Exhibit 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three Years Ended December 31, 1998
(Dollars in millions, except per share amounts)
GENERAL
This discussion and analysis of Armco's financial results should be read
together with the Consolidated Financial Statements and Notes on pages 23
through 35.
Operating Results
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Net sales $1,706.5 $1,829.3 $1,724.0
Special charges - - (8.8)
Operating profit 107.6 105.4 74.7
Sundry other - net 27.7 (1.1) (21.1)
Income from continuing operations 109.6 77.1 26.0
Income from discontinued operations - 2.7 6.5
Extraordinary loss on retirement of debt - (3.0) -
Cumulative effect of a change in accounting
for postretirement benefits 237.5 - -
Net income 347.1 76.8 32.5
Basic earnings per share
Income from continuing operations 0.85 0.55 0.08
Net income 3.05 0.55 0.14
Diluted earnings per share
Income from continuing operations 0.81 0.55 0.08
Net income 2.69 0.55 0.14
- ------------------------------------------------------------------------------
1998 vs. 1997: Net sales in 1998 declined 7% from 1997 levels primarily due to
reduced pricing across all steel and tubular product lines, lower volume in
the specialty semi-finished and galvanized steel lines and lower snowplow and
tubular product shipments. Sales volume for Armco's higher margin specialty
flat-rolled steels increased 9%, somewhat offsetting these declines.
Operating profit increased 2% despite lower sales, reflecting increased volume
of higher margin steel products, lower operating costs, lower pension and
retiree medical benefit expenses, and a one-time gain of $7.1 from a
settlement with a vendor. Postretirement employee benefit expenses in 1998
were again lower as a result of prior years' favorable investment returns on
pension plan assets and lower than expected increases in medical benefit
costs.
The change in sundry other - net between 1997 and 1998 is primarily the result
of pension income and lower medical expenses in 1998 related to retirement
benefits for former employees of Armco facilities that have been shut down or
divested. The pension income resulted from favorable investment returns on
pension plan assets related to the former facilities, and lower medical
expenses were due to lower than expected benefit cost increases. Income of
$24.2 in 1998 and expense of $2.0 in 1997 was included in sundry other - net
for these benefits. Sundry other - net in 1998 also included an additional
gain of $1.1 for the vendor settlement mentioned previously. In 1997, sundry
other - net included a $4.0 gain for the settlement of certain partially
impaired long-term receivables.
In 1998, income from continuing operations included $4.3 for the favorable
settlement of certain state tax issues.
In 1997, Armco recorded $2.7 of income from discontinued operations for a tax
refund related to a previously divested company.
Also in 1997, Armco recorded a $3.0 extraordinary loss upon the early
retirement of debt, which was refinanced by a senior note offering.
Effective January 1, 1998, Armco changed its method of accounting for
unrecognized net gains and losses related to its obligations for pensions and
other postretirement benefits. Armco recognized income of $237.5, or $2.20 per
share of common stock ($1.88 per diluted share), for the cumulative effect of
this accounting change. Under the newly adopted method, Armco recognizes into
income, as a fourth quarter adjustment, any unrecognized net gains and losses
that exceed 10% of the larger of the benefit obligations or plan assets, and
amortizes amounts inside this 10% corridor over the average remaining service
life of active participants (approximately 15 years). Adoption of the new
method increased 1998 income from continuing operations by $3.0 or $0.03 per
share of common stock.
[A BAR CHART APPEARS HERE]
EMPLOYEE BENEFIT EXPENSE/INCOME OF DIVESTED BUSINESS UNITS
$ MILLIONS
95 96 97 98
Expense $39 $22 $2 -
Income - - - $24
<FN>
Favorable returns on pension plan assets and lower than expected medical cost
increases have contributed to continuing lower expense in sundry other - net.
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
16 Armco 1998 Annual Report
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.
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. Included in sundry other -
net for 1996 was the recognition of $6.3 of gains in connection with asset
sales at Greens Port.
Income from discontinued operations consisted of additional gains of $2.7 in
1997 and $6.5 in 1996 for tax refunds related to a previously divested
company.
Outlook for 1999: Armco expects modest volume increases in the Specialty Flat-
Rolled Steels segment. Assuming a favorable outcome in the stainless flat-
rolled steel trade cases filed with the U.S. Department of Commerce and the
International Trade Commission in 1998, Armco expects stainless sheet and
strip pricing to stabilize and possibly improve in the latter half of 1999.
Overall results for the Specialty Flat-Rolled Steels segment are expected to
be negatively affected by higher retiree benefit expenses, primarily due to
lower expected returns on pension plan assets.
Results for the other segments are expected to improve somewhat in 1999
compared to 1998.
BUSINESS SEGMENT RESULTS
Specialty Flat-Rolled Steels
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Net sales $1,418.9 $1,497.0 $1,421.2
Income from continuing operations 105.7 91.3 72.9
- ------------------------------------------------------------------------------
Armco's Specialty Flat-Rolled Steels businesses produce and finish flat-rolled
stainless, electrical and galvanized carbon steels at plants in Butler,
Pennsylvania, and Coshocton, Dover, Mansfield and Zanesville, Ohio. The
segment also includes results of international trading companies that buy and
sell steel and manufactured steel products.
Net sales and shipments by major product line were as follows:
- ------------------------------------------------------------------------------
1998 1997 1996
Sales Tons Sales Tons Sales Tons
- ------------------------------------------------------------------------------
(tons in thousands)
Specialty flat-rolled* $1,133.4 826 $1,103.0 757 $1,108.0 739
Specialty semi-finished 122.5 125 198.8 168 133.9 97
Galvanized and other carbon 129.9 245 165.1 306 144.2 304
Other 33.1 - 30.1 - 35.1 -
- ------------------------------------------------------------------------------
Total $1,418.9 1,196 $1,497.0 1,231 $1,421.2 1,140
- ------------------------------------------------------------------------------
<FN>
* The Specialty flat-rolled product line consists of automotive exhaust
stainless, stainless sheet and strip, and electrical steels.
[A BAR CHART APPEARS HERE]
SPECIALTY FLAT-ROLLED STEELS SALES BY MARKETS
96 97 98
Automotive 44% 39% 42%
Industrial & Electrical Equipment 28% 27% 30%
Service Centers 12% 12% 10%
Other/Conversion 16% 22% 18%
<FN>
Armco is shipping more value-added specialty steels to the automotive and
industrial markets.
1998 vs. 1997: Net sales for the Specialty Flat-Rolled Steels segment
decreased 5% in 1998 primarily as a result of lower pricing in all product
lines and reduced shipments in specialty semi-finished and galvanized steels.
Record import levels continued to depress pricing across most stainless and
electrical steel product lines.
Specialty flat-rolled steel volume increased 9% on the strength of record
shipments of automotive exhaust stainless and the highest electrical steel
shipments in almost 20 years. Automotive exhaust stainless demand was driven
by high levels of North American vehicle production, while electrical steel
sales were stimulated by strong housing starts and demand for electrical
machinery and equipment. However, lower prices, particularly for stainless
sheet and strip products, reduced average sales per ton in this product line
by 6%.
Specialty semi-finished shipments and average sales per ton decreased by 26%
and 17%, respectively, reflecting worldwide market softness, excess capacity
and increased imports.
Galvanized carbon steel shipments, produced by the Dover Operations from
purchased steel coils, decreased 20% due to increased competition and low-
priced imports.
Income from continuing operations in 1998 increased $14.4 over 1997, primarily
as a result of increased sales of higher margin automotive exhaust stainless
and electrical steels, lower operating and raw material costs, a $7.1 gain
from a settlement with a vendor, and reduced pension and other retiree benefit
expenses. In addition, increased efficiencies and higher yields were made
possible by a number of cost reduction and productivity improvement
initiatives. These improvements were partially offset by the continuing
deterioration in selling prices.
1997 vs. 1996: Net 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,
average sales per ton declined 14%, reflecting worldwide overcapacity.
Armco 1998 Annual Report 17
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 income from continuing operations included
an $8.6 credit from various claim settlements, including a business
interruption insurance claim. Excluding the claim settlements, income
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.
Outlook for 1999: Armco anticipates stable volume and further cost reductions
for most product lines during the next twelve months. Although automotive
exhaust stainless shipments are expected to remain strong, supported by North
American vehicle sales, tons shipped may decline slightly from 1998's record
level. 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.
In recent years, record levels of imports have depressed pricing on specialty
steel products in the U.S. In June 1998, Armco and other domestic producers of
flat-rolled stainless sheet and strip products filed petitions with the U.S.
