-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SPP0SAfRsK2X0XDRGgutgSAATAu3e/OadrG2NHRQIdtIC/Ks4UrP5DRcFz/VHnEw uxLfGLvQCVt3DwBpFiy3FA== 0000007383-99-000004.txt : 19990315 0000007383-99-000004.hdr.sgml : 19990315 ACCESSION NUMBER: 0000007383-99-000004 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990312 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ARMCO INC CENTRAL INDEX KEY: 0000007383 STANDARD INDUSTRIAL CLASSIFICATION: STEEL WORKS, BLAST FURNACES ROLLING MILLS (COKE OVENS) [3312] IRS NUMBER: 310200500 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-00873 FILM NUMBER: 99563970 BUSINESS ADDRESS: STREET 1: 301 GRANT ST - 15TH FLR STREET 2: ONE OXFORD CENTRE CITY: PITTSBURGH STATE: PA ZIP: 15219-1415 BUSINESS PHONE: 4122559859 MAIL ADDRESS: STREET 1: 301 GRANT ST - 15TH FLR CITY: PITTSBURGH STATE: PA ZIP: 15219-1415 FORMER COMPANY: FORMER CONFORMED NAME: ARMCO STEEL CORP DATE OF NAME CHANGE: 19790506 10-K405 1 FORM 10-K FOR THE YEAR ENDED 1998 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1998 ----------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to ------------------ -------------- Commission file number 1-873-2 ------- ARMCO INC. ---------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 31-0200500 - ------------------------------- ----------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) One Oxford Centre, 301 Grant Street, Pittsburgh, Pennsylvania 15219-1415 - ------------------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 412/255-9800 Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class on Which Registered ------------------- ------------------- Class A Preferred Stock, without par value New York Stock Exchange Class B Preferred Stock, $1 par value each New York Stock Exchange Common Stock, $.01 par value each/ New York Stock Exchange Rights to Purchase Participating Preferred Stock of Class A Preferred Stock New York Stock Exchange 9% Senior Notes, due 2007 New York Stock Exchange 8 7/8% Senior Notes, due 2008 New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of voting stock held by nonaffiliates of Armco Inc. (assuming solely for purposes of this Form, that all members of registrant's Board of Directors are "affiliates") was approximately $698,241,346 as of February 26, 1999. As of the close of business on February 26, 1999, there were 107,912,948 shares of Common Stock outstanding. Documents incorporated by reference herein include: Annual Report to Shareholders for the year ended December 31, 1998 -- Parts I, II, and IV of this report. Proxy Statement for the 1999 Annual Meeting of Shareholders filed with the Commission under Rule 14a-6 of the Securities Exchange Act of 1934 in connection with the Company's 1999 Annual Meeting of Shareholders -- Part III of this report. PART I ITEM 1. BUSINESS General Armco Inc. ("Armco" or the "Company") was incorporated as an Ohio corporation in 1917 as a successor to a New Jersey corporation incorporated in 1899. Armco believes it is the largest domestic producer of stainless sheet and strip and electrical steels, based on tons shipped. Armco's Sawhill Tubular Division manufactures a wide range of steel pipe and tubing products for use in the construction, industrial and plumbing fields. The Company also owns Douglas Dynamics, L.L.C. ("Douglas Dynamics"), the largest North American manufacturer of snowplows for four-wheel drive light trucks. Armco also operates an industrial park on the Houston, Texas ship channel. Armco's strategic objectives include enhancing and expanding its leading domestic position as a producer of specialty flat-rolled steels via incremental facility additions that add value through cost reductions or productivity gains, or through joint venture/partnership arrangements where value can be added without major capital outlay. In addition, Armco is exploring possible acquisitions of "downstream," fabricating or parts- producing businesses -- such as first and second operations like blanking, stamping, tool and die manufacturing, welding, fabrication and forming operations -- that will allow it to fully utilize its specialty steel technical, manufacturing and customer service expertise. Armco also intends to expand its snowplow business by adding new snowplow and ice control products to reach new market segments as well as modestly expanding its industrial park facility. Business Segments In 1998, Armco adopted Statement of Financial Standards No. 131, Disclosures about Segments of an Enterprise and Related Information. As a result, Armco changed its segment presentation to reflect the operating segments and performance measurements evaluated regularly by its chief executive officer. The Company operates in three business segments: Specialty Flat-Rolled Steels, Tubular Products, and Other Businesses. Information on the amounts of revenue, operating results and identifiable assets attributable to each of Armco's business segments, set forth in Note 8 of the Notes to Consolidated Financial Statements in Armco's Annual Report to Shareholders for the year ended December 31, 1998, is incorporated by reference herein. Additional information about Armco's business segments is set forth in Management's Discussion and Analysis in Armco's Annual Report to Shareholders for the year ended December 31, 1998, which is incorporated by reference herein. Specialty Flat-Rolled Steels Segment Armco's Specialty Flat-Rolled Steels businesses produce and finish flat- rolled stainless, electrical and galvanized carbon steels at manufacturing operations located in Butler, Pennsylvania, and Coshocton, Dover, Mansfield and Zanesville, Ohio. The Butler and Mansfield facilities produce both semi- finished and finished specialty stainless and electrical steels in slab, hot band and sheet and strip form. The Coshocton plant finishes stainless steel in sheet and strip form and the Zanesville plant finishes stainless and electrical sheet and strip. The Dover facility coats carbon steel products at its 1 galvanizing facility. The segment also includes the results of European trading companies that buy and sell steel and manufactured steel products. The stainless and electrical steel industry is a relatively small but distinct segment of the overall steel industry that represented approximately 2% of domestic steel tonnage but accounted for approximately 14% of domestic steel revenues in 1998. These steels differ from basic carbon steel by their metallurgical composition. Electrical steels have properties that make them desirable in the generation and distribution of electricity. Stainless steels are made with a high alloy content, which permits their use in environments that demand exceptional hardness, toughness, strength and resistance to heat, corrosion or abrasion, or combinations thereof. Unlike high-volume carbon steel, stainless and electrical steels are generally produced in relatively small quantities utilizing special processing techniques designed to meet more exacting specifications and tolerances. Stainless and electrical steel products sell at higher prices and generate higher average profit margins than carbon steel products. Stainless steel contains elements such as chromium, nickel and molybdenum that give it the unique qualities of resistance to rust, corrosion and heat; high strength; good wear characteristics; natural attractiveness; and ease of maintenance. Stainless steel is used in the automotive and aerospace industries, and in the manufacture of food handling, chemical processing, pollution control, medical and health equipment and other products where its combination of strength, durability and attractiveness is desirable. Electrical steels are iron-silicon alloys which, through special production techniques, possess unique magnetic properties that make them desirable for use as energy efficient material in such applications as power transmission and distribution transformers, electrical motors and generators. Armco expects that long-term demand for stainless steel will continue to grow due to increasing use in the manufacture of consumer durable goods and industrial applications. Per capita stainless steel usage in many developed countries significantly exceeds per capita usage in the United States and Armco believes that this is an indication of the growth potential of demand for stainless steel in the United States. In addition, the 1990 amendments to the Clean Air Act have resulted in the increasing use of corrosion-resistant materials in a number of applications for which stainless steel is well suited, including industrial pollution control devices and motor vehicle exhaust systems for use in the United States, where Armco now has the leading market share. Another factor that Armco believes will affect demand positively is the increasing issuance of new car bumper-to-bumper warranties and the use of stainless steel in passenger restraint systems and other functional components. Armco produces flat-rolled stainless and electrical sheet and strip products that are used in a diverse range of consumer durables and industrial applications. During the last three years, approximately 77% of Armco's sales of specialty flat-rolled steel has been finished stainless and electrical steels, 10% has been specialty semi-finished and 10% has been galvanized carbon steel. The remaining sales in this segment of Armco's business are primarily related to the foreign subsidiaries that buy, warehouse, and sell specialty steel products. Major markets served are industrial machinery and electrical equipment, automotive, construction and service centers. Armco is the leading producer of chrome stainless grades used primarily in the domestic market for automotive exhaust components. Stainless steel, which formerly was not used in parts of the exhaust system other than the catalytic converter, is now used in the entire exhaust system, from manifold to tailpipe, by many auto manufacturers. Armco has developed a number of specialty grades for this application. Armco is also known for its "bright anneal" finish utilized for automotive and appliance trim and chrome grades used for cutlery, kitchen utensils, scissors and surgical instruments. Specialty chrome nickel grades produced by Armco are used in household cookware, restaurant, food processing and 2 medical equipment. Other Armco stainless products have various automotive, agricultural, heating, air conditioning and various industrial uses. Armco is the only United States manufacturer of a complete line of flat- rolled electrical steel products. It is also the only domestic manufacturer utilizing laser scribing technology. In this process, the surface of electrical steel is etched with high-technology lasers that refine the magnetic domains of the steels, resulting in superior electrical efficiency. Major electrical product categories are: Regular Grain Oriented ("RGO"), used in the cores of power and distribution transformers; Cold Rolled Non-Oriented ("CRNO"), used for electrical motors, generators and lighting ballasts; and TRAN-COR[registered trademark]H, which is used in power transformers and is the only high permeability electrical steel made domestically. Additionally, Armco produces a full range of hot-dipped galvanized products primarily for use in the heating, ventilation and air conditioning ("HVAC") market. Armco's order backlog for its Specialty Flat-Rolled Steels segment was $193.7 million at December 31, 1998, and $188.5 million at December 31, 1997. While substantially all of the orders on hand at year-end 1998 are expected to be shipped in 1999, such orders, as is customary in the industry, are subject to modification, extension or cancellation. Armco's specialty steelmaking operations are located in Pennsylvania and Ohio. Armco's Butler, Pennsylvania facility, which is situated on 1,300 acres with 3.2 million square feet of buildings, continuously casts 100% of its steel. Melting takes place in three 175-ton electric arc furnaces that feed the world's largest (175-ton) argon-oxygen decarburization unit and a 175-ton vacuum degassing unit for refining molten metal that, in turn, feed two double strand continuous casters. The melt capacity at Butler is approximately 950,000 cast tons. Butler operates a hot-strip mill, anneal and pickle units and two fully-automated tandem cold-rolling mills. It also has various intermediate and finishing operations for both stainless and electrical steels. The finishing plant in Coshocton, Ohio, located on 650 acres, is housed in a 600,000 square-foot plant and has three Sendzimer mills and two Z-high mills for cold reduction, four anneal and pickle lines, bell annealing furnaces, three bright anneal lines and other processing equipment, including temper rolling, slitting and packaging facilities. The Mansfield, Ohio plant consists of a 1.4 million square-foot facility, including a melt shop with two electric arc furnaces (170-ton and 128-ton), a 135-ton argon-oxygen decarburization unit, a thin-slab continuous caster, a six-stand hot strip mill, a five-stand tandem cold rolling mill and a pickle line. Armco's Zanesville, Ohio plant, with 508,000 square feet of buildings on 88 acres, is a finishing plant for some of the steel produced at Butler and Mansfield and has a Sendzimer cold-rolling mill, anneal and pickle lines, high temperature box anneal and other decarburization and coating units. The Dover, Ohio plant consists of a 600,000 square foot facility including a 48 inch galvanizing line, bell annealing furnaces and a temper mill. The Dover plant has been the subject of sale negotiations over the past year. However, no assurances can be given that a sale will be completed. Tubular Products Segment This business segment consists of Armco's Sawhill Tubular Division. Sawhill Tubular manufactures a wide range of steel pipe and tubular products for use in the non-residential construction, 3 industrial, plumbing and heating markets at plants in Sharon and Wheatland, Pennsylvania and Warren, Ohio. Armco's order backlog for its Tubular Products segment was $17.3 million at December 31, 1998 and $23.0 million at December 31, 1997. The decrease in 1998 was due to lower volume and selling prices as a result of oversupply in the market, including a high level of imported pipe. While substantially all of the orders on hand at year-end 1998 are expected to be shipped in 1999, such orders, as is customary in this industry, are subject to modification, extension or cancellation. Armco has been, and continues to be, in negotiations for the sale of Sawhill Tubular. However, no assurances can be given that a sale will be completed. Other Businesses The businesses currently included in this segment are described below. -- Douglas Dynamics, L.L.C. is the largest North American manufacturer of snowplows for four-wheel drive light trucks. Douglas Dynamics, which has manufacturing plants in Rockland, Maine, Milwaukee, Wisconsin and Johnson City, Tennessee, sells its snowplows and ice control products under the brand names Western and Fisher through independent distributors in the United States and Canada. Douglas Dynamics' sales depend on the level of four-wheel drive light truck sales and total snowfalls in major markets. -- Greens Port Industrial Park consists of approximately 500 acres on the Houston Ship Channel and leases land, buildings and rail car storage facilities to third parties and operates a deep water loading dock on the channel. Employees At December 31, 1998, Armco had approximately 5,700 employees. Most of Armco's domestic production and maintenance employees are represented by international, national or independent local unions, although some operations are not unionized. Armco has agreements with the United Steelworkers of America at its Mansfield and Dover plants, which terminate September 1, 1999, and at its Sharon plant, which terminates September 30, 1999. Competition The Company faces intense competition from domestic and foreign steel producers, and also from producers of components and other products and manufacturers of competing products other than steel, including aluminum, plastics, composites and ceramics. Competition is based primarily on price, with factors such as reliability of supply, service and quality also being important in certain segments. In addition to existing competition, AK Steel Corporation, an integrated steel company has announced plans to enter the specialty steel market. AK Steel is building a steel finishing facility in Rockport, Indiana that is expected to be completed in mid-1999. When completed, this facility will provide AK Steel with substantial stainless steel processing and finishing capacity. Increases in the production capacity and efficiency of other domestic producers, together with possible new entrants into the specialty steel market, are expected to result in intensified competition that could exert downward pressure on price and market share. 4 Armco's competitors in the domestic galvanized carbon steel market include many of the large integrated and mini-mill flat rolled producers. Since 1989, significant flat-rolled mini-mill capacity has been constructed and these mini-mills now compete with integrated domestic steel producers in most flat-rolled steel markets. Mini-mills generally rely on less capital- intensive hot metal sources, have smaller, non-unionized workforces resulting in lower employment costs per ton shipped and are relatively free of many of the employee, environmental and other obligations that have traditionally burdened non-mini-mill steel producers. There is significant flat-rolled and galvanized capacity under construction or announced with various planned commissioning dates in the next several years. Competition is also presented by foreign producers. Some of these foreign producers have lower labor costs and are subsidized by their governments. Their decisions with regard to production and sales may be influenced more by political and social considerations than prevailing market forces. Many foreign steel producers continue to ship into the United States market despite decreasing profit margins. Depending on a number of market factors, including the strength of the dollar, import levels, and the effectiveness of U.S. trade laws, pricing of the Company's products could be adversely affected. In recent years, record levels of imports have depressed pricing on specialty steel products in the U.S. In June 1998, Armco and other domestic producers of flat-rolled stainless sheet and strip products filed petitions with the U.S. Department of Commerce and the International Trade Commission charging eight foreign countries with violations of U.S. trade laws. On July 24, 1998, the U.S. International Trade Commission issued its preliminary finding that there has been injury to domestic producers. On November 10, 1998, the U.S. Department of Commerce announced preliminary results in the subsidy investigations, establishing countervailing duty rates for companies in France, Italy and South Korea. On December 17, 1998, the U.S. Department of Commerce announced a preliminary determination on antidumping margins for companies in those countries, as well as in Germany, Japan, Mexico, Taiwan and the United Kingdom. Final antidumping determinations are expected to be announced in the second quarter of 1999. A finding that unfairly traded imports have caused injury to domestic producers could result in tariffs that may help slow the flood of imports. In addition, with respect to electrical steels, in mid-1999 the U.S. Department of Commerce and the U.S. International Trade Commission are expected to review existing antidumping and countervailing duties involving Italian and Japanese producers to determine whether these protections should be extended for another five years. The failure to obtain or extend meaningful tariff protections for any of the products Armco sells could adversely affect prices and reduce profitability. Raw Materials and Energy Sources Raw materials represent a major component of production costs in the steel industry. The principal raw materials used by Armco in the production of steels are iron and carbon steel scrap, chrome and nickel and their ferroalloys, stainless steel scrap, silicon, molybdenum and zinc. These materials are purchased in the open market from various outside sources. Since much of this purchased raw material is not covered by long-term contracts, availability and price are subject to world market conditions. Chrome, nickel and certain other materials in mined alloy form can be acquired only from foreign sources, many of them located in developing countries that may be subject to unstable political and economic conditions that might disrupt supplies or affect the price of these materials. A significant portion of Armco's chrome and nickel requirements, however, is obtained from stainless steel scrap rather than mined alloys. While certain raw materials have been in short supply from time to time, Armco currently is not experiencing and does not anticipate any problems obtaining appropriate materials in amounts sufficient to meet its production needs. Armco also uses large amounts of 5 electricity and natural gas in the manufacture of its products. It is expected that such energy sources will continue to be available in the foreseeable future. The Year 2000 Issue A discussion of Year 2000 issues is incorporated herein by reference from Management's Discussion and Analysis under the caption "The Year 2000 Issue" of the Annual Report to Shareholders for the year ended December 31, 1998. Environmental Matters A discussion of environmental matters is incorporated herein by reference from Management's Discussion and Analysis and Notes to Consolidated Financial Statements under the captions "Environmental Matters," "Environmental Liabilities" and "Litigation and Environmental Matters", respectively, of the Annual Report to Shareholders for the year ended December 31, 1998. Research and Development Armco carries on a broad range of research and development activities aimed at improving its existing products and manufacturing processes and developing new products and processes. Armco's research and development activities are carried out primarily at a central technology center located in Middletown, Ohio. This center is engaged in applied materials research related to iron and steel, non-ferrous materials and new materials. In addition, the materials and metallurgy departments at each operating unit develop and implement improvements to products and processes that are directly connected with the activities of such operating unit. Armco spent $14.2 million, $15.3 million and $13.1 million, respectively, on research and development in the years 1998, 1997 and 1996. Discontinued Operations Armco Financial Services Group ("AFSG") Armco's investment in AFSG represents the net assets of its discontinued insurance and finance leasing businesses, which have been largely liquidated. The insurance companies, including Northwestern National Insurance Company (NNIC), have stopped writing new business and are being "run off." These insurance companies have not written any new business for retention since 1986 except for an immaterial amount of guaranteed renewable accident and health business. AFSG is accounted for as a discontinued operation under the liquidation basis of accounting, whereby future cash inflows and outflows are considered. The discontinued insurance companies estimate that 60% of future claims will be paid in the next five years and that substantially all of the claims will