AP

Business Context and Reporting Period

Company: Ampco-Pittsburgh Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2011
Business Segments: Forged and Cast Rolls (steel/aluminum rolling mill rolls) and Air and Liquid Processing (pumps, fans, and air handling equipment).
Share Count: 10,317,658 common shares outstanding as of May 10, 2011.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 8.2% year-over-year, driven by higher shipment volumes in the Forged and Cast Rolls segment and increased utility market demand in Air and Liquid Processing.
• Profitability Decline: Despite higher sales, Net Income decreased 6.5% to $7.68 million. This was primarily due to higher direct material and fixed costs, a shift in product mix, and foreign exchange losses ($191,000 loss in 2011 vs. $920,000 gain in 2010).
• Margin Pressure: Cost of products sold as a percentage of net sales rose to 71.2% from 69.0% in the prior year.
• Cash Flow: Operating cash flow decreased significantly ($4.35M vs. $9.50M) due to increased inventory levels required to support higher business activity. Investing cash outflows decreased substantially as the major capital investment program for the Forged and Cast Rolls segment neared completion.
• Backlog: Total backlog decreased to $357.3 million from $397.0 million at year-end 2010, as shipments outpaced new orders in the Forged and Cast Rolls segment.

Guidance, Outlook, and Risks

Management Commentary:

• Forged and Cast Rolls: Business activity is improving with global steel usage expected to increase in 2011. However, excess inventory levels in the industry and pricing pressures persist. A weak U.S. Dollar and British Pound aid exports.
• Air and Liquid Processing: Institutional construction spending has not yet recovered. The segment is focusing on new product lines and distribution networks. Buffalo Pumps and Aerofin saw volume increases, while Buffalo Air Handling faces margin compression due to competition and state budget issues.
• Capital Expenditures: Approximately $15 million in future capital expenditures have been approved for the next 12-18 months.

Risks and Contingencies:

• Asbestos Litigation: The company faces significant asbestos liability claims. While a reserve of ~$215 million is maintained with ~$139 million in insurance receivables, the company notes that actual expenses or recoveries could differ materially from estimates due to litigation uncertainties and insurer solvency risks.
• Environmental Matters: Potential liability for environmental proceedings is estimated at $1.34 million, which management considers adequate.
• Market Risk: Exposure to foreign currency fluctuations (hedged via contracts) and commodity price volatility (copper and aluminum futures).

Investor Verification Checklist

• Asbestos Reserve Adequacy: Verify the assumptions used by Hamilton, Rabinovitz & Associates (HR&A) regarding future claim frequency and settlement costs, and the solvency of the insurance carriers covering the $139M receivable.
• Inventory Build-up: Assess whether the increase in inventory ($75.6M vs. $68.8M) aligns with the backlog reduction and if there is a risk of obsolescence or write-downs.
• Cost Structure: Monitor the trend of direct material costs and fixed costs, which drove the gross margin compression despite sales growth.
• Backlog Conversion: Track the conversion rate of the $357M backlog into revenue, noting that a significant portion ($137M) of the Forged and Cast Rolls backlog is not expected to ship until after 2011.
• Foreign Exchange Impact: Evaluate the sensitivity of earnings to currency fluctuations, given the shift from FX gains in 2010 to losses in 2011.