HAMILTON, ON, Aug. 10 /CNW/ - Stelco Inc. (TSX:STE) today reported EBITDA
of $19 million and a net loss of $31 million or $1.14 per share for the second
quarter ended June 30, 2006. A number of unusual items during the quarter
negatively impacted EBITDA by $49 million and net income by $54 million. These
items relate primarily to adjustments resulting from the application of fresh
start accounting, and workforce cost reduction initiatives, partially offset
by a net favourable future income tax adjustment due to the enactment of lower
federal corporate income tax rates.
As a result of the reorganization and the continuing revaluation of
Stelco's assets and liabilities under "fresh start" reporting, consolidated
financial and other information reported in the second quarter of 2006 may not
be comparable with consolidated financial and other information reported in
prior periods. The application of "fresh start accounting", on March 31, 2006,
will continue to impact future results due to amortization changes as a result
of revaluing of property, plant and equipment and cost of sales increases in
the near term as the remainder of the revaluation of inventories from the
lower of cost and net realizable value to fair value. The revaluation has not
been finalized. Accordingly, only selective financial information on sales,
production and shipments is commented on by way of comparison with prior
periods.
Net sales revenue for the quarter ended June 30, 2006 was $698 million
compared to $658 million for the same period in 2005. Increased revenues
during the quarter were mainly due to a 15% increase in steel shipments.
Partially offsetting this was an 8% decrease in average revenue per ton
resulting from lower spot and contract pricing, the negative impact of the
higher Canadian dollar, and a shift in mix towards lower valued added
products. Production during the second quarter of 2006 increased to 1,108,000
semi-finished tons with shipments increasing to 971,000 net tons as compared
to 1,054,000 semi-finished tons produced and 840,000 net tons shipped in the
second quarter of 2005.
Net sales revenue for the quarter ended June 30, 2006 was $698 million
compared to $674 million for the quarter ending March 31, 2006. While steel
shipments remained relatively constant, there was a 4% increase in average
revenue per ton. The increase in the average revenue per ton was primarily due
to an increase in Stelco's spot pricing business and a shift in mix from hot
roll into higher priced cold rolled products. Production during the second
quarter of 2006 of 1,108,000 semi-finished tons increased from the 997,000
tons produced in the quarter ending March 31, 2006. Shipments were relatively
constant with 971,000 net tons shipped in the second quarter and 974,000 net
tons in the first quarter.
<<
A number of positive events occurred during the second quarter of 2006
including:
- A new collective agreement was reached with USW Local 1005. This
collective agreement has a term of four years and incorporates a new
level of cooperation with management in seeking out efficiencies on
the shop floor by leveraging the knowledge of those employees who
make the steel and by empowering them to effect change. An incentive
program has recently been introduced to promote and facilitate this
change in thinking.
- The Corporation introduced a number of workforce cost reduction
initiatives. While the net result of these initiatives will have a
negative short-term impact on EBITDA, net earnings and operating cash
flows, these initiatives will have a long-term benefit to the cost
structure and is a major step towards our drive to return Stelco to a
viable and profitable company.
- A number of other initiatives are being developed and implemented
that will further reduce costs by reducing spending, increasing
productivity or increasing production volumes.
>>
Looking forward to the second half of 2006, the steel market is expected
to remain strong. Production for the second half of 2006 is expected to be
2.1 million net tons of semi-finished steel with approximately 2 million net
tons of shipments (including the impact of scheduled outages).
About Stelco
Stelco is one of Canada's largest steel companies. It is focused on its
two Ontario-based integrated steel businesses located in Hamilton and in
Nanticoke. These operations produce high quality value-added hot rolled, cold
rolled, coated sheet and bar products. To learn more about Stelco and its
businesses, please refer to our Web site at www.stelco.ca.
NON-GAAP MEASURES
This press release contains "Non-GAAP" measures such as "EBITDA".
"EBITDA" refers to operating earnings (losses) before interest, income taxes,
amortization and other non operating income and expenses. Information
concerning EBITDA has been included in this press release because management
considers it to be, and uses it as, a meaningful indicator for assessing the
performance of the Corporation. EBITDA does not represent cash generated from
operations as defined by Canadian GAAP and it is not necessarily indicative of
cash available to fund cash needs. Non-Canadian GAAP earnings measures (such
as EBITDA) do not have any standardized meaning and therefore the
Corporation's use of EBITDA measures may not be comparable to measures used by
other companies.
CAUTION REGARDING FORWARD-LOOKING INFORMATION
This press release contains "forward-looking information" that is based
on Stelco's expectations, estimates and projections as of the date of this
press release or as of the date which such information is identified to be
given. This forward-looking information includes, among other things, factors
relating to the business, financial position, operations and prospects of
Stelco, including: Stelco's strategies and plans to reduce costs and the
anticipated outcome of such strategies and plans; anticipated productivity
levels and profitability; labour matters related to Stelco's predominantly
unionized workforce; pension matters; consolidation in the steel industry;
Stelco's energy and raw material costs and the availability of such materials;
the volatility of selling prices for steel; international trade matters,
including increases in steel imports into Canada; employee matters, including
staffing levels, the retention of the skills and knowledge of Stelco's
employees and the ability to attract and retain new employees; changes to
environmental laws and regulations concerned with, among other things,
emissions into the air, discharges to water or land, noise control and the
generation, handling, storage, transportation and disposal of toxic
substances; new technological developments and Stelco's ability to make
capital expenditures to maintain and enhance its technological ability;
development of new products; planned capital expenditures; and currency
fluctuations in the US dollar and its impact on steel pricing, and costs.
Often, but not always, forward-looking information can be identified by the
use of words and phrases such as "plans", "expects" or "does not expect", "is
expected", "budget", "scheduled", "estimates", "forecasts", "intends",
"anticipates" or "does not anticipate", or "believes", or variations of such
words and phrases or states that certain actions, events or results "may",
"could", "would", "might" or "will" be taken, occur or be achieved.
Forward-looking information involves known and unknown risks,
uncertainties and other factors which may cause the actual results,
performance or achievements of Stelco to be materially different from any
future results, performance or achievements expressed or implied by the
forward-looking information. Actual results, performance and achievements are
likely to differ, and may differ materially, from those expressed or implied
by the forward-looking information contained herein. Such forward-looking
information is based on a number of assumptions which may prove to be
incorrect, including, but not limited to: exchange rates, energy and other
anticipated and unanticipated costs; pension contributions and expenses; the
supply and demand for, deliveries of, and the level and volatility of prices
of, steel and raw materials; the continued availability of financing on
appropriate terms; market competition; the impact on Stelco of various
environmental regulations and initiatives; and Stelco's ongoing relations with
its employees and staffing levels. While Stelco anticipates that subsequent
events and developments may cause Stelco's views to change, Stelco
specifically disclaims any obligation to update this forward-looking
information. This forward-looking information should not be relied upon as
representing Stelco's views as of any date subsequent to the date of this
press release.
STELCO INC.
QUARTER 2, 2006
REPORT TO THE SHAREHOLDERS
MANAGEMENT'S DISCUSSION AND ANALYSIS
This Management's Discussion and Analysis (this "MD&A") is dated
August 9, 2006 and is in respect of the interim unaudited consolidated
financial statements (the "Consolidated Financial Statements") of Stelco Inc.
("Stelco" or the "Corporation") for the quarter ended June 30, 2006. The
purpose of Stelco's MD&A is to provide commentary on the Corporation's
financial condition and future prospects and to assist security holders and
others to understand the Corporation and the key factors underlying its
financial results. This MD&A should be read in conjunction with interim
Consolidated Financial Statements and the accompanying notes, Stelco's interim
report for the quarter ended March 31, 2006 and Stelco's 2005 annual report.
The Corporation prepares its interim Consolidated Financial Statements in
accordance with Canadian generally accepted accounting principles ("Canadian
GAAP"). Additional information about Stelco is available in the Corporation's
2005 Annual Information Form, Annual MD&A and Financial Statements, which can
be accessed from SEDAR at www.sedar.com.
This document has been reviewed by the Audit Committee of Stelco's Board
of Directors and contains information current as of August 9, 2006. Events
occurring after that date could render the information contained herein
inaccurate or misleading in a material respect.
BUSINESS DESCRIPTION
Stelco is one of Canada's largest steel companies. The Corporation
operates two integrated steel plants in Ontario, Canada which service
customers in the automotive, steel service centre, appliance, energy,
construction and pipe and tube industries within North America. In addition,
through its ownership interests in iron ore mining properties and related
supply agreements, Stelco has secured approximately 90% of its iron ore
requirements, as feedstock in the steelmaking process. Stelco operates its
businesses through partnerships, subsidiaries and joint ventures. Where
applicable, "Stelco" and the "Corporation" refer to Stelco Inc. and its
partnerships, subsidiaries and joint ventures collectively.
Reorganization and Adoption of "Fresh Start" Reporting
Stelco and certain related entities filed for protection under the
Companies' Creditors Arrangement Act (the "CCAA") on January 29, 2004 and
emerged from CCAA protection at the end of the day on March 31, 2006 upon the
implementation of Stelco's third amended and restated plan of arrangement and
reorganization (the "CCAA Plan"). Also on March 31, 2006, a plan of
arrangement involving Stelco was implemented under the Canada Business
Corporations Act (the "CBCA Plan") pursuant to which Stelco's business was
reorganized and specific assets and liabilities of Stelco were transferred
into nine separate limited partnerships. Stelco's emergence from CCAA
protection and the implementation of the CCAA Plan and the CBCA Plan is
referred to in this MD&A as the "Reorganization". Further information
regarding the Reorganization is set out in Note 1 to the Consolidated
Financial Statements.
When used in this MD&A, the term "Predecessor" refers to Stelco and its
related entities prior to the Reorganization and the term "Successor" refers
to Stelco and its related entities following the Reorganization.
In connection with the Reorganization, Stelco adopted "fresh start"
reporting on March 31, 2006 and, accordingly, is undertaking a comprehensive
revaluation of its assets and liabilities. Pending such finalization, there
have been no changes to the initial estimated fair value adjustment reflected
in Stelco's March 31, 2006 consolidated statement of financial position. See
"Changes in Accounting Policy" in this MD&A and Note 2 to the Consolidated
Financial Statements.
As a result of the Reorganization and the continuing revaluation of
Stelco's assets and liabilities under "fresh start" reporting, consolidated
financial and other information regarding the Successor may not be comparable
with consolidated financial and other information regarding the Predecessor.
Accordingly, selected comparative information in this MD&A regarding sales and
shipments has been provided where such information is not affected by the
Reorganization or the adoption of "fresh start" reporting.
OVERVIEW
The net loss for the second quarter of 2006 was $31 million. Included in
this loss are $90 million of unusual items on a pre-tax basis ($62 million
after tax). These unusual items include:
<<
- a fresh start inventory revaluation included in Costs - $49 million;
- salaried employees severance and voluntary retirement incentive costs
- $27 million; and
- an employee future benefit curtailment expense - $14 million.
>>
In addition, there was a net future income tax recovery of $8 million due
to the enactment of lower future federal income tax rates.
Net Sales
Quarter ended June 30, 2006 compared to quarter ended June 30, 2005
Net sales for the quarter ended June 30, 2006 were 6% higher than the
same quarter of 2005 mainly due to a 15% increase in steel shipments,
partially offset by an 8% decrease in average revenue per ton. Average revenue
per ton in the second quarter of 2006 was lower primarily due to:
<<
- higher pricing in the second quarter of 2005 in both spot and contract
business;
- the negative impact of the higher Canadian dollar; and
- a shift in mix of sales mainly due to increased slab and hot roll
sales.
>>
Quarter ended June 30, 2006 compared to quarter ended March 31, 2006
Net sales for the quarter ended June 30, 2006 were 3% higher than the
first quarter of 2006. Steel shipments remained relatively constant, while
average revenue per ton was 4% higher. The second quarter increase in average
revenue per ton was primarily due to:
<<
- increased pricing predominantly in Stelco's spot price business; and
- a shift in mix from hot roll into higher priced cold rolled product.
>>
Six months ended June 30, 2006 compared to six months ended June 30, 2005
Net sales for the first half of the year were 1% lower than the same
period in 2005. Steel shipments were 11% higher, while average revenue per ton
was down 11% compared to 2005. The six month decrease in average revenue per
ton was primarily due to:
<<
- higher pricing in the second quarter of 2005 in both spot and contract
business;
- the negative impact of the higher Canadian dollar; and
- a shift in mix of sales mainly due to increased slab and hot roll
sales.
>>
Financial Expense and Foreign Exchange Gain
Total financial expense of $17 million was incurred in the second quarter
of 2006. Included in financial expense for the second quarter of 2006 is
approximately $1 million relating to borrowings under the secured revolving
term loan (see Liquidity and Capital Resources - Financing Arrangements) which
is held indirectly by a significant shareholder. The interest on related party
borrowings is calculated in accordance with the applicable related party
lending agreement, yielding approximately 11% as at June 30, 2006. The
majority of related party interest is paid prior to the end of each month,
therefore a nominal amount is outstanding at June 30, 2006.
The Corporation's long-term floating rate notes (see Note 9 to the
Consolidated Financial Statements) are denominated in US dollars
($235 million), resulting in a translation gain of $13 million in the second
quarter of 2006, as the debt was translated at the exchange rate in effect on
June 30, 2006.
Income Tax Expense
Future income tax assets are recognized to the extent that realization is
considered more likely than not. The assessment as to the future realization
of future income tax assets, including loss carry-forwards, is conducted on a
company-by-company basis for the Stelco group of businesses. Realization of
future income tax assets is dependent upon the availability of sufficient
taxable income within the carry-forward periods. The assessment of realization
is based upon the weight of evidence at the respective balance sheet date.
The Corporation had certain future tax assets which existed at March 31,
2006 but were not recognized on the Consolidated Statement of Financial
Position at that date. To the extent that these future tax assets are
subsequently recognized the benefits will not flow through the Consolidated
Statement of Earnings (Loss) but will be treated as an amendment to fresh
start accounting as required by Canadian GAAP.
A net future income tax recovery of $8 million was recorded in the second
quarter 2006 due to the enactment of lower future federal income tax rates.
<<
FINANCIAL AND OPERATIONAL SUMMARY
Stelco Inc.
