Good day everyone and welcome to the Carpenter Technology Corporation's Second Quarter Fiscal Year 2019 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please 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 with your presentation.

Thank you, operator. Good morning, everyone and welcome to Carpenter Technology's earnings conference call for the second quarter ended December 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 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 on Carpenter's most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2018, Form 10-Q for the quarter ended September 30, 2018 and the exhibits attached to those filings. Please also note that in the following discussion, unless otherwise noted, when management discuss the 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.

Thank you, Brad and good morning to everyone on the call today. Let's begin on Slide 4 with an update on our safety performance. Our Total Case Incident Rate or TCIR was 1.2 through the second quarter of fiscal year 2019, up from 1.2 during fiscal year 2018. Although the safety performance in our SAO business has not improved as expected in fiscal year 2019, our PEP business has improved dramatically. The group has achieved three injury free performance months through the first half of fiscal year 2019, an indicator that zero is possible. Our continued passion for hazard elimination, employee engagement, and proper work procedures is key to achieving our core value of a zero injury workplace. Moving to Slide 5, and a review of our second quarter results. Our second quarter results reflect strong operating performance as well as the continuation of two key trends. First, we continue to capitalize on strong market condition through the execution of our solution focused strategy. Second, we are gaining incremental market share across our end use market by deepening our customer relationships and unlocking new opportunities for our advanced materials. As a result, we are building meaningful year-over-year and sequential backlog growth. Market demand remains healthy and we generated year-over-year sales growth in four of our five end use markets. Our commercial execution remained strong and we are capturing growing demand for our solutions. In fact, the second quarter marked the eighth consecutive quarter of year-over-year sales growth in our aerospace and defense end use market. We continue to strengthen our position through market share gained most recently in aerospace jet engines, medical devices and heavy duty powertrain applications. Robust backlog growth continues about 16% on a sequential basis and up 49% compared to last year. The second quarter marked our…

Thank you, Tony. Good morning everyone. I'll start on Slide 8, the income statement summary. Net sales in the second quarter were $556.5 million or $449 million excluding surcharge. Sales excluding surcharge decreased 2% [ph] sequentially on roughly 3% lower volume due primarily to the timing of customer order deliveries. On a year-over-year basis sales excluding surcharge increased 8% on 6% higher volume. Our year-over-year results continue to reflect the benefit of a favorable product mix. As Tony mentioned, we continue to see solid demand across most of our end-use markets as evidenced by our growing backlog. Our total backlog grew by 16% sequentially and 49% compared with the same period last year. SG&A expenses increased by approximately $5 million on a sequential basis primarily due to strategic investments in our additive manufacturing platform, the addition of LPW's SG&A and the LPW acquisition related costs. We expect our SG&A to be in the range of $50 million to $55 million per quarter for the balance of fiscal year 2019. As Tony mentioned, we delivered solid operating performance in our fiscal second quarter. Our results include both a $4.7 million benefit associated with an insurance recovery received this quarter as well as $1.4 million of losses generated by LPW since the acquisition in October. I'll cover this separately later in my remarks. Operating income as a percentage of sales was 12.6% in the quarter. Operating margin improved 270 basis points on a sequential basis due to the improved product mix and the continued progress we are having implementing the Carpenter operating model across our facilities. In the quarter we reported $3.2 million of other expense below operating income mainly related to unfavorable market returns on certain investments. Our effective tax rate for the second quarter was 21.5% which was below our…

Thanks Tim. In today's environment it can be difficult to balance a long-term vision with short-term demand. At Carpenter Technology we are committed to achieving that balance. We understand the urgency to deliver quality earnings every quarter. Supported by our commercial solutions approach and the implementation of the Carpenter operating model we have delivered eight consecutive quarters of year-over-year earnings growth. We also understand that we must plan for the future at sustained profitable revenue growth is the most significant driver of total shareholder return. So we focused on three areas to deliver sustained profitable revenue growth. First is our attractive core, which his supported by solid market fundamentals. Here, we continue to unlock productivity in our existing work centers had moved forward on the qualifications at Athens. Second, we are acting on high value adjacencies by increasing our current capabilities to serve a much bigger share of markets that could grow significantly in the near future, such as electric vehicles and consumer electronics applications. In this area we are aggressively moving forward with investments to expand our soft magnetics footprint. For example, as you recall in March 2018 we announced the planned construction of a hot strip mill in Reading. We see numerous growth opportunities with soft magnetic applications via our current leadership in supporting auxiliary power units for aircrafts and the growing penetration in high-value application consumer electronics. In addition, the expected rise in electric vehicle adoption over the coming years presents an attractive and expanding market for our solutions. We see the total addressable market for our soft magnetics offerings being in the billions compared to our current annual sales of less than 100 million. And this includes opportunities in power conversion where our solutions can deliver improved induction and reduced core loss in motors and generators.…

Thank you. And we will now begin the question-and-answer session. [Operator Instructions] And our first questioner today will be Gautam Khanna with Cowen & Co.. Please go ahead.

