UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From _____ to _____
Commission File Number 1-12001
ALLEGHENY TECHNOLOGIES INCORPORATED
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 25-1792394
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1000 Six PPG Place
Pittsburgh, Pennsylvania 15222-5479
- ---------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(412) 394-2800
---------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer
(as defined by Rule 12b-2 of the Securities Exchange Act of 1934).
Yes X No
--- ---
At April 23, 2004, the registrant had outstanding 81,277,981 shares of its
Common Stock.
ALLEGHENY TECHNOLOGIES INCORPORATED
SEC FORM 10-Q
QUARTER ENDED MARCH 31, 2004
INDEX
Page No.
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 20
Item 3. Quantitative and Qualitative
Disclosures About Market Risk 34
Item 4. Controls and Procedures 37
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 6. Exhibits and Reports on Form 8-K 37
SIGNATURES 39
EXHIBIT INDEX 40
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share and per share amounts)
March 31, December 31,
2004 2003
---- ----
(Unaudited) (Audited)
ASSETS
Cash and cash equivalents $ 67.3 $ 79.6
Accounts receivable, net 311.0 248.8
Inventories, net 366.9 359.7
Income tax refunds 0.3 7.2
Prepaid expenses and other current assets 37.3 48.0
-------- --------
Total Current Assets 782.8 743.3
Property, plant and equipment, net 711.2 711.1
Cost in excess of net assets acquired 206.3 198.4
Deferred pension asset 144.0 144.0
Deferred income taxes 34.3 34.3
Other assets 62.7 53.8
-------- --------
TOTAL ASSETS $1,941.3 $1,884.9
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 219.4 $ 172.3
Accrued liabilities 207.5 194.6
Short-term debt and current portion
of long-term debt 21.8 27.8
-------- --------
Total Current Liabilities 448.7 394.7
Long-term debt 512.4 504.3
Accrued postretirement benefits 518.0 507.2
Pension liabilities 238.6 220.6
Other long-term liabilities 87.3 83.4
-------- --------
TOTAL LIABILITIES 1,805.0 1,710.2
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.10: authorized-
50,000,000 shares; issued-none -- --
Common stock, par value $0.10, authorized-500,000,000
shares; issued-98,951,490 shares at March 31, 2004 and December 31, 2003;
outstanding-81,247,476 shares at March 31, 2004 and 80,654,861 shares
at December 31, 2003 9.9 9.9
Additional paid-in capital 481.2 481.2
Retained earnings 418.9 483.8
Treasury stock: 17,704,014 shares at
March 31, 2004 and 18,296,629 shares
at December 31, 2003 (443.5) (458.4)
Accumulated other comprehensive
loss, net of tax (330.2) (341.8)
-------- --------
Total Stockholders' Equity 136.3 174.7
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,941.3 $1,884.9
======== ========
The accompanying notes are an integral part of these statements.
3
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions except per share amounts)
(Unaudited)
Three Months Ended
March 31,
------------------------
2004 2003
---------- ----------
Sales $ 577.8 $ 480.5
Costs and expenses:
Cost of sales 567.4 465.9
Selling and administrative expenses 53.7 47.7
---------- ----------
Loss before interest, other income and income taxes (43.3) (33.1)
Interest expense, net (8.2) (7.4)
Other income, net 1.1 0.5
---------- ----------
Loss before income tax benefit and cumulative effect
of change in accounting principle (50.4) (40.0)
Income tax benefit -- (14.2)
---------- ----------
Net loss before cumulative effect of change in
accounting principle (50.4) (25.8)
Cumulative effect of change in accounting principle,
net of tax -- (1.3)
---------- ----------
Net loss $ (50.4) $ (27.1)
========== ==========
Basic and diluted net loss per common share before
cumulative effect of change in accounting principle $ (0.63) $ (0.32)
Cumulative effect of change in accounting principle -- (0.02)
---------- ----------
Basic and diluted net loss per common share $ (0.63) $ (0.34)
========== ==========
Dividends declared per common share $ 0.06 $ 0.06
========== ==========
The accompanying notes are an integral part of these statements.
4
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Three Months Ended
March 31,
--------------------
2004 2003
--------- ---------
OPERATING ACTIVITIES:
Net loss $ (50.4) $ (27.1)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Cumulative effect of change in accounting principle - 1.3
Depreciation and amortization 18.8 18.0
Gains on sales of assets (1.6) -
Deferred income taxes - (13.3)
Change in operating assets and liabilities:
Accounts receivable (62.2) (21.2)
Accounts payable 47.0 6.8
Accrued liabilities and other 31.0 13.0
Pension assets and liabilities 17.5 22.4
Inventories (7.2) (3.0)
Income tax refunds receivable 6.9 48.3
--------- ---------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (0.2) 45.2
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (12.1) (11.8)
Asset disposals and other 1.2 5.9
--------- ---------
CASH USED IN INVESTING ACTIVITIES (10.9) (5.9)
FINANCING ACTIVITIES:
Payments on long-term debt and capital leases (12.8) (0.2)
Borrowings on long-term debt 8.5 3.1
Net borrowings under credit facilities 1.2 -
--------- ---------
Net increase (decrease) in debt (3.1) 2.9
Exercises of stock options 1.9 -
Proceeds from interest rate swap settlement - 14.6
Dividends paid - (4.8)
--------- ---------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (1.2) 12.7
--------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (12.3) 52.0
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 79.6 59.4
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 67.3 $ 111.4
========= =========
The accompanying notes are an integral part of these statements.
5
ALLEGHENY TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ACCOUNTING POLICIES
Basis of Presentation
The interim consolidated financial statements include the accounts of
Allegheny Technologies Incorporated and its subsidiaries. Unless the context
requires otherwise, "Allegheny Technologies" and "the Company" refer to
Allegheny Technologies Incorporated and its subsidiaries.
These unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions for Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and note disclosures required by accounting principles generally
accepted in the United States for complete financial statements. In management's
opinion, all adjustments (which include only normal recurring adjustments)
considered necessary for a fair presentation have been included. These unaudited
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
2003 Annual Report on Form 10-K. The results of operations for these interim
periods are not necessarily indicative of the operating results for any future
period. Certain amounts from prior periods have been reclassified to conform
with the current presentation.
Stock-based Compensation
The Company accounts for its stock option plans and other stock-based
compensation in accordance with APB Opinion No. 25, "Accounting for Stock Issued
to Employees", and related interpretations. The following table illustrates the
effect on net loss and per share information if the Company had applied the fair
value recognition provisions of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123").
(in millions, except per share amounts)
Three Months Ended
March 31,
------------------------
2004 2003
---------- ----------
(unaudited)
Net loss as reported $ (50.4) $ (27.1)
Add: Stock-based compensation
expense included in net loss, net of tax 1.2 0.3
Deduct: Net impact of SFAS 123,
net of tax (2.4) (1.1)
---------- ----------
Pro forma net loss $ (51.6) $ (27.9)
========== ==========
Net loss per common share:
Basic and diluted--as reported $ (0.63) $ (0.34)
========== ==========
Basic and diluted--pro forma $ (0.66) $ (0.35)
========== ==========
6
NOTE 2. INVENTORIES
Inventories at March 31, 2004 and December 31, 2003 were as follows (in
millions):
March 31, December 31,
2004 2003
--------- ------------
(unaudited) (audited)
Raw materials and supplies $ 43.6 $ 37.5
Work-in-process 397.8 356.2
Finished goods 96.1 84.9
--------- ---------
Total inventories at current cost 537.5 478.6
Less allowances to reduce current cost
values to LIFO basis (159.8) (111.7)
Progress payments (10.8) (7.2)
--------- ---------
Total inventories, net $ 366.9 $ 359.7
========= =========
NOTE 3. SUPPLEMENTAL FINANCIAL STATEMENT INFORMATION
Property, plant and equipment at March 31, 2004 and December 31, 2003
were as follows (in millions):
March 31, December 31,
2004 2003
----------- ------------
(unaudited) (audited)
Land $ 26.9 $ 26.3
Buildings 228.5 228.2
Equipment and leasehold improvements 1,513.6 1,494.0
---------- ----------
1,769.0 1,748.5
Accumulated depreciation and amortization (1,057.8) (1,037.4)
---------- ----------
Total property, plant and equipment, net $ 711.2 $ 711.1
========== ==========
Reserves for restructuring charges recorded in 2003 and prior years
involving future payments were approximately $8 million at March 31, 2004 and $9
million at December 31, 2003. The reduction in reserves resulted from cash
payments to meet severance and lease payment obligations.
7
NOTE 4. DEBT
Debt at March 31, 2004 and December 31, 2003 was as follows (in
millions):
March 31, December 31,
2004 2003
--------- ------------
(unaudited) (audited)
Allegheny Technologies $300 million 8.375% Notes
due 2011, net (a) $ 313.1 $ 309.4
Allegheny Ludlum 6.95% debentures, due 2025 150.0 150.0
Foreign credit agreements 44.2 35.0
Industrial revenue bonds, due
through 2007 10.6 20.1
Capitalized leases and other 16.3 17.6
--------- ---------
534.2 532.1
Short-term debt and current portion of long-term debt (21.8) (27.8)
--------- ---------
Total long-term debt $ 512.4 $ 504.3
========= =========
(a) Includes fair value adjustments for interest rate swap contracts
of $18.8 million (including $5.4 million for interest rate swap
contracts currently outstanding and $13.4 million for deferred
gains on settled interest rate swap contracts) and $15.2 million
(including $1.4 million for interest rate swap contracts
currently outstanding and $13.8 million for deferred gains on
settled interest rate swap contracts) at March 31, 2004 and
December 31, 2003, respectively.
