AK STEEL HOLDING CORPORATION Executive Overview
We are a leading producer of flat-rolled carbon, stainless and electrical steel
products, primarily for the automotive, infrastructure and manufacturing, and
distributors and converters markets. Our downstream businesses also provide
customer solutions with carbon and stainless steel tubing products, high-end
stainless steel finishing, advanced-engineered solutions, tool design and build,
hot- and cold-stamped steel components and complex assemblies.
Our mission is to create innovative, high-quality steel solutions for our
customers and our key values of safety, quality, productivity and innovation,
along with environmental responsibility and sustainability, are its foundation.
We target customers who require the most technically demanding, highest-quality
steel products, "just-in-time" delivery, technical support and product
development assistance. Our robust product quality and delivery capabilities, as
well as our emphasis on collaborative customer technical support and product
planning, are critical factors in our ability to serve our customer markets. We
focus on value-added steel solutions rather than sales into commodity steel
markets.
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Table of Contents 2019 Financial Overview In 2019, we made significant capital investments to strengthen the company for the long-run, including a major planned outage that will lower our steelmaking costs at Dearborn Works and the construction of a newPrecision Partners facility to grow our market position and capabilities in automotive stamping and complex assembly. While those investments will benefit the company in future years, we faced market headwinds in 2019 that impacted our financial results. Those headwinds included lower shipments resulting from challenging steel market conditions with softening spot market steel prices and a slight decline in automotive demand, including reduced shipments to General Motors as a result of the 40-day strike that halted its vehicle production. Our 2019 net income was$11.2 , or$0.04 per diluted share of common stock, which reflected a charge for theAshland Works closure of$69.3 (or$0.22 per diluted share), compared to 2018 net income of$186.0 , or$0.59 per diluted share. Our 2019 results also reflected a pension settlement charge of$26.9 , or$0.08 per diluted share, from a pension annuity transaction that we entered into in the fourth quarter of 2019 as part of our efforts to de-risk our balance sheet. Our 2018 results reflected a pension settlement charge of$14.5 , or$0.05 per diluted share, for a separate pension annuity transaction that we entered into in 2018. Excluding the Ashland closure and pension settlement charges, 2019 adjusted net income was$107.4 , or$0.34 per diluted share, compared to 2018 adjusted net income of$200.5 , or$0.64 per diluted share. Our adjusted EBITDA (as defined in Non-GAAP Financial Measures) was$446.5 , or 7.0% of net sales, for 2019, compared to adjusted EBITDA of$563.4 , or 8.3% of net sales, for 2018. Our 2019 results reflected lower shipments of flat-rolled steel from a year ago, primarily due to a softening of sales to the distributors and converters market and reduced shipments to the automotive market. The average selling price per flat-rolled steel ton decreased by 1% in 2019 from 2018, primarily due to lower selling prices for carbon spot market sales. These impacts were partially offset by higher selling prices to the automotive market and lower costs for scrap, alloys and energy. Maintenance outage costs in 2019 were$81.0 , compared to$91.1 in 2018. We recorded mark-to-market unrealized gains on iron ore derivatives of$49.6 in 2019, as compared to unrealized gains of$0.2 in 2018. InJanuary 2019 , we announced our intent to closeAshland Works , including the previously idled blast furnace and steelmaking operations ("Ashland Works Hot End"), and the hot dip galvanizing coating line that had remained operational. During 2019, we transitioned products to our other, lower costU.S. coating lines and inNovember 2019 ceased operations at theAshland Works coating line. We recorded a charge of$69.3 , or$0.22 per diluted share, during 2019 for termination of certain take-or-pay agreements, supplemental unemployment and other employee benefit costs, estimated multiemployer plan withdrawal liability, and other costs. See discussion below and in Note 3 to the consolidated financial statements. During 2019, we transferred$615.6 of pension obligations to a highly-rated insurance company for approximately 4,250 retirees or their beneficiaries. Since mid-2016, we have transferred a total of$1.1 billion in pension trust assets to purchase four non-participating annuity contracts that require highly-rated insurance companies to pay the transferred pension obligations to approximately 20,000 pension participants. The settlement charges related to these transactions represent the recognition of unrealized actuarial losses that were being recognized over the future estimated remaining lives of the affected pension participants. 2019 Compared to 2018 Steel Shipments Flat-rolled steel shipments in 2019 were 5,342,200 tons, a 6% decrease compared to 2018 shipments of 5,683,400 tons. The decrease was a result of lower shipments to the distributors and converters market and a 6% decline in shipments to the automotive market, due in part to the 40-day strike at General Motors. Shipments of flat-rolled steel by product category for 2019 and 2018, as a percent of total flat-rolled steel shipments, were as follows: - 23-
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Flat-Rolled Steel Shipments by Product Category
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Net Sales The following table presents information on net sales:
2019 2018 Increase (Decrease)
Net sales $ 6,359.4 $ 6,818.2 (7 )%
Average net selling price per ton 1,078 1,091 (1 )%
Net sales outside the United States 569.4 634.8
Net sales outsidethe United States as a percent of net sales 9 % 9 % The decrease in net sales was driven primarily by lower shipments and lower spot market steel pricing, which includes the effect of surcharges, partly offset by higher selling prices for automotive shipments. The decrease in average net selling price per ton was primarily driven by reduced selling prices in the carbon spot market.
The following table presents the percentage of net sales to each of our markets:
Market 2019 2018
Automotive 66 % 63 %
Infrastructure and Manufacturing 16 % 15 %
Distributors and Converters 18 % 22 %
Cost of Products Sold
Cost of products sold in 2019 of $5,606.3 , or 88.2% of net sales, decreased from
2018 cost of products sold of $5,911.0 , or 86.7% of net sales. The decrease was
largely due to a lower volume of shipments and lower costs for scrap, alloys and
energy, which were partially offset by higher costs for iron ore, coal and
coke. Cost of products sold in 2019 included total outage costs of $81.0 ,
compared to total outage costs in 2018 of $91.1 , which included unplanned outage
costs at our Middletown Works totaling $50.9 . We had $18.9 of insurance
recoveries in 2019, compared to insurance recoveries totaling $15.1 in 2018. We
recorded mark-to-market gains of $49.6 and $0.2 for 2019 and 2018 from iron ore
derivatives that do not qualify as cash flow hedges for accounting purposes.
Selling and Administrative Expense
Selling and administrative expense decreased to$295.2 in 2019 from$322.6 in 2018. The decrease was primarily a result of lower variable compensation expense compared to the prior year. - 24-
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Table of Contents Depreciation Expense Depreciation expense decreased to$192.6 in 2019 from$220.2 in 2018. The decline was primarily a result of a significant amount of fixed assets related to the initial construction of our Rockport Works facility becoming fully depreciated as ofDecember 31, 2018 , partly offset by higher depreciation at SunCoke Middletown. Ashland Works Closure As a result of the decision to permanently closeAshland Works discussed in Note 3 to the consolidated financial statements, we recorded a charge in 2019 of$69.3 , which included$18.5 for termination of certain take-or-pay supply agreements,$20.1 for supplemental unemployment and other employee benefit costs, pension and other postretirement employee benefit ("OPEB") termination benefits of$13.3 (recorded in pension and OPEB (income) expense), an estimated multiemployer plan withdrawal liability of$10.0 , and$7.4 for other costs.
