(

)

Organization and Significant Accounting Policies

Consolidation Policy

The accompanying consolidated financial statements include the accounts of Sypris Solutions, Inc. and its wholly-owned subsidiaries (collectively, “Sypris” or the “Company”) and have been prepared by the Company in accordance with the rules and regulations of the Securities and Exchange Commission. The Company’s operations are domiciled in the United States (U.S.) and Mexico and serve a wide variety of domestic and international customers. All intercompany accounts and transactions have been eliminated.

Nature of Business

Sypris is a diversified provider of truck components, oil and gas pipeline components and aerospace and defense electronics. The Company produces a wide range of manufactured products, often under multi-year, sole-source contracts with corporations and government agencies. The Company offers such products through its

two

business segments, Sypris Technologies, Inc. (“Sypris Technologies”) and Sypris Electronics, LLC (“Sypris Electronics”). Sypris Technologies derives its revenue primarily from the sale of forged, machined, welded and heat-treated steel components primarily for the heavy commercial vehicle and high-pressure energy pipeline applications. Sypris Electronics derives its revenue primarily from circuit card and box build manufacturing, high reliability manufacturing and systems assembly and integration. Most products are built to the customer’s design specifications. The Company also provides engineering design services and repair or inspection services. See Note

for additional information regarding our segments.

Use of Estimates

The preparation of the consolidated financial statements and accompanying notes in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported. Changes in facts and circumstances could have a significant impact on the resulting estimated amounts included in our consolidated financial statements. Actual results could differ from these estimates.

Fair Value Estimates

The Company estimates fair value of its financial instruments utilizing an established

three

-level hierarchy. The hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date as follows: Level

– Valuation is based upon unadjusted quoted prices for identical assets or liabilities in active markets. Level

– Valuation is based upon quoted prices for similar assets and liabilities in active markets, or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instruments. Level

– Valuation is based upon other unobservable inputs that are significant to the fair value measurements.

Cash Equivalents

Cash equivalents include all highly liquid investments with a maturity of

three

months or less when purchased.

Inventory

Inventory is stated at the lower of cost or estimated net realizable value. Costs for raw materials, work in process and finished goods is determined under the

first

-in,

first

-out method. Indirect inventories, which include perishable tooling, repair parts and other materials consumed in the manufacturing process but

not

incorporated into finished products are classified as raw materials.

The Company’s reserve for excess and obsolete inventory is primarily based upon forecasted demand for its product sales, and any change to the reserve arising from forecast revisions is reflected in cost of sales in the period the revision is made.

Property, Plant and Equipment

Property, plant and equipment is stated at cost. Depreciation of property, plant and equipment is generally computed using the straight-line method over their estimated economic lives. For land improvements, buildings and building improvements, the estimated economic life is generally

years. Estimated economic lives range from

three

fifteen

years for machinery, equipment, furniture and fixtures. Leasehold improvements are amortized over the shorter of their economic life or the respective lease term using the straight-line method. Expenditures for maintenance, repairs and renewals of minor items are expensed as incurred. Major rebuilds and improvements are capitalized. Also included in plant and equipment are assets under capital lease, which are stated at the present value of minimum lease payments.

Long-lived Assets

The Company reviews the carrying value of amortizable long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset

may

not

be recoverable. Recoverability of assets to be held for sale and held for use is measured by a comparison of the carrying amount of the asset to the undiscounted future net cash flows expected to be generated by the asset. If facts and circumstances indicate that the carrying value of an asset or groups of assets, as applicable, is impaired, the long-lived asset or groups of long-lived assets are written down to their estimated fair value.

Held for sale

The Company classifies long-lived assets or disposal groups as held for sale in the period: management commits to a plan to sell; the long-lived asset or disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such long-lived assets or disposal groups; an active program to locate a buyer and other actions required to complete the plan to sell have been initiated; the sale is probable within

one

year; the asset or disposal group is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Long-lived assets and disposal groups classified as held for sale are measured at the lower of their carrying amount or fair value less costs to sell.

Stock-based Compensation

The Company accounts for stock-based compensation in accordance with the fair value recognition provisions using the Black-Scholes option-pricing method, which requires the input of several subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (expected term) and the estimated volatility of our common stock price over the expected term. Changes in the subjective assumptions can materially affect the fair value estimate of stock-based compensation and consequently, the related expense is recognized in the consolidated statements of operations.

