NOTE REGARDING FORWARD-LOOKING STATEMENTS
Information contained in this document, other than historical information, may
be considered forward-looking. Forward-looking information reflects Management's
current views of future events and financial performance that involve a number
of risks and uncertainties. The factors that could cause actual results to
differ materially include, but are not limited to, the following: general
economic conditions, changes in financial markets, political conditions and
developments, including conflict in the Middle East and the war on terrorism,
changes in the supply and demand for steel and specific steel products of the
Company, the level of demand outside of North America for steel and steel
products, equipment performance at the Company's manufacturing facilities, the
progress of any material lawsuits, the availability of capital, the ability to
properly and efficiently staff the Company's manufacturing facilities, domestic
and international competitive factors, including the level of steel imports into
the Canadian and United States markets, economic conditions in steel exporting
nations, trade sanction activities and the enforcement of trade sanction
remedies, supply and demand for scrap steel and iron, alloys and other raw
materials, supply, demand and pricing for the electricity and natural gas used
by the Company, changes in environmental and other regulations, including
regulations arising from the Canadian Parliament's ratification of the Kyoto
Protocol, and the magnitude of future environmental expenditures, inherent
uncertainties in the development and performance of new or modified equipment or
technologies, North American interest rates, exchange rates and other risks
detailed in the "Business Risks and Uncertainties" section of this document.
This list is not exhaustive of the factors which may impact the Company's
forward-looking statements. These and other factors should be considered
carefully and readers should not place undue reliance on the Company's
forward-looking statements. As a result of the foregoing and other factors, no
assurance can be given as to any such future results, levels of activity or
achievements and neither the Company nor any other person assumes responsibility
for the accuracy and completeness of these forward-looking statements. The
Company undertakes no obligation to update forward-looking statements contained
in this document.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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GENERAL
IPSCO is a North American steel producer incorporated in Canada with facilities
and process equipment located at 12 sites throughout Canada and the United
States (U.S.). These facilities produce carbon steel slabs, hot rolled discrete
plate and coil, as well as finished tubular products. In addition, IPSCO has
several scrap collection sites located principally in Western Canada.
The Company produces steel in three North American steelworks: Regina,
Saskatchewan, Montpelier, Iowa and Mobile, Alabama. All three steelworks use
electric arc furnace technology to convert scrap steel into liquid steel. Alloys
are added at ladle metallurgy stations to create a wide variety of grades for
various customer applications. Each steelworks casts the liquid steel into slabs
and hot rolls the slabs into discrete plate or coil. The plate and coil can be
sold directly to customers or may be further processed within IPSCO's downstream
facilities. Five coil processing locations produce cut-to-length plate and sheet
to customer requirements. Pipe mills at six locations use coil feedstock to
produce tubular products that range from one and one-half inches up to 16 inches
in diameter ("small diameter") and 16 inches through 80 inches in diameter
("large diameter").
IPSCO currently has over 600 active customers spanning a large number of
applications. IPSCO produces steel plate and sheet in an assortment of widths,
lengths, gauges, and grades used to make railroad cars, barges, and ships;
industrial, construction and farm equipment; storage tanks, bridges, structural
poles, and a host of additional products. Tubular products include pipe for low
pressure water and air distribution; oil and gas well casing and tubing ("oil
country tubular goods" or "OCTG"); pipe for transporting oil and gas from wells,
transmitting oil and/or gas long distances, and for final distribution to
end-customers ("line pipe"); water and sewage transmission pipe; and tubular
products for building and construction applications, most often in square or
rectangular cross-sections ("hollow structural sections", "HSS" or "structural
tubing").
IPSCO markets steel through two separate commercial channels. One sells steel
mill products such as discrete plate, cut plate, and coil. The second sells
tubular products. Each marketing operation is disciplined with regard to the
products it sells and the markets it pursues, and each continually enhances its
diversified product lines. While sales personnel are located to maximize
customer service, each commercial channel is centrally managed. Commercial
employees are experienced and well trained to deal with customer requirements. A
pool of highly trained research and technical experts also supports both sales
organizations.
The Company faces significant competition from steel manufacturers in North
America as well as the rest of the world. Competition also comes from
manufacturers of other materials that can be substituted for steel.
World steelmaking capacity currently exceeds demand, which has led to unfair
trading of steel in the North American market. Because of these conditions, the
Company supports trade actions in the form of anti-dumping and countervailing
duty cases or other trade remedies. In recognition of the overwhelming surge of
imported steel the U.S. government imposed significant sanctions in 2002 against
steel from many offshore sources. The action was taken as the result of the
injury these imports inflicted on domestic producers and to allow domestic
producers an opportunity to recover.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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IPSCO has invested substantial sums of money to construct modern, highly
efficient facilities. The Company has built two steelworks in the U.S.;
Montpelier, Iowa opened in 1997, and Mobile County, Alabama opened in 2001. The
investments resulted in 2.5 million tons of additional plate and coil capacity,
more than tripling IPSCO's prior capacity. Both facilities have modern,
efficient production equipment and highly motivated, well-trained work forces.
The two major investments were sited close to end users and raw material sources
in order to minimize freight costs, a significant cost of business. In addition,
all three of the Company's steelworks can manufacture similar products,
providing increased flexibility, versatility and efficiency, resulting in
improved customer service.
The Company's strategic investments in the two U.S. steelworks were based on
estimates of return spanning a variety of market conditions over long-term
economic cycles, where conditions can vary significantly in the short-term. In
the future IPSCO may pursue a number of other strategic initiatives such as
acquisitions, joint ventures and/or alliances that would allow the Company to
better serve customers and improve financial performance.
Company management must address several key performance drivers simultaneously
in order to compete successfully. The foundation of the commercial operation is
good market intelligence about customer requirements and product alternatives.
Information relating to customer requirements and appropriate pricing is
generated through close, direct coordination and communication with customers as
well as through industry associations and consulting arrangements.
IPSCO has approximately 2,300 employees and uses performance incentives to
reward them for cost, efficiency, service and quality improvements ultimately
leading to increased customer satisfaction. Armed with world-class facilities
and an effective workforce, IPSCO's keys to operational success include reducing
cost, increasing operating efficiency and maximizing capacity utilization.
IPSCO's major steelmaking raw material is scrap for the three steelworks, which
normally trends with prices for plate and coil. Higher plate and coil prices are
generally associated with higher scrap prices. Likewise, prices for industrial
pipe products often track coil feedstock prices. IPSCO manages these variable
costs using a number of strategies. IPSCO owns General Scrap Partnership, a
Canadian scrap metal operation with seven collection locations in western Canada
and two in north central U.S. In addition, IPSCO cultivates close business
relationships with most major scrap yards and brokers throughout mid America.
IPSCO also purchases steel from other steel manufacturers. Coil feedstock for
tubular and coil processing operations can either be sourced internally or
purchased from third party vendors, thereby optimizing IPSCO's steelworks'
utilization rates. Electricity and natural gas are also important variable costs
for IPSCO. These are addressed through different strategies including
competitive long-term supply contracts.
Economic success also rests in large part with the efficient absorption of the
substantial fixed costs at each facility. Optimum absorption requires making the
product right the first time, at maximum throughput rates. High utilization
rates, high yields and superior quality are a reflection of optimum performance.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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Another key performance driver is management's ability to effectively control
working capital, primarily customer receivables, inventory levels and vendor
payables. Most products from the three steelworks are manufactured only when a
firm order is received, either from an external customer or an internal
requirement to provide feedstock for IPSCO's own downstream processing lines.
Production based on demand helps minimize finished inventory levels. However,
some pipe products such as OCTG are produced in advance of orders and made
available at selected sites that are convenient to customer locations. This is
especially important given the seasonal well drilling cycle for the Western
Canadian energy market, as well as the short time interval between customer
order dates and required delivery. Well drilling traditionally is most active in
the late fall and winter season and slowest during the early spring thawing
season.
