EXHIBIT 13
RESTORING EARNINGS POWER . MANAGEMENT'S DISCUSSION AND ANALYSIS
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three Years Ended December 31, 1996
(Dollars in millions, except per share data)
GENERAL
This discussion and analysis of Armco's financial results should be read
together with the Consolidated Financial Statements and Notes on pages 23
through 37.
Operating Results
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1996 1995 1994
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Net sales $1,724.0 $1,559.9 $1,437.6
Special charges (8.8) -- (35.0)
Operating profit 74.7 69.0 39.2
Gain on sale of investments in joint ventures
and related stock -- 27.2 62.6
Credit (provision) for income taxes (1.4) (2.0) 28.7
Income from continuing operations 26.0 23.5 65.8
Income from discontinued operations:
Aerospace and Strategic Materials 6.5 -- --
National-Oilwell -- 6.3 11.9
Net income 32.5 29.8 77.7
Net income per common share 0.14 0.11 0.57
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1996 vs. 1995: Net sales in 1996 were 11% higher than in 1995, primarily due
to higher shipments of automotive exhaust stainless, electrical and carbon
steels in the Specialty Flat-Rolled Steels segment. Higher sales were also
achieved by Douglas Dynamics, LLC, Armco's snowplow manufacturer, whose
results are reported in the Fabricated Products business segment.
Operating profit increased 8% in 1996 due to a significant reduction in losses
at Armco's Mansfield and Dover Operations in the Specialty Flat-Rolled Steels
segment, an increase in profits from Douglas Dynamics and lower employee
benefit costs. These improvements were offset, in part, by lower profits in
the remainder of the Specialty Flat-Rolled Steels segment, due to higher
imports and weak pricing in certain chrome nickel products plus higher sales
of less profitable carbon steel. The decrease in Mansfield and Dover operating
losses reflects improved operating practices and higher levels of production
compared with 1995, which was a ramp-up period following a year-long idling of
these facilities. Employee benefit expenses were lower in 1996 primarily as a
result of increased funding of the pension plans during 1995 and 1996 and
lower interest rates on Armco's liability for retiree health care and life
insurance benefits.
Included in the 1996 operating profit were special charges totaling $8.8 for a
loss on the sale of Armco's nonresidential construction business and a
decision to exit a line of light truck equipment manufactured by Douglas
Dynamics. Operating profit also included nonrecurring income totaling $8.6
from claim settlements, including the partial settlement of a business
interruption insurance claim.
In 1995, Armco sold all of the shares of AK Steel Holding Corporation it had
received in the initial public offering and recapitalization of Armco Steel
Company, L.P., recognizing a gain of $27.2.
Included in income from continuing operations for 1996 was the above-mentioned
special charges and claim settlements and a $6.3 gain, which resulted from the
recognition of gains previously deferred in connection with asset sales at an
industrial park owned by Armco. Armco elected to defer gains resulting from
individual asset sales at this site because of uncertainty concerning
realization of the carrying value of the remaining property. The gains were
recognized following receipt, in March 1996, of an independent appraiser's
report indicating that the remaining land, buildings and dock facilities in
the park had a market value in excess of Armco's historical cost carrying
value.
Income from discontinued operations in 1996 consisted of a $6.5 increase in
the gain on the sale of Armco's Aerospace and Strategic Materials business
segment related to a federal income tax settlement. In 1995, Armco recognized,
in income from discontinued operations, equity income of $6.3 from National-
Oilwell, a joint venture divested in January, 1996.
1995 vs. 1994: Net sales increased in 1995 over 1994 because of strong markets
and higher prices for stainless and electrical steels, and the addition of
sales from Armco's modernized facilities in Mansfield and Dover, Ohio, which
resumed operations in April 1995. The Mansfield and Dover plants, idled in
March of 1994, recorded sales which were $52.1 higher in 1995 than in 1994.
However, Armco's net sales in 1994 included $52.8 from Eastern Stainless
Corporation, which has since been divested. Excluding the results of
Mansfield, Dover and Eastern Stainless, 1995 net sales were 9% higher than
1994 sales. Increased sales for the year in the Specialty Flat-Rolled Steels
segment and by Sawhill Tubular, were partially offset by a decline in sales at
Douglas Dynamics.
During 1994, special charges totaling $35.0 were recorded for expenses
associated with idling the Mansfield and Dover Operations and for employee
benefit and other charges related to the sale of assets by Eastern Stainless.
The results of the Butler, Coshocton and Zanesville Operations in the
Specialty Flat-Rolled Steels segment exceeded 1994 operating profit by 22%. In
addition, results improved at Sawhill Tubular. However, excluding special
charges, operating profit in 1995 was down $5.2 from 1994, as higher losses
generated by the ramp-up of the Mansfield Operations and lower profits from
Douglas Dynamics more than offset the improvements.
Income from continuing operations in 1994 reflected the completion of an
initial public offering and recapitalization of Armco Steel Company, L.P., for
which Armco recognized a pretax gain of $36.5, and a $30.0 tax benefit. Also
in 1994, Armco sold 90% of its investment in North American Stainless for
$73.0 in cash, recognizing a $26.1 gain.
16
Outlook: With reasonably firm demand in most product lines, Armco's expanded
capacity and improved productivity should allow its Specialty Flat-Rolled
Steels segment to compete for more of the available market. Armco expects 1997
sales in the Fabricated Products segment to approximate 1996 levels; however,
an expected decrease in operating profit on snowplows will be only partially
offset by improved profits anticipated in the tubular business.
BUSINESS SEGMENT RESULTS
Specialty Flat-Rolled Steels
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1996 1995 1994
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Customer sales $1,421.2 $1,277.0 $1,114.4
Special charges -- -- (35.0)
Operating profit 72.9 76.0 40.5
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Armco's Specialty Flat-Rolled Steels businesses produce and finish flat-rolled
stainless, electrical and carbon steels at plants in Butler, Pennsylvania, and
Coshocton, Dover, Mansfield and Zanesville, Ohio. The segment also includes
the results of international trading companies that buy and sell steel and
manufactured steel products. Through September 30, 1994, the segment included
stainless steel plate products, which were produced by Eastern Stainless
Corporation, Armco's former 84%-owned subsidiary in Baltimore, Maryland. Armco
stopped consolidating its results on that date following a decision by Eastern
Stainless to sell substantially all of its assets to a third party.
Customer sales and shipments by major product line and annual production were:
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1996 1995 1994
----------- ----------- -----------
(tons in thousands) Sales Tons Sales Tons Sales Tons
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Specialty flat-rolled* $1,108.0 739 $1,013.3 647 $ 875.3 604
Specialty semi-finished 133.9 97 130.5 78 80.2 64
Stainless plate -- -- -- -- 52.8 22
Galvanized and other carbon 144.2 304 94.1 214 62.1 125
Other 35.1 -- 39.1 -- 44.0 --
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Total $1,421.2 1,140 $1,277.0 939 $1,114.4 815
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Cast production 1,439 1,153 947
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<FN>
* The Specialty flat-rolled product line consists of automotive exhaust
stainless, specialty strip and sheet, and electrical steels.
1996 vs. 1995: Customer sales in 1996 exceeded 1995 levels primarily due to
higher sales of automotive exhaust stainless, electrical and galvanized
steels. A 21% increase in shipped tons was made possible by progressively
higher operating levels at Mansfield in the second half of 1996. The higher
operating levels were achieved despite several planned outages necessary to
complete equipment upgrades.
Average sales per ton in 1996 was lower than in the prior year, primarily due
to higher import penetration in a number of product lines, increased sales of
lower-priced carbon products, and the elimination of raw material price
surcharges on certain stainless steels. Armco and other specialty steel
producers add raw material surcharges to the price of their product to
compensate for higher costs incurred when the price of key raw materials such
as nickel, chromium or molybdenum rises above certain levels. In 1996, raw
material prices fell below these levels.
Automotive exhaust stainless shipments reached record levels in 1996, as the
Mansfield Operations shipped significantly more of this product line than in
the prior year. Strong production of North American cars and light trucks, and
increased use of stainless in exhaust systems stimulated current year demand.
Shipments of electrical steel products increased as a result of generally good
market conditions and some easing of capacity constraints. Driven by housing
starts, demand remained strong for grain oriented electrical steel used in
utility distribution transformers. However, shipments of non-oriented
electrical steel used in motors and generators suffered under pressure from
imports, which increased substantially in the second half of the year.
Specialty strip and sheet shipments declined slightly in the year-to-year
comparison due to softer market conditions and increased import penetration.
Average sales per ton were lower in 1996 compared to 1995 as a result of the
elimination of raw material surcharges and base price erosion, resulting from
an increased level of imports.
Specialty semi-finished shipments increased in 1996, primarily due to export
sales. A reduction in average sales per ton reflected worldwide market
softness and the elimination of raw material surcharges. Sales of specialty
semi-finished products have also been adversely affected by import
competition.
Armco's carbon steel shipments increased in 1996 compared to 1995. In the
first half of 1996, Armco exited the lower-priced carbon hot band market,
shifting the carbon steel product mix to more galvanized steel thereby
increasing average sales per ton in the year-to-year comparison.
During 1996, operating profit for this segment was lower than in 1995 due to
price erosion on specialty strip and sheet and specialty semi-finished
products and several planned equipment outages, including outages necessary to
upgrade Armco's finishing facilities as part of the strategic facilities plan.
The outages and the subsequent process of restarting and returning these
facilities to full capability contributed to higher costs and lower yields. To
meet demand during this period, Armco used outside processors to finish some
of its stainless steels, resulting in increased costs.
Specialty Flat-Rolled Steels' 1996 operating profit included $8.6 of income
from various claims settlements, including the partial settlement of a
business interruption insurance claim for a 1995 unplanned outage. The outage
resulted in the use of alternative and more costly product routings, and lost
sales.
Operating profit in 1996 also included a $39.5 loss from the Mansfield and
Dover Operations, compared to a loss of $104.2 in 1995 while Mansfield was
ramping up. The 1996 loss was due, in part, to a number of planned and
unplanned equipment outages and to higher than expected operating costs.
17
RESTORING EARNINGS POWER
[NINE BAR CHARTS APPEAR HERE]
SPECIALTY FLAT-ROLLED STEELS - SALES - BY MARKET
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1996 1995 1994
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Automotive 44% 40% 39%
Industrial and Electrical Equipment 28% 32% 34%
Service Centers 12% 9% 12%
Other 16% 19% 15%
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SPECIALTY FLAT-ROLLED STEELS - SALES - BY PRODUCT LINE
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1996 1995 1994
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Specialty flat-rolled 78% 79% 78%
Specialty semi-finished 9% 10% 7%
Stainless plate 0% 0% 5%
Galvanized and other carbon 10% 7% 6%
Other 3% 4% 4%
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SPECIALTY FLAT-ROLLED STEELS - TONS SHIPPED
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1995 1994 1993
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Specialty flat-rolled 65% 68% 74%
Specialty semi-finished 8% 9% 8%
Stainless plate 0% 0% 3%
Galvanized and other carbon 27% 23% 15%
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1995 vs. 1994: The Mansfield and Dover Operations were idled from March 1994
through the first quarter of 1995, although Dover began limited operations
early in the first quarter of 1995. By mid-year, the Dover plant was fully
operational. With the completion of its new thin-slab caster and modernized
hot strip mill, Mansfield restarted in April 1995. The restart was hampered by
process control system difficulties and the failure of the refractory lining
and a skid in the new walking beam furnace. The furnace problems necessitated
an unscheduled 17-day outage.
Customer sales in 1995 increased 15% over 1994 sales, as demand for most
products remained strong throughout the year. Pricing also remained strong as
a result of raw material surcharges on products containing nickel, chromium
and molybdenum, January 1995 price increases for electrical steel and
industry-wide price increases for chrome nickel products.
Armco's shipments of automotive exhaust stainless increased in 1995,
principally as a result of continued strength in North American car and light
truck production and increased use of stainless steel in exhaust systems.
