Good day, and welcome to the Carpenter Technology Corporation Fourth Quarter Fiscal 2022 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to the management. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology earnings conference call for the fiscal 2022 fourth quarter and year ended June 30, 2022. 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 Thene, President and Chief Executive Officer; and Tim Lain, 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 Technology's 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 quarters ended September 30, 2021, December 31, 2021 and March 31, 2022 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 adjusted operating income excluding special items, and sales excluding surcharge. I will now turn the call over to Tony.

Thank you, Brad, and good morning to everyone on the call today. Let's begin on Slide 4 and a review of our safety performance. For our fiscal year 2022, our total case incident rate was 1.0. It is above our fiscal year 2021 performance of 0.6, which was our best fiscal year safety performance on record. A rate of 1.0 is approximately 65% lower than an all-industry rate. However, our ultimate goal is to be a zero injury workplace. We believe it is possible, and we will continue to work towards that goal. Now let's turn to Slide 5 and a review of the fourth quarter. We continue to see strong increase in demand in each of our end-use markets. Most notably, we see the aerospace and defense end-use market continue to ramp to pre-COVID levels. Although, global passenger traffic is not yet fully recovered, the aerospace ramp is accelerating and our order backlogs are likewise increasing rapidly. And medical end-use market conditions continue to improve as the industry addresses the backlog of surgery delayed by COVID-19. We see many indicators across our end-use markets of the strong demand environment. Let me highlight two. First, our backlog increased 29% sequentially and 191% year-over-year. This marks the sixth consecutive quarter of backlog growth. Second, we continue to realize price gains on both our contractual and transactional business. Specifically, we recently increased base prices on our transactional business by 12% to 15%. This was the fourth such price increase in the last 14 months. We are working closely with our customers, as most are requesting additional volume with accelerated delivery dates. Our focus is on increasing productivity across our operations to meet this aggressive demand. For the quarter, our SAO and PEP segment exceeded our expectations driven by higher net sales as…

Thanks, Tony. Good morning, everyone. I'll start on Slide 8, the income statement summary. Net sales in the fourth quarter were $563.8 million and sales excluding surcharge totaled $403.2 million. Sales excluding surcharge increased 16% from the same period a year ago on 8% higher volume. Sequentially, sales were up 9% on 4% higher volume. Gross profit was $72 million in the quarter compared to negative $21.3 million in the fourth quarter of last year and $39.5 million in the third quarter of fiscal year 2022. It's important to note that the current quarter's gross profit results include a benefit of $11.9 million related to employee retention credits that were recorded and called out as a special item this quarter. The improvement in gross profit, both sequentially and year-over-year, is primarily driven by the higher sales and improving product mix and increasing pricing to offset inflationary cost increases. SG&A expenses were $47.4 million in our recent fourth quarter, largely in line with the same period a year ago and up $9 million sequentially. When adjusting for the special items that we called out in each quarter, SG&A expenses were up roughly $3 million sequentially due to the timing of certain expenses and certain legal reserve adjustments. Note that the SG&A line includes corporate costs, which totaled $15.5 million in the fourth quarter. The reported corporate costs are down about $5 million from the same quarter last year and relatively flat sequentially when considering the special items included in each period. As we look ahead to fiscal ‘23, we would expect corporate costs to run on average between $18 million to $20 million per quarter. Operating income was $24.6 million in the current quarter. When excluding the impact of special items, adjusted operating income was $14.9 million in the current quarter…

Thanks, Tim. Now to recap our fourth quarter and fiscal year 2022. We are well positioned with a backdrop of a strong demand environment and a positive outlook in each of our end-use markets. Notably, the aerospace and medical markets continue to accelerate their recovery. As a result, our backlog continues to grow and we expect it to remain strong for the foreseeable future. We continue to ramp up our operations, deploying our Carpenter operating model to maximize throughput and productivity in key flow paths. We have taken the necessary steps to address the current supply chain challenges and inflationary pressures facing the broader economy. Over the past couple of quarters, we have worked closely with our vendors to ensure a reliable supply of raw materials for our operations given the ongoing geopolitical challenges. Through our raw material surcharge mechanism and our ability to increase prices on our contractual and transactional business, we are able to mitigate a large percentage of the recent inflationary pressures. We continue to work closely with key customers, navigating the recovery and supply chain challenges and partnering to solve their critical needs. As a result of these efforts, we believe we will continue to maintain a healthy liquidity position. Now let's take a look at our near-term and long-term outlook. We are in an advantageous position, as we have a strong outlook across each of our end-use markets. A combination of the recovery from the pandemic and positive macro trends have positioned our materials solutions for both near-term and long-term growth. Near term, the strength of the demand for our materials is confirmed by the acceleration of our order intake and the growth of our backlog. Bookings were up 15% sequentially and 122% year-over-year, and backlogs are up 29% sequentially and 191% year-over-year. On a…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Josh Sullivan with The Benchmark Company. Please go ahead.

