CRS Q1 FY27 Earnings Presentation - CARPENTER TECHNOLOGY CORP

Financial Performance:

• Net sales (excluding surcharge) increased 5% year-over-year but declined 7% sequentially due to planned preventative maintenance outages.
• First-quarter operating income reached a record $196.4 million, a 28% year-over-year increase, driven by productivity, mix management, and pricing.
• Gross profit was $256.3 million (up 18% YoY, down 5% sequentially); SG&A expenses decreased 5% YoY to $59.9 million.
• SAO segment adjusted operating margin matched the record 37.7% set in the prior quarter despite fewer operating days and increased maintenance.
• PEP segment reported operating income of $7.3 million, slightly above guidance, offset by lower titanium sales in the medical market.
• Diluted earnings per share (EPS) were $3.25; effective tax rate was 15.5% due to equity award vesting, expected to be 20-22% for the full fiscal year.
• Operating cash flow was $52.8 million; capital expenditures were $77.7 million, resulting in negative free cash flow of $24.8 million for the quarter.
• Full-year 2027 free cash flow generation is expected to be between $400 million and $430 million despite elevated CapEx for the brownfield expansion.
• Share repurchases totaled $133.9 million in Q1, completing the prior $400 million authorization and part of a new $1 billion program.
• Liquidity stood at $658.6 million ($159.5 million cash + $499.1 million available credit); net debt to EBITDA ratio is 0.6x with no debt maturities until 2034.

Guidance and Future Outlook:

• Fiscal 2027 second-quarter operating income guidance is $192 million to $197 million (implying 24-27% growth YoY), consistent with Q1 results.
• SAO second-quarter operating income is expected to be $214 million to $218 million; PEP is expected to remain similar to Q1 at approximately $7 million.
• Management indicates a high probability of overachieving current fiscal year 2027 and 2029 targets, citing upside in volume, pricing, and productivity.
• Long-term goal for fiscal 2029 operating income is approximately $1.2 billion to $1.3 billion, representing a 20%+ CAGR over three years.
• Fiscal 2028 brownfield capacity expansion project is on budget and schedule, with completion targeted for the start of fiscal 2028.
• Management anticipates further margin expansion in SAO driven by higher volume utilization, continued pricing increases, and productivity gains in H2.

Business Segments and Product Lines:

• Aerospace & Defense (In-Use): The primary sales driver; commercial aerospace sales were the second-highest quarter on record despite maintenance outages.
• Bookings: Aerospace distribution and structural bookings surged 23% sequentially and 49% YoY; aerospace engine bookings rose 10% sequentially and 22% YoY.
• Defense: Bookings declined sequentially and YoY due to funding delays, but strong engagement exists regarding the next-gen FA-XX fighter; a "rush" of orders is anticipated post-budget clarity.
• Fasteners: Bookings were down sequentially (typical inconsistency), but customers indicate activity has not yet caught up to aircraft build rates, signaling future growth.
• Medical: Titanium sales lagged slightly, but overall performance is expected to increase; specific subsets are driving growth as procedure volumes rise.
• Energy: Industrial gas turbines (IGT) remain strong; oil and gas segment is weak but showing signs of recovery.
• Long-Term Agreements (LTA): Recent renewals and new signings feature significantly higher prices and volumes, with customers requesting more material across the board.

Market and Competitive Landscape:

• Aerospace industry is in the early stages of a "super cycle" with backlogs exceeding 16,000 planes (10+ years of production).
• Industry targets for new airplane builds in 2026 are 1,400-1,500, with potential to exceed 2,100 (a 50% increase over current rates).
• FAA approval of the Boeing 737 MAX 10 is viewed as a positive accelerant, representing ~30% of Boeing's backlog.
• Supply-demand gap for nickel superalloys is expanding, keeping pricing elevated and increasing; customers are ordering at rates exceeding current OEM build rates.
• Market sentiment regarding fuel prices and macro events has not dampened demand; air traffic is up 14% sequentially.
• Inventory levels in the structural/distribution submarket are decreasing, correlating with increased bookings.
• Competitive landscape is consolidated with few players; customers are not seeing a "share gain battle" but are securing volume commitments.

Risks and Challenges:

• Defense Funding: Current lack of clear funding flow from the Department of War is delaying orders, creating a disconnect between demand and actual purchase activity.
• Maintenance Outages: Planned preventative maintenance in Q1 caused a sequential sales decline, though managed with minimal impact on margin.
  Working Capital: Increased inventory build-up in Q1 temporarily impacted free cash flow; expected to burn off in H2.
• Capacity Constraints: High utilization limits flexibility in product mix; defense volume displacement creates operational challenges.
• Macro Sensitivity: Potential risks from jet fuel prices, ticket prices, and geopolitical conflicts (e.g., Iran conflict), though currently resilient.

Management Commentary and Tone:

• Tone is highly confident and optimistic, describing a "tight, simple narrative" of record performance and accelerating demand.
• CEO Tony Tain emphasized that the industry is "just at the beginning" of a massive ramp, with no customer concerns about slowing growth.
• Management views the 37.7% SAO margin as sustainable with room for further expansion, rejecting the notion that it is a peak.
• Confidence in overachieving 2027 and 2029 financial targets is explicit, citing volume upside (especially defense), pricing power, and AI-driven productivity.
• Management dismissed negative market sentiment regarding aerospace, stating they have "not found one person" who can logically explain the pessimism.
• Capital allocation remains balanced between funding the brownfield expansion, buybacks, and dividends, supported by a strong balance sheet.

Analyst Questions and Answers:

• Q: Q1 guidance variance? A: Results hit 98-99% of guidance; variance was minimal (~$2M), likely due to minor logistics or customer timing issues.
• Q: Demand and pricing outlook? A: Both demand and pricing outlooks are stronger than last quarter; conviction in 2027-2029 guidance is higher.
• Q: Capacity and productivity? A: Productivity gains are broad-based; managing bottlenecks across the plant allows maintenance of high margins despite downtime.
• Q: Defense backlog and funding? A: Significant pent-up demand exists; a "rush" of orders is expected once budget clarity is achieved post-midterms.
• Q: LTA pricing and volume mix? A: New LTAs carry higher prices and volumes; mix percentage of LTA business is expected to remain relatively stable as volume grows.
• Q: Engine aftermarket demand? A: No evidence of fuel price impacts on demand; engine aftermarket remains robust.
• Q: Levers to beat guidance? A: Upside in volume (defense pent-up demand), pricing (new LTAs), and productivity (AI/efficiency).
• Q: Margins beyond this year? A: Long-term SAO margin expansion is expected driven by higher utilization, pricing, and productivity.

Other Key Points:

• Safety performance: Total case incident rate ended Q1 at 1.7; zero-injury goal remains the focus with investments in leading indicators.
• The brownfield expansion project is critical to absorbing volume from current LTAs and new demand; no specific equipment has been contracted to individual customers yet, but demand is expected to immediately absorb capacity.
• Management highlighted that the current demand environment sees customers ordering at levels that do not even support current OEM build rates, let alone future increases.
• The defense segment is noted as a critical supplier for next-gen fixed-wing, rotary craft, and missile platforms, with meaningful material content in programs like the FA-XX.