Athens is on budget and on schedule for our commercial start up within six months. The radio press is in place, we are beginning to circulate the 46,000 gallons of hydraulic fluid that will drive the unit. The two manipulators for the press are now on site and we have even begin to fire up several of the furnaces. By the way, when we say start up, we mean the target date for our first commercial sale, not when we will turn the equipment on. Cold start has already begun and we expect to be moving hot metal within the next several months.

We have referred to Athens as a lean operation. From a cost-burden perspective, the ongoing Athens overhead rate, excluding depreciation is already fully reflected in our Q1 numbers. So you won't hear us talk about incremental overhead from Athens impacting our results going forward. As stated in our last call, you will hear us clarify one-time start up costs which we expect will total approximately $8 million to $10 million. We will share these numbers with you, as they are incurred, since they are one-time in nature. In Q1, these expenses were approximately $600,000, and are likely to ramp up Q2 as we start up activities.

Enthusiasm for this facility is high. Senior leaders from key customers representing roughly 20% of our aerospace sales have already toured the facility. Their response has been extremely positive. Specific written comments resulting from these business -- from these visits show their excitement.

One customer referred to the project as a, quote, game changer within our industry. Another noted that the facility will create, quote, new ways to work with Carpenter to take advantage of the unique conversion processing. Perhaps most important, a senior leader from the third customers stated that, quote, on the validation approval schedule for the facility, I would really like a committed time plan so our technical teams can plan resources accordingly and we can drive teams to deliver against committed milestones.

Our new capacity is also enabling Carpenter to begin in sourcing approximately 8000 tons of feed stock previously outsourced. Bringing these tons in will not impact revenue, but will lower cost through increased absorption and enable Athens to get to steady-state operations more quickly.

In addition, the new capacity is giving us the headroom to go after new, strategically attractive markets, such as the markets for corrosion resistant materials and the CPI market. These statements are attractive and use our types of materials. However in the past, we could not support them due to our capacity limitations. Several new contracts in these markets have already been signed.

Moving to the second column, as previously announced, we are entering the super alloy powder market and have commissioned the construction of a new facility to be built on our Athens campus. To gain fuel efficiency, arrow manufacturers are designing engines to operate at higher temperatures.

Higher temperatures can be achieved using super alloy powder parts. As a result, we anticipate this trend will lead to a tripling of super alloy powder usage over the next five years. Thus it was essential that we take the strategic action. We appreciate the support and confidence Pratt & Whitney has shown in Carpenter by licensing as their technology entering into long-term supply agreement.

You will recall that we often mentioned that Athens will enable Carpenter to expand operations quickly and efficiency. In the case of this new super alloy powder facility, we will use less than one third of a pre-existing building on the Athens site to house our new operations. The use of this existing infrastructure will reduce construction times by roughly 6 months and capital costs by approximately $10 million.

Moving to the third column, I want to update you on the status of our one-year development agreement that we entered into with US Steel earlier this year. The purpose of this agreement was to determine if our proprietary Temper Tough alloy could be used as a large-scale steel solution to light-weight automobile frame components such as rocker panels.

We are extremely excited about the technical gains we have made Temper Tough. We have showed that Temper Tough has the strength to be used for safety support. We have also demonstrated that Temper Tough has the targeted ductility and elongation to be warm or cold formed using existing equipment in the auto industry today.

We believe Temper Tough can have a large and positive impact in the light-weighting of vehicles which is crucial to be increasing fuel standards. We also believe the initial market in North America will be large, well beyond what we can produce in our mills. Therefore, we expect that Carpenter will ultimately license this technology to an automotive flat-roll producer.

Moving to page 16, we have reviewed our Q1 results extensively. To wrap up, I will wrap up by reemphasize that I believe the Carpenter team executed very well in a difficult environment. Looking forward, we expect the Q2 will be our most difficult quarter. From an operating viewpoint we will melt fewer tons, in addition while volume appears stable, our sales mix will remain weak. In this context, we are very actively managing our costs.

