Carpenter Technology Corp

NYSE:CRS

Earnings Call Transcript 2020-Q4

[Operator]

Good day, and welcome to the Carpenter Technology Fourth Quarter Fiscal 2020 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Brad Edwards. Please go ahead.

[Brad Edwards, Investor Relations]

Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology earnings conference call for the fiscal 2020 fourth quarter and year ended June 30, 2020. This call is also being broadcast over the Internet along with presentation slides.

Please note, for those of you listening by phone, you may experience a time delay in slide movement. Speakers on the call today are Tony Thene, President and Chief Executive Officer; and Tim Lain, Vice President and Chief Financial Officer.

Statements made by management during this earnings presentation that are forward-looking statements are based on current expectations. Risk factors that could cause actual results to differ materially from those forward-looking statements can be found in Carpenter Technology's most recent SEC filings, including the Company's report on Form 10-K for the year ended June 30, 2019, and Form 10-Q for the quarters ended September 30, 2019, December 31, 2019, and March 31, 2020, and the exhibits attached to those filings.

Please also note that in the following discussion, unless otherwise noted, when management discusses sales or revenue, that reference excludes surcharge. When referring to operating margins, that is based on operating income and sales, excluding surcharge.

I will now turn the call over to Tony.

[Tony Thene, President and Chief Executive Officer]

Thank you, Brad, and good morning to everyone on the call today. I hope you and your families are well and safe.

Let's begin on Slide 4 with a review of our safety performance. Our total case incident rate or TCIR is 1.1 for the fiscal year 2020. This is our lowest annual incident rate to date as we continue our journey to a zero-injury workplace. This is an impressive achievement considering the challenges of operating our manufacturing facilities during the COVID-19 pandemic.

Our employees have done and continue to do an exceptional job following the safety protocols in place to keep our plants safe. As we turn to fiscal year 2021, our safety activities built on employee engagement will continue to support our drive to a zero-injury workplace.

Now let's turn to Slide 5 and a review of the fourth quarter performance. Just two quarters ago, at the midpoint of our fiscal year 2020, Carpenter Technology had significant momentum. Our SAO segment was achieving margins at historic highs. We just completed our 12th consecutive quarter of year-over-year sales and earnings growth.

The company was on track for the best financial performance year in our history. And our growth accelerators, such as the investment in Athens facility, soft magnetic and additive manufacturing were poised to start contributing to the bottom line in the years to come.

Of course, the COVID-19 pandemic was thrust upon us, and it had had a devastating impact on our personalized and on the economy. Fortunately, Carpenter Technology was in a strong position. Understanding the magnitude of the downturn, we aggressively pushed forward with portfolio restructurings and cost reduction initiatives to strengthen an already strong liquidity position and balance sheet.

Our actions today include, the elimination of approximately 20% of our global salary positions, implementing a hiring freeze and deferring annual merit increases for most valid employees, reducing our planned capital expenditures by $50 million in fiscal year 2021 compared to fiscal year 2020 after reviewing and prioritizing our capital investments, executing lowering temporary furloughs for certain production, maintenance and salary employees; and completing targeted portfolio actions, including the decision to exit the Amega West oil and gas business, idle our West Virginia powder facility and divest our Rhode Island powder facility.

All of those actions were critically important as sales in the fourth quarter were down 30% year-over-year and 24% sequentially. This depressed volume will likely continue over the next couple of quarters, and a full recovery will take even longer.

We also actively managed the quarter to prioritize free cash flow by accelerating our inventory reduction plan, which was successful in generating cash flow. However, it had a significant negative impact on our operating results. In fact, the primary highlight from our fourth quarter results was a strong free cash flow generation.

We drove $100 million of free cash flow in the quarter, which significantly strengthened our liquidity position. We entered fiscal year 2021 with a total liquidity position of $417 million, which we enhanced even further with a bond offering this month. We have ample liquidity to continue managing through the COVID-19 pandemic.

Equally impressive is our ability to keep all of our facilities operating continuously in this challenging environment. This accomplishment clearly demonstrates the power of our core safety value as well as the steadfast dedication of our employees. Our employees have demonstrated a great commitment to protecting each other and serving our customers during this challenging period. This heightened commitment is resulting in deeper customer relationships and new opportunities for our solutions.

