CARPENTER TECHNOLOGY CORPORATION Background and General
We are a producer and distributor of premium specialty alloys, including
titanium alloys, powder metals, stainless steels, alloy steels and tool steels.
We are a recognized leader in high-performance specialty alloy-based materials
and process solutions for critical applications in the aerospace, defense,
medical, transportation, energy, industrial and consumer markets. We have
evolved to become a pioneer in premium specialty alloys, including titanium,
nickel, and cobalt, as well as alloys specifically engineered for additive
manufacturing ("AM") processes and soft magnetics applications. We have expanded
our AM capabilities to provide a complete "end-to-end" solution to accelerate
materials innovation and streamline parts production. We primarily process basic
raw materials such as nickel, cobalt, titanium, manganese, chromium, molybdenum,
iron scrap and other metal alloying elements through various melting, hot
forming and cold working facilities to produce finished products in the form of
billet, bar, rod, wire and narrow strip in many sizes and finishes. We also
produce certain metal powders and parts. Our sales are distributed directly from
our production plants and distribution network as well as through independent
distributors. Unlike many other specialty steel producers, we operate our own
worldwide network of service and distribution centers. These service centers,
located in the United States , Canada , Mexico , Europe and Asia allow us to work
more closely with customers and to offer various just-in-time stocking programs.
As part of our overall business strategy, we have sought out and considered
opportunities related to strategic acquisitions and joint collaborations as well
as possible business unit dispositions aimed at broadening our offering to the
marketplace. We have participated with other companies to explore potential
terms and structures of such opportunities and expect that we will continue to
evaluate these opportunities.
Our discussions below in this Item 2 are based upon the more detailed
discussions about our business, operations and financial condition included in
Item 7 of our 2022 Form 10-K. Our discussions here focus on our results during
or as of the three-month period ended September 30, 2022 and the comparable
period of fiscal year 2022, and to the extent applicable, on material changes
from information discussed in the 2022 Form 10-K and other important intervening
developments or information that we have reported on Form 8-K. These discussions
should be read in conjunction with the 2022 Form 10-K for detailed background
information and with any such intervening Form 8-K.
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Impact of Raw Material Prices and Product Mix
We value most of our inventory utilizing the last-in, first-out ("LIFO")
inventory costing method. Under the LIFO inventory costing method, changes in
the cost of raw materials and production activities are recognized in cost of
sales in the current period even though these materials may potentially have
been acquired at significantly different values due to the length of time from
the acquisition of the raw materials to the sale of the processed finished goods
to the customers. In a period of rising raw material costs, the LIFO inventory
valuation normally results in higher cost of sales. Conversely, in a period of
decreasing raw material costs, the LIFO inventory valuation normally results in
lower cost of sales.
The volatility of the costs of raw materials has impacted our operations over
the past several years. We, and others in our industry, generally have been able
to pass cost increases on major raw materials through to our customers using
surcharges that are structured to recover increases in raw material costs.
Generally, the formula used to calculate a surcharge is based on published
prices of the respective raw materials for the previous month which correlates
to the prices we pay for our raw material purchases. However, a portion of our
surcharges to customers may be calculated using a different surcharge formula or
may be based on the raw material prices at the time of order, which creates a
lag between surcharge revenue and corresponding raw material costs recognized in
cost of sales. The surcharge mechanism protects our net income on such sales
except for the lag effect discussed above. However, surcharges have had a
dilutive effect on our gross margin and operating margin percentages as
described later in this report.
Approximately 40 percent of our net sales are sales to customers under firm
price sales arrangements. Firm price sales arrangements involve a risk of profit
margin fluctuations, particularly when raw material prices are volatile. In
order to reduce the risk of fluctuating profit margins on these sales, we enter
into commodity forward contracts to purchase certain critical raw materials
necessary to produce the related products sold. Firm price sales arrangements
generally include certain annual purchasing commitments and consumption
schedules agreed to by the customers at selling prices based on raw material
prices at the time the arrangements are established. If a customer fails to meet
the volume commitments (or the consumption schedule deviates from the
agreed-upon terms of the firm price sales arrangements), we may need to absorb
the gains or losses associated with the commodity forward contracts on a
temporary basis. Gains or losses associated with commodity forward contracts are
reclassified to earnings/loss when earnings are impacted by the hedged
transaction. Because we value most of our inventory under the LIFO costing
methodology, changes in the cost of raw materials and production activities are
recognized in cost of sales in the current period attempting to match the most
recently incurred costs with revenues. Gains or losses on the commodity forward
contracts are reclassified from other comprehensive (loss) income together with
the actual purchase price of the underlying commodities when the underlying
commodities are purchased and recorded in inventory. To the extent that the
total purchase price of the commodities, inclusive of the gains or losses on the
commodity forward contracts, are higher or lower relative to the beginning of
year costs, our cost of goods sold reflects such amounts. Accordingly, the gains
and/or losses associated with commodity forward contracts may not impact the
same period that the firm price sales arrangements revenue is recognized, and
comparisons of gross profit from period to period may be impacted. These firm
price sales arrangements are expected to continue as we look to strengthen our
long-term customer relationships by expanding, renewing and in certain cases
extending to a longer-term, our customer long-term arrangements.