($ in millions, except as indicated (x)) (unaudited)
-------------------------------------------------------------------------
Three Three Three Three Six
months months months months months
ended ended ended ended ended
June 30, June 30, June 30, March 31, June 30,
2006 2005(1) 2006(2) 2006(2) 2005(1)
-------------------------------------------------------------------------
(Pre- (Pre- (Pre-
(Successor) decessor) (Successor) decessor) decessor)
Net Sales $ 698 $ 658 $ 698 $ 674 $ 1,386
Costs 679 571 679 695 1,164
-------------------------------------------------------------------------
EBITDA(3) 19 87 19 (21) 222
Amortization of
property, plant
and equipment 28 28 28 27 54
Amortization of
intangible assets 1 1 1 1 2
-------------------------------------------------------------------------
Operating earnings
(loss) (EBIT)(3)
before the following : (10) 58 (10) (49) 166
Employee future
benefits -
workforce reduction
costs (Note 13) 41 - 41 - -
Foreign exchange
gain on long-term
debt (Note 9) (13) - (13) - -
Gain on sale of
plate mill assets - (20) - - (20)
Reorganization items - 13 - 21 34
Financial and other
expense
Interest on long-term
debt and debt subject
to compromise 9 11 9 10 21
Other interest - net 8 1 8 5 5
-------------------------------------------------------------------------
Earnings (loss) before
income tax from
continuing operations (55) 53 (55) (85) 126
Income tax expense
(recovery) (Note 7)
Current 2 9 2 7 30
Future (18) 6 (18) (33) 9
Future income tax
asset valuation
allowance (release) - 3 - 20 11
Future income tax
rate reduction (8) - (8) - -
-------------------------------------------------------------------------
Net earnings (loss)
from continuing
operations (31) 35 (31) (79) 76
Net earnings (loss)
from discontinued
operations (Note 1) - 5 - (43) 13
-------------------------------------------------------------------------
Net earnings (loss) $ (31) $ 40 $ (31) $ (122) $ 89
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Earnings (loss) per
common share from
continuing
operations
(Note 14) (x)$(1.14) (x)$0.34 (x)$(1.14) (x)$(0.77) (x)$0.74
Earnings (loss)
per common share
(Note 14) (x)$(1.14) (x)$0.39 (x)$(1.14) (x)$(1.19) (x)$0.87
Average revenue
per ton (x)$ 719 (x)$ 783 (x)$ 719 (x)$ 692 (x)$ 793
Cost per ton (x)$ 699 (x)$ 680 (x)$ 699 (x)$ 714 (x)$ 666
Semi-finished
steel production
(thousands of
net tons) 1,108 1,054 1,108 997 2,074
Shipments
(thousands of
net tons) 971 840 971 974 1,747
-------------------------------------------------------------------------
(1) Restated to disclose the activities of the Predecessor's
continuing and discontinued operations separately.
(2) The six month period ended June 30, 2006 consists of two quarters
which are not comparable.
(3) Non-GAAP Measures
The financial information contained in this MD&A is presented in
accordance with Canadian GAAP. Reference is also made to "EBITDA"
and "EBIT", which are non-Canadian GAAP measures. "EBITDA" refers to
operating earnings (losses) before interest, income taxes,
amortization and other non-operating income and expenses and, in the
case of the Predecessor, also before restructuring costs and asset
write-downs. "EBIT" refers to operating earnings (losses) before
interest, income taxes and other non-operating income and expenses.
Information concerning EBITDA and EBIT has been included in this MD&A
because management considers it to be, and uses it as, a meaningful
indicator for assessing the performance of the Corporation. EBITDA
does not represent cash generated from operations as defined by
Canadian GAAP and it is not necessarily indicative of cash available
to fund cash needs. Non-Canadian GAAP earnings measures (such as
EBITDA and EBIT) do not have any standardized meaning and therefore
the Corporation's use of EBITDA and EBIT measures may not be
comparable to measures used by other companies. A reconciliation to
net earnings (loss), which is a Canadian GAAP measure, is presented
above in the Financial and Operational Summary.
>>
All note references in this document are to the Consolidated Financial
Statements.
SUMMARY OF QUARTERLY RESULTS
The following table reflects the Corporation's quarterly financial
performance over the last eight quarters. The Corporation does not typically
experience significant seasonal fluctuations in revenues.
As a result of the Reorganization and the continuing revaluation of
Stelco's assets and liabilities under "fresh start" reporting, consolidated
financial and other information regarding the Successor may not be comparable
with consolidated financial and other information regarding the Predecessor.
<<
Stelco Inc.
-------------------------------------------------------------------------
(in millions 2006 2006 2005 2005 2005 2005 2004 2004
except as (1) (1) (1) (1) (1)
indicated(x)) Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3
-------------------------------------------------------------------------
(Successor) (Predecessor)
Net Sales $ 698 674 608 559 658 728 678 691
EBITDA(2) 19 (21) (31) (8) 87 135 78 107
Operating
earnings (loss)
(EBIT)(2) $ (10) (49) (58) (36) 58 108 53 78
Earnings (loss)
before income
tax from
continuing
operations $ (55) (85) (103) (62) 53 73 23 54
Net earnings
(loss) from
continuing
operations $ (31) (79) (67) (18) 35 41 21 42
Net earnings
(loss) $ (31) (122) (120) (42) 40 49 1 58
Earnings (loss)
from
continuing
operations
per common
share(3)
Basic (x)$ (1.14) (0.77) (0.66) (0.18) 0.34 0.40 0.21 0.41
Fully
diluted (x)$ (1.14) (0.77) (0.66) (0.18) 0.30 0.35 0.18 0.36
Net earnings
(loss) per
common
share(3)
Basic (x)$ (1.14) (1.19) (1.17) (0.41) 0.39 0.48 0.01 0.57
Fully
diluted (x)$ (1.14) (1.19) (1.17) (0.41) 0.34 0.41 0.01 0.49
Average
revenue
per ton (x)$ 719 692 685 690 783 803 770 789
Cost per ton (x)$ 699 714 720 700 680 654 681 667
Semi-finished
steel
production
(thousands
of net tons) 1,108 997 982 875 1,054 1,020 1,115 1,141
Shipments
(thousands
of net tons) 971 974 888 810 840 907 881 876
-------------------------------------------------------------------------
(1) Restated to disclose the activities of the Predecessor's
continuing and discontinued operations separately.
(2) EBITDA and Operating earnings (loss) EBIT are non-GAAP financial
measures. See "Financial and Operational Summary - Non GAAP
Measures".
(3) Earnings (loss) per common share is calculated using the weighted
average number of common shares outstanding during the quarter.
>>
LIQUIDITY AND CAPITAL RESOURCES
The liquidity and capital resources of the Corporation are dependent upon
a number of factors, including without limitation market and economic
conditions and the impact of these conditions on the price of steel products,
raw material costs, the ability to fund critical capital projects, pension
issues and labour negotiations and disputes.
The Corporation has a significant requirement of working capital related
primarily to inventories due to the lead time of acquiring raw materials, the
quantities of raw materials that are required to produce semi-finished steel
and the amount of time required to process this semi-finished steel into a
finished product. This working capital requirement is characteristic of many
companies within the steel industry.
With the recapitalization of the Corporation upon emergence from CCAA,
interest will be serviced in accordance with the terms and conditions of the
related debt obligations.
The Corporation's liquidity and capital resources position is summarized
as follows:
<<
-------------------------------------------------------------------------
At June 30, At March 31, At June 30, At December 31,
(in millions) 2006 2006 2005 2005
-------------------------------------------------------------------------
(Successor) (Successor) (Predecessor) (Predecessor)
Cash, cash equivalents
and restricted cash 18 36 35 42
Available lines of
credit(1) 867(2) 886(2) 397(3) 403(3)
Lines of credit drawn
down(4) (436) (427) (128) (191)
-------------------------------------------------------------------------
Net liquidity 449 495 304 254
-------------------------------------------------------------------------
-------------------------------------------------------------------------
(1) After letters of credit usage, and subject to the availability
under their governing agreements.
(2) Includes the amount available from the $600 ABL facility and the
$375 secured revolving term loan.
(3) Includes the former $350 million credit facility and the former
$75 million debtor-in-possession short-term credit facility.
(4) In accordance with Canadian GAAP, the borrowings of the Successor are
classified predominantly as long-term liabilities on the Consolidated
Statement of Financial Position. See Note 8 to the Consolidated
Financial Statements for additional information.
>>
Financing Arrangements
Asset Based Loan Facility
On March 31, 2006, the $75 million debtor-in-possession short-term credit
facility and the $350 million short-term credit facility were replaced by a
long-term asset based loan facility (the "ABL facility"). The ABL facility
bears interest at the Canadian bankers' acceptance rate + 2.25%, prime rate +
0.5%, the US base rate + 0.5% or LIBOR + 2.25%, depending on the nature of the
loan instrument incurred. The ABL facility is available until March 31, 2008
and is secured by a first priority security interest in the eligible inventory
and accounts receivable of Stelco. The ABL facility is additionally secured by
a second priority security interest on all other property and assets of the
Corporation, limited to $300 million, and a fourth priority security interest
for the balance. The available amount of the ABL facility is dependent upon
the value of the underlying collateral and reserves, but will not exceed
$600 million.
Secured Revolving Term Loan
On March 31, 2006, as part of the CCAA Plan, the Corporation entered into
a secured revolving term loan facility with a wholly owned subsidiary of
Tricap Management Limited (a significant shareholder of the Corporation) in
the amount of $375 million for a term of seven years. The facility is
revolving for three years, after which time the facility will cease to revolve
and any amount outstanding on that date will be repayable in full at the end
of the seventh year. The secured revolving term loan currently bears interest
at bankers' acceptance rate plus 6.75%. The secured revolving term loan is
secured by a second priority interest on the working capital assets of Stelco,
except project financings, and a first priority security interest in the
property, plant and equipment of Stelco. The secured revolving term loan is
also secured by all the tangible and non-tangible assets of certain
subsidiaries of Stelco and a pledge of and security interest in all of the
outstanding shares of interests in the subsidiaries, partnerships and joint
ventures of Stelco.
Liquidity Risks
Some of the provisions contained in the Corporation's financing
arrangements provide for the escalation of lending rates in certain
circumstances which, if triggered, could impact the liquidity of the
Corporation depending upon the amount outstanding under the particular
facility. These agreements also contain provisions (along with the
Corporation's long-term debt agreements), which restrict the Corporation's
ability to issue additional debt.
The Corporation has $235 million principal amount of US denominated
floating rate notes outstanding. The amount to be repaid in Canadian dollars
will be dependent upon the US exchange rate in effect upon the maturity of
this obligation in 2016.
<<
Net Cash Flow
-------------------------------------------------------------------------
Three Three Three Three Six
months months months months months
ended ended ended ended ended
June 30, June 30, June 30, March 31, June 30,
(in millions) 2006 2005(1) 2006(2) 2006(2) 2005(1)
-------------------------------------------------------------------------
(Pre- (Pre- (Pre-
(Successor) decessor) (Successor) decessor) decessor)
Cash provided by
(used for)
Net earnings (loss)
from continuing
operations adjusted
for items not
affecting cash $ 17 $ 78 $ 17 $ (40) $ 195
Changes in operating
elements of working
capital (13) (26) (13) (2) (44)
Proceeds from the
sale of non-core
subsidiaries and
assets - 23 - 107 23
Expenditure for
capital assets (41) (45) (41) (49) (62)
Issue of common
shares 5 - 5 - -
Reduction of
long-term debt - - - (12) (6)
Other - net 5 - 5 (1) -
-------------------------------------------------------------------------
Change in net
cash position $ (27) $ 30 $ (27) $ 3 $ 106
-------------------------------------------------------------------------
-------------------------------------------------------------------------
(1) Restated to disclose the activities of the Predecessor's continuing
and discontinued operations separately.
(2) The six month period ended June 30, 2006 consists of two quarters
which are not comparable.
Due to the non-comparable nature of the financial results between the
Successor and Predecessor (see "Reorganization and Adoption of "Fresh Start"
Reporting" in this MD&A), the following commentary pertains to the results of
the Successor only.
For the three months ended June 30, 2006, the Successor required
$27 million of cash. Operating activities generated $17 million, which was
more than offset by $13 million required to finance working capital
requirements and $41 million of capital expenditures.
Working capital requirements were primarily related to the following:
- $14 million for prepaid expenses - largely representing insurance
policies typically renewed in the second quarter;
- $17 million for taxes payable - relating primarily to the final
payments for 2005 income taxes and interim installments for 2006
income tax for certain subsidiaries.
>>
These were partially offset by $26 million sourced from accrued accounts
payable relating primarily to interest accrued on the floating rate notes and
timing on payroll related items.
Capital expenditures of $41 million were incurred during the second
quarter of 2006 relating primarily to the continued spending on Phase 2 hot
strip mill upgrade at Lake Erie Steel and various projects at the
Corporation's mining interests.
The Corporation relied on cash and short-term borrowings of $27 million
to finance its operating and capital requirements during the second quarter of
2006. The Corporation's net liquidity of $449 million is considered sufficient
to meet these short-term needs. A number of initiatives are being pursued by
the Corporation with the expected result of improving operating cash flows to
a level sufficient to exceed both operating and capital requirements on a
sustainable basis and to reduce short-term borrowings.
While certain of the initiatives will initially result in further
short-term borrowings, the expected future cash savings upon the conclusion of
the initiatives will more than offset these costs. More specifically, the cash
cost for the workforce reduction programs, which will predominantly be paid in
the third quarter of 2006, is expected to be approximately $24 million. An
additional $15 million cash payment will be made in the third quarter of 2006
to employees who participated in Stelco's voluntary termination programs (see
"Risk Factors - Employees"). This amount is primarily related to
pre-retirement entitlements and banked vacations, which have been previously
accrued.
While the pension agreement with the Province of Ontario (see Note 13 to
the Consolidated Financial Statements) has a prescribed funding obligation,
pension plan enhancements, such as the recently negotiated hourly pension
indexing, are excluded from this arrangement. Accordingly, the hourly pension
indexing is subject to additional cash funding under the Pension Benefits Act
totalling an estimated $121 million over the next eight years.
Federal Government Grant
The Government of Canada announced on November 23, 2005 that it would
provide a $30 million co-generation grant. The federal contribution
represented approximately 60% of the initial cost of the Corporation's
near-term cogeneration spending. Since the time of the commitment, there was a
change in Government. In June 2006, the Corporation was advised by the
Government that it cancelled its previously announced commitment to contribute
the $30 million grant.
Contractual Obligations
The following is a summary of the principal obligations of the
Corporation at June 30, 2006:
<<
greater than
(in millions) Total 2006 2007-2008 2009-2010 2010
-------------------------------------------------------------------------
Long-term debt(1) $ 442 $ 11 $ 19 $ - $ 412
Revolving term
loans(2) 436 - 411 25 -
Capital leases 6 2 2 2 -
Operating leases(3) 23 10 9 3 1
Purchase obligations
and other
commitments(4) 734 270 252 144 68
-------------------------------------------------------------------------
Total $1,641 $ 293 $ 693 $ 174 $ 481
-------------------------------------------------------------------------
-------------------------------------------------------------------------
(1) See Note 9 to the Consolidated Financial Statements for more
information.
(2) See Note 8 to the Consolidated Financial Statements for more
information.
(3) Principally related to mobile equipment.
(4) Principally related to coal purchases, information technology
services, oxygen and power requirements.
OFF-BALANCE SHEET ARRANGEMENTS
Other than operating leases referred to above, the Corporation had no
off-balance sheet arrangements at June 30, 2006.