Operating Profit
Operating profit for 2019 of
Interest Expense
Interest expense for 2019 decreased to
Pension and OPEB (Income) Expense
Pension and OPEB expense was$12.0 in 2019, compared to income of$19.2 in 2018. The change from income to expense in 2019 was primarily due to pension and OPEB termination benefits of$13.3 recognized in 2019 associated with theAshland Works closure and a lower expected return on plan assets, partially offset by a greater amount of amortization of unrealized gains. We also recorded settlement losses of$26.9 and$14.5 in 2019 and 2018 as a result of purchases of non-participating annuity contracts for certain retirees and lump sum payouts to new retirees. Other (Income) Expense
Other (income) expense was income of
Income Tax Expense (Benefit)
We recorded income tax expense of$6.2 in 2019, compared to an income tax benefit of$6.2 in 2018. Included in 2018 is an income tax benefit of$5.3 as a result of a reduction in our valuation allowance caused by changes to the tax net operating loss carryover rules included in the Tax Cuts and Jobs Act of 2017 that allow us to use certain indefinite-lived deferred tax liabilities as a source of future income to realize deferred tax assets.
Net Income and Adjusted Net Income Attributable to
Net income attributable toAK Holding in 2019 was$11.2 , or$0.04 per diluted share. Net income in 2019 included a charge for theAshland Works closure of$69.3 , or$0.22 per diluted share, and a pension settlement loss of$26.9 , or$0.08 per diluted share. Excluding these items, we reported adjusted net income attributable toAK Holding of$107.4 , or$0.34 per diluted share, for 2019. Net income attributable toAK Holding in 2018 was$186.0 , or$0.59 per diluted share. Net income in 2018 reflected a pension settlement charge of$14.5 , or$0.05 per diluted share. Excluding this item, we reported adjusted net income attributable toAK Holding of$200.5 , or$0.64 per diluted share, for 2018.
Adjusted EBITDA
Adjusted EBITDA was
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For a comparison of the year endedDecember 31, 2018 to the year endedDecember 31, 2017 , refer to 2018 Compared to 2017, which is incorporated herein by reference, of Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2018 . Non-GAAP Financial Measures In certain of our disclosures, we have reported adjusted EBITDA, adjusted EBITDA margin and adjusted net income attributable toAK Holding that exclude the effects of noncontrolling interests, costs associated with the closure ofAshland Works , pension settlement charges and a credit for adjustment to a liability for transportation costs. We believe that reporting adjusted net income attributable toAK Holding (as a total and on a per share basis) with these items excluded more clearly reflects our current operating results and provides investors with a better understanding of our overall financial performance. Adjustments to net income attributable toAK Holding do not result in an income tax effect as any gross income tax effects are offset by a corresponding change in the deferred income tax valuation allowance. EBITDA is an acronym for earnings before interest, taxes, depreciation and amortization. It is a metric that is sometimes used to compare the results of different companies by removing the effects of different factors that might otherwise make comparisons inaccurate or inappropriate. For purposes of this report, we have made the adjustments to EBITDA noted in the preceding paragraph. The adjusted results, although not financial measures under generally accepted accounting principles inthe United States ("GAAP") and not identically applied by other companies, facilitate the ability to analyze our financial results in relation to those of our competitors and to our prior financial performance by excluding items that otherwise would distort the comparison. Adjusted EBITDA, adjusted EBITDA margin and adjusted net income are not, however, intended as alternative measures of operating results or cash flow from operations as determined in accordance with GAAP and are not necessarily comparable to similarly titled measures used by other companies. Neither current stockholders nor potential investors in our securities should rely on adjusted EBITDA, adjusted EBITDA margin or adjusted net income as a substitute for any GAAP financial measure and we encourage investors and potential investors to review the following reconciliations of adjusted EBITDA and adjusted net income. Reconciliation of Adjusted EBITDA 2019 2018
2017
Net income attributable to AK Holding$ 11.2 $ 186.0 $ 103.5 Net income attributable to noncontrolling interests 51.8 58.1 61.4 Income tax expense (benefit) 6.2 (6.2 ) (2.2 ) Interest expense, net 145.7 150.7 150.9 Depreciation and amortization 209.8 237.0 236.3 EBITDA 424.7 625.6 549.9 Less: EBITDA of noncontrolling interests (a) 74.4 76.7 77.7 Ashland Works closure 69.3 - - Pension settlement charges 26.9 14.5 - Credit for adjustment of liability for transportation costs - - (19.3 ) Asset impairment charge - - 75.6 Adjusted EBITDA$ 446.5 $ 563.4 $ 528.5 Adjusted EBITDA margin 7.0 % 8.3 % 8.7 %
(a) The reconciliation of net income attributable to noncontrolling interests
to EBITDA of noncontrolling interests is as follows:
2019 2018 2017
Net income attributable to noncontrolling interests
22.6 18.6 16.3
EBITDA of noncontrolling interests$ 74.4 $ 76.7 $ 77.7 - 26-
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Reconciliation of Adjusted Net Income
2019 2018 2017
Reconciliation to Net Income Attributable to AK
Holding
Net income attributable to AK Holding, as reported $ 11.2 $ 186.0 $ 103.5
Ashland Works closure 69.3 - -
Pension settlement charges 26.9 14.5 -Credit for adjustment of liability for transportation costs
- - (19.3 )
Asset impairment charge -
- 75.6
Adjusted net income attributable to
Reconciliation to Diluted Earnings per Share Diluted earnings per share, as reported$ 0.04 $ 0.59 $ 0.32 Ashland Works closure 0.22 - - Pension settlement charges 0.08 0.05 -
Credit for adjustment of liability for transportation costs
- - (0.06 )
Asset impairment charge - - 0.24
Adjusted diluted earnings per share $ 0.34 $
0.64
Liquidity and Capital Resources
We have a revolving credit facility (the "Credit Facility") that expires inSeptember 2022 with a$1,500.0 commitment. AtDecember 31, 2019 , we had total liquidity of$835.4 , consisting of$30.8 of cash and cash equivalents and$804.6 of availability under the Credit Facility. Our obligations under the Credit Facility are secured by inventory and accounts receivable. Availability under the Credit Facility fluctuates monthly based on our varying levels of eligible collateral. Our eligible collateral was$1,327.1 atDecember 31, 2019 , after application of applicable advance rates. AtDecember 31, 2019 , we had$450.0 of outstanding borrowings under the Credit Facility, and$72.5 of outstanding letters of credit that further reduced availability. During the year endedDecember 31, 2019 , our borrowings from the Credit Facility ranged from$285.0 to$475.0 , with outstanding borrowings averaging$356.0 per day. We believe that our current sources of liquidity will be adequate to meet our obligations for the foreseeable future. We expect to fund future liquidity requirements for items such as capital investments, employee and retiree benefit obligations, scheduled debt maturities and debt redemptions with internally generated cash and other financing sources. As part of our efforts to improve our capital structure, we regularly evaluate accessing the capital markets as a source of liquidity if we view conditions as favorable. We may use the Credit Facility as necessary to fund requirements for working capital, capital investments and other general corporate purposes. We are focused on reducing debt through free cash flow generation. Our Credit Facility is scheduled to expire inSeptember 2022 and any amounts outstanding under it at the time of expiration would need to be repaid or refinanced. From time to time, we may repurchase, as we have done previously, outstanding notes in the open market on an unsolicited basis, by tender offer, through privately negotiated transactions or otherwise. Our forward-looking statements on liquidity are based on currently available information and expectations and, if the information or expectations are inaccurate or conditions deteriorate, there could be a material adverse effect on our liquidity. We have significant debt maturities and other obligations that will be due in future periods, including possible required cash contributions to our qualified pension plan. For further information, see the Contractual Obligations section. Cash from operating activities totaled$265.9 for 2019, which includes$68.6 that was generated by and can only be used by SunCoke Middletown for its operations or for distribution to its equity owners. Cash generated from a$60.2 decrease in accounts receivable, a$73.7 decrease in inventory and a$75.0 decrease in other assets was partially offset by cash used for a$172.8 decrease in accounts payable and other current liabilities. During the year, we made required annual pension contributions of$43.5 and payments for other pension and OPEB benefits of$27.7 . The remaining cash from operations was generated from normal business activities for the year.
