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Executives

Mike Hajost - Vice President, Investor Relations and Treasurer

Bill Wulfsohn - President and CEO

Doug Ralph - Senior Vice President and CFO

Tony Thene - Senior Vice President and In-coming CFO

Andy Ziolkowski - SVP, Commercial, SAO and Latrobe Operations

Sanjay Guglani - Vice President, Performance Engineered Products

Analysts

Edward Marshall - Sidoti & Company

Gautam Khanna - Cowen and Company

Sal Tharani - Goldman

Steve Levenson - Stifel

Arun Viswanathan - Longbow Research

Mark Parr - KeyBanc

Lloyd O'Carroll - Davenport

Josh Sullivan - Sterne Agee

Jonathan Sullivan - Citi

Carpenter Technology Corp. (CRS) F2Q 2013 Results Earnings Call January 31, 2013 10:00 AM ET

Operator

Good day, ladies and gentlemen. And welcome to the Second Quarter 2013 Carpenter Technology Earnings Conference Call. My name is [Dorsal], and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

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

Mike Hajost

Thank you, [Dorsal]. Good morning, everyone. And welcome to Carpenter’s earnings conference call for the second quarter ended December 31, 2012. This call is also being broadcast over the internet.

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

Statements made by management during this conference call that are forward-looking statements are based on current expectations. Risk factors that could cause actual results to differ materially from these forward-looking statements can be found in Carpenter’s most recent SEC filings, including the company’s June 30, 2012 10-K, September 30, 2012 10-Q and the exhibits attached to those filings.

I will now turn the call over to Bill.

Bill Wulfsohn

Thank you, Mike, and good morning, everyone. I know you may have some questions about the business following on January 15th press release. So I’m going to be brief with my prepared comments this morning, which will leave more time for your questions.

In addition, I’ve asked Doug to provide more clarity on our second quarter one-time event and our forward outlook. In our second quarter, Carpenter achieves strong year-over-year volume and earnings growth.

Sales ex surcharge were up 30% and 28% higher volume. This was driven by the Latrobe acquisition, strong demand for our Premium and Ultra-Premium products, primarily in the aerospace and energy markets, solid growth in Europe and Asia-Pacific, and continued Amega West sales growth in the context of a 10% drop in the rig count.

From an earnings perspective, we increased operating income and EPS by about 20% versus the same period in the prior year. This growth was driven by the addition of Latrobe which is realizing about double the expected synergies.

Note, year-over-year the Latrobe manufacturing operation is running at about 17% operating margin. In addition, strong mix has helped to improve our profit per pound within our SAO business.

At the same time, as we described in our 15th -- January 15th press release, during the second quarter we saw the impact of destocking in the titanium medical supply chain, reduce demand for value products at Latrobe and our powder operations, and reduce overhead absorption in our specialty alloy operations as we began to reduce inventory.

As we look to the remainder of fiscal year ‘13. We continue to expect our full year operating income improvement of 20% to 30% versus last year, with strong second half revenue and earnings. The reason for this range is because of the continued short-term demand uncertainty with some of our value products.

Note, that at the same time, we are continuing to see strong demand for our Premium and Ultra-Premium products, especially in aerospace and energy. In addition, we are still planning our debt refinancing and the sale of our distribution business, which will further strengthen our cash and liquidity position. Doug will speak in detail about these actions and their impact.

So in summary, we feel great about our business mix, we feel great about Latrobe and about our projected 20% to 30% profit improvements year-over-year. The prospects for our business remain extremely positive.

Our new Athens facility will be operational in just over a year. This capacity will enable us to accelerate our growth as current demand exceeds our supply capabilities and our targeted Ultra-Premium and Premium markets.

In addition, we continue to make solid progress commercializing new and differentiated technologies as was evidenced by yesterday's announcement about our collaboration agreement with U.S. Steel to lightweight automotive applications.

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

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

Doug Ralph

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

For the second quarter let's start with the topline. Revenue in the quarter was $533 million. Excluding surcharge revenue was up 30% versus the year ago period and about the same level as we reported in the first quarter. Excluding the impact of the Latrobe acquisition our Q2 revenue ex surcharge was up 5% on volume that was up 2%.

On the bottom line, we delivered Q2 EPS of $0.62, which is up 19% versus the $0.52 we reported in a year ago period and below the $0.74 we reported in Q1.

