☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
or
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 1-5828
CARPENTER TECHNOLOGY CORPORATION
(Exact name of Registrant as specified in its Charter)
Delaware
23-0458500
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
1735 Market Street
15th Floor
19103
Philadelphia
Pennsylvania
(Address of principal executive offices)
(Zip Code)
610-208-2000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $5 Par Value
CRS
New York Stock Exchange
Title of each class
Trading Symbol
Name of each exchange on which registered
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files. Yes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
(Do not check if a smaller reporting company)
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☒
The number of shares outstanding of the issuer’s common stock as of October 16, 2019 was 47,720,105.
Common stock — authorized 100,000,000 shares; issued 55,969,677 shares at September 30, 2019 and 55,808,743 shares at June 30, 2019; outstanding 47,719,523 shares at September 30, 2019 and 47,470,363 shares at June 30, 2019
279.8
279.0
Capital in excess of par value
317.5
320.4
Reinvested earnings
1,636.8
1,605.3
Common stock in treasury (8,250,154 shares and 8,338,380 shares at September 30, 2019 and June 30, 2019, respectively), at cost
(329.5
)
(332.8
)
Accumulated other comprehensive loss
(327.6
)
(351.8
)
Total stockholders' equity
1,577.0
1,520.1
Total liabilities and stockholders' equity
$
3,341.5
$
3,187.8
See accompanying notes to consolidated financial statements.
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting of normal and recurring adjustments, considered necessary for a fair statement of the results are reflected in the interim periods presented. The June 30, 2019 consolidated balance sheet data was derived from audited financial statements, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in Carpenter’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019 (the “2019 Form 10-K”). Operating results for the three months ended September 30, 2019 are not necessarily indicative of the operating results for any future period.
As used throughout this report, unless the context requires otherwise, the terms “Carpenter”, "Carpenter Technology", the “Company”, “Registrant”, “Issuer”, “we” and “our” refer to Carpenter Technology Corporation.
2.
Recent Accounting Pronouncements
Recently Issued Accounting Pronouncements - Adopted in current period
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-02 Leases (Topic 842) which improves transparency and comparability among companies by recognizing lease assets and lease liabilities on the balance sheet and by disclosing key information about leasing arrangements. ASU 2016-02 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2018, with early adoption permitted. The Company adopted the provisions of ASU 2016-02 in the first quarter of fiscal year 2020 using the modified retrospective transition method, which did not require the Company to adjust comparative periods. Operating leases are included in other assets, accrued liabilities (current) and other liabilities (long-term) on the consolidated balance sheets. The Company’s right-of-use assets ("ROU") and lease liabilities are recognized on the lease commencement date in an amount that represents the present value of future lease payments. Upon adoption of the new lease guidance, the Company recorded a ROU and lease liability on the consolidated balance sheets for several types of operating leases, including land and buildings, equipment (e.g. trucks and forklifts), vehicles and computer equipment. The adoption of the standard had no impact on the Consolidated Statements of Income or the Consolidated Statements of Cash Flows. There was no cumulative effect of adopting the standard at the date of initial application in reinvested earnings.
The Company elected the package of practical expedients included in this guidance, which allowed it to not reassess: (i) whether any expired or existing contracts contain leases; (ii) the lease classification for any expired or existing leases; and, (iii) the initial direct costs for existing leases. The Company has elected the practical expedient to not separate lease components from nonlease components for all asset classes. The Company will recognize lease expense in the consolidated statements of operations on a straight-line basis over the lease term. The Company also made a policy election to not recognize ROU assets and lease liabilities for short-term leases with an initial term of 12 months or less for all asset classes. Leases with the option to extend their term or terminate early are reflected in the lease term when it is reasonably certain that the Company will exercise such options. The Company has expanded the disclosure of operating leases included in Note 11.
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income (loss) to reinvested earnings for standard tax effects resulting from the Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018. ASU 2018-02 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2018, with early adoption permitted. The Company adopted the provisions of ASU 2018-02 in the first quarter of fiscal year 2020. The adoption of ASU 2018-02 did not materially impact the consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal - Use Software (Subtopic 350-40) - Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract, to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement. ASU 2018-15 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2019, with early adoption permitted. The Company early adopted the provisions of ASU 2018-15 in the first quarter of fiscal year 2020 and elected the prospective adoption method. The adoption of ASU 2018-15 did not materially impact the consolidated financial statements.