Careful accounts receivable management is also important given the cyclical
nature of the steel business. IPSCO uses a number of techniques to minimize
credit risk starting with a thorough knowledge of customers who request credit.
That, combined with variable payment terms and close attention to account
detail, helps minimize losses.
IPSCO supports its operations with a sound capital structure that combines
equity from both common and preferred stock along with a variety of debt
instruments, generally of a long-term fixed rate nature. The long-term structure
of these capital resources is important given both the long-term nature of the
Company's investment in facilities and the cyclical nature of world steel
markets.
BUSINESS RISKS AND UNCERTAINTIES
Continued weakness in the Canadian or U.S. industrial economies could result in
a lessening of demand for IPSCO's steel products. The Company needs to maintain
minimum levels of sales to operate profitably. There can be no assurance that
the overall market demand for IPSCO products will not decrease in the future or
that the Company will be successful in retaining necessary market share for its
products. Reduction in overall market demand or the failure to hold market share
could have an adverse effect on earnings.
The Company supplies tubular goods used for oil and natural gas exploration and
production which are linked to energy prices. There can be no assurance that
future oil and natural gas price volatility will not materially impact the
Company's ability to sell these products and maintain profitability.
Credit risk can be a significant factor in a weak industrial economy. While the
Company uses a number of techniques to address this exposure, there can be no
assurances that losses will not occur.
Excess global capacity and the effect on North American steel prices remain a
significant risk. Excess supply resulted in surges of low-priced steel into
North American markets and drove prices to historically low levels over the past
few years. That led to the March 2002 Section 201 ruling when the U.S.
International Trade Commission concluded that, for the majority of products
reviewed, imported steel had seriously injured domestic producers. There are no
assurances that current remedies beneficial to the North American steel industry
will be sustained long term, or that these actions will allow the domestic
industry to fully recover.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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The Company has substantial investments in facilities in both the U.S. and
Canada. As a result, the Company transacts business in the currencies of both
countries, with the ratio between the U.S. dollar and Canadian dollar
denominated sales and expenditures varying over time. The average value of the
Canadian dollar declined slightly from $0.6460 U.S. in fiscal 2001 to $0.6369
U.S. in fiscal 2002. In addition, the strength of both the Canadian and U.S.
dollars relative to other foreign currencies influences import and export
activity. Both currencies weakened against the Euro and other major currencies
in fiscal 2002. Future fluctuations in the exchange rate between the Canadian
and U.S. dollars and other foreign currencies could have a material effect on
the Company.
IPSCO has accumulated net operating loss carry-forwards, on a tax basis, of $355
million as of December 31, 2002 on its U.S. operations, for which the Company
has recorded future tax benefits. This compares to accumulated net operating
loss carry-forwards of $359 million as of December 31, 2001. The ability to
realize the future tax benefits is dependent on future profitability. Although
99% of the net operating loss carry-forwards do not begin to expire until 2018,
there can be no guarantee the tax benefits related to these carry-forwards will
be realized before they expire.
Approximately 44% of IPSCO's employees are represented by trade unions. The
United Steelworkers of America represents members in Regina, Saskatchewan and
Calgary, Alberta and the International Association of Bridge, Structural and
Ornamental and Reinforcing Ironworkers represents members in Red Deer, Alberta.
These unions represent 98% of IPSCO's unionized labor force. Members of the
unions ratified new labor agreements during 2002 that will expire by August
2006.
Changing environmental legislation and regulatory practices may require future
expenditures to modify operations, install additional pollution control
equipment, dispose of waste products, and perform site remediation. During 2002
non-routine project expense and capital spending on programs aimed at
environmental issues amounted to $2.7 million. The 2002 amount compares to $11.4
million spent in 2001 (including $7.5 million spent on the Mobile Steelworks).
Another substantial risk to IPSCO is continued government subsidies to weaker,
inefficient competition. Subsidized North American and international producers
have hurt Company results. Several companies in the U.S. and Canada, who are
otherwise uncompetitive because of old, inefficient, expensive operations, have
remained in business under the protection of bankruptcy laws. In some cases
competitors have emerged from bankruptcy or stayed in business only because
governments are guaranteeing their debt or paying their obligations for pension
and other benefits. Internationally, government subsidies also often sustain
local producers at the expense of financially sound North American producers
like IPSCO.
The Company uses a systematic approach to routinely maintain all facilities and
equipment. Nonetheless, there is risk of plant equipment failure, either because
of maintenance issues or as the result of operational errors.
Substantial capital costs to construct steelworks, combined with expensive labor
contracts, were traditionally a barrier to entry into the steel industry. Recent
events point to the ability of prospective investors to secure plants and
equipment, especially from those in financial distress, for significantly less
capital than historically
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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required. Traditional labor contracts may be replaced with more competitive
agreements. In addition, new technology may be developed. There is a risk that
these changing conditions could lead to new entrants to the steel industry or
the reconstitution of existing participants with more competitive cost
structures.
Canada is a signatory to the United Nations Framework Convention on Climate
Change. On December 10, 2002, Parliament ratified the Kyoto Protocol, which sets
binding targets to reduce national emissions of carbon dioxide, methane and a
number of other gases collectively referred to as greenhouse gases. With
ratification completed, focus has shifted to future federal and provincial
legislation to implement programs with industry-specific numerical goals to meet
the reductions set by the Protocol. The Canadian Government has issued a Climate
Change Plan that identifies groups of large industrial emitters, which will be
required to reduce emissions in an effort to meet the Protocol targets. "Iron
and Steel Production Facilities" is one of the sectors included in this effort.
While the Canadian Government has expressed its support for limiting the impact
of the Kyoto Protocol on industry, the specific processes for achieving the
targets have yet to be determined. It is too early to say whether implementation
of required processes will have a material adverse impact on the Company's
Canadian operations. The U.S. is not currently a signee of the Kyoto Protocol.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 COMPARED WITH YEARS ENDED DECEMBER 31, 2001 AND
DECEMBER 31, 2000
2002 COMPARED TO 2001
SALES
IPSCO manages its business to maximize total corporate profit dollars, not
individual facility profitability. This is done by optimizing internal
steelmaking capacity, and augmenting internal steel production with outside
feedstock purchases. A drop in the sales of one particular product line may
indicate a fall in demand or a deliberate decision by IPSCO to sell less of that
product in order to generate a more profitable product mix. Such decisions are
taken on the basis of:
1) marginal production costs and revenues,
2) freight rates on raw material and/or steel movements between plants,
and
3) the cost of delivering products to customers,
all balanced by longer-term strategic requirements.
In reading individual product commentaries the shareholder should bear in mind
that the comments reflect the result of corporate profit maximization
activities.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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The following table details tons shipped by major product line:
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TONS SHIPPED
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(in thousands)
2002 2001 2000
Plate and coil 1,543 1,071 944
Coil processing 572 490 434
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2,115 1,561 1,378
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Energy tubulars 382 455 404
Non-energy tubulars 271 295 254
Large diameter pipe 129 134 197
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782 874 855
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Total 2,897 2,435 2,233
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For a sixth consecutive year IPSCO shipped record tonnage, amounting to
2,896,900 tons, 19% more than a year earlier. This achievement took place in a
year when North American apparent steel consumption is expected to be up only
modestly.
Revenue of $1.08 billion in 2002 reflects the significantly higher shipments
made by the Mobile Steelworks, as well as continued market penetration by coil
processing facilities opened over the past few years. Production capabilities
have generally improved quarter over quarter following the Mobile commissioning
process which concluded in September of 2001.
