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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 SEPTEMBER 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 November 4, 2002, the registrant had outstanding 80,635,515 shares of its
Common Stock.
ALLEGHENY TECHNOLOGIES INCORPORATED
SEC FORM 10-Q
QUARTER ENDED SEPTEMBER 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 22
Item 3. Quantitative and Qualitative
Disclosures About Market Risk 37
Item 4. Controls and Procedures 38
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 39
Item 6. Exhibits and Reports on Form 8-K 39
SIGNATURES 40
CERTIFICATIONS 41
EXHIBIT INDEX 46
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)
September 30, December 31,
2002 2001
---- ----
(Unaudited) (Audited)
ASSETS
Cash and cash equivalents $ 75.2 $ 33.7
Accounts receivable, net 254.6 274.6
Inventories, net 420.4 508.4
Accrued income tax receivable 25.2 48.5
Deferred income taxes 31.9 33.5
Prepaid expenses and other current assets 27.4 27.4
---------- ----------
Total Current Assets 834.7 926.1
Property, plant and equipment, net 802.5 828.9
Prepaid pension cost 640.1 632.9
Cost in excess of net assets acquired 192.8 188.4
Other assets 78.7 66.9
---------- ----------
TOTAL ASSETS $ 2,548.8 $ 2,643.2
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 167.9 $ 155.3
Accrued liabilities 182.6 168.2
Short-term debt and current portion
of long-term debt 16.1 9.2
---------- ----------
Total Current Liabilities 366.6 332.7
Long-term debt 508.6 573.0
Accrued postretirement benefits 500.0 506.1
Deferred income taxes 170.0 153.7
Other 110.7 133.0
---------- ----------
TOTAL LIABILITIES 1,655.9 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 September 30,
2002 and December 31, 2001; outstanding-80,635,916
shares at September 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 879.6 957.5
Treasury stock: 18,315,574 shares at
September 30, 2002 and 18,636,866 shares
at December 31, 2001 (469.5) (478.2)
Accumulated other comprehensive
loss, net of tax (8.3) (25.7)
---------- ----------
Total Stockholders' Equity 892.9 944.7
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,548.8 $ 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 Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Sales $ 469.3 $ 537.7 $ 1,453.6 $ 1,634.9
Costs and expenses:
Cost of sales 419.7 470.3 1,316.5 1,431.0
Selling and administrative
expenses 47.1 45.3 146.9 146.2
Restructuring costs 5.5 - 5.5 -
--------- --------- --------- ---------
Income (loss) before interest,
other income and income taxes (3.0) 22.1 (15.3) 57.7
Interest expense, net 8.3 7.1 26.1 22.7
Other income (expense) (2.3) (0.5) (0.7) 0.5
--------- --------- --------- ---------
Income (loss) before income taxes (13.6) 14.5 (42.1) 35.5
Income tax provision (benefit) (6.1) 6.5 (16.0) 14.9
--------- --------- --------- ---------
Net income (loss) $ (7.5) $ 8.0 $ (26.1) $ 20.6
========= ========= ========= =========
Basic and diluted net income
(loss) per common share $ (0.09) $ 0.10 $ (0.32) $ 0.26
========= ========= ========= =========
Dividends declared per common share $ 0.20 $ 0.20 $ 0.60 $ 0.60
========= ========= ========= =========
The accompanying notes are an integral part of these statements.
4
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
----------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(In millions)
(Unaudited)
Nine Months Ended
September 30,
---------------------
2002 2001
------- -------
OPERATING ACTIVITIES:
Net income (loss) $ (26.1) $ 20.6
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 68.5 74.7
Deferred income taxes 18.4 (0.8)
Gains on sales of investments and businesses (2.4) (2.7)
Non-cash restructuring gain (1.7) -
Non-cash write-off of MetalSpectrum investment - 5.5
Change in operating assets and liabilities:
Inventories 88.0 37.5
Income tax refunds received 45.6 -
Accrued income taxes receivable (22.3) -
Accounts receivable 20.2 14.8
Accounts payable 13.1 7.0
Prepaid pension cost (7.3) (30.8)
Accrued liabilities and other 10.3 (31.4)
------- -------
CASH PROVIDED BY OPERATING ACTIVITIES 204.3 94.4
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (35.9) (78.3)
Other 2.2 7.4
------- -------
CASH USED IN INVESTING ACTIVITIES (33.7) (70.9)
FINANCING ACTIVITIES:
Net borrowings (repayments) under credit facilities (72.7) 35.0
Payments on long-term debt and capital leases (8.1) (0.5)
Borrowings on long-term debt - 4.5
------- -------
Net increase (decrease) in debt (80.8) 39.0
Dividends paid (48.3) (48.1)
Other - (2.8)
------- -------
CASH USED IN FINANCING ACTIVITIES (129.1) (11.9)
------- -------
INCREASE IN CASH AND CASH EQUIVALENTS 41.5 11.6
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 33.7 26.2
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 75.2 $ 37.8
======= =======
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 July 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). This statement
establishes accounting guidelines for the recognition and measurement of
liabilities for costs associated with exit or disposal activities initially at
fair value in the period in which the liabilities are incurred, rather than at
the date of a commitment to an exit or disposal plan. This standard is effective
January 1, 2003 for all exit or disposal activities initiated after that date.
The Company intends to adopt this standard at January 1, 2003. Upon adoption,
this standard may affect the periods in which costs are recognized for workforce
reductions or facility closures, although the ultimate amount of costs
recognized would be the same.
In June 2001, the 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 for impairment, or more frequently if
impairment indicators arise. 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 each reporting unit
that has goodwill associated with its operations 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.
