Good day, and welcome to the Carpenter Technology Corporation Second Quarter Fiscal Year 2022 Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Brad Edwards, Investor Relations. Please go ahead..

Thank you, operator. Good morning, everyone. Welcome to the Carpenter Technology Earnings Conference Call for the fiscal 2022 second quarter ended December 31, 2021. 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, 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 these forward-looking statements can be found in Carpenter Technology's most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2021, Form 10-Q for the quarter ended September 30, 2021, and the exhibits attached to those filings.

Please also note that in following discussion, unless otherwise noted, when management discusses sales or revenue, that reference excludes surcharge. When referring to operating margin, that is based on operating income and sales, excluding surcharge. I will now turn the call over to Tony..

Thank you, Brad. And good morning to everyone. Let's begin on Slide 4 and a review of our safety performance. Through the second quarter, our total case incident rate was 1.0, which is a slight improvement from the first quarter. It remains above our fiscal year 2021 performance of 0.6, which was our best fiscal year safety performance on record.

Safety continues to be our #1 core value and we continue to push towards an ultimate goal to be a 0 injury workplace. Our safety teams continue to emphasize key initiatives at work centers, including hand safety, leadership development and employee engagement.

And we are expanding our safety engagement outside of work, emphasizing safety always and encouraging employee families to get involved. You can read more about our safety programs in our 2021 sustainability report, which we released in October.

In addition to highlighting our commitment to the health and safety of our employees, the report details our environmental stewardship and social programs to engage employees and local communities. Now let's turn to Slide 5 and a review of the second quarter.

We continue to see demand improve across each of our end-use markets, though the pace of recovery varies by end-use market. In particular, we see signs of a broad-based recovery taking hold across the supply chain in aerospace market. And the medical end-use market continues to demonstrate strong growth.

One key indicator of demand is backlog growth, which is accelerating. Our backlog increased 35% sequentially, 106% year-over-year, surpassing last quarter's growth. The backlog growth is being driven by the bookings rate, which increased 31% sequentially and 55% year-over-year.

We have continued to work with our customers, preparing for the recovery across that market. As a result, we completed long-term contract renewals with key aerospace and defense customers in the second quarter, locking in share and pricing gains. We also received 3 additional Athens qualifications in the second quarter.

The PEP segment finished ahead of our expectations, largely driven by higher-than-anticipated demand in the medical end-use market. However, performance in the SAO segment was impacted by operational challenges, including labor shortages due to both COVID-19 isolation and hiring challenges in the current labor environment.

Additionally, -- as previously announced, we had an unplanned outage at the Reading 4500 ton press. As you may know, this press is an important piece of equipment, serving customers across multiple end-use markets. Repair efforts are underway and on track. We currently expect to be fully operational during the third quarter of fiscal year 2022.

As a part of the repair process, we are able to pull forward planned maintenance, reducing any additional downtime through the remainder of the fiscal year. Looking ahead, we don't expect any long-term impact from these challenges and expect SAO performance will accelerate as market conditions continue to improve.

Finally, our liquidity remains healthy as we finished the quarter with $392 million in total liquidity. We also continue to provide direct returns to our shareholders through our quarterly dividend program. Now let's move to Slide 6 and the end-use market update.

Our Aerospace and Defense end-use market sales were down 1% sequentially and 10% year-over-year. As a reminder, in the second quarter of fiscal year 2021, we had a variety of onetime customer contract-related items that boosted our quarterly performance and contributed to the year-on-year decline.

Sequentially, demand improvements were offset by operational challenges, including the unplanned outage of the 4500 ton press. Looking ahead, the market continues to recover despite any near-term supply challenges related to the Omicron variant.

Industry consensus is still anticipating an improved calendar year 2022, and we see evidence of this with increased bookings and extended lead times across the applications. And as a result, our backlog continues to rise as customers plan for ongoing improvement.

Specifically, our aerospace and defense end-use market backlog is up 35% sequentially and 72% year-over-year. In the medical end-use market, sales were up 9% sequentially and up 39% compared to last year. The results reflect ongoing improvement in the medical device submarket.

While there are some concerns about the near-term impact of the Omicron variant on hospital staffing levels in certain geographical locations, the overall outlook is positive as medical procedures are expected to rise to pre-pandemic levels in calendar year 2022.

