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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 October 29, 2003, the registrant had outstanding 80,642,479 shares of its
Common Stock.
ALLEGHENY TECHNOLOGIES INCORPORATED
SEC FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2003
INDEX
Page No.
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements 3
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 23
Item 3. Quantitative and Qualitative
Disclosures About Market Risk 40
Item 4. Controls and Procedures 41
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 41
SIGNATURES 43
EXHIBITS 44
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share and per share amounts)
September 30, December 31,
2003 2002
---- ----
(Unaudited) (Audited)
ASSETS
Cash and cash equivalents $ 78.5 $ 59.4
Accounts receivable, net 275.5 239.3
Inventories, net 377.1 392.3
Income tax refunds 17.1 51.9
Deferred income taxes 32.9 20.8
Prepaid expenses and other current assets 25.9 32.0
-------- --------
Total Current Assets 807.0 795.7
Property, plant and equipment, net 751.2 757.6
Deferred pension asset 165.1 165.1
Cost in excess of net assets acquired 194.8 194.4
Deferred income taxes 114.7 85.4
Other assets 65.3 95.0
-------- --------
TOTAL ASSETS $2,098.1 $2,093.2
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 175.5 $ 171.3
Accrued liabilities 177.3 161.0
Short-term debt and current portion
of long-term debt 12.4 9.7
-------- --------
Total Current Liabilities 365.2 342.0
Long-term debt 519.2 509.4
Accrued postretirement benefits 505.0 496.4
Pension liabilities 282.0 216.0
Other long-term liabilities 80.6 80.6
-------- --------
TOTAL LIABILITIES 1,752.0 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 September 30,
2003 and December 31, 2002; outstanding-80,694,559
shares at September 30, 2003 and 80,634,344 shares
at December 31, 2002 9.9 9.9
Additional paid-in capital 481.2 481.2
Retained earnings 721.8 835.1
Treasury stock: 18,256,931 shares at
September 30, 2003 and 18,317,146 shares
at December 31, 2002 (458.6) (469.7)
Accumulated other comprehensive
loss, net of tax (408.2) (407.7)
-------- --------
Total Stockholders' Equity 346.1 448.8
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,098.1 $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 Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Sales $ 482.6 $ 469.3 $ 1,453.0 $ 1,453.6
Costs and expenses:
Cost of sales 464.4 419.7 1,399.4 1,316.5
Selling and administrative expenses 60.3 47.1 161.4 146.9
Restructuring costs 1.2 5.5 1.2 5.5
--------- --------- --------- ---------
Loss before interest, other expense and income taxes (43.3) (3.0) (109.0) (15.3)
Interest expense, net 4.1 8.3 19.9 26.1
Other expense (0.9) (2.3) (0.2) (0.7)
--------- --------- --------- ---------
Loss before income tax benefit and cumulative effect
of change in accounting principle (48.3) (13.6) (129.1) (42.1)
Income tax benefit (19.5) (6.1) (48.5) (16.0)
--------- --------- --------- ---------
Net loss before cumulative effect of change in
accounting principle (28.8) (7.5) (80.6) (26.1)
Cumulative effect of change in accounting principle,
net of tax -- -- (1.3) --
--------- --------- --------- ---------
Net loss $ (28.8) $ (7.5) $ (81.9) $ (26.1)
========= ========= ========= =========
Basic and diluted net loss per common share before
cumulative effect of change in accounting
principle $ (0.36) $ (0.09) $ (0.99) $ (0.32)
Cumulative effect of change in accounting principle -- -- (0.02) --
--------- --------- --------- ---------
Basic and diluted net loss per common share $ (0.36) $ (0.09) $ (1.01) $ (0.32)
========= ========= ========= =========
Dividends declared per common share $ 0.06 $ 0.20 $ 0.18 $ 0.60
========= ========= ========= =========
The accompanying notes are an integral part of these statements.
4
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Nine Months Ended
September 30,
-----------------
2003 2002
------- -------
OPERATING ACTIVITIES:
Net loss $(81.9) $(26.1)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Cumulative effect of change in accounting principle 1.3 --
Depreciation and amortization 55.7 68.5
Deferred income taxes (40.7) 18.4
Gains on sales of businesses and investments (0.8) (2.4)
Non-cash restructuring gain -- (1.7)
Change in operating assets and liabilities:
Pension assets and liabilities 66.0 (7.3)
Accounts receivable (36.2) 20.2
Accrued income tax receivable 34.8 23.3
Inventories 15.2 85.2
Accounts payable 4.2 13.1
Accrued liabilities and other 34.5 13.1
------ ------
CASH PROVIDED BY OPERATING ACTIVITIES 52.1 204.3
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (51.5) (35.9)
Asset disposals and other 4.5 2.2
------ ------
CASH USED IN INVESTING ACTIVITIES (47.0) (33.7)
FINANCING ACTIVITIES:
Borrowings on long-term debt 20.2 --
Net repayments under credit facilities (1.4) (72.7)
Payments on long-term debt and capital leases (5.5) (8.1)
------ ------
Net increase (decrease) in debt 13.3 (80.8)
Proceeds from interest rate swap termination 15.3 --
Dividends paid (14.6) (48.3)
------ ------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 14.0 (129.1)
------ ------
INCREASE IN CASH AND CASH EQUIVALENTS 19.1 41.5
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 59.4 33.7
------ ------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 78.5 $ 75.2
====== ======
The accompanying notes are an integral part of these statements.
5
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ACCOUNTING POLICIES
Basis of Presentation
The interim consolidated financial statements include the accounts of
Allegheny Technologies Incorporated and its subsidiaries. Unless the context
requires otherwise, "Allegheny Technologies" and "the Company" refer to
Allegheny Technologies Incorporated and its subsidiaries.
These unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions for Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and note disclosures required by accounting principles generally
accepted in the United States for complete financial statements. In management's
opinion, all adjustments (which include only normal recurring adjustments)
considered necessary for a fair presentation have been included. These unaudited
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
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. Certain amounts from prior periods have been restated to conform with
the current presentation.
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"). The fair value
recognition provisions of SFAS 123 would not affect the compensation expense
recognized for non-vested stock and other performance-based share programs.
(in millions, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2003 2002 2003 2002
------- ------- ------- -------
(unaudited) (unaudited)
Net loss as reported $(28.8) $ (7.5) $(81.9) $(26.1)
Add: Stock-based compensation expense
included in net loss, net of tax 4.0 0.1 5.2 0.3
Deduct: Net impact of SFAS 123, net of
tax (4.8) (1.1) (7.6) (3.0)
------ ------ ------ ------
Pro forma net loss $(29.6) $ (8.5) $(84.3) $(28.8)
====== ====== ====== ======
Net loss per common share:
Basic and diluted--as reported $(0.36) $(0.09) $(1.01) $(0.32)
====== ====== ====== ======
Basic and diluted--pro forma $(0.37) $(0.10) $(1.04) $(0.35)
====== ====== ====== ======
Stock-based compensation expense included in net loss for the quarter and
year-to-date periods ended September 30, 2003 includes the effects of
terminating the Company's Stock Acquisition and Retention Program. See Note 6.
Management Transition and Restructuring Costs.
6
New Accounting Pronouncements
Effective January 1, 2003, as required, the Company adopted Statement
of Financial Accounting Standards 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 nine months ended September 30, 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.
NOTE 2. INVENTORIES
Inventories at September 30, 2003 and December 31, 2002 were as follows
(in millions):
September 30, December 31,
2003 2002
------------- ------------
(unaudited) (audited)
Raw materials and supplies $ 35.3 $ 32.7
Work-in-process 367.2 358.5
Finished goods 79.9 80.4
------ ------
Total inventories at current cost 482.4 471.6
Less allowances to reduce current cost
values to LIFO basis (97.5) (74.7)
Progress payments (7.8) (4.6)
------ ------
Total inventories, net $377.1 $392.3
====== ======
NOTE 3. SUPPLEMENTAL BALANCE SHEET INFORMATION
Property, plant and equipment at September 30, 2003 and December 31,
2002 were as follows (in millions):
September 30, December 31,
2003 2002
------------- ------------
(unaudited) (audited)
Land $ 26.0 $ 29.5
Buildings 229.2 228.6
Equipment and leasehold improvements 1,553.7 1,521.5
-------- --------
1,808.9 1,779.6
Accumulated depreciation and amortization (1,057.7) (1,022.0)
-------- --------
Total property, plant and equipment, net $ 751.2 $ 757.6
======== ========
Reserves for restructuring charges involving future payments were $4.3
million at September 30, 2003 and $6.8 million at December 31, 2002. During
2003, reserves increased $1.2 million due to additional workforce reductions,
and decreased $3.7 million due to cash payments to meet severance obligations.