Over the past several months, we have enriched and/or extended supply agreements at the request of key Aerospace, Medical and semiconductor customers who expressed concerns about the stability and long-term reliability of other suppliers. We have demonstrated a resiliency that is resonating with customers and winning us market share.

The pandemic has caused near-term challenges for us as well as our entire industry. However, our long-term growth potential and that of the markets we serve remains intact. Our core business was strong prior to COVID-19 pandemic and the long-term outlook for our markets remains robust.

Carpenter Technology is and will remain a trusted solutions provider of critical applications. Our specialty metal alloys are unique, and we are one of a handful of suppliers, in some cases, the sole credible supplier of materials essential to production of aircraft, medical devices and implants, semiconductors, consumer electronics, automobiles and other applications. Our established core business and leadership in critical emerging technologies, including additive manufacturing and soft magnetics supports our long-term sustainable growth profile.

Now let's move to Slide 6 and the end-use market update. Looking first at the Aerospace and Defense end-use market, where sales were down both sequentially and year-over-year. The results were driven by customers across the supply chain adjusting both their production schedules and inventory levels in response to revised production rates from Boeing and Airbus. A large number of cancellations and pushouts has filtered through the entire supply chain, and there remains a high level of uncertainty.

We currently see this challenging operating environment continuing during the second half of calendar year 2020 and then beginning to improve in calendar year 2021. This past quarter, we engaged with many of our customers, who suddenly saw a reduced need for our materials and together develop forward support plans.

These plans included slower shipment of finished products in exchange for share or pricing gain. While conversations with many of our customers are ongoing and at different stages, all are actively engaged with us as they understand we will remain a vital part of their supply equations moving forward.

Over the mid and longer term, we believe end market demand will return, and we are confident Carpenter Technology will play an instrumental role in meeting it. Because our solutions are uniquely capable of providing power efficiency, longevity and performance, they are already found across a wide range of OEMs, platforms and applications. As airline operators rebuild their fleets with today's and tomorrow's models, they will be flying with Carpenter Technology's high-quality, technically assured materials.

Moving on to the Medical end-use market, where we are seeing some near-term impact on demand as the elective surgery market continues to recover. With that said, our cardiology business is resilient and maintained steady demand throughout the quarter, and we expect it to remain steady in the near-term. We expect the recovery of the orthopedic markets to take shape beginning in calendar year 2021, while the market for our dental applications is expected to return to normalized levels later in 2021.

During the fourth quarter, we quickly leveraged our industry-leading portfolio and responded to critical demand for materials used in cardiology and trauma devices. We also responded to restocking needs as OEMs began preparing to address pent-up demand for elective surgeries.

Over the long-term, we believe we are well positioned to continue supporting the medical device market with the largest portfolio of material solutions, coupled with the strategic investments we have made in our capabilities and capacity. Our application solutions are aligned with key industry mega trends, including an aging population and the increased emphasis being placed on improving patient outcomes.

In the Transportation end-use market, the global light vehicle market was significantly impacted by OEM plant closures related to COVID-19. The pandemic also created challenges in the heavy-duty truck market, which had already been working through a cyclical low.

Now moving to the Energy end-use market, where market conditions in North America remain depressed and international activity is largely stagnant. In addition, the power generation submarket continues to work off a low base.

While sales in the Industrial and Consumer market were down, we experienced solid demand for our high-end semiconductor applications. And consumer electronics, our proprietary alloy solutions are gaining an increasing share in applications, including smartphones, smart watches and other wearable technologies.

Now I'll turn the call over to Tim for the financial review.

[Timothy Lain, Vice President and Chief Financial Officer]

Thank you, Tony. Good morning, everyone. I'll start on Slide 8, the income statement summary. Net sales in the fourth quarter were $437 million, and sales excluding surcharge totaled $376 million. Sales excluding surcharge decreased 24% sequentially on 23% lower volume. Compared to the fourth quarter a year ago, sales decreased 30% on 32% lower volumes.

