SFSA CASTEEL REPORTER Steel Founders' Society of America a publication serving

SFSA steel casting industry members 780 McArdle Drive Unit G, Crystal Lake IL 60014

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June — 2020 Casteel Commentary This month’s Casteel Commentary is a public statement from Bradken on the lessons learned and needed company practices in ensuring that the specification compliance testing and reporting has the same type of audit and integrity as the financial records of the company. As an industry, this was traditionally expected to be done with integrity by the employees responsible. Today, our industry is producing critical components for safety and reliability and we need to manage the quality testing and reporting to ensure it is done with integrity and accuracy. Given COVID, the future of our business environment is uncertain. It is not clear how rapidly things will change and what our industry will face. This month’s Market News has a more extended discussion to set a context to at least allow us to think about how to operate today and what challenges we may face in the near future. Cast in Steel We are hosting a virtual event for this year’s Cast in Steel Bowie Knife competition in mid-July. The online event will show the performance testing of all submitted Bowie Knives. The winners of the performance testing, best technical report, and best video will be announced then. More information about the event will be sent to members and will be posted on the Cast in Steel website castinsteel.org. Foundry Intern Scholarships Registration Due July 6! Recruiting students to join our industry and grow into leadership positions remains a critical need in the steel casting industry and a strategic initiative of the Society. The Steel Founders’ Society Foundation aims to attract the next generation workforce by providing scholarships to student interns. To compete for the scholarships, interns are required to work at a member foundry and carry out a specific task or investigation and selected works are presented at the annual T&O conference. If you currently have or plan to have an intern work at your foundry in 2020, be sure to have them complete this registration form by July 6. (https://cdn.ymaws.com/sfsa.site-ym.com/resource/resmgr/sfsa/peaslee_and_schumo_scholarsh.pdf) Research Review – July 21-23 Please make your plans to participate in the annual SFSA Research Review July 21-23. This year there will be three substantial changes to the format of the meeting. First, in light of COVID-19, the meeting will not be in-person but by video conference (virtual meeting). Second, the meeting is being organized by topic instead of by academic partner. Third, the meeting will focus on SFSA’s Digital Innovative Design (DID) program, and be sequenced over three half days. The Review covers the latest in both Carbon & Low Alloy and High Alloy steel casting research, and is your opportunity to interact with the researchers and provide industry steering. The event vets our research portfolio to select the R&D projects to be featured at the National T&O. Registration is required (https://sfsa.site-ym.com/events/EventDetails.aspx?id=1389196) and must be completed by Friday, July 17th to receive the link for the event. For questions, contact David Poweleit.

Going Social Follow Steel Founders’ Society of America on LinkedIn (https://www.linkedin.com/company/steel-founders%27-society-of-america/) for updates and information about these, and other programs. Find the registration link for Research Review, learn what one member found out about keeping employees safe during the pandemic, or get back to basics with 1.0 level whiteboard training. Connect with Kimberley Schumacher (kschumacher@sfsa.org) if you have an idea about how SFSA might best serve you as SFSA Goes Social. Market News Steel foundries have been generally considered essential business and allowed to operate during most of the state restrictions and lockdowns. Improving business levels in the first quarter allowed many steel foundries to see only a 20% or so fall in current business. But… Uncertainty and the broad shutdown of business and commercial activity has made the demand drop significantly for the balance of the year. While the picture is improving, the current levels indicate a 50% drop for the balance of the year in demand. Many of the projects that were finally cued up for release are on hold. The drop in steel casting orders is anticipated by the steep drop in demand and pricing for steel mill products. In Figure 1, the percentage change from a year ago for steel casting shipments in the SFSA Trend Cards and the weekly production of steel reported by AISI is shown. The steel casting market is twice as volatile as steel mill production but the trends are similar and the AISI production is off sharply. The two other common indicators of activity show a less severe drop with a more substantial recovery. These prices are updated weekly and they are shown in Figure 2. Oil had a more significant drop when the production appeared to be exceeding both the demand and the storage available. Improvements in demand for both copper and oil have allowed some recovery. The US economy has been structurally changing for decades but public perception and policies have not adjusted to the new realities. One reason that the policy makers have not been concerned about manufacturing or the health of the U.S. economy is because we were the dominant economy in the world. The U.S. economy has become a smaller part of the World’s economy as the rest of the World grew as seen In Figure 3.

