CARPENTER TECHNOLOGY CORP (CRS) FY 2022 MD&A

Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations

Background and General

Our discussions below in this Item 7 should be read in conjunction with our consolidated financial statements, including the notes thereto, included in this annual report on Form 10-K.

We are a producer and distributor of premium specialty alloys, including titanium alloys, powder metals, stainless steels, alloy steels, and tool steels. We are a recognized leader in high-performance specialty alloy-based materials and process solutions for critical applications in the aerospace, defense, medical, transportation, energy, industrial and consumer markets. We have evolved to become a pioneer in premium specialty alloys, including titanium, nickel, and cobalt, as well as alloys specifically engineered for additive manufacturing ("AM") processes and soft magnetics applications. We have expanded our AM capabilities to provide a complete "end-to-end" solution to accelerate materials innovation and streamline parts production. We primarily process basic raw materials such as nickel, cobalt, titanium, manganese, chromium, molybdenum, iron scrap and other metal alloying elements through various melting, hot forming and cold working facilities to produce finished products in the form of billet, bar, rod, wire and narrow strip in many sizes and finishes. We also produce certain metal powders and parts. Our sales are distributed directly from our production plants and distribution network as well as through independent distributors. Unlike many other specialty steel producers, we operate our own worldwide network of service and distribution centers. These service centers, located in the United States, Canada, Mexico, Europe and Asia allow us to work more closely with customers and to offer various just-in-time stocking programs.

As part of our overall business strategy, we have sought out and considered opportunities related to strategic acquisitions and joint collaborations as well as possible business unit dispositions aimed at broadening our offering to the marketplace. We have participated with other companies to explore potential terms and structures of such opportunities and expect that we will continue to evaluate these opportunities.

While we prepare our financial statements in accordance with U.S. generally accepted accounting principles ("U.S. GAAP"), we also utilize and present certain financial measures that are not based on or included in U.S. GAAP (we refer to these as "Non-GAAP financial measures"). Please see the section "Non-GAAP Financial Measures" below for further discussion of these financial measures, including the reasons why we use such financial measures and reconciliations of such financial measures to the nearest U.S. GAAP financial measures.

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Business Trends

Selected financial results for the past three fiscal years are summarized below:

(1)  See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures.

(2)  Pounds sold data includes Specialty Alloys Operations segment and Dynamet and Additive businesses from the Performance Engineered Products segment.

Our sales are across diverse end-use markets. The table below summarizes our sales by end-use market over the past three fiscal years:

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Impact of Raw Material Prices and Product Mix

We value most of our inventory utilizing the LIFO inventory costing methodology. 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 have been acquired at potentially significantly different values due to the length of time from the acquisition of the raw materials to the sale of the processed finished goods to the customers. In a period of rising raw material costs, the LIFO inventory valuation normally results in higher cost of sales. Conversely, in a period of decreasing raw material costs, the LIFO inventory valuation normally results in lower cost of sales.

The volatility of the costs of raw materials has impacted our operations over the past several years. We, and others in our industry, generally have been able to pass cost increases on major raw materials through to our customers using surcharges that are structured to recover increases in raw material costs. Generally, the formula used to calculate a surcharge is based on published prices of the respective raw materials for the previous month which correlates to the prices we pay for our raw material purchases. However, a portion of our surcharges to customers may be calculated using a different surcharge formula or may be based on the raw material prices at the time of order, which creates a lag between surcharge revenue and corresponding raw material costs recognized in cost of sales. The surcharge mechanism protects our net income on such sales except for the lag effect discussed above. However, surcharges have had a dilutive effect on our gross margin and operating margin percentages as described later in this report.

Approximately 40 percent of our net sales are sales to customers under firm price sales arrangements. Firm price sales arrangements involve a risk of profit margin fluctuations, particularly when raw material prices are volatile. In order to reduce the risk of fluctuating profit margins on these sales, we enter into commodity forward contracts to purchase certain critical raw materials necessary to produce the related products sold. Firm price sales arrangements generally include certain annual purchasing commitments and consumption schedules agreed to by the customers at selling prices based on raw material prices at the time the arrangements are established. If a customer fails to meet the volume commitments (or the consumption schedule deviates from the agreed-upon terms of the firm price sales arrangements), 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 and/or losses on the commodity forward contracts are reclassified from other comprehensive 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.

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Net Pension Benefit

Net pension benefit, as we define it below, includes the net periodic benefit costs related to both our pension and other postretirement plans. The net periodic benefit costs are determined annually based on beginning of year balances and are recorded ratably throughout the fiscal year, unless a significant re-measurement event occurs.

During the fiscal year ended June 30, 2021, we evaluated the need for settlement accounting under Accounting Standards Codification ("ASC') 715-30-35-82 based on the higher than normal lump-sum payments made during fiscal year 2021 in our largest defined benefit plan. We determined that the lump-sum payments exceeded the threshold of service cost and interest cost components and settlement accounting was required. We recorded settlement charges of $11.4 million in the year ended June 30, 2021, within other (income) expense, net.

The following is a summary of the net pension (income) expense for the years ended June 30, 2022, 2021 and 2020:

The service cost component of net pension (income) expense represents the estimated cost of future pension liabilities earned associated with active employees. The pension earnings, interest and deferrals is comprised of the expected return on plan assets, interest costs on the projected benefit obligations of the plans and amortization of actuarial gains and losses and prior service costs and benefits.

During the year ended June 30, 2020, in connection with a restructuring plan, we reduced our global salaried positions by twenty percent. In certain cases, employees were eligible for severance benefits under one of our pension plans. As a result, $3.5 million was funded from this qualified pension plan to cover severance payments and medical coverage for impacted participants.

Net periodic (income) expense is recorded in accounts that are included in both the 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 (income) expense for the years ended June 30, 2022, 2021 and 2020:

As of June 30, 2022 and 2021, amounts capitalized in gross inventory were $1.7 million and $1.0 million, respectively.

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Operating Performance Overview

Fiscal year 2022 proved to be a challenging but successful year. We navigated through an unforeseen outage of our Reading, PA press, continued COVID-19 isolations, a difficult hiring environment and other supply chain challenges. But in addressing each of them, we believe we are emerging from the fiscal year stronger and well-positioned for growth. Looking ahead, we expect to see continued growth across our end-use markets, especially in Aerospace, Defense and Medical applications, where customers are still ramping to pre-pandemic levels. To capitalize on the demand in our core business, we are focused on achieving additional productivity and capacity gains through the Carpenter Operating Model. Further, our strong position in our core business is supported by our capabilities in key emerging areas including electrification and additive manufacturing that further support our long-term growth profile. We believe the continued execution of our strategy will drive sustainable long-term value creation for our customers and shareholders.

For fiscal year 2022, we reported net loss of $49.1 million, or $1.01 loss per diluted share, compared with net loss of $229.6 million, or $4.76 loss per diluted share for fiscal year 2021. Our fiscal year 2022 came to a successful end and placed us on strong ground to deliver accelerated growth in fiscal year 2023. Closing out the year, both the SAO and PEP segments outperformed our expectations. We also continued to expand our backlog across our end-use markets and secured several price increases on our transactional business as overall demand conditions across our end-use markets remain strong. Our backlog grew by 191 percent year-over-year. The fiscal year operating income results were driven by double-digit revenue growth in all end-use markets. We finished fiscal year 2022 with total liquidity of $448.3 million.

Results of Operations — Fiscal Year 2022 Compared to Fiscal Year 2021

For fiscal year 2022, we reported net loss of $49.1 million, or $1.01 loss per diluted share. Excluding special items, loss per diluted share would have been $1.06 for fiscal year 2022. This compares with net loss of $229.6 million, or $4.76 loss per diluted share, a year earlier. Excluding special items, loss per share would have been $2.01 per diluted share for fiscal year 2021. The results for fiscal year 2022 compared to the same period a year ago were driven by growing demand across all our end-use markets.

