Carpenter Technology Corporation — Form 10-Q Summary
Business context and reporting period
Carpenter manufactures, fabricates and distributes specialty metals and related products. This unaudited filing covers the fiscal quarter and six months ended December 31, 2014 (second quarter of fiscal 2015), compared with the corresponding 2013 periods. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). Unless noted otherwise, financial amounts are in millions of dollars.
Financial performance and position
| Metric | Three months ended Dec. 31, 2014 | Six months ended Dec. 31, 2014 |
|---|---|---|
| Net sales | $548.4; up 9% year over year | $1,098.2; up 10% |
| Gross profit / margin | $85.0 / 15.5%, versus $95.4 / 18.9% | $154.1 / 14.0%, versus $198.8 / 19.8% |
| Operating income | $45.0, versus $47.5 | $67.2, versus $103.3 |
| Net income | $24.1, versus $29.5 | $37.6, versus $64.1 |
| Diluted earnings per share | $0.45, versus $0.55 | $0.70, versus $1.19 |
| Operating cash flow | Not separately reported for the quarter | $27.5, versus $63.1 |
For the quarter, sales excluding raw-material surcharges increased 8% to $445.7; shipment volume was flat, with management citing a stronger mix. Gross margin excluding surcharges was 19.1%, versus 23.0%. For the six months, sales excluding surcharges rose 7% to $885.8, while gross margin on that basis fell to 17.4% from 24.0%. These surcharge-adjusted figures are non-GAAP measures.
Six-month capital spending was $127.4, including $66.9 for the Athens facility. Management-defined free cash flow, after capital spending and dividends, was negative $119.1, compared with negative $160.3 in the prior-year period. Cash declined to $28.8 from $120.0 at June 30, 2014. At December 31, short-term debt was $37.0 and long-term debt was $607.1. The $500.0 revolving credit facility had $454.8 available after borrowings and letters of credit; reported total liquidity was approximately $483.6. The company reported compliance with credit covenants, with actual interest coverage of 15.7x against a 3.5x minimum and debt-to-capital of 31% against a 55% maximum.
Material changes versus the prior comparable period
- Despite higher sales, quarterly and six-month profit declined. Management attributed margin and operating-income pressure mainly to higher operating costs, the Athens facility’s higher depreciation, and a press outage; quarterly sales mix and demand improved.
- SAO quarterly sales rose 8%, but segment operating income fell to $43.4 from $54.4. PEP sales rose 18% and operating income increased to $12.6 from $8.6. For the six months, SAO operating income fell to $68.0 from $118.1, while PEP operating income rose to $22.2 from $20.2.
- Interest expense increased to $13.8 for the six months from $8.2, partly reflecting lower capitalized interest after Athens assets entered service. Other income included a favorable $4.4 legal settlement.
- Capital expenditures declined from $204.5 to $127.4 for the six months, largely as Athens construction spending reduced. Inventories increased to $757.1 from $699.2 at fiscal year-end.
- Other comprehensive loss was $37.6 for the six months, including foreign-currency translation and derivative losses; accumulated other comprehensive loss reached $282.8.
Outlook, commentary, risks and unusual items
- Management expected higher sales volume and a stronger mix in the second half of fiscal 2015, based on its markets, orders and backlog. It also forecast PEP earnings to decline 25%–30% in fiscal third-quarter 2015.
- Management warned that falling oil prices and slowing drilling and completion activity were causing SAO oil-and-gas order cancellations and deferrals, and could affect down-hole tools, distribution and, to a lesser extent, powder metals. It said it was adjusting costs in oil-and-gas-focused businesses.
- A Business Management Office was established in January 2015 to pursue profit optimization, cost reduction and inventory reduction. The company also continued to evaluate restructuring opportunities.
- In October 2014, the board authorized repurchases of up to $500.0 over two years. The company repurchased 200,400 shares for $10.0 during the quarter; $490.0 remained authorized at December 31. Repurchases are discretionary.
- Commodity derivatives had a net deferred loss of approximately $31.1 at December 31; about 67% related to contracts supporting firm-price sales with one customer, in addition to trade receivables exposure. The company estimated $11.4 of net derivative losses in accumulated other comprehensive income would be reclassified to earnings within 12 months.
- Environmental remediation liabilities were $15.6. Management did not expect these or routine legal matters to have a material long-term effect, but noted they could be material in a particular quarter or year.
- The filing reports a nonmaterial correction of an equity-method investment translation error, reducing other assets by $4.9 with an offset to accumulated other comprehensive loss. It also describes a prior cash-flow classification revision that did not affect total change in cash. A $1.6 net tax charge reflected tax-law changes, including the effects of bonus depreciation and research credits.
- Gregory A. Pratt, interim President and CEO and Board Chairman, entered into a compensation agreement in February 2015. It provides a $25,000 monthly salary and stock options with an aggregate stated grant-date fair value target of $4.5, subject to service and vesting terms.
Important facts for investors to verify
- Whether the expected second-half volume and mix improvement materializes, and how the oil-price decline affects order cancellations, PEP earnings and related businesses.
- Whether cost initiatives, the Business Management Office and potential restructuring address operating-cost pressure and margin declines, particularly in SAO.
- Whether operating cash generation and working capital improve while the company funds capital spending, dividends and discretionary repurchases; monitor cash and revolver usage.
- The status of Athens facility performance and spending, and whether the reported press outage or higher depreciation continues to affect results.
- Exposure to the customer associated with most of the identified commodity-forward deferred losses, and the timing and earnings impact of derivative reclassifications.
- Developments in environmental remediation, legal contingencies, covenant compliance and the interim CEO’s compensation arrangement.