======================================
Financial Data
Statements of Income 17
Consolidated Balance Sheets 18
Statements of Cash Flows 19
Statements of Common Stockholders'
Equity and Redeemable
Preferred Stock 20
Notes to Financial Statements 21
Management's Report on
Financial Statements 39
Report of Independent Auditors 40
Management's Discussion and
Analysis of Financial Condition
and Results of Operations 41
Selected Financial Data 47
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Statements of Income
Howmet International Inc. Howmet Predecessor
Consolidated Company Combined
--------------------------------------------------------------
Period from Period from
December 14, 1995 January 1, 1995
Year ended December 31, to to
(Dollars in millions, except per share amounts) 1997 1996 December 31, 1995 December 13, 1995
- ------------------------------------------------------------------------------------------------------------------
Net sales $ 1,258.2 $ 1,106.8 $ 51.4 $ 894.1
Operating expenses:
Cost of sales 874.2 803.6 38.0 681.4
Selling, general and administrative expense 145.4 117.3 4.6 105.0
Depreciation and amortization expense 59.5 59.7 2.8 32.6
Research and development expense 24.6 24.2 1.4 25.0
Restructuring credit -- -- -- (1.6)
- ------------------------------------------------------------------------------------------------------------------
1,103.7 1,004.8 46.8 842.4
- ------------------------------------------------------------------------------------------------------------------
Income from operations 154.5 102.0 4.6 51.7
Interest income (expense) from Restricted Trust
and Pechiney Notes, net (Note 8) -- -- -- --
Interest income 1.2 1.7 -- 1.3
Interest expense (31.0) (41.9) (3.1) (3.7)
Interest income, net of expense, affiliates -- -- -- 6.5
Other, net (6.4) (5.9) (1.0) (5.8)
- ------------------------------------------------------------------------------------------------------------------
Income before income taxes 118.3 55.9 .5 50.0
Income taxes 46.3 30.3 .5 23.7
- ------------------------------------------------------------------------------------------------------------------
Income before extraordinary item 72.0 25.6 -- 26.3
Extraordinary item - loss on early retirement
of debt, net of income taxes of $7.9 (12.3) -- -- --
- ------------------------------------------------------------------------------------------------------------------
Net income 59.7 25.6 -- 26.3
Dividends on redeemable preferred stock (5.1) (4.6) (.2) --
- ------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common stock $ 54.6 $ 21.0 $ (.2) $ 26.3
==================================================================================================================
Per common share amounts, basic and diluted:
Income before extraordinary item $ .67 $ .21 $ -- $ .26
Extraordinary item (.12) -- -- --
- ------------------------------------------------------------------------------------------------------------------
Net income $ .55 $ .21 $ -- $ .26
==================================================================================================================
See notes to the financial statements.
PAGE 17
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Consolidated Balance Sheets
December 31,
(Dollars in millions, except share amounts) 1997 1996
- -------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 45.4 $ 23.4
Accounts receivable (less allowance of $4.4 and $5.6) 78.7 76.9
Inventories 155.5 149.4
Retained receivables 20.2 46.1
Deferred income taxes 16.3 21.0
Other current assets 3.9 3.0
- -------------------------------------------------------------------------------------------------------------
Total current assets 320.0 319.8
Property, plant and equipment, net 275.5 291.1
Goodwill, net 226.5 249.0
Patents and technology and other intangible assets, net 118.4 130.1
Other noncurrent assets 53.8 62.4
Restricted Trust(a) 716.4 716.4
- -------------------------------------------------------------------------------------------------------------
Total assets $ 1,710.6 $ 1,768.8
=============================================================================================================
Liabilities, redeemable preferred stock and stockholders' equity
Current liabilities:
Accounts payable $ 84.2 $ 76.5
Accrued liabilities 145.1 157.4
Income taxes payable 28.2 18.6
Long-term debt due within one year -- 56.1
- -------------------------------------------------------------------------------------------------------------
Total current liabilities 257.5 308.6
Accrued retiree benefits other than pensions 93.1 88.5
Other noncurrent liabilities 106.1 70.1
Deferred income taxes 3.4 16.9
Long-term debt, excluding the Pechiney Notes 208.4 294.6
Pechiney Notes(a) 716.4 716.4
Commitments and contingencies (Notes 9 and 18)
Redeemable preferred stock, 9% payment-in-kind dividends, $.01 par value;
liquidation value $10,000 per share; authorized - 15,000 shares; issued and
outstanding: 1997 - 6,001 shares; 1996 - 5,490 shares 60.0 54.9
Stockholders' equity:
Preferred stock, authorized - 9,985,000 shares; issued and outstanding - 0 shares -- --
Common stock, $.01 par value; authorized - 400,000,000 shares;
issued and outstanding - 100,000,000 shares 1.0 1.0
Capital surplus 195.0 195.0
Retained earnings 75.3 20.7
Cumulative translation adjustment (5.6) 2.1
- -------------------------------------------------------------------------------------------------------------
Total stockholders' equity 265.7 218.8
- -------------------------------------------------------------------------------------------------------------
Total liabilities, redeemable preferred stock and stockholders' equity $ 1,710.6 $ 1,768.8
=============================================================================================================
(a) The Restricted Trust holds a note receivable from Pechiney, S.A. and
related letters of credit that secure Pechiney, S.A.'s agreement to repay
the Pechiney Notes. Management believes that it is extremely remote that
the Company will use any assets other than those in the Restricted Trust
to satisfy any payments related to the Pechiney Notes. See Note 8.
See notes to the financial statements.
PAGE 18
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Statements of Cash Flows
Howmet International Inc. Howmet Predecessor
Consolidated Company Combined
--------------------------------------------------------------
Period from Period from
December 14, 1995 January 1, 1995
Year ended December 31, to to
(Dollars in millions) 1997 1996 December 31, 1995 December 13, 1995
- ------------------------------------------------------------------------------------------------------------------
Operating activities
Net income $ 59.7 $ 25.6 $ -- $ 26.3
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 66.9 63.3 3.0 32.6
Equity in (income) loss of
unconsolidated affiliates (1.5) 1.4 .2 4.3
Extraordinary item 12.3 -- -- --
Changes in assets and liabilities:
Receivables 8.4 29.9 (19.8) (11.4)
Inventories (17.9) 17.2 12.4 (1.6)
Accounts payable and accrued liabilities 12.1 39.1 (8.2) (5.9)
Deferred income taxes (.3) (3.2) .2 (2.7)
Income taxes payable 16.9 6.1 (.6) (18.7)
Long-term SARs accrual 31.4 6.6 -- --
Other - net 4.6 (1.5) .1 12.3
- ------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities 192.6 184.5 (12.7) 35.2
Investing activities
Proceeds from disposal of fixed assets .2 .3 -- 3.2
Purchases of property, plant and equipment (56.9) (33.7) (1.6) (41.2)
Increase in advances to Pechiney -- -- -- 237.4
Payments made for investments and other assets (2.0) -- (1.1) (5.8)
Proceeds from sale of refurbishment business, net 44.9 -- -- --
Acquisition of business, net of cash acquired -- 3.6 (737.5) --
- ------------------------------------------------------------------------------------------------------------------
Net cash (used) provided by investing activities (13.8) (29.8) (740.2) 193.6
Financing activities
Issuance of long-term debt 326.2 147.2 50.8 37.0
Repayment of long-term debt (467.6) (288.1) (40.0) (56.9)
Premiums paid on early retirement of debt (13.7) -- -- --
Dividends paid -- -- -- (200.0)
Proceeds from acquisition financing:
Sale of accounts receivable -- -- 51.4 --
Issuance of debt -- -- 450.2 --
Issuance of equity -- -- 250.0 --
Foreign currency rate changes (1.7) -- .1 .2
- ------------------------------------------------------------------------------------------------------------------
Net cash (used) provided by financing activities (156.8) (140.9) 762.5 (219.7)
- ------------------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 22.0 13.8 9.6 9.1
Cash and cash equivalents at beginning of period 23.4 9.6 -- 5.0
- ------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 45.4 $ 23.4 $ 9.6 $ 14.1
==================================================================================================================
See notes to the financial statements.
PAGE 19
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Statements of Common Stockholders' Equity and
Redeemable Preferred Stock
Total
Retained Cumulative Common Redeemable
(Dollars in millions, Common Stock Capital Earnings Translation Stockholders' Preferred Stock
except share amounts) Shares Amount Surplus (Deficit) Adjustment Equity Shares Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Howmet Predecessor
Company Combined:
January 1, 1995 10 $ -- $ 85.6 $297.9 $ 1.3 $384.8 $ --
Net income 26.3 26.3
Dividends - common stock (200.0) (200.0)
Foreign exchange adjustment 8.1 8.1
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 13, 1995 10 $ -- $ 85.6 $124.2 $ 9.4 $219.2 $ --
====================================================================================================================================
Howmet International Inc.
Consolidated:
December 14, 1995,
initial investment (Note 1) 100,000,000 $1.0 $199.0 $ -- $ -- $200.0 5,000 $ 0.0
Net income -- --
Dividends - redeemable
preferred stock (.2) (.2) 24 .2
Return of investment (4.0) (4.0)
Foreign exchange adjustment 1.1 1.1
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 100,000,000 1.0 195.0 (.2) 1.1 196.9 5,024 50.2
- ------------------------------------------------------------------------------------------------------------------------------------
Net income 25.6 25.6
Dividends - redeemable
preferred stock (4.7) (4.7) 466 4.7
Foreign exchange adjustment 1.0 1.0
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 100,000,000 1.0 195.0 20.7 2.1 218.8 5,490 54.9
- ------------------------------------------------------------------------------------------------------------------------------------
Net income 59.7 59.7
Dividends - redeemable
preferred stock (5.1) (5.1) 511 5.1
Foreign exchange adjustment (7.7) (7.7)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 100,000,000 $1.0 $195.0 $ 75.3 $(5.6) $265.7 6,001 $60.0
====================================================================================================================================
See notes to the financial statements.
PAGE 20
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Notes to Financial Statements
1. BASIS OF PRESENTATION
Howmet International Inc. ("HII") was formed on October 11, 1995 to acquire the
group of companies which subsequently comprised Howmet Corporation and its
parent. See "The 1995 Acquisition" below. The acquisition occurred on December
13, 1995. Prior to December 14, 1995 HII had no operations. Consequently, HII's
results of operations and cash flows for the period from December 14, 1995 to
December 31, 1995 were the same as HII's results for the period from October 11,
1995 to December 31, 1995.
These financial statements include the consolidated statements of income,
cash flows, and common stockholders' equity and redeemable preferred stock of
HII for the years ended December 31, 1997 and 1996 and for the period from
December 14, 1995 to December 31, 1995. For the period prior to December 14,
1995 (prior to the Acquisition when HII began operations), these financial
statements include the combined statements of income, cash flows, and common
stockholders' equity and redeemable preferred stock for the Howmet Predecessor
Company. The entities which comprise the Howmet Predecessor Company are those
which generated all HII sales and pre-interest, pre-tax earnings for the years
ended December 31, 1997 and 1996 and for the period from December 14, 1995 to
December 31, 1995. See "Howmet Predecessor Company" below.
The 1995 Acquisition
HII was formed to acquire Pechiney Corporation from Pechiney International, S.A.
and the Cercast group of companies from Howmet Cercast S.A., a subsidiary of
Pechiney International, S.A. (the "Acquisition"). Pechiney International, S.A.
was subsequently merged into Pechiney, S.A. (together "Pechiney, S.A.").
