UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR- 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

Commission File Number 1-898

AMPCO-PITTSBURGH CORPORATION

 

 

Securities registered pursuant to Section 12(b) of the Act: 

 

 

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes        No   ✓   

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes        No   ✓   

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 and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).  Yes   ✓   No        

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [✓]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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.

 

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 aggregate market value of the voting stock of Ampco-Pittsburgh Corporation held by non-affiliates on June 30, 2017 (based upon the closing price of the Registrant’s Common Stock on the New York Stock Exchange on that date) was approximately $89 million.

As of March 12, 2018, 12,362,198 common shares were outstanding.

Documents Incorporated by Reference: Part III of this report incorporates by reference certain information from the Proxy Statement for the 2018 Annual Meeting of Shareholders.

 

 

 

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TABLE OF CONTENTS

 

 

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FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 (the “Act”) provides a safe harbor for forward-looking statements made by us or on our behalf. Management’s Discussion and Analysis of Financial Condition and Results of Operation and other sections of the Annual Report on Form 10-K as well as the consolidated financial statements and notes thereto may contain forward-looking statements that reflect our current views with respect to future events and financial performance.

All statements in this document other than statements of historical fact are statements that are, or could be, deemed “forward-looking statements” within the meaning of the Act. In this document, statements regarding future financial position, sales, costs, earnings, cash flows, other measures of results of operations, capital expenditures or debt levels and plans, objectives, outlook, targets, guidance or goals are forward-looking statements. Words such as “may,” “intend,” “believe,” “expect,” “anticipate,” “estimate,” “project,” “forecast” and other terms of similar meaning that indicate future events and trends are also generally intended to identify forward-looking statements. Forward-looking statements speak only as of the date on which such statements are made, are not guarantees of future performance or expectations, and involve risks and uncertainties. For us, these risks and uncertainties include, but are not limited to, those described under Item 1A. Risk Factors of this Annual Report on Form 10-K. In addition, there may be events in the future that we are not able to predict accurately or control which may cause actual results to differ materially from expectations expressed or implied by forward-looking statements. Except as required by applicable law, we assume no obligation, and disclaim any obligation, to update forward-looking statements whether as a result of new information, events or otherwise.

– PART I –

ITEM 1. BUSINESS

GENERAL DEVELOPMENT OF BUSINESS

Ampco-Pittsburgh Corporation (the “Corporation”) was incorporated in Pennsylvania in 1929. The Corporation, individually or together with its consolidated subsidiaries, is also referred to herein as the “Registrant.” The Corporation classifies its businesses in two segments: Forged and Cast Engineered Products and Air and Liquid Processing.

FINANCIAL INFORMATION ABOUT SEGMENTS

The sales and operating results of the Corporation’s two segments and the identifiable assets attributable to both segments for the three years ended December 31, 2017, are set forth in Note 21 (Business Segments) of this Annual Report on Form 10-K.  

NARRATIVE DESCRIPTION OF BUSINESS

Forged and Cast Engineered Products Segment

Union Electric Steel Corporation produces ingot and forged products that service a wide variety of industries globally. It specializes in the production of forged hardened steel rolls used in cold rolling by producers of steel, aluminum and other metals throughout the world. In addition, it produces ingot and open-die forged products which are used in the oil and gas industry and the aluminum and plastic extrusion industries. Union Electric Steel Corporation is headquartered in Carnegie, Pennsylvania, with three manufacturing facilities in Pennsylvania, one in Indiana and one in Ohio. It is one of the largest producers of forged hardened steel rolls in the world. In addition to a few domestic competitors, several major European, South American and Asian manufacturers also compete in both the domestic and foreign markets. In 2007, a subsidiary of Union Electric Steel Corporation became a 49% partner in a joint venture in China to manufacture large forged backup rolls, principally in weights and sizes larger than those which can be made in the subsidiary’s facilities in the United States. In 2016, the ownership interest in the joint venture was reduced to 33%.

The following entities are indirect subsidiaries of Union Electric Steel Corporation:

Union Electric Steel UK Limited produces cast rolls for hot and cold strip mills, medium/heavy section mills and plate mills in a variety of iron and steel qualities. It is located in Gateshead, England, and is a major supplier of cast rolls to the metalworking industry worldwide. It primarily competes with European, Asian and North and South American companies in both domestic and foreign markets. Union Electric Steel UK Limited is a 24% partner in a Chinese joint venture which produces cast rolls.

Åkers Sweden AB produces cast rolls for hot strip finishing, roughing mills and plate mills and medium/heavy section mills in a variety of iron and steel qualities. It is located in Åkers Styckebruk, Sweden.

Åkers Valji Ravne d.o.o. produces forged rolls for cluster mills and Z-Hi mills, work rolls for narrow and wide strip and aluminum mills, back-up rolls for narrow strip mills, as well as leveling rolls and shafts. It is located in Ravne, Slovenia.

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Shanxi Åkers TISCO Roll Co. Ltd., is a joint venture between Taiyuan Iron and Steel Co Ltd. and Åkers AB, a subsidiary of Union Electric Steel Corporation, that produces cast hot strip mill work rolls. It is located in Taiyuan, Shanxi Province, China. Åkers AB holds a 60% interest in the joint venture.

National Roll Company is a division of Akers National Roll Company, a subsidiary of Union Electric Steel Corporation, that produces cast rolls for hot and cold strip mills, as well as plate mills. It is located in Avonmore, Pennsylvania.

Vertical Seal Company is a division of Akers National Roll Company that manufactures bearings, bushings, key and keyless bearing sleeves, as well as provides a number of services, including rebuild of mill spare parts, chock inspection and repair, and onsite inspections and installations. It is located in Pleasantville, Pennsylvania.

ASW Steel Inc. is a premier specialty steel producer located in Welland, Ontario, Canada.

Alloys Unlimited Processing, LLC is a distributor of tool steels, alloys and carbon round bar, located in Austintown, Ohio.

Air and Liquid Processing Segment

Aerofin Division of Air & Liquid Systems Corporation produces custom-engineered finned tube heat exchange coils and related heat transfer products for a variety of industries including nuclear power generation, automotive, industrial process and HVAC, and is located in Lynchburg, Virginia.

Buffalo Air Handling Division of Air & Liquid Systems Corporation produces large custom air handling systems used in commercial, institutional and industrial buildings and is located in Amherst, Virginia.

Buffalo Pumps Division of Air & Liquid Systems Corporation manufactures a line of centrifugal pumps for the refrigeration, power generation and marine defense industries and is located in North Tonawanda, New York.

All three of the divisions in this segment are principally represented by a common independent sales organization and have several major competitors.

In both segments, the products are dependent on engineering, principally custom designed, and are sold to sophisticated commercial and industrial users located throughout the world.

For additional information on the products produced and financial information about each segment, see Note 21 (Business Segments) of this Annual Report on Form 10-K.

Raw Materials

Raw materials used in both segments are generally available from many sources and neither segment is dependent upon any single supplier for any raw material. Substantial volumes of raw materials used by each segment are subject to significant variations in price. The Corporation’s subsidiaries generally do not purchase or commit for the purchase of a major portion of raw materials significantly in advance of the time they require such materials but do make forward commitments for the supply of natural gas and certain commodities (copper and aluminum). See Note 13 (Derivative Instruments) of this Annual Report on Form 10-K.

Patents and Trademarks

While the Corporation and its subsidiaries hold some patents, trademarks and licenses, in the opinion of management they are not material to either segment.

Backlog

The backlog of orders at December 31, 2017, was approximately $326 million, compared to a backlog of $234 million at year-end 2016. Approximately 6% of the backlog is expected to be released after 2018.

Competition

The Corporation faces considerable competition from a large number of companies in both segments. The Corporation believes, however, that its subsidiaries are significant participants in each of the niche markets which they serve. Competition in both segments is based on quality, service, price and delivery. For additional information, see Part I, Item 1 “General Development of Business” of this Annual Report on Form 10-K.

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Research and Development

As part of an overall strategy to develop new markets and maintain a leadership position in each of the industry niches served, the Corporation’s subsidiaries in both segments incur expenditures for research and development. The activities that are undertaken are designed to develop new products, improve existing products and processes, enhance product quality, adapt products to meet customer specifications and reduce manufacturing costs. In the aggregate, these expenditures approximated $3.39 million in 2017, $2.72 million in 2016 and $1.14 million in 2015.

Environmental Protection Compliance Costs

Expenditures for environmental control matters were not material to either segment in 2017 and are not expected to be material in 2018.

Employees

On December 31, 2017, the Corporation and its subsidiaries had 1,943 active employees.

FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS

The Forged and Cast Engineered Products segment has manufacturing operations in the United States, England, Sweden, Slovenia, China and Canada; and sales offices in Brazil, China, Canada, Egypt, France, Germany, Singapore, Slovenia, Sweden, Taiwan and Turkey. For financial information relating to foreign and domestic operations see Note 21 (Business Segments) of this Annual Report on Form 10-K.

AVAILABLE INFORMATION

The Corporation files annual, quarterly and current reports, amendments to those reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). You may access and read the Corporation’s filings without charge through the SEC’s website at www.sec.gov. You may also read and copy any document the Corporation files at the SEC’s Public Reference Room located at 100 F. Street, N.E., Room 1580, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room.

The Corporation’s internet address is www.ampcopittsburgh.com. The Corporation makes available, free of charge on its internet website, access to these reports as soon as reasonably practicable after such material is filed with, or furnished to, the SEC. The information on the Corporation’s website is not part of this Annual Report on Form 10-K.

EXECUTIVE OFFICERS

The name, age, position with the Corporation⁽¹⁾ and business experience for the past five years of the Executive Officers of the Corporation are as follows:

John S. Stanik (age 64). Mr. Stanik has served as the Corporation’s Chief Executive Officer since January 2015. He previously worked at Calgon Carbon Corporation, an international company specializing in purification products, technologies and services, from 1991 through 2012, when he retired for personal reasons. Mr. Stanik served as President and Chief Executive Officer of Calgon Carbon from 2003 to 2012 and became its Chairman of the Board in 2007. On October 3, 2017, the Corporation announced that Mr. Stanik had notified the Board of Directors of the Corporation of his intention to retire as Chief Executive Officer sometime in the middle of 2018 or at such time as a suitable successor is identified and appointed.