Interest rate swap contracts are used from time-to-time to manage the
Company's exposure to interest rate risks. At the end of the 2002 first quarter,
ATI entered into interest rate swap contracts with respect to a $150 million
notional amount related to its $300 million, 8.375% ten-year Notes, due December
15, 2011, which involved the receipt of fixed rate amounts in exchange for
floating rate interest payments over the life of the contracts without an
exchange of the underlying principal amount. These contracts were designated as
fair value hedges. As a result, changes in the fair value of the swap contracts
and the underlying fixed rate debt are recognized in the statement of
operations. In the 2003 first quarter, the Company terminated the majority of
these interest rate swap contracts and received $14.6 million in cash. The gain
on settlement remains a component of the reported balance of the Notes ($313.1
million at March 31, 2004 including fair value adjustments), and is being
ratably recognized as a reduction to interest expense over the remaining life of
the Notes, which is approximately eight years. In the 2003 first quarter, the
Company entered into new "receive fixed, pay floating" interest rate swap
arrangements related to the 8.375% ten-year Notes which re-established, in
total, the $150 million notional amount which effectively converted this portion
of the Notes to variable rate debt.
8
NOTE 5. PER SHARE INFORMATION
The following table sets forth the computation of basic and diluted net
loss per common share (in millions, except share and per share amounts):
Three Months Ended
March 31,
--------------------------
2004 2003
---------- ----------
(unaudited)
Numerator:
Basic and diluted net loss per common
share before cumulative effect of
change in accounting principle $ (50.4) $ (25.8)
Cumulative effect of change
in accounting principle, net of tax - (1.3)
---------- ----------
Numerator for basic and diluted net loss per common
share $ (50.4) $ (27.1)
========== ==========
Denominator for basic and diluted net loss per common share -
adjusted weighted average shares 80.4 80.7
========== ==========
Basic and diluted net loss per common share before cumulative
effect of change in accounting principle $ (0.63) $ (0.32)
Cumulative effect of change in
accounting principle - (0.02)
---------- ----------
Basic and diluted net loss per common
share $ (0.63) $ (0.34)
========== ==========
For the 2004 and 2003 periods, the effects of stock options were
antidilutive and thus not included in the calculation of dilutive earnings per
share.
NOTE 6. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, were as
follows (in millions):
Three Months Ended
March 31,
---------------------
2004 2003
------- -------
(unaudited)
Net loss $ (50.4) $ (27.1)
------- -------
Foreign currency translation gains 19.5 4.5
Unrealized losses on energy, raw
materials and currency hedges (7.9) -
------- -------
11.6 4.5
------- -------
Comprehensive loss $ (38.8) $ (22.6)
======= =======
9
NOTE 7. INCOME TAXES
First quarter 2004 results do not include an income tax benefit as a
result of a deferred tax valuation allowance recorded in the fourth quarter
2003. The valuation allowance was recorded in accordance with SFAS No. 109,
"Accounting for Income Taxes", due to the uncertainty regarding full utilization
of the Company's net deferred tax assets. The Company is required to maintain a
valuation allowance until a realization event occurs to support reversal of all,
or a portion of, the allowance. The Company recorded a tax benefit on the loss
before income taxes and the cumulative effect of a change in accounting
principle of $14.2 million in the first quarter 2003, using a tax rate of 35.5%.
NOTE 8. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
The Company has defined benefit pension plans and defined contribution
plans covering substantially all employees. Benefits under the defined benefit
pension plans are generally based on years of service and/or final average pay.
The Company funds the U.S. pension plans in accordance with the Employee
Retirement Income Security Act of 1974, as amended, and the Internal Revenue
Code.
The Company also sponsors several postretirement plans covering certain
salaried and hourly employees. The plans provide health care and life insurance
benefits for eligible retirees. In certain plans, Company contributions towards
premiums are capped based on the cost as of a certain date, thereby creating a
defined contribution. For the non-collectively bargained plans, the Company
maintains the right to amend or terminate the plans at its discretion.
For the 2004 and 2003 first quarters, the components of pension expense
for the Company's defined benefit plans and components of postretirement benefit
expense included the following (pretax, in millions):
Three Months Ended
March 31,
--------------------------
2004 2003
------ ------
(unaudited)
Pension Benefits:
Service cost - benefits earned during the year $ 7.5 $ 7.2
Interest cost on benefits earned in prior years 31.3 31.1
Expected return on plan assets (36.8) (34.4)
Amortization of prior service cost 6.3 6.7
Amortization of net actuarial loss 10.7 12.8
------ ------
Net pension expense $ 19.0 $ 23.4
====== ======
Three Months Ended
March 31,
------------------------
2004 2003
----- -----
(unaudited)
Other Postretirement Benefits:
Service cost - benefits earned during the year $ 2.2 $ 2.0
Interest cost on benefits earned in prior years 13.9 11.8
Expected return on plan assets (2.2) (2.4)
Amortization of prior service cost - (1.2)
Amortization of net actuarial loss 3.1 1.2
----- -----
Net postretirement benefit expense $17.0 $11.4
===== =====
Total retirement benefit expense $36.0 $34.8
===== =====
10
The Other Postretirement Benefits obligation, and postretirement
benefits expense recognized through March 31, 2004, does not include the
expected favorable impact of the Medicare Prescription Drug, Improvement and
Modernization Act, which was enacted on December 8, 2003. The Act provides for a
federal subsidy, with tax-free payments commencing in 2006, to sponsors of
retiree health care benefits plans that provide a benefit that is at least
actuarially equivalent to the benefit established by the law. Based upon
estimates from the Company's actuaries, it is expected that the federal subsidy
included in the law will result in a reduction in the Other Postretirement
Benefits obligation of up to $70 million. This reduction is not reflected in the
financial statements or in estimates of 2004 expense because final authoritative
accounting guidance regarding how the benefit is to be recognized in the
financial statements is pending.
NOTE 9. BUSINESS SEGMENTS
Following is certain financial information with respect to the
Company's business segments for the periods indicated (in millions):
Three Months Ended
March 31,
--------------------------
2004 2003
------ ------
(unaudited)
Total sales:
Flat-Rolled Products $332.0 $260.9
High Performance Metals 193.7 170.2
Engineered Products 71.8 64.0
------ ------
597.5 495.1
Intersegment sales:
Flat-Rolled Products 2.4 3.6
High Performance Metals 15.0 9.2
Engineered Products 2.3 1.8
------ ------
19.7 14.6
Sales to external customers:
Flat-Rolled Products 329.6 257.3
High Performance Metals 178.7 161.0
Engineered Products 69.5 62.2
------ ------
$577.8 $480.5
====== ======
Operating profit(loss):
Flat-Rolled Products $(11.0) $ (1.3)
High Performance Metals 7.8 8.3
Engineered Products 3.8 1.8
------ ------
Total operating profit 0.6 8.8
Corporate expenses (5.6) (4.8)
Interest expense, net (8.2) (7.4)
Other expenses, net of
gains on asset sales (1.2) (1.8)
Retirement benefit expense (36.0) (34.8)
------ ------
Loss before income tax
benefit and cumulative
effect of change in
accounting principle $(50.4) $(40.0)
====== ======
Retirement benefit expense represents pension expense and other
postretirement benefit expenses. Operating profit with respect to the Company's
business segments excludes any retirement benefit expense.
11
NOTE 10. FINANCIAL INFORMATION FOR SUBSIDIARY AND GUARANTOR PARENT
The payment obligations under the $150 million 6.95% debentures due
2025 issued by Allegheny Ludlum Corporation (the "Subsidiary") are fully and
unconditionally guaranteed by Allegheny Technologies Incorporated (the
"Guarantor Parent"). In accordance with positions established by the Securities
and Exchange Commission, the financial information in this Note 10 sets forth
separately financial information with respect to the Subsidiary, the
non-guarantor subsidiaries and the Guarantor Parent. The principal elimination
entries eliminate investments in subsidiaries and certain intercompany balances
and transactions. Investments in subsidiaries, which are eliminated in
consolidation, are included in other assets on the balance sheets.
In 1996, the defined benefit pension plans of the Subsidiary were
merged with the defined benefit pension plans of Teledyne, Inc. and Allegheny
Technologies became the plan sponsor. As a result, the balance sheets presented
for the Subsidiary and the non-guarantor subsidiaries do not include the
Allegheny Technologies deferred pension asset, pension liabilities or the
related deferred taxes. The pension assets, liabilities and the related deferred
taxes and pension income or expense are recognized by the Guarantor Parent.
Management and royalty fees charged to the Subsidiary and to the non-guarantor
subsidiaries by the Guarantor Parent have been excluded solely for purposes of
this presentation.
