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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 October 22, 2004, the registrant had outstanding 95,502,412 shares of its
Common Stock.
ALLEGHENY TECHNOLOGIES INCORPORATED
SEC FORM 10-Q
QUARTER ENDED SEPTEMBER 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 45
Item 4. Controls and Procedures 47
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 47
Item 6. Exhibits 48
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)
September 30, December 31,
2004 2003
-------- --------
(Unaudited) (Audited)
ASSETS
Cash and cash equivalents $ 262.6 $ 79.6
Accounts receivable, net 365.2 248.8
Inventories, net 460.8 359.7
Income tax refunds -- 7.2
Prepaid expenses and other current assets 31.0 48.0
-------- --------
Total Current Assets 1,119.6 743.3
Property, plant and equipment, net 727.2 711.1
Cost in excess of net assets acquired 204.6 198.4
Deferred pension asset 144.0 144.0
Deferred income taxes 34.3 34.3
Other assets 59.2 53.8
-------- --------
TOTAL ASSETS $2,288.9 $1,884.9
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 259.1 $ 172.3
Accrued liabilities 218.7 194.6
Short-term debt and current portion
of long-term debt 33.9 27.8
-------- --------
Total Current Liabilities 511.7 394.7
Long-term debt 557.3 504.3
Accrued postretirement benefits 473.8 507.2
Pension liabilities 248.2 220.6
Other long-term liabilities 107.6 83.4
-------- --------
TOTAL LIABILITIES 1,898.6 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 September 30,
2004 and December 31, 2003; outstanding-95,490,205
shares at September 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 320.6 483.8
Treasury stock: 3,461,285 shares at
September 30, 2004 and 18,296,629 shares
at December 31, 2003 (86.7) (458.4)
Accumulated other comprehensive
loss, net of tax (334.7) (341.8)
-------- --------
Total Stockholders' Equity 390.3 174.7
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,288.9 $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 Nine Months Ended
September 30, September 30,
----------------------- -------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Sales $ 730.6 $ 482.6 $ 1,954.9 $ 1,453.0
Costs and expenses:
Cost of sales 653.7 464.4 1,815.0 1,399.4
Selling and administrative
expenses 56.8 60.3 168.3 161.4
Curtailment (gain), net of
restructuring costs -- 1.2 (40.4) 1.2
--------- --------- --------- ---------
Income (loss) before interest,
other expense, and income taxes 20.1 (43.3) 12.0 (109.0)
Interest expense, net (9.3) (4.1) (25.3) (19.9)
Other expense (2.2) (0.9) (1.9) (0.2)
--------- --------- --------- ---------
Income (loss) before income tax
benefit and cumulative effect of
change in accounting principle 8.6 (48.3) (15.2) (129.1)
Income tax benefit -- (19.5) -- (48.5)
--------- --------- --------- ---------
Net income (loss) before cumulative
effect of change in accounting
principle 8.6 (28.8) (15.2) (80.6)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (1.3)
--------- --------- --------- ---------
Net income (loss) $ 8.6 $ (28.8) $ (15.2) $ (81.9)
========= ========= ========= =========
Basic net income (loss) per
common share before cumulative
effect of change in accounting
principle $ 0.10 $ (0.36) $ (0.18) $ (0.99)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
--------- --------- --------- ---------
Basic net income (loss) per common
share $ 0.10 $ (0.36) $ (0.18) $ (1.01)
========= ========= ========= =========
Diluted net income (loss) per
common share before cumulative
effect of change in accounting
principle $ 0.09 $ (0.36) $ (0.18) $ (0.99)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
--------- --------- --------- ---------
Diluted net income (loss) per
common share $ 0.09 $ (0.36) $ (0.18) $ (1.01)
========= ========= ========= =========
Dividends declared per common share $ 0.06 $ 0.06 $ 0.18 $ 0.18
========= ========= ========= =========
The accompanying notes are an integral part of these statements.
4
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Nine Months Ended
September 30,
-------------------
2004 2003
------ ------
OPERATING ACTIVITIES:
Net loss $(15.2) $(81.9)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Cumulative effect of change in accounting principle - 1.3
Depreciation and amortization 56.4 55.7
Non-cash curtailment gain and restructuring
charges, net (45.6) -
Deferred income taxes - (40.7)
Capital (gains) losses on sale of PP&E 0.2 (0.8)
Change in operating assets and liabilities:
Accounts receivable (84.3) (36.2)
Accounts payable 70.5 4.2
Pension assets and liabilities (a) 1.9 66.0
Inventories (43.2) 15.2
Other postretirement benefits 20.0 8.7
Income tax refunds receivable 7.2 34.8
Accrued liabilities and other 40.6 25.8
------ ------
CASH PROVIDED BY OPERATING ACTIVITIES 8.5 52.1
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (39.5) (51.5)
Purchases of businesses and investment in ventures (7.5) (0.8)
Asset disposals and other 0.5 5.3
------ ------
CASH USED IN INVESTING ACTIVITIES (46.5) (47.0)
FINANCING ACTIVITIES:
Payments on long-term debt and capital leases (17.3) (5.5)
Borrowings on long-term debt 11.7 20.2
Net borrowings (repayments) under credit facilities - (1.4)
------ ------
Net increase (decrease) in debt (5.6) 13.3
Issuance of common stock 229.7 -
Dividends paid (9.7) (14.6)
Exercises of stock options 5.1 -
Proceeds from interest rate swap settlement 1.5 15.3
------ ------
CASH PROVIDED BY FINANCING ACTIVITIES 221.0 14.0
------ ------
INCREASE IN CASH AND CASH EQUIVALENTS 183.0 19.1
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 79.6 59.4
------ ------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $262.6 $ 78.5
====== ======
(a) 2004 includes $(50.0) pension contribution.
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 Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Net income (loss) as reported $ 8.6 $(28.8) $(15.2) $(81.9)
Add: Stock-based compensation
expense included in net income (loss), net of tax 1.8 4.2 12.0 5.2
Deduct: Net impact of SFAS 123, net of tax (2.6) (5.0) (14.8) (7.6)
------ ------ ------ ------
Pro forma net income (loss) $ 7.8 $(29.6) $(18.0) $(84.3)
====== ====== ====== ======
Net income (loss) per common share:
Basic - as reported $ 0.10 $(0.36) $(0.18) $(1.01)
Basic - pro forma $ 0.09 $(0.37) $(0.22) $(1.04)
Diluted - as reported $ 0.09 $(0.36) $(0.18) $(1.01)
Diluted - pro forma $ 0.08 $(0.37) $(0.22) $(1.04)
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 benefit to the Company
will be recognized over multiple years as a reduction to postretirement benefit
expense. The Company adopted FSP 106-2 in the beginning of the 2004 third
quarter, resulting in approximately $1 million lower postretirement benefit
expense in the 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 for $67.2 million in total consideration, including the
assumption of certain current liabilities. The purchase price included 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, and 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. 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 is being 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.
7
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.