Investing and Financing Activities
During 2019, net cash used for investing activities totaled$188.2 , primarily for capital investments, including$14.0 of capital investments made by SunCoke Middletown. Cash used for capital investments, excluding SunCoke Middletown, totaled$180.8 in 2019. Our increase in 2019 from 2018 was primarily due to significant capital investments to strengthen the company for the long-run, - 27-
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including a major planned outage that will lower our steelmaking costs at
Dearborn Works and the construction of a new
Net cash used for financing activities in 2019 was$95.3 , primarily for payments to retire the aggregate principal amount of$148.5 of our Exchangeable Notes, partly offset by from borrowings on the Credit Facility. The total cash used for financing activities also includes$55.6 of payments from SunCoke Middletown to SunCoke.
Restrictions Under Debt Agreements
The indentures governing our senior indebtedness and tax-exempt fixed-rate
industrial revenue bonds ("IRBs") (collectively, the "Notes") and Credit
Facility contain restrictions and covenants that may limit our operating
flexibility. The Credit Facility contains customary restrictions, including
limitations on, among other things, distributions and dividends, acquisitions
and investments, dispositions, indebtedness, liens and affiliate transactions.
Availability is calculated as the lesser of the total commitments under the
Credit Facility or eligible collateral after advance rates, less outstanding
revolver borrowings and letters of credit. The Credit Facility requires us to
maintain a minimum fixed charge coverage ratio of one to one if availability
under the Credit Facility is less than $150.0 . We are in compliance with
restrictions and covenants under our Credit Facility and Notes and, in the
absence of any significant and sustained material adverse events, expect that we
will remain in compliance for the foreseeable future.
The indentures governing the Notes include customary restrictions on (a) the
incurrence of additional debt by certain of our subsidiaries, (b) the incurrence
of certain liens, (c) the amount of sale/leaseback transactions, and (d) our
ability to merge or consolidate with other entities or to sell, lease or
transfer all or substantially all of our assets to another entity. The Notes
also contain customary events of default. In addition, the indenture governing
the 7.50% Senior Secured Notes due July 2023 includes covenants with customary
restrictions on the use of proceeds from the sale of collateral.
We do not expect any of these restrictions to affect or limit our ability to
conduct our business in the ordinary course. During 2019, we were in compliance
with all the terms and conditions of our debt agreements.
Employee Benefit Obligations
In recent years, we have taken multiple steps in reducing and de-risking our pension obligations, including freezing all benefits under our major pension plan, closing our pension plans to new participants, and providing lump sum distributions to eligible participants. During 2019, we transferred$615.6 of pension obligations to an insurance company for approximately 4,250 retirees or their beneficiaries. Since mid-2016, we have transferred a total of$1.1 billion in pension trust assets to purchase four non-participating annuity contracts that require highly-rated insurance companies to pay the transferred pension obligations to approximately 20,000 pension participants. These actions greatly reduce our exposure to financial market volatility and the risk of significant increases in future required pension contributions as a result of this volatility. We intend to actively seek options to further de-risk our pension and OPEB obligations. Our pension and OPEB obligations recorded on our consolidated balance sheets declined by$109.8 in 2019, primarily due to contributing$43.5 to the pension trust and achieving favorable investment returns from pension plan assets. We will be required to make contributions to our plan's pension trust of varying amounts until it is fully funded, and some of these contributions could be substantial. We are required to make approximately$45.0 of pension contributions in 2020. Based on current actuarial assumptions, we expect to make required annual pension contributions of approximately$45.0 for 2021 and$35.0 for 2022. The amount and timing of future required contributions to the pension trust depend on assumptions about future events. The most significant of these assumptions are the future investment performance of the pension funds, actuarial data about plan participants and the interest rate we use to discount benefits to their present value. In addition, the amount and timing of future contributions may be affected by future activities we may take to reduce and de-risk our pension obligations. Because of the variability of factors underlying these assumptions, including the possibility of future pension legislation or increased pension insurance premiums, the reliability of estimated future pension contributions decreases as the length of time until we must make the contribution increases. EffectiveJanuary 1, 2020 , we changed our assumption for future expected returns on plan assets to 7.50% from 6.75% in response to a change in asset allocation. We provide healthcare benefits to a significant portion of our employees and retirees. OPEB benefits have been either eliminated for new employees or are subject to caps on the share of benefits we pay. Based on the assumptions used to value other postretirement benefits, primarily retiree healthcare and life insurance benefits, annual cash payments for these benefits are expected to be in a range that trends down from$35.6 in 2020 to$7.6 over the next 30 years. - 28-
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Table of Contents Ashland Works Closure InJanuary 2019 , our Board of Directors approved and we announced the planned closure of ourAshland Works , including the previously idled Ashland Works Hot End and the hot dip galvanizing coating line that continued to operate. Factors that influenced our decision to closeAshland Works included an uncertain global trade landscape influenced by shifting domestic and international political priorities,Ashland Works' high cost of production, and continued intense competition from domestic and foreign steel competitors. These conditions directly impacted our pricing, which in turn directly impacted our assessment of the demand forecasts for the markets we serve. Despite several favorable trade actions, carbon steel imports remained at a high level, driven by global overcapacity, particularly inChina . We expected global overcapacity to be exacerbated by several domestic steel companies that had restarted or planned new capacity additions inthe United States . In addition, we concluded that we had sufficient coating capacity to meet our customers' needs without using our coating operations atAshland Works . We have transitioned products to our other, lower costU.S. coating lines and closed theAshland Works coating line inNovember 2019 . By transitioning production to our other, lower cost operations inthe United States that have available capacity, we have increased those operations' utilization rates. Once fully implemented, these actions are projected to result in annual savings of over$40.0 , primarily from switching production to lower-cost operations, reducing the costs for ongoing maintenance, utilities and supplier obligations atAshland Works , and lowering transportation costs by being able to process steel closer to the end customer and eliminate additional product movement between our facilities. These savings, which began in 2019, and the positive impact of the Administration's policies to address unfair trade practices will help facilitate our longer-term growth plans by helping us maintain and enhance our more cost-effective steelmaking facilities and further driving growth and innovation. For the year endedDecember 31, 2019 , we have recorded a charge of$69.3 , which included$18.5 for termination of take-or-pay supply agreements,$20.1 for supplemental unemployment and other employee benefit costs, pension and OPEB termination benefits of$13.3 (recorded in pension and OPEB (income) expense), an estimated multiemployer plan withdrawal liability of$10.0 (after a fourth quarter 2019 credit of$8.0 to adjust the estimate), and$7.4 for other costs. We made cash payments of$8.8 in 2019 related to the 2019 charge and expect to make cash payments of approximately$25.0 in 2020 and the remaining amount over several years thereafter. The supplemental unemployment and other employee benefit costs are expected to be paid primarily in 2020 and 2021. The actual multiemployer plan withdrawal liability will not be known until a future date and is expected to be paid over a number of years. Ongoing costs to maintain the equipment and utilities and meet supplier obligations related to the idled Ashland Works Hot End were$12.6 ,$20.0 and$21.2 for the years endedDecember 31, 2019 , 2018 and 2017. These cash costs related to closing the facility will decline in future years. We recorded$4.0 of accelerated depreciation related to the coating line fixed assets for the year endedDecember 31, 2019 to fully depreciate them.