Shipments of electrical steel remained at a high level, sustained by strong
demand for both grain oriented and non-oriented electrical steels. Armco's
orders for non-oriented electrical steel were further increased in 1995 by a
54-day strike at a major domestic competitor; however, Armco's ability to ship
this product was limited by capacity constraints.
The increase in Armco's shipments of specialty strip and sheet was primarily
attributable to broad-based increases in the automotive, consumer and
industrial markets, especially in the first half of 1995, as well as the
strike mentioned above. In the second half, demand slowed due to normal
seasonal factors as well as liquidation of customer inventories.
Specialty semi-finished shipments, which consist of hot bands and slabs, grew
22% in 1995 on strong demand from North American customers.
Customer sales for the segment were also affected by the idling and restart of
the Mansfield and Dover Operations and by the divestment of Eastern Stainless.
Sales by Mansfield and Dover increased by $52.1 in 1995. Eastern Stainless
sales of $52.8 were recognized in 1994, before Armco stopped consolidating the
results of this business as a result of the divestment.
During 1994, Armco recognized a $20.0 special charge related to its decision
to idle and restructure the Mansfield and Dover, Ohio plants, while installing
a new thin-slab continuous caster. The special charge consisted of $11.2 for
employee benefits, primarily group insurance and supplemental unemployment
benefits, and $8.8 to write down inventories and fixed assets.
In 1994, Eastern Stainless decided to sell substantially all of its assets for
cash and the assumption of certain liabilities and Armco recognized a $15.0
special charge related to that decision. On March 14, 1995, the transaction
was completed. Net liabilities not assumed by the buyer or satisfied by the
sale proceeds were assumed by Armco. On the date of sale, the net liabilities
assumed by Armco, including amounts recorded at the establishment of the $15.0
special charge, totaled $53.0.
Specialty Flat-Rolled Steels operating profit in 1995 was almost double that
of 1994. Included in the 1995 operating results was a $104.2 operating loss
from the Mansfield and Dover Operations, primarily as a result of the startup
problems described above. The 1994 Specialty Flat-Rolled Steels operating
profit included losses of $86.0 from the Mansfield and Dover Operations,
primarily as a result of the idling. The remaining operations in this segment
realized a 22% increase in operating profit from 1994 to 1995.
Outlook: The strategic facilities upgrades were completed during 1996 and
Armco believes that it is now positioned to operate its plants without major
disruptions throughout 1997. Armco plans to focus on improving productivity
and quality at its specialty flat-rolled steels operations and anticipates
further cost reductions as these improvements are made.
Improved results for this segment are dependent, in part, on steady production
from the Mansfield Operations. Based on fourth quarter 1996 results, Mansfield
has demonstrated its ability to produce quality products at stable operating
levels, providing this business segment with the capacity and flexibility
required to meet expected market conditions.
Automotive exhaust stainless sales are expected to remain strong supported by
North American vehicle sales and an increase in the average amount of
stainless steel used in each vehicle. Stable housing starts are expected to
continue to stimulate demand for oriented electrical steels, while
18
high levels of lower-priced imports continue to adversely affect non-oriented
product sales. In the near term, worldwide oversupply and higher levels of
import penetration are expected to have a continued adverse effect on pricing
for specialty strip and sheet and specialty semi-finished products. Prices and
demand for Armco's galvanized steels, however, are expected to remain stable
through the first half of 1997.
Low-priced foreign imports of specialty steels increased in 1996, adversely
affecting volume and pricing experienced by domestic companies like Armco. As
a result, industry trade groups have begun to gather data to determine whether
there are grounds for trade cases against some foreign producers. However, no
trade cases have been filed to date and there can be no assurance that
sufficient grounds will be found to warrant future filing of trade cases or,
in the event, trade cases are filed, that a favorable result will be obtained.
Fabricated Products
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1996 1995 1994
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Customer sales $302.8 $282.9 $323.2
Special charges (8.8) -- --
Operating profit 22.8 22.0 30.9
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The Fabricated Products business segment includes the results of Sawhill
Tubular, a manufacturer of steel pipe and tubing, and Douglas Dynamics, a
manufacturer of snowplows and ice control products.
1996 vs. 1995: Customer sales in this segment were 7% above last year's level,
largely due to higher sales at Douglas Dynamics. Snowplow shipments in 1996
were the second highest achieved in Douglas Dynamics' history, due to near
record snowfalls and strong light truck sales. Although Sawhill Tubular's
shipment volumes increased in the year-to-year comparison, this was offset by
lower prices caused by increased domestic competitive pressures and a high
level of imports.
In 1996, Armco recorded a special charge of $5.9 for the estimated loss on the
sale of its nonresidential construction business. In 1996, Armco negotiated an
agreement to sell the business and the sale was effective January 1, 1997. The
charge primarily relates to the writedown of assets and recognition of
additional employee benefit liabilities.
Also in 1996, Armco recorded a $2.9 special charge primarily for the writedown
of inventories and severance costs related to the decision to discontinue a
line of light truck equipment manufactured by Douglas Dynamics. Excluding
this special charge, Douglas Dynamics' operating profit was substantially
higher than 1995. Increased sales and cost reductions related to the
elimination of production outsourcing were partially offset by higher fixed
manufacturing, administrative and selling costs, primarily related to the
introduction of new products.
Sawhill Tubular recorded a decrease in operating profits primarily as a result
of higher costs for steel hot bands compared to product selling prices.
1995 vs. 1994: Customer sales decreased by 12% in 1995 compared to 1994
primarily as a result of eliminating the sales of Bowman Metal Deck, a
manufacturer of steel roof and floor decking, which was sold in December 1994,
and lower sales by Douglas Dynamics. The severe winter weather in early 1994
led to the best sales year in Douglas Dynamics' history; however, the mild
winter preceding the 1995 selling season resulted in lower annual snowplow
sales. Sawhill Tubular sales were 3% higher than 1994.
Lower operating profit in 1995 resulted from the reduced sales at Douglas
Dynamics, which was partially offset by Sawhill Tubular's return to
profitability. Douglas Dynamics cut operating costs by reducing manpower to
match lower order backlog, decreasing the amount of production previously
performed by outside parties and periodically ceasing production to control
inventory levels. However, these actions could not fully offset the effects of
the lower sales volume of snowplows and other equipment sales, and higher
expenses related to new product development. Sawhill Tubular's return to
profitability was driven by increased sales, complemented by operational
improvements and cost reduction programs, which not only led to improved
results, but also brought about reductions in inventories.
Outlook: Sales at Douglas Dynamics are expected to be lower in 1997 compared
to 1996, as the snowplow industry continues to experience its normal cyclical
change in volume. During this downturn, Armco expects to maintain market share
and margins, but still anticipates a decrease in operating profits.
Sales at Sawhill Tubular in 1997 are anticipated to be above 1996 levels,
reflecting increased volume and stable, though depressed, pricing. Higher
sales and a reduction in manufacturing costs are expected to result in
improved operating profit.
DISCONTINUED OPERATIONS
Aerospace and Strategic Materials
Oregon Metallurgical Corporation (Oremet), formerly 80% owned by Armco, was
part of the Aerospace and Strategic Materials business segment that Armco sold
in 1985. Prior to the sale, Armco filed a suit on behalf of Oremet in the U.S.
Claims Court, claiming refunds and interest on federal and state taxes.
Pursuant to the sales agreement, Armco retained the benefit of its share of
any proceeds of this action, net of taxes imposed on Oremet and the buyer. In
1988, as a result of a favorable settlement with the Internal Revenue Service
(IRS), Armco recorded a $15.2 net of tax adjustment to the gain on the sale of
this business segment. In 1996, Armco and Oremet reached agreement with the
IRS that the 1988 refund of taxes and interest should not itself have been
taxable to Oremet, further increasing the net proceeds, resulting in Armco
recording an additional $6.5 gain on the sale.
National-Oilwell
National-Oilwell, which sells oil field tubular pipe, and produces and sells
drilling and production equipment and process pumps used in the world's oil
and gas services industry, was a joint venture equally owned by subsidiaries
of Armco and USX Corporation.
Armco and USX reached a definitive agreement, dated September 22, 1995, to
sell their respective partnership interests in National-Oilwell to an entity
formed by Duff & Phelps/Inverness, First Reserve Funds and National-Oilwell
management. The sale was completed on January 16, 1996. For its 50% interest,
Armco received $77.0 in cash, and receivables with a face value of $13.0. The
receivables were recorded at a discounted value of $10.6. After recording $2.1
for recognition of deferred foreign translation losses and miscellaneous
expenses, no gain or loss was recognized on the transaction.
19
RESTORING EARNINGS POWER
Armco Financial Services Group (AFSG)
AFSG consists of insurance companies that have stopped writing new business
and are being liquidated. These companies have not written any new business
for retention except for an immaterial amount of guaranteed renewable accident
and health business since 1986. The number of policyholders of this business
has decreased from approximately 4,000 at December 31, 1986 to 1,007 at
December 31, 1995 and 870 at December 31, 1996.
Liquidity and Financial Resources: Claims are paid by using AFSG's investment
portfolio and the related investment income from such portfolio. The portfolio
had a market value of $172.3 at December 31, 1996. AFSG believes the existing
invested assets, related future income and other assets will provide
sufficient funds to meet all future claims payments.
AFSG's loss reserves net of reinsurance recoverables decreased to $102.2 at
December 31, 1996 from $118.7 at December 31, 1995. AFSG estimates that 60% of
the claims will be paid in the next five years and that substantially all of
the claims will be paid by the year 2017. The ultimate amount of the claims as
well as the timing of the claims payments are estimated based on an annual
review of loss reserves performed by AFSG's independent and consulting
actuaries.
Outlook: Armco management continues to believe, based on current facts and
circumstances and the opinions of outside counsel and advisors, that future
charges, if any, resulting from the runoff of AFSG will not be material to
Armco's financial condition or liquidity. However, it is possible that due to
fluctuations in Armco's results, future developments could have a material
effect on the results of one or more future interim or annual periods.
OTHER INVESTMENTS
Armco Steel Company, L.P. (ASC)
On April 7, 1994, ASC, a limited partnership 50% owned by a subsidiary of
Armco, completed an initial public offering and recapitalization. As part of
this transaction, the business and assets of ASC were transferred to AK Steel
Holding Corporation, a newly formed, publicly traded company. In exchange for
its interest in ASC, Armco received 1,023,987 shares of AK Steel common stock,
representing approximately four percent of the outstanding shares. The number
of shares received and other terms of the restructuring and recapitalization
were determined by arm's-length negotiations.
As a result of the transaction, in 1994 Armco recognized a nonrecurring pretax
gain of $36.5, primarily as a result of its release from certain obligations
to make future cash payments to the former joint venture and recognition of
deferred pension curtailment gains established at ASC's formation. In light of
this transaction, Armco also concluded that the realizable amount of its
deferred tax asset had increased and so recorded a tax benefit of $30.0.
In 1995, Armco sold all of the AK Steel common stock it had received as a
result of the initial public offering and recapitalization for a total of
$27.2, recognizing a gain of the same amount.
Under a toll-rolling agreement that is in effect through the year 2002, AK
Steel hot rolls stainless steel for Armco.
North American Stainless (NAS)
Armco and Acerinox S.A. of Spain each owned a 50% partnership interest in NAS
through their respective subsidiaries, First Stainless, Inc. and Stainless
Steel Invest, Inc. NAS operates a state-of-the-art chrome nickel stainless
steel finishing plant in Carrollton, Kentucky. In 1994, Armco's subsidiary
sold 90% of its 50% equity interest in NAS to its partner for $73.0 in cash
and Armco recorded a $26.1 gain on the sale. Armco decided to sell most of its
investment in NAS because NAS needed cash infusions from its partners to
expand its operations, while Armco chose to use its resources to support its
core business operations. In connection with the transaction, Armco entered
into an annual supply contract with NAS to provide the former joint venture
with semi-finished stainless steel at market prices.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, Armco had $168.9 of cash and cash equivalents, compared
to $136.8 at December 31, 1995. Cash and cash equivalents increased $32.1
during 1996, primarily as a result of net proceeds of $77.0 from the sale of
National-Oilwell, $15.7 of net proceeds from the sale of other assets and
investments, and cash generated from operations. Partially offsetting these
inflows were cash payments, which included $59.8 for capital expenditures,
$41.2 for pension plan funding, $24.3 of principal payments on debt and $17.8
for preferred stock dividends.
