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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
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 July 28, 2004, including the effects of the July 2004 common stock offering
of 13,800,000 shares, the registrant had outstanding 95,282,975 shares of its
Common Stock.
ALLEGHENY TECHNOLOGIES INCORPORATED
SEC FORM 10-Q
QUARTER ENDED JUNE 30, 2004
INDEX
Page No.
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 26
Item 3. Quantitative and Qualitative
Disclosures About Market Risk 44
Item 4. Controls and Procedures 46
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 46
Item 4. Submission of Matters to a Vote of
Security Holders 47
Item 6. Exhibits and Reports on Form 8-K 47
SIGNATURES 49
EXHIBIT INDEX 50
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share and per share amounts)
June 30, December 31,
2004 2003
---- ----
(Unaudited) (Audited)
ASSETS
Cash and cash equivalents $ 64.0 $ 79.6
Accounts receivable, net 337.8 248.8
Inventories, net 451.1 359.7
Income tax refunds 0.3 7.2
Prepaid expenses and other current assets 33.9 48.0
------------ ------------
Total Current Assets 887.1 743.3
Property, plant and equipment, net 733.4 711.1
Cost in excess of net assets acquired 201.3 198.4
Deferred pension asset 144.0 144.0
Deferred income taxes 34.3 34.3
Other assets 58.5 53.8
------------ ------------
TOTAL ASSETS $ 2,058.6 $ 1,884.9
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 245.5 $ 172.3
Accrued liabilities 211.9 194.6
Short-term debt and current portion
of long-term debt 35.9 27.8
------------ ------------
Total Current Liabilities 493.3 394.7
Long-term debt 551.6 504.3
Accrued postretirement benefits 476.2 507.2
Pension liabilities 281.4 220.6
Other long-term liabilities 106.4 83.4
------------ ------------
TOTAL LIABILITIES 1,908.9 1,710.2
------------ ------------
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.10: authorized-
50,000,000 shares; issued-none -- --
Common stock, par value $0.10, authorized-500,000,000
shares; issued-98,951,490 shares at June 30, 2004 and December 31, 2003;
outstanding-81,381,624 shares at June 30, 2004 and 80,654,861 shares
at December 31, 2003 9.9 9.9
Additional paid-in capital 481.2 481.2
Retained earnings 438.9 483.8
Treasury stock: 17,569,866 shares at
June 30, 2004 and 18,296,629 shares
at December 31, 2003 (440.1) (458.4)
Accumulated other comprehensive
loss, net of tax (340.2) (341.8)
------------ ------------
Total Stockholders' Equity 149.7 174.7
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,058.6 $ 1,884.9
============ ============
The accompanying notes are an integral part of these statements.
3
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Sales $ 646.5 $ 489.9 $ 1,224.3 $ 970.4
Costs and expenses:
Cost of sales 593.9 469.1 1,161.3 935.0
Selling and administrative
expenses 57.8 53.4 111.5 101.1
Curtailment gain, net of
restructuring costs (40.4) -- (40.4) --
--------- --------- --------- ---------
Income (loss) before interest,
other income, and income taxes 35.2 (32.6) (8.1) (65.7)
Interest expense, net 7.8 8.4 16.0 15.8
Other income (expense) (0.8) 0.2 0.3 0.7
--------- --------- --------- ---------
Income (loss) before income tax
benefit and cumulative effect of
change in accounting principle 26.6 (40.8) (23.8) (80.8)
Income tax benefit -- (14.8) -- (29.0)
--------- --------- --------- ---------
Net income (loss) before cumulative
effect of change in accounting
principle 26.6 (26.0) (23.8) (51.8)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (1.3)
--------- --------- --------- ---------
Net income (loss) $ 26.6 $ (26.0) $ (23.8) $ (53.1)
========= ========= ========= =========
Basic net income (loss) per
common share before cumulative
effect of change in accounting
principle $ 0.33 $ (0.32) $ (0.30) $ (0.64)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
--------- --------- --------- ---------
Basic net income (loss) per common
share $ 0.33 $ (0.32) $ (0.30) $ (0.66)
========= ========= ========= =========
Diluted net income (loss) per
common share before cumulative
effect of change in accounting
principle $ 0.31 $ (0.32) $ (0.30) $ (0.64)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
Diluted net income (loss) per --------- --------- --------- ---------
common share $ 0.31 $ (0.32) $ (0.30) $ (0.66)
========= ========= ========= =========
Dividends declared per common share $ 0.06 $ 0.06 $ 0.12 $ 0.12
========= ========= ========= =========
The accompanying notes are an integral part of these statements.
4
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Six Months Ended
June 30,
-----------------------------
2004 2003
----------- -----------
OPERATING ACTIVITIES:
Net loss $ (23.8) $ (53.1)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Cumulative effect of change in accounting principle - 1.3
Depreciation and amortization 37.9 37.1
Non-cash curtailment gain and restructuring
charges, net (45.6) -
Deferred income taxes - (26.0)
Capital (gains) losses on sale of PP&E (1.4) (0.8)
Change in operating assets and liabilities:
Accounts receivable (56.9) (35.6)
Accounts payable 56.9 3.8
Pension assets and liabilities 34.8 43.9
Inventories (33.5) (7.6)
Income tax refunds receivable 6.9 48.5
Accrued liabilities and other 46.3 5.6
----------- -----------
CASH PROVIDED BY OPERATING ACTIVITIES 21.6 17.1
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (25.2) (28.8)
Purchases of businesses and investment in ventures (7.5) (0.8)
Asset disposals and other 1.0 7.5
----------- -----------
CASH USED IN INVESTING ACTIVITIES (31.7) (22.1)
FINANCING ACTIVITIES:
Payments on long-term debt and capital leases (14.3) (1.9)
Borrowings on long-term debt 10.7 9.2
Net borrowings (repayments) under credit facilities 0.4 (1.1)
----------- -----------
Net increase (decrease) in debt (3.2) 6.2
Exercises of stock options 2.6 -
Dividends paid (4.9) (9.7)
Proceeds from interest rate swap settlement - 15.3
----------- -----------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (5.5) 11.8
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (15.6) 6.8
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 79.6 59.4
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 64.0 $ 66.2
=========== ===========
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES
On June 1, 2004, a subsidiary of the Company acquired substantially all of the
assets of J&L Specialty Steel, LLC for consideration of $67.2 million. Cash paid
at closing was $7.5 million, with promissory notes payable to the seller of
$59.7 million, one of which is subject to adjustment on the terms set forth in
the asset purchase agreement.
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
2003 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 reclassified 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 income (loss) and per share information if the Company had applied
the fair value recognition provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123").
(in millions, except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -----------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Net income (loss) as reported $ 26.6 $(26.0) $(23.8) $(53.1)
Add: Stock-based compensation
expense included in net income (loss), net of
tax 8.9 0.7 10.1 1.0
Deduct: Net impact of SFAS 123,
net of tax (9.7) (1.5) (12.1) (2.6)
------ ------ ------ ------
Pro forma net income (loss) $ 25.8 $(26.8) $(25.8) $(54.7)
====== ====== ====== ======
Net income (loss) per common share:
Basic - as reported $ 0.33 $(0.32) $(0.30) $(0.66)
Basic - pro forma $ 0.32 $(0.33) $(0.33) $(0.68)
Diluted - as reported $ 0.31 $(0.32) $(0.30) $(0.66)
Diluted - pro forma $ 0.30 $(0.33) $(0.33) $(0.68)
6
Recent Accounting Pronouncement
On May 19, 2004 the Financial Accounting Standards Board issued FASB Staff
Position (FSP) 106-2, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003" that
provides guidance on the accounting for the effects of the Act for employers
that sponsor postretirement health care plans that provide drug benefits. The
Act provides the opportunity for a retiree to obtain a prescription drug benefit
under Medicare, or for a Federal subsidy, with tax-free payments commencing in
2006, to sponsors of retiree health care benefit plans that provide a benefit
that is at least actuarially equivalent to the benefit established by law. Under
FSP 106-2, the effect of the Federal subsidy shall be accounted for as an
actuarial experience gain. In addition, the effect of the Act is taken into
consideration, as appropriate, in determining an employer's future per capita
claims cost. Based upon estimates from the Company's actuaries, it is expected
that the effect of the Act will result in a reduction in the Accumulated Other
Postretirement Benefits obligation of $46 million. The effect of adopting FSP
106-2 on postretirement benefits expense will be recognized commencing in the
2004 third quarter.
NOTE 2. J&L SPECIALTY STEEL, LLC ASSET ACQUISITION
On June 1, 2004, a subsidiary of the Company acquired substantially all of
the assets of J&L Specialty Steel, LLC ("J&L"), a producer of flat-rolled
stainless steel products with operations in Midland, Pennsylvania and
Louisville, Ohio. Consideration for the acquisition of $67.2 million consisted
of a payment of $7.5 million at closing, the issuance to the seller of a
non-interest bearing $7.5 million promissory note that matures on June 1, 2005,
the issuance to the seller of a promissory note in the principal amount of $52.2
million, which is secured by the J&L property, plant and equipment acquired, and
which is subject to adjustment on the terms set forth in the asset purchase
agreement and has a final maturity of July 1, 2011, and the assumption of
certain current liabilities. The transaction was accounted for as a purchase
business combination. The acquired operations are being integrated into the
Allegheny Ludlum operation which is part of the Company's Flat-Rolled Products
business segment.
The closing of the acquisition followed the ratification, on May 28, 2004,
of a new labor agreement by the United Steelworkers of America ("USWA")
represented employees at the Company's Allegheny Ludlum subsidiary and at the
former J&L facilities. The new labor agreement expires in June 2007, and
provides for a workforce restructuring through the reduction in the number of
production and maintenance job grades from 34 to five, and the implementation of
flexible work rules. The number of production and maintenance employees at the
pre-acquisition Allegheny Ludlum facilities will be reduced by 650 employees
through an early retirement program over the next two and a half years pursuant
to which the USWA-represented employees are being offered Transition Assistance
Program ("TAP") incentives, to be paid from the Company's defined benefit
pension trust. The new labor agreement also includes a cap on the Company's
retiree medical costs. In the 2004 second quarter, the Company recorded charges
of $25.4 million for the TAP incentives, and also recorded a $5.7 million charge
as a result of other costs associated with the new labor agreement and the J&L
asset acquisition.
The following is a summary of the preliminary purchase price allocation of
the assets acquired and liabilities assumed or recognized in conjunction with
the acquisition based upon their estimated fair market values.
7
Allocated
Purchase Price
--------------
(in millions)
(unaudited)
Acquired assets:
Accounts receivable $ 32.1
Inventory 57.9
Property, plant and equipment 31.1
Other assets 2.0
------
Total assets 123.1
Assumed liabilities:
Accounts payable 16.3
Accrued current liabilities 9.6
Short term debt 2.4
Long-term debt 2.1
Other post-employment benefits 21.9
Other long-term liabilities 3.6
------
Total liabilities 55.9
------
Purchase price - net assets acquired $ 67.2
======
Under the terms of the asset purchase agreement, the final purchase price of the
J&L asset acquisition is subject to adjustment based upon an audit of the net
working capital acquired. This adjustment is expected to be finalized in the
2004 fourth quarter. In the 2003 fourth quarter, J&L recorded a $242 million
asset impairment charge to write off the entire value of its property, plant and
equipment. The purchase price of the J&L asset acquisition is based on the net
working capital acquired, and the fair value of the net assets acquired is in
excess of the purchase price. In accordance with Statement of Financial
Accounting Standards No. 141, "Business Combinations" ("SFAS 141"), the excess
of fair value over the purchase price represents negative goodwill, which has
been allocated as a pro rata reduction to the amounts that would otherwise have
been assigned to the acquired noncurrent assets, principally property, plant and
equipment.
The following unaudited pro forma financial information for the Company
includes the results of operations of the J&L asset acquisition as if it had
been consummated as of the beginning of the periods presented, including the
effects of the new labor agreement as it pertains to the former J&L facilities,
the effects of the assigned fair value under SFAS 141 of property, plant and
equipment acquired, and the effects of the indebtedness incurred to fund the
asset acquisition. In addition, the unaudited pro forma financial information is
based on historical information and does not purport to represent what the
actual consolidated results of operations of the Company would have been had
these transactions occurred on the dates assumed, nor is it necessarily
indicative of future consolidated results of operations. The unaudited pro forma
financial information does not give affect to additional cost savings and
synergies that the Company anticipates achieving following the acquisition.
