Wheeling-Pittsburgh Corporation (WPC) is a Delaware holding company that, together with its several subsidiaries and joint ventures, produces steel and steel products using both integrated and electric arc furnace technology. WPC sold 2,329,667 tons of steel and steel products in 2006. Net sales totaled $1,770.8 million in 2006. Our principal operating subsidiary is Wheeling-Pittsburgh Steel Corporation (WPSC), a Delaware corporation, whose headquarters is located in Wheeling, West Virginia. WPC was organized as a Delaware corporation on June 27, 1920 under the name Wheeling Steel Corporation.
We produce flat rolled steel products for converters and processors and steel service centers, and the construction, container and agriculture markets. Our product offerings are focused predominantly on higher value-added finished steel products such as cold rolled products, fabricated products and tin and zinc coated products. Higher value-added products comprised 60.8% of our shipments during 2006. In addition, we produce hot rolled steel products, which represent the least processed of our finished goods. The commissioning of our new Consteel ® electric arc furnace (EAF), along with the de-commissioning of one of our two blast furnaces, has transformed our operations from an integrated producer of steel to a hybrid producer with characteristics of both an integrated producer and a mini-mill.
Wheeling Corrugating Company (WCC), an operating division of WPSC, manufactures our fabricated steel products for the construction, agricultural and highway markets. WCC products represented 21.7% of our steel tonnage shipped during 2006. WPSC also has ownership interests in three significant joint ventures. Wheeling-Nisshin, Inc. (Wheeling-Nisshin) and Ohio Coatings Company (OCC), which consumed 23.1% of our steel tonnage shipped during 2006, represented 18.5% of our net sales for 2006. Wheeling-Nisshin and OCC produce value-added steel products from materials and products primarily supplied by us. On September 29, 2005, we entered into a third significant joint venture, Mountain State Carbon, LLC (MSC), which owns and is refurbishing the coke plant facility that we contributed to it. MSC sells the coke produced by the coke plant to us and our joint venture partner.
Prior to August 1, 2003, we were a wholly-owned subsidiary of WHX Corporation. On November 16, 2000, we and eight of our then-existing wholly-owned subsidiaries, which represented substantially all of our business, filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code, and emerged from bankruptcy on August 1, 2003.
Recent Developments
Merger Proposals; Proxy Contest; Directors and Officers
Our strategic partner search process began in the summer of 2005. Our Board of Directors engaged UBS Investment Bank (UBS) and conducted a series of management discussions and site visits with potential strategic partners. Although a number of parties expressed interest, management and their advisers principally held discussions with Esmark Incorporated (Esmark) and Companhia Siderúrgica Nacional (CSN). Initial discussions with Esmark began in June 2005. Wheeling-Pittsburgh and Esmark entered into a confidentiality agreement in July 2005 and Esmark proceeded with preliminary due diligence review. Initial discussions with CSN began in December 2005.
On July 17, 2006, The Bouchard Group LLC and Esmark announced their intention to seek the election of a new slate of directors at our 2006 annual meeting. On October 19, 2006 Esmark filed a definitive proxy statement for the election of their proposed director nominees and stated their further intention, if successful in the election of their nominees to our Board of Directors, to appoint a new management team and to present a merger proposal to our Board of Directors to merge Esmark with the Company.
We announced our preliminary agreement to enter into a merger transaction with CSN in August of 2006, and on October 24, 2006, we entered into a definitive merger agreement with CSN.
At our annual stockholders meeting held on November 17, 2006, our stockholders elected all of the Esmark nominees together with the two representatives of the United Steelworkers of America (USW) who were installed as our Board of Directors on November 30, 2006 upon certification of the election results. Immediately thereafter, the Board of Directors appointed members of our audit committee, compensation committee, nominating and corporate governance committee, executive committee, safety and environmental committee and finance committee.
On December 5, 2006, our Board of Directors appointed a committee comprised of five of its independent directors (Independent Committee) to evaluate third party merger proposals, including the CSN merger agreement and the Esmark merger proposal.
By letter dated December 12, 2006, CSN terminated its merger agreement with us and withdrew its enhanced proposal publicly announced November 6, 2006.
On March 16, 2007, the Company and Esmark entered into a definitive merger agreement providing for the formation of a new holding company (NewCo) in which our existing stockholders would receive one share of NewCo’s common stock for each share of the Company’s common stock held by each of our stockholders. Esmark stockholders would receive 17.5 million shares of the new company’s common stock in the aggregate, plus additional shares of common stock for any new equity raised by Esmark prior to May 15, 2007. In addition to the share for share exchange, our stockholders may elect to receive either (1) a put right allowing the stockholder to put back to NewCo within a ten day period each of the shares of NewCo that were issued to such stockholder in the exchange for $20.00 per share, subject to a maximum of $150.0 million being paid for all exercised put elections, or (2) an underwritten right to purchase one additional share of NewCo common stock for each share of the Company’s stock that was exchanged by such stockholder at $19.00 per share within a ten day period, subject to a maximum of $200.0 million worth of NewCo common stock (at such $19.00 price) being purchased under the purchase rights. As a condition to the closing of the merger, Franklin Mutual Advisers, LLC (Franklin) and the Company are required to enter into a standby purchase agreement that will require Franklin to purchase any of the foregoing unexercised purchase rights (up to a maximum of $200.0 million) and that, in any event, will obligate the Company to provide Franklin a minimum of $50.0 million in purchase rights. In each case, Franklin’s purchase rights are exercisable at a $19.00 per share price. Both the put and rights elections are subject to proration if the elections exceed the specified amounts. The transactions contemplated by the definitive agreement are subject to stockholder approval. The transaction is expected to be completed in the summer of 2007.
New Management
On November 30, 2006, the newly elected Board of Directors elected James P. Bouchard as Chairman of the Board of Directors and Chief Executive Officer of the Company and Craig T. Bouchard as Vice Chairman of the Board of Directors and President of the Company effective December 1, 2006. Shortly thereafter the Board of Directors appointed several new executives to our management team for both the Company and WPSC.
Production, Shipments and Pricing
During 2006, we produced 2,502,315 tons of steel slabs. Our EAF produced 1,220,729 tons of liquid steel during 2006. From November 20, 2006 through January 31, 2007, we discontinued operating our EAF to conserve cash. As a result of excess inventory at steel service centers leading to a decrease in demand for steel products, we decided to produce hot metal using our blast furnace and basic oxygen furnace, utilizing raw materials on hand, rather than operate our EAF which would have required additional outlays for the purchase of scrap. The EAF was restarted in February 1, 2007.
Steel shipments totaled 2,329,667 tons during 2006. Steel prices increased during the first eight months of 2006 before decreasing during the last four months of the year.
We completed installation of hot strip mill automatic roll changers at our primary steel-making facility in February 2006. The automatic roll changers have increased our annual hot rolling capacity to an estimated 3,400,000 tons per year.
Raw Materials
Critical raw materials, principally iron ore, purchased coke, zinc and natural gas, reflected price increases during 2006. The cost of coke produced by our MSC joint venture decreased during 2006.
Insurance Recovery
As the result of the basic oxygen furnace ductwork collapse that occurred in December 2004, we received $12.7 million in business interruption insurance recoveries during the first quarter of 2006. We received an additional recovery of $6.1 million during the first quarter of 2007, which was recorded as a reduction of cost of goods sold in 2006. We continue to pursue additional recoveries related to this matter.
Stock Unit Awards
On March 10, 2006, we granted 145,998 stock unit service awards and 103,339 stock unit performance awards to certain employees under our management stock incentive plan, as amended. On December 19, 2006, we granted an additional 171,000 stock unit service awards under the plan. Stock unit service awards will vest to each individual based solely on service, subject to forfeiture, in general, over a three-year period from the date of grant. Stock unit performance awards will vest to each individual in full, subject to forfeiture, on March 31, 2009, based on a combination of service and market performance, as defined by the plan. Each stock unit award is equivalent to one share of our common stock. We, at our sole discretion, have the option of settling stock unit awards in cash or by issuing common stock or a combination of both.
Net Operating Loss Carryover Limitation
Based on information available to us, we believe that we underwent an “ownership change” pursuant to Section 382 of the Internal Revenue Code in the second quarter of 2006. As a result, our ability to utilize net operating loss carryovers to reduce taxable income in subsequent years will be subject to statutory limitations on an annual basis. Our net operating loss carryover as of December 31, 2006 approximated $344.1 million. We estimate that our ability to offset post-ownership change taxable income will be limited to approximately $8.0 million to $10.0 million per year. We believe that there are built-in gains inherent in the value of the Company’s assets that, when and if realized, may increase this annual limitation during the five-year period from the date of the ownership change. We are currently assessing the extent of these built-in gains.
Termination of Stockholder Rights Plan
On October 24, 2006, we terminated the Stockholder Rights Plan adopted by us on February 14, 2005.
Credit Arrangements and Covenant Compliance
In March 2006, we reached agreement with both the lenders under our term loan agreement and the Emergency Steel Loan Guarantee Board (Loan Board), the Federal loan guarantor, to waive compliance with the leverage, interest coverage and fixed charge coverage ratios under our term loan agreement through the quarter ending June 30, 2007. Through March 16, 2007, the term loan agreement, as amended, required us to maintain minimum borrowing availability of at least $50.0 million under our revolving credit facility at all times or to maintain a minimum fixed charge coverage ratio. Our revolving credit facility also required us to maintain minimum borrowing availability of at least $50.0 million at all times or to comply with a minimum fixed charge coverage ratio.
We met the minimum fixed charge coverage ratio for the quarter ended December 31, 2006. As a result, we are not required to maintain $50.0 million of borrowing availability under our revolving credit facility during the first quarter of 2007.