7
NOTE 4. DEBT
Debt at September 30, 2003 and December 31, 2002 was as follows (in
millions):
September 30, December 31,
2003 2002
------------- ------------
(unaudited) (audited)
Allegheny Technologies $300 million 8.375% Notes due
2011, net (a) $310.6 $312.3
Allegheny Ludlum 6.95% debentures, due 2025 150.0 150.0
Foreign credit agreements 26.5 26.7
Industrial revenue bonds, due through 2011 20.6 21.5
Capitalized leases and other 23.9 8.6
Senior secured domestic revolving credit facility - -
----- ------
531.6 519.1
Short-term debt and current portion of long-term debt (12.4) (9.7)
------ ------
Total long-term debt $519.2 $509.4
====== ======
(a) Includes fair value adjustments for interest rate swap contracts of $16.5
million and $18.7 million at September 30, 2003 and December 31, 2002,
respectively.
During the 2003 second quarter, the Company entered into a $325 million
four-year senior secured domestic revolving credit facility. The facility, which
replaced a $250 million unsecured facility, is secured by all accounts
receivable and inventory of the Company's U.S. operations, and includes capacity
for up to $150 million of letters of credit. There have been no borrowings made
under either the secured credit facility or the former unsecured credit facility
since the beginning of 2002. The Company's outstanding letters of credit issued
under the secured credit facility were approximately $86 million at September
30, 2003. At September 30, 2003, the Company's undrawn availability, as defined
in the credit facility, was approximately $287 million.
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,
the Company 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. During the first nine months of 2003, the Company terminated the
majority of these interest rate swap contracts and received $15.3 million in
cash. The $15.3 million gain on settlement remains a component of the reported
balance of the Notes, and will be ratably recognized as a reduction to interest
expense over the remaining life of the Notes, which is approximately eight
years.
In 2003, 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, a $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 $4.9 million for the nine months ended September 30, 2003, compared
to the fixed interest expense of the Notes that would otherwise have been
realized. At September 30, 2003, the adjustment of these swap contracts to
8
fair market value resulted in the recognition of an asset of $2.3 million on the
balance sheet, included in other assets, with an offsetting increase in
long-term debt.
(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 Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(unaudited) (unaudited)
Total sales:
Flat-Rolled Products $ 266.5 $ 268.4 $ 793.4 $ 814.4
High Performance Metals 175.0 153.4 526.6 497.3
Engineered Products* 59.8 56.8 183.4 174.5
-------- -------- -------- --------
501.3 478.6 1,503.4 1,486.2
Intersegment sales:
Flat-Rolled Products 6.0 2.0 13.9 9.2
High Performance Metals 12.7 7.3 36.5 23.4
-------- -------- -------- --------
18.7 9.3 50.4 32.6
Sales to external customers:
Flat-Rolled Products 260.5 266.4 779.5 805.2
High Performance Metals 162.3 146.1 490.1 473.9
Engineered Products* 59.8 56.8 183.4 174.5
-------- -------- -------- --------
$ 482.6 $ 469.3 $1,453.0 $1,453.6
======== ======== ======== ========
Operating profit (loss):
Flat-Rolled Products $ (4.8) $ 3.9 $ (11.9) $ 4.2
High Performance Metals 9.5 9.3 29.4 22.2
Engineered Products* 1.1 1.6 5.7 3.1
-------- -------- -------- --------
Total operating profit 5.8 14.8 23.2 29.5
Corporate expenses (4.1) (5.6) (14.2) (15.8)
Interest expense, net (4.1) (8.3) (19.9) (26.1)
Management transition and restructuring costs (8.6) (5.5) (8.6) (5.5)
Other expenses, net of gains on asset sales (3.8) (3.6) (7.9) (7.6)
Retirement benefit expense (33.5) (5.4) (101.7) (16.6)
-------- -------- -------- --------
Loss before income tax benefit and cumulative effect
of change in accounting principle $ (48.3) $ (13.6) $ (129.1) $ (42.1)
======== ======== ======== ========
* Formerly the Industrial Products Segment.
Interest expense for the 2003 periods is presented net of $4.0 million
of interest income related to a Federal income tax refund associated with prior
years.
Other expenses, net of gains on asset sales for the third quarter 2002
and nine months ended 2002, include a non-cash charge of $1.7 million related to
the Company's minority interest in net losses of New Piper Aircraft, Inc.
Retirement benefit expense represents pension expense and other
postretirement benefit expenses. Operating profit (loss) with respect to the
Company's business segments excludes any retirement benefit expense.
10
NOTE 6. MANAGEMENT TRANSITION AND RESTRUCTURING COSTS
During the 2003 third quarter, the Company recognized management
transition and restructuring costs of $8.6 million.
As described in the Company's 2003 annual meeting proxy statement,
until the effective date of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"),
the Company maintained a Stock Acquisition and Retention Program ("SARP"). Under
the SARP, certain executives could purchase shares of the Company's common stock
in exchange for a promissory note payable to the Company, and the Company would
match the purchase with a grant of a certain number of shares of restricted
common stock. After the enactment of Sarbanes-Oxley, the Board of Directors
terminated the SARP and no further loans or purchases were permitted. In
connection with the winding up of the SARP, on September 11, 2003 an aggregate
of 691,339 shares, previously purchased under the SARP between 1995 and the
effective date of Sarbanes-Oxley, were sold by participants to a financial
institution in a market transaction; all net proceeds were used to reduce
balances due under SARP promissory notes. In addition, all of the restricted
shares granted to the participants under the SARP in prior years, an aggregate
of 501,970, as well as options to purchase an aggregate of 836,466 shares of
common stock previously granted, were forfeited by SARP participants. In
addition, the Company paid the participants a SARP Termination Payment in cash,
which was used by each participant, net of individual tax consequences, to repay
to the Company all remaining balances owing on the SARP loans. The Board of
Directors has also determined that no equity compensation will be granted to
SARP participants for at least six months. As a net result of the termination of
the SARP, the Company received approximately $0.5 million in cash and recorded
$5.6 million of expenses, which is included in selling and administrative
expenses on the statement of operations.
On July 10, 2003, ATI's Board of Directors selected L. Patrick Hassey
to become president and chief executive officer, effective October 1, 2003. Mr.
Hassey succeeded James. L. Murdy, who retired effective September 30, 2003.
Costs related to the CEO transition of $1.8 million included accelerated vesting
of long-term compensation, and accrued obligations pursuant to an employment
contract.
The Company recognized restructuring costs of $1.2 million during the
third quarter of 2003, related to workforce reductions. These cost reduction
actions affected approximately 80 employees, primarily salaried and
predominately in the Flat-Rolled and Engineered Products segments. Substantially
all of the termination benefits are expected to be paid within the next twelve
months.
During the third quarter of 2002, the Company recorded restructuring
costs of $5.5 million related to workforce reductions affecting approximately
340 salaried employees. The restructuring costs included $7.2 million of
severance expenses partially offset by $1.7 million of non-cash income
recognized on the curtailment of postretirement benefits for terminated
employees.
11
NOTE 7. 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 Nine Months Ended
September 30, September 30,
------------------ ------------------
2003 2002 2003 2002
------- ------- ------- -------
(unaudited) (unaudited)
Numerator:
Basic and diluted net loss per common share
before cumulative effect of change in
accounting principle $(28.8) $ (7.5) $(80.6) $(26.1)
Cumulative effect of change in accounting
principle, net of tax -- -- (1.3) --
------ ------ ------ ------
Basic and diluted net loss per common share $(28.8) $ (7.5) $(81.9) $(26.1)
====== ====== ====== ======
Denominator for basic and diluted net loss per
common share - adjusted weighted average
shares 81.1 80.6 80.9 80.5
====== ====== ====== ======
Basic and diluted net loss per common share
before cumulative effect of change in
accounting principle $(0.36) $(0.09) $(0.99) $(0.32)
Cumulative effect of change in accounting
principle -- -- (0.02) --
------ ------ ------ ------
Basic and diluted net loss per common share $(0.36) $(0.09) $(1.01) $(0.32)
====== ====== ====== ======
For the 2003 and 2002 periods, the effects of stock options were
antidilutive and thus not included in the calculation of dilutive net loss per
share.