Last year, we saw a $0.12 per share earnings reduction from Q1 to Q2. It is likely we will see roughly this level of traction this year. Results can be up or down from this estimate depending on the timing and length of customer holiday shutdowns. It's too early to get a good read as to whether customers will extend holiday shutdowns or use this period to get a jumpstart on 2014.

During Q2, we will complete the majority of the remaining Athens construction. By the end of Q2, we expect to have completed over 80% of the Athens project spend. The remaining 20% will be spent over the remaining 18 months, thus, while we expect Q2 cash flow to be negative, we expect to become a strong cash flow generator by the end of this fiscal year.

Continuing with our discussion on the back half of out fiscal year, we believe we will begin benefiting from increasing demand. When we look at order activity, each month from October 2012 until April 2013, saw a decrease in orders versus the same month of the prior year. However, since May, each month has shown a year-over-year increase. SAO's Backlog in tons has stabilized. That is leading us to believe that demand recovery will occur next calendar year as we have previously communicated.

We also believe that we will begin to benefit from our numerous strategic actions. More specifically, the opening of Athens will give us the needed capacity to grow our sales. The opening of our new Omega West San Antonio facility will position us to better service the Eagleford shale field. And the commissioning of new Dynamet wire line will enable us to support growing demand for titanium aerospace fasteners.

We also believe we will benefit from the upcoming launch of several 2015 North American model vehicle redesigns. As an example, our materials are part of GM's Gen5 engines fuel delivery systems. We also see an increase use of turbo chargers and with it, increased demand for Carpenter's materials.

In summary, we believe market fundamentals dictate a demand recovery. The exact timing of this recovery it is difficult to assess due to short lead times and overall economic uncertainty. That said, we remain optimistic that we will see improved demand and with it, improved profit performance in the second half of the fiscal year.

Note, we remain committed to our previously communicated 10/10/10 program. Essentially, we are targeting 10,000 tons of volume gains with an average margin per pound increase of at least $0.10, while driving positive cash flow after completing the bulk of Athens construction later this quarter. To be clear, we will not drive volume with price.

When I see how our team has responded to the current environment, I'm excited to see what we can deliver when our markets improve. With a longer view, We remain bullish on our business. We have a clear strategy, a solid team, and proven execution skills. Our markets are growing and the need for our type of materials is expanding. Finally, given anticipated cash flow and low level of debt, we believe we will have a great amount of financial flexibility to further enhance shareholder value.

With that, I will turn the call over to the operator so we can take your question.

(Operator instructions) Standby for your first question, which comes from Richard Safran from Buckingham Research Group. Please go ahead

Good morning.

I wanted to ask about free cash flow. It looks to me like it is tracking a little bit better than you expected. It seems to be working capital management, and I heard you remarks about inventory management. I thought you might give some more color on how you're looking at working capital free cash flow for the rest of the year. I know you expect to be free cash flow positive, I just heard your remark on that. Since you're managing working capital better, though, I was just wondering if you had a more positive outlook on free cash flow expectations for the rest of the year.

Yes, this is Tony. I think we're going to pull all the levers that we have in front of us. We know that the CapEx is going to go down. But certainly, working capital is a focus for us. You saw us do that with inventory this quarter and we believe there is still ample opportunity there. I feel pretty confident saying the second half will be free cash flow positive, and I think there's several opportunities we can go chase.

I would just add one more point which is that we did increase the inventory in Q1, and that's really to ramp up in support of the second half of the year demand. We can't produce enough, if you will, or sell enough, if we don't produce the materials from a seasonality perspective earlier in the fiscal year. But with that, we anticipate bringing that inventory level back down over the remainder of the fiscal year. So we see an opportunity to further enhance working capital management with those actions.

Thank you.

The next question we have comes from the line of Sal Tharani Goldman Sachs.

Thank you. I have a couple of questions. First, on the destocking, is it only the OEM engine or in other products also?

Sal, this is Bill. And I think Andy may be able to provide a prospective, as Gary may. But certainly we have seen it at the OEM level, and I think also from the spare part level, as well, although we have a little bit less visibility on the spare part market.