be paid by the year 2017. The ultimate amount of the claims as well as the timing of the claims payments are estimated based on the annual review of loss reserves performed by independent and consulting actuaries. There have been no charges recorded to income with respect to these companies since 1990. There are various pending matters relating to litigation, arbitration and regulatory affairs arising out of the runoff operations of the AFSG companies. In March 1997, North Atlantic Insurance Company, a group of international companies, previously affiliated with AFSG but sold in 1991, filed an application for voluntary liquidation in the United Kingdom. As a result of this voluntary liquidation 6 filing, certain claims have been asserted against NNIC by insureds of North Atlantic. NNIC is defending these claims as well as pursuing related claims against third parties and North Atlantic. Armco management continues to believe, based on current facts and circumstances and the opinions of outside counsel and advisors, that future charges, if any, resulting from the liquidation of AFSG, including matters related to the voluntary liquidation of North Atlantic, will not be material to Armco's financial condition or liquidity. However, it is possible that, due to fluctuations in Armco's operating results, future developments could have a material effect on the results of one or more future interim or annual periods. ITEM 2. PROPERTIES Armco owns and leases property primarily in the United States. This property includes manufacturing facilities, offices and undeveloped property. The locations of Armco's principal plants and materially important physical properties are described in "ITEM 1. BUSINESS". Armco believes that all its operating facilities are being adequately maintained and are in good operating condition. ITEM 3. LEGAL PROCEEDINGS There are various claims pending against Armco and its subsidiaries involving product liability, reinsurance and insurance arrangements, environmental, antitrust, employee benefits and other matters arising out of the conduct of the business of Armco. Environmental Proceedings. Most environmental actions involving Armco -------------------------- relate to alleged contamination at off-site treatment and disposal sites. Other claims sometimes arise from contractual obligations for properties Armco previously owned or leased and from regulatory actions. In most of these cases, Armco is one of many companies who have been identified as potentially responsible parties ("PRPs"). In a few instances, Armco is one of only a few parties or is alleged to be solely liable. It is routinely asserted that joint and several liability will be applied in such cases; thus, a single party could be held liable for all costs related to a site. However, Armco's experience has been that liability is apportioned on the basis of volume and/or toxicity of materials sent to a site and Armco expects that any ultimate liability would be apportioned among Armco and other financially viable parties. Armco intends to assert all meritorious legal and equitable defenses that are available to it with respect to environmental matters. Based on Armco's analysis of the claims against it for contamination, including the presence of other PRPs, Armco's experience in resolving similar claims, and in some instances the type of contamination and expected remediation costs, Armco does not believe that its liability, if any, for these claims would materially impact its consolidated financial position or liquidity. However, it is possible that due to fluctuations in Armco's operating results, future developments with respect to such matters could have a material effect on the results of operations in future interim or annual periods. On February 27, 1995, the Ohio Environmental Protection Agency ("OEPA") issued a Notice of Violation ("NOV") to Armco's Zanesville Operations alleging noncompliance with both a 1993 Order and various state regulations regarding hazardous waste management. Armco continues to work with OEPA to achieve final resolution of this matter. No proposed penalties were included in the NOV and Armco cannot reasonably estimate potential penalties, if any, based on current information. On September 30, 1998, the United States Environmental Protection Agency ("USEPA") issued an order under Section 3013 of the Resource Conservation and Recovery Act requiring environmental investigation at Armco's Mansfield Operations. The cost of the investigation is not expected to have a material effect on future, interim or annual results of operations. Armco has filed a complaint against the 7 USEPA in the U.S. District Court for the Northern District of Ohio, Eastern Division, which seeks injunctive relief and to set aside penalties during the pendency of the legal proceeding. Armco's complaint challenges the legal basis for the Order, the lack of support in the administrative record for such an Order, and the lack of due process the Order provides to Armco in responding to modifications and expansions USEPA could make to the scope of work to be performed under the Order. The complaint was filed on October 30, 1998. On December 30, 1998, USEPA filed a motion to dismiss Armco's complaint primarily on the basis that the Order was not final agency action and therefore, that the court lacked subject matter jurisdiction. Armco is preparing a response to this motion. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of the security holders of Armco during the fourth quarter of the year ended December 31, 1998. Executive Officers of Armco The executive officers of Armco as of March 12, 1999, were as follows:
Years Age as of Tenure in of Service Name March 12, 1999 Office Office(1) with Armco - ---- --------------- ------ ----------- --------- - - James F. Will 60 Chairman, President and Chief Executive Officer 1994(2) 7 Jerry W. Albright 62 Vice President and Chief Financial Officer 1997 2 James L. Bertsch 55 Vice President and Treasurer 1989 33 John B. Corey 55 Vice President - Diversified Businesses and Business Development. President, Douglas Dynamics, L.L.C. 1994 20 John N. Davis 40 Vice President and Controller 1996 7 Gary R. Hildreth 60 Vice President, General Counsel and Secretary 1993 28 Gary L. McDaniel 52 Vice President - Operations 1996 6 M. Dennis McGlone 49 Vice President - Commercial 1996 7 Pat J. Meneely 47 Vice President - Information and Organizational Effectiveness 1995 4 DeWayne W. Tuthill 62 Vice President - Purchasing and Materials Management 1998 1 9 (1) All officers are elected annually by the Board of Directors and hold office until their successors are elected and qualified. Each of the officers named above has held responsible positions with Armco or its subsidiaries during all of the past five years, with the exceptions of Messrs. Albright, Meneely and Tuthill. Prior to joining Armco, Mr. Albright was a consultant and small business owner. Prior to that he was Assistant to the President of Armco Inc. and prior to that he was Vice President and Chief Financial Officer of Cyclops Industries, Inc. Immediately prior to joining Armco, Mr. Meneely worked as an executive consultant and held executive positions with Sara Lee Hosiery and Wheeling-Pittsburgh Steel Corporation. Mr. Tuthill previously served as Group Executive Vice President at Wheeling- Pittsburgh Steel Corporation since October of 1995. Having been with Wheeling-Pittsburgh since 1989, Mr. Tuthill also held the positions of Executive Vice President of Operations and Vice President - Purchasing, Traffic and Raw Materials. (2) Effective February 1, 1996, Mr. Will was elected Chairman of the Board in addition to the positions of President and Chief Executive Officer.
PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Armco's common stock is sold principally on the New York Stock Exchange. At February 26, 1999, there were 19,782 common stock shareholders of record. Other information required by this item is incorporated herein by reference from pages 32 and 36 of the Annual Report to Shareholders for the year ended December 31, 1998. ITEM 6. SELECTED FINANCIAL DATA (In millions, except per share amounts)(1)
1998 1997 1996 1995 1994 ---- ---- ---- ---- -- - -- Net sales $1,706.5 $1,829.3 $1,724.0 $1,559.9 $1,437.6 Special charges - net (2) -- -- (8.8) -- (35.0) Income from continuing operations 109.6 77.1 26.0 23.5 65.8 Income per common share from continuing operations: - Basic 0.85 0.55 0.08 0.05 0.46 - Diluted 0.81 0.55 0.08 0.05 0.46 Total assets 1,893.8 1,881.3 1,867.8 1,896.6 1,934.9 Long-term debt and lease obligations 250.7 306.9 344.3 361.6 363.8 Long-term employee benefit obligations 898.0 1,178.1 1,200.2 1,165.9 1,221.9 - ------------------------------- 9 (1) The information in this Item should be read in conjunction with Armco's financial statements and the notes thereto, which are incorporated by reference in Item 8. (2) Special charges primarily relate to the sale and/or rationalization of operating facilities.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain information required by this Item is incorporated herein by reference from pages 16-21 under the caption Management's Discussion and Analysis in the Annual Report to Shareholders for the year ended December 31, 1998. Other Certain statements made or incorporated by reference in this Form 10-K, or made in press releases or in oral presentations made by Company employees, reflect management's estimates and beliefs and are intended to be, and are hereby identified as, "forward-looking statements" for purposes of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These include statements in the paragraphs entitled Outlook for 1999, Armco Financial Services Group (AFSG), Liquidity And Capital Resources, Environmental Matters, The Year 2000 Issue and New Accounting Standard in the section entitled Management's Discussion and Analysis and in the Letter to Shareholders contained in the Annual Report to Shareholders and in Note 1. Summary of Significant Accounting Policies, relating to Concentration of Credit Risk and New Accounting Standard; Note 9. Litigation and Environmental Matters; and Note 10. Discontinued Operations, relating to AFSG in the Notes to Consolidated Financial Statement in the Annual Report to Shareholders incorporated herein by reference. Armco cautions readers that such forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those currently expected by management. In addition to those noted in the statements themselves, these factors include, but are not limited to, the following: risks of a downturn in the general economy or in the highly cyclical steel industry; volatility in financial markets, which may affect invested pension plan assets and the calculation of benefit plan liabilities and expenses; changes in demand for Armco's products; unplanned plant outages, equipment failures or labor difficulties; actions by Armco's foreign and domestic competitors;; unexpected outcomes of major litigation and contingencies; changes in U.S. trade policy and actions respecting imports; disruptions in the supply of raw materials; actions by reinsurance companies with which AFSG does business, or foreign or domestic insurance regulators; and changes in application or scope of environmental regulations applicable to Armco. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item is incorporated herein by reference from pages 22-35 of the Annual Report to Shareholders for the year ended December 31, 1998. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 10 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item as to executive officers of Armco is contained in Part I of this report under "Executive Officers of Armco" and is incorporated herein by reference. The information required as to directors is incorporated herein by reference from the information set forth under the caption "ELECTION OF DIRECTORS" in the registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders filed with the Securities and Exchange Commission pursuant to Rule 14a-6 of the Securities Exchange Act of 1934, as amended (the "Proxy Statement"). ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated herein by reference from the information set forth in the Proxy Statement under the caption "EXECUTIVE COMPENSATION". ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The security ownership in Armco stock of directors, certain executive officers and directors and executive officers as a group and of persons known by Armco to be the beneficial owners of more than five percent of any class of Armco's voting securities is incorporated herein by reference from the information set forth in the Proxy Statement under the caption "MISCELLANEOUS - -- Stock Ownership". ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K I. Documents Filed as a Part of this Report A. Financial Statements and Financial Statement Schedules Page ---- 1. Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 1998, 1997 and 1996 * 2. Consolidated Balance Sheets as of December 31, 1998 and 1997 * 3. Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 * 4. Notes to Consolidated Financial Statements * 11 5. Independent Auditors' Report * 6. Responsibility for Financial Reporting * - ---------------- * Incorporated in this Annual Report on Form 10-K by reference to pages 22-35 of the Annual Report to Shareholders for the year ended December 31, 1998. Financial Statements and Financial Statement Schedules Omitted The financial statements and financial statement schedules for Armco Inc. and subsidiaries, other than those listed above, are omitted because of the absence of conditions under which they are required, or because the information is set forth in the Notes to Consolidated Financial Statements. B. Exhibits The following is an index of the exhibits included in the Annual Report on Form 10-K. 3(a). Articles of Incorporation of Armco Inc., as amended as of April 4, 1996 (1) 3(b). Regulations of Armco Inc. (2) 4. Armco hereby agrees to furnish to the Securities and Exchange Commission, upon its request, a copy of each instrument defining the rights of holders of long-term debt of Armco and its subsidiaries, omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K. 10(a). Deferred Compensation Plan for Directors* 10(b). 1993 Long-Term Incentive Plan of Armco Inc. (3)* 10(c). Amended Severance Benefit Agreement (4)* 10(d). 1988 Restricted Stock Plan (5)* 10(e). Executive Supplemental Deferred Compensation Plan Trust (6)* 10(f). Executive Supplemental Deferred Compensation Plan (7)* 10(g). Pension Plan for Outside Directors (8)* 10(h). Key Management Severance Policy (9)* 10(i). Minimum Pension Plan (10)* 10(j). Stainless Steel Toll Rolling Services Agreement (11) 10(k). Rights Agreement dated as of February 23, 1996 between Armco Inc. and Fifth Third Bank (12) 12 13. Annual Report to Shareholders for the year ended December 31, 1997. (Filed for information only, except for those portions that are specifically incorporated in this Form 10-K Annual Report for the year ended December 31, 1997.) 21. List of subsidiaries of Armco Inc. 23. Independent Auditors' Consent 27. Financial Data Schedule 99. Description of Armco Capital Stock The annual reports (Form 11-K) for the year ended December 31, 1998 for the Armco Inc. Retirement and Savings Plan and the Armco Inc. Thrift Plan for Hourly Employees will be filed by amendment as exhibits hereto, as permitted under Rule 15d-21. * Management contract or compensatory plan or arrangement required to be filed as an exhibit to the Annual Report on Form 10-K pursuant to Item 14(c) of Form 10-K. - ---------------------- (1) Incorporated by reference from Exhibit 3.1 to Armco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993. (2) Incorporated by reference from Exhibit 3.2 to Armco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994. (3) Incorporated by reference from Exhibit 10 to Armco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993. (4) Incorporated by reference from Exhibit 10(i) to Armco's Annual Report on Form 10-K for the year ended December 31, 1997. (5) Incorporated by reference from Exhibit 10(i) to Armco's Annual Report on Form 10-K for the year ended December 31, 1988 (SEC File No. 001-00873). (6) Incorporated by reference from Exhibit 10(b) to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 (SEC File No. 001- 00873). (7) Incorporated by reference from Exhibit 10(c) to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 (SEC File No. 001- 00873). (8) Incorporated by reference from Exhibit 10(p) to Armco's Annual Report on Form 10-K for the year ended December 31, 1989 (SEC File No. 001-00873). (9) Incorporated by reference from Exhibit 10(p) to Armco's Annual Report on Form 10-K for the year ended December 31, 1990. 13 (10) Incorporated by reference from Exhibit 10(r) to Armco's Annual Report on Form 10-K for the year ended December 31, 1991. (11) Incorporated by reference from Exhibit 10(s) to Armco's Annual Report on Form 10-K for the year ended December 31, 1993. (12) Incorporated by reference from Exhibit 10(p) to Armco's Form 10-K for the year ended December 31, 1995. - ---------------------- II. Reports on Form 8-K The following Report on Form 8-K as filed by Armco during the quarter ended December 31, 1998. Report Date Description - ----------- ----------- December 7, 1998 On December 7, 1998, Armco Inc. (the "Company") announced plans to issue $75 million of Senior Notes maturing in 2008, in a private placement pursuant to Rule 144A under the Securities Act of 1933, as amended. The Company stated that it intends to use the net proceeds of the offering to redeem or repurchase certain outstanding debt securities. 14 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized as of March 12, 1999. ARMCO INC. By JAMES F. WILL ---------------------------------- James F. Will Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of March 12, 1999. By JAMES F. WILL By JOHN C. HALEY - -------------------------------------- ------------------------------- James F. Will John C. Haley Chairman of the Board, President, Director Chief Executive Officer and Director By JERRY W. ALBRIGHT By CHARLES J. HORA, JR. - -------------------------------------- ------------------------------ Jerry W. Albright Charles J. Hora, Jr. Vice President and Director Chief Financial Officer By JOHN N. DAVIS By BRUCE E. ROBBINS - ------------------------------------- ------------------------------ John N. Davis Bruce E. Robbins Vice President and Controller Director By DAN R. CARMICHAEL By JAN H. SUWINSKI - ------------------------------------- ------------------------------ Dan R. Carmichael Jan H. Suwinski Director Director By PAULA H.J. CHOLMONDELEY By JOHN D. TURNER - -------------------------------------- ------------------------------ Paula H.J. Cholmondeley John D. Turner Director Director By DOROTHEA C. GILLIAM - -------------------------------------- Dorothea C. Gilliam Director 15 EXHIBIT INDEX The following is an index of the exhibits included in the Annual Report on Form 10-K. 13. Annual Report to Shareholders for the year ended December 31, 1998. (Filed for information only, except for those portions that are specifically incorporated in this Form 10-K Annual Report for the year ended December 31, 1998.) 21. List of subsidiaries of Armco Inc. 23. Independent Auditors' Consents 27. Financial Data Schedule 99. Description of Armco Capital Stock - ------------------------ EX-13 2 EX-13 Exhibit 13 MANAGEMENT'S DISCUSSION AND ANALYSIS Three Years Ended December 31, 1998 (Dollars in millions, except per share amounts) GENERAL This discussion and analysis of Armco's financial results should be read together with the Consolidated Financial Statements and Notes on pages 23 through 35. Operating Results
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Net sales $1,706.5 $1,829.3 $1,724.0 Special charges - - (8.8) Operating profit 107.6 105.4 74.7 Sundry other - net 27.7 (1.1) (21.1) Income from continuing operations 109.6 77.1 26.0 Income from discontinued operations - 2.7 6.5 Extraordinary loss on retirement of debt - (3.0) - Cumulative effect of a change in accounting for postretirement benefits 237.5 - - Net income 347.1 76.8 32.5 Basic earnings per share Income from continuing operations 0.85 0.55 0.08 Net income 3.05 0.55 0.14 Diluted earnings per share Income from continuing operations 0.81 0.55 0.08 Net income 2.69 0.55 0.14 - ------------------------------------------------------------------------------
1998 vs. 1997: Net sales in 1998 declined 7% from 1997 levels primarily due to reduced pricing across all steel and tubular product lines, lower volume in the specialty semi-finished and galvanized steel lines and lower snowplow and tubular product shipments. Sales volume for Armco's higher margin specialty flat-rolled steels increased 9%, somewhat offsetting these declines. Operating profit increased 2% despite lower sales, reflecting increased volume of higher margin steel products, lower operating costs, lower pension and retiree medical benefit expenses, and a one-time gain of $7.1 from a settlement with a vendor. Postretirement employee benefit expenses in 1998 were again lower as a result of prior years' favorable investment returns on pension plan assets and lower than expected increases in medical benefit costs. The change in sundry other - net between 1997 and 1998 is primarily the result of pension income and lower medical expenses in 1998 related to retirement benefits for former employees of Armco facilities that have been shut down or divested. The pension income resulted from favorable investment returns on pension plan assets related to the former facilities, and lower medical expenses were due to lower than expected benefit cost increases. Income of $24.2 in 1998 and expense of $2.0 in 1997 was included in sundry other - net for these benefits. Sundry other - net in 1998 also included an additional gain of $1.1 for the vendor settlement mentioned previously. In 1997, sundry other - net included a $4.0 gain for the settlement of certain partially impaired long-term receivables. In 1998, income from continuing operations included $4.3 for the favorable settlement of certain state tax issues. In 1997, Armco recorded $2.7 of income from discontinued operations for a tax refund related to a previously divested company. Also in 1997, Armco recorded a $3.0 extraordinary loss upon the early retirement of debt, which was refinanced by a senior note offering. Effective January 1, 1998, Armco changed its method of accounting for unrecognized net gains and losses related to its obligations for pensions and other postretirement benefits. Armco recognized income of $237.5, or $2.20 per share of common stock ($1.88 per diluted share), for the cumulative effect of this accounting change. Under the newly adopted method, Armco recognizes into income, as a fourth quarter adjustment, any unrecognized net gains and losses that exceed 10% of the larger of the benefit obligations or plan assets, and amortizes amounts inside this 10% corridor over the average remaining service life of active participants (approximately 15 years). Adoption of the new method increased 1998 income from continuing operations by $3.0 or $0.03 per share of common stock. [A BAR CHART APPEARS HERE] EMPLOYEE BENEFIT EXPENSE/INCOME OF DIVESTED BUSINESS UNITS $ MILLIONS
95 96 97 98 Expense $39 $22 $2 - Income - - - $24 Favorable returns on pension plan assets and lower than expected medical cost increases have contributed to continuing lower expense in sundry other - net.