Both periods were impacted by special items. Our fiscal year 2022 results were negatively impacted by COVID-19 charges of $5.9 million, a historical environmental site charge of $2.4 million and debt extinguishment losses, net of $6.0 million. These charges were offset by COVID-19 employee retention credits of $12.7 million and an acquisition-related contingent liability release of $4.7 million. Our fiscal year 2021 results negatively impacted by a goodwill impairment charge of $52.8 million, LIFO decrement charges of $52.2 million, inventory write-downs from restructuring of $4.2 million, COVID-19 charges of $17.3 million, non-cash restructuring and asset impairment charges of $16.6 million, pension settlement charges of $11.4 million, and debt extinguishment losses, net of $8.2 million. The LIFO decrement charges were non-cash charges associated with reducing inventory and liquidating LIFO layers that had historical costs in excess of the fiscal year 2021 inventory costs.

Net Sales

Net sales for fiscal year 2022 were $1,836.3 million, which represents a 24 percent increase from fiscal year 2021. Excluding surcharge revenue, sales were 12 percent higher than fiscal year 2021 on 11 percent higher volume. The results reflect double-digit sales growth across all end-use markets versus the prior year period.

Geographically, sales outside the United States increased 20 percent from fiscal year 2021 to $656.4 million. The increase was primarily due to higher product demand in the Medical end-use markets in all regions, higher sales in Aerospace and Defense in the South America region, and stronger demand in the Energy end-use market in the Asia Pacific and Canada regions. 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 fiscal year 2022 compared to fiscal year 2021. International sales as a percentage of our total net sales represented 36 percent and 37 percent for fiscal year 2022 and fiscal year 2021, respectively.

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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.

The following table includes comparative information for our net sales by the same principal end-use markets, but excluding surcharge revenue:

Sales to the Aerospace and Defense market increased 11 percent from fiscal year 2021 to $790.2 million. Excluding surcharge revenue, sales were flat on 4 percent higher shipment volume. The results reflect higher year-over-year demand as COVID-19 travel restrictions eased and the aircraft OEM build rates increased.

Sales to the Medical market increased 48 percent to $212.3 million from fiscal year 2021. Excluding surcharge revenue, sales increased 38 percent on 35 percent higher shipment volume. The results reflect higher demand from the ongoing recovery in elective surgeries, with our customers focused on increasing stock levels to meet demand.

Transportation market sales of $178.3 million reflected a 23 percent increase from fiscal year 2021. Excluding surcharge revenue, sales increased 8 percent on 9 percent higher shipment volume. The results reflect higher demand in all sub-markets but was muted from the continuing chip shortage compared to the prior year period.

Sales to the Energy market of $113.0 million reflected a 29 percent increase from fiscal year 2021. Excluding surcharge revenue, sales increased 8 percent. The results reflect increasing global rig counts and higher oil prices benefiting the oil and gas sub-market. This was partially offset by lower sales for power generation materials compared to the prior year period. The prior year results also include one quarter of the Amega West business, which was divested on September 30, 2020.

Industrial and Consumer market sales of $417.2 million increased 43 percent from 2021. Excluding surcharge revenue, sales increased 22 percent on 18 percent higher shipment volume. The results reflect the impact of stronger demand for materials used across all Consumer and Industrial sub-markets.

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Gross Profit

Gross profit in fiscal year 2022 increased to $149.8 million, or 8.2 percent of net sales, from $1.0 million, or 0.1 percent of net sales for fiscal year 2021. The current year results reflect the impact of higher volumes across all end-use markets, an improving product mix and increased pricing, partially offset by the ongoing inflationary pressures on operating costs related to critical production supplies, freight and labor compared to the same period a year ago. Excluding the impact of surcharge revenue and $11.9 million of COVID-19 employee retention credits, our adjusted gross margin in fiscal year 2022 was 9.9 percent compared to adjusted gross margin of 4.6 percent in fiscal year 2021.

Our surcharge mechanism is structured to recover increases in raw material costs, although in certain cases with a lag effect as discussed above. 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 excluding the impact of the special items. We present and discuss these financial measures because management believes removing the impact of these items provides a more consistent and meaningful basis for comparing results of operations from period to period. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures.

Selling, General and Administrative Expenses

Selling, general and administrative expenses in fiscal year 2022 were $174.7 million, or 9.5 percent of net sales (12.5 percent of net sales excluding surcharge revenue), compared to $180.2 million, or 12.2 percent of net sales (14.4 percent of net sales excluding surcharge revenue), in fiscal year 2021. The lower selling, general and administrative expenses in fiscal year 2022 include a non-cash benefit of $4.7 million from the reversal of a contingent liability associated with a historical acquisition for which the time period expired and lower variable compensation charges compared to the same period a year ago. Partially offsetting these benefits in fiscal year 2022 is an environmental charge of $2.4 million which represents a prior period charge related to a third party Superfund waste-disposal site.

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Restructuring and Asset Impairment Charges

During fiscal year 2022, we had no restructuring and asset impairment charges compared to $16.6 million in fiscal year 2021. Additional restructuring activities were executed in our Additive business in the PEP segment during fiscal year 2021. This included $14.2 million of non-cash pre-tax impairment charges consisting of $8.2 million of property, plant and equipment, $4.3 million associated with certain definite lived intangible assets, $1.3 million related to a lease right of use asset and $0.4 million of other non-cash charges. We also recognized $0.4 million for facility shut-down costs and various personnel costs for severance payments, medical coverage and related items.

In fiscal year 2021, we recorded $2.0 million of non-cash impairment pre-tax charges as a result of the Amega West business exit primarily related to accounts receivable determined to be uncollectible.

Activities undertaken in connection with the fiscal year 2021 Additive restructuring plan were substantially completed in the first quarter of fiscal year 2022.

Goodwill Impairment Charge

In preparing the financial statements for the fiscal year ended June 30, 2021, we identified an impairment triggering event related to the Additive reporting unit within the PEP segment. This reporting unit had 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 year ended June 30, 2021, 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 market conditions, the pace of growth in the future projections for the Additive reporting unit were lowered. As a result, during the year ended June 30, 2021, we recorded an impairment charge of $52.8 million, which represented the entire balance of goodwill for this reporting unit. No goodwill impairment charges were recognized during the fiscal year ended June 30, 2022.

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Operating Loss

Our operating loss in fiscal year 2022 was $24.9 million, or negative 1.4 percent of net sales, as compared with $248.6 million of operating loss, or negative 16.8 percent of net sales, in fiscal year 2021. Excluding surcharge revenue and special items, adjusted operating margin was negative 2.4 percent for fiscal year 2022 and negative 8.4 percent for fiscal year 2021. Results for fiscal year 2022 reflect higher sales in all end-use markets compared to the prior year period as well as the full recognition of various cost saving actions taken in fiscal year 2021 and the fourth quarter of fiscal year 2020. Negatively impacting results for fiscal year 2022 were near-term operational challenges resulting from the Reading press outage, labor shortages and supply chain disruptions as well as the ongoing inflationary pressures on operating costs related to critical production supplies, freight and labor. Our fiscal year 2022 operating results were negatively impacted by COVID-19 charges of $5.9 million and a historical environmental site charge of $2.4 million, offset by COVID-19 employee retention credits of $12.7 million and an acquisition-related contingent liability release of $4.7 million. Our fiscal year 2021 results were negatively impacted by a goodwill impairment charge of $52.8 million, LIFO decrement charges of $52.2 million, inventory write-downs from restructuring of $4.2 million, COVID-19 charges of $17.3 million and non-cash restructuring and asset impairment charges of $16.6 million. The LIFO decrement charges were non-cash charges associated with reducing inventory and liquidating LIFO layers that had historical costs in excess of the fiscal year 2021 inventory costs.

