Business context and reporting period
Carpenter Technology Corporation manufactures, fabricates and distributes specialty metals and related products. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). The filing covers the fiscal third quarter and first nine months ended March 31, 2019, compared with the periods ended March 31, 2018. The request metadata says “2018 Q3,” but the filing itself is for fiscal 2019 Q3.
Financial performance and position
- Third-quarter revenue and earnings: Net sales were $609.9 million, up 7% year over year. Net income was $51.1 million, or $1.05 per diluted share, versus $30.2 million, or $0.63 per diluted share.
- Third-quarter margins: Gross profit was $123.2 million (20.2% of sales), compared with $96.0 million (16.8%). Operating income was $73.2 million (12.0% of sales), versus $45.7 million (8.0%). Excluding surcharge revenue, gross margin was 24.5% versus 20.3%, and operating margin was 14.6% versus 9.7%.
- First nine months: Net sales were $1,738.8 million, up 13%; operating income was $173.6 million, up from $129.3 million. Net income was $118.1 million, down from $145.7 million, and diluted EPS was $2.43 versus $3.04. The prior-year comparison includes a $67.6 million net tax benefit from U.S. tax reform; adjusted diluted EPS was $2.46 versus $1.63.
- Cash flow and investment: Nine-month operating cash flow was $57.2 million, down from $90.7 million. The company-defined free cash flow was negative $169.7 million versus negative $21.0 million; its calculation includes capital spending, the LPW acquisition, dividends and other specified items. Capital expenditures were $130.7 million versus $80.9 million. Inventory increased to $861.0 million from $689.2 million at June 30, 2018, contributing to working-capital cash use.
- Liquidity and debt: At March 31, cash was $18.9 million; total liquidity was $285.9 million, including $267.0 million available under the $400 million revolving facility. Short-term revolver borrowings were $127.0 million and long-term debt was $549.0 million. The company reported compliance with covenants; actual interest coverage was 14.36:1 against a 3.50:1 minimum, and debt-to-capital was 30.3% against a 55% maximum.
- Other measures: The quarterly dividend was $0.20 per share, versus $0.18 a year earlier. The nine-month effective tax rate was 23.0%; the comparable prior period benefited from the tax-reform-related tax benefit.
Material changes and management commentary
- Management described strong demand, favorable product mix and a ninth consecutive quarter of year-over-year sales and earnings growth. Backlog was up 44% year over year, marking its eleventh consecutive quarterly increase.
- Quarterly sales excluding surcharge revenue rose 6% despite shipment volume declining 1%. Aerospace and defense, medical and energy sales grew; transportation and industrial and consumer sales were weaker or flat on an excluding-surcharge basis. Management cited trade actions and tariffs as affecting some customer orders.
- The $11.4 million insurance recovery materially benefited third-quarter results. Nine-month results included $16.1 million of insurance-recovery benefits. Management also cited stronger mix and operating-cost improvements.
- PEP quarterly sales increased 19% and operating income rose to $16.6 million from $5.4 million, including the insurance-recovery benefit. SAO quarterly sales increased 3% and operating income rose to $73.6 million.
- Carpenter acquired LPW Technology Ltd. in October 2018 for $79.0 million, net of cash acquired. The preliminary allocation included $59.0 million of goodwill; final purchase accounting was expected in fiscal Q4 2019.
Outlook, risks and contingencies
- Management expected fiscal 2019 capital expenditures of $180 million to $190 million and approximately $1.2 million of additional qualified pension contributions during the remainder of the fiscal year. It stated that cash and available credit should fund foreseeable needs and that it expected to remain covenant-compliant. No specific revenue or earnings guidance is provided in the supplied filing text.
- Management highlighted investment in additive manufacturing and soft magnetics, continued Athens facility qualification work, and a goal of balancing near-term earnings with long-term investment. It reported four additional Athens qualifications during the quarter.
- Commodity-price and customer-performance exposure warrant attention: the company reported $13.7 million of net deferred losses on commodity forward contracts, approximately 65% of which related to firm-price sales arrangements with one customer. The filing says customers have historically performed and management expects continued performance.
- Customer concentration increased: Arconic represented approximately 11% of quarterly sales and 13% of receivables at March 31, 2019. Other disclosed risks include cyclical end markets, raw-material and energy costs, trade actions, foreign exchange, pension assets, acquisition integration, specialized production equipment and oil-and-gas market fluctuations.
- Recorded environmental remediation liabilities were $16.0 million. Management said these and routine legal matters were not expected to have a material long-term effect, while noting they could be material in a particular quarter or year and that some potential remediation costs cannot yet be estimated.
Important facts for investors to verify
- Confirm the period: this is the fiscal quarter ended March 31, 2019, notwithstanding the request metadata’s “2018 Q3.”
- Assess how much of the earnings improvement reflects recurring operations versus the $11.4 million insurance recovery, and compare GAAP results with the company’s non-GAAP measures.
- Monitor inventory, working-capital cash use, capital spending and the trajectory of company-defined free cash flow.
- Review the customer concentration and commodity-hedge exposure associated with the customer underlying most of the deferred commodity losses.
- Track LPW integration and final purchase accounting, Athens qualifications, and delivery of the stated capital-spending plan.