Carpenter Technology Corp (CRS) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Carpenter Technology first quarter earnings conference call. My name is Annmarie and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS)

I would like to turn the the presentation over to Mr. Jaime Vasquez, Vice President and Treasurer. You may proceed.

Thank you Annmarie. Good afternoon. Welcome to our conference call for the quarter ended September 30th, the first 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 Engineer Products Operations, Dennis Oates, Senior Vice President of our Specialty Alloys Operations, Eric Simons, our Vice President and Corporate Controller.

Some of Carpenter's statements will be forward-looking statements, which are based on current expectations. Risk factors that can 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 30th, 2005 10-K in the exhibits attached to that filing.

During this conference call we will be using 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.

Thank you Jaime. Good afternoon. Earlier today we distributed a news release on the results of our first quarter. We are pleased to report record first quarter earnings and the second best quarter ever, despite this being traditionally the slowest quarter in Carpenter's fiscal year.

These results reflect the leverage that has been created within Carpenter by adhering to an operating strategy that emphasizes product mix management, a constant focus on cost reduction, and the relentless pursuit of operational excellence. Our business model has us well-positioned to leverage the opportunity presented by very favorable market conditions particularly in Aerospace. This market continues to gain momentum which bodes well for several of our materials, including special alloys, titanium, and ceramics.

Now let me provide you with some detail on Carpenter's consolidated first 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 15% from the first quarter a year ago. Sales of our special alloys increased 19% from a year ago to $142 million, which is the second highest quarter resales amounts ever achieved.

The robust activity in the Aerospace market should be sustained, based on the current forecast for commercial aircraft deliveries over the next 4 years. Additionally our strategy to price materials for the value delivered and surcharges contributed to the increased sales of special alloys.

Our stainless-steel sales were $127 million or 7% above the first quarter a year ago. A better product mix, higher base prices, and surcharges were the primary drivers of the increase. Our strategy not to pursue lower margin business as well as reduce sales to the automotive and consumer markets moderated sales growth in the quarter.

Sales of our titanium alloy increased 67% to $38 million, a quarterly record. Our titanium business is benefiting from strong global demand from the Aerospace market. The increased titanium sales also reflected solid demand from the medical market, increased selling prices, and the effect of significantly higher titanium costs.

Sales of ceramic and other materials increased 5% from the first quarter a year ago to $25 million. The improvement is primarily attributable to increased demand from the power generation market for ceramic cores used in the fasting of turbine blades and diesel engine fuel injectors for trucks.

By end-use market, sales to the aerospace market increased 48% from the same quarter a year ago to $114 million. This marked the seventh consecutive quarter of increased sales to that market and was a record for any quarter. The number of commercial aircraft deliveries and the mix of orders favoring larger aircraft should continue to have a positive impact on demand for several of our businesses.

Sales to the medical market of $31 million were 51% above a year ago and also a record for any quarter. The record sales level reflected strong demand, growth in Europe, and pricing actions.

We continue to see steady growth of our special alloys and titanium materials in both the domestic and foreign medical markets. Sales to the power generation market were $22 million or 27% higher than a year ago after adjusting for the sale of Carpenter special products.

Pricing actions, surcharges, and increased demand for maintenance activity on industrial gas turbines were the primary contributors to the increase.

Sales to the automotive and truck markets were $43 million or 8% above the first quarter a year ago. The increase primarily reflected higher sales of ceramic materials used in engine components for trucks, base price actions, and surcharges. The increase was tempered by a reduction in shipments of special and stainless alloys during the quarter.

Industrial sector sales which include materials used in equipment and other capital goods applications increased 4% from the first quarter a year ago to $89 million. The effective base price increases of favorable product mix and surcharges were partially offset by lower volumes and the intentional reduction of marginally profitable products.

Sales to the consumer market of $47 million decreased 9% from a year ago. The decrease reflects reduced volume and the intentional reduction of marginally profitable products.

Now I will provide an overview of our business units. Starting with SAO, first quarter sales of $276 million were 16% higher than a year ago. The increase was primarily due to the sale of higher value materials to the aerospace and medical markets, base pricing actions, and surcharges. The increase was partially tempered by a 16% decline in shipments from a year ago. Most of the decline is a result of our decision not to pursue the sale of marginally profitable products.

A large portion of these products are more generic and are sold into the independent metal distribution market, which is typically more price-sensitive.