Rose Hoover (age 62). Ms. Hoover has been employed by the Corporation for more than thirty-five years. She has served as President and Chief Administrative Officer of the Corporation since August 2015 and Executive Vice President from 2011 to August 2015.

Michael G. McAuley (age 54). Mr. McAuley has served as Vice President, Chief Financial Officer and Treasurer of the Corporation since April 2016. Mr. McAuley was named Senior Vice President in March 2018. Previously, he served as Senior Vice President and Chief Financial Officer of RTI International Metals, Inc., a producer of titanium mill products and fabricated metal components, from July 2014 to October 2015; Chief Financial Officer of ECI Development, Ltd., a private real estate developer, from January 2013 until June 2014, and Vice President and Treasurer of Goodrich Corporation, a manufacturer of aerospace and defense components and systems, from December 2007 until July 2012.

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Maria Trainor (age 43). Ms. Trainor has served as Vice President, General Counsel and Secretary of the Corporation since June 2015. Prior to joining the Corporation, Ms. Trainor was a partner at K&L Gates, LLP, an international law firm, where she had practiced for nearly fourteen years.

Rodney L. Scagline (age 51). Mr. Scagline has served as President of Union Electric Steel Corporation since November 2015; Executive Vice President of Union Electric Steel Corporation from April 2014 to November 2015, Vice President of Manufacturing of Union Electric Steel Corporation from June 2013 to April 2014 and Director of Technology of Union Electric Steel Corporation from July 2011 to May 2013. He previously worked at Akers National Roll Company, a cast engineered product manufacturer that was acquired by the Corporation in 2016 as part of the Åkers group acquisition, where he served as its Vice President of Metallurgical Services for three years and Vice President of Sales and Marketing for one year.

Terrence W. Kenny (age 58). Mr. Kenny has been employed by the Corporation for more than thirty years. He has served as President of the Air & Liquid Systems Corporation for more than five years.

Timothy R. Clutterbuck (age 59).  Mr. Clutterbuck has served as President of ASW Steel Inc. since November 2011.

ITEM 1A. RISK FACTORS

From time to time, important factors may cause actual results to differ materially from future expected results based on performance expressed or implied by any forward-looking statements made by us, including known and unknown risks, uncertainties and other factors, many of which are not possible to predict or control. Several of these factors are described from time to time in our filings with the Securities and Exchange Commission, but the factors described in filings are not the only risks that the Corporation faces.

Cyclical demand for products and economic downturns may reduce the demand for, and sales of, our products, which could adversely affect our margins and profitability.

A significant portion of the Forged and Cast Engineered Products segment’s sales consists of mill rolls to customers in the global steel industry which can be periodically impacted by economic or cyclical downturns. Such downturns, the timing and length of which are difficult to predict, may reduce the demand for, and sales of, our forged and cast steel rolls both in the United States and the rest of the world. Lower demand for rolls may also adversely impact profitability as other competing roll producers lower selling prices in the marketplace in order to fill their manufacturing capacity. Cancellation of orders or deferral of delivery of rolls may occur and produce an adverse impact on financial results. In addition, sales of non-roll product, consisting of open-die forged product primarily for the oil and gas industries, are impacted by fluctuations in global energy prices.

Excess global capacity in steel industry could lower prices for our products, which would adversely affect our sales, margins and profitability, as well as collectability of receivables and salability of in-process inventory.

The global steel manufacturing capacity continues to exceed global consumption of steel products. Such excess capacity often results in manufacturers in certain countries exporting steel at prices significantly below their home market prices (often due to local government assistance or subsidies), which leads to global market destabilization and reduced sales and profitability of some of our and our subsidiaries’ customers, which, in turn, affects our sales and profit margins, as well as collectability of receivables and salability of in-process inventory.

Steel industry consolidation resulted in certain customers having increased buying power, which could put pressure on prices of our products and result in lower profit margins.

As a result of reduced demand for steel products, the steel industry has undergone structural change by way of consolidation and mergers. In certain markets, the resultant reduction in the number of steel plants and the increased buying power of the enlarged steel producing companies may put pressure on the selling prices and profit margins of mill rolls.

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A reduction in the level of export sales, as well as other economic factors in foreign countries, may have an adverse impact on our financial results.

Exports are a significant proportion of our subsidiaries’ sales. Historically, changes in foreign exchange rates, particularly in respect of the U.S. dollar, British pound, Swedish krona and the euro, have impacted the export of our products and may do so again in the future. Other factors that may adversely impact export sales and operating results include political and economic instability, export controls, changes in tax laws and tariffs and new indigenous producers in overseas markets. A reduction in the level of export sales may have an adverse impact on our financial results. In addition, exchange rate changes may allow foreign roll suppliers to compete in our home markets.

Fluctuation of the value of the U.S. dollar relative to other currencies may adversely affect our business, results of operations and financial condition.

Certain of our subsidiaries operate in foreign jurisdictions and, accordingly, earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar. Since our consolidated financial statements are presented in U.S. dollars, we must translate revenues and expenses into U.S. dollars at the average exchange rate during each reporting period, and assets and liabilities into U.S. dollars at the exchange rate in effect at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other major currencies will affect the translated value for revenue, expenses and balance sheet items denominated in foreign currencies and could materially affect our financial results expressed in U.S. dollars.

A downturn in capital spending in the United States and other jurisdictions may reduce demand for and sales of certain of our products, which would result in reduced profit margins.

Each of our businesses is susceptible to the general level of economic activity, particularly as it impacts industrial and construction capital spending. A downturn in capital spending in the United States and elsewhere may reduce demand for and sales of our subsidiaries’ air handling, power generation and refrigeration equipment, forged engineered products and mill rolls. Lower demand may also reduce profit margins due to our competitors and us striving to maximize manufacturing capacity by lowering prices.

Commodity price increases, as well as any reductions in electricity, gas supply or shortage of key production materials, could adversely impact our production, which would result in lower profitability.

Our subsidiaries use certain commodities in the manufacture of their products. These include steel scrap, ferroalloys, energy and graphite electrodes. Any sudden price increase may cause a reduction in profit margins or losses where fixed-priced contracts have been accepted or increases cannot be obtained in future selling prices. In addition, there may be curtailment in electricity or gas supply which would adversely impact production. Shortage of critical materials, while driving up costs, may be of such severity as to disrupt production, all of which may impact sales and profitability. The current global supply shortage of graphite electrodes used for electric arc furnace melting of our steels could materially impact results of operations should we be unable to secure sufficient supply for our production requirements.

We may not be able to realize the expected benefits from the acquisitions that we make, and we may experience difficulties in integrating the acquired businesses.

We have made in the past, and may continue to make, certain acquisitions and enter into joint ventures, which are intended to complement or expand our businesses. These acquisitions involve a variety of challenges and risks. We may encounter difficulties integrating acquired businesses with our operations or applying our internal control processes to these acquisitions. Other risks associated with acquisitions are the diversion of management’s attention from other business concerns, the potential loss of key employees and customers of the acquired companies, the possible assumption of unknown liabilities, and potential disputes with the sellers. We may not be able to complete certain acquisitions due to antitrust laws and regulations in various jurisdictions. Additionally, we may not realize the degree of timing of benefits we anticipate when we first enter into a transaction. Any of the foregoing could adversely affect our business and results of operations.

A work stoppage or another industrial action on the part of any of our unions may be disruptive to our operations.

Our subsidiaries have several key operations which are subject to multi-year collective bargaining agreements with their hourly work forces. While we believe we have good relations with our unions, there is the risk of industrial action or work stoppage at the expiration of an agreement if contract negotiations break down, which may disrupt manufacturing and impact results of operations.

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Dependence on certain equipment may cause an interruption in our production if such equipment is out of operation for an extended period of time, which would result in lower sales and profitability.

Our subsidiaries’ principal business relies on certain unique equipment such as an electric arc furnace and a spin cast work roll machine. Although a comprehensive critical spare inventory of key components for this equipment is maintained, if any such unique equipment is out of operation for an extended period, it may result in a significant reduction in our sales and earnings.

The ultimate liability of our subsidiaries for claims alleging personal injury from exposure to asbestos-containing components historically used in certain products of our subsidiaries could have a material adverse effect on our consolidated financial condition or liquidity in the future.

Our subsidiaries, and in some cases, we, are defendants in numerous claims alleging personal injury from exposure to asbestos-containing components historically used in certain products of our subsidiaries. Through year-end 2017, our insurance has covered a substantial majority of our settlement and defense costs. We believe that the estimated costs net of anticipated insurance recoveries of our pending and future asbestos legal proceedings for the next ten years should not have a material adverse effect on our consolidated financial condition or liquidity. However, there can be no assurance that our subsidiaries or we will not be subject to significant additional claims in the future or that our subsidiaries’ ultimate liability with respect to asbestos claims will not present significantly greater and longer lasting financial exposure than provided in our consolidated financial statements. The ultimate net liability with respect to such pending and any unasserted claims is subject to various uncertainties, including the following:

Because of the uncertainties related to such claims, it is possible that the ultimate liability could have a material adverse effect on our consolidated financial condition or liquidity in the future.

The loss of any of our key management or our inability to attract or retain qualified personnel may prevent us from our implementing our business strategy.

Our success is dependent on the management, experience and leadership skills of our senior management team and key employees. The loss of any of these individuals or an inability to attract, retain and maintain additional personnel with similar industry experience could prevent us from implementing our business strategy. We cannot assure you that we will be able to retain our existing senior management and key personnel or to attract additional qualified personnel when needed.

Potential attacks on information technology infrastructure and other cyber-based business disruptions could have a material adverse effect on our financial condition and results of operations.

We depend on integrated information technology (“IT”) systems to conduct our business. IT systems failures, including risks associated with upgrading our systems or in successfully integrating IT and other systems in connection with the integration of businesses we acquire, network disruptions and breaches of data security could disrupt our operations by impeding our processing of transactions, our ability to protect customer or company information and our financial reporting. Our computer systems, including our back-up systems, could be damaged or interrupted by power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, events such as fires, earthquakes, floods, tornadoes and hurricanes, and/or errors by our employees. Cyber-based risks, in particular, are evolving and include both attacks to our IT infrastructure and attacks to the IT infrastructure of third parties in attempts to gain unauthorized access to our confidential or other proprietary information, or information relating to our employees, customers and other third parties. Although we have taken steps to address these concerns, there can be no assurance that a system failure or data security breach will not have a material adverse effect on our financial condition and results of operations.