In the 2003 third quarter, the Company initiated a stock option
repurchase program whereby stock option plan participants, not including
statutory insiders and certain other executives, could elect to sell to the
Company, for $0.10 per option share, vested stock options with exercise
prices in excess of $20.00 per share. Approximately 1.8 million stock option
shares were repurchased by the Company under this program, which expired in
October 2003. The Board of Directors has also determined that no equity
compensation will be granted to participants for at least six (6) months. There
are approximately 3.2 million shares currently available for grant under the
Company's stock award plans.
12
NOTE 8. COMPREHENSIVE LOSS
The components of comprehensive loss, net of tax, were as follows (in
millions):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2003 2002 2003 2002
-------- ------- -------- --------
(unaudited) (unaudited)
Net loss $ (28.8) $ (7.5) $ (81.9) $ (26.1)
------- ------ ------- -------
Foreign currency translation
gains (losses) (3.3) 8.9 4.3 12.6
Unrealized gains (losses) on
energy, raw materials and
currency hedges, net of tax (2.6) (3.0) (4.7) 4.4
Unrealized holding gains (losses)
arising during the period (0.1) - (0.1) 0.4
------- ------ ------- -------
(6.0) 5.9 (0.5) 17.4
------- ------ ------- -------
Comprehensive loss $ (34.8) $ (1.6) $ (82.4) $ (8.7)
======= ====== ======= =======
NOTE 9. FINANCIAL INFORMATION FOR SUBSIDIARY AND GUARANTOR PARENT
The payment obligations under the $150 million 6.95% debentures due
2025 issued by Allegheny Ludlum Corporation (the "Subsidiary") are fully and
unconditionally guaranteed by Allegheny Technologies Incorporated (the
"Guarantor Parent"). In accordance with positions established by the Securities
and Exchange Commission, the financial information in this Note 9 sets forth
separately financial information with respect to the Subsidiary, the
non-guarantor subsidiaries and the Guarantor Parent. The principal elimination
entries eliminate investments in subsidiaries and certain intercompany balances
and transactions. Investments in subsidiaries, which are eliminated in
consolidation, are included in other assets on the balance sheets.
In 1996, the 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.
13
NOTE 9. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
September 30, 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ------------------------------------ --------- ---------- ------------- ------------ ------------
Assets:
Cash $ 0.1 $ 48.1 $ 30.3 $ - $ 78.5
Accounts receivable, net 0.1 102.3 173.1 - 275.5
Inventories, net - 157.2 219.9 - 377.1
Income tax refunds 17.1 - - - 17.1
Deferred income taxes 32.9 - - - 32.9
Prepaid expenses and other current
assets - 7.2 18.7 - 25.9
-------- -------- -------- --------- --------
Total current assets 50.2 314.8 442.0 - 807.0
Property, plant, and equipment, net - 374.9 376.3 - 751.2
Deferred pension asset 165.1 - - - 165.1
Cost in excess of net assets
acquired - 112.1 82.7 - 194.8
Deferred income taxes 114.7 - - - 114.7
Investments in subsidiaries and
other assets 1,170.3 458.6 334.3 (1,897.9) 65.3
-------- -------- -------- --------- --------
Total assets $1,500.3 $1,260.4 $1,235.3 $(1,897.9) $2,098.1
======== ======== ======== ========= ========
Liabilities and stockholders'
equity:
Accounts payable $ 1.9 $ 94.5 $ 79.1 $ - $ 175.5
Accrued liabilities 555.2 - 53.4 (431.3) 177.3
Short-term debt and current portion
of long-term debt - 0.6 11.8 - 12.4
-------- -------- -------- --------- --------
Total current liabilities 557.1 95.1 144.3 (431.3) 365.2
Long-term debt 310.6 359.4 49.2 (200.0) 519.2
Accrued postretirement benefits - 314.6 190.4 - 505.0
Pension liabilities 282.0 - - - 282.0
Other long-term liabilities 4.5 24.5 51.6 - 80.6
-------- -------- -------- --------- --------
Total liabilities 1,154.2 793.6 435.5 (631.3) 1,752.0
-------- -------- -------- --------- --------
Total stockholders' equity 346.1 466.8 799.8 (1,266.6) 346.1
-------- -------- -------- --------- --------
Total liabilities and stockholders'
equity $1,500.3 $1,260.4 $1,235.3 $(1,897.9) $2,098.1
======== ======== ======== ========= ========
14
NOTE 9. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the nine months ended September 30, 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ------------------------------------ --------- ---------- ------------- ------------ ------------
Sales $ - $ 715.4 $ 737.6 $ - $1,453.0
Cost of sales 69.7 718.6 611.1 - 1,399.4
Selling and administrative expenses 60.4 17.0 84.0 - 161.4
Restructuring costs - 0.5 0.7 - 1.2
Interest expense (income), net 15.3 7.9 (3.3) - 19.9
Other income(expense) including
equity in income of unconsolidated
subsidiaries 18.9 (2.9) 9.1 (25.3) (0.2)
-------- -------- -------- -------- --------
Income (loss) before income
tax benefit and cumulative effect
of change in accounting principle (126.5) (31.5) 54.2 (25.3) (129.1)
Income tax provision (benefit) (45.9) (10.5) 17.0 (9.1) (48.5)
-------- -------- -------- -------- --------
Net income (loss) before cumulative
effect of change in accounting
principle (80.6) (21.0) 37.2 (16.2) (80.6)
Cumulative effect of change in
accounting principle, net of tax (1.3) - - - (1.3)
-------- -------- -------- -------- --------
Net income (loss) $ (81.9) $ (21.0) $ 37.2 $ (16.2) $ (81.9)
======== ======== ======== ======== =========
15
NOTE 9. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Condensed Statements of Cash Flows
For the nine months ended September 30, 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ------------------------------------ --------- ---------- ------------- ------------ ------------
Cash flows provided by (used in)
operating activities $ 24.5 $117.4 $ 33.2 $ (123.0) $ 52.1
Cash flows provided by (used in)
investing activities - (19.9) (28.6) 1.5 (47.0)
Cash flows provided by (used in)
financing activities (24.6) (92.4) 9.5 121.5 14.0
------ ------ ------ -------- ------
Increase (decrease) in cash and cash
equivalents $ (0.1) $ 5.1 $ 14.1 $ -- $ 19.1
====== ====== ====== ======== ======
16
NOTE 9. 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 - 164.9 227.4 - 392.3
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 73.2 299.0 423.5 - 795.7
Property, plant, and equipment, net - 383.2 374.4 - 757.6
Deferred pension asset 165.1 - - - 165.1
Cost in excess of net assets acquired - 112.1 82.3 - 194.4
Deferred income taxes 85.4 - - - 85.4
Investment in subsidiaries and other
assets 1,169.8 625.5 347.1 (2,047.4) 95.0
-------- -------- -------- --------- --------
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
======== ======== ======== ========= ========
17
NOTE 9. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the nine months ended September 30, 2002 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ------------------------------------ --------- ---------- ------------- ------------ ------------
Sales $ - $ 749.8 $ 703.8 $ - $1,453.6
Cost of sales 10.1 721.8 584.6 - 1,316.5
Selling and administrative expenses 35.1 20.0 91.8 - 146.9
Restructuring costs - 4.1 1.4 5.5
Interest expense 16.9 7.8 1.4 - 26.1
Other income(expense) including
equity in income of unconsolidated
subsidiaries 23.4 (0.1) 7.6 (31.6) (0.7)
-------- -------- -------- -------- --------
Income (loss) before income taxes (38.7) (4.0) 32.2 (31.6) (42.1)
Income tax provision (benefit) (12.6) (6.2) 14.8 (12.0) (16.0)
-------- -------- -------- -------- --------
Net income (loss) $ (26.1) $ 2.2 $ 17.4 $ (19.6) $ (26.1)
======== ======== ======== ======== ========
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Condensed Statements of Cash Flows
For the nine months ended September 30, 2002 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ------------------------------------ --------- ---------- ------------- ------------ ------------
Cash flows provided by (used in)
operating activities $ 74.8 $ 79.8 $(52.3) $102.0 $204.3
Cash flows provided by (used in)
investing activities - (8.8) (32.6) 7.7 (33.7)
Cash flows provided by (used in)
financing activities (75.2) (23.8) 79.6 (109.7) (129.1)
------ ------ ------ ------ ------
Increase (decrease) in cash and
cash equivalents $ (0.4) $ 47.2 $ (5.3) $ - $ 41.5
====== ====== ====== ====== ======
18
NOTE 10. COMMITMENTS AND CONTINGENCIES
The Company is subject to various domestic and international
environmental laws and regulations that govern the discharge of pollutants into
the air or water, and 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.
