Q3 2023 Carpenter Technology Corporation Earnings Call
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Comparable John Hewitt, President and CEO engines.
At this time.
Thank you. Thank you operator, good morning, everyone and welcome to the <unk> earnings.
Earnings Conference call for the fiscal 2023 third quarter ended March 31 2023.
This call is also being broadcast over the Internet along with presentation slides. Please note for those of you listening by phone you may experience a time delay in slide movement.
Speakers on the call today are <unk>, President and Chief Executive Officer and Tim.
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.
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.
Forms 10-Q for the quarters ended September 32022, and December 31, 2022, and the exhibits attached to those filings.
Also note that in the following discussion unless otherwise noted when management discuss the sales or revenue.
Excludes surcharge.
When referring to operating margins.
On adjusted operating income, excluding special items and sales excluding surcharge.
I will now turn the call over to Tony.
I will now turn the call over to Tony.
Thank you John and good morning to everyone on the call today.
I'll begin on slide four and review.
Our safety performance.
Through the third quarter of fiscal year 2023, our total case incident rate was one four.
<unk> performance in the third quarter lowering the year to date rate.
As we have discussed in recent quarters the year over year rate increase is largely due to the increase in employee and just taking cash.
Either it's new hires.
Spurs into new roles.
We continue to invest in additional training for any employee new create job or talent.
With frequent monitoring and follow up.
Although I won't for injury rate would rank us it's one of the safest.
Metal manufacturing company, our goal continues to be a zero injury workplace.
Now, let's turn to slide five and a review of the third quarter.
The third quarter performance was driven by higher productivity at our operating facilities and increasing demand in each of our end use markets.
Most notably we see the aerospace and defense end use market ramp accelerating.
With a strong demand environment, our backlog increased 10% sequentially and 70% year over year.
This marks the ninth consecutive quarter of backlog growth.
And with the strong demand environment across our end use markets, we continued to realize price gains, which expands our operating margin.
In fact, this week, we announced another price increase of 7% to 12% on our transactional business.
We continue to improve the productivity of our labor force across our facilities by safely Onboarding new employees across all of our production centers and investing in the training required to accelerate Murray.
We are starting to realize the benefit of these productivity efforts and the performance of our business segments.
For the quarter, the <unk> segment delivered operating income of $49 million exceeding our expectations.
With the improvements in productivity, we were able to ship additional materials to our customers, particularly in the aerospace and defense and medical end use market.
The Pep segment turned in another strong performance with $10 2 million and operating income for the recent quarter.
In particular, we saw strong demand for titanium products for the aerospace and defense and medical end use market.
Finally, our liquidity remains healthy as we can.
Finished the quarter with $212 million in total liquidity.
Now, let's move to slide six and the end use market update.
Although our end use markets were up year over year and sequentially, except the medical end use market, which was effectively flat sequentially.
Our near term and long term outlook for each of our end use market remains positive.
And our record backlog levels support this outlook.
Our aerospace and defense end use market accounted for 49% of sales continues to ramp.
Was up 21% sequentially and 59% year over year.
Customers across our aerospace sub markets continue to urgently request material and seek higher delivery levels.
Global Aerospace traffic continues to grow pushing our supply chain to ramp production for new planes to meet the growing demand.
As a result of the continued increases in demand lead times across the industry has extended and our backlog continues to rise.
Notably our aerospace and defense end use market backlog is up 17% sequentially and 93% year over year.
Our record backlog levels reflect price increases and customer urgency to secure material.
The medical end use market accounted for 13% of sales was essentially flat sequentially and up 35% year over year.
The higher year over year results were driven primarily by ongoing growth in elective surgery.
And to meet growing demand for elective surgery customers are increasing their manufacturing activity.
The overall outlook continues to be positive as medical procedures are expected to rise throughout calendar year 2023.
We are seeing evidence of this replenishment in the supply chain as our medical end use market backlog is up 9% sequentially and 80% year over year.
The transportation end use market accounting for 7% of sales was up 25% sequentially and up 5% compared to last year.
With strong demand and low inventory of both light duty and heavy duty vehicles.
Build rates are expected to increase throughout calendar year 2023.
The energy end use market accounted for 6% of sales was up 27% sequentially and up 24% compared to last year.
Demand for energy continues to outpace supply driving growth in capital investment and demand for our material solutions.
In many cases and materials, we are supplying into the energy end use market are now reaching margins similar to our aerospace and defense business.