Figure 1 SFSA Monthly Trends and AISI weekly production percent change from a year ago

Figure 2 Weekly prices for WTI oil and copper

Globalization coupled with rapid growth outside the U.S. in developing economies, modern communications, shipping containers, etc. allowed the large corporations to develop worldwide supply chains that were interdependent. These corporations with the support of policymakers used free trade to game the international system, siting their activity to gain the best profitability. The bi-lateral trade of U.S., Canada, Mexico and China are shown in Figure 4. The trade balance for many countries are shown in Figure 5. The U.S. is clearly the big net importer. Surprisingly, it is not the low labor countries that dominate the export markets. The two large export economies are China and Germany. Germany has high labor costs but like China has an economy that depends on exports to remain financially healthy. Policymakers are convinced that free trade creates value and that manufacturing in the U.S. is not competitive because they are less efficient or have high labor costs. This view depends on the assumption that my international competitive position is primarily a function of my product value and production efficiencies. This is not the case. Manufacturing in the U.S. accounted for 11.4% of the GDP and employed 8.5% of the work force. Government spending was 38% of the U.S. GDP in 2017, over three times the size of manufacturing. My trade

Figure 3 U.S. as a percent of the World's GDP

Figure 4 Trade between U.S., Canada, Mexico and China

Figure 5 Merchandise Trade balance of imports and exports in 2017

competitiveness is determined more by national public policy than product value or process efficiency. This is why all free trade agreements are mercantilist because trade is dominated by national policy not by manufacturing capability. This also means that government purchases become a driving force in the economy. Another challenge is that the U.S. has a significant trade surplus in services and the trade deficit is in goods. In 2019, the U.S. had a deficit in Goods of $72 billion and a surplus in Services of $24 billion. So, the U.S. prioritizes protection and access for services and negotiated giving access to developing countries for manufactured goods. This is part of another fundamental shift and challenge in the U.S. economy. Since 1980, the U.S. policy has made capital investment in assets less attractive than services. Foreign companies have found it attractive to buy up steel mills, foundries, forge shops but U.S. investors awash with investable money looking for higher returns have spurned those investments. The possible exception is Berkshire, Warren Buffett. Low interest rates are thought to spur investment. Monetary policy in the U.S. over the past two decades however has shifted from encouraging new investment in capital goods to protecting the dollar value of existing equities and bonds. Instead of investment intended to create growth and innovation, monetary policy has been to secure unsecured creditors and investors. Banks that chased higher risk higher return investments have been held harmless. Even in the current COVID crisis, the FED has been supporting financial investors in risky assets. Low interest rates disincentivizes longer term capital investments since they are risky and money has little time value. Our current interest rates reflect the expectation that the economy will grow slowly. On the other hand, COVID exposed the vulnerability of depending on a global supply chain that includes competitors. National security is at risk since critical materials and supplies are not able to be sourced domestically. Globalization allowed the recapitulation of 2004 to 2008 and 2011 to 2014 to not be located in the U.S. or even in allies. Much of the global investment was made in China to take advantage of their growth rates and policy support. Now we are at risk with an inadequate capital base for manufacturing and lack of a qualified and willing workforce. One scenario for the next few years is a Japan like stagnation as the financial policy makers try to avoid losses to re-value failed investments and institutions. The FED is embarked on this course of action. But the problems of international competition and national security may not allow the stability needed for this to be successful. Alternatively, an effort to modestly improve and reinvest in infrastructure and defense with secure domestic sources could make our industry and manufacturing busy and profitable.

Casteel Commentary Public Statement by Bradken, Inc.