Allocated Purchase
Price
------------------
(in millions)
(unaudited)
Acquired assets:
Accounts receivable $ 32.1
Inventory 57.9
Property, plant and equipment 27.9
Other assets 2.1
------
Total assets 120.0
Assumed liabilities:
Accounts payable 16.3
Accrued current liabilities 9.8
Short term debt 2.4
Long-term debt 2.1
Accrued postretirement benefits 18.6
Other long-term liabilities 3.6
------
Total liabilities 52.8
------
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. 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 on retirement benefits expense 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
(In millions, except per share data) Months Nine Months Ended
(unaudited) Ended September 30,
September 30, -------------------------
2003 2004 2003
------------ --------- ---------
Sales $ 585.0 $ 2,158.0 $ 1,777.6
Net loss before cumulative effect of
change in accounting principle (36.3) (8.9) (95.5)
Net loss (36.3) (8.9) (96.8)
Basic and diluted net loss per common share before
cumulative effect of change in accounting
principle $ (0.45) $ (0.11) $ (1.19)
Basic and diluted net loss per common share (0.45) (0.11) (1.21)
NOTE 3. INVENTORIES
Inventories at September 30, 2004 and December 31, 2003 were as follows
(in millions):
September 30, December 31,
2004 2003
------------ -----------
(unaudited) (audited)
Raw materials and supplies $ 55.3 $ 37.5
Work-in-process 516.3 356.2
Finished goods 92.5 84.9
------ ------
Total inventories at current cost 664.1 478.6
Less allowances to reduce current cost
values to LIFO basis (194.4) (111.7)
Progress payments (8.9) (7.2)
------ ------
Total inventories, net $460.8 $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 $8.5 million higher for
the 2004 third quarter and $82.7 million higher for the first nine months of
2004 than would have been recognized if FIFO, rather than LIFO, methodology were
utilized to value inventory. Cost of sales expense was $10.5 million higher for
the 2003 third quarter and $22.8 million higher for the first nine months of
2003 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 September 30, 2004 and December 31, 2003
were as follows (in millions):
September 30, December 31,
2004 2003
------------ -----------
(unaudited) (audited)
Land $ 25.1 $ 26.3
Buildings 230.3 228.2
Equipment and leasehold improvements 1,559.2 1,494.0
-------- --------
1,814.6 1,748.5
Accumulated depreciation and amortization (1,087.4) (1,037.4)
-------- --------
Total property, plant and equipment, net $ 727.2 $ 711.1
======== ========
NOTE 5. DEBT
Debt at September 30, 2004 and December 31, 2003 was as follows (in
millions):
September 30, December 31,
2004 2003
------------ -----------
(unaudited) (audited)
Allegheny Technologies $300 million 8.375% Notes due 2011, net (a) $308.6 $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 12.1 20.1
Capitalized leases and other 16.5 17.6
------ ------
591.2 532.1
Short-term debt and current portion of long-term debt (33.9) (27.8)
------ ------
Total long-term debt $557.3 $504.3
====== ======
(a) Includes fair value adjustments for interest rate swap contracts of
$14.1 million for deferred gains on settled interest rate swap
contracts at September 30, 2004, and $15.2 million (including $1.4
million for interest rate swap contracts then outstanding and $13.8
million for deferred gains on settled interest rate swap contracts)
at December 31, 2003.
Interest rate swap contracts are used from time-to-time to manage the
Company's exposure to interest rate risks. At the end of the 2002 first quarter,
the Company entered into interest rate swap contracts with respect to a $150
million notional amount related to its $300 million, 8.375% ten-year Notes, due
December 15, 2011, which involved the receipt of fixed rate amounts in exchange
for floating rate interest payments over the life of the contracts without an
exchange of the underlying principal amount. These contracts were designated as
fair value hedges. As a result, changes in the fair value of the swap contracts
and the underlying fixed rate debt are recognized in the statement of
operations. During the first nine months of 2003, the Company
10
terminated the majority of these interest rate swap contracts and received $15.3
million in cash. Also in 2003, the Company entered into new "receive fixed, pay
floating" interest rate swap arrangements related to the 8.375% ten-year Notes
which re-established, in total, the $150 million notional amount. In the third
quarter 2004, the Company terminated all of the outstanding interest rate swap
contracts and realized net cash proceeds of $1.5 million. These gains on
settlement remain a component of the reported balance of the Notes ($308.6
million at September 30, 2004 including fair value adjustments), and are being
ratably recognized as a reduction to interest expense over the remaining life of
the Notes, which is approximately seven years.
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 nine months of
2004, or during all of 2003, although a portion of the facility is used to
support $114 million in 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 include 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. STOCKHOLDERS' EQUITY AND PER SHARE INFORMATION
On July 28, 2004, the Company completed a public offering of 13.8 million
shares of common stock at $17.50 per share, and received $229.7 million in net
proceeds after underwriting costs and expenses. The 13.8 million shares were
re-issued from treasury stock. Per share amounts for 2004 reflect the effect of
the public offering on a weighted average basis for the periods presented.
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 Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Numerator:
Net income (loss) per common share before
cumulative effect of change in accounting principle $ 8.6 $(28.8) $(15.2) $(80.6)
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) $ 8.6 $(28.8) $(15.2) $(81.9)
====== ====== ====== ======
Denominator:
Denominator for basic earnings per share -
weighted average shares 89.9 81.1 83.7 80.9
Effect of dilutive securities:
Option equivalents 1.8 -- -- --
Contingently issuable shares 2.4 -- -- --
------ ------ ------ ------
Denominator for diluted net income (loss) per
common share - adjusted weighted average
shares and assumed conversions 94.1 81.1 83.7 80.9
====== ====== ====== ======
Basic net income (loss) per common share before
cumulative effect of change in accounting principle $ 0.10 $(0.36) $(0.18) $(0.99)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
------ ------ ------ ------
Basic net income (loss) per common share $ 0.10 $(0.36) $(0.18) $(1.01)
====== ====== ====== ======
Diluted net income (loss) per common share
before cumulative effect of change in
accounting principle $ 0.09 $(0.36) $(0.18) $(0.99)
Cumulative effect of change in accounting
principle, net of tax -- -- -- (0.02)
------ ------ ------ ------
Diluted net income (loss) per common share $ 0.09 $(0.36) $(0.18) $(1.01)
====== ====== ====== ======
For the nine months ended September 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 Nine Months Ended
September 30, September 30,
------------------ ------------------
2004 2003 2004 2003
----- ------ ------ ------
(unaudited) (unaudited)
Net income (loss) $ 8.6 $(28.8) $(15.2) $(81.9)
----- ------ ------ ------
Foreign currency translation
gain (loss) 8.9 (3.3) 14.0 4.3
Unrealized losses on energy,
raw materials and currency
hedges, net of tax (3.4) (2.7) (6.9) (4.8)
----- ------ ------ ------
5.5 (6.0) 7.1 (0.5)
----- ------ ------ ------
Comprehensive income (loss) $14.1 $(34.8) $ (8.1) $(82.4)
===== ====== ====== ======
NOTE 8. INCOME TAXES
The three months and nine months ended September 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 $19.5 million and $48.5 million in the 2003 third
quarter and first nine months 2003, respectively. The effective tax rate was a
benefit of 40.4% and 37.6% for the 2003 third quarter and first nine 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. In the 2004 third quarter, the Company voluntarily contributed $50 million
to the U.S. pension plan to improve the plan's funded position.
