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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 MARCH 31, 2003
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Securities Exchange Act of 1934).
Yes [X] No [ ]
At April 24, 2003, the registrant had outstanding 80,961,069 shares of its
Common Stock.
ALLEGHENY TECHNOLOGIES INCORPORATED
SEC FORM 10-Q
QUARTER ENDED MARCH 31, 2003
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 39
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 39
SIGNATURES 40
CERTIFICATIONS 41
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)
March 31, December 31,
2003 2002
---- ----
(Unaudited) (Audited)
ASSETS
Cash and cash equivalents $ 111.4 $ 59.4
Accounts receivable, net 260.4 239.3
Inventories, net 412.0 409.0
Income tax refunds 3.6 51.9
Deferred income taxes 17.0 20.8
Prepaid expenses and other current assets 28.7 32.0
------------ ------------
Total Current Assets 833.1 812.4
Property, plant and equipment, net 749.2 757.6
Deferred pension asset 165.1 165.1
Cost in excess of net assets acquired 195.8 194.4
Deferred income taxes 103.2 85.4
Other assets 60.2 78.3
------------ ------------
TOTAL ASSETS $ 2,106.6 $ 2,093.2
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 178.1 $ 171.3
Accrued liabilities 164.7 161.0
Short-term debt and current portion
of long-term debt 10.0 9.7
------------ ------------
Total Current Liabilities 352.8 342.0
Long-term debt 510.9 509.4
Accrued postretirement benefits 501.2 496.4
Pension liabilities 238.3 216.0
Other long-term liabilities 81.2 80.6
------------ ------------
TOTAL LIABILITIES 1,684.4 1,644.4
------------ ------------
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 March 31, 2003 and December 31, 2002;
outstanding-80,961,069 shares at March 31, 2003 and 80,634,344 shares
at December 31, 2002 9.9 9.9
Additional paid-in capital 481.2 481.2
Retained earnings 795.5 835.1
Treasury stock: 17,990,421 shares at
March 31, 2003 and 18,317,146 shares
at December 31, 2002 (461.2) (469.7)
Accumulated other comprehensive
loss, net of tax (403.2) (407.7)
------------ ------------
Total Stockholders' Equity 422.2 448.8
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,106.6 $ 2,093.2
============ ============
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
March 31,
-------------------------------
2003 2002
------------ ------------
Sales $ 480.5 $ 493.1
Costs and expenses:
Cost of sales 465.9 452.7
Selling and administrative
expenses 47.7 50.5
------------ ------------
Loss before interest, other income
and income taxes (33.1) (10.1)
Interest expense, net 7.4 9.9
Other income 0.5 2.0
------------ ------------
Loss before income tax benefit and
cumulative effect of change in
accounting principle (40.0) (18.0)
Income tax benefit (14.2) (6.9)
------------ ------------
Net loss before cumulative effect
of change in accounting principle (25.8) (11.1)
Cumulative effect of change in
accounting principle, net of tax (1.3) --
------------ ------------
Net loss $ (27.1) $ (11.1)
============ ============
Basic and diluted net loss per
common share before cumulative
effect of change in accounting
principle $ (0.32) $ (0.14)
Cumulative effect of change in
accounting principle (0.02) --
------------ ------------
Basic and diluted net loss per
common share $ (0.34) $ (0.14)
============ ============
Dividends declared per common share $ .06 $ 0.20
============ ============
The accompanying notes are an integral part of these statements.
4
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Three Months Ended
March 31,
------------------------------
2003 2002
----------- ------------
OPERATING ACTIVITIES:
Net loss $ (27.1) $ (11.1)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Cumulative effect of change in accounting principle 1.3 --
Depreciation and amortization 18.0 22.8
Deferred income taxes (13.3) 1.8
Change in operating assets and liabilities:
Income tax refunds receivable 48.3 43.2
Pension assets and liabilities 22.4 (3.1)
Accounts receivable (21.2) (16.4)
Accounts payable 6.8 0.2
Inventories (3.0) 47.1
Accrued liabilities and other 13.0 (2.6)
----------- ------------
CASH PROVIDED BY OPERATING ACTIVITIES 45.2 81.9
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (11.8) (15.4)
Asset disposals and other 5.9 2.7
----------- ------------
CASH USED IN INVESTING ACTIVITIES (5.9) (12.7)
FINANCING ACTIVITIES:
Borrowings (repayments) on long-term debt 3.1 (5.9)
Net repayments under credit facilities - (50.4)
Payments on long-term debt and capital leases (0.2) -
----------- ------------
Net increase (decrease) in debt 2.9 (56.3)
Proceeds from interest rate swap termination 14.6 --
Dividends paid (4.8) (16.1)
----------- ------------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 12.7 (72.4)
----------- ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 52.0 (3.2)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 59.4 33.7
----------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 111.4 $ 30.5
=========== ============
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
2002 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.
Stock-based Compensation
The Company accounts for its stock option plans and other stock-based
compensation in accordance with APB Opinion No. 25, "Accounting for Stock Issued
to Employees", and related interpretations. The following table illustrates the
effect on net loss and per share information if the Company had applied the fair
value recognition provisions of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123").
(in millions, except per share amounts)
Three Months Ended
March 31,
--------------------------------
2003 2002
----------- ------------
(unaudited)
Net loss as reported $ (27.1) $ (11.1)
Stock-based compensation
under SFAS 123 fair value method,
net of tax (0.8) (0.8)
----------- ------------
Pro forma net loss $ (27.9) $ (11.9)
=========== ============
Net loss per common share:
Basic and diluted--as reported $ (0.34) $ (0.14)
----------- ------------
Basic and diluted--pro forma $ (0.35) $ (0.15)
----------- ------------
New Accounting Pronouncements
Effective January 1, 2003, as required, the Company adopted Statement of
Financial Accounting Statement No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS 143"). Under SFAS 143, obligations associated with the
retirement of tangible long-lived assets, such as landfill and other facility
closure costs, are capitalized and amortized to expense over an asset's useful
life using a systematic and rational allocation method.
The adoption of SFAS 143 by the Company resulted in recognizing a charge of
$1.3 million, net of income taxes of $0.7 million, or $0.02 per share,
principally for asset retirement obligations related to landfills in the
Company's Flat-Rolled Products segment. This charge is reported in the statement
of operations for the quarter ended March 31, 2003, as a cumulative
6
effect of a change in accounting principle. The pro forma effects of the
application of SFAS 143 as if the Statement had been adopted on January 1, 2002
were not material.
NOTE 2. INVENTORIES
Inventories at March 31, 2003 and December 31, 2002 were as follows (in
millions):
March 31, December 31,
2003 2002
------------ ------------
(unaudited) (audited)
Raw materials and supplies $ 47.4 $ 49.4
Work-in-process 374.4 361.0
Finished goods 75.6 77.9
------------ ------------
Total inventories at current cost 497.4 488.3
Less allowances to reduce current cost
values to LIFO basis (77.7) (74.7)
Progress payments (7.7) (4.6)
------------ ------------
Total inventories, net $ 412.0 $ 409.0
============ ============
NOTE 3. SUPPLEMENTAL BALANCE SHEET INFORMATION
Property, plant and equipment at March 31, 2003 and December 31, 2002 were
as follows (in millions):
March 31, December 31,
2003 2002
------------ ------------
(unaudited) (audited)
Land $ 26.2 $ 29.5
Buildings 227.1 228.6
Equipment and leasehold improvements 1,528.5 1,521.5
------------ ------------
1,781.8 1,779.6
Accumulated depreciation and amortization (1,032.6) (1,022.0)
------------ ------------
Total property, plant and equipment, net $ 749.2 $ 757.6
============ ============
Reserves for restructuring charges recorded in 2002 and prior years
involving future payments were $5.3 million at March 31, 2003 and $6.8 million
at December 31, 2002. The reduction in reserves was from cash payments to meet
severance obligations.
