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Edited Transcript of CRS earnings conference call or presentation 24-Oct-18 2:00pm GMT

Q1 2019 Carpenter Technology Corp Earnings Call

WYOMISSING Oct 25, 2018 (Thomson StreetEvents) -- Edited Transcript of Carpenter Technology Corp earnings conference call or presentation Wednesday, October 24, 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

* Timothy Lain

Carpenter Technology Corporation - VP & CFO

* Tony R. Thene

Carpenter Technology Corporation - President, CEO & Director

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Conference Call Participants

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* Jeffrey Joseph Molinari

Cowen and Company, LLC, Research Division - Research Associate

* Jeremy David Kliewer

Deutsche Bank AG, Research Division - Research Associate

* Joshua Ward Sullivan

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

* Philip Ross Gibbs

KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Carpenter Technology Corporation First 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.

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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 first quarter ended September 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 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's most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2018, and the exhibits attached to that filing.

Please also note that in the following discussion, unless otherwise noted, when management discusses sales or revenue, that reference excludes surcharge. When referring to operating margins, that is based on operating income and sales excluding surcharge.

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 begin with an update of our safety performance on Slide 4.

Our total case incident rate, or TCIR, was 1.7 in the first quarter of fiscal year 2019, up from 1.1 for the full fiscal year 2018.

Our PEP business has continued to make exceptional progress toward a 0 injury workplace, with only 1 recordable injury in the first quarter. However, our SAO business took a step back in terms of safety performance. The results are unacceptable, and our safety teams are using this as an opportunity to increase the level of engagement with employees and to develop and execute action plans to get us back on track.

It's clear to me that every injury to date could have been prevented, and we must regain the uninterrupted focus on hazard elimination and standardized work. As I've stated in the past and I'll state again today, we will not be satisfied with our safety performance until we achieve a core value of a 0-injury workplace.

Now let's turn to Slide 5 and review the first quarter.

Our first quarter results reflect the ongoing execution of our solutions-focused strategy, strong demand patterns across our end-use markets and further market share gains. In terms of earnings, it was the best first quarter since fiscal year 2014. However, we did fall a bit short of our expectations that were communicated in last quarter's earnings call. I will address that now.

In the SAO segment, we completed our planned annual preventive maintenance outage. With the robust market demand that we are experiencing, our equipment is running at high utilization rate, and it is vital that we take critical operations offline to perform necessary preventative maintenance to ensure that the equipment continues to operate at its maximum capability. The outage was extended at certain production centers to ensure we had completed all required tasks sufficiently. The extension of the outage accounted for the majority of the deviation from our quarterly guidance. In addition, certain input prices were higher than originally expected.

In our PEP segment, we were short on our expectations mainly as a result of our Dynamet and Amega West businesses. At Dynamet, the lingering operational impact of the fire recovery and inconsistency in the fastener demand drove lower-than-expected results. For Amega West, this quarter's results were below our expectations mostly due to the timing of certain rental tool arrangements. We remain encouraged by the activity levels at Amega West, especially with our customers in the Permian Basin, and are encouraged by early signs of growth in activities outside the U.S. The fundamentals of both Dynamet and Amega West remain solid, supported by robust end-use markets and customer demand.

In summary, our operations continued to perform well as we took the necessary preventative maintenance shutdowns to preserve our capabilities going forward, all while still generating the best Q1 earnings since fiscal year 2014.

For this quarter's earnings call, there are 4 significant points to emphasize: continued market strength; increased customer urgency on Athens qualifications; Carpenter's acquisition of LPW Technology, which builds on our leading position in the additive manufacturing industry; and our strong balance sheet, leading to direct returns to our shareholders.

Let me speak briefly about each one now and then get into more detail later in the presentation.

Demand conditions across our markets remain strong, and we generated healthy year-over-year sales growth in each of our 5 end-use markets during the quarter. In addition, backlogs continue to grow, up 38% compared to last year and up 9% sequentially. This quarter marks the ninth consecutive quarter of sequential backlog growth. Drawing down specifically to the Aerospace and Defense end-use market, sales increased 11% compared to last year, driven by engine submarket activity remaining at near-record levels and the benefit of our diverse industry participation.