6
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 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 assumptions. In accordance with SFAS 142, the Company will
evaluate goodwill annually for impairment. The Company will perform this test 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 September 30, 2001 was $1.5 million and
$4.4 million, respectively, or $0.01 and $0.03 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):
September 30, December 31,
2002 2001
------------- ------------
(unaudited) (audited)
Raw materials and supplies $ 55.6 $ 85.9
Work-in-process 362.7 419.6
Finished goods 78.5 83.0
-------- --------
Total inventories at current cost 496.8 588.5
Less allowances to reduce current cost
values to LIFO basis (74.6) (77.2)
Progress payments (1.8) (2.9)
-------- --------
Total inventories $ 420.4 $ 508.4
======== ========
7
NOTE 3. SUPPLEMENTAL BALANCE SHEET INFORMATION
Property, plant and equipment were as follows (in millions):
September 30, December 31,
2002 2001
------------- ------------
(unaudited) (audited)
Land $ 30.9 $ 30.6
Buildings 237.3 219.4
Equipment and leasehold improvements 1,554.3 1,534.4
-------- --------
1,822.5 1,784.4
Accumulated depreciation and amortization (1,020.0) (955.5)
-------- --------
Total property, plant and equipment, net $ 802.5 $ 828.9
======== ========
NOTE 4. DEBT
Debt at September 30, 2002 and December 31, 2001 was as follows (in
millions):
September 30, December 31,
2002 2001
------------- ------------
(unaudited) (audited)
Allegheny Technologies $300 million
8.375% Notes due 2011, net (a) $313.7 $292.5
Allegheny Ludlum 6.95% debentures,
due 2025 150.0 150.0
Commercial paper - 70.0
Bank Group credit agreement - -
Foreign credit agreements 23.0 25.6
Industrial revenue bonds, due 2002
through 2011 21.7 22.5
Capitalized leases and other 16.3 21.6
------ ------
524.7 582.2
Short-term debt and current portion
of long-term debt (16.1) (9.2)
------ ------
Total long-term debt $508.6 $573.0
====== ======
(a) Includes fair value adjustments for interest rate swap contracts of
$20.2 million at September 30, 2002.
Scheduled maturities of borrowings through 2006 are $10.2 million for the
remainder of 2002, $9.9 million in 2003, $21.1 million in 2004, $0.6 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. Interest on the Notes is payable semi-annually, on June 15
and December 15. These Notes contain default provisions 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.
Interest rate swap contracts are used from time-to-time 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 contracts and the underlying
8
fixed rate debt are recognized in the statement of operations. At September 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 convert
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 and $3.1 million for the third quarter and nine months ended September
2002, respectively, compared to the fixed interest expense of the ten-year
Notes. At September 30, 2002, the adjustment of these swap contracts to fair
market value resulted in the recognition of an asset of $20.2 million on the
balance sheet, included in Other assets, with an offsetting increase in
Long-term debt. The swap contracts 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.
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 September 30, 2002. The
Company is currently in discussions with its Bank Group to extend the short-term
364-day $130 million portion of the credit facility. Interest on credit facility
borrowings 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 agreement also contains covenants
that require the Company to maintain various financial statement ratios,
including a covenant requiring the maintenance of a specified minimum 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 not exceed a specified maximum ratio of
total consolidated indebtedness to total capitalization ("Leverage Ratio"), both
as defined by the agreement. The Company was compliant with these covenants at
September 30, 2002.
The following table summarizes 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 excludes up to $10 million of cash costs related
to workforce reductions in 2002 and, beginning in 2003, includes the add back of
non-cash pension expense or the deduction of non-cash pension income calculated
in accordance with SFAS No. 87, "Employers' Accounting for Pensions" ("SFAS
87").
The Leverage Ratio requires that total consolidated indebtedness be not
more than 50% of total capitalization. The Leverage Ratio excludes 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. Cash and cash equivalents in excess of
$25 million reduce total consolidated indebtedness and total capitalization by
the amount of that excess.
At September 30, 2002, EBITDA (calculated in accordance with the credit
agreement, which excludes certain non-cash charges) for the prior twelve
9
month period was 2.58 times gross interest expense compared to a required ratio
of at least 2.25 times gross interest expense. At September 30, 2002, the
Leverage Ratio was 37% compared to a required ratio of not more than 50% of
total capitalization. The Leverage Ratio has the effect of limiting the total
amount the Company may borrow and the amount of dividends which may be paid; at
September 30, 2002, the Leverage Ratio would limit the amount of additional
borrowings and dividends to approximately $370 million.
In July 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 October 25, 2002, Moody's Investor Service
lowered its long-term corporate credit ratings for the Company's debt to Baa2
from Baa1. The Moody's Prime-2 short term rating (commercial paper) for the
Company's debt was unchanged. 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 investment grade.
(this space intentionally left blank)
10
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 Nine Months Ended
September 30, September 30,
----------------------- -------------------------
2002 2001 2002 2001
-------- -------- -------- --------
(unaudited) (unaudited)
Total sales:
Flat-Rolled Products $ 268.4 $ 290.0 $ 814.4 $ 865.2
High Performance Metals 153.4 205.0 497.3 634.3
Industrial Products 56.8 67.2 174.5 211.0
-------- -------- -------- --------
478.6 562.2 1,486.2 1,710.5
Intersegment sales:
Flat-Rolled Products 2.0 8.1 9.2 24.8
High Performance Metals 7.3 16.4 23.4 50.8
-------- -------- -------- --------
9.3 24.5 32.6 75.6
Sales to external customers:
Flat-Rolled Products 266.4 281.9 805.2 840.4
High Performance Metals 146.1 188.6 473.9 583.5
Industrial Products 56.8 67.2 174.5 211.0
-------- -------- -------- --------
$ 469.3 $ 537.7 $1,453.6 $1,634.9
======== ======== ======== ========
Operating profit(loss):
Flat-Rolled Products $ 3.9 $ (6.0) $ 4.2 $ (22.7)
High Performance Metals 9.3 22.9 22.2 56.4
Industrial Products 1.6 2.5 3.1 12.0
-------- -------- -------- --------
Total operating profit 14.8 19.4 29.5 45.7
Corporate expenses (5.6) (5.7) (15.8) (19.7)
Interest expense, net (8.3) (7.1) (26.1) (22.7)
Restructuring costs (5.5) - (5.5) -
Other expenses, net of gains
on asset sales (3.6) (2.2) (7.6) (10.8)
Retirement benefit (expense)
income (5.4) 10.1 (16.6) 43.0
-------- -------- -------- --------
Income (loss) before income
taxes $ (13.6) $ 14.5 $ (42.1) $ 35.5
======== ======== ======== ========
Other expenses, net of gains on asset sales for the third quarter 2002 and
nine months ended 2002 include a non-cash, non-recurring charge of $1.7 million,
related to the Company's approximately 30% equity in net losses of New Piper
Aircraft, Inc. The Company's $4 million investment in New Piper Aircraft, Inc.,
which is held for sale, is accounted for using the equity method and is included
in Other assets on the balance sheet. Other expenses, net of gains on asset
sales for the nine 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.
