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
as well as drilling tools. 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.
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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 2020 Form 10-K. Our discussions here focus on our results during
or as of the three and six-month periods ended December 31, 2020 and the
comparable periods of fiscal year 2020, and to the extent applicable, on
material changes from information discussed in the 2020 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 2020
Form 10-K for detailed background information and with any such intervening
Form 8-K.
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 20 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), the Company 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 Expense
Net pension expense, 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 re-measurement event occurs. We currently expect that the total net
periodic benefit costs for fiscal year 2021 will be $16.3 million as compared
with $15.0 million in fiscal year 2020. The following is the net pension expense
for the three and six months ended December 31, 2020 and 2019:
Three Months Ended Six Months Ended
December 31, December 31,
($ in millions) 2020 2019 2020 2019
Pension plans $ 3.2 $ 3.0 $ 6.4 $ 6.0
Other postretirement plans 0.8 0.8 1.7 1.6
Net periodic benefit costs $ 4.0 $ 3.8 $ 8.1 $ 7.6
Net pension expense 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 income (expense), net. The following is a
summary of the classification of net pension expense for the three and six
months ended December 31, 2020 and 2019:
Three Months Ended Six Months Ended
December 31, December 31,
($ in millions) 2020 2019 2020 2019
Service cost included in Cost of sales $ 2.7 $ 2.7 $ 5.4 $ 5.5
Service cost included in Selling, general
and administrative expenses 0.3 0.4 0.7 0.8
Pension earnings, interest and deferrals
included in Other income (expense), net 1.0 0.7 2.0 1.3
Net periodic benefit costs $ 4.0 $ 3.8 $ 8.1 $ 7.6 As of
Operating Performance Overview
Our second quarter results reflect our continued emphasis on driving cash flow generation as we ended the second quarter with$665.4 million in total liquidity including$271.4 million in cash. Over the last six months, we have generated$113.7 million in free cash flow. We moved quickly to implement targeted cost reduction initiatives and portfolio realignments that are delivering significant costs savings. We believe the combination of these strategic actions gives us increased flexibility and places us on solid ground to capitalize on demand patterns as market conditions normalize. During the pandemic, we continued to strengthen our customer relationships. To that end, in the Aerospace and Defense end-use market, we recently secured multiple, beneficial long-term contracts with key customers which further demonstrates the future outlook is strong. We are also well positioned to benefit from a recovery in the Medical end-use market as the supply chain gains confidence to meet pent up demand for elective procedures. Overall, we believe end-use market conditions will gradually improve during the second half of fiscal year 2021 and are working hard to capitalize on the recovery. Our core business is built upon over 130 years of advanced material development, production and expertise. We remain a critical supply chain partner today and have made strategic investments to build upon that position in the years to come. The addition of our hot strip mill will significantly strengthen our soft magnetic capabilities at a time when electrification is helping to shape the long-term profile of many of our end-use markets. We also have built an additive manufacturing platform focused on powder lifecycle management. These investments are a strategic extension of our core business and consistent with our mandate to deliver increasing value to our customers and our stakeholders. 31 -------------------------------------------------------------------------------- Table of Contents Results of Operations - Three Months EndedDecember 31, 2020 vs. Three Months EndedDecember 31, 2019 For the three months endedDecember 31, 2020 , we reported a net loss of$84.9 million , or$1.76 loss per diluted share. Excluding special items, adjusted loss per diluted share was$0.61 in the current quarter. This compares with net income for the same period a year earlier of$38.8 million , or$0.79 earnings per diluted share or$0.83 per diluted share excluding special items. The current period results reflect the continued impact of both the COVID-19 pandemic and the 737 MAX production halt. The results in the current period also include cost savings realized from restructuring actions initiated primarily in the fourth quarter of fiscal year 2020. During the three months endedDecember 31, 2020 , we recognized a goodwill impairment charge of$52.8 million related to our Additive reporting unit. COVID-19 related costs negatively impacted operating results by approximately$3.9 million in the second quarter of fiscal year 2021 compared to$0.0 million in the prior year quarter. These COVID-19 costs principally consist of direct incremental operating costs including outside services to execute enhanced cleaning protocols, additional personal protective equipment, isolation pay for production employees potentially exposed to COVID-19 and various operating supplies necessary to maintain the operations while keeping employees safe against possible exposure in our facilities.
