Good day, and welcome to the Carpenter Technology Fourth Quarter Fiscal 2020 Earnings 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 Brad Edwards. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology earnings conference call for the fiscal 2020 fourth quarter and year ended June 30, 2020. This call is also being broadcast over the Internet along with presentation slides. Please note, for those of you listening by phone, you may experience a time delay in slide movement. Speakers on the call today are Tony Thene, President and Chief Executive Officer; and Tim Lain, 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-K for the year ended June 30, 2019, and Form 10-Q for the quarters ended September 30, 2019, December 31, 2019, and March 31, 2020, 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 margins, that is based on operating income and sales, excluding surcharge. I will now turn the call over to Tony.

Thank you, Brad, and good morning to everyone on the call today. I hope you and your families are well and safe. Let's begin on Slide 4 with a review of our safety performance. Our total case incident rate or TCIR is 1.1 for the fiscal year 2020. This is our lowest annual incident rate to date as we continue our journey to a zero-injury workplace. This is an impressive achievement considering the challenges of operating our manufacturing facilities during the COVID-19 pandemic. Our employees have done and continue to do an exceptional job following the safety protocols in place to keep our plants safe. As we turn to fiscal year 2021, our safety activities built on employee engagement will continue to support our drive to a zero-injury workplace. Now let's turn to Slide 5 and a review of the fourth quarter performance. Just two quarters ago, at the midpoint of our fiscal year 2020, Carpenter Technology had significant momentum. Our SAO segment was achieving margins at historic highs. We just completed our 12th consecutive quarter of year-over-year sales and earnings growth. The company was on track for the best financial performance year in our history. And our growth accelerators, such as the investment in Athens facility, soft magnetic and additive manufacturing were poised to start contributing to the bottom line in the years to come. Of course, the COVID-19 pandemic was thrust upon us, and it had had a devastating impact on our personalized and on the economy. Fortunately, Carpenter Technology was in a strong position. Understanding the magnitude of the downturn, we aggressively pushed forward with portfolio restructurings and cost reduction initiatives to strengthen an already strong liquidity position and balance sheet. Our actions today include, the elimination of approximately 20% of our global salary positions, implementing a…

Thank you, Tony. Good morning, everyone. I'll start on Slide 8, the income statement summary. Net sales in the fourth quarter were $437 million, and sales excluding surcharge totaled $376 million. Sales excluding surcharge decreased 24% sequentially on 23% lower volume. Compared to the fourth quarter a year ago, sales decreased 30% on 32% lower volumes. As Tony covered in his review of the markets, the results reflected weakening demand in the near-term across all end-use markets due to the significant impact of COVID-19. Also, as Tony mentioned, as a result of the current demand conditions, we made the decision to adjust our production schedules and accelerate our inventory reduction program. These actions had a significant positive impact on cash flow results, which we will talk about shortly, but had a negative impact on our operating income results in the quarter. The trade-off between cash flow and operating income was an easy decision, given our focus on strengthening liquidity in the near-term. In addition to the demand implications of COVID-19, we continue to deal with the impacts of the pandemic on our production facilities. The additional safety measures necessary to protect our employees and ensure that we can continually operate have impacted productivity. The teams continue to deal with certain self-isolation measures that affect staffing levels at key work centers. I'll talk more about the COVID-19 mitigation cost impacts on our results shortly in the segment details. SG&A expenses were $42 million in the fourth quarter, down $13 million from the same period a year ago and down about $9 million sequentially. The lower SG&A expenses primarily reflect the impacts of salaried furloughs, remote working impacting certain administrative costs, such as travel and entertainment, and lower costs associated with variable compensation programs. The current quarter's results include $130 million of…

Thanks, Tim. Let's move to Slide 15 and a brief review of our immediate priorities. Our first priority will remain protecting our employees and communities. Our rapid response team remains hard at work, safeguarding our facilities and implementing various COVID-19 protocols. Our self-reporting and self-isolation programs remain in place and are highly effective. We also continue to run our operations in a pod alignment in order to deter virus transmission within a department or shift. Communications with all our key constituents remains frequent, including employees, state and local governments as well as customers. Our ability to keep our facilities open and running during these unprecedented times clearly demonstrates the commitment of all of our employees as well as the benefit of our core safety value and culture. Our second key priority is strengthening our liquidity and maintaining our solid financial position. We've taken aggressive actions to reduce our cost structure through several targeted initiatives and portfolio restructurings. In addition, we reduced our capital spending budget for fiscal year 2021. In total, we expect our efforts will reduce our annual cost by $60 million to $70 million. This will make us a leaner and more flexible company, better positioned to drive accelerated growth when demand levels normalize. Our focus for fiscal year 2021 is cash generation, as we continue to evaluate additional actions to bolster our position. Lastly, we will remain in contact with our customers, and we'll continue to support their evolving material performance needs. The impact of COVID-19 across our end-use markets is severe and has created demand shocks, widespread inventory management and unconventional demand adjustments. We are working closely with our customers to reprioritize our production schedules and accommodate changing orders as well as urgent requests. As I noted earlier, in our key Aerospace and Defense and Medical…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Gautam Khanna with Cowen. Please go ahead.

