Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: First quarter of fiscal 2012, the three months ended September 30, 2011. Comparisons are with the three months ended September 30, 2010 unless otherwise noted. Amounts are in U.S. dollars.
Business context and financial performance
Carpenter manufactures and distributes specialty metals and related products, with operations in Advanced Metals Operations (AMO), Premium Alloys Operations (PAO), and Emerging Ventures. Results benefited from higher pricing, improved product mix, operating performance, and the contribution from Amega West, acquired in December 2010.
| Metric | Q1 FY2012 | Prior-year quarter |
|---|---|---|
| Net sales | $414.1 million | $351.7 million |
| Gross profit / margin | $81.1 million / 19.6% | $49.8 million / 14.2% |
| Operating income | $44.0 million | $14.1 million |
| Income attributable to Carpenter | $23.8 million | $7.6 million |
| Diluted EPS | $0.53 | $0.17 |
| Operating cash flow | $(74.0) million | $(30.5) million |
| Capital expenditures | $27.3 million | $8.1 million |
| Free cash flow, as defined by the company | $(109.2) million | $(46.5) million |
Sales rose 18%; excluding raw-material surcharges, sales increased 19% to $313.6 million. Pounds shipped declined 2%, indicating that pricing and mix, as well as acquired revenue, supported reported growth. Gross margin excluding surcharge revenue was 25.9%, compared with 18.9%. Operating margin excluding surcharges and pension earnings, interest and deferrals (EID) was 15.2%, versus 8.7%; these are non-GAAP measures.
By segment, AMO sales were $275.0 million and operating income was $25.5 million; PAO sales were $125.6 million and operating income was $30.6 million. Emerging Ventures, which includes Amega West, reported sales of $26.3 million and operating income of $2.6 million. Energy-market sales nearly doubled, with Amega West contributing substantially to the increase.
Liquidity, debt, and balance-sheet changes
At September 30, 2011, cash and cash equivalents were $314.8 million, down from $492.5 million at June 30; the company also reported $105 million of cash held at foreign subsidiaries. Total debt was $407.9 million, down from $507.8 million, after repayment of $100 million of maturing debt. No current portion of long-term debt remained on the quarter-end balance sheet. The $350 million revolving facility had $346.5 million available after $3.5 million of letters of credit. Carpenter reported compliance with its covenants: interest coverage of 13.33-to-1 against a 3.25 minimum, and debt-to-capital of 35% against a maximum of 55%.
Operating cash use reflected a $94.9 million inventory cash outflow, $11.6 million of pension contributions, and the $21.8 million Boarhead Farms settlement payment. Inventory increased to $418.5 million from $328.6 million at June 30. The company expects approximately $200 million of capital expenditures for fiscal 2012. Management said available cash, operating cash generation, and credit capacity should fund operating needs, planned investment, the Latrobe transaction, debt maturities, and other obligations.
Material changes and management outlook
- Management said it remained on track for fiscal 2012 goals of a 50% increase in operating income excluding pension EID expense compared with fiscal 2011, and strong double-digit revenue growth.
- Carpenter planned a new approximately 400,000-square-foot facility near Athens, Alabama, at an estimated cost of $500 million. The facility is expected to add about 27,000 tons of annual premium-product capacity and take approximately 30 months to become operational.
- The proposed Latrobe Specialty Metals acquisition remained subject to antitrust approval. Consideration was described as approximately $558 million at the time of the agreement, including 8.1 million Carpenter shares and cash to address Latrobe debt and certain expenses. The filing said closing was expected before calendar year-end 2011; elsewhere management expressed optimism about closing by the end of fiscal Q2. The agreement’s extended termination date was January 16, 2012, subject to its terms.
- Net pension expense declined to $9.9 million from $15.2 million; management expected $39.6 million for fiscal 2012, compared with $60.8 million in fiscal 2011. Required U.S. pension contributions of $16.1 million were expected for the remainder of fiscal 2012.
Risks, contingencies, and unusual items
- Raw-material price volatility, LIFO accounting, surcharge timing, and product mix can materially affect reported margins. Surcharges recover many input-cost increases but dilute margin percentages and may lag cost changes.
- At quarter-end, commodity derivatives had a $50.9 million fair-value liability. The company reported approximately $43.2 million of deferred commodity-contract losses; about 56% related to contracts supporting firm-price sales to one customer. That customer represented 7% of quarterly sales and 17% of accounts receivable at September 30. The company estimated $23.1 million of net derivative losses in accumulated other comprehensive income would be reclassified into earnings within 12 months.
- Comprehensive loss attributable to Carpenter was $17.6 million, despite net income of $23.8 million, chiefly reflecting derivative and foreign-currency translation losses.
- The $21.8 million Boarhead Farms settlement was paid in the quarter and the company expected no further liability from that case. Environmental remediation liabilities were $4.9 million; management said they were not expected to be material long term, though costs could be material in a particular quarter or year.
- A proposed $1.1 million duty-drawback settlement, together with $1.1 million in advance payments, was awaiting approval by U.S. Customs headquarters. The filing said no additional reserve was considered necessary. A separate Commerce Department response regarding possible export-regulation penalties remained pending; the amount, if any, was not determinable and no liability was recorded.
- Other stated risks included cyclical end markets, raw-material and energy supply and prices, pension-asset valuations, customer substitution, acquisition execution, financing availability, and successful construction and operation of the Alabama facility. Repatriating some foreign cash could also result in tax costs.
Important facts for investors to verify
- Whether Latrobe received antitrust approval, closed on the disclosed terms, and required any changes to share consideration, debt assumed, expenses, or transaction timing.
- Whether strong revenue and operating-income growth persisted after accounting for surcharges, shipment volumes, acquisition contributions, and pension EID adjustments.
- Whether inventory converted to cash and operating cash flow improved after the quarter’s inventory build, pension funding, and settlement payment.
- How the $500 million Alabama project’s cost, schedule, incentives, funding, and customer demand assumptions develop.
- Whether the major customer tied to commodity hedges continues to meet firm-price purchase commitments, and how deferred derivative losses affect future earnings and liquidity.
- The status and ultimate cost of the duty-drawback matter and any Commerce Department action on the export-regulation disclosure.