Off-Balance Sheet Arrangements
There were no material off-balance sheet arrangements as of
Selected Factors that Affect Our Operating Results
Automotive Market
We sell a significant portion of our carbon and stainless steel flat-rolled and tubular products directly to automotive manufacturers and their Tier 1 suppliers, as well as to distributors, service centers and converters who in some cases resell the products to the automotive industry. Because the automotive market is an important element of our business and growth strategy, North American light vehicle production has a significant impact on our total sales and shipments. In 2019, North American light vehicle production declined to approximately 16.3 million units from the prior year, due in part to the 40-day strike atGM that halted its vehicle production. As a result of these factors, our flat-rolled steel shipments to the automotive industry declined 6%. Substantially all ofPrecision Partners' revenue is from the automotive market and new vehicle platforms in its hot-stamping and cold-stamping business drove a higher level of revenue in 2019 than in 2018. InMay 2019 ,GM andFord each presented us with prestigious supplier awards. At theGM 27th Annual Supplier of the Year Awards,GM recognized its best suppliers that have consistently exceededGM's expectations, created outstanding value or introduced innovations toGM .AK Steel was awarded as a Supplier of the Year for Non-Fabricated Steel, the second consecutive year that we received the award. In addition, atFord's 21st Annual Ford World Excellence Awards,Ford recognizedAK Steel as a top-performing global supplier and presented us with its Smart Brand Pillar award in recognition of demonstrated leadership inFord's primary brand pillars. Further, AK Tube was one of just three suppliers to receive a Supplier of the Year award fromKirchhoff Automotive in 2019. - 29-
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Table of Contents Carbon Steel Spot Market Since 2016, we have intentionally and substantially reduced our sales and shipments to the commodity carbon steel spot market and implemented a strategy to focus our product mix on value-added steel products. Generally, sales into the carbon steel spot market are at prevailing market prices, which are highly volatile, and are subject to intense competition from both low-cost domestic producers and cheap, unfairly traded foreign imports. Fluctuations in spot market prices have a direct effect on our results and are driven by factors mostly outside our control. In addition, the spot market price fluctuations do not always directly correlate with our raw material and energy costs and, consequently, we have limited ability to pass through increases in costs to customers absent increases in the market price. We reduced shipments of our commodity carbon steels in 2019 compared to 2018, primarily due to declining carbon spot market prices.
Specialty Stainless and Electrical Steel Markets
We are a leading manufacturer of value-added stainless steel, primarily for the automotive market. Stainless steel is typically priced with a fixed base price and surcharges to reflect changes in the cost of certain raw materials. Thus, while we expect changes in revenues will generally offset changes in costs, there may be a timing lag from the change in costs in one period to the change in revenue in a different period. We are also a leading manufacturer of GOES and other electrical steels, which we sell to customers primarily inNorth America andEurope . We have experienced a notable decline in shipments to international markets due to global overcapacity and both direct and indirect effects of European and Chinese trade actions. Our domestic electrical steel sales have also declined due to increased imports of laminations (cut sheets of steel) and transformer cores (which includes both stacked and wound laminations).
Section 232 Investigation of Imported Foreign Steel
OnApril 19, 2017 , theCommerce Department initiated an investigation pursuant to Section 232 of the Trade Expansion Act, as amended by the Trade Act of 1974 ("Section 232"), into whether imports of foreign steel into theU.S. posed a threat toU.S. national security. OnMarch 8, 2018 ,President Trump signed a proclamation pursuant to Section 232 imposing a 25 percent tariff on imported steel. Following the proclamation, theU.S. government announced various agreements for exemptions from the Section 232 steel tariff for certain countries, includingArgentina ,Australia ,Brazil andSouth Korea . Some of these countries, such asSouth Korea andBrazil , have agreed to a quota system that limits their annual imports of steel into theU.S. In addition, although steel products from theEuropean Union , Canada andMexico were initially exempted from the tariff, onJune 1, 2018 , those exemptions expired and the Section 232 tariff was applied to steel imports from these countries as well. In retaliation against the Section 232 tariffs, theEuropean Union ,Mexico andCanada subsequently imposed their own tariffs against certain steel products and other goods imported from theU.S. The Mexican retaliatory tariffs went into effect onJune 5, 2018 , theEuropean Union's tariffs began to apply onJune 22, 2018 , and Canadian tariffs became effective onJuly 1, 2018 . We ship steel products intoCanada ,Mexico and theEuropean Union and have been required to pay tariffs on certain of our shipments. OnMay 17, 2019 ,the United States announced an agreement withCanada andMexico to remove the Section 232 tariffs for steel and aluminum imports from those countries and for the removal of all retaliatory tariffs imposed on American goods by those countries. The agreement provides for aggressive monitoring and a mechanism to prevent surges in imports of steel and aluminum. If surges in imports of specific steel products occur,the United States may re-impose Section 232 tariffs on those products. Any retaliation byCanada andMexico , however, would then be limited to steel products. The Section 232 steel and related retaliatory tariffs still remain in place with theEuropean Union , and negotiations between theU.S. andEuropean Union are ongoing. In addition to the ongoing country-by-country negotiations in which theU.S. government is engaged, theCommerce Department has also implemented a system for petitioning theU.S. government to exempt specific products (for instance, a certain grade of steel) from the tariff and a process for challenging these exemption requests. The possibility exists that, despite our objections, theCommerce Department may grant exemption requests for imported steel products that would have a significant adverse impact on our business. The Section 232 steel tariffs originally only applied to certain steel products, including flat-rolled carbon, stainless and electrical steel products, but not to certain downstream goods that may contain these steels. OnJanuary 24, 2020 ,President Trump signed a proclamation expanding the scope of the duties to a limited number of steel and aluminum derivative products including nails, staples, electrical wires and body stampings for motor vehicles and tractors. Those countries that are currently exempt or subject to a quota are excluded from this action. Downstream electrical steel products were not included. As a result, some third parties or customers may attempt to substitute purchases of our flat-rolled steel with imports of downstream goods containing foreign steel product inputs that are not subject to the tariff or trade cases. These actions would circumvent the purpose and intent of the Section 232 steel tariffs. The effects of the limited scope of the steel tariff are particularly salient to our electrical steel business. Imports of downstream electrical goods not currently covered by the tariff include electrical transformer cores and core assemblies, electrical transformers, and even - 30-
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laminations, which are simply cut pieces of electrical steel. To avoid the Section 232 steel tariff, producers have continued to increase their imports of foreign-made downstream electrical goods or moved some of their domestic production outsidethe United States , which adversely affects our electrical steel business. In the absence of a remedy against these actions to circumvent the Section 232 steel tariff on electrical steel, these actions are likely to increase over time, pressuring our electrical steel business. We continue to proactively work to mitigate or eliminate this potential avenue for avoiding and circumventing the steel tariff, including by communicating our concerns to theU.S. government and requesting appropriate action to address this issue. In the absence of decisive action by theU.S. government or a meaningful change in business or market conditions, we expect our electrical steel business to continue to face material downward pressure. We believethe United States' electrical infrastructure is critical to national security and that additional actions are necessary and should be undertaken by theU.S. government to preserve its short- and long-term integrity. Members of theU.S. Congress have introduced legislation to restrict the President's power to implement tariffs on national security grounds. Some of the proposed legislation has included provisions that would require Congressional approval of the current Section 232 proclamations or they would terminate. If such legislation is passed by both theHouse of Representatives andSenate ,President Trump would have the ability to veto it, which would then require a two-thirds majority vote in each of the branches ofCongress to override the presidential veto. In addition, there are pending challenges to the President's authority and actions under Section 232 in theU.S. court system and before international bodies.
