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Text: Please note, for those of you listening by phone, you may experience a time delay in slide movement.
When referring to operating margins, that is based on operating income and sales, excluding surcharge.
Let's start on slide four and a review of our safety performance.
Through the first half of our fiscal year, our total case incident rate was 0.5.
During this time, we have achieved the lowest incident rate in Carpenter Technology's history and a 60% improvement year-over-year.
This marks another key step forward in our mission to achieve a zero injury workplace.
It is also noteworthy to point out that our PEP segment worked injury-free during the first half of the fiscal year.
We continue to emphasize key initiatives as we look to secure our next safety milestone.
Our safety results to date are especially impressive given the challenges related to COVID-19.
Importantly, every one of our operating facilities has remained open, which is an achievement that I know resonates with our customers and shows a clear resiliency and commitment.
Our second quarter results finished largely in line with our expectations.
Our performance was impacted by ongoing inventory reductions as well as the continued market headwinds.
Despite conditions being challenging, we are actively managing our business and have placed consistent emphasis on three key strategic priorities: first, ensure the safety of our employees.
Second, drive cash flow generation and strengthen our liquidity profile.
We have made further progress against this initiative in the second quarter and delivered $51 million of free cash flow.
Fiscal year-to-date, we have generated almost $114 million in free cash flow.
If you look at the last three quarters, we have generated $214 million of free cash flow.
We ended the second quarter with total liquidity of $665 million, including $271 million of cash and no near-term financial obligations.
Third, focus on the long-term relationships with our customers.
We have successfully deepened our relationships with our key customers across our end-use markets as we partner to address evolving material requirement and the initial signs of recovery across our end-use markets.
A great example of this is in the aerospace and defense end-use market, where we have recently extended multiple long-term agreements with key customers.
There are a couple of critical takeaways from these contract extensions.
Customers fully understand that capacity was limited for the aerospace materials we produce prior to the pandemic and that supply of such aerospace materials will be constrained again when build rates return to normalized levels.
Carpenter Technology is one of only a handful of companies in the world that produce these highly specialized materials and the only one that has invested in capacity, namely the Athens facility.
And the aerospace fundamentals that were present prior to the pandemic remained strong and unchanged going forward.
While we are working to best position our core business to be stronger on the other side of the pandemic, we also continue to take steps to advance our capabilities and leadership in critical emerging technologies.
To that end, our hot strip mill in Reading is now in the commissioning phase.
The mill will be a significant enhancement to our existing soft magnetics leadership position as it expands our capabilities to capitalize on the electrification megatrend that is shaping and growing many of our end-use markets.
I will speak more about our leading position in electrification later in my remarks.
Now let's move to slide six for the end-use market update.
Starting with the aerospace and defense end-use market, where sales were down year-over-year, but up slightly sequentially.
Many of the trends we were seeing last quarter are still prevalent, including changing forward material needs and uncertainty around recovery timing.
While our sequential results were up, we expect our third quarter performance to be choppy as the recovery takes shape.
In the medical end-use market, sales were down 3% sequentially as customers continue to manage inventory levels as concerns around hospital capacity and potential resurgence weighed on the supply chain.
In the transportation end-use market, sales were down year-over-year, but up sequentially due to a rebound in the global light vehicle submarket and the strength of our high-temperature solutions.
Now moving to the energy end-use market.
In terms of the year-over-year comparison, keep in mind that we divested our Amega West business earlier this fiscal year.
Within the oil and gas submarket, conditions in North America remain challenging.
For the power generation submarket, opportunities exist for applications in the gas turbine replacement cycle.
Lastly, for the industrial and consumer end-use market, sales were down year-over-year and sequentially.
However, we continue to experience strong demand for semiconductor and fluid control application.
In addition, consumer market demand was up across all key application areas.
In our industrial end-use market, we expect continued strong demand in the semiconductor industry for our highly engineered ultra high-purity materials.
The strong demand is driven by global growth in semiconductor manufacturing to support 5G smartphones and cloud infrastructure.
In fact, the demand for semiconductor capital equipment is expected to remain robust for the foreseeable future, with the world's largest contract chip maker planning to boost capital spending by almost 50% in 2021.
