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Edited Transcript of CRS earnings conference call or presentation 2-Aug-18 2:00pm GMT

Q4 2018 Carpenter Technology Corp Earnings Call

WYOMISSING Aug 15, 2018 (Thomson StreetEvents) -- Edited Transcript of Carpenter Technology Corp earnings conference call or presentation Thursday, August 2, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brad Edwards

Brainerd Communicators, Inc. - MD

* Damon J. Audia

Carpenter Technology Corporation - Senior VP & CFO

* Tony R. Thene

Carpenter Technology Corporation - President, CEO & Director

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Conference Call Participants

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* Gautam J. Khanna

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* Jeremy David Kliewer

Deutsche Bank AG, Research Division - Research Associate

* Joshua Ward Sullivan

Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst

* Michael David Leshock

KeyBanc Capital Markets Inc., Research Division - Associate

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Presentation

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Operator [1]

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Good day, and welcome to the Carpenter Tech Fourth Quarter and Fiscal Year-end Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

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

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Brad Edwards, Brainerd Communicators, Inc. - MD [2]

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Thank you, operator. Good morning, everyone, and welcome to Carpenter's earnings conference call for the fourth quarter and fiscal year ended June 30, 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 exit 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, Form 10-Q for the quarters ended September 30, 2017, December 31, 2017, and March 31, 2018, and the exhibits attached to those filings.

Please also note that in the following discussion, unless otherwise noted, when management discusses sales or revenue, that reference excludes surcharge. When 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.

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [3]

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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. For fiscal year 2018, we achieved a 45% reduction in our total case incident rate or TCIR, improving to 1.1. Our progress toward an injury-free workplace is noteworthy with the vast majority of our employees working injury free. The progress in fiscal year 2018 is mainly the result of our efforts in 3 specific focus areas; one, shop for leadership development; two, safety systems targeting specific injuries and; three, which I view as the most important, engagement of the entire workforce.

On leadership development, we initiated training programs for supervisors covering core skills such as communication, conflict resolution and explaining the why behind initiatives during the daily interactions with their respective teams. In terms of targeting specific injury types such as hand injuries, actions including critical input from team members on developing solutions for these types of injuries in the future. This year alone, we deployed over 1,000 new hand safe tools designed by the team, which helped to drive hand injuries down 40%.

In addition, we held safety performance reviews for each employee with special emphasis on multiple injury employees. Over 13,000 safety dialogues occurred, contributing to a 65% reduction of injuries in our multiple injury employee population. From a safety engagement perspective, we implemented human performance training, hand safe teams, ergonomic teams and supervisory councils. Human performance training across Carpenter drove awareness, a skill-based mode errors and introduced stop card criteria to improve safety. Over 5,800 stop cards were initiated and corrective actions put into place before work continued. The work done in this area will ultimately be the foundation for a true safety culture of interdependence where each employee has the knowledge to identify and is empowered to correct unsafe working conditions.

I'm pleased with the progress in fiscal year 2018, but will not be satisfied with our safety results until we can achieve our core value of an injury-free workplace.

Now let's turn to Slide 5 and a review of fiscal year 2018. Before we move to the discussion of the results for the fourth quarter, I wanted to take a few minutes to cover progress we've made during a successful fiscal year 2018. In terms of total company year-over-year financial performance, sales ex surcharge increased 15% on 12% higher shipment volumes. Operating income increased 52%. Operating margin improved by 260 basis points and adjusted earnings per share increased 131%. The execution of the solutions-focused approach by our commercial team drove consistent backlog growth, improved product mix, expanded customer relationships and captured key share gains across many of our end-use markets.

Through the ongoing implementation of the Carpenter Operating Model, meaningful incremental capacity was unlocked by our manufacturing team. The manufacturing efficiencies and capacity expansion are and will continue to be critical to service growing customer demand.

We also took several strategic steps forward during fiscal year 2018, as we know that our customer needs and the overall market dynamics will change. To that end, we increased our focus and investment in core growth areas such as additive manufacturing and soft magnetics.