As Tony covered in his review of the markets, the results reflected weakening demand in the near-term across all end-use markets due to the significant impact of COVID-19. Also, as Tony mentioned, as a result of the current demand conditions, we made the decision to adjust our production schedules and accelerate our inventory reduction program.

These actions had a significant positive impact on cash flow results, which we will talk about shortly, but had a negative impact on our operating income results in the quarter. The trade-off between cash flow and operating income was an easy decision, given our focus on strengthening liquidity in the near-term.

In addition to the demand implications of COVID-19, we continue to deal with the impacts of the pandemic on our production facilities. The additional safety measures necessary to protect our employees and ensure that we can continually operate have impacted productivity. The teams continue to deal with certain self-isolation measures that affect staffing levels at key work centers. I'll talk more about the COVID-19 mitigation cost impacts on our results shortly in the segment details.

SG&A expenses were $42 million in the fourth quarter, down $13 million from the same period a year ago and down about $9 million sequentially. The lower SG&A expenses primarily reflect the impacts of salaried furloughs, remote working impacting certain administrative costs, such as travel and entertainment, and lower costs associated with variable compensation programs.

The current quarter's results include $130 million of special items. This includes $95.5 million of restructuring charges, principally associated with the actions we previously announced related to the exit of our Amega West oil and gas business, the disposal of a powder facility in Rhode Island and the idling of a powder facility in West Virginia as well as the cost to execute the elimination of 20% of global salary positions. In addition to the restructuring charges, we also recorded a goodwill impairment charge of $34.6 million associated with our additive business unit.

Operating loss was $148.2 million in the quarter. When excluding the impact of the restructuring and impairment charges, operating loss was $18.1 million compared to operating income of $67.9 million in the prior year period and $58.7 million in Q3 of this year. Our effective tax rate for the fourth quarter was 20.2%. Earnings per share for the quarter was a loss of $2.46 per share. When excluding the impacts of restructuring and impairment charges, earnings per share was a loss of $0.31.

Now turning to Slide 9 and our SAO segment results. Net sales for the quarter were $369.4 million, or $308.6 million excluding surcharge. Compared to the fourth quarter of last year, sales excluding surcharge increased 27% on 31% lower volumes. Sequentially, sales excluding surcharge decreased 23% on 22% lower volumes.

The results reflect demand headwinds across all markets in the quarter, especially in Aerospace and Defense, as the supply chain adjusts to published build rates and in the transportation end-use market as a result of production closures that significantly reduced activity levels across the supply chain.

SAO reported $5.3 million of operating income for the current quarter, with adjusted operating margin at 1.7%. The same quarter a year ago, SAO's operating income was $86.9 million. The actions we took in Q4 to significantly reduce inventory by adjusting production schedules in light of near-term uncertainty had a significant negative impact on SAO's profitability in the quarter.

In addition, the current quarter's results reflect approximately $6.5 million of incremental costs associated with COVID-19. Again, it's worth noting that despite the significant disruption caused by COVID-19, the operating teams ensured that our facilities could safely continue to satisfy customer needs.

Looking ahead, we expect demand conditions across most end-use markets will remain challenged in the first half of fiscal 2021. As we enter the second half, we anticipate demand levels to stabilize and begin to recover. In response to these conditions, we continue our focus on managing our costs and liquidity. We will work closely with our customers to service their needs in the near-term and adjust production schedules accordingly.

To deal with the impacts of lower volumes and reduced production schedules, we have implemented furloughs for certain production and maintenance positions as we match our workforce needs to production schedules in each of our facilities. In this environment of rapidly changing requirements and plans, we continue to emphasize the principles of the Carpenter operating model in areas such as waste elimination, leader standard work and problem solving. We believe the Carpenter operating model will provide significant operating leverage as we navigate these challenging conditions.

Based on current expectations, sales are anticipated to be down 10% to 15% sequentially in Q1 in SAO. In addition, based on assumptions around demand and related production levels and cost actions, we expect SAO to generate an operating loss of approximately $10 million to $15 million in Q1 of fiscal year 2021.