Net sales for the three months endedDecember 31, 2020 were$348.8 million , which was a 39 percent decrease over the same period a year ago. Excluding surcharge revenue, sales decreased 36 percent on a 33 percent decrease in shipment volume from the same period a year ago. The results reflect lower demand in all end-use markets driven by COVID-19 headwinds particularly in our Aerospace and Defense and Medical end-use markets during the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 . The current year net sales results reflect the divestiture of the Amega West business onSeptember 30, 2020 . Geographically, sales outsidethe United States decreased 30 percent from the same period a year ago to$140.6 million for the three months endedDecember 31, 2020 . The decrease is primarily driven by weaker demand in the Aerospace and Defense end-use market across all regions. A portion of our sales outsidethe United States are denominated in foreign currencies. The fluctuations in foreign currency exchange rates resulted in a$0.7 million increase in sales during the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 . Net sales outsidethe United States represented 40 percent and 35 percent of total net sales for the three months endedDecember 31, 2020 and 2019, 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 December 31, $ % ($ in millions) 2020 2019 (Decrease) (Decrease) Aerospace and Defense$ 174.5 $ 348.7 $ (174.2) (50) % Medical 32.4 49.0 (16.6) (34) % Transportation 31.6 38.4 (6.8) (18) % Energy 22.1 31.2 (9.1) (29) % Industrial and Consumer 66.0 78.0 (12.0) (15) % Distribution 22.2 27.7 (5.5) (20) % Total net sales$ 348.8 $ 573.0 $ (224.2) (39) % 32
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The following table includes comparative information for our net sales by the
same principal end-use markets, but excluding surcharge revenue:
Three Months Ended
December 31, $ %
($ in millions) 2020 2019 (Decrease) (Decrease)
Aerospace and Defense $ 148.5 $ 278.8 $ (130.3) (47) %
Medical 29.0 43.5 (14.5) (33) %
Transportation 25.8 30.6 (4.8) (16) %
Energy 17.7 26.9 (9.2) (34) %
Industrial and Consumer 56.3 63.9 (7.6) (12) %
Distribution 22.1 27.5 (5.4) (20) %
Total net sales excluding surcharge revenue $ 299.4 $ 471.2 $ (171.8) (36) %
Sales to the Aerospace and Defense end-use market decreased 50 percent from the
second quarter a year ago to $174.5 million . Excluding surcharge revenue, sales
decreased 47 percent from the second quarter a year ago on a 50 percent decrease
in shipment volume. The results reflect weaker year-over-year demand in all
sub-markets due to the continued impact of lower aircraft OEM build rates due to
COVID-19 travel restrictions and the 737 MAX production halt.
Medical end-use market sales decreased 34 percent from the second quarter a year
ago to $32.4 million . Excluding surcharge revenue, sales decreased 33 percent on
32 percent lower shipment volume from the second quarter a year ago. The results
reflect lower demand as a result of the medical supply chain managing inventory
levels closely related to ongoing concerns associated with delays of elective
medical procedures from the COVID-19 pandemic.
Transportation end-use market sales decreased 18 percent from the second quarter
a year ago to $31.6 million . Excluding surcharge revenue, sales decreased 16
percent on 10 percent lower shipment volume from the second quarter a year ago.
The results are impacted by lower demand for light, medium and heavy duty
vehicles across all regions compared to the prior year period.
Sales to the Energy end-use market of $22.1 million in the current quarter
reflect a 29 percent decrease from the second quarter a year ago. Excluding
surcharge revenue, sales decreased 34 percent from a year ago. The results
reflect severely depressed North American drilling activity and decreased demand
globally as a result of the impact of COVID-19. The current year results reflect
the divestiture of the Amega West business on September 30, 2020 .
Industrial and Consumer end-use market sales of $66.0 million decreased $12.0
million compared to the second quarter a year ago. Excluding surcharge revenue,
sales decreased 12 percent on 8 percent lower shipment volume. The results
reflect lower demand in Industrial driven by COVID-19 related operational
constraints partially offset by higher demand in the electronics sub-market.
Gross Profit
Our gross profit in the second quarter decreased 95 percent to$6.0 million , or 1.7 percent of net sales as compared with$112.6 million , or 19.7 percent of net sales in the same quarter a year ago. Excluding the impact of surcharge revenue, our adjusted gross margin in the second quarter was 2.0 percent as compared to 23.9 percent in the same period a year ago. The current period results were impacted by significantly lower volume resulting from the COVID-19 pandemic, continued targeted inventory reductions and the 737 MAX production halt. 33 -------------------------------------------------------------------------------- Table of Contents While the surcharge generally protects the absolute gross profit dollars, it does have a dilutive effect on gross margin as a percent of sales. The following represents a summary of the dilutive impact of the surcharge on gross margin for the comparative three-month periods. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures. Three Months Ended December 31, ($ in millions) 2020 2019 Net sales $ 348.8 $ 573.0 Less: surcharge revenue 49.4 101.8 Net sales excluding surcharge revenue $ 299.4 $ 471.2 Gross profit $ 6.0 $ 112.6 Gross margin 1.7% 19.7% Adjusted gross margin excluding surcharge revenue 2.0% 23.9%
Selling, General and Administrative Expenses
Selling, general and administrative expenses of$42.2 million were 12.1 percent of net sales (14.1 percent of net sales excluding surcharge) as compared with$55.3 million and 9.7 percent of net sales (11.7 percent of net sales excluding surcharge) in the same quarter a year ago. The lower selling, general and administrative expenses in the current quarter reflect the impacts of the cost saving actions initiated in the fourth quarter of fiscal year 2020 including a reduction of$6.7 million in salaries and benefits in the three months endedDecember 31, 2020 compared to the same period a year ago.
