Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
 

FORM 10-Q
 
 

(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018
 
or
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to            
 
 
Commission File Number 1-5828
 
CARPENTER TECHNOLOGY CORPORATION
(Exact name of Registrant as specified in its Charter)
 

Delaware
 
23-0458500
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1735 Market Street, 15th Floor
Philadelphia, Pennsylvania
 
19103
(Address of principal executive offices)
 
(Zip Code)
610-208-2000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer:
x
 
Accelerated filer:
o
 
 
 
Non-accelerated filer:
o
(Do not check if a smaller reporting company)
Smaller reporting company:
o
 
 
 
 
 
 
 
 
Emerging growth company
o







If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
The number of shares outstanding of the issuer’s common stock as of October 17, 2018 was 47,369,591.


Table of Contents    

CARPENTER TECHNOLOGY CORPORATION
FORM 10-Q
INDEX
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Table of Contents    

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
 
CARPENTER TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
($ in millions, except share data)
 
September 30,
2018
 
June 30,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
17.0

 
$
56.2

Accounts receivable, net
381.6

 
378.5

Inventories
740.5

 
689.2

Other current assets
49.0

 
54.9

Total current assets
1,188.1

 
1,178.8

Property, plant and equipment, net
1,316.8

 
1,313.4

Goodwill
268.7

 
268.7

Other intangibles, net
61.7

 
63.3

Deferred income taxes
4.5

 
4.3

Other assets
167.9

 
178.5

Total assets
$
3,007.7

 
$
3,007.0

LIABILITIES
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
255.9

 
$
214.7

Accrued liabilities
107.5

 
148.6

Total current liabilities
363.4

 
363.3

Long-term debt
545.5

 
545.7

Accrued pension liabilities
285.1

 
288.8

Accrued postretirement benefits
108.7

 
108.2

Deferred income taxes
155.7

 
161.6

Other liabilities
58.6

 
53.5

Total liabilities
1,517.0

 
1,521.1

Contingencies and commitments (see Note 10)

 

STOCKHOLDERS’ EQUITY
 
 
 
Common stock — authorized 100,000,000 shares; issued 55,788,737 shares at September 30, 2018 and 55,712,229 shares at June 30, 2018; outstanding 47,365,484 shares at September 30, 2018 and 47,191,744 shares at June 30, 2018
278.9

 
278.6

Capital in excess of par value
310.0

 
310.0

Reinvested earnings
1,498.8

 
1,475.9

Common stock in treasury (8,423,253 shares and 8,520,485 shares at September 30, 2018 and June 30, 2018, respectively), at cost
(335.9
)
 
(338.8
)
Accumulated other comprehensive loss
(261.1
)
 
(239.8
)
Total stockholders' equity
1,490.7

 
1,485.9

Total liabilities and stockholders' equity
$
3,007.7

 
$
3,007.0


See accompanying notes to consolidated financial statements.

3

Table of Contents    

CARPENTER TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(in millions, except per share data)
 
 
Three Months Ended
September 30,
 
2018
 
2017
Net sales
$
572.4

 
$
479.8

Cost of sales
480.7

 
394.1

Gross profit
91.7

 
85.7

 
 
 
 
Selling, general and administrative expenses
46.7

 
43.5

Operating income
45.0

 
42.2

 
 
 
 
Interest expense
(6.3
)
 
(7.2
)
Other income, net
1.6

 
0.2

 
 
 
 
Income before income taxes
40.3

 
35.2

Income tax expense
8.8

 
11.8

 
 
 
 
Net income
$
31.5

 
$
23.4

 
 
 
 
EARNINGS PER COMMON SHARE:
 

 
 

Basic
$
0.66

 
$
0.49

Diluted
$
0.65

 
$
0.49

 
 
 
 
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 

 
 

Basic
47.6

 
47.1

Diluted
48.2

 
47.3

 
 
 
 
Cash dividends per common share
$
0.20

 
$
0.18

 
See accompanying notes to consolidated financial statements.

4

Table of Contents    

CARPENTER TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
($ in millions)
 
 
Three Months Ended
September 30,
 
2018
 
2017
Net income
$
31.5

 
$
23.4

Other comprehensive (loss) income, net of tax
 

 
 

Cumulative adjustment upon adoption of ASU 2017-12 reclassified to reinvested earnings
(1.0
)
 

Pension and postretirement benefits, net of tax of $(0.5) and $(1.3), respectively
1.7

 
2.1

Net (loss) gain on derivative instruments, net of tax of $8.7 and $(4.9), respectively
(23.0
)
 
8.1

Marketable securities gain, net of tax of $0.0 and $0.0, respectively
0.3

 

Foreign currency translation
0.7

 
1.8

Other comprehensive (loss) income
(21.3
)
 
12.0

Comprehensive income
$
10.2

 
$
35.4

 
See accompanying notes to consolidated financial statements.

5

Table of Contents    

CARPENTER TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
($ in millions)
 
Three Months Ended
September 30,
 
2018
 
2017
OPERATING ACTIVITIES
 

 
 

Net income
$
31.5

 
$
23.4

Adjustments to reconcile net income to net cash provided from (used for) operating activities:
 

 
 

Depreciation and amortization
29.7

 
28.7

Deferred income taxes
1.2

 
0.6

Net pension expense
2.9

 
3.6

Share-based compensation expense
3.0

 
4.2

Net loss on disposals of property and equipment
0.1

 
0.1

Changes in working capital and other:
 

 
 

Accounts receivable
(3.5
)
 
(1.2
)
Inventories
(50.5
)
 
(46.3
)
Other current assets
(6.5
)
 
(9.0
)
Accounts payable
47.5

 
15.9

Accrued liabilities
(40.8
)
 
(21.7
)
Pension plan contributions
(2.3
)
 
(4.2
)
Other postretirement plan contributions
(0.8
)
 
(0.5
)
Other, net
(2.1
)
 
(1.0
)
Net cash provided from (used for) operating activities
9.4

 
(7.4
)
INVESTING ACTIVITIES
 

 
 

Purchases of property, plant, equipment and software
(41.6
)
 
(28.9
)
Proceeds from disposals of property and equipment
0.1

 

Proceeds from sales of marketable securities
2.9

 

Net cash used for investing activities
(38.6
)
 
(28.9
)
FINANCING ACTIVITIES
 

 
 

Net change in short-term credit agreement borrowings

 
3.3

Dividends paid
(9.6
)
 
(8.6
)
Proceeds from stock options exercised
3.2

 
1.4

Withholding tax payments on share-based compensation awards
(4.1
)
 
(0.2
)
Net cash used for financing activities
(10.5
)
 
(4.1
)
Effect of exchange rate changes on cash and cash equivalents
0.5

 
(1.0
)
DECREASE IN CASH AND CASH EQUIVALENTS
(39.2
)
 
(41.4
)
Cash and cash equivalents at beginning of period
56.2

 
66.3

Cash and cash equivalents at end of period
$
17.0

 
$
24.9

SUPPLEMENTAL CASH FLOW INFORMATION:
 

 
 

Non-cash investing activities:
 

 
 

Acquisition of property, plant, equipment and software
$
10.1

 
$
9.0


See accompanying notes to consolidated financial statements.

