Good day, and welcome to the Carpenter Technology Corporation Fourth Quarter 2023 Conference Call. Today all participants will be in a listen-only mode. [Operator Instructions]. Please note that today's event is being recorded. At this time, I would like to turn the conference over to John Huyette, Vice President, Investor Relations. Please go ahead, sir.

Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology earnings conference call for the fiscal 2023 fourth quarter ended June 30, 2023. 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, 2022, and Forms 10-Q for the quarters ended September 30, 2022, December 31, 2022 and March 31, 2023 and the exhibits attached to those filings. Please note that in the following discussion, unless otherwise noted, when management discusses the sales or revenue, that reference excludes surcharge. I'm 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, John, and good morning to everyone on the call today. I will begin on Slide 4 with a review of our safety performance. For fiscal year 2023, our total case incident rate was 1.7. Although 1.7 injury rate would rank as one of the safest metal manufacturing companies, it is not a rate we've come to expect or accept at Carpenter Technology. As we've discussed in previous quarters, the rate increase is largely due to the increased employees undertaking new tasks either as new hires or transfers into new roles. We continue to invest in additional training for any employee new to a job or task with frequent monitoring and follow-up. Our goal continues to be a zero injury workplace. Despite the increase this year, we believe it is possible, and we will continue to invest and work tirelessly to achieve that goal. Now let's turn to Slide 5 and a review of the fourth quarter. More than a year ago, we set out the goal to return to pre-pandemic fiscal year 2019 profitability on a run rate basis by the end of fiscal year 2023. It was an important milestone, marking a way point on our growth trajectory to doubling our operating income by fiscal year 2027. Not only did we achieve that goal in the fourth quarter, we exceeded it. And with increased productivity, improved product mix and the realization of higher prices, we demonstrated accelerating momentum on that growth trajectory. Most notably, the SAO segment significantly exceeded expectations for the quarter, delivering $80 million in operating income above the outlook we provided of $65 million to $70 million. Further, SAO realized an operating margin of 16.8%, a step-up from the 11.9% in the previous quarter. With increasing high levels of demand, net sales increased across…

Thanks, Tony. Good morning, everyone. I'll start on Slide 8, the income statement summary. Net sales in the fourth quarter were $758.1 million, and sales, excluding surcharge totaled $560 million. Sales, excluding surcharge, increased 39% from the same period a year ago on 19% higher volume. Sequentially, sales were up 14% on a 7% higher volume. The higher volumes were driven by strong demand and by our improving productivity and throughput across our operations. Consistent with the last several quarters, sales growth continues to outpace volume growth both sequentially and year-over-year driven by an improving product mix and increased base prices. Gross profit was $119 million in the current quarter compared to $72 million in the same quarter of last year and $93.5 million in the third quarter of fiscal year 2023. Gross profit in the current quarter is up 65% compared to the same quarter last year and up 27% sequentially. The improvement in gross profit is primarily driven by higher sales and improving product mix and increased selling prices, partially offset by inflationary cost increases. SG&A expenses were $56.1 million in the fourth quarter, up about $9 million from the same period a year ago and roughly $2 million higher sequentially. The increase in SG&A expenses versus the same quarter last year is primarily driven by investments and higher variable compensation accruals. The SG&A line includes corporate costs, which totaled $22.5 million in the recent fourth quarter. As we look ahead to the upcoming first quarter of fiscal year 2024, we expect corporate costs to be about $20 million to $22 million. Operating income was $62.9 million in the current quarter. When excluding the impact of special items in the prior year quarter, adjusted operating income was $14.9 million. And in our recent third quarter, operating income was…

Thanks, Tim. And now to recap our fourth quarter of fiscal year 2023. With operating income of $62.9 million, we exceeded our goal to return to pre-pandemic levels of profitability on a run rate basis by the end of fiscal year 2023. A goal we communicated over a year ago. The current quarter's results represented a significant step forward from the previous quarter's operating income of $39.3 million demonstrating increasing operating momentum. Driving the performance was improved productivity and capacity optimization, a stronger product mix and higher realized prices particularly in the SAO segment. We are operating in a strengthening demand environment with positive near-term and long-term outlooks in each of the end-use markets. Notably, the aerospace submarkets continue to accelerate their recovery. With strong demand and improved productivity, we saw sales increase across each of the end-use markets. And we generated $175 million of cash from operations, further strengthening our liquidity position. Taken all together, with increasing volumes, improving mix increasing prices and improving productivity. We are accelerating our momentum heading into fiscal year 2024. Let's turn to the next slide and take a closer look at our near-term and long-term outlook. First, let's review our outlook for the first quarter of fiscal year 2024. On our last earnings call, I said that we expected operating income to be flat sequentially in the first quarter of fiscal year 2024, representing a significant improvement over the historical trend of a sequential Q1 decline. For the first quarter of fiscal year 2024, we expect to be in the range of $61 million to $67 million of operating income. This would put us flat to slightly up sequentially and despite the fact that we outperformed the fourth quarter expectations. Again, this would represent a meaningful step up compared to the historical trend…

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Today's first question comes from Gautam Khanna with TD Cowen. Please proceed.