The following presents our operating loss and operating margin, in each case excluding the impact of surcharge on net sales and excluding special items. We present and discuss these financial measures because management believes removing the impact of these items provides a more consistent and meaningful basis for comparing results of operations from period to period. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures.

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Interest Expense, Net and Debt Extinguishment Losses, Net

Fiscal year 2022 interest expense, net was $44.9 million compared to $32.7 million in fiscal year 2021. Capitalized interest reduced interest expense by $0.8 million for fiscal year 2022 and by $8.1 million in fiscal year 2021. 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 as of September 30, 2020, in connection with the prepayment of the related $250.0 million notes. Interest expense, net for fiscal year 2022 includes no net gains or losses from interest rate swaps compared with $0.4 million of net gains from interest rate swaps for fiscal year 2021. Debt extinguishment losses, net in fiscal year 2022 were $6.0 million of debt prepayment costs made in connection with the prepayment of notes due March 2023. Debt extinguishment losses, net in fiscal year 2021 totaled $8.2 million and included $10.5 million of debt prepayment costs on the notes due July 2021 partially offset by gains of $2.3 million on the related interest rate swaps that were terminated in connection with the prepayment.

Other (Income) Expense, Net

Other income for fiscal year 2022 was $12.7 million compared with other expense of $8.4 million a year ago. The current fiscal year reflects income from pension earnings, interest and deferrals from favorable returns on plan assets compared to expense in the prior year. The fiscal year 2021 expense is primarily due to pension settlement charges of $11.4 million.

Income Taxes

Our effective tax rate (income tax (benefit) expense as a percent of (loss) income before taxes) for fiscal year 2022 was 22.2 percent as compared to 22.9 percent for fiscal year 2021. The fiscal year 2022 tax benefit includes the unfavorable impacts of losses in certain foreign jurisdictions for which no tax benefit can be recognized. The fiscal year 2021 tax benefit included the unfavorable impacts of the $52.8 million non-deductible goodwill impairment charge and losses in certain foreign jurisdictions for which no tax benefit can be recognized, as well as, tax benefits of $2.8 million associated with pension settlement charges, $2.0 million associated with debt extinguishment losses, net, $5.0 million for the impact of restructuring and asset impairment charges and $0.7 million as a result of changes in our prior year tax positions. Additionally, the anticipated benefit for the carryback of the fiscal year 2021 net operating loss to fiscal years with higher tax rates was included in fiscal year 2021. Also included was a tax charge of $1.4 million attributable to employee share-based compensation. Excluding the tax impact of the non-deductible goodwill impairment charge, pension settlement charges, debt extinguishment losses, net, restructuring and asset impairment charges and changes in our prior year tax positions, the tax rate for fiscal year 2021 would have been 28.2 percent.

The Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") was enacted on March 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 provided incremental tax benefits of approximately $7.0 million, which were recognized in fiscal year 2021, 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.

During the quarter ended March 31, 2022, the Company changed its assertion regarding undistributed earnings from foreign subsidiaries. The Company now asserts that substantially all undistributed earnings from foreign subsidiaries will not be considered permanently reinvested. The potential tax implications from the distribution of these earnings are expected to be limited to withholding taxes in certain foreign jurisdictions and are not expected to materially impact the consolidated financial statements.

See Note 18 to the consolidated financial statements in Item 8. "Financial Statements and Supplementary Data" for a full reconciliation of the statutory federal tax rate to the effective tax rates.

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Business Segment Results

Summary information about our operating results on a segment basis is set forth below. For more detailed segment information, see Note 20 to the consolidated financial statements included in Item 8. "Financial Statements and Supplementary Data".

The following table includes comparative information for volumes by business segment:

* Pounds sold data for PEP segment includes Dynamet and Additive businesses only.

The following table includes comparative information for net sales by business segment:

The following table includes comparative information for our net sales by business segment, but excluding surcharge revenue:

Specialty Alloys Operations Segment

Net sales in fiscal year 2022 for the SAO segment increased 24 percent to $1,565.6 million, as compared with $1,262.2 million in fiscal year 2021. Excluding surcharge revenue, net sales increased 9 percent from a year ago. The fiscal year 2022 net sales reflected 12 percent higher shipment volume as compared to fiscal year 2021. The SAO segment results reflect higher sales in all end-use markets except Aerospace and Defense which were flat compared to the prior year.

Operating income for the SAO segment in fiscal year 2022 was $9.6 million, or 0.6 percent of net sales (0.8 percent of net sales excluding surcharge revenue), compared to operating loss of $87.4 million, or negative 6.9 percent of net sales (negative 0.8 percent of net sales excluding surcharge revenue), for fiscal year 2021. Fiscal year 2022 reflects higher volume in all end-use markets partially offset by the near-term operational challenges resulting from labor shortages, supply chain disruptions and the unplanned Reading press outage which was returned to service in the third quarter. The current year also includes a benefit of $10.6 million related to COVID-19 employee retention credits. The prior year period included negative impacts from targeted inventory reductions and LIFO decrement charges of $47.9 million. The LIFO decrement charges are non-cash charges associated with reducing inventory and liquidating LIFO layers that had historical costs in excess of the fiscal year 2021 inventory costs. The fiscal year 2022 results also include $5.2 million of COVID-19 related costs compared to $14.6 million in fiscal year 2021.

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Performance Engineered Products Segment

Net sales for fiscal year 2022 for the PEP segment were $344.5 million as compared with $259.8 million for fiscal year 2021. Excluding surcharge revenue, net sales increased 32 percent from a year ago. The results reflect higher sales in all end-use markets including Energy when excluding the prior year net sales of the Amega West business which was divested on September 30, 2020.

Operating income for the PEP segment for fiscal year 2022 was $18.1 million, or 5.3 percent of net sales, as compared with operating loss of $16.5 million, or negative 6.4 percent of net sales for fiscal year 2021. Fiscal year 2022 results reflect higher sales in all end-use markets and cost savings in the current fiscal year from the restructuring actions taken in fiscal year 2021. The current year also includes a benefit of $2.1 million related to COVID-19 employee retention credits. Fiscal year 2021 included LIFO decrement charges of $4.3 million. The LIFO decrement charges are non-cash charges associated with reducing inventory and liquidating LIFO layers that had historical costs in excess of the fiscal year 2021 inventory costs. The fiscal year 2022 results also include $0.7 million of COVID-19 related costs compared to $2.7 million in fiscal year 2021.

Results of Operations — Fiscal Year 2021 Compared to Fiscal Year 2020

For fiscal year 2021, we reported net loss of $229.6 million, or $4.76 loss per diluted share. Excluding special items, loss per diluted share would have been $2.01 for fiscal year 2021. This compares with net income of $1.5 million, or $0.02 per diluted share, a year earlier. Excluding special items, earnings per share would have been $2.36 per diluted share for fiscal year 2020. The results for fiscal year 2021 compared to fiscal year 2020 were negatively impacted by the significantly lower volume due to the COVID-19 pandemic, targeted inventory reductions to strengthen liquidity and non-cash restructuring and asset impairment charges. These headwinds were partially offset by the various cost savings actions taken by us in fiscal year 2021 and the fourth quarter of fiscal year 2020. Our fiscal year 2021 results were impacted by a goodwill impairment charge totaling $52.8 million, LIFO decrement charges of $52.2 million, COVID-19 charges of $17.3 million, restructuring and asset impairment charges of $16.6 million, pension settlement charges of $11.4 million, debt extinguishment losses, net of $8.2 million and inventory write-downs from restructuring of $4.2 million. The LIFO decrement charges are non-cash charges associated with reducing inventory and liquidating LIFO layers that had historical costs in excess of the fiscal year 2021 inventory costs. Our fiscal year 2020 results reflect goodwill impairment charges totaling $34.6 million, inventory write-downs and restructuring and asset impairment charges of $97.8 million, LIFO decrement charges of $1.8 million and COVID-19 charges of $7.4 million.