And Sal, this is Andy Ziolkowski, also we have been talking over the last few quarters about the distribution market and the relatively short lead times, and this is all symptomatic of the overall environment in that supply chain.

We have also seen some destocking in medical bar and some other markets that the PEP company serves, so it's been broad.

I have a question on the titanium side. You mentioned in your press release about the titanium prices being lower, which we know. And also that -- how does it affect your cost versus your sales contract? Does lower titanium price actually benefit you on the cost side in your fastener if the ingots prices are lower than the fastener stock you're selling?

Actually, we -- in our business model, we are, if you will, a converter, and so the price of those raw materials is reflected in the cost of the product that we sell, or is hedged. Most of the case in titanium fasteners is actually built upon a directed buy with a specific price associated with that material. I think the only dynamic that may come into play is that when scrap prices are low or going down, it creates an environment where, in other parts of the market, people are less inclined to go long on inventory and to hold back.

Great. Thank you very much.

The next question we have comes from Gautam Khanna from Cowen & Co.

Good morning, guys. Just a follow-up first on sales question about how broad-based the aero destocking was. Andy, did you see it also in landing gear products? It didn't sound like you saw it in titanium fastener wire, but was it across the entire product portfolio, including Latrobe?

Yes, it is. And as you can imagine, you've seen by some of the recent communications, public communications, people are also looking at working capital and taking their inventory levels as well, so all of that is conspiring into the destocking realm. So, broad-based across the whole portfolio.

For a little more color on Athens. You guys have been pretty firm about the 10 plus 10 strategy. But just looking at some of the capacity in the space -- be it ATIs or PCPs, SMC -- business where utilization rates appear low in the nickel alloy non-aero markets, they do have conviction, or do you have agreements in place now that, as you start up Athens with customer product running through it, it's going to be at margin-accretive levels or price-accretive levels, or is this more something that you expect the market will just recover, and by the time you get there, will be in a more normal environment? Just wondering your conviction on that.

Sure, sure. Well, first of all, we do believe the market will recover and it wasn't that long ago when capacity was pretty tight, so we anticipate that that will come back and in fact, even become stronger, just based upon the build rates within the industry.

But that being said, I will say we have a strong conviction that we will not price for volume. Now, that does not mean that we won't go after some materials that are very profitable for us, that are consistent with our overall margin within the business, but will help to move additional volume in. Those are markets which were important and interesting to us in the past, but once again because of lack of capacity, we couldn't effectively go after it. So, I want to be clear, we will go after and drive some additional volume in some new markets. But, at the same time, we will not be using price as a lever to drive volume.

Let me ask differently, Bill, and I appreciate your point. If you had the capacity today, if Athens were available today, would we see what you are planning for play out? In other words, in the current demand environment, and I understand you'd go after some value products as well, but in general it would not be price-dilutive or margin-dilutive to the overall segment, or the addition of the 10 Plus 10 strategy?

Exactly. And really, the 10 Plus10 strategy is one that is important for you to note. But I also want to say it's an important one within our organization, and is part of the reason I, if you will, work the concept up, is because I want it to be very clear that while we will seek additional volume, we expect additional volume, it will not be done on the basis of diluting our margins. That is our objective and our strategy, and we think it can be achieved.

Okay and last one, how many tons of material do you expect to run through Athens in the first year?

Some of that will relate to the pace of some of the in-sourcing and the timing of the market recovery. We would like to get to roughly around 8000 tons. That would enable us to have, if you will, steady-state operations, where we won't be seeing variances from our cost standards, which are essentially what we are calling out in our one-time costs.

All right. Thanks and best of luck.

Thank you.

The next question we have comes from the line of Steve Levenson from Stifel.

Thank you, good morning, everybody. I have a question on the powder metals arrangement. Can you tell us if the material you will be making will be used for isothermal forgings, or if it will be used in 3-D printing applications? And is the arrangement exclusive or can you use the technology, the licensed technology, for other products, for other customers, as well?