Inventories increased 14% during 1996, reflecting increased production levels
in the Specialty Flat-Rolled Steels segment. Trade receivables and payables,
primarily in the Specialty Flat-Rolled Steels segment, declined 16% and 8%,
respectively. The decrease in receivables was the result of timelier customer
payments and lower product prices. The decline in payables primarily reflects
lower prices for purchased raw materials and reduced capital expenditures.
At December 31, 1996, Armco had in place two bank credit facilities, totaling
$170.0. Under a receivables facility, Armco sells substantially all its trade
receivables to a wholly owned subsidiary, Armco Funding Corporation (AFC). In
January 1996, AFC entered into a five-year revolving credit agreement with a
group of banks providing up to $120.0 for revolving credit loans and letters
of credit secured by AFC's receivables. At December 31, 1996, there were no
outstanding borrowings under this credit facility; however, $69.9 of the
facility was used as support for letters of credit.
In January 1996, Armco entered into a three-year revolving credit agreement
with a group of banks providing up to $50.0 for revolving credit loans secured
by Armco's inventories. The credit agreement subjects Armco to certain
restrictions and covenants related to, among other things, minimum working
capital, minimum net income, current ratio and interest coverage ratio
requirements. At December 31, 1996, there were no outstanding borrowings under
this credit facility.
Armco has debt maturities of $27.2 and $27.4 in 1997 and 1998, respectively.
In 1999 and 2000, $127.5 and $157.6, respectively, will come due, primarily as
a result of the maturity of the $100.0, 11.375% Senior Notes due 1999 and the
$125.0, 9.375% Senior Notes due 2000.
20
Armco anticipates that its capital expenditures for 1997 will total
approximately $70.0, of which approximately $18.5 relates to finishing
facilities expansion projects. Armco expects that its 1997 cash requirements,
including amounts for debt service, preferred stock dividends and capital
expenditures, will be paid out of existing cash balances and cash generated
from operations.
On January 24, 1997, Armco's Board of Directors declared the regular quarterly
dividends of $.525 per share on the $2.10 cumulative convertible preferred
stock, Class A, and $.90625 per share on the $3.625 cumulative convertible
preferred stock, Class A, each payable March 31, 1997 to shareholders of
record on February 28, 1997. The Board of Directors also declared the regular
quarterly dividend of $1.125 per share on the $4.50 cumulative convertible
preferred stock, Class B, payable April 1, 1997, to shareholders of record on
February 28, 1997. Payment of dividends on Armco's common stock is currently
prohibited under the terms of certain of Armco's debt instruments and under
the terms of its inventory credit facility. Armco does not anticipate paying a
common stock dividend in the foreseeable future.
ENVIRONMENTAL MATTERS
Armco, in common with other United States manufacturers, is subject to various
federal, state and local requirements for environmental controls relating to
its operations. Armco has devoted, and will continue to devote, significant
resources to control air and water pollutants, to dispose of wastes and to
remediate sites of past waste disposal. Armco estimates capital expenditures
for pollution control in its manufacturing operations will be about $20.0 for
the years 1997-2001, with the largest expenditures being made in the Specialty
Flat-Rolled Steels segment. Approximately $7.5 is related to control of air
pollution pursuant to regulations currently promulgated under the Clean Air
Act, as amended, and corresponding state laws. These projections, which have
been prepared internally and without independent engineering or other
assistance, reflect Armco's analysis of both current and expected regulations.
During the period 1991 through 1996, Armco's capital expenditures for
pollution control projects amounted to approximately $35.8, including $7.7 in
1996. Statutory and regulatory requirements in this area continue to evolve
and, accordingly, the type and magnitude of expenditures may change.
Armco has been named as a defendant, or identified as a potentially
responsible party, in various governmental proceedings regarding cleanup of
certain past waste disposal sites. Armco is also a defendant in various
private lawsuits alleging property damage and personal injury from waste
disposal sites. Joint and several liability could be imposed on Armco or other
parties for some of these matters; thus, theoretically, one party could be
held liable for all costs related to a site. While such governmental and
private actions are being contested, the outcome of individual matters cannot
be predicted with assurance. However, based on its experience with such cases
and a review of current claims, Armco expects that in most cases any ultimate
liability will be apportioned between Armco and other financially viable
parties.
From time to time, Armco has been and may be subject to penalties or other
requirements as a result of administrative actions by regulatory agencies and
to claims for indemnification for properties it has previously owned or
leased. In addition, environmental exit costs may be incurred if Armco decides
to dispose of additional properties. It is Armco's policy not to accrue such
costs until a decision is made to dispose of a property.
Based on current facts and circumstances known to Armco, Armco's experience
with site remediation, an understanding of current environmental laws and
regulations, environmental assessments, the existence of other financially
viable parties, expected remediation methods and the years in which Armco is
expected to make payments toward each remediation (which range from the
current year to 30 years or more in the future), Armco believes that the
ultimate liability for environmental remediation matters identified to date,
will not materially affect its consolidated financial condition or liquidity.
However, it is possible that, due to fluctuations in Armco's operating
results, future developments with respect to such matters could have a
material effect on the results of operations of future interim or annual
periods.
Furthermore, the identification of additional sites, changes in known
circumstances with respect to identified sites, the failure of other parties
to contribute their share of remediation costs, decisions to dispose of
additional properties and other changed circumstances may result in increased
costs to Armco, which could have a material effect on its consolidated
financial condition, liquidity and results of operations in future interim or
annual periods. However, it is not possible to determine whether additional
loss, due to changed circumstances, will occur or to reasonably estimate the
amount or range of any potential additional loss.
Statutes and regulations relating to the protection of the environment have
resulted in higher operating costs and capital investments by the industries
in which Armco operates. Although it cannot predict precisely how changes in
environmental requirements will affect its businesses, Armco does not believe
such requirements would affect its competitive position.
On October 10, 1996, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of
Position 96-1, Environmental Remediation Liabilities. The Statement provides
authoritative guidance on specific accounting issues that are present in the
recognition, measurement, display and disclosure of environmental remediation
liabilities. Armco intends to adopt the Statement, when required in 1997, but
does not expect the adoption to have a material effect on its Statements of
Consolidated Financial Position or Consolidated Income.
21
RESTORING EARNINGS POWER . OPINION
Responsibility for Financial Reporting
Armco's management prepared the financial statements presented in this Annual
Report in accordance with generally accepted accounting principles in the
United States. These principles require choices among alternatives and
numerous estimates of financial matters. Armco believes the accounting
principles chosen are appropriate in the circumstances, and the estimates and
judgements involved in Armco's financial reporting are reasonable and
conservative.
Armco's management is responsible for the integrity and objectivity of the
financial information presented in this Annual Report. Armco maintains a
system of internal accounting control and a program of internal audits. They
are designed to provide reasonable assurance that the financial reports are
fairly presented and that Armco employees comply with stated policies and
procedures, including policies on the ethical conduct of business. Armco
continually reviews and updates its policies and system of internal accounting
control as businesses and business conditions change.
Management and the Audit Review Committee of the Board of Directors
recommended, and the Board of Directors approved, the hiring of Deloitte &
Touche LLP as independent auditors for Armco. Deloitte & Touche LLP expresses
an informed professional opinion on Armco's financial statements.
The Audit Review Committee, composed solely of independent outside directors,
oversees Armco's public financial reporting. The Audit Review Committee meets
periodically with management, Deloitte & Touche LLP and Armco's internal
auditors, both individually and jointly, to discuss internal accounting
control and financial reporting matters. Deloitte & Touche LLP and Armco's
internal auditors have free access to the Audit Review Committee to discuss
any matters.
We believe Armco's internal control system, combined with the activities of
the internal and independent auditors and the Audit Review Committee, provides
you reasonable assurance of the integrity of our financial reporting.
/s/ J. F Will /s/ Jerry W. Albright
James F. Will Jerry W. Albright
Chairman, President and Vice President and
Chief Executive Officer Chief Financial Officer
Independent Auditors' Report
Deloitte &
Touche LLP 2500 One PPG Place
- ------------- Pittsburgh, PA 15222
[Deloitte & Touche LLP LOGO]
Armco, Its Shareholders and Directors:
We have audited the statement of consolidated financial position of Armco Inc.
and subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of income and cash flows for each of the three years
in the period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Armco Inc. and subsidiaries at
December 31, 1996 and 1995, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1996,
in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
February 5, 1997
22
RESTORING EARNINGS POWER . INCOME
STATEMENT OF CONSOLIDATED INCOME
For the years ended December 31, 1996, 1995 and 1994
(Dollars in millions, except per share amounts)
- ----------------------------------------------------------------------------
1996 1995 1994
- ----------------------------------------------------------------------------
Net sales $1,724.0 $1,559.9 $1,437.6
Cost of products sold (1,549.7) (1,392.7) (1,267.0)
Selling and administrative expenses (90.8) (98.2) (96.4)
Special charges (Note 8) (8.8) -- (35.0)
- ----------------------------------------------------------------------------
Operating profit 74.7 69.0 39.2
Interest income 10.1 11.8 10.5
Interest expense (36.3) (32.9) (33.8)
Gain on sale of investments in joint ventures
and related stock (Note 10) -- 27.2 62.6
Sundry other-net (Note 2) (21.1) (49.6) (41.4)
- ----------------------------------------------------------------------------
Income before income taxes 27.4 25.5 37.1
Credit (provision) for income taxes (Note 3) (1.4) (2.0) 28.7
- ----------------------------------------------------------------------------
Income from continuing operations 26.0 23.5 65.8
Discontinued operations (Note 11) -
Aerospace and Strategic Materials
Gain on disposal of business 6.5 -- --
National-Oilwell
Income from operations (net of income taxes
of $0.1 in 1995 and $1.0 in 1994) -- 6.3 11.9
- ----------------------------------------------------------------------------
Net income $ 32.5 $ 29.8 $ 77.7
- ----------------------------------------------------------------------------
Income per share-primary (Note 1)
Income from continuing operations $ 0.08 $ 0.05 $ 0.46
Income from discontinued operations 0.06 0.06 0.11
- ----------------------------------------------------------------------------
Net income $ 0.14 $ 0.11 $ 0.57
- ----------------------------------------------------------------------------
Dividends on preferred stock (Note 5)
$2.10 Class A $ 2.10 $ 2.10 $ 2.10
$3.625 Class A 3.625 3.625 3.625
$4.50 Class B 4.50 4.50 4.50
- ----------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements on pages 26 through 37.