We are seeing replenishment in the supply chain to support the expected growth as our medical end-use market backlog is up 39% sequentially and 163% year-over-year. We expect this trend to continue with booking rates and backlog showing further improvement in the coming quarters.

Medical's performance is a key driver of the improvement in Dynamet titanium business. The strong recovery helped the PEP segment beat expectations in the second quarter. In the transportation end-use market, sales were down 9% sequentially and up 10% compared to last year.

The sequential results reflect the supply chain challenges and chip shortages that are impacting the end-use market activity levels. However, the global light-duty vehicle outlook shows renewed optimism that the semiconductor-related shortages will ease.

With consumers continuing to spend even as inventories are at historic lows, we expect strong demand to continue into calendar year 2022. And we see strong demand and market share growth opportunities in the heavy-duty truck, off-road, watercraft and aftermarket submarkets.

In the Energy end-use market, sales were down 1% sequentially and down 10% to last year. Notably, the year-over-year comparison is impacted by the cyclical power generation business, which is down 44% after a strong Q2 in fiscal year 2021. The oil and gas business, on the other hand, is up 25% year-over-year.

The outlook for the oil and gas submarket is solid. In North America, oil and gas submarket continues its steady recovery with the rig count up 100% compared to last year, and capital expenditures growing. International markets are showing signs of their own recovery with 100% increase in new projects and a 23% increase in rates compared to last year.

In the industrial and consumer end-use market, sales were flat on a sequential basis and up 18% on a year-over-year basis. We continue to see historically high demand for our semicon solutions and expect demand to remain strong throughout the fiscal year.

In addition, we continue to see healthy demand in the electronics submarket evidenced by growing backlog. Further, we have strong engagement from our customers in the electronics submarket on our recently commissioned hot strip mill in Reading. Now I'll turn it over to Tim for the financial segment..

Thanks, Tony. Good morning, everyone. I'll start on Slide 8, the income statement summary. Net sales in the second quarter were $396 million, and sales, excluding surcharge, totaled $314.9 million. Sales, excluding surcharge, increased 5% from the same period a year ago or 9% higher volume.

Sequentially, sales were up slightly about 1%, with a slight decrease in volumes. As Tony covered in his comments, we continue to see improving demand conditions across our end-use markets as evidenced by our growing backlog.

With that said, the current quarter's results were negatively impacted by COVID-19 isolations in certain key flow paths, as well as the ongoing challenges associated with staffing targeted production positions. These challenges impacted our ability to meet our production targets for the quarter.

I'll cover those in more detail shortly in the SAO segment summary. Gross profit was $13.1 million in the current quarter compared to $6 million in the second quarter of last year and $25.2 million in the first quarter of fiscal year 2022. The year-over-year improvement in gross profit is primarily due to the higher sales.

In addition, last year's second quarter included the significant negative impact on profitability related to lower activity levels across our facilities combined with targeted inventory reduction actions that were executed.

SG&A expenses were $44.6 million in the second quarter, up $2.4 million from the same period a year ago, and essentially flat sequentially. The year-over-year increase primarily reflects higher amortization costs related to the ERP system that was placed in service at the beginning of calendar year 2021.

The operating loss was $31.5 million in the current quarter. When excluding the impact of special items, adjusted operating loss was $29.8 million in the current quarter compared to a loss of $32.3 million in the prior year period and a loss of $17.5 million in our recent first quarter. Our effective tax rate for the second quarter was 16%.

For the 6 months ended December 31, 2021, the effective rate is just under 27%, which is slightly lower than the full year guidance we gave at the start of the year of 28% to 30%.

As we look forward, we expect the tax rate for the balance of the year to trend lower in the range of 23% to 25% as losses in certain tax jurisdictions for which a tax benefit cannot be recorded are less impactful to our effective tax rate. Earnings per share for the quarter was a loss of $0.61 per share.

When excluding the impact of special items, specifically the COVID-19 costs, adjusted earnings per share was a loss of $0.58 per share. Now turning to Slide 9 and our SAO segment results.

Net sales for the second quarter were $330.8 million, or $251.6 million, excluding surcharge, matching the sales ex surcharge results from the second quarter of last year on a 12% increase in volumes.

The year-over-year net sales results were driven by increased sales in materials to the medical, transportation and industrial and consumer end-use markets that were largely offset by declines in sales to the aerospace and defense and energy end-use markets.