FINANCIAL INSTRUMENTS
The Corporation did not utilize any third party financial instruments to
mitigate interest rate or foreign exchange risk in the second quarter of 2006
and, accordingly, no such financial instruments were outstanding at June 30,
2006.
OUTSTANDING SHARE DATA
Common Shares
-------------------------------------------------------------------------
(in millions,
except share At June 30, At March 31, At June 30, At December 31,
numbers) 2006 2006 2005 2005
-------------------------------------------------------------------------
(Successor) (Successor) (Predecessor) (Predecessor)
New Common Shares 27,100,000 26,100,000 - -
Convertible
Series A - - 101,778,203 100,735,965
Convertible
Series B - - 470,996 1,513,233
-------------------------------------------------------------------------
Total number of
shares 27,100,000 26,100,000 102,249,199 102,249,198
-------------------------------------------------------------------------
Total $149 $144 $781 $781
-------------------------------------------------------------------------
-------------------------------------------------------------------------
>>
Series A and B Common Shares
The Series A and B common shares of the Predecessor were delisted from
the Toronto Stock Exchange as at the close of trading on March 10, 2006. These
shares were eliminated on CCAA Plan implementation with no value being
attributed to them.
New Common Shares
The Corporation issued 26,100,000 new common shares upon emergence from
CCAA with a value of $5.50 per share. On April 2, 2006, the Chief Executive
Officer purchased 1,000,000 common shares from treasury for total
consideration of $5.5 million, bringing the total number of common shares
outstanding as of that date to 27,100,000. As at August 9, 2006, there remain
27,100,000 common shares outstanding.
Warrants
Upon emergence from CCAA, the Corporation issued a total of 2,269,600
warrants. Each warrant entitles the holder to purchase one common share at an
exercise price of $11.00. The total number of common shares issuable upon the
exercise of all outstanding warrants represents approximately 7% of the common
shares outstanding upon the exercise of warrants on a diluted basis. These
warrants have a term of seven years and are exercisable at anytime after June
26, 2006 up to their expiration on March 31, 2013. See Note 11 to the
Consolidated Financial Statements for additional information.
Incentive Stock Option Plan
Effective April 1, 2006, the Board of Directors approved an Incentive
Stock Option Plan (the "ISOP"). The total number of options available under
the ISOP is 2,610,000, of which 1,944,000 were issued at an exercise price of
$5.50 per common share. The options vest semi-annually over a four-year period
from the date of the grant (the "Grant Date") in eight equal installments,
subject to acceleration under certain circumstances. The options expire
10 years after the Grant Date. In accordance with the provisions of the ISOP,
the exercise price of options granted thereunder is required to be the market
value, as defined in the ISOP, of the common shares on the Grant Date. During
the second quarter of 2006, 200,000 options were forfeited and 150,000
additional options were granted. The total options available under the ISOP at
June 30, 2006 is 716,000. See Note 12 to the Consolidated Financial Statements
for more information.
CHANGES IN ACCOUNTING POLICY
Accounting Changes Effective in 2006
Comprehensive Revaluation of Assets and Liabilities
Upon emergence from CCAA on March 31, 2006, there was a substantial
realignment of the equity and non-equity interests in the Corporation. The
Corporation was required, under Canadian GAAP, to adopt "fresh start"
reporting in accordance with CICA Handbook section 1625 - Comprehensive
Revaluation of Assets and Liabilities. All of the assets and liabilities of
the Corporation were revalued to their estimated fair value at the time of
implementation of the CCAA Plan on March 31, 2006. At this time, the
Corporation is continuing to finalize the fair values of the assets and
liabilities of the Successor. While it was anticipated that the results would
be finalized in the second quarter 2006, several factors have contributed to
the delay including complexities associated with the valuation of certain
entities and changes in senior management responsible for review and approval
of the final result. Accordingly, there have been no changes to the initial
estimated fair value adjustment reflected in the March 31, 2006 consolidated
statement of financial position.
CRITICAL ACCOUNTING ASSUMPTIONS AND ESTIMATES
The Corporation's Consolidated Financial Statements are prepared in
accordance with Canadian GAAP as disclosed in Note 3 thereto.
In preparing the Consolidated Financial Statements, management is
required to make certain assumptions and estimates. Choosing one assumption or
estimate from a range of possibilities can materially impact the amounts
reported on the Statement of Earnings (Loss) or the Statement of Financial
Position. Management reviews accounting assumptions and estimates regularly in
light of past experience and current conditions or changes in Canadian GAAP,
and utilizes outside consultants as necessary to arrive at appropriate
assumptions and estimates to be used in the preparation of the Consolidated
Financial Statements. The Audit Committee of the Board of Directors reviews
the significant assumptions and estimates throughout the year.
Management considers assumptions and estimates relating to the following
matters to be the most critical:
<<
- valuation of accounts receivable;
- carrying value of long-lived assets (property, plant and equipment);
- employee future benefits;
- income taxes;
- inventory valuation;
- environmental matters; and
- basis of valuation.
>>
Unless indicated otherwise, all adjustments related to the items below
are reflected in Costs in the Consolidated Statement of Earnings (Loss).
Valuation of Accounts Receivable
Stelco records an allowance for doubtful collection of accounts
receivable based on the Corporation's best estimate of any potential
uncollectible amounts. The best estimate considers past experience with the
customer base and a review of current economic conditions and specific
customer issues. While there is no significant exposure to individual
customers, there is a significant exposure to the automotive industry.
Although the Corporation and its Predecessor have not had significant bad debt
expenses in prior periods, deteriorating economic conditions could result in
financial difficulties in the customer base that could lead to bad debts.
Carrying Value of Long-Lived Assets
In accordance with Canadian GAAP appropriate for a going concern,
property, plant and equipment is carried at cost less accumulated
amortization. This carrying amount is reviewed for impairment whenever events
or circumstances indicate that the carrying amount may not be recoverable. The
carrying value is considered recoverable if the sum of undiscounted cash flows
from operations and cash flow from disposal of the property, plant and
equipment exceeds the carrying amount. Future cash flows are dependent upon
the assumptions used for revenues and costs to produce product. There is a
high degree of uncertainty in estimating future cash flows, primarily as a
result of the uncertainty regarding future prices for steel, operating costs
and economic conditions. The application of different assumptions for steel
prices, operating costs and economic conditions could result in a conclusion
that we would not recover the carrying amount of our property, plant and
equipment and other long-lived assets, which could result in a material charge
to earnings.
Employee Future Benefits
The Corporation's operations participate in a number of employee future
benefit arrangements (principally providing pension and health care benefits)
in Canada and the United States. These benefits represent a substantial
obligation and cost to the Corporation. As indicated in Note 3 to the
Consolidated Financial Statements, these plans are primarily of a defined
benefits nature. As a result, complex actuarial and accounting rules are used
to determine the expense to be recorded for the year and the accrued benefit
obligation as at each measurement date, which generally corresponds to the
year-end date, for the Corporation's principal defined benefit plans.
To arrive at the cost of employee future benefits to be recognized in the
Consolidated Financial Statements, management is required to review and update
various actuarial assumptions each year, based on a going concern concept.
These assumptions include investment yields, discount rates, salary
escalation, health care cost trends, retirement age, mortality rates and other
factors. Management consults certain outside advisors, including actuaries, in
determining these factors in order to ensure that the assumptions chosen are
reasonable. The assumptions used to recalculate the June 30, 2006 obligations
do not impact the second quarter 2006 expense but will impact future expenses.
The Corporation has elected under Canadian GAAP to use the corridor
method to amortize actuarial gains and losses (arising from changes in
actuarial assumptions and experience gains and losses) over the expected
average remaining service life (EARSL) of active employees. Under the corridor
method, amortization is recorded only if the accumulated net actuarial gains
or losses exceed 10% of the greater of the accrued benefit obligation and the
value of the plan assets. These amortizations reflect the concept, as stated
in Canadian GAAP, that the cost of employee future benefits should be recorded
based on long-term assumptions to be consistent with the nature of the
economic benefits derived therefrom. Short-term actuarial gains and losses may
occur which differ from the long-term nature of the assumptions used under
Canadian GAAP. The cost of employee future benefits in any year should not be
unduly impacted by such short-term changes in market returns, discount rates
or in the level of benefits provided. Continued trends in these factors will
be reflected by changes in assumptions if these trends persist, and would
affect future costs.
The following comments highlight the significant 2006 changes and trends
within the Corporation's principal pension and other benefit plans.
Pension Benefits
The major assumptions include:
The discount rate enables the Corporation to calculate the present value
of the benefit obligation as of the measurement date (December 31, subject to
the remeasurements required as at March 31, 2006 and June 30, 2006). The rate
used is the current yield on high-quality fixed income investments whose term
and cash flow are similar to the liabilities under the plan. A higher discount
rate decreases the present value of the benefit obligation and increases
pension expense.
The expected long-term rate of return on plan assets is determined by
assessing historical and anticipated investment returns on the various
categories of plan assets. Similar to the discount rate, lower expected
returns result in increased expense.
Establishment of the expected average retirement age is based on a review
of the actual experience of the pension plans. Lower retirement ages result in
increasing the benefit obligation as well as pension expense.
The mortality rate allows the Corporation to define the duration for
which benefits are expected to be paid. Mortality rates are based on actuarial
tables that are updated periodically to reflect expected mortality trends in
the general population. A lower mortality rate (higher life expectancy)
lengthens the benefit payment stream resulting in a higher benefit obligation
and pension expense.
Pension Plan Amendment and Curtailments
The Hamilton Steel USW Local 1005 union contract ratified in June 2006
includes certain pension benefit improvements. For accounting purposes,
management has determined these changes are a plan amendment and accordingly
the pension plan assets and liabilities have been remeasured to reflect the
impact of these amendments. The participation in the salaried workforce
reduction program has resulted in a significant reduction in estimated future
years of service of the salaried workforce who are members of the defined
benefit pension and post-employment plans. Management has determined this was
a curtailment for accounting and accordingly the pension plan assets and
liabilities have been remeasured. The curtailment has resulted in immediate
recognition in the second quarter 2006 operating results.
As at June 30, 2006, management updated the following assumptions for
three of the four principal pension plans, which were subject to
remeasurement:
<<
- discount rate - from 5.25% to 5.50%; and
- retirement age salaried employees - from 58 to 59.
>>
The consolidated funded status deteriorated from a deficit of
$416 million as at March 31, 2006 to a deficit of $618 million as at June 30,
2006, mainly as a result of the loss on pension plan assets, plan amendments
and early retirements somewhat offset by the revised assumption for the
discount rate for the three remeasured plans (Lake Erie salary, Hamilton and
Corporate salary and Hamilton Steel bargaining unit). Under Canadian GAAP, the
impact of changes to the above assumptions, benefit improvements, actual
investment returns, and other changes are recognized over a number of years
rather than in the year of occurrence. As a result, for accounting purposes,
there is an accrued benefit liability of $431 million on the Consolidated
Statement of Financial Position as at June 30, 2006 reflecting the deficit of
$618 million reduced by $100 million of unamortized net actuarial losses, and
$87 million of unamortized past service costs.
Further details on pension plans are included in Note 13 to the
Consolidated Financial Statements.
Other Benefits
The assumptions for other benefit plans are similar to pension plans,
with the additional factor of health care cost trend rates. Changes in the
health care cost trend rate have a significant effect on the accrued benefit
obligation and recorded expense. As these plans are generally unfunded,
changes to the assumptions do not materially impact cash outlays. Cash outlays
are the actual amounts paid for other benefits.
As at June 30, 2006, management updated the following assumptions for
other benefit plans for three of the four principal plans, which were subject
to remeasurement:
<<
- discount rate - from 5.25% to 5.75%; and
- retirement age salaried employees - from 58 to 59.
>>
The consolidated funded status improved from a deficit of $1,320 million
as at March 31, 2006 to a deficit of $1,194 million as at June 30, 2006,
primarily due to these revised assumptions and plan amendments. Similar to the
accounting rules for pension plans, the full impact of changes in assumptions
is not recognized in the current year. Unamortized actuarial gains and past
service costs of $107 million increased the liability recorded on the
Consolidated Statement of Financial Position to $1,301 million as at June 30,
2006 from $1,320 million as at March 31, 2006.
Further details on other benefit plans are included in Note 13 to the
Consolidated Financial Statements.
Income Taxes
Application of Canadian GAAP concerning future income taxes requires
projection of tax rates expected to be in effect in years in which tax
benefits will be realized. Changes to the amount and timing of tax rates in
future years can impact the amount of income tax expense or recovery
recognized in an accounting period. The realization of future income tax
assets is dependent on the Corporation's ability to generate sufficient
taxable income in future years to utilize income tax benefits and income tax
loss carry-forwards. Deviations of future profitability from estimates would
result in adjustments to the value of future income tax assets and liabilities
that could have a significant effect on earnings. See Note 7 to the
Consolidated Financial Statements.
The Corporation had certain future tax assets which existed at March 31,
2006 but were not recognized on the Consolidated Statement of Financial
Position at that date. To the extent that these future tax assets are
subsequently recognized the benefits will not flow through the Consolidated
Statement of Earnings (Loss) but will be treated as an amendment to fresh
start accounting as required by Canadian GAAP.
Inventory Valuation
Valuation of inventories requires a number of estimates to be made,
including inventory quality, condition and obsolescence. These determinations
require management to exercise judgment. Inventories of raw materials and
supplies are valued at the lower of cost and replacement cost. Finished
products are valued at the lower of cost and net realizable value. Management
must exercise judgment in determining the appropriateness of values used to
determine replacement costs and not realizable values. Cyclical changes in
selling prices and/or input costs can result in material adjustments being
made to the carrying value of finished product inventory. As a result of the
implementation of fresh start accounting on March 31, 2006, the inventory was
revalued to fair value. This revaluation has had an impact on second quarter
2006 operating results and will continue to impact the results in the second
half of 2006 as this inventory is sold.
Environmental
Stelco discloses environmental obligations when known and accrues the
cost associated with the obligations when they are known and the costs can be
reasonably estimated. Stelco owns a number of manufacturing sites that have
been in existence for a significant period of time and as a result may have
unknown environmental obligations.
Basis of Valuation
The Corporation's assets and liabilities on the Consolidated Statement of
Financial Position as at March 31, 2006 were reported at their estimated fair
value, with the exception of future income taxes (see Note 4 to the
Consolidated Financial Statements) and pensions and other post-employment
benefits (see Note 4 to the Consolidated Financial Statements). The
determination of the fair value of the assets and liabilities of the Successor
has not been finalized as at the date of this MD&A. Accordingly there can be
no assurance that the estimates, assumptions and values reflected in the
Consolidated Statement of Financial Position of the Successor as at March 31,
2006, will be the final fair values recognized (see Note 4 to the Consolidated
Financial Statements).
The useful lives of the Corporation's plant, equipment and intangible
assets are currently under review as part of fresh start reporting. Certain of
these assets may have their useful life adjusted upon completion of this
process.