Restructuring and Asset Impairment Charges
Restructuring and asset impairment charges for the three months ended
During the quarter endedSeptember 30, 2020 , we initiated a restructuring plan to consolidate certain operations within the Additive business in the PEP segment. This included$8.7 million of non-cash impairment charges primarily related to certain long-lived assets and certain definite lived intangible assets. We also recognized$1.3 million of charges primarily related to various personnel-related costs for severance payments, medical coverage and related items. Activities undertaken in connection with this fiscal year 2021 restructuring plan are considered substantially complete in the second quarter of fiscal year 2021. Goodwill Impairment Charge In preparing the financial statements for the quarter endedDecember 31, 2020 , we identified an impairment triggering event related to the Additive reporting unit within the PEP segment. This reporting unit has experienced slower than expected growth due to customers shifting their near-term focus away from this emerging area as a result of the continuing impacts of the COVID-19 pandemic. During the quarter endedDecember 31, 2020 we also made strategic decisions to reduce resources allocated to the Additive reporting unit to concentrate on the essential manufacturing business. In light of these decisions and current market conditions, the pace of growth in the future projections for the Additive reporting unit were lowered. As a result, during the three months endedDecember 31, 2020 we recorded an impairment charge of$52.8 million , which represents the entire balance of goodwill for this reporting unit. No goodwill impairment charges were incurred during the three months endedDecember 31, 2019 . 34 -------------------------------------------------------------------------------- Table of Contents Operating (Loss) Income Our operating loss in the recent second quarter was$89.0 million or negative 25.5 percent of net sales as compared with income of$55.0 million or 9.6 percent of net sales in the same quarter a year ago. Excluding surcharge revenue and special items, adjusted operating margin was negative 10.8 percent for the most recent quarter as compared with 12.2 percent a year ago. The results for the second quarter of fiscal year 2021 compared to the same period a year ago were negatively impacted by the significantly lower volume due to the COVID-19 pandemic, targeted inventory reductions to strengthen liquidity and a non-cash goodwill impairment charge. These headwinds were partially offset by the various cost savings actions taken by the Company. During the three months endedDecember 31, 2020 , we recognized a goodwill impairment charge of$52.8 million related to our Additive reporting unit. The following presents our operating (loss) income and operating margin, in each case excluding the impact of surcharge revenue on net sales and special items. We present and discuss these financial measures because management believes removing these items provides a more consistent and meaningful basis for comparing ongoing results of operations from period to period. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures. Three Months Ended December 31, ($ in millions) 2020 2019 Net sales $ 348.8$ 573.0 Less: surcharge revenue 49.4 101.8 Net sales excluding surcharge revenue $
299.4
Operating (loss) income $ (89.0)$ 55.0 Special items: Restructuring and asset impairment charges - 2.3 Goodwill impairment 52.8 - COVID-19 costs 3.9 - Operating (loss) income $ (32.3)$ 57.3 Operating margin (25.5) % 9.6 % Adjusted operating margin excluding surcharge revenue and special items (10.8) % 12.2 % 35
-------------------------------------------------------------------------------- Table of Contents Interest Expense, Net Interest expense, net for the three months endedDecember 31, 2020 was$7.9 million compared with$5.3 million in the same period a year ago. We have historically used interest rate swaps to achieve a level of floating rate debt to fixed rate debt where appropriate; all interest rate swaps were terminated in the prior quarter in connection with the prepayment of related Notes. Interest expense, net includes$0.0 million of activity related to interest rate swaps for the three months endedDecember 31, 2020 and net gains from interest rate swaps of$0.1 million for the three months endedDecember 31, 2019 , respectively. Capitalized interest reduced interest expense, net by$3.0 million for the three months endedDecember 31, 2020 and$2.2 million for the three months endedDecember 31, 2019 .
Other Income, Net
Other income, net for the three months endedDecember 31, 2020 was$1.3 million as compared with$0.8 million of other income, net in the same period a year ago. The current year results include favorable market returns on investments used to fund Company-owned life insurance contracts and investments held in rabbi trusts partially offset by expense from pension earnings, interest and deferrals and foreign exchange losses. The other income, net for the three months endedDecember 31, 2019 includes favorable market returns on investments used to fund Company-owned life insurance contracts and investments held in rabbi trusts partially offset by expense from pension earnings, interest and deferrals. Income Taxes Income tax benefit in the recent second quarter was$10.7 million , or 11.2 percent of pre-tax loss compared with expense of$11.7 million , or 23.2 percent of pre-tax income in the same quarter a year ago. Income tax benefit in the three months endedDecember 31, 2020 includes the unfavorable impacts of a non-deductible goodwill impairment charge and losses in certain foreign jurisdictions for which no tax benefit can be recognized. Additionally, the anticipated benefit for the carryback of the current year net operating loss to fiscal years with higher tax rates is included in this period. Excluding the discrete tax impact of the$52.8 million non-deductible goodwill impairment charge, the tax rate for the second quarter would have been 24.8%. Income tax expense in the three months endedDecember 31, 2019 included the impact of losses in certain foreign jurisdictions for which no tax benefit can be recognized. The Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") was enacted onMarch 27, 2020 . The CARES Act established new provisions, including but not limited to, expanded deduction of certain qualified capital expenditures, delayed payment of certain employment taxes, expanded use of net operating losses, reduced limitations on deductions of interest expense and extension of funding for defined benefit plans. The net operating loss provision is expected to provide incremental tax benefits of approximately$7.0 million due to the higher tax rates in the expanded carryback period. The other provisions in the CARES Act are not expected to have a significant impact on our financial position, results of operations or cash flows. 36 -------------------------------------------------------------------------------- Table of Contents 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 %