Department of Commerce and the International Trade Commission charging eight
foreign countries with violations of U.S. trade laws. A finding that unfairly
traded imports have caused injury to domestic producers could result in
tariffs that may help slow the flood of imports. On July 24, 1998, the
International Trade Commission issued its preliminary finding that there has
been injury to domestic producers. On November 10, 1998, the U.S. Department
of Commerce announced preliminary results in the subsidy investigations,
establishing countervailing duty rates for companies in France, Italy and
South Korea. On December 17, 1998, a preliminary determination on antidumping
margins was announced by the U.S. Department of Commerce for companies in
those three countries, as well as in Germany, Japan, Mexico, Taiwan and the
United Kingdom. Final antidumping determinations are expected to be announced
in the second quarter of 1999.
In addition, with respect to electrical steels, in mid-1999 the U.S.
Department of Commerce and the International Trade Commission are expected to
review existing antidumping and countervailing duties involving Italian and
Japanese producers to determine whether these protections should be extended
for another five years. The failure to obtain or extend meaningful tariff
protections for any of the products Armco sells could adversely affect prices
and reduce profitability.
Assuming a favorable outcome in the stainless sheet and strip trade cases,
Armco expects prices for these products to stabilize in the first half of 1999
and show some improvement in the latter half of the year. Prices for certain
electrical and semi-finished steels, however, are expected to be lower than in
1998.
Overall results for the Specialty Flat-Rolled Steels segment are expected to
be negatively affected by higher retiree benefit expenses, primarily due to
lower expected returns on pension plan assets.
[A TABLE APPEARS HERE]
UNION CONTRACT EXPIRATION DATES
BUTLER OPERATIONS
Hourly 9/30/2001
Represented Non-exempt 9/30/2002
Plant Protection 9/30/2002
ZANESVILLE OPERATIONS
Hourly 5/20/2000
Represented Non-exempt 5/20/2000
MANSFIELD OPERATIONS
Hourly 9/1/1999
Plant Protection 11/1/1999
DOVER OPERATIONS
Hourly 9/1/1999
Represented Non-exempt 9/1/1999
SAWHILL TUBULAR DIVISION
Sharon Hourly 9/30/1999
Warren Hourly 9/30/2000
Wheatland Hourly 1/31/2000
[A BAR CHART APPEARS HERE]
SPECIALTY FLAT-ROLLED STEELS EXPORT SALES
$ MILLIONS
95 96 97 98
$86 $116 $138 $149
<FN>
Despite weak foreign economies and a strong U.S. dollar, international markets
are important areas for growth.
Tubular Products
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Net sales $192.7 $209.4 $189.6
Income from continuing operations 2.4 5.6 0.8
- ------------------------------------------------------------------------------
The Tubular Products business segment represents the results of Sawhill
Tubular, a manufacturer of steel pipe and tubing. Sawhill has plants in Sharon
and Wheatland, Pennsylvania and Warren, Ohio.
1998 vs. 1997: Net sales decreased on lower volume and selling prices, which
reflected a general oversupply in the market, including a high level of
imported pipe, and market softness in certain products. Although some cost
savings were achieved in 1998, income decreased as a direct result of lower
sales and margins.
1997 vs. 1996: Net sales increased 10% in 1997 primarily due to higher
shipments along most major product lines, as well as modest price increases.
Sawhill's income improved in 1997, driven by higher volume and lower operating
costs.
Outlook for 1999: Sawhill Tubular's sales and profitability are expected to
remain flat with slight volume increases, offset by increasing pressure on
pricing from excess capacity and imported pipe.
Armco has been, and continues to be, in negotiations for the sale of Sawhill
Tubular. However, no assurance can be given that a sale will be completed.
18 Armco 1998 Annual Report
Other Businesses
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Net sales $94.9 $122.9 $113.2
Special charge - - (2.9)
Income from continuing operations 28.2 36.1 23.3
- ------------------------------------------------------------------------------
The Other Businesses segment includes the results of Douglas Dynamics, LLC, a
manufacturer of snowplows and ice control products, with plants in Milwaukee,
Wisconsin, Rockland, Maine and Johnson City, Tennessee; and 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.
1998 vs. 1997: Although light truck sales were strong, lower net sales
reflected significantly below average snowfall during the 1997/1998 winter in
Douglas Dynamics' major markets, resulting in lower income from continuing
operations. Greens Port's results improved during 1998 as all phases of its
business posted increases in revenues and profits over last year.
1997 vs. 1996: The segment's income from continuing operations, excluding the
special charge, improved 38% in 1997, due to manufacturing efficiencies
achieved during the year at Douglas Dynamics and reduced operating expenses
following the decision in 1996 to exit certain unprofitable product lines. In
1996, a $2.9 special charge was recorded in this segment 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. In addition,
1997 results increased with the consolidation of Greens Port, which in the
prior year was an investment held for sale.
Outlook for 1999: Douglas Dynamics' 1999 sales will depend on the level of
four-wheel drive light truck sales and total snowfalls in its major markets.
Based on early snowfalls, snowplow shipments are expected to be somewhat
higher in 1999. Greens Port's results are expected to continue to improve due
to recent facility expansions.
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 for periods 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)
Armco's investment in AFSG represents the net assets of its discontinued
insurance and finance leasing businesses, which have been largely liquidated.
The insurance companies, including Northwestern National Insurance Company
(NNIC), have stopped writing new business and are being "run off." These
insurance companies have not written any new business for retention since 1986
except for an immaterial amount of guaranteed renewable accident and health
business.
In March 1997, North Atlantic Insurance Company, a group of international
insurance companies previously affiliated with AFSG but sold in 1991, filed an
application for voluntary liquidation in the United Kingdom. As a result of
this voluntary liquidation filing, certain claims have been asserted against
NNIC by insureds of North Atlantic. NNIC is defending these claims as well as
pursuing related claims against third parties and North Atlantic.
Liquidity and Financial Resources: AFSG is accounted for as a discontinued
operation under the liquidation basis of accounting, whereby future cash
inflows and outflows are considered. AFSG believes the existing invested
assets, related future income and other assets it owns will provide sufficient
funds to meet all future claims payments and other liabilities.
The loss reserves, net of reinsurance recoverables and future investment
income, decreased to $59.9 at December 31, 1998 from $88.1 at December 31,
1997. AFSG estimates that 60% of the claims will be paid in the next five
years and that substantially all of the claims will be paid by the year 2017.
The ultimate amount of the claims as well as the timing of claims payments are
estimated based on an annual review of loss reserves performed by 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, including matters
related to the voluntary liquidation of North Atlantic, 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.
[A BAR CHART APPEARS HERE]
LONG-TERM DEBT MATURITIES
$ MILLIONS
99 00 01 02 03
$117 $6 $1 $1 $0
<FN>
In January 1999, Armco redeemed the remaining $111 million of a senior note
issue. Armco has no major debt due until 2007.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, Armco had $270.8 of cash, cash equivalents and short-
term liquid investments, compared to $194.9 at December 31, 1997. Cash, cash
equivalents and short-term liquid investments increased $75.9 during 1998,
primarily as a result of $95.2 of cash generated by operations and $74.4 from
the issuance of new 8-7/8% 10-year Senior Notes in December. Major cash
payments during the year included $32.6 of capital expenditures, $51.2 for
debt retirement and $17.7 for preferred stock dividends.
The net proceeds of the new debt issue, along with other existing cash
balances, were used to retire Armco's 9-3/8% Senior Notes due 2000 on January
14, 1999. Holders of the 9-3/8% Senior Notes were notified on December 15,
1998 of Armco's intention to redeem this issue. At December 31, 1998, $111.0
of these notes were outstanding, all of which were retired, resulting in the
recognition of an extraordinary loss of $2.8 in the first quarter of 1999.
Armco has no other material debt payments due until the year 2007.
Armco 1998 Annual Report 19
At December 31, 1998, Armco had in place two bank credit facilities, totaling
$170.0. In 1998, the terms of these facilities were extended and both will
expire in 2001.
Under a receivables facility, Armco sells substantially all its trade
receivables to a wholly owned subsidiary, Armco Funding Corporation (AFC). In
1998, AFC and its bank group amended its revolving credit agreement to
provide, depending on its available borrowing base, up to $100.0 for loans and
letters of credit secured by AFC's receivables. At December 31, 1998, there
were no outstanding borrowings under this credit facility. However, $61.1 of
the facility was used as support for letters of credit.
In 1998, Armco and its bank group amended its inventory facility to provide,
depending on its available borrowing base, up to $70.0 for loans and letters
of credit secured by Armco's inventories. The credit agreement subjects Armco
to certain restrictions and covenants related to, among other things, minimum
net worth, leverage ratio and interest coverage ratio requirements. At
December 31, 1998, there were no outstanding borrowings or letters of credit
under this facility. Under both bank credit facilities, a total of $93.3 was
available for borrowing at December 31, 1998.
Armco anticipates that its capital expenditures for 1999 will total
approximately $50.0 to $60.0. Armco expects that its 1999 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.