The supply arrangement that we have is specifically to supply a certain type or number of grades of material to our customer, Pratt & Whitney. How they further process that is really up to them. As it relates to the technology in the marketplace, the technology that we license is being focused and targeted for the support of Pratt & Whitney. However, once we build the infrastructure, we do have significant powder science technology and manufacturing capabilities. We expect and we will target a broader group of customers and seek to develop the relationship with those over time.

However, while we are very excited about additive manufacturing or 3-D printing, we do not see this as the mechanism that will drive that growth. We expect we will be a party to that and we will grow with that market, but it is not specifically based upon this technology.

Got it, thank you very much. Just one other question about the drill collar situation. Is the investment that you need to make for rotables, for rental equipment, significant or relatively minor?

I believe over the last several years, we've really made the majority of the investment that we need to, certainly to support the current levels of business that we have today. It's not going to take extensive capital, and I think this is one of those areas that falls well within the $120-million guideline that Tony has outlined to you in the past. Any capital required to support that market growth should fall within those broad parameters.

Things for the additional detail.

Thank you, Steve.

The next question comes from the line of Julie Yates-Stewart at Credit Suisse.

Good morning. On the comment about F Q2, that you expect the same seasonal decline as last year, how do we think about that in the context that last year's decline from F Q1 to F Q2 was largely driven by the inventory rebalancing initiative, and weakness in the value product side? Today, clearly operational performance is at a much higher level.

I do want to emphasize, obviously we're trying to provide information which we hope will be helpful, but there is some degree of uncertainty at the end of the quarter, back to what I mentioned, as to the ultimate demand we will see in the quarter based upon the holiday shutdown period.

In general, we see that we will have less melt. We will not be building inventory during the quarter. That is our plan and expectation, not that we will necessarily be bringing it down substantially. Again, what we built in the first quarter is to support the second half of the year. But we will have a weaker mix, we'll have less production or less melting as a result of our inventory management.

What we talked about a year ago was related to the fact that we have built a substantial amount of inventory in Q1, and with the weakening of the market, we saw that there was an issue that we needed to deal with throughout the remainder of the fiscal year. I believe we are a very different situation right now, where we feel as though we are in the right place for inventory position as we complete this calendar year and move into what we think will be a steady but slow and expanding environment next calendar year, the beginning part of the calendar year.

Okay. So it's really about the incremental destocking that you saw since last quarter. I think last quarter you had not really seen the same magnitude, especially on the engine OEM side of de-stocking. So what really happened in the first quarter, or how did things really deteriorate?

Well, we have a backlog and our lead times right now are relatively short within the window of the quarter. We also have flexibility with our customers that they can take material within the quarter or they can take it as their quarters close and the next quarter, so some flexibility around that.

In general, the tone that we picked up from our customers, and I think has been consistent with what I've heard and read in some other environments, is just been that given this environment where there is no particular pressure on lead time, no particular pressure on raw material cost, that there is a greater focus on cash and cash management. We are just seeing that play out. It is extending a little deeper and a little longer than we had anticipated at the beginning of the fiscal year, but that is only because of the lack of visibility that we have with our lead times being shorter. Nothing fundamental.

Okay. Great. And Tony, can you just remind us as you near this inflection on free cash, the cash deployment priorities, and then what you're seeing in the M&A pipeline?

As we've said in the past, as we look forward over the next several quarters and we start generating some cash, we will look at all of our options that we have there, as far as redeploying cash. Obviously we're looking at ways to strengthen ourselves in the market, but we will also look at possible dividend increases, share buybacks, all of that is on the table.

And the one thing Julie, and I think you're quite familiar, we really try to focus in the M&A area on, I'd say, a very strong discipline, making sure that if there are any activities, they are based on strong synergies and early accretion. We believe we have the financial flexibility to act, but we are also cautious in terms of taking steps unless there is real value that can be created and quickly.

Okay, thank you.

Thank you.

The next question we have comes from the line of Josh Sullivan from Sterne Agee.