December 31, (Decrease) (Decrease)
(Pounds sold, in thousands) 2020 2019 Increase Increase
Specialty Alloys Operations 38,602 56,564 (17,962) (32) %
Performance Engineered Products * 1,534 3,424 (1,890) (55) %
Intersegment (516) (690) 174 25 %
Consolidated pounds sold 39,620 59,298 (19,678) (33) %
* Pounds sold data for PEP segment includes
The following table includes comparative information for net sales by business
segment:
Three Months Ended $ %
December 31, (Decrease) (Decrease)
($ in millions) 2020 2019 Increase Increase
Specialty Alloys Operations $ 300.4 $ 483.0 $ (182.6) (38) %
Performance Engineered Products 54.8 106.0 (51.2) (48) %
Intersegment (6.4) (16.0) 9.6 60 %
Total net sales $ 348.8 $ 573.0 $ (224.2) (39) %
The following table includes comparative information for our net sales by business segment, but excluding surcharge revenue:
Three Months Ended $ %
December 31, (Decrease) (Decrease)
($ in millions) 2020 2019 Increase Increase
Specialty Alloys Operations $ 251.6 $ 382.5 $ (130.9) (34) %
Performance Engineered Products 54.1 104.1 (50.0) (48) %
Intersegment (6.3) (15.4) 9.1 59 %
Total net sales excluding surcharge revenue $ 299.4 $ 471.2 $ (171.8) (36) %
Specialty Alloys Operations Segment
Net sales for the quarter endedDecember 31, 2020 for the SAO segment decreased 38 percent to$300.4 million , as compared with$483.0 million in the same quarter a year ago. Excluding surcharge revenue, net sales decreased 34 percent on 32 percent lower shipment volume from a year ago. The SAO segment results reflect lower sales in most end-use markets compared to the prior year same quarter caused by the COVID-19 pandemic as well as the 737 MAX production halt. Operating loss for the SAO segment was$11.6 million or negative 3.9 percent of net sales (4.6 percent of net sales excluding surcharge revenue) in the recent second quarter, as compared with operating income of$76.3 million or 15.8 percent of net sales (19.9 percent of net sales excluding surcharge revenue) in the same quarter a year ago. The decrease in operating income reflects lower demand across key end-use markets and impacts from targeted inventory reductions in the current fiscal year as compared to the prior year period. The results for the quarter endedDecember 31, 2020 also include$3.2 million of expenses due to COVID-19 which were not required during the prior year period. 37
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Performance Engineered Products Segment
Net sales for the quarter endedDecember 31, 2020 for the PEP segment decreased 48 percent to$54.8 million , as compared with$106.0 million in the same quarter a year ago. Excluding surcharge revenue, net sales of$54.1 million decreased from$104.1 million a year ago. The results reflect decreases in sales in all end-use markets. This included lower demand in the Medical end-use market from delays in elective procedures caused by COVID-19 as well as prolonged weakness in the oil and gas sub-market and depressed drilling levels in the Energy end-use market. The prior year quarter included net sales from the Amega West business which was divested onSeptember 30, 2020 . Operating loss for the PEP segment was$7.2 million or negative 13.1 percent of net sales in the recent second quarter, compared with operating income of$0.4 million or 0.4 percent of net sales in the same quarter a year ago. The results were impacted by weaker demand in theMedical and Aerospace end-use markets offset by the reduction of expenses in the current year quarter from the Amega West divestiture. The results for the quarter endedDecember 31, 2020 also include$0.7 million of expenses due to COVID-19 which were not required during the prior year period.
Results of Operations - Six Months Ended
Net Sales Net sales for the six months endedDecember 31, 2020 were$702.1 million , which was a 39 percent decrease over the same period a year ago. Excluding surcharge revenue, sales decreased 37 percent on a 31 percent decrease in shipment volume from the same period a year ago. The results reflect ongoing demand impacts driven by COVID-19 related headwinds in all our end-use markets during the six months endedDecember 31, 2020 compared to the six months endedDecember 31, 2019 . Geographically, sales outsidethe United States decreased 33 percent from the same period a year ago to$269.2 million for the six months endedDecember 31, 2020 . The decrease is due to weaker demand in key end-use markets across all regions driven by impacts of COVID-19. A portion of our sales outsidethe United States are denominated in foreign currencies. The fluctuations in foreign currency exchange rates resulted in a$0.8 million increase in sales during the six months endedDecember 31, 2020 compared to the six months endedDecember 31, 2019 . Net sales outsidethe United States represented 38 percent and 35 percent of total net sales for the six months endedDecember 31, 2020 and 2019, 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:
Six Months Ended
December 31, $ %
($ in millions) 2020 2019 (Decrease) (Decrease)
Aerospace and Defense $ 346.4 $ 702.0 $ (355.6) (51) %
Medical 65.2 98.0 (32.8) (33) %
Transportation 60.8 78.4 (17.6) (22) %
Energy 47.2 70.5 (23.3) (33) %
Industrial and Consumer 139.4 151.3 (11.9) (8) %
Distribution 43.1 58.2 (15.1) (26) %
Total net sales $ 702.1 $ 1,158.4 $ (456.3) (39) %
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The following table includes comparative information for our net sales by the same principal end-use markets, but excluding surcharge revenue:
Six Months Ended
December 31, $ %
($ in millions) 2020 2019 (Decrease) (Decrease)
Aerospace and Defense $ 296.0 $ 564.9 $ (268.9) (48) %
Medical 59.0 87.5 (28.5) (33) %
Transportation 50.2 63.6 (13.4) (21) %
Energy 39.0 59.9 (20.9) (35) %
Industrial and Consumer 119.4 124.1 (4.7) (4) %
Distribution 42.9 57.8 (14.9) (26) %
Total net sales excluding surcharge revenue
(37) %
Sales to the Aerospace and Defense end-use market decreased 51 percent from the
same period a year ago to $346.4 million . Excluding surcharge revenue, sales
decreased 48 percent from the same period a year ago on a 48 percent decrease in
shipment volume. The results reflect weaker year-over-year demand in all
sub-markets due to the continued impact of lower aircraft OEM build rates due to
COVID-19 travel restrictions and the 737 MAX production halt.
Medical end-use market sales decreased 33 percent from the same period a year
ago to $65.2 million . Excluding surcharge revenue, sales decreased 33 percent on
33 percent lower shipment volume from the same period a year ago. The results
reflect the impact of customers closely managing inventory levels as a result of
ongoing delays of elective medical procedures from the COVID-19 pandemic.
Transportation end-use market sales decreased 22 percent from the same period a
year ago to $60.8 million . Excluding surcharge revenue, sales decreased 21
percent on 19 percent lower shipment volume from the same period a year ago. The
results are impacted by lower demand for light, medium and heavy duty vehicles
compared to the prior year period.