8
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -------------------------
(In millions, except per share data) 2004 2003 2004 2003
(unaudited) ------ ------ -------- --------
Sales $721.3 $599.0 $1,427.4 $1,192.6
Net income (loss) before cumulative effect of
change in accounting principle 28.2 (33.2) (15.8) (59.1)
Net income (loss) 28.2 (33.2) (15.8) (60.4)
Basic net income (loss) per common share before
cumulative effect of change in accounting
principle 0.35 (0.41) (0.20) (0.73)
Basic net income (loss) per common share 0.35 (0.41) (0.20) (0.75)
Diluted net income (loss) per common share
before cumulative effect of change in
accounting principle 0.33 (0.41) (0.20) (0.73)
Diluted net income (loss) per common share 0.33 (0.41) (0.20) (0.75)
NOTE 3. INVENTORIES
Inventories at June 30, 2004 and December 31, 2003 were as follows (in
millions):
June 30, December 31,
2004 2003
------------ ------------
(unaudited) (audited)
Raw materials and supplies $ 50.5 $ 37.5
Work-in-process 504.1 356.2
Finished goods 92.2 84.9
------------ ------------
Total inventories at current cost 646.8 478.6
Less allowances to reduce current cost
values to LIFO basis (185.9) (111.7)
Progress payments (9.8) (7.2)
------------ ------------
Total inventories, net $ 451.1 $ 359.7
============ ============
Inventories are stated at the lower of cost (last-in, first-out ("LIFO"),
first-in, first-out ("FIFO"), and average cost methods) or market, less progress
payments. Most of the Company's inventory is valued utilizing the LIFO costing
methodology. Inventory of the Company's non-U.S. operations is valued using
average cost or FIFO methods. Cost of sales expense was $26.1 million higher for
the 2004 second quarter and $74.2 million higher for the 2004 first half than
would have been recognized if FIFO, rather than LIFO, methodology were utilized
to value inventory. Cost of sales expense was $9.3 million higher for the 2003
second quarter and $12.3 million higher for the 2003 first half than would have
been recognized if FIFO, rather than LIFO, methodology were utilized to value
inventory.
In the quarter ended June 30, 2004, the Company changed its method of
calculating LIFO inventories at its Allegheny Ludlum subsidiary by reducing the
overall number of Company-wide inventory pools from 15 to eight, and by changing
its calculation method for LIFO from the double-extension method to the
link-chain method. The Company made the change in order to better match costs
with revenues, to reflect the business structure of Allegheny Ludlum following
the J&L asset acquisition, to provide for a LIFO adjustment more representative
of Allegheny Ludlum's
9
actual inflation on its inventories and to conform LIFO accounting methods with
other ATI operations that use the LIFO inventory method. The cumulative effect
of the change in methods and the pro forma effects of the change on prior years'
results of operations were not determinable. The effect of the change on the
results of operations for interim 2004 periods was not material.
NOTE 4. SUPPLEMENTAL FINANCIAL STATEMENT INFORMATION
Property, plant and equipment at June 30, 2004 and December 31, 2003 were
as follows (in millions):
June 30, December 31,
2004 2003
--------- -----------
(unaudited) (audited)
Land $ 26.4 $ 26.3
Buildings 229.2 228.2
Equipment and leasehold improvements 1,545.9 1,494.0
--------- -----------
1,801.5 1,748.5
Accumulated depreciation and amortization (1,068.1) (1,037.4)
--------- -----------
Total property, plant and equipment, net $ 733.4 $ 711.1
========= ===========
NOTE 5. DEBT
Debt at June 30, 2004 and December 31, 2003 was as follows (in millions):
June 30, December 31,
2004 2003
--------------- -----------------
(unaudited) (audited)
Allegheny Technologies $300 million
8.375% Notes due 2011, net (a) $ 303.4 $ 309.4
Allegheny Ludlum 6.95% debentures, due 2025 150.0 150.0
Promissory notes for J&L asset acquisition 59.7 -
Foreign credit agreements 44.3 35.0
Industrial revenue bonds, due through 2007 13.8 20.1
Capitalized leases and other 16.3 17.6
--------------- -----------------
587.5 532.1
Short-term debt and current portion of long-term debt (35.9) (27.8)
--------------- -----------------
Total long-term debt $ 551.6 $ 504.3
=============== =================
(a) Includes fair value adjustments for interest rate swap contracts of
$9.0 million (including ($4.0) million for interest rate swap
contracts currently outstanding and $13.0 million for deferred gains
on settled interest rate swap contracts) and $15.2 million
(including $1.4 million for interest rate swap contracts currently
outstanding and $13.8 million for deferred gains on settled interest
rate swap contracts) at June 30, 2004 and December 31, 2003,
respectively.
Interest rate swap contracts are used from time-to-time to manage the
Company's exposure to interest rate risks. At the end of the 2002 first quarter,
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.
10
As a result, changes in the fair value of the swap contracts and the underlying
fixed rate debt are recognized in the statement of operations. In the first six
months of 2003, the Company terminated the majority of these interest rate swap
contracts and received $15.3 million in cash. The gain on settlement remains a
component of the reported balance of the Notes ($303.4 million at June 30, 2004
including fair value adjustments), and is being ratably recognized as a
reduction to interest expense over the remaining life of the Notes, which is
approximately seven and one half years. In the 2003 first quarter, the Company
entered into new "receive fixed, pay floating" interest rate swap arrangements
related to the 8.375% ten-year Notes which re-established, in total, the $150
million notional amount which effectively converted this portion of the Notes to
variable rate debt.
The Company has a $325 million four-year senior secured domestic revolving
credit facility ("the facility"), which expires in June 2007, and which is
secured by all accounts receivable and inventory of its U.S. operations, and
includes capacity for up to $175 million in letters of credit. There were no
borrowings under the domestic credit facilities during the first six months of
2004, or during all of 2003, although a portion of the facility is used to
support letters of credit.
Promissory notes totaling $59.7 million were issued in June 2004 as part
of the consideration for the J&L asset acquisition. These notes included a
non-interest bearing $7.5 million promissory note payable on June 1, 2005, and a
$52.2 million promissory note, secured by the J&L property, plant and equipment
acquired, which is subject to adjustment on the terms set forth in the J&L asset
purchase agreement, payable to the seller in installments in 2007 through 2011,
which bears interest at a London Interbank Offered Rate plus a 1% margin, with a
maximum interest rate of 6%.
11
NOTE 6. PER SHARE INFORMATION
The following table sets forth the computation of basic and diluted net
income (loss) per common share (in millions, except share and per share
amounts):
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2004 2003 2004 2003
-------- ------ ------ ------
(unaudited) (unaudited)
Numerator:
Net income (loss) per common share
before cumulative effect of
change in accounting principle $ 26.6 $(26.0) $(23.8) $(51.8)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (1.3)
------ ------ ------ ------
Numerator for basic and diluted
net income (loss) per common
share - Net income (loss) $ 26.6 $(26.0) $(23.8) $(53.1)
====== ====== ====== ======
Denominator:
Denominator for basic earnings
per share-weighted average shares 80.6 81.0 80.5 80.8
Effect of dilutive securities:
Option equivalents 1.4 -- -- --
Contingently issuable shares 2.6 -- -- --
------ ------ ------ ------
Denominator for diluted net
income(loss) per common share -
adjusted weighted average
shares and assumed conversions 84.6 81.0 80.5 80.8
====== ====== ====== ======
Basic net income (loss) per common
share before cumulative effect
of change in accounting principal $ 0.33 $(0.32) $(0.30) $(0.64)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
------ ------ ------ ------
Basic net income (loss) per common
share $ 0.33 $(0.32) $(0.30) $(0.66)
====== ====== ====== ======
Diluted net income (loss) per
common share before cumulative
effect of change in accounting principal $ 0.31 $(0.32) $(0.30) $(0.64)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
------ ------ ------ ------
Diluted net income (loss) per
common share $ 0.31 $(0.32) $(0.30) $(0.66)
====== ====== ====== ======
For the six months ended June 30, 2004 and both of the comparable 2003
periods, the effects of stock options were antidilutive and thus not included in
the calculation of diluted earnings per share.
12
NOTE 7. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, were as follows
(in millions):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- --------------------------
2004 2003 2004 2003
-------- ------- -------- --------
(unaudited) (unaudited)
Net income (loss) $ 26.6 $ (26.0) $ (23.8) $ (53.1)
-------- ------- -------- --------
Foreign currency translation gain (loss) (14.4) 3.1 5.1 7.6
Unrealized gains (losses) on energy, raw
materials and currency hedges, net of tax 4.4 (2.1) (3.5) (2.1)
-------- ------- -------- --------
(10.0) 1.0 1.6 5.5
-------- ------- -------- --------
Comprehensive income (loss) $ 16.6 $ (25.0) $ (22.2) $ (47.6)
======== ======= ======== ========
NOTE 8. INCOME TAXES
The three months and six months ended June 2004 results do not include an
income tax provision or benefit due to the uncertainty regarding full
utilization of the Company's net deferred tax assets as a result of cumulative
losses recorded in the 2001 through 2003 period. The Company is required to
maintain a valuation allowance, as recorded in accordance with SFAS No. 109,
"Accounting for Income Taxes", until a realization event occurs to support
reversal of all, or a portion of, the allowance. The Company recorded a tax
benefit on the loss before income taxes and the cumulative effect of a change in
accounting principle of $14.8 million and $29.0 million in the 2003 second
quarter and first six months 2003, respectively. The effective tax rate was a
benefit of 36.3% and 35.9% for the 2003 second quarter and first six months
2003, respectively.
NOTE 9. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
The Company has defined benefit pension plans and defined contribution
plans covering substantially all employees. Benefits under the defined benefit
pension plans are generally based on years of service and/or final average pay.
The Company funds the U.S. pension plans in accordance with the Employee
Retirement Income Security Act of 1974, as amended, and the Internal Revenue
Code.
The Company also sponsors several postretirement plans covering certain
salaried and hourly employees. The plans provide health care and life insurance
benefits for eligible retirees. In certain plans, Company contributions towards
premiums are capped based on the cost as of a certain date, thereby creating a
defined contribution. For the non-collectively bargained plans, the Company
maintains the right to amend or terminate the plans at its discretion.
In the 2004 second quarter in conjunction with the new labor agreement at
ATI's Allegheny Ludlum operation, a $25.4 million charge for pension termination
benefits was recognized for the TAPs. The TAP incentive will be paid from the
Company's pension fund over the next two and a half years to 650 employees. The
new labor contract also includes caps on the Company's retiree medical benefit
costs.
Also in the 2004 second quarter, the Company modified retiree medical
benefits for certain non-collectively bargained employees to cap the
13
Company's cost of benefits, beginning in 2005, and then eliminate the benefits
in 2010. As a result of these actions, a $71.5 million curtailment and
settlement gain was recognized in the 2004 second quarter, comprised of a $72.0
million one-time reduction of postretirement benefit expense, net of a $0.5
million charge to pension expense.
The Accumulated Other Postretirement Benefits obligation ("APBO"), and
postretirement benefits expense recognized through June 30, 2004 does not
include the expected favorable impact of the Medicare Prescription Drug,
Improvement and Modernization Act, which was enacted on December 8, 2003. The
Act provides for a Federal subsidy, with tax-free payments commencing in 2006,
to sponsors of retiree health care benefits plans that provide a benefit that is
at least actuarially equivalent to the benefit established by the law. Based
upon estimates from the Company's actuaries, and including the changes to
retiree medical benefits described above, it is expected that the effect of the
Act will result in a reduction in the APBO of $46 million. As a result of the
changes to retiree medical benefits in the 2004 second quarter and the effects
of the Act, the Company's APBO is expected to be reduced by approximately $331
million.