On March 16, 2007, the revolving credit agreement was amended to allow us to access collateral in excess of the $225.0 million commitment under the facility. If the minimum fixed charge coverage ratio is not met by us at the end of any quarter and excess collateral, as defined by the agreement, is available, we will be able to access up to $45.0 million of such excess collateral over and above the $225.0 million commitment amount and we will be required to maintain at least $50.0 million of borrowing availability at all times. Provided that sufficient collateral will support such borrowings, we will be permitted to borrow up to $220.0 million under the facility. The incremental amount of borrowing availability of up to $45.0 million will decrease by $5.0 million each quarter commencing with the fourth quarter of 2007 through the second quarter of 2008, and will be limited, thereafter, to up to $25.0 million through, but not beyond, November 1, 2008. On this date and thereafter, the previous requirement that we maintain minimum borrowing availability of $50.0 million at all times without access to collateral beyond the $225.0 million amount of the facility, or to maintain a minimum fixed charge coverage ratio, will again be applicable. The amendment also provides for lender approval for the issuance of $50.0 million of convertible debt and an increase in the annual amount of permitted capital expenditures.
Effective March 16, 2007, the term loan agreement was amended to waive compliance with the requirement to maintain minimum borrowing availability of $50.0 million at all times or to maintain a minimum fixed charge coverage ratio. The agreement was further amended to eliminate the leverage and interest coverage ratios for the duration of the agreement. In place of these covenants, a standalone fixed charge coverage ratio will take effect for the second quarter of 2008 and thereafter. To effect the amendment, we agreed to use the proceeds from the issuance of $50.0 million of convertible debt to make a principal prepayment of $37.5 million under our term loan agreement, representing satisfaction of the next six quarterly principal payments due under the term loan agreement and to use the remaining proceeds for general corporate purposes. We also agreed to amend the existing $12.5 million standby letter of credit, previously posted in favor of the term loan lenders, to $11.0 million to cover interest payment obligations to April 1, 2007. The letter of credit will decline as such interest payments are made. The term loan lenders and Loan Board also agreed to waive the excess cash flow mandatory repayment provisions of the agreement, increase the annual amount of permitted capital expenditures for 2007 and 2008, increase the amount of permitted indebtedness, and provide various administrative amendments with regard to activities related to MSC.
The amendment also provides authorization for us to merge with Esmark. As part of the amendment, we also agreed, subject to consummation of the merger with Esmark, to repay or refinance the term loan in full on the later of April 1, 2008 or the date of such consummation and to release the Loan Board of any further obligation under the Federal guarantee as well as the West Virginia Housing Development Fund, the State guarantor, of any further obligation under the state guarantee. In the event that the merger with Esmark is not consummated, we agreed to change the final maturity date of the loan from August 1, 2014 to August 1, 2010.
Private Placement
On March 15, 2007, certain institutional investors who are stockholders of the Company and Esmark, as well as James P. Bouchard, our Chairman and Chief Executive Officer, and Craig T. Bouchard, our Vice Chairman and President agreed to purchase convertible notes from us, and on March 16, 2007, we received $50.0 million and issued convertible subordinated promissory notes. Pursuant to the terms of such notes, the debt will be convertible into our common stock upon consummation of a merger between us and Esmark at a price of $20 per share (and the holders of the convertible notes will be permitted to participate in the Esmark merger as stockholders of the Company), or if not consummated, at the election of the investors, the notes may be converted at an alternative conversion price which will not be more than $20 per share or less than $15 per share or shall be payable in cash on November 15, 2008, subject to limitations relative to our term loan agreement and revolving credit facility. Interest shall be payable in cash at a per annum rate of 6% payable quarterly in arrears. In the event that the merger between us and Esmark is not consummated by January 1, 2008, the per annum interest rate shall increase to 9% per annum retroactively to the issuance date. The $50.0 million will be used to pay down $37.5 million of indebtedness under our term loan agreement and for general corporate purposes.
Business Strategy
Our business strategy has been focused on making our cost structure more variable, reducing our ongoing maintenance and capital expenditure requirements, providing flexibility to react to changing economic conditions, and expanding our participation in markets for higher value-added products. During 2006 we pursued a number of opportunities to join with a strategic partner as an improved means of accomplishing our business strategy. On November 17, 2006, our stockholders elected a new slate of directors that had been proposed by Esmark. Our new Board of Directors appointed a substantially new management team in December, 2006. Esmark presented a merger proposal to the Independent Committee of our Board of Directors, which was formed for the purpose of evaluating third party merger proposals, including the CSN merger agreement and the Esmark merger proposal.
Electric arc furnace production
Our new EAF has transformed our operations from a pure integrated producer of steel to a hybrid producer of steel with characteristics of both an integrated producer and mini-mill. Our EAF is differentiated from the capabilities of most mini-mills by its ability to use both a continuous scrap feed and liquid iron as an alternative metallic input, rather than scrap and scrap substitutes. Compared to integrated steel production, the EAF has several advantages, including lower capital expenditures for construction of facilities, a more variable cost structure, lower energy requirements and limited ongoing maintenance and capital expenditure requirements to sustain operations. Further, the construction of the EAF with the simultaneous de-commissioning of one of our two blast furnaces significantly reduced our requirements for coke as described below.
We expect that the EAF will have an annual capacity of up to 2.5 million tons of liquid steel. Construction and installation of the EAF was completed in the fourth quarter of 2004, with the first heat occurring in November 2004.
The liquid iron that can be used as a metallic input for the EAF will be produced using our remaining blast furnace operation, providing us with additional flexibility relating to raw materials. We believe that the more variable cost structure of the EAF and flexibility in raw material input utilization will enable our costs to more closely track market conditions than those of many integrated producers and will support our margins in market downturns. From November 20, 2006 through January 2007, we discontinued operating our EAF to conserve cash. As a result of excess inventory at steel service centers leading to a decrease in demand for steel products, we decided to produce hot metal using our blast furnace and basic oxygen furnace, utilizing raw materials on hand, rather than operate our EAF which would have required additional outlays for the purchase of scrap. The EAF was restarted in February 2007.
Strategic capital projects to improve productivity and cost position
We completed installation of new automatic roll changers on the finishing mills at our hot strip mill in February 2006, which expanded our annual hot rolling capacity by 0.6 million tons to 3.4 million tons and optimizes throughput, which should result in lower costs. Supplemental slab sourcing arrangements should enable us to utilize of this incremental capacity by rolling purchased slabs and converting slabs for others into hot rolled products. Upgrades of our Yorkville tandem cold rolling mill and continuous anneal line were completed in December 2005 to enable us to gain 70,000 tons per year in production capability of cold rolled products. In addition, we plan to upgrade our temper mill and install a final inspection line at our Allenport facility. These and other improvements are intended to increase our downstream capacity and improve the quality and market penetration of our value-added cold rolled products.
Capitalize on our excess coke capacity
With our new EAF, and the idling of one of our two blast furnaces in May 2005, we had coke production capability in excess of our historical requirements.
On September 29, 2005, WPSC and SNA Carbon LLC (SNA Carbon), a wholly-owned subsidiary of Severstal North America, Inc. (SNA), entered into an Amended and Restated Limited Liability Company Agreement of MSC, a limited liability company formed to own and refurbish the coke plant facility contributed to it by WPSC and to produce and sell metallurgical coke to and for the benefit of both parties. WPSC contributed its existing coke plant facility and has contributed $8.1 million in cash to MSC through December 31, 2006. WPSC is committed to make additional cash contributions of $25.0 million to MSC during 2007. SNA Carbon has contributed $120 million in cash to MSC through December 31, 2006. WPSC and SNA Carbon each received a 50% voting interest in MSC upon formation and a 50% non-voting capital stock interest in MSC once each member contributed a total $90.0 million to MSC. Effective January 1, 2007, both parties are entitled to 50% of the coke produced by the facility.
The refurbishment project includes the rebuild of the No. 8 coke battery, construction of which began in the fourth quarter of 2005 and was substantially completed in early 2007 for a capital investment of approximately $130.0 million. The rebuild is expected to extend the service life of the battery by 12-15 years. The ongoing refurbishment project also includes additional capital investments related to the Nos. 1, 2 and 3 coke batteries, infrastructure, and certain other items.
Achieve balanced exposure to spot and contract business
We aim to achieve a balanced mix between spot and contract business. We believe that contract business, which we define as agreements with terms in excess of three months, offers insulation from the volatility of the spot market. However, contract type business also could limit upside potential in a tight market situation. A reasonable balance offers relatively predictable volumes and an opportunity to enhance product mix as well as to take advantage of spot opportunities. Currently, we have a relatively high exposure to the spot market, comprising approximately 75% of our sales. In the long-term, we seek to increase our mix of contract business to 40% by targeting sales to end use customers versus spot sales to service centers and processors. This mix is expected to provide enhanced stability in fluctuating market conditions and, at the same time, should allow us to take advantage of positive pricing in tighter markets. We will continue to target customers that purchase our products over prolonged periods of time and value consistency of supply.
Optimize the sale of downstream value-added products
We continue to seek a product mix that offers high returns and increases our stability. Our long-term strategy includes a focus on higher value-added products with higher engineering content. We will continue to identify products and markets that offer higher returns and increase stability. We believe that our new operating configuration will allow us to continue to produce a full range of products. We aim to increase our market penetration of cold rolled products through capital expenditures and changes in operating practices at our Allenport and Yorkville cold finishing mills, which are expected to result in higher quality cold rolled products. These initiatives are expected to help to further penetrate the desirable OEM marketplace.
Steel Industry Steel making in the U.S. is a highly competitive and capital-intensive industry with approximately 107 million tons of domestic shipments in 2006. Estimated domestic consumption was approximately 98 million tons in 2006 and is expected to increase in 2007. Total annual steel consumption in the U.S. was approximately 134 million tons in
2006, 114 million tons in 2005 and 127 million tons in 2004. Imports of finished steel totaled approximately 36 million tons in 2006, 25 million tons in 2005 and 28 million tons in 2004.
