Q1 2023 Carpenter Technology Corp Earnings Call
Good morning, and welcome to the Carpenter technology corporations first quarter fiscal 2023 conference call.
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I would now like to turn the conference over to Brad Edwards Investor Relations. Please go ahead.
Thank you operator, good morning, everyone and welcome to the Carpenter Technology earnings Conference call for the fiscal 2023 first quarter ended September 32022.
This call is also being broadcast over the Internet along with presentation slides. Please note for those who would be worsening by phone you may experience a time delay in slide.
Speakers on the call today are Tony James President and Chief Executive Officer and Tim.
Tim Wayne 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.
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 32022, and the exhibits attached to that filing.
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.
Thank you, Brad and good morning to everyone on the call today.
Let's begin on slide four and a review of our safety performance.
For first quarter of fiscal year 2023, our total case incident rate was one point.
While this is less than half a dozen metal manufacturing industry average rate. This performance is not up to the standards to which we hold ourselves.
Fortunately despite the increase in rate the severity of injuries continues to decline.
The rate increase is largely due to the increase of employee undertaking new task, either new hires or transfers into new roles.
To address this we have enhanced and expanded training procedures for Indian point nuclear a job are tasked with frequent monitoring and follow up.
Further we continue to drive our stopped program, which enables employees to stop work whenever there is a potential issue or concern.
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 five and a review of the first quarter.
We continue to see strong demand conditions in each of our English market.
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 in contract negotiations and see your backlogs increase.
Notably our backlog increased 10% sequentially and 155% year over year.
This marks the seventh consecutive quarter of backlog growth.
In order to satisfy this aggressive demand we're focused on increasing productivity across their operations and we are working closely with our customers as most are requesting additional volume with accelerated delivery date.
For the quarter U S. D O segment performed at the upper end of our expectations.
And by the growing market demand and continued operational improvements.
Pet segment was on pace to meet our expectations until hurricane Ian delayed shipments of our dynamic facility in Florida at the end of the quarter.
Fortunately no employees were injured and we were able to return safely to full operations. Shortly after the required evacuation orders windows.
Finally, our liquidity remains healthy.
Finished the quarter with 351 million and total liquidity.
Now, let's move to slide six and the end use market update.
Most of our end use markets were up year over year, reflecting a strong demand environment and the ongoing recovery.
And as you will hear throughout my comments, our near term and long term outlook for each of the end use markets remains positive.
Sequentially. However, we were denim across most of our end use market.
Section of aerospace and defense.
The primary factor was the sharpening up in aerospace pushing out production of material in other end use markets.
In addition, hurricanes Ian delayed shipments from our dynamics facility in Florida.
Now, let's review each of the end use market.
Our aerospace and defense end use market sales were up 3% sequentially and 36% year over year.
Global Aerospace traffic continues its recovery driving up expected build rates.
Its customers across each of the aerospace sub markets work to meet build rates the manpower materials is accelerating it.
Defense Submarket is down sequentially, primarily driven by the combination when certain government budget horizon and extended lead times.
We see this as a short term issue is there's continued interest in our advanced alloys for next generation platforms.
Excluding defense aerospace sales were up 7% sequentially and 40% year over year.
More specifically sales in the Aero engine sub market were up 24% sequentially and up 45% year over year.
As a result of the continued increases in demand lead times across the industry has extended and our backlog continues to rise.
Specifically, our aerospace and defense end use market backlog is up 11% sequentially and 190% year over year.
Notably the backlog value now stands at nearly two X pre pandemic levels, reflecting price increases and customer urgency to secure material.
In the medical end use market sales were down 7% sequentially and up 34% compared to last year.
The year over year results reflect ongoing recovery elective surgeries with hospital staffing levels improving.
Customers are increasing manufacturing activity and required stocking levels to meet demand.
The overall outlook continues to be positive as medical procedures are expected to rise to pre pandemic levels by the end of calendar year 2022.
We are seeing replenishment in the supply chain to support the expected growth as our medical end use market backlog is up 13% sequentially and 211% year over year.
In the transportation end use market sales were down 28% sequentially and down 25% compared to last year.
Light duty vehicle demand remains high with consumers continuing to buy even if inventories are at historic lows.
With strong demand and low inventory build rates are expected to increase throughout calendar year 2022.