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Table of Contents    

CARPENTER TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017
(Unaudited)
($ in millions, except per share data)
 
 
Common Stock
 
Reinvested Earnings
 
Common Stock in Treasury
 
Accumulated Other Comprehensive (Loss) Income
 
Total Equity
 
Par Value of $5
 
Capital in Excess of Par Value
 
 
 
 
Balances at June 30, 2018
$
278.6

 
$
310.0

 
$
1,475.9

 
$
(338.8
)
 
$
(239.8
)
 
$
1,485.9

Cumulative adjustment upon adoption of ASU 2017-12
 
 
 
 
1.0

 
 
 
(1.0
)
 

Net income
 

 
 

 
31.5

 
 

 
 

 
31.5

Pension and postretirement benefits gain, net of tax
 

 
 

 
 

 
 

 
1.7

 
1.7

Marketable securities gain, net of tax
 
 
 
 
 
 
 
 
0.3

 
0.3

Net loss on derivative instruments, net of tax
 

 
 

 
 

 
 

 
(23.0
)
 
(23.0
)
Foreign currency translation
 

 
 

 
 

 
 

 
0.7

 
0.7

Cash Dividends:
 

 
 

 
 

 
 

 
 

 


Common @ $0.20 per share
 

 
 

 
(9.6
)
 
 

 
 

 
(9.6
)
Share-based compensation plans
 

 
(2.9
)
 
 

 
2.9

 
 

 

Stock options exercised
0.3

 
2.9

 
 

 
 

 
 

 
3.2

Balances at September 30, 2018
$
278.9

 
$
310.0

 
$
1,498.8

 
$
(335.9
)
 
$
(261.1
)
 
$
1,490.7

 
 
Common Stock
 
Reinvested Earnings
 
Common Stock in Treasury
 
Accumulated Other Comprehensive (Loss) Income
 
Total Equity
 
Par Value of $5
 
Capital in Excess of Par Value
 
 
 
 
Balances at June 30, 2017
$
276.7

 
$
284.8

 
$
1,321.8

 
$
(341.6
)
 
$
(343.1
)
 
$
1,198.6

Net income
 

 
 

 
23.4

 
 

 
 

 
23.4

Pension and postretirement benefits gain, net of tax
 

 
 

 
 

 
 

 
2.1

 
2.1

Net gain on derivative instruments, net of tax
 

 
 

 
 

 
 

 
8.1

 
8.1

Foreign currency translation
 

 
 

 
 

 
 

 
1.8

 
1.8

Cash Dividends:
 

 
 

 
 

 
 

 
 

 
0

Common @ $0.18 per share
 

 
 

 
(8.6
)
 
 

 
 

 
(8.6
)
Share-based compensation plans
 

 
4.0

 
 

 
0.2

 
 

 
4.2

Stock options exercised
0.3

 
1.1

 
 

 
 

 
 

 
1.4

Balances at September 30, 2017
$
277.0

 
$
289.9

 
$
1,336.6

 
$
(341.4
)
 
$
(331.1
)
 
$
1,231.0

 
See accompanying notes to consolidated financial statements.

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Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
1.
Basis of Presentation
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting of normal and recurring adjustments, considered necessary for a fair statement of the results are reflected in the interim periods presented. The June 30, 2018 consolidated balance sheet data was derived from audited financial statements, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in Carpenter’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018 (the “2018 Form 10-K”). Operating results for the three months ended September 30, 2018 are not necessarily indicative of the operating results for any future period.

As used throughout this report, unless the context requires otherwise, the terms “Carpenter”, the “Company”, “Registrant”, “Issuer”, “we” and “our” refer to Carpenter Technology Corporation.

During the three months ended September 30, 2018 the Company changed the presentation of net periodic pension cost and net periodic postretirement benefit cost in connection with the adoption of ASU 2017-07, Compensation - Retirement Benefits (Topic 715) - Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. Prior year amounts have been reclassified to conform to the three months ended September 30, 2018 presentation.
 
2.
Recent Accounting Pronouncements
 
Recently Issued Accounting Pronouncements - Adopted in current period

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) which outlines a single comprehensive framework for all entities in all industries to apply in the determination of when to recognize revenue, and, therefore, supersedes virtually all existing revenue recognition requirements and guidance. This framework is expected to result in less complex guidance in application while providing a consistent and comparable methodology for revenue recognition. The standard provides a five-step model to be applied to all contracts with customers, with an underlying principle that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services.

The Company has completed its assessment of the impact of the new standard and adopted the new standard for all open contracts as of July 1, 2018 using the modified retrospective transition method. The adoption of the new standard did not have a material impact on the financial position of the Company, the results of its operations or its cash flows as of and for the three months ended September 30, 2018. There was no cumulative effect of adopting the standard at the date of initial application in reinvested earnings. The Company’s revenue recognition accounting policy has been updated for the new standard. As required by the standard, the Company has expanded disclosure of revenues from contracts with customers.
                
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory, which outlines updates to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. ASU 2016-16 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. The Company adopted the provisions of ASU 2016-16 in the first quarter of fiscal year 2019. The adoption of ASU 2016-16 did not materially impact the Company’s consolidated financial statements.


8

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits (Topic 715) - Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The guidance changes how employers that sponsor defined benefit pension and other post-retirement benefit plans disaggregate the service cost components from other components of net periodic benefit costs in the income statement. This amendment requires that the service cost component be reported in net income as “cost of sales” or “selling, general and administrative expenses” in a manner consistent with the classification of direct labor and personnel costs of the eligible employees.  Other components of net periodic benefit costs including interest costs, expected return on plan assets, amortization of net loss, amortization of prior service cost (benefits) (“pension earnings, interest and deferrals”) are classified as non-operating expense in “other income, net” on the consolidated statements of income. The update specifies that only the service cost component is eligible for capitalization, which is consistent with the Company’s current practice. The Company adopted the provisions of ASU 2017-07 effective July 1, 2018 on a retrospective basis. For the three months ended September 30, 2017, $0.1 million has been reclassified from cost of goods sold and $0.4 million has been reclassified from selling, general and administrative expenses to other income, net on the consolidated statement of income.
        
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedge Activities, which amended and simplified the requirements of hedge accounting. ASU 2017-12 enables companies to more accurately present the economic effects of risk management activities in the financial statements. The guidance requires the presentation of all items that affect earnings to be recorded in the same income statement line as the hedged item and is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years with early adoption permitted. The Company adopted the provisions of ASU 2017-12 on July 1, 2018. Upon adoption, the Company reclassified $1.0 million of previously recorded hedge ineffectiveness from reinvested earnings to OCI within the equity section of the balance sheet and provided expanded disclosures of derivative activity.

Recently Issued Accounting Pronouncements - Pending Adoption

In February 2016, the FASB issued ASU 2016-02 Leases (Topic 842) with further clarifications and improvements included in ASU No. 2018-10, Codification Improvements to Topic 842, Leases and ASU 2018-11 Leases (Topic 842) Targeted Improvements, each issued in July 2018, all of which improves transparency and comparability among companies by recognizing lease assets and lease liabilities on the balance sheet and by disclosing key information about leasing arrangements. ASU 2016-02 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2018, with early adoption permitted. The Company is evaluating the impact of the adoption of Topic 842 on the consolidated financial statements.