OnDecember 10, 2019 , representatives of theU.S. ,Mexico andCanada signed a revision to the USMCA, which was proposed to replace the existing North American Free Trade Agreement ("NAFTA") among those countries. Among other requirements, the USMCA, as proposed, includes revised "rules of origin" that encourage automobiles and other products manufactured inNorth America to contain higher levels of North American-made content and that require an increased percentage of work on North American-made automobiles be performed by workers earning at least$16 per hour in order to be exempt from tariffs. The proposed terms of the USMCA also include provisions that incentivize the use of North American steel. Because all of our manufacturing facilities are located inNorth America and our principal market is automotive, we believe that the USMCA has the potential to positively impact our business by incentivizing automakers and other manufacturers to increase manufacturing production inNorth America and to use North American steel. For the proposed USMCA to take effect, legislative bodies for all the countries must approve and ratify the agreement. TheU.S. andMexico have ratified the revised agreement.Canada still has to ratify it and that is expected to occur in 2020. At this time, the USMCA does not alter or affect the terms of Section 232 tariffs on imported steel or related retaliatory tariffs, which continue to remain in effect.
Raw Materials
Iron ore is one of the principal raw materials required for our steel manufacturing operations. We purchased approximately 5.8 million tons of iron ore pellets in 2019 and expect to purchase approximately 6.5 million tons in 2020. We make most of our purchases of iron ore at negotiated prices under multi-year agreements. For 2020, we expect to purchase all of our iron ore from Cliffs. The price we pay for iron ore is affected by a variety of factors under the terms of our contracts, including measures of general industrial inflation and steel prices and a variable-price mechanism that adjusts the annual average price we pay for iron ore based on reference to an iron ore index referred to as the IODEX. A change in one of more of the factors upon which our iron ore price is determined (whether that may be the IODEX, inflation, steel prices or other indices) typically affects to varying degrees the price we pay for iron ore. Accordingly, the actual impact on us from a change in these factors will vary depending on the percentage of the total iron ore we purchase and how much each factor is weighted for pricing under related contracts. In addition, the total net cost we pay for iron ore is affected by our hedging activities, which are described below. Thus, for example, although a significant event could directly or indirectly result in an increase in the IODEX, a material impact on our iron ore costs would be tempered because (i) the IODEX is only one component of our price for iron ore, (ii) our iron ore contracts contain a fixed pellet premium, and (iii) we hedge a substantial portion of our 2020 IODEX exposure. In addition to integrated risk strategies, we employ derivative financial instruments to manage iron ore price risk that we cannot mitigate through our customer contracts. Although we use derivative instruments to reduce our exposure if iron ore costs increase, these instruments may also reduce potential benefits should iron ore costs decline. We employ a systematic approach in our hedging strategy to mitigate iron ore exposure. We hedge a higher proportion of our near-term iron ore exposure and a lower proportion for our longer-term exposure through a combination of swaps and options. As ofDecember 31, 2019 , we have hedged the IODEX component for a portion of our iron ore purchases for 2020 and 2021 through the use of iron ore derivatives with notional amounts of 1,215,000 tons and 280,000 tons, which represents a substantial portion of our 2020 IODEX exposure. Our hedging activities further reduce our exposure to changes in the IODEX on the total cost we pay for iron ore. Our iron ore derivatives do not meet the accounting criteria for hedge accounting treatment. As a result, the changes in fair value for those derivatives are immediately recognized in earnings, instead of when we recognize the underlying cost of iron ore, thus potentially increasing the volatility of our results of operations. This volatility does not affect the ultimate gains or losses on the derivative contracts we will recognize in the financial statements, but only the timing of recognition. - 31-
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Table of ContentsPrecision Partners OnAugust 4, 2017 , we acquired 100% of the equity ofPrecision Partners , which provides advanced-engineered solutions, tool design and build, hot- and cold-stamped steel components and complex assemblies for the automotive market. Founded in 1955,Precision Partners is headquartered inOntario, Canada , and has more than 1,000 employees, including approximately 300 engineers and skilled tool makers, across ten plants inOntario ,Alabama andKentucky .Precision Partners specializes in manufacturing lightweight, complex components and assemblies, and it offers a broad portfolio of highly-engineered solutions. Among other benefits, we believePrecision Partners : • complements our core focus on product innovation, accelerating the development and introduction of existing and new AHSS and PHS to the high-growth automotive lightweighting space;
• provides a fully integrated downstream platform that further strengthens
our close collaboration with our automotive customers and their Tier 1
suppliers; and
• leverages our expertise in metals forming with Precision Partners'
expertise in tool design and advanced product design-engineering
capabilities in hot and cold stamping.
Precision Partners complements our reputation as a well-respected supplier to
our core automotive portfolio. Importantly, we believe that Precision Partners
has accelerated our efforts to drive adoption of our innovative steel products
by automotive manufacturers and their Tier 1 suppliers. Our steelmaking experts
and Precision Partners' engineers have undertaken numerous collaboration
projects aimed at achieving this goal. Precision Partners' expertise in tool
design and stamping capabilities has allowed us to deliver to customers fully
formed prototypes of automotive components utilizing our innovative steel
products. As such, we are now able to provide solutions through prototype
automotive components. This approach has and will continue to demonstrate to
customers that they can significantly lightweight automotive parts on an
accelerated timeline by using our high-strength, highly formable grades of steel
in place of traditional lower-strength grades or alternative materials. In
addition, these collaborative projects are enhancing Precision Partners'
knowledge and experience in tool design and build, and stamping of new, advanced
grades of steel, enabling it to provide expert solutions to automotive customers
now and in the future.
Labor Agreements
At
InApril 2019 , we and theUnited Steelworkers , Local 1865, which represents production employees atAshland Works , reached an agreement to revise and extend the collective bargaining agreement. The new agreement includes terms governing the permanent closure of the facility, including benefits to employees who are terminated or transition to otherAK Steel plants.
In
In
In
In
Agreements that expire within the next twelve months include an agreement with theInternational Association of Machinists and Aerospace Workers , Local 1943, which governs approximately 1,750 production employees at Middletown Works, scheduled to expireMarch 15, 2020 , and an agreement withUnited Steelworkers , Local 1915, which governs approximately 100 production employees at AK Tube's Walbridge plant, scheduled to expireJanuary 22, 2021 .
