Carpenter Technology Corporation — Form 10-Q
Reporting period: Fiscal third quarter and nine months ended March 31, 2011. The filing metadata labels the period “2010 Q3,” but the filing itself reports fiscal 2011 Q3. Unless noted otherwise, amounts are in millions of dollars.
Business context and results
Carpenter manufactures and distributes specialty metals. Its reportable segments are Advanced Metals Operations (AMO), Premium Alloys Operations (PAO), and Emerging Ventures. Management attributed improving performance to stronger demand, higher shipment volumes, pricing actions, and a more favorable product mix. Amega West, acquired December 31, 2010, contributed to Emerging Ventures results.
| Metric | Three months ended March 31, 2011 | Three months ended March 31, 2010 | Nine months ended March 31, 2011 | Nine months ended March 31, 2010 |
|---|---|---|---|---|
| Net sales | $464.2 | $336.9 | $1,191.5 | $834.4 |
| Gross profit | $73.1 | $46.3 | $172.0 | $101.1 |
| Gross margin | 15.7% | 13.7% | 14.4% | 12.1% |
| Operating income | $35.2 | $12.8 | $61.4 | $1.5 |
| Net income (loss) attributable to Carpenter | $28.6 | $2.1 | $45.5 | $(3.8) |
| Diluted EPS | $0.64 | $0.05 | $1.02 | $(0.09) |
| Operating cash flow | Not presented for quarter | Not presented for quarter | $(53.0) | $67.1 |
Financial position, cash flow, and liquidity
- At March 31, 2011, cash and cash equivalents were $184.1 and marketable securities were $28.0, down from $265.4 and $105.2, respectively, at June 30, 2010. Current assets were $894.2 and current liabilities $361.8.
- Total debt was $258.5, including $100.0 classified as current and $158.5 long-term. Debt was $259.6 at June 30, 2010. The $100 million notes mature in August 2011.
- Nine-month operating cash flow was negative $53.0, versus positive $67.1 a year earlier. The main working-capital uses included $110.8 for inventories and $83.7 for receivables.
- Capital spending was $35.6 for the nine months. Management-defined free cash flow was negative $150.4, compared with positive $17.0 a year earlier; this non-GAAP measure also reflects acquisition and equity-investment spending, dividends, and other specified items.
- Management reported approximately $212 million of cash and short-term securities and $196.2 million available under its $200 million revolving facility, and said these resources, together with expected operating cash flow, should cover operations, planned capital spending, the debt maturity, and other obligations for the next 12 months.
- The company was in compliance with credit covenants at March 31: interest coverage was 12.04 to 1 against a 3.25 minimum, and debt to capital was 28% against a 55% maximum. The facility expires November 2012.
Changes versus prior comparable periods
- Third-quarter sales rose 38% and nine-month sales rose 43%; excluding raw-material surcharges, growth was 32% and 35%, respectively. Shipment volume increased 16% for the quarter and 31% for the nine months.
- Profitability improved substantially: third-quarter operating income was $35.2 versus $12.8, and nine-month operating income was $61.4 versus $1.5. Gross margin expanded in both comparisons.
- Energy was a particularly strong end market: sales rose 136% in the quarter and 127% for the nine months. Aerospace, industrial, consumer, medical, and automotive sales also increased.
- Cash generation weakened despite the return to profitability, primarily as working capital expanded to support demand and the company funded acquisitions and investment. Inventory increased to $323.7 from $203.6 at June 30, 2010.
- Comparisons include Amega West only from its December 31, 2010 acquisition date. The acquisition cost $41.6 in cash; the company also paid off $12.4 of assumed debt. The Sandvik partnership included a $6.2 equity-method investment and Sandvik’s $9.1 purchase of a 40% noncontrolling interest in Carpenter Powder Products AB.
Outlook, commentary, and notable items
- Management said demand was strengthening in key aerospace and energy markets and described progress from growth, pricing, and mix-management initiatives. It noted that the benefits of mix and pricing actions took time to emerge because of long lead times and customer commitments made during the downturn.
- Management expected fiscal 2011 capital expenditures of about $60 million and total net pension expense of $60.8 million, versus $61.3 million in fiscal 2010. It intended to refinance the $100 million August 2011 maturity in fiscal fourth-quarter 2011, potentially with a larger debt facility to provide additional liquidity. No specific revenue or earnings guidance was provided.
- Raw-material surcharge arrangements generally recover input-cost increases but can lag costs and dilute reported margin percentages. LIFO accounting, volatile input prices, product mix, and customer order patterns can cause period-to-period margin variability. Management estimated raw-material, inventory, and surcharge-lag effects increased quarterly operating margin by 50 basis points but reduced nine-month margin by 60 basis points.
- Income tax expense included $4.8 of benefits from changes in prior tax positions. The prior-year periods included a $5.9 one-time, non-cash healthcare-reform charge. These items affect comparability of effective tax rates.
- Key contingencies include the Boarhead Farms environmental lawsuit, for which a $21.8 liability was recorded; environmental remediation liabilities of $4.9; and a $2.4 recorded liability related to a U.S. Customs duty-drawback investigation. A possible Commerce Department penalty concerning past export-control issues was unquantified and no liability was recorded. Management cautioned that environmental or other matters could be material in a particular future period.
- Other stated risks include specialty-metals cyclicality, raw-material and energy costs, pension-asset and liability volatility, acquisition integration, financing availability, foreign exchange, labor disruption, supply constraints, and reliance on specialized equipment and key personnel. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor verification points
- Confirm the period is fiscal Q3 2011, ended March 31, 2011, rather than 2010 Q3.
- Track working-capital conversion and whether operating cash flow recovers as inventory and receivables support higher volumes.
- Verify refinancing of the $100 million August 2011 maturity, the resulting financing terms, and continued covenant headroom.
- Assess whether growth and margin improvement persist after separating surcharge revenue, acquisition contributions, and one-time tax benefits.
- Monitor Amega West integration and performance, the Sandvik partnership, and potential cash requirements from earn-out terms.
- Follow developments and possible changes in estimates for Boarhead Farms, the Customs investigation, export-control exposure, and environmental remediation.