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We could be exposed to substantial liabilities resulting from non-compliance with domestic and international environmental laws and regulations.

We and our subsidiaries are subject to various domestic and international environmental laws and regulations that govern the discharge of pollutants and disposal of wastes and which may require that we and our subsidiaries investigate and remediate the effects of the release or disposal of materials at sites associated with past and present operations. We and our subsidiaries could incur substantial cleanup costs, fines and civil or criminal sanctions, third party property damage or personal injury claims as a result of violations or liabilities under these laws or non-compliance with environmental permits required at our facilities.

A change in the existing regulatory environment could negatively affect our operations and financial performance.

We are subject to a wide variety of complex domestic and foreign laws, rules and regulations, and legal compliance risks, including, without limitation, securities laws, employment and pension-related laws, competition laws, export controls and sanctions laws, data privacy and security laws, and laws governing improper business practices. We are affected by new laws and regulations, and changes to existing laws and regulations, including interpretations by courts and regulators. These laws, regulations and policies, and changes thereto, may result in restrictions or limitations to our current operational practices and processes and product/service offerings which could negatively impact our current cost structure, revenue streams, cash flows, and overall financial position.

Additionally, we are subject to tax laws and regulations in the United States and multiple foreign jurisdictions. We are affected by changes in tax laws and regulations, as well as changes in related interpretations and other tax guidance. In the ordinary course of our business, we are subject to examinations and investigations by various tax authorities. In addition to existing examinations and investigations, there could be further examinations and investigations in the future, and existing examinations and investigations could be expanded.

On December 22, 2017, the U.S. federal government enacted the Tax Cuts and Jobs Act (the “Tax Reform”), to become effective as of January 1, 2018, which, among other things, lowered the U.S. corporate statutory income tax rate from 35% to 21%, implemented a modified territorial tax system and imposed a one-time tax on deemed repatriated earnings of foreign subsidiaries. The Tax Reform contains numerous complex provisions impacting U.S. multinational companies, and we continue to review and assess the legislative language and its potential impact on us. The full extent of the impact remains uncertain at this time, and our current interpretations of, and assumptions regarding, the Tax Reform are subject to additional regulatory or administrative developments, including any regulations or other guidance promulgated by the U.S. Internal Revenue Service. As a result, the Tax Reform, including any regulations or other guidance promulgated by the U.S. Internal Revenue Service, and other tax laws could have significant effects on us, some of which may be adverse and could materially and adversely impact our financial condition, results of operations and cash flows.

In 2018, President Trump announced he would impose tariffs of 25% on steel imports and 10% on aluminum imports. As consumers of steel and aluminum in some of our Air & Liquid Processing segment products, our costs could be significantly impacted if the tariffs are imposed, potentially reducing our margins and risking loss of market share to foreign competitors not subject to similar tariffs. In addition, in the ordinary course of business, one of our U.S. subsidiaries purchases intercompany steel produced by another subsidiary located in Canada, which also exports steel to customers in the U.S. Canada is temporarily exempted from the proposed tariffs. If this exemption is not made permanent, we could lose margin and/or market share for the related business. Uncertainties regarding the scope of the proposed tariffs could also pose potential risk to the cost of certain intercompany value-added intermediary product transfers. Accordingly, our financial condition, results of operations and cash flows could be significantly affected.

New trade restrictions and regulatory burdens associated with “Brexit” could adversely impact our operations and financial performance.

On June 23, 2016, voters in the United Kingdom approved a referendum to exit from the European Union (“E.U.”), commonly known as “Brexit.” As the United Kingdom and the E.U. continue negotiations to determine their new relationship, greater restrictions and regulatory burdens may be put upon trade between the United Kingdom and the E.U. This may have an adverse effect on our operations and financial performance.

We may face limitations in availability of capital to fund our growth strategy.

We are parties to a Revolving Credit and Security Agreement (the “Credit Agreement”), a senior secured asset-based revolving credit facility collateralized by a first priority perfected security interest in substantially all of our assets. The Credit Agreement provides for initial borrowings not to exceed $100 million, with an option to increase the credit facility by an additional $50 million at our request and with the approval of the banks, but restricts us from incurring additional indebtedness outside of the Credit Agreement. The Credit Agreement is subject to various affirmative and negative covenants and contains various sub-limits, including those based on type of collateral and borrowings by geographic region. If the financial covenants become difficult to meet or if our borrowing needs increase

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beyond the prescribed limits, our results of operations and liquidity may be materially adversely affected. In addition, our access to public debt markets may be limited based on our size, credit profile and not being a well-known seasoned issuer.

ITEM 1B. UNRESOLVED STAFF COMMENTS

The Corporation has no unresolved staff comments.

ITEM 2. PROPERTIES

The location and general character of the principal locations in each segment, all of which are owned unless otherwise noted, are listed below. In addition, we have sales offices in the following countries: Brazil, China, Egypt, France, Germany, Singapore, Slovenia, Sweden, Turkey and Taiwan. See Note 5 (Property, Plant and Equipment) and Note 8 (Borrowing Arrangements) of this Annual Report on Form 10-K for disclosure of properties held as collateral.

 

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The Corporation leases office space from Union Electric Steel Corporation. The Corporation subleases a portion of its office space to Air & Liquid Systems Corporation for use as its headquarters. All of the owned facilities are adequate and suitable for their respective purposes.

The Forged and Cast Engineered Products segment’s facilities operated within 65% to 75% of their normal capacity during 2017. The facilities of the Air and Liquid Processing segment operated within 60% to 70% of their normal capacity. Normal capacity is defined as capacity under approximately normal conditions with allowances made for unavoidable interruptions, such as lost time for repairs, maintenance, breakdowns, set-up, failure, supply delays, labor shortages and absences, Sundays, holidays, vacation, inventory taking. The number of work shifts is also taken into consideration.

ITEM 3. LEGAL PROCEEDINGS

LITIGATION

The Corporation and its subsidiaries are involved in various claims and lawsuits incidental to their businesses and are also subject to asbestos litigation as described below. In February 2017, the Corporation, its indirect subsidiary Akers National Roll Company, as well as the Akers National Roll Company Health & Welfare Benefits Plan were named as defendants in a class action complaint filed in the United States District Court for the Western District of Pennsylvania, where the plaintiffs (currently retired former employees of Akers National Roll Company and the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial, and Service Workers International Union, AFL-CIO) alleged that the defendants breached collective bargaining agreements and violated the benefit plan by modifying medical benefits of the plaintiffs and similarly situated retirees. The defendants moved to dismiss the case, and plaintiffs petitioned the court to compel arbitration. On June 13, 2017, the District Court compelled arbitration and denied the defendants’ motion to dismiss as moot. Defendants appealed this decision to the Third Circuit Court of Appeals on June 21, 2017. Defendants also filed a motion to stay arbitration pending the resolution of the appeal, and that motion was granted on September 5, 2017. The Third Circuit Court of Appeals will next consider whether the District Court erred in compelling arbitration. While no assurance can be given as to the ultimate outcome of this matter, we believe that the final resolution of this action will not have a material adverse effect on our results of operations, financial position, liquidity or capital resources.  

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Asbestos Litigation

Claims have been asserted alleging personal injury from exposure to asbestos-containing components historically used in some products manufactured by predecessors of Air & Liquid Systems Corporation (“Asbestos Liability”). Air & Liquid Systems Corporation (“Air & Liquid”), and in some cases the Corporation, are defendants (among a number of defendants, often in excess of 50) in cases filed in various state and federal courts.

Asbestos Claims

The following table reflects approximate information about the claims for Asbestos Liability against Air & Liquid and the Corporation for the two years ended December 31, 2017, and 2016.

 

 

A substantial majority of the settlement and defense costs reflected in the above table was reported and paid by insurers. Because claims are often filed and can be settled or dismissed in large groups, the amount and timing of settlements, as well as the number of open claims, can fluctuate significantly from period to period.

Asbestos Insurance

The Corporation and Air & Liquid are parties to a series of settlement agreements (“Settlement Agreements”) with insurers that have coverage obligations for Asbestos Liability (the “Settling Insurers”). Under the Settlement Agreements, the Settling Insurers accept financial responsibility, subject to the terms and conditions of the respective agreements, including overall coverage limits, for pending and future claims for Asbestos Liability. The Settlement Agreements encompass the substantial majority of insurance policies that provide coverage for claims for Asbestos Liability.

The Settlement Agreements include acknowledgements that Howden North America, Inc. (“Howden”) is entitled to coverage under policies covering Asbestos Liability for claims arising out of the historical products manufactured or distributed by Buffalo Forge, a former subsidiary of the Corporation (the “Products”). The Settlement Agreements do not provide for any prioritization on access to the applicable policies or any sublimits of liability as to Howden or the Corporation and Air & Liquid, and, accordingly, Howden may access the coverage afforded by the Settling Insurers for any covered claim arising out of a Product. In general, access by Howden to the coverage afforded by the Settling Insurers for the Products will erode coverage under the Settlement Agreements available to the Corporation and Air & Liquid for Asbestos Liability.

Asbestos Valuations

In 2006, the Corporation retained Hamilton, Rabinovitz & Associates, Inc. (“HR&A”), a nationally recognized expert in the valuation of asbestos liabilities, to assist the Corporation in estimating the potential liability for pending and unasserted future claims for Asbestos Liability. Based on this analysis, the Corporation recorded a reserve for Asbestos Liability claims pending or projected to be asserted through 2013 as of December 31, 2006. HR&A’s analysis has been periodically updated since that time. Most recently, the HR&A analysis was updated in 2016, and additional reserves were established by the Corporation as of December 31, 2016, for Asbestos Liability claims pending or projected to be asserted through 2026. The methodology used by HR&A in its projection in 2016 of the operating subsidiaries’ liability for pending and unasserted potential future claims for Asbestos Liability, which is substantially the same as the methodology employed by HR&A in prior estimates, relied upon and included the following factors:

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Using this information, HR&A estimated in 2016 the number of future claims for Asbestos Liability that would be filed through the year 2026, as well as the settlement or indemnity costs that would be incurred to resolve both pending and future unasserted claims through 2026. This methodology has been accepted by numerous courts.