On the additive manufacturing front, we took aggressive and deliberate actions to expand our growing leadership position. In February, we acquired CalRAM, which added immediate additive manufactured part-making capabilities to our portfolio. We opened an early-stage additive manufacturing tech center on our Reading campus. We secured an exclusive license for an innovative meltless titanium powder manufacturing process, and we announced plans to build a world-class Emerging Technology Center on our Athens, Alabama campus. We are excited about the possibilities for additive manufacturing, and we will continue to expand on our leadership position in this space with end-to-end solutions for our customers.

In terms of our soft magnetics capabilities, we've recently announced our plans to invest $100 million in a new precision strip hot-rolling mill on our Reading campus. We're confident that this investment, coupled with our already impressive soft magnetics capabilities, will unlock significant growth opportunities in the aerospace, consumer electronics and electrical vehicle markets.

During the fiscal year, we also continued to make progress on the Aerospace Vendor Approved Processes, or VAP, at our Athens facility. Most importantly, we completed the submission of the majority of VAP approvals during the year and have received 7 approvals to date.

Let's turn to Slide 6 and a review of our fourth quarter results. We delivered strong fourth quarter results that built upon our performance throughout fiscal year 2018 and marked our best quarterly operating income since the fourth quarter of fiscal year 2014.

Our focus on commercial and manufacturing execution continues to drive strong volume growth combined with a favorable shift in our product mix to higher-value solutions, all while ensuring we are unlocking incremental capacity that is critical to service our growing customer demand.

The benefits of these efforts are clear as demand patterns remain strong with revenue growth across all of our end-use markets. Our solutions-focused commercial approach continues to drive backlog growth, which was up 5% sequentially and 30% year-over-year. It is important to note that while we've been at healthy levels for a few quarters, this is our eighth consecutive quarter of sequential backlog growth.

In the Aerospace and Defense end-use market, we remain well positioned given our participation across an attractive group of submarkets, including engines, fasteners, structural and avionics. The fourth quarter marked the sixth consecutive quarter of year-over-year sales growth in our Aerospace and Defense end-use market. Overall, demand levels remain high, given the engine platform ramp and robust build schedules at the major OEMs. As you know, there've been recent reports of supply chain disruptions in the aerospace engine submarket. However, in no way have they had an adverse impact on our order intake. In fact, our customers are asking if we can produce more for them, as the engine ramp accelerates.

In the Energy end-use market, our sequential oil and gas sales continue to outpace the North American directional and horizontal rig count levels. We've strong relationships with the major U.S. oilfield service providers and continue to gain share in this market. In fact, our strong relationships, coupled with our expertise, have allowed us to work very closely with one major customer to develop additive manufactured tools for the drill string. I'll talk more about this later.

The major highlight in the fourth quarter was SAO's operating performance, which delivered over $74 million in operating income with an operating margin of 18.7%. This performance marked SAO's best operating income since the fourth quarter of fiscal year 2013 and was driven by strong volume growth made possible in part by the incremental capacity realized through manufacturing enhancement and process efficiencies, a notable example of the power of the Carpenter Operating Model.

In the PEP segment, results were driven by further strong demand for our titanium solutions as well as the fourth consecutive quarter of operating profit at Amega West.

Shifting to the progress we are making on our VAP qualifications at our Athens facility. In the current quarter, we obtained 4 additional VAP approvals, including one from a large OEM to support meaningful volume for a single-spec item, which is an encouraging sign of our progress in this critical area.

Lastly, during the fourth quarter, we took additional steps to advance our leadership position in additive manufacturing. I will provide a broader update on our exciting progress in additive manufacturing later in my remarks.

Let's move to Slide 7 and the end-use market update. We'll begin with Aerospace and Defense, where sales were up 13% compared to last year, including double-digit gains in the engine, structural, distribution, avionics and defense submarkets. On a sequential basis, Aerospace and Defense sales held steady at a record level, validating the Aerospace and Defense market remained healthy and robust. Just as important, we've continued to grow our total Aerospace and Defense backlog, which is up 32% compared to last year and up 3% sequentially to a new record high. This is also the eighth consecutive quarter of Aerospace and Defense market backlog growth.