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

Operating income in the PEP segment was $2.6 million lower than the prior quarter level. Our powder revenue and earnings were down due to continued weakness in Europe and other lower value parts of the portfolio.

Revenue and earnings were also off in the Dynamet titanium business with aerospace fasteners continuing to grow, but more than offset by very weak near-term shipments in the medical supply chain.

Note that revenue and earnings in the Amega West energy business increased versus the first quarter. So that business continues to perform well in a market where overall rig counts are off by about 10% versus year ago.

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

That leaves the SAO segment. First on the positive side, overall volume and revenue were up slightly from the first quarter level with continued improvements in our product mix. However, our manufacturing costs were higher in the second quarter as we melted less material in Q2 versus Q1, which resulted in lower cost absorption.

The reductions in plan production levels were made to avoid building excess inventory on lower value products where demand remains weak and also to begin implementing changes that will allow us to manage to lower inventory targets going forward consistent with recommendations from the consulting report that we previously referenced. We collectively referred to this as production balancing in our January 15th press release, which I know some of you found unclear.

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

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

All of this is reflected in our current expectation for full year operating income improvement of 20% to 30% versus a year ago. To be a little more specific on this. If we meet the criteria for reclassifying the distribution business into discontinued operations, the base earnings we are comparing against in fiscal year ’12, in terms of operating income excluding pension EID will change from $237 million to $233 million, growth of 20% to 30% from that new base would therefore imply and operating income improvement of about $50 million to $70 million. As a reminder, this is on top of operating income improvements of $102 million in fiscal year ‘12 and $85 million in fiscal year ’11.

As outlined in today's press release, our operating income growth projections exclude two items, expected one-time impacts of about $3 million this fiscal year for various footprint restructuring opportunities as a result of the Latrobe acquisition.

These include the announced closure of fine wire facility in Orangeburg, South Carolina in Q1, the consolidation of our two U.K. warehouses into one that we're recording in this quarter and a few additional items that will mostly fall in the third quarter. We will continue to include a schedule to our press release that reports the amounts we incur for footprint restructuring projects, which totals $300,000 through the first half.

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

To be clearly the $6 million of startup costs we expect to incur on our Athens facility this fiscal year is also already factored into our 20% to 30% earnings guidance, since this was in our plan from the start.

That hopefully provide you with good clarity on our expectations, if you do the math that would imply that second half operating income excluding the exceptional items will grow in excess of 20% versus the first half.

Beyond this, there will be some other EPS impacts as we outlined in our press release. The debt refinancing and discretionary pension contribution would result in a negative earnings impact of about $0.13 per share from higher interest and income tax expense.

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

Finally, I'd like to elaborate on our multiyear plan to maintain a strong cash and liquidity position on the business as we simultaneously fund our Athens greenfield expansion project.

More specifically, based on our debt plans, inventory reduction initiative and expected distribution sale, we now expect to end fiscal year ‘13 with a cash and liquidity position around the same level as our beginning fiscal year position, despite $350 million of total CapEx investment about two-thirds of which is going toward Athens, previously we expected a negative cash impact of about $125 million this fiscal year.

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

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

Bill Wulfsohn

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

Looking forward, we feel great about our fiscal year 20% to 30% operating income growth target, which is driven primarily by our mix management actions and Latrobe and it’s above plan synergies.

As Doug mentioned, we are also taking actions to improve our cash and liquidity position, while still making a sizable investment in our Athens facility. These actions will enable us to maintain our strong balance sheet and provide us more flexibility to take advantage of business development opportunities.

And last but not least, we are excited -- as excited as ever about our new product development efforts to meet customers evolving needs, including continued progress with PremoMet and TEMPER TOUGH as we just announced yesterday, and further positive developments related for our stainless steel landing gear commercialization.

Altogether, while we have some near-term concerns about demand and some of our value areas of our portfolio. We remain very excited about our growth prospects this year and beyond.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Edward Marshall with Sidoti & Company. Please proceed.

Edward Marshall - Sidoti & Company

Good morning.

Bill Wulfsohn

Good morning.

Edward Marshall - Sidoti & Company

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

Bill Wulfsohn

Okay. To answer that I’m going to turn the question over to Andy Ziolkowski who is our Senior Vice President of Commercial Operations with our SAO business and has also been overseeing our Latrobe operations and integration over the last year. Andy?

