Carpenter Technology Corp (CRS) 2005 Q4 法說會逐字稿

Good day ladies and gentlemen. Welcome to the fourth quarter 2005 Carpenter Technology earnings conference call. My name is Andrea 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 today's conference. (Operator Instructions).

I would now like to turn the presentation over to the host of today's call, Mr. Jaime Vasquez, Vice President and Treasurer. Please proceed.

Thank you, Andrea. Good morning and welcome to our conference call for the period ended June 30, the fourth quarter of Carpenter's fiscal year. This call is also being broadcast over the Internet.

With me today are Bob Torcolini, the 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 Rick Simons (ph), our Vice President and Corporate Controller.

The sum 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 exhibits attached to those filings. During this conference call, we will be using the abbreviation 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.

Thank you, Jaime, good morning. Earlier today, we distributed a news release on the results of our fourth quarter and fiscal year 2005. We are pleased to report record earnings for the quarter and fiscal year. This marks the seventh consecutive quarter of earnings improvement. We achieved these results through the combination of strong market conditions, our strategy of pricing for value, tight cost controls and our continued focus on lean and variation reduction.

Now let we provide you with some detail on Carpenter's consolidated fourth quarter sales, first by product type and then by end-use market. The year-over-year changes in sales that I will reference include surcharges. Excluding surcharge revenue, sales increased 17% from the fourth quarter a year ago. Sales of our special alloys increased 32% from a year ago to $143 million, a record high for any quarter. Demand for our special alloys was particularly robust from the aerospace market. The anticipated increase in commercial airplane deliveries over the next several years is having a pronounced effect on demand for certain materials. Additionally, our strategy to price these materials for the value delivered and surcharges contributed to the increased sales of specialty alloys.

Sales of our titanium alloys increased 56% to $34 million, a quarterly record. Our titanium business is benefiting from strong domestic and foreign demand from the aerospace market. Titanium sales also benefited from growth in the medical market and increased selling prices due to the effect of significantly higher titanium cost.

Our stainless steel sales were $144 million, or 10% above the fourth quarter a year ago. A better product mix, higher base prices and surcharges were the primary drivers of the increase. Sales growth in the quarter was moderated by the intentional reduction of volumes associated with lower valued products.

Sales of ceramic and other materials increased 19% from the fourth quarter a year ago to $27 million. The increase is primarily attributable to higher sales of ceramic cores used in the casting of turbine blades for aircraft engines and diesel engine fuel injectors.

By end use markets, sales to the aerospace market increased 52% from the same quarter a year ago to $107 million. Strong demand from the U.S. and European aerospace markets where high temperature alloys used in jet engine components and for titanium used in airframe structural components were the primary drivers of the increase in revenues. Commercial aircraft build rates are strong relative to just a year ago and are expected to increase over the next several years. The recent Airline Monitor projects 785 commercial jet deliveries in calendar year 2006 and more than 800 deliveries in each of the following two years. This compares with an expected 680 deliveries in 2005. This will continue to positively affect several of our businesses, including special alloys, titanium and ceramics.

Sales to the medical market of $29 million were 43% above a year ago and were a record for any quarter. The record sales level reflected 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 automotive market were $53 million, or 19% above the fourth quarter a year ago. The increase primarily reflected base price increases, global growth with key customers and surcharges. The increase was tempered by a reduction in volume during the quarter. However, we believe that reduced demand is temporary as the supply chain adjusted to lower U.S. auto production rates. Our supply to global customers helped to mitigate the impact from lower production rates in the U.S.

During the past year, our sales to the automotive market have been particularly strong in part due to the increased demand for special alloys. The increased popularity of high-performance engines has benefited our special alloys sales. In addition, more stringent emissions standards for gasoline and diesel engines resulted in higher demand for Carpenter's specialty materials, including ceramics.

Sales to the consumer market of $56 million increased 12% from a year ago. The increase primarily reflected the sale of higher-valued products to the sporting goods and electronic markets.