23
RESTORING EARNINGS POWER . FINANCIAL POSITION
STATEMENT OF CONSOLIDATED FINANCIAL POSITION
December 31, 1996 and 1995
(Dollars in millions, except per share amounts)
- ------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------
Assets
Current assets
Cash and cash equivalents (Note 1) $ 168.9 $ 136.8
Accounts and notes receivable
Trade (less allowance for doubtful accounts of
$3.8 in 1996 and $4.4 in 1995) 137.4 162.8
Other 12.2 6.6
Inventories (Note 1) 246.9 216.2
Investment in National-Oilwell (Note 11) -- 85.5
Other 6.4 5.9
- ------------------------------------------------------------------------------
Total current assets 571.8 613.8
- ------------------------------------------------------------------------------
Investments
Investment in Armco Financial Services Group (Note 11) 85.6 85.6
Other (less allowance for impairment of $12.7 in
1996 and $16.7 in 1995) (Note 1) 52.4 37.2
Property, plant and equipment (net of accumulated deprec-
iation of $597.6 in 1996 and $539.8 in 1995) (Note 1) 670.1 668.5
Deferred tax asset - net (Note 3) 325.8 326.1
Goodwill and other intangible assets (Note 1) 144.8 145.9
Other assets 17.3 19.5
- ------------------------------------------------------------------------------
Total assets $1,867.8 $1,896.6
- ------------------------------------------------------------------------------
Liabilities
Current liabilities
Trade accounts payable $ 136.3 $ 148.2
Employment-related liabilities (Note 2) 115.1 172.4
Other accruals 79.6 72.6
Current portion of long-term debt (Note 4) 27.2 25.8
- ------------------------------------------------------------------------------
Total current liabilities 358.2 419.0
- ------------------------------------------------------------------------------
Long-term debt (Note 4) 344.3 361.6
Long-term employee benefit obligations (Note 2) 1,200.2 1,165.9
Other liabilities 177.1 180.5
Commitments and contingencies (Notes 1, 4, 9 and 11)
- ------------------------------------------------------------------------------
Shareholders' deficit (Note 5)
Preferred stock
Class A 137.6 137.6
Class B 48.3 48.3
Common stock (authorized 150,000,000 shares of
$.01 par value; issued and outstanding
106,457,166 in 1996 and 106,102,560 in 1995) 1.1 1.1
Additional paid-in capital 965.0 963.0
Accumulated deficit (1,363.9) (1,378.5)
Other (0.1) (1.9)
- ------------------------------------------------------------------------------
Total shareholders' deficit (212.0) (230.4)
- ------------------------------------------------------------------------------
Total liabilities and shareholders' deficit $1,867.8 $1,896.6
- ------------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements on pages 26 through 37.
24
RESTORING EARNINGS POWER . CASH FLOWS
STATEMENT OF CONSOLIDATED CASH FLOWS
For the years ended December 31, 1996, 1995 and 1994
- ------------------------------------------------------------------------------
(Dollars in millions) 1996 1995 1994
- ------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 32.5 $ 29.8 $ 77.7
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation 58.7 52.8 48.8
Undistributed earnings from discontinued operations - (6.3) (11.9)
Net gain on sales of investments and facilities (8.9) (28.4) (64.3)
Deferred income tax benefit - - (30.0)
Special charges 8.8 - 35.0
Other 6.3 10.9 12.4
Change in assets and liabilities:
Trade accounts and notes receivable 22.8 6.1 (9.9)
Inventory (33.3) (50.8) 12.4
Payables and accrued operating expenses (13.2) 34.4 (1.8)
Employee benefits obligations (17.4) (26.4) 20.2
Other assets and liabilities - net (13.7) (6.6) (30.1)
- ------------------------------------------------------------------------------
Net cash provided by operating activities 42.6 15.5 58.5
- ------------------------------------------------------------------------------
Cash flows from investing activities:
Net proceeds from the sale of businesses
and assets 14.0 31.5 19.9
Proceeds from the sale and maturity of
liquid investments - 29.7 -
Proceeds from the sale of investments 78.7 30.0 89.4
Purchase of liquid investments (0.3) (6.0) (24.5)
Purchase of investments (0.1) (1.2) (8.8)
Contributions to investees (3.0) (2.0) (7.7)
Capital expenditures (59.8) (143.3) (86.9)
Other (2.6) 1.4 2.4
- ------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 26.9 (59.9) (16.2)
- ------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of debt 5.5 5.0 15.0
Principal payments on debt (24.3) (8.1) (24.3)
Proceeds from issuance of common stock - 2.4 2.8
Dividends paid on preferred stock (17.8) (20.9) (14.8)
Other (0.8) - (1.7)
- ------------------------------------------------------------------------------
Net cash used in financing activities (37.4) (21.6) (23.0)
- ------------------------------------------------------------------------------
Net change in cash and cash equivalents 32.1 (66.0) 19.3
Cash and cash equivalents:
Beginning of year 136.8 202.8 183.5
- ------------------------------------------------------------------------------
End of year $168.9 $136.8 $202.8
- ------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 35.1 $ 31.2 $ 31.1
Income taxes 0.1 0.7 0.7
Supplemental schedule of noncash investing and
financing activities:
Debt incurred or assets exchanged directly
for property - 16.2 9.5
Issuance of restricted stock 2.1 4.7 2.5
Notes receivable and stock in partial payment
for asset sales 10.6 - 7.7
- ------------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements on pages 26 through 37.
25
RESTORING EARNINGS POWER . NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
The accompanying financial statements consolidate the accounts of Armco and
all subsidiaries in which Armco has a controlling interest.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Investments
Armco considers all highly liquid investments purchased with a maturity of
three months or less to be cash equivalents. Cash equivalents which consist
primarily of commercial paper, repurchase agreements, Eurodollar time deposits
and money market mutual funds are stated at amortized cost plus accrued
interest, which approximates fair value.
Under the definitions provided in Statement of Financial Accounting Standards
(SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities, Armco has securities which have been classified as held to
maturity and are, therefore, recorded at amortized cost. At December 31, 1996
and 1995, the securities were as follows:
- ------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------
Cash equivalents $ 139.5 $ 130.1
Restricted collateral deposits 15.5 15.1
- ------------------------------------------------------------------------------
Total securities $ 155.0 $ 145.2
- ------------------------------------------------------------------------------
The restricted collateral deposits are primarily invested in certificates of
deposit which mature within one year and are principally for equipment
financing, self-insurance programs, and environmental and litigation bonds.
These securities are primarily reported in Other investments. The
classification as long-term is based on the expected term of the collateral
requirement and not necessarily the maturity date of the underlying
securities.
Also included in Other investments at December 31, 1996 were receivables from
the sale of National-Oilwell, recorded at a discounted value of $10.6, which
approximates fair value. At December 31, 1996 and 1995, Other investments
included $11.2 and $8.2, respectively, for Armco's limited partnership
interest in North American Stainless (Note 10). It is not practicable to
estimate the fair value of this closely held limited partnership, where
Armco's ownership interest is approximately 5%. At December 31, 1996 and 1995,
Armco had no material investments in derivative financial instruments.
Inventories
Inventories are valued at the lower of cost or market. Cost of inventories at
most domestic operations is measured on the LIFO -- Last In, First Out --
method. Other inventories are measured principally at average cost. Inventory
balances as of December 31, 1996 and 1995 were as follows:
- ------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------
Inventories on LIFO:
Finished and semi-finished $ 259.0 $ 226.8
Raw materials and supplies 21.4 24.8
Adjustment to state inventories at LIFO value (52.8) (57.3)
- ------------------------------------------------------------------------------
Total 227.6 194.3
- ------------------------------------------------------------------------------
Inventories on average cost:
Finished and semi-finished 11.9 15.5
Raw materials and supplies 7.4 6.4
- ------------------------------------------------------------------------------
Total 19.3 21.9
- ------------------------------------------------------------------------------
Total inventories $ 246.9 $ 216.2
- ------------------------------------------------------------------------------
Liquidation of LIFO inventory layers caused by certain inventory reductions
(reduced)/increased net income by $(0.1) in 1996, $0.3 in 1995 and $3.6 or
$.03 per share in 1994.
Research and Development Costs
Armco conducts a broad range of research and development activities. These
activities are aimed at improving existing products and manufacturing
processes and developing new products and processes. Research and development
costs are recorded as expense when incurred. The amounts incurred in 1996,
1995 and 1994 were $13.1, $14.0 and $12.0, respectively.
Property, Plant and Equipment
Depreciation is computed using the straight-line method based on the estimated
useful lives of the related assets. Leasehold improvements are depreciated
over the shorter of the life of the related asset or the life of the lease.
Generally, Armco depreciates its property, plant and equipment at annual rates
of 5% for land improvements, 3% - 5% for buildings and 5% - 33% for machinery
and equipment.
Armco's property, plant and equipment balances as of December 31, 1996 and
1995 were as follows:
- ------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------
Land $ 26.6 $ 26.6
Buildings 90.8 88.4
Machinery and equipment 1,117.5 1,039.4
Construction in progress 32.8 53.9
- ------------------------------------------------------------------------------
Total property, plant and equipment 1,267.7 1,208.3
Accumulated depreciation (597.6) (539.8)
- ------------------------------------------------------------------------------
Property, plant and equipment-net $ 670.1 $ 668.5
- ------------------------------------------------------------------------------
During 1996, 1995 and 1994, Armco expended $153.9, $124.7 and $109.9,
respectively, for maintenance and repair of its property, plant and equipment.
The increase in spending in 1996 and 1995 is largely attributable to expenses
related to major facility upgrades and the restart in 1995 of the Mansfield
Operations, which was idled in 1994.
26
Armco has commitments to purchase property, plant and equipment (including
unexpended amounts relating to projects substantially under way) amounting to
approximately $16.7 at December 31, 1996.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets primarily include goodwill recorded in
connection with the acquisition of Cyclops Industries, Inc. on April 24, 1992.
This goodwill is being amortized using the straight-line method over 40 years.
Also included are goodwill and intangible assets acquired in the purchase of
Douglas Dynamics, LLC on July 2, 1991. These assets are being amortized over
their estimated useful lives, the majority of which do not exceed 17 years.
Annual amortization expense for 1996, 1995 and 1994 was $6.9. At December 31,
1996 and 1995, accumulated amortization of goodwill and other intangible
assets was $35.3 and $28.4, respectively.
Armco assesses whether its goodwill and other intangible assets are impaired
when required by SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, based on an evaluation of
undiscounted projected cash flows through the remaining amortization period.
If an impairment exists, the amount of such impairment is calculated based on
the estimated fair value of the asset.
Earnings Per Share
Primary earnings per share is computed by deducting the amount of dividends on
preferred stock from income. This amount is divided by the weighted average
number of common shares outstanding during the year, plus common equivalent
shares outstanding if the common equivalent shares are dilutive. Common
equivalent shares include dilutive stock options as if the options were
exercised and the proceeds used to acquire common shares. Dilutive stock
options give the right to buy shares at a price which is less than current
market price. The fully diluted per share amounts are not presented in 1996,
1995 and 1994 because such amounts are antidilutive.
Environmental Liabilities
Armco has participated in or funded various cleanup efforts at sites where its
facilities have disposed of wastes, including sites located on its own
properties. Costs related to these efforts are accrued when it is probable
that a liability has been incurred and the amount of that liability can be
reasonably estimated. It is Armco's policy not to accrue environmental exit
costs with respect to ongoing businesses until a decision is made to dispose
of the property.
Concentrations of Credit Risk
Armco is primarily a producer of stainless, electrical and carbon steels and
steel products, which are sold to a number of markets, including automotive,
industrial machinery and equipment, construction, power generation and
appliances. Armco sells domestically to customers primarily in the midwestern
and eastern United States, while 10% of sales are to foreign customers
primarily in Canada, Mexico and western Europe. Approximately 24% of trade
receivables outstanding at December 31, 1996 are due from businesses that
supply the U.S. automotive industry. Except in a few situations where the risk
warrants it, Armco does not require collateral on trade receivables; and while
it believes its trade receivables will be collected, Armco anticipates that in
the event of default it would follow normal collection procedures. Overall,
credit risk related to Armco's trade receivables is limited due to the large
number of customers in differing industries and geographic areas.
Reclassifications
Certain amounts in prior year financial statements have been reclassified to
conform to the 1996 presentation.
2 PENSION AND OTHER EMPLOYEE BENEFITS
Pension Plans
Armco provides noncontributory pension benefits for most employees. The
benefits for most hourly represented employees are based on a fixed dollar
amount per year of service. Effective January 1, 1995, a cash balance program
was established and the pension benefits under the previous formulas were
locked and frozen for most nonrepresented employees. Under the cash balance
program, future increases in earnings will not apply to prior service and lump
sum distributions are available.
The qualified plans have been funded to meet the minimum funding requirements
of the Employee Retirement Income Security Act of 1974. During 1996 and 1995,
contributions of $41.2 and $54.8, respectively, which exceeded the minimum
funding requirements, were made to the plans. As of December 31, 1996, funding
credits of $53.8 were available to offset future minimum funding requirements.
