Carpenter Technology Corporation

Good day, and welcome to the Carpentry Technology Corporation third quarter fiscal 2020 conference call. All participants will be in the listen-only mode. Should you need assistance, please signal conference specialists by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note that this event is being recorded. I will now like to turn the conference over to Brad Edwards from Investor Relations. Please go ahead, sir. Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology earnings conference call for the fiscal third quarter ended March 31st, 2020. 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 Kane, President and Chief Executive Officer, and Tim Wayne, 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 30th, 2019, Form 10-Q for the quarter's ended September 30th, 2019, and December 31st, 2019, and 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 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 on the call today. I hope you and your families are well and safe. Let's begin on slide four, a review of our safety performance. Our total case incident rate of TTIR dropped to 1.1 in the third quarter of fiscal year 2020. We've worked extremely hard in the last five years to make safety the cornerstone of our company culture. The goal of a zero-entry workplace is embedded across all of our locations. With that same mindset, we were able to quickly respond to the COVID-19 pandemic. with an immediate focus on protecting our employees, their families, and our facilities. Let's go to the next slide and talk more about our action. A couple of technologies, especially metal iron, . In some cases, the sole source for treating material solutions is critical applications, making them viable to continue production of essential manufactured products. We fully understand our role as an essential business. and know that it is important for us to continue to operate during this challenging period. We took immediate action, such as remote working, enhanced personal hygiene, social distancing, and limiting access to our facilities. But our total pandemic response is much deeper and complex. We have focused on four pillars, which are game changers in terms of safely operating manufacturing facilities during a pandemic. The first is the Rapid Response Team, made up of employees from multiple disciplines who spend 100% of their time focused on safely operating their facilities during the COVID-19 crisis. The second is a robust self-reporting and self-isolation program. We require all employees to self-report to our medical team if they meet any of the detailed criteria. If being necessary, they are placed on a paid 21-day self-isolation. The third is a modularized pod work environment that acts as a circuit breaker to virus transmission within a department or shift. The pods consist of two fundamental principles. One, full separation between shifts and a 30-minute air gap. And two, strict defined boundaries within a shift. The fourth is temperature streams for everyone on site. employees, contractors, and delivery drivers. Extensive protocols and work instructions have been implemented for each of the four parts. Because of corporate technology's deep-rooted social culture, we have been able to keep our facilities operating while providing unparalleled safety protections for employees. Now, let's turn to slide six, and then we are the third quarter percent. Our ability to act quickly and work safely during a global pandemic is a significant strategic advantage for corporate technology. It sets us apart from other companies and reinforces our position as a resilient and reliable supplier. In the third quarter, we achieved earnings per share of 82 cents. Those results were driven by strong commercial and manufacturing execution in a challenging environment. Our operating income of $68.7 million for the quarter included a negative impact of approximately $5.5 million in COVID-19. Despite the headwinds, FAA delivered operating margin of 19.2%. The fifth consecutive quarter with adjusted operating margin of about 18%. In addition, customer engagement regarding VAP approval, our acting security remains consistent. that we obtained another meaningful approval during approval. In the aerospace and defense in-reach market, sales increased 7% year-over-year, while the aerospace engine sub-market increased 11%. In the medical in-reach market, sales increased 10% sequentially. Although still close to historical highs, backlogs decreased year-over-year for the first time in 18 quarters, down 7%. Our ability to put in orders helps offset the impact of the 737 MAX production hall and COVID-19. However, as the COVID-19 pandemic progressed, all the demand patterns across all English markets began to be impacted. To that end, we have implemented targeted portfolio restructuring and cross-reduction initiatives in order to maintain a strong balance sheet. Tim will provide more details on these portfolio moves and our strong liquidity position during these two months. Make no mistake, we will continue to pursue liquidity and enhance our financial flexibility as we navigate the challenging environment caused by COVID-19. Now, let's move to slide seven in the in-reach market update. I will be brief in discussing the third quarter market details as the primary focus of today's discussion on the forward market outlook, which I already mentioned earlier. Looking first at the airspace and the strength in use market, which accounts for 59% of our sales in the quarter, sales increased 30% compared to last year, and we're up 5% sequentially. Overall, our performance in the quarter was solid, giving a slowdown across the airspace supply chain related to the 737 Max. Moving on to the medical in use market, which accounts for 10% of our sales in the quarter, sales were up 1% year-over-year and up 10% sequentially. The transportation units market accounted for only 6% of total sales in the quarter, and sales were down both year-over-year and sequentially. Activities heavily impacted by lower light vehicle sales due to plant closures around the globe, as well as the flattening of the North American heavy-duty truck market. Now moving to the energy units market, which accounted for just 6% of total sales