Carpenter Technology Corporation — FY2018 Form 10-K
Reporting period: Fiscal year ended June 30, 2018; audited annual results include the fourth quarter ended June 30, 2018. The request metadata says “2017 Q4,” but the filing covers FY2018, not FY2017.
Business context
Carpenter manufactures and distributes specialty metals and engineered products for aerospace and defense, energy, transportation, medical, industrial and consumer markets. Its reportable segments are Specialty Alloys Operations (SAO) and Performance Engineered Products (PEP). Aerospace and defense represented 55% of FY2018 sales. The company reported strong demand, market-share gains, improved product mix and operating efficiencies.
Key financial results
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $2,157.7 million | $1,797.6 million |
| Net sales excluding surcharge revenue (non-GAAP) | $1,792.3 million | $1,558.4 million |
| Gross profit / gross margin | $382.2 million / 17.7% | $284.3 million / 15.8% |
| Gross margin excluding surcharge revenue (non-GAAP) | 21.3% | 18.2% |
| Operating income / margin | $187.1 million / 8.7% | $97.2 million / 5.4% |
| Net income | $188.5 million | $47.0 million |
| Diluted EPS | $3.92 | $0.99 |
| Operating cash flow | $209.2 million | $130.3 million |
| Free cash flow (company-defined non-GAAP) | $34.7 million | $(16.8) million |
| Capital expenditures | $135.0 million | $98.5 million |
FY2018 reported net income included $68.3 million of discrete net tax benefits related to U.S. tax reform and other legislative changes. Excluding the tax-reform item, adjusted diluted EPS was $2.50, versus adjusted EPS of $1.08 in FY2017. The reported effective tax rate was negative 17.7%; excluding the discrete tax benefits, it was 25.0%.
Fourth quarter: Sales were $618.0 million, operating income $59.4 million, net income $42.8 million and diluted EPS $0.88. In FY2017’s fourth quarter, these were $507.7 million, $44.6 million, $25.5 million and $0.54, respectively.
Liquidity, debt and segments
- Cash and cash equivalents were $56.2 million at year-end, down from $66.3 million. Total liquidity was $450.2 million, including $394.0 million available under the $400 million revolving credit facility after letters of credit.
- Long-term debt, net of current portion, was $545.7 million, versus $550.0 million; no current debt portion remained at June 30, 2018. The company repaid $55 million of debt during the year.
- Credit-agreement covenants were met: interest coverage was 11.86x against a 3.50x minimum; debt-to-capital was 27% against a 55% maximum.
- SAO FY2018 sales were $1,803.8 million, up 23%, and operating income was $232.4 million, up from $172.3 million. PEP sales were $429.7 million, up 17%, and operating income was $26.1 million, up from $8.5 million.
- Quarterly dividends remained $0.18 per share; FY2018 dividends totaled $34.4 million.
Material changes and unusual items
- Sales rose 20% year over year; excluding surcharge revenue, sales increased 15% on 12% higher volume. Surcharge revenue rose to $365.4 million from $239.2 million, so reported sales growth includes a material raw-material surcharge component.
- Sales increased across all reported end markets. Medical sales rose 40%, aerospace and defense 21%, and industrial and consumer 22%. International sales rose 22% to $728.3 million and were 34% of total sales.
- Operating income increased 93%, reflecting demand, mix and cost improvements. Management’s adjusted operating margin, excluding surcharge revenue, pension earnings/interest/deferrals and special items, increased to 10.6% from 8.0%.
- Cash from operations improved, partly because FY2017 included a voluntary $100 million pension contribution; FY2018 contributions were $6.7 million. FY2018 capital spending increased, and management expected approximately $190 million of FY2019 capital expenditures.
- The company acquired additive-manufacturing business MB CalRAM for $13.3 million in February 2018. FY2018 backlog, excluding surcharge, was approximately $568 million, up from $438 million, with substantially all expected to ship in FY2019.
Outlook, risks and contingencies
- No specific revenue or earnings guidance is provided. Management cited strong market demand and ongoing growth investments; FY2019 capital expenditures were expected to be about $190 million.
- Key risks include cyclical demand—especially in aerospace, energy and transportation—pricing pressure, substitute materials, volatile or disrupted supplies of critical metals and energy, and delays or cost overruns in capacity expansions. Surcharge and contract mechanisms may lag cost changes; about 30% of sales are under firm-price arrangements.
- Pension plans remained underfunded: the reported pension funded status was $(292.0) million, and management estimated approximately $92.4 million of required pension contributions over the next five years, subject to market and interest-rate assumptions. FY2019 required contribution was estimated at $5.5 million.
- Environmental remediation liabilities were $16.1 million. Management did not expect known environmental or other routine legal contingencies to materially affect results over the long term, but noted they could be material in a particular quarter or year.
- Tax-reform accounting was provisional, including the deferred-tax remeasurement and $5.0 million transition-tax accrual; the transition tax was expected to be paid over eight years beginning FY2019. The company had not completed its assessment of certain new tax provisions.
- Other disclosed risks include execution of the multi-year ERP implementation, equipment failures or geographic disruptions, product liability and quality claims, labor negotiations, foreign-exchange exposure, goodwill impairment, and potential inability to realize deferred tax assets. One customer, Arconic, accounted for 12% of FY2018 sales.
Important facts for investors to verify
- Separate operating improvement from the $68.3 million tax benefit when assessing FY2018 earnings; compare reported results with the company’s non-GAAP adjusted measures and their reconciliations.
- Track whether the $568 million surcharge-excluded backlog converts to shipments and cash in FY2019, and whether demand and margins remain strong across end markets.
- Assess the planned $190 million FY2019 capital program against operating cash generation and the company’s free-cash-flow definition.
- Monitor pension funding requirements, actuarial assumptions and the provisional tax-reform calculations and transition-tax payments.
- Review the full filing’s debt maturities, contractual commitments, raw-material hedges and contingencies. The statements received an unqualified audit opinion, and management and the auditor reported effective internal control over financial reporting at June 30, 2018.