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| CRS > SEC Filings for CRS > Form 10-Q on 10-Nov-2008 | All Recent SEC Filings |
10-Nov-2008
Quarterly Report
Background and General
Carpenter is engaged in the manufacturing, fabrication, and distribution of specialty metals. We primarily process basic raw materials such as nickel, cobalt, titanium, chromium, iron scrap and other metal alloying elements through various melting, hot forming and cold working facilities to produce finished products in the form of billet, bar, rod, wire, narrow strip, special shapes and hollow forms in many sizes and finishes. We also produce certain metal powders. Our sales are distributed directly from our production plants and distribution network as well as through independent distributors.
Our discussions below in this Item 2 are based upon the more detailed discussions about our business, operations and financial condition included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2008, under Item 8 thereof. Our discussions here focus on our results during or as of the three month period ended September 30, 2008 and the comparable period of fiscal year 2008 (the three month period ended September 30, 2007), and, to the extent applicable, on material changes from information discussed in that Form 10-K or other important intervening developments or information since that time that has not previously been reported. These discussions should be read in conjunction with that Form 10-K for detailed background information. Unless specifically stated otherwise, all discussions of operating results reflect continuing operations.
Raw Material Surcharges and Product Mix
The volatility of the costs of raw materials has impacted our operations over the past few years. We, and others in our industry, generally have been able to pass cost increases on certain materials through to our customers using surcharges which are structured to recover increases in raw material costs. In the last several years, as raw material prices have escalated, surcharges have become an increasingly significant component of our net sales, which had a dilutive effect on our gross margin and operating margin percentages as described later in this discussion. Generally, the formula used to calculate the surcharge is based on published prices for the previous month for the respective raw materials, which creates a lag between the raw materials published price change and our corresponding surcharges on sales. Except for the usually modest effect of the lag, the surcharge mechanism protects our net income on such sales. We value most of our inventory utilizing the last-in, first-out ("LIFO") inventory costing methodology. Under the LIFO inventory costing method, changes in the cost of raw materials and production activities are recognized in cost of sales in the current period even though these materials may have been acquired at potentially significantly different values due to the length of time from the time the raw materials are acquired to the time the processed finished goods are sold to the customer. In a period of rising raw material costs, the LIFO inventory valuation normally results in higher costs of sales. Conversely, in period of decreasing raw material costs, the LIFO inventory valuation normally results in lower costs of sales.
We produce hundreds of grades of materials, with a wide range of pricing and profit levels depending on the grade. In addition, our product mix within a period is subject to the fluctuating order patterns of our customers as well as decisions we may make to participate in certain lower margin business in order to utilize available capacity. While we expect to see positive contribution from a more favorable product mix in our margin performance over time, the impact by period may fluctuate, and period-to-period comparisons may vary.
Results of Operations - Three Months Ended September 30, 2008 vs. Three Months Ended September 30, 2007
Operating Performance Overview
For the fiscal quarter ended September 30, 2008, we reported income from continuing operations of $25.8 million or $0.58 per diluted share, compared with record income from continuing operations for the same period a year earlier of $55.4 million or $1.07 per diluted share. The lower earnings reflect higher operating costs, a weaker product mix and the impact of changes in raw materials cost.
As the domestic and international economies soften, we are anticipating a downturn in overall market conditions and we have taken actions internally to streamline our business and reduce our costs. These actions include the restructuring of several layers of our upper management, which has resulted in positions at those levels being reduced by 20 percent.
Net Sales
Net sales for the three months ended September 30, 2008 were $413.7 million, which was an 8 percent decrease over the same period a year ago. Adjusted for surcharge revenue, sales decreased 3 percent. Overall, pounds shipped were 1 percent lower than the first quarter a year ago and compared favorably to last year in all markets except the automotive end-use market.
Geographically, sales outside the United States increased 3 percent from a year ago to $152.9 million. International sales represented 37 percent of total sales for the three months ended September 30, 2008 compared to 33 percent for the three months ended September 30, 2007. The sales growth reflected strength in Europe and Mexico, partially offset by lower sales to customers in Asia-Pacific.
