Delaware 25-1792394
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1000 Six PPG Place
Pittsburgh, Pennsylvania 15222-5479
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(Address of Principal Executive Offices) (Zip Code)
(412) 394-2800
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(Registrant's telephone number, including area code)
Yes (X) No ( )
Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Securities Exchange Act of 1934).
Yes (X) No ( )
At October 22, 2004, the registrant had outstanding 95,502,412 shares of its Common Stock.
Page No.
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 26
Item 3. Quantitative and Qualitative
Disclosures About Market Risk 45
Item 4. Controls and Procedures 47
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 47
Item 6. Exhibits 48
SIGNATURES 49
EXHIBIT INDEX 50
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September 30, December 31,
2004 2003
-------- --------
(Unaudited) (Audited)
ASSETS
Cash and cash equivalents $ 262.6 $ 79.6
Accounts receivable, net 365.2 248.8
Inventories, net 460.8 359.7
Income tax refunds -- 7.2
Prepaid expenses and other current assets 31.0 48.0
-------- --------
Total Current Assets 1,119.6 743.3
Property, plant and equipment, net 727.2 711.1
Cost in excess of net assets acquired 204.6 198.4
Deferred pension asset 144.0 144.0
Deferred income taxes 34.3 34.3
Other assets 59.2 53.8
-------- --------
TOTAL ASSETS $2,288.9 $1,884.9
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 259.1 $ 172.3
Accrued liabilities 218.7 194.6
Short-term debt and current portion
of long-term debt 33.9 27.8
-------- --------
Total Current Liabilities 511.7 394.7
Long-term debt 557.3 504.3
Accrued postretirement benefits 473.8 507.2
Pension liabilities 248.2 220.6
Other long-term liabilities 107.6 83.4
-------- --------
TOTAL LIABILITIES 1,898.6 1,710.2
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.10: authorized-
50,000,000 shares; issued-none -- --
Common stock, par value $0.10, authorized-500,000,000
shares; issued-98,951,490 shares at September 30,
2004 and December 31, 2003; outstanding-95,490,205
shares at September 30, 2004 and 80,654,861 shares
at December 31, 2003 9.9 9.9
Additional paid-in capital 481.2 481.2
Retained earnings 320.6 483.8
Treasury stock: 3,461,285 shares at
September 30, 2004 and 18,296,629 shares
at December 31, 2003 (86.7) (458.4)
Accumulated other comprehensive
loss, net of tax (334.7) (341.8)
-------- --------
Total Stockholders' Equity 390.3 174.7
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,288.9 $1,884.9
======== ========
The accompanying notes are an integral part of these statements.
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Sales $ 730.6 $ 482.6 $ 1,954.9 $ 1,453.0
Costs and expenses:
Cost of sales 653.7 464.4 1,815.0 1,399.4
Selling and administrative
expenses 56.8 60.3 168.3 161.4
Curtailment (gain), net of
restructuring costs -- 1.2 (40.4) 1.2
--------- --------- --------- ---------
Income (loss) before interest,
other expense, and income taxes 20.1 (43.3) 12.0 (109.0)
Interest expense, net (9.3) (4.1) (25.3) (19.9)
Other expense (2.2) (0.9) (1.9) (0.2)
--------- --------- --------- ---------
Income (loss) before income tax
benefit and cumulative effect of
change in accounting principle 8.6 (48.3) (15.2) (129.1)
Income tax benefit -- (19.5) -- (48.5)
--------- --------- --------- ---------
Net income (loss) before cumulative
effect of change in accounting
principle 8.6 (28.8) (15.2) (80.6)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (1.3)
--------- --------- --------- ---------
Net income (loss) $ 8.6 $ (28.8) $ (15.2) $ (81.9)
========= ========= ========= =========
Basic net income (loss) per
common share before cumulative
effect of change in accounting
principle $ 0.10 $ (0.36) $ (0.18) $ (0.99)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
--------- --------- --------- ---------
Basic net income (loss) per common
share $ 0.10 $ (0.36) $ (0.18) $ (1.01)
========= ========= ========= =========
Diluted net income (loss) per
common share before cumulative
effect of change in accounting
principle $ 0.09 $ (0.36) $ (0.18) $ (0.99)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
--------- --------- --------- ---------
Diluted net income (loss) per
common share $ 0.09 $ (0.36) $ (0.18) $ (1.01)
========= ========= ========= =========
Dividends declared per common share $ 0.06 $ 0.06 $ 0.18 $ 0.18
========= ========= ========= =========
|
The accompanying notes are an integral part of these statements.
Nine Months Ended
September 30,
-------------------
2004 2003
------ ------
OPERATING ACTIVITIES:
Net loss $(15.2) $(81.9)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Cumulative effect of change in accounting principle - 1.3
Depreciation and amortization 56.4 55.7
Non-cash curtailment gain and restructuring
charges, net (45.6) -
Deferred income taxes - (40.7)
Capital (gains) losses on sale of PP&E 0.2 (0.8)
Change in operating assets and liabilities:
Accounts receivable (84.3) (36.2)
Accounts payable 70.5 4.2
Pension assets and liabilities (a) 1.9 66.0
Inventories (43.2) 15.2
Other postretirement benefits 20.0 8.7
Income tax refunds receivable 7.2 34.8
Accrued liabilities and other 40.6 25.8
------ ------
CASH PROVIDED BY OPERATING ACTIVITIES 8.5 52.1
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (39.5) (51.5)
Purchases of businesses and investment in ventures (7.5) (0.8)
Asset disposals and other 0.5 5.3
------ ------
CASH USED IN INVESTING ACTIVITIES (46.5) (47.0)
FINANCING ACTIVITIES:
Payments on long-term debt and capital leases (17.3) (5.5)
Borrowings on long-term debt 11.7 20.2
Net borrowings (repayments) under credit facilities - (1.4)
------ ------
Net increase (decrease) in debt (5.6) 13.3
Issuance of common stock 229.7 -
Dividends paid (9.7) (14.6)
Exercises of stock options 5.1 -
Proceeds from interest rate swap settlement 1.5 15.3
------ ------
CASH PROVIDED BY FINANCING ACTIVITIES 221.0 14.0
------ ------
INCREASE IN CASH AND CASH EQUIVALENTS 183.0 19.1
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 79.6 59.4
------ ------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $262.6 $ 78.5
====== ======
|
(a) 2004 includes $(50.0) pension contribution.
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES
On June 1, 2004, a subsidiary of the Company acquired substantially all of the assets of J&L Specialty Steel, LLC for consideration of $67.2 million. Cash paid at closing was $7.5 million, with promissory notes payable to the seller of $59.7 million, one of which is subject to adjustment on the terms set forth in the asset purchase agreement.
The accompanying notes are an integral part of these statements.
NOTE 1. ACCOUNTING POLICIES
Basis of Presentation
The interim consolidated financial statements include the accounts of Allegheny Technologies Incorporated and its subsidiaries. Unless the context requires otherwise, "Allegheny Technologies" and "the Company" refer to Allegheny Technologies Incorporated and its subsidiaries.
These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and note disclosures required by accounting principles generally accepted in the United States for complete financial statements. In management's opinion, all adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation have been included. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2003 Annual Report on Form 10-K. The results of operations for these interim periods are not necessarily indicative of the operating results for any future period. Certain amounts from prior periods have been reclassified to conform with the current presentation.
Stock-based Compensation
The Company accounts for its stock option plans and other stock-based compensation in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. The following table illustrates the effect on net income (loss) and per share information if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123").
(in millions, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Net income (loss) as reported $ 8.6 $(28.8) $(15.2) $(81.9)
Add: Stock-based compensation
expense included in net income (loss), net of tax 1.8 4.2 12.0 5.2
Deduct: Net impact of SFAS 123, net of tax (2.6) (5.0) (14.8) (7.6)
------ ------ ------ ------
Pro forma net income (loss) $ 7.8 $(29.6) $(18.0) $(84.3)
====== ====== ====== ======
Net income (loss) per common share:
Basic - as reported $ 0.10 $(0.36) $(0.18) $(1.01)
Basic - pro forma $ 0.09 $(0.37) $(0.22) $(1.04)
Diluted - as reported $ 0.09 $(0.36) $(0.18) $(1.01)
Diluted - pro forma $ 0.08 $(0.37) $(0.22) $(1.04)
On May 19, 2004 the Financial Accounting Standards Board issued FASB Staff Position (FSP) 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" that provides guidance on the accounting for the effects of the Act for employers that sponsor postretirement health care plans that provide drug benefits. The Act provides the opportunity for a retiree to obtain a prescription drug benefit under Medicare, or for a Federal subsidy, with tax-free payments commencing in 2006, to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to the benefit established by law. Under FSP 106-2, the effect of the Federal subsidy shall be accounted for as an actuarial experience gain. In addition, the effect of the Act is taken into consideration, as appropriate, in determining an employer's future per capita claims cost. Based upon estimates from the Company's actuaries, it is expected that the effect of the Act will result in a reduction in the Accumulated Other Postretirement Benefits obligation of $46 million. The benefit to the Company will be recognized over multiple years as a reduction to postretirement benefit expense. The Company adopted FSP 106-2 in the beginning of the 2004 third quarter, resulting in approximately $1 million lower postretirement benefit expense in the quarter.
