EXHIBIT 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three Years Ended December 31, 1997
(Dollars in millions, except per share data)
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GENERAL
This discussion and analysis of Armco's financial results should be read
together with the Consolidated Financial Statements and Notes on pages 25
through 38.
Operating Results
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- ----------------------------------------------------------------------
1997 1996 1995
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Net sales $1,829.3 $1,724.0 $1,559.9
Special charges -- (8.8) --
Operating profit 105.4 74.7 69.0
Gain on sale of AK Steel stock -- -- 27.2
Sundry other - net (1.1) (21.1) (49.6)
Income from continuing operations 77.1 26.0 23.5
Income from discontinued operations 2.7 6.5 6.3
Extraordinary loss on retirement
of debt (3.0) -- --
Net income 76.8 32.5 29.8
Net income per common share* 0.55 0.14 0.11
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<FN>
* Basic and diluted earnings per share are equal.
1997 vs. 1996: Armco's 1997 net sales increased 6% over 1996 primarily as a
result of higher shipments of specialty steels and tubular products. Partially
offsetting the higher shipments of specialty steel products was a decline in
prices across the stainless and electrical steel product lines, primarily due
to intense global competition.
Operating profit increased 41% in 1997 primarily as a result of lower costs in
the manufacturing operations, the consolidation of Greens Port Industrial
Park, which in the prior year was an investment held for sale, and lower
employee benefit expenses. Benefit expenses were lower as a result of
favorable investment returns on pension plan assets and lower than expected
increases in medical benefit costs.
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 LLC, Armco's snowplow and ice control products manufacturer.
Operating profit in 1996 also included nonrecurring income of $8.6 from claim
settlements, including a business interruption insurance claim.
Income from continuing operations in 1997 included a $4.0 gain on the
settlement of certain partially impaired long-term receivables. Included in
Income from continuing operations for 1996 were the above-mentioned special
charges and claim settlements and a $6.3 gain, which resulted from the
recognition of gains in connection with asset sales at Greens Port.
18 Armco Annual Report
Sundry other - net expense decreased in 1997 as a result of lower expenses
related to long-term benefit obligations for former employees of Armco
facilities that have been shut down or divested. The reductions were a result
of favorable investment returns on pension plan assets and lower than expected
increases in medical benefit costs.
Income from discontinued operations consisted of additional gains on the sale
of Armco's Aerospace and Strategic Materials business segment of $2.7 in 1997
and $6.5 in 1996 related to tax settlements subsequent to the sale of the
business.
During 1997, Armco issued $150.0 of 9% Senior Notes due 2007, using the
proceeds to retire several existing debt issues. Armco recorded a $3.0
extraordinary loss upon retiring certain of this outstanding debt.
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.
Operating profit increased 8% in 1996 due to a 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 expenses.
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. The decrease in Mansfield and Dover
operating losses reflected 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.
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, LP, recognizing a gain of $27.2.
Sundry other - net expense decreased in 1996 from 1995 as a result of lower
employee benefit expenses related to facilities that have been divested or
shut down and the $6.3 gain related to Greens Port asset sales. Employee
benefit expenses were lower primarily due to increased funding of the pension
plans during 1995 and 1996 and lower interest rates on Armco's accrued other
postretirement benefit liabilities.
In 1995, Armco recognized, in income from discontinued operations, equity
income of $6.3 from National-Oilwell, a joint venture divested in January
1996.
Armco Annual Report 19
Outlook for 1998: Armco expects modest volume increases and further cost
reductions in the Specialty Flat-Rolled Steels segment, but anticipates no
immediate relief from import-driven competitive pricing. Overall results for
the Fabricated Products segment are expected to be somewhat lower in 1998
compared to 1997. Favorable trends with respect to lower employee benefit
expenses should continue in 1998.
BUSINESS SEGMENT RESULTS
Specialty Flat-Rolled Steels
- ----------------------------
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1997 1996 1995
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Customer sales $1,497.0 $1,421.2 $1,277.0
Operating profit 88.6 72.9 76.0
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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.
Customer sales and shipments by major product line and annual production were:
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1997 1996 1995
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(tons in thousands) Sales Tons Sales Tons Sales Tons
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Specialty flat-rolled* $1,103.0 757 $1,108.0 739 $1,013.3 647
Specialty semi-finished 198.8 168 133.9 97 130.5 78
Galvanized and other carbon 165.1 306 144.2 304 94.1 214
Other 30.1 -- 35.1 -- 39.1 --
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Total $1,497.0 1,231 $1,421.2 1,140 $1,277.0 939
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Cast production 1,448 1,439 1,153
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<FN>
* The Specialty flat-rolled product line consists of automotive exhaust
stainless, specialty sheet and strip, and electrical steels.
1997 vs. 1996: Customer sales in 1997 were 5% higher than in 1996 on an 8%
increase in tons shipped. A decrease in the segment's overall average sales
per ton resulted from increased shipments of lower priced specialty semi-
finished steels, partially offset by a change in the mix of carbon steel
shipments from hot bands to higher priced galvanized steel products.
A 3% reduction in average sales per ton of specialty flat-rolled products
reflected increased import competition on certain grades of chrome nickel
stainless and cold rolled non-oriented electrical steels and elimination of
most of the remaining surcharges on stainless steel. 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. Such surcharges
were minimal in 1997 and the second half of 1996.
Specialty semi-finished shipments increased substantially in 1997 over 1996,
primarily as a result of increased sales of chrome nickel hot bands. However,
a 14% reduction in average sales per ton reflected worldwide overcapacity.
Shipments of galvanized carbon steel increased in 1997, but the increased tons
were offset by the elimination of carbon hot band shipments. In the first half
of 1996, Armco exited the lower priced hot band market, shifting to higher
priced galvanized steel products and thus increasing average sales per ton by
14% in the year-to-year comparison.
Specialty Flat-Rolled Steels' 1996 operating profit included $8.6 of income
from various claim settlements, including a business interruption insurance
claim. Excluding the claim settlements, operating profit increased in 1997
primarily as a result of lower costs due to facilities upgrades, more stable
operating conditions and lower employee benefit expenses. Costs in 1996 were
adversely affected by several planned 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 substantially increased its use of
outside processors to finish some of its stainless steels, resulting in higher
costs.
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 higher operating
levels at Mansfield compared with 1995, which was a ramp-up period following a
year-long idling for installation of new equipment. The higher operating
levels were achieved despite several planned outages necessary to complete
additional equipment upgrades.
Shipments of specialty flat-rolled steel products increased 14% in 1996 over
1995 driven by strong production of North American vehicles and housing
starts. Partially offsetting the stronger demand for automotive exhaust
stainless and grain oriented electrical steels were lower shipments of non-
oriented electrical steel and specialty sheet and strip, which were both
adversely affected by import competition. Specialty semi-finished shipments
also increased in 1996, primarily in export sales. However, prices for most
stainless steel products, including semi-finished, fell in 1996 primarily due
to pressure from imported steel and reductions in raw material surcharges.
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 stainless steels and semi-finished products and
several planned outages necessary to complete equipment upgrades.
Outlook for 1998: Armco anticipates modest increases in volume and further
cost reductions for most product lines during the next twelve months. However,
during that period, excess global capacity and higher levels of import
penetration are expected to have a continued adverse effect on pricing.
Automotive exhaust stainless shipments are expected to remain strong supported
by North American vehicle sales and increased export sales. Stable housing
starts are expected to continue to stimulate demand for oriented electrical
steels, while high levels of lower-priced imports continue to adversely affect
non-oriented electrical steel product sales.
[A THREE-BAR CHART APPEARS HERE]
SPECIALTY FLAT-ROLLED STEELS
SALES BY MARKET
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97 96 95
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AUTOMOTIVE 39% 44% 40%
INDUSTRIAL & ELECTRICAL EQUIPEMENT 27% 28% 32%
SERVICE CENTERS 12% 12% 9%
OTHER/CONVERSION 22% 16% 19%
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20 Armco Annual Report
In late 1997, Armco management decided to eliminate production of carbon steel
products at its Mansfield Operations and concentrate on producing the more
profitable stainless steel products. Armco's Dover Operations, which
galvanizes carbon steel formerly produced at Mansfield, will purchase carbon
steel from other sources for galvanizing.
