Good day and welcome to the Carpenter Technology Corporation’s Third Quarter Fiscal Year 2019 Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference call over to Mr. Brad Edwards, Investor Relations. Mr. Edwards, the floor is yours, sir.

Thank you, operator. Good morning, everyone and welcome to Carpenter Technology’s earnings conference call for the third quarter ended March 31, 2019. This call is also being broadcast over the Internet along with presentation slides. Please note for those of you listening by phone, you may experience a time delay in slide movement. Speakers on the call today are Tony Thene, President and Chief Executive Officer and Tim Lain, Vice President and Chief Financial Officer. Statements made by management during this earnings presentation that are forward-looking statements are based on current expectations. Risk factors that could cause actual results to differ materially from those forward-looking statements can be found in Carpenter Technology’s most recent SEC filings, including the company’s report on Form 10-K for the year ended June 30, 2018, Form 10-Q for the quarters ended September 30, 2018 and December 31, 2018 and the exhibits attached to those filings. Please also note that in the following discussion, unless otherwise noted, when the management discusses sales or revenue that reference excludes surcharge. When referring to operating margins that is based on operating income and sales excluding surcharge. I will now turn the call over to Tony.

Thank you, Brad and good morning to everyone on the call today. I will start on Slide 4 with an update of our safety performance. Through the third quarter, our total case incident rate, or TCIR, remained at 1.4, up from 1.2 during fiscal year 2018. While some of our business units are operating at zero injuries for the year, clearly we expect improvement. We are placing additional focus on several key areas such as: hand safety, hand injuries, currently represent 49% of our total recordable injuries and we are intensifying our efforts in this area; human performance, we continue to provide training to employees to recognize and stop unsafe work; hazard elimination and action tracking team, which is focused on operator engagement or improvement plans and recommendations; leadership development initiatives, centered on engaging our supervisors to drive accountability; and recently, we initiated a fork truck elimination initiative, where we identified immediate countermeasures to reduce injury risk of interacting with fork trucks. As always, our goal is a zero injury workplace. Now, let’s turn to Slide 5 and a review of our third quarter performance. Overall, our third quarter results reflect the ongoing momentum we are driving across all our core business as we generate strong operational results and delivered our ninth consecutive quarter of year-over-year earnings growth. We continue to capitalize on the solid demand patterns across our end-use markets by weighing incremental market share and expanding our customer relationships. Our success drove year-over-year and sequential sales growth. In fact, it is also the ninth consecutive quarter of year-over-year sales growth. In addition, our backlog increased for the 11th straight quarter, growing 9% sequentially and 44% compared to last year. In our largest end-use market, aerospace and defense, demand remains robust and our submarket diversity continues to drive solid…

Thank you, Tony. Good morning, everyone. I’ll start on Slide 8, the income statement summary. Our results for the quarter reflect continued momentum in our operations, combined with strong market demand. Net sales in the third quarter were $609.9 million or $503 million excluding surcharge. Sales excluding surcharge increased 12% sequentially on 6% higher volume with double-digit growth in all our end-use markets except for industrial and consumer, as Tony just covered. On a year-over-year basis, sales excluding surcharge increased 6% on 1% lower volume driven by growth in several key end-use markets. As Tony mentioned, we continued to see solid demand across most of our end-use markets as evidenced by our growing backlog. Our total backlog grew 9% sequentially and 44% year-over-year. Our current third quarter gross profit includes an $11.4 million benefit related to an insurance recovery associated with a fire that occurred at our Dynamet operations in the third quarter of fiscal year 2018. SG&A expenses decreased by $1.6 million on a sequential basis, mainly due to costs associated with the LPW acquisition that was completed in our second quarter. For the fourth quarter, we expect SG&A expense to be in the range of $50 million to $53 million. Operating income as a percent of sales was 14.6% in the current quarter compared to 12.6% in Q2 of this fiscal year. When normalizing for the insurance recovery benefit in PEP’s results in Q3 and the insurance recovery benefit in SAO’s results in Q2, operating income margin improved by 80 basis points sequentially, year-over-year again normalizing for the insurance recovery benefit, operating income margin improved by 260 basis points. Our effective tax rate for the third quarter was 24.9%. We expect our tax rate to be in the range of 24% to 26% for the fourth quarter. We…