In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to reinvested earnings for standard tax effects resulting from the Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018. ASU 2018-02 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2018, with early adoption permitted. The Company is evaluating the impact of the adoption of ASU 2018-02 on the consolidated financial statements.

3.
Revenue

The Company recognizes revenue in accordance with Topic 606, Revenue from Contracts. The Company applies the five-step model in the FASB’s guidance, which requires the Company to: (i) identify the contract with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when, or as, the Company satisfies a performance obligation.
        

9

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The Company recognizes revenue when performance obligations under the terms of a customer purchase order or contract are satisfied. This occurs when control of the goods and services have been transferred to the customer, which is generally determined when title, ownership, and risk of loss pass to the customer, all of which occurs upon shipment or delivery of the product or the service is performed. Consignment transactions are arrangements where the Company transfers product to a customer location but retains ownership and control of such product until it is used by the customer. Revenue for consignment arrangements is recognized upon usage by the customer. Service revenue is recognized as the services are performed.

The customer purchase order or contract for goods transferred has a single performance obligation for which revenue is recognized at a point in time. The standard terms and conditions of a customer purchase order include general rights of return and product warranty provisions related to nonconforming product. Depending on the circumstances, the product is either replaced or a quality adjustment is issued. Such warranties do not represent a separate performance obligation.

Each customer purchase order or contract sets forth the transaction price for the products and services purchased under that arrangement.  Some customer arrangements include variable consideration, such as volume rebates, which generally depend upon the Company’s customers meeting specified performance criteria, such as a purchasing level over a period of time.  The Company exercises judgment to estimate the most likely amount of variable consideration at each reporting date.

Revenue is measured as the amount of consideration the Company expects to receive in exchange for its product. The normal payment terms are 30 days. The Company has elected to use the practical expedient that permits a Company to not adjust for the effects of a significant financing component if it expects that at the contract inception, the period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less.
 
Amounts billed to customers for shipping and handling activities to fulfill the Company’s promise to transfer the goods are included in revenues and costs incurred by the Company for the delivery of goods are classified as cost of sales in the consolidated statements of income. Shipping terms may vary for products shipped outside the United States depending on the mode of transportation, the country where the material is shipped and any agreements made with the customers.

Contract liabilities are recognized when the Company has received consideration from a customer to transfer goods or services at a future point in time when the Company performs under the purchase order or contract.  Contract liabilities were $12.5 million and $10.4 million at September 30, 2018 and June 30, 2018, respectively, and are included in accrued liabilities on the consolidated balance sheets.

The Company has elected to use the practical expedient that permits the omission of disclosure for remaining performance obligations which are expected to be satisfied within one year or less.  

        
Disaggregation of Revenue

The Company operates in two business segments, Specialty Alloys Operations (“SAO”) and Performance Engineered Products (“PEP”).  Revenue is disaggregated within these two business segments by diversified end-use markets and also by geographical location. Comparative information of the Company’s overall revenues by end-use markets and geography for the three months ended September 30, 2018 and 2017 were as follows:

10

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


End-Use Market Data
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
Aerospace and defense
 
$
310.7

 
$
258.6

Energy
 
44.3

 
32.0

Transportation
 
40.3

 
36.7

Medical
 
47.0

 
38.3

Industrial and consumer
 
96.1

 
84.4

Distribution
 
34.0

 
29.8

  Consolidated net sales
 
$
572.4

 
$
479.8

 
 
 
 
 

Geographic Data
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
United States
 
$
384.0

 
$
319.9

Europe
 
90.0

 
84.9

Asia Pacific
 
48.6

 
37.8

Canada
 
17.7

 
16.1

Mexico
 
22.2

 
11.9

Other
 
9.9

 
9.2

Consolidated net sales
 
$
572.4

 
$
479.8


4.
Acquisitions

On February 21, 2018, the Company acquired all of the outstanding membership interests of MB CalRAM LLC (“CalRAM”), for a cash purchase price of $13.3 million. The acquisition provides the Company with immediate entry into the rapidly expanding part production segment of the additive manufacturing value chain. The purchase price allocation was completed in the fourth quarter of fiscal year 2018 and resulted in the purchase price being allocated to $0.2 million of working capital, $2.6 million of property and equipment, $5.2 million of identifiable intangible assets and $5.3 million of goodwill.
        
5.
Earnings per Common Share
 
The Company calculates basic and diluted earnings per share using the two class method. Under the two class method, earnings are allocated to common stock and participating securities (non-vested restricted shares and units that receive non-forfeitable dividends) according to their participation rights in dividends and undistributed earnings. The earnings available to each class of stock are divided by the weighted average number of outstanding shares for the period in each class. Diluted earnings per share assumes the issuance of common stock for all potentially dilutive share equivalents outstanding.


11

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The calculations of basic and diluted earnings per common share for the three months ended September 30, 2018 and 2017 were as follows: 
 
 
Three Months Ended
September 30,
(in millions, except per share data)
 
2018
 
2017
Net income
 
$
31.5

 
$
23.4

Less: earnings and dividends allocated to participating securities
 
(0.3
)
 
(0.2
)
Earnings available for common stockholders used in calculation of basic earnings per common share
 
$
31.2

 
$
23.2

 
 
 
 
 
Weighted average number of common shares outstanding, basic
 
47.6

 
47.1

 
 
 
 
 
Basic earnings per common share
 
$
0.66

 
$
0.49

 
 
 
 
 
Net income
 
$
31.5

 
$
23.4

Less: earnings and dividends allocated to participating securities
 
(0.3
)
 
(0.2
)
Earnings available for common stockholders used in calculation of diluted earnings per common share
 
$
31.2

 
$
23.2

 
 
 
 
 
Weighted average number of common shares outstanding, basic
 
47.6

 
47.1

Effect of shares issuable under share-based compensation plans
 
0.6

 
0.2

Weighted average number of common shares outstanding, diluted
 
48.2

 
47.3

 
 
 
 
 
Diluted earnings per common share
 
$
0.65

 
$
0.49

 
The following awards issued under share-based compensation plans were excluded from the above calculations of diluted earnings per share because their effects were anti-dilutive:
 
 
 
Three Months Ended
September 30,
(in millions)
 
2018
 
2017
Stock options
 
0.1

 
1.8

 
6.
Inventories
 
Inventories consisted of the following components as of September 30, 2018 and June 30, 2018:
 
($ in millions)
 
September 30,
2018
 
June 30,
2018
Raw materials and supplies
 
$
170.2

 
$
157.5

Work in process
 
414.4

 
372.5

Finished and purchased products
 
155.9

 
159.2

Total inventory
 
$
740.5

 
$
689.2

 
Inventories are valued at the lower of cost or market. Cost for inventories is principally determined using the last-in, first-out (“LIFO”) inventory costing method. The Company also uses the first-in, first-out (“FIFO”) and average cost methods. As of September 30, 2018 and June 30, 2018, $158.9 million and $138.6 million of inventory, respectively, was accounted for using a method other than the LIFO inventory costing method.
 