NOTE 2. J&L SPECIALTY STEEL, LLC ASSET ACQUISITION
On June 1, 2004, a subsidiary of the Company acquired substantially all of the assets of J&L Specialty Steel, LLC ("J&L"), a producer of flat-rolled stainless steel products with operations in Midland, Pennsylvania and Louisville, Ohio for $67.2 million in total consideration, including the assumption of certain current liabilities. The purchase price included payment of $7.5 million at closing, the issuance to the seller of a non-interest bearing $7.5 million promissory note that matures on June 1, 2005, and the issuance to the seller of a promissory note in the principal amount of $52.2 million, which is secured by the J&L property, plant and equipment acquired, and which is subject to adjustment on the terms set forth in the asset purchase agreement and has a final maturity of July 1, 2011. The transaction was accounted for as a purchase business combination. The acquired operations are being integrated into the Allegheny Ludlum operation which is part of the Company's Flat-Rolled Products business segment.
The closing of the acquisition followed the ratification, on May 28, 2004, of a new labor agreement by the United Steelworkers of America ("USWA") represented employees at the Company's Allegheny Ludlum subsidiary and at the former J&L facilities. The new labor agreement expires in June 2007, and provides for a workforce restructuring through the reduction in the number of production and maintenance job grades from 34 to five, and the implementation of flexible work rules. The number of production and maintenance employees at the pre-acquisition Allegheny Ludlum facilities is being reduced by 650 employees through an early retirement program over the next two and a half years pursuant to which the USWA-represented employees are being offered Transition Assistance Program ("TAP") incentives, to be paid from the Company's defined benefit pension trust. The new labor agreement also includes a cap on the Company's retiree medical costs. In the 2004 second quarter, the Company recorded charges of $25.4 million for the TAP incentives, and also recorded a $5.7 million charge as a result of other costs associated with the new labor agreement and the J&L asset acquisition.
Allocated Purchase
Price
------------------
(in millions)
(unaudited)
Acquired assets:
Accounts receivable $ 32.1
Inventory 57.9
Property, plant and equipment 27.9
Other assets 2.1
------
Total assets 120.0
Assumed liabilities:
Accounts payable 16.3
Accrued current liabilities 9.8
Short term debt 2.4
Long-term debt 2.1
Accrued postretirement benefits 18.6
Other long-term liabilities 3.6
------
Total liabilities 52.8
------
Purchase price - net assets acquired $ 67.2
======
Under the terms of the asset purchase agreement, the final purchase price of the J&L asset acquisition is subject to adjustment. This adjustment is expected to be finalized in the 2004 fourth quarter. In the 2003 fourth quarter, J&L recorded a $242 million asset impairment charge to write off the entire value of its property, plant and equipment. The purchase price of the J&L asset acquisition is based on the net working capital acquired, and the fair value of the net assets acquired is in excess of the purchase price. In accordance with Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"), the excess of fair value over the purchase price represents negative goodwill, which has been allocated as a pro rata reduction to the amounts that would otherwise have been assigned to the acquired noncurrent assets, principally property, plant and equipment.
The following unaudited pro forma financial information for the Company includes the results of operations of the J&L asset acquisition as if it had been consummated as of the beginning of the periods presented, including the effects of the new labor agreement on retirement benefits expense as it pertains to the former J&L facilities, the effects of the assigned fair value under SFAS 141 of property, plant and equipment acquired, and the effects of the indebtedness incurred to fund the asset acquisition. In addition, the unaudited pro forma financial information is based on historical information and does not purport to represent what the actual consolidated results of operations of the Company would have been had these transactions occurred on the dates assumed, nor is it necessarily indicative of future consolidated results of operations. The unaudited pro forma financial information does not give affect to additional cost savings and synergies that the Company anticipates achieving following the acquisition.
Three
(In millions, except per share data) Months Nine Months Ended
(unaudited) Ended September 30,
September 30, -------------------------
2003 2004 2003
------------ --------- ---------
Sales $ 585.0 $ 2,158.0 $ 1,777.6
Net loss before cumulative effect of
change in accounting principle (36.3) (8.9) (95.5)
Net loss (36.3) (8.9) (96.8)
Basic and diluted net loss per common share before
cumulative effect of change in accounting
principle $ (0.45) $ (0.11) $ (1.19)
Basic and diluted net loss per common share (0.45) (0.11) (1.21)
|
Inventories at September 30, 2004 and December 31, 2003 were as follows
(in millions):
September 30, December 31,
2004 2003
------------ -----------
(unaudited) (audited)
Raw materials and supplies $ 55.3 $ 37.5
Work-in-process 516.3 356.2
Finished goods 92.5 84.9
------ ------
Total inventories at current cost 664.1 478.6
Less allowances to reduce current cost
values to LIFO basis (194.4) (111.7)
Progress payments (8.9) (7.2)
------ ------
Total inventories, net $460.8 $359.7
====== ======
Inventories are stated at the lower of cost (last-in, first-out ("LIFO"), first-in, first-out ("FIFO"), and average cost methods) or market, less progress payments. Most of the Company's inventory is valued utilizing the LIFO costing methodology. Inventory of the Company's non-U.S. operations is valued using average cost or FIFO methods. Cost of sales expense was $8.5 million higher for the 2004 third quarter and $82.7 million higher for the first nine months of 2004 than would have been recognized if FIFO, rather than LIFO, methodology were utilized to value inventory. Cost of sales expense was $10.5 million higher for the 2003 third quarter and $22.8 million higher for the first nine months of 2003 than would have been recognized if FIFO, rather than LIFO, methodology were utilized to value inventory.
In the quarter ended June 30, 2004, the Company changed its method of calculating LIFO inventories at its Allegheny Ludlum subsidiary by reducing the overall number of Company-wide inventory pools from 15 to eight, and by changing its calculation method for LIFO from the double-extension method to the link-chain method. The Company made the change in order to better match costs with revenues, to reflect the business structure of Allegheny Ludlum following the J&L asset acquisition, to provide for a LIFO adjustment more representative of Allegheny Ludlum's actual inflation on its inventories and to conform LIFO accounting methods with other ATI operations that use the LIFO inventory method. The cumulative effect of the change in methods and the pro forma effects of the change on prior years' results of operations were not determinable. The effect of the change on the results of operations for interim 2004 periods was not material.
Property, plant and equipment at September 30, 2004 and December 31, 2003
were as follows (in millions):
September 30, December 31,
2004 2003
------------ -----------
(unaudited) (audited)
Land $ 25.1 $ 26.3
Buildings 230.3 228.2
Equipment and leasehold improvements 1,559.2 1,494.0
-------- --------
1,814.6 1,748.5
Accumulated depreciation and amortization (1,087.4) (1,037.4)
-------- --------
Total property, plant and equipment, net $ 727.2 $ 711.1
======== ========
Debt at September 30, 2004 and December 31, 2003 was as follows (in millions):
September 30, December 31,
2004 2003
------------ -----------
(unaudited) (audited)
Allegheny Technologies $300 million 8.375% Notes due 2011, net (a) $308.6 $309.4
Allegheny Ludlum 6.95% debentures, due 2025 150.0 150.0
Promissory notes for J&L asset acquisition 59.7 -
Foreign credit agreements 44.3 35.0
Industrial revenue bonds, due through 2007 12.1 20.1
Capitalized leases and other 16.5 17.6
------ ------
591.2 532.1
Short-term debt and current portion of long-term debt (33.9) (27.8)
------ ------
Total long-term debt $557.3 $504.3
====== ======
(a) Includes fair value adjustments for interest rate swap contracts of $14.1 million for deferred gains on settled interest rate swap contracts at September 30, 2004, and $15.2 million (including $1.4 million for interest rate swap contracts then outstanding and $13.8 million for deferred gains on settled interest rate swap contracts) at December 31, 2003.
Interest rate swap contracts are used from time-to-time to manage the Company's exposure to interest rate risks. At the end of the 2002 first quarter, the Company entered into interest rate swap contracts with respect to a $150 million notional amount related to its $300 million, 8.375% ten-year Notes, due December 15, 2011, which involved the receipt of fixed rate amounts in exchange for floating rate interest payments over the life of the contracts without an exchange of the underlying principal amount. These contracts were designated as fair value hedges. As a result, changes in the fair value of the swap contracts and the underlying fixed rate debt are recognized in the statement of operations. During the first nine months of 2003, the Company terminated the majority of these interest rate swap contracts and received $15.3 million in cash. Also in 2003, the Company entered into new "receive fixed, pay floating" interest rate swap arrangements related to the 8.375% ten-year Notes which re-established, in total, the $150 million notional amount. In the third quarter 2004, the Company terminated all of the outstanding interest rate swap contracts and realized net cash proceeds of $1.5 million. These gains on settlement remain a component of the reported balance of the Notes ($308.6 million at September 30, 2004 including fair value adjustments), and are being ratably recognized as a reduction to interest expense over the remaining life of the Notes, which is approximately seven years.