Carlyle-Blade Acquisition Partners, L.P., an affiliate of The Carlyle Group
("Carlyle") and Thiokol Holding Company, a wholly-owned subsidiary of Thiokol
Corporation ("Thiokol"), owned 51% and 49%, respectively, of HII's common stock
from December 13, 1995 until the 1997 ownership change (see "The 1997 Ownership
Change" below). Thiokol owns 100% of HII's 9% Series A Cumulative
payment-in-kind preferred stock.
The Acquisition was effected through a series of transactions, mergers and
name changes resulting in HII owning Howmet Holdings Corporation ("Holdings,"
formerly named Pechiney Corporation). Holdings owns Howmet Corporation. Howmet
Corporation and its subsidiaries, including the Cercast group of companies, is
the only operating subsidiary of Holdings and HII. The Stock Purchase Agreement
provides HII with indemnities from Pechiney, S.A. for certain pre-closing tax,
environmental and product liability matters and the Pechiney Notes (Note 8).
The Acquisition was completed on December 13, 1995 for a total purchase
price, including transaction fees and expenses, of approximately $771.6 million
(after agreed upon 1996 post-closing adjustments). Financing for the Acquisition
included (i) a $250 million cash equity investment from the proceeds of the
issuance of $200 million of HII common stock and $50 million of HII payment-in-
kind preferred stock, (ii) $51.4 million of proceeds from a special purpose
receivables facility, (iii) a $25 million payment-in-kind ("PIK") junior
subordinated purchaser note issued to Pechiney, S.A. and (iv) Company
borrowings.
The Acquisition was accounted for in accordance with the purchase method
of accounting, and accordingly, the consolidated financial statements reflect
the allocation of the purchase price and related acquisition costs to the assets
acquired and liabilities assumed based on their fair values on the date of
acquisition. The 1995 results, on a pro forma basis, after giving effect to the
Acquisition as if it had occurred at the beginning of the year are: net sales
$945.5 million, net loss $19.3 million, and net loss per common share $0.19. The
pro forma information does not necessarily represent what the actual
consolidated results would have been for 1995 and is not intended to be
indicative of future results.
PAGE 21
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Howmet Predecessor Company
The combined statements of operations and retained earnings and cash flows have
been prepared to present the combined operations of Howmet Corporation and
Howmet Cercast Group ("Cercast") (collectively, the "Howmet Predecessor
Company") on a historical cost basis prior to their acquisition by HII. All
transactions between Howmet Corporation and Cercast have been eliminated.
The entities which comprise the Howmet Predecessor Company are those which
generated all HII sales and pre-interest, pre-tax earnings for the years ended
December 31, 1997 and 1996 and for the period from December 14, 1995 to December
31, 1995. These entities were affiliated with common ownership and management.
The Howmet Predecessor Company had significant transactions with Pechiney,
S.A.
The 1997 Ownership Change
In November 1997, Carlyle sold 15 million of its HII common shares to the
public. In December 1997, Carlyle sold 13 million of its HII common shares to
Thiokol. In January 1998, an additional 350,000 common shares were sold to the
public. After these sales, Thiokol, Carlyle and the public hold 62%, 22.65% and
15.35%, respectively, of outstanding HII common shares. Thiokol also owns all of
the outstanding non-voting 9% Series A Cumulative payment-in-kind preferred
stock.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
References to the "Company" relate to both HII and Howmet Predecessor Company.
Principles of Consolidation
The accompanying financial statements include all subsidiary companies and
reflect the use of the equity method of accounting for 50% owned joint ventures.
All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the carrying amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the respective period. Amounts affected include, but are not limited to,
allowances for doubtful accounts, reserves for contract losses and other
accruals. Actual results could differ from those estimates.
Revenue Recognition
The Company recognizes revenue from the sale of its products upon shipment.
Provision for estimated losses on sales commitments are recorded when
identified.
Earnings Per Share
Basic earnings per share is calculated by dividing net income applicable to
common shareholders by the weighted average number of common shares outstanding
(100,000,000). Diluted earnings per share is calculated by dividing net income
applicable to common shareholders by the weighted average number of common
shares outstanding plus the common stock equivalent shares of employee stock
options, calculated using the treasury stock method (8,832 in 1997).
All share and per share data have been retroactively restated to reflect
the October 1997 10,000-to-1 stock split.
PAGE 22
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Cash and Cash Equivalents
The Company considers all investment instruments with a maturity of three months
or less when acquired to be cash equivalents.
Inventories
Inventories are stated at cost, which approximates or is less than replacement
value. The Company values a substantial portion of its inventories on the
last-in, first-out ("LIFO") method and the remainder on the first-in, first-out
method.
Property, Plant and Equipment
Property, plant and equipment is stated at cost. Depreciation is computed
principally on the straight-line method over the estimated useful lives of the
respective assets, ranging from 4 to 8 years for machinery and equipment and
from 19 to 30 years for buildings.
Goodwill
Goodwill is the excess of the purchase price over the fair value of tangible and
identifiable intangible net assets acquired. It is amortized on a straight-line
basis over 40 years.
Impairment of Long-Lived Assets
The Company records impairment losses on goodwill and on long-lived assets used
in operations when events and circumstances indicate that the assets might be
impaired and the undiscounted cash flows estimated to be generated by those
assets are less than net book value.
Acquisition Intangibles
Other acquisition intangible assets consist of the fair value, at the
Acquisition date (Note 1), of patents, technology and a non-compete agreement.
They are being amortized on a straight-line basis over 10 to 15 years.
Translation of Foreign Currencies
All assets and liabilities of the Company's subsidiaries outside of the U.S.,
except for Canada, are translated into U.S. dollars at year-end exchange rates.
Revenues and expenses are translated into U.S. dollars at average rates of
exchange prevailing during the period. Unrealized currency translation
adjustments are deferred in the balance sheets, whereas transaction gains and
losses are recognized currently in the statements of income.
The Canadian operations functional currency is the U.S. dollar. Therefore,
Canadian monetary assets and liabilities are translated at period end exchange
rates, and inventories and other nonmonetary assets and liabilities are
translated at historical rates. Adjustments resulting from translation of
Canadian monetary assets and liabilities at year-end exchange rates are included
in the statements of income.
Derivative Financial Instruments
Derivative financial instruments are utilized by the Company to reduce interest
rate and foreign currency risks. The Company does not hold or issue derivative
financial instruments for trading purposes.
The Company enters into interest rate swap agreements to reduce the risk
on its floating rate debt. The differentials to be received or paid under such
contracts are recognized as an increase or decrease to interest expense. In the
event of an early termination of an interest rate swap, the resulting gain or
loss is deferred and amortized as an adjustment to interest expense over the
remaining life of the debt.
The Company enters into forward foreign exchange contracts to hedge
transactions, primarily firm commitments relating to firm sales backlog and
inventory purchases denominated in foreign currencies. A forward foreign
PAGE 23
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
exchange contract obligates the Company to exchange predetermined amounts of
specified foreign currencies at specified exchange rates on specified dates or
to make an equivalent U.S. dollar payment equal to the value of such exchange.
The gains and losses on foreign currency transaction hedges are recognized in
income and offset the foreign exchange gains and losses on the underlying
transactions. Gains and losses of foreign currency firm commitment hedges are
deferred and included in the basis of the transaction underlying the
commitments.
Income Taxes
Provisions for federal, state, local and foreign income taxes are calculated
based on current tax laws. The provision for income taxes includes, in the
current period, the cumulative effect of any changes in tax rates from those
used previously in determining deferred tax assets and liabilities. Deferred
taxes are provided to recognize the income tax effects of amounts which are
included in different reporting periods for financial statement and tax
purposes.
New Accounting Standards
In January 1997, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 125 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities." The standard establishes accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities, including the sale of receivables. In February
1997, SFAS No. 128, "Earnings Per Share" was issued. This statement changes the
methodology of calculating earnings per share. Adoption of both standards did
not have a material effect on the Company's financial statements.
In June 1997, SFAS No. 130, "Reporting Comprehensive Income" and SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information" were
issued. Adoption of SFAS No. 131 in 1998 is not expected to have a significant
impact on the Company's financial statements. Adoption of SFAS No. 130 in 1998
will not have an effect on the Company's cash flows, financial position or net
income. However, adoption of SFAS No. 130 will require the Company to report
comprehensive income, which will include net income and the change in the
cumulative translation adjustment reported in stockholders' equity.
Reclassification of Prior Period Financial Statements
Certain 1996 and 1995 amounts have been reclassified to be consistent with the
1997 presentation.
3. INVENTORIES
Inventories are summarized as follows (in millions):
December 31,
1997 1996
- --------------------------------------------------------------------------------
Raw materials and supplies $ 62.0 $ 56.1
Work in progress 61.5 53.4
Finished goods 35.4 41.6
- --------------------------------------------------------------------------------
FIFO inventory 158.9 151.1
LIFO valuation adjustment (3.4) (1.7)
- --------------------------------------------------------------------------------
$155.5 $149.4
================================================================================
At December 31, 1997 and 1996, inventories include $122.7 million and
$101.2 million, respectively, that are valued using LIFO. This valuation
adjustment approximates the difference between the LIFO carrying value and
current replacement cost.
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment includes the following
(in millions):
December 31,
1997 1996
- --------------------------------------------------------------------------------
Land $ 12.8 $ 14.6
Buildings 60.2 70.7
Machinery and equipment 267.7 246.8
- --------------------------------------------------------------------------------
340.7 332.1
Accumulated depreciation (65.2) (41.0)
- --------------------------------------------------------------------------------
$275.5 $291.1
================================================================================
Depreciation expense was $41.2 million in 1997, $39.6 million in 1996,
$1.8 million in the period from December 14 to December 31, 1995, and $31.9
million in the period from January 1 to December 13, 1995.
PAGE 24
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
5. GOODWILL
Goodwill relates to the Acquisition (Note 1). Accumulated amortization was $14.6
million and $8.1 million at December 31, 1997 and 1996. The $22.5 million 1997
reduction in goodwill was due to (i) $6.5 million of amortization, (ii) the
recognition of $6.1 million of preacquisition U.S. alternative minimum tax
credits (Note 10) that were not estimable at the acquisition date, (iii) $9.4
million of goodwill associated with the Company's refurbishment business which
was sold in 1997 (Note 19), and (iv) the effects of foreign exchange
translation. The $55.6 million goodwill reduction in 1996 was due to (i) $7.7
million of amortization, (ii) the recognition of $30.5 million of preacquisition
U.S. net operating loss carryforward benefits and alternative minimum tax
credits that were not estimable at the acquisition date, (iii) the reversal of
$22.3 million of restructuring accruals (Note 20), (iv) the 1996 $3.6 million
settlement reduction of the acquisition price, and (v) finalization of the
Acquisition purchase price allocation to the carrying value of certain other
assets and liabilities.