First quarter marks the seventh consecutive quarter of year-over-year sales growth in our Aerospace and Defense end-use market. Another consistent bright spot has been the medical end-use market, where sales were up 18% compared to last year. Our growth in this market is outpacing industry growth projections due to robust demand for our leading titanium solution as well as the success we have had in expanding our customer relationships.

A significant earnings growth enabler for Carpenter is our Athens facility. This quarter, we experienced a noticeable increase in customer engagement concerning qualification of their specific engine products. Our customers recognize the urgency to qualify additional capacity, given increasing lead times and the projected airframe and engine build rates.

Our technical teams are hosting on-site visits with large OEMs and are actively engaged with customer contact to exchange information toward completing each of their qualifications.

This morning, we announced the acquisition of LPW Technology, a leading global developer and supplier of metal powder solutions for additive manufacturing, including software and hardware-based powder life cycle management solutions. The acquisition of LPW adds an innovative solution to managing powder quality during the 3D printing process and improving powder recyclability to our existing additive manufacturing platform. This acquisition keeps Carpenter at the forefront of the additive manufacturing industry, and we continue to build out an impressive group of assets and capabilities.

Lastly, our solid balance sheet gives us the important flexibility to invest for the future and to provide increased direct returns to our shareholders. To that end, during the first quarter, we increased our regular quarterly cash dividend by 11%, which reflects our solid financial position as well as our confidence in our ability to generate sustainable long-term growth.

Let's move to Slide 6 and the end-use market update. I'll begin with Aerospace and Defense, where sales were up 11% on a year-over-year basis, driven primarily by continued strong demand in the engine submarket as well as higher avionic and distribution sales. Our total Aerospace and Defense backlog continues to increase and was up 40% on a year-over-year basis and 12% sequentially. Year-over-year, we experienced backlog growth in each of our submarkets.

In the engine submarket, we achieved another strong quarter, with sales up 17% compared to last year, as market demand remains robust, given the new platform ramp. We also continued to fulfill expedited orders for our OEM partners, given current engine build rates and industry lead times.

The fastener submarket sales were down, both year-over-year and sequentially, as visibility remains limited with inconsistent demand patterns. While the fastener's near-term outlook is hard to predict, we are confident in our market position, given our diverse offerings, and believe the long-term demand levels are supported by the backlog of over 14,000 aircraft.

In the structural submarket, we continued to experience healthy demand for our solutions used on major platforms, including the A320 and the 737. Finally, sales in our defense sub-market increased both year-over-year and sequentially due to program-specific demand.

Now moving to the Energy market and our oil and gas and power generation submarkets. Total energy sales were up 30% year-over-year due to higher oil and gas submarket sales and higher rental and replacement activity at Amega West. The North American directional and horizontal rig count has largely stabilized in the range of 1,100 rigs, and we see further opportunities, particularly in the Permian Basin, where drilling activity by our customers remained at healthy levels.

In the power generation submarket, overall demand and order levels remained at relatively low baseline.

Now onto the Transportation market, where sales were up 3% year-over-year as the rebound in the heavy truck market matures. In this market, we've been making solid progress, expanding into attractive market adjacencies and diversifying our revenue streams. Sales into those additional submarkets, such as heavy-duty off-road, marine and rail were up over 50% compared to the first quarter of last year. While our selective push into these submarkets remains in the early stages, I'm pleased with our progress so far and believe we have additional growth opportunities in these areas.

Moving on to the Medical market. Sales were up 18% compared to last year due to stronger demand for our titanium solutions at Dynamet. Our Medical portfolio has been an area of strategic emphasis over the last several years. We've worked hard to balance our traditional customer base with more direct OEM relationships by diligently implementing the Carpenter operating model to unlock incremental capacity to meet rising customer demand.

Today, we are recognized in this market for both our leading portfolio, our material and processing solutions and our commitment to advance solutions, including additive manufacturing.

In the Industrial and Consumer End-Use Market, revenues were up 4% on a year-over-year basis due to increased sales in certain submarkets, including semiconductors as well as sporting goods.

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

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Timothy Lain, Carpenter Technology Corporation - VP & CFO [4]

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Thank you, Tony. Good morning, everyone. I'll start on Slide 8, the income statement summary.

Our first quarter results represent a strong start to our fiscal year. In fact, as Tony mentioned, this quarter's results mark the strongest first quarter operating income in 5 years.