Retirement benefit (expense) income represents pension income net of other
postretirement benefit expenses. Operating profit with respect to
11
the Company's business segments excludes any retirement benefit expense or
income.
NOTE 6. RESTRUCTURING CHARGES
The Company recorded $5.5 million of restructuring charges during the third
quarter of 2002 related to workforce reductions. These cost reduction actions,
which affected approximately 340 employees, primarily salaried and predominantly
in the Flat-Rolled Products segment, were substantially complete by the end of
the third quarter. The restructuring costs included $7.2 million of severance
expenses partially offset by $1.7 million of non-cash income recognized on the
curtailment of postretirement benefits for terminated employees.
NOTE 7. 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 Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2002 2001 2002 2001
-------- -------- -------- --------
(unaudited) (unaudited)
Numerator for basic and diluted
net income (loss) per common
share - net income (loss) $ (7.5) $ 8.0 $ (26.1) $ 20.6
======== ======== ======== ========
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) $ 0.10 $ (0.32) $ 0.26
======== ======== ======== ========
For the 2002 periods, the effects of stock options were antidilutive and
thus not included in the calculation of dilutive earnings per share.
12
NOTE 8. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, were as follows
(in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2002 2001 2002 2001
------- ------- ------- -------
(unaudited) (unaudited)
Net income (loss) $ (7.5) $ 8.0 $ (26.1) $ 20.6
------- ------- ------- -------
Foreign currency translation
gains 8.9 1.6 12.6 2.9
------- ------- ------- -------
Unrealized gains (losses) on
energy, raw materials and
currency hedges, net of tax (3.0) 0.1 4.4 (8.6)
------- ------- ------- -------
Unrealized holding gains (losses) arising
during the period - (1.9) 0.4 (2.3)
Less: realized gains
included in net income(loss) - - - 1.3
------- ------- ------- -------
- (1.9) 0.4 (3.6)
------- ------- ------- -------
Comprehensive income (loss) $ (1.6) $ 7.8 $ (8.7) $ 11.3
======= ======= ======= =======
NOTE 9. 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 9 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 the Subsidiary
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 the Subsidiary 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 the Subsidiary 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 the Subsidiary or the non-guarantor subsidiaries. Management and royalty fees
charged to the Subsidiary and to the non-guarantor subsidiaries by the Guarantor
Parent have been excluded solely for purposes of this presentation.
13
NOTE 9. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
September 30, 2002 (unaudited)
- ------------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------
Assets:
Cash $ - $ 61.5 $ 13.7 $ - $ 75.2
Accounts receivable, net 0.2 96.0 158.4 - 254.6
Inventories, net - 182.8 237.6 - 420.4
Accrued income tax refunds 25.2 - - - 25.2
Deferred income taxes 31.9 - - - 31.9
Prepaid expenses and other
current assets 0.5 9.3 17.6 - 27.4
-------------------------------------------------------------------------
Total current assets 57.8 349.6 427.3 - 834.7
Property, plant, and
equipment, net - 428.1 374.4 - 802.5
Prepaid pension cost 640.1 - - - 640.1
Cost in excess of net
assets acquired - 112.1 80.7 - 192.8
Other assets 1,200.8 595.6 349.5 (2,067.2) 78.7
-------------------------------------------------------------------------
Total assets $1,898.7 $1,485.4 $1,231.9 $(2,067.2) $2,548.8
=========================================================================
Liabilities and
stockholders' equity:
Current liabilities:
Accounts payable $ 1.4 $ 93.7 $ 72.8 $ - $ 167.9
Accrued liabilities 506.5 61.7 124.6 (510.2) 182.6
Short-term debt - 10.6 5.5 - 16.1
-------------------------------------------------------------------------
Total current liabilities 507.9 166.0 202.9 (510.2) 366.6
Long-term debt 313.7 419.7 34.8 (259.6) 508.6
Accrued postretirement
benefits - 309.4 190.6 - 500.0
Deferred income taxes 170.0 - - - 170.0
Other long-term liabilities 14.2 26.4 70.1 - 110.7
-------------------------------------------------------------------------
Total liabilities 1,005.8 921.5 498.4 (769.8) 1,655.9
-------------------------------------------------------------------------
Total stockholders' equity 892.9 563.9 733.5 (1,297.4) 892.9
-------------------------------------------------------------------------
Total liabilities and
stockholders' equity $1,898.7 $1,485.4 $1,231.9 $(2,067.2) $2,548.8
=========================================================================
14
NOTE 9. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the nine months ended September 30, 2002 (unaudited)
- ----------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ----------------------------------------------------------------------------------------------------------
Sales $ - $ 749.8 $ 703.8 $ - $1,453.6
Cost of sales 10.1 721.8 584.6 - 1,316.5
Selling and administrative
expenses 35.1 20.0 91.8 - 146.9
Restructuring costs - 4.1 1.4 - 5.5
Interest expense 16.9 7.8 1.4 - 26.1
Other income(expense)
including equity in income
of unconsolidated
subsidiaries 23.4 (0.1) 7.6 (31.6) (0.7)
-----------------------------------------------------------------------
Income (loss) before income
taxes (38.7) (4.0) 32.2 (31.6) (42.1)
Income tax provision (benefit) (12.6) (6.2) 14.8 (12.0) (16.0)
-----------------------------------------------------------------------
Net income (loss) $ (26.1) $ 2.2 $ 17.4 $ (19.6) $ (26.1)
=======================================================================
Condensed Statements of Cash Flows
For the nine months ended September 30, 2002 (unaudited)
- ---------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ---------------------------------------------------------------------------------------------------------
Cash flows from operating
activities $ 74.8 $ 79.8 $ (52.3) $ 102.0 $ 204.3
-----------------------------------------------------------------------
Cash flows from investing
activities - (8.8) (32.6) 7.7 (33.7)
-----------------------------------------------------------------------
Cash flows from financing
activities $ (75.2) $ (23.8) $ 79.6 $ (109.7) $ (129.1)
-----------------------------------------------------------------------
15
NOTE 9. 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
Accrued income tax
receivable 48.5 - - - 48.5
Deferred income taxes 33.5 - - - 33.5
Prepaid expenses, and other
current assets 0.1 9.9 17.4 - 27.4
-----------------------------------------------------------------------
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
=======================================================================
16
NOTE 9. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the nine months ended September 30, 2001 (unaudited)
- ----------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ----------------------------------------------------------------------------------------------------------
Sales $ - $ 823.6 $ 811.3 $ - $1,634.9
Cost of sales (24.0) 814.1 640.9 - 1,431.0
Selling and administrative
expenses 6.2 30.1 109.9 - 146.2
Interest expense (income) 27.2 (0.6) (3.9) - 22.7
Other income(expense)
including equity in income
of unconsolidated
subsidiaries 53.2 - 0.6 (53.3) 0.5
-----------------------------------------------------------------------
Income (loss) before income taxes 43.8 (20.0) 65.0 (53.3) 35.5
Income tax provision
(benefit) 23.2 (4.5) 22.5 (26.3) 14.9
-----------------------------------------------------------------------
Net income (loss) $ 20.6 $ (15.5) $ 42.5 $ (27.0) $ 20.6
=======================================================================
Condensed Statements of Cash Flows
For the nine months ended September 30, 2001 (unaudited)
- ----------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ----------------------------------------------------------------------------------------------------------
Cash flows from operating
activities $ 3.5 $ 106.2 $ 85.7 $ (101.0) $ 94.4
-----------------------------------------------------------------------
Cash flows from investing
activities 7.4 (14.5) (61.2) (2.6) (70.9)
-----------------------------------------------------------------------
Cash flows from financing
activities $ (9.7) $ (80.2) $ (25.6) $ 103.6 $ (11.9)
-----------------------------------------------------------------------
NOTE 10. 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
17
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.