Andy Ziolkowski

So thank you, Bill, and Edward, I’ll speak specifically to the nickel and Sanjay Guglani can help us out with the titanium. But on the nickel side in terms of our leadtimes, our leadtimes have been improving.

So specifically in this area we feel about it, can we improve it in leadtime in the products that -- in the nickel product that go into the fastener materials, so very similar to the comments that were made for the titanium demand we’re seeing similar demand on the nickel side.

Edward Marshall - Sidoti & Company

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

Andy Ziolkowski

Edward, I’m not sure we are following, I think what we’re suggesting is that, we are improving, the market has signs of improving and we see a lot of hope there.

Bill Wulfsohn

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

Edward Marshall - Sidoti & Company

Okay.

Sanjay Guglani

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

Bill Wulfsohn

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

Edward Marshall - Sidoti & Company

When I look at the quarter itself and I know you mentioned a little bit of destocking in some of your markets. But the revenue on a sequential basis and seasonally weak December being that seemed to hold in there pretty well, I would say?

When I look December to September, there seems to be more of kind of is it the fixed cost absorption and I think you alluded to that in your prepared remarks. But is that really what say the pressure on earnings had been for this particular quarter and not necessarily something on the revenue side that's from the demand, I guess, they are related too?

Bill Wulfsohn

Sure. To break into the three business segments that we report. The SAO side, the legacy Carpenter mill products area. We actually saw a very similar demand from a tons standpoint to Q1 to Q2, and our contribution for per pound which we look at internally was very consistent with what we would had in Q1 to Q2.

We did see more overhead, so between the direct contribution in the bottom line, we saw an increased overhead and that was really a result of we melted less material and as we melted less material even though we took some cost out, we had less absorption, so it went to the bottom line.

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

Edward Marshall - Sidoti & Company

Thanks guys.

Bill Wulfsohn

Thank you.

Operator

And your next question comes from the line of Gautam Khanna with Cowen and Company. Please proceed.

Gautam Khanna - Cowen and Company

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

Bill Wulfsohn

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

So we began to melt less material specifically in December was really where we focus that energy. And we expect that we will -- we will not more than we did in Q2 but we have taken down our projections from melt in Q3 versus what we had initially anticipated at the start of the year.

And we believe that that will, as Doug mentioned, bring the system back into balance versus our targets. And Doug also mentioned the impact of that is reflected in our full-year forecast and we will see a greater impact of this effort in Q3. In Q4, we will back, what we expect will be above Q1 type of melt rates. So we’re just working that through and again it doesn’t affect our overall forecast.

Gautam Khanna - Cowen and Company

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

So I understand that you're going to get to a lower level of inventory going forward. But what were, sort of, the one-off items in the quarter because we saw a reduction of whatever it was, $5 million of EBIT sequentially at SAO. And I just wondered how much is actually contained to that quarter due to dis-synergies in starting the process, that won't recur?

Bill Wulfsohn

Yeah. Gautam, I think the one-off items was entirely the lower cost absorption from reducing our production levels.

Gautam Khanna - Cowen and Company

Which was how much?

Bill Wulfsohn

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

Gautam Khanna - Cowen and Company

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

Bill Wulfsohn

It does. It does.

Gautam Khanna - Cowen and Company

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

Bill Wulfsohn

So in the third quarter, we will still be impacted by a reduction in production levels versus our originally plan levels as Bill mention will be up a bit in production versus our second quarter level and then back to normal or back in balance by our fourth quarter. And all that is reflected in our 20% to 30% fiscal year earnings projection.

And Gautam, just to just make sure, again very clear that when we look at the contribution, the direct contribution coming from the business or from the sales, the first quarter and second quarter were virtually identical in our SAO operations. So it really was related to this absorption activity which falls below that direct contribution line.

Gautam Khanna - Cowen and Company

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

Bill Wulfsohn

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

Doug Ralph

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

Gautam Khanna - Cowen and Company

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

Andy Ziolkowski

So, Gautam, this is Andy. I'll just kind of refer you back to the communications we did during the investor conference. And we think we are well positioned on some of the new engine platforms, particularly on the single aisle in the A320 and the new variants of that platform as they come forward. And we are starting to see some of the early signs of that.