Sales to the Energy end-use market of $47.2 million in the current period
reflect a 33 percent decrease from the same period a year ago. Excluding
surcharge revenue, sales decreased 35 percent from the same period a year ago.
The results reflect depressed North American drilling activity and decreased
demand globally as a result of the impact of COVID-19. The current year results
reflect the divestiture of the Amega West business on September 30, 2020 .
Industrial and Consumer end-use market sales of $139.4 million decreased $11.9
million from the same period a year ago. Excluding surcharge revenue, sales
decreased 4 percent on 2 percent higher shipment volume from the same period a
year ago. The results reflect lower demand for Consumer products compared to the
prior year period and flat demand for Industrial products.
Gross Profit
Our gross profit in the six months endedDecember 31, 2020 decreased 96 percent to$9.5 million , or 1.4 percent of net sales as compared with$225.3 million , or 19.4 percent of net sales in the same period a year ago. Excluding the impact of surcharge revenue, our adjusted gross margin in the six months endedDecember 31, 2020 was 1.6 percent as compared to 23.5 percent in the same period a year ago. The current period results were impacted by significantly lower volume resulting from the COVID-19 pandemic across all end-use markets, negative impacts from a targeted inventory reduction plan and the 737 MAX production halt. 39 -------------------------------------------------------------------------------- Table of Contents While the surcharge generally protects the absolute gross profit dollars, it does have a dilutive effect on gross margin as a percent of sales. The following represents a summary of the dilutive impact of the surcharge on gross margin for the comparative six-month periods. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures. Six Months Ended December 31, ($ in millions) 2020 2019 Net sales $ 702.1 $ 1,158.4 Less: surcharge revenue 95.6 200.6 Net sales excluding surcharge revenue $ 606.5 $ 957.8 Gross profit $ 9.5 $ 225.3 Gross margin 1.4% 19.4% Adjusted gross margin excluding surcharge revenue 1.6% 23.5%
Selling, General and Administrative Expenses
Selling, general and administrative expenses of$84.5 million were 12.0 percent of net sales (13.9 percent of net sales excluding surcharge) as compared with$108.2 million and 9.3 percent of net sales (11.3 percent of net sales excluding surcharge) in the same period a year ago. The lower selling, general and administrative expenses in the current year reflect the impacts of the cost saving actions initiated in the fourth quarter of fiscal year 2020 including a reduction of$13.4 million in salaries and benefits in the six months endedDecember 31, 2020 compared to the same period a year ago. 40 -------------------------------------------------------------------------------- Table of Contents Restructuring and Asset Impairment Charges Restructuring and asset impairment charges for the six months endedDecember 31, 2020 were$10.0 million as compared with$2.3 million restructuring and asset impairment charges for the six months endedDecember 31, 2019 . During the first quarter endedSeptember 30, 2020 , we initiated a restructuring plan to consolidate certain operations within the Additive business in the PEP segment. This included$8.7 million of non-cash impairment charges primarily related to certain long-lived assets and certain definite lived intangible assets. We also recognized$1.3 million of charges primarily related to various personnel-related costs for severance payments, medical coverage and related items. Activities undertaken in connection with this fiscal year 2021 restructuring plan are considered to be substantially complete in the second quarter of fiscal year 2021. Goodwill Impairment Charge In preparing the financial statements for the quarter endedDecember 31, 2020 , we identified an impairment triggering event related to the Additive reporting unit within the PEP segment. This reporting unit has experienced slower than expected growth due to customers shifting their near-term focus away from this emerging area as a result of the continuing impacts of the COVID-19 pandemic. During the quarter endedDecember 31, 2020 we also made strategic decisions to reduce resources allocated to the Additive reporting unit to concentrate on the essential manufacturing business. In light of these decisions and current market conditions, the pace of growth in the future projections for the Additive reporting unit were lowered. As a result, during the six months endedDecember 31, 2020 we recorded an impairment charge of$52.8 million , which represents the entire balance of goodwill for this reporting unit. No goodwill impairment charges were incurred during the six months endedDecember 31, 2019 .
Operating (Loss) Income
Our operating loss in the six months endedDecember 31, 2020 was$137.8 million or negative 19.6 percent of net sales as compared with income of$114.8 million or 9.9 percent of net sales in the same period a year ago. Excluding surcharge revenue and special items, adjusted operating margin was negative 10.4 percent for the most recent six months as compared with 12.2 percent a year ago. The results for the six months endedDecember 31, 2020 compared to the same period a year ago were negatively impacted by the significantly lower volume due to the COVID-19 pandemic, targeted inventory reductions, and the impacts of the Boeing 737 MAX production halt, partially offset by the various cost savings actions taken by the Company. The current period also reflects a non-cash goodwill impairment charge of$52.8 million recognized for our Additive reporting unit in the PEP segment. The following presents our operating (loss) income and operating margin, in each case excluding the impact of surcharge revenue on net sales and special items. We present and discuss these financial measures because management believes removing these items provides a more consistent and meaningful basis for comparing ongoing results of operations from period to period. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures. 41
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Six Months Ended
December 31,
($ in millions) 2020 2019
Net sales $ 702.1 $ 1,158.4
Less: surcharge revenue 95.6 200.6
Net sales excluding surcharge revenue $ 606.5 $ 957.8
Operating (loss) income $ (137.8) $ 114.8
Special items:
Restructuring and asset impairment charges 10.0 2.3
Goodwill impairment 52.8 -
COVID-19 costs 11.8 -
Operating (loss) income $ (63.2) $ 117.1
Operating margin (19.6) % 9.9 %
Adjusted operating margin excluding surcharge revenue and
special items (10.4) % 12.2 %
Interest Expense, Net and Debt Extinguishment losses, net
Interest expense, net for the six months endedDecember 31, 2020 was$14.6 million compared with$10.7 million in the same period a year ago. We have used interest rate swaps to achieve a level of floating rate debt to fixed rate debt where appropriate. Interest expense, net includes net gains from interest rate swaps of$0.4 million and$0.1 million for the six months endedDecember 31, 2020 and 2019, respectively. The interest rate swaps were terminated in the prior quarter in connection with the prepayment of related Notes. Capitalized interest reduced interest expense, net by$5.7 million for the six months endedDecember 31, 2020 and$4.2 million for the six months endedDecember 31, 2019 . Debt extinguishment losses, net for the six months endedDecember 31, 2020 include$10.5 million of debt prepayment costs on the Notes dueJuly 2021 offset by gains of$2.3 million on the related interest rate swaps that were terminated in connection with the prepayment.