Environmental liabilities are recorded when the Company's liability is
probable and the costs are reasonably estimable. Except as described in this
Note 10, investigations are not 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 proceed 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 asked the Court to reconsider its decision, which the Court denied in
October 2002. The Company intends to appeal the Court's decision. At September
30, 2002, the Company had adequate reserves for this matter.
The Company formerly operated its Teledyne Ryan Aeronautical division at a
facility leased from the San Diego Unified Port District ("Port District") in
San Diego, CA ("San Diego facility"). The lease for the facility has terminated
as discussed below. The Company is conducting an environmental assessment of
portions of the San Diego facility at the request of the California Regional
Water Quality Control Board (RWQCB). At this stage of the assessment, the
Company cannot predict if any remediation will be necessary. The Company
remediated in 1998 and continues to monitor a lagoon near the San Diego
facility. The Company is also seeking approval from the San Diego Department of
Public Health for the 1996 closure of four underground storage tanks at the San
Diego facility. The Company is evaluating potential claims it has against
18
neighboring property owners and other PRPs related to the environmental
condition of the San Diego facility.
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. The Company
believes that most of the contamination at the Site 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. Discovery is ongoing and no trial date has
been set. An adverse resolution of this matter could have a material adverse
effect on the Company's results of operations and financial condition.
At September 30, 2002, reserves for environmental remediation obligations
totaled approximately $44.3 million, of which approximately $13.1 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 $18.3 million for Federal Superfund and comparable state-managed sites,
including the Li Tungsten site referred to in the preceding paragraph; $10.7
million for formerly owned or operated sites for which the Company has
remediation or indemnification obligations, including the former San Diego
facility referred to above; $4.1 million for owned or controlled sites at which
Company operations have been discontinued; and $11.2 million for sites utilized
by the Company in its ongoing operations. The Company is continuing to evaluate
whether it may be able to recover a portion of future costs for environmental
liabilities from third parties 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 has 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. The Company has also disputed the
arbitrability of certain portions of the USWA's calculations. On November 20,
2001, the USWA filed a Complaint to compel the arbitration in these matters. The
Complaint was 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. On July 22, 2002 the
Court issued an order referring the arbitrability issue to arbitration. The
Company has appealed the Court's order and is
19
currently negotiating with the USWA over the procedures for conducting the
arbitration. 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 requests that the court impose a constructive
trust on TDY's equity interest in privately held New Piper Aircraft, Inc., which
represents approximately 30% of the equity of New Piper Aircraft, Inc. In the
alternative, Kaiser also seeks unspecified damages in an amount "to be
determined at trial." The trial for this matter is being rescheduled. 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 Port District entered into a lease of the San
Diego facility on October 1, 1984. 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"). Northrop subleased a portion of the property with the approval of
the Port District 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 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
and other expenses for the property amount to approximately $0.4 million per
month. At September 30, 2002 the Company had a reserve of approximately $3
million to cover the costs of occupying the facility. TDY and the Port District
discussed resolution of this matter but did not reach any agreement even after
court-sponsored mediation. In June 2002 TDY ceased paying rent on the grounds
that the Port District had rescinded the Lease when it refused to allow TDY to
sublease the property. In September 2002 the Port District demanded that rent be
paid or possession of the property be returned to the Port District. TDY
returned possession to the Port District on October 31, 2002 and denied that
any remaining amounts were due under the lease.
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
20
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.
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.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Third quarter 2002
- - The Flat-Rolled Products segment profitability improved modestly on cost
reduction efforts.
- - The High Performance Metals segment was impacted by continued weak
conditions in the commercial aerospace and power generation markets.
- - The Industrial Products segment results were lower than the second quarter
due to continued weak manufacturing economy.
Nine months 2002
- - Cash provided by operating activities was $204.3 million for the first nine
months of 2002.
- - Managed working capital was reduced by $120 million for the first nine
months of 2002.
- - Cost reductions reached $97 million for the first nine 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 nine months of
2002 and 2001:
2002 2001
---- ----
Flat-Rolled Products 55% 51%
High Performance Metals 33% 36%
Industrial Products 12% 13%
For the first nine months of 2002, operating profit was $29.5 million
compared to $45.7 million for the same 2001 period. Sales decreased 11% to
$1,453.6 million for the first nine months of 2002 compared to $1,634.9 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 $26.1 million, or $0.32 loss per diluted share,
for the first nine months of 2002 compared to net income of $20.6 million, or
$0.26 per diluted share, for the first nine months of 2001.