Morning. Just following up on Gautam Khanna's question, I think previously you talked about breakeven at 2000 to 3000 tons? Can we infer, give you are now in-sourcing, about 8000 tons? You're already well on the way to the 10 x 10 goal?

First well, that's a great question. Thank you for asking that.

When we talk about the breakeven tons, we are really talking about commercial profitability that would come from new and incremental tons to the system. In the in-sourcing, we are basically taking materials which are current raw materials for, say our distribution business, and instead of having them sourced externally, we can bring those in-house and as you can appreciate, that does help with absorption and balancing the load as we start off.

That is not the volume that will lead us to our accretions that we expect from the facility. That's why we have been focused aggressively on not only our existing core markets and expanding our long-term agreements, but also making progress in some of these other adjacent markets, where we think there is real potential for us to supply. And we have found great interest, and, I think, good success.

It is an interesting point in the process because we are very excited. We're going to be starting up soon, so we are getting ready to take orders, but we also want to make sure we can deliver on those orders. So we're trying to strike the right time balance. But, that in-sourcing activity would not be related to the 3000 tons we had communicated in the past. It will help, but it won't drive it.

Can you just remind us on the commission of the new Dynamet wire line, I believe in 2014? How's that coming along and what's the scope of that again?

Is coming along well. It should be commissioning in February, so it should be up and running shortly after that.

Okay, great. I think previously you had outlined headwinds from defense spares. Did you see additional headwinds from that in the quarter just given what's going on?

Josh, this is Andy. In the past we have communicated that defense is not a large portion of our business. But the products we sell tend to be the ultra-premium or proprietary nature, and therefore it's definitely part of the weaker mix story that we discussed. We continue to see that progress.

Great, thanks.

Thank you.

The next question comes from the line of Chris Olin from Cleveland Research.

Thanks for taking my call. I just wanted to circle back on this titanium issue, just to make sure I understand where you guys are. In terms of the current ramp for the 787, is that starting to impact your business yet, or is there an inventory situation in the feed stock market as well? Second to that, is are going to be any type of positive impact from the Airbus A350 coming online? Thanks.

Chris, this is Andy, then I will let Gary jump in more particularly on the tire side. We are seeing the build schedules and the recently announced changes from Boeing, moving up to 10, and that we knew. But moving through 12-build schedule in 2016 and then up to 14 by the end of the decade, that will be very good for, particularly, for all of us, but particularly the titanium business. Gary?

Yes, and with titanium fastener wire, we largely support that market out of inventory that we have contractually on hand. We've been talking to our aircraft customers here recently, and they are all very confident that the build rates are going to continue and we should continue to strengthen. So, as we bring new capacity online, it should slip right into that growth, and we should be able to capitalize on it as it comes.

Chris, this is Bill. In answer to the second part of your question, clearly the A350 will also drive demand for titanium fasteners, given its use of composites and the like.

You ship into that channel?

We ship into the manufacturers of fasteners, and then the manufacturer of the fasteners ultimately ship into, of course, the end-user.

We participate broadly at Airbus on their platforms, both single aisle and long range. And we do that through multiple channels, as Bill said. But yes, we will participate, we expect.

Thanks a lot.

The next question comes from the line of Sal Tharani from Goldman Sachs.

Thank you. I just want to confirm on the guidance side, you did mention that there will be acceleration in the start up costs. That guidance includes or excludes the start up cost?

Well for Q2, it certainly includes that. We haven't provided, I don't think, very strong guidance in the second half of our fiscal year, so as we get closer, and we can provide more guidance in that area, we will also call out or reflect the start up costs that we will see or expect to see in the coming quarters.

This quarter here, or Q2 of our fiscal year, it shouldn't be significantly greater than what we experienced in Q1. The majority of that spend will really be coming when we begin to move material through the system, so that would happen in the first and second quarter of the calendar year next year. It may be a million dollars in the quarter this year. But -- we, I want to be clear, and we are trying not to call out all sorts of specials and all that, and this is part of that. We want you to have the information because you have models, and this is one-time in nature, but we are not trying to call these out as, if you will, excuses, for any results or a bridge to get to some other result.