Thanks, Tim. As noted with our strong quarterly results, we are focused on delivering year-over-year earnings growth. In addition, we are identifying key trends on horizon that have the potential to meaningfully impact our industry and our end-use markets. Positioning Carpenter Technology at the forefront of these trends requires investing in high-value market adjacencies as well as building a leadership position in critical emerging technologies. As you will recall, in March of 2018, we announced the planned construction of a precision strip mill on our Reading campus to expand our soft magnetics production capability. Today, we are a leading supplier of soft-magnetic alloys within aerospace and consumer end-use markets. Electrification is becoming an increasingly critical area of focus and investment for global automotive OEMs. While projections might differ with respect to timing, all expect a rapid increase in electric vehicle adoption over the coming years. This presents an attractive addressable market opportunity for our Hiperco and proprietary Hypocore soft-magnetic alloys. Today, OEMs are facing performance- and durability-related challenges, including range, battery life, weight, portability and charging times, to name a few. Our soft-magnetic solutions are among the highest-induction alloys in the world, and we believe they can provide significant performance improvement compared to current applications. At the same time, we will continue to expand our leadership in Aerospace auxiliary power units as well as to further penetrate the consumer electronics market via smartphones, smart watches and other applications. Our second long-term growth driver is building on our leadership position in additive manufacturing. Over the last several years, we have significantly expanded our additive manufacturing capabilities and today operate a leading end-to-end platform. Through a series of recent strategic acquisitions, we added titanium powder production, additive manufacturing part design and production capability as well as Powder Lifecycle Management to our existing…

[Operator Instructions] And the first question we have will come from Gautam Khanna of Cowen & Company.

Yes, thank you guys.

Good morning, Gautam.

Good morning. Wondering if you could just expand upon the four additional Athens part qualifications, were they with different OEMs than Safran or anything you can characterize about the parts if they are high volume, who they are with and what that might mean for the utilization of Athens and at what timeframe?

I can say, Gautam, they were significant approvals for us just in our – where we are at in the process. There were other OEMs other than Safran in those 4.

And in terms of are they high volume parts and when do you – like where is Athens now in terms of kind of utilization? I know it’s hard to measure depending on mix and what have you – and where do you anticipate it would be a year from now?

So, a tough question. I anticipate it being much stronger a year from now than it is now. As I said, I have kind of gotten way from saying what the utilization is of Athens just because we don’t operate as the standalone mill. I will say these four are significant, not just from a we don’t look just from a volume standpoint, but from who we are working with and what that particular product was and the challenges that we overcame to get that qualified. So, this is a those 4 are significant. They are very important to us. I think it’s a major step forward.

And, Tony, one of your competitors has talked about challenges in the nickel powdered billet supply chain. I’m curious are you guys working towards being part of the solution in that more challenged part of the supply chain?

Well, Gautam, as you might know, we’re in the final stages of receiving qualification to produce an atomized dis-quality powder and sell that powder. And that’s it, to sell the powder. We do not participate in the next steps of that specific supply chain, which is billetizing that powder and then ultimately forging that into a disk. We do not play in that piece of the supply chain.

Right. But up in the powder, you do. And I just wonder do you guys have an opportunity to pick up some market share with roles in that constrained part of the supply chain?

Well, if my understanding is right, the constrained piece isn’t on the powder atomization.

Okay. I think it was both, but maybe I’m wrong. That’s okay. And then the last one from me, just on cash flow. I know usually the second half of the fiscal year you guys generate cash as you work down some inventory. What do you anticipate happens in fiscal Q4, just given we’re a little bit out of normal seasonality through the 3 quarters?