We 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 $37 million during the
third quarter of 2002 and $97 million during the first nine months of 2002 in
gross cost reductions before the effect of inflation. We have targeted at least
$100 million of gross cost reductions for the full year 2002 and expect to
exceed that target.
Third quarter 2002 results included net after-tax non-recurring charges of
$4.5 million, or $0.05 per share. These charges included $3.4 million, or $0.04
per share, resulting from workforce reductions.
22
These cost reductions, presented as restructuring costs in the financial
statements, affected approximately 340 employees, primarily salaried and
predominately in the Flat-Rolled Products segment, and were substantially
complete by the end of the third quarter. These actions are expected to provide
annual pre-tax cost savings of approximately $23 million. In addition, the 2002
third quarter included a non-recurring, non-cash after-tax charge of $1.1
million, or $0.01 per share, related to our approximately 30% equity in net
losses of New Piper Aircraft, Inc., an investment held for sale.
Business conditions remain very difficult and uncertain, and the potential
exists for further weakening in the fourth quarter, especially in the commercial
aerospace and capital goods markets.
Sales and operating profit (loss) for our three business segments are
discussed below.
FLAT-ROLLED PRODUCTS SEGMENT
Third quarter Flat-Rolled Products segment sales decreased 6% compared to
the third quarter of 2001 primarily due to weakness in the capital goods
markets. Operating profit improved to $3.9 million in the third quarter of 2002
compared to a $6.0 million loss in the 2001 third quarter primarily due to cost
reductions. For the first nine months of 2002, sales declined 4% to $805.2
million and operating profit was $4.2 million compared to a $22.7 million loss
in the same 2001 period. Operating results in the 2002 third quarter and first
nine months of 2002 benefited significantly from gross cost reductions within
the segment, before the effect of inflation, of $21.0 million and $56.4 million,
respectively.
For the third quarter 2002, compared to the third quarter 2001, finished
commodity product shipments in the segment (including stainless steel sheet and
plate, silicon electrical steel, and tool steel, among other products) were 10%
lower while average prices increased 4%, primarily due to product mix and the
impact of raw material surcharges. High-value product shipments (including
standard strip, Precision Rolled Strip(R) products, nickel-based alloys and
specialty steels, and titanium and titanium alloys) increased 7%, but average
prices decreased 10%.
For the first nine months of 2002, finished commodity product shipments in
the segment were 4% lower compared to the same 2001 period. Average prices for
finished commodity products decreased 1% during the same period. High-value
product shipments in the segment increased 4% compared to the first nine months
of 2001, while average prices for high-value products decreased 7%. First nine
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.
Imports of some stainless steel flat-rolled products rose during the first
seven months of 2002, according to the most recent data available from industry
trade associations. Imports of stainless steel sheet and strip rose 8% during
the first seven months and accounted for 17% of the market compared to 18% in
the same period last year. Imports of stainless steel plate products rose 26%,
reaching a 21% market share in the first seven months of 2002 compared to 18%
during the same period in 2001. The Section 201 trade case actions that were
initiated by the U.S. Government imposing tariffs on certain types of steel
imports are insignificant to our business and do not impact the imports of
products discussed above.
23
Comparative information on the segment's products is provided in the
following table (unaudited):
Three Months
Ended
September 30,
------------------------- %
2002 2001 Change
---------------------------------------
Volume (finished tons):
Commodity 87,884 97,711 (10)
High Value 34,365 32,249 7
-------- --------
Total 122,249 129,960 (6)
Average prices (per finished ton):
Commodity $ 1,594 $ 1,531 4
High Value $ 3,617 $ 4,030 (10)
Combined Average $ 2,163 $ 2,151 1
Nine Months
Ended
September 30,
------------------------- %
2002 2001 Change
---------------------------------------
Volume (finished tons):
Commodity 267,798 278,609 (4)
High Value 104,734 100,252 4
-------- --------
Total 372,532 378,861 (2)
Average prices (per finished ton):
Commodity $ 1,541 $ 1,557 (1)
High Value $ 3,682 $ 3,966 (7)
Combined Average $ 2,143 $ 2,195 (2)
During the third quarter of 2002, we announced a capital investment
designed to significantly reduce operating costs and increase productivity at
the Allegheny Ludlum melt shop located in Brackenridge, PA. We plan to install
two new high-powered electric arc furnaces and related equipment at a cost of
approximately $35 million. Cost savings are estimated to be over $20 million
annually after completion of the project. The first furnace is scheduled to be
operational in December 2003 and the second furnace is expected to be
operational in December 2004.
HIGH PERFORMANCE METALS SEGMENT
For the third quarter 2002, sales declined 23% compared to the third
quarter 2001 and operating profit decreased to $9.3 million compared to $22.9
million in the third quarter of 2001 due primarily to reduced demand from the
segment's two largest markets, commercial aerospace and power generation.
Shipments of nickel-based and specialty steel products decreased 38% and average
prices increased 8%, primarily due to product mix. Shipments of titanium
products decreased 30% and average prices increased 6%, primarily due to product
mix. Shipments of exotic alloys increased 53% and average prices were 9% lower
due to product mix.
Sales declined 19% to $473.9 million for the first nine months of 2002
compared to the same period of last year while operating profit declined to
$22.2 million compared to $56.4 million in the year-ago
24
period. The decline in sales and operating profit resulted from reduced demand
in the commercial aerospace and power generation markets and the effects of a
seven month labor strike at our Wah Chang facility, settled in March 2002.
Shipments of nickel-based and specialty steel products decreased 31% while
average prices increased 3%, primarily due to product mix. Shipments of titanium
products decreased 19% while shipments of exotic alloys increased 14%, primarily
due to product mix. Average prices in both these categories were flat compared
to the prior year period.
Backlog of confirmed orders within the segment declined to approximately
$250 million at September 30, 2002, 9% lower than at June 30, 2002, and 29%
lower than at December 31, 2001, primarily due to reduced demand from the
commercial aerospace and power generation markets.
