Allegheny Technologies line



1997 Annual Report

To Our Stockholders

To describe 1997 as a busy year for us is to understate the obvious. Considering all the significant changes, 1997 could rank as the most momentous year in the history of either of the two companies -- Allegheny Ludlum or Teledyne -- that combined to form Allegheny Teledyne in August 1996.

And while we have a great deal more to accomplish in the future, 1997 was also a year of outstanding overall performance.

Including special items, which reflect the disposal of assets, sale of equity interests and restructuring charges, total earnings increased to $297.6 million, or $1.70 per common share, compared to $213.0 million, or $1.20 per common share in 1996. Before special items, net earnings increased over 16% to $273.9 million from $234.9 million and earnings per common share increased to $1.56 from $1.33. Sales reached $3.7 billion, slightly below last year's level.

Operating margins before merger and restructuring costs rose to 12.4 percent for the year compared to 11.9 percent in the prior year.

Return on capital employed improved to 21.6 percent, and return on equity increased to 29.3 percent before special items. This performance reflects our continued focus on efficient use of capital.

All of these results were achieved despite the negative impact of significantly lower prices for commodity stainless steel products.

At year-end 1997, our total debt was $329 million. This represents a $264 million reduction in the precombination debt of Allegheny Ludlum and Teledyne, and has resulted in significant savings in interest expense. Our capital structure continued to strengthen, and net debt to total capitalization at year-end improved to 21.8 percent. Strong cash flow enabled the company to repurchase 3.8 million shares prior to discontinuing the repurchase program on October 31, 1997. Total stockholders' equity reached $1 billion.

Gross proceeds from the sale of businesses and investments and the disposal of surplus assets totaled $143 million in 1997. The sold operations contributed revenues of $98 million in 1997. Further disposals of assets are expected as we move to our strategic goal of having all of our remaining businesses meet the tests of critical mass, opportunities for profitable growth, and strategic fit.

Internal Focus Important

We concentrated on internal and external areas last year. The internal focus we applied to the company was far less visible, but perhaps most important to our success in the future. In this area, we addressed the critical task of combining Allegheny Ludlum's deeply involved operating style with the more decentralized approach of Teledyne. While we have made a great deal of progress in developing a single company culture, we are not yet where we intend to be.

During 1997 we moved ahead in several important areas:

  • The merger of corporate staffs has been completed. Our headquarters is located in Pittsburgh, PA.

  • Responsibility and accountability have been clearly defined. Substantial corporate overhead reductions have been achieved. In 1998, corporate expenses, including staff, aircraft and international offices, are expected to be $32 million below 1995 (the last full year before the combination).

  • Major progress has been achieved in implementing cost reduction and quality improvement programs at every Allegheny Teledyne company and at the corporate office. Results of these programs are reported quarterly to the segment executives and to me.

  • Enhanced detailed cost systems have been installed or are in the final stages of implementation at every Allegheny Teledyne company. These systems will enable our operating managers to understand each cost element of their businesses and to develop sales and marketing programs to capitalize on that information. I cannot stress too much how important I believe these systems are to our future success. We believe the well-proven maxim: "If you can't measure it, you can't manage it."

  • A comprehensive management appraisal program was implemented at locations where past practices had been inadequate. This will be extended to every level of management in 1998. Everyone should know what is expected and how their performance is perceived. In addition, programs are being implemented to develop the future leaders of our company.

  • Working capital reduction programs instituted in 1997 enable each company to understand how it ranks compared to other companies and to identify how to accomplish important working capital objectives. We recognize that companies serving different markets often face different business issues. However, we believe we can recover substantial cash from better management of receivables, inventories and trade payables.

  • A new planning process was installed for preparation of the 1998 business plan. Annual incentive compensation for our managers will be measured against achievement of that plan.

  • After great study, a new total compensation plan has been installed. It provides incentives both for short term and long term performance, and is designed to encourage senior management to own stock in Allegheny Teledyne and even more closely align compensation with stockholder interests.

  • A stock purchase program was extended to most employees of Allegheny Teledyne. The plan is intended to offer eligible employees an opportunity to invest in the future of the company.

Top Management Team in Place

Our top management team is in place to implement all these programs. Dr. Robert Mehrabian, formerly president of Carnegie Mellon University, was appointed senior vice president and segment executive in charge of our aerospace and electronics companies. He has already made a significant impact by implementing many of the programs outlined above and providing leadership to this important segment.

David F. Lewis, who has more than 25 years management experience in the consumer electronics industry, was appointed a corporate vice president and assistant to me. He provides leadership and direction to the industrial and consumer segments.

Judd R. Cool, an established executive with multi-industry experience, was appointed senior vice president of human resources to assist me, the segment executives and the corporate staff to effectively manage our human resources. one of his primary tasks will be to aid the segment executives and the company presidents in creating management development programs to improve the performance of all of our managers.

These executives join the other members of our team: Dr. Arthur H. Aronson, executive vice president and segment executive, specialty metals; James L. Murdy, executive vice president, finance and administration and chief financial officer; and Jon D. Walton, senior vice president, general counsel and secretary. Together, this team provides overall direction to the company.