In the energy end use market sales were down 13% sequentially and up 13% compared to last year.
And the oil and gas sub market demand continues to outpace supply driving growth and capital investment.
The supply shortage has been further challenged by recent geopolitical disruptions.
We see growing demand for advanced premium alloy solutions for drilling activities in harsh environment.
In the industrial and consumer end use market sales were down 17% sequentially and up 3% year over year.
We continue to see healthy demand in the electronics sub market largely driven by customer engagement for materials from our hot strip mill in already which was commissioned just over a year ago.
Now I will turn it over to Tim for the financial summary.
Thanks, Tony Good morning, everyone I'll start on slide eight the income statement summary.
Net sales in the first quarter were $522 9 million and sales excluding surcharge totaled $375 7 million.
Sales, excluding surcharge increased 20% from the same period, a year ago on 3% higher volume.
Sequentially sales were down 7% on 13% lower volume.
Gross profit was $54 8 million in the current quarter compared to $25 2 million in the same quarter of last year and $72 million in the fourth quarter of fiscal year 2022.
As we pointed out on last quarter's call the fourth quarter of fiscal year 2022 gross profit results included a benefit of $11 9 million related to employee retention credits that were recorded and called out as a special item during that quarter.
Sequentially adjusting for the roughly $12 million of nonrecurring benefits gross profit is down slightly due to the lower sales from Q4 to Q1.
The significant improvement in gross profit year over year is primarily driven by the higher sales and improving product mix and increased selling prices to offset inflationary cost increases.
SG&A expenses were $46 5 million in the first quarter up about $2 million from the same period a year ago.
When adjusting for the special items that we called out in the fourth quarter of fiscal year 2022.
G&A expenses were up roughly $1 million sequentially.
Yeah.
Note that the SG&A line includes corporate costs, which totaled $17 1 million in the recent first quarter.
The reported corporate cost increased about $3 million from the same quarter last year and about $4 million sequentially when considering the special items included in the fourth quarter.
As we look ahead to the balance of fiscal year 2023, we continue to expect corporate cost to run between $18 million to $20 million per quarter.
Operating income was $8 3 million in the current quarter when excluding the impact of special items in prior quarters.
Adjusted operating loss was $17 5 million in the same quarter last year and adjusted operating income was $14 9 million and our recent fourth quarter.
Our effective tax rate for the first quarter was 11, 5%.
The first quarter rate is lower than the statutory rate largely due to the outsized impact that certain non taxable earnings and permanent items have on the rate given our pretax loss in the recent quarter.
As pre tax levels increase throughout the fiscal year, we expect that the full year effective tax rate will be approximately 22% to 24% for the full fiscal year 2023, but we will continue to have variability on a quarterly basis.
Earnings per share for the quarter was a loss of <unk> 14 per share.
Now turning to slide nine in our <unk> segment results.
Net sales for the first quarter were $447 3 million or $305 7 million excluding surcharge.
Compared to the same period last year net sales, excluding surcharge increased 18% on 4% higher volumes.
Sequentially sales decreased 7% on 14% lower volumes.
The year over year improvement in net sales was driven by increased volume as well as an improving product mix.
Across most of our key end use markets as Tony reviewed on the market slide.
Moving to operating results <unk> reported operating income of $19 9 million and our recent first quarter.
The same quarter a year ago.
Adjusted operating loss was $4 6 million and then the fourth quarter of fiscal year 2022.
C O reported adjusted operating income of $20 million.
The $24 5 million improvement in adjusted operating performance on a year over year basis was largely due to higher sales, coupled with an improving mix and increased selling prices.
Looking ahead, our backlog remained strong and grew sequentially again this quarter as order rates across all of our key end use markets remains strong.
As we've highlighted we continue to see increased activity across the aerospace supply chain to meet anticipated increases in bill rates by the Oems.
Our teams remain focused on ensuring that we accelerate activity levels and production flow to meet the needs of our customers for the foreseeable future.
Based on current expectations, we anticipate.
Well generate operating income in the range of 30 to 32 million in the upcoming second quarter of fiscal year 2023.
Now turning to slide 10 in our Pep segment results.
Net sales in the first quarter of fiscal year 2023 were $93 2 million were $87 7 million excluding surcharge.