Low-priced foreign imports of specialty steels remained high in 1997,
adversely affecting volume and pricing experienced by domestic companies like
Armco. As a result, industry trade groups are gathering 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
of the outcome if cases are filed.
Fabricated Products
- -------------------
<CAPTION
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1997 1996 1995
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Customer sales $332.3 $302.8 $282.9
Special charges -- (8.8) --
Operating profit 41.9 22.8 22.0
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The Fabricated Products business segment includes the results of Sawhill
Tubular, a manufacturer of steel pipe and tubing; Douglas Dynamics, a
manufacturer of snowplows and ice control products; and, effective January 1,
1997, Greens Port Industrial Park, which leases land, buildings and rail car
storage facilities and operates a deep water loading dock on the Houston Ship
Channel.
1997 vs. 1996: Customer sales increased in 1997 primarily due to higher
shipments at Sawhill Tubular and the consolidation of Greens Port. Higher
sales at Sawhill were a result of volume increases along most major product
lines.
Douglas Dynamics' and Sawhill's operating profit improved in 1997. Douglas
Dynamics' results improved due to manufacturing efficiencies achieved during
the year and reduced operating expenses following the decision in 1996 to exit
certain unprofitable product lines. The increase in Sawhill's profits was
driven by higher volume as well as lower costs.
In 1996, Armco recorded a special charge of $5.9 for an 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 assets and severance costs related to the decision to discontinue a line of
light truck equipment manufactured by Douglas Dynamics.
1996 vs. 1995: Customer sales in 1996 were 7% above 1995 levels, 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
sales prices caused by increased domestic competitive pressures and a high
level of imports.
Excluding the special charge in 1996, Douglas Dynamics' operating profit was
substantially higher than in 1995 due to increased sales and cost reductions.
Sawhill Tubular's operating profits decreased primarily as a result of higher
costs for steel hot bands.
Outlook for 1998: Douglas Dynamics' snowplow shipments are expected to be
somewhat lower in 1998. However, the actual level of sales will depend on the
level of four-wheel drive light truck sales and snowfalls in the markets
Douglas Dynamics serves.
Sawhill Tubular's sales and profitability are expected to exceed 1997's levels
due to anticipated continued higher volumes and lower costs.
DISCONTINUED OPERATIONS
Aerospace and Strategic Materials
- ---------------------------------
Armco sold its Aerospace and Strategic Materials business segment in 1985.
Pursuant to the sales agreement, Armco retained the benefit of its share of
any net proceeds of certain tax refund claims it had filed prior to the sale.
In 1996, Armco received a federal tax refund and recorded a $6.5 increase to
its gain on the sale of the segment. In 1997, Armco recognized another $2.7
gain for state and federal tax refunds.
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 since 1986 except for an immaterial amount of guaranteed
renewable accident and health business. The number of policyholders of this
business has decreased from approximately 4,000 at December 31, 1986 to 870 at
December 31, 1996 and 713 at December 31, 1997.
In March 1997, a group of international insurance companies, previously
affiliated with AFSG and sold in 1991, filed an application for voluntary
liquidation in the United Kingdom. Northwestern National Insurance Company,
one of the AFSG companies, is currently investigating its exposure with
respect to transactions entered into with these companies. Armco believes that
its investment in AFSG will not be materially affected as a result of pending
claims or contingent liabilities related to this matter.
Liquidity and Financial Resources: Claims are paid from AFSG's investment
portfolio and the related investment income from such portfolio. The portfolio
had a market value of $174.9 at December 31, 1997. 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 $88.1 at
December 31, 1997 from $102.2 at December 31, 1996. AFSG estimates that 67% 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 liquidation of AFSG will not be material
to Armco's financial condition or liquidity. However, it is possible that, due
to fluctuations in Armco's operating results, future developments could have a
material effect on the results of one or more future interim or annual
periods.
Armco Annual Report 21
POSTRETIREMENT EMPLOYEE BENEFIT LIABILITIES
Armco maintains pension and other postretirement benefit plans for employees
and retirees of its current operating locations as well as for retirees of
businesses that have been shut down or divested. Each year, Armco commissions
its outside actuary to calculate the present value of future obligations
associated with these plans. With this information, and following the guidance
in Statement of Financial Accounting Standards (SFAS) No. 87, Employers'
Accounting for Pensions, and SFAS No. 106, Employers' Accounting for
Postretirement Benefits Other Than Pensions, Armco records the expenses and
liabilities of its retirement benefit plans. The following compares the most
current actuarially determined obligations, net of plan assets, with the
accrued liabilities recorded in Employment-related liabilities and Long-term
employee benefit liabilities in the Consolidated Balance Sheets at December
31, 1997:
- ---------------------------------------------------------------
Other Postretirement
Pensions Benefits
- ---------------------------------------------------------------
Projected benefit obligations $2,099.0 $ 755.2
Plan assets 2,106.4 --
- ---------------------------------------------------------------
Obligations greater (less)
than plan assets (7.4) 755.2
Accrued liabilities 189.4 1,037.7
- ---------------------------------------------------------------
Accrued liabilities in excess
of obligations $ 196.8 $ 282.5
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The total accrued liabilities in excess of current estimated obligations was
$479.3 for 1997. Of this amount, $419.3 relates to unrecognized net gains
which arose primarily as a result of favorable investment returns on pension
plan assets and lower than expected increases in medical benefit costs.
Unrecognized net gains to the extent they exceed 10% of the larger of the
benefit obligations or plan assets are amortized into income over the average
remaining service life of active participants, which at Armco is currently
about 15 years. The majority of the remaining difference relates to
unrecognized negative prior service costs and an unrecognized transition
obligation, which are also amortized over a long period of time. These amounts
and their effect on consolidated income are more fully described in Note 2,
Pension and Other Employee Benefits, in the Notes to the Consolidated
Financial Statements
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, Armco had $194.9 of cash, cash equivalents and short-
term liquid investments, compared to $169.2 at December 31, 1996. Cash, cash
equivalents and short-term liquid investments increased $25.7 during 1997,
primarily as a result of $90.8 of cash generated from operations and proceeds
from the sale of businesses, assets and investments of $22.8, partially offset
by cash payments including $41.9 for capital expenditures, $26.6 for net debt
retirement and $17.9 for preferred stock dividends.
In September 1997, Armco issued $150.0 of 9% Senior Notes due 2007, using the
proceeds to retire $100.0 of 11-3/8% Senior Notes due 1999, $20.0 of 9.2%
Sinking Fund Debentures due 2000 and $28.5 of 8.5% Sinking Fund Debentures due
2001. Following the refinancing of its long-term debt, Armco has debt
maturities of $38.2, $7.0 and $132.2 in 1998, 1999 and 2000, respectively.
Debt maturing in 1998 includes prepayment of $22.3 of variable rate private
placement notes, and debt maturing in 2000 includes $125.0 of 9-3/8% Senior
Notes, which are callable in November 1998.
At December 31, 1997, 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 an available borrowing base of AFC's receivables. At
December 31, 1997, there were no outstanding borrowings under this credit
facility. However, $56.8 of the facility was used as support for letters of
credit and $26.6 was available for borrowing.
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, 1997, there were no outstanding borrowings under
this credit facility. Armco expects to enter into a new revolving credit
agreement to replace this facility when it expires at the end of 1998. Under
both bank credit facilities, a total of $76.6 was available for borrowing at
December 31, 1997.
Inventories increased 9% during 1997, reflecting increased production levels
at Douglas Dynamics and Sawhill Tubular. Trade receivables and payables,
primarily in the Specialty Flat-Rolled Steels segment, increased 7% and 9%,
respectively. These increases were the result of higher operating levels.