Now turning to Slide 10 and our PEP segment results. Net sales excluding surcharge were $76 million, which were down 39% from Q4 of fiscal year 2019 and down 29% sequentially. Demand conditions across all end-use markets have been impacted by COVID-19, especially in Aerospace and Defense and distribution.

The distribution demand is more sensitive to overall general economic conditions and faced significant headwinds from the impacts of shutdowns across auto manufacturing in the current quarter. The results also included sequential and year-over-year weakness in energy sales, more specifically in the oil and gas submarket.

The declining demand conditions in oil and gas that were further amplified by the COVID-19 pandemic were the driving force behind our decision to exit the Amega West oil and gas business during the quarter. We have taken the necessary actions and are near completion of exiting this business.

In addition, during the fourth quarter, we completed the disposal of a powder facility in Rhode Island, and we idled the powder facility in West Virginia. These portfolio actions were identified and executed in short order as part of our overall cost savings initiatives to streamline the business to save cost.

In the current quarter, PEP reported an operating loss of $8.4 million. Again, the results for PEP were heavily influenced by the COVID-19 situation. Despite significant operating challenges, credit goes to the teams for doing whatever it took to ensure employee safety and keep the facilities operational at this critical time. As we look ahead, we anticipate PEP will generate an operating loss of $3 million to $5 million in the first quarter of fiscal year 2021.

Now turning to Slide 11 and a review of free cash flow. In the current quarter, we generated $137 million of cash from operating activities and free cash flow was $100 million. As a result of the strong free cash flow performance, we ended the year with $417 million of total liquidity. Within the quarter, we decreased inventory by $117 million, with the bulk of the inventory reduction coming from SAO. This reduction is significant and necessary given the uncertainty created by the pandemic. As we move forward, we expect that inventory remains an opportunity for additional cash flow generation.

In the fourth quarter, we spent $27 million on capital expenditures and finished the year spending just over $170 million as planned. With the majority of our growth projects completed, we have an opportunity to significantly reduce capital spending in fiscal year 2021, as we had previously disclosed.

Let's move to Slide 12 to talk about our recent bond issuance. Shortly after year-end, in July 2020, we completed a $400 million bond offering. The proceeds will be used to repay $250 million of notes that mature in July 2021, and further bolster our already healthy liquidity position. With the proceeds and resulting redemption of the $250 million notes, we estimate that our pro forma liquidity after giving effect to these transactions would be approximately $553 million. The bonds are senior unsecured notes that mature in July 2028. With the repayment of the July 2021 notes, we have also extended our debt maturity profile.

As a reminder, we have a $400 million revolving credit facility that expires in March 2022, which provides flexible access to liquidity as we need it. We have a solid banking group and continue to maintain positive ongoing relationships with the banks who participate in the facility.

It's also important to note that we are currently well within requirements for compliance with the covenants under the credit facility. As we look ahead, we have no near-term debt maturities or significant pension contributions and believe that the strength of our balance sheet and our healthy liquidity position continues to represent a competitive advantage, especially in the current environment.

With that, let's move to Slide 13 to talk about selected fiscal year 2021 guidance. We're providing this selected information to help modeling for fiscal year 2021. Depreciation and amortization is expected to increase from $124 million in fiscal year 2020 to $130 million in fiscal year 2021.

As we previously disclosed, we carefully evaluated our capital spending for fiscal year 2021 and expect to reduce capital expenditures by about $50 million to $120 million in fiscal year 2021. We've completed significant growth investments in the Emerging Tech Center on our Athens campus, invested in Dynamet capacity to enhance our growing position in the medical end-use market, and we'll complete the $100 million hot strip mill project in fiscal year 2021.

Pension required minimum contributions are expected to increase from $7 million to about $20 million in fiscal year 2021 and non-cash net pension expense is expected to remain relatively flat.

Interest expense is expected to increase to $35 million in fiscal year 2021, which reflects the new debt issuance and redemption of the $250 million July 2021 notes to be completed during Q1.

Lastly, the effective income tax rate, excluding the impact of any special items, is expected to be 32% to 35% for fiscal year 2021.

With that, I will turn the call back over to Tony.

