Carpenter Technology Corp (CRS) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quarter Three 2005 Carpenter Technology Earnings Conference Call. My name is Anika (ph) and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's call, Mr. Jaime Vasquez, Vice President and Treasurer.

Good morning. Welcome to our conference call for the quarter ended March 31, the third quarter of Carpenter's fiscal year. This call is also being broadcast over the Internet. With me today are Bob Torcolini, Chairman, President, and Chief Executive Officer, Terry Geremski, Senior Vice President of Finance and Chief financial Officer, Mike Shor, Senior Vice President of our Engineered Products Operations, Dennis Oates, Senior Vice President of our Specialty Alloys Operations, and Rich Chamberlain, Vice President and Corporate Controller.

Some of Carpenter's statements will be forward-looking statements, which 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's recent SEC filings, including the Company's June 30, 2004 10-K and subsequent Forms 10-Q and the exhibits attached to those filings.

During this call, we will be using the abbreviations SAO to represent Specialty Alloys Operations, and EPG to represent our Engineered Products Group.

I will now turn the call over to Bob, who will start with a brief overview.

Thanks, Jaime, and good morning. Earlier today, we distributed a news release on the results of our third quarter of fiscal 2005. As we stated in the release, Carpenter achieved a record level of quarterly net income in the third quarter. We are pleased to report that our lean and variation reduction efforts, coupled with our initiatives to eliminate marginally profitable products while pricing others for the value delivered, is creating significant operating leverage for Carpenter.

Now, let me provide you with some detail on Carpenter's consolidated third-quarter sales, first by product type and then by end-use market. The year-over-year changes in sales that I will reference include raw material surcharges. Excluding surcharge revenue, sales increased approximately 17% from the third quarter a year ago. Sales of our special alloys increased 36% from a year ago to $140 million, a record high for any quarter. The record sales level for special alloys was driven by strong demand from the Aerospace and power generation markets. Additionally, higher based selling prices and surcharges were major contributors to the increased sales of special alloys.

Sales of our titanium alloys also benefited from robust demand from the Aerospace market, as sales increased 53% from the third quarter a year ago to $30 million. This was a near record high for titanium sales, which also benefited from growth in the medical market and higher based selling prices. Additionally, the sales increase also reflected the impact of significantly higher titanium costs.

Our stainless steel sales were $132 million or 6% above the third quarter a year ago. Better product mix, higher based selling prices and surcharges were the primary drivers of the increase. Partially offsetting the sales increase was an intentional reduction in the sale of lower-value products.

Sales of ceramic and other materials increased 16% from the third quarter a year ago to $25 million. Higher sales of ceramic cores used in the casting of diesel engine fuel injectors and turbine blades for aircraft engines contributed to the increase. Also included in this increase are sales of structural ceramic components for the industrial market.

By end-use markets, sales to the Aerospace market totaled nearly $100 million, which is 50% higher than the third quarter a year ago. Strong demand from the U.S. and European Aerospace markets for high-temperature alloys used in jet engine components and titanium used in airframe structural components were the primary drivers of this increase. Industrial sector sales, which include materials used in equipment and other capital goods applications, increased to $93 million or 23% from the third quarter a year ago. The increase reflects the effects of base price increases, surcharges and the continued strength of capital investments by the manufacturing sector. Sales to the automotive market were $50 million or 12% above the third quarter a year ago. The increase reflected the sale of higher-value materials, base price increases and surcharges. Our sales to this market held up relatively well, given the decline in U.S. automotive production during the past quarter versus a year ago. The sales increase to the automotive market can be attributed to growth with key customers and the favorable effect of a weaker U.S. dollar. In addition, the increased popularity of high-performance engines and more stringent emission standards resulted in higher demand for Carpenter's specialty materials.

Sales to the medical market of $26 million were 31% above a year ago, reflecting strong demand, market share gains and pricing actions. We continue to see steady growth for our Special Alloys and titanium materials in both the domestic and foreign medical markets.

Sales to the power generation market of $24 million were 13% higher than the third quarter a year ago. Sales to this market benefited from maintenance activity on industrial gas turbines and the sale of new turbines internationally.