For the three months and six months ended June 30, 2004 and 2003, the components
of pension expense for the Company's defined benefit plans and components of
postretirement benefit expense included the following (in millions):
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Pension Benefits:
Service cost - benefits earned
during the year $ 7.0 $ 7.1 $ 14.5 $ 14.3
Interest cost on benefits earned
in prior years 31.7 32.0 63.0 63.1
Expected return on plan assets (36.9) (35.2) (73.7) (69.6)
Amortization of prior service cost 6.3 6.7 12.6 13.4
Amortization of net actuarial loss 10.7 12.7 21.4 25.5
------ ------ ------ ------
18.8 23.3 37.8 46.7
Termination benefits 25.4 -- 25.4 --
Plan design change 0.5 -- 0.5 --
------ ------ ------ ------
Total pension expense $ 44.7 $ 23.3 $ 63.7 $ 46.7
====== ====== ====== ======
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Other Postretirement Benefits:
Service cost - benefits earned
during the year $ 1.5 $ 1.4 $ 3.7 $ 3.4
Interest cost on benefits earned
in prior years 13.2 11.0 27.1 22.8
Expected return on plan assets (2.2) (2.3) (4.4) (4.7)
Amortization of prior service cost (4.5) (1.2) (4.5) (2.4)
Amortization of net actuarial loss 7.2 1.2 10.3 2.4
------ ------ ------ ------
15.2 10.1 32.2 21.5
Curtailment and settlement gain (72.0) -- (72.0) --
------ ------ ------ ------
Total postretirement benefit
(income) expense $(56.8) $ 10.1 $(39.8) $ 21.5
====== ====== ====== ======
Total retirement benefit (income)
expense $(12.1) $ 33.4 $ 23.9 $ 68.2
====== ====== ====== ======
14
NOTE 10. RESTRUCTURING CHARGES
In the 2004 second quarter, the Company recorded $5.7 million in
restructuring charges in the Flat-Rolled Products segment related to the new
labor agreement and the J&L asset acquisition. Charges included labor agreement
costs of $4.6 million, severance costs of $0.6 million related to approximately
30 salaried employees, and $0.5 million for asset impairment charges for
redundant equipment following the J&L asset acquisition. Approximately $1.4
million of the restructuring charges represent future cash payments that are
expected to be paid within one year.
Reserves for restructuring charges recorded in 2003 and prior years
involving future payments were approximately $6 million at June 30, 2004 and $9
million at December 31, 2003. The reduction in reserves resulted from cash
payments to meet severance and lease payment obligations.
NOTE 11. BUSINESS SEGMENTS
Following is certain financial information with respect to the Company's
business segments for the periods indicated (in millions):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2004 2003 2004 2003
------- ------- -------- -------
(unaudited) (unaudited)
Total sales:
Flat-Rolled Products $ 381.2 $ 263.0 $ 713.2 $ 523.9
High Performance Metals 207.7 180.5 401.4 350.7
Engineered Products 81.2 66.3 153.0 130.3
------- ------- -------- -------
670.1 509.8 1,267.6 1,004.9
Intersegment sales:
Flat-Rolled Products 2.0 4.3 4.4 7.9
High Performance Metals 15.2 13.7 30.2 22.9
Engineered Products 6.4 1.9 8.7 3.7
------- ------- -------- -------
23.6 19.9 43.3 34.5
Sales to external customers:
Flat-Rolled Products 379.2 258.7 708.8 516.0
High Performance Metals 192.5 166.8 371.2 327.8
Engineered Products 74.8 64.4 144.3 126.6
------- ------- -------- -------
$ 646.5 $ 489.9 $1,224.3 $ 970.4
======= ======= ======== =======
Operating profit (loss):
Flat-Rolled Products $ 20.0 $ (6.2) $ 9.0 $ (7.5)
High Performance Metals 12.6 11.6 20.4 19.9
Engineered Products 5.5 3.2 9.3 5.0
------- ------- -------- -------
Total operating profit 38.1 8.6 38.7 17.4
Corporate expenses (8.9) (5.3) (14.5) (10.1)
Interest expense, net (7.8) (8.4) (16.0) (15.8)
Curtailment gain, net of
restructuring costs 40.4 - 40.4 -
Other expenses, net
of gains on asset sales (1.2) (2.3) (2.4) (4.1)
Retirement benefit expense (34.0) (33.4) (70.0) (68.2)
------- ------- -------- -------
Income (loss) before income
tax benefit and cumulative
effect of change in
accounting principle $ 26.6 $ (40.8) $ (23.8) $ (80.8)
======= ======= ======== =======
15
Curtailment gain, net of restructuring costs, includes the $71.5 million
curtailment and settlement gain, the $25.4 million pension termination benefit
charge, and the $5.7 million restructuring charges.
Segment retirement benefit expense represents pension expense and other
postretirement benefit expenses, excluding the curtailment and settlement gain,
and pension termination benefits. Operating profit with respect to the Company's
business segments excludes any retirement benefit expense.
NOTE 12. 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 12 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. Subsidiary
results in 2004 include the effects of the J&L asset acquisition, including
indebtedness incurred in conjunction with the acquisition.
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.
16
NOTE 12. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
June 30, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ------------------------------ --------- ---------- ------------ ------------ ------------
Assets:
Cash and cash equivalents $ 0.2 $ 24.6 $ 39.2 $ - $ 64.0
Accounts receivable, net 0.2 152.5 185.1 - 337.8
Inventories, net - 216.3 234.8 - 451.1
Income tax refunds 0.3 - - - 0.3
Prepaid expenses and other
current assets 0.2 8.4 25.3 - 33.9
-------- -------- -------- ---------- ---------
Total current assets 0.9 401.8 484.4 - 887.1
Property, plant and
equipment, net - 347.8 385.6 - 733.4
Cost in excess of net
assets acquired - 112.1 89.2 - 201.3
Deferred pension asset 144.0 - - - 144.0
Deferred income taxes 34.3 - - - 34.3
Investments in subsidiaries
and other assets 1,113.8 416.0 603.9 (2,075.2) 58.5
-------- -------- -------- ---------- ---------
Total assets $1,293.0 $1,277.7 $1,563.1 $ (2,075.2) $ 2,058.6
======== ======== ======== ========== =========
Liabilities and
stockholders' equity:
Accounts payable $ 2.7 $ 128.0 $ 114.8 $ - $ 245.5
Accrued liabilities 538.8 91.9 335.8 (754.6) 211.9
Short-term debt and current
portion of long-term debt - 8.5 27.4 - 35.9
-------- -------- -------- ---------- ---------
Total current liabilities 541.5 228.4 478.0 (754.6) 493.3
Long-term debt 303.4 404.4 43.8 (200.0) 551.6
Accrued postretirement
benefits - 272.6 203.6 - 476.2
Pension liabilities 281.4 - - - 281.4
Other long-term liabilities 17.0 29.5 59.9 - 106.4
-------- -------- -------- ---------- ---------
Total liabilities 1,143.3 934.9 785.3 (954.6) 1,908.9
-------- -------- -------- ---------- ---------
Total stockholders' equity 149.7 342.8 777.8 (1,120.6) 149.7
-------- -------- -------- ---------- ---------
Total liabilities and
stockholders' equity $1,293.0 $1,277.7 $1,563.1 $ (2,075.2) $ 2,058.6
======== ======== ======== ========== =========
17
NOTE 12. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the six months ended June 30, 2004 (unaudited)
Non-
Guarantor guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- --------------------------- -------- ---------- ------------ ------------ ------------
Sales $ - $ 648.6 $ 575.7 $ - $1,224.3
Cost of sales 51.1 633.7 476.5 - 1,161.3
Selling and administrative
expenses 47.7 11.4 52.4 - 111.5
Curtailment gain, net of
restructuring costs - (40.4) - - (40.4)
Interest expense, net 11.0 4.2 0.8 - 16.0
Other income(expense)
including equity in income
of unconsolidated
subsidiaries 86.0 0.6 2.4 (88.7) 0.3
-------- -------- -------- -------- --------
Income (loss) before income
tax provision (benefit) (23.8) 40.3 48.4 (88.7) (23.8)
Income tax provision
(benefit) - - - - -
-------- -------- -------- -------- --------
Net income (loss) $ (23.8) $ 40.3 $ 48.4 $ (88.7) $ (23.8)
======== ======== ======== ======== ========
18
NOTE 12. CONTINUED
Condensed Statements of Cash Flows
For the six months ended June 30, 2004 (unaudited)
Non-
Guarantor guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- -------------------------- --------- ---------- ------------ ------------ ------------
Cash flows provided by
(used in) operating
activities $ 8.5 $ 114.9 $ (39.9) $ (61.9) $ 21.6
Cash flows provided by
(used in) investing
activities - (15.6) (17.4) 1.3 (31.7)
Cash flows provided by
(used in) financing
activities (8.6) (117.0) 59.5 60.6 (5.5)
-------- --------- ---------- ----------- ------------
Increase (decrease) in
cash and cash equivalents $ (0.1) $ (17.7) $ 2.2 $ - $ (15.6)
======== ========= ========== =========== ============
19
NOTE 12. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
December 31, 2003 (audited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Assets:
Cash and cash equivalents $ 0.3 $ 42.3 $ 37.0 $ - $ 79.6
Accounts receivable, net 0.1 89.4 159.3 - 248.8
Inventories, net - 147.3 212.4 - 359.7
Income tax refunds 7.2 - - - 7.2
Prepaid expenses, and other
current assets - 11.5 36.5 - 48.0
-------- -------- --------- ---------- ---------
Total current assets 7.6 290.5 445.2 - 743.3
Property, plant and
equipment, net - 326.3 384.8 - 711.1
Cost in excess of net
assets acquired - 112.1 86.3 - 198.4
Deferred pension asset 144.0 - - - 144.0
Deferred income taxes 34.3 - - - 34.3
Investment in subsidiaries
and other assets 994.4 546.0 326.9 (1,813.5) 53.8
-------- -------- --------- ---------- ---------
Total assets $1,180.3 $1,274.9 $ 1,243.2 $ (1,813.5) $ 1,884.9
======== ======== ========= ========== =========
Liabilities and
stockholders' equity:
Accounts payable $ 2.5 $ 92.4 $ 77.4 $ - $ 172.3
Accrued liabilities 465.6 70.2 181.2 (522.4) 194.6
Short-term debt and current portion
of long-term debt - 9.6 18.2 - 27.8
-------- -------- --------- ---------- ---------
Total current liabilities 468.1 172.2 276.8 (522.4) 394.7
Long-term debt 309.4 349.9 45.1 (200.1) 504.3
Accrued postretirement
benefits - 316.8 190.4 - 507.2
Pension liabilities 220.6 - - - 220.6
Other long-term liabilities 7.5 22.8 53.1 - 83.4
-------- -------- --------- ---------- ---------
Total liabilities 1,005.6 861.7 565.4 (722.5) 1,710.2
-------- -------- --------- ---------- ---------
Total stockholders' equity 174.7 413.2 677.8 (1,091.0) 174.7
-------- -------- --------- ---------- ---------
Total liabilities and
stockholders' equity $1,180.3 $1,274.9 $ 1,243.2 $ (1,813.5) $ 1,884.9
======== ======== ========= ========== =========
20
NOTE 12. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the six months ended June, 30 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- -------------------------------- --------- ---------- ------------- ------------ ------------
Sales $ - $ 476.7 $ 493.7 $ - $ 970.4
Cost of sales 47.6 479.7 407.7 - 935.0
Selling and administrative
expenses 33.5 12.0 55.6 - 101.1
Interest expense, net 10.2 5.2 0.4 - 15.8
Other income(expense)
including equity in income of
unconsolidated subsidiaries 11.0 (1.8) 7.0 (15.5) 0.7
------ --------- -------- ---------- --------
Income (loss) before income
tax provision (benefit)
and cumulative effect of
change in accounting
principle (80.3) (22.0) 37.0 (15.5) (80.8)
Income tax provision
(benefit) (28.5) (8.6) 13.6 (5.5) (29.0)
------ --------- -------- ---------- --------
Net income (loss) before
cumulative effect of
change in accounting
principle (51.8) (13.4) 23.4 (10.0) (51.8)
Cumulative effect of change
in accounting principle,
net of tax (1.3) - - - (1.3)
------ --------- -------- ---------- --------
Net income (loss) $(53.1) $ (13.4) $ 23.4 $ (10.0) $ (53.1)
====== ========= ======== ========== ========
21
NOTE 12. CONTINUED
Condensed Statements of Cash Flows
For the six months ended June 30, 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- -------------------------------- ------- ---------- ------------ ------------ ------------
Cash flows provided by (used in)
operating activities $ 1.9 $ 137.7 $ 48.2 $ (170.7) $ 17.1
Cash flows provided by (used in)
investing activities - (13.8) (13.7) 5.4 (22.1)
Cash flows provided by (used in)
financing activities (2.1) (126.9) (24.5) 165.3 11.8
------- ------- -------- -------- ---------
Increase (decrease) in cash and
cash equivalents $ (0.2) $ (3.0) $ 10.0 $ -- $ 6.8
======= ======= ======== ======== =========
22
NOTE 13. COMMITMENTS AND CONTINGENCIES
The Company is subject to various domestic and international environmental
laws and regulations that govern the discharge of pollutants into the air or
water and disposal of hazardous substances, which may require that it
investigate and remediate the effects of the release or disposal of materials at
sites associated with past and present operations, including sites at which the
Company has been identified as a potentially responsible party ("PRP") under the
Federal Superfund laws and comparable state laws. The Company could incur
substantial cleanup costs, fines, and civil or criminal sanctions, third party
property damage or personal injury claims as a result of violations or
liabilities under these laws or noncompliance with environmental permits
required at its facilities. The Company is currently involved in the
investigation and remediation of a number of the Company's current and former
sites as well as third party sites under these laws.