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 September 30, 2003, the Company's reserves for environmental
remediation obligations totaled approximately $38.3 million, of which
approximately $11.9 million were included in other current liabilities. The
reserve includes estimated probable future costs of $13.9 million for Federal
Superfund and comparable state-managed sites; $8.8 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 $12.4 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.
19
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 in 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, 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 September 30,
2003, the Company had adequate reserves, including accrued interest, 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
20
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 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 with
certainty, 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. 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 has been continued until February 2004.
Despite the Port District's failure to consent to the three subleases,
TDY continued its marketing efforts to sublease the San Diego facility. At
September 30, 2003, the Company had a reserve of approximately $3.7 million to
cover the costs of decommissioning 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 July 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 alleged breach of contract for failure to pay rent and for certain
environmental contamination on the property. In June 2003, the Port District
amended the cross-complaint and eliminated the allegations relating to
environmental contamination. In the amended complaint, the Port District seeks
$1.2 million in past rent, along with future rent. 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. TDY has various defenses to the allegations in the Port
District's State Court Cross-Complaint and denies that it has any obligation to
the Port District.
In June 2003, the Port District also commenced a separate action in
United States District Court in San Diego against the Company ("Federal Court
Complaint"). The Federal Court Complaint alleges cost recovery and contribution
under CERCLA as well as state and common law claims related to alleged
environmental contamination on the property. The Complaint seeks an unspecified
amount of damages and a declaratory judgment as to TDY's liability for
contamination on the property. The Company filed a Motion to Dismiss portions of
the Complaint on the basis that the time period allowed for bringing state and
common law claims had elapsed and the allegations are therefore barred. Briefing
on the motion to dismiss was completed in July 2003 and a ruling will be made by
the District Court. The Company denied the remaining allegations in the Federal
Court Complaint.
21
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. In response to the Port District's request, on
October 30, 2003 DTSC informed the Company that the closure of the four solid
waste management units ("unit") at the San Diego facility is subject to DTSC
oversight and that since facility-wide corrective action is proceeding under the
oversight of the San Diego Regional Water Quality Control Board ("Regional
Board"), DTSC's involvement would be limited, to the extent applicable, to unit
closure and post-closure. The Company is evaluating DTSC's positions.
The Company conducted an environmental assessment of portions of the
San Diego facility at the request of the Regional Board. A report of the
assessment was submitted to the Regional Board and 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 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. The Company has been informed by the Port
District that it has commenced a state-wide environmental investigation of the
Property. The Port District has also stated that it will be removing, rather
than closing in place, all of the underground storage tanks.
While the outcome of these matters cannot be predicted with certainty,
and the Company believes that the claims against it are not meritorious, an
adverse resolution of the matters relating to the San Diego facility could have
a material adverse affect on the Company's results of operations and financial
condition.
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
U.S. 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
U.S. Government. No trial date has been scheduled. In March 2003, the Court
ordered the parties, including the U.S. Government, to fund a portion of the
remediation costs at the Site. At EPA's request, in May 2003, the Company made
an offer of settlement to EPA, which was rejected by EPA without any counter
offer. EPA subsequently made a settlement offer to TDY, which is being evaluated
in light of the U.S. Government settlement with EPA.
The U.S. Government and two other PRPs have reached a settlement with
EPA ("the Settlement"), the terms of which may preclude TDY's complaint from
proceeding against the U.S. Government. The Settlement is subject to public
comment and approval by the Court. The Company intends to submit comments on the
Settlement on the grounds that it is not supported by the facts, and is unfair
and unreasonable. The Company expects to oppose entry of the Settlement by the
Court. The Company is also seeking contribution from other PRPs 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,
22
including those pertaining to environmental, government contracting, product
liability, patent infringement, commercial, employment, employee benefits, 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 nine months
of 2003 and 2002:
2003 2002
-------- --------
Flat-Rolled Products 54% 55%
High Performance Metals 34% 33%
Engineered Products 12% 12%
For the first nine months of 2003, operating profit decreased to $23.2
million compared to $29.5 million for the same 2002 period, primarily due to
weak market conditions and higher raw material, energy and insurance costs. The
decrease resulted even though we attained $85 million in cost reductions, before
the effects of inflation, for the nine months ended September 30, 2003. Our cost
reduction goal for 2003 is $115 million. In our continuing effort to improve
productivity and align the size of our workforce with current business
conditions, we anticipate additional workforce reductions which would result in
restructuring costs in the fourth quarter of 2003. Sales were virtually flat at
$1,453 million for the nine months of 2003 compared to the same 2002 period.
Business conditions in most of our end-markets remained challenging.
These market conditions combined with higher pension, healthcare, energy and
insurance costs resulted in a net loss before cumulative effect of a change in
accounting principle of $80.6 million, or a loss of $0.99 per diluted share, for
the first nine months of 2003 compared to a net loss of $26.1 million, or a loss
of $0.32 per diluted share, for the first nine months of 2002. Pre-tax
retirement benefit expense was $101.7 million in the first nine months of 2003,
compared to $16.6 million in the comparable year ago period. Substantially all
of this $85 million increase in retirement benefit expense was non-cash. On a
per share basis, retirement benefit expense represented $0.78 per share of our
$0.99 per share net loss, before the cumulative effect of a change in accounting
principle, for the nine months ended September 30, 2003. The increased
retirement benefit expense was a result of the severe decline in the equity
markets from 2000 through 2002 combined with the impact of lower expected
returns on benefit plan investments and a lower discount rate assumption for
determining liabilities.
23
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 was reported as a cumulative effect of a
change in accounting principle in the 2003 first quarter.
Sales and operating profit (loss) for our three business segments are
discussed below.
FLAT-ROLLED PRODUCTS SEGMENT
Third quarter 2003 sales for the Flat-Rolled Products segment declined
2% to $260.5 million, compared to the third quarter 2002, primarily due to
continued weakness in non-residential construction and most capital goods
markets. The segment had an operating loss of $4.8 million compared to an
operating profit of $3.9 million in the prior year due to lower base prices,
reduced demand, and higher energy and raw material costs, which more than offset
lower depreciation expense. For the first nine months of 2003, sales for the
segment declined 3% to $779.5 million resulting in an operating loss of $11.9
million compared to a $4.2 million profit in the same 2002 period.
As a result of higher natural gas and electricity prices, energy costs
increased by $3.1 million and $12.9 million for the quarter and nine months
ended September 30, 2003, compared to the comparable 2002 periods, net of
approximately $0.2 million and $6.2 million, respectively, in gains from natural
gas derivatives. Results for the 2003 third quarter and first nine months
benefited from $15 million and $43 million, respectively, in cost reductions,
before the effects of inflation and higher energy costs. In addition, results
for the September 30, 2003 quarter and year to date periods were favorably
impacted by approximately $4 million and $12 million, respectively, in lower
depreciation expense compared to the comparable prior year periods as a result
of assets becoming fully depreciated at the end of 2002.
For the third quarter of 2003, total shipments decreased 2% compared to
the same period of 2002. For the comparable periods, average transaction prices
to customers were basically flat due primarily to higher raw materials
surcharges; however, average base selling prices realized by the Company, which
do not include surcharges, declined by approximately 5%.
For the first nine months of 2003, total product shipments were 4%
lower compared to the same 2002 period. For the comparable periods, average
transaction prices to customers increased 1% due primarily to higher raw
material surcharges; however, average base selling prices realized by the
Company declined by approximately 4%.