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
the Company'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 U.S. defined benefit 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.
13
Also 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. 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.
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act was enacted into law. 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 Accumulated Other Postretirement Benefits Obligation ("APBO") of $46
million. This reduction in the APBO will be recognized over multiple years as a
reduction to postretirement benefit expense.
The changes to retiree medical benefits in the 2004 second quarter and the
effects of the Act are expected to reduce the Company's APBO by approximately
$331 million.
For the three months and nine months ended September 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 Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Pension Benefits:
Service cost - benefits earned during the year $ 6.5 $ 7.1 $ 21.0 $ 21.4
Interest cost on benefits earned in prior years 31.4 32.1 94.4 95.2
Expected return on plan assets (36.9) (35.2) (110.6) (104.8)
Amortization of prior service cost 6.3 6.7 18.9 20.1
Amortization of net actuarial loss 10.6 12.7 32.0 38.2
------ ------ ------ ------
17.9 23.4 55.7 70.1
Termination benefits -- -- 25.4 --
Plan design change -- -- 0.5 --
------ ------ ------ ------
Total pension expense $ 17.9 $ 23.4 $ 81.6 $ 70.1
====== ====== ====== ======
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Other Postretirement Benefits:
Service cost - benefits earned during the year $ 0.7 $ 1.4 $ 4.4 $ 4.8
Interest cost on benefits earned in prior years 9.2 11.0 36.3 33.8
Expected return on plan assets (2.2) (2.3) (6.6) (7.0)
Amortization of prior service cost (6.5) (1.2) (11.0) (3.6)
Amortization of net actuarial loss 5.7 1.2 16.0 3.6
------ ------ ------ ------
6.9 10.1 39.1 31.6
Curtailment and settlement gain -- -- (72.0) --
------ ------ ------ ------
Total postretirement benefit (income) expense $ 6.9 $ 10.1 $(32.9) $ 31.6
====== ====== ====== ======
Total retirement benefit expense $ 24.8 $ 33.5 $ 48.7 $101.7
====== ====== ====== ======
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
million of the restructuring charges represent future cash payments that are
expected to be paid within one year.
The Company recognized restructuring costs of $1.2 million during the
third quarter of 2003, related to workforce reductions. These cost reduction
actions affected approximately 80 employees, primarily salaried and
predominantly in the Flat-Rolled and Engineered Products segments.
Reserves for restructuring charges recorded in 2003 and prior years
involving future payments were approximately $6 million at September 30, 2004
and $9 million at December 31, 2003. The reduction in reserves resulted from
cash payments to meet severance and lease payment obligations.
15
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 Nine Months Ended
September 30, September 30,
--------------------- -----------------------
2004 2003 2004 2003
-------- -------- -------- --------
(unaudited) (unaudited)
Total sales:
Flat-Rolled Products $ 469.1 $ 265.0 $1,182.3 $ 788.9
High Performance Metals 204.7 174.9 606.1 525.6
Engineered Products 76.5 63.2 229.5 193.5
-------- -------- -------- --------
750.3 503.1 2,017.9 1,508.0
Intersegment sales:
Flat-Rolled Products 3.6 6.1 8.0 14.0
High Performance Metals 12.2 12.6 42.4 35.5
Engineered Products 3.9 1.8 12.6 5.5
-------- -------- -------- --------
19.7 20.5 63.0 55.0
Sales to external customers:
Flat-Rolled Products 465.5 258.9 1,174.3 774.9
High Performance Metals 192.5 162.3 563.7 490.1
Engineered Products 72.6 61.4 216.9 188.0
-------- -------- -------- --------
$ 730.6 $ 482.6 $1,954.9 $1,453.0
======== ======== ======== ========
Operating profit (loss):
Flat-Rolled Products $ 26.7 $ (4.9) $ 35.7 $ (12.4)
High Performance Metals 21.4 9.5 41.8 29.4
Engineered Products 5.2 1.2 14.5 6.2
-------- -------- -------- --------
Total operating profit 53.3 5.8 92.0 23.2
Corporate expenses (7.4) (4.1) (21.9) (14.2)
Interest expense, net (9.3) (4.1) (25.3) (19.9)
Curtailment gain, net of
restructuring costs - - 40.4 -
Management transition and
restructuring costs - (8.6) - (8.6)
Other expenses, net
of gains on asset sales (3.2) (3.8) (5.6) (7.9)
Retirement benefit expense (24.8) (33.5) (94.8) (101.7)
-------- -------- -------- --------
Income (loss) before income tax benefit
and cumulative effect of change in
accounting principle $ 8.6 $ (48.3) $ (15.2) $ (129.1)
======== ======== ======== ========
The curtailment gain for the first nine months of 2004, 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.
During the 2003 third quarter, the Company recognized management
transition and restructuring costs of $8.6 million. In connection with the
termination of the Stock Acquisition and Retention Program ("SARP"), in
September 2003 the Company terminated the remaining loans outstanding under the
SARP, received approximately $0.5 million in cash and recorded $5.6 million of
expenses, which is included in selling and administrative expenses on the
statement of operations. CEO transition costs of $1.8 million included
accelerated vesting of long-term
16
compensation, and accrued obligations pursuant to an employment contract which
is included in selling and administrative expenses in the statement of
operations. The Company also recognized restructuring costs of $1.2 million
related to workforce reductions, primarily salaried and predominantly in the
Flat-Rolled and Engineered Products segments.
Interest expense for the 2003 periods is presented net of $4.0 million of
interest income related to a Federal income tax refund associated with prior
years.
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 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.