Environmental liabilities are recorded when the Company's liability is
probable and the costs are reasonably estimable. In many cases, however,
investigations are not at a stage where the Company has been able to determine
whether it is liable or, if liability is probable, to reasonably estimate the
loss or range of loss, or certain components thereof. Estimates of the Company's
liability remain subject to additional uncertainties regarding the nature and
extent of site contamination, the range of remediation alternatives available,
evolving remediation standards, imprecise engineering evaluations and estimates
of appropriate cleanup technology, methodology and cost, the extent of
corrective actions that may be required, and the number, participation, and
financial condition of other PRPs, as well as the extent of their responsibility
for the remediation. Accordingly, the Company periodically reviews accruals as
investigation and remediation of these sites proceed. As the Company receives
new information, the Company expects that it will adjust its accruals to reflect
the new information. Future adjustments could have a material adverse effect on
the Company's results of operations in a given period, but the Company cannot
reliably predict the amounts of such future adjustments.
Based on currently available information, the Company does not believe
that there is a reasonable possibility that a loss exceeding the amount already
accrued for any of the sites with which the Company is currently associated
(either individually or in the aggregate) will be an amount that would be
material to a decision to buy or sell the Company's securities.
Additional future developments, administrative actions or liabilities
relating to environmental matters however could have a material adverse effect
on the Company's financial condition or results of operations.
At June 30, 2004, the Company's reserves for environmental remediation
obligations totaled approximately $36.5 million, of which approximately $16.0
million were included in other current liabilities. The reserve includes
estimated probable future costs of $11.1 million for federal Superfund and
comparable state-managed sites; $9.0 million for formerly owned or operated
sites for which the Company has remediation or indemnification obligations; $6.3
million for owned or controlled sites at which Company operations have been
discontinued; and $10.1 million for sites utilized by the Company in its ongoing
operations. The Company continues to evaluate whether it may be able to recover
a portion of future costs for environmental liabilities from third parties other
than participating potentially responsible parties.
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 which it has been identified in up to thirty
years.
23
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 appealed the Court decision and on April 28, 2004, the Third Circuit
vacated and remanded the case to the District Court for further consideration.
At June 30, 2004, the Company had adequate reserves for this matter.
As described in the Company's Annual Report on Form 10-K for the year
ended December 31, 2003, TDY Industries, Inc. ("TDY") and the San Diego Unified
Port District ("Port District") have been involved in litigation in State Court
in San Diego, California concerning a lease of property located in San Diego,
California ("San Diego facility"). Following trial of this state court matter,
the jury rendered a verdict in favor of the Port and judgment was entered in the
amount of $22.7 million, which includes the jury award, attorneys' fees and
related costs and prejudgment interest. The Company appealed the verdict to the
California State Court of Appeals in July 2004. At June 30, 2004, the Company
had adequate reserves for this matter.
In June 2003, the Port District also commenced a separate action in the
United States District Court in San Diego against the Company ("Federal Court
Complaint") alleging Federal, state and common law claims related to alleged
environmental contamination on the property. The Federal Court Complaint seeks
an unspecified amount of damages and a declaratory judgment as to TDY's
liability for contamination on the property. In the second quarter 2004, the
Federal Court granted in part the Company's Motion to Dismiss portions of the
Federal Court Complaint relating to alleged violations of state law. The Port
filed an amended Complaint, which the Company has answered, essentially denying
all claims and asserting a counterclaim.
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, to the extent applicable, to
unit closure and post-closure. The Port District is addressing the DTSC's issues
in connection with its investigation of the site.
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 beyond that
contemplated by the Port District.
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
24
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. The U.S. Government and two other PRPs reached a proposed
settlement with EPA in 2003 ("the Settlement"), the terms of which could have
precluded TDY's complaint from proceeding against the U.S. Government. The
Company submitted comments on the Settlement on the grounds that it was not
supported by the facts, and was unfair and unreasonable, and was granted
intervention by the Court. In July 2004, TDY, the U.S. Government and EPA
entered an Interim Agreement. Under the Interim Agreement, the U.S. Government
will fund $20.9 million and TDY will fund $1 million of the remediation costs at
the Site, EPA will undertake the remediation, the Settlement will be withdrawn
and TDY and the U.S. Government will mediate the cost recovery and contribution
action. In addition, EPA agreed that TDY will not be required to perform
additional work at the Site and will not be subject to enforcement action, if
any, prior to February 18, 2005 unless the mediation ends earlier than that
date. TDY also expects to seek 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, including
those pertaining to product liability, patent infringement, commercial,
employment, employee benefits, environmental and stockholder matters. Certain of
such lawsuits, claims and proceedings are described in the Company's Annual
Report on Form 10-K for the year ended December 31, 2003. While the outcome of
litigation cannot be predicted with certainty, and some of these lawsuits,
claims or proceedings may be determined adversely to the Company, management
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.
NOTE 14. SUBSEQUENT EVENT - COMMON STOCK OFFERING
On July 28, 2004, the Company completed the sale of 13.8 million shares of
its common stock in a public offering, including 1.8 million shares to cover
overallotments, at $17.50 per share. Net proceeds were $230 million, after
underwriting costs and other expenses. At July 28, 2004, shares outstanding
after the offering were 95,282,975. The 13.8 million shares were re-issued from
treasury stock.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We believe 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.
We operate in the following three business segments, which accounted for
the following percentages of total external sales for the first six months of
2004 and 2003:
2004 2003
---- ----
Flat-Rolled Products 58% 53%
High Performance Metals 30% 34%
Engineered Products 12% 13%
On June 1, 2004, our Allegheny Ludlum operation, the largest business in
our Flat-Rolled Products segment, completed the acquisition of substantially all
of the assets of J&L Specialty Steel, LLC, ("J&L") a producer of flat-rolled
stainless steel products with operations in Midland, Pennsylvania and
Louisville, Ohio, for $67.2 million in total consideration and the assumption of
certain current liabilities. The purchase price is subject to final audit
adjustment and included $7.5 million cash paid at closing, the issuance of a
non-interest bearing $7.5 million promissory note to the seller payable on June
1, 2005, and the issuance to the seller of a promissory note in the principal
amount of $52.2 million secured by the J&L property, plant and equipment
acquired, payable in installments in 2007 through 2011, which bears interest at
a London Interbank Offered Rate plus a 1% margin, with a maximum interest rate
of 6%.
In connection with the J&L asset acquisition, we reached a new labor
agreement with the United Steelworkers of America ("USWA") covering both
Allegheny Ludlum and former J&L employees. The new agreement provides for a
workforce restructuring through which we expect to achieve productivity
improvements. Through a reduction in the number of job classifications and the
implementation of flexible work rules, employees are being given broader
responsibilities and the opportunity to become more involved in the business.
The number of production and maintenance employees at the pre-acquisition
Allegheny Ludlum facilities will be reduced by 650 employees through an early
retirement program over the next two and a half years pursuant to which the
employees are being offered transition incentives. We expect over 40% of these
retirements to be effective by the end of 2004, and over 70% of the program to
be completed by the end of 2005 and 100% of these retirements to be effective by
June 2006.
With the addition of the J&L assets, we estimate that our Allegheny Ludlum
operation will be capable of annual shipments in excess of 700,000 tons of
flat-rolled specialty metals with approximately 2,650 production and maintenance
employees. By comparison, Allegheny Ludlum shipped 478,000 tons of these metals
in 2003 with over 3,000 production and maintenance employees.
The acquisition of the J&L assets and the negotiation of the new labor
agreement with the USWA are expected to improve the performance of our Allegheny
Ludlum business. We expect the new labor agreement, combined with the
integration of the J&L operations, to generate annual cost structure
improvements relative to the combined performance of the former J&L Specialty
and Allegheny Ludlum operations of approximately $200 million when workforce
restructuring and synergies are fully implemented in the second half of 2006. We
anticipate these cost structure improvements to come from reduced labor costs,
operating synergies, improved product mix, and reduced fixed costs. In
26
the aggregate, we expect these initiatives to result in a competitive cost
structure for our stainless steel business.
On July 28, 2004, we completed the sale of 13.8 million shares of our
common stock in a public offering, including 1.8 million shares to cover
overallotments, and received $230 million in net proceeds. The 13.8 million
shares were reissued from treasury stock. We intend to use a portion of the net
proceeds from this offering to enhance our abilities to make growth-oriented
investments, including capital investments and acquisitions that we believe will
offer attractive returns. We also intend to use a portion of the net proceeds to
strengthen our balance sheet by reducing our outstanding liabilities, which may
include making voluntary contributions to our U.S. defined benefit trust or the
repayment or repurchase of our long-term debt securities. We may also use a
portion of the net proceeds for other general corporate purposes.
RESULTS OF OPERATIONS
Sales for the second quarter 2004 were $646.5 million, up 32% compared to
the second quarter 2003. Sales were up 47% in the Flat-Rolled Products segment,
15% in the High Performance Metals segment, and 16% in the Engineered Products
segment. During the quarter, we increased base-selling prices for most of our
products and implemented additional surcharges for certain raw materials for
many of our products. Approximately $18 million of sales relating to less than
one month of the former J&L operations are included in second quarter 2004
results.
Operating profit for the second quarter 2004 increased to $38.1 million
compared to $8.6 million for the same period of 2003 as a result of improved
performance across all of our business segments. This improvement was led by the
Flat-Rolled Products segment with an operating profit of $20.0 million, the
first operating profit for this segment since the 2002 third quarter. Results
for 2004 included a LIFO (last-in, first-out) inventory valuation reserve charge
of $26.1 million, due primarily to an increase in costs in the second quarter
2004 compared to the fourth quarter 2003 for most of the major raw materials
that we use, especially chromium, molybdenum, and scrap. For the same 2003
period, the LIFO inventory valuation reserve charge was $9.3 million.
Net income for the second quarter 2004 was $26.6 million, or $0.31 per
share, and included a net gain of $40.4 million comprised of a curtailment and
settlement gain related to retiree medical benefit changes of $71.5 million, net
of pension termination benefits of $25.4 million, and other costs associated
with Allegheny Ludlum's new labor agreement and the J&L asset acquisition of
$5.7 million. Retirement benefit expense, which is presented in our segment
results excluding the settlement and curtailment gain and the pension
termination benefits, was $34.0 million in the quarter and was primarily
non-cash. 2004 results do not include an income tax provision or benefit as a
result of cumulative losses recorded in the 2001 through 2003 period.
In the second quarter 2003, we reported a net loss of $26.0 million, or
$0.32 per share.
For the first six months of 2004, sales increased 26.2% to $1,224.3
million, and operating profit increased to $38.7 million compared to $17.4
million for the same 2003 period, as a result of improved performance across all
of the business segments. The results for the six months ended June 30, 2004
also included a LIFO inventory valuation reserve charge of $74.2 million,
primarily due to the effects of rapidly rising raw material costs. The first six
months of 2003 results included a LIFO inventory valuation reserve charge of
$12.3 million. Cost reductions, before the effects of inflation, totaled $63.2
million through the six months ended June 30, 2004. Our initial cost reduction
goal for 2004 was $104 million.