Net sales in the first quarter were $572 million, or $456 million, excluding surcharge. Sales excluding surcharge decreased by 8% on a sequential basis on 10% lower volume. Historically, our first quarter sales relative to the preceding fourth quarter decline due to the timing of our planned annual preventative maintenance shutdowns at key work centers across our facilities.

We continued to see signs of strength in our business, including increased demand across most of our end-use markets as we execute on our solutions-focused strategy.

From the first quarter a year ago, sales were up 11% on 4% higher volumes. In addition, our backlog continues to grow, most notably in Aerospace and Defense, with year-over-year backlog growth of 40% and sequential growth of 12%.

SG&A expenses declined by $8.3 million sequentially to $47 million. The reduction is mostly attributable to the timing of certain costs in Q4 that did not repeat in Q1. Year-over-year SG&A expenses increased by $3.2 million due mostly to targeted investments in key areas. As an administrative note, given the current adoption of a recent accounting standard, operating income and the reporting we previously made related to operating income, excluding pension EID, are now one and the same and will simply be referred to as operating income. Prior period numbers have been recast to conform to the current year presentation.

As percent of sales, operating income was 9.9% in the quarter. Our margin declined as expected on a sequential basis compared to 12.1% in the fourth quarter due to lower volume. Operating margin declined 40 basis points as compared to the first quarter of fiscal year 2018.

In addition, our operating margin was also negatively impacted by ongoing fire recovery efforts at our Dynamet business, which we will discuss in more detail in a moment. Our effective tax rate for the first quarter was 21.8%, which reflects certain discrete tax benefits associated with stock-based compensation, equity awards vesting and exercises in the current quarter. We continue to expect our effective tax rate to be in the range of 24% to 26% for the balance of fiscal year 2019.

First quarter net income was $31.5 million, or $0.65 per share. Year-over-year, EPS grew 33%.

Now turning to Slide 9 and a review of free cash flow. Free cash flow in the first quarter was negative $42 million compared to positive $56 million in the fourth quarter of fiscal year 2018. This performance was consistent with historical sequential declines, as the fourth quarter is generally our strongest free cash flow quarter in each year. We generally build inventory in the first half of the fiscal year to support the higher sales volumes in the second half of our fiscal year. To that end, we increased inventory by $51 million during the current quarter, as we aligned inventory levels with demand patterns we're experiencing across our end-use markets and our increasing backlog. On a year-over-year basis, free cash flow was relatively flat, with higher cash from operations mainly as a result of increased earnings and improving working capital, offset by higher capital expenditures in the current period.

Capital expenditures in the first quarter of fiscal year 2019 were $41 million. We continue to expect capital expenditures for the full year to be about $190 million. As we talked about last quarter, the elevated CapEx levels relative to historical rates reflect our strategic investments in growth projects associated with additive manufacturing and soft magnetics. Free cash flow on the quarter also reflects the impact of the increase in our quarterly cash dividend. The dividend increase is another signal of the confidence we have in the strength of our business as well as our commitment to delivering direct returns to our shareholders.

At September 30, we had $411 million of total liquidity, including $17 million of cash and $394 million of availability under our credit facility. Our solid financial position is supported by no debt maturities or major required pension contributions until fiscal year 2022. We remain well positioned to continue investing in targeted growth areas and strengthening our foundation for long-term sustainable growth.

Now turning to Slide 10 and an update on our SAO segment. Net sales, excluding surcharge, were $362 million, which was down $34 million, or 9%, on a sequential basis on 11% lower shipment volume. Again, the sequential decline reflects the seasonal impact of our planned annual preventative maintenance during the first fiscal quarter.

On a year-over-year basis, sales, excluding surcharge, increased $36 million, or 11%, on 2% higher shipment volume. The increase reflects continuing strong demand patterns across most of our end-use markets, driven by Aerospace and Defense, and Medical, combined with an improving product mix.

SAO operating income in the current quarter was $52.8 million, down $21 million compared to the fourth quarter and up $2 million year-over-year.

The sequential decline in operating income reflects the reduced shipment volumes and higher input prices on certain production elements.

