Business context and reporting period
Carpenter Technology Corporation filed this unaudited Form 10-Q for its fiscal first quarter ended September 30, 2010, comparing results with the quarter ended September 30, 2009. The company manufactures and distributes specialty metals through Advanced Metals Operations (AMO) and Premium Alloys Operations (PAO). Dollar figures below are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Quarter ended Sep. 30, 2010 | Quarter ended Sep. 30, 2009 |
|---|---|---|
| Net sales | $351.7 | $233.7 |
| Gross profit / margin | $49.8 / 14.2% | $19.2 / 8.2% |
| Operating income (loss) | $14.1 | ($13.3) |
| Net income (loss) | $7.6 | ($9.3) |
| Diluted earnings (loss) per share | $0.17 | ($0.21) |
| Operating cash flow | ($30.5) | $36.2 |
| Capital expenditures | $8.1 | $11.3 |
| Free cash flow, as defined by the company | ($46.5) | $17.8 |
- Sales rose 50%; excluding $88.0 of surcharge revenue, sales increased 40%. Pounds shipped increased 39%.
- Gross margin excluding surcharge revenue was 18.9%, versus 10.2%. Management attributed higher gross profit primarily to greater volume and improved cost performance, partly offset by weaker product mix.
- Reported operating margin excluding surcharges and pension earnings, interest and deferrals (a company-defined non-GAAP measure) was 8.7%, compared with negative 2.0%.
- Net pension expense was $15.2, or $0.21 per diluted share, versus $15.3, or $0.21 per share. Management expects FY2011 pension expense of $60.8, compared with $61.3 in FY2010.
- At September 30, cash and cash equivalents were $258.3 and current marketable securities were $68.5. Total debt, including the current portion, was $260.1. The $100.0 note due in August 2011 was reclassified as current; management intends to refinance it.
- The $200.0 revolving facility expires November 2012; $196.2 remained available after letters of credit. The company reported covenant compliance, with interest coverage of 9.5:1 against a 3.0:1 minimum and debt-to-capital of 30% against a 55% maximum.
- Inventory increased to $272.7 from $203.6 at June 30. Management said the working-capital investment supported rising demand. Cash and current securities totaled approximately $326.8; management considered liquidity, operating cash generation and available borrowing capacity sufficient for foreseeable needs.
- Quarterly dividends were $0.18 per share, totaling $8.0. Management expected FY2011 capital expenditures of about $70.
Material changes and segment performance
- Demand strengthened across the company’s end markets; sales outside the United States increased 53% to $109.8. Energy sales rose 145%, aerospace 42%, and industrial 68% year over year.
- AMO sales increased 41% to $246.6, while segment operating income improved to $8.6 from a $2.6 loss. Management cited volume growth, partly offset by weaker mix in lower-value markets.
- PAO sales increased 82% to $107.7, and operating income rose to $24.3 from $7.9, reflecting higher volume, particularly in aerospace and energy applications.
- International sales remained 31% of total sales. One customer represented 10% of sales, compared with 11% a year earlier.
- On October 19, 2010, Carpenter announced a strategic powder-metals partnership with Sandvik Materials Technology. Each company will acquire a 40% interest in the other’s relevant powder business; each business had approximately $20 million in annual revenue.
Outlook, risks, and contingencies
- Management reported tight capacity and longer customer lead times as order activity grew. It was hiring and training employees, increasing inventory, taking pricing actions and managing product mix to support demand and profitability. It said operating margin was maintained versus the prior quarter on slightly lower seasonally adjusted volumes, in line with expectations.
- Results remain exposed to specialty-metals and end-market cyclicality; raw-material, energy and freight cost volatility; surcharge timing and LIFO accounting; customer and product mix; foreign exchange; pension asset and obligation changes; manufacturing capacity and equipment concentration; labor and supply-chain risks; and customer substitution. Surcharges generally recover raw-material increases but can dilute reported margin percentages and may lag costs.
- Environmental remediation liabilities were $4.9; no additional accrual was recorded in the quarter. The company cautioned that future costs are uncertain and could be material in an individual period.
- A Boarhead Farms judgment imposing 80% responsibility for past and future cleanup costs was vacated and remanded in April 2010; the company continues to contest the matter and carried a $21.8 liability.
- A U.S. Customs duty-drawback investigation and internal review remained ongoing; the company recorded a $2.5 reserve against $6.9 of historical refunds. A separate export-regulation matter involving a divested unit remained unresolved with the Department of Commerce; no liability was recorded because any penalty could not be estimated.
- The filing provides no full-year revenue or earnings guidance. The interim statements are unaudited, and management cautioned that quarterly results are not necessarily indicative of future results.
Important facts for investors to verify
- Whether demand, shipment growth and improved margins persist, especially in aerospace and energy, and whether added capacity keeps pace with orders.
- Whether inventory converts into sales and operating cash flow; quarterly operating cash flow and free cash flow were negative despite the return to profitability.
- How the August 2011 $100.0 debt maturity will be refinanced and whether the company maintains ample covenant headroom.
- How product mix, surcharge timing, raw-material prices and LIFO accounting affect margins in coming quarters.
- Developments and potential cash exposure in the Boarhead Farms litigation, Customs investigation and export-regulation matter.
- Execution and financial effects of the Sandvik powder-metals partnership, announced after quarter-end.