In conjunction with developing the aggregate liability estimate referenced above, the Corporation also developed an estimate of probable insurance recoveries for its Asbestos Liabilities. In developing the estimate, the Corporation considered HR&A’s projection for settlement or indemnity costs for Asbestos Liability and management’s projection of associated defense costs (based on the current defense to indemnity cost ratio), as well as a number of additional factors. These additional factors included the Settlement Agreements then in effect, policy exclusions, policy limits, policy provisions regarding coverage for defense costs, attachment points, prior impairment of policies and gaps in the coverage, policy exhaustions, insolvencies among certain of the insurance carriers, and the nature of the underlying claims for Asbestos Liability asserted against the subsidiaries and the Corporation as reflected in the Corporation’s asbestos claims database, as well as estimated erosion of insurance limits on account of claims against Howden arising out of the Products. In addition to consulting with the Corporation’s outside legal counsel on these insurance matters, the Corporation consulted with a nationally recognized insurance consulting firm it retained to assist the Corporation with certain policy allocation matters that also are among the several factors considered by the Corporation when analyzing potential recoveries from relevant historical insurance for Asbestos Liabilities. Based upon all of the factors considered by the Corporation, and taking into account the Corporation’s analysis of publicly available information regarding the credit-worthiness of various insurers, the Corporation estimated the probable insurance recoveries for Asbestos Liability and defense costs through 2026. Although the Corporation believes that the assumptions employed in the insurance valuation were reasonable and previously consulted with its outside legal counsel and insurance consultant regarding those assumptions, there are other assumptions that could have been employed that would have resulted in materially lower insurance recovery projections.

Based on the analyses described above, the Corporation’s reserve at December 31, 2016, for the total costs, including defense costs, for Asbestos Liability claims pending or projected to be asserted through 2026, was $171 million of which approximately 70% was attributable to settlement costs for unasserted claims projected to be filed through 2026 and future defense costs. The reserve at December 31, 2017, was $150 million. While it is reasonably possible that the Corporation will incur additional charges for Asbestos Liability and defense costs in excess of the amounts currently reserved, the Corporation believes that there is too much uncertainty to provide for reasonable estimation of the number of future claims, the nature of such claims and the cost to resolve them beyond 2026. Accordingly, no reserve has been recorded for any costs that may be incurred after 2026.

The Corporation’s receivable at December 31, 2016, for insurance recoveries attributable to the claims for which the Corporation’s Asbestos Liability reserve has been established, including the portion of incurred defense costs covered by the Settlement Agreements in effect through December 31, 2016, and the probable payments and reimbursements relating to the estimated indemnity and defense costs for pending and unasserted future Asbestos Liability claims, was $116 million ($100 million at December 31, 2017).

The following table summarizes activity relating to insurance recoveries for each of the years ended December 31, 2017, and 2016.

 

 

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The insurance receivable recorded by the Corporation does not assume any recovery from insolvent carriers and a substantial majority of the insurance recoveries deemed probable is from insurance companies rated A – (excellent) or better by A.M. Best Corporation. There can be no assurance, however, that there will not be further insolvencies among the relevant insurance carriers, or that the assumed percentage recoveries for certain carriers will prove correct. The difference between insurance recoveries and projected costs is not due to exhaustion of all insurance coverage for Asbestos Liability. The Corporation and the subsidiaries have substantial additional insurance coverage which the Corporation expects to be available for Asbestos Liability claims and defense costs that the subsidiaries and it may incur after 2026. However, this insurance coverage also can be expected to have gaps creating significant shortfalls of insurance recoveries against claims expense, which could be material in future years.

The amounts recorded by the Corporation for Asbestos Liabilities and insurance receivables rely on assumptions that are based on currently known facts and strategy. The Corporation’s actual expenses or insurance recoveries could be significantly higher or lower than those recorded if assumptions used in the Corporation’s or HR&A’s calculations vary significantly from actual results. Key variables in these assumptions are identified above and include the number and type of new claims to be filed each year, the average cost of disposing of each such new claim, average annual defense costs, compliance by relevant parties with the terms of the Settlement Agreements, the resolution of remaining coverage issues with insurance carriers, and the solvency risk with respect to the relevant insurance carriers. Other factors that may affect the Corporation’s Asbestos Liability and ability to recover under its insurance policies include uncertainties surrounding the litigation process from jurisdiction to jurisdiction and from case to case, reforms that may be made by state and federal courts, and the passage of state or federal tort reform legislation.

The Corporation intends to evaluate its estimated Asbestos Liability and related insurance receivables as well as the underlying assumptions on a regular basis to determine whether any adjustments to the estimates are required. Due to the uncertainties surrounding asbestos litigation and insurance, these regular reviews may result in the Corporation incurring future charges; however, the Corporation is currently unable to estimate such future charges. Adjustments, if any, to the Corporation’s estimate of its recorded Asbestos Liability and/or insurance receivables could be material to operating results for the periods in which the adjustments to the liability or receivable are recorded, and to the Corporation’s liquidity and consolidated financial position.

ENVIRONMENTAL

The Corporation is currently performing certain remedial actions in connection with the sale of real estate previously owned and periodically incurs costs to maintain compliance with environmental laws and regulations. Appropriate reserves have been established.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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– PART II –

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The shares of common stock of Ampco-Pittsburgh Corporation are traded on the New York Stock Exchange (symbol AP). The Corporation paid cash dividends on common shares in every year since 1965. In June 2017, the Corporation announced that it would suspend quarterly cash dividends, beginning with the second quarter of 2017. 

 

 

The number of registered shareholders at December 31, 2017, and 2016, equaled 385 and 392, respectively.

STOCK PERFORMANCE GRAPH

Comparison of Five Year Cumulative Total Return*

Standard & Poors 500 Index, NYSE Composite and Morningstar’s Steel Industry

Performance Results through December 2017

 

 

Assumes $100 invested at the close of trading on the last trading day preceding January 1, 2012 in Ampco-Pittsburgh Corporation common stock, Standard & Poors 500 Index, NYSE Composite Index and Morningstar’s Steel Industry group.

*Cumulative total return assumes reinvestment of dividends.

In the above graph, the Corporation has used Morningstar’s Steel Industry group for its peer comparison. The diversity of products produced by subsidiaries of the Corporation makes it difficult to match to any one product-based peer group. Although not totally comparable, the Steel Industry group was chosen because the largest percentage of the Corporation’s sales is to the global steel industry. Historical stock price performance shown on the above graph is not necessarily indicative of future price performance.  

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ITEM 6. SELECTED FINANCIAL DATA

Our selected financial data includes the results of operations of Åkers AB and certain of its affiliates from March 3, 2016, and ASW Steel Inc. from November 1, 2016, their respective dates of acquisition, and their financial position beginning as of December 31, 2016. Accordingly, our selected data for 2017 and 2016 is not fully comparable to earlier years and may not be indicative of our future results of operations or financial position. The information set forth below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data” and notes thereto.

 

 

2016 – After-tax charges of $26,676 or $2.23 per common share principally for the write-off of goodwill in the Forged and Cast Engineered Products reporting unit deemed to be impaired (see Note 2 to Consolidated Financial Statements), $30,405 or $2.54 per common share to recognize a valuation allowance against certain deferred income tax assets (see Note 15 to Consolidated Financial Statements), and $4,565 or $0.38 per common share for estimated costs of asbestos-related litigation through 2026, net of estimated insurance recoveries (see Note 19 to Consolidated Financial Statements), and a settlement with an insurance carrier for an amount in excess of the receivable estimated.

2015 – After-tax asbestos-related proceeds of $9,316 or $0.89 per common share received from two insurance carriers in rehabilitation.

2014 – An after-tax charge of $2,916 or $0.28 per common share for estimated costs of asbestos-related litigation through 2024, net of estimated insurance recoveries.

2013 – An after-tax credit of $10,621 or $1.03 per common share for estimated additional insurance recoveries expected to be available to satisfy the Asbestos Liability through 2022, resulting from settlement agreements reached with various insurance carriers, offset by an after-tax charge of $4,165 or $0.40 per common share to recognize an other-than-temporary impairment of our investment in a forged roll joint venture company for a net increase to net income of $6,456 or $0.63 per common share.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

(in thousands, except per share amounts)

EXECUTIVE OVERVIEW

Ampco-Pittsburgh Corporation and its subsidiaries (the “Corporation”) manufacture and sell highly engineered, high-performance specialty metal products and customized equipment utilized by industry throughout the world. We operate in two business segments – the Forged and Cast Engineered Products segment and the Air and Liquid Processing segment.

Forged and Cast Engineered Products

The Forged and Cast Engineered Products segment historically consisted of Union Electric Steel Corporation (“Union Electric Steel” or “UES”) and Union Electric Steel UK Limited (“UES-UK”). In March 2016, UES acquired the stock of Åkers AB and certain of its affiliated companies, including Åkers AB’s 60% equity interest in a Chinese joint venture company (collectively, “Åkers”). Åkers has been a leader in the production of forged and cast rolls since 1806. Collectively doing business as Union Electric Åkers, this portion of the segment produces forged hardened steel rolls used mainly for cold rolling by producers of steel, aluminum and other metals and cast rolls for hot and cold strip mills, medium/heavy section mills and plate mills in a variety of iron and steel qualities.

The segment also produces ingot and open-die forged products (“forged engineered products”) which are used in the oil and gas industry and the aluminum and plastic extrusion industries. In July 2015, UES acquired the assets of Alloys Unlimited & Processing, Inc. (“AUP”) and, in November 2016, the stock of ASW Steel Inc. (“ASW”). AUP is a supplier of specialty tool, alloy, and carbon steel round bar and is located in the United States. ASW is a specialty steel producer based in Canada. Both acquisitions support our diversification efforts in the open-die forging market.

The segment has operations in the United States, England, Sweden, Slovenia, Canada and an equity interest in three joint venture companies in China. Collectively, the segment primarily competes with European, Asian and North and South American companies in both domestic and foreign markets and distributes a significant portion of its products through sales offices located throughout the world. The consolidated financial statements of the Corporation include the results of operations of the acquired companies from their respective dates of acquisition.

