Carpenter Technology Corporation

Good morning and welcome to the Carpenter Technologies Second Quarter Fiscal 2020 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. 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, and welcome to the Carpenter Technology earnings conference call for the fiscal second quarter ended December 31st, 2019. This call is also being broadcast over the internet along with presentation slides. Please note, for those of you listening by phone, you may experience a time delay in slide movement. Speakers on the call today are Tony Tain, President and Chief Executive Officer, and Tim Lane, 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 Technologies' most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2019, Form 10-Q for the quarter ended September 30, 2019, and the exhibits attached to those filings. Please also note that in the following discussion, unless otherwise noted, when management discusses sales or revenue, that reference excludes surcharge. When referring to operating margins, that is based on operating income and sales excluding surcharge. I will now turn the call over to Tony.

Thank you, Brad, and good morning to everyone on the call today. Let's begin on slide four and a review of our safety performance. Our total case incident rate, or TCIR, stands at 1.3 through the second quarter of fiscal year 2020. Our employees are the face of our safety program. They are the most knowledgeable about the workplace and know how to make it safer. Their engagement and promotion of our safety system is essential for our success. While TCIR is our primary measure of performance, we continue to see improvements in our leading indicators. For instance, When we look at our total injuries, which include first aid treatment cases, our injury frequency rate has improved 17% year over year. In addition, proactive activities such as reporting of near misses and safety stops have increased by 44%. The emphasis we have placed on improving our safety culture has resulted in a reduced severity of injuries, which is a direct result of our employees' involvement and engagement. we're confident that continued focus on ongoing investment in our safety systems will deliver our ultimate goal of a zero-injury workplace. Now let's turn to slide five and a review of the second quarter performance. Our second quarter results demonstrate our ability to deliver consistent year-over-year earnings growth and drive backlog expansion while generating record performance at SAO. This past quarter marked our 12th consecutive quarter of year-over-year sales and earnings growth. It also marked the 12th consecutive quarter of year-over-year backlog growth as we continue to execute at a high level. Our solutions help customers address critical performance requirements, and this is driving expanded sales opportunities and share gains across our in-use markets. At SAO, we are driving a richer product mix, which contributed to record second-quarter operating income. This marked the second consecutive quarter of record operating income performance at SAO. In addition, our deliberate mixed shift, the benefit of our Athens facility, and productivity improvements resulted in adjusted operating margin of 19.9% during the second quarter. This is the fifth consecutive quarter in which SAO adjusted operating margin was above 18%. In the aerospace and defense in-use market, sales increased 19% year-over-year, and backlog was up 14% compared to last year. Our sales and backlog performance in the aerospace and defense in-use market demonstrate the benefits of our broad solution portfolio, our strong presence across attractive sub-markets, and participation on almost all the major platforms. In addition, customer activity and dialogue at Athens remains high. and we received four additional VAP approvals during the second quarter. Sales in the medical end-use market, which accounts for approximately 9% of total company revenue, increased 13% compared to last year. Our high-value solutions continue to capitalize on strong demand patterns. Lastly, we continue to be committed to building on our strong core business by making strategic investments in critical emerging technologies. These are areas that we believe will be significant in the future of our industry, and our investments will strengthen our long-term position as a solutions provider and critical supply chain partner for our customers. I will touch more on this subject later in the presentation. Now let's move to slide six and the in-market update. Looking first at aerospace and defense, where sales increased 19% compared to last year. This is year-over-year growth in each of our aerospace sub-markets. The 737 MAX grounding and recent production halt is a major and ongoing development for the entire aerospace supply chain. While we are certainly not immune to the situation, we do believe we are well positioned to navigate the near-term impact. I will provide more detailed comments on this topic shortly. Moving on to the medical end-use market, where sales were up 13% year-over-year. This growth was due to share gains primarily in the orthopedic and dental submarkets. It is clear our solutions bring significant value to customers as we are winning market share, and our deepened OEM relationships are unlocking incremental opportunities for our high-value applications. Capacity expansion projects at Dynamet are nearing completion, which will allow us to further capitalize on the strong forward demand indicators we see in this end-use market. We see ongoing strong demand for applications across many of our submarkets, including orthopedics, cardiology, and dental. In the transportation end-use market, sales were up 4% compared to last year. In the light vehicle submarket, there's increasing demand in North America for local content and high-temperature resistant alloys. We are capitalizing on these demand patterns with our high-temperature bar and strip solutions that are specifically designed to address increasing engine performance requirements. Now moving to the energy in-use market and our oil and gas and power generation submarkets. Total energy sales declined 26% year over year. The oil and gas market is facing significant headwinds in North America as operators have reduced drilling activity, idled equipment, and continue to operate with a focus on managing free cash flow. The North American directional and horizontal rig count fell 9% sequentially and was down 23% compared to last year. The oil and gas submarket accounts for only 5% of total company revenues. Given the ongoing challenges facing the oil and gas business, especially in North America, we initiated restructuring actions at