In prior years, certain of Armco's financing arrangements included covenants
that prohibited the payment of common stock dividends. These prohibitions have
been eliminated; however, at December 31, 1998, certain outstanding financing
arrangements contain financial tests which must be met before dividends can be
paid. Currently, Armco meets these covenant requirements and is not prohibited
from paying dividends under the terms of its credit facilities, long-term debt
issues or under Ohio law.
Armco is permitted to purchase shares of its capital stock under the terms of
Ohio law only to the extent that it has positive equity surplus. At December
31,1998, Armco had a negative equity surplus balance of $8.3.
On January 22, 1999, 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, 1999 to shareholders of
record on February 26, 1999. 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, 1999, to shareholders of record on
February 26, 1999.
[A BAR CHART APPEARS HERE]
CASH AND LIQUID INVESTMENTS
$ MILLIONS
95 96 97 98
$137 $169 $195 $271
<FN>
Operations are generating strong cash flow, which is making it possible to
reduce debt. Late in 1998, Armco issued $75 million of debt, which with other
available funds, was used to redeem the remaining $111 million of higher
interest rate debt in January 1999.
ENVIRONMENTAL MATTERS
In common with other U.S. manufacturers, Armco is subject to various federal,
state and local environmental requirements. Armco has spent substantial
amounts of money to control air and water pollution pursuant to applicable
environmental requirements. Armco has also spent, and will continue to spend,
substantial amounts for proper handling and disposal of waste material and for
the environmental investigation and cleanup of properties. During the period
1994 through 1998, Armco's capital expenditures for pollution control projects
amounted to $36.4, including $1.4 in 1998. Along with capital investments and
operating costs relating to environmental matters, from time to time Armco has
been and may be subject to penalties and other requirements as a result of
administrative action by regulatory agencies.
Statutory and regulatory requirements in this area continue to evolve and,
accordingly, Armco cannot predict with certainty the type and magnitude of
expenditures that will be required in the future. However, total expenditures
for capital projects for pollution control during the five-year period from
1999 through 2003 are estimated to be approximately $29.0. Of this amount,
approximately $7.4 is related to control of air pollution as required by
amendments to the federal Clean Air Act, corresponding state laws and
implementing regulations. A substantial portion of these capital expenditures
is also attributable to the control of water pollution under the Clean Water
Act. 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.
Armco is, and may in the future be, subject to other types of environmental
claims and costs, for which it accrues when it is probable that a liability
has been incurred and it is possible to reasonably estimate the amount or
range of any such loss.
Armco is a defendant, or identified as a potentially responsible party in
various pending claims regarding waste disposal sites. Joint and several
liability could be imposed on Armco or other parties for these or similar
matters; thus, theoretically, one party could be held liable for all costs
related to a site. Though the outcome of such 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. Periodically,
there are claims alleging property damage or personal injury in conjunction
with waste disposal or releases. Armco is also subject to claims for
contractual indemnification related to previously divested properties. If
Armco disposes of additional properties, it may incur additional environmental
exit costs. Armco accrues exit costs when it decides to dispose of a property
or records a sale.
20 Armco 1998 Annual Report
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 remediation. However, it is possible that due to fluctuations in
Armco's operating results, changes in the facts or circumstances of known
matters, or the addition of significant new matters, environmental liabilities
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 existing computer systems may not be able to appropriately interpret
dates after December 31, 1999 because such systems allow only two digits to
indicate a year in the date field. If not corrected, many computers and
computer applications could fail or create erroneous results, causing safety,
operational and financial problems. If such a failure were to occur to certain
of its computer systems, Armco's manufacturing and financial systems could be
temporarily shut down, resulting in a material adverse effect on its financial
condition, liquidity and results of operations. In addition, the failure of
vendor computer systems could cause interruption of deliveries of key supplies
or utilities, which might result in similar material adverse impacts. Because
of the complexity of the issues and the number of parties involved, Armco
cannot reasonably predict with certainty the nature or likelihood of such
impacts.
However, Armco, using its internal staff and outside consultants, is actively
addressing this situation and anticipates that it will not experience a
material adverse impact to its operations, liquidity or financial condition
related to systems under its control. Armco has completed an assessment of
substantially all business information, manufacturing and facility control
systems to identify areas of concern. Armco is in the process of modifying or
replacing noncompliant computer hardware and software used internally. In
addition, Armco has surveyed its suppliers in regard to their Year 2000
preparations, focusing on those suppliers most critical to its operations.
Armco intends to continue to monitor the Year 2000 compliance efforts of its
suppliers and to obtain, to the extent possible, assurances that they will be
able to deliver their products and services without interruption.
To prepare for the reasonably likely worst case scenario, Armco is developing
a contingency plan designed to mitigate the effects on its operations in case
certain of its systems or suppliers fail to perform as planned. This plan is
expected to be completed by the end of the second quarter of 1999. Contingency
planning will consist of providing all required resources to repair internal
systems should they fail at critical times, as well as establishing additional
inventories and back-up procedures in the event suppliers are unable to
deliver raw materials and services in a timely manner.
Armco has prioritized its efforts, planning to complete work on noncompliant
systems in the most critical areas first, with the expectation that virtually
all Year 2000 compliance activities, including system testing, will be
completed by September 30, 1999. In this process, Armco has redirected its
systems resources from noncritical projects to Year 2000 compliance
activities, resulting in an immaterial increase in expense. In 1998, Armco
spent approximately $6.0 on Year 2000 compliance activities and currently
anticipates spending an additional $11.0 in 1999. These expenditures, which
are expected to consist primarily of capital expenditures, outside consultants
and internal personnel costs, have been and will be funded out of operating
cash flows.
NEW ACCOUNTING STANDARD
In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS No. 133). Armco intends to adopt the new standard
when required in 2000. Armco does not expect that SFAS No. 133 will have a
material effect on its financial statements; however, its effect, if any, will
depend on Armco's exposure to derivative instruments at the time of adoption
and thereafter.
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 1999, Armco Financial Services Group
(AFSG), Liquidity and Capital Resources, Environmental Matters, The Year 2000
Issue and New Accounting Standard; and in Note 1, Summary of Significant
Accounting Policies, relating to Concentration of Credit Risk and New
Accounting Standard; Note 9, Litigation and Environmental Matters; and Note
10, 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
currently expected by management. In addition to those noted in the statements
themselves, 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; volatility in financial markets, which may affect invested pension
plan assets and the calculation of benefit plan liabilities and expenses;
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.
Armco 1998 Annual Report 21
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, 1998 and 1997, and the related consolidated
statements of income and comprehensive income and of cash flows for each of
the three years in the period ended December 31, 1998. 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, 1998 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
As discussed in Note 2 to the financial statements, in 1998 Armco Inc. changed
its method of amortizing unrecognized net gains and losses related to its
obligations for pension and other postretirement benefits.
/s/ Deloitte & Touche LLP
February 5, 1999
22 Armco 1998 Annual Report
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the years ended December 31, 1998, 1997 and 1996
- ------------------------------------------------------------------------------
(Dollars in millions, except per share amounts) 1998 1997 1996
- ------------------------------------------------------------------------------
Net sales $ 1,706.5 $ 1,829.3 $ 1,724.0
Cost of products sold (1,503.1) (1,623.9) (1,548.4)
Selling and administrative expenses (95.8) (100.0) (92.1)
Special charges (Note 7) - - (8.8)
- ------------------------------------------------------------------------------
Operating profit 107.6 105.4 74.7
Interest income 9.0 10.6 10.1
Interest expense (28.9) (35.5) (36.3)
Sundry other - net (Note 2) 27.7 (1.1) (21.1)
- ------------------------------------------------------------------------------
Income before income taxes 115.4 79.4 27.4
Provision for income taxes (Note 3) (5.8) (2.3) (1.4)
- ------------------------------------------------------------------------------
Income from continuing operations 109.6 77.1 26.0
Discontinued operation - Gain on disposal of
Aerospace and Strategic Materials (Note 10) - 2.7 6.5
- ------------------------------------------------------------------------------
Income before extraordinary loss and
cumulative effect of an accounting change 109.6 79.8 32.5
Extraordinary loss on retirement of debt
(Note 4) - (3.0) -
Cumulative effect of a change in accounting
for postretirement benefits (Note 2) 237.5 - -
- ------------------------------------------------------------------------------
Net income 347.1 76.8 32.5
Foreign currency translation adjustments 0.3 (1.4) 1.1
Minimum pension liability adjustment (2.6) - -
- ------------------------------------------------------------------------------
Comprehensive income $ 344.8 $ 75.4 $ 33.6
- ------------------------------------------------------------------------------
Basic earnings per share (Note 1)
Income from continuing operations $ 0.85 $ 0.55 $ 0.08
Income from discontinued operations - 0.03 0.06
Extraordinary loss on retirement of debt - (0.03) -
Cumulative effect of an accounting change 2.20 - -
- ------------------------------------------------------------------------------
Net income $ 3.05 $ 0.55 $ 0.14
- ------------------------------------------------------------------------------
Diluted earnings per share (Note 1)
Income from continuing operations $ 0.81 $ 0.55 $ 0.08
Income from discontinued operations - 0.03 0.06
Extraordinary loss on retirement of debt - (0.03) -
Cumulative effect of an accounting change 1.88 - -
- ------------------------------------------------------------------------------
Net income $ 2.69 $ 0.55 $ 0.14
- ------------------------------------------------------------------------------
Pro forma presentation assuming accounting
change applied retroactively
Income before extraordinary loss and
cumulative effect of an
accounting change $ 109.6 $ 83.5 $ 33.6
Basic earnings per share 0.85 0.61 0.15
Diluted earnings per share 0.81 0.59 0.15
Net income $ 109.6 $ 80.5 $ 33.6
Basic earnings per share 0.85 0.60 0.15
Diluted earnings per share 0.81 0.58 0.15
Dividends on preferred stock (Note 5)
$2.10 Class A $ 2.10 $ 2.10 $ 2.10
$3.625 Class A 3.625 3.625 3.625
$4.50 Class B 4.50 4.50 4.50
- ------------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements on pages 26 through 35.