Industrial sector sales, which include materials used in equipment and other capital goods applications, increased 7% from the fourth quarter a year ago to $98 million. The year-over-year increase in sales moderated from the double-digit increases experienced over the past few quarters. The effects of base price increases, a favorable product mix and surcharges were partially offset by lower volume. Industrial sector sales continue to pace near record levels.

Sales to the power generation market of $20 million were flat with the fourth quarter a year ago. However, maintenance activity on industrial gas turbines and the sale of new turbines internationally have sustained revenues at healthy levels.

Now I will provide an overview of our business units. Starting with Specialty Alloy Operations, or SAO, fourth quarter sales increased 19% from a year ago to $285 million. The increase was due to higher sales to the aerospace and medical markets and a better product of materials sold to the automotive and consumer markets. In addition, SAO's sales increase reflects our strategy to price products for the value delivered as well as surcharges.

Sales of bar products increased 5% from the fourth quarter a year ago, despite a 20% decline in volume. The increase in sales reflected a more favorable product mix, pricing actions and surcharges. The volume decline is consistent with our strategy to reduce the sale of lower-valued stainless products. The decline also reflects the inventory adjustment in the automotive supply chain and lower volume to the industrial markets.

Sales of coiled products increased 26% despite a 20% decline in volume from a year ago. Sales benefited from an increased emphasis on the sale of higher-valued coil products and increased base prices which more than offset the lower volume. Again, the lower volume primarily reflects our intentional reduction in the sale of marginally profitable products.

Our forged bar and billet product sales increased 41% from a year ago; the primary drivers of the increase were higher shipments to the aerospace market which yielded a better product mix and higher selling prices. At Dynamet, which primarily sells titanium products, sales increased 69% in the fourth quarter from a year ago to $32 million, a record level for any quarter. The record sales level at Dynamet was driven by strong demand in the aerospace market and growth in the medical market. During the past few years, Dynamet has increased the sale of materials for use in orthopedic implants and spinal fixation devices. Sales to the medical market has the highest level ever in the fourth quarter. Dynamet's sales also reflected price increases and the impact of significantly higher titanium costs.

Sales for the Engineered Products Group increased 15% to $33 million in the fourth quarter from a year ago. Increased volumes and better pricing resulted in higher sales across most end-use market. Certech, which is the largest business within this group, continued to experience strong demand for its ceramic cores used in the casting of turbine blades for jet engines and diesel engines fuel injectors. 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 fourth quarter were $362 million, or 22% higher than a year ago. As Bob mentioned, the increase was driven by pricing actions and a better product mix. Excluding surcharge revenues, sales increased by 17%. Gross profit in the fourth quarter increased to $93 million, or 25.6% of sales, from $63 million, or 21.1% of sales, a year ago. The 450 basis point increase in the gross margin is attributable to base price increases, a better product mix and continued operational improvements. Additionally, the gross profit was aided by a lower net pension expense.

Selling and administrative expenses of $35 million were 9.6% of sales compared to $31 million or 10.5% of sales a year ago. The increase reflects a $4 million additional accrual for a reserve associated with an operation that was closed in 1987. At the end of the fourth quarter, Carpenter completed the sale of a subsidiary; Carpenter Special Products Corporation, or CSPC. The divestiture, which resulted in a gain of $8.7 million was part of the Company's strategy to focus on its specialty material businesses. CSPC had sales of less than $30 million in fiscal 2005 and represented approximately 2% of consolidated operating income.

Primarily as a result of the increase in gross profit, operating income excluding the gain on the sale of CSPC, increased to $58 million or 16.1% of sales. This was a 560 basis point improvement from last year when operating income totaled $31 million or 10.5% of sales. Interest expense decreased slightly to $5.4 million from $5.6 million a year ago. The benefit of lower debt levels was partially offset by higher interest rates.