During the fourth quarter, engine submarket sales increased 12% compared to last year. For the total fiscal year 2018, engine submarket sales were the highest in Carpenter's history, eclipsing our previous record by 15%. Fastener submarket sales were down 11% year-over-year, which was magnified by the impact of the fire at our Dynamet facility earlier this year. Historically, the demand signals in the fastener supply chain had been inconsistent, which makes visibility in this submarket challenging. With that said, we remain one of the broader suppliers of fastener solutions in the market and have strong and established partnerships across the supply chain. Demand in the aerospace structural submarket remained strong. Revenues were up significantly year-over-year and stayed close to record levels on a sequential basis. Activity continues to be driven by our high-value solutions used on major platforms, including the A320 and the 737. The structural submarket is important to Carpenter, as we are engaging frequently with customers about additional opportunities for our solutions. Performance in our aerospace distribution submarket remains healthy with revenue up both year-over-year and sequentially. Finally, sales in our defense submarket increased both sequentially and year-over-year due to program-specific demand.

Turning now to the Energy market and an update on our oil and gas and power generation submarkets. Total Energy sales increased 21% sequentially, due primarily to higher rental and replacement activity at that Amega West. On a year-over-year basis, Energy sales increased 16%, driven entirely by higher sales in the oil and gas submarket. Sales in oil and gas submarket continue to track well compared to the North American directional and horizontal rig count as a result of our decision to stay close to our customers during the downturn and position Amega West for share gains when the overall market recovers. And as activity in North America outside the Permian Basin continues to increase, we're working closely with the major oilfield service providers as they allocate their resources to other major basins. Capital spending budgets for North America remained at healthy levels, while current macroeconomic factors largely support current oil prices. Outside North American land activity, the outlook in the international and offshore markets, although still lagging, has improved, and we are seeing early modest signs of recovery in select geographies.

Moving to the Transportation market. Sales were relatively flat sequentially with notable strength in newer areas like aftermarket and heavy-duty off-road. On a year-over-year basis, Transportation revenues were up 5%, driven by demand for materials used in heavy-duty trucks as well as growth of new submarket sales. The North American light vehicle market continues to perform below prior year levels, but the overall global market is attractive, and we are working to offset lower domestic sales through expanded market share overseas. We also expect demand to pick up in the heavy-duty truck submarket, following flat production builds during the fourth quarter. I believe the success we are having expanding newer revenue streams in Transportation speaks to the value our solutions provide with respect to heat resistance, corrosion, lightweighting and other critical performance factors.

Moving on to the Medical market, where sales were up 9% sequentially and 14% compared to last year. On a year-over-year basis, the sales increase was driven by growth across all product forms as well as share gains across all sales channels. We continue to make progress gaining share at the OEM level as well as driving expanded sales opportunities for our orthopedic and cardiology solutions. Our sequential performance was driven by ongoing strong demand for our titanium solutions and high-value cobalt materials.

In the Industrial and Consumer end-use market, sales were up 13% sequentially and 8% on a year-over-year basis. The increases for both periods were due to increased demand in select submarkets such as semiconductors.

Now I'll turn it over to Damon for the financial review.

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Damon J. Audia, Carpenter Technology Corporation - Senior VP & CFO [4]

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Thank you, Tony. Good morning, everyone.

Turning to Slide 9 and the income statement summary. Our strong financial results for the fourth quarter and full year reflect the continuous execution on our solutions-focused commercial strategy and the further implementation of the Carpenter Operating Model. This was our best fourth quarter and full year operating income performance since fiscal year 2014.

We delivered year-over-year revenue growth in all of our end-use markets. This further demonstrates that our focus on the high-value solutions is resonating in the market, and we continue to gain market share by deepening our existing relationships and adding new customers across our end-use markets.

Net sales in the fourth quarter were $618 million, our highest quarterly sales revenue in 6 years. Sales, excluding surcharge, were $495 million in the current quarter, a sequential increase of $22 million on a 6% increase in volume. This increase reflects growth across almost all of our end-use markets. On a year-over-year basis, sales, excluding surcharge, increased 13% on 11% higher volume led by double-digit gains in Aerospace and Defense, Energy and Medical end-use markets.

SG&A expenses increased by $4.7 million on a sequential basis, mostly due to timing of certain expenses. Going forward, in fiscal year 2019, we would expect SG&A expenses to be in the range of $50 million to $55 million per quarter as we increase our strategic efforts in R&D and specifically in additive manufacturing.

Operating income as a percent of sales was 12.1% in the quarter, excluding pension EID. This was up from 9.7% in the third quarter and was effectively flat compared to the fourth quarter of fiscal year 2017.