Net Sales

Net sales for fiscal year 2021 were $1,475.6 million, which was a 32 percent decrease from fiscal year 2020. Excluding surcharge revenue, sales were 31 percent lower than fiscal year 2020 on 27 percent lower volume. The results reflected the on-going financial disruptions caused by COVID-19, resulting in lower sales across all end-use markets except transportation versus the prior year period.

Geographically, fiscal year 2021 sales outside the United States decreased 30 percent from fiscal year 2020 to $549.0 million. The decrease was primarily due to lower product demand in the Aerospace and Defense and Medical end-use markets in all regions. 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 $3.8 million increase in sales during fiscal year 2021 compared to fiscal year 2020. International sales as a percentage of our total net sales represented 37 percent and 36 percent for fiscal year 2021 and fiscal year 2020, 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 performance of the business from period to period.

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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:

Sales to the Aerospace and Defense market decreased 46 percent from fiscal year 2020 to $790.2 million. Excluding surcharge revenue, sales decreased 44 percent on 47 percent lower 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.

Sales to the Medical market decreased 27 percent to $212.3 million from fiscal year 2020. Excluding surcharge revenue, sales decreased 28 percent on 24 percent lower shipment volume. The results reflect lower demand as a result of the medical supply chain managing inventory levels closely related to ongoing concerns and delays of elective medical procedures due to the COVID-19 pandemic.

Transportation market sales of $178.3 million reflected a 9 percent increase from fiscal year 2020. Excluding surcharge revenue, sales increased 7 percent on 12 percent higher shipment volume. The results reflect improved demand for materials used in light-duty and heavy-duty vehicles in fiscal year 2021.

Sales to the Energy market of $113.0 million reflected a 35 percent decrease from fiscal year 2020. Excluding surcharge revenue, sales decreased 39 percent. The results reflect depressed North American drilling activity and decreased demand globally as a result of the impact of COVID-19. This is slightly offset by higher demand in power generation materials. The fiscal year 2020 results include a full year of sales for the Amega West business, which we divested on September 30, 2020.

Industrial and Consumer market sales decreased 1 percent to $417.2 million for fiscal year 2021. Excluding surcharge revenue, sales decreased 2 percent on 4 percent higher shipment volume. The flat results reflected the ongoing demand for materials used in the select industrial applications and steady demand for consumer electronics and sporting goods.

Gross Profit

Gross profit in fiscal year 2021 decreased to $1.0 million, or 0.1 percent of net sales from $329.4 million, or 15.1 percent of net sales for fiscal year 2020. The fiscal year 2021 results were impacted by significantly lower volume resulting from the COVID-19 pandemic, continued targeted inventory reductions which resulted in $52.2 million of LIFO decrement charges and $4.2 million of inventory write-downs from restructuring. Excluding the impact of the surcharge revenue, LIFO decrement and the inventory write-downs, our adjusted gross margin in fiscal year 2021 was 4.6 percent compared to adjusted gross margin of 19.7 percent in fiscal year 2020.

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Our surcharge mechanism is structured to recover increases in raw material costs, although in certain cases with a lag effect as discussed above. 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 and special items. We present and discuss these financial measures because management believes removing the impact of surcharge provides a more consistent and meaningful basis for comparing results of operations from period to period. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures.

Selling, General and Administrative Expenses

Selling, general and administrative expenses in fiscal year 2021 were $180.2 million, or 12.2 percent of net sales (14.4 percent of net sales excluding surcharge revenue), compared to $201.0 million, or 9.2 percent of net sales (11.0 percent of net sales excluding surcharge revenue), in fiscal year 2020. The lower selling, general and administrative expenses in fiscal year 2021 reflect the impacts of the cost saving actions initiated in the fourth quarter of fiscal year 2020 including lower salaries and benefits compared to the same period a year ago.

Restructuring and Asset Impairment Charges

During fiscal year 2021, restructuring and asset impairment charges were $16.6 million compared to $68.5 million in fiscal year 2020. Additional restructuring activities were executed in our Additive business in the PEP segment during fiscal year 2021. This included $14.2 million of non-cash pre-tax impairment charges consisting of $8.2 million of property, plant and equipment, $4.3 million associated with certain definite lived intangible assets, $1.3 million related to a lease right of use asset and $0.4 million of other non-cash charges. We also recognized $0.4 million for facility shut-down costs and various personnel costs for severance payments, medical coverage and related items.

We recorded $2.0 million of non-cash impairment pre-tax charges as a result of the Amega West business exit primarily related to accounts receivable determined to be uncollectible.

Activities undertaken in connection with the fiscal year 2021 Additive restructuring plan were substantially complete in the first quarter of fiscal year 2022.

Goodwill Impairment Charge

In preparing the financial statements for the fiscal year ended June 30, 2021, we identified an impairment triggering event related to the Additive reporting unit within the PEP segment. This reporting unit had 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 year ended June 30, 2021, 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 market conditions, the pace of growth in the future projections for the Additive reporting unit were lowered. As a result, during the year ended June 30, 2021, we recorded an impairment charge of $52.8 million, which represented the entire balance of goodwill for this reporting unit.

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Operating (Loss) Income

Our operating loss in fiscal year 2021 was $248.6 million, or negative 16.8 percent of net sales as compared with $25.3 million of operating income, or 1.2 percent of net sales in fiscal year 2020. Excluding surcharge revenue and special items, adjusted operating margin was negative 8.4 percent for fiscal year 2021 and 9.1 percent for fiscal year 2020. The results for fiscal year 2021 compared to fiscal year 2020 were negatively impacted by the significantly lower volume due to the COVID-19 pandemic, targeted inventory reductions to strengthen liquidity and non-cash restructuring and asset impairment charges. These headwinds were partially offset by the various cost savings actions taken in fiscal year 2021 and the fourth quarter of fiscal year 2020. Our fiscal year 2021 results were also impacted by a goodwill impairment charge totaling $52.8 million, LIFO decrement charges of $52.2 million, COVID-19 charges of $17.3 million, restructuring and asset impairment charges of $16.6 million, and inventory write-downs from restructuring of $4.2 million.

The following presents our operating income and operating margin, in each case excluding the impact of surcharge on net sales and excluding special items. We present and discuss these financial measures because management believes removing the impact of these items provides a more consistent and meaningful basis for comparing results of operations from period to period. See the section "Non-GAAP Financial Measures" below for further discussion of these financial measures.

Interest Expense, Net and Debt Extinguishment Losses, Net

Fiscal year 2021 interest expense was $32.7 million compared to $19.8 million in fiscal year 2020. 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 as of September 30, 2020, in connection with the prepayment of the related $250.0 million notes. Interest expense, net for fiscal year 2021 includes net gains from interest rate swaps of $0.4 million compared with $1.4 million of net gains from interest rate swaps for fiscal year 2020. Capitalized interest reduced interest expense by $8.1 million for fiscal year 2021 and by $9.0 million in fiscal year 2020. Debt extinguishment losses, net in fiscal year 2021 include $10.5 million of debt prepayment costs on the notes due July 2021 partially 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 for fiscal year 2021 was $8.4 million compared with other income of $0.6 million in fiscal year 2020. The fiscal year 2021 expense was primarily due to pension settlement charges of $11.4 million. There were no pension settlement charges in fiscal year 2020.