Operating margin was 14.6% compared to 18.7% in the fourth quarter of last year and 15.5% in last year's first quarter. Looking ahead, demand across our end-use markets remains strong, and we are continuing to drive backlog growth. We are confident we will continue to expand customer relationships and capitalize on emerging market opportunities. Given the number of production days available in Q2, we currently estimate that operating income for SAO will increase up to 10% sequentially from Q1 to Q2, which would represent the best second quarter operating income performance in 6 years.

Now turning to Slide 11 and a review of our PEP segment results. PEP net sales, excluding surcharge, were $108 million, down $6 million sequentially, or 5%. On a year-over-year basis, PEP sales, excluding surcharge, increased $8 million, or 7%, driven by continued growth in our high-value titanium solutions for the Medical market and increased demand at Amega West.

Operating income in the first quarter was $7.3 million, down $600,000 compared to the fourth quarter and up $2 million year-over-year.

As Tony mentioned earlier, the PEP results in the current quarter were below our expectations as a result of our Dynamet and Amega West business units. To reiterate, our Dynamet business continues to deal with short-term headwinds from a fire at one of its facilities earlier this calendar year. Operating income continues to be impacted by suboptimal production flow path. Reconstruction of the damaged facility is well underway and is expected to be completed over the next several months. In addition, Dynamet continues to deal with inconsistencies in fastener demand patterns, which negatively impacted the results of this quarter relative to our expectations.

At Amega West, the current quarter's results were lower than our expectations due to the timing of certain rental tool arrangements.

Looking at the second quarter of fiscal year 2019, we currently expect PEP's operating income, excluding any impacts of our recent LPW acquisition, to improve sequentially by up to 10%.

With that, I will 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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Thanks, Tim. Over the past several years, we have focused on expanding our capabilities in the additive manufacturing space, evolving our platform to ensure we are positioned at the forefront of this rapidly changing and disruptive technology. We strengthened our powder capabilities by acquiring titanium powder producer Puris and then last fiscal year acquired CalRAM, which brought extensive additive manufacturing product design and part production capabilities. In addition, last fiscal year, we announced our investment in an emerging technology center in Athens, Alabama, which will enhance our technical capabilities and scale. We've also mobilized over 30 engineers, scientists, operators and technicians, who specialize specifically in additive manufacturing technology. Having this expertise from free stock through design and component production positions Carpenter as an irreplaceable technical partner with our customers.

During our last call, I talked about our collaboration with one of the major U.S. oilfield service providers to develop a unique 3D design and printed in-hole tool for the drill string. Overall, collaborations like this one are steadily increasing, as a growing number of customers are engaging with Carpenter Technology due to our end-to-end additive manufacturing solutions. Additive manufacturing technology maturation is now presenting commercial opportunities in advanced applications such as jet engine components, satellite structurals, downhole oil and gas drilling system, surgical instruments, medical implants and state-of-the-art defense platforms.

And today, we took another meaningful step forward with the acquisition of LPW Technology to enhance the value proposition we offer customers in the additive manufacturing market and to build on our leading position in this space. The acquisition of LPW Technology strengthens our additive manufacturing platform through the addition of innovative and tightly controlled powder design material optimization and life cycle management solutions throughout the additive manufacturing process. LPW addresses a critical need in the metals additive manufacturing marketplace by enabling quality assurance and traceability of metal powders. This is achieved by linking the physical powder product to a digital platform, which collects real-time data from sensors and other hardware, starting from the powder development phase through the printing process and multiple cycles of powder reuse. As an example, the software can accurately measure moisture and oxygen levels at different points, since variations beyond certain thresholds can lead to compromised part integrity, subpar performance or failed quality. LPW solutions can help identify and resolve problems before they happen. Another major challenge-facing additive manufacturing today is powder reuse. LPW's platform is aimed at improving the life cycle cost of powder and achieving significant cost savings by minimizing degradation issues and enabling repeat uses of metal grade powders.

LPW's approach to data collection and digital manufacturing assists in making it easy to track and analyze the alloy powders, leading to more rapid innovation, product enhancement and overall part integrity. These life cycle management tools can increase the probability of achieving 3D part printing success earlier in the development process. From a customer standpoint, LPW has established relationships across many major industries, including Aerospace, Medical, Transportation and Energy. We're excited about the LPW acquisition as it accelerates Carpenter's leadership position in the emerging additive manufacturing industry, with an integrated end-to-end solution.