1997 vs. 1996: Armco's 1997 net sales increased 6% over 1996 primarily as a result of higher shipments of specialty steels and tubular products. Partially offsetting the higher shipments of specialty steel products was a decline in prices across the stainless and electrical steel product lines, primarily due to intense global competition. Operating profit increased 41% in 1997 primarily as a result of lower costs in the manufacturing operations, the consolidation of Greens Port Industrial Park, which in the prior year was an investment held for sale, and lower employee benefit expenses. Benefit expenses were lower as a result of favorable investment returns on pension plan assets and lower than expected increases in medical benefit costs. Included in the 1996 operating profit were special charges totaling $8.8 for a loss on the sale of Armco's nonresidential construction 16 Armco 1998 Annual Report business and a decision to exit a line of light truck equipment manufactured by Douglas Dynamics, LLC, Armco's snowplow and ice control products manufacturer. Operating profit in 1996 also included nonrecurring income of $8.6 from claim settlements, including a business interruption insurance claim. Sundry other - net expense decreased in 1997 as a result of lower expenses related to long-term benefit obligations for former employees of Armco facilities that have been shut down or divested. Included in sundry other - net for 1996 was the recognition of $6.3 of gains in connection with asset sales at Greens Port. Income from discontinued operations consisted of additional gains of $2.7 in 1997 and $6.5 in 1996 for tax refunds related to a previously divested company. Outlook for 1999: Armco expects modest volume increases in the Specialty Flat- Rolled Steels segment. Assuming a favorable outcome in the stainless flat- rolled steel trade cases filed with the U.S. Department of Commerce and the International Trade Commission in 1998, Armco expects stainless sheet and strip pricing to stabilize and possibly improve in the latter half of 1999. Overall results for the Specialty Flat-Rolled Steels segment are expected to be negatively affected by higher retiree benefit expenses, primarily due to lower expected returns on pension plan assets. Results for the other segments are expected to improve somewhat in 1999 compared to 1998. BUSINESS SEGMENT RESULTS Specialty Flat-Rolled Steels
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Net sales $1,418.9 $1,497.0 $1,421.2 Income from continuing operations 105.7 91.3 72.9 - ------------------------------------------------------------------------------
Armco's Specialty Flat-Rolled Steels businesses produce and finish flat-rolled stainless, electrical and galvanized carbon steels at plants in Butler, Pennsylvania, and Coshocton, Dover, Mansfield and Zanesville, Ohio. The segment also includes results of international trading companies that buy and sell steel and manufactured steel products. Net sales and shipments by major product line were as follows:
- ------------------------------------------------------------------------------ 1998 1997 1996 Sales Tons Sales Tons Sales Tons - ------------------------------------------------------------------------------ (tons in thousands) Specialty flat-rolled* $1,133.4 826 $1,103.0 757 $1,108.0 739 Specialty semi-finished 122.5 125 198.8 168 133.9 97 Galvanized and other carbon 129.9 245 165.1 306 144.2 304 Other 33.1 - 30.1 - 35.1 - - ------------------------------------------------------------------------------ Total $1,418.9 1,196 $1,497.0 1,231 $1,421.2 1,140 - ------------------------------------------------------------------------------ * The Specialty flat-rolled product line consists of automotive exhaust stainless, stainless sheet and strip, and electrical steels.
[A BAR CHART APPEARS HERE] SPECIALTY FLAT-ROLLED STEELS SALES BY MARKETS
96 97 98 Automotive 44% 39% 42% Industrial & Electrical Equipment 28% 27% 30% Service Centers 12% 12% 10% Other/Conversion 16% 22% 18% Armco is shipping more value-added specialty steels to the automotive and industrial markets.
1998 vs. 1997: Net sales for the Specialty Flat-Rolled Steels segment decreased 5% in 1998 primarily as a result of lower pricing in all product lines and reduced shipments in specialty semi-finished and galvanized steels. Record import levels continued to depress pricing across most stainless and electrical steel product lines. Specialty flat-rolled steel volume increased 9% on the strength of record shipments of automotive exhaust stainless and the highest electrical steel shipments in almost 20 years. Automotive exhaust stainless demand was driven by high levels of North American vehicle production, while electrical steel sales were stimulated by strong housing starts and demand for electrical machinery and equipment. However, lower prices, particularly for stainless sheet and strip products, reduced average sales per ton in this product line by 6%. Specialty semi-finished shipments and average sales per ton decreased by 26% and 17%, respectively, reflecting worldwide market softness, excess capacity and increased imports. Galvanized carbon steel shipments, produced by the Dover Operations from purchased steel coils, decreased 20% due to increased competition and low- priced imports. Income from continuing operations in 1998 increased $14.4 over 1997, primarily as a result of increased sales of higher margin automotive exhaust stainless and electrical steels, lower operating and raw material costs, a $7.1 gain from a settlement with a vendor, and reduced pension and other retiree benefit expenses. In addition, increased efficiencies and higher yields were made possible by a number of cost reduction and productivity improvement initiatives. These improvements were partially offset by the continuing deterioration in selling prices. 1997 vs. 1996: Net sales in 1997 were 5% higher than in 1996 on an 8% increase in tons shipped. A decrease in the segment's overall average sales per ton resulted from increased shipments of lower priced specialty semi-finished steels, partially offset by a change in the mix of carbon steel shipments from hot bands to higher priced galvanized steel products. A 3% reduction in average sales per ton of specialty flat-rolled products reflected increased import competition on certain grades of chrome nickel stainless and cold rolled non-oriented electrical steels and elimination of most of the remaining surcharges on stainless steel. Armco and other specialty steel producers add raw material surcharges to the price of their product to compensate for higher costs incurred when the price of key raw materials such as nickel, chromium or molybdenum rises above certain levels. Such surcharges were minimal in 1997 and the second half of 1996. Specialty semi-finished shipments increased substantially in 1997 over 1996, primarily as a result of increased sales of chrome nickel hot bands. However, average sales per ton declined 14%, reflecting worldwide overcapacity. Armco 1998 Annual Report 17 Shipments of galvanized carbon steel increased in 1997, but the increased tons were offset by the elimination of carbon hot band shipments. In the first half of 1996, Armco exited the lower priced hot band market, shifting to higher priced galvanized steel products and thus increasing average sales per ton by 14% in the year-to-year comparison. Specialty Flat-Rolled Steels' 1996 income from continuing operations included an $8.6 credit from various claim settlements, including a business interruption insurance claim. Excluding the claim settlements, income increased in 1997 primarily as a result of lower costs due to facilities upgrades, more stable operating conditions and lower employee benefit expenses. Costs in 1996 were adversely affected by several planned outages, including outages necessary to upgrade Armco's finishing facilities as part of the strategic facilities plan. The outages and the subsequent process of restarting and returning these facilities to full capability contributed to higher costs and lower yields. To meet demand during this period, Armco substantially increased its use of outside processors to finish some of its stainless steels, resulting in higher costs. Outlook for 1999: Armco anticipates stable volume and further cost reductions for most product lines during the next twelve months. Although automotive exhaust stainless shipments are expected to remain strong, supported by North American vehicle sales, tons shipped may decline slightly from 1998's record level. Stable housing starts are expected to continue to stimulate demand for oriented electrical steels, while high levels of lower priced imports continue to adversely affect non-oriented electrical steel product sales. In recent years, record levels of imports have depressed pricing on specialty steel products in the U.S. In June 1998, Armco and other domestic producers of flat-rolled stainless sheet and strip products filed petitions with the U.S. Department of Commerce and the International Trade Commission charging eight foreign countries with violations of U.S. trade laws. A finding that unfairly traded imports have caused injury to domestic producers could result in tariffs that may help slow the flood of imports. On July 24, 1998, the International Trade Commission issued its preliminary finding that there has been injury to domestic producers. On November 10, 1998, the U.S. Department of Commerce announced preliminary results in the subsidy investigations, establishing countervailing duty rates for companies in France, Italy and South Korea. On December 17, 1998, a preliminary determination on antidumping margins was announced by the U.S. Department of Commerce for companies in those three countries, as well as in Germany, Japan, Mexico, Taiwan and the United Kingdom. Final antidumping determinations are expected to be announced in the second quarter of 1999. In addition, with respect to electrical steels, in mid-1999 the U.S. Department of Commerce and the International Trade Commission are expected to review existing antidumping and countervailing duties involving Italian and Japanese producers to determine whether these protections should be extended for another five years. The failure to obtain or extend meaningful tariff protections for any of the products Armco sells could adversely affect prices and reduce profitability. Assuming a favorable outcome in the stainless sheet and strip trade cases, Armco expects prices for these products to stabilize in the first half of 1999 and show some improvement in the latter half of the year. Prices for certain electrical and semi-finished steels, however, are expected to be lower than in 1998. Overall results for the Specialty Flat-Rolled Steels segment are expected to be negatively affected by higher retiree benefit expenses, primarily due to lower expected returns on pension plan assets. [A TABLE APPEARS HERE] UNION CONTRACT EXPIRATION DATES BUTLER OPERATIONS Hourly 9/30/2001 Represented Non-exempt 9/30/2002 Plant Protection 9/30/2002 ZANESVILLE OPERATIONS Hourly 5/20/2000 Represented Non-exempt 5/20/2000 MANSFIELD OPERATIONS Hourly 9/1/1999 Plant Protection 11/1/1999 DOVER OPERATIONS Hourly 9/1/1999 Represented Non-exempt 9/1/1999 SAWHILL TUBULAR DIVISION Sharon Hourly 9/30/1999 Warren Hourly 9/30/2000 Wheatland Hourly 1/31/2000
[A BAR CHART APPEARS HERE] SPECIALTY FLAT-ROLLED STEELS EXPORT SALES $ MILLIONS
95 96 97 98 $86 $116 $138 $149 Despite weak foreign economies and a strong U.S. dollar, international markets are important areas for growth.
Tubular Products
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Net sales $192.7 $209.4 $189.6 Income from continuing operations 2.4 5.6 0.8 - ------------------------------------------------------------------------------
The Tubular Products business segment represents the results of Sawhill Tubular, a manufacturer of steel pipe and tubing. Sawhill has plants in Sharon and Wheatland, Pennsylvania and Warren, Ohio. 1998 vs. 1997: Net sales decreased on lower volume and selling prices, which reflected a general oversupply in the market, including a high level of imported pipe, and market softness in certain products. Although some cost savings were achieved in 1998, income decreased as a direct result of lower sales and margins. 1997 vs. 1996: Net sales increased 10% in 1997 primarily due to higher shipments along most major product lines, as well as modest price increases. Sawhill's income improved in 1997, driven by higher volume and lower operating costs. Outlook for 1999: Sawhill Tubular's sales and profitability are expected to remain flat with slight volume increases, offset by increasing pressure on pricing from excess capacity and imported pipe. Armco has been, and continues to be, in negotiations for the sale of Sawhill Tubular. However, no assurance can be given that a sale will be completed. 18 Armco 1998 Annual Report Other Businesses
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Net sales $94.9 $122.9 $113.2 Special charge - - (2.9) Income from continuing operations 28.2 36.1 23.3 - ------------------------------------------------------------------------------
The Other Businesses segment includes the results of Douglas Dynamics, LLC, a manufacturer of snowplows and ice control products, with plants in Milwaukee, Wisconsin, Rockland, Maine and Johnson City, Tennessee; and Greens Port Industrial Park, which leases land, buildings and rail car storage facilities and operates a deep water loading dock on the Houston Ship Channel. 1998 vs. 1997: Although light truck sales were strong, lower net sales reflected significantly below average snowfall during the 1997/1998 winter in Douglas Dynamics' major markets, resulting in lower income from continuing operations. Greens Port's results improved during 1998 as all phases of its business posted increases in revenues and profits over last year. 1997 vs. 1996: The segment's income from continuing operations, excluding the special charge, improved 38% in 1997, due to manufacturing efficiencies achieved during the year at Douglas Dynamics and reduced operating expenses following the decision in 1996 to exit certain unprofitable product lines. In 1996, a $2.9 special charge was recorded in this segment primarily for the writedown of assets and severance costs related to the decision to discontinue a line of light truck equipment manufactured by Douglas Dynamics. In addition, 1997 results increased with the consolidation of Greens Port, which in the prior year was an investment held for sale. Outlook for 1999: Douglas Dynamics' 1999 sales will depend on the level of four-wheel drive light truck sales and total snowfalls in its major markets. Based on early snowfalls, snowplow shipments are expected to be somewhat higher in 1999. Greens Port's results are expected to continue to improve due to recent facility expansions. DISCONTINUED OPERATIONS Aerospace and Strategic Materials Armco sold its Aerospace and Strategic Materials business segment in 1985. Pursuant to the sales agreement, Armco retained the benefit of its share of any net proceeds of certain tax refund claims for periods prior to the sale. In 1996, Armco received a federal tax refund and recorded a $6.5 increase to its gain on the sale of the segment. In 1997, Armco recognized another $2.7 gain for state and federal tax refunds. Armco Financial Services Group (AFSG) Armco's investment in AFSG represents the net assets of its discontinued insurance and finance leasing businesses, which have been largely liquidated. The insurance companies, including Northwestern National Insurance Company (NNIC), have stopped writing new business and are being "run off." These insurance companies have not written any new business for retention since 1986 except for an immaterial amount of guaranteed renewable accident and health business. In March 1997, North Atlantic Insurance Company, a group of international insurance companies previously affiliated with AFSG but sold in 1991, filed an application for voluntary liquidation in the United Kingdom. As a result of this voluntary liquidation filing, certain claims have been asserted against NNIC by insureds of North Atlantic. NNIC is defending these claims as well as pursuing related claims against third parties and North Atlantic. Liquidity and Financial Resources: AFSG is accounted for as a discontinued operation under the liquidation basis of accounting, whereby future cash inflows and outflows are considered. AFSG believes the existing invested assets, related future income and other assets it owns will provide sufficient funds to meet all future claims payments and other liabilities. The loss reserves, net of reinsurance recoverables and future investment income, decreased to $59.9 at December 31, 1998 from $88.1 at December 31, 1997. AFSG estimates that 60% of the claims will be paid in the next five years and that substantially all of the claims will be paid by the year 2017. The ultimate amount of the claims as well as the timing of claims payments are estimated based on an annual review of loss reserves performed by independent and consulting actuaries. Outlook: Armco management continues to believe, based on current facts and circumstances and the opinions of outside counsel and advisors, that future charges, if any, resulting from the liquidation of AFSG, including matters related to the voluntary liquidation of North Atlantic, will not be material to Armco's financial condition or liquidity. However, it is possible that, due to fluctuations in Armco's operating results, future developments could have a material effect on the results of one or more future interim or annual periods. [A BAR CHART APPEARS HERE] LONG-TERM DEBT MATURITIES $ MILLIONS
99 00 01 02 03 $117 $6 $1 $1 $0 In January 1999, Armco redeemed the remaining $111 million of a senior note issue. Armco has no major debt due until 2007.
LIQUIDITY AND CAPITAL RESOURCES At December 31, 1998, Armco had $270.8 of cash, cash equivalents and short- term liquid investments, compared to $194.9 at December 31, 1997. Cash, cash equivalents and short-term liquid investments increased $75.9 during 1998, primarily as a result of $95.2 of cash generated by operations and $74.4 from the issuance of new 8-7/8% 10-year Senior Notes in December. Major cash payments during the year included $32.6 of capital expenditures, $51.2 for debt retirement and $17.7 for preferred stock dividends. The net proceeds of the new debt issue, along with other existing cash balances, were used to retire Armco's 9-3/8% Senior Notes due 2000 on January 14, 1999. Holders of the 9-3/8% Senior Notes were notified on December 15, 1998 of Armco's intention to redeem this issue. At December 31, 1998, $111.0 of these notes were outstanding, all of which were retired, resulting in the recognition of an extraordinary loss of $2.8 in the first quarter of 1999. Armco has no other material debt payments due until the year 2007. Armco 1998 Annual Report 19 At December 31, 1998, Armco had in place two bank credit facilities, totaling $170.0. In 1998, the terms of these facilities were extended and both will expire in 2001. Under a receivables facility, Armco sells substantially all its trade receivables to a wholly owned subsidiary, Armco Funding Corporation (AFC). In 1998, AFC and its bank group amended its revolving credit agreement to provide, depending on its available borrowing base, up to $100.0 for loans and letters of credit secured by AFC's receivables. At December 31, 1998, there were no outstanding borrowings under this credit facility. However, $61.1 of the facility was used as support for letters of credit. In 1998, Armco and its bank group amended its inventory facility to provide, depending on its available borrowing base, up to $70.0 for loans and letters of credit secured by Armco's inventories. The credit agreement subjects Armco to certain restrictions and covenants related to, among other things, minimum net worth, leverage ratio and interest coverage ratio requirements. At December 31, 1998, there were no outstanding borrowings or letters of credit under this facility. Under both bank credit facilities, a total of $93.3 was available for borrowing at December 31, 1998. Armco anticipates that its capital expenditures for 1999 will total approximately $50.0 to $60.0. Armco expects that its 1999 cash requirements, including amounts for capital expenditures, debt service and preferred stock dividends will be paid out of existing cash balances and cash generated from operations. In prior years, certain of Armco's financing arrangements included covenants that prohibited the payment of common stock dividends. These prohibitions have been eliminated; however, at December 31, 1998, certain outstanding financing arrangements contain financial tests which must be met before dividends can be paid. Currently, Armco meets these covenant requirements and is not prohibited from paying dividends under the terms of its credit facilities, long-term debt issues or under Ohio law. Armco is permitted to purchase shares of its capital stock under the terms of Ohio law only to the extent that it has positive equity surplus. At December 31,1998, Armco had a negative equity surplus balance of $8.3. On January 22, 1999, Armco's Board of Directors declared the regular quarterly dividends of $.525 per share on the $2.10 cumulative convertible preferred stock, Class A, and $.90625 per share on the $3.625 cumulative convertible preferred stock, Class A, each payable March 31, 1999 to shareholders of record on February 26, 1999. The Board of Directors also declared the regular quarterly dividend of $1.125 per share on the $4.50 cumulative convertible preferred stock, Class B, payable April 1, 1999, to shareholders of record on February 26, 1999. [A BAR CHART APPEARS HERE] CASH AND LIQUID INVESTMENTS $ MILLIONS
95 96 97 98 $137 $169 $195 $271 Operations are generating strong cash flow, which is making it possible to reduce debt. Late in 1998, Armco issued $75 million of debt, which with other available funds, was used to redeem the remaining $111 million of higher interest rate debt in January 1999.
