Carpenter Technology - Earnings Call - Q4 2021

Transcript

Speaker 0

Hello, and welcome to the Copper Technology Corporation Fourth Quarter Fiscal twenty twenty one Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note, today's event is being recorded. I will now turn the conference over to Brad Edwards, Investor Relations.

Mr. Edwards, please go ahead.

Speaker 1

Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology Earnings Conference Call for the Fiscal twenty twenty one Fourth Quarter and Full Year ended 06/30/2021. 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 those forward looking statements can be found in Carpenter Technology's most recent SEC filings, including the company's report on Form 10 ks for the year ended 06/30/2020, Form 10 Q for the quarters ended 09/30/2020, 12/31/2020 and 03/31/2021 and the exhibits attached to those filings. Please also note that in the following discussion, unless otherwise noted, when management discuss 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.

Speaker 2

Thank you, Brad, and good morning to everyone on the call this morning. Let's begin on Slide four and a review of our safety performance. For fiscal year twenty twenty one, our total case incident rate was 0.6, marking the best fiscal year safety performance on record. Today, Carpenter Technology is one of the safest manufacturing companies in The United States. However, our ultimate goal is a zero injury workplace.

The continued progress we made in fiscal year twenty twenty one was due to our focus on fundamental safety programs, including hand safety, human performance, leadership development and employee engagement activities. In fiscal year twenty twenty two, we plan to build upon the momentum and take our next step towards a zero injury workplace. Now let's turn to Slide five and a review of the fourth quarter. Our fourth quarter results finished ahead of our expectations. The results reflect our efforts to position ourselves to capitalize on the emerging recovery and market opportunities.

While the recovery remains in the early stages and varies by end use market, we are encouraged by the market signals we are seeing. We saw demand conditions improve sequentially across our major end use markets, including aerospace and defense and medical. During the quarter, we continued to execute a strategy focused on driving liquidity, strengthening key customer relationships and advancing our manufacturing capabilities. We generated free cash flow of $43,000,000 and for the full year delivered free cash flow of 132,000,000 quite an accomplishment when many in the industry burned through cash during the market downturn. We finished the fiscal year with $582,000,000 in total liquidity, including $287,000,000 in cash.

Customer engagement around Athens remains high as we continue to broaden our capabilities and customer base. Notably, we received another important qualification during the quarter. The Athens facility will be a competitive differentiator for Carpenter Technology as industry build rates rise and lead times begin to extend. In addition, I'm excited to share that our hot strip mill at our Reading campus recently completed its commissioning. The timing for the strip mill coming online is ideal.

As prior to the pandemic and now into the recovery, we have seen and continue to see steady growth from existing applications like high temperature engine gaskets, fasteners and electrification applications including motor stack laminations for auxiliary power units and generators. The mill significantly strengthens our soft magnetics capabilities and production capacity at a time when electrification is increasingly disrupting major end use markets. The higher frequency motors being used for electrification require thinner strip, which is more challenging to produce. As these markets grow, enhanced thin flat rolled product capabilities would become increasingly critical to overall system performance. The productivity, quality and consistency of our new hot strip mill will create an advantage for Carpenter Electrification motor stacks assembled from these thin laminations.

We are already producing materials to support new EV Asian motors that are in the process of FAA certification. We are also producing products for sensors and resistors that are now in newer, more advanced electric vehicle electronic systems. Now let's move to Slide six and the end use market update. As I mentioned earlier, we are seeing increasing signs of recovery across our end use markets. We continue to believe the worst is behind us and that demand conditions across end use markets will further improve as we move through fiscal year twenty twenty two.

Our aerospace and defense market sales were up 21% sequentially and a growing number of our customers are pointing to further demand acceleration in early calendar year twenty twenty two. Activity in the defense submarket continues to be strong, and we are generating increased interest in our advanced materials as customers source for new programs. In the medical end use market, sales were up 22% sequentially. Elective procedures volumes increased in the fourth quarter as patient sentiment and hospital capacity continued to improve due to higher global vaccination rates. Conditions continue to vary by region depending on COVID-nineteen concerns and the impact on procedures.

Results in our orthopedic and cardiology submarkets were also strong, and we began to see increased stocking activity in the distribution channel. Looking ahead, our customers expect order rates and backlog to show further improvement in the current quarter as the overall market continues to ramp in support of the ongoing recovery and elective surgeries. It is predicted that orthopedic procedures will reach eighty five to ninety percent of pre pandemic levels in the coming quarter, while cardiovascular procedures will reach eighty percent to eighty five percent of pre pandemic levels. Although the emergence of the Delta variant could soften the elective surgeries increase in some areas. We had been delivering consistently strong growth in our medical end use market prior to the pandemic and believe it will return to being one of our fastest growing markets post pandemic.