Armco 1998 Annual Report 23
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
- ------------------------------------------------------------------------------
(Dollars in millions, except per share amounts) 1998 1997
- ------------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents (Note 1) $ 263.8 $ 189.9
Short-term liquid investments 7.0 5.0
Accounts receivable
Trade (less allowance for doubtful accounts of
$3.4 in 1998 and $4.0 in 1997) 146.7 147.0
Other 11.2 9.6
Inventories (Note 1) 250.7 268.0
Other current assets 13.4 17.9
- ------------------------------------------------------------------------------
Total current assets 692.8 637.4
- ------------------------------------------------------------------------------
Investments
Investment in Armco Financial Services Group (Note 10) 85.6 85.6
Other (less allowance for impairment of $8.7 in 1998
and $8.1 in 1997) 28.4 30.3
Property, plant and equipment (net of accumulated deprec-
iation of $714.3 in 1998 and $653.0 in 1997) (Note 1) 621.8 652.5
Deferred tax asset (Note 3) 315.8 319.3
Goodwill and other intangible assets (Note 1) 128.6 137.4
Other assets 20.8 18.8
- ------------------------------------------------------------------------------
Total assets $1,893.8 $ 1,881.3
- ------------------------------------------------------------------------------
LIABILITIES
Current liabilities
Trade accounts and notes payable $ 115.7 $ 148.9
Employment-related liabilities (Note 2) 128.0 126.4
Other current liabilities 56.5 72.8
Current portion of long-term debt (Note 4) 116.9 38.2
- ------------------------------------------------------------------------------
Total current liabilities 417.1 386.3
- ------------------------------------------------------------------------------
Long-term debt (Note 4) 250.7 306.9
Long-term employee benefit liabilities (Note 2) 898.0 1,178.1
Other long-term liabilities 149.3 162.5
Commitments and contingencies (Notes 1, 9 and 10)
SHAREHOLDERS' EQUITY (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 107,908,385 in 1998 and
107,129,561 in 1997) 1.1 1.1
Additional paid-in capital 972.0 967.7
Accumulated deficit (975.8) (1,305.0)
Other (4.5) (2.2)
- ------------------------------------------------------------------------------
Total shareholders' equity (deficit) 178.7 (152.5)
- ------------------------------------------------------------------------------
Total liabilities and shareholders' equity (deficit) $1,893.8 $ 1,881.3
- ------------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements on pages 26 through 35.
24 Armco 1998 Annual Report
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1998, 1997 and 1996
- ------------------------------------------------------------------------------
(Dollars in millions) 1998 1997 1996
- ------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 347.1 $ 76.8 $ 32.5
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 63.3 61.3 58.7
Net gain on disposal of investments and facilities (0.8) (4.5) (8.9)
Loss on retirement of debt - 3.0 -
Special charges - - 8.8
Cumulative effect of accounting change (237.5) - -
Other 5.8 6.4 6.3
Changes in assets and liabilities:
Trade accounts receivable 1.3 (9.1) 22.8
Inventories 18.6 (21.4) (33.3)
Payables and accrued operating expenses (25.1) 22.1 (13.2)
Employee benefit obligations (48.8) (13.5) (17.4)
Other assets and liabilities - net (28.7) (30.3) (13.7)
- ------------------------------------------------------------------------------
Net cash provided by operating activities 95.2 90.8 42.6
- ------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net proceeds from the sale of businesses and assets 1.7 7.7 14.0
Proceeds from the sale and maturity of
liquid investments 5.6 0.3 -
Proceeds from the sale of investments 6.0 15.1 78.7
Purchase of liquid investments (7.6) (5.0) (0.3)
Contributions to investees - - (3.0)
Capital expenditures (32.6) (41.9) (59.8)
Other 0.2 (0.2) (2.7)
- ------------------------------------------------------------------------------
Net cash (used in) provided by investing activities (26.7) (24.0) 26.9
- ------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of debt 74.4 151.1 5.5
Payments on debt (51.2) (177.7) (24.3)
Dividends paid on preferred stock (17.7) (17.9) (17.9)
Other (0.1) (1.3) (0.7)
- ------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 5.4 (45.8) (37.4)
- ------------------------------------------------------------------------------
Net increase in cash and cash equivalents 73.9 21.0 32.1
Cash and cash equivalents:
Beginning of year 189.9 168.9 136.8
- ------------------------------------------------------------------------------
End of year $ 263.8 $ 189.9 $ 168.9
- ------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of capitalized interest) $ 28.8 $ 34.7 $ 35.1
Income taxes 2.5 2.8 0.1
Supplemental schedule of non-cash investing
and financing activities:
Issuance of restricted stock 4.0 2.7 2.0
Notes receivable in partial payment
for asset sales - 0.3 10.6
- ------------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements on pages 26 through 35.
Armco 1998 Annual Report 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
- ------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
The accompanying financial statements consolidate the accounts of Armco and
all subsidiaries in which Armco has a controlling interest.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
INVESTMENTS
Armco considers all highly liquid investments purchased with a maturity of
three months or less to be cash equivalents. Cash equivalents consist of
commercial paper, corporate notes, 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, 1998 and 1997, these securities were as follows:
- ------------------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------------------
Cash equivalents $256.7 $180.4
Short-term liquid investments 7.0 5.0
Restricted collateral deposits 10.1 15.5
- ------------------------------------------------------------------------------
Total securities $273.8 $200.9
- ------------------------------------------------------------------------------
The restricted collateral deposits are primarily invested in certificates of
deposit which mature within one year and are principally used as security for
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, 1998 and 1997, 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%. At December
31, 1998 and 1997, 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 at December 31, 1998 and 1997 were as follows:
- ------------------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------------------
Inventories on LIFO
Finished and semi-finished $254.7 $280.3
Raw materials and supplies 15.8 25.8
Adjustment to state inventories at LIFO value (37.2) (54.0)
- ------------------------------------------------------------------------------
Total 233.3 252.1
- ------------------------------------------------------------------------------
Inventories on average cost
Finished and semi-finished 12.3 10.8
Raw materials and supplies 5.1 5.1
- ------------------------------------------------------------------------------
Total 17.4 15.9
- ------------------------------------------------------------------------------
Total inventories $250.7 $268.0
- ------------------------------------------------------------------------------
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 1998,
1997 and 1996 were $14.2, $15.3 and $13.1, 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.