Since Carpenter Technology is a global leader in providing ultra-clean materials to support critical semiconductor applications, we are constantly evaluating customer request to increase our already strong participation in this space.
As we move into the second half of fiscal year 2021, we expect continued strength in the transportation in these markets.
Our high-value solutions play a significant role in delivering advanced powertrains across both passenger and commercial vehicles.
These are increasingly in demand as global emission standards tighten.
Strong sales have been met with low inventory levels as U.S. vehicle inventory remains below 50 days of supply, down approximately 16% year-over-year.
The heavy-duty truck market has rebounded and is projected to be up 40% in calendar year 2021.
That's positive news as Carpenter Technology supplies high-temperature exhaust valve materials and specialty fuel delivery solutions to the top three engine producers.
In our aerospace and defense end-use market, we continue to build on our already strong leadership position as we look forward to the market recovery.
In the near-term, demand will likely continue to remain low and choppy at times as specific programs and customers are recovering at different rates.
However, we expect a demand reset to higher levels if customers confidently reorient to increasing OEM demand.
Of course, Carpenter Technology will benefit from this recovery as a critical supplier across multiple applications on virtually all aircraft platforms.
Our customers continue to plan for the long-term, and we, likewise, are working with them to map out appropriate support plans.
As I mentioned earlier, we continue to secure beneficial long-term contracts even during this downturn, with substantial price increases.
These key aerospace customers understand robust demand will return and value our support.
We remain very active in our defense submarket by offering advanced solutions.
As a notable example, recently, a key customer accomplished a step change in performance of a target platform with the help of our material solutions.
Our solutions are and will continue to be important for designers working on programs from aerospace electrification to next-generation defense systems.
Now turning to our medical end-use market.
States are beginning to lift restrictions on elective surgeries, spurring a restocking actions that will continue over the coming quarters at both end-user OEM customers as well as distributors supporting the medical device market.
These restocking efforts have more impact on elective surgery applications such as orthopedic and dental as opposed to the more nonelective cardiology segment, which has been more resilient.
The medical market is recovering ahead of aerospace, and our role as a critical supplier to the industry has been strongly reinforced and will provide incremental bottom line impact as demand recovers.
As I mentioned earlier, we continue to invest in critical emerging technology.
In addition to supporting an already strong aerospace position and auxiliary power units and generators, our new hot strip mill will enable the launch of products to provide lead time benefits and capacity for growing aerospace electrification applications, automotive-based engine turbocharger designs and the transition to electric vehicles.
As electric vehicle demand continues to grow and program activity increases for electrifying short-range air travel, we are increasing our investment in motor technology and our soft magnetic solutions.
Specifically, we are investing in advanced part capabilities and state-of-the-art modeling and testing.
These capabilities ensure our customers realize the full material performance benefits in their motor and powertrain designs.
We've also invested in emerging technologies related to additive manufacturing and digital platforms, where adoption could be accelerated due to changes caused by this pandemic.
All are exciting developments to say the least and accelerators of earnings growth moving into the future.
I'll start on slide nine, the income statement summary.
Net sales in the second quarter were $348.8 million.
And sales, excluding surcharge, totaled $299.4 million.
Sales excluding surcharge decreased 3% sequentially on a 11% lower volume.
Compared to the second quarter a year ago, sales decreased 36% on 33% lower volume.
As Tony covered in his review of the end-use markets, the year-over-year decline is attributable to the ongoing demand headwinds in our key end-use markets of aerospace and defense and medical as a result of the global pandemic.
As expected, the demand was similar to our recent Q1 levels.
Given the current demand environment, we continue to actively manage our production schedules and focus on executing against our targeted inventory reduction program.
As we said on prior calls, while the reduction in inventory drives near-term cash flow generation as evidenced by our growing liquidity, it negatively impacts our operating income performance.
SG&A expenses were $42.2 million in the second quarter, down $13 million from the same period a year ago and flat sequentially.
The lower year-over-year SG&A expenses primarily reflect the actions we took to reduce costs, including the elimination of about 20% of our salary positions, managing discretionary spend closely, as well as the impact of remote working conditions that reduce certain administrative costs, such as travel and entertainment.
