FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended September 30, 1999 Commission File Number 1-3610 ALCOA INC. (Exact name of registrant as specified in its charter) PENNSYLVANIA 25-0317820 (State of incorporation) (I.R.S. Employer Identification No.) 201 Isabella Street, Pittsburgh, Pennsylvania 15212-5858 (Address of principal executive offices) (Zip Code) Office of Investor Relations 412-553-3042 Office of the Secretary 412-553-4707 (Registrant's telephone number including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No As of October 18, 1999, 366,406,853 shares of common stock, par value $1.00, of the Registrant were outstanding. A07-15911 -1- PART I - FINANCIAL INFORMATION <TABLE> <CAPTION> Alcoa and subsidiaries Condensed Consolidated Balance Sheet (in millions) (unaudited) September 30 December 31 ASSETS 1999 1998 ------------ ----------- <S> <C> <C> Current assets: Cash and cash equivalents (includes cash of $69.9 in 1999 and $131.1 in 1998) $ 211.9 $ 342.2 Short-term investments 85.1 39.4 Receivables from customers, less allowances: 1999-$62.6; 1998-$61.4 2,213.1 2,163.2 Other receivables 192.9 171.0 Inventories (B) 1,583.5 1,880.5 Deferred income taxes 185.6 198.0 Prepaid expenses and other current assets 282.3 230.8 --------- --------- Total current assets 4,754.4 5,025.1 --------- --------- Properties, plants and equipment, at cost 18,136.2 18,224.5 Less, accumulated depreciation, depletion and Amortization 9,157.7 9,091.0 --------- --------- Net properties, plants and equipment 8,978.5 9,133.5 --------- --------- Goodwill, net of accumulated amortization of $205.8 in 1999 and $179.3 in 1998 1,333.1 1,414.1 Other assets 1,798.5 1,889.8 --------- --------- Total assets $16,864.5 $17,462.5 ========= ========= LIABILITIES Current liabilities: Short-term borrowings $ 611.9 $ 431.0 Accounts payable, trade 1,167.2 1,044.3 Accrued compensation and retirement costs 559.9 553.2 Taxes, including taxes on income 276.1 431.3 Other current liabilities 512.4 627.4 Long-term debt due within one year 48.0 181.1 --------- --------- Total current liabilities 3,175.5 3,268.3 --------- --------- Long-term debt, less amount due within one year (C) 2,668.9 2,877.0 Accrued postretirement benefits 1,749.8 1,840.1 Other noncurrent liabilities and deferred credits 1,488.0 1,587.1 Deferred income taxes 418.0 358.1 --------- --------- Total liabilities 9,500.2 9,930.6 --------- --------- MINORITY INTERESTS 1,409.0 1,476.0 --------- --------- CONTINGENT LIABILITIES (D) - - SHAREHOLDERS' EQUITY Preferred stock 55.8 55.8 Common stock 394.7 394.7 Additional capital 1,712.3 1,675.9 Retained earnings 5,727.9 5,305.1 Treasury stock, at cost (1,310.0) (1,028.7) Accumulated other comprehensive loss (E) (625.4) (346.9) --------- --------- Total shareholders' equity 5,955.3 6,055. 9 --------- --------- Total liabilities and shareholders' equity $16,864.5 $17,462.5 ========= ========= The accompanying notes are an integral part of the financial statements. </TABLE> -2- <TABLE> <CAPTION> Alcoa and subsidiaries Condensed Statement of Consolidated Income (unaudited) (in millions, except per share amounts) Third quarter Nine months ended ended September 30 September 30 ------------- ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> REVENUES Sales $4,052.3 $4,108.9 $12,069.7 $11,141.0 Other income 38.5 47.8 77.7 94.2 ------- ------- -------- -------- 4,090.8 4,156.7 12,147.4 11,235.2 ------- ------- -------- -------- COSTS AND EXPENSES Cost of goods sold 3,119.7 3,235.8 9,387.7 8,670.7 Selling, general administrative and other Expenses 202.0 217.8 596.5 531.2 Research and development expenses 33.6 28.8 91.4 81.2 Provision for depreciation, depletion and amortization 223.8 233.2 663.2 604.1 Interest expense 51.1 59.0 153.2 140.0 ------- ------- -------- -------- 3,630.2 3,774.6 10,892.0 10,027.2 ------- ------- -------- -------- EARNINGS Income before taxes on income 460.6 382.1 1,255.4 1,208.0 Provision for taxes on income (F) 147.4 115.9 401.7 392.6 ------- ------- -------- -------- Income from operations 313.2 266.2 853.7 815.4 Less: Minority interests' share (54.1) (48.5) (133.5) (180.7) ------- ------- -------- -------- NET INCOME $ 259.1 $ 217.7 $ 720.2 $ 634.7 ======= ======= ======== ======== EARNINGS PER SHARE (G) Basic $ .71 $ .61 $ 1.96 $ 1.84 ======= ======= ======== ======== Diluted $ .69 $ .61 $ 1.91 $ 1.83 ======= ======= ======== ======== Dividends paid per common share $ .20125 $ .1875 $ .60375 $ .5625 ======= ======= ======== ======== The accompanying notes are an integral part of the financial statements. </TABLE> -3- <TABLE> <CAPTION> Alcoa and subsidiaries Condensed Statement of Consolidated Cash Flows (unaudited) (in millions) Nine months ended September 30 ------------ 1999 1998 ---- ---- <S> <C> <C> CASH FROM OPERATIONS Net income $ 720.2 $ 634.7 Adjustments to reconcile net income to cash from operations: Depreciation, depletion and amortization 673.7 614.1 Increase (reduction) in deferred income taxes 89.2 (2.5) Equity income before additional taxes, net of dividends (3.7) (18.0) Gains from investing activities (12.0) - Book value of asset disposals 11.3 30.9 Minority interests 133.5 180.7 Other 8.7 16.4 Changes in assets and liabilities, excluding the effects of acquisitions and divestitures: (Increase) reduction in receivables (153.8) 8.4 Reduction in inventories 286.7 110.7 Increase in prepaid expenses and other current assets (51.7) (75.2) Reduction in accounts payable and accrued expenses (124.1) (18.1) (Reduction) increase in taxes, including taxes on income (65.9) 77.5 Reduction in deferred hedging gains (62.7) (19.4) Net change in noncurrent assets and liabilities (39.8) (136.3) -------- -------- CASH FROM OPERATIONS 1,409.6 1,403.9 -------- -------- FINANCING ACTIVITIES Net changes in short-term borrowings 181.4 322.9 Common stock issued and treasury stock sold 576.9 30.5 Repurchase of common stock (838.1) (293.5) Dividends paid to shareholders (223.0) (193.2) Dividends paid and return of capital to minority interests (64.2) (169.9) Net change in commercial paper - 774.7 Additions to long-term debt 318.1 839.0 Payments on long-term debt (725.9) (1,015.8) -------- -------- CASH (USED FOR) FROM FINANCING ACTIVITIES (774.8) 294.7 -------- -------- INVESTING ACTIVITIES Capital expenditures (608.9) (594.7) Acquisitions, net of cash acquired (52.2) (1,352.7) Proceeds from the sale of subsidiaries 30.9 7.4 Additions to investments (89.8) (110.9) Proceeds from the sale of assets 13.7 - Net change in short-term investments (45.7) 42.3 Changes in minority interests (0.2) 37.8 Other (9.6) (9.0) -------- -------- CASH USED FOR INVESTING ACTIVITIES (761.8) (1,979.8) -------- -------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (3.3) 1.5 -------- -------- CHANGES IN CASH Net change in cash and cash equivalents (130.3) (279.7) Cash and cash equivalents at beginning of year 342.2 800.8 -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 211.9 $ 521.1 ======== ======== The accompanying notes are an integral part of the financial statements. </TABLE> -4- Notes to Condensed Consolidated Financial Statements (in millions) A. Common Stock Split - On January 8, 1999, the board of directors declared a two-for-one common stock split, which was distributed on February 25, 1999 to shareholders of record at the close of business on February 8, 1999. In this report, all per-share amounts and number of shares have been restated to reflect the stock split. B. Inventories <TABLE> <CAPTION> September 30 December 31 1999 1998 ------------ ----------- <S> <C> <C> Finished goods $ 378.9 $ 418.2 Work in process 557.0 591.7 Bauxite and alumina 277.0 346.5 Purchased raw materials 225.1 361.1 