Yes, Gautam, this is Tim. So, as we talked about in our remarks, I think we’ve been pretty deliberate about managing our inventory, in certain cases, building inventory to meet the growing backlog. But as I said, I think we recognize inventory as a pretty significant opportunity for us to deliver some cash flow here in Q4 as we work through the constraints and get more out the back end of the mill. We’ve done some work in the front end of the operations, namely in melting and improving capacity and throughput and productivity there, now we’re working through that in the back end of the facility in the finishing operations to get more out of the door. So, we view the inventory as a significant opportunity for cash flow in Q4.

And next we have Josh Sullivan of Seaport Global.

Hi, guys. This is actually Adam Friedman on for Josh. Thank you so much for taking the time. Just assuming that volume eventually gets to the 57 per month rate, either it’s sort of late this year or early next year, how should we think about sort of the long-term margin potential for SAO? I guess, just following on to that, do your long-term assumptions assume 57 per month in the 737 and on the A320 eventually getting to that 63 per month rate?

Well, I mean, your main question is, what do we think SAO margins can go? And I have talked about this several times over the last couple of quarters. I believe, we can do better than we are now. Think about being at 18.7%, I think it’s the third time that we’ve in the last 4 quarters that we’ve been above 18%. The last time we’d really seen 18% was back in fiscal year 2014. But I can tell you there’s a lot more productivity that we can go achieve in our SAO facilities. And you see that, quite frankly, in some of the reasons for the inventory build. I think its great internal competition that the front end of our process now has gained such significant productivity improvement. That’s putting pressure on the back end of our process now, and they’re up to the challenge to say, “We need to increase our rates as well so we can increase the overall shipments out of that facility.” So, I think SAO can do better than what they’re doing now. Great performance this quarter and the last couple of quarters, but we still have much more in the tank when it comes to productivity.

Okay, great thanks for that. And then just given sort of the volatility that you talked about in the oil prices, I guess, how are you thinking about the oil and gas business over the next, call it, like three to four quarters or two to three quarters, whatever sort of color you can give would be great?

I think, Adam, we’re cautiously optimistic. We talked about we see the oil price volatility continue to play a factor in how companies are making decisions on where they’re investing. I think we’re in this quarter, we saw some uptick in activity internationally, which has kind of not been the case for the last several quarters. So, I’d say, it’s fair to say we’re cautiously optimistic, but I think it’s going to be a rising waterline as opposed to any big wins here in the next couple quarters.

Okay great. Thanks so much for the time guys and I will get back in the queue.

[Operator Instructions] The next question we have will come from Chris Olin of Longbow Research.

Hi good morning everybody.

Good morning.

Good morning.

My question is, when companies within the industry or even yourselves talk about constrained capacity within the nickel-based alloy or, call it, the premium alloy markets, does that refer to the actual melting capacity, call it, like the VAR or VIM furnaces or does that refer to the limited, I guess, downstream supply such as like the Athens forge?

I think, from our standpoint, when we speak about constrained capacity in the nickel billet area, it would include the primary and secondary melting as well as the press or the forge operations.

Okay. I guess I was curious, so when you talk about applying the Carpenter operating model to downstream fabrication, is that what we’re talking about here as well is loosening up some volume on a go-forward basis or is that more of a cost item?

Well, I think, it’s opening up volume. I mean, if you look at the downstream for Carpenter or any comparable company, there is hundreds of work centers there. And right now, from a productivity standpoint, we have seen bigger increases in the upstream. For us, that’s good. Those are the most recognizable constraints and we are pushing that constraint downstream. That’s good news for Carpenter and that’s good news for the industry.

Okay. And then just lastly I want to make sure I understand the strategy here, when we see the approvals come in on the jet engine businesses, should I assume that, that is volume that could already be done at Reading or maybe Latrobe that will ultimately be shifted to Athens, so then you can have a more flexible mix at the legacy mills, is that how you think about it?

Not 100%. I mean, it is true that the qualifications that we are receiving that we now produce those products at our existing facilities, but this market isn’t about shifting a pound from Reading to Athens. As you well know, this is about making two pounds instead of 1. I mean, we’re increasing the amount, of engines that are being made, not keeping them flat. So therefore, the premise that all it is shifting from one plant to another doesn’t isn’t logical.