The Company has a $325 million four-year senior secured domestic revolving credit facility ("the facility"), which expires in June 2007, and which is secured by all accounts receivable and inventory of its U.S. operations, and includes capacity for up to $175 million in letters of credit. There were no borrowings under the domestic credit facilities during the first nine months of 2004, or during all of 2003, although a portion of the facility is used to support $114 million in letters of credit.
Promissory notes totaling $59.7 million were issued in June 2004 as part of the consideration for the J&L asset acquisition. These notes include a non-interest bearing $7.5 million promissory note payable on June 1, 2005, and a $52.2 million promissory note, secured by the J&L property, plant and equipment acquired, which is subject to adjustment on the terms set forth in the J&L asset purchase agreement, payable to the seller in installments in 2007 through 2011, which bears interest at a London Interbank Offered Rate plus a 1% margin, with a maximum interest rate of 6%.
On July 28, 2004, the Company completed a public offering of 13.8 million shares of common stock at $17.50 per share, and received $229.7 million in net proceeds after underwriting costs and expenses. The 13.8 million shares were re-issued from treasury stock. Per share amounts for 2004 reflect the effect of the public offering on a weighted average basis for the periods presented.
The following table sets forth the computation of basic and diluted net income (loss) per common share (in millions, except share and per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Numerator:
Net income (loss) per common share before
cumulative effect of change in accounting principle $ 8.6 $(28.8) $(15.2) $(80.6)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (1.3)
------ ------ ------ ------
Numerator for basic and diluted net income (loss)
per common share - Net income (loss) $ 8.6 $(28.8) $(15.2) $(81.9)
====== ====== ====== ======
Denominator:
Denominator for basic earnings per share -
weighted average shares 89.9 81.1 83.7 80.9
Effect of dilutive securities:
Option equivalents 1.8 -- -- --
Contingently issuable shares 2.4 -- -- --
------ ------ ------ ------
Denominator for diluted net income (loss) per
common share - adjusted weighted average
shares and assumed conversions 94.1 81.1 83.7 80.9
====== ====== ====== ======
Basic net income (loss) per common share before
cumulative effect of change in accounting principle $ 0.10 $(0.36) $(0.18) $(0.99)
Cumulative effect of change in
accounting principle, net of tax -- -- -- (0.02)
------ ------ ------ ------
Basic net income (loss) per common share $ 0.10 $(0.36) $(0.18) $(1.01)
====== ====== ====== ======
Diluted net income (loss) per common share
before cumulative effect of change in
accounting principle $ 0.09 $(0.36) $(0.18) $(0.99)
Cumulative effect of change in accounting
principle, net of tax -- -- -- (0.02)
------ ------ ------ ------
Diluted net income (loss) per common share $ 0.09 $(0.36) $(0.18) $(1.01)
====== ====== ====== ======
For the nine months ended September 30, 2004 and both of the comparable 2003 periods, the effects of stock options were antidilutive and thus not included in the calculation of diluted earnings per share.
The components of comprehensive income (loss), net of tax, were as follows (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2004 2003 2004 2003
----- ------ ------ ------
(unaudited) (unaudited)
Net income (loss) $ 8.6 $(28.8) $(15.2) $(81.9)
----- ------ ------ ------
Foreign currency translation
gain (loss) 8.9 (3.3) 14.0 4.3
Unrealized losses on energy,
raw materials and currency
hedges, net of tax (3.4) (2.7) (6.9) (4.8)
----- ------ ------ ------
5.5 (6.0) 7.1 (0.5)
----- ------ ------ ------
Comprehensive income (loss) $14.1 $(34.8) $ (8.1) $(82.4)
===== ====== ====== ======
|
NOTE 8. INCOME TAXES
The three months and nine months ended September 2004 results do not include an income tax provision or benefit due to the uncertainty regarding full utilization of the Company's net deferred tax assets as a result of cumulative losses recorded in the 2001 through 2003 period. The Company is required to maintain a valuation allowance, as recorded in accordance with SFAS No. 109, "Accounting for Income Taxes", until a realization event occurs to support reversal of all, or a portion of, the allowance. The Company recorded a tax benefit on the loss before income taxes and the cumulative effect of a change in accounting principle of $19.5 million and $48.5 million in the 2003 third quarter and first nine months 2003, respectively. The effective tax rate was a benefit of 40.4% and 37.6% for the 2003 third quarter and first nine months 2003, respectively.
NOTE 9. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
The Company has defined benefit pension plans and defined contribution plans covering substantially all employees. Benefits under the defined benefit pension plans are generally based on years of service and/or final average pay. The Company funds the U.S. pension plans in accordance with the Employee Retirement Income Security Act of 1974, as amended, and the Internal Revenue Code. In the 2004 third quarter, the Company voluntarily contributed $50 million to the U.S. pension plan to improve the plan's funded position.
The Company also sponsors several postretirement plans covering certain salaried and hourly employees. The plans provide health care and life insurance benefits for eligible retirees. In certain plans, Company contributions towards premiums are capped based on the cost as of a certain date, thereby creating a defined contribution. For the non-collectively bargained plans, the Company maintains the right to amend or terminate the plans at its discretion.
In the 2004 second quarter in conjunction with the new labor agreement at the Company's Allegheny Ludlum operation, a $25.4 million charge for pension termination benefits was recognized for the TAPs. The TAP incentive will be paid from the Company's U.S. defined benefit pension fund over the next two and a half years to 650 employees. The new labor contract also includes caps on the Company's retiree medical benefit costs.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act was enacted into law. The Act provides for a Federal subsidy, with tax-free payments commencing in 2006, to sponsors of retiree health care benefits plans that provide a benefit that is at least actuarially equivalent to the benefit established by the law. Based upon estimates from the Company's actuaries, and including the changes to retiree medical benefits described above, it is expected that the effect of the Act will result in a reduction in the Accumulated Other Postretirement Benefits Obligation ("APBO") of $46 million. This reduction in the APBO will be recognized over multiple years as a reduction to postretirement benefit expense.
The changes to retiree medical benefits in the 2004 second quarter and the effects of the Act are expected to reduce the Company's APBO by approximately $331 million.
For the three months and nine months ended September 30, 2004 and 2003, the components of pension expense for the Company's defined benefit plans and components of postretirement benefit expense included the following (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Pension Benefits:
Service cost - benefits earned during the year $ 6.5 $ 7.1 $ 21.0 $ 21.4
Interest cost on benefits earned in prior years 31.4 32.1 94.4 95.2
Expected return on plan assets (36.9) (35.2) (110.6) (104.8)
Amortization of prior service cost 6.3 6.7 18.9 20.1
Amortization of net actuarial loss 10.6 12.7 32.0 38.2
------ ------ ------ ------
17.9 23.4 55.7 70.1
Termination benefits -- -- 25.4 --
Plan design change -- -- 0.5 --
------ ------ ------ ------
Total pension expense $ 17.9 $ 23.4 $ 81.6 $ 70.1
====== ====== ====== ======
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Other Postretirement Benefits:
Service cost - benefits earned during the year $ 0.7 $ 1.4 $ 4.4 $ 4.8
Interest cost on benefits earned in prior years 9.2 11.0 36.3 33.8
Expected return on plan assets (2.2) (2.3) (6.6) (7.0)
Amortization of prior service cost (6.5) (1.2) (11.0) (3.6)
Amortization of net actuarial loss 5.7 1.2 16.0 3.6
------ ------ ------ ------
6.9 10.1 39.1 31.6
Curtailment and settlement gain -- -- (72.0) --
------ ------ ------ ------
Total postretirement benefit (income) expense $ 6.9 $ 10.1 $(32.9) $ 31.6
====== ====== ====== ======
Total retirement benefit expense $ 24.8 $ 33.5 $ 48.7 $101.7
====== ====== ====== ======
In the 2004 second quarter, the Company recorded $5.7 million in restructuring charges in the Flat-Rolled Products segment related to the new labor agreement and the J&L asset acquisition. Charges included labor agreement costs of $4.6 million, severance costs of $0.6 million related to approximately 30 salaried employees, and $0.5 million for asset impairment charges for redundant equipment following the J&L asset acquisition. Approximately $1 million of the restructuring charges represent future cash payments that are expected to be paid within one year.
The Company recognized restructuring costs of $1.2 million during the third quarter of 2003, related to workforce reductions. These cost reduction actions affected approximately 80 employees, primarily salaried and predominantly in the Flat-Rolled and Engineered Products segments.
Reserves for restructuring charges recorded in 2003 and prior years involving future payments were approximately $6 million at September 30, 2004 and $9 million at December 31, 2003. The reduction in reserves resulted from cash payments to meet severance and lease payment obligations.