RISK FACTORS
Stelco's business and future performance is subject to a number of risk
factors including, among others, risks relating to the volatility of selling
prices for steel, Stelco's energy and raw material costs, planned capital
expenditures, currency fluctuations in the US dollar and environmental
matters. The following discussion is an update to the section entitled "Risk
Factors" in management's discussion and analysis included in Stelco's 2005
annual report and in Stelco's interim report for the quarter ended March 31,
2006.
Pricing
Due to price volatility, the Corporation cannot rely on high selling
prices being sustainable in the longer term and believes it cannot compete
effectively in the longer term unless it takes steps to lower its overall
costs.
Costs
Stelco is continuing with its efforts to lower costs in order to ensure
its long-term viability, which includes improved productivity and a leaner
management structure. There can be no assurance that cost reduction
initiatives will be sufficient to sustain long-term viability.
Unplanned Repairs or Equipment Outages
There can be no assurance that unplanned downtime at any of Stelco's
facilities will not have a material adverse effect on Stelco. In addition, the
failure of planned outages to be completed as scheduled could have a material
adverse effect on Stelco.
Pension Plans
Stelco and the Province of Ontario entered into a pension agreement that
prescribes the funding arrangements with respect to Stelco's four main pension
plans. Despite the level of contributions required under the pension
agreement, the solvency deficiency could grow as a result of future actuarial
losses and benefit changes.
Steel Industry Consolidation
Stelco could face risks related to cost competitiveness and access to
large customers as a result of the steel industry consolidation.
Supply and Pricing of Raw Material and Energy
Wabush Mines has recently been experiencing production problems, which
will negatively impact Stelco's cost of iron ore for the remainder of the
year. Plans for Wabush are being reviewed to improve production and lower
costs.
Employees
In June 2006, the Salaried Transition Assistance Program (STAP) was made
available to active salaried employees who are defined benefit pension plan
members. The STAP provided incentives for early retirement or resignation to
eligible employees. Similarly, the Transition Assistance Program (TAP) was
made available to Hamilton Steel bargaining unit employees as part of the new
collective agreement negotiated in June 2006. The TAP provided incentives for
early retirement to eligible employees.
Stelco is evaluating its manpower requirements consistent with its
succession plans and attrition rates. Retention of the skills and knowledge of
Stelco's employees, and the ability to attract and retain new employees where
replacement is considered necessary, are essential to Stelco's continued
operations.
Labour Matters
Risks relating to possible labour difficulties and resultant loss of
production and revenue have been mitigated by the agreement reached in June
2006 with USW Local 1005 to renew the 2002 Hamilton Steel collective agreement
for a period expiring on July 31, 2010.
OUTLOOK
Entering the second half of 2006, management does not foresee any
prevailing factors that will significantly change the steel market from the
second quarter 2006. The North American automotive market is stable with U.S.
light vehicle sales for 2006 projected to reach 16.5 - 16.8 million units. The
heavy truck market is expected to stay strong through 2006.The pipe and tube
markets are forecasted to remain strong and stable through year-end and steel
service center's inventories are currently being managed. Production for the
second half of 2006 is expected to be 2.1 million net tons of semi-finished
steel with approximately 2 million net tons of shipments, including the
impacts of scheduled outages.
The emphasis of the management team will be to develop a new culture
within Stelco where all employees anticipate and embrace necessary change.
This includes changes that focus on making steel and servicing customers,
increase volume and grow revenues and lower costs and improve productivity in
order to ensure profitability and long-term viability.
The application of "fresh start accounting" will continue to impact
future financial results. All assets and liabilities of the Corporation are
being revalued to their estimated fair value at the time of implementation of
the CCAA Plan. Some of the impacts include amortization changes as a result of
revaluing fixed assets, cost of sales increases as a result of the revaluation
of inventories from the lower of cost and net realizable value to fair value,
and a decrease in pension and other post-employment benefits expense as
previously unamortized actuarial losses and past service costs were eliminated
from the Consolidated Statement of Financial Position. The revaluation has not
yet been finalized.
Stelco's President and Chief Executive Officer, Rodney Mott, has recently
added J. Kenneth Rutherford to Stelco's management team. Mr. Rutherford has
assumed the responsibilities of Chief Financial Officer, replacing William E.
Vaughan, who retired in May 2006.
<<
-------------------------------------------------------------------------
Forward-Looking Statements
This MD&A contains "forward-looking information" that is based on
Stelco's expectations, estimates and projections as of the date of this
MD&A or as of the date which such information is identified to be given.
This forward-looking information includes, among other things, factors
relating to the business, financial position, operations and prospects of
Stelco, including: Stelco's strategies and plans to reduce costs and the
anticipated outcome of such strategies and plans; anticipated
productivity levels and profitability; labour matters related to Stelco's
predominantly unionized workforce; pension matters; consolidation in the
steel industry; Stelco's energy and raw material costs and the
availability of such materials; the volatility of selling prices for
steel; international trade matters, including increases in steel imports
into Canada; employee matters, including staffing levels, the retention
of the skills and knowledge of Stelco's employees and the ability to
attract and retain new employees; changes to environmental laws and
regulations concerned with, among other things, emissions into the air,
discharges to water or land, noise control and the generation, handling,
developments and Stelco's ability to make capital expenditures to
maintain and enhance its technological ability; development of new
products; planned capital expenditures; and currency fluctuations in the
US dollar and their impact on the Corporation's US dollar denominated
long-term debt, steel pricing and costs. Often, but not always, forward-
looking information can be identified by the use of words and phrases
such as "plans", "expects" or "does not expect", "is expected", "budget",
"scheduled", "estimates", "forecasts", "intends", "anticipates" or
"does not anticipate", or "believes", or variations of such words and
phrases or states that certain actions, events or results "may", "could",
"would", "might" or "will" be taken, occur or be achieved.
Forward-looking information involves known and unknown risks,
uncertainties and other factors which may cause the actual results,
performance or achievements of Stelco to be materially different from any
future results, performance or achievements expressed or implied by the
forward-looking information. Actual results, performance and achievements
are likely to differ, and may differ materially, from those expressed or
implied by the forward-looking information contained herein. Such
forward-looking information is based on a number of assumptions which may
prove to be incorrect, including, but not limited to: exchange rates,
energy and other anticipated and unanticipated costs; pension
contributions and expenses; the supply and demand for, deliveries of, and
the level and volatility of prices of steel and raw materials; the
continued availability of financing on appropriate terms; market
competition; the impact on Stelco of various environmental regulations
and initiatives; and Stelco's ongoing relations with its employees and
staffing levels. While Stelco anticipates that subsequent events and
developments may cause Stelco's views to change, Stelco specifically
disclaims any obligation to update this forward-looking information. This
forward-looking information should not be relied upon as representing
Stelco's views as of any date subsequent to the date of this MD&A.
-------------------------------------------------------------------------
ADDITIONAL FINANCIAL INFORMATION
Additional information concerning Stelco, including the Corporation's 2005
Annual Information Form, may be viewed on the System for Electronic Document
Analysis and Retrieval at www.sedar.com, and at Stelco's Web site
www.stelco.ca.
Rodney B. Mott J. Kenneth Rutherford
President and Chief Executive Officer Chief Financial Officer
HAMILTON, ONTARIO
August 9, 2006
CONSOLIDATED STATEMENT OF EARNINGS (LOSS)
-------------------------------------------------------------------------
Three Three Three Three Six
(in millions, months months months months months
except per ended ended ended ended ended
share amounts) June 30, June 30, June 30, March 31, June 30,
(unaudited) 2006 2005(1) 2006(2) 2006(2) 2005(1)
-------------------------------------------------------------------------
(Pre- (Pre- (Pre-
(Successor) decessor) (Successor) decessor) decessor)
Net Sales $ 698 $ 658 $ 698 $ 674 $ 1,386
Costs 679 571 679 695 1,164
-------------------------------------------------------------------------
19 87 19 (21) 222
Amortization of
property, plant
and equipment 28 28 28 27 54
Amortization of
intangible assets 1 1 1 1 2
-------------------------------------------------------------------------
Operating earnings
(loss) before the
following: (10) 58 (10) (49) 166
Employee future
benefits -
workforce
reduction costs
(Note 13) 41 - 41 - -
Foreign exchange
gain on long-term
debt (Note 9) (13) - (13) - -
Gain on sale of
plate mill assets - (20) - - (20)
Reorganization items - 13 - 21 34
Financial expense
Interest on
long-term debt
and debt subject
to compromise 9 11 9 10 21
Other interest
- net 8 1 8 5 5
-------------------------------------------------------------------------
Earnings (loss) before
income tax from
continuing operations (55) 53 (55) (85) 126
Income tax expense
(recovery) (Note 7)
Current 2 9 2 7 30
Future (18) 6 (18) (33) 9
Future income
tax asset
valuation
allowance (release) - 3 - 20 11
Future income
tax rate reduction (8) (8)
-------------------------------------------------------------------------
Net earnings (loss)
from continuing
operations (31) 35 (31) (79) 76
Net earnings (loss)
from discontinued
operations (Note 1) - 5 - (43) 13
-------------------------------------------------------------------------
Net earnings (loss) $ (31) $ 40 $ (31) $ (122) $ 89
-------------------------------------------------------------------------
Earnings (loss) per
common share
(Note 14)
Basic
Continuing
operations $ (1.14) $ 0.34 $ (1.14) $ (0.77) $ 0.74
Net earnings
(loss) $ (1.14) $ 0.39 $ (1.14) $ (1.19) $ 0.87
Fully diluted
Continuing
operations $ (1.14) $ 0.30 $ (1.14) $ (0.77) $ 0.64
Net earnings
(loss) $ (1.14) $ 0.34 $ (1.14) $ (1.19) $ 0.75
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Weighted average
common shares
outstanding -
millions 27.1 102.2 27.1 102.2 102.2
-------------------------------------------------------------------------
-------------------------------------------------------------------------
(1) Restated to disclose the activities of the Predecessor's continuing
and discontinued operations separately.
(2) The six month period ended June 30, 2006 consists of two quarters
which are not comparable.
See accompanying Notes to the Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF RETAINED DEFICIT
-------------------------------------------------------------------------
Three Three Three Three Six
months months months months months
ended ended ended ended ended
(in millions) June 30, June 30, June 30, March 31, June 30,
(unaudited) 2006 2005 2006(1) 2006(1) 2005
-------------------------------------------------------------------------
(Pre- (Pre- (Pre-
(Successor) decessor) (Successor) decessor) decessor)
Balance at
beginning of
period $ - $ (339) $ - $ (461) $ (388)
Net earnings (loss) (31) 40 (31) (122) 89
-------------------------------------------------------------------------
Balance at end
of period $ (31) $ (299) $ (31) $ (583) $ (299)
--------------------------------------------------- ---------
--------------------------------------------------- ---------
Fresh start adjustment 583
---------
Balance at end of
period - post
fresh start $ -
---------
---------
(1) The six month period ended June 30, 2006 consists of two quarters
which are not comparable.
See accompanying Notes to the Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
-------------------------------------------------------------------------
At June 30, At March 31, At December 31,
(in millions) (unaudited) 2006 2006 2005(1)
-------------------------------------------------------------------------
(Successor) (Successor) (Predecessor)
(Note 4)
Assets
Current assets
Cash and cash equivalents $ 13 $ 2 $ 25
Restricted cash (Note 5) 5 34 17
Accounts receivable 419 413 294
Inventories 708 755 783
Prepaid expenses 38 24 29
Future income taxes (Note 7) 30 7 22
Assets held for sale - - 351
-------------------------------------------------------------------------
1,213 1,235 1,521
-------------------------------------------------------------------------
Other assets
Property, plant, equipment,
and intangible assets - net 1,776 1,774 1,004
Future income taxes (Note 7) 11 19 12
Deferred pension cost - - 112
Other 30 36 21
-------------------------------------------------------------------------
1,817 1,829 1,149
-------------------------------------------------------------------------
Total Assets $ 3,030 $ 3,064 $ 2,670
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities
Bank and other short-term
indebtedness $ - $ - $ 191
Revolving term loans (Note 8) 25 35 -
Accounts payable and accrued 260 241 232
Employee future benefits (Note 13) 59 60 60
Pension liability (Note 13) 68 67 -
Income and other taxes - 17 8
Long-term debt due within one year
(Note 9) 16 18 23
Liabilities held for sale - - 206
Liabilities subject to compromise - - 630
-------------------------------------------------------------------------
428 438 1,350
-------------------------------------------------------------------------
Other liabilities
Employee future benefits (Note 13) 1,242 1,260 834
Pension liability (Note 13) 363 349 -
Long-term debt (Note 9) 334 346 20
Revolving term loans (Note 8) 411 392 -
Future income taxes (Note 7) 107 110 92
Asset retirement obligation (Note 6) 23 22 15
-------------------------------------------------------------------------
2,480 2,479 961
-------------------------------------------------------------------------
Total Liabilities 2,908 2,917 2,311
-------------------------------------------------------------------------
Shareholders' Equity
Convertible debenture conversion
option - - 23
Capital stock (Note 11) 149 144 781
Contributed surplus 1 - 16
Warrants (Note 11) 3 3 -
Retained deficit (31) - (461)
-------------------------------------------------------------------------
Total Shareholders' Equity 122 147 359
-------------------------------------------------------------------------
Total Liabilities and Shareholders'
Equity $ 3,030 $ 3,064 $ 2,670
-------------------------------------------------------------------------
-------------------------------------------------------------------------
(1) Due to the application of fresh start reporting (Note 4), the
Consolidated Statement of Financial Position of the Predecessor and
Successor are not directly comparable.
Commitments and contingencies (Note 10).