24
Comparative information on the segment's products is provided in the following
table (unaudited):
Three Months Ended
September 30,
-------------------- %
2003 2002 Change
-------- -------- ---------
Volume (finished tons):
Commodity 86,519 87,884 (2)
High Value 33,045 34,365 (4)
-------- --------
Total 119,564 122,249 (2)
Average prices (per finished ton):
Commodity $ 1,570 $ 1,594 (2)
High Value $ 3,722 $ 3,617 3
Combined Average $ 2,165 $ 2,163 -
Nine Months Ended
September 30,
-------------------- %
2003 2002 Change
-------- -------- ---------
Volume (finished tons):
Commodity 257,348 267,798 (4)
High Value 101,734 104,734 (3)
-------- --------
Total 359,082 372,532 (4)
Average prices (per finished ton):
Commodity $ 1,561 $ 1,541 1
High Value $ 3,660 $ 3,682 (1)
Combined Average $ 2,156 $ 2,143 1
Flat-rolled commodity products include stainless steel hot roll and
cold roll sheet, stainless steel plate and silicon electrical steel, among other
products. Flat-rolled high value products include stainless steel strip,
Precision Rolled Strip(R) products, super stainless steel, nickel alloy and
titanium products.
HIGH PERFORMANCE METALS SEGMENT
Sales increased 11% to $162.3 million for the quarter ended September
30, 2003, compared to the prior year's quarter, due primarily to strong demand
from government defense and high-energy physics markets. Operating profit in the
quarter improved to $9.5 million compared to $9.3 million in the year-ago period
due to strong demand for our exotic alloys and benefits from cost reductions,
partially offset by higher raw material costs. Results for the 2003 third
quarter benefited from $11 million in cost reductions, before the effects of
inflation. Shipments of nickel-based and specialty steel products increased 13%
and shipments of titanium-based products increased 15%. Average prices of
nickel-based and specialty steel products decreased 4%, while average prices of
titanium-based products decreased 10%, both due primarily to product mix.
Shipments of exotic alloys increased 9% and average prices were 9% higher.
Sales increased 3% to $490.1 million for the first nine months of 2003
compared to the same period of 2002 while operating profit increased to $29.4
million compared to $22.2 million in the year-ago period, primarily due to cost
reductions and improved demand and pricing for exotic alloys. Operating results
for the year-to-date 2002 period was 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 were flat and shipments of titanium-based products
decreased 3%. Average prices of nickel-based and specialty steel products
increased 1%, while average prices of titanium-based
25
products were flat. Shipments of exotic alloys increased 10% and average prices
were 11% higher. Cost reductions, before the effects of inflation, were $33
million in the segment for the nine months ended September 30, 2003.
Backlog of confirmed orders within the segment declined to
approximately $278 million at September 30, 2003, 7% lower than at December 31,
2002. Backlog of confirmed orders within the segment was approximately $250
million at September 30, 2002.
Certain comparative information on the segment's major products is
provided in the following table (unaudited):
Three Months Ended
September 30,
--------------------- %
2003 2002 Change
--------- --------- --------
Volume (000's pounds):
Nickel-based and specialty steel alloys 8,965 7,901 13
Titanium mill products 4,813 4,186 15
Exotic alloys 1,052 967 9
Average prices (per pound):
Nickel-based and specialty steel alloys $ 6.44 $ 6.72 (4)
Titanium mill products $ 11.05 $ 12.25 (10)
Exotic alloys $ 38.16 $ 35.16 9
Nine Months Ended
September 30,
--------------------- %
2003 2002 Change
--------- --------- --------
Volume (000's pounds):
Nickel-based and specialty steel alloys 27,114 27,113 -
Titanium mill products 14,045 14,411 (3)
Exotic alloys 3,144 2,851 10
Average prices (per pound):
Nickel-based and specialty steel alloys $ 6.54 $ 6.49 1
Titanium mill products $ 11.68 $ 11.65 -
Exotic alloys $ 38.01 $ 34.16 11
ENGINEERED PRODUCTS SEGMENT
The principal business of the Engineered Products Segment, formerly
referred to as the Industrial Products segment, produces tungsten powder,
tungsten carbide materials, and carbide cutting tools.
Sales increased 5% to $59.8 million and operating profit was $1.1
million for the 2003 third quarter, compared to an operating profit of $1.6
million for the same 2002 period. For the first nine months of 2003, sales
increased 5% to $183.4 million and operating profit was $5.7 million, compared
to an operating profit of $3.1 million in the first nine months of 2002. While
demand from most markets remained weak, demand for tungsten product materials
from the oil and gas market improved. Results for the 2003 third quarter were
adversely affected by higher material costs and lower prices. Continuing cost
reduction efforts totaled $2 million and $6 million, before the effects of
inflation, in the 2003 third quarter and first nine months of 2003,
respectively.
26
MANAGEMENT TRANSITION AND RESTRUCTURING COSTS
Third quarter 2003 results include pre-tax management transition and
restructuring costs of $8.6 million. This amount included $5.6 million
associated with the termination of a stock-based management incentive program
and was reported in "selling and administrative expenses" on the consolidated
statement of operations; $1.8 million for contractual obligations related to the
CEO transition, which was included in "selling and administrative expenses" on
the consolidated statement of operations; and $1.2 million related to reductions
in workforce in the Flat-Rolled Products and Engineered Products segments, which
was reported in "restructuring costs" on the consolidated statement of
operations.
As described in our 2003 annual meeting proxy statement, until the
effective date of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"), we
maintained a Stock Acquisition and Retention Program ("SARP"). Under the SARP,
certain executives could purchase shares of our common stock in exchange for a
promissory note payable to us, and we would match the purchase with a grant of a
certain number of shares of restricted common stock. After the enactment of
Sarbanes-Oxley, our Board of Directors terminated the SARP and no further loans
or purchases were permitted. In connection with the winding up of the SARP, on
September 11, 2003 an aggregate of 691,339 shares, previously purchased under
the SARP between 1995 and the effective date of Sarbanes-Oxley, were sold by
participants to a financial institution in a market transaction; all net
proceeds were used to reduce balances due under SARP promissory notes. In
addition, all of the restricted shares granted to the participants under the
SARP in prior years, an aggregate of 501,970, as well as options to purchase an
aggregate of 836,466 shares of common stock previously granted, were forfeited
by SARP participants. In addition, we paid the participants a SARP Termination
Payment in cash, which was used by each participant, net of individual tax
consequences, to repay to us all remaining balances owing on the SARP loans. The
$5.6 million of expense recognized for the SARP termination included $10.3
million of SARP Termination Payments, net of $4.7 million in reversals of
previously-recognized compensation expense on the forfeited, unvested restricted
stock. We received approximately $0.5 million in cash as a net result of the
transaction. Our Board of Directors has also determined that no equity
compensation will be granted to SARP participants for at least six months.
On July 10, 2003, our Board of Directors selected L. Patrick Hassey to
become president and chief executive officer, effective October 1, 2003. Mr.
Hassey succeeded James. L. Murdy, who retired effective September 30, 2003.
Costs related to the CEO transition of $1.8 million included accelerated vesting
of long-term compensation, and accrued obligations pursuant to an employment
contract.
Restructuring costs of $1.2 million were recognized, primarily for
severance expense, for approximately 80 salaried employees in the Flat-Rolled
Products and Engineered Products segments. Substantially all of the termination
benefits are expected to be paid within the next twelve months.
CORPORATE ITEMS
Corporate expenses decreased to $4.1 million for the third quarter of
2003 and decreased 10% to $14.2 million for the first nine months of 2003,
compared to the respective 2002 periods. Savings realized at the corporate
office in 2003 associated with reductions in staffing and related costs were
partially offset by higher insurance costs. Net interest expense decreased to
$4.1 million for the third quarter 2003 from $8.3 million in the same period
last year. This decrease was primarily due to $4 million of interest income
related to a Federal income tax settlement associated with prior years. This
interest income is netted against interest expense in the consolidated financial
statements.