27
Business conditions in most of our end markets reflected increased demand
for many of our products during the first six months of 2004. These improved
market conditions were offset by higher raw material costs and by retirement
benefit expenses, which resulted in a net loss of $23.8 million, or $0.30 per
diluted share, for the first six months of 2004 compared to a net loss before
cumulative effect of a change in accounting principle of $51.8 million, or $0.64
per diluted share, for the first six months of 2003. As discussed above, 2004
results do not include an income tax provision or benefit. For the first six
months of 2003, results included an income tax benefit of $29.0 million, or
$0.36 per share. Retirement benefit expense was $70.0 million for the first six
months of 2004, compared to $68.2 million in the comparable year ago period.
This retirement benefit expense comparison excludes the 2004 curtailment and
settlement gain and the pension termination benefits.
On January 1, 2003, we adopted Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). The
adoption of SFAS 143 resulted in an after-tax charge of $1.3 million or $0.02
per diluted share. This charge is reported as a cumulative effect of a change in
accounting principle.
Sales and operating profit (loss) for our three business segments are
discussed below.
FLAT-ROLLED PRODUCTS SEGMENT
Second quarter 2004 sales increased 47% to $379.2 million, compared to the
second quarter 2003, primarily due to improved demand from capital goods
markets, the impact of higher raw material surcharges and base-selling price
increases, and the J&L asset acquisition. Demand continued to be strong from the
residential construction and remodeling markets, demand remained good from the
automotive and Asian infrastructure markets, and demand improved in the
transportation and construction machinery markets. The benefits of additional
surcharges, higher base-selling prices, and cost reduction initiatives more than
offset higher raw material and energy costs, resulting in operating income of
$20.0 million for the quarter, compared to an operating loss of $6.2 million in
the comparable 2003 period. Higher raw material costs resulted in a LIFO
inventory valuation reserve charge of $15.2 million in the second quarter 2004
compared to a LIFO inventory valuation reserve charge of $9.1 million in the
comparable 2003 period. Energy costs increased by $3.5 million compared to 2003,
net of approximately $1.0 million in gains from natural gas derivatives, as a
result of higher natural gas and electricity prices. Results for 2004 benefited
from $21 million in gross cost reductions, before the effects of inflation.
The J&L asset acquisition was completed June 1, 2004, and second quarter
2004 results include less than one month of sales, approximately $18 million,
related to this transaction. However, since the acquisition was accounted for as
a purchase, second quarter results essentially did not include any operating
profit on sales of the purchased J&L inventory. In addition, results for the
third quarter will not include any operating profit on sales of purchased
inventory until this inventory is depleted, which is expected to occur in the
second half of the 2004 third quarter.
28
Comparative information on the segment's products for the three months ended
June 30, 2004 and 2003 is provided in the following table:
Three Months Ended
June 30,
--------------------- %
2004 2003 Change
-------- -------- ------
Volume (finished tons):
Commodity 92,838 87,337 6
High Value 40,920 33,217 23
-------- --------
Total 133,758 120,554 11
Average prices (per finished ton):
Commodity $ 2,189 $ 1,550 41
High Value $ 4,291 $ 3,708 16
Combined Average $ 2,738 $ 2,144 28
For the six months ended June 30, 2004, Flat-Rolled Products sales
increased 37.4%, to $708.8 million, and operating profit was $9.0 million,
compared to an operating loss of $7.5 million for the prior year-to-date period.
Segment results for the 2004 year-to-date period included a LIFO inventory
reserve charge of $52.8 million due to increasing raw material costs, compared
to a prior year LIFO inventory reserve charge of $13.0 million, or approximately
a $40 million cost of sales increase in 2004. Energy costs, net of hedging
activities, were $6 million higher in the first six months of 2004 compared to
the comparable 2003 period. Raw material surcharges, base price increases, and
year-to-date 2004 cost reductions of $34 million more than offset the raw
material cost and energy cost increases.
Comparative information on the segment's products for the six months ended
June 30, 2004 and 2003 is provided in the following table:
Six Months Ended
June 30,
--------------------- %
2004 2003 Change
-------- -------- ------
Volume (finished tons):
Commodity 179,854 170,829 5
High Value 78,891 68,689 15
-------- --------
Total 258,745 239,518 8
Average prices (per finished ton):
Commodity $ 2,101 $ 1,557 35
High Value $ 4,190 $ 3,630 15
Combined Average $ 2,738 $ 2,151 27
HIGH PERFORMANCE METALS SEGMENT
Sales increased 15% to $192.5 million in the second quarter 2004, compared
to the second quarter 2003, due primarily to improved demand for spare parts
from the commercial aerospace market and continued strong demand from the
military aerospace market. Our exotic alloys business continued to benefit from
sustained high demand from government, high energy physics and medical markets,
and corrosion markets, particularly in Asia. Operating profit in the quarter
increased to $12.6 million, or 6.5% of sales, compared to $11.6 million, or 7.0%
of sales, in the year-ago period. Higher sales and cost reduction initiatives
offset the impact of higher raw material costs, and production inefficiencies
and start-up costs associated with the Richburg, South Carolina rolling mill
following the completion of an extensive upgrade. Higher raw material costs
resulted in a LIFO inventory valuation reserve charge of $6.1 million in the
second quarter 2004 compared to a LIFO inventory
29
valuation reserve charge of $0.2 million in the comparable 2003 period. Results
for 2004 benefited from $12 million of gross cost reductions, before the effects
of inflation.
Certain comparative information on the segment's major products for the
three months ended June 30, 2004 and 2003 is provided in the following table:
Three Months Ended
June 30,
---------------------- %
2004 2003 Change
------ ------ ------
Volume (000's pounds):
Nickel-based and specialty steel alloys 8,644 9,457 (9)
Titanium mill products 5,656 4,617 23
Exotic alloys 1,082 1,160 (7)
Average prices (per pound):
Nickel-based and specialty steel alloys $ 8.15 $ 6.47 26
Titanium mill products $11.20 $11.16 -
Exotic alloys $41.41 $38.10 9
For the six months ended June 2004, segment sales increased 13.3% to
$371.2 million. Operating profit was $20.4 million for the six months ended June
2004, or 5.5% of sales, compared to $19.9 million, or 6.1% of sales for the
comparable prior year to date period. The effect of the LIFO inventory valuation
reserve charge was $14.7 million in 2004, compared to $1.2 million in 2003.
Year-to-date 2004 cost reductions of $22 million were largely offset by higher
raw material costs, and production inefficiencies and start-up costs related to
the Richburg, South Carolina rolling mill upgrade.
Comparative information on the segment's products for the six months ended
June 30, 2004 and 2003 is provided in the following table:
Six Months Ended
June 30,
---------------------- %
2004 2003 Change
------- ------- ------
Volume (000's pounds):
Nickel-based and specialty steel alloys 17,588 18,149 (3)
Titanium mill products 10,679 9,232 16
Exotic alloys 2,267 2,092 8
Average prices (per pound):
Nickel-based and specialty steel alloys $ 7.94 $ 6.59 20
Titanium mill products $ 11.30 $ 12.00 (6)
Exotic alloys $ 38.75 $ 37.94 2
ENGINEERED PRODUCTS SEGMENT
Sales for the second quarter 2004 increased 16% to $74.8 million.
Operating profit in the quarter improved to $5.5 million, or 7.4% of sales,
compared to $3.2 million, or 5.0% of sales, in the second quarter 2003. Higher
sales volumes, improved pricing, and benefits from cost reductions more than
offset higher raw material costs. The rise in raw material costs resulted in a
LIFO inventory valuation reserve charge of $4.8 million in the second quarter
2004, compared to no effect in the comparable 2003 period. Results for 2004
benefited from $3 million in gross cost reductions, before the effects of
inflation. Demand for tungsten products in our Metalworking Products operation
remained strong from the oil and gas market and demand improved from the
automotive and transportation markets. Demand remained strong for forged
products from the Class 8 truck market and for cast products
30
from the improving manufacturing sector and transportation and wind energy
markets.
For the six months ended June 2004, sales increased 14.0% to $144.3
million, and operating profit was $9.3 million, or 6.4% of sales, compared to
$5.0 million, or 3.9% of sales in 2003. Cost of sales in 2004 included a $6.7
million LIFO inventory valuation reserve charge, compared to a LIFO valuation
reserve benefit of $1.9 million for the six months ended June 2003. Higher sales
volumes, improved pricing and 2004 gross cost reductions of approximately $5
million more than offset rising raw material and other cost increases.
CORPORATE ITEMS
Net interest expense decreased to $7.8 million for the second quarter 2004
from $8.4 million for the same period last year. For the six months ended June
2004, net interest expense was $16.0 million compared to $15.8 million in 2003.
Interest expense for the quarter and year to date periods ended June 2003
included costs of $1.2 million to recognize the unamortized costs associated
with the former unsecured credit facility that was replaced with the secured
facility in June 2003. Our "receive fixed, pay floating" interest rate swap
contracts for $150 million related to the $300 million, 8.375%, ten-year Notes,
which effectively convert this portion of the Notes to variable rate debt,
decreased year-to-date interest expense by $3.0 million in 2004, and $3.4
million in 2003, compared to the fixed interest expense of the Notes that would
otherwise be applicable.
Retirement benefit expense was $34.0 million in the second quarter 2004,
compared to $33.4 million in the second quarter 2003. Pension expense decreased
to $18.8 million for the 2004 second quarter from $23.3 million for same period
of last year as actual returns on pension assets in 2003 were higher than
expected. This was partially offset by the use in 2004 of a lower assumed
discount rate to value pension benefit liabilities. However, other
postretirement benefit expense increased for the 2004 second quarter to $15.2
million from $10.1 million in the comparable 2003 period as a result of a
projected rise in the medical cost inflation rate and a lower assumed discount
rate. Second quarter 2004 postretirement benefit expense includes one month of
favorable effects from the new Flat-Rolled Products segment labor agreement.
Approximately $27.2 million of the second quarter 2004 retirement benefit
expense was non-cash. In the second quarter 2004 and 2003, retirement benefit
expense increased cost of sales by $25.3 million and $23.5 million,
respectively, and increased selling and administrative expenses by $8.7 million
and $9.9 million, respectively.
For the year to date periods, 2004 retirement benefit expense was $70.0
million, compared to $68.2 million in 2003. Approximately 81% of the year to
date 2004 retirement benefit expense was non-cash. Retirement benefit expense
increased cost of sales for the six months ended June 2004 by $52.9 million, and
increased selling and administrative expenses by $17.1 million. For the six
months ended June 2003, retirement benefit expenses increased cost of sales by
$47.9 million and increased selling and administrative expenses by $20.3
million.
The 2004 retirement benefit expense discussed above does not include the
effects of the $71.5 million curtailment and settlement gain related to the
elimination of retiree medical benefits for certain non-collectively bargained
employees beginning in 2010, nor does this expense include the $25.4 million
charge related to the Transition Assistance Program ("TAP") incentives
associated with the new labor agreement at Allegheny Ludlum, which will be paid
from the ATI pension trust. Additionally, retirement benefit expense recognized
through June 2004 does not include the favorable impact on our postretirement
medical expense from the enactment of the Federal Medicare prescription drug
benefit program in December 2003.
31
We are not required to make cash contributions to the defined benefit
pension plan for 2004 and, based upon current actuarial studies, we do not
expect to be required to make cash contributions to the defined benefit pension
plan during the next several years.
Corporate expenses increased to $8.9 million for the second quarter of
2004 compared to $5.3 million for the second quarter of 2003. For the six months
ended June 2004, corporate expenses were $14.5 million compared to $10.1 million
for the comparable prior year period. These increases are due primarily to
non-cash expenses associated with our stock-based long-term incentive
compensation programs, which more than offset savings associated with reductions
in staffing and other efforts to control costs at the corporate office.
Excluding the effects of retirement benefit expense and an increase of $7.0
million in non-cash stock-based compensation expense compared to the prior year
period, selling and administrative expenses as a percentage of sales declined to
6.5% in the 2004 second quarter from 8.6% in the same period of 2003. Excluding
the effects of retirement benefit expense and an increase of $13.1 million in
non-cash stock-based compensation expense compared to the prior year period,
selling and administrative expenses as a percentage of sales declined to 6.9% in
the first half 2004 from 8.6% in the same period of 2003.