External Focus for Further Growth

Our external focus has been to acquire companies that will meet our criteria of strategic fit, add to the critical mass of our businesses, and provide additional opportunities for profitable growth. We believe that we have been particularly productive: we announced the proposed acquisition of Oregon Metallurgical Corporation (OREMET® Titanium) which we hope to have closed by the time you receive this report; we completed the acquisition of the aerospace division of Sheffield Forgemasters; and we agreed to acquire certain stainless steel producing assets and obtain access to conversion facilities from Bethlehem Steel Corporation after it completes its acquisition of Lukens Inc.

The pending acquisition of OREMET and the recent acquisition of the aerospace division of Sheffield Forgemasters clearly indicate our intention to continue strengthening our niche specialty metals businesses. The combination of those two companies with Allvac and Wah Chang -- utilizing the equipment assets of Allegheny Ludlum -- will create a high performance group of companies which we believe is unsurpassed in the highly competitive world marketplace we serve. As a result of these acquisitions, Allegheny Teledyne will offer a full range of metals and alloys that includes stainless steel, nickel-based superalloys, titanium and titanium alloys in most product forms.

OREMET is one of two fully integrated U.S. titanium producers. As a producer of a single metal -- titanium -- OREMET has been subjected to the swings in the titanium market over the past 40 years. But in difficult years prior to 1996, OREMET showed outstanding capabilities and performed exceedingly well. The acquisition of OREMET for stock on a pooling basis is expected to provide Allegheny Teledyne with critical mass in the titanium business serving aerospace as well as chemical, industrial and consumer markets.

Combining Allvac and OREMET will make Allegheny Teledyne an important producer of nickel-based superalloys and titanium. Utilizing Allegheny Ludlum facilities, we intend to serve the titanium flat-rolled market, something which OREMET could never do as a stand-alone company.

The potential for cost and marketing synergies from the two acquisitions is significant, and we expect to move rapidly to implement our plans. Cost reductions and sales synergies from OREMET alone could exceed $45 million in the third full year after the merger closes. We expect the acquisition to be accretive to earnings in 1998.

After the OREMET acquisition is closed, Dr. Carlos Aguirre, currently chairman and chief executive officer of OREMET, will lead the new high performance group of companies and report to Dr. Aronson. These companies will include OREMET, Wah Chang, Allvac, and the aerospace division of Sheffield Forgemasters.

Forgemasters' aerospace division, with its principal assets located in the United Kingdom, was acquired for cash. It provides a manufacturing location in Europe for nickel-based and titanium-based superalloys for aerospace, the oil industry and other important markets. With equipment similar to Allvac, the aerospace division provides additional capacity at a time of shortage. We expect to significantly increase the productive capacity of the acquired assets with modest new capital investment combined with Allvac's operating techniques. We also expect to expand our ability to market, and to serve customers, throughout Europe.

We are excited by the prospects this new acquisition provides. The aerospace division has an outstanding technical reputation. Its acquisition is expected to greatly improve our ability to more effectively compete in the global marketplace. This acquisition is also expected to be accretive to earnings and cash flow in the first full year.

In January 1998, we announced three agreements with Bethlehem Steel that are designed to meet the strategic needs of Allegheny Ludlum. As a result of the agreements, we expect to obtain additional melt capacity and the capability to produce wide coiled plate. In addition, we expect to enhance Allegheny Ludlum's ability to provide customers with 60-inch wide stainless steel sheet. The agreements also would require Allegheny Ludlum to supply Bethlehem with hot roll bands for further processing at Lukens' stainless steel cold finishing facilities until Bethlehem sells those facilities.

The agreements are subject to the closing of Bethlehem's acquisition of Lukens and customary closing conditions.

We are also pursuing opportunities in other areas of our business. In early November, we acquired a controlling interest in Aerotronics Controls, Inc., a startup company focused on development of electronic engine controls for piston aircraft engines. These systems are expected to modernize the engine management systems of new and existing piston-powered light aircraft, including those produced by Teledyne Continental Motors, one of the operating companies in our aerospace and electronics segment.

Specialty Metals Segment Performed Well

The specialty metals segment completed an excellent year despite worldwide commodity stainless steel price difficulties. Overcapacity has continued to plague the industry, despite increased demand worldwide for stainless steel products. Commodity stainless steel sheet prices are now at their lowest levels in over ten years in nominal dollars. Although raw material costs have declined, the price declines which have occurred since mid-1996 greatly exceed raw material cost declines and other cost reductions, so margins have been squeezed. Allegheny Ludlum and Rodney Metals performed well compared to many of the stainless steel companies worldwide who suffered losses or produced only minimal profits in 1997. We expect that 1998 will be another difficult year for commodity stainless steel.

In the face of these challenges, Dr. Aronson and his team have achieved synergies which nearly triple those originally forecasted for the Allegheny Ludlum and Teledyne metals companies. Efforts to identify and realize synergies continue. Our high value specialty metals businesses reflected strong demand from commercial aerospace and chemical processing industries for products such as nickel-based superalloys, titanium, niobium, and zirconium. And, as previously announced, the pension plans of Allegheny Ludlum and Teledyne have been merged, providing full funding of these pension plans with sufficient excess to cover Teledyne and Allegheny Ludlum retiree health benefit costs.

