Brad Edwards - The Plunkett Group Tony R. Thene - Carpenter Technology Corp. Damon J. Audia - Carpenter Technology Corp..

Josh Ward Sullivan - Seaport Global Securities LLC Chris D. Olin - Longbow Research LLC Gautam Khanna - Cowen and Company, LLC Philip N. Gibbs - KeyBanc Capital Markets, Inc..

Good morning and welcome to the Carpenter Technology Corporation Third Quarter Fiscal Year 2018 Financial Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

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

Thank you, operator. Good morning, everyone, and welcome to Carpenter's earnings conference call for the third quarter ended March 31, 2018. 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 Damon Audia, Senior 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 the Carpenter's most recent SEC filings including the company's report on Form 10-K for the year ended June 30, 2017, Form 10-Q for the quarters ended September 30, 2017 and December 31, 2017, and the exhibits attached to those filings.

Please also note that in the following discussion, unless otherwise noted, when management discusses the sales or revenue, that reference excludes surcharge. When discussing operating income, that reference excludes pension earnings, interest, and deferrals or EID.

When referring to operating margins, that is based on sales excluding surcharge and operating income excluding pension EID. I will now turn the call over to Tony..

Thank you, Brad, and good morning to everyone on the call today. Let's start on slide 4 and a review of our safety performance. Our total case incident rate is at 1.1 for the year-to-date fiscal year 2018.

We continue to work diligently toward reaching our goal of a zero injury workplace, and our performance to-date keeps us on path to achieve our best fiscal year performance in Carpenter's history.

Last quarter, I mentioned our extensive human performance program that reinforces tools, practices, and methods to reduce or eliminate errors in safety, quality, and manufacturing. This program is focused on engaging the employee at the task level.

For example, one of the concepts of human performance safety training is to empower employees to observe the environment around them, and when a potentially unsafe activity is observed, they are empowered to stop the activity by issuing a stop card.

Every time a stop card is issued, a detailed action plan is assigned and tracked to closure to ensure this activity is corrected. This may seem basic, but I'm encouraged by the fact that to-date, over 4,000 stop cards have been initiated.

Also, by completing a certification process, multiple employees have become human performance advocates who now train fellow employees in the principles of error reduction. This is true engagement in action.

While we have made encouraging progress to-date, there is much more work to be done, and our commitment to this core value, a zero injury workplace, will not waver. Now, let's turn to slide 5 and a review of our third quarter highlights.

The third quarter marked a continuation of the strong financial and operating performance we have delivered over the last several quarters. We are executing our commercial strategy and capitalizing on positive market trends as indicated by growing customer demand for our high-value solutions.

We drove sequential sales growth across each of our end-use markets including double-digit gains in aerospace and defense, energy and transportation. This is an outstanding team effort by both our commercial and manufacturing teams.

Our manufacturing team has worked to unlock the additional capacity needed to produce higher volumes of complex materials while maintaining our strict, quality, environmental, and safety standards.

In addition to posting volume gains, we are also steadily transitioning our product mix to higher margin applications while consistently expanding our total backlog, which is up 13% on a sequential basis during the third quarter and up 27% compared to last year.

Total aerospace and defense sales were up 18% sequentially, driven by growth across every one of our sub-markets including engines, which increased 19% over the prior quarter. In addition, the third quarter marked the fifth consecutive quarter of year-over-year sales growth in aerospace and defense.

We expect demand levels in this market to remain strong. At the end of the third quarter, backlog for aerospace and defense was up 9% sequentially ,marking the seventh consecutive quarter of growth and up 35% on a year-over-year basis.

In the energy end-use market, revenue growth in our oil and gas sub-market once again outpaced the increase in the North American directional and horizontal rig count. This performance speaks to the success we are having, deepening our customer relationships, and gaining market share.

From a business segment perspective, SAO delivered its best third quarter performance since fiscal year 2013 and the fifth consecutive quarter of operating margins above 15%. We continue to drive a stronger product mix through SAO while also actively managing our operating costs.

Our PEP business delivered another solid quarter, paced by increased sales at Amega West, which delivered its third consecutive quarter of profitability since the beginning of the oil and gas turndown. During the quarter, we continued to expand the Carpenter Operating Model.

Unlocking incremental capacity in this high-demand environment has become the critical focus of the Carpenter Operating Model for fiscal year 2018. On last quarter's call, I noted that we had submitted VAP qualification packages for our Athens facility to the major OEMs for engine disc and the ring quality materials.

We view this as well timed as it corresponds directly with the aggressive aero engine ramp-up and tight supply chain. More specifically, lead times for nickel billet remained extended. As mentioned earlier, demand levels continued to increase as seen in our 19% sequential increase in engine sales, and our aerospace backlog continues to grow.