Sales by End-Use Markets
Our sales are to customers across a diversified list of end-use markets. The
table below includes comparative information for our estimated sales by end-use
markets:
Three Months Ended $ %
September 30, Increase/ Increase/
($ in millions) 2008 2007 (decrease) (decrease)
Aerospace $ 157.4 $ 162.3 ($4.9 ) (3 )%
Industrial 103.5 111.1 (7.6 ) (7 )
Energy 53.4 47.8 5.6 12
Automotive 35.9 57.0 (21.1 ) (37 )
Consumer 35.6 38.9 (3.3 ) (8 )
Medical 27.9 30.9 (3.0 ) (10 )
Total net sales $ 413.7 $ 448.0 ($34.3 ) (8 )%
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The following table includes comparative information for our estimated net sales by the same principal end-use markets, but excluding surcharge revenues:
Three Months Ended $ %
September 30, Increase/ Increase/
($ in millions) 2008 2007 (decrease) (decrease)
Aerospace $ 115.4 $ 114.9 $ 0.5 - %
Industrial 70.3 69.0 1.3 2
Energy 44.0 37.1 6.9 19
Automotive 25.8 37.8 (12.0 ) (32 )
Consumer 24.0 25.5 (1.5 ) (6 )
Medical 22.4 26.5 (4.1 ) (15 )
Total net sales excluding surcharge revenues $ 301.9 $ 310.8 ($8.9 ) (3 )%
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Sales to the aerospace market decreased 3 percent from the first quarter a year ago to $157.4 million. Excluding surcharge revenue, sales were essentially flat from the first quarter a year ago on higher volume of 3 percent. The sales results principally reflect the strike at Boeing, as well as the cumulative impact of production postponements of the 787 and A380 airliners and reductions in the U.S. domestic commercial aircraft fleets.
Industrial market sales decreased 7 percent from the first quarter a year ago to $103.5 million. Adjusted for surcharge revenue, sales increased approximately 2 percent as a result of a 2 percent increase in volume. The results reflect growth in general industrial applications offset by slowing demand for materials used in semiconductors and in valves and fittings.
Sales to the energy market of $53.4 million reflected a 12 percent increase from the first quarter of fiscal 2008. Excluding surcharge revenue, sales increased 19 percent from a year ago on higher volume of 21 percent. The growth experienced in the energy market largely reflects strong demand for materials used in industrial gas turbines produced by customers in the U.S. and the Middle East. Oil and gas segment sales growth has slowed in response to excess inventory conditions within the supply chain.
Automotive market sales decreased 37 percent from the first quarter a year ago to $35.9 million. Excluding surcharge revenue, sales decreased 32 percent on 29 percent lower volume. An already weak auto sector deteriorated further in the recent first quarter as consumer demand declined significantly and OEM's prepared to accelerate the timing of planned plant closings and force operations reductions.
Sales to the consumer market decreased 8 percent to $35.6 million from a year ago. Adjusted for surcharge revenue, sales decreased 6 percent with volume up 1 percent. The results reflect a weaker mix of products sold in the recent first quarter as compared to the same period a year ago.
Sales to the medical market decreased 10 percent to $27.9 million from a year ago. Adjusted for surcharge revenue, sales decreased 15 percent, while volumes increased 1 percent. The decline in sales reflects the effects of substantially lower titanium prices compared to last year as well as a weaker mix of products.
