Business context and reporting period
Carpenter Technology Corporation’s Form 10-Q covers its fiscal first quarter ended September 30, 2020, compared with the quarter ended September 30, 2019. The company produces and distributes specialty alloys and related products through Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP), serving aerospace and defense, medical, transportation, energy, industrial and consumer, and distribution markets.
Financial performance and liquidity
| Metric | Q1 FY2021 | Q1 FY2020 |
|---|---|---|
| Net sales | $353.3 million | $585.4 million |
| Gross profit / margin | $3.5 million / 1.0% | $112.6 million / 19.2% |
| Operating income (loss) | $(48.8) million | $59.8 million |
| Net income (loss) | $(47.1) million | $41.2 million |
| Diluted EPS | $(0.98) | $0.85 |
| Cash from operating activities | $88.0 million | $0.7 million |
| Capital expenditures | $33.3 million | $47.5 million |
Management reported adjusted loss per diluted share of $0.58, excluding debt prepayment costs, restructuring and impairment charges, and COVID-19 costs. Adjusted operating margin excluding surcharge revenue and special items was negative 10.1%, versus positive 12.3% a year earlier. These are non-GAAP measures.
Free cash flow, as defined by the company, was $62.6 million, compared with negative $56.4 million. It includes $17.6 million of proceeds from the Amega West divestiture. Working-capital changes were a major source of operating cash: inventory reductions generated $84.9 million and accounts receivable collections generated $42.0 million. Cash and equivalents were $218.9 million at quarter-end, with total available liquidity of $612.9 million, including $394.0 million available under the revolving facility.
Long-term debt was $693.8 million, up from $551.8 million at June 30, 2020; cash less reported debt was approximately $474.9 million. In July, the company issued $400 million of 6.375% senior notes due 2028 and used part of the proceeds to repay $250 million of notes due July 2021. The quarter included $8.2 million of net debt prepayment costs. The company reported compliance with credit-facility covenants; its actual interest coverage ratio was 6.68 to 1.00 against a 3.50 minimum, and debt-to-capital was 33.0% against a 55% maximum.
Material changes versus the prior comparable period
- Sales fell 40%; excluding surcharge revenue, sales declined 37% on a 29% decrease in shipment volume.
- Aerospace and defense sales decreased 51%, medical 33%, transportation 27%, and energy 36%. Industrial and consumer sales were approximately flat, while sales excluding surcharges in that market increased 5%.
- SAO sales declined 39% and the segment moved from $81.0 million operating income to an $18.6 million loss. PEP sales declined 44%; its operating loss widened to $3.6 million from $2.0 million.
- Gross margin contracted sharply amid lower volume, inventory reduction, COVID-19 disruption and the Boeing 737 MAX production halt. SG&A fell to $42.3 million from $52.8 million, including a $6.7 million reduction in salaries and benefits.
- Inventory fell to $633.9 million from $724.3 million at June 30, 2020. Cash increased from $193.1 million, while current liabilities declined from $452.1 million to $264.5 million, including repayment of $170 million in short-term credit-facility borrowings.
Outlook, management commentary, risks and unusual items
Management said COVID-19 headwinds were expected to continue affecting demand across end markets, while describing the long-term outlook for its markets as solid. It emphasized cost discipline, cash generation, customer supply agreements, and growth opportunities in soft magnetics and additive manufacturing. No specific sales or earnings guidance was provided. Fiscal 2021 capital expenditures were expected to be approximately $120 million; the company expected to contribute a further $16.4 million to qualified pension plans during the rest of the fiscal year.
- The quarter included $10.0 million of restructuring and asset impairment charges, including $8.7 million of non-cash impairment and $1.3 million of personnel-related charges for consolidating Additive operations. The company expected this plan to be substantially complete in fiscal Q2.
- COVID-19-related costs were approximately $7.9 million, including $3.1 million associated with an aerospace customer bankruptcy. Management cited enhanced cleaning, protective equipment and other employee-safety costs.
- Amega West was sold for $20.0 million on September 30; $17.6 million was received in the quarter and $2.4 million remained in escrow. The company reported no significant continuing operational involvement.
- The company identified potential future goodwill or intangible-asset impairment risk if COVID-19 or other developments weaken forecasts. At June 30, 2020, Additive’s carrying value exceeded fair value by approximately 24.1%; SAO’s fair value exceeded carrying value by approximately 4.5%.
- Environmental remediation liabilities were $16.1 million. Management did not expect known environmental or routine legal matters to have a material long-term effect, but noted that costs could be material in a particular quarter or year; some potential site costs could not be reasonably estimated.
- Other risks include continuing pandemic effects, aerospace demand and the 737 MAX disruption, customer and supply-chain conditions, commodity and currency movements, pension assumptions, covenant compliance, and execution of restructuring and business exits.
Important facts for investors to verify
- Whether sales volumes and margins stabilize as COVID-19 effects and the 737 MAX disruption evolve, particularly in aerospace and defense and medical markets.
- How much of operating cash flow and reported free cash flow is repeatable; the quarter benefited from inventory and receivables reductions and Amega West proceeds.
- Debt-service costs and refinancing capacity following the 2028 notes issuance, including continued covenant headroom.
- Whether planned cost reductions, restructuring and Additive consolidation deliver expected savings without further impairments.
- Whether goodwill valuations, environmental liabilities and customer-related exposures change as economic and operating conditions develop.