And we continue to see and capitalize on expedited order request from major aerospace OEMs. For this quarter's update, I am encouraged with the progress we continue to make on Athens qualifications. During the quarter, we received VAP approvals on three specific grades from two key OEMs.

While the recent approvals are associated with smaller volumes, they are important steps as we progress towards approvals that support more meaningful volumes. We have significantly elevated the value we deliver to our customers and are a critical partner to enabling their success.

However, we know their needs, and our industry will see significant change in the future. As such, we know that we must strategically invest for the future and strengthen our position as a critical supply chain partner and solutions provider for our customers.

Our solid financial position and strong free cash flow generation enables us to make these critical strategic investments. Last quarter, I discussed the investment we are making in our soft magnetics capabilities and capacity.

This is strategically important given our market leadership in auxiliary power units for aerospace, increasing penetration of the high-value consumer electronics market and the tremendous disruptive potential of electric vehicles.

And now, we have strengthened our solutions offering in the additive manufacturing space through the recent acquisition of CalRAM. The CalRAM business provides us with direct entry into the rapidly expanding part production segment of the additive manufacturing value chain.

This moves us closer to customers across each of our end-use markets and will enable us to deliver an additive manufacturing offering from powder to part. In addition, our value proposition in additive manufacturing was strengthened by a recent agreement for an exclusive license for an innovative meltless titanium powder manufacturing process.

This provides Carpenter with the potential to produce low-cost titanium powder and maximize efficiencies across the entire asset manufacturing development and production chain. I will talk more about our strategy in this market in a few minutes. Let's move to slide 6 and the end-use market update.

We'll begin with aerospace and defense where sales increased 18% sequentially and 22% year-over-year. Sales increased sequentially across each of our sub-markets led by engines, avionics, and distribution. Also our aerospace and defense backlog reached a record level this quarter.

While our engine submarket bookings eclipsed last quarter's record level by 12%. During the third quarter, engine sub-market sales increased 19% sequentially and 32% compared to last year. We remain well-positioned given our participation on the new engine platforms, and we expect continued solid growth in this sub-market.

Moving on to our fastener sub-market where sales were up 9% sequentially but down slightly compared to last year. The current fastener market shows pockets of demand, but forecasting long-term demand remains challenging as the supply chain continues to adjust to the platform ramps.

Looking at the structural sub-market, our growth continues to be driven by critical materials used on key programs including the A320 and the 737.

This is a sub-market where we see an expanding number of market opportunities for our solutions, given the breadth of our offerings and our expanding additive capabilities at a time when OEMs are showing increased interest in the potential benefits of additive manufactured structural components.

Performance in our aero distribution sub-market remains strong as the channels are restocking inventory despite price increases. This is yet another indicator of the strong underlying aerospace demand given the major OEMs backlog of over 14,000 aircraft.

Finally, sales in our defense sub-market increased both sequentially and year-over-year due to program-specific demand. Moving to the energy market and a review of our oil and gas and power generation submarkets. Total energy sales increased 15% sequentially due primarily to higher rental and replacement activity at Amega West.

On a year-over-year basis, energy sales declined 9% as a 35% increase in oil and gas sales was more than offset by lower power generation sales.

As previously mentioned, our oil and gas submarket sales are consistently outpacing the North American directional and horizontal rig count, and Amega West is capturing incremental market share as activity levels rise.

While activity at Amega West remains more heavily weighted on the rental side, we are seeing signs of an increase in replacement activity of critical tools by service providers, which is a positive sign for the overall market.

Key contributors to our success in the oil and gas business include our strong position in the Permian Basin, the strength of our horizontal drilling and artificial disc solutions, and our deep relationships with major service providers.

It's not surprising that certain production bottlenecks have risen given the concentrated drilling activity in the Permian Basin. Today, we are working closely with our customers to break those bottlenecks by improving the life of the tools we sell and rent and developing innovative solutions including additive manufactured solutions.

Looking outside the Permian Basin, we remain well positioned to support our customers as activity increases in other key regions. Global conditions remain largely supportive of rising oil prices, while expected North American spending budgets remain healthy.

Outside North America, conditions remain more subdued as higher crude oil prices need to be sustained before activity meaningfully accelerates. Last week, the power generation sub-market remains at historic low levels due to industry-wide challenges in industrial gas turbines or IGT.

The replacement cycle for the current aging turbine fleet has been delayed, which is impacting us and other industry participants. But keep in mind that power generation submarket currently accounts for only 1% of our total net sales.

Transportation sales increased 14% sequentially as demand increased across multiple product applications for the North American light vehicle market and in heavy truck where the recovery continues to strengthen. On a year-over-year basis, transportation sales rose 8%.

Compared to the same quarter last year, we are clearly seeing a favorable shift in product mix as sales of our high-temp products have outpaced the lower-value materials. The expectation for North America light vehicle production encountered in the year 2018 remains below prior-year levels.

