May 4, 2006 — Algoma Steel Inc. reported net income of $32.7 million on revenues of $499.6 million for the three months ended March 31, 2006.
Net income of $32.7 million compares to $55.0 million for the fourth quarter of 2005 and $89.1 million for the comparable quarter of 2005. The decrease in net income from the previous quarter was mainly due to higher income taxes because of the favorable impact on income taxes in the fourth quarter of 2005 related to the $50.0 million pension contribution made in December and the related reduction in pension contributions in the first quarter of 2006. The absence of coke sales also reduced profitability versus the previous quarter, as did the higher financial expense due mainly to the $7.9 million premium paid to redeem the 11% Notes in January 2006. This was partially offset by higher shipments and lower administrative and selling costs. Significantly lower steel prices account for most of the decline in net income versus the first quarter of 2005. Higher production costs and higher income taxes, offset in part by higher shipments and lower profit sharing expense, were contributing factors.
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Algoma's profitability is highly correlated with the level of steel prices, which is a major factor causing variation in quarterly operating results.
In recent years, raw material and energy costs have also emerged as significant factors.
Industry pricing is largely dependent on global supply, the level of steel imports into North America and economic conditions in North America.
Since U.S. markets establish pricing levels, the exchange rate of the Canadian dollar to the U.S. dollar significantly impacts pricing realizations for Canadian producers.
The cost of raw materials and natural gas escalated in 2004 and 2005 as input prices responded to the stronger demand. Iron ore prices, under a long-term supply agreement denominated in U.S. dollars, increased approximately 85% in 2005 and a further increase is expected in 2006.
The impact of an increase in raw material pricing on earnings is delayed by the consumption of existing inventories acquired at the previous year's price. Coal costs also escalated in 2005 primarily because of spot market purchases due to temporary supply disruptions from the company's main coal supplier.
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Denis Turcotte, President and CEO, commented, "We are encouraged by the continued strong commercial and manufacturing performance which resulted in record shipments in the quarter. Our strong balance sheet, positive free cash flow, the resolution of the Paulson issue, and strengthening industry fundamentals position Algoma to take advantage of opportunities and continue driving shareholder value."
Revenue, $499.6 million, reflects an increase of $22.0 million compared to the previous quarter and an increase of $0.6 million versus the comparable period in 2005. The increase from the previous quarter was due mainly to higher shipments. The increase over the first quarter of 2005 was due to significantly higher steel shipments, offset by lower steel prices. Steel prices averaged $737 per ton in the first quarter as compared to $751 per ton in the previous quarter and $859 per ton in the first quarter of 2005. Steel shipments totaled 642,900 tons, which was 60,400 tons higher than the fourth quarter of 2005 and 93,600 tons higher than the first quarter of 2005.
EBITDA was $80.5 million, which compares to $77.6 million for the previous quarter and $157.8 million for the first quarter of 2005. The improvement from the previous quarter was mainly due to higher shipments and lower selling and administrative expenses, offset in part by higher production costs and the absence of coke sales in the first quarter. The decline from the comparable quarter in 2005 was mainly attributable to lower steel selling prices, while higher production costs and higher financial expense were offset in part by higher steel shipments and lower employee profit sharing.
There were no sales of coke, which compares to sales of 27,200 tons in the fourth quarter of 2005, which had generated approximately $7.9 million of EBITDA. Coke sales in the first quarter of 2005 totaled 13,500 tons and contributed $3.1 million to EBITDA.
Cost of sales per ton shipped for steel products (excluding employees' profit sharing expense) was $577, virtually unchanged from the previous quarter and an increase of $48 per ton from the comparable period in 2005. Increased costs were offset by the effect of a lower proportion of higher-cost plate shipments on the average steel cost per ton in the first quarter. The benefit of lower natural gas prices as compared to the fourth quarter was partially offset by a research and development tax credit recognized in the fourth quarter and higher costs due in part to winter operations. The full benefit of lower natural gas prices in the first quarter was not fully realized due to inventory effects. The increase in cost of sales over the first quarter of 2005 was mainly attributable to higher costs for iron ore, partially offset by purchased coal cost penalties in 2005 due to supply disruptions with the Company's primary supplier.
The company had inventory of 29,000 tons of purchased slabs at December 31, 2005 compared to 13,000 tons at March 31, 2006. Approximately 35,000 tons of finished goods produced from purchased slabs were sold in the first quarter, and these additional sales generated approximately an additional $3 million of operating income. The company expects to purchase an additional 150,000 tons over the balance of the year, although the quantity purchased will be highly dependent on market conditions in North America and the cost of purchased slabs.