[Tony Thene, President and Chief Executive Officer]

Thanks, Tim. Let's move to Slide 15 and a brief review of our immediate priorities. Our first priority will remain protecting our employees and communities. Our rapid response team remains hard at work, safeguarding our facilities and implementing various COVID-19 protocols.

Our self-reporting and self-isolation programs remain in place and are highly effective. We also continue to run our operations in a pod alignment in order to deter virus transmission within a department or shift.

Communications with all our key constituents remains frequent, including employees, state and local governments as well as customers. Our ability to keep our facilities open and running during these unprecedented times clearly demonstrates the commitment of all of our employees as well as the benefit of our core safety value and culture.

Our second key priority is strengthening our liquidity and maintaining our solid financial position. We've taken aggressive actions to reduce our cost structure through several targeted initiatives and portfolio restructurings. In addition, we reduced our capital spending budget for fiscal year 2021.

In total, we expect our efforts will reduce our annual cost by $60 million to $70 million. This will make us a leaner and more flexible company, better positioned to drive accelerated growth when demand levels normalize. Our focus for fiscal year 2021 is cash generation, as we continue to evaluate additional actions to bolster our position.

Lastly, we will remain in contact with our customers, and we'll continue to support their evolving material performance needs. The impact of COVID-19 across our end-use markets is severe and has created demand shocks, widespread inventory management and unconventional demand adjustments. We are working closely with our customers to reprioritize our production schedules and accommodate changing orders as well as urgent requests.

As I noted earlier, in our key Aerospace and Defense and Medical end-use markets, we have accepted deferrals and order pushouts in exchange for increased share on key growth platforms. In addition, despite scale back production rates across our markets, we continue to win spot business due to our reliability of our operations, competitive lead times and quality of our solutions.

Ultimately, we expect to emerge on the other side of COVID-19 with stronger customer relationships as well as meaningful share gains across key platforms and applications in Aerospace and Defense, Medical and other end-use markets.

Let's move to Slide 16 and my closing comments. It is clear that market conditions in the near-term will remain challenging due to COVID-19. And our first quarter fiscal year 2021 net sales could be down an additional 10% to 15% compared to the fourth quarter of fiscal year 2020.

This decreased volume, combined with a weaker mix, continued inventory reduction initiatives and COVID-19 mitigation costs as well as higher interest expense will likely result in a quarterly earnings per share loss of $0.55 to $0.65. This aligns with the segment guidance Tim gave earlier in the presentation.

However, most importantly, we expect to generate additional positive free cash flow in the first quarter of fiscal year 2021. Looking forward, we currently project the second half of fiscal year 2021 to improve versus the first half.

During this significant market downturn, successful companies are the ones that can remain cash flow positive, deepen relationships with their customers and continue to move forward on innovative growth platforms for the future. Carpenter Technology checks each of those boxes.

Despite the near-term headwind, we are well positioned across our end-use markets and our long-term outlook for each remains intact. We are one of a handful and sometimes the only supplier of critical applications to customers across our end-use markets.

We have gained share on key platforms in our key end-use markets of Aerospace and Defense and Medical and see additional opportunities to deepen customer relationships, gain incremental share and unlock attractive market adjacencies.

While they might not necessarily get as much attention, the Transportation and Industrial Consumer end-use markets also offer solid long-term growth potential. And our established core business is supported by investments, we have made in critical emerging technologies, including additive manufacturing and soft magnetics for electrification.

Despite the market challenges caused by COVID-19, we expect to generate positive free cash flow and positive EBITDA for our full fiscal year 2021. That is a powerful statement and one that I believe speaks to the resiliency, the impact of strategic actions we've already taken, and our continued commitment to actively managing our business.

We ended the fiscal year in a strong financial position with total liquidity of $417 million. In addition, our recent bond offering increases our total liquidity further and extends our debt maturity profile. The key to success in this downturn is the ability to generate cash and maintain a healthy liquidity position. Carpenter Technology is poised to do both. We are confident that we can and will continue to navigate these challenging times and emerge a stronger company.

Thank you for your interest, and I'll turn it back to the operator to field your questions.