ENVIRONMENTAL MATTERS In common with other U.S. manufacturers, Armco is subject to various federal, state and local environmental requirements. Armco has spent substantial amounts of money to control air and water pollution pursuant to applicable environmental requirements. Armco has also spent, and will continue to spend, substantial amounts for proper handling and disposal of waste material and for the environmental investigation and cleanup of properties. During the period 1994 through 1998, Armco's capital expenditures for pollution control projects amounted to $36.4, including $1.4 in 1998. Along with capital investments and operating costs relating to environmental matters, from time to time Armco has been and may be subject to penalties and other requirements as a result of administrative action by regulatory agencies. Statutory and regulatory requirements in this area continue to evolve and, accordingly, Armco cannot predict with certainty the type and magnitude of expenditures that will be required in the future. However, total expenditures for capital projects for pollution control during the five-year period from 1999 through 2003 are estimated to be approximately $29.0. Of this amount, approximately $7.4 is related to control of air pollution as required by amendments to the federal Clean Air Act, corresponding state laws and implementing regulations. A substantial portion of these capital expenditures is also attributable to the control of water pollution under the Clean Water Act. Although it cannot predict precisely how changes in environmental requirements will affect its businesses, Armco does not believe such requirements would affect its competitive position. Armco is, and may in the future be, subject to other types of environmental claims and costs, for which it accrues when it is probable that a liability has been incurred and it is possible to reasonably estimate the amount or range of any such loss. Armco is a defendant, or identified as a potentially responsible party in various pending claims regarding waste disposal sites. Joint and several liability could be imposed on Armco or other parties for these or similar matters; thus, theoretically, one party could be held liable for all costs related to a site. Though the outcome of such matters cannot be predicted with assurance, Armco's experience has been that, in most cases, ultimate liability is apportioned among Armco and other financially viable parties. Periodically, there are claims alleging property damage or personal injury in conjunction with waste disposal or releases. Armco is also subject to claims for contractual indemnification related to previously divested properties. If Armco disposes of additional properties, it may incur additional environmental exit costs. Armco accrues exit costs when it decides to dispose of a property or records a sale. 20 Armco 1998 Annual Report While the outcome of environmental matters cannot be predicted with assurance, Armco believes that the ultimate liability for such matters, identified to date, will not materially affect its consolidated financial condition or liquidity. This belief is based on current facts and circumstances known to Armco, including current laws and regulations as well as Armco's experience with site remediation. However, it is possible that due to fluctuations in Armco's operating results, changes in the facts or circumstances of known matters, or the addition of significant new matters, environmental liabilities could have a material effect on the results of operations of future interim or annual periods. It is not possible to determine whether additional loss will occur or to reasonably estimate the amount or range of any such loss. THE YEAR 2000 ISSUE Many existing computer systems may not be able to appropriately interpret dates after December 31, 1999 because such systems allow only two digits to indicate a year in the date field. If not corrected, many computers and computer applications could fail or create erroneous results, causing safety, operational and financial problems. If such a failure were to occur to certain of its computer systems, Armco's manufacturing and financial systems could be temporarily shut down, resulting in a material adverse effect on its financial condition, liquidity and results of operations. In addition, the failure of vendor computer systems could cause interruption of deliveries of key supplies or utilities, which might result in similar material adverse impacts. Because of the complexity of the issues and the number of parties involved, Armco cannot reasonably predict with certainty the nature or likelihood of such impacts. However, Armco, using its internal staff and outside consultants, is actively addressing this situation and anticipates that it will not experience a material adverse impact to its operations, liquidity or financial condition related to systems under its control. Armco has completed an assessment of substantially all business information, manufacturing and facility control systems to identify areas of concern. Armco is in the process of modifying or replacing noncompliant computer hardware and software used internally. In addition, Armco has surveyed its suppliers in regard to their Year 2000 preparations, focusing on those suppliers most critical to its operations. Armco intends to continue to monitor the Year 2000 compliance efforts of its suppliers and to obtain, to the extent possible, assurances that they will be able to deliver their products and services without interruption. To prepare for the reasonably likely worst case scenario, Armco is developing a contingency plan designed to mitigate the effects on its operations in case certain of its systems or suppliers fail to perform as planned. This plan is expected to be completed by the end of the second quarter of 1999. Contingency planning will consist of providing all required resources to repair internal systems should they fail at critical times, as well as establishing additional inventories and back-up procedures in the event suppliers are unable to deliver raw materials and services in a timely manner. Armco has prioritized its efforts, planning to complete work on noncompliant systems in the most critical areas first, with the expectation that virtually all Year 2000 compliance activities, including system testing, will be completed by September 30, 1999. In this process, Armco has redirected its systems resources from noncritical projects to Year 2000 compliance activities, resulting in an immaterial increase in expense. In 1998, Armco spent approximately $6.0 on Year 2000 compliance activities and currently anticipates spending an additional $11.0 in 1999. These expenditures, which are expected to consist primarily of capital expenditures, outside consultants and internal personnel costs, have been and will be funded out of operating cash flows. NEW ACCOUNTING STANDARD In 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133). Armco intends to adopt the new standard when required in 2000. Armco does not expect that SFAS No. 133 will have a material effect on its financial statements; however, its effect, if any, will depend on Armco's exposure to derivative instruments at the time of adoption and thereafter. FORWARD-LOOKING STATEMENTS Certain statements made in this Management's Discussion & Analysis, in the Notes to Consolidated Financial Statements and in the Letter to Shareholders contained in this Annual Report, reflect management's estimates and beliefs and are intended to be, and are hereby identified as, "forward-looking statements" for purposes of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These include statements in the foregoing paragraphs entitled Outlook for 1999, Armco Financial Services Group (AFSG), Liquidity and Capital Resources, Environmental Matters, The Year 2000 Issue and New Accounting Standard; and in Note 1, Summary of Significant Accounting Policies, relating to Concentration of Credit Risk and New Accounting Standard; Note 9, Litigation and Environmental Matters; and Note 10, Discontinued Operations, relating to AFSG. Armco cautions readers that such forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those currently expected by management. In addition to those noted in the statements themselves, these factors include, but are not limited to, the following: risks of a downturn in the general economy or in the highly cyclical steel industry; volatility in financial markets, which may affect invested pension plan assets and the calculation of benefit plan liabilities and expenses; changes in demand for Armco's products; unplanned plant outages, equipment failures or labor difficulties; actions by Armco's foreign and domestic competitors; unexpected outcomes of major litigation and contingencies; changes in U.S. trade policy and actions respecting imports; disruptions in the supply of raw materials; actions by reinsurance companies with which AFSG does business, or foreign or domestic insurance regulators; and changes in application or scope of environmental regulations applicable to Armco. Armco 1998 Annual Report 21 RESPONSIBILITY FOR FINANCIAL REPORTING Armco's management prepared the financial statements presented in this Annual Report in accordance with generally accepted accounting principles in the United States. These principles require choices among alternatives and numerous estimates of financial matters. Armco believes the accounting principles chosen are appropriate in the circumstances, and the estimates and judgments involved in Armco's financial reporting are reasonable and conservative. Armco's management is responsible for the integrity and objectivity of the financial information presented in this Annual Report. Armco maintains a system of internal accounting control and a program of internal audits. They are designed to provide reasonable assurance that the financial reports are fairly presented and that Armco employees comply with stated policies and procedures, including policies on the ethical conduct of business. Armco continually reviews and updates its policies and system of internal accounting control as businesses and business conditions change. Management and the Audit Review Committee of the Board of Directors recommended, and the Board of Directors approved, the hiring of Deloitte & Touche LLP as independent auditors for Armco. Deloitte & Touche LLP expresses an informed professional opinion on Armco's financial statements. The Audit Review Committee, composed solely of independent outside directors, oversees Armco's public financial reporting. The Audit Review Committee meets periodically with management, Deloitte & Touche LLP and Armco's internal auditors, both individually and jointly, to discuss internal accounting control and financial reporting matters. Deloitte & Touche LLP and Armco's internal auditors have free access to the Audit Review Committee to discuss any matters. We believe Armco's internal control system, combined with the activities of the internal and independent auditors and the Audit Review Committee, provides you reasonable assurance of the integrity of our financial reporting. /s/ James F. Will James F. Will Chairman, President and Chief Executive Officer /s/ Jerry W. Albright Jerry W. Albright Vice President and Chief Financial Officer INDEPENDENT AUDITORS' REPORT Deloitte & 2500 One PPG Place Touche LLP Pittsburgh, PA 15222 - -------------- [D&T LOGO] Armco, Its Shareholders and Directors: We have audited the accompanying consolidated balance sheets of Armco Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income and comprehensive income and of cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Armco Inc. and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. As discussed in Note 2 to the financial statements, in 1998 Armco Inc. changed its method of amortizing unrecognized net gains and losses related to its obligations for pension and other postretirement benefits. /s/ Deloitte & Touche LLP February 5, 1999 22 Armco 1998 Annual Report CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME For the years ended December 31, 1998, 1997 and 1996
- ------------------------------------------------------------------------------ (Dollars in millions, except per share amounts) 1998 1997 1996 - ------------------------------------------------------------------------------ Net sales $ 1,706.5 $ 1,829.3 $ 1,724.0 Cost of products sold (1,503.1) (1,623.9) (1,548.4) Selling and administrative expenses (95.8) (100.0) (92.1) Special charges (Note 7) - - (8.8) - ------------------------------------------------------------------------------ Operating profit 107.6 105.4 74.7 Interest income 9.0 10.6 10.1 Interest expense (28.9) (35.5) (36.3) Sundry other - net (Note 2) 27.7 (1.1) (21.1) - ------------------------------------------------------------------------------ Income before income taxes 115.4 79.4 27.4 Provision for income taxes (Note 3) (5.8) (2.3) (1.4) - ------------------------------------------------------------------------------ Income from continuing operations 109.6 77.1 26.0 Discontinued operation - Gain on disposal of Aerospace and Strategic Materials (Note 10) - 2.7 6.5 - ------------------------------------------------------------------------------ Income before extraordinary loss and cumulative effect of an accounting change 109.6 79.8 32.5 Extraordinary loss on retirement of debt (Note 4) - (3.0) - Cumulative effect of a change in accounting for postretirement benefits (Note 2) 237.5 - - - ------------------------------------------------------------------------------ Net income 347.1 76.8 32.5 Foreign currency translation adjustments 0.3 (1.4) 1.1 Minimum pension liability adjustment (2.6) - - - ------------------------------------------------------------------------------ Comprehensive income $ 344.8 $ 75.4 $ 33.6 - ------------------------------------------------------------------------------ Basic earnings per share (Note 1) Income from continuing operations $ 0.85 $ 0.55 $ 0.08 Income from discontinued operations - 0.03 0.06 Extraordinary loss on retirement of debt - (0.03) - Cumulative effect of an accounting change 2.20 - - - ------------------------------------------------------------------------------ Net income $ 3.05 $ 0.55 $ 0.14 - ------------------------------------------------------------------------------ Diluted earnings per share (Note 1) Income from continuing operations $ 0.81 $ 0.55 $ 0.08 Income from discontinued operations - 0.03 0.06 Extraordinary loss on retirement of debt - (0.03) - Cumulative effect of an accounting change 1.88 - - - ------------------------------------------------------------------------------ Net income $ 2.69 $ 0.55 $ 0.14 - ------------------------------------------------------------------------------ Pro forma presentation assuming accounting change applied retroactively Income before extraordinary loss and cumulative effect of an accounting change $ 109.6 $ 83.5 $ 33.6 Basic earnings per share 0.85 0.61 0.15 Diluted earnings per share 0.81 0.59 0.15 Net income $ 109.6 $ 80.5 $ 33.6 Basic earnings per share 0.85 0.60 0.15 Diluted earnings per share 0.81 0.58 0.15 Dividends on preferred stock (Note 5) $2.10 Class A $ 2.10 $ 2.10 $ 2.10 $3.625 Class A 3.625 3.625 3.625 $4.50 Class B 4.50 4.50 4.50 - ------------------------------------------------------------------------------ See Notes to Consolidated Financial Statements on pages 26 through 35.
Armco 1998 Annual Report 23 CONSOLIDATED BALANCE SHEETS December 31, 1998 and 1997
- ------------------------------------------------------------------------------ (Dollars in millions, except per share amounts) 1998 1997 - ------------------------------------------------------------------------------ ASSETS Current assets Cash and cash equivalents (Note 1) $ 263.8 $ 189.9 Short-term liquid investments 7.0 5.0 Accounts receivable Trade (less allowance for doubtful accounts of $3.4 in 1998 and $4.0 in 1997) 146.7 147.0 Other 11.2 9.6 Inventories (Note 1) 250.7 268.0 Other current assets 13.4 17.9 - ------------------------------------------------------------------------------ Total current assets 692.8 637.4 - ------------------------------------------------------------------------------ Investments Investment in Armco Financial Services Group (Note 10) 85.6 85.6 Other (less allowance for impairment of $8.7 in 1998 and $8.1 in 1997) 28.4 30.3 Property, plant and equipment (net of accumulated deprec- iation of $714.3 in 1998 and $653.0 in 1997) (Note 1) 621.8 652.5 Deferred tax asset (Note 3) 315.8 319.3 Goodwill and other intangible assets (Note 1) 128.6 137.4 Other assets 20.8 18.8 - ------------------------------------------------------------------------------ Total assets $1,893.8 $ 1,881.3 - ------------------------------------------------------------------------------ LIABILITIES Current liabilities Trade accounts and notes payable $ 115.7 $ 148.9 Employment-related liabilities (Note 2) 128.0 126.4 Other current liabilities 56.5 72.8 Current portion of long-term debt (Note 4) 116.9 38.2 - ------------------------------------------------------------------------------ Total current liabilities 417.1 386.3 - ------------------------------------------------------------------------------ Long-term debt (Note 4) 250.7 306.9 Long-term employee benefit liabilities (Note 2) 898.0 1,178.1 Other long-term liabilities 149.3 162.5 Commitments and contingencies (Notes 1, 9 and 10) SHAREHOLDERS' EQUITY (DEFICIT) (Note 5) Preferred stock - Class A 137.6 137.6 Preferred stock - Class B 48.3 48.3 Common stock (authorized 150,000,000 shares of $0.01 par value; issued and outstanding 107,908,385 in 1998 and 107,129,561 in 1997) 1.1 1.1 Additional paid-in capital 972.0 967.7 Accumulated deficit (975.8) (1,305.0) Other (4.5) (2.2) - ------------------------------------------------------------------------------ Total shareholders' equity (deficit) 178.7 (152.5) - ------------------------------------------------------------------------------ Total liabilities and shareholders' equity (deficit) $1,893.8 $ 1,881.3 - ------------------------------------------------------------------------------ See Notes to Consolidated Financial Statements on pages 26 through 35.
24 Armco 1998 Annual Report CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 1998, 1997 and 1996
- ------------------------------------------------------------------------------ (Dollars in millions) 1998 1997 1996 - ------------------------------------------------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 347.1 $ 76.8 $ 32.5 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 63.3 61.3 58.7 Net gain on disposal of investments and facilities (0.8) (4.5) (8.9) Loss on retirement of debt - 3.0 - Special charges - - 8.8 Cumulative effect of accounting change (237.5) - - Other 5.8 6.4 6.3 Changes in assets and liabilities: Trade accounts receivable 1.3 (9.1) 22.8 Inventories 18.6 (21.4) (33.3) Payables and accrued operating expenses (25.1) 22.1 (13.2) Employee benefit obligations (48.8) (13.5) (17.4) Other assets and liabilities - net (28.7) (30.3) (13.7) - ------------------------------------------------------------------------------ Net cash provided by operating activities 95.2 90.8 42.6 - ------------------------------------------------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES Net proceeds from the sale of businesses and assets 1.7 7.7 14.0 Proceeds from the sale and maturity of liquid investments 5.6 0.3 - Proceeds from the sale of investments 6.0 15.1 78.7 Purchase of liquid investments (7.6) (5.0) (0.3) Contributions to investees - - (3.0) Capital expenditures (32.6) (41.9) (59.8) Other 0.2 (0.2) (2.7) - ------------------------------------------------------------------------------ Net cash (used in) provided by investing activities (26.7) (24.0) 26.9 - ------------------------------------------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of debt 74.4 151.1 5.5 Payments on debt (51.2) (177.7) (24.3) Dividends paid on preferred stock (17.7) (17.9) (17.9) Other (0.1) (1.3) (0.7) - ------------------------------------------------------------------------------ Net cash provided by (used in) financing activities 5.4 (45.8) (37.4) - ------------------------------------------------------------------------------ Net increase in cash and cash equivalents 73.9 21.0 32.1 Cash and cash equivalents: Beginning of year 189.9 168.9 136.8 - ------------------------------------------------------------------------------ End of year $ 263.8 $ 189.9 $ 168.9 - ------------------------------------------------------------------------------ Supplemental disclosures of cash flow information: Cash paid during the year for: Interest (net of capitalized interest) $ 28.8 $ 34.7 $ 35.1 Income taxes 2.5 2.8 0.1 Supplemental schedule of non-cash investing and financing activities: Issuance of restricted stock 4.0 2.7 2.0 Notes receivable in partial payment for asset sales - 0.3 10.6 - ------------------------------------------------------------------------------ See Notes to Consolidated Financial Statements on pages 26 through 35.