In the transportation end use market, sales were up 25% sequentially and 111% compared to last year. The global light vehicle production forecast for calendar year 2021 remains robust, and we achieved record shipments for heavy duty truck applications in the quarter due to increasing demand for our exhaust valve solutions. We continue to see market share growth opportunities in both the light vehicle and heavy duty truck submarkets and continue to further penetrate key market adjacencies, including off road, marine and aftermarket. Now moving to the energy end use market. In The U.

S. Oil and gas submarket, we are seeing initial signs of recovery, but the pace is measured. The international markets have largely stabilized and the outlook is becoming more positive. As a reminder, the prior year fourth quarter results included our Omega West business that was divested early in fiscal year twenty twenty one. In the power generation submarket, we are working closely with customers as the maintenance upgrade cycle continues.

Lastly, for the industrial and consumer end use market, sales were up 21 on both a sequential and year over year basis. Growth for both periods was driven by historically high demand for our semicon solutions, recovery in industrial distribution as well as increased consumer electronics demand. Now I will turn it over to Tim for the financial review.

Speaker 3

Thanks, Tony. Good morning, everyone. I'll start on Slide eight, the income statement summary. Net sales in the fourth quarter were $421,600,000 and sales excluding surcharge totaled 348,100,000.0 Sales excluding surcharge increased 17% sequentially on twenty seven percent higher volume. Compared to the fourth quarter a year ago, sales decreased 7% on flat volume.

As Tony covered in his review of the end use markets, we continue to see signals of improving demand conditions across most of our end use markets. SG and A expenses were $47,900,000 in the fourth quarter, up $6,000,000 from the same period a year ago and relatively flat sequentially. The year over year increase reflects higher amortization costs related to the ERP system that was placed in service during fiscal year twenty twenty one and higher accruals related to certain incentive compensation programs. These items were partially offset by the actions we took to reduce costs, including the elimination of certain salary positions late last fiscal year. The current quarter's operating results include $58,200,000 of special items, which include the following.

First, 52,200,000.0 of LIFO decrement charges. About $48,000,000 of this charge is included in the SAO segment's results with the remainder or $4,000,000 related to our Dynamet business within the PEP segment. The LIFO decrement charge is due to our significant reduction of inventory. As required, we recorded a non cash charge to reflect the liquidated historical LIFO layers that are well above current inventory costs. Second, 2,900,000.0 of COVID-nineteen costs, which are in line with the $2,700,000 of COVID-nineteen costs incurred in our recent third quarter.

As a reminder, these costs include direct incremental operating costs such as outside services to execute enhanced cleaning protocols, isolation pay for employees potentially exposed to COVID-nineteen and additional personal protective equipment and other operating supplies necessary to maintain our operations while keeping employees safe against possible exposure. Third, the current quarter special items include about $3,000,000 of restructuring and asset impairment charges. The restructuring and asset impairment charges, including inventory write downs, are associated with executing the near final steps against our planned actions to reduce costs and narrow focus in our additive business unit within our PAP segment. The operating loss was $70,700,000 in the current quarter. When excluding the impact of the special items I just highlighted, adjusted operating loss was $12,500,000 in the current quarter compared to $8,900,000 in the prior year period and $29,700,000 in the third quarter of fiscal year twenty twenty one.

Again, the current quarter's results exceeded the expectations we set at the beginning of the quarter and reflect the impact of higher than anticipated shipments, coupled with our continued focus on cost controls. Our effective tax rate for the fourth quarter was 27.7%. Earnings per share for the quarter was a loss of $1.18 per share. When excluding the impact of special items, adjusted earnings per share was a loss of $0.28 per share. Now turning to Slide nine and our SAO segment results.

Net sales for the quarter were $361,500,000 or $289,900,000 excluding surcharge. Compared to the fourth quarter last year, sales excluding surcharge decreased 6% on 3% higher volume. Sequentially, sales excluding surcharge increased 18% on 28% higher volume. The sequential sales improvement reflects higher sales across all end use markets other than energy. The largest contributor to the sequential sales growth was aerospace and defense, where sales were up 20% sequentially.