Net sales, excluding surcharge increased 19% from the same quarter last year and were down 6% sequentially.
The year over year growth in net sales reflects increased demand across all business units.
In our <unk> titanium business net sales increased in both the aerospace and defense and medical end use markets from the same quarter a year ago.
We've also seen significant improvement in year over year sales and are additive and distribution businesses.
The sequential decrease in net sales was influenced by the impact of Miss shipments.
From our Dynamite, Florida facility as a result of the hurricane in late September .
In the current quarter Pep reported operating income of $6 3 million.
This compares to adjusted operating income a point.
<unk> 9 million in the same quarter, a year ago, and adjusted operating income of $8 2 million in the fourth quarter of fiscal year 2022.
The operating income improvement year over year is primarily the result of increased net sales across each of the business units driven by the ongoing improving market demand conditions.
Sequentially operating income was down slightly due again, primarily to the hurricane impact on shipments for the quarter.
As we look ahead, we remain confident that overall demand conditions will remain strong in the coming quarters.
We currently anticipate that the Pep segment will deliver operating income in the range of $8 million to $10 million for the upcoming second quarter.
Now turning to slide 11, and a review of free cash flow.
In the current quarter, we used $78 million of cash for operating activities.
The cash used for operations in the current quarter was driven by increasing inventory.
During the quarter, we increased inventory by $121 million.
The increased inventory is the result of ramping up production activities to satisfy the growing demand, namely the targeted shipments for the second half of fiscal year 2023.
We continue to actively manage our supply chain to minimize potential disruptions.
We maintain regular contact with key suppliers to ensure we have a steady supply of our critical raw materials and other operating supplies for the foreseeable future.
In the first quarter of fiscal year 2023, we spent $13 million on capital expenditures.
We continue to target about $100 million of capital expenditures for fiscal year 2023.
I will also highlight we continued to find a constant dividend to our shareholders, which we consider as part of our free cash flow.
With those details in mind, we used $101 million of free cash flow in the first quarter of fiscal year 2023.
Our liquidity remains healthy and we ended the current quarter with total liquidity of $351 million.
Including $53 million of cash and $298 million of available borrowings under our credit facility.
With that I'll turn the call back to Tony.
Thanks Kim.
Now to recap our first quarter of fiscal year 2023.
We are well positioned to achieve our target of delivering operating income at the fiscal year 2019 run rate.
Fourth quarter of fiscal year 2023.
We are operating in a strong demand environment with a positive outlook in each of our end use markets.
Notably the aerospace and medical markets continue to accelerate the recovery.
As a result, our backlog continues to grow and we expect it to remain strong for the foreseeable future.
We continue to ramp our operations with an ongoing focus on maximizing throughput and productivity in key flow paths.
Through our raw material surcharge mechanism and our ability to increase prices more contractual and transactional business.
Been able to mitigate a large percentage of the recent inflationary pressures.
We continue to work closely with key customers navigating a recovery in 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 closer look at our full fiscal year 2023.
Last quarter I spoke about our projection that by the fourth quarter of fiscal year 2023, we could achieve in operating income run rate equal to our fiscal year 2019 performance.
To be specific this means that we expect to reach quarterly operating income of at least $60 million by the fourth quarter of fiscal year 2023.
Our current view of productivity throughput inflation supply chain constraints and labor availability are built into the projections.
I will spend a few minutes now to provide more detail, how we plan to get there.
First we project sales, excluding surcharge to grow at a 13% to 15% compound growth rate over the next three quarters.
As mentioned in previous fly we have a strong outlook across each of our end use markets for both near term and long term growth.
Despite concerns of a potential recession, our materials are required in industries, where demand exceeds supply.
We see these dynamics in aerospace medical energy and light duty vehicle industry among others.
Strength of the demand for our materials is confirmed by the continued growth in our backlog.
Backlogs are up 10% sequentially and 155% year over year.
Second with the increase in revenue and associated volumes, we will realize improved margins.
And while inflationary pressures have increased our cost price increases on both transactional and contract businesses over the last 12 months will help offset those pressures.
In particular, the sales segment will have a meaningful improvement in operating margin.
With return to pre pandemic sales, we expect to approach pre pandemic operating margins in the <unk> segment.
