Good morning, and welcome to the Carpenter Technology Corporation Third Quarter 2024 Fiscal Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to John Huyette, Vice President of Investor Relations. Please go ahead..

Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology earnings conference call for the fiscal 2024 third quarter ended March 31, 2024. This call is also being broadcast over the Internet, along with presentation slides. Please note, for those of you listening by phone, you may experience a time delay in slide movement.

Speakers on the call today are Tony Thene, President and Chief Executive Officer; and Tim Lain, Senior Vice President and Chief Financial Officer. Statements made by management during this presentation that are forward-looking statements are based on current expectations.

Risk factors that could cause actual results to differ materially from these forward-looking statements can be found in Carpenter Technology's most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2023, Forms 10-Q for the quarters ended September 30, 2023, and December 31, 2023, 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'll now turn the call over to Tony..

Thank you, John, and good morning to everyone on the call today. I will begin on Slide 4 with a review of our safety performance. Through the third quarter of fiscal year 2024, our total case incident rate was 1.7. This marks an improvement over the last quarter, reflecting the impact of ongoing employee engagement programs.

We continue to diligently work towards our goal of a zero injury workplace. Now let's turn to Slide 5 for an overview of our financial performance and outlook. Our third quarter performance was exceptional. And has set us up for an unprecedented finish to fiscal year 2024.

We beat our third quarter guidance by approximately 18%, generating $90 million in adjusted operating income. This was our most profitable quarter on record, up 29% from the second quarter of fiscal year 2024, and we expect to take another historic step forward in the fourth quarter.

We are raising our guidance for the fourth quarter to a range of $110 million to $115 million in operating income. This marks an 8% increase over our previous fourth quarter guidance and a 25% increase over our all-time record third quarter performance just achieved.

With our third quarter earnings beat and increased fourth quarter guidance, we expect to end fiscal year 2024 with $339 million to $344 million in adjusted operating income, which would be an annual earnings record for Carpenter Technology. Let's move to the next slide for additional detail on third quarter performance.

The strong beat for the third quarter is the result of continuing improvement in productivity, product mix optimization and pricing actions. Notably, the SAO segment exceeded expectations, delivering $103.5 million in operating income, well above the outlook we provided on last quarter's call and 24% above the second quarter performance.

In addition, SAO continued to expand margins, achieving an adjusted operating margin of 21.4%, a step-up from the 20% in the previous quarter. Importantly, we generated $61.9 million of free cash flow during the quarter, as this quarter serves as a clear turning point into a period of significant free cash flow generation.

And to wrap up this slide, we continue to see strong current and future demand for our impressive portfolio of solutions. Let's turn to Slide 7 and take a closer look at our third quarter sales and market dynamics. In the third quarter of fiscal year 2024, sales increased 14% sequentially on higher volumes, improving product mix and pricing actions.

Across our end-use markets, we continue to see demand for our premium material solutions well above supply levels. In the third quarter, the increased productivity at key melt work centers was a primary driver of our performance.

We continue to remain focused on allocating capacity to where customers value it most and over the last quarter, realized higher sales to aerospace and defense and medical end-use markets. In our aerospace market, customers continue to stress their near and long-term supply needs.

Customers remain focused on surety of supply, with increasing requests to extend or secure long-term agreements with us. Additionally, MRO-related needs have emerged as very acute. And we are actively prioritizing areas to help customers mitigate line-down situations. In the defense market, our customers remain very active, given ongoing world events.

Our defense customers remain highly concerned with long lead times and are asking for more of our capacity to serve them. We have worked over the last quarter to accommodate emergency drop-in needs for critical defense applications. We will continue efforts to prioritize critical defense orders given the essential nature of our support.

Altogether, sales to our aerospace and defense customers, 57% of revenue for the current quarter, were up 28% sequentially and up 30% year-over-year. Our long-term outlook for aerospace and defense continues to remain strong given fundamentals of increasing air travel and air demand as well as defense needs. Moving to our medical end-use market.