The components of net periodic pension cost, including amounts related to
divested units and assumptions used to determine such expenses, were as
follows:
- ------------------------------------------------------------------------------
1996 1995 1994
- ------------------------------------------------------------------------------
Cost of benefits earned during the year $ 15.6 $ 13.7 $ 19.1
Interest cost on the projected benefit
obligation 141.0 153.1 149.3
Actual loss (return) on plan assets (252.1) (354.0) 21.9
Net amortization and deferral 112.0 204.3 (163.7)
- ------------------------------------------------------------------------------
Net periodic pension cost $ 16.5 $ 17.1 $ 26.6
- ------------------------------------------------------------------------------
Weighted average discount rate 7.00% 8.50% 7.25%
Weighted average expected long-term rate
of return on assets 8.00% 9.50% 8.25%
Rate of future compensation increases 4.00% 4.00% 4.00%
- ------------------------------------------------------------------------------
Net periodic pension cost decreased in 1995 primarily due to changes in the
pension provisions for most nonrepresented employees and the higher discount
rate. Net periodic pension expense in 1994 includes $1.5, which was charged to
previously established accruals for divested units.
Net curtailment and settlement losses on pensions of $5.2 in 1994, mainly for
reductions in the work force, were primarily recorded as special charges. A
curtailment loss of $1.7 was recorded in 1995. Curtailment and settlement
losses are not included in the net periodic pension cost above. Certain units
that were previously identified for disposal had hourly employees
participating in multi-employer pension and welfare plans. The total expense
for contributions to those programs, of $1.1 in 1996, $1.7 in 1995, and $2.4
in 1994, are not included in net periodic pension cost shown above.
27
RESTORING EARNINGS POWER
The following table presents the funded status of pension plans using discount
rates of 7.75% and 7% at December 31, 1996 and 1995, respectively. The assumed
rate of future compensation increases was 4% in both years. Plan assets are
primarily invested in U.S. and foreign equities and debt securities issued by
the U.S. government, U.S. corporations and foreign entities. The funded status
of the pension plans improved during 1996 as a result of favorable investment
returns, the increase in the discount rate, and discretionary contributions to
the plans by Armco.
- ------------------------------------------------------------------------------
Plans for which Plans for which
Assets Exceed Accumulated
Accumulated Benefits Total
1996 Benefits Exceed Assets All Plans
- ------------------------------------------------------------------------------
Actuarial present value of benefit
obligations:
Vested benefits $1,242.3 $ 705.6 $1,947.9
Nonvested benefits 33.2 8.2 41.4
- ------------------------------------------------------------------------------
Accumulated benefit obligation $1,275.5 $ 713.8 $1,989.3
- ------------------------------------------------------------------------------
Projected benefit obligation $1,283.5 $ 716.8 $2,000.3
Plan assets at fair value 1,316.1 691.4 2,007.5
- ------------------------------------------------------------------------------
Projected benefit obligation greater
(less) than plan assets (32.6) 25.4 (7.2)
Reconciliation of funded status to
recorded amounts:
Unrecognized negative prior service (cost) 4.0 (8.5) (4.5)
Unrecognized net gain 148.6 82.3 230.9
Unrecognized transition obligation (29.7) (4.0) (33.7)
Amount required to recognize minimum
liability -- 8.2 8.2
- ------------------------------------------------------------------------------
Accrued pension liability $ 90.3 $ 103.4 $ 193.7
- ------------------------------------------------------------------------------
1995
- ------------------------------------------------------------------------------
Actuarial present value of benefit
obligations:
Vested benefits $ 3.8 $2,015.8 $2,019.6
Nonvested benefits 0.1 54.7 54.8
- ------------------------------------------------------------------------------
Accumulated benefit obligation $ 3.9 $2,070.5 $2,074.4
- ------------------------------------------------------------------------------
Projected benefit obligation $ 5.2 $2,097.5 $2,102.7
Plan assets at fair value 4.9 1,908.6 1,913.5
- ------------------------------------------------------------------------------
Projected benefit obligation greater than
plan assets 0.3 188.9 189.2
Reconciliation of funded status to recorded
amounts:
Unrecognized negative prior service -- 7.6 7.6
Unrecognized net gain (loss) (0.8) 56.6 55.8
Unrecognized transition obligation -- (40.0) (40.0)
Amount required to recognize minimum
liability -- 2.9 2.9
- ------------------------------------------------------------------------------
Accrued pension liability (benefit) $ (0.5) $ 216.0 $ 215.5
- ------------------------------------------------------------------------------
Retiree Health Care and Life Insurance Benefits
In addition to providing pension benefits, Armco provides various health care
and life insurance benefits to most retirees. Most employees become eligible
for these benefits when they retire. Retiree health and life insurance
benefits are funded as claims are paid.
The components of the net periodic postretirement benefit cost and assumptions
used to determine such expenses were as follows:
- ------------------------------------------------------------------------------
1996 1995 1994
- ------------------------------------------------------------------------------
Cost of benefits earned during the year $ 4.9 $ 5.6 $ 8.5
Interest cost on accumulated postretirement
benefit obligation 61.8 74.7 66.8
Amortization of plan changes (3.8) (3.7) (1.4)
- ------------------------------------------------------------------------------
Net periodic postretirement benefit cost $62.9 $76.6 $73.9
- ------------------------------------------------------------------------------
Weighted average discount rate 7.00% 8.50% 7.25%
Current year health care trend rate - Pre-age 65 9.25% 10.25% 11.25%
Current year health care trend rate - Post-age 64 7.25% 8.25% 8.25%
Ultimate health care trend rate 5.00% 6.50% 5.25%
Weighted average trend rate 5.60% 7.30% 6.25%
- ------------------------------------------------------------------------------
Net periodic postretirement benefit cost in 1996 decreased primarily due to
the lower discount rate and additional plan amendments.
Net curtailment gains (losses) on postretirement benefits of $10.2 in 1995 and
$(0.8) in 1994 were not included in net periodic postretirement benefit cost.
Total claims paid were approximately $55.2 in 1996, $64.0 in 1995 and $62.6 in
1994.
The following table shows the funded status of the postretirement benefit
plans and the amounts recognized in the Statement of Consolidated Financial
Position as of December 31, 1996 and 1995:
- ------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------
Accumulated postretirement benefit obligation:
Retirees $ 672.0 $ 753.5
Fully eligible active plan participants 59.7 84.2
Other active plan participants 51.5 77.4
- ------------------------------------------------------------------------------
Total 783.2 915.1
Plan assets at fair value -- --
- ------------------------------------------------------------------------------
Accumulated postretirement benefit obligation
in excess of plan assets 783.2 915.1
Reconciliation of obligation to recorded amounts:
Unrecognized negative prior service 76.7 49.2
Unrecognized net gains 190.3 78.3
- ------------------------------------------------------------------------------
Accrued postretirement benefit liability $1,050.2 $1,042.6
- ------------------------------------------------------------------------------
Assumptions used to determine obligation:
Discount rate 7.75% 7.00%
Current year health care trend rate - Pre-age 65 8.25% 9.25%
Current year health care trend rate - Post-age 64 6.25% 7.25%
Ultimate health care trend rate 5.75% 5.00%
Weighted average trend rate 6.00% 5.60%
- ------------------------------------------------------------------------------
28
The accumulated postretirement benefit obligation decreased in 1996 primarily
due to favorable claims experience, use of Medicare risk HMO's beginning in
1996, and certain changes in retiree benefit programs.
The current year health care trend rates are assumed to decrease one
percentage point per year until they reach the ultimate rate. A one percentage
point increase in the assumed health care trend rate would increase the
accumulated postretirement benefit obligation as of December 31, 1996 by
approximately $70.0, and increase the annual net periodic postretirement
benefit cost by approximately $7.0.
Employee Benefit Obligations of Former Business Units
Armco has recorded, in its employee benefit obligations, the present value of
estimated pension and health care benefits for former employees associated
with facilities that have been divested. Sundry other-net includes interest
costs of $22.1, $38.5 and $35.8 in 1996, 1995 and 1994, respectively, related
to these liabilities. The decrease in costs in 1996 was primarily due to
increased funding of the pension plans during 1995 and 1996 and lower interest
rates on Armco's accrued other postretirement benefit obligations.
3 INCOME TAXES
Armco files a consolidated U. S. federal income tax return. This return
includes all domestic companies 80% or more owned by Armco and the
proportionate share of Armco's interest in partnership investments. State tax
returns are filed on a consolidated, combined or separate basis depending on
the applicable laws relating to Armco and its domestic subsidiaries.
The United States and foreign components of Income before income taxes consist
of the following:
- ------------------------------------------------------------------------------
1996 1995 1994
- ------------------------------------------------------------------------------
United States $24.4 $22.8 $ 36.0
Foreign 3.0 2.7 1.1
- ------------------------------------------------------------------------------
Total $27.4 $25.5 $ 37.1
- ------------------------------------------------------------------------------
Provisions (credits) for income taxes for Armco and consolidated subsidiaries
are as follows:
- ------------------------------------------------------------------------------
1996 1995 1994
- ------------------------------------------------------------------------------
Current:
U. S. state $ -- $ 0.8 $ 0.8
Foreign 1.4 1.2 0.5
- ------------------------------------------------------------------------------
Total 1.4 2.0 1.3
Deferred:
U.S. federal -- -- (27.3)
U. S. state -- -- (2.7)
- ------------------------------------------------------------------------------
Total -- -- (30.0)
- ------------------------------------------------------------------------------
Provision (credit) for income taxes $ 1.4 $ 2.0 $(28.7)
- ------------------------------------------------------------------------------
The following is a reconciliation of the statutory federal income tax rate
applied to pretax book income with the provision for income taxes in the
Statement of Consolidated Income for the year 1996:
- ------------------------------------------------------------------------------
Federal taxes at statutory rate $ 9.6
State income taxes, net of federal benefit 1.6
Reduction in deferred tax valuation allowance (9.8)
- ------------------------------------------------------------------------------
Provision for income taxes $ 1.4
- ------------------------------------------------------------------------------
During 1996, Armco's capital loss carryforward increased by $45.0 due to a tax
loss associated with the sale of National-Oilwell (Note 11). Net operating
loss carryforwards increased due to the $43.0 net operating loss for tax
purposes incurred in 1996. The difference between the pretax book income of
$27.4 and the 1996 tax loss of $43.0 is primarily due to costs associated with
employee benefits, pensions and restructuring actions, which had been accrued
for financial accounting purposes in prior years, but actually paid in 1996.
Tax basis depreciation for the year, which exceeded depreciation expense
recorded on the books, was another key factor contributing to the tax loss.
In 1994, the income tax benefit recognized of $28.7 was primarily the result
of decreasing the beginning balance of the deferred tax asset valuation
allowance by $30.0 due to the effects, including the elimination of Armco
Steel Company's (ASC) (Note 10) estimated future taxable losses, that the
initial public offering and recapitalization of ASC had on management's
assessment of the amount of deferred tax asset that is more likely than not to
be realized in the future.
At December 31, 1996, Armco had capital and net operating loss (NOL)
carryforwards for federal tax purposes expiring as follows:
- ------------------------------------------------------------------------------
Year Capital
expires losses NOL
- ------------------------------------------------------------------------------
1998 $ 56.0 $ 59.7
1999 -- 106.7
2000 117.4 --
2001 45.0 123.3
2004 -- 9.1
2005 -- 130.3
2006 -- 239.3
2007 -- 186.9
2008 -- 133.3
2009 -- 35.4
2010 -- 53.5
2011 -- 43.0
- ------------------------------------------------------------------------------
Total loss carryforwards $218.4 $1,120.5
- ------------------------------------------------------------------------------
Armco has $797.0 in U.S. alternative minimum tax net operating losses.
Additionally, Armco has $11.4 of alternative minimum tax credits that have no
expiration.
