Unassociated Document
Filed
Pursuant to Rule 424(b)(1)
Registration
No. 333-138239
PROSPECTUS
Grupo
Simec, S.A.B. de C.V.
52,173,915 SERIES
B
COMMON SHARES
We
are
selling 30,000,000 series B shares in the form of American depositary shares,
or
ADSs, in an international offering. Concurrently, we are selling 22,173,915
series B shares in an offering in Mexico. Each ADS represents the right to
receive three series B shares. The ADSs will be evidenced by American depositary
receipts, or ADRs. The ADSs offered in the international offering may be
delivered in the form of series B shares. The offering price and underwriting
discounts and commissions in the international offering and the offering in
Mexico will be substantially equivalent. We have granted the underwriters and
the Mexican underwriters options to purchase up to an aggregate 7,826,085
additional series B shares, in each case, to cover over-allotments.
The
ADSs
are listed on the American Stock Exchange under the symbol “SIM”, and the series
B shares are listed on the Mexican Stock Exchange under the symbol “SIMEC.B”. On
February 6, 2007, the last reported sales price of the ADSs on the American
Stock Exchange was $13.65 per ADS, and the last reported sales price of the
series B shares on the Mexican Stock Exchange was Ps. 50.26 per series B
share.
Investing
in the ADSs and series B shares involves risks. See “Risk Factors” beginning
on
page 16.
Neither
the Securities and Exchange Commission nor any state securities commission
has
approved or disapproved of these securities or determined if this prospectus
is
truthful or complete. Any representation to the contrary is a criminal
offense.
|
|
Per
series B share
|
|
Per
ADS
|
|
Total
|
|
Public
Offering Price
|
|
Ps. |
45.70
|
|
$
|
12.50
|
|
$
|
217,391,313
|
|
Underwriting
Discount
|
|
Ps. |
1.1425
|
|
$
|
0.3125
|
|
$
|
5,434,783
|
|
Proceeds
to Grupo Simec, S.A.B. de C.V. (before
expenses)
|
|
Ps. |
44.5575
|
|
$
|
12.1875
|
|
$
|
211,956,530
|
|
The
underwriters expect to deliver the ADSs and series B shares to purchasers on
or
about February 13, 2007.
Citigroup
Co-Manager
Morgan
Stanley
February
8, 2007
You
should rely only on the information contained in this prospectus. We have not,
and the underwriters have not, authorized anyone to provide you with different
information. If anyone provides you with different information, you should
not
rely on it. We are not making an offer of these securities in any state where
the offer is not permitted. The information in this prospectus is accurate
only
as of the date of this prospectus.
TABLE
OF CONTENTS
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iv
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1
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16
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28
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29
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30
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31
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38
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39
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42
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46
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65
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94
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101
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102
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103
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114
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121
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125
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130
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131
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131
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131
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132
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F-1
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I-1
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PRESENTATION
OF FINANCIAL AND OTHER INFORMATION
Grupo
Simec, S.A.B. de C.V. is a corporation (sociedad
anónima bursatil de capital variable)
organized under the laws of the United Mexican States. Prior to October 24,
2006, our name was Grupo Simec, S.A. de C.V. (sociedad
anónima de capital variable).
Our
name change resulted from the recent amendment to our by-laws incorporating
the
provisions required by the Mexican Securities Market Law.
We
publish our financial statements in Mexican pesos and pursuant to accounting
principles generally accepted in Mexico (“Mexican GAAP”), which differ in
certain respects from accounting principles generally accepted in the United
States (“U.S. GAAP”). Note 19 to our audited consolidated financial statements
for the years ended December 31, 2005, 2004 and 2003 and Note 16 to our
unaudited condensed consolidated financial statements for the six-month period
ended June 30, 2006 provide a summary of the principal differences between
Mexican GAAP and U.S. GAAP as they relate to our business, along with a
reconciliation to U.S. GAAP of net income and stockholders’ equity, and
statements of changes in stockholders’ equity and, for the unaudited condensed
consolidated financial statements, of cash flows under U.S. GAAP.
Our
audited financial statements and all other financial information contained
herein with respect to the years ended December 31, 2005, 2004 and 2003 are
presented in constant pesos with purchasing power as of June 30, 2006, unless
otherwise noted. Our unaudited condensed consolidated interim financial
statements for the six-month period ended June 30, 2006, which include
comparative unaudited financial information for the six-month period ended
June
30, 2005, and all other financial information presented herein with respect
to
the six-month periods ended June 30, 2006 and 2005 are presented in constant
pesos with purchasing power as of June 30, 2006.
We
have
announced our unaudited results of operations for the nine months ended
September 30, 2006. For a description of these unaudited results, see
Exhibit I beginning on page I-1. Since we have presented the unaudited
financial information set forth in Exhibit I in pesos of constant
purchasing power as of September 30, 2006, it is not directly comparable to
the financial information presented elsewhere in this prospectus, which unless
otherwise stated, we have presented in pesos of constant purchasing power as
of
June 30, 2006. The financial information presented elsewhere in this
prospectus stated in pesos of constant purchasing power as of June 30, 2006
would require the application of a restatement factor of 1.018 for such
financial information to be comparable with the unaudited financial information
presented in Exhibit I. We do not believe that the application of such
factor represents a material change in the purchasing power of the Mexican
peso
during this period.
In
August
2004, we and our subsidiary, Compañía Siderúrgica de California, S.A. de C.V.
acquired certain of the Mexican assets of Industrias Ferricas del Norte, S.A.
(Corporación Sidenor of Spain or “Grupo Sidenor”). These assets consisted of
steel production facilities in Apizaco and Cholula (the “Atlax Acquisition”).
The purchase price of these assets was approximately U.S.$120 million. Our
consolidated financial statements reflect the Atlax Acquisition as of August
1,
2004. We consummated the Atlax Acquisition on August 9, 2004. We have not
included separate financial information relating to the Atlax Acquisition in
this prospectus.
In
July
2005, we and our controlling shareholder, Industrias CH, S.A.B. de C.V.
(“Industrias CH”), acquired 100% of the stock of PAV Republic, Inc.
(“Republic”), a producer of special bar quality (“SBQ”) steel in the United
States. We acquired 50.2% of Republic’s stock through our majority owned
subsidiary, SimRep Corporation (“SimRep”), and Industrias CH purchased the
remaining 49.8% through its minority ownership interest in SimRep.
We
have
included in this prospectus the audited consolidated financial statements of
Republic for the year ended December 31, 2004 and for the period from
January 1, 2005 through July 22, 2005 prepared in accordance with U.S.
GAAP. We also have included in this prospectus unaudited pro forma condensed
combined statements of income reflecting our and Republic’s combined accounts on
a pro forma basis for the year ended December 31, 2005 and for the six-month
period ended June 30, 2005. These pro forma financial statements are unaudited
and may not be indicative of the results of operations that we actually would
have achieved had we acquired Republic at the beginning of the periods presented
and do not purport to be indicative of future results. We have prepared these
unaudited pro forma condensed combined statements of income in accordance with
Mexican GAAP, which differs in certain respects from U.S. GAAP and included
a
reconciliation to U.S. GAAP net income.
Certain
market data and other statistical information used throughout this prospectus
are based on third party sources, and other data is based on estimates, which
are derived from our review of internal surveys, as well as independent
sources. Although we believe that these sources are reliable, we have not
independently verified the information and cannot guarantee its accuracy or
completeness.
References
in this prospectus to “dollars”, “U.S. dollars”, “$” or “U.S.$” are to the
lawful currency of the United States. References in this prospectus to “pesos”,
“Pesos” or “Ps.” are to the lawful currency of Mexico. References to “tons” in
this prospectus refer to metric tons; a metric ton equals 1,000 kilograms or
2,204 pounds. We publish our financial statements in Pesos.
The
terms
“special bar quality steel” or “SBQ steel” refer to steel that is hot rolled or
cold finished round square and hexagonal steel bars that generally contain
higher proportions of alloys than lower quality grades of steel. SBQ steel
is
produced with precise chemical specifications and generally is made to order
following client specifications.
This
prospectus contains translations of certain peso amounts to U.S. dollars at
specified rates solely for your convenience. These translations do not mean
that
the peso amounts actually represent such dollar amounts or could be converted
into U.S. dollars at the rate indicated. Unless otherwise indicated, we have
translated these U.S. dollar amounts from pesos at the exchange rate of Ps.
11.3973 per U.S.$1.00, the interbank transactions rate in effect on June 30,
2006. On February
6, 2007, the interbank transactions rate for the Peso was Ps. 10.982 per
U.S.$1.00.
The
following table sets forth, for the periods indicated, the high, low, average
and period-end, free-market exchange rate expressed in pesos per U.S. dollar.
The average annual rates presented in the following table were calculated by
using the average of the exchange rates on the last day of each month during
the
relevant period. The data provided in this table is based on noon buying rates
published by the Federal Reserve Bank of New York for cable transfers in Mexican
pesos. We have not restated the rates in constant currency units. All amounts
are stated in pesos. We make no representation that the Mexican peso amounts
referred to in this prospectus could have been or could be converted into U.S.
dollars at any particular rate or at all.
Exchange
Rates
Year
Ended December 31
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High
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Low
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Average
(1)
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Period
End
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2002
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10.43
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9.00
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9.66
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10.43
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2003
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11.41
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10.11
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10.79
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11.24
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2004
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11.64
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10.81
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11.29
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11.15
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2005
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11.41
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10.41
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10.89
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10.63
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2006:
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August
2006
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11.02
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10.74
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10.87
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10.91
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September
2006
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11.10
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10.84
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10.99
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10.98
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October
2006
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11.06
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10.71
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10.89
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10.77
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November
2006
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11.05
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10.75
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10.91
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11.01
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December
2006
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10.99
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10.77
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10.85
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10.80
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2007:
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January
2007
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11.09
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10.77
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10.96
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11.04
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February
2007(2)
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11.00
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10.92
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10.96
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10.92
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_____________
(1)
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Average
of month-end or period-end rates or daily rates, as applicable.
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(2)
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Through
February 6, 2007.
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Except
for the period from September through December 1982, during a liquidity crisis,
the Mexican Central Bank has consistently made foreign currency available to
Mexican private-sector entities (such as us) to meet their foreign currency
obligations. Nevertheless, in the event of renewed shortages of foreign
currency, there can be no assurance that foreign currency would continue to
be
available to private-sector companies or that foreign currency needed by us
to
service foreign currency obligations or to import goods could be purchased
in
the open market without substantial additional cost.
Fluctuations
in the exchange rate between the peso and the U.S. dollar will affect the U.S.
dollar value of securities traded on the Mexican Stock Exchange, including
the
series B shares and, as a result, will likely affect the market price of the
ADSs. Such fluctuations will also affect the U.S. dollar conversion by the
depositary of any cash dividends paid in pesos on series B shares represented
by
ADSs.
This
section summarizes selected information contained elsewhere in this prospectus
and is qualified in its entirety by the more detailed information and financial
statements included elsewhere in this prospectus. This prospectus includes
specific terms of the ADSs and the series B shares that we are offering, as
well
as information regarding our business and detailed financial information. You
should carefully review the entire prospectus, including the risk factors,
the
financial statements and the notes related thereto and the other documents
to
which this prospectus refers, before making an investment
decision.
Unless
the context requires otherwise, when used in this prospectus, the terms “we”,
“our” and “us” refer to Grupo Simec, S.A.B. de C.V., together with its
consolidated subsidiaries.
Our
Company
We
are a
diversified manufacturer, processor and distributor of special bar quality
(“SBQ”) steel and structural steel products with production and commercial
operations in the United States, Mexico and Canada.
We
believe that we are the leading producer of SBQ products in North America,
with
leading market positions in both the United States and Mexico and that we offer
the broadest SBQ product range in those markets today. We also believe that
we
are the leading producer of structural and light structural steel products
in
Mexico and have an increasing presence in the U.S. market. In the first half
of
2006, almost all of our consolidated sales were in the North American market,
27.9% in Mexico, 71.9% in the United States and Canada. The remaining 0.2%
of
our consolidated sales were exports to other markets outside North America.
Our
SBQ
products are used across a broad range of highly engineered end-user
applications, including axles, hubs and crankshafts for automobiles and light
trucks, machine tools and off-highway equipment. Our structural steel products
are mainly used in the non-residential construction market and other
construction applications.
We
focus
on the Mexican and U.S. specialty steel markets by providing high value added
products and services from our strategically located plants. The quality of
our
products and services, together with the cost advantage generated by our
facility locations has allowed us to develop long standing relationships with
most of our SBQ clients, which include U.S. and Mexico based automotive and
industrial equipment manufacturers and their suppliers. In addition, our
facilities located in the North West and Central parts of Mexico allow us to
serve the structural steel and construction markets in those regions and
southwest California with a significant advantage in the cost of freight.
In
Mexico, the United States and Canada, we own and operate ten state of the art
steel making, processing and/or finishing facilities with a combined annual
crude steel installed production capacity of 3.4 million tons and a combined
annual installed rolling capacity of 2.9 million tons. We operate both mini-mill
and integrated steel making facilities, which gives us the flexibility to
optimize our production and reduce production costs based on the relative prices
of raw materials (e.g., scrap for our mini-mills and iron ore for our blast
furnace).
In
the
first half of 2006, we had net sales of Ps. 11.9 billion, marginal profit of
Ps.
2.2 billion and net income attributable to majority interest of Ps. 1.3 billion.
In 2005, we had net sales of Ps. 13.0 billion, marginal profit of Ps. 2.6
billion and net income attributable to majority interest of Ps. 1.3
billion.
The
chart
outlines our corporate structure:
(1)
|
Includes
the following non-operating subsidiaries: Compañía Siderúrgica del
Pacífico, S.A. de C.V. (99.99%), Coordinadora de Servicios Siderúrgicos de
Calidad, S.A. de C.V. (100%), Administradora de Servicios de la Industria
Siderúrgica ICH, S.A. de C.V. (99.99%), Industrias del Acero y del
Alambre, S.A. de C.V. (99.99%), Procesadora Mexicali, S.A. de C.V.
(99.99%), Servicios Simec, S.A. de C.V. (100%), Sistemas de Transporte
de
Baja California, S.A. de C.V. (100%), Operadora de Metales, S.A.
de C.V.
(100%), Operadora de Servicios Siderúrgicos de Tlaxcala, S.A. de C.V.
(100%), Administradora de Servicios Siderúrgicos de Tlaxcala, S.A. de C.V.
(100%), Operadora de Servicios de la Industria Siderúrgica ICH, S.A. de
C.V. (100%), Arrendadora Simec S.A. de C.V. (100%), Controladora
Simec
S.A. de C.V. (100%) and Compañía Siderúrgica de Guadalajara S.A. de C.V.
(100%).
|
(2)
|
Our
principal Mexican facilities consist of steel-making facilities in
Guadalajara, Jalisco, Mexicali, Baja California, and Apizaco, Tlaxcala,
and a cold finishing facility in Cholula,
Puebla.
|
(3)
|
The
remaining 49.8% of SimRep Corporation is owned by our controlling
shareholder, Industrias CH, S.A.B. de
C.V.
|
(4)
|
SimRep
owns 100% of Republic Engineered Products. Our principal U.S. and
Canadian
facilities consist of a steel-making facility in Canton, Ohio, a
steel-making and hot-rolling facility in Lorain, Ohio, a hot-rolling
facility in Lackawanna, New York, and cold finishing facilities in
Massillon, Ohio, Gary, Indiana, and Hamilton, Ontario,
Canada.
|
Our
Competitive Strengths
We
believe the following are our principal competitive strengths:
Leading
SBQ producer in North America.
We
believe we have been the leading market producer and supplier of SBQ steel
in
Mexico since August 2004 and in the United States since July 2005. In 2005,
we
supplied approximately 28% of the Mexican market and 20% of the U.S.
market.
Higher
value-added product mix.
To
maximize operating margins, we focus our production on higher value-added SBQ
products, which represented 79% of our total sales in the first six months
of
2006.
Long-standing
customer relationships.
Our
SBQ
products are highly engineered and tailored to specific client needs. We
continuously work with our clients on design engineering and new product
development to meet the requirements of their evolving platforms. We believe
that the quality of our products and services allows us to develop long lasting
direct relationships with the largest end-users of SBQ products in North
America, which, we believe, increases switching costs and improves our
competitive position.
Reduced
price volatility.
The
quality requirements of the majority of our SBQ clients and the nature of our
relationships have allowed us to implement favorable pricing policies that
include annual price revisions and price adjustments based on the price of
key
inputs such as scrap, iron ore, energy, alloys and other key raw materials.
These contribute to maintaining operating margins against raw material price
fluctuations relatively stable.
Competitive
cost structure.
We
believe our cost structure is highly favorable due to our:
|
·
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Competitive
cost of raw materials. We
believe our centralized purchasing strategy and strong financial
position
allow us to obtain favorable terms from our raw materials
suppliers.
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·
|
Low
freight expenses. We
believe the strategic location of our facilities allows us to serve
our
SBQ steel and other clients with lower distribution and freight costs
than
most of our competitors.
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|
·
|
Relatively
low cost of labor in Mexico. Our
Mexican operations benefit from the relatively lower cost of labor
in the
Mexican market compared to the United States. In addition, our Mexican,
U.S. and Canadian operations do not currently have any significant
legacy
liabilities or their associated
costs.
|
|
·
|
Favorable
labor agreement in the United States. The
labor agreement in place in our U.S. operations has eliminated legacy
costs and enhances our ability to maximize workforce flexibility,
allowing
us to reduce production costs.
|
|
·
|
Lean
operational structure and overhead cost. We
maintain non-operating costs at low levels by relying on a lean and
cost
efficient overhead structure.
|
State-of-the-art
production facilities.
We
have
recently completed the revamping of our mini-mill steel-making facility in
Canton, Ohio including the installation of a new continuous caster. We believe
that our remaining steel making and processing facilities in Mexico and the
United States are among the most modern and well maintained in North
America.
Extensive
track record of profitable growth.
Over
the
last two years we have significantly increased our installed capacity through
the acquisition of Republic and of plants in Tlaxcala and Cholula, Mexico.
As a
result of these acquisitions, organic growth and operational improvements,
we
have increased our installed capacity from 0.7 million tons as of December
31,
2003 to 3.4 million tons of crude steel as of June 30, 2006.
Significant
organic growth opportunities.
Our
liquid steel making capacity exceeds our rolling and finished steel capacity,
which allows us to continue increasing our finished product capacity through
comparatively low levels of capital investments. We intend to pursue this option
and plan to invest approximately U.S.$250 million in a rolling mill with an
annual capacity of 600,000 tons in our facilities. We also intend to explore
expanding our liquid steel-making facilities in Lorain, Ohio by bringing an
existing second blast furnace online at a cost significantly lower than that
of
purchasing a new blast furnace with the same capacity.
Solid
financial position.
We
seek
to maintain a conservative capital structure and prudent leverage levels. We
currently have no significant financial debt or significant legacy liabilities.
We believe that these factors, combined with our strong cash flow generation,
provide us with the financial flexibility and resources to continue to pursue
growth enhancing initiatives.
Experienced
and committed management team.
Our
management team has extensive experience in, and knowledge of, the North
American steel industry and in evaluating, pursuing and completing both
strategic and organic growth opportunities as well as a track-record of
increasing productivity and reducing costs.
Our
Business Strategy
We
intend
to consolidate further our position as a leading producer, processor and
distributor of SBQ steel in North America and structural steel in Mexico. We
also intend to expand our overall presence in the steel industry by identifying
and pursuing growth opportunities and value enhancing initiatives. Our strategy
includes:
Further
integrating our operations.
We
intend
to continue the integration of our Mexican, U.S. and Canadian operations to
capitalize on the commercial and cost related synergies contemplated at the
time
of the Atlax Acquisition in 2004 and the acquisition of Republic in
2005.
Improving
our cost structure.
We
have
substantially reduced our operating cost and non-operating expenses and plan
to
continue to do so by reducing overhead expenses and operating costs through
sharing best practices among our operating facilities and maintaining a
conservative capital structure.
Focusing
on high margin and value-added products.
We
prioritize the production of high margin steel products over volume and
utilization levels. We plan to continue to base our production decisions on
achieving relatively high margins.
Building
on our strong customer relationships.
We
intend
to strengthen our long-standing customer relationships by maintaining strong
customer service and proactively responding to changing customer
needs.
Pursuing
strategic growth opportunities.
We
have
successfully grown our business by acquiring, integrating and improving under-
performing operations. In addition, we intend to continue in pursuit of
acquisition opportunities that will allow for disciplined growth of our business
and value creation for our shareholders. We also intend to pursue organic growth
by reinvesting the cash that our operating activities generate to expand the
capacity and increase the efficiency of our existing facilities.
Risks
Related to Our Business
Our
business is subject to certain risks that could impact our competitive position
and strengths, as well as our ability to execute our business strategy. Many
of
these risks are beyond our control, such as factors affecting the global demand
for steel products, our exposure to the fluctuations in the cost of raw
materials, our dependence on a limited number of key suppliers of raw materials
and the cyclical nature of the industries and markets that we serve.
Furthermore, these risks include those generally associated with being a
producer of steel products in Mexico, the United States and Canada, including
foreign exchange exposure and political risk. Intense competition from other
steel producers could reduce our market share in the countries where we operate,
and the capital intensive nature of the steel industry. Our dependence on the
availability of capital resources to continue to modernize and upgrade our
facilities and to expand our operations could affect the implementation of
our
strategy. For additional risks relating to our business and this offering,
see
“Risk Factors” beginning on page 16 of this prospectus.
The
Offering
Issuer
|
|
Grupo
Simec, S.A.B. de C.V.
|
|
|
|
Securities
offered
|
|
A
total of 52,173,915 series B shares which include 30,000,000 series
B
shares in the form of ADSs in an international offering and 22,173,915
series B shares in an offering in Mexico.
|
|
|
|
Public
offering price per series B share
|
|
Ps.
45.70
|
|
|
|
Public
offering price per ADS
|
|
$12.50
|
|
|
|
International
offering
|
|
The
underwriters are offering an aggregate amount of 30,000,000 series
B
shares in the form of ADSs in the United States and other countries
outside of Mexico.
|
|
|
|
Mexican
offering
|
|
Simultaneously
with the international offering, the Mexican underwriters are offering
an
aggregate amount of 22,173,915 series B shares in a public offering
in
Mexico.
|
|
|
|
ADSs
|
|
Each
ADS represents three series B shares. The ADSs will be evidenced
by
American depositary receipts, or ADRs, issued under the deposit agreement.
ADRs are certificates that evidence ADSs, just as share certificates
evidence a holding of shares in a company. See “Description of American
Depositary Receipts”.
|
|
|
|
Trading
market for series B shares
|
|
The
series B shares are listed on the Mexican Stock Exchange under the
symbol
“SIMEC.B”.
|
|
|
|
Trading
market for ADSs
|
|
The
ADSs are listed on the American Stock Exchange under the symbol
“SIM”.
|
|
|
|
Use
of proceeds
|
|
We
expect to use the net proceeds from the sale of the ADSs and series
B
shares for general corporate purposes, including investments in fixed
assets aimed at increasing our installed capacity in our core business
as
well as potential acquisitions intended to increase our market share
and
complement our business strategy.
|
|
|
|
Depositary
|
|
The
Bank of New York
|
|
|
|
Expected
offering timetable
|
|
Expected
pricing date: February 8, 2007
|
|
|
|
|
|
Expected
closing date: February 13, 2007
|
Settlement
|
|
Settlement
of the series B shares will be made through the book-entry system
of S.D.
Indeval, S.A. de C.V., Institución
para el Depósito de Valores
(“INDEVAL”). Settlement of the ADSs will be made through the book-entry
system of The Depository Trust Company, or DTC.
|
|
|
|
Lock-up
provision
|
|
We,
our officers and directors and our principal shareholders have agreed
that, for a period of 180 days from the date of this prospectus, we
and they will not, without the prior written consent of the representative
of the underwriters, dispose of or hedge any series B shares or any
securities convertible into or exchangeable for our series B shares.
The
representative of the underwriters, in its sole discretion, may release
any of the securities subject to these lock-up agreements at any
time
without notice. See “Underwriting”.
|
|
|
|
Voting
rights
|
|
Each
series B share will entitle the holder to one vote at any shareholders’
meeting. ADS holders may instruct the depositary how to exercise
the
voting rights of the shares represented by the ADSs. For the benefit
of
ADS holders, we have agreed to notify the depositary of any shareholders’
meetings, and the depositary has agreed to mail notices of these
meetings
to ADS holders and explain the procedures necessary to exercise voting
rights. See “Description of American Depositary Receipts” and “Description
of Capital Stock” for a discussion of the depositary's role, our agreement
with the depositary and your voting rights.
|
|
|
|
Dividend
policy
|
|
We
have not paid dividends in the past and currently do not intend to
pay
dividends in the near future. See “Dividends and Dividend Policy”.
|
|
|
|
Taxation
|
|
Under
current Mexican law, dividends paid to holders who are not residents
of
Mexico for tax purposes, and sales of ADSs by ADS holders who are
not
residents of Mexico for tax purposes, are not subject to any Mexican
withholding or other similar tax. See “Taxation” for a discussion of
Mexican tax issues related to payment of dividends and disposition
of the
series B shares or the ADSs.
|
|
|
|
Risk
Factors
|
|
Investing
in the ADSs and series B shares involves a high degree of risk. You
should
carefully read and consider the information set forth under the heading
“Risk Factors” and all other information set forth in this prospectus
before investing in the series B shares or the
ADSs.
|
Summary
Consolidated Financial Information
The
following tables present our summary consolidated financial information for
each
of the periods indicated. This information should be read in conjunction with,
and is qualified in its entirety by reference to, our financial statements,
including the notes thereto, as well as “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” included elsewhere in this
prospectus. Our financial statements are prepared in accordance with Mexican
GAAP, which differs in certain respects from U.S. GAAP. Note 19 to our audited
consolidated financial statements for the years ended December 31, 2005, 2004
and 2003 and Note 16 to our unaudited condensed consolidated financial
statements for the six-month period ended June 30, 2006 provide a summary of
the
principal differences between Mexican GAAP and U.S. GAAP as they relate to
our
business, along
with a reconciliation to U.S. GAAP of net income and stockholders’ equity, a
statement of changes in stockholders’ equity and, for the unaudited condensed
consolidated financial statements, a statement of cash flows under U.S.
GAAP.
Mexican
GAAP provides for the recognition of certain effects of inflation by restating
non-monetary assets and non-monetary liabilities using the Mexican National
Consumer Price Index, restating the components of stockholders’ equity using the
Mexican National Consumer Price Index and recording gains or losses in
purchasing power from holding monetary liabilities or assets. Mexican GAAP
also
requires the restatement of all financial statements to constant Mexican pesos
as of the date of the most recent balance sheet presented. Our audited financial
statements and all other financial information contained herein with respect
to
the years ended December 31, 2001, 2002, 2003, 2004 and 2005 are accordingly
presented in constant pesos with purchasing power as of June 30, 2006, unless
otherwise noted. Our unaudited condensed interim financial statements for the
six-month period ended June 30, 2006, which include comparative unaudited
financial information for the six-month period ended June 30, 2005, and all
other financial information presented herein with respect to the six-month
periods ended June 30, 2006 and 2005 are presented in constant pesos with
purchasing power as of June 30, 2006. Our results of operations for the
six-month period ended June 30, 2006 are not necessarily indicative of our
expected results of operations for the year ended December 31, 2006 and should
not be construed as such.
The
financial information includes the consolidation of Republic from July 22,
2005 and the consolidation of the Atlax Acquisition from August 1, 2004. Period
to period comparison of our results of operations and financial condition is
made more difficult as a result of the inclusion of financial information
relating to the acquisition of Republic only from July 22, 2005 and of financial
information relating to the Atlax Acquisition only from August 1,
2004.
We
have
derived the selected financial and operating information set forth below in
part
from our consolidated financial statements, which have been reported on by
KPMG
Cárdenas, Dosal, S.C. for the fiscal years ended December 31, 2001, 2002, 2003
and 2004 and by Mancera S.C., a Member Practice of Ernst & Young Global, an
independent registered public accounting firm for the fiscal year ended December
31, 2005. In so doing, Mancera, S.C. has relied on the audited consolidated
financial statements of our subsidiary SimRep and its subsidiaries, reported
on
by BDO
Hernández Marrón y Cía., S.C., a member firm of BDO International.
For
unaudited selected consolidated financial information as of September 30, 2006
and for the nine month periods ended September 30, 2005 and 2006, and a
discussion of our unaudited financial results for the nine month periods ended
September 30, 2005 and 2006, which are presented in pesos of constant
purchasing power as of September 30, 2006, see Exhibit I to this
prospectus. Since the unaudited financial information set forth in
Exhibit I is presented in pesos of constant purchasing power as of
September 30, 2006, it is not directly comparable to the financial
information presented elsewhere in this prospectus, which
unless otherwise stated, is presented in pesos of constant purchasing power
as
of June 30, 2005. The financial information presented elsewhere in this
prospectus stated in pesos of constant purchasing power as of June 30, 2006
would require the application of a restatement factor
of
1.018
for such financial information to be comparable with the unaudited financial
information presented in Exhibit I. We do not believe that the application
of such factor represents a material change in the purchasing power of the
Mexican peso during this period.
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
|
|
(except
per share and per ADS data)
|
|
Income
Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
2,288
|
|
|
2,403
|
|
|
3,047
|
|
|
5,910
|
|
|
12,967
|
|
|
1,138
|
|
|
3,574
|
|
|
11,912
|
|
|
1,045
|
|
Direct
cost of sales
|
|
|
1,536
|
|
|
1,608
|
|
|
2,002
|
|
|
3,435
|
|
|
10,371
|
|
|
910
|
|
|
2,327
|
|
|
9,682
|
|
|
849
|
|
Marginal
profit
|
|
|
752
|
|
|
795
|
|
|
1,045
|
|
|
2,475
|
|
|
2,596
|
|
|
228
|
|
|
1,247
|
|
|
2,230
|
|
|
196
|
|
Indirect
manufacturing, selling, general and administrative
expenses
|
|
|
376
|
|
|
327
|
|
|
308
|
|
|
371
|
|
|
692
|
|
|
61
|
|
|
244
|
|
|
462
|
|
|
41
|
|
Depreciation
and amortization
|
|
|
160
|
|
|
177
|
|
|
199
|
|
|
222
|
|
|
326
|
|
|
29
|
|
|
131
|
|
|
202
|
|
|
18
|
|
Operating
income
|
|
|
216
|
|
|
291
|
|
|
538
|
|
|
1,882
|
|
|
1,578
|
|
|
138
|
|
|
872
|
|
|
1,566
|
|
|
137
|
|
Financial
income (expense)
|
|
|
6
|
|
|
(141
|
)
|
|
(27
|
)
|
|
(38
|
)
|
|
(145
|
)
|
|
(13
|
)
|
|
(35
|
)
|
|
45
|
|
|
4
|
|
Other
income (expense), net
|
|
|
73
|
|
|
(41
|
)
|
|
(32
|
)
|
|
(38
|
)
|
|
55
|
|
|
5
|
|
|
8
|
|
|
33
|
|
|
3
|
|
Income
before taxes, employee profit sharing and minority
interest
|
|
|
295
|
|
|
109
|
|
|
479
|
|
|
1,806
|
|
|
1,488
|
|
|
131
|
|
|
845
|
|
|
1,644
|
|
|
144
|
|
Income
tax expense and employee profit sharing
|
|
|
19
|
|
|
(25
|
)
|
|
159
|
|
|
344
|
|
|
191
|
|
|
17
|
|
|
98
|
|
|
105
|
|
|
9
|
|
Net
income (loss)
|
|
|
276
|
|
|
134
|
|
|
320
|
|
|
1,462
|
|
|
1,297
|
|
|
114
|
|
|
747
|
|
|
1,539
|
|
|
135
|
|
Minority
interest
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
17
|
|
|
2
|
|
|
0
|
|
|
193
|
|
|
17
|
|
Majority
interest
|
|
|
276
|
|
|
134
|
|
|
320
|
|
|
1,462
|
|
|
1,280
|
|
|
112
|
|
|
747
|
|
|
1,346
|
|
|
118
|
|
Net
income per share
|
|
|
2
|
|
|
0.4
|
|
|
1
|
|
|
4
|
|
|
3
|
|
|
0.27
|
|
|
2
|
|
|
3
|
|
|
0.28
|
|
Net
income per ADS (2)
|
|
|
5
|
|
|
1
|
|
|
3
|
|
|
11
|
|
|
9
|
|
|
0.81
|
|
|
6
|
|
|
10
|
|
|
0.84
|
|
Weighted
average shares outstanding (thousands)(5)
|
|
|
164,448
|
|
|
299,901
|
|
|
357,159
|
|
|
398,916
|
|
|
413,790
|
|
|
|
|
|
405,209
|
|
|
419,451
|
|
|
|
|
Weighted
average ADSs outstanding
(thousands)
|
|
|
54,816
|
|
|
99,967
|
|
|
119,053
|
|
|
132,972
|
|
|
137,930
|
|
|
|
|
|
135,070
|
|
|
139,817
|
|
|
|
|
U.S.
GAAP including effects of inflation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
2,288
|
|
|
2,403
|
|
|
3,048
|
|
|
5,911
|
|
|
12,967
|
|
|
1,138
|
|
|
3,573
|
|
|
11,912
|
|
|
1,045
|
|
Direct
cost of sales
|
|
|
1,530
|
|
|
1,612
|
|
|
2,007
|
|
|
3,429
|
|
|
10,375
|
|
|
910
|
|
|
2,329
|
|
|
9,594
|
|
|
842
|
|
Marginal
profit
|
|
|
758
|
|
|
791
|
|
|
1,041
|
|
|
2,482
|
|
|
2,592
|
|
|
228
|
|
|
1,244
|
|
|
2,318
|
|
|
203
|
|
Operating
income(4)
|
|
|
200
|
|
|
255
|
|
|
544
|
|
|
1,865
|
|
|
1,544
|
|
|
135
|
|
|
875
|
|
|
1,660
|
|
|
146
|
|
Financial
income (expense)
|
|
|
7
|
|
|
(141
|
)
|
|
(27
|
)
|
|
(38
|
)
|
|
(145
|
)
|
|
(13
|
)
|
|
(35
|
)
|
|
45
|
|
|
4
|
|
Other
income (expense), net
|
|
|
657
|
|
|
(74
|
)
|
|
(32
|
)
|
|
(4
|
)
|
|
93
|
|
|
8
|
|
|
8
|
|
|
33
|
|
|
3
|
|
Income
before taxes, employee profit sharing and minority interest
|
|
|
864
|
|
|
40
|
|
|
485
|
|
|
1,823
|
|
|
1,492
|
|
|
130
|
|
|
848
|
|
|
1,737
|
|
|
152
|
|
Income
tax expense (income)
|
|
|
69
|
|
|
(182
|
)
|
|
207
|
|
|
389
|
|
|
197
|
|
|
17
|
|
|
102
|
|
|
118
|
|
|
10
|
|
Income
before minority interest
|
|
|
795
|
|
|
222
|
|
|
278
|
|
|
1,434
|
|
|
1,295
|
|
|
113
|
|
|
746
|
|
|
1,619
|
|
|
142
|
|
Minority
interest
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
17
|
|
|
1
|
|
|
0
|
|
|
193
|
|
|
17
|
|
U.S.
GAAP Adjustment on minority interest
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
40
|
|
|
3
|
|
Net
Income
|
|
|
795
|
|
|
222
|
|
|
278
|
|
|
1,434
|
|
|
1,278
|
|
|
112
|
|
|
746
|
|
|
1,386
|
|
|
125
|
|
Income
per share (5)
|
|
|
5
|
|
|
1
|
|
|
1
|
|
|
4
|
|
|
3
|
|
|
0.27
|
|
|
2
|
|
|
3.3
|
|
|
0.30
|
|
Income
per ADS
|
|
|
14
|
|
|
2
|
|
|
2
|
|
|
11
|
|
|
9
|
|
|
0.81
|
|
|
6
|
|
|
10
|
|
|
0.89
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
|
5,557
|
|
|
5,035
|
|
|
6,570
|
|
|
9,306
|
|
|
14,588
|
|
|
1,280
|
|
|
9,531
|
|
|
16,439
|
|
|
1,442
|
|
Total
long-term liabilities(3)
|
|
|
803
|
|
|
881
|
|
|
1,153
|
|
|
1,513
|
|
|
2,244
|
|
|
197
|
|
|
1,439
|
|
|
2,003
|
|
|
176
|
|
Total
stockholders’ equity
|
|
|
3,338
|
|
|
4,089
|
|
|
5,062
|
|
|
6,848
|
|
|
9,628
|
|
|
845
|
|
|
7,368
|
|
|
11,902
|
|
|
1,044
|
|
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
|
|
(except
per share and per ADS data)
|
|
U.S.
GAAP including effects of inflation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
|
6,507
|
|
|
6,228
|
|
|
6,497
|
|
|
9,173
|
|
|
14,796
|
|
|
1,298
|
|
|
9,548
|
|
|
16,421
|
|
|
1,441
|
|
Total
long-term liabilities(3)
|
|
|
803
|
|
|
914
|
|
|
1,097
|
|
|
1,476
|
|
|
2,303
|
|
|
202
|
|
|
1,426
|
|
|
1,974
|
|
|
173
|
|
Total
stockholders’ equity
|
|
|
3,949
|
|
|
4,338
|
|
|
5,045
|
|
|
6,752
|
|
|
7,969
|
|
|
699
|
|
|
7,442
|
|
|
9,613
|
|
|
843
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
46
|
|
|
10
|
|
|
65
|
|
|
1,285
|
|
|
503
|
|
|
44
|
|
|
6
|
|
|
167
|
|
|
15
|
|
Adjusted
EBITDA(6)
|
|
|
376
|
|
|
468
|
|
|
737
|
|
|
2,104
|
|
|
1,904
|
|
|
167
|
|
|
1,003
|
|
|
1,768
|
|
|
155
|
|
Depreciation
and amortization from continuing operations
|
|
|
160
|
|
|
177
|
|
|
199
|
|
|
222
|
|
|
326
|
|
|
29
|
|
|
131
|
|
|
202
|
|
|
18
|
|
Working
capital
|
|
|
(560
|
)
|
|
(11
|
)
|
|
1,023
|
|
|
1,968
|
|
|
4,063
|
|
|
356
|
|
|
2,907
|
|
|
5,854
|
|
|
514
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operational
information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual installed
capacity (thousands of tons)
|
|
|
730
|
|
|
730
|
|
|
730
|
|
|
1,210
|
|
|
2,847
|
|
|
|
|
|
1,210
|
|
|
2,902
|
|
|
|
|
Tons
shipped
|
|
|
561
|
|
|
609
|
|
|
628
|
|
|
773
|
|
|
1,708
|
|
|
|
|
|
524
|
|
|
1,369
|
|
|
|
|
Mexico
|
|
|
512
|
|
|
529
|
|
|
547
|
|
|
676
|
|
|
899
|
|
|
|
|
|
449
|
|
|
461
|
|
|
|
|
United
States, Canada and others
|
|
|
49
|
|
|
80
|
|
|
81
|
|
|
97
|
|
|
809
|
|
|
|
|
|
75
|
|
|
908
|
|
|
|
|
SBQ
steel
|
|
|
78
|
|
|
78
|
|
|
63
|
|
|
168
|
|
|
923
|
|
|
|
|
|
170
|
|
|
997
|
|
|
|
|
Structural
and other steel
products
|
|
|
483
|
|
|
531
|
|
|
565
|
|
|
605
|
|
|
785
|
|
|
|
|
|
352
|
|
|
372
|
|
|
|
|
Per
ton:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales per ton
|
|
|
4,080
|
|
|
3,943
|
|
|
4,851
|
|
|
7,644
|
|
|
7,591
|
|
|
666
|
|
|
6,825
|
|
|
8,699
|
|
|
763
|
|
Cost
of sales per ton
|
|
|
2,740
|
|
|
2,639
|
|
|
3,187
|
|
|
4,442
|
|
|
6,072
|
|
|
533
|
|
|
4,443
|
|
|
7,070
|
|
|
620
|
|
Operating
income per ton
|
|
|
385
|
|
|
476
|
|
|
857
|
|
|
2,435
|
|
|
924
|
|
|
81
|
|
|
1,666
|
|
|
1,144
|
|
|
100
|
|
Adjusted
EBITDA per ton
|
|
|
670
|
|
|
767
|
|
|
1,174
|
|
|
2,722
|
|
|
1,115
|
|
|
98
|
|
|
1,916
|
|
|
1,291
|
|
|
113
|
|
Number
of employees
|
|
|
1,386
|
|
|
1,333
|
|
|
1,288
|
|
|
2,018
|
|
|
4,360
|
|
|
|
|
|
1,975
|
|
|
|
|
|
4,340
|
|
(1)
|
Peso
amounts have been translated into U.S. dollars solely for the convenience
of the reader, at the rate of Ps. 11.3973 per $1.00, the interbank
transactions rate in effect on June 30,
2006.
|
(2)
|
Following
our stock split effective May 30, 2006, one ADS represents three
series B
shares; previously one ADS represented one series B
share.
|
(3)
|
Total
long-term liabilities include amounts relating to deferred
taxes.
|
(4)
|
Reflects
a reclassification in 2005 from other expenses under Mexican GAAP
to
operating expenses under U.S. GAAP of Ps. 38 million due to the
cancellation of technical
assistance.
|
(5)
|
For
U.S. GAAP and Mexican GAAP purposes, the weighted average shares
outstanding were calculated to give effect to the stock split described
in
Note 13(a) to the audited financial
statements.
|
(6)
|
Adjusted
EBITDA is not a financial measure computed under Mexican or U.S.
GAAP.
Adjusted EBITDA derived from our Mexican GAAP financial information
means
Mexican GAAP net income (loss) excluding (i) depreciation and
amortization, (ii) financial income (expense), net (which is composed
of
net interest expense, foreign exchange gain or loss and monetary
position
gain or loss), (iii) other income (expense) and (iv) income tax expense
and employee statutory profit-sharing
expense.
|
Adjusted
EBITDA does not represent, and should not be considered as, an alternative
to
net income, as an indicator of our operating performance, or as an alternative
to cash flow as an indicator of liquidity. In making such comparisons, however,
you should bear in mind that adjusted EBITDA is not defined and is not a
recognized financial measure under Mexican GAAP or U.S. GAAP and that it may
be
calculated differently by different companies and must be read in conjunction
with the explanations that accompany it. Adjusted EBITDA as presented in this
table does not take into account our working capital requirements, debt service
requirements and other commitments.
We
believe that adjusted EBITDA can be useful to facilitate comparisons of
operating performance between periods and with other companies in our industry
because it excludes the effect of (i) depreciation and amortization, which
represents a non-cash charge to earnings, (ii) certain financing costs, which
are significantly affected by external factors, including interest rates,
foreign currency exchange rates, and inflation rates, which have little or
no
bearing on our operating performance, (iii) other income (expense) that are
not
constant operations and (iv) income tax expense and employee statutory
profit-sharing expense. However, adjusted EBITDA has certain material
limitations, including that (i) it does not include taxes, which are a necessary
and recurring part of our operations; (ii) it does not include depreciation
and
amortization, which, because we must utilize property, equipment and other
assets in order to generate revenues in our operations, is a necessary and
recurring part of our costs; (iii) it does not include comprehensive cost of
financing, which reflects our cost of capital structure and assisted us in
generating revenue; and (iv) it does not include other income and expenses
that
are part of our net income. Therefore, any measure that excludes any or all
of
taxes, depreciation and amortization, comprehensive cost of financing and other
income and expenses has material limitations.
Adjusted
EBITDA should not be considered in isolation or as a substitute for net income,
net cash flow from operating activities or net cash flow from investing and
financing activities. Reconciliation of net income to adjusted EBITDA is as
follows:
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
|
|
(except
per share and per ADS data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
276
|
|
|
134
|
|
|
320
|
|
|
1,462
|
|
|
1,297
|
|
|
114
|
|
|
747
|
|
|
1,539
|
|
|
135
|
|
Depreciation
and amortization
|
|
|
160
|
|
|
177
|
|
|
199
|
|
|
222
|
|
|
326
|
|
|
28
|
|
|
131
|
|
|
202
|
|
|
18
|
|
Financial
income (expense)
|
|
|
6
|
|
|
(141
|
)
|
|
(27
|
)
|
|
(38
|
)
|
|
(145
|
)
|
|
(13
|
)
|
|
(35
|
)
|
|
45
|
|
|
4
|
|
Income
tax expense and employee profit sharing
|
|
|
19
|
|
|
(25
|
)
|
|
159
|
|
|
344
|
|
|
191
|
|
|
17
|
|
|
98
|
|
|
105
|
|
|
9
|
|
Other
income (expense)
|
|
|
73
|
|
|
(41
|
)
|
|
(32
|
)
|
|
(38
|
)
|
|
55
|
|
|
5
|
|
|
8
|
|
|
33
|
|
|
3
|
|
Adjusted
EBITDA
|
|
|
376
|
|
|
468
|
|
|
737
|
|
|
2,104
|
|
|
1,904
|
|
|
167
|
|
|
1,003
|
|
|
1,768
|
|
|
155
|
|
SUMMARY
PRO FORMA COMBINED FINANCIAL INFORMATION
The
following tables present our and Republic’s unaudited pro forma condensed
combined pro forma financial information reflecting our and Republic’s combined
accounts on a pro forma basis as of and for the periods indicated.
Also
included in this prospectus, beginning on Page F-142, are unaudited pro forma
condensed combined statements of income reflecting our and Republic’s combined
accounts on a pro forma basis for the year ended December 31, 2005 and for
the
six-month period ended June 30, 2005.
All
pro
forma financial information included in this prospectus is unaudited and may
not
be indicative of the results of operations that actually would have been
achieved had we acquired Republic at the beginning of the periods presented
and
do not purport to be indicative of future results. The information in the
following tables should also be read together with “Management’s Discussion and
Analysis of Financial Condition and Results of Operations”.
The
unaudited pro forma condensed combined financial information is prepared in
accordance with Mexican GAAP, which differs in certain respects from U.S.
GAAP.
For
additional information regarding financial information presented in this
prospectus, see “Presentation of Financial and Other Information”.
|
|
Pro
Forma
|
|
Actual
|
|
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant June 30, 2006 pesos)
|
|
(Millions
of dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of dollars)
|
|
|
|
(except
per share and per ADS data)
|
|
Income
Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
22,380
|
|
|
1,964
|
|
|
12,388
|
|
|
11,912
|
|
|
1,045
|
|
Direct
cost of sales
|
|
|
18,556
|
|
|
1,628
|
|
|
9,987
|
|
|
9,682
|
|
|
849
|
|
Marginal
profit
|
|
|
3,824
|
|
|
336
|
|
|
2,401
|
|
|
2,230
|
|
|
196
|
|
Indirect
manufacturing, selling, general and administrative
expenses
|
|
|
1,246
|
|
|
109
|
|
|
707
|
|
|
462
|
|
|
41
|
|
Depreciation
and amortization
|
|
|
339
|
|
|
30
|
|
|
144
|
|
|
202
|
|
|
18
|
|
Operating
income
|
|
|
2,239
|
|
|
196
|
|
|
1,550
|
|
|
1,566
|
|
|
137
|
|
Financial
income (expense)
|
|
|
(234
|
)
|
|
(21
|
)
|
|
(120
|
)
|
|
45
|
|
|
4
|
|
Other
income (expense), net
|
|
|
45
|
|
|
4
|
|
|
34
|
|
|
33
|
|
|
3
|
|
Income
before taxes, employee profit sharing and minority
interest
|
|
|
2,050
|
|
|
180
|
|
|
1,464
|
|
|
1,644
|
|
|
144
|
|
Income
tax expense and employee profit sharing
|
|
|
390
|
|
|
34
|
|
|
323
|
|
|
105
|
|
|
9
|
|
Net
income (loss)
|
|
|
1,660
|
|
|
146
|
|
|
1,141
|
|
|
1,539
|
|
|
135
|
|
Minority
interest
|
|
|
198
|
|
|
17
|
|
|
196
|
|
|
193
|
|
|
17
|
|
Majority
interest
|
|
|
1,462
|
|
|
128
|
|
|
945
|
|
|
1,346
|
|
|
118
|
|
Net
income per share
|
|
|
4
|
|
|
0.31
|
|
|
2
|
|
|
3
|
|
|
0.28
|
|
Net
income per ADS (2)
|
|
|
11
|
|
|
0.93
|
|
|
7
|
|
|
10
|
|
|
0.84
|
|
Weighted
average shares outstanding (thousands)(5)
|
|
|
413,790
|
|
|
|
|
|
405,209
|
|
|
419,451
|
|
|
|
|
|
|
Pro
Forma
|
|
Actual
|
|
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant June 30, 2006 pesos)
|
|
(Millions
of dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of dollars)
|
|
Weighted
average ADSs outstanding
(thousands)
|
|
|
137,930
|
|
|
|
|
|
135,070
|
|
|
139,817
|
|
|
|
|
U.S.
GAAP including effects of inflation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
22,380
|
|
|
1,964
|
|
|
12,388
|
|
|
11,912
|
|
|
1,045
|
|
Operating
income(4)
|
|
|
2,239
|
|
|
196
|
|
|
1,550
|
|
|
1,660
|
|
|
146
|
|
Minority
interest
|
|
|
198
|
|
|
17
|
|
|
196
|
|
|
193
|
|
|
17
|
|
Net
Income
|
|
|
1,462
|
|
|
128
|
|
|
945
|
|
|
1,386
|
|
|
122
|
|
Income
per share (5)
|
|
|
4
|
|
|
0.37
|
|
|
2
|
|
|
3
|
|
|
0.29
|
|
Income
per ADS
|
|
|
11
|
|
|
0.93
|
|
|
7
|
|
|
10
|
|
|
0.87
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
503
|
|
|
44
|
|
|
6
|
|
|
167
|
|
|
15
|
|
Adjusted
EBITDA(6)
|
|
|
2,578
|
|
|
226
|
|
|
1,694
|
|
|
1,768
|
|
|
155
|
|
Depreciation
and amortization from continuing operations
|
|
|
339
|
|
|
30
|
|
|
144
|
|
|
202
|
|
|
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operational
information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual installed
capacity (thousands
of tons)
|
|
|
2,847
|
|
|
|
|
|
2,847
|
|
|
2,902
|
|
|
|
|
Tons
shipped
|
|
|
2,683
|
|
|
|
|
|
1,400
|
|
|
1,369
|
|
|
|
|
Mexico
|
|
|
910
|
|
|
|
|
|
449
|
|
|
461
|
|
|
|
|
United
States, Canada and others
|
|
|
1,773
|
|
|
|
|
|
951
|
|
|
908
|
|
|
|
|
SBQ
steel
|
|
|
1,936
|
|
|
|
|
|
1,047
|
|
|
997
|
|
|
|
|
Structural
and other steel products
|
|
|
747
|
|
|
|
|
|
352
|
|
|
372
|
|
|
|
|
Per
ton:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales per ton
|
|
|
8,341
|
|
|
732
|
|
|
8,849
|
|
|
8,699
|
|
|
763
|
|
Cost
of sales per ton
|
|
|
6,916
|
|
|
607
|
|
|
7,134
|
|
|
7,070
|
|
|
620
|
|
Operating
income per ton
|
|
|
835
|
|
|
73
|
|
|
1,107
|
|
|
1,144
|
|
|
100
|
|
Adjusted
EBITDA per ton
|
|
|
961
|
|
|
84
|
|
|
1,210
|
|
|
1,291
|
|
|
113
|
|
Number
of employees
|
|
|
4,360
|
|
|
|
|
|
1,975
|
|
|
4,340
|
|
|
|
|
(1)
|
Peso
amounts have been translated into U.S. dollars solely for the convenience
of the reader, at the rate of Ps. 11.3973 per $1.00, the interbank
transactions rate in effect on June 30,
2006.
|
(2)
|
Following
our stock split effective May 30, 2006, one ADS represents three
series B
shares; previously, one ADS represented one series B
share.
|
(3)
|
Long-term
debt includes amounts relating to deferred
taxes.
|
(4)
|
Reflects
a reclassification in 2005 from other expenses under Mexican GAAP
to
operating expenses under U.S. GAAP of Ps. 38 million due to the
cancellation of technical
assistance.
|
(5)
|
For
U.S. GAAP and Mexican GAAP purposes, the weighted average shares
outstanding were calculated to give effect to the stock split described
in
Note 13(a) to the Consolidated Financial
Statements.
|
(6)
|
Adjusted
EBITDA is not a financial measure computed under Mexican or U.S.
GAAP.
Adjusted EBITDA derived from our Mexican GAAP financial information
means
Mexican GAAP net income (loss) excluding (i) depreciation and
amortization, (ii) financial income (expense), net (which is composed
of
net interest expense, foreign exchange gain or loss and monetary
position
gain or loss), (iii) other income (expense) and (iv) income tax expense
and employee statutory profit-sharing expense.
|
Adjusted
EBITDA does not represent, and should not be considered as, an alternative
to
net income, as an indicator of our operating performance, or as an alternative
to cash flow as an indicator of liquidity. In making such comparisons, however,
you should bear in mind that adjusted EBITDA is not defined and is not a
recognized financial measure under Mexican GAAP or U.S. GAAP and that it may
be
calculated differently by different companies and must be read in conjunction
with the explanations that accompany it. Adjusted EBITDA as presented in this
table does not take into account our working capital requirements, debt service
requirements and other commitments.
We
believe that adjusted EBITDA can be useful to facilitate comparisons of
operating performance between periods and with other companies in our industry
because it excludes the effect of (i) depreciation and amortization, which
represents a non-cash charge to earnings, (ii) certain financing costs, which
are significantly affected by external factors, including interest rates,
foreign currency exchange rates, and inflation rates, which have little or
no
bearing on our operating performance, (iii) other income (expense) that are
not
constant operations and (iv) income tax expense and employee statutory
profit-sharing expense. However, adjusted EBITDA has certain material
limitations, including that (i) it does not include taxes, which are a necessary
and recurring part of our operations; (ii) it does not include depreciation
and
amortization, which, because we must utilize property, equipment and other
assets in order to generate revenues in our operations, is a necessary and
recurring part of our costs; (iii) it does not include comprehensive cost of
financing, which reflects our cost of capital structure and assisted us in
generating revenue; and (iv) it does not include other income and expenses
that
are part of our net income. Therefore, any measure that excludes any or all
of
taxes, depreciation and amortization, comprehensive cost of financing and other
income and expenses has material limitations.
Adjusted
EBITDA should not be considered in isolation or as a substitute for net income,
net cash flow from operating activities or net cash flow from investing and
financing activities. Reconciliation of net income to adjusted EBITDA is as
follows:
|
|
Pro
Forma
|
|
Actual
|
|
|
|
Year
Ended
December
31,
|
|
Six
Months Ended
June
30,
|
|
|
|
2005
|
|
2005
|
|
2005
|
|
2006
|
|
2006
|
|
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
1,660
|
|
|
146
|
|
|
1,141
|
|
|
1,539
|
|
|
135
|
|
Depreciation
and amortization
|
|
|
339
|
|
|
30
|
|
|
144
|
|
|
202
|
|
|
18
|
|
Financial
income (expense)
|
|
|
(234
|
)
|
|
(20
|
)
|
|
(120
|
)
|
|
45
|
|
|
4
|
|
Income
tax expense and employee profit sharing
|
|
|
390
|
|
|
34
|
|
|
323
|
|
|
105
|
|
|
9
|
|
Other
income (expense)
|
|
|
45
|
|
|
4
|
|
|
34
|
|
|
33
|
|
|
3
|
|
Adjusted
EBITDA
|
|
|
2,578
|
|
|
226
|
|
|
1,694
|
|
|
1,768
|
|
|
155
|
|
Investing
in the series B shares and the ADSs involves a high degree of risk. You should
consider carefully the following risks, as well as all the other information
presented in this prospectus, before making an investment decision. Any of
the
following risks, if they were to occur, could materially and adversely affect
our business, results of operations, prospects and financial condition.
Additional risks and uncertainties not currently known to us or that we
currently deem immaterial may also materially and adversely affect our business,
results of operations, prospects and financial condition. In either event,
the
market price of our series B shares and ADSs could decline, and you could lose
all or part of your investment.
Risks
Related to Our Business
We
may not be able to pass along price increases for raw materials to our customers
to compensate for fluctuations in price and supply.
Prices
for raw materials necessary for production have fluctuated significantly in
the
past and significant increases could adversely affect our margins. During
periods when prices for scrap metal, iron ore, alloys, coke and other important
raw materials have increased, our industry historically has sought to maintain
profit margins and pass along increased raw materials costs to customers by
means of price increases.
We
may
not be able to pass along these and other possible cost increases in the future
and, therefore, our margins and profitability may be adversely affected. Even
when we can successfully apply surcharges, interim reductions in profit margins
frequently occur due to a time lag between the increase in raw material prices
and the market acceptance of higher selling prices for finished steel products.
We cannot assure you that any of our future customers will agree to pay
increased prices based on surcharges or that any of our current customers will
continue to pay such surcharges.
Implementing
our growth strategy, which may include acquisitions, may adversely affect our
operations.
As
part
of our growth strategy, we may need to expand our existing facilities, build
additional plants, acquire other steel assets, enter into joint ventures or
form
strategic alliances that we expect will expand or complement our existing
business. If any of these transactions occur, they will likely involve some
or
all of the following risks:
|
•
|
disruption
of our ongoing business;
|
|
•
|
diversion
of our resources and of management’s time;
|
|
•
|
decreased
ability to maintain uniform standards, controls, procedures and policies;
|
|
•
|
difficulty
managing the operations of a larger company;
|
|
•
|
increased
likelihood of involvement in labor, commercial or regulatory disputes
or
litigation related to the new enterprise;
|
|
•
|
potential
liability to joint venture participants or to third parties;
|
|
•
|
difficulty
competing for acquisitions and other growth opportunities with companies
having greater financial resources; and
|
|
•
|
difficulty
integrating the acquired operations and personnel into our existing
business.
|
Our
operations are capital intensive. We require capital for, among other purposes,
acquiring new equipment, maintaining existing equipment and complying with
environmental laws and regulations. We may not be able to fund our capital
expenditures from operating cash flow or from borrowings. If we are unable
to
fund our capital requirements we may not be able to implement our business
plan.
We
intend
to continue to pursue a growth strategy, the success of which will depend in
part on our ability to acquire and integrate additional facilities. Some of
these acquisitions may be outside of Mexico. Acquisitions involve a number
of
special risks that could adversely affect our business, financial condition
and
results of operations, including the diversion of management’s attention, the
assimilation of the operations and personnel of the acquired facilities, the
assumption of legacy liabilities and the potential loss of key employees. We
cannot assure you that any acquisition we make will not materially and adversely
affect us or that any such acquisition will enhance our business. We are unable
to predict the likelihood of any additional acquisitions being proposed or
completed in the near future or the terms of any such acquisitions. If we
determine to make any significant acquisition, we may be required to sell
additional equity or debt securities or obtain additional credit facilities,
which could result in additional dilution to our stockholders. There can be
no
assurance that adequate equity or debt financing would be available to us for
any such acquisitions.
We
may not be able to integrate successfully our recently acquired steel facilities
into our operations.
In
2005,
we and our controlling shareholder, Industrias CH, acquired 100% of the stock
of
Republic, a U.S. producer of SBQ steel. We acquired 50.2% of Republic’s stock
through our majority owned subsidiary, SimRep, and Industrias CH purchased
the
remaining 49.8% through SimRep. Our future success will depend in part on our
ability to integrate the operations of Republic successfully into our historic
operations. Furthermore, while we have not yet encountered any material problems
related to the assets acquired, there can be no assurance that problems will
not
arise in the future and that the costs associated with those problems, should
they arise, will not be significant.
We
face significant price and industry competition from other steel producers,
which may adversely affect our profitability and market
share.
Competition
in the steel industry is significant. Continuous advances in materials sciences
and resulting technologies have given rise to products such as plastics,
aluminum, ceramics and glass, all of which compete with steel products.