Sales by Product Class
The following table includes comparative information for our net sales by major
product class:
Three Months Ended $ %
September 30, Increase / Increase /
($ in millions) 2008 2007 (Decrease) (Decrease)
Special alloys $ 205.2 $ 227.6 ($22.4 ) (10 )%
Stainless steels 144.9 158.8 (13.9 ) (9 )
Titanium products 41.8 42.5 (0.7 ) (2 )
Other materials 21.8 19.1 2.7 14
Total net sales $ 413.7 $ 448.0 ($34.3 ) (8 )%
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The following table includes comparative information for our net sales by the same major product class, but excluding surcharge revenues:
Three Months Ended $ %
September 30, Increase / Increase /
($ in millions) 2008 2007 (Decrease) (Decrease)
Special alloys $ 137.7 $ 143.2 ($5.5 ) (4 )%
Stainless steels 101.3 106.7 (5.4 ) (5 )
Titanium products 41.8 42.5 (0.7 ) (2 )
Other materials 21.1 18.4 2.7 15
Total net sales excluding surcharge revenues $ 301.9 $ 310.8 ($8.9 ) (3 )%
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Sales of special alloys products decreased 10 percent from a year ago to $205.2 million. Adjusted for surcharge revenue, sales decreased 4 percent on a 2 percent increase in volume. The sales decrease principally reflected the decline in demand from the automotive markets being offset by the growth that we have experienced in our energy end-use market.
Sales of stainless steels decreased 9 percent from a year ago to $144.9 million. Excluding surcharge revenue, sales decreased 5 percent on 3 percent lower volume. The decrease resulted primarily from reduced shipments of materials used in the automotive markets.
Sales of titanium products decreased 2 percent from a year ago to $41.8 million on 15 percent higher volume. The decrease reflects the impact of significantly lower titanium prices being partially offset by a modest increase in shipments to the aerospace market compared to last year's first quarter.
Gross Profit
Our gross profit in the first quarter decreased 36 percent to $73.7 million, or 17.8 percent of net sales, as compared with $115.3 million, or 25.7 percent of net sales, in the same quarter a year ago. The lower gross profit reflects overall higher operating costs, the impact of raw material price differences, and a somewhat lower margin product mix. The higher operating costs in the recent first quarter reflect production inefficiencies due to the significant amount of equipment upgrade and maintenance activity that we undertook in the first quarter of this fiscal year. In addition, we experienced increased costs in a variety of areas including general inflation, energy, freight, depreciation and supplies, which were only partially recovered through our surcharges and pricing.
Our surcharge mechanism is structured to recover increases in raw material costs, although generally with a one month lag effect. While the surcharge generally protects the absolute gross profit dollars, it does have a dilutive effect on gross margin as a percent of sales. The following represents a summary of the dilutive impact of the surcharges on gross margin for the three months ended September 30:
Three Months Ended
September 30,
(in millions) 2008 2007
Net sales $ 413.7 $ 448.0
Less: surcharge revenues 111.8 137.2
Net sales excluding surcharges $ 301.9 $ 310.8
Gross profit $ 73.7 $ 115.3
Gross margin 17.8 % 25.7 %
Gross margin excluding dilutive effect of surcharges 24.4 % 37.1 %
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In addition to the impact of the surcharge mechanism that is discussed above, fluctuations in raw material prices combined with fluctuations in inventory levels have impacted our gross profit from quarter to quarter. We estimate that the effect of the raw material fluctuations combined with changes in inventory levels positively impacted gross profit by $5.6 million when comparing gross profit for the quarter ended September 30, 2008 to the gross profit for the quarter ended September 30, 2007. The impact of raw material prices on our inventory build was more positive in this year's first quarter as compared to the same quarter last year. However, as with last year, we believe this impact will come back as a negative in the latter part of our fiscal year as inventories are reduced. We estimate that the lag effect of the surcharge mechanism, which results from calculating the surcharge amount for each month using the previous month's raw material prices, negatively impacted gross margin by approximately 10 basis points during the quarter ended September 30, 2008, and positively impacted gross margin by approximately 120 basis points during the prior year's quarter.
Our gross profit for the quarter ended September 30, 2008 also reflects the impacts of a weaker product mix, as we shipped more low-end than high-end stainless products. Additionally, the mix of aerospace and energy markets was weaker than last year's first quarter.