Armco anticipates that its capital expenditures for 1998 will total
approximately $60.0 to $70.0. Armco expects that its 1998 cash requirements,
including amounts for capital expenditures, debt service and preferred stock
dividends will be paid out of existing cash balances and cash generated from
operations.
On January 23, 1998, 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, 1998 to shareholders of
record on February 27, 1998. 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, 1998, to shareholders of record on
February 27, 1998. 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 near term.
[A BAR GRAPH APPEARS HERE]
CASH, CASH EQUIVALENTS AND
SHORT-TERM LIQUID INVESTMENTS
$ MILLIONS
- ---------------------------------------------------------------
95 96 97
- ---------------------------------------------------------------
$137 $169 $195
- ---------------------------------------------------------------
<FN>
Armco's cash position grew by 15% in 1997. Armco ended the year with $195
million in cash, cash equivalents and short-term liquid investments.
22 Armco Annual Report
ENVIRONMENTAL MATTERS
Armco, as a U. S. manufacturer, is subject to various federal, state and local
environmental requirements. Armco estimates capital expenditures for pollution
control in its manufacturing operations will be about $30.0 for the years
1998-2002, with the largest expenditures being made in the Specialty Flat-
Rolled Steels segment. Approximately $8.0 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 current laws and regulations. The type
and magnitude of these projected expenditures can change based on changes in
applicable laws and regulations, such as recent proposals to modify air
requirements, and availability of new technologies. 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. During the period 1993 through 1997, Armco's capital
expenditures for pollution control projects amounted to approximately $36.1,
including $2.2 in 1997.
Armco has been named as a defendant, or identified as a potentially
responsible party in various pending claims regarding past 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. However, while the outcome of these matters
cannot be predicted with assurance, Armco's experience has been that in most
cases, ultimate liability is apportioned among Armco and other financially
viable parties.
Armco has been and may in the future be subject to other types of
environmental claims. These claims included contractual indemnification
related to previously divested properties. If Armco disposes of additional
properties, it may incur additional environmental exit costs. Armco accrues
such costs when a decision is made to dispose of a property or a sale is
recorded. In addition, costs may be incurred for penalties or other
requirements as a result of administrative actions by government agencies.
Periodically, there are also claims alleging property damage or personal
injury in conjunction with waste disposal sites. Armco accrues for these
matters when it is probable that a liability has been incurred and it is
possible to reasonably estimate the amount or range.
While the outcome of environmental matters cannot be predicted with assurance,
Armco believes that the ultimate liability for such matters, identified to
date, will not materially affect its consolidated financial condition or
liquidity. This belief is based on current facts and circumstances known to
Armco, including current laws and regulations as well as Armco's experience
with site redemption. However, it is possible that due to fluctuations in
Armco's operating results or changes in the facts or circumstances of these
matters, future developments with respect to such matters could have a
material effect on the results of operations of future interim or annual
periods. It is not possible to determine whether additional loss will occur or
to reasonably estimate the amount or range of any such loss.
THE YEAR 2000 ISSUE
Many financial, information and operational computer systems in use today may
not be able to appropriately interpret dates after December 31, 1999, because
such systems allow only two digits to indicate the year in a date. This could
have adverse consequences on the operations and integrity of information
processing, causing safety, operational and financial problems. Armco is in
the process of determining the extent to which its systems are year 2000
compliant. In 1997, Armco began to update or replace non-compliant systems and
anticipates that it will be able to complete this process before the year
2000. Armco also is reviewing whether its suppliers expect to be in
compliance. The financial impact of making the required changes is not
expected to be material to Armco's consolidated financial condition, liquidity
or results of operations.
FORWARD-LOOKING STATEMENTS
Certain statements made in this Management's Discussion & Analysis, in the
Notes to Consolidated Financial Statements and in the Letter to Shareholders
contained in this Annual Report, reflect management's estimates and beliefs
and are intended to be, and are hereby identified as, "forward-looking
statements" for purposes of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. These include statements in the
foregoing paragraphs entitled Outlook for 1998, Armco Financial Services Group
(AFSG), Liquidity and Capital Resources, Environmental Matters and The Year
2000 Issue; and in Note 1, Summary of Significant Accounting Policies,
relating to Concentration of Credit Risk; Note 9, Litigation and Environmental
Matters; and Note 11, Discontinued Operations, relating to AFSG.
Armco cautions readers that such forward-looking statements involve risks and
uncertainties that could cause actual results to differ materially from those
expected by management. These factors include, but are not limited to, the
following: risks of a downturn in the general economy or in the highly
cyclical steel industry; changes in demand for Armco's products; unplanned
plant outages, equipment failures or labor difficulties; actions by Armco's
foreign and domestic competitors; unexpected outcomes of major litigation and
contingencies; changes in U.S. trade policy and actions respecting imports;
disruptions in the supply of raw materials, actions by reinsurance companies
with which AFSG does business or foreign or domestic insurance regulators, and
changes in application or scope of environmental regulations applicable to
Armco.
NEW ACCOUNTING STANDARDS
During 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
130, Reporting Comprehensive Income. SFAS No. 130 requires the display of a
new expanded measure of income with the same prominence as net income. Armco
will adopt SFAS No. 130 in 1998, but anticipates that the difference between
its reported net income and the new measure of income will be minor.
Also during 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information, which establishes standards for
determining reportable operating segments and the information about segments
to be reported. Armco will adopt SFAS No. 131 when required in 1998. While
Armco anticipates no material change in the composition of its Specialty Flat-
Rolled Steels segment, adoption of this standard will likely result in changes
to the Fabricated Products segment and to the discussion and disclosures for
all segments.
Armco Annual Report 23
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
judgments 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/ James F. Will
James F. Will
Chairman, President and
Chief Executive Officer
/s/ Jerry W. Albright
Jerry W. Albright
Vice President and
Chief Financial Officer
INDEPENDENT AUDITORS' REPORT
Deloitte & 2500 One PPG Place
Touche LLP Pittsburgh, PA 15222
- --------------
[D&T LOGO]
Armco, Its Shareholders and Directors:
We have audited the accompanying consolidated balance sheets of Armco Inc. and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of income and cash flows for each of the three years in the period
ended December 31, 1997. 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, 1997 and 1996, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
February 9, 1998
24 Armco Annual Report
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31, 1997, 1996 and 1995
- ------------------------------------------------------------------------
(Dollars in millions, except
per share amounts)
1997 1996 1995
- ------------------------------------------------------------------------
Net sales $1,829.3 $1,724.0 $1,559.9
Cost of products sold (1,623.9) (1,548.4) (1,392.7)
Selling and administrative expenses (100.0) (92.1) (98.2)
Special charges (Note 7) - (8.8) -
- ------------------------------------------------------------------------
Operating profit 105.4 74.7 69.0
Interest income 10.6 10.1 11.8
Interest expense (35.5) (36.3) (32.9)
Gain on sale of AK Steel stock
(Note 10) - - 27.2
Sundry other - net (Note 2) (1.1) (21.1) (49.6)
- ------------------------------------------------------------------------
Income before income taxes 79.4 27.4 25.5
Provision for income taxes (Note 3) (2.3) (1.4) (2.0)
- ------------------------------------------------------------------------
Income from continuing operations 77.1 26.0 23.5
Discontinued operations (Note 11)
Aerospace and Strategic Materials
Gain on disposal of business 2.7 6.5 --
National-Oilwell
Income from operations - -- 6.3
- ------------------------------------------------------------------------
Income before extraordinary loss 79.8 32.5 29.8
Extraordinary loss on retirement
of debt (Note 4) (3.0) - --
- ------------------------------------------------------------------------
Net income $76.8 $32.5 $29.8
- ------------------------------------------------------------------------
Basic and diluted earnings
per share (Note 1)
Income from continuing operations $0.55 $0.08 $0.05
Income from discontinued operations 0.03 0.06 0.06
Extraordinary loss on retirement
of debt (0.03) -- --
- ------------------------------------------------------------------------
Net income $0.55 $0.14 $0.11
- ------------------------------------------------------------------------
Cash dividends per share (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 28 through 38.
