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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From _____ to _____
Commission File Number 1-12001
ALLEGHENY TECHNOLOGIES INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 25-1792394
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1000 Six PPG Place
Pittsburgh, Pennsylvania 15222-5479
(Address of Principal Executive Offices) (Zip Code)
(412) 394-2800
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No | |
At August 5, 2002, the registrant had outstanding 80,635,916 shares of its
Common Stock.
ALLEGHENY TECHNOLOGIES INCORPORATED
SEC FORM 10-Q
QUARTER ENDED JUNE 30, 2002
INDEX
Page No.
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 20
Item 3. Quantitative and Qualitative
Disclosures About Market Risk 32
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 4. Submission of Matters to a Vote
of Security Holders 34
Item 6. Exhibits and Reports on Form 8-K 34
SIGNATURES 35
CERTIFICATION 36
EXHIBIT INDEX 37
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share and per share amounts)
June 30, December 31,
2002 2001
---- ----
(Unaudited) (Audited)
ASSETS
Cash and cash equivalents $ 70.2 $ 33.7
Accounts receivable, net 265.2 274.6
Inventories, net 424.5 508.4
Deferred income taxes 51.0 33.5
Income tax refunds, prepaid expenses,
and other current assets 25.6 75.9
-------- --------
Total Current Assets 836.5 926.1
Property, plant and equipment, net 811.6 828.9
Prepaid pension cost 638.0 632.9
Cost in excess of net assets acquired 189.7 188.4
Other assets 67.7 66.9
-------- --------
TOTAL ASSETS $2,543.5 $2,643.2
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 168.6 $ 155.3
Accrued liabilities 164.6 168.2
Short-term debt and current portion
of long-term debt 14.8 9.2
-------- --------
Total Current Liabilities 348.0 332.7
Long-term debt 494.6 573.0
Accrued postretirement benefits 503.0 506.1
Deferred income taxes 170.5 153.7
Other 117.3 133.0
-------- --------
TOTAL LIABILITIES 1,633.4 1,698.5
STOCKHOLDERS' EQUITY: -------- --------
Preferred stock, par value $0.10: authorized-
50,000,000 shares; issued-none -- --
Common stock, par value $0.10, authorized-500,000,000
shares; issued-98,951,490 shares at June 30, 2002 and December 31, 2001;
outstanding-80,592,383 shares at June 30, 2002 and 80,314,624 shares
at December 31, 2001 9.9 9.9
Additional paid-in capital 481.2 481.2
Retained earnings 903.9 957.5
Treasury stock: 18,359,107 shares at
June 30, 2002 and 18,636,866 shares
at December 31, 2001 (470.7) (478.2)
Accumulated other comprehensive
loss, net of tax (14.2) (25.7)
-------- --------
Total Stockholders' Equity 910.1 944.7
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,543.5 $2,643.2
======== ========
The accompanying notes are an integral part of these statements.
3
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Sales $ 491.2 $ 554.7 $ 984.3 $ 1,097.2
Costs and expenses:
Cost of sales 444.1 483.8 896.8 960.7
Selling and administrative
expenses 49.3 52.5 99.8 100.9
--------- --------- --------- ---------
Income (loss) before interest,
other income and income taxes (2.2) 18.4 (12.3) 35.6
Interest expense, net 7.9 7.6 17.8 15.6
Other income (expense) (0.4) (0.2) 1.6 1.0
--------- --------- --------- ---------
Income (loss) before income taxes (10.5) 10.6 (28.5) 21.0
Income tax provision (benefit) (3.0) 4.4 (9.9) 8.4
--------- --------- --------- ---------
Net income (loss) $ (7.5) $ 6.2 $ (18.6) $ 12.6
========= ========= ========= =========
Basic and diluted net income
(loss) per common share $ (0.09) $ 0.08 $ (0.23) $ 0.16
========= ========= ========= =========
Dividends declared per common share $ 0.20 $ 0.20 $ 0.40 $ 0.40
========= ========= ========= =========
The accompanying notes are an integral part of these statements.
4
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Six Months Ended
June 30,
------------------
2002 2001
------ ------
OPERATING ACTIVITIES:
Net income (loss) $(18.6) $ 12.6
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 45.4 49.6
Non-cash write-off of MetalSpectrum investment -- 5.5
Deferred income taxes 2.7 (5.0)
Gains on sales of investments and businesses (2.4) (2.7)
Change in operating assets and liabilities:
Inventories 83.8 23.1
Accrued income taxes 45.6 --
Accounts payable 13.7 4.8
Accounts receivable 9.6 (8.3)
Prepaid pension cost (5.2) (12.8)
Accrued liabilities and other (3.7) (16.3)
------ ------
CASH PROVIDED BY OPERATING ACTIVITIES 170.9 50.5
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (25.5) (49.6)
Other 2.1 7.3
------ ------
CASH USED IN INVESTING ACTIVITIES (23.4) (42.3)
FINANCING ACTIVITIES:
Net borrowings (repayments) under credit facilities (71.3) 18.5
Borrowings on long-term debt -- 4.5
Payments on long-term debt and capital leases (7.5) (0.3)
------ ------
Net increase (decrease) in debt (78.8) 22.7
Dividends paid (32.2) (32.1)
Other -- (2.8)
------ ------
CASH USED IN FINANCING ACTIVITIES (111.0) (12.2)
------ ------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 36.5 (4.0)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 33.7 26.2
------ ------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 70.2 $ 22.2
====== ======
The accompanying notes are an integral part of these statements.
5
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ACCOUNTING POLICIES
Basis of Presentation
The interim consolidated financial statements include the accounts of
Allegheny Technologies Incorporated and its subsidiaries. Unless the context
requires otherwise, "Allegheny Technologies" and "the Company" refer to
Allegheny Technologies Incorporated and its subsidiaries.
These unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions for Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and note disclosures required by accounting principles generally
accepted in the United States for complete financial statements. In management's
opinion, all adjustments (which include only normal recurring adjustments)
considered necessary for a fair presentation have been included. These unaudited
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
2001 Annual Report on Form 10-K. The results of operations for these interim
periods are not necessarily indicative of the operating results for any future
period.
Certain amounts from 2001 have been reclassified to conform with the 2002
presentation.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"), and Statement of Financial Accounting Standards
No. 143, Accounting for Asset Retirement Obligations ("SFAS 143"). These
statements change the accounting for goodwill and intangible assets, and asset
retirement obligations.
Under SFAS 142, goodwill and indefinite-lived intangible assets are no
longer amortized but are reviewed annually, or more frequently if impairment
indicators arise, for impairment. Separable intangible assets that have finite
lives will continue to be amortized over their useful lives, with no maximum
life. In addition, SFAS 142 changes the test for goodwill impairment. The new
impairment test for goodwill requires a comparison of the fair value of the
reporting unit with its carrying amount, including goodwill. If this comparison
reflects impairment, then the loss would be measured as the excess of recorded
goodwill over its implied fair value. Implied fair value is the excess of the
fair value of the reporting unit over the fair value of all recognized and
unrecognized assets and liabilities.
During the second quarter 2002, the Company completed its initial
impairment evaluation for the January 1, 2002 transition to SFAS 142. No
impairment of the $188 million of goodwill, which was comprised of approximately
$127 million for the Flat-Rolled Products segment, $51 million for the High
Performance Metals segment, and $10 million for the Industrial Products segment,
was determined to exist. The evaluation of goodwill included estimating the fair
market value of each of the reporting units which have goodwill associated with
their operations using discounted cash flow and multiples of cash earnings
valuation techniques, plus valuation comparisons to recent public sale
transactions of similar businesses, if any. These valuation methods require the
Company to make estimates and assumptions regarding its future cash flows,
profitability, and the cost of capital. Although the Company believes that the
estimates and assumptions used were reasonable, actual results could differ from
those estimates and
6
assumptions. In accordance with SFAS 142, the Company will evaluate goodwill
annually for impairment in the fourth quarter, beginning in the 2002 fourth
quarter.
Effective January 1, 2002, in accordance with the SFAS 142 pronouncement,
the Company discontinued amortizing goodwill. Goodwill amortization for the
quarter and year to date periods ended June 30, 2001 was $1.5 million and $2.9
million, respectively, or $0.01 and $0.02 per diluted share, respectively.
Under SFAS 143, obligations associated with the retirement of tangible
long-lived assets, such as landfill and other facility closure costs, would be
capitalized and amortized to expense over an asset's useful life using a
systematic and rational allocation method. This standard is effective for fiscal
years beginning after June 15, 2002. The Company is currently evaluating
adoption of SFAS 143 and has not yet determined the impact on its overall
financial condition, if any, that may result.
NOTE 2. INVENTORIES
Inventories were as follows (in millions):
June 30, December 31,
2002 2001
----------- ------------
(unaudited) (audited)
Raw materials and supplies $ 51.4 $ 85.9
Work-in-process 365.6 419.6
Finished goods 85.5 83.0
------ ------
Total inventories at current cost 502.5 588.5
Less allowances to reduce current cost
values to LIFO basis (75.0) (77.2)
Progress payments (3.0) (2.9)
------ ------
Total inventories $424.5 $508.4
====== ======
NOTE 3. SUPPLEMENTAL BALANCE SHEET INFORMATION
Property, plant and equipment were as follows (in millions):
June 30, December 31,
2002 2001
----------- ------------
(unaudited) (audited)
Land $ 30.6 $ 30.6
Buildings 228.8 219.4
Equipment and leasehold improvements 1,548.9 1,534.4
-------- --------
1,808.3 1,784.4
Accumulated depreciation and amortization (996.7) (955.5)
-------- --------
Total property, plant and equipment, net $ 811.6 $ 828.9
======== ========
7
NOTE 4. DEBT
Debt at June 30, 2002 and December 31, 2001 was as follows:
(In millions)
June 30, 2002 December 31, 2001
------------- -----------------
(unaudited) (audited)
Allegheny Technologies $300 million
8.375% Notes due 2011, net $297.8 $292.5
Allegheny Ludlum 6.95% debentures,
due 2025 150.0 150.0
Commercial paper -- 70.0
Bank Group credit agreement -- --
Foreign credit agreements 21.9 25.6
Industrial revenue bonds, due 2002
through 2011 22.3 22.5
Capitalized leases and other 17.4 21.6
------ ------
509.4 582.2
Short-term debt and current portion
of long-term debt (14.8) (9.2)
------ ------
Total long-term debt $494.6 $573.0
====== ======
Scheduled maturities of borrowings are $14.8 million for the remainder of
2002, $1.5 million in 2003, $20.5 million in 2004, $10.3 million in 2005 and
$0.6 million in 2006.