17
NOTE 12. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
September 30, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- ----------------------------------- --------- ---------- ------------- ------------ ------------
Assets:
Cash and cash equivalents $ 0.1 $ 147.0 $ 115.5 $ - $ 262.6
Accounts receivable, net 0.2 178.2 186.8 - 365.2
Inventories, net - 222.1 238.7 - 460.8
Prepaid expenses and other
current assets 0.1 8.2 22.7 - 31.0
-------- -------- -------- --------- --------
Total current assets 0.4 555.5 563.7 - 1,119.6
Property, plant and
equipment, net - 342.0 385.2 - 727.2
Cost in excess of net
assets acquired - 112.1 92.5 - 204.6
Deferred pension asset 144.0 - - - 144.0
Deferred income taxes 34.3 - - - 34.3
Investments in subsidiaries and
other assets 1,388.6 410.5 642.0 (2,381.9) 59.2
-------- -------- -------- --------- --------
Total assets $1,567.3 $1,420.1 $1,683.4 $(2,381.9) $2,288.9
======== ======== ======== ========= ========
Liabilities and
stockholders' equity:
Accounts payable $ 2.4 $ 153.3 $ 103.4 $ - $ 259.1
Accrued liabilities 598.9 85.6 318.5 (784.3) 218.7
Short-term debt and current portion
of long-term debt - 7.5 26.4 - 33.9
-------- -------- -------- -------- --------
Total current liabilities 601.3 246.4 448.3 (784.3) 511.7
Long-term debt 308.6 404.3 44.4 (200.0) 557.3
Accrued postretirement
benefits - 267.2 206.6 - 473.8
Pension liabilities 248.2 - - - 248.2
Other long-term liabilities 18.9 30.9 57.8 - 107.6
-------- -------- -------- -------- --------
Total liabilities 1,177.0 948.8 757.1 (984.3) 1,898.6
-------- -------- -------- -------- --------
Total stockholders' equity 390.3 471.3 926.3 (1,397.6) 390.3
-------- -------- -------- -------- --------
Total liabilities and
stockholders' equity $1,567.3 $1,420.1 $1,683.4 $(2,381.9) $2,288.9
======== ======== ======== ========= ========
18
NOTE 12. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the nine months ended September 30, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- --------------------------------- --------- ---------- ------------- ------------ ------------
Sales $ - $1,077.5 $ 877.4 $ - $1,954.9
Cost of sales 72.2 1,033.1 709.7 - 1,815.0
Selling and administrative
Expenses 70.2 17.5 80.6 - 168.3
Curtailment (gain), net of
restructuring costs - (40.4) - - (40.4)
Interest expense, net (18.0) (7.0) (0.3) - (25.3)
Other income (expense)
including equity in income of
unconsolidated subsidiaries 145.2 1.4 0.9 (149.4) (1.9)
-------- -------- -------- -------- --------
Income (loss) before income
tax provision (benefit) (15.2) 61.7 87.7 (149.4) (15.2)
Income tax provision (benefit) - - - - -
-------- -------- -------- -------- --------
Net income (loss) $ (15.2) $ 61.7 $ 87.7 $ (149.4) $ (15.2)
======== ======== ======== ======== ========
19
NOTE 12. CONTINUED
Condensed Statements of Cash Flows
For the nine months ended September 30, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- --------------------------------- --------- ---------- ------------- ------------ ------------
Cash flows provided by
(used in) operating activities $ (8.2) $ 27.5 $ (3.9) $ (6.9) $ 8.5
Cash flows provided by
(used in) investing activities (221.1) (22.3) (124.6) 321.5 (46.5)
Cash flows provided by
(used in) financing activities 229.1 99.5 207.0 (314.6) 221.0
------ ------ ------ ------ ------
Increase (decrease) in
cash and cash equivalents $ (0.2) $104.7 $ 78.5 $ - $183.0
====== ====== ====== ====== ======
20
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
======== ======== ======== ========= ========
21
NOTE 12. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the nine months ended September, 30 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminationss Consolidated
- ------------------------------------ --------- ---------- ------------- ------------- ------------
Sales $ - $ 715.4 $ 737.6 $ - $1,453.0
Cost of sales 69.7 718.6 611.1 - 1,399.4
Selling and administrative
expenses 60.4 17.0 84.0 - 161.4
Restructuring costs - 0.5 0.7 - 1.2
Interest income (expense), net (15.3) (7.9) 3.3 - (19.9)
Other income (expense)
including equity in income of
unconsolidated subsidiaries 18.9 (2.9) 9.1 (25.3) (0.2)
-------- -------- -------- -------- --------
Income (loss) before income
tax provision (benefit) and
cumulative effect of change
in accounting principle (126.5) (31.5) 54.2 (25.3) (129.1)
Income tax provision (benefit) (45.9) (10.5) 17.0 (9.1) (48.5)
-------- -------- -------- -------- --------
Net income (loss) before cumulative
effect of change in accounting
principle (80.6) (21.0) 37.2 (16.2) (80.6)
Cumulative effect of change in
accounting principle, net of tax (1.3) - - - (1.3)
-------- -------- -------- -------- --------
Net income (loss) $ (81.9) $ (21.0) $ 37.2 $ (16.2) $ (81.9)
======== ======== ======== ======== ========
22
NOTE 12. CONTINUED
Condensed Statements of Cash Flows
For the nine months ended September 30, 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
- --------------------------------- --------- ---------- ------------- ------------ ------------
Cash flows provided by (used in)
operating activities $ 24.5 $117.4 $ 33.2 $(123.0) $ 52.1
Cash flows provided by (used in)
investing activities - (19.9) (28.6) 1.5 (47.0)
Cash flows provided by (used in)
financing activities (24.6) (92.4) 9.5 121.5 14.0
------ ------ ------ ------- ------
Increase (decrease) in cash and
cash equivalents $ (0.1) $ 5.1 $ 14.1 $ -- $ 19.1
====== ====== ====== ======= ======
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
23
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 September 30, 2004, the Company's reserves for environmental
remediation obligations totaled approximately $34.3 million, of which
approximately $13.2 million were included in other current liabilities. The
reserve includes estimated probable future costs of $10.0 million for federal
Superfund and comparable state-managed sites; $9.2 million for formerly owned or
operated sites for which the Company has remediation or indemnification
obligations; $6.0 million for owned or controlled sites at which Company
operations have been discontinued; and $9.1 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.
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 September 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 September 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 and seeking injunctive relief.
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
24
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. In October 2004, the Regional Board issued
the Company an order directing that it clean up the San Diego facility and
adjacent lagoon, which the Company has appealed.
TDY and another wholly-owned subsidiary of the Company, among others, have
been identified by the U.S. Environmental Protection Agency ("EPA") as PRPs at
the Li Tungsten Superfund Site in Glen Cove, New York. The Company believes that
most of the contamination at the Site resulted from work done while the U.S.
Government either owned or controlled operations at the Site, or from processes
done for various agencies of the United States, and that the United States is
liable for a substantial portion of the remediation costs at the Site. In
November 2000, TDY filed a cost recovery and contribution action against the
U.S. Government. 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. In October, 2004, EPA released a proposed plan to address additional areas
related to the site, and is seeking public comment on the proposed plan. 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 currently and
formerly owned businesses, including those pertaining to product liability,
patent infringement, commercial, employment, employee benefits, environmental
and health and safety, 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.
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 nine months of
2004 and 2003:
2004 2003
---- ----
Flat-Rolled Products 60% 53%
High Performance Metals 29% 34%
Engineered Products 11% 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, including the
assumption of certain current liabilities. The purchase price included $7.5
million cash paid at closing, the issuance to the seller of a non-interest
bearing $7.5 million promissory note payable on June 1, 2005, and the issuance
to the seller of a promissory note in the principal amount of $52.2 million,
which is subject to final adjustment, and 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
USWA-represented employees at our Allegheny Ludlum subsidiary and at the former
J&L facilities. 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 is being 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, over
70% of these retirements to be effective 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 former J&L operations, to generate annual cost structure
improvements relative to the combined performance of the former J&L and
pre-acquisition 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
26
fixed costs. In the aggregate, we expect these initiatives to result in a
competitive cost structure for our flat-rolled 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 $229.7 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. In September
2004, we executed a portion of this strategy by making a voluntary contribution
of $50 million to our U.S. defined benefit plan to improve the funded position
of our U.S. defined benefit pension plan. Based on current actuarial studies, we
do not expect to be required to make cash contributions to this defined benefit
pension plan during the next several years. However, we may elect, depending
upon the investment performance of the pension plan assets and other factors, to
make additional cash contributions to this pension plan in the future.