7
NOTE 4. DEBT
Debt at March 31, 2003 and December 31, 2002 was as follows (in millions):
March 31, December 31,
2003 2002
------------ ------------
(unaudited) (audited)
Allegheny Technologies $300 million
8.375% Notes due 2011, net (a) $ 310.0 $ 312.3
Allegheny Ludlum 6.95% debentures,
due 2025 150.0 150.0
Foreign credit agreements 27.9 26.7
Industrial revenue bonds, due
through 2011 21.3 21.5
Capitalized leases and other 11.7 8.6
Unsecured domestic credit agreement - -
------------ ------------
520.9 519.1
Short-term debt and current portion
of long-term debt (10.0) (9.7)
------------ ------------
Total long-term debt $ 510.9 $ 509.4
============ ============
(a) Includes fair value adjustments for interest rate swap contracts of
$16.3 million and $18.7 million at March 31, 2003 and December 31,
2002, respectively.
Interest rate swap contracts are used from time-to-time to manage the
Company's exposure to interest rate risks. At the end of the 2002 first quarter,
ATI entered into interest rate swap contracts with respect to a $150 million
notional amount related to its $300 million, 8.375% ten-year Notes, due December
15, 2011, which involved 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 were 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. In the 2003 first quarter, the Company terminated the majority of
these interest rate swap contracts and received $14.6 million in cash. The $14.6
million gain on settlement remains a component of the reported balance of the
Notes ($310 million at March 31, 2003 including fair value adjustments), and
will be ratably recognized as a reduction to interest expense over the remaining
life of the Notes, which is approximately nine years.
In the 2003 first quarter, the Company entered into new "receive fixed, pay
floating" interest rate swap arrangements related to the 8.375% ten-year Notes
which re-established, in total, the $150 million notional amount which
effectively converted this portion of the Notes to variable rate debt. Including
accretion of the gain on termination of the swap contracts described above, the
result of the "receive fixed, pay floating" arrangements was a decrease in
interest expense of $1.7 million for the quarter ended March 31, 2003, compared
to the fixed interest expense of the Notes that would otherwise have been
realized. At March 31, 2003, the adjustment of these swap contracts to fair
market value resulted in the recognition of an asset of $1.8 million on the
balance sheet, included in other assets, with an offsetting increase in
long-term debt. Substantially all of the swap contracts contain a provision
which allows the swap counterparty to terminate the swap contracts in the event
that ATI's senior unsecured debt credit rating falls below investment grade.
The Company has a primary unsecured domestic credit agreement facility
which consists of a short-term 364-day $100 million credit facility which
expires in December 2003, and a $150 million credit facility which expires in
December 2006. There were no borrowings made under the credit facility during
2003, or all of 2002. 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
8
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 March 31, 2003.
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"), and adds back postretirement benefits expenses that are funded by
Voluntary Employee Benefit Association (VEBA) trusts.
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. The definitions of total indebtedness
and total capitalization deduct up to $50 million of cash, and cash equivalent
balances held in excess of $25 million reduce total consolidated indebtedness
and total capitalization by the amount of that excess.
At March 31, 2003, EBITDA (calculated in accordance with the credit
agreement, which excludes certain non-cash charges) for the prior twelve month
period was 2.37 times gross interest expense compared to a required ratio of at
least 2.00 times gross interest expense. At March 31, 2003, the Leverage Ratio
was 37% compared to a required ratio of not more than 50% of total
capitalization.
Commitments under separate standby letters of credit outstanding were $48.9
million at March 31, 2003.
(this space intentionally left blank)
9
NOTE 5. BUSINESS SEGMENTS
Following is certain financial information with respect to the Company's
business segments for the periods indicated (in millions):
Three Months Ended
March 31,
--------------------------------
2003 2002
------------ ------------
(unaudited)
Total sales:
Flat-Rolled Products $ 262.4 $ 265.4
High Performance Metals 170.7 181.4
Industrial Products 60.7 58.1
------------ ------------
493.8 504.9
Intersegment sales:
Flat-Rolled Products 3.6 3.3
High Performance Metals 9.7 8.5
------------ ------------
13.3 11.8
Sales to external customers:
Flat-Rolled Products 258.8 262.1
High Performance Metals 161.0 172.9
Industrial Products 60.7 58.1
------------ ------------
$ 480.5 $ 493.1
============ ============
Operating profit(loss):
Flat-Rolled Products $ (1.0) $ (0.4)
High Performance Metals 8.3 4.3
Industrial Products 1.5 (0.7)
------------ ------------
Total operating profit 8.8 3.2
Corporate expenses (4.8) (5.7)
Interest expense, net (7.4) (9.9)
Other (expenses) income, net
of gains on asset sales (1.8) 0.1
Retirement benefit expense (34.8) (5.7)
------------ ------------
Loss before income tax
benefit and cumulative
effect of change in
accounting principle $ (40.0) $ (18.0)
============ ============
Retirement benefit expense represents pension expense and other
postretirement benefit expenses. Operating profit with respect to the Company's
business segments excludes any retirement benefit expense.
10
NOTE 6. PER SHARE INFORMATION
The following table sets forth the computation of basic and diluted net
loss per common share (in millions, except share and per share amounts):
Three Months Ended
March 31,
--------------------------------
2003 2002
------------ ------------
(unaudited)
Numerator:
Basic and diluted net loss per common
share before cumulative effect of
change in accounting principle $ (25.8) $ (11.1)
Cumulative effect of change
in accounting principle, net of tax (1.3) --
------------ ------------
Basic and diluted net loss per common
share $ (27.1) $ (11.1)
============ ============
Denominator for basic and diluted net
loss per common share - adjusted
weighted average shares 80.7 80.4
============ ============
Basic and diluted net loss per
common share before cumulative
effect of change in accounting
principle $ (0.32) $ (0.14)
Cumulative effect of change in
accounting principle (0.02) --
------------ ------------
Basic and diluted net loss per common
share $ (0.34) $ (0.14)
============ ============
For the 2003 and 2002 periods, the effects of stock options were
antidilutive and thus not included in the calculation of dilutive earnings per
share.
11
NOTE 7. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, were as follows
(in millions):
Three Months Ended
March 31,
--------------------------------
2003 2002
------------ ------------
(unaudited)
Net loss $ (27.1) $ (11.1)
------------ ------------
Foreign currency translation gains 4.5 -
Unrealized gains on energy, raw materials
and currency hedges, net of tax - 7.8
Unrealized holding gains arising during
the period - 0.4
------------ ------------
4.5 8.2
------------ ------------
Comprehensive loss $ (22.6) $ (2.9)
============ ============
NOTE 8. FINANCIAL INFORMATION FOR SUBSIDIARY AND GUARANTOR PARENT
The payment obligations under the $150 million 6.95% debentures due 2025
issued by Allegheny Ludlum Corporation (the "Subsidiary") are fully and
unconditionally guaranteed by Allegheny Technologies Incorporated (the
"Guarantor Parent"). In accordance with positions established by the Securities
and Exchange Commission, the financial information in this Note 8 sets forth
separately financial information with respect to the Subsidiary, the
non-guarantor subsidiaries and the Guarantor Parent. The principal elimination
entries eliminate investments in subsidiaries and certain intercompany balances
and transactions. Investments in subsidiaries, which are eliminated in
consolidation, are included in other assets on the balance sheets.
In 1996, the defined benefit pension plans of the Subsidiary were merged
with the 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 deferred pension asset, pension liabilities or the
related deferred taxes. The pension assets, liabilities and the related deferred
taxes and pension income or expense are recognized by the Guarantor Parent.
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.