12
NOTE 10. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
March 31, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
---------- ---------- ------------- ------------ ------------
Assets:
Cash and cash equivalents $ 0.1 $ 27.4 $ 39.8 $ - $ 67.3
Accounts receivable, net 0.2 123.1 187.7 - 311.0
Inventories, net - 143.6 223.3 - 366.9
Income tax refunds 0.3 - - - 0.3
Prepaid expenses and other
current assets 0.2 10.0 27.1 - 37.3
---------- ---------- ---------- ---------- ----------
Total current assets 0.8 304.1 477.9 - 782.8
Property, plant, and
equipment, net - 321.0 390.2 - 711.2
Cost in excess of net
assets acquired - 112.1 94.2 - 206.3
Deferred pension asset 144.0 - - - 144.0
Deferred income taxes 34.3 - - - 34.3
Investments in subsidiaries and
other assets 1,015.4 450.4 546.3 (1,949.4) 62.7
---------- ---------- ---------- ---------- ----------
Total assets $ 1,194.5 $ 1,187.6 $ 1,508.6 $ (1,949.4) $ 1,941.3
========== ========== ========== ========== ==========
Liabilities and
stockholders' equity:
Accounts payable $ 3.4 $ 110.7 $ 105.3 $ - $ 219.4
Accrued liabilities 495.2 80.5 351.5 (719.7) 207.5
Short-term debt and current portion
of long-term debt - - 21.8 - 21.8
---------- ---------- ---------- ---------- ----------
Total current liabilities 498.6 191.2 478.6 (719.7) 448.7
Long-term debt 313.1 350.0 49.3 (200.0) 512.4
Accrued postretirement
benefits - 319.4 198.6 - 518.0
Pension liabilities 238.6 - - - 238.6
Other long-term liabilities 7.9 25.5 53.9 - 87.3
---------- ---------- ---------- ---------- ----------
Total liabilities 1,058.2 886.1 780.4 (919.7) 1,805.0
---------- ---------- ---------- ---------- ----------
Total stockholders' equity 136.3 301.5 728.2 (1,029.7) 136.3
---------- ---------- ---------- ---------- ----------
Total liabilities and
stockholders' equity $ 1,194.5 $ 1,187.6 $ 1,508.6 $ (1,949.4) $ 1,941.3
========== ========== ========== ========== ==========
13
NOTE 10. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the three months ended March 31, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Sales $ - $ 301.7 $ 276.1 $ - $ 577.8
Cost of sales 26.6 310.0 230.8 - 567.4
Selling and administrative
expenses 21.1 5.4 27.2 - 53.7
Interest expense, net 5.1 2.7 0.4 - 8.2
Other income(expense)
including equity in income of
unconsolidated subsidiaries 2.4 0.3 2.2 (3.8) 1.1
------- -------- -------- ------ --------
Income (loss) before income
tax provision (benefit) (50.4) (16.1) 19.9 (3.8) (50.4)
Income tax provision (benefit) - - - - -
------- -------- -------- ------ --------
Net income (loss) $ (50.4) $ (16.1) $ 19.9 $ (3.8) $ (50.4)
======= ======== ======== ====== ========
14
NOTE 10. CONTINUED
Condensed Statements of Cash Flows
For the three months ended March 31, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Cash flows provided by (used in)
operating activities $ (15.2) $ 93.7 $ (26.4) $ (52.3) $ (0.2)
Cash flows provided by (used in)
investing activities - (3.5) (9.1) 1.7 (10.9)
Cash flows provided by (used in)
financing activities 15.0 (105.1) 38.3 50.6 (1.2)
------- -------- ------- ------- ------
Increase (decrease) in
cash and cash equivalents $ (0.2) $ (14.9) $ 2.8 $ - $(12.3)
======= ======== ======= ======= ======
15
NOTE 10. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Balance Sheets
December 31, 2003 (audited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Assets:
Cash and cash equivalents $ 0.3 $ 42.3 $ 37.0 $ - $ 79.6
Accounts receivable, net 0.1 89.4 159.3 - 248.8
Inventories, net - 147.3 212.4 - 359.7
Income tax refunds 7.2 - - - 7.2
Prepaid expenses, and other
current assets - 11.5 36.5 - 48.0
-------- --------- --------- ---------- ---------
Total current assets 7.6 290.5 445.2 - 743.3
Property, plant, and
equipment, net - 326.3 384.8 - 711.1
Cost in excess of net
assets acquired - 112.1 86.3 - 198.4
Deferred pension asset 144.0 - - - 144.0
Deferred income taxes 34.3 - - - 34.3
Investment in subsidiaries
and other assets 994.4 546.0 326.9 (1,813.5) 53.8
-------- --------- --------- ---------- ---------
Total assets $1,180.3 $ 1,274.9 $ 1,243.2 $ (1,813.5) $ 1,884.9
======== ========= ========= ========== =========
Liabilities and
stockholders' equity:
Accounts payable $ 2.5 $ 92.4 $ 77.4 $ - $ 172.3
Accrued liabilities 465.6 70.2 181.2 (522.4) 194.6
Short-term debt and current portion of
long-term debt - 9.6 18.2 - 27.8
-------- --------- --------- ---------- ---------
Total current liabilities 468.1 172.2 276.8 (522.4) 394.7
Long-term debt 309.4 349.9 45.1 (200.1) 504.3
Accrued postretirement
benefits - 316.8 190.4 - 507.2
Pension liabilities 220.6 - - - 220.6
Other long-term liabilities 7.5 22.8 53.1 - 83.4
-------- --------- --------- ---------- ---------
Total liabilities 1,005.6 861.7 565.4 (722.5) 1,710.2
-------- --------- --------- ---------- ---------
Total stockholders' equity 174.7 413.2 677.8 (1,091.0) 174.7
-------- --------- --------- ---------- ---------
Total liabilities and
stockholders' equity $1,180.3 $ 1,274.9 $ 1,243.2 $(1,813.5) $ 1,884.9
======== ========= ========= ========= =========
16
NOTE 10. CONTINUED
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent
Statements of Operations
For the three months ended March 31, 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Sales $ - $ 237.2 $ 243.3 $ - $ 480.5
Cost of sales 25.1 239.5 201.3 - 465.9
Selling and administrative
expenses 12.7 6.0 29.0 - 47.7
Interest expense, net 4.7 2.6 0.1 - 7.4
Other income(expense)
including equity in income of
unconsolidated subsidiaries 1.8 (0.2) 3.5 (4.6) 0.5
-------- --------- --------- ---------- ---------
Income (loss) before income
tax provision (benefit) and cumulative
effect of change in accounting
principle (40.7) (11.1) 16.4 (4.6) (40.0)
Income tax provision (benefit) (14.9) (3.3) 5.5 (1.5) (14.2)
-------- --------- --------- ---------- ---------
Net income (loss) before cumulative
effect of change in accounting
principle (25.8) (7.8) 10.9 (3.1) (25.8)
Cumulative effect of change in accounting
principle, net of tax (1.3) - - - (1.3)
-------- --------- --------- ---------- ---------
Net income (loss) $ (27.1) $ (7.8) $ 10.9 $ (3.1) $ (27.1)
======== ========= ========= ========== =========
17
NOTE 10. CONTINUED
Condensed Statements of Cash Flows
For the three months ended March 31, 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------- ---------- ------------- ------------ ------------
Cash flows provided by (used in)
operating activities $ 1.8 $ 158.2 $ 22.2 $ (137.0) $ 45.2
Cash flows provided by (used in)
investing activities - (5.9) (3.4) 3.4 (5.9)
Cash flows provided by (used in)
financing activities (2.1) (111.8) (7.0) 133.6 12.7
-------- --------- --------- ---------- ---------
Increase (decrease) in cash and
cash equivalents $ (0.3) $ 40.5 $ 11.8 $ - $ 52.0
======== ========= ========= ========== =========
18
NOTE 11. COMMITMENTS AND CONTINGENCIES
The Company is subject to various domestic and international
environmental laws and regulations that govern the discharge of pollutants into
the air or water and disposal of hazardous substances, which may require that it
investigate and remediate the effects of the release or disposal of materials at
sites associated with past and present operations, including sites at which the
Company has been identified as a potentially responsible party ("PRP") under the
Federal Superfund laws and comparable state laws. The Company could incur
substantial cleanup costs, fines, and civil or criminal sanctions, third party
property damage or personal injury claims as a result of violations or
liabilities under these laws or noncompliance with environmental permits
required at its facilities. The Company is currently involved in the
investigation and remediation of a number of the Company's current and former
sites as well as third party sites under these laws.
Environmental liabilities are recorded when the Company's liability is
probable and the costs are reasonably estimable. In many cases, however,
investigations are not at a stage where the Company has been able to determine
whether it is liable or, if liability is probable, to reasonably estimate the
loss or range of loss, or certain components thereof. Estimates of the Company's
liability remain subject to additional uncertainties regarding the nature and
extent of site contamination, the range of remediation alternatives available,
evolving remediation standards, imprecise engineering evaluations and estimates
of appropriate cleanup technology, methodology and cost, the extent of
corrective actions that may be required, and the number, participation, and
financial condition of other PRPs, as well as the extent of their responsibility
for the remediation. Accordingly, the Company periodically reviews accruals as
investigation and remediation of these sites proceed. As the Company receives
new information, the Company expects that it will adjust its accruals to reflect
the new information. Future adjustments could have a material adverse effect on
the Company's results of operations in a given period, but the Company cannot
reliably predict the amounts of such future adjustments.
Based on currently available information, the Company does not believe
that there is a reasonable possibility that a loss exceeding the amount already
accrued for any of the sites with which the Company is currently associated
(either individually or in the aggregate) will be an amount that would be
material to a decision to buy or sell the Company's securities.
Additional future developments, administrative actions or liabilities
relating to environmental matters however could have a material adverse effect
on the Company's financial condition or results of operations. At March 31,
2004, the Company's reserves for environmental remediation obligations totaled
approximately $39.8 million, of which approximately $19.1 million were included
in other current liabilities. The reserve includes estimated probable future
costs of $12.9 million for federal Superfund and comparable state-managed sites;
$9.1 million for formerly owned or operated sites for which the Company has
remediation or indemnification obligations; $5.9 million for owned or controlled
sites at which Company operations have been discontinued; and $11.9 million for
sites utilized by the Company in its ongoing operations. The Company continues
to evaluate whether it may be able to recover a portion of future costs for
environmental liabilities from third parties other than participating
potentially responsible parties.
The timing of expenditures depends on a number of factors that vary by
site, including the nature and extent of contamination, the number of
participating PRPs, the timing of regulatory approvals, the complexity of the
investigation and remediation, and the standards for remediation. The Company
expects that it will expend present accruals over many
19
years, and will complete remediation of all sites with which it has been
identified in up to thirty years.