In December 2001, the Company issued $300 million of 8.375% Notes due
December 15, 2011 in a transaction exempt from registration pursuant to Rule
144A under the Securities Act of 1933, as amended. In the second quarter of
2002, in accordance with the terms of the original Notes offering, the holders
of the Notes exchanged the outstanding Notes for new Notes with substantially
identical terms, but which are registered under the Securities Act. Interest on
the Notes is payable semi-annually, on June 15 and December 15. These Notes
contain default provisions with respect to default for the following, among
other things: nonpayment of interest on the Notes for 30 days, default in
payment of principal when due, or failure to cure the breach of a covenant as
provided in the Notes. Any violation of the default provision could result in
the requirement to immediately repay the borrowings.
In December 2001, the Company entered into a credit agreement with a group
of banks ("Bank Group") that provides for borrowings of up to $325 million on a
revolving credit basis. The credit agreement consists of a short-term 364-day
$130 million credit facility which expires in December 2002, and a $195 million
credit facility which expires in December 2006. There were no borrowings
outstanding under the revolving credit agreement through June 30, 2002. Interest
is payable based upon London Interbank Offered Rates ("LIBOR") plus a spread,
which can vary depending on the Company's credit rating. The Company also has
the option of using other alternative interest rate bases. The agreement has
various covenants that limit the Company's ability to dispose of assets and
merge with another corporation. The Company is also required to maintain various
financial statement ratios, including a covenant requiring the maintenance of a
specified ratio of consolidated earnings before interest, taxes, depreciation
and amortization ("EBITDA") to gross interest expense ("Interest Coverage
Ratio") and a second covenant that requires the Company to maintain a ratio of
total consolidated indebtedness to total capitalization ("Leverage Ratio"), both
as defined by the agreement. At June 30, 2002, EBITDA (calculated in accordance
with the credit agreement, which excludes certain non-cash charges) for the
prior twelve month period was 3.3 times gross interest expense compared to a
required ratio of at least 3.0 times gross interest expense. At June 30, 2002,
the Leverage Ratio was 38% compared to a required ratio of not more than 60% of
total capitalization. The Company was compliant with all aspects of its credit
agreement at June 30, 2002.
8
In August 2002, the Company reached an agreement with the Bank Group to
revise these financial covenants. The following table summarizes the revised
agreement with regard to the Interest Coverage Ratio requirement which, in
accordance with the agreement, is calculated for the preceding twelve month
period from the balance sheet date:
September 30, 2002 through June 30, 2003 2.25X
After June 30, 2003 through June 30, 2004 2.75X
After June 30, 2004 through December 31, 2004 3.00X
Thereafter 3.50X
The definition of EBITDA was also amended to exclude up to $10 million of
cash costs related to workforce reductions in 2002 and, beginning in 2003, to
add back non-cash pension expense or to deduct non-cash pension income
calculated in accordance with SFAS No. 87, "Employers' Accounting for Pensions"
("SFAS 87").
The August 2002 credit agreement amendment also changes the Leverage Ratio
to require that total consolidated indebtedness be not more than 50% of total
capitalization. The revised Leverage Ratio would exclude any changes to
capitalization resulting from non-cash balance sheet adjustments due to changes
in net pension assets or liabilities recognized in accordance with the minimum
liability provisions of SFAS 87. The amendment revises the definitions of total
indebtedness and total capitalization such that cash and cash equivalents in
excess of $25 million reduce total consolidated indebtedness and total
capitalization by the amount of that excess.
On July 23, 2002, Standard & Poor's Ratings Services lowered its long-term
and short-term corporate credit ratings for the Company's debt to BBB from BBB+
and to A-3 from A-2, respectively. On July 26, 2002, Moody's Investor Service
placed under review for possible downgrade the Baa1 senior debt ratings and
Prime-2 short term rating (commercial paper) for the Company's debt. As a result
of these changes and under current market conditions, the Company expects to be
limited in its ability to issue commercial paper. The Company's credit ratings
remain at investment grade.
The Company's goal is to maintain a balance between fixed and floating
rate debt in order to maximize liquidity as well as minimize financing costs.
Interest rate swap contracts are used to manage the Company's exposure to
interest rate risks. These contracts involve the receipt of fixed rate amounts
in exchange for floating rate interest payments over the life of the contracts
without an exchange of the underlying principal amount. These contracts are
designated as fair value hedges. As a result, changes in the fair value of the
swap agreements and the underlying fixed rate debt are recognized in the
statement of operations. At June 30, 2002, the Company had entered into "receive
fixed, pay floating" arrangements for $150 million related to the 8.375%
ten-year Notes, which effectively converts this portion of the Notes to variable
rate debt. The result of the "receive fixed, pay floating" arrangements was a
decrease in interest expense of $1.6 million for the second quarter and six
months ended June 2002, compared to the fixed interest expense of the ten-year
Notes. At June 30, 2002, the adjustment of these swap contracts to fair market
value resulted in the recognition of an asset of $5.2 million on the balance
sheet, included in Other Assets, with an offsetting increase in long-term debt,
which represents the change in fair value of the Company's 8.375% ten-year
Notes. The swap contracts also contain a provision which allows the swap
counterparty to terminate the swap contracts in the event the Company's
senior unsecured debt credit rating falls below investment grade.
9
NOTE 5. BUSINESS SEGMENTS
Following is certain financial information with respect to the Company's
business segments for the periods indicated (in millions):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
(unaudited) (unaudited)
Total sales:
Flat-Rolled Products $ 280.6 $ 285.7 $ 546.0 $ 575.2
High Performance Metals 162.5 224.0 343.9 429.3
Industrial Products 59.6 71.1 117.7 143.8
-------- -------- -------- --------
502.7 580.8 1,007.6 1,148.3
Intersegment sales:
Flat-Rolled Products 3.9 9.7 7.2 16.7
High Performance Metals 7.6 16.4 16.1 34.4
-------- -------- -------- --------
11.5 26.1 23.3 51.1
Sales to external customers:
Flat-Rolled Products 276.7 276.0 538.8 558.5
High Performance Metals 154.9 207.6 327.8 394.9
Industrial Products 59.6 71.1 117.7 143.8
-------- -------- -------- --------
$ 491.2 $ 554.7 $ 984.3 $1,097.2
======== ======== ======== ========
Operating profit (loss):
Flat-Rolled Products $ 0.7 $ (12.2) $ 0.3 $ (16.7)
High Performance Metals 8.6 22.5 12.9 33.5
Industrial Products 2.2 5.4 1.5 9.5
-------- -------- -------- --------
Total operating profit 11.5 15.7 14.7 26.3
Corporate expenses (4.5) (7.0) (10.2) (14.0)
Interest expense, net (7.9) (7.6) (17.8) (15.6)
Other expenses, net of gains
on asset sales (4.1) (6.9) (4.0) (8.6)
Retirement benefit (expense)
income (5.5) 16.4 (11.2) 32.9
-------- -------- -------- --------
Income (loss) before income
taxes $ (10.5) $ 10.6 $ (28.5) $ 21.0
======== ======== ======== ========
Other expenses, net of gains on asset sales for the second quarter and six
months ended 2001 include a non-cash charge of $5.5 million related to the
write-off of the Company's minority investment in the e-Business site,
MetalSpectrum, which terminated operations during the second quarter of 2001.
Pension income is allocated to business segments to offset pension and
other postretirement benefit expenses. Retirement benefit (expense) income
represents total pension income net of other postretirement benefit expenses.
10
NOTE 6. NET INCOME (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted net
income (loss) per common share (in millions, except per share amounts):
Three Months Ended Six Months Ended
(unaudited) June 30, June 30,
------------------ ------------------
2002 2001 2002 2001
------ ------ ------ ------
Numerator for basic and diluted
net income (loss) per common
share - net income (loss) $ (7.5) $ 6.2 $(18.6) $ 12.6
====== ====== ====== ======
Denominator:
Weighted average shares 80.6 80.2 80.5 80.2
Contingent issuable stock -- 0.1 -- 0.1
------ ------ ------ ------
Denominator for basic net
income (loss) per common
share 80.6 80.3 80.5 80.3
Effect of dilutive securities:
Dilutive potential common shares - employee stock
options -- 0.2 -- 0.2
------ ------ ------ ------
Denominator for diluted net
income (loss) per common share -
adjusted weighted
average shares 80.6 80.5 80.5 80.5
====== ====== ====== ======
Basic and diluted net income
(loss) per common share $(0.09) $ 0.08 $(0.23) $ 0.16
====== ====== ====== ======
For the 2002 periods, the effects of stock options were antidilutive and
thus not included in the calculation of dilutive earnings per share.
NOTE 7. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, were as follows
(in millions):
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
(unaudited) 2002 2001 2002 2001
----- ----- ------ -----
Net income (loss) $(7.5) $ 6.2 $(18.6) $12.6
----- ----- ------ -----
Foreign currency translation
gains (losses) 3.7 (1.8) 3.7 1.3
----- ----- ------ -----
Unrealized gains (losses) on
energy, raw material and
currency hedges, net of tax (0.4) (3.6) 7.4 (8.7)
----- ----- ------ -----
Unrealized holding gains
(losses) arising during the period -- 0.9 0.4 (0.4)
Less: realized gains
included in net income (loss) -- 1.3 -- 1.3
----- ----- ------ -----
-- (0.4) 0.4 (1.7)
----- ----- ------ -----
Comprehensive income (loss) $(4.2) $ 0.4 $ (7.1) $ 3.5
===== ===== ====== =====
11
NOTE 8. FINANCIAL INFORMATION FOR SUBSIDIARY AND GUARANTOR PARENT
The payment obligations under the $150 million 6.95% debentures due 2025
issued by Allegheny Ludlum Corporation (the "Subsidiary") are fully and
unconditionally guaranteed by Allegheny Technologies Incorporated (the
"Guarantor Parent"). In accordance with positions established by the Securities
and Exchange Commission, the financial information in this Note 8 sets forth
separately financial information with respect to the Subsidiary, the
non-guarantor subsidiaries and the Guarantor Parent. The principal elimination
entries eliminate investments in subsidiaries and certain intercompany balances
and transactions. Investments in subsidiaries, which are eliminated in
consolidation, are included in Other Assets on the balance sheets.