Gautam Khanna - Cowen and Company

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

Andy Ziolkowski

Hey Gautam, this is Andy again. I’ll take that one as well. I think we’ve been actually very consistent. Our business tends to track more of the OEMs. So the guidance by GE is something we look at. We tend to ship into larger forgers. And we are consistent with their build schedules. We’ve seen a little bit of a increase in demand right now. And we’ll participate in that increase in demand and the mix of turbines that they are doing. So we’re seeing that and we are booking activities filling into the second half of the year.

Bill Wulfsohn

It’s actually an area that we’ve seen a bit of an uptick on since the first of the year.

Gautam Khanna - Cowen and Company

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

Bill Wulfsohn

We’ve references in our earnings release that we've really seen strong demand growth across all the range of our fastener product. The consumption of fastener material is clearly going up and we are not seeing any impact of, if you will, competitive incursion in that area.

The majority of our businesses at least on the titanium area would be related to the wire. And so I don't know specifically what others have referenced. Our smaller portion is to borrow that, maybe where the focus is but we see record demand right now. We have a number of long-term agreements that we put in place that we've extended and we think give us a very strong position going forward.

And while there are capable companies out there, that with right effort can always make progress. This is an area that takes -- it takes some time to get into the market. So we’re not seeing that today in a material way and don’t expect that it will have any significant impact in the near future on us.

Gautam Khanna - Cowen and Company

Thank you.

Operator

And your next question comes from the line of Sal Tharani with Goldman. Please proceed.

Sal Tharani - Goldman

Thank you. Hi. How are you?

Bill Wulfsohn

Good.

Sal Tharani - Goldman

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

Doug Ralph

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

Sal Tharani - Goldman

Okay. Great. Thank you very much.

Doug Ralph

You’re welcome.

Operator

And your next question comes from the line of Steve Levenson with Stifel. Please proceed.

Steve Levenson - Stifel

Thanks. Good morning, everybody.

Bill Wulfsohn

Good morning.

Steve Levenson - Stifel

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

Doug Ralph

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

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

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

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

Steve Levenson - Stifel

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

Bill Wulfsohn

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

That being said the additive manufacturing growth and opportunity is a longer-term potential or prospect and we would not see that having a significant impact in the next several years. But it does fit very well with our premium and also premium strategy and we do have good working relationships with those parties that are working and developing this technology for practical application. So I would say this is an area where we’ll have some more commentary to come in the future.

Steve Levenson - Stifel

Okay. Thank you very much.

Operator

And your next question comes from the line of Arun Viswanathan with Longbow Research. Please proceed.

Arun Viswanathan - Longbow Research

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

Doug Ralph

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

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

Arun Viswanathan - Longbow Research

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

Bill Wulfsohn

Well, I think we feel that we are well booked through the third quarter, and we feel we have good visibility on that. Your eyes run the risk that customers can delay taking orders even though they’re produced per schedule but we’re not seeing that now. In fact, we’re seeing strong early shipments and good demand. So that's not what we’re seeing today. So really it comes down to in our view, more of, how will the order book fill in for the latter part of the fourth quarter.

And again our order intake rate has been good since the start of the year. So we don’t see any issues there but we’re trying to be responsible by sharing that there is some degree of uncertainty out there. And that can affect the results as we’ve described.

Arun Viswanathan - Longbow Research

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

Doug Ralph

Well, we are -- as we’ve mentioned, we’ve taken down our melt production versus our original plans. It will be up over what we did in Q2 but we expect in Q3, it will be below what we had anticipated maybe six to nine months ago and that is reflected in the guidance that we’ve provided, the numbers going forward.

So we'll see a stronger impact of that in Q3 but again it’s within our numbers and then I think by the time we get to Q4, there should be a subject that we really won’t need to reference much again.

Arun Viswanathan - Longbow Research

Thanks. Just a clarification, you said the pension, once that's done, the net positive after the increased interest expense is going to be $0.08 to $0.09 a quarter, is that right?

Doug Ralph

$0.08 to $0.09 for next fiscal year.

Arun Viswanathan - Longbow Research

Next fiscal year. And then…

Doug Ralph

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

Arun Viswanathan - Longbow Research

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

Doug Ralph

Yeah.

Arun Viswanathan - Longbow Research

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

Bill Wulfsohn

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

Arun Viswanathan - Longbow Research

Okay. Thanks.

