Carpenter Technology Corporation (NYSE:CRS) Q3 2024 Earnings Call Transcript May 1, 2024
Carpenter Technology Corporation beats earnings expectations. Reported EPS is $1.19, expectations were $0.94. Carpenter Technology Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: 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.
John Huyette: 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.
Tony Thene: 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.
Tim Lain: 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.
Tony Thene: 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.
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