6. PATENTS AND TECHNOLOGY AND OTHER INTANGIBLE
ASSETS, NET AND OTHER NONCURRENT ASSETS
Patents and technology and other intangible assets, net includes the following
(in millions):
December 31,
1997 1996
- --------------------------------------------------------------------------------
Patents and technology, net of
accumulated amortization of
$13.8 and $7.1 $ 53.6 $ 60.3
Non-compete agreement, net of
accumulated amortization of
$10.2 and $5.2 64.8 69.8
- --------------------------------------------------------------------------------
$118.4 $130.1
================================================================================
Other noncurrent assets in the consolidated balance sheet at December 31,
1997 and 1996 includes net deferred financing costs of $.8 million and $13.8
million, respectively. The deferred financing costs are being amortized over the
life of the financings. In 1997, substantially all of the deferred financing
amounts were expensed because the related financings were repaid and/or
terminated (Note 7). Other noncurrent assets at December 31, 1997 and 1996 also
includes $7.2 million and $8.2 million, respectively, of indemnification
receivables from Pechiney, S.A. related to insurance claims. Equal amounts are
included in the amounts captioned "Other noncurrent liabilities" on the
consolidated balance sheets. The December 31, 1997 and 1996 "Other noncurrent
assets" amount also includes indemnification receivables of $32.4 million and
$26.7 million, respectively, related to environmental matters (Note 18).
7. FINANCING ARRANGEMENTS
In the fourth quarter of 1997, the Company terminated its senior credit
facilities and repaid all outstanding borrowings thereunder, and the Company
tendered for and repaid all but $3 million of its $125 million senior
subordinated notes. As a result of these transactions, the Company recorded an
extraordinary loss from the early retirement of debt of $12.3 million, after
tax. The loss includes the write-offs of unamortized debt issuance costs, a
tender premium for the senior subordinated notes and transaction costs. The debt
repayments were funded with borrowings under a new $300 million bank revolving
credit facility, which was entered into in the fourth quarter. Also in the
fourth quarter, the Company elected to repay all but $6 million of its
payment-in-kind junior subordinated notes. This payment was also funded with
borrowings under the new $300 million bank revolving credit facility.
PAGE 25
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Long-term debt, excluding Pechiney Notes (Note 8), is summarized as
follows (in millions):
December 31,
1997 1996
- --------------------------------------------------------------------------------
Revolving credit facility $198.0 $ --
Retired debt issues -- 309.0
Payment-in-kind junior
subordinated notes 6.0 27.7
Other 4.4 14.0
- --------------------------------------------------------------------------------
208.4 350.7
Less current portion -- 56.1
- --------------------------------------------------------------------------------
$208.4 $294.6
================================================================================
Principal maturities for the succeeding five years ended December 31 are
as follows: $0 in 1998-2001 and $198 million in 2002. At December 31, 1997, $7.6
million of letters of credit were outstanding and $94.4 million of borrowing
capacity was available under the Revolving Credit Facility.
In December 1997, the Company (through its wholly-owned and only
operating subsidiary, Howmet Corporation) entered into a $300 million bank
revolving credit facility ("Revolving Credit Facility"). The facility expires on
December 16, 2002 and provides for an unsecured revolving credit line and
letters of credit of up to $300 million in the aggregate. Interest is based on
(i) the higher of a bank's corporate base rate or the Federal funds rate plus
1/2% ("Floating Rate") for swing line loans which can be made daily or (ii) at
the Company's option the Floating Rate or the Eurodollar rate plus 1/4% (6.22%
at December 31, 1997) for advance loans which require three days notice.
Terms of the Revolving Credit Facility require Howmet Corporation to meet
certain interest coverage and leverage ratios and maintain certain minimum net
worth amounts. In addition, there are restrictions customarily found in such
agreements, such as limits on indebtedness and payments for acquisitions or
investments. The agreement contains events of default including a change of
control (as defined) of the Company and its subsidiaries, and cross defaults
with respect to other debt and the receivables facility.
The Company is a holding company, which conducts its only operations
through Howmet Corporation and its subsidiaries and, accordingly, is dependent
on the receipt of cash from these subsidiaries to meet its expenses and other
obligations. Terms of the Revolving Credit Facility which limit transfers of
cash to the Company from Howmet Corporation, affect the Company's ability to
obtain funds for any purposes, including dividends, stock redemption, debt
service and normal business activities. Based on current and anticipated
activities, this limitation is not expected to have an effect on the Company's
ability to conduct its normal activities.
The 10% payment-in-kind junior subordinated purchaser note is due December
13, 2006. Interest accumulates through the issuance of PIK notes through
December 13, 2003 and is payable in cash semi-annually thereafter. The notes may
be prepaid at any time without penalty or notice.
The Company has an agreement to sell, on a revolving basis, an undivided
interest in a defined pool of accounts receivable. At December 31, 1997 the
defined pool of outstanding accounts receivable amounted to $75.2 million. The
Company received $55 million from the sale of such eligible receivables to a
master trust and has deducted this amount from accounts receivable in the
December 31, 1997 and 1996 consolidated balance sheets. Losses on the sale of
receivables for the years ended December 31, 1997 and 1996 and for the period
from December 14, 1995 to December 31, 1995 were $3.8 million, $4.5 million and
$.7 million, respectively. These losses are included in the line captioned
"Other, net" in the statements of income. At December 31, 1997 and 1996 the
$20.2 million and $46.1 million differences, between the total eligible pool and
the $55 million sold, represent retainage on the sale in the event the
receivables are not fully collected. The Company has retained the responsibility
for servicing and collecting the accounts receivable sold or held in the master
trust. Any incremental additional costs related to such servicing and collection
efforts are not significant.
PAGE 26
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
In 1997, 1996, the period from December 14 to December 31, 1995 and the
period from January 1 to December 13, 1995, the Company paid interest of $20.1
million, $36.2 million, $0 million and $5.3 million, respectively.
8. RESTRICTED TRUST AND RELATED PECHINEY NOTES PAYABLE
In 1988, Pechiney Corporation, which as a wholly-owned subsidiary of Pechiney,
S.A., issued indebtedness maturing in 1999 (the "Pechiney Notes") to third
parties in connection with the purchase of American National Can Company. As a
result of the Acquisition, Pechiney Corporation (now named Howmet Holdings
Corporation, "Holdings") became a wholly-owned subsidiary of the Company. The
Pechiney Notes remained at Holdings, but Pechiney, S.A., which retained American
National Can Company, agreed with the Company to be responsible for all payments
due on or in connection with the Pechiney Notes. Accordingly, Pechiney, S.A.
issued its own note to Holdings in an amount sufficient to satisfy all
obligations under the Pechiney Notes. The Pechiney, S.A. note was deposited in a
trust for the benefit of Holdings (the "Restricted Trust"). If Pechiney, S.A.
fails to make any payments required by its note, the trustee under the
Restricted Trust (the "Trustee") has irrevocable letters of credit in the
aggregate amount of $772 million issued to the Restricted Trust by Banque
Nationale de Paris ("BNP"), a French bank which has an A+ credit rating from
Standard & Poors Ratings Group ("S&P"), to draw upon to make such payments. In
the event that there is an impediment to a draw under the BNP letters of credit
held by the Trustee, the Trustee has substantially identical "back-up" letters
of credit in the aggregate amount of $772 million issued to the Restricted Trust
by Caisse des Depots et Consignations, a French bank which has an AAA credit
rating from S&P. In addition, the holders of the Pechiney Notes have a third set
of letters of credit (also issued by BNP), which can be drawn upon by such
holders in the event that principal and/or interest payments on the Pechiney
Notes are not made. Pechiney, S.A. is solely responsible as reimbursement party
for draws under the various letters of credit referenced above, and by agreement
with the banks neither Holdings nor the Company has any responsibility therefor.
However, Holdings remains liable as the original issuer of the Pechiney Notes in
the event that Pechiney, S.A. and both banks fail to meet their obligations
under their respective letters of credit. Management believes that it is
extremely remote that the Company will be required to use any of its assets
other than those in the Restricted Trust to satisfy any payments due on or in
connection with the Pechiney Notes. Upon repayment of the Pechiney Notes, the
Restricted Trust terminates and any assets of the Restricted Trust are to be
returned to Pechiney, S.A.
The Pechiney Notes are due on January 2, 1999 and may not be prepaid prior
to that date. Interest is at three-month LIBOR plus 25 basis points (5.98% for
the quarter ended December 31, 1997). Interest is paid on the last business day
of each calendar quarter. Interest expense on these notes was $42.8 million and
$42.1 million for the year ended December 31, 1997 and 1996 and $2.2 million for
the period from December 14, 1995 to December 31, 1995. Interest income from the
Restricted Trust for the aforementioned periods was equal to the interest
expense and is netted in these financial statements.
9. COMMITMENTS
The Company and its subsidiaries have noncancellable operating leases relating
principally to manufacturing and office facilities and certain equipment. Future
minimum payments under noncancellable leases as of December 31, 1997 are as
follows: 1998 - $5.2 million, 1999 - $4.3 million, 2000 - $3.3 million, 2001 -
$1.6 million, 2002 - $.8 million and thereafter $2.8 million.
Total rental expense for all operating leases was $7.3 million in 1997, $8
million in 1996, $.4 million in the period from December 14 to December 31, 1995
and $6.7 million in the period from January 1 to December 13, 1995.
As of December 31, 1997, the Company is committed to spend $20.1 million
for 1998 capital expenditures.
PAGE 27
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
10. INCOME TAXES
Income taxes were provided in the following amounts (in millions):
Howmet International Inc. Howmet Predecessor
Consolidated Company Combined
----------------------------------------------------------------
Period from Period from
December 14, 1995 January 1, 1995
Year ended December 31, to to
1997 1996 December 31, 1995 December 13, 1995
- ----------------------------------------------------------------------------------------------------------------------
Current income taxes:
U.S. Federal $23.0 $15.5 $ .2 $22.9
State 7.8 11.7 -- 4.0
Foreign 7.9 6.3 .3 2.8
- ----------------------------------------------------------------------------------------------------------------------
38.7 33.5 .5 29.7
Deferred income taxes (.3) (3.2) -- (6.0)
- ----------------------------------------------------------------------------------------------------------------------
$38.4 $30.3 $ .5 $23.7
======================================================================================================================
In 1997 tax expense includes $46.3 million of expense related to income
before the extraordinary loss, and a $7.9 million benefit related to the
extraordinary loss from early retirement of debt.