Armco's property, plant and equipment balances at December 31, 1998 and 1997
were as follows:
- ------------------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------------------
Land $ 28.8 $ 28.1
Buildings 95.7 93.2
Machinery and equipment 1,185.6 1,156.9
Construction in progress 26.0 27.3
- ------------------------------------------------------------------------------
Total property, plant and equipment 1,336.1 1,305.5
Accumulated depreciation (714.3) (653.0)
- ------------------------------------------------------------------------------
Property, plant and equipment-net $ 621.8 $ 652.5
- ------------------------------------------------------------------------------
Armco had commitments to purchase property, plant and equipment (including
unexpended amounts relating to projects substantially underway) totaling
approximately $17.8 at December 31, 1998.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets primarily consist of 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 other intangible assets acquired in the
purchase of Douglas Dynamics, LLC on July 2, 1991. These assets are being
amortized over their estimated
26 Armco 1998 Annual Report
useful lives, the majority of which do not exceed 17 years. Annual
amortization expense for 1998, 1997 and 1996 was $6.1, $6.5 and $6.9,
respectively. At December 31, 1998 and 1997, accumulated amortization of
goodwill and other intangible assets was $42.6 and $36.5, 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
The following information was used in the calculation of basic and diluted
earnings per share:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Income from continuing operations
Income as reported $109.6 $ 77.1 $ 26.0
Less: Preferred stock dividends (17.9) (17.9) (17.9)
- ------------------------------------------------------------------------------
Income available to common shareholders - Basic 91.7 59.2 8.1
Assumed conversion of $3.625 Class A
preferred stock 9.8 9.8 -
- ------------------------------------------------------------------------------
Income available to common shareholders - Diluted $101.5 $ 69.0 $ 8.1
- ------------------------------------------------------------------------------
Common shares (in millions)
Weighted average shares outstanding - Basic 107.8 107.0 106.6
Assumed exercise of stock options 0.1 - -
Assumed conversion of $3.625 Class A
preferred stock 18.3 18.3 -
- ------------------------------------------------------------------------------
Weighted average shares outstanding - Diluted 126.2 125.3 106.6
- ------------------------------------------------------------------------------
At the end of each year, Armco had outstanding exercisable stock options and
convertible preferred stock whose exercise or conversion could, under certain
circumstances, further dilute earnings per share. The following shares of
potentially issuable common stock were not included in the above weighted
average shares outstanding because to do so would have had an antidilutive
effect on earnings per share in the years presented:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Common shares (in millions)
Exercisable stock options 2.7 2.2 1.7
Convertible preferred stock (Note 5)
$2.10 Class A 2.2 2.2 2.2
$3.625 Class A - - 18.3
$4.50 Class B 2.2 2.2 2.2
- ------------------------------------------------------------------------------
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 and electrical 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 12% of sales are to foreign
customers, primarily in Canada, Mexico and Western Europe. Approximately 37%
of trade receivables outstanding at December 31, 1998 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.
NEW ACCOUNTING STANDARD
In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS No. 133). Armco intends to adopt the new standard
when required in 2000. Armco does not expect that SFAS No. 133 will have a
material effect on its financial statements; however, its effect, if any, will
depend on Armco's exposure to derivative instruments at the time of adoption
and thereafter.
FAIR VALUE
The fair value of financial instruments is disclosed in Notes 1 and 4.
- ------------------------------------------------------------------------------
2. PENSION AND OTHER POSTRETIREMENT BENEFITS
Armco provides noncontributory pension benefits to most employees and provides
various health care and life insurance benefits to most retirees. Retiree
health and life insurance benefits are funded as claims are paid. Pension
benefits are funded as required. As of December 31, 1998, pension funding
credits of $57.3 were available to offset future minimum funding requirements
of the Employee Retirement Income Security Act of 1974.
The components of net periodic benefit cost, including amounts related to
divested units, are as follows:
- ------------------------------------------------------------------------------
Pension Benefits Other Benefits
-------------------------- --------------------------
1998 1997 1996 1998 1997 1996
- ------------------------------------------------------------------------------
Cost of benefits earned
during the year $ 16.8 $ 15.4 $ 15.6 $ 4.4 $ 4.1 $ 4.9
Interest cost 140.4 147.8 141.0 50.7 58.3 61.8
Expected return on
plan assets (186.2) (167.5) (147.3) - - -
Amortization of unrecog-
nized net obligation 6.3 6.4 6.4 - - -
Amortization of prior
service cost 1.0 0.9 0.4 (9.0) (7.3) (3.8)
Amortization of losses
(gains) (7.6)* (2.1) 0.4 (5.1)* (7.7) -
- ------------------------------------------------------------------------------
Net periodic benefit
cost $(29.3)* $ 0.9 $16.5 $41.0* $47.4 $62.9
- ------------------------------------------------------------------------------
<FN>
* Note: Amount excludes the cumulative effect of a change in accounting in
1998.
Armco 1998 Annual Report 27
Effective January 1, 1998, Armco changed its method of amortizing unrecognized
net gains and losses related to its obligations for pensions and other
postretirement benefits. In 1998, Armco recognized income of $237.5, or $2.20
per share of common stock ($1.88 per diluted share), for the cumulative effect
of this accounting change.
At the time it originally adopted the standards governing accounting for
pensions and other postretirement benefits, Armco chose to use a minimum
amortization method whereby unrecognized net gains and losses, to the extent
they exceeded 10% of the larger of the benefit obligations or plan assets,
were amortized over the average remaining service life of active participants.
At Armco, the average remaining service life is approximately 15 years. Use of
this method, however, resulted in the accumulation of $419.3 of unrecognized
net gains for pensions and other postretirement benefits through 1997. Under
the new accounting method, Armco recognizes into income, as a fourth quarter
adjustment, any unrecognized net gains and losses which exceed the 10%
corridor, as described above, and amortizes amounts inside the corridor over
the average remaining service life of active participants. Adoption of the new
method increased 1998 income from continuing operations by approximately $3.0,
or $0.03 per share of common stock.
- ------------------------------------------------------------------------------
Pension Benefits Other Benefits
------------------ --------------------
1998 1997 1998 1997
- ------------------------------------------------------------------------------
Change in Benefit Obligation
Benefit obligation at beginning of
the year $2,099.0 $2,000.3 $ 755.2 $ 783.2
Service cost 16.8 15.4 4.4 4.1
Interest cost 140.4 147.8 50.7 58.3
Plan participants' contributions - - 8.5 7.8
Actuarial losses (gains) 37.2 138.5 23.9 (14.0)
Plan amendments 15.0 0.4 (18.0) (16.4)
Benefits paid (199.1) (203.4) (66.5) (67.8)
- ------------------------------------------------------------------------------
Benefit obligation at year end $2,109.3 $2,099.0 $ 758.2 $ 755.2
- ------------------------------------------------------------------------------
Change in plan assets
Fair value of plan assets at beginning
of year $2,106.4 $2,007.5 $ - $ -
Actual return on plan assets 166.1 300.6 - -
Employer contributions 2.0 1.7 58.0 60.0
Plan participants' contributions - - 8.5 7.8
Benefits paid (199.1) (203.4) (66.5) (67.8)
- ------------------------------------------------------------------------------
Fair value of plan assets at year end $2,075.4 $2,106.4 $ - $ -
- ------------------------------------------------------------------------------
Funded status $ (33.9) $ 7.4 $(758.2) $ (755.2)
Unrecognized net gain (41.4) (223.7) (47.3) (195.6)
Unrecognized prior service cost 18.2 4.2 (96.0) (86.9)
Unrecognized transition obligation 21.0 27.4 - -
- ------------------------------------------------------------------------------
Net amount recognized $ (36.1) $ (184.7) $(901.5) $(1,037.7)
- ------------------------------------------------------------------------------
Detail of Balance Sheet Amounts:
Accrued benefit liability $ (42.7) $ (189.4) $(901.5) $(1,037.7)
Intangible asset 4.0 4.7 - -
Accumulated other comprehensive income 2.6 - - -
- ------------------------------------------------------------------------------
Net amount recognized $ (36.1) $ (184.7) $(901.5) $(1,037.7)
- ------------------------------------------------------------------------------
The following are weighted-average assumptions as of December 31:
- ------------------------------------------------------------------------------
Pension Benefits Other Benefits
------------------ --------------------
1998 1997 1998 1997
- ------------------------------------------------------------------------------
Discount rate 6.75% 7.00% 6.75% 7.00%
Expected return on plan assets 8.75% 9.25% - -
Rate of compensation increase 4.00% 4.00% 4.00% 4.00%
- ------------------------------------------------------------------------------
At December 31, 1998, pension plan assets include 3.6 million shares of Armco
common stock with a fair value of $15.7. No Armco stock was held by the plans
at December 31,1997.
For measurement purposes, a 4.75% annual increase in health care costs is
assumed for post-age 64 retirees. Health care costs for pre-age 65 retirees
are assumed to increase 6% in 1999. This rate declines annually until it
reaches 4.75% in 2001 and thereafter.
Assumed health care cost trend rates have a significant effect on the amounts
reported for health care plans. A one percentage-point change in assumed
health care cost trend rates would have the following effects:
- ------------------------------------------------------------------------------
One Percentage- One Percentage-
Point Increase Point Decrease
- ------------------------------------------------------------------------------
Increase (decrease) in total of service and
interest cost components $ 5.6 $ (5.0)
Increase (decrease) in postretirement
benefit obligation 63.5 (57.5)
- ------------------------------------------------------------------------------
The projected benefit obligation, accumulated benefit obligation and fair
value of plan assets for plans with accumulated benefit obligations in excess
of plan assets, including unfunded nonqualified pension plans, was $24.4,
$19.4 and $1.3, respectively, at December 31, 1998, and $19.3, $16.2 and $1.2,
respectively, at December 31, 1997.
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 $7.4, $6.7 and $2.9 for 1998, 1997 and 1996,
respectively. A portion of the expense of these plans varies based on Armco's
profitability.