Another very significant recent development at Allegheny Ludlum was the signing of a new three-year contract with the United Steelworkers of America four months before expiration of the existing contract on June 30, 1998. The negotiating teams, the employees, and the union should be complimented in achieving this milestone. It reaffirms the company's commitment to its customers and employees.

Other Business Segments Contribute

The aerospace and electronics segment had mixed results in 1997. Teledyne Electronic Technologies had an outstanding year and further growth in sales and income is planned for 1998. Demand for electro- mechanical relays, circuit board contract manufacturing, and microelectronic hybrid products paced results in 1997.

On a negative note, The Boeing Company has notified Teledyne Ryan Aeronautical that it has decided to terminate the long-standing agreement with Ryan to fabricate the Apache helicopter fuselage. Although Ryan will continue to produce airframes and kits for airframes in 1998, future business for this product from Boeing appears to be unlikely. The impact of this decision will not be material to our financial results.

Teledyne Brown Engineering experienced lower shipments and funding levels on defense and NASA contracts in 1997. Brown also incurred costs associated with restructuring its operations. Continental Motors showed improved results by the fourth quarter after disruptions caused by a new manufacturing process in the first quarter of 1997.

The Global Hawk, the high altitude long range unmanned aerial vehicle being developed for the Pentagon by Ryan Aeronautical, made its first flight in February, 1998. Successful development of this sophisticated aircraft bodes well for future orders. Ryan has built two of these vehicles and the Pentagon has authorized Ryan to build two more and to begin procuring items for a fifth.

Our consumer and industrial segments performed exceedingly well last year. Each of our important consumer and industrial product lines improved. Cost reductions and favorable performance of new products generated gains in sales and operating profit.

Most of our companies are achieving excellent returns on capital. Disposal of businesses in the future will occur only after careful examination, using our criteria of critical mass, opportunities for profitable growth and strategic fit. Because our plate was full in 1997, we have not been able to complete studies of all of our businesses to our satisfaction. We expect to make additional decisions in 1998.

The body of this report highlights many accomplishments of our companies in all of our business segments.

Operating Management Changes

Succession planning for our company has involved many operating management appointments.

Dr. Jack W. Shilling was appointed president of Allegheny Ludlum Corporation, Allegheny Teledyne's largest company. He is a long-time Allegheny Ludlum employee and has held a series of important technical and operating positions. He led the team which conducted the successful negotiations with the United Steelworkers.

David M. Hogan was appointed president of Teledyne Metalworking Products. He has been an executive with the company for 20 years. Teledyne Metalworking Products produces tungsten, tungsten carbide and tungsten carbide cutting tools and has developed a strategic plan which, if achieved, would double its size in four years.

Richard A. Holloway was recruited as president of Brown Engineering, located in Huntsville, Alabama. He has had an outstanding career in the aerospace field.

Outlook

While we cannot forecast the future, we expect continued progress in reducing costs and improving quality. We expect continued development of growth strategies for all of our businesses, even for those businesses which we may eventually sell.

On balance, while none of us are ever fully satisfied, 1997 was a very good year. We believe that our stockholders were well served in a market where the recent overall perception of metals companies was adversely affected by the Asian monetary crisis. At this point, we are watching events in Asia with a cautious attitude and cannot be certain of the effect they will have on our company.

We will continue to focus on achieving superior returns on capital while seeking profitable growth. Our balance sheet is strong. Indeed, at 21.8 percent net debt to total capitalization, some analysts believe that we are underleveraged. The acquisition of the aerospace division of Sheffield Forgemasters and the assets under the Bethlehem Steel agreements will not weaken our strong credit position.

Thanks to Employees, Customers and Stockholders

Our ability to build value for stockholders is related to value created by our employees and for our customers. I want to express personal thanks to all employees who have supported the many changes made in 1997 and to welcome new employees who have joined our company. We are a team committed to high quality, excellent service, and on-time delivery. Thanks also to our customers for their loyalty and continued faith in our products and services. All of us at Allegheny Teledyne take a personal interest in customer satisfaction.

I am indebted to our board of directors for their counsel and support. Their collective wisdom is a major reason for the success of the company, and I value their contributions.

A special note of thanks to Fayez Sarofim, who has announced his intention to retire from the board of directors on May 14. He served on the board of directors of Teledyne for many years. His wisdom and counsel will be missed.

Thanks to our stockholders for your confidence in our company. We continue to work at building a company that remains a very attractive investment. Our interests are linked, since the directors and officers of Allegheny Teledyne own almost 15 percent of the outstanding shares. on a personal note, I have again asked the board to pay my 1998 base compensation entirely in Allegheny Teledyne stock as it was in 1997.

We believe that we will never be any better than the standards we establish. We will continue to set high standards in all regards.


Richard P. Simmons

Chairman,
President and Chief Executive Officer
March 16, 1998