IPSCO's average unit selling price declined to $369 per ton in 2002 from $380
per ton in 2001, primarily due to changes in product mix (a higher percentage of
steel mill products compared to tubular products) but also due to continued
price competition.
Shipments to U.S. customers reached 2,125,800 tons, over 73% of the total, while
Canadian based customers accounted for 771,100 tons, about 27%. Despite growth
in the Company's total shipments, Canadian shipments were 11% below that of
2001, indicating that the U.S. market continued to provide the growth in sales.
STEEL MILL PRODUCTS
Shipments of 2,115,000 tons of discrete plate, cut plate and hot rolled coil
("steel mill products") surpassed those of a year earlier by 35%. U.S. destined
tons increased by 50% while Canadian tons fell 5%.
IPSCO's average unit selling price for steel mill products improved about 4% on
a year-over-year basis primarily as the result of modest price increases and
selective commercial practices offset by regional pricing differences. Market
conditions did not improve appreciably year-over-year.
Shipments from coil processing facilities were 572,100 tons, 17% higher than a
year earlier. Canadian destined shipments were virtually identical to 2001
levels while U.S. shipments rose 26%. The average unit selling price increased
3% on a year-over-year basis. IPSCO's coil processing facilities in Houston, St.
Paul,
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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and Toronto all make temper-leveled plate products which offer superior
flatness, surface quality, and higher strengths without furnace treatment, and
which are gaining market share over competitors' cut-to-length plate.
IPSCO estimates that its market share for plate, hot rolled steel coil, and
sheet products reached about 5% of combined U.S. and Canadian markets in 2002.
TUBULAR PRODUCTS
About 27% of the Company's total shipments in 2002 were tubular products, down
from about 36% in 2001, reflecting the impact of both the Mobile Steelworks
ramp-up and a slow market for many tubular product lines. IPSCO produces tubular
products from coil at eight facilities. By adding value to the basic steel mill
product, profitability is enhanced. Further, because a number of these products
involve some degree of customization, they are often less susceptible to unfair
price competition from generic imported steel.
Tubular product volume fell 11% from 2001 levels to 782,000 tons. Shipments of
these products to U.S. customers fell 4% while shipments to Canadian customers
fell 16%. Pipe sales declined due to the soft economy and slow activity within
the oil and gas industries. Total shipments of large diameter pipe fell 4% to
129,300 tons from 134,400 tons. Shipments of OCTG and small diameter line pipe
fell 14% from 445,000 tons to 381,400 tons. The average number of active
drilling rigs fell on a year-over-year basis from 1,156 to 830 in the U.S. and
from 341 to 263 in Canada for a combined decrease of 27%. Shipments of
non-energy tubulars dropped from 294,800 tons to 271,200 tons, or 8%, primarily
because of slower sales of both standard pipe and hollow structural pipe in the
U.S.
IPSCO's average unit selling price of energy tubular products fell about 3%
while non-energy tubular prices increased about 8% over 2001. Large diameter
pipe pricing, which can vary significantly based on project specifications and
mix, fell about 2% year-over-year. The selling price decrease experienced by
energy tubulars reflected the softer market conditions as evidenced by the 27%
drop in drilling rates. The increase in average pricing for non-energy tubulars,
however, was primarily the result of significantly higher feedstock costs, some
of which were passed on to the ultimate consumer, even though market conditions
were not appreciably better in 2002 than 2001.
COST OF SALES
Cost of sales increased 21% to $976.4 million compared to $807.9 million in
2001. Gross margin decreased slightly to 10% of sales from 11% in 2001,
reflecting both increased sales of the lower than average margin products from
the Mobile Steelworks, and decreased tubular product sales, which generate
higher margins. This trend was partially offset by higher pricing for steel mill
products and improved production costs at both U.S. steelworks, the result of
higher production levels and therefore improved utilization.
The choice of facility at which a given order will be produced is often based on
the freight cost to a given customer location. However, some products tend to be
unique to one of the steelworks; wide plate and coil to Montpelier and Mobile,
narrow alloy plate to Regina. The operating level for a tubular facility is
determined by whether or not feedstock is available at a low enough cost such
that the facility can
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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generate an incremental financial return. Given that IPSCO's third party sales
of steel mill products (combined with the steel consumption of our own
downstream operations) can exceed the capacity of IPSCO's steelworks, individual
facilities' operating levels are determined by whether or not purchased steel is
available at a suitable price. Thus plant operating levels are constantly
adjusted to maximize corporate profitability.
RAW MATERIALS
In 2002, a total of $500 million dollars was spent on major raw materials and
consumables for the Company's three steelworks, up by 27% from the $395 million
spent in 2001. Included in the amount are expenditures for steel scrap, pig
iron, alloy materials, carbon electrodes, oxygen, refractories, limestone,
natural gas and electricity.
During 2002, IPSCO recycled 3.3 million tons of purchased scrap, the principal
raw material for its steel mills, at an average cost per ton about 15% higher
than the previous year. IPSCO's General Scrap Partnership and IPSCO Direct Inc.,
an Alberta scrap collection company, provided 12% of the Company's overall
needs. The remainder was readily available from other parties.
Energy constitutes a significant portion of an electric furnace steelmaker's
costs. In 2002 IPSCO's cost per kilowatt-hour edged up just slightly more than
4% due to escalation clauses in long term supply contracts. Natural gas costs
per millions of British Thermal Units fell by about 26%. The combination had a
negligible impact on production costs.
IPSCO's coil processing and tubular operations consumed 118,200 tons of hot
rolled coil purchased from third parties, supplementing the Company's own
production. This was 70% below the 389,900 tons consumed a year earlier. The
principal reason for the reduction was internal supply available from our
steelworks coupled with restricted supply from third parties.
MAINTENANCE AND OTHER EXPENSES
Maintenance is an extremely important cost factor for IPSCO. With newer
facilities, IPSCO enjoys lower maintenance costs relative to many competitors
with older facilities. IPSCO has separate maintenance reserve accounts for every
major production segment of the three steelworks as well as each coil processing
and tubular facility. IPSCO provides for the anticipated costs of maintaining
these segments (relining furnaces, replacing motors, etc.) based on maintenance
schedules and past experience. When IPSCO does have scheduled maintenance
shutdowns, like the 14-day outage in Regina last September, most costs to
complete the work are charged against the reserves. However, fixed costs, which
aren't absorbed into inventory as the result of the shutdown, are expensed as
incurred.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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Pension expenses, principally for the defined benefit plans under Canadian labor
contracts, increased $2.0 million compared to 2001. One-third of the increase
was attributable to benefit improvements granted as part of new labor agreements
reached during 2002. Future annual pension expenses are expected to increase
significantly (an estimated $5 million in 2003) because of:
1) increased service costs attributable to the new labor
agreements
2) increased interest costs on benefit obligations which are
escalating, and
3) increased amortization of shortfalls in plan asset investment
actual losses relative to expected investment returns incurred
over the last two years.
Amortization of capital assets increased by 38% to $51.0 million in 2002 from
$37.1 million in 2001. Most of the increase reflects a full year's amortization
of the Mobile Steelworks with just a minor increase from other assets placed
into service in 2002.
CAPACITY UTILIZATION
Capacity utilization is a key driver of performance for IPSCO. Tons of output
are related to the number of production turns at each facility. Theoretically,
all production equipment is available for 168 hours a week, less operating
downtime for routine maintenance. That is equivalent to operating 7 days per
week, 24 hours per day. Therefore, in order to maximize plant and equipment
utilization and minimize absorbed cost per ton of output, maximum performance
occurs at IPSCO when four crews run the facilities around the clock. Optimum
utilization after routine maintenance therefore is 95%.