Our effective tax rate for the fourth quarter was 20%. The reported rate includes an income tax benefit of $700,000 in the quarter, resulting from our continued assessment of the impact of U.S. tax reform enacted in December of 2017. Excluding the special tax item, our tax rate in the fourth quarter would have been 21.3%.

We reported net income of $42.8 million in the fourth quarter or $0.88 per share. Excluding the impact of the special item, adjusted diluted earnings per share would have been $0.87, up 45% versus the $0.60 in the third quarter and up 50% versus the fourth quarter of fiscal year 2017.

Now turning to Slide 10. We generated free cash flow of $56 million in the fourth quarter, which is a strong improvement from the $35 million generated in the third quarter. Our free cash flow performance in the quarter is a result of strong earnings performance, coupled with a $40 million reduction in inventory. The free cash flow performance was even more impressive when considering capital expenditures were $54 million in the fourth quarter, up from the spending levels in the prior quarters of fiscal year 2018. This reflects the timing of our increased investment in core growth projects such as soft magnetics and additive manufacturing. Capital expenditures for the year were $135 million, which was consistent with our historic expenditures, coupled with the increased investments enabled by the cash savings benefit associated with tax reform discussed during our second quarter conference call. I'll provide guidance on our planned fiscal year 2019 expenditures in a few minutes.

We remain committed to maintaining a strong liquidity position and healthy balance sheet. As of June 30, we had $450 million of total liquidity, including $56 million of cash and $394 million of availability under our credit facility. Additionally, we repaid $55 million of debt that matured in the fourth quarter, further strengthening our balance sheet. We have no further debt maturities until fiscal year 2022 and with only modest pension contributions required over the next several years, we are well positioned to invest in growth projects to position ourselves for long-term success.

Turning to Slide 11 and our SAO segment results. SAO continued its strong performance with net sales of $518 million or $395 million, excluding surcharge, representing an increase of $14 million or 4% on a sequential basis. On a year-over-year basis, sales, excluding surcharge, were up $50 million or 14%. The sequential increase was driven by our solutions-focused commercial approach, share gains across our end-use markets and overall strong customer demand levels that drove meaningful volume growth.

Operating income was $74 million, up $16 million compared to the third quarter and up $14 million year-over-year. As Tony noted, this quarter marked SAO's best quarterly operating performance since Q4 of fiscal year 2013. SAO's performance in the quarter exceeded our expectations, as our team's ability to capitalize on strong demand for our premium products help deliver exceptionally strong results. Operating margin was 18.7% compared to the operating margin of 15.2% in the third quarter and 17.3% in last year's fourth quarter. The Carpenter Operating Model continues to yield manufacturing improvements and increased capacity. In the fourth quarter, SAO shipped the most tons since Q4 of fiscal year 2014 with a richer mix of products.

As we look to the first quarter of fiscal year 2019, we remain confident in the continued market demand momentum across most of our end-use markets as evidenced by our strong backlog. As expected, our results will be impacted by the traditional downtime related to our annual preventative maintenance. Fewer production days to serve our strong customer demand will result in lower productivity and profitability as in past years. Given this planned downtime, we currently expect SAO operating income to be down 15% to 20%, sequentially. This Q1 performance would represent our best first quarter in 5 years and would be an increase of 20% to 25% versus Q1 last year, as we continue to execute on our strategy.

Now turning to Slide 12 and the PEP segment overview. On a sequential basis, PEP sales, excluding surcharge, increased 6% or $6 million to $114 million. On a year-over-year basis, sales increased $8 million or 7%. The increase reflects stronger demand for our titanium solutions, primarily in the medical market as well as the impact of incremental capacity secured through the implementation of the Carpenter Operating Model. In addition, Amega West continued its momentum with strong rental demand and increasing manufacturing demand.

Operating income for the quarter was $7.9 million, reflecting PEP's strong operating performance and higher sales. The $7.9 million continues to reflect fire recovery-related cost, which we estimate to be approximately $1 million in the current quarter, as we continue to serve our customers via suboptimal (inaudible) [pass] . The quarter represents another strong sequential step by the entire PEP organization, as they continue to capitalize on market opportunities. Amega West, specifically, has executed well as they have now grown their operating results, sequentially 10 quarters in a row.