Due to the unique solutions and overall demand environment.
The industrial and consumer end use market accounted for 19% of sales.
It was up 22% sequentially and up 17% year over year.
We remain focused on high margin high growth businesses like a material solutions used in semiconductor fabrication.
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 third quarter were $690 1 million and sales excluding surcharge totaled $491 5 million.
Sales, excluding surcharge increased 33% from the same period, a year ago on 15% higher volume.
Sequentially sales were up 17% on 13% higher volume.
The higher volumes were driven by our improving productivity and throughput across our operations.
I would also note that the sales growth outpaced the volume growth both sequentially and year over year, driven by an improving product mix and increased base prices.
Gross profit was $93 $5 million in the current quarter compared to $39 5 million in the same quarter of last year and $70 million in the second quarter of fiscal year 2023.
Gross profit is up 137% compared to the same quarter last year and up 34% sequentially.
The improvement in gross profit is primarily driven by higher sales.
An improving product mix and increased selling prices, partially offset by inflationary cost increases.
SG&A expenses were $54 2 million in the third quarter up about $16 million from the same period, a year ago, and roughly $7 million higher sequentially.
When adjusting for the special item in last year's third quarter, SG&A expenses were up roughly $11 million year over year.
The increase in SG&A expenses, largely reflects higher variable compensation accruals higher travel costs and the timing of certain other expenses.
The SG&A line includes corporate costs, which totaled $19 6 million in the recent third quarter.
As we look ahead to the upcoming fourth quarter of fiscal year 2023.
We expect corporate cost to be about $21 million.
Operating income of $39 $3 million in the current quarter when excluding the impact of special items in the prior year quarter. Adjusted operating loss was $1 6 million and in our recent second quarter operating income was $22 6 million.
Again, the improvement in profitability is being driven by the increasing productivity driving volume gains along with mix and price benefits.
Although not shown on the slide interest expense was $14 $5 million in the current quarter compared to $13 million and our recent second quarter.
The increase was due to the rising interest rates on our outstanding revolver borrowings.
We currently expect interest expense to be about $15 million and our upcoming fourth quarter.
Our effective tax rate for the third quarter was 22, 5%.
We continue to expect that the full year 2023 effective tax rate will be approximately 22% to 24%.
Earnings per share for the current quarter was <unk> 38 per share.
The results demonstrate our continued momentum supported by improving productivity and a strong demand environment.
Now turning to slide nine and our <unk> segment results.
Net sales for the third quarter were $603 4 million or $411 5 million excluding surcharge.
Compared to the same period last year net sales, excluding surcharge increased 37% on 13% higher volumes.
Sequentially net sales, excluding surcharge increased 19% and 14% higher volume.
The year over year improvement in net sales was driven by higher shipment volumes due to productivity gains the impacts of higher prices and an improving product mix across our key end use markets as Tony reviewed on the market side.
Sequentially, we continued to drive momentum in net sales as the operating efficiencies drove higher volumes combined with a stronger mix of products.
Moving to operating results <unk> reported operating income of $49 million and our recent third quarter a.
A significant improvement versus both the same quarter last year and our recent second quarter.
The improving operating income results reflect continued progress towards returning to our fiscal year 2019 run rates.
On a year over year basis the.
Adjusted operating income improvement of $41 4 million is largely due to higher sales driven from increased production activity and throughput, which has also improved our cost performance.
This was coupled with an improving product mix and price increases on both transactional and contract business.
On a sequential basis operating income improved $18 7 million, which is ahead of the expectations, we set last quarter.
This was driven by increased volumes as we continue to ramp our operations to meet the strong demand, partially offset by higher variable compensation accruals in the current quarter.
Looking ahead, the Seo team remained focused on accelerating activity levels and production flow in a safe manner to meet the needs of our customers for the foreseeable future.
Based on current expectations, we anticipate <unk> will generate operating income in the range of $65 million to $70 million in the upcoming fourth quarter of fiscal year 2023.
This is significant as it would have been <unk> returned to pre pandemic operating income levels.
Now turning to slide 10 in our Pep segment results.
Net sales in the third quarter of fiscal year, 2023 were $115 1 million or $103 8 million excluding surcharge.
Net sales, excluding surcharge increased 20% from the same quarter last year and 6% sequentially.
The year over year growth in net sales reflects increased demand primarily in our dynamo titanium and additive businesses.
And 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 a significant improvement in year over year sales in our additive business, driven primarily by aerospace and defense market applications.
