Carpenter Technology Corp

NYSE:CRS

Earnings Call Transcript 2018-Q4

[Operator]

Good day, and welcome to the Carpenter Tech Fourth Quarter and Fiscal Yearend Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded and I'll turn the conference over to Brad Edwards, Investor Relations. Please go ahead.

[Brad Edwards, The Plunkett Group]

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 Executive Officer; and Damon Audia, Senior Vice President and Chief Financial Officer.

Statements made by management during this earnings presentation that are forward-looking statements are based on current expectations. Risk factors that could cause actual results to differ materially from those forward-looking statements can be found in Carpenter's most recent SEC filings including the company's report on Form 10-K for the year ended June 30, 2017, Form 10-Q for the quarters ended September 30, 2017 and 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 discuss the 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.

[Tony R. Thene, Carpenter Technology Corp.]

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 three specific focus areas. One, shop for (00:02:43) 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 explain the why, behind initiatives during the daily interactions with their respective teams. In terms of targeting specific injury type such as hand injuries, actions including credible 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 dialogs 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 (00:04:09) 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 have made during this 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 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 magnetic capabilities, we recently announced our plans to invest $100 million in a new precision strip, hot rolling mill on our Reading campus. We are 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 continue 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 seven 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's important to note that while we have 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 a 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 OEM.

As you know, there have 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 continued to outpace the North American directional and horizontal rig count levels. We have 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 manufacturing 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 marks SAO's best operating income since the fourth quarter 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 four 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.

Last week 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 will 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 that aerospace and defense market remains healthy and robust.

Just as important, we have 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 has been inconsistent, which makes visibility in this submarket challenging.

With that said, we remain one of the broadest suppliers of fastener solutions in the market and have strong and established partnerships across the supply chain. Demand in the aerospace structural submarket remains 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 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 the oil and gas submarket continued 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 gain, when the overall market recovers. And as activity in North America outside the Permian Basin continues to increase, we are working closely with the major oilfield service providers as they allocate their resources to other major basins.

Capital spending budgets for North America remain 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 are 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 trucks 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, light-weighting 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.

[Damon J. Audia, Carpenter Technology Corp.]

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 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 six 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 a 11% higher volume, but 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 that 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 we're $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 will 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 in 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 as sales best quarterly operating performance since Q4 of fiscal year 2013. As sales 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 five 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 in 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 to 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 fault pass (00:24:54).

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 celebrating our rate of capital expenditures to strengthen our long-term market position, as we continue to strategically position Carpenter as a 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. Our 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 re-measurement 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.

[Tony R. Thene, Carpenter Technology Corp.]

Thank you, Damon. Over the past several years, we have 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 the 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 provided for applications like the jet engine fuel nozzle. During fiscal year 2017, we began advancing our additive manufacturing strategy by leveraging our 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 power facility given its critical role in additive manufacturing. Shortly after this acquisition, we combined our expertise and feedback from our titanium power customers to create an additive manufacturing specific grade powder Puris 5+, which provides lower oxygen content and more designed 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 and the additive manufacturing industry continue 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 have 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 the industry leader in this space with the recent acquisition of CalRAM. As I mentioned on our 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 port design and printing capabilities, we can design and produce the best overall solution for customers.

We are 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 the 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 have been actively working with one of the major U.S. oil field service providers to develop a unique 3D design 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 their engineering teams as we work to optimize the design of the part to secure better print fidelity and maximize the parts performance. We subsequently printed a uniquely designed part in a matter of weeks, which demonstrates how we can shorten the timeline 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 were in the process of printing several more with 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 are 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 one of just three launch partners of the GE Additive Manufacturing Partner Network. We have a long 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 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 five 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 131%.

The markets we serve, remain strong 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 improvement 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 we'll 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 preventive 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 expected 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 have 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 three specific grades from two key OEMs. This quarter, we received four 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 rate 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 into 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 active manufacturing solution that combines metallurgical expertise, powder and wire 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 zero injuries, unquestionable quality, intimate customer connections, innovative growth, creative technology, and engage talent.

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

[Operator]

We'll now begin the question-and-answer session. Our first question today comes from Gautam Khanna with Cowen and Company. Please go ahead.

[Gautam Khanna, Cowen and Company, LLC]

Yes. Thanks. Good morning.

[Tony R. Thene, Carpenter Technology Corp.]

Good morning.

[Gautam Khanna, Cowen and Company, LLC]

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 you to be working more during what's traditionally 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 2019 at, based on the approvals you have and expect to get? Thanks.

[Tony R. Thene, Carpenter Technology Corp.]

Good morning, Gautam. 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 the engine build and the corresponding increase in airframe or (00:40:02) activity. So, I think you get through our normal preventive 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 there but it's very difficult to project out four quarters of 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.

That just makes – there's just no reason to believe that you won't – 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 – the most urgent rate that the stringent policies would allow.