Operating supplies 145.5 163.0 ------ ------- $1,583.5 $1,880.5 ======= ======= </TABLE> Approximately 55% of total inventories at September 30, 1999 were valued on a LIFO basis. If valued on an average cost basis, total inventories would have been $722.7 and $702.8 higher at September 30, 1999 and December 31, 1998, respectively. C. Long-Term Debt - In 1998, Alcoa issued $300 of thirty-year 6.75% bonds due 2028, $250 of 6.5% term debt due in 2018 and $200 of 6.125% term debt due in 2005. Also, in 1998, Alcoa issued $1,100 of commercial paper. Current commercial paper borrowings total approximately $1,300. The proceeds from these borrowings were used to fund acquisitions and for general corporate purposes. D. Contingent Liabilities - Various lawsuits, claims and proceedings have been or may be instituted or asserted against Alcoa, including those pertaining to environmental, product liability and safety and health matters. While the amounts claimed may be substantial, the ultimate liability cannot now be determined because of the considerable uncertainties that exist. Therefore, it is possible that results of operations or liquidity in a particular period could be materially affected by certain contingencies. However, based on facts currently available, management believes that the disposition of matters that are pending or asserted will not have a materially adverse effect on the financial position of the company. Alcoa Aluminio (Aluminio) is currently party to a hydroelectric construction project in Brazil. Total estimated construction costs are $600, of which the company's share is 24%. In the event that other participants in this project fail to fulfill their financial responsibilities, Aluminio may be liable for its pro rata share of the deficiency. Alcoa of Australia (AofA) is party to a number of natural gas and electricity contracts that expire between 2001 and 2022. Under these take-or-pay contracts, AofA is obligated to pay for a minimum amount of natural gas or electricity even if these commodities are not required for operations. Commitments related to these contracts total $163 in 1999, $166 in 2000, $162 in 2001, $158 in 2002, $156 in 2003 and $2,125 thereafter. Expenditures under these contracts totaled $171 in 1998. -5- E. Comprehensive Income <TABLE> <CAPTION> Third quarter Nine months ended Ended September 30 September 30 ------------- ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Net income $259.1 $217.7 $720.2 $634.7 Other comprehensive income (loss) (179.0) 24.0 (278.5) (22.6) ----- ----- ----- ----- Comprehensive income $ 80.1 $241.7 $441.7 $612.1 ===== ===== ===== ===== See footnote L for additional detail regarding the translation adjustment component of other comprehensive income. </TABLE> F. Income Taxes - The income tax provision for the period is based on the effective tax rate expected to be applicable for the full year. The 1999 third quarter rate of 32% differs from the statutory rate primarily because of lower taxes on foreign income. G. Earnings Per Share - Basic earnings per share (EPS) amounts are computed by dividing earnings applicable to common shareholders by the average number of common shares outstanding. Diluted EPS amounts assume the issuance of common stock for all potentially dilutive equivalents outstanding. Anti-dilutive outstanding stock options have been excluded from the diluted EPS calculation. The detail of basic and diluted EPS follows: <TABLE> <CAPTION> Third quarter Nine months ended ended September 30 September 30 ------------- ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Net income $259.1 $217.7 $720.2 $634.7 Less: Preferred stock dividends .5 .5 1.5 1.5 ----- ----- ----- ----- Income available to common $258.6 $217.2 $718.2 $633.2 stockholders Weighted average shares outstanding 366.6 357.3 366.9 343.8 Basic EPS $ .71 $ .61 $ 1.96 $ 1.84 ===== ===== ===== ===== Effect of dilutive securities: Add: Shares issuable upon exercise of outstanding stock options 8.6 1.5 8.6 1.5 Diluted shares outstanding 375.2 358.8 375.5 345.3 Diluted EPS $ .69 $ .61 $ 1.91 $ 1.83 ===== ===== ===== ===== </TABLE> H. Acquisitions - In August 1999, Alcoa and the Reynolds Metals Company (Reynolds) announced they had reached a definitive agreement to merge. Under the agreement, Alcoa will acquire all of the outstanding shares of Reynolds at an exchange rate of 1.06 shares of Alcoa common stock for each share of Reynolds. The value of the transaction is approximately $4,800. The combined company will have annual revenues of $22,500, approximately 120,000 employees and will operate over 300 locations in 36 countries around the world. The acquisition is subject to the expiration of antitrust waiting periods and other customary conditions including approval by stockholders of Reynolds owning a majority of the Reynolds shares. In February 1998, Alcoa acquired Inespal, S.A. of Madrid, Spain. Alcoa paid approximately $150 in cash and assumed $260 of debt and liabilities in exchange for substantially all of Inespal's businesses. The acquisition included an alumina refinery, three aluminum smelters, three aluminum rolling facilities, two extrusion plants and an administrative center. -6- In July 1998, Alcoa completed its acquisition of Alumax Inc. (Alumax) for a total consideration of approximately $3,800. The purchase price consisted of cash of approximately $1,500, stock of approximately $1,300 and assumed debt of approximately $1,000. Alumax operates a number of manufacturing facilities in 22 states, Canada, Western Europe and Mexico. Alcoa's acquisitions have been accounted for using the purchase method. The purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair market values. Any excess purchase price over the fair market value of the net assets acquired has been recorded as goodwill. The following presents pro forma information assuming that the acquisition of 100% of Alumax by Alcoa had occurred at the beginning of 1998. Adjustments that have been included to arrive at the pro forma totals primarily include those related to acquisition financing, the amortization of goodwill, the elimination of transactions between Alcoa and Alumax and additional depreciation related to the increase in basis that resulted from the transaction. Tax effects from the pro forma adjustments noted above also have been included at the 35% statutory rate. <TABLE> <CAPTION> Nine months Ended September 30, 1998 ------------------ <S> <C> Sales $12,567.5 Net income 657.8 Basic earnings per share 1.77 Diluted earnings per share 1.76 </TABLE> The pro forma results are not necessarily indicative of what actually would have occurred if the transaction had been in effect for the entire periods presented, are not intended to be a projection of future results and do not reflect any cost savings that might be achieved from the combined operations. I. Recently Issued Accounting Standards - In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." The standard requires that entities value all derivative instruments at fair value and record the instruments on the balance sheet. The standard also significantly changes the requirements for hedge accounting. In June 1999, the FASB approved a delay in the effective date of this standard until January 2001. The company believes that the adoption of the standard will have a material impact on its financial statements. Upon adoption, Alcoa's aluminum, foreign exchange and interest rate derivative contracts, as well as certain underlying exposures, will be recorded on the balance sheet at fair value. Management is currently assessing the details of the standard and is preparing a plan of implementation. J. Reclassifications - Certain