Our customers continue to see strong forward market demand and maintain very positive outlooks based on robust patient backlogs. As in aerospace, lead times for premium medical products are very extended.

More and more, our medical customers are discussing with us the need for tight engagement to secure their supplies and view specialty material supply as a key strategic area.

In addition to surety of supply, our medical customers also remain focused on new product innovations driven by increasing use of robotics, minimally-invasive surgeries and alloy sensitivities among others. Engagement with customers on new products and applications remains high, with multiple product areas we supply seeing high-growth projections.

Altogether, our medical sales in the quarter were 15% of total revenue, increasing 15% sequentially and 35% year-over-year. This was another record quarter for medical sales following a very strong first half and reflects concerted efforts to accelerate shipments.

Taken together, our aerospace and defense and medical end-use markets are nearly three-quarters of our overall business. Across our other end-use markets, customer engagement is high and demand for our premium solutions remains positive. We continue to see strong bookings and increasing lead times.

In addition, our backlog remains at record levels despite ongoing efforts to limit order intake. Specifically, backlog is up 3% sequentially and 12% year-over-year, currently at three times the pre-COVID level. Altogether, the near and long-term demand outlook for Carpenter Technology remains very positive.

Bottom line is that we are operating in a strong market environment right now, and we anticipate that to continue and expand in the near and long term.

We are reminded every day of the critical role we play in supply chains across our markets, and we'll proudly continue to work to deliver high-quality solutions that our customers rely on to drive performance. Now, I will turn it over to Tim for the financial summary..

Thanks, Tony. Good morning, everyone. I'll start on Slide 9, the income statement summary. Net sales in the third quarter were $684.9 million, with sales excluding surcharge totaling $553.8 million. Sales excluding surcharge increased 14% sequentially on 2% higher volume.

The growth in net sales in excess of volume growth is the result of the ongoing shift in product mix as we continue to focus our capacity on more complex, higher-value materials. As Tony highlighted in his remarks, this is driving the significant growth in our key end-use markets of aerospace and defense and medical.

Gross profit was $147 million in the current quarter compared to $122.6 million in our recent second quarter. SG&A expenses were $57 million in the third quarter, up roughly $4 million sequentially. Note the SG&A line includes corporate costs, which totaled $23.3 million in the recent third quarter.

As we look ahead to the upcoming fourth quarter of fiscal year 2024, we expect corporate costs to remain at approximately $23 million. Operating income was $75.9 million in the current quarter or $90 million of adjusted operating income, which is 29% higher than the $69.8 million in our recent second quarter of fiscal year 2024.

The record adjusted operating income results for the quarter reflects the impact of an improving product mix, ongoing pricing actions and our focused efforts to increase productivity across our manufacturing operations. And it continues the momentum we've been building over the last several quarters going back to the start of fiscal year 2023.

Notably, we continue to expand our operating margins, reaching adjusted operating margin of 16.3% in the current quarter. Although we are pleased with the results, we continue to see opportunities to carry this momentum even further, as you can see from the outlook we provided for our upcoming fourth quarter. Moving on to our effective tax rate.

For the recent third quarter, our effective tax rate was 37.6%. When excluding the impact of the special items, the effective rate for the quarter is closer to 21%. The adjusted rate is slightly lower than our expectations due to benefits associated with certain changes in prior year tax positions taken in the current quarter.

For the upcoming fourth quarter, we expect the effective tax rate to be in the range of 21% to 23%. Adjusted earnings per share was $1.19 for the current quarter.

The adjusted earnings per share results exclude the impact of non-cash charges for goodwill impairment related to our distribution business in the PEP segment as well as a non-cash pension settlement charge.

I will highlight that the pension settlement charge is the result of proactive risk reduction steps we took in the current quarter to annuitize a portion of future pension obligations. The adjusted earnings per share results for the quarter of $1.19 demonstrate our improving profitability, driven by solid execution in a strong demand environment.

