Carpenter Technology Corporation — Form 10-Q Summary
Business and period: Carpenter manufactures, fabricates and distributes specialty metals and engineered products. This report covers the quarter and six months ended December 31, 2018 (fiscal 2019 Q2), compared with the corresponding prior-year periods. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP).
Financial performance
| Metric | Quarter ended Dec. 31, 2018 | Six months ended Dec. 31, 2018 |
|---|---|---|
| Net sales | $556.5 million; +14% year over year | $1,128.9 million; +17% |
| Sales excluding raw-material surcharges | $449.4 million; +8% | $905.8 million; +10% |
| Gross profit / margin | $107.0 million / 19.2% | $198.7 million / 17.6% |
| Operating income / margin | $55.4 million / 10.0% | $100.4 million / 8.9% |
| Net income | $35.5 million | $67.0 million |
| Diluted EPS | $0.73; adjusted $0.76 | $1.38; adjusted $1.41 |
| Operating cash flow | Not separately reported for the quarter | $47.2 million, versus $17.3 million |
Quarterly gross margin excluding surcharges was 23.8%, up from 20.6%; the six-month measure was 21.9%, versus 20.8%. Adjusted EPS and surcharge-adjusted margins are non-GAAP measures as defined by the company.
Cash, debt and liquidity: At December 31, cash was $28.5 million, short-term revolver borrowings were $100.6 million and long-term debt was $547.7 million. The $400 million revolving facility had $293.4 million available; reported total liquidity was $321.9 million. The company reported compliance with its covenants, including actual interest coverage of 13.08-to-1 against a 3.50 minimum and debt-to-capital of 30.1% against a 55% maximum.
Cash investment: Six-month investing cash outflow was $157.7 million, including $81.7 million of capital expenditures and $79.0 million for the LPW acquisition. Free cash flow, the company’s non-GAAP measure that also subtracts dividends, was negative $132.7 million, versus negative $55.6 million. Inventory rose to $844.2 million from $689.2 million at June 30, 2018; cash declined from $56.2 million.
Material changes and business drivers
- Quarterly sales growth reflected 6% higher shipment volume and favorable mix; excluding surcharges, sales rose 8%. Aerospace and defense sales increased 13%, energy 35%, and industrial and consumer 17%. Transportation demand was affected by trade actions and tariffs.
- SAO quarterly operating income increased to $69.0 million from $49.8 million. PEP operating income declined to $4.4 million from $7.5 million, reflecting order timing and a $1.4 million LPW-related loss.
- Management reported the strongest second-quarter performance since fiscal 2013, backlog growth of 49% year over year and ten consecutive quarters of sequential backlog growth. Aerospace and defense backlog grew 21% sequentially.
- Carpenter acquired LPW Technology Ltd. on October 22, 2018, for $79.0 million net of cash acquired. The preliminary allocation included $69.8 million of goodwill; valuation was not final. LPW adds metal-powder lifecycle and additive-manufacturing capabilities.
Outlook, risks and unusual items
- No specific earnings or sales guidance is provided. Management expects fiscal 2019 capital expenditures of approximately $190 million and expects $2.4 million of additional qualified pension contributions in the remainder of the fiscal year. It expects fiscal 2019 net periodic benefit costs of $11.4 million.
- Management cited continued investment in additive manufacturing and soft magnetics, operating-model execution and further Athens facility qualifications as priorities.
- Quarterly results included a $4.7 million insurance recovery benefiting gross and operating income, $1.2 million of acquisition-related costs, and unfavorable returns on life-insurance and rabbi-trust investments. PEP included the $1.4 million LPW-related loss.
- Net income comparisons are heavily affected by the prior-year tax benefit: the 2017 quarter included a $66.0 million net tax benefit from U.S. tax reform and other legislative changes. The 2018 quarter had $9.7 million of tax expense; its effective rate was 21.5%.
- Commodity-price movements, surcharge timing and firm-price contracts can affect margins. The company reported $18.1 million of net deferred commodity-hedge losses; approximately 55% related to contracts supporting firm-price arrangements with one customer. That customer also represented about 13% of receivables at quarter end.
- Other disclosed risks include cyclical end markets, tariffs and currency movements, acquisition integration, specialized-facility disruption, raw-material and energy availability, and pension-asset valuation. Environmental remediation liabilities were $15.9 million; management said long-term effects were not expected to be material, while a particular quarter or year could be affected. The filing also identifies cyber threats as a risk.
Most important facts for investors to verify
- Whether backlog growth converts into shipments and earnings, and whether strong aerospace, energy and other end-market demand persists.
- Whether margin gains excluding surcharges are sustainable, separating recurring operating improvements from the $4.7 million insurance recovery and other special items.
- Whether working-capital needs, inventory growth and planned capital spending allow cash generation to improve after the acquisition-related outflows.
- LPW’s final purchase-price allocation, integration progress and contribution to PEP results.
- Exposure to the concentrated customer through receivables and commodity hedges, and the potential impact if customer commitments or forecasts change.
- Liquidity, covenant compliance and refinancing conditions; the filing reports compliance and available capacity at December 31, 2018.