amounts have been reclassified to conform to current year presentation. K. Segment Information - Alcoa is primarily a producer of aluminum products. Its segments are organized by product on a worldwide basis. Alcoa's management reporting system evaluates performance based on a number of factors; however, the primary measure of performance is the after-tax operating income (ATOI) of each segment. Nonoperating items such as interest income, interest expense, foreign exchange gains/losses and minority interest are excluded from segment profit. In addition, certain expenses such as corporate general administrative expenses, depreciation and amortization on corporate assets and certain special items are not included in segment results. Alcoa's products are used primarily by transportation (including aerospace, automotive, rail and shipping), packaging, building and construction, and industrial customers worldwide. Alcoa's reportable segments include Alumina and chemicals, Primary metals, Flat-rolled products and Engineered products. Businesses that do not fall into these categories are listed as Other. The following details sales and ATOI for each reportable segment for the three-month and nine-month periods ended September 30, 1999 and 1998. -7- <TABLE> <CAPTION> Third quarter ended Alumina and Primary Flat-rolled Engineered September 30, 1999 chemicals metals products products Other Total <S> <C> <C> <C> <C> <C> <C> Sales: Third-party sales $473.9 $ 559.9 $1,273.0 $917.1 $828.4 $4,052.3 Intersegment sales 214.1 686.2 13.6 6.0 - 919.9 ----- ------- ------- ----- ----- ------- Total sales $688.0 $1,246.1 $1,286.6 $923.1 $828.4 $4,972.2 ===== ======= ======= ===== ===== ======= After-tax operating Income $ 82.7 $ 167.8 $ 73.5 $ 42.2 $ 50.4 $ 416.6 Third quarter ended September 30, 1998 Sales: Third-party sales $398.4 $ 596.0 $1,308.6 $968.0 $832.3 $4,103.3 Intersegment sales 238.2 634.6 16.6 2.5 - 891.9 ----- ------- ------- ----- ----- ------- Total sales $636.6 $1,230.6 $1,325.2 $970.5 $832.3 $4,995.2 ===== ======= ======= ===== ===== ======= After-tax operating Income $ 57.3 $ 91.2 $ 76.7 $ 44.8 $ 39.7 $ 309.7 </TABLE> <TABLE> <CAPTION> Nine months ended Alumina and Primary Flat-rolled Engineered September 30, 1999 chemicals metals products products Other Total <S> <C> <C> <C> <C> <C> <C> Sales: Third-party sales $1,350.0 $1,612.2 $3,800.2 $2,798.7 $2,502.3 $12,063.4 Intersegment sales 665.9 2,024.5 39.1 13.0 - 2,742.5 ------- ------- ------- ------- ------- -------- Total sales $2,015.9 $3,636.7 $3,839.3 $2,811.7 $2,502.3 $14,805.9 ======= ======= ======= ======= ======= ======== After-tax operating Income $ 204.2 $ 329.6 $ 210.9 $ 148.1 $ 148.2 $ 1,041.0 Nine months ended September 30, 1998 Sales: Third-party sales $1,394.5 $1,475.0 $3,608.4 $2,131.2 $2,522.4 $11,131.5 Intersegment sales 570.0 1,661.9 47.9 7.6 - 2,287.4 ------- ------- ------- ------- ------- -------- Total sales $1,964.5 $3,136.9 $3,656.3 $2,138.8 $2,522.4 $13,418.9 ======= ======= ======= ======= ======= ======== After-tax operating income $ 248.7 $ 249.2 $ 239.7 $ 125.4 $ 127.3 $ 990.3 </TABLE> -8- The following table reconciles Alcoa's measure of segment profit to consolidated net income. <TABLE> <CAPTION> Third quarter Nine months Ended Ended September 30 September 30 ------------- ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Total after-tax operating income $416.6 $309.7 $1,041.0 $990.3 Elimination of intersegment profit (8.1) (4.0) (27.2) (16.0) Unallocated amounts (net of tax): Interest income 7.1 18.7 20.3 56.8 Interest expense (33.3) (38.4) (99.6) (91.1) Minority interest (54.1) (48.5) (133.5) (180.7) Mark-to-market gains (losses) 4.6 (2.7) 10.6 (43.6) Corporate expense (33.5) (39.7) (110.4) (118.2) Other (1) (40.2) 22.6 19.0 37.2 ----- ----- ------ ----- Consolidated net income $259.1 $217.7 $ 720.2 $634.7 ===== ===== ======= ===== <FN> (1) Other is comprised of differences between segment and corporate taxes, the results of internal hedging contracts between corporate and the segments, external hedging gains and losses, LIFO charges and credits and other miscellaneous items. </TABLE> L. Foreign Currency - Effective July 1, 1999, the Brazilian Real became the functional currency for translating the financial statements of Alcoa's 59%-owned Brazilian subsidiary, Alcoa Aluminio. Economic factors and circumstances related to Aluminio's operations have changed significantly since the devaluation of the Real in the 1999 first quarter. Under SFAS 52, "Foreign Currency Translation," the change in these facts and circumstances requires a change to Aluminio's functional currency. As a result of the change, at July 1, 1999, Alcoa's shareholders' equity (cumulative translation adjustment) and minority interests were reduced by $156 and $108, respectively. These amounts were driven principally by a reduction in fixed assets. One of the factors affecting the change in Aluminio's functional currency was Alcoa's recent purchase of approximately $185 of Aluminio's 7.5% secured export notes. The repurchase of these notes is consistent with Alcoa's recent policy change regarding the manner in which large subsidiaries are capitalized and will result in lower overall financing costs to the company. -9- In the opinion of the company, the financial statements and summarized financial data in this Form 10-Q report include all adjustments, including those of a normal recurring nature, necessary to fairly state the results for the periods. This Form 10-Q report should be read in conjunction with the company's annual report on Form 10-K for the year ended December 31, 1998. The financial information required in this Form 10-Q by Rule 10-01 of Regulation S-X has been subject to a review by PricewaterhouseCoopers LLP, the company's independent certified public accountants, as described in their report on page 11. -10- Independent Accountant's Review Report To the Shareholders and Board of Directors Alcoa Inc. (Alcoa) We have reviewed the unaudited condensed consolidated balance sheet of Alcoa and subsidiaries as of September 30, 1999, the unaudited condensed statements of consolidated income for the three-month and nine-month periods ended September 30, 1999 and 1998, and the unaudited condensed statement of consolidated cash flows for the nine-month periods ended September 30, 1999 and 1998, which are included in Alcoa's Form 10-Q for the period ended September 30, 1999. These financial statements are the responsibility of Alcoa's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of Alcoa and subsidiaries as of December 31, 1998, and the related statements of consolidated income, shareholders' equity, and cash flows for the year then ended (not presented herein). In our report dated January 8, 1999, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1998, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Pittsburgh, Pennsylvania October 6, 1999 -11- Management's Discussion and Analysis of the Results of Operations and Financial Condition (dollars in millions, except share amounts and ingot prices; shipments in thousands of metric tons (mt)) <TABLE> <CAPTION> Results of Operations Principal income and operating data follow. Third quarter ended Nine months ended September 30 September 30 ------------ ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Sales $4,052.3 $4,108.9 $12,069.7 $11,141.0 Net income 259.1 217.7 720.2 634.7 Basic earnings per common share .71 .61 1.96 1.84 Diluted earnings per common share .69 .61 1.91 1.83 Shipments of aluminum products 1,100 1,133 3,349 2,777 Shipments of alumina 1,814 1,536 5,314 5,346 Alcoa's average realized ingot price .71 .67 .66 .69 </TABLE> Earnings Summary Alcoa reported 1999 