A number of lawsuits, claims and proceedings have been or may be
asserted against the Company relating to the conduct of its business, including
those pertaining to product liability, patent infringement, commercial,
employment, employee benefits, environmental and stockholder matters. Certain of
such lawsuits, claims and proceedings are described in the Company's Annual
Report on Form 10-K for the year ended December 31, 2003. While the outcome of
litigation cannot be predicted with certainty, and some of these lawsuits,
claims or proceedings may be determined adversely to the Company, management
does not believe that the disposition of any such pending matters is likely to
have a material adverse effect on the Company's financial condition or
liquidity, although the resolution in any reporting period of one or more of
these matters could have a material adverse effect on the Company's results of
operations for that period.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Allegheny Technologies Incorporated is one of the largest and most
diversified producers of specialty materials in the world. Unless the context
requires otherwise, "we", "our" and "us" refer to Allegheny Technologies
Incorporated and its subsidiaries.
RESULTS OF OPERATIONS
We operate in the following three business segments, which accounted
for the following percentages of total external sales for the first three months
of 2004 and 2003:
2004 2003
---- ----
Flat-Rolled Products 57% 54%
High Performance Metals 31% 34%
Engineered Products 12% 12%
For the first three months of 2004, operating profit decreased to $0.6
million compared to $8.8 million for the same 2003 period, primarily due to
higher raw material costs. Results included a LIFO inventory valuation reserve
increase of $48.1 million, primarily due to the effects of rapidly rising raw
materials costs, which increased approximately 30% in the first quarter 2004
compared to the fourth quarter 2003. The higher raw material costs more than
offset the benefits of additional surcharges, higher base selling prices and
cost reduction initiatives. Cost reductions, before the effects of inflation,
totaled $26.6 million in the first quarter 2004. First quarter 2003 results
included a LIFO inventory valuation reserve increase of $3.0 million. Sales
increased 20% to $577.8 million for the first three months of 2004 compared to
$480.5 million for the same 2003 period. During the first quarter 2004, we
increased base selling prices for most of our products and implemented
additional surcharges for certain raw materials for many of our products.
Business conditions in most of our end markets reflected increased
demand for many of our products during the first quarter of 2004. These improved
market conditions were offset by higher raw material and retirement benefit
expenses, which resulted in a net loss of $50.4 million, or $0.63 per diluted
share, for the first three months of 2004 compared to a net loss before
cumulative effect of a change in accounting principle of $25.8 million, or $0.32
per diluted share, for the first three months of 2003. First quarter 2004
results do not
20
include an income tax benefit as a result of a deferred tax valuation allowance
recorded in the fourth quarter 2003. First quarter 2003 results included an
income tax benefit of $14.2 million, or $0.18 per share. Retirement benefit
expense was $36.0 million in the first quarter of 2004, compared to $34.8
million in the comparable year ago period. Essentially all of this $1.2 million
increase in expense is non-cash.
On January 1, 2003, we adopted Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143").
The adoption of SFAS 143 resulted in an after-tax charge of $1.3 million or
$0.02 per diluted share. This charge is reported as a cumulative effect of a
change in accounting principle.
Sales and operating profit (loss) for our three business segments are
discussed below.
FLAT-ROLLED PRODUCTS SEGMENT
Sales increased 28% to $329.6 million in the 2004 first quarter,
compared to the prior year period, primarily due to improved demand from capital
goods markets, and the impact of higher raw material surcharges and base selling
price increases. Higher raw material and energy costs more than offset the
benefits of additional surcharges, higher base selling prices and cost reduction
initiatives, resulting in an operating loss of $11.0 million for the quarter,
compared to an operating loss of $1.3 million in the comparable 2003 period.
Higher raw material costs resulted in a LIFO inventory valuation reserve
increase of $37.6 million in the first quarter 2004 compared to a LIFO inventory
valuation reserve increase of $3.9 million in the comparable 2003 period. Energy
costs increased by $2.4 million compared to 2003, net of approximately $0.4
million in gains from natural gas derivatives, as a result of higher natural gas
and electricity prices. Results for 2004 benefited from $13 million in gross
cost reductions, before the effects of inflation.
For the first quarter of 2004, total tons shipped increased 5% compared
to the same period of 2003. For the comparable periods, shipments of commodity
products increased 4% and shipments of high-value products increased 7%. Average
transaction prices for the comparable periods, which include raw material
surcharges, were 22% higher. Average base selling prices for the first quarter
of 2004, which exclude surcharges, increased by approximately 3% compared to the
first quarter of 2003.
Comparative information on the segment's products is provided in the
following table (unaudited):
Three Months Ended
March 31,
------------------- %
2004 2003 Change
------- ------- ------
Volume (finished tons):
Commodity 87,016 83,492 4
High Value 37,971 35,472 7
------- -------
Total 124,987 118,964 5
Average prices (per finished ton):
Commodity $ 2,006 $ 1,563 28
High Value $ 4,081 $ 3,557 15
Combined Average $ 2,636 $ 2,158 22
21
HIGH PERFORMANCE METALS SEGMENT
Sales increased 11% to $178.7 million due primarily to improved demand
from the commercial aerospace market for nickel-based superalloys and titanium
alloys. Our exotic alloys business continued to benefit from sustained high
demand from government and high energy physics markets and corrosion markets,
particularly in Asia. Operating profit declined to $7.8 million compared to $8.3
million in the year-ago period because the impact of higher raw material costs
offset increased sales and the benefits of cost reduction initiatives. The rise
in raw material costs resulted in a LIFO inventory valuation reserve increase of
$8.6 million in 2004, compared to $1.0 million in the first quarter 2003.
Results for 2004 benefited from $10 million of gross cost reductions, before the
effects of inflation.
Shipments were up 3% for nickel-based and specialty steel alloys, 9% for
titanium alloys, and 27% for exotic alloys compared to the same period of 2003.
Certain comparative information on the segment's major products is provided in
the following table (unaudited):
Three Months Ended
March 31,
------------------ %
2004 2003 Change
------ ------- ------
Volume (000's pounds):
Nickel-based and specialty steel alloys 8,944 8,692 3
Titanium mill products 5,023 4,615 9
Exotic alloys 1,185 932 27
Average prices (per pound):
Nickel-based and specialty steel alloys $ 7.73 $ 6.73 15
Titanium mill products $11.41 $ 12.85 (11)
Exotic alloys $36.32 $ 37.75 (4)
ENGINEERED PRODUCTS SEGMENT
Sales improved 12% to $69.5 million. Operating profit improved to $3.8
million for the first quarter of 2004 compared to $1.8 million in the prior year
quarter. Higher sales volumes, improved pricing, and the benefits from cost
reductions offset higher raw material costs. The rise in raw material costs
resulted in an increase to the LIFO inventory valuation reserve of $1.9 million
in 2004, compared to a decrease of $1.9 million in 2003. Gross cost reductions,
before the effects of inflation, totaled $2 million in the first quarter 2004.
Demand for tungsten products in our Metalworking Products operation remained
strong from the oil and gas market and demand improved for tungsten carbide
products and cutting tools due to a pickup in overall manufacturing activity.
Demand improved considerably for forged products from the Class 8 truck market
and for cast products from the improving manufacturing sector and transportation
and wind energy markets.
CORPORATE ITEMS
Corporate expenses increased to $5.6 million for the first quarter of
2004 compared to $4.8 million for the first quarter of 2003. This increase is
due primarily to non-cash expenses associated with our stock-based long-term
incentive compensation programs, which offset savings associated with reductions
in staffing and other efforts to control costs at the corporate office. Net
interest expense increased to $8.2 million for the first quarter of 2004 from
$7.4 million for the same period last year. The increase was primarily due to
higher costs associated with the secured credit facility we entered into in June
2003. Our "receive fixed, pay floating" interest rate swap contracts for $150
million related to the $300 million, 8.375%, ten-year Notes,
22
which effectively convert this portion of the Notes to variable rate debt,
decreased interest expense by $1.7 million in both periods, compared to the
fixed interest expense of the Notes that would otherwise be applicable.
Retirement benefit expense was $36.0 million in the first quarter 2004,
compared to $34.8 million in the first quarter 2003. Pension expense decreased
to $19.0 million for the 2004 first quarter from $23.4 million for same period
of last year as actual returns on pension assets in 2003 were higher than
expected, partially offset by the use in 2004 of a lower assumed discount rate
to value pension benefit liabilities. However, other postretirement benefit
expense increased for the 2004 first quarter to $17.0 million from $11.4 million
in the comparable 2003 period as a result of a projected rise in medical cost
inflation and a lower assumed discount rate. Approximately $29.7 million of the
first quarter 2004 retirement benefit expense was non-cash. The 2004 retirement
benefit expense does not include the expected favorable impact on our
postretirement medical expense from the enactment of the Federal Medicare
prescription drug benefit program in December 2003, pending final authoritative
accounting guidance regarding how the benefit is to be recognized in the
financial statements. For the first quarter 2004, retirement benefit expense
increased cost of sales by $27.6 million, and selling and administrative
expenses by $8.4 million. For the first quarter 2003, retirement benefit expense
increased cost of sales by $24.4 million, and selling and administrative
expenses by $10.4 million.
We are not required to make cash contributions to the defined benefit
pension plan for 2004 and, based upon current actuarial studies, we do not
expect to be required to make cash contributions to the defined benefit pension
plan during the next several years.
INCOME TAXES
First quarter 2004 results do not include an income tax benefit as a
result of a deferred tax valuation allowance recorded in the fourth quarter
2003. The valuation allowance was recorded in accordance with SFAS No. 109,
"Accounting for Income Taxes", based upon the results of our quarterly
evaluation concerning the estimated probability that the net deferred tax asset
would be realizable. We are required to maintain a valuation allowance until a
realization event occurs to support reversal of all or a portion of the
allowance. Our effective tax rate was a benefit of 35.5% for the 2003 first
quarter. We received federal income tax refunds of $6.9 million and $48.3
million in the 2004 and 2003 first quarters, respectively. Under current tax
laws we are substantially unable to carry-back any current year or future year
tax losses to prior periods to obtain cash refunds of taxes paid during those
periods. Current year tax losses, if any, can be carried forward for up to 20
years and applied against any taxes owed in those future years.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2003, as required, we adopted Statement of
Financial Accounting Statement No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS 143"). Under SFAS 143, obligations associated with the
retirement of tangible long-lived assets, such as landfill and other facility
closure costs, are capitalized and amortized to expense over an asset's useful
life using a systematic and rational allocation method.