Competition in the steel industry exerts a downward pressure on prices, and,
due
to high start-up costs, the economics of operating a steel mill on a continuous
basis may encourage mill operators to establish and maintain high levels of
output even in times of low demand, which further decreases prices and profit
margins. The recent trend of consolidation in the global steel industry may
increase competitive pressures on independent producers of our size if large
steel producers formed through consolidations adopt predatory pricing strategies
that decrease prices and profit margins even further. If we are unable to remain
competitive with these producers, our market share and financial performance
may
be adversely affected.
Approximately
27.9% of our sales for the six-months ended June 30, 2006 were in Mexico, where
we face strong competition from other Mexican steel producers. A number of
our
Mexican competitors have undertaken modernization and expansion plans, including
the installation of production facilities and manufacturing capacity for certain
products that will compete with our products. As these producers become more
efficient, we may experience
increased
competition from them and a loss of market share. In addition, we face
competition from international steel producers. Increased international
competition, especially when combined with excess production capacity, could
force us to lower our prices or to offer increased services at a higher cost
to
us, which could reduce our gross margins and net income.
Since
most of our sales are in the United States and Canada, we also face strong
competition from other steel producers. A number of our competitors have
undertaken modernization and expansion plans, including the installation of
production facilities and manufacturing capacity for certain products that
will
compete with our products. As these producers become more efficient, we may
experience increased competition from them and a loss of market share. In
addition, we face competition from international steel producers.
Increased international competition, especially when combined with excess
production capacity, could force us to lower our prices or to offer increased
services at a higher cost to us, which could reduce our gross margins and net
income.
We
depend on distributions from our operating subsidiaries to finance our
operations.
We
need
to receive sufficient funds from our subsidiaries for a substantial portion
of
our internal cash flow, including cash flow to fund any future investment plans
and to service our future financial obligations. As a result, our cash flow
will
be adversely affected if we do not receive dividends and other income from
our
subsidiaries. The ability of most of our subsidiaries to pay dividends and
make
other transfers to us may be restricted by any indebtedness that we may incur
or
by Mexican law. Any such reduction in cash flow could materially adversely
affect us.
The
operation of our facilities depends on good labor relations with our employees.
At
September 30, 2006, approximately 83% of our non-Mexican and 59% of our Mexican
employees were members of unions. Collective bargaining agreements are typically
negotiated on a facility by facility basis for our Mexican facilities. The
compensation terms of our labor contracts are adjusted on an annual basis,
and
all other terms of the labor contracts are renegotiated every two years. Any
failure to reach an agreement on new labor contracts or to negotiate these
labor
contracts might result in strikes, boycotts or other labor disruptions. These
potential labor disruptions could have a material adverse effect on our results
of operations and financial condition. There have been no labor disruptions
in
the past five years in our Mexicali and Guadalajara facilities, and there have
been no labor disruptions in the Apizaco and Cholula facilities or our U.S.
and
Canadian facilities since we acquired them in 2004 and 2005, respectively. Labor
disruptions, strikes or significant negotiated wage increases could reduce
our
sales or increase our cost, and accordingly could have a material adverse effect
on our business.
Operations
at our Lackawanna, New York facility depend on our right to use certain property
and assets of an adjoining facility that the Mittal Steel Company N.V. (“Mittal
Steel”) owns. The termination of any such rights could interrupt our operations
and have a material adverse effect on our results of operations and financial
condition.
The
operations at our Lackawanna facility depend on certain easements and other
recorded agreements that the International Steel Group Inc. made in our favor
relating to, among other things, use of certain oxygen pipelines, engine rooms,
water pipelines, natural gas and compressed air distribution systems and
electrical equipment. Currently we and Mittal Steel are negotiating to extend
these services and utility arrangements for a period of three years. Our
respective rights under these agreements may be terminated in the event of
force
majeure or plant closures by either party. In the event that a plant closure
occurs and affects the supply of utilities or services, either party, upon
notice, has the right of ingress, egress and regress to enter the other party’s
premises for the sole purpose of continuing the supply of the utility affected.
All of these rights are assignable in the event of a sale of either of the
parties. These rights are essential to the use and operation of the Lackawanna
facility. In the event of a termination of any of these rights, we could be
required to cease some or all of our operations at the Lackawanna facility.
Because we produced certain types of products in the Lackawanna facility that
we
do not produce in our other facilities, an interruption of production at the
Lackawanna facility could result in a substantial loss of revenue and could
damage our relationships with customers.
Our
sales are highly concentrated and could be significantly reduced if one of
our
major customers reduced its purchases of our products or was unable to fulfill
its financial obligations to us.
Our
sales
are concentrated among a relatively small number of customers. Any of our major
customers can stop purchasing our products or significantly reduce their
purchases at any time. For the six-months ended June 30, 2006, direct sales
of
our products to two of our customers, United States Steel Corporation (“U.S.
Steel”) and American Axle & Manufacturing Holdings, Inc. (“American Axle”)
accounted for approximately 18.7% of our revenue. A disruption in sales to
either of these customers could adversely effect our cash flow and results
of
operations.
There
can
be no assurance that we will be able to maintain our current level of sales
to
these customers or that we will be able to sell our products to other customers
on terms that will be favorable. The loss of, or substantial decrease in the
amount of purchases by, or a write-off of any significant receivables from,
any
of our major customers would adversely affect our business, results of
operations, liquidity and financial condition.
Unanticipated
problems with our manufacturing equipment and facilities could have an adverse
impact on our business.
Our
capacity to manufacture steel products depends on the suitable operation of
our
manufacturing equipment, including blast furnaces, electric arc furnaces,
continuous casters, reheating furnaces and rolling mills. Although we perform
maintenance to our equipment on a continuous basis, breakdowns requiring
significant time and/or resources to repair, as well as the occurrence of
adverse events such as fires, explosions or adverse meteorological conditions,
could cause temporary production interruptions that could adversely affect
our
results of operations.
We
have
not obtained insurance against all risks, and do not maintain insurance covering
losses resulting from catastrophes or business interruptions. In the event
we
are not able to quickly and cost-effectively remedy problems creating any
significant interruption of our manufacturing capabilities, our operations
could
be adversely affected. In addition, in the event any of our plants were
destroyed or significantly damaged or its production capabilities otherwise
significantly decreased, we would likely suffer significant losses; furthermore,
the capital investments necessary to repair any destroyed or damaged facilities
or machinery would adversely affect our cash flows and our
profitability.
Because
a significant portion of our sales are to the automotive industry, a decrease
in
automotive manufacturing could reduce our cash flows and adversely affect our
results of operations.
Direct
sales of products to automotive assemblers and manufacturers accounted for
approximately 45% of our total net sales in 2005. Demand for our products is
affected by, among other things, the relative strength or weakness of the U.S.
automotive industry. U.S. automotive manufacturers have experienced significant
reductions in market share to mostly Asian companies and have announced planned
reduction in working capacity. Many large original equipment manufacturers
such
as Dana Corporation, Delphi Corporation (“Delphi”) and others, have sought
bankruptcy protection. A reduction in vehicles manufactured in North America,
the principal market for Republic’s SBQ steel products, would have an adverse
effect on our results of operations. In addition, the U.S. automotive industry
is significantly unionized and subject to unanticipated and extended work
slowdowns and stoppages resulting from labor disputes. We also sell to
independent forgers, components suppliers and steel service centers, all of
which sell to the automotive market as well as other markets. Developments
affecting the U.S. automotive industry may adversely affect us.
If
we are unable to obtain or maintain quality and environmental management
certifications for our facilities, we may lose existing customers and fail
to
attract new customers.
Most
of
our automotive parts customers in Mexico and the United States require that
we
have ISO 9001 or 14001 certification. All of the U.S. facilities that sell
to
automotive parts customers are currently ISO 9001 or 14001 certified, as
required.
If
the
foregoing certifications are canceled, if approvals are withdrawn or if
necessary additional standards are not obtained in a timely fashion, our ability
to continue to serve our targeted market, retain our customers or attract new
customers may be impaired. For example, our failure to maintain these
certifications could cause customers to refuse shipments, which could materially
affect our revenues and results of operations.
In
order
to continue to serve the premium part of the SBQ products market, our U.S.
facilities will need to be ISO/TS 16949 certified as of December 15, 2006.
We
currently are in compliance with this new standard but cannot assure you of
our
future compliance.
In
the
SBQ market, all participants must satisfy quality audits and obtain
certifications in order to obtain the status of “approved supplier”. The
automotive industry has put these stringent conditions in place for the
production of auto parts to assure a vehicle’s quality and safety. We currently
are an approved supplier for our automotive parts customers. Maintaining these
certifications is crucial in preserving and increasing our market share because
these conditions can be a barrier to entry in the SBQ market and we cannot
assure you that we will do so.
In
the event of environmental violations at our facilities we may incur significant
liabilities.
Our
operations are subject to a broad range of environmental laws and regulations
regulating our impact on air, water, soil and groundwater and exposure to
hazardous substances. We cannot assure you that we will at all times operate
in
compliance with environmental laws and regulations. If we fail to comply with
these laws and regulations, we may be assessed fines or penalties, be required
to make large expenditures to comply with such laws and regulations and/or
be
forced to shut down noncompliant operations. You should also consider that
environmental laws and regulations are becoming increasingly stringent and
it is
possible that future laws and regulations may require us to incur material
environmental compliance liabilities and costs. In addition, we need to maintain
existing and obtain future environmental permits in order to operate our
facilities. The failure to obtain necessary permits or consents or the loss
of
any permits could result in significant fines or penalties or prevent us from
operating our facilities. We may also be subject, from time to time, to legal
proceedings brought by private parties or governmental agencies with respect
to
environmental matters, including matters involving alleged property damage
or
personal injury that could result in significant liability. Certain of our
facilities in the United States have been the subject of administrative action
by state and local environmental authorities. See “Business—Legal Matters and
Regulations—Legal Proceedings—Environmental Claims.”
If
we are required to remediate contamination at our facilities we may incur
significant liabilities.
We
may be
required to remediate contamination at certain of our facilities and have
established a reserve to deal with such liabilities. However, we cannot assure
you that our environmental reserves will be adequate to cover such liabilities
or that our environmental expenditures will not differ significantly from our
estimates or materially increase in the future. Failure to comply with any
legal
obligations requiring remediation of contamination could result in liabilities,
imposition of cleanup liens and fines, and we could incur large expenditures
to
bring our facilities into compliance.
We
could incur losses due to product liability claims and may be unable to maintain
product liability insurance on acceptable terms, if at
all.
We
could
experience losses from defects or alleged defects in our steel products that
subject us to claims for monetary damages. For example, many of our products
are
used in automobiles and light trucks and it is possible that a defect in one
of
these vehicles could result in product liability claims against us. In
accordance with normal commercial sales, some of our products include implied
warranties that they are free from defects, are suitable for their intended
purposes and meet certain agreed upon manufacturing specifications. We cannot
assure you that future product liability claims will not be brought against
us,
that we will not incur liability in excess of our insurance coverage, or that
we
will be able to maintain product liability insurance with adequate coverage
levels and on acceptable terms, if at all.
Our
controlling shareholder, Industrias CH, is able to exert significant influence
on our business and policies and its interests may differ from those of other
shareholders.
As
of
June 30, 2006, Industrias CH, which the chairman of our board of directors,
Rufino
Vigil González,
controls, owned approximately 85% of our shares. Industrias CH nominated and
elected all of the current members of our board of directors, and Industrias
CH
continues and, after this offering, will continue to be in a position to elect
our future directors and to exercise substantial influence and control over
our
business and policies, including the timing and payment of dividends. The
interests of Industrias CH may differ significantly from those of other
shareholders. Furthermore, as a result of the significant equity position of
Industrias CH, there is currently limited liquidity in our series B shares
and
ADSs, and we cannot assure you liquidity will increase significantly as a result
of this offering.
We
have had a number of transactions with our
affiliates.
Historically,
we have engaged in a significant number and variety of transactions on market
terms with affiliates, including entities that Industrias CH owns or controls.
We expect that in the future we will continue to enter into transactions with
our affiliates, and some of these transactions may be significant.
We
depend on our senior management and their unique knowledge of our business
and
of the SBQ industry, and we may not be able to replace key executives if they
leave.
We
depend
on the performance of our executive officers and key employees. Our senior
management has significant experience in the steel industry, and the loss of
any
member of senior management or our inability to attract, retain additional
senior management could adversely affect our business, results of operations,
prospects and financial condition. We believe that the SBQ steel market is
a
niche market where specific industry experience is key to success. We depend
on
the knowledge of our business and the SBQ industry of our senior management
team, including Luis Garcia Limon, our chief executive officer. See
“Management”. In addition, we attribute much of the success of our growth
strategy to our ability to retain most of the key senior management personnel
of
the companies and businesses that we have acquired. Competition for qualified
personnel is significant, and we may not be able to find replacements with
sufficient knowledge of, and experience in, the SBQ industry for our existing
senior management or any of these individuals if their services are no longer
available. Our business could be adversely affected if we cannot attract or
retain senior management or other necessary personnel.
Risks
Related to the Steel Industry
Our
results of operations are significantly influenced by the cyclical nature of
steel industry.
The
steel
industry is cyclical in nature and sensitive to national and international
macroeconomic conditions. Global demand for steel as well as overall supply
levels significantly influence prices for our products. Changes in these two
factors likely will impact our operating results. Although global steel prices
increased significantly during 2004, they fell in 2005 over 2004 levels,
increasing again in the first nine months of 2006 but showing signs of weakening
in the last quarter. We cannot predict or give you any assurances as to prices
of steel in the future.
The
costs
of ferrous scrap and iron ore, the principal raw materials used in our steel
operations, are subject to price fluctuations. Although our wholly-owned scrap
collection and processing operations furnish a material portion of our scrap
requirements, we must acquire the remainder of our scrap from other sources.
Because increases in the prices we are able to charge for our finished steel
products may lag increases in ferrous scrap prices, such increases in scrap
prices can adversely affect our operating results. In 2004, the price of scrap
increased significantly. However, scrap prices decreased significantly in 2005
over 2004 levels. In the first four months of 2006, scrap prices remained
similar to 2005 levels. There can be no assurance that scrap prices will not
increase and, if so, there can be no assurance that we will be able to pass
all
or a portion of these increases on through higher finished product
prices.
U.S.
Steel supplies the majority of our iron ore and a portion of our coke
requirements. We purchase the balance of our requirements in the open market.
We
expect to purchase increasing amounts of our iron ore requirements in the open
market in the future. In 2004, U.S. Steel supplied essentially all of Republic’s
iron ore and coke requirements under terms of a supply agreement that was
beneficial to us. In 2005, the prices of these materials increased when we
negotiated new contracts with U.S. Steel, and, therefore, we purchased more
of the material in the open market. In the first six months of 2006, iron ore
and coke prices decreased from 2005 levels. We cannot guarantee that we
will be able to continue to find suppliers of these raw materials in the open
market or that the prices of these materials will not increase or that the
quality will remain the same. There is no assurance we will be able to pass
all
or a portion of higher raw material prices on through finished product
prices.
The
energy costs involved in our production processes are subject to fluctuations
that are beyond our control and could significantly increase our costs of
production.
Energy
costs constitute a significant component of our costs of operations. Energy
cost
as a percentage of net sales was 13% for the year ended December 31, 2005.
Our
manufacturing processes are dependent on adequate supplies of electricity and
natural gas. A substantial increase in the cost of natural gas or electricity
could have a material adverse effect on our margins. In addition, a disruption
or curtailment in supply could have a material adverse effect on our production
and sales levels.
The
Mexican government is currently the only supplier of energy in Mexico and has,
in some cases, increased prices above international levels. We, like all other
high volume users of electricity in Mexico, pay special rates to the Mexican
federal electricity commission (Comisión
Federal de Electricidad
or
“CFE”) for electricity. We also pay special rates to Pemex, Gas
y
Petroquímica Básica, (“PEMEX”), the
national oil company, for gas used at the Guadalajara facility. There can be
no
assurance these special rates will continue to be available to us or that these
rates may not increase significantly in the future. We enter into futures
contracts to fix and reduce volatility of natural gas prices. We have not always
been able to pass the effect of these increases on to our customers and there
is
no assurance that we will be able to pass the effect of these increases on
to
our customers in the future or to maintain futures contracts to reduce
volatility in natural gas prices. Changes in the price or supply of natural
gas
would materially and adversely affect our business and results of
operations.
Risks
Related to Mexico
Mexican
governmental, political and economic factors may adversely impact our
business.
The
Mexican government has exercised, and continues to exercise, significant
influence over the Mexican economy. Accordingly, Mexican governmental actions
concerning the economy and state-owned enterprises could have a significant
impact on Mexican private sector entities in general and us, in particular,
and
on market conditions, prices and returns on Mexican securities, including ours.
Our
financial condition, results of operations and prospects may also be affected
by
currency fluctuations, inflation, interest rates, regulation, taxation, social
instability and other political, social and economic developments in or
affecting Mexico. There can be no assurance that future developments in the
Mexican political, economic or social environment, over which we have no
control, will not have a material adverse effect on our business, results of
operations, financial condition or prospects or adversely affect the market
price of the ADSs and the series B shares.
The
Mexican economy has in the past experienced balance of payment deficits and
shortages in foreign exchange reserves. While the Mexican government does not
currently restrict the ability of Mexican or foreign persons or entities to
convert pesos to foreign currencies generally, and to U.S. dollars in
particular, it has done so in the past and no assurance can be given that the
Mexican government will not institute a restrictive exchange control policy
in
the future. The effect of any exchange control measures adopted by the Mexican
government on the Mexican economy cannot be predicted.
In
the
Mexican national elections held on July 2, 2000, Vicente Fox of the Partido
Accion Nacional
(the
National Action Party) or PAN, won the presidency. His victory ended more than
70 years of presidential rule by the Partido
Revolucionario Institucional (the
Institutional Revolutionary Party) or PRI. Neither the PRI nor the PAN succeeded
in securing a majority in either house of the Mexican Congress. Further,
elections held in 2003 and 2004, resulted in a reduction in the number of seats
held by the PAN in the Mexican Congress and state governorships. The resulting
gridlock impeded the progress of structural reforms in Mexico.
On
July
2, 2006, Mexico held presidential and federal congressional elections, and
Felipe Calderón Hinojosa, the PAN candidate, won by a very narrow margin.
However, the Partido
de la Revolución Democrática
(the
Revolutionary Democratic Party or PRD), the leading opposition party, has
contested the results of the election. On September 6, 2006, the Tribunal
Electoral
del Poder Judicial de la Federación
(the
Federal Electoral Chamber) unanimously declared Mr. Calderón to be the
president-elect whose term as president will run from December 1, 2006
until November 30, 2012. We cannot predict whether the PRD will continue to
generate political unrest in the country or whether any such unrest would affect
our financial condition results of operations or prospects.
High
levels of inflation and interest rates in Mexico, and weakness in the Mexican
economy, could adversely impact our financial condition and results of
operation.
In
the
past, Mexico has experienced high levels of inflation and high domestic interest
rates. If the Mexican economy falls into a recession, or if inflation and
interest rates increase, consumer purchasing power may decrease, and as a
result, demand for steel products may decrease. In addition, a recession could
affect our operations to the extent we are unable to reduce our costs and
expenses in response to falling demand. Furthermore, our growth strategy of
acquiring other companies and assets may be impaired in the future if interest
rates increase, and we are not able to obtain acquisition financing on favorable
terms. These events could adversely affect our business, results of operations,
financial condition or prospects.
Devaluation
or depreciation of the peso against the U.S. dollar may adversely affect the
dollar value of an investment in the ADSs and the series B shares, as well
as the dollar value of any dividend or other distributions that we may
make.
Fluctuations
in the exchange rate between the peso and the U.S. dollar, particularly peso
depreciations, may adversely affect the U.S. dollar equivalent of the peso
price
of the Series B shares on the Mexican Stock Exchange. As a result, such
peso depreciations will likely affect our revenues and earnings in U.S. dollar
terms and the market price of the ADSs. Exchange rate fluctuations could also
affect the depositary’s ability to convert into U.S. dollars, and make timely
payment of, any peso cash dividends and other distributions paid in respect
of
the Series B shares.
Our
financial statements are prepared in accordance with Mexican GAAP, and therefore
may not be directly comparable to financial statements of other companies
prepared under U.S. GAAP or other accounting
principles.
All
Mexican companies must prepare their financial statements in accordance with
Mexican GAAP, which differs in certain respects from U.S. GAAP. Among other
differences, Mexican companies are required to incorporate the effects of
inflation directly in their accounting records and in their published financial
statements. Accordingly, Mexican financial statements and reported earnings
may
differ from those of companies in other countries in this and other respects.
See Note 19 to our 2005 consolidated financial statements for a description
of
the principal differences between Mexican GAAP and U.S. GAAP as they relate
to
us.
Tariffs,
anti-dumping and countervailing duty claims imposed in the future could harm
our
ability to export our products.
A
substantial part of our operations are outside the United States, and we export
products from those facilities to the United States. In recent years, the U.S.
government has imposed anti-dumping and countervailing duties against Mexican
and other foreign steel producers, but has not imposed any such penalties
against us or our products. In the first quarter of 2002, the U.S. government
imposed tariffs of 15% on rebar and 30% on hot rolled bar and cold finish bar
against imports of steel from all the countries with the exception of Mexico,
Canada, Argentina, Thailand and Turkey; in the first quarter of 2003, the
tariffs were reduced to 12% on rebar and 24% on hot rolled bar and cold finish
bar, and these tariffs were eliminated in late 2003, prior to their originally
scheduled termination date. There can be no assurance that anti-dumping or
countervailing duties suits will not be initiated against us or that the U.S.
government will not impose tariffs on steel imports from Mexico or that existing
tariffs on U.S. steel imports from other countries, will not be lifted in the
future.
In
September 2001, the Mexican government imposed tariffs of 25% against imports
for all products that we produce from all countries with the exception of those
which have a free trade agreement with Mexico, which includes the United States.
In April 2002, the Mexican government increased these tariffs to 35%. These
tariffs have subsequently been reduced over time and are currently 7% for steel
products. There
can
be no assurances that these tariffs will not be further reduced or that
countries seeking to export steel products to Mexico will not impose similar
tariffs on Mexican exports to those countries.
We
are subject to different corporate disclosure and accounting standards than
U.S.
companies.
A
principal objective of the securities laws of the United States, Mexico and
other countries is to promote full and fair disclosure of all material corporate
information. However, there may be less publicly available information about
non-U.S. issuers of securities listed in the United States than is regularly
published by or about U.S. issuers of listed securities. In addition, we
prepare our financial statements in accordance with Mexican GAAP, which differs
from U.S. GAAP in a number of respects. For example, under Mexican GAAP we
must incorporate the effects of inflation directly in our accounting records
and
published financial statements. While we are required to reconcile our net
income and stockholders’ equity to those amounts that would be derived under
U.S. GAAP, the effects of inflation accounting under Mexican GAAP are not
eliminated in such reconciliation. For this and other reasons, the presentation
of Mexican financial statements and reported earnings may differ from that
of
U.S. companies in this and other important respects. Please see Note 19 to
our audited consolidated financial statements for the years ended December
31,
2005, 2004 and 2003 beginning on page F-38 of this prospectus and Note 16 to
our
unaudited condensed consolidated financial statements for the six-month period
ended June 30, 2006 beginning on page F-68 of this prospectus.
Risks
Related to the Global Offering
As
a result of the lower level of liquidity and the higher level of volatility
of
the Mexican securities market, the market price of our series B shares, and
as a
result, our ADSs, may experience extreme price and trading volume
fluctuations.
The
Mexican Stock Exchange is one of Latin America’s largest exchanges in terms of
market capitalization, but it remains relatively small, illiquid and volatile
compared to other major world markets. Although the public participates in
the
trading of securities on the Mexican Stock Exchange, a substantial portion
of
such activity consists of transactions by or on behalf of institutional
investors. These market characteristics may limit the ability of a holder of
series B shares to sell its shares and may also adversely affect the market
price of the series B shares and, as a result, the market price of the ADSs.
The
trading volume for securities issued by emerging market companies tends to
be
lower than the trading volume of securities issued by companies in more
developed countries.
You
may not be entitled to participate in future preemptive rights
offerings.
Under
Mexican law, if we issue new shares for cash as part of a capital increase,
other than in a public offering, we must grant our stockholders the right to
purchase a sufficient number of shares to maintain their existing ownership
percentage in our company. Rights to purchase shares in these circumstances
are
known as preemptive rights. We may not legally be permitted to allow holders
of
ADSs or holders of series B shares in the United States to exercise any
preemptive rights in any future capital increase unless: (1) we file a
registration statement with the U.S. Securities and Exchange Commission, or
the
SEC, with respect to that future issuance of shares; or (2) the offering
qualifies for an exemption from the registration requirements of the Securities
Act. At the time of any future capital increase, we will evaluate the costs
and
potential liabilities associated with filing a registration statement with
the
SEC and any other factors that we consider important to determine whether we
will file such a registration statement.
We
cannot
assure you that we will file a registration statement with the SEC to allow
holders of ADSs or holders of series B shares in the United States to
participate in a preemptive rights offering. In addition, under current Mexican
law, sales by the depositary of preemptive rights and distribution of the
proceeds from such sales to you, the ADS holders, is not possible. As a result,
your equity interest in us may be diluted proportionately.
ADS
holders may only vote through the depositary and are not entitled to attend
shareholders’ meetings.
Under
the
terms of the ADSs, you have a right to instruct the depositary, The Bank of
New
York, to vote the shares underlying our ADSs. If we provide the depositary
with
notice of shareholders’ meetings, the depositary will notify you of
shareholders’ meetings. Otherwise, you will not be able to exercise your right
to vote unless you withdraw the series B shares underlying the ADSs. We will
use
our best efforts to request that the depositary notify you of upcoming votes
and
ask for your instructions. However, you may not receive voting materials in
time
to ensure that you are able to instruct the depositary to vote your shares
or
otherwise learn of shareholders’ meetings to withdraw your series B shares to
allow you to cast your vote with respect to any specific matter. In addition,
the depositary and its agents may not be able to send out your voting
instructions on time or carry them out in the manner you have instructed. As
a
result, you may not be able to exercise your right to vote and you may lack
recourse if the series B shares underlying your ADSs are not voted as you
requested.
In
addition, Mexican law and our by-laws require shareholders to deposit their
shares with our secretary or with a Mexican custodian or provide evidence of
their status as shareholders in order to attend shareholders’ meetings. ADS
holders will not be able to meet this requirement and accordingly are not
entitled to attend shareholders’ meetings. ADS holders will also not be
permitted to vote the series B shares underlying the ADSs directly at a
shareholders’ meeting or to appoint a proxy to do so without withdrawing the
series B shares. Please see “Description of American Depositary Receipts” for
further discussion regarding the deposit agreement and your voting
rights.
It
may be difficult to enforce civil liabilities against us or our directors,
officers and controlling persons.
We
are
organized under the laws of Mexico, and most of our directors, officers and
controlling persons reside in Mexico. In addition, a substantial portion of
our
assets and their assets are located in Mexico. As a result, it may be difficult
for investors to effect service of process on such persons within the United
States or elsewhere outside of Mexico or to enforce judgments against us or
them, including in any action based on civil liabilities under U.S. federal
securities laws. There is doubt as to the enforceability in Mexico, whether
in
original actions or in actions to enforce judgments of U.S. courts or other
courts outside of Mexico, of liabilities based solely on U.S. federal securities
laws.
Future
sales of shares may depress the price of our series B shares and
ADSs.
As
of
June 30, 2006, we had 421,214,706 series B shares outstanding. After this
offering, the series B shares and ADSs sold in this offering will be freely
tradable, without restriction, under the Securities Act, except for any shares
purchased by our “affiliates”, as defined in the Securities Act. Sales of
substantial amounts of any remaining series B shares may depress our stock
price
and, as a result, the price of our ADSs, and we cannot assure you that our
stock
price would recover from any such loss in value.
This
discussion assumes the effectiveness of certain lock-up arrangements with the
underwriters under which we have agreed not to issue, sell or otherwise dispose
of shares. We cannot assure you that these lock-up arrangements will not be
terminated prior to 180 days after the global offering without prior notice
to
you by the underwriters.
We
may issue additional series B shares or ADSs in the future which may dilute
the
interest of the public investors.
We
may
offer additional series B shares or ADSs in the future, although we have no
current intention to do so. Any such offering or the market perception that
such
an offering could occur may result in a decrease in the market price of the
series B shares and ADSs.
FORWARD
LOOKING STATEMENTS
This
prospectus contains certain statements regarding our business that may
constitute “forward looking statements” within the meaning of the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. When used
in
this prospectus, the words “anticipates”, “plans”, “believes”, “estimates”,
“intends”, “expects”, “projects” and similar expressions are intended to
identify forward looking statements, although not all forward looking statements
contain those words. These statements, including but not limited to our
statements regarding our strategy for raw material acquisition, products and
markets, production processes and facilities, sales and distribution and
exports, growth and other trends in the steel industry and various markets,
operations and liquidity and capital resources are based on management’s
beliefs, as well as on assumptions made by, and information currently available
to, management, and involve various risks and uncertainties, some of which
are
beyond our control. Our actual results could differ materially from those
expressed in any forward looking statement. In light of these risks and
uncertainties there can be no assurance that forward looking statements will
prove to be accurate. Factors that might cause actual results to differ from
forward looking statements include, but are not limited to,
|
·
|
factors
relating to the steel industry (including the cyclicality of the
industry,
finished product prices, worldwide production capacity, the high
degree of
competition from Mexican and foreign producers and the price of ferrous
scrap, iron ore and other raw materials);
|
|
·
|
our
ability to operate at high capacity
levels;
|
|
·
|
the
costs of compliance with U.S. and Mexican environmental
laws;
|
|
·
|
the
integration of the Mexican steel manufacturing facilities located
in
Apizaco and Cholula, as well as the recently acquired Republic in
the
United States;
|
|
·
|
future
capital expenditures and
acquisitions;
|
|
·
|
future
devaluations of the peso;
|
|
·
|
the
imposition by Mexico of foreign exchange controls and price
controls;
|
|
·
|
the
influence of economic and market conditions in other countries on
Mexican
securities; and
|
|
·
|
the
factors discussed in “Risk Factors” beginning on page
16.
|
Forward
looking statements speak only as of the date they were made, and we undertake
no
obligation to update publicly or to revise any forward looking statements after
we distribute this prospectus because of new information, future events or
other
factors. In light of the risks and uncertainties described above, the forward
looking events and circumstances discussed in this prospectus might not
occur.
We
estimate that the proceeds from the combined offering will be approximately
Ps. 2,324,739,218 (U.S.$211,956,530 million) (or approximately
Ps. 2,673,450,000 (U.S.$243,750,000 million) if the over-allotment options
are exercised in full) after deducting underwriting discounts and commissions
but before our estimated expenses of approximately U.S. $3 million associated
with the combined offering.
We
intend
to use the proceeds that we obtain from the combined offering for general
corporate purposes, including approximately U.S.$110 million for investments
in
fixed assets aimed at increasing our installed capacity in our various
facilities in the United States, Canada and Mexico. We expect that these
investments will include an increase in our melt shop capacity (approximately
U.S.$15 million), a new oxygen plant (approximately U.S.$10 million), new roll
mills (approximately U.S.$27 million), a project to increase production of
new
SBQ products (approximately U.S.$20 million), investments to increase stainless
steel production (approximately U.S.$20 million) and a new inspection system
for
finished products (approximately U.S.$8 million), as well as possibly potential
acquisitions intended to improve our market share and complement our business
strategy.
The
following table sets forth our unaudited short-term debt and capitalization
under Mexican GAAP as of November 30, 2006 and as adjusted to give effect to
our
receipt of the net proceeds of the sale of our series B shares in the combined
offering (assuming no exercise of the over-allotment options).
You
should read this table together with our audited financial statements and our
unaudited financial statements included in this prospectus. Information in
the
following table is presented in constant pesos as of November 30, 2006 and
dollar amounts are translated at the rate of Ps. 11.0454 per U.S.$1.00, the
interbank transactions rate on November 30, 2006.
|
|
As
of November 30, 2006
|
|
|
|
Actual
|
|
As
Adjusted
|
|
|
|
($
Millions)
|
|
(Ps.
Millions)
|
|
($
Millions)
|
|
(Ps.
Millions)
|
|
Short-term
debt
|
|
|
17
|
|
|
181
|
|
|
17
|
|
|
181
|
|
Long-term
debt
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
Total
stockholders’ equity
|
|
|
1,148
|
|
|
12,684
|
|
|
1,356
|
|
|
14,977
|
|
Total
Capitalization
|
|
|
1,165
|
|
|
12,865
|
|
|
1,373
|
|
|
15,158
|
|
We
have
prepared the information concerning the Mexican securities market set forth
below based on materials obtained from public sources, including the Mexican
National Banking and Securities Commission, the Mexican Stock Exchange, the
Mexican Central Bank, and publications by market participants.
Our
ADSs
are listed on the American Stock Exchange under the symbol “SIM”, and our series
B shares are listed on the Mexican Stock Exchange under the symbol “SIMEC.B”.
We
cannot
predict the extent to which investors will choose to take delivery of series
B
shares in the form of ADSs as compared to series B shares, or the extent to
which investors will be interested in our ADSs. We also cannot predict the
liquidity of any such market. If the trading volume of our ADSs or series B
shares in any such market falls below certain levels, our shares or ADSs could
be delisted or deregistered in that market.
Trading
on the Mexican Stock Exchange
Overview
The
Mexican Stock Exchange, located in Mexico City, is the only stock exchange
in
Mexico. Operating continuously since 1907, the Mexican Stock Exchange is
organized as a corporation (sociedad
anonima de capital variable).
Securities trading on the Mexican Stock Exchange occurs each business day from
8:30 a.m. to 3:00 p.m., Mexico City time.
Since
January 1999, all trading on the Mexican Stock Exchange has been effected
electronically. The Mexican Stock Exchange may impose a number of measures
to
promote an orderly and transparent trading price of securities, including the
operation of a system of automatic suspension of trading in shares of a
particular issuer when price fluctuation exceeds certain limits. The Mexican
Stock Exchange may also suspend trading in shares of a particular issuer as
a
result of:
|
· |
non-disclosure
of material events; or
|
|
· |
changes
in the offer or demand, volume traded, or prevailing share price
that are
inconsistent with the shares’ historical performance and cannot be
explained through publicly available
information.
|
The
Mexican Stock Exchange may reinstate trading in suspended shares when it deems
that the material events have been adequately disclosed to public investors
or
when it deems that the issuer has adequately explained the reasons for the
changes in offer and demand, volume traded, or prevailing share price. Under
current regulations, the Mexican Stock Exchange may consider the measures
adopted by the other stock exchanges in order to suspend and/or resume trading
in an issuer’s shares in cases where the relevant securities are simultaneously
traded on a stock exchange outside of Mexico.
Settlement
on the Mexican Stock Exchange is effected two business days after a share
transaction. Deferred settlement is not permitted without the approval of the
Mexican National Banking and Securities Commission, even where mutually agreed.
Most securities traded on the Mexican Stock Exchange are on deposit with the
INDEVAL, a privately owned securities depositary that acts as a clearinghouse,
depositary, and custodian, as well as a settlement, transfer, and registration
agent for Mexican Stock Exchange transactions, eliminating the need for physical
transfer of securities.
Although
the Mexican Securities Market Law (Ley
del Mercado de Valores) provides
for the existence of an over-the-counter market, no such market for securities
in Mexico has developed.
Market
Regulation
In
1925,
the Mexican National Banking Commission (Comisión
Nacional Bancaria)
was
established to regulate banking activity and in 1946, the Mexican Securities
Commission (Comisión
Nacional de Valores)
was
established to regulate stock market activity. In 1995, these two entities
were
merged to form the Mexican National Banking and Securities Commission
(Comisión
Nacional Bancaria y de Valores).
The
Mexican Securities Market Law, which took effect in 1975, introduced important
structural changes to the Mexican financial system, including the organization
of brokerage firms as corporations (sociedades
anónimas).
The
Mexican Securities Market Law sets standards for authorizing companies to
operate as brokerage firms, which authorization is granted at the discretion
of
the Mexican Ministry of Finance and Public Credit (Secretaria
de Hacienda y Credito Publico),
upon
the recommendation of the National Banking and Securities Commission. In
addition to setting standards for brokerage firms, the Mexican Securities Market
Law authorizes the National Banking and Securities Commission, among other
things, to regulate the public offering and trading of securities, corporate
governance, disclosure and reporting standards and to impose sanctions for
the
illegal use of insider information and other violations of the Mexican
Securities Market Law. The National Banking and Securities Commission regulates
and supervises the Mexican securities market, the Mexican Stock Exchange,
INDEVAL and brokerage firms through a board of governors composed of 13
members.
On
December 30, 2005, a new Mexican Securities Market Law was enacted and published
in the Official Gazette. The new Securities Market Law became effective on
June
28, 2006, however, in some cases an additional period of 180 days (until late
December 2006) will be available for issuers to incorporate the new corporate
governance and other requirements derived from the new law into their by-laws.
The new Mexican Securities Market Law changed the Mexican securities regulation
in various material respects. The reforms were intended to update the Mexican
regulatory framework applicable to the securities market and publicly traded
companies in accordance with international standards.
In
particular, the new Mexican Securities Market Law (i) establishes that public
entities and the entities controlled by them will be considered a single
economic unit, (ii) clarifies the rules for tender offers, dividing them into
voluntary and mandatory categories, (iii) clarifies standards for disclosure
of
holdings of shareholders of public companies, (iv) expands and strengthens
the
role of the board of directors of public companies, (v) defines the standards
applicable to the board of directors and the duties of the board, each director,
its secretary, the general director and executive officers (introducing concepts
such as the duty of care, duty of loyalty and safe harbors), (vi) replaces
the
statutory auditor (comisario)
and its
duties with an audit committee, a corporate practices committee and external
auditors, (vii) clearly defines the roles and responsibilities of executive
officers, (viii) improves the rights of minority shareholders relating to legal
remedies and access to company information, (ix) introduces concepts such as
consortiums, groups of related persons or entities, control, related parties
and
decision-making power, (x) sets out three new types of companies different
to
the ones which are set out by the Mexican Companies Law, the (a) sociedad
anónima promotora de inversión,
by
which the investment of national and foreigner investors shall be promoted,
(b)
sociedad
anónima promotora de inversión bursátil
and
(c) sociedad
anónima bursátil, and
(xi)
expands the definition of applicable sanctions for violations of the Mexican
Securities Market Law, including the punitive damages and criminal
penalties.
In
March
2003, the National Banking and Securities Commission issued certain general
regulations applicable to issuers and other securities market participants.
The
general regulations, which repealed several previously enacted National Banking
and Securities Commission regulations (circulares),
now
provide a single set of rules governing issuers and issuer activity, among
other
things. In September 2006, these general regulations were amended to give effect
to the provisions of the Mexican Securities Market Law.
In
addition, in September 2004, the National Banking and Securities Commission
issued general rules applicable to brokerage firms, the National Banking and
Securities Commission Rules for Brokerage Firms (circulares
aplicables a casas de bolsa).
These
rules now provide a single set of rules governing participation of Mexican
underwriters in public offerings, among other things.
Registration
and Listing Standards
To
offer
securities to the public in Mexico, an issuer must meet specific qualitative
and
quantitative requirements. In addition, only securities that have been
registered with the Mexican National Securities Registry as authorized by
National Banking and Securities Commission approval may be listed on the Mexican
Stock Exchange. The authorization of the National Banking and Securities
Commission with respect to the registration does not imply any kind of
certification or assurance related to the investment quality of the securities,
the solvency of the issuer, or the accuracy or completeness of any information
delivered to the National Banking and Securities Commission. The general
regulations state that the Mexican Stock Exchange must adopt minimum
requirements for issuers to list their securities in Mexico. These requirements
relate to matters such as operating history, financial and capital structure,
minimum trading volumes and minimum public floats, among others. The general
regulations also state that the Mexican Stock Exchange must implement minimum
requirements for issuers to maintain their listing in Mexico. These requirements
relate to matters such as financial condition, trading minimums, capital
structure and minimum public floats, among others. The National Banking and
Securities Commission may waive some of these requirements in certain
circumstances. In addition, some of the requirements are applicable to each
series of shares of the relevant issuer.
The
Mexican Stock Exchange will review compliance with the foregoing requirements
and other requirements on an annual, semi-annual and quarterly basis, and may
also do it at any other time. The Mexican Stock Exchange must inform the
National Banking and Securities Commission of the results of its review and
this
information must, in turn, be disclosed to investors. If an issuer fails to
comply with any of the foregoing requirements, the Mexican Stock Exchange will
request that the issuer propose a plan to cure the violation. If the issuer
fails to propose a plan, if the plan is not satisfactory to the Mexican Stock
Exchange or if an issuer does not make substantial progress with respect to
the
corrective measures, trading of the relevant series of shares on the Mexican
Stock Exchange will be temporarily suspended. In addition, if an issuer fails
to
propose a plan or ceases to follow the plan once proposed, the National Banking
and Securities Commission may suspend or cancel the registration of the shares,
in which case the majority shareholder or any controlling group must carry
out a
tender offer to acquire 100% of the outstanding shares of the issuer in
accordance with the tender offer rules discussed below.
Reporting
Obligations
Issuers
of listed securities are required to file unaudited quarterly financial
statements and audited annual financial statements as well as various periodic
reports with the National Banking and Securities Commission and the Mexican
Stock Exchange. Mexican issuers must file the following reports with the
National Banking and Securities Commission:
|
·
|
an
annual report prepared in accordance with the National Banking and
Securities Commission general regulations by no later than June 30
of each
year;
|
|
·
|
quarterly
reports, within 20 business days following the end of each of the
first
three quarters and 40 business days following the end of the fourth
quarter; and
|
|
·
|
reports
disclosing material events promptly upon their
occurrence.
|
Pursuant
to the National Banking and Securities Commission’s general regulations, the
internal rules of the Mexican Stock Exchange were amended to implement an
automated electronic information transfer system, or SEDI (Sistema
Electrónico de Envío y Difusión de Información),
for
information required to be filed with the Mexican Stock Exchange. Issuers of
listed securities must prepare and disclose their financial information via
a
Mexican Stock Exchange-approved electronic financial information system, or
SIFIC (Sistema
de Información Financiera Computarizada).
Immediately upon its receipt, the Mexican Stock Exchange makes the financial
information submitted via SIFIC available to the public.
The
National Banking and Securities Commission’s general regulations and the rules
of the Mexican Stock Exchange require issuers of listed securities to file
information through SEDI that relates to any act, event or circumstance that
could influence issuers’ share price. If listed securities experience unusual
price volatility, the Mexican Stock Exchange must immediately request that
an
issuer inform the public as to the causes of the volatility or, if the issuer
is
unaware of the causes, that an issuer make a statement to that effect. In
addition, the Mexican Stock Exchange must immediately request that issuers
disclose any information relating to relevant material events, when it deems
the
information currently disclosed to be insufficient, as well as instruct issuers
to clarify the information when necessary. The Mexican Stock Exchange may
request that issuers confirm or deny any material events that have been
disclosed to the public by third parties when it deems that the material event
may affect or influence the securities being traded. The Mexican Stock Exchange
must immediately inform the National Banking and Securities Commission of any
such requests.
An
issuer
may defer the disclosure of material events under some circumstances, as long
as:
|
·
|
the
issuer implements adequate confidentiality measures (including maintaining
records of persons or entities in possession of confidential
information);
|
|
·
|
the
information is related to incomplete
transactions;
|
|
·
|
there
is no misleading public information relating to the material event;
and
|
|
·
|
no
unusual price or volume fluctuation
occurs.
|
Similarly,
if an issuer’s securities are traded on both the Mexican Stock Exchange and a
foreign securities exchange, the issuer must simultaneously file the information
that it is required to file pursuant to the laws and regulations of the foreign
jurisdiction with the National Banking and Securities Commission and the Mexican
Stock Exchange.
The
new
Mexican Securities Market Law has not substantially modified the reporting
obligations of issuers of equity securities listed on the Mexican Stock
Exchange.
Suspension
of Trading
In
addition to the authority of the Mexican Stock Exchange under its internal
regulations as described above, pursuant to the rules of National Banking and
Securities Commission, the National Banking and Securities Commission and the
Mexican Stock Exchange may suspend trading in an issuer’s securities:
|
·
|
if
the issuer does not disclose a material event;
or
|
|
·
|
upon
price or volume volatility or changes in the offer or demand in respect
of
the relevant securities that are not consistent with the historic
performance of the securities and cannot be explained solely through
information made publicly available pursuant to the National Banking
and
Securities Commission’s general
regulations.
|
The
Mexican Stock Exchange must immediately inform the National Banking and
Securities Commission and the general public of any such suspension. An issuer
may request that the National Banking and Securities Commission or the Mexican
Stock Exchange resume trading, provided it demonstrates that the causes
triggering the suspension have been resolved and that it is in full compliance
with the periodic reporting requirements under applicable law. If an issuer’s
request has been granted, the Mexican Stock Exchange will determine the
appropriate mechanism to resume trading. If trading in an issuer’s securities is
suspended for more than 20 business days and the issuer is authorized to resume
trading without conducting a public offering, the issuer must disclose via
SEDI
a description of the causes that resulted in the suspension and reasons why
it
is now authorized to resume trading before trading may resume.
Insider
Trading, Trading Restrictions and Tender Offers
The
Mexican Securities Market Law contains specific regulations regarding insider
trading, including, (i) the requirement that persons in possession of
information deemed privileged abstain (x) from trading in the relevant issuer’s
securities, (y) from making recommendations to third parties to trade in such
securities and (z) from trading in options and derivatives of the underlying
security issued by such entity, and (ii) providing a counterparty not privy
to
insider information with a right of indemnification from the party possessing
privileged information.
In
addition, if an issuer’s securities are traded on both the Mexican Stock
Exchange and a foreign securities exchange, the issuer must simultaneously
file
with the National Banking and Securities Commission the information that it
is
required to file pursuant to the rules and regulations of the foreign securities
exchange.
Pursuant
to the Mexican Securities Market Law, the following persons must notify the
National Banking and Securities Commission of any transactions undertaken by
a
listed issuer:
|
·
|
members
of a listed issuer’s board of
directors;
|
|
·
|
shareholders
controlling 10% or more of a listed issuer’s outstanding share
capital;
|
|
·
|
groups
controlling 10% or more of a listed issuer’s outstanding share capital;
and
|
In
addition, under the Mexican Securities Market Law insiders must abstain from
purchasing or selling securities of the issuer within 90 days from the last
sale
or purchase, respectively.
Shareholders
of issuers listed on the Mexican Stock Exchange must notify the National Banking
and Securities Commission before effecting transactions outside of the Mexican
Stock Exchange that result in a transfer of 10% or more of an issuer’s share
capital. Transferring shareholders must also inform the National Banking and
Securities Commission of the effect of the transactions within three days
following their completion, or, alternatively, that the transactions have not
been consummated. The National Banking and Securities Commission will notify
the
Mexican Stock Exchange of these transactions on a no-name basis.
The
Mexican Securities Market Law also provides that, for purposes of determining
any of the foregoing percentages, convertible securities, warrants and
derivatives must be taken into account.
Subject
to certain exceptions, any acquisition of a public company’s shares that results
in the acquiror owning 10% or more, but less than 30%, of an issuer’s
outstanding share capital must be publicly disclosed to the National Banking
and
Securities Commission and the Mexican Stock Exchange by no later than one
business day
following the acquisition. Any acquisition by an insider that results in the
insider holding an additional 5% or more of a public company’s outstanding share
capital must also be publicly disclosed to the National Banking and Securities
Commission and the Mexican Stock Exchange no later than the day following the
acquisition. Some insiders must also notify the National Banking and Securities
Commission of share purchases or sales that occur within a three-month or
five-day term and that exceed certain value thresholds. The Mexican Securities
Market Law requires that convertible securities, warrants and derivatives to
be
settled in kind be taken into account in the calculation of share ownership
percentages.
The
Mexican Securities Market Law contains provisions relating to public tender
offers and certain other share acquisitions occurring in Mexico. Under the
law,
tender offers may be voluntary or mandatory. Voluntary tender offers, or offers
where there is no requirement that they be initiated or completed, are required
to be made pro
rata.
Any
intended acquisition of a public company’s shares that results in the acquiror
owning 30% or more, but less than a percentage that would result in the acquiror
obtaining control, of a company’s voting shares requires the acquiror to make a
mandatory tender offer for (i) the greater of the percentage of the share
capital intended to be acquired or (ii) 10% of the company’s outstanding
share capital stock. Finally, any intended acquisition of a public company’s
shares that is aimed at obtaining voting control requires the potential acquiror
to make a mandatory tender offer for 100% of the company’s outstanding share
capital (however, under certain circumstances the National Banking and
Securities Commission may permit an offer for less than 100%). The tender offer
must be made at the same price to all shareholders and classes of shares. The
board of directors, with the advice of the audit committee, must issue its
opinion of any tender offer resulting in a change of control, which opinion
must
take minority shareholder rights into account and which may be accompanied
by an
independent fairness opinion.
Under
the
Mexican Securities Market Law, all tender offers must be open for at least
20
business days and not 15 business days as required by the general rules and
purchases thereunder are required to be made pro rata to all tendering
shareholders. The Mexican Securities Market Law also permits the payment of
certain amounts to controlling shareholders over and above the offering price
if
these amounts are (i) fully disclosed, (ii) approved by the board of
directors and (iii) paid in connection with non-compete or similar
obligations. The law also provides exceptions to the mandatory tender offer
requirements and specifically sets forth remedies for non-compliance with these
tender offer rules (e.g., suspension of voting rights, possible annulment of
purchases, etc.) and other rights available to prior shareholders of the
issuer.
Anti-Takeover
Protections
The
Mexican Securities Market Law provides that public companies may include
anti-takeover provisions in their by-laws if such provisions (i) are approved
by
a majority of the shareholders, with no more than 5% of the outstanding capital
shares voting against such provisions, (ii) do not exclude any shareholder(s)
or
group of shareholder(s) and (iii) do not restrict, in an absolute manner,
a
change of control.
Market
Price of Series B shares
Our
series B shares are traded on the Mexican Stock Exchange under the symbol
“SIMEC.B”. As of October 24, 2006, the date of our annual shareholders meeting,
there were 421,214,706 series B shares issued and outstanding. As of such date,
13,735,221
shares
were held in the United States in the form of ADSs by 22 record holders, and
407,479,485 shares were held in Mexico by approximately 46 record holders.
The
ADSs are evidenced by ADRs issued by The Bank of New York (the “Depositary”), as
depositary under a Deposit Agreement, dated as of July 8, 1993, as amended,
among us, the Depositary and the holders from time to time of ADRs. Because
certain of the shares are held by nominees, the number of record holders may
not
be representative of the number of beneficial owners.
Share
Price Information
The
following table sets forth for the periods indicated the high and low sales
prices expressed in historical pesos of a series B shares on the Mexican Stock
Exchange and the high and low sales price expressed in dollars of the ADSs
on
the American Stock Exchange. (Table adjusted to reflect May 30, 2006 3 for
1
stock split.)
|
|
Mexican
Stock
Exchange
|
|
American
Stock
Exchange
|
|
|
|
High
|
|
Low
|
|
High
|
|
Low
|
|
2002
|
|
|
0.89
|
|
|
0.50
|
|
|
1.75
|
|
|
0.80
|
|
2003
|
|
|
37.50
|
|
|
10.20
|
|
|
5.34
|
|
|
0.85
|
|
2004
|
|
|
95.99
|
|
|
22.40
|
|
|
8.75
|
|
|
2.10
|
|
2005
|
|
|
95.00
|
|
|
40.75
|
|
|
8.70
|
|
|
3.63
|
|
2006
|
|
|
84.00
|
|
|
22.00
|
|
|
21.64
|
|
|
3.96
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
Quarter
|
|
|
95.00
|
|
|
49.99
|
|
|
8.70
|
|
|
4.24
|
|
Second
Quarter
|
|
|
54.00
|
|
|
40.75
|
|
|
4.80
|
|
|
3.63
|
|
Third
Quarter
|
|
|
56.60
|
|
|
42.30
|
|
|
5.45
|
|
|
3.91
|
|
Fourth
Quarter
|
|
|
49.00
|
|
|
42.50
|
|
|
4.80
|
|
|
3.77
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
Quarter
|
|
|
80.00
|
|
|
43.28
|
|
|
7.48
|
|
|
3.96
|
|
Second
Quarter
|
|
|
84.00
|
|
|
22.00
|
|
|
9.49
|
|
|
5.55
|
|
Third
Quarter
|
|
|
57.50
|
|
|
25.00
|
|
|
15.90
|
|
|
6.60
|
|
Fourth
Quarter
|
|
|
79.40
|
|
|
50.00
|
|
|
21.64
|
|
|
13.50
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
July
|
|
|
37.10
|
|
|
25.00
|
|
|
10.34
|
|
|
6.60
|
|
August
|
|
|
45.50
|
|
|
34.50
|
|
|
12.66
|
|
|
9.47
|
|
September
|
|
|
57.50
|
|
|
43.09
|
|
|
15.90
|
|
|
11.77
|
|
October
|
|
|
67.41
|
|
|
50.32
|
|
|
19.03
|
|
|
13.50
|
|
November
|
|
|
79.40
|
|
|
62.00
|
|
|
21.64
|
|
|
17.00
|
|
December
|
|
|
77.50
|
|
|
50.00
|
|
|
21.00
|
|
|
13.57
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January
|
|
|
55.91
|
|
|
45.95
|
|
|
15.46
|
|
|
12.42
|
|
February
(through February 6)
|
|
|
53.50
|
|
|
50.14
|
|
|
14.90
|
|
|
13.63
|
|
On
February 20, 2003, we effected a 1 for 20 reverse stock split. On May 30, 2006,
we effected a 3 for 1 stock split. Following the May 30 split, we adjusted
the ADS to share ratio from one ADS representing one share to one ADS
representing three shares.
DIVIDENDS
AND DIVIDEND POLICY
A
vote by
the majority of our shareholders present at a shareholders’ meeting, generally
upon a recommendation of our board of directors, determines the declaration,
amount and payment of dividends. The declaration and payment of dividends is
subject to limitations under Mexican law and in case of the existence of debt
instruments, to any covenants contained in any of such instruments. Our
controlling shareholder, Industrias CH, currently has the power and, after
giving effect to the combined offering, will continue to have the power to
determine our dividend policy. See “Risk Factors - Our controlling shareholder,
Industrias CH, is able to exert significant influence on our business and
policies and its interests may differ from those of other shareholders” and
“Major Shareholders”.
We
have
not paid dividends in the past. Because we intend to devote a substantial
portion of our future cash flows to funding our expansion plan and working
capital requirements, we do not currently expect to pay dividends in the near
future. We may consider paying dividends in the future based on a number of
factors, including our results of operations, financial condition, cash
requirements, tax considerations, future prospects and other factors that our
board of directors and our shareholders may deem relevant, including the terms
and conditions of any future debt instruments that might limit our ability
to
pay dividends.
UNAUDITED
PRO FORMA CONDENSED COMBINED FINANCIAL
INFORMATION
The
following tables present our and Republic’s unaudited pro forma condensed
combined pro forma financial information reflecting our and Republic’s combined
accounts on a pro forma basis as of and for the periods indicated.
Also
included in this prospectus, beginning on Page F-142, are our unaudited combined
consolidated pro forma statements of income reflecting our and Republic’s
combined accounts on a pro forma basis for the year ended December 31, 2005
and
as of and for the six-month period ended June 30, 2005.
All
pro
forma financial information included in this prospectus is unaudited and may
not
be indicative of the results of operations that actually would have been
achieved and we acquired Republic at the beginning of the periods presented
and
do not purport to be indicative of future results. The information in the
following tables should also be read together with “Management’s Discussion and
Analysis of Financial Condition and Results of Operations”.
The
unaudited pro forma condensed combined financial information is prepared in
accordance with Mexican GAAP, which differs in certain respects from U.S.
GAAP.
For
additional information regarding financial information presented in this
prospectus, see “Presentation of Financial and Other Information”.
|
|
Pro
Forma
|
|
Actual
|
|
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
|
|
(except
per share and per ADS data)
|
|
Income
Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
22,380
|
|
|
1,964
|
|
|
12,388
|
|
|
11,912
|
|
|
1,045
|
|
Direct
cost of sales
|
|
|
18,556
|
|
|
1,628
|
|
|
9,987
|
|
|
9,682
|
|
|
849
|
|
Marginal
profit
|
|
|
3,824
|
|
|
336
|
|
|
2,401
|
|
|
2,230
|
|
|
196
|
|
Indirect
manufacturing, selling, general and administrative
expenses
|
|
|
1,246
|
|
|
109
|
|
|
707
|
|
|
462
|
|
|
41
|
|
Depreciation
and amortization
|
|
|
339
|
|
|
30
|
|
|
144
|
|
|
202
|
|
|
18
|
|
Operating
income
|
|
|
2,239
|
|
|
196
|
|
|
1,550
|
|
|
1,566
|
|
|
137
|
|
Financial
income (expense)
|
|
|
(234
|
)
|
|
(21
|
)
|
|
(120
|
)
|
|
45
|
|
|
4
|
|
Other
income (expense), net
|
|
|
45
|
|
|
4
|
|
|
34
|
|
|
33
|
|
|
3
|
|
Income
before taxes, employee profit sharing and minority
interest
|
|
|
2,050
|
|
|
180
|
|
|
1,464
|
|
|
1,644
|
|
|
144
|
|
Income
tax expense and employee profit sharing
|
|
|
390
|
|
|
34
|
|
|
323
|
|
|
105
|
|
|
9
|
|
Net
income (loss)
|
|
|
1,660
|
|
|
146
|
|
|
1,141
|
|
|
1,539
|
|
|
135
|
|
Minority
interest
|
|
|
198
|
|
|
17
|
|
|
196
|
|
|
193
|
|
|
17
|
|
Majority
interest
|
|
|
1,462
|
|
|
128
|
|
|
945
|
|
|
1,346
|
|
|
118
|
|
Net
income per share
|
|
|
4
|
|
|
0.31
|
|
|
2
|
|
|
3
|
|
|
0.28
|
|
Net
income per ADS (2)
|
|
|
11
|
|
|
0.93
|
|
|
7
|
|
|
10
|
|
|
0.84
|
|
Weighted
average shares outstanding (thousands)(5)
|
|
|
413,790
|
|
|
|
|
|
405,209
|
|
|
419,451
|
|
|
|
|
Weighted
average ADSs outstanding
(thousands)
|
|
|
137,930
|
|
|
|
|
|
135,070
|
|
|
139,817
|
|
|
|
|
|
|
Pro
Forma
|
|
Actual
|
|
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
|
|
(except
per share and per ADS data)
|
|
U.S.