Armco 1998 Annual Report 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions, except per share amounts) - ------------------------------------------------------------------------------ 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES GENERAL The accompanying financial statements consolidate the accounts of Armco and all subsidiaries in which Armco has a controlling interest. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. INVESTMENTS Armco considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Cash equivalents consist of commercial paper, corporate notes, time deposits and other money market instruments, including mutual funds. Under the definitions provided in Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, Armco has securities which have been classified as held to maturity and are, therefore, recorded at amortized cost. The carrying amounts for these securities approximate fair value due to the short maturities of the instruments. At December 31, 1998 and 1997, these securities were as follows:
- ------------------------------------------------------------------------------ 1998 1997 - ------------------------------------------------------------------------------ Cash equivalents $256.7 $180.4 Short-term liquid investments 7.0 5.0 Restricted collateral deposits 10.1 15.5 - ------------------------------------------------------------------------------ Total securities $273.8 $200.9 - ------------------------------------------------------------------------------
The restricted collateral deposits are primarily invested in certificates of deposit which mature within one year and are principally used as security for self-insurance programs and environmental and litigation bonds. These securities are reported in other current assets or other investments. The classification is determined based on the expected term of the collateral requirement and not necessarily the maturity date of the underlying securities. At December 31, 1998 and 1997, other investments also included $11.2 for Armco's limited partnership interest in North American Stainless. It is not practicable to estimate the fair value of this closely held limited partnership, in which Armco's ownership interest is less than 5%. At December 31, 1998 and 1997, Armco had no material investments in derivative financial instruments. INVENTORIES Inventories are valued at the lower of cost or market. Cost of inventories at most domestic operations is measured on the LIFO - Last In, First Out - method. Other inventories are measured principally at average cost. Inventory balances at December 31, 1998 and 1997 were as follows:
- ------------------------------------------------------------------------------ 1998 1997 - ------------------------------------------------------------------------------ Inventories on LIFO Finished and semi-finished $254.7 $280.3 Raw materials and supplies 15.8 25.8 Adjustment to state inventories at LIFO value (37.2) (54.0) - ------------------------------------------------------------------------------ Total 233.3 252.1 - ------------------------------------------------------------------------------ Inventories on average cost Finished and semi-finished 12.3 10.8 Raw materials and supplies 5.1 5.1 - ------------------------------------------------------------------------------ Total 17.4 15.9 - ------------------------------------------------------------------------------ Total inventories $250.7 $268.0 - ------------------------------------------------------------------------------
RESEARCH AND DEVELOPMENT COSTS Armco conducts a broad range of research and development activities. These activities are aimed at improving existing products and manufacturing processes and developing new products and processes. Research and development costs are recorded as expense when incurred. The amounts incurred in 1998, 1997 and 1996 were $14.2, $15.3 and $13.1, respectively. PROPERTY, PLANT AND EQUIPMENT Depreciation is computed using the straight-line method based on the estimated useful lives of the related assets. Leasehold improvements are depreciated over the shorter of the life of the related asset or the life of the lease. Generally, Armco depreciates its property, plant and equipment at annual rates of 5% for land improvements, 3% to 5% for buildings and 5% to 33% for machinery and equipment. Armco's property, plant and equipment balances at December 31, 1998 and 1997 were as follows:
- ------------------------------------------------------------------------------ 1998 1997 - ------------------------------------------------------------------------------ Land $ 28.8 $ 28.1 Buildings 95.7 93.2 Machinery and equipment 1,185.6 1,156.9 Construction in progress 26.0 27.3 - ------------------------------------------------------------------------------ Total property, plant and equipment 1,336.1 1,305.5 Accumulated depreciation (714.3) (653.0) - ------------------------------------------------------------------------------ Property, plant and equipment-net $ 621.8 $ 652.5 - ------------------------------------------------------------------------------
Armco had commitments to purchase property, plant and equipment (including unexpended amounts relating to projects substantially underway) totaling approximately $17.8 at December 31, 1998. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and other intangible assets primarily consist of goodwill recorded in connection with the acquisition of Cyclops Industries, Inc. on April 24, 1992. This goodwill is being amortized using the straight-line method over 40 years. Also included are goodwill and other intangible assets acquired in the purchase of Douglas Dynamics, LLC on July 2, 1991. These assets are being amortized over their estimated 26 Armco 1998 Annual Report useful lives, the majority of which do not exceed 17 years. Annual amortization expense for 1998, 1997 and 1996 was $6.1, $6.5 and $6.9, respectively. At December 31, 1998 and 1997, accumulated amortization of goodwill and other intangible assets was $42.6 and $36.5, respectively. Armco assesses whether its goodwill and other intangible assets are impaired as required by SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, based on an evaluation of undiscounted projected cash flows through the remaining amortization period. If an impairment exists, the amount of such impairment is calculated based on the estimated fair value of the asset. EARNINGS PER SHARE The following information was used in the calculation of basic and diluted earnings per share:
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Income from continuing operations Income as reported $109.6 $ 77.1 $ 26.0 Less: Preferred stock dividends (17.9) (17.9) (17.9) - ------------------------------------------------------------------------------ Income available to common shareholders - Basic 91.7 59.2 8.1 Assumed conversion of $3.625 Class A preferred stock 9.8 9.8 - - ------------------------------------------------------------------------------ Income available to common shareholders - Diluted $101.5 $ 69.0 $ 8.1 - ------------------------------------------------------------------------------ Common shares (in millions) Weighted average shares outstanding - Basic 107.8 107.0 106.6 Assumed exercise of stock options 0.1 - - Assumed conversion of $3.625 Class A preferred stock 18.3 18.3 - - ------------------------------------------------------------------------------ Weighted average shares outstanding - Diluted 126.2 125.3 106.6 - ------------------------------------------------------------------------------
At the end of each year, Armco had outstanding exercisable stock options and convertible preferred stock whose exercise or conversion could, under certain circumstances, further dilute earnings per share. The following shares of potentially issuable common stock were not included in the above weighted average shares outstanding because to do so would have had an antidilutive effect on earnings per share in the years presented:
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Common shares (in millions) Exercisable stock options 2.7 2.2 1.7 Convertible preferred stock (Note 5) $2.10 Class A 2.2 2.2 2.2 $3.625 Class A - - 18.3 $4.50 Class B 2.2 2.2 2.2 - ------------------------------------------------------------------------------
ENVIRONMENTAL LIABILITIES Armco has participated in or funded various cleanup efforts at sites where its facilities have disposed of wastes, including sites located on its own properties. Costs related to these efforts are accrued when it is probable that a liability has been incurred and the amount of that liability can be reasonably estimated. It is Armco's policy not to accrue environmental exit costs with respect to ongoing businesses until a decision is made to dispose of the property. CONCENTRATION OF CREDIT RISK Armco is primarily a producer of stainless and electrical steels and steel products, which are sold to a number of markets, including automotive, industrial machinery and equipment, construction, power distribution and appliances. Armco sells domestically to customers primarily in the Midwestern and Eastern United States, while approximately 12% of sales are to foreign customers, primarily in Canada, Mexico and Western Europe. Approximately 37% of trade receivables outstanding at December 31, 1998 are due from businesses that supply the U.S. automotive industry. Except in a few situations where the risk warrants it, Armco does not require collateral on trade receivables; and while it believes its trade receivables will be collected, Armco anticipates that in the event of default it would follow normal collection procedures. Overall, credit risk related to Armco's trade receivables is limited due to the large number of customers in differing industries and geographic areas. NEW ACCOUNTING STANDARD In 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133). Armco intends to adopt the new standard when required in 2000. Armco does not expect that SFAS No. 133 will have a material effect on its financial statements; however, its effect, if any, will depend on Armco's exposure to derivative instruments at the time of adoption and thereafter. FAIR VALUE The fair value of financial instruments is disclosed in Notes 1 and 4. - ------------------------------------------------------------------------------ 2. PENSION AND OTHER POSTRETIREMENT BENEFITS Armco provides noncontributory pension benefits to most employees and provides various health care and life insurance benefits to most retirees. Retiree health and life insurance benefits are funded as claims are paid. Pension benefits are funded as required. As of December 31, 1998, pension funding credits of $57.3 were available to offset future minimum funding requirements of the Employee Retirement Income Security Act of 1974. The components of net periodic benefit cost, including amounts related to divested units, are as follows:
- ------------------------------------------------------------------------------ Pension Benefits Other Benefits -------------------------- -------------------------- 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------ Cost of benefits earned during the year $ 16.8 $ 15.4 $ 15.6 $ 4.4 $ 4.1 $ 4.9 Interest cost 140.4 147.8 141.0 50.7 58.3 61.8 Expected return on plan assets (186.2) (167.5) (147.3) - - - Amortization of unrecog- nized net obligation 6.3 6.4 6.4 - - - Amortization of prior service cost 1.0 0.9 0.4 (9.0) (7.3) (3.8) Amortization of losses (gains) (7.6)* (2.1) 0.4 (5.1)* (7.7) - - ------------------------------------------------------------------------------ Net periodic benefit cost $(29.3)* $ 0.9 $16.5 $41.0* $47.4 $62.9 - ------------------------------------------------------------------------------ * Note: Amount excludes the cumulative effect of a change in accounting in 1998.
Armco 1998 Annual Report 27 Effective January 1, 1998, Armco changed its method of amortizing unrecognized net gains and losses related to its obligations for pensions and other postretirement benefits. In 1998, Armco recognized income of $237.5, or $2.20 per share of common stock ($1.88 per diluted share), for the cumulative effect of this accounting change. At the time it originally adopted the standards governing accounting for pensions and other postretirement benefits, Armco chose to use a minimum amortization method whereby unrecognized net gains and losses, to the extent they exceeded 10% of the larger of the benefit obligations or plan assets, were amortized over the average remaining service life of active participants. At Armco, the average remaining service life is approximately 15 years. Use of this method, however, resulted in the accumulation of $419.3 of unrecognized net gains for pensions and other postretirement benefits through 1997. Under the new accounting method, Armco recognizes into income, as a fourth quarter adjustment, any unrecognized net gains and losses which exceed the 10% corridor, as described above, and amortizes amounts inside the corridor over the average remaining service life of active participants. Adoption of the new method increased 1998 income from continuing operations by approximately $3.0, or $0.03 per share of common stock.
- ------------------------------------------------------------------------------ Pension Benefits Other Benefits ------------------ -------------------- 1998 1997 1998 1997 - ------------------------------------------------------------------------------ Change in Benefit Obligation Benefit obligation at beginning of the year $2,099.0 $2,000.3 $ 755.2 $ 783.2 Service cost 16.8 15.4 4.4 4.1 Interest cost 140.4 147.8 50.7 58.3 Plan participants' contributions - - 8.5 7.8 Actuarial losses (gains) 37.2 138.5 23.9 (14.0) Plan amendments 15.0 0.4 (18.0) (16.4) Benefits paid (199.1) (203.4) (66.5) (67.8) - ------------------------------------------------------------------------------ Benefit obligation at year end $2,109.3 $2,099.0 $ 758.2 $ 755.2 - ------------------------------------------------------------------------------ Change in plan assets Fair value of plan assets at beginning of year $2,106.4 $2,007.5 $ - $ - Actual return on plan assets 166.1 300.6 - - Employer contributions 2.0 1.7 58.0 60.0 Plan participants' contributions - - 8.5 7.8 Benefits paid (199.1) (203.4) (66.5) (67.8) - ------------------------------------------------------------------------------ Fair value of plan assets at year end $2,075.4 $2,106.4 $ - $ - - ------------------------------------------------------------------------------ Funded status $ (33.9) $ 7.4 $(758.2) $ (755.2) Unrecognized net gain (41.4) (223.7) (47.3) (195.6) Unrecognized prior service cost 18.2 4.2 (96.0) (86.9) Unrecognized transition obligation 21.0 27.4 - - - ------------------------------------------------------------------------------ Net amount recognized $ (36.1) $ (184.7) $(901.5) $(1,037.7) - ------------------------------------------------------------------------------ Detail of Balance Sheet Amounts: Accrued benefit liability $ (42.7) $ (189.4) $(901.5) $(1,037.7) Intangible asset 4.0 4.7 - - Accumulated other comprehensive income 2.6 - - - - ------------------------------------------------------------------------------ Net amount recognized $ (36.1) $ (184.7) $(901.5) $(1,037.7) - ------------------------------------------------------------------------------
The following are weighted-average assumptions as of December 31:
- ------------------------------------------------------------------------------ Pension Benefits Other Benefits ------------------ -------------------- 1998 1997 1998 1997 - ------------------------------------------------------------------------------ Discount rate 6.75% 7.00% 6.75% 7.00% Expected return on plan assets 8.75% 9.25% - - Rate of compensation increase 4.00% 4.00% 4.00% 4.00% - ------------------------------------------------------------------------------
At December 31, 1998, pension plan assets include 3.6 million shares of Armco common stock with a fair value of $15.7. No Armco stock was held by the plans at December 31,1997. For measurement purposes, a 4.75% annual increase in health care costs is assumed for post-age 64 retirees. Health care costs for pre-age 65 retirees are assumed to increase 6% in 1999. This rate declines annually until it reaches 4.75% in 2001 and thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one percentage-point change in assumed health care cost trend rates would have the following effects:
- ------------------------------------------------------------------------------ One Percentage- One Percentage- Point Increase Point Decrease - ------------------------------------------------------------------------------ Increase (decrease) in total of service and interest cost components $ 5.6 $ (5.0) Increase (decrease) in postretirement benefit obligation 63.5 (57.5) - ------------------------------------------------------------------------------
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for plans with accumulated benefit obligations in excess of plan assets, including unfunded nonqualified pension plans, was $24.4, $19.4 and $1.3, respectively, at December 31, 1998, and $19.3, $16.2 and $1.2, respectively, at December 31, 1997. In addition to the defined benefit pension plans, most employees are eligible to participate in various defined contribution plans. Total company expense related to these plans was $7.4, $6.7 and $2.9 for 1998, 1997 and 1996, respectively. A portion of the expense of these plans varies based on Armco's profitability. 28 Armco 1998 Annual Report EMPLOYEE BENEFIT OBLIGATIONS OF FORMER BUSINESS UNITS Included in employee benefit liabilities is the present value of estimated pension and health care benefits for former employees associated with facilities that have been divested. Sundry other-net includes income of $24.2 in 1998 and expense of $2.0 and $22.1 in 1997 and 1996, respectively, related to these liabilities. The decrease in costs in 1997 and 1998 was primarily due to continuing favorable investment returns on pension plan assets and lower than expected increases in medical benefit costs. - ------------------------------------------------------------------------------ 3. INCOME TAXES Armco files a consolidated U.S. federal income tax return. This return includes all domestic companies 80% or more owned by Armco and the proportionate share of Armco's interest in partnership investments. State tax returns are filed on a consolidated, combined or separate basis depending on the applicable laws relating to Armco and its domestic subsidiaries. The United States and foreign components of income before income taxes consist of the following:
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ United States $113.2 $77.8 $24.4 Foreign 2.2 1.6 3.0 - ------------------------------------------------------------------------------ Total $115.4 $79.4 $27.4 - ------------------------------------------------------------------------------
Provisions for income taxes for Armco and consolidated subsidiaries are as follows:
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Current U.S. federal $1.0 $1.2 $ - U.S. state 0.2 0.3 - Foreign 1.1 0.8 1.4 - ------------------------------------------------------------------------------ Total 2.3 2.3 1.4 - ------------------------------------------------------------------------------ Deferred U.S. federal 3.5 - - - ------------------------------------------------------------------------------ Total $5.8 $2.3 $1.4 - ------------------------------------------------------------------------------
The following is a reconciliation of the statutory federal income tax rate applied to income before income taxes with the provision for income taxes:
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Federal taxes at statutory rate $ 40.4 $ 27.8 $ 9.6 State taxes, net of federal benefit 0.1 0.2 - Change in deferred tax valuation allowance (34.7) (25.7) (8.2) - ------------------------------------------------------------------------------ Total $ 5.8 $ 2.3 $ 1.4 - ------------------------------------------------------------------------------
During 1998, Armco's net operating loss carryforwards decreased by approximately $54.3 due to taxable income generated in the year. Armco's capital loss carryforward decreased by approximately $50.4, of which $14.3 was the result of taxable capital gains generated in the year, and $36.1 was due to the expiration of unused capital losses available from 1993. The difference between pretax book income of $115.4 and 1998 taxable income is primarily due to costs associated with employee benefits, environmental and restructuring actions, which had been accrued for financial accounting purposes in prior years, but actually paid in 1998; and additional net deductions resulting from the 1998 operations of the Armco Financial Services Group. At December 31, 1998, Armco had capital loss and net operating loss (NOL) carryforwards for federal tax purposes expiring as follows:
- ------------------------------------------------------------------------------ Year Capital expiring loss NOL - ------------------------------------------------------------------------------ 1999 $ - $ 106.7 2000 117.4 - 2001 46.0 123.3 2004 - 9.1 2005 - 129.4 2006 - 238.6 2007 - 186.2 2008 - 125.2 2009 - 29.9 2010 - 44.4 2011 - 31.1 - ------------------------------------------------------------------------------ Total loss carryforwards $163.4 $1,023.9 - ------------------------------------------------------------------------------
Armco has $698.0 in U.S. alternative minimum tax net operating losses. Additionally, Armco has $13.0 of alternative minimum tax credits that have no expiration. Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and (b) operating loss and tax credit carryforwards. At December 31, 1998 and 1997, the net deferred tax asset, included on the Consolidated Balance Sheets, was as follows:
- ------------------------------------------------------------------------------ 1998 1997 - ------------------------------------------------------------------------------ Other current assets $ 9.2 $ 9.2 Deferred tax asset 315.8 319.3 - ------------------------------------------------------------------------------ Net deferred tax asset $325.0 $328.5 - ------------------------------------------------------------------------------
Armco 1998 Annual Report 29 Major components of Armco's year-end net deferred tax asset are as follows:
- ------------------------------------------------------------------------------ 1998 1997 - ------------------------------------------------------------------------------ Tax effects of Operating loss and tax credit carryforwards $ 478.4 $ 522.2 Employee benefits 433.0 556.4 Other assets (including contingencies and accruals) 123.8 133.5 - ------------------------------------------------------------------------------ Gross deferred tax asset 1,035.2 1,212.1 Valuation allowance (448.6) (593.0) - ------------------------------------------------------------------------------ Deferred tax asset 586.6 619.1 - ------------------------------------------------------------------------------ Property, plant and equipment (155.1) (148.8) Other liabilities (106.5) (141.8) - ------------------------------------------------------------------------------ Deferred tax liability (261.6) (290.6) - ------------------------------------------------------------------------------ Net deferred tax asset $ 325.0 $ 328.5 - ------------------------------------------------------------------------------
Management believes it is more likely than not that Armco will generate future taxable income sufficient to realize that portion of the tax benefit associated with future deductible temporary differences and NOL carryforwards, represented by the $325.0 net deferred tax asset. Armco prepares a calculation annually in which it estimates future income and schedules the future effects of temporary differences and NOL carryforwards. Because any forecast has inherent uncertainties and because of the structural changes Armco has undergone over the last nine years, Armco uses what it believes to be conservative estimates and assumptions. Considering all available evidence, both positive and negative, Armco periodically determines if there has been a significant change in the net deferred tax asset. During the last several years, based on forecasts and consideration of available evidence, Armco believes that there has been no significant change in the amount of its net deferred tax asset. Armco's belief that realization of its net deferred tax asset is more likely than not is based on, among other factors, changes in operations that have occurred during the 1990s, as well as consideration of available tax planning strategies. Specifically, cost savings resulting from new capital investments are being realized and are expected to continue to improve operating results. Armco has operated in a highly cyclical industry and, consequently, has had a history of generating and then utilizing significant amounts of NOL carryforwards. In 1997 and 1998, in addition to using its temporary differences, principally related to employee benefit obligations, to reduce taxable income, Armco utilized approximately $70.0 of its NOL carryforwards. These were the first two years of taxable income for Armco after seven years of tax losses. However, if Armco is unable to generate sufficient taxable income in the future through operating results, increases in the valuation allowance may be required through a charge to income. On the other hand, if Armco achieves sufficient profitability to utilize a greater portion of the deferred tax asset, the valuation allowance will be reduced through a credit to income. United States income tax returns of Armco for 1994 and prior years have been subject to examination by the Internal Revenue Service and are closed to assessments. However, the NOL carryforwards from some of these years remain open to adjustment. Armco has been in a cumulative NOL carryforward position since 1983 and believes that it has sufficient loss carryforwards in excess of any potential audit adjustments that might be made by the Internal Revenue Service for any open years. - ------------------------------------------------------------------------------ 4. LONG-TERM DEBT AND OTHER FINANCING LONG-TERM DEBT At December 31, 1998 and 1997, Armco's long-term debt was as follows:
- ------------------------------------------------------------------------------ 1998 1997 - ------------------------------------------------------------------------------ Senior notes 8-7/8% due 2008 $ 75.0 $ - 9% due 2007 150.0 150.0 9-3/8% due 2000 111.0 125.0 Variable rate loan (LIBOR plus 2.75%) due 2001 - 31.2 5% loan due 2000 10.2 15.3 8-1/8% pollution control revenue bonds due 2005 - 12.1 Variable rate revenue refunding bonds due 2008 (1998 average 3.53%) 12.1 - Variable rate economic development revenue bonds due 2020 (1998 average 3.67%) 7.3 8.5 Other 2.0 3.0 - ------------------------------------------------------------------------------ Total debt 367.6 345.1 Less current maturities (116.9) (38.2) - ------------------------------------------------------------------------------ Long-term debt $ 250.7 $ 306.9 - ------------------------------------------------------------------------------
Maturities of existing long-term debt during the five years ending December 31, 2003, are as follows: 1999, $116.9; 2000, $5.9; 2001, $0.8; 2002, $0.8 and 2003, zero. The 1999 maturities include the January 14, 1999 redemption of $111.0 of the 9-3/8% Senior Notes. These notes were redeemed with the proceeds of the December 1998 issuance of $75.0 of 8-7/8% Senior Notes due 2008 and other available funds. In the first quarter of 1999, Armco recognized an extraordinary loss of $2.8 related to this redemption. 30 Armco 1998 Annual Report At December 31, 1998, the fair value of Armco's long-term debt, including current maturities, was approximately $372.9. This amount was determined by calculating a value based on cash flow yield to maturity and comparing that amount to market information where possible. The fair value estimate was based on pertinent information available to management as of December 31, 1998. Management is not aware of any significant factors that would materially alter this estimate since that date. The fair value of Armco's long-term debt, including current maturities, at December 31, 1997, was approximately $347.4. At December 31, 1998 and 1997, $13.2 and $50.2, respectively, of long-term debt, including current maturities, represented financing utilized to construct certain of Armco's fixed assets, which are pledged as collateral on these loans. During 1997, Armco recorded an extraordinary loss upon retiring certain of its outstanding debt of $3.0 or $0.03 per share of common stock. BANK CREDIT AGREEMENTS At December 31, 1998, Armco had in place two bank credit facilities, totaling $170.0. In 1998, the terms of these facilities were extended and both will expire in 2001. Under a receivables facility, Armco sells substantially all its trade receivables to a wholly owned subsidiary, Armco Funding Corporation (AFC). In 1998, AFC and its bank group amended its revolving credit agreement to provide, depending on its available borrowing base, up to $100.0 for loans and letters of credit secured by AFC's receivables. At December 31, 1998, there were no outstanding borrowings under this credit facility; however, $61.1 of the facility was used as support for letters of credit. In 1998, Armco and its bank group amended its revolving credit agreement to provide, depending on its available borrowing base, up to $70.0 for loans and letters of credit secured by Armco's inventories. This credit agreement subjects Armco to certain restrictions and covenants related to, among other things, minimum net worth, leverage ratio and interest coverage ratio requirements. At December 31, 1998, there were no outstanding borrowings or letters of credit under this facility. Under both bank credit facilities, a total of $93.3 was available for borrowing at December 31, 1998. LONG-TERM LEASES Rental expense under operating leases was $6.7 in 1998, $6.9 in 1997 and $7.7 in 1996. At December 31, 1998, commitments to make future minimum lease payments for operating leases are $4.3 in 1999, $2.9 in 2000, $2.4 in 2001, $3.0 in 2002, $1.3 in 2003 and $1.2 thereafter. - ------------------------------------------------------------------------------ 5. SHAREHOLDERS' EQUITY (DEFICIT) PREFERRED STOCK Armco has outstanding two classes of preferred stock that rank equally with respect to dividend payments, redemption and liquidation rights. The preferred stock ranks senior to Armco's common stock with respect to dividends and upon liquidation. At December 31, 1998 and 1997, there were authorized and issuable in series, 6,697,231 shares of Class A preferred stock with no par value and 5,000,000 shares of $1 par value Class B preferred stock. Armco has two series of Class A and one series of Class B preferred stock outstanding. Except as noted, the following relates to each issue at December 31, 1998 and 1997:
- ------------------------------------------------------------------------------ $2.10 $3.625 $4.50 Class A Class A Class B - ------------------------------------------------------------------------------ Number of shares outstanding 1,697,231 2,700,000 999,900 Total book value of shares outstanding $7.2 $130.4 $48.3 Per share data: Cumulative dividend (annual rate) $2.10 $3.625 $4.50 Common stock conversion rate 1.27 6.78 2.22 Redemption price (at Armco's option) $40.00 $51.45* $50.00 Liquidation value $15.00 $50.00 $50.00 Voting rights 1 vote 1 vote No vote - ------------------------------------------------------------------------------ * Price as of December 31, 1998. This price declines at 12-month intervals to $50 per share on and after October 15, 2002.
COMMON STOCK At December 31, 1998, 22,681,261 unissued shares of Armco's common stock were reserved for the conversion of preferred stock and 4,343,247 unissued shares of common stock were reserved for the exercise of stock options (see Note 6). Activity for the years 1996, 1997 and 1998 related to Armco's common stock was as follows:
- ------------------------------------------------------------------------------ Additional Paid-in Shares Par Value Capital - ------------------------------------------------------------------------------ Balance, December 31, 1995 106,102,560 $1.1 $963.0 Exercise of options 3,100 - - Restricted stock issued - net of cancellations 347,313 - 2.0 Directors' stock purchase plan 4,193 - - - ------------------------------------------------------------------------------ Balance, December 31, 1996 106,457,166 1.1 965.0 Exercise of options 25,500 - - Restricted stock issued - net of cancellations 643,013 - 2.7 Directors' stock purchase plan 3,882 - - - ------------------------------------------------------------------------------ Balance, December 31, 1997 107,129,561 1.1 967.7 Exercise of options 62,900 - 0.3 Restricted stock issued - net of cancellations 707,802 - 4.0 Directors' stock purchase plan 8,122 - - - ------------------------------------------------------------------------------ Balance, December 31, 1998 107,908,385 $1.1 $972.0 - ------------------------------------------------------------------------------
SHAREHOLDER RIGHTS PLAN In 1996, Armco adopted a Shareholder Rights Plan designed to deter coercive takeover tactics and prevent an acquirer from gaining control of Armco without offering a fair price to all of Armco's shareholders. Under the terms of the plan, preferred stock purchase rights were distributed as a dividend at the rate of one right for each share of common stock held as of the close of business on June 26, 1996. Until the rights become exercisable, common stock issued will also have one right attached. Each right will entitle shareholders to buy one two-hundredth of a share of a currently unissued series of Class A participating preferred stock of Armco at an exercise price of $20. Each right will thereafter entitle the holder to receive upon exercise, common stock or, in certain circumstances, preferred stock or other securities or assets of the company having a value of $40. The rights will be exercisable only if a person or group acquires beneficial ownership of Armco 1998 Annual Report 31 20% or more of Armco's common stock or announces a tender or exchange offer, after which such person or group would beneficially own 20% or more of the common stock, or if the Board of Directors declares any person to be an "adverse person" as defined in the plan. A total of 750,000 shares of Class A participating preferred stock have been reserved for issuance upon exercise of the rights. Armco, except as otherwise provided in the plan, will generally be able to redeem the rights at $0.0025 per right at any time during a ten-day period following public announcement that a 20% position in Armco has been acquired or after the effective date the Board of Directors declares any person to be an "adverse person." During this ten-day period, Armco may also extend the time during which it may redeem the rights. The rights are not exercisable until the expiration of the redemption period. The rights will expire on June 26, 2006. ACCUMULATED DEFICIT, DEFERRED COMPENSATION AND ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Activity for the years 1996, 1997 and 1998 related to Armco's accumulated deficit, deferred compensation and accumulated other comprehensive income (loss) was as follows:
- ------------------------------------------------------------------------------ Accumulated Other Comprehensive Income (Loss) -------------------- Foreign Minimum Accumulated Deferred Currency Pension Deficit Compensation Translation Liability - ------------------------------------------------------------------------------ Balance, December 31, 1995 $(1,378.5) $(2.8) $ 0.9 $ - Net income 32.5 - - - Preferred stock dividends declared (17.9) - - - National-Oilwell foreign currency translation - - 1.4 - Foreign currency translation adjustment - - (0.4) - Amortization and cancellation of deferred compensation - 2.0 - - Deferred compensation on restricted stock issued - (1.2) - - - ------------------------------------------------------------------------------ Balance, December 31, 1996 (1,363.9) (2.0) 1.9 - Net income 76.8 - - - Preferred stock dividends declared (17.9) - - - Foreign currency translation adjustment - - (1.4) - Amortization and cancellation of deferred compensation - 1.7 - - Deferred compensation on restricted stock issued - (2.4) - - - ------------------------------------------------------------------------------ Balance, December 31, 1997 (1,305.0) (2.7) 0.5 - Net income 347.1 - - - Preferred stock dividends declared (17.9) - - - Foreign currency translation adjustment - - 0.3 - Amortization and cancellation of deferred compensation - 2.0 - - Deferred compensation on restricted stock issued - (2.0) - - Minimum pension liability adjustment - - - (2.6) - ------------------------------------------------------------------------------ Balance, December 31, 1998 $ (975.8) $(2.7) $ 0.8 $(2.6) - ------------------------------------------------------------------------------
DIVIDENDS In prior years, certain of Armco's financing arrangements included covenants that prohibited the payment of common stock dividends. These prohibitions have been eliminated; however, at December 31, 1998, certain outstanding financing arrangements contain financial tests which must be met before dividends can be paid. Currently, Armco meets these covenant requirements and is not prohibited from paying dividends under the terms of its credit facilities, long-term debt issues or under Ohio law. Armco is permitted to purchase shares of its capital stock under the terms of Ohio law only to the extent that it has positive equity surplus. At December 31,1998, Armco had a negative equity surplus balance of $8.3. The Board of Directors at its January 1999 meeting declared the regular quarterly dividends payable on both series of Armco's Class A preferred stock and on its Class B preferred stock. - ------------------------------------------------------------------------------ 6. COMMON STOCK OPTIONS Armco maintains plans that provide for granting options to purchase common stock for not less than 100% of its market price on the date the option is granted. The vesting period for stock options granted under these plans is two years from the date of grant and, although they may terminate earlier under certain conditions, stock options generally expire 10 years after the grant date. Armco also has plans that provide for issuing stock, subject to restrictions as to sale and forfeiture over a three- to five-year period. Under certain circumstances, this vesting schedule may be accelerated by one year. At December 31, 1998, 5,492,769 shares of common stock were available for granting of awards under these plans. During 1996, 1997 and 1998, stock option activity was as follows:
- ------------------------------------------------------------------------------ Weighted Average Shares Exercise Price - ------------------------------------------------------------------------------ Outstanding at December 31, 1995 3,193,517 $ 7.58 Granted 947,158 5.24 Exercised (3,100) 4.94 Forfeited (159,645) 6.15 Expired (441,672) 9.38 - ------------------------------------------------------------------------------ Outstanding at December 31, 1996 3,536,258 6.80 Granted 472,201 4.13 Exercised (25,500) 4.76 Forfeited (8,700) 6.39 Expired (464,125) 10.27 - ------------------------------------------------------------------------------ Outstanding at December 31, 1997 3,510,134 6.00 Granted 1,117,239 5.31 Exercised (62,900) 4.74 Forfeited (34,926) 5.46 Expired (186,300) 8.83 - ------------------------------------------------------------------------------ Outstanding at December 31, 1998 4,343,247 5.72 - ------------------------------------------------------------------------------
The total number of options exercisable at the end of each year was as follows:
- ------------------------------------------------------------------------------ Weighted Average Shares Exercise Price - ------------------------------------------------------------------------------ 1996 1,741,811 $7.66 1997 2,161,324 6.72 1998 2,756,807 6.16 - ------------------------------------------------------------------------------
32 Armco 1998 Annual Report The following relates to the options outstanding at December 31, 1998:
- ------------------------------------------------------------------------------ Exercise Price Ranges $4.09 - $7.56 $12.06 - ------------------------------------------------------------------------------ Options outstanding Number of shares 4,219,347 123,900 Weighted average exercise price $5.54 $12.06 Average remaining contractual life 7 years 1 year Options exercisable Number of shares 2,632,907 123,900 Weighted average exercise price $5.88 $12.06 - ------------------------------------------------------------------------------
In 1996, Armco adopted SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 provides that companies may change their method of accounting for stock options to a fair value method using an option pricing model. Armco uses the intrinsic value approach specified in Accounting Principles Board Opinion No. 25 in accounting for stock options and did not change from this method upon adoption of the new standard. Had Armco changed its accounting method, its net income for 1998 would have been reduced by $1.7 to $345.4, or $3.04 per basic share and $2.67 per diluted share. Net income for 1997 would have been reduced by $1.2 to $75.6, or $0.54 per basic and diluted share, and net income for 1996 would have been reduced by $1.7 to $30.8, or $0.12 per basic and diluted share. These pro forma adjustments were calculated using the Black-Scholes option pricing model under the following assumptions in each year:
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Risk free interest rate 5.5% 6.25% 5.5% Expected volatility 40% 35% 30% Expected life of options 5 years 5 years 5 years Expected dividends None None None - ------------------------------------------------------------------------------
Based on the option pricing model, options granted during 1998, 1997 and 1996 had fair values of $2.32, $1.72 and $1.90 per share, respectively. During 1998, 1997 and 1996, Armco issued to certain employees 786,562, 646,013 and 570,158 shares of common stock, subject to restrictions, with weighted average grant-date fair values of $5.31, $4.07 and $5.69 per share, respectively. Total compensation cost recognized in income for stock-based employee compensation awards was $1.7 in 1998, $1.6 in 1997 and $1.1 in 1996. - ------------------------------------------------------------------------------ 7. SPECIAL CHARGES In 1996, Armco recognized a special charge of $5.9 to record a loss on the sale of its nonresidential construction business, which was sold effective January 1, 1997. The charge primarily related to the writedown of assets and recognition of additional employee benefit liabilities. Also in 1996, Armco recorded a $2.9 special charge primarily for the writedown of assets and severance costs related to its decision to discontinue a line of light truck equipment manufactured by Armco's snowplow and ice control products business. - ------------------------------------------------------------------------------ 8. SEGMENT INFORMATION Armco's reportable operating segments are three separately managed business units that offer different products and services. They are: (1) Specialty Flat-Rolled Steels, consisting of plants in Butler, Pennsylvania and Coshocton, Dover, Mansfield and Zanesville, Ohio that produce and finish flat- rolled stainless, electrical and galvanized carbon steels for the automotive, industrial machinery and equipment, construction, and service center markets; and international trading companies, that buy and sell steel and manufactured steel products. (2) Tubular Products, consisting of Sawhill Tubular with operations in Sharon and Wheatland, Pennsylvania and Warren, Ohio that produce steel pipe and tubular products for the industrial machinery, construction and appliance markets. And, (3) Other Businesses, consisting of Douglas Dynamics, LLC with plants in Milwaukee, Wisconsin, Rockland, Maine and Johnson City, Tennessee, that manufacture snowplows and ice control equipment for four-wheel drive light trucks and Greens Port Industrial Park, which leases land, buildings and rail car storage facilities and operates a deep water loading dock on a ship channel in Houston, Texas. A substantial portion of the Other Businesses segment represents the snowplow and ice control products business. Accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1. Armco's management evaluates segment performance based on income from continuing operations. Armco does not allocate interest expense, interest income, income tax expense or employee benefits for certain divested businesses to its segments. Armco's segment information is as follows:
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Net sales Specialty Flat-Rolled Steels $1,418.9 $1,497.0 $1,421.2 Tubular Products 192.7 209.4 189.6 Other Businesses 94.9 122.9 113.2 - ------------------------------------------------------------------------------ Total $1,706.5 $1,829.3 $1,724.0 - ------------------------------------------------------------------------------ Income from continuing operations Specialty Flat-Rolled Steels $ 105.7 $ 91.3 $ 72.9 Tubular Products 2.4 5.6 0.8 Other Businesses 28.2 36.1 23.3 Corporate (26.7) (55.9) (71.0) - ------------------------------------------------------------------------------ Total $ 109.6 $ 77.1 $ 26.0 - ------------------------------------------------------------------------------ Depreciation Specialty Flat-Rolled Steels $ 54.2 $ 52.6 $ 50.4 Tubular Products 4.5 4.3 4.1 Other Businesses 3.0 2.9 2.6 Corporate 1.6 1.5 1.6 - ------------------------------------------------------------------------------ Total $ 63.3 $ 61.3 $ 58.7 - ------------------------------------------------------------------------------ Capital expenditures Specialty Flat-Rolled Steels $ 22.2 $ 31.4 $ 55.9 Tubular Products 2.8 2.6 1.4 Other Businesses 4.6 5.5 1.7 Corporate 3.0 2.4 0.8 - ------------------------------------------------------------------------------ Total $ 32.6 $ 41.9 $ 59.8 - ------------------------------------------------------------------------------ Total assets Specialty Flat-Rolled Steels $ 871.2 $ 923.7 $ 934.2 Tubular Products 103.6 100.5 92.8 Other Businesses 76.7 78.6 70.4 Corporate 756.7 692.9 684.8 Discontinued operations 85.6 85.6 85.6 - ------------------------------------------------------------------------------ Total $1,893.8 $1,881.3 $1,867.8 - ------------------------------------------------------------------------------
Armco 1998 Annual Report 33 Total assets include the following assets reported in Corporate:
- ------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------ Cash and liquid investments $268.5 $192.0 $162.5 Deferred taxes 325.0 328.5 328.5 Goodwill and other intangibles 114.7 121.0 126.0 Other - net 48.5 51.4 67.8 - ------------------------------------------------------------------------------ Total Corporate $756.7 $692.9 $684.8 - ------------------------------------------------------------------------------
Other Businesses income from continuing operations for 1996 includes a $2.9 special charge (see Note 7). Armco's net sales to customers located outside the United States totaled $196.7, $185.4 and $165.4 for 1998, 1997 and 1996, respectively. - ------------------------------------------------------------------------------ 9. LITIGATION AND ENVIRONMENTAL MATTERS Armco and its subsidiaries are involved in various pending claims regarding product liability, patent, employee benefits, environmental matters, reinsurance and insurance arrangements, and other matters arising out of the conduct of Armco's business. The actual liability for legal claims against Armco at December 31, 1998 cannot be determined, but in Armco's opinion, based on current facts and circumstances, the ultimate liability resulting from such claims will not materially affect its consolidated financial position or liquidity. However, it is possible that due to fluctuations in Armco's operating results, future developments with respect to such matters could have a material effect on its results of operations in future interim or annual periods. In common with other U.S. manufacturers, Armco is subject to various federal, state and local environmental laws. These laws necessitate expenditures to meet environmental compliance requirements at Armco's facilities and to remediate sites where contamination has occurred. Compliance costs are either expensed as they are incurred or, when appropriate, are recorded as capital expenditures. Environmental exit costs are accrued when a decision is made to dispose of a property or a sale is recorded. Armco is a defendant, or identified as a potentially responsible party, in proceedings alleging liability for remediation, property damage or personal injury related to certain waste disposal sites. Armco has also received claims for indemnification for some properties it has previously owned or leased. In most cases involving waste disposal sites, Armco is one of many potentially responsible parties. In these cases, joint and several liability could be imposed on Armco or other parties; thus, theoretically, one party could be held liable for all costs related to a site. However, based on its experience and a review of current claims, Armco believes that any ultimate liability will be apportioned among Armco and other financially viable parties. Armco accrues its estimate of remediation and other costs for sites where it is probable that a liability has been incurred and the amount can be reasonably estimated. In establishing liabilities, Armco assesses the range of reasonably estimated outcomes and determines the most likely outcome for its liabilities within the range. Costs are estimated based on experience with site remediation, an understanding of current environmental laws and regulations, environmental assessments, the existence of other financially viable parties, expected remediation methods and the years in which Armco is expected to make payments toward each remediation (which range from the current year to 30 years or more in the future). These liabilities are not discounted. The cost estimates are reviewed regularly to assess changed conditions, including current interpretations of environmental laws and regulations, and changes in remediation technology and methods. Adjustments are made if changed conditions have a significant effect on cost estimates. Liabilities have not been adjusted for expected recoveries from insurers or other parties. The recorded amounts are currently believed by management to be sufficient. However, such estimates could significantly change in future periods to reflect new laws or regulations, advances in technologies, additional sites requiring remediation, new requirements at existing sites and Armco's share of liability at multi-party sites. It is not possible to determine whether additional loss, due to such changed circumstances, will occur or to reasonably estimate the amount or range of any potential additional loss. At December 31, 1998, Armco had recorded on its Consolidated Balance Sheets, $11.4 in other current liabilities and $50.4 in other long-term liabilities for estimated probable costs relating to legal and environmental matters. - ------------------------------------------------------------------------------ 10. DISCONTINUED OPERATIONS AEROSPACE AND STRATEGIC MATERIALS Oregon Metallurgical Corporation (Oremet), formerly 80% owned by Armco, was part of the Aerospace and Strategic Materials business segment that Armco sold in 1985. Prior to the sale, Armco filed a suit on behalf of Oremet in the U.S. Claims Court, claiming refunds and interest on federal and state taxes. Pursuant to the sales agreement, Armco retained the benefit of its share of any proceeds of this action, net of taxes imposed on Oremet and the buyer. In 1996, Armco and Oremet reached agreement with the Internal Revenue Service that a previous refund of taxes and interest should not itself have been taxable to Oremet, further increasing the net proceeds, which resulted in Armco recording an additional $6.5 gain on the sale. In 1997, Armco received an additional $2.7 in state and federal tax refunds. ARMCO FINANCIAL SERVICES GROUP (AFSG) Armco's investment in AFSG represents the net assets of its discontinued insurance and finance leasing businesses, which have been largely liquidated. The insurance companies, including Northwestern National Insurance Company (NNIC), have stopped writing new business and are being "run off." These companies are accounted for as discontinued operations under the liquidation basis of accounting, whereby future cash inflows and outflows are considered. Armco believes, based on current facts and circumstances, including the opinion of outside actuaries, that future changes in estimates of net losses relating to the ultimate liquidation of AFSG will not be material to Armco's financial position or liquidity. The following sets forth AFSG's consolidated summarized financial information at December 31, 1998:
- ------------------------------------------------------------------------------ Assets Invested assets $151.9 Reinsurance recoverable 79.1 Other 12.2 - ------------------------------------------------------------------------------ Total assets 243.2 - ------------------------------------------------------------------------------ Liabilities Losses and loss reserves (net of future investment income of $35.1) 139.0 Other 18.6 - ------------------------------------------------------------------------------ Total liabilities 157.6 - ------------------------------------------------------------------------------ Net assets $ 85.6 - ------------------------------------------------------------------------------
34 Armco 1998 Annual Report At December 31, 1998, AFSG's invested assets included $23.0 of various Senior Notes of Armco. On January 14, 1999, AFSG tendered $5.0 of the Senior Notes, which were redeemed by Armco on that date (see Note 4). Currently, insurance regulators having supervisory authority over the AFSG insurance companies retain substantial control over certain transactions, including the payment of dividends to Armco. In March 1997, North Atlantic Insurance Company, a group of international insurance companies previously affiliated with AFSG but sold in 1991, filed an application for voluntary liquidation in the United Kingdom. As a result of this voluntary liquidation filing, certain claims have been asserted against NNIC by insureds of North Atlantic. NNIC is defending these claims as well as pursuing related claims against third parties and North Atlantic. There are various pending matters relating to litigation, arbitration and regulatory affairs, including the above-mentioned voluntary liquidation. The ultimate liability from such matters at December 31, 1998 cannot be determined but, in Armco's opinion, based on current facts and circumstances and the views of outside counsel and advisors, any liability resulting will not materially affect Armco's financial position or liquidity. However, it is possible that due to fluctuations in Armco's results, future developments with respect to changes in the ultimate liability could have a material effect on future interim or annual results of operations. - ------------------------------------------------------------------------------ 11. QUARTERLY INFORMATION (UNAUDITED)
- ------------------------------------------------------------------------------ 1998 4Q 3Q 2Q 1Q - ------------------------------------------------------------------------------ Net sales $ 1,706.5 $ 393.3 $ 415.4 $ 450.1 $ 447.7 Cost of products sold (1,503.1) (342.0) (360.6) (396.1) (404.4) Income from discon- tinued operations (1) - - - - - Income before extra- ordinary loss and cumulative effect of an accounting change 109.6 27.5 30.7 31.1 20.3 Extraordinary loss (2) - - - - - Cumulative effect of a change in accounting for postretirement benefits (3) 237.5 - - - 237.5 Net income 347.1 27.5 30.7 31.1 257.8 Basic earnings per share Income from discon- tinued operations - - - - - Income before extra- ordinary loss and cumulative effect of an accounting change 0.85 0.21 0.24 0.25 0.15 Extraordinary loss - - - - - Cumulative effect of a change in accounting for postretirement benefits 2.20 - - - 2.21 Net income 3.05 0.21 0.24 0.25 2.36 Diluted earnings per share Income from discon- tinued operations - - - - - Income before extra- ordinary loss and cumulative effect of an accounting change 0.81 0.20 0.23 0.23 0.15 Extraordinary loss - - - - - Cumulative effect of a change in accounting for postretirement benefits 1.88 - - - 1.89 Net income 2.69 0.20 0.23 0.23 2.04 - ------------------------------------------------------------------------------ 1997 4Q 3Q 2Q 1Q - ------------------------------------------------------------------------------ Net sales $ 1,829.3 $ 436.4 $ 461.3 $ 490.3 $ 441.3 Cost of products sold (1,623.9) (387.4) (402.9) (436.1) (397.5) Income from discontinued operation (1) 2.7 1.4 - 1.3 - Income before extra- ordinary loss and cumulative effect of an accounting change 79.8 19.2 29.7 21.5 9.4 Extraordinary loss (2) (3.0) - (3.0) - - Cumulative effect of a change in accounting for postretirement benefits (3) - - - - - Net income 76.8 19.2 26.7 21.5 9.4 Basic earnings per share Income from discontinued operation 0.03 0.01 - 0.01 - Income before extra- ordinary loss and cumulative effect of an accounting change 0.58 0.14 0.24 0.16 0.05 Extraordinary loss (0.03) - (0.03) - - Cumulative effect of a change in accounting for postretirement benefits - - - - - Net income 0.55 0.14 0.21 0.16 0.05 Diluted earnings per share Income from discontinued operation 0.03 0.01 - 0.01 - Income before extra- ordinary loss and cumulative effect of an accounting change 0.58 0.14 0.22 0.16 0.05 Extraordinary loss (0.03) - (0.02) - - Cumulative effect of a change in accounting for postretirement benefits - - - - - Net income 0.55 0.14 0.20 0.16 0.05 - ------------------------------------------------------------------------------ (1) See Note 10. (2) See Note 4. (3) See Note 1.
Armco 1998 Annual Report 35 PRICE RANGE AND DIVIDENDS OF ARMCO STOCK (UNAUDITED) (Stock price lines reflect weekly closing prices)
- ------------------------------------------------------------------------------ - --------- 1997 1998 - ------------------------------------------------------------------------------ - --------- Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 - ------------------------------------------------------------------------------ - --------- COMMON STOCK NYSE: AS High 4-7/8 4-1/8 6-3/8 6-3/16 6-1/4 7-1/16 6-9/16 5-1/4 Low 3-3/8 3-3/8 3-13/16 4-1/2 4-7/16 5-1/4 3 3-11/16 $2.10 CLASS A PREFERRED STOCK Quarterly dividend per share: $.525 High 24 23-7/8 26 26-3/16 25-9/16 26-1/8 25-15/16 26 Low 21 21-1/4 23-1/2 24-1/4 23-1/2 21-5/8 22 22-1/2 $3.625 CLASS A PREFERRED STOCK Quarterly dividend per share: $.90625 High 43-1/4 42-7/8 52-1/8 51-3/4 52 54-3/4 52-1/4 44-1/2 Low 39 41-1/4 42-7/8 46-3/8 45-1/4 49 41-11/16 39-1/8 $4.50 CLASS B PREFERRED STOCK Quarterly dividend per share: $1.125 High 49-1/2 49 51-3/4 51-3/16 51-1/2 52-1/4 51-3/4 51-5/16 Low 46-1/4 47 48-9/16 49-5/8 49-1/2 50-3/8 49-3/16 47-5/8 - ------------------------------------------------------------------------------ - --------
36 Armco 1998 Annual Report EX-21 3 EX-21 Exhibit 21 ARMCO INC. SUBSIDIARIES
State/Country of Name Incorporation ---- ------------------ AFSG Holdings, Inc. Delaware Armco Europe Limited United Kingdom Armco Financial Services Corporation Delaware Armco Financial Services International, Inc. Ohio Armco Financial Services International, Ltd. Delaware Armco Funding Corporation Delaware Armco Insurance Group Inc. Delaware Armco Limited United Kingdom Armco Management Corporation Delaware Armco Pacific Financial Services Limited Vanuatu Armco Pacific Limited Singapore Compass Insurance Company Delaware Douglas Dynamics, L.L.C. Delaware FSA Services Corp. Delaware Materials Insurance Company Cayman Islands Northwestern National Insurance Company Wisconsin of Milwaukee, Wisconsin Talbico, Inc. New York
EX-23 4 EX-23 Exhibit 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 33-24258, 33-24259, 33-60405, 33-54351, 33-54353, 33-54355, 33-65946, 333- 01687 and 333-67801 and in Post-Effective Amendment No. 1 to Registration Statement Nos. 33-20852 and 33-20853 of Armco Inc., all on Form S-8, of our report dated February 5, 1999 on the consolidated financial statements of Armco Inc. and subsidiaries incorporated by reference in this Annual Report on Form 10-K of Armco Inc. for the year ended December 31, 1998. /s/ Deloitte & Touche LLP Pittsburgh, Pennsylvania March 12, 1999 EX-27 5 ARTICLE 5 FDS FOR 1998 FORM 10-K
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ARMCO INC. CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000007383 ARMCO INC. 1,000 U.S. DOLLAR JAN-01-1998 12-MOS DEC-31-1998 DEC-31-1998 1 263,800 7,000 161,300 3,400 250,700 692,800 1,336,100 714,300 1,893,800 417,100 250,700 0 185,900 1,100 (8,300) 1,893,800 1,706,500 1,706,500 1,503,100 1,503,100 0 0 28,900 115,400 5,800 109,600 0 0 237,500 347,100 3.05 2.69
EX-99 6 EX-99 Exhibit 99 DESCRIPTION OF CAPITAL STOCK General The authorized capital stock of Armco Inc. ("Armco" or the "Company") consists of (i) 150,000,000 shares of Common Stock, par value $.01 per share ("Armco Common Stock"), of which, at February 26, 1999, 107,912,948 shares were issued and outstanding; (ii) 6,697,231 shares of Class A Preferred Stock, no par value ("Class A Preferred Stock"), issuable in series, of which, at February 26, 1999, 1,697,231 shares of Armco $2.10 Cumulative Convertible Preferred Stock ("$2.10 Preferred Stock") were issued and outstanding and 2,700,000 shares of $3.625 Cumulative Convertible Preferred Stock ("$3.625 Preferred Stock") were issued and outstanding; and of which 750,000 shares had been designated Participating Preferred Stock (the "Participating Preferred Stock"), none of which have been issued; and (iii) 5,000,000 shares of Class B Preferred Stock, par value $1 per share ("Class B Preferred Stock"), issuable in series, of which, at February 26, 1999, 999,900 shares of $4.50 Cumulative Convertible Preferred Stock ("$4.50 Preferred Stock") were issued and outstanding. The Class A Preferred Stock and the Class B Preferred Stock are sometimes referred to herein as the "Armco Preferred Stock." No class of authorized capital stock of Armco, including the Armco Common Stock, has preemptive or other subscription rights. Armco is authorized to issue the Armco Preferred Stock in one or more series with such designations, powers, preferences and rights, and qualifications, limitations or restrictions thereon, as are permitted under Armco's Amended Articles of Incorporation and as shall be stated in the resolutions providing for the issue thereof as may be adopted by the Armco Board of Directors. The Class A Preferred Stock and the Class B Preferred Stock rank equally, whether or not dividend rates, dividend payment dates, redemption or liquidation prices per share of any series of Class A Preferred Stock differ from those of the Class B Preferred Stock, and the holders of Class A Preferred Stock and Class B Preferred Stock shall be entitled to the receipt of dividends and of the amounts distributable upon liquidation, dissolution or winding up, in proportion to their respective rates or liquidation prices, without preference or priority one over the other. Shares of Class A Preferred Stock that shall have been purchased, redeemed or otherwise acquired by Armco, including shares that have been converted or exchanged into another class or series of capital stock or other securities of Armco, shall be deemed retired and shall not be reissued or resold. Shares of Class B Preferred Stock purchased, redeemed or otherwise acquired by Armco will be restored to the status of authorized but unissued shares of Class B Preferred Stock, without designation as to series, and may thereafter be issued by the Armco Board of Directors. Each issued and outstanding share of Armco Preferred Stock is currently convertible into shares of Common Stock -- each $2.10 Preferred Stock share into 1.27 shares, each $4.50 Preferred Stock share into 2.22 shares and each $3.625 Preferred Stock share into 6.78 shares; provided, that the conversion rights of any shares of Armco Preferred Stock called for redemption shall terminate at the close of business on the business day (or on the fifth day, in the case of the $3.625 Preferred Stock) preceding the date fixed for redemption, unless there shall be a default in payment of the redemption price. The -1- number of shares of Armco Common Stock into which such Armco Preferred Stock shares are convertible is subject to adjustment under certain circumstances, such as splits or combinations of the Armco Common Stock or dividends on the Armco Common Stock paid in Armco Common Stock or non-cash assets. In addition, under certain circumstances involving a Change of Control (as defined in the terms of the $3.625 Preferred Stock), each issued and outstanding share of the $3.625 Preferred Stock may be converted, at the option of the holder, for a limited period into a number of shares of Armco Common Stock determined by formula. These special conversion rights of the $3.625 Preferred Stock may deter certain mergers, tender offers or other takeover attempts. On February 23, 1996, the Armco Board of Directors adopted a Stockholder Rights Plan and declared a dividend distribution of one preferred stock purchase right (a "Right") for each outstanding share of Armco Common Stock to stockholders of record at the close of business on June 26, 1996. Each Right, when exercisable, entitles the registered holder to purchase from Armco a unit consisting of one two-hundredths of a share of Participating Preferred Stock. Prior to the earlier of the Distribution Date and the Expiration Date (each as hereinafter defined), one Right will be distributed with each share of Armco Common Stock issued. See "Preferred Stock Purchase Rights." Armco's prior existing Stockholder Rights Plan expired on June 26, 1996. The documents defining the terms and provisions of the Armco Common Stock, the Rights and the Armco Preferred Stock are available for inspection upon request at the office of the Secretary of Armco. Such documents are also on file with and available for inspection at the Securities and Exchange Commission, 450 Fifth Street N.W., Washington, D.C. 20549, and the New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005. The statements set forth below are only summaries of such terms and provisions and reference should be made to such documents and instruments for complete statements of such terms and provisions. Dividend Rights Subject to the prior rights of the holders of Armco Preferred Stock to receive dividends in cash at the rate provided for, and subject to any restrictions or limitations contained in the express terms and provisions of any shares of Armco Preferred Stock, dividends may be declared and paid upon the Armco Common Stock, as and when determined by the Armco Board of Directors, out of funds legally available therefor. The corporate statute of Ohio, the Company's state of incorporation, provides that Ohio corporations that recognize immediately the full