Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: Quarter ended September 30, 2019, the first quarter of fiscal 2020 (not calendar 2019 Q1). Comparative results are for the quarter ended September 30, 2018. Dollar amounts are in millions unless stated otherwise.
Business context and results
Carpenter produces and distributes specialty alloys and engineered products serving aerospace and defense, medical, transportation, energy, industrial and consumer markets. It reports two segments: Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP).
- Net sales were $585.4, up 2%; sales excluding raw-material surcharge revenue, a non-GAAP measure, were $486.6, up 7%.
- Net income rose to $41.2 from $31.5. Diluted EPS was $0.85 versus $0.65.
- Gross profit increased to $112.6 from $91.7; GAAP gross margin expanded to 19.2% from 16.0%. Management reported adjusted gross margin excluding surcharge revenue of 23.1% versus 20.1%.
- Operating income was $59.8 versus $45.0; operating margin was 10.2% versus 7.9%. Adjusted operating margin excluding surcharge revenue was 12.3% versus 9.9%.
- Interest expense declined to $5.4 from $6.3. The effective tax rate rose to 23.8% from 21.8%, primarily due to foreign losses without recognized tax benefits and a lower share-based compensation tax benefit.
Segment and market performance
- SAO: Sales of $491.1 increased 3%; excluding surcharges, sales increased 9% despite 4% lower shipment volume. Operating income rose to $81.0 from $52.8, with improved margins attributed to productivity, capacity gains and product mix.
- PEP: Sales of $109.4 decreased 2%; excluding surcharges, sales were approximately flat. PEP recorded a $2.0 operating loss versus $7.3 operating income, reflecting additive-manufacturing investment and weaker North American oil and gas activity.
- Aerospace and defense sales increased 14% (19% excluding surcharges); medical sales increased 4% (11% excluding surcharges). Industrial and consumer sales fell 24%, energy fell 11%, and distribution fell 10%.
- Total shipment volume declined 5%. Backlog increased 26% year over year; aerospace and defense backlog rose 40% and medical backlog rose 15%.
Cash flow, liquidity and debt
- Operating cash flow was $0.7, down from $9.4, as working-capital investment offset higher earnings. Inventory increased to $837.6 from $787.7.
- Capital spending was $47.5 versus $41.6. Free cash flow, a company-defined non-GAAP measure that includes capital spending and dividends, was negative $56.4 versus negative $41.7.
- Cash was $24.6. The company reported total liquidity of $341.1, including $316.5 available under its $400.0 revolving credit facility after $77.6 of borrowings and $5.9 of letters of credit.
- Long-term debt was $550.9, comprising notes due 2021 and 2023. The company was in compliance with credit covenants: interest coverage was 16.24x against a 3.50x minimum, and debt-to-capital was 28.5% against a 55% maximum.
- Total assets were $3,341.5 and total liabilities were $1,764.5 at quarter-end. The quarterly dividend was $0.20 per share.
Outlook, commentary and notable matters
- Management cited strong core-business momentum, favorable product mix and manufacturing improvements, and said this was the 11th consecutive quarter of year-over-year sales and earnings growth. It highlighted continued investment in additive manufacturing, soft magnetics and the Athens facility’s qualification process.
- Fiscal 2020 capital expenditures were expected to be approximately $170. Management expected $3.8 of additional qualified pension contributions during the remainder of fiscal 2020 and total fiscal 2020 net periodic benefit costs of $15.0. No specific earnings or revenue guidance is provided in the filing text.
- Raw-material surcharges help recover input-cost increases but dilute reported margin percentages; about 25% of sales were under firm-price arrangements, which can expose margins to commodity-price and customer-volume risks. Management also cited trade actions and tariffs, weaker domestic oil and gas activity, and softer industrial demand.
- Environmental remediation liabilities were $15.9. Management said long-term effects were not expected to be material, but costs could be material in an individual quarter or year. Routine litigation and other claims were also disclosed; outcomes cannot be predicted.
- The company adopted lease accounting in fiscal 2020, recording $53.8 of operating lease right-of-use assets and liabilities at adoption. It reported a material weakness in billing-process controls related to accuracy and completeness of price, quantity and customer data. Disclosure controls were therefore deemed ineffective; no financial-statement misstatements were identified, and remediation was expected before fiscal 2020 year-end.
Important facts for investors to verify
- Whether SAO’s margin improvement and backlog growth translate into sustained sales, earnings and cash generation.
- Whether PEP’s operating loss narrows as additive-manufacturing investments progress, and whether the anticipated Athens qualifications are achieved.
- Working-capital and capital-spending trends, including progress toward the approximately $170 fiscal 2020 capital expenditure plan.
- Liquidity, revolver borrowings and covenant headroom if operating cash flow remains weak.
- Progress and testing of controls remediation, and any updates to environmental, litigation or other contingencies.
- How much of reported growth reflects underlying demand and product mix versus surcharge revenue; adjusted margins and free cash flow are non-GAAP measures.