Certain comparative information on the segment's major products is provided
in the following table (unaudited):
Three Months
Ended
September 30,
------------------------- %
2002 2001 Change
---------------------------------------
Volume (000's pounds):
Nickel-based and specialty steel alloys 7,901 12,783 (38)
Titanium mill products 4,186 5,960 (30)
Exotic alloys 967 632 53
Average prices (per pound):
Nickel-based and specialty steel alloys $ 6.72 $ 6.23 8
Titanium mill products $ 12.25 $ 11.53 6
Exotic alloys $ 35.16 $ 38.66 (9)
Nine Months
Ended
September 30, %
--------------------------
2002 2001 Change
---------------------------------------
Volume (000's pounds):
Nickel-based and specialty steel alloys 27,113 39,040 (31)
Titanium mill products 14,411 17,851 (19)
Exotic alloys 2,851 2,493 14
Average prices (per pound):
Nickel-based and specialty steel alloys $ 6.49 $ 6.29 3
Titanium mill products $ 11.65 $ 11.69 -
Exotic alloys $ 34.16 $ 34.04 -
INDUSTRIAL PRODUCTS SEGMENT
Due to the generally weak manufacturing sector of the economy, third
quarter 2002 sales decreased 16% to $56.8 million, compared to the same period
last year. Operating profit was $1.6 million compared to $2.5 million in the
same 2001 period. For the first nine months 2002, sales decreased 17% to $174.5
million compared to $211.0 million in the same 2001 period. Operating profit for
the first nine months of 2002 decreased to $3.1 million compared to $12.0
million in the same 2001 period.
25
CORPORATE ITEMS
Corporate expenses decreased slightly to $5.6 million for third quarter of
2002 and decreased 20% to $15.8 million for the first nine months of 2002,
compared to the respective 2001 periods. Continued cost reductions and lower
incentive compensation accruals contributed to the decline in corporate expenses
for the first nine months of 2002. Net interest expense increased to $8.3
million for the third quarter of 2002 from $7.1 million for the third quarter of
2001. For the first nine months of 2002, net interest expense was $26.1 million
compared to $22.7 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. During 2002, we entered into "receive fixed, pay floating"
interest rate swap contracts for $150 million related to these Notes, which
effectively convert this portion of the Notes to variable rate debt. The result
of the swap contracts was a decrease in interest expense of $1.6 million and
$3.1 million for the third quarter 2002 and nine months ended 2002,
respectively, compared to the fixed interest expense of the Notes.
The 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 $5.4 million in the third quarter of 2002 and
$16.6 million for the first nine months of 2002 compared to retirement income of
$10.1 million in the third quarter of 2001 and $43.0 million for the first nine
months of 2001. This retirement benefit expense, as compared to net retirement
income in the prior year comparable periods, had, and will have, a negative
effect on both cost of sales and selling and administrative expenses for 2002.
The further decline in the equity markets thus far in 2002 is likely to result
in a significant increase in non-cash pre-tax retirement benefit expense for
2003, compared to 2002. However, based upon current actuarial analyses and
forecasts, we do not expect to make cash contributions to the defined benefit
pension plan for at least the next several years.
SPECIAL ITEMS
During the third quarter, we substantially completed previously announced
workforce reductions of approximately 340 employees, primarily salaried and
predominately in the Flat-Rolled Products segment. As a result of these cost
reduction actions, we recorded a one-time pre-tax charge in the third quarter
2002 of approximately $7.2 million pre-tax, which was partially offset by $1.7
million of non-cash income recognized on the curtailment of postretirement
benefits for terminated employees. These actions are estimated to provide an
annual pre-tax cost savings of approximately $23 million.
In addition, the 2002 third quarter included a non-recurring, non-cash
pre-tax charge of $1.7 million related to our approximately 30% equity in net
losses of New Piper Aircraft, Inc. This investment, which is held for sale and
has a carrying value of $4 million, is accounted for using the equity method and
is included in Other assets on the balance sheet.
The 2001 nine months results include an after-tax non-cash charge of $3.4
million, or $0.04 per share, related to the write-off of our 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.
26
INCOME TAX PROVISION (BENEFIT)
Our effective tax rate was (44.9%) and (38.0%) for quarter and year to date
periods ended September 30, 2002, respectively, compared to 44.8% and 42.0% for
the same periods in 2001. The income tax benefits for the third quarter 2002
include the effects of adjustments to estimates of prior years' tax liabilities.
FINANCIAL CONDITION AND LIQUIDITY
CASH FLOW AND WORKING CAPITAL
During the nine months ended September 30, 2002, cash generated from
operations was $204.3 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 $80.8 million, pay
dividends of $48.3 million and invest $35.9 million in capital expenditures. At
September 30, 2002, cash and cash equivalents totaled $75.2 million, an increase
of $41.5 million from December 31, 2001.
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 nine months of 2002, managed working
capital, which is defined as gross inventory plus accounts receivable less
accounts payable, declined by $120.1 million, or 17%, to $605.6 million. The
decline in managed working capital resulted from a $89.3 million decrease in
gross inventory, a $19.7 million decrease in accounts receivable, and a $11.1
million increase in accounts payable.
Working capital decreased to $468.1 million at September 30, 2002 compared
to $593.4 million at December 31, 2001. The current ratio decreased to 2.3 from
2.8 in this same period. The change in working capital and current ratio at
September 30, 2002 compared to December 31, 2001 was primarily due to a
reduction in inventories and accounts receivable.
Capital expenditures for 2002 are expected to be approximately $50 million,
of which $35.9 million had been expended through September 30, 2002. Capital
expenditures currently authorized for 2003 are approximately $56 million and
primarily relate to the upgrade of the melt shop at Allegheny Ludlum's
Brackenridge, Pennsylvania facility and investments to enhance the high
performance metals capabilities at Allvac's Richburg, South Carolina long
products rolling mill facility.
On September 10, 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
August 26, 2002. The 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.
27
DEBT
At September 30, 2002, we had $524.7 million in total outstanding debt. Our
debt to capitalization ratio decreased to 37.0% at September 30, 2002 from 38.1%
at December 31, 2001. Our net debt to total capitalization ratio decreased to
33.5% at September 30, 2002 from 36.7% at December 31, 2001. These lower ratios
resulted primarily from the use of operating cash flows to repay $80.8 million
of debt.