Other (Expense) Income, Net
Other expense, net for the six months endedDecember 31, 2020 was$1.1 million as compared with$0.5 million of other income, net in the same period a year ago. The current year results include greater expense from pension earnings, interest and deferrals compared to the prior year period.
Income Taxes
Income tax benefit in the six months endedDecember 31, 2020 was$29.7 million , or 18.4 percent of pre-tax loss compared with expense of$24.6 million , or 23.5 percent of pre-tax income in the six months endedDecember 31, 2020 . Income tax benefit in the six months endedDecember 31, 2020 includes the unfavorable impacts of a non-deductible goodwill impairment charge and losses in certain foreign jurisdictions for which no tax benefit can be recognized as well as discrete tax benefits of$2.0 million associated with the debt extinguishment losses, net and$2.4 million for the impact of restructuring and asset impairment charges. Additionally, the anticipated benefit for the carryback of the current year net operating loss to fiscal years with higher tax rates is included in this period. Also included is a tax charge of$1.2 million attributable to employee share-based compensation. Excluding the discrete tax impacts of the$52.8 million non-deductible goodwill impairment charge, debt extinguishment losses, net and restructuring and asset impairment charges, the tax rate for the six months endedDecember 31, 2020 would have been 27.1%. Income tax expense in the six months endedDecember 31, 2019 included the impact of losses in certain foreign jurisdictions for which no tax benefit can be recognized as well as tax benefits of$0.5 million attributable to employee share-based compensation. 42 -------------------------------------------------------------------------------- Table of Contents The Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") was enacted onMarch 27, 2020 . The CARES Act established new provisions, including but not limited to, expanded deduction of certain qualified capital expenditures, delayed payment of certain employment taxes, expanded use of net operating losses, reduced limitations on deductions of interest expense and extension of funding for defined benefit plans. The net operating loss provision is expected to provide incremental tax benefits of approximately$7.0 million due to the higher tax rates in the expanded carryback period. The other provisions in the CARES Act 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:
Six Months Ended %
December 31, (Decrease) (Decrease)
(Pounds sold, in thousands) 2020 2019 Increase Increase
Specialty Alloys Operations 81,970 116,606 (34,636) (30) %
Performance Engineered Products * 2,998 6,674 (3,676) (55) %
Intersegment (1,000) (1,684) 684 41 %
Consolidated pounds sold 83,968 121,596 (37,628) (31) %
*Pounds sold data for PEP segment includes
The following table includes comparative information for net sales by business
segment:
Six Months Ended $ %
December 31, (Decrease) (Decrease)
($ in millions) 2020 2019 Increase Increase
Specialty Alloys Operations $ 601.1 $ 974.1 $ (373.0) (38) %
Performance Engineered Products 116.7 215.4 (98.7) (46) %
Intersegment (15.7) (31.1) 15.4 50 %
Total net sales $ 702.1 $ 1,158.4 $ (456.3) (39) %
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The following table includes comparative information for our net sales by business segment, but excluding surcharge revenue:
Six Months Ended $ %
December 31, (Decrease) (Decrease)
($ in millions) 2020 2019 Increase Increase
Specialty Alloys Operations $ 506.4 $ 775.7 $ (269.3) (35) %
Performance Engineered Products 115.3 212.0 (96.7) (46) %
Intersegment (15.2) (29.9) 14.7 49 %
Total net sales excluding surcharge revenue
(37) %
Specialty Alloys Operations Segment
Net sales for the six months endedDecember 31, 2020 for the SAO segment decreased 38 percent to$601.1 million , as compared with$974.1 million in the same period a year ago. Excluding surcharge revenue, net sales decreased 35 percent on 30 percent lower shipment volume from a year ago. The SAO segment results reflect lower sales in all end-use markets compared to the prior year caused by the COVID-19 pandemic as well as the 737 MAX production halt. Operating loss for the SAO segment was$30.2 million or negative 5.0 percent of net sales (6.0 percent of net sales excluding surcharge revenue) in the recent six months, as compared with operating income of$157.3 million or 16.1 percent of net sales (20.3 percent of net sales excluding surcharge revenue) in the same period a year ago. The decrease in operating income reflects lower demand across all key end-use markets and the impacts from targeted inventory reductions in the current fiscal year as compared to the prior year period. The results for the six months endedDecember 31, 2020 also include$10.4 million of expenses due to COVID-19 which were not required during the prior year period.