Finally, we have positioned ourselves operationally to capture the growth and realize our goals as we continue to focus on improving our productivity across facilities.
And as noted earlier, we built some inventory in the first quarter to make sure we have the necessary resources to achieve our goal.
The Bottomline is that Carpenter technology is poised to return to pre pandemic levels and significantly increase earnings over the longer term due to the strong markets, we participate in our innovative solutions.
I would customer relationships.
Our growth opportunities.
You for your time and now I will turn it over to the operator to take your questions.
We will now begin the question and answer session.
To ask a question you May press Star then one on your telephone keypad.
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At this time, we will pause momentarily to assemble our roster.
And our first question here will come from Gautam Khanna with Cowen. Please go ahead.
Right.
Yeah.
Gautam Khanna your line is open.
Yes.
Alrighty, we will take our next question from Michael the shock with Keybanc capital markets. Please go ahead.
Hey, good morning, guys.
I wanted to ask on scrap availability. It seems like that's improving and do you see that as an enabler to margin upside as the year progresses with N S. A L.
Well, it's a good question and that's something that is can be cyclical as far as availability right now that's not an issue for us and we're being selective about what.
What we do out in the market so not an issue for US right now and as you well know scrap usage is a very high percentage for us in our in our process.
And then just looking at the guidance you gave for the balance of the year, what kind of contribution are we seeing from from soft Mag and is there any view on just what we should be thinking.
Within that business.
Soft Mag is material over the next couple of quarters. In fact, we just Oh, we're finalizing a very attractive contract for us with a major customer a very nice margins are good contracts for both of us. So over the next couple of quarters. It will be material and then as you get into FY 'twenty four and beyond.
Becomes even a bigger part of our business.
And then just lastly for me on an inventory levels here, you talked about the increase quarter over quarter to kind of meet the ramp needs are you comfortable with the levels here or as the ramp progresses do you see the need to increase further.
You know, we'll we'll build inventory again in the second quarter by the end of the year. Our plan is to flush that out. So you would probably be about the same year over year over year, you'll in what I'm, saying youll in FY 'twenty three about the same place you are in FY 'twenty two.
But right now when you've got market situation like we have where the demand is.
Significantly above the supply levels, we're trying to do all we can to maximize our output and what that means right. Now is building some of that inventory because our production rates across key centers are 100% aligned so we'll build that inventory when we get the chance.
For the most part in the upstream and be able to ship that out to our customers in the second part of the year.
Great. Thank you.
Thank you.
Again, if you have a question you May press Star then one to join the queue.
Our next question here will come from Josh Sullivan from the Benchmark Company. Please go ahead.
Hey, good morning.
Good morning.
Did that ever you mentioned in the prepared remarks, where end markets outside of aerospace were dislocated by the strong aerospace demand.
Yeah, just given aerospace is gonna be growing but it's a more complex purified product is there any tiny gap, where it takes more time to manufacture the aerospace grade materials to the various furnaces and the lower grade materials they are replacing.
Yeah.
Yeah, I alluded to that at times based on the proxy were running that the aerospace materials could have a longer production cycle again I wanted to make sure I am clear on this I think this is short term, where we're always moving our production schedule around.
But in the first quarter that was a bit more extreme as we're trying to.
You'll meet the demand from our aerospace customers I think over the next couple of quarters that will even out a little bit.
Uh huh.
And then I know, it's hard to measure of aerospace aftermarket demand, but you know if you look at the number of engines delivered by Pratt GE roles.
Versus the material you know you've delivered by Carpenter does that suggest aftermarket needs are accelerating faster than passenger traffic or do you think Oems are stocking inventory just a pet production risks given some of the issues with the broader.
Hi, Chad.
When we talk to customers every one of them say they don't have enough inventory right now and they all want it faster than what the current lead times are so I don't I don't see a mismatch there and I think you know maybe Josh its a good time that question kind of leads to a bigger piece.
And I think it's really important to note that from an aerospace standpoint really for an overall market standpoint.
There's not a market demand problem. In fact, you know where demand is at its there is strong it's accelerating and you always hear this news you know like you've mentioned about aftermarket AR inventory levels build rates for the for the airplane framers, whether they're decreasing are pushing out.