I should point out that the year-over-year comparisons for the aerospace and defense end-use market are challenging, given some of the dynamics from the year ago quarter as we had several nonrecurring benefits in Q2 of last year, related to customer contracts. Sequentially, sales excluding surcharge decreased 3% on 1% higher volume.

The sequential results reflect increased shipments to the medical end-use market, which were more than offset by decreases in other markets. Moving to operating results. SAO reported an operating loss of $20.3 million for the current quarter.

The same quarter a year ago, SAO's operating loss was $11.6 million; and in the first quarter of this fiscal year, SAO reported an operating loss of $5.9 million.

As I mentioned earlier, SAO's operating results were influenced by some near-term operational challenges, including COVID-19 isolations at certain key work centers and hiring challenges to staff certain production roles. These operational challenges were compounded by the Reading press outage late in the quarter.

Year-over-year operating results declined by just over $10 million when adjusting for the impacts of the COVID-19 costs in both periods.

The decline in SAO operating performance was largely due to higher operating costs as we continued to increase production staff to meet the growing demand as well as inflationary pressures and some critical operating supplies.

In addition, the year-over-year results were impacted by higher amortization and depreciation costs associated with our ERP system that was placed in service during fiscal year 2021 and the newly commissioned hot strip mill. The negative impacts were partially offset by the impacts of fluctuating inventory levels in each period.

In the current quarter, we built $37 million of inventory in SAO compared with a $58 million reduction in the same quarter last year.

From a sequential perspective, the lower operating results were largely a factor of the increased COVID-19 employee isolations as well as the negative impacts of rising raw material prices during the quarter as we continued to build inventory. Looking ahead, we expect the demand conditions across most end-use markets will continue to improve.

As Tony mentioned earlier, our backlogs have grown, and we continue to expect a more pronounced aerospace supply chain recovery to take shape in the second half of our fiscal year 2022.

Our teams are focused on ensuring that the movement of materials and critical flow paths continues to increase, which is necessary to keep pace with the growing demand. We are working diligently on making the necessary repairs to the Reading press and remain on schedule for the press to come back online later this quarter.

Based on current expectations, we anticipate SAO will generate operating results in the range of breakeven to a $5 million loss in the upcoming quarter. Now turning to Slide 10 and our PEP segment results. Net sales in the second quarter of fiscal year 2022 were $85.7 million or $83.8 million, excluding surcharge.

Net sales, excluding surcharge, increased 55% from the same quarter last year and were up 14%, sequentially. The year-over-year growth in net sales reflects increased sales across all business units, led by our Dynamet titanium business where year-over-year demand increased in both Aerospace and Defense and Medical end-use markets.

We've also seen a significant improvement in sales driven by demand in our additives and distribution businesses. The sequential increase in net sales was led by growth in additive sales. Our distribution business and Dynamet business also drove sequential sales growth supported by stronger demand.

In the current quarter, PEP reported operating income of $3 million. This compares to an operating loss of $7.2 million in the same quarter a year ago and operating income of $0.6 million in our recent first quarter.

The year-over-year operating income improvement is primarily the result of increased net sales as well as benefits from the actions we took to restructure the additive business unit in fiscal year 2021. As we look ahead, we believe that demand conditions will continue to improve in the coming quarters.

We currently anticipate that the PEP segment will deliver operating income in the range of $4 million to $5 million for the third quarter. Now turning to Slide 11 and a review of free cash flow. In the current quarter, we used $89 million of cash for operating activities.

The cash flow used in operations was primarily the result of increase in inventory by $43 million in the current quarter. The increased inventory in the current quarter, is primarily the result of the near-term operational challenges I mentioned earlier.

We expect this build-in inventory to be temporary and have plans in place to reduce inventory levels throughout the balance of the year despite improving demand conditions. With the inventory reduction in the second half of the fiscal year, we expect to generate positive cash flow in the second half of fiscal year 2022. Moving down.

We previously provided guidance that we do not expect to have any required minimum pension contributions for our U.S. qualified plans during fiscal year 2022. In the second quarter of fiscal year 2022, we spent $19 million on capital expenditures. At the beginning of the year, we targeted $125 million of capital expenditures for fiscal year 2022.