Income Taxes

The Company uses the liability method in accounting for income taxes. Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements, using the statutory tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than

not

that such assets will be realized. On

December 22, 2017,

the Tax Cuts and Jobs Act (the “Act”) was signed into law. The Act significantly changes U.S. corporate income tax laws by, among other things, reducing the U.S. corporate income tax rate to

21%

beginning in

2018

(see Note

In the ordinary course of business there is inherent uncertainty in quantifying the Company’s income tax positions. The Company assesses its income tax positions and records tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances, and information available at the reporting dates. For those tax positions where it is more-likely-than-

not

that a tax benefit will be sustained, the Company has recorded the largest amount of tax benefit with a greater than

50%

likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is

not

more-likely-than-

not

that a tax benefit will be sustained,

tax benefit has been recognized in the financial statements. Where applicable, associated interest has also been recognized.

The Company recognizes liabilities or assets for the deferred tax consequences of temporary differences between the tax bases of assets or liabilities and their reported amounts in the financial statements in accordance with ASC

740,

Income Taxes

. The Company recognizes interest accrued related to unrecognized tax benefits in income tax expense. Penalties, if incurred, would be recognized as a component of income tax expense.

Net

Revenue

and Cost of Sales

The Company recognizes revenue when it satisfies a performance obligation by transferring control of a promised product or rendering a service to a customer. The amount of revenue recognized reflects the consideration the Company expects to be entitled to in exchange for the product or service (the “transaction price”). The Company’s transaction price in its contracts with customers is generally fixed;

payment discounts, rebates or refunds are included within its contracts. The Company does

not

provide service-type warranties nor does it allow customer returns. In connection with the sale of various parts to customers, the Company is subject to typical assurance warranty obligations covering the compliance of the electronics parts produced to agreed-upon specifications. Customer returns, when they occur, relate to quality rework issues and are

not

connected to any repurchase obligation of the Company.

A performance obligation is a promise in a contract to transfer a distinct product or render a service to a customer and is the unit of account to which the transaction price is allocated under ASC

606,

Revenue from Contracts with Customers

(“ASC

606”

). When a contract contains multiple performance obligations, we allocate the transaction price to the individual performance obligations using the price at which the promised goods or services would be sold to customers on a standalone basis. For most sales within our Sypris Technologies segment and a portion of sales within Sypris Electronics, control transfers to the customer at a point in time. Indicators that control has transferred to the customer include the Company having a present right to payment, the customer obtaining legal title and the customer having the significant risks and rewards of ownership. The Company’s principal terms of sale are FOB Shipping Point, or equivalent, and, as such, the Company primarily transfers control and records revenue for product sales upon shipment.

For contracts where Sypris Electronics serves as a contractor for aerospace and defense companies under federally funded programs, we generally recognize revenue over time as we perform due to the continuous transfer of control to the customer. This continuous transfer of control to the customer is supported by clauses in the contracts that allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. Because control is transferred over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. We use labor hours incurred as a measure of progress for these contracts because it best depicts the Company’s performance of the obligation to the customer, which occurs as we incur labor on our contracts. Under this measure of progress, the extent of progress towards completion is measured based on the ratio of labor hours incurred to date to the total estimated labor hours at completion of the performance obligation.

Our contract profit margins

may

include estimates of revenues for goods or services on which the customer and the Company have

not

reached final agreements, such as contract changes, settlements of disputed claims, and the final amounts of requested equitable adjustments permitted under the contract. These estimates are based upon management’s best assessment of the totality of the circumstances and are included in our contract profit based upon contractual provisions and our relationships with each customer.

Allowance for Doubtful Accounts

An allowance for uncollectible trade receivables is recorded when accounts are deemed uncollectible based on consideration of write-off history, aging analysis, and any specific, known troubled accounts.

Product Warranty Costs

The provision for estimated warranty costs is recorded at the time of sale and is periodically adjusted to reflect actual experience. The Company’s warranty liability, which is included in accrued liabilities in the accompanying balance sheets, as of

December

31,

2018

and

2017,

was

$582,000

and

$666,000,

respectively. The Company’s warranty expense for the years ended

December

31,

2018

and

2017

was

$136,000

and

$253,000,

respectively.