29
RESTORING EARNINGS POWER
Deferred income taxes reflect the net tax effects of (a) temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes and (b) operating loss
and tax credit carryforwards. At December 31, 1996 and 1995, the net deferred
tax asset, included in the Statement of Consolidated Financial Position, was
as follows:
- ------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------
Other current assets $ 2.7 $ 2.4
Deferred tax asset 325.8 326.1
- ------------------------------------------------------------------------------
Net deferred tax asset $328.5 $328.5
- ------------------------------------------------------------------------------
Major components of Armco's net deferred tax asset are as follows:
- ------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------
Tax effects of:
Operating loss and tax credit carryforwards $ 539.5 $ 480.6
Employee benefits 565.4 576.9
Other assets (incl. contingencies and accruals) 159.0 214.0
- ------------------------------------------------------------------------------
Gross deferred tax asset 1,263.9 1,271.5
Valuation allowance (644.4) (669.1)
- ------------------------------------------------------------------------------
Deferred tax asset 619.5 602.4
Property, plant and equipment (138.4) (132.0)
Other liabilities (152.6) (141.9)
- ------------------------------------------------------------------------------
Deferred tax liabilities (291.0) (273.9)
- ------------------------------------------------------------------------------
Net deferred tax asset $ 328.5 $ 328.5
- ------------------------------------------------------------------------------
Even though Armco has incurred tax losses for the past seven fiscal years,
management believes that it is more likely than not that Armco will generate
taxable income sufficient to realize a portion of the tax benefit associated
with future deductible temporary differences and NOL carryforwards prior to
their expiration. This belief is based upon, among other factors, changes in
operations that have occurred during the last five years, as well as
consideration of available tax planning strategies. Specifically, cost savings
associated with new capital investments are being realized and are expected to
continue to improve operating results. Armco has operated in a highly cyclical
industry and, consequently, has had a history of generating and then utilizing
significant amounts of NOL carryforwards. During the years 1987-1989, Armco
utilized approximately $350.0 of NOL carryforwards. However, management
believes that a valuation allowance is appropriate given the current estimates
of future taxable income. If Armco is unable to generate sufficient taxable
income in the future through operating results, increases in the valuation
allowance will be required through a charge to income. However, if Armco
achieves sufficient profitability to utilize a greater portion of the deferred
tax asset, the valuation allowance will be reduced through a credit to income.
United States income tax returns of Armco for 1992 and prior years have been
subject to examination by the Internal Revenue Service and are closed to
assessments. However, the NOL carryforwards from some of these years remain
open to adjustment. Armco has been in a cumulative net operating loss
carryforward position since 1983 and believes that it has sufficient loss
carryforwards in excess of any potential audit adjustments that might be made
by the Internal Revenue Service for any open years.
4 LONG-TERM DEBT AND OTHER FINANCING
Long-Term Debt
At December 31, 1996 and 1995, Armco's long-term debt, less current
maturities, was as follows:
- ------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------
Sinking fund debentures:
8.5% due 2001 $ 28.5 $ 35.0
9.2% due 2000 20.0 25.0
Notes payable:
9.375% due 2000 125.0 125.0
11.375% due 1999 100.0 100.0
Variable rate (LIBOR plus 2.75%) due 2001 31.2 38.6
5.0% due 2000 15.3 20.4
Pollution control revenue bonds due 2005 - 8.125% 12.1 13.2
Variable rate economic development revenue bonds
due 2020 (1996 average 3.71%) 8.5 --
Other 3.7 4.4
- ------------------------------------------------------------------------------
Total $344.3 $361.6
- ------------------------------------------------------------------------------
Maturities of existing long-term debt during the five years ending December
31, 2001, are as follows: 1997, $27.2; 1998, $27.4; 1999, $127.5; 2000,
$157.6; and 2001, $15.7.
At December 31, 1996, the fair value of Armco's long-term debt, including
current maturities, was approximately $369.0. This amount was determined by
calculating a value based on cash flow yield to maturity and comparing that
amount to market information where possible. The fair value estimate was based
on pertinent information available to management as of December 31, 1996.
Management is not aware of any significant factors that would materially alter
this estimate since that date. The fair value of Armco's long-term debt,
including current maturities, at December 31, 1995 was approximately $385.4.
At December 31, 1996 and 1995, $38.2 and $45.5, respectively, of long-term
debt, including current maturities, represented financing utilized to
construct the thin-slab caster at the Mansfield, Ohio facility. The caster is
pledged as collateral on these loans. At December 31, 1996 and 1995, $26.7 and
$29.6, respectively, of long-term debt, including current maturities, was
financing utilized to construct a cold rolling mill at Armco's Butler,
Pennsylvania facility. The cold rolling mill is pledged as collateral on this
loan.
30
Bank Credit Agreements
At December 31, 1996, Armco had in place two bank credit facilities, totaling
$170.0. Under a receivables facility, Armco sells substantially all its trade
receivables to a wholly owned subsidiary, Armco Funding Corporation (AFC). In
January 1996, AFC entered into a five-year revolving credit agreement with a
group of banks providing up to $120.0 for revolving credit loans and letters
of credit secured by AFC's receivables. At December 31, 1996, there were no
outstanding borrowings under this credit facility; however, $69.9 of the
facility was used as support for letters of credit.
In January 1996, Armco entered into a three-year revolving credit agreement
with a group of banks providing $50.0 for revolving credit loans secured by
Armco's inventories. This credit agreement subjects Armco to certain
restrictions and covenants related to, among other things, minimum working
capital, minimum net income, current ratio and interest coverage ratio
requirements. At December 31, 1996, there were no outstanding borrowings under
this credit facility.
Capitalized Interest
Armco capitalized interest on projects during construction of $0.8, $5.1 and
$4.5 in 1996, 1995 and 1994, respectively. Capitalized interest for 1995 and
1994 primarily relates to the construction of the thin-slab caster in
Mansfield, Ohio.
Long-Term Leases
Rental expense under operating leases was $7.7 in 1996, $7.7 in 1995 and $7.2
in 1994. At December 31, 1996, commitments to make future minimum lease
payments for operating leases are $7.6 in 1997, $5.2 in 1998, $3.4 in 1999,
$2.1 in 2000, $1.4 in 2001 and $1.7 in the year 2002 and thereafter.
5 SHAREHOLDERS' DEFICIT
Preferred Stock
Armco has outstanding two classes of preferred stock. The two classes rank
equally with respect to dividend payments, redemption and liquidation rights.
The preferred stock ranks senior to Armco's common stock with respect to
dividends and upon liquidation. At December 31, 1996 and 1995, there were
authorized and issuable in series, 6,697,231 shares of Class A preferred stock
with no par value and 5,000,000 shares of $1 par value Class B preferred
stock.
Armco has two series of Class A preferred stock outstanding. The $2.10 Class A
preferred stock pays cumulative dividends at the annual rate of $2.10 per
share. Shareholders of the $2.10 Class A preferred stock have one vote per
share and each share is convertible into 1.27 shares of Armco's common stock.
This series of Class A preferred stock may be redeemed at Armco's option for
$40 per share, plus accrued but unpaid dividends. The $2.10 Class A preferred
stock had a total involuntary liquidation value of $25.5 at December 31, 1996
and 1995.
The $3.625 Class A preferred stock pays cumulative dividends at the annual
rate of $3.625 per share. Shareholders of this series of Class A preferred
stock are entitled to one vote per share and each share is convertible into
6.78 shares of Armco's common stock. The $3.625 Class A preferred stock may be
redeemed at Armco's option at a current price of $52.175 per share, plus
accrued but unpaid dividends. This price declines at 12-month intervals, to
$50 per share on and after October 15, 2002. The $3.625 preferred Class A
stock had a total involuntary liquidation value of $135.0 at December 31, 1996
and 1995.
Armco's outstanding series of Class B preferred stock is nonvoting and pays
cumulative dividends at the annual rate of $4.50 per share. Each share is
convertible into 2.22 shares of Armco's common stock. The Class B preferred
stock may be redeemed at Armco's option for $50 per share, plus accrued but
unpaid dividends. The Class B preferred stock had a total involuntary
liquidation value of $50.0 at December 31, 1996 and 1995.
At December 31, 1996, 1995 and 1994, the number of shares outstanding and book
value of Class A preferred stock were 4,397,231 and $137.6. At December 31,
1996, 1995 and 1994, Armco had outstanding 999,900 shares of Class B preferred
stock with a book value of $48.3.
Common Stock
At December 31, 1996, 22,681,261 unissued shares of Armco's common stock were
reserved for the conversion of preferred stock and 3,536,258 unissued shares
of common stock were reserved for the exercise of stock options and other
stock awards (Note 6).
Activity for the years 1994, 1995 and 1996 related to Armco's common stock was
as follows:
- ------------------------------------------------------------------------------
Additional
Paid-in
Shares Par Value Capital
- ------------------------------------------------------------------------------
Balance, December 31, 1993 104,122,974 $ 1.0 $ 951.1
Exercise of options 29,378 -- 0.2
Restricted stock issued -
net of cancellations 512,260 0.1 2.4
Issued for employee savings plan 424,534 -- 2.6
- ------------------------------------------------------------------------------
Balance, December 31, 1994 105,089,146 1.1 956.3
Exercise of options 108,962 -- 0.5
Restricted stock issued -
net of cancellations 587,596 -- 4.1
Issued for employee savings plan 314,544 -- 2.1
Directors' stock purchase plan 2,312 -- --
- ------------------------------------------------------------------------------
Balance, December 31, 1995 106,102,560 1.1 963.0
Exercise of options 3,100 -- --
Restricted stock issued -
net of cancellations 347,313 -- 2.0
Directors' stock purchase plan 4,193 -- --
- ------------------------------------------------------------------------------
Balance, December 31, 1996 106,457,166 $ 1.1 $ 965.0
- ------------------------------------------------------------------------------
Shareholder Rights Plan
On February 23, 1996, Armco adopted a Shareholder Rights Plan designed to
deter coercive takeover tactics and prevent an acquirer from gaining control
of Armco without offering a fair price to all of Armco's shareholders. This
plan replaces the plan adopted by Armco in 1986, which expired in 1996.
31
RESTORING EARNINGS POWER
Under the terms of the plan, preferred stock purchase rights were distributed
as a dividend at the rate of one right for each share of common stock held as
of the close of business on June 26, 1996. Until the rights become
exercisable, common stock issued will also have one right attached. Each right
will entitle shareholders to buy one two-hundredth of a share of a currently
unissued series of Class A participating preferred stock of Armco at an
exercise price of $20. Each right will thereafter entitle the holder to
receive upon exercise, common stock or, in certain circumstances, preferred
stock or other securities or assets of the company having a value of $40. The
rights will be exercisable only if a person or group acquires beneficial
ownership of 20% or more of Armco's common stock or announces a tender or
exchange offer, after which such person or group would beneficially own 20% or
more of the common stock or if the Board of Directors declares any person to
be an "adverse person" as defined in the plan. A total of 750,000 shares of
Class A participating preferred stock have been reserved for issuance upon
exercise of the rights.
Armco, except as otherwise provided in the plan, will generally be able to
redeem the rights at $0.0025 per right at any time during a ten-day period
following public announcement that a 20% position in Armco has been acquired
or after the effective date the Board of Directors declares any person to be
an "adverse person." During this ten-day period, Armco may also extend the
time during which it may redeem the rights. The rights are not exercisable
until the expiration of the redemption period. The rights will expire on
June 26, 2006.
Dividends
Under the terms of the inventory credit facility (Note 4), Armco cannot pay
cash dividends on its common stock. In addition, under the terms of indentures
for Armco's 11.375% Senior Notes due 1999 and 9.375% Senior Notes due 2000,
Armco can pay a dividend on its common stock only if it meets certain
financial tests described in the indentures. Armco does not expect to satisfy
these tests and, therefore, Armco does not expect to be able to pay a common
stock dividend or repurchase its capital stock in the near future. The payment
of preferred stock dividends is prohibited if Armco is in default under the
credit facility.
Under Ohio law, at December 31, 1996, the surplus from which Armco is
permitted to pay dividends was $89.3. Under the terms of Ohio law, Armco is
currently not permitted to purchase shares of its capital stock.