GAAP including effects of inflation:
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
22,380
|
|
|
1,964
|
|
|
12,388
|
|
|
11,912
|
|
|
1,045
|
|
Operating
income(4)
|
|
|
2,241
|
|
|
197
|
|
|
1,554
|
|
|
1,660
|
|
|
146
|
|
Minority
interest
|
|
|
198
|
|
|
17
|
|
|
196
|
|
|
193
|
|
|
17
|
|
Net
Income
|
|
|
1,457
|
|
|
128
|
|
|
943
|
|
|
1,386
|
|
|
122
|
|
Income
per share (5)
|
|
|
4
|
|
|
0.31
|
|
|
2
|
|
|
3
|
|
|
0.28
|
|
Income
per ADS
|
|
|
11
|
|
|
1
|
|
|
7
|
|
|
10
|
|
|
0.87
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
53
|
|
|
5
|
|
|
6
|
|
|
167
|
|
|
15
|
|
Adjusted
EBITDA(6)
|
|
|
2,578
|
|
|
226
|
|
|
1,694
|
|
|
1,768
|
|
|
155
|
|
Depreciation
and amortization from continuing operations
|
|
|
339
|
|
|
30
|
|
|
144
|
|
|
202
|
|
|
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operational
information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual Installed
capacity (thousands
of tons)
|
|
|
2,847
|
|
|
|
|
|
2,897
|
|
|
2,902
|
|
|
|
|
Tons
shipped
|
|
|
2,683
|
|
|
|
|
|
1,400
|
|
|
1,369
|
|
|
|
|
Mexico
|
|
|
910
|
|
|
|
|
|
449
|
|
|
461
|
|
|
|
|
United
States, Canada and others
|
|
|
1,773
|
|
|
|
|
|
951
|
|
|
908
|
|
|
|
|
SBQ
steel
|
|
|
1,936
|
|
|
|
|
|
1,047
|
|
|
997
|
|
|
|
|
Structural
and other steel products
|
|
|
747
|
|
|
|
|
|
352
|
|
|
372
|
|
|
|
|
Per
ton:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales per ton
|
|
|
8,341
|
|
|
732
|
|
|
8,849
|
|
|
8,699
|
|
|
763
|
|
Cost
of sales per ton
|
|
|
6,916
|
|
|
607
|
|
|
7,134
|
|
|
7,070
|
|
|
620
|
|
Operating
income per Ton
|
|
|
835
|
|
|
73
|
|
|
1,107
|
|
|
1,144
|
|
|
100
|
|
Adjusted
EBITDA per ton
|
|
|
961
|
|
|
84
|
|
|
1,210
|
|
|
1,291
|
|
|
113
|
|
Number
of employees
|
|
|
4,360
|
|
|
|
|
|
4,433
|
|
|
4,340
|
|
|
|
|
(1)
|
Peso
amounts have been translated into U.S. dollars solely for the convenience
of the reader, at the rate of Ps. 11.3973 per $1.00, the interbank
transactions rate in effect on June 30,
2006.
|
(2)
|
Due
to a stock split effective May 30, 2006, one ADS represents three
series B
shares; previously one ADS represented one series B
share.
|
(3)
|
Long-term
debt includes amounts relating to deferred
taxes.
|
(4)
|
Reflects
a reclassification in 2005 from other expenses under Mexican GAAP
to
operating expenses under U.S. GAAP of Ps. 38 million due to the
cancellation of technical
assistance.
|
(5)
|
For
U.S. GAAP and Mexican GAAP purposes, the weighted average shares
outstanding were calculated to give effect to the stock split described
in
Note 13(a) to the audited financial
statements.
|
(6)
|
Adjusted
EBITDA is not a financial measure computed under Mexican or U.S.
GAAP.
Adjusted EBITDA derived from our Mexican GAAP financial information
means
Mexican GAAP net income (loss) excluding (i) depreciation and
amortization, (ii) financial income (expense), net (which is composed
of
net interest expense, foreign exchange gain or loss and monetary
position
gain or loss), (iii) other income (expense) and (iv) income tax expense
and employee statutory profit-sharing
expense.
|
Adjusted
EBITDA does not represent, and should not be considered as, an alternative
to
net income, as an indicator of our operating performance, or as an alternative
to cash flow as an indicator of liquidity. In making such comparisons, however,
you should bear in mind that adjusted EBITDA is not defined and is not a
recognized financial measure under Mexican GAAP or U.S. GAAP and that it may
be
calculated differently by different companies and must be read in conjunction
with the explanations that accompany it. Adjusted EBITDA as presented in this
table does not take into account our working capital requirements, debt service
requirements and other commitments.
We
believe that adjusted EBITDA can be useful to facilitate comparisons of
operating performance between periods and with other companies in our industry
because it excludes the effect of (i) depreciation and amortization, which
represents a non-cash charge to earnings, (ii) certain financing costs, which
are significantly affected by external factors, including interest rates,
foreign currency exchange rates, and inflation rates, which have little or
no
bearing on our operating performance, (iii) other income (expense) that are
not
constant operations and (iv) income tax expense and employee statutory
profit-sharing expense. However, adjusted EBITDA has certain material
limitations, including that (i) it does not include taxes, which are a necessary
and recurring part of our operations; (ii) it does not include depreciation
and
amortization, which, because we must utilize property, equipment and other
assets in order to generate revenues in our operations, is a necessary and
recurring part of our costs; (iii) it does not include comprehensive cost of
financing, which reflects our cost of capital structure and assisted us in
generating revenue; and (iv) it does not include other income and expenses
that
are part of our net income. Therefore, any measure that excludes any or all
of
taxes, depreciation and amortization, comprehensive cost of financing and other
income and expenses has material limitations.
Adjusted
EBITDA should not be considered in isolation or as a substitute for net income,
net cash flow from operating activities or net cash flow from investing and
financing activities. Reconciliation of net income to adjusted EBITDA is as
follows:
|
|
Pro
Forma
|
|
Actual
|
|
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2005
|
|
2005
|
|
2005
|
|
2006
|
|
2006
|
|
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
1,660
|
|
|
146
|
|
|
1,141
|
|
|
1,539
|
|
|
135
|
|
Depreciation
and amortization
|
|
|
339
|
|
|
30
|
|
|
144
|
|
|
202
|
|
|
18
|
|
Financial
income (expense)
|
|
|
(234
|
)
|
|
(20
|
)
|
|
(120
|
)
|
|
45
|
|
|
4
|
|
Income
tax expense and employee profit sharing
|
|
|
390
|
|
|
34
|
|
|
323
|
|
|
105
|
|
|
9
|
|
Other
income (expense)
|
|
|
45
|
|
|
4
|
|
|
34
|
|
|
33
|
|
|
3
|
|
Adjusted
EBITDA
|
|
|
2,578
|
|
|
226
|
|
|
1,694
|
|
|
1,768
|
|
|
155
|
|
SELECTED
CONSOLIDATED FINANCIAL INFORMATION
The
following tables present our summary consolidated financial information for
each
of the periods indicated. This information should be read in conjunction with,
and is qualified in its entirety by reference to, our financial statements,
including the notes thereto, as well as “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” included elsewhere in this
prospectus. Our financial statements are prepared in accordance with Mexican
GAAP, which differs in certain respects from U.S. GAAP. Note 19 to our audited
consolidated financial statements and Note 16 to our unaudited condensed
consolidated interim financial statements for the six-month period ended June
30, 2006 provide a summary of the principal differences between Mexican GAAP
and
U.S. GAAP as they relate to our business, along with a reconciliation to U.S.
GAAP of net income and stockholders’ equity, a statement of changes in
stockholders’ equity and, for the unaudited condensed consolidated interim
financial statements, a statement of cash flows under U.S. GAAP.
Mexican
GAAP provides for the recognition of certain effects of inflation by restating
non-monetary assets and non-monetary liabilities using the Mexican National
Consumer Price Index, restating the components of stockholders’ equity using the
Mexican National Consumer Price Index and recording gains or losses in
purchasing power from holding monetary liabilities or assets. Mexican GAAP
also
requires the restatement of all financial statements to constant Mexican pesos
as of the date of the most recent balance sheet presented. Our audited
consolidated financial statements and all other financial information contained
herein with respect to the years ended December 31, 2001, 2002, 2003, 2004
and
2005 are accordingly presented in constant pesos with purchasing power as of
June 30, 2006, unless otherwise noted. Our unaudited interim financial
statements for the six-month period ended June 30, 2006, which include
comparative unaudited financial information for the six-month period ended
June
30, 2005, and all other financial information presented herein, with respect
to
the six-month periods ended June 30, 2006 and 2005 are presented in constant
pesos with purchasing power as of June 30, 2006. Our results of operations
for
the six-month period ended June 30, 2006 are not necessarily indicative of
our
expected results of operations for the year ended December 31, 2006 and should
not be construed as such.
The
financial information includes the consolidation of Republic from July 22,
2005 and the consolidation of the Atlax Acquisition from August 1, 2004. Period
to period comparison of our results of operations and financial condition is
made more difficult as a result of the inclusion of financial information
relating to the acquisition of Republic only from July 22, 2005 and of
financial information relating to the Atlax Acquisition only from August 1,
2004.
We
have
derived the selected financial and operating information set forth below in
part
from our consolidated financial statements, which have been reported on by
KPMG
Cárdenas, Dosal, S.C. for the fiscal years ended December 31, 2001, 2002, 2003
and 2004 and by Mancera S.C., a Member Practice of Ernst & Young Global, an
independent, registered public accounting firm for the fiscal year ended
December 31, 2005. In so doing, Mancera, S.C. has relied on the audited
consolidated financial statements of our subsidiary SimRep and its subsidiaries,
reported on by BDO Hernández Marrón y Cía., S.C., a member firm of BDO
International.
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
|
|
(except
per share and per ADS data)
|
|
Income
Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
2,288
|
|
|
2,403
|
|
|
3,047
|
|
|
5,910
|
|
|
12,967
|
|
|
1,138
|
|
|
3,574
|
|
|
11,912
|
|
|
1,045
|
|
Direct
cost of sales
|
|
|
1,536
|
|
|
1,608
|
|
|
2,002
|
|
|
3,435
|
|
|
10,371
|
|
|
910
|
|
|
2,327
|
|
|
9,682
|
|
|
849
|
|
Marginal
profit
|
|
|
752
|
|
|
795
|
|
|
1,045
|
|
|
2,475
|
|
|
2,596
|
|
|
228
|
|
|
1,247
|
|
|
2,230
|
|
|
196
|
|
Indirect
manufacturing, selling, general and administrative
expenses
|
|
|
376
|
|
|
327
|
|
|
308
|
|
|
371
|
|
|
692
|
|
|
61
|
|
|
244
|
|
|
462
|
|
|
41
|
|
Depreciation
and amortization
|
|
|
160
|
|
|
177
|
|
|
199
|
|
|
222
|
|
|
326
|
|
|
29
|
|
|
131
|
|
|
202
|
|
|
18
|
|
Operating
income
|
|
|
216
|
|
|
291
|
|
|
538
|
|
|
1,882
|
|
|
1,578
|
|
|
138
|
|
|
872
|
|
|
1,566
|
|
|
137
|
|
Financial
income (expense)
|
|
|
6
|
|
|
(141
|
)
|
|
(27
|
)
|
|
(38
|
)
|
|
(145
|
)
|
|
(13
|
)
|
|
(35
|
)
|
|
45
|
|
|
4
|
|
Other
income (expense), net
|
|
|
73
|
|
|
(41
|
)
|
|
(32
|
)
|
|
(38
|
)
|
|
55
|
|
|
5
|
|
|
8
|
|
|
33
|
|
|
3
|
|
Income
before taxes, employee profit sharing and minority interest
|
|
|
295
|
|
|
109
|
|
|
479
|
|
|
1,806
|
|
|
1,488
|
|
|
131
|
|
|
845
|
|
|
1,644
|
|
|
144
|
|
Income
tax expense and employee profit sharing
|
|
|
19
|
|
|
(25
|
)
|
|
159
|
|
|
344
|
|
|
191
|
|
|
17
|
|
|
98
|
|
|
105
|
|
|
9
|
|
Net
income (loss)
|
|
|
276
|
|
|
134
|
|
|
320
|
|
|
1,462
|
|
|
1,297
|
|
|
114
|
|
|
747
|
|
|
1,539
|
|
|
135
|
|
Minority
interest
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
17
|
|
|
2
|
|
|
0
|
|
|
193
|
|
|
17
|
|
Majority
interest
|
|
|
276
|
|
|
134
|
|
|
320
|
|
|
1,462
|
|
|
1,280
|
|
|
112
|
|
|
747
|
|
|
1,346
|
|
|
118
|
|
Net
income per share
|
|
|
2
|
|
|
0.4
|
|
|
1
|
|
|
4
|
|
|
3
|
|
|
0.27
|
|
|
2
|
|
|
3
|
|
|
0.28
|
|
Net
income per ADS (2)
|
|
|
5
|
|
|
1
|
|
|
3
|
|
|
11
|
|
|
9
|
|
|
0.81
|
|
|
6
|
|
|
10
|
|
|
0.84
|
|
Weighted
average shares outstanding (thousands)(5)
|
|
|
164,448
|
|
|
299,901
|
|
|
357,159
|
|
|
398,916
|
|
|
413,790
|
|
|
|
|
|
405,209
|
|
|
419,451
|
|
|
|
|
Weighted
average ADSs outstanding
(thousands)
|
|
|
54,816
|
|
|
99,967
|
|
|
119,053
|
|
|
132,972
|
|
|
137,930
|
|
|
|
|
|
135,070
|
|
|
139,817
|
|
|
|
|
U.S.
GAAP including effects of inflation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
2,288
|
|
|
2,403
|
|
|
3,048
|
|
|
5,911
|
|
|
12,967
|
|
|
1,138
|
|
|
3,573
|
|
|
11,912
|
|
|
1,045
|
|
Direct
cost sales
|
|
|
1,530
|
|
|
1,612
|
|
|
2,007
|
|
|
3,429
|
|
|
10,375
|
|
|
910
|
|
|
2,329
|
|
|
9,594
|
|
|
842
|
|
Marginal
profit
|
|
|
758
|
|
|
791
|
|
|
1,041
|
|
|
2,482
|
|
|
2,592
|
|
|
228
|
|
|
1,244
|
|
|
2,318
|
|
|
203
|
|
Operating
income(4)
|
|
|
200
|
|
|
255
|
|
|
544
|
|
|
1,865
|
|
|
1,544
|
|
|
135
|
|
|
875
|
|
|
1,660
|
|
|
146
|
|
Financial
income (expense)
|
|
|
7
|
|
|
(141
|
)
|
|
(27
|
)
|
|
(38
|
)
|
|
(145
|
)
|
|
(13
|
)
|
|
(35
|
)
|
|
45
|
|
|
4
|
|
Other
income (expense), net
|
|
|
657
|
|
|
(74
|
)
|
|
(32
|
)
|
|
(4
|
)
|
|
93
|
|
|
8
|
|
|
8
|
|
|
33
|
|
|
3
|
|
Income
before taxes, employee profit sharing and minority interest
|
|
|
864
|
|
|
40
|
|
|
485
|
|
|
1,823
|
|
|
1,492
|
|
|
130
|
|
|
848
|
|
|
1,737
|
|
|
152
|
|
Income
tax expense (income)
|
|
|
69
|
|
|
(182
|
)
|
|
207
|
|
|
389
|
|
|
197
|
|
|
17
|
|
|
102
|
|
|
118
|
|
|
10
|
|
Income
before minority interest
|
|
|
795
|
|
|
222
|
|
|
278
|
|
|
1,434
|
|
|
1,295
|
|
|
113
|
|
|
746
|
|
|
1,619
|
|
|
142
|
|
Minority
interest
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
17
|
|
|
1
|
|
|
0
|
|
|
193
|
|
|
17
|
|
U.S.
GAAP adjustment on minority
interest
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
40
|
|
|
3
|
|
Net
Income
|
|
|
795
|
|
|
222
|
|
|
278
|
|
|
1,434
|
|
|
1,278
|
|
|
112
|
|
|
746
|
|
|
1,426
|
|
|
125
|
|
Income
per share (5)
|
|
|
5
|
|
|
1
|
|
|
1
|
|
|
4
|
|
|
3
|
|
|
0.27
|
|
|
2
|
|
|
3
|
|
|
0.30
|
|
Income
per ADS
|
|
|
14
|
|
|
2
|
|
|
2
|
|
|
11
|
|
|
9
|
|
|
0.81
|
|
|
6
|
|
|
10
|
|
|
0.89
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
|
5,557
|
|
|
5,035
|
|
|
6,570
|
|
|
9,306
|
|
|
14,588
|
|
|
1,280
|
|
|
9,531
|
|
|
16,439
|
|
|
1,442
|
|
Total
long-term liabilities(3)
|
|
|
803
|
|
|
881
|
|
|
1,153
|
|
|
1,513
|
|
|
2,244
|
|
|
197
|
|
|
1,439
|
|
|
2,003
|
|
|
176
|
|
Total
stockholders’ equity
|
|
|
3,338
|
|
|
4,089
|
|
|
5,062
|
|
|
6,848
|
|
|
9,628
|
|
|
845
|
|
|
7,368
|
|
|
11,902
|
|
|
1,044
|
|
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
|
|
(except
per share and per ADS data)
|
|
U.S.
GAAP including effects of inflation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
|
6,507
|
|
|
6,228
|
|
|
6,497
|
|
|
9,173
|
|
|
14,796
|
|
|
1,298
|
|
|
9,548
|
|
|
16,421
|
|
|
1,441
|
|
Total
long-term liabilities(3)
|
|
|
803
|
|
|
914
|
|
|
1,097
|
|
|
1,476
|
|
|
2,303
|
|
|
202
|
|
|
1,426
|
|
|
1,974
|
|
|
173
|
|
Total
stockholders’ equity
|
|
|
3,949
|
|
|
4,338
|
|
|
5,045
|
|
|
6,752
|
|
|
7,969
|
|
|
699
|
|
|
7,442
|
|
|
9,613
|
|
|
843
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
46
|
|
|
10
|
|
|
65
|
|
|
1,285
|
|
|
503
|
|
|
44
|
|
|
6
|
|
|
167
|
|
|
15
|
|
Adjusted
EBITDA(6)
|
|
|
376
|
|
|
468
|
|
|
737
|
|
|
2,104
|
|
|
1,904
|
|
|
167
|
|
|
1,003
|
|
|
1,768
|
|
|
155
|
|
Depreciation
and amortization from
continuing operations
|
|
|
160
|
|
|
177
|
|
|
199
|
|
|
222
|
|
|
326
|
|
|
29
|
|
|
131
|
|
|
202
|
|
|
18
|
|
Working
capital
|
|
|
(560
|
)
|
|
(11
|
)
|
|
1,023
|
|
|
1,968
|
|
|
4,063
|
|
|
356
|
|
|
2,907
|
|
|
5,854
|
|
|
514
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operational
information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual installed
capacity (thousands
of tons)
|
|
|
730
|
|
|
730
|
|
|
730
|
|
|
1,210
|
|
|
2,847
|
|
|
|
|
|
2,847
|
|
|
2,902
|
|
|
|
|
Tons
shipped(7)
|
|
|
561
|
|
|
609
|
|
|
628
|
|
|
773
|
|
|
1,708
|
|
|
|
|
|
524
|
|
|
1,369
|
|
|
|
|
Mexico
|
|
|
512
|
|
|
529
|
|
|
547
|
|
|
676
|
|
|
899
|
|
|
|
|
|
449
|
|
|
461
|
|
|
|
|
United
States, Canada and others
|
|
|
49
|
|
|
80
|
|
|
81
|
|
|
97
|
|
|
809
|
|
|
|
|
|
75
|
|
|
908
|
|
|
|
|
SBQ
steel
|
|
|
78
|
|
|
78
|
|
|
63
|
|
|
168
|
|
|
923
|
|
|
|
|
|
170
|
|
|
997
|
|
|
|
|
Structural
and other steel products
|
|
|
483
|
|
|
531
|
|
|
565
|
|
|
605
|
|
|
785
|
|
|
|
|
|
352
|
|
|
372
|
|
|
|
|
Per
ton:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales per ton
|
|
|
4,080
|
|
|
3,943
|
|
|
4,851
|
|
|
7,644
|
|
|
7,591
|
|
|
666
|
|
|
6,825
|
|
|
8,699
|
|
|
763
|
|
Cost
of sales per ton
|
|
|
2,740
|
|
|
2,639
|
|
|
3,187
|
|
|
4,442
|
|
|
6,072
|
|
|
533
|
|
|
4,443
|
|
|
7,070
|
|
|
620
|
|
Operating
income per Ton
|
|
|
385
|
|
|
476
|
|
|
857
|
|
|
2,435
|
|
|
924
|
|
|
81
|
|
|
1,666
|
|
|
1,145
|
|
|
100
|
|
Adjusted
EBITDA per ton
|
|
|
670
|
|
|
767
|
|
|
1,174
|
|
|
2,722
|
|
|
1,115
|
|
|
98
|
|
|
1,916
|
|
|
1,291
|
|
|
113
|
|
Number
of employees
|
|
|
1,386
|
|
|
1,333
|
|
|
1,288
|
|
|
2,018
|
|
|
4,360
|
|
|
-
|
|
|
1,975
|
|
|
4,340
|
|
|
-
|
|
(1)
|
Peso
amounts have been translated into U.S. dollars solely for the convenience
of the reader, at the rate of Ps. 11.3973 per $1.00, the interbank
transactions rate in effect on June 30, 2006 and at the rate of Ps.
10.7777 per $1.00, the interbank transactions rate in effect on December
31, 2005.
|
(2)
|
Due
to a stock split effective May 30, 2006, one ADS represents three
series B
shares; previously one ADS represented one series B
share.
|
(3)
|
Total
long-term liabilities include amounts relating to deferred
taxes.
|
(4)
|
Reflects
a reclassification in 2005 from other expenses under Mexican GAAP
to
operating expenses under U.S. GAAP of Ps. 38 million due to the
cancellation of technical
assistance.
|
(5)
|
For
U.S. GAAP and Mexican GAAP purposes, the weighted average shares
outstanding were calculated to give effect to the stock split described
in
Note 13(a) to the Consolidated Financial
Statements.
|
(6)
|
Adjusted
EBITDA is not a financial measure computed under Mexican or U.S.
GAAP.
Adjusted EBITDA derived from our Mexican GAAP financial information
means
Mexican GAAP net income (loss) excluding (i) depreciation and
amortization, (ii) financial income (expense), net (which is composed
of
net interest expense, foreign exchange gain or loss and monetary
position
gain or loss), (iii) other income (expense) and (iv) income tax expense
and employee statutory profit-sharing expense.
|
Adjusted
EBITDA does not represent, and should not be considered as, an alternative
to
net income, as an indicator of our operating performance, or as an alternative
to cash flow as an indicator of liquidity. In making such comparisons, however,
you should bear in mind that adjusted EBITDA is not defined and is not a
recognized financial measure under Mexican GAAP or U.S. GAAP and that it may
be
calculated differently by different companies and must be read in conjunction
with the explanations that accompany it. Adjusted EBITDA as presented in this
table does not take into account our working capital requirements, debt service
requirements and other commitments.
We
believe that adjusted EBITDA can be useful to facilitate comparisons of
operating performance between periods and with other companies in our industry
because it excludes the effect of (i) depreciation and amortization, which
represents a non-cash charge to earnings, (ii) certain financing costs, which
are significantly affected by external factors, including interest rates,
foreign currency exchange rates, and inflation rates, which have little or
no
bearing on our operating performance, (iii) other income (expense) that are
not
constant operations and (iv) income tax expense and employee statutory
profit-sharing expense. However, adjusted EBITDA has certain material
limitations, including that (i) it does not include taxes, which are a necessary
and recurring part of our operations; (ii) it does not include depreciation
and
amortization, which, because we must utilize property, equipment and other
assets in order to generate revenues in our operations, is a necessary and
recurring part of our costs; (iii) it does not include comprehensive cost of
financing, which reflects our cost of capital structure and assisted us in
generating revenue; and (iv) it does not include other income and expenses
that
are part of our net income. Therefore, any measure that excludes any or all
of
taxes, depreciation and amortization, comprehensive cost of financing and other
income and expenses has material limitations.
Adjusted
EBITDA should not be considered in isolation or as a substitute for net income,
net cash flow from operating activities or net cash flow from investing and
financing activities. Reconciliation of net income to adjusted EBITDA is as
follows:
|
|
Year
Ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2001
|
|
2002
|
|
2003
|
|
2004
|
|
2005
|
|
2005(1)
|
|
2005
|
|
2006
|
|
2006(1)
|
|
|
|
(Millions
of constant June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
(Millions
of constant
June
30, 2006 pesos)
|
|
(Millions
of
dollars)
|
|
|
|
(except
per share and per ADS data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
276
|
|
|
134
|
|
|
320
|
|
|
1,462
|
|
|
1,297
|
|
|
114
|
|
|
747
|
|
|
1,539
|
|
|
135
|
|
Depreciation
and amortization
|
|
|
160
|
|
|
177
|
|
|
199
|
|
|
222
|
|
|
326
|
|
|
28
|
|
|
131
|
|
|
202
|
|
|
18
|
|
Financial
income (expense)
|
|
|
6
|
|
|
(141
|
)
|
|
(27
|
)
|
|
(38
|
)
|
|
(145
|
)
|
|
(13
|
)
|
|
(35
|
)
|
|
45
|
|
|
4
|
|
Income
tax expense and employee profit sharing
|
|
|
19
|
|
|
(25
|
)
|
|
159
|
|
|
344
|
|
|
191
|
|
|
17
|
|
|
98
|
|
|
105
|
|
|
9
|
|
Other
income (expense)
|
|
|
73
|
|
|
(41
|
)
|
|
(32
|
)
|
|
(38
|
)
|
|
55
|
|
|
5
|
|
|
8
|
|
|
33
|
|
|
3
|
|
Adjusted
EBITDA
|
|
|
376
|
|
|
468
|
|
|
737
|
|
|
2,104
|
|
|
1,904
|
|
|
167
|
|
|
1,003
|
|
|
1,768
|
|
|
155
|
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The
following discussion is derived from our audited financial statements, which
are
presented elsewhere in this prospectus. This discussion does not include all
of
the information included in our financial statements. You should read our
financial statements to gain a better understanding of our business and our
historical results of operations.
We
have prepared our financial statements in accordance with Mexican GAAP, which
differs in certain respects from U.S. GAAP. See Note 19 to our audited financial
statements for the years ended December 31, 2003, 2004 and 2005 and Note
16 to
our unaudited condensed consolidated financial statements for the six-month
period ended June 30, 2006 for a summary of the principal differences
between Mexican GAAP and U.S. GAAP as they relate to us and a reconciliation
to
U.S. GAAP of net income and stockholders’ equity, a statement of changes in
stockholders’ equity and, in our unaudited condensed consolidated interim
financial statements, a statement of cash flows under U.S. GAAP. Our audited
financial statements and all other financial information contained herein with
respect to the years ended December 31, 2003, 2004 and 2005 are presented in
constant pesos with purchasing power as of June 30, 2006, unless otherwise
noted. Our unaudited consolidated
financial statements for the six-month period ended June 30, 2006, which include
comparative unaudited financial information for the six-month period ended
June
30, 2005, and all other financial information presented below with respect
to
the six-month periods ended June 30, 2006 and 2005 are presented in constant
pesos with purchasing power as of June 30, 2006, unless otherwise noted.
Our
financial statements and the corresponding discussion below includes the
consolidation of Republic from July 22, 2005 and the consolidation of the
Atlax Acquisition from August 1, 2004. Period to period comparison of our
results of operations and financial condition may be difficult as a result
of
the inclusion of the Republic financial information only from July 22, 2005
and of the Atlax Acquisition financial information only from August 1,
2004.
Overview
We
are
producers of SBQ and structural steel products. Accordingly, our net sales
and
profitability are highly dependent on market conditions in the steel industry
which is greatly influenced by general economic conditions in North America
and
elsewhere. As a result of the significant competition in the steel industry
and
the commodity-like nature of some of our products, we have limited pricing
power
over many of our products. The North American and global steel markets influence
finished steel product prices. Nevertheless, the majority of our products are
SBQ products for which competition is limited, therefore generating somewhat
higher margins as compared with our more commoditized steel products. We attempt
to adjust the mix of our product output toward higher margin products to the
extent that we are able to do so, and we also adjust our overall product levels
based on the product demand and marginal profitability of doing so.
We
focus
on controlling our direct cost of sales as well as our indirect manufacturing,
selling, general and administrative expenses. Our direct cost of sales largely
consist of the costs of acquiring the raw materials necessary to manufacture
steel, primarily scrap and iron ore. Market supply and demand generally
determine scrap and iron ore prices, and, as a result, we have limited ability
to influence their cost or the costs of other raw materials, including energy
costs. There
is
a correlation between the prices of scrap and iron ore and finished product
prices, although the degree and timing of this correlation varies from time
to
time, so we may not always be able to fully pass along scrap, iron ore and
other
raw material price increases to our customers. Therefore, our ability to
decrease our direct cost of sales as a percentage of net sales is largely
dependent on increasing our productivity. Our ability to control indirect
manufacturing, selling, general and administrative expenses, which do not
correlate to net sales as closely as direct costs of sales do, is a key element
of our profitability.
Production
costs at our U.S. facilities are higher than those in our facilities in Mexico
principally due to the higher cost of labor and the higher cost of ferroalloys
used to manufacture SBQ steel, which is the only steel product that we produce
in the United States.
Sales
Volume, Price and Cost Data, 2003 - 2005
|
|
Year
ended
December
31,
|
|
Six
months ended
June
30
|
|
|
|
2003
|
|
2004
|
|
2005
|
|
2005
|
|
2006
|
|
Shipments
(thousands of tons)
|
|
|
628
|
|
|
773
|
|
|
1,708
|
|
|
524
|
|
|
1,369
|
|
Guadalajara
and Mexicali
|
|
|
628
|
|
|
617
|
|
|
617
|
|
|
311
|
|
|
307
|
|
Apizaco
and Cholula
|
|
|
-
|
|
|
156
|
|
|
416
|
|
|
213
|
|
|
210
|
|
Republic
facilities
|
|
|
-
|
|
|
-
|
|
|
675
|
|
|
-
|
|
|
852
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Sales (Ps. mm)
|
|
|
3,047
|
|
|
5,910
|
|
|
12,967
|
|
|
3,574
|
|
|
11,912
|
|
Guadalajara
and Mexicali
|
|
|
3,047
|
|
|
4,669
|
|
|
3,957
|
|
|
2,101
|
|
|
2,107
|
|
Apizaco
and Cholula
|
|
|
-
|
|
|
1,241
|
|
|
2,750
|
|
|
1,473
|
|
|
1,439
|
|
Republic
facilities
|
|
|
-
|
|
|
-
|
|
|
6,260
|
|
|
-
|
|
|
8,366
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
Cost of Sales (Ps.
mm)
|
|
|
2,002
|
|
|
3,435
|
|
|
10,371
|
|
|
2,327
|
|
|
9,682
|
|
Guadalajara
and Mexicali
|
|
|
2,002
|
|
|
2,567
|
|
|
2,442
|
|
|
1,273
|
|
|
1,204
|
|
Apizaco
and Cholula
|
|
|
-
|
|
|
868
|
|
|
2,028
|
|
|
1,054
|
|
|
1,012
|
|
Republic
facilities
|
|
|
-
|
|
|
-
|
|
|
5,901
|
|
|
-
|
|
|
7,466
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
Price per Ton (Ps.)
|
|
|
4,852
|
|
|
7,646
|
|
|
7,592
|
|
|
6,821
|
|
|
8,701
|
|
Guadalajara
and Mexicali
|
|
|
4,852
|
|
|
7,567
|
|
|
6,413
|
|
|
6,756
|
|
|
6,863
|
|
Apizaco
and Cholula
|
|
|
-
|
|
|
7,955
|
|
|
6,611
|
|
|
6,915
|
|
|
6,852
|
|
Republic
facilities
|
|
|
-
|
|
|
-
|
|
|
9,274
|
|
|
-
|
|
|
9,819
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
Cost per Ton (Ps.)
|
|
|
3,188
|
|
|
4,444
|
|
|
6,072
|
|
|
4,441
|
|
|
7,072
|
|
Guadalajara
and Mexicali
|
|
|
3,188
|
|
|
4,160
|
|
|
3,958
|
|
|
4,093
|
|
|
3,922
|
|
Apizaco
and Cholula
|
|
|
-
|
|
|
5,564
|
|
|
4,875
|
|
|
4,948
|
|
|
4,819
|
|
Republic
facilities
|
|
|
-
|
|
|
-
|
|
|
8,742
|
|
|
-
|
|
|
8,763
|
|
Our
results are affected by general global trends in the steel industry and by
the
economic conditions in the countries in which we operate and in other steel
producing countries. Our results are also affected by the specific performance
of the automotive, non-residential construction, industrial equipment, tooling
equipment and other related industries. Our profitability is also impacted
by
events that affect the price and availability of raw materials and energy inputs
needed for our operations. The variables and trends mentioned below could also
affect our results and profitability.
Our
primary source of revenue is the sale of SBQ steel and structural steel
products.
In
August
2004, we completed the Atlax Acquisition. In July 2005, we and our controlling
shareholder, Industrias CH, completed the acquisition of Republic. These
acquisitions allowed us to become the leading producer of SBQ steel in North
America and the leading producer of structural and light structural steel in
Mexico. We expect the sale of SBQ steel, structural steel and other steel
products to continue to be our primary source of revenue. The markets for our
products are highly competitive and highly dependent on developments in global
markets for those products. The main competitive factors are price, product
quality and customer relationships and service.
Our
results are affected by economic activity, steel consumption and end-market
demand for steel products.
Our
results of operations depend largely on macroeconomic conditions in North
America. Historically, there has been a strong correlation between the annual
rate of steel consumption and the annual change in gross domestic products
(“GDP”) in the Mexican, U.S. and Canadian markets.
We
sell
our steel products to the construction, automotive, manufacturing and other
related industries. These industries are generally cyclical, and their demand
for steel is impacted by the stage of their industry market cycles and the
country’s economic performance. In 2004 and 2005, Mexico’s GDP increased 4.2%
and 3.0%, respectively. In 2004 and 2005, the U.S. GDP increased 3.9% and 3.2%,
respectively. Recession or a deterioration in economic conditions in the
countries in which we operate could adversely affect our results
Our
results are affected by international steel prices and trends in the global
steel industry.
Steel
prices are generally set by reference to world steel prices, which are
determined by global supply and demand trends. As a result of general excess
capacity in the industry, the world steel industry was previously subject to
substantial downward pricing pressure, which negatively impacted the results
of
steel companies in the second half of 2000 and all of 2001. International steel
prices generally improved beginning in 2003, driven by a strong increase in
global demand fostered by economic growth in Asia and an economic recovery
in
the United States, combined with increased rationalization of production
capacity in the United States and elsewhere.
However,
this new period of high prices for steel encouraged reactivation of investment
in production capacity, and, consequently, an increase in the supply of steel
products that contributed to a decline in steel prices. Average steel prices
in
2005 were below those of 2004, but remained substantially higher than steel
prices for the 2001 to 2003 period. In the first nine months of 2006, steel
prices increased to levels above those of 2005 due to strong end-market demand
fundamentals for a number of key steel-consuming industries, continued strong
steel demand in China, India and other developing economies, relatively high
raw
material and energy costs and reductions in U.S. production from some of the
industry’s largest producers. In the last quarter of 2006, global steel prices
have shown signs of weakening.
In
recent
years, there has been a trend toward consolidation of the steel industry. For
example, Aceralia, Arbed and Usinor merged in February 2002 to create Arcelor,
and LNM Holdings and Ispat International merged in October 2004 to create Mittal
Steel, which subsequently acquired International Steel Group. In 2006, Arcelor
completed the acquisition of Dofasco in Canada, and Mittal Steel announced
the
acquisition of Arcelor, forming the largest steel company in the world. In
addition, a number of other steel acquisition transactions have been announced,
including the pending acquisition of Oregon Steel by Evraz and the pending
acquisition of Corus by either Tata Steel or CSN. Consolidation has enabled
steel companies to lower their production costs and allowed for more stringent
supply-side discipline, including through selective capacity closures or idling,
as the ones observed recently in the United States by Mittal Steel, U.S. Steel
and others. Consolidation may result in increased competition and could
adversely affect our results.
Our
results are affected by competition from imports.
Our
ability to sell our products is influenced, to varying degrees, by global trade
for steel products, particularly trends in imports of steel products into the
Mexican and U.S. markets. In 2004, imports to Mexico declined as international
market conditions improved and the peso weakened. During 2005, the Mexican
government, at the request of CANACERO, implemented several measures to prevent
unfair trade practices such as dumping in the steel import market. These
measures include initiating anti-dumping and countervailing duty proceedings
temporarily increasing import tariffs for countries with which Mexico does
not
have free trade agreements. As a result, the competitive price pressure from
dumping declined, contributing to a general upward trend in domestic Mexican
steel prices.
Steel
imports to the United States. accounted for an estimated 25% of the domestic
steel market in 2005 and an estimated 26% in 2004. Foreign producers typically
have lower labor costs, and are in some cases are owned, controlled or
subsidized by their governments, allowing production and pricing decisions
to be
influenced by political and economic policy considerations as well as prevailing
market conditions. Increases in future levels of imported steel in the United
States could reduce future market prices and demand levels for steel in the
United States. To this extent, the U.S. Department of Commerce and the U.S.
International Trade Commission are currently conducting five year “sunset”
reviews of existing trade relief in several different steel products. Imports
represent less of a threat to SBQ producers like us in the United States than
to
commodity steel producers because of the high quality requirements and standard
required by buyers of SBQ steel products.
Our
results are affected by the cost of raw materials and energy.
We
purchase substantial quantities of raw materials, including scrap, iron ore,
coal and ferroalloys for use in the production of our steel products. The
availability and price of these inputs vary according to general market and
economic conditions and thus are influenced by industry cycles. Since 2003,
the
general recovery of the North American economy, the significant increase in
the
demand for steel in China and shortage of shipping capacity has resulted in
a
tight market and higher prices for these raw materials.
In
addition to raw materials, natural gas and electricity are both relevant
components of our cost structure. We purchase natural gas and electricity at
prevailing market prices in Mexico and the United States. These prices are
impacted by general demand and supply for energy in the United States and Mexico
and have increased significantly in 2004 and 2005 as economic activity fueled
energy demand and the supply and price of oil was impacted by geopolitical
conflicts.
Comparison
of Six Months Ended June 30, 2006 and 2005
Net
Sales
Our
net
sales in the six months ended June 30, 2006 increased 233% to Ps. 11,912 million
(including sales in Mexico of Ps. 3,546 million and net sales in our newly
acquired Republic plants in the United States and Canada, or our “Republic
facilities”, of Ps. 8,366 million), compared to Ps. 3,574 million in the same
period of 2005 (which sales were only in Mexico). We attribute this increase
to
net sales generated by the Republic facilities. Sales in tons of basic steel
products increased 162% to 1,369,352 metric tons in the six months ended June
30, 2006 (including 851,752 metric tons generated by the Republic facilities)
compared to 523,501 metric tons in the same period of 2005. Our net sales in
the
six-months ended June 30, 2006 decreased 4% to $11,912 million compared to
$12,388 million in the same period in 2005 on a pro forma basis.
Sales
outside Mexico (including sales by our U.S. subsidiaries) of basic steel
products increased 1,116% to 908,283 metric tons in the six months ended June
30, 2006 (including 851,752 metric tons generated by the Republic facilities)
compared to 74,692 metric tons in the same period of 2005. We attribute this
increase to sales from our Republic facilities. We sold 1,388 metric tons of
billet in the six months ended June 30, 2006, compared to 12,870 tons of billet
in the same period of 2005. Billet sales do not contribute materially to our
net
sales or to our operating results.
The
average price of our steel products (excluding the sales from our Republic
facilities) increased 2% in real terms in the six months ended June 30, 2006
compared to the same period of 2005. We attribute this increase to higher prices
prevailing in the Mexican steel markets.
Direct
Cost of Sales
Our
direct cost of sales in the six months ended June 30, 2006 increased 316% to
Ps.
9,682 million (including Ps. 7,466 million relating to the newly acquired
Republic facilities) compared to Ps. 2,327 million in the same period of 2005.
Direct cost of sales as a percentage of our net sales was 81% (62% excluding
the
cost of sales of Republic) in the six months ended June 30, 2006 compared to
65%
in the same period of 2005 and 81% on a pro forma basis. We attribute the higher
cost of sales in the six months ended June 30, 2006 primarily to the cost of
sales of the products that we produce in our Republic facilities. The higher
cost of sales of the Republic facilities is mainly a result of higher labor
costs prevailing in our U.S. operations, and the higher cost of raw materials,
which our U.S. operations use in the production of SBQ steel. Hourly wages
at
our Mexican operations are approximately $4 per hour on average compared to
average hourly wages in our U.S. operations of an average of more than $30
per
hour. Although raw material costs are similar in the United States and Mexico,
our U.S. operations produce only the more costly SBQ steel, which requires
more
expensive raw materials such as chromium, nickel, molybdenum and other alloys.
Our Mexican operations require these alloys to a lesser extent, because they
produce commodity steel as well as SBQ steel. The average cost of raw materials
that we used to produce steel products (excluding the production of Republic)
decreased 2% in real terms in the six months ended June 30, 2006 compared to
the
same period of 2005, primarily as a result of decreases in the price of scrap
and certain other raw materials.
Marginal
Profit
Our
marginal profit in the six months ended June 30, 2006 increased 79% to Ps.
2,230
million (including Ps. 900 million relating to the newly acquired plants of
Republic) compared to Ps. 1,247 million in the same period of 2005. We attribute
this increase to the increase in sales from the Republic facilities and to
higher prices prevailing in the Mexican steel markets. In early April 2006,
one
of our competitors, Siderurgica Lazaro Cardenas Las Truchas, S.A. (“SICARTSA”),
the principal producer of rebar in Mexico, stopped production because its
employees went on strike until mid-August 2006. The strike generated a shortage
in the supply of rebar and light section structurals, which generated a price
increase in those products compared to international prices because of an
imbalance in the supply and demand in the Mexican market. As a percentage of
net
sales, marginal profit was 19% (37% excluding the marginal profit of Republic)
in the six months ended June 30, 2006 compared to 35% in the same period of
2005
and 19% on a pro forma basis. This decrease is the result of the higher cost
of
sales prevailing at our Republic facilities.
Indirect
Manufacturing, Selling, General and Administrative Expenses
Our
indirect manufacturing, selling, general, and administrative expenses (including
depreciation and amortization) in the six months ended June 30, 2006 increased
77% to Ps. 664 million (including Ps. 304 million relating to the Republic
facilities) from Ps. 375 million in the same period of 2005. We recorded an
increase of Ps. 71 million, or 54%, in depreciation and amortization expense,
which in the six months ended June 30, 2006 was Ps. 202 million (including
Ps.
68 million relating to the Republic facilities) compared to Ps. 131 million
in
the same period of 2005 and increase of Ps. 58 million, or 40%, compared to
Ps.
144 million on a pro forma basis. We attribute this increase to the operating
expenses from our Republic facilities, which we acquired in July of
2005.
Operating
Income
Our
operating income in the six months ended June 30, 2006 increased 79% to Ps.
1,566 million (including Ps. 596 million relating to the newly acquired plants
of Republic) compared to Ps. 872 million in the same period of 2005. Operating
income was 13% of net sales in the six months ended June 30, 2006 compared
to
24% of net sales in the same period of 2005 and 13% on a pro forma basis. We
attribute the overall decrease as a percentage of our net sales to the
consolidation of Republic’s lower operating income with the operating income at
the Mexican facilities.
Financial
Income (Expense)
We
recorded financial income of Ps. 45 million in the six months ended June 30,
2006 compared to financial expense of Ps. 35 million in the same period of
2005.
Financial income or expense reflects the sum of three components: exchange
gain
or loss, net interest income or expense, and gain or loss from monetary
position. We recorded an exchange gain of approximately Ps. 19 million in the
six months ended June 30, 2006 compared to an exchange loss of Ps. 36 million
in
the same period of 2005, reflecting a 5.7% decrease in the value of the peso
compared to the dollar in the six months ended June 30, 2006 compared to a
3.7%
increase in the value of the peso versus the dollar in the same period of 2005.
Net interest income was Ps. 15 million in the six months ended June 30, 2006
compared to Ps. 8 million in the same period of 2005 and Ps. 77 million on
a pro
forma basis. We recorded a gain from monetary position of Ps. 12 million in
the
six months ended June 30, 2006 compared to a loss from monetary position of
Ps.
8 million in the same period of 2005, reflecting the domestic inflation rate
of
0.7% in the six months ended June 30, 2006 as compared to 0.8% in the same
period of 2005. We attribute the increase in financial income to exchange gains
due to a decrease in the value of the peso relative to the dollar and to higher
interest net income due in part to our low levels of debt.
Other
Income (Expense), Net
We
recorded other income, net, of Ps. 33 million in the six-months ended June
30,
2006, consisting of (i) income of Ps. 15 million from the cancellation of labor
obligations in the acquisition of Atlax and Metamex, (ii) income of Ps. 3
million from recovery of expenses, (iii) income of Ps. 2 million from recovery
of insurance freight charges and (iv) other income net, related to other
financial operations of Ps. 13 million. Other income, net of Ps. 8 million
in
the same period of 2005 consisted of (i) income of Ps. 4 million for the
recovery of added value tax, (ii) income of Ps. 1 million from recovery of
insurance freight charges and (iii) other income net, related to other financial
operations of Ps. 3 million.
Income
Tax and Employee Profit Sharing
We
recorded an income tax provision of Ps. 105 million for income tax and employee
profit sharing in the six months ended June 30, 2006 (including a benefit of
Ps.
63 million with respect to deferred income tax) compared to a provision of
Ps.
97 million in the same period of 2005 and Ps. 323 million on a pro forma basis
(including an increase in the provision of Ps. 24 million with respect to
deferred income tax). This provision increased due to higher net sales,
operating income and financial income.
The
effective tax rate was 12% and 7% for the six month periods ended June 30,
2005
and 2006 respectively. For the six month period ended June 30, 2005 the
effective tax rate was lower than the 30% applicable tax rate in Mexico, mainly
because in 2005 the company determined a tax benefit due of the non-accumulation
of taxes, in the coming years, of its inventory balance at December 31, 2004
due
to a corporate restructure (spin-off of its subsidiary COSICA) of the company.
In addition, there was a decrease in the deferred assets valuation allowance
based on an improvement on the recovery of these assets. For the six month
period ended June 30, 2006 the effective tax rate was lower than the 29% and
35%
tax rates applicable in Mexico and the United States respectively, mainly
because in 2006 the company amortized all of its deferred credit (see Note
1f to
the interim financial statements) which is non-taxable income.
Net
Consolidated Income
Our
net
income increased 106% in the six months ended June 30, 2006 to Ps. 1,539 million
compared to net income of Ps. 747 million in the same period of 2005 and 35%
to
Ps. 1,141 million on a pro forma basis. We attribute this increase primarily
to
net income from the Republic facilities, higher prices in the Mexican steel
market and higher financial income.
Comparison
of Years Ended December 31, 2005, 2004 and 2003
Net
Sales
Our
net
sales in 2005 increased 119% to Ps. 12,967 million (including the net sales
of
Ps. 2,750 million generated by the plants that we acquired in August 2004 in
Apizaco and Cholula and of Ps. 6,260 million generated by the plants of Republic
that we acquired in July 2005) compared to Ps. 5,910 million in 2004 (including
the net sales of Ps. 1,241 million generated since August 1, 2004 by the plants
in Apizaco and Cholula) and in 2004 increased 94% compared to Ps. 3,047 million
in 2003. We attribute the increase in 2005 net sales compared to 2004 to the
inclusion for the full year 2005 of net sales of Ps. 2,750 million from the
plants in Apizaco and Cholula as well as Ps. 6,260 million from the Republic
plants. We attribute the increase in 2004 net sales compared to 2003 net sales
to substantially higher prices for our basic steel products, reflecting global
steel price increases, primarily in the second quarter of the year and from
significantly higher production levels, largely resulting from the inclusion
of
production by the Apizaco and Cholula facilities. Sales in tons of basic steel
products increased 121% in 2005 to 1,708,140 tons (including 413,925 metric
tons
generated by the plants in Apizaco and Cholula and 674,957 metric tons generated
by the Republic plants) from 773,297 tons in 2004, which in turn had increased
23% in 2004 (including 155,614 tons produced by the plants in Apizaco and
Cholula) from 628,243 tons in 2003.
Sales
outside Mexico of steel products (including sales of our U.S. subsidiaries)
increased 733% to 809,083 metric tons in 2005 (including 19,261 tons from our
plants in Apizaco and Cholula and 674,957 metric tons from the Republic
facilities) compared to 97,126 metric tons 2004 (including 12,394 metric tons
from the plants in Apizaco and Cholula). Exports of basic steel products in
2004
increased 20% compared to 2003 to 97,126 tons (including 12,394 tons from the
plants in Apizaco and Cholula). We sold 14,488 tons of billet in 2005, 41,832
tons of billet in 2004 and 63,616 tons of billet in 2003. Billet sales do not
contribute materially to our net sales or otherwise to our operating results.
The
average price of steel products (excluding the sales of Republic) decreased
14%
in real terms in 2005 compared to 2004 and increased 63% in real terms in 2004
compared to 2003. We attribute the 2005 decrease to the global decrease of
finished steel product prices reflecting higher inventory levels worldwide,
and
we attribute the 2004 increase to the significant global rise in overall demand
and of finished steel product prices.
Direct
Cost of Sales
Our
direct cost of sales increased 202% in 2005 to Ps. 10,371 million (including
Ps.
2,028 million relating to the newly acquired plants in Apizaco and Cholula
and
Ps. 5,901 million relating to the newly acquired Republic facilities) compared
to Ps. 3,435 million in 2004 (including Ps. 868 million relating to the Apizaco
and Cholula plants) and in 2004 increased 72% compared to Ps. 2,002 million
in
2003. Our direct cost of sales as a percentage of net sales increased to 80%
in
2005 from 58% in 2004 and 66% in 2003.
We
attribute our higher direct cost of sales in 2005 compared to 2004 to the cost
of sales relating to the Republic plants, which represented 94.3% as a
percentage of net sales. The higher cost of sales was mainly the result of
higher labor costs prevailing in our U.S. operations and the higher cost of
raw
material involved in the production of SBQ steel, which is the only steel
product that we produce in the United States. We attribute our higher direct
cost of sales in 2004 compared to 2003 to the increased cost of raw materials
and somewhat higher production levels. The average cost of raw materials that
we
used to produce steel products (excluding the production of Republic) increased
1% in real terms in 2005 compared to 2004, primarily as a result of increases
in
the price of scrap and certain other raw materials. The average cost of raw
materials that we used to produce steel products in 2004 increased 44% from
2003, primarily as a result of increases in the price of scrap, electricity
and
gas.
In
2004
we experienced a 45% increase in the price of scrap and other raw materials.
However, due to strong customer demand reflecting low inventory levels, we
were
able to increase our prices by 63%. During this uptrend in the steel cycle
in
2004, we were able to pass on to our customers substantially all raw material
increases through surcharges. As inventory levels started to rise in early
2005
in the international and Mexican markets, we reduced our prices by 14%
(excluding the production of Republic) from 2004 levels, while our direct costs
of sales per ton increased 1 %.
Marginal
Profit
Our
marginal profit in 2005 increased 5% to Ps. 2,596 million (including Ps. 722
million relating to the newly acquired plants in Apizaco and Cholula and Ps.
359
million relating to the newly acquired plants of Republic) compared to Ps.
2,475
million in 2004 (including Ps. 373 million relating to the plants in Apizaco
and
Cholula) and in 2004 increased 137% compared to Ps. 1,045 million in 2003.
As a
percentage of net sales, our marginal profit was 20% in 2005 (33% without
Republic) compared to 42% in 2004 and 34% in 2003. We attribute the decrease
in
marginal profit as a percentage of net sales in 2005 to higher labor costs
prevailing in our U.S. operations and higher cost of raw material involved
in
the production of SBQ steel, and we attribute the increase in 2004 to the
significant global rise of finished product prices. Because of low steel
inventories in 2004, we were able to pass on to customers, through surcharges,
more than the cost increases in scrap and certain other raw materials.
Therefore, our marginal profit as a percentage of net sales increased to 42%
in
2004 compared to 34% in 2003. As international steel inventory levels increased
in 2005, prices and surcharges decreased, with our marginal profit as a
percentage of net sales falling to 33% which was similar to our 34% marginal
profit level in 2003.
Indirect
Manufacturing, Selling, General and Administrative Expenses
Indirect
manufacturing, selling, general and administrative expenses, which include
depreciation and amortization, increased 72% (25% without Republic) to Ps.
1,018
million in 2005 (including Ps. 249 million relating to the newly acquired plants
in Apizaco and Cholula and Ps. 271 million relating to the newly acquired
Republic plants) compared to Ps. 593 million in 2004 (including Ps. 75 million
relating to the plants in Apizaco and Cholula) and in 2004 increased 17%
compared to Ps. 507 million in 2003.
We
attribute the increase in these expenses in 2005 compared to 2004 primarily
to
the Republic plants. We attribute the increase in these expenses in 2004
compared to 2003 primarily to the Apizaco and Cholula plants.
Depreciation
and amortization increased by 47% to Ps. 326 million in 2005 (including Ps.
60
million relating to the plants in Apizaco and Cholula and Ps. 69 million
relating to the Republic plants) and increased by 11% to Ps. 222 million in
2004
(including Ps. 25 million relating to the plants in Apizaco and Cholula) from
Ps. 199 million in 2003. We attribute the increase in 2005 compared to 2004
to
the inclusion for the full year 2005 of the depreciation that the Apizaco and
Cholula plants generated and the depreciation relating to the Republic plants.
We attribute the increase in 2004 compared to 2003 to the depreciation relating
to the Apizaco and Cholula plants.
Operating
Income
Our
operating income decreased by 16% to Ps. 1,578 million in 2005 from Ps. 1,882
million in 2004 and in 2004 increased 250% from Ps. 538 million in 2003.
Operating income represented 12%, 32% and 18% of our net sales in 2005, 2004
and
2003, respectively. We attribute the decrease in 2005 to the global decrease
of
finished steel product prices, and we attribute the increase in 2004 to the
significant global rise in demand and in finished steel product
prices.
Financial
Income (Expense)
Our
financial expense increased 282% to Ps. 145 million in 2005 from Ps. 38 million
in 2004, and in 2004 increased 40% from Ps. 27 million in 2003. Financial income
or expense reflects the sum of three components: exchange gain or loss, net
interest income or expense and gain or loss from monetary position. We recorded
an exchange loss of approximately Ps. 75 million in 2005 compared to an exchange
gain of Ps. 4 million in 2004 and an exchange loss of Ps. 3 million in 2003.
These exchange results reflect the 4.3% increase in the value of the peso versus
the dollar in 2005 compared to a decrease of 0.3% in the value of the peso
versus the dollar in 2004. The exchange gain in 2004 also reflected lower debt
levels than in the prior year. During 2003 and 2004, we made various prepayments
on our bank debt and we also converted certain loans from our parent to
equity.
Net
interest expense was Ps. 16 million in 2005 compared to Ps. 6 million of net
interest income in 2004 and Ps. 14 million of net interest expense during 2003.
The increase in 2005 reflected a higher amount of debt outstanding during 2005
compared to 2004 resulting from the acquisition of Republic, and the decrease
in
2004 reflected a lower amount of debt outstanding compared to 2003.
We
recorded a loss from monetary position of Ps. 54 million in 2005 compared to
a
loss from monetary position of Ps. 47 million in 2004 and a loss from monetary
position of Ps. 10 million in 2003. These increases reflected the domestic
inflation rate of 3.3% in 2005 as compared to 5.2% in 2004 and 4% in 2003 as
well as higher debt levels during 2005 compared to 2004 and in 2004 lower debt
levels as compared to 2003 as a result of the developments discussed above.
Other
Income (Expense), Net
We
recorded other income, net, of Ps. 55 million in 2005. This amount
reflected:
|
·
|
income
from the amortization of the deferred credit of Ps. 67
million;
|
|
·
|
expense
for the cancellation of the technical assistance of Ps. 38
million;
|
|
·
|
income
from the recovery of a commission from Banco Nacional de Comercio
Exterior
for Ps. 8 million; and
|
|
·
|
other
income, net, related to other financial operations of Ps. 18
million.
|
We
recorded other expense, net, of Ps. 38 million in 2004. This amount
reflected:
|
·
|
income
from the reversal of an account recorded as a doubtful account of
Ps. 14
million;
|
|
·
|
a
reserve of Ps. 6 million relating to the clean-up of contaminated
land at
the Pacific Steel facilities;
|
|
·
|
a
reserve of Ps. 13 million relating to the realizable value of idle
machinery and equipment;
|
|
·
|
a
reserve for doubtful accounts of Ps. 10 million;
and
|
|
·
|
other
expense related to other financial operations of Ps. 23
million.
|
We
recorded other expense, net, of Ps. 32 million in 2003. This amount
reflected:
|
·
|
a
reserve of Ps. 12 million relating to the clean-up of contaminated
land at
the Pacific Steel facilities;
|
|
·
|
a
reserve of Ps. 19 million relating to the realizable value of idle
machinery and equipment; and
|
|
·
|
other
expense, net, related to other financial operations of Ps. 1
million.
|
Income
Tax and Employee Profit Sharing
For
the
years ended December 31, 2005, 2004 and 2003 we recorded an income tax provision
of Ps. 191 million, Ps. 344 million and Ps. 159 million, respectively. These
amounts included a provision for deferred income taxes of Ps. 112 million in
2005, Ps. 320 million in 2004 and Ps. 140 million in 2003.
Our
effective income tax rates for the fiscal years ended December 31, 2005, 2004
and 2003 were 12.8%, 19.02% and 31.98% respectively. The effective income tax
rate in 2005 was less than the statutory rate of 30%, mainly for the following
reasons:
|
·
|
In
2004, we had a valuation allowance that covered almost the total
amount of
the recoverable asset tax and tax loss carryforwards due to the
uncertainty of their recovery. However, in 2005 we recovered Ps.
84
million of assets tax. As a result of this recovery and future
estimations, we reduced our valuation allowance on our deferred tax
asset
as of December 31, 2005. The net change in the valuation allowance
for the
year ended December 31, 2005 was a decrease of Ps. 132.4 million.
|
|
·
|
In
accordance with tax laws in effect through December 31, 2004, inventory
purchases were tax deductible in the year in which they were made,
regardless of the time of sale of finished goods. As of 2005, the
cost of
acquiring inventories was tax deductible only when sold, although
the law
provides transition provisions to tax the ending inventory balance
at
December 31, 2004 over periods that vary depending on the circumstances
of
each entity. During 2005 we obtained a tax benefit of Ps. 420.5 million,
because of the non-accumulation, in subsequent years, of tax on our
inventory balance at December 31, 2004 due to our corporate restructuring
(spin-off of its subsidiary COSICA). Also, we recorded an additional
deferred tax liability for the amount of Ps. 303.5 million, to account
for
the difference of the net income of the 2005 period for which we
did not
pay taxes. See Note 13(c) to the Consolidated Financial
Statements.
|
These
changes resulted in favorable tax differences that had a one time impact in
our
effective income tax rate for 2005 and 2004.
A
new
income tax law was enacted in Mexico on December 1, 2004, which established
an
income tax rate of 30% for 2005, 29% for 2006, and 28% for 2007 and subsequent
years. As a result of these changes, for the year ended December 31, 2004,
we
recognized a decrease in the net deferred tax liability of Ps. 288.5 million
which was credited to results of operations.
Net
Consolidated Income
We
recorded net income of Ps. 1,280 million, Ps. 1,462 million and Ps. 320 million
in 2005, 2004 and 2003, respectively. We attribute the decrease in 2005 to
the
global decrease of finished steel product prices, and we attribute the increase
in 2004 to the significant global increase in overall demand and in finished
steel product prices.
Liquidity
and Capital Resources
As
a
result of the economic crisis in Mexico arising from the devaluation of the
peso
versus the U.S. dollar in 1994, including the liquidity crisis which affected
the Mexican banking system, the insolvency of our former parent, Sidek, and
our
high levels of short-term indebtedness, we became unable to generate or borrow
funds to refinance our debt or to support our operations and capital
improvements. As of December 15, 1997, and immediately prior to the consummation
of the restructuring discussed below, we had total outstanding indebtedness
of
approximately $322 million. Over half of our debt had matured and was unpaid
and
substantially all of the balance was subject to acceleration.
In
December 1997, we consummated a corporate reorganization and restructuring
of
our liabilities. As part of this restructuring, our wholly-owned subsidiary,
Compañía Siderúrgica de Guadalajara, S.A. de C.V. (“CSG”), incurred new bank
debt and issued new debt securities and paid limited amounts of accrued interest
on certain outstanding debt in exchange for and in an aggregate amount
approximately equal to our aggregate outstanding consolidated debt at the date
of consummation of the restructuring. In exchange, CSG received equity in all
of
our subsidiaries, and we eliminated the intercompany debt that CSG owed to
us.
The
restructuring did not result in a reduction in the overall amount of our
consolidated outstanding debt, and, accordingly, following the restructuring,
through CSG, we continued be highly leveraged. In 2001, subsequent to Industrias
CH’s acquisition of a controlling interest in us, CSG redeemed or repurchased
all of the outstanding debt securities it had issued in connection with the
restructuring, which it financed principally with borrowings from Industrias
CH.
