Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2014; filed May 2, 2014. The request metadata says “2013 Q3,” but the filing covers fiscal 2014 Q3.
Business context
Carpenter manufactures, fabricates and distributes specialty metals and related products. Fiscal 2014 reporting uses two segments: Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP), following integration of the Latrobe businesses.
Financial performance
- Quarter: Net sales were $566.3 million, down 3% year over year; pounds shipped rose 8%. Net income attributable to Carpenter was $30.6 million versus $32.9 million, and diluted EPS was $0.57 versus $0.62.
- Nine months: Net sales were $1,568.4 million, down 6%; pounds shipped rose 6%. Net income attributable to Carpenter was $94.7 million versus $105.1 million, and diluted EPS was $1.76 versus $1.97.
- Margins: Quarterly gross profit was $94.5 million (16.7% of sales), versus $101.0 million (17.4%). Nine-month gross profit was $293.2 million (18.7%), versus $313.0 million (18.9%). Excluding surcharge revenue, gross margin was 20.2% for the quarter and 22.7% year to date, compared with 21.4% and 23.3%, respectively.
- Operating income: $49.5 million for the quarter, down from $53.0 million; $152.8 million for nine months, down from $167.3 million. Management’s non-GAAP operating margin excluding surcharges and pension EID expense was 11.9% for the quarter (12.9% prior year) and 13.0% year to date (14.2% prior year).
- Cash flow and investment: Nine-month operating cash flow was $144.0 million, versus $9.3 million. Capital expenditures were $298.2 million, versus $201.1 million; reported free cash flow was negative $182.7 million, compared with negative $220.6 million. Higher capital spending, largely for the Alabama facility, outweighed the operating cash improvement.
- Liquidity and debt: Cash was $85.3 million at March 31, 2014, down from $257.5 million at June 30, 2013. Long-term debt was $604.3 million. The $500 million revolving facility had $491.8 million available after letters of credit; total liquidity was approximately $577.1 million. The company reported covenant compliance, with interest coverage of 23.30x against a 3.50x minimum and debt-to-capital of 30% against a 55% maximum.
- Other measures: Quarterly dividend remained $0.18 per share; nine-month dividends paid were $28.8 million. Inventory increased to $722.4 million from $659.2 million at June 30, 2013.
Material changes and management commentary
- Quarterly sales excluding surcharges declined 1%, despite higher shipment volume; management cited unfavorable product mix and weaker demand for ultra-premium aerospace and fastener materials. For nine months, sales excluding surcharges fell 4%, with aerospace and energy softness among the key factors.
- SAO quarterly revenue fell 4% and operating income fell to $51.6 million from $59.6 million, reflecting weaker mix and weather costs. PEP revenue rose 4% and operating income increased to $13.1 million from $11.4 million, supported by titanium, distribution and down-hole tool activity.
- Severe Northeast weather added approximately $8.0 million of expense in the quarter. Management said excluding this cost, operating margins would have increased 120 basis points from the preceding quarter; year-to-date gross margin would have been flat year over year excluding the weather expense.
- The company is building a superalloy powder facility under agreements with United Technologies/Pratt & Whitney. Construction was expected to take about 18 months and cost approximately $20 million; after qualification, supply could continue for up to 20 years, with minimum purchase quantities specified for 12 years. The company also agreed to a $13.0 million technology license fee.
- Management expected fiscal 2014 net periodic pension benefit costs of $60.4 million, versus $68.8 million in fiscal 2013, and approximately $1.7 million of pension contributions for the remainder of fiscal 2014. It stated that cash, operating cash generation and available borrowing capacity should cover foreseeable needs. No specific earnings or revenue guidance was provided.
Risks, contingencies and unusual items
- Goodwill testing found no impairment, but Latrobe Manufacturing’s fair value exceeded carrying value by less than 5%; $195.5 million of goodwill was associated with that unit. A strategic assessment of the underperforming powder business was due in fiscal Q4, with implications to be considered in year-end impairment testing.
- At March 31, commodity forward contracts had approximately $27.4 million of net deferred losses; approximately 85% related to contracts supporting firm-price sales with one customer, in addition to trade receivables exposure to that customer.
- Environmental remediation liabilities were $15.0 million. Management did not expect these or routine legal matters to have a material long-term effect, but noted individual future periods could be affected.
- The filing revised prior-year cash-flow classifications: for the nine months ended March 31, 2013, operating cash flow was revised from $31.7 million to $9.3 million and investing cash flow from negative $215.2 million to negative $192.8 million. The revision did not affect total change in cash or other financial statements and was assessed as immaterial.
- Management identified risks including specialty-materials market cyclicality, raw-material and energy costs, surcharge timing, pension asset and liability changes, foreign exchange, customer substitution, specialized equipment dependence, and execution of cost and growth initiatives.
Important facts for investors to verify
- Whether demand and mix improve in aerospace, energy and ultra-premium products, and whether the reported volume gains translate into stronger margins.
- Progress, spending and customer qualification for the Alabama and UTC-related powder facilities, including expected returns and timing.
- Powder-business assessment and the year-end goodwill impairment test, particularly the limited valuation cushion at Latrobe Manufacturing.
- Exposure to the customer representing most deferred commodity-hedge losses, and the timing of hedge losses moving into earnings.
- Cash needs and liquidity as elevated capital expenditures continue, together with working-capital and inventory trends.