The Board of Directors at its January 1997 meeting declared the regular
quarterly dividends payable on both series of Armco's Class A preferred stock
and on its Class B preferred stock.
Accumulated Deficit and Other Shareholders' Equity (Deficit)
Activity for the years 1994, 1995 and 1996 related to Armco's accumulated
deficit and other shareholders' equity (deficit) was as follows:
- ------------------------------------------------------------------------------
Net Unrealized
Accumulated Gains on
Deficit Equity Securities Other
- ------------------------------------------------------------------------------
Balance, December 31, 1993 $(1,450.3) $ -- $ (0.8)
Net income 77.7 -- --
Preferred stock dividends declared (17.8) -- --
Adjustment to net unrealized gains -- 31.6 --
Foreign currency translation adjustment -- -- 0.5
Deferred compensation on restricted
stock issued -- -- (2.7)
- ------------------------------------------------------------------------------
Balance, December 31, 1994 (1,390.4) 31.6 (3.0)
Net income 29.8 -- --
Preferred stock dividends declared (17.9) -- --
Sale of equity securities -- (31.6) --
Foreign currency translation adjustment -- -- 1.1
Amortization and cancellation of
deferred compensation -- -- 2.1
Deferred compensation on restricted
stock issued -- -- (2.1)
- ------------------------------------------------------------------------------
Balance, December 31, 1995 (1,378.5) -- (1.9)
Net income 32.5 -- --
Preferred stock dividends declared (17.9) -- --
National-Oilwell foreign currency
translation (Note 11) -- -- 1.4
Foreign currency translation adjustment -- -- (0.4)
Amortization and cancellation of
deferred compensation -- -- 2.0
Deferred compensation on restricted
stock issued -- -- (1.2)
- ------------------------------------------------------------------------------
Balance, December 31, 1996 $(1,363.9 ) $ -- $ (0.1 )
- ------------------------------------------------------------------------------
6 COMMON STOCK OPTIONS
Armco shareholders adopted Common Stock Option Plans in 1983 and 1988. In
addition, stock options may be granted under the 1993 and 1996 long-term
incentive plans. These plans provide for granting options to purchase common
stock for not less than 100% of the market price on the date the option is
granted. The 1983 and 1988 Plans have expired as to new grants. For
outstanding options containing stock appreciation rights, the excess of the
market price of the stock over the option price is accrued. The vesting period
for stock options granted under the long-term incentive plans is two years
from the date of grant and, although they may terminate earlier under certain
conditions, all stock options generally expire 10 years after the grant date.
The long-term incentive plans also provide for issuing stock, subject to
restrictions as to sale and forfeiture over a three to five-year period. As of
December 31, 1996, 2,686,640 shares of common stock were available for
granting of awards under the long-term incentive plans.
32
During 1994, 1995 and 1996, stock option activity was as follows:
- ------------------------------------------------------------------------------
Weighted Average
1994 Shares Exercise Price
- ------------------------------------------------------------------------------
Outstanding at January 1, 3,015,774 $ 8.98
Granted 464,000 4.75
Exercised (42,389) 4.98
Forfeited (23,750) 7.38
Expired (316,139) 12.57
- ------------------------------------------------------------------------------
Outstanding at December 31, 3,097,496 8.05
- ------------------------------------------------------------------------------
Exercisable at December 31, 2,241,996 8.85
- ------------------------------------------------------------------------------
1995
- ------------------------------------------------------------------------------
Outstanding at January 1, 3,097,496 $ 8.05
Granted 1,019,333 6.58
Exercised (347,646) 5.06
Forfeited (56,566) 6.23
Expired (519,100) 10.20
- ------------------------------------------------------------------------------
Outstanding at December 31, 3,193,517 7.58
- ------------------------------------------------------------------------------
Exercisable at December 31, 1,524,536 9.10
- ------------------------------------------------------------------------------
1996
- ------------------------------------------------------------------------------
Outstanding at January 1, 3,193,517 $ 7.58
Granted 947,158 5.24
Exercised (3,100) 4.94
Forfeited (159,645) 6.15
Expired (441,672) 9.38
- ------------------------------------------------------------------------------
Outstanding at December 31, 3,536,258 6.80
- ------------------------------------------------------------------------------
Exercisable at December 31, 1,741,811 7.66
- ------------------------------------------------------------------------------
The following relates to the options outstanding at December 31, 1996:
- ------------------------------------------------------------------------------
Exercise Price Ranges
$4.56 - $7.56 $10.13 - $13.69
- ------------------------------------------------------------------------------
Options outstanding:
Number of shares 2,984,758 551,500
Weighted average exercise price $5.90 $11.65
Average remaining contractual life 7 years 2 years
Options exercisable:
Number of shares 1,190,311 551,500
Weighted average exercise price $5.82 $11.65
- ------------------------------------------------------------------------------
In 1996, Armco adopted SFAS No. 123, Accounting for Stock-Based Compensation.
SFAS No. 123 provides that companies may choose to change their method of
accounting for stock options to a fair value method using an option pricing
model. Armco uses the intrinsic value approach specified in Accounting
Principle Board Opinion No. 25 in accounting for stock options and did not
change from this method upon adoption of the new standard. Had Armco changed
its accounting method, its net income for 1996 would have been reduced by $1.7
to $30.8, or $.12 per share. Net income for 1995 would have been reduced by
$1.3 to $28.5, or $.10 per share. These pro forma adjustments were calculated
using the Black-Scholes option pricing model to value all stock options
granted since January 1, 1995, under the following assumptions in each year:
- ------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------
Risk free interest rate 5.5% 7.75%
Expected volatility 30% 35%
Expected life of options 5 years 5 years
Expected dividends none none
- ------------------------------------------------------------------------------
Based on the option pricing model, options granted during 1996, 1995 and 1994
had fair values of $1.90, $2.91 and $1.93 per share, respectively.
During 1996, 1995 and 1994, Armco issued to certain employees 570,158, 660,762
and 534,060 shares of common stock, subject to restrictions, with weighted-
average grant-date fair values of $5.69, $6.63 and $4.75 per share,
respectively. Total compensation cost recognized in income for stock-based
employee compensation awards was $1.1 in 1996, $2.2 in 1995 and $1.3 in 1994.
33
RESTORING EARNINGS POWER
7 SEGMENT INFORMATION
The following are Armco's business segments: (1) Specialty Flat-Rolled Steels,
consisting of plants in Butler, Pennsylvania and Coshocton, Dover, Mansfield
and Zanesville, Ohio that produce flat-rolled stainless, electrical and carbon
steels for the automotive, industrial machinery and equipment, construction
and service center markets; international trading companies, that buy and sell
steel and manufactured steel products; and, until September 30, 1994, a
stainless steel plate producer; and (2) Fabricated Products, consisting of
operations in Sharon and Wheatland, Pennsylvania and Warren, Ohio that produce
steel tubular products for the industrial machinery, construction and
appliance markets, as well as plants in Milwaukee, Wisconsin, Rockland, Maine
and Johnson City, Tennessee, that manufacture snowplows and ice control
equipment for light trucks, including four-wheel drive pickup trucks and
utility vehicles.
Armco's industry segment information is as follows:
- ------------------------------------------------------------------------------
1996 1995 1994
- ------------------------------------------------------------------------------
Customer sales:
Specialty Flat-Rolled Steels $1,421.2 $1,277.0 $1,114.4
Fabricated Products 302.8 282.9 323.2
- ------------------------------------------------------------------------------
Total $1,724.0 $1,559.9 $1,437.6
- ------------------------------------------------------------------------------
Operating profit: (1)
Specialty Flat-Rolled Steels $72.9 $76.0 $40.5
Fabricated Products 22.8 22.0 30.9
Corporate general (21.0) (29.0) (32.2)
- ------------------------------------------------------------------------------
Total $ 74.7 $ 69.0 $ 39.2
- ------------------------------------------------------------------------------
Capital expenditures:
Specialty Flat-Rolled Steels $ 55.9 $ 153.6 $ 89.4
Fabricated Products 3.1 5.3 6.2
Corporate general 0.8 0.6 0.8
- ------------------------------------------------------------------------------
Total $ 59.8 $ 159.5 $ 96.4
- ------------------------------------------------------------------------------
Depreciation:
Specialty Flat-Rolled Steels $ 50.4 $ 43.4 $ 40.2
Fabricated Products 6.7 7.6 6.6
Corporate general 1.6 1.8 2.0
- ------------------------------------------------------------------------------
Total $ 58.7 $ 52.8 $ 48.8
- ------------------------------------------------------------------------------
Identifiable assets:
Specialty Flat-Rolled Steels $1,052.1 $1,034.8 $ 871.0
Fabricated Products 163.2 173.0 190.9
Corporate general (2) 566.9 517.7 696.4
Discontinued operations 85.6 171.1 176.6
- ------------------------------------------------------------------------------
Total $1,867.8 $1,896.6 $1,934.9
- ------------------------------------------------------------------------------
<FN>
(1) In 1996, operating profit for the Fabricated Products segment includes
special charges totaling $8.8. In 1994, operating profit for the Specialty
Flat-Rolled Steels segment includes special charges totaling $35.0. (See Note
8).
(2) Corporate general identifiable assets at December 31, 1996 includes $163.0
of cash and cash equivalents and deferred tax assets of $328.5 (See Note 3).
During 1996 and 1995, operations in the Specialty Flat-Rolled Steels segment
sold $2.5 and $5.6, respectively, of its products to the Fabricated Products
segment. Sales from the Fabricated Products segment to the Specialty Flat-
Rolled Steels segment were not material. Sales between foreign and domestic
companies are also not material. Intersegment sales are eliminated in
consolidation and prices generally approximate cost.
8 SPECIAL CHARGES
In the fourth quarter of 1996, Armco recognized a special charge of $5.9 to
record a change in the estimated loss on the sale of its nonresidential
construction business. In 1993, Armco decided to exit this business, along
with several other operations. Armco continued to operate the construction
business while attempting to complete a sale. In 1996, Armco negotiated a sale
agreement and the business was sold effective January 1, 1997. Based on the
agreement, the 1996 charge primarily relates to the writedown of certain
assets and recognition of additional employee benefit liabilities.
Also in the fourth quarter of 1996, Armco recorded a $2.9 special charge
primarily for the writedown of inventory and severance costs related to its
decision to discontinue a line of light truck equipment manufactured by
Armco's snowplow and ice control equipment business.
In 1994, Armco recorded a special charge of $20.0 for expenses associated with
the temporary idling and restructuring of its steelmaking facilities in
Mansfield and Dover, Ohio. The decision to idle the facilities came after the
failure of a key piece of equipment at the Mansfield plant crippled
production, and management undertook a study to determine if losses could be
reduced by idling the facilities. These facilities were idled commencing in
March 1994. The Dover plant started limited production in early 1995 and by
mid-year was fully operational. The Mansfield plant remained idle until
construction of a new thin-slab continuous caster and renovation of its hot
strip mill were completed late in the first quarter of 1995. The special
charge consisted of $11.2 for employee benefits, primarily group insurance and
supplemental unemployment benefits; and $8.8 to write down inventories and
fixed assets. Reserves established for these charges have been used for their
intended purpose.
Also in 1994, Armco recognized a charge of $15.0 related to a decision by
Eastern Stainless Corporation to sell substantially all of its assets to
Avesta Sheffield Holding Company, a stainless steel plate manufacturer, for
cash and the assumption of certain liabilities. The sale closed on March 14,
1995. Approximately $8.6 of the charge was to cover increases in pension and
other employee benefit obligations, $1.8 was for the writedown of assets and
$4.6 was for operating losses, transaction fees and expenses. At December 31,
1996, the nonemployee benefit reserves had been used for their intended
purposes, while the pension and other employee benefit liabilities will be
paid out over many years.