Hey, thank you. Good morning, guys.

Good morning, Gautam.

I had a couple of questions, Tony. Maybe I missed it in the opening remarks, but the backlog in the quarter, how did that trend maybe sequential or...

Yes. The backlog was up 4% sequentially, 38% year-over-year. That number is going to become less relevant, Gautam, because we've closed the order book a couple of times now already just to control the flow. So you're at a very strong level and anticipate staying there for quite some time.

Okay. That's helpful. And then Tony, I hate to ask, but just do you have any directional commentary on the December quarter, just given that you're kind of not -- you're bucking normal seasonal trends in the September quarter, but then you do have the maintenance dynamics. So I'm just curious what are you thinking for December directionally?

Yes. Directionally, our goal is to the floor would be the first quarter that we just guided to. As you all know, historically, the second half is going to be a jump up for us, especially since we see significant ramps in productivity. Again, Gautam, what really drives the message here is that the demand is there. In many ways, that's locked in. So it's really all about our ability to continue to improve the productivity. So I would anticipate -- our goal is for another step up and then hitting the second half in a very good position.

And just following up on the productivity comments, what changed sequentially? What kind of explained the throughput increase? What happened in the productivity?

Yes. Specifically in SAO, the team is doing a really nice job just eliminating bottlenecks, understanding the flow. Remember, the products that we're making now are quite different than what they were in 2019. A lot of people don't realize that. Customers have moved to different diameters. There's different specifications, different testing that's required now that changes the production for quite a bit. That's a big challenge that they've been able to get on top of. And number two, it was just another quarter. We've made some great hires, some great operators and they just got another quarter under their belt of learning that system, learning how to operate safely, and you see it come through in the numbers.

And lastly, on the Performance Engineering segment. It was a little bit below the expectation you laid out. Could you elaborate on what explained to that?

Yes. It's one of those items that we never speak about, Gautam quite frankly, in the whole company, it wasn't material. But with PEP, the size of PEP it was, and that's just getting a little misaligned with the cost and the production flow. I see that coming back. That's not a market problem. And we see PEP, quite frankly, as we get through FY '24 could see a big improvement in their profitability. So no red flags, not an issue. It's disappointing, not happy with the way we paced our product flow for the quarter, but we'll get that back next quarter.

Okay, I will turn it back.

Thanks.

The next question comes from Josh Sullivan with The Benchmark Company. Please proceed.

Hey, good morning.

Good morning, Josh.

Just wanted to -- just wanted to follow-up on that comment about closing the order book. When you close the order book, what's the gating factor to reopen it? Is it customers meeting your price? Or is it your ability to supply?

Neither one, it's really about how far out those orders are, right? So it's about -- we'll open it back up once, for example, another quarter goes by in your 12 months out in advance and say, okay, now it's time to open it up again. So it's really from a timing standpoint, not to get too far ahead of us to get orders too far out there.

And then just a follow-up on PEP as well. The dynamic that you're talking about, did it impact the volume of titanium wire that was supplied to the market? Or was it more related to Carpenter cost issue?

Yes. Not to -- it didn't impact our sales. We got the sales out. It's just where you have the product and the process flow and how your cost accounting works. Again, this isn't the story really of the quarter. This is a small event. It just stands out because we have a smaller PEP segment, so not an issue here at all for us.

Got it. And then just with high-value aerospace products take more and more of your capacity. Can you talk about your non-aerospace markets. What's the ceiling on how far you can push that pricing mix or maybe historically, when aerospace was commanding significant share, how much of a mix shift could you get out of those non-aerospace markets?