In the U.S., flat rolled steel is produced either by integrated steel facilities or mini-mills. Integrated steel makers typically produce flat rolled products by using blast furnaces to combine iron ore, limestone and coke into hot iron. Scrap metal is then added to the hot iron to produce liquid steel through a basic oxygen furnace (BOF), which removes impurities. After the liquid steel is metallurgically refined, it is processed through a continuous caster to form slabs. These slabs are further shaped or rolled into flat sheets at a hot strip mill or a plate mill. Various finishing processes may follow whereby the steel is treated through pickling, cold-rolling, annealing, tempering or coating.
The quality of steel products produced through the integrated process is generally more suitable for a wider variety of high quality specialized uses than those produced through the mini-mill process because less scrap, which contains impurities, is used. As a result, integrated steel products are typically used for more value-added applications. Integrated mills are also characterized by more production steps and man-hours and higher costs of productive capacity and ongoing maintenance. Current restructuring efforts by integrated steel mills have focused on reducing these costs through increased labor flexibility and efficiency and using automation to increase labor productivity.
A mini-mill utilizes an EAF to melt scrap and scrap substitutes, eliminating the need for iron ore and coke inputs. The liquid steel can be metallurgically refined before it is cast into thin slabs which are further processed in-line to produce flat sheets similar to those produced by integrated steel makers. Similar finishing processes often follow.
The quality of mini-mill produced steel products is dependent on the quality of the scrap used as a raw material. However, in recent years, domestic mini-mills have increased the quality of their steel products. Typically, mini-mills are more cost efficient than integrated producers because they require less capital to operate and maintain. The correlation of scrap prices with steel selling prices represents the main advantage of the mini-mill and EAF strategy. This correlation has historically provided a relatively constant metal margin, or the difference between steel selling prices and scrap prices, to the mini-mills over the business cycle. This relatively constant metal margin has typically caused mini-mills to perform better in downturns than integrated producers.
Industry Consolidation
The fragmented U.S. steel industry has experienced volatile market conditions, characterized by declining prices, fluctuating capacity, low demand growth and increased foreign imports. These conditions and additional constraints produced by significant underfunded pension and retiree health care obligations have led to widespread bankruptcies in the industry. Including us, over 40 companies have filed for Chapter 11 bankruptcy protection since January 1998, including Bethlehem, LTV and National Steel (formerly the second, third and fifth largest U.S. integrated steel producers) in addition to Rouge Steel, Republic Engineered Products and Weirton Steel. A number of these steel producers were purchased as a result of bankruptcy, consolidation and rationalization of the industry.
As a result of industry consolidation, the top three steel producers in the U.S. held approximately 67%, 63% and 46% of market share for flat-rolled products in 2006, 2005 and 2004, respectively.
Imports
As the single largest steel consuming country in the western hemisphere, the U.S. market has long been a focus of steel producers in Europe and Japan. Steel producers from Korea, Taiwan, Brazil and other large economies such as Russia and China recognized the U.S. as a target market. The domestic steel market is affected by factors influencing worldwide supply and demand, with excess production generally seeking the most lucrative markets. Favorable conditions in the U.S. market have historically resulted in significant imports of steel and substantially reduced sales, margins and profitability of domestic steel producers. Imports surged in 1998 due to severe economic conditions in Southeast Asia, Latin America, Japan and Russia, among others. Steel product prices reached historical cyclical lows in December 2001 as a result of low domestic demand and increased foreign imports.
As a result, the U.S. government took various protective actions during 2001 and 2002, including the enactment of various steel import quotas and tariffs under Section 201 of the U.S. Trade Act of 1974, as amended, which
contributed to a decrease of some U.S. steel imports during 2003. However, these protective measures were only temporary, and many foreign steel manufacturers were granted exemptions from applications of these measures. Following a November 2003 decision by the World Trade Organization Appellate Body declaring that the tariffs imposed by the U.S. on steel imports violated global trade rules, the steel import quotas and Section 201 tariffs were lifted in December 2003. The elimination of the protections offered by these trade remedies has lead to increased competition from foreign importers. Steel imports of flat rolled products as a percentage of domestic apparent consumption were approximately 27.6% in 2006, representing an all-time high for steel imports.
Raw Material Pricing and Steel Prices
Increased global demand, especially from mills in China, has put upward pressure on raw material prices, including iron ore, scrap, coke and coal. In particular, world iron ore prices increased by approximately 70% during 2005, and remained at those elevated levels in 2006. Shortages of coke put pressure on integrated steel producers with spot prices rising as much as $400 per ton in late 2004. Faced with higher raw material costs and increasing world demand, domestic steel producers began to both increase base prices and implement raw material surcharges starting in January 2004. This combination of factors resulted in historically high prices for steel products during 2004.
Steel prices fell from these historically high levels through the first three quarters of 2005. Steel prices began to strengthen during the fourth quarter of 2005. Steel prices rose during the first eight months of 2006 before decreasing during the last four months of the years when demand for steel products fell dramatically.
Segments and Geographic Area
We are engaged in one line of business and operate in one business segment, the making, processing and fabricating of steel and steel products. We have a diverse customer base, substantially all of which is located in the United States. All of our operating assets are located in the United States.
Products and product mix
The following table reflects our product mix as a percentage of total tons shipped.
| Year Ended | ||||||||||||
| December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Product Category: |
||||||||||||
Higher value added products as a percentage of total shipments: |
||||||||||||
Cold rolled products — trade |
5.8 | % | 6.5 | % | 8.0 | % | ||||||
Cold rolled products — Wheeling-Nisshin |
17.3 | % | 17.3 | % | 19.3 | % | ||||||
Coated products |
7.8 | % | 7.1 | % | 8.7 | % | ||||||
Tin mill products |
8.2 | % | 11.9 | % | 13.6 | % | ||||||
Fabricated products |
21.7 | % | 21.6 | % | 19.7 | % | ||||||
Higher value-added products |
60.8 | % | 64.4 | % | 69.3 | % | ||||||
Hot rolled products (including semi-finished products) |
39.2 | % | 35.6 | % | 30.7 | % | ||||||
Total |
100.0 | % | 100.0 | % | 100.0 | % | ||||||
Average net sales per ton of steel products sold |
$ | 730 | $ | 686 | $ | 661 |
Hot Rolled Products
Hot rolled coils represent the least processed of our finished goods. Approximately 61% of our production of hot rolled coils during the year ended December 31, 2006 was further processed into value-added finished products. Hot rolled black or pickled (acid cleaned) coils are sold to a variety of consumers such as converters and processors, steel service centers and the appliance industry.
Cold Rolled Products
Cold rolled coils are manufactured from hot rolled coils by employing a variety of processing techniques, including pickling, cold reduction, annealing and temper rolling. Cold rolled processing is designed to reduce the thickness and improve the shape, surface characteristics and formability of the product.
Coated Products
We manufacture a number of corrosion-resistant, zinc-coated products, including hot-dipped galvanized sheets for resale to trade accounts. The coated products are manufactured from a steel substrate of cold rolled or hot rolled pickled coils by applying zinc to the surface of the material to enhance its corrosion protection. Our trade sales of galvanized products are heavily oriented to unexposed applications, principally in the appliance, construction, service center and automotive markets.
Tin Mill Products
Tin mill products consist of blackplate and tinplate. Blackplate is a cold rolled substrate (uncoated), the thickness of which is less than .0142 inches, and is utilized extensively in the manufacture of pails and shelving and sold to OCC for the manufacture of tinplate products. Tinplate is produced by the electro-deposition of tin to a blackplate substrate and is utilized principally in the manufacture of food, beverage, general line and aerosol containers. We produce all of our tin-coated products through OCC. OCC’s tin coating mill has an annual capacity of over 250,000 tons.
Fabricated Products
Fabricated products consist of cold rolled or coated products further processed mainly via sheeting and roll forming and are sold by the construction, agricultural and specialty products groups.
Construction Products
Construction products consist of roll-formed sheets, which are utilized in sectors of the non-residential building market such as commercial, institutional and manufacturing. They are classified into three basic categories: roof deck, form deck, and composite floor deck.
Agricultural Products
Agricultural products consist of roll-formed corrugated sheets that are used as roofing and siding in the construction of barns, farm machinery enclosures, light commercial buildings and certain residential roofing applications.
Specialty Products
Specialty products consist of coil and galvanized sheet steel supporting the culvert and heating, ventilation and air conditioning markets. Specialty products are produced by Wheeling-Nisshin and Feralloy-Wheeling Specialty Processing Co.
Revenues from external customers by product line for the periods indicated below were as follows:
| Year Ended | ||||||||||||
| December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
| (Dollars in thousands) | ||||||||||||
Product: |
||||||||||||
Hot rolled |
$ | 541,794 | $ | 420,745 | $ | 365,089 | ||||||
Cold rolled |
476,555 | 471,235 | 514,511 | |||||||||
Galvanized |
150,889 | 109,264 | 132,178 | |||||||||
Fabricated products |
507,087 | 466,914 | 375,090 | |||||||||
Ore, coke and coke by products |
79,471 | 85,268 | 9,074 | |||||||||
Conversion and other (1) |
14,969 | 7,087 | 9,852 | |||||||||
| $ | 1,770,765 | $ | 1,560,513 | $ | 1,405,794 | |||||||
(1) Includes semi-finished, conversion and resale products.
Customers and Markets
We market an extensive mix of products to a wide range of manufacturers, converters and processors. Our 10 largest customers, including our Wheeling-Nisshin and OCC joint ventures, accounted for approximately 38.6%, 40.3% and 43.3% of our net sales in 2006, 2005 and 2004, respectively. Wheeling-Nisshin accounted for
approximately 14.1%, 13.9% and 17.5% of our net sales in 2006, 2005 and 2004, respectively. OCC accounted for approximately 4.4%, 8.1% and 8.6% of our net sales in 2006, 2005 and 2004, respectively. Geographically, the majority of our customers are located within a 350-mile radius of the Ohio Valley. However, we have taken advantage of our river-oriented production facilities to market via barge into more distant locations such as the Houston, Texas and St. Louis, Missouri areas.