27
The severe decline in the equity markets from 2000 through 2002,
combined with 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 $33.5 million in the third quarter 2003 compared
to $5.4 million in the third quarter 2002, and $101.7 million compared to $16.6
million for the first nine months of 2003 and 2002, respectively. This increase
in retirement benefits expense resulted in a $28.1 million pre-tax, or $0.21 per
share after-tax, increase in the third quarter 2003 loss compared to the same
period of 2002. The increase in retirement benefits expense for the first nine
months resulted in a $63.5 million pre-tax, or $0.78 per share after-tax
increase in the nine months 2003 net loss. The increase in retirement benefit
expense in 2003 negatively affected both cost of sales and selling and
administrative expenses in the 2003 third quarter and first nine months of 2003
compared to the same periods last year. For the third quarter ended September
30, 2003, retirement benefit expense impacted cost of sales by $23.1 million and
selling and administrative expenses by $10.4 million. For the third quarter
ended September 30, 2002, retirement benefit expense impacted cost of sales by
$1.8 million and selling and administrative expenses by $3.6 million. For the
first nine months ended September 30, 2003, retirement benefit expense impacted
cost of sales by $71 million and selling and administrative expenses by $30.7
million. For the first nine months ended September 30, 2002, retirement benefit
expense impacted cost of sales by $4.1 million and selling and administrative
expenses by $12.5 million. The majority of these retirement benefit expenses
relate to our Allegheny Ludlum operation. For the 2003 third quarter and first
nine months 2003, approximately $26 million and $79 million, respectively, of
the retirement benefit expense was non-cash.
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 for at least the next several years.
INCOME TAX BENEFIT AND DEFERRED INCOME TAXES
Our effective tax rate was a benefit of 40.4% and 37.6% for the 2003
third quarter and first nine months 2003, respectively, compared to a benefit of
44.9% and 38.0% for the same periods in 2002. The effective tax rate for the
third quarter 2003 was favorably impacted by the settlement of previous years'
Federal income tax obligations, resulting in a $17.1 million income tax refund
receivable at September 30, 2003. This refund is expected to be received in the
2003 fourth quarter. Additionally, we received federal income tax refunds of
$48.5 million in 2003 and $45.6 million in 2002, almost entirely in the first
quarter in both years. Under current tax laws we are limited in our ability to
carryback 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 taxes owed in
those future years. As of December 31, 2002, we did not have any Federal income
tax net operating loss carryforwards.
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, based on all
available evidence, we believe that our deferred income tax assets will be
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.
28
Additionally, if a valuation allowance for the net deferred tax asset
was established, and should we generate pre-tax losses in subsequent periods, a
tax benefit would not be recorded and the valuation allowance recorded would
increase. Under these circumstances the net loss recognized and net loss per
share for that period would be larger than a comparable period when a favorable
tax benefit was recorded. However, tax provisions or benefits would continue to
be recognized, as appropriate, on state and local taxes, and taxes related to
foreign jurisdictions.
At September 30, 2003, we had a net deferred income tax asset, net of
deferred income liabilities, of $147.6 million. This net deferred income tax
asset is net of valuation allowances for certain state tax benefits that are not
currently 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 deductible for
income tax reporting purposes until the benefits are paid. These benefit
payments are expected to occur over an extended period of years.
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 historical operating results
including recent years with reported losses, the estimated timing of future
reversals of existing taxable temporary differences, estimated future taxable
income exclusive of reversing temporary differences and carryforwards, and
potential tax planning strategies which may be employed to prevent an operating
loss or tax credit carryforward from expiring unused. We continue to evaluate
whether our deferred tax assets are impaired given the recent operating losses,
the current economic conditions impacting most of our end markets, and other tax
considerations. It is possible that our evaluation, as proscribed by Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes" may
indicate that a valuation allowance is required for a portion or all of the
$147.6 million net deferred tax asset, even though a significant portion of the
deferrals does not expire for a number of years while other deferrals have
indefinite lives. If a valuation allowance were required at any point in time,
it would result in a non-cash additional tax expense. The charge would not
affect our ability to utilize the deferred tax asset in the future. In addition,
a charge, if taken, may be reversed in a future period based upon consideration
of all available evidence.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2003, as required, we adopted Statement of
Financial Accounting Standards 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.
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
nine months ended September 30, 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.
29
FINANCIAL CONDITION AND LIQUIDITY
CASH FLOW AND WORKING CAPITAL
During the first nine months ended September 30, 2003, cash generated
from operations was $52.1 million, which included Federal income tax refunds for
the 2002 tax year of $48.5 million. Managed working capital increased by $36.2
million in the first nine months of 2003 primarily from an increase in accounts
receivable due to a higher level of sales in the 2003 third quarter compared to
fourth quarter of 2002, and higher gross inventories, mostly as a result of
higher raw material costs, primarily nickel. Capital expenditures of $51.5
million and dividend payments of $14.6 million were offset by $15.3 million in
proceeds from terminating some of our interest rate swap contracts, and $6.7
million in proceeds from sales of non-strategic real estate assets. At September
30, 2003, cash and cash equivalents totaled $78.5 million.
Cash and cash equivalents increased $12.3 million in the third quarter
of 2003 compared to the second quarter of 2003. This increase in cash resulted
primarily from a decrease in managed working capital of $18 million for the
third quarter primarily due to reduced inventories.
We focus on controlling managed working capital, which we define as
accounts receivable and inventories less accounts payable. We exclude the
effects of LIFO inventory and other valuation reserves. At September 30, 2003,
managed working capital was 30.6% of annualized sales compared to 32.4% of
annualized sales at December 31, 2002.
The components of managed working capital were as follows:
(Unaudited, in Millions)
SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31,
2003 2003 2003 2002
------------- --------- ----------- --------------
Accounts receivable $ 275.5 $ 274.8 $ 260.4 $ 239.3
Inventory 377.1 401.5 396.6 392.3
Accounts payable (175.5) (175.1) (178.1) (171.3)
------------- --------- ----------- --------------
Subtotal 477.1 501.2 478.9 460.3
Allowance for doubtful accounts 9.8 9.3 10.3 10.1
LIFO reserve 97.5 87.0 77.7 74.7
Corporate and other 15.5 20.4 18.4 18.2
------------- --------- ----------- --------------
Managed working capital $ 599.9 $ 617.9 $ 585.3 $ 563.3
============= ========= =========== ==============
Annualized prior 2 months
sales $ 1,962.0 $ 1,953.0 $ 1,992.0 $ 1,741.0
============= ========= =========== ==============
Managed working capital as a % of
annualized sales 30.6% 31.6% 29.4% 32.4%
Certain amounts from prior periods have been reclassified to conform with the
2003 presentation.
30
CAPITAL EXPENDITURES
Capital expenditures for 2003 are expected to be approximately $70
million, of which $51.5 million had been expended in the 2003 first nine months.
Capital expenditures primarily relate to the upgrade of our Flat-Rolled Products
melt shop located in Brackenridge, PA and investments to enhance the
capabilities of our High Performance Metals long products rolling mill facility
located in Richburg, SC.
DIVIDENDS
On September 9, 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
August 25, 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, and any
limitations imposed by law, credit agreements or senior securities, and other
factors deemed relevant and appropriate.
DEBT
At September 30, 2003, we had $531.6 million in total outstanding debt,
compared to $519.1 million at December 31, 2002. The increase in debt was
primarily due to $12.4 million of additional debt for project financing related
to enhancements to the Richburg, SC long products rolling mill facility. We
anticipate funding a total of approximately $17 million in 2003 with this
project financing, which will be ratably repaid over a five year period
commencing in early 2004.
During the 2003 second quarter, we entered into a $325 million
four-year senior secured domestic revolving credit facility. The facility, which
replaced a $250 million unsecured facility, is secured by all accounts
receivable and inventory of our U.S. operations, and includes capacity for up to
$150 million in letters of credit. There have been no borrowings made under
either the secured credit facility or the former unsecured credit facility since
the beginning of 2002. Outstanding letters of credit issued under the secured
credit facility were approximately $86 million at September 30, 2003.