Other than energy, all other end use markets reported sales up sequentially 20% or higher. SAO reported an operating loss of $47,300,000 for the current quarter. The same quarter a year ago, SAO's operating income was $5,300,000 and in the third quarter of fiscal year twenty twenty one, SAO reported an operating loss of 9,900,000.0 It's important to note that the current quarter's operating results for SAO include $47,900,000 related to the LIFO decrement charge I mentioned earlier and also include $2,100,000 of COVID-nineteen costs. When excluding those two items, SAO would have reported operating income of $2,700,000 Again, excluding the impact of the LIFO decrement in COVID-nineteen costs, the sequential improvement in operating income performance is due primarily to the higher sales. Also of note, excluding the impact of the non cash LIFO decrement charge, SEO reduced inventory by $47,000,000 in the current quarter and for the full fiscal year 2021, SAO reduced inventory by 193,000,000 Looking ahead, we expect that demand conditions across most end use markets will continue to improve.

Based on current expectations, we anticipate SAO will generate a similar sequential operating income performance in the first quarter of fiscal year twenty twenty two. For clarity, I want to highlight a couple of key points in this guidance. First, this estimate includes similar sequential COVID-nineteen related costs in the upcoming first quarter. And second, we do not expect any further LIFO liquidation impacts at this time. The anticipated results take into account our continued focus on managing costs closely as activity levels begin to normalize, as the broader market recovery takes shape and we execute against our planned annual maintenance shutdowns, which are critical to ensure our operations can meet future anticipated demand.

Now turning to Slide 10 and our PEP segment results. Net sales excluding surcharge were $75,600,000 which were essentially flat from the same quarter a year ago and up 16% sequentially. It's important to note that sales were essentially flat year over year despite the fact that the same quarter of last year included sales associated with our Amega West business that was divested in the first quarter of fiscal year twenty twenty one. The year over year growth excluding Amega West was driven primarily by growth in our additive sales as well as improving demand conditions in our distribution business. The sequential increase in sales reflects increased demand for titanium materials used in the aerospace and defense and medical end use markets.

In addition, our additive business drove a sequential increase in sales as demand conditions continue to improve. In the current quarter, PEP reported an operating loss of $2,300,000 This compares to an operating loss of $8,400,000 in the same quarter a year ago and an operating loss of $3,300,000 in the third quarter of fiscal year twenty twenty one. For clarity, the current quarter's results include a $4,300,000 LIFO decrement charge associated with our Dynamet business unit. Excluding that LIFO decrement charge, operating income for the current quarter would have been 2,000,000 The sequential operating results reflect the favorable impacts of higher volumes. The year over year results reflect the benefits of the portfolio actions we have taken over the last several quarters, particularly focused on reducing costs in our additive business unit and the divestiture of Omega West business earlier this fiscal year.

As we look ahead, we believe that demand conditions will continue to improve in the coming quarters. With that said, given some of the same dynamics that SAO faces, some planned summer shutdowns in Q1 for both us and our customers, we currently anticipate PEP will generate operating results of breakeven to a $2,000,000 loss in our upcoming first quarter. Also as I mentioned for SAO, the PEP guidance includes COVID-nineteen costs largely in line with the fourth quarter. Now turning to Slide 11 and a review of free cash flow. In the current quarter, we generated $75,000,000 of cash from operating activities and a total of $250,000,000 for the full fiscal year.

As you can see within the cash flow generated from operations, we continue to reduce inventory. In the current quarter, we drove a $57,000,000 reduction. For all of fiscal year twenty twenty one, reduced inventory by just under $240,000,000 Moving down, we funded the minimum required contributions to our qualified pension plans of $20,000,000 as planned for fiscal year twenty twenty one. In the fourth quarter, we spent $22,000,000 of capital expenditures and finished the year with just over $100,000,000 of capital expenditures. We finished the year with lower capital spending than expected largely as a result of our concentrated efforts to complete the Hodt strip mill project and the lack of availability of contractors and other resources to start certain projects.

We also continue to fund a constant dividend to our shareholders, which we consider as part of our free cash flow. We continue to highlight that we have paid a regular dividend to our shareholders despite the market headwinds. This was an important signal to our shareholders of our conviction in the long term outlook for our business as well as our desire to continue to return value to our shareholders. With those details in mind, we generated $43,000,000 of free cash flow in the quarter and $132,000,000 for the year. From a liquidity perspective, we ended the current quarter with total liquidity of $582,000,000 including $287,000,000 of cash and $295,000,000 of available borrowings under our credit facility.

With that, let's move to Slide 12 to talk about selected fiscal year twenty twenty two guidance. We're providing the selected information to help for modeling the current fiscal year. Depreciation and amortization is expected to increase from 124,000,000 in fiscal year twenty twenty one to $135,000,000 in fiscal year twenty twenty two. The increase reflects a full year of amortization related to the new ERP system that we implemented in fiscal year twenty twenty one as well as a full year of depreciation for the hot strip mill that was recently placed in service. We expect to spend about $125,000,000 in capital expenditures in fiscal year twenty twenty two.