12
NOTE 8. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
March 31, 2003 (unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------
Assets:
Cash $ - $ 83.4 $ 28.0 $ - $ 111.4
Accounts receivable, net 0.1 93.5 166.8 - 260.4
Inventories, net - 181.8 230.2 - 412.0
Income tax refunds 3.6 - - - 3.6
Deferred income taxes 17.0 - - - 17.0
Prepaid expenses and other
current assets 0.2 7.8 20.7 - 28.7
--------------------------------------------------------------------------------------------
Total current assets 20.9 366.5 445.7 - 833.1
Property, plant, and
equipment, net - 379.7 369.5 - 749.2
Cost in excess of net
assets acquired - 112.1 83.7 - 195.8
Deferred pension asset 165.1 - - - 165.1
Deferred income taxes 103.2 - - - 103.2
Investments in subsidiaries
and other assets 1,127.9 466.4 333.2 (1,867.3) 60.2
--------------------------------------------------------------------------------------------
Total assets $ 1,417.1 $ 1,324.7 $ 1,232.1 $ (1,867.3) $ 2,106.6
============================================================================================
Liabilities and
stockholders' equity:
Accounts payable $ 2.2 $ 98.7 $ 77.2 $ - $ 178.1
Accrued liabilities 440.7 70.2 92.1 (438.3) 164.7
Short-term debt and current
portion of long-term debt - 0.8 9.2 - 10.0
--------------------------------------------------------------------------------------------
Total current liabilities 442.9 169.7 178.5 (438.3) 352.8
Long-term debt 310.0 364.2 41.4 (204.7) 510.9
Accrued postretirement
benefits - 311.7 189.5 - 501.2
Pension liabilities 238.3 - - - 238.3
Other long-term liabilities 3.7 22.3 55.2 - 81.2
--------------------------------------------------------------------------------------------
Total liabilities 994.9 867.9 464.6 (643.0) 1,684.4
--------------------------------------------------------------------------------------------
Total stockholders' equity 422.2 456.8 767.5 (1,224.3) 422.2
--------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $ 1,417.1 $ 1,324.7 $ 1,232.1 $ (1,867.3) $ 2,106.6
============================================================================================
13
NOTE 8. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the three months ended March 31, 2003 (unaudited)
- ------------------------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------
Sales $ - $ 237.2 $ 243.3 $ - $ 480.5
Cost of sales 25.1 239.5 201.3 - 465.9
Selling and administrative
expenses 12.7 6.0 29.0 - 47.7
Interest expense 4.7 2.6 0.1 - 7.4
Other income(expense)
including equity in income
of unconsolidated
subsidiaries 1.8 (0.2) 3.5 (4.6) 0.5
---------------------------------------------------------------------------------
Income (loss) before income
tax benefit and
cumulative effect of
change in accounting
principle (40.7) (11.1) 16.4 (4.6) (40.0)
Income tax provision
(benefit) (14.9) (3.3) 5.5 (1.5) (14.2)
---------------------------------------------------------------------------------
Net income (loss) before
cumulative effect of change
in accounting principle (25.8) (7.8) 10.9 (3.1) (25.8)
Cumulative effect of change in
accounting principle,
net of tax (1.3) - - - (1.3)
---------------------------------------------------------------------------------
Net income (loss) $ (27.1) $ (7.8) $ 10.9 $ (3.1) $ (27.1)
=================================================================================
14
NOTE 8. CONTINUED
Condensed Statements of Cash Flows
For the three months ended March 31, 2003 (unaudited)
- --------------------------------------------------------------------------------------------------------------------
Non-
Guarantor guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- --------------------------------------------------------------------------------------------------------------------
Cash flows provided by
(used in) operating
activities $ 1.8 $ 158.2 $ 22.2 $ (137.0) $ 45.2
Cash flows provided by
(used in) investing
activities - (5.9) (3.4) 3.4 (5.9)
Cash flows provided by
(used in) financing
activities (2.1) (111.8) (7.0) 133.6 12.7
----------------------------------------------------------------------------
Increase (decrease) in
cash and cash equivalents $ (0.3) $ 40.5 $ 11.8 $ -- $ 52.0
============================================================================
15
NOTE 8. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
December 31, 2002 (audited)
- -------------------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- -------------------------------------------------------------------------------------------------------------------
Assets:
Cash and cash equivalents $ 0.2 $ 43.0 $ 16.2 $ - $ 59.4
Accounts receivable, net - 82.3 157.0 - 239.3
Inventories, net - 181.6 227.4 - 409.0
Income tax refunds 51.9 - - - 51.9
Deferred income taxes 20.8 - - - 20.8
Prepaid expenses, and other
current assets 0.3 8.8 22.9 - 32.0
---------------------------------------------------------------------------
Total current assets 73.2 315.7 423.5 - 812.4
Property, plant, and
equipment, net - 383.2 374.4 - 757.6
Cost in excess of net
assets acquired - 112.1 82.3 - 194.4
Deferred pension asset 165.1 - - - 165.1
Deferred income taxes 85.4 - - - 85.4
Investment in subsidiaries
and other assets 1,169.8 608.8 347.1 (2,047.4) 78.3
---------------------------------------------------------------------------
Total assets $ 1,493.5 $ 1,419.8 $ 1,227.3 $ (2,047.4) $ 2,093.2
===========================================================================
Liabilities and
stockholders' equity:
Accounts payable $ 1.9 $ 96.3 $ 73.1 $ - $ 171.3
Accrued liabilities 510.8 52.1 97.9 (499.8) 161.0
Short-term debt and current
portion of long-term debt - 0.6 9.1 - 9.7
---------------------------------------------------------------------------
Total current liabilities 512.7 149.0 180.1 (499.8) 342.0
Long-term debt 312.4 441.3 37.2 (281.5) 509.4
Accrued postretirement
benefits - 308.1 188.3 - 496.4
Pension liabilities 216.0 - - - 216.0
Other long-term liabilities 3.6 23.1 53.9 - 80.6
---------------------------------------------------------------------------
Total liabilities 1,044.7 921.5 459.5 (781.3) 1,644.4
---------------------------------------------------------------------------
Total stockholders' equity 448.8 498.3 767.8 (1,266.1) 448.8
---------------------------------------------------------------------------
Total liabilities and
stockholders' equity $ 1,493.5 $ 1,419.8 $ 1,227.3 $ (2,047.4) $ 2,093.2
===========================================================================
16
NOTE 8. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the three months ended March 31, 2002 (unaudited)
- --------------------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- --------------------------------------------------------------------------------------------------------------------
Sales $ - $ 252.9 $ 240.2 $ - $ 493.1
Cost of sales 3.5 243.6 205.6 - 452.7
Selling and administrative
expenses 12.9 6.9 30.7 - 50.5
Interest expense 6.9 3.0 - - 9.9
Other income(expense)
including equity in income
of unconsolidated
subsidiaries 6.4 (0.8) 4.7 (8.3) 2.0
----------------------------------------------------------------------------
Income (loss) before income
taxes (16.9) (1.4) 8.6 (8.3) (18.0)
Income tax provision
(benefit) (5.8) (2.4) 4.2 (2.9) (6.9)
----------------------------------------------------------------------------
Net income (loss) $ (11.1) $ 1.0 $ 4.4 $ (5.4) $ (11.1)
============================================================================
Condensed Statements of Cash Flows
For the three months ended March 31, 2002 (unaudited)
- --------------------------------------------------------------------------------------------------------------------
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- --------------------------------------------------------------------------------------------------------------------
Cash flows provided by
(used in) operating
activities $ 53.6 $ 27.0 $ (37.5) $ 38.8 $ 81.9
Cash flows provided by
(used in) investing
activities - (3.3) (11.9) 2.5 (12.7)
Cash flows provided by
(used in) financing
activities (54.0) (22.0) 44.9 (41.3) (72.4)
----------------------------------------------------------------------------
Increase (decrease) in
cash and cash
equivalents $ (0.4) $ 1.7 $ (4.5) $ - $ (3.2)
============================================================================
17
NOTE 9. COMMITMENTS AND CONTINGENCIES
The Company is subject to various domestic and international environmental
laws and regulations that govern the discharge of pollutants into the air or
water, and the disposal of hazardous substances, which may require that the
Company 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, as
well as 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 its facilities. The Company is currently involved in the
investigation and remediation at a number of its current and former sites as
well as third party sites under these laws.