Well, I'll answer it this way. We have some very attractive markets outside of aerospace. Medical being at the forefront. We're looking for ways to grow our medical business now, excellent margins, excellent customers. So we want to continue to grow that market. On the energy side, you have customers now competing to get time on the mill with aerospace customers, for example. So margins have gone up significantly in the energy market, Josh. Different from what we saw back in 2018, 2019. So that's a market that we'll continue to stay active in, albeit at a much lower level than aerospace, for sure. And then when you look at our industrial market, those are very good submarkets for us as well. So we see very high-end valves and fittings in very unique and complex applications. So we're very happy that we have a broad portfolio. We think it insulates us from different macro changes. And the key is that we're always going to operate at the very, very top of the pyramid in very difficult environment. Very unique applications. So we're looking across all of our markets and how we can move even higher up that supply chain.

And maybe just one last one on free cash flow. Just what do you think about the cadence throughout 2024? Any difference or just any thoughts there would be great. Thank you.

Yes. Well, we have the opportunity, as you well know, as we talked in the Investor Day to generate significant amount of cash. Now we're going to be proven throughout the year because we want to make sure we serve our customers to the best of our ability, especially in this environment. And there could be times that in a quarter, the way a quarter ends that we'll build some inventory because we have the opportunity in our schedules. And we're going to do that. So you could see some quarters that are down a bit because of that or just the opposite. So I mean, at the end of the day, we want to -- we want to serve our customers the best we can. You know this better than most over that three to four year period, that's going to be significant cash generation. So I think that's the best way to look at it.

Great, thank you for the time.

Thank you, Josh.

[Operator Instructions]. Our next question comes from Michael Leshock with KeyBanc Capital Markets. Please proceed.

Hey, good morning guys.

Good morning.

First, I wanted to ask on your 1Q guidance. I know that's typically a heavier planned maintenance quarter and weaker seasonality. And you called out planned maintenance as a priority. So I want to better understand the moving pieces that drive that flat to up EBIT guide. Is there going to be some sort of element of seasonality maybe on the volume side that's going to be offset by pricing mix, just given some of the planned maintenance that you're taking?

Well, I think guiding the 61 to 67 answers your question, right? I mean, usually, the first quarter is down significantly because of seasonality now off of a very strong fourth quarter, we're saying it's flat to sequentially up. So that kind of takes off the plate any issues around seasonality.

But is the seasonality on the volume side going to be similar to what you've seen in the past and the pricing and mix is going to offset that?

No. It's -- as I just said, I think this puts to rest any seasonality for the first quarter. You've got customers now that are wanting as much material as we can get them sooner. Of course, there's going to be some work stoppages or whatever from some of our customers as they do those, but the demand environment now just overshadows that. So I don't see that. I think the gating factor or the factor if you look over the next several quarters from results because demand is so robust that I can ship everything I produce. And many times, the difference between quarter-to-quarter is going to be when I strategically take preventive maintenance outages. That's going to be one of the driving factors as well as a continuing increase of productivity.

Got it. And then on SAO, how do you see margins there progressing throughout fiscal '24, 4Q was a very strong quarter. And I know you have some price increases flowing through on a lag. So just wondering how much further do you see SAO margins progressing? And what needs to occur for that to happen?

Well, I think it was approximately a five percentage point increase quarter-over-quarter this time. Prior to the pandemic, SAO was in the 20% range. That's our target to get back there. That's -- we have line of sight to that. And where we're at right now, where the market is so strong, it really is about our ability to drive productivity, which the translation of that is higher margins. And we're running many pieces of our equipment above nameplate capacity, and we'll continue to find ways to get more and more out of the equipment in a very efficient manner. So that's what they do out on the manufacturing floor every day is trying to get more and more out of that system because we know we have very good customers that want it.

And then lastly for me on jet engine sales. Could you provide that number for the quarter, either sequentially or year-over-year?

Jet engines, up 92% year-over-year, 34% sequentially.

Okay, all right. Thanks guys.

Thank you.

The next question is a follow-up from Gautam Khanna with TD Cowen. Please proceed.

Yes. Tony, you mentioned the medical demand being pretty strong. What are you seeing in terms of aerospace fastener demand, 787 related titanium and non-titanium feedstock?

Both of those are increasing for us, Gautam. I can tell you that sequentially, fastener submarket was up 31% year-over-year, 135%.

Okay. And you expect that to continue? I mean, at least at these absolute levels to continue to rise?

Well, I think you'll look -- we'll start looking at sequential, right, because the year-over-year is going to fall off. In many cases, that year-over-year, we're still compared to very low quarters, obviously, a year ago. So as those roll off, I think we'll focus on the sequential growth, but we know we're not at the top there as far as satisfying demand across many of the aerospace submarkets.