Hey, good morning guys.

Good morning Gautam.

Tony I was wondering if you could just give us a little bit more color on the Safran agreement and if you could talk a little bit about the pace of Athens qualifications and whether you are close to having some high volume aerospace parts being qualified and when we should expect that to hit the P&L? Thanks.

Yes, sure. Well certainly last qualifications that we picked up I think you recall [indiscernible] high volume. Those are very important ones. Specifically on Safran I can't get into all the contract details, but a couple of important bullets is one it’s a long term agreement. The bulk of that material will come out of Athens. I would say that approximately 50% of the total volume over that period of time is incremental to where we're at today and as a side note, we've also agreed that we'll have a partnership on additive manufacturing going forward. So from our standpoint, the combination of all those are quite positive and I think it speaks to the increased – progress we're making now at Athens.

And when would you anticipate that that product to start to flow through the facility and into the income statement if you will?

Yes, I think it's - that's a good question. I think over the next six months you can see products starting to move to Athens. We have to make sure that we do everything in coordination with the qualification and I think what's important for a customer like this is with backlogs continue to grow it gives them an opportunity to pull in some of that material that's not in the backlog now because quite frankly, those orders a majority of those customers would take that product today right as opposed to in that long lead time.

That makes sense. And Tony, can you give us some context for what we should be expecting or what you guys are pursuing in terms of additional qualifications for product at Athens? You got the big Safran one, is there, how do we track you know whether there's another sizable chunk of products that get qualified or are you even expecting a whole lot more or was this the big one if you will?

No this was a significant one. There are other significant ones that we're working on, that I hope to come here in the near future. Also we don't talk about specific customers. In this case Safran was willing to allow us to do that, we appreciate that very much. So I see those qualifications continuing. We still have a couple larger product types with significant customers that we're working through. As you well know better than most that each one of these customers have their own specific qualification cycle, right and so we will work with each of them individually.

Thanks, I appreciate it.

Thank you.

And the next questioner today will be Josh Sullivan with Seaport Global. Please go ahead.

Hey, good morning.

Good morning.

On LPW how should we be thinking about the contributions just over the next may be 6 to 12 months just going forward?

Yes, this is Timothy, I’ll take that. We talked about in our prepared remarks LPW being about a $1.04 million of a loss in Q2. I think on a go forward basis it will be similar. There's a lot of work to do around transition and building on synergies in going, building out the whole go-to-market approach. So there is upside there, but I think for now we're expecting kind of a consistent run rate for the balance of the year.

Hey Josh, this is Tony. If I could just add, in the additive manufacturing field I think the debate is over on whether this is going to be a game changer or not. The main outstanding question is, when do you robustly move from prototyping stage into mass production and that and therefore earnings right from additive manufacturing. Someone told me not too long ago that you know the only people making money in additive manufacturing right now are the consultants. So it is important to realize that if you're going to go down the additive manufacturing road and put time and effort in there and make some of these acquisitions that all of them right now are actually in a negative cash flow position. And that's why you see a lot of these service bureaus being purchased by larger companies that can support that negative cash flow and that's exactly what we're doing at Carpenter. We've worked really hard to establish our core business to get the types of earnings that were and a strong balance sheet that we're able to go out and do this now at additive manufacturing that we know over the next couple of years will be significant from a growth standpoint.

And then just one on the medical market, are you taking share of those new products, where do you think you are relative to the share that you can may be take over the next 12 months?

Yes, I appreciate you asking that question because honestly aerospace is 50% of our revenue, but medical is an area we've been growing quite a bit. So yes, we've been gaining share across multiple large customers and I would say that's really been over the last 12 months. One of our bright spots as far as being able to increase our capabilities, increase the supply that we can put into the market and pick up share. I'll tell you as you talk to those medical customers, not only are you talking about traditional products, but in almost every case our position in additive manufacturing is quite attractive to them and we've been working with each one of them on the steps going forward in the AEM field.

And then just one last one on the soft magnetics investment, have any customers begun to commit to any capacity at this point?