And I can tell you the bottom line is that none of that's going to have a negative impact for the rest of this fiscal year and into the next year and beyond and the main issue is that right now demand significantly outpaces current supply and that's that's not going to change anytime soon so it's why we're very confident in our fourth quarter.
Target and then saying we're going to double that by FY 'twenty six I mean, those types of items are news items in the industry.
It's just not going to change because we have more than enough demand right now.
Got it.
And then.
The Russian titanium supply chain realignment, yeah, just any quantifiable moves this quarter.
Big and Josh you didn't hear the last piece of that Russian titanium supply chain realignment.
Carpenter C any meaningful new relationships as a result of that.
Yeah, I think it's a good you know that's come up a couple of times and maybe I can give you just a couple pieces, where where we would play in May you will make it more clear for everyone in aerospace of course, the U S entities that provide the large titanium forgings they could pick up some share.
Because of this and in turn we could participate the.
Conversion services that we have for those companies.
On the medical side, we compete with with V. S. M. P O on that through dynamic and there are some points. There we're working with customers where they are assessing their risks still making some sourcing decisions there.
In terms of how this stacks up for Carpenter technology, its really not going to be a major game changer compared to what we have going for us in this massive demand on the aerospace medical electrification, so there'll be some opportunities for us.
But not as big maybe it's for some of the companies that actually milk a tie.
Titanium as you know we're not a we're not a military titanium. So hopefully that gives you a little bit more insight to what we do in that area.
Okay. Thank you for the time.
Thank you.
Our next question will come from myself Gibbs with Keybanc capital markets. Please go ahead.
Hey, thanks for them.
It's very much a question was just on net working capital you you mentioned the seasonality of the build in and obviously, you've got you've got very strong volume aspirations.
As the year progresses.
Should we think about not working capital this quarter and then over the balance of the year.
Yeah.
I'll, let Tim take that one.
Yeah, Phil Good morning, Tony covered the details on inventory I mean, that's obviously our biggest component.
The rest will follow Youll payables will follow inventory to a certain extent, it's all based on timing and then receivables obviously a sales ramp.
Assuming we maintain a relatively consistent DSO, we should see some increase in and they are as our sales ramp and the last the rest of the working capital should be should be fairly in line.
Those movements.
Okay.
And then regarding aerospace specifically.
Are you guys seeing any material differentiation between engine and non engine.
For you I know include structural and landing gear avionics and.
And whatnot is there a difference between where the poles are stronger.
Well Phil this is Tony.
I mean, all of our Submarkets across aerospace are are strong right now there could be a quarter that you see a little dip maybe in distribution or one of the smaller ones, but when it comes to engines and even more so now fasteners.
That demand is extremely strong and again every one of our customers are asking for more and sooner. There. There is there is no deviation from that it is.
We need more and we need it sooner.
And that's across all of our Aero Submarkets.
And then last question for me and I. Appreciate it is just on labor and labor productivity, obviously, a big talking point for the OEM and the and the suppliers alike.
Where where do you all find you are on that our labor productivity curve do you need more had head count and you know and or where where do you think you are on the productivity curve as the cycle progresses. Thanks, yes. Its a good question Phil Thanks for asking that across their locations, there's still a couple of locations.
<unk>, where we're still.
Actively hiring you should because we're bringing on another line or we know that we've got demand coming in the future for our larger locations who are in pretty good shape as far as the number the real key for US is on the training piece because during the last couple of years. As you stated we've had the industry had a pretty good.
Good.
Turnover of the workforce whether that be through.
Retirements or other other actions and we need to train that workforce as you know we have a very complex complicated.
Manufacturing system we.
Have never failed products.
We have to maintain that quality so from a rate standpoint.
We're running full but we're not running at the rates that we ran in 2019 and that's why you see it's coming up over the next couple of quarters, we need to do that in a very structured a very.
Three planned process to make sure of all of our employees are trained properly and they can operate that equipment at the at the very highest quality standards.
Thank you.
Yeah.
This concludes our question and answer session I would like to turn the conference back over to Brad Edwards for any closing remarks.
Thanks, Joe and thanks to everyone for joining us today for our fiscal first quarter 2023 earnings call. We appreciate you spending the time and I have a great rest of your day take care.
The conference has now concluded. Thank you very much for attending today's presentation. You may now disconnect your lines.