Carpenter Technology Corporation — Form 10-Q Summary
Business context and reporting period
Carpenter produces and distributes specialty alloys and engineered products serving aerospace and defense, medical, transportation, energy, industrial and consumer markets. This unaudited filing covers the quarter and six months ended December 31, 2019 (the second quarter of fiscal 2020), compared with the same periods a year earlier. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP).
Financial and operating performance
| Metric | Three months ended Dec. 31, 2019 | Six months ended Dec. 31, 2019 |
|---|---|---|
| Net sales | $573.0 million, up 3% | $1,158.4 million, up 3% |
| Gross profit / margin | $112.6 million / 19.7% | $225.3 million / 19.4% |
| Operating income | $55.0 million | $114.8 million |
| Net income | $38.8 million | $80.0 million |
| Diluted EPS | $0.79 | $1.64 |
- Against the prior-year periods, quarterly net income rose from $35.5 million and diluted EPS from $0.73; six-month net income rose from $67.0 million and diluted EPS from $1.38. Six-month operating income increased from $100.4 million.
- Excluding surcharge revenue, sales increased 5% for the quarter and 6% for the six months, despite shipment volume declining 7% and 6%, respectively. Management attributed underlying growth and improved margins chiefly to richer product mix and stronger aerospace and medical demand. These adjusted measures are non-GAAP.
- Quarterly operating income was slightly below the prior year ($55.0 million versus $55.4 million), despite higher sales and gross profit; increased SG&A and $2.3 million of restructuring charges offset operating gains. Adjusted diluted EPS was $0.83 versus $0.76, excluding special items.
- For the six months, adjusted operating margin excluding surcharges and special items was 12.2%, versus 11.2%; adjusted diluted EPS was $1.67 versus $1.41. The reported period included $2.3 million of restructuring charges; the comparative period included $1.2 million of acquisition-related costs.
- SAO’s six-month operating income increased to $157.3 million from $121.7 million. PEP reported a six-month operating loss of $1.7 million, compared with income of $11.7 million, with tariffs, weaker energy and distribution activity, and additive-manufacturing investment cited as factors.
- Cash from operations was $22.6 million, compared with $47.2 million. Capital expenditures were $94.3 million, and company-defined free cash flow was negative $91.0 million (negative $132.7 million in the prior-year period). Working-capital investment, including a $108.2 million inventory cash use, and higher capital spending weighed on cash generation.
- At December 31, cash was $29.9 million; short-term revolver borrowings were $118.9 million and long-term debt was $550.6 million. Of the $400 million revolving facility, $275.2 million was available; reported total liquidity was $305.1 million. The company reported covenant compliance, with a 17.49-to-1 interest coverage ratio against a 3.50 minimum and a 29.5% debt-to-capital ratio against a 55% maximum.
- Current assets were $1,357.7 million and current liabilities $499.4 million. Inventory increased to $896.6 million from $787.7 million at June 30, 2019.
Changes, outlook and risks
- Aerospace and defense sales rose 17% in the quarter and 15% for the six months; medical sales also increased. Energy, industrial and consumer, and distribution sales declined. Management reported the twelfth consecutive quarter of year-over-year sales growth and backlog expansion.
- Management expected fiscal 2020 capital expenditures of approximately $170 million and an additional $2.6 million of pension contributions for the remainder of the fiscal year. It said cash and available borrowing capacity should meet foreseeable cash needs. No specific revenue or earnings guidance was provided in the supplied filing text.
- The Boeing 737 MAX grounding and production halt had not significantly affected the reported periods, but a significant, prolonged reduction in aerospace build rates could harm future results. Management described demand as broadly healthy while noting oil-and-gas weakness, pricing pressure, trade actions and tariffs, and investment spending.
- Raw-material surcharges generally help recover input-cost increases but dilute reported margins as a percentage of sales; timing lags, volatile raw-material prices, product mix and customer order patterns can affect comparisons. Approximately 25% of sales were under firm-price arrangements. The company disclosed $5.4 million of net deferred commodity-hedge losses, about 75% associated with arrangements with one customer, in addition to receivables exposure.
- Environmental remediation liabilities were $15.9 million. The company also faces routine legal claims and potential environmental costs that it says are not expected to be material long term, but could be material in a particular quarter or year.
- Disclosure controls were assessed as ineffective because of a previously identified material weakness in the accuracy and completeness of billing data inputs. No financial-statement misstatements were identified; remediation controls were implemented and were being tested, but management had not yet deemed the weakness remediated.
- Operating lease adoption brought $53.8 million of right-of-use assets and lease liabilities onto the balance sheet at July 1, 2019; the filing says adoption did not affect income or cash flows.
Important facts for investors to verify
- Whether billing-control remediation is completed and tested effective, and whether subsequent filings report any related errors.
- Whether aerospace demand, including effects from the 737 MAX disruption, and the company’s backlog develop as management expected.
- Whether inventory and working-capital investment convert to cash, and capital spending remains consistent with the approximately $170 million fiscal-year expectation.
- PEP’s recovery from its operating loss and exposure to tariffs, energy-market weakness, and additive-manufacturing costs.
- Concentration of commodity-hedge losses and receivables with one customer, and any change in environmental or legal contingencies.
- Continued covenant compliance, revolver availability, and the company’s ability to fund investment and dividends from operating cash flow.