28 Armco 1998 Annual Report
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 income of $24.2
in 1998 and expense of $2.0 and $22.1 in 1997 and 1996, respectively, related
to these liabilities. The decrease in costs in 1997 and 1998 was primarily due
to continuing favorable investment returns on pension plan assets and lower
than expected increases in medical benefit costs.
- ------------------------------------------------------------------------------
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:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
United States $113.2 $77.8 $24.4
Foreign 2.2 1.6 3.0
- ------------------------------------------------------------------------------
Total $115.4 $79.4 $27.4
- ------------------------------------------------------------------------------
Provisions for income taxes for Armco and consolidated subsidiaries are as
follows:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Current
U.S. federal $1.0 $1.2 $ -
U.S. state 0.2 0.3 -
Foreign 1.1 0.8 1.4
- ------------------------------------------------------------------------------
Total 2.3 2.3 1.4
- ------------------------------------------------------------------------------
Deferred
U.S. federal 3.5 - -
- ------------------------------------------------------------------------------
Total $5.8 $2.3 $1.4
- ------------------------------------------------------------------------------
The following is a reconciliation of the statutory federal income tax rate
applied to income before income taxes with the provision for income taxes:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Federal taxes at statutory rate $ 40.4 $ 27.8 $ 9.6
State taxes, net of federal benefit 0.1 0.2 -
Change in deferred tax valuation allowance (34.7) (25.7) (8.2)
- ------------------------------------------------------------------------------
Total $ 5.8 $ 2.3 $ 1.4
- ------------------------------------------------------------------------------
During 1998, Armco's net operating loss carryforwards decreased by
approximately $54.3 due to taxable income generated in the year. Armco's
capital loss carryforward decreased by approximately $50.4, of which $14.3 was
the result of taxable capital gains generated in the year, and $36.1 was due
to the expiration of unused capital losses available from 1993. The difference
between pretax book income of $115.4 and 1998 taxable income is primarily due
to costs associated with employee benefits, environmental and restructuring
actions, which had been accrued for financial accounting purposes in prior
years, but actually paid in 1998; and additional net deductions resulting from
the 1998 operations of the Armco Financial Services Group.
At December 31, 1998, Armco had capital loss and net operating loss (NOL)
carryforwards for federal tax purposes expiring as follows:
- ------------------------------------------------------------------------------
Year Capital
expiring loss NOL
- ------------------------------------------------------------------------------
1999 $ - $ 106.7
2000 117.4 -
2001 46.0 123.3
2004 - 9.1
2005 - 129.4
2006 - 238.6
2007 - 186.2
2008 - 125.2
2009 - 29.9
2010 - 44.4
2011 - 31.1
- ------------------------------------------------------------------------------
Total loss carryforwards $163.4 $1,023.9
- ------------------------------------------------------------------------------
Armco has $698.0 in U.S. alternative minimum tax net operating losses.
Additionally, Armco has $13.0 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, 1998 and 1997, the net deferred
tax asset, included on the Consolidated Balance Sheets, was as follows:
- ------------------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------------------
Other current assets $ 9.2 $ 9.2
Deferred tax asset 315.8 319.3
- ------------------------------------------------------------------------------
Net deferred tax asset $325.0 $328.5
- ------------------------------------------------------------------------------
Armco 1998 Annual Report 29
Major components of Armco's year-end net deferred tax asset are as follows:
- ------------------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------------------
Tax effects of
Operating loss and tax credit carryforwards $ 478.4 $ 522.2
Employee benefits 433.0 556.4
Other assets (including contingencies and accruals) 123.8 133.5
- ------------------------------------------------------------------------------
Gross deferred tax asset 1,035.2 1,212.1
Valuation allowance (448.6) (593.0)
- ------------------------------------------------------------------------------
Deferred tax asset 586.6 619.1
- ------------------------------------------------------------------------------
Property, plant and equipment (155.1) (148.8)
Other liabilities (106.5) (141.8)
- ------------------------------------------------------------------------------
Deferred tax liability (261.6) (290.6)
- ------------------------------------------------------------------------------
Net deferred tax asset $ 325.0 $ 328.5
- ------------------------------------------------------------------------------
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 $325.0 net deferred tax asset. Armco prepares a calculation
annually 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 nine 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.
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 and 1998, in addition to using its temporary
differences, principally related to employee benefit obligations, to reduce
taxable income, Armco utilized approximately $70.0 of its NOL carryforwards.
These were the first two years of taxable income for Armco after seven years
of tax losses. 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 1994 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.
- ------------------------------------------------------------------------------
4. LONG-TERM DEBT AND OTHER FINANCING
LONG-TERM DEBT
At December 31, 1998 and 1997, Armco's long-term debt was as follows:
- ------------------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------------------
Senior notes
8-7/8% due 2008 $ 75.0 $ -
9% due 2007 150.0 150.0
9-3/8% due 2000 111.0 125.0
Variable rate loan (LIBOR plus 2.75%) due 2001 - 31.2
5% loan due 2000 10.2 15.3
8-1/8% pollution control revenue bonds due 2005 - 12.1
Variable rate revenue refunding bonds due 2008
(1998 average 3.53%) 12.1 -
Variable rate economic development revenue bonds
due 2020 (1998 average 3.67%) 7.3 8.5
Other 2.0 3.0
- ------------------------------------------------------------------------------
Total debt 367.6 345.1
Less current maturities (116.9) (38.2)
- ------------------------------------------------------------------------------
Long-term debt $ 250.7 $ 306.9
- ------------------------------------------------------------------------------
Maturities of existing long-term debt during the five years ending December
31, 2003, are as follows: 1999, $116.9; 2000, $5.9; 2001, $0.8; 2002, $0.8 and
2003, zero. The 1999 maturities include the January 14, 1999 redemption of
$111.0 of the 9-3/8% Senior Notes. These notes were redeemed with the proceeds
of the December 1998 issuance of $75.0 of 8-7/8% Senior Notes due 2008 and
other available funds. In the first quarter of 1999, Armco recognized an
extraordinary loss of $2.8 related to this redemption.
30 Armco 1998 Annual Report
At December 31, 1998, the fair value of Armco's long-term debt, including
current maturities, was approximately $372.9. 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, 1998.
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, 1997, was approximately $347.4.
At December 31, 1998 and 1997, $13.2 and $50.2, 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.
During 1997, Armco recorded an extraordinary loss upon retiring certain of its
outstanding debt of $3.0 or $0.03 per share of common stock.
BANK CREDIT AGREEMENTS
At December 31, 1998, Armco had in place two bank credit facilities, totaling
$170.0. In 1998, the terms of these facilities were extended and both will
expire in 2001.
Under a receivables facility, Armco sells substantially all its trade
receivables to a wholly owned subsidiary, Armco Funding Corporation (AFC). In
1998, AFC and its bank group amended its revolving credit agreement to
provide, depending on its available borrowing base, up to $100.0 for loans and
letters of credit secured by AFC's receivables. At December 31, 1998, there
were no outstanding borrowings under this credit facility; however, $61.1 of
the facility was used as support for letters of credit.
In 1998, Armco and its bank group amended its revolving credit agreement to
provide, depending on its available borrowing base, up to $70.0 for loans and
letters of credit secured by Armco's inventories. This credit agreement
subjects Armco to certain restrictions and covenants related to, among other
things, minimum net worth, leverage ratio and interest coverage ratio
requirements. At December 31, 1998, there were no outstanding borrowings or
letters of credit under this facility. Under both bank credit facilities, a
total of $93.3 was available for borrowing at December 31, 1998.
LONG-TERM LEASES
Rental expense under operating leases was $6.7 in 1998, $6.9 in 1997 and $7.7
in 1996. At December 31, 1998, commitments to make future minimum lease
payments for operating leases are $4.3 in 1999, $2.9 in 2000, $2.4 in 2001,
$3.0 in 2002, $1.3 in 2003 and $1.2 thereafter.
- ------------------------------------------------------------------------------
5. SHAREHOLDERS' EQUITY (DEFICIT)
PREFERRED STOCK
Armco has outstanding two classes of preferred stock that 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, 1998 and 1997, 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 and one series of Class B preferred stock
outstanding. Except as noted, the following relates to each issue at December
31, 1998 and 1997:
- ------------------------------------------------------------------------------
$2.10 $3.625 $4.50
Class A Class A Class B
- ------------------------------------------------------------------------------
Number of shares outstanding 1,697,231 2,700,000 999,900
Total book value of shares outstanding $7.2 $130.4 $48.3
Per share data:
Cumulative dividend (annual rate) $2.10 $3.625 $4.50
Common stock conversion rate 1.27 6.78 2.22
Redemption price (at Armco's option) $40.00 $51.45* $50.00
Liquidation value $15.00 $50.00 $50.00
Voting rights 1 vote 1 vote No vote
- ------------------------------------------------------------------------------
<FN>
* Price as of December 31, 1998. This price declines at 12-month intervals to
$50 per share on and after October 15, 2002.