At this time there are no issued pronouncements pending adoption that would materially impact the Company.
3.
Revenue
The Company recognizes revenue in accordance with Topic 606, Revenue from Contracts. The Company applies the five-step model in the FASB’s guidance, which requires the Company to: (i) identify the contract with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when, or as, the Company satisfies a performance obligation.
The Company recognizes revenue when performance obligations under the terms of a customer purchase order or contract are satisfied. This occurs when control of the goods and services has transferred to the customer, which is generally determined when title, ownership, and risk of loss pass to the customer, all of which occurs upon shipment or delivery of the product or the service is performed. Consignment transactions are arrangements where the Company transfers product to a customer location but retains ownership and control of such product until it is used by the customer. Revenue for consignment arrangements is recognized upon usage by the customer. Service revenue is recognized as the services are performed.
The customer purchase order or contract for goods transferred has a single performance obligation for which revenue is recognized at a point in time. The standard terms and conditions of a customer purchase order include general rights of return and product warranty provisions related to nonconforming product. Depending on the circumstances, the product is either replaced or a quality adjustment is issued. Such warranties do not represent a separate performance obligation.
Each customer purchase order or contract sets forth the transaction price for the products and services purchased under that arrangement. Some customer arrangements include variable consideration, such as volume rebates, which generally depend upon the Company’s customers meeting specified performance criteria, such as a purchasing level over a period of time. The Company exercises judgment to estimate the most likely amount of variable consideration at each reporting date.
Revenue is measured as the amount of consideration the Company expects to receive in exchange for its product. The standard payment terms are 30 days. The Company has elected to use the practical expedient that permits a Company to not adjust for the effects of a significant financing component if it expects that at the contract inception, the period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less.
Amounts billed to customers for shipping and handling activities to fulfill the Company’s promise to transfer the goods are included in revenues and costs incurred by the Company for the delivery of goods and are classified as cost of sales in the consolidated statements of income. Shipping terms may vary for products shipped outside the United States depending on the mode of transportation, the country where the material is shipped and any agreements made with the customers.
Contract liabilities are recognized when the Company has received consideration from a customer to transfer goods or services at a future point in time when the Company performs under the purchase order or contract. Contract liabilities were $11.7 million and $10.5 million at September 30, 2019 and June 30, 2019, respectively, and are included in accrued liabilities on the consolidated balance sheets.
The Company has elected to use the practical expedient that permits the omission of disclosure for remaining performance obligations which are expected to be satisfied in one year or less.
Disaggregation of Revenue
The Company operates in two business segments, Specialty Alloys Operations (“SAO”) and Performance Engineered Products (“PEP”). Revenue is disaggregated within these two business segments by diversified end-use markets and by geographical location. Comparative information of the Company’s overall revenues by end-use markets and geography for the three months ended September 30, 2019 and 2018 were as follows:
End-Use Market Data
Three Months Ended September 30,
($ in millions)
2019
2018
Aerospace and Defense
$
353.3
$
310.7
Medical
48.9
47.0
Transportation
40.0
40.3
Energy
39.3
44.3
Industrial and Consumer
73.3
96.1
Distribution
30.6
34.0
Consolidated net sales
$
585.4
$
572.4
Geographic Data
Three Months Ended September 30,
($ in millions)
2019
2018
United States
$
384.9
$
384.0
Europe
101.5
90.0
Asia Pacific
53.4
48.6
Mexico
21.9
22.2
Canada
13.4
17.7
Other
10.3
9.9
Consolidated net sales
$
585.4
$
572.4
4.
Acquisitions
On October 22, 2018, the Company acquired all the outstanding shares of LPW Technology Ltd. (“LPW”), for a cash purchase price of $79.0 million, net of cash acquired. The acquisition combines LPW’s metal powder lifecycle management technology and processes with the Company's technical expertise in producing highly engineered metal powders and additively manufactured components. The purchase price allocation was completed in the fourth quarter of fiscal year 2019 and resulted in the purchase price being allocated to: $2.1 million of accounts receivable, $4.5 million of inventory, $0.5 million of other current assets, $11.9 million of property, plant and equipment, $11.4 million of identifiable intangible assets, $59.0 million of goodwill, $4.4 million of accounts payable, $2.5 million of current liabilities and $3.5 million of other liabilities.