Operator

And your next question comes from the line of [Zack Saffron] with Buckingham Research. Please proceed.

Unidentified Analyst

Hi. Good morning.

Bill Wulfsohn

Good morning.

Unidentified Analyst

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

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

Andy Ziolkowski

Zack, this is Andy. I'll take that one. Direct operating responsibility for Latrobe, so the guidance we gave was $25 million and thus far we are running about two times of that rate.

So, I think you can stick with that. This has, however, somewhat helped offset some of the value discussion we've been having. So it has helped offset if you will some of the softness that we've seen in the value segment. So when that returns we believe there is some upside potential.

Unidentified Analyst

Thanks very much.

Operator

And your next question comes from the line of Mark Parr with KeyBanc. Please proceed.

Mark Parr - KeyBanc

Thank you. Hey, good morning, guys.

Bill Wulfsohn

Good morning

Mark Parr - KeyBanc

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

Bill Wulfsohn

Sure. From a volume and standpoint, I think majority of our growth would be coming from the addition of Latrobe to Carpenter. We within the SAO business have been really focusing more here. We are trying to optimize our mix, trying to continue to provide more premium and ultra premium products.

And so as we gain opportunities in that area, we've been exiting some other more value-oriented areas. So, I think it's fair to say that a very significant majority of our growth from a peer volume standpoint is directly related to Latrobe.

Mark Parr - KeyBanc

Okay. And then, along those lines, it looks like your production momentum came down pretty meaningfully in the December quarter from the September quarter. And I was wondering if you could provide some more color behind that.

I mean, was there a need to really build inventory early in the year, or is this really the pullback? Is this all a function of some of the downdraft you're seeing in the value business and kind of the slower growth environment for the end markets?

Bill Wulfsohn

I think it’s really both of those items. I mean, we are targeting over the next -- we’ll say 18 to 24 months to see roughly a half turn improvement on our inventory, which, knowing our business would be very significant.

So we begun efforts as it relates to that, but there's no question that we also, as we saw some weakness in the value area rather than build up and carry a lot of extra inventory kind of going into this calendar year. I thought that that would be the best and most appropriate place to slow our production down. So it’s really a combination of the two.

Mark Parr - KeyBanc

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

Bill Wulfsohn

Thank you.

Doug Ralph

Thanks, Mark

Operator

And your next question comes from the line of Lloyd O'Carroll with Davenport. Please proceed.

Lloyd O'Carroll - Davenport

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

Bill Wulfsohn

Okay. Why don’t you go into question two? We are looking through our notes here. It’s a factoid for you if you will.

Doug Ralph

Okay. As I interpret what you're doing is that value has slowed somewhat. You’ve got destocking, but the major impact was from taking out working capital on a permanent basis.

And in order to do that you had to melt substantially less product in the quarter and some degree in the current quarter as well in order to achieve that. Hence, cost absorption issue, margins down.

I interpret that as an operation, a one-time operation that has no implications for the future other than you will be operating with lower inventory going forward and therefore be more efficient. Is that the proper interpretation?

Bill Wulfsohn

Well, thank you. You said it very succinctly and I think very accurately.

Lloyd O'Carroll - Davenport

Okay. Yeah. And this is something that all metals companies need to do, and some others have done a pretty decent job. And…

Bill Wulfsohn

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

Lloyd O'Carroll - Davenport

Yeah. This is a major operation and then you’ll just be in a continuous improvement mode going forward.

Bill Wulfsohn

Well said.

Lloyd O'Carroll - Davenport

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

Bill Wulfsohn

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

Lloyd O'Carroll - Davenport

Okay. And so if you find the power gen number that…

Bill Wulfsohn

We do have some information on that. So, thank you for the three questions. It helped us to hold that up.

Doug Ralph

Yeah. Thanks for buying us some time late, but overall volume in the power gen area was down about 6% in the second quarter versus the prior year.

Lloyd O'Carroll - Davenport

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

Doug Ralph

That is correct, Lloyd.

Lloyd O'Carroll - Davenport

Yeah. That is correct. Okay. Thank you.

Bill Wulfsohn

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

Lloyd O'Carroll - Davenport

Okay. All right. Thank you.

Operator

And your next question comes from the line of Josh Sullivan with Sterne Agee. Please proceed.