Concentrations of Credit Risk

Financial instruments which potentially expose the Company to concentrations of credit risk consist of accounts receivable. The Company’s customer base consists of a number of customers in diverse industries across geographic areas, primarily in North America and Mexico, and aerospace and defense companies under contract with the U.S. Government. The Company performs periodic credit evaluations of its customers’ financial condition and does

not

require collateral on its commercial accounts receivable. Credit losses are provided for in the consolidated financial statements and consistently have been within management’s expectations. Approximately

40%

of accounts receivable outstanding at

December

31,

2018

is due from

two

customers. More specifically, Northrop Grumman Corporation (Northrop Grumman) and Sistemas Automotrices de Mexico, S.A. de C. V. (Sistemas) comprise

22%

and

18%,

respectively, of

December

31,

2018

outstanding accounts receivables. Approximately

30%

of accounts receivable outstanding at

December

31,

2017

is due from

two

customers. More specifically, Sistemas Automotrices de Mexico, S.A. de C. V. (Sistemas) and Northrop Grumman Corporation (Northrop Grumman) comprise

15%

and

15%,

respectively, of

December

31,

2017

outstanding accounts receivables.

The Company’s largest customers for the year ended

December

31,

2018

were Sistemas, Northrop Grummon and Detroit Diesel, which represented approximately

19%,

14%

and

14%,

respectively, of the Company’s total net revenue. Detroit Diesel and Sistemas are both customers within the Sypris Technologies segment and Northrop Grummon is a customer within the Sypris Electronics segment. Detroit Diesel, Northrop Grummon and Sistemas were the Company’s largest customers for the year ended

December

31,

2017,

which represented approximately

14%,

13%

and

13%,

respectively, of the Company’s total net revenue.

other single customer accounted for more than

10%

of the Company’s total net revenue for the years ended

December

31,

2018

2017.

Foreign Currency Translation

The functional currency for the Company’s Mexican subsidiaries is the Mexican peso. Assets and liabilities are translated at the period end exchange rate, and income and expense items are translated at the weighted average exchange rate. The resulting translation adjustments are recorded in comprehensive loss as a separate component of stockholders’ equity. Remeasurement gains or losses for U.S. dollar denominated accounts of the Company’s Mexican subsidiaries are included in other income, net.

Collective Bargaining Agreements

Approximately

459,

64%

of the Company’s employees, all within Sypris Technologies, were covered by collective bargaining agreements at

December 31, 2018.

Excluding certain Mexico employees covered under an annually ratified agreement, collective bargaining agreements covering

employees expire within the next

months. Certain Mexico employees are covered by an annually ratified collective bargaining agreement. These employees represented approximately

59%

of the Company’s workforce, or

423

employees as of

December

31,

2018.

Recently Issued Accounting Standards

2014,

the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)

2014

Revenue from Contracts with Customers

(ASC

606

), which supersedes nearly all existing revenue recognition guidance. Subsequent to the issuance of ASU

2014

09,

the FASB clarified the new guidance through several additional ASUs; hereinafter the collection of revenue guidance is referred to as “ASC

606.”

ASC

606

is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and any assets recognized from costs incurred to fulfill a contract. The Company adopted the guidance effective

January 1, 2018

using the modified retrospective approach for all contracts

not

completed as of the date of adoption. Results for reporting periods beginning

January

2018

are presented under ASC

606,

while prior period amounts were

not

adjusted and continue to be reported in accordance with the Company’s historic accounting under ASC

605,

Revenue Recognition.

We recorded a net decrease to beginning accumulated deficit of

$170,000

as of

January 1, 2018,

for the cumulative impact of adopting the new guidance. The impact primarily arises from a change in how we account for certain federally funded programs within Sypris Electronics where we transfer control of the products to the customer as they are produced (i.e., a change from recognizing revenue at a point in time to recognizing revenue over time, resulting in revenue being recognized earlier in the process of completing the performance obligation).

