Carpenter Technology Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2015; comparisons are with the corresponding 2014 periods. Financial statements are unaudited. Carpenter manufactures, fabricates and distributes specialty metals and related products through Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP).
Financial performance
| Metric | Three months ended Dec. 31, 2015 | Six months ended Dec. 31, 2015 |
|---|---|---|
| Net sales | $443.8 million, down 19% | $899.4 million, down 18% |
| Gross profit | $66.3 million; 14.9% margin | $134.9 million; 15.0% margin |
| Operating income | $21.8 million | $46.7 million |
| Net income | $11.5 million | $20.4 million |
| Diluted EPS | $0.23 | $0.41 |
| Cash from operations | Not presented separately for the quarter | $71.6 million |
| Capital expenditures | Not presented separately for the quarter | $49.5 million |
| Free cash flow, as defined by Carpenter | Not presented separately for the quarter | $8.5 million |
For the six-month period, sales excluding raw-material surcharge revenue fell 14% to $764.6 million, while shipment volume fell 17%. Reported gross margin was 14.0% in the prior-year six-month period; excluding surcharge revenue, gross margin was 17.6% versus 17.4%. In the quarter, reported gross margin was 15.5% a year earlier, and margin excluding surcharge revenue was 17.5% versus 19.1%.
Reported operating margin was 4.9% versus 8.2% in the quarter and 5.2% versus 6.1% for six months. Management’s non-GAAP operating margin, excluding surcharge revenue, pension earnings, interest and deferrals (EID), and specified special items, was 7.7% versus 10.6% in the quarter and 8.1% in both six-month periods. These adjusted measures are not GAAP results.
At December 31, cash was $21.1 million; short-term debt was $39.5 million and long-term debt was $608.4 million. Total debt was therefore $647.9 million. The $500 million revolving facility had $452.9 million available, and reported total liquidity was $474.0 million. The company reported compliance with credit covenants: interest coverage of 9.96x against a 3.50x minimum and debt-to-capital of 35% against a 55% maximum.
Material changes and operating drivers
- Quarterly sales excluding surcharges declined 15%, primarily due to weaker Energy and Industrial and Consumer demand. Energy sales fell 67% and Industrial and Consumer sales fell 33%; Aerospace and Defense sales declined 2%, while Transportation and Medical were broadly stable.
- For six months, SAO operating income rose to $82.7 million from $68.0 million, helped by product mix, cost improvements and a $4 million insurance recovery, despite lower volume. PEP shifted to a $3.3 million operating loss from $22.2 million income, primarily reflecting oil-and-gas weakness.
- Six-month net income declined to $20.4 million from $37.6 million. Prior-year results included a $4.4 million favorable legal settlement in other income. Current-period costs included $5.1 million of consulting costs and $0.4 million of restructuring charges.
- Operating cash flow increased to $71.6 million from $27.5 million. Capital spending fell to $49.5 million from $127.4 million, largely as construction spending on the Athens facility wound down. Cash declined by $48.9 million during the six months, including $96.3 million used for share repurchases.
- Inventory rose $31.9 million from June 30 to $687.7 million. Management expects inventory to decline in the second half of fiscal 2016 and end the year roughly in line with June 30, 2015 levels.
Outlook, risks and unusual items
- Management expects second-half fiscal 2016 volumes to be up modestly from the first half, while emphasizing cost control, operational improvements, working-capital efficiency and capital-spending discipline. No EPS or revenue guidance is provided.
- Management warned that further deterioration or a longer oil-and-gas downturn could require additional cost actions, restructuring charges or asset impairments. Goodwill at certain oil-and-gas-exposed reporting units, including Amega West and Specialty Steel Supply, is particularly sensitive to the duration of the downturn.
- One customer, Alcoa, represented approximately 14% of sales for both the quarter and six-month period, and 15% of receivables at December 31. Carpenter disclosed $67.3 million of net deferred commodity-hedge losses; approximately 62% related to contracts supporting firm-price sales arrangements with one customer, in addition to receivables exposure.
- Recorded environmental remediation liabilities were $16.0 million. The company also identified potential responsibility at additional sites for which expected costs could not be reasonably estimated. Routine litigation includes product, commercial, employment and personal-injury matters; management said it did not expect the total liability to materially affect long-term financial position, results or cash flows, while noting a particular period could be affected.
- Six-month tax expense included a $2.0 million discrete charge related to a decision to sell an India equity investment and a $0.8 million net benefit associated primarily with research-and-development tax credits. Pension and postretirement periodic benefit costs rose to $26.9 million from $23.0 million; management expected fiscal 2016 costs of $53.6 million.
- The $500 million share-repurchase authorization had $279.2 million remaining at December 31; future purchases are discretionary. The company also noted that repatriating some foreign cash could trigger taxes.
Most important facts for investors to verify
- Whether Energy and Industrial and Consumer demand, shipment volumes and the oil-and-gas downturn improve as management anticipates.
- Whether PEP returns to profitability and SAO’s stronger margins persist as volumes and product mix change.
- Whether working capital, especially inventory, converts to cash as expected, and whether free cash flow supports capital needs, dividends and buybacks.
- Customer performance under firm-price arrangements, particularly the customer associated with most of the disclosed concentrated commodity-hedge losses and with significant sales and receivables exposure.
- Goodwill recoverability at oil-and-gas-exposed reporting units, environmental and litigation developments, and compliance with credit covenants.