12

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


7.
Accrued Liabilities
 
Accrued liabilities consisted of the following as of September 30, 2018 and June 30, 2018:
 
($ in millions)
 
September 30,
2018
 
June 30,
2018
Accrued compensation and benefits
 
$
42.5

 
$
83.3

Accrued postretirement benefits
 
15.4

 
15.4

Deferred revenue
 
12.5

 
10.4

Derivative financial instruments
 
4.0

 

Accrued interest expense
 
3.8

 
10.4

Accrued pension liabilities
 
3.3

 
3.3

Accrued income taxes
 
2.7

 
1.4

Other
 
23.3

 
24.4

Total accrued liabilities
 
$
107.5

 
$
148.6

 
8.
Pension and Other Postretirement Benefits
 
The components of the net periodic benefit cost related to the Company’s pension and other postretirement benefits for the three months ended September 30, 2018 and 2017 were as follows:
 
Three months ended September 30,
 
Pension Plans
 
Other Postretirement Plans
($ in millions)
 
2018
 
2017
 
2018
 
2017
Service cost
 
$
2.3

 
$
2.4

 
$
0.6

 
$
0.7

Interest cost
 
13.2

 
13.0

 
2.5

 
2.4

Expected return on plan assets
 
(16.2
)
 
(16.5
)
 
(1.7
)
 
(1.7
)
Amortization of net loss
 
2.6

 
3.4

 
0.4

 
0.7

Amortization of prior service cost (benefit)
 
0.5

 
0.5

 
(1.3
)
 
(1.3
)
    Net periodic benefit costs
 
$
2.4

 
$
2.8

 
$
0.5

 
$
0.8

During the three months ended September 30, 2018 and 2017, the Company made $2.3 million and $4.2 million, respectively, of contributions to its qualified defined benefit pension plans. The Company currently expects to contribute $3.2 million to its qualified defined benefit pension plans during the remainder of fiscal year 2019.
9.
Debt
 
The Company maintains a $400.0 million unsecured revolving credit facility (“Credit Agreement”) that extends to March 2022. Interest on the borrowings under the Credit Agreement accrue at variable rates, based upon LIBOR or a defined “Base Rate,” both are determined based upon the rating of the Company’s senior unsecured long-term debt (the “Debt Rating”). The applicable margin to be added to LIBOR ranges from 1.00% to 1.75% (1.50% as of September 30, 2018), and for Base Rate-determined loans, from 0.00% to 0.75% (0.50% as of September 30, 2018). The Company also pays a quarterly commitment fee ranging from 0.125% to 0.400% (0.275% as of September 30, 2018), determined based upon the Debt Rating, of the unused portion of the $400.0 million commitment under the Credit Agreement. In addition, the Company must pay certain letter of credit fees, ranging from 1.00% to 1.75% (1.50% as of September 30, 2018), with respect to letters of credit issued under the Credit Agreement. The Company has the right to voluntarily prepay and re-borrow loans and to terminate or reduce the commitments under the facility. As of September 30, 2018, the Company had $6.0 million of issued letters of credit with the balance of $394.0 million available to the Company.


13

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The Company is subject to certain financial and restrictive covenants under the Credit Agreement, which, among other things, require the maintenance of a minimum interest coverage ratio of 3.50 to 1.00. 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 percent. 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 of September 30, 2018 and June 30, 2018, the Company was in compliance with all of the covenants of the Credit Agreement.
 
Long-term debt outstanding as of September 30, 2018 and June 30, 2018 consisted of the following:
 
($ in millions)
 
September 30,
2018
 
June 30,
2018
Senior unsecured notes, 5.20% due July 2021 (face value of $250.0 million at September 30, 2018 and June 30, 2018)
 
$
246.3

 
$
246.6

Senior unsecured notes, 4.45% due March 2023 (face value of $300.0 million at September 30, 2018 and June 30, 2018)
 
299.2

 
299.1

Total
 
545.5

 
545.7

Less: amounts due within one year
 

 

Long-term debt
 
$
545.5

 
$
545.7

 
For the three months ended September 30, 2018 and 2017, interest costs totaled $7.2 million and $7.7 million, respectively, of which $0.9 million and $0.5 million, respectively, were capitalized as part of the cost of property, equipment and software.

10.
Contingencies and Commitments

Environmental
 
The Company is 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 the Company’s operations, compliance costs to date have not been material. The Company has environmental remediation liabilities at some of its owned operating facilities and has been designated as a potentially responsible party (“PRP”) with respect to certain third party Superfund waste-disposal sites and other third party-owned sites. The Company accrues amounts for environmental remediation costs that represent management’s best estimate of the probable and reasonably estimable future costs related to environmental remediation. During the three months ended September 30, 2018, the Company decreased the liability for a Company-owned former operating site by $0.2 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 September 30, 2018 and June 30, 2018 were $15.9 million and $16.1 million, respectively. Additionally, the Company has been notified that it may be a PRP with respect to other Superfund sites as to which no proceedings have been instituted against the Company. 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, the Company cannot reasonably estimate expected costs for such matters. The liability for future environmental remediation costs that can be reasonably estimated is evaluated by management 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 the Company's financial position, results of operations or cash flows over the long-term.  However, such costs could be material to the Company's financial position, results of operations or cash flows in a particular future quarter or year.


14

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Other
 
The Company is defending various routine claims and legal actions that are incidental to its business and common to its 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, the Company, from time to time, has 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. The Company provides 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 the Company’s 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, management believes that the total liability from these matters will not have a material effect on the Company’s 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 the Company’s financial position, results of operations or cash flows in a particular future quarter or year.

11.
Fair Value Measurements
 
The fair value hierarchy has three levels based on the inputs used to determine fair value. Level 1 refers to quoted prices in active markets for identical assets or liabilities. Level 2 refers to observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Level 3 refers to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Currently, the Company does not use Level 1 and 3 inputs.
 
The following tables present the Company’s assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy:
 
September 30, 2018
 
Fair Value
Measurements Using
Input Type
($ in millions)
 
Level 2
Assets:
 
 

Derivative financial instruments
 
$
11.2

 
 
 

Liabilities:
 
 

Derivative financial instruments
 
$
12.0

 
June 30, 2018
 
Fair Value
Measurements Using
Input Type
($ in millions)
 
Level 2
Assets:
 
 

Marketable securities:
 
 

Municipal auction rate securities
 
$
2.9

Derivative financial instruments
 
35.2

Total assets
 
$
38.1

 
 
 

Liabilities:
 
 

Derivative financial instruments
 
$
3.4

 

15

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The Company’s derivative financial instruments consist of commodity forward contracts, foreign currency forward contracts and interest rate swaps. These instruments are measured at fair value using the market method valuation technique. The inputs to this technique utilize information related to commodity prices, foreign exchange rates and interest rates published by third party leading financial news and data providers. This is observable data; however, the valuation of these instruments is not based on actual transactions for the same instruments and, as such, they are classified as Level 2. The Company’s use of derivatives and hedging policies are more fully discussed in Note 12.
 