The Forged and Cast Engineered Products segment had been operating at levels significantly below capacity and, in April 2017, we temporarily idled a portion of one of our cast rolls plants. While it is anticipated that market conditions in the United States, Europe and other world regions will remain difficult, protectionist acts (tariffs) and reduced output from China appear to be benefitting our two largest markets – North America and Europe. Additionally, many of our customers have announced improved financial results which should lead to additional demand and better pricing. Backlog for mill rolls has increased roughly 39% from year end 2016 to year end 2017. With respect to the oil and gas market, activity remains strong as oil and gas prices remain elevated. Backlog for forged engineered products at December 31, 2017, has nearly tripled from the prior year.

Air and Liquid Processing

The Air and Liquid Processing segment includes Aerofin, Buffalo Air Handling and Buffalo Pumps, all divisions of Air & Liquid Systems Corporation (“Air & Liquid”), a wholly owned subsidiary of the Corporation. Aerofin produces custom-engineered finned tube heat exchange coils and related heat transfer products for a variety of industries including OEM/commercial, nuclear power generation and industrial manufacturing. Buffalo Air Handling produces large custom-designed air handling systems for institutional (e.g., hospital, university), pharmaceutical and general industrial building markets. Buffalo Pumps manufactures centrifugal pumps for the fossil-fuel power generation, marine defense and industrial refrigeration industries. The segment has operations in Virginia and New York with headquarters in Carnegie, Pennsylvania. The segment distributes a significant portion of its products through a common independent group of sales offices located throughout the United States and Canada.

For the Air and Liquid Processing segment, business activity in the specialty centrifugal pump industry has been negatively impacted by a decline in activity in the fossil-fueled power generation market, partially offset by increased activity in the marine defense market. For the heat exchanger business, there are early signs of growth in the OEM/commercial, nuclear power generation and industrial markets. Additionally, demand for custom air handling systems continues to improve although competitive pricing pressures remain. The focus for this segment is to grow revenues, increase margins, strengthen engineering and manufacturing capabilities, and continuing to improve the sales distribution network.

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CONSOLIDATED RESULTS OF OPERATIONS OVERVIEW

The Corporation

 

 

Consolidated net sales for 2017 increased from 2016 principally due to higher sales for the Forged and Cast Engineered Products segment. Specifically, sales of forged engineered products for the oil and gas industry improved by approximately $73,000, of which approximately $38,000 represents the estimated full year effect of the ASW acquisition, which took place in November 2016. Sales of mill rolls to the steel industry increased by approximately $24,000. Sales for the Air and Liquid Processing segment also improved when compared to a year ago. The increase in net sales in 2016, when compared to 2015, is primarily the result of the acquisition of Åkers and ASW, which had net sales, from their respective dates of acquisition, of $128,602.

Consolidated (loss) income from operations for 2016 includes a pre-tax charge of $26,676 for the write-off of goodwill in the Forged and Cast Engineered Products reporting unit deemed to be impaired and, for our Air and Liquid Processing segment, a net pre-tax charge of $4,565 for the estimated costs of asbestos-related litigation through 2026, net of estimated insurance recoveries, and a settlement with an insurance carrier in excess of the receivable amount estimated. By comparison, consolidated (loss) income from operations for 2015 includes pre-tax asbestos-related proceeds of $14,333 received from two insurance carriers in rehabilitation. Higher operating losses for Åkers, including integration-related restructuring costs and unfavorable effects from purchase accounting, further impacted 2016 operating results. Corporate expenses increased in the current year due to higher employee-related costs and professional fees, offset by lower acquisition-related costs. The increase in corporate expenses in 2016, when compared to 2015, is attributable to including a full year effect of centralizing the back office functions, which transferred approximately $800 of additional costs from the operating entities to Corporate, and higher professional fees, resulting primarily from the acquisition of Åkers and ASW. Acquisition-related costs approximated $3,056 and $3,383 in 2016 and 2015, respectively.

A discussion of sales, (loss) income from operations and backlog for the Corporation’s two segments is included below.

Gross margin, excluding depreciation and amortization, as a percentage of net sales, was 17.3%, 16.7% and 17.8% for 2017, 2016 and 2015, respectively. The decrease in 2016, when compared to 2017 and 2015, is principally due to the acquisition of Åkers and unfavorable effects from purchase accounting.

Selling and administrative expenses totaled $61,310 (14.2% of net sales), $58,175 (17.5% of net sales) and $39,510 (16.6% of net sales) for 2017, 2016 and 2015, respectively. The net increase in 2017, as compared to 2016, is principally due to higher commission charges of $1,680, associated with the increase in the volume of shipments, and higher corporate expenses of $1,195, offset by subsequent proceeds of $1,322 received in the current year related to a customer who had filed for bankruptcy in 2016. While the current year includes a full-year effect of the acquisitions, the prior year includes acquisition-related costs of $3,056 and a reserve of $1,513 against the receivable from the customer who filed for bankruptcy protection. The increase for 2016, versus 2015, is primarily due selling and administrative expenses of Åkers and ASW, which approximated $17,145, including the reserve of $1,513 related to the receivable from a customer who had filed for Chapter 11 bankruptcy protection, and higher corporate expenses. Acquisition-related costs for 2016 and 2015 were comparable.

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The charge for asbestos litigation in 2016 represents an extension of the estimated costs of pending and future asbestos claims, net of additional insurance recoveries, from 2024 to the end of 2026, partly offset by asbestos-related proceeds received from a settlement with an insurance carrier in excess of the amount estimated and included as an insurance receivable. The credit for asbestos litigation in 2015 represents asbestos-related proceeds received from two insurance carriers in rehabilitation which, because of their potential insolvency, were not included in the insurance receivable previously recorded. See Note 19 to Consolidated Financial Statements.

The charges for impairment in 2016 represent primarily the write-off of goodwill in the Forged and Cast Engineered Products reporting unit deemed to be impaired. Goodwill is not amortized but is tested for impairment at the reporting unit level at least annually, as of October 1, or whenever events and circumstances indicate the carrying amount may not be recoverable. In connection with our strategic planning process and goodwill impairment testing completed in the fourth quarter of 2016, we determined that goodwill in the Forged and Cast Engineered Products reporting unit was fully impaired, primarily as a result of depressed market conditions.

Interest expense for the current year continued to increase, when compared to the prior years, principally as a result of a full year effect of interest and related costs on the:  (i) notes issued in 2016 in connection with the purchase of Åkers; (ii) loan payable to the non-controlling shareholder of the Åkers Chinese joint venture; and (iii) revolving credit facility, which was entered into in May 2016. Additionally, in 2017, we incurred interest, fees and early termination costs associated with extinguishing ASW’s outstanding credit facility and term loan.

On December 22, 2017, the U.S. federal government enacted the Tax Cuts and Jobs Act (the “Tax Reform”), to become effective as of January 1, 2018, which, among other things, lowered the U.S. corporate statutory income tax rate from 35% to 21%, implemented a modified territorial tax system and imposed a one-time tax on deemed repatriated earnings of foreign subsidiaries. The Tax Reform negatively impacted our income tax provision by approximately $1,565, principally related to the one-time repatriation transition tax offset by income tax benefits resulting from 100% bonus depreciation. There was no cash outlay due to the Tax Reform, however, it reduced the amount of our carryback refund that we would have been able to receive. Additionally, there was no significant impact from remeasuring our U.S. deferred income tax assets and liabilities at the new enacted statutory income tax rate since these net deferred income tax assets are fully valued. We will continue to analyze the Tax Reform and refine our provisional amounts, which could potentially impact the measurement of our tax balances.

In response to the enacted Tax Reform, Staff Accounting Bulletin No. 118 (SAB 118) was issued to address the application of U.S. Generally Accepted Accounting Principles in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform. As of December 31, 2017, in accordance with SAB 118, we made a reasonable estimate of the:  (i) one-time repatriation transition tax; (ii) increased bonus depreciation for assets placed in service on or after September 27, 2017; and (iii) effects on our existing deferred tax balances, but have not completed our full accounting for the tax effects of enactment of the Tax Reform. We anticipate U.S. regulatory agencies will issue further regulations during 2018, which may alter this estimate. We are continuing to analyze our earnings and profits in foreign jurisdictions and our deferred tax balances. 

 

In January 2018, the Financial Accounting Standards Board (“FASB”) released guidance on the accounting for tax on the global intangible low-taxed income (“GILTI”) provisions of the Tax Reform. The GILTI provisions impose a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. The guidance indicates that either accounting for deferred taxes related to GILTI inclusions or to treating any taxes on GILTI inclusions as period cost are both acceptable methods, subject to an accounting policy election. We are still evaluating the GILTI provisions and have not yet elected an accounting policy for GILTI. The final determination of the tax effects of enactment of the Tax Reform will be completed within the measurement period of up to one year from the enactment date as permitted by SAB 118, and any adjustments to provisional amounts that are identified during the measurement period will be recorded in the reporting period in which the adjustment is determined.

For 2016, our income tax provision includes valuation allowances against certain of our deferred income tax assets. To determine whether a valuation allowance was needed, we assessed available positive and negative evidence and estimated whether sufficient future taxable income would be generated to permit use of the existing deferred income tax assets. However, during 2016, we incurred three years of cumulative losses, inclusive of the acquired Åkers businesses as if the businesses were held during the entire three-year period. Such objective evidence limits our ability to consider other subjective evidence, such as projections for future growth and profitability. On the basis of this evaluation, we established valuation allowances of $30,405 to reduce the estimated portion of deferred income tax assets to an amount that is “more likely than not” to be realized. The valuation allowance is a non-cash charge and the deferred income tax assets remain available to offset future income tax payments. Additionally, if and when we return to a level of sustained profitability sufficient to conclude that it is more likely than not that deferred income tax assets will be realized, we will reduce the valuation allowance accordingly.

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Prior to the Tax Reform, our U.S. corporate statutory income tax rate equaled 35%. The effective income tax rate for 2016 is higher than our corporate statutory income tax rate principally due to the recognition of valuation allowances against certain of our deferred income tax assets and the write-off of goodwill, which is non-deductible for tax purposes until the associated entities are sold. The effective income tax rate for 2015 is higher than our corporate statutory income tax rate due to the non-deductibility of acquisition-related costs, state income taxes and a lower statutory income tax rate in jurisdictions where foreign operations incurred a net loss (thereby generating less of a tax benefit).