However, Carpenter remains well-positioned as we offer a broad suite of products addressing key OEM challenges such as heat resistance, corrosion, and lightweighting. We are also well-positioned in the light truck segment of the U.S. market where sales are expected to outpace passenger sedans.

Outside the U.S., we remain hard at work, increasing our penetration and market share in key regions including Europe and China. Moving on to the medical market, sales were up 1% on a sequential basis and 19% compared to last year.

Our sequential performance was impacted by the short-term disruption related to the fire at one of our Dynamet facilities. Excluding the impact of the Dynamet fire, we estimate medical sales would have been up 10% sequentially.

Our sequential and year-over-year growth reflects ongoing strong demand for our titanium solutions as well as the impact of noble share gains we have captured in the orthopedic and cardiology sub-markets.

We maintain strong relationships with our key medical distributors and are making further progress in deepening our connections at the OEM level given our diverse product portfolio. In the industrial and consumer end-use market, sales were up 3% sequentially and 8% on a year-over-year basis.

The increases were driven by higher demand for select industrial applications, partially offset by lower consumer sales. Now, I will turn it over to Damon for the financial review..

Thank you, Tony. Good morning, everyone. Turning to slide 8 and the income statement summary. We generated significant improvement in our operating results in our fiscal third quarter.

We benefited from the successful execution of our commercial strategy coupled with the improving market conditions as well as our focus on driving improvements through the Carpenter Operating Model. The quarter marked our best third quarter operating income performance since fiscal year 2014.

We delivered year-over-year revenue growth in four of our five end-use markets. Although energy was down, it is solely related to the industrial gas turbine industry and the corresponding adverse impact on the power generation sub-market.

Overall, we're capitalizing on strong demand trends across multiple end-use markets, building share through increased business among current customers while creating new relationships with companies that recognize the unique value proposition we offer. Net sales in the third quarter were $572 million or $473 million excluding surcharge.

Sales excluding surcharge increased $57 million on a sequential basis on a 14% increase in volume. This increase reflects revenue growth across all our end-use markets as well as favorable mix.

On a year-over-year basis, sales excluding surcharge increased 14% on a 9% gain in volume, led by a 22% increase in aerospace and defense and a 19% gain in medical. SG&A expenses increased by $5.9 million on a sequential basis at $50.8 million, reflecting the timing of certain expenses.

For the fourth quarter, we expect SG&A expense to be in the range of $47 million to $50 million. Operating income as a percent of sales was 9.7% in the quarter excluding pension EID. This was effectively flat compared to the 9.9% in the second quarter and down slightly from 10% in the third quarter of fiscal year 2017.

Operating income in the quarter was negatively impacted by the cost associated with the fire at our Dynamet facility in January. Excluding these costs of approximately $3 million, operating income as a percent of sales would have been over 10% and up both year-over-year as well as sequentially.

In addition, given the increase in certain commodity cost, the headwinds related to the raw material surcharge lag continued for certain customers. Our effective tax rate for the third quarter was 19.9%. The reported rate includes an income tax benefit of $1.6 million in the quarter, resulting from our continued assessment of the impact of U.S.

tax reform that was enacted in December of 2017. Excluding the special tax item, our tax rate in the third quarter would have been 24.1%. For the fourth quarter, we expect our tax rate to be in the range of 26% to 28%. We reported net income of $30.2 million in the third quarter or $0.63 per share.

Excluding the impact of the tax special item, adjusted diluted earnings per share would have been $0.60 for the quarter, which was up from $0.55 in the second quarter of fiscal year 2018 and $0.44 in the third quarter of last year. Now, turning to slide 9.

We generated free cash flow of $35 million in the third quarter, representing a notable improvement compared to the negative $11 million in the second quarter of 2018. Our free cash flow performance in the quarter is a result of our strong revenue performance.

The shipment volume and ongoing work by the operations team drove a $41 million reduction in inventory for the quarter. Regarding inventory, we currently expect to further reduce inventory by around $40 million in the fourth quarter, which would effectively keep inventory flat on a full-year basis versus June 30, 2017 levels on a total company basis.

Within that guidance, we expect a reduction in our SAO's inventory for a full year as a result of the increasing demand levels and ongoing efficiencies gained from the Carpenter Operating Model.

However, given the strengthening demand in our Amega West business over the last few quarters and the correlating impact on its inventory, we expect this increase will largely offset the SAO inventory reduction.

As we've said in the past, we will continue to align our inventory levels with the opportunities and trends we see across our end-use markets. Also, during the quarter, we acquired CalRAM for approximately $13 million as part of our growth plans in additive manufacturing, which Tony will touch on in a moment.

Finishing up on free cash flow, we spent $25 million in capital expenditures during the quarter, essentially in line with the $27 million spent in the second quarter of fiscal year 2018.

