CARPENTER TECHNOLOGY CORP (CRS) FY 2024 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 processes and soft magnetics applications. 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 45 percent of our net sales are sales to customers under firm price sales arrangements. Firm price sales arrangements involve a risk of profit margin fluctuations, particularly when raw material prices are volatile. In order to reduce the risk of fluctuating profit margins on these sales, we enter into commodity forward contracts to purchase certain critical raw materials necessary to produce the related products sold. Firm price sales arrangements generally include certain annual purchasing commitments and consumption schedules agreed to by the customers at selling prices based on raw material prices at the time the arrangements are established. If a customer fails to meet the volume commitments (or the consumption schedule deviates from the agreed-upon terms of the firm price sales arrangements), we may need to absorb the gains or losses associated with the commodity forward contracts on a temporary basis. Gains or losses associated with commodity forward contracts are reclassified to earnings (loss) when earnings are impacted by the hedged transaction. Because we value most of our inventory under the LIFO costing methodology, changes in the cost of raw materials and production activities are recognized in cost of sales in the current period attempting to match the most recently incurred costs with revenues. Gains and/or losses on the commodity forward contracts are reclassified from accumulated other comprehensive income (loss) ("AOCI") 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.

Impact of Inflation and Supply Chain Disruption

Recent inflationary pressures affecting the general economy have impacted our operating costs including increased costs for raw materials, energy, key operating supplies and labor.

Additionally, global supply chain disruptions have affected our operations, including the availability and cost of labor, as well as the supply of industrial goods. As a result, we are experiencing higher labor rates, extended lead times for certain supplies, as well as delay of certain capital expenditures due to the availability of equipment and outside contractors. These disruptions have resulted in increased direct costs and certain inefficiencies in our operations.

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We have taken steps that we believe are necessary to mitigate inflationary pressures and supply chain disruptions. As discussed above, we have certain mechanisms in place to reduce the impact for the most significant of these items and have been able to recover these increases through our raw material surcharge and other pricing strategies. We have long-term relationships with major suppliers who provide availability of material at competitive prices along with arrangements with certain vendors to provide consigned materials at our manufacturing facilities available for our consumption as necessary. We also continue to execute on targeted initiatives to maximize productivity and achieve capacity gains.

While these inflation and supply chain factors could negatively impact our business in the near-term, we do not currently expect them to materially impact our business outlook or operational goals over the long-term.

Net Pension Expense (Income)

Net pension expense (income), 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, 2024, we executed a buy-out annuity transaction for our largest defined benefit plan. We determined that the annuity settlement and lump-sum payments exceeded the threshold of service cost and interest cost components and therefore settlement accounting was required. We recorded a noncash settlement charge of $51.9 million in the year ended June 30, 2024, within other expense (income), net.

The following is a summary of the net pension expense (income) for the years ended June 30, 2024, 2023 and 2022:

The service cost component of net pension expense (income) 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.

Net periodic expense (income) 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 expense (income), net. The following is a summary of the classification of net pension expense (income) for the years ended June 30, 2024, 2023 and 2022:

As of June 30, 2024 and 2023, amounts capitalized in gross inventory were $1.6 million and $2.8 million, respectively.

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Operating Performance Overview

Fiscal year 2024 was the most profitable year in Carpenter Technology’s history, achieving $354.1 million in adjusted operating income. Further, we generated adjusted free cash flow of $179.0 million for the full fiscal year. We continue to drive earnings momentum through improved productivity, product mix optimization and pricing actions. Notably, the SAO segment generated $408.5 million in operating income with an adjusted operating margin of 16.7 percent of net sales (21.8 percent of net sales excluding surcharge revenue).

With our operating momentum, we are pulling forward our previously communicated fiscal year 2027 goal of doubling our operating income versus fiscal year 2019. We expect to achieve $460.0 million to $500.0 million in operating income in fiscal year 2025. Having just realized over 60 percent of our goal in fiscal year 2024, we are accelerating a four-year goal into a two-year goal. We expect a strong start to fiscal year 2025, with first quarter operating income in the range of $114.0 million to $120.0 million. Further, we expect to generate $250.0 million to $300.0 million in adjusted free cash flow in fiscal year 2025.

With a strong balance sheet and meaningful adjusted free cash flow, we will continue to take a balanced approach to capital allocation: sustaining our current asset base to achieve our targets, investing in incremental growth initiatives, and returning cash to stockholders. We recently announced that our Board of Directors approved a share repurchase program up to $400.0 million of our outstanding common stock. Carpenter Technology continues to exceed performance and outlook expectations. Having just completed a historic fourth quarter and fiscal year 2024, we believe we are well positioned to achieve our accelerated goals and believe our earnings growth journey will extend far beyond fiscal year 2025.