RESULTS OF OPERATIONS
Sales for the third quarter 2004 were $730.6 million, up 51% compared to
the third quarter 2003. Sales increased 80% in the Flat-Rolled Products segment,
19% in the High Performance Metals segment, and 18% in the Engineered Products
segment. The increase in sales resulted primarily from higher base-selling
prices and raw material surcharges for most of our products compared to the
prior year period, and higher shipment volume, predominantly in the Flat-Rolled
Products segment.
Operating profit for the third quarter 2004 increased to $53.3 million,
compared to $5.8 million for the same period of 2003, as a result of improved
performance across all of our business segments. The Flat-Rolled Products
segment led this improvement with an operating profit of $26.7 million. Results
for the third quarter 2004 included a LIFO (last-in, first-out) inventory
valuation reserve charge of $8.5 million, due primarily to a third quarter 2004
increase in raw material costs, especially for nickel, chromium, molybdenum,
iron scrap, and titanium scrap. For the same 2003 period, the LIFO inventory
valuation reserve charge was $10.5 million.
Net income for the third quarter 2004 was $8.6 million, or $0.09 per
share. Retirement benefit expense was $24.8 million in the third quarter of 2004
compared to $33.5 million in the third quarter of 2003, down primarily as a
result of actions taken in the second quarter 2004 to control certain retiree
medical costs. 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 third quarter 2003, we reported a net loss of $28.8 million, or
$0.36 per share, on sales of $482.6 million. Third quarter 2003 results included
an income tax benefit of $19.5 million.
For the first nine months of 2004, sales increased 34.5% to $1,954.9
million, and operating profit increased to $92.0 million compared to $23.2
million for the same 2003 period, as a result of improved performance across all
of the business segments. Business conditions in most of our end markets
reflected increased demand and improved pricing for many of our products during
the first nine months of 2004, compared to the same period of 2003. These
improved market conditions were partially offset by LIFO inventory reserve
charges due to higher raw material costs, which resulted in a net loss of $15.2
million, or $0.18 per share, for the first nine months of 2004 compared to a net
loss before cumulative effect of a change in
27
accounting principle of $80.6 million, or $0.99 per share, for the first nine
months of 2003. As discussed above, 2004 results do not include an income tax
provision or benefit. For the first nine months of 2003, results included an
income tax benefit of $48.5 million, or $0.60 per share.
The results for the nine months ended September 30, 2004, also included a
LIFO inventory valuation reserve charge of $82.7 million, primarily due to the
effects of rapidly rising raw material costs. The first nine months of 2003
results included a LIFO inventory valuation reserve charge of $22.8 million.
Retirement benefit expense was $94.8 million for the first nine months of 2004,
compared to $101.7 million in the comparable year ago period. This retirement
benefit expense comparison excludes the previously discussed curtailment and
settlement gain and the pension termination benefits recorded in the second
quarter of 2004. Cost reductions, before the effects of inflation, totaled
$103.2 million through the nine months ended September 30, 2004. Our initial
cost reduction goal for 2004 was $104 million.
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
Third quarter 2004 sales increased 80% to $465.5 million, compared to the
third quarter 2003, primarily due to improved demand from capital goods markets,
the impact of higher raw material surcharges and base-selling price increases,
and higher shipment volume resulting from the recently acquired assets in
Midland, Pennsylvania and Louisville, Ohio. Total finished tons shipped
increased by over 50,000 tons, or 42%, in the third quarter 2004 compared to the
third quarter of 2003. Shipments of commodity products increased 49% and
shipments of high-value products increased 24% from the comparable 2003 period.
Average transaction prices, which include surcharges, were 26% higher. The
average base-selling price, which excludes surcharges, for stainless steel
cold-rolled sheet increased 25% compared to the third quarter 2003.
Demand continued to be strong from the residential construction and
remodeling markets, and capital goods markets such as chemical processing, oil
and gas, and power generation. Demand remained good from the automotive and
appliance markets. As a result of these improved business conditions, operating
profit increased to $26.7 million for the third quarter 2004, compared to an
operating loss of $4.9 million in the comparable 2003 period. The benefits of
increased shipment volumes, additional surcharges, higher base-selling prices,
and cost reduction initiatives were partially offset by higher raw material
costs, which resulted in a LIFO inventory valuation reserve charge of $9.2
million in the third quarter 2004, and approximately $2.0 million of costs
associated with flooding at our facilities in Western Pennsylvania resulting
from the remnants of Hurricane Ivan. The 2003 third quarter included a LIFO
inventory valuation reserve charge of $7.5 million. Energy costs increased by
$0.2 million compared to 2003, net of approximately $0.4 million in gains from
natural gas derivatives, as a result of higher natural gas and electricity
prices. Results for the 2004 third quarter benefited from $19.5 million in gross
cost reductions, before the effects of inflation.
The J&L asset acquisition was completed June 1, 2004. Since the
acquisition was accounted for as a purchase, third quarter 2004 results did not
include any operating profit on sales of the purchased J&L inventory on hand at
the acquisition date.
28
Comparative information on the segment's products for the three months ended
September 30, 2004 and 2003 is provided in the following table:
Three Months Ended
September 30,
---------------------- %
2004 2003 Change
-------- -------- ------
Volume (finished tons):
Commodity 129,184 86,519 49
High Value 40,997 33,045 24
-------- --------
Total 170,181 119,564 42
Average prices (per finished ton):
Commodity $ 2,198 $ 1,570 40
High Value $ 4,418 $ 3,722 19
Combined Average $ 2,732 $ 2,165 26
For the nine months ended September 30, 2004, Flat-Rolled Products sales
increased 51.5%, to $1,174.3 million, and operating profit was $35.7 million,
compared to an operating loss of $12.4 million for the prior year-to-date
period. Segment results for the 2004 year-to-date period included a LIFO
inventory reserve charge of $62.0 million due to significantly higher raw
material costs, compared to a prior year LIFO inventory valuation reserve charge
of $20.5 million. Energy costs, net of hedging activities, were $6.1 million
higher in the first nine months of 2004 compared to the comparable 2003 period.
Increased shipment volume, raw material surcharges, base price increases, and
year-to-date 2004 cost reductions of $53.8 million more than offset the LIFO
inventory valuation reserve charges and energy cost increases.
Comparative information on the segment's products for the nine months
ended September 30, 2004 and 2003 is provided in the following table:
Nine Months Ended
September 30,
---------------------- %
2004 2003 Change
-------- -------- ------
Volume (finished tons):
Commodity 309,038 257,348 20
High Value 119,888 101,734 18
-------- --------
Total 428,926 359,082 19
Average prices (per finished ton):
Commodity $ 2,141 $ 1,561 37
High Value $ 4,268 $ 3,660 17
Combined Average $ 2,736 $ 2,156 27
HIGH PERFORMANCE METALS SEGMENT
Sales increased 19% to $192.5 million in the third quarter 2004, compared
to the third quarter 2003. The commercial aerospace market showed early signs of
a cyclical recovery as demand improved from the commercial OEM market. Demand
for high performance metals remained strong for spare parts from the commercial
and military aerospace markets. Our exotic alloys business continued to benefit
from sustained high demand from government and medical markets, and from
corrosion markets, particularly in Asia. Operating profit in the quarter
increased to $21.4 million, or 11.1% of sales, compared to $9.5 million, or 5.9%
of sales, in the year-ago period as a result of improved sales and pricing and
cost reduction initiatives. Changes from the second quarter 2004 in raw material
costs, inventory levels and mix resulted in a LIFO inventory valuation reserve
benefit of $2.1 million, compared to a $3.4 million charge in the third quarter
of 2003. Results for the third quarter
29
2004 benefited from $17.1 million of gross cost reductions, before the effects
of inflation.