See accompanying Notes to the Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF CASH FLOWS
-------------------------------------------------------------------------
Three Three Three Three Six
months months months months months
ended ended ended ended ended
(in millions) June 30, June 30, June 30, March 31, June 30,
(unaudited) 2006 2005(1) 2006(2) 2006(2) 2005(1)
-------------------------------------------------------------------------
(Pre- (Pre- (Pre-
(Successor) decessor) (Successor) decessor) decessor)
Cash provided by
(used for)
Operating activities
Net earnings (loss)
from continuing
operations $ (31) $ 35 $ (31) $ (79) $ 76
Adjustments for
items not affecting
cash
Reorganization items (12) - (12) (1) -
Amortization of
property, plant,
and equipment 28 28 28 27 54
Amortization of
intangible assets 1 1 1 1 2
Future income taxes
(Note 7) (18) 6 (18) (33) 9
Future income tax
asset valuation
allowance (release)
(Note 7) - 3 - 20 11
Future income tax
rate reduction
(Note 7) (8) - (8) - -
Employee pension
and other future
benefits (17) 28 (17) 28 65
Foreign exchange
gain on floating
rate notes (Note 9) (13) - (13) - -
Employee future
benefits - workforce
reduction costs 32 - 32 - -
Fresh start inventory
revaluation 49 - 49 - -
Gain on sale of plate
mill assets - (20) - - (20)
Other 6 (3) 6 (3) (2)
-------------------------------------------------------------------------
17 78 17 (40) 195
Changes in operating
elements of working
capital (see below) (13) (26) (13) (2) (44)
Other - net 5 - 5 (1) -
Discontinued operations - 21 - - 7
-------------------------------------------------------------------------
9 73 9 (43) 158
Investing activities
Proceeds from sale of
non-core assets - 23 - 107 23
Expenditures for capital
assets (41) (45) (41) (49) (62)
Discontinued operations - (6) - - (9)
-------------------------------------------------------------------------
(41) (28) (41) 58 (48)
Financing activities
Decrease in bank
indebtedness - (76) - (9) (134)
Increase in revolving
term loans (Note 8) 9 - 9 - -
Reduction of long-term
debt (Note 9) - - - (12) (6)
Proceeds from issue of
common shares (Note 11) 5 - 5 - -
Discontinued operations - 8 - - 13
-------------------------------------------------------------------------
14 (68) 14 (21) (127)
Cash, cash equivalents
and restricted cash
Net increase (decrease) (18) (23) (18) (6) (17)
Balance at beginning
of period 36 49 36 42 43
-------------------------------------------------------------------------
Balance at end of
period $ 18 $ 26 $ 18 $ 36 $ 26
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Consists of:
Cash and cash
equivalents $ 13 $ 12 $ 13 $ 2 $ 12
Restricted cash
(Note 5) 5 14 5 34 14
-------------------------------------------------------------------------
$ 18 $ 26 $ 18 $ 36 $ 26
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Changes in operating
elements of working
capital
Accounts receivable $ (6) $ 87 $ (6) $ (127) $ (5)
Inventories (2) (119) (2) 102 (64)
Prepaid expenses (14) (3) (14) 5 (4)
Accounts payable
and accrued 26 13 26 9 9
Income and other taxes (17) (4) (17) 9 20
-------------------------------------------------------------------------
$ (13) $ (26) $ (13) $ (2) $ (44)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
(1) Restated to disclose the activities of the Predecessor's continuing
and discontinued operations separately.
(2) The six month period ended June 30, 2006 consists of two quarters
which are not comparable.
See accompanying Notes to the Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1. BUSINESS DESCRIPTION AND CCAA HISTORY
Business Description
Stelco Inc. ("Stelco" or the "Corporation") is one of Canada's
largest steel companies. The Corporation operates two integrated
steel plants in Ontario, Canada which service customers in the
automotive, steel service center, appliance, energy, construction and
pipe and tube industries within North America. In addition, Stelco
has ownership interests in three iron ore properties, which provide
to the integrated steel plants approximately 90% of their iron ore
requirements as feedstock in the steelmaking process. Stelco operates
its businesses through partnerships, subsidiaries and joint ventures.
Where applicable, "Stelco" and the "Corporation", refer to Stelco
Inc. and its partnerships, subsidiaries and joint ventures
collectively.
CCAA History
On January 29, 2004, Stelco and certain related entities filed for
protection under the Companies' Creditors Arrangement Act ("CCAA")
and obtained an order (the "Initial Order") from the Ontario Superior
Court of Justice granting it creditor protection. On the same date,
Stelco made a concurrent petition for recognition of the Initial
Order and ancillary relief under Section 304 of the U.S. Bankruptcy
Code (the "U.S. Proceedings"). The Canadian proceedings included
Stelco and its wholly owned subsidiaries, Stelpipe Ltd. ("Stelpipe"),
CHT Steel Company Inc. ("CHT Steel"), Welland Pipe Ltd. ("Welland
Pipe"), and Stelwire Ltd. ("Stelwire"), which were collectively
referred to as the "Applicants". The U.S. Proceedings included
Stelco, Stelpipe, and Stelwire. The Corporation's other subsidiaries
and joint ventures were not included in the proceedings. For the
periods prior to emergence from CCAA, collectively, the Applicants
and the Corporation's other subsidiaries and joint ventures are
referred to as the "Predecessor" in the consolidated financial
statements and notes.
At the end of the day on March 31, 2006, the Predecessor implemented
its Third Amended and Restated Plan of Arrangement and Reorganization
(the "CCAA Plan"), as approved by the Court on January 20, 2006, and
emerged from CCAA protection. For the purpose of these Consolidated
Financial Statements the Corporation is referred to as the
"Successor" in respect of the period after implementation of the CCAA
Plan. Also, on March 31, 2006, a plan of arrangement under the Canada
Business Corporation's Act ("the CBCA") that involved the Corporation
(the "CBCA Plan") was implemented. In accordance with the CBCA Plan,
the Predecessor's business was reorganized with specific assets and
liabilities being transferred into separate limited partnerships.
Upon implementation of this reorganization, Stelco became the parent
company and limited partner of these limited partnerships. Further
information on the CCAA Plan and CBCA Plan is outlined below.
Discontinued Operations
As part of the CCAA, Stelco divested all of its manufactured products
and mini-mill businesses. The impact on earnings for the three months
ended March 31, 2006 was a net loss of $43 million (net of income tax
of $2 million), for the three months ended June 30, 2005 was net
earnings of $5 million (net of income tax of $2 million) and for the
six months ended June 30, 2005 net earnings of $13 million (net of
income tax of $6 million).
Treatment of Stakeholders Compromised Under the CCAA Plan
Holders of Affected Claims
Under the CCAA Plan, the claims of the unsecured creditors (the
"Affected Creditors") were not satisfied in full by the consideration
distributed under the CCAA Plan. At March 31, 2006, the final
accepted Affected Creditor claims of $547 million were settled in
exchange for the following:
- New Secured Floating Rate Notes ("FRNs") in the US dollar
equivalent of $275 million Canadian;
- 6,364,000 newly issued common shares (the "New Common Shares") of
Stelco (1,100,000 prorated among all Affected Creditors and
5,264,000 prorated based on amounts elected through the share
election process);
- Cash of $108,548,000;
- Warrants for 1,418,500 New Common Shares (the "New Warrants") with
an exercise price of $11.00 per New Common Share and a seven-year
term.
Holders of Series A and B voting Common Shares
The Series A and B voting common shares previously outstanding were
exchanged into new redeemable shares, at a ratio of 0.000001 for each
such share. Such shares were then redeemed and cancelled on March 31,
2006 for nil consideration.
Agreements
Plan Sponsor Agreement
The New Common Shares of the restructured Stelco were divided among
three groups under the CCAA Plan: the Affected Creditors (as referred
to above), the Province of Ontario (the "Province") and Tricap
Management Limited ("Tricap"), Sunrise Partners Limited Partnership
("Sunrise") and Appaloosa Management LP ("Appaloosa") (collectively
the "Equity Sponsors"). The Province obtained its equity interest as
part of the financing provided to Stelco (Note 9) wherein it received
warrants to purchase 851,100 New Common Shares. The Equity Sponsors
acquired their equity interests for cash pursuant to a Plan Sponsor
Agreement ("the PSA") between the Corporation and the Equity
Sponsors.
Pursuant to the PSA, the Equity Sponsors agreed to purchase
19,736,000 New Common Shares of Stelco at a price of $5.50 per share
for proceeds of $108,548,000. These funds were used for the cash
distribution to Affected Creditors under the Plan as referred to
above.
Pension Plan Funding Agreement
Stelco and the Province along with the Superintendent of Financial
Services of Ontario and certain of the newly formed LPs entered into
a pension funding agreement (the "Pension Agreement") on March 31,
2006 that outlines the funding arrangements with respect to Stelco's
four main pension plans. The purpose of the Pension Agreement is to
transition the four main plans from the Section 5.1 election of
Regulation 909 of the Pension Benefits Act (Ontario) (the "PBA"),
which had exempted the four main plans from funding of the solvency
deficiencies under the plans in exchange for higher pension benefit
guarantee fund payments, to the general regulatory requirements of
the PBA by no later than January 1, 2016. See Notes 9, 11, and 13 for
further details.
Plan Financing
New financing was raised under the Plan from the following sources:
- New ABL Facility (asset based loan) (Note 8) up to $600 million
- New Secured Revolving Term Loan (Note 8) $375 million
- New Province Note (Note 9) $150 million
- Federal Government Grant (Note 10) $30 million
2. BASIS OF PRESENTATION
As a result of a substantial realignment of equity and non-equity
interests in the Corporation (Note 4), "fresh start" reporting was
adopted on March 31, 2006. In accordance with CICA Handbook Section
1625 - "Comprehensive Revaluation of Assets and Liabilities", the
Corporation is undertaking a comprehensive revaluation of its assets
and liabilities. As required by CICA Handbook Section 1625, the
enterprise value has been allocated based upon management's best
estimate of the relative fair values of the identifiable assets and
liabilities of the Corporation in accordance with the guidance in
CICA Handbook Section 1581 - "Business Combinations". As the
Corporation has only recently emerged from CCAA, it is not
practicable to definitely allocate the enterprise value. Once this
matter has been resolved, the Corporation will reassess its initial
allocation (see Note 4). The effect may be to transfer amounts
between property, plant and equipment, inventories and intangible
assets and future income taxes. The amount, if any, is not presently
determinable.
The Consolidated Statement of Financial Position as at March 31, 2006
reflects the accounts of the Successor. While not comparable, the
Consolidated Statement of Earnings (Loss) and the corresponding
Consolidated Statement of Cash Flows reflects the activities of the
Successor and Predecessor for the three months and six months ended
June 30, 2006 and 2005.
While the Predecessor was under creditor protection (January 29, 2004
- March 31, 2006), the Predecessor applied the guidance in the
American Institute of Certified Public Accountants Statement of
Position 90-7, "Financial Reporting by Entities in Reorganization
under the Bankruptcy Code" (SOP 90-7), where it did not conflict with
Canadian generally accepted accounting principles ("Canadian GAAP"),
in the preparation of its consolidated financial statements. As a
result, the Predecessor made adjustments to isolate assets,
liabilities, revenues, and expenses related to the reorganization and
restructuring activities so as to distinguish these events and
transactions from those associated with the ongoing operation of the
business.
The consolidated financial statements of the Successor and
Predecessor companies are expressed in Canadian dollars and are
prepared in accordance with Canadian GAAP using the going concern
concept which assumes that the Corporation will be able to realize
its assets and discharge its liabilities in the normal course of
business for the foreseeable future. These interim financial
statements do not include all of the disclosure required for annual
financial statements and should be read in conjunction with the most
recent annual consolidated financial statements.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These consolidated financial statements are prepared in accordance
with Canadian GAAP, which require management to make assumptions and
estimates that affect the reported amounts of assets and liabilities
and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ
from those estimates.
The significant policies are summarized below:
Basis of Valuation
The Corporation's assets and liabilities on the Consolidated
Statement of Financial Position as at March 31, 2006 were reported at
their estimated fair value (Note 4), with the exception of future
income taxes, which have been reported in accordance with CICA
Handbook Section 3465 - Income Taxes (Note 7) and pension and other
post-employment benefits, which have been reported in accordance with
CICA Handbook Section 3461 - Employee Future Benefits (Note 13).
Intangible assets will be recognized at their fair value effective
March 31, 2006, including those identified through the fresh start
process but not previously recorded. This process is not complete at
this time (see Note 4).
The useful lives of the Corporation's plant, equipment and intangible
assets are currently under review as part of fresh start reporting.
Certain of these assets may have their useful life adjusted upon
completion of this process.
Principles of Consolidation
The consolidated financial statements include the accounts of Stelco
Inc., its wholly owned subsidiaries and partnerships, and its
proportionate share of the accounts of its joint ventures.
Foreign Currencies
Monetary assets and liabilities originating in foreign currencies are
translated at quarter-end exchange rates. All other assets and
liabilities originating in foreign currencies are translated at the
quarter-end exchange rate or at historic rates prevailing when the
assets were acquired or the liabilities incurred for transactions
after March 31, 2006. Income and expense items, other than those
related to assets and liabilities translated at historic rates, are
generally translated at the rate in effect at the time the
transaction occurs.
Gains or losses resulting from foreign currency translations are
reflected in the Consolidated Statement of Earnings (Loss).
The temporal method of translation of foreign currency is followed
for foreign subsidiaries, all of which are considered to be
financially and operationally integrated. Translation of foreign
currencies for the foreign subsidiaries using the temporal method is
consistent with the method described above.
Inventories
Inventories on hand at March 31, 2006 are recorded at estimated fair
values on March 31, 2006 pursuant to the reorganization implemented
by the Corporation on that date. Post March 31, 2006 inventories of
raw materials and supplies are valued at the lower of cost and
replacement cost. Semi-finished product inventories are valued at
actual cost. Finished product inventories are valued at the lower of
cost and net realizable value.
Property, Plant, and Equipment
Property, plant and equipment purchased prior to April 1, 2006 is
recorded at the estimated fair value on March 31, 2006 pursuant to
the financial reorganization implemented by the Corporation on that
date. Property, plant, and equipment purchased after March 31, 2006
is carried at cost less accumulated amortization, and includes
construction in progress. The Corporation expenses interest costs
directly associated with capital projects. Amortization is provided
using the straight-line method applied to the cost of the assets at
rates based on their estimated useful life and beginning from the
point when production commences except for the cost of blast furnace
relines (see below) and at certain mining properties where
amortization is calculated on a unit-of-production basis. The
following annual amortization rates are in effect:
- Buildings 20 to 30 years
- Equipment 15 to 20 years
- Automotive and mobile equipment 5 to 10 years
- Raw material plants and properties 20 years
Blast Furnace Relines
The Corporation's blast furnaces periodically require extensive
relining. Costs incurred in the reline of a blast furnace that extend
the useful life of the furnace are capitalized and amortized over
their estimated useful life on a unit-of-production basis. Other
repair and maintenance costs that may be incurred during the reline
are expensed.
Intangible Assets
Intangible assets of the Corporation are computer systems and
applications. Intangible assets purchased prior to April 1, 2006 are
recorded at the estimated fair value on March 31, 2006 pursuant to
the reorganization implemented by the Corporation on that date.
Intangible assets purchased after March 31, 2006 are recorded at
historical cost. Amortization is recorded on a straight-line basis
over an estimated eight-year life beginning from March 31, 2006 or
the purchase date if after March 31, 2006.
Impairment of Long-Lived Assets
An impairment loss would be recognized when the carrying value of a
long-lived asset exceeds the total undiscounted cash flows expected
from its use and eventual disposition. The impairment loss would be
calculated as the amount by which the carrying value of the asset
exceeds its fair value.
Employee Future Benefits
The Corporation, its wholly owned business units, wholly owned
subsidiaries, and joint ventures maintain a number of defined benefit
and defined contribution plans providing pension, other retirement
and post-employment benefits to most of its employees.
Pension plan assets are valued at market-related value and are used
to calculate the expected rate of return on plan assets. Market-
related value is the market value of pension plan assets averaged
over a three-year period.