We produce hundreds of grades of materials with a wide range of pricing and
profit levels depending on the grade. In addition, our product mix within a
period is subject to the fluctuating order patterns of our customers as well as
decisions we may make on participation in certain products based on available
capacity, including the impacts of capacity commitments we may have under
existing customer agreements. While we expect to see positive contribution from
a more favorable product mix in our margin performance over time, the impact by
period may fluctuate and period-to-period comparisons may vary.
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Net Pension Benefit
Net pension benefit, as we define it below, includes the net periodic benefit
costs related to both our pension and other postretirement plans. The net
periodic benefit costs are determined annually based on beginning of year
balances and are recorded ratably throughout the fiscal year, unless a
significant remeasurement event occurs. We currently expect the total net
pension expense for fiscal year 2023 will be
The following is the net pension expense (income) for the three months ended
Three Months Ended
September 30,
($ in millions) 2022 2021
Pension plans $ 5.2 $ (1.0)
Other postretirement plans (0.2) (0.8)
Net pension expense (income) $ 5.0 $ (1.8)
Net pension expense (income) is recorded in accounts that are included in cost
of sales and selling, general and administrative expenses based on the function
of the associated employees and in other expense (income), net. The following is
a summary of the classification of net pension expense (income) for the three
months ended September 30, 2022 and 2021:
Three Months Ended
September 30,
($ in millions) 2022 2021
Service cost included in Cost of sales $
2.2
Service cost included in Selling, general and administrative expenses
0.3 0.3
Pension earnings, interest and deferrals included in Other expense (income), net
2.5 (4.5)
Net pension expense (income) $
5.0
As ofSeptember 30, 2022 andJune 30, 2022 , service cost amounts related to the net pension expense (income) capitalized in gross inventory were$2.6 million and$1.7 million , respectively.
Operating Performance Overview
During the quarter endedSeptember 30, 2022 , demand in each of our end-use markets remained strong, with our backlog up 10 percent sequentially and 155 percent year-over-year. The growth was led by increasing sales across each of the Aerospace sub-markets with lead times extending for our materials. The SAO segment finished the quarter endedSeptember 30, 2022 , at the upper end of our expected range, driven by the aerospace growth and continued improvement in our operations. The PEP segment came in just below expectations due to delayed shipments caused by Hurricane Ian at ourDynamet facility inFlorida . We remain confident as we continue to see strength across all of our end-use markets with order entry activity driving backlog growth, and with continued improvement in our operations.
Results of Operations - Three Months Ended
For the three months endedSeptember 30, 2022 , we reported net loss of$6.9 million , or$0.14 loss per diluted share. This compares with net loss for the same period a year earlier of$14.8 million , or$0.31 loss per diluted share. There were no reported special items for the quarter endedSeptember 30, 2022 . COVID-19 related costs negatively impacted operating results by$1.6 million in the three months endedSeptember 30, 2021 . Excluding these costs, adjusted loss per diluted share was$0.28 for the quarter endedSeptember 30, 2021 . The results for the three months endedSeptember 30, 2022 reflect improving demand patterns, higher prices and improving mix with 35 percent increased sales compared to the prior year quarter. 29 -------------------------------------------------------------------------------- Table of ContentsNet Sales Net sales for the three months endedSeptember 30, 2022 were$522.9 million , which was a 35 percent increase over the same period a year ago. Excluding surcharge revenue, sales increased 20 percent on a 3 percent increase in shipment volume from the same period a year ago. The results reflect higher demand in all end-use markets except Transportation during the three months endedSeptember 30, 2022 compared to the three months endedSeptember 30, 2021 . Net sales in the Aerospace and Defense end-use market increased 57 percent compared to the same period a year ago. Geographically, sales inthe United States increased 29 percent from the same period a year ago to$319.6 million . The increase is driven by higher demand in all end-use markets except Transportation. Sales outsidethe United States increased 44 percent from the same period a year ago to$203.3 million for the three months endedSeptember 30, 2022 . The increase is driven primarily by higher demand in the Aerospace and Defense end-use market in the European andSouth America regions. A portion of our sales outsidethe United States are denominated in foreign currencies. The fluctuations in foreign currency exchange rates resulted in a$2.8 million decrease in sales during the three months endedSeptember 30, 2022 compared to the three months endedSeptember 30, 2021 . Net sales outsidethe United States represented 39 percent and 36 percent of total net sales for the three months endedSeptember 30, 2022 and 2021, respectively.
