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spk04: Good day and welcome to the Carpenter Technology Corporation second quarter fiscal year 2022 conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star, then zero. After today's presentation, there will be an opportunity to ask questions. If you'd like to ask a question, you may press star, then one on a touch-tone phone to join the queue. To withdraw your question, please press star, then two.
spk03: 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 2022 second quarter ended december 31st 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 Tain, President and Chief Executive Officer, and Tim Lane, 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, 2021, Form 10-Q for the quarter ended September 30, 2021, 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 margin, that is based on operating income and sales excluding surcharge. I will now turn the call over to Tony.
spk07: Thank you, Brad. Good morning to everyone. Let's begin on slide four and a review of our safety performance. In 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 number one core value, and we continue to push towards an ultimate goal to be a zero 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 five and a review of the second quarter. We continue to see demand improve across each of our end-use markets. so 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 markets, 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 and 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 three 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 in-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 4,500-ton press. As you may know, This press is an important piece of equipment, serving customers across multiple in-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 finish 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 six in the in-use market update. Our aerospace and defense in-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 one-time 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 4,500-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 applications. And as a result, our backlog continues to rise as customers plan for ongoing improvement. Specifically, our aerospace and defense in-use market backlog is up 35% sequentially and 72% year over year. In the medical in-use market, sales were up 9% sequentially and up 39% compared to last year. The results reflect ongoing improvement in the medical device sub-market. 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 in-use market backlog is up 39% sequentially and 163% year-over-year. We expect this trend to continue, with booking rates and backlogs showing further improvement in the coming quarters. Medical's performance is a key driver of the improvements in Dynamet's 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 and 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 sub-market is solid. The North America oil and gas sub-market 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 a 100% increase in new projects and a 23% increase in rigs 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 a semi-com solution and expect demand to remain strong throughout the fiscal year. In addition, we continue to see healthy demand in the electronics sub-market, evidenced by growing backlog. Further, we have strong engagement from our customers in the electronic cell market on our recently commissioned Hodgkin Mill inwriting. Now, we'll turn it over to Tim for the financial summary.
spk09: Thanks, Tony. Good morning, everyone. I'll start on slide eight, 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 on 9% higher volume. Sequentially, sales were up slightly, or about 1%, with a slight decrease in volumes. As Tony covered in his comments, we continue to see improving demand conditions across our NUS 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 SEO 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 six months ended December 31st, 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 61 cents per share. When excluding the impact of special items, specifically the COVID-19 costs, adjusted earnings per share was a loss of 58 cents per share. Now turning to slide nine 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 of 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 non-recurring 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 is largely due to higher operating costs as we continue to increase production staff to meet the growing demand as well as inflationary pressures in 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 bill. 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 unused markets will continue to improve. As Tony mentioned earlier, our backlogs are growing, 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 in 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 SAL 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 percent from the same quarter last year and were up 14 percent 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 and use markets. We've also seen a significant improvement in sales driven by demand in our additive 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 $.6 million in our recent first quarter. A 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 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 increasing 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 US 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 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.
spk07: Thanks, Tim. Demand across our end-use markets 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 ready 4500 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 increase 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 active manufacturing platforms offer long-term growth opportunities.
spk01: Thank you for your time, and now I will turn it over to the operator to take your questions. We will now begin the question and answer session.
spk04: If you'd like to ask a question, press star, then 1 to join the queue. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question from the queue, press star, then 2.
spk01: We will pause momentarily to assemble our roster. And the first question comes from Josh Sullivan with the Benchmark Company. Please go ahead.
spk02: Hey, good morning.
spk01: Morning.
spk02: 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?
spk07: Well, good morning, 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 a repair plan 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 on what you find, but we had the game plan already in place and the spares on 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.
spk02: And then just on Athens, can you help us understand the overall value of the qualifications you've received? I understand the number of qualifications going up. I think you said you had three 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 the number of qualifications versus the value maybe that they represent.
spk07: Yeah, Josh, I think the best way to look at that is Some time ago, we stated we're not going to bifurcate between all of our locations because we run them 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, uh, in the marketplace today is serving us well as we, you know, re renegotiate those contracts going forward.
spk02: And then just one last one on, on the soft magnetics, uh, hot strip mill. Yeah. How should we think of the electrification demand cycle?
spk07: there and backlogs you know i want to say you know 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 we go forward over the next couple 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 the demand in that new strip mill has been significant in the in the first you know, a couple months if it's existing. 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 years.
spk00: Thank you for the time. Thank you.
spk01: The next question comes from Michael Leshock with KeyBank Capital Markets.
spk04: Please go ahead.
spk06: Hey, good morning. You guys mentioned share game 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?
spk07: 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.
spk06: 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 zero, Where are you shipping in regards to those rates? Or are there any aerospace platforms where you're shipping above or below rate?
spk07: Interesting question. We're shipping, you know, 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, the specific parts, they have increased their order intake considerably over the last couple months. You can see that in the numbers that I stated in terms of backlog growth and booking. So you've got an industry right now that is ramping up pretty quickly. There's certainly concern in the market. Can the 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 last couple months. And that's good news for carpenter technology and for our futures. We see the demand coming back to us.
spk06: 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. Thanks.
spk07: I'll leave that one to Tim.
spk08: Yeah, Mike, we do have an active hedging program. We hedge a pretty significant portion of our forward natural gas expected purchases, you know, 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.
spk00: Okay, thank you.
spk01: Again, if you'd like to ask a question, press star then 1 to join the queue. The next question comes from Matthew Fields.
spk00: Actually, just one moment, please. Sorry about that.
spk04: The next question comes from Matthew Fields with Bank of America Merrill Lynch. Please go ahead.
spk05: Hey, guys. I just want 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 one-time contribution you plan on this year that you can let us know about?
spk08: Matt, it's Tim Lane. No, we don't have any minimum required pension contributions this year of any significance, so no.
spk05: And you don't plan on making a voluntary one?
spk08: That's right.
spk05: 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 six months, about 140 million use. Do you plan on getting back to break even 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?
spk08: 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 for the build in 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 and there to build inventory where we think it's appropriate, but that's at least what we're planning to do for the balance of the year is try and take that out. The amount we build in the first half, take it out in the second half.
spk05: Okay, so try to get back to kind of break even for the full year is sort of what I'm trying to pick up.
spk08: Yes, for inventory, that is.
spk05: Okay. And then, you know, 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 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?
spk01: Well, where we sit today, Matt, I'd say we're pretty comfortable with where we are from a total liquidity perspective.
spk08: 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 – you know, 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.
spk05: All right, no need to monetize any assets or issue equity or kind of any transactions, you know, to bolster your kind of liquidity position at this time.
spk07: No, and Matthew, this is Tony. I'd say we're not even close to that. So, I mean, it's not even a discussion selling or monetizing assets and issuing equity. We're not even close to that area. So, a little surprised with your question, quite frankly. I mean... Certainly with some of the issues we've had with the press outage, we 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, this is 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.
spk05: Okay. Great. Well, thank you very much, and good luck on the back half.
spk04: 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.
spk03: Great. Thanks, Tom. Thanks to everyone for joining us today for our 2022 fiscal second quarter earnings call. We look forward to connecting with all of you again in the near future.
spk01: Take care. Have a great day. The conference is now concluded. Thank you for attending today's presentation you may now disconnect.
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