The cost of pension and other post-employment benefits (including
medical benefits, dental care, life insurance and certain compensated
absences) is charged to income annually. The cost is computed on an
actuarial basis using the projected benefit method by estimating
the usage, frequency and cost of services covered and management's
best estimate of the long-term rate of return on plan assets,
discount rates, salary escalation, health care cost trends,
retirement age, mortality and other factors. These assumptions relate
to factors that are of a long-term nature and, consequently, are
subject to a degree of uncertainty. Actual trends and values may
differ from those assumed at this time resulting in changes in the
cost of pension and other post-employment benefits in future periods.
The assumptions are reviewed and updated annually or more frequently
where the level of benefits provided to employees changes. Past
service costs (such as increased benefits provided under labour
contract settlements) are amortized over the estimated average
remaining service life ("EARSL") of the employees at the date of the
amendment.
The Corporation has elected under Canadian GAAP to use the corridor
method to amortize actuarial gains and losses (arising from
changes in actuarial assumptions and experience gains and losses)
over the EARSL of active employees. Under the corridor method,
amortization is recorded only if the accumulated net actuarial gains
or losses exceed 10% of the greater of the accrued benefit obligation
and the value of the plan assets. These amortizations reflect the
concept, as stated in Canadian GAAP, that the cost of employee future
benefits should be recorded based on long-term assumptions to be
consistent with the nature of the economic benefits derived
therefrom. Short-term actuarial gains and losses may occur which
differ from the long-term nature of the assumptions used under
Canadian GAAP. The cost of employee future benefits in any year
should not be unduly impacted by such short-term changes in market
returns, discount rates or in the level of benefits provided.
Continued trends in these factors will be reflected by changes in
assumptions if these trends persist, and would affect future costs.
Salaried employees hired after July 31, 1997 participate in the
Corporation's "Opportunity" or similar programs, which include a
flexible credit plan for benefits and a self-directed group RRSP.
These employees do not participate in the defined benefit plans.
These programs are accounted for as defined contribution plans. Costs
of defined contribution plans are expensed as incurred.
Income Taxes
The Corporation follows the liability method of accounting for future
income taxes. Under the liability method, future income tax assets
and liabilities are determined based on "temporary differences"
(differences between the accounting basis and the tax basis of the
assets and liabilities) and are measured using the currently enacted,
or substantively enacted, tax rates and laws expected to apply when
these differences reverse. A valuation allowance is recorded against
any future income tax asset if it is more likely than not that the
asset will not be realized. Income tax expense or benefit is the sum
of the Corporation's provision for current income taxes and the
differences between the opening and ending balances of the future
income tax assets and liabilities. The effect of increases and
decreases to future income tax assets and liabilities arising from
changes in tax rates is recognized in income in the period the
changes occur.
The Corporation had certain future tax assets which existed at March
31, 2006 but were not recognized on the Consolidated Statement of
Financial Position at that date. To the extent that these future tax
assets are subsequently recognized the benefits will not flow through
the Consolidated Statement of Earnings (Loss) but will be treated as
an amendment to fresh start accounting.
Measurement Uncertainty
The preparation of consolidated financial statements in conformity
with Canadian GAAP requires management to make estimates and
assumptions which affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the stated
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
4. FRESH START REPORTING
As outlined in Note 2, Stelco adopted fresh start reporting on March
31, 2006. As a result, all assets and liabilities of the Successor
have been reported at fair values, except for future income taxes,
which are reported in accordance with the requirements of CICA
Handbook Section 3465, and pension and other post-employment
benefits, which are reported in accordance with CICA Handbook Section
3461.
The fair values of the assets and liabilities of the Successor have
been based on management's best estimates as of March 31, 2006. The
determination of the fair values of the assets and liabilities of the
Successor has not been finalized as at the date of these interim
consolidated financial statements. The Successor is continuing to
finalize its valuation of assets and liabilities, primarily property,
plant and equipment, inventories, intangibles and future income
taxes. Any adjustments will be made to the Consolidated Statement of
Financial Position as at March 31, 2006. The determination of fair
values involves certain estimates and assumptions, which are
inherently subject to significant uncertainties and contingencies.
Accordingly, there can be no assurance that the estimates,
assumptions and values reflected in the Consolidated Statement of
Financial Position of the Successor as at March 31, 2006 will result
in their final fair values. At this time, the fair value adjustment
is estimated to be an asset of $739 million and has currently been
allocated to Property, plant, equipment and intangible assets on the
Consolidated Statement of Financial Position.
The following Consolidated Statement of Financial Position as at
March 31, 2006 was included in the first quarter 2006 report
(Note 5). The adjustments to the Predecessor balances related to
predecessor shareholders, affected creditors and equity sponsors and
pensions and financing were finalized upon emergence from CCAA. As
indicated above, the fresh start adjustments are under review and may
be subject to further change.
Stelco Inc.
Consolidated Statement of Financial Position
Third Amended and Restated Plan
of Arrangement and Reorganization
---------------------------------------------------------------------
Affected
Creditors
At March 31, Predecessor and Equity
(in millions) 2006 Shareholders Sponsors
---------------------------------------------------------------------
(Predecessor)
Assets
Current assets
Cash and cash equivalents $ 2 $ - $ 108(2)
(108)(1)
Restricted cash (Note 5) 34 - -
Accounts receivable 413 - -
Inventories 680 - -
Prepaid expenses 24 - -
Future income taxes (Note 7) 5 - -
---------------------------------------------------------------------
1,158 - -
---------------------------------------------------------------------
Other assets
Property, plant, equipment,
and intangible assets - net 1,035 - -
Deferred pension cost 99 - -
Future income taxes (Note 7) 38 - -
Other 21 - -
---------------------------------------------------------------------
1,193 - -
---------------------------------------------------------------------
Total Assets 2,351 - -
---------------------------------------------------------------------
Liabilities and Shareholders'
Equity
Current liabilities
Bank and other short-term
Indebtedness 182 - -
Revolving term loans (Note 8) - - -
Accounts payable and accrued 241 - -
Employee future benefits 60 - -
Pension liability - - -
Income and other taxes 17 - -
Long-term debt due within one
year - existing (Note 9) 18 - -
Future income taxes (Note 7) - - -
Liabilities subject to
compromise 640 - (640)(1)
---------------------------------------------------------------------
1,158 - (640)
---------------------------------------------------------------------
Other liabilities
Employee future benefits 847 - -
Pension liability - - -
Long-term debt - existing
(Note 9) 14 - -
Long-term debt - New Secured
Floating Rate Notes (Note 9) - - 275(1)
Long-term debt - New Province
Note - (Note 9) - - -
Revolving term loans (Note 8) - - -
Future income taxes (Note 7) 79 - -
Asset retirement obligation
(Note 6) 16 - -
---------------------------------------------------------------------
956 - 275
---------------------------------------------------------------------
Total Liabilities 2,114 - (365)
---------------------------------------------------------------------
Shareholders' Equity
Convertible debentures
conversion option 23 - (23)(1)
Capital stock 781 (781)(1) 36(1)
108(2)
New Warrants (Note 11) - - 2(1)
Province Warrants (Note 11) - - -
Contributed surplus 16 (16)(1) -
Retained deficit (583) 797(1) 242(1)
---------------------------------------------------------------------
Total Shareholders' Equity 237 - 365
---------------------------------------------------------------------
Total Liabilities and
Shareholders' Equity $ 2,351 $ - $ -
---------------------------------------------------------------------
---------------------------------------------------------------------
Third Amended and Restated Plan
of Arrangement and Reorganization
---------------------------------------------------------------------
Pensions and Fresh Start At March 31,
(in millions) Financing Adjustments 2006
---------------------------------------------------------------------
(Successor)
Assets
Current assets
Cash and cash equivalents $ (382)(6) $ - $ 2
150(4)
232(5)
Restricted cash (Note 5) - - 34
Accounts receivable - - 413
Inventories - 75(7) 755
Prepaid expenses - - 24
Future income taxes (Note 7) - 2(8) 7
---------------------------------------------------------------------
- 77 1,235
---------------------------------------------------------------------
Other assets
Property, plant, equipment,
and intangible assets - net - 739(7) 1,774
Deferred pension cost - (99)(7) -
Future income taxes (Note 7) - (19)(8) 19
Other 13(3) 2(7) 36
---------------------------------------------------------------------
13 623 1,829
---------------------------------------------------------------------
Total Assets 13 700 3,064
---------------------------------------------------------------------
Liabilities and Shareholders'
Equity
Current liabilities
Bank and other short-term
Indebtedness (182)(5) - -
Revolving term loans (Note 8) 35(3,5) - 35
Accounts payable and accrued - - 241
Employee future benefits - - 60
Pension liability - 67(7) 67
Income and other taxes - - 17
Long-term debt due within one
year - existing (Note 9) - - 18
Future income taxes (Note 7) - - -
Liabilities subject to
compromise - - -
---------------------------------------------------------------------
(147) 67 438
---------------------------------------------------------------------
Other liabilities
Employee future benefits - 413(7) 1,260
Pension liability (382)(6) 731(7) 349
Long-term debt - existing
(Note 9) - - 14
Long-term debt - New Secured
Floating Rate Notes (Note 9) - - 275
Long-term debt - New Province
Note - (Note 9) 149(4) (92)(7) 57
Revolving term loans (Note 8) 392(3,5) - 392
Future income taxes (Note 7) - 31(8) 110
Asset retirement obligation
(Note 6) - 6(7) 22
---------------------------------------------------------------------
159 1,089 2,479
---------------------------------------------------------------------
Total Liabilities 12 1,156 2,917
---------------------------------------------------------------------
Shareholders' Equity
Convertible debentures
conversion option - - -
Capital stock - - 144
New Warrants (Note 11) - - 2
Province Warrants (Note 11) 1(4) - 1
Contributed surplus - - -
Retained deficit - (456)(7) -
---------------------------------------------------------------------
Total Shareholders' Equity 1 (456) 147
---------------------------------------------------------------------
Total Liabilities and
Shareholders' Equity $ 13 $ 700 $ 3,064
---------------------------------------------------------------------
---------------------------------------------------------------------
The following legend describes the adjustments made to the
Predecessor accounts resulting from the implementation of the Plan
and consummation of the various agreements:
(1) Implementation of the Plan as outlined in Note 1.
The following table reconciles the Predecessor's liabilities
subject to compromise to those that were accepted claims under
the Plan:
At At At
March 31, March 31, December 31,
(in millions) 2006 2005 2005
-----------------------------------------------------------------
(Predecessor) (Predecessor) (Predecessor)
Liabilities subject to
compromise
Accepted claims $ 547 $ 532 $ 546
Post-filing interest 83 44 73
Unfiled claims 10 12 11
------------------------------------- ---------------------------
Total liabilities subject
to compromise $ 640 $ 588 $ 630
------------------------------------- ---------------------------
Settlement ---------------------------
Cash $ 108
FRN's 275
New Common Shares 36
New Warrants 2
-------------------------------------
Total consideration $ 421
-------------------------------------
Excess of claims over
distribution 219
Convertible debenture
conversion option 23
-------------------------------------
Total adjustment to
retained deficit $ 242
-------------------------------------
-------------------------------------
The holders of Series A and B voting common shares received nil
consideration.
(2) Issuance of shares for cash under the Plan Sponsor Agreement
(Note 1).
(3) Payment of financing fees on implementation of the Plan, which
have been deferred and will be amortized over the term of the
related facilities (Note 8).
(4) Receipt of cash under the Province Agreement in exchange for a
note payable and issuance of warrants (Note 9).
(5) Repayment of borrowings under the Predecessor's line of credit
and increase in revolving term loans in order to make pension
funding payment.
(6) Initial pension funding made under the Province Agreement.
(7) Comprehensive revaluation of assets and liabilities and
elimination of the deficit.
(8) Future income taxes have been adjusted to reflect the tax effects
of differences between the fair value of identifiable assets and
liabilities and their estimated tax bases and the benefits of any
unused tax losses and other deductions to the extent that these
amounts are more likely than not to be realized. The resulting
future tax amounts have been measured based on the rates
substantively enacted that are expected to apply when the
temporary differences reverse or the unused tax losses or other
deductions are realized.
The Corporation had certain future tax assets which existed at March
31, 2006 but were not recognized on the Consolidated Statement of
Financial Position at that date. To the extent that these future tax
assets are subsequently recognized the benefits will not flow through
the Consolidated Statement of Earnings (Loss) but will be treated as
an amendment to fresh start accounting.
Included under the Fresh Start Adjustment caption are all tax
adjustments required to transition the Predecessor's accounts to the
Successor's accounts at March 31, 2006
5. RESTRICTED CASH
The Predecessor's restricted cash represented funds being held in
trust with the monitor under the CCAA proceedings pending direction
from the Ontario Superior Court of Justice for its use. The
composition of these funds is derived as follows:
---------------------------------------------------------------------
At At At
June 30, March 31, December 31,
(in millions) 2006 2006 2005
---------------------------------------------------------------------
(Successor) (Successor) (Predecessor)
Proceeds relating to the sale
of Welland Pipe Ltd., CHT
Steel Inc., and Stelpipe Ltd.
assets $ - $ - $ 17
Proceeds from the sale of the
shares of Norambar Inc.,
Stelwire Ltd., and Stelfil LtDee - 30 -
Proceeds from the sale of the
shares of AltaSteel Ltd. 5 4 -
---------------------------------------------------------------------
$ 5 $ 34 $ 17
---------------------------------------------------------------------
---------------------------------------------------------------------
During the second quarter of 2006, the monitor released the proceeds
held in trust pertaining to the sale of the shares of Norambar Inc.,
Stelwire Ltd., and Stelfil LtGee. in accordance with the related
purchase and sale agreement. The remaining restricted cash will be
released in the fourth quarter of 2006 as per the terms of the
related purchase and sale agreement.
6. ASSET RETIREMENT OBLIGATIONS
Asset retirement obligations relate to the site restoration and
reclamation of iron ore properties at the Corporation's mining
interests in Wabush, Tilden and Hibbing. The following table provides
the pertinent information associated with these obligations:
---------------------------------------------------------------------
At At At
June 30, March 31, December 31,
(in millions) 2006 2006 2005
---------------------------------------------------------------------
(Successor) (Successor) (Predecessor)
Opening balance $ 22 $ - $ 12
Accretion expense 1 - 2
Effect of change in estimates - - 1
Liabilities incurred (settled) - - -
---------------------------------------------------------------------
Ending balance $ 23 $ 22(1) $ 15
---------------------------------------------------------------------
Underlying assumptions:
Undiscounted cash flow
estimates 86 86 86
Credit-adjusted interest
rate 12.00%(2) 12.00%(2) 16.65%
Time frame to settle the
obligations (years) 2013 - 2050 2013 - 2050 2013 - 2050
---------------------------------------------------------------------
(1) Reflects the estimated fair value assigned to this obligation
under fresh start reporting (Note 4).
(2) Reflects the estimated credit-adjusted interest rate of the
Corporation, subject to finalization upon completion of the
Corporation's comprehensive revaluation of assets and liabilities
(Note 4).