At this level, we'll spend the required amounts for maintenance type CapEx, but this also allows us opportunities to make targeted investments in growth areas as well as expand capacity in certain constrained flow paths. Moving to minimum required pension contributions. In fiscal year twenty twenty one, as I mentioned, we contributed $20,000,000 to our qualified pension plans. With the enactment of the American Rescue Plan Act of 2021 in March of twenty twenty one, our minimum pension contributions are effectively eliminated for fiscal year twenty twenty two. For non cash net pension expense, as a result of favorable asset returns and slightly higher discount rates, we expect net pension expense to decline by $21,000,000 and move from $13,000,000 of net pension expense to net pension benefit of $8,000,000 in fiscal year twenty twenty two.

For clarity, the fiscal year twenty twenty one number on the slide excludes $11,400,000 of pension settlement charges recorded in fiscal year twenty twenty one. Net interest expense is estimated to increase from $33,000,000 in fiscal year twenty twenty one to $41,000,000 in fiscal year twenty twenty two. The increase is driven largely by lower capitalized interest due to the completion of several large multi year projects in the current fiscal year. Lastly, the effective income tax rate. For fiscal year twenty twenty one, our reported effective tax rate was about 23%.

However, when excluding the impact of special items, the fiscal year twenty twenty one rate was about 29%. For fiscal year twenty twenty two, we expect the effective rate to be 28% to 30%. With that, I will turn the call back over to Tony.

Speaker 2

Thanks, Tim. Let's turn to Slide 14 and my closing remarks. The last year has been a challenging but successful year for Carpenter Technology. In navigating the pandemic, we have strengthened our company to best capitalize on the coming recovery. With respect to our facilities and employees, fiscal year twenty twenty one was the safest in the history of the company, despite operating in unprecedented conditions.

In terms of managing our business, we moved quickly to execute various portfolio initiatives and cost reduction programs, which will deliver between 60,000,000 and $70,000,000 in annualized cost savings. In addition, we have been relentlessly implementing the Carpenter operating model across key work centers and have secured notable productivity gains. We also focused on driving liquidity and finished the fiscal year 2021 with total liquidity of $582,000,000 including $287,000,000 in cash. Our enhanced operations and strong financial position will provide us with increased flexibility as we look to best capitalize on market opportunities and the overall recovery as it continues to take shape. We also expect to benefit from our Athens facility as the incremental capacity it offers to aerospace market as production levels rise and industry capacity begins to tighten.

We have meaningfully expanded and strengthened key customer relationships during the downturn. We have worked closely with our customers to address their changing material needs and production schedules and demonstrated that Carpenter Technology is both a critical solution provider as well as a valued business partner. We remain a market leader in our core business, where we have provided mission critical solutions to the world's largest industries for more than one hundred and thirty years. In addition, we have invested in emerging areas like our soft magnetic portfolio as electrification is a major trend moving forward. As I said last quarter, the worst is behind us and the recovery has started.

And while different recovery time lines across our end markets will continue to influence our shorter term quarter to quarter performance, we are excited about the midterm and longer term outlook. Thank you for your time. And now I will turn it over to the operator to take your questions.

Speaker 0

Yes. Thank you. At this time, we will begin the question and answer session. And the first question comes from Gautam Khanna with Cowen.

Speaker 4

Yes. Hey, thanks. Good morning, guys.

Speaker 2

Yes. Good morning.

Speaker 4

I was wondering at SAO, there was mention of some closeouts in the quarter benefiting sales and profits. Any way you can quantify that?

Speaker 2

Not to the exact number, Gautam, but we just wanted to mention that there was some of that a year ago when we worked with our customers to delay some shipments. We trued that up in this quarter here. So not overall significantly material, but it wasn't one of the drivers to higher sales in the quarter.

Speaker 4

Okay. And the commentary around the fiscal Q1 SAO being similar to Q4,

Speaker 2

I was curious what are

Speaker 4

you seeing in the aerospace like backlogs? Where are you seeing demand picking up? It engines? Is it fasteners? Is it structures?

How can you characterize sort of what's been going on in that channel?

Speaker 2

Well, I can say if you look forward and why we're confident, is a couple of data points. Overall, our total backlog is up 20% sequentially, and that's across all of our end use markets, different percentages, but all of our end use markets, the backlog is increasing. Bookings sequentially were up 14%. Some markets higher than that, for example, in medical that had very strong bookings in the quarter. And lead times are extending across the board as well.