In 1996, the underfunded defined benefit pension plans of Allegheny Ludlum
Corporation were merged with the overfunded defined benefit pension plans of
Teledyne, Inc. and Allegheny Technologies became the plan sponsor. As a result,
the balance sheets presented for Allegheny Ludlum Corporation and the
non-guarantor subsidiaries do not include the Allegheny Technologies net prepaid
pension asset or the related deferred taxes. Solely for purposes of this
presentation, pension income has been allocated to Allegheny Ludlum Corporation
and the non-guarantor subsidiaries to offset pension and postretirement expenses
which may be funded with pension assets. This allocated pension income has not
been recorded in the financial statements of Allegheny Ludlum Corporation or the
non-guarantor subsidiaries. Management and royalty fees charged to Allegheny
Ludlum Corporation and to the non-guarantor subsidiaries by the Guarantor Parent
have been excluded solely for purposes of this presentation.
(this space intentionally left blank)
12
NOTE 8. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
June 30, 2002 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Assets:
Cash $ -- $ 54.1 $ 16.1 $ -- $ 70.2
Accounts receivable, net 0.1 100.4 164.7 -- 265.2
Inventories, net -- 189.5 235.0 -- 424.5
Deferred income taxes 51.0 -- -- -- 51.0
Income tax refunds, prepaid
expenses, and other current
assets 0.1 9.3 16.2 -- 25.6
-------- -------- -------- -------- --------
Total current assets 51.2 353.3 432.0 -- 836.5
Property, plant, and
equipment, net -- 439.0 372.6 -- 811.6
Prepaid pension cost 638.0 -- -- -- 638.0
Cost in excess of net
assets acquired -- 112.1 77.6 -- 189.7
Other assets 1,203.0 578.3 325.1 (2,038.7) 67.7
-------- -------- -------- -------- --------
Total assets $1,892.2 $1,482.7 $1,207.3 $(2,038.7) $2,543.5
======== ======== ======== ======== ========
Liabilities and
stockholders' equity:
Current Liabilities:
Accounts payable $ 1.1 $ 98.8 $ 68.7 $ -- $ 168.6
Accrued liabilities 498.0 54.7 124.6 (512.7) 164.6
Short-term debt -- 10.6 4.2 -- 14.8
-------- -------- -------- -------- --------
Total current liabilities 499.1 164.1 197.5 (512.7) 348.0
Long-term debt 297.8 396.3 31.4 (230.9) 494.6
Accrued postretirement
benefits -- 310.7 192.3 -- 503.0
Deferred income taxes 170.5 -- -- -- 170.5
Other long-term liabilities 14.7 24.4 78.2 -- 117.3
-------- -------- -------- -------- --------
Total liabilities 982.1 895.5 499.4 (743.6) 1,633.4
-------- -------- -------- -------- --------
Total stockholders' equity 910.1 587.2 707.9 (1,295.1) 910.1
-------- -------- -------- -------- --------
Total liabilities and
stockholders' equity $1,892.2 $1,482.7 $1,207.3 $(2,038.7) $2,543.5
======== ======== ======== ======== ========
13
NOTE 8. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the six months ended June 30, 2002 (unaudited)
Non-
Guarantor guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------ ------------ ------------
Sales $ -- $517.7 $466.6 $ -- $984.3
Cost of sales 6.7 499.9 390.2 -- 896.8
Selling and administrative
expenses 20.6 13.8 65.4 -- 99.8
Interest expense (income) 11.7 5.4 0.7 -- 17.8
Other income (expense)
including equity in income
of unconsolidated
subsidiaries 8.6 (1.1) 5.6 (11.5) 1.6
------- ------ ------ ------ ------
Income (loss) before income
taxes (30.4) (2.5) 15.9 (11.5) (28.5)
Income tax provision (benefit) (11.8) (3.5) 9.5 (4.1) (9.9)
------- ------ ------ ------ ------
Net income (loss) $ (18.6) $ 1.0 $ 6.4 $ (7.4) $(18.6)
======= ====== ====== ====== ======
Condensed Statement of Cash Flows
For the six months ended June 30, 2002 (unaudited)
Non-
Guarantor guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------ ------------ ------------
Cash flows from operating
activities $ 123.0 $ 68.8 $(47.1) $ 26.2 $ 170.9
------- ------ ------ ------ -------
Cash flows from investing
activities -- (6.3) (21.4) 4.3 (23.4)
------- ------ ------ ------ -------
Cash flows from financing
activities $(123.4) $(22.7) $ 65.6 $(30.5) $(111.0)
------- ------ ------ ------ -------
14
NOTE 8. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
December 31, 2001 (audited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Assets:
Cash $ 0.4 $ 14.3 $ 19.0 $ -- $ 33.7
Accounts receivable, net 0.1 84.8 189.7 -- 274.6
Inventories, net -- 249.2 259.2 -- 508.4
Deferred income taxes 33.5 -- -- -- 33.5
Income tax refunds, prepaid
expenses, and other current
assets 48.6 9.9 17.4 -- 75.9
-------- -------- -------- --------- --------
Total current assets 82.6 358.2 485.3 -- 926.1
Property, plant, and
equipment, net -- 459.7 369.2 -- 828.9
Prepaid pension cost 632.9 -- -- -- 632.9
Cost in excess of net
assets acquired -- 112.1 76.3 -- 188.4
Other assets 1,175.6 539.3 337.4 (1,985.4) 66.9
-------- -------- -------- --------- --------
Total assets $1,891.1 $1,469.3 $1,268.2 $(1,985.4) $2,643.2
======== ======== ======== ========= ========
Liabilities and
stockholders' equity:
Current liabilities:
Accounts payable $ 1.4 $ 77.4 $ 76.5 $ -- $ 155.3
Accrued liabilities 413.2 45.0 222.5 (512.5) 168.2
Short-term debt -- 0.5 8.7 -- 9.2
-------- -------- -------- --------- --------
Total current liabilities 414.6 122.9 307.7 (512.5) 332.7
Long-term debt 362.5 370.4 40.0 (199.9) 573.0
Accrued postretirement
benefits -- 302.4 203.7 -- 506.1
Deferred income taxes 153.7 -- -- -- 153.7
Other long-term liabilities 15.6 28.7 88.7 -- 133.0
-------- -------- -------- --------- --------
Total liabilities 946.4 824.4 640.1 (712.4) 1,698.5
-------- -------- -------- --------- --------
Total stockholders' equity 944.7 644.9 628.1 (1,273.0) 944.7
-------- -------- -------- --------- --------
Total liabilities and
stockholders' equity $1,891.1 $1,469.3 $1,268.2 $(1,985.4) $2,643.2
======== ======== ======== ========= ========
15
NOTE 8. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the six months ended June 30, 2001 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Sales $ -- $ 546.9 $ 550.3 $ -- $1,097.2
Cost of sales (20.2) 545.6 435.3 -- 960.7
Selling and administrative
expenses 2.9 19.6 78.4 -- 100.9
Interest expense (income) 9.7 5.8 0.1 -- 15.6
Other income (expense)
including equity in income
of unconsolidated
subsidiaries 13.6 7.1 2.3 (22.0) 1.0
-------- -------- -------- -------- --------
Income (loss) before income taxes 21.2 (17.0) 38.8 (22.0) 21.0
Income tax provision
(benefit) 8.6 (1.8) 9.1 (7.5) 8.4
-------- -------- -------- -------- --------
Net income (loss) $ 12.6 $ (15.2) $ 29.7 $ (14.5) $ 12.6
======== ======== ======== ======== ========
Condensed Statement of Cash Flows
For the six months ended June 30, 2001 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Cash flows from operating
activities $ 72.8 $ 46.7 $ 43.0 $ (112.0) $ 50.5
-------- -------- -------- -------- --------
Cash flows from investing
activities -- (8.5) (44.0) 10.2 (42.3)
-------- -------- -------- -------- --------
Cash flows from financing
activities $ (71.8) $ (36.4) $ (5.8) $ 101.8 $ (12.2)
-------- -------- -------- -------- --------
NOTE 9. COMMITMENTS AND CONTINGENCIES
The Company is subject to various domestic and international environmental
laws and regulations that govern the discharge of pollutants into the air or
water, and disposal of hazardous substances, and which may require that it
investigate and remediate the effects of the release or disposal of materials at
sites associated with past and present operations, including sites at which the
Company has been identified as a potentially responsible party ("PRP") under the
federal Superfund laws and comparable state laws. The Company could incur
substantial cleanup costs, fines, and civil or criminal sanctions, third party
property damage or personal injury claims as a result of violations or
liabilities under these laws or noncompliance with environmental permits
required at the Company's facilities. The Company is currently involved in the
investigation and remediation of a number of the Company's current and former
sites as well as third party location sites under these laws.
16
Environmental liabilities are recorded when the Company's liability is
probable and the costs are reasonably estimable. Except as described in this
Note 9, investigations are not yet at a stage where the Company has been able to
determine whether it is liable or, if liability is probable, to reasonably
estimate the loss or range of loss, or certain components thereof. Estimates of
the Company's liability are further subject to additional uncertainties
regarding the nature and extent of site contamination, the range of remediation
alternatives available, evolving remediation standards, imprecise engineering
evaluations and estimates of appropriate cleanup technology, methodology and
cost, the extent of corrective actions that may be required, and the number and
financial condition of other PRPs, as well as the extent of their responsibility
for the remediation. Accordingly, as investigation and remediation of these
sites proceeds, and as the Company receives new information, the Company expects
that it will adjust its accruals to reflect the new information. Future
adjustments could have a material adverse effect on the Company's results of
operations in a given period, but the Company cannot reliably predict the
amounts of such future adjustments.