Bradken, Inc. is an American manufacturer of steel products. Bradken operates a foundry in Tacoma, Washington that supplies high quality steel castings, including HY-80 and HY-100 steel castings, to prime contractors with the U.S. Navy. The high yield castings produced by Bradken under these subcontracts are critical components for the shipbuilders, and are required to meet rigorous testing specifications. Because of the importance of Bradken's role in the defense of our country and the protection of our nation's sailors, Bradken understands that it must hold itself to the highest standards of quality and integrity. It was, therefore, highly dismaying to Bradken to learn in May 2017 that one of its trusted employees at the Tacoma foundry metallurgy lab had falsified test results for HY-80 and HY-100 steel. The employee certified the falsified test results to the customer, causing substandard castings to be installed on U.S Navy vessels. We now know that the employee engaged in this practice for over 30 years, resulting in the installation of hundreds of substandard castings on Navy vessels. When Bradken management discovered the fraud, we immediately notified the customer, and ultimately the Navy, of the discovery. We are proud of that initial response. Unfortunately, following that initial disclosure, Bradken made a series of inaccurate statements, which were provided to the Navy, suggesting that there was a legitimate explanation for discrepancies in Bradken's databases. These statements minimized the evidence that the employee had engaged in deliberate fraud, and downplayed the possibility that the fraud was as broad in scope as we now know it was. We understand, and deeply regret, that these statements caused the Navy to limit its investigation and delayed the Navy's ultimate discovery that the employee had deliberately falsified hundreds of test results. All of this resulted in significant legal consequences for Bradken. The United States Department of Justice (DOJ) is filing a criminal fraud charge against the company, though DOJ has agreed, pursuant to a deferred prosecution agreement, to dismiss that charge in three years if Bradken meets certain conditions. Bradken has also reached a civil settlement with the DOJ, under which Bradken will make a substantial payment to resolve liability under the False Claims Act. And, Bradken has entered into a compliance agreement with the Navy under which Bradken must meet strict standards to prevent further fraud at the company. Bradken is grateful that it will continue to serve as a subcontractor for the United States. The following is an account of Bradken's discovery of the fraud; what Bradken did right and wrong in response to that discovery; and what the corporation did in the aftermath of this turmoil to pay for its mistakes and to ensure that they are not repeated. Bradken hopes that this account will help others to learn from its experience.

Bradken 's Discovery of the Fraud

In 1977, Atlas (a predecessor of Bradken) hired a young metallurgist who went on to work at the company for nearly forty years, eventually becoming the Director of Metallurgy. That individual (who will be referred to as the "senior metallurgist") was responsible for certifying the Tacoma foundry's metallurgical test results. In early 2017, the senior metallurgist entered early retirement, working only part-time.

With that transition, a new Metallurgy Manager at Bradken (the "new metallurgist"), who had recently started with the company as a young metallurgist, began taking over the senior metallurgist's role. In May 2017, while reviewing historical product data as part of an audit by the prime contractor, the new metallurgist discovered a discrepancy between test results recorded in the company's internal systems and the results that were certified to the customer. Notably, the set of numbers certified to the customer met specification requirements, while the other set did not. Upon further inspection, the new metallurgist also deciphered that the change had been made by the senior metallurgist, who had altered the results on a test card to increase each test result by exactly twenty points.

The new metallurgist immediately elevated the issue within the company. The Tacoma facility's management team met with the senior metallurgist immediately upon the person's return to the office the next day. The senior metallurgist admitted to changing the test results so that the product would meet specification requirements. The senior metallurgist added that the other test results were "excellent" and asserted that, because of this, the original results "couldn't be correct." But, as the management team knew, there is never a valid reason to intentionally alter records or to certify test results known to be false. The senior metallurgist also made statements to the management team suggesting that this was not an isolated incident, that is, that the senior metallurgist had falsified other test results as well. The impact of these startling admissions from a trusted employee would reverberate for years to come. Three years later, and after a process that encompassed a massive internal review, a full-blown Government investigation, and thousands of hours of time from employees and consultants, Bradken has come to understand that, between 1985 and 2017, the employee falsified hundreds of test results, resulting in the installation of substandard steel on numerous Navy submarines. Bradken has now reached a global resolution with the Government addressing Bradken's civil, criminal, and administrative liability. Through this process, Bradken has learned some important lessons that it believes should be shared with the community.