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Income Taxes

Our effective tax rate (income tax (benefit) expense as a percent of (loss) income before taxes) for fiscal year 2021 was 22.9 percent as compared to 75.4 percent for fiscal year 2020. The fiscal year 2021 tax benefit includes the unfavorable impacts of the $52.8 million non-deductible goodwill impairment charge and losses in certain foreign jurisdictions for which no tax benefit can be recognized, as well as, tax benefits of $2.8 million associated with pension settlement charges, $2.0 million associated with debt extinguishment losses, net, $5.0 million for the impact of restructuring and asset impairment charges and $0.7 million as a result of changes in our prior year tax positions. Additionally, the anticipated benefit for the carryback of the fiscal year 2021 net operating loss to fiscal years with higher tax rates is included in the period. Also included is a tax charge of $1.4 million attributable to employee share-based compensation. Excluding the tax impact of the non-deductible goodwill impairment charge, pension settlement charges, debt extinguishment losses, net restructuring and asset impairment charges and changes in our prior year tax positions, the tax rate for fiscal year 2021 would have been 28.2 percent. The fiscal year 2020 tax expense includes the unfavorable impact of the $10.7 million non-deductible goodwill impairment charge and losses in certain foreign jurisdictions for which no tax benefit can be recognized, as well as, tax benefits of $27.0 million for the impact of restructuring and asset impairment charges and $1.0 million as a result of changes in our prior year tax positions. Excluding the impact of the non-deductible goodwill impairment charge, restructuring and asset impairment charges and changes in our prior year tax positions, the tax rate for fiscal year 2020 would have been 23.6 percent.

The net operating loss provision of the CARES Act provided 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.

Undistributed earnings of our foreign subsidiaries, totaling $56.4 million were considered permanently reinvested. If these earnings were to be repatriated, approximately $0.8 million of tax expense would be incurred.

See Note 18 to the consolidated financial statements in Item 8. "Financial Statements and Supplementary Data" for a full reconciliation of the statutory federal tax rate to the effective tax rates.

Business Segment Results

Summary information about our operating results on a segment basis is set forth below. For more detailed segment information, see Note 20 to the consolidated financial statements included in Item 8. "Financial Statements and Supplementary Data".

The following table includes comparative information for volumes by business segment:

* Pounds sold data for PEP segment includes Dynamet and Additive businesses only.

The following table includes comparative information for net sales by business segment:

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The following table includes comparative information for our net sales by business segment, but excluding surcharge revenue:

Specialty Alloys Operations Segment

Net sales in fiscal year 2021 for the SAO segment decreased 31 percent to $1,262.2 million, as compared with $1,831.6 million in fiscal year 2020. Excluding surcharge revenue, net sales decreased 30 percent from fiscal year 2020. The fiscal year 2021 net sales reflected 25 percent lower shipment volume compared to fiscal year 2020. The SAO segment results reflect lower sales in the Aerospace and Defense and Medical end-use markets compared to the prior year caused by the market impact from the COVID-19 pandemic. Sales in the Transportation end-use market increased in fiscal year 2021 compared to fiscal year 2020.

Operating loss for the SAO segment in fiscal year 2021 was $87.4 million, or negative 6.9 percent of net sales (negative 8.4 percent of net sales excluding surcharge revenue), compared to operating income of $239.0 million, or 13.0 percent of net sales (16.1 percent of net sales excluding surcharge revenue), for fiscal year 2020. Fiscal year 2021 included LIFO decrement charges of $47.9 million compared to $1.8 million in fiscal year 2020. The LIFO decrement charges are non-cash charges associated with reducing inventory and liquidating LIFO layers that had historical costs in excess of the fiscal year 2021 inventory costs. The fiscal year 2021 results also include $14.6 million of COVID-19 related costs compared to $6.5 million in fiscal year 2020.

Performance Engineered Products Segment

Net sales for fiscal year 2021 for the PEP segment were $344.5 million as compared with $401.1 million for fiscal year 2020. Excluding surcharge revenue, net sales decreased 35 percent from 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 fiscal year 2021 net sales results reflect the divestiture of the Amega West business on September 30, 2020.

Operating loss for the PEP segment for fiscal year 2021 was $16.5 million, or negative 6.4 percent of net sales, as compared with operating loss of $10.4 million, or negative 2.6 percent of net sales for fiscal year 2020. Fiscal year 2021 included LIFO decrement charges of $4.3 million. The LIFO decrement charges are non-cash charges associated with reducing inventory and liquidating LIFO layers that had historical costs in excess of the fiscal year 2021 inventory costs. The fiscal year 2021 results also include $2.7 million of COVID-19 related costs compared to $0.9 million in fiscal year 2020.

Liquidity and Financial Resources

During fiscal year 2022, we generated cash from operating activities of $6.0 million as compared with $250.0 million in fiscal year 2021. Our free cash flow, which we define under "Non-GAAP Financial Measures" below, was negative $122.3 million as compared to positive $132.0 million for the same period a year ago. The change in operating cash flow primarily reflects the impact of higher earnings after non-cash adjustments to net income in fiscal year 2022 offset by changes in inventory compared to a year ago. The current year reflects cash used to build inventory of $71.9 million compared to cash from targeted inventory reductions of $238.5 million in fiscal year 2021. The current period also includes $47.1 million from certain income tax refunds received related to prior years. The free cash flow results reflect lower capital spending levels in the current period as compared to the prior year period. Fiscal year 2021 results also included $20.0 million of proceeds related to the sale of our Amega West business.

Capital expenditures for property, plant, equipment and software were $91.3 million for fiscal year 2022 as compared to $100.5 million for fiscal year 2021. In fiscal year 2023, we expect capital expenditures to be approximately $100 million.

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We evaluate liquidity needs for alternative uses including funding external growth opportunities, share repurchases as well as funding consistent dividend payments to stockholders. Dividends for fiscal year 2022 were $39.2 million, as compared to $39.1 million in the prior year period. In fiscal years 2022, 2021 and 2020 we declared and paid quarterly cash dividends of $0.20 per share.

For the fiscal years ended June 30, 2022, 2021 and 2020, interest costs totaled $45.7 million, $40.8 million and $28.8 million, respectively, of which $0.8 million, $8.1 million and $9.0 million, respectively, were capitalized as part of the cost of property, plant, equipment and software. Debt extinguishment losses, net for the fiscal year ended June 30, 2022 were $6.0 million as compared with $8.2 million of debt extinguishment losses, net for the fiscal year ended June 30, 2021 which included $10.5 million of debt prepayment costs on notes due July 2021, offset by gains of $2.3 million on related interest rate swaps that were terminated in connection with the prepayment. For the fiscal year ended June 30, 2020, there were no debt extinguishment losses, net.

We have demonstrated the ability to generate cash to meet our needs through cash flows from operations, management of working capital and the ability to access capital markets to supplement internally generated funds. We target minimum liquidity of $150 million, consisting of cash and cash equivalents added to available borrowing capacity under our Credit Facility.

On March 26, 2021, we entered into our $300.0 million secured revolving credit facility (the "Credit Facility"). The Credit Facility amended and restated our previous revolving credit facility, dated March 31, 2017, which had been set to expire in March 2022. The Credit Facility extends the maturity to March 31, 2024, subject to a springing maturity of November 30, 2022. If, by November 30, 2022, our outstanding $300.0 million 4.45% Senior Notes due in March 2023 were not redeemed, repurchased or refinanced with indebtedness having a maturity date of October 1, 2024 or later, all indebtedness under the Credit Facility would be due. The springing maturity clause has been fulfilled with the issuance of the 2030 Notes and subsequent payment in full of the 4.45% Senior Notes, as discussed in Note 10, Debt. The Credit Facility contains a revolving credit commitment amount of $300.0 million, subject to our right, from time to time, to request an increase of the commitment to $500.0 million in the aggregate; and provides for the issuance of letters of credit subject to a $40.0 million sub-limit. We have the right to voluntarily prepay and re-borrow loans, to terminate or reduce the commitments under the Credit Facility, and, subject to certain lender approvals, to join subsidiaries as subsidiary borrowers.