Sales by End-Use Markets
We sell to customers across diversified end-use markets. The following table
includes comparative information for our net sales, which includes surcharge
revenue by principal end-use markets. We believe this is helpful supplemental
information in analyzing the performance of the business from period to period:
Three Months Ended $
September 30, Increase %
($ in millions) 2022 2021 (Decrease) Increase (Decrease)Aerospace and Defense$ 261.6 $ 166.9 $ 94.7 57 % Medical 59.2 43.1 16.1 37 % Transportation 36.9 41.6 (4.7) (11) % Energy 27.9 22.2 5.7 26 % Industrial and Consumer 105.0 86.6 18.4 21 % Distribution 32.3 27.2 5.1 19 % Total net sales$ 522.9 $ 387.6 $ 135.3 35 %
The following table includes comparative information for our net sales by the same principal end-use markets, but excluding surcharge revenue:
Three Months Ended $
September 30, Increase %
($ in millions) 2022 2021 (Decrease) Increase (Decrease)Aerospace and Defense$ 183.5 $ 134.9 $ 48.6 36 % Medical 49.8 37.1 12.7 34 % Transportation 23.7 31.4 (7.7) (25) % Energy 18.3 16.2 2.1 13 % Industrial and Consumer 68.4 66.3 2.1 3 % Distribution 32.0 27.0 5.0 19 % Total net sales excluding surcharge revenue$ 375.7 $ 312.9 $ 62.8 20 % 30
-------------------------------------------------------------------------------- Table of Contents Sales to the Aerospace and Defense end-use market increased 57 percent from the first quarter a year ago to$261.6 million . Excluding surcharge revenue, sales increased 36 percent from the first quarter a year ago on a 24 percent increase in shipment volume. The results for the three months endedSeptember 30, 2022 reflect increases in all sub-markets driven by ramping activity levels across the aerospace supply change due to higher aircraft build rates to meet increasing passenger travel. Medical end-use market sales increased 37 percent from the first quarter a year ago to$59.2 million . Excluding surcharge revenue, sales increased 34 percent on 20 percent higher shipment volume from the first quarter a year ago. The current first quarter results reflect stronger demand as a result of the medical supply chain replenishing inventory levels with steady increases in elective medical procedures. Transportation end-use market sales decreased 11 percent from the first quarter a year ago to$36.9 million . Excluding surcharge revenue, sales decreased 25 percent on 42 percent lower shipment volume from the first quarter a year ago. The results reflect reduced heavy-duty build rates from ongoing supply shortages and lower demand for light, medium and heavy duty vehicles internationally.
Sales to the Energy end-use market of
Industrial and Consumer end-use market sales of$105.0 million increased$18.4 million compared to the first quarter a year ago. Excluding surcharge revenue, sales increased 3 percent on 2 percent lower shipment volume. The results reflect higher demand for semiconductor materials and increased sales in the electronic sub-market. Gross Profit Our gross profit in the first quarter increased$29.6 million to$54.8 million , or 10.5 percent of net sales as compared with$25.2 million , or 6.5 percent of net sales in the same quarter a year ago. Excluding the impact of surcharge revenue, our adjusted gross margin in the first quarter was 14.6 percent as compared to 8.1 percent in the same period a year ago. The increased gross profit for the three months endedSeptember 30, 2022 reflects improving demand patterns with 35 percent increased sales and a stronger product mix, higher prices and improved operational efficiencies. While the surcharge generally protects the absolute gross profit dollars, it does have a dilutive effect on gross margin as a percent of sales. The following represents a summary of the dilutive impact of the surcharge on gross margin for the comparative three-month periods. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures. Three Months Ended September 30, ($ in millions) 2022 2021 Net sales $ 522.9$ 387.6 Less: surcharge revenue 147.2 74.7 Net sales excluding surcharge revenue $ 375.7$ 312.9 Gross profit $ 54.8$ 25.2 Gross margin 10.5 % 6.5 % Gross margin excluding surcharge revenue 14.6 % 8.1 % 31
-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses Selling, general and administrative expenses of$46.5 million were 8.9 percent of net sales (12.4 percent of net sales excluding surcharge) as compared with$44.3 million and 11.4 percent of net sales (14.2 percent of net sales excluding surcharge) in the same quarter a year ago. The selling, general and administrative expenses for the three months endedSeptember 30, 2022 reflect higher salary and benefit costs compared to the same period a year ago. . Operating Income (Loss) Our operating income in the recent first quarter was$8.3 million , or 1.6 percent of net sales, as compared with operating loss of$19.1 million or negative 4.9 percent of net sales in the same quarter a year ago. Excluding surcharge revenue, adjusted operating margin was 2.2 percent for the current quarter as compared with negative 5.6 percent a year ago excluding special items. The operating results for the three months endedSeptember 30, 2022 reflect higher sales compared to the prior year quarter and improved operational efficiencies. The three months endedSeptember 30, 2021 reflected the ongoing impact from COVID-19 with lower demand and operational challenges with labor shortages and supply chain interruptions. The following presents our operating income (loss) and operating margin, in each case excluding the impact of surcharge revenue on net sales and special items. We present and discuss these financial measures because management believes removing these items provides a more consistent and meaningful basis for comparing ongoing results of operations from period to period. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures. Three Months Ended September 30, ($ in millions) 2022 2021 Net sales $ 522.9$ 387.6 Less: surcharge revenue 147.2 74.7 Net sales excluding surcharge revenue $ 375.7$ 312.9 Operating income (loss) $ 8.3$ (19.1) Special item: COVID-19 costs - 1.6 Adjusted operating income (loss) $ 8.3$ (17.5) Operating margin 1.6 % (4.9) % Adjusted operating margin excluding surcharge revenue and special item 2.2 % (5.6) % Interest Expense, Net Interest expense, net for the three months endedSeptember 30, 2022 was$12.6 million compared with$10.2 million in the same period a year ago. Capitalized interest reduced interest expense by$0.3 million for the three months endedSeptember 30, 2022 and$0.1 million for the three months endedSeptember 30, 2021 . The higher interest expense is largely due to higher interest costs on debt that was refinanced. Other Expense (Income), Net Other expense, net for the three months endedSeptember 30, 2022 was$3.5 million as compared with$4.1 million of other income, net for the three months endedSeptember 30, 2021 . The current quarter reflects$2.5 million of expense from pension earnings, interest and deferrals compared to$4.5 million of pension income in the prior year driven by favorable returns on plan assets. 32 -------------------------------------------------------------------------------- Table of Contents Income Taxes Income tax benefit was$0.9 million , or 11.5 percent of pre-tax loss for the three months endedSeptember 30, 2022 , as compared with$10.4 million , or 41.3 percent of pre-tax loss in the same quarter a year ago. Income tax benefit for the three months endedSeptember 30, 2022 includes the unfavorable impact of losses in certain foreign jurisdictions for which no tax benefit can be recognized. Also included is a discrete tax charge of$0.6 million for the impact of a state tax legislative change and a discrete tax benefit of$0.3 million attributable to employee share-based compensation. Income tax benefit for the three months endedSeptember 30, 2021 included the unfavorable impacts of losses in certain foreign jurisdictions for which no tax benefit can be recognized. The Inflation Reduction Act of 2022 (the "IRA") was enacted onAugust 16, 2022 . The IRA includes climate and energy provisions, extends the Affordable Care Act subsidies, increases Internal Revenue Enforcement funding and allows Medicare to negotiate prescription drug prices. The IRA creates a 15 percent corporate alternative minimum tax on profits of corporations whose average annual adjusted financial statement income for any consecutive three-tax-year period preceding the tax year exceeds$1.0 billion and is effective for tax years beginning afterDecember 31, 2022 . The IRA also creates an excise tax of 1 percent on stock repurchases by publicly tradedU.S. corporations, effective for repurchases afterDecember 31, 2022 . The provisions of the IRA are not expected to have a significant impact on our financial position, results of operations or cash flows.