We continued to invest in core growth areas including additive manufacturing and soft magnetics as we look to strengthen our long-term growth profile and become an increasingly critical solutions provider to our customers. For the year, we expect capital expenditures to be in the range of $130 million to $135 million.

Turning now to slide 10 and a brief review of our capital structure. We remain committed to maintaining a strong liquidity position and healthy balance sheet. As of March 31, we had $441 million of total liquidity including $47 million of cash and $394 million of availability under our credit facility.

We have $55 million of long-term debt maturing in the upcoming fourth quarter that we currently expect to repay with cash. Beyond that maturity, we have no debt obligations until fiscal year 2022. We also have no significant required pension plan contributions until fiscal year 2022. Our financial position remains solid.

We are focused on leveraging our balance sheet and free cash flow generation while investing in next-generation growth areas.

We have the right strategy to capitalize on current conditions, improve our manufacturing operations, increase our capacity, and strategically invest in our future while still returning capital directly back to our shareholders. Now, turning to slide 11 and our SAO segment results.

SAO delivered another solid quarter with net sales of $482.4 million or $381.3 million excluding surcharge, representing an increase of $49.5 million or 15% on a sequential basis. On a year-over-year basis, sales excluding surcharge were up $59 million or 18%.

The sequential increase was supported by the successful execution of our solutions-focused strategy and increased demand across our end-use markets. As Tony highlighted, our backlog increased on both a sequential and a year-over-year basis.

Operating income was $58 million, up $8.2 million compared to the second quarter and up $6.1 million year-over-year. This quarter marked SAO's best third quarter operating income performance since fiscal year 2013. Operating margin was 15.2% compared to the operating margin of 15% in the second quarter and down from 16.1% in last year's third quarter.

Operating margin performance was impacted by the timing of certain expenses in the quarter as well as the continued raw material surcharge lag, which, based on current commodity prices, will persist into the fourth quarter.

We continue to benefit from the Carpenter Operating Model as we capture manufacturing improvements and identified pathways to unlock capacity, which is increasingly important given market conditions and increasing customer requirements.

The Carpenter Operating Model allowed SAO to ship the most tons since Q3 of fiscal year 2015 but with a much richer and more complex mix as we focus on those customers who value the solutions we offer.

Looking to the fourth quarter, we continue to see healthy demand trends across most of our end-use markets as reflected in the notable growth in our backlog.

As we continue to execute our solutions-driven commercial strategy and build share and extend the benefits of the Carpenter Operating Model, we currently expect SAO operating income to increase up to 10% on a sequential basis. Now, turning to slide 12 and the PEP segment overview.

On a year-over-year basis, PEP sales excluding surcharge increased 9% or $9 million to $107.5 million. On a sequential basis, sales rose approximately $3 million. This was PEP's sixth consecutive profitable quarter, while Amega West achieved its third consecutive profitable quarter. Operating income for the quarter was $5.4 million.

The $5.4 million reflects the net impact of the strong underlying operating performance for the PEP businesses coupled with the net cost related to the fire at one of our Dynamet facilities of approximately $3 million in the quarter.

Over the last several months, the team has done an exceptional job in both minimizing the impact to our customers and to Carpenter while beginning the restoration process. More importantly, the team has been able to accomplish these major tasks without any safety-related incidents.

I want to thank everyone who has played a role in helping minimize the impact of this event for our customers as well as our associates. It's in these types of challenging times that you see people's true commitment and passion.

Looking at the fourth quarter, we expect to see strong demand for our titanium products and a further increase in activity levels at Amega West. We will, however, continue to deal with increased cost associated with the servicing of some of our customers while we work on the restoration of the Dynamet facility.

For the fourth quarter, we expect PEP operating income to increase approximately 55% to 60% versus the $5.4 million in Q3. In summary, strong execution of our solutions-focused approach is driving revenue growth across our new markets and broadening the application areas for our products. Now, I'll turn the call back over to Tony..

Thank you, Damon. We firmly believe the future of our industry and that of our customers across every end-use market is going to be impacted in some form by additive manufacturing.

Our strategy to be a leading solutions provider and an irreplaceable supply chain partner relies on our ability to evolve and best position Carpenter at the forefront of disruptive change.

Customers across all of our end-use markets are actively exploring additive manufacturing as they seek to elevate the performance of their products and meet ever increasing design requirements for mission-critical applications.

A growing premium is being placed on characteristics such as lightweighting, corrosion resistance, and a product's ability to withstand high temperature, stress, and thermal variation.

Today, we produced many powder grades that we have engineered specifically for additive manufacturing including Puris 5+, the world's first high-strength, low-oxygen titanium powder solution. In fact, Puris 5+ exceeds standard Grade 5 strength levels by nearly 18%, giving 3D part designers significantly more flexibility in their designs.