No, I think we're still a little early there, we're still probably a year out as far as getting that in place. I don't see any issue whatsoever of utilizing that mill.

Good, thank you.

[Operator Instructions] And the next question will come from Phil Gibbs with KeyBanc. Please go ahead.

Hey, good morning.

Good morning, Phil.

Tony, in terms of the engine business, can you give us some color there in terms of how much that business grew relative to last year?

Year-over-year it was up a couple percentage points Phil on the submarket engines alone. I think what's - I mean I'm glad you asked that question because I think what's important for the engine market which is half of our overall aerospace market, the demand there remains high. If you look at over the last eight or nine quarters really when we had the dip in aerospace right, the policy right before the ramp started, since that time we've had sequential, the sequential number for engines has been up, a couple times it's been down, but almost always it's up year-over-year. So even though we were up just a couple percentage points, down sequentially in this quarter I believe it was the highest quarterly bookings for engines that we've had. So it's really not about, you're a couple points high or low and the second point I'll make Phil that I think is important is, I said engines is half of our overall aerospace portfolio. We have very strong business in structural, fasteners, defense, avionics in most cases to the same customer. So we are working with that customer to prioritize what is their top product that they want out. So we might make a decision to ship another one of those products versus engine based on a customer preference. So that drives some of the up and down quarter over quarter as well.

Okay and then there's at least in terms of my purview there's and then this is an area where you all have been and are going in the future as well, but maybe it's in different applications, but on the powder side can you just remind us where you all play in that supply chain and how you may be looking to create some synergies with your recently acquired businesses and that position that you have?

Well, we're really trying to develop and end-to-end process, especially when it comes to additive manufacturing. We've been in the powder business for quite some time. So we sell not just into additive manufacturing but into a lot of other markets whether it be mettle injection molding or other areas. We have currently five powder facilities. Our real goal is to connect the dots from that feedstock being the powder to the end customer and that's why you see the acquisitions that we made. We bought a titanium powder facility as opposed to building it on our own. We have bought a parts producer, so we can design and produce finished parts. And then with the acquisition of LPW, that's really the middle where we can from a software and hardware standpoint recyclability, analyzing the powder from a property standpoint that it runs the most efficiently through the machine. So now we can go to a customer and really don't need anyone else. We can go from start to finish, design a product, make the powder, produce the part and do all the post processing. That's really where we want to go where we have that type of relationship with a customer from end-to-end.

Most of your powder sales right now basically merchant sales mainly are going to somebody else that's going to process that into something versus being able to use it on your own you are needing…

Yes, sorry Phil. That's correct.

Okay and in the future you want to move more towards using that supply on your own as you go end-to-end is that what you're trying to communicate?

Yes, especially in additive manufacturing. I think they'll be. There will be customers that we will sell bulk powder to on the AEM side and we will want to do that, that will make sense to do that depending on their size and their breadth and what their capabilities are. I think they'll be other customers that will do an end-to-end solution for them. So I think it will range based on where that certain customer is and what they would like to keep in-house versus letting someone like Carpenter do and I think it will be – that will be some of - every one of those options.

And then just a last follow up if I could, I appreciate all this, I think you mentioned that the power gen has picked up slightly up of low levels, everyone has been impacted by that malaise the last couple of years, may be any color in terms of what you're seeing and whether not you think that balance is sustained? Thanks.

Yes, Phil I think that we've seen some positive signs there from an order intake standpoint. Remember from our standpoint power generation is maybe 1%, 1.5% of our total revenue, so it is relatively small. But we have seen and it's at a very low level right now, but we have seen an uptick here over the last, I would say besides the last quarter, maybe two quarters.

Thanks Tony.

Yes, thank you.

And this will conclude our question and answer session. I would now like to turn the conference back over to Brad Edwards for any closing remarks. Actually we did have someone jump in. It is Josh Sullivan with Seaport Global with a follow up. Please go ahead.

Yes, I was just curious if the aerospace OEMs were to like to take up production rates beyond some of these announced levels, how would we see that flow through to Carpenter? We see a rash of qualifications and then what's the typical timeline from when the metals made it to the Carpenter’s to let me get on a jet engine just so we – your delivery rather just sort of kind of an outline if we do see rates go up here?