We are actively managing our preventive maintenance schedules to protect our unique assets, serve our customers and maximize shipments. Macro trends are increasing demand across our end-use markets for our broad portfolio of specialized solutions. We have leading capabilities and capacity with a difficult-to-replicate system of assets, and we continue to drive improved productivity to capture the demand.

Results of Operations — Fiscal Year 2024 Compared to Fiscal Year 2023

For fiscal year 2024, we reported net income of $186.5 million, or $3.70 earnings per diluted share. This compares with net income of $56.4 million, or $1.14 earnings per diluted share, in fiscal year 2023. Excluding special items, as identified below, adjusted earnings per diluted share was $4.74 in fiscal year 2024. There were no reported special items for fiscal year 2023. The results for fiscal year 2024 compared to fiscal year 2023 reflect ongoing improvement in product mix, higher realized prices, as well as expanded operating efficiencies.

Special items included in our fiscal year 2024 results include a noncash goodwill impairment charge of $14.1 million related to the Latrobe Distribution reporting unit in the PEP segment. We recorded restructuring and asset impairment charges of $16.9 million as a result of actions taken to streamline operations in the Carpenter Additive business. $15.8 million of this amount represent noncash asset impairment charges. We also recorded a noncash pension settlement charge of $51.9 million as a result of executing de-risking actions to annuitize certain pension plan obligations. During fiscal year 2024, we also reduced income tax expense by $18.4 million related to a U.S. tax benefit that was generated as a result of the Carpenter Additive restructuring actions.

Net Sales

Net sales for fiscal year 2024 were $2,759.7 million, which represents an 8 percent increase from fiscal year 2023. Excluding surcharge revenue, sales were 17 percent higher than fiscal year 2023 on 4 percent lower volume. The results reflect double-digit sales growth across Aerospace and Defense, Medical and Energy end-use markets versus the prior year period driven by realized price increases and improved product mix.

Geographically, domestic net sales increased 4 percent from fiscal year 2023. Excluding surcharge revenue, domestic sales increased 15 percent driven by stronger demand in the end-use markets of Aerospace and Defense, Medical and Energy Net sales outside the United States increased 14 percent from fiscal year 2023 to $1,136.7 million for fiscal year 2024. Excluding surcharge revenue, sales outside the United States increased 21 percent, reflecting stronger demand in the end-use markets of Aerospace and Defense, Medical and Energy in the European and Asia Pacific regions compared to fiscal year 2023. 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 $1.9 million increase in sales during fiscal year 2024 compared to fiscal year 2023. International sales as a percentage of our total net sales represented 41 percent and 39 percent for fiscal year 2024 and fiscal year 2023, respectively.

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Sales by End-Use Markets

We sell to customers across diversified end-use markets. We believe that net sales by end-use markets 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, which includes surcharge revenue, by principal end-use markets:

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 end-use market increased 19 percent from fiscal year 2023 to $1,538.8 million. Excluding surcharge revenue, sales increased 30 percent on 11 percent higher shipment volume. The fiscal year 2024 results reflect increases across nearly all Aerospace end-use sub-markets. This was driven by increased demand in the aerospace supply chain due to continued higher aircraft build rates to replace aging fleets and to meet increasing passenger travel demand and to realize fuel efficiency new aircrafts can achieve. The fiscal year 2023 results reflected increases across all Aerospace end-use sub-markets. This was driven by ramping activity levels across the aerospace supply chain due to higher aircraft build rates to replace aging fleets and to meet increasing passenger travel demand.

Sales to the Medical end-use market increased 25 percent to $375.6 million from fiscal year 2023. Excluding surcharge revenue, sales increased 31 percent on 14 percent higher shipment volume. The fiscal year 2024 results reflect higher demand across all applications as the medical supply chain replenishes inventory levels to meet higher patient demand for elective medical procedures.

Transportation end-use market sales of $149.1 million reflected a 19 percent decrease from fiscal year 2023. Excluding surcharge revenue, sales decreased 11 percent on 23 percent lower shipment volume. The results reflect lower demand across light, medium and heavy-duty vehicle applications offset partially by higher demand in specialty transportation applications compared to fiscal year 2023. The fiscal year 2024 results also reflect the negative impact of employee union strikes in North America which did not occur in fiscal year 2023.

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Sales to the Energy end-use market of $185.8 million reflected a 14 percent increase from fiscal year 2023. Excluding surcharge revenue, sales increased 25 percent on 12 percent higher shipment volume. The fiscal year 2024 results reflect increasing global oil consumption benefiting the oil and gas sub-market and higher demand for power generation materials compared to fiscal year 2023.

Industrial and Consumer end-use market sales of $415.3 million decreased 15 percent from fiscal year 2023. Excluding surcharge revenue, sales decreased 6 percent on 26 percent lower shipment volume. The fiscal year 2024 results reflect lower demand in both Industrial and Consumer end-use markets partially offset by realized price increases compared to fiscal year 2023.