The sequential increase in net sales primarily reflects increases in both Dynamo titanium sales and additive sales to the aerospace and defense end use market.
In the current quarter Pep reported operating income of $10 2 million.
This compares to adjusted operating income of $4 4 million in the same quarter, a year ago and operating income of $9 3 million in the second quarter of fiscal year 2023.
The operating income improvement year over year is largely driven by higher sales in our dynamic and additive businesses.
We currently anticipate that the Pep segment will deliver operating income in the range of 10% to $11 million for the upcoming fourth quarter of fiscal year 2023.
Now turning to slide 11, and a review of adjusted free cash flow.
In the current quarter, we generated $5 million of cash from operating activities.
We're at $91 million sequential improvement.
The increase is largely attributable to the higher earnings combined with an inventory reduction of $13 million compared to an inventory build in the prior quarter.
We anticipate that we will reduce inventories from the current levels in the upcoming fourth quarter.
The reduction will be driven by increased shipments and a more balanced flow of materials across the operations.
In terms of other working capital the current quarter $69 million use of cash is largely due to increased accounts receivable driven by higher sales as the quarter progressed.
In the third quarter of fiscal year 2023, we spent $21 million on capital expenditures.
We expect fiscal year 2023 capital expenditures to be in the range of $80 million to $85 million, which is down slightly from the previous guidance of $85 million to $90 million due to timing of our capital projects.
Lastly, as I continued to highlight we continued to fund a constant dividend to our shareholders, which is included in our adjusted free cash flow and an important part of our overall shareholder return.
With those details in mind, we reported adjusted free cash flow of negative $26 million in the third quarter of fiscal year 2023.
Looking ahead to the fourth quarter, we expect to generate positive adjusted free cash flow.
Our liquidity remains healthy and we ended the current quarter with total liquidity of $212 million, including $22 million of cash and $190 million of available borrowings under our credit facility.
Earlier this month, we executed an agreement with our banking group to amend and extend our credit facility.
Under the agreement, we increased our credit facility size from $300 million to $350 million and extended the maturity to April 2028.
You should note that the incremental $50 million is not reflected in this slide as the increase was effective post quarter end.
With that I will turn the call back to Tony.
Thanks, Tim.
Now to recap our third quarter of fiscal year 2023.
Demand continues to increase with positive near term and long term outlook in each of our English market.
Notably the aerospace Submarkets continue to accelerate the recovery.
As a result, our backlog continues to grow and we expect it to remain strong for the foreseeable future.
To meet the demand we are continuing to increase production rates at all of our manufacturing facilities.
To do that we are focused on safely onboarding and training new employees across work centers to improve productivity.
By increasing volumes, improving mix, increasing prices and improving productivity, we will continue to see margin expansion.
Notably, we expect margins to continue to improve.
Sales cycle.
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 evident we just announced our latest round of turning to actual price increases.
7% to 12% this week.
It is important to note that inventory levels decreased during the quarter and we expect inventory to further decrease during the remainder of the fiscal year.
And most importantly, 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 our last earnings call I reviewed the path to achieving our fiscal year 2019 operating income run rate by the fourth quarter of this fiscal year.
As you can see in the chart on the right. We have finished the third quarter ahead of our expectation.
A recent third quarter performance was primarily driven by the increased productivity across our manufacturing facility.
<unk> in a 17% sales increase sequentially ahead of the 12% to 13% we previously guided to.
With that momentum we remain on track to achieve our fourth quarter fiscal year 2023 operating income goal.
Demand remains strong across all of our English market.
Evidenced by growing backlog and extending lead times.
We remain focused on safely training and developing our workforce to continue to drive production rate.
Earlier, Tim communicated the SCO and Pep segment fourth quarter operating income outlook.
Those combined with estimated corporate cost.
And a total company operating income range of $54 million to $60 million for the fourth quarter.
And looking ahead, we expect to continue to see strong performance in the first quarter of fiscal year 2024.
It is an exciting time for Carpenter technology as we are in the midst of a demand upturn in our key in each market.
We are well positioned to return to pre pandemic, earning levels in this fiscal year and we have a path to significantly increase earnings over the coming years.
We have scheduled an investor day event on May 16th.
And we will go into more detail on our portfolio of materials solutions are unique assets and capability and our financial outlook for the next several years, we look forward to sharing our vision with you for more information about the event. Please visit our Investor Relations website.
Thank you for your time and now I'll turn it over to the operator to take your questions.