When it is probable that a liability has been incurred or an asset of the
Company has been impaired, a loss is recognized if the amount of the loss can be
reasonably estimated.
Environmental liabilities are recorded when the Company's liability is
probable and the costs are reasonably estimable, but generally not later than
the completion of a feasibility study or the recommendation of a remedy or a
commitment to an appropriate plan of action. The accruals are reviewed
periodically and, as investigations and remediations proceed, adjustments are
made as necessary. Accruals for losses from environmental remediation
obligations do not take into account the effects of inflation, and anticipated
expenditures are not discounted to their present values. The accruals are not
reduced by possible recoveries from insurance carriers or other third parties,
but do reflect allocations among PRPs at Federal Superfund sites or similar
state-managed sites after an assessment is made of the likelihood that such
parties will fulfill their obligations at such sites and after appropriate
cost-sharing or other agreements are entered into. The Company's measurement of
environmental liabilities is based on currently available facts, present laws
and regulations, and current technology. Estimates take into consideration the
Company's prior experience in site investigation and remediation, the data
concerning cleanup costs available from other companies and regulatory
authorities, and the professional judgment of the Company's environmental
experts in consultation with outside environmental specialists, when necessary.
Estimates of the Company's liability are subject to 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 participation and financial
condition of other PRPs, as well as the extent of their responsibility for the
remediation.
At March 31, 2003, the Company's reserves for environmental remediation
obligations totaled approximately $39.7 million, of which approximately $12.0
million were included in other current liabilities. The reserve includes
estimated probable future costs of $15.7 million for federal Superfund and
comparable state-managed sites; $9.3 million for formerly owned or operated
sites for which the Company has remediation or indemnification obligations; $3.2
million for owned or controlled sites at which Company operations have been
discontinued; and
18
$11.5 million for sites utilized by the Company in its ongoing operations. In
some cases the Company is evaluating whether it 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
participating PRPs, the timing of regulatory approvals, the complexity of the
investigation and remediation, and the standards for remediation. The Company
expects that it will expend present accruals over many years, and will complete
remediation of all sites with respect to which accruals have been made in up to
thirty years.
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 environmental matters with which it is currently
associated (either individually or in the aggregate) will be an amount that
would be material to a decision to buy or sell its securities. Additional future
developments, administrative actions or liabilities relating to environmental
matters, however, could have a material adverse effect on the Company's
financial condition and results of operations.
Various claims (whether based on U.S. Government or Company audits and
investigations or otherwise) have been or may be asserted against the Company
related to its U.S. Government contract work, principally related to the former
operations of Teledyne, Inc., including claims based on business practices and
cost classifications and actions under the False Claims Act. Depending on the
circumstances and the outcome, such proceedings could result in fines,
penalties, compensatory and treble damages or the cancellation or suspension of
payments under one or more U.S. Government contracts. Under government
regulations, a company, or one or more of its operating divisions or units, can
also be suspended or debarred from government contracts based on the results of
investigations. Given the limited extent of the Company's current business with
the U.S. Government, the Company believes that a suspension or debarment of the
Company would not have a material adverse effect on the future operating results
and consolidated financial condition of the Company. Although the outcome of
these matters cannot be predicted with certainty, management does not believe
there is any audit, review or investigation currently pending against the
Company of which management is aware that is 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.
In the spin-offs of Teledyne and Water Pik, completed in November 1999, the
new companies agreed to assume and to defend and hold the Company harmless
against all liabilities (other than certain income tax liabilities) associated
with the historical operations of their businesses, including all government
contracting, environmental, product liability and other claims and demands,
whenever any such claims or demands might arise or be made. If the new companies
were unable or otherwise fail to satisfy these assumed liabilities, the Company
could be required to satisfy them, which could have a material adverse effect on
the Company's results of operations and financial condition.
The Company becomes involved from time to time in various lawsuits, claims
and proceedings relating to the conduct of its business, including those
pertaining to environmental, government contracting,
19
product liability, patent infringement, commercial, employment, employee
benefits, and stockholder matters.
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 has appealed the Court's decision. At March 31, 2003,
the Company had adequate reserves, including accrued interest, for this matter.
Allegheny Ludlum and the United Steelworkers of America ("USWA") are
parties to various collective bargaining agreements which set forth a "Profit
Sharing Plan". The Company and the USWA were involved in litigation regarding
Profit Sharing Pool calculations for 1996, 1997, 1998 and 1999. The USWA claimed
adjustments that alleged the Company owed to USWA-represented employees
approximately $32 million. The Company maintained that its certified
determinations of the Profit Sharing Pool calculations were made as prescribed
by the Profit Sharing Plan. On January 13, 2003, the Company formalized a
settlement agreement with the USWA that provided for an aggregate $5 million
distribution to eligible employees, which is expected to be paid in the 2003
second quarter. At March 31, 2003, the Company had adequate reserves for this
matter.
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 and Dimeling Schreiber & Park
("DS&P"), DS&P's general partners, and New Piper Aircraft, Inc. 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 bankruptcy
reorganization plan for acquiring 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 has requested 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 has not been
scheduled. 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 and the San Diego Unified Port District ("Port District") entered into
a lease of property located in San Diego, California ("San Diego facility") on
October 1, 1984. TDY operated its Teledyne Ryan Aeronautical division ("Ryan")
at the San Diego facility 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 brought a lawsuit against the Port District.
20
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. The
trial for this matter is scheduled for October 2003.
Despite the Port District's failure to consent to the three subleases, TDY
continued its marketing efforts to sublease the San Diego facility. The rental
payments and other expenses for the property amounted to approximately $0.4
million per month. At March 31, 2003, the Company had a reserve of approximately
$3 million to cover the costs of occupying the San Diego 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 and that the Port District's
condemnation of the property voided the lease. 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.
The Port District filed a cross-complaint against TDY in March 2003. The
Complaint alleges breach of contract for failure to pay rent and for certain
environmental contamination on the property. The Port District seeks $1.2
million in past rent, along with future rent and an unspecified sum of damages
for failure to remedy. The Port District also alleges anticipatory breach
relating to removal of structures and debris from the San Diego facility and
seeks specific performance or reimbursement to the Port District. The Port
District further alleges that it is entitled to indemnity for potential
liability related to environmental matters at the San Diego facility, and seeks
a declaratory judgment in its favor. TDY has various defenses to the allegations
in the Port District's Complaint and denies that it has any obligation to the
Port District.
In another matter related to the San Diego facility, the Port District
requested that the California Department of Toxic Substances Control ("DTSC")
evaluate whether the property is regulated as a hazardous waste transportation,
storage, or disposal facility under the Resource Conservation and Recovery Act
("RCRA") and similar state laws. DTSC recognizes that the information pertaining
to the RCRA permitting status of the property is ambiguous and referred the
issue of the property's RCRA permitting status to DTSC's Legal Office for
further consideration. TDY discussed this matter directly with DTSC's Legal
Office and DTSC agreed to refrain from taking action regarding this issue until
after completion of DTSC's Legal Office review. To the extent the facility is
subject to RCRA permitting and corrective action is required at the property,
DTSC has agreed that the San Diego Regional Water Quality Control Board
("Regional Board") is the appropriate agency to oversee the corrective action
work. The Regional Board is currently overseeing other investigative work at the
site, the expected costs of which are included in our environmental reserves.