Josh Sullivan - Sterne Agee

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

Bill Wulfsohn

I think that would be a difficult one to break out at least if you will on this call. We’d have to do a little work behind the scenes on that one. But I would say that what we have done is we've built some materials over the course of the last year. So kind of in the middle of our process, so we could be more responsive.

And I think that that's valued or the amount of that will be proportional to our business activity within those relatives segments. So, yeah, we did bring down in some of our value melting activities. We bought some of that down based upon activity and that's kind of our first target. But I think our inventories are pretty balanced across our portfolio at this point in time.

Josh Sullivan - Sterne Agee

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

Bill Wulfsohn

Sure. We believe that it’s going to be 6 to 12 months before we’ll see a real recovery in that area. Inventories were built up and right now, you’ll still see falling titanium scrap prices and so there's not a great incentive for the distributors to bulk up if you will on materials.

Hopefully, in a little period of time that inventory will have been depleted and will begin to see the titanium prices rise, and with that we would expect to see then our products becoming greater demand for that segment.

Josh Sullivan - Sterne Agee

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

Bill Wulfsohn

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

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

Josh Sullivan - Sterne Agee

Great. Thanks.

Operator

And your next question comes from the line of Gautam Khanna with Cowen and Company. Please proceed.

Gautam Khanna - Cowen and Company

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

Bill Wulfsohn

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

And obviously this is in the context of, in general not the most robust economic environment. And just back to what we described before, the types of things where we’ve seen the weakening have really been in the value areas, which wouldn't per se necessarily go through the Athens operations. They are really through some of the more legacy assets.

Gautam Khanna - Cowen and Company

Okay. And maybe just if we could step back at a higher level, when we think about some of the longer-term growth, the airplane production rates effectively plateau at some time next year, second half the next year ex the A350. And so that's assuming Boeing and Airbus can execute to get there. And I would assume we back Carpenter and other alloy suppliers up six months perhaps, 12 months and their inventory corrections and what have you along the way.

But I guess what I wonder is how should we think about sort of SAOs post-fiscal -- second half of fiscal '14 growth rate? Does it start to slow down because you will already be sort of operating at that peak level with respect to engine builds and the like, or do you have a lot more chair on the A350 or I mean, a lot more share on the next generation engines that's going to continue the robust growth you are putting up this year at SAO, for example?

Bill Wulfsohn

On the aerospace side, we see that there will be a change mix to wide-body aircraft which inherently drives significantly more material, the types that we provide. In addition on the new aircraft design, once again we see increased participation on those new aircraft, A320 and 737.

In addition to that, the energy market is continuing to grow and our position within that is growing and there are number of other areas that we have historically not necessarily been able to support and we will have a greater opportunity for going after and participating in those market areas in the future.

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

Gautam Khanna - Cowen and Company

Okay. And just one higher-level question. On the PCP acquisition of TIMET, I know you do some outside conversion for TIMET already. How secure do you think that business is? PCP has talked about downstream conversion being insular, and what have you. I just wonder, a, what is your exposure there?

What contractual protections or other protections do you have that would maybe limit the ability for them to take that in house? And just looking more broadly, you are one of the few kind of unintegrated alloy manufacturers and aerospace. Now if you look at PCC, you look at ATI and there's others, [DSFDO] and what have you. Does this worry you?

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

Bill Wulfsohn

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

Interestingly enough you know that PCC is a major customer for Carpenter. We focus intensively on trying to be their best external supplier and we continue to make efforts to hopefully position ourselves in a better and stronger way with them.

The purchase of TIMET has a couple of interactions if you will with us, one is, we’re now a customer for PCC, because we buy a lot of our titanium from TIMET and we have a long-term agreement as it relates to that. So there is a chance that we might be able to buy more and become a more significant customer for them which would be good.

The conversion contracts we have are also long-term agreements. We say long-term, these are multi-decade agreements that were established several years back and PCC will have the ability to move some of that material logically if they want to within their own operations, but there are minimums.

And I would say that as we've seen with other acquisitions that PCC has made that if we can be a good, dependable, effective supplier for them, we’re optimistic that as they went in the marketplace, hopefully, that will have trickle-down effect to us.

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

But we don’t feel the need to move downstream, we are not interested in being competitors with our customers, if it turns out that the others downstream or the others in our spaces consume more and more if you were downstream customers and the first question is, will they have the capacity to support that, again, there's kind of an aggregate amount of capacity in the industry. So that doesn’t change regardless of who owns the forging house or whatever.