Shipments historically have been concentrated within five major market segments: converters and processors, construction, steel service centers, containers and agriculture. Our overall participation in the construction and the converters and processors markets substantially exceeds the industry average and our reliance on automotive shipments, as a percentage of total shipments, is substantially less than the industry average.
The following table reflects the percentage of total tons shipped to our major market segments:
| Percentage of Total Tons Shipped | ||||||||||||
| Year Ended | ||||||||||||
| December 31, | ||||||||||||
| 2006 | 2005 (2) | 2004 (2) | ||||||||||
Converters and processors (1) |
39 | % | 39 | % | 35 | % | ||||||
Construction |
25 | % | 22 | % | 20 | % | ||||||
Steel service centers |
16 | % | 16 | % | 16 | % | ||||||
Containers (1) |
10 | % | 13 | % | 18 | % | ||||||
Agriculture |
4 | % | 5 | % | 4 | % | ||||||
Other |
6 | % | 5 | % | 7 | % | ||||||
Total |
100 | % | 100 | % | 100 | % | ||||||
| (1) | Products shipped to Wheeling-Nisshin and OCC are included primarily in the converters and processors and containers markets, respectively. | |
| (2) | Certain amounts reported for 2005 and 2004 have been reclassified to correspond to classifications reported for 2006. |
Set forth below is a description of our major customer categories:
Converters and Processors
Shipments to the converters and processors market are principally shipments of cold rolled products to Wheeling-Nisshin, which uses cold rolled coils as a substrate to manufacture a variety of coated products, including hot-dipped galvanized and aluminized coils for the automotive, appliance and construction markets. The converters and processors industry also represents a major outlet for our hot rolled products, which are converted into finished commodities such as pipe, tubing and cold rolled strip.
Construction
The shipments to the construction industry are heavily influenced by fabricated product sales. We service the non-residential and agricultural building and highway markets, principally through shipments of hot-dipped galvanized and painted cold rolled products. We have been able to market our products into broad geographical areas due to our numerous regional facilities.
Steel Service Centers
The shipments to steel service centers are heavily concentrated in the areas of hot rolled and hot dipped galvanized coils. Due to increased internal costs to steel companies during the 1980’s for processing services such as slitting, shearing and blanking, steel service centers have become a major factor in the distribution of hot rolled products to ultimate end users. In addition, steel service centers have become a significant factor in the sale of hot dipped galvanized products to a variety of small consumers such as mechanical contractors, who desire not to be burdened with large steel inventories.
Containers
The vast majority of shipments to the container market are concentrated in tin mill products, which are utilized extensively in the manufacture of food, aerosol, beverage and general line cans. The container industry has represented a stable market. The balance of shipments to this market consists of cold rolled products for pails and drums. We sell black plate to our OCC joint venture for tin-coating.
Agriculture
The shipments to the agricultural market are principally sales of roll-formed, corrugated sheets, which are used as roofing and siding in the construction of barns, farm machinery enclosures and light commercial buildings.
Joint Ventures
Wheeling-Nisshin
WPSC owns a 35.7% equity interest in Wheeling-Nisshin, which is a joint venture between Nisshin Steel Co., Ltd. and WPSC. Wheeling-Nisshin owns a state-of-the-art processing facility located in Follansbee, West Virginia which has capacity to produce over 700,000 tons annually of coated steel and offers some of the lightest-gauge galvanized steel products manufactured in the U.S. for construction, heating, ventilation and air-conditioning and after-market automotive applications. Wheeling-Nisshin products are marketed through trading companies.
WPSC is a party to a supply agreement with Wheeling-Nisshin that expires in 2013. Wheeling-Nisshin may terminate this agreement at any time WPSC and its subsidiaries and parent, if any, in the aggregate own less than 20% of the common stock of Wheeling-Nisshin. Pursuant to that agreement, WPSC is required to provide not less than 75% of Wheeling-Nisshin’s steel substrate requirements, up to an aggregate maximum of 9,000 tons per week, subject to product quality requirements and at negotiated prices based on prevailing actual market rates. Shipments of steel by WPSC to Wheeling-Nisshin were approximately 409,000 tons, or 17.6% of our total tons shipped in 2006; approximately 379,000 tons, or 17.5% of our total tons shipped in 2005; and approximately 413,000 tons, or 19.4% of our total tons shipped in 2004. We derived 14.1%, 13.9% and 17.5% of our net sales from sales of steel to Wheeling-Nisshin in 2006, 2005 and 2004, respectively. For the years ended December 31, 2006, 2005 and 2004, Wheeling-Nisshin had operating income of $26.8 million, $18.3 million and $42.5 million, respectively, and we received dividends of $10.7 million, $5.0 million in 2005 and $2.5 million in 2004 from Wheeling-Nisshin. As of December 31, 2006, Wheeling-Nisshin had cash and investment securities totaling $71.7 million and had no outstanding indebtedness.
A shareholders agreement between WPSC and Nisshin Steel Co., Ltd. contains provisions that may directly or indirectly restrict the transfer of the shares of Wheeling-Nisshin owned by WPSC, including the following:
| • | WPSC may not sell its Wheeling-Nisshin shares at any time that it is in breach of the shareholders agreement or any other agreement with Wheeling-Nisshin, including the supply agreement. | |
| • | If WPSC seeks to sell some or all of its Wheeling-Nisshin shares, it must first offer to sell, transfer or assign the offered shares to the other Wheeling-Nisshin shareholder. |
In addition, WPSC has pledged its shares in Wheeling-Nisshin to the lenders under our term loan agreement and revolving credit facility, and to the holders of our Series A notes and Series B notes.
Ohio Coatings Company
WPSC owns a 50% voting interest and an approximately 44% equity interest in OCC, which is a joint venture among WPSC, Dong Yang Tinplate America Corp., a leading South Korea-based tin plate producer, and Nippon Steel Trading America, Inc., formerly known as Nittetsu Shoji America, Inc., a U.S.-based tinplate importer. Dong Yang Tinplate America also holds a 50% voting interest and an approximately 44% equity interest in OCC. Additionally, Nippon Steel Trading America holds nonvoting preferred stock in OCC, which represents an approximately 11% equity interest in OCC and is subject to repurchase by OCC. OCC commenced commercial operations in January 1997.
Pursuant to a raw material supply agreement between WPSC and OCC, WPSC has the right to supply up to 230,000 net tons in any calendar year of the blackplate and cold rolled steel requirements of OCC through 2012, subject to quality requirements and at negotiated prices based on prevailing market rates. OCC may terminate this agreement
if at any time WPSC owns less than 33% of the common stock of OCC. Shipments of steel by WPSC to OCC were approximately 129,000, or 5.5% of our total tons shipped in 2006; 207,000 tons, or 9.6% of our total tons shipped in 2005; and approximately 240,000 tons, or 11.3% of our total tons shipped in 2004. We derived approximately 4.4%. 8.1% and 8.6% of our net sales from sales of steel to OCC in 2006, 2005 and 2004, respectively. Prior to July 2003, WPSC was the exclusive distributor for all of OCC’s products and marketed approximately 70% of OCC’s products through Nippon Steel Trading America. In July 2003, Nippon Steel Trading America became the exclusive distributor for approximately 70% of OCC’s products and WPSC remained a distributor for the balance. In April 2004, OCC began selling to certain customers directly, which reduced WPSC’s distributorship to approximately 20% of OCC’s products. WPSC ceased distributing any OCC product in 2005. For the years ended December 31, 2006, 2005 and 2004, OCC had operating income of $5.2 million, $6.9 million and $8.0 million, respectively. OCC did not pay any dividends during those periods. At December 31, 2006, OCC had $22.5 million in outstanding indebtedness.
A shareholders’ agreement among WPSC, Dong Yang Tinplate America, Nippon Steel Trading America and OCC contains certain provisions that may restrict WPSC’s ability to transfer its shares of OCC, including the following:
| • | Any pledge, transfer or other distribution of shares of OCC must be previously approved by shareholders holding at least 66.67% of the voting power of the common shares of OCC. | |
| • | For 45 days after a shareholder receives notice from the other party that a change of control of the other party has occurred, the party receiving notice has the option to purchase all, but not less than all, of the shares owned by the other party at a price equal to $10,000 per share plus 10% interest or fair market value, whichever is higher. For purposes of the shareholders’ agreement, ‘‘change of control’’ for WPSC means, the transfer to persons (other than a holding company) of a majority of the capital stock of WPSC, or any transfer of substantially all of its assets. |
WPSC has pledged its shares in OCC to the lenders under our term loan agreement and revolving credit facility, and to the holders of our Series A notes and Series B notes.
Pursuant to a loan agreement dated January 8, 1996, WPC loaned OCC $16.5 million. The loan bears interest at a variable rate that currently approximates 7.1%. As of December 31, 2006, OCC owed $5.6 million under the loan.
In April 2006, OCC entered into a four-year credit agreement with Bank of America, N.A., providing for a revolving line of credit for loans and letters of credit in an amount of up to $20.0 million and a term loan in the aggregate principal amount of $4.2 million. OCC is restricted from declaring dividends under the terms of its credit agreement. However, OCC is permitted to make distributions of interest and principal in respect of its indebtedness to WPC, subject to certain limitations set forth in the credit agreement and in the subordination agreement described below. OCC has made principal payments in each of the last four years. In connection with this refinancing, WPC (i) entered into a subordination agreement, acknowledging that amounts owed by OCC to WPC pursuant to the loan agreement described in the previous paragraph are subordinate to any indebtedness owed by OCC to Bank of America under OCC’s term loan agreement; and (ii) WPSC entered into a no-offset agreement, agreeing that it will not offset against accounts payable to OCC any indebtedness of OCC to WPSC.