In 2016, Union Electric Steel sold a portion of its interest in Union Electric Steel MG Roll Co., Ltd., and, as part of that transaction, the joint venture company was renamed Masteel Gongchang Roll Co., Ltd. (“MG”). Certain proceeds are being recognized when received since, at the time of the sale, collectability was not assured. Additionally, as a result of the sale, we re-evaluated our ability to exercise significant influence over the joint venture and determined that we no longer were able to exercise such influence. Accordingly, equity gains (losses) in joint venture for 2017 represent principally proceeds received from the sale of the equity interest. For 2016, equity gains (losses) in joint venture represent the gain on the sale of the equity interest in MG and Union Electric Steel’s share of earnings of MG and, for 2015, its share of losses. See Note 3 to Consolidated Financial Statements.

As a result of the above, for 2017, we incurred a net loss of $12,089, or $0.98 per common share. For 2016, we incurred a net loss of $79,820, or $6.68 per common share, which includes after-tax charges of $26,676, or $2.23 per common share, principally for the write-off of goodwill in the Forged and Cast Engineered Products reporting unit deemed to be impaired; $30,405, or $2.54 per common share, for valuation allowances established against certain of our deferred income tax assets; and $4,565, or $0.38 per common share, for estimated costs of asbestos-related litigation through 2026, net of estimated insurance recoveries estimated and a settlement with an insurance carrier for an amount in excess of the receivable estimated. For 2015, we earned $1,373, or $0.13 per common share, which includes an after-tax credit of $9,316, or $0.89 per common share, for the net benefit of proceeds received from insurance carriers in rehabilitation.

Forged and Cast Engineered Products

 

 

Net sales for 2017 increased from the prior year as a result of higher shipments for each of the segment’s product lines. Net sales of forged engineered products contributed $73,000 of additional sales of which approximately $38,000 represents the estimated full year effect of the ASW acquisition in November 2016, with the balance due to improved demand as a result of elevated pricing in the oil and gas market. Sales of forged and cast mill rolls improved by $11,000 and $13,000, respectively, principally on a higher volume of shipments, both domestically and abroad. Changes in exchange rates used to translate sales and operating results of our foreign operations to the U.S. dollar did not have a significant effect on comparability between 2017 and 2016.

 

Net sales for 2016 include the net sales of Åkers and ASW from their respective dates of acquisition, or $128,602. Net sales of legacy businesses decreased from 2015 primarily as a result of a decline in traditional roll shipments of $15,015 and forged engineered products of $13,170. Additionally, the exchange rate used to translate sales of our U.K. operations from the British pound to the U.S. dollar reduced 2016 net sales by approximately $5,032 when compared to 2015; the impact on operating results, however, was not significant.

Operating results for 2017 improved from a year ago, which includes the write-off of goodwill in the Forged and Cast Engineered Products reporting unit deemed to be impaired of approximately $26,676 and integration-related restructuring expenses. Operating results for the current year principally benefited from the higher volume of shipments (approximately $11,000) and a full-year of contribution from ASW including proceeds received for a customer who filed for bankruptcy protection in 2016 (combined, approximately $5,400). While margins improved from better pricing, unfavorable absorption associated with the temporary idling of one of our cast roll facilities and higher operating and raw material costs minimized the contribution to operating results. Additionally, freight and commissions exceeded the prior year (approximately $3,400) on the higher volume of shipments.

Operating results for 2016 includes the operating results of Åkers and ASW of approximately $(37,207), including the write-off of goodwill, and the incurrence of integration-related expenses and unfavorable effects from purchase accounting. In addition, when compared to 2015, operating results for 2016 were also affected by weaker margins on shipments of our forged and cast mill rolls and forged engineered products by our legacy businesses of $3,003. While our operating results for 2016 were further impacted by a lower volume of shipments of cast rolls and forged engineered products, the effect on operating results was offset by a higher volume of forged roll shipments.

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Backlog at December 31, 2017, increased from the prior year due to improved demand for mill rolls, both forged and cast, and forged engineered products. Of the increase in backlog, approximately 80% is attributable to mill rolls and 20% to forged engineered products. The majority of the increase in backlog at December 31, 2016, from 2015, is due to the inclusion of backlog for Åkers and ASW, or $88,590. As of December 31, 2017, approximately $20,318 of the backlog is expected to be released after 2018.

Air and Liquid Processing

 

 

Net sales for the segment were higher in 2017, when compared to the prior two years. Specifically, sales of air handling systems continued to improve, 14% over the two-year period, as a result our market share growth, principally in the hospital and pharmaceutical industries. While sales of centrifugal pumps fell slightly in the current year, sales over the two-year period grew by a net 8%, principally due to an increase in shipments to U.S. Navy shipbuilders offset by a decrease in commercial pump shipments. Sales of heat exchange coils rose slightly in the current year on additional sales to the nuclear industry; however, sales are approximately 11% less than 2015 due to a reduced level of shipments to the fossil-fueled utility, industrial and OEM/commercial markets resulting from lower demand and increased competition.

Operating income for 2016 and 2015 includes asbestos-related items. For 2016, operating income includes a pre-tax charge of $5,632 for estimated costs of asbestos-related litigation through 2026, net of estimated insurance recoveries, offset by proceeds received of $1,067 from an asbestos-related insurance carrier greater than the receivable estimated. For 2015, operating income includes $14,333 of proceeds received from two insurance carriers in rehabilitation which, because of their potential insolvency, were not included in the insurance receivable previously recorded. Otherwise, operating income for 2017 and 2016 benefited principally from a better product mix and cost containment efforts.

Backlog at the end of 2017 improved from 2016 and 2015 as a result of a higher level of orders for U.S. Navy shipbuilders. Year-end backlog for air handling units was comparable to a year ago and better than 2015 due to improved market demand.  Backlog for heat exchange coils continued to decrease from the previous two years primarily due to a decline in orders for the fossil-fueled utility, industrial and OEM/commercial markets. The majority of the year-end backlog is scheduled to ship in 2018.

LIQUIDITY AND CAPITAL RESOURCES

Net cash flows (used in) provided by operating activities for 2017 equaled $(15,839) compared to $(5,634) and $20,505 for 2016 and 2015, respectively. The increase in cash used for operating activities in 2017, when compared to 2016, is primarily due to our investment in trade working capital as a result of the growth in the mill roll and forged engineered product businesses during the year and anticipated in 2018. Cash flows for the current year benefitted from U.S. federal and state income tax refunds of $6,540. The increase in cash used for operating activities in 2016, when compared to 2015, is principally due to a net loss being incurred in 2016 whereas 2015 was profitable.

In 2016, we recognized non-cash charges for:  (i) the write-off of goodwill in the Forged and Cast Engineered Products reporting unit deemed to be impaired; (ii) valuation allowances to reduce our deferred income tax assets to an amount that is “more likely than not” to be realized; and (iii) the revaluation of our Asbestos Liability and insurance receivables. While these non-cash charges impacted earnings, they did not affect cash flows by the same amount. Instead, since goodwill represents the excess of the purchase price of a business over the fair value of net tangible and intangible assets acquired and liabilities assumed, cash flow is affected at the time the consideration is paid. Additionally, the deferred income tax assets remain available to offset future income tax payments. Finally, the Asbestos Liability, net of insurance recoveries, will be paid over a number of years and will generate tax benefits. Net asbestos-related payments equaled $5,828, $4,630 and $3,971 in 2017, 2016 and 2015, respectively, and are expected to approximate $5,000 in 2018. In 2016, we received proceeds of $1,067 from a settlement with an insurance carrier for asbestos liabilities in excess of the receivable amount estimated and, in 2015, proceeds of $14,333 from two insurance carriers in rehabilitation.

Net cash flows used in investing activities were $13,181, $40,878 and $14,299 in 2017, 2016 and 2015, respectively. The cash portion of the purchase price, net of cash acquired, approximated $27,031 and $3,265 for Åkers and ASW, respectively. The purchase of AUP in 2015 approximated $5,000. During 2017, Union Electric Steel received proceeds of $1,500 from the sale of a portion of its interest in MG; certain proceeds are being recognized when received since, at the time of the sale, collectability was not assured. The majority of the capital expenditures are for our Forged and Cast Engineered Products segment and, as of December 31, 2017, expected future capital expenditures approximated $4,000, which are anticipated to be spent over the next 12-18 months.

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Net cash outflows provided by (used in) financing activities improved in 2017, when compared to 2016 and 2015. During the current year, we borrowed $20,349, net, under our revolving credit facility, which exceeded the cash requirements to pay off the net borrowings (term debt and credit facility) assumed as part of the ASW acquisition. In June 2017, we announced that we would suspend quarterly cash dividends, beginning with the second quarter of 2017. Accordingly, dividends paid in 2017 equaled $0.18 per common share (including $0.09 per common share for dividends declared in 2016 but paid in 2017) versus $0.36 per common share in 2016 and $0.72 per common share in 2015.

The effect of exchange rate changes on cash and cash equivalents is primarily attributable to the fluctuation of the British pound and Swedish krona against the U.S. dollar.

As a result of the above, cash and cash equivalents decreased by $17,879 in 2017 and ended the year at $20,700, in comparison to $38,579 and $95,122 at December 31, 2016, and 2015, respectively. Cash held by our foreign operations equaled $15,809, $12,539 and $10,785 at December 31, 2017, 2016 and 2015, respectively. Under the Tax Reform, future distributions of non-U.S. assets to the U.S. will no longer be subject to U.S. taxation; however, local and withholding taxes may continue to apply. The cash held by our foreign operations is considered to be permanently reinvested; accordingly, a provision for estimated local and withholding tax has not been made. If we were to remit any foreign earnings to the U.S., the estimated tax impact would be insignificant.

We have sufficient net operating loss carryforwards available to offset any cash payments that would otherwise be required under the Tax Reform; accordingly, the repatriation transition tax is not currently expected to have a significant impact on our cash resources. Funds on hand, funds generated from future operations and availability under our revolving credit facility (approximately $56,000 at December 31, 2017, which remained undrawn) are expected to be sufficient to finance our operational and capital expenditure requirements. While the revolving credit facility limits the amount of distributions upstream, we have not historically relied on or have been dependent on distributions from our subsidiaries and are not expected to be in the future. Additionally, we had approximately $800 (£250 in the United Kingdom and €400 in Belgium) available under short-term lines of credit at December 31, 2017.