[Operator]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Gautam Khanna with Cowen. Please go ahead.

[Gautam Khanna, Cowen and Company, LLC]

Yes. Thanks. Good morning, guys.

[Tony Thene, President and Chief Executive Officer]

Good morning, Gautam.

[Gautam Khanna, Cowen and Company, LLC]

I had a couple of questions. First, I was curious you have the visibility of the down sales sequentially in Q1. What can you say at this point about Q2? Have – like how much visibility do you have on customer order schedules and are you still seeing kind of a shuffling of delivery schedules where folks are asking to push things out? Yes, if you could just expand on what you're seeing.

[Tony Thene, President and Chief Executive Officer]

Good morning, Gautam. I hope you and your family are doing well. Yes, there's still some movement as far as visibility in the second quarter, but I believe we have a pretty good line of sight. I mean we gave you EPS guidance for the second quarter, and said that we would remain free cash flow positive. So I think we have a pretty good handle on what we think is going to happen over the next quarter.

[Gautam Khanna, Cowen and Company, LLC]

I'm sorry. I thought you gave EPS guidance for Q1, correct? Fiscal Q1.

[Tony Thene, President and Chief Executive Officer]

Yes.

[Gautam Khanna, Cowen and Company, LLC]

Did you also give it for Q2?

[Tony Thene, President and Chief Executive Officer]

No, no, I apologize. That's right. Just for Q1.

[Gautam Khanna, Cowen and Company, LLC]

Okay.

[Tony Thene, President and Chief Executive Officer]

I think – let me expand a little bit. I think the first half of FY 2021 is going to be muted. And I think you'll see the recovery coming in the last two quarters. I think we really went out to provide guidance for the first quarter, not ready to do that in that specificity for the second quarter.

But I do believe it's going to be the end of this calendar year until we start seeing some improvement. And I think that lines up the fact, I know that lines up with many of the companies that have reported to date. Sorry for the confusion. When you said guidance, I thought you were talking about the first quarter, my apologies.

[Gautam Khanna, Cowen and Company, LLC]

No problem. And just to be clear, what do you – I mean, so that would imply – because the rates – the production rates on the Aerospace side are obviously going down and then they stay down. So I guess, what is the reason that it would come back in the second half of the fiscal year? Is it just some level of destocking that's amplifying the current downturn? Or is it seasonality? I'm just curious like what – and if so, what is the order of magnitude of the destocking and/or seasonality that we could expect to come back.

[Tony Thene, President and Chief Executive Officer]

Yes, it's a good point. You're exactly right. With the downturn, everybody is adjusting based to the change in build rates for the primary aircraft manufacturers. That's what everybody is pivoting off of. It was even magnified for us because there was, as you suggested, rightly so a destocking impact. So that amplified the impact for us.

Now as you start to rebuild, remember that the supply signal for us will probably be two to three quarters in front of that. So we get hit pretty hard when you just shut off the flow because of the destocking is able to come back quicker. I believe that when – because it's such a distinct halt when you do see that demand signal come back, that's going to be pretty significant. And I think you go right back to shortages.

Remember, when we went into this pandemic on the products that we produce, you were out of capacity. Athens being the only capacity coming on and with the long lead times, and I think you'll go back to that pretty quickly.

[Gautam Khanna, Cowen and Company, LLC]

Okay. And then just to follow-up on your remarks about increased market share. Could you speak to any – can you give us any specifics around it? Is it – was that in the engine channel? Was it in the landing gear side? Was it fasteners? What specifically, what product areas have you been able to secure more share? And why do you think that is the case? I mean are you seeing other suppliers that compete with Carpenter maybe falling off a little bit in terms of quality or just financial distress? Anything you could expand on there would be helpful.

[Tony Thene, President and Chief Executive Officer]

Yes, it's a good question. The majority of those customers are the larger customers, or big customers. I would go as far as saying it's primarily on the engine side, but it does filter in some fasteners and some other pieces. I think the main issue is, right now, the focus is on delivery performance and lead times.