Armco Annual Report 25
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
- ------------------------------------------------------------------------
(Dollars in millions, except per share amounts) 1997 1996
- ------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents (Note 1) $ 189.9 $ 168.9
Short-term liquid investments 5.0 0.3
Accounts and notes receivable
Trade (less allowance for doubtful accounts
of $4.0 in 1997 and $3.8 in 1996) 147.0 137.4
Other 9.6 12.2
Inventories (Note 1) 268.0 246.9
Other current assets 17.9 6.1
- ------------------------------------------------------------------------
Total current assets 637.4 571.8
- ------------------------------------------------------------------------
Investments
Investment in Armco Financial Services Group
(Note 11) 85.6 85.6
Other (less allowance for impairment of
$8.1 in 1997 and $12.7 in 1996) 30.3 52.4
Property, plant and equipment (net of accumulated
depreciation of $653.0 in 1997 and $597.6 in 1996)
(Note 1) 652.5 670.1
Deferred tax asset (Note 3) 319.3 325.8
Goodwill and other intangible assets (Note 1) 137.4 144.8
Other assets 18.8 17.3
- ------------------------------------------------------------------------
Total assets $1,881.3 $1,867.8
- ------------------------------------------------------------------------
LIABILITIES
Current liabilities
Trade accounts and notes payable $148.9 $136.3
Employment-related liabilities (Note 2) 126.4 115.1
Other current liabilities 72.8 79.6
Current portion of long-term debt (Note 4) 38.2 27.2
- ------------------------------------------------------------------------
Total current liabilities 386.3 358.2
- ------------------------------------------------------------------------
Long-term debt (Note 4) 306.9 344.3
Long-term employee benefit liabilities (Note 2) 1,178.1 1,200.2
Other long-term liabilities 162.5 177.1
Commitments and contingencies (Notes 1, 9 and 11)
SHAREHOLDERS' DEFICIT (Note 5)
Preferred stock - Class A 137.6 137.6
Preferred stock - Class B 48.3 48.3
Common stock (authorized 150,000,000 shares of
$0.01 par value; issued and outstanding
107,129,561 in 1997 and 106,457,166 in 1996) 1.1 1.1
Additional paid-in capital 967.7 965.0
Accumulated deficit (1,305.0) (1,363.9)
Other (2.2) (0.1)
- ------------------------------------------------------------------------
Total shareholders' deficit (152.5) (212.0)
- ------------------------------------------------------------------------
Total liabilities and shareholders' deficit $1,881.3 $1,867.8
- ------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements on pages 28 through 38.
26 Armco Annual Report
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1997, 1996 and 1995
- ------------------------------------------------------------------------------
(Dollars in millions) 1997 1996 1995
- ------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 76.8 $ 32.5 $ 29.8
Adjustments to reconcile net income to
net cash provided
by operating activities:
Depreciation expense 61.3 58.7 52.8
Undistributed earnings from
discontinued operations -- -- (6.3)
Net gain on sales of investments and assets (4.5) (8.9) (28.4)
Extraordinary loss on retirement of debt 3.0 -- --
Special charges -- 8.8 --
Other 6.4 6.3 10.9
Change in assets and liabilities:
Trade accounts and notes receivable (9.1) 22.8 6.1
Inventories (21.4) (33.3) (50.8)
Payables and accrued operating expenses 22.1 (13.2) 34.4
Employee benefit liabilities (13.5) (17.4) (26.4)
Other assets and liabilities - net (30.3) (13.7) (6.6)
- ------------------------------------------------------------------------------
Net cash provided by operating activities 90.8 42.6 15.5
- ------------------------------------------------------------------------------
Cash flows from investing activities:
Net proceeds from the sale of businesses
and assets 7.7 14.0 31.5
Proceeds from the sale and maturity of
liquid investments 0.3 -- 29.7
Proceeds from the sale of investments 15.1 78.7 30.0
Purchase of liquid investments (5.0) (0.3) (6.0)
Contributions to investees - (3.0) (2.0)
Capital expenditures (41.9) (59.8) (143.3)
Other (0.2) (2.7) 0.2
- ------------------------------------------------------------------------------
Net cash (used in) provided by investing
activities (24.0) 26.9 (59.9)
- ------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of debt 151.1 5.5 5.0
Payments on debt (177.7) (24.3) (8.1)
Dividends paid on preferred stock (17.9) (17.9) (20.9)
Proceeds from issuance of common stock 0.1 -- 2.4
Other (1.4) (0.7) --
- ------------------------------------------------------------------------------
Net cash used in financing activities (45.8) (37.4) (21.6)
- ------------------------------------------------------------------------------
Net change in cash and cash equivalents 21.0 32.1 (66.0)
Cash and cash equivalents:
Beginning of year 168.9 136.8 202.8
- ------------------------------------------------------------------------------
End of year $ 189.9 $ 168.9 $ 136.8
- ------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 34.7 $ 35.1 $ 31.2
Income taxes 2.8 0.1 0.7
Supplemental schedule of noncash investing
and financing activities:
Debt incurred or assets exchanged directly
for property -- -- 16.2
Issuance of restricted stock 2.6 2.1 4.7
Notes receivable and stock in partial
payment for asset sales 0.3 10.6 --
- ------------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements on pages 28 through 38.
Armco Annual Report 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
- ---------------------------------------------------------------------------
NOTE 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 consist of
commercial paper, repurchase agreements, Eurodollar time deposits and other
money market instruments, including mutual funds.
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. The carrying amounts
for these securities approximate fair value due to the short maturities of the
instruments. At December 31, 1997 and 1996, these securities were as follows:
- ---------------------------------------------------------------------------
1997 1996
- ---------------------------------------------------------------------------
Cash equivalents $180.4 $139.5
Short-term liquid investments 5.0 0.3
Restricted collateral deposits 15.5 15.2
- ---------------------------------------------------------------------------
Total securities $200.9 $155.0
- ---------------------------------------------------------------------------
The restricted collateral deposits are primarily invested in certificates of
deposit which mature within one year and are principally used as security for
equipment financing, self-insurance programs, and environmental and litigation
bonds. These securities are reported in Other current assets or Other
investments. The classification is determined based on the expected term of
the collateral requirement and not necessarily the maturity date of the
underlying securities.
At December 31, 1997 and 1996, Other investments also included $11.2 for
Armco's limited partnership interest in North American Stainless. It is not
practicable to estimate the fair value of this closely held limited
partnership, in which Armco's ownership interest is less than 5%. 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 approximated
fair value (Note 11). These receivables were collected by Armco during 1997.
At December 31, 1997 and 1996, 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, 1997 and 1996 were as follows:
- ---------------------------------------------------------------------------
1997 1996
- ---------------------------------------------------------------------------
Inventories on LIFO:
Finished and semi-finished $271.2 $259.0
Raw materials and supplies 25.8 21.4
Adjustment to state inventories at LIFO value (54.0) (52.8)
- ---------------------------------------------------------------------------
Total 243.0 227.6
- ---------------------------------------------------------------------------
Inventories on average cost:
Finished and semi-finished 19.9 11.9
Raw materials and supplies 5.1 7.4
- ---------------------------------------------------------------------------
Total 25.0 19.3
- ---------------------------------------------------------------------------
Total inventories $268.0 $246.9
- ---------------------------------------------------------------------------
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 1997,
1996 and 1995 were $15.3, $13.1 and $14.0, 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% to 5% for buildings and 5% to 33% for
machinery and equipment.
28 Armco Annual Report
Armco's property, plant and equipment balances as of December 31, 1997 and
1996 were as follows:
- ---------------------------------------------------------------------------
1997 1996
- ---------------------------------------------------------------------------
Land $ 28.1 $ 26.6
Buildings 93.2 90.8
Machinery and equipment 1,156.9 1,117.5
Construction in progress 27.3 32.8
- ---------------------------------------------------------------------------
Total property, plant and equipment 1,305.5 1,267.7
Accumulated depreciation (653.0) (597.6)
- ---------------------------------------------------------------------------
Property, plant and equipment-net $ 652.5 $ 670.1
- ---------------------------------------------------------------------------
Armco had commitments to purchase property, plant and equipment (including
unexpended amounts relating to projects substantially underway) totaling
approximately $19.0 at December 31, 1997.