34
9 LITIGATION AND ENVIRONMENTAL MATTERS
There are various claims pending involving Armco and its subsidiaries
regarding product liability, patent, employee benefits, antitrust,
environmental matters, reinsurance and insurance arrangements, and other
matters arising out of the conduct of Armco's business. The actual liability
for legal claims against Armco at December 31, 1996 cannot be determined; but
in Armco's opinion, based on current facts and circumstances, the ultimate
liability resulting from such claims will not materially affect its
consolidated financial position or liquidity. However, it is possible that due
to fluctuations in Armco's operating results, future developments with respect
to such matters could have a material effect on the results of operations in
future interim or annual periods.
Like other manufacturers, Armco is subject to various environmental laws.
These laws necessitate expenditures to meet environmental compliance
requirements at Armco's facilities and to remediate sites where contamination
has occurred. Compliance costs are either expensed as they are incurred or,
when appropriate, are recorded as capital expenditures. Environmental exit
costs are accrued when a decision is made to dispose of a property.
Armco is a defendant or a potentially responsible party in proceedings
alleging liability for remediation, property damage or personal injury related
to certain past waste disposal sites. Armco has also received claims for
indemnification for some properties it has previously owned or leased. In most
cases involving waste disposal sites, Armco is one of many potentially
responsible parties. In these cases, joint and several liability could be
imposed on Armco or other parties; thus, theoretically, one party could be
held liable for all costs related to a site. However, based on its experience
and a review of current claims, Armco believes that any ultimate liability
will be apportioned between Armco and other financially viable parties,
generally on the basis of volume and/or toxicity of wastes disposed at the
specific sites. While such actions are being contested, the outcome of
individual matters cannot be predicted with assurance. Armco accrues its
estimate of remediation and other costs for sites where it is probable that a
liability has been incurred and the amount can be reasonably estimated.
In establishing reserves, Armco assesses the range of possible liability and
determines the most likely outcome for its liabilities within the range of
reasonably estimated outcomes. Costs are estimated based on experience with
site remediation, an understanding of current environmental laws and
regulations, environmental assessments, the existence of other financially
viable parties, expected remediation methods and the years in which Armco is
expected to make payments toward each remediation (which range from the
current year to 30 years or more in the future). Liabilities are not
discounted. These estimates are reviewed quarterly to assess changed
conditions, including current interpretation of environmental laws and
regulations. Adjustments are made if changed conditions have a significant
effect on cost estimates. Reserves have not been adjusted for expected
recoveries from insurers or other parties.
The recorded amounts are currently believed by management to be sufficient.
However, such estimates could significantly change in future periods to
reflect new laws or regulations, advances in technologies, additional sites
requiring remediation, new requirements at existing sites and Armco's share of
liability at multi-party sites. It is not possible to determine whether
additional loss, due to such changed circumstances, will occur or to
reasonably estimate the amount or range of any potential additional loss.
Armco believes, based on current facts and circumstances known to Armco, that
the ultimate liability for pending claims, contingent liabilities and
environmental matters identified to date will not materially affect its
consolidated financial condition or liquidity. However, it is possible that,
due to fluctuations in Armco's operating results, future developments with
respect to such matters could have a material effect on the results of
operations in future interim or annual periods.
At December 31, 1996, Armco had recorded, in its Statement of Consolidated
Financial Position, $17.5 in Other accruals and $67.0 in Other liabilities for
estimated probable costs relating to legal and environmental matters.
10 OTHER INVESTMENTS
Armco Steel Company, L.P. (ASC)
On April 7, 1994, ASC, a limited partnership 50% owned by a subsidiary of
Armco, completed an initial public offering and recapitalization. As part of
this transaction, the business and assets of ASC were transferred to AK Steel
Holding Corporation, a newly formed, publicly traded company. In exchange for
its interest in ASC, Armco received 1,023,987 shares of AK Steel common stock,
representing approximately four percent of the outstanding shares. The number
of shares received and other terms of the restructuring and recapitalization
were determined by arm's-length negotiations.
As a result of the transaction, in 1994 Armco recognized a nonrecurring pretax
gain of $36.5, primarily as a result of its release from certain obligations
to make future cash payments to the former joint venture and recognition of
deferred pension curtailment gains established at ASC's formation. At the same
time, Armco reevaluated its deferred tax asset position in light of this
transaction and concluded that the amount of deferred tax asset, for which
realization of a future benefit was more likely than not, had increased by
$30.0. This amount was recorded as a tax benefit.
In 1995, Armco sold all of the shares in AK Steel it had received as a result
of the initial public offering and recapitalization for a total of $27.2,
recognizing a gain of the same amount.
Under a toll-rolling agreement that is in effect through the year 2002, AK
Steel hot rolls stainless steel for Armco.
35
RESTORING EARNINGS POWER
North American Stainless (NAS)
Armco and Acerinox S.A. of Spain each owned a 50% partnership interest in NAS
through their respective subsidiaries, First Stainless, Inc. and Stainless
Steel Invest, Inc. In 1994, First Stainless, Inc. sold 90% of its 50% equity
interest in NAS to its partner for $73.0 in cash, recording a $26.1 gain on
the sale. In connection with the transaction, Armco entered into an annual
supply contract with NAS to provide the former joint venture with semi-
finished stainless steel at market prices.
11 DISCONTINUED OPERATIONS
Aerospace and Strategic Materials
Oregon Metallurgical Corporation (Oremet), formerly 80% owned by Armco, was
part of the Aerospace and Strategic Materials business segment that Armco sold
in 1985. Prior to the sale, Armco filed a suit on behalf of Oremet in the U.S.
Claims Court, claiming refunds and interest on federal and state taxes.
Pursuant to the sales agreement, Armco retained the benefit of its share of
any proceeds of this action, net of taxes imposed on Oremet and the buyer. In
1988, as a result of a settlement with the Internal Revenue Service (IRS),
Armco recorded a $15.2 net of tax adjustment to its gain on the sale of this
business segment. In 1996, Armco and Oremet reached agreement with the IRS
that the 1988 refund of taxes and interest should not itself have been taxable
to Oremet, further increasing the net proceeds, and resulting in Armco
recording an additional $6.5 gain on the sale.
National-Oilwell
National-Oilwell, which sells oil field tubular pipe, and produces and sells
drilling and production equipment and process pumps used in the world's oil
and gas services industry, was a joint venture equally owned by subsidiaries
of Armco and USX Corporation.
Armco and USX reached a definitive agreement, dated September 22, 1995, to
sell their respective partnership interests in National-Oilwell to an entity
formed by Duff & Phelps/Inverness, First Reserve Funds and National-Oilwell
management. The sale was completed on January 16, 1996. For its 50% interest,
Armco received $77.0 in cash, and receivables with a face value of $13.0. The
receivables were recorded at a discounted value of $10.6. After recording $2.1
for recognition of deferred foreign translation losses and miscellaneous
expenses, no gain or loss was recognized on the transaction.
Armco recognized equity income from National-Oilwell until September 22, 1995,
when the definitive agreement was signed. After that date, Armco's investment
in National-Oilwell was equal to its estimated net realizable value and no
additional equity income was recorded. The results of National-Oilwell are
reported as discontinued operations in the Statement of Consolidated Income.
Armco Financial Services Group (AFSG)
AFSG consists of insurance companies that have stopped writing new business
and are being liquidated. These companies are accounted for as discontinued
operations under the liquidation basis of accounting, whereby all future cash
inflows and outflows are considered. Armco believes, based on current facts
and circumstances, including the opinion of outside actuaries, that future
changes in estimates of net losses relating to the ultimate liquidation of
AFSG will not be material to Armco's financial position or liquidity. The
following sets forth AFSG's summarized financial information at December 31,
1996:
- ------------------------------------------------------------------------------
Assets:
Invested assets $172.3
Reinsurance recoverable 107.4
Other 18.2
- ------------------------------------------------------------------------------
Total assets 297.9
- ------------------------------------------------------------------------------
Liabilities:
Losses and loss reserves (net of future investment
income of $45.3) 184.9
Other 27.4
- ------------------------------------------------------------------------------
Total liabilities 212.3
- ------------------------------------------------------------------------------
Net assets $ 85.6
- ------------------------------------------------------------------------------
Currently, insurance regulators having supervisory authority over the AFSG
companies retain substantial control over certain transactions, including the
payment of dividends to Armco.
There are various pending matters relating to litigation, arbitration and
regulatory affairs, including matters related to Northwestern National
Insurance Company, an AFSG company currently involved in, among other matters,
litigation with respect to certain reinsurance programs. The ultimate
liability from such matters at December 31, 1996 cannot be determined; but, in
Armco's opinion, based on current facts and circumstances and the views of
outside counsel and advisors, any liability resulting will not materially
affect Armco's financial position or liquidity. However, it is possible that
due to fluctuations in Armco's results, future developments with respect to
changes in the ultimate liability could have a material effect on future
interim or annual results of operations.
36
12 QUARTERLY INFORMATION (Unaudited)
- ------------------------------------------------------------------------------
4th 3rd 2nd 1st
1996: Year Qtr. Qtr. Qtr. Qtr.
- ------------------------------------------------------------------------------
Net sales $ 1,724.0 $ 413.6 $ 429.2 $ 450.8 $ 430.4
Cost of products sold (1,549.7) (360.0) (381.2) (415.6) (392.9)
Special charges (1) (8.8) (8.8) -- -- --
Income from discontinued
operation (2) 6.5 -- 6.5 -- --
Net income (loss) 32.5 13.2 16.4 (4.0) 6.9
Per share:
Income from discontinued
operation 0.06 -- 0.06 -- --
Net income (loss) 0.14 0.08 0.11 (0.08) 0.02
- ------------------------------------------------------------------------------
1995:
- ------------------------------------------------------------------------------
Net sales $ 1,559.9 $ 396.8 $ 404.1 $ 390.6 $ 368.4
Cost of products sold (1,392.7) (358.9) (364.1) (342.0) (327.7)
Gain on sale of
stock (3) 27.2 -- -- 25.9 1.3
Income from discontinued
operation (2) 6.3 -- 2.0 2.8 1.5
Net income (loss) 29.8 (8.4) (0.1) 35.9 2.4
Per share:
Income from discontinued
operation 0.06 -- 0.02 0.03 0.01
Net income (loss) 0.11 (0.12) (0.04) 0.30 (0.02)
- ------------------------------------------------------------------------------
<FN>
(1) See Note 8.
(2) See Note 11.
(3) See Note 10.
PRICE RANGE AND DIVIDENDS OF ARMCO STOCK (Unaudited)
- ------------------------------------------------------------------------------
1st 2nd 3rd 4th
Qtr. Qtr. Qtr. Qtr
- ------------------------------------------------------------------------------
Common Stock
1996 price per share: High $ 6 1/2 $ 6 $ 5 1/8 $ 4 5/8
Low 5 1/4 4 3/4 4 1/8 3 5/8
1995 price per share: High 7 1/4 7 1/2 7 3/4 6 1/2
Low 6 1/8 6 5 7/8 5 3/8
- ------------------------------------------------------------------------------
Preferred Stock Class A $2.10
Quarterly dividend per share: .525
1996 price per share: High 24 1/2 24 1/4 23 5/8 24
Low 23 1/2 22 3/4 22 22 1/8
1995 price per share: High 23 3/8 24 1/8 26 1/4 25 3/8
Low 20 22 1/4 22 7/8 23 3/8
- ------------------------------------------------------------------------------
Preferred Stock Class A $3.625
Quarterly dividend per share: .90625
1996 price per share: High 52 51 1/4 47 3/8 45 1/4
Low 49 5/8 47 44 1/4 42 3/8
1995 price per share: High 54 1/4 56 1/4 57 3/4 51 7/8
Low 48 3/8 48 49 3/8 47 5/8
- ------------------------------------------------------------------------------
Preferred Stock Class B $4.50
Quarterly dividend per share: 1.125
1996 price per share: High 49 3/8 49 3/4 47 5/8 47 1/2
Low 47 1/2 46 3/4 45 3/4 45 3/8
1995 price per share: High 46 3/4 49 1/4 50 3/8 49 1/4
Low 41 1/2 45 5/8 48 5/8 47
- ------------------------------------------------------------------------------
37