Potential Impact of Climate Change Legislation
On an ongoing basis we assess the potential impacts and implications of climate change and associated legislation and regulation on our business, operations, customers, suppliers, markets and other relevant areas. In 2010, theEPA issued a final "tailoring rule" providing new regulations governing major stationary sources of greenhouse gas emissions under the Clean Air Act. Generally, the tailoring rule requires that new or modified sources of high volumes of greenhouse gases must follow heightened permit standards and - 32-
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lower emissions thresholds. TheEPA continues to work on further greenhouse gas emissions rules that would apply more broadly and to lower levels of emission sources. In 2014, theU.S. Supreme Court partially upheld and partially invalidated the tailoring rule. The decision's impact will often require us to conduct a best available control technology analysis for greenhouse gases for new major projects. The tailoring rule will not materially adversely affect us in the near term and we cannot reliably estimate the regulation's long-term impact. However, there are a number of factors that may affect us, including theEPA 's tailoring rule and other similar regulations, such as theEPA 's Clean PowerPlant Rule established onAugust 3, 2015 , implications from theParis Climate Agreement arising from the 2015United Nations Climate Change Conference or similar accords relating to climate change. These and other factors could cause us to suffer negative financial impacts over time from increased energy, environmental and other costs needed to comply with the limitations that our suppliers would impose on us directly or indirectly. In 2017, theEPA announced its intention to repeal the Clean PowerPlant Rule and theU.S. State Department gave formal notice of its intent to withdraw from the Paris Climate Agreement. The earliest date forthe United States to completely withdraw from the Paris Agreement isNovember 4, 2020 . Given these recent developments, we expect the near-term negative impacts to our business directly arising from climate change legislation to be low. However, we do not expect the potential challenges to our business arising from climate change to decline in the long term, and we do not expect our key customers in our principal markets to substantially reduce their focus on climate change-related issues. This is particularly true for our automotive manufacturer customers, who remain subject to CAFE standards and other regulations aimed at reducing vehicle emissions, as well as potential changes in global consumer demands for vehicles with lower impacts on the environment. In addition, automotive manufacturers typically design light vehicle platforms for multiple international markets, so other countries' climate change legislation and regulations that govern the automotive manufacturers likely will continue to affect their approach for the U.S. market. In addition, the possibility exists that some form of federally-enacted legislation or additional regulations in theU.S. may further impose limitations on greenhouse gas emissions. In the past, bills have been introduced in theUnited States Congress that aim to limit carbon emissions over long periods from facilities that emit significant amounts of greenhouse gases. Such bills, if enacted, would apply to the steel industry, in general, and to us, in particular, because producing steel from elemental iron creates carbon dioxide, one of the targeted greenhouse gases. Although we and other steel producers inthe United States are actively participating in research and development to develop technology, processes and approaches for reducing greenhouse gas emissions, these developments will take time and it is impossible to predict when or to what degree these efforts will be successful. To address this need for developing new technologies, approaches and processes, not just in the steel industry but elsewhere, proposed legislation has been introduced in the past that included a system of carbon emission credits. Such credits would be available to certain companies for a period, similar to theEuropean Union's existing "cap and trade" system. However, it is virtually impossible to forecast the provisions of any such final legislation and its effects on us. If regulation or legislation to address climate change or regulate carbon emissions is enacted, it is reasonable to assume that the net financial impact on us will be negative, despite some potential benefits discussed below. On balance, such regulation or legislation likely would cause us to incur increased energy, environmental and other costs to comply with the limitations that would be imposed on greenhouse gas emissions. For example, additional costs could take the form of new or retrofitted equipment or the development of new technologies (e.g., sequestration) to try to control or reduce greenhouse gas emissions. The future enactment of climate control or greenhouse gas emissions legislation or regulation could produce benefits for us that would offset somewhat the adverse effects noted above. For example, if climate control legislation or regulation continues to drive automotive manufacturers to meet higher fuel efficiency targets, we could benefit from increased sales of our broad portfolio of products: NOES for H/EV motors, GOES for upgrading electrical grid infrastructure required to support more H/EVs, stainless steels needed for exhaust systems and other components for more efficient engines, and AHSS products to lightweight automobiles. Moreover, if climate change legislation provides further incentives for energy efficiency, up to certain levels, we could benefit from increased sales of our GOES products, which are already among the most energy-efficient electrical steels in the world. We sell our electrical steels primarily to manufacturers of power transmission and distribution transformers and electrical motors and generators, the demand for which could grow if energy efficiency standards increase. In addition, climate control legislation may enhance sales of our products in different ways. For instance, if the legislation promotes the use of renewable energy technology, such as wind or solar technology, it could increase demand for our high-efficiency electrical steel products used in power transformers, which are needed to connect these new sources to the electricity grid. The ultimate impacts on us from any additional climate change or emissions reduction legislation or regulation would depend on the final terms of any such legislation or regulation. Presently, we are unable to predict with any reasonable degree of accuracy when or even if climate control legislation or regulation will be enacted, or if it is, what its terms and applicability to us will be. As a result, we currently have no reasonable basis to reliably predict or estimate the specific effects any eventually enacted laws may have on us or how we may be able to reduce any negative impacts on our business and operations. In the meantime, the items described above provide some indication of the potential mixed impact on us from climate control legislation or regulation generally. - 33-
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Table of Contents Cleveland-Cliffs Acquisition OnDecember 2, 2019 , we entered the Merger Agreement pursuant to which, subject to the satisfaction or (to the extent permissible) waiver of the conditions set forth therein, Cliffs will acquireAK Holding by way of the Merger. Under the terms of the Merger Agreement, at the effective time of the Merger,AK Holding stockholders will become entitled to receive 0.40 Cliffs common shares for each outstanding share ofAK Holding common stock they own at the effective time. Upon completion of the proposed Merger,AK Holding stockholders are expected to own approximately 32% and Cliffs shareholders to own approximately 68% of the combined company on a fully diluted basis. The completion of the Merger is subject to the receipt of antitrust clearance inthe United States . Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended ("HSR Act"), and the rules promulgated thereunder, the Merger may not be completed until we and Cliffs have each filed notification and report forms with theUnited States Federal Trade Commission ("FTC"), and theAntitrust Division of theUnited States Department of Justice ("DOJ"), and the applicable waiting period (or any extension thereof) has expired or been terminated. OnJanuary 22, 2020 , we and Cliffs each received notification from theFTC of the early termination of the waiting period applicable to the Merger under the HSR Act. Each of our and Cliffs' obligation to effect the Merger is also subject to obtaining regulatory approval from the antitrust authorities inCanada andMexico . OnFebruary 12, 2020 , we and Cliffs each received a "no-action" letter from theCanadian Competition Bureau , clearing the Merger under Canadian competition law. OnJanuary 6, 2020 , we and Cliffs each submitted notifications and an application forMexican Competition Commission (Comisión Federal de Competencia Económica) clearance of the Merger and that process is ongoing. OnFebruary 4, 2020 , theSEC declared effective the registration statement on Form S-4 that Cliffs had filed with theSEC in connection with the Merger and Cliffs filed a final prospectus with respect to the Cliffs common shares that will be issued to our stockholders in the Merger. We also filed our definitive joint proxy statement with theSEC onFebruary 4, 2020 , and we and Cliffs each commenced mailing the definitive joint proxy statement to our respective stockholders onFebruary 5, 2020 . The definitive joint proxy statement contains information relating to the Merger and also announced that each company will hold a special meeting of its respective stockholders onMarch 10, 2020 , where the stockholders of each company will be asked to vote on matters related to the transaction, including for our stockholders to approve the adoption of the Merger Agreement and Cliffs shareholders to approve the Merger Agreement and related transactions, including the issuance of the Cliffs common shares to our stockholders in the Merger. We expect to complete the Merger in the first quarter of 2020, subject to the receipt of customary regulatory and stockholder approvals and the satisfaction or (to the extent permissible) waiver of the other closing conditions under the Merger Agreement.