Business Segment Results
We have two reportable business segments: SAO and PEP.
The following table includes comparative information for volumes by business
segment:
Three Months Ended
September 30, %
(Pounds sold, in thousands) 2022 2021 Increase (Decrease) Increase (Decrease)
Specialty Alloys Operations 44,562 43,008 1,554 4 %
Performance Engineered Products * 2,326 2,372 (46) (2) %
Intersegment (1,998) (1,852) (146) (8) %
Consolidated pounds sold 44,890
43,528 1,362 3 %
* Pounds sold data for PEP segment includes
The following table includes comparative information for net sales by business
segment:
Three Months Ended
September 30, $ %
($ in millions) 2022 2021 Increase Increase
Specialty Alloys Operations $ 447.3 $ 331.9 $ 115.4 35 %
Performance Engineered Products 93.2 74.6 18.6 25 %
Intersegment (17.6) (18.9) 1.3 7 %
Total net sales $ 522.9 $ 387.6 $ 135.3 35 %
The following table includes comparative information for our net sales by business segment, but excluding surcharge revenue:
Three Months Ended
September 30, $ %
($ in millions) 2022 2021 Increase Increase
Specialty Alloys Operations $ 305.7 $ 258.2 $ 47.5 18 %
Performance Engineered Products 87.7 73.6 14.1 19 %
Intersegment (17.7) (18.9) 1.2 6 %
Total net sales excluding surcharge revenue $ 375.7 $ 312.9 $ 62.8 20 %
33-------------------------------------------------------------------------------- Table of Contents Specialty Alloys Operations Segment Net sales for the quarter endedSeptember 30, 2022 for the SAO segment increased 35 percent to$447.3 million , as compared with$331.9 million in the same quarter a year ago. Excluding surcharge revenue, net sales for the current quarter increased 18 percent on 4 percent higher shipment volume from a year ago. The higher sales in the SAO segment reflect increases in all end-use markets except Transportation driven by improving demand and price increases compared to the prior year same quarter. Operating income for the SAO segment was$19.9 million or 4.4 percent of net sales (6.5 percent of net sales excluding surcharge revenue) in the recent first quarter, as compared with operating loss of$5.9 million or negative 1.8 percent of net sales (negative 2.3 percent of net sales excluding surcharge revenue) in the same quarter a year ago. The operating income reflects higher volume in all end-use markets except Transportation and Industrial and Consumer, stronger product mix and improved operational efficiencies in the quarter endedSeptember 30, 2022 . The results for the quarter endedSeptember 30, 2021 continued to be impacted by COVID-19 including labor shortages and supply chain disruptions.
Performance Engineered Products Segment
Net sales for the quarter endedSeptember 30, 2022 for the PEP segment increased 25 percent to$93.2 million , as compared with$74.6 million in the same quarter a year ago. Excluding surcharge revenue, net sales for the current quarter of$87.7 million increased from$73.6 million a year ago. The results reflect improving demand in all end-use markets except Industrial and Consumer compared to the prior year period. In particular, the Medical end-use market increased 45 percent with steady increases in elective surgical procedures compared to the same period last year. Operating income for the PEP segment was$6.3 million or 6.8 percent of net sales (7.2 percent of net sales excluding surcharge revenue) in the current first quarter, compared with operating income of$0.6 million or 0.8 percent of net sales in the same quarter a year ago. The improved results for the quarter endedSeptember 30, 2022 reflect stronger demand conditions partially offset by delayed shipments caused by Hurricane Ian at ourDynamet facility inFlorida .
Liquidity and Financial Resources
During the three months endedSeptember 30, 2022 , we used cash for operating activities of$78.0 million compared to cash used for operating activities of$47.0 million in the same period a year ago. Our free cash flow, which we define under "Non-GAAP Financial Measures" below, was negative$101.3 million as compared to negative$71.2 million for the same period a year ago. The decrease in cash provided from operating activities and free cash flow for the three months endedSeptember 30, 2022 compared to the same period a year ago resulted from higher inventory to meet growing demand partially offset by improved earnings. Cash used to build inventory was$121.2 million in the current period endedSeptember 30, 2022 compared to$66.5 million in the same period a year ago. The increase in inventory during the current fiscal year is in response to growing demand. During the three months endedSeptember 30, 2022 , cash used for accounts receivable was$12.1 million compared to$3.8 million in the same period a year ago.