Okay. And just lastly before I forget too, your Aerospace distribution business, I was curious approximately roughly how big that is and could there be any risk that, that part of the business gets weaker because of the uncertainty surrounding Boeing?

I think that’s a great question. The distribution business is, for a total amount, it’s in single digits. But I think, if you saw any noise there, it would be across the distribution channel as they’re playing, they’re very focused on inventory turns, you could potentially see a pause there. I don’t think that will be an overall material impact of Carpenter, but I do think that that’s where you would see some potential issue there.

Okay, thank you.

And next we have Phil Gibbs of KeyBanc Capital Markets.

Excellent thanks for taking my questions good morning.

Good morning.

Good morning.

Hi Tony, how did the I may have missed the comments early, because I was jumping from the Reliance call, but excuse me, not Reliance, but the close call. But did you say what the engine subsegment did in terms of either quarter-over-quarter or year-over-year revenue growth?

Yes. Sorry about that Phil. I don’t think I did mention that specifically. Engines quarter-over-quarter were up 15% from a sales standpoint.

Okay. Perfect. And I think you talked a little bit about it just now, Tim, but you said international is showing some life, which we’re hearing from others. But are you seeing a pickup in your order book on the oil and gas side moving forward, given the improvement in pricing?

Yes. I guess there, Phil. I may go back to saying we’re cautiously optimistic. I mean, there is – we would even say there is early signs of this international growth. We did see that demand pickup in the quarter. But in terms of outlook, I am not sure that we are prepared to say anything more than that, just being cautiously optimistic about that improvement.

Do you participate much in the offshore side?

We do. I guess, we are more concentrated in the Permian right now, but just because that’s where all the activity is. But historically, we have participated in the offshore side as well.

Okay. And I think you all did better than your guidance in the third quarter and in SAO on margins at least relative to what we were thinking, but PEP was a little bit light maybe by a couple of million dollars, if you exclude the insurance gain. So, what missed perhaps relative to your expectations there?

Yes, you are right. So that was a couple million dollars. So, in the whole scheme of things, not that large compared to we had almost $80 million in two segments combined. But we are, I guess, the positive to that is that I think, it’s very specific to our Amega West business, primarily. It’s not a market issue. It’s a specific new tool that we’ve developed and the adoption of that tool has not been what we would like it to be. So that’s one specific. We had great expectations for that and we’ve fallen flat, and we need to make that correction, but it’s not a market issue. And if you look at the other businesses inside of PEP, Dynamet, quite frankly, is doing very well. They did a great job recovering from the fire that we had, did our best to take care of all of our customers, and I’m very proud of how they’ve done that. And now we’re investing money in both of our Dynamet locations to increase capacity because of the share gains that we’ve added, particularly on the Medical side. So, PEP is a pretty strong business for us, and we need to get after, on the Amega West side, those specific tools that we take to market and make sure we have the appropriate marketing plan to take advantage of their capabilities. And in this case here, we did not do it.

Okay, perfect. And one more question, if I could, because, I think it’s important for what we’re all seeing right now. Boeing has cut production, as everyone knows at this point in time. So, is there any change in cadence that you’re hearing from either the structural side or the engine side? Or is there any difference in terms of what you’re hearing from both of those supply chains, meaning does one feel tighter or looser than another? Thanks.

Thanks, Phil. We speak with all of our customers on a daily basis and we engage directly with all of them on this issue, and none of us none of them have told to us to slow down. So, we are not changing any production plans at this time based on that specific incident with the 737 MAX.

Thanks, Tony. Appreciate it.

Yes, thank you.

The next question will come from Jeremy Kliewer of Deutsche Bank.

Hi good morning. Regarding your soft magnetics program up at Reading, can you remind us how much of that is already cut down with the new capacity that you’ll add on there?

Sorry, Jeremy. Repeat the question. We didn’t we lost you.