Looking at the first quarter of fiscal year 2019, we expect continued strong demand for our titanium solutions and favorable market conditions for Amega West. For the first quarter, we expect PEP operating income to increase approximately 15% compared to the fourth quarter of fiscal year 2018.

Now turning to Slide 13 and some selected guidance for fiscal year 2019. We expect depreciation and amortization to be approximately $120 million for the year, effectively in line with fiscal year 2018. As previously discussed, the U.S. tax legislation passed in December of 2017 is expected to reduce our cash taxes by $90 million to $100 million between fiscal years 2018 and 2022. These savings are significant and allows us the opportunity to increase our investments in strategic growth areas beyond our historical capital expenditure levels. We are accelerating our rate of capital expenditures to strengthen our long-term market position as we continue to strategically position Carpenter as the complete solutions provider.

In January, we announced our plans to build a new hot strip rolling mill, which will help us capture expected growth and increase our focus on soft magnetics. In addition, we recently announced our Emerging Technology Center, initially focused on additive manufacturing technology development with future investments slated for soft magnetics and meltless titanium powder. The timing of the spend on these investments, coupled with our historical run rate of capital expenditures, will result in full year spend of approximately $190 million. We'll continue to make investments, which align with our strategy and our customers' future needs.

As shown on the Slide, fiscal year 2019 pension expense and pension contributions are expected to be similar to fiscal year 2018 levels. We expect interest expense to be approximately flat with last year at $28 million. And full year effective tax rate for fiscal year 2019 is expected to be in the range of 24% to 26% compared to the negative 18% in fiscal year 2018. The fiscal year 2018 effective tax rate included $68 million of discrete tax benefits, primarily related to the remeasurement of our net deferred tax liability at the reduced tax rate enacted with the tax reform legislation. Adjusting for this, our effective tax rate would have been 25%.

We are entering fiscal year 2019 with momentum across our business and a commitment to our strategy, customers and future.

I'll now turn the call back over to Tony.

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [5]

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Thank you, Damon. Over the past several years, we've placed strategic emphasis on expanding our capabilities and value proposition in the additive manufacturing market as we seek to become a leader in this evolving disruptive technology and help facilitate its adoption across industries, while at the same time, becoming a complete solutions provider for our customers. We have long been a critical partner in the additive manufacturing space, mainly as materials provider for applications like the jet engine fuel nozzle. During fiscal year 2017, we began advancing our additive manufacturing strategy by leveraging a foundation in metallurgical processes and expertise to build on our leading position as an additive manufacturing feedstock supplier.

Looking at the market potential and listening to our customers, we acquired Puris, a titanium powder facility given its critical role in additive manufacturing. Shortly after this acquisition, we combined our expertise and feedback from our titanium powder customers to create an additive manufacturing specific grade powder, Puris 5+, which provides a lower oxygen content and more design flexibility in 3D printing. We also took the next step in the value chain by establishing a strategic partnership with Burloak Technologies, which allowed us to collaborate on materials and actual part design.

As we learn more in the additive manufacturing industry continued to grow and advance, we took several critical steps during fiscal year 2018 to ensure we stayed at the forefront of this rapidly evolving technology. We opened an additive manufacturing technology center on our Reading campus, where we are focused on technology development across an array of different printing technologies. This facility allows us to better explore and design alloys that deliver the best solutions for our customers. This past year, we also entered into an exclusive license agreement for a meltless titanium offering that could have the potential to be groundbreaking for the industry, and we are excited about its early promising results. And we further advance our position as an industry leader in this pace with the recent acquisition of CalRAM. As I mentioned on a prior call, the responses from our customers have been very positive. We can now provide our customers an optimal solution for their 3D printed needs. Between our material science expertise, years of being a key additive manufacturing materials provider and CalRAM's part design and printing capability, we can design and produce the best overall solution for customers.