5.
Earnings per Common Share
The Company calculates basic and diluted earnings per share using the two class method. Under the two class method, earnings are allocated to common stock and participating securities (non-vested restricted shares and units that receive non-forfeitable dividends) according to their participation rights in dividends and undistributed earnings. The earnings available to each class of stock are divided by the weighted average number of outstanding shares for the period in each class. Diluted earnings per share assumes the issuance of common stock for all potentially dilutive share equivalents outstanding.
The calculations of basic and diluted earnings per common share for the three months ended September 30, 2019 and 2018 were as follows:
Three Months Ended September 30,
(in millions, except per share data)
2019
2018
Net income
$
41.2
$
31.5
Less: earnings and dividends allocated to participating securities
(0.4
)
(0.3
)
Earnings available for common stockholders used in calculation of basic earnings per common share
$
40.8
$
31.2
Weighted average number of common shares outstanding, basic
47.9
47.6
Basic earnings per common share
$
0.85
$
0.66
Net income
$
41.2
$
31.5
Less: earnings and dividends allocated to participating securities
(0.4
)
(0.3
)
Earnings available for common stockholders used in calculation of diluted earnings per common share
$
40.8
$
31.2
Weighted average number of common shares outstanding, basic
47.9
47.6
Effect of shares issuable under share-based compensation plans
0.4
0.6
Weighted average number of common shares outstanding, diluted
48.3
48.2
Diluted earnings per common share
$
0.85
$
0.65
The following awards issued under share-based compensation plans were excluded from the above calculations of diluted earnings per share because their effects were anti-dilutive:
Three Months Ended September 30,
(in millions)
2019
2018
Stock options
0.8
0.1
6.
Inventories
Inventories consisted of the following components as of September 30, 2019 and June 30, 2019:
($ in millions)
September 30, 2019
June 30, 2019
Raw materials and supplies
$
194.3
$
169.8
Work in process
459.2
425.7
Finished and purchased products
184.1
192.2
Total inventory
$
837.6
$
787.7
Inventories are valued at the lower of cost or market. Cost for inventories is principally determined using the last-in, first-out (“LIFO”) inventory costing method. The Company also uses the first-in, first-out (“FIFO”) and average cost methods. As of September 30, 2019 and June 30, 2019, $179.6 million and $172.3 million of inventory, respectively, was accounted for using a method other than the LIFO inventory costing method.
Accrued liabilities consisted of the following as of September 30, 2019 and June 30, 2019:
($ in millions)
September 30, 2019
June 30, 2019
Accrued compensation and benefits
$
42.1
$
71.2
Accrued postretirement benefits
14.7
14.7
Deferred revenue
11.7
10.5
Derivative financial instruments
10.7
16.7
Current portion of lease liabilities
10.2
—
Accrued income taxes
7.0
4.2
Accrued interest expense
3.8
10.4
Accrued pension liabilities
3.4
3.4
Other
25.5
26.5
Total accrued liabilities
$
129.1
$
157.6
8.
Pension and Other Postretirement Benefits
The components of the net periodic benefit cost related to the Company’s pension and other postretirement benefits for the three months ended September 30, 2019 and 2018 were as follows:
Pension Plans
Other Postretirement Plans
Three Months Ended September 30,
Three Months Ended September 30,
($ in millions)
2019
2018
2019
2018
Service cost
$
2.4
$
2.3
$
0.7
$
0.6
Interest cost
11.7
13.2
2.3
2.5
Expected return on plan assets
(15.5
)
(16.2
)
(1.8
)
(1.7
)
Amortization of net loss
3.9
2.6
0.6
0.4
Amortization of prior service cost (benefit)
0.5
0.5
(1.0
)
(1.3
)
Net periodic benefit costs
$
3.0
$
2.4
$
0.8
$
0.5
During the three months ended September 30, 2019 and 2018, the Company made $2.4 million and $2.3 million, respectively, of contributions to its qualified defined benefit pension plans. The Company currently expects to contribute $3.8 million to its qualified defined benefit pension plans during the remainder of fiscal year 2020.