Following is certain financial information with respect to the Company's business segments for the periods indicated (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- -----------------------
2004 2003 2004 2003
-------- -------- -------- --------
(unaudited) (unaudited)
Total sales:
Flat-Rolled Products $ 469.1 $ 265.0 $1,182.3 $ 788.9
High Performance Metals 204.7 174.9 606.1 525.6
Engineered Products 76.5 63.2 229.5 193.5
-------- -------- -------- --------
750.3 503.1 2,017.9 1,508.0
Intersegment sales:
Flat-Rolled Products 3.6 6.1 8.0 14.0
High Performance Metals 12.2 12.6 42.4 35.5
Engineered Products 3.9 1.8 12.6 5.5
-------- -------- -------- --------
19.7 20.5 63.0 55.0
Sales to external customers:
Flat-Rolled Products 465.5 258.9 1,174.3 774.9
High Performance Metals 192.5 162.3 563.7 490.1
Engineered Products 72.6 61.4 216.9 188.0
-------- -------- -------- --------
$ 730.6 $ 482.6 $1,954.9 $1,453.0
======== ======== ======== ========
Operating profit (loss):
Flat-Rolled Products $ 26.7 $ (4.9) $ 35.7 $ (12.4)
High Performance Metals 21.4 9.5 41.8 29.4
Engineered Products 5.2 1.2 14.5 6.2
-------- -------- -------- --------
Total operating profit 53.3 5.8 92.0 23.2
Corporate expenses (7.4) (4.1) (21.9) (14.2)
Interest expense, net (9.3) (4.1) (25.3) (19.9)
Curtailment gain, net of
restructuring costs - - 40.4 -
Management transition and
restructuring costs - (8.6) - (8.6)
Other expenses, net
of gains on asset sales (3.2) (3.8) (5.6) (7.9)
Retirement benefit expense (24.8) (33.5) (94.8) (101.7)
-------- -------- -------- --------
Income (loss) before income tax benefit
and cumulative effect of change in
accounting principle $ 8.6 $ (48.3) $ (15.2) $ (129.1)
======== ======== ======== ========
|
The curtailment gain for the first nine months of 2004, net of restructuring costs, includes the $71.5 million curtailment and settlement gain, the $25.4 million pension termination benefit charge, and the $5.7 million restructuring charges.
During the 2003 third quarter, the Company recognized management transition and restructuring costs of $8.6 million. In connection with the termination of the Stock Acquisition and Retention Program ("SARP"), in September 2003 the Company terminated the remaining loans outstanding under the SARP, received approximately $0.5 million in cash and recorded $5.6 million of expenses, which is included in selling and administrative expenses on the statement of operations. CEO transition costs of $1.8 million included accelerated vesting of long-term compensation, and accrued obligations pursuant to an employment contract which is included in selling and administrative expenses in the statement of operations. The Company also recognized restructuring costs of $1.2 million related to workforce reductions, primarily salaried and predominantly in the Flat-Rolled and Engineered Products segments.
Interest expense for the 2003 periods is presented net of $4.0 million of interest income related to a Federal income tax refund associated with prior years.
Segment retirement benefit expense represents pension expense and other postretirement benefit expenses, excluding the curtailment and settlement gain, and pension termination benefits. Operating profit with respect to the Company's business segments excludes any retirement benefit expense.
NOTE 12. FINANCIAL INFORMATION FOR SUBSIDIARY AND GUARANTOR PARENT
The payment obligations under the $150 million 6.95% debentures due 2025 issued by Allegheny Ludlum Corporation (the "Subsidiary") are fully and unconditionally guaranteed by Allegheny Technologies Incorporated (the "Guarantor Parent"). In accordance with positions established by the Securities and Exchange Commission, the financial information in this Note 12 sets forth separately financial information with respect to the Subsidiary, the non-guarantor subsidiaries and the Guarantor Parent. The principal elimination entries eliminate investments in subsidiaries and certain intercompany balances and transactions. Investments in subsidiaries, which are eliminated in consolidation, are included in other assets on the balance sheets. Subsidiary results in 2004 include the effects of the J&L asset acquisition, including indebtedness incurred in conjunction with the acquisition.
In 1996, the defined benefit pension plans of the Subsidiary were merged with the defined benefit pension plans of Teledyne, Inc. and Allegheny Technologies became the plan sponsor. As a result, the balance sheets presented for the Subsidiary and the non-guarantor subsidiaries do not include the Allegheny Technologies deferred pension asset, pension liabilities, or the related deferred taxes. The pension assets, liabilities, and the related deferred taxes, and pension expense are recognized by the Guarantor Parent. Management and royalty fees charged to the Subsidiary and to the non-guarantor subsidiaries by the Guarantor Parent have been excluded solely for purposes of this presentation.
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent Balance Sheets
September 30, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
----------------------------------- --------- ---------- ------------- ------------ ------------
Assets:
Cash and cash equivalents $ 0.1 $ 147.0 $ 115.5 $ - $ 262.6
Accounts receivable, net 0.2 178.2 186.8 - 365.2
Inventories, net - 222.1 238.7 - 460.8
Prepaid expenses and other
current assets 0.1 8.2 22.7 - 31.0
-------- -------- -------- --------- --------
Total current assets 0.4 555.5 563.7 - 1,119.6
Property, plant and
equipment, net - 342.0 385.2 - 727.2
Cost in excess of net
assets acquired - 112.1 92.5 - 204.6
Deferred pension asset 144.0 - - - 144.0
Deferred income taxes 34.3 - - - 34.3
Investments in subsidiaries and
other assets 1,388.6 410.5 642.0 (2,381.9) 59.2
-------- -------- -------- --------- --------
Total assets $1,567.3 $1,420.1 $1,683.4 $(2,381.9) $2,288.9
======== ======== ======== ========= ========
Liabilities and
stockholders' equity:
Accounts payable $ 2.4 $ 153.3 $ 103.4 $ - $ 259.1
Accrued liabilities 598.9 85.6 318.5 (784.3) 218.7
Short-term debt and current portion
of long-term debt - 7.5 26.4 - 33.9
-------- -------- -------- -------- --------
Total current liabilities 601.3 246.4 448.3 (784.3) 511.7
Long-term debt 308.6 404.3 44.4 (200.0) 557.3
Accrued postretirement
benefits - 267.2 206.6 - 473.8
Pension liabilities 248.2 - - - 248.2
Other long-term liabilities 18.9 30.9 57.8 - 107.6
-------- -------- -------- -------- --------
Total liabilities 1,177.0 948.8 757.1 (984.3) 1,898.6
-------- -------- -------- -------- --------
Total stockholders' equity 390.3 471.3 926.3 (1,397.6) 390.3
-------- -------- -------- -------- --------
Total liabilities and
stockholders' equity $1,567.3 $1,420.1 $1,683.4 $(2,381.9) $2,288.9
======== ======== ======== ========= ========
|
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent Statements of Operations
For the nine months ended September 30, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------------------------------- --------- ---------- ------------- ------------ ------------
Sales $ - $1,077.5 $ 877.4 $ - $1,954.9
Cost of sales 72.2 1,033.1 709.7 - 1,815.0
Selling and administrative
Expenses 70.2 17.5 80.6 - 168.3
Curtailment (gain), net of
restructuring costs - (40.4) - - (40.4)
Interest expense, net (18.0) (7.0) (0.3) - (25.3)
Other income (expense)
including equity in income of
unconsolidated subsidiaries 145.2 1.4 0.9 (149.4) (1.9)
-------- -------- -------- -------- --------
Income (loss) before income
tax provision (benefit) (15.2) 61.7 87.7 (149.4) (15.2)
Income tax provision (benefit) - - - - -
-------- -------- -------- -------- --------
Net income (loss) $ (15.2) $ 61.7 $ 87.7 $ (149.4) $ (15.2)
======== ======== ======== ======== ========
|
Condensed Statements of Cash Flows
For the nine months ended September 30, 2004 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------------------------------- --------- ---------- ------------- ------------ ------------
Cash flows provided by
(used in) operating activities $ (8.2) $ 27.5 $ (3.9) $ (6.9) $ 8.5
Cash flows provided by
(used in) investing activities (221.1) (22.3) (124.6) 321.5 (46.5)
Cash flows provided by
(used in) financing activities 229.1 99.5 207.0 (314.6) 221.0
------ ------ ------ ------ ------
Increase (decrease) in
cash and cash equivalents $ (0.2) $104.7 $ 78.5 $ - $183.0
====== ====== ====== ====== ======
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent Balance Sheets
December 31, 2003 (audited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
----------------------------------- --------- ---------- ------------- ------------ ------------
Assets:
Cash and cash equivalents $ 0.3 $ 42.3 $ 37.0 $ - $ 79.6
Accounts receivable, net 0.1 89.4 159.3 - 248.8
Inventories, net - 147.3 212.4 - 359.7
Income tax refunds 7.2 - - - 7.2
Prepaid expenses, and other
current assets - 11.5 36.5 - 48.0
-------- -------- -------- --------- --------
Total current assets 7.6 290.5 445.2 - 743.3
Property, plant and
equipment, net - 326.3 384.8 - 711.1
Cost in excess of net
assets acquired - 112.1 86.3 - 198.4
Deferred pension asset 144.0 - - - 144.0
Deferred income taxes 34.3 - - - 34.3
Investment in subsidiaries
and other assets 994.4 546.0 326.9 (1,813.5) 53.8
-------- -------- -------- --------- --------
Total assets $1,180.3 $1,274.9 $1,243.2 $(1,813.5) $1,884.9
======== ======== ======== ========= ========
Liabilities and
stockholders' equity:
Accounts payable $ 2.5 $ 92.4 $ 77.4 $ - $ 172.3
Accrued liabilities 465.6 70.2 181.2 (522.4) 194.6
Short-term debt and current portion
of long-term debt - 9.6 18.2 - 27.8
-------- -------- -------- --------- --------
Total current liabilities 468.1 172.2 276.8 (522.4) 394.7
Long-term debt 309.4 349.9 45.1 (200.1) 504.3
Accrued postretirement
benefits - 316.8 190.4 - 507.2
Pension liabilities 220.6 - - - 220.6
Other long-term liabilities 7.5 22.8 53.1 - 83.4
-------- -------- -------- --------- --------
Total liabilities 1,005.6 861.7 565.4 (722.5) 1,710.2
-------- -------- -------- --------- --------