And I think when you look at Carpenter Technology in the long-term and their ability to have that additional capacity. We are a company that these other customers want to partner with. So it's a really – it hasn't been a difficult discussion to say we're willing to work with you in exchange for some increased market share in the future. That's been a very productive conversation, and quite frankly, not a difficult one.

[Gautam Khanna, Cowen and Company, LLC]

Okay. Thank you very much.

[Operator]

[Operator Instructions] Our next question comes from Josh Sullivan with The Benchmark Company. Please go ahead.

[Joshua Sullivan, The Benchmark Company, LLC]

Good morning.

[Tony Thene, President and Chief Executive Officer]

Good morning, Joshua.

[Joshua Sullivan, The Benchmark Company, LLC]

Just to follow-up on the first half outlook. I know you're looking for steady demand across end markets. But which end markets do you have more confidence that we're closer to bottom in?

[Tony Thene, President and Chief Executive Officer]

Well, Aerospace and Medical make up over 70% of our market portfolio. So those are the ones we're focused on. Certainly, Transportation and Industrial Consumer are important to us, but their percentages are much lower. I can't tell you whether we're at the bottom now or not. It feels like we are. I'm sure you can listen to the phone calls from the other large engine manufacturers and airplane builders.

And I think that maybe we're getting close to that. I do believe – I think what's important is that there's a significant amount of airplanes that are being retired early. There was a significant amount that needed to be retired. This pandemic has pulled back forward. So when air travel does come back, I think you're going to see the need to build – to continue to build those airplanes, which in turn means supply from corporate technology and other suppliers into the Aerospace supply chain.

[Joshua Sullivan, The Benchmark Company, LLC]

Got it. Well, and then kind of a related question. I mean, can you – is there any detectable difference between demand for materials on next-generation engines versus legacy engines, which might be more aftermarket related?

[Tony Thene, President and Chief Executive Officer]

Difficult question. Right now, I think going forward, there is going to be a need to build the newer planes. I think that's just – if you look at the mega trends and you believe that the air traffic is coming back as we do, you look at the increased retirements of planes and the cost savings you can get. I think it makes sense that you see those new planes being built.

Again for us, we're a bit agnostic because we make materials that go on across every platform. I would say that we're more heavily concentrated on the OEM versus the spares market, but we supply probably material across the entire spectrum.

[Joshua Sullivan, The Benchmark Company, LLC]

Got it. And then just on the inventory reduction plans, what metrics on days outstanding or otherwise, where do you think you're comfortable going should you need to use inventory as a source of cash, as you mentioned in the prepared remarks?

[Tony Thene, President and Chief Executive Officer]

Well, Tim mentioned that I think, earlier in his comments that we have more room to go on the inventory side. I mean because of the dynamics of the market prior to the pandemic, we used our balance sheet to build inventory because we didn't want to disappoint any of our customers when we had 50-week lead time, know capacity actives being ramped up.

As we continue to work our Carpenter operating model, we were achieving significant productivity gains, but you don't get all of those evenly across the system. So in the front end of our process, on the melting side, primarily on the forging side, we were getting productivity gains quicker than on the back end and the finishing.

In truly manufacturing, we would have idled the upstream to balance those, but we didn't want to do that because we need it eventually. We gained that productivity in the finishing side, and we would flush that in [indiscernible] sales demand that was out there.

So when the pandemic hit, that gave us a mismatch of inventory that allowed us to bring that down to a more reasonable level. I think there's still more to go. And one of the main points of the Carpenter operating model is to have the most efficient inventory levels possible.

So there's still a lot of opportunity we have there. I wouldn't say that it will be at this magnitude that we had in the fourth quarter and every quarter, but there's still plenty of opportunity on the inventory side to generate some cash.

[Joshua Sullivan, The Benchmark Company, LLC]

Got it. Thank you for your time.

[Operator]

Our next question comes from Michael Leshock with KeyBanc. Please go ahead.

[Michael Leshock, KeyBanc Capital Markets Inc.]

Hey, guys. Good morning.

[Tony Thene, President and Chief Executive Officer]

Good morning.

[Michael Leshock, KeyBanc Capital Markets Inc.]