third quarter net income of $259.1, a 19% increase from the 1998 third quarter. The increase was due primarily to improved cost performance and higher shipments of alumina and fabricated products. These positive factors were partly offset by lower prices for flat-rolled and engineered products. For the year-to- date period, net income rose 13.5% to $720.2. Positive factors that lead to the increase were higher volumes, which were driven by the Alumax acquisition, along with cost reductions. Partially offsetting these factors was the impact of lower prices and higher depreciation and administrative costs, which resulted from the Alumax acquisition. Revenues in the 1999 quarter fell 1.4% to $4.1 billion from the 1998 third quarter, and increased 8.3% from the 1998 nine-month period to $12.1 billion. The decrease in revenues for the 1999 third quarter was due to lower overall prices, which were partly offset by higher shipments of alumina and fabricated products. The increase in the 1999 nine-month period from 1998 was the result of higher shipments which more than offset the impact of lower aluminum prices. Higher volumes for non-aluminum products also helped to boost revenues. Annualized return on shareholders' equity was 15.7% for the 1999 year- to-date period, compared with 17.1% in the 1998 quarter. The decline is due to higher shareholders' equity in 1999, resulting primarily from the Alumax acquisition in 1998, partially offset by higher earnings. -12- Segment Information I. Alumina and chemicals <TABLE> <CAPTION> Third quarter ended Nine months ended September 30 September 30 ------------ ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Third-party alumina shipments 1,814 1,536 5,314 5,346 Third-party sales $473.9 $398.4 $1,350.0 $1,394.5 Intersegment sales 214.1 238.2 665.9 570.0 ----- ----- ------- ------- Total sales $688.0 $636.6 $2,015.9 $1,964.5 ===== ===== ======= ======= After-tax operating income $ 82.7 $ 57.3 $ 204.2 $ 248.7 </TABLE> This segment's activities include the mining of bauxite, which is then refined into alumina. The alumina is sold to internal and external customers worldwide or is processed into industrial chemical products. A majority of the third-party sales from this segment are derived from alumina. Shipments of alumina were up 18% from the 1998 third quarter due to improved operating performance and an increase in capacity at the company's Australian refineries, along with higher production at the St. Croix refinery. This, along with a 23% increase in realized prices, drove a 45% increase in third-party alumina revenues. For the nine-month period, alumina revenues rose 2% on a 3% increase in prices. Third-party shipments fell 1% due to the Alumax acquisition. Prior to the acquisition, Alumax had purchased alumina from Alcoa. Accordingly, shipments to Alumax smelters which were recorded as third- party sales, are now recorded as intersegment. Without the effects of the Alumax acquisition, third-party alumina shipments would have been up 12% for the year-to-date period. After-tax operating income for this segment rose 44% to $82.7 for the 1999 third quarter, and fell 18% to $204.2 for the nine-month period. The quarter-over-quarter increase is primarily due to higher prices and shipments and improved cost performance. Year-over-year, lower internal prices, partly offset by improved cost performance, resulted in the decline. In early October, Alcoa World Alumina (AWA) announced that it had completed expansion of its Wagerup, Australia, alumina refinery. The expansion resulted in a 9% capacity increase at the facility, bringing total system capacity within Western Australia to 7.3 million metric tons per year. II. Primary metals <TABLE> <CAPTION> Third quarter ended Nine months ended September 30 September 30 ------------ ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Third-party aluminum shipments 335 390 1,059 951 Third-party sales $ 559.9 $ 596.0 $1,612.2 $1,475.0 Intersegment sales 686.2 634.6 2,024.5 1,661.9 ------- ------- ------- ------- Total sales $1,246.1 $1,230.6 $3,636.7 $3,136.9 ======= ======= ======= ======= After-tax operating income $ 167.8 $ 91.2 $ 329.6 $ 249.2 </TABLE> -13- This segment's primary focus is Alcoa's worldwide smelter system. Primary metals receives alumina from the alumina and chemicals segment and produces aluminum ingot to be used by a variety of Alcoa's other segments, as well as sold to outside customers. The sale of ingot represents over 90% of this segment's third-party sales. Third-party ingot revenues fell 10% from the 1998 quarter as a 15% decline in shipments overshadowed a rise in prices. For the year- to-date period, revenues rose 6% as an 11% increase in shipments, primarily from acquired companies and Brazil, more than offset a decline in prices. Intersegment sales in the 1999 nine-month period rose 22% from 1998 as the addition of Alumax's fabricating operations resulted in higher internal demand for metal. Alcoa's average realized third-party price for ingot rose 6% from the 1998 third quarter to 71 cents per pound, in contrast to the 4% decline in average realized prices from the 1998 nine-month period. Average realized prices reflect the decline and subsequent rise in aluminum prices that has occurred over the last eighteen months. Primary metals ATOI rose 84% to $167.8 in the 1999 quarter and 32% to $329.6 in the 1999 year-to-date period. The increases in ATOI are attributable to higher overall volumes and improved cost performance. Prices, which rose in the quarter but fell in the year-to-date period, also impacted ATOI. Contributing to the year-over-year and quarter- over-quarter increases were improved results from smelting operations in Brazil and Australia, partly offset by weaker performance in Europe. Shutdown of the company's smelting operations in Suriname had a minimal impact on ATOI for the 1999 year-to-date and quarter. III. Flat-rolled products <TABLE> <CAPTION> Third quarter ended Nine months ended September 30 September 30 ------------ ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Third-party aluminum shipments 496 483 1,479 1,285 Third-party sales $1,273.0 $1,308.6 $3,800.2 $3,608.4 Intersegment sales 13.6 16.6 39.1 47.9 ------- ------- ------- ------- Total sales $1,286.6 $1,325.2 $3,839.3 $3,656.3 ======= ======= ======= ======= After-tax operating income $ 73.5 $ 76.7 $ 210.9 $ 239.7 </TABLE> This segment's principal business is the production and sale of aluminum sheet, plate and foil. This segment includes rigid container sheet(RCS), which is used to produce aluminum beverage cans and mill products used in the transportation and distributor markets. Approximately one-half of the third-party sales from this segment are derived from mill products and approximately one-third are from RCS. Third-party flat-rolled product's sales rose 5% from the 1998 year-to- date period. The increase was due to a 15% increase in shipments, which were driven by acquisitions, partly offset by lower prices. For the 1999 quarter, shipments rose 3% and prices fell 6%, resulting in a 3% decline in third-party revenues. Third-party sales of RCS were down 8% as shipments were flat and prices fell over the 1998 nine-month period. For comparison purposes, total market shipments of aluminum beverage cans for the eight months ended in August 1999 were 1% lower than the comparable 1998 period. Quarter- to-quarter, revenues fell 4% as prices slipped 5%. -14- Mill product's revenues rose 20% from the 1998 nine-month period as shipments, driven by acquisitions, increased 42%. For the 1999 quarter, revenues were flat as shipments rose 12%. Realized prices for mill products in 1999 have declined over 1998 