On February 14, 2022, we entered into an amendment (the “Amendment”) to our secured revolving Credit Facility. The Amendment revised the interest coverage ratio covenant under the Credit Facility so that the first test date is June 30, 2022, and to require a minimum interest coverage ratio of 2.00 to 1.00 at June 30, 2022 (calculated for the two fiscal quarters then ended), 3.00 to 1.00 at September 30, 2022 (calculated for the three fiscal quarters then ended) and 3.50 to 1.00 at December 31, 2022 and thereafter (calculated for the four fiscal quarters then ended). The Amendment revised the restricted period under the Credit Facility, during which the Company is prohibited from incurring any secured debt other than purchase money financing for new equipment and is subject to additional restrictions on its ability to make dividends or distributions or to make certain investments, to expire on September 30, 2022.

On March 16, 2022, we completed our offering and sale of $300.0 million in aggregate principal amount of 7.625% Senior Notes due 2030 (the "2030 Notes"). The 2030 Notes accrue interest at the rate of 7.625% per annum, with interest payable in cash semi-annually in arrears on March 15 and September 15, commencing September 15, 2022. The 2030 Notes will mature on March 15, 2030. The 2030 Notes are senior unsecured indebtedness, ranking equally in right of payment with all its existing and future senior unsecured indebtedness and senior to its future subordinated indebtedness. We used the net proceeds from the issuance of the 2030 Notes to repay, in April 2022, in full $300.0 million in principal of its 4.45% senior unsecured notes due March 2023, including any interest and premium due thereon.

As of June 30, 2022, we had $5.9 million of issued letters of credit and no short-term borrowings under the Credit Facility. The balance of the Credit Agreement, $294.1 million, remains available to us. As of June 30, 2022, the borrowing rate for the Credit Facility was 3.67 percent.

We believe that our total liquidity of $448.3 million, as of June 30, 2022, which includes cash and cash equivalents of $154.2 million and available borrowing capacity of $294.1 million under the Credit Facility, will be sufficient to fund our cash needs over the foreseeable future.

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During fiscal year 2022, we made pension contributions of $0.7 million in total to our qualified defined benefit pension plans. We are not required to make cash contributions to our domestic qualified pension plans during fiscal year 2023 as a result of the American Rescue Plan Act of 2021. Over the next five years, current estimates indicate that we will be required to make approximately $67.4 million of cash contributions to our domestic qualified defined benefit pension plans, based on the laws in effect for pension funding as of June 30, 2022, and subject to market returns and interest rate assumptions.

As of June 30, 2022, we had cash and cash equivalents of approximately $40.6 million held at various foreign subsidiaries. Our global cash deployment considers, among other things, the 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 fiscal year ended June 30, 2022, we repatriated cash of $19.8 million from foreign jurisdictions.

We are subject to certain financial and restrictive covenants under the Credit Facility, which, among other things, require the maintenance of a minimum interest coverage ratio. The interest coverage ratio is defined in the Credit Facility as, for any period, the ratio of consolidated earnings before interest, taxes, depreciation and amortization and non-cash net pension expense ("EBITDA") to consolidated interest expense for such period. The interest coverage covenant was waived until the quarter ended June 30, 2022 at which time it is required to be 2.00 to 1.00, for the quarter ended September 30, 2022 it will be 3.00 to 1.00 and then 3.50 to 1.00 thereafter. The Credit Facility also requires us to maintain a debt to capital ratio of less than 55 percent. The debt to capital ratio is defined in the Credit Facility as the ratio of consolidated indebtedness, as defined therein, to consolidated capitalization, as defined therein. In addition, we are subject to an asset coverage ratio minimum of 1.10 to 1.00. The asset coverage ratio is defined in the Credit Facility as eligible receivables and inventory, as defined therein, to outstanding loans and obligations, as defined therein. As of June 30, 2022, we were in compliance with all of the covenants of the Credit Facility.

The following table shows our actual ratio performance with respect to the financial covenants, as of June 30, 2022:

To the extent that we do not comply with the current or modified covenants under the Credit Facility, this could reduce our liquidity and flexibility due to potential restrictions on borrowings available to us unless we are able to obtain waivers or modifications of the covenants.

Non-GAAP Financial Measures

The following provides additional information regarding certain non-GAAP financial measures that we use in this report. Our definitions and calculations of these items may not necessarily be the same as those used by other companies.

Net Sales and Gross Margin Excluding Surcharge Revenue and Special Items

This report includes discussions of net sales as adjusted to exclude the impact of raw material surcharge and special items and the resulting impact on gross margins, which represent financial measures that have not been determined in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). We present and discuss these financial measures because management believes removing the impact of raw material surcharge from net sales provides a more consistent basis for comparing results of operations from period to period for the reasons discussed earlier in this report. In addition, management believes that excluding special items from gross profit and gross margin is helpful in analyzing our operating performance as the inventory write-downs from restructuring 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 "Gross Profit" for a reconciliation of net sales and gross margin, excluding surcharge revenue and special items, to net sales as determined in accordance with U.S. GAAP. Net sales and gross margin excluding surcharge revenue and special items is not a U.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 with U.S. GAAP.

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Adjusted Operating (Loss) Income and Adjusted Operating Margin Excluding Surcharge Revenue and Special Items

This report includes discussions of operating (loss) income and 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 with U.S. GAAP. We present and discuss these financial measures because management believes removing the impact of raw material surcharge from net sales provides a more consistent 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 loss for a reconciliation of adjusted operating (loss) income and adjusted operating margin excluding special items to operating (loss) income and operating margin determined in accordance with U.S. GAAP. Adjusted operating (loss) income and adjusted operating margin excluding surcharge revenue and special items is not a U.S. GAAP financial measure and should not be considered in isolation of, or as a substitute for, operating (loss) income and operating margin calculated in accordance with U.S. GAAP.

Adjusted Loss Per Share

The following provides a reconciliation of adjusted loss per share, to its most directly comparable U.S. GAAP financial measures:

* Impact per diluted share calculated using weighted average common shares outstanding of 48.5 million for the fiscal year ended June 30, 2022.

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* Impact per diluted share calculated using weighted average common shares outstanding of 48.3 million for the fiscal year ended June 30, 2021.

Management believes that the presentation of loss per share adjusted to exclude the impact of special items is helpful in analyzing the operating performance of the Company, 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, the Company's board of directors and others. Our definitions and calculations of these items may not necessarily be the same as those used by other companies. Adjusted loss per share is not a U.S. GAAP financial measure and should not be considered in isolation of, or as a substitute for, loss per share calculated in accordance with U.S. GAAP.

Free Cash Flow

The following provides a reconciliation of free cash flow, as used in this annual report, to its most directly comparable U.S. GAAP financial measures:

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.

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Critical Accounting Policies and Estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. On an on-going basis, we evaluate our estimates, including those related to bad debts, customer claims, inventories, pensions and other postretirement benefits, intangible assets, goodwill, leases, environmental liabilities, income taxes, derivative instruments and hedging activities and contingencies and litigation.