Total stockholders' equity 174.7 413.2 677.8 (1,091.0) 174.7
-------- -------- -------- --------- --------
Total liabilities and
stockholders' equity $1,180.3 $1,274.9 $1,243.2 $(1,813.5) $1,884.9
======== ======== ======== ========= ========
|
Allegheny Technologies Incorporated
Financial Information for Subsidiary and Guarantor Parent Statements of Operations
For the nine months ended September, 30 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminationss Consolidated
------------------------------------ --------- ---------- ------------- ------------- ------------
Sales $ - $ 715.4 $ 737.6 $ - $1,453.0
Cost of sales 69.7 718.6 611.1 - 1,399.4
Selling and administrative
expenses 60.4 17.0 84.0 - 161.4
Restructuring costs - 0.5 0.7 - 1.2
Interest income (expense), net (15.3) (7.9) 3.3 - (19.9)
Other income (expense)
including equity in income of
unconsolidated subsidiaries 18.9 (2.9) 9.1 (25.3) (0.2)
-------- -------- -------- -------- --------
Income (loss) before income
tax provision (benefit) and
cumulative effect of change
in accounting principle (126.5) (31.5) 54.2 (25.3) (129.1)
Income tax provision (benefit) (45.9) (10.5) 17.0 (9.1) (48.5)
-------- -------- -------- -------- --------
Net income (loss) before cumulative
effect of change in accounting
principle (80.6) (21.0) 37.2 (16.2) (80.6)
Cumulative effect of change in
accounting principle, net of tax (1.3) - - - (1.3)
-------- -------- -------- -------- --------
Net income (loss) $ (81.9) $ (21.0) $ 37.2 $ (16.2) $ (81.9)
======== ======== ======== ======== ========
|
Condensed Statements of Cash Flows
For the nine months ended September 30, 2003 (unaudited)
Guarantor Non-guarantor
(In millions) Parent Subsidiary Subsidiaries Eliminations Consolidated
--------------------------------- --------- ---------- ------------- ------------ ------------
Cash flows provided by (used in)
operating activities $ 24.5 $117.4 $ 33.2 $(123.0) $ 52.1
Cash flows provided by (used in)
investing activities - (19.9) (28.6) 1.5 (47.0)
Cash flows provided by (used in)
financing activities (24.6) (92.4) 9.5 121.5 14.0
------ ------ ------ ------- ------
Increase (decrease) in cash and
cash equivalents $ (0.1) $ 5.1 $ 14.1 $ -- $ 19.1
====== ====== ====== ======= ======
|
NOTE 13. COMMITMENTS AND CONTINGENCIES
The Company is subject to various domestic and international environmental laws and regulations that govern the discharge of pollutants into the air or water and disposal of hazardous substances, which may require that it investigate and remediate the effects of the release or disposal of materials at sites associated with past and present operations, including sites at which the Company has been identified as a potentially responsible party ("PRP") under the Federal Superfund laws and comparable state laws. The Company could incur substantial cleanup costs, fines, and civil or criminal sanctions, third party property damage or personal injury claims as a result of violations or liabilities under these laws or noncompliance with environmental permits required at its facilities. The Company is currently involved in the investigation and remediation of a number of the Company's current and former sites as well as third party sites under these laws.
Environmental liabilities are recorded when the Company's liability is probable and the costs are reasonably estimable. In many cases, however, investigations are not at a stage where the Company has been able to determine whether it is liable or, if liability is probable, to reasonably estimate the loss or range of loss, or certain components thereof. Estimates of the Company's liability remain subject to additional uncertainties regarding the nature and extent of site contamination, the range of remediation alternatives available, evolving remediation standards, imprecise engineering evaluations and estimates of appropriate cleanup technology, methodology and cost, the extent of corrective actions that may be required, and the number, participation, and financial condition of other PRPs, as well as the extent of their responsibility for the remediation. Accordingly, the Company periodically reviews accruals as investigation and remediation of these sites proceed. As the Company receives new information, the Company expects that it will adjust its accruals to reflect the new information. Future adjustments could have a material adverse effect on the Company's results of operations in a given period, but the Company cannot reliably predict the amounts of such future adjustments.
Based on currently available information, the Company does not believe that there is a reasonable possibility that a loss exceeding the amount already accrued for any of the sites with which the Company is currently associated (either individually or in the aggregate) will be an amount that would be material to a decision to buy or sell the Company's securities.
Additional future developments, administrative actions or liabilities relating to environmental matters however could have a material adverse effect on the Company's financial condition or results of operations.
At September 30, 2004, the Company's reserves for environmental remediation obligations totaled approximately $34.3 million, of which approximately $13.2 million were included in other current liabilities. The reserve includes estimated probable future costs of $10.0 million for federal Superfund and comparable state-managed sites; $9.2 million for formerly owned or operated sites for which the Company has remediation or indemnification obligations; $6.0 million for owned or controlled sites at which Company operations have been discontinued; and $9.1 million for sites utilized by the Company in its ongoing operations. The Company continues to evaluate whether it may be able to recover a portion of future costs for environmental liabilities from third parties other than participating potentially responsible parties.
The timing of expenditures depends on a number of factors that vary by site, including the nature and extent of contamination, the number of participating PRPs, the timing of regulatory approvals, the complexity of the investigation and remediation, and the standards for remediation. The Company expects that it will expend present accruals over many years, and will complete remediation of all sites with which it has been identified in up to thirty years.
In June 1995, the U.S. Government commenced an action against Allegheny Ludlum in the United States District Court for the Western District of Pennsylvania alleging multiple violations of the Federal Clean Water Act. The trial of this matter concluded in February 2001. In February 2002, the Court issued a decision imposing a penalty of $8.2 million for incidents at five facilities that occurred over a period of approximately six years which Allegheny Ludlum had reported to the appropriate environmental agencies. The Company appealed the Court decision and on April 28, 2004, the Third Circuit vacated and remanded the case to the District Court for further consideration. At September 30, 2004, the Company had adequate reserves for this matter.
As described in the Company's Annual Report on Form 10-K for the year ended December 31, 2003, TDY Industries, Inc. ("TDY") and the San Diego Unified Port District ("Port District") have been involved in litigation in State Court in San Diego, California concerning a lease of property located in San Diego, California ("San Diego facility"). Following trial of this state court matter, the jury rendered a verdict in favor of the Port and judgment was entered in the amount of $22.7 million, which includes the jury award, attorneys' fees and related costs and prejudgment interest. The Company appealed the verdict to the California State Court of Appeals in July 2004. At September 30, 2004, the Company had adequate reserves for this matter.
In June 2003, the Port District also commenced a separate action in the United States District Court in San Diego against the Company ("Federal Court Complaint") alleging Federal, state and common law claims related to alleged environmental contamination on the property. The Federal Court Complaint seeks an unspecified amount of damages and a declaratory judgment as to TDY's liability for contamination on the property. In the second quarter 2004, the Federal Court granted in part the Company's Motion to Dismiss portions of the Federal Court Complaint relating to alleged violations of state law. The Port filed an amended Complaint, which the Company has answered, essentially denying all claims and asserting a counterclaim and seeking injunctive relief.
In another matter related to the San Diego facility, the Port District requested that the California Department of Toxic Substances Control ("DTSC") evaluate whether the property is regulated as a hazardous waste transportation, storage, or disposal facility under the Resource Conservation and Recovery Act ("RCRA") and similar state laws. In response to the Port District's request, on October 30, 2003, DTSC informed the Company that the closure of the four solid waste management units ("unit") at the San Diego facility is subject to DTSC oversight and that since facility-wide corrective action is proceeding under the oversight of the San Diego Regional Water Quality Control Board ("Regional Board"), DTSC's involvement would be limited to, to the extent applicable, to unit closure and post-closure. The Port District is addressing the DTSC's issues in connection with its investigation of the site.
The Company conducted an environmental assessment of portions of the San Diego facility at the request of the Regional Board. A report of the assessment was submitted to the Regional Board and at this stage of the assessment, the Company cannot predict if any remediation will be necessary beyond that contemplated by the Port District. In October 2004, the Regional Board issued the Company an order directing that it clean up the San Diego facility and adjacent lagoon, which the Company has appealed.