In 2001, we converted approximately $90 million of bank debt to equity, which
equity Industrias CH acquired. From 2001 through 2004, CSG continued to pay
down
its outstanding bank debt, making scheduled amortization payments as well as
additional principal payments which it financed primarily by capital
contributions from Industrias CH or borrowings from Industrias CH which it
later
converted to equity. In March 2004, we prepaid $1.7 million of the remainder
of
our outstanding bank debt.
At
June
30, 2006, our total consolidated debt consisted of U.S.$302,000 of 8-7/8%
medium-term notes due 1998 (accrued interest at June 30, 2006 was U.S.$322,798).
We conducted exchange offers for the MTNs in October 1997 and August of 1998.
This amount reflects sums that we did not pay to holders that we could not
identify at the time of the exchange offers.
At
December 31, 2005, our total consolidated debt consisted of U.S.$38 million
(Ps.
433 million), of which U.S.$33.4 million was debt held by GE Capital, U.S.$4.3
million was held by the Ohio Department of Development Loan, and U.S.$302,000
was 8-7/8% medium-term notes due 1998 (accrued interest at December 31, 2005
was
U.S.$309,311). The U.S.$309,311 reflects sums that we did not pay to holders
that we could not identify at the time of the exchange offers. At December
31,
2003 and 2004, respectively, our total consolidated debt consisted of U.S.$2
million (Ps. 25 million) and U.S.$13.9 million (Ps. 163 million).
On
August
9, 2004, we acquired the property, plant and equipment and the inventories,
and
assumed liabilities associated with seniority premiums of employees, of the
Mexican steel-making facilities of Grupo Sidenor located in Apizaco and Cholula.
Our total net investment in this transaction was approximately U.S.$122 million
((Ps. 1,483 million) which amount excludes value added tax of $16 million (Ps.
196 million)) which we paid in 2004 and recouped from the Mexican government
in
2005), funded with our internally generated resources and capital contributions
from Industrias CH of U.S.$19 million (Ps. 230 million) for capital stock to
be
issued in the second quarter of 2005. Approximately $107.5 million (Ps. 1,260
million) of our investment related to the acquisition of property, plant and
equipment, approximately $7 million (Ps. 86 million) related to a technical
assistance contract with the seller and the balance relates to inventories
acquired.
On
July
22, 2005, we and our parent company Industrias CH acquired 100% of the stock
of
Republic. We acquired 50.2% of Republic’s stock for U.S.$115 million (Ps. 1,310
million) through our majority owned subsidiary, SimRep, and Industrias CH
purchased the remaining 49.8% through SimRep for U.S.$114 million (Ps. 1,299
million). We financed our portion of the U.S.$229 million (Ps. 2,609 million)
purchase price principally from a loan received through Industrias CH that
has
since been repaid in full. At December 31, 2005, the total amount of
Republic’s debt was U.S.$37.7 million (Ps. 409 million), which debt has since
been repaid in full.
We
depend
heavily on cash generated from operations as our principal source of liquidity.
Other sources of liquidity have included financing made available to us by
our
parent Industrias CH (primarily in the form of equity, or debt substantially
all
of which was subsequently converted to equity), most significantly for the
purpose of repaying third party indebtedness, and limited amounts of vendor
financing. We have had very limited access to and have not borrowed any material
amounts from unaffiliated third parties since consummation of the restructuring.
We believe that our existing cash, cash equivalents and cash generated from
operations will be sufficient to satisfy our currently anticipated cash
requirements through the next 12 months, including our currently anticipated
capital expenditures.
Republic
has a committed secured revolving line of credit from General Electric Capital
Corporation (“GE Capital”) under which it can borrow up to U.S.$150 million (the
“GE Facility”), which matures on May 20, 2009, extendible for one year at the
option of Republic. This facility is secured by all of Republic’s inventory and
accounts receivable and bears interest based on one of the two following
formulas, at Republic’s discretion: (1) at an indexed rate equal to the highest
prime rate published by the Wall Street Journal, plus the applicable margin,
or
the federal funds rate plus 50 base percentage points per year and the
applicable margin, or (2) LIBOR plus the applicable margin. Margins were
adjusted based on the available rate for the quarter on a base established
in
advance. Republic currently has no debt outstanding under this
facility.
The
GE
Facility contains covenants including restrictions on engaging in any business
other than our current businesses or businesses reasonably related to our
current businesses, sales of properties or other assets (including the stock
of
any of our subsidiaries), and the amount of capital expenditures; for example,
on a consolidated basis with our subsidiaries, we are restricted from making
unfinanced capital expenditures during any fiscal year that exceed U.S.$ 110
million in the aggregate. However, we may increase our unfinanced capital
expenditures in any fiscal year by the lesser of (i) U.S.$ 7.5 million and
(ii)
the amount (if any) equal to U.S.$100 million minus the actual amount of
unfinanced capital expenditures in the prior fiscal year. The GE Facility also
restricts our ability to incur additional indebtedness. For example, during
any
fiscal quarter, we may not prepay more than U.S.$ 7.5 million in the aggregate
of the senior secured promissory notes due 2009. In addition, after prepayment,
we must have on a consolidated basis with our subsidiaries a fixed charge
coverage ratio for the fiscal quarter most recently ended of not less than
1.1:1.0. The GE Facility also requires that on a consolidated basis with our
subsidiaries, we maintain a fixed charge coverage ratio of 1.00:1.0 for the
12-month period most recently ended if at any time 85% of the book value of
our
eligible accounts plus the lesser of (i) 65% of the book value of our eligible
inventory at the lower of cost or market, (ii) 85% of the net orderly
liquidation percentage of eligible inventory and (iii) U.S.$ 115 million, minus
the sum of the revolving loan and swing line loan then outstanding, is less
than
U.S.$ 30 million. In the GE Facility, the term “fixed charge coverage ratio”
means the ratio of (i) EBITDA less direct proceeds of business interruption
insurance solely to the extent attributable to claims arising as a consequence
of events occurring prior to May 20, 2004 to (ii) the aggregate of all interest
expense paid or accrued during that period, plus payments of principal with
respect to indebtedness during that period plus unfinanced capital expenditures
during that period plus income taxes paid or payable in cash with respect to
that fiscal period (but excluding income taxes, if any on insurance proceeds)
plus to the extent not otherwise deducted in the determination of EBITDA,
restricted payments made during that period.
Our
principal use of cash has generally been to fund our operating activities,
for
debt repayments, to acquire businesses and, to a significantly lesser degree,
capital expenditure programs. The following is a summary of cash flows for
the
three years ended December 31, 2005 and for the six months ended June 30,
2006:
Principal
Cash Flows
|
|
Years
ended December 31,
|
|
Six
Months Ended June 30,
|
|
|
|
2003
|
|
2004
|
|
2005
|
|
2005
|
|
2006
|
|
|
|
(millions
of constant Pesos)
|
|
Resources
provided by
operating activities
|
|
|
436
|
|
|
915
|
|
|
1,863
|
|
|
664
|
|
|
778
|
|
Resources
provided by (used in) financing
|
|
|
31
|
|
|
404
|
|
|
(242
|
)
|
|
(158
|
)
|
|
(287
|
)
|
Resources
provided by (used in) investing activities
|
|
|
(26
|
)
|
|
(1,357
|
)
|
|
(1,938
|
)
|
|
133
|
|
|
248
|
|
Our
net
resources provided by operations were Ps. 778 million in the six-month period
ended June 30, 2006 compared to Ps. 664 million of net resources provided by
operations in the same period of 2005 and reflected our net income for the
period. Our net resources provided by operating activities was Ps. 1,863 million
in 2005 and reflected the net income of the year. Our net resources provided
by
operating activities was Ps. 915 million in 2004 and reflected significant
net
income offset by increases in inventories and receivables attributable to the
acquisition of the Apizaco and Cholula facilities. Our net resources provided by
operating activities was Ps. 436 million in 2003 and reflected the conversion
of
loans of Industrias CH into our series B shares for Ps. 201
million.
Our
net
resources used by financing activities were Ps. 287 million in the six-month
period ended June 30, 2006 (which amount includes the prepayment of Ps. 409
million (U.S.$37.7 million) of Republic’s bank debt and a capital contribution
of certain minority shareholders of Simec of Ps. 122 million) compared to Ps.
158 million of net resources used by financing activities in the same period
of
2005. Our net resources used in financing activities was Ps. 242 million in
2005. This amount reflected the prepayment of Ps. 1,052 million of bank debt
of
Republic and the loan from Industrias CH for Ps. 451 million. Our net resources
provided by financing activities was Ps. 404 million in 2004. This amount
reflected prepayment of bank debt of U.S.$20 million (Ps. 228 million), the
increase in capital stock issued to minority shareholders of Ps. 25 million
and
a capital contribution from Industrias CH to us in the amount of Ps. 230 ($20
million) for capital stock to be issued in the second quarter of 2005. Our
net
resources provided by financing activities was Ps. 31 million in 2003. This
amount reflected the semi-annual amortization installments on our bank debt
of
Ps. 16 million (U.S.$1.4 million), the prepayment of Ps. 352 million ($30
million) of bank debt, the conversion into shares by Industrias CH of Ps. 201
million of loans plus accrued interest thereon, the increase of the capital
stock by the minority shareholders for Ps. 21 million and the conversion into
series B shares of the capital contribution from Industrias CH to us in the
amount of Ps. 169 million (U.S.$15 million) in 2003.
We
attribute our net resources used in investing activities primarily to the
acquisition of property, plant and equipment and other non-current assets and
reflects changes in long-term inventories and proceeds from insurance claim.
Our
net resources provided by investing activities (to acquire property, plant
and
equipment and other non-current assets) were Ps. 248 million for the six months
ended June 30, 2006 compared to net resources provided by investing activities
of Ps. 133 million in the same period of 2005. Our net resources used in
investing activities (to acquire property, plant and equipment and other
non-current assets) were Ps. 1,938 million in 2005, and our net resources used
to acquire Republic were Ps. 1,310 million. Our net resources used in investing
activities were Ps. 1,357 million in 2004 (which amount reflects the acquisition
of the Apizaco and Cholula facilities) and Ps. 26 million in 2003.
At
June
30, 2006, our total consolidated debt consisted of approximately $302,000 (Ps.
3.4 million) of U.S. dollar denominated debt (accrued interest at June 30,2006
was $322,798). At December 31, 2005, our total consolidated debt consisted
of
approximately $38 million of U.S. dollar denominated debt. At December 31,
2004,
we had outstanding approximately $13.9 million of U.S. dollar-denominated debt.
In
December 2003, we acquired Administradora de Cartera de Occidente, S.A. de
C.V.
(“Acosa”) from Industrias CH for nominal consideration. Acosa’s sole asset is a
portfolio of defaulted receivables it acquired in June 2003 from various Mexican
banks which are in the process of liquidation. The purchase price of the
portfolio is payable by Acosa solely from recoveries, if any, net of expenses
of
collection, with respect to the defaulted receivables. Upon payment of the
purchase price from recoveries on the portfolio, Acosa and the Mexican banks
will share in any additional recoveries, net of expenses of collection, on
a
50%/50% basis. At December 31, 2005, we did not have any recoveries with respect
to the defaulted receivables. We sold Acosa in October of 2006 for nominal
consideration.
In
May
2004, certain minority of our shareholders exercised their pre-emptive rights
arising as a result of the conversion by Industrias CH of certain indebtedness
to purchase capital stock for Ps. 24.7 million at the price per share of Ps.
14.59 (the equivalent of U.S.$1.25 per ADS). See “Related Party Transactions”
below.
We
do not
have in place any interest rate or currency hedging instruments. We are not
a
party to any non-exchange traded contracts accounted for at fair value other
than, as described in Note 6 to the audited financial statements, certain
futures contracts that we entered into in late 2003 to fix the price of our
natural gas purchases from 2004 to 2006.
Off-Balance
Sheet Arrangements
We
do not
have any off-balance sheet arrangements.
Contractual
Obligations
The
table
below sets forth our significant long-term contractual obligations as of
December 31, 2005:
|
|
Maturity
|
|
|
|
Less
than
1
year
|
|
1
- 3 years
|
|
4
- 5 years
|
|
In
excess of 5 years
|
|
Total
|
|
|
|
(millions
of constant Pesos)
|
|
Long-term
debt obligations
|
|
|
18
|
|
|
29
|
|
|
362
|
|
|
0
|
|
|
409
|
|
Long-term
debt obligations (MTNs)
|
|
|
3
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
3
|
|
Long-term
contractual obligations
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
Total
|
|
|
21
|
|
|
29
|
|
|
362
|
|
|
0
|
|
|
412
|
|
As
of
December 31, 2005, Republic had U.S.$0.1 million included in property, plant
and
equipment for various equipment and computer capital leases. Republic’s capital
leases required future minimum payments of U.S.$0.3 million for 2006 and were
repaid in full in 2006.
Quantitative
and Qualitative Disclosures About Market Risk
We
are
exposed to market risk, which is the potential risk of loss in fair values,
cash
flows or earnings due to changes in interest rates and foreign currency rates
(primarily the peso/dollar exchange rate), as a result of our holdings of
financial instrument positions. Our financial instruments include cash and
cash
equivalents, trade and other accounts receivable, accounts payable, long-term
debt securities and related party debt. We do not maintain a trading portfolio.
Our borrowings are entirely denominated in dollars. We do not utilize derivative
financial instruments to manage our market risks with respect to our financial
instruments. Historically, based on the last ten years of data, inflation in
Mexico has been 327% higher
than the Mexican peso’s devaluation relative to the dollar.
We
are
exposed to market risk due to fluctuations of the purchase price of natural
gas.
To limit our exposure, in late 2003, we entered into futures contracts
with
PEMEX.
We
expect
the contracts will guarantee a portion of our natural gas consumption in our
Mexican operations at a fixed price of $4.462 per million
British thermal unit (“MMBtu”). Through December 31, 2006, our Mexican
operations obtained approximately 95% of their natural gas consumption, or
2,200,000 MMBtus, from PEMEX. Between January 1, 2007 and January 31, 2007,
we
expect that our operations in the United States will obtain approximately 15%
of
their natural gas consumption, or 1,800,000 MMBtus, from futures contracts.
These futures contracts are not entered into for trading purposes but, subject
to market prices of natural gas, are expected to be settled by delivery of
natural gas at the contract price. As described in Note 6 to our audited
financial statements, at December 31, 2005, we recorded an asset of
Ps. 57.5 million with respect to these contracts. We do not believe our
market risk with respect to these natural gas futures contracts is
material.
Market
Risk Measurement
We
measure our market risk related to our financial instruments based on changes
in
interest rates and foreign currency rates utilizing a sensitivity analysis.
The
sensitivity analysis measures the potential loss in fair values, cash flows
and
earnings based on a hypothetical increase in interest rates and a decline in
the
peso/dollar exchange rate. We used market rates as of December 31, 2005 on
our
financial instruments to perform the sensitivity analysis. We believe that
these
potential changes in market rates are reasonably possible in the near-term
(one
year or less). Based upon our analysis of the impact of a 100 basis point
increase in interest rates and a 10% decline in the peso/dollar exchange rate,
we have determined that such increase in interest rates and such decline in
the
peso/dollar exchange rate would have a material adverse effect on our earnings.
Because there is no active trading market for our debt instruments, we are
not
able to determine the impact of these changes on the fair value of those debt
instruments. The sections below describe our exposure to interest rates and
currency rates including the impact of changes in these rates on our
earnings.
Interest
Rate Exposure
Our
primary interest rate exposure relates to long-term debt. On the asset side,
we
are exposed to changes in short-term interest rates as we invest in short-term
dollar-denominated interest bearing investments. On the liability side, we
utilize a combination of floating rate debt and fixed rate debt. The floating
rate debt is exposed to changes in interest expense and cash flows from changes
in LIBOR, while the fixed rate debt is mostly exposed to changes in fair value
from changes in medium term interest rates. Based on an immediate 100 basis
point rise in interest rates, we estimate that our earnings before taxes over
a
one-year time horizon would decrease by Ps. 4 million ($0.38
million).
Currency
Rate Exposure
Our
primary foreign currency exchange rate exposure relates to our debt securities
as well as our dollar-denominated trade receivables and trade payables. Our
principal currency exposure is to changes in the peso/dollar exchange rate.
We
estimate that a 10% decline in the peso/dollar exchange rate would result in
a
decrease in our earnings before taxes of Ps. 41 million ($3.8
million).
The
sensitivity analysis is an estimate and should not be viewed as predictive
of
our future financial performance. Additionally, we cannot assure that our actual
losses in any particular year will not exceed the amounts indicated above.
However, we do believe that these amounts are reasonable based on the financial
instrument portfolio at December 31, 2005 and assuming that the hypothetical
market rate changes selected by us in our market risk analysis occur during
2006. The sensitivity analysis does not give effect to the impact of inflation
on its exposure to increases in interest rates or the decline in the peso/dollar
exchange rate.
Critical
Accounting Policies
The
discussion in this section is based upon our financial statements, which have
been prepared in accordance with Mexican GAAP. The preparation of these
financial statements requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at year-end, and the reported amount of
revenues and expenses during the year. Management regularly evaluates these
estimates, including those related to the carrying value of property, plant
and
equipment and other non-current assets, inventories and direct cost of sales,
income taxes and employee profit sharing, foreign currency transactions and
exchange differences, valuation allowances for receivables, inventories and
deferred income tax assets, liabilities for deferred income taxes, valuation
of
financial instruments, obligations relating to employee benefits, potential
tax
deficiencies, environmental obligations, and potential litigation claims and
settlements. Management estimates are based on historical experience and various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Accordingly, actual results may differ materially from current
expectations under different assumptions or conditions.
Management
believes that the critical accounting policy which requires the most significant
judgments and estimates used in the preparation of the financial statements
relates to the impairment of property, plant and equipment and valuation
allowance on accounts receivable. We evaluate periodically the adjusted values
of our property, plant and equipment, to determine whether there is an
indication of potential impairment. Impairment exists when the carrying amount
of an asset exceeds future revenues or net cash flow expected to be generated
by
the asset. If such assets are considered to be impaired, the impairment to
be
recognized is measured by the amount by which the carrying amount of the asset
exceeds the expected revenues or fair value. Assets to be disposed of are
reported at the lower of the carrying amount or realizable value. Significant
judgment is involved in estimating future revenues and cash flows or realizable
value, as applicable, of our property, plant and equipment due to the
characteristics of those assets. The class of our assets which most require
complex determinations based upon assumptions and estimates relates to idle
machinery.
With
respect to valuation allowance on accounts receivable, on a periodic basis
management analyzes the recoverability of accounts receivable in order to
determine if, due to credit risk or other factors, some receivables may not
be
collected. If management determines that such a situation exists, the book
value
of the non-recoverable assets is adjusted and charged to the income statement
through an increase in the doubtful accounts allowance. This determination
requires substantial judgment by management. As a result, final losses from
doubtful accounts could differ significantly from estimated
allowances.
New
Accounting Pronouncements
The
following accounting bulletins issued by the Mexican Institute of Public
Accountants are obligatory as of January 1, 2005.
Business
Acquisitions
The
most
significant issues in Bulletin B-7 are as follows: (i) use of the purchase
method as the only alternative for valuing businesses acquired and investments
in associated companies, (ii) change in the accounting for goodwill, eliminating
amortization and also requiring that negative goodwill not fully amortized
at
the date of adoption of Bulletin B-7 be carried to the results of operations,
as
a change in accounting principle and (iii) establishment of specific rules
to
account for the acquisition of minority interest and for transfers of assets
or
exchange of shares among entities under common control.
We
opted
for the early adoption of this Bulletin (see Note 14 to the audited financial
statements).
Labor
Obligations
The
new
accounting Bulletin D-3, Labor
Obligations,
was
issued in January 2004. The revised Bulletin replaces and nullifies the previous
Bulletin D-3, issued in January 1993 and revised in 1998. The observance of
Bulletin D-3 is compulsory for fiscal years beginning on or after January 1,
2004, except for termination payments, which were in force as of January 1,
2005.
The
revised Bulletin incorporates the matter of remunerations for other
post-retirement benefits, thus nullifying the provisions of Circular 50,
Interest
rates to be used in the valuation of labor obligations and supplementary
application of accounting principles related to labor
obligations.
Bulletin D-3 also eliminates the subject related to unexpected payments and,
instead includes the subject related to termination payments, defining such
payments as those granted to workers at the end of their employment before
reaching the age of retirement, which include two types: (i) due to corporate
restructuring, for which the guidelines of Mexican accounting Bulletin C-9,
Liabilities,
Provisions,
Contingent Assets and Liabilities and Commitments, must be followed, and (ii)
due to reasons other than restructuring, for which we must apply the valuation
and disclosure rules required for retirement pensions and seniority premiums
payments, thus allowing at the time that this Bulletin is adopted, to
immediately recognize the transition asset or liability in results of
operations, or its amortization, in conformity with the remaining working life
of the workers.
We
believe that the adoption of this Bulletin did not have a material effect on
our
financial position or on our results of operations.
Other
Pronouncements
As
of May
31, 2004, the Mexican Institute of Public Accountants, or IMCP, formally
transferred the function of establishing and issuing financial reporting
standards to the Mexican Board for Research and Development of Financial
Reporting Standards, or CINIF, consistent with the international trend of
requiring this function to be performed by an independent entity.
Accordingly,
the task of establishing bulletins of Mexican GAAP and circulars issued by
the
IMCP was transferred to CINIF, who subsequently renamed the standards of Mexican
GAAP as Normas
de Información Financiera,
or
Financial Reporting Standards and determined that the Financial Reporting
Standards would encompass (i) new bulletins established under the new function;
(ii) any interpretations issued thereon; (iii) any Mexican GAAP bulletins that
have not been amended, replaced or revoked by the new Financial Reporting
Standards; and (iv) International Financial Reporting Standards, or IFRS, that
are supplementary guidance to be used when Mexican GAAP does not provide primary
guidance.
One
of
the main objectives of CINIF is to achieve greater concurrence with IFRS. To
this end, it started by reviewing the Conceptual Framework, or “CF” contained in
Mexican GAAP and modifying it to support the development of financial reporting
standards and to serve as a reference in resolving issues arising in the
accounting practice. The CF consists of eight financial reporting standards,
which comprise the Financial Reporting Standards-A series. The Financial
Reporting Standards-A series, together with Financial Reporting Standards B-1,
were issued on October 31, 2005. Their provisions are effective for years
beginning January 1, 2006 and thereafter, and supersede all existing Mexican
GAAP series A bulletins.
The
new
Financial Reporting Standards are as follows:
|
·
|
Financial
Reporting Standards A-1, Structure of Financial Reporting
Standards
|
|
·
|
Financial
Reporting Standards A-2, Fundamental
Principles
|
|
·
|
Financial
Reporting Standards A-3, Users’ Needs and Financial Statement
Objectives
|
|
·
|
Financial
Reporting Standards A-4, Qualitative Characteristics of Financial
Statements
|
|
·
|
Financial
Reporting Standards A-5, Basic Elements of Financial
Statements
|
|
·
|
Financial
Reporting Standards A-6, Recognition and
Valuation
|
|
·
|
Financial
Reporting Standards A-7, Presentation and
Disclosure
|
|
·
|
Financial
Reporting Standards A-8, Supplementary Standards to Mexican
GAAP
|
|
·
|
Financial
Reporting Standards B-1, Accounting
Changes
|
The
most
significant changes established under standards are as follows:
|
·
|
In
addition to the statement of changes in financial position, Financial
Reporting Standards A-3 makes reference to a cash flows statement,
which
should be issued when required by a particular
standard.
|
|
·
|
Financial
Reporting Standards A-5 includes a new classification for revenues
and
expenses: ordinary and not ordinary. Ordinary revenues and expenses
are
derived from transactions or events that are within the normal course
of
business or that are inherent in the entity’s activities, whether frequent
or not; revenues and expenses classified as not ordinary refer to
unusual
transactions and events, whether frequent or not.
|
|
·
|
Financial
Reporting Standards A-7 requires the presentation of comparative
financial
statements for at least the preceding period. Through December 31,
2004,
the presentation of prior years’ financial statements was optional. The
financial statements must disclose the authorized date for their
issuance,
and the names of any officers or administrative bodies authorizing
the
related issuance.
|
|
·
|
Financial
Reporting Standards B-1 establishes that changes in particular standards,
reclassifications and corrections of errors must be recognized
retroactively. Consequently, basic financial statements presented
on a
comparative basis with the current year that might be affected by
the
change, must be adjusted as of the beginning of the earliest period
presented.
|
The
implementation of these new standards did not have a significant impact on
our
financial information.
Our
History and Development
General
We
are a
diversified manufacturer, processor and distributor of SBQ steel and structural
steel products with production and commercial operations in the United States,
Mexico and Canada.
We
believe that we are the leading producer of SBQ products in North America,
with
leading market positions in both the United States and Mexico and that we offer
the broadest SBQ product range in those markets today. We also believe that
we
are the leading producer of structural and light structural steel products
in
Mexico, and we have an increasing presence in the U.S. market.
Our
SBQ
products are used across a broad range of highly engineered end-user
applications, including axles, hubs and crankshafts for automobiles and light
trucks, machine tools and off-highway equipment. Our structural steel products
are mainly used in the non-residential construction market and other
construction applications.
We
focus
on the Mexican and U.S. specialty steel markets by providing high value added
products and services from our strategically located plants. The quality of
our
products and services, together with the cost advantage generated by our
facility locations has allowed us to develop long standing relationships with
most of our SBQ clients, which include U.S. and Mexico based automotive and
industrial equipment manufacturers and their suppliers. In addition, our
facilities located in the North West and Central parts of Mexico allow us to
serve the structural steel and construction markets in those regions and South
West California with a significant advantage in the cost of freight.
In
the
United States and Mexico, we own and operate ten state-of-the-art steel making,
processing and/or finishing facilities with a combined annual crude steel
installed production capacity of 3.4 million tons and a combined annual
installed rolling capacity of 2.9 million tons. We operate both mini-mill and
integrated steel making facilities, which gives us the flexibility to optimize
our production and reduce production costs based on the relative prices of
raw
materials (e.g., scrap for mini-mills and iron ore for blast
furnace).
We
currently own and operate:
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·
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Mexico’s
largest non-flat structural steel mini-mill, located in Guadalajara,
Jalisco;
|
|
·
|
a
mini-mill in Mexicali, Baja California Norte;
|
|
·
|
a
mini-mill in Apizaco, Tlaxcala;
|
|
·
|
a
cold finishing facility in Cholula, Puebla; all of these facilities
are
owned through our indirect wholly-owned subsidiaries, Simec International,
S.A. de C.V. (“SI”), Controladora Simec S.A. de C.V. and Compañia
Siderurgica de Guadalajara S.A. de C.V.; and
|
|
·
|
a
mini mill in Canton, Ohio, an integrated facility in Lorain, Ohio
and
value-added rolling and finishing facilities in Canton, Lorain and
Massillon, Ohio; Lackawanna, New York; Gary, Indiana; and Hamilton,
Ontario, all of which are owned through our majority-owned subsidiary,
Republic.
|
We
are
domiciled in the city of Guadalajara, Jalisco, and our principal administrative
office is located at Calzada Lázaro Cárdenas 601, Guadalajara, Jalisco, Mexico
44440. Our telephone number is 011-52-33-1057-5757.
In
the
first half of 2006, almost all of our consolidated sales were in the North
American market, 27.9% in Mexico, 71.9% in the United States and Canada, and
0.2% of our consolidated sales were exports to markets outside North America.
In
2005,
we had net sales of Ps. 13.0 billion, marginal profit of Ps. 2.6 billion and
net
income attributable to majority interest of Ps. 1.3 billion. In the first half
of 2006, our net sales were Ps. 11.9 billion, marginal profit of Ps. 2.2 billion
and net income attributable to majority interest of Ps. 1.3
billion.
The
chart
below sets forth a summary of our corporate structure:
(1)
|
Includes
the following non-operating subsidiaries: Compañía Siderúrgica del
Pacífico, S.A. de C.V. (99.99%), Coordinadora de Servicios Siderúrgicos de
Calidad, S.A. de C.V. (100%), Administradora de Servicios de la Industria
Siderúrgica ICH, S.A. de C.V. (99.99%), Industrias del Acero y del
Alambre, S.A. de C.V. (99.99%), Procesadora Mexicali, S.A. de C.V.
(99.99%), Servicios Simec, S.A. de C.V. (100%), Sistemas de Transporte
de
Baja California, S.A. de C.V. (100%), Operadora de Metales, S.A.
de C.V.
(100%), Operadora de Servicios Siderúrgicos de Tlaxcala, S.A. de C.V.
(100%), Administradora de Servicios Siderúrgicos de Tlaxcala, S.A. de C.V.
(100%), and Operadora de Servicios de la Industria Siderúrgica ICH, S.A.
de C.V. (100%), Arrendadora Simec S.A. de C.V. (100%), Controladora
Simec
S.A. de C.V. (100%) Compañía Siderúrgica de Guadalajara S.A. de C.V.
(100%).
|
(2)
|
Our
principal Mexican facilities consist of steel-making facilities in
Guadalajara, Jalisco, Mexicali, Baja California, and Apizaco, Tlaxcala,
and a cold finishing facility in Cholula,
Puebla.
|
(3)
|
The
remaining 49.8% of SimRep Corporation is owned by our controlling
shareholder, Industrias CH, S.A.B. de
C.V.
|
(4)
|
SimRep
owns 100% of Republic Engineered Products. Our principal U.S. and
Canadian
facilities consist of a steel-making facility in Canton, Ohio, a
steel-making and hot-rolling facility in Lorain, Ohio, a hot-rolling
facility in Lackawanna, New York, and cold finishing facilities in
Massillon, Ohio, Gary, Indiana, and Hamilton, Ontario,
Canada.
|
Our
History
Our
steel
operations commenced in 1969 when a group of families from Guadalajara, Jalisco,
formed CSG, a mini-mill steel company. In 1980, Grupo Sidek, S.A. de C.V.
(“Sidek”), our former parent, was incorporated and became the holding company of
CSG. In 1990, Sidek consolidated its steel and aluminum operations into a
separate subsidiary, Grupo Simec, S.A. de C.V., a Mexican corporation with
limited liability.
In
March
2001, Sidek consummated the sale of its entire approximate 62% controlling
interest in us to Industrias CH. In June 2001, Industrias CH increased its
interest in us to 82.5% by acquiring additional shares from certain of our
bank
creditors that had converted approximately $95.4 million of our debt ($90.2
million of principal and $5.2 million of interest) into our common shares.
Industrias CH subsequently increased its equity position in us through various
conversions of debt to equity and capital contributions to an 85%
interest.
In
August
2004, we acquired the property, plant and equipment and the inventories, and
assumed liabilities associated with the seniority premiums of employees of
the
Mexican steel-making facilities of Grupo Sidenor located in Apizaco, Tlaxcala
and Cholula, Puebla. Our total net investment in this transaction was
approximately U.S.$122 million (excluding value added tax of approximately
$16
million paid in 2004 and recouped from the Mexican government in 2005), funded
with cash from operations, and a $19 million capital contribution from
Industrias CH. We began to operate the plants in Apizaco, Tlaxcala and Cholula,
Puebla on August 1, 2004, and, as a result, the operations of both plants are
reflected in our financial results since that date.
In
July
2005, we and Industrias CH acquired 100% of the stock of Republic, a U.S.
producer of SBQ steel. We acquired 50.2% of Republic’s stock through our
majority owned subsidiary, SimRep, and Industrias CH purchased the remaining
49.8% through SimRep. We financed our portion of the U.S.$229 million purchase
price principally through a loan we received from Industrias CH that we have
repaid in full.
Competitive
Strengths
We
believe the following are our principal competitive strengths:
Leading
SBQ producer in North America.
We
believe we have been the leading market producer and supplier of SBQ steel
in
Mexico since August 2004 and in the United States since July 2005. In 2005,
we
supplied approximately 28% of the Mexican market and 20% of the U.S.
market.
Higher
value-added product mix.
To
maximize operating margins, we focus our production on higher value-added SBQ
products, which represented 79% of our total sales in the first six months
of
2006.
Long-standing
customer relationships.
Our
SBQ
products are highly engineered and tailored to specific client needs. We
continuously work with our clients on design engineering and new product
development to meet the requirements of their evolving platforms. We believe
that the quality of our products and services allows us to develop long lasting
direct relationships with the largest end-users of SBQ products in North
America, which, we believe, increases switching costs and improves our
competitive position.
Reduced
price volatility.
The
quality requirements of the majority of our SBQ clients and the nature of our
relationships have allowed us to implement favorable pricing policies that
include annual price revisions and price adjustments based on the price of
key
inputs such as scrap, iron ore, energy, alloys and other key raw materials.
These contribute to maintaining operating margins against raw material price
fluctuations relatively stable.
Competitive
cost structure.
We
believe our cost structure is highly favorable due to our:
|
·
|
Competitive
cost of raw materials. We
believe our centralized purchasing strategy and strong financial
position
allow us to obtain favorable terms from our raw materials
suppliers.
|
|
·
|
Low
freight expenses. We
believe the strategic location of our facilities allows us to serve
our
SBQ steel and other clients with lower distribution and freight costs
than
most of our competitors.
|
|
·
|
Relatively
low cost of labor in Mexico. Our
Mexican operations benefit from the relatively lower cost of labor
in the
Mexican market compared to the United States. In addition, our Mexican,
U.S. and Canadian operations do not currently have any significant
legacy
liabilities or their associated
costs.
|
|
·
|
Favorable
labor agreement in the United States. The
labor agreement in place in our U.S. operations has eliminated legacy
costs and enhances our ability to maximize workforce flexibility,
allowing
us to reduce production costs.
|
|
·
|
Lean
operational structure and overhead cost. We
maintain non-operating costs at low levels by relying on a lean and
cost
efficient overhead structure.
|
State-of-the-art
production facilities.
We
have
recently completed the revamping of our mini-mill steel-making facility in
Canton, Ohio including the installation of a new continuous caster. We believe
that our remaining steel making and processing facilities in Mexico and the
United States are among the most modern and well maintained in North
America.
Extensive
track record of profitable growth.
Over
the
last two years we have significantly increased our installed capacity through
the acquisition of Republic and of plants in Tlaxcala and Cholula, Mexico.
As a
result of these acquisitions, organic growth and operational improvements,
we
have increased our installed capacity from 0.7 million tons as of December
31,
2003 to 3.4 million tons of crude steel as of June 30, 2006.
Significant
organic growth opportunities.
Our
liquid steel making capacity exceeds our rolling and finished steel capacity,
which allows us to continue increasing our finished product capacity through
comparatively low levels of capital investments. We intend to pursue this option
and plan to invest approximately U.S.$250 million in a rolling mill with an
annual capacity of 600,000 tons in our facilities. We also intend to explore
expanding our liquid steel-making facilities in Lorain, Ohio by bringing an
existing second blast furnace online at a cost significantly lower than that
of
purchasing a new blast furnace with the same capacity.
Solid
financial position.
We
seek
to maintain a conservative capital structure and prudent leverage levels. We
currently have no significant financial debt or significant legacy liabilities.
We believe that these factors, combined with our strong cash flow generation,
provide us with the financial flexibility and resources to continue to pursue
growth enhancing initiatives.
Experienced
and committed management team.
Our
management team has extensive experience in, and knowledge of, the North
American steel industry and in evaluating, pursuing and completing both
strategic and organic growth opportunities as well as a track-record of
increasing productivity and reducing costs.
Business
Strategy
We
intend
to further consolidate our position as a leading producer, processor and
distributor of SBQ steel in North America and structural steel in Mexico. We
also intend to expand our presence in the steel industry by identifying and
pursuing growth opportunities and value enhancing initiatives. Our strategy
includes:
Further
integrating our operations.
We
intend
to continue the integration of our Mexican, U.S. and Canadian operations to
capitalize on the commercial and cost related synergies contemplated at the
time
of the Atlax Acquisition in 2004 and of the acquisition of Republic in
2005.
Improving
our cost structure.
We
have
substantially reduced our operating cost and non-operating expenses and plan
to
continue to do so by reducing overhead expenses and operating costs through
sharing best practices among our operating facilities and maintaining a
conservative capital structure.
Focusing
on high margin and value-added products.
We
prioritize the production of high margin steel products over volume and
utilization levels. We plan to continue to base our production decisions on
achieving relatively high margins.
Building
on our strong customer relationships.
We
intend
to strengthen our long-standing customer relationships by maintaining strong
customer service and proactively responding to changing customer
needs.
Pursuing
strategic growth opportunities.
We
have
successfully grown our business by acquiring, integrating and improving under-
performing operations. In addition, we intend to continue in pursuit of
acquisition opportunities that will allow for disciplined growth of our business
and value creation for our shareholders. We also intend to pursue organic growth
by reinvesting the cash generated by our operating activities to expand the
capacity and increase the efficiency of our existing facilities.
Business
Overview
Our
Products
We
produce a wide range of value-added SBQ steel, long steel and medium-sized
structural steel products. In our Mexican facilities, we produce I-beams,
channels, structural and commercial angles, hot rolled bars (round, square
and
hexagonals), flat bars, rebars, and cold finished bars. In our U.S. facilities,
we produce hot rolled bars, cold finished bars, semi-finished tube rounds and
other semi-finished trade products. The following is a description of these
products and their main uses:
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I-beams.
I-beams, also known as standard beams, are “I” form steel structural
sections with two equal parallel sides joined together by the center
with
a transversal section, forming 90º angles. We produce I-beams in our
Mexican facilities and they are mainly used by the industrial construction
as structure supports.
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Channels.
Channels, also known as U-Beams because of their “U” form, are steel
structural sections with two equal parallel sides joined together
by its
ends with a transversal section, forming 90º angles. We produce channels
in our Mexican facilities and they are mainly used by industrial
construction as structure supports and for stocking systems.
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Angles.
Angles are two equal sided sections joined by their ends with a 90º angle,
forming an “L” form. We produce angles in our Mexican facilities and they
are used mainly by the construction and furniture industries as joist
structures and framing systems.
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·
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Hot
rolled bars. Hot rolled bars are round, square and hexagonal steel
bars
that can be made of special or commodity steel. The construction,
autopart
and furniture industries mainly use the round and square bars. The
hexagonal bars are made of special steel and are mainly used by the
hand
tool industry. We produce the steel sections in our Mexican and U.S.
facilities.
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·
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Flat
bars. Flat bars are rectangular steel sections that can be made of
special
or commodity steel. We produce flat bars in our Mexican facilities.
The
auto part industry mainly uses special steel as springs, and the
construction industry uses the commodity steel flat bars as supports.
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Rebar.
Rebar is reinforced, corrugated round steel bars with sections from
0.375
to 1.5 inches in diameter, and we produced rebar our Mexican facilities.
Rebar is only used by the construction sector to reinforce concrete.
Rebar
is considered a commodity product due to general acceptance by most
costumers of standard industry
specifications.
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Cold-finished
bars. Cold-finished bars are round and hexagonal SBQ steel bars
transformed through a diameter reduction process. This process consists
of
(1) reducing the cross sectional area of a bar by drawing the material
through a die without any pre-heating or (2) turning or “peeling” the
surface of the bar. The process changes the mechanical properties
of the
steel, and the finished product is accurate to size, free from scale
with
a bright surface finish. We produce these bars in our Mexican, U.S.
and
Canadian facilities, and mainly the auto part industry uses
them.
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·
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Semi-finished
tube rounds. These are wide round bars used as raw material for the
production of seamless pipe. The semi-finished tube rounds are made
of SBQ
steel, and we produce them in our U.S. facilities. Seamless pipe
manufacturers use them to produce pipes used in the oil extraction
and
construction industry.
|
The
following table sets forth, for the periods indicated, our sales volume for
basic steel products. These figures reflect the sales of products manufactured
at the Apizaco and Cholula facilities as of August 1, 2004 and sales of
products manufactured at the U.S. and Canadian facilities as of July 22, 2005.
Steel
Product Sales Volume
|
|
Years
ended December 31,
|
|
Six
months ended June 30,
|
|
|
|
2003
|
|
2004
|
|
2005
|
|
2005
|
|
2006
|
|
|
|
(Thousands
of tons)
|
|
I-Beams
|
|
|
83.8
|
|
|
76.1
|
|
|
82.2
|
|
|
41.4
|
|
|
42.2
|
|
Channels
|
|
|
50.7
|
|
|
58.9
|
|
|
59.7
|
|
|
23.7
|
|
|
35.1
|
|
Angles(1)
|
|
|
108.5
|
|
|
135.7
|
|
|
222.6
|
|
|
87.5
|
|
|
107.9
|
|
Hot-rolled
Bars (round, square and hexagonal rods)
|
|
|
174.6
|
|
|
189.0
|
|
|
600.0
|
|
|
100.9
|
|
|
602.0
|
|
Flat
Bar
|
|
|
45.7
|
|
|
91.7
|
|
|
188.5
|
|
|
99.7
|
|
|
81.1
|
|
Rebar
|
|
|
139.0
|
|
|
191.9
|
|
|
239.1
|
|
|
144.1
|
|
|
135.8
|
|
Cold
Finished Bars
|
|
|
17.1
|
|
|
15.7
|
|
|
105.6
|
|
|
22.2
|
|
|
101.7
|
|
Semi-finished
tube rounds
|
|
|
0.00
|
|
|
0.00
|
|
|
165.2
|
|
|
0
|
|
|
210.0
|
|
Other
semi-finished trade products(2)
|
|
|
0.00
|
|
|
0.00
|
|
|
43.3
|
|
|
0
|
|
|
48.5
|
|
Other
|
|
|
8.8
|
|
|
14.3
|
|
|
1.9
|
|
|
2.8
|
|
|
4.0
|
|
Total
Steel Sales
|
|
|
628.2
|
|
|
773.3
|
|
|
1,708.1
|
|
|
522.3
|
|
|
1,368.3
|
|
_________________
(1) Angles
include structural angles and commercial angles.
(2) Includes
billets and blooms (wide section square and round bars).
Our
Operations and Production Facilities
We
conduct our operations at ten facilities throughout North America. At June
30,
2006, our crude steel production capacity was 3.4 million tons, of which 1.0
million tons were based on an integrated blast furnace technology, and 2.4
million were based on electric arc furnace, or mini-mill, technology. Our
Mexican facilities have 1.1 million tons of crude steel production capacity,
operating three mini-mill facilities. Our U.S. operations have 2.2 million
tons
of crude steel production capacity. In addition, we have 2.9 million tons of
rolling and finishing capacity, of which 1.2 million are located in Mexico,
and
1.6 million are located in the United States and Canada.
We
operate four mini-mills, three in Mexico and one in the United States. The
Mexican mini-mills are located in Guadalajara, Jalisco; Apizaco, Tlaxcala and
Mexicali, Baja California. Our mini-mill in the United States is located in
Canton, Ohio, and we have recently completed a revamping process that has
increased capacity of the mill to 1,300,000 tons of steel billet. We also
operate an integrated blast furnace in Lorain, Ohio. There is a second blast
furnace in the same facility with 750,000 tons of yearly capacity that is not
currently operating, but that we believe could be made operational with
relatively low levels of investment. We operate rolling and finishing facility
in each of our mill facilities in Cholula and in the United States and Canada.
Because
we operate both mini-mill and integrated blast furnace production facilities,
we
can allocate production between each type of facility based on efficiency and
cost. In addition, as long as our facilities are not operating at full capacity,
we can allocate production based on the relative cost of basic inputs (iron
ore,
coke, scrap and electricity) to the facility where production costs would be
the
lowest. Our production facilities are designed to permit the rapid changeover
from one product to another. This flexibility permits us to efficiently produce
small volume orders to meet customer needs and to produce varying quantities
of
standard product. Production runs, or campaigns, occur on four to eight weeks
cycles, minimizing customer waiting time for both standard and specialized
products.
We
use
ferrous scrap and iron ore to produce our finished steel products. We produce
molten steel using both an electric arc furnace and integrated blast furnace
technology, alloying elements and carbon are added, and which then is
transported to continuous casters for solidification. The continuous casters
produce long, square strands of steel that are cut into billet and transferred
to the rolling mills for further processing or, in some cases, sold to other
steel producers. In the rolling mills, the billet is reheated in a walking
beam
furnace with preheating burners, passed through a rolling mill for size
reduction and conformed into final sections and sizes. The shapes are then
cut
into a variety of lengths. In addition, to producing billet, our Canton, Ohio
facility also produces blooms.
Our
mini-mill plants use an electric arc furnace to melt ferrous scrap and other
metallic components, which are then cast into long, square bars called billet
in
a continuous casting process, all of which occurs in a melt shop. The billet
is
then transferred to a rolling mill, reheated and rolled into finished product.
In contrast, an integrated steel mill heats iron pellets and other primary
materials in a blast furnace to first produce pig iron, that must be refined
in
a basic oxygen furnace to liquid steel, and then cast to billet and finished
product. Mini-mill plants typically produce certain steel products more
efficiently because of the lower energy requirements resulting from their
smaller size and because of their use of ferrous scrap. Mini-mills are designed
to provide shorter production runs with relatively fast product changeover
times. Integrated steel mills are more efficient in producing longer runs and
are able to produce certain steel products that a mini-mill cannot.
The
production levels and capacity utilization rates for our melt shops and rolling
mills for the periods indicated are presented below. These figures reflect
the
sales of products manufactured at the Apizaco and Cholula facilities starting
from August 1, 2004. These figures reflect the sales of the products
manufactured at the Republic facilities starting from July 22,
2005.
Production
Volume and Capacity Utilization
|
|
Years
ended December 31,
|
|
Six
months ended June 30,
|
|
|
|
2003
|
|
2004
|
|
2005
|
|
2005
|
|
2006
|
|
|
|
(Tons
in thousands)
|
|
Melt
shops
|
|
|
|
Steel
billet production
|
|
|
705.9
|
|
|
877.5
|
|
|
1,748.2
|
|
|
532.6
|
|
|
1,550.5
|
|
Annual
installed capacity(1)
|
|
|
780.0
|
|
|
1,160.0
|
|
|
3,115.9
|
|
|
1,160.0
|
|
|
3,398.1
|
|
Effective
capacity utilization
|
|
|
90.5
|
%
|
|
93.5
|
%
|
|
89.6
|
%
|
|
91.8
|
%
|
|
91.3
|
%
|
Rolling
mills
|
Total
production
|
|
|
598.1
|
|
|
766.0
|
|
|
1,544.0
|
|
|
502.6
|
|
|
1,242.3
|
|
Annual
installed capacity(1)
|
|
|
730.0
|
|
|
1,210.0
|
|
|
2,847.5
|
|
|
1,210.0
|
|
|
2,901.9
|
|
Effective
capacity utilization
|
|
|
81.9
|
%
|
|
82.4
|
%
|
|
81.6
|
%
|
|
83.1
|
%
|
|
85.6
|
%
|
(1)
|
Annual
installed capacity is determined based on the assumption that billet
of
various specified diameters, width and length is produced at the
melt
shops or that a specified mix of rolled products are produced in
the
rolling mills on a continuous basis throughout the year except for
periods
during which operations are discontinued for routine maintenance,
repairs
and improvements. Amounts presented represent annual installed capacity
as
at December 31 for each year. The percentage of effective capacity
utilization for 2004 is determined in the case of the Apizaco and
Cholula
facilities based on utilization over the period from August 1 to
December
31, 2004. The percentage of effective capacity utilization for 2005
is
determined in the case of Republic facilities based on utilization
over
the period from July 22 to December 31,
2005.
|
Mexican
Operations and Facilities
The
following table presents production by product at each of our Mexican facilities
as a percentage of total production at that facility for the six-months ended
June 30, 2006.
Mexican
Production per Facility by Product
|
|
Location
|
|
Product
|
|
Guadalajara
|
|
Mexicali
|
|
Apizaco/Cholula
|
|
Total
|
|
|
|
(Production
%)
|
|
|
|
|
|
|
|
|
|
|
|
I
Beams
|
|
|
20.6
|
%
|
|
0.7
|
%
|
|
0
|
%
|
|
8.1
|
%
|
Channels
|
|
|
9.6
|
%
|
|
14.8
|
%
|
|
0
|
%
|
|
6.8
|
%
|
Angles
|
|
|
24.0
|
%
|
|
13.6
|
%
|
|
21.2
|
%
|
|
20.9
|
%
|
Hot
Rolled Bars (round, square
and hexagonal rods)
|
|
|
18.8
|
%
|
|
9.0
|
%
|
|
18.4
|
%
|
|
16.6
|
%
|
Rebar
|
|
|
14.2
|
%
|
|
60.0
|
%
|
|
21.5
|
%
|
|
26.3
|
%
|
Flat
Bars
|
|
|
7.9
|
%
|
|
1.9
|
%
|
|
30.0
|
%
|
|
15.7
|
%
|
Cold
Finished Bars
|
|
|
3.2
|
%
|
|
0
|
%
|
|
8.9
|
%
|
|
4.8
|
%
|
Other
|
|
|
1.7
|
%
|
|
0
|
%
|
|
0.0
|
%
|
|
0.8
|
%
|
Total
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
Guadalajara.
Our
Guadalajara mini-mill facility is located in central western Mexico in
Guadalajara, Jalisco, which is Mexico’s third largest city. Our Guadalajara
facilities and equipment include one improved electric arc furnace utilizing
water-cooled sidewalls and roof, one four-strand continuous caster, five
reheating furnaces and three rolling mills. The Guadalajara mini-mill has an
annual installed capacity of 350,000 tons of billet and an annual installed
capacity of finished product of 480,000 tons. In 2005, the Guadalajara mini-mill
produced 304,295 tons of steel billet and 393,958 tons of finished product
operating at 87% capacity for billet production and 82% capacity for finished
product production. The Guadalajara rolling facilities process billet production
from our Mexicali and Apizaco mills. Our Guadalajara facility is 336 miles
from
Mexico D.F. Our Guadalajara facility mainly produces structurals, SBQ steel,
light structurals and rebars.
Guadalajara
Mini-Mill
|
|
Years
ended December 31,
|
|
Six
months ended June 30
|
|
|
|
2003
|
|
2004
|
|
2005
|
|
2005
|
|
2006
|
|
Steel
Sales (thousands of tons)
|
|
|
430
|
|
|
430
|
|
|
407
|
|
|
204
|
|
|
203
|
|
Average
finished product price per ton
|
|
|
Ps.
4,650
|
|
|
Ps.
7,375
|
|
|
Ps.
6,556
|
|
|
Ps.
6,959
|
|
|
Ps.
6,903
|
|
Average
scrap cost per ton
|
|
|
1,713
|
|
|
2,774
|
|
|
2,343
|
|
|
2,535
|
|
|
2,349
|
|
Average
manufacturing conversion cost per ton of finished product
|
|
|
1,366
|
|
|
1,387
|
|
|
1,645
|
|
|
1,625
|
|
|
1,617
|
|
Average
manufacturing conversion cost per ton of billet
|
|
|
848
|
|
|
961
|
|
|
1,050
|
|
|
1,020
|
|
|
1,074
|
|
Mexicali.
In
1993, we began operations at our mini-mill located in Mexicali, Baja California.
The mini-mill is strategically located approximately 22 miles south of the
California border and approximately 220 miles from Los Angeles.
Our
Mexicali facilities and equipment include one electric arc furnace utilizing
water-cooled sidewalls and roof, one four-strand continuous caster, one walking
beam reheating furnace, one SACK rolling mill, a Linde oxygen plant and a water
treatment plant. This facility has an annual installed capacity of 430,000
tons
of steel billet and an annual installed capacity of finished product of 250,000
tons. Excess billet produced at the Mexicali facility is used primarily by
the
Guadalajara facility. This allows us to increase the utilization of the
Guadalajara facility’s finishing capacity, which exceeds its production
capacity. In 2005, the Mexicali mini-mill produced approximately 385,873 tons
of
billet, of which the Guadalajara mini-mill used 104,415 tons, the Apizaco
mini-mill 60,124 used tons, and we sold 14,488 tons to third parties. In 2005,
the Mexicali mini-mill produced 201,607 tons of finished product. In 2005 we
operated the Mexicali mini-mill at 90% capacity for billet production and at
81%
capacity for finished product production. Our facility is strategically located
and has access to key markets in Mexico and the United States, stable sources
of
scrap, electricity, a highly skilled workforce and other raw materials. The
Mexicali mini-mill also is situated near major highways and a railroad linking
the Mexicali and Guadalajara mini-mills, allowing for coordinated production
at
the two facilities. Our Mexicali facility mainly produces structurals, light
structurals and rebar. In 2005, 66% of the products produced at the Mexicali
mini-mill were rebar, 15% were angles, 9% were hot rolled bars (round, square
and hexagonal rods) and the remaining 10% were other products, principally
channels and flat bars.
Mexicali
Mini-Mill
|
|
Years
ended December 31,
|
|
Six
months ended June 30
|
|
|
|
2003
|
|
2004
|
|
2005
|
|
2005
|
|
2006
|
|
Steel
Sales (thousands of tons)
|
|
|
199
|
|
|
187
|
|
|
210
|
|
|
105
|
|
|
105
|
|
Average
finished product price per ton
|
|
|
Ps.
4,310
|
|
|
Ps.
7,031
|
|
|
Ps.
5,680
|
|
|
Ps.
5,803
|
|
|
Ps.
6,691
|
|
Average
scrap cost per ton
|
|
|
1,373
|
|
|
2,046
|
|
|
2,034
|
|
|
2,100
|
|
|
2,041
|
|
Average
manufacturing conversion cost per ton of finished product
|
|
|
1,294
|
|
|
1,426
|
|
|
1,516
|
|
|
1,492
|
|
|
1,520
|
|
Average
manufacturing conversion cost per ton of billet
|
|
|
817
|
|
|
857
|
|
|
908
|
|
|
890
|
|
|
918
|
|
Apizaco
mini-mill and Cholula facility.
We have
operated the Apizaco mini-mill and Cholula facility since August 1, 2004. The
mini-mill is located in central Mexico in Apizaco, Tlaxcala. Our Apizaco
facilities and equipment include one EBT Danieli electric arc furnace utilizing
water-cooled sidewalls and roof, two ladle stations (one Danieli and the other
Daido), one Daido degasification station, one Danieli four-strand continuous
caster, two walking beam reheating furnaces and two rolling mills (one Danieli
and the other Pomini). This facility has an annual installed capacity of 380,000
tons of steel billet and an annual installed capacity of finished product of
432,000 tons. In 2005, the Apizaco mini-mill produced 377,832 tons of steel
billet, of which the Guadalajara mini-mill used 3,685 tons, and 392,681 tons
of
finished products. Our Apizaco facility is 1,112 miles from Mexicali and less
than 124 miles from Mexico D.F. Our Apizaco facility mainly produces SBQ steel,
light structurals and rebar. Our Cholula facility is approximately 25 miles
from
our Apizaco facility, which allows the integrated operations of the Apizaco
mini-mill and Cholula facility. Our Cholula facilities and equipment include
cold drawing and turning machines for peeling bars. This facility has an annual
installed capacity of finished product of 48,000 tons. In 2005, the Cholula
facility produced 32,494 tons of finished product, at 68% capacity. Our Cholula
facility mainly produces cold finished SBQ steel.
In
2005,
17% of the products we produced at the Apizaco and Cholula facilities were
rebar, 23% were angles, 17% were hot rolled bars (round, square and hexagonals)
and the remaining 43% were other products, flat merchant bar and cold finished
products.
Apizaco
Mini-Mill and Cholula Facility
|
|
Years
ended December 31,
|
|
Six
months ended June 30,
|
|
|
|
2004(1)
|
|
2005
|
|
2005
|
|
2006
|
|
Steel
Sales (thousands of tons)
|
|
|
156
|
|
|
416
|
|
|
213
|
|
|
209
|
|
Average
finished product price per ton
|
|
|
Ps.
7,822
|
|
|
Ps.
6,632
|
|
|
Ps.
6,923
|
|
|
Ps.
6,891
|
|
Average
scrap cost per ton
|
|
|
3,112
|
|
|
2,745
|
|
|
2,850
|
|
|
2,614
|
|
Average
manufacturing conversion cost per ton of finished product
|
|
|
2,135
|
|
|
2,091
|
|
|
2,023
|
|
|
2,134
|
|
Average
manufacturing conversion cost per ton of billet
|
|
|
1,428
|
|
|
1,416
|
|
|
1,457
|
|
|
1,400
|
|
(1) |
Since
August 1, 2004.
|
U.S.
and Canada Operations and Facilities
We
have
operated our Republic facilities (in Ohio, New York, Indiana and Canada) since
we acquired them from Republic on July 22, 2005. As of December 31, 2005, these
facilities had an annual installed capacity of 1,956,000 tons of billet and
1,637,000 tons of finished product. From July 22, 2005 to December 31, 2005,
the
Republic facilities produced 680,219 tons of steel billet, of which 165,201
tons
were sold as semi-finished tube rounds and 43,273 were sold as other
semi-finished trade products. The remainder went to the Lorain, Ohio and
Lackawanna, New York facilities for further processing. For the same period,
the
Republic facilities produced 453,509 tons of hot-rolled bar, of which 49,624
tons were used by the cold finish facilities. The Republic facilities produced
69,764 tons of cold finish bars. During this period, 60% of the products
produced at the Republic facilities were hot-rolled bars, 9% were cold-finished
bars, 25% were semi-finished tube rounds, and 6% were other semi-finished trade
products.
The
following table sets forth, for the periods indicated, selected operating data
for our Republic facilities.
|
|
July
22 - December 31
|
|
Six
months ended June 30
|
|
|
|
2005
|
|
2006
|
|
Steel
Sales (thousands of tons)
|
|
|
675
|
|
|
852
|
|
Average
finished product price per ton
|
|
|
Ps.
8,245
|
|
|
Ps.
9,822
|
|
Average
scrap cost per ton
|
|
|
1,800
|
|
|
2,291
|
|
Average
iron ore pellet cost per ton
|
|
|
647
|
|
|
661
|
|
Average
manufacturing conversion cost per ton of finished product(1)
|
|
|
5,033
|
|
|
4,787
|
|
Average
manufacturing conversion cost per ton of billet(1)
|
|
|
3,729
|
|
|
3,545
|
|
(1) |
Manufacturing
conversion cost is defined as all production costs excluding the
cost of
scrap and related yield loss.
|
Lorain,
Ohio.
The
Lorain facility mainly produces SBQ steel and operates an integrated steel
mill.
We operate one blast furnace, two 220-ton basic oxygen furnaces, a ladle
metallurgy facility, a vacuum degasser, a five-strand continuous bloom caster,
a
six-strand billet caster, a billet rolling mill and two bar rolling mills.
Our
Lorain facility had, at December 31, 2005, an annual installed capacity of
1,170,000 tons of steel billet and 840,000 tons of finished product. During
the
period of July 22 to December 31, 2005, the Lorain facility, was operated at
82.5% capacity for steel billet and for finished product, 64.6% for 9-10”
rolling mill and 70.1% for 20” mill finishing and shipping production, and it
produced 376,130 tons of billets and 240,000 tons of finished
products.
Canton,
Ohio.
Our
Canton facility mainly produces SBQ steel and includes two 200-ton top charge
electric arc furnaces, a 5-strand bloom/billet caster, two ladle metallurgical
furnaces, two vacuum degassers and two slag rakes. This facility also includes
a
combination Caster rolling facility that continuously casts blooms in a 4-strand
caster, heats the blooms to rolling temperature in a walking beam furnace,
then
rolls billets through an 8-stand rolling mill in an inline operation. We
installed and commissioned the electric arc furnace, the bloom/billet caster,
ladle metallurgical furnace and vacuum degasser in 2005. Other Canton equipment
includes a Mecana billet inspection line, four stationary billet grinders,
a saw
line and a quality verification line (or “QVL line”).
Canton
produces blooms and billets for the three rolling mills in the Republic
facilities and for trade customers. We use the QVL inspection line to inspect
finished bar produced in Lackawanna and Lorain. As of December 2005, the Canton
facility had annual installed capacity of 790,000 tons of steel billet. In
the period from July 22, 2005 to December 31, 2005, this facility produced
302,000 tons of blooms, billets and other semi-finished trade product and was
operated at 88.0% capacity of steel billet.
Lackawanna,
New York.