Capacity, utilization and production are as follows:
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Facilities Capacity (tons)(1) Utilization % Production (tons)(2)
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(in thousands)
2002 2001 2000 2002 2001 2000
Regina 1,000 89 94 93 961 1,068 1,041
Montpelier 1,250 91 87 90 1,114 967 980
Mobile(3) 1,250 80 -- -- 932 379 --
Coil Processing 1,200 37 38 35 559 502 439
Small Diameter 1,125 58 68 68 588 660 613
Large Diameter 600 34 45 38 142 189 231
1) In thousands of tons of finished product.
2) In thousands; liquid steel for steelworks; finished production for other
facilities.
3) Mobile was not in commercial production until fourth quarter 2001,
therefore values are not included for 2000 and 2001.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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STEELMAKING
Production at the Regina Steelworks dropped to 961,200 liquid tons, about 10%
less than 2001, primarily because of a 14-day scheduled maintenance outage in
September (also reflected in the decline in capacity utilization).
The Montpelier Steelworks recorded production of 1,114,400 liquid tons of steel,
more than 15% above 2001. Utilization increased to 91% reflecting product mix
considerations, despite a mechanical failure on its static shear and an
eight-day scheduled maintenance outage during 2002.
The Mobile Steelworks produced 932,100 tons of liquid steel in 2002 vs. 379,000
tons in 2001. The percentage of prime production is increasing as the operation
matures.
The number of man-hours required to produce a ton of coil or discrete plate
averaged 0.78 for the combined steelworks.
A total of 559,000 tons of coil were processed by IPSCO's coil processing
facilities, up 11% over 2001's 501,400 tons, reflecting market share
improvements as customers demand higher quality. IPSCO's coil processing
facilities include three temper leveling mills which provide the superior gauge
control, flatness and surface quality features sought by end-users.
TUBULAR OPERATIONS
IPSCO pipe mills produced 14% fewer tons than a year earlier as a result of the
impact of lower drilling activity on demand for energy tubulars and the negative
impact of a slow economy on demand for non-energy tubulars. Production of large
diameter gas transmission pipe was down 25%, and shipments decreased 4% to
129,300 tons, reflecting a limited number of projects in the transmission
industry. The large diameter mills in Regina experienced a 34% utilization rate,
lower than the 45% recorded a year earlier.
The man-hours required to convert finished steel to one ton of finished pipe
averaged 2.52 identical to 2.52 man-hours in 2001. This was despite the
commissioning of new welding equipment on the mid-size mill in Regina.
SELLING, RESEARCH AND ADMINISTRATION EXPENSE
Selling, research and administrative expenses of $55.2 million were 4% lower
than the $57.5 million reported in 2001. Bad debt expense was down $5.1 million
reflecting the unusually high provisions recorded in 2001. Administrative
expenses for the Mobile Steelworks were up $6.1 million reflecting the first
full year of operation for that facility. Insurance costs were also $2.0 million
higher than 2001, because of well-publicized problems in that industry.
INTEREST ON LONG-TERM DEBT
Interest expense on long-term debt increased to $23.8 million in 2002 compared
to $6.6 million in the prior year. Most interest on long-term debt was
capitalized to the Mobile Steelworks project during 2000 and 2001 under Canadian
Generally Accepted Accounting Principles.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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2001 COMPARED TO 2000
SALES
Sales revenues decreased by 5% to $903.7 million in 2001, reflecting the price
erosion that resulted from oversupply conditions largely attributed to dumping
of unfairly priced imported steel.
For a fifth consecutive year record tonnage shipments were recorded, amounting
to 2,435,100 tons or 9% higher than 2000. This achievement took place in a year
when a manufacturing recession saw North American apparent steel consumption
fall by 13%.
The average unit selling price declined by about 10% from $421 per ton in 2000
to $380 per ton, but in the last quarter dropped to $366 per ton, partly due to
product mix (a higher percentage of steel mill products as compared to tubular
products) but more generally indicative of severe price competition.
Shipments to U.S. customers reached 1,570,300 tons, almost 65% of the total,
while Canadian based customers accounted for 864,800 tons, about 35%. Despite
growth in the Company's total shipments the Canadian figure was 7% below that of
2000, indicating that the U.S. market provided the growth in sales.
STEEL MILL PRODUCTS
Shipments of 1,561,000 tons of steel mill products surpassed those of
2000 by 13%, with the U.S. destined tonnage increasing 21% while Canadian tons
fell 4%. In the U.S., unlike 2000 when equipment problems at the Montpelier
Steelworks limited IPSCO's ability to service the market, the coming on stream
of the new Mobile Steelworks meant that order receipt to delivery times became
shorter and therefore more competitive in the second half, resulting in higher
sales.
The average unit selling price received by IPSCO for these products dropped
almost 13% on a year-overyear basis as the result of supply-demand imbalances
caused by the excess supply sited previously. The first quarter of the year saw
lower price realizations than the closing quarter of 2000, followed by further
erosion in the second quarter, a relatively flat third quarter, followed by an
even more significant drop in the fourth.
Coil processing steel shipments were 489,700 tons of the total, 13% higher than
2000. Canadian destined shipments were virtually identical to 2000 levels while
U.S. shipments rose 21%.
IPSCO estimated that its market share in the sizes and grades of steel mill
products that it sold to third parties reached about 4% of the combined U.S. and
Canadian markets in 2001.
TUBULAR PRODUCTS
Tubular products tonnage rose from 855,000 tons in 2000 to 874,200 tons in 2001.
This was possible because of IPSCO's diverse product line and ability to address
product mix issues based on market conditions. The drop in sales of large
diameter oil and gas transmission pipe and non-energy tubulars in Canada
exceeded sales increases for OCTG and small diameter line pipe, resulting in an
overall 9% drop in shipments to Canadian customers. On the other hand U.S. sales
tonnage rose 19% because of higher sales of OCTG and small diameter line pipe as
well as non-energy tubulars.
12
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MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
Total large diameter tonnage fell 32% to 134,400 tons from 197,400 tons. There
were no major orders requiring oil or gas transmission pipe 16 inches or greater
in diameter. On the other hand the tonnage of oil country tubulars and small
diameter line pipe rose 10% from 404,100 tons to 445,000 as the average number
of active rigs drilling rose on a year-over-year basis from 916 to 1,155 in the
U.S. and from 383 to 392 in Canada. The normal pattern of sales of these
products failed to materialize in Canada as weather conditions in the fourth
quarter of 2001 proved to be less than conducive to a high drilling rate.
Tonnage shipments of non-energy tubulars rose to 294,800 tons from 253,500 tons
or 16% primarily because of higher sales of standard pipe in the U.S. Shipments
of hollow structurals in both countries and standard pipe in Canada decreased.
IPSCO estimates that its market share in North America for tubular products
within the size and grade ranges that it manufactures was 8% in 2001.
The average unit selling price of tubulars fell by just under 5%, largely due to
substantial price erosion in non-energy tubular products. These products are
less sophisticated than higher value added energy tubulars and therefore
demonstrate price volatility more or less in line with steel mill products.
However, the continued successful penetration of these markets plays an
important role in providing diversity and flexibility to deal with market
conditions, as mentioned above.
COST OF SALES
Cost of sales increased to $807.9 million from $799.9 million in 2000. Gross
income as a percentage of sales was 11%, down from 16% in 2000. This significant
decline primarily reflects the detrimental effects of price erosion caused by
excess supply including unfairly priced imported steel. In addition, gross
margin dropped 1% because the Mobile Steelworks operated below capacity.
RAW MATERIALS
In 2001 a total of $395 million was spent on major raw materials and consumables
for the Company's three steelworks, up by 13% from the $351 million expended in
2000. Included in the figure are steel scrap, pig iron, alloy materials, carbon
electrodes, oxygen, refractories, limestone, natural gas, and electricity. The
startup of the Mobile Steelworks, with the resultant increase in company-wide
steel production, as well as higher unit natural gas prices, exceeded the impact
of lower unit scrap costs.
