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spk03: Technology Corporation Third Quarter 2023 Conference Call. All participants will be in listening mode. If you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be opportunity to ask questions. Please note that this event is being recorded. I would like to turn the conference over to Mr. John Hewitt, Vice President and Ambassador of Relations. Please go ahead and serve at this time. Thank you.
spk00: Thank you, operator. Good morning, everyone, and welcome to the Carbon Technology Earnings Conference Call for the fiscal 2023 third quarter, ended March 31, 2023. This call is also being broadcast over the internet along the 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 Tain, President and Chief Executive Officer and Tim Lane, 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 Technologies' most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2022, Forms 10Q for the quarters ended September 30, 2022 and December 31, 2022, and the exhibits attached to those filings. Please also note that in the following discussion, unless otherwise noted, when management discusses the 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.
spk04: 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 1.4. We saw improved 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 increased employees undertaking new tasks, either as new hires or transfers into new roles. We continue to invest in additional training for any employee new to a job or task with frequent monitoring and follow-up. Although a 1.4 injury rate would rank us as one of the safest metal manufacturing companies, 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 in-use markets. Most notably, we see the aerospace and defense in-use market ramp accelerating. With a strong demand environment, our backlog increased 10% substantially and 70% year over year. This marks the ninth consecutive quarter of backlog growth. And with the strong demand environment across our in-use markets, we continue to realize price gains, which expands our operating margins. 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 learning. We are starting to realize the benefits of these productivity efforts in the performance of our business segments. For the quarter, the SAO segment delivered operating income of $49 million, exceeding our expectations. With the improvements in productivity, we were able to shift additional material to our customers, particularly in the aerospace and defense and medical in-use markets. The PEP segment turned in another strong performance with $10.2 million in operating income for the recent quarter. In particular, we saw strong demand for titanium products for the aerospace and defense and medical in-use markets. Finally, our liquidity remains healthy as we finish the quarter with $212 million in total liquidity. Now let's move to slide six and the in-use market update. All of our end-use markets were up year-over-year and sequentially, except the medical end-use market, which was essentially flat sequentially. Our near-term and long-term outlook for each of our end-use markets remains positive, and our record backlog levels support this outlook. Our airspace and defense end-use market, accounting for 49% of sales, continues to ramp and was up 21% sequentially and 59% year-over-year. Customers across our aerospace submarkets continue to urgently request material and seek higher delivery levels. Global aerospace traffic continues to grow, pushing the 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 have extended, and our backlog continues to rise. Notably, our aerospace and defense in-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 in-use market, accounting for 13% of sales, is 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 in-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, accounting 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, the materials we are supplying into the energy and 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, accounting for 19% of sales, was up 22% sequentially and up 17% year over year. We remain focused on high margin, high growth business, like a material solution used in semiconductor fabrication. Now, I will turn it over to Tim for the financial summary.
spk06: Thanks, Tony. Good morning, everyone. I'll start on slide 8, 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 are up 17% on 13% higher volumes. The higher volumes are 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 costs to be about 21 million. Operating income was 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 in our recent second quarter. The increase is due to the rising interest rates on our outstanding revolver borrowings. We currently expect interest expense to be about $15 million in 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 38 cents per share. The results demonstrate our continued momentum supported by improving productivity and a strong demand environment. Now turning to slide nine and our SAO 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% on 14% higher volumes. 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 slide. 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, SAO reported operating income of $49 million in our recent third quarter, 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 SAO 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 SAO team remains 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 SAO will generate operating income in the range of 65 to 70 million in the upcoming fourth quarter of fiscal year 2023. This is significant as it would mark a return to pre-pandemic operating income levels. Now turning to slide 10 and 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 dynamite titanium and additive businesses. In our dynamite 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 dynamite titanium sales and additive sales to the aerospace and defense end-use market. In the current quarter, PEF 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 dynamite 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, or a $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's 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 to 85 million. which is down slightly from the previous guidance of 85 to 90 million due to timing of our capital projects. Lastly, as I continue to highlight, we continue 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 precash 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 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.