Yes. Thanks. Good morning, guys.

Good morning, Gautam.

I had a couple of questions. First, I was curious you have the visibility of the down sales sequentially in Q1. What can you say at this point about Q2? Have – like how much visibility do you have on customer order schedules and are you still seeing kind of a shuffling of delivery schedules where folks are asking to push things out? Yes, if you could just expand on what you're seeing.

Good morning, Gautam. I hope you and your family are doing well. Yes, there's still some movement as far as visibility in the second quarter, but I believe we have a pretty good line of sight. I mean we gave you EPS guidance for the second quarter, and said that we would remain free cash flow positive. So I think we have a pretty good handle on what we think is going to happen over the next quarter.

I'm sorry. I thought you gave EPS guidance for Q1, correct? Fiscal Q1.

Yes.

Did you also give it for Q2?

No, no, I apologize. That's right. Just for Q1.

Okay.

I think – let me expand a little bit. I think the first half of FY 2021 is going to be muted. And I think you'll see the recovery coming in the last two quarters. I think we really went out to provide guidance for the first quarter, not ready to do that in that specificity for the second quarter. But I do believe it's going to be the end of this calendar year until we start seeing some improvement. And I think that lines up the fact, I know that lines up with many of the companies that have reported to date. Sorry for the confusion. When you said guidance, I thought you were talking about the first quarter, my apologies.

No problem. And just to be clear, what do you – I mean, so that would imply – because the rates – the production rates on the Aerospace side are obviously going down and then they stay down. So I guess, what is the reason that it would come back in the second half of the fiscal year? Is it just some level of destocking that's amplifying the current downturn? Or is it seasonality? I'm just curious like what – and if so, what is the order of magnitude of the destocking and/or seasonality that we could expect to come back.

Yes, it's a good point. You're exactly right. With the downturn, everybody is adjusting based to the change in build rates for the primary aircraft manufacturers. That's what everybody is pivoting off of. It was even magnified for us because there was, as you suggested, rightly so a destocking impact. So that amplified the impact for us. Now as you start to rebuild, remember that the supply signal for us will probably be two to three quarters in front of that. So we get hit pretty hard when you just shut off the flow because of the destocking is able to come back quicker. I believe that when – because it's such a distinct halt when you do see that demand signal come back, that's going to be pretty significant. And I think you go right back to shortages. Remember, when we went into this pandemic on the products that we produce, you were out of capacity. Athens being the only capacity coming on and with the long lead times, and I think you'll go back to that pretty quickly.

Okay. And then just to follow-up on your remarks about increased market share. Could you speak to any – can you give us any specifics around it? Is it – was that in the engine channel? Was it in the landing gear side? Was it fasteners? What specifically, what product areas have you been able to secure more share? And why do you think that is the case? I mean are you seeing other suppliers that compete with Carpenter maybe falling off a little bit in terms of quality or just financial distress? Anything you could expand on there would be helpful.

Yes, it's a good question. The majority of those customers are the larger customers, or big customers. I would go as far as saying it's primarily on the engine side, but it does filter in some fasteners and some other pieces. I think the main issue is, right now, the focus is on delivery performance and lead times. And I think when you look at Carpenter Technology in the long-term and their ability to have that additional capacity. We are a company that these other customers want to partner with. So it's a really – it hasn't been a difficult discussion to say we're willing to work with you in exchange for some increased market share in the future. That's been a very productive conversation, and quite frankly, not a difficult one.

Okay. Thank you very much.

[Operator Instructions] Our next question comes from Josh Sullivan with The Benchmark Company. Please go ahead.

Good morning.

Good morning, Joshua.

Just to follow-up on the first half outlook. I know you're looking for steady demand across end markets. But which end markets do you have more confidence that we're closer to bottom in?

Well, Aerospace and Medical make up over 70% of our market portfolio. So those are the ones we're focused on. Certainly, Transportation and Industrial Consumer are important to us, but their percentages are much lower. I can't tell you whether we're at the bottom now or not. It feels like we are. I'm sure you can listen to the phone calls from the other large engine manufacturers and airplane builders. And I think that maybe we're getting close to that. I do believe – I think what's important is that there's a significant amount of airplanes that are being retired early. There was a significant amount that needed to be retired. This pandemic has pulled back forward. So when air travel does come back, I think you're going to see the need to build – to continue to build those airplanes, which in turn means supply from corporate technology and other suppliers into the Aerospace supply chain.

Got it. Well, and then kind of a related question. I mean, can you – is there any detectable difference between demand for materials on next-generation engines versus legacy engines, which might be more aftermarket related?

Difficult question. Right now, I think going forward, there is going to be a need to build the newer planes. I think that's just – if you look at the mega trends and you believe that the air traffic is coming back as we do, you look at the increased retirements of planes and the cost savings you can get. I think it makes sense that you see those new planes being built. Again for us, we're a bit agnostic because we make materials that go on across every platform. I would say that we're more heavily concentrated on the OEM versus the spares market, but we supply probably material across the entire spectrum.

