Business context and reporting period
Carpenter Technology Corporation manufactures and distributes specialty metals and high-performance products, including components for directional drilling. This unaudited Form 10-Q covers the second quarter and first six months of fiscal 2012, ended December 31, 2011; comparisons are with the corresponding fiscal 2011 periods. The company reported two segments: Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP).
Key financial metrics
| Metric | Quarter ended Dec. 31 | Six months ended Dec. 31 |
|---|---|---|
| Net sales | $431.1 million | $845.2 million |
| Gross profit / gross margin | $84.3 million / 19.6% | $165.5 million / 19.6% |
| Operating income | $43.9 million | $87.9 million |
| Net income attributable to Carpenter | $23.6 million | $47.4 million |
| Diluted earnings per share | $0.52 | $1.05 |
| Operating cash flow | Not separately presented | $(27.8) million |
| Capital expenditures | Not separately presented | $60.3 million |
| Free cash flow (company-defined, non-GAAP) | Not separately presented | $(105.5) million |
At December 31, 2011, cash and cash equivalents were $318.8 million; total debt was $407.4 million, all classified as long-term. The $350 million revolving credit facility had $346.5 million available after letters of credit. Management reported total liquidity of approximately $665 million. The company was in compliance with its credit covenants, with interest coverage of 13.76x against a 3.50x minimum and debt-to-capital of 35% against a 55% maximum. Current assets were $1,034.8 million and current liabilities $305.9 million.
Material changes versus prior comparable periods
- Quarterly sales rose 15% year over year, while sales excluding raw-material surcharges rose 19%. Shipment pounds fell 7%; management attributed stronger profitability to pricing and a richer product mix. Quarterly gross profit increased 72%, and operating income rose from $12.1 million to $43.9 million.
- For the first six months, sales increased 16% and sales excluding surcharges increased 19%, despite a 5% decline in pounds shipped. Operating income rose to $87.9 million from $26.2 million; Carpenter-attributable net income increased to $47.4 million from $16.9 million.
- For the quarter, SAO sales increased 11% and operating income rose to $50.9 million from $26.7 million. PEP sales increased 81% and operating income rose to $10.4 million from $4.7 million, helped in part by the Amega West acquisition.
- Cash decreased $173.7 million from June 30, 2011. Operating cash use improved to $27.8 million from $64.1 million in the prior-year half, but inventory increased $103.9 million on the balance sheet and drove substantial working-capital use. Capital spending increased from $17.7 million to $60.3 million.
- Total debt declined from $507.8 million at June 30, 2011 after repayment of $100 million of debt. The current portion of long-term debt was zero at December 31, versus $100 million at June 30.
- Quarterly income tax expense was $14.7 million, a 38.2% effective rate, versus $1.4 million and 13.0% a year earlier. The six-month effective rate was 36.4% versus 23.4%; current-period tax expense was affected by a state tax change and nondeductible Latrobe-related costs, while prior periods included a research-credit benefit.
Outlook, management commentary, risks and unusual items
- Management expected approximately $175 million of capital expenditures for fiscal 2012. A planned Alabama facility was estimated to cost about $500 million, take approximately 30 months to become operational, and add capacity of roughly 27,000 tons per year, primarily for premium products. Management anticipated modestly negative free cash flow over the next several fiscal years, followed by consistently positive annual free cash flow after peak facility spending.
- The Latrobe Specialty Metals merger remained subject to antitrust clearance after the FTC issued a Second Request. The company expected closing in fiscal Q3 2012 and planned to issue 8.1 million shares and use approximately $170 million in cash to address Latrobe debt and certain transaction costs. Either party could terminate if the transaction had not closed by April 30, 2012; the company could owe a $5 million fee plus certain reimbursable costs in that circumstance.
- Management reported quarterly noncash net pension expense of $9.8 million and expected fiscal 2012 net pension expense of $39.4 million, compared with $60.8 million in fiscal 2011. Required U.S. pension contributions were $15.4 million in the first half, with another $12.3 million expected for the remainder of fiscal 2012.
- The six-month cash-flow statement includes a $21.8 million payment resolving the Boarhead Farms litigation; the company expected no further liability from that matter. U.S. Customs accepted a $1.1 million duty-drawback settlement, and the company did not expect additional liability. Potential Department of Commerce export penalties remained unquantified and unrecorded; the agency had not responded to the company’s voluntary disclosure.
- Environmental remediation liabilities were $4.9 million. Management said they were not expected to materially affect results over the long term, but could be material in a particular quarter or year. Other routine legal matters were also disclosed.
- Commodity and currency exposure, volatile raw-material prices, surcharge timing, pension asset and liability values, cyclical end markets, acquisition execution, and successful construction and operation of the Alabama facility were identified among key risks. Deferred commodity-contract losses were approximately $26.2 million; about 47% related to contracts supporting firm-price arrangements with one customer.
- The filing reports a change in segment structure and recasts prior-period segment data. Management also cautioned that interim results are not necessarily indicative of future results.
Most important facts for investors to verify
- Confirm reported six-month sales against the MD&A: the financial statements and segment tables report $845.2 million, but one MD&A passage says $854.2 million.
- Track Latrobe antitrust clearance, final consideration and funding needs, and the April 30, 2012 termination provisions.
- Monitor inventory and working-capital trends, cash generation, the planned capital-spending program, and liquidity after anticipated Latrobe funding and future debt maturities.
- Assess execution, cost, timing, and demand assumptions for the Alabama facility, alongside the company’s expectation of several years of modestly negative free cash flow.
- Review exposure to the concentrated firm-price customer and deferred commodity losses, as well as pension funding needs and the unresolved export-regulation matter.