The Company maintains a $400.0 million unsecured revolving credit facility (“Credit Agreement”) that extends to March 2022. Interest on the borrowings under the Credit Agreement accrue at variable rates, based upon LIBOR or a defined “Base Rate”. Both are determined based upon the credit rating of the Company’s senior unsecured long-term debt (the “Debt Rating”). The applicablemargin to be added to LIBOR ranges from 1.00% to 1.75% (1.25% as of September 30, 2019), and for Base Rate-determined loans, from 0.00% to 0.75% (0.25% as of September 30, 2019). The Company also pays a quarterly commitment fee ranging from 0.125% to 0.400% (0.20% as of September 30, 2019), determined based upon the Debt Rating, of the unused portion of the $400.0 million commitment under the Credit Agreement. In addition, the Company must pay certain letter of credit fees, ranging from 1.00% to 1.75% (1.25% as of September 30, 2019), with respect to letters of credit issued under the Credit Agreement. The Company has the right to voluntarily prepay and re-borrow loans and to terminate or reduce the commitments under the facility. As of September 30, 2019, the Company had $5.9 million of issued letters of credit and $77.6 million of short-term borrowings under the Credit Agreement with the balance of $316.5 million available to the Company. As of September 30, 2019, the borrowing rate for the Credit Agreement was 3.30%.
The Company is subject to certain financial and restrictive covenants under the Credit Agreement, which, among other things, require the maintenance of a minimum interest coverage ratio of 3.50 to 1.00. The interest coverage ratio is defined in the Credit Agreement as, for any period, the ratio of consolidated earnings before interest, taxes, depreciation and amortization and non-cash net pension expense (“EBITDA”) to consolidated interest expense for such period. The Credit Agreement also requires the Company to maintain a debt to capital ratio of less than 55 percent. The debt to capital ratio is defined in the Credit Agreement as the ratio of consolidated indebtedness, as defined therein, to consolidated capitalization, as defined therein. As of September 30, 2019 and June 30, 2019, the Company was in compliance with all of the covenants of the Credit Agreement.
Long-term debt outstanding as of September 30, 2019 and June 30, 2019 consisted of the following:
($ in millions)
September 30, 2019
June 30, 2019
Senior unsecured notes, 5.20% due July 2021 (face value of $250.0 million at September 30, 2019 and June 30, 2019)
$
251.5
$
251.2
Senior unsecured notes, 4.45% due March 2023 (face value of $300.0 million at September 30, 2019 and June 30, 2019)
299.4
299.4
Total
550.9
550.6
Less: amounts due within one year
—
—
Long-term debt, net of current portion
$
550.9
$
550.6
For the three months ended September 30, 2019 and 2018, interest costs totaled $7.4 million and $7.2 million, respectively, of which $2.0 million and $0.9 million, respectively, were capitalized as part of the cost of property, plant, equipment and software.
The Company is subject to various federal, state, local and international environmental laws and regulations relating to pollution, protection of public health and the environment, natural resource damages and occupational safety and health. Although compliance with these laws and regulations may affect the costs of the Company’s operations, compliance costs to date have not been material. The Company has environmental remediation liabilities at some of its owned operating facilities and has been designated as a potentially responsible party (“PRP”) with respect to certain third party Superfund waste-disposal sites and other third party-owned sites. The Company accrues amounts for environmental remediation costs that represent management’s best estimate of the probable and reasonably estimable future costs related to environmental remediation. During the three months ended September 30, 2019, the Company decreased the liability for a company-owned former operating site by $0.2 million. The liabilities recorded for environmental remediation costs at Superfund sites, other third party-owned sites and Carpenter-owned current or former operating facilities remaining at September 30, 2019 and June 30, 2019 were $15.9 million and $16.1 million, respectively. Additionally, the Company has been notified that it may be a PRP with respect to other Superfund sites as to which no proceedings have been instituted against the Company. Neither the exact amount of remediation costs nor the final method of their allocation among all designated PRPs at these Superfund sites have been determined. Accordingly, at this time, the Company cannot reasonably estimate expected costs for such matters. The liability for future environmental remediation costs that can be reasonably estimated is evaluated by management on a quarterly basis.