Based on currently available information, the Company does not believe
that there is a reasonable possibility that a loss exceeding the amount already
accrued for any of the sites with which the Company is currently associated
(either individually or in the aggregate) will be an amount that would be
material to a decision to buy or sell the Company's securities. However,
additional future developments, administrative actions or liabilities relating
to environmental matters could have a material adverse effect on the Company's
financial condition and results of operations.
In June 1995, the U.S. Government commenced an action against Allegheny
Ludlum in the United States District Court for the Western District of
Pennsylvania, alleging multiple violations of the federal Clean Water Act. The
trial of this matter concluded in February 2001. In February 2002, the Court
issued a decision imposing a penalty of $8.2 million for incidents at five
facilities that occurred over a period of approximately six years, which
Allegheny Ludlum had reported to the appropriate environmental agencies. The
Company has asked the Court to reconsider its decision and in the interim is
considering appealing the Court's decision. At June 30, 2002, the Company had
adequate reserves for this matter.
TDY Industries, Inc. (TDY) and another wholly-owned subsidiary, among
others, have been identified by the U.S. Environmental Protection Agency (EPA)
as PRPs at the Li Tungsten Superfund Site in Glen Cove, New York. However, the
Company believes that most of the contamination at these sites resulted from
work done while the United States government either owned or controlled
operations at the Site, or from processes done for various agencies of the
United States, and that the United States is liable for a substantial portion of
the remediation costs at the Site. In November 2000, TDY filed a cost recovery
and contribution action against the United States government. Negotiations
between TDY and the United States are ongoing. An adverse resolution of this
matter could have a material adverse effect on the Company's results of
operations and financial condition.
At June 30, 2002, reserves for environmental remediation obligations
totaled approximately $45.9 million, of which approximately $17.7 million,
including the federal Clean Water Act matter referred to above, were included in
other current liabilities. The reserves include estimated probable future costs
of $19.2 million for federal Superfund and comparable state-managed sites
including the Li Tungsten site referred to in the preceding paragraph; $4.2
million for formerly owned or operated sites for which the Company has
remediation or indemnification obligations; $11.1 million for owned or
controlled sites at which Company operations have been discontinued; and $11.4
million for sites utilized by the Company in its ongoing operations. The Company
is evaluating whether it may be able to recover a portion of future costs for
environmental liabilities from third parties
17
other than the currently participating PRPs.
The timing of expenditures depends on a number of factors that vary by
site, including the nature and extent of contamination, the number of PRPs, the
timing of regulatory approvals, the complexity of the investigation and
remediation, and the standards for remediation. The Company expects to expend
present accruals over many years and to complete remediation of various sites
with which it has been identified within thirty years.
Allegheny Ludlum and the United Steelworkers of America ("USWA") are
parties to various collective bargaining agreements which set forth a "Profit
Sharing Plan." The USWA disputes the Company's Profit Sharing Pool calculations
for 1996, 1997, 1998, 1999, and 2000 and claims that calculations are required
for the first six months of 2001. The USWA's outside accountant, KPMG LLP,
asserted certain adjustments it believes should be made to the Profit Sharing
Pool calculations and that the net effect of those adjustments would result in
additional amounts allegedly owed to USWA represented employees of approximately
$32 million. The Company maintains that its certified determinations of the
Profit Sharing Pool calculations were made as prescribed by the Profit Sharing
Plan and that no calculations are required for the first six months of 2001. On
November 20, 2001, the USWA filed a Complaint to compel the arbitration in this
matter. The Complaint has been filed in the United States District Court for the
Western District of Pennsylvania and is captioned United Steelworkers of
America, AFL-CIO CLC v. Allegheny Ludlum Corporation, Civil Action No. 01-2196.
The Company denies that any adjustments to the Profit Sharing Pool calculations
are required and intends to contest the USWA's claim vigorously. On July 22,
2002 the Court issued an order referring the matter to arbitration. The Company
is considering appealing the Court's order. While the outcome of the matter
cannot be predicted, and the Company believes that the claims are not
meritorious, an adverse resolution of this matter could have a material adverse
effect on the Company's results of operations and financial condition.
In March 1995, Kaiser Aerospace & Electronics Corporation ("Kaiser") filed
a civil complaint against Teledyne Industries, Inc. (now TDY Industries, Inc.
("TDY")), a wholly-owned subsidiary of the Company, in the state court for
Miami-Dade County, Florida. The complaint alleged that TDY breached a
Cooperation and Shareholder's Agreement with Kaiser under which the parties
agreed to cooperate in the filing and promotion of a proposed plan for acquiring
out of bankruptcy the assets of Piper Aircraft, a manufacturer of general
aviation aircraft. TDY and Kaiser are engaged in discovery and have agreed to
participate in a mediation. Kaiser's complaint requests that the court impose a
constructive trust on approximately 68% of the equity interest in privately held
New Piper Aircraft, Inc. The Company owns approximately 30% of the equity of New
Piper Aircraft. In the alternative, Kaiser seeks unspecified damages in an
amount "to be determined at trial." This matter is scheduled for trial during
the first quarter of 2003. While the outcome of the litigation cannot be
predicted, and the Company believes that the claims are not meritorious, an
adverse resolution of this matter could have a material adverse effect on the
Company's results of operations and financial condition.
TDY Industries, Inc. and the San Diego Unified Port District ("Port
District") entered into a lease of property located in San Diego, California on
October 1, 1984. The current lease term expires in March 2004. TDY operated its
Teledyne Ryan Aeronautical division ("Ryan") at the property until May 1999,
when substantially all the assets and business of Ryan were sold to Northrop
Grumman Corporation ("Northrop") with the approval of the Port District.
Northrop subleased a portion of the property until early 2001. TDY also entered
into three separate sublease arrangements for portions of the property subject
to the approval of the Port District, which the Port District refused. After its
administrative appeal to the Port District was
18
denied, TDY commenced a lawsuit against the Port District. The complaint, filed
in December 2001 in state court in San Diego, alleges breach of contract,
inverse condemnation, tortious interference with a prospective economic
advantage and other causes of action relating to the Port District's failure to
consent to subleases of the space. The Complaint seeks at least $4 million for
damages from the Port District and declaratory relief.
Despite the Port District's failure to consent to the three subleases, TDY
continued its marketing efforts to sublease the property. The rental payments
for the property amount to approximately $0.4 million per month. At June 30,
2002 the Company had a reserve of approximately $3.7 million to cover the costs
of occupying the facility. TDY and the Port District have discussed resolution
of this matter but have not reached any agreement. The Court ordered the parties
to mediate the dispute prior to engaging in litigation. Mediation is likely to
occur in September 2002.
In the spin-offs of Teledyne and Water Pik, completed in November 1999,
the new companies agreed to assume and to defend and hold the Company harmless
against all liabilities (other than certain income tax liabilities) associated
with the historical operations of their businesses, including all government
contracting, environmental, product liability and other claims and demands,
whenever any such claims or demands might arise or be made. If the new companies
were unable or otherwise fail to satisfy these assumed liabilities, the Company
could be required to satisfy them, which could have a material adverse effect on
the Company's results of operations and financial condition.
In connection with the spin-offs of Teledyne and Water Pik, the Company
received a tax ruling from the Internal Revenue Service stating that the
spin-offs will be tax-free to the Company and the Company's stockholders. While
the tax ruling relating to the qualification of the spin-offs as tax-free
distributions within the meaning of the Internal Revenue Code generally is
binding on the Internal Revenue Service, the continuing validity of the tax
ruling is subject to certain factual representations and uncertainties that,
among other things, require the new companies to take or refrain from taking
certain actions. If a spin-off were not to qualify as a tax-free distribution
within the meaning of the Internal Revenue Code, the Company would recognize
taxable gain generally equal to the amount by which the fair market value of the
common stock distributed to the Company's stockholders in the spin-off exceeded
the Company's basis in the new company's assets. In addition, the distribution
of the new company's common stock to Company stockholders would generally be
treated as taxable to the Company's stockholders in an amount equal to the fair
market value of the common stock they received. If a spin-off qualified as a
distribution within the meaning of the Internal Revenue Code but was
disqualified as tax-free to the Company because of certain post-spin-off
circumstances, the Company would recognize taxable gain as described in the
preceding sentence, but the distribution of the new company's common stock to
the Company's stockholders in the spin-off would generally be tax-free to each
Company stockholder. In the spin-offs, the new companies executed tax sharing
and indemnification agreements in which each agreed to be responsible for any
taxes imposed on and other amounts paid by the Company, its agents and
representatives and its stockholders as a result of the failure of the spin-off
to qualify as a tax-free distribution within the meaning of the Internal Revenue
Code if the failure or disqualification is caused by post-spin-off actions by or
with respect to that company or its stockholders. Potential liabilities under
these agreements could exceed the respective new company's net worth by a
substantial amount. If either or both of the spin-offs were not to qualify as
tax-free distributions to the Company or its stockholders, and either or both of
the new companies were unable or otherwise failed to satisfy the liabilities
they assumed under the tax sharing and indemnification agreements, the Company
could be required to satisfy them without full recourse against the new
companies. This could have a material adverse effect on the Company's results of
operations and financial condition.
19
Other lawsuits, claims and proceedings have been or may be asserted
against the Company relating to the conduct of its business, including those
pertaining to product liability, patent infringement, commercial, employment,
employee benefits, environmental and stockholder matters. While the outcome of
litigation cannot be predicted with certainty, and some of these lawsuits,
claims or proceedings may be determined adversely to the Company, management
believes that the disposition of any such pending matters is not likely to have
a material adverse effect on the Company's financial condition or liquidity,
although the resolution in any reporting period of one or more of these matters
could have a material adverse effect on the Company's results of operations for
that period.