Our
Lackawanna facility mainly produces SBQ steel and includes a three-zone walking
beam billet reheat furnace, a recently upgraded 22 stand rolling mill capable
of
producing rounds, squares, and hexagons in both cut length and coils. This
facility produces hot rolled bar sizes that range from .562" to 3.250" with
coil
weights up to 6000 lb. Our Lackawanna facility’s finishing equipment includes a
QVL inspection line and three saw lines. We sell a portion of the hot rolled
bars produced at our Lackawanna facility to trade customers, and we also ship
a
portion of the finished bars to our cold finishing operations for further
processing. As of December 2005, the Lackawanna facility had annual installed
capacity of 540,000 tons of hot rolled bars. In the period from July 22, 2005
to
December 31, 2005 this facility produced 212,000 tons of hot rolled bars and
was
operated at 89.6% capacity of finished product.
Massillon,
Ohio.
Our
Massillon facility mainly produces SBQ steel and contains a cold finishing
facility which includes the machinery and equipment to clean, draw, turn,
chamfer, anneal, grind, straighten and saw bars. Our Massillon facility had,
at
December 31, 2005, an annual installed capacity of 125,000 tons of finished
product. During the period of July 22 to December 31, 2005, the Massillon
facility was operated at 70.3% capacity of finished product and produced 39,000
tons of cold finished bars.
Gary,
Indiana.
Our
Gary facility mainly produces SBQ steel and has a cold finishing facility which
includes the machinery and equipment to clean, draw, turn, chamfer, anneal,
grind, straighten and saw bars. As of December 2005, the Gary facility had
annual installed capacity of 70,000 tons of cold finished bars. In the period
from July 22, 2005 to December 31, 2005, this facility produced 16,000 tons
of
cold finished bars and was operated at 53.0% capacity of finished
product.
Hamilton,
Ontario, Canada.
Our
Hamilton facility mainly produces SBQ steel and has a cold finishing facility
which includes the machinery and equipment to clean, draw, turn, chamfer,
anneal, grind, straighten and saw bars. As of December 2005, the Hamilton
facility had annual installed capacity of 60,000 tons of cold finished bars.
In
the period from July 22, 2005 to December 31, 2005, this facility produced
14,000 tons of cold finished bars and was operated at 56.5% capacity of finished
product.
The
following table shows the products that we produce, the equipment that we use
and the volume that we produce in each of our separate production
facilities:
Production
per Facility by Product, Equipment and Volume
Location
|
|
Product
(%)
|
|
Equipment
|
|
2005
Annual Production Volume (tons)
|
|
Finished
Product Annual Installed
Capacity (tons)(2)
|
Guadalajara
|
|
Structurals
(56%); Light Structurals (16%); SBQ
(21%), Rebar (7%)
|
|
electric
arc furnace with continuous caster, rolling mill and bar processing
lines
|
|
393,958
|
|
480,000
|
|
|
|
|
|
|
|
|
|
Mexicali
|
|
Structurals
(7%); Rebar (67%); Light
Structurals (26%)
|
|
electric
arc furnace with continuous caster and bar rolling mills
|
|
201,607
|
|
250,000
|
|
|
|
|
|
|
|
|
|
Apizaco
and Cholula
|
|
SBQ
(60%); Rebar (17%); Light Structurals (23%)
|
|
electric
arc furnace with vacuum tank degasser, continuous caster, bar rolling
mills, cold drawn and bar turning equipment
|
|
425,175
|
|
480,000
|
|
|
|
|
|
|
|
|
|
Lorain
|
|
SBQ
(100%)
|
|
blast
furnace, vacuum tank degasser, continuous caster, bar and wire rod
rolling
mills
|
|
240,000(1)
|
|
840,000
|
|
|
|
|
|
|
|
|
|
Canton
|
|
SBQ
(100%)
|
|
electric
arc furnace, vacuum tank degasser, continuous caster, rolling
mills
|
|
302,000(1)
|
|
790,000(3)
|
|
|
|
|
|
|
|
|
|
Lakawanna
|
|
SBQ
(100%)
|
|
reheat
furnace, bar and wire rod rolling mills
|
|
212,000(1)
|
|
540,000
|
|
|
|
|
|
|
|
|
|
Massillon
|
|
SBQ
(100%)
|
|
cold
drawn bar turning and heat treating equipment
|
|
39,000(1)
|
|
125,000
|
|
|
|
|
|
|
|
|
|
Gary
|
|
SBQ
(100%)
|
|
cold
drawn bar turning and heat treating equipment
|
|
16,000(1)
|
|
70,000
|
|
|
|
|
|
|
|
|
|
Hamilton
|
|
SBQ
(100%)
|
|
cold
drawn bar turning and heat treating equipment
|
|
14,000(1)
|
|
60,000
|
(1)
|
Production
from July 22, 2005 to December 31,
2005.
|
(2)
|
At
December 31, 2005.
|
(3)
|
Installed
capacity at Canton increased to 1,200,000 tons at June 30, 2006 due
to the
additional 400,000 tons of rolling
capacity.
|
Principal
Capital Expenditures and Divestitures
We
continually seek to improve our operating efficiency and increase sales of
our
products through capital investments in new equipment and technology.
In
2005,
we spent $46.4 million (Ps. 503 million) on capital investments in our Mexican
and our U.S. operations. Projects at the Guadalajara facilities in 2005 included
the addition of a railroad weighing-machine and improvements to the warehouse.
Projects at the Mexicali facility in 2005 included the addition of a cooling
bed
for the rolling mill, special site for dust and a co-jet system for the melt
shop in order to increase productivity and reduce energy consumption. Projects
at the Apizaco facility included the addition of a Straightening Line for the
rolling mill and an inspection system for the rolling mill. From July 22, 2005
to December 31, 2005, capital investments in our Republic facilities were $34.4
million (Ps. 392 million), including $17.8 million (Ps. 203 million) for the
new
five strand combined billet/bloom caster in our Canton, Ohio facility, and
the
remainder for the revamping of the Canton melt shop, maintenance, general
capital and infrastructure improvements and modernization.
In
2004,
we spent $109.7 million (Ps. 1,285 million) on capital investments ($107.5
million of which (Ps. 1,225 million) we allocated to the acquisition of the
Apizaco and Cholula facilities). Projects at the Guadalajara facilities in
2004
included the addition of a reheating furnace and a new stand for the rolling
mill. Projects at the Mexicali facility in 2004 included the addition of a
special site for dust.
In
2003,
we spent $5.4 million (Ps. 64 million) on capital investments. Projects at
the
Guadalajara facility included the addition of a slitting system in order to
increase production at the rolling mill. Projects at the Mexicali facility
included the addition of a digital regulation system to the electric arc furnace
in order to reduce energy consumption at the melt shop.
We
anticipate capital investments of $34.1 million (Ps. 389 million) at our
Republic facilities in 2006, including $23.4 million (Ps. 267 million) at the
Canton, Ohio facility, $9.2 million (Ps. 105 million) at the Lorain, Ohio
facility, $0.5 million (Ps. 5.7 million) at the Lackawanna, New York facility,
$0.4 million (Ps. 4.6 million) at the Massillon, Ohio facility, $0.1 million
(Ps. 1.1 million) at the Hamilton, Ontario, Canada facility, $0.2 million (Ps.
2.3 million) at the Gary, Indiana facility and $0.3 million (Ps. 3.4 million)
at
our corporate location in Fairlawn, Ohio. We expect to have spent $9.4 million
(Ps. 107 million) on capital improvements at our facilities in Mexico in 2006,
including $7.7 million (Ps. 88 million) at the Apizaco facility, $1.4 million
(Ps. 16 million) at the Mexicali facility and $0.3 million (Ps. 3.4 million)
at
the Guadalajara facility.
Sales
and Distribution
We
sell
and distribute our steel products throughout North America. We also export
steel
products from Mexico to Central and South America and Europe. We believe that
on
a pro forma basis, including Republic for all of 2005, approximately 79% of
our
steel product sales represented SBQ steel products, of which we sold 45% to
the
auto part industry, 15% to service centers, 13% for energy related products,
5%
for hand tools, 5% for mining equipment and the remaining 17% to other
industries. We estimate that 85% of our total production comes from special
orders from our clients.
The
following table sets forth, for the periods indicated, our Mexico, U.S. and
Canada sales as a percentage of total product sales by market. These figures
reflect the sales of products manufactured at the Apizaco and Cholula facilities
starting since August 1, 2004 and the sales of products manufactured at our
U.S.
facilities starting since July 22, 2005.
Steel
Product Sales By Region
|
|
Mexico
|
|
U.S.
and Canada(1)
|
|
Mexico
|
|
U.S.
and Canada(1)
|
|
|
|
Years
ended December 31,
|
|
Six
months ended June 30,
|
|
|
|
2003
|
|
2004
|
|
2005
|
|
2003
|
|
2004
|
|
2005
|
|
2005
|
|
2006
|
|
2005
|
|
2006
|
|
I-Beams
|
|
|
99
|
%
|
|
100
|
%
|
|
99
|
%
|
|
1
|
%
|
|
0
|
%
|
|
1
|
%
|
|
100
|
%
|
|
98
|
%
|
|
0
|
%
|
|
2
|
%
|
Channels
|
|
|
81
|
%
|
|
80
|
%
|
|
81
|
%
|
|
19
|
%
|
|
20
|
%
|
|
19
|
%
|
|
85
|
%
|
|
59
|
%
|
|
15
|
%
|
|
41
|
%
|
Angles
|
|
|
89
|
%
|
|
95
|
%
|
|
94
|
%
|
|
11
|
%
|
|
5
|
%
|
|
6
|
%
|
|
94
|
%
|
|
90
|
%
|
|
6
|
%
|
|
10
|
%
|
Hot-rolled
Bars(round, square and hexagonal rods)
|
|
|
96
|
%
|
|
91
|
%
|
|
10
|
%
|
|
4
|
%
|
|
9
|
%
|
|
90
|
%
|
|
88
|
%
|
|
12
|
%
|
|
12
|
%
|
|
88
|
%
|
Rebar
|
|
|
67
|
%
|
|
71
|
%
|
|
66
|
%
|
|
33
|
%
|
|
29
|
%
|
|
34
|
%
|
|
65
|
%
|
|
91
|
%
|
|
35
|
%
|
|
9
|
%
|
Flat
bar
|
|
|
89
|
%
|
|
95
|
%
|
|
98
|
%
|
|
11
|
%
|
|
5
|
%
|
|
2
|
%
|
|
97
|
%
|
|
97
|
%
|
|
3
|
%
|
|
3
|
%
|
Cold
Drawn finished bars
|
|
|
96
|
%
|
|
95
|
%
|
|
40
|
%
|
|
4
|
%
|
|
5
|
%
|
|
60
|
%
|
|
99
|
%
|
|
23
|
%
|
|
1
|
%
|
|
77
|
%
|
Semi-finished
tube rounds
|
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
100
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
100
|
%
|
Other
semi-finished trade products
|
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
100
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
100
|
%
|
Other
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
100
|
%
|
|
100
|
%
|
|
0
|
%
|
|
0
|
%
|
Total
(weighted average)
|
|
|
87
|
%
|
|
87
|
%
|
|
53
|
%
|
|
13
|
%
|
|
13
|
%
|
|
47
|
%
|
|
86
|
%
|
|
34
|
%
|
|
14
|
%
|
|
66
|
%
|
(1)
|
Includes
sales principally into the United States and
Canada.
|
During
the six months ended June 30, 2006, approximately 66% of our sales by volume
came from the U.S. market, with almost 100% of such sales representing SBQ
products. The Mexican market represents approximately 34% of our sales by
volume, with SBQ products representing approximately 28.5% of such sales and
the
remainder representing commercial steel products. Approximately 61% of our
sales
in the United States and Canadian markets come from contractual long-term
agreements that establish minimum quantities and prices, which are adjustable
based on fluctuations of key production materials. The remainder of our sales
in
the United States and Canadian markets are spot sales either directly to end
customers through our sales force or through independent
distributors.
We
sell
to the Mexican market through a group of approximately 100 independent
distributors, who also carry other steel companies’ product lines, and through
our wholly owned distribution center in Guadalajara. Our sales force and
distribution center are an important source of information concerning customer
needs and market developments. By working through our distributors, we believe
that we have established and can maintain market leadership with small and
mid-market end-users throughout Mexico. We believe that our domestic customers
are highly service-conscious.
We
sell
to customers in the U.S. and Canadian markets through a staff of professional
sales representatives and sales technicians located in the major manufacturing
centers of the Midwest, Great Lakes and Southeast regions of the United States.
We
distribute our exports outside North America primarily through independent
distributors who also carry other product lines. In addition, we have three
full-time employees in Mexico dedicated exclusively to exports.
During
2004 and 2005, we received orders for our products in our Mexican facilities
on
average approximately two weeks before producing those products. We generally
fill orders for our U.S. and Canadian SBQ steel products within one to 12 weeks
of the order depending on the product, customer needs and other production
requirements. Customer orders are generally cancelable without penalty prior
to
finish size rolling and depend on customers’ changing production schedules.
Accordingly, we do not believe that backlog is a significant factor in our
business. A substantial portion of our production is ordered by our customers
prior to production. There can be no assurance that significant levels of
pre-production sales orders will continue.
We
have
long term relationships with most of our major customers, in some cases for
10
to 20 years or longer. Our major direct and indirect costumers include leading
automotive and industrial equipment manufacturers General Motors Corporation,
Ford Motor Company, DaimlerChrysler AG, Honda Motor Co., Ltd. Toyota Motor
Corporation, and Caterpillar Inc., first tier suppliers to automotive and
industrial equipment manufacturers such as American Axle, ArvinMeritor, Inc.,
Delphi, Formtech Industries LLC, NTN Driveshaft, Inc., TRW Automotive Holdings
Corp., and Visteon Corporation; forger Jernberg Industries, Inc.; service
centers which include AM Castle & Co., Earle M. Jorgensen Co., and Eaton
Steel Bar Company; and tubular product manufacturer, U.S. Steel. In 2002 we
entered into a long term supply contract with U.S. Steel, which we have extended
several times. On September 22, 2006, we renewed our long term supply contract
with U.S. Steel through September 30, 2008. This contract provides for our
obligation to produce and sell to U.S. Steel, and U.S. Steel’s obligation to
purchase from us 25,000 to 30,000 tons of our tube rounds per month, and we
may
agree to sell rounds to U.S. Steel in excess of 30,000 tons. We may not deliver
fewer than 75,000 tons during any quarter without paying a penalty, unless
the
shortfall is based solely on U.S. Steel’s act or omission.
Our
U.S.
and Canadian facilities are strategically located to serve the majority of
consumers of SBQ products in the United States. Our U.S. and Canadian facilities
ship products between their mills and finished products to customers by rail
and
truck. Customer needs and location dictate the type of transportation used
for
deliveries. The proximity of our rolling mills and cold finishing plants to
our
U.S. customers allows us to provide competitive rail and truck freight rates
and
flexible deliveries in order to satisfy just-in-time and other customer
manufacturing requirements. We believe that the ability to meet the product
delivery requirements of our customers in a timely and flexible fashion is
a key
to attracting and retaining customers as more SBQ product consumers reduce
their
in-plant raw material inventory. We optimize freight costs by using our
significantly greater scale of operations to maintain favorable transportation
arrangements, continuing to combine orders in shipments whenever possible and
“backhauling” scrap and other raw materials.
Competition
Mexico
We
compete in the Mexican domestic market and in its export markets for non-flat
steel products primarily on the basis of price and product quality. In addition,
we compete in the domestic market based upon our responsiveness to customer
delivery requirements. We believe that we are one of the lowest cost producers
of non-flat steel products in Mexico. We endeavor to enhance our competitive
position in Mexico by working closely with our clients and distributors and
adjusting our production schedule to meet customer requirements. The flexibility
of our production facilities, allows us to respond quickly to the demand for
our
products. We also believe that the geographic locations of our various
facilities throughout Mexico and large variety of products help us to maintain
our competitive market position in Mexico and in the southwestern United States.
Our Mexicali mini-mill, one of the closest mini-mills to the southern California
market, provides a production and transportation cost advantage in northwestern
Mexico and southern California.
We
believe that our competitors’ closest plants to the southern California market
are: Nucor Steel, located in Plymouth, Utah, Schnitzer Steel (Cascade), located
in McMimville, Oregon, Oregon Steel (Rocky Mountain Steel Mills), located in
Pueblo, Colorado, Tamco Steel, located in Rancho Cucamanga, California and
Grupo
Villacero (Border Steel), located in El Paso, Texas. We believe that in addition
to our significant advantage in terms of lower transportation cost, we also
believe that we have an advantage in lower labor cost in our Mexican operations.
We believe our transportation costs in northwestern Mexico compare favorably
to
other local producers, including Grupo Villacero (SICARTSA), located in Lazaro
Cardenas, Michoacan; Ternium (Hylsa), located in Apodaca, Nuevo Leon and
DeAcero, located in Saltillo, Coahuila.
We
estimate, based on information compiled by Mexico’s National Steel and Iron
Industry Chamber (Cámara
Nacional de la Industria del Hierro y del Acero, or
“CANACERO”), that we are the sole Mexican producer of 5 inch, 6 inch and 200 mm
I-beams and that there is one other small producer of 4-inch I-beams. These
products accounted for approximately 75,894 tons, or 10%, and approximately
80,000 tons, or 5%, of our total finished product sales in 2004 and 2005,
respectively. The revenue that we derived from I-beam products represented
10%
and 5% of our net sales in 2005 and 2004, respectively. Total imports of these
products, which come mainly from Spain and the United States, represent
approximately 10% of the Mexican market.
In
2005,
we sold approximately 200,000 tons of I-beams, channels and angles at least
three inches in width (including the 80,000 tons of I-beams described above)
which represented approximately 12% of our total finished product sales for
the
year. In 2004, we sold approximately 180,000 tons of I-beams, channels and
angles at least three inches in width (including the 75,000 tons of I-beams
described above) which represented approximately 24% of our total finished
product sales for the year. We believe that the domestic competitors in the
Mexican market for structural steel are Altos Hornos de Mexico, S.A. de C.V.
(“Ahmsa”), Siderúrgica del Golfo, S.A. de C.V. (a wholly-owned subsidiary of
Industrias CH), Aceros Corsa, S.A. de C.V. (“Corsa”) and Gerdão, S.A. We
estimate that our share of Mexican production of structural steel was 71% in
2005 and 64% in 2004.
In
2005,
we sold approximately 700,000 tons of hot rolled and cold finished steel bar,
compared to 200,000 tons in 2004. We estimate, based on information compiled
by
CANACERO, that our share of domestic production of steel bar was 41% in 2005
and
37% in 2004. Our other major product lines are rebar and light structural steel
(angles less than three inches in width and flat bar), for which our share
of
domestic production in 2005 was 7% and 88%, respectively, compared to 6% and
40%, respectively, in 2004. Rebar and light structural steel together accounted
for approximately 600,000 tons, or 35%, of our total production of finished
steel products in Mexico and the United States in 2005, compared to
approximately 390,000 tons, or 50%, in 2004. We compete in the Mexican market
with a number of producers of these products, including Ahmsa, Hylsamex, S.A.
de
C.V., Sicartsa, S.A. de C.V., Corsa, Aceros Tultitlán, S.A. de C.V., Commercial
Metals Inc., Belgo Mineira Aceralia Perfiles Bergara, S.A., Chaparral Steel
Company, Aceros San Luis, S.A. de C.V., Deacero, S.A. de C.V., Talleres y Acero,
Nucor Corporation and Bayou Steel Corporation.
We
distributed our sales of SBQ steel in Mexico as of December 31, 2005 as
follows:
|
· |
auto
parts industry, 63%,
|
|
· |
bar
processing industry, 15%.
|
We
have
been able to maintain our domestic market share and profitable pricing levels
in
Mexico in part because the central Mexico sites of the Guadalajara, Apizaco
and
Cholula facilities afford us substantial cost advantages relative to U.S.
producers when shipping to customers in central and southern Mexico, and our
flexible production facility gives us the ability to ship specialty products
in
relatively small quantities with short lead times. The Mexicali mini-mill has
helped to increase sales in northwestern Mexico and the southwestern United
States because of its relatively close proximity to these areas reduces our
freight costs.
United
States and Canada
In
the
United States and Canada, we compete primarily with both domestic SBQ steel
producers and importers. Our U.S. domestic competition for hot-rolled engineered
bar products is both large U.S. domestic steelmakers and specialized mini-mills.
Non-U.S. competition may impact segments of the SBQ market, particularly where
certifications are not required, and during periods when the U.S. dollar is
strong as compared with foreign currencies.
The
principal areas of competition in our markets are product quality and range,
delivery reliability, service and price. Special chemistry and precise
processing requirements characterize SBQ steel products. Maintaining high
standards of product quality, while keeping production costs low, is essential
to our ability to compete in our markets. We believe that we have the widest
selection of product grades and sizes in our industry and in many cases provide
“niche” products to our customer base that our U.S. competitors cannot provide;
for example we are the sole U.S. producer of long lead steel. The ability of
a
manufacturer to respond quickly to customer orders currently is, and is expected
to remain, important as customers continue to reduce their in-plant raw material
inventory.
We
estimate that the total market for SBQ products in the United States is 8
million tons per year, and in 2005 we produced 1.7 million tons. We, therefore,
estimate that we have a market share of more than 20%.
We
believe our principal competitors in the U.S. market, depending on the product,
include Nucor Corporation, Niagara LaSalle, Mittal Steel, Charter Steel, Steel
Dynamics, Inc., The Timken Company and QUANEX Corporation.
Certifications
ISO
is a
worldwide federation of national standards bodies which have united to develop
internationally accepted standards so that customers and manufacturers have
a
system in place to provide a product of known quality and standards. The
standards set by ISO cover every facet of quality from management responsibility
to service and delivery. We believe that adhering to the stringent ISO
procedures not only creates efficiency in manufacturing operations, but also
positions us to meet the strict standards that our customers require. We are
engaged in a total quality program designed to improve customer service, overall
personnel qualifications and team work.
The
facilities at Apizaco and Cholula have received ISO 9001:2000 certification
from
International Quality Certifications covering the period January 16, 2004 to
January 15, 2007.
Our
U.S.
operations are currently QS-9000 certified. QS-9000 sets forth a standard set
of
quality requirements for components and materials suppliers to the automotive
industry. Certification requirements vary in scope and generally take between
three and twelve months to achieve. Frequently, the qualification process
requires a producer to supply one or more trial heats of SBQ products for
customer evaluation, although some customers have longer pre-qualification
requirements.
The
QS-9000 standard will cease to be a certification standard as of December 15,
2006. Suppliers currently certified under QS-9000 will need to update their
certifications to comply with the ISO/TS 16949 standard. We are actively working
toward transitioning to this standard in all of our facilities. The ISO/TS
16949
standard, developed by the International Automotive Task Force, is the result
of
the harmonization of the supplier quality requirements of vehicle manufacturers
worldwide and provides for a single quality management system of continuous
improvement, defect prevention and reduction of variation and waste in the
supply chain. It places greater emphasis on management’s commitment to quality
and customer focus.
Our
Republic facilities are currently ISO 14001 certified. This certification is
a
voluntary international standard that defines the organizational structure,
responsibilities, procedures, processes and resources for implementing
environmental management systems (“EMS”). It also requires the development of an
environmental policy statement which includes commitments to prevention of
pollution, continual improvement of the EMS leading to improvements in overall
environmental performance and compliance with applicable statutory and
regulatory compliance. Most of the automotive customers of our Republic
facilities require this certification. The certification is effective until
November 2007.
Employees
At
June
30, 2006, we had 4,340 employees (of whom 1,912 were employed at our Mexico
facilities, and 1,143 were unionized, and 2,428 were employed at the Republic
facilities, of whom 2,014 were unionized) compared to 4,360 employees at
December 31, 2005 (of whom 1,905 were employed at our Mexican facilities, and
1,141 were unionized, and 2,455 were employed at the Republic facilities, and
2,007 were unionized), compared to 2,018 employees at December 31, 2004 (781
employed at the Apizaco and Cholula facilities and 1,237 employed at the
Guadalajara and Mexicali facilities, and across these facilities a total of
1,194 were unionized) compared with 1,288 employees at December 31, 2003 (or
whom 889 were unionized).
The
unionized employees in each of our Mexican facilities are affiliated with
different unions. Salaries and benefits of our Mexican unionized employees
are
determined annually through union contracts. Set forth below is the union
affiliation of the employees of each of our Mexican facilities and the
expiration date of the current contract.
|
· |
Guadalajara
facilities:
Sindicato de Trabajadores en la Industria Siderúrgica y Similares en el
Edo. de Jalisco. The contract expires in February 14,
2008.
|
|
· |
Mexicali
facilities:
Sindicato de Trabajadores de la Industria Procesadora y Comercialización
de Metales de Baja California. The contract expires in January 16,
2008.
|
|
· |
Apizaco
facilities:
Sindicato Nacional de Trabajadores de Productos Metalicos, Similares
y
Conexos de la República Mexicana. The contract expires in January 16,
2007.
|
|
· |
Cholula
facilities:
Sindicato Industrial "Acción y Fuerza" de Trabajadores Metalurgicos
Fundidores, Mecánicos y Conexos Crom del Estado. The contract expires in
March 1, 2008.
|
We
have
had good relations with the unions in our Mexican facilities. The bargaining
agreements are revised every two years, and wages are adjusted every
year.
The
employees of our Republic facilities are affiliated with United Steelworkers
of
America. The existing labor agreement with the employees of our Republic
facilities includes an employee profit sharing program, to which our Republic
subsidiary must contribute 15% of its quarterly net income before taxes
exceeding $12.5 million (Ps. 142 million) for the period ending June 30, 2006
for unionized employees and 3% of its quarterly net income before taxes
exceeding $12.5 million (Ps. 142 million) for the period ending June 30,2006
for
the non-unionized employees.
Wages
and
benefits for non-unionized employees are fixed by a compensation system that
incorporates both performance incentives and market wages. We believe that
our
relations with employees are satisfactory within all our operating subsidiaries,
and we have had no strikes or work stoppage in our history. We consider employee
training a priority and, as a result, have implemented programs in the
professional and technical areas of each operating facility.
Raw
Materials
In
2005,
our cost of sales in Mexico was 67% compared to our U.S. operations where our
cost of sales was 94%, and our consolidated cost of sales was 80%.
Ferrous
scrap, electricity, iron ore coke, ferroalloys, electrodes and refractory
products are the principal materials that we use to manufacture our steel
products.
Scrap.
Ferrous
scrap is among the most important components for our steel production and
accounted for approximately 36% of our consolidated direct cost of sales in
2005
(56% of the direct cost in our Mexico operations and 17.5% of the direct cost
in
our U.S. operations) and 59% of our direct cost of sales in 2004, and
represented 32% of our consolidated direct costs in sales for the six months
ended June 30, 2006 (55% of the direct cost in our Mexico operations and 25%
of
the direct cost in our U.S. operations). Ferrous scrap is principally generated
from automobile, industrial, naval and railroad industries. The market for
ferrous scrap is influenced by availability, freight costs, speculation by
scrap
brokers and other conditions largely beyond our control. Fluctuations in scrap
costs directly influence the cost of sales of finished goods.
We
purchase raw scrap from dealers in Mexico and the San Diego area, and processes
the raw scrap into refined ferrous scrap at our Guadalajara, Mexicali and
Apizaco facilities. We meet our refined ferrous scrap requirements through
three
sources: (i) our wholly owned scrap processing facilities, which in the
aggregate provided us with approximately 5% and 6% of our refined scrap tonnage
in 2005 and 2004, respectively, and (ii) purchases from third party scrap
processors in Mexico and the southwestern United States, which, in the
aggregate, provided us with approximately 84% and 11% in 2005, respectively,
and
approximately 64% and 30% in 2004, respectively, of our refined ferrous scrap
requirements. We are a dominant scrap collector in the Mexicali, Tijuana and
Hermosillo regions, and, by primarily dealing directly with small Mexican scrap
collectors, we believe we have been able to purchase scrap at prices lower
than
those in the international and Mexican markets. We purchase scrap on the open
market through a number of brokers or directly from scrap dealers for our U.S.
and Canadian facilities. We do not depend on any single scrap supplier to meet
our scrap requirements.
Iron
Ore Pellets and Coke.
Our
U.S. and Canadian facilities purchase iron ore pellets and coke. These are
the
principal raw materials used in our blast furnaces. Iron ore pellets and coke
accounted for approximately 19% of our U.S. and Canadian facilities’ direct
costs for the six months ended June 30, 2006. In 2005, our U.S. and Canadian
facilities purchase 100% of their iron ore pellet and a portion of their coke
requirement from U.S. Steel. For the six month period ended June 30, 2006,
we
used iron ore pellets and coke in our Lorain, Ohio facility. The iron ore
pellets and coke made up 9% and 10%, respectively, of the direct costs of sales
in this period. We purchase the remainder of our coke requirement on the open
market. Our Mexican facilities do not use iron ore pellets or coke.
Ferroalloys,
Electrodes and Refractory Products.
In our
Mexican operations, ferroalloys, electrodes and refractory products collectively
accounted for approximately 13% of our direct cost of sales in 2005 and 11%
in
2004, and they accounted for 20.8% of our direct cost of sales for the six
months ended June 30, 2006 in our U.S. and Canadian facilities. Ferroalloys
are
essential for the production of steel and are added to the steel during
manufacturing process to reduce undesirable elements and to enhance its
hardness, durability and resistance to friction and abrasion. For our Mexican
operations, we buy most of our manganese ferroalloys from Compañía Minera
Autlán, S.A., and the remainder from Electrometalúrgica de Veracruz, S.A. de
C.V., Manuchar Internacional, S.A. de C.V. and Industria Nacional de la
Fundición, S.A. de C.V.
We
obtain
electrodes used to melt raw materials from Ucar Carbon Mexicana, S.A. de C.V.,
Graphite Electrode Sales and SGL Carbon, LLC.
Refractory
products include firebricks, which line and insulate furnaces, ladles and other
transfer vessels. We purchase our refractory products from RHI
Refmex, S.A. de C.V., LWB de México, S.A. de C.V., Fedmet Resources Corp.,
Vesivius de México, S.A. de C.V., Mayerton Refractories and Tecnologías
Minerales de México, S.A. de C.V. Our U.S. and Canadian facilities purchase most
of their ferroalloys from International Nickel, Climax Molybdenum Co., Considar
Inc., Minerais U.S. LLC and Glencore LTD. The direct cost for the ferroalloys
represents 14% of our consolidated costs, 8% of the direct costs incurred at
our
Mexican operations and 18.7% of the direct costs incurred at our U.S.
operations.
Electricity.
As of
December 31, 2005, electricity accounted for approximately 7% of our
consolidated direct cost of sales for the period (10% of the direct cost of
our
Mexican operations and 4% of the direct cost of our U.S. operations).
Electricity accounted for 10% of our direct cost of sales in 2005 and 9% of
direct cost of sales in 2004 and is supplied by the Comisión
Federal de Electricidad
(“CFE”)
in our Mexico facilities. It accounted for 3.6% of direct costs of sales from
July 22 to December 31, 2005 in our U.S. and Canadian operations and is supplied
by American Electric Power Company and Ohio Edison. We, like all other high
volume users of electricity in Mexico, pay special rates to CFE for electricity.
Energy prices in Mexico have historically been very volatile and subject to
dramatic price increases in short periods of time. In the late 1990s, the CFE
began to charge for electricity usage based on the time of use during the day
and the season (summer or winter). As a result, we have modified our production
schedule in order to reduce electricity costs by limiting production during
periods when peak rates are in effect. There can be no assurance that any future
cost increases will not have a material adverse effect on our business. From
May
through October 2005 and August through October 2004, the Mexicali facility
acquired electricity from Sempra Energy Solutions (“Sempra”), a company based in
San Diego, California. The Comisión
Reguladora de Energía
of the
Mexican Secretary of Energy authorized this agreement for peak hours in the
period; the rates were less expensive than the rates of CFE in the same period.
In 2006, the Mexicali facility entered into a new contract with Sempra for
the
period May through October 2006.
Natural
Gas.
Natural
gas (including “combustoleo” which is an oil derivative that is less refined
than gasoline and diesel fuel oil that can be used instead of gasoline in our
Mexicali plant) consisted of approximately 8% of our consolidated direct cost
of
sales (4.5% of the direct cost of our Mexican operations and 11% of the direct
cost of our U.S. operations). We use natural gas cash-flow exchange contracts
or
swaps where we receive a floating price and pay a fixed price to hedge our
risk
of from fluctuations in natural gas prices. Fluctuations in natural gas prices
from volume consumed are recognized as part of our operating costs. As
applicable, we recognized the fair value of instruments either as liabilities
or
assets. Such fair value and thus, the value of these assets or liabilities
were
restated at each month’s-end. As indicated in Note 6 to the audited financial
statements, we opted for the early adoption of Bulletin C-10 “Derivative
Financial Instruments and Hedging”;
therefore, at December 31, 2005 and 2004, we recognized the fair value of the
natural gas swap designated for hedging exposure of future gas consumption
for
the remaining period of January 2004 to December 2006 in terms of fluctuations
in natural gas prices, were recognized within the comprehensive income account
in stockholders’ equity.
Our
contracts are forwards with a minimum volume required to purchase.
At
the
end of 2003, we entered into derivative transactions with PEMEX, to hedge
against fluctuations in natural gas prices. The derivatives will guarantee
a
portion of our natural gas consumption from 2004 to 2006 at a fixed price of
$4.462 per MMBtu. At the end of 2005, we also held in one of our subsidiaries
in
the United States, 23 open contracts for natural gas swaps, entered to offset
the potential natural gas price volatility for the months of January through
March 2006. These swaps resulted in marking to market all of our open contracts
as of December 2005 and a liability for $1.2 million (Ps. 13
million).
Natural
gas consisted of approximately 9.0% of our U.S. and Canadian facilities’ direct
costs for the period from July 22 through December 31, 2005. Our U.S. and
Canadian operations have a hedging policy to manage their exposure to natural
gas price fluctuations when practical. During 2005, we began using cash flow
hedges with respect to natural gas. Our policy includes establishing a risk
management philosophy and objectives designed to cap our exposure to the extreme
price volatility of natural gas and thereby limiting the unfavorable effect
of
price increases on our operating costs. We do not enter into contracts for
the
purpose of speculation. We account for these derivative instruments in
accordance with Statement of Financial Accounting Standards No. 133,
“Accounting
for Derivative Instruments and Hedging Activities”
and with
Mexican GAAP relating to Bulletin C-10 “Derivative
Financial Instruments and Hedging”.
At
December 31, 2005, we held cash flow hedges for natural gas with the effective
portion of such instruments reflected in accumulated other comprehensive
loss.
Legal
Matters and Regulations
U.S.
and Canadian Operations
We
are
subject to U.S. federal, state and local environmental laws and administrative
regulations concerning, among other things, hazardous materials disposal. Our
U.S. operations have been the subject of administrative action by state and
local environmental authorities. The resolution of any of these claims may
result in significant liabilities. See “Risk Factors—Risk Factors Related to our
Business—In the event of environmental violations at our facilities we may incur
significant liabilities” and “Legal Proceedings—Environmental Claims”.
Environmental
Matters
We
are
subject to a broad range of environmental laws and regulations, including those
governing the following:
|
· |
discharges
to the air, water and soil;
|
|
· |
the
handling and disposal of solid and hazardous
wastes;
|
|
· |
the
release of petroleum products, hazardous substances, hazardous wastes,
or
toxic substances to the environment;
and
|
|
· |
the
investigation and remediation of contaminated soil and
groundwater.
|
We
monitor our compliance with these laws and regulations through our environmental
management system, and believe that we currently are in substantial compliance
with them, although we cannot assure you that we will at all times operate
in
compliance with all such laws and regulations. If we fail to comply with these
laws and regulations, we may be assessed fines or penalties which could have
a
material effect on us.
Future
changes in the applicable environmental laws and regulations, or changes in
the
regulating agencies' approach to enforcement or interpretation of their
regulations, could cause us to make additional capital expenditures beyond
what
we currently anticipate. We do not believe that any of our facilities are
subject to the Maximum Achievable Control Technology standard for Iron &
Steel Manufacturers, or the Maximum Achievable Control Technology standard
for
Industrial, Commercial and Institutional Boilers and Process Heaters, because
they do not emit hazardous air pollutants above the regulatory threshold.
However, it is possible that in the future the regulatory agency could disagree
with our determination or that operations at one or more of our facilities
will
change such that the applicability threshold is exceeded. In that event, or
under similar circumstances, we could incur additional costs of
compliance.
Various
federal, state and local laws, regulations and ordinances govern the removal,
encapsulation or disturbance of asbestos-containing materials (“ACMs”). These
laws and regulations may impose liability for the release of ACMs and may permit
third parties to seek recovery from owners or operators of facilities at which
ACMs were or are located for personal injury associated with exposure to ACMs.
We are aware of the presence of ACMs at our facilities, but we believe that
such
materials are being properly managed and contained at this time.
Mexican
Operations
We
are
subject to Mexican federal, state and municipal laws, administrative regulations
and Mexican Official Rules (Normas
Oficiales Mexicanas)
relating
to a variety of environmental matters, anti-trust matters, trade regulations,
and tax and employee matters.
Among
other matters, Mexican tax returns are open for review generally for a period
of
five years, and, according to Mexican tax law, the purchaser of a business
may
become jointly and severally liable for unpaid tax liabilities of the business
prior to its acquisition, which may have an impact on the liabilities and
contingencies derived from any such acquisitions. Although we believe that
we
are in compliance with all material Mexican federal, state and municipal laws,
administrative regulations and Mexican Official Rules, we cannot assure you
that
the interpretation of the Mexican authorities of the laws and regulations
affecting our business or the enforcement thereof will not change in a manner
that could increase our costs of doing business or could have a material adverse
effect on our business, results of operations, financial condition or
prospects.
Environmental
Matters
We
are
subject to various Mexican federal, state and municipal laws, administrative
regulations and Mexican Official Rules (Normas
Oficiales Mexicanas)
relating
to the protection of human health, the environment and natural
resources.
The
major
federal environmental laws applicable to our operations are: (i) the General
Law
of Ecological Balance and Environmental Protection (Ley
General del Equilibrio Ecológico y la Protección al Ambiente
or
“LGEEPA”) and its regulations, which are administered and overseen by the
Ministry of the Environment and Natural Resources (Secretaría
de Medio Ambiente y Recursos Naturales
or
“SEMARNAT”) and enforced by the Ministry’s enforcement branch, the Federal
Attorney’s Office for the Protection of the Environment (Procuraduría
Federal de Protección al Ambiente or“PROFEPA”);
(ii) the General Law for the Prevention and Integral Management of Waste
(Ley
General para la Prevención y Gestión Integral de los Residuos
or the
“Law on Wastes”), which is also administered by SEMARNAT and enforced by
PROFEPA; and (iii) the National Waters Law (Ley
de Aguas Nacionales)
and its
regulations, which are administered and enforced by the National Waters
Commission (Comisión
Nacional de Agua),
also a
branch of SEMARNAT.
In
addition to the foregoing, Mexican Official Rules, which are technical standards
issued by applicable regulatory authorities pursuant to the General
Normalization Law (Ley
General de Metrología y Normalización)
and to
other laws that include the environmental laws described above, establish
standards relating to air emissions, waste water discharges, the generation,
handling and disposal of hazardous wastes and noise control, among others.
Mexican Official Rules regarding soil contamination and waste management were
enacted in order to protect this potential contingencies. Although not
enforceable, the internal administrative criteria on soil contamination
established by PROFEPA are widely used as guidance in cases where soil
remediation, restoration or clean-up is required.
LGEEPA
sets forth the legal framework applicable to the generation and handling of
hazardous wastes and materials, the release of contaminants into the air, soil
and water, as well as the environmental impact assessment of the construction,
development and operation of different projects, sites, facilities and
industrial plants similar to the ones owned and/or operated by us and our
subsidiaries. In addition to LGEEPA, the Law on Wastes regulates the generation,
handling, transportation, storage and final disposal of hazardous
waste.
LGEEPA
also mandates that companies that contaminate soil be responsible for the
clean-up. Furthermore, the Law on Wastes provides that owners and lessors of
real property with soil contamination are jointly and severally liable for
the
remediation of such contaminated sites, irrespective of any recourse or other
actions such owners and lessors may have against the contaminating party, and
aside from the criminal or administrative liability to which the contaminating
party may be subject. The Law on Wastes also restricts the transfer of
contaminated sites.
PROFEPA
can bring administrative, civil and criminal proceedings against companies
that
violate environmental laws, regulations and Mexican Official Rules, and has
the
power to impose a variety of sanctions. These sanctions may include, among
others, monetary fines, revocation of authorizations, concessions, licenses,
permits or registries, administrative arrests, seizure of contaminating
equipment, and in certain cases, temporary or permanent closure of
facilities.
Additionally,
as part of its inspection authority, PROFEPA is entitled to periodically visit
the facilities of companies whose activities are regulated by Mexican
environmental legislation, and verify compliance. Similar rights are granted
to
state environmental authorities pursuant to applicable state environmental
laws.
Companies
in Mexico are required to obtain proper authorizations, concessions, licenses,
permits and registries from competent environmental authorities for the
performance of activities that may have an impact on the environment or may
constitute a source of contamination. Such companies in Mexico are also required
to comply with a variety of reporting obligations that include, among others,
providing PROFEPA and SEMARNAT with periodic reports regarding compliance with
various environmental laws. Among other permits, the operations and related
activities of the steel industry are subject to the prior obtainment of an
environmental impact authorization granted by SEMARNAT.
We
believe that we have obtained all the necessary authorizations, concessions,
general operating licenses, permits and registries from the applicable
environmental authorities to duly operate our facilities, plants and sites,
and
sell our products and that we are in material compliance with applicable
environmental legislation. We, through our subsidiaries, have made significant
capital investments to assure our production and operation facilities comply
with requirements of federal, state and municipal law and administrative
regulation, and to remain in compliance with our current authorizations,
concessions, licenses, permits and registries.
We
cannot
assure you that in the future, we and our subsidiaries will not be subject
to
stricter Mexican federal, state or municipal environmental laws and
administrative regulations, or more stringent interpretation or enforcement
of
existing laws and administrative regulations. Mexican environmental laws and
administrative regulations have become increasingly stringent over the last
decade, and this trend is likely to continue, influenced recently by the North
American Agreement on Environmental Cooperation entered into by Mexico, the
United States and Canada in connection with the North American Free Trade
Agreement or NAFTA. Further, we cannot assure you that we will not be required
to devote significant expenditures to environmental matters, including
remediation-related matters. In this regard, any obligation to remedy
environmental damages caused by us or any contaminated sites owned or leased
by
us could require significant unplanned capital expenditures and be materially
adverse to our financial condition and results of operations.
Water
In
Mexico, the National Waters Law regulates water resources. In addition, the
Mexican Official Rules govern the quality of water. A concession granted by
the
National Waters Commission is required for the use and exploitation of national
waters. All of our facilities have a five-year renewable concession to use
and
exploit underground waters from wells in order to meet the water requirements
of
our production processes. We pay the National Waters Commission duties per
cubic
meter of water extracted under our concessions. We believe we are in substantial
compliance with all the requirements imposed by each of the concessions we
have obtained.
Pursuant
to the National Waters Law, companies that discharge waste into national water
bodies must comply with certain requirements, including maximum permissible
contaminant levels. Periodic reports on water quality must be provided by
dischargers to applicable authorities. Liability may result from the
contamination of underground waters or recipient water bodies. We believe that
we are in substantial compliance with all water and waste water legislation
applicable to us.
Antitrust
Matters
We
are
also subject to the Mexican Antitrust Law (Ley
Federal de Competencia Económica),
which
regulates monopolies and monopolistic practices in Mexico and requires Mexican
government approval of certain mergers, acquisitions and joint ventures. We
believe that we are currently in compliance with the Mexican Antitrust Law.
However, due to our growth strategy of acquiring new businesses and assets
and
because we are a large manufacturer with a significant share of the markets
in
Mexico with respect to certain of our products, we may be subject to greater
regulatory scrutiny in the future.
Measurements
Law
Mexico’s
Ministry of Economy (Secretaría
de Economía),
through the General Rules Department (Dirección
General de Normas
or
“DGN”), promulgates regulations regarding many products that we manufacture.
Specifically, pursuant to the Measurements Law (Ley
Federal sobre Metrología y Normalización),
the
DGN issues specifications on the quality and safety standards for our product
lines. We believe that all of our products are in material compliance with
all
applicable DGN regulations.
Trade
Regulation Matters
We
have
experienced significant competition from imports into Mexico in the past as
a
result of excess worldwide steel production capacity, particularly in periods
of
economic slowdown, and as a consequence of the Peso’s appreciation, making
imports cheaper and more competitive in Peso terms. In 2003, imports declined
as
international market conditions improved and the Peso weakened. Recently, the
Mexican government, at the request of CANACERO, has taken several measures
to
prevent unfair trade practices such as dumping the steel import market. The
overall climate for imports in Mexico is influenced by the free trade agreements
that Mexico has entered into with other countries, as well as the level of
tariffs and anti-dumping duties (some of which are described
below).
We
have
benefited from the free trade agreements that Mexico has entered into.
Specifically, we have directly benefited from our ability to export finished
steel products directly to export markets and compete with similar products
manufactured in those markets. We have also indirectly benefited from increased
demand from our domestic customers who similarly manufacture their products
to
foreign markets under free trade agreements.
North
American Free Trade Agreement.
NAFTA
became effective on January 1, 1994. NAFTA provided for the progressive
elimination over a period of ten years of the 10% duties formerly in effect
on
most steel products imported into Mexico from the United States and Canada,
including those that compete with our main product lines. The 1% duty on most
steel imports into Mexico from the United States and Canada that remained in
2003 was eliminated in 2004. There is currently no duty.
Mexican-European
Community Free Trade Agreement.
The
Mexican-European Free Trade Agreement, or “MEFTA”, became effective on July 1,
2000. MEFTA provides for the progressive elimination of Mexican duties for
steel
producers that are members of the European Union over a period of 6.5 years
for
finished steel products, including those that compete with our products. In
July
of 2000, European imports of steel products paid an initial duty of 8% when
importing into Mexico, which is scheduled to be reduced progressively until
reaching zero in 2007. This agreement also provides an opportunity to increase
our exports to the European countries that are parties to MEFTA since their
duties on Mexican steel products were reduced to 1.7% in July 2002 and
eliminated in 2003. Since 2004, following the commitment of the G-7, the duties
were established at a zero percent rate, giving us an opportunity to increase
our sales to the United States.
Mexico-Japan
Economic Association (the “Association”).
The
governments of Mexico and Japan started negotiations to sign the Association
in
June 2001. The negotiations ended up until March 2004 where after fourteen
rounds of negotiations the Association was signed. After the approval from
the
legislative authorities of both countries, the Association was effective as
of
April 1, 2005.
On
January 1, 2004, Japan and the other members of the G-7, agreed to reduce the
steel tariffs to zero percent, so Mexico has been benefit from this rate since
such date. However, Mexico is sensitive to the steel exports coming from Japan,
so the Association was negotiated in the following terms: (i) the specialized
steel that is not produced in Mexico, and that is used to produce vehicles,
spare parts, electronics, machinery and heavy equipment, was released from
any
tariffs, as from the effective date of the Association, (ii) the Japanese steel
that Mexico imports will be maintained without changes (13% and 18%) during
the
first five years as of the effective date (iii) the steel products coming from
Japan will start paying less taxes gradually as from January 1, 2010 until
reaching a zero percent rate in 2015, (iv) the products to be imported from
the
Sectors Programs, will pay the tariffs pursuant to the fixed tariffs established
in such Sector Programs, so the electronic and vehicles industries will be
exempted as of the effective date of the Association.
Other
Trade Agreements.
In the
last several years, Mexico has signed other free trade agreements with Israel
(2000), Iceland, Norway, Liechtenstein and Switzerland (2001), and with the
following Latin American countries: Chile (1992 and amended in 1999); Venezuela
and Colombia (1995); Costa Rica (1995); Bolivia (1995); Nicaragua (1998);
Honduras, El Salvador and Guatemala (2001); and Uruguay (2003). We do not
anticipate any significant increase in competition in the Mexican steel market
as a result of these trade agreements due to their minimal steel production
or,
in the case of Venezuela and Chile, minimal share of the Mexican
market.
Dumping
and Countervailing Duties.
We are
or have been a party to, or have been affected by, numerous steel dumping and
countervailing duty claims. Many of these claims have been brought by Mexican
steel producers against international steel companies, while others have been
brought against Mexican steel companies. In certain instances, such cases have
resulted in duties being imposed on certain imported steel products and, in
a
few instances, duties have been imposed on Mexican steel exports. In the
aggregate, these duties have not had a material impact on our results of
operations.
U.S.
and Mexican Safeguard Tariffs on Steel Imports.
In
September 2001, Mexico’s Ministry of Economy announced a one-year increase in
tariffs to 25% on 39 steel products imported into Mexico from countries with
which Mexico does not have a free trade agreement. On March 15, 2002, Mexico’s
Ministry of Economy announced an immediate increase of such tariffs to 35%.
In
September 2002, the average tariffs returned to 25% and remained at that level
for 12 months. From September 2003 to March 2003, tariffs were set at 18%,
and
in April 2004, they returned to their previous levels (18% for coated steel
and
13% for the rest of the products).
From
January to October 2002, imports of steel plaques coming from Romania, Russia
and Ukraine increased. The Mexican authorities found sufficient elements to
start an investigation in 2003, and in 2004, the government announced a
preliminary resolution imposing anti-dumping duties of 120.4% to the exports
of
steel plaques coming from Romania, 36.8% coming from Russia and 60.9% coming
from Ukraine. On March 17, 2006 a final resolution was announced imposing final
anti-dumping duties of 67.6% to the exports of steel plaques coming from
Romania, 36.8% coming from Russia and 60.1% from Ukraine.
Legal
Proceedings
Mexico
With
the
exception of the tax litigation noted below, there are currently no material
legal or administrative proceedings pending in Mexico against us or any of
our
subsidiaries which we expect to have a material adverse effect on our financial
condition or results of operations, or we expect to result in material capital
expenditures or materially adversely affect our competitive
position.
Tax
Litigation. On
July
2, 2003, CSG filed a suit with the Mexican Federal Tax and Administrative Court
of Justice in response to an official communication of the Central International
Fiscal Auditing Office of the Tax Administration Service that stated that CSG
owed unpaid taxes in the amount of Ps. 89,970 and that alleged that CSG failed
to withhold income from third parties on interest payments abroad in 1998,
1999,
2000 and for the period from January 1, 2001 through June 30, 2001. CSG is
currently waiting for the authorities to respond to its suit. See Note 16(g)
to
the audited financial statements for the year ended December 31,
2005.
United
States
Our
operations in the United States and Canada have been the subject of various
environmental claims, including those described below. The resolution of any
claims against us may result in significant liabilities.
Department
of Toxic Substances Control. In
September 2002, the Department of Toxic Substances Control inspected Pacific
Steel’s facilities based on an alleged complaint from neighbors due to Pacific
Steel’s excavating to recover scrap metal on its property and on a neighbor’s
property which it rents from a third party. In this same month, the Department
of Toxic Substances Control issued an enforcement order of imminent and
substantial endangerment determination, which alleges that certain soil piles,
soil management and metal recovery operations may cause an imminent and
substantial danger to human health and the environment. Consequently, the
department sanctioned Pacific Steel for violating hazardous waste laws and
the
State of California Security Code and imposed the obligation to make necessary
changes to the location. In July 2004, in an effort to continue with this order,
the department filed a Complaint for Civil Penalties and Injunctive Relief
in
San Diego Superior Court. On July 26, 2004, the court issued a judgment, whereby
Pacific Steel is obligated to pay $235,000 (payable in four payments of $58,750
over the course of one year) for fines of $131,250, the department's costs
of
$45,000 and an environmental project of $58,750. At December 31, 2005, Pacific
Steel has made all of the payments.
In
August
2004, Pacific Steel and the Department of Toxic Substances Control entered
into
a corrective action consent agreement. In September 2005, the Department of
Toxic Substances Control approved the Corrective Measures Plan presented by
Pacific Steel, provided it obtains permits from the corresponding local
authorities, which are in process at date.
Due
to
the fact that the cleanliness levels have not yet been defined by the Department
and since the characterization of all the property has not yet been finished,
the allowance for the costs for the different remedy options are still subject
to considerable uncertainty.
We
estimated, based on experience in prior years and using the same processes,
a
liability of between $0.8 million and $1.7 million. Due to the above, at
December 31, 2002 and 2003, we created a reserve for this contingency of
approximately $0.8 million and $1.7 million, respectively. At December 31,
2005,
such reserve is Ps. 15,079 million ($1.4 million).
The
Community Development Commission. The
Community Development Commission of National City, California (CDC) has
expressed its intention to develop the site and is preparing a purchase offer
for Pacific Steel’s land at market value, less the cost of remediation and less
certain investigation costs incurred. Pacific Steel has informed the CDC that
the land will not be voluntarily sold unless there is an alternate property
where it could relocate its business. The CDC, in accordance with the State
of
California law, has the power to expropriate in exchange for payment at market
value and, in the event that there is no other land available to relocate the
business, it would also have to pay Pacific Steel the land’s book value. The CDC
made an offer to purchase the land from Pacific Steel for $6.9 million, based
on
a business appraisal. The expropriation process was temporarily suspended
through an agreement entered into by both parties in April 2006. This agreement
allows Pacific Steel to explore the possibility of finishing the remediation
process of the land and to propose an attractive alternative to CDC which would
allow us to remain in the area.
Due
to
this situation and considering the imminent expropriation of part of the land
on
which Pacific Steel carries out certain operations, for the year ended December
31, 2002, Pacific Steel recorded its land at realizable value based on an
appraisal by independent experts. Such appraisal caused a decrease in the value
of part of the land of Ps. 22,562 (19,750 historical pesos) and a charge to
results of operations of 2002 for the same amount.
Environmental
Liabilities. At
December 31, 2005, we recorded under the caption of “Other Long-term
Liabilities”, a reserve of Ps. 44.0 million to cover probable environmental
liabilities and compliance activities. The current portions of the environmental
reserve are included in the caption “Other Accounts Payable and Accrued
Expenses”, in the attached consolidated balance sheets. We have no knowledge of
any additional environmental remediation liabilities or contingent liabilities
related to environmental issues in regards to the facilities; consequently,
it
would not be appropriate to establish an additional reserve at this
time.
As
is the
case for most steel producers in the United States and Canada, we may incur
material expenses related to future environmental issues, including those which
arise from environmental compliance activities and the remediation of past
administrative waste practices in our U.S. facilities.
Directors
Election
of Directors
Our
board
of directors is responsible for managing our business. Pursuant to our by-laws,
the board of directors shall consist of a maximum of 21 but not less than five
members elected at an ordinary general meeting of shareholders. Alternate
directors are authorized to serve on the board of directors in the absence
of
directors. Our board of directors currently consists of seven directors and
seven alternate directors, each of whom is elected at the annual shareholders’
meeting for a term of one year or until a successor has been appointed. Under
the Mexican Securities Market Law and our by-laws, at least 25% of our directors
must be independent. Under the law, the determination as to the independence
of
our directors made by our shareholders’ meeting may be contested by the Mexican
National Banking and Securities Commission.
At
each
shareholders’ meeting for the election of directors, the holders of shares are
entitled pursuant to our by-laws to elect the directors and their alternates.
Each person (or group of persons acting together) holding 10% of our capital
stock is entitled to designate one director and an alternate.
The
current members of our board of directors were nominated and elected to such
position at the 2006 general meeting of shareholders as proposed by Industrias
CH. We expect that Industrias CH will be in a position to continue to elect
the
majority of our directors and to exercise substantial influence and control
over
our business and policies and to influence us to enter into transactions with
Industrias CH and affiliated companies. However, our by-laws provide that at
least two of our directors must be independent from us and our affiliates,
and
our board of directors has passed a resolution requiring the approval of two
independent directors for certain transactions between us and our affiliates
which are not our subsidiaries.
Under
Mexican law, a majority shareholder has no fiduciary duty to minority
shareholders but may not act contrary to the interests of the corporation for
the majority shareholder’s benefit. Such a majority shareholder is required to
abstain from voting on any matter in which it directly or indirectly has a
conflict of interest and can be liable for actual and consequential damages
if
such matter passes as a result of its vote in favor thereof. In addition, the
directors of a Mexican corporation owe a duty to act in a manner which, in
their
independent judgment, is in the best interests of the corporation and all its
shareholders.
Our
board
of directors adopted a code of ethics in December 2002.
Authority
of the Board of Directors
The
board
of directors is our legal representative. The board of directors must approve,
among other matters:
|
·
|
annual
approval of the business plan and the investment
budget;
|
|
·
|
capital
investments not considered in the approved annual budget for each
fiscal
year;
|
|
·
|
proposals
to increase our capital or that of our
subsidiaries;
|
|
·
|
with
input from the audit and corporate practices committee, on an individual
basis: (i) any transactions with related parties, subject to certain
limited exceptions, (ii) our management structure and any amendments
thereto, and (iii) the election of our chief executive officer, his
compensation and removal for justified causes; (iv) our financial
statements and those of our subsidiaries, (v) unusual or non-recurrent
transactions and any transactions or series of related transactions
during
any calendar year that involve (a) the acquisition or sale of assets
with
a value equal to or exceeding 5% of our consolidated assets or (b)
the
giving of collateral or guarantees or the assumption of liabilities,
equal
to or exceeding 5% of our consolidated assets, and (vi) contracts
with
external auditors;
|
|
·
|
calling
shareholders’ meetings and acting on their
resolutions;
|
|
·
|
any
transfer by us of shares in our
subsidiaries;
|
|
·
|
creation
of special committees and granting them the power and authority,
provided
that the committees will not have the authority which by law or under
our
by-laws is expressly reserved for the
shareholders;
|
|
·
|
determining
how to vote the shares that we hold in our subsidiaries;
and
|
|
·
|
the
exercise of our general powers in order to comply with our corporate
purpose.
|
Meetings
of the board of directors will be validly convened and held if a majority of
our
members are present. Resolutions at the meetings will be valid if approved
by a
majority of the members of the board of directors, unless our by-laws require
a
higher number. The chairman has a tie-breaking vote. Notwithstanding the board’s
authority, our shareholders pursuant to decisions validly taken at a
shareholders’ meeting at all times may override the board.
Duty
of Care and Duty of Loyalty
The
Mexican Securities Market Law imposes a duty of care and a duty of loyalty
on
directors. The duty of care requires our directors to act in good faith and
in
the best interests of the company. In carrying out this duty, our directors
are
required to obtain the necessary information from the general director, the
executive officers, the external auditors or any other person to act in the
best
interests of the company. Our directors are liable for damages and losses caused
to us and our subsidiaries as a result of violating their duty of
care.
The
duty
of loyalty requires our directors to preserve the confidentiality of information
received in connection with the performance of their duties and to abstain
from
discussing or voting on matters in which they have a conflict of interest.
In
addition, the duty of loyalty is violated if a shareholder or group of
shareholders is knowingly favored or if, without the express approval of the
board of directors, a director takes advantage of a corporate opportunity.
The
duty of loyalty is also violated, among other things, by (i) failing to disclose
to the audit and corporate practices committee or the external auditors any
irregularities that the director encounters in the performance of his or her
duties or (ii) disclosing information that is false or misleading or omitting
to
record any transaction in our records that could affect our financial
statements. Directors are liable for damages and losses caused to us and our
subsidiaries for violations of this duty of loyalty. This liability also extends
to damages and losses caused as a result of benefits obtained by the director
or
directors or third parties, as a result of actions of such
directors.
Our
directors may be subject to criminal penalties of up to 12 years’ imprisonment
for certain illegal acts involving willful misconduct that result in losses
to
us. Such acts include the alteration of financial statements and
records.
Liability
actions for damages and losses resulting from the violation of the duty of
care
or the duty of loyalty may be exercised solely for our benefit and may be
brought by us, or by shareholders representing 5% or more of our capital stock,
and criminal actions only may be brought by the Mexican Ministry of Finance,
after consulting with the Mexican National Banking and Securities Commission.
