Carpenter Technology Corporation — Form 10-Q Summary
Business context and reporting period
This filing covers the first quarter of fiscal 2017, the three months ended September 30, 2016, with comparisons to the quarter ended September 30, 2015. Carpenter manufactures, fabricates and distributes specialty metals and related products. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). Results are unaudited.
Financial highlights
| Metric | Quarter ended Sep. 30, 2016 | Prior-year quarter |
|---|---|---|
| Net sales | $389.0 million | $455.6 million |
| Gross profit / margin | $46.0 million / 11.8% | $68.6 million / 15.1% |
| Operating income | $1.4 million | $24.8 million |
| Net income (loss) | $(6.2) million; $(0.13) diluted EPS | $8.9 million; $0.18 diluted EPS |
| Operating cash flow | $3.9 million | $41.5 million |
| Capital expenditures | $26.6 million | $29.9 million |
| Free cash flow (company-defined) | $(31.2) million | $6.6 million |
Sales excluding raw-material surcharge revenue were $339.8 million, down 12%. Gross margin excluding surcharge revenue was 13.5%, versus 17.8%. Adjusted diluted loss per share, excluding specified special items, was $0.08, compared with adjusted earnings of $0.26 a year earlier; these are non-GAAP measures.
At September 30, cash was $50.9 million, current assets were $1,043.1 million and current liabilities were $264.3 million. Long-term debt was $609.6 million. The $500 million revolving facility had $494.2 million available after letters of credit; reported total liquidity was $545.1 million. The company was in covenant compliance: interest coverage was 9.2x against a 3.5x minimum, and debt to capital was 35.2% against a 55% maximum. In October, after quarter-end, Carpenter paid a voluntary $100 million pension contribution.
Material changes versus the prior comparable period
- Net sales fell 15%; shipment volume declined 7%. Management attributed the weakness to lower demand and less favorable product mix, partly offset by operating cost efficiencies.
- SAO sales declined 15% to $315.1 million and operating income fell to $25.0 million from $41.1 million. PEP sales declined 14% to $78.5 million, and its operating loss widened to $2.8 million from $0.4 million.
- Sales declined across all listed end markets: Aerospace and Defense 13%, Energy 26%, Transportation 19%, Medical 14%, Industrial and Consumer 14%, and Distribution 6%.
- Operating cash flow decreased to $3.9 million, with negative free cash flow; inventory increased to $661.6 million from $628.7 million at June 30.
- Cash declined to $50.9 million from $82.0 million at June 30. Debt was broadly stable at $609.6 million, compared with $611.3 million.
Outlook, management commentary, risks and unusual items
- Management cited aerospace submarket uncertainty, lower program build rates and supply-chain inventory reduction, especially in fasteners and structural products. New-engine-platform volumes were up year over year, but transactional aerospace orders were below expectations. Management sees longer-term aerospace growth potential but gave no specific revenue or earnings forecast.
- Management plans to continue cost reductions and operating-efficiency work through the Carpenter Operating Model. It expects fiscal 2017 net periodic pension costs of $48.2 million, versus $53.8 million in fiscal 2016, and estimated $50 million in annual run-rate net cost savings from freezing defined-benefit accruals for certain employees effective December 31, 2016. About 1,900 employees are affected.
- The quarter included a $0.5 million pension curtailment charge and a $2.1 million discrete tax charge related to the subsequent $100 million pension contribution. The pension-plan remeasurement reduced accrued pension liabilities by $18.7 million during the quarter.
- Demand softness in energy reflected continued low oil and gas drilling activity; the North American directional rig count was down 41% year over year. Other cited risks include cyclical markets, raw-material and energy prices, customer and supplier consolidation, foreign exchange, pension asset and liability valuation, and the ability to deliver cost savings.
- Environmental remediation liabilities were $16.0 million at quarter-end; management said reasonably estimable future costs were not expected to be material long term, while noting costs could be material in a particular period. Routine legal matters were not believed likely to materially affect long-term results, but outcomes remain uncertain.
- Commodity hedging warrants attention: the company reported about $21.7 million of net deferred losses on commodity forwards, approximately 53% related to contracts supporting firm-price sales with one customer. Alcoa represented about 12% of quarterly sales; Alcoa and Precision Castparts together accounted for about 24% of receivables.
Key facts for investors to verify
- Whether aerospace order patterns, shipment volumes and product mix stabilize, and whether new-engine growth offsets weakness in fasteners and structural applications.
- Whether cost actions improve operating performance and whether the announced pension freeze delivers expected savings; consider the cash and liquidity effect of the $100 million contribution.
- Whether inventory converts to cash and operating cash flow recovers from the quarter’s low level.
- The company’s exposure to deferred commodity-hedge losses and customer performance under firm-price arrangements, especially the concentrated single-customer exposure.
- Continued covenant headroom, available borrowing capacity and the status of environmental and other legal contingencies.