Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: First quarter of fiscal 2013, the three months ended September 30, 2012. The interim financial statements are unaudited. Comparisons are with the three months ended September 30, 2011 unless otherwise noted. Amounts are in millions except per-share data.
Business context and results
Carpenter manufactures, fabricates and distributes specialty metals and related products. The quarter included the Latrobe Specialty Metals business, acquired February 29, 2012. Management reported strong demand for premium and ultra-premium products, particularly in aerospace and defense, while noting softness in some markets.
| Metric | Q1 FY2013 | Q1 FY2012 |
|---|---|---|
| Net sales | $544.9 | $414.1 |
| Gross profit / gross margin | $109.3 / 20.1% | $81.1 / 19.6% |
| Operating income | $61.6 | $44.0 |
| Income before taxes | $59.1 | $36.3 |
| Net income attributable to Carpenter | $39.2 | $23.8 |
| Diluted earnings per share | $0.74 | $0.53 |
| Operating cash flow | $(36.7) | $(74.0) |
| Capital expenditures | $56.4 | $27.3 |
| Free cash flow, as defined by the company | $(102.7) | $(109.2) |
Material changes and financial position
- Sales increased 32%, and pounds shipped rose 36%, primarily reflecting the Latrobe acquisition and higher volumes. Excluding surcharge revenue, sales increased 41%; excluding Latrobe, sales excluding surcharges grew 9% on 4% higher volume.
- Gross profit increased 35%. Gross margin excluding surcharge revenue was 24.8%, down from 25.9%; management said surcharge revenue dilutes reported margin percentages. Operating margin excluding surcharges and pension earnings, interest and deferrals was 15.8%, versus 15.2%.
- Latrobe contributed approximately $127.7 of sales and $16.3 of operating income. Management reported $0.07 of net diluted EPS accretion from Latrobe’s operating results after the share issuance impact, excluding synergies to Carpenter’s existing business.
- Cash and equivalents were $112.6 at September 30, down from $211.0 at June 30. Inventory rose to $722.2 from $642.0. Operating cash use reflected working-capital needs, including inventory, and $48.1 of pension contributions.
- Long-term debt, including the current portion, was $406.6. The $350.0 revolving facility had $342.8 available after letters of credit. Total liquidity was approximately $455.0. The company reported compliance with covenants; actual interest coverage was 17.4 to 1.0 against a 3.5 minimum, and debt to capital was 26% against a 55% maximum.
- Quarterly pension expense rose to $17.2 from $9.9. Accumulated other comprehensive loss improved to $(384.1) from $(412.5), including positive derivative and currency translation changes.
Outlook, commentary and risks
- Management said it remained on track for its fiscal-year financial targets and expected strong shipment levels in the second half, citing backlog and fully utilized available premium capacity. No specific revenue or earnings guidance figures were provided.
- Capital expenditures were expected to be about $350 for fiscal 2013. The new Athens, Alabama facility was expected to cost approximately $500 million in the filing’s project description; the liquidity discussion refers to a planned $518 million facility. Management expected it to be operational by April 2014 and capable of adding about 27,000 tons of annual premium-product capacity.
- The company expected $33.4 of additional pension contributions during the remainder of fiscal 2013 and estimated approximately $400 of minimum required contributions over five years, subject to market returns and interest rates. It was considering a debt issuance in the second half of fiscal 2013 that could combine a discretionary pension contribution with refinancing the $101 debt maturity due in May 2013.
- Management expected modestly negative free cash flow over the next several fiscal years during peak capital spending, followed by consistently positive annual free cash flow after that spending subsides. A consulting-led inventory reduction initiative could affect fiscal 2013 earnings, but the amount was not estimable.
- Costs for facility start-up, footprint optimization and the inventory initiative totaled $1.6 in the quarter, reducing diluted EPS by $0.02. The company announced plans to close its Orangeburg, South Carolina wire facility and move certain assets to Ohio.
- Carpenter had begun a process to sell the Latrobe and Mexico distribution businesses; at quarter-end, they did not qualify for held-for-sale or discontinued-operations accounting. Management said proceeds, if realized, would be reinvested in more strategic businesses.
- Key risks include cyclical or weakening end-market demand, raw-material and energy cost volatility and surcharge timing, pension funding and expense, acquisition integration and synergies, and customer or supplier disruptions. About 92% of deferred losses on commodity forward contracts related to one customer’s firm-price arrangements, in addition to outstanding trade receivables to that customer.
- Environmental remediation liabilities were $4.9. A possible civil penalty related to historical export-regulation disclosures remained unquantifiable and unrecorded; the Department of Commerce had not responded. Routine legal matters were also pending. Management did not expect these matters to have a material long-term effect, while noting particular periods could be affected.
Important facts for investors to verify
- Whether second-half shipment expectations and full-year targets are achieved, particularly if demand softens in medical, distribution, European powder metals or other markets.
- Latrobe’s ongoing performance, integration synergies, and progress and terms of the announced Latrobe and Mexico distribution business sale process.
- Inventory reduction progress and any resulting earnings or cash-flow effects, alongside the planned capital spending and facility schedule.
- Pension contribution requirements, any proposed debt issuance, and refinancing of the May 2013 maturity; monitor cash, liquidity and covenant headroom.
- Exposure to the customer associated with most deferred commodity-hedge losses, as well as the outcome of the unresolved export-regulation matter and environmental or other legal contingencies.
- The project-cost references differ: approximately $500 million for the facility and $518 million in the liquidity discussion. Confirm the current expected total cost.