TDY and another wholly-owned subsidiary of the Company, among others, have been identified by the U.S. Environmental Protection Agency ("EPA") as PRPs at the Li Tungsten Superfund Site in Glen Cove, New York. The Company believes that most of the contamination at the Site resulted from work done while the U.S. Government either owned or controlled operations at the Site, or from processes done for various agencies of the United States, and that the United States is liable for a substantial portion of the remediation costs at the Site. In November 2000, TDY filed a cost recovery and contribution action against the U.S. Government. The U.S. Government and two other PRPs reached a proposed settlement with EPA in 2003 ("the Settlement"), the terms of which could have precluded TDY's complaint from proceeding against the U.S. Government. The Company submitted comments on the Settlement on the grounds that it was not supported by the facts, and was unfair and unreasonable, and was granted intervention by the Court. In July 2004, TDY, the U.S. Government and EPA entered an Interim Agreement. Under the Interim Agreement, the U.S. Government will fund $20.9 million and TDY will fund $1 million of the remediation costs at the Site, EPA will undertake the remediation, the Settlement will be withdrawn and TDY and the U.S. Government will mediate the cost recovery and contribution action. In addition, EPA agreed that TDY will not be required to perform additional work at the Site and will not be subject to enforcement action, if any, prior to February 18, 2005 unless the mediation ends earlier than that date. In October, 2004, EPA released a proposed plan to address additional areas related to the site, and is seeking public comment on the proposed plan. TDY also expects to seek contribution from other PRPs at the Site. Based on information presently available, the Company believes its reserves on this matter are adequate. An adverse resolution of this matter could have a material adverse effect on the Company's results of operations and financial condition.
A number of other lawsuits, claims and proceedings have been or may be asserted against the Company relating to the conduct of its currently and formerly owned businesses, including those pertaining to product liability, patent infringement, commercial, employment, employee benefits, environmental and health and safety, and stockholder matters. Certain of such lawsuits, claims and proceedings are described in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. While the outcome of litigation cannot be predicted with certainty, and some of these lawsuits, claims or proceedings may be determined adversely to the Company, management does not believe that the disposition of any such pending matters is likely to have a material adverse effect on the Company's financial condition or liquidity, although the resolution in any reporting period of one or more of these matters could have a material adverse effect on the Company's results of operations for that period.
OVERVIEW
We believe Allegheny Technologies Incorporated is one of the largest and most diversified producers of specialty materials in the world. Unless the context requires otherwise, "we", "our" and "us" refer to Allegheny Technologies Incorporated and its subsidiaries.
We operate in the following three business segments, which accounted for the following percentages of total external sales for the first nine months of 2004 and 2003:
2004 2003
---- ----
Flat-Rolled Products 60% 53%
High Performance Metals 29% 34%
Engineered Products 11% 13%
On June 1, 2004, our Allegheny Ludlum operation, the largest business in our Flat-Rolled Products segment, completed the acquisition of substantially all of the assets of J&L Specialty Steel, LLC, ("J&L") a producer of flat-rolled stainless steel products with operations in Midland, Pennsylvania and Louisville, Ohio, for $67.2 million in total consideration, including the assumption of certain current liabilities. The purchase price included $7.5 million cash paid at closing, the issuance to the seller of a non-interest bearing $7.5 million promissory note payable on June 1, 2005, and the issuance to the seller of a promissory note in the principal amount of $52.2 million, which is subject to final adjustment, and secured by the J&L property, plant and equipment acquired, payable in installments in 2007 through 2011, which bears interest at a London Interbank Offered Rate plus a 1% margin, with a maximum interest rate of 6%.
In connection with the J&L asset acquisition, we reached a new labor agreement with the United Steelworkers of America ("USWA") covering USWA-represented employees at our Allegheny Ludlum subsidiary and at the former J&L facilities. The new agreement provides for a workforce restructuring through which we expect to achieve productivity improvements. Through a reduction in the number of job classifications and the implementation of flexible work rules, employees are being given broader responsibilities and the opportunity to become more involved in the business. The number of production and maintenance employees at the pre-acquisition Allegheny Ludlum facilities is being reduced by 650 employees through an early retirement program over the next two and a half years pursuant to which the employees are being offered transition incentives. We expect over 40% of these retirements to be effective by the end of 2004, over 70% of these retirements to be effective by the end of 2005, and 100% of these retirements to be effective by June 2006.
With the addition of the J&L assets, we estimate that our Allegheny Ludlum operation will be capable of annual shipments in excess of 700,000 tons of flat-rolled specialty metals with approximately 2,650 production and maintenance employees. By comparison, Allegheny Ludlum shipped 478,000 tons of these metals in 2003 with over 3,000 production and maintenance employees.
The acquisition of the J&L assets and the negotiation of the new labor agreement with the USWA are expected to improve the performance of our Allegheny Ludlum business. We expect the new labor agreement, combined with the integration of the former J&L operations, to generate annual cost structure improvements relative to the combined performance of the former J&L and pre-acquisition Allegheny Ludlum operations of approximately $200 million when workforce restructuring and synergies are fully implemented in the second half of 2006. We anticipate these cost structure improvements to come from reduced labor costs, operating synergies, improved product mix, and reduced fixed costs. In the aggregate, we expect these initiatives to result in a competitive cost structure for our flat-rolled stainless steel business.
On July 28, 2004, we completed the sale of 13.8 million shares of our common stock in a public offering, including 1.8 million shares to cover overallotments, and received $229.7 million in net proceeds. The 13.8 million shares were reissued from treasury stock. We intend to use a portion of the net proceeds from this offering to enhance our abilities to make growth-oriented investments, including capital investments and acquisitions that we believe will offer attractive returns. We also intend to use a portion of the net proceeds to strengthen our balance sheet by reducing our outstanding liabilities, which may include making voluntary contributions to our U.S. defined benefit trust or the repayment or repurchase of our long-term debt securities. We may also use a portion of the net proceeds for other general corporate purposes. In September 2004, we executed a portion of this strategy by making a voluntary contribution of $50 million to our U.S. defined benefit plan to improve the funded position of our U.S. defined benefit pension plan. Based on current actuarial studies, we do not expect to be required to make cash contributions to this defined benefit pension plan during the next several years. However, we may elect, depending upon the investment performance of the pension plan assets and other factors, to make additional cash contributions to this pension plan in the future.
RESULTS OF OPERATIONS
Sales for the third quarter 2004 were $730.6 million, up 51% compared to the third quarter 2003. Sales increased 80% in the Flat-Rolled Products segment, 19% in the High Performance Metals segment, and 18% in the Engineered Products segment. The increase in sales resulted primarily from higher base-selling prices and raw material surcharges for most of our products compared to the prior year period, and higher shipment volume, predominantly in the Flat-Rolled Products segment.
Operating profit for the third quarter 2004 increased to $53.3 million, compared to $5.8 million for the same period of 2003, as a result of improved performance across all of our business segments. The Flat-Rolled Products segment led this improvement with an operating profit of $26.7 million. Results for the third quarter 2004 included a LIFO (last-in, first-out) inventory valuation reserve charge of $8.5 million, due primarily to a third quarter 2004 increase in raw material costs, especially for nickel, chromium, molybdenum, iron scrap, and titanium scrap. For the same 2003 period, the LIFO inventory valuation reserve charge was $10.5 million.
Net income for the third quarter 2004 was $8.6 million, or $0.09 per share. Retirement benefit expense was $24.8 million in the third quarter of 2004 compared to $33.5 million in the third quarter of 2003, down primarily as a result of actions taken in the second quarter 2004 to control certain retiree medical costs. 2004 results do not include an income tax provision or benefit as a result of cumulative losses recorded in the 2001 through 2003 period.
In the third quarter 2003, we reported a net loss of $28.8 million, or $0.36 per share, on sales of $482.6 million. Third quarter 2003 results included an income tax benefit of $19.5 million.
For the first nine months of 2004, sales increased 34.5% to $1,954.9 million, and operating profit increased to $92.0 million compared to $23.2 million for the same 2003 period, as a result of improved performance across all of the business segments. Business conditions in most of our end markets reflected increased demand and improved pricing for many of our products during the first nine months of 2004, compared to the same period of 2003. These improved market conditions were partially offset by LIFO inventory reserve charges due to higher raw material costs, which resulted in a net loss of $15.2 million, or $0.18 per share, for the first nine months of 2004 compared to a net loss before cumulative effect of a change in accounting principle of $80.6 million, or $0.99 per share, for the first nine months of 2003. As discussed above, 2004 results do not include an income tax provision or benefit. For the first nine months of 2003, results included an income tax benefit of $48.5 million, or $0.60 per share.
The results for the nine months ended September 30, 2004, also included a LIFO inventory valuation reserve charge of $82.7 million, primarily due to the effects of rapidly rising raw material costs. The first nine months of 2003 results included a LIFO inventory valuation reserve charge of $22.8 million. Retirement benefit expense was $94.8 million for the first nine months of 2004, compared to $101.7 million in the comparable year ago period. This retirement benefit expense comparison excludes the previously discussed curtailment and settlement gain and the pension termination benefits recorded in the second quarter of 2004. Cost reductions, before the effects of inflation, totaled $103.2 million through the nine months ended September 30, 2004. Our initial cost reduction goal for 2004 was $104 million.
On January 1, 2003, we adopted Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). The adoption of SFAS 143 resulted in an after-tax charge of $1.3 million or $0.02 per diluted share. This charge is reported as a cumulative effect of a change in accounting principle.
Sales and operating profit (loss) for our three business segments are discussed below.