in the quarter. Sales declined 29% year-over-year. The oil and gas downturn rapidly accelerated in the third quarter due to a combination of COVID-19 and oversupply dynamics. In the industrial and consumer earnings market, revenues were down 6% year-over-year, but increased sequentially by 6%. due to the continued strength in the semiconductor demand and higher consumer electronic sales. Now I'll turn it over to Tim for the financial review. Thanks, Tony. Good morning, everyone. I'll start on slide nine, the income savings summary. Net sales in the third quarter were $585.4 million, and sales excluding surcharge totaled $495 million. Sales excluding surcharge increased 5% sequentially on 5% higher volume. Compared to the third quarter a year ago, sales decreased 2% on 9% lower volumes. As Tony covered in his review of the markets, the year-over-year results reflected strong growth in aerospace sales, offset by weakening demand in the energy and transportation in these markets. The performance is significant given the challenges that we face late in the quarter related to COVID-19. This impacted our ability to get shipments out of our mills, both due to enhanced safety measures implemented in our facilities, as well as the impact on certain customers who are unable to accept deliveries as they were forced to shut down their operations, particularly in Europe, as a result of the pandemic. Our production teams adjusted extremely well to the additional safety measures, but the transition to this new way of working clearly impacted productivity. The teams also had to deal with certain self-isolation measures that affected staffing levels at key work centers. I'll talk more about the impacts on our results shortly in the segment details. SG&A expenses were $50.8 million in the third quarter, up roughly $1 million from the same period a year ago, and down $4.5 million sequentially. The sequential change reflects the timing of certain expenses from quarter to quarter. Operating income was $58.7 million in the quarter compared to $73.2 million in the prior year period. As Tony mentioned, the current quarter's results include about 5.5 million of COVID-19-related impacts. Last year's third quarter included an 11.4 million insurance recovery benefit related to our Dynamite facility that was included in our PEP segment's operating income results. Adjusted operating income as a percentage of sales was 11.9% in the quarter, representing margin contraction of 270 basis points as compared to Q3 in fiscal year 2019. When excluding the impact of the insurance recovery, year-over-year margin came down about 40 basis points, which is impressive considering the challenging environment. While not specifically shown on this slide, our results for the current quarter include mark-to-market losses related to investments we hold for certain benefit plans. The mark-to-market losses, totaling $3.9 million, are included in other income loss, and are the result of a significant decline in equity values of these underlying assets during the quarter, especially in March. Our effective tax rate for the third quarter was 20%. The tax rate was favorable versus our expectation due to a favorable adjustment related to prior year taxes that were finalized during the current quarter. Net income for the quarter was $39.99, or $0.82 per diluted share. Now turning to slide 10. NRSA segment results. Net sales for the quarter were $488.1 million, or $398.8 million, excluding surcharge. Sales excluding surcharge increased 1% year-over-year on 10% lower volumes. The results reflect strong demand in the aerospace and defense and medical end-use markets, partially offset by weakness in the energy and transportation markets. The aerospace and defense performance speaks to the underlying strength of our position in the supply chain. We offer solutions across multiple platforms, applications, and a broad base of customers. The results are especially significant given the ongoing headwinds facing the supply chain recently related to the 737 MAX production call. Sequentially, sales excluding surcharge increased 4% on 4% higher volumes. SAO operating income was $76.4 million for the third quarter, with adjusted operating margin at 19.2%. The same quarter a year ago, SAO's operating income was $73.6 million. Again, it's worthy to note that despite the significant disruption caused by COVID-19 late in the quarter, the operating teams ensured that our facilities could safely continue to satisfy customer needs. The current quarter's performance reflects approximately $5 million of operating income impacts for SAO, including both delayed shipments and incremental expenses due to COVID-19. Looking ahead to the fourth quarter, we are expecting operating income to be down approximately 50% when compared to our recent Q3 results. Most of the decline in operating income in SAO will be driven by the impacts of the significant reduction in inventory in Q4, as we look to manage cash. Although we had already planned to produce inventory in the fourth quarter, as we demonstrated last year, we are now targeting further reductions in inventory. The significant reductions in new material starts and the associated reduction in raw materials in a time of declining prices will have a significant negative impact on our upcoming fourth quarter's profitability. We are also expecting sales to be down sequentially as the global economy adjusts to the ongoing disruption caused by the current pandemic. Fold visibility is limited, and the impact to each individual market will vary. In addition, individual customer demand adjustments or reactions will vary depending on their individual situation. Our main objective is to stay close to our key customers to understand their needs and further strengthen their positions. To deal with the impacts of lower volumes, we've implemented furloughs for certain production and maintenance positions as we match our workforce needs to production schedules in each of our facilities. In this environment of rapidly changing requirements and plans, we continue to emphasize the importance of the customer operating model. We will continue to lean heavily on areas such as waste elimination, leader standard work, and problem solving. The actions we have