Hey. Good morning.

Good morning, Gosh.

This week, there's been a lot of discussion just around castings in the aerospace market and some limits that it's put on Boeing and Airbus deliveries. Can you just talk about how Carpenter fits into that discussion? Is it limiting your growth or are customers taking your materials to build stocks while capacity builds throughout the industry? And then just what do your aerospace lead times look like right now versus the previous quarter?

Yes, Josh. Thanks for your question. So just at a high level, certainly aware of the commentary that's out there around supply chain issues and how that may impact deliveries. I can tell you from our standpoint, we still see extremely high demand, high output rate targets per month. Now there's some discussion around this, but we don't see this being any drag on what we're going to produce over the coming quarters. I mean, the market is just too tight right now. In terms of lead times, right now for us, and I would think the industry in total, from an engine standpoint, nickel billet for engines were in that high 40s to low 50-week lead times.

Got it. And then the Europeans look to be allowing Russian titanium supply coming through, but then you have U.S. firms like Raytheon are committed to altering their supply base or even in the medical markets. Have you received any firm contracts resulting from reassuring titanium supply chains at this point?

Josh, are you saying people moving away from Russian supply?

Yes. Is there any incremental activity on the titanium front given the change in the Russian supply dynamic?

Yeah. I think it's two pieces. I mean, one, you could see some U.S. entities that provide large titanium origins. They may pick up some share, and in that case, we would participate the conversion services to those customers and would be on the aerospace side. On the medical side, we compete via Dynamet with some of those suppliers, and as customers are looking at accessing what they want to do going forward, that could be an opportunity for us as well. If you put it all together, depending on how that plays out, that could be a meaningful opportunity for our Dynamet business.

And then just one last one, the move into stacks, how vertically integrated could Carpenter get in the electric motor space? Could we see a name brands, Carpenter product at some point? Or could you just explain some of your vertical integration strategy there?

Well, we'll take one step at a time. I mean, right now, we're building out the stack piece of it right now at a lower rate levels, but getting a lot of interest from customers and producing as we speak right now. Could we take that next step? It's possible as we do our analysis. But right now, we're focused on the stack piece.

Got it. Thank you for the time.

Thank you.

[Operator Instructions] The next question comes from Michael Leshock with KeyBanc Capital Markets. Please go ahead.

Hey. Good morning. I wanted to follow up on the castings commentary. As we look down the road and the market isn't as tight as it is today, where do you see that castings capacity? In other words, when we were at much higher rates pre-pandemic, where did the capacity go that supported those rates? Is that still in place or is some of that permanently off-line?

Yeah, Mike. I can't speak to the castings side of the market since we don't participate there.

Okay. And then on your transactional business, you had called out the price increases, the 12% to 15%. What percentage of your business is transactional? Is that something you've given? And where does the transactional piece compare to where it historically is as a percentage of sales?

Yeah. We don't give that exact percentage, but I can give you this guidance. All of the larger customers are under long-term contracts. So that will give you a pretty good idea of what the split is. It's stayed relatively the same over the last several years.

Okay. And then did you give your jet engine revenues in the quarter?

Well, I can tell you that engines are -- the revenue was up 5% sequentially. That's usually the question that you folks at key ask.

All right. Well, thank you guys. Appreciate it.

Yeah. Thank you.

Our next question comes from Gautam Khanna with Cowen. Please go ahead.

Sorry, I joined late so I don't know if this was asked. But I wanted to get your perspective, Tony, on some of the complaints we're hearing about engine supply chain constraints, and maybe if you could help us identify where they might be coming from. Are they broad-based among your customers or are they isolated to one or 2? Or -- just I'd love to get your perspective on it because it seems like that's pushing Airbus taking up the A320 rate. And obviously, Boeing made comments to that effect yesterday on their earnings call about how they would ramp production faster on the 737 MAX if it wasn't for the engine supply chain. So I just wanted to get your perspective on where do you see the pinch points among your customers. And is it isolated to 1? Or anything you could say on that?

Yeah. Good morning, Gautam. If you remember, who knows probably a year or so ago we were talking, and I -- we both kind of predicted that this is where we would be, right? You're at a period where everybody believes that aerospace is never coming back. And we'll get to the point where it will come back quickly and there'll be pinch points across the entire supply chain. And guess what, that's where we're at. So I don't think there's any one specific area in the supply chain that's behind. I think it's multiple areas in the supply chain that are running really fast to get ramped up. As you know, there's many workflows that go into the manufacturing of an engine. So I don't think there's just one area. Across the board, all of our customers in that area in the engine side believe their inventories are too low and that they'd like to have more material at a shorter lead time. So that's what we're working on now as we ramp -- continue to ramp up our production. As you well know, these are very sophisticated equipment. So you don't just turn it on like you turn on a water faucet. They are very high-quality products. So we have to do that in a very structured way, and that's what we're doing over the next couple of quarters as you see us going into the first quarter and the second quarter, as we continue to bring on more capacity.