The Company has currently chosen not to elect the fair value option for any items that are not already required to be measured at fair value in accordance with accounting principles generally accepted in the United States of America.
 
The carrying amounts of other financial instruments not listed in the table below approximate fair value due to the short-term nature of these items. The carrying amounts and estimated fair values of the Company’s financial instruments not recorded at fair value in the financial statements were as follows:
 
 
 
September 30, 2018
 
June 30, 2018
($ in millions)
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Long-term debt
 
$
545.5

 
$
550.8

 
$
545.7

 
$
558.3

Company-owned life insurance
 
$
17.0

 
$
17.0

 
$
16.4

 
$
16.4

 
The carrying amount of Company-owned life insurance reflects cash surrender values based upon the market values of underlying securities, using Level 2 inputs, net of any outstanding policy loans. The carrying value associated with the cash surrender value of these policies is recorded in other assets in the accompanying consolidated balance sheets.
 
The fair values of long-term debt as of September 30, 2018 and June 30, 2018 were determined by using current interest rates for debt with terms and maturities similar to the Company’s existing debt arrangements and accordingly would be classified as Level 2 inputs in the fair value hierarchy.
 
12.
Derivatives and Hedging Activities
 
The Company uses commodity forwards, interest rate swaps, forward interest rate swaps and foreign currency forwards to manage risks generally associated with commodity price, interest rate and foreign currency rate fluctuations. The following explains the various types of derivatives and includes a summary of the impact the derivative instruments had on the Company’s financial position, results of operations and cash flows.
 
Cash Flow Hedging — Commodity forward contracts: The Company enters into commodity forward contracts to fix the price of a portion of anticipated future purchases of certain critical raw materials and energy to manage the risk of cash flow variability associated with volatile commodity prices. The commodity forward contracts have been designated as cash flow hedges. The qualifying hedge contracts are marked-to-market at each reporting date and any unrealized gains or losses are included in accumulated other comprehensive (loss) income (“AOCI”) and reclassified to cost of sales in the period during which the hedged transaction affects earnings or it becomes probable that the forecasted transaction will not occur. As of September 30, 2018, the Company had forward contracts to purchase 22.0 million pounds of certain raw materials with settlement dates through December 2023.
 
Cash Flow Hedging — Forward interest rate swaps: Historically, the Company has entered into forward interest rate swap contracts to manage the risk of cash flow variability associated with fixed interest debt expected to be issued. The forward interest rate swaps were designated as cash flow hedges. The qualifying hedge contracts were marked-to-market at each reporting date and any unrealized gains or losses were included in AOCI and reclassified to interest expense in the period during which the hedged transaction affected earnings or it became probable that the forecasted transaction would not occur.  Upon the issuance of the fixed rate debt, the forward interest rate swap contracts were terminated. The realized gains at the time the interest rate swap contracts were terminated are being amortized over the term of the underlying debt. For the three months ended September 30, 2018 and 2017, net gains of $0.1 million and $0.1 million, respectively, related to the previously terminated contracts, were recorded as a reduction to interest expense.

16

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Cash Flow Hedging — Foreign currency forward contracts: The Company uses foreign currency forward contracts to hedge a portion of anticipated future sales denominated in foreign currencies, principally the Euro and Pound Sterling, in order to offset the effect of changes in exchange rates. The qualifying hedge contracts are marked-to-market at each reporting date and any unrealized gains or losses are included in AOCI and reclassified to net sales in the period during which the transaction affects earnings or it becomes probable that the forecasted transaction will not occur.
 
The Company also uses foreign currency forward contracts to protect certain short-term asset positions denominated in foreign currencies against the effect of changes in exchange rates. These positions do not qualify for hedge accounting and accordingly are marked-to-market at each reporting date through charges to other income and expense. As of September 30, 2018 and June 30, 2018, the fair value of the outstanding foreign currency forwards not designated as hedging instruments and the charges to income for changes in fair value for these contracts were not material.
 
Fair Value Hedging - Interest rate swaps: The Company uses interest rate swaps to achieve a level of floating rate debt relative to fixed rate debt where appropriate. The Company has designated fixed to floating interest rate swaps as fair value hedges. Accordingly, the changes in the fair value of these instruments are immediately recorded in earnings. The mark-to-market values of both the fair value hedging instruments and the underlying debt obligations are recorded as equal and offsetting gains and losses in interest expense in the consolidated statements of income. As of September 30, 2018 and June 30, 2018, the total notional amount of floating interest rate contracts was $150.0 million for both periods. For the three months ended September 30, 2018 and 2017, net losses of $0.3 million were recorded as an increase to interest expense and net gains of $0.2 million were recorded as a reduction to interest expense, respectively.
 

17

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The fair value and location of outstanding derivative contracts recorded in the accompanying consolidated balance sheets were as follows as of September 30, 2018 and June 30, 2018:
 
September 30, 2018
 
Interest
Rate Swaps
 
Foreign
Currency
Contracts
 
Commodity
Contracts
 
Total
Derivatives
($ in millions)
 
 
 
 
Asset Derivatives:
 
 

 
 

 
 

 
 

Derivatives designated as hedging instruments:
 
 

 
 

 
 

 
 

Other current assets
 
$

 
$
0.7

 
$
2.6

 
$
3.3

Other assets
 

 

 
7.9

 
7.9

Total asset derivatives
 
$

 
$
0.7

 
$
10.5

 
$
11.2

Liability Derivatives:
 
 

 
 

 
 

 
 

Derivatives designated as hedging instruments:
 
 

 
 

 
 

 
 

Accrued liabilities
 
$
0.2

 
$
0.1

 
$
3.8

 
$
4.1

Other liabilities
 
3.2

 

 
4.7

 
7.9

Total liability derivatives
 
$
3.4

 
$
0.1

 
$
8.5

 
$
12.0

 
June 30, 2018
 
Interest
Rate Swaps
 
Foreign
Currency
Contracts
 
Commodity
Contracts
 
Total
Derivatives
($ in millions)
 
 
 
 
Asset Derivatives:
 
 

 
 

 
 

 
 

Derivatives designated as hedging instruments:
 
 

 
 

 
 

 
 

Other current assets
 
$
0.1

 
$
0.4

 
$
15.3

 
$
15.8

Other assets
 

 

 
19.4

 
19.4

Total asset derivatives
 
$
0.1

 
$
0.4

 
$
34.7

 
$
35.2

Liability Derivatives:
 
 

 
 

 
 

 
 

Derivatives designated as hedging instruments:
 
 

 
 

 
 

 
 

Accrued liabilities
 
$

 
$
0.1

 
$

 
$
0.1

Other liabilities
 
2.9

 

 
0.4

 
3.3

Total liability derivatives
 
$
2.9

 
$
0.1

 
$
0.4

 
$
3.4


Substantially all of the derivative contracts are subject to master netting arrangements, or similar agreements with each counterparty, which provide for the option to settle contracts on a net basis when they settle on the same day and in the same currency. In addition, these arrangements provide for a net settlement of all contracts with a given counterparty in the event that the arrangement is terminated due to the occurrence of default or a termination event. The Company presents the outstanding derivative contracts on a net basis by counterparty in the consolidated balance sheets. If the Company had chosen to present the derivative contracts on a gross basis, the total asset derivatives would have been $19.6 million and total liability derivatives would have been $20.4 million as of September 30, 2018.