So as you look at all those things start to come together, it gives you a very positive outlook. Now it's fair to say that not all customers are at the same point. We have some customers that are ordering right now for immediate needs. We have other customers that are telling us, hey, I've got another thirty, sixty, ninety days of inventory I need to burn through. So they're all at different points in time.

But as I said, overall, when you take a look at lead times, bookings, backlogs and orders, it points to a pretty clear signal that we're moving forward.

Speaker 4

And any meaningful differences between engines, fasteners and structural components?

Speaker 2

In terms of sales, backlog

Speaker 4

or terms of demand, orders, Yes. Lead Sales

Speaker 2

on the sales side, engines were strong. They were up 26% sequentially. Fasteners were down a bit, but as you well know, that can be up and down. Since if you look at from a backlog standpoint, all of the submarkets in aerospace was up except structural, which was flat quarter over quarter. And then if you look at bookings, we had bookings were up slightly in aerospace and some mixing differences inside the submarkets.

Speaker 4

Okay. And lead times in general, I imagine the faster lead times are short, but how are they trending in engines?

Speaker 2

Would I remember correctly, yes, if I remember correctly, last quarter, I said that engines spreads are about ten to twelve weeks. We track pretty closely with the others in the industry, maybe a couple of weeks here or there are different. And if you look at this quarter, lead times roughly are extended fifty sixty percent. So several weeks push out on the lead times. And I've said this, Gautam, every quarter, and that's going to continue.

Prior to the pandemic, we were at roughly 52. And here we are, I said 10 to 12. Last quarter, you're in the high teens, maybe this quarter. That's going to continue to increase as more and more customers start placing those increased orders.

Speaker 4

Yes. Thank you very much. I appreciate it.

Speaker 2

Yes. Thanks, Gautam. Have a good day.

Speaker 3

You.

Speaker 4

You too.

Speaker 3

Thank you.

Speaker 0

And the next question comes from Michael Leshock with KeyBanc Capital Markets.

Speaker 5

Hey guys, good morning. Yes, good morning. So first I just wanted to ask about your current inventory levels. Do you feel comfortable with where they're at now? Or should we expect further destocking in the first quarter?

Or do you see any benefit from inventory absorption going forward?

Speaker 2

Yes, it's a good question. Thanks for asking. I think that we spent the last year really diving deeper into the Carpenter operating model to to get our inventories at a lower rate overall. So when you look at days on hand overall, we want that number to be lower going forward. Prior to pandemic, we consciously moved our inventories up because, again, we were at fifty two week lead times.

We wanted to supply our customers. We were melting nonstop. Right? And we invested in our customers and put that into inventory. We were allowed to balance that more during this pandemic.

So as we go forward, I do not see us going back to those higher inventory levels because we've taken some corrective actions. Now will every quarter be a step down? No. You could see quarters over the next year or two where we build a little bit of inventory because of some specialized situation. But overall, going forward, our inventories will stay flat and we believe that we still have some opportunity to take them down over a longer period.

Hopefully that helps out.

Speaker 5

Yes, that's helpful. And then on different platforms, do you see some platforms that are destocking more or less than others within aerospace, whether that be by platform or by product. But just want to know what opportunities do you see are there to ship more upon the recovery given some of the supply chain inventory levels?

Speaker 2

Well, as you know, we're on all of the platforms. Whichever ones are coming back quicker or slower for us, the demand is still there. So like I said, if you just take a look at the lead times in the backlog and the bookings across the entire aerospace industry right now, that's pretty compelling data that says we're moving forward in this recovery. I do think it's important to note that over the next couple of quarters, even when I say that you have a positive trend moving forward, it could be lumpy in the aerospace market. You could see a quarter where engines are down a couple of points going forward.

And that's nothing to be alarmed about. I think if you look at it year over year, though, you're going to see positive increases going forward. And what we are saying on the call today lines up spot on to what you're hearing from other manufacturers in the industry that have released earnings recently and or have talked external recently. So I think we're right in line with what you're hearing other people in the industry saying.

Speaker 5

Got it. Appreciate the color. Thanks guys. Thank

Speaker 0

you. And this concludes the question and answer session.

Speaker 4

And now I'd like to

Speaker 0

turn the conference back over to Brad Edwards for any closing comments.

Speaker 1

Thanks, Keith. Thank you everyone for joining us today for our earnings conference call. We look forward to speaking with all of you again in the near future. Enjoy the rest of your day and have a great summer.

Speaker 0

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