Gross Profit

Gross profit in fiscal year 2024 increased to $584.3 million, or 21.2 percent of net sales, from $337.3 million, or 13.2 percent of net sales for fiscal year 2023. The fiscal year 2024 results reflect 8 percent increased sales with a stronger product mix driven by higher prices and improved operational efficiencies, partially offset by inflationary cost increases compared to fiscal year 2023. Excluding the impact of surcharge revenue, our adjusted gross margin in fiscal year 2024 was 27.0 percent. This compares to adjusted gross margin of 18.3 percent in fiscal year 2023.

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. 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 2024 were $230.2 million, or 8.3 percent of net sales (10.6 percent of net sales excluding surcharge revenue), compared to $204.2 million, or 8.0 percent of net sales (11.0 percent of net sales excluding surcharge revenue), in fiscal year 2023. The higher selling, general and administrative expenses in fiscal year 2024 reflect higher variable compensation charges compared to fiscal year 2023.

Restructuring and Asset Impairment Charges

During fiscal year 2024, restructuring and asset impairment charges were $16.9 million, compared to no restructuring and asset impairment charges in fiscal year 2023. Restructuring activities were a result of actions taken to streamline operations in our Carpenter Additive business in the PEP segment during fiscal year 2024. This included $15.8 million of noncash pre-tax impairment charges related to $8.8 million of property, plant, equipment and software and $7.0 million associated with a certain definite lived intangible asset.

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Goodwill Impairment Charge

During fiscal year 2024, we identified an impairment triggering event in the Latrobe Distribution reporting unit within the PEP segment related to a decline in customer ordering patterns. This combined with market headwinds due to general industrial macroeconomic conditions including rising interest rates has contributed to lower sales and profit margins compared to the established annual operation plan for fiscal year 2024. Despite our efforts to mitigate the market challenges, results did not improve for the Latrobe Distribution reporting unit during fiscal year 2024. In light of these market conditions at the time, the pace of growth in the future projections for the Latrobe Distribution reporting unit were lowered. We determined the goodwill associated with the Latrobe Distribution reporting unit was impaired and recorded an impairment charge of $14.1 million during the third quarter of fiscal year 2024, which represented the entire balance of goodwill for this reporting unit. No goodwill impairment charges were recognized during fiscal year 2023.

Operating Income

Our operating income in fiscal year 2024 was $323.1 million, or 11.7 percent of net sales, as compared with $133.1 million of operating income, or 5.2 percent of net sales, in fiscal year 2023. Excluding surcharge revenue and special items, adjusted operating income was $354.1 million or adjusted operating margin of 16.3 percent for fiscal year 2024 and 7.2 percent for fiscal year 2023. Results for fiscal year 2024 reflect ongoing improvement in product mix, higher realized prices, as well as expanded operating efficiencies compared to fiscal year 2023. Our fiscal year 2023 operating results reflected higher sales in key end-use markets, increased productivity at our facilities, improved product mix and realized price increases.

Special items included in fiscal year 2024 operating income include a noncash goodwill impairment charge of $14.1 million related to the Latrobe Distribution reporting unit in the PEP segment and restructuring and asset impairment charges of $16.9 million as a result of actions taken to streamline operations in the Carpenter Additive business.

The following presents our operating income and operating margin, in each case excluding the impact of surcharge on net sales and 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

Fiscal year 2024 interest expense, net was $51.0 million compared to $54.1 million in fiscal year 2023. Capitalized interest reduced interest expense by $1.6 million for fiscal year 2024 and by $1.5 million in fiscal year 2023. The lower interest expense, net in fiscal year 2024 is largely due to less short-term borrowings under our Credit Facility compared to fiscal year 2023.

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Other Expense, Net

Other expense, net for fiscal year 2024 was $60.5 million compared with other expense, net of $6.5 million in fiscal year 2023. Fiscal year 2024 reflects $14.4 million of expense from pension earnings, interest and deferrals compared to $10.0 million of expense from pension earnings, interest and deferrals in fiscal year 2023, driven by lower than expected returns on plan assets. The results for fiscal year 2024 also include a noncash pension settlement charge of $51.9 million.

Income Taxes

Our effective tax rate (income tax expense (benefit) as a percent of income (loss) before taxes) for fiscal year 2024 was 11.9 percent as compared to 22.2 percent for fiscal year 2023. The fiscal year 2024 tax expense includes $18.4 million for U.S. tax benefits related to the closure of Carpenter Additive operations in the United Kingdom, $12.4 million associated with the pension settlement charge and $6.8 million attributable to employee share-based compensation. Tax expense also reflects the unfavorable impacts of the $14.1 million non-deductible goodwill impairment charge, $16.9 million non-deductible restructuring charges and losses in certain foreign jurisdictions for which no tax benefit can be recognized. Excluding the tax impact of the pension settlement charge, non-deductible goodwill impairment charge, restructuring charges and tax benefits related to the closure of the Carpenter Additive operations in the United Kingdom, the rate for fiscal year 2024 would have been 19.0 percent.