We also experienced reduced demand from the automotive and consumer markets, which contributed to the decline of shipments. Sales of barred (ph) products increased 12% from the first quarter a year ago despite a 16% decline in shipments. The increase in sales reflected a more favorable product mix, pricing actions, and surcharges.

As I just mentioned most of the decline in shipments is associated with our decision not to pursue or produce the more generic products.

Our forge bar and billet product sales were 69% higher than a year ago. A 27% increase in shipments, higher foreign sales and base pricing actions contributed to the increase. Sales of coil products decreased 5% primarily as a result of a 35% decline in shipments. The lower shipments are attributed to our focus on higher value in materials as well as reduced demand from the consumer industrial markets for certain coil products.

At Dynamet, which primarily sells titanium products, first quarter sales increased 59% from a year ago to $36 million, a record level for any quarter, aiding growth with strong demand from the aerospace market for materials used in structural fasteners. Dynamet's successful diversification into the medical market also contributed to the increase.

During the past quarter, sales to the medical market benefited from growth, with key domestic and foreign customers.

Sales for the Engineer Product Group was $25 million in the first quarter, a 5% increase from a year ago after adjusting for the sale of Carpenter special products.

Certek (ph), which produces ceramic cores using the investment casting of turbine blades and diesel engine fuel injectors experienced solid demand from the aerospace, power generation, and truck markets.

Now I'd like to turn the call over to Terry.

Thank you, Bob. As we detailed in today's earnings announcement, consolidated net sales in the first quarter were 346 million or 16% higher than a year ago. The increase was driven primarily by pricing actions and a better product mix, as a result of increased shipments to the Aerospace, medical, and power generation markets. Excluding surcharge revenue, sales increased by 15%.

Gross profit in the first quarter increased to 92 million or 26.5% of sales from 63 million or 21.3% of sales a year ago. The 520 basis point increase in the gross margin is largely attributable to increased sales of higher value materials to the Aerospace, medical, and power generation markets and base pricing actions.

Selling and administrative expenses of 28 million were essentially the same as a year ago. However as a percentage of sales, selling and administrative expenses declined to 8.1% from 9.3% a year ago. We continue to be diligent in managing our costs and expect selling and administrative expenses to be at the same level as a year ago.

Primarily as a result of the increase in gross profit, operating income increased to 64 million or 18.4% of sales. This was up a 640 basis point improvement from last year when operating income totaled 36 million or 12% of sales.

Interest expense increased slightly to 6 million from 5.8 million a year ago. The increase is primarily due to a larger mix of floating rate debt a year ago, which benefited from the low interest rate environment at that time.

Other income of 3 million increased from .6 million in the first quarter a year ago. The increase primarily reflected higher income from increased balances of invested cash in foreign exchange dividends (ph).

As a result of the strong operating performance, Carpenter generated record first quarter net income which totaled $40.1 million or $1.54 per diluted share. This compares to net income of $19.8 million or $0.80 per diluted share in the quarter a year ago.

Turning to the balance sheet, Accounts Receivable were $26 million higher than a year ago due primarily to the increased level of sales. Day sales outstanding of 49 days compared to 48 days at the end of the first quarter a year ago. The increase in day sales outstanding is primarily attributed to a higher level of international base sales.

Inventories of $254 million were $51 million higher than a year ago, also due to the increased level of sales. The strength of orders for higher value aerospace medical and power generation materials, many of which have longer throughput times, contributed largely to the increase in inventory.

We continue to work diligently to improve our working capital position, and feel confident that it will improve throughout the balance of the fiscal year. For the quarter, free cash flow was $.7 million versus $27.3 million in the quarter a year ago.

The change in free cash flow reflected several factors. Foremost was an increase in inventory needed to support the higher level of future sale, especially to the Aerospace and medical market. Also a reduction in Accounts Payable and the payment of annual variable performance compensation in July for all Carpenter employees contributed to the reduced free cash flow in the first quarter.

We expect that our earnings growth and working capital improvements through the balance of the year will allow us to generate more than $125 million in free cash flow.

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

Thanks Terry. Let me close by saying we are pleased by our performance in the first quarter. Our traditional seasonality was not evident this quarter because of the strong Aerospace market, continued growth in international market, and solid demand for our higher value materials.