Capital expenditures for property, plant, equipment and software were
Dividends during the three months endedSeptember 30, 2022 and 2021 were$9.8 million and$9.8 million , respectively, and were paid at the same quarterly rate of$0.20 per share of common stock in both periods. We have demonstrated the ability to generate cash to meet our needs through cash flows from operations, management of working capital and the ability to access capital markets to supplement internally generated funds. We target minimum liquidity of$150 million , consisting of cash and cash equivalents added to available borrowing capacity under our Credit Facility. 34 -------------------------------------------------------------------------------- Table of Contents OnMarch 26, 2021 , we entered into our$300.0 million secured revolving Credit Facility. The Credit Facility amended and restated our previous revolving credit facility, datedMarch 31, 2017 , which had been set to expire inMarch 2022 . The Credit Facility extends the maturity toMarch 31, 2024 , subject to a springing maturity ofNovember 30, 2022 . If, byNovember 30, 2022 , our$300.0 million 4.45% Senior Notes due inMarch 2023 were not redeemed, repurchased or refinanced with indebtedness having a maturity date ofOctober 1, 2024 or later, all indebtedness under the Credit Facility will be due. The springing maturity clause has been satisfied with the issuance of the 2030 Notes and subsequent payment in full of the 4.45% Senior Notes, as discussed in Note 8 Debt. The Credit Facility contains a revolving credit commitment amount of$300.0 million , subject to our right, from time to time, to request an increase of the commitment to$500.0 million in the aggregate; and provides for the issuance of letters of credit subject to a$40.0 million sub-limit. We have the right to voluntarily prepay and re-borrow loans, to terminate or reduce the commitments under the Credit Facility, and, subject to certain lender approvals, to join subsidiaries as subsidiary borrowers. OnFebruary 14, 2022 , we entered into the Amendment to the Credit Facility. The Amendment revised the interest coverage ratio covenant under the Credit Facility so that the first test date wasJune 30, 2022 , and required a minimum interest coverage ratio of 2.00 to 1.00 atJune 30, 2022 (calculated for the two fiscal quarters then ended), 3.00 to 1.00 atSeptember 30, 2022 (calculated for the three fiscal quarters then ended) and 3.50 to 1.00 atDecember 31, 2022 and thereafter (calculated for the four fiscal quarters then ended). The Amendment revised the restricted period under the Credit Facility, during which we were prohibited from incurring any secured debt other than purchase money financing for new equipment and were subject to additional restrictions on its ability to make dividends or distributions or to make certain investments. This expired onSeptember 30, 2022 . As ofSeptember 30, 2022 , we had$1.8 million of issued letters of credit and no short-term borrowings under the Credit Facility. The balance of the Credit Facility,$298.2 million , remains available to us. As ofSeptember 30, 2022 , the borrowing rate for the Credit Facility was 5.12%. We believe that our total liquidity of$350.8 million as ofSeptember 30, 2022 , which includes total cash and cash equivalents of$52.6 million and available borrowing capacity of$298.2 million under our credit facility, will be sufficient to fund our cash needs over the foreseeable future. During the three months endedSeptember 30, 2022 , we made no pension contributions to our qualified defined benefit pension plans. We currently do not expect to contribute to our qualified defined benefit pension plans during the remainder of fiscal year 2023. As ofSeptember 30, 2022 , we had cash and cash equivalents of approximately$17.9 million held at various foreign subsidiaries. Our global deployment considers, among other things, geographic location of our subsidiaries' cash balances, the locations of our anticipated liquidity needs, and the cost to access international cash balances, as necessary. During the three months endedSeptember 30, 2022 , we repatriated no cash from foreign jurisdictions. From time to time, we may make short-term intercompany borrowings against our cash held outsidethe United States in order to reduce or eliminate any required borrowing under our Credit Agreement. 35 -------------------------------------------------------------------------------- Table of Contents We are subject to certain financial and restrictive covenants under the Credit Facility, which, among other things, require the maintenance of a minimum interest coverage ratio. The interest coverage ratio is defined in the Credit Facility as, for any period, the ratio of consolidated earnings before interest, taxes, depreciation and amortization and non-cash net pension expense ("EBITDA") to consolidated interest expense for such period. The interest coverage covenant was waived until the quarter endedJune 30, 2022 at which time it was required to be 2.00 to 1.00, for the quarter endedSeptember 30, 2022 it is 3.00 to 1.00 and then 3.50 to 1.00 thereafter. The Credit Facility also requires us to maintain a debt to capital ratio of less than 55 percent. The debt to capital ratio is defined in the Credit Facility as the ratio of consolidated indebtedness, as defined therein, to consolidated capitalization, as defined therein. In addition, we are subject to an asset coverage ratio minimum of 1.10 to 1.00. The asset coverage ratio is defined in the Credit Facility as eligible receivables and inventory, as defined therein, to outstanding loans and obligations, as defined therein. As ofSeptember 30, 2022 , we were in compliance with all of the covenants of the Credit Facility.