The fiscal year 2023 tax expense included the unfavorable impacts of losses in certain foreign jurisdictions for which no tax benefit can be recognized as well as tax charges of $0.3 million for the impact of a state tax legislative change and $0.4 million resulting from changes in our prior year tax positions. Also included were tax benefits of $1.0 million for anticipated interest on IRS income tax refund claims and $0.9 million for decreases in state valuation allowances for deferred tax assets resulting from changes in our ability to utilize certain state net operating loss carryforwards.

On October 8, 2021, the Organization for Economic Co-operation and Development ("OECD") released a statement on the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting, which agreed to a two-pillar solution to address tax challenges of the digital economy. On December 20, 2021, the OECD released Pillar Two model rules defining a 15 percent global minimum tax rate for large multinational corporations. The OECD continues to release additional guidance and countries are implementing legislation with widespread adoption of the Pillar Two Framework expected by calendar year 2024. We are continuing to evaluate the Pillar Two Framework and its potential impact on future periods.

We assert that substantially all undistributed earnings from foreign subsidiaries are not 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 17 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 19 to the consolidated financial statements included in Item 8. "Financial Statements and Supplementary Data."

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

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

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The following table includes comparative information for our 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 2024 for the SAO segment increased 10 percent to $2,443.8 million, as compared with $2,213.6 million in fiscal year 2023. Excluding surcharge revenue, net sales increased 22 percent on 2 percent lower shipment volume as compared to fiscal year 2023. The higher sales excluding surcharge revenue in the SAO segment reflect double-digit percentage growth in the end-use markets of Aerospace and Defense, Medical and Energy driven by productivity gains, stronger product mix and pricing actions compared to fiscal year 2023.

Operating income for the SAO segment in fiscal year 2024 was $408.5 million, or 16.7 percent of net sales (21.8 percent of net sales excluding surcharge revenue), compared to operating income of $179.1 million, or 8.1 percent of net sales (11.6 percent of net sales excluding surcharge revenue), for fiscal year 2023. Fiscal year 2024 reflects stronger product mix and improved operational efficiencies, partially offset by inflationary cost increases compared to fiscal year 2023.

Performance Engineered Products Segment

Net sales for fiscal year 2024 for the PEP segment were $411.0 million as compared with $433.7 million for fiscal year 2023. Excluding surcharge revenue, net sales decreased 5 percent from fiscal year 2023 on 15 percent lower shipment volume. The results reflect higher sales in Aerospace and Defense and Medical end-use markets, in particular Medical end-use market sales excluding surcharge increased 17 percent compared to fiscal year 2023.

Operating income for the PEP segment for fiscal year 2024 was $36.0 million, or 8.8 percent of net sales (9.5 percent of net sales excluding surcharge revenue), as compared with operating income of $31.8 million, or 7.3 percent of net sales (8.0 percent of net sales excluding surcharge revenue) for fiscal year 2023. Fiscal year 2024 results reflect stronger product mix and improved operational efficiencies, partially offset by inflationary cost increases compared to fiscal year 2023.

Results of Operations — Fiscal Year 2023 Compared to Fiscal Year 2022

For fiscal year 2023, we reported net income of $56.4 million, or $1.14 earnings per diluted share. This compares with net loss of $49.1 million, or $1.01 loss per diluted share in fiscal year 2022. There were no reported special items for fiscal year 2023. Excluding special items for fiscal year 2022, loss per share would have been $1.06. The results for fiscal year 2023 compared to fiscal year 2022 were driven by growing demand across all our end-use markets, increased productivity at our facilities, improved product mix and realized price increases.

Special items included in our fiscal year 2022 results included negative impacts from 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 benefits related to COVID-19 employee retention credits of $12.7 million and an acquisition-related contingent liability release of $4.7 million.

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Net Sales

Net sales for fiscal year 2023 were $2,550.3 million, which represents a 39 percent increase from fiscal year 2022. Excluding surcharge revenue, sales were 32 percent higher than fiscal year 2022 on 14 percent higher volume. The results reflect double-digit sales growth across Aerospace and Defense, Medical, Energy and Industrial and Consumer end-use markets versus the prior year period.

Geographically, sales outside the United States increased 51 percent from fiscal year 2022 to $994.1 million. The increase was due to higher product demand in all regions and in all end-use markets except Distribution. In particular, Aerospace and Defense outside the United States increased 89 percent. 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 $5.8 million decrease in sales during fiscal year 2023 compared to fiscal year 2022. International sales as a percentage of our total net sales represented 39 percent and 36 percent for fiscal year 2023 and fiscal year 2022, respectively.