But beyond that as you’ve seen, if we continue to be good suppliers to those customers, we think we can grow and if we needed to will have the financial flexibility as we go towards later half of this decade to look at making moves around in that area. But I'll tell you that that is not our intention, that we prefer and think our good advantages for the approach that we have taken. So, we have the flexibility but that’s not our intention.

Gautam Khanna - Cowen and Company

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

Bill Wulfsohn

I believe that it would be fair to say and we’ll be seeing you shortly, so I can try to provide a better number, but to say that it would less than 2% of our kind of Premium production that is potentially in play, I think would be a reasonable ballpark. But that’s, I prefer to give you a more button down number on that. But it’s not 25% of what we do or something like that. It’s a much smaller part of our overall activity. And it’s also conversion work. It’s not our highest contributing product line area if you will well either, its conversion.

Gautam Khanna - Cowen and Company

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

Bill Wulfsohn

Sure. The good news is that, I think just triangulating when a number of folks say they see their business growing, they are probably all telling the truth, because the marketplace is growing and as they, the engines kind of increase their size with widebody and have more rigorous requirement in the heart section of the engine, it creates opportunity not just for us but for others in the industry.

We have mapped and for internal purposes kind of part for part and that’s the basis by which we talk about our growth on new platforms. It’s not kind of thumb in the air. It’s an assessment. I think you hear -- hear us talk pretty considerably about the impact that Custom 465 is having in the marketplace right now.

That’s not our newest alloy. It is a proprietary alloy and I think that’s actually a good example where a new product that comes out today isn’t really necessary adopted four or five or 10 years and it takes awhile to get involved in the design.

We continue to invest in other differential alloys, some of which we talk about in our Investor Day and we could actually make that part of our forward communications, I don’t know that time really permits us right now to go into them.

But we believe we are investing as a percentage of sales, the highest in the industry as it relates to new product development and we believe we’re seeing an impact of that in our overall sales mix. So why don’t we leave it at that just because of the time issues and again, we know we’ll have the opportunity to catch-up down the road, we will try to show a little more granularity on that with you.

Gautam Khanna - Cowen and Company

Thank you.

Operator

And your next question comes from the line of Jonathan Sullivan with Citi. Please proceed.

Jonathan Sullivan - Citi

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

Andy Ziolkowski

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

Jonathan Sullivan - Citi

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

Bill Wulfsohn

Yeah. Our goal is to bring inventories down from where they are, where they were in the second quarter. And our target inventories is tough to kind of dial into the dollar -- specific dollar but our goal is to be very close and very similar to where we started the year.

And we were up -- in the first quarter, I believe, we are up close to $60 million in inventories. So that gives you roughly the size of the target that we’re working towards.

Jonathan Sullivan - Citi

Traffic. Thanks a lot.

Operator

And your next question comes from the line of Sal Tharani with Goldman. Please proceed.

Sal Tharani - Goldman

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

Bill Wulfsohn

That’s a good question because as you known our model is one which we don’t say we profit or suffer based upon the relative price of nickel but that’s really over the course of, if you will, a year or so. You can have some short-term impacts because of the timing kind of the lagging surcharge.

I believe that it would be fair to say that when nickel prices are growing up that you would tend to see a more positive affect if there were a lag effect then when they’re going down. So I don’t believe that this would be something that we would anticipate would hurt us. But once again we wouldn't be looking at -- calling this out as a material event for us one way or the other.

Sal Tharani - Goldman

Great. Thank you.

Operator

And your next question comes from the line of Mark Parr with KeyBanc. Please proceed.

Mark Parr - KeyBanc

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

Bill Wulfsohn

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

So that’s what I would say about December. January is clearly as stronger month then December was and again their related orders are pretty much in line with our overall shipments.

Mark Parr - KeyBanc

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

Bill Wulfsohn

You talking about orders or shipments?

Mark Parr - KeyBanc

Yeah, orders. No, orders.

Bill Wulfsohn

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

Mark Parr - KeyBanc

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

Bill Wulfsohn

Sure.

Operator

And there are no further questions at this time. And there are no further questions at this time.

Mike Hajost

All right. Thank you. Thank you again for participating on today’s call. We look forward to speaking with you again next quarter. Thank you and good bye.

Operator

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

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