Our adoption of SFAS 143 resulted in recognizing a charge of $1.3
million, net of income taxes of $0.7 million, or $0.02 per share, principally
for asset retirement obligations related to landfills in our Flat-Rolled
Products segment. This charge is reported in the statement
23
of operations for the quarter ended March 31, 2003 as a cumulative effect of a
change in accounting principle.
FINANCIAL CONDITION AND LIQUIDITY
CASH FLOW AND WORKING CAPITAL
During the three months ended March 31, 2004, cash used by operations
was $0.2 million, due primarily to a $75.4 million increase in managed working
capital in the quarter, partially offset by the receipt of a $6.9 million
Federal income tax refund pertaining to our 2003 tax return. Capital
expenditures of $12.1 million, and $3.1 million of net debt repayments were the
principal investing and financing activities, respectively. At March 31, 2004,
cash and cash equivalents totaled $67.3 million, a decrease of $12.3 million
from December 31, 2003.
As part of managing the liquidity of our business, we focus on
controlling managed working capital, which is defined as gross accounts
receivable and gross inventories, less accounts payable. In measuring
performance in controlling this managed working capital, we exclude the effects
of LIFO inventory valuation reserves, excess and obsolete inventory reserves,
and reserves for uncollectible accounts receivable which, due to their nature,
are managed separately. At March 31, 2004, managed working capital was 26.4% of
annualized sales compared to 30.7% of annualized sales at December 31, 2003.
During the first three months of 2004, managed working capital increased by
$75.4 million, to $650.9 million. The increase in managed working capital from
December 31, 2003 was due to increased accounts receivable, which reflects the
higher level of sales in the first quarter 2004 compared to the fourth quarter
2003, and increased inventory, mostly as a result of higher raw material costs,
which was partially offset by increased accounts payable. The majority of the
increase in raw material costs should be recovered through surcharges.
The components of managed working capital were as follows:
(Unaudited, in millions) March 31, December 31,
2004 2003
-------- ------------
Accounts receivable $ 311.0 $ 248.8
Inventories 366.9 359.7
Accounts payable (219.4) (172.3)
-------- --------
Subtotal 458.5 436.2
Allowance for doubtful accounts 11.0 10.2
LIFO reserves 159.8 111.7
Corporate and other 21.6 17.4
-------- --------
Managed working capital $ 650.9 $ 575.5
======== ========
Annualized prior 2 months sales $2,463.0 $1,874.0
======== ========
Managed working capital as a
% of annualized sales 26.4% 30.7%
Capital expenditures for 2004 are expected to be between $60 and $70
million, of which $12.1 million had been expended in the 2004 first quarter.
Capital expenditures primarily relate to the upgrade of our flat-rolled products
melt shop located in Brackenridge, PA and investments to enhance the high
performance metals capabilities of our high performance metals long products
rolling mill facility located in Richburg, SC.
A regular quarterly dividend of $0.06 per share of common stock was
declared on March 11, 2004, payable to stockholders of record at the
24
close of business on March 22, 2004. The payment of dividends and the amount of
such dividends depends upon matters deemed relevant by our Board of Directors,
such as our results of operations, financial condition, cash requirements,
future prospects, any limitations imposed by law, credit agreements or senior
securities, and other factors deemed relevant and appropriate.
DEBT
At March 31, 2004, we had $534.2 million in total outstanding debt,
largely unchanged from the $532.1 million at December 31, 2003. The increase in
debt was due to fair value adjustments related to interest rate swap contracts
on our $300 million, 8.375% ten year Notes, due December 15, 2011, which offset
a net decrease in other debt of $3.1 million. We repaid $9.5 million in
industrial revenue bonds, and borrowed $6.5 million, net, at our STAL joint
venture.
Interest rate swap contracts are used from time-to-time to manage our
exposure to interest rate risks. At the end of the 2002 first quarter, we
entered into interest rate swap contracts with respect to a $150 million
notional amount related to our Notes, which involved the receipt of fixed rate
amounts in exchange for floating rate interest payments over the life of the
contracts without an exchange of the underlying principal amount. These
contracts were designated as fair value hedges. As a result, changes in the fair
value of the swap contracts and the underlying fixed rate debt are recognized in
the statement of operations. In the 2003 first quarter, we terminated the
majority of these interest rate swap contracts and received $14.6 million in
cash. The gain on settlement remains a component of the reported balance of the
Notes ($313.1 million at March 31, 2004, including fair value adjustments), and
is being ratably recognized as a reduction to interest expense over the
remaining life of the Notes, which is approximately eight years.
In the 2003 first quarter, we entered into new "receive fixed, pay
floating" interest rate swap arrangements related to the Notes which
re-established, in total, the $150 million notional amount which effectively
converted this portion of the Notes to variable rate debt. Including accretion
of the gain on termination of the swap contracts described above, the result of
the "receive fixed, pay floating" arrangements was a decrease in interest
expense of $1.7 million for both the 2004 and 2003 first quarters, compared to
the fixed interest expense of the Notes that would otherwise have been realized.
At March 31, 2004, the adjustment of these swap contracts to fair market value
resulted in the recognition of an asset of $5.4 million on the balance sheet,
included in other assets, with an offsetting increase in long-term debt.
We did not borrow funds under our domestic credit facilities during the
2004 first quarter, or during all of 2003 or 2002. We have a $325 million
four-year senior secured domestic revolving credit facility ("the facility"),
which expires in June 2007, and which is secured by all accounts receivable and
inventory of our U.S. operations, and includes capacity for up to $150 million
in letters of credit. Outstanding letters of credit issued under the facility at
March 31, 2004 were approximately $94 million. The secured credit facility
limits capital expenditures, investments and acquisitions of businesses, new
indebtedness, asset divestitures, payment of dividends, and common stock
repurchases which we may incur or undertake during the term of the facility
without obtaining permission of the lending group. In addition, the secured
credit facility contains a financial covenant, which is not measured unless our
undrawn availability under the facility is less than $150 million. This
financial covenant, when measured, requires us to maintain a ratio of
consolidated earnings before interest, taxes,
25
depreciation and amortization ("EBITDA") to fixed charges of at least 1.0 to
1.0. EBITDA is adjusted for non-cash items such as income/loss on investments
accounted for under the equity method of accounting, non-cash pension
expense/income, and that portion of retiree medical and life insurance expenses
paid from the our VEBA trust. EBITDA is reduced by capital expenditures and cash
taxes paid, and increased for cash tax refunds. Fixed charges include gross
interest expense, dividends paid and scheduled debt payments. Our ability to
borrow under the secured credit facility in the future could be adversely
affected if we fail to maintain the applicable covenants under the agreement
governing the facility. At March 31, 2004, our undrawn availability under the
facility, which is calculated including outstanding letters of credit and
domestic cash on hand, was $259 million, and the amount that we could borrow at
that date prior to requiring the application of a financial covenant test was
$109 million. We expect our undrawn availability will decrease by up to $33
million in connection with the planned appeal of an unfavorable jury verdict
received on March 10, 2004 concerning litigation between our wholly-owned
subsidiary TDY Industries, Inc. and the San Diego Unified Port District
involving a lease of property. This matter is more fully described in our Report
on Form 10-K for the year ended December 31, 2003.
During the next several months, due to rising raw material prices and
improving business volumes, we expect to maintain a lower domestic cash balance
from 2003 year end levels, and we may borrow funds from the secured facility
from time-to-time to support working capital requirements or investment
opportunities. We believe that internally generated funds, current cash on hand
and capacity provided from our secured credit facility will be adequate to meet
our foreseeable liquidity needs.
CRITICAL ACCOUNTING POLICIES
INVENTORY
Inventories are stated at the lower of cost (last-in, first-out (LIFO),
first-in, first-out (FIFO) and average cost methods) or market, less progress
payments. Costs include direct material, direct labor and applicable
manufacturing and engineering overhead, and other direct costs. Most of our
inventory is valued utilizing the LIFO costing methodology. Inventory of our
non-U.S. operations is valued using average cost or FIFO methods. Under the LIFO
inventory valuation method, changes in the cost of raw materials and production
activities are recognized in cost of sales in the current period even though
these material and other costs may have been incurred at significantly different
values. In a period when raw material or other costs are extremely volatile, the
use of the LIFO inventory method may result in cost of sales expense which is
not indicative of cash costs during that period. In a period of rising prices,
cost of sales expense is typically higher than the cash costs, and inventory as
presented on the balance sheet is typically lower than it would be under most
alternative costing methods.
Selling prices for the majority of our stainless products include
surcharges for raw materials. These surcharges have been effective in helping to
offset the impact of increased raw material costs we have experienced in the
2004 first quarter on a cash basis. The majority of raw material surcharges,
which prevail throughout the stainless steel industry, are structured to recover
cash costs for the raw materials incurred to produce the products shipped. For
example the surcharge for nickel, which is a significant raw material used in
the production of stainless steel, is included in current month's selling price
based upon the average cost for nickel as priced on the London Metals Exchange
(plus a margin for handling and delivery) for the period two months
26
prior to shipment. This two-month lag convention is used to align the cost of
the raw material melted to the transaction price to the customer. While the
surcharge formula is effective in recovering the cash costs for raw materials,
it by design approximates the production cycle.
We evaluate product lines on a quarterly basis to identify inventory
values that exceed estimated net realizable value. The calculation of a
resulting reserve, if any, is recognized as an expense in the period that the
need for the reserve is identified. It is our general policy to write-down to
scrap value any inventory that is identified as obsolete and any inventory that
has aged or has not moved in more than twelve months. In some instances this
criterion is up to twenty-four months.