Let's turn to Slide 14 and my closing comments.

In closing, we are making continued progress in strengthening our long-term growth potential by executing our commercial strategy at a very high level, broadening our customer relationships and investing strategically in targeted growth areas. Our first quarter results included a number of important highlights. We were successful in completing a critical preventative maintenance outage that will allow us to continue to serve a robust market while delivering year-over-year earnings growth. We capitalized on strong demand trends and generated year-over-year revenue growth across all of our end-use markets. And we benefited from a continued strong market, and our solutions approach is driving further backlog growth, up 38% compared to last year and 9% sequentially. Our facility in Athens, Alabama remains a major growth driver with fully qualified and will offer significant incremental capacity for the aerospace industry during this major upcycle.

As I noted earlier, our dialogue with customers is accelerating, and we are seeing increasing urgency to qualify their major aircraft components. The future of our industry also offers significant growth opportunities for Carpenter. We know that industries and markets evolve, and with that change comes new technologies as well as enhanced customer needs. We have spent the last several years transforming Carpenter into a complete solutions provider. That transformation must continue in the years ahead as we make the strategic investments needed to remain at the forefront of disruptive change impacting our customers and our end-use market. This includes additive manufacturing. With the addition of LPW's leading powder life cycle management solution, we have built a platform that offers materials and metallurgical processing expertise, powder development and optimization, part design and production capabilities, a technology-based platform that manages powder during the 3D printing process, and a solution to improve powder reuse and recyclability. Our future growth drivers also include our high-value soft magnetic portfolio, where we are investing to significantly increase our capabilities and capacity.

Today, we are the market leader in auxiliary power units for aerospace and see strong future growth potential, given the current aerospace cycle and projected build rates. We also see attractive future growth opportunities for our soft magnetic solutions in consumer electronics and electric vehicle applications. Our solutions-focused strategy is working and delivering solid performance in a high-demand environment, and we have multiple long-term growth drivers that position Carpenter for sustainable growth in the years ahead.

With all of the mentioned progress, we have continued to maintain a solid balance sheet that gives us the important flexibility to continue investing in the future and provide increased direct returns to our shareholders, as evidenced by the 11% increase in our regular quarterly cash dividend.

In summary, we have just presented a positive outlook for the future. We project our SAO business earnings to be up as much as 17% on a year-over-year basis next quarter, with PEP earnings projected to increase by as much as 7% on a year-over-year basis next quarter. We see no indications of market weakness. In fact, the markets are strengthening, especially for aerospace, as backlogs and lead times continue to increase and expedited orders become more common. Our Athens facility is the only new capacity coming into the market, and qualification activity has increased significantly over the last quarter. The Carpenter operating model has delivered meaningful results, but future opportunities can be significant as we continue to implement. And we continue to make strategic investments in exciting growth areas, such as soft magnetics and additive manufacturing. The Carpenter team is committed to this journey and excited about the near and long-term future. 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) The first question we have will come from Gautam Khanna of Cowen and Company.

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Jeffrey Joseph Molinari, Cowen and Company, LLC, Research Division - Research Associate [2]

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This is Jeff Molinari on for Gautam. So I know you talked a bunch about normally season planned maintenance being an issue at SAO. We were just wondering if there is anything else that kind of is dealing with this, whether it be mix issues or other inefficiencies that could have amplified the sequential EBIT drop?

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

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Well, Jeff, this was primarily due to the outage, our decision in some areas to extend that outage. Demand was up across all of our end-use markets. Backlog was up. So this was not a mix issue. This was not a demand issue. This is simply that we have equipment right now that is running at very high utilizations, and we have to take this equipment down to make sure we protect Carpenter for the long run, protect our customers for the long run. And it -- it's easy to get caught up in that quarterly earnings cycle, where you make decisions that are hurtful to the business long term, and we're just not going to do that. So we had a preventative maintenance shutdown. We took the time that was needed, and it impacted us versus the guidance we gave last quarter. But keep in mind that the difference between our guidance and what we actually performed was as little as $5 million. So it's a rather small amount compared to the fact that our markets are getting stronger and backlogs are increasing, and we see next quarter being up significantly year-over-year. I think that's the real point.