Critical Accounting Estimates
We prepare our financial statements in conformity with accounting principles generally accepted inthe United States of America . These principles permit choices among alternatives and require numerous estimates of financial matters. Accounting estimates are based on historical experience and information that is available to us about current events and actions we may take in the future. We believe the accounting principles chosen are appropriate under the circumstances, and that the estimates, judgments and assumptions involved in financial reporting are reasonable. There can be no assurance that actual results will not differ from these estimates. We believe the accounting estimates discussed below represent those accounting estimates requiring the exercise of judgment where a different set of judgments could result in the greatest changes to reported results.
Asset Impairment
We have various assets that are subject to impairment testing, including property, plant and equipment, goodwill and equity method investments. If circumstances indicate that an asset has lost value below its carrying amount, we review the asset for impairment. We evaluate the effect of changes in operations and estimate future cash flows to measure fair value. We use assumptions, such as revenue growth rates, terminal growth rates, EBITDA margins and cost of capital, as part of these analyses and our selections of the assumptions to use can result in different conclusions. We believe the data and assumptions used are appropriate in the circumstances and consistent with internal projections. The most recent annual goodwill impairment tests indicated that the fair values of the relevant reporting units were in excess of their carrying value. However, while an improvement from the prior year, the estimated fair value of thePrecision Partners reporting unit was still relatively close to its carrying amount. We believe that this result is reasonable as this reporting unit was acquired inAugust 2017 . Changes in certain assumptions in the impairment tests could have resulted in various scenarios, including an increase in fair value or a decrease in fair value below the carrying amount ofPrecision Partners . We believe certain key assumptions, such as cost of capital and terminal growth rates, used in our assessment have an appropriate degree of conservatism. For the tubular reporting unit, AK Tube's estimated fair value was substantially higher than its carrying amount. Our businesses operate in highly cyclical industries and the valuation of these businesses can fluctuate, which may lead to impairment charges in future periods. Fair value is determined using quoted market prices, estimates based on prices of similar assets, or anticipated cash flows discounted at a rate commensurate with risk. - 34-
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We consider the need to evaluate long-lived assets for indicators of impairment at least quarterly to determine if events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. We evaluate long-lived assets associated with our steelmaking operations for impairment based on a collective asset grouping that includes the operations of all facilities. We manage these operations as part of an "integrated process" that allows us to route production to various facilities so that we can maximize financial results and cash flows. If the carrying value of a long-lived asset group exceeds its fair value, we determine that an impairment has occurred and we recognize a loss based on the amount that the carrying value exceeds the fair value, less cost to dispose, for assets we plan to sell or abandon.
Income Taxes
We recognize deferred tax assets and liabilities based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the enacted tax laws. We regularly evaluate the need for a valuation allowance against our deferred tax assets by assessing whether it is more likely than not that we will realize the deferred tax assets in the future. We assess the need for a valuation allowance each reporting period, with any additions or adjustments reflected in earnings in the period of assessment. We have maintained a full valuation allowance against our netU.S. deferred tax assets since 2012, with appropriate consideration for the future reversal of our taxable temporary differences. AtDecember 31, 2019 , our deferred tax asset valuation allowance was$659.4 . In assessing the need for a valuation allowance, we have considered both positive and negative evidence related to the likelihood of realization of the deferred tax assets for each jurisdiction. AtDecember 31, 2019 , we considered the existence of recent cumulative income fromU.S. operations as a source of positive evidence. We generated losses fromU.S. operations for several periods through 2016 and in 2019 and accordingly generated significant cumulative losses in those periods, which is a significant source of objective negative evidence. Despite income reported in 2017 and 2018 fromU.S. operations, the following forms of negative evidence concerning our ability to realize our domestic deferred tax assets were considered:
• we have historical evidence that the steel industry we operate within has
business cycles of longer than a few years and therefore attribute
significant weight to our cumulative losses over longer business cycles in
evaluating our ability to generate future taxable income;
• the global steel industry has been experiencing global overcapacity and
periods of increased foreign steel imports into the U.S. , which has
created volatile economic conditions and uncertainty relative to
predictions of future taxable income;
• while we have changed our business model to de-emphasize sales ofcommodity business and believe that this model will generate improved
financial results throughout an industry cycle, we have not experienced
all parts of the cycle and therefore we do not know what results our
business model will produce in those circumstances;
• our U.S. operations have generated losses in 2019 and cumulatively
significant losses in prior years and the competitive landscape in thesteel industry reflects shifting domestic and international political
priorities, an uncertain global trade landscape, and continued intense
competition from domestic and foreign steel competitors, all of which
present significant uncertainty regarding our ability to routinely
generate U.S. income in the near term;
• significant volatility in spot market selling prices for carbon steel; and
• a substantial portion of our U.S. deferred tax assets are tax
carryforwards with expiration dates that may prevent us from using them
prior to expiration.
At December 31, 2019 , we concluded that objective and subjective negative
evidence outweighed positive evidence, and therefore it was not more likely than
not that we would be able to realize our net deferred tax assets. As a result of
the cyclical nature of our industry and to the extent that the improvement in
our financial results is sustainable, there is the potential for different
weighting of positive and negative factors in the future as facts and
circumstances change. Accordingly, material changes in the valuation allowance
may be recognized in future periods.
We evaluate uncertainty in our tax positions and only recognize benefits when
the tax position is believed to be more likely than not to be sustained upon
audit. We have tax filing requirements in many states and are subject to audit
in these states, as well as at the federal level. Tax audits by their nature are
often complex and can require several years to resolve. In the preparation of
the consolidated financial statements, we exercise judgment in estimating the
potential exposure of unresolved tax matters. While actual results could vary,
we believe that we have adequately accrued the ultimate outcome of these
unresolved tax matters.
Pension and OPEB Plans
Accounting for retiree pension and healthcare benefits requires the use of
actuarial methods and assumptions, including assumptions about current
employees' future retirement dates, anticipated mortality rates, the benchmark
interest rate used to discount benefits to their present value, anticipated
future increases in healthcare costs and our obligations under collective
bargaining agreements with respect to pension and healthcare benefits for
retirees. Changing any of these assumptions could have a material effect on the
calculation of our total obligation for future pension and healthcare benefits.