We had the following contractual obligations outstanding as of December 31, 2017:

 

 

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With respect to environmental matters, we are currently performing certain remedial actions in connection with the sale of real estate previously owned and periodically incur costs to maintain compliance with environmental laws and regulations. Environmental exposures are difficult to assess and estimate for numerous reasons, including lack of reliable data, the multiplicity of possible solutions, the years of remedial and monitoring activity required, and the identification of new sites. However, we believe the potential liability for remedial actions and environmental compliance measures of approximately $440 accrued at December 31, 2017, is considered adequate based on information known to date (see Note 20 to Consolidated Financial Statements).

The nature and scope of our business brings us into regular contact with a variety of persons, businesses and government agencies in the ordinary course of business. Consequently, we and certain of our subsidiaries from time to time are named in various legal actions. Generally, we do not anticipate that our financial condition or liquidity will be materially affected by the costs of known, pending or threatened litigation (see Note 19 to Consolidated Financial Statements). However, claims have been asserted, principally against Air & Liquid, alleging personal injury from exposure to asbestos-containing components historically used in some products and there can be no assurance that future claims will not present significantly greater and longer lasting financial exposure than presently contemplated.

OFF-BALANCE SHEET ARRANGEMENTS

Our off-balance sheet arrangements include operating leases, capital expenditures and purchase obligations disclosed in the contractual obligations table, and letters of credit unrelated to the Industrial Revenue Bonds, as discussed in Note 10 to the Consolidated Financial Statements. These arrangements are not considered significant to our liquidity, capital resources, market risk or credit risk.

EFFECTS OF INFLATION

While inflationary and market pressures on costs are likely to be experienced, it is anticipated that ongoing improvements in manufacturing efficiencies and cost savings efforts will mitigate the effects of inflation on 2018 operating results. The ability to pass on increases in the price of commodities to the customer is contingent upon current market conditions, with us potentially having to absorb some portion to all of the increase. Product pricing for the Forged and Cast Engineered Products segment is reflective of current costs, with a portion of orders subject to a variable-index surcharge program which helps to protect the segment and its customers against the volatility in the cost of certain raw materials. Additionally, long-term labor agreements exist at each of the key locations. Although one of these agreements expired in 2017, employees continue to work under the expired agreement while negotiations proceed. Additionally, other agreements expire in 2018. As is consistent with past practice, we will negotiate with the intent to secure mutually beneficial arrangements covering multiple years (see Note 10 to Consolidated Financial Statements). Finally, commitments have been executed for natural gas usage and certain commodities (copper and aluminum) to cover a portion of orders in the backlog (see Note 13 to Consolidated Financial Statements).

APPLICATION OF CRITICAL ACCOUNTING POLICIES

We have identified critical accounting policies that are important to the presentation of our financial condition, changes in financial condition and results of operations and involve the most complex or subjective assessments. Critical accounting policies relate to assessing recoverability of property, plant and equipment and accounting for business combinations (including intangibles and goodwill and the recoverability thereof), pension and other postretirement benefits, litigation and loss contingencies, and income taxes.

Property, plant and equipment is reviewed for recoverability whenever events or circumstances indicate the carrying amount of the long-lived assets may not be recoverable. If the undiscounted cash flows generated from the use and eventual disposition of the assets are less than their carrying value, then the asset value may not be fully recoverable potentially resulting in a write-down of the asset value. Estimates of future cash flows are based on expected market conditions over the remaining useful life of the primary asset(s). Accordingly, assumptions are made about pricing, volume and asset-resale values. Actual results may differ from these assumptions. We believe the amounts recorded in the accompanying consolidated financial statements for property, plant and equipment are recoverable and are not impaired as of December 31, 2017.

Business combinations are accounted for under the purchase method of accounting. Accordingly, the amount paid for an acquisition is initially allocated to the tangible assets acquired and liabilities assumed based on their estimated fair values as of the date of acquisition. The purchase price in excess of net tangible assets acquire is then allocated to identifiable intangible assets based on detailed valuations. Any excess purchase price over the fair value of the net tangible and intangible assets acquired and liabilities assumed is allocated to goodwill.

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Significant judgments and assumptions are required in determining the estimated fair value of assets acquired and liabilities assumed. We utilize third-party valuation specialists and actuaries to assist in determining the fair value of assets acquired and liabilities assumed based on information and assumptions provided by us. The valuation of purchased intangible assets is based upon estimates of future performance and cash flows of the acquired business. Each asset is measured at fair value from the perspective of a market participant. The valuation of employee benefit obligations is consistent with the critical accounting policy outlined below. Significant business and valuation assumptions used in the purchase price allocation include, but are not limited to, the valuation methodology, projected revenues and expenses and related growth rates, and discount rates. If different assumptions are used, it could materially impact the estimated fair values of assets acquired and liabilities assumed. Additionally, initial estimates of the fair value of assets acquired and liabilities assumed are provisional and could change as additional information is received. We finalize our valuations as soon as practicable, but not later than one year from the date of acquisition.

Intangible assets with definite lives are amortized using the straight-line method over their estimated useful life, which is determined by identifying the period over which most of the cash flows are expected to be generated. Additionally, intangible assets, both definite and indefinite lived, are assessed for impairment at least annually, as of October 1, or whenever events or circumstances indicate the carrying amount may not be recoverable. If the undiscounted cash flows attributable to the assets are less than their carrying value, then the asset value may not be fully recoverable potentially resulting in a write-down of the asset value. In assessing recoverability, we make assumptions regarding estimated future cash flows and discount rates. If these estimates or related assumptions change in the future, we may be required to record an impairment charge. Also, if the estimate of an intangible asset’s remaining useful life changes, we will amortize the remaining carrying value of the intangible asset prospectively over the revised remaining useful life. We believe the amounts recorded in the accompanying consolidated financial statements for intangible assets are recoverable and are not impaired as of December 31, 2017.

See Note 2 to the Consolidated Financial Statements.

Accounting for pension and other postretirement benefits involves estimating the cost of benefits to be provided well into the future and attributing that cost over the time period each employee works. To accomplish this, input from our actuaries is evaluated and extensive use is made of assumptions about inflation, long-term rate of return on plan assets, longevity, rates of increases in compensation, employee turnover and discount rates. The curtailment of various U.S. defined benefit plans and amendment of various other postretirement benefit plans in 2016 will help to mitigate the volatility in net periodic pension and other postretirement benefit costs resulting from changes in these assumptions.

The expected long-term rate of return on plan assets is an estimate of average rates of earnings expected to be earned on funds invested or to be invested to provide for the benefits included in the projected benefit obligation. Since these benefits will be paid over many years, the expected long-term rate of return is reflective of current investment returns and investment returns over a longer period. Also, consideration is given to target and actual asset allocations, inflation and real risk-free return. We believe the expected long-term rate of return ranging between 6.95% and 7.50% for our domestic plans and 4.45% for our UES-UK plan to be reasonable. Actual returns on plan assets for 2017 approximated 14.38% for our domestic plans and 7.68% for our UES-UK plan. The remaining foreign plans are not funded and the obligations are not significant.

The discount rates used in determining future pension obligations and other postretirement benefits for each of our plans are based on rates of return for high-quality fixed-income investments currently available and expected to be available during the period to maturity of pension and other postretirement benefits. High-quality fixed-income investments are defined as those investments which have received one of the two highest ratings given by a recognized rating agency with maturities of 10+ years. We believe the assumed discount rates ranging between 3.63% and 3.72% for our domestic plans, 3.46% and 3.69% for our other postretirement benefits plans and 2.45% for our foreign plans as of December 31, 2017, to be reasonable.

We believe that the amounts recorded in the accompanying consolidated financial statements related to pension and other postretirement benefits are based on appropriate assumptions although actual outcomes could differ. A percentage point decrease in the expected long-term rate of return would increase annual pension expense by approximately $2,400. A 1/4 percentage point decrease in the discount rate would increase projected and accumulated benefit obligations by approximately $11,000. Conversely, an increase in the expected long-term rate of return would decrease annual pension expense by approximately $2,400 and an increase in the discount rate would decrease projected and accumulated benefit obligations by approximately $11,000.

Litigation and loss contingency accruals are made when it is determined that it is probable that a liability has been incurred and the amount can be reasonably estimated. Specifically, we and certain of our subsidiaries are involved in various claims and lawsuits incidental to their businesses. In addition, claims have been asserted, principally against Air & Liquid, alleging personal injury from exposure to asbestos-containing components historically used in some products manufactured by certain companies which now operate as divisions of Air & Liquid. To assist us in determining whether an estimate could be made of the potential liability for pending and unasserted future claims for Asbestos Liability along with applicable insurance coverage, and the amounts of any

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estimates, we hire a nationally recognized asbestos-liability expert and insurance consultant. Based on their analyses, reserves for probable and reasonably estimable costs for the Asbestos Liability including defense costs and receivables for the insurance recoveries that are deemed probable are established. These amounts rely on assumptions which are based on currently known facts and strategy.

In 2016, we undertook a review of Asbestos Liability claims, defense costs and the likelihood for insurance recoveries. Key variables in these assumptions are summarized in Note 19 to the Consolidated Financial Statements and include the number and type of new claims to be filed each year, the average cost of disposing of each new claim, average annual defense costs, the resolution of coverage issues with insurance carriers, and the solvency risk with respect to the relevant insurance carriers. Other factors that may affect the Asbestos Liability and our ability to recover under our insurance policies include uncertainties surrounding the litigation process from jurisdiction to jurisdiction and from case to case, reforms that may be made by state and federal courts, and the passage of state or federal tort reform legislation. Actual expenses or insurance recoveries could be significantly higher or lower than those recorded if assumptions used in the calculations vary significantly from actual results.

We intend to evaluate the estimated Asbestos Liability and related insurance receivables as well as the underlying assumptions on a regular basis to determine whether any adjustments to the estimates are required. Due to the uncertainties surrounding asbestos litigation and insurance, these regular reviews may result in the incurrence of future charges; however, we are currently unable to estimate such future charges. Adjustments, if any, to our estimate of recorded Asbestos Liability and/or insurance receivables could be material to our operating results for the periods in which the adjustments to the liability or receivable are recorded, and to our liquidity and consolidated financial position when such liabilities are paid.