The Company is conducting an environmental assessment of portions of the
San Diego facility at the request of the Regional Board. 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. Also, the Company is
21
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 neighboring property
owners and other PRPs related to the environmental condition of the San Diego
facility.
TDY and another wholly-owned subsidiary of the Company, 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 but no trial date has been
scheduled. In March 2003, the Court ordered the parties, including the United
States government, to fund a portion of the remediation costs at the Site. Based
on information presently available, the Company believes its reserves on this
matter are adequate. An adverse resolution of this matter could have a material
adverse effect on the Company's results of operations and financial condition.
A number of 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 lawsuits,
claims or proceedings may be determined adversely to the Company, management
does not believe that the disposition of any such pending matters is 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Allegheny Technologies Incorporated is one of the largest and most
diversified producers of specialty materials in the world. Unless the context
requires otherwise, "we", "our" and "us" refer to Allegheny Technologies
Incorporated and its subsidiaries.
RESULTS OF OPERATIONS
We operate in the following three business segments, which accounted for
the following percentages of total external sales for the first three months of
2003 and 2002:
2003 2002
---- ----
Flat-Rolled Products 54% 53%
High Performance Metals 34% 35%
Industrial Products 12% 12%
For the first three months of 2003, operating profit improved to $8.8
million compared to $3.2 million for the same 2002 period,
22
primarily due to our cost reduction initiatives. Sales decreased 3% to $480.5
million for the first three months of 2003 compared to $493.1 million for the
same 2002 period. The decrease in sales is primarily due to continuing difficult
business conditions in the end markets we serve, especially commercial
aerospace, power generation, capital goods and electrical energy.
Business conditions in most of our end markets remained very difficult and
uncertain during the first quarter of 2003. These market conditions combined
with higher pension, healthcare, and energy costs resulted in the net loss
before cumulative effect of a change in accounting principle of $25.8 million,
or $0.32 loss per diluted share, for the first three months of 2003 compared to
a net loss of $11.1 million, or $0.14 per diluted share, for the first three
months of 2002. Pre-tax retirement benefit expense was $34.8 million in the
first quarter of 2003, compared to $5.7 million in the comparable year ago
period. Essentially all of this $29.1 million increase in expense is non-cash.
On a per share basis, retirement benefit expense represented $0.28 per share of
our $0.32 per share first quarter net loss before the cumulative effect of a
change in accounting principle. The increased retirement benefit expense was a
result of the severe decline in the equity markets over the past three years
combined with the impact of lower expected returns on benefit plan investments
and a lower discount rate assumption on liabilities.
On January 1, 2003, we adopted Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). The
adoption of SFAS 143 resulted in an after-tax charge of $1.3 million or $0.02
per diluted share. This charge is reported as a cumulative effect of a change in
accounting.
Sales and operating profit (loss) for our three business segments are
discussed below.
FLAT-ROLLED PRODUCTS SEGMENT
Sales declined 1% to $258.8 million in the 2003 first quarter, compared to
the prior year period, primarily due to continued weakness in capital goods
markets. Low pricing, higher energy costs and operating inefficiencies more than
offset lower depreciation expense resulting in an operating loss of $1.0 million
for the quarter, compared to an operating loss of $0.4 million in the comparable
2002 period. Energy costs increased by $5.2 million compared to 2002, net of
approximately $5 million in gains from natural gas derivatives, as a result of
higher natural gas and electricity prices. Results for 2003 benefited from $15
million in gross cost reductions, before the effects of inflation and higher
energy costs, and the cancellation of $4.0 million in previously accrued
management incentive compensation. In addition, results for the 2003 first
quarter were favorably impacted by approximately $4 million in lower
depreciation expense compared to the same quarter of the prior year as a result
of assets becoming fully depreciated at the end of 2002. Total shipments
decreased 2%, while average prices increased 1%, primarily due to higher raw
material surcharges.
While overall demand remained weak and pricing poor in our Flat-Rolled
Products segment, our commercial successes in 2002 improved our position in
several key markets. Shipments of cold-rolled sheet, net of emission control
alloys, improved by 10%, silicon electrical steel
23
shipments improved by 8%, and shipments of Precision Rolled Strip(R) products
improved by 10%, compared to the same period last year. However, shipments of
continuous-mill-plate (CMP) products were reduced significantly, primarily due
to the fourth quarter 2002 indefinite idling of our wide CMP finishing facility
and continuing weak demand for these products.
Comparative information on the segment's products is provided in the
following table (unaudited):
Three Months Ended
March 31,
-------------------- %
2003 2002 Change
-------- --------------------
Volume (finished tons):
Commodity 83,492 87,431 (5)
High Value 35,472 34,362 3
-------- --------
Total 118,964 121,793 (2)
Average prices (per finished ton):
Commodity $ 1,564 $ 1,487 5
High Value $ 3,557 $ 3,761 (5)
Combined Average $ 2,159 $ 2,129 1
HIGH PERFORMANCE METALS SEGMENT
Sales declined 7% to $161.0 million due primarily to reduced demand from
the commercial aerospace and power generation markets, which was partially
offset by strong demand for premium exotic alloys from government and high
energy physics markets. Operating profit improved to $8.3 million compared to
$4.3 million in the year-ago period. Results for 2003 benefited from $10 million
of gross cost reductions, before the effects of inflation. Operating results for
the 2002 period were adversely affected by a labor strike at our Wah Chang
operation, which was settled in March 2002. Shipments of nickel-based and
specialty steel products decreased 19% and shipments of titanium-based products
decreased 7%. Average prices of nickel-based and specialty steel products
increased 4%, while average prices of titanium-based products increased 6%, both
due primarily to product mix. Shipments of exotic alloys increased 7% and
average prices were 8% higher.
Backlog of confirmed orders within the segment increased to approximately
$315 million at March 31, 2003, 5% higher than at December 31, 2002, due to
increases in orders from the medical and government defense markets.
24
Certain comparative information on the segment's major products is provided in
the following table (unaudited):
Three Months Ended
March 31,
--------------------- %
2003 2002 Change
------- -----------------
Volume (000's pounds):
Nickel-based and specialty steel alloys 8,692 10,765 (19)
Titanium mill products 4,615 4,949 (7)
Exotic alloys 932 869 7
Average prices (per pound):
Nickel-based and specialty steel alloys $ 6.73 $ 6.46 4
Titanium mill products $ 12.85 $ 12.11 6
Exotic alloys $ 37.75 $ 35.03 8
INDUSTRIAL PRODUCTS SEGMENT
Sales improved 4% to $60.7 million resulting in an operating profit of $1.5
million for the 2003 first quarter compared to an operating loss of $0.7 million
for the same period of 2002. Gross cost reductions, before the effects of
inflation, totaled $2 million in the first quarter 2003. At our Metalworking
Products operation, increased sales, particularly from the oil and gas market,
and continued cost reductions resulted in improved operating profit.
CORPORATE ITEMS
Corporate expenses decreased to $4.8 million for the first quarter of 2003
compared to $5.7 million for the first quarter of 2002, primarily due to cost
reductions and lower incentive compensation accruals. Net interest expense
decreased to $7.4 million for the first quarter of 2003 from $9.9 million in the
same period last year. At the end of the 2002 first quarter, we entered into
"receive fixed, pay floating" interest rate swap contracts for $150 million
related to the $300 million, 8.375%, ten-year Notes, which effectively convert
this portion of the Notes to variable rate debt. The swap contracts effectively
decreased interest expense by $1.7 million compared to the same period last
year.