As
a safe harbor for directors, the liabilities specified above (including criminal
liability) will not be applicable if the director acting in good faith (i)
complied with applicable law, (ii) made the decision based upon information
provided by our executive officers or third-party experts, the capacity and
credibility of which could not be subject to reasonable doubt, (iii) selected
the most adequate alternative in good faith or if the negative effects of such
decision could not have been foreseeable, and (iv) complied with
shareholders’ resolutions provided the resolutions do not violate applicable
law.
The
members of the board are liable to our shareholders only for the loss of net
worth suffered as a consequence of disloyal acts carried out in excess of their
authority or in violation of our by-laws.
In
accordance with the Mexican Securities Market Law, supervision of our management
is entrusted to our board of directors, which shall act through an audit and
corporate practices committee for such purposes, and to our external auditor.
The audit and corporate practices committee (together with the board of
directors) replaces the statutory auditor (comisario) that previously had been
required by the Mexican Corporations Law. See “Management -
Committees”.
The
following table sets forth the names and the year of their initial appointment
to their position, of the members of our board of directors and their
alternates.
Name
|
|
Director
Since
|
Directors:
|
Rufino
Vigil González
|
|
2001
|
Raúl
Arturo Pérez Trejo
|
|
2003
|
Eduardo
Vigil González
|
|
2001
|
Raúl
Vigil González
|
|
2001
|
José
Luis Rico Maciel
|
|
2001
|
Rodolfo
García Gómez de Parada
|
|
2001
|
Gerardo
Arturo Avendaño Guzmán
|
|
2001
|
|
|
|
Alternate
Directors:
|
Manuel
Rivero Figueroa
|
|
2003
|
José
Luis Romero Suárez
|
|
2001
|
Sergio
Vigil González
|
|
2001
|
Juan
Méndez Martínez
|
|
2001
|
Luis
García Limón(1)
|
|
2006
|
Jaime
Vigil Sánchez Conde
|
|
2001
|
Sergio
Villagómez Martínez
|
|
2003
|
|
(1)
|
Luis
García Limón is also our Chief Executive
Officer.
|
Biographical
Information
Gerardo
Arturo Avendaño Guzmán.
Mr.
Avendaño was born in 1955. He is an independent director for purposes of Mexican
law and has been a member of our board of directors and the audit committee
since 2001 and is a member of our audit and corporate practices committee.
Mr.
Avendaño is an independent lawyer specializing in civil, mercantile and fiscal
litigation.
Rodolfo
García Gómez de Parada.
Mr.
García was born in 1953. He has been a member of our board of directors since
2001 and is an independent director for purposes of Mexican law. He has been
the
tax adviser of Industrias CH since 1978 and our tax adviser since 2001 and
is a
member of the board of directors of a group of self-service stores and
restaurants since 1990.
Raúl
Arturo Pérez Trejo.
Mr.
Pérez was born in 1959. He has been a member of our board of directors since
2003, and is an independent director for purposes of Mexican law, and is a
member of our audit and corporate practices committee. Mr. Pérez has also served
since 1992 as the chief financial officer of a group that produces and sells
structural steel racks for warehousing and other industrial
storage.
José
Luis Rico Maciel.
Mr. Rico
was born in 1926. He has been a member of our board of directors since 2001
and
is an independent director for purposes of Mexican law. He also serves as our
corporate legal and tax director and is a member of the board of directors
of a
group of self-service stores and restaurants since 1957.
Eduardo
Vigil González.
Mr.
Vigil was born in 1957. He has been a member of our board of directors since
2001. Since 1976, Mr. Vigil has been chief executive officer of a welded pipe
corporation. Mr. Vigil is a brother of Rufino Vigil González and Raúl Vigil
González.
Raúl
Vigil González.
Mr.
Vigil was born in 1961. He has been a member of our board of directors since
2001. Since 1992 he has been chief executive officer of a steel company. In
addition, he has also been general manager of a steel distribution company.
Mr.
Vigil is a brother of Rufino Vigil González and Eduardo Vigil
González.
Rufino
Vigil González.
Mr.
Vigil was born in 1948. He is currently the chairman of our board of directors
and has been a member of the board of directors since 2001. Since 1973, Mr.
Vigil has been chief executive officer of a steel related products corporation.
From 1988 to 1993, Mr. Vigil was a member of the board of directors of a Mexican
investment bank and from 1971 to 1973 he was a construction corporation manager.
Mr. Vigil is a brother of Eduardo Vigil González and Raúl Vigil
González.
Luis
García Limón.
Mr.
García was born in 1944. He is currently our chief executive officer. From 1982
to 1990 he was general director of CSG, from 1978 to 1982 he was operation
director of CSG, from 1974 to 1978 he was general manager of Moly Cop and Pyesa,
and from 1969-1974 he was engineering manager of CSG. In addition, from 1967
to
1969 Mr. García was the director of electrical installation of a construction
company.
Manuel
Rivero Figueroa. Mr.
Rivero was born in 1957. He has been financial manager of the Monclova facility
of Industrias CH since 1994.
José
Luis Romero Suárez.
Mr.
Romero was born in 1956. Since 1984, he has been commercial director of Procesos
de Acero, S.A. de C.V. He is the brother-in-law of Rufino, Eduardo, Sergio
and
Raúl Vigil González.
Sergio
Vigil González.
Mr.
Vigil was born in 1962. Since 2001 he has served as chief financial officer
of
Industrias CH. He is the brother of Rufino, Eduardo and Raul Vigil González and
the uncle of Jaime Vigil Sánchez Conde.
Juan
Méndez Martínez.
Mr.
Méndez was born in 1956. Since 1978 he has served as the chief financial officer
of Operadora Manufacturera de Tubos, S.A. de C.V.
Jaime
Vigil Sánchez Conde.
Mr.
Vigil was born in 1980. Since 2001 he has served as investors’ relations manager
of Industrias CH. He is the son of Rufino Vigil González and the nephew of
Sergio, Raul and Eduardo Vigil González.
Sergio
Villagómez Martínez.
Mr.
Villagómez was born in 1956. Since 1981 he has served as the general manager of
Perfiles Estructurales del Norte, S.A. de C.V., a steel producing corporation.
The
business address of our directors and executive officers is our principal
executive headquarters.
Committees
Our
by-laws provide for an audit and corporate practices committee to assist the
board of directors with the management of our business.
Audit
and Corporate Practices Committee
The
audit
and corporate practices committee is currently composed of three members. Raúl
Arturo Pérez Trejo, the president of the audit and corporate practices
committee, was elected at our ordinary and extraordinary shareholders’ meeting
held on October 24, 2006, and Gerardo Arturo Avendaño Guzmán and Rodolfo García
Gómez de Parada were appointed. Raúl Arturo Pérez Trejo has been appointed as
the “audit committee financial expert”. Our by-laws provide that a shareholders’
meeting shall determine the number of members of the audit and corporate
practices committee, all of which must be members of our board of directors.
The
chairman of the audit and corporate practices committee is elected by our
shareholders’ meeting, and the board of directors appoints the remaining
members.
The
audit
and corporate practices committee is responsible, among others, for (i)
supervising our external auditors and analyzing their reports, (ii) analyzing
and supervising the preparation of our financial statements, (iii) informing
the
board of our internal controls and their adequacy, (iv) requesting reports
of
our board of directors and executive officers whenever it deems appropriate,
(v)
informing the board of any irregularities that it may encounter, (vi) receiving
and analyzing recommendations and observations made by the shareholders, members
of the board, executive officers, our external auditors or any third party
and
taking the necessary actions, (vii) calling shareholders’ meetings, (viii)
supervising the activities of our general director, (ix) providing an annual
report to the board, (x) providing opinions to our board of directors, (xi)
requesting and obtaining opinions from independent third parties and (xii)
assisting the board in the preparation of annual reports and other reporting
obligations.
The
chairman of the audit and corporate practices committee, shall prepare an annual
report to our board of directors with respect to the findings of the audit
and
corporate practices committee, which shall include (i) the status of the
internal controls and internal audits and any deviations and deficiencies
thereof, taking into consideration the reports of external auditors and
independent experts, (ii) the results of any preventive and corrective measures
taken based on results of investigations in respect of non-compliance of
operating and accounting policies, (iii) the evaluation of external auditors,
(iv) the main results from the review of our financial statements and those
of
our subsidiaries, (v) the description and effects of changes to accounting
policies, (vi) the measures adopted as result of observations of shareholders,
directors, executive officers and third parties relating to accounting, internal
controls, and internal or external audits; (vii) compliance with shareholders’
and directors’ resolutions; (viii) observations with respect to relevant
directors and officers; (ix) the transactions entered into with related parties;
and (x) the remunerations paid to directors and officers.
Executive
Officers
The
following table sets forth the names of our executive officers, their current
position with us and the year of their initial appointment to that
position.
Name
|
|
Position
|
|
Position
Held
Since
|
Luis
García Limón
|
|
Chief
Executive Officer
|
|
1982*
|
José
Flores Flores
|
|
Chief
Financial Officer
|
|
2005
|
Juan
José Acosta Macías
|
|
Chief
Operating Officer
|
|
2004
|
Marcos
Magaña Rodarte
|
|
Chief
Sales Officer
|
|
2001
|
*Represents
the date as of which Mr. García Limón first held this office with our
predecessor, CSG.
Luis
García Limón.
Mr.
García was born in 1944. He is currently our chief executive officer. From 1982
to 1990 he was general director of CSG, from 1978 to 1982 he was Operation
Director of CSG, from 1974 to 1978 he was general manager of Moly Cop and Pyesa,
and from 1969-1974 he was Engineering Manager of CSG. In addition, from 1967
to
1969 Mr. García was the director of electrical installation of a construction
company.
José
Flores Flores.
Mr.
Flores was born in 1950. He is currently our chief financial officer. From
2001
to 2004 he was our chief corporate financial planning officer. From 1990 to
2001
he was our manager of financial analysis and stock market disclosure. Before
that, Mr. Flores was the auditor manager of a food company from 1988 to 1990,
the controller manager of Grupo Situr, Holding Company of Hotels, a subsidiary
of Grupo Sidek from 1986 to 1988, and our auditor manager from 1983 to
1986.
Juan
José Acosta Macías.
Mr.
Acosta was born in 1960. He is currently our chief operating officer. From
1998
to 2004 he was production manager of CSG, he has been working with us since
1983. Prior to working with us, Mr. Acosta worked for Mexicana de Cobre as
a
supervisor in 1982.
Marcos
Magaña Rodarte.
Mr.
Magaña was born in 1965. He is currently our marketing and sales director.
Before holding this position, Mr. Magaña was domestic sales manager of CSG from
1997 to 2001, sales manager for the western region of CSG from 1994 to 1996,
sales manager of Metálica las Torres, our subsidiary, from 1992 to 1994 and a
salesman for CSG, from 1990 to 1992. Before working with us, Mr. Magaña worked
for a bank as executive promoter of sales.
Our
chief
executive officer and executive officers are required, under the Mexican
Securities Market Law, to act for our benefit and not that of a shareholder
or
group of shareholders. Our chief executive is required, principally, to (i)
implement the instructions of our shareholders’ meeting and our board of
directors, (ii) submit to the board of directors for approval the principal
strategies for the business, (iii) submit to the audit and corporate practices
committee proposals for the systems of internal control, (iv) disclose all
material information to the public and (v) maintain adequate accounting and
registration systems and mechanisms for internal control. Our chief executive
officer and our executive officers will also be subject to liability of the
type
described above in connection with our directors.
The
business address of our directors and executive officers is our principal
executive headquarters.
Compensation
of Directors and Executive Officers
For
the
year ended December 31, 2005 and for the six months ended June 30, 2006, we
paid
no fees to our seven directors and seven alternate directors, and the aggregate
compensation our executive officers earned was approximately Ps. 17 million
and
Ps. 11 million, respectively.
None
of
our directors or executive officers are entitled to benefits upon termination
under their service contracts with us, except for what is due them according
to
the Mexican Federal Labor Law (Ley Federal del Trabajo).
RELATED
PARTY TRANSACTIONS
We
have
engaged from time to time in a number of transactions with certain of our
shareholders and companies that are owned or controlled, directly or indirectly,
by our controlling shareholder, Industrias CH. These transactions were made
on
terms that we believe were not less favorable to us than those obtainable on
an
arm’s length basis. See note 4 to our financial statements and note 3 to our
unaudited financial statements. On July 22, 2005, we and Industrias CH acquired
100% of the stock of Republic through SimRep. We acquired 50.2% (U.S.$115
million Ps. 1,310 million) of Republic’s stock through our majority owned
subsidiary, SimRep, and Industrias CH purchased the remaining 49.8% (U.S.$114
million Ps. 1,299) through SimRep.
We
financed our portion of the U.S.$229 million (Ps. 2,609 million) purchase price
principally from a loan that we received through Industrias CH that has since
been repaid in full. At December 31, 2005, the total amount of Republic’s debt
liabilities was U.S.$37.7 million (Ps. 430 million). Republic’s debt has since
been repaid in full.
We
have
borrowed various amounts from Industrias CH, primarily to finance acquisitions
(including the acquisition of Republic), debt redemptions and bank loan
amortization and interest payments, a substantial portion of which borrowings
were converted to equity. We have also received various capital contributions
from Industrias CH.
From
time
to time we sell steel products, primarily billet, to Industrias CH and its
affiliates. In 2003, these sales totaled Ps. 190 million, in 2004, these sales
totaled Ps. 129 million, and in 2005 these sales totaled Ps. 25 million. In
addition, in 2004 we purchased Ps. 11 million of steel products from Industrias
CH and its affiliates, and in 2005 we purchased Ps. 2 million of steel products
from Industrias CH and its affiliates. We negotiated these prices on an
arms-length basis.
We
have a
services agreement with Industrias CH, by which Industrias CH provides
administrative services to us and other of our subsidiaries. The term of the
agreement is indefinite. The payments are paid to Industrias CH on a monthly
basis. In 2003, we paid to Industrias CH for its services Ps. 9 million, in
2004
we paid Ps. 9 million, and in 2005 we paid Ps. 8 million.
In
1992,
we sold Ferrometal de Baja California, S.A. de C.V. (“Ferrometal”), which
operates steel distribution centers in northwestern Mexico, to two individuals,
Sergio Luis González Melo (our former director) and an executive officer of
Ferrometal. The purchase price of U.S.$2.9 million was determined based upon
arms-length negotiations. The amounts payable from such individuals were
initially denominated in dollars bearing interest at 15% per annum. In 1995,
we
entered into an agreement with the purchasers pursuant to which the interest
accrued as of December 31, 1994 was capitalized, the debt was converted into
pesos with no interest accruing from January 1995, and the entire principal
amount was to be paid no later than December 31, 1996. The executive officer
of
Ferrometal timely paid his obligations. Mr. González, however, still owes us
approximately Ps. 10 million in nominal pesos at December 31, 2002. We obtained
favorable judgments against him in February 2002, June 2002 and February 2003.
This proceeding is not completed, however, and we are not yet entitled to
execute on the judgment. We have established a reserve equal to 100% of the
amount owed by Mr. González. In January 2004 we and Mr. González’ successors
entered into an agreement to pay $1.3 million Ps. 15.6 million to us. In 2004,
the successors of Mr. González paid us a total of $1.3 million (Ps. 15.6
million).
As
of
September 30, 2006, based on information available to us, we believe that
our officers and directors own no series B shares. Accordingly, on an individual
basis, and as a group, our directors and executive officers beneficially owned
less than one percent of any class of our shares. None of our directors or
officers holds any options to purchase series B shares or preferred shares.
Industrias
CH and its direct wholly-owned subsidiaries currently hold approximately 84%
of
our series B shares. Rufino Vigil González,
the
chairman of our board of directors, owns approximately 63% of Industrias CH
directly or through its subsidiaries. Members of the Vigil family currently
control indirectly approximately another 10% of our series B
shares.
The
following table shows the ownership of our series B shares immediately
prior to the offering and as adjusted to give effect to the combined offering,
assuming no exercise of the over-allotment options.
Name
of Shareholder
|
|
Number
of shares owned prior to the offering
|
|
%
of shares
owned
prior to
the
offering
|
|
Number
of shares after the offering
|
|
%
of shares
owned
after
the
offering
|
Industrias
CH
|
|
260,184,672
|
|
62%
|
|
260,184,672
|
|
55%
|
Tuberías
Procarsa, S.A. de C.V.
(1)
|
|
93,977,250
|
|
22%
|
|
93,977,250
|
|
20%
|
Operadora
de Manufacturera de
Tubos, S.A. de C.V.
(2)
.
|
|
25,707,345
|
|
6%
|
|
25,707,345
|
|
5%
|
Aceros
y Laminados Sigosa, S.A.
de C.V(1).
|
|
4,136,373
|
|
1%
|
|
4,136,373
|
|
1%
|
SEYCO
Estructuras S.A. de C.V.
(2)
|
|
5,847,159
|
|
1%
|
|
5,847,159
|
|
1%
|
Industrial
de Herramientas CH,
S.A. de C.V. (2) .
|
|
2,117,073
|
|
1%
|
|
2,117,073
|
|
1%
|
Compañia
Mexicana de Tubos, S.A.
de C.V.
(2).
|
|
3,629,274
|
|
1%
|
|
3,629,274
|
|
1%
|
Public
Investors.
|
|
25,615,560
|
|
6%
|
|
77,789,475
|
|
16%
|
|
|
|
|
|
|
|
|
|
Total
|
|
421,214,706
|
|
100%
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473,388,621
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100%
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(1)
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A
subsidiary of Industrias CH.
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(2)
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Companies
directly or indirectly owned by members of the Vigil
family.
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DESCRIPTION
OF CAPITAL STOCK
Set
forth
below is a description of our capital stock and a brief summary of material
provisions of our by-laws and Mexican law (including the new Mexican Securities
Market Law). This description gives effect to the amendment and restatement
of
our by-laws, which we adopted on October 24, 2006.
General
We
were
incorporated under the name Grupo Simec, S.A. de C.V. on August 22, 1990, as
a
variable capital corporation (sociedad
anónima de capital variable)
under
the laws of Mexico.
On
October 24, 2006, we amended and restated our by-laws to incorporate the
provisions required by the Mexican Securities Market Law. As a result, we became
a public variable capital corporation, a new corporate form for corporations
with stock registered with the Mexican National Securities Registry
(Registro
Nacional de Valores)
maintained by the National Banking and Securities Commission and listed on
the
Mexican Stock Exchange.
The
following table sets forth our authorized capital stock and our issued and
outstanding capital stock at October 24, 2006, the date of our last meeting
of
shareholders.
Capital
Stock
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Authorized
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Issued
and outstanding
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Series
B shares
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481,214,706
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421,214,706
|
|
Total
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|
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481,214,706
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421,214,706
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All
ordinary shares confer equal rights and obligations to holders within each
series. Our capital stock is divided into ordinary series B and limited series
L
shares. Prior to June 2002, our capital stock also included series A shares.
On
June 5, 2002, we converted all of our series A shares to series B shares on
a
one-for-one basis.
Shares
other than ordinary shares, having limited, restricted or no voting rights,
may
never represent
more than 25% of our outstanding capital stock. Series B shares represent 100%
of our capital stock. We have issued no series L shares. At September 30, 2006,
our total share capital was Ps. 3,513 million,
represented by a fixed portion of Ps. 1,306
million,
and a
variable portion of Ps. 2,207 million. On February 20, 2003, we effected a
1 for
20 reverse stock split. On May 30, 2006, we effected a 3 for 1 stock
split.
The
fixed
portion of our capital stock may be increased or decreased by a resolution
adopted at a general extraordinary shareholders’ meeting and upon amendment to
our by-laws. The variable portion of our capital stock may be increased or
decreased by a resolution adopted at a general ordinary shareholders’ meeting
and without amending our by-laws. Increases or decreases in the fixed or
variable portion of the capital stock must be recorded in our registry of
capital variations and in our share registry. New shares cannot be issued unless
the then-issued and outstanding shares have been paid in full.
Voting
Rights and Shareholders’ Meetings
Each
series B share entitles its holder to one vote at any meeting of our
shareholders. Each series L share would entitle its holder to one vote at any
meeting at which holders of series L shares are entitled to vote. Holders of
series L shares would be entitled to vote only on the following
matters:
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our
transformation from one type of company to
another;
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extension
of our corporate existence;
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to
elect one member of our board of directors and the corresponding
alternate
director pursuant to the provisions of our by-laws and the Securities
Market Law;
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any
merger or corporate spin-off in which we are not the surviving
entity;
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our
dissolution or liquidation;
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cancellation
of the registration of our shares with the National Registry of
Securities; and
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any
action that would prejudice the rights of holders of series L shares
and
not prejudice the other classes of shares similarly. A resolution
on any
such action requires the affirmative vote of a majority of all outstanding
series L shares.
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Shareholders
may vote by proxy duly appointed in writing. Under Mexican law, holders of
shares of any series are also entitled to vote as a class on any action that
would prejudice the rights of holders of shares of such series but not rights
of
holders of shares of other series, and a holder of shares of such series would
be entitled to judicial relief against any such action taken without such a
vote. Our board of directors or other party calling for shareholder action
initially would determine whether an action requires a class vote on these
grounds. A negative determination would be subject to judicial challenge by
an
affected shareholder, and a court ultimately would determine the necessity
for a
class vote. There are no other procedures for determining whether a proposed
shareholder action requires a class vote, and Mexican law does not provide
extensive guidance on the criteria to be applied in making such a
determination.
Under
Mexican law and our by-laws, we may hold three types of shareholders’ meetings:
ordinary, extraordinary and special. Ordinary shareholders’ meetings are those
called to discuss any issue not reserved for extraordinary shareholders’
meeting. An annual ordinary shareholders’ meeting must be convened and held
within the first four months following the end of each fiscal year to discuss,
among other things, the board of director’s report on our financial statements,
the appointment of members of the board of directors, declaration of dividends
and the determination of compensation for members of the board of directors.
Under the Mexican Securities Market Law, our ordinary shareholders’ meeting, in
addition to those matters described above, will have to approve any transaction
representing 20% or more of our consolidated assets, executed in a single or
a
series of transactions, during any fiscal year.
Extraordinary
shareholders’ meetings are those called to consider any of the following
matters:
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extension
of a company’s duration or voluntary
dissolution;
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an
increase or decrease in a company’s minimum fixed
capital;
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change
in corporate purpose or
nationality;
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any
transformation, merger or spin-off involving the
company;
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·
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any
stock redemption or issuance of preferred stock or
bonds;
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the
cancellation of the listing of our shares with the National Securities
Registry or on any stock exchange;
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any
other amendment to our by-laws; and
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any
other matters for which applicable Mexican law or our by-laws specifically
require an extraordinary meeting.
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Special
shareholders’ meetings are those that shareholders of the same series or class
call and hold to consider any matter particularly affecting the relevant series
or class of shares.
Shareholders’
meetings are required to be held in our corporate domicile, which is
Guadalajara, Jalisco. Calls for shareholders’ meetings must be made by the
chairman or the secretary of the board of directors or the chairman of our
audit
and corporate practices committee. Any shareholder or group of shareholders
representing at least 10% of our capital stock has the right to request that
the
chairman of the board of directors or the chairman of the audit and corporate
practices committee call a shareholders’ meeting to discuss the matters
indicated in the relevant request. If the chairman of the board of directors
or
the chairman of the audit and corporate practices committee fail to call a
meeting within 15 calendar days following receipt of the request, the
shareholder or group of shareholders representing at least 10% of our capital
stock may request that the call be made by a competent court.
Calls
for
shareholders’ meetings must be published in the official gazette of the state of
Jalisco or any major newspaper located in the City of Guadalajara, Jalisco
at
least 15 calendar days prior to the date of the meeting. Each call must set
forth the place, date and time of the meeting and the matters to be addressed.
Calls must be signed by whomever makes them, provided that calls made by the
board of directors or the audit and corporate practices committee must be signed
by the chairman, the secretary or a special delegate appointed by the board
of
directors or the audit and corporate practices committee as appropriate, for
that purpose. Shareholders’ meetings will be validly held and convened without
the need of a prior call or publication whenever all the shares representing
our
capital are duly represented.
To
be
admitted to any shareholders’ meeting, shareholders must: (i) be registered
in our share registry; and (ii) at least 24 hours prior to the
commencement of the meeting submit (a) an admission ticket issued by us for
that purpose, and (b) a certificate of deposit of the relevant stock
certificates issued by the Secretary or by a securities deposit institution,
a
Mexican or foreign bank or securities dealer in accordance with the Mexican
Securities Market Law. Shareholders may be represented at any shareholders’
meeting by one or more attorneys-in-fact, and these representatives may not
be
one of our directors. Representation at shareholders’ meetings may be
substantiated pursuant to general or special powers of attorney or by a proxy
executed before two witnesses.
At
or
prior to the time of the publication of any call for a shareholders’ meeting, we
will provide copies of the publication to the depositary for distribution to
the
holders of ADSs. Holders of ADSs are entitled to instruct the depositary as
to
the exercise of voting rights pertaining to the Series B shares. See
“Description of American Depository Receipts — Voting Rights”.
Quorums
Ordinary
meetings are regarded as legally convened pursuant to a first call when shares
representing more than 50% of our capital are present or duly represented.
Resolutions at ordinary meetings of shareholders are valid when approved by
a
majority of the shares present at the meeting approves them. Any number of
shares represented at an ordinary meeting of shareholders convened pursuant
to a
second or subsequent call constitutes a quorum. Resolutions at ordinary meetings
of shareholders convened pursuant to a second or subsequent call are valid
when
a majority of the shares present at the meeting approves them.
Extraordinary
shareholders’ meetings are regarded as legally convened pursuant to a first call
when shares representing at least 75% of our capital are present or duly
represented, and extraordinary shareholders’ meetings convened pursuant to a
second or subsequent call are regarded as legally convened when shares
representing 50% of our capital are present or duly represented. Resolutions
at
extraordinary meetings of shareholders are valid when approved by 50% of our
capital. Special meetings of holders of series L shares are governed by the
same
rules applicable to extraordinary general meeting of holders of series B shares.
The quorum for an extraordinary general meeting at which holders of series
L
shares may not vote is 75% of the series B shares, and the quorum for an
extraordinary general meeting at which holders of L shares are entitled to
vote
is 75% of the outstanding capital stock. Whether on first, second or subsequent
call, actions at an extraordinary general meeting generally may be taken by
a
majority vote of the series B shares outstanding and, on matters which holders
of series L shares are entitled to vote, a majority vote of all the outstanding
capital stock.
Our
by-laws also establish that a delisting of our shares requires the vote of
holders of 95% of our capital stock.
Right
of Redemption
Whenever
the shareholders approve a change of corporate purposes, change of nationality
of the corporation or transformation from one form of corporate organization
to
another, the Mexican Corporations Law provides that any shareholder entitled
to
vote on that change that has voted against it may withdraw from its shares.
The
redemption of the shareholders’ shares will be effected at the lower of
(a) 95% of the average trading price determined based on the average of the
prices of our shares on the 30 days on which the shares may have been
quoted prior to the date of the meeting, or (b) the book value of the
shares in accordance with the most recent audited financial statements approved
by our shareholders’ meeting, provided that the shareholder exercises that right
within 15 days following the adjournment of the meeting at which the change
was approved.
Mandatory
Redemption
In
accordance with the Mexican Corporation Law shares representing our capital
stock are subject to redemption in connection with either (i) a reduction of
capital stock or (ii) a redemption with retained earnings, which in either
case
must be approved by our shareholders. In connection with a capital reduction,
the redemption of shares shall be made pro rata among the shareholders, or,
if
affecting the variable portion of the capital stock, as otherwise determined
in
the relevant shareholders’ meeting, but in no case shall the redemption price be
less than the book value of the shares according to our latest balance sheet
approved at a general ordinary shareholders’ meeting. In the case of a
redemption with retained earnings, such redemption shall be conducted (a) by
means of a tender offer conducted on the Mexican Stock Exchange at prevailing
market prices, in accordance with the Mexican Corporations Law, the new Mexican
Securities Market Law and our by-laws or (b) pro rata among the
shareholders.
Registration
and Transfer
Our
shares are registered with the National Securities Registry, as required under
the Mexican Securities Market Law and regulations issued by the National Banking
and Securities Commission. Our shares are evidenced by share certificates in
registered form, and registered dividend coupons may be attached thereto. Our
shareholders either may hold their shares directly, in the form of physical
certificates, or indirectly, in book-entry form, through institutions that
have
accounts with INDEVAL.
INDEVAL
is the holder of record in respect of all such shares held in book-entry form.
INDEVAL will issue certificates on behalf of our shareholders upon request.
INDEVAL participants, brokers, banks, other financial entities or other entities
approved by the National Banking and Securities Commission maintain accounts
at
INDEVAL. We maintain a stock registry and only those persons listed in such
stock registry, and those holding certificates issued by INDEVAL indicating
ownership, and any relevant INDEVAL participants, will be recognized as our
shareholders.
Dividends
and Distributions
At
the
annual general ordinary shareholders’ meeting, the board of directors submits
our financial statements for the previous fiscal year, together with their
report on us, to the series B shareholders for approval. Under our by-laws
and
Mexican law, our annual net income, based upon our audited financial statements
prepared in accordance with Mexican GAAP, is applied as follows: (i) five
percent of our net earnings must be allocated to a legal reserve fund, until
such fund reaches an amount equal to a least 20% of our then current capital
stock (which, as of June 30, 2006, was approximately Ps. 3,513 million),
(ii) thereafter, a certain percentage of net earnings may be allocated to any
general or specific reserve fund, and (iii) the remainder of any net earnings
is
allocated as determined by the majority of our shareholders and may be
distributed as dividends. All shares that are fully paid and outstanding at
the
time a dividend or other distribution is declared are entitled to share equally
in any or other distribution. We will distribute through INDEVAL cash dividends
on shares held through INDEVAL. Any cash dividends on shares evidenced by
physical certificates will be paid by surrendering to us the relevant dividend
coupon registered in the name of its holder. See “Dividends and Dividend
Policy”.
To
the
extent that we declare and pay dividends on our shares, owners of ADSs at the
time a dividend or other distribution is declared will be entitled to receive
any dividends payable in respect of the series B shares underlying their ADSs,
subject to the terms of the Deposit Agreement. Cash dividends will be paid
to
the Depositary in pesos, and, except as otherwise described under “Description
of American Depositary Receipts—Dividends, Other Distribution and Rights”, the
Depositary will convert them into dollars and pay them to the holders of ADSs
net of currency expenses and applicable fees.
A
shareholder’s entitlement to uncollected dividends lapses within five years
following the stated payment date, in favor of us.
For
additional tender offer and insider trading rules applicable to our securities
pursuant to Mexican Law, see “Market Information”.
Changes
in Capital Stock
Increases
and reductions of our share capital must be approved at an ordinary or
extraordinary shareholders’ meeting, subject to the provisions of our by-laws
and the Mexican Corporations Law.
Subject
to the individual ownership limitations set forth in our by-laws, in the event
of an increase of our capital stock, other than (i) in connection with mergers,
(ii) for the conversion of convertible debentures as provided in Section 210
Bis
of the Mexican General Law on Negotiable Instruments and Credit Transactions,
(iii) for purposes of conducting a public offering of such shares or (iv) for
the resale of shares maintained in our treasury as a result of repurchase of
shares conducted on the Mexican Stock Exchange, our shareholders will have
a
preemptive right to subscribe and pay for new stock issued as a result of such
increase in proportion to their shareholder interest at that time. This
preemptive right must be exercised by any method provided in Section 132 of
the
Mexican Corporations Law, by subscription and payment of the relevant stock
within fifteen business days after the date of publication of the corresponding
notice to our shareholders in the in the official gazette of the state of
Jalisco and in one of the newspapers of general circulation in Mexico, provided
that if at the corresponding meeting all of our shares are duly represented,
the
fifteen business day period shall commence on the date of the
meeting.
Preemptive rights cannot be waived in advance and cannot be traded separately
from the corresponding shares that give rise to such right.
Holders
of ADSs may exercise preemptive rights in limited circumstances. See
“Description of American Depositary Receipts—Dividends, Other Distributions and
Rights”. If a holder of series B shares or ADSs were unable or unwilling to
exercise its preemptive rights in connection with such a capital increase,
such
holder’s proportionate share of dividends and other distributions and voting
rights would decline. In addition, depending on the series of shares increased
and the pattern in which preemptive rights were exercised, such a capital
increase might increase or reduce the portion of our capital stock represented
by series B shares and ADSs or increase or reduce the proportionate voting
rights of such holder.
Our
capital stock may be reduced by resolution of a shareholders’ meeting taken
pursuant to the rules applicable to capital increases. Our capital stock also
may be reduced upon withdrawal of a shareholder as provided in Section 206
of
the Mexican Corporations Law, see “—Voting Rights and Shareholders’ Meetings”
above, or by repurchase of our own stock in accordance with the Mexican
Securities Market Law, see “—Share Repurchases” below.
Share
Repurchases
We
may
choose to acquire our own shares through the Mexican Stock Exchange on the
following terms and conditions:
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the
acquisition must be carried out through the Mexican Stock
Exchange;
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the
acquisition must be carried out at market price, unless a public
offer or
auction has been authorized by the National Banking and Securities
Commission;
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the
acquisition must be carried out against our net worth (capital
contable)
without adopting a reduction in capital stock or against our capital
stock, and the shares so acquired will be held as treasury stock
without
any requirement to adopt a reduction in capital stock. No shareholder
consent is required for such
purchases.
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the
amount and price paid in all share repurchases must be made
public;
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the
annual ordinary shareholders meeting must determine the maximum amount
of
resources to be used in the fiscal year for the repurchase of shares;
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we
may not be delinquent on payments due on any outstanding debt issued
by us
that is registered with the National Securities Registry;
and
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any
acquisition of shares must be in conformity with the requirements
of
Article 54 of the Mexican Securities Market Law, and we must maintain
a
sufficient number of outstanding shares to meet the minimum trading
volumes required by the stock markets on which our shares are
listed.
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Ownership
of Capital Stock by Subsidiaries
Our
subsidiaries may not, directly or indirectly, invest in our shares, except
for
shares acquired as part of an employee stock option plan and in conformity
with
the Mexican Securities Market Law.
Delisting
Pursuant
to the Mexican Securities Market Law, in the event that we decide to cancel
the
registration of our shares in the National Securities Registry and the listing
of our shares on the Mexican Stock Exchange, or if the National Banking and
Securities Commission orders such cancellation, we will be required to conduct
a
tender offer for the shares held by minority shareholders and to create a trust
with a term of six months, with amounts sufficient to purchase all shares not
participating in the tender offer. Under the law, our controlling shareholders
will be secondarily liable for these obligations. The price at which the shares
must be purchased in the offer must be the greater of (i) the average of the
trading price on the Mexican Stock Exchange during the last 30 days on which
the
shares were quoted prior to the date on which the tender offer is made or (ii)
the book value of such shares as determined pursuant to our latest quarterly
financial information filed with the National Banking and Securities Commission
and the Mexican Stock Exchange. If the National Banking and Securities
Commission orders the cancellation, we must launch the tender offer within
180
days from the date of their request. If we initiate it, under the Mexican
Securities Market Law, the cancellation must be approved by 95% of our
shareholders.
Other
Provisions
Information
to Shareholders
The
Mexican Corporations Law establishes that companies, acting through their boards
of directors, must annually present a report at a shareholder’s meeting that
includes:
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a
report of the directors on the operations of the company during the
preceding year, as well as on the policies followed by the directors
and
on the principal existing projects,
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a
report explaining the principal accounting and information policies
and
criteria followed in the preparation of the financial
information,
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a
statement of the financial condition of the company at the end of
the
fiscal year,
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a
statement showing the results of operations of the company during
the
preceding year, as well as changes in the company’s financial condition
and capital stock during the preceding
year,
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the
notes which are required to complete or clarify the above mentioned
information, and
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In
addition to the foregoing, our by-laws provide that our board of directors
also
should prepare the information referred to above with respect to any subsidiary
that represents at least 20% of our net worth (based on the financial statements
most recently available).
Shareholders’
Conflict of Interest
Under
Mexican law, any shareholder that has a conflict of interest with respect to
any
transaction must abstain from voting thereon at the relevant shareholders’
meeting. A shareholder that votes on a transaction in which its interest
conflicts with ours may be liable for damages in the event the relevant
transaction would not have been approved without such shareholder’s
vote.
Liquidation
In
the
event we are liquidated, the surplus assets remaining after payment of all
our
creditors will be divided among our shareholders in proportion to their
respective share holdings. Shares that are only partially paid will participate
in the distribution in the proportion that they were paid. The general
extraordinary shareholders’ meeting at which the liquidation resolution is made,
will appoint one or more liquidators.
Foreign Investment
Ownership
by foreign investors of shares of Mexican enterprises in certain economic
sectors is regulated by the Foreign Investment Law and the regulations
thereunder. The Ministry of the Economy and the National Commission on Foreign
Investment are responsible for the administration of the Foreign Investment
Law
and Regulations.
Pursuant
to the Mexican Foreign Investment Law and Regulations, foreign investors may
acquire up to 100% of the capital stock of Mexican companies or entities in
the
steel industry. In accordance with our by-laws, Mexican and non-Mexican
nationals may own all series of our share capital. We have registered any
foreign owner of our shares, and the depositary with respect to the ADSs
representing our shares, with the National Registry of Foreign
Investment
(Registro Nacional de Inversión Extranjera).
Other
Provisions
Forfeiture
of Shares.
As
required by Mexican law, our by-laws provide that “any alien who at the time of
incorporation or at any time thereafter acquires an interest or participation
in
the capital of the corporation shall be considered, by virtue thereof, as
Mexican in respect thereof and shall be deemed to have agreed not to invoke
the
protection of his own government, under penalty, in case of breach of such
agreement, of forfeiture of such interest or participation in favor of the
Mexican nation”. Under this provision, a non-Mexican shareholder is deemed to
have agreed not to invoke the protection of his own government by asking such
government to interpose a diplomatic claim against the Mexican government with
respect to the shareholder’s rights as a shareholder but is not deemed to have
waived any other rights it may have, including any rights under the U.S.
securities laws, with respect to its investment in us. If the shareholder
invokes such governmental protection in violation of this agreement, its shares
could be forfeited to the Mexican government. Mexican law requires that such
a
provision be included in the by-laws of all Mexican corporations unless such
by-laws prohibit ownership of shares by non-Mexican persons or
entities.
Duration.
Our
existence under our by-laws is indefinite.
Certain
Differences between Mexican and U.S. Corporate Law
You
should be aware that the Mexican Corporations Law and the Mexican Securities
Market Law, which apply to us, differ in certain material respects from laws
generally applicable to U.S. corporations and their shareholders.
Independent
Directors
The
Mexican Securities Market Law requires that 25% of the directors of Mexican
public companies must be independent. Pursuant to the rules and regulations
of
the American Stock Exchange, 50% of the directors of listed companies must
be
independent, and foreign companies subject to reporting requirements under
the
U.S. federal securities laws and listed on the American Stock Exchange must
maintain an audit committee comprised entirely of independent directors as
defined in the U.S. federal securities laws.
Mergers,
Consolidations, and Similar Arrangements
A
Mexican
company may merge with another company only if a majority of the shares
representing its outstanding capital stock approve the merger at a duly convened
general extraordinary shareholders’ meeting, unless the company’s by-laws impose
a higher threshold. Dissenting shareholders are not entitled to appraisal
rights. Creditors have ninety days to oppose a merger judicially, provided
they
have a legal interest to oppose the merger.
Under
Delaware law, with certain exceptions, a merger, consolidation, or sale of
all
or substantially all the assets of a corporation must be approved by the board
of directors and a majority of the outstanding shares entitled to vote thereon.
Under Delaware law, a shareholder of a corporation participating in certain
major corporate transactions, under certain circumstances, may be entitled
to
appraisal rights pursuant to which the shareholder may receive payment in the
amount of the fair market value of the shares held by the shareholder (as
determined by a court) in lieu of the consideration the shareholder would
otherwise receive in the transaction. Delaware law also provides that a parent
corporation, by resolution of its board of directors and without any shareholder
vote, may merge with any subsidiary of which it owns at least 90% of each class
of share capital. Upon any such merger, dissenting shareholders of the
subsidiary would have appraisal rights.
Anti-Takeover
Provisions
Subject
to the approval of the National Banking and Securities Commission, the Mexican
Securities Market Law permits public companies to include anti-takeover
provisions in their by-laws that restrict the ability of third parties to
acquire control of the company without obtaining approval of the company’s board
of directors. See “Market Information¾Market
Regulation¾Anti-Takeover
Protections”.
Under
Delaware law, corporations can implement shareholder rights plans and other
measures, including staggered terms for directors and super-majority voting
requirements, to prevent takeover attempts. Delaware law also prohibits a
publicly-held Delaware corporation from engaging in a business combination
with
an interested shareholder for a period of three years after the date of the
transaction in which the shareholder became an interested shareholder
unless:
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prior
to the date of the transaction in which the shareholder became an
interested shareholder, the board of directors of the corporation
approves
either the business combination or the transaction that resulted
in the
shareholder becoming an interested
shareholder;
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·
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upon
consummation of the transaction that resulted in the shareholder
becoming
an interested shareholder, the interested shareholder owns at least
85% of
the voting stock of the corporation, excluding shares held by directors,
officers, and employee stock plans;
or
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at
or after the date of the transaction in which the shareholder became
an
interested shareholder, the business combination is approved by the
board
of directors and authorized at a shareholders’ meeting by at least 66
2/3%
of the voting stock which is not owned by the interested
shareholder.
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Shareholders’
Suits
Pursuant
to the Mexican Securities Market Law (Ley
de Mercado de Valores),
only a
shareholder or group of shareholders holding at least 5% of our outstanding
shares may bring a claim against some or all of our directors, secretary of
the
board of directors or relevant executives for violation of their duty of care
or
duty of loyalty. In addition, such shareholder or group of shareholders must
include in its claim the amount of damages or losses caused to the company
and
not only the damages or losses caused to the shareholder or group of
shareholders bringing the claim, provided that any amount recovered as
indemnification arising from the liability action will be for the benefit of
the
company, and not for the benefit of the shareholder or group of shareholders.
The shareholder or group or shareholders must demonstrate the direct and
immediate link between the damage or loss caused to the company, and the acts
alleged to have caused it. There is no requirement for the shareholder or group
of shareholders to hold the shares for a certain period of time in order to
bring a claim.
If
the
court determines that the shareholder or group of shareholders that initiated
the claim acted in bad faith, such shareholder or group of shareholders will
be
liable to pay the legal fees and legal proceeding expenses.
The
statute of limitations for these actions is five years from the date on which
the act or event that caused the damage or loss occurred. These actions must
be
brought in the federal or local courts in Guadalajara, Jalisco (Mexico) and
the
court must personally notify the parties that have been sued, and must comply
with all other legal formalities in order to satisfy the due process
requirements of the Mexican Constitution.
Process
must be served on the defendant personally, or, in the defendant’s absence,
process can be served by a judicial officer on the defendant’s domicile whether
or not the defendant is present. A method of service that does not comply with
these requirements could be considered void. Class action lawsuits are not
permitted under Mexican law.
Shareholder
Proposals
Under
Mexican law and our by-laws, holders of at least 10% of our outstanding capital
stock are entitled to appoint one member of our board of directors and an
alternate.
Delaware
law does not include a provision restricting the manner in which nominations
for
directors may be made by shareholders or the manner in which business may be
brought before a meeting.
Calling
of Special Shareholders’ Meetings
Under
Mexican law and our by-laws, the board of directors, the chairman of the board
of directors or the chairman of the audit and corporate practices committee
may
call a shareholders’ meeting. Any shareholder or group of shareholders with
voting rights representing at least 10% of our capital stock may request that
the chairman of the board of directors or the audit and corporate practices
committee call a shareholders’ meeting to discuss the matters indicated in the
written request. If the chairman of the board of directors or the chairman
of
the audit and corporate practices committee fails to call a meeting within
15
calendar days following date of the written request, the shareholder or group
of
shareholders may request that a competent court call the meeting. A single
shareholder may call a shareholders’ meeting if no meeting has been held for two
consecutive years or if matters to be dealt with at an ordinary shareholders’
meeting have not been considered.
Delaware
law permits the board of directors or any person who is authorized under a
corporation’s certificate of incorporation or by-laws to call a special meeting
of shareholders.
Cumulative
Voting
Under
Mexican law, cumulative voting for the election of directors is not
permitted.
Under
Delaware law, cumulative voting for the election of directors is permitted
if
expressly authorized in the certificate of incorporation.
Staggered
Board of Directors
Mexican
law does not permit companies to have a staggered board of directors, while
Delaware law does permit corporations to have a staggered board of
directors.
Approval
of Corporate Matters by Written Consent
Mexican
law permits shareholders to take action by unanimous written consent of the
holders of all shares entitled to vote. These resolutions have the same legal
effect as those adopted in a general or special shareholders’ meeting. The board
of directors may also approve matters by unanimous written consent.
Delaware
law permits shareholders to take action by written consent of holders of
outstanding shares having more than the minimum number of votes necessary to
take the action at a shareholders’ meeting at which all voting shares were
present and voted.
Amendment
of Certificate of Incorporation
Under
Mexican law, it is not possible to amend a company’s certificate of
incorporation (acta
constitutiva).
However, the provisions that govern a Mexican company are contained in its
by-laws, which may be amended as described below. Under Delaware law, a
company’s certificate of incorporation generally may be amended by a vote of
holders of a majority of the outstanding stock entitled to vote thereon (unless
otherwise provided in the certificate of incorporation), subsequent to a
resolution of the board of directors proposing such amendment.
Amendment
of By-laws
Under
Mexican law, amending a company’s by-laws requires shareholder approval at an
extraordinary shareholders’ meeting. Mexican law requires that at least 75% of
the shares representing a company’s outstanding capital stock be present at the
meeting in the first call (unless the by-laws require a higher threshold) and
that the resolutions be approved by a majority of the shares representing a
company’s outstanding capital stock.
Under
Delaware law, holders of a majority of the outstanding stock entitled to vote
and, if so provided in the certificate of incorporation, the directors of the
corporation, have the power to adopt, amend, and repeal the by-laws of a
corporation.
DESCRIPTION
OF AMERICAN DEPOSITARY RECEIPTS
American
Depositary Receipts
The
Bank
of New York, as depositary, will execute and deliver the ADRs. ADRs are American
Depositary Receipts. Each ADR is a certificate evidencing a specific number
of
American Depositary Shares, also referred to as ADSs. Each ADS will represent
three series B shares (or a right to receive three series B shares) deposited
with the principal Mexico office of BBVA
Bancomer, S.A. de C.V.,
as
custodian for the depositary. Each ADS will also represent any other securities,
cash or other property which may be held by the depositary. The depositary’s
corporate trust office at which the ADRs will be administered is located at
101
Barclay Street, New York, New York 10286. The Bank of New York’s principal
executive office is located at One Wall Street, New York, New York
10286.
You
may
hold ADSs either directly (by having an ADR registered in your name) or
indirectly through your broker or other financial institution. If you hold
ADSs
directly, you are an ADR holder. This description assumes you hold your ADSs
directly. If you hold the ADSs indirectly, you must rely on the procedures
of
your broker or other financial institution to assert the rights of ADR holders
described in this section. You should consult with your broker or financial
institution to find out what those procedures are.
As
an ADR
holder, we will not treat you as one of our shareholders and you will not have
shareholder rights. Mexican law governs shareholder rights. The depositary
will
be the holder of the series B shares underlying your ADSs. As a holder of ADRs,
you will have ADR holder rights. A deposit agreement among us, the depositary
and you, as an ADR holder, and the beneficial owners of ADRs set out ADR holder
rights as well as the rights and obligations of the depositary. New York law
governs the deposit agreement and the ADRs.
The
following is a summary of the material provisions of the deposit agreement.
For
more complete information, you should read the entire deposit agreement and
the
form of ADR. Directions on how to obtain copies of those documents are provided
on page 130.
Dividends
and Other Distributions
How
will you receive dividends and other distributions on the series B
shares?
The
depositary has agreed to pay to you the cash dividends or other distributions
it
or the custodian receives on series B shares or other deposited securities,
after deducting its fees and expenses. You will receive these distributions
in
proportion to the number of series B shares your ADSs represent.
•
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Cash.
The depositary will convert any cash dividend or other cash distribution
we pay on the series B shares into U.S. dollars, if it can do so
on a
reasonable basis and can transfer the U.S. dollars to the United
States.
If that is not possible or if any government approval is needed and
can
not be obtained, the deposit agreement allows the depositary to distribute
the foreign currency only to those ADR holders to whom it is possible
to
do so. It will hold the foreign currency it cannot convert for the
account
of the ADR holders who have not been paid. It will not invest the
foreign
currency and it will not be liable for any interest.
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Before
making a distribution, any withholding taxes that must be paid will be deducted.
See “Taxation”. It will distribute only whole U.S. dollars and any balance not
distributable will be held by the depositary (without liability for interest
thereon) and will be added to and become part of the next sum received by the
depositary for distribution to ADR holders then outstanding. If
the exchange rates fluctuate during a time when the depositary cannot convert
the foreign currency, you may lose some or all of the value of the
distribution.
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Series
B shares.
The depositary may, with our approval and will if we request, distribute
additional ADSs representing any series B shares we distribute as
a
dividend or free distribution. The depositary will only distribute
whole
ADSs. It will sell series B shares which would require it to deliver
a
fractional ADS and distribute the net proceeds in the same way as
it does
with cash. If the depositary does not distribute additional ADRs,
the
outstanding ADSs will also represent the new series B
shares.
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•
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Rights
to purchase additional series B shares.
If
we offer holders of our securities any rights to subscribe for additional
series B shares or any other rights, the depositary may make these
rights
available to you. If the depositary decides it is not legal and practical
to make the rights available but that it is practical to sell the
rights,
the depositary may sell the rights and distribute the proceeds in
the same
way as it does with cash. The depositary will allow rights that are
not
distributed or sold to lapse. In
that case, you will receive no value for them.
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If
the
depositary makes rights available to you, it will exercise the rights and
purchase the series B shares on your behalf. The depositary will then deposit
the series B shares and deliver ADSs to you. It will only exercise rights if
you
pay it the exercise price and any other charges the rights require you to pay.
U.S.
securities laws may restrict transfers and cancellation of the ADSs represented
by series B shares purchased upon exercise of rights. For example, you may
not
be able to trade these ADSs freely in the United States. In this case, the
depositary may deliver restricted depositary series B shares that have the
same
terms as the ADRs described in this section except for changes needed to put
the
necessary restrictions in place.
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Other
Distributions.
The depositary will send to you anything else we distribute on deposited
securities by any means it thinks is legal, fair and practical. If
it
cannot make the distribution in that way, the depositary has a choice.
It
may decide to sell what we distributed and distribute the net proceeds,
in
the same way as it does with cash. Or, it may decide to hold what
we
distributed, in which case ADSs will also represent the newly distributed
property. However, the depositary is not required to distribute any
securities (other than ADSs) to you unless it receives satisfactory
evidence from us that it is legal to make that distribution.
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The
depositary is not responsible if it decides that it is unlawful or impractical
to make a distribution available to any ADR holders. We have no obligation
to
register ADSs, series B shares, rights or other securities under the Securities
Act. We also have no obligation to take any other action to permit the
distribution of ADRs, series B shares, rights or anything else to ADR holders.
This
means that you may not receive the distributions we make on our series B shares
or any value for them if it is illegal or impractical for us to make them
available to you.
Deposit
and Withdrawal
How
are ADSs issued?
The
depositary will deliver ADSs if you or your broker deposit series B shares
or
evidence of rights to receive series B shares with the custodian. Upon payment
of its fees and expenses and of any taxes or charges, such as stamp taxes or
stock transfer taxes or fees, the depositary will register the appropriate
number of ADSs in the names you request and will deliver the ADRs at its
corporate trust office to the persons you request.
How
do ADS holders cancel an ADR and obtain series B shares?
You
may
surrender your ADRs at the depositary’s corporate trust office. Upon payment of
its fees and expenses and of any taxes or charges, such as stamp taxes or stock
transfer taxes or fees, the depositary will deliver the series B shares and
any
other deposited securities underlying the ADR to you or a person you designate
at the office of the custodian. Or, at your request, risk and expense, the
depositary will deliver the deposited securities at its corporate trust office,
if feasible.
Voting
Rights
How
do you vote?
You
may
instruct the depositary to vote the number of series B shares your ADSs
represent. Upon receipt of notice of any meeting or solicitation of consents
or
proxies, the depositary will notify you of shareholders’ meetings and arrange to
deliver our voting materials to you. Those materials will describe the matters
to be voted on and explain how you may instruct the depositary how to vote
the
series B shares or other deposited securities underlying your ADSs as you
direct. For instructions to be valid, they must reach the depositary by a date
set by the depositary. The depositary will try, as far as practical, subject
to
Mexican law and the provisions of the our Estatutos Sociales, to vote or to
have
its agents vote the series B shares or other deposited securities as you
instruct. If the depositary does not receive voting instructions from you by
the
specified date, the depositary shall vote or cause to be voted the deposited
securities in the same manner as directed by the majority of instructions which
the Depositary has received for that meeting, or if no such instructions have
been received or if there is no majority, the depositary shall vote or cause
to
be voted the deposited securities in the same manner as informed by us that
the
majority of deposited securities is voted as such meeting.
We
can
not assure you that you will receive the voting materials or otherwise learn
of
an upcoming shareholders’ meeting in time to ensure that you can instruct the
depositary to vote your series B shares. In addition, the depositary and its
agents are not responsible for failing to carry out voting instructions or
for
the manner of carrying out voting instructions. This
means that you may not be able to exercise your right to vote and there may
be
nothing you can do if your series B shares are not voted as you
requested.
Fees
and Expenses
Persons
depositing series B shares or ADR holders must
pay:
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For:
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·
$5.00
(or less) per 100 ADSs (or portion of 100 ADSs)
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·
Issuance
of ADSs, including issuances resulting from a distribution of series
B
shares or rights or other property
·
Cancellation
of ADSs for the purpose of withdrawal, including if the deposit agreement
terminates
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|
·
$.02
(or less) per ADS
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·
Any
cash distribution to you
|
·
Registration
or transfer fees
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|
·
Transfer
and registration of series B shares on our series B share register
to or
from the name of the depositary or its agent when you deposit or
withdraw
series B shares
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·
Expenses
of the depositary
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·
Cable,
telex and facsimile transmissions (when expressly provided in the
deposit
agreement)
·
converting
foreign currency to U.S. dollars
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·
Taxes
and other governmental charges the depositary or the custodian have
to pay
on any ADR or series B share underlying an ADR, for example, stock
transfer taxes, stamp duty or withholding taxes
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·
As
necessary
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The
depositary has agreed to reimburse us for expenses that we incur that are
related to establishment and maintenance of the ADR program, including investor
relations expenses and AMEX application and listing fees. There are limits
on the amount of expenses for which the depositary will reimburse us, but the
amount of reimbursement available to us is not related to the amounts of fees
the depositary collects from investors.
The
depositary collects its fees for issuance and cancellation of ADSs directly
from
investors depositing shares or surrendering ADSs for the purpose of withdrawal
or from intermediaries acting for them. The depositary collects fees for
making distributions to investors by deducting those fees from the amounts
distributed or by selling a portion of distributable property to pay the
fees. The depositary generally may refuse to provide fee-attracting
services until its fees for those services are paid.
Payment
of Taxes
You
will
be responsible for any taxes or other governmental charges payable on your
ADRs
or on the deposited securities underlying your ADRs. The depositary may, and
upon receipt of instructions from us will, refuse to transfer your ADRs or
allow
you to withdraw the deposited securities underlying your ADRs until such taxes
or other charges are paid. It may apply payments owed to you or sell deposited
securities underlying your ADRs, by public or private sale, to pay any taxes
owed and you will remain liable for any deficiency. If the depositary sells
deposited securities, it will, if appropriate, reduce the number of ADSs to
reflect the sale and pay to you any proceeds, or send to you any property,
remaining after it has paid the taxes.
Reclassifications,
Recapitalizations and Mergers
If
we:
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Then:
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·
Change
the par value of our series B shares
·
Reclassify,
split up or consolidate any of the deposited securities
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|
The
series B shares or other securities received by the depositary will
become
deposited securities. Each ADS will automatically represent its equal
series B share of the new deposited securities.
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·
Distribute
securities on the series B shares that are not distributed to
you
·
Recapitalize,
reorganize, merge, liquidate, sell all or substantially all of our
assets,
or take any similar action
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The
depositary may, with our approval or at our request, deliver new
ADRs or
ask you to surrender your outstanding ADRs in exchange for new ADRs
identifying the new deposited
securities.
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Amendment
and Termination
How
may the deposit agreement be amended?
We
may
agree with the depositary to amend the deposit agreement and the ADRs without
your consent for any reason. If an amendment adds or increases fees or charges,
(except for taxes and other governmental) or prejudices a substantial right
of
ADR holders, it will not become effective for outstanding ADRs until three
months after the depositary notifies ADR holders of the amendment. At
the time an amendment becomes effective, you are considered, by continuing
to
hold your ADR, to agree to the amendment and to be bound by the ADRs and the
deposit agreement as amended.
How
may the deposit agreement be terminated?
The
depositary will terminate the deposit agreement at our direction by mailing
notice of termination to the ADS holders then outstanding at least 30 days
prior
to the date fixed in such notice for such termination. The depositary may also
terminate the deposit agreement by mailing notice of termination to us and
the
ADS holders then outstanding if 90 days have passed since the depositary told
us
it wants to resign but a successor depositary has not been appointed and
accepted its appointment.
After
termination, the depositary and its agents will do the following under the
deposit agreement but nothing else: collect distributions on the deposited
securities, sell rights and other property, and deliver series B shares and
other deposited securities upon cancellation of ADRs. One year after
termination, the depositary may sell any remaining deposited securities by
public or private sale. After that, the depositary will hold the money it
received on the sale, as well as any other cash it is holding under the deposit
agreement for the pro rata
benefit
of the ADR holders that have not surrendered their ADRs. It will not invest
the
money and has no liability for interest. The depositary’s only obligations will
be to account for the money and other cash. After termination our only
obligations will be to indemnify the depositary and to pay fees and expenses
of
the depositary that we agreed to pay.
Limitations
on Obligations and Liability
Limits
on our Obligations and the Obligations of the Depositary; Limits on Liability
to
Holders of ADRs
The
deposit agreement expressly limits our obligations and the obligations of the
depositary. It also limits our liability and the liability of the depositary.
We
and the depositary:
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|
agree
to use our best judgment, good faith and diligence in the performance
of
our obligations specifically set forth in the deposit
agreement;
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·
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are
not liable if either of us is prevented or delayed by law or circumstances
beyond our control from performing our obligations under the deposit
agreement;
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·
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are
not liable if either of us exercises discretion permitted under the
deposit agreement;
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·
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have
no obligation to become involved in a lawsuit or other proceeding
related
to the ADRs or the deposit agreement on your behalf or on behalf
of any
other person;
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·
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are
not liable for any action or non-action by it in reliance upon the
advice
of or information from legal counsel, accountants, any person presenting
shares for deposit, any ADR holder or beneficial owner or any other
person
believed by it in good faith to be competent to give such advice
or
information.
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In
the
deposit agreement, we and the depositary agree to indemnify each other under
certain circumstances.
Requirements
for Depositary Actions
Before
the depositary will deliver or register a transfer of an ADR, make a
distribution on an ADR, or permit withdrawal of series B shares or other
property, the depositary may require:
·
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payment
of stock transfer or other taxes or other governmental charges and
transfer or registration fees charged by third parties for the transfer
of
any series B shares or other deposited securities;
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·
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satisfactory
proof of the identity and genuineness of any signature or other
information it deems necessary; and
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·
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compliance
with reasonable regulations it may establish, from time to time,
consistent with the deposit agreement, including presentation of
transfer
documents.
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The
depositary may refuse to deliver ADRs or register transfers of ADRs generally
when the transfer books of the depositary or our transfer books are closed
or at
any time if the depositary or we think it advisable to do so.
Your
Right to Receive the Series B shares Underlying your ADRs
You
have
the right to cancel your ADRs and withdraw the underlying series B shares at
any
time except:
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|
When
temporary delays caused by closing our or the depositary’s transfer books
or the deposit of shares in connection with voting at a shareholders’
meeting, or the payment of dividends.