According to the provisions of the Company’s derivative arrangements, in the event that the fair value of outstanding derivative positions with certain counterparties exceeds certain thresholds, the Company may be required to issue cash collateral to the counterparties. As of September 30, 2018 and June 30, 2018, the Company had no cash collateral held by counterparties.
 
The Company is exposed to credit loss in the event of nonperformance by counterparties on its derivative instruments as well as credit or performance risk with respect to its customer commitments to perform. Although nonperformance is possible, the Company does not anticipate nonperformance by any of the parties. In addition, various master netting arrangements are in place with counterparties to facilitate settlements of gains and losses on these contracts.
 

18

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Cash Flow and Fair Value Hedges
 
For derivative instruments that are designated and qualify as cash flow hedges, the gain or loss on the derivative is reported as a component of AOCI and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings or it becomes probable the forecasted transactions will not occur. The following is a summary of the (losses) gains related to cash flow hedges recognized during the three months ended September 30, 2018 and 2017:
 
 
 
Amount of (Loss) Gain
Recognized in AOCI on
Derivatives
 
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
Derivatives in Cash Flow Hedging Relationship:
 
 

 
 

  Commodity contracts
 
$
(33.6
)
 
$
9.6

  Foreign exchange contracts
 
0.2

 
(0.4
)
Total
 
$
(33.4
)
 
$
9.2

 
($ in millions)
 
Location of (Loss) Gain Reclassified from AOCI into
Income
 
Amount of (Loss) Gain Reclassified from AOCI
into Income
 
 
Three Months Ended
September 30,
 
 
2018
 
2017
Derivatives in Cash Flow Hedging Relationship:
 
 
 
 
 
 
  Commodity contracts
 
Cost of sales
 
$
(2.0
)
 
$
(2.6
)
  Foreign exchange contracts
 
Net sales
 
0.2

 
(0.4
)
  Forward interest rate swaps
 
Interest expense
 
0.1

 
0.1

Total
 
 
 
$
(1.7
)
 
$
(2.9
)























19

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The following is a summary of total amounts presented in the consolidated statements of income in which the effects of cash flow and fair value hedges are recorded during the three months ended September 30, 2018 and 2017:

($ in millions)
 
Three Months Ended
 
Three Months Ended
 
September 30, 2018
 
September 30, 2017
 
Net Sales
 
Cost of Sales
 
Interest Expense
 
Net Sales
 
Cost of Sales
 
Interest Expense
Total amounts presented in the consolidated statements of income in which the effects of cash flow and fair value hedges are recorded
 
$
572.4

 
$
480.7

 
$
6.3

 
$
479.8

 
$
394.1

 
$
7.2

 
 
 
 
 
 
 
 
 
 
 
 
 
Gain (loss) on Derivatives in Cash Flow Hedging Relationship:
 

 

 

 

 

 

   Commodity contracts
 
 
 

 

 

 

 

Amount of loss reclassified from AOCI to income
 
$

 
$
(2.0
)
 
$

 
$

 
$
(2.6
)
 
$

   Foreign currency forward contracts
 
 
 

 

 

 

 

Amount of gain (loss) reclassified from AOCI to income
 
0.2

 

 

 
(0.4
)
 

 

   Interest rate swap agreements
 
 
 

 

 

 

 

Amount of gain reclassified from AOCI to income
 

 

 
0.1

 

 

 
0.1

Gain (loss) on Derivatives in Fair Value Hedging Relationship:
 
 
 

 

 

 

 

   Interest rate swap agreements
 
 
 
 
 
 
 
 
 
 
 
 
         Hedged Item
 

 

 
0.3

 

 

 
(0.2
)
Derivatives designated as hedging instruments
 

 

 
(0.3
)
 

 

 
0.2

Total gain (loss)
 
$
0.2

 
$
(2.0
)
 
$
0.1

 
$
(0.4
)
 
$
(2.6
)
 
$
0.1


 The Company estimates that $0.6 million of net derivative gains included in AOCI as of September 30, 2018 will be reclassified into income within the next 12 months. No significant cash flow hedges were discontinued during the three months ended September 30, 2018.
    
As of September 30, 2018, and June 30, 2018, the following amounts were recorded on the consolidated balance sheets related to cumulative basis adjustments for fair value hedges of interest rate risk:

 
 
Carrying amount of the hedged liabilities
 
Cumulative amount of fair value (gain) loss in the carrying amount of the hedged liabilities
($ in millions)
 
September 30, 2018
 
June 30,
 2018
 
September 30, 2018
 
June 30,
2018
Line item in the consolidated balance sheets in which the hedged item is included:
 
 
 
 
 
 
 
 
Long-Term Debt
 
$
146.8

 
$
147.1

 
$
(3.2
)
 
$
(2.9
)

   

20

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


13.
Other Income, Net
 
Other income, net consisted of the following:
 
 
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
Unrealized gains on company-owned life insurance contracts and investments held in rabbi trusts
 
$
1.0

 
$
0.6

Foreign exchange gain
 
0.5

 
0.1

Interest income
 
0.1

 

Pension earnings, interest and deferrals
 

 
(0.5
)
Total other income, net
 
$
1.6

 
$
0.2

 
14.
Income Taxes
 
The effective tax rate used for interim periods is the estimated annual effective consolidated tax rate, based on the current estimate of full year results, except that taxes related to specific events, if any, are recorded in the interim period in which they occur. The annual effective tax rate is based upon a number of significant estimates and judgments, including the estimated annual pre-tax income of the Company in each tax jurisdiction in which it operates, and the development of tax planning strategies during the year. In addition, the Company’s tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits, and other factors that cannot be predicted with certainty. As such there can be significant volatility in interim tax provisions.
 
Income tax expense for the three months ended September 30, 2018 was $8.8 million, or 21.8 percent of pre-tax income as compared with $11.8 million, or 33.5 percent of pre-tax income for the three months ended September 30, 2017.

An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 (the “Act”) was enacted on December 22, 2017. The Act included provisions that reduced the federal corporate income tax rate, created a territorial tax system with a one-time mandatory tax on previously deferred foreign earnings (i.e. transition tax), and changed certain business deductions including allowing for immediate expensing of certain qualified capital expenditures and limitations on deductions of interest expense. The permanent reduction to the U.S. federal corporate income tax rate from 35 percent to 21 percent was effective January 1, 2018. Based on the Company's interpretation of the Act, during fiscal year 2018, the Company recorded a provisional tax charge of $5.0 million for the transition tax and a provisional tax benefit of $74.6 million for the re-measurement of deferred tax assets and liabilities.