our Omega West business during the second quarter. In the industrial and consumer end-use market, revenues were down 18% year-over-year, and sales declined mainly due to reduced infrastructure activity and some volatility in the semiconductor market. It is also important to note that our sales into the industrial sub-market continue to be impacted by portfolio prioritization as we further shift our production to higher-value solutions. Now let's move to slide seven, where I will update you on the 737 MAX discussion. Over the last several years, we have worked hard to refine our strategic vision, which is to be a preferred solutions provider of mission-critical products and an irreplaceable partner in the supply chains we participate. I've mentioned several times in the past that the breadth of our solutions portfolio is a strategic advantage. That advantage is evident today as the supply chain manages through the 737 MAX disruption. More than half of our total revenue is generated from the aerospace and defense end-use market, which as you know, is an attractive margin business. However, we also provide key solutions in other strategic end-use markets, such as medical, industrial and consumer, and transportation. It's important to note that across every one of these end-use markets, we participate in the top 1% of the value pyramid, high-end, specially alloyed products that address critical application performance requirements. In our aerospace and defense market, we participate in rich submarkets, such as engines, fasteners, structural, and defense, with exposure on practically all commercial platforms. We believe our diverse industry participation from an application and submarket standpoint is an important differentiator when compared to other aerospace supply chain participants. As such, this portfolio breadth provides opportunities to partially mitigate disruptions in the market, such as the current 737 MAX issue, over the next couple quarters. With that said, it's clear that the supply chain reaction to the recent 737 MAX development remains in a state of flux. We are working closely with our customers to understand their material needs and evaluate how their reaction to the 737 MAX production halt will ultimately impact our production plans. Of course, every customer is different. For instance, we know of certain customers that already anticipated the latest negative news to some degree and adjusted their projected requirements. We've also seen certain customers reporting a high need for spares and asking for urgent spot support. To be clear, when I speak of the need for spares, I'm referring to older engines which are still in service and are running longer. Of course, there are many supply chain participants who are still evaluating how they want to proceed as they look to balance near-term reduced requirements against the need to maintain production rate readiness. This is a critical concept to manage as production capacity in this complex supply chain can't easily and effectively be turned off and on. Finally, there are participants that did not anticipate the recent news. Having built ahead, they are now expressing reduced near-term requirements. That takes us to the ultimate question. What is the anticipated impact of carpet technology due to the 737 MAX disruption? Carpet technology provides specialty materials to our customers, who in turn use that material to forge and manufacture parts that are ultimately used in the production of aircraft and related components. This makes it more difficult for us to specifically identify which platform or application each pound of material that we sell will be used in. However, we know our customers well and can make certain assumptions. Those assumptions are based on where we believe our customers are positioned in the supply chain and what portion of their business is allocated to each aircraft platform, as well as where they might be leading or lagging actual demand. With that framework in mind and based on what we know today, we estimate the net impact for our SAO segment in the third quarter to be approximately $10 million of operating income. Let me offer a few points of clarification. The estimate is not exact, but rather represents the average of a range based on varying time assumptions. The estimated financial impact is a net impact number. In other words, it is our estimated gross impact less an estimate of any mitigating action. And finally, this estimate is for SAO Q3 only and may not be relevant to other periods. Assuming this estimated net impact, SAO operating income in Q3 is projected to be similar to the results delivered in Q2. The result would be a record third quarter for SAO despite the negative impact of the 737 max disruption. I think that speaks to the earning strength of SAO. For our PEP segment, we estimate that the net impact in Q3 will be between $1.5 and $2.5 million in operating income. The same clarifications I just made apply to the PEP segment estimate as well. Obviously, the fourth quarter is less clear. We would expect that the gross impact will be higher, but we also have more opportunity to exercise the mitigating actions. That being said, it is possible that the fourth quarter net impact is similar to what I just communicated for the third quarter. As I mentioned, the exposure we are referring to is net of actions we anticipate will reduce the disruption impact. Those actions in the near term include redeploying capacity to non-737 MAX demand for firm orders currently in our backlog. This would include firm orders for the broader aerospace and defense market, as well as high-value applications across our other in-use markets, including transportation, medical, energy, and industrial consumer in-use markets. In some cases, the long lead times we have seen due to the ramp in aerospace demand over the last several years have been limiting our ability to capitalize on sales opportunities in other markets. We believe we may be able to be more flexible in these high-value areas by redeploying our capacity as the aerospace supply chain digests the 737 MAX production situation. While the ongoing 737 MAX situation is certainly a major development, we continue to believe in the strong, long-term underlying fundamentals of the aerospace market. 737 MAX situation clearly presents challenges for the overall aerospace supply chain. However, we believe we are better positioned than many other companies to weather this situation. We will continue to evaluate the situation, stay in close contact with our customers, and execute initiatives aimed at partially offsetting the negative impact of the 737 MAX disruption. Now I'll turn it over to Tim for the financial review.