The following table summarizes the cumulative effect of the changes to our consolidated balance sheet as of

January

2018

from the adoption of ASC

606:

							Opening
	Balance at			ASC 606			Balance at
	Dec. 31, 2017			Adjustments			Jan. 1, 2018
Assets
Inventories – net	$	17,641		$	(655	)	$	16,986
Contract assets		0			825			825

Liabilities and Equity
Accumulated deficit	$	(111,591	)	$	170		$	(111,421	)

Under the modified retrospective method of adoption, we are also required to disclose in the

first

year of adoption the hypothetical impact to our financial statements if we had continued to follow our accounting policies under ASC

605

during the period. We estimate that the impact to revenue for the year ended

December

31,

2018

would have been a decrease of

$600,000,

representing the amount of revenue recognized over time versus at a point in time under ASC

606.

Additionally, the adoption of ASC

606

increased our operating loss and net loss by

$106,000,

or less than

$0.01

per share for year ended

December 31, 2018.

The following table summarizes the effect of adopting ASC

606

on our consolidated statement of operations for the year ended

December

31,

2018:

	Legacy GAAP			Impact of			As Reported
	Dec. 31, 2018			ASC 606			Dec. 31, 2018
Net revenue	$	87,369		$	600		$	87,969
Cost of sales		79,691			706			80,397
Gross profit		7,678			(106	)		7,572

Selling, general and administrative		10,474			0			10,474
Severance, equipment relocation and other costs		1,394			0			1,394
Operating loss		(4,190	)		(106	)		(4,296	)

Interest expense, net		850			0			850
Other (income), net		(1,436	)		0			(1,436	)
Loss before taxes		(3,604	)		(106	)		(3,710	)

Income tax (benefit) expense, net		(205	)		0			(205	)

Net loss	$	(3,399	)	$	(106	)	$	(3,505	)

The following table summarizes the cumulative effect of the changes to our consolidated balance sheets as of

December

31,

2018

from the adoption of ASC

606:

	Legacy GAAP			Impact of			As Reported
	Dec. 31, 2018			ASC 606			Dec. 31, 2018
Assets
Inventories – net	$	19,945		$	(1,361	)	$	18,584
Contract assets		0			839			839

Liabilities and Equity
Accumulated deficit	$	(114,989	)	$	63		$	(114,926	)

February 2016,

the FASB issued ASU

No.

2016

02,

Leases

(ASC

842

). The new standard was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This standard affects any entity that enters into a lease, with some specified scope exemptions. The guidance in this update supersedes FASB Accounting Standards Codification (“ASC”)

840,

Leases. The amendments in this ASU are effective for fiscal years beginning after

December 15, 2018,

including interim periods within those fiscal years. In

July 2018,

the FASB issued ASU

No.

2018

11,

Leases

(Topic

842

): Targeted Improvements

, which provides an alternative modified transition method. Under this method, the cumulative-effect adjustment to the opening balance of retained earnings is recognized on the date of adoption with prior periods

not

restated.

The new standard provides a number of optional practical expedients in transition. The Company expects to elect the ‘package of practical expedients’, which permits it

not

to reassess under the new standard its prior conclusions about lease identification, lease classification, and initial direct costs. In addition, the new standard provides practical expedients for an entity’s ongoing accounting that the Company anticipates making, such as the (

) the election for certain classes of underlying asset to

not

separate non-lease components from lease components and (

) the election for short-term lease recognition exemption for all leases that qualify.

The Company will adopt this update beginning on

January 1, 2019

using the alternative modified retrospective transition method. The Company expects to elect to utilize the FASB approved option for transition relief with adoption occurring through a cumulative-effect adjustment as of

January 1, 2019.

The Company expects the valuation of right of use assets (ROU) and lease liabilities, previously described as operating leases, to be the present value of the Company’s forecasted future lease commitments. The Company is continuing to assess the overall impacts of the new standard, including the discount rate to be applied in these valuations, and expects the amendments will have a material impact on our consolidated financial statements, primarily from the recognition of right-of-use assets and lease liabilities on our consolidated balance sheets and changes to related disclosures. The Company believes the largest impact will be on the consolidated balance sheets for the accounting of facilities-related leases, which represents a majority of its operating leases it has entered into as a lessee. These leases will be recognized under the new standard as ROU assets and operating lease liabilities. The Company will also be required to provide expanded disclosures for its leasing arrangements. As of

December 31, 2018,

the Company had

$11,273,000

of undiscounted future minimum operating lease commitments that are

not

recognized on its consolidated balance sheets as determined under the current standard. In connection with the adoption of the new guidance, the Company expects to recognize ROU asset in the range of

$7,000,000

$8,000,000,

and lease liabilities in the range of

$7,500,000

$8,500,000

million on its statement of financial position for operating leases and a cumulative effect adjustment to opening retained earnings of

$1,442,000

related to a deferred gain on a sale-leaseback transaction, with limited impact to its results of operations and cash flows.