[Gautam Khanna, Cowen and Company, LLC]

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 2018 at Athens and venture to guess what it might be in fiscal 2019?

[Damon J. Audia, Carpenter Technology Corp.]

Yeah, Gautam, so for FY 2018 directionally you're correct, it was in call it in that low-to-mid 30s of unabsorbed cost headwind to SAO. As Tony alluded to, for FY 2019 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 migrate 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.

[Gautam Khanna, Cowen and Company, LLC]

Thank you, guys.

[Operator]

The next question comes from Josh Sullivan with Seaport Global. Please go ahead.

[Josh Ward Sullivan, Seaport Global Securities LLC]

Hi, good morning. Nice quarter here. Yeah, just on the comments, if we do see aircraft OEMs fill production schedules with some of the legacy aircrafts until some of the teething issues of some of the new engines are figured out, how does that impact Carpenter? Does it help you pare down an inventory at the legacy alloys? You mentioned that it wasn't a negative impact, is it a positive impact in any way?

[Tony R. Thene, Carpenter Technology Corp.]

I don't see any impact for the industry, if you're 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 pinch point only becomes more severe going forward, not less.

[Josh Ward Sullivan, Seaport Global Securities LLC]

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

[Tony R. Thene, Carpenter Technology Corp.]

Well, we have submitted the majority of all 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.

[Josh Ward Sullivan, Seaport Global Securities LLC]

Okay. And then just with regard to the soft magnetics investment here, have – have customers began to approach Carpenter for capacity or I guess another way to ask you know has any portion of the planned plant capacity been contracted at this point?

[Tony R. Thene, Carpenter Technology Corp.]

The answer is no. We were two 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 APUs in aerospace and some in consumer electronics and avionics. But our customers are pulling us and saying that is the market that's going to get significantly bigger, if we 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 two years out, but yes, definitely associated with customer – interested customer pool (00:45:24).

[Josh Ward Sullivan, Seaport Global Securities LLC]

Okay. Great. I'll join back in the queue. Thank you.

[Operator]

And our next question comes from Michael Leshock with KeyBanc. Please go ahead.

[Michael Leshock, KeyBanc Capital Markets, Inc.]

Hey. Good morning.

[Damon J. Audia, Carpenter Technology Corp.]

Good morning, Mike.

[Michael Leshock, KeyBanc Capital Markets, Inc.]

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?

[Damon J. Audia, Carpenter Technology Corp.]

Yeah. Mike, what we said in our opening remarks was that we would expect the numbers to these in SAG (00:46:02) 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 color around $18 million to $20 million per quarter.

[Michael Leshock, KeyBanc Capital Markets, Inc.]

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

[Tony R. Thene, Carpenter Technology Corp.]

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.

[Michael Leshock, KeyBanc Capital Markets, Inc.]

All right. Great. Thank you, guys.

[Tony R. Thene, Carpenter Technology Corp.]

You're welcome.

[Operator]

The next question comes from Jeremy Kliewer with Deutsche Bank. Please go ahead.

[Jeremy Kliewer, Deutsche Bank Securities, Inc.]

Hey, guys, good morning.

[Tony R. Thene, Carpenter Technology Corp.]

Good morning.

[Jeremy Kliewer, Deutsche Bank Securities, Inc.]

Just a little bit more color on the SAO significant (00:47:01). You mentioned there was a lot of product – but is that product mix supposed to stay rich moving forward that was like the next-gen engine ramp or are you anticipating normalized as your legacy quarters or (00:47:16) Q1 through Q3 levels?

[Tony R. Thene, Carpenter Technology Corp.]

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.

[Jeremy Kliewer, Deutsche Bank Securities, Inc.]

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 prior list is it shareholder returns or is it M&A activity just following your soft alloy and all the other investments as you've already identified?

[Damon J. Audia, Carpenter Technology Corp.]

Yeah, Jeremy. I think as you see, we're allocating more capital to growth CapEx in fiscal year 2019, as we've alluded to especially in the areas of additive and soft magnetics. With that tax legislation change has resulted in lower cash taxes and we have redeployed that back in the 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 2022 and we have no significant pension plan contributions until FY 2022 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 that's complete solutions provider. As we think about growing the business for the customers, we've done a couple of things as you've seen, we acquired Puris a couple 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've said in the past and then, we'll also compare that against incremental returns to the shareholders.

[Jeremy Kliewer, Deutsche Bank Securities, Inc.]

Okay. Thank you. Good luck.

[Operator]

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

[Josh Ward Sullivan, Seaport Global Securities LLC]

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

[Damon J. Audia, Carpenter Technology Corp.]

Yeah. 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 2018 inventory levels were flat compared to 2017. 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 2019, 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 if you go back to my comments, we're going to monitor that based on the market demands.

[Josh Ward Sullivan, Seaport Global Securities LLC]

Okay. Thank you.

[Operator]

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.

[Brad Edwards, The Plunkett Group]

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

[Operator]

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