The severe decline in the equity markets over the past three years, and
lower expected returns on benefit plan investments and a lower discount rate
assumption for determining liabilities, resulted in a pre-tax retirement benefit
expense of $34.8 million in the first quarter of 2003 compared to $5.7 million
in the first quarter of 2002. This increase in retirement benefits expense
resulted in a $29.1 million pre-tax, or $0.24 per share after-tax, reduction in
first quarter 2003 earnings compared to the same period of 2002. The increase in
retirement benefit expense in 2003 negatively affected both cost of sales and
selling and administrative expenses in the first quarter of 2003 compared to the
same period last year. For the three months ended March 31, 2003, retirement
benefit expense impacted cost of sales by $24.4 million and selling and
administrative expenses by $10.4 million. For the three months ended March 31,
2002, retirement benefit expense impacted cost of sales by $1.3 million and
selling and administrative expenses by $4.4 million. The majority of these
retirement benefit expenses relate to our Allegheny Ludlum operation.
Approximately $28 million of the first quarter 2003 retirement benefit expense
is non-cash.
25
We are not required to make cash contributions to the defined benefit
pension plan for 2003 and, based upon current actuarial studies, we do not
expect to be required to make cash contributions to the defined benefit pension
plan during the next several years.
INCOME TAX BENEFIT
Our effective tax rate was a benefit of 35.5% for the 2003 first quarter
and a benefit of 38.3% for the 2002 comparable period. These income tax benefits
are expected to be realized by refunds of taxes paid in prior years, or as a
reduction of future tax obligations. We received federal income tax refunds of
$48.3 million in the 2003 first quarter, and $43.2 million in the 2002 first
quarter. Under current tax laws we are substantially unable to carry-back any
current year or future year tax losses to prior periods to obtain cash refunds
of taxes paid during those periods. Current year tax losses, if any, can be
carried forward for up to 20 years and applied against any taxes owed in those
future years.
Deferred income taxes result from temporary differences in the recognition
of income and expense for financial and income tax reporting purposes, or
differences between the fair value of assets acquired in business combinations
accounted for as purchases for financial reporting purposes and their
corresponding tax bases. Deferred income taxes represent future tax benefits
(assets) or costs (liabilities) to be recognized when those temporary
differences reverse. We evaluate, on a quarterly basis, whether deferred income
tax assets are realizable. If it were determined that all or a portion of the
deferred income tax assets are not realizable, a valuation allowance would be
recognized as a non-cash charge to the income tax provision with an offsetting
reserve against the deferred income tax asset. Such a valuation allowance, if
required, would be reversed or increased in future years if the estimated
realizability of the deferred income tax asset changed. Future realization of
deferred income tax assets ultimately depends upon the existence of sufficient
taxable income within the carryback, carryforward period available under tax
law. Determining if a valuation allowance is needed involves judgment and the
consideration of all available evidence, both positive and negative, regarding
estimated future taxable income, potential tax planning strategies which might
be employed to prevent an operating loss or tax credit carryforward from
expiring unused, and the estimated timing of reversals of existing taxable
temporary differences. At March 31, 2003, we had a net deferred income tax
asset, net of deferred income liabilities, of $120.2 million. This net deferred
income tax asset is net of valuation allowances for certain state tax benefits
that are not expected to be realized. A significant portion of this net deferred
income tax asset relates to postretirement employee benefit obligations, which
have been recognized for financial reporting purposes but are not recognized for
income tax reporting purposes until the benefits are paid. These benefits
payments are expected to occur over an extended period of years. Although
realization is not assured, we have concluded that our net deferred income tax
asset should be realizable based upon our history of earnings, expectations of
future earnings, and potential tax planning strategies, including possible asset
sales.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2003, as required, we adopted Statement of Financial
Accounting Statement No. 143, "Accounting for Asset Retirement Obligations"
("SFAS 143"). Under SFAS 143, obligations associated with
26
the retirement of tangible long-lived assets, such as landfill and other
facility closure costs, are capitalized and amortized to expense over an asset's
useful life using a systematic and rational allocation method.
Our adoption of SFAS 143 resulted in recognizing a charge of $1.3 million,
net of income taxes of $0.7 million, or $0.02 per share, principally for asset
retirement obligations related to landfills in our Flat-Rolled Products segment.
This charge is reported in the statement of operations for the quarter ended
March 31, 2003 as a cumulative effect of a change in accounting principle. The
pro forma effects of the application of SFAS 143 as if the Statement had been
adopted on January 1, 2002 were not material.
FINANCIAL CONDITION AND LIQUIDITY
CASH FLOW AND WORKING CAPITAL
During the three months ended March 31, 2003, cash generated from
operations was $45.2 million, which included Federal income tax refunds for the
2002 tax year of $48.3 million, which more than offset a $12.7 increase in
managed working capital. The increase in managed working capital was primarily
due to a $21 million increase in accounts receivable because of higher sales in
the first quarter 2003 compared to the fourth quarter of 2002. Capital
expenditures of $11.8 million and dividend payments of $4.8 million were offset
by $14.6 million in proceeds from terminating some of our interest rate swap
contracts, and $5.9 million in proceeds from sales of non-strategic real estate
assets. At March 31, 2003, cash and cash equivalents totaled $111.4 million, an
increase of $52.0 million from December 31, 2002.
As part of managing the liquidity of our business, we focus on controlling
managed working capital, which is defined as gross accounts receivable and gross
inventories, less 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. At March
31, 2003, managed working capital was 30% of annualized sales compared to 33% of
annualized sales at December 31, 2002. During the first three months of 2003,
managed working capital increased by $12.7 million, to $592.8 million.
The components of managed working capital were as follows:
(Unaudited, in millions) March 31, December 31,
2003 2002
--------- ------------
Accounts receivable $ 260.4 $ 239.3
Inventories 412.0 409.0
Accounts payable (178.1) (171.3)
--------- --------
Subtotal 494.3 477.0
Allowance for doubtful accounts 10.3 10.1
LIFO reserves 77.7 74.7
Corporate and other 10.5 18.3
--------- --------
Managed working capital $ 592.8 $ 580.1
========= ========
Annualized prior 2 months sales $ 1,992.0 $1,741.0
========= ========
Managed working capital as a
% of annualized sales 30% 33%
27
Capital expenditures for 2003 are expected to be approximately $70 million,
of which $11.8 million had been expended in the 2003 first quarter. Capital
expenditures primarily relate to the upgrade of our Flat-Rolled Products melt
shop located in Brackenridge, PA and investments to enhance the high performance
metals capabilities of our High Performance Metals long products rolling mill
facility located in Richburg, SC.
On March 11, 2003, a regular quarterly dividend of $0.06 per share of
common stock was paid to stockholders of record at the close of business on
February 24, 2003. 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.
DEBT
At March 31, 2003, we had $520.9 million in total outstanding debt, largely
unchanged from the $519.1 million at December 31, 2002.
Interest rate swap contracts are used from time-to-time to manage our
exposure to interest rate risks. At the end of the 2002 first quarter, we
entered into interest rate swap contracts with respect to a $150 million
notional amount related to our $300 million, 8.375% ten-year Notes, due December
15, 2011, which involved 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 were 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. In the 2003 first quarter, we terminated the majority of these
interest rate swap contracts and received $14.6 million in cash. The $14.6
million gain on settlement remains a component of the reported balance of the
Notes ($310 million at March 31, 2003 including fair value adjustments), and
will be ratably recognized as a reduction to interest expense over the remaining
life of the Notes, which is approximately nine years.
