Carpenter Technology Corporation — Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three months ended September 30, 2013, Carpenter’s first quarter of fiscal 2014; comparisons are with the quarter ended September 30, 2012. Carpenter manufactures, fabricates and distributes specialty metals and related products. The company reorganized reporting into Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP), with prior-year segment data recast.
Financial performance
| Metric | Q1 FY2014 | Q1 FY2013 | Change / context |
|---|---|---|---|
| Net sales | $498.6 million | $544.9 million | Down 8%; down 7% excluding surcharges |
| Gross profit | $103.3 million | $109.3 million | Down 5%; gross margin 20.7% versus 20.1% |
| Operating income | $55.8 million | $61.6 million | Operating margin 11.2% versus 11.3% |
| Net income attributable to Carpenter | $34.6 million | $39.2 million | Down 12% |
| Diluted EPS | $0.65 | $0.74 | Down 12% |
| Cash from operations | $64.0 million | $(36.7) million | Improved, including working-capital management and lower pension contributions |
| Capital expenditures | $114.9 million | $56.4 million | Higher, mainly for the Alabama facility under construction |
| Free cash flow | $(60.5) million | $(102.7) million | Company-defined non-GAAP measure; includes dividends |
Shipment volume increased 1% overall. Softer premium-alloy demand and an unfavorable product mix weighed on sales; increased shipments of lower-value materials and strong manufacturing execution helped sustain margins. SAO sales declined 8% and operating income was $63.7 million, compared with $67.2 million. PEP sales declined 12% and operating income was $11.6 million, compared with $14.5 million. Aerospace and defense sales fell 9%, energy sales fell 14%, and powder-metals sales fell 35% year over year.
At September 30, 2013, cash and cash equivalents were $201.0 million, down from $257.5 million at June 30. Total assets were $2,925.5 million; current assets were $1,223.3 million and current liabilities were $427.6 million. Inventories rose to $707.1 million from $659.2 million. Long-term debt was $604.2 million, unchanged from June 30. The $500 million revolving credit facility had $491.8 million available after letters of credit. Total liquidity, as defined by the company, was approximately $692.8 million. Carpenter reported compliance with its debt covenants; the actual interest-coverage ratio was 20.48:1 and debt-to-capital ratio was 31%.
Changes, outlook and management commentary
Management said results were in line with expectations in a challenging environment: market demand remained soft, raw-material and scrap prices were low, lead times were short, and economic uncertainty was elevated. Aerospace and energy supply-chain destocking reduced demand for premium products; lower-value transportation and industrial/consumer sales provided some offset. International sales fell 15%, reflecting continued weakness in Europe.
Management estimated fiscal 2014 net pension expense at $59.7 million, compared with $68.8 million in fiscal 2013, and expected approximately $4.8 million of additional pension contributions during the remainder of fiscal 2014. The filing does not provide a specific revenue or earnings forecast. Carpenter stated that cash, operating cash generation and available borrowing capacity were expected to fund foreseeable cash needs.
On September 30, 2013, Carpenter entered into technology-assistance and long-term powder-supply agreements with United Technologies Corporation’s Pratt & Whitney division. Carpenter plans to build a superalloy powder facility, expected to take about 18 months and cost an estimated $20 million. Following qualification, Carpenter will supply powder for up to 20 years; the agreement includes minimum purchase quantities for 12 years. A $13 million licensing fee is payable in quarterly installments beginning December 15, 2013.
Risks, contingencies and unusual items
- Raw-material volatility, LIFO accounting, surcharges and timing differences can affect reported margins. Approximately 25% of sales were under firm-price arrangements.
- At quarter-end, approximately $63.3 million of deferred losses related to commodity forward contracts; about 72% related to contracts supporting firm-price sales with one customer, in addition to trade receivables exposure to that customer.
- Environmental remediation liabilities were $14.9 million. Management did not expect these costs to be material over the long term, but noted they could be material in a particular quarter or year. Routine legal matters were also described; outcomes and timing remain uncertain.
- Cash-flow improvement did not cover the quarter’s elevated capital spending and dividends; free cash flow remained negative. Cash declined by $56.5 million.
- About $89 million of cash was held at foreign subsidiaries. Repatriation could create tax costs; the company was evaluating options and said near-term plans aimed to limit adverse tax consequences.
- Other stated risks include cyclical end markets, customer destocking and cancellations, pension-asset valuation, raw-material and energy availability and costs, foreign exchange, and reliance on specialized manufacturing equipment.
Important facts for investors to verify
- Whether demand and mix in aerospace, energy and powder products improve, and whether lower-value growth can offset premium-product weakness.
- Execution, cost, timing and customer qualification of the planned Alabama and superalloy-powder facilities, alongside the elevated capital program.
- Customer performance under firm-price arrangements, particularly the customer associated with most of the deferred commodity-hedge losses.
- Cash generation, inventory levels, pension contributions, credit-facility availability and continued covenant compliance.
- Potential timing and amount of environmental and legal costs, and any tax consequences of repatriating foreign cash.