During the year IPSCO recycled some 2.6 million tons of purchased scrap, the
principal raw material for its steelmaking, at an average cost per ton that was
about 10% lower than the previous year. IPSCO's 91% owned General Scrap
Partnership and fully owned IPSCO Direct Inc., an Alberta scrap collection
company, provided some 17% of the Company's overall needs.
Energy constitutes a significant portion of an electric furnace steelmaker's
costs. In 2001 IPSCO's cost per kilowatt hour edged up just slightly more than
3% as the result of escalation clauses in long term supply contracts. Natural
gas costs per millions of British Thermal Units rose by over 50% due to higher
costs in the earlier part of the year resulting in additional cost of sales of
$10 million. These comparisons exclude Mobile, which was not operating in 2000.
13
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MANAGEMENT'S DISCUSSION AND ANALYSIS
- ------------------------------------
IPSCO's coil processing and tubular operations consumed 389,900 tons of hot
rolled coil purchased from third parties, supplementing the Company's own
production. This was 27% below the 534,200 tons used a year earlier. The
principal reasons for the reduction were the softer markets and new capacity to
source internally from Mobile.
STEELMAKING
Liquid steel production at 2,414,500 tons exceeded the previous year by 19%,
reflecting the startup of the new Mobile Steelworks.
Production at the Regina Steelworks reached 1,068,400 liquid tons, just under 3%
higher than 2000. Capacity utilization was 94%.
The Montpelier Steelworks recorded production of 967,100 tons of liquid steel,
just slightly more than 1% below the year-earlier figure. This translated into
an effective utilization rate of 70% because the facility was plagued by
original equipment malfunctions and breakdowns.
The new Mobile Steelworks produced 379,000 tons of liquid steel after initial
production began at the end of the first quarter. While the first nine months of
operation saw the typical issues involved in getting a steel mill of its size up
and running, management considers it a success.
The number of man-hours required to produce a ton of finished steel in discrete
plate or coil form averaged 0.75 for Montpelier and Regina combined, somewhat
higher than the 0.70 reported for 2000, chiefly as the result of the decision to
perform certain maintenance functions in-house at Montpelier. Previously these
had been undertaken by outside contractors whose manpower statistics are not
reported to IPSCO.
A total of 501,400 tons was handled by IPSCO's coil processing facilities, 14%
higher than the 439,000 tons in 2000.
TUBULAR OPERATIONS
IPSCO pipe mills produced a record 848,800 tons, 1% higher than a year earlier,
despite continuing weak markets for large diameter gas transmission pipe and the
negative impact of a slowing economy on the demand for non-energy tubulars.
Average capacity utilization at IPSCO's small diameter pipe mills remained at
68% while production tonnage rose 7% due to the improved efficiencies at the
Blytheville, Arkansas pipe works and the Camanche, Iowa pipe works.
The large diameter mills in Regina had 45% utilization, higher than the 38%
recorded a year earlier.
The man-hours required to convert finished steel to one ton of finished pipe
averaged 2.52. This compares to 2.43 man-hours in 2000 and reflects a more
labor-intensive product mix rather than a decrease in efficiency.
SELLING, RESEARCH AND ADMINISTRATION EXPENSES
Selling, research and administration expenses decreased 7% in 2001 to $57.5
million from the $62.1 million reported in the prior year.
14
------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
Significant costs incurred in 2000 for research and development and for legal
and related expenses associated with the Mannesmann Demag lawsuit were not
repeated in 2001. These decreases were partially offset by a $4 million increase
in allowances for bad debts and expenses incurred by the Mobile Steelworks which
were expensed subsequent to the end of its commissioning period ending September
30, 2001. In total, selling, research and administration expenses represent 6%
of consolidated sales in 2001, compared to 7% in 2000.
INTEREST ON LONG-TERM DEBT
Interest on long-term debt expensed decreased by 4% to $6.6 million in 2001
after decreasing by 64% to $6.9 million in the prior year. The decrease in
interest on long-term debt expensed in 2001 results from the increase in
interest capitalized on the Mobile Steelworks more than offsetting increased
interest incurred (refer to "Capital Structure"). Interest on long-term debt
expensed in 2000 also decreased due to the increase in interest that was
capitalized for the Mobile Steelworks.
2002 COMPARED TO 2001 AND 2000
INCOME BEFORE INCOME TAXES, NET INCOME AND NET INCOME AVAILABLE TO
COMMON SHAREHOLDERS
Income before income taxes decreased by 48% (20% excluding non-recurring items)
to $31.7 million in 2002 as a result of the changes described in the previous
sections. These results include one non-recurring transaction during 2002 and
two non-recurring transactions during 2001. In 2002 the Company successfully
completed the sale of certain assets held for sale and recorded associated
pretax income of $6.5 million. In 2001 the Company settled a lawsuit against the
turnkey contractor of the Montpelier Steelworks for $49 million. A total of $39
million represented claims for lost business and reimbursement of legal costs
and was recorded in other income, and the $10 million balance was used to
replace equipment. Additionally in 2001 a non-cash charge of $10 million was
recorded to adjust the carrying value of assets held for sale to their estimated
net realizable value. Income before income taxes for 2001 decreased by 25% to
$60.7 million from $80.8 million in 2000.
Net income decreased by 48% (20% excluding non-recurring items) to $20.3 million
in 2002, after having decreased 33% to $38.9 million in 2001. Net income
available to common shareholders declined 68% (46% excluding non-recurring
items) to $8.9 million in 2002 from $27.4 million in 2001.
EARNINGS PER SHARE
Basic earnings per share fell 72% to $0.19 in 2002 after having fallen 42% to
$0.67 in 2001 from $1.15 in 2000. Net non-recurring items represented $0.09 of
the $0.19 reported for 2002 and $0.45 of the $0.67 in 2001. Diluted earnings per
share fell 71% to $0.19 in 2002 after having fallen 27% to $0.66 in 2001 from
$0.91 in 2000.
RETURN ON COMMON SHAREHOLDERS' EQUITY
The return on common shareholders' equity was 1% in 2002, down from 4% in 2001
and 6% in 2000.