Sales to the consumer market of $52 million declined 4% from a year ago. The decline primarily reflected the intentional reduction in the sale of marginally profitable products. This impacted materials sold for certain electronic, housing and sporting goods applications.

Now, I will provide an overview of our business units. Starting with SAO, third-quarter sales increased 19% from a year ago. A more favorable product mix as a result of higher sales to the Aerospace and power generation markets, increased sales to Europe and Asia, and pricing actions drove the increase. Sales of bar products increased 20% from the third quarter a year ago, reflecting increased sales of higher-value product and surcharges. Volume declined 10% in the third quarter from a year ago, primarily due to the intentional reduction in the sale of marginally profitable products.

Sales of coil products increased 3% despite a 26% decline in volume from a year ago. Sales increased despite the lower volume due to higher base prices and the intentional reduction in the sale of marginally profitable products. Our Ford (ph) bar and billet products realized a 47% increase in sales from a year ago. A better product mix due the increased shipments to the Aerospace and power generation markets and higher selling prices were the primary drivers of the increase.

At Dynamet, which primarily sells titanium products, sales increased 60% in the third quarter from the same period a year ago. Dynamet sales benefited from robust demand from the Aerospace market, which was at its highest level in 3.5 years. Also, sales of specialty titanium products used in the medical market for applications, such as orthopedic implants and spinal fixation devices, reached a record level in the recent third quarter. Dynamet sales also reflected price increases and the impact of significantly higher titanium costs.

Sales for the Engineered Product Group increased 14% to $32 million in the third quarter from a year ago. Increased volumes and better pricing resulted in higher sales. Certech, which is the largest business within this group, experienced strong demand for its ceramic cores used in the manufacture of diesel engine fuel injectors. Sales also benefited from increased demand for ceramic cores used in the casting of turbine blades sold to the Aerospace market.

Now, I would like to turn the call over to Terry.

Thank you, Bob. As we detailed in today's earnings announcement, consolidated net sales in the third quarter were $342 million or 22% higher than a year ago. As Bob mentioned, the increase was driven by a better product mix and pricing actions. Excluding surcharge revenue, sales increased by approximately 17%.

Carpenter's gross profit in the third quarter increased $85 million or 24.9% of sales from $49 million or 17.6% of sales a year ago. The 730 basis-point increase in the gross margin is attributed to the effects of a better product mix, base price increases and continued operational improvement. Additionally, a reduced net pension expense contributed to the increased gross profit.

Selling and Administrative expenses were $29 million or 8.4% of sales, compared to $30 million or 10.6% of sales in the third quarter a year ago. The decrease was due primarily to reduced depreciation and a lower net pension expense including in Selling and Administrative expenses. As a result of increase in gross profit, operating income, excluding the net pension effect, increased to $57 million or 16.7% of sales. This was an 840 basis point improvement from last year when operating income totaled $23 million or 8.3% of sales.

Interest expense of $5.9 million was $300,000 higher than year ago, due to higher interest rates. Other income of $2.4 million increased from the $700,000 in the third quarter a year ago. The change mainly reflects the increase in interest income from higher balances of invested cash and foreign exchange gains.

During the recent third quarter, Carpenter had a favorable adjustment for estimated tax credits. This had the effect of reducing Carpenter's effective tax rate to 33.5% in the third quarter. For the full year, Carpenter's effective tax rate will be approximately 32%. As a result of the strong operating performance, Carpenter generated record quarterly net income, which totaled $35 million or $1.38 per diluted share. This compares to net income of $10 million or $0.42 per diluted share in the quarter a year ago.

Turning to the balance sheet, Accounts Receivable, after adjusting for the effects of the receivables purchase facility in the prior year, were $41 million higher due to the increased level of sales. However, Days of Sales Outstanding of 49 days remains unchanged from a year ago. Inventories of $225 million were $42 million higher than a year ago, due to the increased level of sales. A shift in orders to higher-value Aerospace materials contributed to the increase in inventory. However, inventory turns remain flat from a year ago at 2.4 times.

