CARPENTER TECHNOLOGY CORP annual report, FY2022

Business context and reporting period

Carpenter Technology Corporation manufactures and distributes specialty alloys and related products for aerospace and defense, medical, transportation, energy, industrial and consumer markets. It reports two segments: Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). This Form 10-K covers the fiscal year ended June 30, 2022, and compares results primarily with fiscal 2021; it is not a report for calendar-year 2021 or a standalone 2021 fourth quarter.

Key financial results

Sales rose 24% year over year, while sales excluding raw-material surcharges increased 12% on 11% higher volume. Surcharge revenue increased to $436.3 million from $222.8 million, so reported growth materially exceeded underlying sales growth. Adjusted gross margin excluding surcharge revenue and specified special items improved to 9.9% from 4.6%; adjusted operating margin on that basis remained negative, improving to (2.4)% from (8.4)%. These adjusted measures are non-GAAP.

At June 30, 2022, cash was $154.2 million, total debt was $691.8 million, and stockholders’ equity was $1,330.5 million. The company reported total liquidity of $448.3 million, including $294.1 million available under its revolving facility. Current assets were $1,119.4 million and current liabilities $375.6 million. Inventory increased to $496.1 million from $425.7 million. The company paid $39.2 million in dividends.

Material changes versus prior year

• Both segments improved: SAO reported $9.6 million operating income versus an $87.4 million loss; PEP reported $18.1 million operating income versus a $16.5 million loss.
• Sales increased across all reported end markets. Medical sales rose 48%, industrial and consumer 43%, and aerospace and defense 11%; excluding surcharges, aerospace and defense sales were essentially flat.
• Operating cash flow fell to $6.0 million, primarily reflecting a $71.9 million cash use for inventory build, versus $238.5 million of cash released by inventory reductions in FY2021. Accounts receivable also used $79.0 million of cash.
• FY2021 included substantial charges not repeated in FY2022, including a $52.8 million goodwill impairment, $52.2 million LIFO decrement, $16.6 million restructuring and asset impairment charges, and $4.2 million inventory write-downs.
• FY2022 special items included $5.9 million of COVID-related costs, a $2.4 million environmental charge and $6.0 million of debt-extinguishment losses, offset in part by $12.7 million of employee retention credits and a $4.7 million acquisition-related liability release.

Outlook, risks and unusual items

Management described demand and backlog as strong and expected continued growth, particularly in aerospace, defense and medical as customers continued recovering toward pre-pandemic levels. Backlog, excluding surcharge, was $1,539.3 million at year-end, compared with $529.3 million a year earlier; most was expected to ship in FY2023. Management cited productivity and capacity gains as priorities and expected FY2023 capital expenditures of approximately $100 million. The filing does not provide quantified revenue or earnings guidance.

Management identified operational headwinds during FY2022, including an unplanned Reading press outage, labor shortages, COVID-related absences, supply-chain disruption and inflation in production supplies, freight and labor. The press returned to service in the third quarter. Principal ongoing risks include cyclical end markets, raw-material and energy availability and pricing, the ability to pass through cost increases, production concentration and specialized equipment, labor relations, environmental liabilities, pension obligations, cybersecurity, and possible impairment of goodwill or other assets.

In March 2022, Carpenter issued $300 million of 7.625% senior notes due 2030 and used the proceeds to repay $300 million of 4.45% notes due 2023, extending maturity but increasing coupon cost. The company was in compliance with its credit-facility covenants at year-end; reported interest coverage was 3.65 to 1.00 against a 2.00 minimum for that test date. Environmental remediation liabilities were $18.3 million, including a newly recorded $2.4 million site liability; management said costs could be material in an individual period. Pension and postretirement plans remained underfunded by $291.5 million in aggregate, although FY2022 discount-rate-driven actuarial gains reduced recorded obligations. The auditor issued unqualified opinions on the financial statements and internal controls and identified goodwill impairment assessment as a critical audit matter.

Important facts for investors to verify

• Confirm the reporting period: the filing is for FY2022 ended June 30, 2022, notwithstanding the request metadata stating “2021 Q4.”
• Assess whether backlog converts to shipments and profitable sales, especially given the difference between reported sales growth and growth excluding surcharges.
• Track inventory, receivables and operating cash flow; FY2022 free cash flow was negative despite the improved operating result.
• Review covenant headroom and the cost and terms of debt, including the 7.625% notes and the facility’s rising interest-coverage requirements.
• Monitor execution and costs of capacity projects, the Reading press recovery, hiring and supply-chain conditions, and whether pricing offsets inflation.
• Evaluate assumptions supporting goodwill valuations and the range and timing of environmental and pension cash requirements.