As we look to the balance of fiscal 2006, we anticipate continuing strength and demand for our Aerospace materials and sustained levels of demand for our other high value products. At this time we do not believe that the moderation in the automotive and consumer markets will alter our momentum. Based on current market conditions, we expect that Carpenter will achieve another record year.

Finally, I would like to acknowledge all of the people throughout Carpenter who are working diligently to continually improve the performance of the Company. Annmarie, we would now open the call to analysts' and investors' questions.

(OPERATOR INSTRUCTIONS) Michael Gambardella with Carpenter Technology.

This is Mike Gambardella but with J.P. Morgan. Congratulations on another great quarter. I have a question on some end market demand. Now you've clearly seen very strong Aerospace and medical and a couple of other markets but have you started to see any increasing order activity from say, what you would would call alternative energy sources?

With the high price of oil, other types of energy looking to build some capacity whether it be nukes or even retrofitting refineries?

These are all projects that really haven't taken place in 25, 30 years. And I think you and maybe Allegheny are the only 2 suppliers of some of these specialty steels that would go in there; and they are all very kind of specialty steel in terms of projects.

I would say that, perhaps, the one area we didn't articulate much is the oil and gas area. Obviously with gas -- with crude at above 60, drilling activity and also the natural gas prices as well, that has been an area where we've seen -- the activity is robust. And I would expect that it is going to continue.

But specific to your question on alternative energy sources, obviously, there are some developmental projects that people are evaluating and looking at materials. But I would say that they are not -- I wouldn't say that they are really of a move the needle status at this point in time.

Last question, I think your net debt total capital is down to only 5% now and I guess shortly you'll be going to a position where you have more cash than debt. Could you prioritize the -- what you're going to do with the cash?

Mike, in the past we've talked about the usual stuff. And I think there are some relatively small needs that we've had around Vivatoli (ph) . You might note that for the first quarter our capital spending is up a bit and that is in line with the guidance we've given before, that we are going to be in that 25 million possibly $30 million range going forward.

But one of the key things that obviously we are looking at is to grow and diversify the Company as we go forward. So that is something that we are going to be taking a much more serious look at in this fiscal year and in the year ahead.

Michael Parr. KeyBanc Capital Markets.

It's Mark, I'm Michael's brother. Congratulations on another great result. I was wondering -- I guess based on your answer to Michael's question about use of cash, there is nothing really new you can add as far as the acquisition pipeline but if there is, that of the various I would love to hear about that.

Nothing at this time, Mark.

Secondly I just would like to get a little more color on the SG&A line. I know that you've been -- obviously you've been growing your business. You have been really doing a fantastic job of putting more units up. But, typically, that is associated with an increase in SG&A. And I just wonder if you could just talk a little bit about your strategy about that? Why that line item hasn't been growing for you and what you might expect over the next couple of years?

Well, I'm sure as you remember, we have worked very hard to get our SG&A in line. And a few years back we reduced a lot of the direct labor and also a lot of salaried labor. But we've never in that whole process had what I would call a hiring freeze on because we really want to make sure we have the right talent in the organization.

But we are very mindful of really making sure that our SG&A costs are controlled. I would also say that a lot of the lean initiatives that we have are really focused -- focusing on doing more with less on eliminating non-value-added activities whether they are in the factory or whether they're in the administrative side of the business.

So it is one of our objectives to make sure that we control our SG&A costs. Having said that, one of the things that we also feel that is really important is to continue to develop new products across all of our businesses. So in addition to what we have been doing in terms of some of the recently revised moderate capital spending is also to put some more effort and emphasis toward some of our R&D and business development activities particularly as it relates to new products and selling into new geographies.

Any color you could give us on magnitude of potential SG&A growth over the next several years?

I would say it would be modest.

Terrific. Congratulations again on a great quarter.

Thank you.

(indiscernible) Max McGeary (ph) with Sentinel Asset Management.

I am wondering if you could just walk me through again sort of continuing on Gambardella's questioning about uses of cash. Just talk to me how you think about buybacks as well -- prior to today? You could have bought your stock for a pretty nice multiple. And I'm just sort of thinking about how you balance that option against what is available in the M&A market. I've got to think those evaluations are getting stretched in some parts. Just walk me through sort of you think about that?

I will ask Terry to help with this response as well but we've in the past said there is usual five or six suspects. As I mentioned earlier, there are some kind of immediate needs. We look at those strategic capital expenditures, we look at funding our Vivatoli (ph), which is a relatively modest amount.