COMMON STOCK
At December 31, 1998, 22,681,261 unissued shares of Armco's common stock were
reserved for the conversion of preferred stock and 4,343,247 unissued shares
of common stock were reserved for the exercise of stock options (see Note 6).
Activity for the years 1996, 1997 and 1998 related to Armco's common stock was
as follows:
- ------------------------------------------------------------------------------
Additional
Paid-in
Shares Par Value Capital
- ------------------------------------------------------------------------------
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
Exercise of options 62,900 - 0.3
Restricted stock issued -
net of cancellations 707,802 - 4.0
Directors' stock purchase plan 8,122 - -
- ------------------------------------------------------------------------------
Balance, December 31, 1998 107,908,385 $1.1 $972.0
- ------------------------------------------------------------------------------
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
Armco 1998 Annual Report 31
20% or more of Armco's common stock or announces a tender or exchange offer,
after which such person or group would beneficially own 20% or more of the
common stock, or if the Board of Directors declares any person to be an
"adverse person" as defined in the plan. A total of 750,000 shares of Class A
participating preferred stock have been reserved for issuance upon exercise of
the rights.
Armco, except as otherwise provided in the plan, will generally be able to
redeem the rights at $0.0025 per right at any time during a ten-day period
following public announcement that a 20% position in Armco has been acquired
or after the effective date the Board of Directors declares any person to be
an "adverse person." During this ten-day period, Armco may also extend the
time during which it may redeem the rights. The rights are not exercisable
until the expiration of the redemption period. The rights will expire on June
26, 2006.
ACCUMULATED DEFICIT, DEFERRED COMPENSATION AND ACCUMULATED OTHER COMPREHENSIVE
INCOME (LOSS)
Activity for the years 1996, 1997 and 1998 related to Armco's accumulated
deficit, deferred compensation and accumulated other comprehensive income
(loss) was as follows:
- ------------------------------------------------------------------------------
Accumulated Other
Comprehensive
Income (Loss)
--------------------
Foreign Minimum
Accumulated Deferred Currency Pension
Deficit Compensation Translation Liability
- ------------------------------------------------------------------------------
Balance, December 31, 1995 $(1,378.5) $(2.8) $ 0.9 $ -
Net income 32.5 - - -
Preferred stock dividends declared (17.9) - - -
National-Oilwell foreign currency
translation - - 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) (2.0) 1.9 -
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) (2.7) 0.5 -
Net income 347.1 - - -
Preferred stock dividends declared (17.9) - - -
Foreign currency translation
adjustment - - 0.3 -
Amortization and cancellation of
deferred compensation - 2.0 - -
Deferred compensation on
restricted stock issued - (2.0) - -
Minimum pension liability
adjustment - - - (2.6)
- ------------------------------------------------------------------------------
Balance, December 31, 1998 $ (975.8) $(2.7) $ 0.8 $(2.6)
- ------------------------------------------------------------------------------
DIVIDENDS
In prior years, certain of Armco's financing arrangements included covenants
that prohibited the payment of common stock dividends. These prohibitions have
been eliminated; however, at December 31, 1998, certain outstanding financing
arrangements contain financial tests which must be met before dividends can be
paid. Currently, Armco meets these covenant requirements and is not prohibited
from paying dividends under the terms of its credit facilities, long-term debt
issues or under Ohio law.
Armco is permitted to purchase shares of its capital stock under the terms of
Ohio law only to the extent that it has positive equity surplus. At December
31,1998, Armco had a negative equity surplus balance of $8.3.
The Board of Directors at its January 1999 meeting declared the regular
quarterly dividends payable on both series of Armco's Class A preferred stock
and on its Class B preferred stock.
- ------------------------------------------------------------------------------
6. COMMON STOCK OPTIONS
Armco maintains plans that provide for granting options to purchase common
stock for not less than 100% of its market price on the date the option is
granted. The vesting period for stock options granted under these 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. Armco also has plans that provide for issuing stock, subject to
restrictions as to sale and forfeiture over a three- to five-year period.
Under certain circumstances, this vesting schedule may be accelerated by one
year.
At December 31, 1998, 5,492,769 shares of common stock were available for
granting of awards under these plans. During 1996, 1997 and 1998, stock option
activity was as follows:
- ------------------------------------------------------------------------------
Weighted Average
Shares Exercise Price
- ------------------------------------------------------------------------------
Outstanding at December 31, 1995 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, 1996 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, 1997 3,510,134 6.00
Granted 1,117,239 5.31
Exercised (62,900) 4.74
Forfeited (34,926) 5.46
Expired (186,300) 8.83
- ------------------------------------------------------------------------------
Outstanding at December 31, 1998 4,343,247 5.72
- ------------------------------------------------------------------------------
The total number of options exercisable at the end of each year was as
follows:
- ------------------------------------------------------------------------------
Weighted Average
Shares Exercise Price
- ------------------------------------------------------------------------------
1996 1,741,811 $7.66
1997 2,161,324 6.72
1998 2,756,807 6.16
- ------------------------------------------------------------------------------
32 Armco 1998 Annual Report
The following relates to the options outstanding at December 31, 1998:
- ------------------------------------------------------------------------------
Exercise Price Ranges $4.09 - $7.56 $12.06
- ------------------------------------------------------------------------------
Options outstanding
Number of shares 4,219,347 123,900
Weighted average exercise price $5.54 $12.06
Average remaining contractual life 7 years 1 year
Options exercisable
Number of shares 2,632,907 123,900
Weighted average exercise price $5.88 $12.06
- ------------------------------------------------------------------------------
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 Principles 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 1998 would have been reduced by $1.7 to $345.4, or $3.04
per basic share and $2.67 per diluted share. Net income for 1997 would have
been reduced by $1.2 to $75.6, or $0.54 per basic and diluted share, and net
income for 1996 would have been reduced by $1.7 to $30.8, or $0.12 per basic
and diluted share. These pro forma adjustments were calculated using the
Black-Scholes option pricing model under the following assumptions in each
year:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Risk free interest rate 5.5% 6.25% 5.5%
Expected volatility 40% 35% 30%
Expected life of options 5 years 5 years 5 years
Expected dividends None None None
- ------------------------------------------------------------------------------
Based on the option pricing model, options granted during 1998, 1997 and 1996
had fair values of $2.32, $1.72 and $1.90 per share, respectively.
During 1998, 1997 and 1996, Armco issued to certain employees 786,562, 646,013
and 570,158 shares of common stock, subject to restrictions, with weighted
average grant-date fair values of $5.31, $4.07 and $5.69 per share,
respectively. Total compensation cost recognized in income for stock-based
employee compensation awards was $1.7 in 1998, $1.6 in 1997 and $1.1 in 1996.
- ------------------------------------------------------------------------------
7. SPECIAL CHARGES
In 1996, Armco recognized a special charge of $5.9 to record a loss on the
sale of its nonresidential construction business, which was sold effective
January 1, 1997. The charge primarily related 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 its decision to discontinue a line of
light truck equipment manufactured by Armco's snowplow and ice control
products business.
- ------------------------------------------------------------------------------
8. SEGMENT INFORMATION
Armco's reportable operating segments are three separately managed business
units that offer different products and services. They are: (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 galvanized 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. (2) Tubular Products, consisting of Sawhill Tubular with
operations in Sharon and Wheatland, Pennsylvania and Warren, Ohio that produce
steel pipe and tubular products for the industrial machinery, construction and
appliance markets. And, (3) Other Businesses, consisting of Douglas Dynamics,
LLC with plants in Milwaukee, Wisconsin, Rockland, Maine and Johnson City,
Tennessee, that manufacture snowplows and ice control equipment for four-wheel
drive light trucks and 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. A substantial portion of the Other
Businesses segment represents the snowplow and ice control products business.
Accounting policies of the segments are the same as those described in the
summary of significant accounting policies in Note 1. Armco's management
evaluates segment performance based on income from continuing operations.
Armco does not allocate interest expense, interest income, income tax expense
or employee benefits for certain divested businesses to its segments.