We currently have an additive manufacturing R&D center that is focused on exploring and developing new and improved additive manufacturing alloys and qualified additive processes with the goal of creating better parts for our customers.

In addition, as we announced last quarter, we are finalizing plans to build an industry-leading emerging technology center focused on key growth platforms including additive manufacturing where under one roof, we will have the capability to go from powder to part.

In February, we significantly enhanced our capabilities through the acquisition of CalRAM, a leader in powder bed fusion additive manufacturing metal printing services. CalRAM brings parts production to our existing capabilities and will allow us to create a turnkey additive manufacturing offering to a broad range of customers.

This vertical integration positions Carpenter as a total solutions provider for customers in the rapidly expanding additive manufacturing space by starting with our customers' application requirements and providing solutions at each step of the additive manufacturing process.

Immediately after the acquisition of CalRAM, we began hearing from customers in all of our end-use markets who clearly recognize the potential of combining our existing metallurgical processing expertise and additive manufacturing grade feedstock capabilities with a leader in part production.

In addition, it is exciting to report that our position in additive manufacturing is also strengthened by an exclusive license agreement that we recently entered into for an innovative meltless titanium process.

This innovative process has the capability to uniquely tailor titanium powder for additive manufacturing applications across multiple end-use markets.

We believe that this capability along with the potential for substantial cost reductions in the manufacture of titanium powder will help unlock an expanding number of additive manufacturing opportunities and other high-performance application areas.

Although commercialization of this process will take some time, we are excited about its prospects and its ability to further advance our competitive position. Building a leadership position in additive manufacturing is a critical component of our long-term growth strategy.

We remain focused on positioning Carpenter as an industry leader from feedstock development and part design to commercialization and final parts supply. This total solutions approach can be a major competitive advantage at this crucial stage in the evolution and adoption of additive manufacturing. Now, let's turn to slide 15 and my closing comments.

During the third quarter, we built upon a fiscal year-to-date performance through strong commercial and operational execution. The transformation initiated several years ago is bearing fruit and is well timed given the robust demand environment in our key end-use markets.

Our solutions approach is driving revenue growth across our end-use market as we capture market share, expanding our customer relationships, and consistently growing our backlog.

The benefits of our diverse participation in aerospace and defense is clear, and Carpenter is well positioned as the engine ramp (00:32:16) continues and the overall aerospace cycle accelerates. Activity levels in the oil and gas sub-market are increasing, and we are focused on continuing to build upon our recent market share gains.

Given the overall high demand environment, our implementation of the Carpenter Operating Model is increasingly focused on maximizing capacity across our facilities. This will allow us to capitalize on our strong commercial execution and the tailwinds we are experiencing across all our end-use markets.

During the quarter, we received VAP approvals on three specific grades from two key OEMs at a critical time for the aerospace industry with robust build rates and extended lead times. Our Athens facility will provide that much needed incremental state-of-the-art capacity for the industry.

Investing in the future of our industry will remain a critical element of our strategy.

In the last year, we have secured immediate entry into the titanium powder market with the Puris acquisition, announced a major investment in the high-growth, high-value soft magnetic space, launched our first additive manufacturing technology center, and announced plans for a new state-of-the-art emerging technology center, significantly enhanced our presence in the additive value chain through the acquisition CalRAM and its additive manufacturing production capabilities, and secured an exclusive license for its innovative meltless titanium powder technology that has the potential to transform the industry.

We are making the strategic investments in core growth areas to position ourselves for long-term sustainable growth and increasing value for shareholders. Carpenter today is a significantly stronger company in every way. Our customers recognize the value of our brand and view us as a critical supply chain partner.

Thank you for your attention, and I will turn it back to the operator to field your questions..

Yes. Thank you. We will now begin the question-answer-session. And today's first question comes from Josh Sullivan with Seaport Global..

Good morning..

Good morning, Josh..

Nice quarter here. Just on the aerospace side, Airbus has been making some comments about taking rates up on the A320. Boeing has indicated there is upward pressure on the 737s. However, there were some other comments out of the engine supply chain suggesting that there is challenges getting to those elevated rates.

How is Carpenter's capacity to potentially meet those elevated levels either at SAO on any particular grade or even in PEP with the fastener facilities?.

Well, good morning, Josh. This is Tony. A couple of points there. Number one, we've increased our capacity across our legacy assets over the last 12 months, so we've been able to step up and supply that demand especially on the expedited orders that we have received over the last couple of quarters. That's number one.

Number two, the biggest opportunity is we have Athens coming on line. So, we've received qualifications, as you know, for three specific grades for two OEMs. That will open up enormous capacity in the short term. And then specifically on Dynamet, we are investing in both of our facilities in Washington, PA and in Clearwater, Florida..