The current quarter's operating results include a $52.8 million goodwill impairment charge associated with our additive reporting unit that is in our PEP segment.
In addition, our results for the quarter include $3.9 million in COVID-19 related costs.
Included in this amount are direct incremental operating costs, including outside services to execute enhanced cleaning protocols, isolation pay for employees potentially exposed to COVID-19 and additional personal protective equipment and other operating supplies necessary to maintain the operations while keeping the employees safe against possible exposure.
The operating loss was $89 million in the quarter.
When excluding the impact of the special items, namely the goodwill impairment charge and the COVID-19 costs, adjusted operating loss was $32.3 million compared to adjusted operating income of $57.3 million in the prior year period and an adjusted operating loss of $30.9 million in the first quarter of fiscal year 2021.
Again, the current quarter's results reflect the impact of significantly lower volume, combined with the targeted inventory reduction, partially offset by the cost reduction efforts.
Our effective tax rate for the second quarter was 11.2%.
When factoring out the disproportionate impact of the goodwill impairment charge on the tax rate, the income tax rate for the quarter would have been approximately 25%.
For the balance of the year, we currently expect the tax rate to be in the range of 28% to 32%.
Earnings per share for the quarter was a loss of $1.76 per share.
When excluding the impact of the special items, adjusted earnings per share was a loss $0.61 per share.
Before we move on to the segment slides, I would like to highlight a couple of modeling items.
The first is related to interest expense.
We provided fiscal year 2021 guidance for net interest expense of $35 million, which reflected the impact of the bond refinancing we completed in Q1 and the assumptions around capitalized interest for the large projects expected to be placed in service in 2021.
Through six months, we reported interest expense of about $15 million and continue to expect full-year fiscal '21 interest expense to be about $35 million.
The second is depreciation and amortization.
Our guidance for fiscal year 2021 remains at $130 million.
Through six months, we reported depreciation and amortization of $60 million.
Now turning to slide 10 and our SAO segment results.
Net sales for the quarter were $300.4 million or $251.6 million, excluding surcharge.
Compared to the second quarter last year, sales excluding surcharge decreased 34% on 32% lower volume.
Sequentially sales, excluding surcharge, were essentially flat on 11% lower volume.
The sequential results reflect similar demand conditions in our largest end-use market of aerospace and defense as the supply chain continues to deal with near-term reductions in OEM build rates.
This was partially offset by stronger shipments in transportation as North American light vehicle production continues to ramp back up.
The industrial and consumer end-use market saw weaker demand in general industrial applications that was partially offset by higher demand for consumer applications.
SAO reported an operating loss of $11.6 million for the current quarter.
The same quarter a year ago, SAO's operating income was $76.3 million; and in the first quarter of fiscal year 2021, SAO reported an operating loss of $18.6 million.
The year-over-year reduction in operating income primarily reflects the impact of lower volume as well as the negative income statement impacts of reducing inventory, partially offset by the actions taken to reduce operating costs.
During the current quarter, SAO reduced inventory by approximately $58 million and year-to-date has reduced inventory by $131 million.
Sequentially, the lower operating loss is principally the result of lower volume, offset by a favorable product mix and a less pronounced impact of the inventory reduction relative to the first quarter due in part to rising raw material prices.
In addition, the current quarter's results reflect approximately $3.2 million of direct incremental costs associated with our efforts to protect our facilities and employees in light of COVID-19.
This compares with $7.3 million in COVID-19 costs in Q1, which as we disclosed last quarter, included $3.1 million associated with a bad debt write off.
Looking ahead, we expect demand conditions across most end-use markets will stabilize and begin to gradually recover in the second half of our fiscal year 2021.
Based on current expectations, we anticipate SAO will generate an operating loss of approximately $8 million to $11 million in the third quarter of fiscal year 2021.
The anticipated results reflect incremental operating expense reductions as a result of cost savings actions taken to date, combined with a less pronounced impact of inventory reductions, partially offset by higher sequential depreciation and amortization costs as our global ERP system and hot strip mill investments come online.
This estimate includes similar sequential COVID-19 related costs in the upcoming third quarter.
Now turning to slide 11 and our PEP segment results.
Net sales, excluding surcharge, were $54.1 million, which were down 48% from the same quarter a year ago and down 12% sequentially.
