Good day, everyone, and welcome to the Carpenter Technology Corporation First Quarter Fiscal 2018 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please do note that today's event is being recorded. I would now like to turn the conference over to Brad Edwards of Investor Relations. Please go ahead, sir.

Thank you, operator. Good morning, everyone, and welcome to Carpenter's Earnings Conference Call for the First Quarter ended September 30, 2017. 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 Carpenter's most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2017, and the exhibits attached to that filing. Please also note that in the following discussion, unless otherwise noted, when management discusses sales or revenue, that reference excludes surcharge. When discussing operating income, that reference excludes pensions, earnings, interest and deferrals or EID and special items. When referring to operating margins, that is based on sales excluding surcharge, and operating income excluding pension, EID and special items. I will now turn the call over to Tony.

Thank you, Brad, and good morning to everyone. As always, I will begin with a review of our safety performance on Slide 4. In the quarter, our total case incident rate, or TCIR, improved significantly to 1.2. This improvement has been supported by our investment in leadership development programs that touch every supervisor across Carpenter, giving them valuable skills to work with their team members as well as ongoing training in human performance, management principles for all employees. In addition, we continue to increase the intensity and frequency of employee engagement activities such as hand safe, ergonomic and communication teams across the company. The TCIR improvement in the first quarter of fiscal year 2018 is encouraging, but the level of engagement must increase even further as we drive to our ultimate goal of a 0 injury workplace. Turning to Slide 5, and a summary of our first quarter performance. Our first quarter results represent a solid start to fiscal year 2018. Our strategy, values and vision were evident in our performance. While our first quarter results reflect a typical seasonal decline on a sequential basis, the decline was much less than the historical trend. Our Carpenter Operating Model and our new commercial approach continue to produce sustainable improvements in our results, as this quarter marks the best fiscal first quarter in four years. With that said we know we have not reached our full potential and remain committed to fulfilling that potential and strengthening our position as an irreplaceable partner in the supply chain. Let me mention a few first quarter highlights. In our largest end-use market, Aerospace and Defense, we delivered another strong quarter. As I just stated, our first quarter is historically down versus our fourth quarter due to seasonality. Over the last four years, the average decline…

Thank you, Tony. Good morning, everyone. Turning to Slide 8, and the income statement summary. As Tony mentioned, our first quarter results mark a very strong start to fiscal year 2018. Consistent execution of our commercial and manufacturing strategies, coupled with improved market conditions, drove our best Q1 operating performance in four years. Net sales in the first quarter were $480 million or $410 million excluding surcharge. Sales excluding surcharge decreased by 7% on a sequential basis on 3% lower volume due to the regular seasonality of our business. Historically, we tend to see a seasonal effect in our first quarter sales relative to the preceding fourth quarter performance, which is generally our strongest quarter. However, I think it's worth noting that both the declines in sales ex-surcharge, and volumes in our recent Q1 were noticeably less than we have historically experienced during previous fiscal first quarters. This demonstrates the positive impact of our solutions-focused commercial approach coupled with the strengthening conditions across most of our markets. On a year-over-year basis, net sales excluding surcharge increased $70 million or 21% on 17% higher volume. Sales increased across most of our end-use markets, including 24% growth in Aerospace and Defense end-use market and 45% growth in the medical end-use market. SG&A expenses declined by $1 million on a sequential basis and were effectively in line with our expectations at $44 million. Going forward, we continue to expect our SG&A expense to be in the range of $45 million to $47 million per quarter in fiscal year 2018. Operating income as a percent of sales was 10.3% in the quarter when excluding pension, EID and special items. This was down as expected on a sequential basis compared to the 12.2% in the fourth quarter due to lower sequential volume, but up significantly…