15
- ------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
- ------------------------------------
[GRAPHIC OMITTED - BAR CHART] [GRAPHIC OMITTED - BAR CHART]
SELLING, RESEARCH INTEREST ON
AND ADMINISTRATION LONG-TERM DEBT
EXPENSES ($ millions)
($ millions)
O0 7
00 62 01 7
01 58 02 24
02 55
[GRAPHIC OMITTED - BAR CHART]
INCOME BEFORE INCOME TAXES,
NET INCOME AND NET INCOME
AVAILABLE TO COMMON SHAREHOLDERS
($ millions)
NET INCOME AVAILABLE TO
INCOME BEFORE TAX NET INCOME COMMON SHAREHOLDERS
----------------- ---------- -------------------
00 81 58 47
01 61 39 27
02 32 20 9
[GRAPHIC OMITTED - BAR CHART] [GRAPHIC OMITTED - BAR CHART]
DILUTED EARNINGS RETURN ON COMMON
PER SHARE SHAREHOLDERS' EQUITY
($ per share) (%)
00 0.91 00 6
01 0.66 01 4
02 0.19 02 1
16
- --------------------------------------------------------------------------------
QUARTERLY RESULTS
- --------------------------------------------------------------------------------
Results by quarter for 2002, 2001 and 2000 were as follows:
2002 2001 2000
TONS SHIPPED (thousands)
(including Mobile shipments
during commissioning in 2001)
1st Quarter 749.5 583.6 590.4
2nd Quarter 810.9 587.7 559.0
3rd Quarter 697.8 659.0 524.3
4th Quarter 638.7 604.8 559.5
----------------------------------------
Total 2,896.9 2,435.1 2,233.2
========================================
SALES (millions)
(excluding Mobile sales during
commissioning in 2001)
1st Quarter $ 271.1 $ 232.5 $ 257.8
2nd Quarter 287.6 219.6 236.6
3rd Quarter 266.9 229.1 223.0
4th Quarter 256.1 222.5 231.9
----------------------------------------
Total $1,081.7 $ 903.7 $ 949.3
========================================
NET INCOME (LOSS) AVAILABLE TO
COMMON SHAREHOLDERS (millions)
1st Quarter $ (3.4) $ 5.7 $ 15.2
2nd Quarter 1.2 28.7 12.3
3rd Quarter 1.1 8.5 9.4
4th Quarter 10.0 (15.5) 9.9
----------------------------------------
Total $ (8.9) $ 27.4 $ 46.8
========================================
BASIC EARNINGS (LOSS)
PER COMMON SHARE
1st Quarter $ (0.08) $ 0.14 $ 0.37
2nd Quarter 0.03 0.70 0.30
3rd Quarter 0.02 0.21 0.23
4th Quarter 0.21 (0.38) 0.24
Year 0.19 0.67 1.15
========================================
DILUTED EARNINGS (LOSS)
PER COMMON SHARE
1st Quarter $ (0.08) $ 0.14 $ 0.33
2nd Quarter 0.03 0.57 0.27
3rd Quarter 0.02 0.20 0.20
4th Quarter 0.19 (0.38) 0.20
Year 0.19 0.66 0.91
========================================
17
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MANAGEMENT'S DISCUSSION AND ANALYSIS
- ------------------------------------
ANALYSIS OF IPSCO'S TOTAL CAPITALIZATION
The return on common shareholders' equity for 2002 decreased to 1% from 4% in
2001. This level of return is below the 2002 inflation rates of 3.9% in Canada
and 2.4% in the U.S. Inflation rates in Canada and the U.S. in 2001 were 0.7%
and 1.6% respectively.
During 2002, IPSCO reduced borrowings under its committed $200 million revolving
term bank line by $10.0 million for a total outstanding balance of $118.0
million at December 31, 2002. This contributed to the net decrease in long-term
debt to $342.2 million as at December 31, 2002 from $386.8 million at the end of
2001. The Company converted its $50.0 million unsecured demand operating
facility to an unsecured committed 364-day facility in 2002. Also, during the
year, the Company completed an offering of 6.5 million common shares that netted
proceeds of $90.7 million after payment of associated costs.
SIGNIFICANT DIFFERENCES BETWEEN CANADIAN AND U.S. GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (GAAP)
IPSCO, a Canadian company, uses U.S. dollars as the basis of reporting and
follows Canadian Generally Accepted Accounting Principles (GAAP) in reporting
financial results. The U.S./Canadian GAAP differences generally relate to timing
issues for expense recognition. The 2001 differences were more significant than
normal primarily because of the treatment of major transactions associated with
start-up and commissioning of the new Mobile Steelworks. The differences in the
reported results arising from using U.S. as opposed to Canadian GAAP are
summarized in Note 21 to the 2002 financial statements.
CRITICAL ACCOUNTING POLICIES
The Company prepares its financial statements in conformity with Canadian GAAP.
The Company's significant accounting polices are discussed in the notes to the
consolidated financial statements. The application of these policies requires
significant judgments or estimation that can impact financial position, results
of operations and cash flows. The Company believes the accounting principles
chosen are appropriate under the circumstances, and that the estimates,
judgments and assumptions involved in its financial reporting are reasonable.
Accounting estimates made by management of the Company are based on an analysis
of historical experience and information on current events that is available to
management at the time the estimate is made. If circumstances on which estimates
were based change, the impact is included in the results of operations for the
period in which the change occurs. Senior management has discussed the
development and selection of the critical accounting estimates and the related
financial statement disclosure with the Audit Committee of the Board of
Directors. Critical accounting policies for the Company that are subject to
significant estimates and assumptions are summarized on the following pages.
18
------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
VALUATION OF LONG-LIVED ASSETS
The Company reviews long-lived assets for impairment whenever events or changes
in circumstances indicate the carrying amount of such assets may not be
recoverable. Impairment losses are recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amounts. The impairment loss is measured by comparing the fair value of
the asset to its carrying amount. Factors that could impact IPSCO's estimate of
undiscounted cash flows include, among other things, technological changes,
economic conditions or changes in operating performance, resulting in the need
to write-down those assets to fair value.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company has established an allowance for doubtful accounts for losses
resulting from the potential that some customers may be unable to make payments.
Management continually monitors payment patterns of customers, investigates
past-due accounts to assess likelihood of collection and monitors industry and
economic trends to derive an estimation of the required allowance. If the
financial condition of IPSCO's customers were to deteriorate resulting in an
impairment or inability to make payments, additional allowances would be
recognized.
INVENTORY VALUATION
Inventories are valued at the lowest of average cost, replacement cost and net
realizable value. On a monthly basis IPSCO performs an analysis to determine
whether any reduction in the average cost of inventory is necessary to record
inventory at the lowest value. In addition, and on an ongoing basis, an analysis
is performed to determine whether saleable products on hand need to be written
down to reflect their estimated net realizable value given the intended sales
channel for the product. If the products do not achieve this lower net
realizable value, further losses in their disposition would be recognized.
FUTURE INCOME TAX ASSETS
As part of the process of preparing consolidated financial statements IPSCO is
required to estimate income taxes in each jurisdiction. This process involves
estimating current tax exposure together with assessing temporary differences
resulting from differing treatment of items for tax and accounting purposes.
These differences result in future tax assets and liabilities which are included
within the consolidated balance sheet. An assessment is made as to the
likelihood that the future tax assets will be recovered from future taxable
income. To the extent recovery is not likely a valuation allowance is
established.
The Company has recorded a valuation allowance to reduce the recorded future tax
assets to an amount that is more likely than not to be realized. In determining
the valuation allowance management has utilized certain tax planning strategies
considered to be prudent and feasible to allow for the realization of the future
tax assets. In the event the probability of realizing the future tax asset does
not meet the more likely than not threshold, the valuation allowance would be
increased and a corresponding charge against income would be recorded.
19
- ------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
- ------------------------------------
OBLIGATIONS RELATING TO EMPLOYEE PENSION PLANS
The Company provides retirement benefits for substantially all of its employees
under several defined benefit and defined contribution plans. The defined
benefit plans provide benefits that are based on a combination of years of
service and an amount that is either fixed or based on final earnings. The
Company's policy with regard to the defined benefit plans is to fund the amount
that is required by governing legislation. Independent actuaries perform the
required calculations to determine pension expense in accordance with GAAP.
Various statistical methods which attempt to anticipate future events are used
in calculating the expense and liabilities related to the plans. The actuarial
assumptions used by the Company may differ from actual results due to changing
market and economic conditions, higher or lower withdrawal rates or longer or
shorter life spans of participants. These differences may impact the net pension
expense and liability recorded by the Company, as well as future funding
requirements.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows Working capital derived from operations in 2002 was $72.4 million
compared to $57.8 million for the year ended December 31, 2001. Cash used for
working capital totaled $59.8 million and was primarily comprised of increased
receivables due to higher sales levels and increased inventory levels.
Inventories were built in anticipation of improved seasonal drilling rates in
the oil and gas sector and also to ensure uninterrupted customer service in the
event of a work stoppage during the contract negotiations concluded in December
2002. Cash derived from working capital in 2001 totaled $50.5 million. In 2001
lower sales levels and the receipt of 2000 income tax refunds were the main
sources of that cash. Net cash derived from operations totaled $12.6 million in
2002, down considerably from the $108.3 million in 2001.