We're working on these types of solutions across all of our end-use markets, and I want to give you a specific example that demonstrates the power of the complete Carpenter additive portfolio. I've mentioned on prior calls that customers in oil and gas market have been actively exploring additive manufacturing to improve the life of their drill strings and lower the overall cost per barrel. Since the addition of CalRAM, we've been actively working with one of the major U.S. oilfield service providers to develop a unique 3D designed in-hole tool via additive manufacturing. We began collaborating with our R&D team to develop a solution beginning with identifying the best material and print parameters. We then collaborate with our engineering teams as we work to optimize the design of the part to secure better fidelity and maximize the part's performance. We subsequently printed a uniquely designed part in a matter of weeks, which demonstrates how we can shorten the time line and the number of prototyping and tooling iterations. We then machined it at our Amega West operations and delivered it to the customer. The customer's response to the final additive manufacturing tool was enthusiastic. And today, we're in the process of printing several more for this customer, which could result in hundreds of parts per year. This is just one example of the potential we see in this rapidly expanding area and demonstrates the very unique capabilities we have at Carpenter.

As we enter fiscal year 2019, we continue to take steps to further advance our position in this space. At the recent Farnborough Airshow, we announced the investment we're making on our Athens campus to build our Emerging Technology Center, which will allow us to stay at the forefront of change, impacting the industry and our customers, while strengthening our position as an irreplaceable solutions provider. Our expertise in this space was further validated at the airshow with the announcement of Carpenter becoming 1 of just 3 launch partners of the GE Additive Manufacturing Partner Network. We have a longer history of partnership and innovation with GE and are thrilled to expand our relationship and deepen our collaboration in the additive manufacturing space as we work together to advance this technology. We've placed a strategic emphasis on expanding our additive manufacturing capabilities and believe this partnership with GE Additive speaks to our leadership position in this space. As we look forward, we know we will need to continue to innovate and identify opportunities in the value chain that will allow us to further strengthen our position.

Now let's turn to Slide 16 and my closing comments. In closing, let me highlight a couple of very important takeaways from the quarter and for the fiscal year ahead. To start, our performance in the quarter was impressive. Total company quarterly operating income was the best since the fourth quarter of fiscal year 2014. SAO's operating income of $74 million was the best since fourth quarter of fiscal year 2013, with an operating margin of 18.7%, which is the highest in almost 5 years. And the PEP segment continues to drive increasing levels of operating income.

For the full fiscal year compared to last year operating income increased 52%, operating margin improved by 260 basis points and adjusted earnings per share increased a 131%.

The markets we serve remain stronger as our commercial team is driving consistent sales and backlog growth, while deepening customer relationships and unlocking new product opportunities. And the Carpenter Operating Model continues to deliver manufacturing improvements and provide incremental capacity in a rising demand environment. As I've said many times, we are in the early innings of the deployment of the Carpenter Operating Model and will continue to push incremental value to the bottom line in the years ahead.

As we look forward to next quarter, we expect to maintain our positive performance trend. As Damon mentioned earlier, SAO will experience some seasonality in our first quarter, albeit less than in previous years, driven by the normal preventative maintenance outages that are planned for the first quarter. Even with the downtime, we currently expect SAO's upcoming first quarter to be up 20% to 25% versus year ago quarter and expect it to be the best first quarter since fiscal year 2014. This is meaningful improvement in our run rate profitability. And in the PEP segment, we believe we can deliver up to a 15% sequential improvement as the group continues to drive value through the market and operational efficiencies.

As our core business continues to improve, we've positioned ourselves with additional growth projects that will accelerate profitability beyond the next quarter. The most visible is our Athens facility. Last quarter, I announced we had received VAP approvals on 3 specific grades from 2 key OEMs. This quarter, we received 4 additional VAP approvals, including an approval from a large OEM to support meaningful volume for a single-spec item. At a critical time for the Aerospace industry with robust build rates and extended lead times, our Athens facility can provide that much needed incremental state-of-the-art capacity for the industry.

With no debt maturities until fiscal year 2022 and only modest pension contributions required over the next several years, we have leveraged our solid financial position and positive free cash flow generation to strategically invest in 2 significant growth areas, soft magnetics and additive manufacturing.

Two quarters ago, we announced the investment in our soft magnetics portfolio that will significantly increase our 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.

As I discussed in some detail earlier, today we can deliver an end-to-end additive manufacturing solution that combines metallurgical expertise, powder in large feedstock offerings, part design and production capabilities with potential further actions.

