Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2010. Financial statements are unaudited; dollar amounts are in millions except per-share data.
Business context and performance
Carpenter manufactures and distributes specialty metals for aerospace, industrial, energy, medical, consumer, and automotive markets. Its two reportable segments are Advanced Metals Operations (AMO) and Premium Alloys Operations (PAO).
| Metric | Quarter ended Dec. 31, 2010 | Six months ended Dec. 31, 2010 |
|---|---|---|
| Net sales | $375.6; up 42% year over year | $727.3; up 46% |
| Sales excluding raw-material surcharges | $277.0; up 34% | $540.7; up 37% |
| Gross profit / gross margin | $49.1 / 13.1% | $98.9 / 13.6% |
| Operating income (loss) | $12.1 | $26.2, versus a loss of $11.3 in 2009 |
| Net income attributable to Carpenter | $9.3; diluted EPS $0.21 | $16.9; diluted EPS $0.38, versus a loss of $5.9 and EPS of $(0.14) in 2009 |
| Operating cash flow | Not separately reported for the quarter | $(64.1), versus $58.9 provided in 2009 |
Gross margin excluding surcharge effects was 17.7% for the quarter and 18.3% for the six months, compared with 17.2% and 13.9%, respectively, in 2009. Management also reported non-GAAP operating margins excluding surcharges and pension earnings, interest and deferrals of 7.5% for the quarter (5.5% in 2009) and 8.1% for the six months (1.9% in 2009). These adjusted measures are not GAAP results.
Quarterly shipment volume rose 43%; six-month volume rose 41%. Demand increased across all reported end markets, with particularly strong energy growth. In the quarter, PAO operating income was $22.2, versus $9.4 for AMO; PAO benefited from aerospace and energy demand, while AMO’s growth included more lower-value applications.
Liquidity, cash flow, debt, and balance sheet
- At December 31, cash and cash equivalents were $157.2 and current marketable securities were $66.7. Cash plus short-term securities totaled approximately $224, down from $370.6 at June 30, 2010.
- Operating cash use of $64.1 in the six months reflected primarily a $116.5 inventory increase, alongside higher receivables and accrued-liability cash uses. Inventories rose to $327.8 from $203.6.
- Investing cash use was $27.0, including $41.6 for the Amega West acquisition and $6.2 for a strategic-partnership investment, partly offset by net marketable-security proceeds. Financing cash use was $18.9, including $16.0 of dividends.
- Management-defined free cash flow was negative $136.4, versus positive $24.7 in 2009. Its definition includes acquisition and investment spending, dividends, and specified proceeds, so it is broader than operating cash flow less capital expenditures.
- Total debt was $259.1, including $100.0 classified as current and due in August 2011. The company said it intended to refinance the notes and had hedged interest-rate risk associated with refinancing. It had $196.2 available on its $200 revolving facility, which expires in November 2012, and was in compliance with covenants.
- Management said available cash, short-term securities, operating cash generation, and revolver capacity were expected to cover operations, planned capital spending, the debt maturity, and other obligations for the next 12 months.
Material changes and unusual items
- On December 31, 2010, Carpenter acquired Amega West Services for $41.6 cash and assumed $12.4 of debt, which it paid off at closing. Amega West results were not included in reported operations because the acquisition closed on the period’s final day. Purchase-price allocation remained preliminary.
- In November 2010, Carpenter acquired a 40% interest in Sandvik Powdermet AB for $6.2 and accounted for it as an equity-method investment. Sandvik acquired a 40% interest in Carpenter Powder Products AB for $9.1, recorded as a noncontrolling interest.
- The quarter’s earnings benefited from the retroactive research and development tax credit. Management said that benefit was largely offset by Amega West acquisition costs, unplanned equipment outages, and customer-requested volume shifts into the third quarter.
- Other income declined to $3.0 for the quarter from $6.7, chiefly because Continued Dumping and Subsidy Offset Act receipts fell to $0.4 from $5.8. The six-month comparison was $4.5 versus $8.2.
Outlook, risks, and contingencies
- Management expected fiscal 2011 capital expenditures of approximately $60. It expected full-year net pension expense of $60.8, compared with $61.3 in fiscal 2010. The filing provides no formal earnings or revenue guidance.
- Management described strengthening demand in key markets, including aerospace and energy, while noting that product mix, raw-material prices, surcharge timing, and customer order patterns can cause results and margins to fluctuate. Surcharges generally recover raw-material costs but can dilute reported margin percentages and lag cost changes.
- Key disclosed risks include cyclical end markets; volatile raw-material and energy costs; manufacturing capacity and equipment outages; pension asset and liability valuation; foreign-exchange exposure; customer substitution; acquisition integration; supply and credit availability; labor disruptions; and dependence on specialized equipment and key personnel.
- Environmental remediation liabilities were $4.9. Carpenter had recorded $21.8 for the Boarhead Farms matter, whose prior judgment was vacated on appeal and remanded for further proceedings; the outcome remains uncertain. A $2.5 liability was recorded for a U.S. Customs duty-drawback investigation. Possible export-control penalties remained unquantified, with no liability recorded. Management cautioned that environmental or other matters could be material in a particular future period.
- Commodity, foreign-exchange, and interest-rate derivatives are used for hedging; the filing reports counterparty and collateral risks. Management’s disclosed 10% commodity/energy price decrease and 10% U.S. dollar strengthening sensitivity scenarios were not expected to materially affect results.
Most important facts for investors to verify
- Whether demand and shipment growth continue, and whether mix and surcharge timing support reported margins.
- How inventory accumulation converts to cash and whether operating cash flow recovers after the acquisition and working-capital build.
- Execution and integration of Amega West, including final purchase-price allocation and earn-out obligations.
- Plans and financing terms for the $100.0 debt maturity in August 2011, and continued compliance with credit covenants.
- Developments in the Boarhead Farms litigation, Customs investigation, and export-regulation matter.
- Whether the approximately $60 capital-spending outlook and $60.8 pension-expense estimate remain on track.