In February 2002, the Company issued 6.5 million shares of common stock for net
cash proceeds of $90.7 million, used to pay down debt. The Company also
renegotiated the terms of the $200.0 million revolving term facility to increase
its flexibility, and converted the $50.0 million demand facility into a
committed 364-day facility that expired February 18, 2003 and will not be
renewed.
Net repayments of long-term debt (including the revolving term credit facility)
during 2002 were $31.1 million, compared to net issuances of $46.9 million in
2001. During 2001, the Company raised $15.0 million from the sale and leaseback
of equipment at its Houston coil processing facility. The Company's commitments
under this and other sale and leaseback transactions are accounted for as
operating leases. Accordingly, the contractual obligations are included in the
operating lease section of the commitments table that follows. The $35 million
bank indebtedness outstanding at December 31, 2001, was also repaid during 2002.
Interest paid on the Junior Subordinated Notes in 2002 amounted to $8.5 million,
the same amount paid in 2001. Dividends to holders of common shares and Series 1
preferred shares amounted to $6.1 million and
20
------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
$5.3 million respectively during 2002, compared to $11.2 million and $5.3
million in 2001. The significant drop in common stock dividend payments is
discussed later under Capital Structure. During 2002 $3.0 million was raised
from common shares issued pursuant to the share option plan compared with $0.4
million in 2001. In 2002 $1.7 million was invested in General Scrap Partnership,
increasing IPSCO's residual participation to 100%. The $2.0 million investment
in General Scrap Partnership in 2001 brought IPSCO's participation up to 91%.
The effect of exchange rates resulted in a decrease in cash of $0.5 million in
2002, compared to a $3.5 million decrease in 2001. Capital spending in 2002 of
$34.2 million was down substantially from $155.8 million spent in 2001,
primarily due to the completion of the Mobile Steelworks. Cash received from the
sale of assets held for sale during 2002 totaled $1.5 million.
Cash, net of bank indebtedness, increased by $20.4 million during 2002 to $22.9
million. This compares to a decrease of $15.7 million during 2001. There was no
short-term bank indebtedness at the end of 2002, compared to $35.0 million
outstanding at the end of 2001.
RATINGS
Standard & Poor's (S&P) and Dominion Bond Rating Service (DBRS) lowered their
ratings on IPSCO's debt securities in November 2002. Both services cited
continuing demand weakness for IPSCO's core products. The corporate credit and
senior unsecured debt ratings were lowered by S&P from BBB- to BB+. The
preferred stock rating was reduced to P-4 (high) on the Canadian scale (B+
Global scale) from P-3 (BB). DBRS lowered the unsecured debentures and preferred
shares to BBB and Pfd-3 from BBB (high) and Pfd-3 (high) respectively. DBRS
continues to regard IPSCO as investment grade, based in large part on a strong
balance sheet and sufficient access to liquidity, regardless of how the markets
perform in the near term. The ratings changes did not result in additional
finance expenses under current outstanding financing arrangements. Improved
earnings and successful generation of positive free cash flow will be needed to
raise the ratings.
CAPITAL INVESTMENTS
Spending was kept to minimum levels consistent with the slow demand within the
North American steel market and the resulting decreased cash generation. Total
capital expenditures for 2002 were held to $34.2 million, down significantly
from $155.8 million invested in 2001.
In 2002, payments of $5.9 million were made for holdbacks on various equipment
supply contracts for the Mobile Steelworks. In 2001, capital outlays for the
Mobile Steelworks were $129.1 million. A substantial portion of the 2001
disbursements went to liquidating holdbacks on various equipment supply
contracts and for capitalized start-up costs. Also in 2001, under Canadian GAAP,
losses during the six-month commissioning period and interest during that period
were recorded as capital items. These amounts were $35 million and $14 million
respectively.
The Mobile Steelworks operated at 80% effective capacity during 2002, a
reasonable rate given the stage of mill development and market demand. Mobile,
like Montpelier, is capable of producing coil as well as
21
- ------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
- ------------------------------------
heavy and light discrete plate. The Mobile Steelworks produced its first liquid
steel late in the first quarter of 2001, within the time frame announced at the
commencement of the project, but about three months behind the time specified in
the construction contract that included a guaranteed-not-to-exceed cost
provision. The contractual amount was exceeded and damages of over $60 million
are being sought by IPSCO in a court action commenced in September 2001. The
defendant has denied liability and asserted certain counterclaims which the
Company believes are without merit. The case remains in the discovery stage.
Montpelier capital spending was $8.7 million in 2002 and reflects the benefit of
improvements made in 2001 as well as management's control of capital spending.
Capital spending for 2001 at Montpelier was $13.1 million.
CAPITAL STRUCTURE
IPSCO strives to maintain a strong balance sheet and a flexible capital
structure. The Company believes that the principal indicators of its
creditworthiness are its ability to generate cash from operations, its debt to
total capitalization percentage, and the degree to which covenants in its
existing lending agreements may affect its future ability to access debt
markets.
The Company's most restrictive covenant at December 31, 2002 with respect to
funded debt requires that funded debt not exceed 50.0% of consolidated tangible
net worth. In February 2002 the Company completed negotiations with its banking
syndicate partners to amend the covenant to allow that funded debt not exceed
50.0% of consolidated tangible net worth, an increase from the 45.0% in the
prior agreement. This amendment added short-term borrowings to the definition of
funded debt contained in the existing covenant.
For purposes of this covenant, funded debt includes:
a) long-term debt (including the current portion),
b) the Junior Subordinated Notes,
c) the lease of the meltshop and caster equipment at the Montpelier
Steelworks,
d) certain letters of credit, and e) borrowings under the 364-day
facility.
At December 31, 2002, the percentage of funded debt, so calculated, to tangible
net worth was 38.7% as compared to 43.0% at the end of 2001.
Based on the aforementioned funded debt to tangible net worth covenant, the
Company estimates that as at December 31, 2002 up to $363 million in additional
funded debt could have been raised while still complying with this covenant.
This compares to just $56 million available for draw at the end of 2001. This
amount does not include amounts available for draw by the Company under its
operating line or that may be available for use by the Company under other
methods of financing which would not constitute funded debt for purposes of the
Company's lending agreements.
22
------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
The Company had a receivables securitization facility arranged through a major
Canadian bank that permitted the sale of up to CDN $75.0 million, or the U.S.
dollar equivalent, of its Canadian or U.S. accounts receivable. The November
2002 reduction in the Company's debt ratings resulted in a termination event
under the agreement. The Company has not sought, and has no plans to seek, a
renegotiation of that agreement. No accounts receivable had ever been sold under
the agreement.
The ratio of the Company's long-term debt to total capitalization, as calculated
based on Canadian GAAP financial statements at the end of 2002 decreased to 24%
from 28% as at the end of 2001. The difference between the ratio of the
Company's long-term debt to total capitalization and the ratio of the Company's
funded debt to tangible net worth as described above results primarily from the
differences in the accounting treatment given, under the relevant lending
agreement and under Canadian GAAP, to the Company's Junior Subordinated Notes
and the Montpelier Steelworks melt shop and slab caster lease.
IPSCO's most restrictive covenant with respect to equity maintenance requires
that tangible net worth, as defined by and calculated in accordance with the
relevant lending agreement (excluding the Junior Subordinated Notes), be
maintained at a minimum of $570 million, plus 50 percent of net income earned
after December 31, 1998. The Company's equity exceeded this requirement by $317
million or 48% at December 31, 2002, and by $225 million or 34% at the end of
2001.