We enter fiscal year 2019 with notable momentum across our business. The success we delivered in fiscal year 2018 is yet another key step in our journey to transform Carpenter. We remain focused on elevating our performance further and plan to continue the relentless execution of our strategy to be the preferred solution provider in specialty materials with a reputation for 0 injuries, unquestionable quality, intimate customer connections, innovative growth, creative technology and engaged talent.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today comes from Gautam Khanna with Cowen and Company.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [2]

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I was wondering if you could talk a little bit about seasonality. I mean, you mentioned the Q1 guidance, but what about Q2? Do we expect kind of to be working more during what's traditionally being -- been a slow second half of December given the backlogs? And then if you could just comment on kind of the pace of ramp, what you expect the Athens utilization to be exiting fiscal '19 at based on the approvals you have and expect to get?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [3]

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A couple comments to your first question. I see second quarter being at a normal run rate. As I've said to you before, it's really about the days available. I think seasonality has become less of an issue just because of the robust ramp in engine build and the corresponding increase in airframer activity. So I think you get through our normal preventative maintenance shutdowns in the first quarter, and we're running every day in the second quarter.

Concerning Athens utilization, that's a tough question, as you know, because it really depends on the OEMs and the urgency that we put into Athens and to getting that qualified. And that urgency has increased significantly over the last couple of months. I assume that it will continue to be that, but it's very difficult to project out 4 quarters on what the Athens utilization would be. My guess would be, if I'd venture in that area that we would have significantly or substantially more qualifications than we do today. There just makes -- there is just no reason to believe that you won't because, number one, we have a process in Athens that is capable, we have a market that is robust, increasing backlogs, increasing lead times, increasing expedited orders. I can say when the team was in Farnborough here recently, there was a new state of urgency across all of our customers. Every one of our customers is asking for more. So that combination would lead, I think, any reasonable person to say that Athens will be qualified at the most urgent rate that the stringent policies would allow.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [4]

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And do you have an estimate on what the unabsorbed cost will be? And what it was? Was it $34 million to $35 million in fiscal '18 at Athens? And venture to guess what it might be in fiscal '19?

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Damon J. Audia, Carpenter Technology Corporation - Senior VP & CFO [5]

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Gautam, so for FY '18, directionally, you're correct, it was in -- call it in that low- to mid-30s of unabsorbed of costs of our headwind to SAO. As Tony alluded to, for FY '19, it's very hard for us to know what the run rates are going to be or what the utilization rates for incremental production are going to be in Q3 and Q4. So I think as Tony alluded to, as we get additional qualifications, as we might freight those over to the Athens facility, the incremental utilization goes up, that obviously will help into absorb some of that mid-30s sort of a headwind we were dealing with, but we don't have any specific guidance beyond that.

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Operator [6]

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The next question comes from Josh Sullivan with Seaport Global.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [7]

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Just on the comments, if we do see aircraft OEMs fill production schedules with some of the legacy aircraft until some of the teething issues of some of the new engines are figured out, how does that impact Carpenter? Does it help you pair down any inventory at the legacy alloys? You mentioned that it wasn't a negative impact. Is it a positive impact in any way?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [8]

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I don't see any impact for the industry, if you are a specialty metals supplier on whether it's legacy or new platform. You have an industry that is at capacity. And as you move to the legacy platforms, in many cases, the content is higher. So I think the pinchpoint only becomes more severe going forward, not less.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [9]

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Okay. And then just following up on the Athens questions. You mentioned you received 7 approvals so far. What's the total number of the VAPs you've submitted at this point?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [10]

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Well, we've submitted the majority of all of the packages to the OEMs. Josh, as you, I know, are aware of, each individual product and size is qualified independently. So that number could be quite high.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [11]

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Okay. And then just with regard to the soft magnetics investment here. Have customers begun to approach Carpenter for capacity? Or I guess, another way to ask, has any portion of the plant capacity been contracted at this point?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [12]

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The answer is no. We're 2 years out from coming online. But I will say, from a positive standpoint, we have -- our customers have pulled us into that arena, right. We are the leader now in soft magnetics in terms of AP use in aerospace and some in consumer electronics and avionics. But our customers are pulling us and saying that is a market that's going to get significantly bigger. If you remember, we talked briefly about this on the last call. So we put -- we're investing money in this area because the customers are pulling us not because it's one of those build it, and we hope that the customer would come. So no, not a specific order just because we're 2 years out. But yes, definitely associated with customer interest and customer pull.

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Operator [13]

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(Operator Instructions) And our next question comes from Michael Leshock with KeyBanc.