NOTE 10. SUBSEQUENT EVENT
On July 22, 2002, the Company announced workforce reductions of
approximately 275 salaried employees, primarily in the Flat-Rolled Products
segment. These reductions should be substantially completed by the end of the
third quarter of 2002. The Company expects to record a one-time pre-tax charge
of approximately $5.0 million, or $0.04 per share after-tax, in the third
quarter of 2002.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
- - The Flat-Rolled Products segment recorded its first profitable quarter
since the fourth quarter of 2000.
- - The High Performance Metals segment was impacted by continued weak
conditions in the commercial aerospace and power generation markets.
- - The Industrial Products segment results improved on continued cost
reduction efforts.
- - Cost reductions reached $35 million for the second quarter 2002 and $60
million for the first six months of 2002.
- - Managed working capital was reduced by $70 million for the second quarter
2002 and $112 million for the first six months of 2002.
- - Cash flows from operations were $89 million for the second quarter 2002
and $171 million for the first six months of 2002.
- - Debt was reduced by $22 million for the second quarter 2002 and $79
million for the first six months of 2002.
RESULTS OF OPERATIONS
Allegheny Technologies Incorporated is one of the largest and most
diversified producers of specialty materials in the world. Unless the content
requires otherwise, "we", "our" and "us" refer to Allegheny Technologies
Incorporated and its subsidiaries. We operate in the following three business
segments, which accounted for the following percentages of total external sales
for the first six months of 2002 and 2001:
2002 2001
---- ----
Flat-Rolled Products 55% 51%
High Performance Metals 33% 36%
Industrial Products 12% 13%
For the first six months of 2002, operating profit was $14.7 million
compared to $26.3 million for the same 2001 period. Sales decreased 10% to
20
$984.3 million for the first six months of 2002 compared to $1,097.2 million
for the same 2001 period. The decrease in sales is primarily due to continuing
difficult business conditions in the end markets we serve, especially commercial
aerospace, capital goods and electrical energy.
We incurred a net loss of $18.6 million, or $0.23 loss per diluted share,
for the first six months of 2002 compared to net income of $12.6 million, or
$0.16 per diluted share, for the first six months of 2001.
We continually strive to align our cost structure to deliver profitable
performance utilizing cost reduction initiatives that will allow us to achieve a
higher level of profitability. To that end, we have realized $60 million in cost
reductions during the first six months of months of 2002 and $35 million during
the second quarter of 2002. We have targeted at least $100 million of cost
reductions for the full year 2002.
On July 22, 2002, we announced workforce reductions of approximately 275
salaried employees, primarily in the Flat-Rolled Products segment. These
reductions should be substantially completed by the end of the third quarter of
2002. We expect to record a one-time pre-tax charge in the third quarter 2002 of
approximately $5.0 million, or $0.04 per share after-tax, in connection with
these workforce reductions. This action is estimated to provide an annual
pre-tax cost savings of approximately $18 million.
We expect business conditions to remain difficult. Looking at the third
quarter, we currently expect modest improvement in operating profit compared to
the second quarter 2002. In the Flat-Rolled Products segment, the combination of
some price increases and additional cost reductions should result in an
improvement in operating profit. In the High Performance Metals segment, we
expect further weakening demand from commercial aerospace and power generation
markets to be partially offset by continuing improvement at our Wah Chang
operations. In the Industrial Products segment, we expect business conditions to
be relatively flat with the second quarter 2002.
Sales and operating profit (loss) for our three business segments are
discussed below.
FLAT-ROLLED PRODUCTS SEGMENT
Second quarter Flat-Rolled Products segment sales were flat compared to
the second quarter of 2001. However, the segment recorded an operating profit of
$0.7 million for the 2002 second quarter compared to an operating loss of $12.2
million in the second quarter of 2001. For the first six months of 2002, sales
declined 4% to $538.8 million and operating profit was $0.3 million compared to
a $16.7 million loss in the same 2001 period. Operating results in the 2002
second quarter and first six months of 2002 benefited significantly from cost
reductions of $17.8 million and $35.4 million, respectively, within the segment.
For the second quarter 2002, finished commodity product shipments in the
segment (including stainless steel sheet and plate, silicon electrical steel,
and tool steel, among other products) were flat while average prices increased
2%. High-value product shipments (including standard strip, Precision Rolled
Strip(R), nickel-based alloys and specialty steels, and titanium and titanium
alloys) increased 7%, but average prices decreased 7%, primarily due to weak
capital goods and aerospace markets.
For the first six months of 2002, finished commodity product shipments in
the segment were flat compared to the same 2001 period. Average prices for
finished commodity products decreased 3% during the same period. High-value
product shipments in the segment increased 3% compared to the first six months
of 2001, while average prices for high-value products decreased 6%. First six
months 2002 results were also negatively impacted by a weaker demand for our
Flat-Rolled products from several consumer durables markets and capital goods
markets.
21
Comparative information on the segment's products is provided in the
following table (unaudited):
Three Months
Ended
June 30,
--------------------- %
2002 2001 Change
--------------------- ------
Volume (finished tons):
Commodity 92,483 91,134 1
High Value 36,007 33,791 7
-------- --------
Total 128,490 124,925 3
Average prices (per finished ton):
Commodity $ 1,541 $ 1,517 2
High Value $ 3,668 $ 3,942 (7)
Combined Average $ 2,141 $ 2,171 (1)
Six Months
Ended
June 30,
--------------------- %
2002 2001 Change
--------------------- ------
Volume (finished tons):
Commodity 179,914 180,898 (1)
High Value 70,369 68,003 3
-------- --------
Total 250,283 248,901 1
Average prices (per finished ton):
Commodity $ 1,515 $ 1,564 (3)
High Value $ 3,713 $ 3,948 (6)
Combined Average $ 2,135 $ 2,216 (4)
HIGH PERFORMANCE METALS SEGMENT
For the second quarter, sales declined 25% and operating profit decreased
to $8.6 million compared to $22.5 million in the second quarter of 2001.
Shipments of nickel-based and specialty steel products decreased 37% with
essentially flat average prices, due to product mix. Shipments of titanium
products decreased 8% and average prices decreased 12%. Shipments of exotic
alloys decreased 9% and average prices increased 7%, primarily due to product
mix. Although improved from the first quarter of 2002, second quarter 2002
results compared to the prior year period were negatively impacted by the
carryover effect of the now-resolved strike at our Wah Chang facility, discussed
below.
Sales declined 17% to $327.8 million for the first six months of 2002
compared to the same period of last year due primarily to reduced demand from
the segment's two largest markets, commercial aerospace and electrical energy.
The decline in sales and the effects of the seven month labor strike at Wah
Chang lowered operating profit to $12.9 million compared to $33.5 million in the
year-ago period. Shipments of nickel-based and specialty steel products
decreased 27% and average prices increased 1%. Shipments of titanium products
decreased 14% and average prices decreased 3%. Shipments of exotic alloys
increased 1% and average prices increased 4%, due to product mix.
On March 22, 2002, we announced that our Wah Chang facility had reached
a new six-year labor agreement ending a seven-month strike, which began on
September 4, 2001. The new agreement covers approximately 660 employees. The new
agreement became effective on April 1, 2002 and expires on March 31, 2008. The
increase in labor costs as a result of the new agreement is less than one
percent of our overall labor costs and is not material.
22
Certain comparative information on the segment's major products is
provided in the following table (unaudited):
Three Months
Ended
June 30,
------------------- %
2002 2001 Change
------- ------- ------
Volume (000's pounds):
Nickel-based and specialty steel alloys 8,447 13,393 (37)
Titanium mill products 5,276 5,752 (8)
Exotic alloys 1,015 1,120 (9)
Average prices (per pound):
Nickel-based and specialty steel alloys $ 6.32 $ 6.33 --
Titanium mill products $ 10.76 $ 12.22 (12)
Exotic alloys $ 32.45 $ 30.27 7
Six Months
Ended
June 30,
------------------- %
2002 2001 Change
------- ------- ------
Volume (000's pounds):
Nickel-based and specialty steel alloys 19,212 26,257 (27)
Titanium mill products 10,225 11,891 (14)
Exotic alloys 1,884 1,861 1
Average prices (per pound):
Nickel-based and specialty steel alloys $ 6.40 $ 6.31 1
Titanium mill products $ 11.41 $ 11.77 (3)
Exotic alloys $ 33.64 $ 32.47 4
INDUSTRIAL PRODUCTS SEGMENT
Second quarter 2002 sales decreased 16% to $59.6 million, compared to the
same period last year. Operating profit was $2.2 million compared to $5.4
million in the same 2001 period. For the first six months 2002, sales decreased
18.2% to $117.7 million compared to $143.8 million in the same 2001 period.
Operating profit for the first six months of 2002 decreased to $1.5 million
compared to $9.5 million in the same 2001 period. This segment has experienced a
downturn in its markets, particularly the oil and gas, cutting tools and heavy
truck markets.
CORPORATE ITEMS
Corporate expenses decreased 36% to $4.5 million for second quarter of
2002 and decreased 27% to $10.2 million for the first six months of 2002,
compared to the respective 2001 periods, due to continued cost reductions and
lower incentive compensation accruals. Net interest expense increased to $7.9
million for the second quarter of 2002 from $7.6 million for the second quarter
of 2001. For the first six months of 2002, net interest expense was $17.8
million compared to $15.6 million for the comparable prior year period. In 2002,
higher interest costs associated with the ten-year Notes issued in December 2001
more than offset the reduction in overall indebtedness from the repayment of all
short-term debt.
A decline in the equity markets in 2001 and higher benefit liabilities
from long-term labor contracts negotiated in 2001 and 2002 resulted in pre-tax
retirement benefit expense of $5.5 million in the second quarter of 2002 and
$11.2 million for the first six months of 2002 compared to retirement
income of $16.4 million in the second quarter of 2001 and $32.9 million for the
first six months of 2001. This retirement benefit expense, as compared to net
retirement income in the prior year comparable periods, had and will have
23
a negative effect on both cost of sales and selling and administrative expenses
for 2002. A further decline in the value of pension assets between June 30, 2002
and the end of 2002, as compared to the levels at the end of 2001, would result
in a further increase in pre-tax retirement benefit expense for 2003.