Thanks, Damon. On our last earnings call, I spoke about our successes at the Paris Air Show. The exciting future of additive manufacturing or AM, and the significant impact we believe it will have on our end-use markets over the long term. AM remains a strategic focus as we continue expanding our relationships with customers and collaborate with them to address their future growth opportunities as well as helping their products reach the next level of performance, whether it's higher strength to weight ratios, longer duty cycles, corrosion resistance or general design flexibility. There are many published growth projections for the AM market, including an Ernst & Young 2016 study that points to a 42% compound annual growth rate with a $1.6 billion opportunity by 2020. While growth projections vary from study to study, most point to robust market expansion potential and increasing adoption of additive manufacturing in the years and decades ahead, especially in the Aerospace and Defense, Transportation and medical market. In fact, AM solutions for key applications are a major focus of new joint initiatives with customers across each of our end-use markets, especially the ones that realize the disruptive potential of AM and how it could fundamentally transform their industry. In aerospace, AM is aligned with several key industry trends, including light weighting and fuel efficiency. There are a number of AM components being used in engines today, including the GE fuel nozzle for which Carpenter currently supplies the powder. Drilling operators in the energy market are increasingly focused on rig efficiency and lowering their cost per barrel. Given the steady increases in lateral feet drilled and the more corrosive and challenging environment they are drilling through, operators are beginning to look at AM component as a potential solution to tailor and strengthen their down hole…

[Operator Instructions] And the first questioner today will be Chris Olin with Longbow Research. Please go ahead.

Hi, good morning.

Good morning Chris.

Wanted to start with the guidance on the SAO segment, you suggested a 5% increase in the operating income quarter-to-quarter, so you're talking about $2 million to $3 million on top of what we saw here. I'm wondering what type of revenue we should assume in that number, and is there any outstanding cost items in there that could affect the margins?

Yes. I think, Chris – so you're correct on your numbers there. I would say, the revenue – again, look at the margins that we're generating for SAO and you can sort of – relatively similar sort of margins slightly improving as the operating model continues to generate cost improvements and it gives you sort of the back end to – really the back up into the revenue there. No significant cost issues that are noteworthy between Q1 and Q2 that I would point you to.

Okay, thanks. Is the impact from Athens consistent with your previous guidance of like the $10 million per quarter? And how should we start to think about that over the next quarters, now that you've got these energy qualifications in place?

Yes. Chris, I think as Tony mentioned on his scripted remarks, the utilization rate has gone up to just around 40%. We are starting to see and Tony may want to elaborate on some of the wins that we're seeing incoming from Athens here. So as we move up to that 40%, you can assume a part of that is starting to become an incremental value add to Carpenter, reducing our cost base here or reducing that $40 million in annual cost drag that we've been dealing with here.

Hi, Chris, this is Tony. Several quarters ago, we were probably at that $10 million a month with utilization increasing. That's probably decreased by $1 million to $1.5 million possibly.

Okay, thanks. I will get back into queue.

And our next questioner today will be Gautam Khanna with Cowen & Company. Please go ahead.

Thanks. Good morning. Tony, I was wondering if you gave some color on the Carpenter Operating System and the improvements you've made, I was wondering if you could talk about when you set out on this journey a couple of years ago, you had talked about getting to the root cause and that there was a lot of work to do. How far along do you think you are in that evolution? And maybe in a nine inning baseball analogy, what inning are we in? And how do you see that being expressed as we move forward? Could we see margins kind of surpass that 20% in this cycle at SAO? Any comments you can give around that.

Yes. Good morning, Gautam. I would say that we're in the early innings of this journey, which is good news for Carpenter shareholders I believe, because it says we have a tremendous amount of potential out in front of us. I think in the first year, our variable cost was down 5% to 6%. Last year, we were in that 3% range. We've committed that we're always going to be 3% year-over-year. I can see years going forward where we could increase that quite a bit. So when we visit the plants, it's more than just reducing the cost, it's about unlocking the capacity. Because as you know, in many markets, not just aerospace, but across some of the medical markets and others, there is capacity constraints in the ability to implement the operating model and unlock some of that is of great value.

[Operator Instructions] And our next questioner will be Josh Sullivan with Seaport Global. Please go ahead.

Hi, good morning.

Good morning Josh.

With the new energy qualification, is there any way to quantify the new opportunity set maybe on a total addressable market basis?

Sorry, Josh, could you repeat the question?

Sorry, about that. Did you – you mentioned some new qualifications in the energy market. Is there any way to quantify what that opportunity set is or what that market looks like?

Josh, sorry about that. We have a little bit of background noise here. By getting that additional qualification at Athens that opens up a whole spectrum of business to us, because a lot of that material is sold through distributors and they don't want to really take on that material unless they have qualifications across all of our customers. It adjust allows them not to have that [derogate], et cetera. So picking up that last qualification was a significant issue for us. Now the market will decide how quickly that comes. But I can tell you that at Athens, going forward, we perceive that to be a significant oil and gas facility, primarily because the lead times we can have there are significantly lower than our customer can get anywhere else, because of the efficient flow that we have at that plant.