A reconciliation of the United States statutory rate to the effective
income tax rate follows:
Howmet International Inc. Howmet Predecessor
Consolidated Company Combined
----------------------------------------------------------------
Period from Period from
December 14, 1995 January 1, 1995
Year ended December 31, to to
1997 1996 December 31, 1995 December 13, 1995
- ----------------------------------------------------------------------------------------------------------------------
Statutory rate 35.0% 35.0% 35.0% 35.0%
Effect of:
State income taxes, net of federal benefit 3.1 10.1 10.1 4.0
Foreign tax differential .1 .3 17.1 5.0
Goodwill amortization 2.3 4.8 46.1 1.2
Research & development credits (3.3) (.4) -- --
Adjustment to prior years' provision -- -- -- 2.3
Other 1.9 4.4 (14.7) (.1)
- ----------------------------------------------------------------------------------------------------------------------
Effective rate 39.1% 54.2% 93.6% 47.4%
======================================================================================================================
Domestic and foreign components of pre-tax income, including the 1997
$20.2 million extraordinary loss from early retirement of debt, are as follows
(in millions):
Howmet International Inc. Howmet Predecessor
Consolidated Company Combined
----------------------------------------------------------------
Period from Period from
December 14, 1995 January 1, 1995
Year ended December 31, to to
1997 1996 December 31, 1995 December 13, 1995
- ----------------------------------------------------------------------------------------------------------------------
United States $71.8 $37.0 $(2.0) $37.9
Foreign 26.3 18.9 2.5 12.1
- ----------------------------------------------------------------------------------------------------------------------
$98.1 $55.9 $ .5 $50.0
======================================================================================================================
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HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
The components of the net deferred income tax asset (liability) are as
follows (in millions):
December 31,
1997 1996
- --------------------------------------------------------------------------------
State and foreign net operating losses $ 24.7 $ 29.9
U.S. alternative minimum tax credits 7.9 18.3
Accrued retiree benefits
other than pensions 39.8 38.0
Vacation and deferred
compensation accruals 24.2 9.9
Pension liability 6.6 6.7
Other accruals 23.1 25.2
- --------------------------------------------------------------------------------
Gross deferred tax asset 126.3 128.0
Valuation allowance (18.0) (22.2)
- --------------------------------------------------------------------------------
Total deferred tax asset 108.3 105.8
- --------------------------------------------------------------------------------
Inventory (27.0) (27.3)
Property, plant and equipment (46.9) (50.1)
Patents and technology (21.5) (24.3)
- --------------------------------------------------------------------------------
Total deferred tax liability (95.4) (101.7)
- --------------------------------------------------------------------------------
Net deferred tax asset $ 12.9 $ 4.1
================================================================================
Balance sheet classification:
Current assets $ 16.3 $ 21.0
Noncurrent liabilities (3.4) (16.9)
- --------------------------------------------------------------------------------
$ 12.9 $ 4.1
================================================================================
The change in net deferred tax asset includes a $.3 million and $3.2
million deferred tax benefit which is included in the net 1997 and 1996 income
tax expense, respectively. Also, in 1997 and 1996 net deferred tax assets were
increased by $6.1 million and $30.1 million, respectively, and goodwill was
reduced by the respective amounts. The principal reason for these reductions was
the recognition of $36.6 million of preacquisition U.S. net operating loss
carryforward benefits and alternative minimum tax credits, which were acquired
as part of the December 13, 1995 acquisition and were not estimable at the
acquisition date. All the U.S. net operating loss carryforwards have been used
to offset U.S. Federal taxes that would have otherwise been payable in 1996. A
majority of the alternative minimum tax credits were used to offset U.S. Federal
taxes that would have otherwise been payable in 1997. The alternative minimum
tax credits have no expiration date. The 1997 deferred tax assets increased an
additional $2.4 million primarily due to the cumulative foreign exchange
adjustment.
At December 31, 1997 and 1996, the Company had available $131 million and
$151.8 million, respectively, of state net operating loss carryforwards. Of the
1997 amount, $101 million expires in 1998 and $30 million expires in 1999. At
December 31, 1997 and 1996, the Company had available approximately $10.5
million and $15.8 million, respectively, of foreign net operating loss
carryforwards which can only be used to offset foreign taxable income. A
majority of these carryforwards have no expiration date. At December 31, 1997
and 1996, the Company also had foreign tax benefits of $6.8 million and $7.8
million, respectively, which will be realized over the next three years.
At December 31, 1997 and 1996, the Company carried a valuation allowance
equal to the deferred tax asset associated with all state and foreign net
operating loss carryforwards. The Company has no other valuation allowance
because management believes it is more likely than not that future operations
will generate sufficient taxable income to realize the other deferred tax
assets. A continuation of the 1997 level of earnings will provide ample taxable
income for such realizations.
In 1997 the deferred tax valuation allowance related to state net
operating losses decreased by $2.6 million as some losses were used to offset
1997 income and others expired. In 1997 the deferred tax valuation allowance
related to foreign net operating losses was reduced by $1.6 million because some
losses were used to offset 1997 income and because of the reducing effect of
foreign exchange translation. During 1996 the Company's deferred tax valuation
allowance decreased by $2.2 million, principally due to a change in estimated
foreign net operating losses.
In 1997, 1996, the period from December 14 to December 31, 1995 and the
period from January 1 to December 13, 1995, the Company paid income taxes, net
of refunds, of $45.6 million, $28.4 million, $.9 million, and $42.6 million,
respectively.
PAGE 29
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
11. PENSIONS
The Company has noncontributory defined benefit retirement plans covering
substantially all of its employees in the U.S. and Canada. In accordance with
the Stock Purchase Agreement for the Acquisition, Pechiney, S.A. is responsible
for the benefits of the nonunion hourly employees who were retired at the
Acquisition date. Pechiney, S.A. is also responsible for all salaried employee
benefits earned prior to the Acquisition date. The Company is responsible for
all other covered nonunion hourly employees and for all salaried employee
benefits earned subsequent to the Acquisition date. Effective January 1, 1997,
Howmet Corporation has amended the salaried plan to change the formula from
"final pay" to "cash balance." This change resulted in a 1997 unrecognized prior
service cost reduction of $37.9 million, and 1997 expense of $2.6 million less
than it would have been using the prior plan formula. The Company intends to
make annual contributions to the retirement plans in amounts up to the maximum
allowable for tax deduction purposes.
The following items are the components of the net periodic pension cost
for the U.S. and Canadian plans (in millions):
Howmet International Inc. Howmet Predecessor
Consolidated Company Combined
----------------------------------------------------------------
Period from Period from
December 14, 1995 January 1, 1995
Year ended December 31, to to
1997 1996 December 31, 1995 December 13, 1995
- ----------------------------------------------------------------------------------------------------------------------
Service cost - benefits earned during the period $10.1 $ 8.6 $ .4 $ 7.8
Interest cost on the projected benefit obligation 8.2 9.7 .4 8.0
Actual return on plan assets (18.1) (10.9) (.4) (12.8)
Net amortization and deferral 5.0 1.0 -- 4.7
- ----------------------------------------------------------------------------------------------------------------------
Net periodic pension cost $ 5.2 $ 8.4 $ .4 $ 7.7
======================================================================================================================
The following table sets forth the U.S. and Canadian plans' funded status
and amounts recognized in the balance sheets (in millions):
December 31, 1997 December 31, 1996
Actuarial benefit obligation Actuarial benefit obligation
-------------------------------------------------------------
Exceed Less than Exceed Less than
plan assets plan assets plan assets plan assets
- ------------------------------------------------------------------------------------------------------------------------------------
Actuarial present value of benefit obligations:
Vested benefit obligation $(16.1) $(86.5) $ (8.9) $(80.3)
Nonvested benefit obligation (1.3) (4.8) (2.5) (3.4)
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated benefit obligation (17.4) (91.3) (11.4) (83.7)
Additional benefits based on estimated future salary increases (5.2) (1.1) (41.2) (1.1)
- ------------------------------------------------------------------------------------------------------------------------------------
Projected benefit obligation (22.6) (92.4) (52.6) (84.8)
Fair value of plan assets 14.3 125.4 2.4 112.2
- ------------------------------------------------------------------------------------------------------------------------------------
Projected benefit obligation (in excess of) less than plan assets (8.3) 33.0 (50.2) 27.4
Prior service cost (reduction) not yet recognized in net periodic cost (37.9) .6 -- --
Unrecognized net loss (gain) 4.9 (7.3) 2.0 (1.5)
- ------------------------------------------------------------------------------------------------------------------------------------
Accrued pension liability $(41.3) $ 26.3 $(48.2) $ 25.9
====================================================================================================================================
PAGE 30
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
The discount rate used to determine the actuarial present value of the
projected benefit obligation was 7.5% at December 31, 1997 and 1996. The
expected rate of return was 9% at December 31, 1997 and 1996 and 9.5% at
December 31, 1995 for U.S. plan assets and 8% for Canadian plan assets at
December 31, 1997, 1996 and 1995. The expected increase in future salaries for
those plans using future compensation assumptions was 5% at December 31, 1997
and 1996 for the U.S. plans and 6% for the Canadian plans at December 31, 1997
and 1996. The unrecognized net asset and the unrecognized prior service cost are
being amortized based on the projected future service lives of employees, which
range from 15-25 years. Plan assets are primarily invested in equity securities,
debt securities and temporary cash investments. Accrued pension cost is included
in the amounts captioned "Accrued liabilities" and "Other noncurrent
liabilities" in the consolidated balance sheets.
The net pension expense for the Company's United Kingdom operations was
$1.2 million in 1997 and $1.1 million in both 1996 and 1995.
The Company sponsors matching 401(k) savings plans for eligible employees.
The Company matches up to 5% of salaried employee contributions and up to 6% of
the contribution of all full time nonunion hourly employees. Company
contributions to the matching savings plans were approximately $6.8 million in
1997 and $4 million in both 1996 and 1995.
12. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company provides postretirement health care and life insurance benefits to
its eligible active and retired employees, including certain union, nonunion and
salaried employees. Components of the net periodic postretirement benefit cost
were as follows (in millions):
Howmet International Inc. Howmet Predecessor
Consolidated Company Combined
-------------------------------------------------------------
Period from Period from
December 14, 1995 January 1, 1995
Year ended December 31, to to
1997 1996 December 31, 1995 December 13, 1995
- ---------------------------------------------------------------------------------------------------------------------------------
Service cost - benefits attributable to service during the period $ 3.4 $ 2.9 $ .1 $ 2.4
Interest cost on accumulated postretirement benefit obligation 7.5 6.6 .4 6.3
Net amortization and deferral .4 -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Net periodic postretirement benefit cost $11.3 $ 9.5 $ .5 $ 8.7
=================================================================================================================================
The amounts recognized as a liability in the Company's consolidated
balance sheets are as follows (in millions):
December 31,
1997 1996
- --------------------------------------------------------------------------------
Retirees $(53.4) $(49.8)
Fully eligible active plan participants (19.9) (14.0)
Other plan participants (37.0) (32.1)
Unrecognized prior service cost 4.5 --
Unrealized net loss 6.7 1.4
- --------------------------------------------------------------------------------
Total (99.1) (94.5)
Less current portion 6.0 6.0
- --------------------------------------------------------------------------------
$(93.1) $(88.5)
================================================================================
The 1997 unrecognized prior service cost is primarily due to lowering
eligibility requirements for union hourly employees. The accumulated
postretirement benefit obligation was determined using weighted average discount
rates of 7.5% for 1997 and 1996. The health care cost trend rate assumption for
below age 65 benefits was 10% in 1997 and 11% in 1996 and is assumed to decline
1% annually to 6% in the year 2001 and remain constant thereafter. The health
care cost trend rate for above age 65 benefits was 8.2% in 1997 and 9% in 1996
and is assumed to decline gradually to 5% in the year 2001 and remain constant
thereafter. A 1% increase in the health care cost trend rate would have
increased the accumulated postretirement benefit obligation by $1.3 million and
$6.1 million at December 31, 1997 and 1996, respectively, and the net periodic
cost by $.5 million in 1997 and $.7 million in 1996.
PAGE 31
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
13. COMMON AND PREFERRED STOCK
On October 8, 1997, the Board of Directors approved a 10,000-to-1 stock split in
the form of a stock dividend, which increased outstanding common stock from
10,000 to 100,000,000 shares. All share and per share data in the accompanying
financial statements have been retroactively adjusted to reflect the
aforementioned changes.
An amendment to the Company's Restated Certificate of Incorporation was
approved by the Board of Directors and the stockholders of the Company on
October 8, 1997. The amendment increased authorized common stock to 400,000,000
shares and authorized 10,000,000 shares of preferred stock, $.01 par value per
share. The Board of Directors is authorized to determine the terms of any new
series of preferred stock. Of the 10,000,000 shares of authorized preferred
stock, 15,000 shares are designated as 9% Series A Senior Cumulative Preferred
Stock. Dividends on this preferred stock are at 9% and are payable-in-kind. The
Company is obligated to redeem these shares in 2005 or immediately prior to a
merger or consolidation of the Company with, or the sale or transfer of
substantially all assets to, any entity other than a wholly-owned subsidiary.