The secured credit facility limits capital expenditures, investments
and acquisitions of businesses, new indebtedness, asset divestitures, payment of
dividends, and common stock repurchases which we may incur or undertake during
the term of the facility without obtaining permission of the lending group. In
addition, the secured credit facility contains a financial covenant, which is
not measured unless our undrawn availability under the facility is less than
$150 million. This financial covenant, when measured, requires us to maintain a
ratio of consolidated earnings before interest, taxes, depreciation and
amortization ("EBITDA") to fixed charges of at least 1.0 to 1.0. EBITDA is
adjusted for non-cash items such as income/loss on investments accounted for
under the equity method of accounting, non-cash pension expense/income, and that
portion of retire medical and life insurance expenses paid from the our VEBA
trust. EBITDA is reduced by capital expenditures and cash taxes paid, and
increased for cash tax refunds. Fixed charges include gross interest expense,
dividends paid and scheduled debt payments. At September 30, 2003, our undrawn
availability, as defined in the credit facility, was $287 million.
On October 23, 2003, Standard & Poor's Ratings Services placed its
ratings on us on CreditWatch with negative implications. A ratings change, if
any, would not affect our ability to borrow under our credit facilities.
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
31
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. During the first nine months of 2003, we terminated the
majority of these interest rate swap contracts and received $15.3 million in
cash. The $15.3 million gain on settlement remains a component of the reported
balance of the Notes, and will be ratably recognized as a reduction to interest
expense over the remaining life of the Notes, which is approximately eight
years.
During 2003, 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, a $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 $4.9 million for the nine months ended September 30, 2003, compared
to the fixed interest expense of the Notes that would otherwise have been
realized. At September 30, 2003, the adjustment of these swap contracts to fair
market value resulted in the recognition of an asset of $2.3 million on the
balance sheet, included in other assets, with an offsetting increase in
long-term debt.
We believe that internally generated funds, current cash on hand and
capacity provided from our secured credit facility will be adequate to meet our
foreseeable liquidity needs. We have not borrowed funds under our domestic
secured or unsecured credit facilities during 2003 or during all of 2002, and at
this time we do not expect to draw on the secured credit facility for the
remainder of 2003. Our ability to borrow under the secured credit facility in
the future could be negatively affected if we fail to maintain the required
covenants under the agreement governing the facility.
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
32
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 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. If the five year average
of the fair market values of plan assets had been used to calculate retirement
benefit costs, we estimate that retirement benefit expense for the first nine
months of 2003 would have been approximately $75 million less than the $102
million expense recognized using the fair market value approach.
At the end of November of 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 increased pension liabilities by approximately $47 million and
annual pension expense by approximately $4 million for 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.
Accounting standards require a minimum pension liability be recorded
when the value of pension assets is less than the accumulated benefit obligation
("ABO") at the annual measurement date. As of November 30, 2002, our last
measurement date for pension accounting, the value of the ABO exceeded the value
of pension investments by approximately $192 million as a result of a severe
decline in the equity markets in 2000, 2001 and 2002, higher benefit liabilities
from long-term labor contracts negotiated in 2001, and a lower assumed discount
rate for valuing the pension liabilities. As a result, in the 2002 fourth
quarter, we recorded a non-cash charge against stockholders' equity of $406
million, net of deferred taxes, to write off our prepaid pension cost
representing the overfunded portion of the pension plan, and to record a
deferred pension asset of $165 million for the unamortized prior service cost
relating to prior benefit enhancements. In accordance with accounting standards,
the charge against stockholders' equity will be adjusted in the fourth quarter
of subsequent years to reflect the value of pension assets compared to the ABO
as of the end of November. If the level of pension assets exceeded the ABO as of
the measurement date, the full charge against stockholders' equity would be
reversed. The fair market value of assets as of September 30, 2003 was
approximately $1.66 billion. If the level of pension assets remained below the
ABO, the minimum pension liability and the charge against stockholders' equity
would be adjusted to reflect the relative values as of the November 30, 2003
measurement date.
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
33
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 increased 2003 postretirement benefit liabilities by
approximately $11 million and 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 was
10.3% for 2003 and was assumed to gradually decrease to 5.0% in the year 2009
and remain level thereafter.
Certain of these postretirement 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.
After declining during the first half of 2003, corporate bond rates
increased during the 2003 third quarter, but remain at levels below rates as of
November 2002. If corporate bonds rates remain at present levels, it is likely
to result in lower discount rate assumptions used to value pension and
postretirement benefit plan liabilities at the end of 2003. Lowering the
discount rate would result in increases in pension and postretirement benefit
liabilities and retirement benefit expenses for 2004. During 2003, medical costs
for active and retired employees continued to increase. This rise in medical
costs is expected to continue in 2004 and is likely to result in significantly
higher postretirement medical expense for 2004. Valuations in the equity markets
have increased significantly during 2003 resulting in better than expected
returns on pension assets. This recovery in the equity markets, at present
levels, is not expected to offset the potential negative effects of lower
assumed discount rates and medical cost inflation. Based upon these factors, we
currently expect retirement benefit expenses for 2004 to be higher than the 2003
expenses.
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 and will
perform the 2003 annual impairment test in the fourth quarter of 2003. 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
34
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.
OTHER MATTERS
Board of Directors
On July 10, 2003, L. Patrick Hassey became a member of the Board of
Directors. On that date, ATI's Board of Directors selected Mr. Hassey to become
president and chief executive officer, effective October 1, 2003. Mr. Hassey
succeeded James. L. Murdy, who retired effective September 30, 2003. Effective
upon his retirement on September 30, 2003, James L. Murdy resigned from our
Board of Directors.
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.
35
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
our 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 our 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 nearly 9,600 employees. A portion of our workforce is
represented under various collective bargaining agreements, principally with the
United Steelworkers of America ("USWA"), including: approximately 3,300
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 are ongoing for a new
collective bargaining agreement with the USWA affecting approximately 100
employees at the Casting Service facility in LaPorte, IN. During the 2003 second
quarter, we requested the reopening of labor agreements with the USWA pertaining
to the Allegheny Ludlum and Oremet operations. Discussions with the USWA on this
matter are ongoing.
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, or in modifying existing agreements where
we have requested a reopening of an agreement.
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
36
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 33
of such sites, excluding those at which we believe we have no future liability.
Our involvement is very limited or de minimis at approximately 15 of these
sites, and the potential loss exposure with respect to any of the remaining 18
individual sites is not considered to be material. At September 30, 2003, we had
adequate reserves for these 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. We
asked the Court to reconsider its decision, which the Court denied in October
2002. We appealed the Court's decision. At September 30, 2003, we had adequate
reserves, including accrued interest, for this matter.
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 has been continued until February 2004.
Despite the Port District's failure to consent to the three subleases,
TDY continued its marketing efforts to sublease the San Diego facility. At
September 30, 2003, we had a reserve of approximately $3.7 million to cover the
costs of decommissioning 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 July 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. In June 2003, the Port District
amended the cross-complaint and eliminated the allegations relating to
environmental contamination. In the amended complaint, the Port District seeks
$1.2 million in past rent, along with future rent. 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. TDY has various defenses to the allegations in the Port
District's State Court Cross-Complaint and denies that it has any obligation to
the Port District.
37
In June 2003, the Port District also commenced a separate action in
United States District Court in San Diego against the Company ("Federal Court
Complaint"). The Federal Court Complaint alleges cost recovery and contribution
under CERCLA as well as state and common law claims related to alleged
environmental contamination on the property. The Complaint seeks an unspecified
amount of damages and a declaratory judgment as to TDY's liability for
contamination on the property. We filed a Motion to Dismiss portions of the
Complaint on the basis that the time period allowed for bringing state and
common law claims had elapsed and the allegations are therefore barred. Briefing
on the motion to dismiss was completed in July 2003 and a ruling will be made by
the District Court. We denied the remaining allegations in the Federal Court
Complaint.
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. In response to the Port District's request, on
October 30, 2003 DTSC informed us that the closure of the four solid waste
management units ("unit") at the San Diego facility is subject to DTSC oversight
and that since facility-wide corrective action is proceeding under the oversight
of the San Diego Regional Water Quality Control Board ("Regional Board") ,
DTSC's involvement would be limited, to the extent applicable, to unit closure
and post-closure. We are evaluating DTSC's positions.
We conducted an environmental assessment of portions of the San Diego
facility at the request of the Regional Board. A report of the assessment was
submitted to the Regional Board and 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. We have been informed by the
Port District that it has commenced a site-wide environmental investigation of
the Property. The Port District has also stated that it will be removing, rather
than closing in place, all of the underground storage tanks.
While the outcome of these matters cannot be predicted with certainty,
and we believe that the claims against us are not meritorious, an adverse
resolution of the matters relating to the San Diego facility could have a
material adverse affect on our results of operations and financial condition.