For the quarter, free cash flow totaled $46 million, which compared to $47 million in the third quarter a year ago. As a result of the free cash flow, total net debt at the end of the third quarter was $117 million or $16 million lower than at the end of the previous quarter and $149 million lower than the year ago. Subsequent to the end of the third quarter, Carpenter made a $20 million payment on a maturing medium-term note. Cash and marketable securities at March 31 were $237 million versus 179 million at the end of the previous quarter.

In the third quarter of fiscal 2005, Carpenter had net non-cash pension and retiree medical expenses of $600,000, which was offset by the favorable tax effects of Medicare Part D. As a result, Carpenter's net pension expense did not have a measurable impact on earnings per share in the recent third quarter. This compares to non-cash pension and retiree medical expenses of $2 million or $0.09 per diluted share for the same quarter a year ago.

I will now turn the call back to Bob for concluding remarks.

Thanks, Terry. We are encouraged by our recent operating performance, which demonstrates the earnings potential of Carpenter. We still see a significant opportunity to further improve our operating performance through lean and variation-reduction initiatives. We expect that market conditions will remain favorable, especially Aerospace, which based on our backlogs should have a continued positive impact on several of our business units.

In closing, I would like to thank our employees for their continuing efforts to improve Carpenter's performance. Operator, we will now open the call to analysts' and investors' questions.

(OPERATOR INSTRUCTIONS). Mark Parr of KeyBanc Capital Markets.

Good morning, guys. Congratulations, great quarter! One thing I was curious about -- you had recently announced the implementation of titanium surcharges, I believe. Is that correct?

That correct, Mark.

Okay, could you give us some sense of what sort of impact that may have on the upcoming quarter or the timing of when you expect that to begin having an impact?

Bob Torcolini Let me first just answer this, Mark. Just a clarification -- you know, we did mention a lot about titanium in Dynamet. That titanium surcharge is really related to the Specialty Alloy Operations, so it's really as an alloying element that we are adding to those Specialty Alloy grades. So just so there's no confusion, that's not a titanium surcharge related to Dynamet; that's really related to Specialty Alloy Operations as an alloy element. Okay?

So, what that really represents -- and that is going to be implemented May 1 and any of alloys that we made that we're adding titanium to, we've essentially added this element, which previously had not been part of the group of elements that had the surcharge.

I'm sensing that the reason for that or the justification for that surcharge in the specialty area is just that the price of titanium has been moving up dramatically. Is that fair?

That's correct, yes.

Could you talk maybe in more broad terms about what's going on in the titanium market and the outlook for pricing momentum for Dynamet over the next 12 to 18 months as a result?

Well, I had mentioned, in the call, that titanium prices have really risen significantly, and you can see that year-over-year on a one-year basis, it's been probably over a 200% increase. So, you know, that's the trend that we've expensed. I think, right now, titanium prices are probably at a near 24-year high.

So the outlook for that is that demand for titanium will remain reasonably strong, very strong, actually, with the Aerospace demand, chemical process industry demand and there's not a lot of excess capacity out there in terms of sponge capacity and even the availability of scrap. So, I think the outlook, from a price perspective on titanium, is very strong.

Terrific. Well, congratulations again and keep up the great performance.

John Tumazos of Prudential.

Good morning. Congratulations on all the progress. There's a big dichotomy between the 60% titanium revenue gain, the 50% overall Aerospace revenue gain, and the just 13% IGT revenue gain. Presumably a lot of that's the same alloy 7-18 (ph) sort of material. The IGT gain is small, given that the ingredients cost a little bit more. I presume there was no volume decline in IGT. Could you just comment on the gas power-generation sector? Is it withering a little bit because the gas price is high?

John, let me hit a few points on that. First of all, the IGT market hits Carpenter across a couple of different product areas. It is true, in the Specialty Alloys end of things, which you've reverenced, the 7-18 like (ph) alloy -- alloys -- but it also impacts our ceramics business. We make a lot of ceramic cores for both blade (indiscernible) in the IGT. So when we talk about the IGT business, it really is impacting both of those.