Other income of $1.1 million increased from $600,000 in the fourth quarter a year ago. The increase primarily reflects higher income from increased balances of invested cash. In the recent fourth quarter, net income was favorably impacted by $0.23 per diluted share primarily as a result of two factors; first, a $3 million benefit from the reversal of a portion of the state tax net operating loss carryforward valuation allowances and secondly, a $2.8 million benefit due to an adjustment of a state effective deferred tax rate. This had the effect of reducing Carpenter's effective tax rate in the fourth quarter to 23.6% and 28.7% for the full year. For fiscal 2006, we expect that Carpenter's effective tax rate will be approximately 34%.

As a result of the strong operating performance, Carpenter generated record quarterly net income which totaled $48 million, or $1.86 per diluted share. This compares to net income of $18 million, or $0.73 per diluted share in the quarter, a year ago.

Turning to the balance sheet, accounts receivable were $28 million higher than a year ago due to the increased level of sales. However, day sales outstanding of 48 days remained relatively unchanged from a year ago. Inventories of $229 million were $44 million higher than a year ago also due to the increased level of sale. A shift in orders to higher value aerospace materials contributed to the increase in inventory.

For the quarter, free cash flow was $45.1 million versus $9.4 million in the quarter a year a go. Free cash flow in the recent fourth quarter included $15.4 million in net cash proceeds from the sale of CSPC. Also in the quarter, free cash flow was reduced by $25 million as a result of the Company's voluntary contribution to a VEBA trust that funds post-retirement medical expenses. Carpenter also made a $25 million voluntary contribution to the trust in last year's fourth quarter.

As a result of the free cash flow, total net debt at the end of the fourth quarter was $64 million, or $53 million lower than at the end of the previous quarter and $186 million lower than a year ago. In the fourth quarter of fiscal 2005, Carpenter had pretax net pension expense of $600,000 which was offset by the favorable tax effects of Medicare Part B. As a result, Carpenter's net pension expense did not have a measurable impact on earnings per share in the recent fourth quarter. This compares to pretax net pension expense of $3.6 million, or $0.9 per diluted share for the same quarter a year ago.

For fiscal 2005, the Company's net pension expense was equivalent to $0.01 per diluted share versus $0.42 per diluted share a year ago. As you may recall, the net pension amount is actuarially determined as of each June 30th and is typically held constant throughout the fiscal year. In fiscal 2006, Carpenter will have a pretax net pension expense of approximately $11.5 million or the equivalent of $0.24 per diluted share. This change in this rate is used to value the long-term pension liabilities. The Company's defined benefit pension plan remains well funded, and as in prior years, the Company is not required to make a cash contribution to the plan in fiscal 2006. I will now turn the call back to Bob for concluding remarks.

Thank you, Terry. We established our financial objectives more than three years ago. One key goal has been to deliver a return that exceeds our cost of capital, regardless of business conditions as we continue to work relentlessly on lean initiatives and variation reductions so we can consistently generate strong returns and further enhance shareholder value.

Our performance in fiscal 2005 validates the strategy that we have pursued over the past few years. Our focus on operational excellence has significantly elevated our performance during this period of favorable market conditions.

As we enter fiscal 2006, market conditions remain favorable, especially for our special alloys, titanium and ceramics as a result of a robust aerospace market. Because of these conditions, we expect further improvement in our operating results.

Andrea, we will now open the call to analyst and investors' questions.

(Operator Instructions) Andrew O'Connor, Wells (ph) Capital.

Good morning, gentlemen. I wanted to know, can you further characterize the pricing environment for both your Specialty Metals and Engineered Products segments and how you see prices trending in the first half of fiscal '06? Thanks so much.

Andrew, as I mentioned in the call and in the conference, in certain of our markets, the demand is still very robust. Any place where we have very robust demand and also raw material prices are stable, and I should say maybe able to volatile at relatively high levels. There is obviously no pressure on pricing there. If anything, the pressure is on the upward side because of some capacity constraints in the industry.

Titanium, we mentioned that that titanium market is very strong at the moment and the titanium supply is relatively tight. And so I think in those areas, we're going to see continued price moves.