FLAT-ROLLED PRODUCTS SEGMENT
Third quarter 2004 sales increased 80% to $465.5 million, compared to the third quarter 2003, primarily due to improved demand from capital goods markets, the impact of higher raw material surcharges and base-selling price increases, and higher shipment volume resulting from the recently acquired assets in Midland, Pennsylvania and Louisville, Ohio. Total finished tons shipped increased by over 50,000 tons, or 42%, in the third quarter 2004 compared to the third quarter of 2003. Shipments of commodity products increased 49% and shipments of high-value products increased 24% from the comparable 2003 period. Average transaction prices, which include surcharges, were 26% higher. The average base-selling price, which excludes surcharges, for stainless steel cold-rolled sheet increased 25% compared to the third quarter 2003.
Demand continued to be strong from the residential construction and remodeling markets, and capital goods markets such as chemical processing, oil and gas, and power generation. Demand remained good from the automotive and appliance markets. As a result of these improved business conditions, operating profit increased to $26.7 million for the third quarter 2004, compared to an operating loss of $4.9 million in the comparable 2003 period. The benefits of increased shipment volumes, additional surcharges, higher base-selling prices, and cost reduction initiatives were partially offset by higher raw material costs, which resulted in a LIFO inventory valuation reserve charge of $9.2 million in the third quarter 2004, and approximately $2.0 million of costs associated with flooding at our facilities in Western Pennsylvania resulting from the remnants of Hurricane Ivan. The 2003 third quarter included a LIFO inventory valuation reserve charge of $7.5 million. Energy costs increased by $0.2 million compared to 2003, net of approximately $0.4 million in gains from natural gas derivatives, as a result of higher natural gas and electricity prices. Results for the 2004 third quarter benefited from $19.5 million in gross cost reductions, before the effects of inflation.
The J&L asset acquisition was completed June 1, 2004. Since the acquisition was accounted for as a purchase, third quarter 2004 results did not include any operating profit on sales of the purchased J&L inventory on hand at the acquisition date.
Three Months Ended
September 30,
---------------------- %
2004 2003 Change
-------- -------- ------
Volume (finished tons):
Commodity 129,184 86,519 49
High Value 40,997 33,045 24
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Total 170,181 119,564 42
Average prices (per finished ton):
Commodity $ 2,198 $ 1,570 40
High Value $ 4,418 $ 3,722 19
Combined Average $ 2,732 $ 2,165 26
For the nine months ended September 30, 2004, Flat-Rolled Products sales increased 51.5%, to $1,174.3 million, and operating profit was $35.7 million, compared to an operating loss of $12.4 million for the prior year-to-date period. Segment results for the 2004 year-to-date period included a LIFO inventory reserve charge of $62.0 million due to significantly higher raw material costs, compared to a prior year LIFO inventory valuation reserve charge of $20.5 million. Energy costs, net of hedging activities, were $6.1 million higher in the first nine months of 2004 compared to the comparable 2003 period. Increased shipment volume, raw material surcharges, base price increases, and year-to-date 2004 cost reductions of $53.8 million more than offset the LIFO inventory valuation reserve charges and energy cost increases.
Comparative information on the segment's products for the nine months ended September 30, 2004 and 2003 is provided in the following table:
Nine Months Ended
September 30,
---------------------- %
2004 2003 Change
-------- -------- ------
Volume (finished tons):
Commodity 309,038 257,348 20
High Value 119,888 101,734 18
-------- --------
Total 428,926 359,082 19
Average prices (per finished ton):
Commodity $ 2,141 $ 1,561 37
High Value $ 4,268 $ 3,660 17
Combined Average $ 2,736 $ 2,156 27
HIGH PERFORMANCE METALS SEGMENT
Sales increased 19% to $192.5 million in the third quarter 2004, compared to the third quarter 2003. The commercial aerospace market showed early signs of a cyclical recovery as demand improved from the commercial OEM market. Demand for high performance metals remained strong for spare parts from the commercial and military aerospace markets. Our exotic alloys business continued to benefit from sustained high demand from government and medical markets, and from corrosion markets, particularly in Asia. Operating profit in the quarter increased to $21.4 million, or 11.1% of sales, compared to $9.5 million, or 5.9% of sales, in the year-ago period as a result of improved sales and pricing and cost reduction initiatives. Changes from the second quarter 2004 in raw material costs, inventory levels and mix resulted in a LIFO inventory valuation reserve benefit of $2.1 million, compared to a $3.4 million charge in the third quarter of 2003. Results for the third quarter 2004 benefited from $17.1 million of gross cost reductions, before the effects of inflation.
Certain comparative information on the segment's major products for the three months ended September 30, 2004 and 2003 is provided in the following table. The increases in selling prices were primarily due to product mix and higher raw material indices.
Three Months Ended
September 30,
------------------------ %
2004 2003 Change
--------- ---------
Volume (000's pounds):
Nickel-based and specialty steel alloys 8,227 8,965 (8)
Titanium mill products 5,130 4,813 7
Exotic alloys 912 1,052 (13)
Average prices (per pound):
Nickel-based and specialty steel alloys $ 9.09 $ 6.44 41
Titanium mill products $ 12.53 $ 11.05 13
Exotic alloys $ 46.12 $ 38.16 21
For the nine months ended September 2004, segment sales increased 15.0% to $563.7 million. Operating profit was $41.8 million for the nine months ended September 2004, or 7.4% of sales, compared to $29.4 million, or 6.0% of sales for the comparable prior year to date period. The effect of the LIFO inventory valuation reserve charge was $12.6 million in 2004, compared to $4.6 million in 2003. Year-to-date 2004 cost reductions of $39.2 million were offset, in part, by higher LIFO inventory valuation reserve charges, and production inefficiencies and start-up costs related to the Richburg, South Carolina rolling mill upgrade, which was commissioned on October 11, 2004.
Comparative information on the segment's products for the nine months ended September 30, 2004 and 2003 is provided in the following table:
Nine Months Ended
September 30,
-------------------------- %
2004 2003 Change
---------- ---------- ------
Volume (000's pounds):
Nickel-based and specialty steel alloys 25,815 27,114 (5)
Titanium mill products 15,809 14,045 13
Exotic alloys 3,179 3,144 1
Average prices (per pound):
Nickel-based and specialty steel alloys $ 8.30 $ 6.54 27
Titanium mill products $ 11.70 $ 11.68 -
Exotic alloys $ 40.86 $ 38.01 7
ENGINEERED PRODUCTS SEGMENT
Sales for the third quarter 2004 increased 18% to $72.6 million. Demand for tungsten products remained strong from the oil and gas, mining, cutting tool and medical markets. Demand remained strong for forged products from the Class 8 truck market and improved from the oil and gas and off-road vehicle markets. Demand for cast products improved from the transportation and wind energy markets. Operating profit in the quarter improved to $5.2 million, or 7.2% of sales, compared to $1.2 million, or 2.0% of sales, in the third quarter 2003. Higher sales volumes, improved pricing, and benefits from cost reductions more than offset higher raw material costs and approximately $0.5 million of costs associated with flooding at our Rome Metals operation in Western Pennsylvania resulting from the remnants of Hurricane Ivan. The rise in raw material costs resulted in a LIFO inventory valuation reserve charge of $1.4 million in the third quarter 2004, compared to a $0.4 million benefit in the third quarter of 2003. Results for the third quarter 2004 benefited from $2.4 million in gross cost reductions, before the effects of inflation.
For the nine months ended September 2004, sales increased 15.4% to $216.9 million, and operating profit was $14.5 million, or 6.7% of sales, compared to $6.2 million, or 3.3% of sales in 2003. Cost of sales in 2004 included an $8.1 million LIFO inventory valuation reserve charge, compared to a LIFO valuation reserve benefit of $2.3 million for the nine months ended September 2003. Higher sales volumes, improved pricing and 2004 gross cost reductions of approximately $7.2 million more than offset rising raw material and other cost increases.
CORPORATE ITEMS
Net interest expense increased to $9.3 million for the third quarter 2004 from $4.1 million for the same period last year, primarily as a result of the recognition in the third quarter 2003 of interest income of $4 million related to a Federal income tax settlement associated with prior years, and interest expense associated with the financing of the June 1, 2004, J&L asset acquisition. For the nine months ended September 2004, net interest expense was $25.3 million compared to $19.9 million in 2003, with the 2004 year-to-date increase due primarily to the aforementioned third quarter items. Our "receive fixed, pay floating" interest rate swap contracts for $150 million related to the $300 million, 8.375%, ten-year Notes due 2011, which effectively converted this portion of the Notes to variable rate debt, decreased year-to-date interest expense by $4.0 million in 2004, and $4.9 million in 2003, compared to the fixed interest expense of the Notes that would otherwise be applicable. These swap contracts were terminated in the third quarter 2004.