While substantially complete, the Company is still in the process of finalizing its evaluation of the effect of ASU

842

on the Company’s financial statements and disclosures. The Company will finalize its accounting assessment and quantitative impact of the adoption during the

first

quarter of fiscal year

2019.

As the Company completes its evaluation of this new standard, new information

may

arise that could change the Company’s current understanding of the impact to leases. Additionally, the Company will continue to monitor industry activities and any additional guidance provided by regulators, standards setters, or the accounting profession, and adjust the Company’s assessment and implementation plans accordingly.

June 2016,

the FASB issued ASU

2016

13,

Credit Losses – Measurement of Credit Losses on Financial Instruments

, new guidance for the accounting for credit losses on certain financial instruments. This guidance introduces a new approach to estimating credit losses on certain types of financial instruments and modifies the impairment model for available-for-sale debt securities. This guidance, which becomes effective

January 1, 2020,

not

expected to have a material impact on our consolidated financial statements.

October 2016,

the FASB issued ASU

2016

16,

Income Taxes (Topic

740

): Intra-Entity Transfers of Assets Other Than Inventory

. ASU

2016

modifies the recognition of income tax expense resulting from intra-entity transfers of assets other than inventory. Pursuant to this amendment, entities should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This amendment eliminates the exception for an intra-entity transfer of assets other than inventory. The Company adopted ASU

2016

as of

January 1, 2018

with

material impact on the Company’s consolidated financial statements.

November 2016,

the FASB issued ASU

2016

18,

Restricted Cash

. This ASU requires that amounts generally described as restricted cash and restricted cash equivalents are included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The Company adopted this ASU on

January 1, 2018

using the retrospective method. The adoption of ASU

2016

had an impact on our financial statement presentation within the Consolidated Statement of Cash Flows, as amounts generally described as restricted cash and restricted cash equivalents are now included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows and transfers of these amounts between balance sheet line items are

longer presented as an operating, investing or financing cash flow. For the year ended

December

31,

2017,

cash flow from investing activities decreased by

$1,500,000

as a result of the adoption of this ASU. The Company did

not

have any restricted cash balances as of

December 31, 2018

2017.

March 2017,

the FASB issued ASU

No.

2017

07,

Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost

(ASU

2017

). The update requires employers to present the service cost component of the net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. The other components of net benefit cost, including interest cost, expected return on plan assets, amortization of prior service cost/credit and actuarial gain/loss, and settlement and curtailment effects, are to be presented outside of any subtotal of operating income. The income statement guidance requires application on a retrospective basis. The Company adopted the ASU on

January 1, 2018,

and as a result operating income increased

$398,000

and other income decreased by

$398,000

for the year ended

December

31,

2017.

The Company used the practical expedient provided in ASU

2017

that permits the use of the amounts disclosed in its benefit plans notes for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. These changes in presentation do

not

result in any changes to net loss or loss per share. Details of the components of net periodic benefit costs are provided in Note

16.

February 2018,

the FASB issued ASU

No.

2018

02,

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

(ASU

2018

). Under existing U.S. GAAP, the effects of changes in tax rates and laws on deferred tax balances are recorded as a component of income tax expense in the period in which the law was enacted. When deferred tax balances related to items originally recorded in accumulated other comprehensive income are adjusted, certain tax effects become stranded in accumulated other comprehensive income. The amendments in ASU

2018

allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act. The amendments in this ASU also require certain disclosures about stranded tax effects. The guidance is effective for fiscal years beginning after

December 15, 2018,

and interim periods within those fiscal years. Early adoption in any period is permitted. The Company does

not

expect the adoption of ASU

2018

to have a material impact on the Company’s consolidated financial statements.

August 2018,

the FASB issued ASU

2018

15,

Intangibles-Goodwill and Other-Internal-Use Software: Customer

’

s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract

(ASU

2018

). ASU

2018

aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This new guidance will be effective for public companies for fiscal years beginning after

December 15, 2019

and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effect that the new guidance will have on its consolidated financial statements and related disclosures.