Carpenter Technology Corporation — Form 10-Q Summary
Business context and reporting period
Carpenter manufactures, fabricates and distributes specialty metals and related products. This filing covers the quarter and six months ended December 31, 2016, the second quarter and first half of fiscal 2017. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). Unless noted otherwise, amounts are in millions of dollars.
Financial performance and position
| Metric | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2016 |
|---|---|---|
| Net sales | $427.4; down 4% year over year | $816.3; down 9% |
| Gross profit and margin | $62.5; 14.6% margin | $108.5; 13.3% margin |
| Operating income | $15.4; 3.6% margin | $16.8; 2.1% margin |
| Net income and diluted EPS | $7.0; $0.15 | $0.8; $0.01 |
| Operating cash flow | Not presented by quarter | $(25.8), versus $71.6 provided in prior-year period |
| Capital spending | Not presented by quarter | $45.1 |
| Free cash flow | Not presented by quarter | $(87.9), versus $8.5 positive in prior-year period |
Gross margin excluding surcharge revenue was 17.0% for the quarter and 15.4% for the six months, compared with 17.5% and 17.6%, respectively, in the prior-year periods. Management’s non-GAAP operating margin, excluding surcharge revenue, pension earnings, interest and deferrals (EID), and special items, was 5.7% for the quarter and 4.2% for the six months, versus 7.7% and 8.1%.
At December 31, cash was $22.5, total debt was $629.0 ($25.0 short-term and $604.0 long-term), and total liabilities were $1,647.1. The $500.0 revolving credit facility had $469.2 available, including after $5.8 of letters of credit; reported total liquidity was $491.7. The company reported compliance with its covenants: interest coverage of 8.93x against a 3.50x minimum, and debt to capital of 35.8% against a 55% maximum. Inventory was $700.7, up from $628.7 at June 30, 2016. Accrued pension liabilities fell to $405.3 from $509.3.
Material changes versus the prior comparable periods
- Quarterly sales fell 4%; excluding surcharges, sales declined 3% on 6% lower shipment volume. For the first half, sales fell 9%; excluding surcharges, they declined 8% on 7% lower volume.
- Quarterly net income declined to $7.0 from $11.5 and diluted EPS to $0.15 from $0.23. First-half net income fell to $0.8 from $20.4 and diluted EPS to $0.01 from $0.41. Prior-year adjusted EPS was $0.24 for the quarter and $0.51 for the first half; current-period adjusted EPS was $0.15 and $0.06, respectively.
- SAO quarterly operating income was $35.6, down from $41.5. PEP returned to quarterly operating income of $0.8 from a loss of $2.9, its first positive result in six quarters; its first-half operating loss was $2.0, improved from $3.3.
- Operating cash flow swung to an outflow, chiefly reflecting the $100.0 voluntary pension contribution and higher inventory, partly offset by approximately $39 of cash tax benefits associated with the contribution. The company also paid $17.0 in dividends.
Outlook, management commentary, risks and unusual items
- Management described stronger product mix and improving conditions in several markets, particularly Aerospace and Defense, and signs of Energy-market recovery. It cited new-engine demand, cost efficiencies and backlog growth, and expects further PEP operating-margin leverage if demand improves. It provided no specific revenue or EPS forecast in this filing.
- Management expects fiscal 2017 net periodic benefit costs of $48.2, compared with $53.8 in fiscal 2016, and expects no further qualified-plan contributions for the remainder of fiscal 2017. It froze future pension benefit accruals for approximately 1,900 eligible employees effective December 31, 2016; the first-half results include a $0.5 curtailment charge.
- The company’s principal exposures include cyclical end markets, weak oil and gas activity, raw-material and energy prices, currency movements, pension-asset and liability valuations, customer and supplier concentration, and execution of cost reductions and growth plans. One customer, Arconic, represented approximately 15% of first-half sales and 23% of receivables at December 31.
- Net deferred commodity-hedge losses were approximately $16.6; about 39% related to contracts supporting firm-price arrangements with one customer, alongside credit already extended to that customer. A customer default or failure to meet volume commitments could expose the company to losses.
- Environmental remediation liabilities were $16.1. Management said routine litigation and other claims were not expected to have a material long-term effect, while noting that particular future periods could be affected. The company reported no impairment trigger from its first-half results.
- On January 30, 2017, after quarter-end, Carpenter agreed to acquire substantially all assets of titanium-powder producer Puris LLC for $35.0 in cash, subject to customary closing conditions; closing was expected in the quarter ending March 31, 2017. The share-repurchase authorization expired in October 2016 and was not extended.
Important facts for investors to verify
- Whether volume, product mix and demand recovery improve enough to reverse the first-half decline in sales, margins and earnings, especially across SAO and PEP.
- Whether working capital and inventory normalize and operating cash flow recovers after the pension contribution and seasonal first-half inventory build.
- Liquidity, covenant headroom and debt requirements as the $500.0 credit facility approaches its June 2018 expiry.
- Customer performance under firm-price sales arrangements and the exposure represented by concentrated receivables and commodity-hedge losses.
- Closing, integration and expected economics of the Puris acquisition, and the realized effects of pension-plan changes and future benefit costs.