Great. So, if we did go to those levels, your capacity wouldn't be one of the issues..

Well, I think that when you look at specialty alloys, that is a tight market, and that's why I think Athens coming on line right now is perfect timing. So, we anticipate our ability to meet that demand..

Okay. Great.

And then just one on the medical side, should we expect to see the demand that was held back by the fire this quarter? How long do you think it's going to take for that demand to release over the next couple of quarters here?.

Yeah, Josh. So, as we mentioned, they were in the midst of the restoration process right now. As I mentioned last quarter, we've sort of looked at alternative sources to supply these customers, either working with other Carpenter facilities for potentially outsourcing.

The restoration process is going to probably take us at least another one to two quarters to get things back up and running to its normal run rate. But in the interim, we're working to sort of service the customers in these alternative passes (00:37:10) to recover that volume.

But again, I think what you're going to see is the volume start to come back over the next two to three quarters, but the cost of doing so will be somewhat elevated over the next two quarters..

Okay. Great.

And then just one last one, what's the timeline of the soft magnetics investment? Is there any qualification time period that we should be thinking about or just how should we look at that investment?.

It will take us about two-and-a-half years to bring that online. We'd like to do it sooner. The qualification cycle will be minimal..

Okay. Thanks. I'll get back in the queue..

Thank you. And the next question comes from Chris Olin with Longbow Research..

Hey. Good morning..

Good morning..

Good morning, Chris..

Let me just start off by congratulating you on getting those approvals at Athens. I know it's been a long patient process, so good job..

Thank you..

Just in terms of Athens, can we get an update on where the operating rate is today, perhaps any guidance you can give or update in terms of what the EBIT impact on the quarter was and how these approvals perhaps changed your timeline now?.

Yeah, these approvals do not change our timeline at all because we expected them. You remember on the last call I said that I thought we would have a couple by the end of our fiscal year. A couple of those have come in as we reported. Keep in mind that those are on the smaller volume grade.

That's a normal progression as we move the qualification cycle down the field. And I can tell you that, as we speak now, from an incremental standpoint, which is when you think about utilization at Athens, it's important to say what's the incremental utilization, and that is about 10%, which it was the last quarter as well..

And then in terms of how should I think about in terms of what the EBIT headwind is for that asset right now?.

Josh (sic) [Chris] (00:39:10), what we've cited, without any incremental, it was about $40 million of cost per year, while $20 million of that was depreciation and about $20 million of that was the cash cost, and we were running at utilization rates at the low 30s, call it 32, 33. We were sort of saying that none of that was really incremental.

So, you can sort of back in as Tony gives you the utilization rates being up around 40 now. You can sort of back into sort of what that delta is or what that incremental component would be..

Okay. And then when I back into that number, it still seems like the margins maybe were a little bit light, and I know you referenced some early costs. I was wondering if you could be more specific in terms of what the impact was there..

I'll take that one. I think it's fair to say that Athens is not really contributing anything for margin expansion. I mean, Athens even at these rates is a drag on our overall margin expansion. So, it's not a positive to this date. But it is a good question when you talk about the SAO margins and something we spent quite a bit of time on.

I think it's important to remember, as you've noted already, just to take a step back. In fact, the SAO segment just delivered the best quarter since fiscal year 2013. But as I said (00:40:25), certainly, there is a lot of upside on the margin. Damon mentioned that we had the raw material surcharge lag.

We also had the timing of certain expenses as we get to the end of our fiscal year. And if you would just eliminate those two, that would increase your margins by about 200 basis points. That puts you in the 17% range.

We know that to-date that our cost reduction efforts haven't been where we want them to be when we talk about 3% year-over-year primarily because the mix has got richer, so the complexity has gotten tougher, and that we put a focus on increasing capacity and supplying every one of those expedited orders we get from our customer.

So, we are going to sacrifice cost in some ways to make sure we get that product out the door for our customers when they need it because they can't get it from another source. So, if you take that in consideration and as Athens comes on line, you can see a path to 20% and above fairly quickly..

Okay. That's very helpful. And the last question I had was just looking at Dynamet specifically, has that company been affected by what looks like slower demand or destocking taking place on the fastener side especially in Europe? I guess, I'm not sure how to think about the leverage or the mix between Boeing and Airbus..

We see the normal patterns on the fastener business. Remember we produce titanium and nickel. So, over the last several quarters, there has not been any real difference. Dynamet, in fact, as you see in the numbers, is one of the main reasons why the PEP segment is doing so well.

As I said, we're increasing capacity in both the Clearwater facility and the Washington facility primarily to serve the medical market, but Dynamet is on the rise right now, and we see good numbers coming out of them over the next couple quarters..

Thank you very much..

Thank you. And the next question comes from Gautam Khanna with Cowen and Company..

Yeah. Thanks. Great results, guys..

Thank you..