The Company determined that the amounts recorded during fiscal year 2018 for the transition tax are provisional because various components of the computation are not yet finalized as of September 30, 2018, including the following significant items: the actual aggregate foreign cash position and the earnings and profits of the foreign entities as of June 30, 2018, the interpretation and identification of cash positions as of June 30, 2018, and computations of accumulated earnings and profits balances as of November 2, 2017 and December 31, 2017. Under the Act, the transition tax will be paid over an eight-year period beginning in fiscal year 2019.

The Company also determined that the re-measurement of deferred tax assets and liabilities at the lower federal corporate income tax rate is provisional until such time that the underlying temporary differences are known rather than estimated.

Future adjustments to the provisional amounts related to the Act will be recorded as discrete adjustments to income tax expense in the period in which those adjustments are determined.

Prior to the Act, undistributed earnings of foreign subsidiaries, totaling $93.8 million, were considered permanently reinvested. The Company is in the process of evaluating its assertion for indefinite reinvestment.


21

Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The Act also established new tax provisions that become effective in fiscal year 2019, including but not limited to eliminating the corporate alternative minimum tax, creating the base erosion anti-abuse tax (“BEAT”), establishing new limitations on deductible interest expense and certain executive compensation, creating a new provision designed to tax global intangible low-tax income (“GILTI”) and generally eliminating U.S. Federal income taxes on dividends from foreign subsidiaries. The Company does not anticipate being subject to the BEAT provision due to the revenue thresholds. An accounting policy election must be made to either treat taxes due on future GILTI inclusions in U.S. taxable income as a current period expense when incurred or reflect such portion of the future GILTI inclusions in U.S. taxable income that relate to existing basis differences in the Company’s current measurement of deferred taxes. The Company has treated the GILTI inclusion in U.S. taxable income as a current period expense in its annual effective tax rate for fiscal year 2019 but continues to analyze the new GILTI rules and its impacts before finalizing its policy election.

15.
Business Segments
 
The Company has two reportable segments, SAO and PEP.
 
The SAO segment is comprised of the Company’s major premium alloy and stainless steel manufacturing operations. This includes operations performed at mills primarily in Reading and Latrobe, Pennsylvania and surrounding areas as well as South Carolina and Alabama. The combined assets of the SAO operations are being managed in an integrated manner to optimize efficiency and profitability across the total system.
 
The PEP segment is comprised of the Company’s differentiated operations. This segment includes the Dynamet titanium business, the Carpenter Powder Products business, the Amega West business, the CalRAM business, and the Latrobe and Mexico distribution businesses. The businesses in the PEP segment are managed with an entrepreneurial structure to promote flexibility and agility to quickly respond to market dynamics. 
 
The Company’s executive management evaluates the performance of these operating segments based on sales, operating income and cash flow generation. Segment operating profit excludes general corporate costs, which includes executive and director compensation and other corporate facilities and administrative expenses not allocated to the segments.
        
On a consolidated basis, one customer, Arconic, Inc., accounted for approximately 10 percent and 11 percent of net sales for the three months ended September 30, 2018 and 2017, respectively. No single customer accounted for 10 percent or more of the accounts receivable outstanding at September 30, 2018 or June 30, 2018.
 
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
Net Sales:
 
 

 
 

Specialty Alloys Operations
 
$
475.5

 
$
396.8

Performance Engineered Products
 
111.7

 
100.7

Intersegment
 
(14.8
)
 
(17.7
)
Consolidated net sales
 
$
572.4

 
$
479.8

 
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
Operating Income:
 
 

 
 

Specialty Alloys Operations
 
$
52.8

 
$
50.5

Performance Engineered Products
 
7.3

 
5.3

Corporate
 
(15.8
)
 
(12.9
)
Intersegment
 
0.7

 
(0.7
)
Consolidated operating income
 
$
45.0

 
$
42.2


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Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
Depreciation and Amortization:
 
 

 
 

Specialty Alloys Operations
 
$
23.7

 
$
23.1

Performance Engineered Products
 
5.0

 
5.0

Corporate
 
1.2

 
0.9

Intersegment
 
(0.2
)
 
(0.3
)
Consolidated depreciation and amortization
 
$
29.7

 
$
28.7

 
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
Capital Expenditures:
 
 

 
 

Specialty Alloys Operations
 
$
20.6

 
$
17.2

Performance Engineered Products
 
13.6

 
4.9

Corporate
 
7.7

 
7.1

Intersegment
 
(0.3
)
 
(0.3
)
Consolidated capital expenditures
 
$
41.6

 
$
28.9

 
 
September 30,
2018
 
June 30,
2018
($ in millions)
 
 
Total Assets:
 
 

 
 

Specialty Alloys Operations
 
$
2,319.0

 
$
2,312.1

Performance Engineered Products
 
540.4

 
513.6

Corporate
 
158.5

 
193.2

Intersegment
 
(10.2
)
 
(11.9
)
Consolidated total assets
 
$
3,007.7

 
$
3,007.0



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Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


16.
Reclassifications from Accumulated Other Comprehensive (Loss) Income (AOCI)
 
The changes in AOCI by component, net of tax, for the three months ended September 30, 2018 and 2017 were as follows:
 

Three Months Ended September 30, 2018
($ in millions) (a)
 
Cash flow
hedging items
 
Pension and
other
postretirement
benefit plan
items
 
Unrealized
(losses) gains on
available-for-
sale securities
 
Foreign currency items
 
Total
Balance at June 30, 2018
 
$
23.8

 
$
(220.4
)
 
$
(0.3
)
 
$
(42.9
)
 
$
(239.8
)
Cumulative adjustment upon adoption of ASU 2017-12 reclassified to reinvested earnings
 
(1.0
)
 

 

 

 
(1.0
)
Other comprehensive (loss) income before reclassifications
 
(24.3
)
 

 
0.3

 
0.7

 
(23.3
)
Amounts reclassified from AOCI (b)
 
1.3

 
1.7

 

 

 
3.0

Net other comprehensive (loss) income
 
(24.0
)
 
1.7

 
0.3

 
0.7

 
(21.3
)
Balance at September 30, 2018
 
$
(0.2
)
 
$
(218.7
)
 
$

 
$
(42.2
)
 
$
(261.1
)
 

Three Months Ended September 30, 2017
($ in millions) (a)
 
Cash flow
hedging items
 
Pension and
other
postretirement
benefit plan
items
 
Unrealized
losses on
available-for-
sale securities
 
Foreign currency items
 
Total
Balance at June 30, 2017
 
$
(2.3
)
 
$
(299.0
)
 
$
(0.3
)
 
$
(41.5
)
 
$
(343.1
)
Other comprehensive income before reclassifications
 
6.3

 

 

 
1.8

 
8.1

Amounts reclassified from AOCI (b)
 
1.8

 
2.1

 

 

 
3.9

Net other comprehensive income
 
8.1

 
2.1

 

 
1.8

 
12.0

Balance at September 30, 2017
 
$
5.8

 
$
(296.9
)
 
$
(0.3
)
 
$
(39.7
)
 
$
(331.1
)
 
(a)
All amounts are net of tax. Amounts in parentheses indicate debits.
(b)
See separate table below for further details.