spk04: Thanks, Tim. Now to recap our third quarter of fiscal year 2023. Demand continues to increase with positive near-term and long-term outlooks in each of our in-use markets. Notably, the aerospace sub-markets continue to accelerate their 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 this, 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 in the SAO segment. We will continue to offset inflationary pressures through our raw material surcharge mechanism and our ability to increase pricing on both our contractual and transactional business. As evident, we just announced our latest round of transactional price increases of 7 to 12% this week. It is important to note that inventory levels decreased during the quarter, and we expect inventory to further decrease through 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 the 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 the manufacturing facility, resulting 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 markets, as evidenced by growing backlog, and extending lead time. We remain focused on safely training and developing the workforce to continue to drive production rates. Earlier, Kim communicated the SAO and PEP segment fourth quarter operating income outlook. Those combined with estimated corporate costs results in a total company operating income range of 54 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, when we will go into more detail on our portfolio of material solutions, our unique assets and capabilities, 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 we'll turn it over to the operator to take your questions.
spk03: Thank you. We'll now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw 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.
spk02: Hey, good morning.
spk03: Good morning, Josh.
spk02: Good morning. How do we think of system-wide SAO capacity relative to 2019? You've implemented the carpenter operating model during COVID. Athens has more qualifications. How much more can you sweat the assets, given you've got aerospace demand coupled with strength across other segments now?
spk04: I can give you at a high level, Josh. You mentioned a couple of them. One, our productivity is higher or projected to be higher than what it was in FY19. In FY19, Athens effectively was at 0% utilization. So now you have them coming on. And we changed the mix of our products as well, where we've, quote, cut off the tail on some of the products and focused more on higher margin products such as aerospace and defense. So those three combined, you should see a significant or a meaningful, I should say, increase in our capacity versus...
spk02: And just with regards to the new hire component there, can you give us some color maybe on what does the learning curve look like recently, retention rates, any particular skill sets that still need some focus?
spk04: Well, the big difference this year, and I think most companies are experiencing this, is that the workforce or the new employees that we bring in have less manufacturing experience than they did maybe four, five, six years ago. So the learning curve is steeper for us. We're making great progress. You could 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's still some areas that we need to hire a couple more people. Reading, at our dynamic facility, we want to bring on more capacity, so there'll be more hiring there as well. But we're in a very good place right now and looking forward to take it to the next level in the fourth quarter as well.
spk02: Got it. And then maybe just one last one on PEP. What does the aerospace fastener cycle look like? Are you having big build rates ahead of these build rate jumps at the OEMs or customers building inventory to avoid disruptions? Or is it more hand-to-mouth?
spk04: Yeah, nobody's building inventory right now, right? But Dynamet, from a supply-demand standpoint, is just like SAO. You know, it is Dynamet 6040 medical aerospace, and both of those markets are extremely tight. So think of Dynamet just like you think about SAO from a supply-demand standpoint.
spk02: Got it. Thank you for the time.
spk04: Thank you.
spk03: Thank you. Next question will be from Michael Leshock, KeyBank Capital Markets. Please go ahead.
spk01: Hey, good morning. I wanted to start out asking how the 1Q, how are you expecting that to fare versus three months ago and maybe what platforms are driving the growth for you sequentially, just given some of the seasonal downtime that you typically experience in that quarter? Are you seeing stronger mixed contributions or is that more of an ongoing volume ramp despite the seasonality?
spk04: Yeah, thanks for the question. Let me maybe take a little bit of time on that because certainly since you asked the question, you know how impactful that would be. So as you said, I mean, given productivity improvements, continuing strong demand, we don't expect the same level of seasonality in our fiscal fourth quarter going to 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 has probably averaged around 30% and it's been as high as 60%. So that's 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. We'll 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 is 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 planned maintenance, preventive maintenance outages during that time, and As you know, we'd love to run the equipment 24-7 right now, and the demand is there, but we need to continue to be good operators, and we need to perform that essential preventive maintenance. And 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 that factored in, you've got at least essentially flat first quarter to the fourth And as I said earlier, that would be an extremely major positive earnings growth inflection point for us.