A couple questions. I think you mentioned, Tony, in your opening remarks that you're seeing expedited orders, and I was wondering if you could expand upon and what product areas were you seeing those and why do you think you are seeing them.

Is it just because the pace of demand is quickening or is it because some of the other suppliers that manufacture these products are coming up short and in what product areas?.

Good morning, Gautam. We're seeing that across many of the aerospace sub-markets, right? And it has to do with quality, with the extending lead times, and yes, there are some suppliers in the market that are not supplying as required. As I said, we take every one of those calls, we step up on every one of those requests.

And as I said on the earlier question, we're willing to sacrifice some costs right now to manipulate our process flow and get them into the queue..

Okay.

So, when you say it's across all the sub areas, you mean some fasteners to (00:44:02) to jet engines to airframe, structural parts, everything?.

Yes. But it's primarily... (00:44:08).

Yeah, primarily on the engine, aero engine and aero structural side..

Okay. And then to follow up on your comments about the fastener market, sort of you said it was up sequentially. Could you quantify how much? And it sounded like in response to Chris's question, you were suggesting that it's going to accelerate over the next two quarters.

I want to make sure, is that aerospace fasteners or is that a medical product out of Dynamet like what are you seeing in the fastener market?.

Yeah. Good question. On aero fastener specifically, we were up about 9% sequentially. We were down about 1% to 2% year-over-year.

And to your second part of your question, when I talk about Dynamet going forward, obviously, aerospace fasteners is a solid business for us, but the majority of the growth that we see in Dynamet and primarily why we're investing capital is on the medical side..

Okay.

Any explanation that you can come with for why the aero fastener business on a year-on-year basis is a little bit more subdued?.

I don't think there is anything specific there for us, Gautam, as far as the year-over-year..

Okay.

And then another comment you made in your opening remarks about backlog being up 9% sequential, I wanted to clarify, was that for the entire company or was that at SAO? And related to that, normally, we enter a seasonally strong June quarter, which you've guided to, but then it's usually followed by a pretty sharp reduction in the September quarter due to the normal seasonality in the industry.

How should we think about your backlog comments given it seems like it might portend a less seasonal kind of pattern this year in September and December quarters?.

Yeah, I talked about this briefly last quarter. I think from a seasonality standpoint, it's all going to be about how many days are in that quarter, right? I understand that there is seasonality in Europe during the summer months. I understand that there is certain quarters where there might be shutdowns, but we're running as fast as we can.

We're continually working to open up capacity. As I said, we continue to get expedited orders. So, for us, seasonality means how many days are there in the quarter and how is that different from any other quarter..

And with that then, September – typically, I don't remember the exact number, but at times is around the 15% decline sequentially in terms of top line and then the associated impacts on margin.

Is it safe to say that this year will be less of a decline? Because I mean, (00:47:11) the number of days are dramatically different, September versus June in terms of Carpenter's ability to produce. So, I'm just wondering if that step-down is going to be a lot less than what we see historically..

And for us, I think, Tony has talked about the market impacts that we see sort of a reduced impact year-over-year as we go from Q4 to Q1. Remember, as we talked in the past during our fourth quarter and into our fiscal first quarter, we do have some operational, some preventative maintenance that we go through.

So, as we go through that summer holiday, we go through a period of time we're not really utilizing the asset. So, even though there may be holidays, differences, we do have a period of downtime here, which really increases the costs and thus, has a negative impact on the margin.

But there's nothing unique to our first quarter beyond traditional first quarters other than we've seen stronger market demand than what we did last year. (00:48:13).

And one last one. Yeah, please go ahead, Tony..

I want to answer your question before that. I omitted that. The backlog sequential growth of 13% is on total Carpenter. And what I mentioned just is the total Carpenter aerospace, the backlog is up 9% sequentially..

Oh. Okay. Thank you for that. Last one, you alluded to the 20% SAO kind of bogey way (00:48:39) out there. When do you think realistically is the soonest that's possible, in what quarter? I mean, because it seems like you're progressing well. You've kind of turned the corner. Demand is cooperating.

I just wonder are we eight quarters away from that, four quarters away? What's your best guess without obviously – I'm not going to hold you to it. I'm just curious what do you think is achievable..

Yeah, I think it depends on Athens, right? So, if we can get Athens to a reasonable level by the end of this calendar year, then I think you'd be bumping up against the 20%. I mean, I believe we're running in the 17% range right now. That's doable today even with the Athens drag. So, let's get Athens to a point that it's not a negative on the margin.

And let's get back on track and get that 3% variable cost reduction. I think you're right at 20%..

Okay. Great news. Thanks, guys, really appreciate it..

Thank you. And the next question comes from Phil Gibbs with KeyBanc Capital..

Hey. Good morning..

Good morning..

Good morning, Phil..

