Carpenter Technology Corporation — Q2 FY2018 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2017. The company manufactures, fabricates and distributes specialty metals and reports two segments: Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). Comparisons below are with the corresponding prior-year periods unless noted.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $487.8 million, up 14% | $967.5 million, up 19% |
| Gross profit and margin | $85.7 million; 17.6%, versus $62.5 million and 14.6% | $171.3 million; 17.7%, versus $108.5 million and 13.3% |
| Operating income and margin | $40.8 million; 8.4%, versus $15.4 million and 3.6% | $82.5 million; 8.5%, versus $16.8 million and 2.1% |
| Net income | $92.1 million, including a tax benefit; prior year $7.0 million | $115.5 million, including a tax benefit; prior year $0.8 million |
| Diluted EPS | $1.92 reported; $0.55 excluding the $66 million tax-reform benefit | $2.41 reported; $1.03 excluding the $66 million tax-reform benefit |
| Operating cash flow | $17.3 million for the six months, versus cash used of $25.4 million |
- Sales excluding raw-material surcharge revenue increased 13% in the quarter and 17% year to date. Shipment volume rose 13% and 15%, respectively. Higher demand and product mix supported earnings and margins; management estimated surcharge lag reduced quarterly operating income by $3.0 million.
- For the six months, capital expenditures were $55.7 million, dividends paid were $17.2 million, and reported free cash flow (company-defined as operating cash flow less capital expenditures and dividends) was negative $55.6 million, improving from negative $87.5 million.
- Cash was $20.7 million at December 31, 2017, down from $66.3 million at June 30. Total debt was approximately $612.6 million, including $9.3 million of revolving-credit borrowings; long-term debt including the current portion was $603.3 million. The $400 million revolving facility had $384.7 million available after borrowings and letters of credit. Total liquidity was $405.4 million.
- Current assets were $1,159.5 million and current liabilities $387.8 million. Inventories increased to $771.8 million from $690.4 million at fiscal year-end, contributing to working-capital cash use.
- SAO quarterly sales were $406.3 million, up 17%, and operating income was $49.8 million, up from $35.6 million. PEP sales were $104.8 million, up 26%, and operating income was $7.5 million, versus $0.8 million. For the six months, SAO operating income was $100.3 million versus $60.6 million; PEP improved to $12.8 million from an operating loss of $2.0 million.
Material changes and unusual items
- The quarter’s and half-year’s unusually high reported net income primarily reflects U.S. tax reform enacted December 22, 2017. Carpenter recorded a provisional $66.0 million net discrete tax benefit, including a $73.3 million deferred-tax remeasurement benefit, a $5.1 million transition-tax charge and a $2.2 million state-tax charge. The federal corporate rate reduction from 35% to 21% takes effect January 1, 2018. The company said the tax calculations remain provisional and may be adjusted.
- Excluding surcharge revenue, quarterly gross margin was 20.6%, up from 17.0%; for the six months it was 20.8%, up from 15.4%. The company’s non-GAAP adjusted operating margin for the six months, excluding surcharge, pension earnings/interest/deferrals and special items, was 10.1%, versus 4.2%.
- Six-month pension and postretirement benefit costs were $7.1 million, compared with $31.0 million a year earlier. Management expected total FY2018 net periodic benefit costs of $14.0 million, versus $48.2 million in FY2017.
- The company acquired substantially all Puris LLC assets in February 2017 for $35.3 million, adding titanium powder and additive-manufacturing capabilities. It divested its Specialty Steel Supply business in FY2017 for $12.0 million.
Outlook, commentary and risks
- Management described demand and backlog as improving, citing stronger aerospace and defense, medical, and industrial and consumer markets. It reported progress on qualifications for its Athens facility and said it was working with major customers to secure approvals. It also planned to accelerate investment in additive manufacturing and soft magnetics following U.S. tax reform.
- FY2018 capital expenditures were expected to be approximately $135 million. Management expected to contribute approximately $1.8 million more to qualified pension plans during the remainder of FY2018. The $55.0 million medium-term notes due in FY2018’s fourth quarter were expected to be funded with available cash. No quantified earnings or revenue guidance is provided in the filing.
- Management said cash and available credit should fund foreseeable needs. The company reported compliance with its credit covenants: interest coverage of 10.91 to 1.00 against a 3.50 minimum, and debt-to-capital of 31.4% against a 55% maximum.
- Key exposures include cyclical end markets, raw-material and energy prices, surcharge timing, customer commitments and product mix, foreign exchange, pension asset and liability assumptions, oil and gas conditions, and specialized manufacturing equipment. One customer, Arconic, represented about 10% of current-quarter and six-month sales; two customers accounted for about 22% of receivables at December 31.
- Recorded environmental remediation liabilities were $16.2 million. The company also faces routine litigation and potential environmental claims whose ultimate outcomes and costs may be uncertain; management did not expect the recorded matters to have a long-term material effect, but noted future matters could affect a particular period.
Important facts for investors to verify
- How much of the reported earnings increase reflects operating improvement versus the one-time, provisional tax-reform benefit; review the company’s non-GAAP reconciliations and assumptions.
- Whether improving demand, backlog and product mix persist, including the pace of customer approvals for the Athens facility and recovery in energy markets.
- Whether inventory and other working-capital investment converts to cash as shipments grow, while planned capital spending increases.
- Debt maturities, liquidity and covenant headroom, particularly around the $55.0 million notes due in FY2018’s fourth quarter.
- Developments in tax-reform estimates, customer concentration, surcharge recovery and environmental or litigation exposures.