We have looked at and always look at things like share buyback. But from a standpoint of trying to create more long-term value in the Company, we are understanding that we would like to have a more balanced portfolio of businesses. Today, we are very heavily invested in the metal sector and we see other materials opportunities.

So our goal, longer term, is to have a more balanced portfolio. So one of the things that we would like to do is evaluate those opportunities. I think your point is well taken, that valuations can be rather lofty.

So timing is everything but, clearly, this is something that we have had in our minds that when the timing is correct and is right, we want to be in a position to be able to act on that.

Right and I would also comment that, relative to the timing of stock buybacks, because Bob has not suggested that we would exclude them. They are among alternative uses of cash. The question is under what circumstances, timing, and size?

Currently, you alluded to our recent stock price. We think that the current volatility is something that is kind of difficult to understand whether or not we will be idle to sustain the incremental benefit of the stock buybacks at certain levels. But it is one of the continuing kind of calculations we do.

Also, relative to a growth strategy through acquisitions, one of the things Bob has expressed in the past is that we would be looking for more critical mass in that arena than we have undertaken in past acquisition strategies. So that takes a more conscious consideration toward the amount of cash accumulating for that purpose.

Marshall Levine with Cumberland Associates.

Thanks very much for taking the question. Everything is looking terrific in the business but I had one question about the stock sales by some of the top execs. Looks to me like these are kind of substantial percentages of holdings, according to the proxy but I don't know if these numbers are correct.

It looks like -- did your CFO, Geremski, sold over 80% and Torcolini as well over 80. Michael Shor over 70. Are these numbers even close to correct?

Let me just say this. We -- first of all, we all have ownership guidelines. In my case it is three times my base salary and in the case of a Senior Vice President it is 1.5 times. And we also all have well in excess of that.

Like I'm sure any prudent financial adviser would advise us, it is important to diversify -- particularly those of us like myself who've been in this business for 32 years and received stock options over a period of years, many of which were not too valuable.

So from a standpoint of diversification it is probably -- it is the right thing to do and I think we are well in excess of our ownership guidelines. So I think this is pretty much the kind of personal investing things that I think any prudent people would do.

We are still very large holders. Personally I hold in, beneficially, over almost 50,000 shares and have a lot more of -- in other forms, options, and so on.

So this is just purely diversification? You've had a tremendous rise, obviously, in the past 2 1/2 years or so.

Yes the other thing I might like to point out, Marshall, is there have been times in the past where we were very conservative with blackout periods, even through the period of the '90s. Carpenter was making acquisitions, even though some of them were relatively small, that precluded trading and then there was that period, of course, a few years ago, where we really didn't have any value there.

So those types of things tend to also restrict the ability to diversify. So it was an opportunity and that is why this management team has done that. But I would just go back that we have got well in excess of our ownership guidelines and will continue to do that and report that to the Board, frankly, every year.

Of course and these percentages are in the ballpark then, right?

Yes.

John Tumazos with Prudential Equity Group.

Congratulations on the great results. The SSINA data shows relatively high import shares for stainless. Bar, rod, and wire categories generally over 50%. Are those data accurate and has Carpenter evolved so much with the high value specialty metals, titanium, etc., that the commodity bar rod market doesn't matter anymore?

I guess the short answer would that, yes, we believe that those data are accurate and I would state that in what you've been reading and talk about in our press releases and in our conference call scripts, we are talking about that there are -- intentionally, that we are reducing our participation in some of what we called marginally profitable products.

And you heard in today's commentary I said some of the products are very generic. And the generics are typically the ones that are the most sensitive to imports and are also the ones that are most price sensitive. So what we have been doing over time is decreasing our dependence and our reliance on that and focusing more of our capacity and energy toward higher value products, some of which had already been in our mix and some of which we are going to continue to develop.

That is not to say we don't have stainless steel bar and wire in our mix today. Because there are still some very high-value, high-performance stainless steels that we continue to make and even continue to develop in both product forms -- in both the bar form and the wire form and, frankly, even in the strip form where we have a very -- we have traditionally had a lot of electronic alloy strip.

Now we're making some very high-strength stainless strip materials for both consumer markets and Aerospace.

I don't what to leave you with the impression that we are not making stainless steel any longer. We're just not making what I call the more generic more commodity products to the extent that we have in the past.