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 1997, 1996 and 1995 was $6.5, $6.9 and $6.9,
respectively. At December 31, 1997 and 1996, accumulated amortization of
goodwill and other intangible assets was $36.5 and $35.3, respectively.
Armco assesses whether its goodwill and other intangible assets are impaired
as 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
Basic earnings per share (EPS) is computed by dividing income available to
common shareholders by the weighted-average number of common shares
outstanding for the year. In arriving at income available to common
shareholders, preferred stock dividends of $17.9 were deducted in each year
presented. Diluted EPS reflects the potential dilution that could occur if
dilutive securities and other contracts to issue common stock were exercised
or converted into common stock or resulted in the issuance of common stock
that then shared in the earnings of Armco.
Average shares outstanding for basic EPS was 107 million in 1997. The
calculation of diluted EPS in 1997 included the assumed conversion of the
$3.625 Class A preferred stock into common stock, the effect of which would be
to decrease preferred dividends by $9.8 and increase average shares
outstanding by 18.3 million shares. This change had no effect on the
calculated EPS amount. Average shares outstanding for both basic and diluted
EPS was 106.6 million for 1996 and 106 million for 1995.
At December 31, 1997, 1996 and 1995, 5.4 million shares of preferred stock,
which were convertible into 22.7 million common shares, were outstanding. All
of these potential common shares were excluded from the computation of diluted
EPS for 1996 and 1995, and approximately 4.4 million of the potential common
shares were excluded for 1997 because their inclusion would have had an
antidilutive effect on EPS. At December 31, 1997, 1996 and 1995 substantially
all of the 2.2 million, 1.7 million and 1.5 million, respectively, of the
exercisable stock options and stock appreciation rights were excluded from the
computation of diluted EPS because the options' exercise prices were greater
than the average market price of the common shares.
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.
CONCENTRATION OF CREDIT RISK
Armco is primarily a producer of stainless, electrical and galvanized carbon
steels and steel products, which are sold to a number of markets, including
automotive, industrial machinery and equipment, construction, power
distribution and appliances. Armco sells domestically to customers primarily
in the Midwestern and Eastern United States, while approximately 10% of sales
are to foreign customers, primarily in Canada, Mexico and Western Europe.
Approximately 21% of trade receivables outstanding at December 31, 1997 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 1997 presentation.
Armco Annual Report 29
- ---------------------------------------------------------------------------
NOTE 2 PENSION AND OTHER EMPLOYEE BENEFITS
- ---------------------------------------------------------------------------
PENSION PLANS
Armco provides noncontributory pension benefits to most employees. 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, 1997, funding
credits of $52.8 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 are as
follows:
- ---------------------------------------------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------
Cost of benefits earned during the year $ 15.4 $ 15.6 $ 13.7
Interest cost on the projected
benefit obligation 147.8 141.0 153.1
Return on plan assets
Actual (300.6) (252.1) (354.0)
Deferral 133.1 104.8 197.8
Net amortization 5.2 7.2 6.5
- ---------------------------------------------------------------------------
Net periodic pension cost $ 0.9 $ 16.5 $ 17.1
- ---------------------------------------------------------------------------
Weighted average discount rate 7.75% 7.00% 8.50%
Weighted average expected long-term rate
of return on assets 8.75% 8.00% 9.50%
Rate of future compensation increases 4.00% 4.00% 4.00%
- ---------------------------------------------------------------------------
Net periodic pension cost decreased in 1997 primarily due to continued
favorable returns on pension plan assets.
The following table presents the funded status of pension plans using discount
rates of 7% and 7.75% for 1997 and 1996, respectively. The assumed rate of
future compensation increases was 4% in both years.
- -----------------------------------------------------------------------------
Plans for which Plans for which
Assets Exceed Accumulated
Accumulated Benefits Total
1997 Benefits Exceed Assets All Plans
- -----------------------------------------------------------------------------
Actuarial present value of
benefit obligations:
Vested benefits $2,034.5 $ 15.6 $2,050.1
Nonvested benefits 28.8 0.6 29.4
- -----------------------------------------------------------------------------
Accumulated benefit obligation $2,063.3 $16.2 $2,079.5
- -----------------------------------------------------------------------------
Projected benefit obligation $2,079.7 $19.3 $2,099.0
Plan assets at fair value 2,105.2 1.2 2,106.4
- -----------------------------------------------------------------------------
Projected benefit obligation greater
(less) than plan assets (25.5) 18.1 (7.4)
Reconciliation of funded status to
recorded amounts:
Unrecognized negative prior
service (cost) 2.3 (6.5) (4.2)
Unrecognized net gain (loss) 224.3 (0.6) 223.7
Unrecognized transition obligation (27.1) (0.3) (27.4)
Amount required to recognize
minimum liability -- 4.7 4.7
- -----------------------------------------------------------------------------
Accrued pension liability $ 174.0 $ 15.4 $ 189.4
- -----------------------------------------------------------------------------
1996
- -----------------------------------------------------------------------------
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
- -----------------------------------------------------------------------------
30 Armco Annual Report
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.
In addition to the defined benefit pension plans, most employees are eligible
to participate in various defined contribution plans. Total company expense
related to these plans was $6.7, $2.9 and $4.4 for 1997, 1996 and 1995,
respectively. A portion of the expense of these plans varies based on Armco's
profitability.
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. 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 are as follows:
- -----------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------
Cost of benefits earned during the year $ 4.1 $ 4.9 $ 5.6
Interest cost on accumulated postretirement
benefit obligation 58.3 61.8 74.7
Amortization of deferred gains and plan changes (15.0) (3.8) (3.7)
- -----------------------------------------------------------------------------
Net periodic postretirement benefit cost $47.4 $62.9 $76.6
- -----------------------------------------------------------------------------
Weighted average discount rate 7.75% 7.00% 8.50%
Current year health care trend rate - Pre-age 65 8.25% 9.25% 10.25%
Current year health care trend rate - Post-age 64 6.25% 7.25% 8.25%
Ultimate health care trend rate 5.75% 5.00% 6.50%
Weighted average trend rate 6.00% 5.60% 7.30%
- -----------------------------------------------------------------------------
Net periodic postretirement benefit cost decreased in 1997 primarily due to
the decrease in the accumulated postretirement benefit obligation at the end
of 1996 resulting primarily from favorable claims experience.
Net curtailment gains of $10.2 in 1995 were not included in net periodic
postretirement benefit cost.
Total claims paid were approximately $60.0 in 1997, $55.2 in 1996 and $64.0 in
1995.
The following table presents the funded status of the postretirement benefit
plans for 1997 and 1996:
- -----------------------------------------------------------------------------
1997 1996
- -----------------------------------------------------------------------------
Accumulated postretirement benefit obligation:
Retirees $ 643.7 $ 672.0
Fully eligible active plan participants 48.7 59.7
Other active plan participants 62.8 51.5
- -----------------------------------------------------------------------------
Total 755.2 783.2
Plan assets at fair value -- --
- -----------------------------------------------------------------------------
Accumulated postretirement benefit obligation
in excess of plan assets 755.2 783.2
Reconciliation of obligation to recorded amounts:
Unrecognized negative prior service 86.9 76.7
Unrecognized net gains 195.6 190.3
- -----------------------------------------------------------------------------
Accrued postretirement benefit liability $1,037.7 $1,050.2
- -----------------------------------------------------------------------------
Assumptions used to determine obligation:
Discount rate 7.00% 7.75%
Current year health care trend rate - Pre-age 65 7.25% 8.25%
Current year health care trend rate - Post-age 64 5.25% 6.25%
Ultimate health care trend rate 5.00% 5.75%
Weighted average trend rate 5.10% 6.00%
- -----------------------------------------------------------------------------
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 for 1997 by approximately $66.0,
and increase the annual net periodic postretirement benefit cost by
approximately $5.6.