Retirement benefit expense declined to $24.8 million in the third quarter 2004, compared to $33.5 million in the third quarter 2003, primarily as a result of actions taken in the second quarter 2004 to control certain retiree medical costs. Pension expense decreased to $17.9 million for the 2004 third quarter from $23.4 million for same period of last year as actual returns on pension assets in 2003 were higher than expected. This was partially offset by the use in 2004 of a lower assumed discount rate to value pension benefit liabilities. Other postretirement benefit expense also decreased for the 2004 third quarter to $6.9 million from $10.1 million in the comparable 2003 period, as effects of the new labor agreement at our Allegheny Ludlum operations in the 2004 second quarter and the effects of the 2003 Federal Medicare prescription drug benefit program, which we began to recognize in the 2004 third quarter, more than offset a projected rise in the medical cost inflation rate and a lower assumed discount rate utilized for the current year. In the third quarter 2004 and 2003, retirement benefit expense increased cost of sales by $17.7 million and $23.1 million, respectively, and increased selling and administrative expenses by $7.1 million and $10.4 million, respectively.
For the year-to-date periods, 2004 retirement benefit expense was $94.8 million, compared to $101.7 million in 2003. Retirement benefit expense increased cost of sales for the nine months ended September 2004 by $70.6 million, and increased selling and administrative expenses by $24.2 million. For the nine months ended September 2003, retirement benefit expenses increased cost of sales by $71.0 million and increased selling and administrative expenses by $30.7 million.
The 2004 retirement benefit expense discussed above does not include the effects of the $71.5 million curtailment and settlement gain related to the elimination of retiree medical benefits for certain non-collectively bargained employees beginning in 2010, nor does this expense include the $25.4 million charge related to the Transition Assistance Program ("TAP") incentives associated with the new labor agreement at Allegheny Ludlum, which will be paid from our U.S. defined benefit pension plan. Additionally, retirement benefit expense recognized through September 2004 includes only about $1 million of the expected $46 million favorable impact on our postretirement medical expense from the enactment of the Federal Medicare prescription drug benefit program in December 2003. The reduction in postretirement expense from this program will be recognized over multiple years.
We are not required to make cash contributions to the U.S. defined benefit pension plan for 2004. During the third quarter 2004, we made a $50 million voluntary cash contribution to this defined benefit pension plan to improve the plan's funded position. Based on current actuarial studies, we do not expect to be required to make cash contributions to this defined benefit pension plan during the next several years. However, we may elect, depending upon investment performance of the pension plan assets and other factors, to make additional cash contributions to this pension plan in the future.
Corporate expenses increased to $7.4 million for the third quarter of 2004 compared to $4.1 million for the third quarter of 2003. For the nine months ended September 2004, corporate expenses were $21.9 million compared to $14.2 million for the comparable prior year period. These increases are due primarily to non-cash expenses associated with our stock-based long-term incentive compensation programs and costs of complying with Sarbanes-Oxley regulations, which more than offset savings associated with reductions in staffing and other efforts to control costs at the corporate office. Selling and administrative expenses were largely unchanged in dollar terms from the prior year quarter and year-to-date periods, but declined as a percentage of sales due to increased sales in 2004. Excluding the effects of retirement benefit expense and an increase of $1.8 million in non-cash stock-based compensation expense compared to the prior year period, selling and administrative expenses as a percentage of sales declined to 6.6% in the 2004 third quarter, from 8.8% in the same period of 2003. For the nine months ended September 2004, selling and administrative expenses declined to 6.8% of sales, from 8.7% of sales in the prior year-to-date period, excluding the effects of retirement benefit expense, non-cash stock-based compensation expense and prior year management transition costs described below.
CURTAILMENT GAIN, NET OF RESTRUCTURING COSTS
In the 2004 second quarter, we recorded a curtailment gain, net of restructuring costs of $40.4 million, which includes the $71.5 million curtailment and settlement gain and the $25.4 million pension termination benefit charge discussed in Corporate Items, above, and $5.7 million of restructuring charges. The restructuring charges related to the new labor agreement at our Allegheny Ludlum operations, and the J&L asset acquisition, and included labor agreement costs of $4.6 million, severance costs of $0.6 million related to approximately 30 salaried employees, and $0.5 million for asset impairment charges for redundant equipment following the J&L asset acquisition.
MANAGEMENT TRANSITION AND RESTRUCTURING COSTS
Third quarter 2003 results included pretax management transition and restructuring costs of $8.6 million. This amount included $5.6 million associated with the termination of the Stock Acquisition and Retention Program ("SARP"), which was reported in selling and administrative expenses on the consolidated statement of operations. In September 2003, we terminated the remaining loans outstanding under the SARP, received approximately $0.5 million in cash and recorded $5.6 million of expenses. CEO transition costs of $1.8 million included accelerated vesting of long-term compensation, and accrued obligations pursuant to an employment contract, which were reported in selling and administrative expenses on the consolidated statement of operations. Workforce reductions of $1.2 million related to the Flat-Rolled Products and Engineered Products segments were reported in restructuring costs on the consolidated statement of operations.
The 2004 third quarter and first nine months 2004 results do not include an income tax provision or benefit due to the uncertainty regarding full utilization of our net deferred tax assets as a result of cumulative losses recorded in the 2001 through 2003 period. A valuation allowance was recorded in accordance with SFAS No. 109, "Accounting for Income Taxes", based upon the results of our quarterly evaluation concerning the estimated probability that the net deferred tax asset would be realizable. We are required to maintain a valuation allowance until a realization event occurs to support reversal of all or a portion of the allowance. Our effective tax rate was a benefit of 40.4% and 37.6% for the 2003 third quarter and first nine months 2003, respectively. The effective tax rate for the third quarter 2003 was favorably impacted by the settlement of previous years' Federal income tax obligations, resulting in a $17.1 million income tax refund receivable at September 30, 2003. We received Federal income tax refunds of $7.2 million in 2004 and $48.5 million in 2003, almost entirely in the first quarter of both years. Under current tax laws we are substantially unable to carry-back any current year or future year tax losses to prior periods to obtain cash refunds of taxes paid during those periods. Our 2003 Federal net operating loss tax carryforward of $42 million, and current year Federal tax losses, if any, can be carried forward for up to 20 years and applied against any taxes owed in those future years.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2003, as required, we adopted Statement of Financial Accounting Statement No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). Under SFAS 143, obligations associated with the retirement of tangible long-lived assets, such as landfill and other facility closure costs, are capitalized and amortized to expense over an asset's useful life using a systematic and rational allocation method.
Our adoption of SFAS 143 resulted in recognizing a charge of $1.3 million, net of income taxes of $0.7 million, or $0.02 per share, principally for asset retirement obligations related to landfills in our Flat-Rolled Products segment. This charge is reported in the statement of operations for the quarter ended March 31, 2003 as a cumulative effect of a change in accounting principle.
FINANCIAL CONDITION AND LIQUIDITY
CASH FLOW AND WORKING CAPITAL
At September 30, 2004, cash and cash equivalents totaled $262.6 million, an increase of $183.0 million from December 31, 2003. On July 28, 2004, the sale of 13.8 million shares of ATI common stock was completed in a public offering at $17.50 per share with net cash proceeds of $229.7 million. During the first nine months ended September 30, 2004, cash generated from operations was $8.5 million as improved operating results for 2004 and the receipt of a $7.2 million Federal income tax refund pertaining to our 2003 tax return offset a $147.7 million increase in managed working capital and a $50 million voluntary contribution to our U.S. defined benefit pension plan. The increase in managed working capital, excluding the effects of the J&L asset acquisition, was primarily due to a $85.4 million increase in accounts receivable resulting from a higher level of sales in the third quarter of 2004 compared to the fourth quarter of 2003, and a $133.1 million increase in inventory as a result of increased operating volume and higher raw material costs, partially offset by a $70.8 million increase in accounts payable. Investing activities included capital expenditures of $39.5 million and the initial cash consideration for the J&L asset acquisition of $7.5 million.
As part of managing the liquidity of our business, we focus on controlling managed working capital, which is defined as gross accounts receivable and gross inventories, less accounts payable. In measuring performance in controlling this managed working capital, we exclude the effects of LIFO inventory valuation reserves, excess and obsolete inventory reserves, and reserves for uncollectible accounts receivable which, due to their nature, are managed separately. At September 30, 2004, managed working capital was 26.3% of annualized sales compared to 30.7% of annualized sales at December 31, 2003. During the first nine months of 2004, managed working capital increased by $147.7 million. The increase in managed working capital from December 31, 2003 was due to increased accounts receivable, which reflects the higher level of sales in the third quarter 2004 compared to the fourth quarter 2003, and increased inventory, mostly as a result of increased operating levels and higher raw material costs, which was partially offset by increased accounts payable. The majority of the increase in raw material costs should be recovered through surcharges. While inventory and accounts receivable balances increased during the first nine months of 2004, gross inventory turns, which excludes the effect of LIFO inventory valuation reserves, and days sales outstanding, which measures actual collection timing for accounts receivable, both improved over December 31, 2003 levels.
The components of managed working capital were as follows:
(in millions) September 30, December 31,
2004 2003
------------ -----------
Accounts receivable $ 365.2 $ 248.8
Inventories 460.8 359.7
Accounts payable (259.1) (172.3)
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Subtotal 566.9 436.2
Allowance for doubtful accounts 11.2 10.2
LIFO reserves 194.4 111.7
Corporate and other 24.5 17.4
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Managed working capital $ 797.0 $ 575.5
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Annualized prior 2 months sales $3,026.0 $1,874.0