Selling, General and Administrative Expenses
Selling, general and administrative expenses of $33.4 million were 8.1 percent of net sales as compared with $33.2 million or 7.4 percent of net sales in the same quarter a year ago. The relatively flat levels of selling, general and administrative expenses reflect an increase in the net pension expense during the recent quarter being offset by reductions in compensation expense.
Based on the decline in the market value of the securities in our defined benefit pension plans as of June 30, 2008, the Company will experience a pre-tax net pension expense during fiscal 2009 of $20.1 million. This is a non-cash expense that will be amortized equally during the fiscal year. The pension expense equates to a year-to-year difference in reported earnings of $0.28 per share, with a first quarter pre-tax impact of $5.1 million or $0.06 per share.
Interest Expense
Interest expense for the quarter was $4.5 million, as compared with $5.5 million in the same quarter in the prior year. The decrease in interest expense is attributable to reductions in outstanding debt related to repayments as well as increased amounts of capitalized interest associated with several large construction projects.
Other Income, Net
Other income for the recent first quarter was $3.9 million as compared with $6.4 million in the first quarter a year ago. The decrease was primarily due to reduced interest income on invested cash due to general market conditions and a more conservative excess cash investment portfolio.
Income Taxes
Our tax provision in the recent first quarter was $13.9 million, or 35.0 percent of pre-tax income, versus $27.6 million, or 33.3 percent, in the same quarter a year ago. The increase in the effective income tax rate principally relates to a reduction in tax-exempt interest earned during the quarter ended September 30, 2008 compared to the quarter ended September 30, 2007.
Business Segment Results
Following the divestiture of our ceramics and metals shapes businesses during fiscal year 2008, which historically comprised the Company's Engineered Products Operations segment, we have two reportable business segments: Advanced Metals Operations and Premium Alloys Operations.
The following table includes comparative information for our net sales by business segment:
Three Months Ended $ %
September 30, Increase / Increase /
($ in millions) 2008 2007 (Decrease) (Decrease)
Advanced Metals Operations $ 295.2 $ 322.3 ($27.1 ) (8 )%
Premium Metals Operations 121.2 129.3 (8.1 ) (6 )
Intersegment (2.7 ) (3.6 ) 0.9 25
Total net sales $ 413.7 $ 448.0 ($34.3 ) (8 )%
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The following table includes comparative information for our net sales by business segment, but excluding surcharge revenues:
Three Months Ended $ %
September 30, Increase / Increase /
($ in millions) 2008 2007 (Decrease) (Decrease)
Advanced Metals Operations $ 216.4 $ 225.8 ($9.4 ) (4 )%
Premium Metals Operations 88.2 88.6 (0.4 ) -
Intersegment (2.7 ) (3.6 ) 0.9 25
Total net sales excluding surcharge revenues $ 301.9 $ 310.8 ($8.9 ) (3 )%
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Advanced Metals Operations ("AMO") Segment
Net sales for the quarter ended September 30, 2008 for the AMO segment decreased 8 percent during the quarter ended September 30, 2008 to $295.2 million, as compared with $322.3 million in the same quarter a year ago. Excluding surcharge revenues, net sales decreased 4 percent on 3 percent lower volume from a year ago. The decrease reflects a decrease in pounds shipped due to lower automotive demand.
Operating income for the AMO segment was $19.2 million or 7 percent of net sales (9 percent of net sales excluding surcharge revenues) in the recent first quarter, as compared with $48.9 million or 15 percent of net sales (22 percent of net sales excluding surcharge revenues) in the same quarter a year ago. The decrease in operating income principally reflects the lower sales levels, the impacts of higher operating costs associated with manufacturing inefficiencies as a result of the significant equipment upgrade activity, the impact of raw material prices and an unfavorable shift in product mix in the current quarter.
Premium Alloys Operations ("PAO") Segment
Net sales for the quarter ended September 30, 2008 for the PAO segment decreased 6 percent to $121.2 million during the quarter ended September 30, 2008, as compared with $129.3 million in the same quarter a year ago. Excluding surcharge revenues, net sales were essentially flat on 5 percent higher volume from a year ago. The increase was largely driven by strong international demand particularly from the power generation sector of our energy market.