CURTAILMENT GAIN, NET OF RESTRUCTURING COSTS
Curtailment gain, net of restructuring costs of $40.4 million includes the
$71.5 million curtailment and settlement gain and the $25.4 million pension
termination benefit charge discussed in Corporate Items, above, and $5.7 million
of restructuring charges. The restructuring charges related to the new labor
agreement and the J&L asset acquisition, and included labor agreement costs of
$4.6 million, severance costs of $0.6 million related to approximately 30
salaried employees, and $0.5 million for asset impairment charges for redundant
equipment following the J&L asset acquisition.
INCOME TAXES
The 2004 second quarter and first six months 2004 results do not include
an income tax provision or benefit due to the uncertainty regarding full
utilization of our net deferred tax assets as a result of cumulative losses
recorded in the 2001 through 2003 period. A valuation allowance was recorded in
accordance with SFAS No. 109, "Accounting for Income Taxes", based upon the
results of our quarterly evaluation concerning the estimated probability that
the net deferred tax asset would be realizable. We are required to maintain a
valuation allowance until a realization event occurs to support reversal of all
or a portion of the allowance. Our effective tax rate was a benefit of 36.3% and
35.9% for the 2003 second quarter and first six months 2003, respectively. We
received federal income tax refunds of $6.9 million and $48.3 million in the
2004 and 2003 first quarters, respectively. Under current tax laws we are
substantially unable to carry-back any current year or future year tax losses to
prior periods to obtain cash refunds of taxes paid during those periods. Current
year Federal tax losses, if any, can be carried forward for up to 20 years and
applied against any taxes owed in those future years.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2003, as required, we adopted Statement of Financial
Accounting Statement No. 143, "Accounting for Asset Retirement Obligations"
("SFAS 143"). Under SFAS 143, obligations associated with 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
32
retirement obligations related to landfills in our Flat-Rolled Products segment.
This charge is reported in the statement of operations for the quarter ended
March 31, 2003 as a cumulative effect of a change in accounting principle.
FINANCIAL CONDITION AND LIQUIDITY
CASH FLOW AND WORKING CAPITAL
During the first six months ended June 30, 2004, cash generated from
operations was $21.6 million as improved operating results for 2004 and the
receipt of a $6.9 million Federal income tax refund pertaining to our 2003 tax
return offset a $110.9 million increase in managed working capital. The increase
in managed working capital was primarily due to a $89 million increase in
accounts receivable resulting from a higher level of sales in the second quarter
of 2004 compared to the fourth quarter of 2003, and a $91.4 million increase in
inventory as a result of higher raw material costs, partially offset by a $73.2
million increase in accounts payable. Investing activities included the initial
cash consideration for the J&L asset acquisition of $7.5 million and capital
expenditures of $25.2 million. At June 30, 2004, cash and cash equivalents
totaled $64.0 million, a decrease of $15.6 million from December 31, 2003.
On July 28, 2004, we completed the sale of 13.8 million shares of our
common stock in a public offering, including 1.8 million shares to cover
overallotments, and received $230 million in net proceeds. The 13.8 million
shares were reissued from treasury stock. We intend to use a portion of the net
proceeds from this offering to enhance our abilities to make growth-oriented
investments, including capital investments and acquisitions that we believe will
offer attractive returns. We also intend to use a portion of the net proceeds to
strengthen our balance sheet by reducing our outstanding liabilities, which may
include making voluntary contributions to our U.S. defined benefit trust or the
repayment or repurchase of our long-term debt securities. We may also use a
portion of the net proceeds for other general corporate purposes.
As part of managing the liquidity of our business, we focus on controlling
managed working capital, which is defined as gross accounts receivable and gross
inventories, less accounts payable. In measuring performance in controlling this
managed working capital, we exclude the effects of LIFO inventory valuation
reserves, excess and obsolete inventory reserves, and reserves for uncollectible
accounts receivable which, due to their nature, are managed separately. Managed
working capital at June 2004 excludes the effect of the J&L asset acquisition,
which added $73.8 million of managed working capital. At June 30, 2004,
excluding the J&L asset acquisition, managed working capital was 26.9% of
annualized sales compared to 30.7% of annualized sales at December 31, 2003.
During the first six months of 2004, managed working capital increased by $110.9
million, to $686.4 million. The increase in managed working capital from
December 31, 2003 was due to increased accounts receivable, which reflects the
higher level of sales in the second quarter 2004 compared to the fourth quarter
2003, and increased inventory, mostly as a result of higher raw material costs,
which was partially offset by increased accounts payable. The majority of the
increase in raw material costs should be recovered through surcharges. While
inventory and accounts receivable balances increased during the 2004 first half,
gross inventory turns, which excludes the effect of LIFO inventory valuation
reserves, improved to 3.8 turns at June 30, 2004 from 3.6 turns at December 31,
2003, and days sales outstanding, which measures actual collection timing for
accounts receivable, continued to improve.
33
The components of managed working capital were as follows:
June 30, December 31,
(in millions) 2004 2003 Change
-------- ------------ ------
Accounts receivable $ 337.8 $ 248.8
Inventories 451.1 359.7
Accounts payable (245.5) (172.3)
-------- --------
Subtotal 543.4 436.2
Acquisition of managed working capital
(73.8) -
Allowance for doubtful accounts 10.7 10.2
LIFO reserves 185.9 111.7
Corporate and other 20.2 17.4
-------- --------
Managed working capital $ 686.4 $ 575.5 $110.9
======== ======== ======
Annualized prior 2 months sales $2,548.7 $1,874.0
======== ========
Managed working capital as a % of
annualized sales 26.9% 30.7%
CAPITAL EXPENDITURES
Capital expenditures for 2004 are expected to be between $60 and $70
million, of which $25.2 million had been expended in the first six months of
2004. Capital expenditures primarily relate to the upgrade of our flat-rolled
products melt shop located in Brackenridge, Pennsylvania and investments to
enhance the high performance metals capabilities of our high performance metals
long products rolling mill facility located in Richburg, South Carolina.
DIVIDENDS
A regular quarterly dividend of $0.06 per share of common stock was
declared on June 10, 2004, payable to stockholders of record at the close of
business on June 21, 2004. While we have historically paid cash dividends on our
common stock, we cannot make assurances that in the future we will not reduce
the amount of dividends paid, or stop paying dividends, on our common stock. For
example, in the fourth quarter of 2002, our Board of Directors substantially
reduced the amount of our quarterly dividend from the levels we had been paying
in previous quarters. The declaration and payment of dividends, if any, and the
amount of any such dividends depends upon matters deemed relevant by our Board
of Directors on a quarterly basis, such as our results of operations, financial
condition, cash requirements, future prospects, any limitations imposed by law,
credit agreements or senior securities, and other factors deemed relevant and
appropriate.
DEBT
At June 30, 2004, we had $587.5 million in total outstanding debt,
compared to $532.1 million at December 31, 2003, an increase of $55.4 million.
The increase in debt was primarily due to $59.7 million in seller financing for
the J&L asset acquisition, net borrowings of $8.7 million at our STAL joint
venture, partially offset by debt repayments of $12.3 million primarily for
industrial revenue bonds, and fair value adjustments of $6.2 million related to
interest rate swap contracts.
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 Notes, 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
34
contracts were designated as fair value hedges. As a result, changes in the fair
value of the swap contracts and the underlying fixed rate debt are recognized in
the statement of operations. In the first six months of 2003, we terminated the
majority of these interest rate swap contracts and received $15.3 million in
cash. The gain on settlement remains a component of the reported balance of the
Notes ($303.4 million at June 30, 2004, including fair value adjustments), and
is being ratably recognized as a reduction to interest expense over the
remaining life of the Notes, which is approximately seven and a half years.
In 2003, we entered into new "receive fixed, pay floating" interest rate
swap arrangements related to the Notes which re-established, in total, the $150
million notional amount which effectively converted this portion of the Notes to
variable rate debt. At June 30, 2004, the adjustment of these swap contracts to
fair market value resulted in the recognition of a liability of $4.0 million on
the balance sheet, included in other long-term liabilities, with an offsetting
decrease in long-term debt.
We did not borrow funds under our domestic credit facilities during the
first six months of 2004, or during all of 2003. We have a $325 million
four-year senior secured domestic revolving credit facility ("the facility"),
which expires in June 2007, and which is secured by all accounts receivable and
inventory of our U.S. operations, and includes capacity for up to $175 million
in letters of credit. On April 15, 2004, the lenders under the secured facility
consented to amend the facility to allow for the acquisition of the J&L assets
by one of our subsidiaries, increase letters of credit capacity by $25 million,
to $175 million, allow prepayment of indebtedness in certain circumstances, and
revise certain other provisions including the threshold for when the financial
covenant is measured, as described below. Outstanding letters of credit issued
under the facility at June 30, 2004 were approximately $123 million.
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 as described in 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 retiree 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. Our ability to borrow under the
secured credit facility in the future could be adversely affected if we fail to
maintain the applicable covenants under the agreement governing the facility. At
June 30, 2004, our undrawn availability under the facility, which is calculated
including outstanding letters of credit and domestic cash on hand, was $226
million, and the amount that we could borrow at that date prior to requiring the
application of a financial covenant test was $126 million.
We believe that internally generated funds, current cash on hand, the
proceeds of the July 2004 common stock offering, and capacity provided from our
secured credit facility will be adequate to meet our foreseeable liquidity
needs.
35
CRITICAL ACCOUNTING POLICIES
INVENTORY
Inventories are stated at the lower of cost (last-in, first-out (LIFO),
first-in, first-out (FIFO) and average cost methods) or market, less progress
payments. Costs include direct material, direct labor and applicable
manufacturing and engineering overhead, and other direct costs. Most of our
inventory is valued utilizing the LIFO costing methodology. Inventory of our
non-U.S. operations is valued using average cost or FIFO methods. Under the LIFO
inventory valuation method, changes in the cost of raw materials and production
activities are recognized in cost of sales in the current period even though
these material and other costs may have been incurred at significantly different
values due to the length of time of our production cycle. The prices for many of
the raw materials we use have recently been extremely volatile, especially
during the first half of 2004 when raw material prices rose rapidly. Since we
value most of our inventory utilizing the LIFO inventory costing methodology, a
rapid rise in raw material costs has a negative effect on our operating results.
For example in the 2004 first half, the increase in raw material costs on our
LIFO inventory valuation method resulted in cost of sales which was $74.2
million higher than would have been recognized if we utilized the FIFO
methodology to value our inventory. In a period of rising prices, cost of sales
expense recognized under LIFO is generally higher than the cash costs incurred
to acquire the inventory sold. Conversely, in a period of declining raw material
prices, cost of sales recognized under LIFO is generally lower than cash costs
incurred to acquire the inventory sold.
In the 2004 second quarter, we changed our method of calculating LIFO
inventories at our Allegheny Ludlum subsidiary by reducing the overall number of
Company-wide inventory pools from 15 to eight, and by changing its calculation
method for LIFO from the double-extension method to the link-chain method. We
made the change in order to better match costs with revenues, to reflect the
business structure of Allegheny Ludlum following the J&L asset acquisition, to
provide for a LIFO adjustment more representative of Allegheny Ludlum's actual
inflation on its inventories and to conform LIFO accounting methods with our
other operations that use the LIFO inventory method. The cumulative effect of
the change in methods and the pro forma effects of the change on prior years'
results of operations were not determinable. The effect of the change on the
results of operations for interim 2004 periods was not material.
Selling prices for the majority of our stainless products include
surcharges for raw materials. These surcharges have been effective in helping to
offset the impact of increased raw material costs we have experienced in the
2004 first half on a cash basis. The majority of raw material surcharges, which
prevail throughout the stainless steel industry, are structured to recover cash
costs for the raw materials incurred to produce the products shipped. For
example, the surcharge for nickel, which is a significant raw material used in
the production of stainless steel, is included in current month's selling price
based upon the average cost for nickel as priced on the London Metals Exchange
(plus a margin for handling and delivery) for the period two months prior to
shipment. This two-month lag convention is used to align the cost of the raw
material melted to the transaction price to the customer. While the surcharge
formula is effective in recovering the cash costs for raw materials, it by
design approximates the production cycle.