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Michael David Leshock, KeyBanc Capital Markets Inc., Research Division - Associate [14]

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So just looking at corporate costs, they were a bit higher in this quarter than they've been historically. How should we think about corporate costs in Q1 sequentially versus Q4?

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Damon J. Audia, Carpenter Technology Corporation - Senior VP & CFO [15]

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Yes, Mike, what we said in our opening remarks is that we would expect the numbers to be -- SAG to be in the $50 million to $55 million range. If you're looking at the corporate costs that are in the press release that would sort of translate into a number of call it around $18 million to $20 million per quarter.

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Michael David Leshock, KeyBanc Capital Markets Inc., Research Division - Associate [16]

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Okay, great. And then could you touch a bit on what you're seeing in the supply chains for your PowerGen and the electrical energy?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [17]

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I would say, the power generation market is extremely depressed. It is 1% or less of our total sales. And in the near term, we do not see any significant recovery.

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Operator [18]

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The next question comes from Jeremy Kliewer with Deutsche Bank.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [19]

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Just a little bit more color on the SAO significant beat. You mentioned there's a lot of product. Is that product mix supposed to stay rich moving forward with like the NexGen engine ramp? Or are you anticipating (inaudible) normalized as your legacy quarters or Q1 through Q3 levels?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [20]

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I do not expect our product mix to get worse going forward. I expect it to remain where we're at today or get better.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [21]

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All right. And then on the free cash flow side. You guys generated some decent free cash flow this quarter, and it appears to be likely going forward. So can you just kind of put us on a priority list, is it shareholder returns? Or is it M&A activity this following your soft alloy and all the other investments as you've already identified?

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Damon J. Audia, Carpenter Technology Corporation - Senior VP & CFO [22]

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Yes, Jeremy, I think, as you see, we're allocating more capital to grow CapEx in fiscal year '19. As we've alluded to, especially in the areas of additive and soft magnetics. With that tax legislation change it's resulted in lower cash taxes, and we have redeployed that back into growth CapEx. As we look at the balance sheet, as I mentioned in my comments, we repaid the $55 million in short-term debt. So we have no debt maturities until FY '22, and we have no significant pension plan contributions until FY '22 and even then that's only about $28 million. So it's not really meaningful. So it gives us a lot of flexibility to really invest in our business, invest in the capabilities, as we try to become more of that complete solutions provider. As we think about growing the business with our customers, we've done a couple of things as you've seen. We acquired Puris a couple of years ago. We acquired CalRAM in February, we've done the soft magnetics. So that's our focus. We'll continue to evaluate those types of actions as well as the balance sheet and we'll look to maintain our investment grade, as we said in the past, and then we'll also compare that against incremental returns to the shareholders.

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Operator [23]

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Next question is a follow-up from Josh Sullivan with Seaport Global.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [24]

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Just looking at the inventory levels, how should we think about turns going forward? I know you mentioned there's more to do in the Carpenter Operating Model. What are the thoughts there?

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Damon J. Audia, Carpenter Technology Corporation - Senior VP & CFO [25]

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Yes. Josh, this is Damon. So again for our inventory for fiscal year 2019, I think you've heard Tony and I talk in the past that, we're going to continue to align our inventory with the opportunities that we see across our end markets. We're not going to risk current customer relationships. We're not going to turn away from new attractive customers that as we see -- as we become a critical part of their supply chain. For us, we're going to carry the level of inventory we think is appropriate to service the customers and capitalize on those strong market demands. For us, FY '18 inventory levels were flat compared to '17. So we did this at the same time of increasing revenue. So again effectively increasing our turns, and this is what we would have expected to happen as we continue to roll out the Carpenter Operating Model. For FY '19, I don't have any specific guidance on inventory other than we don't expect it to be a material source or use of cash right now. But again, it's -- go back to my comments, we're going to monitor that based on the market demands.

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Operator [26]

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At this time, this will conclude today's question-and-answer session. I'd like to turn the conference back over to Brad Edwards for any closing remarks.

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Brad Edwards, Brainerd Communicators, Inc. - MD [27]

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Thanks, Brian, and thanks, everyone for joining us today for our fourth quarter and fiscal year-end conference call. We look forward to speaking with all of you again on our first quarter call. Have a great day.

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Operator [28]

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