Mountain State Carbon
In September 2005, WPSC and SNA Carbon entered into an Amended and Restated Limited Liability Company Agreement of MSC. MSC is a Delaware limited liability company which was formed to own and refurbish coke batteries contributed to it by WPSC and to produce and sell the coke produced by these batteries for the benefit of WPSC and SNA Carbon. WPSC and SNA Carbon concurrently executed various agreements, including management and operating agreements, pursuant to which WPSC will operate and manage MSC’s coke facilities, and various coke supply agreements.
WPSC contributed to MSC its coke-producing batteries and related facilities and assets located in Follansbee, West Virginia, and Steubenville, Ohio, which had a fair value of approximately $86.9 million and SNA Carbon contributed capital of $50.0 million to MSC. In return for these initial contributions, WPSC and SNA Carbon each received 50% of MSC’s voting capital stock interests, which allow WPSC and SNA Carbon each to elect two of the four Managers on MSC’s Board of Managers. During the period from inception to December 31, 2006, WPSC and
SNA Carbon contributed and additional $8.1 million and $70.0 million in cash to MSC, respectively. WPSC and SNA Carbon each received a 50% non-voting capital stock interest in MSC once each member had contributed a total of $90.0 million to MSC. Contributions in excess of $90.0 million had no effect on WPSC’s or SNA Carbon’s non-voting capital interest in MSC. WPSC is obligated to make additional cash contributions of $25.0 million to MSC during 2007. No further capital contributions are anticipated.
Subject to certain exceptions, WPSC and SNA Carbon also are obligated to make loans to MSC from time to time, up to $35.0 million in the aggregate for all such loans, to satisfy any deficiency in MSC’s working capital needs. These loans are to be made by WPSC and SNA Carbon proportionate to their respective projected coke purchases. WPSC made a working capital loan of $9.9 million to MSC during 2005, of which $5.4 million was repaid during 2006. Because coke prices charged by MSC will be at its fully absorbed costs (including depreciation, a non-cash expense), plus a stipulated profit, it is projected that MSC will not have a significant need for such sources of working capital beyond 2007.
If either WPSC or SNA Carbon breaches any of its funding obligations, the defaulting party’s non-voting capital stock interests could be diluted, and the quantity of coke that MSC would be obligated to sell to the defaulting party could be permanently reduced. SNA has guaranteed SNA Carbon’s funding obligations. If SNA Carbon’s non-voting capital stock interests are diluted, WPSC would have the right to dilute SNA Carbon’s voting capital stock interests, in which event WPSC would control MSC’s Board of Managers. WPSC’s voting capital stock interests may not be diluted below 50% under any circumstances.
WPSC and MSC executed a Coke Supply Agreement in September 2005 (the WPSC Coke Supply Agreement), pursuant to which MSC was required to sell to WPSC all coke produced by MSC during 2005 and up to 600,000 tons of coke in 2006. SNA Carbon and MSC separately executed a Coke Supply Agreement in September 2005 (the SNA Carbon Coke Supply Agreement), pursuant to which MSC was required to sell to SNA Carbon 355,000 tons of coke in 2006. Beginning in 2007, WPSC and SNA Carbon will each purchase, under their respective coke supply agreements with MSC, 50% of MSC’s total production of coke, allocated on a weekly basis. WPSC and SNA Carbon may cause a reduction of the amount of coke that MSC is required to sell to the other party if the other party defaults in its funding obligations to MSC. All coke sold to WPSC and SNA Carbon under the coke supply agreements is required to meet certain specifications.
Coke prices charged by MSC pursuant to the WPSC Coke Supply Agreement and the SNA Carbon Coke Supply Agreement are set so as to cover all of MSC’s fully absorbed production and administrative costs, less demolition costs and any by-product revenue, plus a 5% mark-up. MSC’s excess operating cash must first be used to repay any outstanding debt to WPSC and SNA Carbon.
WPSC is paid a fee and manages and operates MSC’s coke facilities using its current hourly and salaried workforce, subject to ultimate oversight by MSC’s Board of Managers, under its management and operating agreements. WPSC retained environmental obligations related to the operation and condition of the facilities prior to September 29, 2005, and has agreed to indemnify SNA Carbon and MSC against any environmental liabilities related to or arising out of the condition of the real property contributed by WPSC to MSC. MSC has agreed to indemnify WPSC and SNA Carbon against liabilities arising in connection with the management or ownership of MSC.
For the year ended December 31, 2006, MSC had an operating loss of $1.2 million and for the period September 29, 2005 through December 31, 2005, MSC had an operating loss of $1.5 million. At December 31, 2006, MSC had operating cash of $11.2 million and had a member loan due to WPSC of $4.5 million, which bears interest at the prime rate plus 1.25%.
Other Joint Ventures
WPSC owns 49% of the outstanding common stock of Feralloy-Wheeling Specialty Processing, Co. (Feralloy) and 50% of the outstanding common stock of Jensen Bridge and Roofing Company, LLC (Jensen Bridge). Neither of these joint ventures are material, individually, or in the aggregate.
Under generally accepted accounting principles, Wheeling-Nisshin, OCC, Feralloy and Jensen Bridge are accounted for using the equity method of accounting. MSC has been consolidated in our financial statements from inception
through December 31, 2006. As a result of additional capital contributions made to MSC by SNA Carbon during 2006, increasing their non-voting economic capital stock interest in the joint venture to 50.0%, and due to the fact that all coke production subsequent to 2006 will be sold to each joint venture partner on an equal basis, MSC will be deconsolidated effective January 1, 2007.
Competition
We believe that the main competitive factors in our market are:
| • | quality; | |
| • | reliability; | |
| • | product market price; | |
| • | product offerings; | |
| • | location and shipping costs; and | |
| • | raw material and operating costs. |
The steel industry is cyclical in nature and has been marked historically by global overcapacity, resulting in intense competition, which we expect to continue. Many of our competitors are large, with the top three domestic steel-producers holding approximately 67% of market share for flat-rolled products in 2006. We believe our major competitors include the following:
| • | domestic integrated steel producers, such as United States Steel Corporation, Mittal Steel USA, Inc., AK Steel Corporation and SNA; | |
| • | mini-mills, such as Nucor Corporation, Steel Dynamics Inc. and Gallatin Steel Company; | |
| • | converters and fabricators, such as The Techs, Winner Steel, Inc., United Steel Deck and Metal Sales; and | |
| • | steel producers from Europe, Asia and other regions. |
Domestic integrated steel producers have lost market share in recent years to domestic mini-mill producers, culminating in mini-mill production currently exceeding integrated production. Mini-mills are generally smaller-volume steel producers that melt ferrous scrap metals, their basic raw material, in electric furnaces. Mini-mills rely on less capital-intensive steel production methods, typically have certain advantages over integrated producers, such as lower capital expenditures for construction of facilities, a more variable operating cost structure, and limited ongoing capital needs to sustain operations. These mini-mills now compete with integrated producers in virtually all product lines, including flat-rolled and value added products, and since mini-mills typically are not unionized, they have more flexible work rules that have resulted in lower employment costs per net ton shipped.
We also face competition from domestic and foreign integrated producers. The increased competition in commodity product markets influence integrated producers to increase product offerings to compete with our custom products. Additionally, as the single largest steel consuming country in the western world, the U.S. has long been a focus of steel producers in Europe and Japan. Steel producers from Korea, Taiwan, Brazil, and other large economies such as Russia and China have also recognized the U.S. as a target market.
We also compete to some extent with producers of other materials that can be used in place of steel. A number of steel substitutes, including plastics, aluminum, composites and glass, have reduced the growth of domestic steel consumption.
Sales and Marketing
Our sales and marketing functions are principally located in our Wheeling, West Virginia headquarters. Our sales force consists of two distinct sales groups: our steel division and WCC, our corrugating division. Steel division products include, in ascending value-added order, hot rolled, cold rolled, galvanized steel products and tin mill products. Historically, there have been improved margins within each category because selling prices increase and cost absorption is enhanced as steel is processed from hot rolled to cold rolled to galvanized. WCC is divided into three product groups, including construction products, agricultural products and specialty products. WCC’s product groups are generally higher value-added than those of our steel division.
Manufacturing Process
With the commissioning of our EAF, along with the idling of one of our two blast furnaces, we have transformed our operations from a pure integrated producer to a hybrid producer of steel with characteristics of both an integrated producer and mini-mill, producing liquid steel with both our EAF and our BOF.
Utilizing both electric energy and oxygen injection, the EAF melts recycled scrap and scrap substitutes to produce liquid steel. In addition, we believe that the EAF will be able to use liquid iron as a metallic input, which can be produced using our remaining blast furnace, providing us with additional flexibility relating to raw materials. The continuous process also includes a reliable scrap preheating system to reduce electric power requirements. We believe the higher portion of variable costs of the EAF and flexibility in raw material input utilization will produce a cost structure that more closely tracks market conditions and will support our margin in market downturns.
In our integrated steel making process, iron ore pellets, coke, limestone and other raw materials are consumed in the blast furnace to produce hot metal. Hot metal is further converted into liquid steel through our BOF process where impurities are removed, recycled scrap is added and metallurgical properties for end use are determined on a batch-by-batch (heat) basis.
Heats of liquid steel are sent to the ladle metallurgy facility from both the EAF and BOF, where the temperature and chemistry of the steel are adjusted to precise tolerances. Liquid steel from the ladle metallurgy facility then is formed into slabs through the process of continuous casting. After continuous casting, slabs are reheated, reduced and finished by extensive rolling, shaping, tempering and, in certain cases, by the application of coatings at our downstream operations. Finished products are normally shipped to customers in the form of coils or fabricated products. We have linked our steel making and rolling equipment with a computer based manufacturing control system to coordinate production tracking and status of customer orders.
Raw Materials
In 2004, we entered into a long-term supply agreement for scrap based on prevailing market prices, with an initial term expiring in April 2009. The agreement is designed to provide us with an adequate and reliable source of scrap for our EAF operations. The scrap supply agreement does not require us to make any minimum purchases, and we believe that we have access to alternative supplies of scrap, if necessary. Under the agreement, the supplier has constructed a scrap handling facility to enable it to provide us with the scrap contemplated by the agreement. The introduction of our EAF has increased our dependence on external scrap and scrap alternatives from approximately 25% of our steel melt in 2004 to approximately 60% of our steel melt in 2006.