Certain comparative information on the segment's major products for the
three months ended September 30, 2004 and 2003 is provided in the following
table. The increases in selling prices were primarily due to product mix and
higher raw material indices.
Three Months Ended
September 30,
------------------------ %
2004 2003 Change
--------- ---------
Volume (000's pounds):
Nickel-based and specialty steel alloys 8,227 8,965 (8)
Titanium mill products 5,130 4,813 7
Exotic alloys 912 1,052 (13)
Average prices (per pound):
Nickel-based and specialty steel alloys $ 9.09 $ 6.44 41
Titanium mill products $ 12.53 $ 11.05 13
Exotic alloys $ 46.12 $ 38.16 21
For the nine months ended September 2004, segment sales increased 15.0% to
$563.7 million. Operating profit was $41.8 million for the nine months ended
September 2004, or 7.4% of sales, compared to $29.4 million, or 6.0% of sales
for the comparable prior year to date period. The effect of the LIFO inventory
valuation reserve charge was $12.6 million in 2004, compared to $4.6 million in
2003. Year-to-date 2004 cost reductions of $39.2 million were offset, in part,
by higher LIFO inventory valuation reserve charges, and production
inefficiencies and start-up costs related to the Richburg, South Carolina
rolling mill upgrade, which was commissioned on October 11, 2004.
Comparative information on the segment's products for the nine months
ended September 30, 2004 and 2003 is provided in the following table:
Nine Months Ended
September 30,
-------------------------- %
2004 2003 Change
---------- ---------- ------
Volume (000's pounds):
Nickel-based and specialty steel alloys 25,815 27,114 (5)
Titanium mill products 15,809 14,045 13
Exotic alloys 3,179 3,144 1
Average prices (per pound):
Nickel-based and specialty steel alloys $ 8.30 $ 6.54 27
Titanium mill products $ 11.70 $ 11.68 -
Exotic alloys $ 40.86 $ 38.01 7
ENGINEERED PRODUCTS SEGMENT
Sales for the third quarter 2004 increased 18% to $72.6 million. Demand
for tungsten products remained strong from the oil and gas, mining, cutting tool
and medical markets. Demand remained strong for forged products from the Class 8
truck market and improved from the oil and gas and off-road vehicle markets.
Demand for cast products improved from the transportation and wind energy
markets. Operating profit in the quarter improved to $5.2 million, or 7.2% of
sales, compared to $1.2 million, or 2.0% of sales, in the third quarter 2003.
Higher sales volumes, improved pricing, and benefits from cost reductions more
than offset higher raw material costs and approximately $0.5 million of costs
associated with flooding at our Rome Metals operation in Western Pennsylvania
resulting from the remnants of Hurricane Ivan. The rise
30
in raw material costs resulted in a LIFO inventory valuation reserve charge of
$1.4 million in the third quarter 2004, compared to a $0.4 million benefit in
the third quarter of 2003. Results for the third quarter 2004 benefited from
$2.4 million in gross cost reductions, before the effects of inflation.
For the nine months ended September 2004, sales increased 15.4% to $216.9
million, and operating profit was $14.5 million, or 6.7% of sales, compared to
$6.2 million, or 3.3% of sales in 2003. Cost of sales in 2004 included an $8.1
million LIFO inventory valuation reserve charge, compared to a LIFO valuation
reserve benefit of $2.3 million for the nine months ended September 2003. Higher
sales volumes, improved pricing and 2004 gross cost reductions of approximately
$7.2 million more than offset rising raw material and other cost increases.
CORPORATE ITEMS
Net interest expense increased to $9.3 million for the third quarter 2004
from $4.1 million for the same period last year, primarily as a result of the
recognition in the third quarter 2003 of interest income of $4 million related
to a Federal income tax settlement associated with prior years, and interest
expense associated with the financing of the June 1, 2004, J&L asset
acquisition. For the nine months ended September 2004, net interest expense was
$25.3 million compared to $19.9 million in 2003, with the 2004 year-to-date
increase due primarily to the aforementioned third quarter items. Our "receive
fixed, pay floating" interest rate swap contracts for $150 million related to
the $300 million, 8.375%, ten-year Notes due 2011, which effectively converted
this portion of the Notes to variable rate debt, decreased year-to-date interest
expense by $4.0 million in 2004, and $4.9 million in 2003, compared to the fixed
interest expense of the Notes that would otherwise be applicable. These swap
contracts were terminated in the third quarter 2004.
Retirement benefit expense declined to $24.8 million in the third quarter
2004, compared to $33.5 million in the third quarter 2003, primarily as a result
of actions taken in the second quarter 2004 to control certain retiree medical
costs. Pension expense decreased to $17.9 million for the 2004 third quarter
from $23.4 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.
Other postretirement benefit expense also decreased for the 2004 third quarter
to $6.9 million from $10.1 million in the comparable 2003 period, as effects of
the new labor agreement at our Allegheny Ludlum operations in the 2004 second
quarter and the effects of the 2003 Federal Medicare prescription drug benefit
program, which we began to recognize in the 2004 third quarter, more than offset
a projected rise in the medical cost inflation rate and a lower assumed discount
rate utilized for the current year. In the third quarter 2004 and 2003,
retirement benefit expense increased cost of sales by $17.7 million and $23.1
million, respectively, and increased selling and administrative expenses by $7.1
million and $10.4 million, respectively.
For the year-to-date periods, 2004 retirement benefit expense was $94.8
million, compared to $101.7 million in 2003. Retirement benefit expense
increased cost of sales for the nine months ended September 2004 by $70.6
million, and increased selling and administrative expenses by $24.2 million. For
the nine months ended September 2003, retirement benefit expenses increased cost
of sales by $71.0 million and increased selling and administrative expenses by
$30.7 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 our U.S. defined benefit pension plan. Additionally, retirement
31
benefit expense recognized through September 2004 includes only about $1 million
of the expected $46 million favorable impact on our postretirement medical
expense from the enactment of the Federal Medicare prescription drug benefit
program in December 2003. The reduction in postretirement expense from this
program will be recognized over multiple years.
We are not required to make cash contributions to the U.S. defined benefit
pension plan for 2004. During the third quarter 2004, we made a $50 million
voluntary cash contribution to this defined benefit pension plan to improve the
plan's funded position. Based on current actuarial studies, we do not expect to
be required to make cash contributions to this defined benefit pension plan
during the next several years. However, we may elect, depending upon investment
performance of the pension plan assets and other factors, to make additional
cash contributions to this pension plan in the future.