SPECIAL ITEMS
The 2001 second quarter and six months results include an after-tax
non-cash charge of $3.4 million, or $0.04 per share, related to the write-off of
the Company's minority investment in the e-Business site, MetalSpectrum, which
terminated operations during the second quarter of 2001. This non-cash charge
was included in other income.
INCOME TAX PROVISION (BENEFIT)
Our effective tax rate was (28.6%) and (34.7%) for quarter and year to
date periods ended June 30, 2002, respectively, compared to 41.5% and 40.0% for
the same periods in 2001. The income tax benefits for the 2002 periods result
from the tax benefits associated with pretax losses.
FINANCIAL CONDITION AND LIQUIDITY
CASH FLOW AND WORKING CAPITAL
During the six months ended June 30, 2002, cash generated from operations
was $170.9 million, which included federal income tax refunds for the 2001 tax
year of $45.6 million. Cash generated from operations and cash on hand at the
beginning of the year was utilized to reduce debt by $78.8 million, pay
dividends of $32.2 million and invest $25.5 million in capital expenditures. At
June 30, 2002, cash and cash equivalents totaled $70.2 million, an increase of
$36.5 million from December 31, 2001.
Working capital decreased to $488.5 million at June 30, 2002 compared to
$593.4 million at December 31, 2001. The current ratio decreased to 2.4 from 2.8
in this same period. The change in working capital and current ratio at June 30,
2002 compared to December 31, 2001 was primarily due to a reduction in
inventories.
As part of managing the liquidity of our business, we focus on controlling
inventory, accounts receivable and accounts payable. In measuring performance in
controlling this managed working capital, we exclude the effects of LIFO
inventory valuation reserves, excess and obsolete inventory reserves, and
reserves for uncollectible accounts receivable which, due to their nature, are
managed separately. During the first six months of 2002, managed working
capital, which is defined as gross inventory plus accounts receivable less
accounts payable, declined by $111.7 million, or 15%, to $614.1 million. The
decline in managed working capital resulted from a $85.7 million decrease in
gross inventory, an $8.0 million decrease in accounts receivable, and a $18.0
million increase in accounts payable.
Capital expenditures for 2002 are expected to be approximately $50.0
million, of which $25.5 million had been expended through June 30, 2002.
On June 11, 2002, a regular quarterly dividend of $0.20 per share of
common stock was paid to stockholders of record at the close of business on May
29, 2002. On July 31, 2002, the Board of Directors declared a regular quarterly
dividend of $0.20 per share of common stock. The dividend will be paid on
September 10, 2002 to stockholders of record at the close of business on August
26, 2002. The future payment of dividends and the amount of such dividends
depends upon matters deemed relevant by our Board of Directors, such as our
results of operations, financial condition, cash requirements, future prospects,
any limitations imposed by law, credit agreements or senior securities, and
other factors deemed relevant and appropriate.
24
DEBT
At June 30, 2002, we had $509.4 million in total outstanding debt. Our
debt to capitalization ratio decreased to 35.9% at June 30, 2002 from 38.1% at
December 31, 2001. Our net debt to total capitalization ratio decreased to 32.6%
at June 30, 2002 from 36.7% at December 31, 2001. These lower ratios resulted
primarily from the use of operating cash flows to repay $78.8 million of debt.
In December 2001, we issued $300 million of 8.375% Notes due December 15,
2011 in a transaction exempt from registration pursuant to Rule 144A under the
Securities Act of 1933, as amended. In the second quarter of 2002, in accordance
with the terms of the original Notes offering, the holders of the Notes
exchanged the outstanding Notes for new Notes with substantially identical
terms, but which are registered under the Securities Act. Interest on the Notes
is payable semi-annually, on June 15 and December 15. These Notes contain
default provisions with respect to default for the following, among other
things: nonpayment of interest on the Notes for 30 days, default in payment of
principal when due, or failure to cure any breach of a covenant as provided
in the Notes. Any violation of the default provision could result in the
requirement to immediately repay the borrowings.
In December 2001, we entered into a credit agreement with a group of banks
("Bank Group") that provides for borrowings of up to $325 million on a revolving
credit basis. The credit agreement consists of a short-term 364-day $130 million
credit facility which expires in December 2002, and a $195 million credit
facility which expires in December 2006. We had no borrowings outstanding under
the revolving credit agreement through June 30, 2002. Interest is payable based
upon London Interbank Offered Rates ("LIBOR") plus a spread, which can vary
depending on our credit rating. We also have the option of using other
alternative interest rate bases. The agreement has various covenants that limit
our ability to dispose of assets and merge with another corporation. We are also
required to maintain various financial statement ratios, including a covenant
requiring the maintenance of a specified ratio of consolidated earnings before
interest, taxes, depreciation and amortization ("EBITDA") to gross interest
expense ("Interest Coverage Ratio") and a second covenant that requires us to
maintain a ratio of total consolidated indebtedness to total capitalization
("Leverage Ratio"), both as defined by the agreement. At June 30, 2002, EBITDA
(calculated in accordance with the credit agreement, which excludes certain
non-cash charges) for the prior twelve month period was 3.3 times gross interest
expense compared to a required ratio of at least 3.0 times gross interest
expense. At June 30, 2002, the Leverage Ratio was 38% compared to a required
ratio of not more than 60% of total capitalization. We were compliant with all
aspects of our credit agreement at June 30, 2002.
In August 2002, we reached an agreement with the Bank Group to revise
these financial covenants. The following table summarizes the revised agreement
with regard to the Interest Coverage Ratio requirement, which in accordance
with the agreement, is calculated for the preceding twelve month period from the
balance sheet date:
September 30, 2002 through June 30, 2003 2.25X
After June 30, 2003 through June 30, 2004 2.75X
After June 30, 2004 through December 31, 2004 3.00X
Thereafter 3.50X
The definition of EBITDA was also amended to exclude up to $10 million of
cash costs related to workforce reductions in 2002, and beginning in 2003, to
add back non-cash pension expense or to deduct non-cash pension income
calculated in accordance with SFAS No. 87, "Employers' Accounting for Pensions"
(SFAS 87).
The August 2002 credit agreement amendment also changes the Leverage Ratio
to require that total consolidated indebtedness be not more than 50% of
25
total capitalization. The revised Leverage Ratio would exclude any changes to
capitalization resulting from non-cash balance sheet adjustments due to changes
in net pension assets or liabilities recognized in accordance with the minimum
liability provisions of SFAS 87. The amendment revises the definitions of total
indebtedness and total capitalization such that cash and cash equivalents in
excess of $25 million reduce total consolidated indebtedness and total
capitalization by the amount of that excess.
On July 23, 2002, Standard & Poor's Ratings Services lowered its long-term
and short-term corporate credit ratings for our debt to BBB from BBB+
and to A-3 from A-2, respectively. On July 26, 2002, Moody's Investor Service
placed under review for possible downgrade the Baa1 senior debt ratings and
Prime-2 short term rating (commercial paper) for our debt. As a result
of these changes and under current market conditions, we expect to be
limited in our ability to issue commercial paper. Our credit ratings
remain at investment grade.
We believe that internally generated funds, current cash on hand and
borrowings from existing credit lines will be adequate to meet our foreseeable
needs. However, our ability to continue to utilize borrowings from existing
credit lines may be adversely affected by further deterioration in our financial
performance as well as other factors beyond our control.
CRITICAL ACCOUNTING POLICIES
RETIREMENT BENEFITS
Accounting standards require a minimum pension liability be recorded if
the value of pension assets are less than the accumulated pension benefit
obligation (ABO) at the end of each year. If this condition exists at the end of
2002, we would record a non-cash charge to stockholders' equity equal to the
value of the prepaid pension asset then recognized on the balance sheet, as
well as the required minimum pension liability, both net of deferred taxes. The
effect of such a non-cash charge would be a reduction in stockholders' equity by
a minimum of approximately $400 million. Such a non-cash charge, which would not
affect earnings, is likely if the performance of the equity markets does not
improve during the remainder of the year.
We have defined benefit pension plans and defined contribution plans
covering substantially all of our employees. We have not made contributions to
the defined benefit pension plan in the past six years because the plan has been
fully funded. We are not required to make a contribution to the defined benefit
pension plan for 2002. We will not be required to make a contribution for 2003
unless there is a substantial further decline in the value of pension assets.
We account for our defined benefit pension plans in accordance with SFAS
87, which requires that amounts recognized in financial statements be determined
on an actuarial basis, rather than as contributions are made to the plan. A
significant element in determining our pension income (expense) in accordance
with SFAS 87 is the expected investment return on plan assets. We have assumed,
based upon the types of securities comprising the plan assets and the long-term
historical returns on these investments, that the long-term expected return on
pension assets will be 9%. The assumed long-term rate of return on assets is
applied to the market value of plan assets at the end of the previous year. This
produces the expected return on plan assets that is included in annual pension
income (expense) for the current year. The cumulative difference between this
expected return and the actual return on plan assets is deferred and amortized
into pension income or expense over future periods. The expected return on plan
assets can vary significantly from year to year since the calculation is
dependent on the market value of plan assets as of the end of the preceding
year. Accounting principles generally accepted in the United States allow
companies to calculate the expected return on pension assets using either an
average of fair market
26
values of pension assets over a period not to exceed five years, which reduces
the volatility in reported pension income or expense, or their fair market value
at the end of the previous year. However, the Securities and Exchange Commission
currently does not permit companies to change from the fair market value at the
end of the previous year methodology to an averaging of fair market values of
plan assets methodology. As a result, our results of operations and those of
other companies, including companies with which we compete, may not be
comparable due to these different methodologies in calculating the expected
return on pension assets in 2002, as compared to the levels at the end of 2001.
At the end of each year, we determine the discount rate to be used to
value pension plan liabilities. A discount rate of 7% was used for the valuation
of pension obligations at December 31, 2001. In accordance with SFAS 87, the
discount rate reflects the current rate at which the pension liabilities could
be effectively settled at the end of the year. In estimating this rate, we
assess the rates of return on high quality, fixed-income investments. Changes in
the discount rate, as well as the net effect of other changes in actuarial
assumptions and experience, are deferred in accordance with SFAS 87.