The following table shows our actual ratio performance with respect to the
financial covenants as of
Covenant Covenant Requirement Actual Ratio Consolidated debt to capital 55% (maximum) 35%
Consolidated interest coverage ratio 3.00 to 1.00 (minimum) 3.69 to 1.00 Asset coverage ratio
1.10 to 1.00 (minimum) 233.7 to 1.00
To the extent that we do not comply with the current or modified covenants under the Credit Facility, this could reduce our liquidity and flexibility due to potential restrictions on borrowings available to us unless we are able to obtain waivers or modifications of the covenants.
Non-GAAP Financial Measures
The following provides additional information regarding certain non-GAAP financial measures that we use in this report. Our definitions and calculations of these items may not necessarily be the same as those used by other companies.
This report includes discussions of net sales as adjusted to exclude the impact of raw material surcharge and special items and the resulting impact on gross margins, which represent financial measures that have not been determined in accordance with accounting principles generally accepted inthe United States of America ("U.S. GAAP"). We present and discuss these financial measures because management believes removing the impact of raw material surcharge from net sales provides a more consistent basis for comparing results of operations from period to period for the reasons discussed earlier in this report. Management uses its results excluding these amounts to evaluate its operating performance and to discuss its business with investment institutions, our board of directors and others. See our earlier discussion of "Gross Profit" for a reconciliation of net sales and gross margin, excluding surcharge revenue, to net sales as determined in accordance withU.S. GAAP. Net sales and gross margin excluding surcharge revenue is not aU.S. GAAP financial measure and should not be considered in isolation of, or as a substitute for, net sales and gross margin calculated in accordance withU.S. GAAP.
Adjusted Operating Margin Excluding Surcharge Revenue and Special Items
This report includes discussions of operating margin as adjusted to exclude the impact of raw material surcharge revenue and special items which represent financial measures that have not been determined in accordance withU.S. GAAP. We present and discuss this financial measure because management believes removing the impact of raw material surcharge from net sales provides a more consistent and meaningful basis for comparing results of operations from period to period for the reasons discussed earlier in this report. In addition, management believes that excluding special items from operating margin is helpful in analyzing our operating performance, as these items are not indicative of ongoing operating performance. Management uses its results excluding these amounts to evaluate its operating performance and to discuss its business with investment institutions, our board of directors and others. See our earlier discussion of operating income (loss) for a reconciliation of operating income (loss) and operating margin excluding surcharge revenue and special items to operating income (loss) and operating margin determined in accordance withU.S. GAAP. Operating margin excluding surcharge revenue and special items is not aU.S. GAAP financial measure and should not be considered in isolation of, or as a substitute for, operating margin calculated in accordance withU.S. GAAP. 36 -------------------------------------------------------------------------------- Table of Contents Adjusted Loss Per Share
The following provides a reconciliation of adjusted loss per share, to its most
directly comparable
($ in millions, except per share Loss Before Income Tax Loss Per amounts) Income Taxes Benefit Net Loss Diluted Share* Three Months EndedSeptember 30, 2022 , as reported$ (7.8) $ 0.9 $ (6.9) $ (0.14) Special item: None reported - - - - Three Months EndedSeptember 30, 2022 , as adjusted$ (7.8) $ 0.9 $ (6.9) $ (0.14)
* Impact per diluted share calculated using weighted average common shares
outstanding of 48.7 million for the three months ended
Loss Before Income Tax Loss Per
($ in millions, except per share amounts) Income Taxes Benefit Net Loss Diluted Share*
Three Months Ended September 30, 2021 , as
reported $ (25.2) $ 10.4 $ (14.8) $ (0.31)
Special item:
COVID-19 costs 1.6 (0.7) 0.9 0.03
Three Months Ended September 30, 2021 , as
adjusted $ (23.6) $ 9.7 $ (13.9) $ (0.28) * Impact per diluted share calculated using weighted average common shares
outstanding of 48.5 million for the three months ended
Management believes that the presentation of loss per share adjusted to exclude special items is helpful in analyzing the operating performance of the Company, as these items are not indicative of ongoing operating performance. Our definitions and calculations of these items may not necessarily be the same as those used by other companies. Management uses its results excluding these amounts to evaluate its operating performance and to discuss its business with investment institutions, our board of directors and others. Adjusted loss per share is not aU.S. GAAP financial measure and should not be considered in isolation of, or as a substitute for, loss per share calculated in accordance withU.S. GAAP. Free Cash Flow
The following provides a reconciliation of free cash flow, as used in this
report, to its most directly comparable
Three Months Ended
September 30,
($ in millions) 2022 2021
Net cash used for operating activities $ (78.0) $ (47.0)
Purchases of property, plant, equipment and software (13.5) (14.4)
Dividends paid (9.8) (9.8)
Free cash flow $ (101.3) $ (71.2)
Management believes that the presentation of free cash flow provides useful
information to investors regarding our financial condition because it is a
measure of cash generated which management evaluates for alternative uses. It is
management's current intention to use excess cash to fund investments in capital
equipment, acquisition opportunities and consistent dividend payments. Free cash
flow is not a U.S. GAAP financial measure and should not be considered in
isolation of, or as a substitute for, cash flows calculated in accordance with
U.S. GAAP.