Armco's segment information is as follows:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Net sales
Specialty Flat-Rolled Steels $1,418.9 $1,497.0 $1,421.2
Tubular Products 192.7 209.4 189.6
Other Businesses 94.9 122.9 113.2
- ------------------------------------------------------------------------------
Total $1,706.5 $1,829.3 $1,724.0
- ------------------------------------------------------------------------------
Income from continuing operations
Specialty Flat-Rolled Steels $ 105.7 $ 91.3 $ 72.9
Tubular Products 2.4 5.6 0.8
Other Businesses 28.2 36.1 23.3
Corporate (26.7) (55.9) (71.0)
- ------------------------------------------------------------------------------
Total $ 109.6 $ 77.1 $ 26.0
- ------------------------------------------------------------------------------
Depreciation
Specialty Flat-Rolled Steels $ 54.2 $ 52.6 $ 50.4
Tubular Products 4.5 4.3 4.1
Other Businesses 3.0 2.9 2.6
Corporate 1.6 1.5 1.6
- ------------------------------------------------------------------------------
Total $ 63.3 $ 61.3 $ 58.7
- ------------------------------------------------------------------------------
Capital expenditures
Specialty Flat-Rolled Steels $ 22.2 $ 31.4 $ 55.9
Tubular Products 2.8 2.6 1.4
Other Businesses 4.6 5.5 1.7
Corporate 3.0 2.4 0.8
- ------------------------------------------------------------------------------
Total $ 32.6 $ 41.9 $ 59.8
- ------------------------------------------------------------------------------
Total assets
Specialty Flat-Rolled Steels $ 871.2 $ 923.7 $ 934.2
Tubular Products 103.6 100.5 92.8
Other Businesses 76.7 78.6 70.4
Corporate 756.7 692.9 684.8
Discontinued operations 85.6 85.6 85.6
- ------------------------------------------------------------------------------
Total $1,893.8 $1,881.3 $1,867.8
- ------------------------------------------------------------------------------
Armco 1998 Annual Report 33
Total assets include the following assets reported in Corporate:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Cash and liquid investments $268.5 $192.0 $162.5
Deferred taxes 325.0 328.5 328.5
Goodwill and other intangibles 114.7 121.0 126.0
Other - net 48.5 51.4 67.8
- ------------------------------------------------------------------------------
Total Corporate $756.7 $692.9 $684.8
- ------------------------------------------------------------------------------
Other Businesses income from continuing operations for 1996 includes a $2.9
special charge (see Note 7).
Armco's net sales to customers located outside the United States totaled
$196.7, $185.4 and $165.4 for 1998, 1997 and 1996, respectively.
- ------------------------------------------------------------------------------
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, 1998 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 its results of operations in future interim or annual
periods.
In common with other U.S. manufacturers, Armco is subject to various federal,
state and local 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 identified as a potentially responsible party, in
proceedings alleging liability for remediation, property damage or personal
injury related to certain waste disposal sites. Armco has also received claims
for indemnification for some properties it has previously owned or leased. In
most cases involving waste disposal sites, Armco is one of many potentially
responsible parties. In these cases, joint and several liability could be
imposed on Armco or other parties; thus, theoretically, one party could be
held liable for all costs related to a site. However, based on its experience
and a review of current claims, Armco believes that any ultimate liability
will be apportioned 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 liabilities, 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 regularly to assess changed conditions, including current
interpretations of environmental laws and regulations, and changes in
remediation technology and methods. Adjustments are made if changed conditions
have a significant effect on cost estimates. Liabilities 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, 1998, Armco had recorded on its Consolidated Balance Sheets,
$11.4 in other current liabilities and $50.4 in other long-term liabilities
for estimated probable costs relating to legal and environmental matters.
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10. 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.
ARMCO FINANCIAL SERVICES GROUP (AFSG)
Armco's investment in AFSG represents the net assets of its discontinued
insurance and finance leasing businesses, which have been largely liquidated.
The insurance companies, including Northwestern National Insurance Company
(NNIC), have stopped writing new business and are being "run off." These
companies are accounted for as discontinued operations under the liquidation
basis of accounting, whereby 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 consolidated
summarized financial information at December 31, 1998:
- ------------------------------------------------------------------------------
Assets
Invested assets $151.9
Reinsurance recoverable 79.1
Other 12.2
- ------------------------------------------------------------------------------
Total assets 243.2
- ------------------------------------------------------------------------------
Liabilities
Losses and loss reserves (net of future investment
income of $35.1) 139.0
Other 18.6
- ------------------------------------------------------------------------------
Total liabilities 157.6
- ------------------------------------------------------------------------------
Net assets $ 85.6
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34 Armco 1998 Annual Report
At December 31, 1998, AFSG's invested assets included $23.0 of various Senior
Notes of Armco. On January 14, 1999, AFSG tendered $5.0 of the Senior Notes,
which were redeemed by Armco on that date (see Note 4).
Currently, insurance regulators having supervisory authority over the AFSG
insurance companies retain substantial control over certain transactions,
including the payment of dividends to Armco.
In March 1997, North Atlantic Insurance Company, a group of international
insurance companies previously affiliated with AFSG but sold in 1991, filed an
application for voluntary liquidation in the United Kingdom. As a result of
this voluntary liquidation filing, certain claims have been asserted against
NNIC by insureds of North Atlantic. NNIC is defending these claims as well as
pursuing related claims against third parties and North Atlantic.
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, 1998 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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11. QUARTERLY INFORMATION (UNAUDITED)
- ------------------------------------------------------------------------------
1998 4Q 3Q 2Q 1Q
- ------------------------------------------------------------------------------
Net sales $ 1,706.5 $ 393.3 $ 415.4 $ 450.1 $ 447.7
Cost of products sold (1,503.1) (342.0) (360.6) (396.1) (404.4)
Income from discon-
tinued operations (1) - - - - -
Income before extra-
ordinary loss and
cumulative effect of
an accounting change 109.6 27.5 30.7 31.1 20.3
Extraordinary loss (2) - - - - -
Cumulative effect of a
change in accounting
for postretirement
benefits (3) 237.5 - - - 237.5
Net income 347.1 27.5 30.7 31.1 257.8
Basic earnings per share
Income from discon-
tinued operations - - - - -
Income before extra-
ordinary loss and
cumulative effect of
an accounting change 0.85 0.21 0.24 0.25 0.15
Extraordinary loss - - - - -
Cumulative effect of a
change in accounting
for postretirement
benefits 2.20 - - - 2.21
Net income 3.05 0.21 0.24 0.25 2.36
Diluted earnings per share
Income from discon-
tinued operations - - - - -
Income before extra-
ordinary loss and
cumulative effect of
an accounting change 0.81 0.20 0.23 0.23 0.15
Extraordinary loss - - - - -
Cumulative effect of a
change in accounting
for postretirement
benefits 1.88 - - - 1.89
Net income 2.69 0.20 0.23 0.23 2.04
- ------------------------------------------------------------------------------
1997 4Q 3Q 2Q 1Q
- ------------------------------------------------------------------------------
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 extra-
ordinary loss and
cumulative effect of
an accounting change 79.8 19.2 29.7 21.5 9.4
Extraordinary loss (2) (3.0) - (3.0) - -
Cumulative effect of a
change in accounting
for postretirement
benefits (3) - - - - -
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 extra-
ordinary loss and
cumulative effect of
an accounting change 0.58 0.14 0.24 0.16 0.05
Extraordinary loss (0.03) - (0.03) - -
Cumulative effect of a
change in accounting
for postretirement
benefits - - - - -
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 extra-
ordinary loss and
cumulative effect of
an accounting change 0.58 0.14 0.22 0.16 0.05
Extraordinary loss (0.03) - (0.02) - -
Cumulative effect of a
change in accounting
for postretirement
benefits - - - - -
Net income 0.55 0.14 0.20 0.16 0.05
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<FN>
(1) See Note 10.
(2) See Note 4.
(3) See Note 1.
Armco 1998 Annual Report 35
PRICE RANGE AND DIVIDENDS OF ARMCO STOCK (UNAUDITED)
(Stock price lines reflect weekly closing prices)
- ------------------------------------------------------------------------------
- ---------
1997 1998
- ------------------------------------------------------------------------------
- ---------
Q1 Q2 Q3 Q4 Q1 Q2 Q3
Q4
- ------------------------------------------------------------------------------
- ---------
COMMON STOCK
NYSE: AS
High 4-7/8 4-1/8 6-3/8 6-3/16 6-1/4 7-1/16 6-9/16
5-1/4
Low 3-3/8 3-3/8 3-13/16 4-1/2 4-7/16 5-1/4 3
3-11/16
$2.10 CLASS A
PREFERRED STOCK
Quarterly dividend
per share: $.525
High 24 23-7/8 26 26-3/16 25-9/16 26-1/8 25-15/16
26
Low 21 21-1/4 23-1/2 24-1/4 23-1/2 21-5/8 22
22-1/2
$3.625 CLASS A
PREFERRED STOCK
Quarterly dividend
per share: $.90625
High 43-1/4 42-7/8 52-1/8 51-3/4 52 54-3/4 52-1/4
44-1/2
Low 39 41-1/4 42-7/8 46-3/8 45-1/4 49 41-11/16
39-1/8
$4.50 CLASS B
PREFERRED STOCK
Quarterly dividend
per share: $1.125
High 49-1/2 49 51-3/4 51-3/16 51-1/2 52-1/4 51-3/4
51-5/16
Low 46-1/4 47 48-9/16 49-5/8 49-1/2 50-3/8 49-3/16
47-5/8
- ------------------------------------------------------------------------------
- --------
36 Armco 1998 Annual Report