Okay.
Thank you we will now begin the question and answer session.
Second question you May Press Star then one under our comfort zone.
We are using a speakerphone please pick up your handset before pressing the keys.
Draw. Your question. Please press Star then two.
This time, we'll pause momentarily to assemble the roster.
First question will be from Josh Sullivan of the benchmark company. Please go ahead.
Hey, good morning.
Good morning, Josh.
Yep.
How do we think of system wide.
Capacity relative to 2019.
<unk> the Carpenter operating model during Covid.
<unk> has more qualification how much more can you sweat the assets.
Aerospace demand coupled with strength across all other segments now.
I can give you at a high level, Josh you mentioned a couple of them. One on productivity is higher are projected to be higher than what it was in 2019 in FY 19 Athens effectively.
Was that zero percent utilization. So now you have them.
Coming on and we changed the mix of our products as well, where we've cut off the tail on some of the products and focus more on higher margin products, such as aerospace and defense. So those three combined you should see a significant or meaningful I should say increasingly capacity versus.
So 2019.
Okay and then just.
With regards to the new higher component there can you give us some color maybe on what is the learning curve look like recently and our retention rates any particular skills skill sets that still need some focus.
Well the big difference this year and I think most companies are experiencing is that the workforce or the new employees that we bring in have less manufacturing experience than they did maybe 456 years ago. So the learning curve is steeper for us we're making great.
Progress you can see it in the numbers for the third quarter here that was a big step up so you're seeing that we're being successful in that area.
There are still some areas that we need to hire a couple more people reading at our <unk> facility, we want to bring on more capacity, so there'll be more hiring there as well.
But we're in a good very good place right now and looking forward to take it to the next level in the fourth quarter as well.
And then maybe just one last one on pet.
What does the aerospace fasteners cycle look like are you, having big build rates ahead of us still big jumps at the Oems or customers building inventory to avoid disruptions.
More hand to mouth, yes, Nobody's building inventory right now right, but dynamed from a supply demand standpoint is just like Sio.
You know it is.
Dynamite 60, 40 medical aerospace and both of those markets are extremely tight so think of Dynamed. Just like you think about <unk> from a supply demand standpoint.
Got it thank you for the time thank.
Thank you.
Thank you.
Next question will be from Michael Ashok Keybanc capital markets. Please go ahead.
Hey, good morning.
Wanted to start out asking.
So <unk> how are you expecting that to fair versus three months ago, and maybe what platforms are driving the growth for us sequentially just given some of the seasonal downtime that you typically experienced in that quarter.
Are you seeing stronger mix contribution or is that more of an ongoing volume ramp despite the seasonality.
Yes. Thanks for the question, let me, maybe take a little bit of time on that because <unk>.
Certainly since you asked the question you know highly impactful.
That would be so as you said I mean, given productivity improvements continuing strong demand. We don't we don't expect the same level of seasonality in our fiscal.
Fourth quarter.
Go into our fiscal first quarter that we've seen in previous years. So we don't see that same type of seasonality now as you know over the past.
Eight to 10 years.
That dip in the first quarter versus the fourth is probably averaged around 30% and it's been as high as 60%. So that's that's a significant so for us to tell you that.
We're not going to see that is a real meaningful comment I think in the last earnings call. In fact, I said, we'd see another meaningful increase in the fourth quarter.
Or another step up now we will give you some more color for the first quarter as we get to the next earnings call, but I think it's safe to say that.
Even if the first quarter sequentially flat to the fourth quarter that would be major positive earnings growth inflection versus the past.
Fiscal year first quarters now you talked about the normal seasonality.
We usually do our our planned maintenance preventive maintenance outage during that time.
You know wed love to run the equipment $24 seven right now and the demand is there, but we need to continue to be good operators and we needed to perform that that essential preventative maintenance and we're going we're going through those schedules as we speak to try to understand how we can minimize that type of preventive maintenance.
But even with all of that factored in and <unk> got.
At least.
Essentially flat first quarter to the fourth and as I said earlier that would be extremely.
That would be extremely major positive earnings growth inflection point for us.
And then I wanted to ask on the price increase on the transactional business.
What percent of your business does that apply to you today and I know you wouldn't be repricing your backlog, but if you look at orders that are out maybe.
Over a year does it apply to that business as well.
Yes, it's a good question.
At any point in time were roughly 40% to 50% of our business is under some type of longer term contract whether that'd be in.
And the LTA or one year pricing agreements.