Corporate expenses increased to $7.4 million for the third quarter of 2004
compared to $4.1 million for the third quarter of 2003. For the nine months
ended September 2004, corporate expenses were $21.9 million compared to $14.2
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 and costs of complying with Sarbanes-Oxley regulations,
which more than offset savings associated with reductions in staffing and other
efforts to control costs at the corporate office. Selling and administrative
expenses were largely unchanged in dollar terms from the prior year quarter and
year-to-date periods, but declined as a percentage of sales due to increased
sales in 2004. Excluding the effects of retirement benefit expense and an
increase of $1.8 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 6.6% in the 2004 third quarter, from 8.8% in the same period
of 2003. For the nine months ended September 2004, selling and administrative
expenses declined to 6.8% of sales, from 8.7% of sales in the prior year-to-date
period, excluding the effects of retirement benefit expense, non-cash
stock-based compensation expense and prior year management transition costs
described below.
CURTAILMENT GAIN, NET OF RESTRUCTURING COSTS
In the 2004 second quarter, we recorded a curtailment gain, net of
restructuring costs of $40.4 million, which 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 at our Allegheny Ludlum operations, 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.
MANAGEMENT TRANSITION AND RESTRUCTURING COSTS
Third quarter 2003 results included pretax management transition and
restructuring costs of $8.6 million. This amount included $5.6 million
associated with the termination of the Stock Acquisition and Retention Program
("SARP"), which was reported in selling and administrative expenses on the
consolidated statement of operations. In September 2003, we terminated the
remaining loans outstanding under the SARP, received approximately $0.5 million
in cash and recorded $5.6 million of expenses. CEO transition costs of $1.8
million included accelerated vesting of long-term compensation, and accrued
obligations pursuant to an employment contract, which were reported in selling
and administrative expenses on the consolidated statement of operations.
Workforce reductions of $1.2 million related to the Flat-Rolled Products and
Engineered Products segments were reported in restructuring costs on the
consolidated statement of operations.
32
INCOME TAXES
The 2004 third quarter and first nine 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 40.4% and
37.6% for the 2003 third quarter and first nine months 2003, respectively. The
effective tax rate for the third quarter 2003 was favorably impacted by the
settlement of previous years' Federal income tax obligations, resulting in a
$17.1 million income tax refund receivable at September 30, 2003. We received
Federal income tax refunds of $7.2 million in 2004 and $48.5 million in 2003,
almost entirely in the first quarter of both years. 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. Our 2003 Federal net operating loss tax carryforward of $42 million,
and 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
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
At September 30, 2004, cash and cash equivalents totaled $262.6 million,
an increase of $183.0 million from December 31, 2003. On July 28, 2004, the sale
of 13.8 million shares of ATI common stock was completed in a public offering at
$17.50 per share with net cash proceeds of $229.7 million. During the first nine
months ended September 30, 2004, cash generated from operations was $8.5 million
as improved operating results for 2004 and the receipt of a $7.2 million Federal
income tax refund pertaining to our 2003 tax return offset a $147.7 million
increase in managed working capital and a $50 million voluntary contribution to
our U.S. defined benefit pension plan. The increase in managed working capital,
excluding the effects of the J&L asset acquisition, was primarily due to a $85.4
million increase in accounts receivable resulting from a higher level of sales
in the third quarter of 2004 compared to the fourth quarter of 2003, and a
$133.1 million increase in inventory as a result of increased operating volume
and higher raw material costs, partially offset by a $70.8 million increase in
accounts payable. Investing activities included capital expenditures of $39.5
million and the initial cash consideration for the J&L asset acquisition of $7.5
million.
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
33
inventory valuation reserves, excess and obsolete inventory reserves, and
reserves for uncollectible accounts receivable which, due to their nature, are
managed separately. At September 30, 2004, managed working capital was 26.3% of
annualized sales compared to 30.7% of annualized sales at December 31, 2003.
During the first nine months of 2004, managed working capital increased by
$147.7 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 third quarter 2004 compared to the fourth quarter 2003, and
increased inventory, mostly as a result of increased operating levels and 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 first nine months of 2004, gross inventory turns, which excludes the effect
of LIFO inventory valuation reserves, and days sales outstanding, which measures
actual collection timing for accounts receivable, both improved over December
31, 2003 levels.
The components of managed working capital were as follows:
(in millions) September 30, December 31,
2004 2003
------------ -----------
Accounts receivable $ 365.2 $ 248.8
Inventories 460.8 359.7
Accounts payable (259.1) (172.3)
-------- --------
Subtotal 566.9 436.2
Allowance for doubtful accounts 11.2 10.2
LIFO reserves 194.4 111.7
Corporate and other 24.5 17.4
-------- --------
Managed working capital $ 797.0 $ 575.5
======== ========
Annualized prior 2 months sales $3,026.0 $1,874.0
======== ========
Managed working capital as a
% of annualized sales 26.3% 30.7%
September 30, 2004 change in managed
working capital $ 221.5
Acquisition of J&L managed working capital (73.8)
--------
Net change in managed working capital $ 147.7
========
CAPITAL EXPENDITURES
Capital expenditures for 2004 are expected to be approximately $60
million, of which $39.5 million had been expended in the first nine 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 September 2, 2004, payable to stockholders of record at the close of
business on September 20, 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
34
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 September 30, 2004, we had $591.2 million in total outstanding debt,
compared to $532.1 million at December 31, 2003, an increase of $59.1 million.
The increase in debt was primarily due to $59.7 million in seller financing for
the J&L asset acquisition, and net borrowings of $7.8 million at our STAL joint
venture, partially offset by net debt repayments of $13.4 million, primarily for
industrial revenue bonds.
In managing our overall capital structure, one of the measures on which we
focus is net debt to total capitalization, which is the percentage of our debt
to our total invested and borrowed capital. In determining this measure, debt
and total capitalization are net of cash on hand which may be available to
reduce borrowings. Our net debt to total capitalization ratio improved to 45.7%
at September 30, 2004 from 72.1% at December 31, 2003, primarily as a result of
the $229.7 million of cash proceeds received from the July 2004 common stock
offering. The net debt to capital ratio was determined as follows:
(Unaudited - dollars in millions) September 30, December 31,
2004 2003
------------ -----------
Total debt $591.2 $532.1
Less: cash (262.6) (79.6)
------ ------
Net debt $328.6 $452.5
Net debt $328.6 $452.5
Stockholders' equity 390.3 174.7
------ ------
Total capital $718.9 $627.2
Net debt to capital ratio 45.7% 72.1%
====== ======
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 8.375% ten-year Notes due 2011 ("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 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 nine months of 2003, we terminated the majority of these interest rate
swap contracts and received $15.3 million in cash. Also in 2003, we entered into
new "receive fixed, pay floating" interest rate swap arrangements related to
Notes which re-established, in total, the $150 million notional amount. In the
third quarter 2004, we terminated all of the outstanding interest rate swap
contracts and realized net cash proceeds of $1.5 million. These gains on
settlement remain a component of the reported balance of the Notes ($308.6
million at September 30, 2004, including fair value adjustments), and are being
ratably recognized as a reduction to interest expense over the remaining life of
the Notes, which is approximately seven years.
We did not borrow funds under our secured domestic credit facility during
the first nine 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. Outstanding letters of credit issued under the facility at
September 30, 2004 were approximately $114 million.