We evaluate product lines on a quarterly basis to identify inventory
values that exceed estimated net realizable value. The calculation of a
resulting reserve, if any, is recognized as an expense in the period that the
need for the reserve is identified. It is our general policy to write-down to
scrap value any inventory that is identified as obsolete and any inventory that
has aged or has not moved in more than twelve months. In some instances this
criterion is up to twenty-four months.
36
INCOME TAXES
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. Valuation allowances are established when it is estimated that it is
probable (more likely than not) that the tax benefit of the deferred tax asset
will not be realized. The evaluation, as prescribed by Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," includes 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.
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.
The recognition of a valuation allowance is recorded as a non-cash charge
to the income tax provision with an offsetting reserve against the deferred
income tax asset. Should we generate pretax losses in future 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. The recognition of a valuation allowance does not affect
our ability to utilize the deferred tax asset in the future. The valuation
allowance could be reduced or increased in future years if the estimated
realizability of the deferred income tax asset changes, based upon consideration
of all available evidence, including changes in the carryback period available
under tax law.
At June 30, 2004, we had a net deferred income tax asset, net of deferred
income tax liabilities, of $34.3 million. This net deferred income tax asset is
presented net of a valuation allowance for certain tax benefits that are not
currently expected to be realized. A significant portion of our 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. We have not had
a federal net operating loss or tax credit carryforward expire unutilized.
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 U.S. defined benefit pension plan in the past several years. We are not
required to make a contribution to the U.S. defined benefit pension plan for
2004, and, based upon current actuarial analyses and forecasts, we do not expect
to be required to make cash contributions to the U.S. defined benefit pension
plan for at least the next several years.
We account for our defined benefit pension plans in accordance with
Statement of Financial Accounting Standards No. 87, "Employers' Accounting for
Pensions" ("SFAS 87"), which requires that amounts recognized in financial
statements be determined on an actuarial basis, rather than as contributions
37
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 2004 and 2003, our expected return on pension plan
investments is 8.75%. The cumulative difference between this expected return and
the actual return on plan assets is deferred and amortized into pension income
or expense over future periods. The expected return on plan assets can vary
significantly from year-to-year since the calculation is dependent on the market
value of plan assets as of the end of the preceding year. Accounting principles
generally accepted in the United States allow companies to calculate the
expected return on pension assets using either an average of fair market values
of pension assets over a period not to exceed five years, which reduces the
volatility in reported pension income or expense, or their fair market value at
the end of the previous year. However, the Securities and Exchange Commission
currently does not permit companies to change from the fair market value at the
end of the previous year methodology, which is the methodology that we use, to
an averaging of fair market values of plan assets methodology. As a result, our
results of operations and those of other companies, including companies with
which we compete, may not be comparable due to these different methodologies in
calculating the expected return on pension investments.
At the end of November each year, we determine the discount rate to be
used to value pension plan liabilities. In accordance with SFAS 87, the discount
rate reflects the current rate at which the pension liabilities could be
effectively settled. In estimating this rate, we receive input from our
actuaries regarding the rates of return on high quality, fixed-income
investments with maturities matched to the expected future retirement benefit
payments. Based on this assessment at the end of November 2003, we established a
discount rate of 6.5% for valuing the pension liabilities as of the end of 2003,
and for determining the pension expense for 2004. We had previously assumed a
discount rate of 6.75% for 2002, which determined the 2003 expense. The effect
of lowering the discount rate will increase annual pension expense by
approximately $4 million in 2004. 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, 2003, our measurement
date for pension accounting, the value of the ABO exceeded the value of pension
investments by approximately $195 million. In accordance with accounting
standards, the charge against stockholders' equity is adjusted in the fourth
quarter to reflect the value of pension assets compared to the ABO as of the end
of November. If the level of pension assets exceeds the ABO as of a future
measurement date, the full charge against stockholders' equity would be
reversed.
In the 2004 second quarter in conjunction with the new labor agreement at
ATI's Allegheny Ludlum operation, a $25.4 million charge for pension termination
benefits was recognized for the TAPs. The TAP incentive will be paid from the
Company's defined benefit pension fund over the next two and a half years to 650
employees.
We also sponsor several 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, our contributions
towards premiums are capped based upon the cost as of a certain date, thereby
creating a defined contribution. For the non-collectively bargained plans, we
maintain the right to amend or terminate the plans in the future. We account
38
for these benefits in accordance with SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions" ("SFAS 106"), which requires that
amounts recognized in financial statements be determined on an actuarial basis,
rather than as benefits are paid. We use actuarial assumptions, including the
discount rate and the expected trend in health care costs, to estimate the costs
and benefits obligations for the plans. The discount rate, which is determined
annually at the end of November of each year, is developed based upon rates of
return on high quality, fixed-income investments. At the end of 2003, we
determined this rate to be 6.5%, a reduction from a 6.75% discount rate in 2002.
The effect of lowering the discount rate to 6.5% from 6.75% increased 2003
postretirement benefit liabilities by approximately $22 million, and 2004
expenses are expected to increase by approximately $3 million. Based upon
significant 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 10.4% for 2004 and was assumed to gradually decrease to 5.0% in
the year 2014 and remain level thereafter.
In the 2004 second quarter, the Company modified retiree medical benefits
for certain non-collectively bargained employees to cap the Company's cost of
benefits, beginning in 2005, and then eliminate the benefits in 2010. A $71.5
million curtailment and settlement gain was recognized in the June 2004 quarter,
comprised of a $72.0 million one-time reduction of postretirement benefit
expense, net of a $0.5 million charge to pension expense related to the retiree
medical benefit changes.
The Other Postretirement Benefits obligation, and postretirement benefit
expense recognized through June 30, 2004, does not include the expected
favorable impact of the Medicare Prescription Drug, Improvement and
Modernization Act, which was enacted on December 8, 2003. The Act provides for a
Federal subsidy, with tax-free payments commencing in 2006, to sponsors of
retiree health care benefits plans that provide a benefit that is at least
actuarially equivalent to the benefit established by the law. Based upon
estimates from our actuaries, we expect that the federal subsidy included in the
law will result in a reduction in the Other Postretirement Benefits obligation
of $46 million.
As a result of actions taken during the second quarter 2004 to control
retiree medical costs and the favorable impact from the enactment of the Federal
Medicare prescription drug benefit program, we expect our Other Postretirement
Benefits obligation to be reduced by approximately $331 million, or 36%. At the
beginning of 2004, retirement benefit expense (pension plus postretirement
benefits) was estimated at $143 million for the year, including $68 million for
postretirement benefit expenses. As a result of the reduction in Other
Postretirement Benefits obligation, the revised postretirement benefit expense
for 2004 is expected to be $46 million. Based upon current actuarial
assumptions, we expect the postretirement expense for 2005 to be further reduced
to approximately $23 million.
In accordance with labor agreements covering employees at the Company's
Allegheny Ludlum operations and the facilities related to the J&L asset
acquisition, certain of these postretirement benefits are funded using plan
investments held in Voluntary Employee Benefit Association ("VEBA") trusts. The
Company may continue to fund benefits utilizing the plan assets held in the VEBA
trusts if the value of plan assets exceeds $25 million. 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 the VEBA's 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
39
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 resulted in an increase in annual
postretirement benefits expense of approximately $7 million for 2003. Our
expected return on investments in the VEBA trust remains 9% for 2004.
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. Changes in the expected use of a long-lived asset group, and the
financial performance of the long-lived asset group and its operating segment,
are evaluated as indicators of possible impairment. Future cash flow value may
include appraisals for property, plant and equipment, land and improvements,
future cash flow estimates from operating the long-lived assets, and other
operating considerations.
Goodwill is required to be reviewed annually, or more frequently if
impairment indicators arise. The impairment test for goodwill is a two-step
process. The first step is a comparison of the fair value of the reporting unit
with its carrying amount, including goodwill. If this comparison reflects
impairment, then the loss would be measured as the excess of recorded goodwill
over its implied fair value. Implied fair value is the excess of the fair value
of the reporting unit over the fair value of all recognized and unrecognized
assets and liabilities.
Our evaluation of goodwill for possible impairment 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 operating results, cash flows
including changes in working capital and capital expenditures, selling prices,
profitability, and the cost of capital. Although we believe that the estimates
and assumptions used were reasonable, actual results could differ from those
estimates and assumptions.
OTHER SIGNIFICANT ACCOUNTING POLICIES
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, 2003.
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
A summary of factors that could cause actual results to differ from forward
looking statements is discussed in the section entitled "Quantitative and
Qualitative Disclosures about Market Risk and Other Factors" in our Report on
40
Form 10-K for the year ended December 31, 2003, and should be read in
conjunction with our Report on Form 10-Q for the quarter ended June 30, 2004.
Product Pricing
Intense competition and excess manufacturing capacity in the commodity
stainless steel industry have resulted in reduced prices over the last few
years, excluding raw material surcharges, for many of our stainless steel
products. As a result of these factors, our revenues, operating results and
financial condition have been and may continue to be adversely affected.
Although inflationary trends in recent years have been moderate, during
the same period certain critical raw material costs, such as nickel and scrap
containing iron and nickel, have been volatile. While we are able to mitigate
some of the adverse impact of rising raw material costs through surcharges to
customers, rapid increases in raw material costs may adversely affect our
results of operations.
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
any price increases may be delayed due to long manufacturing lead times and the
terms of existing contracts.
Volatility of Prices of Critical Raw Materials; Availability of Critical Raw
Materials and Services
We rely to a substantial extent on outside vendors to supply certain raw
materials that are critical to the manufacture of products. We also depend on
third parties to provide conversion services that may be critical to the
manufacture of our products. Purchase prices and availability of these critical
raw materials are subject to volatility. At any given time, we may be unable to
obtain an adequate supply of these critical raw materials or services on a
timely basis, on price and other terms acceptable, or at all.
If suppliers increase the price of critical raw materials, we may not have
alternative sources of supply. In addition, to the extent that we have quoted
prices to customers and accepted customer orders for products prior to
purchasing necessary raw materials, we may be unable to raise the price of
products to cover all or part of the increased cost of the raw materials.
The manufacture of some of our products is a complex process and requires
long lead times. As a result, we have in the past and may in the future
experience delays or shortages in the supply of raw materials. If unable to
obtain adequate and timely deliveries of required raw materials or conversion
services, we may be unable to timely manufacture sufficient quantities of
products. This could cause us to lose sales, incur additional costs, delay new
product introductions and suffer harm to our reputation.
We acquire certain important raw materials that we use to produce
specialty materials, including nickel, chrome, cobalt, titanium sponge and
ammonia paratungstate, from foreign sources. Some of these sources operate in
countries that may be subject to unstable political and economic conditions.
These conditions may disrupt supplies or affect the prices of these materials.
Volatility of Energy Prices; Availability of Energy Resources
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
41
control. Disruptions in the supply of energy resources could temporarily impair
the ability to manufacture products for customers. Further, increases in energy
costs, or changes in costs relative to energy costs paid by competitors, have
and may continue to adversely affect our profitability. To the extent that these
uncertainties cause suppliers and customers to be more cost sensitive, increased
energy prices may have an adverse effect on our results of operations and
financial condition.
Labor Matters
We have approximately 9,000 full time employees. A portion of our
workforce is represented under various collective bargaining agreements,
principally with the USWA, including: approximately 3,300 Allegheny Ludlum and
former J&L Specialty Steel production, office and maintenance employees covered
by collective bargaining agreements with 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 100
employees at the Casting Service facility in LaPorte, Indiana.
Generally, agreements that expire may be terminated after notice by the
union. After termination, the union may authorize a strike. A strike by the
employees covered by one or more of the collective bargaining agreements could
materially adversely affect our operating results. There can be no assurance
that we will succeed in concluding collective bargaining agreements with the
unions to replace those that expire.
Environmental
When it is probable that a liability has been incurred or an asset has
been impaired, we recognize a loss if the amount of the loss can be reasonably
estimated.
We are 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 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 Federal
Superfund laws, and comparable state laws. We could incur substantial cleanup
costs, fines and civil or criminal sanctions, third party property damage or
personal injury claims as a result of violations or liabilities under these laws
or non-compliance with environmental permits required at our facilities. We are
currently involved in the investigation and remediation of a number of our
current and former sites as well as third party 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 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.