Sales by End-Use Markets

We sell to customers across diversified end-use markets. We believe this is helpful supplemental information in analyzing performance of the business from period to period. The following table includes comparative information for our net sales, which includes surcharge revenue, by principal end-use markets:

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

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Sales to the Aerospace and Defense end-use market increased 63 percent from fiscal year 2022 to $1,290.7 million. Excluding surcharge revenue, sales increased 53 percent on 34 percent higher shipment volume. The fiscal year 2023 results reflect increases across all Aerospace end-use sub-markets. This was driven by ramping activity levels across the aerospace supply chain due to higher aircraft build rates to replace aging fleets and meet increasing passenger travel demand. The fiscal year 2022 results reflected short-term operational challenges associated with the Reading press outage and labor shortages.

Sales to the Medical end-use market increased 42 percent to $301.6 million from fiscal year 2022. Excluding surcharge revenue, sales increased 36 percent on 30 percent higher shipment volume. The fiscal year 2023 results reflect higher demand across all applications as the medical supply chain replenishes inventory levels to meet higher patient demand for elective medical procedures.

Transportation end-use market sales of $185.0 million reflected a 4 percent increase from fiscal year 2022. Excluding surcharge revenue, sales decreased 3 percent on 20 percent lower shipment volume. The fiscal year 2023 results reflect an improved mix from recent price increases, particularly in light-duty vehicle applications, offset by reduced medium and heavy-duty build rates compared to fiscal year 2022.

Sales to the Energy end-use market of $163.3 million reflected a 45 percent increase from fiscal year 2022. Excluding surcharge revenue, sales increased 37 percent on 35 percent higher shipment volume. The fiscal year 2023 results reflect increasing global rig counts and higher oil prices benefiting the oil and gas sub-market along with slightly higher demand for power generation materials compared to fiscal year 2022.

Industrial and Consumer end-use market sales of $487.2 million increased 17 percent from fiscal year 2022. Excluding surcharge revenue, sales increased 14 percent on 1 percent lower shipment volume. The fiscal year 2023 results reflect stronger product mix, higher demand for semiconductor materials and increased sales in the electronic sub-market.

Gross Profit

Gross profit in fiscal year 2023 increased to $337.3 million, or 13.2 percent of net sales, from $149.8 million, or 8.2 percent of net sales for fiscal year 2022. The fiscal year 2023 results reflect the impact of higher volumes across key end-use markets with 39 percent increased net sales, a stronger product mix, higher prices and improved operational efficiencies, partially offset by inflationary cost increases compared to fiscal year 2022. Excluding the impact of surcharge revenue, our adjusted gross margin in fiscal year 2023 was 18.3 percent. This compares to adjusted gross margin of 9.9 percent in fiscal year 2022 after excluding the impact of surcharge revenue and COVID-19 employee retention credits of $11.9 million.

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.

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Selling, General and Administrative Expenses

Selling, general and administrative expenses in fiscal year 2023 were $204.2 million, or 8.0 percent of net sales (11.0 percent of net sales excluding surcharge revenue), compared to $174.7 million, or 9.5 percent of net sales (12.5 percent of net sales excluding surcharge revenue), in fiscal year 2022. The higher selling, general and administrative expenses in fiscal year 2023 reflect higher variable compensation charges compared to fiscal year 2022. Fiscal year 2022 included a noncash benefit of $4.7 million from the reversal of a contingent liability associated with a historical acquisition for which the time period expired. Partially offsetting this benefit in fiscal year 2022 was an environmental charge of $2.4 million which represents a historical environmental site liability.

Operating Income (Loss)

Our operating income in fiscal year 2023 was $133.1 million, or 5.2 percent of net sales, as compared with $24.9 million of operating loss, or negative 1.4 percent of net sales in fiscal year 2022. Excluding surcharge revenue and special items, adjusted operating margin was 7.2 percent for fiscal year 2023 and negative 2.4 percent for fiscal year 2022. Results for fiscal year 2023 reflect higher sales in key end-use markets compared to fiscal year 2022, increased productivity at our facilities, improved product mix and realized price increases. 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.

The following presents our operating income (loss) and operating margin, in each case excluding the impact of surcharge on net sales and 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 2023 interest expense, net was $54.1 million compared to $44.9 million in fiscal year 2022. Capitalized interest reduced interest expense by $1.5 million for fiscal year 2023 and by $0.8 million in fiscal year 2022. Debt extinguishment losses, net in fiscal year 2023 were $0.0 million. Debt extinguishment losses, net in fiscal year 2022 were $6.0 million due to debt prepayment costs made in connection with the notes due in March 2023. The higher interest expense in fiscal year 2023 is largely due to higher interest rates on debt that was refinanced and short-term borrowings under our Credit Facility.