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Steel pricing levels increased in the fourth quarter of 2003 and throughout the first three quarters of 2004 due to stronger global markets, particularly China, and improved steel demand in North America.
Excess steel inventories at the end of 2004 and weaker North American demand from several market sectors contributed to lower prices in 2005, reaching a low in August 2005 as excess inventories were depleted.
Selling prices rose in the fourth quarter of 2005 due to a better balance between supply and demand and were relatively stable through the first quarter of 2006.
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A $4.6 million ($7 per ton) expense for employees' profit sharing was recorded in the first quarter versus a $5.9 million expense ($10 per ton) in the fourth quarter of 2005 and $12.5 million ($23 per ton) for the three months ended March 31, 2005.
Raw steel production for the three months ended March 31, 2006 totaled 637,000 tons versus 671,000 tons for the previous quarter and 638,000 tons for the first quarter of 2005.
Iron Ore Contract Dispute — Algoma's long-term iron ore supply agreement with Cleveland-Cliffs runs through 2016 (Ore Supply Agreement). Pricing under the Ore Supply Agreement is based on a formula linked to global ore prices (pricing formula). The Ore Supply Agreement also provides that, in certain years, either party may request a price negotiation (Reopener Years) if prices under the Ore Supply Agreement differ from a specified benchmark price. It is Algoma's position that the Reopener Years are 2007, 2010 and 2013. Cliffs' position is that the Reopener Years are 2008, 2011 and 2014. Algoma and Cliffs have agreed to resolve this issue through binding arbitration, which is anticipated to be completed by the end of 2006. The amount of the variance, if any, between the pricing formula and the benchmark price for a particular Reopener Year depends on future events and is therefore currently not determinable.
Resolution of the Paulson Situation — On March 7, 2006, Paulson & Co. Inc. agreed to withdraw its requisition for a special meeting of shareholders, which had been scheduled for March 22. Algoma announced its intent to distribute $200 million to shareholders by mid-year and agreed to appoint two new mutually-agreeable directors to the Board selected through its normal governance process. Subsequently, Algoma and Paulson agreed that only one new director would be added. The company also announced it would continue a strategic process that would include assessing the potential for value creation through a sale, merger, acquisition or future distributions of excess capital if or when appropriate.
Algoma filed an application for an advance tax ruling in mid-March with respect to a corporate reorganization involving a proposed return of $200 million of paid-up capital to shareholders. The Canada Revenue Agency provided a negative response to the ruling request. The company is currently reassessing the form of distribution to be utilized.
Algoma noted that Steven Bowsher has resigned as a director of Algoma and Nicholas Tolerico has joined the Board. The Board of Directors will be recommending the addition of Nicholas Tolerico as a new Board member for approval by shareholders at the June 29, 2006 Annual and Special Meeting of Shareholders.
Outlook — Despite increased imports in the first quarter and an expectation that the increase will be maintained, market fundamentals remain strong and are expected to support second quarter shipments of over 600,000 tons and higher selling prices. Price increases have been announced for sheet and plate products commencing in May, consistent with general industry announcements. Algoma currently has contract sales approximating 40% of overall sales which are not subject to the price increases. The substantial strengthening of the Canadian dollar versus the U.S. dollar over the past month is a concern due to the potential effect on future earnings. Higher iron ore costs are expected due to the effect of the 2006 price increase, but this is expected to be offset by realizing the full benefit of lower prices for natural gas. Selling prices and costs are subject to a high degree of variability. The company currently expects to sell approximately 11,000 tons of coke in the second quarter.
The company expects a price increase on iron ore in 2006 and is currently making payments to its ore supplier based on its estimate of an increase of 15%. The actual increase could vary significantly from this estimate depending on the outcome of global pricing.
In 2005, 100% of coal inventories were carried by Algoma's primary coal supplier until the point of consumption. In 2006, approximately 66% of Algoma's coal requirements will be carried by the primary supplier in this fashion, with the balance to be purchased from other suppliers at the point of coal delivery. As a result, coal inventory levels are expected to increase over 2005 commencing in April 2006, peaking at about $25 million at year-end due to the normal seasonal build. Coal inventories totaled $2.4 million at March 31 and are expected to increase to $13-$15 million by the end of the second quarter.
Blast Furnace Maintenance — The company has cancelled plans to shut down its blast furnace for a period of 15 days in the second half of 2006 to perform work related to extending the blast furnace reline to 2010 or beyond. The company is currently assessing alternative plans for this work to be scheduled in 2007. A decision regarding the timing and duration of this outage will be determined by the end of the second quarter.