INCOME TAXES
Deferred income taxes result from temporary differences in the
recognition of income and expense for financial and income tax reporting
purposes, or differences between the fair value of assets acquired in business
combinations accounted for as purchases for financial reporting purposes and
their corresponding tax bases. Deferred income taxes represent future tax
benefits (assets) or costs (liabilities) to be recognized when those temporary
differences reverse. We evaluate on a quarterly basis whether, based on all
available evidence, we believe that our deferred income tax assets will be
realizable. Valuation allowances are established when it is estimated that it is
probable (more likely than not) that the tax benefit of the deferred tax asset
will not be realized. The evaluation, as prescribed by Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," includes the
consideration of all available evidence, both positive and negative, regarding
historical operating results including recent years with reported losses, the
estimated timing of future reversals of existing taxable temporary differences,
estimated future taxable income exclusive of reversing temporary differences and
carryforwards, and potential tax planning strategies which may be employed to
prevent an operating loss or tax credit carryforward from expiring unused.
Future realization of deferred income tax assets ultimately depends upon the
existence of sufficient taxable income within the carryback, carryforward period
available under tax law.
The recognition of a valuation allowance is recorded as a non-cash
charge to the income tax provision with an offsetting reserve against the
deferred income tax asset. Should we generate pretax losses in future periods, a
tax benefit would not be recorded and the valuation allowance recorded would
increase. Under these circumstances the net loss recognized and net loss per
share for that period would be larger than a comparable period when a favorable
tax benefit was recorded. However, tax provisions or benefits would continue to
be recognized, as appropriate, on state and local taxes, and taxes related to
foreign jurisdictions. The recognition of a valuation allowance does not affect
our ability to utilize the deferred tax asset in the future. The valuation
allowance could be reduced or increased in future years if the estimated
realizability of the deferred income tax asset changes, based upon consideration
of all available evidence, including changes in the carryback period available
under tax law.
At March 31, 2004, we had a net deferred income tax asset, net of
deferred income tax liabilities, of $34.3 million. This net deferred income tax
asset is presented net of a valuation allowance for certain tax benefits that
are not currently expected to be realized. A significant portion of our deferred
income tax asset relates to postretirement employee benefit obligations, which
have been recognized for financial reporting purposes but are not deductible for
income tax reporting purposes until the benefits are paid. These benefit
payments are expected to occur over an extended period of years. We have not had
27
a federal net operating loss or tax credit carryforward expire unutilized.
RETIREMENT BENEFITS
We have defined benefit pension plans and defined contribution plans
covering substantially all of our employees. We have not made contributions to
the U.S. defined benefit pension plan in the past several years. We are not
required to make a contribution to the U.S. defined benefit pension plan for
2004, and, based upon current actuarial analyses and forecasts, we do not expect
to be required to make cash contributions to the U.S. defined benefit pension
plan for at least the next several years.
We account for our defined benefit pension plans in accordance with
Statement of Financial Accounting Standards No. 87, "Employers' Accounting for
Pensions" ("SFAS 87"), which requires that amounts recognized in financial
statements be determined on an actuarial basis, rather than as contributions are
made to the plan. A significant element in determining our pension (expense)
income in accordance with SFAS 87 is the expected investment return on plan
assets. In establishing the expected return on plan investments, which is
reviewed annually in the fourth quarter, we take into consideration types of
securities the plan investments are invested in, how those investments have
performed historically, and expectations for how those investments will perform
in the future. For 2004 and 2003, our expected return on pension plan
investments is 8.75%. The cumulative difference between this expected return and
the actual return on plan assets is deferred and amortized into pension income
or expense over future periods. The expected return on plan assets can vary
significantly from year-to-year since the calculation is dependent on the market
value of plan assets as of the end of the preceding year. Accounting principles
generally accepted in the United States allow companies to calculate the
expected return on pension assets using either an average of fair market values
of pension assets over a period not to exceed five years, which reduces the
volatility in reported pension income or expense, or their fair market value at
the end of the previous year. However, the Securities and Exchange Commission
currently does not permit companies to change from the fair market value at the
end of the previous year methodology, which is the methodology that we use, to
an averaging of fair market values of plan assets methodology. As a result, our
results of operations and those of other companies, including companies with
which we compete, may not be comparable due to these different methodologies in
calculating the expected return on pension investments.
At the end of November each year, we determine the discount rate to be
used to value pension plan liabilities. In accordance with SFAS 87, the discount
rate reflects the current rate at which the pension liabilities could be
effectively settled. In estimating this rate, we receive input from our
actuaries regarding the rates of return on high quality, fixed-income
investments with maturities matched to the expected future retirement benefit
payments. Based on this assessment at the end of November 2003, we established a
discount rate of 6.5% for valuing the pension liabilities as of the end of 2003,
and for determining the pension expense for 2004. We had previously assumed a
discount rate of 6.75% for 2002, which determined the 2003 expense. The effect
of lowering the discount rate will increase annual pension expense by
approximately $4 million in 2004. The effect on pension liabilities for changes
to the discount rate, as well as the net effect of other changes in actuarial
assumptions and experience, are deferred and amortized over future periods in
accordance with SFAS 87.
Accounting standards require a minimum pension liability be recorded
when the value of pension assets is less than the accumulated benefit obligation
("ABO") at the annual measurement date. As of November 30,
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2003, our measurement date for pension accounting, the value of the accumulated
pension benefit obligation (ABO) exceeded the value of pension investments by
approximately $195 million. In accordance with accounting standards, the charge
against stockholders' equity is adjusted in the fourth quarter to reflect the
value of pension assets compared to the ABO as of the end of November. If the
level of pension assets exceeds the ABO as of a future measurement date, the
full charge against stockholders' equity would be reversed.
We also sponsor several postretirement plans covering certain hourly
and salaried employees and retirees. These plans provide health care and life
insurance benefits for eligible employees. In certain plans, our contributions
towards premiums are capped based upon the cost as of a certain date, thereby
creating a defined contribution. For the non-collectively bargained plans, we
maintain the right to amend or terminate the plans in the future. We account for
these benefits in accordance with SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions" ("SFAS 106"), which requires that
amounts recognized in financial statements be determined on an actuarial basis,
rather than as benefits are paid. We use actuarial assumptions, including the
discount rate and the expected trend in health care costs, to estimate the costs
and benefits obligations for the plans. The discount rate, which is determined
annually at the end of November of each year, is developed based upon rates of
return on high quality, fixed-income investments. At the end of 2003, we
determined this rate to be 6.5%, a reduction from a 6.75% discount rate in 2002.
The effect of lowering the discount rate to 6.5% from 6.75% increased 2003
postretirement benefit liabilities by approximately $22 million, and 2004
expenses are expected to increase by approximately $3 million. Based upon
significant cost increases quoted by our medical care providers and predictions
of continued significant medical cost inflation in future years, the annual
assumed rate of increase in the per capita cost of covered benefits for health
care plans was 10.4% for 2004 and was assumed to gradually decrease to 5.0% in
the year 2014 and remain level thereafter.
The Other Postretirement Benefits obligation, and postretirement
benefit expense recognized through March 31, 2004, does not include the expected
favorable impact of the Medicare Prescription Drug, Improvement and
Modernization Act, which was enacted on December 8, 2003. The Act provides for a
federal subsidy, with tax-free payments commencing in 2006, to sponsors of
retiree health care benefits plans that provide a benefit that is at least
actuarially equivalent to the benefit established by the law. Based upon
estimates from our actuaries, we expect that the federal subsidy included in the
law will result in a reduction in the Other Postretirement Benefits obligation
of up to $70 million. This reduction is not reflected in the financial
statements or in estimates of 2004 expense because final authoritative
accounting guidance regarding how the benefit is to be recognized in the
financial statements is pending.
Certain of these postretirement benefits are funded using plan
investments held in a VEBA trust. The expected return on plan investments is a
significant element in determining postretirement benefits expenses in
accordance with SFAS 106. In establishing the expected return on plan
investments, which is reviewed annually in the fourth quarter, we take into
consideration the types of securities the plan investments are invested in, how
those investments have performed historically, and expectations for how those
investments will perform in the future. For 2003, as a result of a reduction in
the percentage of the VEBA's private equity investments, we lowered our expected
return on investments held in the VEBA trust to 9%. A 15% return on investments
was assumed in prior years. This assumed long-term rate of return on investments
is applied to the market value of plan investments at the end of the previous
year. This produces the expected return on plan investments that is included in
annual postretirement benefits expenses
29
for the current year. The effect of lowering the expected return on plan
investments resulted in an increase in annual postretirement benefits expense of
approximately $7 million for 2003. Our expected return on investments in the
VEBA trust remains 9% for 2004.
ASSET IMPAIRMENT
We monitor the recoverability of the carrying value of our long-lived
assets. An impairment charge is recognized when the expected net undiscounted
future cash flows from an asset's use (including any proceeds from disposition)
are less than the asset's carrying value, and the asset's carrying value exceeds
its fair value. Changes in the expected use of a long-lived asset group, and the
financial performance of the long-lived asset group and its operating segment,
are evaluated as indicators of possible impairment. Future cash flow value may
include appraisals for property, plant and equipment, land and improvements,
future cash flow estimates from operating the long-lived assets, and other
operating considerations.
Goodwill is required to be reviewed annually, or more frequently if
impairment indicators arise. The impairment test for goodwill is a two-step
process. The first step is a comparison of the fair value of the reporting unit
with its carrying amount, including goodwill. If this comparison reflects
impairment, then the loss would be measured as the excess of recorded goodwill
over its implied fair value. Implied fair value is the excess of the fair value
of the reporting unit over the fair value of all recognized and unrecognized
assets and liabilities.