7. COMPONENTS OF CONSOLIDATED INCOME TAXES
The income tax expense (recovery) differs from the amount calculated
by applying Canadian income tax rates (federal and provincial) to the
earnings (loss) before income taxes from continuing operations, as
follows:
Three
months
ended
June 30,
(in millions) 2006
---------------------------------------------------------------------
(Successor)
(Loss) before income taxes from continuing operations $ (55)
---------------------------------------------------------------------
Income tax expense (recovery) computed using statutory
income tax rates (2006 - 43%) (24)
---------------------------------------------------------------------
Add (deduct):
Manufacturing and processing credit 5
Resource allowance/depletion (1)
Impact of federal income tax rate reduction (8)
Foreign exchange gain on US denominated debt (2)
Impact of intercompany foreign exchange 4
Other 2
---------------------------------------------------------------------
-
---------------------------------------------------------------------
Income tax expense (recovery) (24)
---------------------------------------------------------------------
Net (loss) $ (31)
---------------------------------------------------------------------
---------------------------------------------------------------------
Components of future income tax and liabilities are summarized as
follows:
---------------------------------------------------------------------
At At At
June 30, March 31, December 31,
(in millions) 2006 2006 2005
---------------------------------------------------------------------
(Successor) (Successor) (Predecessor)
Future income tax assets
Employee future benefits $ 408 $ 445 $ 300
Pension liability 133 143 -
Non-capital loss carry-forwards 117 154 97
Corporate minimum taxes 17 17 18
Net capital losses 24 27 7
Other 31 24 17
---------------------------------------------------------------------
Total future income tax assets
before valuation allowance $ 730 $ 810 $ 439
Less: valuation allowance (439) (483) (289)
---------------------------------------------------------------------
Total future income tax assets
after valuation allowance $ 291 $ 327 $ 150
---------------------------------------------------------------------
Future income tax liabilities
Plant and equipment -
difference in net book value
and unamortized capital cost $ 303 $ 335 $ 118
Deferred pension cost - - 37
Investment in joint ventures 29 35 36
Other 25 41 17
---------------------------------------------------------------------
Total future income tax
liabilities 357 411 208
---------------------------------------------------------------------
Net future income tax asset
(liability) $ (66) $ (84) $ (58)
---------------------------------------------------------------------
The future income tax asset (liability) is reflected in the
Consolidated Statement of Financial Position as follows:
---------------------------------------------------------------------
At At At
June 30, March 31, December 31,
(in millions) 2006 2006 2005
---------------------------------------------------------------------
(Successor) (Successor) (Predecessor)
Future income tax asset -
current $ 30 $ 7 $ 22
Future income tax asset -
non-current 11 19 12
Future income tax liability -
non-current (107) (110) (92)
---------------------------------------------------------------------
Net future income tax asset
(liability) $ (66) $ (84) $ (58)
---------------------------------------------------------------------
Future Income Taxes
Future income tax assets are recognized to the extent that
realization is considered more likely than not. The assessment as to
the future realization of future income tax assets, including loss
carry-forwards, is conducted on a company-by-company basis for the
Stelco group of businesses. Realization of future income tax assets
is dependent upon the availability of sufficient taxable income
within the carry-forward periods. The assessment of realization is
based upon the weight of evidence at the respective balance sheet
date.
The Corporation had certain future tax assets which existed at March
31, 2006 but were not recognized on the Consolidated Statement of
Financial Position at that date. To the extent that these future tax
assets are subsequently recognized the benefits will not flow through
the Consolidated Statement of Earnings (Loss) but will be treated as
an amendment to fresh start accounting.
8. BANK AND OTHER SHORT-TERM INDEBTEDNESS AND REVOLVING TERM LOANS
---------------------------------------------------------------------
At At At
June 30, March 31, December 31,
(in millions) 2006 2006 2005
---------------------------------------------------------------------
(Successor) (Successor) (Predecessor)
Bank and other short-term
indebtedness $ - $ - $ 191
Revolving term loans
Current 25 35 -
Non-current 411 392 -
---------------------------------------------------------------------
Total $ 436 $ 427 $ 191
---------------------------------------------------------------------
---------------------------------------------------------------------
Revolving Term Loans
Asset Based Loan Facility
On March 31, 2006, the $75 million debtor-in-possession short-term
credit facility and the $350 million short-term credit facility were
replaced by a long-term asset based loan facility (the "ABL
facility"). The ABL facility bears interest at the Canadian bankers'
acceptance rate + 2.25%, prime rate + 0.5%, the US Base rate + 0.5%
or London Inter-Bank Overnight Rate ("LIBOR") + 2.25%, depending on
the nature of the loan instrument incurred. The ABL facility is
available until March 31, 2008 and, prior to each anniversary date,
the facility can be renewed for a period of two years if the lendor
and Stelco mutually agree. The ABL facility is secured by a first
priority security interest in the eligible inventory and eligible
accounts receivable of Stelco. The ABL facility is additionally
secured by a second priority security interest in all other property
and assets of the Corporation, limited to $300 million, and a fourth
priority security interest for the balance. The available amount of
the ABL facility is dependent upon the value of the underlying
collateral of eligible accounts receivable and eligible inventory and
reserves, but will not exceed $600 million. The ABL facility incurs
an annual fee of 0.375% of any non-use of funds available under the
facility. The facility is subject to certain restrictive covenants.
Secured Revolving Term Loan
On March 31, 2006, as part of the CCAA Plan, the Corporation entered
into a secured revolving term loan facility with a wholly owned
subsidiary of Tricap Management Ltd. (a shareholder of the
Corporation - Note 1), in the amount of $375 million for a term of
seven years. The facility is revolving for three years, after which
time the facility will cease to revolve and any amount outstanding on
that date will be repayable in full at the end of the seventh year.
The secured revolving term loan currently bears interest at bankers'
acceptance rate plus 6.75% until March 31, 2009 after which the loan
bears interest at bankers' acceptance rate plus 7.25%. The secured
revolving term loan is secured by a second priority interest on the
working capital assets of Stelco, except project financings, and a
first priority security interest in the fixed assets of Stelco. The
secured revolving term loan is also secured by all the tangible and
non-tangible assets of certain subsidiaries of Stelco and a pledge of
and security interest in all of the outstanding shares of interests
in certain subsidiaries, partnerships and joint ventures of Stelco.
Stelco intends to repay amounts borrowed under this facility within
one year, therefore these borrowings have been reflected as a current
liability on the Statement of Financial Position. Under this
facility, Stelco is required to pay an annual fee of 3% of the
aggregate commitment of $375 million on each anniversary date of Plan
implementation. In addition, the facility requires the Company to pay
3% of the outstanding credit facility in place at March 31, 2009, if
it intends to extend the facility.
Included in financial expense for the second quarter of 2006 is
approximately $1 million relating to borrowings under this agreement.
The interest on borrowings is calculated in accordance with the
applicable lending agreement, yielding approximately 11% as at June
30, 3006. The majority of interest is paid prior to the end of each
month, therefore a nominal amount is outstanding at June 30, 2006.
9. LONG-TERM DEBT
---------------------------------------------------------------------
At At At
June 30, March 31, December 31,
(in millions) 2006 2006 2005
---------------------------------------------------------------------
(Successor) (Successor) (Predecessor)
Long-term debt of Stelco
subject to compromise $ - $ - $ 412
Term loans associated with
discontinued operations(4) - - 16
Floating rate notes at LIBOR
+ 8.50%(1)(5) 262 275 -
1% province note(2) 149 149 -
1% province note - fair value
adjustment(2) (91) (92) -
Term loan at Canadian prime
rate plus 2.50% matured on
June 10, 2005(3) 3 5 22
Term loan at bankers'
acceptance rate plus
1.50% maturing on
January 31, 2008(6) 27 27 33
---------------------------------------------------------------------
Long-term debt 350 364 483
Less amount subject to
compromise or held for sale - - (440)
Less amount due within one year (16) (18) (23)
---------------------------------------------------------------------
Long-term debt $ 334 $ 346 $ 20
---------------------------------------------------------------------
---------------------------------------------------------------------
(1) Floating Rate Notes
As part of the consideration in settlement of the affected claims
of the Predecessor, affected creditors received floating rate
notes ("FRN's") equal to the US dollar equivalent of $275 million
Canadian dollars ($235 million US dollars). The FRN's mature on
March 31, 2016. Interest on the FRN's is payable semi-annually.
At Stelco's option, the FRN's will bear an interest rate of LIBOR
plus 5.50% if paid in cash and LIBOR plus 8.50% if paid in new
FRN's. For periods after March 31, 2008, the interest rate will
be calculated in the same manner as noted above, with the
exception that under certain conditions, the interest rate will
be subject to a reduction of 0.50%. For periods after March 31,
2011, interest is payable in cash only. The FRN's are callable at
110% of face value until March 31, 2008; then callable at 105% of
face value until March 31, 2009; then at 102.5% of face value
until March 31, 2010; and at par thereafter, in each case payable
in cash. The FRN's are secured by a security interest in the
assets of Stelco, subordinated and postponed to the security
granted to the ABL facility and the secured revolving term loan
(Note 8) in all respects including rights to payment and
enforcement until both the ABL facility and secured revolving
term loan are repaid in full.
(2) Province Note
In accordance with the Pension Agreement (see Note 13), the
Province of Ontario provided Stelco with $150 million on March
31, 2006 in exchange for a note payable (the "Province Note") and
warrants to purchase 851,100 common shares of Stelco. The
Province Note is unsecured and is repayable on December 31, 2015,
at Stelco's option, in cash or by delivering an equivalent value
in Stelco common shares. The Province Note is also subject to a
75% discount if the solvency deficiencies in Stelco's four main
pension plans are eliminated on or before the maturity date. At
this time, there is no assurance that the Corporation will
receive the 75% discount. The Province Note bears an interest
rate of 1% per annum, payable semi-annually in cash or, at
Stelco's option, by delivering Stelco common shares. At March 31,
2006, the $150 million was allocated between the Province Note
and the fair value of the warrants (see Note 11 for terms of the
warrants). Upon the application of fresh start reporting on March
31, 2006, the Province Note was adjusted to its estimated fair
value of $57 million (see Note 4) and will be accreted up to its
face value over the term of the Note assuming an effective
interest rate of 12%. During the second quarter of 2006 an
accretion expense of $1 million was recorded in interest on
long-term debt on the Consolidated Statement of Earnings (Loss).
(3) The term loan is an obligation of a wholly owned subsidiary of
the Corporation. The loan is currently in default and the assets
remaining in the subsidiary are not sufficient to satisfy this
obligation.
(4) These term loans were assumed by the purchaser upon completion of
the sale of the non-core subsidiaries during the first quarter of
2006.
(5) A $13 million gain was recorded during the second quarter of 2006
due to the revaluation of the notes using the June 30, 2006 U.S.
dollar exchange rate.
(6) The term loan is an obligation of a wholly owned subsidiary of
the Corporation.
10. COMMITMENTS AND CONTINGENCIES
Capital Programs and Other Commitments
Stelco has binding commitments for capital programs totalling
$21 million. Of this amount, $17 million relates to Phase 2 of the
Lake Erie Steel Limited Partnership hot strip mill upgrade.
Pursuant to an outsourcing agreement, the Corporation has committed
approximately $110 million up to and including year 2012.
Federal Government Grant
The Government of Canada announced on November 23, 2005, that it
would provide a $30 million co-generation grant. The federal
contribution represented approximately 60% of the initial cost of the
Corporation's near-term cogeneration spending. Since the time of the
commitment, there was a change in Government. In June 2006, the
Corporation was advised by the Government that it cancelled its
previously announced commitment to contribute the $30 million.
Contingencies
Georgian Windpower Corporation ("GWC") commenced a lawsuit against
Stelco Inc. during the course of the CCAA proceedings alleging, among
other things, breach of contract by Stelco in connection with
Stelco's termination in April 2005 of a Memorandum of Understanding
("MOU") and Agreement to Enter into a Land Lease Agreement ("AELLA")
between Stelco and GWC. GWC has claimed damages of $350 million. The
Corporation is vigorously defending this action. The result and value
of the GWC claim is not determinable at this time and consequently
the Corporation has not recorded any provisions in the consolidated
financial statements.
11. CAPITAL STOCK
Common Shares
At June 30, At March 31,
2006 2006
---------------------------------------------------------------------
(Successor) (Successor)
Total number of common shares 27,100,000 26,100,000
Total (in millions) $ 149 $ 144
---------------------------------------------------------------------
New Common Shares
The Corporation issued 26,100,000 new common shares upon emergence
from CCAA with a value of $5.50 per share. On April 2, 2006, the
President and Chief Executive Officer purchased 1,000,000 common
shares from treasury for cash consideration of $5.5 million, bringing
the total number of common shares outstanding as of that date to
27,100,000.
Warrants
Upon emergence from CCAA, the Corporation issued a total of 2,269,600
warrants. The holders of liabilities subject to compromise received
1,418,500 warrants with an estimated fair value of $2 million as
partial consideration in exchange for their claim accepted under
CCAA. The Province received 851,100 warrants with an estimated fair
value of $1 million as partial consideration for the province loan
(Note 9). Each warrant entitles the holder to purchase one common
share at an exercise price of $11.00. The total number of common
shares issuable under the exercise of all outstanding warrants
represents approximately 7% of common shares outstanding upon the
exercise of warrants on a diluted basis. These warrants have a term
of seven years and are exercisable at any time after June 26, 2006 up
to their expiration on March 31, 2013.
12. STOCK-BASED COMPENSATION
Incentive Stock Option Plan
Effective April 1, 2006, the Board of Directors approved an Incentive
Stock Option Plan (the "ISOP"). The ISOP is intended to attract and
retain superior directors, officers, advisors, employees and other
persons engaged to provide ongoing services to the Corporation or its
affiliates. The total number of stock options available under the
ISOP is 2,610,000, of which 1,944,000 were issued at an exercise
price of $5.50 per common share. The options vest semi-annually over
a four-year period from the date of the grant (the "Grant Date") in
eight equal installments, subject to acceleration under certain
circumstances. The options expire 10 years after the Grant Date. In
accordance with the provisions of the ISOP, the exercise price of
options granted thereunder is required to be the market value, as
defined in the ISOP, on the Grant Date. During the second quarter of
2006, 200,000 options were forfeited and 150,000 additional options
were granted. The total options available under the ISOP at June 30,
2006 is 716,000.
Total compensation expense of $0.4 million has been included in costs
for the second quarter of 2006.
The compensation expense for grants made under the ISOP was
determined at the grant date using the fair value method by applying
the Black-Scholes option-pricing model using the following
assumptions:
---------------------------------------------------------------------
Grant date June 21, April 1,
2006 2006
Expected volatility 40% 40%
Risk-free interest rate 4.33% 4.00%
Expected life 0 - 4 years 0 - 4 years
Expected dividends Nil Nil
---------------------------------------------------------------------
The weighted average exercise price for options outstanding at
June 30, 2006 is $6.47.