As we move through the fiscal year, we currently expect that the full year capital expenditures will be in the range of $100 million to $110 million, given some delays in projects due to the availability of outside contractors as well as extended lead times for certain materials.

We also continue to fund a constant dividend to our shareholders, which we consider as part of our free cash flow. With those details in mind, we reported $116 million of negative free cash flow in the quarter.

Our liquidity remains healthy, and we ended the current quarter with total liquidity of $392 million, including $97 million of cash and $295 million of available borrowings under our credit facility. With that, I will turn the call back over to Tony..

Thanks, Tim. Demand across our end-use market continues to improve, and we are focused on meeting demand from the recovery. We saw strong bookings and backlog growth generated during our second quarter, and we expect it to continue for the foreseeable future.

We continue to work closely with our key customers, navigating the recovery and partnering to solve their critical needs. In the second quarter, we renewed several long-term contracts, locking in price increases and share gains.

While the results for the second quarter of fiscal year 2022 were impacted by near-term operational challenges, we believe they are short term in nature and won't impact our ability to serve our customers and drive growth over the long term.

We are on track to complete repairs at the Reading 4,500 ton press in the third quarter, and have pulled forward planned maintenance that will open capacity through the rest of the fiscal year.

With additional qualifications for our Athens facility, we continue to prepare ourselves to provide the capacity and capability required for the aerospace recovery. We continue to implement the Carpenter Operating Model to address short-term labor challenges and increased productivity across facilities.

In the second half of the fiscal year, we intend to reduce inventory, which will have a positive impact on our cash flow and retain our strong liquidity position throughout the fiscal year. Finally, our soft magnetics and additive manufacturing platforms offer long-term growth opportunities. Thank you for your time.

And now I will turn it over to the operator to take your questions..

And the first question comes from Josh Sullivan with the Benchmark Company..

Just as far as the press outage, what's the history of that press or other similar presses like it as far as turnaround and getting the equipment back into service?.

Josh, one thing, this type of failure that we had, it's not common. So it's not something that we deal with quite a bit. Every press that's in this category is going to have this type of failure at some time in its life. The good news is that we had a maintenance and repair planned on the shelf. We knew what we were going to do.

It's always a little bit different as you start to deconstruct the press and what you find, but we had the game plan already in place and the spares on the site. So we were able to mobilize pretty quickly. And as we speak today, the process is on track, and we're prepared to come back online as we had communicated earlier..

Okay. Got it. And then just on Athens, can you help us understand the overall value of the qualifications you received? I understand a number of qualifications going up, I think you had 3 this quarter.

But how do we bridge that gap between the number of qualifications versus that potential value or maybe what those qualifications represented at the old facilities? Just trying to understand the difference between a number of qualifications versus the value maybe that they represent?.

Yes, Josh, I think the best way to look at that, some time ago, we stated we're not going to bifurcate between all of our locations because we run as a total system. So we're moving product among our facilities as we speak.

I think the best way to look at it is as you see our sales increase and you see some of the contracts that we are signing today in this quarter, for example, that is for an increased share you should assume that, that is largely due to the fact that we have Athens and the ability to supply more.

So the fact that we have that capacity in the marketplace today is serving us well. And we renegotiate those contracts going forward..

And then just one last one on the soft magnetics hot strip mill, how should we think of the electrification demand cycle there and backlogs? Let's say historically, that was an aerospace market, but just curious how you think we should be looking at backlogs going forward as the broader electrification demand trend kind of plays out..

Yes. As we go forward over the next couple of quarters, we're going to be more vocal in that area and give you some more information. I can tell you that the interest in demand in that new strip mill has been significant in the first couple of months, since its existence. So I'm very pleased with that mill and the investment we made.

And that's going to be a really nice earnings accelerator for us over the next couple of years..

The next question comes from Michael Leshock with KeyBanc Capital Markets..

You guys mentioned share gain opportunities. And I just wanted to get your take on how the competitive environment looks right now.

And are you seeing opportunities to take share from competitors? Or is it more secular growth and expansion of long-term contracts?.

Well, in this area, and I'm sure you're speaking primarily on the aerospace billet area. There's not a large amount of competitors in the space. Of course, the market is going to be growing, so that's part of it. And then we're always looking to find where we can provide a more stable supply to our customers.

So it's a combination of both of those, Michael..

Okay.