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·
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When
you owe money to pay fees, taxes and similar charges.
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·
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When
it is necessary to prohibit withdrawals in order to comply with any
laws
or governmental regulations that apply to ADRs or to the withdrawal
of
series B shares or other deposited securities.
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This
right of withdrawal may not be limited by any other provision of the deposit
agreement.
Pre-release
of ADRs
The
deposit agreement permits the depositary to deliver ADRs before deposit of
the
underlying series B shares. This is called a pre-release of the ADR. The
depositary may also deliver series B shares upon cancellation of pre-released
ADRs (even if the ADRs are canceled before the pre-release transaction has
been
closed out). A pre-release is closed out as soon as the underlying series B
shares are delivered to the depositary. The depositary may receive ADRs instead
of series B shares to close out a pre-release. The depositary may pre-release
ADRs only under the following conditions: (1) before or at the time of the
pre-release, the person to whom the pre-release is being
made
represents to the depositary in writing that it or its customer owns the series
B shares or ADRs to be deposited; (2) the pre-release is fully collateralized
with cash or other collateral that the depositary considers appropriate; and
(3)
the depositary must be able to close out the pre-release on not more than five
business days' notice. In addition, the depositary will limit the number of
ADSs
that may be outstanding at any time as a result of pre-release, although the
depositary may disregard the limit from time to time, if it thinks it is
appropriate to do so.
The
following summary contains a description of the material anticipated U.S. and
Mexican federal income tax consequences of the purchase, ownership and
disposition of the series B shares or ADSs by a holder that is a citizen or
resident of the United States or a U.S. domestic corporation or that otherwise
will be subject to U.S. federal income tax on a net income basis in respect
of
the series B shares or ADSs and that is a “non-Mexican holder” (as defined
below) (a “U.S. holder”), but it does not purport to be a comprehensive
description of all of the tax considerations that may be relevant to a decision
to purchase the series B shares or ADSs. In particular, the summary deals only
with U.S. holders that will hold the series B shares or ADSs as capital assets
and use the U.S. dollar as their functional currency and does not address the
tax treatment of a U.S. holder that owns or is treated as owning 10% or more
of
our outstanding voting shares. In addition, the summary does not address any
U.S. or Mexican state or local tax considerations that may be relevant to U.S.
holders that are subject to special tax rules, such as banks, securities
dealers, insurance companies, tax-exempt entities, persons that hold ADSs or
series B shares as a hedge or as part of a straddle, conversion transaction
or
other risk reduction transaction for tax purposes.
The
summary is based upon the federal income tax laws of the United States and
Mexico as in effect on the date of this prospectus, including the provisions
of
the income tax treaty between the United States and Mexico and protocol thereto
(the “Tax Treaty”), all of which are subject to change, possibly with
retroactive effect in the case of U.S. federal income tax law. Prospective
investors in the series B shares or ADSs should consult their own tax advisors
as to the U.S., Mexican or other tax consequences of the purchase, ownership
and
disposition of the series B shares or ADSs, including, in particular, the effect
of any foreign, state or local tax laws and their entitlement to the benefits,
if any, afforded by the Tax Treaty.
For
purposes of this summary, the term “non-Mexican holder” shall mean a holder that
is not a resident of Mexico and that will not hold the series B shares or ADSs
or a beneficial interest therein in connection with the conduct of a trade
or
business through a permanent establishment or fixed base in Mexico.
An
individual is a resident of Mexico for tax purposes, if he established his
home
in Mexico. When the individual in question has a home in another country, the
individual will be deemed a resident in Mexico if his “center of vital
interests” is located in Mexico. This will be deemed to occur if (i) more than
50% of the aggregate income realized by such individual in the calendar year
is
from a Mexican source or (ii) the principal center of his professional
activities is located in Mexico.
A
Mexican
national who files a change of tax residence notice with a country or
jurisdiction that does not have a comprehensive exchange of information
agreement with Mexico and in which his income is subject to a preferred tax
regime pursuant to the provisions of the Mexican Income Tax Law, will be
considered a Mexican resident for tax purposes during the year the notice is
filed and during the following three years. Unless otherwise proven, a Mexican
national is deemed a resident of Mexico for tax purposes.
An
entity
in Mexico is a resident of Mexico if it maintains its principal place of
business or its place of effective management in Mexico. If non-residents of
Mexico are deemed to have a permanent establishment in Mexico for tax purposes,
all income attributable to the permanent establishment will be subject to
Mexican taxes, in accordance with applicable Mexican tax law.
In
general, for U.S. federal income tax purposes, holders of ADSs will be treated
as the beneficial owners of the series B shares represented by those
ADSs.
Taxation
of Dividends
Mexican
Tax Considerations
Under
Mexican Income Tax Law provisions (Ley
del Impuesto Sobre la Renta),
dividends paid to non-Mexican holders with respect to the series B shares
represented by the ADSs are not subject to Mexican withholding tax.
Dividends
paid from distributable earnings that have not been subject to corporate income
tax are subject to a corporate-level dividend tax at a rate of 38.89% for the
year ended December 31, 2007. The corporate-level dividend tax on the
distribution of earnings is not final and may be credited against income tax
payable during the fiscal year in which the dividend tax was paid and for the
following two years. Dividends paid from distributable earnings, after corporate
income tax has been paid with respect to these earnings, are not subject to
this
corporate-level dividend tax. Currently, after corporate tax dividend
distributions are not subject to individual withholding taxes for shareholder
recipients thereof.
Distributions
made by us to our shareholders other than as dividends, including capital
reductions, amortization of shares or otherwise, would be subject to taxation
in
Mexico at the corporate rate of 28% or at the rate mentioned above, as the
case
may be.
U.S.
Federal Income Tax Considerations
The
gross
amount of any distributions paid with respect to the series B shares represented
by the ADSs, to the extent paid out of our current or accumulated earnings
and
profits, as determined for U.S. federal income tax purposes, will be taxable
as
dividends and generally will be includible in the gross income of a U.S. holder
as ordinary income on the date on which the distributions are received by the
depositary and will not be eligible for the dividends received deduction allowed
to certain corporations under the U.S. Internal Revenue Code of 1986, as
amended. Subject to certain exceptions for short-term and hedged positions,
the
U.S. dollar amount of dividends received by an individual prior to January
1,
2011 with respect to the B shares and ADSs will be subject to taxation at a
maximum rate of 15% if the dividends are “qualified dividends”. Dividends paid
on the B shares and ADSs will be treated as qualified dividends if (i) the
issuer is eligible for the benefits of a comprehensive income tax treaty with
the United States that the IRS has approved for the purposes of the qualified
dividend rules and (ii) we were not, in the year prior to the year in which
the
dividend was paid, and our not, in the year in which the dividend is paid,
a
passive foreign investment company (“PFIC”). The income tax treaty between
Mexico and the United States has been approved for the purposes of the qualified
dividend rules. Based on our audited financial statements and relevant market
and shareholder data, we believe that we were not treated as a PFIC for U.S.
federal income tax purposes with respect to our 2005 taxable year. In addition,
based on our unaudited financial statements for our first three fiscal quarters
of 2006 and our current expectations regarding the value and nature of our
assets, the sources and nature of our income and relevant market and shareholder
data, we do not anticipate having become a PFIC for our 2006 taxable
year.
To
the
extent that a distribution exceeds our current and accumulated earnings and
profits, it generally will be treated as a non-taxable return of basis to the
extent thereof, and thereafter as capital gain from the sale of series B shares
or ADSs. Distributions, which will be made in pesos, will be includible in
the
income of a U.S. holder in a U.S. dollar amount calculated by reference to
the
exchange rate in effect on the date they are received by the depositary whether
or not they are converted into U.S. dollars. U.S. holders should consult their
own tax advisors regarding the treatment of foreign currency gain or loss,
if
any, on any pesos received that are converted into U.S. dollars on a date
subsequent to receipt. Dividend income generally will constitute foreign source
“passive income” or, in the case of certain U.S. holders, “financial services
income” for U.S. foreign tax credit purposes.
Distributions
of additional series B shares to holders of ADSs with respect to their ADSs
that
are made as part of a pro rata distribution to all our stockholders generally
will not be subject to U.S. federal income tax.
Taxation
of Dispositions of Shares or ADSs
Mexican
Tax Considerations
Gain
on
the sale or other disposition of ADSs by a U.S. holder will generally not be
subject to Mexican tax. Deposits and withdrawals of series B shares in exchange
for ADSs will not give rise to Mexican tax or transfer duties.
Gain
on
the sale of series B shares by a U.S. holder will not be subject to any Mexican
tax if the transaction is carried out through the Mexican Stock Exchange or
other stock exchange or securities markets approved by the Mexican Ministry
of
Finance and Public Credit. Gain on sales or other dispositions of series B
shares made in other circumstances generally would be subject to Mexican tax
at
a rate of 25% based on the total amount of the transaction or, subject to
certain requirements applicable to the seller, at a rate of 28% for the year
ended December 31, 2007 of gains realized from the disposition.
Under
the
Tax Treaty, a U.S. holder that is eligible to claim the benefits of the Tax
Treaty will be exempt from Mexican tax on gains realized on a sale or other
disposition of series B shares, in a transaction that is not carried out through
the Mexican Stock Exchange or such other approved securities markets, so long
as
the holder did not own, directly or indirectly, 25% or more of our share capital
(including ADSs) during the twelve-month period preceding the sale or other
disposition, and the value of those shares does not derive mainly from immovable
property located in Mexico. Specific formalities apply to claim such as treaty
benefits.
U.S.
Federal Income Tax Considerations
Upon
the
sale or other disposition of the series B shares or ADSs, a U.S. holder
generally will recognize capital gain or loss in an amount equal to the
difference between the amount realized on the sale or other disposition and
such
U.S. holder’s tax basis in the series B shares or ADSs. Gain or loss recognized
by a U.S. holder on such sale or other disposition generally will be long-term
capital gain or loss if, at the time of the sale or other disposition, the
series B shares or ADSs have been held for more than one year. Long-term capital
gain recognized by a U.S. holder that is an individual generally is subject
to a
maximum federal income tax rate of 15%. The deduction of a capital loss is
subject to limitations for U.S. federal income tax purposes. Deposits and
withdrawals of series B shares by U.S. holders in exchange for ADSs will not
result in the realization of gain or loss for U.S. federal income tax
purposes.
A
U.S.
holder that receives pesos upon sale or other disposition of the series B shares
will realize an amount equal to the U.S. dollar value of the pesos upon the
date
of sale (or in the case of cash basis and electing accrual basis taxpayers,
the
settlement date). A U.S. holder will have a tax basis in the pesos received
equal to the U.S. dollar value of the pesos received translated at the same
rate
the U.S. holder used to determine the amount realized on its disposal of the
series B shares. Any gain or loss realized by a U.S. holder on a subsequent
conversion of the pesos generally will be a U.S. source ordinary income or
loss.
Other
Mexican Taxes
There
are
no Mexican inheritance, gift, succession or value added taxes applicable to
the
ownership, transfer or disposition of the series B shares or ADSs by non-Mexican
holders; provided, however, that gratuitous transfers of the series B shares
or
ADSs may in certain circumstances cause a Mexican federal tax to be imposed
upon
the recipient. There are no Mexican stamp, issue, registration or similar taxes
or duties payable by non-Mexican holders of the series B shares or
ADSs.
U.S.
Backup Withholding Tax and Information Reporting Requirements
In
general, information reporting requirements will apply to certain payments
by a
paying agent to a U.S. holder of dividends in respect of the series B shares
or
ADSs or the proceeds received on the sale or other disposition of the series
B
shares or ADSs, and a backup withholding tax may apply to such amounts if the
U.S. holder fails to provide an accurate taxpayer identification number to
the
paying agent or fails to establish an exemption or otherwise comply with these
provisions. Amounts withheld as backup withholding tax will be creditable
against the U.S. holder’s U.S. federal income tax liability, provided that the
required information is furnished to the U.S. Internal Revenue
Service.
The
combined offering consists of:
|
· |
an
international offering of 10,000,000 ADSs outside of Mexico
and
|
|
· |
an
offering of 22,173,915 series B shares in Mexico.
|
Citigroup
Global Markets Inc. is the global coordinator of the combined offering, the
sole
book-runner of the international offering, and is acting as representative
of
the international underwriters named below. Citigroup Global Markets Inc. is
located at 388 Greenwich Street, New York, NY 10013.
Subject
to the terms and conditions stated in the international underwriting agreement
dated the date of this prospectus, each international underwriter named below
has agreed to purchase, and we have agreed to sell to that international
underwriter, the number of ADSs set forth opposite the international
underwriter’s name.
Underwriter
|
|
Number
of
ADSs
|
|
Citigroup
Global Markets Inc.
|
|
|
8,000,000
|
|
Morgan
Stanley & Co. Incorporated
|
|
|
2,000,000
|
|
Total
|
|
|
10,000,000
|
|
The
international underwriting agreement provides that the obligations of the
international underwriters to purchase the series B shares included in this
offering are subject to the approval of legal matters by counsel and to other
conditions. The international underwriters are obligated to purchase all the
series B shares (other than those covered by the over-allotment option described
below) if they purchase any of the series B shares.
We
also
have entered into a Mexican underwriting agreement with a syndicate of Mexican
underwriters providing for the concurrent offer and sale of series B shares
in
Mexico. The offering price and the total underwriting discounts and commissions
per series B share for the international offering and the Mexican offering
will
be substantially equivalent. In addition, the international and Mexican
offerings are each conditioned on the closing of the other.
The
international underwriters propose to offer some of the series B shares directly
to the public at the public offering price set forth on the cover page of this
prospectus and some of the series B shares to dealers at the public offering
price less a concession not to exceed $ 0.1875 per ADS. If all of the series
B
shares are not sold at the initial offering price, the representative may change
the public offering price and the other selling terms.
We
have
granted to the international and Mexican underwriters options, exercisable
for
30 days from the date of this prospectus, to purchase up to an aggregate of
7,826,085 additional series B shares or the equivalent in ADSs at the public
offering price less the underwriting discount. The underwriters may exercise
the
option solely for the purpose of covering over-allotments, if any, in connection
with this offering. To the extent the option is exercised, each underwriter
must
purchase a number of additional series B shares (a portion of which may be
in
the form of ADSs) approximately proportionate to that underwriter’s initial
purchase commitment.
The
Mexican underwriters and the international underwriters have entered into an
agreement in which they agree to restrictions on where and to whom they and
any
dealer purchasing from them may offer series B shares. The Mexican and
international underwriters also have agreed that they may sell ADSs or series
B
shares between their respective underwriting syndicates. The number of ADSs
or
series B shares actually allocated to each offering may differ from the amount
initially offered due to reallocation between the Mexican and international
offerings.
We
and
our officers, directors and principal shareholders have agreed that, for a
period of 180 days from the date of this prospectus, we will not, without the
prior written consent of Citigroup Global Markets Inc., dispose of or hedge
any
of our series B shares or any securities convertible into or exchangeable for
our series B shares. Citigroup Global Markets Inc. in its sole discretion may
release any of the securities subject to these lock-up agreements at any time
without notice. The 180-day restricted period described above is subject to
extension such that, in the event that either (1) during the last 17 days of
the
180-day restricted period, we issue an earnings release or material news, or
a
material event relating to us occurs or (2) prior to the expiration of the
180-day restricted period, we announce that we will release earnings results
during the 16-day period beginning on the last day of the 180-day period, the
‘‘lock-up’’ restrictions described above will continue to apply until the
expiration of the 18-day period beginning on the issuance of the earnings
release or the occurrence of the material news or material event.
Citigroup
Global Markets Inc. has no present intent or arrangement to release any of
the
securities subject to these lock-up agreements. The release of any lock-up
is
considered on a case by case basis. Factors in deciding whether to release
securities may include the length of time before the lock-up expires, the number
of shares involved, the reason for the requested release, market conditions,
the
trading price of our series B shares and ADSs, historical trading volumes of
our
common stock and whether the person seeking the release is an officer, director
or affiliate of us.
In
relation to each member state of the European Economic Area that has implemented
the Prospectus Directive (each, a relevant member state), with effect from
and
including the date on which the Prospectus Directive is implemented in that
relevant member state (the relevant implementation date), an offer of ADSs
or
series B shares described in this prospectus may not be made to the public
in
that relevant member state prior to the publication of a prospectus in relation
to the ADSs or series B shares that has been approved by the competent authority
in that relevant member state or, where appropriate, approved in another
relevant member state and notified to the competent authority in that relevant
member state, all in accordance with the Prospectus Directive, except that,
with
effect from and including the relevant implementation date, an offer of
securities may be made to the public in that relevant member state at any
time:
|
· |
to
any legal entity that is authorized or regulated to operate in the
financial markets or, if not so authorized or regulated, whose corporate
purpose is solely to invest in securities;
or
|
|
· |
to
any legal entity that has two or more of (1) an average of at least
250
employees during the last financial year; (2) a total balance sheet
of
more than €43,000,000;
and (3) an annual net turnover of more than €50,000,000,
as shown in its last annual or consolidated accounts;
or
|
|
· |
in
any other circumstances that do not require the publication of a
prospectus pursuant to Article 3 of the Prospectus
Directive.
|
Each
purchaser of ADSs or series B shares described in this prospectus located within
a relevant member state will be deemed to have represented, acknowledged and
agreed that it is a ‘‘qualified investor’’ within the meaning of Article 2(1)(e)
of the Prospectus Directive.
For
purposes of this provision, the expression an ‘‘offer to the public’’ in any
relevant member state means the communication in any form and by any means
of
sufficient information on the terms of the offer and the securities to be
offered so as to enable an investor to decide to purchase or subscribe the
securities, as the expression may be varied in that member state by any measure
implementing the Prospectus Directive in that member state, and the expression
‘‘Prospectus Directive’’ means Directive 2003/71/EC and includes any relevant
implementing measure in each relevant member state.
We
have
not authorized and do not authorize the making of any offer of ADSs or series
B
shares through any financial intermediary on our behalf, other than offers
made
by the underwriters with a view to the final placement of the ADSs or series
B
shares as contemplated in this prospectus. Accordingly, no purchaser of the
ADSs
or series B shares, other than the underwriters, is authorized to make any
further offer of the ADSs or series B shares on behalf of us or the
underwriters.
This
prospectus is only being distributed to, and is only directed at, persons in
the
United Kingdom that are qualified investors within the meaning of Article
2(1)(e) of the Prospectus Directive (‘‘Qualified Investors’’) that are also (i)
investment professionals falling within Article 19(5) of the Financial Services
and Markets Act 2000 (Financial Promotion) Order 2005 (the ‘‘Order’’); or (ii)
high net worth entities, and other persons to whom it may lawfully be
communicated, falling within Article 49(2)(a) to (d) of the Order (all such
persons together being referred to as ‘‘relevant persons’’). This prospectus and
its contents are confidential and should not be distributed, published or
reproduced (in whole or in part) or disclosed by recipients to any other persons
in the United Kingdom. Any person in the United Kingdom that is not a relevant
person should not act or rely on this document or any of its
contents.
Neither
this prospectus nor any other offering material relating to the ADSs or series
B
shares described in this prospectus has been submitted to the clearance
procedures of the Autorité
des Marchés Financiers or
by the
competent authority of another member state of the European Economic Area and
notified to the Autorité
des Marchés Financiers. The
ADSs
and series B shares have not been offered or sold and will not be offered or
sold, directly or indirectly, to the public in France. Neither this prospectus
nor any other offering material relating to the ADSs or series B shares has
been
or will be:
|
· |
released,
issued, distributed or caused to be released, issued or distributed
to the
public in France; or
|
|
· |
used
in connection with any offer for subscription or sale of the ADSs
or
series B shares to the public in
France.
|
Such
offers, sales and distributions will be made in France only:
|
· |
to
qualified investors (investisseurs
qualifiés)
and/or to a restricted circle of investors (cercle
restreint d’investisseurs),
in each case investing for their own account, all as defined in,
and
in accordance
with, Article L.411-2, D.411-1, D.411-2, D.734-1, D.744-1, D.754-1
and
D.764-1 of the
French Code
Monétaire et financier;
or
|
|
· |
to
investment services providers authorized to engage in portfolio management
on behalf of third parties; or
|
|
· |
in
a transaction that, in accordance with article L.411-2-II-1°-or-2°-or 3°
of the French Code
Monétaire et Financier and
article 211-2 of the General Regulations (Réglement
Général)
of the Autorité
des Marchés Financiers, does not constitute a public offer (appel
public á l’épargne).
|
The
ADSs
and series B shares may be resold directly or indirectly, only in compliance
with Articles L.411-1, L.411-2, L.412-1 and L.621-8 through L.621-8-3 of the
French Code
Monétaire et Financier.
The
ADSs
are listed on the AMEX under the symbol ‘‘SIM”, and the series B shares are
listed on the Mexican Stock Exchange under the symbol “SIMEC.B”.
The
following table shows the underwriting discounts and commissions that we are
to
pay to the international underwriters in connection with this offering. These
amounts are shown assuming both no exercise and full exercise of the
international underwriters’ option to purchase additional series B
shares.
|
|
Paid
by Grupo Simec, S.A.B. de C.V.
|
|
|
|
No
Exercise
|
|
Full
Exercise
|
|
Per
series B share
|
|
Ps. |
1.1425
|
|
Ps. |
1.1425
|
|
Per
ADS
|
|
$
|
0.3125
|
|
$
|
0.3125
|
|
Total
|
|
$
|
3,125,000
|
|
$
|
3,593,750
|
|
We
estimate that our portion of the total expenses of this offering will be
approximately $3 million.
In
connection with the offering, the representative on behalf of the underwriters,
may purchase and sell ADSs or series B shares in the open market. These
transactions may include short sales, syndicate covering transactions and
stabilizing transactions. Short sales involve syndicate sales of ADSs or series
B shares in excess of the number of ADSs or series B shares to be purchased
by
the Mexican underwriters and the international underwriters in the offering,
which creates a syndicate short position. ‘‘Covered’’ short sales are sales of
ADSs or series B shares made in an amount up to the number of ADSs or series
B
shares represented by the Mexican underwriters’ and international underwriters’
over-allotment option. In determining the source of series B shares to close
out
the covered syndicate short position, the representative will consider, among
other things, the price of ADSs or series B shares available for purchase in
the
open market as compared to the price at which they may purchase ADSs or series
B
shares through the over-allotment option. Transactions to close out the covered
syndicate short position involve either purchases of ADSs or series B shares
in
the open market after the distribution has been completed or the exercise of
the
over-allotment option. The international underwriters may also make ‘‘naked’’
short sales of ADSs in excess of the over-allotment option. The Mexican
underwriters are not permitted to make “naked” short sales of series B shares on
the Mexican Stock Exchange. The international underwriters must close out any
naked short position by purchasing ADSs in the open market. A naked short
position is more likely to be created if the Mexican underwriters and the
international underwriters are concerned that there may be downward pressure
on
the price of the ADSs or series B shares in the open market after pricing that
could adversely affect investors who purchase in the offering. Stabilizing
transactions consist of bids for or purchases of ADSs or series B shares in
the
open market while the offering is in progress.
The
underwriters also may impose a penalty bid. Penalty bids permit the underwriters
to reclaim a selling concession from a syndicate member when Citigroup Global
Markets Inc. repurchases ADSs originally sold by that syndicate member in order
to cover syndicate short positions or make stabilizing purchases.
Any
of
these activities may have the effect of preventing or retarding a decline in
the
market price of the ADSs or series B shares. They may also cause the price
of
the ADSs or series B shares to be higher than the price that would otherwise
exist in the open market in the absence of these transactions. The international
underwriters and the Mexican underwriters may conduct these transactions on
the
AMEX or the Mexican Stock Exchange or in the over-the-counter market, or
otherwise. If the international underwriters and the Mexican underwriters
commence any of these transactions, they may discontinue them at any
time.
The
underwriters may, from time to time, engage in transactions with us and perform
services for us in the ordinary course of their business. The underwriters
have,
from time to time, performed, and expect to perform in the future, investment
banking and advisory services for us and our affiliates, for which they have
received, and may continue to receive, customary fees and expenses.
A
prospectus in electronic format may be made available on the websites maintained
by one or more of the underwriters. The representative may agree to allocate
a
number of ADSs, in the form of ADSs or series B shares, to international
underwriters for sale to their online brokerage account holders. The
representative will allocate ADSs, in the form of ADSs or series B shares,
to
international underwriters that may make Internet distributions on the same
basis as other allocations. In addition, ADSs, in the form of ADSs or series
B
shares, may be sold by the international underwriters to securities dealers
who
resell ADSs, in the form of ADSs or series B shares, to online brokerage account
holders.
We
have
agreed to indemnify the international underwriters against certain liabilities,
including liabilities under the Securities Act, or to contribute to payments
the
international underwriters may be required to make because of any of those
liabilities.
NOTICE
TO CANADIAN RESIDENTS
Resale
Restrictions
The
distribution of the series B shares in Canada is being made only on a private
placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of series B shares are made. Any resale of the series B shares in Canada
must be made under applicable securities laws which will vary depending on
the
relevant jurisdiction, and which may require resales to be made under available
statutory exemptions or under a discretionary exemption granted by the
applicable Canadian securities regulatory authority. Purchasers are advised
to
seek legal advice prior to any resale of the shares.
Representations
of Purchasers
By
purchasing shares in Canada and accepting a purchase confirmation a purchaser
is
representing to us, the selling shareholder and the dealer from whom the
purchase confirmation is received that¾
|
· |
the
purchaser is entitled under applicable provincial securities laws
to
purchase the shares without the benefit of a prospectus qualified
under
those securities laws,
|
|
· |
where
required by law, that the purchaser is purchasing as principal and
not as
agent, and
|
|
· |
the
purchaser has reviewed the text above under Resale
Restrictions.
|
Rights
of Action¾Ontario
Purchasers
The
securities being offered are those of a foreign issuer and Ontario purchasers
will not receive the contractual right of action prescribed by Ontario
securities law. As a result, Ontario purchasers must rely on other remedies
that
may be available, including common law rights of action for damages or
rescission or rights of action under the civil liability provisions of the
U.S.
federal securities laws.
Enforcement
of Legal Rights
All
of
the issuer’s directors and officers as well as the experts named herein and the
selling shareholder may be located outside of Canada and, as a result, it may
not be possible for Canadian purchasers to effect service of process within
Canada upon the issuer or such persons. All or a substantial portion of the
assets of the issuer and such persons may be located outside of Canada and,
as a
result, it may not be possible to satisfy a judgment against the issuer or
such
persons in Canada or to enforce a judgment obtained in Canadian courts against
such issuer or persons outside of Canada.
Taxation
and Eligibility for Investment
Canadian
purchasers of shares should consult their own legal and tax advisors with
respect to the tax consequences of an investment in the shares in their
particular circumstances and about the eligibility of the shares for investment
by the purchaser under relevant Canadian legislation.
WHERE
CAN YOU FIND MORE INFORMATION
We
have
filed with the Commission a registration statement (including amendments and
exhibits to the registration statement) on Form F-1 under the Securities Act.
This prospectus, which is part of the registration statement, does not contain
all of the information set forth in the registration statement and the exhibits
and schedules to the registration statement. For further information, we refer
you to the registration statement and the exhibits and schedules filed as part
of the registration statement. If a document has been filed as an exhibit to
the
registration statement, we refer you to the copy of the document that has been
filed.
We
are
subject to the informational requirements of the U.S. Securities Exchange Act
of
1934, or the Exchange Act. Accordingly, we file reports and other information
with the Commission, including annual reports on Form 20-F and reports on Form
6-K. You may inspect and copy the reports and other information that we file
with the Commission at the public reference facilities of the Commission at
100
F. Street, N.E., Washington D.C. 20549. You may obtain information on the
operation of the Commission’s public reference room by calling the Commission in
the United States at 1-800-SEC-0330. In addition, the Commission maintains
an
internet website at
www.sec.gov
from
which you can electronically access the registration statement and the other
materials that we file with the Commission.
As
a
foreign private issuer, we are not subject to the same disclosure requirements
as a domestic U.S. registrant under the Exchange Act. For example, we are not
required to prepare and issue quarterly reports. However, we are required to
file with the SEC, promptly after it is made public or filed, information that
we make public in Mexico, file with the Mexican Stock Exchange or the National
Banking and Securities Commission or distribute to our securityholders. As
a
foreign private issuer, we are exempt from Exchange Act rules regarding proxy
statements and short-swing profits.
We
are
not making offers to, nor are accepting offers to buy from, holders in any
jurisdiction in which this offer would not comply with local securities laws.
Initial offers and sales of series B shares outside the United States may
be made in reliance on Regulation S under the Securities Act.
ENFORCEABILITY
OF CIVIL LIABILITIES
We
are a
corporation organized under the laws of Mexico. All of our directors and
officers, and certain of the experts named in this prospectus reside in Mexico.
In addition, a substantial portion of our assets are located in Mexico. Our
Mexican counsel, Mijares, Angoita, Cortés Fuentes, S.C., has advised us that you
may not be able to serve process within the United States upon these individuals
or enforce against them judgments of U.S. courts, including judgments based
on
the civil liability provisions of the federal securities laws of the United
States, and Mexican courts may not recognize the grounds or remedies for actions
originally brought in a Mexican court against us, our directors and officers,
the Mexican government and any expert named in this prospectus based on the
federal securities laws of the United States.
The
validity of the ADSs will be passed upon for us by Thacher Proffitt & Wood
llp,
our
U.S. counsel, and for the underwriters by Milbank, Tweed, Hadley & McCloy
llp,
U.S.
counsel to the underwriters. The validity of the series B shares will be passed
upon for us by Mijares, Angoitia, Cortés y Fuentes, S.C., our Mexican counsel,
and for the underwriters by Creel Garcia-Cuellar y Muggenberg, S.C., Mexican
counsel to the underwriters.
Our
consolidated financial statements for the fiscal years ended December 31, 2003
and 2004, included in this prospectus have been audited by KPMG Cárdenas, Dosal,
S.C., an independent registered public accounting firm, as stated in their
report and have been so included in reliance upon the report of such firm given
upon their authority as experts in accounting and auditing.
The
consolidated financial statements of Grupo Simec, S.A.B. de C.V. at December
31,
2005, and for the year then ended, appearing in this Prospectus and Registration
Statement have been audited by Mancera S.C., a Member Practice of Ernst &
Young Global, an independent registered public accounting firm, as set forth
in
their report thereon appearing elsewhere herein which, as to the year 2005,
are
based on the report of BDO Hernández Marrón y Cia, S.C., a member firm of BDO
International, an independent registered public accounting firm. The financial
statements referred to above are included in reliance upon such reports given
on
the authority of such firms as experts in accounting and auditing.
The
Republic financial statements for the fiscal year ended December 31, 2004
included in this prospectus have been audited by KPMG LLP, an independent
registered public accounting firm, as stated in their report and have been
so
included in reliance upon the report of such firm given upon their authority
as
experts in accounting and auditing. The Republic financial statements for the
period from January 1, 2005 through July 22, 2005 included in this
prospectus have been audited by BDO Seidman, LLP, an independent registered
public accounting firm, as stated in their report and have been so included
in
reliance upon the report of such firm given upon their authority as experts
in
accounting and auditing.
INDEX
TO FINANCIAL STATEMENTS
Grupo
Simec, S.A.B. de C.V.
Audited
Consolidated Financial Statements
|
|
|
|
|
F-1
|
|
|
|
F-2
|
|
|
|
F-3
|
|
|
|
F-4
|
|
|
|
F-5
|
|
|
|
F-6
|
|
|
|
F-7
|
|
|
|
F-8
|
|
|
Unaudited
Condensed Consolidated Financial Statements
|
|
|
|
|
F-50
|
|
|
|
F-51
|
|
|
|
F-52
|
|
|
|
F-53
|
|
|
|
F-54
|
|
|
PAV
Republic, Inc.
|
|
|
|
|
F-77
|
|
|
|
F-78
|
|
|
|
F-79
|
|
|
|
F-80
|
|
|
|
F-81
|
|
|
|
F-82
|
|
|
|
F-104
|
|
|
|
F-105
|
|
F-106
|
|
|
|
F-107
|
|
|
|
F-108
|
|
|
|
F-109
|
|
|
|
F-126
|
|
|
|
F-127
|
|
|
|
F-128
|
|
|
|
F-129
|
|
|
|
F-130
|
|
|
Unaudited
Pro Forma Condensed Combined Financial Statements
|
|
|
|
|
F-142
|
Schedules
to Financial Statements
|
|
|
|
|
|
|
F-148
|
|
|
|
|
|
F-149
|
|
|
|
|
|
F-150
|
|
|
|
|
|
F-151
|
Report
of Independent Registered Public Accounting Firm
The
Stockholders of
Grupo
Simec, S.A. de C.V. and Subsidiaries
We
have
audited the accompanying consolidated balance sheet of Grupo Simec, S.A.
de C.V.
and subsidiaries (the “Company”) as of December 31, 2005, and the related
consolidated statements of income, changes in stockholders’ equity, and changes
in financial position for the year then ended. These consolidated financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit. We did not audit the financial statements
of
Simrep Corporation and subsidiaries, a majority owned subsidiary, which
statements reflect total assets of Ps. 6,023,387 (thousand), as of December
31,
2005, and total revenues of Ps. 6,260,674 (thousand), for the period then
ended.
Those statements were audited by other auditors whose report has been furnished
to us, and our opinion, insofar as it relates to the amounts included for
Simrep
Corporation and subsidiaries, is based solely on the report of the other
auditors.
We
conducted our audit in accordance with auditing standards generally accepted
in
Mexico and in accordance with the Standards of the Public Company Accounting
Oversight Board (United States of America). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform
an
audit of the Company’s internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a
basis
for designing audit procedures that are appropriate in the circumstances,
but
not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control over financial reporting. Accordingly, we express no
such opinion. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management,
and
evaluating the overall financial presentation. We believe that our audit
and the
report of other independent auditors provide a reasonable basis for our
opinion.
In
our
opinion, based on our audit and the report of the other independent auditors,
the above-mentioned consolidated financial statements present fairly, in
all
material respects, the consolidated financial position of Grupo Simec, S.A. de
C.V. and subsidiaries at December 31, 2005, and the consolidated results
of
their operations and changes in their financial position for the year then
ended, in conformity with accounting principles generally accepted in Mexico,
which differ in certain respects from those followed in the United States
of
America (see Note 19).
|
Mancera,
S.C.
|
|
A
Member Practice of
|
|
Ernst
& Young Global
|
|
|
|
C.P.C.
Jose Maria Tabares
|
Guadalajara,
Jalisco México
April
28,
2006 (except for Note 19,
as
to
which the date is June 28, 2006;
and
for
the restatement to constant Pesos
as
of
June 30, 2006, for Note 13 a v) and
for
the
share and per share information both
as
to
which the date is July 11, 2006 and for
Note
15
as to which the date is January 4, 2007)
Report
of Independent Registered Public Accounting Firm
The
Board
of Directors and Stockholders of
Grupo
Simec, S. A. de C. V.:
We
have
audited the accompanying consolidated balance sheet of Grupo Simec, S.A.
de C.V.
and subsidiaries (the Company) as of December 31, 2004 and the related
consolidated statements of income, stockholders’ equity and changes in financial
position for each of the years in the two-year period ended December 31,
2004.
These consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We
conducted our audits in accordance with the Standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As
mentioned in note 14 to the consolidated financial statements, on August
9, 2004
the Company acquired, as an industrial unit, assets and labor obligations
accrued at such date. The assets consist of inventories and steel
plants.
In
our
opinion, the consolidated financial statements referred to above present
fairly,
in all material respects, the financial position of Grupo Simec, S.A. de
C.V.
and subsidiaries as of December 31, 2004, and the results of their operations
and the changes in their financial position for each of the years in the
two-year period ended December 31, 2004, in conformity with accounting
principles generally accepted in Mexico.
As
described in note 2, the accompanying consolidated balance sheet, statements
of
income, stockholders’ equity and changes in financial position have been
restated to reflect their presentation in Mexican pesos of constant purchasing
power as of June 30, 2006.
Accounting
principles generally accepted in Mexico vary in certain significant respects
from accounting principles generally accepted in the United States of America.
Information relating to the nature and effect of such differences is presented
in note 19 to the consolidated financial statements.
|
KPMG
CARDENAS DOSAL, S. C.
|
|
|
|
|
|
Jorge
O. Pérez Zermeño
|
Guadalajara,
Mexico.
April
25,
2005, except for the restatement to June 30, 2006 constant Mexican pesos,
as to
which the date is July 10, 2006.
· Contadores
Pûblicos y
· Consultores
de Empresas
|
· Av.
Ejército Nacional 904 Piso 7
· Los
Morales Polanco
· 11510
México, D.F.
· Tel. (52-55)
5901-3900
· Fax (52-55)
5901-3925
· www.bdo-mexico.com
|
Report
of Independent Registered Public Accounting Firm
To
the Board of Directors and Shareholders of
SimRep
Corporation
We
have
audited the consolidated balance sheet of SimRep
Corporation and subsidiaries
as of
December 31, 2005, and the related consolidated statements of operations,
changes in shareholders’ equity and changes in financial position for the period
from July 22 (date of acquisition) to December 31, 2005. These financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based
on
our audit.
We
conducted our audit in
accordance with the standards of the Public Company Accounting Oversight
Board
(United States). Those standards require that we plan and perform the audit
to
obtain reasonable assurance about whether the financial statements are free
of
material misstatement. The Company is not required to have, nor were we engaged
to perform, an audit of its internal control over financial reporting. Our
audit
included consideration of internal control over financial reporting as a
basis
for designing audit procedures that are appropriate in the circumstances,
but
not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
as
well as evaluating the overall financial statement presentation. We believe
that
our audit provides a reasonable basis for our opinion.
Accounting
principles generally accepted in Mexico vary in certain significant respects
from accounting principles generally accepted in the United States of
America. Information relating to the nature and effect of such differences
is presented in Note 22 to the financial statements.
In
our
opinion, the accompanying consolidated financial statements present fairly,
in
all material respects, the consolidated financial position of SimRep
Corporation and subsidiaries
as of
December 31, 2005, and the consolidated results of their operations, the
changes
in shareholders’ equity and the changes in their financial position for the
period from July 22 (date of acquisition) to December 31, 2005, in conformity
with accounting principles generally accepted in Mexico.
These
consolidated financial statements have been translated into English solely
for
the convenience of readers of this language.
Hernández,
Marrón y Cía., S.C.
Bernardo
Soto Peñafiel, CPA
Partner
Mexico
City
April
28, 2006, except for the restatement to June 30, 2006 constant Mexican pesos,
as
to which the date is July 10, 2006.
GRUPO
SIMEC, S.A. DE C.V. AND SUBSIDIARIES
Consolidated
Balance Sheets
December
31, 2005 and 2004
(Thousands
of constant Mexican pesos as of June 30, 2006)
Assets
|
|
|
|
2005
|
|
|
|
2004
|
|
Current
assets:
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
|
Ps.
|
|
|
209,416
|
|
|
Ps.
|
|
|
526,743
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade
|
|
|
|
|
|
2,316,954
|
|
|
|
|
|
1,016,826
|
|
Related
parties (Note 4)
|
|
|
|
|
|
2,456
|
|
|
|
|
|
5,499
|
|
Recoverable
value added tax
|
|
|
|
|
|
115,703
|
|
|
|
|
|
164,332
|
|
Other
receivables
|
|
|
|
|
|
216,537
|
|
|
|
|
|
12,676
|
|
|
|
|
|
|
|
2,651,650
|
|
|
|
|
|
1,199,333
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
allowance for doubtful accounts
|
|
|
|
|
|
31,273
|
|
|
|
|
|
15,080
|
|
Total
accounts receivable, net
|
|
|
|
|
|
2,620,377
|
|
|
|
|
|
1,184,253
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventories,
net (Note 5)
|
|
|
|
|
|
3,660,501
|
|
|
|
|
|
1,175,075
|
|
Prepaid
expenses
|
|
|
|
|
|
230,226
|
|
|
|
|
|
8,935
|
|
Derivative
financial instruments (Note 6)
|
|
|
|
|
|
57,477
|
|
|
|
|
|
19,025
|
|
Total
current assets
|
|
|
|
|
|
6,777,997
|
|
|
|
|
|
2,914,031
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-current
inventories (Note 2e)
|
|
|
|
|
|
76,843
|
|
|
|
|
|
68,982
|
|
Property,
plant and equipment, net (Note 7)
|
|
|
|
|
|
7,114,996
|
|
|
|
|
|
6,007,190
|
|
Other
assets and deferred charges, net (Note 2h)
|
|
|
|
|
|
618,721
|
|
|
|
|
|
315,444
|
|
|
|
|
Ps.
|
|
|
14,588,557
|
|
|
Ps.
|
|
|
9,305,647
|
|
Liabilities
and stockholders' equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes
payable to banks (Note 9a)
|
|
|
Ps.
|
|
|
-
|
|
|
Ps.
|
|
|
159,252
|
|
Current
portion of long-term debt (Note 9b)
|
|
|
|
|
|
21,034
|
|
|
|
|
|
3,538
|
|
Accounts
Payable
|
|
|
|
|
|
1,411,813
|
|
|
|
|
|
612,449
|
|
Accruals
(Note 8)
|
|
|
|
|
|
15,208
|
|
|
|
|
|
8,938
|
|
Other
accounts payable and accrued expenses
|
|
|
|
|
|
675,565
|
|
|
|
|
|
161,543
|
|
Related
parties (Note 4)
|
|
|
|
|
|
460,228
|
|
|
|
|
|
21
|
|
Deferred
credit (Note 2l)
|
|
|
|
|
|
131,441
|
|
|
|
|
|
-
|
|
Total
current liabilities
|
|
|
|
|
|
2,715,289
|
|
|
|
|
|
945,741
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt (Note 9b)
|
|
|
|
|
|
391,550
|
|
|
|
|
|
-
|
|
Seniority
premiums and termination benefits (Note 10)
|
|
|
|
|
|
19,777
|
|
|
|
|
|
7,002
|
|
Other
long-term liabilities (Notes 2q and 16e)
|
|
|
|
|
|
112,067
|
|
|
|
|
|
15,067
|
|
Deferred
income tax (Note 12)
|
|
|
|
|
|
1,513,079
|
|
|
|
|
|
1,490,545
|
|
Deferred
credit (Note 2l)
|
|
|
|
|
|
208,114
|
|
|
|
|
|
-
|
|
Total
long-term liabilities
|
|
|
|
|
|
2,244,587
|
|
|
|
|
|
1,512,614
|
|
Total
liabilities
|
|
|
|
|
|
4,959,876
|
|
|
|
|
|
2,458,355
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity (Note 13):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
stock
|
|
|
|
|
|
3,476,499
|
|
|
|
|
|
3,408,488
|
|
Additional
paid-in-capital
|
|
|
|
|
|
845,018
|
|
|
|
|
|
682,066
|
|
Contributions
for future capital stock increases
|
|
|
|
|
|
-
|
|
|
|
|
|
230,309
|
|
Retained
earnings
|
|
|
|
|
|
4,519,677
|
|
|
|
|
|
3,239,779
|
|
Cumulative
deferred income tax
|
|
|
|
|
|
(905,828
|
)
|
|
|
|
|
(905,828
|
)
|
Result
of non-monetary assets
|
|
|
|
|
|
(154,723
|
)
|
|
|
|
|
179,309
|
|
Fair
value of derivative financial instruments (Note 6)
|
|
|
|
|
|
40,354
|
|
|
|
|
|
12,847
|
|
Majority
stockholders' equity
|
|
|
|
|
|
7,820,997
|
|
|
|
|
|
6,846,970
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
|
|
|
1,807,684
|
|
|
|
|
|
322
|
|
Total
stockholders' equity
|
|
|
|
|
|
9,628,681
|
|
|
|
|
|
6,847,292
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14,588,557
|
|
|
Ps.
|
|
|
9,305,647
|
|
See
accompanying notes to consolidated financial statements.
GRUPO
SIMEC, S.A. DE C.V. AND SUBSIDIARIES
Consolidated
Statements of Income
Years
ended December 31, 2005, 2004 and 2003
(Thousands
of constant Mexican pesos as of June 30, 2006, except earnings per share
figures)
|
|
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales (Notes 14 and 15)
|
|
|
Ps.
|
|
|
12,966,627
|
|
|
5,910,363
|
|
|
3,047,392
|
|
Direct
cost of sales (Note 14)
|
|
|
|
|
|
10,370,940
|
|
|
3,435,057
|
|
|
2,001,987
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marginal
profit
|
|
|
|
|
|
2,595,687
|
|
|
2,475,306
|
|
|
1,045,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indirect
overhead, selling, general and administrative expenses
|
|
|
|
|
|
1,018,105
|
|
|
593,276
|
|
|
507,272
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
|
|
|
1,577,582
|
|
|
1,882,030
|
|
|
538,133
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financing cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
(expense) income, net
|
|
|
|
|
|
(15,728
|
)
|
|
5,791
|
|
|
(13,499
|
)
|
Foreign
exchange (loss) gain, net
|
|
|
|
|
|
(75,279
|
)
|
|
3,987
|
|
|
(2,783
|
)
|
Monetary
position loss
|
|
|
|
|
|
(53,663
|
)
|
|
(47,411
|
)
|
|
(10,424
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financial result, net
|
|
|
|
|
|
(144,670
|
)
|
|
(37,633
|
)
|
|
(26,706
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expenses), net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment
to the recovery value of land, machinery and equipment
|
|
|
|
|
|
-
|
|
|
(14,722
|
)
|
|
(19,499
|
)
|
Deferred
credit amortization
|
|
|
|
|
|
67,175
|
|
|
-
|
|
|
-
|
|
Other,
net
|
|
|
|
|
|
(11,686
|
)
|
|
(23,402
|
)
|
|
(12,905
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense), net
|
|
|
|
|
|
55,489
|
|
|
(38,124
|
)
|
|
(32,404
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income tax and statutory employee profit sharing
|
|
|
|
|
|
1,488,401
|
|
|
1,806,273
|
|
|
479,023
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax (Note 12):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
78,877
|
|
|
23,136
|
|
|
13,419
|
|
Deferred
|
|
|
|
|
|
111,718
|
|
|
320,466
|
|
|
139,779
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
income tax
|
|
|
|
|
|
190,595
|
|
|
343,602
|
|
|
153,198
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statutory
employee profit sharing (Note 12)
|
|
|
|
|
|
417
|
|
|
-
|
|
|
5,302
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
consolidated income
|
|
|
Ps.
|
|
|
1,297,389
|
|
|
1,462,671
|
|
|
320,523
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation
of net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
|
|
|
17,491
|
|
|
-
|
|
|
1
|
|
Majority
interest
|
|
|
|
|
|
1,279,898
|
|
|
1,462,671
|
|
|
320,522
|
|
|
|
|
Ps.
|
|
|
1,297,389
|
|
|
1,462,671
|
|
|
320,523
|
|
Majority
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
413,788,797
|
|
|
398,917,437
|
|
|
357,158,043
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share (pesos)
|
|
|
Ps.
|
|
|
3.09
|
|
|
3.67
|
|
|
0.90
|
|
See
accompanying notes to consolidated financial statements.
GRUPO
SIMEC, S.A. DE C.V. AND SUBSIDIARIES
Consolidated
Statements of Changes in Stockholders' Equity
Years
ended December 31, 2005, 2004 and 2003
(Thousands
of constant Mexican pesos as of June 30, 2006)
|
|
Capital
stock
|
|
Stock
premium
|
|
Contributions
for
future capital stock increases
|
|
Retained
earnings
|
|
Cumulative
deferred
income
tax
|
|
Result
of holding non-monetary assets
|
|
Fair
value of derivative financial instruments (Note
6)
|
|
Total
majority
interest
|
|
Minority
interest
|
|
Total
stockholders' equity
|
|
Balance
at December 31, 2002
|
|
Ps. |
2,991,443
|
|
Ps. |
682,066
|
|
|
-
|
|
Ps. |
1,456,586
|
|
Ps. |
(905,828
|
)
|
Ps. |
(135,864
|
)
|
|
-
|
|
Ps. |
4,088,403
|
|
Ps. |
275
|
|
Ps. |
4,088,678
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increases
in capital stock (Note 13)
|
|
|
392,352
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
392,352
|
|
|
-
|
|
|
392,352
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income (Note 13)
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
320,522
|
|
|
-
|
|
|
249,263
|
|
|
10,483
|
|
|
580,268
|
|
|
-
|
|
|
580,268
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2003
|
|
|
3,383,795
|
|
|
682,066
|
|
|
-
|
|
|
1,777,108
|
|
|
(905,828
|
)
|
|
113,399
|
|
|
10,483
|
|
|
5,061,023
|
|
|
275
|
|
|
5,061,298
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increases
in capital stock (Note 13)
|
|
|
24,693
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
24,693
|
|
|
-
|
|
|
24,693
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contributions
for future capital stock increases (Note 13)
|
|
|
-
|
|
|
-
|
|
|
230,309
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
230,309
|
|
|
-
|
|
|
230,309
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income (Note 13)
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1,462,671
|
|
|
-
|
|
|
65,910
|
|
|
2,364
|
|
|
1,530,945
|
|
|
47
|
|
|
1,530,992
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
at December 31, 2004
|
|
|
3,408,488
|
|
|
682,066
|
|
|
230,309
|
|
|
3,239,779
|
|
|
(905,828
|
)
|
|
179,309
|
|
|
12,847
|
|
|
6,846,970
|
|
|
322
|
|
|
6,847,292
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increases
in capital stock (Note 13)
|
|
|
68,011
|
|
|
162,952
|
|
|
(230,309
|
)
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
654
|
|
|
-
|
|
|
654
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income (Note 13)
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1,279,898
|
|
|
-
|
|
|
(334,032
|
)
|
|
27,507
|
|
|
973,373
|
|
|
1,807,362
|
|
|
2,780,735
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
at December 31, 2005
|
|
Ps. |
3,476,499
|
|
|
845,018
|
|
|
-
|
|
Ps. |
4,519,677
|
|
Ps. |
(905,828
|
)
|
Ps. |
(154,723
|
)
|
|
40,354
|
|
Ps. |
7,820,997
|
|
Ps. |
1,807,684
|
|
Ps. |
9,628,681
|
|
See
accompanying notes to consolidated financial statements.
GRUPO
SIMEC, S.A. DE C.V. AND SUBSIDIARIES
Consolidated
Statements of Changes in Financial Position
Years
ended December 31, 2005, 2004 and 2003
(Thousands
of constant Mexican pesos as of June 30, 2006)
|
|
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
Operating
activities:
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
Ps.
|
|
|
1,297,389
|
|
|
1,462,671
|
|
|
320,523
|
|
Add
(deduct) items not requiring the use of resources
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
|
|
|
325,671
|
|
|
222,415
|
|
|
199,303
|
|
Deferred
income tax
|
|
|
|
|
|
111,718
|
|
|
320,466
|
|
|
139,779
|
|
Write-down
of idle machinery
|
|
|
|
|
|
-
|
|
|
14,722
|
|
|
19,499
|
|
Deferred
credit amortization
|
|
|
|
|
|
(67,175
|
)
|
|
-
|
|
|
-
|
|
Seniority
premiums and termination benefits
|
|
|
|
|
|
5,212
|
|
|
1,338
|
|
|
271
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,672,815
|
|
|
2,021,612
|
|
|
679,375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade
receivables, net
|
|
|
|
|
|
(129,339
|
)
|
|
(529,890
|
)
|
|
(21,981
|
)
|
Other
accounts receivable and prepaid expenses
|
|
|
|
|
|
(222,986
|
)
|
|
(168,282
|
)
|
|
61,465
|
|
Inventories,
net
|
|
|
|
|
|
623,584
|
|
|
(859,030
|
)
|
|
(9,910
|
)
|
Derivative
financial instruments
|
|
|
|
|
|
(10,946
|
)
|
|
-
|
|
|
(15,646
|
)
|
Related
parties receivables
|
|
|
|
|
|
3,044
|
|
|
(1,725
|
)
|
|
(3,774
|
)
|
Accounts
payable, other accounts payable and accrued expenses
|
|
|
|
|
|
(165,392
|
)
|
|
453,402
|
|
|
(65,754
|
)
|
Other
long-term liabilities
|
|
|
|
|
|
91,883
|
|
|
-
|
|
|
-
|
|
Related
parties payable
|
|
|
|
|
|
-
|
|
|
(830
|
)
|
|
(188,220
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Resources
provided by operating activities
|
|
|
|
|
|
1,862,663
|
|
|
915,257
|
|
|
435,555
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Related
parties payable (financing)
|
|
|
|
|
|
451,307
|
|
|
-
|
|
|
-
|
|
Increases
in capital stock
|
|
|
|
|
|
654
|
|
|
24,693
|
|
|
392,351
|
|
Contribution
for future capital stock increases
|
|
|
|
|
|
-
|
|
|
230,309
|
|
|
-
|
|
Unpaid
foreign exchange gain
|
|
|
|
|
|
8,900
|
|
|
-
|
|
|
6,048
|
|
Short-term
loans (repaid) obtained
|
|
|
|
|
|
(136,510
|
)
|
|
159,252
|
|
|
-
|
|
Financial
debt repayment
|
|
|
|
|
|
(1,052,050
|
)
|
|
(19,833
|
)
|
|
(362,673
|
)
|
Decrease
in debt due to restatement to constant Mexican pesos as of year
end
|
|
|
|
|
|
(5,246
|
)
|
|
(1,213
|
)
|
|
(4,319
|
)
|
Other
long-term liabilities
|
|
|
|
|
|
-
|
|
|
10,899
|
|
|
82
|
|
Increase
of investment in PAV Republic by Industrias CH
|
|
|
|
|
|
490,533
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Resources
(used in) provided by financing activities
|
|
|
|
|
|
(242,412
|
)
|
|
404,107
|
|
|
31,489
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Increase)
decrease in long-term inventories
|
|
|
|
|
|
(7,861
|
)
|
|
(811
|
)
|
|
63,953
|
|
Acquisition
of property, plant and equipment
|
|
|
|
|
|
(503,735
|
)
|
|
(1,284,970
|
)
|
|
(64,372
|
)
|
Effect
from the acquisition of Pav Republic
|
|
|
|
|
|
(1,309,783
|
)
|
|
-
|
|
|
-
|
|
Increase
(decrease) in other noncurrent assets
|
|
|
|
|
|
16,659
|
|
|
(71,507
|
)
|
|
(26,002
|
)
|
Effect
from the acquisition of OAL
|
|
|
|
|
|
(132,858
|
)
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Resources
used in investing activities
|
|
|
|
|
|
(1,937,578
|
)
|
|
(1,357,288
|
)
|
|
(26,421
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in cash and cash equivalents
|
|
|
|
|
|
(317,327
|
)
|
|
(37,924
|
)
|
|
440,623
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At
beginning of year
|
|
|
|
|
|
526,743
|
|
|
564,667
|
|
|
124,044
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At
end of year
|
|
|
Ps.
|
|
|
209,416
|
|
|
526,743
|
|
|
564,667
|
|
See
accompanying notes to consolidated financial statements.
GRUPO
SIMEC, S.A. DE C.V. AND SUBSIDIARIES
Notes
to
Consolidated Financial Statements
December
31, 2005 and 2004
(Amounts
in thousands of Constant Mexican pesos as of June 30, 2006, unless otherwise
indicated)
(1)
|
Description
of the Business and Significant
Transactions
|
Description
of the Business
The
principal activities of Grupo Simec, S.A. de C.V. and subsidiaries (the Company)
are the manufacture and sale of iron and steel products for the construction
and
automotive industries both in Mexico and abroad. The Company is a subsidiary
of
Industrias CH, S.A. de C.V. (Industrias CH).
Significant
Transactions
|
(a)
|
As
mentioned in Note 14 a) of these notes, on July 22, 2005, the Company
and
Industrias CH acquired the outstanding shares of PAV Republic Inc.
(Republic) through its subsidiary SimRep Corporation, a U.S. company.
Such
transaction, was valued at USD 245 million where USD 229 million
corresponds to the purchase price and USD 16 million, to the direct
cost
of the business combination. The Company contributed US 123 million
to
acquire 50.2% of the representative shares of SimRep Corporation
and
Industrias CH, the holding company, acquired the remaining
49.8%.
|
The
total
purchase price of Republic was allocated among the assets acquired and
liabilities assumed based on their fair values at July 22, 2005. The purchase
price gave rise to negative goodwill that was allocated among all the
non-current assets acquired.
|
(b)
|
On
July 20, 2005, the Company acquired all the shares of Operadora
de Apoyo
Logístico, S.A. de C.V., (“OAL”) a subsidiary of Grupo TMM, S.A. de C.V.,
for a purchase price of Ps. 133 million, for the purpose of converting
the
acquired company into the operator of three of the iron and steel
plants
in Mexico. OAL’s primary assets consisted of deferred tax assets resulting
from net operating losses carryforwards (See Note 14
b).
|
|
(c)
|
On
November 2005 the Company’s Board of Directors decided to spin off its
subsidiary Compañía Siderúrgica de California, S.A. de C.V., transferring
all of the subsidiary’s assets, liabilities and stockholders’ equity to
the following two new companies: Controladora Simec, S.A. de C.V.
and
Arrendadora Simec, S.A. de C.V.; consequently, the original company
was
dissolved to separate the control over the shares of the subsidiaries
from
the assets that comprise the industrial plants in Guadalajara and
Mexicali. This restructure had no effect on the consolidated financial
statements.
|
|
(d)
|
As
mentioned in Note 14 c) of these notes, on August 9, 2004, the
Company
acquired the majority of the assets of Atlax, S.A. de C.V. and
certain
assets of Operadora Metamex, S.A. de C.V., as well as their accumulated
labor obligations at such date. Such assets consisted of inventories
and
steel plants located in Apizaco, Tlaxcala and Cholula, Puebla,
which
produce specialty steel products and commercial profiles. The purchase
price of these assets was approximately USD 120
million.
|
|
(e)
|
In
2003, the Company’s subsidiaries Compañía Siderúrgica de Guadalajara, S.A.
de C.V. (CSG), Compañía Siderúrgica de Occidente, S.A. de C.V. (CSO) and
Compañía Siderúrgica de California, S.A. de C.V. (CSC) repaid USD
1,452,887 for installments due in such year on
the industrial mortgage loan agreement.
Furthermore,
in 2003, said companies also prepaid USD 29,930,517 on the loan.
On
March 18, 2004, the Company prepaid USD 1,697,952 plus interest,
thus
repaying the loan in full as mentioned in Note
9c.
|
|
(f)
|
In
2005, 2004 and 2003, capital increases and certain changes in stock
ownership were carried out, which are described in Note
13.
|
|
(g)
|
As
mentioned in Note 16 f) of these notes, Pacific
Steel, Inc (PS) (subsidiary company located in the U.S.) has been
sued by
the Government of the State of California in the U.S., which requires
that
PS clean up and relocate part of its facilities related to the
generation,
storage, transportation and disposal of materials classified as
hazardous
waste.
The Company has filed an appeal against these claims; however,
at the date
of issue of the consolidated financial statements, the final results
of
such appeals remain unknown.
|
|
(h)
|
Pursuant
to a public bidding process for non-performing loans without recourse,
in
2003, Industrias CH acquired through its subsidiary Administradora
de
Cartera de Occidente, S.A. de C.V. (ACOSA), the assignment of shared
recovery loans as well as litigation rights and certain loan-related
obligations. Subsequently, on December 11, 2003, with the authorization
of
the assignor banks, Industrias CH sold 99.98% of the ACOSA shares
to the
Company. At December 31, 2003, the total investment amount was
Ps. 10,905.
When the Company reaches its break-even point it must pay the assignors
50% of the amounts recovered (after deducting authorized expenses
spent on
recovering these amounts), which should be paid in the first five
business
days of the month following the recovery. At December 31, 2004,
ACOSA
fully reserved the balance of this account since it has not recovered
any
amounts. At December 31, 2005, Simec did not have any recoveries
with
respect to the defaulted
receivables.
|
(2)
|
Summary
of Significant Accounting
Policies
|
(a) Basis
of preparation and disclosure
The
Company recognizes the effects of inflation on financial information as required
by Mexican Accounting Principles Bulletin B-10, “Accounting recognition of the
effects of inflation on financial information,” issued by the Mexican Institute
of Public Accountants (MIPA). Consequently, the amounts shown in the
accompanying financial statements and in these notes are expressed in thousands
of constant Mexican Pesos as of June 30, 2006, solely to facilitate comparison
with our unaudited condensed consolidated financial statements as of such
date,
and except for restatement of financial information in constant pesos, no
change
has been made to our 2005, 2004 and 2003 audited financial
statements.