Upon liquidation or dissolution of the Company, holders of this preferred stock
would be entitled to be paid from the assets of the Company before any payment
could be made to the common stockholders. All outstanding shares of this
preferred stock are owned by Thiokol.
14. SARs AND STOCK OPTION PLANS
Stock Appreciation Rights ("SARs")
In early 1996, the Company adopted a SARs plan. Under the plan, SARs
representing up to 5% of the Company's equity value were authorized to be issued
to executive officers of the Company. The SARs are similar to phantom stock
options and are valued based on appreciation of the value of the Company's
common stock above the base per share of the SARs. In November 1997, the Company
amended its SARs plan (the "Amended SARs Program"). Pursuant to the Amended SARs
Program, the maximum per share value of the outstanding SARs is limited to the
difference between $15 and the base price per share of the SARs (generally $2).
In exchange for accepting such limitation, each holder of SARs was granted a
non-qualified stock option (a "Howmet Option") to purchase, at the $15 per share
initial public offering price, a number of shares of common stock equal to the
number of shares with respect to which such employee had SARs (approximately 4.4
million Howmet Options in total).
The SARs vest over a five-year period ending in 2001 based upon passage of
time, the operating performance of the Company, and tenure of the executives.
Vesting accelerates if there is a sale of substantially all assets, liquidation,
or a change in control of the Company.
At December 31, 1997 there were approximately 4.4 million SARs
outstanding. Compensation costs of $31.4 million and $6.6 million were charged
against income for the SARs plan in 1997 and 1996, respectively. At December 31,
1997 and 1996, $38 million and $6.6 million, respectively, was included in the
amount captioned "Other noncurrent liabilities" in the consolidated balance
sheet.
PAGE 32
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Howmet Options
In November 1997, the Company adopted its 1997 Stock Awards Plan (the "Plan")
which provides for grants of stock options, shares of restricted stock and SARs
to key Company employees. The Plan provides for grants involving up to an
aggregate 5 million shares of Howmet International Inc. common stock. In
December 1997, 4,377,500 options were granted as a result of the aforementioned
Amended SARs Program. All such options have a $15 per share exercise price and
are outstanding at December 31, 1997. Such options will vest and become
exercisable in 25% increments on January 1 of each year beginning in 1999. The
options expire eight years after the date of grant. The Company has reserved 5
million common shares for issue pursuant to the 1997 Stock Awards Plan.
On January 1, 1997, the Company adopted SFAS No. 123 "Accounting for
Stock-Based Compensation." In accordance with the provisions of SFAS No. 123,
the Company chose to continue to account for stock-based compensation using the
intrinsic value method under APB Opinion No. 25 and, accordingly, does not
recognize compensation cost for options issued at the market price at date of
grant. If the Company recognized compensation cost based on the fair value of
the options granted at grant date as prescribed by SFAS No. 123, net income
applicable to common stock and earnings per common share, on a pro forma basis
would have been reduced by approximately 1.2% and 1.8%, respectively, in 1997.
The fair value of the Howmet options was estimated using the Black-Scholes
option pricing model with the following weighted-average assumptions: risk-free
interest rate of 5.71%; volatility of the expected market price of the Company's
common stock of .288 and a weighted-average option life of 6 years.
Thiokol Options
Certain key executives of the Company hold 195,000 contingent stock options for
Thiokol common stock. The exercise price of the options is the market price of
Thiokol common stock on the date of the grant ($35.50-$40.94). The options will
vest only if Thiokol acquires 100% of the Company prior to December 13, 2001.
The options vest, and are exercisable, 50% on the date of such acquisition and
25% each year thereafter. They expire not later than ten years after the date of
the grant.
Thiokol has informed holders of the Thiokol Options of Thiokol's intention
to adopt a plan that would allow the holders to benefit from such options even
if Thiokol does not acquire 100% of the Company prior to December 13, 2001. At
December 13, 2001 each participant will become vested in the difference as of
December 13, 2001 between the aggregate market value of all of the shares of
Thiokol common stock represented by the participant's Thiokol Options and the
aggregate exercise price of all such options. Holders of Thiokol Options who
retire before December 13, 2001 would receive a pro rata portion of the benefits
described above based on the portion of time employed by the Company during the
period from December 13, 1995 to December 13, 2001.
Whether the executives vest in the Thiokol Options or vest in the
alternative plan, the Company will record compensation expense for one but not
both plans. Because vesting is assured under the alternative plan, the Company
is recording compensation expense related to that plan over the six year vesting
period ending December 13, 2001. In 1997 $2.9 million of compensation expense
was charged against income. There was no comparable expense recorded prior to
1997.
PAGE 33
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
15. GEOGRAPHIC INFORMATION
The Company operates in a single industry as a manufacturer of investment cast
components primarily for sale to the defense and commercial aircraft and
industrial gas turbine engine industries. The Company is a multinational entity
with operating subsidiaries in two geographic regions, North America (including
the United States and Canada) and Europe (including France and the United
Kingdom). Intercompany transfers between geographic areas are not significant.
In computing earnings from operations for subsidiaries outside of the United
States, no allocations of general corporate expenses have been made. Allocated
identifiable assets exclude the $716.4 million Restricted Trust (Note 8).
(in millions) North America Europe Total
- --------------------------------------------------------------------------------
Howmet International Inc.
Consolidated:
1997
Sales to unaffiliated
customers $1,026.9 $ 231.3 $1,258.2
Income from
operations 135.7 18.8 154.5
Identifiable assets 779.3 214.9 994.2
1996
Sales to unaffiliated
customers 876.9 229.9 1,106.8
Income from
operations 88.2 13.8 102.0
Identifiable assets 829.2 223.2 1,052.4
Period from
December 14, 1995 to
December 31, 1995
Sales to unaffiliated
customers 34.9 16.5 51.4
Income from
operations 2.1 2.5 4.6
Howmet Predecessor
Company Combined:
Period from
January 1, 1995 to
December 13, 1995
Sales to unaffiliated
customers 703.6 190.5 894.1
Income from
operations 45.0 6.7 51.7
- --------------------------------------------------------------------------------
Sales to unaffiliated customers include export sales of $331.9 million in
1997, $330.1 million in 1996, $19.3 million in the period from December 14 to
December 31, 1995, and $278.1 million in the period from January 1 to December
13, 1995. Export sales of domestic operations, included in total export sales,
were $254.1 million in 1997, $235 million in 1996, $10.1 million in the period
from December 14 to December 31, 1995, and $160.4 million in the period from
January 1 to December 13, 1995. In 1997, 1996 and 1995, approximately 50% to 61%
of export sales of domestic operations were to Western Europe, approximately 25%
to 41% were to Canada and approximately 8% to 16% were to the Far East.
The Company's sales to its two largest customers were $253.4 million and
$185.1 million in 1997, $206 million and $159.5 million in 1996, $10.5 million
and $7.9 million in the period from December 14 to December 31, 1995, and $184
million and $138.1 million in the period from January 1, 1995 to December 13,
1995. Receivables from these customers were $12.4 million and $17 million at
December 31, 1997 and $16.5 million and $12.7 million at December 31, 1996.
16. TRANSACTIONS WITH AFFILIATES
Prior to the 1997 ownership change (Note 1), the Company had management
agreements with Carlyle and with Thiokol for certain management and financial
advisory services. Each agreement provided for the payment of an annual
management fee of $1 million. In addition, in 1995 Carlyle and Thiokol each
received $2 million for services provided in connection with the acquisition of
the Company. This transaction was reflected as a reduction of capital surplus in
the consolidated balance sheet. In November 1997, the agreement with Carlyle was
amended to reduce the annual fee to $.5 million and the agreement with Thiokol
was terminated. The Company and Thiokol have entered into a new service
agreement whereby Thiokol will provide a wide range of administrative services
for which the Company will generally pay Thiokol's cost plus a fee.
PAGE 34
HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
In connection with the 1997 ownership change, Thiokol and Carlyle amended
and restated their December 1995 shareholders agreement and entered into an
agreement with the Company. Pursuant to such agreements, (1) Carlyle has one
position on the Company's Board of Directors as long as it owns not less than 5%
of the outstanding common stock; (2) Carlyle will not dispose of any of its
shares of common stock prior to the earlier of December 1999 or a change of
control of Thiokol; (3) during the two-year period starting December 1999,
Thiokol will have an option to acquire Carlyle's shares of common stock (all, or
in increments of 25%) and a right of first refusal to acquire any shares Carlyle
proposes to sell, in each case at market price; (4) generally, if Thiokol
disposes of any of its shares of common stock to an unaffiliated third party
prior to December 2001, Carlyle will have the right to participate in such sale
with respect to a proportionate number of its shares on the same terms; (5)
Carlyle has certain registration rights (exercisable between December 1999 and
December 2002) for its remaining shares of common stock; and (6) Thiokol has
certain preemptive rights. In addition, Thiokol has agreed that, without prior
consent of the Carlyle director and a majority (but not less than two) of the
non-employee directors of the Company who are not directors or employees of
Thiokol or Carlyle, neither Thiokol nor any of its affiliates may acquire any
Publicly Held Shares if, after such acquisition, the number of Publicly Held
Shares then outstanding would be less than 14% of the total number of shares
outstanding, other than (x) pursuant to a tender offer to acquire all of the
outstanding shares of common stock not then beneficially owned by Thiokol, or
(y) pursuant to a merger or other business combination in which all holders of
Publicly Held Shares are treated equally. "Publicly Held Shares" means the
outstanding shares of common stock other than shares held by Thiokol, Carlyle or
their respective affiliates.
In December 1995, certain executives of the Howmet Predecessor Company
invested $4.7 million in Carlyle. Upon the 1997 sale of Carlyle's interest in
the Company, the executives received a cash distribution from Carlyle, pro rata
to their investment in Carlyle.
The Howmet Predecessor Company had financing and other transactions with
Pechiney Corporation. Interest income earned from advances to Pechiney
Corporation was based on short-term borrowing rates obtained by Pechiney
Corporation. The average advance balance was $148.7 million for the period from
January 1 to December 13, 1995.
17. FINANCIAL INSTRUMENTS
Financial instruments which potentially subject the Company to credit risk
consist principally of trade receivables. The Company does not require
collateral and maintains reserves for potential credit losses related to trade
accounts receivable. The Company's accounts receivable are principally due from
companies in the aerospace and industrial gas turbine engine industries. See
Note 15 for receivables from the Company's two largest customers.
The fair values of the Company's trade receivables and payables
approximate their carrying amounts. Because the Revolving Credit Facility
borrowings are at variable interest rates, their carrying value approximates
their fair value at December 31, 1997.
The Company enters into forward exchange contracts as a hedge against
currency fluctuations of certain foreign currency transactions. At December 31,
1997, the Company had contracts to purchase 7.6 million Canadian dollars with
maturity dates from January to September 1998 for $5.5 million. At December 31,
1997, the fair value of these contracts was $5.3 million. The fair value of
foreign currency contracts was estimated by obtaining quotes from brokers. The
market value gains or losses arising from foreign exchange contracts offset
foreign exchange gains or losses on the underlying hedged assets or liabilities.
The Company's exposure to currency risk is limited to currency rate movement and
is considered to be negligible.
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HOWMET 1997 ANNUAL REPORT
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The counterparties to the foreign exchange transactions are major
financial institutions. The Company does not anticipate nonperformance by the
counterparties.