And given the current build rates that we got from the OEMs, specifically with Boeing, the MAX at 26 per month and the 787 near 0, where are you shipping in regards to those rates? Or are there any aerospace platforms where you're shipping above or below rate?.

Interesting question. We're shipping -- we don't ship directly to Boeing. So we ship to their suppliers. And I can tell you for the most part, all of those suppliers are becoming more and more confident in the specific platforms with specific parts. They have increased their order intake considerably over the last couple of months.

You can see that in the numbers that I stated in terms of backlog growth and bookings. So you've got an industry right now that is ramping up pretty quickly. There are certainly a concern in the market, can supply keep up. That's why it's so important and critical and strategic for us to have Athens.

So the discussions and the traffic is getting much more pronounced here in the next couple -- the last couple of months. And that's good news for Carpenter Technology and for our future as we see the demand coming back to us..

And then just lastly for me, what are the implications of a natural gas price spike here if you could provide any sensitivity around that and the hedges you might have in place?.

I'll leave that one to Tim..

Yes, Mike, we do have an active hedging program. We hedge pretty significant portion of our forward natural gas, expected purchases about 65% on an average basis. So we feel pretty protected from a price spike in the future. So not a significant impact for us. We don't expect..

The next question comes from Matthew Fields with Bank of America Merrill Lynch..

I just wanted to ask about some kind of discrete cash flow items. You haven't made a pension contribution yet this year -- this fiscal year.

Are you intending to make a kind of similar pension contribution as previous years? Or is there kind of a bigger onetime contribution you plan on this year that you can let us know about?.

Matt, it's Tim Lain. No, we don't have any minimum required pension contributions this year of any significance. So no..

And you don't plan on making a voluntary one..

That's right..

Okay. And then working capital, you touched on a little bit in your prepared remarks about your desire to reduce inventory. Working capital has been a pretty big use so far in the 6 months about $140 million use.

Do you plan on getting back to breakeven for the full year? Or is that going to be kind of a big use of capital for the full year despite your kind of efforts on the inventory side in the back half?.

I'd say sticking particularly with inventory, that's the biggest piece of that working capital draw. We talked about how we built it and the reasons were better than the first half. We've got plans in place to take that down in the second half and we would certainly target getting back to near where we started the year.

There may be some opportunities here near to build inventory where we think is appropriate. But that's at least what we're planning to do for the balance of the year is trying to take that out, the amount we build in the first half take it out in the second half..

Okay.

So try to get back to kind of breakeven for the full year is sort of what I'm trying to pick up?.

Yes, for inventory that is..

Okay. And then basically, the bigger picture of sort of cash and cash position and cash flow, it seems like this year is going to be a pretty significant use of free cash, even with inventory reductions in the second half.

Given the environment, the press outage, continued disruptions, inflation, are you comfortable with your liquidity position? I know you have the full kind of revolver available, but do you feel like you need to put more liquidity on the capital structure with either some kind of additional issuance in the capital markets..

Well, where we sit today, Matt, I'd say we're pretty comfortable with where we are from a liquidity -- total liquidity perspective. There obviously is going to be ups and downs in each quarter, but we're pretty satisfied with where we sit today.

In terms of the capital markets, we do have some notes that mature or that become current over the coming months that we'll address. But no plans to -- that's something we'll evaluate in the future. So nothing today and we feel pretty good about where we are from a liquidity perspective..

No need to monetize any assets or issue equity or kind of any transactions to bolster your kind of liquidity position at this time?.

No. Matthew, this is Tony. I'd say we're not even close to that. So I mean, that's not even a discussion selling -- monetizing assets and issuing equity. We're not even close to that area. So I'm a little surprised with your question, quite frankly.

I mean, certainly, with some of the issues we've had with the press outage, we've built inventory in the first half strategically to make sure we could do everything we could for our customers in the second half, naturally that will come out. And with the demand coming back, we see a very healthy free cash flow positive business.

So there's no concerns on us that we have to do some of the extreme things that you just mentioned..

Okay, great..

It looks like we have no further questions. So this concludes our question-and-answer session. I'll turn the conference back over to Brad Edwards for closing remarks..

Great. Thanks, Tom. Thanks, everyone, for joining us today for 2022 fiscal second quarter earnings call. We look forward to connecting with all of you again in the near future. Take care. Have a great day..

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