Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: Three months ended September 30, 2014, Carpenter’s fiscal first quarter of FY2015. Comparisons are with the three months ended September 30, 2013 unless noted. Unaudited interim results are not necessarily indicative of full-year performance.
Business context
Carpenter manufactures, fabricates and distributes specialty metals and related products. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP).
Key financial results
| Metric | Q1 FY2015 | Prior-year quarter |
|---|---|---|
| Net sales | $549.8 million | $498.6 million |
| Gross profit | $69.1 million | $103.3 million |
| Gross margin | 12.6% | 20.7% |
| Operating income | $22.1 million | $55.8 million |
| Net income | $13.5 million | $34.6 million |
| Diluted EPS | $0.25 | $0.65 |
| Operating cash flow | $15.0 million | $39.5 million |
| Capital expenditures | $59.0 million | $90.4 million |
Sales increased 10%; excluding $109.7 million of surcharge revenue, sales rose 7% to $440.1 million, with shipment volume up 11%. Gross margin excluding surcharge was 15.7%, versus 25.1%. Management’s non-GAAP operating margin excluding surcharge revenue and pension earnings, interest and deferrals (EID) was 5.6%, versus 15.0%. Free cash flow, as defined by the company, was negative $53.5 million, compared with negative $60.5 million.
Adjusted EBITDA, a company-defined non-GAAP measure, was $63.9 million versus $97.5 million. Interest expense was $7.0 million versus $4.4 million; the current period included only $0.7 million of capitalized interest, compared with $3.5 million. The effective tax rate was 32.5%, compared with 32.8%. A $4.4 million legal settlement contributed to reported other income of $4.9 million.
Financial position and liquidity
At September 30, 2014, cash and equivalents were $66.0 million, total assets $3.012 billion, long-term debt $604.2 million, total liabilities $1.527 billion and equity $1.486 billion. Cash declined $54.0 million during the quarter. Inventory rose to $728.1 million from $699.2 million at June 30.
The $500 million revolving credit facility expires in June 2018; $491.8 million was available after letters of credit. Total liquidity, including cash, was approximately $557.8 million. The company reported compliance with its covenants: interest coverage of 18.3x against a 3.5x minimum and debt-to-capital of 29% against a 55% maximum. Carpenter said liquidity, operating cash generation and available borrowing capacity should fund foreseeable needs. About $63 million of cash was held at foreign subsidiaries; repatriation may have tax consequences.
Changes, outlook and management commentary
- Management attributed the sharp earnings decline primarily to weaker product mix and SAO operating disruptions: startup problems at Reading after a scheduled shutdown and an unplanned Latrobe press outage. These drove higher labor, maintenance and supply costs and lower output. Latrobe’s press was back online and performance and mix improved later in the quarter.
- SAO sales increased 10% to $436.0 million, but operating income fell to $24.6 million from $63.7 million. PEP sales increased 10% to $129.9 million; operating income declined to $9.7 million from $11.6 million.
- By end market, sales increased in industrial and consumer (18%), energy (19%), transportation (28%), medical (8%) and aerospace and defense (2%). Excluding surcharges, aerospace and defense sales were down 1%; management cited weaker demand for certain high-value engine and defense materials and weaker mix. Industrial, energy and transportation demand was described as stronger.
- Management expected FY2015 net periodic pension benefit costs of $45.9 million, compared with $60.1 million in FY2014, and approximately $12.7 million of qualified pension contributions for the remainder of FY2015.
- The company had authorized a share repurchase program of up to $500 million over two years, at management’s discretion; no program repurchases were reported in the quarter. The filing gives no specific earnings or revenue guidance.
- Carpenter is building a superalloy powder facility under an agreement with United Technologies/Pratt & Whitney. Construction was expected to take about 18 months and cost approximately $30 million; following customer qualification, supply could continue for up to 20 years, with minimum purchase commitments for 12 years.
Risks, contingencies and unusual items
- Raw-material price volatility, LIFO accounting, surcharge timing and product mix can cause margin fluctuations. About 25% of sales were under firm-price arrangements. Net deferred commodity-hedge losses were approximately $20.5 million; about 71% related to contracts supporting firm-price sales with one customer, in addition to trade receivables exposure to that customer.
- Commodity derivative liabilities rose to $25.1 million from $10.9 million at June 30, while derivative assets fell to $6.1 million from $20.4 million. A net derivative loss of $18.2 million, after tax, contributed to the quarter’s $23.1 million comprehensive loss despite net income of $13.5 million. The company estimated $6.7 million of net derivative losses in accumulated other comprehensive income would be reclassified into earnings within 12 months.
- Environmental remediation liabilities were $15.6 million. Management did not expect them to be material over the long term, but noted costs could be material in an individual quarter or year. Routine litigation and other claims were also disclosed; outcomes cannot be predicted.
- The company revised the prior-year cash-flow classification for unpaid property and equipment purchases: for the September 2013 quarter, operating cash flow was reduced by $24.5 million and investing cash outflow reduced by the same amount. Management said the classification error was not material and did not affect total change in cash or other financial statements.
- Other stated risks include specialty-materials cyclicality, customer and supplier concentration, raw-material and energy availability and costs, foreign exchange, pension asset valuations, specialized-equipment failures, labor and credit-market conditions.
Important facts for investors to verify
- Whether SAO’s Reading and Latrobe operations sustain the reported late-quarter recovery and restore margins.
- Whether volume growth translates into stronger earnings despite product-mix, surcharge and raw-material effects.
- Customer performance under firm-price commitments, particularly the customer associated with most of the disclosed deferred commodity losses.
- Cash conversion, inventory levels, capital spending and funding needs, including foreign cash accessibility and the planned share repurchases.
- Execution, cost and customer qualification milestones for the UTC/Pratt & Whitney powder facility and supply agreement.
- Future pension costs and contributions, derivative-related earnings effects, and developments in environmental remediation or litigation exposures.