Good morning, and welcome to the Carpenter Technology Corporation Second Quarter 2023 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Brad Edwards of Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology earnings conference call for the fiscal 2023 second quarter ended December 31, 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, 2022, and Form 10-Q for the quarter ended September 30, 2022 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 adjusted operating income, excluding special items and sales, excluding surcharge. I will now turn the call over to Tony.

Thanks, Brad, and good morning to everyone on the call today. Let's begin on Slide 4 and a review of our safety performance. Through the second quarter of fiscal year 2023, our total case incident rate was 1.5. We did see improved performance in the second quarter, lowering the year-to-date rate. The year-over-year rate increase is largely due to the increase of employees undertaking new tasks, either as new hires or transfers into new roles. To address this, we have enhanced and expanded training procedures for any employee new to a job or task with frequent monitoring and follow-up. Our ultimate goal continues 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 second quarter. Second quarter performance was driven by the strong demand environment in each of our end-use markets and the increase in productivity across our operating facilities. We continue to see solid demand conditions in each of our end-use markets, with our backlog up 9% sequentially and 107% year-over-year. This marks the eighth consecutive quarter of backlog growth. Most notably, we see the aerospace and defense end-use market ramp accelerating. As a result of the strong demand environment across our end-use markets, we continue to realize price gains. We announced another price increase on our transactional business in November and continue to raise prices through our regular contract negotiations. In order to satisfy demand, we are focused on accelerating the productivity of our labor force across our facilities, most notably by safely onboarding new employees across all our production centers. And we are working closely with our customers to deliver more material sooner. For the quarter, the SAO segment delivered operating income of $30.3 million, in…

Thanks, Tony. Good morning, everyone. I'll start on Slide 8, the income statement summary. Net sales in the second quarter were $579.1 million, and sales, excluding surcharge, totaled $420.8 million. Sales excluding surcharge increased 34% from the same period a year ago, on 17% higher volume. Sequentially, sales were up 12% on 12% higher volume. Gross profit was $70 million in the current quarter compared to $13.1 million in the same quarter of last year and $54.8 million in the first quarter of fiscal year 2023. Gross profit is up substantially compared to the same quarter last year and up 28% 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 $47.4 million in the second quarter, up about $3 million from the same period a year ago. Note that the SG&A line includes corporate costs, which totaled $16.4 million in the recent second quarter. The reported corporate costs increased about $2 million from the same quarter last year and are largely in line sequentially. As we look ahead to the balance of fiscal year 2023, we expect corporate cost to be $19 million to $20 million per quarter. Operating income was $22.6 million in the current quarter. When excluding the impact of special items in the prior year quarter, adjusted operating loss was $29.8 million in the same quarter last year, and operating income was $8.3 million in our recent first quarter. Our effective tax rate for the second quarter was 19.5%. As we said last quarter, as pretax levels increased throughout the fiscal year, we expect that the full year effective tax rate will be approximately 22% to 24%, but may continue to have variability on a quarterly basis.…

Thanks, Tim. Now to recap our second quarter of fiscal year 2023. We are operating in a strong demand environment with positive near-term and long-term outlooks in each of our end-use markets. Notably, the aerospace submarkets 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 will continue to offset inflationary pressures through our raw material surcharge mechanism and our ability to increase prices on both our contractual and transactional business. As I noted earlier, we are focused on increasing the productivity of our labor force across the facility by safely onboarding a significant influx of new employees across all of our production centers. By increasing volumes, improving mix, increasing prices and improving productivity, we will continue to see margin expansion. As a result, we will continue to maintain a healthy liquidity position. We did build inventory at certain stages of the production flow in the first half of the fiscal year to make sure we have the necessary resources to serve our customers. As Tim mentioned earlier, we expect the inventory balance will come down as we move through the second half of the fiscal year. And looking ahead, we are positioned to achieve our goal of delivering operating income at the fiscal year 2019 run rate range in the fourth quarter of fiscal year 2023. Let's turn to the next slide and take a closer look at our full fiscal year 2023 outlook. On the last two earnings calls, we talked about our goal of achieving the fiscal year 2019 operating income run rate by the fourth quarter of this fiscal year. Let me provide more insight into how we see the next two quarters playing out. Demand remains strong across all of…

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

Thanks, guys. I just want to make sure I have this right, first on the guidance comments. Did you say 12% to 13% ex surcharge sales growth in Q3 and Q4? Did I hear that right?

That's correct. Yes, Gautam. Good morning.

Good morning. Does that imply a sequential decline in sales ex surcharge?

No. You take the second quarter sales. Third quarter will be 12% to 13% higher and then take another 12% to 13% on that.

You meant sequentially. I apologize. Okay. I just want to make sure wasn't year-over-year. The commentary on Q4, now the range of $54 million to $60 million, previously, it was around $60 million. Is there anything specific that explains the slightly lower midpoint or low end?

Yeah. As I said in my comments ---

Corporate cost.

No, it's not corporate cost. It's not demand. It's really our workforce and training them safely and effectively to produce those rates to run at the rates. That's really the gating factor right now. And I've heard that from many other companies in the industry as well. If you remember, our workforce decreased significantly during COVID and now we're building that back up. So it takes some time to get them trained. Now I'm a quarter closer. I just want to give a little bit of range. If we hit what we say we're going to hit, we'll be closer to the 60% in terms of the training.