Performance Engineered Products Segment
Net sales for the six months endedDecember 31, 2020 for the PEP segment decreased 46 percent to$116.7 million , as compared with$215.4 million in the same period a year ago. Excluding surcharge revenue, net sales of$115.3 decreased from$212.0 million a year ago. The results reflect decreases in sales in all end-use markets. This included lower demand in the Medical end-use market from delays in elective procedures caused by COVID-19. The current year net sales results reflect the divestiture of the Amega West business onSeptember 30, 2020 . Operating loss for the PEP segment was$10.9 million or negative 9.3 percent of net sales in the recent six months, compared with operating loss of$1.7 million or negative 0.8 percent of net sales in the same period a year ago. The results were impacted by weaker demand in theMedical and Aerospace end-use markets. The results for the six months endedDecember 31, 2020 also include$1.4 million of expenses due to COVID-19 which were not required during the prior year period.
Liquidity and Financial Resources
During the six months endedDecember 31, 2020 , we generated cash from operations of$171.6 million compared to$22.6 million in the same period a year ago. Our free cash flow, which we define under "Non-GAAP Financial Measures" below, was positive$113.7 million as compared to negative$91.0 million for the same period a year ago. The increase in cash provided from operating activities for the six months endedDecember 31, 2020 compared to the same period a year ago was driven by working capital improvements. Cash generated from reductions in inventory was$155.8 million in the current period endedDecember 31, 2020 compared to cash used for inventory of$108.2 million in the prior year. The current year reflects impacts from targeted inventory reductions to strengthen liquidity. During the six months endedDecember 31, 2020 , we generated cash from accounts receivable of$64.2 million compared to the generation of cash of$5.0 million in the same period a year ago. The free cash flow results reflect lower capital spending levels in the current period as compared to the prior year period. Current period results also include$20.0 million of proceeds related to the sale of ourAmega West business. 44 -------------------------------------------------------------------------------- Table of Contents Capital expenditures for property, plant, equipment and software were$59.9 million for the six months endedDecember 31, 2020 as compared to$94.3 million for the same period a year ago. In fiscal year 2021, we expect capital expenditures to be approximately$120 million .
Dividends during the six months ended
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 generally target minimum liquidity of$150 million , consisting of cash and cash equivalents added to available borrowing capacity under our Credit Agreement. Our Credit Agreement contains a revolving credit commitment of$400 million , which expires inMarch 2022 . As ofDecember 31, 2020 , we had$6.0 million of issued letters of credit and no short-term borrowings under the Credit Agreement. The balance of the Credit Agreement,$394.0 million , remains available to us. As ofDecember 31, 2020 , we had total liquidity of$665.4 million , including$271.4 million of cash and cash equivalents. From time to time during the six months endedDecember 31, 2020 , we have borrowed under our Credit Agreement. The weighted average daily borrowing under the Credit Agreement during the six months endedDecember 31, 2020 was approximately$25.6 million with daily outstanding borrowings ranging from$0.0 million to$170.0 million during the period. As ofDecember 31, 2020 , the borrowing rate for the Credit Agreement was 1.65%. We believe that our cash and cash equivalents of$271.4 million as ofDecember 31, 2020 and available borrowing capacity of$394.0 million under our credit facility will be sufficient to fund our cash needs over the foreseeable future. During the six months endedDecember 31, 2020 , we made pension contributions of$4.7 million to our qualified defined benefit pension plans. We currently expect to make$15.0 million of additional contributions to our qualified defined benefit pension plans during the remainder of fiscal year 2021. As ofDecember 31, 2020 , we had cash and cash equivalents of approximately$25.8 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 six months endedDecember 31, 2020 , we repatriated cash of approximately$9.8 million from a foreign jurisdiction that resulted in minimal tax cost. We are subject to certain financial and restrictive covenants under the Credit Agreement, which, among other things, require the maintenance of a minimum interest coverage ratio (3.50 to 1.00 as ofDecember 31, 2020 ). The interest coverage ratio is defined in the Credit Agreement 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 Credit Agreement also requires the Company to maintain a debt to capital ratio of less than 55%. The debt to capital ratio is defined in the Credit Agreement as the ratio of consolidated indebtedness, as defined therein, to consolidated capitalization, as defined therein. As ofDecember 31, 2020 , the Company was in compliance with all of the covenants of the Credit Agreement.
The following table shows our actual ratio performance with respect to the
financial covenants as of
Covenant Covenant Requirement Actual
Consolidated interest coverage 3.50 to 1.00 (minimum) 3.80 Consolidated debt to capital
55% (maximum) 34.2%
To the extent that we do not comply with the current or modified covenants under
the Credit Agreement, 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.
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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 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 and cost of 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 and cost of 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 for a reconciliation of operating income and operating margin excluding surcharge revenue and special items to operating income 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.