In the 2003 first quarter, we entered into new "receive fixed, pay
floating" interest rate swap arrangements related to the 8.375% ten-year Notes
which re-established, in total, the $150 million notional amount which
effectively converted this portion of the Notes to variable rate debt. Including
accretion of the gain on termination of the swap contracts described above, the
result of the "receive fixed, pay floating" arrangements was a decrease in
interest expense of $1.7 million quarter ended March 31, 2003, compared to the
fixed interest expense of the Notes that would otherwise have been realized. At
March 31, 2003, the adjustment of these swap contracts to fair market value
resulted in the recognition of an asset of $1.8 million on the balance sheet,
included in other assets, with an offsetting increase in long-term debt.
Substantially all of the swap contracts contain a provision which allows the
swap counterparty to terminate the swap contracts in the event our senior
unsecured debt credit rating falls below investment grade.
We have a primary unsecured domestic credit facility which consists of a
short-term 364-day $100 million credit facility which expires in December 2003,
and a $150 million credit facility which expires in
28
December 2006. 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 Ratio"),
both as defined by the agreement. We were compliant with these covenants at
March 31, 2003.
The definition of EBITDA excludes up to $10 million of cash costs related
to workforce reductions in 2002, adds back non-cash pension expense or deducts
non-cash pension income calculated in accordance with SFAS No. 87, "Employers'
Accounting for Pensions" ("SFAS 87"), and adds back postretirement benefits
expenses that are funded by Voluntary Employee Benefit Association (VEBA)
trusts.
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. The definitions of total indebtedness
and total capitalization deduct up to $50 million of cash and cash equivalent
balances held in excess of $25 million.
At March 31, 2003, EBITDA (calculated in accordance with the credit
agreement, which excludes certain non-cash charges) for the prior twelve month
period was 2.37 times gross interest expense compared to a required ratio of at
least 2.00 times gross interest expense. At March 31, 2003, 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 March 31, 2003,
the Leverage Ratio would limit the amount of additional borrowings and dividends
to approximately $300 million.
We believe that internally generated funds, current cash on hand and
borrowings from existing unsecured credit lines will be adequate to meet our
foreseeable liquidity needs. We did not borrow funds under our primary unsecured
credit facilities during 2003 or during all of 2002. However our ability to
borrow under existing unsecured credit lines in the future could be negatively
affected if we fail to maintain required financial ratios under the agreement
governing our primary unsecured credit facilities.
Our ability to access the credit markets in the future to renew our
unsecured credit facilities, or obtain other or additional unsecured financing,
if needed, will be influenced by our credit rating. In April 2003, Standard &
Poor's Ratings Services placed on CreditWatch with negative implications our
credit rating. Currently, our long-term credit rating from Standard & Poor's is
BBB, and from Moody's Investor Services is Baa2. Both of these ratings represent
investment grade. Changes in our credit rating do not impact our access to our
existing credit unsecured credit facility but may affect our borrowing costs in
the event we borrow money. A downgrade of our long-term credit rating to below
investment grade by both ratings services may negatively affect our ability to
continue certain raw material and energy hedging activities which use financial
instruments.
29
A portion of our existing unsecured credit facility is subject to annual
renewal in December on each year. With the continuing economic uncertainty and
the limited availability in the bank credit markets, we are considering
alternatives which could take the place of our unsecured credit facility. A
possible alternative may be to replace our current unsecured credit facility
with a credit facility secured by our accounts receivable and inventories. Such
a facility could be arranged with a longer fixed term than our existing
unsecured credit facility and with less stringent financial covenants.
Commitments under separate standby letters of credit outstanding were $48.9
million at March 31, 2003.
CRITICAL ACCOUNTING POLICIES
RETIREMENT BENEFITS
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 several years. We are not required
to make a contribution to the defined benefit pension plan for 2003, and, based
upon current actuarial analyses and forecasts, we do not expect to be required
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 (expense) income in accordance
with SFAS 87 is the expected investment return on plan assets. In establishing
the expected return on plan investments, which is reviewed annually in the
fourth quarter, we take into consideration types of securities the plan
investments are invested in, how those investments have performed historically,
and expectations for how those investments will perform in the future. For 2003,
in light of the declines in the equity markets over the past several years,
which comprise a significant portion of our pension plan investments, we have
lowered our expected return on pension plan investments to 8.75%, from a 9%
expected return on pension plan investments which was used in 2002. 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 (expense) income for the current year. The effect of lowering the
expected return on pension plan investments will result in an increase in annual
pension expense of approximately $4 million for 2003. 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, which is
the methodology that we use, to an averaging of fair market
30
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 investments.
At the end of November each year, we determine the discount rate to be used
to value pension plan liabilities. In accordance with SFAS 87, the discount rate
reflects the current rate at which the pension liabilities could be effectively
settled. In estimating this rate, we assess the rates of return on high quality,
fixed-income investments. Based on the Moody's average Aa corporate bond yield
at the end of November 2002, we established a discount rate of 6.75% for valuing
the pension liabilities as of the end of 2002, and for determining the pension
expense for 2003. We had previously assumed a discount rate of 7% for 2001,
which determined the 2002 expense. The effect of lowering the discount rate will
increase annual pension expense by approximately $4 million in 2003. 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.
We also sponsor several defined benefit postretirement plans covering
certain hourly and salaried employees and retirees. 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 account for these benefits in
accordance with SFAS No. 106, "Employers' Accounting for Postretirement Benefits
Other Than Pensions" ("SFAS 106"), which requires that amounts recognized in
financial statements be determined on an actuarial basis, rather than as
benefits are paid. 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, 2002, we determined this rate to be
6.75%. In prior years, a 7% discount rate was used. The effect of lowering the
discount rate will increase 2003 postretirement benefit expenses by
approximately $2 million. Based upon cost increases quoted by our medical care
providers and predictions of continued significant medical cost inflation in
future years, the annual assumed rate of increase in the per capita cost of
covered benefits for health care plans is estimated at 10.3% in 2003 and is
assumed to gradually decrease to 5.0% in the year 2009 and remain level
thereafter. Certain of these benefits are funded using plan investments held in
a VEBA trust. The expected return on plan investments is a significant element
in determining postretirement benefits expenses in accordance with SFAS 106. In
establishing the expected return on plan investments, which is reviewed annually
in the fourth quarter, we take into consideration the types of securities the
plan investments are invested in, how those investments have performed
historically, and expectations for how those investments will perform in the
future. For 2003, as a result of a reduction in the percentage of our private
equity investments, we lowered our expected return on investments held in the
VEBA trust to 9%. A 15% return on investments was assumed in prior years. This
assumed long-term rate of return on investments is applied to the market value
of plan investments at the end of the previous year. This produces the expected
return on plan investments that is included in annual postretirement benefits
expenses for the current year. The effect of lowering the expected return on
plan investments will result in an increase in annual postretirement benefits
expense of approximately $7 million for 2003.
31
Changes in the equity markets may have a significant impact on retirement
benefit expenses that would be recognized in future years. For example, based
upon the expected composition of pension plan investments, for each $100 million
change in the value of pension assets, retirement benefit expense would change
by approximately $19 million, pre-tax, in the year subsequent to the measurement
date.
ASSET IMPAIRMENT
We monitor the recoverability of the carrying value of our long-lived
assets. An impairment charge is recognized when the expected net undiscounted
future cash flows from an asset's use (including any proceeds from disposition)
are less than the asset's carrying value, and the asset's carrying value exceeds
its fair value.
Goodwill and indefinite-lived intangible assets are reviewed annually for
impairment, or more frequently if impairment indicators arise. We perform this
annual impairment test in the fourth quarter of each fiscal year. The goodwill
impairment test 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.
Our evaluation of goodwill includes 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 that we use are
reasonable, actual results could differ from those estimates and assumptions.
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, 2002.
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.
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 9,650 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. Also, negotiations have
begun for a new collective bargaining agreement with the USWA affecting
approximately 100 employees at the Casting Service facility in LaPorte, IN.