So first, I just wanted to touch on the Boeing and Airbus cuts to their wide-body platforms over the past 24 hours or so. You mentioned some customers who are responding to these prior cuts. But what have you been hearing in the aero supply chain? There's obviously been some destocking, but was there any anticipation of further cuts on these platforms?

[Tony Thene, President and Chief Executive Officer]

I would say that the Aerospace supply chain is a very sophisticated supply chain. We stay in very close contact with their ultimate customers. So I think the majority of the supply chain is aware of what that production levels are going to be and anticipated where that is. I wouldn't say that's for everybody, but for a majority, I would say that they have a pretty good handle on what they think those production rates will be. And I've spent the last several months adjusting accordingly.

Now some customers or suppliers are certainly in a different position. If you are – if you came into this pandemic, where we were – did not have the strongest of balance sheet, you might take more severe actions and destock even quicker than what you might. That means you're going to have to build up your inventory levels quicker when the demand comes back. I think it's a big positive for Carpenter Technology because we came in with such a strong balance sheet.

And when you talk to many companies in this pandemic, one of the questions you're asking what the cash burn is going to be, right. And that's not a question you have to ask – need to ask Carpenter Technology because we're generating cash today this quarter and the next quarter and say, we'll be free cash flow positive. I think that's a big benefit for Carpenter Technology versus maybe some of the aviation supply chain.

[Michael Leshock, KeyBanc Capital Markets Inc.]

Got it. That's helpful. And then on – how were jet engine sales in the quarter, either year-over-year or quarter-over-quarter?

[Tony Thene, President and Chief Executive Officer]

They were pretty consistent overall. They were about 30% – roughly 30% down quarter-over-quarter and 30% down year-over-year. That compares to our total that was 30% year-over-year and 24% sequentially. Engines – Aerospace was about 30% year-over-year, down 20% quarter-over-quarter, and engines, year-over-year about 29% and quarter-over-quarter 30%.

[Michael Leshock, KeyBanc Capital Markets Inc.]

And how are current backlog levels just for the overall business in the quarter? And what's been the biggest driver for that delta?

[Tony Thene, President and Chief Executive Officer]

Well, backlog is down. If you look year-over-year, our overall backlog is down approximately 30%, by sequentially 25%. It's driven by Aerospace, primarily. In all of the markets, the backlogs are down. I think that makes sense based on the severe economic downturn that we're in right now.

[Michael Leshock, KeyBanc Capital Markets Inc.]

Okay. And then lastly, just on the COVID cost, you had an impact of $6.5 million this quarter. I think it was $5.5 million the prior quarter. How do you see these costs going forward? I'm just trying to gauge the cadence on when these incremental costs will level out. Thanks.

[Tony Thene, President and Chief Executive Officer]

That's a good question, and it allows me to talk about that a little bit. I'm not going to skimp on those costs. I mean my point of view is I'm going to protect our employees. We're able to run those facilities. So $6 million is a big number for us, but it's a lot less than if I have to shut down a facility like you've seen in some of the other industries.

So those costs include where we have a very robust self-reporting system, where if one of our employees meets a certain criteria, symptoms, travel, whatever it might be, they self-report to our medical team, our medical team decides they need to go on self-isolation and not come in to our facility.

They are still paid. We still pay them as if they're in that facility, to encourage them to self-report and keep everyone safe. That includes the extra cost of cleaning whenever we have any type of issue where we think that's appropriate. We put ourselves in a pod environment, so there's some extra cost there. So I think those costs will continue into our second quarter. And I don't really see us easing those much over the next six months.

But again, that's going to depend on the pandemic, and I'm going to be very conservative there. I'm not going to put our employees and ask them to come into our facilities and work really hard in a tough situation and not do everything I can to protect the health of the employees and their families, and the community, quite frankly.

[Michael Leshock, KeyBanc Capital Markets Inc.]

Appreciate the detail. Thanks guys.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Brad Edwards for any closing remarks.

[Brad Edwards, Investor Relations]

Thank you. Thanks, everyone, for joining us for our fourth quarter earnings call. We look forward to speaking with you all again on our first quarter 2021 earnings call. Take care and enjoy the rest of your summer.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.