The year-over-year decline in sales was driven by market headwinds, largely due to the global pandemic.
Additionally, sales in the energy end-use market declined as a result of our exit of the Amega West oil and gas business in the first quarter of this fiscal year.
The sequential decline in sales reflects near-term demand pressures in aerospace and defense and medical end-use markets due primarily to the impact of a global pandemic and its impact on aircraft OEM build rates and medical elective procedures.
These declines were partially offset by modest growth in sales in our distribution business.
In the current quarter, PEP reported an operating loss of $7.2 million.
This compares to an operating loss of $3.6 million in the first quarter of fiscal year 2021 and operating income of $0.4 million in the same quarter last year.
The sequential operating results reflect the unfavorable impacts of lower sales.
We continue to drive opportunities for incremental cost reductions across the businesses while realizing the ongoing benefits of the cost reduction and portfolio actions already taken.
As we look ahead, we believe that demand conditions will gradually begin to improve in the coming quarters, and we continue to evaluate opportunities to reduce cost and manage working capital closely all while maintaining our ability to meet future anticipated demand.
We currently anticipate PEP will generate an operating loss of $3 million to $5 million in our upcoming third quarter.
Now turning to slide 12 and a review of free cash flow.
In the current quarter, we generated $84 million of cash from operating activities.
This cash generation was driven by improvements in working capital, primarily inventory.
Within the quarter, we decreased inventory by $71 million.
This reduction is substantial on the result of considerable effort to continue to execute against our targeted inventory reduction programs across our facilities.
Over the last three quarters, beginning with our fourth quarter of fiscal year 2020, we've reduced inventory by $273 million.
We remain in constant communication with key customers to ensure that we maintain the appropriate inventory levels and lead times are aligned as demand patterns change.
In the second quarter, we spent $27 million on capital expenditures.
We remain on track to spend about $120 million in capital expenditures for fiscal year 2021 as planned.
As a reminder, our fiscal year 2021 capital spend includes completing the $100 million multiyear hot strip mill project, which will come online later this fiscal year.
Tony will comment on the capabilities of the new hot strip mill and how it fits into our strategy in the coming slides.
With those highlights in mind, we generated $51 million of free cash flow in the quarter.
From a liquidity perspective, we ended the current quarter with total liquidity of $665 million, including $271 million of cash and $394 million of available borrowings under our credit facility.
Our focus on liquidity is essential in the near-term as we work our way through disruptions brought on by COVID-19 in our end-use markets.
It's also important to note that as a result of the actions we had taken to date to reduce cost and protect liquidity, we have been able to maintain a constant dividend to our shareholders.
We believe that demonstrates our conviction in our ability to deal with the temporary impacts of the market disruption and our confidence in the long-term future for our business.
On last quarter's earnings call, I announced the launch of the Carpenter Electrification brand.
Interest has been extremely high, and I want to take some time to give you more insights into our vision.
Carpenter Technology has spent decades perfecting the processing of soft magnet materials with the highest induction, permeability and lowest core losses.
Historically, our materials have supported our leading position as a solutions provider for generator and auxiliary power unit, APU, applications, and this business has grown consistently with the aerospace market.
Our Hiperco alloy motor technology is well-known in the aerospace market, where Hiperco stator cores are used in over two three of the APUs, which generate the power to kick off the main engine in aircraft.
To support our existing business and further capitalize on the growing trend in electrification, we are in the final stages of commissioning our new hot strip mill on Reading campus.
The new strip mill is another critical component of our electrification strategy.
The bulk of the construction is complete, and the team is working diligently on the commissioning process.
In early December, we hit an important milestone when the first hot metal was rolled on the new mill.
Although there is still work to be done to ensure the facility is up and running, it is fair to say we are all excited about the potential for this facility.
I thought I would highlight some of the technical details of the mill.
The mill is designed to roll slabs from five inches thick down to coils with a minimum size of 0.08 inches, with width ranging from eight to 19 inches.
It is designed to run iron, nickel and cobalt materials.
And is also capable of rolling copper, manganese and titanium.
The mill includes automated surface inspection equipment and a digital real-time quality and maintenance system.