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Other Expense (Income), Net

Other expense, net for fiscal year 2023 was $6.5 million compared with other income, net of $12.7 million in fiscal year 2022. The fiscal year 2023 reflects expense from pension earnings, interest and deferrals compared to income from pension earnings, interest and deferrals from favorable returns on plan assets in fiscal year 2022.

Income Taxes

Our effective tax rate (income tax expense (benefit) as a percent of income (loss) before taxes) for fiscal year 2023 was 22.2 percent which was the same as 22.2 percent for fiscal year 2022. The fiscal year 2023 tax expense includes the unfavorable impacts of losses in certain foreign justifications for which no tax benefit can be recognized as well as tax charges of $0.3 million for the impact of a state tax legislative change and $0.4 million resulting from changes in our prior year tax positions. Also included are tax benefits of $1.0 million for anticipated interest on Internal Revenue Service ("IRS") income tax refund claims and $0.9 million for decreases in state valuation allowances for deferred tax assets resulting from changes in our ability to utilize certain state net operating loss carryforwards. The fiscal year 2022 tax benefit included the unfavorable impacts of losses in certain foreign jurisdictions for which no tax benefit can be recognized.

Business Segment Results

Summary information about our operating results on a segment basis is set forth below. For more detailed segment information, see Note 19 to the consolidated financial statements included in Item 8. "Financial Statements and Supplementary Data."

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

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

The following table includes comparative information for our 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 2023 for the SAO segment increased 41 percent to $2,213.6 million, as compared with $1,565.6 million in fiscal year 2022. Excluding surcharge revenue, net sales increased 35 percent from fiscal year 2022 on 13 percent higher shipment volume. The SAO segment results reflect higher sales in all end-use markets except Transportation compared to fiscal year 2022. In particular, Aerospace and Defense sales excluding surcharge increased 54 percent as compared to fiscal year 2022.

Operating income for the SAO segment in fiscal year 2023 was $179.1 million, or 8.1 percent of net sales (11.6 percent of net sales excluding surcharge revenue), compared to operating income of $9.6 million, or 0.6 percent of net sales (0.8 percent of net sales excluding surcharge revenue), for fiscal year 2022. Fiscal year 2023 reflects increased productivity, improved product mix and realized price increases. Fiscal year 2022 included a benefit of $10.6 million related to COVID-19 employee retention credits offset by COVID-19 related costs of $5.2 million.

Performance Engineered Products Segment

Net sales for fiscal year 2023 for the PEP segment were $433.7 million as compared with $344.5 million for fiscal year 2022. Excluding surcharge revenue, net sales increased 18 percent from a year ago on 11 percent higher shipment volume. The fiscal year 2023 net sales reflect 11 percent higher shipment volume as compared to fiscal year 2022. The results reflect higher sales in all end-use markets except Distribution. In particular, Medical end-use market sales excluding surcharge increased 32 percent.

Operating income for the PEP segment for fiscal year 2023 was $31.8 million, or 7.3 percent of net sales (8.0 percent of net sales excluding surcharge revenue), as compared with operating income of $18.1 million, or 5.3 percent of net sales for fiscal year 2022. Fiscal year 2023 results reflect stronger demand conditions compared to fiscal year 2022. Fiscal year 2022 included a benefit of $2.1 million related to COVID-19 employee retention credits offset by COVID-19 related costs of $0.7 million.

Liquidity and Financial Resources

During fiscal year 2024, we generated cash from operating activities of $274.9 million as compared with $14.7 million in fiscal year 2023. Our adjusted free cash flow, which we define under "Non-GAAP Financial Measures" below, was positive $179.0 million as compared to negative $67.6 million for fiscal year 2023. The change in operating cash flow and adjusted free cash flow in fiscal year 2024 primarily reflects the impact of higher earnings after noncash adjustments to net income and lower cash used for inventory compared to a year ago. The current year reflects cash used to build inventory of $96.7 million compared to $140.3 million in fiscal year 2023. The adjusted free cash flow results also reflect lower capital spending levels in the current period as compared to the prior year period.

Capital expenditures for property, plant, equipment and software were $96.6 million for fiscal year 2024 as compared to $82.3 million for fiscal year 2023. In fiscal year 2025, we expect capital expenditures to be approximately $125 million.

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 2024 were $40.0 million, as compared to $39.4 million in the prior year period. In fiscal years 2024, 2023 and 2022 we declared and paid quarterly cash dividends of $0.20 per share. Additionally, we will discretionarily use excess cash for a recently approved share repurchase program up to $400.0 million of our outstanding common stock. The primary use of this program will be to offset dilution.