We also sponsor several defined benefit postretirement plans covering
certain hourly and salaried employees. These plans provide health care and life
insurance benefits for eligible employees. In certain plans, contributions
towards premiums are capped based upon the cost as of a certain date, thereby
creating a defined contribution. We use actuarial assumptions, including the
discount rate and the expected trend in health care costs, to estimate the costs
and benefits obligations for the plans. The discount rate, which is determined
annually at the end of each year, is developed based upon rates of return on
high quality, fixed-income investments. At December 31, 2001, we determined this
rate to be 7%. Based upon cost increases quoted by our medical care providers
for the remainder of 2002 and predictions of continued significant medical cost
inflation in future years, we raised our expected trend in health care costs.
The annual assumed rate of increase in the per capita cost of covered benefits
for health care plans is estimated at 11% in 2002 and is assumed to decrease to
5% in the year 2009 and remain level thereafter.
A further decline in the value of pension assets between June 30, 2002 and
the end of 2002, as compared to the levels at the end of 2001, would result in a
further increase in pre-tax retirement benefit expense for 2003.
GOODWILL AND INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets ("SFAS 142").
Under SFAS 142, goodwill and indefinite-lived intangible assets are no
longer amortized but are reviewed annually, or more frequently if impairment
indicators arise, for impairment. Separable intangible assets that have finite
lives will continue to be amortized over their useful lives, with no maximum
life. In addition, SFAS 142 changes the test for goodwill impairment. The new
impairment test for goodwill requires a comparison of the fair value of the
reporting unit with its carrying amount, including goodwill. If this comparison
reflects impairment, then the loss would be measured as the excess of recorded
goodwill over its implied fair value. Implied fair value is the excess of the
fair value of the reporting unit over the fair value of all recognized and
unrecognized assets and liabilities.
During the second quarter, we completed our initial impairment evaluation
for the January 1, 2002 transition to SFAS 142. No impairment of the $188
million of goodwill, which was comprised of approximately $127 million
27
for the Flat-Rolled Products segment, $51 million for the High Performance
Metals segment, and $10 million for the Industrial Products segment, was
determined to exist. The evaluation of goodwill included estimating the fair
market value of each of the reporting units which have goodwill associated with
their operations using discounted cash flow and multiples of cash earnings
valuation techniques, plus valuation comparisons to recent public sale
transactions of similar businesses, if any. These valuation methods require
us to make estimates and assumptions regarding our future cash flows,
profitability, and the cost of capital. Although we believe that the estimates
and assumptions used were reasonable, actual results could differ from those
estimates and assumptions. In accordance with SFAS 142, we will evaluate
goodwill for impairment annually in the fourth quarter, beginning in the 2002
fourth quarter.
Effective January 1, 2002, in accordance with the SFAS 142 pronouncement,
we discontinued amortizing goodwill. Goodwill amortization for the quarter
and year to date periods ended June 30, 2001 was $1.5 million and $2.9 million,
respectively, or $0.01 and $0.02 per diluted share, respectively.
OTHER
A summary of other significant accounting policies is discussed in Note 1
in our Annual Report on Form 10-K for the year ended December 31, 2001.
The preparation of the financial statements in accordance with accounting
principles generally accepted in the United States requires us to make
judgments, estimates and assumptions regarding uncertainties that affect the
reported amounts of assets and liabilities. Areas of uncertainty that require
judgments, estimates and assumptions include the accounting for derivatives,
retirement plans, environmental and other contingencies as well as asset
impairment, inventory valuation and collectibility of accounts receivable. We
use historical information and other information which we consider to be
relevant to make these judgments and estimates. However, actual results may
differ from those estimates and assumptions that are used to prepare our
financial statements.
28
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, Accounting for Asset Retirement Obligations ("SFAS 143"). This
statement changes the accounting for asset retirement obligations.
Under SFAS 143, obligations associated with the retirement of tangible
long-lived assets, such as landfill and other facility closure costs, would be
capitalized and amortized to expense over an asset's useful life using a
systematic and rational allocation method. This standard is effective for fiscal
years beginning after June 15, 2002. We are currently evaluating adoption of
SFAS 143 and have not yet determined the impact on our overall financial
condition, if any, that may result.
OTHER MATTERS
Board of Directors
On July 11, 2002, Brian P. Simmons was elected to the Board of Directors.
Mr. Simmons is a partner and one of the founders of Code Hennessy & Simmons LLC,
a private equity investment firm. He is also the son of Richard P. Simmons, who
beneficially owns more than 5% of the Common Stock of the Company and retired as
Chairman of the Company in 2000.
Costs and Pricing
Although inflationary trends in recent years have been moderate, during
the same period certain critical raw material costs, such as nickel and scrap
containing nickel, have been volatile. We primarily use the last-in, first-out
method of inventory accounting that reflects current costs in the cost of
products sold. We consider these costs, the increasing costs of equipment and
other costs in establishing our sales pricing policies and have instituted raw
material surcharges on certain of our products to the extent permitted by
competitive factors in the marketplace. We continue to emphasize cost reductions
and containment in all aspects of our business.
We change prices on certain of our products from time to time. The ability
to implement price increases is dependent on market conditions, economic
factors, raw material costs and availability, competitive factors, operating
costs and other factors, some of which are beyond our control. The benefits of
price increases may be delayed due to long manufacturing lead times and the
terms of existing contracts. During the second quarter of 2002, we announced
price increases of 3% to 6% on various types of our stainless steel products
effective with shipments on July 1, 2002.
Labor Matters
We have over 10,000 employees. A portion of our workforce is represented
under various collective bargaining agreements, principally with the United
Steelworkers of America ("USWA"), including: approximately 3,700 Allegheny
Ludlum production and maintenance employees covered by collective bargaining
agreements between Allegheny Ludlum and the USWA, which are effective through
June 2007; approximately 325 Oremet employees covered by a collective bargaining
agreement with the USWA which is effective through June 2007; and approximately
660 Wah Chang employees covered by a collective bargaining agreement with the
USWA which continues through March 2008.
On July 22, 2002, we announced workforce reductions of approximately 275
salaried employees, primarily in the Flat-Rolled Products segment. These
reductions should be substantially completed by the end of the third quarter of
2002. We expect to record a one-time pre-tax charge of approximately $5.0
million, or $0.04 per share after-tax, in the third quarter 2002 in connection
with these workforce reductions. This action is estimated to provide an annual
pre-tax cost savings of approximately $18 million.
29
During the second quarter of 2002, certain office and technical workers at
Allegheny Ludlum voted to be represented by the USWA. The collective bargaining
unit will consist of approximately 190 full and part-time employees at various
Allegheny Ludlum facilities in Western Pennsylvania.
Generally, agreements that expire may be terminated after notice by the
union. After termination, the union may authorize a strike. A strike by the
employees covered by one or more of the collective bargaining agreements could
materially adversely affect our operating results. There can be no assurance
that we will succeed in concluding collective bargaining agreements with the
unions to replace those that expire.
Environmental
We are subject to various domestic and international environmental laws
and regulations that govern the discharge of pollutants into the air or water,
and disposal of hazardous substances, and which may require that we investigate
and remediate the effects of the release or disposal of materials at sites
associated with past and present operations, including sites at which we have
been identified as a potentially responsible party ("PRP") under the
Comprehensive Environmental Response, Compensation and Liability
Act, commonly known as Superfund, and comparable state laws. We could incur
substantial cleanup costs, fines and civil or criminal sanctions, third party
property damage or personal injury claims as a result of violations or
liabilities under these laws or non-compliance with environmental permits
required at our facilities. We are currently involved in the investigation and
remediation of a number of the our current and former sites as well as third
party location sites under these laws.
With respect to proceedings brought under the federal Superfund laws or
similar state statutes, we have been identified as a PRP at approximately 30 of
such sites, excluding those at which we believe we have no future liability. Our
involvement is very limited or de minimis at approximately 13 of these sites,
and the potential loss exposure with respect to any of the remaining 17
individual sites is not considered to be material.
In June 1995, the U.S. Government commenced an action against Allegheny
Ludlum in the United States District Court for the Western District of
Pennsylvania, alleging multiple violations of the federal Clean Water Act. The
trial of this matter concluded in February 2001. In February 2002, the Court
issued a decision imposing a penalty of $8.2 million for incidents at five
facilities that occurred over a period of approximately six years, which
Allegheny Ludlum had reported to the appropriate environmental agencies. We have
asked the Court to reconsider its decision and in the interim are considering
appealing the Court's decision. At June 30, 2002, we had adequate reserves for
this matter.
TDY Industries, Inc. (TDY) and another wholly-owned subsidiary, among
others, have been identified by the U.S. Environmental Protection Agency (EPA)
as PRPs at the Li Tungsten Superfund Site in Glen Cove, New York. However, we
believe that most of the contamination at these sites resulted from work done
while the United States government either owned or controlled operations at the
Site, or from processes done for various agencies of the United States, and
that the United States is liable for a substantial portion of the remediation
costs at the Site. In November 2000, TDY filed a cost recovery and contribution
action against the United States government. Negotiations between TDY and the
United States are ongoing. An adverse resolution of this matter could have a
material adverse effect on our results of operations and financial condition.
At June 30, 2002, our reserves for environmental remediation obligations
totaled approximately $45.9 million, of which approximately $17.7 million,
including the federal Clean Water Act matter referred to above, were included in
other current liabilities. The reserves include estimated probable future
30
costs of $19.2 million for federal Superfund and comparable state-managed sites
including the Li Tungsten Site referred to in the preceding paragraph; $4.2
million for formerly owned or operated sites for which we have remediation or
indemnification obligations; $11.1 million for owned or controlled sites at
which our operations have been discontinued; and $11.4 million for sites
utilized by us in our ongoing operations. We are evaluating whether we may be
able to recover a portion of future costs for environmental liabilities from
third parties other than participating PRPs.