We believe the following are the critical accounting policies and areas affected by significant judgments and estimates impacting the preparation of our consolidated financial statements.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. We perform ongoing credit evaluations of our customers and monitor their payment patterns. Should the financial condition of our customers deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventories

Inventories are valued at the lower of cost or market for those inventories determined by the LIFO method. We value other inventory at the lower of cost or net realizable value, determined by the FIFO and average cost methods. As of June 30, 2022 and 2021, $122.9 million and $107.5 million of inventory, respectively, was accounted for using a method other than the LIFO method.

Costs include direct materials, direct labor, applicable manufacturing overhead and other direct costs. Under the LIFO inventory valuation 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 and other costs may have been incurred at significantly different values due to the length of time of our production cycle. The prices for many of the raw materials we use have been volatile. Since we value most of our inventory utilizing the LIFO inventory costing methodology, rapid changes in raw material costs have an impact on our operating results. In a period of rising prices, cost of sales expense recognized under LIFO is generally higher than the cash costs incurred to acquire the inventory sold. Conversely, in a period of declining raw material prices, cost of sales expense recognized under LIFO is generally lower than the cash costs incurred to acquire the inventory sold.

Since the LIFO inventory valuation methodology is designed for annual determination, interim estimates of the annual LIFO valuation are required. We evaluate the effects of the LIFO inventory valuation method on an interim basis by estimating the expected annual LIFO cost based on cost changes to date and recognize effects that are not expected to be replaced by year-end in the interim period in which the liquidation occurs. These projections of annual LIFO inventory valuation reserve changes are updated quarterly and are evaluated based upon material, labor and overhead costs.

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Pension and Other Postretirement Benefits

The amount of net pension (income) expense, which is determined annually, or upon remeasurement, is based upon the value of the assets in the pension trusts at the beginning of the fiscal year as well as actuarial assumptions, such as the discount rate and the expected long-term rate of return on plan assets. The assumed long-term rate of return on pension plan assets is reviewed at each year-end based on the plan's investment policies, an analysis of the historical returns of the capital markets and current interest rates. Based on the current funding level, the benchmark allocation policy for the Company's largest pension plan assets is to have approximately 75 percent in return seeking assets and 25 percent in liability-hedging assets. Return seeking assets include global equities, diversified credit and real assets. Liability-hedging assets include bond funds and cash. When the funding level of the plan reaches 95 percent and improves to fully or over-funded status in increments of 5 percent, assets will be shifted from return seeking to liability-hedging assets in accordance with the glidepath policy outlined in the pension plan’s Investment Policy Statement. The plan discount rate is determined by reference to the Bond:Link interest rate model based upon a portfolio of highly rated U.S. corporate bonds with individual bonds that are theoretically purchased to settle the plan's anticipated cash outflows. The fluctuations in stock and bond markets could cause actual investment results to be significantly different from those assumed, and therefore, significantly impact the valuation of the assets in our pension trusts. Changes in actuarial assumptions could significantly impact the accounting for the pension assets and liabilities. If the assumed long-term rate of return on plan assets was changed by 0.25 percent, the net pension (income) expense would change by $2.2 million. If the discount rate was changed by 0.25 percent, the net pension (income) expense would change by $0.3 million.

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

Goodwill is not amortized but instead is tested at least annually for impairment as of June 1, or more frequently if events or circumstances indicate that the carrying amount of goodwill may be impaired. Effective in fiscal year 2022 and prospectively, we will perform the required annual goodwill impairment test as of June 1 rather than on June 30 which was our previous practice. We believe this change is preferable as it more closely aligns with the timing of our annual budgeting process. We do not believe this change resulted in any delay, acceleration or avoidance of impairment. Furthermore, a retrospective application to prior periods is impracticable as we are unable to objectively determine, without the use of hindsight, the assumptions which would be used in earlier periods.

Potential impairment is identified by comparing the fair value of a reporting unit to its carrying value. If the carrying value of the reporting unit exceeds its fair value, any impairment loss is measured by the difference between the carrying value of the reporting unit and its fair value, not to exceed the carrying amount of goodwill. The discounted cash flow analysis for each reporting unit tested requires significant estimates and assumptions related to cash flow forecasts, discount rates, terminal values and income tax rates. The cash flow forecasts include significant judgments and assumptions related to revenue growth rates, which include perpetual growth rates, gross margin and weighted average cost of capital. The cash flow forecasts are developed based on assumptions about each reporting unit's markets, product offerings, pricing, capital expenditure and working capital requirements as well as cost performance.

The discount rates used in the discounted cash flow are estimated based on a market participant's perspective of each reporting unit's weighted average cost of capital. The terminal value, which represents the value attributed to the reporting unit beyond the forecast period, is estimated using a perpetuity growth rate assumption. The income tax rates used in the discounted cash flow analysis represent estimates of the long-term statutory income tax rates for each reporting unit based on the jurisdictions in which the reporting units operate.

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In preparing the financial statements for the quarter ended December 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 ended December 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 ended December 31, 2020, which represents the entire balance of goodwill for this reporting unit. No other asset 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 of June 30, 2022, we have three reporting units with goodwill recorded. Goodwill associated with the SAO reporting unit as of June 30, 2022, was $195.5 million and represents approximately 81 percent of total goodwill as of June 30, 2022. The remaining goodwill is associated with the PEP segment, which includes two reporting units, Dynamet and Latrobe Distribution, with goodwill recorded as of June 30, 2022, of $31.9 million and $14.0 million, respectively. The fair value for all three reporting units is estimated using a weighting of discounted cash flows and the use of market multiples valuation techniques.

Goodwill associated with the SAO reporting unit is tested at the SAO segment level. As of June 1, 2022, the fair value of the SAO reporting unit exceeded the carrying value by approximately 38.2 percent. The discounted cash flows analysis for the SAO reporting unit includes assumptions related to our ability to increase volume, improve mix, expand product offerings and continue to implement opportunities to reduce costs over the next several years. For purposes of the discounted cash flow analysis for SAO's fair value, a weighted average cost capital of 9.5 percent and a terminal growth rate assumption of 2.5 percent were used. If the long-term growth rate for this reporting unit had been hypothetically reduced by 0.5 percent at June 1, 2022, the SAO reporting unit would have a fair value that exceeded the carrying value by approximately 34.5 percent.

Goodwill associated with the PEP segment is tested at the Dynamet and Latrobe Distribution reporting unit level. As of June 1, 2022, the fair value of the Dynamet reporting unit exceeded the carrying value by approximately 54.1 percent. For purposes of the discounted cash flow analysis for Dynamet's fair value, a weighted average cost capital of 13.0 percent and a terminal growth rate assumption of 2.5 percent were used. If the long-term growth rate for this reporting unit had been hypothetically reduced by 0.5 percent at June 1, 2022, the Dynamet reporting unit would have a fair value that exceeded the carrying value by approximately 52.0 percent. As of June 1, 2022, the fair value of the Latrobe Distribution reporting unit exceeded the carrying value by approximately 34.5 percent. For purposes of the discounted cash flow analysis for Latrobe Distribution's fair value, a weighted average cost capital of 11.0 percent and a terminal growth rate assumption of 2.5 percent were used. If the long-term growth rate for this reporting unit had been hypothetically reduced by 0.5 percent at June 1, 2022, the Latrobe Distribution reporting unit would have a fair value that exceeded the carrying value by approximately 32.1 percent.

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.