And <unk>.
Presently when we're 52 to 60 week lead times.
The price increases that we just now.
Noted would be on that business now remember we've.
We.
<unk> several price increases over the last year that is hitting now with this specific one would be on that transactional business than that.
That is coming coming to us approximately 52 weeks from now one year.
Got it that makes sense.
And then on your aerospace business do you have visibility into the breakout what is MRO versus OEM business that youre supplying into.
Yes.
We're on all platforms and I get that question a lot just like I get is it wide body of single aisle is at Boeing or Airbus I mean at this point right now it doesn't matter, we're sold out we can't make enough and I don't see that changing.
Anytime in the near future.
Great and then lastly for me did you provide jet engine sales.
The quarter, either sequentially or year over year I can do that.
For you I didn't do that in my prepared remarks.
Aerospace engine sales were up about 50% year over year, they were roughly flat sequentially, but but really thats sequentially is primarily a matter of mix of product being run as our total aerospace sales were up 59% year over year, and 21% sequentially and I can also note just as a point of reference.
Our aerospace engine backlog was up 24% sequentially and the Aero engine bookings in the quarter were at record levels. So.
Full speed ahead on aerospace engines.
Great. Thank you.
Sure.
Thank you again, if you have a question. Please press Star then one.
Yes, Tom our next question will be from Gautam when you cough.
Please go ahead.
Okay.
Hi, good morning.
Hello Gautam.
Tony I was wondering if you could talk a little bit about the December quarter, just based on your backlog visibility.
Is that.
And are you guys going to maybe work through holidays or what have you. So that we actually do better than.
From a normal seasonality in that quarter as well.
Yeah, So you're talking about our second quarter fiscal right.
Yes, correct, yeah well.
Yes, I think we're in a period now not think I know we're in a period now where we're trying to minimize our downtime and we're getting trying to get smarter in the way, we do preventive maintenance.
And because.
Throughout FY 'twenty for the next.
Next year.
We're going to be able to sell everything we make and that is going to be extended through the next three or four years. So yes.
Yes, Gautam I as I said, you look at the first quarter.
At least flat and Youll continue to see.
Improvement over the next quarters of FY 'twenty four.
A little early for me to tell you exactly what those will be would be but I don't anticipate any significant sequential pullback as we work through FY 'twenty four.
Okay and you commented on.
Some of the non stop.
Having a better pricing.
When do we start to see that flow through.
Their results.
Is it already flowing through or is it kind of pick up as we move.
Through the second half of this calendar year.
Under long linear agreements long term agreements, yes, so we've seen that today that price.
It's coming through we still have a couple theres still a couple of major contracts that will expire this calendar year, so there'll be.
More negotiation there.
I wish 100% of that price would hit the bottom line, but as you know there has been.
Some input cost inflation as well now our pricing is offsetting that.
But we don't get 100% of the pricing hit the bottom line. So I guess high level to your question, we've seen that over the last several quarters and we'll continue to see some price improvement.
Over the next year.
And just one last one on the backlog.
We look back historically.
<unk> backlog.
Represents I don't know, 30% to 40% of.
One year forward sales today.
So it's a very elevated level.
I'm just curious is it because the customers want the backlog as quickly as you can ship. It is there like what is the constraint on.
Maybe applying that similar ratio.
40% of forward sales and backlog.
Today is it just production constraints is it.
Or is that the customers want it later on.
I'm just curious like.
What prevents you guys from doing even better.
Yes, so right now its just ramping up the operations.
Not at 100%, yet and that's primarily driven by on boarding new employees just like as you will know other companies in this industry have stated the same thing we have so that's the main gating factor right now I could.
I could sell significantly more material right now.
<unk>.
If my production rates are higher obviously, they were higher in the third quarter, they're going to have to take another step up in the fourth quarter and into FY 'twenty, four and Thats the plans but.
There is really nobody.
<unk> orders now that if I went to them and said I can increase deliveries to you by.
25%, 30%.
I'd say no they would take it.
Okay.
Thanks, a lot I personally wouldn't be to build inventory right that would be they would take that material right now.
Interesting. Thank you.
Youre welcome.
Thank you. This concludes our question and answer session I'll turn the call back over to Mr. John Hewitt for closing remarks.
Thank you operator.
You everyone for joining us today for our fiscal 2023 third quarter conference call have a great rest of your day.
Thank you conference is now concluded. Thank you for attending today's presentation you may now disconnect.