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Jeffrey Joseph Molinari, Cowen and Company, LLC, Research Division - Research Associate [4]

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No, that's definitely helpful, and it makes sense. We just wanted to make sure there was nothing else kind of at play. We understand you don't want to have -- you want to make sure that you can get those maintenance things completed. Just one other question, if you don't mind. Can you update us on the status of the repairs -- recoveries in the Dynamet facility? I know you said it's expected to be completed in the next several months. Would you say that you're still meeting your delivery requirements? And as you said in the past, are you -- would you say the issues, kind of like the costs associated with this, are largely behind you?

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

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Okay, Jeff, that's a good question. Thanks for asking. The new building now, I was just there about 10 days ago, it is now under roof and moving quickly. So we still have several months to go there to finish out the inside of that building. We are using alternative flow paths, which are more costly, to supply our customers. It's been tight with many of our customers. I think they would say that we have worked very well with them to get their material when they needed, but I'll be honest, in many cases, it has been hand to mouth. So we think over the next couple of months, we'll continue to work around the clock to make sure those customers get what they need and, hopefully, here by early spring, we can have that building completed.

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Operator [6]

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The next question we have will come from Josh Sullivan of 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 as we think about the historical cadence of earnings through the year, given the results here and the outlook essentially for the first half, should we expect a similar historic -- the historical bump in the second half at this point? Or just how are we thinking about the cadence for the year now?

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Timothy Lain, Carpenter Technology Corporation - VP & CFO [8]

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Yes, Josh, I think that's a fair assessment. Given the number of production days in Q2 versus Q1, just not enough time to produce what we need to produce. And the second half, if you look over a historical period, second half is generally stronger than the first for us.

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

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And then just on the preventative maintenance. I know you said you extended the outage. Did you find something you didn't expect? Or did you do something extra just given the high utilization rates, which may, I guess, benefit you down the road?

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

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Yes, we didn't find anything that we didn't expect. There were no major issues, but we just wanted to make sure that everything is done appropriately. And there were some items that we wanted to -- we just wanted to make sure that we had everything done exactly the way it should be. Some areas took longer, quite frankly, than we expected from a manpower standpoint, from a parts standpoint, took a little longer, so if you add all that in. In a market where you can sell everything you make, even when you extend for a week in some work centers, has a significant impact on the bottom line.

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

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So I mean, I guess, next year, do you think we would expect similar type outages? Or was this a special event just given...

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

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Well, we've done an annual outage at Carpenter for as long as I've been here and probably for decades and usually do that in the August timeframe just because that's when some of your customers, especially European customers, take a little time off. I think we're always looking for ways to do this better, and I would suggest that, going forward, as opposed to taking one large outage, you could see us on more of a rolling schedule, where we hit different points throughout the year and smooth that out a bit.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [13]

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And then just one on Athens. Where do you see the elbow in Athens' contributions at this point? Is there a certain production rate on the 737 or A320 where we go above maybe 50% utilization at Athens?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [14]

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Let me make sure I understand your definition of elbow. Are you saying when...?

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [15]

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Just as you define it. I mean, when can we -- when do you think Athens really kicks in? I mean, is there a rate on the OEM side that we can tie it to? Just how are you looking at Athens and maybe when we get above 50% utilization? When do you see that happening?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [16]

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I think it is difficult to tie it to a specific rate. If you just look at what the engine manufacturers are going to do over the next year to 2x, sometimes more and just do some rough math based on the raw material supply, the nickel supply, you're going to need all of Athens to supply that engine demand. So whether that happens in the next 6 months, over the next 12 months, it's still going to be governed by the qualification rate. And as I said, we had a significant uptick in the last quarter. Only as the ramp continues and these engine manufacturers, who are managing a very, very large supply chain, works with us, understands the need, those discussions have intensified. Now with that said, and rightly so, we're not going to take any shortcuts on the quality side. The customers are not going to take any shortcuts on their qualification methods, and we don't expect that. But I can tell you every week, we get closer and closer.

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Operator [17]

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(Operator Instructions) Next we have Phil Gibbs with KeyBanc Capital Markets.