With the capacity addition up at Reading, how much of that is contracted, if any?

I would say, none of it is actually under a long-term contract today. We supply into that industry now so we have contracts in place across multiple customers. This piece of equipment is put in for 2 reasons. One, it’s a significant cost savings, because it brings the entire process in-house. So, we do not we’re not as reliant on external support. And two, we see this as a significantly growing market that we will pick up that business as we go. So those contracts will come. Some existing customers, their demand will increase, because it’s much like the engine market. As you see the electrification of the world increase, the demand is going to increase. So, we built that facility based on a better cost base and on the fact that this is a market that we believe is going to grow significantly over the next couple years.

Alright, thank you for that. And then regarding the SAO, you guys have about $3 million to $7 million coming in 4Q compared to both 3Q and 4Q last year. How much of that is a market share gain versus just the overall markets in general increasing?

Jeremy, can you ask that question again, please?

So, in your SAO, your guidance, you have a 5% to 10% growth coming in 4Q. That’s roughly $3 million to $7 million. How much of that is market share gains and clients coming to you for more product versus just the overall markets increasing production rates?

Well, I think, it’s a combination. I mean, I haven’t broken that down specifically externally. But it’s a combination of market share, of course. I think the market’s going to continue to grow quarter-over-quarter as you see engine manufacturers increase their production schedules, and we’re going to continue to work on productivity. We’ll take inventory out in the fourth quarter just because from a sales standpoint that’s required and that won’t be a positive from an earnings standpoint. But I would say it’s a combination of all of those that you mentioned.

Right thank you good luck.

Thanks.

And next we have a follow-up from Chris Olin, Longbow Research.

Hello. Again question on medical, actually, a couple of questions on medical, but my first one was, any of the business you have today, would it be considered cobalt alloys and was there any impact from the kind of surcharge movement?

The answer to the first question is, yes, and the second part of your question, the answer is no.

Okay. And then I’m still trying to understand the strength in this business. It’s been a strong grower for like 4 or 5 quarters now. And I was under the assumption there weren’t very many competitors in, call it, titanium fabrication, I guess. I’m just wondering, is there a way to look at what the underlying market is growing? And how much is actually benefit from market share movement?

Well, I don’t think there’s a lot of players that do what we do from the titanium standpoint. Our big focus really is on the orthopedic side and the cardiology side. And that is primarily the reason why we’re expanding both of our Dynamet locations, is on the titanium side. I think you see a move from Medical into additive manufacturing because it can improve patient outcomes, which is the ultimate goal. So, titanium wire becomes very attractive that you turn that into a powder and then make the eventual part. So, we see ourselves there growing with specific influential customers in that area.

Okay. But most of the growth came from another competitor?

When you say, most of the growth came from another competitor, I don’t follow.

The volumes you want, it was a market share or a contract movement, basically?

Well, I think, the market’s getting larger. I think in medical you see them moving more and more to additive manufacturing parts. I think they’re on the front end of that. So, it’s a market that’s getting larger as people have more procedures just because the outcome of those procedures, are much more positive because of the increase in technology.

Okay. And then just lastly, in that whole Dynamet environment, have we seen the full impact from Airbus canceling the A380? Is, there any issues there?

Well, the A380, obviously, is a large plane. So, there’s a lot of content on that. However, there’s a lot of that’s not going to change the overall planes that are manufactured over the next 2, 3, 5 years. So, although that was a profitable plane for us, there’s many other places where our material’s going to go, and we don’t so that being an adverse impact on us whatsoever.

Thanks again.

I am showing no further questions. We will conclude our question-and-answer session. I would now like to turn the conference call back over to Brad Edwards of Investor Relations for the closing remarks. Sir?

Thanks Mike and thanks everyone for joining us today for our third quarter earnings call. We look forward to speaking with all of you on our fourth quarter call. Have a great day.

And we thank you, sir, and to the rest of management team also for your time today. Again, the conference call is now concluded. At this time, you may disconnect your lines. Thank you. Take care everyone and have a great day.