 
    


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Table of Contents
CARPENTER TECHNOLOGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The following is a summary of amounts reclassified from AOCI for the three months ended September 30, 2018 and 2017:
 
Details about AOCI Components
 
Location of
(loss) gain
 
Amount Reclassified from AOCI
Three Months Ended September 30,
($ in millions) (a)
 
 
2018
 
2017
Cash flow hedging items:
 
 
 
 

 
 

Commodity contracts
 
Cost of sales
 
$
(2.0
)
 
$
(2.6
)
Foreign exchange contracts
 
Net sales
 
0.2

 
(0.4
)
Forward interest rate swaps
 
Interest expense
 
0.1

 
0.1

Total before tax
 
 
 
(1.7
)
 
(2.9
)
Tax benefit
 
 
 
0.4

 
1.1

Net of tax
 
 
 
$
(1.3
)
 
$
(1.8
)
 

Details about AOCI Components
 
Location of
(loss) gain
 
Amount Reclassified from AOCI
Three Months Ended September 30,
($ in millions) (a)
 
 
2018
 
2017
Amortization of pension and other postretirement benefit plan items:
 
 
 
 

 
 

Net actuarial loss
 
(b)
 
$
(3.0
)
 
$
(4.1
)
Prior service benefit
 
(b)
 
0.8

 
0.8

Total before tax
 
 
 
(2.2
)
 
(3.3
)
Tax benefit
 
 
 
0.5

 
1.2

Net of tax
 
 
 
$
(1.7
)
 
$
(2.1
)

(a)
Amounts in parentheses indicate debits to income/loss.
(b)
These AOCI components are included in the computation of net periodic benefit cost (see Note 8. Pension and Other Postretirement Benefits for additional details).

17.
Subsequent Event

On October 22, 2018, the Company acquired LPW Technology Ltd. (“LPW”) for a cash purchase price of approximately $81.0 million.  LPW is a leader in the development and supply of advanced metal powders and powder lifecycle management solutions to the additive manufacturing industry. LPW is based in Widnes, Cheshire, United Kingdom with additional processing operations near Pittsburgh, Pennsylvania.


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Table of Contents    


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Background and General
 
We are engaged in the manufacturing, fabrication and distribution of specialty metals. 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. We also manufacture and rent down-hole drilling tools and components used in the oil and gas industry.

As part of our overall business strategy, we have sought out and considered opportunities related to strategic acquisitions, divestitures and joint collaborations aimed at broadening our offerings 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 2018 Form 10-K. Our discussions here focus on our results during or as of the three-month period ended September 30, 2018 and the comparable period of fiscal year 2018, and to the extent applicable, on material changes from information discussed in the 2018 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 2018 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.


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Table of Contents    

Approximately 30 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 income (loss) 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.
 
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 2019 will be $11.4 million as compared with $14.0 million in fiscal year 2018.  The following is the pension expense for the three months ended September 30, 2018 and 2017:
 
 
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
Pension plans
 
$
2.4

 
$
2.8

Other postretirement plans
 
0.5

 
0.8

Net periodic benefit costs
 
$
2.9

 
$
3.6

 

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Table of Contents    

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, net. The following is a summary of the classification of net pension expense for the three months ended September 30, 2018 and 2017:
 
 
 
Three Months Ended
September 30,
($ in millions)
 
2018
 
2017
Cost of sales:
 
 

 
 

Service cost
 
$
2.5

 
$
2.7

Selling, general and administrative expenses:
 
 
 
 
Service cost
 
0.4

 
0.4

Other Income, net:
 
 
 
 
Pension earnings, interest and deferrals
 

 
0.5

Net pension expense
 
$
2.9

 
$
3.6

 
As of September 30, 2018 and June 30, 2018, amounts related to the net pension expense capitalized in gross inventory were $1.6 million and $1.7 million, respectively.
 
Operating Performance Overview
 
Our first quarter results reflect further execution of our commercial strategy and success in capitalizing on strong market conditions partially offset by our annual preventative maintenance shutdowns. While this created a near-term headwind, our solutions-focused approach continues to generate significant customer response as our backlog increased 38% compared to the first quarter a year ago.

Demand patterns are strong and all five of our end-use markets delivered year-over-year revenue growth.  In the Aerospace and Defense end-use market, engine activity remains near record levels and we are also generating healthy customer demand in other sub-markets. We also continue to experience strong demand for our titanium solutions in the Medical end-use market as we further implement our solutions-focused strategy and broaden our relationships with key customers.

Results of Operations — Three Months Ended September 30, 2018 vs. Three Months Ended September 30, 2017
 
For the three months ended September 30, 2018, we reported net income of $31.5 million, or $0.65 per diluted share. This compares with net income for the same period a year earlier of $23.4 million, or $0.49 per diluted share. The current period results primarily reflect stronger end-use market conditions compared to the prior year period as well as the further execution of our solutions-focused commercial approach and the positive impact of the reduced corporate tax rate. 

Net Sales
 
Net sales for the three months ended September 30, 2018 were $572.4 million, which was a 19 percent increase over the same period a year ago. Excluding surcharge revenue, sales increased 11 percent on a 4 percent increase in shipment volume from the same period a year ago. The results primarily reflect the impact of stronger product demand and improved product mix across most end-use markets.
 
Geographically, sales outside the United States increased 18 percent from the same period a year ago to $188.4 million for the three months ended September 30, 2018. The increase is primarily due to stronger product demand in the Aerospace and Defense end-use market in Asia Pacific and Mexico. A portion of our sales outside the United States are denominated in foreign currencies. The impact of fluctuations in foreign currency exchange rates resulted in a $0.7 million decrease in sales during the three months ended September 30, 2018 compared to the three months ended September 30, 2017. Net sales outside the United States represented 33 percent of total net sales for both the three months ended September 30, 2018 and 2017.

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Table of Contents    


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
 
%
Increase
($ in millions)
 
2018
 
2017
 
 
Aerospace and Defense
 
$
310.7

 
$
258.6

 
$
52.1

 
20
%
Energy
 
44.3

 
32.0

 
12.3

 
38
%
Transportation
 
40.3

 
36.7

 
3.6

 
10
%
Medical
 
47.0

 
38.3

 
8.7

 
23
%
Industrial and Consumer
 
96.1

 
84.4

 
11.7

 
14
%
Distribution
 
34.0

 
29.8

 
4.2

 
14
%
Total net sales
 
$
572.4

 
$
479.8

 
$
92.6

 
19
%
 
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
 
%
Increase
($ in millions)
 
2018
 
2017
 
 
Aerospace and Defense
 
$
239.6

 
$
215.6

 
$
24.0

 
11
%
Energy
 
37.5

 
28.8

 
8.7

 
30
%
Transportation
 
31.4

 
30.6

 
0.8

 
3
%
Medical
 
39.5

 
33.4

 
6.1

 
18
%
Industrial and Consumer
 
74.6

 
71.7

 
2.9

 
4
%
Distribution
 
33.7

 
29.7

 
4.0

 
13
%
Total net sales excluding surcharge
 
$
456.3

 
$
409.8

 
$