taken to implement the corporate operating model are expected to pay further dividends, and we believe will provide significant operating leverage as we continue to navigate these challenging conditions. Now turning to slide 11 and our PEP segment results. Net sales excluding surcharge were $107.1 million, which were down $18.8 million from Q3 of fiscal year 2019 and up slightly sequentially. The year-over-year decline reflects ongoing weakness in energy sales, more specifically in the oil and gas submarket, as well as weaker sales in the distribution business that is more sensitive to global economic conditions. On the positive side, we continue to see year-over-year and sequential growth in medical sales. In fact, sales to the medical market increased 27% sequentially and 19% year-over-year. In the current quarter, PEP reported an operating loss of $0.3 million. For clarity, last year's third quarter operating income of $16.6 million included an $11.4 million benefit from insurance recovery. The results for PEP were influenced modestly by the COVID-19 situation. Again, credit goes to the teams for doing whatever it took to ensure our employees' safety and to keep the facilities operational at this critical time. As we look ahead to the fourth quarter, we expect to see headwinds across most of the markets related to COVID-19. Given the uncertainty associated with COVID-19 on the PEP business, we have initiated several key actions focused on reducing costs and preserving our liquidity. Similar to SAO, we have initiated furloughs for production and maintenance positions across most of the facilities. In addition, we have also recently made several key strategic decisions affecting the PEP segment. Given the ongoing weakness in the oil market, which has worsened since the end of the quarter, we have decided to exit the Omega West business. Actions to exit this business, including strategic discussions with third parties, are underway and anticipated to be completed by the end of our upcoming fourth quarter. We have also decided to idle two domestic metal powder production facilities. We remain committed to metal powder production but consider it necessary to close these two facilities to save costs and preserve cash flow in the near term. Action plans have been initiated and we expect those facilities to be closed during the fourth quarter. We expect that the actions to exit the Omega West business and idle the two powder facilities will generate estimated annual savings of 15 to 20 million based on the current run rates for these businesses. As we look ahead, we expect PEP to report an operating loss of 5 to 6 million in the fourth quarter. Now turning to slide 12 and a review of cash flow. Pre-cash flow in the third quarter was positive 13 million. Within the quarter, we decreased inventory by 23 million. As I mentioned earlier, we expect to continue to reduce inventory in the fourth quarter. In the third quarter, we spent 50 million on capital expenditures. We expect to spend $170 million on capital expenditures for fiscal year 2020, consistent with the guidance we previously provided. Within the $170 million, there are several large multi-year projects. First, the $100 million Hobbs grid mill being constructed on our Reading, PA campus. This investment will be completed next fiscal year and will enhance our soft magnetics portfolio and increase capacity. we have substantially completed the capacity expansion projects for our dynamite titanium business, allowing us to capture emerging growth for high-value titanium solutions in the medical market. Finally, we completed our emerging technology center, which demonstrates and drives the commercialization of new technologies, supporting the company's growth programs. I'll talk a little bit about our future CapEx plans, as well as our liquidity on the next slide. As we move to Flight 13, our liquidity position remains solid, which is critical in today's environment. As of the close of the current quarter, we have 317.1 million in total liquidity, including 93 million of cash. I should note that during the third quarter, given the significant uncertainty as the COVID-19 situation unfolded, we drew 50 million from our credit facility as a preventative measure in the event there were any potential issues with our ability to access our credit facility as needed. We did this purely as a precaution and we remain in regular contact with our banking group participants. We are confident in our banking group's ability to meet the funding commitments under our credit facility. It is also important to note that we are well within requirements for compliance with the covenants under the credit facility. As I mentioned numerous times already, our focus clearly has shifted to preserving liquidity in response to the uncertainty created by the pandemic. Although our current liquidity is strong at $317 million, we are continuing to execute plans to increase cash flow. First, as I mentioned, we are rigorously evaluating our production schedule and related inventory levels to ensure we are aligned with our customer needs. We believe inventory represents a significant cash flow lever for us over the next several quarters. Second, we are actively managing our cost structure. We have already taken actions such as production and maintenance workforce furloughs and a global hiring freeze. Also, given that we are finished with the bulk of our spending on growth projects, we expect to be able to reduce capital expenditures for fiscal year 2021 by 25 to 30% or 40 to 50 million. In addition, as I mentioned, we've taken strategic steps to rationalize our business and facilities portfolio. We've initiated plans to exit a mega left and idle two powder facilities. Again, these strategic actions are anticipated to save 15 to 20 million annually based on current run rates. We've identified additional levers available to us in the event the situation worsens. We have evaluated various scenarios and believe even in scenarios where demand is meaningfully depressed for an extended period of time, we have ample liquidity. Although we have no near-term maturities, we will continue to actively evaluate options to access the capital markets as necessary to ensure the strength of our balance sheet and continue to execute against our disciplined capital allocation philosophy. The actions we have taken over the last several years to ensure the strength of our balance sheet and financial position have put us on solid footing, even as we face the current uncertainty. With that, I'll turn the call back over to Tony. Thanks, Tim. Let's move to slide 15 and a more detailed market outlook. Let me give you a bit more color on how we see our markets for this coming quarter and into our fiscal year 2021. In our aerospace and defense industry market, you see our next quarter as a pause and reset quarter. Clearly, the near and mid-term demand profile has changed, and no one yet understands what the final demand profile will be. We're going to use this time to strengthen our relationship with our customers to maximize our share and work directly with them as they are processing large updates to their forward needs almost daily. We believe we will show more resilience than our competitors, as we have seen a few struggle with COVID-related operating disruptions. Assuming we have some macro return to normalcy in our fiscal year 2021 first quarter, as some are now suggesting, the industry could begin firming up its net back rate and needs. That, in turn, could allow us and our customers higher confidence and visibility into the future. According to our medical news market, although states are currently beginning to reduce restrictions on elective surgery, we do expect restocking efforts to continue in the third quarter of both in-user O&M customers as well as distributors supporting the medical device market as the market adjusts to the change in demand initiated in the third quarter. These restocking efforts are expected to continue to affect our orthopedic and dental markets. We expect the return of electric soldiers to continue to the first quarter of the fiscal year 2021, mostly in orthopedic markets. We expect in-user OEMs and distributors will replenish from the previous stocking levels and begin to attempt . We have enjoyed some success in transportation in this market where we supply high-value solutions. In the fiscal year 2024 quarter, we expect this market will be extremely challenged, as North America, Europe, and South America have been effectively closed through the month of April. As we move into fiscal year 2021, we do expect some stabilization, but at much lower levels. For energy in this market, we see a continuation of a slowdown in oil and gas, with the rig count in North America reducing to historic lows. We expect oil and gas will remain at the correct levels the furthest sale back in the U.S. to around 200 at the end of calendar year 2020. This forward outlook coupled with the continued disruption resulting from COVID-19 is what prompted our decision to exit the American oil business. In summary, it was no surprise we had a subdued outlook over the next couple of quarters. According to technology, it was an advantage that approximately 70% of our total sales originated in the aerospace industry. and the market, both markets that are supported by long-term . In addition, we have emerging technologies, such as , that could be accelerated due to changes caused by this . As I said in my opening comments, the first priority is to protect our employees who have demonstrated another level of dedication and commitment during these challenging times. We have stayed strong in our employees and facilities, delivering on customer and material needs, working diligently to ensure our supply chain is functional and taking decisive action to manage our cost structure and strengthen our financial position. We executed from both a commercial and manufacturing perspective. to deliver a strong survey performance of . And that includes 5.5 million negative impacts due to COVID-19. Today, and certainly as we know, we are all ready to find . With a copy of technology, we have a task force to successfully navigate the near-term disruption caused by COVID-19. We have an effective manufacturing system that includes unique assets capable of producing products and few in the world can match. We produce highly specialized products, several proprietary, that are focused on innovative solutions that are customer-required. Our customer relationships are strong and growing. Over the last several years, those relationships have resulted in meaningful share-giving. During these challenging times, we have demonstrated our resiliency, and that has grown our customers even closer. A strong balance sheet maybe underappreciated in the past, is now critical to our customers and shareholders. And, as Kim mentioned, we have multiple cost reductions and cash generation actions available to us that will allow us to remain in a cash-positive position even in extreme market downtime. In addition, our lead position in airspace and defense and high-value product offerings in the medical market account for approximately 70% At the exit of the Mega West business, we reduced our presence in the volatile energy market to just 3% of total sales and preserved an estimated 15 to 20 million in operating income in the upcoming one year period. Over the last several years, we have consistently delivered quarter over quarter in sales. We've also made investments in critical emerging technologies, including aggregate manufacturing and soft magnetics. that will enhance our long-term sustainable growth profile. Huffington Technology has led many market ventures and difficult operating lines over a 130-plus year history. After previous challenges we have faced, we will navigate this current crisis with a unified approach to safety, serving our customers, supporting the foundation of our business, and delivering value to our shareholders. We are already looking to the future to envision what the new normal will look like once we defeat COVID-19 and our markets begin to recover. We are working on strategic plans to capture opportunities and build on our long-term growth potential. We will emerge from this crisis with an even stronger safety culture, stronger relationships with our customers, and a business well-positioned to excel in the new normal economy. Thank you for your interest, and I'll turn it back to you, operator, to field your question.