as a result of a lower value-added mix, due principally to the Alumax acquisition. ATOI for this segment fell 12% to $210.9 for the 1999 year-to-date period. The majority of the decline relates to RCS, as lower selling prices had a negative impact on margins. Mill product's impact on segment ATOI was nearly unchanged from the 1998 year-to-year period, as higher volumes, aided by acquisitions, and improved cost performance offset the impact of lower prices and a less profitable mix. For the 1999 quarter, ATOI fell 4% as cost improvements were overshadowed by lower RCS prices. IV. Engineered products <TABLE> <CAPTION> Third quarter ended Nine months ended September 30 September 30 ------------ ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Third-party aluminum shipments 249 240 756 489 Third-party sales $917.1 $968.0 $2,798.7 $2,131.2 Intersegment sales 6.0 2.5 13.0 7.6 ----- ----- ------- ------- Total sales $923.1 $970.5 $2,811.7 $2,138.8 ===== ===== ======= ======= After-tax operating income $ 42.2 $ 44.8 $ 148.1 125.4 </TABLE> This segment includes hard and soft alloy extrusions, aluminum forgings, and wire, rod and bar. These products serve the transportation, construction and distributor markets. Revenues from third-party sales of engineered products fell 5% from the 1998 third quarter, while rising 31% from the 1998 nine-month period. For the quarter, higher shipments were more than offset by lower prices. For the nine-month period, higher volumes, which were aided by the Alumax acquisition, were partly offset by lower prices. Approximately 80% of the revenues from this segment are derived from the sale of extrusions. Third-party sales of soft extrusions were up 60% from the 1998 year on a 77% increase in shipments. The large increase in shipments was primarily due to the Alumax acquisition, which nearly doubled Alcoa's existing soft alloy business. For the quarter, soft alloy revenues fell 4% as shipments rose 5% and prices fell. Revenues from hard alloy extrusions for the nine-month period fell 24% as shipments were down 22%. For the quarter, revenues fell 32% on a similar decline in shipments. Revenues from the sale of forged aluminum wheels increased 30% in the 1999 nine-month period, driven by a 31% increase in shipments. For the 1999 quarter, revenues rose 42% on a 40% increase in shipments. Segment ATOI increased 18% to $148.1 in the 1999 year-to-date period. Higher shipments of soft alloy extrusions partly offset by lower hard alloy margins generated the increase. Lower operating costs also contributed to the improvement in ATOI. For the quarter, ATOI declined 5% as lower revenues, driven by lower prices, were nearly offset by improved cost performance. -15- V. Other <TABLE> <CAPTION> Third quarter ended Nine months ended September 30 September 30 ------------ ------------ 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Third-party aluminum shipments 20 20 55 52 Third-party sales $828.4 $832.3 $2,502.3 $2,522.4 After-tax operating income $ 50.4 $ 39.7 $ 148.2 $ 127.3 </TABLE> This segment includes Alcoa Fujikura Ltd. (AFL), which produces electrical components for the automotive industry as well as telecommunications products. In addition, Alcoa's aluminum and plastic closures operations and residential building products operations are included in this group. Revenues for this segment were nearly unchanged in the 1998 third quarter and were down 1% from the 1998 nine-month period. AFL, which generates approximately half of the revenues reported in this segment, experienced a 5% increase in revenues from the 1998 quarter and year-to- date periods as higher volumes were party offset by lower prices. Revenues from sales of plastic closures and building products also increased over both the 1998 quarter and nine-month periods. More than offsetting the above mentioned revenue gains were lower revenues from Alcoa Aluminio's packaging operations, which were negatively impacted by the currency devaluation in the 1999 first quarter and economic conditions in Brazil. ATOI for this segment in the 1999 third quarter was $50.4, up 27% from 1998. Strong cost control at Alcoa's automotive and building products businesses contributed to the increase. Year-to-date, ATOI rose 16% as improved results from these same businesses, along with AFL, were partly offset by losses from packaging operations in Brazil. Costs and Other Cost of Goods Sold - Cost of goods sold fell $116.1, or 3.6%, from the 1998 third quarter. The decrease reflects lower volumes and improved cost performance. Cost of goods sold as a percentage of sales in the 1999 third quarter was 77.0% versus 78.8% in the 1998 quarter. The improved ratio in 1999 is primarily due to cost performance and the impact of higher metal prices on revenues. On a year-to-date basis, this percentage was unchanged at 77.8%, as lower metal prices were offset by cost improvements. Selling and General Administrative Expenses - Selling, general and administrative (SG&A) expenses were down $15.8, or 7.3%, from the 1998 third quarter and were up $65.3, or 12.3%, on a year-to-date basis. The decrease quarter-over-quarter was due to the impact of integrating Alumax and eliminating duplicate overhead functions. Year-over-year these costs were higher due to the Alumax acquisition, as Alcoa's 1999 results include Alumax for all nine months versus the 1998 nine-month period that included Alumax for only three months. On a pre- acquisition basis these costs were down approximately 1%. SG&A as a percentage of revenue fell to 5.0% in the 1999 third quarter, compared with 5.3% in the 1998 period. Alcoa's objective is to maintain SG&A costs below 5.0% of revenues. Interest Expense - Interest expense totaled $51.1 in the 1999 third quarter, a decrease of 13.4% over the comparable 1998 period. The decrease is due to lower debt levels as excess cash has been used to reduce debt. Year-over-year, interest expense rose $13.2 or 9.4% as debt levels for the 1999 period were higher than the 1998 period. In 1998, Alcoa issued $300 of thirty-year 6.75% bonds due 2028, $250 of 6.5% term debt due in 2018 and $200 of 6.125% term debt due in 2005. Alcoa also issued $1,100 of commercial paper. These borrowings were used primarily to fund acquisitions and for general corporate purposes. -16- Income Taxes - The income tax provision for the period is based on the effective tax rate expected to be applicable for the full year. The 1999 third quarter rate of 32% differs from the statutory rate primarily because of lower taxes on foreign income. Other Income - Other income fell 19.5% to $38.5 in the 1999 third quarter. The decrease was due to lower interest income and higher foreign exchange losses, partly offset by mark-to-market gains in 1999 versus losses in 1998 and higher equity income. Year-to-date, other income fell $16.5 or 17.5% as improved mark-to-market results were more than offset by lower interest income, higher foreign exchange losses and lower equity income. Foreign Currency - Effective July 1, 1999, the Brazilian Real became the functional currency for translating the financial statements of Alcoa's 59%-owned Brazilian subsidiary, Alcoa Aluminio. Economic factors and circumstances related to Aluminio's operations have changed significantly since the devaluation of the Real in the 1999 first quarter. Under SFAS 52, Foreign Currency Translation, the change in these facts and circumstances requires a change to Aluminio's functional currency. As a result of the change, at July 1, 1999, Alcoa's shareholders' equity and minority interests were reduced by $156 and $108, respectively. These amounts were driven principally by a reduction in fixed assets. One of the