In December 2001, we issued $300 million of 8.375% Notes due December 15,
2011. Interest on the Notes is payable semi-annually, on June 15 and December
15. These Notes contain default provisions 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.
Interest rate swap contracts are used from time-to-time to manage our
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 contracts and the underlying fixed rate debt are recognized in
the statement of operations. At September 30, 2002, we had entered into "receive
fixed, pay floating" arrangements for $150 million related to the 8.375%
ten-year Notes which effectively convert 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 and $3.1 million for the third
quarter and nine months ended September 2002, respectively, compared to the
fixed interest expense of the ten-year Notes. At September 30, 2002, the
adjustment of these swap contracts to fair market value resulted in the
recognition of an asset of $20.2 million on the balance sheet, included in Other
assets, with an offsetting increase in Long-term debt. The swap contracts
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.
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 September 30, 2002. We are currently in
discussions with our Bank Group to extend the short-term 364-day $130 million
portion of the credit facility. Interest on credit facility borrowings 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. The
agreement also contains covenants that require us to maintain various financial
statement ratios, including a covenant requiring the maintenance of a specified
minimum 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 not exceed a specified maximum ratio
of total consolidated indebtedness to total capitalization ("Leverage
28
Ratio"), both as defined by the agreement. We were compliant with these
covenants at September 30, 2002.
The following table summarizes 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 excludes up to $10 million of cash costs related
to workforce reductions in 2002 and, beginning in 2003, includes the add back of
non-cash pension expense or the deduction of non-cash pension income calculated
in accordance with SFAS No. 87, "Employers' Accounting for Pensions" ("SFAS
87").
The Leverage Ratio requires that total consolidated indebtedness be not
more than 50% of total capitalization. The Leverage Ratio excludes 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. Cash and cash equivalents in excess of
$25 million reduce total consolidated indebtedness and total capitalization by
the amount of that excess.
At September 30, 2002, EBITDA (calculated in accordance with the credit
agreement, which excludes certain non-cash charges) for the prior twelve month
period was 2.58 times gross interest expense compared to a required ratio of at
least 2.25 times gross interest expense. At September 30, 2002, the Leverage
Ratio was 37% compared to a required ratio of not more than 50% of total
capitalization. The Leverage Ratio has the effect of limiting the total amount
we may borrow and the amount of dividends which we may pay; at September 30,
2002, the Leverage Ratio would limit the amount of additional borrowings and
dividends to approximately $370 million.
In July 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. Also, in October 2002, Moody's Investor Service lowered
its long-term corporate credit ratings for the Company's debt to Baa2. Moody's
Prime-2 short term rating (commercial paper) for our debt was unchanged. 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
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 factors beyond our control.
CRITICAL ACCOUNTING POLICIES
RETIREMENT BENEFITS
Accounting standards require a minimum pension liability be recorded if the
value of pension assets is less than the accumulated pension
29
benefit obligation (ABO) at the end of each year. If this condition exists on
our November 30, 2002 measurement date, we would reduce stockholders' equity by
eliminating the prepaid pension asset currently recognized on the balance sheet
and by recording the required minimum pension liability, both net of deferred
taxes. The effect would be a reduction in stockholders' equity by a minimum of
approximately $400 million. Such a non-cash charge, which would not affect the
statement of operations, is likely if the performance of the equity markets does
not improve significantly prior to the measurement date.
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, and, based upon current actuarial analyses and forecasts,
we do not expect to make cash contributions to the defined benefit pension plan
for at least the next several years.
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 expected rate of return on
assets is reviewed annually for reasonableness. This assumed rate 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 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. The effect
on pension liabilities for changes to the discount rate, as well as the net
effect of other changes in actuarial assumptions and experience, are deferred
and amortized over future periods in accordance with SFAS 87.
30
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.
The continuing decline in the equity markets thus far in 2002 is likely to
result in a significant increase in non-cash pre-tax pension retirement benefit
expense for 2003, compared to 2002. For example, for each $100 million decline
in the value of pension assets in 2002, retirement benefit expense would
increase for 2003 by approximately $19 million, pre-tax.
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 for impairment, or more frequently if
impairment indicators arise. 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 each reporting unit
that has goodwill associated with its operations 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, 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 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 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
31
142, the Company will evaluate goodwill annually for impairment. We will perform
this test 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 September 30, 2001 was $1.5 million and $4.4 million,
respectively, or $0.01 and $0.03 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. Significant areas of uncertainty
that require judgments, estimates and assumptions include the accounting for
derivatives, retirement plans, income taxes, environmental and other
contingencies as well as asset impairment, inventory valuation and
collectibility of accounts receivable. We use historical and other information
that 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.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS 146"). This statement establishes accounting guidelines for the
recognition and measurement of liabilities for costs associated with exit or
disposal activities initially at fair value in the period in which the
liabilities are incurred, rather than at the date of a commitment to an exit or
disposal plan. This standard is effective January 1, 2003 for all exit or
disposal activities initiated after that date. We intend to adopt this standard
at January 1, 2003. Upon adoption, this standard may affect the periods in which
costs are recognized for workforce reductions or facility closures, although the
ultimate amount of costs recognized would be the same.
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.
32
OTHER MATTERS
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.
We maintain various types of insurance coverages. Insurance programs are
largely annual policies that are renewed each year. Due to a number of factors
outside our control, many of these insurance policies have increased in cost
while certain coverages have decreased.
Energy resources markets are subject to conditions that create uncertainty
in the prices and availability of energy resources. We rely upon third parties
for our supply of energy resources consumed in the manufacture of products. The
prices for and availability of electricity, natural gas, oil and other energy
resources are subject to volatile market conditions. These market conditions
often are affected by political and economic factors beyond our control.
Disruptions in the supply of energy resources could temporarily impair the
ability to manufacture products for customers. Further, increases in energy
costs, or changes in costs relative to energy costs paid by competitors, have
and may continue to adversely affect our profitability. To the extent that these
uncertainties cause suppliers and customers to be more cost sensitive, increased
energy prices may have an adverse effect on our results of operations and
financial condition. We use approximately 10 to 12 million MMBtu's of natural
gas annually, depending upon business conditions, in the manufacture of our
products. These purchases of natural gas expose us to a risk of higher gas
prices. For example, a hypothetical $1.00 per MMBtu increase in the price of
natural gas would result in increased annual energy costs of approximately $10
to $12 million.
As part of its risk management strategy, from time-to-time, we purchase
swap contracts to manage exposure to changes in natural gas costs. The 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.