spk01: And then I wanted to ask on the price increase on the transactional business, what percent of your business does that apply to 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?
spk04: Yeah, it's a good question. At any point in time, we're roughly 40 to 50% of our business is under some type of longer-term contract, whether that be an LTA or one-year pricing agreements. And presently, when we're 52 to 60-week lead times, these price increases that we just noted would be on that business. Now, remember, we've communicated several price increases over the last year that, that is hitting now, but this specific one would be on that transactional business then that's, that's coming, coming to us, uh, approximately 52 weeks from now, one year.
spk01: Got it. That makes sense. And, um, and then on your aerospace business, do you have visibility into the breakout? What is MRO versus OEM business that you're supplying into?
spk04: Yeah, it's, uh, You know, we're on all platforms, and I get that question a lot, just like I get, is it wide body or single aisle? Is it 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 any time in the near future.
spk01: Great. And then lastly for me, did you provide jet engine sales for the quarter, either sequentially or year over year?
spk04: 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 really that sequential is primarily a matter of a 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.
spk01: Great. Thank you.
spk04: Thank you.
spk03: Thank you. Again, if you have a question, please press $1. This time, our next question will be from Gottman.com. Please go ahead.
spk05: Hi. Good morning. Hello, Gotham. Tony, I was wondering if you could talk a little bit about the December quarter, just based on your backlog visibility. Is that, you know, are you guys going to maybe work through holidays or what have you so that we actually do better than normal seasonality in that quarter as well?
spk04: Yeah, so you're talking about our second quarter fiscal, right?
spk05: Yes, correct.
spk04: Yeah, well... Yes, I think we're in a period now. Not think, I know we're in a period now, but we're trying to minimize our downtime. We're trying to get smarter in the way we do preventive maintenance. And because throughout FY24, the next year, we're going to be able to sell everything we make. And that's going to be extended through the next three or four years. So yes, Gotham, as I said, you look at the first quarter, at least flat and you'll continue to see improvement over the next quarters of FY24. It's a little early for me to tell you exactly what those would be, but I don't anticipate any significant sequential pullback as we work through FY24.
spk05: Okay. And you commented on some of the non-spot business having better pricing. When do we start to see that flow through your results? Is it already flowing through? Is it going to pick up as we move through the second half of this calendar year on your long-term agreements?
spk04: Oh, long-term agreements, yeah. So we've seen that today, that price is coming through. We still have a couple, there's still a couple 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 price and 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.
spk05: And just one last one on the backlog. You know, when we look back historically, Carpenter's backlog represents, I don't know, 30% to 40% of one-year forward sales. Today, you know, it's a very elevated level. And I'm just curious. Do the customers want the backlog as quickly as you can ship it? What is the constraint on maybe applying that similar ratio? Let's call it 40% of forward sales and backlog today. Is it just production constraints? Or is it the customers want it later on? I'm just curious, what prevents you guys from doing even better?
spk04: Yeah, for right now, it's just ramping up the operations. We're not at 100% yet, and that's primarily driven by onboarding new employees. Just like, as you all know, other companies in this industry have stated the same thing we have. So that's the main gating factor right now. I could sell significantly more material right now. if my production rates were 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 FY24, and that's the plans. But there's really nobody placing orders now that if I went to them and said, I can increase deliveries to you by 25%, 30%, that they would say no. They would take it.
spk05: Thanks a lot.
spk04: And that wouldn't be to build inventory, right? They would take that material right now. Interesting. Thank you. You're welcome.
spk03: Thank you. This concludes our question and answer session. I'll turn the call back over to Mr. John Hewitt for closing remarks.
spk00: Thank you, Operator. Thank you, everyone, for joining us today for our fiscal 2023 third quarter conference call. Have a great rest of your day.
spk03: Thank you. Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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