Okay. And I was curious if there's any residual impact from the press outage back in December or are we totally beyond that at this point?

Yeah. Well, really, this fourth quarter, Gautam, was the first full quarter we had with the press being back up, right, because it came back at roughly the end of March time frame or so. So I would anticipate over the next quarter, this first quarter that we'll continue to work on that. And then as we get into the second quarter, we'll have that behind us. I'm not saying we'll be ahead and we'll be at much lower lead times, because at the same time we're pulling out and recovering from the press outage, demand is increasing. So that's going to be the case here, I think, over the next several quarters as the entire industry ramps up. As you know, our lead times -- or I shouldn't say lead times, our production time for our products are usually somewhere between three months on the short end and four or five months on the longer side. So it does take quite a while to kind of cycle that through.

Got it. And at one point, you guys had suggested that there could be a quarter in fiscal ‘23 that approaches the run rate established in 2019.

Yeah.

I was curious, do you still see that as possible this year, like a dollar in any one of the quarters of fiscal 2023? Or a dollar of earning.

Yeah. As you said earlier, you joined a little late. I know you've probably got a lot of different companies out there you're covering. But I did mention that in my in my prepared comments in that right now, as we look forward, a couple of comments, we believe that we'll be at that run rate by the fourth quarter, right? So -- and I tried to make it a little bit easier to cover so I moved and said, let's just talk about operating income. So we're not talking about the noise below the line. So if you look at FY ‘19 operating income, that we would be at that annualized run rate by the fourth quarter of this year, right? So I gave a little bit more clarity on that than what I had said publicly before. A couple of comments I made around that is that we believe that, that growth between now and the fourth quarter, which is only a couple of quarters away, would be relatively linear. Number two, we're working really hard to see if maybe we can pull that even into the third quarter, Gautam, that we can make that even a quarter earlier. And I think that's really the story, right? The story is, Hey, what's going to be your next quarter? I know we'd like to talk about that. But I think the real story for Carpenter Technology and maybe many others in the industry as they ramp up is, where do you think you can be in a relatively short period of time. It's only a couple of quarters away. And for us, if you can say by the end of this year, maybe even the third quarter, that I can be at the rate that I was pre-pandemic, that was one of the highest financial performance years in our history, I think that's a really good thing to point to. And I think that's really the compelling point around Carpenter Technology right now.

No, that makes sense. And last question, just as some of the folks in the industry, customers in the industry move away from VSMPO, I was curious, have you guys seen any benefit in the medical business or in aerospace fastener, coil, wire and bar? Because I know VSMPO was a bit player in those markets. I don't know if it helped you at all yet.

Yes. They are a significant player, and we have had discussions with customers. Some might decide to stay with that supplier, some may decide to leave. So they're looking through those sourcing decisions as we speak. We do believe there's an opportunity for us. It could be meaningful for Dynamet facility as we go forward. So we could probably provide a little bit more clarity as that gets more firm in the coming quarters.

Thanks a lot Tony. Appreciate it.

Yeah. Thank you. Have a good day.

The next question comes from Michael Glick with JPMorgan. Please go ahead.

Hey, guys. Just had a couple of follow-ups on your 4Q comments. Just as we think about margin progression in SAO, should that be pretty linear as well? And then is the free cash flow growing at that kind of linear rate as well?

Yes, it's a good question. The margins will move with that operating income, right? So as we continue to ramp up, you'll see those margins improve in SAO. Free cash flow, yes, it should follow the operating income. I will tell you early on, we'll make some investments in working capital, primarily inventory work in process. Because as we ramp up, and I just said to the other question that our production times are three to six months, so you know you're going to increase your WIP, right? So we'll have to do -- we'll have to offset that. But then when you see these types of increases, if you just look at this fourth quarter SAO operating income and -- or I'd say, say, total Carpenter operating income and what we're saying it would be in the fourth quarter of FY ‘23, you're more than 4 times higher. So it's significant. So those increased sales will certainly lead to improved free cash flow. But do keep in mind, we will build some inventory WIP in the short term to support that.

Got it. Thank you and good quarter.

Yeah. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Brad Edwards for any closing remarks.

Thank you, and thanks to everyone for joining us today for our fourth quarter earnings conference call. We appreciate your interest and your questions, and look forward to connecting with everybody soon. Have a great rest of your day.

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