Lesson #1: Implement Internal Controls Sufficient to Detect Fraud. Bradken failed to detect the senior metallurgist's falsified test results for years because it lacked sufficient internal controls, and instead relied too heavily on the integrity of a single employee. For example, test results were typically handwritten on notecards and later entered into multiple databases. The senior metallurgist generally maintained the accurate results in one database, and recorded fraudulent, passing, results in a second database, which the senior metallurgist used in Bradken's certifications to the customer. If these activities had been subject to oversight, or if Bradken had engaged in periodic internal audits of the various recordkeeping systems, it would have discovered the fraud many years earlier.

In response to this incident, Bradken has implemented a host of internal controls. Bradken's Board of Directors has created an Audit and Risk Committee that will be responsible for overviewing and auditing risk and compliance processes across the company. In addition, Bradken has hired, or will be hiring, multiple new employees who will have oversight of the testing process. For example, Bradken has hired a Quality Control Specialist, whose responsibility will be to verify that all heat treatment and testing is compliant with specifications. Bradken has also eliminated the practice of using handwritten notecards to record test results, and now employs a fully electronic system of recording results on a tablet. Bradken is also in the process of developing a custom Laboratory Information Management System, which will protect test results and prevent improper alterations by requiring a full audit

trail and double approval before recorded data can be changed. Finally, employees have been retrained on all new and updated procedures, with emphasis on those related to compliance, reporting, and Bradken's zero-tolerance fraud policy. If Bradken had implemented these policies from the outset, the senior metallurgist likely would not have been able to perpetrate this fraud.

Lesson #2: If Your Company Detects Fraud in Connection with Government Contracts, Disclose it Immediately—and Fully—to the Government

Upon hearing their senior metallurgist admit to altering test records for a military product, the management team took two swift actions. First, that same day, the senior metallurgist was terminated, locked out of the computer system, and removed from the workplace. Second, the management team immediately notified Bradken’s customer, which in turn conveyed the disclosure to the Government. Within days, Bradken also participated in a call with representatives of its shipbuilder customers and the Navy, in which it reiterated the admission made by its former employee, disclosed that it now knew details of other test results altered by this employee, and committed to a full audit of its test records to find any other discrepancies. Bradken understands that its immediate and open disclosure of its former employee’s misconduct was an important factor in the Government’s assessment of the case, and resulted in a more favorable final resolution than Bradken otherwise would have been able to reach.

Lesson #3: Don’t Backtrack on Your Voluntary Disclosure While Bradken acted appropriately in immediately disclosing its discovery, some of the steps it took next were regrettable. Shortly after terminating the senior metallurgist, and as part of its efforts to investigate the matter, the company asked the senior metallurgist to return to the foundry for a second interview. During that interview, the senior metallurgist recanted the prior statement that the test results were intentionally altered, and instead stated there must have been a “good reason” for making the changes. However, the senior metallurgist was unable to provide a credible explanation for this assertion, and Bradken management continued to believe the senior metallurgist had likely falsified test results.

Despite Bradken’s serious skepticism about the senior metallurgist’s justifications, and the lack of support for them, the company, after consulting with counsel and its customers, issued further letters to its customers endorsing the senior metallurgist’s denials. The letters repeated the senior metallurgist’s denial of wrongdoing, inaccurately characterized the rationale provided as “well-founded,” and vouched for the senior metallurgist’s character and integrity. Bradken knew this information would be conveyed to the Government. The letters gave the misleading impression that, based on Bradken’s further investigation, Bradken had concluded that the senior metallurgist had not acted fraudulently; that there were legitimate reasons for the discrepancies in Bradken’s databases; and that there was no evidence that the senior metallurgist had falsified other test results. Bradken made these statements notwithstanding the fact that the employee had previously admitted to the fraud; had made statements suggesting that senior metallurgist had falsified multiple test results; and had never been able to explain the discrepancies in Bradken’s records. Bradken’s letters had the effect of misleading the Navy into initially concluding that the evidence of falsification was not as significant as it actually was, thereby delaying the Navy’s discovery of the fraud’s true scope.

Bradken understands that the misleading statements it made in these letters were a significant negative consideration in the Government’s evaluation of Bradken’s conduct. The company has learned from this the importance of not only disclosing all potential fraud as soon as it is

discovered, but also fully and fairly characterizing the evidence and the scope of the potential fraud and resisting any temptation to diminish the misconduct.