factors affecting the change in Aluminio's functional currency was Alcoa's recent purchase of approximately $185 of Aluminio's 7.5% secured export notes. The repurchase of these notes is consistent with Alcoa's recent policy change regarding the manner in which large subsidiaries are capitalized, and will result in lower overall financing costs to the company. Minority Interests - Minority interests' share of income from operations fell 26.1% from the 1998 year-to-date period to $133.5. The decrease is due primarily to lower earnings from Aluminio, which were negatively impacted by the Brazilian currency devaluation and resulting economic events in the 1999 first quarter. In addition, lower earnings at AWA also contributed to the decline. Risk Factors In addition to the risks inherent in its operations, Alcoa is exposed to financial, market, political and economic risks. The following discussion, which provides additional detail regarding Alcoa's exposure to the risks of changing commodity prices, foreign exchange rates and interest rates, includes forward-looking statements that involve risk and uncertainties. Actual results could differ materially from those projected in these forward-looking statements. Commodity Price Risks - Alcoa is a leading global producer of aluminum ingot and aluminum fabricated products. As a condition of sale, customers often require Alcoa to commit to fixed-price contracts that sometimes extend a number of years into the future. Customers will likely require Alcoa to enter into similar arrangements in the future. These contracts expose Alcoa to the risk of fluctuating aluminum prices between the time the order is accepted and the time the order ships. -17- In the U.S., Alcoa is net metal short and is subject to the risk of higher aluminum prices for the anticipated metal purchases required to fulfill the long-term customer contracts noted above. To hedge this risk, Alcoa enters into long positions, principally using futures and options. Alcoa follows a stable pattern of purchasing metal; therefore, it is highly likely that anticipated metal requirements will be met. At September 30, 1999 and 1998, these contracts totaled approximately 225,000 and 875,000 mt, respectively. These contracts act to fix the purchase price for these metal purchase requirements, thereby reducing Alcoa's risk to rising metal prices. The futures and options contracts noted above are with creditworthy counterparties and are further supported by cash, treasury bills or irrevocable letters of credit issued by carefully chosen banks. The expiration dates of the options and the delivery dates of the futures contracts noted above do not always coincide exactly with the dates on which Alcoa is required to purchase metal to meet its contractual commitments with customers. Accordingly, some of the futures and options positions will be rolled forward. This may result in significant cash inflows if the hedging contracts are "in-the-money" at the time they are rolled forward. Conversely, there could be significant cash outflows if metal prices fall below the price of contracts being rolled forward. In addition to the above-noted aluminum positions, Alcoa had 35,000 mt and 30,000 mt of futures and options contracts outstanding at September 30, 1999 and 1998, respectively, that cover long-term, fixed- price commitments to supply customers with metal from internal sources. Accounting convention requires that these contracts be marked-to- market, which resulted in an after-tax credit (charge) to earnings of $4.6 and $(2.7) at September 30, 1999 and 1998, respectively. Alcoa also purchases certain other commodities, such as gas and copper, for its operations and enters into futures contracts to eliminate volatility in the prices of such products. None of these contracts are material. Financial Risk - Alcoa is subject to significant exposure from fluctuations in foreign currencies. As a matter of company policy, foreign currency exchange contracts, including forwards and options, are sometimes used to limit the risk of fluctuating exchange rates. In addition, Alcoa also attempts to maintain a reasonable balance between fixed and floating rate debt and uses interest rate swaps and caps to keep financing costs as low as possible. Risk Management - All of the aluminum and other commodity contracts, as well as the various types of financial instruments, are straightforward and held for purposes other than trading. They are used primarily to mitigate uncertainty and volatility, and principally cover underlying exposures. Alcoa's commodity and derivative activities are subject to the management, direction and control of the Strategic Risk Management Committee (SRMC). SRMC is composed of the chief executive officer, the chief financial officer and other officers and employees that the chief executive officer may select from time to time. SRMC reports to the board of directors at each of the Boards scheduled meetings on the scope of the committee's derivative activities. Environmental Matters Alcoa continues to participate in environmental assessments and cleanups at a number of locations, including at operating facilities and adjoining properties, at previously owned or operated facilities and at Superfund and other waste sites. A liability is recorded for environmental remediation costs or damages -18- when a cleanup program becomes probable and the costs or damages can be reasonably estimated. As assessments and cleanups proceed, the liability is adjusted based on progress in determining the extent of remedial actions and related costs and damages. The liability can change substantially due to factors such as the nature and extent of contamination, changes in remedial requirements and technological changes. Therefore, it is not possible to determine the outcomes or to estimate with any degree of accuracy the ranges of potential costs for certain matters. For example, there are issues related to the Massena, New York, and Pt. Comfort, Texas sites that allege natural resource damage or off-site contaminated sediments, where investigations are ongoing. The following discussion provides additional details regarding the current status of these two sites. MASSENA/GRASSE RIVER. Sediments and fish in the Grasse River adjacent to Alcoa's Massena, New York plant site contain varying levels of polychlorinated biphenyl (PCB). Alcoa has been identified by the U.S. Environmental Protection Agency (EPA) as potentially responsible for this contamination and, since 1989, has been conducting investigations and studies of the river under order from the EPA issued under the Comprehensive Environmental Response, Compensation and Liability Act. During 1998, Alcoa continued to perform studies and investigations on the Grasse River. In addition, Alcoa proposed to submit the report of remedial alternatives to EPA in phases, as additional information is obtained from these ongoing studies and investigations. In October 1998, Alcoa submitted the first of these phased reports, consisting of a summary of results of certain river and sediment studies performed over the past several years. Based on these studies, Alcoa has proposed to EPA that pilot scale tests be performed to assess the feasibility of performing certain sediment covering techniques. The costs of these pilot scale tests have been fully reserved. The results of these tests and other related field pilot studies should permit the development of the remaining phases of the remedial alternative report. Alcoa is awaiting EPA approval for these pilot tests. Based on the above, the costs to complete a remedy related to this site currently cannot be estimated since they will depend