Got it. And then the Q1 comment, did you mean to suggest it will be higher than the $54 million to $60 million, so way better than normal seasonality?

Yes, because I think -- keep in mind, inflection where our shareholders or people that might -- that needs a little bit more runway as far as what they see us doing. So I'm always trying to be a couple of quarters out there. Now I might not give all the color that someone like yourself might like, but at least trying to give some directional guidance, assuming there's always your normal risk factors. But assuming that it goes the way we see it. But yes, we would see the first quarter then take another step up from that 50-40-60.

And then I was just curious on the cash use in the first half. The cash balances quite low at ending the quarter and then the leverage is a bit up. What do you think will happen with respect to free cash flow in the second half? Do you guys have an updated forecast for that?

Well, I'll tell you this, Tim mentioned it on the call. I think I mentioned it as well that we intend to take inventory down in the second half. And we're not going to do that randomly. I mean the demand is going to be higher, so it's going to pull that inventory. And then the earnings are going to be significantly higher as well, right? I mean that 54% to 60%. If you hit that, that's -- as I said, it's 140% higher than what we just did. So your free cash flow will follow those two items. I think you'll have pretty healthy free cash flow, obviously, compared to the first half.

Okay. And just stepping back on backlog, you mentioned a 9% increase. Could you just talk a little bit about engines versus fasteners versus other structural components in aero? And then maybe just give some flavor for where you're seeing the order strength maybe sustain and improve, and if you're seeing any areas that are a little bit softer?

Well, right now, I'm not seeing any areas that are soft. I mean all of our customers are asking for more sooner. I mean to answer your question specifically, year-over-year, engines backlog is up 180%-plus, faster than 160%. If you look sequentially, it's up 8%, 9%. So big increases in all the backlog. And you're getting to a point where the backlog isn't as meaningful. In other words, we're over 52 weeks. And there's plenty of demand out there. So we're at -- I think we're at 2x the backlog we had even back in FY '19 when you had the type of demand you had back then.

Thanks, Tony.

Thank you, Gautam.

[Operator Instructions] Our next question comes from Joshua Sullivan from the Benchmark Company. Please go ahead.

Good morning. As we think of that labor influx now to support that step up into the fourth quarter, will you need additional labor inputs to get to the Q1 numbers and beyond? Or is there a leveling off at some point in headcount?

Yeah, it's a good question. So -- and I'm glad -- I appreciate you asking it. Let me give a couple of bullets around that. I just -- that might be helpful for you. I mean, certainly, as I just mentioned to Gautam, like most companies during the COVID pandemic, we allowed our maintenance production workforce to decrease significantly through attrition. We had a higher rate of retirements during that period of time. Now over the last year, we've had an accelerated pace in bringing back employees across all of our locations. So of course, that gives you a less experienced workforce. And I jotted down a little stat here. If you look at some of our critical work centers at our largest facility, you could have anywhere range from 30% to 35% of employees at that workstation have less than a year. So you know your way around a manufacturing site. That is a significant amount to be able to produce it through rates you want to produce that. Now certainly, there's a tight labor market. I believe our -- we're making very good progress. We have very fulfilling jobs. We have competitive wages, attractive benefit plans. So we're right there. I would say we're probably 85% to 90% as far as the work staff -- workforce that we need. There's some more that we want to hire in a couple of critical work centers. Now to give you some comfort, that's not a couple of thousand, that's maybe 200 or 300 more on roughly 2,500 person our workforce in SAO.

Got it. And then any commentary out of the aerospace supply chain, they can't get enough engine-related materials. But from Carpenter's perspective, what takes aerospace sales incrementally higher from here? Is it increased capacity on your end? Or is it increased pull from customers just given where you guys supply chain?

Yeah. Three things, not in any particular order. One, yeah, we increase our productivity. And remember, part of that increased productivity is our Athens facility. So we have that. So we know demand is going to go higher. We have organic productivity at our existing plants, and then we have Athens. We have mixed management, as you see some of these markets like aerospace and medical get stronger and stronger. You'll see us move more towards those markets and cut off the tail, if you will, even more than we have in the past. And then the third big driver is price. We've been able to increase price significantly. And even if you do some math, quick math and SAO with -- take the sales and we give you shipments by pound, do the math, you're probably a pound higher than you were in FY '19, which was one of our best financial years ever. So pricing is a big item that a lot of people tend to forget about because they all want to know how are you going to get more productivity, where is the capacity, the price and the mix management is a big factor in that.

Yeah. And then just on the defense impact you mentioned, can you just highlight some of the dynamics there? What types of alloys or defense products is that impacting? And then how might we see that rebound?

Sometimes, it's such a small piece, you sometimes wonder whether that's even really relevant in the whole scheme of our earnings release. I don't see any issues there. You know the areas that we that we provide in defense were more on the munition side than armament, but we have a variety of alloys that we sell into defense. And quite frankly, we see defense as a growth area for us going forward. But because of the dynamics, you'll see some variability up and down every quarter. It was only a couple of quarters ago, I think that it was a big increase in defense, and I said not to get too excited about that, that's just the normal variability inside the defense submarket.

Yeah. Thank you for the time.

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.

Thanks, Jason. I appreciate it. Thanks, everyone, for joining us today for our fiscal 2023 second quarter conference call. We appreciate your time and support and look forward to connecting with all of you in the near future. Thanks again, and have a great rest of your day.

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