Estimates of the amount and timing of future costs of environmental remediation requirements are inherently imprecise because of the continuing evolution of environmental laws and regulatory requirements, the availability and application of technology, the identification of currently unknown remediation sites and the allocation of costs among the PRPs. Based upon information currently available, such future costs are not expected to have a material effect on the Company's financial position, results of operations or cash flows over the long-term. However, such costs could be material to the Company's financial position, results of operations or cash flows in a particular future quarter or year.
Other
The Company is defending various routine claims and legal actions that are incidental to its business and common to its operations, including those pertaining to product claims, commercial disputes, patent infringement, employment actions, employee benefits, compliance with domestic and foreign laws, personal injury claims and tax issues. Like many other manufacturing companies in recent years, the Company, from time to time, has been named as a defendant in lawsuits alleging personal injury as a result of exposure to chemicals and substances in the workplace such as asbestos. The Company provides for costs relating to these matters when a loss is probable and the amount of the loss is reasonably estimable. The effect of the outcome of these matters on the Company’s future results of operations and liquidity cannot be predicted because any such effect depends on future results of operations and the amount and timing (both as to recording future charges to operations and cash expenditures) of the resolution of such matters. While it is not feasible to determine the outcome of these matters, management believes that the total liability from these matters will not have a material effect on the Company’s financial position, results of operations or cash flows over the long-term. However, there can be no assurance that an increase in the scope of pending matters or that any future lawsuits, claims, proceedings or investigations will not be material to the Company’s financial position, results of operations or cash flows in a particular future quarter or year.
11.
Leases
As a result of adoption of ASU 2016-02, Leases, the Company recorded ROU assets and operating lease liabilities, each in the amount of $53.8 million, on the consolidated balance sheet as of July 1, 2019 for several types of operating leases, including land and buildings, equipment (e.g. trucks and forklifts), vehicles, and computer equipment. These amounts are equivalent to the aggregate future lease payments on a discounted basis. The discount rate applied to these leases is the Company’s incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. Some leasing arrangements require variable payments that are dependent on usage, output, or may vary for other reasons, such as insurance and tax payments. The variable lease payments are not presented as part of the initial ROU asset or lease liability. The leases have remaining terms of one to eighteen years.
The below table as of June 30, 2019 is carried forward, including certain amounts that were historically included in the table as a result of the historical lease term conclusions but were not included in the initial ROU asset and lease liability measurement as of June 30, 2019. Minimum lease payments for operating leases under ASC 840 expiring subsequent to June 30, 2019 were as follows:
($ in millions)
June 30, 2019
2020
$
12.7
2021
10.4
2022
8.3
2023
6.6
2024
5.0
Thereafter
23.5
Total future minimum lease payments
$
66.5
12.
Fair Value Measurements
The fair value hierarchy has three levels based on the inputs used to determine fair value. Level 1 refers to quoted prices in active markets for identical assets or liabilities. Level 2 refers to observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Level 3 refers to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Currently, the Company does not use Level 1 and 3 inputs.
The following tables present the Company’s assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy:
The Company’s derivative financial instruments consist of commodity forward contracts, foreign currency forward contracts and interest rate swaps. These instruments are measured at fair value using the market method valuation technique. The inputs to this technique utilize information related to commodity prices, foreign exchange rates and interest rates published by third party leading financial news and data providers. This is observable data; however, the valuation of these instruments is not based on actual transactions for the same instruments and, as such, they are classified as Level 2. The Company’s use of derivatives and hedging policies are more fully discussed in Note 13.
The Company has currently chosen not to elect the fair value option for any items that are not already required to be measured at fair value in accordance with accounting principles generally accepted in the United States of America.
The carrying amounts of other financial instruments not listed in the table below approximate fair value due to the short-term nature of these items. The carrying amounts and estimated fair values of the Company’s financial instruments not recorded at fair value in the financial statements were as follows:
September 30, 2019
June 30, 2019
($ in millions)
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
Long-term debt
$
550.9
$
566.2
$
550.6
$
560.6
Company-owned life insurance
$
18.5
$
18.5
$
17.9
$
17.9
The fair values of long-term debt as of September 30, 2019 and June 30, 2019 were determined by using current interest rates for debt with terms and maturities similar to the Company’s existing debt arrangements and accordingly would be classified as Level 2 inputs in the fair value hierarchy.