on the remedial method chosen. Alcoa is also aware of a natural resource damage claim that may be asserted by certain federal, state and tribal natural resource trustees at this location. PT. COMFORT/LAVACA BAY. In 1990, Alcoa began discussions with certain state and federal natural resource trustees concerning alleged releases of mercury from its Pt. Comfort, Texas facility into the adjacent Lavaca Bay. In March 1994, EPA listed the "Alcoa (Point Comfort)/Lavaca Bay Site" on the National Priorities List and, shortly thereafter, Alcoa and EPA entered into an administrative order on consent under which Alcoa is obligated to conduct certain remedial investigations and feasibility studies. In accordance with this order, Alcoa recently submitted a draft remedial investigation and a draft baseline risk assessment to EPA. Alcoa expects to submit a draft feasibility study during 1999. In addition, Alcoa recently commenced construction of the EPA-approved project to fortify an offshore dredge disposal island. The probable and estimable costs of these actions are fully reserved. Additional costs to complete a remedy currently cannot be estimated since these costs will depend on the extent of remediation required, if any, the remedial method chosen and the time frame to complete any remediation activity. Since the order with EPA, Alcoa and the natural resource trustees have continued efforts to understand natural -19- resource injury and ascertain appropriate restoration alternatives. That process is expected to be completed within the next 12 to 24 months. Based on the above, it is possible that results of operations in a particular period could be materially affected by certain of these matters. However, based on facts currently available, management believes that the disposition of these matters will not have a materially adverse effect on the financial position or liquidity of the company. Alcoa's remediation reserve balance at the end of the 1999 third quarter was $186.9 (of which $62.8 was classified as a current liability) and reflects the most probable costs to remediate identified environmental conditions for which costs can be reasonably estimated. About 22% of the reserve relates to Alcoa's Massena, New York plant site, and 13% relates to Alcoa's Pt. Comfort, Texas plant site. Remediation expenses charged to the reserve during the 1999 third quarter were $10.8. These include expenditures currently mandated, as well as those not required by any regulatory authority or third party. Included in annual operating expenses are the recurring costs of managing hazardous substances and environmental programs. These costs are estimated to be about 2% of cost of goods sold. Liquidity and Capital Resources Cash from Operations Cash from operations during the 1999 year-to-date period totaled $1,409.6, compared with $1,403.9 in the 1998 period. The increase reflects higher net income, a decrease in noncurrent assets and liabilities and an increase in deferred income taxes. Partially offsetting these items was a reduction in deferred hedging activity and a decrease in minority interests' share of income. Financing Activities Financing activities used $774.8 of cash in the 1999 year-to-date period, compared with $294.7 of cash generated in the 1998 period. The primary reason for the difference was Alcoa's issuance of debt in the 1998 period, which was used primarily to fund acquisitions. In the 1999 year-to-date period, Alcoa used $838.1 to repurchase 15,604,534 shares of the Company's common stock, versus $293.5 used in the 1998 period. These repurchases were partially offset by $576.9 and $30.5 in the 1999 and 1998 periods, respectively, of stock issued for employee stock option plans. In July 1999, Alcoa announced that the board of directors had authorized the repurchase of 20 million shares of Alcoa common stock. This action replaces a similar authorization approved by the board in January 1999. Approximately 12 million shares were repurchased under the prior authorization. Dividends paid to shareholders were $223.0 in the 1999 nine-month period, an increase of $29.8 over the 1998 period. The increase was primarily due to Alcoa's variable dividend program, which paid out 60.375 cents in the first half of 1999. This compares with 56.25 cents per share in the 1998 nine-month period. Investing Activities Investing activities in 1998 used $1,979.8 of cash, $1,218.0 more than the 1999 requirement of $761.8. Capital expenditures were the majority of the 1999 spending, totaling $608.9, up 2.4% from 1998 levels. Acquisitions represented the bulk of investing activities in the 1998 period. These include Alcoa's purchases of Alumax and Inespal. During the 1999 period, Alcoa acquired the bright products business of Pechiney's Rhenalu rolling plant located near Toulouse, France and Reynolds' aluminum extrusion plant in Irurzun, Spain. Alcoa -20- also acquired the remaining 50% interest in its A-CMI partnership from Hayes Lemmerz. A-CMI was a joint venture between Alcoa and CMI International formed to produce cast aluminum products for the automotive industry. A-CMI has operating locations in Kentucky, Michigan and Lista, Norway. In addition, Alcoa also added $89.8 and $110.0 to its investments in 1999 and 1998, respectively, primarily to acquire an interest in the Norweigan metals producer, Elkem. Year 2000 issue Alcoa, like other businesses, is facing the Year 2000 issue. The Year 2000 issue arises from the past practice of utilizing two digits (as opposed to four) to represent the year in some computer programs and software. If uncorrected, this could result in computational errors as dates are compared across the century boundary. As a basic materials supplier, the vast majority of the products produced and sold by Alcoa are unaffected by Year 2000 issues in use or operation since they contain no microprocessors. Alcoa is addressing the Year 2000 issue through a formal program that reports to the company's chief information and financial officers. Alcoa's methodology encompasses four phases: Awareness/Inventory; Assessment; Remediation and Compliance Testing. Ongoing leadership is provided by a Global Program Office, which is directly linked into Alcoa's business units and resource units, including the acquired Alumax facilities. The Global Program Office provides processes and tools to the business units and monitors progress through systematic reporting and on-site verification reviews in cooperation with the company's internal auditors. Progress is reported regularly to the company's senior executives and to the Audit Committee of Alcoa's board of directors. Internally, computer and microprocessor based systems such as mainframe, mini-computer and personal computer systems and the software they utilize have been assessed. Operational support, process control, facilities, infrastructure and mechanical systems are being addressed as well. These systems assist in the control of Alcoa's operations by performing such functions as maintaining manufacturing parameters, monitoring environmental conditions and assisting with facilities management and security. Many of these systems rely on software or contain embedded electronic components that could be affected by Year 2000 compliance issues. Since many of these systems are common across operating locations, information sharing and efficiencies have been realized in the Year 2000 efforts. Priority for any required remediation efforts has been assigned based on the criticality of the system or business process affected. As of September 30, 1999, the remediation phase had been completed for 99% of Alcoa's critical components with 99% of all critical components