18. CONTINGENCIES
The Company has received test results indicating levels of polychlorinated
biphenyls ("PCBs") at its Dover, New Jersey facility which will require
remediation. These levels have been reported to the New Jersey Department of
Environmental Protection ("NJDEP"), and the Company is preparing a work plan to
define the risk and to test possible clean-up options. The statement of work
must be approved by the NJDEP pursuant to an Administrative Consent Order
entered into between the Company and NJDEP on May 20, 1991 regarding clean-up of
the site. Various remedies are possible and could involve expenditures ranging
from $2 million to $22 million or more. The Company has recorded a $2 million
long-term liability as of December 31, 1997 and 1996 for this matter. Given the
uncertainties, it is possible that the estimated range of this cost and the
amount accrued will change within a one year period. The indemnification
discussed below applies to the costs associated with this matter.
In addition to the above, liabilities arising for clean-up costs
associated with hazardous types of materials in several waste disposal
facilities exist. In particular, the Company has been or may be named a
potentially responsible party under the Comprehensive Environmental Response,
Compensation and Liability Act or similar state laws at eleven on-site and
off-site locations. At December 31, 1997 and 1996, $4.4 million of accrued
environmental liabilities are included in the consolidated balance sheet for
such matters.
In connection with the Acquisition, Pechiney, S.A. indemnified the Company
for environmental liabilities relating to Howmet Corporation and stemming from
events occurring or conditions existing on or prior to the Acquisition, to the
extent that such liabilities exceed a cumulative $6 million. This
indemnification applies to all of the aforementioned environmental matters. It
is highly probable that changes in any of the aforementioned accrued liabilities
will result in an equal change in the amount receivable from Pechiney, S.A.
pursuant to this indemnification.
In addition to the above environmental matters, and unrelated to Howmet
Corporation, Holdings and Pechiney, S.A. are jointly and severally liable for
environmental contamination and related costs associated with certain
discontinued mining operations owned and/or operated by a predecessor-in-
interest until the early 1960s. These liabilities include approximately $21.3
million in remediation and natural resource damage liabilities at the Blackbird
Mine site in Idaho and a minimum of $8 million in investigation and remediation
costs at the Holden Mine site in Washington. Pechiney, S.A. has agreed to
indemnify the Company for such liabilities. In connection with these
environmental matters, the Company recorded a $29.3 million liability and an
equal $29.3 million receivable from Pechiney, S.A. as of December 31, 1997 and
$24.7 million for both the liability and receivable as of December 31, 1996.
Estimated environmental costs are not expected to materially impact the
financial position or the results of the Company's operations in future periods.
However, environmental clean-up periods are protracted in length and
environmental costs in future periods are subject to changes in environmental
remediation regulations. Any losses which are not covered by the Pechiney, S.A.
indemnifications and which are in excess of amounts currently accrued will be
charged to operations in the periods in which they occur.
The Company, in its ordinary course of business, is involved in other
litigation, administrative proceedings and investigations of various types in
several jurisdictions. The Company believes these are routine in nature and
incidental to its operations, and that the outcome of any proceedings to which
the Company currently is a party will not have a material adverse effect upon
its operations or financial condition.
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HOWMET 1997 ANNUAL REPORT
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At December 31, 1997, the Company guaranteed certain indebtedness
aggregating $5.9 million of a 50% owned entity.
19. SALE OF REFURBISHMENT BUSINESS
In September 1997, the Company sold its aircraft engine component refurbishment
business (other than its coating operations). The Company received net cash
proceeds of approximately $44.9 million after tax and related expenses. The
sales transaction had an immaterial effect on net income. Net sales of such
business were approximately $53 million in 1997 for the period prior to the
September sale and approximately $69 million for the full year 1996. Income
from operations of this business were immaterial in all periods.
20. RESTRUCTURING
1992 and 1994 Restructuring
In 1992 the Company recorded a restructuring provision for reengineering
programs and capacity rationalization. In 1994 the Company recorded an
additional restructuring provision for costs to close a wax facility, for
closure of an administrative office, and for costs to exit the airmelt alloy
business. The decision to exit the airmelt alloy business was reversed in 1995,
and the related restructuring accrual was credited to income in 1995.
The following table sets forth the 1995, 1996 and 1997 activity for these
restructuring accruals (in millions):
1992 1994
Restructuring Restructuring
- --------------------------------------------------------------------------------
December 31, 1994 balance $12.4 $ 4.0
Cash disbursements (9.3) (1.9)
Changes in estimates -- (1.6)
- --------------------------------------------------------------------------------
December 31, 1995 balance 3.1 .5
Cash disbursements -- (.1)
Changes in estimates (2.8) (.4)
- --------------------------------------------------------------------------------
December 31, 1996 balance .3 --
Cash disbursements (.3) --
- --------------------------------------------------------------------------------
December 31, 1997 balance $ -- $ --
================================================================================
The 1996 accrual reductions resulted in a reduction of goodwill.
1995/1996 Restructuring Provision
In connection with the Acquisition, management determined that certain
manufacturing capabilities would be eliminated and the related facilities would
be utilized for purposes other than for manufacturing. Accordingly, a reserve of
$21 million, principally for severance costs, was recorded. The extent of the
restructuring was less than initially anticipated; consequently, in 1996 $19.1
million of the accrual was reversed and goodwill was reduced by an equal amount.
Expenditures in 1996 for this restructuring effort were $1 million, principally
for termination costs for 45 permanent and temporary employees. The $.9 million
December 31, 1996 accrual balance is included in amounts captioned "Accrued
liabilities" in the consolidated balance sheet. This amount was spent in 1997,
principally for termination costs related to 15 employees.
21. OTHER INFORMATION
Other, net in the income statements includes equity in income (loss) of
unconsolidated affiliates of $1.5 million, $(1.4) million, $(.2) million and
$(4.3) million for the years ended December 31, 1997, 1996, the period from
December 14 to December 31, 1995 and the period from January 1 to December 13,
1995, respectively. It also includes losses on sales of receivables (Note 7) and
$2.6 million of 1997 costs associated with the 1997 public offering of common
stock.
The 1996 reduction of receivables reported in the statement of cash flows
includes $21.1 million for collection of long-term customer receivables.
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HOWMET 1997 ANNUAL REPORT
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22. QUARTERLY FINANCIAL HIGHLIGHTS (UNAUDITED)
The table below presents the Company's quarterly financial highlights for 1997
and 1996. The Company's business is generally not seasonal. However, the timing
of customer inventory needs in relation to engine production and delivery
schedules can cause quarterly fluctuations in the Company's operating
performance that are not necessarily related to underlying business conditions.
(in millions, except per share amounts) 1997 Quarter Ended 1996 Quarter Ended
- --------------------------------------------------------------------------------------------------------------------------
Dec. 31 Sept. 28 June 29 Mar. 30 Dec. 31 Sept. 29 June 30 Mar. 31
- --------------------------------------------------------------------------------------------------------------------------
Net sales (a) $ 306.2 $ 309.0 $ 330.4 $ 312.6 $ 283.5 $ 278.5 $ 283.4 $ 261.4
Gross profit 93.5 94.3 103.6 92.6 80.5 76.7 74.6 71.4
Income before extraordinary item(b)(c)(d) 12.7 21.2 22.6 15.5 9.8 9.2 5.0 1.6
Extraordinary item - loss on
early retirement of debt (12.3) -- -- -- -- -- -- --
Net income .4 21.2 22.6 15.5 9.8 9.2 5.0 1.6
Income per common share before
extraordinary item (basic and diluted) .11 .20 .21 .14 .09 .08 .04 .01
==========================================================================================================================
(a) Includes $3.4 million and $6.3 million of additional revenue (with no
associated costs) in the first and second quarters of 1997, respectively,
from a pricing adjustment with a customer that is not expected to recur in
future periods.
(b) Includes expense related to the Company's SARs plan of $7.9 million, $8
million, $5.1 million and $10.4 million in the first, second, third and
fourth quarters of 1997, respectively, and $.9 million, $.9 million and
$4.8 million in the second, third and fourth quarters of 1996,
respectively.
(c) Includes expense of $1.3 million and $2.8 million in the second and third
quarters of 1997, respectively, for the accelerated write-off of debt
issuance costs associated with debt that was repaid ahead of schedule.
(d) Includes $.6 million and $2 million in the third and fourth quarters of
1997, for costs associated with the Company's November 1997 public
offering of common stock.
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HOWMET 1997 ANNUAL REPORT
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Management's Report on Financial Statements
Management has prepared, and is responsible for, the consolidated financial
statements and all related financial information contained in the Annual Report.
The consolidated financial statements, which include amounts based on estimates
and judgments, were prepared in accordance with generally accepted accounting
principles appropriate in the circumstances and applied on a consistent basis.
Other financial information in this report is consistent with that in the
consolidated financial statements.
Management maintains an accounting system and related internal controls
which it believes provide reasonable assurance, at appropriate cost, that
transactions are properly executed and recorded, that assets are safe-guarded,
and that accountability for assets is maintained. An environment that provides
an appropriate level of control is maintained and monitored and includes
examinations by an internal audit staff.
Management recognizes its responsibilities for conducting the Company's
affairs in an ethical and socially responsible manner. The Company has written
standards of business conduct, including its business code of ethics which
emphasize the importance of personal and corporate conduct, that demands
compliance with federal and state laws governing the Company. The importance of
ethical behavior is communicated to all employees.
The Audit Committee of the Board of Directors is composed of two outside
directors. This Committee meets periodically and also meets separately with
representatives of the independent auditors, Company officers, and the internal
auditors to review their activities.
The consolidated financial statements have been examined by Ernst & Young
LLP, independent auditors, whose report follows.
/s/ John C. Ritter
John C. Ritter
Senior Vice President and
Chief Financial Officer
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HOWMET 1997 ANNUAL REPORT
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Report of Independent Auditors
The Board of Directors and Stockholders
Howmet International Inc.
We have audited the accompanying consolidated balance sheets of Howmet
International Inc. as of December 31, 1997 and 1996, and the related
consolidated statements of income, common stockholders' equity and redeemable
preferred stock, and cash flows for the years ended December 31, 1997 and 1996,
and for the period from December 14, 1995 to December 31, 1995, and the related
combined statements of income, common stockholders' equity and redeemable
preferred stock, and cash flows for the period from January 1, 1995 to December
13, 1995 (Howmet Predecessor Company). These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
1995 financial statements of Howmet SA, CIRAL SNC and Howmet Limited (UK),
wholly-owned subsidiaries, which statements reflect total revenues of $221
million for the year ended December 31, 1995. Those statements were audited by
other auditors whose reports have been furnished to us, and our opinion, insofar
as it relates to data included for Howmet SA, CIRAL SNC and Howmet Limited (UK),
is based solely on the reports of other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts (including the allocation of the results of operations of Howmet SA,
CIRAL SNC and Howmet Limited (UK) for the period from December 14, 1995 to
December 31, 1995) and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the reports of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and, for 1995, the reports of other
auditors, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Howmet International
Inc. as of December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for the years ended December 31, 1997 and 1996,
and for the period from December 14, 1995 to December 31, 1995 and the combined
results of its operations and its cash flows for the period from January 1, 1995
to December 13, 1995 (Howmet Predecessor Company) in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Stamford, Connecticut
January 28, 1998
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HOWMET 1997 ANNUAL REPORT
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Management's Discussion and Analysis of
Financial Condition and Results of Operations
GENERAL
The Company is a manufacturer of investment cast components for the aerospace
and industrial gas turbine industries through operating companies located in the
United States, France, the United Kingdom and Canada. See Note 15 of Notes to
Financial Statements.