A comment just on the volumes -- if you go back to the '01 period when things were very, very strong in IGT, we are nowhere near those types of peaks. What we are really seeing now, John, is some refurbishment, in other words the rebuilds, the overhauls of the units that were installed a few years back. So that's impacting both of our ceramics and our Specialty Alloys units. So that's really where the demand is coming from. We are seeing a little bit of new frame units being built as infrastructures are getting established in places like Asia, but you know, we can see the numbers, everybody can read the numbers from the major airframe players like GE and others and they are nowhere near where they were in the '01 period. But they are recovering, primarily because of the spares and we're starting to see just a slight uptick in the number of new units that are going up.

Continuing with the IGT, when Alcoa bought Howmet Turbines five or six years ago, one of their investment theses was a portion of the turbine is replaced after three years of wear and the entire turbine after six, so that the market grows not just from potentially new installations increasing but from the replacement of the installed base every six years.

The only 13% gain in power gen suggests that, when you combine the sort of built-in increase from new installations that were accelerating six years ago and the minor increase in some of the metallics like malivdimum (ph), that the new unit sales or the raw materials for new unit sales appear to fall.

John, the one thing that we are always doing is doing a comparison of this third quarter versus the last third quarter. The last third quarter was a very strong quarter for us, so that 13% is a relative number.

How much do you think the IGT market is growing?

Defined by new units or defined by just the consumption of our kinds of product?

Whichever way you are most comfortable in being accurate.

I think that growth, as we see it, John, is relatively modest at this time. I don't think it's really strong growth, as I said earlier, because coming off that '01 peak, what we're really looking at is a replacement market. So I can't really comment on the Alcoa thing that you just quoted there. Certainly, there is a time before overall on these units just like there is on an aircraft engine. I think the big unknown that occurred here is that no one really knew what the insides of these turbines were going to look like, and you know, after the first overhaul, would they just need (indiscernible) and blades? Would they need -- would there be any disks, anything else that would be involved? I think that had to be determined as things were really being disassembled.

There have been a few cases where we've been pleasantly surprised, and I think a lot of -- there's also inventory issues whereas when people typically pull apart a turbine, they really want to have all the parts on the shelf to put it back together as opposed to having any unscheduled delays. So I think a lot of us in the supply chain are just really learning about how things are going to unfold going forward, but we don't -- we're not really planning on huge growth on this; we're really just looking at the business really incrementally going up year-over-year. It probably isn't going to be until 2007 that we're going to start to see a major uptick in the delivery of new machines.

I just want to thank you and congratulate you, not only on your earnings but in scheduling your conference call on a day when there's no other metals companies reporting and we all can listen and read your release and be intent.

Thank you very much, John, and Jaime, who is sitting next to me here, he's nodding his head up-and-down. Thanks.

(OPERATOR INSTRUCTIONS). Michael Gambardella of JP Morgan.

Yes, good morning and congratulations on the quarter and the progress you've made.

Thank you, Mike.

Can you give us a synopsis of where you stand overseas and you businesses overseas, and the status?

Mike, in terms of demand, you know, obviously you note that our sales overseas, if you look at it year-to-date, our international sales are up about 34% and about 22% in the quarter. You know, those things -- there's always opportunity, we feel, to improve our international sales. Primarily what we're seeing is a lot of sales in Europe and Asia, and I think we're being helped by the dollar but typically what we sell overseas are pretty much high-end products. A lot of also the sales of some of our ceramic products overseas are benefiting from strength in some of those markets, so as we referenced, Aerospace sales, I mean, they are pretty much global, both here in the States and in Europe, and our sales in Asia are typically less Aerospace, more in the areas of electronics, consumer products and just some other general automotive and the like.

How about for your operations, your assets overseas? What's the status there? Any plans for expansion?

Let's talk about -- we make ceramics in the UK; we make ceramics in Australia; we make ceramics in Mexico. We're planning to expand our Mexican ceramic operations and our UK operations as well. So there are some expansions planned in response to market growth and new product introduction in those parts of the world.

Is there anything new with your efforts in either China or India?

No.

Okay, thanks a lot.

Leo Larkin of Standard & Poor's.

Good morning, a couple of questions. One, your automotive business has certainly held up a lot better than I thought it might. How does it look going forward? Do you think you can maintain this pretty solid growth in spite of what's taking place in build schedules?

Leo, this is Bob. Let me just say that, again, this really -- automotive sales were really characterizing our metals and ceramics, because we're making some ceramic components that go -- that we characterize as automotive, particularly going into some of the trucks and off-road fuel injection systems.