Now turning to Slide 10 and our SAO segment results. Net sales, excluding surcharge for the third quarter were $483 million, up 16% sequentially on slightly higher volume. The improvement in net sales was driven by the impact of a favorable product mix and pricing actions across our key end-use markets, as Tony reviewed earlier.

Moving to operating results. SAO reported operating income of $103.5 million in our recent third quarter, which outpaced our expectations and represents a significant new record in the history of SAO. As shown on the slide for context, SAO operating income improved by $54.5 million, more than doubling profitability from the same quarter last year.

And on a sequential basis, operating income improved by $20.2 million or a 24% increase. The improvements in productivity, product mix and pricing are evident in the adjusted operating margin, which has increased to 21.4% in the current quarter.

Again, these operating results for the quarter for SAO represent record levels by historical standards, and we believe they are only milestones on the path towards our future profitability goals.

The SAO team remains focused on executing actions to further increase production levels and to continue to actively manage the product mix to maximize capacity for high-value products.

Looking ahead to our upcoming fourth quarter of fiscal year 2024, we anticipate SAO will generate operating income in the range of $124 million to $127 million, which would represent a 20% growth over our third quarter results. Now turning to Slide 11 and our PEP segment results.

Net sales, excluding surcharge in the third quarter of fiscal year 2024 were $94.6 million, up 8% sequentially. In the current quarter, PEP reported operating income of $9.2 million, up from $7.1 million in the second quarter of fiscal year 2024.

Sequential sales and profitability growth is primarily driven by our Dynamet titanium business, which like SAO, is seeing strong demand in key end-use markets and is working to further increase production rates across the operations.

With that in mind, we currently anticipate that the PEP segment will deliver operating income in the range of $9.5 million to $11 million for the upcoming fourth quarter of fiscal year 2024. Now turning to Slide 12 and a review of adjusted free cash flow.

In the current quarter, we generated $83.4 million of cash from operating activities compared to $14.6 million in our recent second quarter.

As we outlined last quarter, for the first half of fiscal year 2024, we increased in-process inventory as we continue to ramp manufacturing activity to meet the strong demand environment while we focused our efforts on increasing production rates across our operations.

And as planned, we held inventory relatively flat in the third quarter, driven by higher activity and sales levels. This was also driven by increased productivity at key work centers, improving the flow of material through our facilities.

The inventory management focus, combined with increased profitability, drove the significant improvement in cash flow from operations. With those details in mind, we reported adjusted free cash flow of $62 million in the third quarter of fiscal year 2024.

The strong results for the third quarter more than offset the negative free cash flow in the first half of fiscal year '24 and resulted in year-to-date free cash flow generation of $37 million compared to negative $212 million in the same period last year.

As we look ahead to the upcoming fourth quarter of fiscal year 2024, we anticipate inventory levels to trend down further to finish out the fiscal year. We expect to spend about $100 million in capital expenditures for the full fiscal year 2024, which is down from our previously communicated target of $125 million.

With our outlook for earnings and working capital, we expect to increase our liquidity even further and generate over $100 million in adjusted free cash flow in the upcoming fourth quarter of fiscal year 2024. With that, I will turn the call back to Tony..

Thanks, Tim. So far on this call, Tim and I have provided the details of our record financial performance in the third quarter and how that is expected to continue into the fourth quarter. For those of you who have been following our story, the strong performance and outlook is probably not a surprise.

We are executing against the plan we communicated a year ago. And for those of you who are new to our story, I'd like to take a moment to review Carpenter Technology's unique value proposition.

We are a capabilities company committed to our strategy of serving customers with high-value applications in high-growth markets that value our unique material solutions. For the end markets that we serve, the near-term and longer-term demand outlook is strong as evidenced by our record backlogs.

