Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2017. The request metadata labels this “2016 Q3,” but the filing itself is for the quarter ended March 31, 2017.
Business context and results
Carpenter manufactures, fabricates and distributes specialty metals and metal powders, serving aerospace and defense, energy, transportation, medical, industrial and consumer markets. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP).
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | $473.6 million, up 4% | $1,289.9 million, down 5% |
| Gross profit / margin | $83.1 million / 17.5% | $191.6 million / 14.9% |
| Operating income | $35.8 million; 7.6% margin | $52.6 million; 4.1% margin |
| Net income (loss) | $20.7 million, or $0.44 diluted EPS | $21.5 million, or $0.45 diluted EPS |
| Operating cash flow | Not separately presented for the quarter | $35.5 million |
| Capital expenditures | Not separately presented for the quarter | $63.1 million |
Financial position and liquidity
- At March 31, 2017, cash was $16.6 million, total debt was $618.3 million ($14.2 million short-term and $604.1 million long-term), and stockholders’ equity was $1,161.6 million.
- Working capital was $729.2 million; inventory was $718.3 million, up from $628.7 million at June 30, 2016.
- Nine-month free cash flow, as defined by the company, was negative $82.2 million versus positive $55.4 million a year earlier. Operating cash flow fell to $35.5 million from $137.2 million.
- Cash generation was affected by a $100 million voluntary pension contribution, the $35.3 million Puris acquisition and higher inventory. Management cited approximately $39 million of cash tax benefits associated with the pension contribution.
- A new $400 million revolving credit facility extends to March 2022. At quarter-end, $380 million was available after $14.2 million of borrowings and $5.8 million of letters of credit. Reported total liquidity, including cash, was $396.6 million.
- The company was in compliance with covenants: interest coverage was 8.94:1 against a 3.50:1 minimum; debt-to-capital was 34.7% against a 55% maximum.
Material changes versus the prior comparable period
- Quarterly sales rose 4%, with a 3% increase excluding surcharges and a 3% increase in shipment volume. Quarterly net income improved from a $23.9 million loss; the prior-year quarter included inventory, restructuring and goodwill impairment charges.
- Quarterly gross margin increased to 17.5% from 10.4%. Excluding surcharge revenue and the prior-year inventory write-down, management reported gross margins of 20.1% versus 17.4%.
- For the nine-month period, sales declined 5% and shipment volume declined 3%. Net income improved from a $3.6 million loss, but adjusted diluted EPS was $0.50 versus $0.81 in the prior year, reflecting weaker first-half demand and lower adjusted operating margin.
- Nine-month adjusted operating margin, excluding surcharges, pension earnings/interest/deferrals and special items, was 6.4% versus 8.3%.
- Quarterly SAO sales increased 3% and operating income rose to $51.9 million from $45.6 million. PEP sales increased 8%, and the segment returned to operating income of $4.7 million from a $0.9 million loss.
Outlook, management commentary and risks
- Management described improving demand in the third quarter, particularly in aerospace and defense, industrial and consumer, medical, and oil-and-gas-related markets. It said backlog was growing and cited operating efficiencies and potential operating leverage. The filing provides no specific sales or earnings forecast.
- The Puris asset acquisition, completed February 28 for $35.3 million, provides entry into titanium powder and additive manufacturing. Its purchase-price allocation was preliminary; management expected to finalize it in fiscal Q4 2017.
- Management expected fiscal 2017 net periodic pension benefit costs of $48.2 million, versus $53.8 million in fiscal 2016, and expected no further qualified-plan contributions for the remainder of fiscal 2017.
- Risks include cyclicality and uneven end-market recovery, raw-material cost and surcharge timing, customer volume commitments under firm-price contracts, foreign exchange, pension obligations, acquisition integration, and potential customer or supplier concentration. One customer represented about 10% of quarterly sales; another represented about 12% of nine-month sales. A single customer accounted for about 10% of receivables at quarter-end.
- Recorded environmental remediation liabilities were $16.2 million. Additional potential Superfund-site costs could not be reasonably estimated. Management said routine legal matters were not expected to have a material long-term effect, while noting that particular periods could be affected.
- Commodity and foreign-exchange derivatives expose the company to counterparty and market risks. About 27% of deferred commodity-contract losses related to contracts supporting firm-price sales with one customer. Management reported no material modeled effect from specified 10% commodity-price or U.S.-dollar changes.
Most important facts for investors to verify
- Whether the third-quarter demand and backlog improvement persisted, and how much of sales growth reflects volume, mix, surcharges or acquisition contribution.
- Whether free cash flow and working capital improve after the pension contribution and Puris purchase; assess inventory growth and cash levels alongside available credit.
- How SAO and PEP margins develop, particularly against the nine-month decline in adjusted operating margin and the uneven end-market recovery.
- Final Puris purchase-price allocation, integration progress and the acquisition’s contribution to revenue, earnings and cash flow.
- Exposure to pension assumptions and required contributions, as well as covenant headroom, customer concentration, firm-price contract performance and unquantified environmental matters.