13. EMPLOYEE FUTURE BENEFITS
Benefit Plan Cost
The defined benefit costs recognized in the second quarter and first
six months of 2006 and 2005 are outlined as follows:
-------------------------------------------------------
Three months Three months
ended ended
June 30, June 30,
(in millions) 2006 2005
-------------------------------------------------------
(Successor) (Predecessor)
Pensions $ 3 $ 37
Other benefit plans 20 21
-------------------------------------------------------
Total reported in costs 23 58
-------------------------------------------------------
Curtailments 14 -
Severance 8 -
Voluntary retirement incentives 19 -
-------------------------------------------------------
Total reported as workforce
reduction costs 41 -
-------------------------------------------------------
Total net benefit plan costs $ 64 $ 58
-------------------------------------------------------
-------------------------------------------------------
---------------------------------------------------------------------
Three months Three months Six months
ended ended ended
June 30, March 31, June 30,
(in millions) 2006(1) 2006(1) 2005
---------------------------------------------------------------------
(Successor) (Predecessor) (Predecessor)
Pensions $ 3 $ 36 $ 77
Other benefit plans 20 27 47
---------------------------------------------------------------------
Total reported in costs 23 63 124
---------------------------------------------------------------------
Curtailments 14 - -
Severance 8 - -
Voluntary retirement incentives 19 - -
---------------------------------------------------------------------
Total reported as workforce
reduction costs 41 - -
---------------------------------------------------------------------
Total net benefit plan costs $ 64 $ 63 $ 124
---------------------------------------------------------------------
---------------------------------------------------------------------
(1) The six month period ended June 30, 2006 consists of two quarters
which are not comparable.
Substantially all of the Corporation's pension benefit plans are not
fully funded.
Pension Plans
At June Remeasure- Plan At June
30, 2006 ment Amendments Retirements 30, 2006
---------------------------------------------------------------------
Affected Plans
Plan assets $ 2,781 $ (142) $ - $ - $ 2,639
Accrued benefit
obligations 3,124 (75) 87 63 3,199
---------------------------------------------------------------------
Funded status (343) (67) (87) (63) (560)
Unamortized net
actuarial
(gains) losses (6) 67 - 39 100
Unamortized past
service costs - - 87 - 87
---------------------------------------------------------------------
Accrued benefit
obligation (349) - - (24) (373)
Unaffected Plans
Accrued benefit
obligation (58) - - - (58)
---------------------------------------------------------------------
Total accrued
benefit
obligation (407) - - (24) (431)
---------------------------------------------------------------------
---------------------------------------------------------------------
Current (68) - - - (68)
Non-current (339) - (24) (363)
---------------------------------------------------------------------
Total accrued
benefit
obligation $ (407) $ - $ - $ (24) $ (431)
---------------------------------------------------------------------
---------------------------------------------------------------------
Other Benefit Plans
At June Remeasure- Plan At June
30, 2006 ment Amendments Retirements 30, 2006
---------------------------------------------------------------------
Affected Plans
Plan assets $ - $ - $ - $ - $ -
Accrued benefit
obligations 1,015 (66) (74) 23 898
---------------------------------------------------------------------
Funded status (1,015) 66 74 (23) (898)
Unamortized net
actuarial
(gains) losses - (66) - 20 (46)
Unamortized past
service costs - - (74) 13 (61)
---------------------------------------------------------------------
Accrued benefit
obligation (1,015) - - 10 (1,005)
Unaffected Plans
Accrued benefit
obligation (296) - - - (296)
---------------------------------------------------------------------
Total accrued
benefit
obligation (1,311) - - 10 (1,301)
---------------------------------------------------------------------
---------------------------------------------------------------------
Current (59) - - - (59)
Non-current (1,252) - - 10 (1,242)
---------------------------------------------------------------------
Total accrued
benefit
obligation $ (1,311) $ - $ - $ 10 $ (1,301)
---------------------------------------------------------------------
---------------------------------------------------------------------
Assumptions
At June 30, At March 31,
2006 2006
---------------------------------------------------------------------
Discount Rate
Pension plans discount rate 5.50% 5.25%
Other benefit plans - healthcare 5.75% 5.25%
Other benefit plans - compensated absences 5.50% 5.00%
Retirement Age
Salaried employees 59 58
---------------------------------------------------------------------
As a result of the emergence from CCAA on March 31, 2006, the
Corporation was required to undertake a comprehensive revaluation of
its assets and liabilities, which included a remeasurement of all of
the Corporation's pension and other benefit plan obligations under
CICA Handbook Section 3461 - Employee Future Benefits. The results of
the remeasurement, as reported in the first quarter 2006, included
the elimination of previously recorded unamortized net actuarial
losses and unamortized past service costs. As a result, this had the
effect of reducing the employee future benefit expense in the second
quarter 2006 by $40 million.
In the second quarter 2006, there was:
- a contract settlement reached with USW Local 1005 which contained
pension and benefit improvements, including an annual pension
indexing tied to a cost of living adjustment;
- announced reductions in the other benefit programs, which
substantially impacted the active salary workforce (and salaried
retirees);
- a Salaried Transition Assistance Program ("STAP"), which provided
incentives for early retirement or resignation to employees who
were members of the two principal salary defined benefit pension
plans. The program closed on June 30, 2006;
- a Transition Assistance Program ("TAP"), which provided incentives
for early retirement to Hamilton Steel bargaining unit employees
as part of the contract settlement reached with USW Local 1005.
The program closed on July 14, 2006.
The STAP resulted in a severance expense of $19 million in the second
quarter 2006 which, when combined with other terminations in the
period of $8 million, resulted in a total cost of $27 million. The
TAP will result in a severance cost of $5 million which will be
recognized in the third quarter 2006.
These events had an impact on three of the Corporation's four
principal pension and other benefit plans (the Hamilton Steel
bargaining unit plans and the salary plans covering the Lake Erie
Steel salary workforce and the combined Corporate and Hamilton Steel
salary workforce). The Lake Erie Steel bargaining unit plans are not
impacted by these changes as they are covered under a separate labour
agreement.
As a result of the significant reduction of the salary workforce
arising from the STAP program and the impact of certain reductions in
the salary other benefit programs there was a net curtailment expense
recognized in the second quarter 2006 of $14 million.
Two plan amendments (the Hamilton Steel bargaining unit pension
indexing adjustment, net of a reduction in the salary early
retirement pension benefit) resulted in net pension unamortized past
service cost of $87 million. While this amount did not impact second
quarter 2006 earnings, the amount will be amortized over the expected
average remaining service life ("EARSL") of the active employees.
Other benefit plan amendments which primarily reflect an extensive
reduction to the salary health care benefits resulted in an
unamortized past service gain of $74 million. Similar to the pension
impact noted above, this amount did not impact second quarter 2006
earnings and will be amortized over EARSL.
As a result of the significant plan amendments, there was a
requirement to remeasure the affected plans described above. The
remeasurement required a review and update of all significant
assumptions underlying these plans, including the discount rate,
retirement age, and expected long term rate of return on pension plan
assets. The change in assumptions is tabled in this note. In the case
of the pension plans the actual negative returns experienced since
the last remeasurement in March 2006 compared to the expected rate of
return exceeded the favourable impact of the 0.25% increase in the
pension discount rate, resulting in a net pension unamortized
actuarial loss of $67 million. The effect of employee reductions both
prior to and including the TAP program for the Hamilton bargaining
unit plan added an additional $39 million to the actuarial loss.
In the case of the other benefit plans, the increase in the discount
rate by 0.5% resulted in an unamortized actuarial gain of
$66 million. The effect of employee reductions, both prior to and
including the STAP and TAP, resulted in an unamortized actuarial loss
of $20 million.
Pension Plan Funding Arrangements
As a condition of the CCAA Plan, Stelco and the Province entered into
the Pension Agreement, effective on March 31, 2006, which contains
the following principal terms:
- Stelco was obligated to make an initial up-front payment of
$400 million to its four main pension plans less any contributions
to plans already made in 2006. As a result, Stelco made a
$382 million payment to the plans on March 31, 2006;
- Stelco will fund its four main pension plans in the following
amounts in the years subsequent to December 31, 2005:
Years 1 - 5: $65 million per year ($32.5 million in 2006),
payable monthly, commencing July 1, 2006; and
Years 6 - 10: $70 million per year, payable monthly;
- Stelco will make additional pension plan payments to fund any
solvency deficiency in the Stelco four main pension plans if
Stelco generates free cash flow in excess of certain minimum
thresholds as set out in the Pension Agreement, subject to Stelco
having more than a minimum liquidity amount; and
- Stelco will not be required to make any adjustments to its pension
funding based on annual actuarial valuations up to December 31,
2015 provided that any future benefit improvements which will be
required to be funded in accordance with the Pension Benefits Act
and will be in addition to the funding payments outlined above.
While the Pension Agreement with the Province has a prescribed
funding obligation as outlined above, pension plan enhancements, such
as the recently negotiated hourly pension indexing, are excluded from
this arrangement. Accordingly, the hourly pension indexing is subject
to additional cash funding under the Pension Benefits Act, totalling
an estimated $121 million over the next eight years.
Interest on the convertible debentures is recorded in the
Consolidated Statement of Earnings (Loss) as interest on long-term
debt and debt subject to compromise. This amount, net of tax, is
added back to net earnings (loss) from continuing operations and net
earnings (loss) in order to calculate fully diluted earnings (loss)
from continuing operations and fully diluted earnings (loss) per
common share. Fully diluted earnings (loss) per common share is
calculated by applying the treasury stock method for the potential
exercise of stock options, and assuming the dilutive effect of the
conversion of all outstanding convertible debentures at the $4.50 per
share conversion price applicable to these debentures.
-------------------------------------------------------
Three months Three months
ended ended
June 30, June 30,
(in millions) 2006 2005
-------------------------------------------------------
(Successor) (Predecessor)
Basic net earnings (loss)
from continuing operations $ (31) $ 35
Convertible debentures -
interest expense net of tax - 2
-------------------------------------------------------
Fully diluted net earnings (loss)
from continuing operations $ (31) $ 37
-------------------------------------------------------
-------------------------------------------------------
Basic net earnings (loss) (31) 40
Convertible debentures -
interest expense net of tax - 2
-------------------------------------------------------
Fully diluted net earnings
(loss) $ (31) $ 42
-------------------------------------------------------
-------------------------------------------------------
Weighted average number of
common shares outstanding -
basic 27,100,000 102,249,199
Incremental number of
common shares assumed to
be issued on the exercise
of stock options 1,253,744 86,957
Incremental number of
common shares assumed to
be issued on the exercise
of warrants 965,232 -
Common shares issued on
the assumed conversion
of convertible - 20,000,000
-------------------------------------------------------
Weighted average number of
common shares outstanding -
fully diluted 29,318,976 122,336,156
-------------------------------------------------------
-------------------------------------------------------
Options to purchase common
shares not included in the
above calculation(1) - 4,807,015
-------------------------------------------------------
-------------------------------------------------------
---------------------------------------------------------------------
Three months Three months Six months
ended ended ended
June 30, March 31, June 30,
(in millions) 2006(2) 2006(2) 2005
---------------------------------------------------------------------
(Successor) (Predecessor) (Predecessor)
Basic net earnings (loss)
from continuing operations $ (31) $ (79) $ 76
Convertible debentures -
interest expense net of tax - 1 3
---------------------------------------------------------------------
Fully diluted net earnings (loss)
from continuing operations $ (31) $ (78) $ 79
---------------------------------------------------------------------
---------------------------------------------------------------------
Basic net earnings (loss) (31) (122) 89
Convertible debentures -
interest expense net of tax - 1 3
---------------------------------------------------------------------
Fully diluted net earnings
(loss) $ (31) $ (121) $ 92
---------------------------------------------------------------------
---------------------------------------------------------------------
Weighted average number of
common shares outstanding -
basic 27,100,000 102,249,198 102,249,200
Incremental number of
common shares assumed to
be issued on the exercise
of stock options 1,253,744 - 122,340
Incremental number of
common shares assumed to
be issued on the exercise
of warrants 965,232 - -
Common shares issued on
the assumed conversion
of convertible - 20,000,000 20,000,000
---------------------------------------------------------------------
Weighted average number of
common shares outstanding -
fully diluted 29,318,976 122,249,198 122,371,540
---------------------------------------------------------------------
---------------------------------------------------------------------
Options to purchase common
shares not included in the
above calculation(1) - 4,986,012 4,807,015
---------------------------------------------------------------------
---------------------------------------------------------------------
(1) Exercise prices were greater than the average market price of the
common shares during the periods.
(2) The six month period ended June 30, 2006 consists of two quarters
which are not comparable.
During the three months ended June 30, 2006 and March 31, 2006, a
basic net loss from continuing operations and a basic net loss were
incurred, therefore options warrants and convertible debentures
related information have not been used to calculate fully diluted
earnings per share from continuing operations and fully diluted
earnings per share as both are anti-dilutive where applicable.
15. SEGMENTED INFORMATION
Due to the vertical integration of the Corporation and the similarity
in products produced and sold at Stelco's integrated steel mills and
their interrelationship, there is only one identifiable reportable
segment consistent with the way Stelco manages its business.
The following provides segmented information where the information
cannot otherwise be found directly in the consolidated financial
statements:
-------------------------------------------------------
Three months Three months
ended ended
June 30, June 30,
(in millions) 2006 2005
-------------------------------------------------------
(Successor) (Predecessor)
Geographic segments
Net sales
Canada $ 632 $ 590
United States 61 63
Other 5 5
-------------------------------------------------------
Net Sales $ 698 $ 658
-------------------------------------------------------
-------------------------------------------------------
Capital assets - net(1)
Canada $ 977 $ 1,014
United States 60 57
-------------------------------------------------------
Capital assets - net $ 1,037 $ 1,071
-------------------------------------------------------
-------------------------------------------------------
---------------------------------------------------------------------
Three months Three months Six months
ended ended ended
June 30, March 31, June 30,
(in millions) 2006(2) 2006(2) 2005
---------------------------------------------------------------------
(Successor) (Predecessor) (Predecessor)
Geographic segments
Net sales
Canada $ 632 $ 609 $ 1,248
United States 61 60 127
Other 5 5 11
---------------------------------------------------------------------
Net Sales $ 698 $ 674 $ 1,386
---------------------------------------------------------------------
---------------------------------------------------------------------
Capital assets - net(1)
Canada $ 977 $ 977 $ 1,014
United States 60 58 57
---------------------------------------------------------------------
Capital assets - net $ 1,037 $ 1,035 $ 1,071
---------------------------------------------------------------------
---------------------------------------------------------------------
(1) The valuation of assets under fresh start accounting is still
under review (Note 4) therefore these capital assets are reported
at historical cost.
(2) The six month period ended June 30, 2006 consists of two quarters
which are not comparable.
>>
%SEDAR: 00001549E