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 U.S.
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
U.S. Government. No trial date has been scheduled. In March 2003, the Court
ordered the parties, including the U.S. Government, to fund a portion of the
remediation costs at the Site. At EPA's request, in May 2003, the Company made
an offer of settlement to EPA, which was rejected by EPA without any counter
offer. EPA subsequently made a settlement offer to TDY, which is being evaluated
in light of the U.S. Government settlement with EPA.
The U.S. Government and two other PRPs have reached a settlement with
EPA ("the Settlement"), the terms of which may preclude TDY's complaint from
proceeding against the U.S. Government. The Settlement is subject to public
38
comment and approval by the Court. We intend to submit comments on the
Settlement on the grounds that it is not supported by the facts, and is unfair
and unreasonable. We expect to oppose entry of the Settlement by the Court. We
are also seeking contribution from other PRPs 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 September 30, 2003, our reserves for environmental remediation
obligations totaled approximately $38.3 million, of which approximately $11.9
million were included in other current liabilities. The reserve includes
estimated probable future costs of $13.9 million for Federal Superfund and
comparable state-managed sites; $8.8 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 $12.4 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.
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 in 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.
39
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use derivative financial instruments from time-to-time to hedge
ordinary business risks for product sales denominated in foreign currencies, to
partially hedge against volatile energy and raw material cost fluctuations in
the Flat-Rolled Products and High Performance Metals segments and to manage
exposure to changes in interest rates.
Foreign currency exchange contracts are used to limit transactional
exposure to changes in currency exchange rates. We sometimes purchase foreign
currency forward contracts that permit us to sell specified amounts of foreign
currencies expected to be received from our export sales for pre-established
U.S. dollar amounts at specified dates. The forward contracts are denominated in
the same foreign currencies in which export sales are denominated. These
contracts are designated as hedges of the variability in cash flows of a portion
of our forecasted export sales transactions in which settlement will occur in
future periods and which otherwise would expose us, on the basis of aggregate
net cash flows in respective currencies, to foreign currency risk. Changes in
the fair value of our foreign currency derivatives are recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value is immediately
recognized in the statement of operations.
As part of our risk management strategy, we purchase exchange-traded
futures contracts from time-to-time to manage exposure to changes in nickel
prices, a component of raw material cost for some of our flat-rolled and high
performance metals products. The nickel futures contracts obligate us to make or
receive a payment equal to the net change in value of the contract at its
maturity. These contracts are designated as hedges of the variability in cash
flows of a portion of our forecasted purchases of nickel. Changes in the fair
value of our nickel derivatives are recognized in other comprehensive income
until the hedged item is recognized in the statement of operations. The
ineffective portion of a derivative's change in fair value is immediately
recognized in the statement of operations.
We also enter into energy swap contracts as part of our overall risk
management strategy. The swap contracts are used to manage exposure to changes
in natural gas costs, a component of production costs for our operating units.
The energy swap contracts obligate us to make or receive a payment equal to the
net change in value of the contract at its maturity. These contracts are
designated as hedges of the variability in cash flows of a portion of our
forecasted energy payments. Changes in the fair value of our energy derivatives
are recognized in other comprehensive income until the hedged item is recognized
in the statement of operations. The ineffective portion of a derivative's change
in fair value is immediately recognized in the statement of operations.
At September 30, 2003, we had aggregate consolidated indebtedness of
approximately $532 million, most of which bears interest at fixed rates. In a
period of declining interest rates, we face the risk of required interest
payments exceeding those based on the then current market rate. From
time-to-time, we enter into interest rate swap contracts to manage our exposure
to interest rate risks. At September 30, 2003, we had entered into "receive
fixed, pay floating" arrangements for $150 million notional amount related to
our 8.375% ten-year Notes, which effectively converted this portion of the Notes
to variable rate debt. 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.
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 $4.9 million for the first nine months of 2003
compared to the fixed interest expense of the Notes that would otherwise have
been realized. At September 30, 2003, the adjustment of these swap contracts to
fair market value resulted in the
40
recognition of an asset of $2.3 million on the balance sheet, included in other
assets, with an offsetting increase in long-term debt.
We believe that adequate controls are in place to monitor these hedging
activities. However, many factors, including those beyond our control such as
changes in domestic and foreign political and economic conditions, as well as
the magnitude and timing of interest rate, energy price and nickel price
changes, could adversely affect these activities.
We market our products to a diverse customer base, principally
throughout the United States. Trade credit is extended based upon evaluations of
each customer's ability to perform its obligations, which are updated
periodically. Sales of our products are dependent upon the economic condition of
the markets in which we serve. The continuing difficult and uncertain business
environment may affect our customer's creditworthiness and ability to pay their
obligations.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer have evaluated
the Company's disclosure controls and procedures as of September 30,
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
September 30, 2003.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Certificate of Incorporation of Allegheny Technologies
Incorporated, as amended, (incorporated by reference to
Exhibit 3.1 to the Registrant's report on Form 10-K for the
year ended December 31, 1999 (File No. 1-12001)).
3.2 Amended and Restated Bylaws of Allegheny Technologies
Incorporated (incorporated by reference to Exhibit 3.2 to the
Registrant's report on Form 10-K for the year ended December
31, 1998 (File No. 1-12001)).
4.1 Revolving Credit and Security Agreement dated June 13, 2003
(incorporated by reference to Exhibit 99.1 to the Registrant's
current report on Form 8-K dated June 19, 2003 (File No.
1-12001)).
4.2 Indenture dated as of December 18, 2001 between Allegheny
Technologies Incorporated and The Bank of New York, as
trustee, relating to Allegheny Technologies Incorporated
8.375% Notes due 2011 (incorporated by reference to Exhibit
4.2 to the Registrant's Report on Form 10-K for the year ended
December 31, 2001 (File No. 1-12001)).
4.3 Form of 8.375% Notes due 2011 (included as part of Exhibit
4.2).
41
4.4 Indenture dated as of December 15, 1995 between Allegheny
Ludlum Corporation and The Chase Manhattan Bank (National
Association), as trustee (relating to Allegheny Ludlum
Corporation's 6.95% Debentures due 2025) (incorporated by
reference to Exhibit 4(a) to Allegheny Ludlum Corporation's
Report on Form 10-K for the year ended December 31, 1995 (File
No. 1-9498)), and First Supplemental Indenture by and among
Allegheny Technologies Incorporated, Allegheny Ludlum
Corporation and The Chase Manhattan Bank (National
Association), as Trustee, dated as of August 15, 1996
(incorporated by reference to Exhibit 4.1 to Registrant's
report on Form 8-K dated August 15, 1996 (File No. 1-12001)).
4.5 Rights Agreement dated March 12, 1998, including Certificate
of Designation for Series A Junior Participating Preferred
Stock as filed with the State of Delaware on March 13, 1998
(incorporated by reference to Exhibit 1 to the Registrant's
report on Form 8-K dated March 12, 1998 (File No. 1-12001)).
10.1 Employment Agreement Dated August 26, 2003 between Allegheny
Technologies Incorporated and L. Patrick Hassey (filed
herewith).*
31.1 Section 302 Certification of the President and Chief Executive
Officer
31.2 Section 302 Certification of the Executive Vice
President-Finance and Chief Financial Officer
32 Section 906 Certification
*Management contract or compensatory plan or arrangement required to be filed as
an exhibit to this Report.
(b) Current Reports on Form 8-K filed by the Company -
Date Nature of the Report
---- --------------------
October 22, 2003 Disclosure pursuant to Item 12-Results of Operations
and Financial Condition for the Third Quarter 2003.
September 11, 2003 Disclosure regarding termination of the Stock
Acquisition and Retention Program.
July 23, 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.
42
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLEGHENY TECHNOLOGIES INCORPORATED
(Registrant)
Date: November 4, 2003 By: /s/ Richard J. Harshman
-----------------------------------
Richard J. Harshman
Executive Vice President-Finance
and Chief Financial Officer
(Principal Financial Officer and
Duly Authorized Officer)
Date: November 4, 2003 By: /s/ Dale G. Reid
-----------------------------------
Dale G. Reid
Vice President, Controller and
Chief Accounting Officer
(Principal Accounting Officer)
43