Labor Matters
- -------------
We have approximately 10,000 employees. A portion of our workforce is
represented under various collective bargaining agreements, principally with the
United Steelworkers of America ("USWA"), including:
33
approximately 3,500 Allegheny Ludlum production and maintenance employees
covered by collective bargaining agreements between Allegheny Ludlum and the
USWA, which are effective through June 2007; approximately 165 Oremet employees
covered by a collective bargaining agreement with the USWA which is effective
through June 2007; and approximately 600 Wah Chang employees covered by a
collective bargaining agreement with the USWA which continues through March
2008. Negotiations are ongoing for a new collective bargaining agreement with
the USWA affecting approximately 140 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.
During the third quarter, we substantially completed previously announced
workforce reductions of approximately 340 employees, primarily salaried and
predominately in the Flat-Rolled Products segment. As a result of these cost
reduction actions, we recorded a one-time pre-tax charge in the third quarter
2002 of approximately $7.2 million, which was partially offset by $1.7 million
of non-cash income recognized on the curtailment of postretirement benefits for
terminated employees. These actions are estimated to provide an annual pre-tax
cost savings of approximately $23 million.
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 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
34
approximately six years, which Allegheny Ludlum had reported to the appropriate
environmental agencies. We asked the Court to reconsider its decision which the
Court denied in October 2002. We intend to appeal the Court's decision. At
September 30, 2002, we had adequate reserves for this matter.
We formerly operated our Teledyne Ryan Aeronautical division at a facility
leased from the San Diego Unified Port District ("Port District") in San Diego,
CA ("San Diego facility"). We are conducting an environmental assessment of
portions of the San Diego facility at the request of the California Regional
Water Quality Control Board (RWQCB). At this stage of the assessment, we cannot
predict if any remediation will be necessary. We remediated in 1998 and continue
to monitor a lagoon near the San Diego facility. We are also seeking approval
from the San Diego Department of Public Health for the 1996 closure of four
underground storage tanks at the San Diego facility. We are evaluating
potential claims we have against neighboring property owners and other PRPs
related to the environmental condition of the San Diego facility.
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. We believe
that most of the contamination at the Site 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. Discovery is ongoing but no trial date has
been set. An adverse resolution of this matter could have a material adverse
effect on our results of operations and financial condition.
At September 30, 2002, our reserves for environmental remediation
obligations totaled approximately $44.3 million, of which approximately $13.1
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 $18.3 million for Federal Superfund and comparable state-managed
sites, including the Li Tungsten site referred to in the preceding paragraph;
$10.7 million for formerly owned or operated sites for which we have remediation
or indemnification obligations, including the San Diego facility referred to
above; $4.1 million for owned or controlled sites at which our operations have
been discontinued; and $11.2 million for sites utilized by us in our ongoing
operations. We are continuing to evaluate 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.
35
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. 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 PRPs, 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. Additional future developments,
administrative actions or liabilities relating to environmental matters,
however, 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,"
"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.
36
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 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 natural gas costs, 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.
At September 30, 2002, we had aggregate consolidated indebtedness of
approximately $525 million, most of which bears interest at fixed rates. In a
period of declining interest rates, we face the risk of required interest
payments exceeding those based on the then current market rate. From
time-to-time, we enter into interest rate swap contracts to manage our exposure
to interest rate risks. At September 30, 2002, we had entered into "receive
fixed, pay floating" arrangements for $150 million related to our 8.375%
ten-year Notes, which effectively convert this portion of the Notes to variable
rate debt. These contracts are designated as fair value hedges.
37
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 and $3.1 million for the third quarter and nine
months ended September 2002, respectively, compared to the fixed interest
expense of the ten-year Notes. At September 30, 2002, the adjustment of these
swap contracts to fair market value resulted in the recognition of an asset of
$20.2 million on the balance sheet, included in Other assets, with an offsetting
increase in Long-term debt. The swap contracts contain a provision which allows
the swap counterparty to terminate the swap contract in the event our senior
unsecured debt credit rating falls below investment grade.
We believe that adequate controls are in place to monitor these hedging
activities. 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.
We market our products to a diverse customer base, principally throughout
the United States. Trade credit is extended based upon evaluations of each
customer's ability to perform its obligations, which are updated periodically.
Sales of our products are dependent upon the economic condition of the markets
in which we serve. The continuing difficult and uncertain business environment
may affect our customer's creditworthiness and ability to pay their obligations.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer have evaluated the
Company's disclosure controls and procedures as of November 13, 2002, and
they concluded that these controls and procedures are effective.
(b) Changes in Internal Controls
There are no significant changes in internal controls or in other factors
that could significantly affect these controls subsequent to November 13,
2002.
38
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.
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 46 of
this Report and incorporated by reference.
(b) Current Reports on Form 8-K filed by the Company -
Date Nature of the Report
---- --------------------
August 14, 2002 Statement, dated August 13, 2002, of the
principal executive officer and principal
financial officer of the Company relating
to the Company's filings under the
Securities Exchange Act of 1934.
39
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: November 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: November 14, 2002 By /s/ D.G. Reid
------------------------------------------
Dale G. Reid
Vice President, Controller and
Chief Accounting Officer
(Principal Accounting Officer)
40
CERTIFICATIONS
--------------
I, James L. Murdy, President and Chief Executive Officer of Allegheny
Technologies Incorporated, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Allegheny
Technologies Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date");
(c) and presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
41
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002
/s/ James L. Murdy
-------------------------------------------
James L. Murdy
President and Chief Executive Officer
42
CERTIFICATIONS
--------------
I, Richard J. Harshman, Senior Vice President-Finance and Chief Financial
Officer of Allegheny Technologies Incorporated, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Allegheny
Technologies Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(c) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(d) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date");
(c) and presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
43
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002
/s/ Richard J. Harshman
-----------------------------------------
Richard J. Harshman
Senior Vice President-Finance
and Chief Financial Officer
44
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 September 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: November 14, 2002 /s/ James L. Murdy
--------------------------------------------
James L. Murdy
President and Chief Executive Officer
Date: November 14, 2002 /s/ Richard J. Harshman
--------------------------------------------
Richard J. Harshman
Senior Vice President-Finance and
Chief Financial Officer
45
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)).
46