amount of their transition obligation under Statement of Financial Accounting Standards ("SFAS"), SFAS 106, as Armco did, could increase the amount available for payment of dividends by adding to the corporation's surplus at the time of the dividend the amount of the difference between the reduction in the corporation's surplus that resulted from the immediate recognition of the SFAS 106 transition obligation and the amount of the transition obligation that would have been recognized at the time of the dividend had the corporation elected to amortize its recognition of such transition obligation. The express terms and provisions of the $4.50 Preferred Stock provide that the holders of shares of $4.50 Preferred Stock are entitled to receive cumulative dividends at the annual rate of $4.50 per share before cash dividends are paid on the Armco Common Stock. The express terms and provisions of the $3.625 Preferred Stock provide that the holders of shares of $3.625 Preferred Stock are entitled to receive cumulative dividends at the annual rate of $3.625 per share before cash dividends are paid on the -2- Armco Common Stock. The express terms and provisions of the $2.10 Preferred Stock provide that the holders of shares of $2.10 Preferred Stock are entitled to receive cumulative dividends at the annual rate of $2.10 per share before cash dividends are paid on the Armco Common Stock. If Armco has failed to pay any accrued cumulative dividends on any shares of Armco Preferred Stock or has not paid or declared and provided for the dividends on outstanding shares of Armco Preferred Stock for the then current dividend period, Armco may not purchase or redeem any shares of Armco Common Stock. See "Dividend Payment and Stock Purchase Restrictions". Voting Rights Except as otherwise required by law, the holders of Armco Common Stock, as well as the holders of Class A Preferred Stock, are entitled at all times to one vote for each share of such stock owned by them. Except as set forth below, the holders of Class B Preferred Stock are not entitled to vote on any matter. If proper and timely notice is given by any shareholder before the time fixed for holding a meeting for the election of directors that such shareholder desires to cumulate his votes at such election, and if an announcement of the giving of such notice is made upon the convening of the meeting, each shareholder shall have the right to cumulate his votes and give one candidate as many votes as equal the number of directors to be elected multiplied by the number of votes to which he is entitled, or to distribute them on the same principle among as many candidates as such shareholder sees fit. Shareholders who are entitled to vote in the election of directors generally may nominate director candidates for election. Such shareholders must deliver written notice thereof to the Secretary of Armco not later than (i) with respect to an election to be held at any annual meeting of shareholders, 90 days prior to the date that is one year from the date of the immediately preceding annual meeting of shareholders, and (ii) with respect to an election to be held at any special meeting of shareholders for the election of directors, the close of business on the tenth day following the date on which notice of such meeting is first given to shareholders. The provision relating to director nomination may have the effect of delaying, deferring or preventing a change in control of Armco. In the event of a default in the payment of the equivalent of six quarterly dividends payable to holders of the Class A Preferred Stock or the Class B Preferred Stock, the respective holders of the outstanding shares of the Class A Preferred Stock or the Class B Preferred Stock, as the case may be, voting as a class, are entitled to elect two additional directors to serve on the Armco Board of Directors until such default is cured. In addition, as a prerequisite to the adoption of (i) any amendment of the Armco Amended Articles of Incorporation (the "Armco Articles") materially altering any existing provision of the Class A Preferred Stock or the Class B Preferred Stock, such amendment must receive the affirmative approval of at least two- thirds of the outstanding shares of the Class A Preferred Stock or the Class B Preferred Stock, as the case may be, voting as a class, and (ii) any amendment of the Armco Articles that increases the authorized number of shares of the Class A Preferred Stock or the Class B Preferred Stock or creates any class of shares that ranks equally with or prior to the Class A Preferred Stock or the Class B Preferred Stock, such amendment must receive the affirmative approval of a majority of the outstanding shares of the Class A Preferred Stock or the Class B Preferred Stock, as the case may be, voting as a class. -3- Liquidation Rights In the event of any voluntary or involuntary liquidation of Armco, the holders of shares of the $4.50 Preferred Stock will be entitled to receive from the assets of Armco, prior to any payment to the holders of Armco Common Stock, the sum of $50 per share, plus dividends accrued and unpaid to the date of payment. In the event of any voluntary or involuntary liquidation of Armco, the holders of shares of the $3.625 Preferred Stock will be entitled to receive from the assets of Armco, prior to any payment to the holders of Armco Common Stock, the sum of $50 per share, plus dividends accrued and unpaid to the date of payment. In the event of the voluntary liquidation of Armco, the holders of shares of the $2.10 Preferred Stock will be entitled to receive from the assets of Armco, prior to any payment to the holders of Armco Common Stock, the sum of $40 per share, plus dividends accrued and unpaid to the date of payment. In the event of the involuntary liquidation of Armco, the holders of shares of the $2.10 Preferred Stock similarly will be entitled to receive from the assets of Armco the sum of $15 per share, plus dividends accrued and unpaid to the date of payment, prior to any distribution to holders of Armco Common Stock. After such payments to the holders of Armco Preferred Stock, any remaining assets available for distribution to common shareholders will be distributed to the holders of the Armco Common Stock pro rata in accordance with their respective shares. Redemptions Shares of the $4.50 Preferred Stock may be redeemed at Armco's option for a purchase price of $50 per share, plus dividends accrued and unpaid to the date of redemption. Shares of the $3.625 Preferred Stock may be redeemed at Armco's option for a purchase price of $51.45 per share and declining, at 12- month intervals, to $50 on and after October 15, 2002, plus dividends accrued and unpaid to the date of redemption. Shares of the $2.10 Preferred Stock may be redeemed at Armco's option for a purchase price of $40 per share, plus dividends accrued and unpaid to the date of redemption. Notice of any redemption of shares of Armco Preferred Stock shall be given not less than thirty days prior to the date fixed for redemption to the holders of record of the shares to be redeemed by mail to the respective addresses of such holders as the same shall appear on the stock books of Armco and, if the Armco Board of Directors so determines, by publication of notice in the manner prescribed by the Board of Directors. Dividend Payment and Stock Purchase Restrictions Armco has restrictive covenants under various loan agreements relating to the payment of dividends on, or the purchase of, its capital stock. At December 31, 1998, Armco and Armco Funding Corporation, a wholly owned subsidiary, had two credit facilities with a group of banks, which together provide for borrowings of up to $170 million on a revolving credit basis with security provided by certain of Armco's receivables and inventories. Under a receivables purchase agreement, Armco sells substantially all of its trade receivables to Armco Funding Corporation. These receivables are used to secure a $100 million receivables credit facility between Armco Funding Corporation and the banks. Under an inventory credit facility, Armco has a revolving credit agreement with a group of banks providing $70 million for revolving credit loans secured by Armco's inventories. Both facilities expire in 2001. -4- The inventory credit agreement subjects Armco to certain restrictions and covenants related to, among other things, minimum net worth, leverage ratio and interest coverage ratio requirements. The inventory credit facility permits the payment of dividends on the outstanding $4.50 Preferred Stock, the outstanding $3.625 Preferred Stock and the outstanding $2.10 Preferred Stock so long as Armco is not in default under the credit facility. Under the terms of the inventory credit facility, Armco is permitted to pay cash dividends on its common stock up to an amount not exceeding 30% of Net Income (as defined therein) for the immediately preceding fiscal year so long as it is not in default under the credit facility. Under the terms of Ohio law, Armco is currently permitted to purchase shares of its capital stock only to the extent that it has positive equity surplus. At December 31, 1998, Armco had a negative equity surplus of $8.3 million. Preferred Stock Purchase Rights The Rights are issued under a Rights Agreement between Armco and Fifth Third Bank. Each Right entitles the registered holder to purchase a unit consisting of one two-hundredths of a share (a "Unit") of Participating Preferred Stock at a purchase price of $20.00 per Unit, subject to adjustment. The Rights are attached to all Armco Common Stock certificates representing shares outstanding, and no separate Rights Certificates were distributed. The Rights will separate from the Armco Common Stock and a distribution date (the "Distribution Date") will occur upon the earliest of (i) ten business days following a public announcement (the "Stock Acquisition Date") that a person or group of affiliated or associated persons (a "Person") has acquired, or obtained the right to acquire, beneficial ownership of 20% or more of the outstanding shares of Armco Common Stock (an "Acquiring Person") or (ii) ten business days following the commencement of a tender offer or exchange offer that would, if consummated, result in a Person becoming an Acquiring Person or (iii) ten business days after the Board of Directors of the Company shall declare any Person to be an "Adverse Person," upon a determination that such Person has or will become the beneficial owner of 10% or more of the outstanding shares of Armco Common Stock (provided that any such determination shall not be effective until such Person has become the Beneficial Owner of 10% or more of the outstanding shares of Armco Common Stock) and a determination by at least a majority of the "Continuing Directors" (who generally are those directors who were directors of Armco on February 23, 1996 or who subsequently became directors and whose elections or nominations were approved by a majority of the continuing directors) including consultation with such persons as such directors shall deem appropriate, that (a) such beneficial ownership by such Person is intended to cause, is reasonably likely to cause or will cause the Company to repurchase the Armco Common Stock beneficially owned by such Person or to cause pressure on the Company to take action or enter into a transaction or series of transactions intended to provide such Person with short-term financial gain under circumstances where the Board of Directors determines that the best long-term interests of the Company and its stockholders would not be served by taking such action or entering into such transactions or series of transactions at the time or (b) such beneficial ownership is causing or is reasonably likely to cause a material adverse impact (including, but not limited to, impairment) of relationships with customers or impairment of the Company's ability to maintain its competitive position) on the business or prospects of the Company or (c) such beneficial ownership otherwise is determined to be not in the best interests of the Company and its stockholders, employees, customers and communities in which the Company and its subsidiaries do business. -6- However, the Board of Directors may not declare a Person to be an Adverse Person if, prior to the time that the Person acquired 10% or more of the shares of Armco Common Stock then outstanding, such Person provided to the Board of Directors in writing a statement of the Person's purpose and intentions in connection with the proposed acquisition of Armco Common Stock, together with any other information reasonably requested of the Person by the Board of Directors, and the Board of Directors, based on such statement and reasonable inquiry and investigation as it deems appropriate, determines to notify and notifies such person in writing that it will not declare the Person to be an Adverse Person; provided, however, that the Board of Directors may expressly condition in any manner a determination not to declare a Person an Adverse Person on such conditions as the Board of Directors may select, including, without limitation, such Person's not acquiring more than a specified amount of stock and/or on such Person's not taking actions inconsistent with the purposes and intentions disclosed by such Person in the statement provided to the Board of Directors. In the event that the Board of Directors should at any time determine, upon reasonable inquiry and investigation, that such Person has not met or complied with any conditions specified by the Board of Directors, the Board of Directors may at any time thereafter declare the Person to be an Adverse Person. Until the Distribution Date (i) the Rights will be evidenced by the Armco Common Stock certificates and will be transferred with and only with such Armco Common Stock certificates, (ii) new Armco Common Stock certificates issued after June 26, 1996 will contain a notation incorporating the Rights Agreement by reference and (iii) the surrender for transfer of any certificates for Armco Common Stock outstanding will also constitute the transfer of the Rights associated with the Armco Common Stock represented by such certificate. The Rights are not exercisable until the Distribution Date and will expire at the close of business on June 26, 2006 (the "Expiration Date"), unless earlier redeemed by the Company as described below. As soon as practicable after the Distribution Date, Rights Certificates will be mailed to holders of record of the Armco Common Stock as of the close of business on the Distribution Date and, thereafter, the separate Rights Certificates alone will represent the Rights. Except for certain issuances in connection with outstanding options and convertible securities and as otherwise determined by the Board of Directors, only shares of Armco Common Stock issued prior to the Distribution Date will be issued with Rights. In the event that the Board of Directors determines that a Person is an Adverse Person or, at any time following the Distribution Date, a Person becomes the beneficial owner of 25% or more of the then-outstanding shares of Armco Common Stock, each holder of a Right will thereafter have the right to receive at the time specified in the Rights Agreement, (x) upon exercise and payment of the exercise price, Armco Common Stock (or, in certain circumstances, cash, property or other securities of Armco) having a value equal to two times the exercise price of the Right or (y) at the discretion of the Board of Directors, upon exercise and without payment of the exercise price, Armco Common Stock (or, in certain circumstances, cash, property or other securities of Armco) having a value equal to the difference between the exercise price of the Right and the value of the consideration which would be payable under clause (x). Notwithstanding the foregoing, following the occurrence of any of the events set forth in this paragraph, all Rights that are, or (under circumstances specified in the Rights Agreement) were, beneficially owned by any Acquiring Person or Adverse Person will be null and void. However, Rights are not exercisable following the occurrence of either of the events set forth above until such time as the Rights are no longer redeemable by Armco as set forth below. -6- In the event that, at any time following the Stock Acquisition Date, (i) Armco is acquired in a merger or other business combination transaction in which the Company is not the surviving corporation (other than a merger which follows an offer described above), or (ii) 50% or more of the Company's assets or earning power is sold or transferred, each holder of a Right (except Rights that previously have been voided) shall thereafter have the right to receive, upon exercise, common stock of the acquiring company having a value equal to two times the exercise price of the Right. The events set forth are hereinafter referred to as the "Triggering Events." The Purchase Price payable, and the number of Units of Preferred Stock or other securities or property issuable, upon exercise of the Rights are subject to adjustment from time to time to prevent dilution (i) in the event of a stock dividend on, or a subdivision, combination or reclassification of, the Preferred Stock, (ii) if holders of the Preferred Stock are granted certain rights or warrants to subscribe for Preferred Stock or convertible securities at less than the current market price of the Preferred Stock, or (iii) upon the distribution to holders of the Preferred Stock of evidences of indebtedness or assets (excluding regular quarterly cash dividends) or of subscription rights or warrants (other than those referred to above). With certain exceptions, no adjustment in the Purchase Price will be required until cumulative adjustments amount to at least 1% of the Purchase Price. No fractional Units will be issued and, in lieu thereof, an adjustment in cash will be made based on the market price of the Preferred Stock on the last trading date prior to the date of exercise. In general, the Company may redeem the Rights in whole, but not in part, at a price of $0.0025 per Right, at any time until 10 business days following the Stock Acquisition Date; provided, however, that with certain exceptions the Company shall be so entitled to redeem the Rights only if the Board of Directors then consists of a majority of Continuing Directors. Moreover, redemption would not be permitted after 10 business days following the effective date of any declaration by the Board of Directors that any Person is an Adverse Person. After the redemption period has expired, the Company's right of redemption may be reinstated if an Acquiring Person or Adverse Person reduces his beneficial ownership to less than 10% of the outstanding shares of Armco Common Stock in a transaction or series of transactions not involving the Company and there are no other Acquiring Persons or Adverse Persons. Immediately upon the action of the Board of Directors ordering redemption of the Rights, the Rights will terminate and the only right of the holders of Rights will be to receive the $0.0025 redemption price. Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Company, including, without limitation, the right to vote or to receive dividends. While the distribution of the Rights will not be taxable to stockholders or to the Company, stockholders may, depending upon the circumstances, recognize taxable income in the event that the Rights become exercisable for stock (or other consideration) of the Company or for common stock of the acquiring company as set forth above. Other than those provisions relating to the principal economic terms of the Rights, any of the provisions of the Rights Agreement may be amended by the Board of Directors prior to the Distribution Date. After the Distribution Date, the provisions of the Rights Agreement may be amended by the Board of Directors in order to cure any ambiguity, to make changes that do not adversely affect the interests of holders of Rights (excluding the interests of any Acquiring Person or Adverse Person), or to shorten or lengthen any time period under the Rights Agreement; provided, however, that no amendment to adjust -7- the time period governing redemption shall be made when the Rights are not redeemable; and provided further, that any amendment to the redemption provision shall be effective only if the Board of Directors consists of a majority of Continuing Directors. Participating Preferred Stock The Participating Preferred Stock purchasable upon exercise of the Rights will be non-redeemable and will rank in parity with all other series of Armco Preferred Stock as to the payment of dividends and distribution of assets. Each share of Participating Preferred Stock will be entitled to receive a preferential quarterly dividend equal to the greater of (i) $75 or (ii), subject to certain adjustments, 200 times all dividends or other distributions, other than a dividend payable in shares of Armco Common Stock or a subdivision of the outstanding shares of Armco Common Stock, declared on the Armco Common Stock, since the last dividend payment date. In the event of any liquidation of Armco, the holders of the Participating Preferred Stock will receive a preferred liquidation payment of $7,000 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, and, if greater, will be entitled to receive an aggregate liquidation payment equal to 200 times the payment made per share of Armco Common Stock, subject to certain adjustments. Each share of Participating Preferred Stock will have one vote. The Participating Preferred Stock is not convertible into Armco Common Stock or any other security of Armco and is not redeemable. The foregoing rights of the Participating Preferred Stock are protected against dilution in the event additional shares of Armco Preferred Stock or other capital stock are issued pursuant to a stock split, stock dividend or similar recapitalization. Miscellaneous The Armco Common Stock has no conversion rights, and there are no redemption or sinking fund provisions applicable thereto. The Fifth Third Bank is transfer agent and registrar for the Armco Common Stock, $4.50 Preferred Stock , $3.625 Preferred Stock and $2.10 Preferred Stock. The Armco Common Stock, $4.50 Preferred Stock, $3.625 Preferred Stock and $2.10 Preferred Stock are traded on the New York Stock Exchange, the principal market therefor. In addition, the Armco Common Stock is traded on the Midwest Stock Exchange and other regional exchanges. -----END PRIVACY-ENHANCED MESSAGE-----