EMPLOYEE BENEFIT OBLIGATIONS OF FORMER BUSINESS UNITS
Included in employee benefit liabilities is the present value of estimated
pension and health care benefits for former employees associated with
facilities that have been divested. Sundry other-net includes costs of $2.0,
$22.1 and $38.5 in 1997, 1996 and 1995, respectively, related to these
liabilities. The decrease in costs in 1997 was primarily due to continuing
favorable investment returns on pension plan assets and favorable experience
on health care claims.
Armco Annual Report 31
- ---------------------------------------------------------------------------
NOTE 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:
- -----------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------
United States $ 77.8 $ 24.4 $ 22.8
Foreign 1.6 3.0 2.7
- -----------------------------------------------------------------------------
Total $ 79.4 $ 27.4 $ 25.5
- -----------------------------------------------------------------------------
Provisions for current income taxes for Armco and consolidated subsidiaries
are as follows:
- -----------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------
U. S. federal $ 1.2 $ -- $ --
U. S. state 0.3 -- 0.8
Foreign 0.8 1.4 1.2
- -----------------------------------------------------------------------------
Total $ 2.3 $ 1.4 $ 2.0
- -----------------------------------------------------------------------------
The following is a reconciliation of the statutory federal income tax rate
applied to Income before income taxes with the provision for income taxes:
- -----------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------
Federal taxes at statutory rate $ 27.8 $ 9.6 $ 8.9
State taxes, net of federal benefit 4.0 1.6 1.5
Change in deferred
tax valuation allowance (29.5) (9.8) (8.4)
- -----------------------------------------------------------------------------
Total $ 2.3 $ 1.4 $ 2.0
- -----------------------------------------------------------------------------
During 1997, Armco's net operating loss carryforwards decreased by
approximately $19.0 due to taxable income generated in the year, and by $17.4
due to the elimination of loss carryforwards which were related to companies
leaving the consolidated group. Armco's capital loss carryforward decreased by
approximately $6.0 of taxable capital gains generated in the year. The
difference between pretax book income of $79.4 and 1997 taxable income is
primarily due to costs associated with employee benefits and restructuring
actions, which had been accrued for financial accounting purposes in prior
years, but actually paid in 1997; and tax basis depreciation, which exceeded
depreciation expense recorded in the financial statements.
At December 31, 1997, Armco had capital loss and net operating loss (NOL)
carryforwards for federal tax purposes expiring as follows:
- -----------------------------------------------------------------------------
Year Capital
expiring loss NOL
- -----------------------------------------------------------------------------
1998 $ 52.4 $ 40.7
1999 -- 106.7
2000 117.4 --
2001 43.6 123.3
2004 -- 9.1
2005 -- 130.3
2006 -- 239.3
2007 -- 186.9
2008 -- 128.8
2009 -- 31.1
2010 -- 46.3
2011 -- 34.6
- -----------------------------------------------------------------------------
Total loss carryforwards $213.4 $1,077.1
- -----------------------------------------------------------------------------
Armco has $731.4 in U.S. alternative minimum tax net operating losses.
Additionally, Armco has $12.7 of alternative minimum tax credits that have no
expiration.
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, 1997 and 1996, the net deferred
tax asset, included on the Consolidated Balance Sheets, was as follows:
- -----------------------------------------------------------------------------
1997 1996
- -----------------------------------------------------------------------------
Other current assets $ 9.2 $ 2.7
Deferred tax asset 319.3 325.8
- -----------------------------------------------------------------------------
Net deferred tax asset $328.5 $328.5
- -----------------------------------------------------------------------------
Major components of Armco's net deferred tax asset are as follows:
- -----------------------------------------------------------------------------
1997 1996
- -----------------------------------------------------------------------------
Tax effects of:
Operating loss and tax credit carryforwards $ 522.2 $ 539.5
Employee benefits 556.4 565.4
Other assets (including contingencies
and accruals) 133.5 159.0
- -----------------------------------------------------------------------------
Gross deferred tax asset 1,212.1 1,263.9
Valuation allowance (593.0) (644.4)
- -----------------------------------------------------------------------------
Deferred tax asset 619.1 619.5
Property, plant and equipment (148.8) (138.4)
Other liabilities (141.8) (152.6)
- -----------------------------------------------------------------------------
Deferred tax liability (290.6) (291.0)
- -----------------------------------------------------------------------------
Net deferred tax asset $ 328.5 $ 328.5
- -----------------------------------------------------------------------------
32 Armco Annual Report
Management believes it is more likely than not that Armco will generate future
taxable income sufficient to realize that portion of the tax benefit
associated with future deductible temporary differences and NOL carryforwards,
represented by the $328.5, above. Armco prepares a calculation in which it
estimates future income and schedules the future effects of temporary
differences and NOL carryforwards. Because any forecast has inherent
uncertainties and because of the structural changes Armco has undergone over
the last eight years, Armco uses what it believes to be conservative estimates
and assumptions. Considering all available evidence, both positive and
negative, Armco periodically determines if there has been a significant change
in the net deferred tax asset. During the last several years, based on
forecasts and consideration of available evidence, Armco believes that there
has been no significant change in the amount of its net deferred tax asset.
Therefore, amounts that would otherwise have been recognized as a provision
for income taxes have been offset by a change in the valuation allowance.
Armco's belief that realization of its net deferred tax asset is more likely
than not is based on, among other factors, changes in operations that have
occurred during the 1990s, as well as consideration of available tax planning
strategies. Specifically, cost savings resulting from 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. In 1997, Armco utilized approximately $19.0 of the NOL
carryforwards. This represents the first year of taxable income in the last
eight years. However, if Armco is unable to generate sufficient taxable income
in the future through operating results, increases in the valuation allowance
may be required through a charge to income. On the other hand, 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 1993 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 NOL 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.
- ---------------------------------------------------------------------------
NOTE 4 LONG-TERM DEBT AND OTHER FINANCING
- ---------------------------------------------------------------------------
LONG-TERM DEBT
At December 31, 1997 and 1996, Armco's long-term debt was as follows:
- ---------------------------------------------------------------------------
1997 1996
- ---------------------------------------------------------------------------
Sinking fund debentures:
8.5% due 2001 $ -- $ 35.0
9.2% due 2000 -- 25.0
Notes payable:
9% due 2007 150.0 --
9-3/8% due 2000 125.0 125.0
11-3/8% due 1999 -- 100.0
Variable rate (LIBOR plus 2.75%) due 2001 31.2 40.1
5% due 2000 15.3 20.4
Pollution control revenue bonds due 2005 - 8-1/8% 12.1 13.2
Variable rate economic development revenue bonds
due 2020 (1997 average 3.88%) 8.5 8.5
Other 3.0 4.3
- ---------------------------------------------------------------------------
Total debt 345.1 371.5
Less current maturities (38.2) (27.2)
- ---------------------------------------------------------------------------
Long-term debt $306.9 $344.3
- ---------------------------------------------------------------------------
Maturities of existing long-term debt during the five years ending December
31, 2002, are as follows: 1998, $38.2; 1999, $7.0; 2000, $132.2; 2001, $2.2
and 2002, $2.3. The 1998 maturities include prepayment of $22.3 of variable
rate private placement notes payable.
At December 31, 1997, the fair value of Armco's long-term debt, including
current maturities, was approximately $347.4. 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, 1997.
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, 1996 was approximately $369.0.
Armco Annual Report 33
In September 1997, Armco issued $150.0 of 9% Senior Notes due 2007, using the
proceeds to retire $100.0 of 11-3/8% Senior Notes due 1999, $20.0 of 9.2%
Sinking Fund Debentures due 2000 and $28.5 of 8.5% Sinking Fund Debentures due
2001. Armco recorded a $3.0 extraordinary loss upon retiring certain of its
outstanding debt.