The Company's operating performance is affected by general economic trends and
by the following key factors.
Industry Trends. The Company manufactures superalloy, titanium and aluminum
castings for turbine engines and airframes applications for customers worldwide
in the commercial and military aviation and the industrial gas turbine ("IGT")
markets.
Demand for the Company's products is affected by trends in the commercial
aviation market, which are currently favorable. Worldwide output of large
commercial aviation engines, for which the Company makes the majority share of
airfoils, increased significantly from 1996 to 1997. Scheduled aircraft
deliveries give some indication of engine and component requirements, although
the deliveries of engine components precede actual aircraft deliveries by
approximately nine months. Approximately 495 large aircraft (over 50 passengers)
were delivered in 1996, and an estimated 684 units were delivered in 1997. Spare
part sales for engines in service, which contribute approximately one-half of
the Company's sales to the commercial aviation market, are also increasing as a
result of the higher number of aircraft in service and increased flight hours,
among other factors.
Military and defense contractor sales comprised approximately 14% of the
Company's total 1997 sales. Such sales are principally in North America and are
affected by a portion of United States defense spending which has been declining
since the 1980s. In the near term, the Company expects its military and defense
contractor sales to remain stable.
Growth in demand for efficient, lower cost electrical generation
facilities with shorter construction lead times has resulted in IGT engines now
accounting for approximately 25% of new electric utility generating capacity
ordered worldwide. Management believes that continued growth in global electric
power demand provides continued opportunity for the Company's IGT castings
through demand for new engines and for replacement spare parts. Sales of spare
parts currently represent approximately 38% of total IGT revenues, but are
expected to increase as the installed base of IGT engines grows and ages.
Pricing. The Company has experienced pressure from all of its major customers
for price reductions. This pressure is the result of the competitive environment
which the Company's OEM customers are facing in the selling of their products in
the worldwide market. The Company's strategy to provide added value and service
to its customers has been successful in offsetting much of the pricing
pressures.
Cost Reduction and Productivity Programs. Since 1992 the Company has
significantly reduced costs and improved productivity, delivery and cycle times.
On-time deliveries (measured in terms of 100% on-time deliveries of complete
orders, not simply by individual pieces) have increased from 68% in 1992 to 87%
in 1997 and cycle times (measured by work-in-process inventory days) have fallen
from 44 days in 1992 to 18 days in 1997, in each case despite the fact that the
complexity and volume of the Company's products have increased significantly
during the same period. As a result of these improvements, the Company has
significantly enhanced its financial performance, and management believes
further improvements can be achieved. The Company employs specific programs
designed to achieve these improvements. These programs include synchronous
manufacturing, kaizen events (in which solutions to specific operational
problems are achieved by teams of workers in concentrated time periods), quick
shop intelligence (daily meetings of plant staff in which product-specific
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HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
manufacturing issues are reviewed and solved), and standardization of
manufacturing and business processes throughout the Company's facilities
worldwide, specialization by plants in the production of certain families of
castings and inter-facility manufacturing and technical support, including the
sharing of best practices, under a "One Howmet" concept.
Sale of Refurbishment Business. In September 1997, the Company sold its aircraft
engine component refurbishment business (other than its coating operations). The
Company received net cash proceeds of approximately $44.9 million after tax
payments and related expenses. The sale had an immaterial effect on net income.
Net sales of this business were approximately $53 million in 1997 for the period
prior to the September sale and approximately $69 million for the full year
1996. Earnings from operations of this business were immaterial in all periods.
Backlog. The Company's backlog of orders as of December 31, 1997 and 1996 were
$793 million and $648 million, respectively. Because of the short lead and
delivery times often involved and because the Company's orders are often
affected by deferrals and cancellations, backlog may not be a significant
indicator of future performance of the Company.
RESULTS OF OPERATIONS
See Note 1 of Notes to Financial Statements for a discussion of the October 11,
1995 formation of the Company and its December 13, 1995 acquisition of all of
the Company's current operating entities (the "Acquisition"). The Company had no
operations prior to December 14, 1995. For the period prior to December 14,
1995, results of Howmet Predecessor Company are used for comparison purposes
below. This is appropriate because the entities which comprise Howmet
Predecessor Company are those which generated all of the Company's sales and
pre-interest, pre-tax earnings since December 13, 1995.
For the purpose of comparing the Company's results of operations for the
year ended December 31, 1995, the results of the Company for the period from
December 14, 1995 to December 31, 1995 and the results of Howmet Predecessor
Company for the period from January 1, 1995 to December 13, 1995 have been
combined.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Summary financial information for the years ended December 31 follows (in
millions, except per share amounts):
1997 1996 Better/(Worse) Percent
- -----------------------------------------------------------------------------------------------------------------
Net Sales $ 1,258.2 $ 1,106.8 $ 151.4 14
- -----------------------------------------------------------------------------------------------------------------
Gross profit $ 384.0 $ 303.2 $ 80.8 27
Selling, general and administrative expense 145.4 117.3 (28.1) (24)
Depreciation and amortization expense 59.5 59.7 0.2 --
Research and development expense 24.6 24.2 (0.4) (2)
- -----------------------------------------------------------------------------------------------------------------
Income from operations 154.5 102.0 52.5 51
Net interest expense (29.8) (40.2) 10.4 26
Other, net (6.4) (5.9) (0.5) (8)
Income taxes (46.3) (30.3) (16.0) (53)
- -----------------------------------------------------------------------------------------------------------------
Income before extraordinary item 72.0 25.6 46.4 181
Extraordinary item (12.3) -- (12.3) --
- -----------------------------------------------------------------------------------------------------------------
Net income $ 59.7 $ 25.6 $ 34.1 133
=================================================================================================================
Income per share before extraordinary item (basic and diluted) $ .67 $ .21 $ .46 219
- -----------------------------------------------------------------------------------------------------------------
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HOWMET 1997 ANNUAL REPORT
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Net sales increased significantly in 1997 due primarily to volume
increases, principally in the aerospace market. The favorable effects of higher
volume were partially offset by lower prices. Such price reductions are a
function of competitive factors and sharing cost reductions with customers. In
1997 the Company received $9.7 million of additional revenue from a pricing
adjustment with a customer that is not expected to recur in future periods.
Gross profit increased by 27% in 1997 primarily from leveraging the higher
sales volume and improved operating performance. Cost reductions and
productivity improvements were partially offset by the aforementioned price
reductions. A $6.5 million warranty expense charge in 1997 and the $9.7 million
additional revenue (which had no associated costs) also affect comparability.
All of these factors resulted in a 1997 gross margin percentage of 30.5%
compared to 27.4% in 1996.
Selling, general and administrative expense increased by $28.1 million in
1997. The increase was primarily due to $24.8 million of higher 1997 expense
recorded in connection with the Company's stock appreciation rights plan.
Net interest expense decreased $10.4 million in 1997. Interest expense was
reduced by $14.5 million due to lower debt levels and, to a lesser extent, lower
rates resulting from achievements of financial targets. Partially offsetting
this reduction is a $4.1 million accelerated write-off of debt issuance costs
associated with debt that was repaid ahead of schedule in the second and third
quarters.
The effective tax rate for 1997 was 39.1% compared to 54.2% for 1996. The
lower effective rate for 1997 is attributable primarily to the diminished impact
of nondeductible goodwill amortization in relation to higher 1997 income,
higher 1997 research and development credits, and a lower state tax rate.
Income before extraordinary item increased by 181%, and the resulting per
share amount increased by 219%, due to the factors outlined above, including the
favorable impact of the lower effective tax rate. Per share amounts are
calculated assuming 100 million common shares were outstanding for all years.
In 1997 the Company recorded a $12.3 million extraordinary loss from early
debt retirement. (See "Liquidity and Capital Resources" below.)
The impact of inflation on net sales and earnings from operations was not
significant.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Summary financial information for the years ended December 31 follows (in
millions, except per share amounts):
1996 1995 Better/(Worse) Percent
- -------------------------------------------------------------------------------------------------
Net Sales $ 1,106.8 $ 945.5 $ 161.3 17
- -------------------------------------------------------------------------------------------------
Gross profit $ 303.2 $ 226.1 $ 77.1 34
Selling, general and administrative expense 117.3 109.6 (7.7) (7)
Depreciation and amortization expense 59.7 35.4 (24.3) (69)
Research and development expense 24.2 26.4 2.2 8
Restructuring credit -- (1.6) (1.6) --
- -------------------------------------------------------------------------------------------------
Income from operations 102.0 56.3 45.7 81
Net interest (expense) income (40.2) 1.0 (41.2) --
Other, net (5.9) (6.8) 0.9 13
Income taxes (30.3) (24.2) (6.1) (25)
- -------------------------------------------------------------------------------------------------
Net income $ 25.6 $ 26.3 $ (0.7) (3)
=================================================================================================
Net income per share (basic and diluted) $ .21 $ .26 $ (.05) (19)
- -------------------------------------------------------------------------------------------------
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HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
Net sales increased by 17% in 1996 primarily due to volume increases. The
increases reflect strength in all markets served, with the largest improvement
in IGT.
Gross profit increased by 34% in 1996 primarily from leveraging higher
sales volume and improved operating performance. Cost reductions and
productivity improvements were partially offset by price reductions. Other
contributing factors included a $2.6 million lower LIFO charge in 1996 and a
$5.4 million workers' compensation charge in 1995 with no comparable amount in
1996. All of these factors resulted in a 1996 gross margin percentage of 27.4%
compared to 23.9% in 1995.
Selling, general and administrative expense increased by $7.7 million in
1996. The increase was due primarily to performance-based incentive compensation
costs.
Depreciation and amortization expense increased by $24.3 million in 1996.
Most of the increase relates to the December 13, 1995 Acquisition asset
additions and revaluations including goodwill, patents, non-compete agreements,
and step-ups of property, plant and equipment.
Net interest expense was $40.2 million in 1996, and net interest income
was $1 million for 1995. The expense in 1996 resulted principally from the
December 13, 1995 Acquisition financing-related debt. In 1995 the Company
recorded net interest income on loans to/from its former owner, which are no
longer outstanding.
The effective tax rate for 1996 was 54.2% compared to an effective tax
rate of 47.9% for 1995. The higher rate in 1996 reflects certain losses and
expenses for which there were no associated tax benefits, principally goodwill
amortization.
Net income was 3% lower in 1996 due to the factors outlined above,
including the adverse effects of the December 13, 1995 Acquisition on interest
expense and depreciation and amortization. Net income per share declined 19% for
the aforementioned reasons and because of dividends on redeemable preferred
stock which was part of the December 13, 1995 Acquisition financing.
In connection with the Acquisition in December 1995, management determined
that certain manufacturing operations would be eliminated. Accordingly, a
reserve of $21 million, principally for severance costs, was established. In
1996, as a result of increased customer orders for parts produced by such
operations, operational improvements and a general improvement of the prospects
of such operations, management re-evaluated its decision and concluded that such
operations should be retained. As a result of the decision to retain these
operations, in 1996 $19.1 million of the original accrual (principally relating
to severance costs) was reversed and goodwill was reduced by an equal amount.
See Note 20 of Notes to Financial Statements.