The timing of expenditures depends on a number of factors that vary by
site, including the nature and extent of contamination, the number of PRPs,
the timing of regulatory approvals, the complexity of the investigation and
remediation, and the standards for remediation. We expect to expend present
accruals over many years, and to complete remediation of various sites with
which we have been identified within thirty years.
We are a party to various cost-sharing arrangements with other PRPs at the
sites. The terms of the cost-sharing arrangements are subject to non-disclosure
agreements as confidential information. Nevertheless, the cost-sharing
arrangements generally require all PRPs to post financial assurance of the
performance of the obligations or to pre-pay into an escrow or trust account
their share of anticipated site-related costs. In addition, the Federal
government, through various agencies, is a party to several such arrangements.
We believe that we operate our businesses in compliance in all material
respects with applicable environmental laws and regulations. However, we are a
party to lawsuits and other proceedings involving alleged violations of
environmental laws. When our liability is probable and we can reasonably
estimate our costs, we record environmental liabilities on our financial
statements. Except as described in this report, investigations are not at a
stage where we have been able to determine liability, or if liability is
probable, to reasonably estimate the loss, or range of loss, or certain
components thereof. Estimates of our liability remain subject to additional
uncertainties regarding the nature and extent of site contamination, the range
of remediation alternatives available, evolving remediation standards, imprecise
engineering evaluations and estimates of appropriate cleanup technology,
methodology and cost, the extent of corrective actions that may be required, and
the number and financial condition of other potentially responsible parties, as
well as the extent of their responsibility for the remediation. Accordingly, as
investigation and remediation of these sites proceed and as we receive new
information, we expect that we will adjust our accruals to reflect the new
information. Future adjustments could have a material adverse effect on our
results of operations in a given period, but we cannot reliably predict the
amounts of such future adjustments.
Based on currently available information, management does not believe that
there is a reasonable possibility that a loss exceeding the amount already
accrued for any of the sites with which we are currently associated (either
individually or in the aggregate) will be an amount that would be material to a
decision to buy or sell our securities. However, additional future developments,
administrative actions or liabilities relating to environmental matters could
have a material adverse effect on our financial condition and results of
operations.
FORWARD-LOOKING AND OTHER STATEMENTS
From time to time, we have made and may continue to make "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Certain statements in this report relate to future events and
expectations and, as such, constitute forward-looking statements.
Forward-looking statements include those containing such words as "anticipates,"
31
"believes," "estimates," "expects," "would," "should," "will," "will likely
result," "forecast," "outlook," "projects," and similar expressions. Such
forward-looking statements are based on management's current expectations and
include known and unknown risks, uncertainties and other factors, many of which
we are unable to predict or control, that may cause our actual results or
performance to materially differ from any future results or performance
expressed or implied by such statements. Various of these factors are described
from time to time in our filings with the Securities and Exchange Commission,
including our Report on Form 10-K for the year ended December 31, 2001. We
assume no duty to update our forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use derivative financial instruments from time to time to hedge
ordinary business risks for product sales denominated in foreign currencies, to
partially hedge against volatile energy and raw material cost fluctuations in
the Flat-Rolled Products and High Performance Metals segments and to manage
exposure to changes in interest rates.
Foreign currency exchange contracts are used to limit transactional
exposure to changes in currency exchange rates. We sometimes purchase foreign
currency forward contracts that permit us to sell specified amounts of foreign
currencies expected to be received from our export sales for pre-established
U.S. dollar amounts at specified dates. The forward contracts are denominated in
the same foreign currencies in which export sales are denominated. These
contracts, which are not financially material, are designated as hedges of the
variability in cash flows of a portion of our forecasted export sales
transactions in which settlement will occur in future periods and which
otherwise would expose us, on the basis of aggregate net cash flows in
respective currencies, to foreign currency risk. Changes in the fair value of
our foreign currency derivatives are recognized in other comprehensive income
until the hedged item is recognized in earnings. The ineffective portion of a
derivative's change in fair value is immediately recognized in the statement of
operations.
As part of our risk management strategy, we purchase exchange-traded
futures contracts from time to time to manage exposure to changes in nickel
prices, a component of raw material cost for some of our flat-rolled and high
performance metals products. The nickel futures contracts obligate us to make or
receive a payment equal to the net change in value of the contract at its
maturity. These contracts are designated as hedges of the variability in cash
flows of a portion of our forecasted purchases of nickel. Changes in the fair
value of our nickel derivatives are recognized in other comprehensive income
until the hedged item is recognized in the statement of operations. The
ineffective portion of a derivative's change in fair value is immediately
recognized in the statement of operations.
We also enter into energy swap contracts as part of our overall risk
management strategy. The swap contracts are used to manage exposure to changes
in energy prices, a component of production costs for our operating units. The
energy swap contracts obligate us to make or receive a payment equal to the net
change in value of the contract at its maturity. These contracts are designated
as hedges of the variability in cash flows of a portion of our forecasted energy
payments. Changes in the fair value of our energy derivatives are recognized in
other comprehensive income until the hedged item is recognized in the statement
of operations. The ineffective portion of a derivative's change in fair value is
immediately recognized in the statement of operations.
As part of our strategy to manage our exposure to changes in interest
rates by maintaining a mix of fixed and variable rate debt, we enter into
interest rate swap contracts. At June 30, 2002, we have entered into "receive
fixed, pay floating" arrangements for $150 million related to our 8.375%
ten-year Notes, which effectively converts this portion of the Notes to variable
rate debt. These contracts are designated as fair value hedges.
32
As a result, changes in the fair value of the swap contracts and the underlying
fixed rate debt are recognized in the statement of operations. The result of the
"receive fixed, pay floating" arrangements was a decrease in interest expense of
$1.6 million for the second quarter and six months ended June 2002 compared to
the fixed interest expense of the ten-year Notes. At June 30, 2002, the
adjustment of these swap contracts to fair market value resulted in the
recognition of an asset of $5.2 million on the balance sheet, included in Other
Assets, with an offsetting increase in long-term debt, which represents the
change in fair value of our 8.375% ten-year Notes. The swap contracts also
contain a provision which allows the swap counterparty to terminate the swap
contracts in the event our senior unsecured debt credit rating falls below
investment grade.
We have guaranteed the outstanding $150 million Allegheny Ludlum fixed
rate 6.95% debentures due in 2025. In a period of declining interest rates, we
face the risk of required interest payments exceeding those based on the then
current market rate. To mitigate interest rate risk, we attempt to maintain a
balance between fixed and floating rate debt in order to maximize liquidity and
minimize financing costs.
We believe that adequate controls are in place to monitor these hedging
activities, which are not financially material. However, many factors, including
those beyond our control such as changes in domestic and foreign political and
economic conditions, as well as the magnitude and timing of interest rate,
energy price and nickel price changes, could adversely affect these activities.
33
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The litigation to which the Company is a party is more fully discussed in
Item 3. of the Company's Annual Report on Form 10-K for the year ended December
31, 2001.
On October 1, 2001, the Company received an Administrative Complaint from
the U.S. Environmental Protection Agency alleging that Allegheny Rodney failed
to file required Toxic Chemical Release Reports for its Waterbury, Connecticut
facility for the years 1996 through 1999. The EPA proposed the imposition of a
civil penalty of $330,000 on account of this failure. The Company denied the
allegations and set forth its defenses. A Consent Agreement and Final Order was
finalized on July 30, 2002 in the amount of $29,400 settling all claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our 2002 annual meeting of stockholders was held on May 9, 2002. Proxies
for the meeting were solicited by us pursuant to Regulation 14A under the
Securities Exchange Act of 1934. At that meeting, the five nominees for election
as directors named in the proxy statement for the meeting were elected, having
received the following number of votes:
Number of Votes Number of Votes
Name For Withheld
Robert P. Bozzone 56,559,394 15,556,485
Frank V. Cahouet 70,733,397 1,382,482
James C. Diggs 71,173,971 941,908
W. Craig McClelland 71,185,550 930,329
Charles J. Queenan 68,719,829 3,396,050
In addition, the stockholders voted on a proposal to ratify the selection
of Ernst & Young LLP as independent auditors of the Company for the 2002 fiscal
year. The number of votes cast for the ratification was 68,932,351, the number
of votes cast against approval was 2,821,905 and the number of abstentions was
360,123. There were no broker no-votes in connection with the ratification of
the selection of Ernst & Young LLP.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
A list of exhibits included in this Report or incorporated by
reference is found in the Exhibit Index beginning on page 37 of
this Report and incorporated by reference.
(b) Current Reports on Form 8-K filed by the Company -
None.
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLEGHENY TECHNOLOGIES INCORPORATED
(REGISTRANT)
Date: August 14, 2002 By /s/ R.J. Harshman
----------------------------------
Richard J. Harshman
Senior Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer and
Duly Authorized Officer)
Date: August 14, 2002 By /s/ D.G. Reid
----------------------------------
Dale G. Reid
Vice President, Controller and
Chief Accounting Officer
(Principal Accounting Officer)
35
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Allegheny Technologies Incorporated
(the "Company") on Form 10-Q for the period ended June 30, 2002 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), each
of the undersigned, in the capacities and on the dates indicated below, hereby
certifies pursuant to 19 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, that to his knowledge:
1. The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
Date: August 14, 2002 /s/ James L. Murdy
------------------- --------------------------------------
James L. Murdy
President and Chief Executive Officer
Date: August 14, 2002 /s/ Richard J. Harshman
------------------- --------------------------------------
Richard J. Harshman
Senior Vice President-Finance and
Chief Financial Officer
36
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
- ------- -----------
3.1 Certificate of Incorporation of Allegheny Technologies Incorporated, as
amended, (incorporated by reference to Exhibit 3.1 to the Registrant's
Report on Form 10-K for the year ended December 31, 1999 (File No.
1-12001)).
3.2 Amended and Restated Bylaws of Allegheny Technologies Incorporated
incorporated by reference to Exhibit 3.2 to the Registrant's Report on
Form 10-K for the year ended December 31, 1998 (File No. 1-12001)).
4.1 First Amendment dated as of August 12, 2002 to the Credit Agreement
dated as of December 21, 2001 (filed herewith).
37