Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: Three months ended September 30, 2018, Carpenter’s first quarter of fiscal 2019. The filing is unaudited. Comparisons are with the three months ended September 30, 2017, unless otherwise stated.
Business context and results
Carpenter manufactures, fabricates, and distributes specialty metals and related products. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). Management attributed the quarter’s improvement to stronger end-market demand, improved product mix, execution of its commercial strategy, and a lower tax rate; annual maintenance shutdowns were a near-term headwind.
| Metric | Q1 FY2019 | Prior-year quarter |
|---|---|---|
| Net sales | $572.4 million | $479.8 million |
| Gross profit / margin | $91.7 million / 16.0% | $85.7 million / 17.9% |
| Operating income / margin | $45.0 million / 7.9% | $42.2 million / 8.8% |
| Income before taxes | $40.3 million | $35.2 million |
| Net income | $31.5 million | $23.4 million |
| Diluted earnings per share | $0.65 | $0.49 |
| Operating cash flow | $9.4 million | $(7.4) million |
| Capital expenditures | $41.6 million | $28.9 million |
Financial position and material changes
- Sales increased 19%; excluding raw-material surcharge revenue, sales rose 11% to $456.3 million, on 4% higher shipment volume. Surcharge revenue was $116.1 million, compared with $70.0 million.
- Gross profit rose 7%, but reported gross margin declined to 16.0%. Excluding surcharge revenue, gross margin was 20.1%, versus 20.9%. Operating margin excluding surcharges was 9.9%, versus 10.3%.
- All reported end-use markets grew in sales. Aerospace and defense sales rose 20% to $310.7 million; energy rose 38% to $44.3 million; medical rose 23% to $47.0 million. SAO sales increased 20% and operating income increased to $52.8 million. PEP sales increased 11% and operating income increased to $7.3 million.
- Effective tax rate fell to 21.8% from 33.5%, reflecting the lower U.S. federal tax rate and a discrete employee share-based compensation benefit. Management also noted that prior-year tax-reform estimates remain provisional.
- Cash and equivalents were $17.0 million at September 30, down from $56.2 million at June 30. Free cash flow, as defined by the company (operating cash flow less capital spending, plus property-disposal proceeds and less dividends), was negative $41.7 million, compared with negative $44.9 million.
- Inventory increased to $740.5 million from $689.2 million. Operating cash flow benefited from higher earnings and working-capital movements, but was affected by inventory growth and other accrued-liability payments.
- Long-term debt was $545.5 million, essentially unchanged from June 30. The company reported $394 million of available capacity under its $400 million revolving credit facility, $411 million total liquidity including cash, and compliance with its debt covenants. Actual interest coverage was 12.35x against a 3.50x minimum; debt-to-capital was 26.8% against a 55% maximum.
- Other comprehensive loss was $21.3 million, largely reflecting a $23.0 million after-tax loss on derivatives. These cash-flow hedge changes were recorded in other comprehensive income, not as an equivalent current-period operating loss.
Outlook, commentary, risks, and unusual items
- Management said backlog was up 38% from the year-earlier first quarter and described demand as strong, including aerospace and defense and medical. The filing provides no earnings or revenue guidance.
- Fiscal 2019 capital expenditures were expected to be approximately $190 million. Management expected $3.2 million of additional qualified pension-plan contributions during the remainder of fiscal 2019 and total fiscal-year net periodic benefit costs of $11.4 million, versus $14.0 million in fiscal 2018.
- Management stated that $17 million of cash and $394 million of available facility capacity should fund foreseeable needs; its target minimum liquidity is $150 million. It cited growth investment, including additive manufacturing and soft magnetics, as a reason for higher capital spending.
- On October 22, 2018, after quarter-end, Carpenter acquired LPW Technology Ltd. for approximately $81 million in cash. LPW supplies advanced metal powders and powder lifecycle-management solutions for additive manufacturing. The filing does not provide post-acquisition operating results.
- Key risks identified include specialty-materials market cyclicality, raw-material and energy costs and surcharge recovery, customer and supplier concentration or consolidation, foreign exchange and trade actions, pension-asset valuation, labor and manufacturing interruptions, oil and gas conditions, and acquisition integration. The company also cited environmental remediation and routine litigation; recorded environmental liabilities were $15.9 million. Management said these matters were not expected to have a material long-term effect, while noting particular future periods could be affected.
- Commodity and foreign-exchange hedges reduce exposures but can create losses if customer commitments or forecast transactions change. The company reported a large quarterly negative mark in cash-flow hedge amounts within other comprehensive income. It stated that specified 10% raw-material/energy-price and U.S.-dollar sensitivity scenarios would not materially affect results.
Important facts for investors to verify
- Whether demand and backlog growth translate into sustained shipment growth and improved margins, particularly after maintenance shutdowns.
- How much of sales growth and margin movement reflects surcharges versus underlying price, volume, and product mix.
- Working-capital requirements, inventory growth, capital spending, and the effect on cash generation and liquidity.
- Integration, funding, and expected returns from the LPW acquisition, alongside the company’s other growth investments.
- Changes in derivative values and hedge timing, tax estimates under the 2017 U.S. tax law, and environmental or legal exposures.