The carrying amount of Company-owned life insurance reflects cash surrender values based upon the market values of underlying securities, using Level 2 inputs, net of any outstanding policy loans. The carrying value associated with the cash surrender value of these policies is recorded in other assets in the accompanying consolidated balance sheets.
13.
Derivatives and Hedging Activities
The Company uses commodity forwards, interest rate swaps, forward interest rate swaps and foreign currency forwards to manage risks generally associated with commodity price, interest rate and foreign currency rate fluctuations. The following explains the various types of derivatives and includes a summary of the impact the derivative instruments had on the Company’s financial position, results of operations and cash flows.
Cash Flow Hedging — Commodity forward contracts: The Company enters into commodity forward contracts to fix the price of a portion of anticipated future purchases of certain critical raw materials and energy to manage the risk of cash flow variability associated with volatile commodity prices. The commodity forward contracts have been designated as cash flow hedges. The qualifying hedge contracts are marked-to-market at each reporting date and any unrealized gains or losses are included in accumulated other comprehensive (loss) income (“AOCI”) and reclassified to cost of sales in the period during which the hedged transaction affects earnings or it becomes probable that the forecasted transaction will not occur. As of September 30, 2019, the Company had forward contracts to purchase 17.3 million pounds of certain raw materials with settlement dates through December 2023.
Cash Flow Hedging — Forward interest rate swaps: Historically, the Company has entered into forward interest rate swap contracts to manage the risk of cash flow variability associated with fixed interest debt expected to be issued. The forward interest rate swaps were designated as cash flow hedges. The qualifying hedge contracts were marked-to-market at each reporting date and any unrealized gains or losses were included in AOCI and reclassified to interest expense in the period during which the hedged transaction affected earnings or it became probable that the forecasted transaction would not occur. Upon the issuance of the fixed rate debt, the forward interest rate swap contracts were terminated. The realized gains at the time the interest rate swap contracts were terminated are being amortized over the term of the underlying debt. For the three months ended September 30, 2019 and 2018, net gains of $0.1 million and $0.1 million, respectively, related to the previously terminated contracts, were recorded as a reduction to interest expense.
Cash Flow Hedging — Foreign currency forward contracts: The Company uses foreign currency forward contracts to hedge a portion of anticipated future sales denominated in foreign currencies, principally the Euro and Pound Sterling, in order to offset the effect of changes in exchange rates. The qualifying hedge contracts are marked-to-market at each reporting date and any unrealized gains or losses are included in AOCI and reclassified to net sales in the period during which the transaction affects earnings or it becomes probable that the forecasted transaction will not occur.
The Company also uses foreign currency forward contracts to protect certain short-term asset positions denominated in foreign currencies against the effect of changes in exchange rates. These positions do not qualify for hedge accounting and accordingly are marked-to-market at each reporting date through charges to other income and expense. As of September 30, 2019 and June 30, 2019, the fair value of the outstanding foreign currency forwards not designated as hedging instruments and the charges to income for changes in fair value for these contracts were not material.
Fair Value Hedging - Interest rate swaps: The Company uses interest rate swaps to achieve a level of floating rate debt relative to fixed rate debt where appropriate. The Company has designated fixed to floating interest rate swaps as fair value hedges. Accordingly, the changes in the fair value of these instruments are immediately recorded in earnings. The mark-to-market values of both the fair value hedging instruments and the underlying debt obligations are recorded as equal and offsetting gains and losses in interest expense in the consolidated statements of income. As of September 30, 2019 and June 30, 2019, the total notional amount of floating interest rate contracts was $150.0 million for both periods. For the three months ended September 30, 2019 and 2018, net losses of $0.0 million and $0.3 million, respectively, were recorded as an increase to interest expense, respectively.
The fair value and location of outstanding derivative contracts recorded in the accompanying consolidated balance sheets were as follows as of September 30, 2019 and June 30, 2019: