Carpenter Technology Corporation

Good morning and welcome to Carpenter Technology Corporation's second quarter 2021 fiscal 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 that this event is being recorded. I'd like to turn the conference over to Mr. 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 2021 second quarter, ended December 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 Tain, President and Chief Executive Officer, and Tim Wayne, 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 Technologies' most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2020, Form 10-Q for the quarter ended September 30, 2020, and the exhibits attached to those filings. Please also note that in the following discussion, unless otherwise noted, when management discusses the 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. Let's start on slide four in a review of our safety performance. Through the first half of our fiscal year, our total case incident rate was 0.5. During this time, we have achieved the lowest incident rate in carpenter technology's history and a 60% improvement year over year. This marks another key step forward in our mission to achieve a zero-injury workplace. It is also noteworthy to point out that our PEP segment worked injury-free during the first half of the fiscal year. We continue to emphasize key initiatives as we look to secure our next safety milestone. Our safety results today are especially impressive given the challenges related to COVID-19. Importantly, every one of our operating facilities has remained open, which is an achievement that I know resonates with our customers and shows a clear resiliency and commitment. Now let's turn to slide five and a review of the second quarter. Our second quarter results finished largely in line with our expectations. Our performance was impacted by ongoing inventory reductions as well as the continued market headwinds. Despite conditions being challenging, we are actively managing our business and have placed consistent emphasis on three key strategic priorities. First, ensure the safety of our employees. Second, drive cash flow generation and strengthen our liquidity profiles. We have made further progress against this initiative in the second quarter and delivered 51 million of free cash flow. Fiscal year to date, we have generated almost 114 million in free cash flow. If you look at the last three quarters, we have generated 214 million of free cash flow. We ended the second quarter with total liquidity of 665 million, including 271 million of cash and no near-term financial obligations. Third, focus on the long-term relationships with our customers. We have successfully deepened our relationships with our key customers across our in-use markets as we partner to address evolving material requirements and the initial signs of recovery across our in-use markets. A great example of this is in the aerospace and defense in-use market, where we have recently extended multiple long-term agreements with key customers. There are a couple critical takeaways from these contract extensions. Customers fully understand that capacity was limited for the aerospace materials we produce prior to the pandemic, and that supply of such aerospace materials will be constrained again when build rates return to normalized levels. Carpenter Technology is one of only a handful of companies in the world that produce these highly specialized materials, and the only one that has invested in capacity, namely the Athens Facility. and the aerospace fundamentals that were present prior to the pandemic remain strong and unchanged going forward. While we are working to best position our core business to be stronger on the other side of the pandemic, we also continue to take steps to advance our capabilities and leadership in critical emerging technologies. To that end, our hot strip mill in Redding is now in the commissioning phase. The mill will be a significant enhancement to our existing soft magnetics leadership position as it expands our capabilities to capitalize on the electrification megatrend that is shaping and growing many of our end-use markets. I will speak more about our leading position in electrification later in my remarks. Now let's move to slide six for the end-use market update. Starting with the aerospace and defense end-use market where sales were down year over year but up slightly sequentially. Many of the trends we were seeing last quarter are still prevalent, including changing forward material needs and uncertainty around recovery timing. While our sequential results were up, we expect our third quarter performance to be choppy as the recovery takes shape. In the medical end-use market, sales were down 3% sequentially as customers continued to manage inventory levels as concerns around hospital capacity and potential resurgence weighed on the supply chain. In the transportation end-use market, sales were down year-over-year, but up sequentially due to a rebound in the global light vehicle sub-market and the strength of our high-temperature solutions. Now moving to the energy end-use market. In terms of the year-over-year comparison, keep in mind that we divested our Megawest business earlier this fiscal year. Within the oil and gas sub-market, conditions in North America remain challenging. For the power generation sub-market, opportunities exist for applications in a gas turbine replacement cycle. Lastly, for the industrial and consumer end-use market, sales were down year-over-year and sequentially. However, we continue to experience strong demand for semiconductor and fluid control applications. In addition, consumer market demand was up across all key application areas. Let's turn to slide seven and discuss the longer-term market outlook and how carpenter technology is positioned to emerge stronger as the market recovers. In our industrial in-use market, we expect continued strong demand in the semiconductor industry for our highly engineered, ultra-high purity materials. This strong demand is driven by global growth in semiconductor manufacturing to support 5G smartphones and cloud infrastructure. In fact, the demand for semiconductor capital equipment is expected to remain robust for the foreseeable future, with the world's largest contract chip maker planning to boost capital spending by almost 50% in 2021. Since Carpenter Technology is a global leader in providing ultra-clean materials to support critical semiconductor applications, we are constantly evaluating customer requests to increase our already strong participation in this space. As we move into the second half of fiscal year 2021, we expect continued strength in the transportation in this market. Our high-value solutions play a significant role in delivering advanced powertrains across both passenger and commercial vehicles. These are increasingly in demand as global emission standards tighten. Strong sales have been met with low inventory levels as U.S. vehicle inventory remains below 50 days of supply. down approximately 16% year-over-year. The heavy-duty truck market has rebounded and is projected to be up 40% in calendar year 2021. That's positive news as Carpenter Technologies supplies high-temperature exhaust valve materials and specialty fuel delivery solutions to the top three engine producers. In our aerospace and defense-in-use market, we continue to build on our already strong leadership position as we look forward to the market recovery. In the near term, demand will likely continue to remain low and choppy at times, as specific programs and customers are recovering at different rates. However, we expect a demand reset to higher levels as customers confidently reorient to increasing OEM demand. Of course, Carpenter Technology will benefit from this recovery as a critical supplier across multiple applications on virtually all aircraft platforms. Our customers continue to plan for the long term, and we likewise are working with them to map out appropriate support plans. As I mentioned earlier, we continue to secure beneficial long-term contracts, even during this downturn, with substantial price increases. These key aerospace customers understand robust demand will return and value our support. We remain very active in our defense sub-market by offering advanced solutions. As a notable example, recently a key customer accomplished a step change in performance of a target platform with the help of our material solutions. Our solutions are and will continue to be important for designers working on programs from aerospace electrification to next-generation defense systems. Now turning to our medical end-use market. States are beginning to lift restrictions on elective surgeries, spurring restocking actions that will continue over the coming quarters, and both end-user OEM customers as well as distributors supporting the medical device market. These restocking efforts have more impact on elective surgery applications, such as orthopedic and dental, as opposed to the more non-elective cardiology segment, which has been more resilient. The medical market is recovering ahead of aerospace, and our role as a critical supplier to the industry has been strongly reinforced and will provide incremental bottom-line impact as demand recovers. As I mentioned earlier, we continue to invest in critical emerging technology. In addition to supporting an already strong aerospace position in auxiliary power units and generators, our new hot strip mill will enable the launch of products to provide lead time benefits and capacity for growing aerospace electrification applications, automotive-based engine turbocharger designs, and the transition to electric vehicles. As electric vehicle demand continues to grow and program activity increases for electrifying short-range air travel, we are increasing our investment in motor technology and our soft magnetic solutions. Specifically, we are investing in advanced part capabilities and state-of-the-art modeling and testing. These capabilities ensure our customers realize the full material performance benefits in their motor and powertrain designs. We've also invested in emerging technologies related to additive manufacturing and digital platforms where adoption could be accelerated due to changes caused by this pandemic. All are exciting developments, to say the least, and accelerators of earnings growth moving into the future. Now I will turn it over to Tim for the financial review.