having completed compliance testing. The majority of remaining critical systems are planned for remediation as part of scheduled maintenance and system upgrades. Alcoa relies on numerous third parties for a wide variety of goods and services, including raw materials, telecommunications and utilities such as water and electricity. Many of the company's operating locations would be adversely affected if these supplies and services were curtailed as a result of a supplier's Year 2000 noncompliance. Alcoa has surveyed its vendors and suppliers using questionnaires and, based on the response and significance to the company's operations, is conducting follow-up activities with critical and important suppliers. If Alcoa concludes that a third party presents a substantial risk of a Year 2000 based business disruption, an effort will be made to resolve the issue. If necessary, a new vendor or supplier will be qualified and secured. Communication with these third parties regarding Year 2000 issues is a continuing process. Alcoa and certain of its trading partners utilize electronic data interchange (EDI) to effect business communications. The company's EDI system software has been upgraded to support transactions in a Year 2000 compliant format. Migration of EDI -21- transactions to this new format will occur as Alcoa and its EDI trading partners, on a case-by-case basis, modify existing EDI transaction formats. Some Alcoa customers have indicated that they will not modify EDI transaction sets but will rely on other techniques to achieve Year 2000 capability. Alcoa does not expect Year 2000- related disruptions to occur in these situations. In order to minimize operational effects, Alcoa is utilizing a structured contingency planning process throughout the company to identify and analyze Year 2000 operational risks. This is in addition to disaster recovery plans that already exist for critical systems within the company. Each business unit is required to identify planning units based on key departments or business processes. Risk assessment workshops are conducted for each planning unit with cross-departmental participation. The resulting risk scenarios identified in the workshops are documented and reviewed by operational management, and detailed contingency plans are developed for scenarios of greatest risk. As of the end of the third quarter, 80% of Alcoa's contingency plans are complete. In addition to contingency plans, Alcoa businesses are refining plans for the Year 2000 transition. These include site specific preparations to ensure a safe Year 2000 transition and communication activities to permit global sharing of transition information within Alcoa. Alcoa's Year 2000 program utilizes on-site verification of Year 2000 efforts at its various operating locations. Using audit-like techniques, the Year 2000 Global Program Office and the company's internal auditors verify that business and resource units have followed the prescribed processes and methodologies and also sample local Year 2000 readiness. During 1998 and through the third quarter of 1999, Alcoa has conducted over 170 reviews of US and non US locations and has found consistent adherence to the Alcoa Year 2000 methodology globally. Based on internal efforts and formal communications with third parties, Alcoa does not believe that Year 2000 issues are likely to result in significant operational problems or will have a material adverse impact on its consolidated financial position, operations or cash flow. Based on current information, Alcoa believes that the most likely worst case scenario to result from a Year 2000 failure by Alcoa, its suppliers, or customers would be a short-term reduction in manufacturing capability at one or more of Alcoa's operations and a temporary limitation on Alcoa's ability to deliver products to customers. Nonetheless, failures of suppliers, third-party vendors or customers resulting from Year 2000 issues could result in a short-term material adverse effect. For the 1999 nine-month period, Alcoa incurred approximately $27.4 million of direct costs in connection with its Year 2000 program. These costs include external consulting costs and the cost of hardware and software replaced as a result of Year 2000 issues. Total direct costs for 1999 are estimated to be between $35 and $50. -22- PART II - OTHER INFORMATION Item 1. Legal Proceedings. As previously reported, in October 1998, Region V of the U.S. Environmental Protection Agency (EPA) referred various alleged environmental violations at Alcoa's Lafayette Operations to the civil division of the U.S. Department of Justice (DOJ). The alleged violations relate to water permit exceedances as reported on monthly discharge monitoring reports. Alcoa and the DOJ entered into a tolling agreement to suspend the statute of limitations related to the alleged violations in order to facilitate settlement discussions with the DOJ and EPA. The parties have been unable to reach settlement on this matter. On June 11, 1999, the DOJ and EPA filed a complaint against Alcoa in the United States District Court for the Northern District of Indiana. Alcoa filed a motion to dismiss and a motion to strike certain parts of the government's complaint requesting sediment remediation on August 20, 1999. In March 1999, two search warrants were executed by various federal and state agencies on the Alcoa Port Allen Works of Discovery Aluminas, Inc., a subsidiary, in Port Allen, Louisiana. Also in March, Discovery Aluminas, Inc. was served with a grand jury subpoena that required the production to a federal grand jury of certain company records relating to alleged environmental issues involving wastewater discharges and management of solid or hazardous wastes at the plant. In April 1999, the Port Allen plant manager was indicted for a single count of violating the Clean Water Act. In October 1999, a second grand jury subpoena for documents was issued to Alcoa requesting information regarding wastewater discharges from a Port Allen plant. Alcoa intends to provide a complete and timely response to the subpoena. Alcoa also is engaged in discussions seeking to resolve the situation. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 10(n). Amended and Restated Revolving Credit Agreement (364-Day), dated as of August 13, 1999. 12. Computation of Ratio of Earnings to Fixed Charges 15. Independent Accountants' letter regarding unaudited financial information 27. Financial Data Schedule (b) Reports on Form 8-K. Alcoa filed a Form 8-K, dated August 18, 1999, with the Securities and Exchange Commission that announced Alcoa Inc., RLM Acquisition Corp., a wholly owned subsidiary of Alcoa, and Reynolds Metal Company had entered into an agreement and plan of merger, dated as of August 18, 1999, pursuant to which each outstanding share of common stock, no par value, of Reynolds will be converted into 1.06 shares of common stock, par value $1.00 per share, of Alcoa. -23- SIGNATURES Pursuant to the requirements 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. Alcoa Inc. October 19, 1999 By /s/ RICHARD B. KELSON - ---------------- ------------------------ Date Richard B. Kelson Executive Vice President and Chief Financial Officer (Principal Financial Officer) October 19, 1999 By /s/ TIMOTHY S. MOCK - ---------------- ------------------------ Date Timothy S. Mock Vice President and Controller (Chief Accounting Officer) -24- EXHIBITS Page 10(n). Amended and Restated Revolving Credit Agreement (364-Day), dated as of August 13, 1999. 12. Computation of Ratio of Earnings to Fixed Charges 25 15. Independent Accountants' letter regarding 26 unaudited financial information 27. Financial Data Schedule -25-