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During fiscal year 2024, we made $11.3 million of pension contributions to our qualified defined benefit pension plans. Over the next five years, current estimates indicate that we will be required to make approximately $128.7 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, 2024, and subject to market returns and interest rate assumptions.

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 $150.0 million, consisting of cash and cash equivalents added to available borrowing capacity under our Credit Facility.

On April 14, 2023, we entered into a Second Amended and Restated Credit Agreement with Bank of America, N.A., as administrative agent, swing line lender and letter of credit issuer and the other lenders, agents and arrangers party thereto (the "Credit Facility"). The Credit Facility amended and restated our then existing Amended and Restated Credit Agreement dated as of March 26, 2021 which had been set to expire on March 31, 2024. The Credit Facility extends the maturity to April 12, 2028.

The Credit Facility is a secured revolving credit facility with a commitment of $350.0 million subject to our right, from time to time, to request an increase of the commitment by the greater of (i) $300.0 million or (ii) an amount equal to our consolidated EBITDA; 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.

As of June 30, 2024, the borrowing rate for the Credit Facility was 7.09%, however we had no short-term borrowings. As of June 30, 2024, we had $1.2 million of issued letters of credit under the Credit Facility and the balance of the Credit Facility, $348.8 million, remains available to us. From time to time during the fiscal year ended June 30, 2024, we borrowed under our Credit Facility. The weighted average daily borrowing under the Credit Facility during the fiscal year ended June 30, 2024 was approximately $19.1 million with daily outstanding borrowings ranging from $0.0 million to $67.8 million.

We believe that our total liquidity of $547.9 million, as of June 30, 2024, which includes cash and cash equivalents of $199.1 million and available borrowing capacity of $348.8 million under the Credit Facility, will be sufficient to fund our cash needs over the foreseeable future.

As of June 30, 2024, we had cash and cash equivalents of $22.0 million held at various foreign subsidiaries. Our global cash deployment considers, among other things, the geographic and institutional 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, 2024, we repatriated cash of $4.3 million from foreign jurisdictions. From time to time, we may make short-term intercompany borrowings against our cash held outside the United States in order to reduce or eliminate any required borrowing under our Credit Facility.

We are subject to certain financial and restrictive covenants under the Credit Facility which requires the maintenance of a minimum interest coverage ratio of 3.00 to 1.00 and a consolidated net leverage ratio of no more than 4.00 to 1.00. The restrictions of these covenants (other than the financial ratio covenants) are subject to certain exceptions or threshold triggering amounts or events specified in the Credit Facility, and in some cases the restrictions may be waived by the lenders. As of June 30, 2024, 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, 2024:

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.

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Non-GAAP Financial Measures

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

Net Sales and Gross Margin Excluding Surcharge Revenue

This report includes discussions of net sales as adjusted to exclude the impact of raw material surcharge and the resulting impact on gross margins, which represent financial measures that have not been determined in accordance with accounting principles generally accepted 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. Management uses its results excluding these amounts to evaluate its operating performance and to discuss its business with investment institutions, our Board of Directors and others. See our earlier discussion of "Gross Profit" for a reconciliation of net sales and gross margin, excluding surcharge revenue, to net sales as determined in accordance with U.S. GAAP. Net sales and gross margin excluding surcharge revenue 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.

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

This report includes discussions of operating income (loss) 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 income (loss) for a reconciliation of adjusted operating income (loss) and adjusted operating margin excluding special items to operating income (loss) and operating margin determined in accordance with U.S. GAAP. Adjusted operating income (loss) and adjusted operating margin excluding surcharge revenue and special items are not U.S. GAAP financial measures and should not be considered in isolation of, or as a substitute for, operating income (loss) and operating margin calculated in accordance with U.S. GAAP.

Adjusted Earnings Per Share

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

* Impact per diluted share calculated using weighted average common shares outstanding of 50.3 million for the fiscal year ended June 30, 2024.

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* Impact per diluted share calculated using weighted average common shares outstanding of 49.2 million for the fiscal year ended June 30, 2023.

Management believes that the presentation of earnings 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 earnings per share is not a U.S. GAAP financial measure and should not be considered in isolation of, or as a substitute for, earnings per share calculated in accordance with U.S. GAAP.

Adjusted Free Cash Flow

This report includes discussions of adjusted free cash flow which is a non-GAAP financial measure and may not be comparable to adjusted free cash flow reported by other companies. The following provides a reconciliation of adjusted free cash flow, as used in this Annual Report, to its most directly comparable U.S. GAAP financial measure:

Management believes that the presentation of adjusted 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. Additionally, we will discretionarily use excess cash for a recently approved share repurchase program up to $400.0 million of our outstanding common stock. The primary use of this program will be to offset dilution. Adjusted 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.

