Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2013; comparable periods ended December 31, 2012. Balance-sheet comparisons are against June 30, 2013. Amounts are in millions except per-share data.
Business context and reporting period
Carpenter manufactures, fabricates and distributes specialty metals and powders, and produces and rents oil-and-gas drilling tools. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). The company reorganized segment reporting in fiscal 2014 after integrating Latrobe; prior-year segment results were recast.
Financial performance and liquidity
| Metric | Three months ended Dec. 31, 2013 | Six months ended Dec. 31, 2013 | Comparable 2012 period |
|---|---|---|---|
| Net sales | $503.5 | $1,002.1 | $533.5; $1,078.5 |
| Gross profit | $95.4 | $198.8 | $102.6; $212.0 |
| Gross margin | 18.9% | 19.8% | 19.2%; 19.7% |
| Operating income | $47.5 | $103.3 | $52.7; $114.3 |
| Net income attributable to Carpenter | $29.5 | $64.1 | $33.0; $72.2 |
| Diluted EPS | $0.55 | $1.19 | $0.62; $1.35 |
Quarterly sales decreased 6% and six-month sales decreased 7% year over year. Excluding raw-material surcharges, sales fell 4% and 5%, respectively, while shipments increased 8% and 4%. Quarterly gross margin excluding surcharges was 23.0% versus 23.8%; six-month margin was 24.0% versus 24.3%. Operating margin excluding surcharges and pension earnings, interest and deferrals (EID) was 12.4% for the quarter versus 14.1%, and 13.7% for six months versus 15.0%. These are company-presented non-GAAP measures.
For the quarter, SAO sales were $407.5 and operating income $54.4; PEP sales were $113.7 and operating income $8.6. For six months, SAO sales and operating income were $802.5 and $118.1; PEP reported $232.2 and $20.2.
Six-month operating cash flow was $71.0, compared with $2.2 a year earlier. Capital expenditures were $212.4 versus $136.9; company-defined free cash flow was negative $160.3 versus negative $154.2. Cash declined to $106.2 from $257.5 at June 30. Long-term debt was $604.3, nearly unchanged from $604.2. The $500 million revolving credit facility had $491.8 available after letters of credit; reported total liquidity was approximately $598.0. The company was in compliance with its covenants: interest coverage was 20.75x against a 3.50x minimum, and debt-to-capital was 31% against a 55% maximum. Dividends were $0.18 per share per quarter.
Material changes and management commentary
- Management said quarterly earnings were in line with expectations, but weaker product mix—particularly lower premium and ultra-premium aerospace demand—reduced operating margins. Cost control and lower production costs partly offset this effect.
- Aerospace and defense sales declined 10% in both the quarter and six-month period; energy sales fell 7% and 11%. Transportation sales increased 12% and 3%, respectively. PEP experienced lower shipments and sales, while SAO shipment volumes rose despite lower sales.
- Cash from operations improved year over year partly because pension contributions fell to $3.1 from $57.9, following a substantial discretionary contribution in the prior-year period. The improvement was more than offset in free cash flow by higher capital spending, largely for the Limestone County, Alabama facility.
- Carpenter expects fiscal 2014 net periodic pension and postretirement benefit costs of $60.4, compared with $68.8 in fiscal 2013, and expects approximately $3.2 of additional pension contributions in the fiscal year’s second half. The filing provides no numerical revenue or earnings guidance.
Outlook, risks, contingencies and unusual items
- Carpenter expects cash, operating cash generation and available borrowing capacity to fund foreseeable needs. It targets at least $150 of liquidity. Approximately $73 of cash was held at foreign subsidiaries; repatriation may trigger tax costs, and management said it was considering only repatriation with minimal or no near-term net adverse tax consequences.
- A September 2013 agreement with United Technologies’ Pratt & Whitney includes a superalloy-powder technology license and long-term supply arrangement. Carpenter plans an approximately $20 facility, expected to take about 18 months to build; once qualified, it may supply powder for up to 20 years. The agreement provides minimum purchase quantities for 12 years. The $13 license fee is payable in quarterly installments; $9.7 remained accrued at December 31.
- Commodity and other derivative liabilities had a fair value of $63.9. Carpenter disclosed $61.9 of deferred losses on commodity forwards; approximately 77% related to contracts supporting firm-price sales with one customer, in addition to outstanding receivables from that customer. Customer nonperformance could expose Carpenter to losses. The company said customers had historically performed.
- Environmental remediation liabilities were $14.9. Management did not expect these or routine legal matters to have a material long-term effect, but noted they could be material in a particular quarter or year. Other risks include cyclical end markets, raw-material and energy costs, surcharge timing, pension-asset valuations, foreign exchange, manufacturing capacity and specialized equipment dependencies.
- During the quarter, Carpenter began capitalizing additional pension EID costs related to current manufacturing employees in inventory; the reported increase in capitalized periodic benefit costs was $2.2. Management said the change had no material effect on previously reported amounts.
Important facts for investors to verify
- Whether aerospace and energy customer destocking eases and premium-product mix and margins recover.
- Whether the Alabama and planned powder-facility investments deliver expected operating returns, and how capital spending affects cash and liquidity.
- The financial exposure represented by commodity-forward losses and the concentration of those contracts with one customer, including that customer’s ability to meet firm-price commitments.
- Whether foreign cash can be accessed without significant tax cost, and whether covenant compliance and liquidity remain adequate.
- How pension costs, contributions and the inventory-capitalization change affect future earnings and cash flows; the filing cautions that interim results are not necessarily indicative of future results.