Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: The filing covers the fiscal third quarter and nine months ended March 31, 2012, compared with the same periods in 2011. This differs from the “2011 Q3” period in the request metadata.
Business context
Carpenter manufactures, fabricates and distributes specialty metals and also produces precision components for directional drilling. During the quarter, the company completed its acquisition of Latrobe Specialty Metals, expanding premium-metal capacity and adding alloy and tool-steel and distribution operations. Carpenter reported three segments: Specialty Alloys Operations (SAO), Performance Engineered Products (PEP) and Latrobe.
Financial performance and key metrics
| Metric | Three months ended March 31, 2012 | Nine months ended March 31, 2012 |
|---|---|---|
| Net sales | $539.9 million; up 16% | $1,385.1 million; up 16% |
| Net sales excluding surcharges (company-presented non-GAAP measure) | $419.0 million; up 24% | $1,062.9 million; up 21% |
| Gross profit / gross margin | $105.1 million / 19.5% | $270.6 million / 19.5% |
| Operating income | $55.7 million | $143.6 million |
| Net income attributable to Carpenter | $33.0 million | $80.3 million |
| Diluted earnings per share | $0.69 | $1.75 |
Gross margin excluding surcharge revenue was 25.1% for the quarter and 25.5% for the nine-month period, versus 21.6% and 19.6%, respectively, a year earlier. Management attributed improved results principally to pricing, a richer product mix and operating performance. Surcharges recover raw-material costs but dilute reported margin percentages and can lag cost movements. The nine-month effective tax rate was 36.3%, versus 15.5% in 2011; current-period taxes included a state tax exposure and nondeductible Latrobe acquisition expenses, while prior-year results included $4.8 million of tax benefits.
- Cash flow: Nine-month operating cash flow was $47.9 million, versus cash used of $53.0 million in 2011. The company’s defined free cash flow was negative $95.9 million, compared with negative $150.4 million. Working-capital needs, including higher inventory, pension contributions of $19.3 million and the $21.8 million Boarhead Farms settlement affected cash generation.
- Investment: Capital expenditures were $107.3 million for nine months, versus $35.6 million. Carpenter expected fiscal 2012 capital expenditures of $175–$185 million.
- Liquidity and debt: Cash and equivalents were $175.1 million at March 31, 2012, down from $492.5 million at June 30, 2011. Long-term debt was $407.2 million, down from $507.8 million, after repayment of $100 million of notes and Latrobe debt. The company reported approximately $519 million in total liquidity, including $344 million available on its revolving facility. It was in compliance with covenants; actual interest coverage was 13.9-to-1 against a 3.5-to-1 minimum, and debt to capital was 25% against a 55% maximum.
- Balance sheet: Inventory rose to $677.5 million from $328.6 million, while total assets increased to $2,596.3 million from $1,991.9 million, largely reflecting the Latrobe acquisition and increased working capital.
Material changes versus prior periods
- Quarterly earnings attributable to Carpenter increased from $28.6 million to $33.0 million; diluted EPS rose from $0.64 to $0.69. For nine months, attributable earnings increased from $45.5 million to $80.3 million, and diluted EPS rose from $1.02 to $1.75.
- Quarterly shipments rose 10% overall, including Latrobe; excluding Latrobe, sales excluding surcharges increased 13% on flat volume. For nine months, shipments were approximately flat overall; excluding Latrobe, sales excluding surcharges rose 17% on 3% lower volume.
- SAO quarterly operating income increased to $66.7 million from $42.1 million. PEP operating income declined to $9.8 million from $11.4 million, with management citing manufacturing performance and growth-related infrastructure spending. Latrobe reported $2.9 million of quarterly operating income, including $2.9 million of acquisition-accounting inventory fair-value expense.
- Acquisition-related costs were $7.9 million in the quarter and $11.7 million for nine months; including inventory fair-value adjustments, total acquisition-related costs were $10.8 million and $14.6 million before tax, respectively. Latrobe contributed approximately $42 million of consolidated sales since acquisition; the filing reports approximately $2.2 million of operating income from Latrobe operations since acquisition, net of inventory fair-value adjustments.
- Interest expense increased to $5.6 million for the quarter and $18.4 million for nine months, primarily reflecting higher debt levels despite lower average rates. The share issuance for Latrobe increased the weighted-average diluted share count.
Outlook, management commentary and risks
- Carpenter planned a roughly $500 million, 400,000-square-foot Alabama manufacturing facility, expected to add capacity of about 27,000 tons per year and be operational by April 2014. Management expected modestly negative free cash flow over the next several fiscal years because of growth investment, working capital and pension funding, with consistently positive annual free cash flow expected after peak facility spending.
- Management described demand as strong in aerospace and defense, energy and medical markets, and said premium-product mix and pricing initiatives supported margins. It also noted weaker powder-products performance, particularly in Europe, and lower industrial and consumer volumes.
- Commodity-price volatility, LIFO inventory accounting, surcharge timing and firm-price customer commitments can affect margins and cash flows. The company disclosed $32.1 million of deferred losses on commodity forward contracts; approximately 57% related to contracts supporting firm-price sales with one customer. Management said customers had historically performed and it expected them to honor commitments.
- Derivative liabilities totaled $46.5 million at quarter-end, and the company expected $22.8 million of net derivative losses in accumulated other comprehensive income to be reclassified into earnings within 12 months. Commodity and currency sensitivity scenarios disclosed by the company were not expected to materially affect results.
- Environmental remediation liabilities were $5.1 million. The Boarhead Farms litigation was settled for $21.8 million, paid in September 2011, and the duty-drawback matter was settled with U.S. Customs without expected additional liability. A Department of Commerce response remained pending on a voluntary export-regulations disclosure; the potential penalty could not be estimated and no liability was recorded.
- Acquisition goodwill was preliminarily valued at $201.3 million and was not expected to be tax deductible; the purchase-price allocation remained subject to change. FTC approval required transfer of assets and technical knowledge to support a second source for two alloys.
- Management identified risks including cyclical end markets, raw-material and energy costs, acquisition integration and synergies, foreign exchange, pension-asset valuation, labor availability, customer substitution and reliance on specialized manufacturing equipment. Disclosure controls were reported effective as of March 31, 2012.
Important facts for investors to verify
- Whether Latrobe’s eventual purchase-price allocation, integration costs, synergies and operating contribution differ from preliminary estimates.
- Whether planned capital spending, especially the Alabama facility, remains within the stated cost, schedule and capacity expectations—and how it affects liquidity and free cash flow.
- Whether inventory and working-capital levels convert into cash as demand and production evolve.
- How much of reported growth and margin improvement is sustained in the legacy business versus attributable to Latrobe, pricing, mix and surcharge effects.
- Whether the deferred commodity-hedge losses and customer concentration create material exposure if firm-price customers do not meet commitments.
- Any developments in the pending export-regulations matter, environmental claims or other contingencies, and the upcoming $101 million debt maturity identified for fiscal 2013.