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
42
account their share of anticipated site-related costs. In addition, the Federal
government, through various agencies, is a party to several such arrangements.
Environmental liabilities are recorded when our liability is probable and
the costs are reasonably estimable. In many cases, investigations are not at a
stage where we are able to determine whether we are liable or, if liability is
probable, to reasonably estimate the loss, or certain components thereof.
Accordingly, as investigation and remediation of these sites proceed and as we
receive new information, we expect that we will adjust our accruals to reflect
the new information. Future adjustments could have a material adverse effect on
our results of operations in a given period, but we cannot reliably predict the
amounts of such future adjustments. At June 30, 2004, our reserves for
environmental matters totaled approximately $36.5 million.
Environmental liabilities are recorded when our liability is probable and
the costs are reasonably estimable, but generally not later than the completion
of the feasibility study or our recommendation of a remedy or 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 value. 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. Our measurement of environmental liabilities is based on
currently available facts, present laws and regulations, and current technology.
Such estimates take into consideration our prior experience in site
investigation and remediation, the data concerning cleanup costs available from
other companies and regulatory authorities, and the professional judgment of our
environmental experts in consultation with outside environmental specialists,
when necessary. Estimates of our liability are further subject to additional
uncertainties regarding the nature and extent of site contamination, the range
of remediation alternatives available, evolving remediation standards, imprecise
engineering evaluations and estimates of appropriate cleanup technology,
methodology and cost, the extent of corrective actions that may be required, and
the participation, number and financial condition of other PRPs, as well as the
extent of their responsibility for the remediation.
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 matters with which we are currently associated (either individually
or in the aggregate) will be an amount that would be material to a decision to
buy or sell our securities. Future developments, administrative actions or
liabilities relating to environmental matters, however, could have a material
adverse effect on our financial condition and results of operations.
J&L Specialty Steel Asset Acquisition and New Labor Agreement
We may not achieve all of the anticipated cost savings and other benefits
from the J&L Specialty Steel asset acquisition and our new labor agreement.
While we have achieved some of these savings and benefits already, there can be
no assurance that we will achieve any or all of the anticipated balance, or that
the savings we are able to achieve can be sustained over the long term.
In the event we are unable to successfully implement any of our planned
cost savings or business initiatives, or are unable to sustain any that we do
successfully implement, we may not realize all of the benefits we currently
anticipate from the J&L Specialty Steel asset acquisition and the new labor
contract, and our results of operations may suffer as a result.
43
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, 2003. We
assume no duty to update our forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use derivative financial instruments from time to time to hedge
ordinary business risks for product sales denominated in foreign currencies, to
partially hedge against volatile energy and raw material cost fluctuations in
the Flat-Rolled Products and High Performance Metals segments and to manage
exposure to changes in interest rates.
Foreign currency exchange contracts are used to limit transactional
exposure to changes in currency exchange rates. We sometimes purchase foreign
currency forward contracts that permit us to sell specified amounts of foreign
currencies expected to be received from our export sales for pre-established
U.S. dollar amounts at specified dates. The forward contracts are denominated in
the same foreign currencies in which export sales are denominated. These
contracts are designated as hedges of the variability in cash flows of a portion
of our forecasted export sales transactions in which settlement will occur in
future periods and which otherwise would expose us, on the basis of aggregate
net cash flows in respective currencies, to foreign currency risk. Changes in
the fair value of our foreign currency derivatives are recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value is immediately
recognized in the statement of operations.
As part of our risk management strategy, we purchase exchange-traded
futures contracts from time to time to manage exposure to changes in nickel
prices, a component of raw material cost for some of our flat-rolled and high
performance metals products. The nickel futures contracts obligate us to make or
receive a payment equal to the net change in value of the contract at its
maturity. These contracts are designated as hedges of the variability in cash
flows of a portion of 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.
While we enter into raw materials futures contracts from time to time to
hedge exposure to price fluctuations, such as for nickel, we cannot be certain
that our hedge position adequately reduces exposure. We believe that we have
adequate controls to monitor these contracts, but we may not be able to
accurately assess exposure to price volatility in the markets for critical raw
materials.
In addition, although we occasionally use raw materials surcharges to
offset the impact of increased costs, competitive factors in the marketplace can
limit our ability to institute such surcharges, and there can be a delay
44
between the increase in the price of raw materials and the realization of the
benefit of surcharges. For example, since we generally use in excess of 35,000
tons of nickel each year, a hypothetical change of $1.00 per pound in nickel
prices would result in increased costs of approximately $70 million. In
addition, in 2003 we also used in excess of 270,000 tons of ferrous scrap in the
production of our Flat-Rolled products. During 2003 and entering into 2004,
ferrous scrap prices have increased significantly. A hypothetical change of
$10.00 per ton would result in increased costs of approximately $2.7 million.
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. 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.
At June 30, 2004, we had aggregate consolidated indebtedness of
approximately $587 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 June 30, 2004, we had entered into "receive fixed,
pay floating" arrangements for $150 million related to our 8.375% ten-year
Notes, which effectively convert this portion of the Notes to variable rate
debt. These contracts are designated as fair value hedges. As a result, changes
in the fair value of the swap contracts and the underlying fixed rate debt are
recognized in the statement of operations. Including accretion of the gain on
termination of the swap contracts, the result of the "receive fixed, pay
floating" arrangements was a decrease in interest expense of $3.0 million for
the six months ended June 2004 compared to the fixed interest expense of the
Notes. At June 30, 2004, the adjustment of these swap contracts to fair market
value resulted in the recognition of a liability of $4.0 million on the balance
sheet, included in other assets, with an offsetting decrease 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. Difficulties and uncertainties in the business environment
may affect our customer's creditworthiness and ability to pay their obligations.
45
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 June 30, 2004, 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 during the fiscal quarter
ended June 30, 2004.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March 2003, the United States Environmental Protection Agency (EPA)
advised a subsidiary of the Company that it was contemplating filing an
action to recover civil penalties for alleged violations of the Resource
Conservation and Recovery Act (RCRA) at our Allvac facility in Albany,
Oregon. The EPA alleged that the company managed hazardous wastes at the
plant without the proper permit. The company denied the allegations but
entered into a settlement agreement with the EPA in June 2004. Under the
terms of the settlement agreement, and without admitting any violations,
the company agreed to pay a civil penalty of $250,000 and to implement two
supplemental environmental projects valued at $498,000 in the aggregate.
The supplemental environmental projects include the elimination of the
acid cracking process for washing titanium chips and dedication as
wetlands of 12 acres of land valued at $300,000. The City of Albany will
be granted a conservation easement over the property.
In a letter dated May 20, 2004, the EPA informed a subsidiary of the
Company that it alleges that the company is not in compliance with the
Unilateral Administrative Order (UAO) issued to the company for the South
El Monte Operable Unit of the San Gabriel Valley (California) Superfund
Site; a multi-part area-wide groundwater cleanup. The EPA indicated that
it may take action to enforce the UAO and collect penalties, as well as
reimbursement of the EPA's costs associated with the site. The company is
in negotiations with the EPA to resolve its obligations under the UAO on
both technical and legal grounds.
A number of other lawsuits, claims and proceedings have been or may be
asserted against the Company relating to the conduct of its business,
including those pertaining to product liability, patent infringement,
commercial, employment, employee benefits, environmental and stockholder
matters. Certain of such lawsuits, claims and proceedings are described in
our Annual Report on Form 10-K for the year ended December 31, 2003. While
the outcome of litigation cannot be predicted with certainty, and some of
these lawsuits, claims or proceedings may be determined adversely to the
Company, management 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.
46
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our 2004 annual meeting of stockholders was held on May 6, 2004. Proxies
for the meeting were solicited by us pursuant to Regulation 14A under the
Securities Exchange Act of 1934. At that meeting, the three nominees for
election as directors named in the proxy statement for the meeting were
elected, having received the following number of votes:
Number of Votes
Name Number of Votes For Withheld
H. Kent Bowen 71,195,981 1,812,608
L. Patrick Hassey 71,880,381 1,128,208
John D. Turner 71,877,704 1,130,885
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
18 Preferability letter from Independent Registered Public
Accounting Firm regarding change in the method of accounting for
LIFO inventories (filed herewith).
31.1 Certification of Chief Executive Officer required by Securities
and Exchange Commission Rule 13a - 14(a) or 15d - 14(a) (filed
herewith).
31.2 Certification of Chief Financial Officer required by Securities
and Exchange Commission Rule 13a - 14(a) or 15d - 14(a) (filed
herewith).
32.1 Certification pursuant to 18 U.S.C. Section 1350 (filed
herewith).
(b) Current Reports on Form 8-K filed by the Company
Filing Date Nature of the Report
----------- --------------------
April 2, 2004 Press Release, dated April 1, 2004, commenting on the first
quarter 2004 and updating the status of the previously
announced J&L Specialty Steel Asset Purchase Agreement.
April 21, 2004 Press Release, dated April 21, 2004, announcing the first
quarter 2004 financial results.
May 3, 2004 Press Releases dated May 2, 2004, announcing the rescheduling
of the targeted closing date for the J&L Specialty Steel asset
acquisition.
May 10, 2004 Press Release, dated May 7, 2004, announcing a tentative
agreement on a labor contract covering USWA-represented
employees of ATI Allegheny Ludlum and J&L Specialty Steel.
47
May 28, 2004 Press Release, dated May 28, 2004, announcing that the USWA
ratified the new labor agreement covering USWA-represented
employees of ATI Allegheny Ludlum and J&L Specialty Steel.
June 2, 2004 Press Release, dated June 1, 2004, announcing the completion
of the J&L Specialty Steel asset acquisition and filing as an
exhibit an amendment to our senior secured domestic revolving
credit agreement.
June 15, 2004 Reporting information regarding the completion of the J&L
Specialty Steel asset acquisition.
June 28, 2004 Press Release, dated June 28, 2004, commenting on the second
quarter 2004 and transformation of the Company's stainless
steel business.
July 8, 2004 Press Release, dated July 8, 2004, announcing the resignation of
a director and certain appointments to Board committees.
July 12, 2004 Amending Form 8-K, filed on June 15, 2004, to report
historical financial statements of J&L Specialty Steel and pro
forma financial information relating to the J&L Specialty
Steel, LLC asset acquisition.
July 20, 2004 Filing as exhibits the Company's 2004 Annual Incentive Plan,
Administrative Rules for the Total Shareholder Return
Incentive Compensation Program and Form of Total Shareholder
Return Incentive Compensation Plan Agreement for 2004, Form of
Restricted Stock Agreement and Key Employee Performance Plan,
and furnishing Press Release, dated July 20, 2004, announcing
second quarter 2004 financial results.
July 23, 2004 Press Release, dated July 22, 2004, announcing our agreement
to sell 12,000,000 shares of common stock, plus up to
1,800,000 shares subject to an overallotment option, and
filing as exhibits the Underwriting Agreement relating to the
offering, a specimen stock certificate and the legal opinion
regarding the validity of the common stock to be sold in the
offering.
July 27, 2004 Press Release, dated July 27, 2004, announcing the underwriters'
exercise of an overallotment option on our common stock offering.
48
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: July 30, 2004 By /s/ Richard J. Harshman
-------------------------------------
Richard J. Harshman
Executive Vice President-Finance and
Chief Financial Officer
(Principal Financial Officer and
Duly Authorized Officer)
Date: July 30, 2004 By /s/ Dale G. Reid
--------------------------------------
Dale G. Reid
Vice President, Controller and
Chief Accounting Officer and Treasurer
(Principal Accounting Officer)
49
EXHIBIT INDEX
18 Preferability letter from Independent Registered Public Accounting Firm regarding change in the method of accounting for
LIFO inventories (filed herewith).
31.1 Certification of Chief Executive Officer required by Securities and Exchange Commission Rule 13a - 14(a) or 15d - 14(a)
(filed herewith).
31.2 Certification of Chief Financial Officer required by Securities and Exchange Commission Rule 13a - 14(a) or 15d - 14(a)
(filed herewith).
32.1 Certification pursuant to 18 U.S.C. Section 1350 (filed herewith).
50