Certainly the woes that we have been reading about in the last month for GM does have an impact and we do have products that are ultimately winding up in GM cars, but we have a lot of other what we characterize as automotive, so I not only ceramics into the Class 8 but also a lot of the metals that we've got are going into the Class 8 trucks. There has been a pretty substantial increase in the production of those, primarily driven by emission and fuel economy reasons.

Also, a lot of international sales -- I mentioned, in some prior conference calls, that the weak dollar is really helping us export, some of the materials that we make for both valve and fuel injectors everywhere, you know, both Europe and Asia.

The other thing is growing with some key customers. There are some real major players out there that are involved not just with the domestics but also with the transplants. We've done well with being able to grow with them and provide some products. You know, we also characterize that some of the materials that we make are actually going into large engines that are not necessarily just cars and trucks but are things like locomotives and marine, and those areas have held up pretty well. I did mention, in the conference call, the high-performance engine. Despite the cost of fuel right now, the high gasoline costs, the high-performance engines, the 5.7 liters and the big engines like that which do utilize a lot more of the higher-performance materials, are actually continuing to sell well, particularly in light trucks.

So you know, despite the issues that are out there and GM is going to different, definitely according to what we're reading, you know, cutting back their production 10, 15%, we're still looking at a build rate projected right now of about 16.5 million, which isn't bad. The fact that we've got a good, broad-base in automotive is holding up pretty well for us.

Okay, the other question -- do you have any preliminary CapEx figure for the fiscal '06?

Leo, you can see, through nine months, we've spent about a little less than $9 million, which is about what we spent all of last year. We will probably finish this year somewhere, you know, in the 12 or so range and next year, you know, as we've said every year, we typically look at a normal level of CapEx for our business in that kind of 25 to $30 million range. There are some infrastructure needs that we're going to be stepping up to, going forward, so I think the historical level -- you're starting to see a little increase in that and you're probably going to see that continue in the next year.

Okay, so we should expect some bump-up next year?

Yes.

A follow-up question from the line of John Tumazos.

Concerning the Airbus A380 to begin deliveries soon, how much more, per plane, of your particular applications, materials would be used compared to the A320, excuse me? The aluminum companies are saying there's 10 times as much heat-treated aluminum played. I'm assuming that you're not enjoying the degree of good fortune and that that aluminum plate is somehow proportionate.

John, this is Mike Shor. On the titanium fastener side, the smaller planes typically use somewhere between 2 and 5,000 pounds and the A380 will use somewhere between 5 and 10 times that of the smaller planes are out there, so a significant increase in titanium usage.

John, that's probably more of the fastener look. You know, there's a lot of other structural titanium in that plane, both landing gear, bulkheads, wing carry through beams (ph), things like that that Mike's just talking about the fastener side.

On the other, the other alloy side, talking about the size of those engines, Denny, do you want to comment on that?

When you look at the size, Mike, I don't think the percentage is the same in terms of the increased use of material from the Specialty Alloys Operations, but clearly, if you look at the engines and the type of material and the quantity of material used, just based upon size, it's going to be fairly significant.

Would significant be a double?

When you say double, compared to --?

Say the engine for an A320?

Probably, yes.

Again, John, think of the -- if you think of the more widely used engines like a CFM 56 and you look at the size of that engine compared to the size of the A380 kind of engines, they are significantly larger. Remember, in SAO's case, we're primarily talking about hot section components, so we're talking shafting, we're talking about high-pressure turbines, things on the hot end of the engine. But proportionate size is significantly larger, although -- so the number of planes that CFM 56s are hanging on are much, much larger in number than what the A380 will be coming out, but they are relatively significant users of raw material.

Thank you.

Gentlemen, there are no further questions at this time.

Okay, in closing, I'd like to thank you all for your interest in Carpenter. We look forward to talking with you at our next conference call and I will turn the call now back over to Jaime.

Thank you, Bob. We would like to thank you for your participation in today's conference call and your continued support of Carpenter. A replay of this call will be available at our Web site, cartech.com. Please contact us if you have any questions. Thank you.

Once again, ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.