Had a question on the jet engine business specifically.

I think you mentioned it was up pretty strongly quarter-on-quarter, but any color, Tony, on what that comparison was year-over-year?.

I can tell you that it was up 32% year-over-year, so 19% sequentially, 32% year-over-year..

Okay. Perfect. And then also to some of the commentary on the expedites, where are you specifically seeing that? Because I know that on a lot of your products you're qualified and probably you're most likely under contract.

So, help me understand in terms of why you would be seeing the level of expedites given the fact that a lot of your business is under contract and under program-based agreements..

When we sell, as you know, Phil, to all of those customers, we don't always have 100% share. So, we're producing those products today when they have a shortfall in the market. Whether it's due to quality or lead times, we're able to step in and effectively increase our market share in those areas..

Okay. Perfect.

And then any color outside of the fastener business on the structural side of aerospace in terms of how that business is faring year-over-year?.

On the structural side, year-over-year – I mean, if you take structural fasteners and avionics and combine them together – I'm just looking at the numbers real quick – I think year-over-year, we are up 12%..

Okay. Perfect.

And then just to dig a little bit deeper on the Athens side, when you say 10% is incremental to Athens, do you mean 10% of the 40% capacity or do you mean 25% of the 40% capacity?.

I mean, 25% of the 40%..

Okay.

Where is most of the incremental coming from right now? Because I know when you were first getting that ramped up, a lot of that was tailored to oil and gas, but are you starting to texturize the mix here?.

Yeah, we're making some aerospace materials down there now that aren't on specific VAP or VAP approvals are not required, so we'll move that down to Athens. As we continue to pick up approvals, we will move to Athens as well. So, there is aerospace material being run at Athens today..

Okay. I appreciate that. And last question for me is on the oil and gas side. Clearly seeing a pickup in rig count here domestically. I know your business can be a little bit more balanced between U.S.

and international, so maybe some color in terms of what you're seeing here and abroad and basically, where are we seeing the strength and perhaps less strength when you look at your entire basket. I'm not talking about power gen, just the oil and gas component itself.

And then just a general comment maybe on what you see the inventory positioning out there from the customers. Thanks..

Okay. Thank you, Phil. Yeah, for us, I mean, Amega West is primarily a North American sales business specifically the Permian basin. So, that is really what's been driving the growth. The international side, as I think I might have said in my comments, are lagging a bit.

I think you're going to have to see the oil price stay a bit more consistent to see any type of activity there. But right now, I can tell you we're staying awfully busy just supplying the North American market. I'll let Damon take the inventory question..

So, I think your question is more what do we see in the field for the customers' inventory levels.

Is that correct?.

Yes, correct..

So, what we hear from at least from the Amega West side of the house, again, is that customers are starting to rebuild some of their inventory levels at a slow pace. I would tell you they're being cautious.

But as you've heard us talk over the last couple quarters, we've seen more activity on the rental side of Amega West versus the manufacturing and sales side.

Over the last quarter plus or so, we are seeing more demand coming in on the manufacturing side, which is what I alluded to in my comment about the inventory, as you do have Amega West building more tools not only to service on the rental side, but ultimately, for the sales as they sell that into the marketplace.

So, market appears to be getting stronger but at more of a cautious pace..

Thanks, guys. Is there any broad impact, positive or negative, from a lot of these geopolitical headlines we're seeing from the Russian situation? I know they do have some (00:55:23) into the aerospace supply chain and maybe some industrial titanium.

But anything that you guys can point to in terms of disruptions or customer concerns or anything that you're seeing? I have heard that some certain off-contract titanium prices have gone up, but I know you're probably pretty hedged from that. But just anything that you can point to would be helpful .Thanks..

Yeah, Phil. Nothing material to report from our side. I mean, obviously, we monitor the situation actively, and you said a lot of things going on out there, but no real direct impact to Carpenter. And we've talked to our suppliers, and again, as we ask the questions, most don't feel to be a disruption.

If they do, there are contingency plans they already have in place and have reviewed with us. So, again, as we sit here today, we feel okay so far..

Thank you..

Thank you. And next, we have a follow-up from Josh Sullivan with Seaport Global..

I just had a question on, have you seen any increased requirements on inspections at the manufacturing level? And have you (00:56:33) seen any increased ultrasonic or nondestructive testing, just given what happened with the CFM56 engine recently or even on the supply chain with the next-generation engines?.

Well, Josh, obviously, the industry is very strict today. But we have not seen any additional requirements come out of that specific incident. I think it's still very early days..

Okay. Thank you..

Thank you. And as there are no more questions at the present time, I would like to turn the call to Brad Edwards for any closing comments..

Thanks, Keith, and thanks, everyone, for joining us on our third quarter earnings conference call. We look forward to speaking with you all again on our fourth quarter call. Have a great day..

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