In particular, we continued to experience meaningful growth in the aerospace and defense and medical end-use markets, as detailed earlier in the call. To create our unique portfolio of material solutions, we have leading capabilities with a difficult-to-replicate system of assets.

Further, we are qualified to supply material for applications with significant and highly stringent qualification standards in the aerospace and defense and medical industries. As a result, over the last several quarters, we have consistently delivered strong financial performance with expanding margins quarter after quarter.

By continuing to improve our productivity, optimize our capacity and expand our profit margins, we have a strong growth outlook in both the near term and longer term, with opportunities to further accelerate and increase profitability. Let's move to the next slide and review how we are accelerating our earnings growth.

As you can see from the chart on the left, we are rapidly accelerating quarterly earnings performance. Multiple initiatives such as improved productivity, product mix optimization and pricing actions are exceeding expectations and driving this quickly accelerating performance.

The third quarter adjusted operating income of $90 million was up 29% sequentially and is the highest in the history of Carpenter Technology. And we increased our fourth quarter guidance to be another significant sequential increase of 25%, which would be another quarterly earnings record.

Moving to the chart on the right, you can see that given the strong third quarter performance, and our fourth quarter guidance, we are increasing our full year adjusted operating income guidance to a range of $339 million to $344 million. As I stated earlier, this would be an annual earnings record for Carpenter Technology.

It is clear to see that fiscal year 2024 will be a meaningful step towards the current FY '27 goal, realizing approximately 60% of the opportunity in the first year of a four-year goal. Concerning the FY '27 target, it is also clear that it has proven to be conservative based on our current profitability and near-term outlook.

With that in mind, we are taking the incremental step of pulling forward the FY '27 target by one year at this time. This update maintains our conservative approach to our external guidance and the importance we place on doing what we say.

We do see a path to pulling the FY '27 target in even sooner than the one year, and we'll certainly keep you updated as we continue to accelerate performance. In closing, let me leave you with five big takeaways from this call. One, we beat our guidance for the third quarter, up 29% sequentially off an already strong second quarter.

Two, we increased our guidance for the fourth quarter, guiding to be up another 25% sequentially off a record third quarter. Three, we generated meaningful cash flow for the current quarter, and we expect to increase cash flow in the fourth quarter.

Four, due to our exceptional performance and strong outlook, we are pulling forward our FY '27 guidance by one year at this time, maintaining our conservative approach to external guidance. And five, in terms of earnings growth, we are just getting started and early in our cycle.

We have beat guidance, raised guidance and put forward an aggressive four-year target and we have line of sight to even exceeding that by staying focused on our execution and living our values. Thank you for your attention. I will now turn the call back to the operator..

[Operator Instructions] The first question comes from Gautam Khanna with TD Cowen. Please go ahead..

Hey, good morning, guys. Was wondering if you could just frame for us any impact you've seen whatsoever from the lower production rates on the 737 MAX and the 787, if at all. And....

Well, good morning, Gautam..

Yeah. Thanks, Tony. Go ahead..

Yeah. Hope you are doing well. We see no impact near term and anticipate no impact longer term. As you well know, there's always going to be disruptions in the supply chain, it's this large and complex. And then when you're in this environment where demand significantly outpaces supply, any gaps caused by such disruptions, they're immediately filled.

Whether in this case, it's with increased MRO, other platforms ramping, competing markets, but absolutely no impact in the near term, and we see none going forward..

And could you talk a little bit about the various end markets within aerospace and defense.

So, like, the engine channel, I assume that's where you're referencing it, but what about fasteners? What about some of the structural deals you make and the like?.

I’ll give you a couple of numbers there, Gautam, to answer that question. On the engine submarket, sales up 29% sequentially, 40% year-over-year. Fasteners up 25% sequentially, up 35% year-over-year. So strong bookings across all of our submarkets inside of aerospace continue, and we see that continuing going forward..