Generally, agreements that expire may be terminated after notice by the
union. After termination, the union may authorize a strike. A strike by the
employees covered by one or more of the collective bargaining agreements could
materially adversely affect our operating results. There can be no assurance
that we will succeed in concluding collective bargaining agreements with the
unions to replace those that expire.
Environmental
We are subject to various domestic and international environmental laws and
regulations that govern the discharge of pollutants into the air or water, and
disposal of hazardous substances, 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, as well as 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 at a
number of our current and former sites as well as third party 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 31 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 18
individual sites is not considered to be material.
In June 1995, the U.S. Government commenced an action against Allegheny
Ludlum in the United States District Court for the Western District of
Pennsylvania alleging multiple violations of the Federal Clean Water Act. The
trial of this matter concluded in February 2001. In February 2002, the Court
issued a decision imposing a penalty of $8.2 million for incidents at five
facilities that occurred over a period of approximately six years, which
Allegheny Ludlum had reported to the appropriate environmental agencies. We
asked the Court to reconsider its decision, which the Court denied in October
2002. We appealed the Court's decision. At March 31, 2003, we had adequate
reserves, including accrued interest, for this matter.
34
TDY and the San Diego Unified Port District ("Port District") entered into
a lease of property located in San Diego, California ("San Diego facility") on
October 1, 1984. TDY operated its Teledyne Ryan Aeronautical division ("Ryan")
at the San Diego facility 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 brought 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. The
trial for this matter is scheduled for October 2003.
Despite the Port District's failure to consent to the three subleases, TDY
continued its marketing efforts to sublease the San Diego facility. The rental
payments and other expenses for the property amounted to approximately $0.4
million per month. At March 31, 2003, we had a reserve of approximately $3
million to cover the costs of occupying the San Diego 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 and that the Port District's condemnation of the
property voided the lease. 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.
The Port District filed a cross-complaint against TDY in March 2003. The
Complaint alleges breach of contract for failure to pay rent and for certain
environmental contamination on the property. The Port District seeks $1.2
million in past rent, along with future rent and an unspecified sum of damages
for failure to remedy. The Port District also alleges anticipatory breach
relating to removal of structures and debris from the San Diego facility and
seeks specific performance or reimbursement to the Port District. The Port
District further alleges that it is entitled to indemnity for potential
liability related to environmental matters at the San Diego facility, and seeks
a declaratory judgment in its favor. TDY has various defenses to the allegations
in the Port District's Complaint and denies that it has any obligation to the
Port District.
In another matter related to the San Diego facility, the Port District
requested that the California Department of Toxic Substances Control ("DTSC")
evaluate whether the property is regulated as a hazardous waste transportation,
storage, or disposal facility under the Resource Conservation and Recovery Act
("RCRA") and similar state laws. DTSC recognizes that the information pertaining
to the RCRA permitting status of the property is ambiguous and referred the
issue of the property's RCRA permitting status to DTSC's Legal Office for
further consideration. TDY discussed this matter directly with DTSC's Legal
Office and DTSC agreed to refrain from taking action regarding this issue until
after completion of DTSC's Legal Office review. To the extent the facility is
subject to RCRA permitting and corrective action is required at the property,
DTSC has agreed that the San Diego Regional
35
Water Quality Control Board ("Regional Board") is the appropriate agency to
oversee the corrective action work. The Regional Board is currently overseeing
other investigative work at the site, the expected costs of which are included
in our environmental reserves.
We are conducting an environmental assessment of portions of the San Diego
facility at the request of the Regional Board. 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. Also, we are
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 and another wholly-owned subsidiary of the Company, 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
scheduled. In March 2003, the Court ordered the parties, including the United
States government, to fund a portion of the remediation costs at the Site. Based
on information presently available, we believe our reserves on this matter are
adequate. An adverse resolution of this matter could have a material adverse
effect on our results of operations and financial condition.
At March 31, 2003, our reserves for environmental remediation obligations
totaled approximately $39.7 million, of which approximately $12.0 million were
included in other current liabilities. The reserve includes estimated probable
future costs of $15.7 million for federal Superfund and comparable state-managed
sites; $9.3 million for formerly owned or operated sites for which we have
remediation or indemnification obligations; $3.2 million for owned or controlled
sites at which our operations have been discontinued; and $11.5 million for
sites utilized by us in our ongoing operations. In some cases we are evaluating
whether we may be able to recover a portion of future costs for environmental
liabilities from third parties other than participating potentially responsible
parties.
We are a party to various cost-sharing arrangements with other PRPs at the
sites. The terms of the cost-sharing arrangements are subject to non-disclosure
agreements as confidential information. Nevertheless, the cost-sharing
arrangements generally require all PRPs to post financial assurance of the
performance of the obligations or to pre-pay into an escrow or trust account
their share of anticipated site-related costs. In addition, the Federal
government, through various agencies, is a party to several such arrangements.
The timing of expenditures depends on a number of factors that vary by
site, including the nature and extent of contamination, the number of
participating PRPs, the timing of regulatory approvals, the complexity of the
investigation and remediation, and the standards for remediation. We expect that
we will expend present accruals over many years, and will complete remediation
of all sites with respect to which accruals have been made in up to thirty
years.
36
Based on currently available information, we do not believe that there is a
reasonable possibility that a loss exceeding the amount already accrued for any
of the environmental matters 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. 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, 2002. We
assume no duty to update our forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use derivative financial instruments from time to time to hedge ordinary
business risks for product sales denominated in foreign currencies, to partially
hedge against volatile energy and raw material cost fluctuations in the
Flat-Rolled Products and High Performance Metals segments and to manage exposure
to changes in interest rates.
Foreign currency exchange contracts are used to limit transactional
exposure to changes in currency exchange rates. We sometimes purchase foreign
currency forward contracts that permit us to sell specified amounts of foreign
currencies expected to be received from our export sales for pre-established
U.S. dollar amounts at specified dates. The forward contracts are denominated in
the same foreign currencies in which export sales are denominated. These
contracts 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
37
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 March 31, 2003, we had aggregate consolidated indebtedness of
approximately $521 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 March 31, 2003, 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.
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.
Including accretion of the gain on termination of the swap contracts described
above, the result of the "receive fixed, pay floating" arrangements was a
decrease in interest expense of $1.7 million for the 2003 first quarter compared
to the fixed interest expense of the Notes. At March 31, 2003, the adjustment of
these swap contracts to fair market value resulted in the recognition of an
asset of $1.8 million on the balance sheet, included in other assets, with an
offsetting increase in long-term debt. In the 2003 first quarter, we terminated
some of the swap contracts and received $14.6 million in cash. The gain on the
swap termination will be ratably recognized over the remaining life of the
Notes, which is approximately nine years. Some of 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.
38
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 April 29, 2003, and they
concluded that these controls and procedures are effective.
(b) Changes in Internal Controls
There were no significant changes in internal controls or in other factors
that could significantly affect these controls subsequent to April 29, 2003.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None.
(b) Current Reports on Form 8-K filed by the Company -
Date Nature of the Report
---- --------------------
April 22, 2003 Disclosure pursuant to Item 12 -
Results of Operations and Financial Condition,
furnished under Item 9 in accordance with
interim guidance in SEC Release No. 33-8216.
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: April 30, 2003 By /s/ R.J. Harshman
---------------------------------
Richard J. Harshman
Senior Vice President-Finance and
Chief Financial Officer
(Principal Financial Officer and
Duly Authorized Officer)
Date: April 30, 2003 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: April 30, 2003
/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: April 30, 2003
/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 March 31, 2003 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: April 30, 2003 /s/ James L. Murdy
-------------------------------------
James L. Murdy
President and Chief Executive Officer
Date: April 30, 2003 /s/ Richard J. Harshman
-------------------------------------
Richard J. Harshman
Senior Vice President-Finance and
Chief Financial Officer
45