We have long-term contracts to purchase our iron ore requirements. The iron ore price under our primary contract is based upon prevailing world market prices, less 3%. With our new EAF and a single blast furnace operation, we consumed approximately 1.6 million gross tons of iron ore pellets in our blast furnace during 2006.
We have long-term supply agreements with third parties to provide us with a substantial portion of the metallurgical coal to meet the requirements of MSC at specified contract prices, which are subject to adjustment at stated times during the term of the contracts. Several of these suppliers have reduced required shipments claiming force majeure prohibited shipments, which led to depleted coal inventory levels, substantially increased costs to purchase metallurgical coal from alternative sources and at times reduced production levels. MSC’s coking operations require a substantial amount of metallurgical coal. Through MSC, we currently produce substantially all of our coke requirements and burn the resultant by-product coke oven gas in downstream operations. In 2006, we and MSC consumed approximately 1.1 million tons of coking coal to produce approximately .7 million tons of blast furnace coke.
Beginning in 2003 and continuing into 2006, coal, coke and scrap prices increased for purchases in the spot market. We are passing these costs through to our customers when possible.
Our operations require significant amounts of other raw materials, including zinc and natural gas. These raw materials are readily available and are purchased on the open market. The cost of these materials has been susceptible in the past to price fluctuations, but worldwide competition in the steel industry has frequently limited the ability of steel producers to raise finished product prices to recover higher material costs. However, the rapid economic expansion in China, among other factors, has affected the supply of steel in the U.S. and allowed price
increases to offset higher raw material costs. Certain of our raw material supply contracts provide for price adjustments in the event of increased commodity or energy prices. Zinc prices rose dramatically during 2006, increasing by approximately 120% as compared to 2005 prices. Natural gas prices have been volatile in the past, having increased 6% in 2006, 37% in 2005 and 1% in 2004.
Energy
During 2006, coal constituted approximately 65% of our total energy consumption, natural gas 25% and electricity 10%. Many of our major facilities that use natural gas are equipped to use alternative fuels. As production from our EAF increases, electricity consumption, as a percentage of our total energy consumption, will increase.
Backlog
Our backlog was 336,234 tons at December 31, 2006, as compared to 457,778 tons at December 31, 2005. Most orders related to the backlog at December 31, 2006 are expected to be shipped during the first quarter of 2007, subject to delays at customers’ requests. The order backlog represents orders received but not yet completed or shipped. In times of strong demand, a higher order backlog may allow us to increase production runs, thereby enhancing production efficiencies.
Environmental Matters
We, like all other steel producers, are subject to numerous federal, state and local laws and regulations relating to the protection of the environment. These laws are constantly evolving and have become increasingly stringent. We are involved in a number of environmental remediation projects relating to our facilities and operations, and may in the future become involved in more remediation projects. While we reserve for costs relating to such projects when the costs are probable and estimable, those reserves may need to be adjusted as new information becomes available, whether from third parties, new environmental laws or otherwise. Total accrued environmental liabilities amounted to $10,511 and $9,872 at December 31, 2006 and 2005, respectively. These accruals were based on all information available to the Company. Unless stated above, the time frame over which these liabilities will be satisfied is presently unknown. Further, the Company considers it reasonably possible that it could ultimately incur additional liabilities relative to the above exposures of up to $5,000.
The ultimate impact of complying with environmental laws and regulations is not always clearly known or determinable because regulations under some of these laws have not yet been promulgated or are undergoing revision. Except as expressly noted above we do not anticipate any material impact on our recurring operating costs or future profitability as a result of our compliance with current environmental regulations. Moreover, because all domestic steel producers operate under the same set of federal environmental regulations, we believe that we are not competitively disadvantaged by its need to comply with these regulations.
For a further discussion of Environmental Matters, See Item 3 “Legal Proceedings”.
Employees
At December 31, 2006, we had 3,133 employees of whom 2,418 were represented by the USW, 84 were represented by other unions, 606 were salaried employees and the remaining 25 were non-union operating employees. WPC, WPSC and the USW negotiated a new labor agreement, which became effective upon the date of reorganization and which expires on September 1, 2008. The labor agreement includes, among other things, provisions regarding wages, health care and pension benefits, profit sharing and employee security, and a retirement incentive program pursuant to which 650 hourly personnel accepted early retirement incentives in August 2003.
Cautionary Statement Concerning Forward-Looking Statements
This annual report on Form 10-K contains statements that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that may be identified by their use of words like “anticipates”, “believes”, “estimates”, “expects”, “intends”, “plans”, “projects”, “targets”, “can”, “could”, “may”, “should”, ‘will”, “would” or similar expressions and the negative, thereof, and may contain projections or other statements regarding future events or our future financial performance that involve risks and uncertainties.
You are cautioned that these forward-looking statements are based on our current expectations and projections about future events, and are subject to various risks and uncertainties, some of which are beyond our control, that could cause actual results to differ materially from those projected in these forward-looking statements. In light of the risks and uncertainties, there can be no assurance that the forward-looking information will in fact prove to be
accurate. We have undertaken no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. See Item 1A. — “Risk Factors”.
Available Information
We maintain an Internet Website http://www.wpsc.com. We make available free of charge under the “Financial Reports” heading on our website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after providing such information electronically to the Securities and Exchange Commission (SEC). In addition, we also make available free of charge under the “Investor Relations” heading on our website, the Company’s audit committee, compensation committee, nominating and corporate governance committee, executive committee, safety and environmental committee and finance committee charters, as well as, the Company’s corporate governance guidelines, code of business conduct, whistleblower policy, and policy on trading of securities. You also may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, District of Columbia 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site at www.sec.gov, which contains reports, proxy information and information statements and other information regarding issuers like us, which file electronically with the SEC.
Item 1A. Risk Factors
If any of the following risks actually occurs, our business, financial condition or results of operations could be harmed and the market price of our stock could be adversely affected. See the information under the caption “Cautionary Statement Concerning Forward-looking Statements” in Item 1 — “Business”.
We emerged from Chapter 11 bankruptcy reorganization in August 2003, have sustained losses in the past and may not be able to achieve profitability on a consistent basis.
Because we emerged from bankruptcy on August 1, 2003 and have incurred losses in the past, we cannot assure you that we will be able to achieve profitability on a consistent basis in the future. We have sought protection under Chapter 11 of the Bankruptcy Code twice since 1985, most recently in November 2000. We emerged from our more recent Chapter 11 bankruptcy reorganization as a new reporting entity on August 1, 2003. Prior to and during this reorganization, we incurred substantial net losses.
We reported a net loss of $39.0 million for the five months ended December 31, 2003 following our emergence from bankruptcy, net income of $62.2 million for the year ended December 31, 2004, a net loss of $33.8 million for the year ended December 31, 2005, and net income of $6.5 million for the year ended December 31, 2006. If we cannot achieve profitability on a consistent basis, our liquidity may be adversely affected and threaten our ability to continue operations.
We may not be able to comply with our financial covenants, which may result in a default under our credit agreements.
We are subject to certain financial covenants contained in our credit agreements. Our term loan agreement required us to maintain certain leverage, interest coverage and fixed charge coverage ratios. In March 2006, our term loan lenders and the Loan Board agreed to waive compliance with these ratios through the quarter ending June 30, 2007. Through March 16, 2007, the term loan agreement, as amended, required us to maintain minimum borrowing availability of at least $50.0 million under our revolving credit facility at all times or to maintain a minimum fixed charge ratio. Our revolving credit facility also required us to maintain minimum borrowing availability of at least $50.0 million at all times or to comply with a minimum fixed charge coverage ratio.
On March 16, 2007, the revolving credit agreement was amended to allow us to access collateral in excess of the $225.0 million commitment under the facility. If the minimum fixed charge coverage ratio is not met by us at the end of any quarter and excess collateral, as defined by the agreement, is available, we will be able to access up to $45.0 million of such excess collateral over and above the $225.0 million commitment amount and we will be required to maintain at least $50.0 million of borrowing availability at all times. Provided that sufficient collateral will support such borrowings, we will be permitted to borrow up to $220.0 million under the facility. The incremental amount of
borrowing availability of up to $45.0 million will decrease by $5.0 million each quarter commencing with the fourth quarter of 2007 through the second quarter of 2008, and will be limited, thereafter, to up to $25.0 million through, but not beyond, November 1, 2008. On this date and thereafter, the previous requirement that we maintain minimum borrowing availability of $50.0 million at all times without access to collateral beyond the $225.0 million amount of the facility, or to maintain a minimum fixed charge coverage ratio, will again be applicable. The amendment also provides for lender approval for the issuance of $50.0 million of convertible debt and an increase in the annual amount of permitted capital expenditures.
Effective March 16, 2007, the term loan agreement was amended to waive compliance with the requirement to maintain minimum borrowing availability of $50.0 million at all times or to maintain a minimum fixed charge coverage ratio. The agreement was further amended to eliminate the leverage and interest coverage ratios for the duration of the agreement. In place of these covenants, a standalone fixed charge coverage ratio will take effect for the second quarter of 2008 and thereafter. To effect the amendment, we agreed to use the proceeds from the issuance of $50.0 million of convertible debt to make a principal prepayment of $37.5 million under our term loan agreement, representing satisfaction of the next six quarterly principal payments due under the term loan agreement and to use the remaining proceeds for general corporate purposes. We also agreed to amend the existing $12.5 million standby letter of credit, previously posted in favor of the term loan lenders, to $11.0 million to cover interest payment obligations to April 1, 2007. The letter of credit will decline as such interest payments are made. The term loan lenders and Loan Board also agreed to waive the excess cash flow mandatory repayment provisions of the agreement, increase the annual amount of permitted capital expenditures for 2007 and 2008, increase the amount of permitted indebtedness, and provide various administrative amendments with regard to activities related to MSC. The amendment also provides authorization for us to merge with Esmark. As part of the amendment, we also agreed, subject to consummation of the merger with Esmark, to repay or refinance the term loan in full on the later of April 1, 2008 or the date of such consummation and to release the Loan Board of any further obligation under the Federal guarantee as well as the West Virginia Housing Development Fund, the State guarantor, of any further obligation under the state guarantee. In the event that the merger with Esmark is not consummated, we agreed to change the final maturity date of the loan from August 1, 2014 to August 1, 2010.