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The 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 September 30, 2004, our undrawn availability under the facility, which
is calculated including outstanding letters of credit and domestic cash on hand,
was $325 million, and the amount that we could borrow at that date prior to
requiring the application of a financial covenant test was $175 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.
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 nine months of 2004 when raw material prices rose rapidly,
compared to 2003. 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 first nine months of 2004,
the increase in raw material costs on our LIFO inventory valuation method
resulted in cost of sales which was $82.7 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 operations 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
36
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
first nine months of 2004 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.
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
37
does not affect our ability to utilize the deferred tax asset in the future. The
valuation allowance could be reduced or increased in future periods 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 September 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, excluding the valuation allowance, 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. During the third quarter 2004, we
made a $50 million voluntary cash contribution to our U.S. defined pension plan
to improve the plan's funded position. Based on current actuarial studies, we do
not expect to be required to make cash contributions to this defined benefit
pension plan during the next several years. However, we may elect, depending
upon the investment performance of the pension plan assets and other factors, to
make additional cash contributions to this pension plan in the future.
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 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
38
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 this lower discount rate will increase annual pension
expense by approximately $4 million in 2004, compared to 2003. The effect on
pension liabilities for changes to the discount rate, as well as the net effect
of other changes in actuarial assumptions and experience, are deferred and
amortized over future periods in accordance with SFAS 87.
Accounting standards require a minimum pension liability be recorded when
the value of pension assets is less than the accumulated benefit obligation
("ABO") at the annual measurement date. As of November 30, 2003, our last
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 will be adjusted
in the fourth quarter 2004 to reflect the value of pension assets compared to
the ABO as of the end of November 2004, our next measurement date. If the level
of pension assets exceeds the ABO as of a future measurement date, the full
charge against stockholders' equity would be reversed. If the level of pension
assets remains below the ABO, the minimum pension liability and the charge
against stockholders' equity would be adjusted to reflect the relative values at
that measurement date.
In the 2004 second quarter in conjunction with the new labor agreement at
our Allegheny Ludlum operations, a $25.4 million charge for pension termination
benefits was recognized for the previously discussed Transition Assistance
Program ("TAP") incentives. The TAP incentives will be paid from our U.S.
defined benefit pension trust to 650 employees over the next two and a half
years.
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 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
postretirement benefit expenses will 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, we modified retiree medical benefits for
certain non-collectively bargained employees to cap our cost of these benefits,
beginning in 2005, and then eliminate the benefits in 2010. A $71.5 million
curtailment and settlement gain was recognized in the second quarter 2004,
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 September 30, 2004, includes only a minimal amount of
the expected favorable impact of the Medicare Prescription Drug,
39
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. We will recognize this reduction in the Other
Postretirement Benefits obligation on an actuarially determined basis over
several years, as a reduction to postretirement benefit expense.
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 the 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 our 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. We 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. At our November 2002 measurement date,
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 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.
Corporate bond rates have decreased in 2004 from the rates as of November
2003. If corporate bonds rates remain at October 2004 levels, it is likely to
result in lower discount rate assumptions used to value pension and
postretirement benefit plan liabilities at the end of 2004. Lowering the
discount rate would result in increases in pension and postretirement benefit
liabilities and retirement benefit expenses for 2005.
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.
40
Goodwill is required to be reviewed annually, or more frequently if
impairment indicators arise. We perform the annual impairment review in the
fourth quarter of each fiscal year. 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.
BOARD OF DIRECTORS
On September 2, 2004, ATI announced that Michael J. Joyce and Louis J.
Thomas were elected to our Board of Directors. Mr. Joyce was appointed to serve
on the Audit Committee and was designated an "audit committee financial expert".
Mr. Thomas was appointed to serve on the Board's Technology Committee. Both Mr.
Joyce and Mr. Thomas will stand for election at the 2005 Annual Meeting of
Stockholders.
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
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 September 30,
2004.
Product Pricing
From time-to-time, intense competition and excess manufacturing capacity
in the commodity stainless steel industry have resulted in reduced prices,
excluding raw material surcharges, for many of our stainless steel products.
These factors have had and may have an adverse impact on our revenues, operating
results and financial condition.
41
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 or have existing contracts, 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 may experience delays or shortages in the
supply of raw materials or conversion services. 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 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.
42
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 2,900 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. The wages and pension benefits for a
new collective bargaining agreement with the USWA affecting approximately 120
employees at the Casting Service facility in LaPorte, Indiana are presently the
subject of arbitration proceedings.
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 31 of
such sites, excluding those at which we believe we have no future liability. Our
involvement is limited or de minimis at approximately 17 of these sites, and the
potential loss exposure with respect to any of the remaining 14 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 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
43
the amounts of such future adjustments. At September 30, 2004, our reserves for
environmental matters totaled approximately $34.3 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 Asset Acquisition and New Labor Agreement
We may not achieve all of the anticipated cost savings, operating
synergies and other benefits from the J&L 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 asset acquisition and the new labor agreement, and our
results of operations may suffer as a result.
Internal Controls Over Financial Reporting
Section 404 of the Sarbanes-Oxley Act of 2002 ("Section 404") requires
that management evaluate and report on the effectiveness of the Company's
internal controls over financial reporting and to provide management's
assessment of the effectiveness of internal control over financial reporting in
our Annual Report on Form 10-K for the year ended December 31, 2004. Our
independent auditors also must attest to, and report on, management's assessment
of our internal controls over financial reporting. While we believe, based on
our procedures performed during 2003 and 2004, that no material weakness exists
in our internal controls over financial reporting, we cannot assure you that we
will determine, and our auditors will attest to, a positive assessment as to
44
the effectiveness of our internal controls over financial reporting at December
31, 2004.
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.
45
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 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 throughout 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 September 30, 2004, we had aggregate consolidated indebtedness of
approximately $591 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 may enter into interest rate swap contracts to manage our
exposure to interest rate risks. In the 2004 third quarter, we terminated our
"receive fixed, pay floating" interest rate swap contracts related to our 8.375%
ten-year Notes due 2011, which had a total notional amount of $150 million, and
we received $1.5 million in cash. These interest rate swap contracts effectively
converted this portion of the Notes to variable rate debt, and 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. The $1.5 million settlement gain, as well as previous settlement
gains on interest rate swap terminations, are deferred and ratably recognized
over the life of the underlying fixed rate 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 customers' creditworthiness and ability to pay their obligations.
46
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer have evaluated the
Company's disclosure controls and procedures as of September 30, 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 September 30, 2004. In the course of management's ongoing evaluation
of the effectiveness of internal controls over financial reporting,
certain exceptions and deficiencies have been identified. These exceptions
and deficiencies are being evaluated and remediated, to the extent
required, as part of our Section 404 implementation.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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 current or
formerly owned businesses, including those pertaining to product
liability, patent infringement, commercial, employment, employee benefits,
environmental and health and safety, 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.
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ITEM 6. EXHIBITS
(a) Exhibits
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).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLEGHENY TECHNOLOGIES INCORPORATED
(REGISTRANT)
Date: November 4, 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: November 4, 2004 By /s/ Dale G. Reid
---------------------------------------
Dale G. Reid
Vice President, Controller and
Chief Accounting Officer and Treasurer
(Principal Accounting Officer)
49
EXHIBIT INDEX
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