Our evaluation of goodwill for possible impairment includes estimating
the fair market value of each of the reporting units which have goodwill
associated with their operations using discounted cash flow and multiples of
cash earnings valuation techniques, plus valuation comparisons to recent public
sale transactions of similar businesses, if any. These valuation methods require
us to make estimates and assumptions regarding future operating results, cash
flows including changes in working capital and capital expenditures, selling
prices, profitability, and the cost of capital. Although we believe that the
estimates and assumptions used were reasonable, actual results could differ from
those estimates and assumptions.
OTHER
A summary of other significant accounting policies is discussed in Note
1 in our Annual Report on Form 10-K for the year ended December 31, 2003.
The preparation of the financial statements in accordance with
accounting principles generally accepted in the United States requires us to
make judgments, estimates and assumptions regarding uncertainties that affect
the reported amounts of assets and liabilities. Significant areas of uncertainty
that require judgments, estimates and assumptions include the accounting for
derivatives, retirement plans, income taxes, environmental and other
contingencies as well as asset impairment, inventory valuation and
collectibility of accounts receivable. We use historical and other information
that we consider to be relevant to make these judgments and estimates. However,
actual results may differ from those estimates and assumptions that are used to
prepare our financial statements.
30
OTHER MATTERS
J&L Specialty Steel Transaction
On February 17, 2004, we announced that an Asset Purchase Agreement was
signed with Arcelor S. A. ("Arcelor") and J&L Specialty Steel, LLC under which a
wholly owned ATI subsidiary will acquire substantially all of the assets of J&L
Specialty Steel. J&L Specialty Steel is a leading manufacturer of flat-rolled
stainless steel products, and is a wholly owned subsidiary of Arcelor. Since
that date, we announced that several conditions to the acquisition have been
successfully completed. These conditions included completion of integration
trials which tested the combined operational capabilities of Allegheny Ludlum
and J&L Specialty Steel, completion of business and legal due diligence, the
grant by the U.S. Department of Justice of our request for early termination of
its review of the acquisition under the Hart-Scott-Rodino Antitrust Improvements
Act, and the consent to the acquisition by our lenders under our senior secured
domestic revolving credit facility. The lenders' consent is set forth in an
amendment to the credit facility, which will become effective upon the closing
of the purchase of the J&L assets. The transaction, which is targeted for
closing on May 3, 2004, remains subject to negotiation and ratification of new
collective bargaining agreements with the United Steelworkers of America
("USWA"). The purchase price for the assets acquired will be determined under
the Asset Purchase Agreement based upon the net working capital of J&L Specialty
Steel, and will include $7.5 million in cash at closing, up to $7.5 million
payable in one year, and the remaining amount payable in installments through
2011.
Product Pricing
Intense competition and excess manufacturing capacity in the commodity
stainless steel industry have resulted in reduced prices over the last few
years, excluding raw material surcharges, for many of our stainless steel
products. As a result of these factors, our revenues, operating results and
financial condition have been and may continue to be adversely affected.
Although inflationary trends in recent years have been moderate, during
the same period certain critical raw material costs, such as nickel and scrap
containing iron and nickel, have been volatile. While we are able to mitigate
some of the adverse impact of rising raw material costs through surcharges to
customers, rapid increases in raw material costs adversely affect our results of
operations.
We change prices on certain of our products from time to time. The
ability to implement price increases is dependent on market conditions, economic
factors, raw material costs and availability, competitive factors, operating
costs and other factors, some of which are beyond our control. The benefits of
any price increases may be delayed due to long manufacturing lead times and the
terms of existing contracts.
Volatility of Prices of Critical Raw Materials; Unavailability of Raw Materials
We rely to a substantial extent on outside vendors to supply certain
raw materials that are critical to the manufacture of products. Purchase prices
and availability of these critical raw materials are subject to volatility. At
any given time, we may be unable to obtain an adequate supply of these critical
raw materials on a timely basis, on price and other terms acceptable, or at all.
If suppliers increase the price of critical raw materials, we may not
have alternative sources of supply. In addition, to the extent that we have
quoted prices to customers and accepted customer orders for
31
products prior to purchasing necessary raw materials, we may be unable to raise
the price of products to cover all or part of the increased cost of the raw
materials.
The manufacture of some of our products is a complex process and
requires long lead times. As a result, we have in the past and may in the future
experience delays or shortages in the supply of raw materials. If unable to
obtain adequate and timely deliveries of required raw materials, we may be
unable to timely manufacture sufficient quantities of products. This could cause
us to lose sales, incur additional costs, delay new product introductions and
suffer harm to our reputation.
We acquire certain important raw materials that we use to produce
specialty materials, including nickel, chrome, cobalt, titanium sponge and
ammonia paratungstate, from foreign sources. Some of these sources operate in
countries that may be subject to unstable political and economic conditions.
These conditions may disrupt supplies or affect the prices of these materials.
Volatility of Energy Prices; Availability of Energy Resources
Energy resources markets are subject to conditions that create
uncertainty in the prices and availability of energy resources. We rely upon
third parties for our supply of energy resources consumed in the manufacture of
products. The prices for and availability of electricity, natural gas, oil and
other energy resources are subject to volatile market conditions. These market
conditions often are affected by political and economic factors beyond our
control. Disruptions in the supply of energy resources could temporarily impair
the ability to manufacture products for customers. Further, increases in energy
costs, or changes in costs relative to energy costs paid by competitors, have
and may continue to adversely affect our profitability. To the extent that these
uncertainties cause suppliers and customers to be more cost sensitive, increased
energy prices may have an adverse effect on our results of operations and
financial condition.
Labor Matters
We have approximately 8,800 employees. A portion of our workforce is
represented under various collective bargaining agreements, principally with the
USWA, including: approximately 3,000 Allegheny Ludlum production, office and
maintenance employees covered by collective bargaining agreements between
Allegheny Ludlum and the USWA, which are effective through June 2007;
approximately 165 Oremet employees covered by a collective bargaining agreement
with the USWA which is effective through June 2007; and approximately 600 Wah
Chang employees covered by a collective bargaining agreement with the USWA which
continues through March 2008. Negotiations are ongoing for a new collective
bargaining agreement with the USWA affecting approximately 100 employees at the
Casting Service facility in LaPorte, IN. We have requested the re-opening of
labor agreements with the USWA pertaining to the Allegheny Ludlum and Oremet
operations, and the successful negotiation and ratification of new labor
agreements with Allegheny Ludlum is a pre-condition of closing the J&L Specialty
Steel acquisition. Discussions with the USWA on this matter are ongoing.
Generally, agreements that expire may be terminated after notice by the
union. After termination, the union may authorize a strike. A strike by the
employees covered by one or more of the collective bargaining agreements could
materially adversely affect our operating results. There can be no assurance
that we will succeed in concluding collective bargaining agreements with the
unions to replace those that expire.
32
Environmental
When it is probable that a liability has been incurred or an asset has
been impaired, we recognize a loss if the amount of the loss can be reasonably
estimated.
We are subject to various domestic and international environmental laws
and regulations that govern the discharge of pollutants into the air or water
and the disposal of hazardous substances, which may require that we investigate
and remediate the effects of the release or disposal of materials at sites
associated with past and present operations, including sites at which we have
been identified as a potentially responsible party ("PRP") under the Federal
Superfund laws, and comparable state laws. We could incur substantial cleanup
costs, fines and civil or criminal sanctions, third party property damage or
personal injury claims as a result of violations or liabilities under these laws
or non-compliance with environmental permits required at our facilities. We are
currently involved in the investigation and remediation of a number of our
current and former sites as well as third party sites under these laws.
With respect to proceedings brought under the Federal Superfund laws,
or similar state statutes, we have been identified as a PRP at approximately 33
of such sites, excluding those at which we believe we have no future liability.
Our involvement is limited or de minimis at approximately 15 of these sites, and
the potential loss exposure with respect to any of the remaining 18 individual
sites is not considered to be material.
We are a party to various cost-sharing arrangements with other PRPs at
the sites. The terms of the cost-sharing arrangements are subject to
non-disclosure agreements as confidential information. Nevertheless, the
cost-sharing arrangements generally require all PRPs to post financial assurance
of the performance of the obligations or to pre-pay into an escrow or trust
account their share of anticipated site-related costs. In addition, the Federal
government, through various agencies, is a party to several such arrangements.
Environmental liabilities are recorded when our liability is probable
and the costs are reasonably estimable. In many cases, investigations are not at
a stage where we are able to determine whether we are liable or, if liability is
probable, to reasonably estimate the loss, or certain components thereof.
Accordingly, as investigation and remediation of these sites proceed and as we
receive new information, we expect that we will adjust our accruals to reflect
the new information. Future adjustments could have a material adverse effect on
our results of operations in a given period, but we cannot reliably predict the
amounts of such future adjustments. At March 31, 2004, our reserves for
environmental matters totaled approximately $39.8 million.
Environmental liabilities are recorded when our liability is probable
and the costs are reasonably estimable, but generally not later than the
completion of the feasibility study or our recommendation of a remedy or
commitment to an appropriate plan of action. The accruals are reviewed
periodically and, as investigations and remediations proceed, adjustments are
made as necessary. Accruals for losses from environmental remediation
obligations do not take into account the effects of inflation, and anticipated
expenditures are not discounted to their present value. The accruals are not
reduced by possible recoveries from insurance carriers or other third parties,
but do reflect allocations among PRPs at Federal Superfund sites or similar
state-managed sites after an assessment is made of the likelihood that such
parties will fulfill their obligations at such sites and after appropriate
cost-sharing or other agreements are entered. Our measurement of environmental
liabilities is based on currently available
33
facts, present laws and regulations, and current technology. Such estimates take
into consideration our prior experience in site investigation and remediation,
the data concerning cleanup costs available from other companies and regulatory
authorities, and the professional judgment of our environmental experts in
consultation with outside environmental specialists, when necessary. Estimates
of our liability are further subject to additional uncertainties regarding the
nature and extent of site contamination, the range of remediation alternatives
available, evolving remediation standards, imprecise engineering evaluations and
estimates of appropriate cleanup technology, methodology and cost, the extent of
corrective actions that may be required, and the participation, number and
financial condition of other PRPs, as well as the extent of their responsibility
for the remediation.