Did you guys see any perturbations in orders, though, with respect to -- I understand you may be able to backfill with other demand if like lease-related orders were a little softer.

Did you see any change to order intake that was unusual relative to a typical quarter? Or -- I'm just curious if you actually saw some and then are just being backfilled by better wide-body demand, MRO demand or if you haven't seen any in the first instance. Any change in the….

Yes, there's always adjustments that are being made across the supply chain, as you [Technical Difficulty] there's many levels. So there could be people out there that are making slight adjustments. I will say that a lot of that though is backed by the fact that nobody [Technical Difficulty]. Nobody wants to pull an order off.

You see instead of taking an order off, it's some type of repositioning of that order. So we just did not see that at a high level..

I appreciate that, Tony.

And just given your comments on pulling forward the $6 to $7 earnings target by a year, do you have any preliminary view on the September or December quarters? Any way you want to frame it, whether it's kind of not a difficult seasonality relative to the June quarter or however you want to characterize it if you can?.

I was about 100% sure, Gautam, you were going to ask that question. So I'm prepared for you. I mean, certainly, you understand you've been around this business for some time, the magnitude of these results that we just submitted and then what we say we're going to do for the fourth quarter.

It is a significant step change in where we're going from a financial performance standpoint for this company and certainly is -- should cause a reset in the valuation of this company. I mean this is a significant turning point.

And to get more specific to your question, as you noted, historically, our first quarter of the fiscal year has been down due to seasonality. Sometimes that has been significant. Also, as you remember, last year, we broke that norm. And in fact, our first quarter I believe the numbers were about 10% higher than the fourth quarter.

So you saw us move past that because demand was so strong. I can tell you that. Next quarter, as we always do, we will give you guidance for the fourth -- for the first quarter by segment. But at a high level, Gautam, I can tell you that it's going to be in line with the fourth quarter, plus or minus 10%. But just to put that into context.

I just told you that the fourth quarter is going to be $110 million to $115 million, 25% higher than what we just did in the third quarter. And now I'm telling you that the -- our first quarter of fiscal year 2025 is going to be in line with that. I mean that is off the charts type of performance.

And I'm sure you of all people recognize just the massive step change that, that is..

Yeah, I appreciate it. I'll get back in the queue. Thank you..

Thank you, sir..

The next question comes from Josh Sullivan with The Benchmark Company. Please go ahead..

Hey, good morning. Congratulation on these results here..

Good morning, Josh..

As far as the free cash flow yield expectations on the new long-term guidance, what are some moving factors there? What do you think the long-term naturalized yield is at this point?.

Let me just stay at a high level with the free cash flow. We obviously almost a year ago at our Investor Day, not only gave an operating income target, which is the most talked about target. We also gave free cash flow.

So as you see us moving this in for now, I would say, you can keep that same type of relationship, right, as far as you're going to see that exploration also of the free cash flow. So keep the same type of relationship that you've had from our last Investor Day.

And as we go forward, too, I mean there's a lot of moving parts here as we're accelerating a bit quickly. As I said in my prepared comms, a lot of our initiatives we are over-exceeding on. So we're continuously updating all of those guidance points, if you will. And we'll give you some more over the next coming quarters as we see that come together.

But for now, keep free cash flow [above] (ph) the operating income, as we've said before..

Got it. And then what do lead times look like? What are some of the moving parts there? Previously, you talked about the fact that you didn't really want to extend them, if you could, the pricing that you were getting. Any comments you can give us just kind of on lead times at this point..

Last quarter, I believe I said 65 plus in terms of weeks, and we always use engine, build it as the proxy. And we're standing there now, if not a little bit more extended. So 65-plus weeks, in some cases, maybe some specific products even a little longer..

Got it. And then just one last one. Did I hear you right on the production and CapEx expectations for this year? Just what's changing in the schedule.

And then maybe what are your thoughts on capacity expansion and what you would need from the industry to think about that at some point?.