As part of the regular review of the dividend level on common shares, IPSCO
decided to change the quarterly dividend from CDN $0.125 per share to CDN $0.05
per share in the fourth quarter of 2001. This reduction was made to conserve
cash because of short-term uncertainty in the North American steel industry.
This dividend rate has been retained due to continued uncertainty.
Even though there are no maintenance interest coverage restrictions related to
IPSCO's current borrowings, the number of times that the Company's earnings
before interest and taxes can cover its interest on long-term debt ("interest
coverage") is an important indication of its ability to issue additional
long-term debt.
Interest incurred, capitalized and charged to earnings in 2002, 2001, and 2000
are as follows:
- --------------------------------------------------------------------------------
2000 2001 2002
- --------------------------------------------------------------------------------
(millions)
Incurred $23.8 $26.1 $23.1
Capitalized -- 19.5 16.2
- --------------------------------------------------------------------------------
Charged to Earnings $23.8 $ 6.6 $ 6.9
================================================================================
IPSCO's interest coverage in 2002 decreased to 2.3 times from 2.6 times in 2001,
on an interest-incurred basis. The Mobile commissioning phase was completed in
2001 and no new major projects were initiated, therefore no interest was
capitalized in 2002.
23
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MANAGEMENT'S DISCUSSION AND ANALYSIS
- ------------------------------------
The most restrictive covenant in the Company's lending agreements with respect
to working capital requires that the Company maintain a working capital ratio of
1.5:1. The Company comfortably exceeded this requirement with working capital
ratios of 2.8:1 and 2.1:1 at the end of 2002 and 2001 respectively.
LIQUIDITY
The principal indicators of IPSCO's liquidity are its cash position and amounts
available to be drawn under its bank lines of credit.
The Company has a committed revolving term facility of $200.0 million to March
4, 2005, and had a 364-day facility of $50.0 million to February 18, 2003. These
lines of credit can be drawn at spreads over the Canadian prime rate, the U.S.
base rate, Canadian Bankers' Acceptances Reference Discount Rate or U.S. dollar
LIBOR, in either Canadian or U.S. funds, subject to maintaining the prescribed
working capital ratio and other financial covenants. At December 31, 2002,
$118.0 million was drawn under the term bank lines and there were no drawings
under the 364-day committed line. Letters of credit of $12.1 million were
outstanding. In 2003, $35.4 million of long-term debt will mature compared to
$21.1 million which was paid in 2002.
During 2002, IPSCO's cash position decreased by $14.6 million to $22.9 million
while the working capital ratio increased from 2.1:1 to 2.8:1.
As at December 31, 2002 the committed cost to complete in-process capital
projects was $5 million. As at the end of 2001, this amount was $4.7 million.
Management, for the second consecutive year, plans to control spending by
limiting 2003 investment to under $40 million for new and existing capital
programs.
Assuming continuing profitability, IPSCO expects that it will be able to finance
future expenditures from its cash position, cash from operations, and its bank
lines of credit but may also consider operating lease financing as well as
additional debt or equity financing as appropriate.
From time to time IPSCO makes use of interest rate swaps and foreign currency
contracts to manage the Company's interest rate and foreign exchange risks. At
the end of December 2002, the Company did not have any such contracts
outstanding. The Company has entered into a swap agreement to hedge the cost of
purchasing natural gas. The agreement fixes the price the Company must pay for
1,500 gigajoules per day through October 31, 2004. As at December 31, 2002 the
unrealized loss under the swap agreement was $0.1 compared to an unrealized loss
of $1.9 million at the end of 2001.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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COMMITMENTS
The Company had ongoing commitments under various contractual and commercial
obligations at December 31, 2002, as follows:
- --------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS (MILLIONS) PAYMENTS DUE BY PERIOD
- --------------------------------------------------------------------------------
Less than 1 to 3 4 to 5 After
Total 1 year years years 5 years
Long-term debt $378 $ 35 $247 $ 43 $ 53
Operating leases 234 30 60 37 107
Other long-term obligations 292 45 107 59 81
- --------------------------------------------------------------------------------
Total contractual cash obligations $904 $110 $414 $139 $241
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OFF-BALANCE SHEET ARRANGEMENTS
IPSCO's only significant off-balance sheet arrangements are related to the sale
and leaseback of certain equipment and letters of credit. The sale and leaseback
arrangements originally totalled $173 million, the most significant being the
$150 million sale and leaseback of the Montpelier Steelworks meltshop and slab
caster, completed in 2000. For Canadian GAAP purposes this transaction was
treated as a sale, and the subsequent lease payments as operating expenses. For
U.S. GAAP purposes this transaction was recorded as a financing lease, with no
recognition of the disposal of the assets. See Note 19 "Commitments" and Note 21
"Significant Differences Between Canadian and United States Generally Accepted
Accounting Principles" of the 2002 financial statements for further information.
The Company's letters of credit have been previously referred to.
OUTLOOK
Developments in the overall condition of the North American steel business have
been well documented through 2002. The end user demand for steel products in
IPSCO's target markets has been flat or declining through the year. The impact
of the slowing capital goods economy, overlaid with inventory adjustments
through the distribution chain, resulted in an inverted saucer-shaped pattern of
demand for IPSCO steel products over the last 12 months. Entering 2003 the steel
products demand picture appears to be flat at best with some expectations of an
improving industrial economy as overall economic recovery occurs. Within this
weak demand environment IPSCO continues to consolidate market share gains and to
adjust its product mix based on profitability determinations.
Non-energy tubular product demand follows patterns similar to steel mill
products demand including the significant distribution channel impact. Energy
tubular product demand lagged expectations through 2002 given the underlying oil
and natural gas price environment. Outside of the general steel demand pattern
however there has been a more sustained pick-up in the demand for OCTG products,
starting in December 2002 in Canada and continuing into the first quarter of
2003.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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The major changes in the market for IPSCO products in 2003 however are likely to
be on the steel supply side. Significant structural change in the industry has
started with major consolidation activity. While most of this activity has had a
limited direct impact on IPSCO's major markets this process is still at an early
stage and the final outcome is not apparent. In addition the trade issues in
steel continue to attract attention both within North America and
internationally. To date there appears to be little tangible progress in dealing
with excess global capacity. Rapidly shifting patterns of steel sector ownership
and production internationally, along with the impact of exchange rates and
quota, tariff and other import controlling measures, is resulting in the
potential for a continued unsettled pattern of steel trade flows. Within the
U.S. the 201 safeguard action is entering year two of its three year cycle with
periodic reviews attracting considerable pressure from parties opposed to the
President's steel program.
Through all of this restructuring of the North American and international steel
industry, IPSCO, based on its world-class facilities, expects to continue to
gain market share in the North American steel market.
Pricing is the result of all of the issues noted above. Given the essentially
flat or declining demand and uncertainties on the supply side, IPSCO anticipates
that the pricing for the majority of its products will be under pressure
throughout 2003. Significant downward pressure would result from a further
stalled economy or revitalized competitor. It is anticipated however that any
further significant downward movement in pricing would be short lived based on
the limited capability of the industry producers to sustain such lower prices.
Likewise, meaningful price increases will require a more active economy or a
material reduction in supply capacity aimed at those markets. Over the next
several months IPSCO expects prices, particularly for steel mill products, to
decline from fourth quarter 2002 levels based on the competitive pressures noted
earlier. However they will be above first half 2002-price levels, which were at
record lows. As part of its overall growth plans IPSCO continues to advance its
product mix towards higher priced, value added products.
The overall outlook then is one filled with considerable uncertainty based on
macro trends. IPSCO's modern and effective supply capability will enable the
Company to deal with the anticipated fluctuations in the coming year and remain
very well positioned to take advantage as the economy picks up and the industry
itself is rationalized.
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