Accounting for income taxes includes our evaluation of the underlying accounts, permanent and temporary differences, our tax filing positions and interpretations of existing tax law. A valuation allowance is recorded against deferred income tax assets to reduce them to the amount that is “more likely than not” to be realized. In doing so, assumptions are made about the future profitability of our operations and the nature of that profitability. Actual results may differ from these assumptions. If we determined we would not be able to realize all or part of the deferred income tax assets in the future, an adjustment to the valuation allowance would be established resulting in a charge to net income (loss). Likewise, if we determined we would be able to realize deferred income tax assets in excess of the net amount recorded, we would release a portion of the existing valuation allowance resulting in a credit to net income (loss). As of December 31, 2017, the valuation allowance approximates $38,112 reducing our deferred income tax assets, net of deferred income tax liabilities, to $1,157, an amount we believe is “more likely than not” to be realized.

We do not recognize a tax benefit in the financial statements related to a tax position taken or expected to be taken in a tax return unless it is “more likely than not” that the tax authorities will sustain the tax position solely on the basis of the position’s technical merits. Consideration is given primarily to legislation and statutes, legislative intent, regulations, rulings and case law as well as their applicability to the facts and circumstances of the tax position when assessing the sustainability of the tax position. In the event a tax position no longer meets the “more likely than not” criteria, we would reverse the tax benefit by recognizing a liability and recording a charge to earnings. Conversely, if we subsequently determined that a tax position meets the “more likely than not” criteria, we would recognize the tax benefit by reducing the liability and recording a credit to earnings. As of December 31, 2017, based on information known to date, we believe the amount of unrecognized tax benefits of $117 for tax positions taken or expected to be taken in a tax return which may be challenged by the tax authorities is adequate.

We have recorded provisional estimates associated with the December 2017 enactment of the Tax Reform. The SEC has provided accounting and reporting guidance that allows us to report provisional amounts within a measurement period up to one year due to the complexities inherent in adopting the changes. We consider both the recognition of the repatriation transition tax and the remeasurement of our deferred income tax assets and liabilities as incomplete. New guidance from regulators, interpretation of the law, and refinement of our estimates from ongoing analysis of data and tax positions may change the provisional amounts. The repatriation transition tax is based on our total post-1986 foreign earnings and profits that were previously deferred from U.S. taxation. We have not yet completed our substantiation of the underlying data and therefore our taxable base estimates may change. Our estimates of foreign tax credits may also change as we substantiate tax credits claimed. Further, the repatriation transition tax is based in part on the amount of foreign earnings held in cash and other liquid assets. The repatriation transition tax may change as we more precisely calculate amounts held in liquid and illiquid assets at the various measurement dates. If the final tax outcome of these matters is different than provisional amounts, it will impact the provision for income taxes and the effective tax rate in the period recorded.

In 2017, we recognized the tax impact of including certain foreign earnings in U.S. taxable income. Additional taxes, local and withholding, may result when earnings are repatriated to the U.S. We have not recognized any additional charge for local and withholding taxes that could be incurred on any distributions of non-U.S. earnings, because such non-U.S. earnings are deemed to be permanently invested. Remittances of non-U.S. earnings are based on estimates and judgments of projected cash flow needs, as well as the working capital and investment requirements of our non-U.S. and U.S. operations. Material changes in our estimates of cash,

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working capital, and investment needs in various jurisdictions could require repatriation of indefinitely reinvested non-U.S. earnings, which could be subject to applicable non-U.S. income and withholding taxes, however, the amount is not expected to be significant.

See Note 15 to the Consolidated Financial Statements.

RECENTLY IMPLEMENTED ACCOUNTING PRONOUNCEMENTS

In January 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income, which allows for a reclassification from accumulated other comprehensive income (loss) to retained earnings for the stranded tax effects resulting from the Tax Reform. A stranded tax effect is defined as the difference in the tax effect of amounts recognized as other comprehensive income (loss) items, using the income tax rate in effect at the time of recognition and the newly enacted income tax rate. ASU 2018-02 is relevant only to the reclassification of the income tax effects of the Tax Reform; accordingly, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The guidance becomes effective for interim and annual periods beginning after December 15, 2018; however, early adoption is permitted. We adopted the new guidance in our 2017 accounts and, as a result, $6,088 was reclassified between accumulated other comprehensive loss and retained earnings.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. The guidance also requires presentation of excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity. The amended guidance became effective for us January 1, 2017, and did not have a significant impact on our financial position, operating results or liquidity.

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory, which revises the measurement of inventory at the lower of cost or market. In accordance with ASU 2015-11, an entity will measure inventory at the lower of cost and net realizable value, which is defined as the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. The amendment does not apply to inventory that is measured using the last-in, first out (LIFO) method. The guidance became effective for us January 1, 2017, and did not have a significant impact on our financial position, operating results or liquidity.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging, which amends and simplifies existing guidance to allow companies to more accurately present the economic effects of risk management activities in the financial statements. The amended guidance will be effective for interim and annual periods beginning after December 15, 2018; however, early adoption is permitted. We are currently evaluating the impact the guidance will have on our financial position and operating results. It will not, however, affect our liquidity.

In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting, which provides guidance about which changes to the terms and conditions of a share-based payment award require an entity to apply modification accounting. The amendment will be applied prospectively to an award modified on or after the adoption date. The amended guidance will be effective for interim and annual periods beginning after December 15, 2017. The guidance will not affect our financial position, operating results and liquidity as of the date of adoption.

In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires an employer who offers defined benefit and postretirement benefit plans to report the service cost component of net periodic benefit cost in the same line item or items as other compensation costs arising from services rendered by employees during the period. The other components of net periodic benefit cost are required to be presented in the income statement separately from the service cost component and outside the subtotal of income from operations. The amendment also allows only for the service cost component of net periodic benefit cost to be eligible for capitalization when applicable. The amended guidance does not change the amount of net periodic benefit cost to be recognized, only where it is to be recognized in the income statement. The amended guidance becomes effective for interim and annual periods beginning after December 15, 2017, and must be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension and other postretirement costs in the income statement and prospectively for capitalization of the service cost component of net periodic benefit cost in inventory. A practical expedient is available permitting employers to use the amounts disclosed in its pension and other postretirement benefit plan footnote (Note 9 to the Consolidated Financial Statements) as the estimate to apply retrospectively. The guidance will not affect our financial position or liquidity.

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In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, which clarifies guidance on the classification of certain cash receipts and payments in the statement of cash flows. The amended guidance will be effective for interim and annual periods beginning after December 15, 2017. The guidance will not have a significant impact on the presentation of our cash flow statement, and it will not affect our financial position, operating results or liquidity.

In May 2016, April 2016, March 2016 and May 2014, the FASB issued ASUs 2016-12, 2016-10, 2016-08 and 2014-09, respectively, Revenue from Contracts with Customers (Topic 606), which provides a common revenue standard for U.S. GAAP and IFRS. The guidance establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from a company’s contracts with customers. It requires companies to apply a five-step model when recognizing revenue relating to the transfer of goods or services to customers in an amount that reflects the consideration that the company expects to be entitled to receive for those goods and services. It also requires comprehensive disclosures regarding revenue recognition. The guidance becomes effective for interim and annual periods beginning after December 15, 2017, and can be implemented on either a full or modified retrospective basis. We will use the modified retrospective method (a cumulative adjustment to our January 1, 2018 retained earnings). Based on the evaluation of our current contracts and revenue streams, we determined they will be recorded consistently under both existing generally accepted accounting principles and the new standard. Accordingly, the new guidance will not have a material effect on our financial position, operating results or liquidity. Our disclosures, however, will change significantly in response to the requirements of the new guidance.  

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with a term of more than one year. Accounting by lessors will remain similar to existing generally accepted accounting principles. The guidance becomes effective for us January 1, 2019. We are currently evaluating the impact the guidance will have on our financial position, operating results and liquidity.

 

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities, which simplifies the accounting and disclosures related to equity investments. ASU 2016-01 will require entities to carry certain investments in equity securities at fair value with changes in fair value recorded through net income (loss) versus other comprehensive income (loss).     ASU 2016-01 does not apply to investments that qualify for the equity method of accounting or to those that result in consolidation of the investee. The guidance becomes effective for interim and annual periods beginning after December 15, 2017, and must be adopted by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. At December 31, 2017, unrealized holding gains on securities approximated $600 which will be recorded as the cumulative-effect adjustment to retained earnings. Prospectively, the guidance is not expected to have a significant effect on our financial position, operating results and liquidity.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Of our primary market risk exposures, we view changes in foreign currency rates and commodity prices to be significant enough to mitigate through derivative instruments and forward purchase agreements. To manage certain foreign currency exchange exposures, our policy is to hedge a portion of our foreign currency denominated sales and receivables, primarily U.S. sales denominated in euros and U.K. sales denominated in U.S. dollars and euros. Although strengthening of the U.S. dollar could result in a lower volume of exports from the United States and at reduced margins, exports of our foreign operations may increase and gross margins might improve. Additionally, strengthening of the British pound could result in a lower volume of exports from the United Kingdom and at reduced margins; however, exports for our domestic operations may increase and gross margins might improve. A weakening of the euro, as compared to the U.S. dollar and British pound, could result in a lower volume of exports and at reduced margins.

To reduce the effect of price changes for certain of our raw materials and energy, we enter into contracts for particular commodities (copper and aluminum) and purchase a portion of our energy usage in advance. Based on estimated annual purchases, a 10% fluctuation in commodity prices (including electricity, natural gas, steel scrap and ferroalloys) would have impacted 2017 and 2016 by approximately $14,000 and $8,000 (or approximately $11,000 if the Åkers and ASW acquisitions were completed as of the beginning of the year), respectively. There is no guarantee that fluctuations in commodity prices will be limited to 10%. The ability to pass on increases in the price of commodities to the customer is contingent upon current market conditions with us potentially having to absorb a portion to all of such increase. However, a sales price surcharge mechanism is in place with a portion of the customers of our Forged and Cast Engineered Products segment which helps to protect against the volatility in the cost of certain raw materials.

See also Note 13 to the Consolidated Financial Statements.  

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED BALANCE SHEETS

 

 

See Notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF OPERATIONS