The mill will also enable us to produce materials in our existing portfolio with improved throughput, quality and responsiveness.
To serve customers at every step of the way and to realize improved motor responses using these high-performance alloys, we have continued to expand our expertise into the production of stator and rotor stacks.
Understanding that soft magnetic materials are sensitive to processing steps that can reduce their performance, our material experts are further advancing technical and manufacturing knowhow associated with the production of motor stack through a multitude of methods tailored to customers' performance requirements.
These capabilities ensure our customers realize the full material performance benefits in their motor and powertrain designs.
As we build our motor technology capabilities, we are already engaging with a wide variety of customers to utilize our Hiperco stack technology to solve the need of generating orders of magnitude improvements in power compared to conventional systems.
Electrification trend across several of our end-use markets is clearly gaining significant momentum.
Electrification of passenger vehicles is already a growing reality.
The number of electrical vehicles sold is expected by some industry experts to increase from 2.5 million to over 10 times that by the year 2030.
In addition, there is clearly momentum building for the electrification of transport trucks that could enable lower maintenance, better efficiency and lower ownership cost of transporting a payload, not to mention the substantial environmental benefit of zero-emission trucks.
The anticipated growth for electric truck is one that we are watching closely.
As we continue to hear from OEMs, a significant challenge to the expansion of electric trucks is the lack of sufficient energy density in the battery.
We believe our materials and expertise can provide innovative solutions for this challenge.
In addition, with our long-standing position in the aerospace supply chain, we see a concerted effort in commercial aerospace to move toward more efficient electric applications in existing aircraft and future paths to hybrid and full electric aircraft.
Electrification benefits can also be seen in highly efficient and responsive motors for medical equipment.
In consumer electronics, high performance, high induction, high permeability and low loss soft magnetic alloys are important for device performance benefits and product development flexibility.
As you can see, the market opportunity is substantial.
It's projected that the total electrification market, which includes motors, power electronics and legacy applications such as APUs will grow from approximately one billion today to as much as five times that number by the year 2030.
With this type of growth, it is easy to see why Carpenter Electrification is an important component of our strategic plans going forward.
The collaborations we're having with customers across many markets in support of their innovative designs to increase power, range or efficiency can be truly revolutionary in shaping the future.
While the past nine months have presented significant challenges, we have acted decisively and quickly in response to unpredictable market conditions.
First, we implemented enhanced safety protocols and a strategic action plan aimed at safeguarding our employees and facilities as well as continuing to fulfill customer needs.
Second, we moved quickly to align our cost structure and portfolio to new market conditions.
We have reduced our cost, idled facilities and divested businesses.
Third, we have placed an emphasis on driving increased cash flow and strengthening our liquidity position.
In the last nine months, we have generated $214 million of free cash flow.
And our total liquidity at the end of this quarter was $665 million, including $271 million in cash.
Our enhanced liquidity and streamlined cost structure places us on solid ground to drive accelerated growth as markets continue to recover.
Today, we are confident that we will emerge on the other side of COVID-19, a stronger company and one with an established and profitable core business as well as a leadership position in disruptive technologies that will impact the future of our industry and our customers.
Our capabilities in our soft magnetic space will be significantly strengthened following the completion of our hot strip mill in Reading.
And the potential of our additive manufacturing platform, while delayed a bit due to COVID-19, remains highly attractive.
We have taken significant steps and made difficult decisions during these last nine months, but believe we will be a stronger, cleaner and more flexible company moving forward.
As I mentioned, the long-term outlook across our end-use markets remain strong, and we are an established and trusted supply chain partner in each.
At the beginning of this fiscal year, we stated that it was our expectation to generate positive free cash flow and positive adjusted EBITDA in fiscal year 2021 despite volume headwinds and increased costs related to COVID-19.
We are well on our way to over-delivering on that expectation.
From a free cash flow perspective, we have generated $114 million through the first half of the fiscal year, and we remain confident that there is opportunity to generate incremental free cash flow in the upcoming second half of our fiscal year.

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carpenter technology q2 loss per share $1.76.
q2 adjusted loss per share $0.61 excluding items.
q2 loss per share $1.76.
q2 sales fell 39 percent to $348.8 million.

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