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Leases

Determination of whether a contract is or contains a lease at contract inception is based on the presence of identified assets and the right to obtain substantially all of the economic benefit from or to direct the use of such assets. When it is determined a lease exists, a right-of-use ("ROU") asset and corresponding lease liability are recorded on the consolidated balance sheets. ROU assets represent the right to use an underlying asset for the lease term. Lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets are recognized at commencement date at the value of the lease liability and are adjusted for any prepayments, lease incentives received, and initial direct costs incurred. Lease liabilities are recognized at lease commencement date based on the present value of remaining lease payments over the lease term. As the discount rate implicit in the lease is not readily determinable in most leases, an incremental borrowing rate is used. Lease terms include options to extend or terminate the lease when it is reasonably certain that the option will be exercised. Lease contracts with a term of 12 months or less are not recorded in the consolidated balance sheets. Fixed lease expense is recognized for operating leases on a straight-line basis over the lease term. Lease agreements with lease and non-lease components, are accounted for as a single lease component for all underlying asset classes. Accordingly, all costs associated with a lease contract are accounted for as lease costs. Some leasing arrangements require variable payments that are dependent on usage, output, or may vary for other reasons, such as insurance and tax payments. The variable lease payments are not presented as part of the ROU asset or lease liability.

Environmental Expenditures

Environmental expenditures that pertain to current operations or to future revenues are expensed or capitalized consistent with Carpenter's capitalization policy for property, plant and equipment. Expenditures that result from the remediation of an existing condition caused by past operations and that do not contribute to current or future revenues are expensed. Liabilities are recognized for remedial activities when the remediation is probable and the cost can be reasonably estimated. Most estimated liabilities are not discounted to present value due to the uncertainty as to the timing and duration of expected costs. For one former operating facility site, due to the routine nature of the expected costs, the liability for future costs is discounted to present value over 20 years assuming a discount rate of approximately 3 percent as of June 30, 2022 and 2021.

Income Taxes

Deferred income taxes result from temporary differences in the recognition of income and expense for financial and income tax reporting purposes, or differences between the fair value of assets acquired in business combinations accounted for as purchases for financial reporting purposes and their corresponding tax bases. Deferred income taxes represent future tax benefits (assets) or costs (liabilities) to be recognized when those temporary differences reverse. We evaluate on a quarterly basis whether, based on all available evidence, we believe that our deferred income tax assets will be realizable. Valuation allowances are established when it is estimated that it is more likely than not that the tax benefit of the deferred tax assets will not be realized. The evaluation includes the consideration of all available evidence, both positive and negative, regarding historical operating results including recent years with reported losses, the estimated timing of future reversals of existing taxable temporary differences, estimated future taxable income exclusive of reversing temporary differences and carryforwards, and potential tax planning strategies which may be employed to prevent an operating loss or tax credit carryforward from expiring unused. Future realization of deferred income tax assets ultimately depends upon the existence of sufficient taxable income within the carryback or carryforward period available under tax law.

Management determines whether a tax position should be recognized in the financial statements by evaluating whether it is more likely than not that the tax position will be sustained upon examination by the tax authorities based upon the technical merits of the position. For those tax positions which should be recognized, the measurement of a tax position is determined as being the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Interest and penalties on estimated liabilities for uncertain tax positions are recorded as components of the provision for income taxes.

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Derivative Financial Instruments

Our current risk management strategies include the use of derivative instruments to reduce certain risks. The critical strategies include: (1) the use of commodity forward contracts to fix the price of a portion of anticipated future purchases of certain raw materials and energy to offset the effects of changes in the costs of those commodities; and (2) the use of 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 commodity forwards and foreign currency forwards have been designated as cash flow hedges and unrealized net gains and losses are recorded in the accumulated other comprehensive loss component of stockholders' equity. The unrealized gains or losses are reclassified to the statement of operations when the hedged transaction affects earnings or if the anticipated transactions are no longer expected to occur. We may use interest rate swaps to maintain a certain level of floating rate debt relative to fixed rate debt. Interest rate swaps have been designated as fair value hedges. Accordingly, the mark-to-market values of both the interest rate swap and the underlying debt obligations are recorded as equal and offsetting gains and losses in the interest expense component of the consolidated statement of operations. We have also used forward interest rate swaps to manage the risk of cash flow variability associated with fixed interest debt expected to be issued. We also use foreign currency forward contracts to protect certain short-term asset or liability 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.

New Accounting Pronouncements

For information with respect to new accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 3 to Notes to Consolidated Financial Statements included in Item 8. "Financial Statements and Supplementary Data".

Off Balance Sheet Arrangements

We had no off balance sheet arrangements during the periods presented.

Market Sensitive Instruments and Risk Management

See "Item 7A. Quantitative and Qualitative Disclosures About Market Risk" for discussion of market sensitive instruments and associated market risk for Carpenter.

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 potentially responsible party ("PRP") with respect to certain third party Superfund waste-disposal sites and other third party-owned sites. 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. We accrue amounts for environmental remediation costs that represent our best estimate of the probable and reasonably estimable future costs related to environmental remediation. 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 June 30, 2022 and 2021 were $18.3 million and $16.0 million, respectively. During fiscal year 2022 we recorded a liability for a third party Superfund waste-disposal site, Helen Kramer Landfill, of $2.4 million. In December 1997, we were named as a party in the Helen Kramer Landfill Settlement Agreement. As a result of the settlement agreement, we were obligated to reimburse the settling work defendants for 31.4 percent of up to $7.5 million in capital expenditure costs as they were incurred, which was prior to fiscal year 2022. We recorded a $2.4 million liability for our proportional share of the capital expenditure amount. We intend to pay these remediation costs during the next fiscal year. During fiscal year 2022, we also decreased the liability for a company-owned former operating site by $0.1 million.

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Estimates of the amount and timing of future costs of environmental remediation requirements are inherently imprecise because of the continuing evolution of environmental laws and regulatory requirements, the availability and application of technology, the identification of currently unknown remediation sites and the allocation of costs among the PRPs. Based upon information currently available, such future costs are not expected to have a material effect on our financial position, results of operations or cash flows over the long-term. However, such costs could be material to our financial position, results of operations or cash flows in a particular future quarter or year.

Other

We are defending various routine claims and legal actions that are incidental to our business, and that are common to our operations, including those pertaining to product claims, commercial disputes, patent infringement, employment actions, employee benefits, compliance with domestic and foreign laws, personal injury claims and tax issues. Like many other manufacturing companies in recent years we, from time to time, have been named as a defendant in lawsuits alleging personal injury as a result of exposure to chemicals and substances in the workplace. 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.

Forward-Looking Statements

This Annual Report on Form 10-K 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 in this Form 10-K. 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 on Carpenter Technology's business such as new competitors, the consolidation of competitors, customers, and suppliers or the transfer of manufacturing capacity from the United States to foreign countries; (2) the ability of Carpenter 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 in Carpenter 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 to Carpenter 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 in Reading and Latrobe, Pennsylvania and Athens, Alabama for which there may be limited alternatives if there are significant equipment failures or a catastrophic event; (14) the ability to hire and retain key personnel, including members of the executive management team, management, metallurgists and other skilled personnel; (15) fluctuations in oil and gas prices and production; (16) uncertainty regarding the return to service of the Boeing 737 MAX aircraft and the related supply chain disruption; (17) potential impacts of the COVID-19 pandemic on our operations, financial results and financial position; (18) our efforts and efforts by governmental authorities to mitigate the COVID-19 pandemic, such as travel bans, shelter in place orders and business closures, and the related impact on resource allocations and manufacturing and supply chains; (19) our ability to execute our business continuity, operational, budget and fiscal plans in light of the COVID-19 pandemic; and (20) our ability to successfully carry out restructuring and business exit activities on the expected terms and timelines. Any of these factors could have an adverse and/or fluctuating effect on Carpenter Technology's results of operations. The forward-looking statements in this document are intended to be subject to the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended. We caution you not to place undue reliance on forward-looking statements, which speak only as of the date of this Form 10-K or as of the dates otherwise indicated in such forward-looking statements. Carpenter Technology undertakes no obligation to update or revise any forward-looking statements.

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