Got it. And then just on the inventory reduction plans, what metrics on days outstanding or otherwise, where do you think you're comfortable going should you need to use inventory as a source of cash, as you mentioned in the prepared remarks?

Well, Tim mentioned that I think, earlier in his comments that we have more room to go on the inventory side. I mean because of the dynamics of the market prior to the pandemic, we used our balance sheet to build inventory because we didn't want to disappoint any of our customers when we had 50-week lead time, know capacity actives being ramped up. As we continue to work our Carpenter operating model, we were achieving significant productivity gains, but you don't get all of those evenly across the system. So in the front end of our process, on the melting side, primarily on the forging side, we were getting productivity gains quicker than on the back end and the finishing. In truly manufacturing, we would have idled the upstream to balance those, but we didn't want to do that because we need it eventually. We gained that productivity in the finishing side, and we would flush that in [indiscernible] sales demand that was out there. So when the pandemic hit, that gave us a mismatch of inventory that allowed us to bring that down to a more reasonable level. I think there's still more to go. And one of the main points of the Carpenter operating model is to have the most efficient inventory levels possible. So there's still a lot of opportunity we have there. I wouldn't say that it will be at this magnitude that we had in the fourth quarter and every quarter, but there's still plenty of opportunity on the inventory side to generate some cash.

Got it. Thank you for your time.

Our next question comes from Michael Leshock with KeyBanc. Please go ahead.

Hey, guys. Good morning.

Good morning.

So first, I just wanted to touch on the Boeing and Airbus cuts to their wide-body platforms over the past 24 hours or so. You mentioned some customers who are responding to these prior cuts. But what have you been hearing in the aero supply chain? There's obviously been some destocking, but was there any anticipation of further cuts on these platforms?

I would say that the Aerospace supply chain is a very sophisticated supply chain. We stay in very close contact with their ultimate customers. So I think the majority of the supply chain is aware of what that production levels are going to be and anticipated where that is. I wouldn't say that's for everybody, but for a majority, I would say that they have a pretty good handle on what they think those production rates will be. And I've spent the last several months adjusting accordingly. Now some customers or suppliers are certainly in a different position. If you are – if you came into this pandemic, where we were – did not have the strongest of balance sheet, you might take more severe actions and destock even quicker than what you might. That means you're going to have to build up your inventory levels quicker when the demand comes back. I think it's a big positive for Carpenter Technology because we came in with such a strong balance sheet. And when you talk to many companies in this pandemic, one of the questions you're asking what the cash burn is going to be, right. And that's not a question you have to ask – need to ask Carpenter Technology because we're generating cash today this quarter and the next quarter and say, we'll be free cash flow positive. I think that's a big benefit for Carpenter Technology versus maybe some of the aviation supply chain.

Got it. That's helpful. And then on – how were jet engine sales in the quarter, either year-over-year or quarter-over-quarter?

They were pretty consistent overall. They were about 30% – roughly 30% down quarter-over-quarter and 30% down year-over-year. That compares to our total that was 30% year-over-year and 24% sequentially. Engines – Aerospace was about 30% year-over-year, down 20% quarter-over-quarter, and engines, year-over-year about 29% and quarter-over-quarter 30%.

And how are current backlog levels just for the overall business in the quarter? And what's been the biggest driver for that delta?

Well, backlog is down. If you look year-over-year, our overall backlog is down approximately 30%, by sequentially 25%. It's driven by Aerospace, primarily. In all of the markets, the backlogs are down. I think that makes sense based on the severe economic downturn that we're in right now.

Okay. And then lastly, just on the COVID cost, you had an impact of $6.5 million this quarter. I think it was $5.5 million the prior quarter. How do you see these costs going forward? I'm just trying to gauge the cadence on when these incremental costs will level out. Thanks.

That's a good question, and it allows me to talk about that a little bit. I'm not going to skimp on those costs. I mean my point of view is I'm going to protect our employees. We're able to run those facilities. So $6 million is a big number for us, but it's a lot less than if I have to shut down a facility like you've seen in some of the other industries. So those costs include where we have a very robust self-reporting system, where if one of our employees meets a certain criteria, symptoms, travel, whatever it might be, they self-report to our medical team, our medical team decides they need to go on self-isolation and not come in to our facility. They are still paid. We still pay them as if they're in that facility, to encourage them to self-report and keep everyone safe. That includes the extra cost of cleaning whenever we have any type of issue where we think that's appropriate. We put ourselves in a pod environment, so there's some extra cost there. So I think those costs will continue into our second quarter. And I don't really see us easing those much over the next six months. But again, that's going to depend on the pandemic, and I'm going to be very conservative there. I'm not going to put our employees and ask them to come into our facilities and work really hard in a tough situation and not do everything I can to protect the health of the employees and their families, and the community, quite frankly.

Appreciate the detail. Thanks guys.

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. Thanks, everyone, for joining us for our fourth quarter earnings call. We look forward to speaking with you all again on our first quarter 2021 earnings call. Take care and enjoy the rest of your summer.

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