And Tony, you've talked about pricing being more favorable and not quoting business out too far in advance as a result. Could you remind us on the engine side, how much of the business is under long-term contract? And maybe how much of that business turns over every year in terms of pricing? And just to give us a sense for what the potential tailwind would be in year-over-year?

Yes, it's a difficult question. The contracts are spaced out differently. It seems like every year, 1.5 years, there is a significant one that comes up. I will tell you all of the primary customers, customers that you would consider the largest or the most strategic in the industry are under some form of long-term contract with us.

Okay. I guess -- and so given that, do you expect kind of pricing to continue to be a tailwind as we move out 12 months, 24 months, et cetera or we had the reset from here just kind of state?

Yes, there's still some over the next year that will reset. So there are still significant contracts to be negotiated over the next 12 months.

And can you give us an update on Athens. I know you view the production system across the three major facilities, but any sense for like utilization levels, how much where are you at Athens with respect to output and where do you expect to be over the next year?

Yes, we're still ramping up Athens. Obviously, we run a subset of our aerospace business through there. The energy business that I spoke about earlier, giving more attention there. and we do a fair amount of conversion work through there as well. In terms of ramping up, I would tell you right now, we are still hiring people at Athens. So we still have a fair amount of people that we want to hire in Athens right now, maybe another 10% on the current workforce to be able to even push more volume out of that plant.

And is it still kind of a lower-cost facility as you have been ramping it? Is it proving out to be that way?

Well, it's a lower-cost facility just because the flow is much more compact and much more efficient. It's a straight line. So that by itself gives us advantages over our other facilities. They share some of the same costs when it comes to energy and supplies and some of that. But certainly from a flow standpoint, is more efficient.

Okay. And just lastly on -- I know you're not a huge beneficiary of VSMPO being, kind of, displaced. But in the titanium wire bar coil world, have you seen any kind of inroads maybe with the medical customers where they had some traction switching over to Carpenter or...

We see a large increase in our demand in the titanium side regardless of what's going on with VSMPO. So we're driving market share mainly because of the solutions that we provide. Certainly, out there in the market. I mean we're not melters of titanium. So this whole VSMPO scenario really plays to areas entities that melt titanium and certainly, you're seeing a shift there.

Yes, but not so much on the downstream where they stood up a facility seven, eight years ago.

I'm not sure, we're at sold-out levels, customers wanting more and it has nothing to do with VSMPO. It's just that we have a good product. The market is growing, and they're looking to Carpenter Technology to be that supplier.

Last one for me. Just any update on soft magnetics and automotive penetration there. What you guys...

Yes, thanks. I appreciate the question. A lot of that gets lost because aerospace is so dynamic right now. But we're doing really well as far as filling up that new mill there in Reading, a lot of interest from the EVTOL crowd as these companies try to get FAA certification even quicker. So you're seeing a lot more activity there, and we're very happy with the pace there. Obviously, that's a little longer term than the current aerospace market we have today. But we feel it's important for us to always be involved in some of these other submarkets that will have significant growth maybe past the 12-month period that we're always looking at to continue to enhance our earnings going forward.

Thanks a lot guys. Appreciate it.

Gautam, thanks for the questions.

The next question is a follow-up from Josh Sullivan with The Benchmark Company. Please proceed.

I just wanted to follow up on that as well. So the consumer electronics demand you called out in the presentation, is that EVTOL or is that something else for the hot strip mill?

Well, it's different, right. There's, it's really on the electrification side. I just mentioned EVTOL is one area. That's not a lot of volume in that area right now, as you well know, because that's going to be muted until they get FAA certification. But that's one area that's very attractive for us going forward. In the more immediate mode, that's not having the same impact. obviously. And it's more on some of the traditional electrification areas that's driving that growth. And on the semiconductor side, it's still strong.

And on the semiconductor side, I mean, some others have material providers have called that out as a softer market. So just curious the strength you're seeing there, is that on some of these new capital builds? Or just where in the semiconductor market, are you seeing the strength?

Yes. I've seen that. We've not experienced that at all. Remember, our product goes into manufacturing the equipment that then makes the semiconductor. So a very harsh environment, and that's where our product goes into. And we've not seen any softness in that area.

Okay. Thank you.

Yes, thank you.

At this time, I'm showing no further questioners in the queue, and this does conclude our question-and-answer session. I would now like to turn the conference back over to John Huyette for any closing remarks.

Thank you, operator, and thank you everyone for joining us today for our fiscal year 2023 fourth quarter conference call. Have a great rest of your day.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.