How many shifts a week do your primary melt shops in Reading and (indiscernible) Mills and Reading and the Carolinas operate?

Well it's what we have are some various types of melting and you're talking about the specialty alloy business, John?

Sure.

If you're talking about the materials that are focused on premium products, whether it be Aerospace, PowerGen, or medical we are operating those very extensively. Because those are the high-value products. In some of our other areas we are not -- we are doing five-day kind of operations not seven days around the seven day a week around the clock.

But that is fundamentally part of our strategy to utilize our assets to the extent we believe that they are going to provide us with good returns. And where appropriate, we will shift assets and resources around in order to address the more desirable demand in the marketplace.

So we are not fixated. It is not really a volume absorption type of strategy. It is wanting to going to try to optimize the value that we can deliver from the assets that we have.

Henry McCosco (ph) with Lord Abbett.

Is there a next question, Annmarie?

(technical difficulty) from Lord Abbett. Please proceed.

I wondered about gross margins with regard to going forward. First off, historically, are they -- have they been higher and what would you say your expectations might be going forward?

Obviously I think what you have seen in our reported results is continuous improvement, if you will, in our margins owing to many of the things that we talked about. Our cost reductions, our lean initiative, our improved mix in terms of higher value products. All of those things and our efficiencies are really enhancing that.

If the nature of your question would be are we satisfied at where we are, the answer would be absolutely not. We believe we have got more leverage to continually improve the performance of the business because as you may have heard me say in the past, on a scale of 1 to 10 in our lean journey we are probably a 3, so there is more for us to do there. And as we continue to innovate and develop new products, clearly, these are things that we are focusing on high-value, high-margin applications.

So I would say that we can't rest on any laurel that we have right now. And I think you'd have to go back many years in Carpenter's history to see the kind of margins that we are at today. But I'm sure if you went back far enough there were periods where our margins were even higher.

With respect to -- you let go a number of different businesses and customers that were lower margin. Would you say that the run rate today in the current quarter, have you let go of all of the business that you expect to in the future?

Basically that has been -- the answer would be that in -- this is really something that we been doing over almost 2 1/2 maybe year period. And we continually evaluate the products that we are making on an item by item basis. And that would be not only in the metals business but in our titanium business, our ceramics businesses. We are really trying to understand real product line profitability and we continue to evaluate that.

In some cases by -- we may have decreased our participation but as our cost actually continued to get lower some of the products we evaluate as to whether or not we wouldn't want to put them back into the mix so it is an (indiscernible) process that we have to keep going back over. Because markets don't stay the same and our cost performance doesn't necessarily stay the same. So we don't do this as something that has a kind of a final end date. It is something we continue to do.

Having said that, we have really made a lot of progress in that area. And that is why I think you're seeing the results of the performance that we were able to deliver.

What you would expect in the quarters going forward the amount of business that is let go would decline but still occur but at a slower rate, perhaps?

Yes, probably at a slower rate because typically what you hear us always do is make comparisons to the quarter a year ago. So as we progress in this journey, when we make comparisons back to a quarter or a year ago, obviously, we now have 3 to 4 quarters' worth of additional rationalization work under our belt.

So that's why you hear us quoting, volumes are down as particularly in the metals business where we measure volume by tons or pounds.

Finally in the medical area in the last, say, quarter or 2, how many new customers have you added or is the growth in the medical pretty much strictly with regard to existing customers?

There is a lot of -- you have heard in our comments that we are focusing heavily on the medical business as it relates to share gain at existing customers both here in the U.S. and abroad. Also we do have a lot of emphasis on new product development in, again, both the specialty alloys business, the titanium business and looking hard in the ceramics space, as well, for new products.

So I would say so far, we have had a lot of success with share gain.

But with new customers or existing customers?

We already had a very I would say broad coverage, globally, on the customers that are the major players for our types of materials. Not to say that there aren't new markets developing particularly in places like Asia. So we are positioning ourselves to be able to respond to those needs as well.

You have no further questions at this time. I'd like to return the conference back over to Mr. Bob Torcolini for any closer remarks.

Thank you. So in closing, I'd like to thank all of you for your interest in Carpenter and we look forward to talking you at our next quarterly conference call. Thank you very much. Bye bye.

Ladies and gentlemen, thank you so much for your participation in today's conferences. This does conclude the presentation.