The impact of inflation on net sales and earnings from operations was not
significant.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of liquidity are cash flow from operations and
borrowings under its revolving credit facility. The Company's principal
requirements for cash are to provide working capital, service debt, finance
capital expenditures and fund research and development. Based upon the current
level of operations, management believes that cash from the aforementioned
sources will be adequate to meet the Company's anticipated requirements for
working capital, interest payments and scheduled debt principal payments,
capital expenditures and research and development for the next year. To date,
cash available after satisfaction of these requirements has been used to
voluntarily repay debt prior to mandatory due dates.
In the fourth quarter of 1997, the Company completed a comprehensive
refinancing to take advantage of favorable interest rates. The Company
terminated its senior credit facilities and repaid all outstanding borrowing
thereunder, and the Company tendered for and repaid all but $3 million of its
$125 million senior subordinated notes. As a result of these transactions, the
Company recorded a $12.3 million, after tax, extraordinary loss from early
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HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
retirement of debt. The loss included write-offs of unamortized debt issuance
costs, a tender premium for the senior subordinated notes and transactions
costs. The debt repayments were funded with borrowings under a new $300 million
bank revolving credit facility which was entered into in the fourth quarter.
Also in the fourth quarter, the Company elected to repay in cash all amounts
owed under its payment-in-kind junior subordinated note except for $6 million.
This payment was also funded with borrowings under the new $300 million
revolving credit facility. As a result of these refinancings, the Company
reduced interest expense on the $146.4 million of debt from a fixed rate of 10%
to a variable rate, currently at 6.22%.
At December 31, 1997, there were $7.6 million standby letters of credit
and $198 million outstanding borrowings under the $300 million bank revolving
credit facility. Total debt at December 31, 1997 was $208.4 million, and total
minimum payments over the next five years under non-cancelable operating leases
are $15.2 million. In 1997 net debt repayments were $141.4 million. The source
of $44.9 million of the cash used for the debt repayments was the sale of the
aircraft engine component refurbishment business, discussed above.
Capital expenditures for 1997 of $56.9 million were for replacement of
existing equipment, for capacity expansion and for several projects to support
new products and enhanced process capabilities. In 1998 capital expenditures are
expected to be approximately $80 million. The 1998 increase is attributable to
the completion of capacity expansions needed to serve the core business, as well
as, additional expenditures to support new products and process enhancement
activities.
Debt plus redeemable preferred stock as a percentage of total
capitalization (debt plus redeemable preferred stock plus common shareholders'
equity) has been reduced to 50% at December 31, 1997 from 65% at December 31,
1996. The current ratios (excluding long-term debt due within one year) at
December 31, 1997 and 1996 were 1.2 and 1.3, respectively. Working capital
(excluding long-term debt due within one year) was $62.5 million and $67.3
million at December 31, 1997 and 1996, respectively.
At December 31, 1997, the Company's balance sheet includes $716.4 million
of Pechiney Notes and a $716.4 million Restricted Trust asset. See Note 8 of
Notes to Financial Statements.
Since December 31, 1996, the cumulative translation adjustment, which is
included in stockholders' equity, changed by $7.7 million, resulting in a $5.6
million negative balance at December 31, 1997. The change is primarily due to
the strengthening of the U.S. dollar relative to the French Franc.
ENVIRONMENTAL AND OTHER LEGAL MATTERS
In view of the indemnification from the Company's previous owners granted in
connection with the acquisition described in Note 1 of Notes to Financial
Statements, the Company does not expect resolution of environmental matters to
have a material effect on its liquidity or results of operations. See Note 18 of
Notes to Financial Statements.
The Company, in its ordinary course of business, is involved in other
litigation, administrative proceedings and investigations of various types in
several jurisdictions. The Company believes these are routine in nature and
incidental to its operations, and that the outcome of any proceedings to which
the Company currently is a party will not have a material adverse effect upon
its operations or financial condition.
YEAR 2000 COMPLIANCE
The Company does not anticipate a disruption in operations as a result of
computer software issues associated with the Year 2000. A dedicated team of both
Company and contract programmers are actively addressing the Company's Year 2000
compliance issues. All data logic problems on the Company's central mainframe
and distributed server applications have been identified, and remedial action to
correct or
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HOWMET 1997 ANNUAL REPORT
=======================================-----------------------------------------
replace problematic code is currently underway. Project work on this phase of
the effort started in late 1996 and is scheduled to be completed by June 30,
1999.
The Year 2000 compliance team is concurrently working with the various
remote plant facilities to identify and begin implementing any needed changes to
both local business applications and shop floor control systems. The inventory
and assessment phase of this effort will be completed in the second quarter of
1998. To date no material risk of non-compliance has been identified.
The Company has also initiated formal communications with all of its
significant suppliers, including raw materials, services, and computer
hardware/software suppliers, and large customers to determine the extent to
which Howmet's manufacturing processes and interface systems are vulnerable to
those third parties' failure to resolve their own Year 2000 issues. There can be
no guarantee that the systems of other companies on which Howmet's systems rely
will be timely converted and would not have an adverse effect on the Howmet
systems. However, at this point, the Company has not been made aware of any
material problems.
The Company has incurred and expects to incur incremental costs for its
Year 2000 efforts of $1 million, $2.5 million, $2.5 million and $.5 million,
respectively, for the full years 1997, 1998, 1999 and 2000. The Company has also
diverted internal resources with an additional annual cost of approximately $.6
million for each of 1997, 1998 and 1999.
RISK FACTORS
Except for the historical information contained herein, certain statements in
this annual report are "forward-looking statements" as defined in the Private
Securities Litigation Reform Act of 1995, which involve risks and uncertainties
that include changing economic and political conditions in the United States and
in other countries, including those in Asia, where economic disruption could
delay their receipt of aero or industrial gas turbine engines. The impact of
such delay in receipt of new engines would be offset in part by higher spare
parts sales to these consumers. Risks and uncertainties also include but are not
limited to changes in governmental laws and regulations, the outcome of
environmental matters, the availability and cost of raw materials, and the
effects of: (i) aerospace and IGT industry economic conditions, (ii) aerospace
industry cyclicality, (iii) a concentrated customer base, (iv) competition and
(v) pricing pressures. All forecasts and projections in this report are
"forward-looking statements", and are based on management's current expectations
of the Company's results, based on current information available pertaining to
the Company and its products including the aforementioned risk factors. Actual
future results and trends may differ materially from projections made herein.
NEW ACCOUNTING STANDARDS
In June 1997, Statement of Financial Accounting Standards ("SFAS") No. 130,
"Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" were issued. Adoption of SFAS No. 131
in 1998 is not expected to have a significant impact on the Company's financial
statements. Adoption of SFAS No. 130 in 1998 will not have an effect on the
Company's cash flows, financial position or net income. However, adoption of
SFAS No. 130 will require the Company to report comprehensive income, which will
include net income and the change in the cumulative translation adjustment
reported in stockholders' equity.
RECENT MARKET PRICES AND DIVIDENDS
The market price of the Company's common stock since it began public trading in
November 1997 through December 31, 1997, ranged from a low of $14.69 to a high
of $16.00 per share.
The Company did not pay dividends in either 1997 or 1996.
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HOWMET 1997 ANNUAL REPORT
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Selected Financial Data
Howmet International Inc. Howmet Predecessor
Consolidated (a) Company Combined (a)
------------------------------------------------------------------------------
Period from Period from
December 14, January 1,
1995 to 1995 to
Year Ended December 31 December 31, December 13, Year Ended December 31
(Dollars in millions, except per share amounts) 1997 1996 1995 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Income Data(a)
Net sales $ 1,258.2 $ 1,106.8 $ 51.4 $ 894.1 $ 858.3 $ 832.7
Operating expenses:
Cost of sales 874.2 803.6 38.0 681.4 647.3 603.4
Selling, general and administrative(b) 145.4 117.3 4.6 105.0 90.9 104.5
Depreciation and amortization 59.5 59.7 2.8 32.6 33.1 31.0
Research and development 24.6 24.2 1.4 25.0 19.2 23.3
Restructuring charges (credit) -- -- -- (1.6) 2.5 --
Goodwill write-off -- -- -- -- 47.4 --
- ------------------------------------------------------------------------------------------------------------------------------------
Income from operations 154.5 102.0 4.6 51.7 17.9 70.5
Interest (expense) income, net (29.8) (40.2) (3.1) 4.1 5.2 0.4
Other, net (6.4) (5.9) (1.0) (5.8) (0.1) (0.1)
Income taxes 46.3 30.3 .5 23.7 46.0 27.8
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary
item and cumulative effect of
change in accounting(c) $ 72.0 $ 25.6 $ -- $ 26.3 $ (23.0) $ 43.0
====================================================================================================================================
Net income (loss)(c) $ 59.7 $ 25.6 $ -- $ 26.3 $ (23.0) $ (6.3)
Dividends on redeemable preferred stock (5.1) (4.6) (.2) -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common stock $ 54.6 $ 21.0 $ (.2) $ 26.3 $ (23.0) $ (6.3)
====================================================================================================================================
Per common share amounts(d):
Income (loss) before extraordinary
item and cumulative effect of
change in accounting $ .67 $ .21 $ -- $ .26 $ (.23) $ (.06)
====================================================================================================================================
Net income (loss) $ .55 $ .21 $ -- $ .26 $ (.23) $ (.06)
====================================================================================================================================
Other Data (end of period, where applicable):(a)(e)
Total assets, excluding Restricted Trust $ 994.2 $ 1,052.4 $ 1,127.8 $ -- $ 509.9 $ 579.6
Restricted Trust(f) 716.4 716.4 716.4 -- -- --
Long-term debt, including current
maturities, excluding Pechiney Notes 208.4 350.7 488.6 -- 42.1 44.5
Pechiney Notes(f) 716.4 716.4 716.4 -- -- --
Redeemable preferred stock 60.0 54.9 50.2 -- -- --
Stockholders' equity 265.7 218.8 196.9 -- 166.3 239.1
Net cash provided (used) by operating activities 192.6 184.5 (12.7) 35.2 91.4 95.4
Capital expenditures 56.9 33.7 1.6 41.2 38.0 33.1
Number of employees 10,352 10,035 9,577 -- 8,702 8,990
====================================================================================================================================
(a) In 1995 Howmet International Inc. was formed to acquire its only
operations, which are those of the entities that comprise Howmet
Predecessor Company Combined. Data for periods after December 13, 1995
reflect the allocation of the acquisition purchase price to assets and
liabilities of the Company, the financing of the Acquisition, and the
subsequent amortization, depreciation, interest expense and other effects
related thereto.
(b) Includes charges related to the Company's stock appreciation rights plan
of $31.4 million in 1997 and $6.6 million in 1996.
(c) In 1997 the Company recorded a $12.3 million after-tax extraordinary loss
on early retirement of debt. In 1993 a $49.3 million after-tax charge was
recorded as the cumulative effect of adopting Statement of Financial
Accounting Standards ("SFAS") No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions."
(d) All per common share amounts are both basic and diluted and were
calculated assuming that the 100 million common shares outstanding at
December 31, 1997 were outstanding for all periods.
(e) Excludes related party advances to Pechiney Corporation (1994-$238.7
million, 1993-$203.7 million) and excludes related party dividends and
notes payable (1994-$20 million, 1993-$20.5 million).
(f) The Restricted Trust holds a note receivable from Pechiney, S.A. and
related letters of credit that secures Pechiney, S.A.'s agreement to repay
the Pechiney Notes. Management believes that it is extremely remote that
the Company will use any assets other than those in the Restricted Trust
to satisfy any payments related to the Pechiney Notes. See Note 8 of Notes
to Financial Statements.