The only area that there is some, let's say competition if you will, is on the commodity side of the stainless area in the Specialty Alloys business. And that would be a portion of our business which is probably less than 10% of our sales. It's going into the distributor end of the market and that's where the imports and things like that have some impact.

So I guess it would depend largely on which business and in what areas. Primarily, the engineered products that we have are fairly customized, co-engineered if you will, and those products are typically priced at a value that they are delivering, and we will continue to do that.

Okay. And then secondly, maybe I missed this. Was there a CapEx estimate offered for fiscal '06?

For fiscal '06, we will probably be in the range of 20 to 30 million, which is greater than it has been and it's because we're looking at some strategic capital expenditures to improve our efficiencies and yields.

Okay. And then your estimate of free cash flow for fiscal '06 of more than 100 million with CapEx of 20 to 30 million -- are there other assumptions you can share with us which go into your free cash flow estimate for fiscal '06? I was thinking of D&A, dividends paid, anything else you might be able to share?

Terry, on the D&A side in fiscal '06, I think we are planning about 50 million.

Okay. And dividends paid in '06 the same as in '05, or would that be incorporated in your estimate of free cash again?

At the current rate.

That's all we have. Thanks very much.

(Operator Instructions). Mark Parr, KeyBanc Capital Markets.

Thank you, good morning. So one question just related to the reduction, volume reduction that you're doing in commodity stainless. I would assume that there is eventually a point where that's going to begin to wind down. I just wondered if you could give us some color on that? And then along those lines, also as you exit that business, to what extent does capacity then become available for higher-valued products, and how well are you accessing that new capacity availability?

On the commodity stainless side of the business, I think in the past what we have said is that there are some products that are kind of unattractive for us, particularly those that are marginally profitable. And so what we have been doing systematically over a period of actually a couple of years is we have declined, if you will, primarily through pricing to participate in some of those markets.

Are you like in the fifth inning of that process or in the third inning or in the eighth inning? Can give us some sense of that?

I would say, we're probably in the eighth inning of that. I think that has pretty well taken its course. I would say that, although we continually look at our product mix and when we continually look at what's attractive to us and what's not attractive to us, I would say that we have realized a lot of that.

The other thing is, keep in mind that when we report, we're reporting quarter-over-quarter to quarter. So when we look at the fourth quarter of fiscal '05 versus '04, we have had a year's worth of the impact of our rationalizing some of those products. And so that's why when we report our volume. And primarily what we're talking about is really in the SAO business, in the Specialty Alloys Business. But that's part of our strategy to really focus on really the higher valued products, which we think are really our core competency.

So then to your second question of how do we shift our capacities in, I think that's exactly the point is that rather than have a lot of our capacities, both equipment and manpower, tied up with making products that have very little return, what we're trying to do is really focus on the higher valued products. And so we're putting those capacities to work on that.

Just as a follow-up, could you give us a sense of your current utilization in titanium products?

On the titanium products, which is primarily through Dynamet, the demand has increased but it has not increased to the same volume levels that we saw in 1998. So I would say that there's more freeboard (ph) in that business.

Can you tell us how close you might be to those 98 levels?

We are probably at about 85% of those levels.

Congratulations on another great quarter.

Thank you very much.

Leo Larkin, Standard & Poor's.

Good morning. Could you give us the guidance range just expensed this coming year?

I'm sorry, Leo, could you repeat that?

Interest expense for the coming year?

About 23 million. About 23 million, Leo.

Okay, thank you.

Ladies and ,gentlemen this concludes the question-and-answer portion of today's call. I would now like to turn the presentation back to Robert Torcolini for closing remarks.

We would like to thank you for your interest in Carpenter. We look forward to talking to you at our next quarterly conference call. I will now turn the call back to Jamie.

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 website, cartech.com. Please contact us if you have any questions. Thank you.

Ladies and gentlemen, thank you for your participation in today's call. This does conclude your presentation. You may now disconnect, good day.