Based on currently available information, we do not believe that there
is a reasonable possibility that a loss exceeding the amount already accrued for
any of the matters with which we are currently associated (either individually
or in the aggregate) will be an amount that would be material to a decision to
buy or sell our securities. Future developments, administrative actions or
liabilities relating to environmental matters, however, could have a material
adverse effect on our financial condition and results of operations.
FORWARD-LOOKING AND OTHER STATEMENTS
From time to time, we have made and may continue to make
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Certain statements in this report relate to
future events and expectations and, as such, constitute forward-looking
statements. Forward-looking statements include those containing such words as
"anticipates," "believes," "estimates," "expects," "would," "should," "will,"
"will likely result," "forecast," "outlook," "projects," and similar
expressions. Such forward-looking statements are based on management's current
expectations and include known and unknown risks, uncertainties and other
factors, many of which we are unable to predict or control, that may cause our
actual results or performance to materially differ from any future results or
performance expressed or implied by such statements. Various of these factors
are described from time to time in our filings with the Securities and Exchange
Commission, including our Report on Form 10-K for the year ended December 31,
2003. We assume no duty to update our forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use derivative financial instruments from time to time to hedge
ordinary business risks for product sales denominated in foreign currencies, to
partially hedge against volatile energy and raw material cost fluctuations in
the Flat-Rolled Products and High Performance Metals segments and to manage
exposure to changes in interest rates.
Foreign currency exchange contracts are used to limit transactional
exposure to changes in currency exchange rates. We sometimes purchase foreign
currency forward contracts that permit us to sell specified amounts of foreign
currencies expected to be received from our export sales for pre-established
U.S. dollar amounts at specified dates. The forward contracts are denominated in
the same foreign currencies in which export sales are denominated. These
contracts are designated as hedges of the variability in cash flows of a portion
of our forecasted export sales transactions in which settlement will occur in
future periods and which otherwise would expose us, on the basis of aggregate
net cash flows in respective currencies, to foreign currency risk. Changes in
the fair value of our foreign currency derivatives are
34
recognized in other comprehensive income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value is
immediately recognized in the statement of operations.
As part of our risk management strategy, we purchase exchange-traded
futures contracts from time to time to manage exposure to changes in nickel
prices, a component of raw material cost for some of our flat-rolled and high
performance metals products. The nickel futures contracts obligate us to make or
receive a payment equal to the net change in value of the contract at its
maturity. These contracts are designated as hedges of the variability in cash
flows of a portion of our forecasted purchases of nickel. Changes in the fair
value of our nickel derivatives are recognized in other comprehensive income
until the hedged item is recognized in the statement of operations. The
ineffective portion of a derivative's change in fair value is immediately
recognized in the statement of operations.
While we enter into raw materials futures contracts from time to time
to hedge exposure to price fluctuations, such as for nickel, we cannot be
certain that our hedge position adequately reduces exposure. We believe that we
have adequate controls to monitor these contracts, but we may not be able to
accurately assess exposure to price volatility in the markets for critical raw
materials.
In addition, although we occasionally use raw materials surcharges to
offset the impact of increased costs, competitive factors in the marketplace can
limit our ability to institute such surcharges, and there can be a delay between
the increase in the price of raw materials and the realization of the benefit of
surcharges. For example, since we generally use in excess of 35,000 tons of
nickel each year, a hypothetical change of $1.00 per pound in nickel prices
would result in increased costs of approximately $70 million. In addition, we
also use in excess of 270,000 tons of ferrous scrap in the production of our
Flat-Rolled products. During 2003 and entering into 2004, ferrous scrap prices
have increased significantly. A hypothetical change of $10.00 per ton would
result in increased costs of approximately $2.7 million.
We also enter into energy swap contracts as part of our overall risk
management strategy. The swap contracts are used to manage exposure to changes
in natural gas costs, a component of production costs for our operating units.
The energy swap contracts obligate us to make or receive a payment equal to the
net change in value of the contract at its maturity. These contracts are
designated as hedges of the variability in cash flows of a portion of our
forecasted energy payments. Changes in the fair value of our energy derivatives
are recognized in other comprehensive income until the hedged item is recognized
in the statement of operations. The ineffective portion of a derivative's change
in fair value is immediately recognized in the statement of operations. We use
approximately 10 to 12 million MMBtu's of natural gas annually, depending upon
business conditions, in the manufacture of our products. These purchases of
natural gas expose us to a risk of higher gas prices. For example, a
hypothetical $1.00 per MMBtu increase in the price of natural gas would result
in increased annual energy costs of approximately $10 to $12 million.
At March 31, 2004, we had aggregate consolidated indebtedness of
approximately $534 million, most of which bears interest at fixed rates. In a
period of declining interest rates, we face the risk of required interest
payments exceeding those based on the then current market rate. From
time-to-time, we enter into interest rate swap contracts to manage our exposure
to interest rate risks. At March 31, 2004, we had entered into "receive fixed,
pay floating" arrangements for $150 million related to our 8.375% ten-year
Notes, which effectively convert this portion of the Notes to variable rate
debt. These contracts are designated as fair value hedges. As a result, changes
in the fair value of the swap contracts and the underlying fixed rate debt are
recognized in the
35
statement of operations. Including accretion of the gain on termination of the
swap contracts, the result of the "receive fixed, pay floating" arrangements was
a decrease in interest expense of $1.7 million for the 2004 first quarter
compared to the fixed interest expense of the Notes. At March 31, 2004, the
adjustment of these swap contracts to fair market value resulted in the
recognition of an asset of $5.4 million on the balance sheet, included in other
assets, with an offsetting increase in long-term debt.
We believe that adequate controls are in place to monitor these hedging
activities. However, many factors, including those beyond our control such as
changes in domestic and foreign political and economic conditions, as well as
the magnitude and timing of interest rate, energy price and nickel price
changes, could adversely affect these activities.
We market our products to a diverse customer base, principally
throughout the United States. Trade credit is extended based upon evaluations of
each customer's ability to perform its obligations, which are updated
periodically. Sales of our products are dependent upon the economic condition of
the markets in which we serve. Difficulties and uncertainties in the business
environment may affect our customer's creditworthiness and ability to pay their
obligations.
36
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer have evaluated
the Company's disclosure controls and procedures as of March 31, 2004,
and they concluded that these controls and procedures are effective.
(b) Changes in Internal Controls
There were no significant changes in internal controls or in other
factors that could significantly affect these controls subsequent to
March 31, 2004.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
A number of lawsuits, claims and proceedings have been or may be
asserted against the Company relating to the conduct of its business,
including those pertaining to product liability, patent infringement,
commercial, employment, employee benefits, environmental and
stockholder matters. Certain of such lawsuits, claims and proceedings
are described in our Annual Report on Form 10-K for the year ended
December 31, 2003. While the outcome of litigation cannot be predicted
with certainty, and some of these lawsuits, claims or proceedings may
be determined adversely to the Company, management does not believe
that the disposition of any such pending matters is likely to have a
material adverse effect on the Company's financial condition or
liquidity, although the resolution in any reporting period of one or
more of these matters could have a material adverse effect on the
Company's results of operations for that period.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer required by
Securities and Exchange Commission Rule 13a - 14(a)
or 15d - 14(a) (filed herewith).
31.2 Certification of Chief Financial Officer required by
Securities and Exchange Commission Rule 13a - 14(a)
or 15d - 14(a) (filed herewith).
32.1 Certification pursuant to 18 U.S.C. Section 1350
(filed herewith).
(b) Current Reports on Form 8-K filed by the Company
Filing Date Nature of the Report
January 21, 2004 Press Release, dated January 21, 2004,
regarding fourth quarter 2003 results of
operations and financial condition.
February 17, 2004 Press Release, dated February 17, 2004,
announcing an agreement to acquire the
assets of J&L Specialty Steel, LLC and
related Asset Purchase Agreement dated
February 16, 2004.
37
February 18, 2004 Amends and restates in its entirety the
Report on Form 8-K filed earlier on
February 17, 2004, regarding the Press
Release, dated February 17, 2004,
announcing an agreement to acquire the
assets of J&L Specialty Steel, LLC and
related Asset Purchase Agreement dated
February 16, 2004.
March 11, 2004 Press Release, dated March 11, 2004,
announcing an unfavorable jury verdict
in litigation between TDY Industries,
Inc., an ATI subsidiary, and the San
Diego Unified Port District concerning
lease of a property in San Diego, CA.
April 2, 2004 Press Release, dated April 1, 2004,
concerning the first quarter 2004 and
updating the status of the previously
announced J&L Specialty Steel Asset
Purchase Agreement dated February 16,
2004.
April 21, 2004 Press Release, dated April 21, 2004,
regarding first quarter 2004 results of
operations and financial condition.
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLEGHENY TECHNOLOGIES INCORPORATED
(REGISTRANT)
Date: April 28, 2004 By /s/ Richard J. Harshman
-----------------------------------------
Richard J. Harshman
Executive Vice President-Finance and
Chief Financial Officer
(Principal Financial Officer and
Duly Authorized Officer)
Date: April 28, 2004 By /s/ Dale G. Reid
-----------------------------------------
Dale G. Reid
Vice President, Controller and
Chief Accounting Officer and Treasurer
(Principal Accounting Officer)
39
EXHIBIT INDEX
31.1 Certification of Chief Executive Officer required by
Securities and Exchange Commission Rule 13a - 14(a) or 15d -
14(a) (filed herewith).
31.2 Certification of Chief Financial Officer required by
Securities and Exchange Commission Rule 13a - 14(a) or 15d -
14(a) (filed herewith).
32.1 Certification pursuant to 18 U.S.C. Section 1350 (filed
herewith).
40