Okay, great. And I guess, just on that lead time, is there any way to quantify how that looks this quarter versus maybe previous quarter? I understand that the seasonality might – it might not be a perfect comp, but how...?

Well, maybe I just think about – I'll think about Athens in total, if you look from an aerospace standpoint, just in general, I would say on current standards that lead times out of Athens could be 4x different. The current standard could be 4x more than what Athens can provide. And on the oil and gas industry, you could be in that 4 to 5-week range, which is pretty significant.

Okay, great. And then I guess, you spent some time on the AM market there. I mean, is there something that's happening that's causing you to be a little more excited about it from a customer perspective? Or are you guys just getting ahead of the market?

On the energy – the energy market?

So on the additive manufacturing market.

I just think it's important always for us to talk about in each one of our calls what we see out there in the future. I think for Carpenter to be the best company we can be, it's got to be outside of the traditional growth zones. We have a long history of being a power producer as well as a rock producer, so those two together, I think, puts us in a very unique position to supply value going forward. We've had quite a few discussions with all of our customers around AM and how we can help them, so I think it's just important to let folks know what we're doing there.

And then just one last one on the fastener demand cycle, any thoughts on the recent weakness? Boeing taking up the 787 production rate? Is it just too early to see the demand for titanium fasteners?

Well, as you know, the fastener market is rather volatile. What I think is important for Carpenter is we continue to get better in terms of our cost control improvements in markets across all the ones we serve, market share gains, technology road maps, that the quarter-to-quarter variability in fasteners is really not material like it used to be to Carpenter. So fasteners can be up a bit. They can be down a bit. It's not going to impact the overall quarter-over-quarter improvement that Carpenter is going to be able to sustain going forward.

Great, thanks. I will get back in queue.

And our next questioner today will be Phil Gibbs with KeyBanc Capital. Please go ahead.

Hi, good morning.

Good morning Phil.

How are you?

Great.

Had a question on the aerospace supply chain. It looked like your revs there were up. I think base revs were up about 24% year-on-year, just curious if you could break that out between engine and non-engine sales?

Would you repeat that, Phil?

I just thought your base aero sales look to be up about 24% versus last year. I was curious if you could break that out versus engine and non-engine?

Yes, I think, I said engine was up 24% as well. Just by coincidence, the total aerospace and engine were both up 24%.

Okay. So pretty consistent growth then across the board then is what you're indicating?

Well, engines are about 40% to 50% of our total aerospace market. If you look, fasteners were down. I think fasteners were 10% to 15% up sequentially. Our disruption market was up quite a bit, so that gives you the total of about 24%.

Oh, I was just – is the 24% relative to last year, Tony? Is that what we're talking about here?

Yes, sorry, sorry, it's year-over-year. Correct.

Okay. And then a question also on the VAP approval on the aerospace side, I apologize if I missed it, but you're getting some final specs into customers this year to sort of set the table for final qualifications in '18. And so this will be more of a kind of ending the qualification process in '18?

Yes, let me kind of expand a bit on that question, because I think it's an important point with the whole aerospace supply chain and how Athens plays in. If you take a look now just at this – the magnitude of this engine ramp-up and the numerous suppliers that are involved, and you would stand a reason that there's going to be significant pinch points across this complicated supply chain. And I think it's important to say and the critical products that Carpenter provides over the last couple of quarters, we've been asked multiple times to step up where there has been supply chain disruption. And based on our capabilities and our capacity, we've been able to deliver to our customers. As we said earlier, you also see lead times on these products extending, in some cases, quite a bit. So if you remember on the last earnings call I said, if you take a look at this current scenario, increased aerospace demand, a very tight supply, those are really two of the primary reasons that Carpenter made the decision to build Athens quite some time ago. So in this particular environment, we've begun to win orders directly due to the capabilities we have in Athens such as the attractive lead times that I've talked about compared to the industry standard. And I expect that momentum to continue as we see – as we receive more approvals. Now to your specific question, we do remain on schedule to submit those qualification packages to the OEMs by the end of this calendar year. I think it's important to say that in some cases, we're currently working very closely with the OEM to expedite that qualification process and other OEMs are becoming much more aware of the critical role that Athens will play going forward in this stressed supply chain.

