Carpenter Technology Corporation — Form 10-Q Summary
Business context and reporting period. This filing covers the first quarter of fiscal 2016, the three months ended September 30, 2015, with comparisons to the three months ended September 30, 2014. Carpenter manufactures, fabricates and distributes specialty metals and related products. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). Amounts below are in millions except per-share data.
Financial performance
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Net sales | $455.6 | $549.8 |
| Gross profit / gross margin | $68.6 / 15.1% | $69.1 / 12.6% |
| Operating income | $24.8 | $22.1 |
| Income before taxes | $16.1 | $20.0 |
| Net income | $8.9 | $13.5 |
| Diluted EPS | $0.18 | $0.25 |
| Operating cash flow | $41.5 | $15.0 |
| Capital expenditures | $29.9 | $59.0 |
- Net sales fell 17%; excluding raw-material surcharge revenue, sales decreased 12% to $385.1. Shipment volume declined 19%.
- Gross profit dollars were nearly flat, while reported gross margin improved to 15.1%. Excluding surcharge revenue, gross margin was 17.8%, versus 15.7%.
- Management reported adjusted diluted EPS of $0.26, excluding restructuring charges, consulting costs and a discrete tax item; this is a non-GAAP measure.
- Income tax expense was $7.2, or 44.7% of pretax income, versus $6.5, or 32.5%, in the prior-year quarter. The current quarter included a $2.0 discrete deferred tax charge related to a change in plans for foreign earnings.
- Operating cash flow was $41.5. Management-defined free cash flow was positive $6.6, compared with negative $53.5; this non-GAAP measure includes capital spending, dividends and insurance proceeds.
Material changes and segment performance
- Weakness in Energy, particularly oil and gas, and related softness in Industrial and Consumer markets drove much of the decline. Energy sales fell 53% to $37.2; Industrial and Consumer sales fell 32% to $87.4.
- Aerospace and Defense sales declined 3% to $228.9, while Transportation sales rose 8% to $45.1. Excluding surcharges, Transportation sales increased 19%.
- SAO sales decreased 15% to $372.6, but operating income rose to $41.1 from $24.6, reflecting product mix, cost improvements and a $4.0 insurance recovery, partly offset by lower volume.
- PEP sales declined 30% to $91.5, and the segment recorded an operating loss of $0.4 versus income of $9.7, primarily reflecting reduced oil-and-gas-related rentals and down-hole drilling tool sales.
- Other expense was $2.1, versus other income of $4.9 a year earlier. The current period included foreign-exchange and investment-related losses; the prior-year period included a favorable $4.4 legal settlement.
Balance sheet, liquidity and debt
- At September 30, cash and equivalents were $30.6, total assets $2,871.1, total liabilities $1,593.9 and stockholders’ equity $1,277.2.
- Long-term debt was $611.0, compared with $607.1 at June 30, 2015. The company reported $492.9 available under its $500.0 revolving credit facility, after $7.1 of letters of credit, and total liquidity of $523.5. It was compliant with covenants; reported interest coverage was 10.71-to-1 against a 3.50-to-1 minimum, and debt-to-capital was 33% against a 55% maximum.
- Inventory increased to $686.7 from $655.8 at June 30. Management said it intended to reduce inventory from June 30 levels. Working capital changes included a $33.0 cash use from inventory growth.
- The company repurchased 1,206,600 shares for $45.9 during the quarter. $329.6 remained authorized for future repurchases under the $500.0, two-year program. Quarterly dividends remained $0.18 per share.
Outlook, risks and contingencies
- Management expected second-quarter volume to be in line with the first quarter and forecast higher volumes in the second half of fiscal 2016, citing expected Aerospace demand and Transportation opportunities. It also cited continued cost-improvement and working-capital efforts and stated that cash deployment would prioritize the repurchase program.
- Management warned that a further deterioration or longer-than-expected downturn in oil and gas could prompt additional cost actions, restructuring charges or asset impairment charges. The filing identifies cyclicality, raw-material and energy costs, foreign exchange, pension valuations, customer demand, credit availability and execution of restructuring as risks.
- Environmental remediation liabilities were $15.9. The company noted additional potential Superfund exposure for which costs could not then be reasonably estimated. Routine litigation was not expected by management to have a material long-term effect, although a material effect in a particular period could not be ruled out.
- Net deferred losses on commodity forwards were approximately $59.5; about 62% related to contracts supporting firm-price sales arrangements with one customer, in addition to receivables exposure. Alcoa represented approximately 13% of quarterly sales and 16% of receivables at quarter-end.
- The fiscal 2016 estimated annual net periodic pension and postretirement benefit cost was $53.6, versus $44.5 for fiscal 2015. Management expected no qualified pension contributions for the remainder of fiscal 2016.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the expected second-half volume recovery materializes, especially in Aerospace and Transportation, and whether oil-and-gas weakness continues to affect PEP and related markets.
- Whether inventory declines as planned and operating cash generation remains sufficient to support capital needs, dividends and share repurchases.
- How the commodity hedge losses and concentrated customer exposure develop, including the customer’s performance under firm-price arrangements.
- Whether adjusted earnings comparisons appropriately account for the quarter’s tax charge, consulting costs, restructuring expense and SAO insurance recovery.
- Any change in credit-facility covenant headroom, environmental exposure, pension costs or potential restructuring and impairment charges.