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

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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, 2024 and 2023, $152.2 million and $133.2 million of inventory, respectively, was accounted for using a method other than the LIFO method. If the FIFO method of inventory had been used instead of the LIFO method, inventories would have been $371.0 million and $517.2 million higher as of June 30, 2024 and 2023, respectively.

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.

Pension and Other Postretirement Benefits

The amount of net pension expense (income), 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 BondLink 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 expense (income) would change by $1.4 million. If the discount rate was changed by 0.25 percent, the net pension expense (income) 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.

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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.

As of June 30, 2024, we have two reporting units with goodwill recorded. Goodwill associated with the SAO reporting unit as of June 30, 2024, was $195.5 million and represents 86 percent of total goodwill as of June 30, 2024. The remaining goodwill recorded as of June 30, 2024 of $31.8 million is associated with the Dynamet reporting unit in the PEP segment. The fair value for both reporting units is estimated using a weighting of discounted cash flows and the use of market multiples valuation techniques.

In preparing the financial statements for the quarter ended March 31, 2024, we identified an impairment triggering event in the Latrobe Distribution reporting unit within the PEP segment related to a decline in customer ordering patterns. This combined with market headwinds due to general industrial macroeconomic conditions including rising interest rates has contributed to lower sales and profit margins compared to the established annual operation plan for fiscal year 2024. Despite the efforts we made to mitigate the market challenges, results had not improved for the Latrobe Distribution reporting unit during the quarter ended March 31, 2024. In light of these market conditions at the time, the pace of growth in the future projections for Latrobe Distribution reporting unit were lowered.

We determined the goodwill associated with the Latrobe Distribution reporting unit was impaired and recorded an impairment charge of $14.1 million during the quarter ended March 31, 2024, which represented the entire balance of goodwill. The fair value was 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, 2024, the fair value of the SAO reporting unit exceeded the carrying value by 203 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, 2024, the SAO reporting unit would have a fair value that exceeded the carrying value by approximately 196 percent.

Goodwill associated with the PEP segment is tested at the Dynamet reporting unit level. As of June 1, 2024, the fair value of the Dynamet reporting unit exceeded the carrying value by 144 percent. For purposes of the discounted cash flow analysis for Dynamet'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, 2024, the Dynamet reporting unit would have a fair value that exceeded the carrying value by approximately 140 percent.

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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.

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 the 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 the 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 the Company'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 with a discount rate of approximately 6 percent as of June 30, 2024 and approximately 5 percent as of June 30, 2023.

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 expense (income), net.

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 Technology Corporation.

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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. We accrue amounts for environmental remediation costs that represent our best estimate of the probable and reasonably estimable future costs related to environmental remediation. 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. 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, 2024 and 2023 were $17.3 million and $16.5 million, respectively.

In December 1997, we were named as a party in a Landfill Settlement Agreement related to a third-party Superfund waste-disposal site. As a result of this Agreement, we were obligated to reimburse the settling work defendants for capital expenditure costs as they were incurred, which was prior to fiscal year 2022. During fiscal year 2022, we recorded a $2.4 million liability related to these costs. During fiscal year 2023, we paid the liability related to the prior capital expenditure costs and incurred minimal additional costs related to ongoing studies. We expect to incur additional claims as a result of this ongoing study that cannot be quantified at this time.

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 and regulations, personal injury claims and tax issues. Like many other manufacturing companies in recent years we, from time to time, have been named as a defendant in lawsuits alleging personal injury as a result of exposure to chemicals and substances in the workplace such as asbestos. We provide for costs relating to these matters when a loss is probable and the amount of the loss is reasonably estimable. The effect of the outcome of these matters on our future results of operations and liquidity cannot be predicted because any such effect depends on future results of operations and the amount and timing (both as to recording future charges to operations and cash expenditures) of the resolution of such matters. While it is not feasible to determine the outcome of these matters, we believe that the total liability from these matters will not have a material effect on our financial position, results of operations or cash flows over the long-term. However, there can be no assurance that an increase in the scope of pending matters or that any future lawsuits, claims, proceedings or investigations will not be material to our financial position, results of operations or cash flows in a particular future quarter or year.

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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 and interest 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 a qualified workforce and 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) the impact of potential cyber attacks and information technology or data security breaches; (17) the ability of suppliers to meet obligations due to supply chain disruptions or otherwise; (18) the ability to meet increased demand, production targets or commitments; (19) the ability to manage the impacts of natural disasters, climate change, pandemics and outbreaks of contagious diseases and other adverse public health developments; and (20) geopolitical, economic, and regulatory risks relating to our global business, including geopolitical and diplomatic tensions, instabilities and conflicts, such as the war in Ukraine, the war between Israel and HAMAS, and Houthi attacks on commercial shipping vessels and other naval vessels as well as compliance with U.S. and foreign trade and tax laws, sanctions, embargoes and other regulations. 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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