Lesson #4: True Cooperation Means Being Proactive Following its initial disclosures, Bradken commenced a records review to ferret out other instances of potentially discrepant test results. Bradken undertook a review of test result records covering the prior ten-year period and reported all data discrepancies it discovered. While the investigation was undertaken in good faith, unfortunately, Bradken’s review did not identify, and so Bradken did not disclose, all of the falsifications. Those falsifications were discovered only when the Government reinitiated and expanded its own investigation, analyzing records going back to the 1980s.

The Government’s investigation detected many more instances of fraudulent alterations by the senior metallurgist that Bradken had previously failed to identify through its limited review. The government also discovered patterns in Bradken’s internal data, which Bradken had not previously disclosed, that demonstrated that the discrepancies were the result of deliberate fraud.

Over the last 18 months, Bradken has cooperated with the Government’s investigation, making employee witnesses available for interviews, producing hundreds of thousands of pages of documents, responding to all requests for information, and hosting site visits and equipment demonstrations for Government investigators. That cooperation was an important positive consideration in the Government’s evaluation of Bradken’s conduct.

But Bradken has learned that true cooperation means more than just responding to requests as they are received. It also means independently seeking evidence of wrongdoing within the company, rather than making the Government find it for you. In other words, true cooperation means not just being reactive, but being proactive. Bradken also learned that it is important to always deal with the Government investigators with complete candor. Bradken regrets that its cooperation efforts fell short in the initial stages of the investigation.

Lesson #5: You are Legally Responsible for the Actions of Your Employees

Both the Government's investigation and Bradken's internal review revealed no evidence that any member of Bradken's management was aware of or involved in the fraudulent conduct of its senior metallurgist at the time it occurred. As discussed above, Bradken recognizes that its own lack of internal controls allowed this fraud to go undetected. Bradken also recognizes and accepts that as a corporation it is criminally and civilly liable for the actions of its employees—even if the employee's conduct violates corporate policies.

This incident has been an abrupt wakeup call. While Bradken is proud of its initial response when it discovered the fraud (and of the employee who made the discovery), it regrets making subsequent statements that minimized the evidence of the breadth of the fraud. However, over the past 18 months Bradken has shared all information requested of it and assisted in determining the impact of the misconduct.

Bradken believes that its experience can serve as a learning experience for other companies. Although it greatly regrets this experience, it has done its best to learn from it. Bradken remains committed to continuing, and improving upon, its tradition of outstanding service to its customers.

STEEL FOUNDERS' SOCIETY OF AMERICA BUSINESS REPORT

SFSA Trend Cards 12 Mo Avg 3 Mo Avg April March February (%-12 mos. Ago) Carbon & Low Alloy Shipments -5.2 -20.8 -30.0 -16.8 -15.5 Bookings -15.5 -19.9 -28.6 -20.0 -11.0 Backlog (wks) 8.9 7.7 8.0 7.1 8.0

High Alloy Shipments -0.4 -9.2 -15.0 2.5 -15.0 Bookings -6.4 -10.2 -20.0 -7.5 -3.0 Backlog (wks) 9.8 9.0 8.0 9.6 9.5

Department of Commerce Census Data Iron & Steel Foundries (million $) Shipments 1,420.3 1,279.7 1,116 1,347 1,376 New Orders 1,395.8 1,245.0 1,159 1,342 1,234 Inventories 2,165.8 2,217.0 2,197 2,216 2,238

Nondefense Capital Goods (billion $) Shipments 73.5 69.6 63.6 72.9 72.3 New Orders 67.3 55.8 49.8 46.2 71.5 Inventories 192.8 189.6 190.3 190.0 188.6

Nondefense Capital Goods less Aircraft (billion $) Shipments 68.1 64.3 61.6 65.3 66.2 New Orders 67.9 64.6 61.6 65.6 66.5 Inventories 129.4 128.3 128.9 128.4 127.6

Inventory/Orders 1.9 2.0 2.09 1.96 1.92 Inventory/Shipments 0.0 2.0 2.09 1.97 1.93 Orders/Shipments 0.0 1.0 1.00 1.00 1.00

American Iron and Steel Institute Raw Steel Shipments 7.8 7.1 5.6 7.8 7.8 (million net tons)