Our ability to comply with these financial covenants will depend on our future financial performance, which will be subject to prevailing economic conditions and other factors beyond our control. Our failure to comply with these covenants would result in a default or an event of default, permitting the lenders to accelerate the maturity of our indebtedness under the credit agreements and to foreclose upon any collateral securing our indebtedness.
In the event that additional modifications or waivers are necessary under our credit agreements, and these additional modifications and waivers are not obtained by us, an event of default will occur. If the event of default results in an acceleration of our term loan or our revolving credit facility, such event would also result in the acceleration of substantially all of our other indebtedness pursuant to cross-default or cross-acceleration provisions. If the indebtedness under our term loan, the revolving credit facility and our other debt instruments were to be accelerated, there can be no assurance that our assets would be sufficient to repay in full such indebtedness.
In addition, if we fail to reasonably demonstrate compliance with the financial covenants contained in our credit agreements and we receive a going-concern opinion from our independent registered public accounting firm with respect to our annual audited financial statements, such failure will constitute an event of default under our credit agreements.
Restrictive covenants in our debt instruments may limit our flexibility and our ability to implement our business plan.
Our credit agreements contain restrictive financial and operating covenants, including, but not limited to, provisions that limit our ability to make capital expenditures, incur additional indebtedness, create liens, make investments, sell assets and enter into transactions with affiliates. In addition, our debt instruments may not provide us with sufficient flexibility to permit us to make all necessary capital expenditures and take other measures that we believe are necessary to run our business effectively and to achieve our business plan. If we are unable to make necessary capital expenditures as a result of these covenants, our competitive position could be adversely affected which could ultimately affect our financial performance.
We may not be viable as a stand alone company if we are unable to find a strategic partner.
We believe for us to be viable as a stand alone company that we need to find a strategic partner, including Esmark, or if that merger fails, another strategic partner, in order to achieve benefits such as economies of scale, greater access to markets for our products, greater access to raw materials, or greater access to financial resources.
Because we are significantly leveraged, we may not be able to successfully run our business, service our debt obligations or refinance our indebtedness.
We are significantly leveraged. Because we are significantly leveraged, it may be difficult for us to successfully run our business and to generate sufficient amounts for necessary capital expenditures. In addition, if we do not generate sufficient operating cash flow, we may not be able to meet our debt service obligations. As of December 31, 2006, our current assets totaled $400.5 million, including $212.2 million of inventory, and our current liabilities totaled $327.5 million. As of December 31, 2006, our total indebtedness was $397.1 million and total shareholders’ equity was $286.2 million. Based on our total indebtedness as of December 31, 2006, we expect that our total debt service obligations (including scheduled principal and interest payments and an $18.7 million prepayment under our term loan agreement for scheduled principal payments originally due in 2008) will approximate $77.8 million (assuming a blended interest rate of 6.8% per annum) in 2007 and that our debt service obligations related to variable interest rate debt will increase $2.5 million on an annual basis for each 1.0% increase in interest rates.
Our ability to meet our ongoing debt service obligations will depend on our ability to successfully run our business, including the successful operation of our EAF, and a number of other factors, including factors beyond our control. We may not be able to generate sufficient operating cash flow to repay, when due or earlier if accelerated due to an event of default, the principal amounts outstanding under our primary credit facilities which have a final maturity as early as 2008 in the case of our term loan and 2009 in the case of our revolving credit facility. We expect that we will be required to refinance such amounts as they become due and payable; however, we may not be able to consummate such refinancing to repay our obligations or to secure a refinancing on terms satisfactory to us. If we are unable to refinance all or any significant portion of our indebtedness, we may be required to sell assets or equity interests in our company. However, we may not be able to sell assets or equity interests in an amount sufficient to repay our obligations or on terms satisfactory to us. Our leverage, together with the restrictions imposed by our credit agreements, may limit our ability to obtain additional financing and to take advantage of business opportunities that may arise. In addition, this leverage increases our vulnerability to adverse general economic and steel industry conditions.
Intense competition in the steel industry and substitute materials could adversely affect our results of operations, and ultimately, our liquidity, financial condition and the trading price of our common stock.
Competition within the steel industry, both domestic and worldwide, is intense and is expected to remain so in the future. We compete with domestic steel producers, steel processors, mini-mills and foreign importers. Mini-mills typically enjoy certain competitive advantages, such as more variable raw material costs that tend to rise and fall in tandem with steel selling prices, non-unionized work forces with lower employment costs and more flexible work rules, and lower ongoing maintenance and capital expenditure needs for construction and operation of their steel-making facilities. Additionally, mini-mills now compete with integrated producers in virtually all product lines, which has provided a competitive alternative to most of the steel products that we produce. Furthermore, many of our competitors have superior financial resources or more favorable cost structures, and we may be at a competitive disadvantage. In addition, it is also possible that competitive pressures resulting from the industry trend toward consolidation could adversely affect our growth and profit margins. Moreover, steel products may be replaced to a certain extent by other substitute materials, such as plastic, aluminum, graphite, composites, ceramics, glass, wood and concrete. Our competitors may be successful in capturing our market share, and we may be required to reduce selling prices in order to compete. Reduced selling prices could adversely impact our results of operations and, ultimately, our liquidity, financial condition and the trading price of our common stock.
Increased imports from China or other countries could lower domestic steel prices and adversely affect our revenue, profitability and cash flow.
We sell steel almost exclusively in the U.S. market. The domestic steel market is affected by factors influencing worldwide supply and demand, with excess global production generally seeking the most lucrative markets. In particular, the balance of supply and productive capacity in China may result in increased imports to the U.S. market. During several years prior to 2003, favorable conditions in the U.S. market compared to the global markets resulted in significant imports of steel and substantially reduced sales, margins and profitability of domestic steel producers, leading to imposition of import quotas and tariffs under Section 201 of the U.S. Trade Act of 1974, as amended. In 2004, the convergence of the weakened U.S. dollar, increased demand for steel and raw materials in China and other developing countries, and higher raw material and ocean freight costs, led to substantial increases in steel selling prices, even though the Section 201 tariffs were lifted in December 2003.
Total and finished imports for 2006, as compared to 2005, increased by approximately 42%. Changes in the U.S.
dollar exchange rate, a decrease in demand for foreign steel in China and certain other developing countries, improved domestic steel production in those countries, lower ocean freight costs and other factors could lead to sustained high, or even higher, levels of imports in the future resulting in excess domestic steel capacity and lower prices for our products, and may have an adverse affect on our revenue, profitability and cash flow.
The cyclical nature of the industries we serve may cause significant fluctuations in the demand for our products and lead to periods of decreased demand.
Demand for most of our products is cyclical in nature and sensitive to general economic conditions. Our business supports cyclical industries such as the appliance and construction industries. In addition, a substantial portion of our sales are made at prevailing market prices rather than under long-term agreements, which we define as contracts exceeding three months. As a result, downturns in the U.S. or global economies or in any of the industries we support could adversely affect the demand for and selling prices of steel, which could have an adverse effect on our results of operations and cash flows.
We may not be able to sustain our level of total revenue or rate of revenue growth, if any, on a quarterly or annual basis. It is likely that, in some future quarters, our operating results may fall below our targets and the expectations of stock market analysts and investors. In such event, the trading price of our common stock could decline significantly.
We may be unsuccessful in increasing the production of our electric arc furnace, which would adversely affect our near-term and long-term financial performance.
Our business plan depends, in part, on the successful operation of, and an increase in production from, our EAF. Our inability to successfully manage the operation of the EAF and to increase production at the EAF could make it difficult to implement our long-term business strategy and could have an adverse effect on our near-term and long-term financial performance.
From November 20, 2006 through January 31, 2007, we discontinued operating our EAF to conserve cash. As a result of excess inventory at steel service centers leading to a decrease in demand for steel products, we decided to produce hot metal using our blast furnace and basic oxygen furnace, utilizing raw materials on hand, rather than operate our EAF which would have required additional outlays for the purchase of scrap. The EAF was restarted in February 1, 2007.
Any decrease in the availability, or increase in the cost, of steel slabs could adversely affect our production and sale of steel products or increase our costs.
In February 2006, we completed installation of hot strip mill automatic roll changers at our primary steel-making facility. As a result, we increased our hot rolling capacity from 2.8 million tons per year to 3.4 million tons per year. Our business plan depends, in part, on increasing the production and sale of steel products. Our inability to successfully source steel slabs from third party suppliers could adversely affect the volume of our steel production and the sale of steel products and an increase in the cost of third party steel slabs could adversely affect our cost to produce steel, both of which could have an adverse effect on profitability, liquidity and financial condition.
Any decrease in the availability, or increase in cost, of raw materials and energy could materially increase our costs and adversely impact our cash flow and liquidity.
Our operations depend heavily on various raw materials and energy resources, including iron ore, coal used in our coke plant joint venture, scrap, steel slabs, zinc, electricity, natural gas and certain other gases. The availability of raw materials and energy resources could decrease and their prices may be volatile as a result of, among other things, changes in overall supply and demand levels and new laws or regulations. Any disruption in the supply of our raw materials or energy resources may impair, at least temporarily, our ability to manufacture some of our products, or require us to pay higher prices in order to obtain these raw materials from other sources. In the event our raw material and energy costs increase, we may not be able to pass these higher costs on to our customers in full or in part. Any increases in the prices for raw materials or energy resources may materially increase our costs and lower our earnings and adversely impact our cash flow and liquidity.