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Philip Ross Gibbs, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [18]

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Tony, a question just on the input cost pressures. I think you made that comment or Tim did, I can't remember. What input cost inflation are we looking at? Are you speaking about more of the staggered increase in electrode and refractories and rolls and lubricants and things like that hitting more aggressively this quarter? Is that what we should read? Or is there other things that you're talking about?

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Timothy Lain, Carpenter Technology Corporation - VP & CFO [19]

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I think, Phil, it's just more of a general sense of there are inflation pressures out there. In the past, we did talk about electrodes. I think we've got recoveries there with the surcharge we implemented over the last 6 to 12 months. I would say, the input prices we're talking about now are more just as the supply and demand question as scrap prices are out there, the availability and sometimes is lacking, so we're trying to be opportunistic about buying scrap in the open market at spot prices, which may be above what we had anticipated maybe 3 or 4 months ago.

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Philip Ross Gibbs, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [20]

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Okay. And the comments and color on the backlog growth, particularly in aerospace, are, obviously, very strong, up double digits sequentially, up 40% year-over-year. But the question I'm struggling with right now is, does the backlog growth mean anything in terms of whether or not the supply chain can actually effectuate that into getting a product to market. So that's sort of the philosophical question, I think, people are trying to wrestle with is, can we deliver on some of these requirements? Can the build rates move forward? Or is everybody just so -- effectively, is everybody just so wrapped up with trying to get up the curve here?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [21]

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So, Phil, let me try that one and come back with a follow-up question, if I don't hit the exact point you're looking for. I think the backlogs are meaningful. We noted that, that product is required. Lead times, for example, I don't think I mentioned this when I was speaking, in the last quarter have increased for us and we know for the other players in the industry. It reached 15% to 20% quarter-over-quarter. You have for engine material now, the lead time is approximately 9 months. So that's real demand out there. That's why you see a lot of these expedited orders, people trying to move up in the queue, and we try to do that the best we can to take care of our customers. But this demand is real, and I think it will -- to be able to meet that demand, you'll have to see additional productivity improvements from the existing assets, which we're doing. I talked about that over the last couple of quarters how we've been able to really increase the productivity of our press units as well as our melting furnaces. And then it comes down to Athens, Phil. As I said earlier, Athens is required to hit those types of engine builds and to meet the demand that's out there in the market. Let me know if that hit on what you were going after.

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Philip Ross Gibbs, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [22]

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No, that's very helpful. And just the last one, if I could sneak it in here is, I may have missed it, but did you give any color in terms of what the jet engine revenue growth may have been either sequentially or year-over-year? That's all I have.

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [23]

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Sure, thanks. Year-over-year, the aero engine growth on a sales basis was 17%. Sequentially, it was flat, but if you remember the last 3 quarters, we've been at the top level as far as sales in the jet engines, probably record levels as far as the history of Carpenter, and we've maintained that high level now the last 3 quarters.

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Operator [24]

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Next, we have Jeremy Kliewer of Deutsche Bank.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [25]

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Looking for a little bit more clarity on your SAO guidance. The 10% increase, is that inclusive or excluding the kind of extended maintenance impacts?

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Timothy Lain, Carpenter Technology Corporation - VP & CFO [26]

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Jeremy, it would just be 10% over what's reported here in Q1.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [27]

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Okay, so more of a kind of normalized flat rate then over your Q1 results?

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Timothy Lain, Carpenter Technology Corporation - VP & CFO [28]

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Correct.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [29]

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Assuming that there was...

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Timothy Lain, Carpenter Technology Corporation - VP & CFO [30]

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Given the number of production days in Q2 versus Q1 with shutdowns, yes.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [31]

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Yes. And then in regards to LPW, how should we view this on kind of an accretion standpoint? Is that going to do anything for revenues or earnings? Or is this just more of a long term, as you stated, kind of end-to-end powder capabilities and additive manufacturing capabilities?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [32]