Adjusted (Loss) Earnings Per Share
The following provides a reconciliation of adjusted (loss) earnings 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 endedDecember 31, 2020 as reported$ (95.6) $ 10.7 $ (84.9) $ (1.76) Special items: Goodwill impairment 52.8 (0.1) 52.7 1.09 COVID-19 costs 3.9 (0.9) 3.0 0.06 Three months endedDecember 31, 2020 as adjusted$ (38.9) $ 9.7 $ (29.2) $ (0.61)
* Impact per diluted share calculated using weighted average common shares
outstanding of 48.3 million for the three months ended
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Income Before Income Tax Earnings Per
($ in millions, except per share amounts) Income Taxes Expense Net Income Diluted Share*
Three months ended December 31, 2019 as
reported $ 50.5 $ (11.7) $ 38.8 $ 0.79
Special item:
Restructuring and asset impairment
charges 2.3 (0.5) 1.8 0.04
Three months ended December 31, 2019 as
adjusted $ 52.8 $ (12.2) $ 40.6 $ 0.83 * Impact per diluted share calculated using weighted average common shares
outstanding of 48.5 million for the three months ended
Income Tax
Loss Before Benefit (Loss) Per
($ in millions, except per share amounts) Income Taxes (Expense)
Net Loss Diluted Share*
Six months ended December 31, 2020 , as
reported $ (161.7) $
29.7
8.2 (2.0) 6.2 0.13
Restructuring and asset impairment charges 10.0 (2.4) 7.6 0.16
Goodwill impairment 52.8 (0.1) 52.7 1.09
COVID-19 costs 11.8 (3.5) 8.3 0.17
Six months ended December 31, 2020 as
adjusted $ (78.9) $ 21.7 $ (57.2) $ (1.19) * Impact per diluted share calculated using weighted average common shares
outstanding of 48.3 million for the six months ended
Income Before Income Tax Earnings Per
($ in millions, except per share amounts) Income Taxes Expense Net Income Diluted Share*
Six months ended December 31, 2019 , as
reported $ 104.6 $ (24.6) $ 80.0 $ 1.64
Special item:
Restructuring and asset impairment
charges 2.3 (0.5) 1.8 0.03
Six months ended December 31, 2019 as
adjusted $ 106.9 $ (25.1) $ 81.8 $ 1.67 * Impact per diluted share calculated using weighted average common shares
outstanding of 48.4 million for the six months ended
Management believes that the presentation of (loss) earnings 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) earnings per share is not aU.S. GAAP financial measure and should not be considered in isolation of, or as a substitute for, (loss) earnings per share calculated in accordance withU.S. GAAP. 47 -------------------------------------------------------------------------------- Table of Contents Free Cash Flow
The following provides a reconciliation of free cash flow, as used in this
report, to its most directly comparable
Six Months Ended
December 31,
($ in millions) 2020 2019
Net cash provided from operating activities $ 171.6 $ 22.6
Purchases of property, plant, equipment and software (59.9) (94.3)
Proceeds from disposals of property, plant and equipment and assets held for sale
1.5 0.1
Proceeds from divestiture of business 20.0 -
Dividends paid (19.5) (19.4)
Free cash flow $ 113.7 $ (91.0)
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.
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 six months ended December 31, 2020 , 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 at December 31, 2020 and June 30, 2020 were $16.1 million
and $16.0 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.
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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 2020 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.
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 at least annually tested for impairment as ofJune 30 , 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. The fair value is estimated using a weighting of discounted cash flows and the use of market multiples valuation techniques for the SAO reporting unit and two of the PEP segment reporting units. The fair value for the Additive reporting unit is estimated using a discounted cash flow technique. If the carrying value of the reporting unit exceeds its fair value, any impairment loss is measured by comparing the carrying value of the reporting unit's goodwill to its implied fair value. 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 relating to revenue growth rates. 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. 49 -------------------------------------------------------------------------------- Table of Contents In preparing the financial statements for the quarter endedDecember 31, 2020 , we identified an impairment triggering event related to the Additive reporting unit within the PEP segment. This reporting unit has experienced slower than expected growth due to customers shifting their near-term focus away from this emerging area as a result of the continuing impacts of the COVID-19 pandemic. During the quarter endedDecember 31, 2020 we also made strategic decisions to reduce resources allocated to the Additive reporting unit to concentrate on the essential manufacturing business. In light of these decisions and current market conditions, the pace of growth in the future projections for the Additive reporting unit were lowered. We determined the goodwill associated with this reporting unit was impaired and recorded an impairment charge of$52.8 million during the quarter endedDecember 31, 2020 , which represents the entire balance of goodwill for this reporting unit. No other impairment was identified at the impairment testing date. The carrying value of the Additive reporting unit was greater than the fair value by approximately 37.7 percent. For purposes of the discounted cash flow technique for Additive's fair value, we used a weighted average cost of capital of 15.5 percent and a terminal growth rate assumption of 3.0 percent. If a terminal growth rate of 4.0 percent was used the Additive reporting unit would have a carrying value in excess of fair value of approximately 34.2 percent, still resulting in a full impairment. As ofDecember 31, 2020 , after the impairment loss, we have three reporting units with goodwill recorded.Goodwill associated with our SAO reporting unit is tested at the SAO segment level and represents approximately 81 percent of our total goodwill. All other goodwill is associated with our PEP segment, which includes two reporting units with goodwill recorded. As ofJune 30, 2020 , the fair value of the SAO reporting unit exceeded the carrying value by approximately 4.5 percent. The goodwill recorded related to the SAO reporting unit as ofJune 30, 2020 was$195.5 million . 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, we used a weighted average cost capital of 10.5 percent and a terminal growth rate assumption of 3 percent. If the fair value of this reporting unit had been hypothetically reduced by 5 percent atJune 30, 2020 , the SAO reporting unit would have a fair value that would approximate net book value. 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. Given the evolving nature of and uncertainty driven by the COVID-19 pandemic, we will continue to evaluate the impact on the reporting units as adverse changes to these assumptions could result in future impairments. 50 -------------------------------------------------------------------------------- Table of Contents 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, 2020 , Form 10-Q for the quarter endedSeptember 30, 2020 and the exhibits attached to those filings. 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 status as a "critical", "essential" or "life-sustaining" business in light of COVID-19 business closure laws, orders and guidance being challenged by a governmental body or other applicable authority; (20) our ability to execute our business continuity, operational, budget and fiscal plans in light of the COVID-19 pandemic; and (21) 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.Carpenter Technology undertakes no obligation to update or revise any forward-looking statements. 51
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