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Actuarial net gains and losses occur when actual experience differs from any of the many assumptions used to value the benefit plans or when the assumptions change, as they may each year when a valuation or remeasurement is performed. The major factors contributing to our actuarial gains and losses are changes in the discount rate used to value plan liabilities as of the measurement date and changes in the expected lives of plan participants. We believe the mortality assumptions selected for determining the expected lives of plan participants are most closely associated with the expected lives of our plan participants. However, selecting other available assumptions would likely increase the plan obligations. In addition, a major factor contributing to actuarial gains and losses for our pension plan is the difference between expected and actual returns on plan assets. For OPEB plans, differences in estimated versus actual healthcare costs and changes in assumed healthcare cost trend rates are additional factors generally contributing to actuarial gains and losses. However, we do not expect changes in these OPEB assumptions to have a material effect on us since most of our plans have caps on the share of benefits we pay. In addition to their effect on the funded status of the plans and their potential for corridor adjustments, these factors affect future net periodic benefit expenses. Changes in key assumptions can have a material effect on the amount of benefit obligation and annual expense we record. For example, a 25 basis point decrease in the discount rate would decrease the interest cost component of pension income in 2020 by$3.0 . A 25 basis point decrease in the discount rate would have increased the pension obligation atDecember 31, 2019 , by approximately$36.0 and the OPEB obligation by approximately$10.0 . A 25 basis point decrease in the expected rate of return on pension plan assets would decrease the projected 2020 pension income by approximately$3.0 . Under our method of accounting for pension and OPEB plans, we recognize into income any unrecognized actuarial net gains or losses that exceed 10% of the larger of projected benefit obligations or plan assets as of the measurement date, defined as the corridor. Amounts inside the corridor are amortized over the plan participants' life expectancy. Our method results in faster recognition of actuarial net gains and losses than the minimum amortization method permitted by prevailing accounting standards and used by the vast majority of companies inthe United States . Faster recognition under this method also results in the potential for highly volatile and difficult to forecast corridor adjustments.
Environmental and Legal Contingencies
We are involved in a number of environmental and other legal proceedings. We record a liability when we determine that litigation has commenced or a claim or assessment has been asserted and, based on available information, it is probable that the outcome of the litigation, claim or assessment, whether by decision or settlement, will be unfavorable and the amount of the liability is reasonably estimable. We measure the liability using available information, including the extent of damage, similar historical situations, our allocable share of the liability and, in the case of environmental liabilities, the need to provide site investigation, remediation and future monitoring and maintenance. We record accruals for probable costs based on a combination of litigation and settlement strategies on a case-by-case basis and, where appropriate, supplement those with incurred-but-not-reported development reserves. However, amounts we record in the financial statements in accordance with accounting principles generally accepted inthe United States exclude costs that are not probable or that may not be currently estimable. The ultimate costs of these environmental and legal proceedings may, therefore, be higher than those we have recorded on our financial statements. In addition, changes in assumptions or the effectiveness of our strategies can materially affect results of operations in future periods.
Contractual Obligations
In the ordinary course of business, we enter into agreements that obligate us to make legally enforceable future payments. These agreements include those for borrowing money, leasing equipment and purchasing goods and services. The following table summarizes by category expected future cash outflows associated with contractual obligations we have as ofDecember 31, 2019 . Payment due by period Less More than 1 than 5 Contractual Obligations year 1-3 years 3-5
years years Total Long-term debt$ 7.3 $ 856.2 $ 442.0 $ 691.8 $ 1,997.3 Interest on debt (a) 124.2 205.6 113.0 81.4 524.2 Operating lease obligations 67.8 97.9 67.0 144.5 377.2 Purchase obligations and commitments 2,006.2 2,334.7 1,070.6 1,512.7 6,924.2 Pension and OPEB obligations (b) 41.0 78.2 74.2 565.4 758.8 Other non-current liabilities (c) - 51.8 23.5 78.8 154.1 Total$ 2,246.5 $ 3,624.4 $ 1,790.3 $ 3,074.6 $ 10,735.8
(a) Amounts include contractual interest payments using the interest rates as
of
interest rates for fixed-rate debt.
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(b) Future cash contributions to our qualified pension trust are not included
in the table above. We have approximately
for 2020. Based on current actuarial assumptions, the estimates for our
contributions are approximately $45.0 for 2021 and $35.0 for
2022. Estimates of cash contributions to the pension trust to be madeafter 2020 are uncertain since several variable factors impact defined
benefit pension plan contributions and required contributions are
significantly affected by asset returns. Because we expect the pension
trust to make pension benefit payments beyond the next five years, the net
pension liability is included in the More than 5 years column. We estimate
other postretirement benefit payments, after receipt of Medicare subsidy
reimbursements, will be
$7.6 over the next 30 years. For a more detailed description of these obligations, see Note 8 to the consolidated financial statements.
(c) Excludes the long-term portion of operating lease obligations.
In calculating the amounts for purchase obligations, we identified contracts where we have a legally enforceable obligation to purchase products or services from the vendor or make payments to the vendor for an identifiable period. For each identified contract, we determined our best estimate of payments to be made under the contract assuming (1) the continued operation of existing production facilities, (2) normal business levels, (3) both parties would adhere to the contract in good faith throughout its term, and (4) prices in the contract. Because of changes in the markets we serve, changes in business decisions regarding production levels or unforeseen events, the actual amounts paid under these contracts could differ significantly from the amounts presented above. For example, circumstances could arise which create exceptions to minimum purchase obligations in the contracts. We calculated the purchase obligations in the table above without considering such exceptions. A number of our purchase contracts specify a minimum volume or price for the products or services covered by the contract. If we were to purchase only the minimums specified, the payments in the table would be reduced. Under "requirements contracts" the quantities of goods or services we are required to purchase may vary depending on our needs, which are dependent on production levels and market conditions at the time. If our business deteriorates or increases, the amount we are required to purchase under such a contract would likely change. Many of our agreements for the purchase of goods and services allow us to terminate the contract without penalty if we give 30 to 90 days' notice. Any such termination could reduce the projected payments. Our consolidated balance sheets contain liabilities for pension and OPEB and other long-term obligations. We calculate the benefit plan liabilities using actuarial assumptions that we believe are reasonable under the circumstances. However, because changes in circumstances can have a significant effect on the liabilities and expenses associated with these plans including, in the case of pensions, pending or future legislation, we cannot reasonably and accurately project payments into the future. While we do include information about these plans in the above table, we also discuss these benefits elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations and in the notes to the consolidated financial statements. The other long-term liabilities on our consolidated balance sheets include accruals for environmental and legal issues, employment-related benefits and insurance, liabilities established for uncertain tax positions, and other obligations. These amounts generally do not arise from contractual negotiations with the parties receiving payment in exchange for goods and services. The ultimate amount and timing of payments are uncertain and, in many cases, depend on future events occurring, such as the filing of a claim or completion of due diligence investigations, settlement negotiations, audit and examinations by taxing authorities, documentation or legal proceedings.
New Accounting Pronouncements
The information called for by this section is incorporated herein by reference to the Adoption of New Accounting Principles section of Note 1 of the consolidated financial statements.
Forward-Looking Statements
Certain statements we make or incorporate by reference in this Form 10-K, or make in other documents we furnish to or file with theSecurities Exchange Commission , as well as in press releases or in presentations made by our employees, reflect our estimates and beliefs and are intended to be, and are hereby identified as "forward-looking statements" for purposes of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words such as "expects," "anticipates," "believes," "intends," "plans," "estimates" and other similar references to future periods typically identify such forward-looking statements. We caution readers that forward-looking statements reflect our current beliefs and judgments, but are not guarantees of future performance or outcomes. They are based on a number of assumptions and estimates that are inherently subject to economic, competitive, regulatory, and operational risks, uncertainties and contingencies that are beyond our control, and upon assumptions about future business decisions and conditions that may change. In particular, these include, but are not limited to, statements in the Liquidity and Capital Resources section and Item 7A, Quantitative and Qualitative Disclosures about Market Risk. We caution readers that such forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those currently expected. See Item 1A, Risk Factors for more information on certain of these risks and uncertainties. - 37-
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Any forward-looking statement made in this document speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.
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