37
--------------------------------------------------------------------------------Table of Contents Contingencies Environmental We are subject to various federal, state, local and international environmental laws and regulations relating to pollution, protection of public health and the environment, natural resource damages and occupational safety and health. Although compliance with these laws and regulations may affect the costs of our operations, compliance costs to date have not been material. We have environmental remediation liabilities at some of our owned operating facilities and have been designated as a PRP with respect to certain third party Superfund waste-disposal sites and other third party-owned sites. We accrue amounts for environmental remediation costs that represent our best estimate of the probable and reasonably estimable future costs related to environmental remediation. During the three months endedSeptember 30, 2022 , the Company increased the liability for a Company-owned former operating site by$0.1 million . The liabilities recorded for environmental remediation costs at Superfund sites, other third party-owned sites and Carpenter-owned current or former operating facilities remaining atSeptember 30, 2022 andJune 30, 2022 were$18.4 million and$18.3 million , respectively. Additionally, we have been notified that we may be a PRP with respect to other Superfund sites as to which no proceedings have been instituted against us. Neither the exact amount of remediation costs nor the final method of their allocation among all designated PRPs at these Superfund sites have been determined. Accordingly, at this time, we cannot reasonably estimate expected costs for such matters. The liability for future environmental remediation costs that can be reasonably estimated is evaluated on a quarterly basis. Estimates of the amount and timing of future costs of environmental remediation requirements are inherently imprecise because of the continuing evolution of environmental laws and regulatory requirements, the availability and application of technology, the identification of currently unknown remediation sites and the allocation of costs among the PRPs. Based upon information currently available, such future costs are not expected to have a material effect on our financial position, results of operations or cash flows over the long-term. However, such costs could be material to our financial position, results of operations or cash flows in a particular future quarter or year.
Other
We are defending various routine claims and legal actions that are incidental to our business, and that are common to our operations, including those pertaining to product claims, commercial disputes, patent infringement, employment actions, employee benefits, compliance with domestic and foreign laws, personal injury claims and tax issues. Like many other manufacturing companies in recent years we, from time to time, have been named as a defendant in lawsuits alleging personal injury as a result of exposure to chemicals and substances in the workplace such as asbestos. We provide for costs relating to these matters when a loss is probable and the amount of the loss is reasonably estimable. The effect of the outcome of these matters on our future results of operations and liquidity cannot be predicted because any such effect depends on future results of operations and the amount and timing (both as to recording future charges to operations and cash expenditures) of the resolution of such matters. While it is not feasible to determine the outcome of these matters, we believe that the total liability from these matters will not have a material effect on our financial position, results of operations or cash flows over the long-term. However, there can be no assurance that an increase in the scope of pending matters or that any future lawsuits, claims, proceedings or investigations will not be material to our financial position, results of operations or cash flows in a particular future quarter or year.
Critical Accounting Policies and Estimates
A summary of other significant accounting policies is discussed in our 2022
Form 10-K Item 7. "Management's Discussion and Analysis of Financial Condition
and Results of Operations", and in Note 1, Summary of Significant Accounting
Policies, of the Notes to our consolidated financial statements included in
Part II, Item 8 thereto.
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Long-Lived Assets
Long-lived assets are reviewed for impairment and written down to fair value
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable through estimated future undiscounted cash flows. The amount
of the impairment loss is the excess of the carrying amount of the impaired
assets over the fair value of the assets based upon estimated future discounted
cash flows. We evaluate long-lived assets for impairment by individual business
unit. Changes in estimated cash flows could have a significant impact on whether
or not an asset is impaired and the amount of the impairment.
Goodwill is not amortized but instead is tested at least annually for impairment as ofJune 1 , or more frequently if events or circumstances indicate that the carrying amount of goodwill may be impaired. Potential impairment is identified by comparing the fair value of a reporting unit to its carrying value. If the carrying value of the reporting unit exceeds its fair value, any impairment loss is measured by the difference between the carrying value of the reporting unit and its fair value, not to exceed the carrying amount of goodwill. The discounted cash flow analysis for each reporting unit tested requires significant estimates and assumptions related to cash flow forecasts, discount rates, terminal values and income tax rates. The cash flow forecasts include significant judgments and assumptions related to revenue growth rates, which include perpetual growth rates, gross margin and weighted average cost of capital. The cash flow forecasts are developed based on assumptions about each reporting unit's markets, product offerings, pricing, capital expenditure and working capital requirements as well as cost performance. The discount rates used in the discounted cash flow are estimated based on a market participant's perspective of each reporting unit's weighted average cost of capital. The terminal value, which represents the value attributed to the reporting unit beyond the forecast period, is estimated using a perpetuity growth rate assumption. The income tax rates used in the discounted cash flow analysis represent estimates of the long-term statutory income tax rates for each reporting unit based on the jurisdictions in which the reporting units operate. As ofSeptember 30, 2022 , we have three reporting units with goodwill recorded.Goodwill associated with the SAO reporting unit as ofSeptember 30, 2022 was$195.5 million and represents approximately 81 percent of our total goodwill. The remaining goodwill is associated with the PEP segment, which includes two reporting units,Dynamet and Latrobe Distribution, with goodwill recorded as ofSeptember 30, 2022 of$31.9 million and$14.0 million , respectively.Goodwill associated with the SAO reporting unit is tested at the SAO segment level. The fair