At December 31, 1997 and 1996, $50.2 and $64.9, respectively, of long-term
debt, including current maturities, represented financing utilized to
construct certain of Armco's fixed assets, which are pledged as collateral on
these loans.
BANK CREDIT AGREEMENTS
At December 31, 1997, 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, 1997, there were no
outstanding borrowings under this credit facility; however, $56.8 of the
facility was used as support for letters of credit and $26.6 was available for
borrowing.
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, 1997, there were no outstanding borrowings under
this credit facility. Armco expects to enter into a new revolving credit
agreement to replace this facility when it expires at the end of 1998. Under
both bank credit facilities, a total of $76.6 was available for borrowing at
December 31, 1997.
CAPITALIZED INTEREST
Armco capitalized interest on projects during construction of $0.4, $0.8 and
$5.1 in 1997, 1996 and 1995, respectively. Capitalized interest for 1995
primarily relates to the construction of the thin-slab caster in Mansfield,
Ohio.
LONG-TERM LEASES
Rental expense under operating leases was $6.9 in 1997, $7.7 in 1996 and $7.7
in 1995. At December 31, 1997, commitments to make future minimum lease
payments for operating leases are $5.7 in 1998, $3.9 in 1999, $2.4 in 2000,
$1.8 in 2001, $2.2 in 2002 and $0.6 thereafter.
- ---------------------------------------------------------------------------
NOTE 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, 1997 and 1996, 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, 1997
and 1996.
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 $51.8125 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, 1997
and 1996.
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, 1997 and 1996.
At December 31, 1997, 1996 and 1995 the number of shares outstanding and book
value of Class A preferred stock were 4,397,231 and $137.6. At December 31,
1997, 1996 and 1995, Armco had outstanding 999,900 shares of Class B preferred
stock with a book value of $48.3.
COMMON STOCK
At December 31, 1997, 22,681,261 unissued shares of Armco's common stock were
reserved for the conversion of preferred stock and 3,510,134 unissued shares
of common stock were reserved for the exercise of stock options (Note 6).
Activity for the years 1995, 1996 and 1997 related to Armco's common stock was
as follows:
- ---------------------------------------------------------------------------
Additional
Paid-in
Shares Par Value Capital
- ---------------------------------------------------------------------------
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
Exercise of options 25,500 -- --
Restricted stock issued -
net of cancellations 643,013 -- 2.7
Directors' stock purchase plan 3,882 -- --
- ---------------------------------------------------------------------------
Balance, December 31, 1997 107,129,561 $1.1 $967.7
- ---------------------------------------------------------------------------
SHAREHOLDER RIGHTS PLAN
In 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. 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
34 Armco Annual Report
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 9-3/8% 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 currently satisfy these tests. The payment of
preferred stock dividends is prohibited if Armco is in default under the
credit facility.
At December 31, 1997, the surplus from which Armco is permitted to pay
dividends under Ohio law was $118.3. 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 1998 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 1995, 1996 and 1997 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, 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)
Net income 76.8 -- --
Preferred stock dividends declared (17.9) -- --
Foreign currency translation adjustment -- -- (1.4)
Amortization and cancellation of
deferred compensation -- -- 1.7
Deferred compensation on restricted
stock issued -- -- (2.4)
- ---------------------------------------------------------------------------
Balance, December 31, 1997 $(1,305.0) $ -- $(2.2)
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
NOTE 6 COMMON STOCK OPTIONS
- ---------------------------------------------------------------------------
Armco shareholders adopted a common stock option plan in 1988 and a long-term
incentive plan in 1993. In addition, stock options may be granted under a 1996
long-term incentive plan. 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 1988 plan has expired as to new stock option 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, stock options generally expire 10 years after the grant date. A
1988 restricted stock plan and 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. At December 31, 1997, 2,273,884 shares of common stock
were available for granting of awards under these plans.
During 1995, 1996 and 1997, stock option activity was as follows:
- ---------------------------------------------------------------------------
Weighted Average
1995 Shares Exercise Price
- ---------------------------------------------------------------------------
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
- ---------------------------------------------------------------------------
1997
- ---------------------------------------------------------------------------
Outstanding at January 1 3,536,258 $ 6.80
Granted 472,201 4.13
Exercised (25,500) 4.76
Forfeited (8,700) 6.39
Expired (464,125) 10.27
- ---------------------------------------------------------------------------
Outstanding at December 31 3,510,134 6.00
- ---------------------------------------------------------------------------
Exercisable at December 31 2,161,324 6.72
- ---------------------------------------------------------------------------
The following relates to the options outstanding at December 31, 1997:
- ---------------------------------------------------------------------------
Exercise Price Ranges $4.09 - $7.56 $10.13 - $12.06
- ---------------------------------------------------------------------------
Options outstanding:
Number of shares 3,271,034 239,100
Weighted average exercise price $5.62 $11.22
Average remaining contractual life 7 years 1 year
Options exercisable:
Number of shares 1,922,224 239,100
Weighted average exercise price $6.16 $11.22
- ---------------------------------------------------------------------------
Armco Annual Report 35
In 1996, Armco adopted SFAS No. 123, Accounting for Stock-Based Compensation.
SFAS No. 123 provides that companies may 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 1997 would have been reduced by $1.2 to $75.6, or $.54 per
share. Net income for 1996 would have been reduced by $1.7 to $30.8, or $.12
per share and 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:
- ---------------------------------------------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------
Risk free interest rate 6.25% 5.5% 7.75%
Expected volatility 35% 30% 35%
Expected life of options 5 years 5 years 5 years
Expected dividends none none none
- ---------------------------------------------------------------------------
Based on the option pricing model, options granted during 1997, 1996 and 1995
had fair values of $1.72, $1.90 and $2.91 per share, respectively.
During 1997, 1996 and 1995, Armco issued to certain employees 646,013, 570,158
and 660,762 shares of common stock, subject to restrictions, with weighted-
average grant-date fair values of $4.07, $5.69 and $6.63 per share,
respectively. Total compensation cost recognized in income for stock-based
employee compensation awards was $1.6 in 1997, $1.1 in 1996 and $2.2 in 1995.
- ---------------------------------------------------------------------------
NOTE 7 SPECIAL CHARGES
- ---------------------------------------------------------------------------
In 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 1996, Armco recorded a $2.9 special charge primarily for the writedown
of assets 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.
- ---------------------------------------------------------------------------
NOTE 8 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 and finish flat-rolled stainless, electrical
and carbon steels for the automotive, industrial machinery and equipment,
construction and service center markets and international trading companies,
that buy and sell steel and manufactured steel products; and (2) Fabricated
Products, consisting of operations in Sharon and Wheatland, Pennsylvania and
Warren, Ohio that produce steel pipe and tubular products for the industrial
machinery, construction and appliance markets, 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, effective January 1, 1997, Greens Port Industrial Park, which
leases land, buildings and rail car storage facilities and operates a deep
water loading dock on a ship channel in Houston, Texas.
Armco's industry segment information is as follows:
- ---------------------------------------------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------
Customer sales:
Specialty Flat-Rolled Steels $1,497.0 $1,421.2 $1,277.0
Fabricated Products 332.3 302.8 282.9
- ---------------------------------------------------------------------------
Total $1,829.3 $1,724.0 $1,559.9
- ---------------------------------------------------------------------------
Operating profit: (1)
Specialty Flat-Rolled Steels $ 88.6 $ 72.9 $ 76.0
Fabricated Products 41.9 22.8 22.0
Corporate general (25.1) (21.0) (29.0)
- ---------------------------------------------------------------------------
Total $ 105.4 $ 74.7 $ 69.0
- ---------------------------------------------------------------------------
Capital expenditures:
Specialty Flat-Rolled Steels $ 31.4 $ 55.9 $ 153.6
Fabricated Products 8.1 3.1 5.3
Corporate general 2.4 0.8 0.6
- ---------------------------------------------------------------------------
Total $ 41.9 $ 59.8 $ 159.5
- ---------------------------------------------------------------------------
Depreciation:
Specialty Flat-Rolled Steels $ 52.6 $ 50.4 $ 43.4
Fabricated Products 7.2 6.7 7.6
Corporate general 1.5 1.6 1.8
- ---------------------------------------------------------------------------
Total $ 61.3 $ 58.7 $ 52.8
- ---------------------------------------------------------------------------
Identifiable assets:
Specialty Flat-Rolled Steels $1,038.3 $1,052.1 $1,034.8
Fabricated Products 179.1 163.2 173.0
Corporate general (2) 578.3 566.9 517.7
Discontinued operations 85.6 85.6 171.1
- ---------------------------------------------------------------------------
Total $1,881.3 $1,867.8 $1,896.6
- ---------------------------------------------------------------------------
<FN>
(1) In 1996, operating profit for the Fabricated Products segment includes
special charges totaling $8.8 (See Note 7).