We also rely on a limited number of suppliers for a substantial portion of our raw material needs, such as iron ore, and scrap, as well as metallurgical coal for our coke plant joint venture, all of which are required to meet certain technical specifications. Any failure of these suppliers to meet our needs for any reason could have an adverse effect on our financial results and operating performance. During 2003 through 2006, we experienced disruptions
in the supply of coal from our two largest suppliers. This led to depleted coal inventory levels, which substantially increased costs to purchase metallurgical coal from alternative sources, adversely affecting our operating results. Additional disruptions would cause our coke plant joint venture to purchase additional coal on the spot market, which may increase our coke costs and adversely impact our financial condition, results of operations and liquidity. We have also experienced, and continue to experience, problems associated with the supply of scrap from our long-term scrap supplier. We believe that we have access to alternative supplies of scrap, if necessary.
We rely on a core group of significant customers for a substantial portion of our net sales, and a reduction in demand, or inability to pay, from this group could adversely affect our total revenue.
Although we have a large number of customers, sales to our two largest customers, our Wheeling-Nisshin and OCC joint ventures, accounted for approximately 18.5% of our sales for the year ended December 31, 2006 and 22.0% of our net sales for the year ended December 31, 2005. Sales to our 10 largest customers, including to Wheeling-Nisshin and OCC, accounted for 38.6 % of our net sales for the year ended December 31, 2006 and 40.3% of our net sales for the year ended December 31, 2005. We are likely to continue to depend upon a core group of customers for a material percentage of our net sales in the future. Our significant customers may not order steel products from us in the future or may reduce or delay the amount of steel products ordered. Any reduction or delay in orders could negatively impact our revenues. If one or more of our significant customers were to become insolvent or otherwise were unable to pay us for the steel products provided, our results of operations would be adversely affected.
We may not be able to implement our business plan because we may be unable to fund the substantial ongoing capital and maintenance expenditures that our operations require.
Our operations are capital intensive. We require capital for, among other purposes, acquiring new equipment, maintaining the condition of our existing equipment and maintaining compliance with environmental laws and regulations. Our business plan provides that capital expenditures for the three-year period ending December 31, 2009 will aggregate approximately $169.0 million, excluding capital expenditures to be made to complete the refurbishment of the coke plant facility that we contributed to our coke plant joint venture, MSC. We may not be able to fund our capital expenditures from operating cash flow and from the proceeds of borrowings available for capital expenditures under our credit facilities. If we are unable to fund our capital requirements, we may be unable to implement our business plan, and our financial performance may be adversely impacted.
A significant interruption or casualty loss at any of our facilities could increase our production costs and reduce our sales and earnings.
Our steel-making facilities may experience interruptions or major accidents and may be subject to unplanned events such as explosions, fires, inclement weather, acts of God, terrorism, accidents and transportation interruptions. Any shutdown or interruption of a facility would reduce the production from that facility, which could substantially impair our business. Interruptions in production capabilities will inevitably increase production costs and reduce our sales and earnings. In addition to the revenue losses, longer-term business disruptions could result in a loss of customers. To the extent these events are not covered by insurance, our revenues, margins and cash flows may be adversely impacted by events of this type.
Our production costs may increase and we may not be able to sustain our sales and earnings if we fail to maintain satisfactory labor relations.
A majority of our hourly employees are covered by a collective bargaining agreement with the USW that expires on September 1, 2008. The final rate increase of 3.0% under the existing contract is scheduled for March 31, 2007. Of our total employees, approximately 79.9% are unionized, including 77.2% of which are members of the USW. Any potential strikes or work stoppages in the future, and the resulting adverse impact on our relationships with our customers, could have a material adverse effect on our business, financial condition or results of operations. Additionally, other steel producers may have or may be able to negotiate labor agreements that provide them with a competitive advantage. In addition, many mini-mill producers and certain foreign competitors and producers of comparable products do not have unionized work forces. This may place us at a competitive disadvantage.
In addition, the USW has the unilateral right to veto any merger or other transaction that constitutes a change in control of WPC, as defined by the collective bargaining agreement, unless the party gaining such control enters into a new collective bargaining agreement with the USW as a part of the transaction.
Our senior management also work for another company whose interests may be different from ours.
James P. Bouchard, our Chairman and Chief Executive Officer, and Craig T. Bouchard, our President, also serve as Chairman of the Board and President, respectively, of Esmark, a steel services company. Our Board of Directors, pursuant to the Company’s Ethics Code, authorized and approved the continued roles of Jim and Craig Bouchard in the operation and management of Esmark. Because the Company and Esmark may be engaged in the same, similar or related lines of business, our interests may differ from those of Esmark. Our Board of Directors has adopted guidelines to be used in conducting commercial business with Esmark to address potential conflicts of interest. To date we do not believe that we have been negatively impacted by the other positions held by Jim or Craig Bouchard.
Delays or transition issues in implementing changes under new executive management could adversely impact the Company.
As a result of our new Board of Directors and executive management, we are in the process of reviewing and implementing changes to our operations and commercial activities, as well as changes to human resources, information technology, financial services and outside vendors. We may encounter delays or transition issues in implementing these changes which could have an adverse effect on our business.
Environmental compliance and remediation costs could decrease our net cash flow, reduce our results of operations and impair our financial condition.
Our business and our ownership of real property are subject to numerous Federal, state and local laws and regulations relating to the protection of the environment. These laws are constantly evolving and have become increasingly stringent. The ultimate impact of complying with environmental laws and regulations is not always clearly known or determinable because regulations under some of these laws have not yet been promulgated or are undergoing revision. We incur substantial capital expenditures and other costs to comply with these environmental laws and regulations, particularly the Federal Clean Air Act and the Federal Resource Conservation and Recovery Act, and future developments under these or other laws could result in substantially increased capital, operating and compliance costs. Additionally, future decisions to terminate operations at any of our facilities may result in facility closure and cleanup costs. In addition, if we are unable to comply with environmental regulations, we may incur fines or penalties or may be required to cease some operations.
We are involved in a number of environmental remediation projects relating to our facilities and operations, and may in the future become involved in more remediation projects. While we reserve for costs relating to such projects when the costs are probable and estimable, those reserves may need to be adjusted as new information becomes available, whether from third parties, new environmental laws or otherwise.
Increases in our healthcare costs for active employees and future retirees may lower our earnings and negatively affect our competitive position in the industry.
We maintain defined benefit retiree healthcare plans covering all active union represented employees upon their retirement. We also provide medical benefits for qualified retired salaried employees until they reach the age of 65. Healthcare benefits for active employees and future retirees are provided through comprehensive hospital, surgical and major medical benefit provisions or through health maintenance organizations, both the subject of various cost-sharing features. These benefits are provided for the most part based on fixed amounts negotiated in labor contracts with the appropriate unions. Additionally, mini-mills, foreign competitors and many producers of products that compete with steel typically provide lesser benefits to their employees and retirees, and this difference in cost could adversely impact our competitive position. If our costs under our benefit programs for active employees and future retirees exceed our projections, our business, financial condition and results of operations could be materially adversely affected.
You may not be able to compare our historical financial information to our current financial information, which will make it more difficult to evaluate an investment in our company.
As a result of the completion of our reorganization plan, we are operating our business under a new capital structure. In addition, we adopted fresh-start reporting in accordance with Statement of Position (“SOP”) 90-7, as of July 31, 2003. Because SOP 90-7 required us to account for our assets and liabilities at their then-current fair values, our financial condition and results of operations after our reorganization are not comparable in some material respects to the financial condition or results of operations reflected in our historical financial statements for periods prior to August 1, 2003. This may make it difficult to assess our future prospects based on historical performance.
Certain U.S. Federal income tax considerations may increase the amount of taxes we pay which could adversely affect our liquidity and reduce profitability.
Based on information available to us, we believe that we underwent an “ownership change” pursuant to Section 382 of the Internal Revenue Code in the second quarter of 2006. As a result, our ability to utilize net operating loss carryovers to reduce taxable income in 2006 and subsequent years will be subject to statutory limitations on an annual basis. Our net operating loss carryover as of December 31, 2005 approximated $344.1 million. We estimate that our ability to offset post-ownership change taxable income will be limited to approximately $4.0 million to $5.0 million in 2006 and $8.0 million to $10.0 million for years subsequent to 2006. We believe that there are built-in gains inherent in the value of our assets that, when and if realized, may increase this annual limitation during the five-year period from the date of the ownership change. We are currently assessing the extent of these built-in gains. There can be no assurance that these built-in gains, if any, will be realized. The annual limitation on our net operating loss carryforwards that can be used to offset post-ownership change taxable income could adversely affect our liquidity and cash flow, and reduce profitability.
Future sales of our common stock by our existing stockholders could adversely affect the market price of our common stock.
Our common stock has a limited trading market and is held by a concentrated number of investors, including the Wheeling-Pittsburgh Steel Corporation Retiree Benefits Plan Trust (VEBA trust). As a result, sales of our common stock in the public market could adversely affect the market price of our common stock. Any increase in the selling volume of shares of our common stock, including sales by our significant stockholders, such as the VEBA trust or others, also may adversely affect the trading price of our common stock.
The market price of our common stock could be subject to wide price fluctuations in response to numerous factors, many of which are beyond our control. These factors, include, among other things, failure to consummate a merger with Esmark, low trading volume of our common stock, quarterly variations of our financial results, the nature and content of our earnings releases and our competitors’ earnings releases, developments in the steel industry, including those impacting worldwide supply of, and demand for, steel products, such as governmental regulation and market conditions affecting the demand for steel in China, changes in financial estimates by securities analysts, business conditions in our market and the general state of the securities industry, governmental legislation and regulation, as well as general economic and market conditions. As a result, you could lose all or a part of your investment.
Item 1B. Unresolved Staff Comments
None.