Got it. And Tony, you mentioned in your prepared remarks that the pressure is on the macro side in the market position, the key markets, the [finance] was the word you used. I just want to understand, are you gaining some market share, you think, from others in your key markets?

Sal, this is Andy, I will take that for Tony. And as Bill said and we exemplified in the UTC agreement, we are well positioned to take advantage of the build rates and increase in build rates going forward, and we continue to advance our positions as we go.

Is it commensurate with the build rate? It's not that you can access market share from others?

We have our own list of market share gains and losses and we feel like we are doing well in that, if you will, win-loss column, but we have very capable competitors and they are also working hard. The good news is this is a market that albeit a little slow now is a growing and expanding market. We expect to do well not only in general but with new capacity, and I don't think we will be the only ones who will benefit from what we see as a demand increase coming up.

But again, Sal, this is Andy, and I would say we are well-positioned to take advantage of the build schedules and the duration of those contracts leads into the timing of when they will accelerate and the commissioning of Athens.

Okay, great. Thank you very much.

The next question comes from the line of Gautam Khanna from Cowen and Co.

Yes. Just two quick follow ups. Can you remind us what product forms you will be making at Athens besides forged billet in bar?

This is Dave. The product coming out of Athens will be in the neighborhood of 4 inches to 18 inches, but that will also feed our rolling mills, then, for bar and wire products, as well.

Who do you perceive to be the direct competitors to that product portfolio at Athens?

It depends upon which particular market that you are referencing coming out of that. For example, I think we know who are the primary competitors in the aerospace market, as you get into energy, there are a couple of other things that enter into the list, and certainly as you go into transportation and other areas, you continue to expand the list.

We believe that we will have unique capabilities, unique capacity, unique cost structure, and also unique lead time capabilities that we think will allow us to excel in all of those markets. The primary market, not surprisingly, is aerospace in energy and of course you know the players there.

Okay. And lastly, if you could talk about, in the titanium fastener wire and nickel fastener wire markets, have you see any disparities between the relative growth rates or levels demand?

I think you might get two answers, one from Andy and one from Gary. Why don't we start with Gary?

This is Gary. It is difficult to tie the number of aircraft builds directly into an expectation for demand in titanium fasteners, but what we have seen is steady demand, it's been as expected, and we think it's going to continue to grow as we've been saying. I'm not sure the answer is exactly what you're asking. But, Andy?

On the Nichols side, there is definitely a lag between the announced build schedules and the rates we are seeing from the fastener OEMs at this point.

Is that broad-based or specific to any one major OEM?

It's broad-based.

I said two questions and I've asked four now.

That's okay.

To clarify, in response to my question and then the follow-up from someone else, in year one you expect to have how much product going out the door at Athens? Was it 8000 tons? Did I hear that correctly? Or was that an answer to a different question?

Thank you for asking. It's important. We throw around a lot of numbers and we want to be clear. The 8000 tons would be the level of production we are targeting out of Athens, at that includes a mix of new product sales or new customers, increased demand, along with increased in-sourcing activity. By the way, some of that activity will also benefit Latrobe and the Reading facility as well. Adding to the overall system.

In the first year we will be going through a fair number of approvals and certifications, but we're looking -- we have not made any specific projections. I can tell you that from an internal standpoint, we have a laser-focus on making sure the facility is accretive at a very early stage. And I would like to point out then if you exclude the onetime expense of which we will call out and at least you will be aware of, like I said, right now, the overhead associated with that facility, you see in our quarter one numbers, it's in our quarter two numbers, and three numbers and four. So, any commercial volume that we bring into the system should help to improve our profitability, as well as our profits.

Things again for the detailed answers, appreciate it.

Thank you. Good questions.

That concludes your question-and-answer session today. Now let me turn the call over to Mr. Mike Hajost for closing remarks.

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

That concludes your presentation, you may now disconnect. Have a good day.