Operating income for the PAO segment was $28.9 million or 24 percent of net sales (33 percent of net sales excluding surcharge revenues) in the recent first quarter, compared with $36.5 million or 28 percent of net sales (41 percent of net sales excluding surcharge revenues) in the same quarter a year ago. The decrease in operating income principally reflects an unfavorable shift in product mix during the quarter ended September 30, 2008 as compared to the same period in the prior year.
Liquidity and Financial Condition:
We have maintained the ability to generate cash to meet our needs through cash flow from operations, management of working capital and the flexibility to use outside sources of financing to supplement internally generated funds. We believe that our cash and cash equivalents of approximately $372.4 million as of September 30, 2008, together with cash generated from operations and available borrowing capacity of approximately $188 million under our credit facilities, will be sufficient to fund our operating activities, planned capital expenditures and other obligations for the foreseeable future.
During the three months ended September 30, 2008, our free cash flow, as defined under "Non-GAAP Financial Measures" below, was $12.7 million as compared to $24.1 million for the same period a year ago. The decrease reflects the impact of increased investments in equipment, lower earnings, higher-short-term inventory levels, partially offset by the proceeds received from the sale of businesses.
Cash provided from operating activities was $43.0 million for the three months ended September 30, 2008 as compared with $48.9 million or the same period last year. This overall decrease reflects a reduction in earnings for the period, partially offset by the lower changes experienced in net working capital. Particularly, favorable changes in accounts receivable increased due to lower sales trends in the recent first quarter compared to the first quarter in the prior year and a favorable change in accounts payable was attributable to the significant price declines in raw materials during the quarter ended September 30, 2008. These favorable changes in working capital were partially offset by the unfavorable impact of increasing inventory levels during the quarter ended September 30, 2008 compared to the quarter ended September 30, 2007.
Capital expenditures for plant, equipment and software were $35.8 million for the three months ended September 30, 2008 as compared with $18.4 million for the same period a year ago. A significant portion of the capital expenditures that were incurred in the quarter ended September 30, 2008 related to the expansion of our premium melt facilities, which is expected to be completed by the end of calendar year 2009.
Dividends during the three months ended September 30, 2008 were $7.9 million as compared with $7.6 million in the same period last year. On August 19, 2008, the Company's Board of Directors declared a quarterly cash dividend of $0.18 per share of common stock and that dividend was paid on September 5, 2008 to stockholders of record on September 2, 2008.
During the three months ended September 30, 2008, we used $46.1 million to purchase 1,218,900 shares of our common stock pursuant to the terms of the $250 million share repurchase program authorized by our Board of Directors in December 2007. As of September 30, 2008, the Company had completed the share purchases authorized under the share repurchase program.
Non-GAAP Financial Measures:
The following provides additional information regarding certain non-GAAP financial measures. Our definitions and calculations of these items may not necessarily be the same as those used by other companies.
Net Sales Excluding Surcharges
This quarterly report includes discussions of net sales as adjusted to exclude the impact of raw material surcharges, which represents a financial measure that has not been determined in accordance with U.S. GAAP. We present and discuss this financial measure because management believes removing the impact of raw material surcharges from net sales provides a more consistent basis for comparing results of operations from period to period for the reasons discussed above. See discussion of Gross Profit above for a reconciliation of net sales excluding surcharges to net sales as determined in accordance with U.S. GAAP.
Free Cash Flow
The following provides a reconciliation of free cash flow, as used in this
quarterly report, to its most directly comparable U.S. GAAP financial measures:
Three Months Ended
September 30,
(in millions) 2008 2007
Net cash provided from operating activities $ 43.0 $ 48.9
Net proceeds from sale of businesses 13.4 -
Purchases of property, equipment and software (35.8 ) (18.4 )
Proceeds from disposals of property and equipment - 1.2
Dividends paid (7.9 ) (7.6 )
. . .
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