Yeah. I'll let Tim take the first one on CapEx, and then I'll come back..

Yeah, Josh. Good morning. you heard me correctly. The number for fiscal '24 is about $100 million for the full year. That's down from the $125 million when we started the year. It's more a function of timing, a lot of good projects in there, but getting those projects complete and getting the materials we need and subcontractors and things like that.

It's pushing the timing a little bit. So that's why we're reducing expectations to about $100 million this year..

And then, Josh, I'll come back to your question around adding capacity. Again, as you all know, you're very familiar with the market. This is very complex capacity that takes a long time to build, install and then qualify. So it is difficult from a financial return standpoint, to make the numbers work on some of this capacity.

And even if you have -- even if you can make that work, the process knowledge that has taken decades to accumulate to be able to make these very stringent products, there's only a few people in the world that can do it, as you well know.

Now with that said, we've talked about the fact that over the next couple of years, we're going to be generating a lot of cash. What do we want to do with that cash? We've been very clear that we want to look at growth projects for us, but also a return of cash to shareholders. So those are our two priorities.

When it comes to capacity adding, they're going to have to be very strong returns and accretive very quickly. So we're looking at different areas that we can do that in, in very specific areas. And certainly, if any of those come to fruition, we'll let everyone know..

Good. Thank you for the time..

Thank you..

[Operator Instructions] The next question comes from Michael Leshock with KeyBanc Capital Markets. Please go ahead..

Hey, good morning. I wanted to ask on the aftermarket. You had alluded to strength in aerospace MRO markets. It sounds like that strong demand could last for several years.

So I'm just wondering what are the biggest opportunities for Carpenter within aftermarket going forward? Is that price and mix or volumes? Any way you could frame that opportunity?.

Well, Michael, I think the overall aerospace and defense market in total is growing and going to be growing for quite some time. I agree with the phrase some people use as we're in a super cycle, and I agree with that. And I think any time we see even build rates being pushed out, that just extends the super cycle.

So there is demand across all subsegments of aerospace. As you know, I believe in Carpenter, we supply to OEM, MRO, narrowbody, widebody, Boeing, Airbus, what it might be. So from our standpoint, you're sitting here effectively sold-out right now. And I don't see that changing over the next near or longer term..

And then just on your guidance, you came in well above your prior guide and raised 4Q.

What were the main moving pieces that exceeded your expectations versus three months ago? Is that primarily a function of more favorable mix or is there something else? And then as we look forward, what could potentially drive results above your revised expectations?.

Well, as I said in the prepared comments, it's really three main drivers, and we're exceeding on all of them. We're improving productivity. I mean improving productivity is the name of the game in this environment right now. Capacity is hard to bring on, I should say, new capacity. So we're trying to get everything we can out of our existing equipment.

And at the same time, [Technical Difficulty] doing all the preventive maintenance that we need to do. It's all about productivity and running the facility. [Technical Difficulty] has been quicker than what we had anticipated. That's good news.

From a product mix standpoint, we continue to push on that and [Technical Difficulty] upgrade our facility as efficiently as possible. That's good news. And also on the pricing action you continue to see. And this is a reflection of the tight market improvements above what we had anticipated in that area as well.

So it's really all three of those working together to get that -- exceeding that performance. But we're going to push in the fourth quarter and as we go forward over the next couple of years, [Technical Difficulty] all those three. And the good thing about technology is, as I said at the end, we're not maxed out. There's a lot of runway in front of us.

There's a lot of opportunities that we see out on the shop floor on how we can get better, how we can become more efficient. So that's great news for current and future shareholders of Carpenter Technology..

Great. Thank you..

Yes, sir..

This concludes our question-and-answer session. I would like to turn the conference back over to John Huyette for any closing remarks..

Thank you, operator, and thank you, everyone, for joining us in fiscal year 2024 third quarter conference call. Have a great rest of your day..

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