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Yes. So Jeremy, on the additive manufacturing side, all of these acquisitions that you have seen over the last year or 2, the majority of them are not earnings positive. We were very early in this stage -- in this development. Now, we look for companies that aren't significantly EBITDA losers but that's where we're at today. And if you want to play in this market, now is the time for you to get in it, because 2 years from now, it is going to be priced exceptionally higher than what it is now, and I believe you're going to miss the boat. What's important with Carpenter and why we're so interested in additive manufacturing because it has a direct line to our traditional business. As an alloy development company, we work with these customers on a day-to-day basis and now they're interested in taking a leap that's potentially in additive manufacturing in some of these specific applications that I mentioned earlier, like satellite, structural material, some jet engine components, oil and gas drilling systems, medical instruments, et cetera. So we can transition very easily from being a wrought supplier, a solutions provider and now say, listen, we don't just make powder for AM, we develop that powder. We now have the ability to design additive manufacturing parts. We have the ability to actually do the part production, to do the post-processing. And now with LPW, you bring in an entirely new set of skills as far as the digital side of it, powder design, life cycle management, recyclability. I would say, from a raw material supplier, there's no one that has what we have now, where we can go from powder through design, which is critical, and make the final part. And to be honest with you, we made calls to some of our customers this morning with the LPW announcement, and it has been absolute excitement that we've added this other piece to the puzzle. And I think over the next couple of years, as additive manufacturing continues to grow, Carpenter will, in fact, be a primary player in that field.

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Operator [33]

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Next, we have a question -- follow-up question from the location of Gautam Khanna of Cowen & Company.

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Jeffrey Joseph Molinari, Cowen and Company, LLC, Research Division - Research Associate [34]

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This is Jeff, again. I had another question on the aerospace fastener market. I think you mentioned that you were dealing with some inconsistencies in demand patterns, and you're having kind of trouble with visibility. Can you just kind of expand upon that and also specifically answer whether or not you are seeing spot demand and picking up business from others?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [35]

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Jeff, aerospace fasteners is a habitually inconsistent submarket. It has been -- I've been around for a long time. It has been, as long as I've been in this industry, and I think, going forward, it will be as well. I think you're going to see stocking and destocking. Every time there's an acquisition, it's going to impact the demand. Every time there is a signal that says we're going to be potentially short, it's going to trigger overpurchasing at some time. The critical thing for Carpenter is that we are the broadest supplier of aerospace fasteners out there. We have our titanium supply. We have our nickel supply. We touch all customers. It's a very nice margin business for us, and I think we're just going to have to accept the fact that it will be inconsistent from quarter to quarter.

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Jeffrey Joseph Molinari, Cowen and Company, LLC, Research Division - Research Associate [36]

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And would you segregate the titanium and nickel? Or would you kind of characterize them both the same characteristics?

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Tony R. Thene, Carpenter Technology Corporation - President, CEO & Director [37]

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I would say, there are differences, but in totality, they are very similar.

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Operator [38]

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And the next question we have will also be a follow-up, and this will be from Josh Sullivan of Seaport Global.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [39]

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Just how big is your powder business at this point with CalRAM, LRW (sic) [LPW] and your other operations? Just how big is the powder additive vertical at this point?

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Timothy Lain, Carpenter Technology Corporation - VP & CFO [40]

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It's a good question, Josh. I think I'd say, it's -- depending on the year and what volumes we're able to get out, it's roughly a $100 million business, top line.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [41]

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And then on LRW (sic) [LPW] -- I was just going to say, on LRW (sic) LPW , what percentage of it is software at this point. Is it entirely software? Or...

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Timothy Lain, Carpenter Technology Corporation - VP & CFO [42]

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No, it's not. So LPW, it's not an entirely software company. I mean, they are very heavy into IP. They have developed the solutions that I talked about earlier. But they also optimize powder. They have one atomizer in place with a second one on order. So even if -- even as a subset, they have become fully integrated as well where they produce the powder, they optimize the powder and then they sell to different service providers. LPW, in fact, has been a customer of Carpenter in the past.

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Operator [43]

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Well, at this time, we're showing no further questions. We'll go ahead and conclude the question-and-answer session. I will now like to turn the conference call back over to Mr. Brad Edwards for any closing remarks. Sir?

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Brad Edwards, Brainerd Communicators, Inc. - MD [44]

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Thank you, Michael, and thanks, everyone, for joining us today on our first quarter conference call. We look forward to speaking with all of you again on our next earnings call. Have a great day.

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Operator [45]

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And we thank you, sir, and also to the rest of the management team for your time also today. Again, we thank you all for attending today's presentation. At this time, you may disconnect. Thank you. Take care. And again, have a great day, everyone.