Tony, I was just trying to get a gauge of whether or not we should think that a lot of the qualifications will take place over the course of the next, call it, 12 months. And so the Athens utilizations will have taken a step here, but they'll take another step up in '19. Is that the way I should think about it?

Yes, I just want to make sure, Phil, did you hear the last part of the comment I made previously?

Yes.

Yes, I think that's a big key when you say how quickly will the next step go. I think that's the point I was trying to make is that, we're working closely with some OEMs right now to expedite that qualification process. And the point that as this supply chains becomes tighter and tighter, I think other OEMs are going to see the criticality of Athens, and you're going to see that qualification process accelerate where it could go possibly to the normal timing that you would see.

Okay, very good. My last one here, if I could squeeze it in is just, you said you are on track with the inventory reduction targets. I was just curious in terms of what the cadence you see as you move into the second quarter and then also into the back half? Thank you.

Yes, I think, Phil, for us, say, we were up 46 in the first quarter. I think what you'll see is a sort of flat to modest build in the second quarter here. And then you'll see that decline coming back into Q3 and strongly in Q4 as we would have – as those are our two stronger sell out seasons.

Thanks everyone.

[Operator Instructions] And our next question will be a follow-up from Gautam Khanna with Cowen & Company. Please go ahead.

Yes, thanks for the follow up. Well, two questions really. One, I was wondering can you frame for us the level of industrial gas turbine sales as a percentage of the company total maybe off of the fiscal '17 revenue base?

I can answer that for you, it's about 1% of our total net sales.

Okay, so it's small.

Yes.

I wanted to ask anyway, as we think about the engine ramp and contract renewals over the next couple of years, is there – do you feel like Carpenter is still in a good position? Or are you disadvantaged in any way by the lack of downstream integration? You're not – you sell to the forgers, you don't control the forging operations, unlike ATI, unlike Precision Castparts, parts of Arconic. Does that disadvantage you guys in any way, as you talk about additives, as you talk about contracts renewals with the OEMs?

I can say that, if you remember the last quarter I talked about some of the many commercial wins that we've had. And I can tell you, as I visit customers, I have not heard that one time that they think it's a disadvantage that we don't have it. Not once.

Okay. And lastly, Tony, you mentioned some emergent demand, you were able to fill some spot demand as some of the subcontractors in the supply chain are delivering. Any way you can size for us how much of the 24% growth in the quarter – year-over-year was maybe related to that on the aerospace side?

Yes, it's the minority. I mean, the majority of that growth is because just to the inherent growth in the new engines. But those are significant opportunities for us to continue to strengthen our relationship with those customers when we're able to step up and meet that demand.

I guess, what I'm – I just want to make sure I don't overestimate sales going forward. Was it – could we expect a step down? Or is it sort of going to be indecipherable in result as we move forward?

I think it's going to – I don't think that us stepping in for individuals – for customers when needed is going to be the major driver between quarter-over-quarter volatility.

Okay. Thanks a lot guys. I appreciate it.

And our next questioner will be Jeremy Kliewer with Deutsche Bank. Please go ahead.

Good morning.

Good morning.

I was just wondering on the roughly $1 million incremental PEP segment EBIT, how much of that is the kind of the bounce back recovery of the $1 million lost during first quarter?

Yes, Jeremy, what I would tell you is the $1 million or so that we lost related to the impacts from the hurricane is really not recoverable. That was just lost production in our facilities where effectively had capacity constraints there. So the upside that we're seeing, the 20% to 25%, is really just the organic growth opportunities that we're seeing. The percents are large because it's coming off of a sort of an artificially lower base here given that hurricane, but it's not a recovery of that $1 million.

And then also on your end market demand, when is that kind of year-over-year growth rates, when do you expect those to flatten out or kind of dissipate because there are significant increases in most of your end markets?

Well, I think on the aerospace side, this is going to be over the next three to five years. I think you're going to see significant growth. Just look at the engine ramp-up that's being published. On the other markets, we're aggressively going after new applications, and we have capacity now coming online at Athens that allows us to do that. So we anticipate growing as we go forward.

Thank you.

And this will conclude the question-and-answer session. I would now like to turn the conference back over to Brad Edwards for his closing remarks.

Thanks, William, and thanks, everyone, for joining us today for our first quarter call. We look forward to connecting with you all again on our second quarter conference call. Thanks. Have a great day.

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