Yes, so listen I think the interest in qualifying Athens is on a scale from one to 10 is a 10. So I don't know what - I don't think it, I don't think that interest can get any higher than Athens now. Every one of those OEMs are working with this quite closely. When you say, how does that impact? I think from a very simplistic standpoint, whatever rate increase you see in net increase in engines at the very least that's what Carpenter will receive. So whatever share they have today will increase from a volume standpoint with the increase in net engines. And on top of that, I think there's even increased opportunity and you saw it in the Safran contract where we increased our incremental piece there. So from our standpoint, you have a capacity tight industry, Athens is the only capacity that is coming online. We're going to move at the very minimum with the market going up and has an accelerator, hopefully gained some business because we're able to supply.

Okay, thank you.

Yep.

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

Hey good morning.

Good morning, Jeremy. The rate of the growth I think of your aerospace and defense sales has slowed to about 6% or just still good, but should we anticipate this getting back up to double digits following the contracts with the qualifications down at Athens?

I think the answer to that question is, much like what I just said take whatever rate the overall aerospace business is growing and we're going to be right in line with that. I mean the math has to work right there, so you're not going to be able to increase the engines build rate without it impacting Carpenter in a positive manner, so I think they'll go hand-in-hand. They're certainly not 100% aligned, that's what you're going to see going forward for us.

All right, and then you guys use of free cash flow. You built about a $150 million bucks worth of inventory over the first half, do you anticipate getting of that back in the second half?

Hey Jeremy, this is Tim Lain. We're not going to give any specific guidance on free cash flow or inventory levels. I think what we said is, we're following historical trends. We tend to build inventory in the first half of the year and take it out in the second half, just given the second half is generally stronger than the first half. Well our comments around the market continue to get stronger, backlogs are growing, lead times are pushing out. So again going back to our comments, we've got a strong balance sheet that gives us the flexibility to invest in some kind of very strategic inventory staged in the right spot and we can take valuable some short wins and wins with customer, so it's a very deliberate process, but we're not going to give any necessarily guidance about the value of inventory that's going to come out in the second half other than it seems very natural that inventory should come out in the second half.

All right, could you comment maybe on how long do you think it will take to pay back the revolver?

Yes, I think so. A fair amount of that balance is really related to the LPW acquisition about $80 million. So, I mean, we do have the opportunity to reduce inventory like I said naturally in the second half, so I think at least for the next couple of quarters we will have some borrowings on revolving.

All right, thank you.

And our next question for today will be Gautam Khanna with Cowen and Company. Please go ahead.

Yes, just a quick follow up Tim on that question of inventory and but more specifically on SAO segment operating margins excluding surcharge as you mentioned 18.1% in the quarter. I'm just curious, you've built a lot of inventory but presumably production so that helped absorption, but in the second half that would continue. The absorption would be really good I would think. So is there a chance we actually hit 20% in one of the remaining two quarters of the fiscal year or do you think mix was unusually good in Q2 or something else that might kind of even out as we move into the second half.

Hey Gautam, this is Tony. I’ll take it. Yes, I mean you and I have talked about this multiple times that's the goal. I think we can get to those types of margins, inventory going up and down. If you look at for a full year for the most part balances out. So any benefit you get from inventory build will have the opposite impact when you take it out, but that's really not the point in this whole discussion. The point is that we're at an excellent market, a tight demand market. And as you well know to make an aerospace in this particular case product it's not going through one or two work centers it's going through hundreds of work centers. All of those centers aren’t perfectly aligned, so in an area or in a time where I want to meet every demand I can for my customers. I'm going to produce where I can produce and sometimes that means over producing in one work center knowing that that next work center can't absorb it next quarter. But if I don't do that, I can't get it back until the next quarter. So I'm going to do that every day and I'm - we've worked hard to put our balance sheet in the position that it's in to give us the flexibility to do that. And I'm certainly not going to apologize that my inventory went up, when I'm really doing that to make sure I can capture every saddle and satisfy every customer I can, that's the way we view it.

Yes, I know it makes complete sense I guess I just want to make sure that there wasn't anything in fiscal Q2 SAO segment margins, outside of the $4.7 million.

Yes, no it's very, I think you should take obviously that 4.7 was a negative several quarters ago right? I mean that's the real we got that insurance because for a reason and but I think it's fair to take that out and that puts you in that 18.1 as you well know because you keep track of it, that's a pretty good margin. But when you look at from a productivity standpoint, there's still options out there that I can go get, even if volume stays the same. I can go get that and drive those margins up a couple more points. That's the goal over the next several quarters to push towards that.

Great, thank you, I appreciate it.

Yep.

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

Thanks William. We appreciate everybody joining us today for our second quarter conference call and we’ll connect with everybody on our third quarter call. Have a great day.

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