(2) Corporate general identifiable assets at December 31, 1997 includes $187.0
of cash and cash equivalents and net deferred tax assets of $328.5 (See Note
3).
36 Armco Annual Report
- ---------------------------------------------------------------------------
NOTE 9 LITIGATION AND ENVIRONMENTAL MATTERS
- ---------------------------------------------------------------------------
Armco and its subsidiaries are involved in various pending claims regarding
product liability, patent, employee benefits, 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, 1997 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 or a sale
is recorded.
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 past 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 among Armco and other financially viable parties. 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 reasonably estimated
outcomes and determines the most likely outcome for its liabilities within the
range. 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). These liabilities are not discounted. The cost 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.
At December 31, 1997, Armco had recorded on its Consolidated Balance Sheets,
$18.8 in Other current liabilities and $53.6 in Other long-term liabilities
for estimated probable costs relating to legal and environmental matters.
- ---------------------------------------------------------------------------
NOTE 10 OTHER INVESTMENTS
- ---------------------------------------------------------------------------
In 1995, Armco sold the 1,023,987 shares of AK Steel Holding Corporation
common stock it had received as a result of an initial public offering and
recapitalization of its former joint venture, Armco Steel Company, LP. The
stock was sold for a total of $27.2 and Armco recognized 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.
- ---------------------------------------------------------------------------
NOTE 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
1996, Armco and Oremet reached agreement with the Internal Revenue Service
that a previous refund of taxes and interest should not itself have been
taxable to Oremet, further increasing the net proceeds, which resulted in
Armco recording an additional $6.5 gain on the sale. In 1997, Armco received
an additional $2.7 in state and federal tax refunds.
NATIONAL-OILWELL
National-Oilwell 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. The sale was completed on January 16, 1996. 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 equaled its estimated net realizable value and no additional
equity income or gain or loss was recorded on the sale. The results of
National-Oilwell are reported as discontinued operations in the Consolidated
Statements of Income.
Armco Annual Report 37
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,
1997:
- ---------------------------------------------------------------------------
Assets:
Invested assets $174.9
Reinsurance recoverable 96.9
Other 19.4
- ---------------------------------------------------------------------------
Total assets 291.2
- ---------------------------------------------------------------------------
Liabilities:
Losses and loss reserves (net of future investment
income of $37.3) 185.0
Other 20.6
- ---------------------------------------------------------------------------
Total liabilities 205.6
- ---------------------------------------------------------------------------
Net assets $ 85.6
- ---------------------------------------------------------------------------
At December 31, 1997, AFSG's invested assets included $10.0 each of Armco's 9%
Senior Notes due 2007 and 9-3/8% Senior Notes due 2000 (Note 4).
Currently, insurance regulators having supervisory authority over the AFSG
companies retain substantial control over certain transactions, including the
payment of dividends to Armco.
In March 1997, a group of international insurance companies, previously
affiliated with AFSG and sold in 1991, filed an application for voluntary
liquidation in the United Kingdom. Northwestern National Insurance Company,
one of the AFSG runoff companies, is currently investigating its exposure with
respect to transactions entered into with these companies. Armco believes that
its investment in AFSG will not be materially affected as a result of pending
claims or contingent liabilities related to this matter.
There are various pending matters relating to litigation, arbitration and
regulatory affairs, including the above mentioned voluntary liquidation. The
ultimate liability from such matters at December 31, 1997 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.
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NOTE 12 QUARTERLY INFORMATION (UNAUDITED)
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4th 3rd 2nd 1st
1997 Year Qtr. Qtr. Qtr. Qtr.
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Net sales $ 1,829.3 $ 436.4 $ 461.3 $ 490.3 $ 441.3
Cost of products sold (1,623.9) (387.4) (402.9) (436.1) (397.5)
Income from discontinued
operation (1) 2.7 1.4 -- 1.3 --
Income before
extraordinary loss 79.8 19.2 29.7 21.5 9.4
Extraordinary loss (2) (3.0) -- (3.0) -- --
Net income 76.8 19.2 26.7 21.5 9.4
Basic earnings per share:
Income from discontinued
operation 0.03 0.01 -- 0.01 --
Income before
extraordinary loss 0.58 0.14 0.24 0.16 0.05
Extraordinary loss (0.03) -- (0.03) -- --
Net income 0.55 0.14 0.21 0.16 0.05
Diluted earnings per share:
Income from discontinued
operation 0.03 0.01 -- 0.01 --
Income before
extraordinary loss 0.58 0.14 0.22 0.16 0.05
Extraordinary loss (0.03) -- (0.02) -- --
Net income 0.55 0.14 0.20 0.16 0.05
1996
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Net sales $ 1,724.0 $ 413.6 $ 429.2 $ 450.8 $ 430.4
Cost of products sold (1,548.4) (360.0) (382.8) (414.3) (391.3)
Special charges (3) (8.8) (8.8) -- -- --
Income from discontinued
operation (1) 6.5 -- 6.5 -- --
Net income (loss) 32.5 13.2 16.4 (4.0) 6.9
Basic earnings per share:
Income from discontinued
operation 0.06 -- 0.06 -- --
Net income (loss) 0.14 0.08 0.11 (0.08) 0.02
Diluted earnings per share:
Income from discontinued
operation 0.06 -- 0.06 -- --
Net income (loss) 0.14 0.08 0.11 (0.08) 0.02
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<FN>
(1) See Note 11.
(2) See Note 4.
(3) See Note 7.
38 Armco Annual Report
PRICE RANGE AND DIVIDENDS OF ARMCO STOCK (UNAUDITED)
1997 1996
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4th 3rd 2nd 1st 4th 3rd 2nd 1st
Qtr. Qtr. Qtr. Qtr. Qtr. Qtr. Qtr. Qtr.
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Common Stock:
Price per share:
High $ 6 3/16 $ 6 3/8 $ 4 1/8 $ 4 7/8 $ 4 5/8 $ 5 1/8 $ 6 $ 6 1/2
Low 4 1/2 3 13/16 3 3/8 3 3/8 3 5/8 4 1/8 4 3/4 5 1/4
PREFERRED STOCK
CLASS A $2.10:
Quarterly dividend
per share: $.525
Price per share:
High 26 3/16 26 23 7/8 24 24 23 5/8 24 1/4 24 1/2
Low 24 1/4 23 1/2 21 1/4 21 22 1/8 22 22 3/4 23 1/2
PREFERRED STOCK
CLASS A $3.625:
Quarterly dividend
per share: $.90625
Price per share:
High 51 3/4 52 1/8 42 7/8 43 1/4 45 1/4 47 3/8 51 1/4 52
Low 46 3/8 42 7/8 41 1/4 39 42 3/8 44 1/4 47 49 5/8
PREFERRED STOCK
CLASS B $4.50:
Quarterly dividend
per share: $1.125
Price per share:
High 51 3/16 51 3/4 49 49 1/2 47 1/2 47 5/8 49 3/4 49 3/8
Low 49 5/8 48 9/16 47 46 1/4 45 3/8 45 3/4 46 3/4 47 1/2
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Armco Annual Report 39