value is estimated using a weighting of discounted cash flows and the use of market multiples valuation techniques. As ofJune 1, 2022 , the fair value of the SAO reporting unit exceeded the carrying value by approximately 38.2 percent. The discounted cash flows analysis for the SAO reporting unit includes assumptions related to our ability to increase volume, improve mix, expand product offerings and continue to implement opportunities to reduce costs over the next several years. For purposes of the discounted cash flow analysis for SAO's fair value, a weighted average cost capital of 9.5 percent and a terminal growth rate assumption of 2.5 percent were used. If the long-term growth rate for this reporting unit had been hypothetically reduced by 0.5 percent atJune 1, 2022 , the SAO reporting unit would have a fair value that exceeded the carrying value by approximately 34.5 percent.Goodwill associated with the PEP segment is tested at theDynamet andLatrobe Distribution reporting unit level. As ofJune 1, 2022 , the fair value of theDynamet reporting unit exceeded the carrying value by approximately 54.1 percent. For purposes of the discounted cash flow analysis forDynamet's fair value, a weighted average cost capital of 13.0 percent and a terminal growth rate assumption of 2.5 percent were used. If the long-term growth rate for this reporting unit had been hypothetically reduced by 0.5 percent atJune 1, 2022 , theDynamet reporting unit would have a fair value that exceeded the carrying value by approximately 52.0 percent. As ofJune 1, 2022 , the fair value of the Latrobe Distribution reporting unit exceeded the carrying value by approximately 34.5 percent. For purposes of the discounted cash flow analysis forLatrobe Distribution's fair value, a weighted average cost capital of 11.0 percent and a terminal growth rate assumption of 2.5 percent were used. If the long-term growth rate for this reporting unit had been hypothetically reduced by 0.5 percent atJune 1, 2022 , the Latrobe Distribution reporting unit would have a fair value that exceeded the carrying value by approximately 32.1 percent. 39 -------------------------------------------------------------------------------- Table of Contents The estimate of fair value requires significant judgment. We based our fair value estimates on assumptions that we believe to be reasonable but that are unpredictable and inherently uncertain, including estimates of future growth rates and operating margins and assumptions about the overall economic climate and the competitive environment for our business units. There can be no assurance that our estimates and assumptions made for purposes of our goodwill and identifiable intangible asset testing as of the time of testing will prove to be accurate predictions of the future. If our assumptions regarding business projections, competitive environments or anticipated growth rates are not correct, we may be required to record goodwill and/or intangible asset impairment charges in future periods, whether in connection with our next annual impairment testing or earlier, if an indicator of an impairment is present before our next annual evaluation. We continuously monitor for events and circumstances that could negatively impact the key assumptions in determining fair value of the reporting units.
New Accounting Pronouncements
For information with respect to new accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 2 to Notes to Consolidated Financial Statements included in Item 1.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ from those projected, anticipated or implied. The most significant of these uncertainties are described inCarpenter Technology's filings with theSecurities and Exchange Commission , including its report on Form 10-K for the year endedJune 30, 2022 , and the exhibits attached to such filing. They include but are not limited to: (1) the cyclical nature of the specialty materials business and certain end-use markets, including aerospace, defense, medical, transportation, energy, industrial and consumer, or other influences onCarpenter Technology's business such as new competitors, the consolidation of competitors, customers, and suppliers or the transfer of manufacturing capacity fromthe United States to foreign countries; (2) the ability ofCarpenter Technology to achieve cash generation, growth, earnings, profitability, operating income, cost savings and reductions, qualifications, productivity improvements or process changes; (3) the ability to recoup increases in the cost of energy, raw materials, freight or other factors; (4) domestic and foreign excess manufacturing capacity for certain metals; (5) fluctuations in currency exchange rates; (6) the effect of government trade actions; (7) the valuation of the assets and liabilities inCarpenter Technology's pension trusts and the accounting for pension plans; (8) possible labor disputes or work stoppages; (9) the potential that our customers may substitute alternate materials or adopt different manufacturing practices that replace or limit the suitability of our products; (10) the ability to successfully acquire and integrate acquisitions; (11) the availability of credit facilities toCarpenter Technology , its customers or other members of the supply chain; (12) the ability to obtain energy or raw materials, especially from suppliers located in countries that may be subject to unstable political or economic conditions; (13)Carpenter Technology's manufacturing processes are dependent upon highly specialized equipment located primarily in facilities inReading andLatrobe, Pennsylvania andAthens, Alabama for which there may be limited alternatives if there are significant equipment failures or a catastrophic event; (14) the ability to hire and retain key personnel, including members of the executive management team, management, metallurgists and other skilled personnel; (15) fluctuations in oil and gas prices and production; (16) uncertainty regarding the return to service of the Boeing 737 MAX aircraft and the related supply chain disruption; (17) potential impacts of the COVID-19 pandemic on our operations, financial results and financial position; (18) our efforts and efforts by governmental authorities to mitigate the COVID-19 pandemic, such as travel bans, shelter in place orders and business closures, and the related impact on resource allocations and manufacturing and supply chains; (19) our ability to execute our business continuity, operational, budget and fiscal plans in light of the COVID-19 pandemic; and (20) our ability to successfully carry out restructuring and business exit activities on the expected terms and timelines. Any of these factors could have an adverse and/or fluctuating effect onCarpenter Technology's results of operations. The forward-looking statements in this document are intended to be subject to the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended. We caution you not to place undue reliance on forward-looking statements, which speak only as of the date of this Form 10-Q or as of the dates otherwise indicated in such forward-looking statements.Carpenter Technology undertakes no obligation to update or revise any forward-looking statements. 40
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