The
annual rates of inflation used to recognize the effects of inflations, as
determined based on the National Consumer Price Index (NCPI), published by
Banco
de México. were as follows:
Date
|
|
NCPI
|
|
Inflation
|
June
30, 2006
|
|
117.059
|
|
0.65%
Six months
|
December
31, 2005
|
|
116.301
|
|
3.33%
Year
|
December
31, 2004
|
|
112.550
|
|
5.19%
Year
|
December
31, 2003
|
|
106.996
|
|
3.97%
Year
|
The
preparation of financial statements requires management to make estimates
and
assumptions that affect the reported amount of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the year.
Significant items subject to such estimates and assumptions include the carrying
amount of property, plant and equipment, other non-current assets, the valuation
allowance of accounts receivable, inventories and deferred tax assets, the
valuation of financial instruments, and the liability for labor obligations.
Actual results could differ from these estimates and assumptions.
For
purposes of disclosure in these notes, hereinafter the term “pesos” or
abbreviation “Ps.” shall refer to Mexican pesos; the term dollars, or
abbreviation USD shall be taken to mean U.S. dollars.
(b)
Basis of consolidation
The
consolidated financial statements include the financial statements of Grupo
Simec, S.A. de C.V. and those of its majority-owned and/or controlled
subsidiaries. All significant intercompany balances and transactions have
been
eliminated in the consolidation. The consolidation was based on the audited
financial statements of the issuing companies, which were prepared under
Mexican
GAAP.
The
Company’s subsidiaries and its equity percentage are as follows:
|
|
Equity
interest %
|
|
-
Compañía Siderúrgica de Guadalajara, S.A. de C.V.
|
|
|
99.99
|
%
|
-
Compañía Siderúrgica de California, S.A. de C.V. (spun off in
2005)
|
|
|
100
|
%
|
-
Arrendadora Simec, S.A. de C.V.
|
|
|
100
|
%
|
-
Simec International, S.A. de C.V.
|
|
|
100
|
%
|
-
Controladora Simec, S.A. de C.V.
|
|
|
100
|
%
|
-
SimRep Corporation and Subsidiaries (1)
|
|
|
50.22
|
%
|
-
Undershaft Investments, N.V.
|
|
|
100
|
%
|
-
Pacific Steel, Inc.
|
|
|
100
|
%
|
-
Compañía Siderúrgica del Pacífico, S.A. de C.V.
|
|
|
99.99
|
%
|
-
Consorcio Internacional, S.A. de C.V. (liquidated in 2004)
|
|
|
99.79
|
%
|
-
Coordinadora de Servicios Siderúrgicos de Calidad, S.A. de
C.V.
|
|
|
100
|
%
|
-
Administradora de Servicios de la Industria Siderúrgica ICH, S.A. de C.V.
|
|
|
99.99
|
%
|
-
Industrias del Acero y del Alambre, S.A. de C.V.
|
|
|
99.99
|
%
|
-
Procesadora Mexicali, S.A. de C.V.
|
|
|
99.99
|
%
|
-
Servicios Simec, S.A. de C.V.
|
|
|
100
|
%
|
-
Sistemas de Transporte de Baja California, S.A. de C.V.
|
|
|
100
|
%
|
-
Operadora de Metales, S.A. de C.V. (2)
|
|
|
100
|
%
|
-
Operadora de Servicios Siderúrgicos de Tlaxcala, S.A. de C.V. (2)
|
|
|
100
|
%
|
-
Administradora de Servicios Siderúrgicos de Tlaxcala, S.A,. de C.V.
(2)
|
|
|
100
|
%
|
-
Operadora de Servicios de la Industria Siderúrgica ICH, S.A. deC.V.
(2)
|
|
|
100
|
%
|
-
Administradora de Cartera de Occidente, S.A. de C.V. (3)
|
|
|
99.99
|
%
|
____________________
|
(1)
|
Companies
that started being part of Grupo Simec during
2005.
|
|
(2)
|
Companies
that started being part of Grupo Simec during
2004.
|
|
(3)
|
Companies
that started being part of Grupo Simec during
2003.
|
(c) Basis
of translation of financial statements of foreign
subsidiaries
For
consolidation purposes, the financial statements of the subsidiaries abroad,
Simrep and subsidiaries, Pacific Steel and Undershaft Investment, were
translated into pesos in conformity with Mexican accounting Bulletin B-15,
Transactions
in Foreign Currency and Translation of Financial Statements of Foreign
Operations.
The
subsidiary SimRep was considered as a foreign entity for translation purposes;
therefore the financial statements as reported by the subsidiary abroad were
adjusted to conform with Mexican GAAP, which includes the recognition of
the
effects of inflation as required by Mexican accounting Bulletin B-10, applying
inflation adjustment factors derived from the U.S. Consumer Price Index (CPI)
published by the U.S. labor department. The financial information already
restated to include inflationary effects, is translated to Mexican pesos
as
follows:
|
-
|
By
applying the prevailing exchange rate at the consolidated balance
sheet
date for monetary and non-monetary assets and
liabilities.
|
|
-
|
By
applying the prevailing exchange rate for stockholders’ equity accounts,
at the time capital contributions were made and earnings were
generated.
|
|
-
|
By
applying the prevailing exchange rate at the consolidated balance
sheet
date for revenues and expenses during the reporting
period.
|
|
-
|
The
related effect of translation is recorded in stockholders’ equity under
the caption Equity adjustments for non monetary
assets.
|
|
-
|
The
resulting amounts were restated applying adjustment factors derived
from
the NCPI, in conformity with Mexican accounting Bulletin
B-10.
|
The
subsidiaries Pacific Steel and Undershaft Investment, were considered an
“integral part of the operations” of the Company; and the financial statements
of such subsidiaries were translated into Mexican pesos as follows:
|
-
|
By
applying the prevailing exchange rate at the consolidated balance
sheet
date for monetary items.
|
|
-
|
By
applying the prevailing exchange rate at the time the non-monetary
assets
and capital are generated, and the weighted average exchange rate
of the
period for income statement items.
|
|
-
|
The
related effect of translation is recorded in the statement of operations
as part of the caption Comprehensive financing
cost.
|
|
-
|
The
resulting amounts were restated applying adjustment factors derived
from
the Mexican NCPI, in conformity with Mexican accounting Bulletin
B-10.
|
(d) Cash
equivalents
Cash
equivalents consist of bank deposits, foreign currency and other highly liquid
investments with maturities of less than 90 days. At the date of the financial
statements, interest income and foreign exchange gains and losses are included
in the results of operations under the caption Comprehensive financing
cost.
(e) Inventories
and cost of sales
Domestic
subsidiaries’ inventories are recorded initially at average cost and then
adjusted to the lower of replacement cost or net realizable market value
under
the direct costing system.
Foreign
subsidiaries’ inventories are valued on a last-in, first-out (LIFO). For
translation effects into Mexican GAAP the inventories have been adjusted
from
LIFO to the lower of replacement cost or net realizable market
value.
The
inventory values of the Company were determined as follows:
Billet,
finished goods and work in process.
|
At
the most recent direct production
cost
|
Direct
cost of sales represents the replacement cost of inventories at the time
of
sale, expressed in constant pesos as of the most recent balance sheet date
reported on.
Raw
materials.
|
At
the prevailing market purchase price at the consolidated balance
sheet
date
|
Materials,
spare parts and rollers.
|
At
historical cost, restated using the inflation rates of the steel
industry
|
The
Company classifies rollers and spare parts as long-term inventories, which
in
accordance with historical data and production trends will not be used in
the
short-term (one year).
The
restated value of inventories at the balance sheet date is not in excess
of
market.
The
reserve for slow-moving inventories is determined considering the reprocessing
cost of the materials and finished products inventories with a turnover above
one year.
(f) Derivative
financial instruments
In
2005,
2004 and 2003, the Company used derivative financial instruments for hedging
risks associated with natural gas prices for which it conducted studies on
historical consumption, future requirements and commitments acquired, thus
diminishing its exposure to risks other than its normal operating
risks.
To
mitigate the risks associated with changes in natural gas prices occurring
naturally as a result of the supply and demand on international markets,
the
Company uses natural gas cash-flow exchange contracts or natural gas swaps
to
offset fluctuations in the price of natural gas, whereby the Company receives
a
floating price and pays a fixed price. Fluctuations in natural gas prices
from
volumes consumed are recognized as part of the Company’s operating
costs.
The
Company recognizes the fair value as an asset or liability and records the
offsetting amount in other comprehensive income/loss (OCI). The cumulative
OCI
is reversed in the month of settlement and the net settlement and any related
contract costs are booked to cost of goods sold in the month of
settlement.
The
fair
value of these assets or liabilities is restated at the end of each month
based
on the new estimate. As mentioned in Note 6 of these notes, the Company opted
for the early adoption of Mexican accounting Bulletin C-10, Accounting
for Derivative Instruments and Hedging Activities;
consequently, at December 31, 2005, 2004 and 2003, these contracts were
recognized on the balance sheet at fair value, either as liabilities or assets.
The Company periodically evaluates the changes in the cash flows of the
derivative instruments to analyze if the swaps are highly effective for
mitigating the exposure to natural gas price fluctuations. In 2005, 2004
and
2003 the derivatives qualified as a derivative financial hedging instrument
of
the cash flow type and thus the fair value and subsequent changes of the
swaps
are recorded under stockholders’ equity as Comprehensive income net of the
deferred tax effect.
(g) Property
plant and equipment
Property,
plant and equipment is recorded initially at acquisition cost, and then adjusted
for inflation by applying NCPI factors, except for imported machinery and
equipment, which is restated based on the inflation rate in the country of
origin and changes in the foreign exchange rate of the country’s particular
currency in relation to the peso.
Depreciation
of property, plant and equipment is computed using the straight-line method
based on the estimated remaining useful lives of the related
assets.
The
comprehensive financing cost which includes (i) the interest cost, (ii) any
foreign currency fluctuations, and (iii) the related monetary position result
of
assets under construction or installation is capitalized as part of the value
of
such assets and is restated based on the NCPI factors from the date capitalized
through year-end and amortized over the average depreciation period of the
related assets.
The
estimated useful lives of the Company’s property, plant and equipment are as
follows:
|
Years
|
Buildings
|
15
to 65
|
Machinery
and equipment
|
10
to 40
|
Transportation
equipment
|
4
|
Furniture,
fixtures and computer equipment
|
10
|
Maintenance
and minor repairs are expensed as incurred.
(h) Other
assets, intangible assets and deferred charges
Other
assets include mainly technical assistance, organization and pre-operating
expenses and, except for technical assistance, are restated for inflation
based
on the NCPI factors. Amortization is computed on restated values using the
straight-line method, over periods ranging from 3 to 20 years.
As
mentioned in note 1 a), as a result of the Republic acquisition, the Company
identified and recorded intangible assets at a fair value totaling Ps. 347.8
million. As of December 31, 2005 the Company’s intangible assets and deferred
charges include Ps. 320.6 million net of Ps. 27.2 of accumulated depreciation
related to the Republic trade name, customer list, and certain labor, licenses,
and suppliers agreements. The Republic trade name has an indefinite useful
life
and will not be amortized.
The
estimated useful lives and amortization are as follows:
INTANGIBLES
|
|
|
|
|
|
|
|
Value
at
|
|
Useful
|
|
2005
|
|
Estimated
Future Amortization
|
|
|
|
22-Jul-05
|
|
Life
|
|
Amortization
|
|
2006
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Republic
Tradename
|
|
Ps. |
79,276
|
|
|
Indefinite
|
|
Ps. |
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Union
Agreements
|
|
|
127,727
|
|
|
24.5
months
|
|
|
23,496
|
|
|
62,560
|
|
|
41,671
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Kobe
Tech
|
|
|
92,487
|
|
|
144
months
|
|
|
2,897
|
|
|
7,740
|
|
|
7,740
|
|
|
7,740
|
|
|
7,740
|
|
|
7,740
|
|
Customer
Relationships
|
|
|
48,440
|
|
|
240
months
|
|
|
911
|
|
|
2,423
|
|
|
2,423
|
|
|
2,423
|
|
|
2,423
|
|
|
2,423
|
|
|
|
Ps |
347,930 |
|
|
|
|
Ps |
27,304
|
|
|
72,723
|
|
|
51,834
|
|
|
10,163
|
|
|
10,163
|
|
|
10,163
|
|
At
December 31, 2005 intangible assets subject to amortization are being amortized
over periods ranging from 2 to 20 years with a weighted average amortization
period of approximately 9 years. Amortization expense aggregated Ps. 27.3
million from the date Republic was acquired through the date of the financial
statements.
(i) Accruals
Based
on
management estimates, the Company recognizes accruals for these present
obligations for which the transfer of assets or the rendering of services
exist,
arise as a consequence of past events (such events refer primarily to salaries
and other amounts payable to employees, and fees) or it is probable that
the
effects will materialize and can be reasonably quantified.
(j) Seniority
premiums and termination payments
The
accumulated benefits for seniority premiums to which employees are entitled
by
law, are recognized in the results of operations of each year, based on
actuarial computations of the present value of such obligation. Past service
costs are being amortized over the estimated remaining working lifetime of
employees. At December 31, 2005, the estimated average working lifetime of
the
Company’s employees entitled to pension benefits ranges from 8 to 9 years,
approximately.
Through
2004, other compensations to which employees were entitled, mainly termination
payments, were charged to results of operations of the year, if and when
the
payments were vested.
The
revised Mexican accounting Bulletin D-3, Labor
Obligations,
issued
by the Mexican Institute of Public Accountants and adopted in 2005 by the
Company, establishes the overall rules for the valuation, presentation and
disclosure of so-called “other post-retirement benefits and the reduction and
early extinguishment of such benefits”, and includes rules applicable to
employee termination pay.
(k) Income
tax, asset tax and employee profit sharing
Deferred
income tax is accounted for using the asset and liability method, which is
based
on a comparison of the book and tax values of balance sheet accounts. Deferred
tax assets and liabilities are recognized on temporary differences between
assets and liabilities for financial and tax reporting purposes, as well
as the
available tax loss carryforward and creditable asset tax paid. Deferred tax
assets and liabilities are determined using the enacted income tax rate at
the
balance sheet date, or the enacted income tax rate that will be in effect
at the
time the temporary differences giving rise to deferred tax assets and
liabilities are expected to be recovered or paid, respectively. The effect
on
deferred tax assets and liabilities due to changes in tax rates is recognized
in
results of operations in the period in which such changes are
approved.
The
Company is required to estimate income taxes in each of the jurisdictions
in
which it operates. This process involves the jurisdiction-by-jurisdiction
estimation of actual current tax exposure and the assessment of temporary
differences.
Asset
tax
is offset against deferred income tax, making the appropriate evaluation
of
recovery. Deferred tax assets are evaluated periodically, providing, if
necessary, an estimate for those amounts of doubtful recovery.
The
Company records a valuation allowance to reduce the deferred tax assets to
an
amount that it considers is more likely than not to be realized. In assessing
the need for the valuation allowance, the Company considers future taxable
income. In the event that estimates of projected future taxable income change,
or amendments in current tax regulations are enacted that would impose
restrictions on the timing or extent of our ability to utilize the tax benefits
of the deferred income tax assets, an adjustment to the recorded amount of
net
deferred tax assets would be made, with a related charge to income.
Significant
management judgment is required in determining our provisions for income
taxes,
deferred tax assets and liabilities. If actual results differ from these
estimates, or we adjust these estimates in future periods, our financial
position and results of operations may be materially affected.
Deferred
employee profit sharing is recognized only on temporary differences determined
in the reconciliation of current year net income and taxable income for employee
profit sharing purposes, provided it may be reasonably estimated that a future
liability or benefit will arise and there is no indication that the related
liability or benefit will not be realized in the future.
(l) Deferred
credit
The
Company applied on a supplementary basis to Mexican GAAP, US EITF 98-11
“Accounting for Acquired Temporary Differences in Certain Purchase Transactions
that are not Accounted for as Business Combinations” to the OAL acquisition. The
deferred credit is obtained from the difference between the amount paid and
the
deferred tax asset recognized resulting from the purchase of future tax benefits
from OAL.
The
deferred credit is being amortized to results of operations in the same
proportion to the realization of the tax benefits that gave rise to the deferred
credit (See note 14b).
(m)
Restatement of capital stock, other capital contributions and retained
earnings
The
restatement of capital stock, other capital contributions and retained earnings
is determined by applying the NCPI from the time contributions
were made and earnings were generated through the most recent
year-end.
The
resulting amount represents the amount needed to maintain the stockholders’
investment at a constant level.
(n)
Cumulative deferred income tax
This
caption represents the accumulated effect of deferred taxes determined at
the
time the related accounting principle was first applied, restated at the
most
recent balance sheet date.
(o)
Equity adjustment for non-monetary assets
This
caption represents the difference between the restatement of non-monetary
assets
using the specific-cost method and the restatement based on the NCPI, reduced
by
the related deferred tax effect at the time Bulletin B-10 was first
applied.
(p)
Comprehensive financing cost
Comprehensive
financing cost consists of interest, net exchange differences and the monetary
effect. Transactions in foreign currency are recorded at the prevailing exchange
rate on the day of the related transactions. Monetary assets and liabilities
denominated in foreign currency are translated using the prevailing exchange
rate at the balance sheet date. Exchange differences determined on foreign
currency denominated assets or liabilities are charged or credited to results
of
operations.
The
monetary effect is determined by multiplying the difference between monetary
assets and liabilities at the beginning of each month by the rate of inflation
through year-end. The result thereby obtained represents the net monetary
position gain or loss on inflation and is credited or charged to results
of
operations.
(q)
Environmental costs
It
is the
Company’s policy to endeavor to comply with applicable environmental laws and
regulations. The Company established a liability for an amount which the
Company
believes it is appropriate, based on information currently available, to
cover
costs of environmental remediation it deems probable and estimable.
The
recorded amounts represent estimates of the environmental remediation costs
associated with future events triggering or confirming the costs that, in
management’s judgment, are probable. These estimates are based on currently
available facts, existing technology and presently enacted laws and regulations,
and take into consideration the likely effects of inflation and other societal
and economic factors.
(r)
Revenue recognition
Revenues
from the sale of products are recognized at the time products are shipped
and
the related risks and benefits of merchandise are transferred to the customer.
The
Company provides for freight expenses, returns and sales discounts at the
time
the related revenue is recognized. These provisions are deducted from net
sales
in the income statement.
(s)
Business and credit concentration-
The
Company does not believe it has significant concentrations of credit risks
in
its accounts receivable. The Company has a large customer base and
geographically diverse, consequently, no significant concentration in a specific
customer or market. The Company records an allowance for doubtful accounts
which
covers accounts receivables with specific collection problems based on analyses
and estimates made by management.
(t)
Earnings per share
The
basic
earnings per share of each period have been computed by dividing the net
consolidated income by the weighted average number of shares outstanding
of each
period.
(u)
Use of estimates
The
preparation of consolidated financial statements requires management to make
estimates and assumptions that affect the financial statements, the disclosure
of contingent assets and liabilities at the date of the financial statements
and
the reported amounts of revenues and expenses during the year. Actual results
could differ from these estimates.
The
Company has made significant accounting estimates with respect to the valuation
allowances of accounts receivable, inventories, long-lived assets, deferred
tax
assets and liabilities, environmental obligations and employee health care
obligations.
The
following is the rollforward of the allowance for bad debt for the year ended
December 31, 2005 (previous years’ allowance was considered not
significant):
Balance
as of December 31, 2004
|
|
|
Ps.
|
|
|
15,080
|
|
|
|
|
|
|
|
|
|
Provision
for the year
|
|
|
|
|
|
26,399
|
|
|
|
|
|
|
|
|
|
Write-off
of uncollectible accounts
|
|
|
|
|
|
(10,450
|
)
|
|
|
|
|
|
|
|
|
Restatement
of the initial balance
|
|
|
|
|
|
244
|
|
|
|
|
|
|
|
|
|
Balance
as of December 31, 2005
|
|
|
Ps.
|
|
|
31,273
|
|
(v)
Contingencies
Significant
liabilities or losses derived from contingencies are recognized when it is
probable that such contingencies will materialize and when there are reasonable
elements for quantifying the related liabilities. When a reasonable estimate
cannot be made, contingencies are disclosed qualitatively in the notes to
the
consolidated financial statements.
(w)
Impairment in the value of property, machinery and equipment and other
non-current assets
The
Company periodically evaluates the book value of its long-lived assets,
machinery and equipment, intangibles and other assets to determine whether
there
are any indications of impairment (i.e., carrying value in excess of recoverable
amount). The recoverable amount represents the net potential income that
may
reasonably be expected to be obtained from the use or sale of such assets.
If
the book value of a given asset is determined to be excessive, the Company
makes
the necessary allowances to reduce the carrying value of the asset to its
recoverable amount. Assets to be sold are presented in the financial statements
at the lower of their carrying value or recoverable amount.
(3)
|
Foreign
Currency Position
|
Foreign
currency denominated assets and liabilities at December 31, 2005 and 2004
were
as follows:
|
|
Thousands
of U.S. dollars
|
|
Thousands
of euros
|
|
Thousands
of pounds sterling
|
|
Thousands
of deutsche marks
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Current
assets
|
|
USD |
163,318
|
|
USD |
68,091
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
(180,511
|
)
|
|
(32,809
|
)
|
EUR |
(86
|
)
|
EUR |
(78
|
)
|
GBP |
(87
|
)
|
GBP |
(87
|
)
|
DEM |
(49
|
)
|
DEM |
(49
|
)
|
Long-term
liabilities
|
|
|
(36,095
|
)
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Total
liabilities
|
|
|
(216,606
|
)
|
|
(32,809
|
)
|
|
(86
|
)
|
|
(78
|
)
|
|
(87
|
)
|
|
(87
|
)
|
|
(49
|
)
|
|
(49
|
)
|
Net
assets (liabilities)
|
|
|
(53,288
|
)
|
|
35,282
|
|
|
(86
|
)
|
|
(78
|
)
|
|
(87
|
)
|
|
(87
|
)
|
|
(49
|
)
|
|
(49
|
)
|
The
exchange rates at April 28, 2006 and at December 31, 2005 and 2004 were as
follows (amounts in pesos):
|
|
April
28 2006
|
|
December
31, 2005
|
|
December
31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dollar
|
|
|
Ps.
|
|
|
11.1578
|
|
|
Ps.
|
|
|
10.7777
|
|
|
Ps.
|
|
|
11.264
|
|
Euro
|
|
|
|
|
|
13.9983
|
|
|
|
|
|
12.5797
|
|
|
|
|
|
15.169
|
|
Pound
sterling
|
|
|
|
|
|
20.1838
|
|
|
|
|
|
18.3570
|
|
|
|
|
|
21.474
|
|
Deutsche
mark
|
|
|
|
|
|
7.1572
|
|
|
|
|
|
6.4319
|
|
|
|
|
|
7.755
|
|
At
December 31, 2005 and 2004, the Company had the following monetary position
from
foreign non-monetary assets, or from assets whose replacement cost can only
be
determined in U.S. dollars.
|
|
Thousands
of U.S. dollars
|
|
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
Machinery
and equipment, net
|
|
|
Ps.
|
|
|
341,302
|
|
|
Ps.
|
|
|
280,909
|
|
Inventories
|
|
|
|
|
|
287,043
|
|
|
|
|
|
38,105
|
|
Ps.
|
|
|
Ps.
|
|
|
628,345
|
|
|
Ps.
|
|
|
319,014
|
|
The
summary of transactions carried out in U.S. dollars for the years ended December
31, 2005, 2004 and 2003, excluding imports of machinery and equipment, is
as
follows:
|
|
Thousands
of U.S. dollars
|
|
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
Sales
|
|
|
USD
|
|
|
650,508
|
|
|
USD
|
|
|
52,468
|
|
|
USD
|
|
|
28,810
|
|
Purchases
(raw materials)
|
|
|
|
|
|
(392,269
|
)
|
|
|
|
|
(78,422
|
)
|
|
|
|
|
(24,304
|
)
|
Other
expenses (spare parts)
|
|
|
|
|
|
(7,522
|
)
|
|
|
|
|
(4,898
|
)
|
|
|
|
|
(462
|
)
|
Interest
expense
|
|
|
|
|
|
|
)
|
|
|
|
|
(28
|
)
|
|
|
|
|
(3,312
|
)
|
The
exchange rate of the peso to foreign currencies used by the Company is based
on
the weighted average of free market rates available to settle its overall
foreign currency transactions.
The
Company has three foreign subsidiaries, whose combined assets, liabilities
and
stockholders’ equity are as follows:
|
|
Thousands
of U.S. dollars
|
|
|
|
2005
|
|
2004
|
|
Current
monetary assets
|
|
|
110,499
|
|
|
1,292
|
|
Inventories
and prepaid expenses
|
|
|
278,157
|
|
|
7
|
|
Current
liabilities
|
|
|
(121,745
|
)
|
|
(6,824
|
)
|
|
|
|
|
|
|
|
|
Working
capital
|
|
|
266,911
|
|
|
(5,525
|
)
|
|
|
|
|
|
|
|
|
Property,
plant and equipment
|
|
|
139,787
|
|
|
1,766
|
|
Other
assets and deferred charges
|
|
|
32,702
|
|
|
-
|
|
Long-term
liabilities
|
|
|
(100,233
|
)
|
|
-
|
|
Stockholders’
equity
|
|
|
339,167
|
|
|
(3,759
|
)
|
(4)
|
Related
Party Transactions and
Balances
|
Transactions
carried out with related parties, primarily with Industrias CH, during the
years
ended December 31, 2005, 2004 and 2003 were as follows:
|
|
2005
|
|
2004
|
|
2003
|
|
Sales
(1)
|
|
|
Ps
|
|
|
24,968
|
|
|
129,562
|
|
|
189,632
|
|
Purchases
|
|
|
|
|
|
1,659
|
|
|
11,076
|
|
|
13,822
|
|
Interest
income
|
|
|
|
|
|
-
|
|
|
-
|
|
|
2,754
|
|
Administrative
services expenses (2)
|
|
|
|
|
|
8,191
|
|
|
8,777
|
|
|
9,174
|
|
|
(1)
|
Primarily
this transaction relates to Intercompany sales of inventory with
Industrias CH
|
|
(2)
|
These
operations relate to Intercompany payroll services primarily with
Administración de empresas CH, S.A. de
C.V.
|
Balances
due from/to, related companies at December 31, 2005 and 2004 are as
follows:
|
|
2005
|
|
2004
|
|
Accounts
receivable:
|
|
|
|
|
|
Industrias
CH (1)
|
|
|
Ps.
|
|
|
-
|
|
|
Ps.
|
|
|
5,499
|
|
Administración
de empresas CH, S.A. de C.V. (2)
|
|
|
|
|
|
2,456
|
|
|
|
|
|
|
|
|
|
|
Ps.
|
|
|
2,456
|
|
|
Ps.
|
|
|
5,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industrias
CH (1)
|
|
|
Ps.
|
|
|
460,228
|
|
|
|
|
|
-
|
|
Other
|
|
|
|
|
|
-
|
|
|
|
|
|
21
|
|
|
|
|
Ps.
|
|
|
460,228
|
|
|
Ps.
|
|
|
21
|
|
The
account payable to Industrias CH is for an indefinite term and is a current
account that bears no interest. The balance of this payable is derived from
funds that the company received to finance the acquisition of PAV
Republic.
Inventories
are comprised as follows:
|
|
2005
|
|
2004
|
|
Finished
goods
|
|
|
Ps.
|
|
|
2,915,705
|
|
|
Ps.
|
|
|
172,983
|
|
Work
in process
|
|
|
|
|
|
8,946
|
|
|
|
|
|
1,626
|
|
Billets
|
|
|
|
|
|
124,06
|
|
|
|
|
|
160,198
|
|
Raw
materials and supplies
|
|
|
|
|
|
276,183
|
|
|
|
|
|
586,300
|
|
Materials,
spare parts and rollers
|
|
|
|
|
|
131,425
|
|
|
|
|
|
86,132
|
|
Advances
to suppliers and others
|
|
|
|
|
|
147,597
|
|
|
|
|
|
114,776
|
|
Goods
in transit
|
|
|
|
|
|
60,581
|
|
|
|
|
|
57,010
|
|
|
|
|
|
|
|
3,664,501
|
|
|
|
|
|
1,179,025
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
allowance for obsolescence
|
|
|
|
|
|
4,000
|
|
|
|
|
|
3,950
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ps.
|
|
|
3,660,501
|
|
|
Ps.
|
|
|
1,175,075
|
|
(6)
|
Derivative
Financial Instruments
|
The
Company uses derivative financial instruments primarily to offset its exposure
to financial risks related to the price of natural gas. Derivative instruments
currently used by the Company consist of natural gas swap contracts. These
contracts are recognized on the balance sheet at fair value. The swaps are
considered as cash flow hedges since the cash flow exchanges under the swap
are
highly effective in mitigating exposure to natural gas price fluctuations.
The
fair value of the swaps are recorded as part of Comprehensive income in
stockholders’ equity, in conformity with Mexican accounting Bulletin C-10,
Accounting
for Derivative Instruments and Hedging Activities,
which
the Company adopted early at December 31, 2003.
In
Mexico
the Company entered into these types of contracts with PEMEX Gas and
Petroquímica Básica (PGPB) under which the Company pays a fixed price and
receives a floating price during the contract period of 2004-2006. In the
United
States the swap contracts entered by the Company are for terms of less than
one
year.
At
December 31, 2005 and 2004, the swaps gave rise to the recognition of an
asset
of Ps. 57,477 and Ps. 19,025, and a deferred tax liability of Ps. 16,669
and Ps.
5,708, as well as a net comprehensive income item in stockholders’ equity of Ps.
40,354 and Ps. 12,847, respectively. Amounts recorded in comprehensive income
were Ps. 10,483, Ps. 2,364 and Ps. 27,507 in the years 2005, 2004 and 2003
respectively.
Based
on
its inventory turnover, the Company believes that the natural gas burned
and
incorporated in its products during a given month is reflected in the cost
of
sales of the subsequent month; consequently, the realized effects of this
hedge
are reclassified from the comprehensive income account to results of operations
in the following month. According to the contract termination dates, the
whole
value of the swaps will be realized during the year 2006. In the year ended
December 31, 2005, the Company recorded Ps. 35.1 million as a reduction in
the
cost of sales as a result of the transactions settled.
(7)
|
Property,
Plant and Equipment
|
Property,
plant and equipment are comprised as follows:
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
Buildings
|
|
|
Ps.
|
|
|
1,894,157
|
|
|
Ps.
|
|
|
1,774,205
|
|
Machinery
and equipment
|
|
|
|
|
|
6,527,797
|
|
|
|
|
|
6,129,556
|
|
Transportation
equipment
|
|
|
|
|
|
48,598
|
|
|
|
|
|
48,021
|
|
Furniture,
fixtures and computer equipment
|
|
|
|
|
|
54,699
|
|
|
|
|
|
40,215
|
|
|
|
|
|
|
|
8,525,251
|
|
|
|
|
|
7,991,997
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
accumulated depreciation
|
|
|
|
|
|
2,516,798
|
|
|
|
|
|
2,520,848
|
|
|
|
|
|
|
|
6,008,453
|
|
|
|
|
|
5,471,149
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land
|
|
|
|
|
|
515,189
|
|
|
|
|
|
492,664
|
|
Construction
in progress (1)
|
|
|
|
|
|
560,587
|
|
|
|
|
|
11,586
|
|
Idle
machinery and equipment
|
|
|
|
|
|
30,767
|
|
|
|
|
|
31,791
|
|
|
|
|
Ps.
|
|
|
7,114,996
|
|
|
Ps.
|
|
|
6,007,190
|
|
|
(1)
|
Construction
in progress corresponds primarily to machinery. The completion
date of
these projects is scheduled for May 2006 and the pending investment
amount
is Ps. 5,610.
|
Through
December 31, 2005 and 2004, the Company has capitalized the comprehensive
financing cost of building and machinery and equipment in the net amount
of Ps.
7,593, and Ps. 480,707, respectively, as an addition to the acquisition
cost.
At
December 31, 2005 and 2004, the specific restatement rate of machinery and
equipment was lower than the NCPI, since a significant portion of such machinery
is imported and accordingly, the inflation factor of the country of origin
and
the devaluation of the peso versus the respective currency were lower than
the
NCPI.
Accruals
at December 31, 2005 and 2004 include the following:
Salaries
and other
personnel
benefits
|
|
December
31, 2005
|
|
|
|
Fees
|
|
Total
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2004
|
|
|
Ps.
|
|
|
5,336
|
|
|
Ps.
|
|
|
3,601
|
|
|
Ps.
|
|
|
8,937
|
|
Increases
charged to operations
|
|
|
|
|
|
256,597
|
|
|
|
|
|
3,120
|
|
|
|
|
|
259,717
|
|
Payments
|
|
|
|
|
|
(251,076
|
)
|
|
|
|
|
(2,370
|
)
|
|
|
|
|
(253,446
|
)
|
Balance
at December 31, 2005
|
|
|
Ps.
|
|
|
10,857
|
|
|
Ps.
|
|
|
4,351
|
|
|
Ps.
|
|
|
15,208
|
|
December
31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2003
|
|
|
Ps.
|
|
|
8,149
|
|
|
Ps.
|
|
|
1,533
|
|
|
Ps.
|
|
|
9,682
|
|
Increases
charged to operations
|
|
|
|
|
|
52,157
|
|
|
|
|
|
6,428
|
|
|
|
|
|
58,585
|
|
Payments
|
|
|
|
|
|
(54,969
|
)
|
|
|
|
|
(4,360
|
)
|
|
|
|
|
(59,329
|
)
|
Balance
at December 31, 2004
|
|
|
Ps.
|
|
|
5,337
|
|
|
Ps.
|
|
|
3,601
|
|
|
Ps.
|
|
|
8,938
|
|
(9)
|
Notes
Payable, Long-term Debt and Medium-term
Notes
|
(a)
Notes payable
This
caption includes uncollateralized loans with BBVA Bancomer, S.A. that bear
annual interest ranging from 3.24% to 3.37% and mature at March 31,
2005.
(b)
Long-term debt
At
December 31, 2005 and 2004, the Company’s long-term debt is as
follows:
|
|
2005
|
|
2004
|
|
Debt
with Ohio Department of Development
|
|
|
Ps.
|
|
|
46,994
|
|
|
Ps.
|
|
|
- |
|
Revolving
loan with General Electric Capital (GE)
|
|
|
|
|
|
362,315
|
|
|
|
|
|
-
|
|
Medium-term
notes
|
|
|
|
|
|
3,275
|
|
|
|
|
|
3,538
|
|
Total
long-term debt
|
|
|
|
|
|
412,584
|
|
|
|
|
|
3,538
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
current portion of long-term debt
|
|
|
|
|
|
21,034
|
|
|
|
|
|
3,538
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt excluding current portion
|
|
|
Ps.
|
|
|
391,550
|
|
|
Ps.
|
|
|
-
|
|
Long-term
debt
The
company has a loan with Ohio Department of Development that was used to
modernize the plant in Lorain, Ohio. The project concluded in 2003. The initial
amount of the loan was USD 5 million, bearing 3% annual interest and maturing
on
the first day of each month, through the final maturity of July 2008. Principal
amounts of USD 1.6 million, USD 1.7 million and USD 1 million mature during
2006, 2007 and 2008, respectively. The loan is guaranteed by the project
to
modernize the 20-inch bar mill in the Lorain plant.
Revolving
line of credit with General Electric Capital (GE)
On
July
22, 2005, Republic one of the Company’s subsidiaries located in USA had an
available revolving line of credit with a guarantee of Ps 2,700.6 million
(USD
250 million) with General Electric Capital Corporation (GE capital). Such
loan
matures in May 2009 but may be rolled over through May 20, 2010. As of November
1, 2005, the available credit line of Ps 2,700 millions (USD 250 million)
was
reduced to Ps 1,620.4 millions (USD 150 million).
At
December 31, 2005 has an outstanding balance with GE Capital of Ps 362.3
million
(USD 33.4 million) and Ps 35.6 million (USD 3.3 million) on letters of credit.
The company’s available balance at December 31, 2005 aggregates Ps 1,223.9
million (USD 113.3 million). The company has to pay a 0.50% annual commission
on
the unused credit. The available draw downs are limited to the sum of 85%
of
Republic’s determined accounts receivable plus 65% of its determined
inventory.
The
loan
is unconditionally and irrevocably guaranteed by Republic’s subsidiaries and
specifically with their current inventories and accounts receivable, as well
as
its subsequent acquisitions. As of December 31, 2005 the inventories and
accounts receivables aggregated Ps 2,769 million and Ps 1,167 millions
respectively.
Such
loan
bears interest based on one of the two following options, which the Company
shall choose at its own discretion: 1) at an indexed rate equal to the highest
prime rate published by the Wall Street Journal, plus the applicable margin,
or
the federal funds rate plus 50 base percentage points per year and the
applicable margin; 2) the LIBOR plus the applicable margin. Margins were
adjusted based on the available rate for the quarter on a base established
in
advance. The base for the applicable margin for the indexed rate was adjusted
between 0.00% and 1.00%, and the rate for margins applicable to the LIBOR
was
adjusted between 1.75% and 2.75%. From November 1, 2005 through the end of
2005,
the rate was fixed at 0.00% for the applicable margins for the prime rate
and
1.00% for the applicable margin for the LIBOR. At December 31, 2005, the
loans
from GE Capital bear interest at an annual 7.25% rate for the loans at indexed
rates and an annual 5.38% rate for those at the LIBOR.
As
of
January 1, 2006, the applicable margins will be adjusted from 0.00% to 0.25%
for
the indexed rate, and 0.875% to 1.25% for the loans at the LIBOR, based on
the
average daily availability of the preceding quarter. The new agreement also
changes the commission on the unused credit from 0.50% to 0.375%. Based on
the
last quarter of 2005, in accordance with the available daily rate, the initial
margins for 2006 will be 0.00% for the indexed rate, 0.875% for the LIBOR,
0.500% for the commission on the unused credit, and 0.875% applicable to
the
letters of credit.
The
loan
from GE Capital establishes a series of requirements, obligations and
restrictive covenants, including limitations in capital investments and
maintenance. Expenses in capital investment exclusively in Republic for any
fiscal year are limited to Ps 1,084.8 million (USD 100 million), excluding
expenses on capital investments financed by earnings from insurance recoveries.
At December 31, 2005, the Company is in compliance with all such requirements,
obligations and restrictive covenants established in the loan with GE
Capital.
(c)
Industrial mortgage loan
Advance
payments of USD 1,697,952 were made on the industrial mortgage loan in 2004,
plus the corresponding interest. On March 18, 2004, the Company repaid in
full
the loan in the amount of USD 1,697,952.
The
Company and all of its subsidiaries that own property, plant and equipment
took
out an industrial mortgage as security on this loan. The Company’s management is
in the process of canceling the guarantees established in the restructuring
agreement entered into with the banks, which allows the industrial mortgage
to
be released.
(10)
|
Seniority
Premiums and Termination
Payments
|
The
cost,
obligations and other components of seniority premiums and termination payments
mentioned in note 2j were determined based on actuarial computations at December
31, 2005, 2004 and 2003.
The
components of the net period cost for the years ended December 31, 2005,
2004
and 2003 are as follows:
|
|
|
|
2005
|
|
|
|
2004
|
|
|
|
2003
|
|
Net
period cost
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Labor
cost
|
|
|
Ps.
|
|
|
2,859
|
|
|
Ps.
|
|
|
593
|
|
|
Ps.
|
|
|
309
|
|
Financial
cost
|
|
|
|
|
|
1,057
|
|
|
|
|
|
321
|
|
|
|
|
|
216
|
|
Amortization
of transition liability
|
|
|
|
|
|
1,128
|
|
|
|
|
|
405
|
|
|
|
|
|
259
|
|
Amortization
of prior service cost and plan modifications
|
|
|
|
|
|
198
|
|
|
|
|
|
95
|
|
|
|
|
|
69
|
|
Effect
of cancelled obligations
|
|
|
|
|
|
(31
|
)
|
|
|
|
|
371
|
|
|
|
|
|
-
|
|
Net
period cost
|
|
|
Ps.
|
|
|
5,211
|
|
|
Ps.
|
|
|
1,785
|
|
|
Ps.
|
|
|
853
|
|
An
analysis of the present value of benefit obligations is as follows:
|
|
|
|
2005
|
|
|
|
2004
|
|
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Projected
benefit obligation
|
|
|
Ps.
|
|
|
21,752
|
|
|
Ps.
|
|
|
8,093
|
|
|
Ps.
|
|
|
6,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized
items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transition
liability
|
|
|
|
|
|
(9,506
|
)
|
|
|
|
|
(2,978
|
)
|
|
|
|
|
(2,508
|
)
|
Prior
service cost and plan modifications
|
|
|
|
|
|
(357
|
)
|
|
|
|
|
(410
|
)
|
|
|
|
|
-
|
|
Variances
in assumptions and experience adjustments
|
|
|
|
|
|
1,308
|
|
|
|
|
|
(338
|
)
|
|
|
|
|
(333
|
)
|
Additional
liability
|
|
|
|
|
|
6,580
|
|
|
|
|
|
2,635
|
|
|
|
|
|
2,044
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
projected liability recognized in consolidated balance sheets (1)
|
|
|
Ps.
|
|
|
19,777
|
|
|
Ps.
|
|
|
7,002
|
|
|
Ps.
|
|
|
5,608
|
|
|
(1)
|
The
Net projected liability as of December 31, 2005 includes Ps.6.3
million
related to a defined retiree health care plan of PAV Republic which
is one
of the company’s subsidiaries located in US. Such plan covers
approximately 14 union hourly employees. This plan assumed a health
care
cost rate for the year of 10%.
|
The
remainder of the increase as of December 31, 2005 in the net periodic cost
and
the net projected liability is due mainly to inclusion of the termination
payment obligation starting January 1, 2005, as required by revised accounting
Bulletin D-3.
The
most
significant assumptions used in determining the net period cost of the plan
are
as follows:
|
|
2005
|
|
2004
|
|
Actual
discount rate used to reflect present value of obligations
|
|
|
4.5
|
%
|
|
4.5
|
%
|
Actual
rate of future salary increases
|
|
|
1
|
%
|
|
1
|
%
|
Actual
expected return rate of plan assets
|
|
|
4.5
|
%
|
|
4.5
|
%
|
From
the
companies of the group only Republic offers other benefit plans for its
employees. Most of the production workers are insured by collective contracting
with the United Steelworkers of America (USWA). The collective contracting
expires August 15, 2007 (labor agreement). From the Mexican operations
approximately 60% of the employees are under a collective contract. The Mexican
collective contracts expire in periods greater than one year.
The
labor
agreement provides a defined health and retirement contribution program and
pension benefits. Republic is required to contribute to the program for each
work hour accrued at a rate of Ps. 41 (actual amount) per hour until the
labor
agreement expires. For the period from July 22, 2005 through December 31,
2005,
During 2005 there was an expense of Ps. 69.1 million.
The
labor
agreement includes an employee profit sharing program, to which Republic
must
contribute 15% of its quarterly earnings exceeding Ps. 135.1 million before
taxes. For the period from July 22, 2005 through December 31, 2005, there
was an
expense of Ps. 7.5 million for the profit sharing program.
In
addition, Republic has a defined retirement contribution plan which covers
virtually all of its non-union salaried employees. This plan is designed
to
provide retirement benefits through the Company contributions and deferred
employee compensation. Republic contributes to this plan each payment period
based on the age and length of service of its personnel at January of each
year.
The contribution amount is equal to the base salary multiplied by the
appropriate percentage as determined based on the worker’s age and years of
service.
The
full
contribution percentage is acquired upon completing 5 years of service.
Furthermore, workers are allowed to make contributions to a 401(k) plan through
wage discounts. The Company contributes to the Republic’s employees 25% on the
first 5% of wages that the worker chooses to contribute. Workers eventually
acquire a 100% match of 401(k) contributions from the Company. For the period
from July 22, 2005 through December 31, 2005, there was a recorded expense
of
Ps. 12 million on retirement contribution plans and 401(k) contribution
plans.
In
accordance with the profit sharing plan for salary and non-union workers,
excluding a select group of managers and executives, Republic contributed
3% of
quarterly earnings exceeding Ps. 135.1 million before taxes. For the period
from
July 22, 2005, through December 31, 2005, there was a recorded expense of
Ps.
1.1 million.
Republic
offers, an administrative incentive plan to a select group of managers and
executives. The incentives are based on the achievement of select corporate
and
individual objectives which include financial results, improvement in product
yield, energy use, quality and safety standards and cash flow. For the period
from July 22, 2005 through December 31, 2005, there was not any recorded
expense
for this plan. In regards to the acquisition of Republic on July 22, 2005,
the
Company assumed the accumulated liability for this plan of Ps. 9.8 million,
which was paid in January 2006. The Company also assumed an incentive
compensation for Republic’s C.E.O Joseph Lapinsky of Ps. 5.4 million, which was
paid in January 2006.
Republic
has a deferred compensation plan that covers certain key workers. The plan
allows the worker to defer an annual amount of his/her base salary and grants
an
annual fixed contribution by Republic based on a percentage of salary. For
the
period from July 22, 2005 through December 31, 2005, there was a related
expense
recorded of Ps. 1.1 million.
(12)
|
Income
Tax, Asset Tax and Employee Profit Sharing and Tax Loss
Carryforwards
|
Industrias
CH, holding company files a Consolidated Tax Return. Under Mexican Income
Tax
Law (MITL) Industrias CH does not have to allocate any tax to its subsidiaries
since each of its subsidiaries has the obligation to calculate on a stand
alone
basis its own taxes and only pay the minority part of such taxes directly
to the
Mexican Income Revenue Service (IRS). The majority interest for consolidated
tax
purposes is paid through the holding company. The Company computes its tax
provision on a stand alone basis.
Under
current tax regulations, companies must pay the greater between income tax
and
asset tax. The
computation of both taxes considers the effects of inflation, although
differently from accounting principles generally accepted in
Mexico.
Statutory
employee profit sharing is computed practically on the same basis as income
tax,
but excluding the effects of inflation.
The
Mexican Asset Tax Law establishes payment of a 1.8% tax on the value of restated
assets net of certain liabilities.
An
analysis of income tax charged to results of operations for the years ended
December 31, 2005, 2004 and 2003 is as follows:
|
|
|
|
2005
|
|
|
|
2004
|
|
|
|
2003
|
|
Current
Income Tax Mexican Subsidiaries
|
|
|
Ps.
|
|
|
124,037
|
|
|
Ps.
|
|
|
21,137
|
|
|
Ps.
|
|
|
13,006
|
|
Current
Income Tax Foreign Subsidiaries
|
|
|
|
|
|
(45,160
|
)
|
|
|
|
|
1,999
|
|
|
|
|
|
413
|
|
Deferred
Income Tax Mexican Subsidiaries
|
|
|
|
|
|
40,806
|
|
|
|
|
|
320,466
|
|
|
|
|
|
139,779
|
|
Deferred
Income Tax Foreign Subsidiaries
|
|
|
|
|
|
70,912
|
|
|
|
|
|
-
|
|
|
|
|
|
-
|
|
Income
tax expense
|
|
|
Ps.
|
|
|
190,595
|
|
|
Ps.
|
|
|
343,602
|
|
|
Ps.
|
|
|
153,198
|
|
At
December 31, 2005 and 2004 and 2003, the tax expense attributable to income
before income tax, employee profit sharing and minority interest differed
from
the expense computed by applying the income tax rate of 30% in 2005, 33%
in 2004
and 34% in 2003 to income before these provisions and minority interest.
An
analysis is as follows:
|
|
|
|
2005
|
|
|
|
2004
|
|
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected
tax expense
|
|
|
Ps.
|
|
|
446,521
|
|
|
Ps.
|
|
|
596,069
|
|
|
Ps.
|
|
|
162,868
|
|
Increase
(decrease) resulting from:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
effect of inflation
|
|
|
|
|
|
30,601
|
|
|
|
|
|
35,025
|
|
|
|
|
|
42,691
|
|
Adjustments
for enacted changes in tax laws and rates
|
|
|
|
|
|
-
|
|
|
|
|
|
(288,455
|
)
|
|
|
|
|
(34,652
|
)
|
Change
in valuation allowance of deferred tax assets (1)
|
|
|
|
|
|
(132,326
|
)
|
|
|
|
|
(1,536
|
)
|
|
|
|
|
(46,993
|
)
|
Majority
asset tax
|
|
|
|
|
|
5,840
|
|
|
|
|
|
10,757
|
|
|
|
|
|
13,278
|
|
Effect
of beginning inventory due to change in Tax laws and corporate
restructure(2)
|
|
|
|
|
|
(420,537
|
)
|
|
|
|
|
-
|
|
|
|
|
|
-
|
|
Deferred
credit amortization (3)
|
|
|
|
|
|
(20,072
|
)
|
|
|
|
|
-
|
|
|
|
|
|
-
|
|
Additional
liability
|
|
|
|
|
|
303,461
|
|
|
|
|
|
-
|
|
|
|
|
|
-
|
|
Others,
net
|
|
|
|
|
|
(22,893
|
)
|
|
|
|
|
(8,258
|
)
|
|
|
|
|
16,006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
Ps.
|
|
|
190,595
|
|
|
Ps.
|
|
|
343,602
|
|
|
Ps.
|
|
|
153,198
|
|
|
(1)
|
The
valuation allowance for deferred assets at December 31, 2005 and
2004 is
Ps. 68,329 and Ps. 200,655, respectively. In 2004, the Company
had a
valuation allowance that covered almost the total amount of the
recoverable asset tax and tax loss carryforwards due to the uncertainty
of
their recovery. However, in 2005 the Company recovered part of
the
recoverable asset tax and reduced deferred tax assets by Ps. 84,086.
As a
result of the asset tax recovery, the Company estimated that a
higher
amount of deferred tax assets is more likely than not to be recovered,
consequently it reduced its valuation allowance on its deferred
tax asset
as of December 31, 2005 The net change in the valuation allowance
for the
years ended December 31, 2005 and 2004 was a decrease of Ps. 132,326
and
Ps. 1,536, respectively.
|
|
(2)
|
In
conformity with the Mexican Income Tax Law (MITLA) in force through
December 31, 2004, the cost of sales was considered as a non-deductible
expense and instead, purchases of inventory and production costs
were
considered as deductible items. This tax treatment in the MITLA
gave rise
to a deferred tax liability because of the difference in the
book value of
inventories and its corresponding tax value. Effective January
1, 2005,
the MITLA considers cost of sales as a deductible item instead
of
inventory purchases and production costs. The MITLA established
transition
rules to be followed to accumulate the December 31, 2004 inventory
balance
into taxable revenue. However, during 2005 the Company recorded
a tax
benefit of Ps. 420,537, because of the non-accumulation, in the
coming
years, of its inventory balance at December 31, 2004 in compliance
with
the specific transition rules of MITLA as a result of a corporate
restructuring (liquidation of its Subsidiary, COSICA) of the
Company
|
Also,
the
Company recorded an additional deferred tax liability for the amount of Ps.
303,461 to account for the difference in net income of the 2005 period for
which
the Company did not pay taxes (See Note 13c). This additional tax liability
primarily relates to the inventory item and tax law change described above
as it
is the primary source of income for which the Company did not pay
taxes.
|
(3)
|
Benefit
in the Income Tax derived from Net Operating Losses (NOLs) obtained
through OAL acquisition (Note 14
b).
|
The
effective tax rate for the fiscal years ending December 31, 2005, 2004 and
2003
were 12.8%, 19.02% and 31.98% respectively. The effective income tax rate
during
2005 had a significant improvement that was the result of a corporate
restructure. These changes resulted in favorable tax differences that had
a one
time impact in our effective income tax rate for the year ended December
31,
2005
The
tax
effects of temporary differences that give rise to significant portions of
the
deferred tax assets and liabilities at December 31, 2005 and 2004 are as
follows:
|
|
|
|
2005
|
|
|
|
2004
|
|
Deferred
tax assets:
|
|
|
|
|
|
|
|
|
|
Allowance
for bad debts
|
|
|
Ps.
|
|
|
60,864
|
|
|
Ps.
|
|
|
7,222
|
|
Liability
provisions
|
|
|
|
|
|
106,591
|
|
|
|
|
|
19,046
|
|
Advances
from customers
|
|
|
|
|
|
22,392
|
|
|
|
|
|
29,825
|
|
Tax
loss carryforward
|
|
|
|
|
|
316,796
|
|
|
|
|
|
18,594
|
|
Recoverable
asset tax
|
|
|
|
|
|
103,931
|
|
|
|
|
|
188,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
gross deferred assets
|
|
|
|
|
|
610,574
|
|
|
|
|
|
262,704
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
valuation allowance
|
|
|
|
|
|
68,329
|
|
|
|
|
|
200,655
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
assets, net
|
|
|
|
|
|
542,245
|
|
|
|
|
|
62,049
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventories
|
|
|
|
|
|
399,042
|
|
|
|
|
|
325,907
|
|
Derivative
financial instruments
|
|
|
|
|
|
16,669
|
|
|
|
|
|
5,708
|
|
Property,
plant and equipment
|
|
|
|
|
|
1,246,885
|
|
|
|
|
|
1,030,126
|
|
Pre-operating
expenses
|
|
|
|
|
|
89,240
|
|
|
|
|
|
76,204
|
|
Purchase
commitment
|
|
|
|
|
|
-
|
|
|
|
|
|
108,243
|
|
Others
|
|
|
|
|
|
27
|
|
|
|
|
|
6,406
|
|
Additional
liabilities resulting from excess of book value of stockholders’ equity
over its tax value
|
|
|
|
|
|
303,461
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
deferred liabilities
|
|
|
|
|
|
2,055,324
|
|
|
|
|
|
1,552,594
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax liability, net
|
|
|
Ps.
|
|
|
1,513,079
|
|
|
Ps.
|
|
|
1,490,545
|
|
For
the
years ended December 31, 2005 and 2004, deferred employee profit sharing
is
deemed immaterial.
An
analysis of partnership capital tax accounts at December 31, 2005 is as
follows:
|
|
|
|
Restated
contributed capital account (CUCA)
|
|
|
Ps.
|
|
|
4,316,203
|
|
Net
tax profit account (CUFIN)
|
|
|
|
|
|
189
|
|
Tax
loss
carryforward and recoverable asset tax at December 31, 2005 expire as
follows:
|
|
|
|
Restated
amount at June 30, 2006
|
|
Year
of expiration
|
|
|
|
Tax
loss Carryforward
|
|
|
|
Recoverable
asset tax
|
|
2006
|
|
|
Ps.
|
|
|
582
|
|
|
Ps.
|
|
|
7,115
|
|
2007
|
|
|
|
|
|
4,683
|
|
|
|
|
|
13,328
|
|
2008
|
|
|
|
|
|
17,805
|
|
|
|
|
|
20,513
|
|
2009
|
|
|
|
|
|
31,252
|
|
|
|
|
|
16,847
|
|
2010
|
|
|
|
|
|
2,367
|
|
|
|
|
|
18,671
|
|
2011
|
|
|
|
|
|
399
|
|
|
|
|
|
15,396
|
|
2012
|
|
|
|
|
|
5,754
|
|
|
|
|
|
3,234
|
|
2013
|
|
|
|
|
|
150,097
|
|
|
|
|
|
1,802
|
|
2014
|
|
|
|
|
|
14,874
|
|
|
|
|
|
2,089
|
|
2015(1)
|
|
|
|
|
|
3,757,154
|
|
|
|
|
|
4,936
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ps.
|
|
|
3,984,967
|
|
|
Ps.
|
|
|
103,931
|
|
|
(1)
|
Includes
tax loss
carryforwards as described in Note 14
b.
|
A
new
income tax law in México was enacted on December 1, 2004, which established an
income tax rate of 30%
for
2005, 29% for 2006, and 28% for 2007 and subsequent years. As
a
result of these changes, for the year ended December 31, 2004, the Company
recognized a decrease in the net deferred tax liability of Ps. 288,455 which
was
credited to results of operations.
(13)
|
Stockholders’
Equity
|
(a)
Structure of capital stock
|
i)
|
At
an Extraordinary Stockholders’ Meeting held on April 29, 2005, the
stockholders agreed to convert 15,000,000 shares owned by Industrias
CH
consisting of variable capital stock, which have a nominal value
of Ps.
220,245, into fixed capital shares. In the same meeting, the stockholders
approved a 3-for-1 stock split (effective until May 30, 2006) for
all
outstanding shares to increase the number of shares, thus facilitating
their tradability. The Company’s Board of Directors is delegated the power
to approve, on the date the Board sees fit, the terms and conditions
under
which the Company shall perform the approved split and the secretary
of
the Board of Directors shall be advised as to how and when to proceed
with
the cancellation of the replaced shares received once all the Company’s
shares have been exchanged.
|
|
ii)
|
At
a regular stockholders’ meeting held on April 29, 2005, it was agreed to
increase the Company’s variable capital stock by Ps. 110,303 (Ps. 103,785
nominal amount) by issuing 7,114,285 common “B” series shares, 4,386,615
of which were subscribed and paid in by Industrias CH through the
capitalization of contributions for future capital increases of
Ps. 68,011
(Ps. 63,992 nominal amount) and a stock premium of Ps. 162,952
(Ps.
152,707 nominal amount). The remaining 2,727,670 shares are to
be offered
to the rest of the Company’s stockholders, with prior authorization of the
National Registry of Securities, so as to provide them the opportunity
to
exercise their preemptive rights to subscribe and pay in the capital
increase in proportion to their stock holding. It was agreed that
the Ps.
34.81(actual amount) difference between the nominal theoretical
value of
the shares of Ps. 14.59 (actual amount) and the subscription price
of the
shares of the capital increase of Ps. 49.40 (actual amount) would
be
recorded by the Company as a stock
premium.
|
|
iii)
|
At
a Board of Directors’ meeting held on December 3, 2004, it was resolved to
record Ps. 230,309 (Ps. 216,698 historical) as contributions for
future
capital stock increases corresponding to various contributions
by
Industrias CH, for the purpose of having the Company and CSC acquire
the
assets of the steel plants located in Tlaxcala and Puebla, as well
as for
the assignment of a technical assistance agreement derived from
such
acquisition.
|
|
iv)
|
At
a Board of Directors’ meeting held on May 13, 2004, the Company’s minority
stockholders exercised their preemptive rights to subscribe and
pay in the
increase in variable capital stock declared on November 19, 2003,
contributing Ps. 24,693 (Ps. 22,902 nominal amount) through the
subscription and payment of 1,569,962 shares. A total of 301,153
shares
that were neither subscribed nor paid in were
cancelled.
|
|
v)
|
At
an extraordinary stockholders’ meeting held on May 30, 2006, the
stockholders approved the increase on that same date in the number
of
outstanding shares by means of a three-for-one stock split. All
per share
and shares outstanding data in these financial statements have
been
retroactively restated to reflect the three-for-one stock
split.
|
Subsequent
to the above-mentioned resolutions and activities, the Company’s capital stock
aggregates Ps. 3,476,499, represented by 413,788,797 common “B” series shares
(137,929,599 common “B” series shares prior to the stock split) with no par
value. Such shares may be subscribed and paid in by both Mexican and foreign
individuals or companies.
Shares
outstanding for 2005, 2004 and 2003 are as follows:
|
|
2005
|
|
2004
|
|
2003
|
|
Common
“B” series shares
|
|
|
413,788,797
|
|
|
400,628,952
|
|
|
395,919,066
|
|
Common
“B” series shares prior to the stock split
|
|
|
137,929,599
|
|
|
133,542,984
|
|
|
131,973,022
|
|
Each
share has the right to one vote at stockholders’ meetings.
Minimum
fixed capital not subject to withdrawal is Ps. 441,786, nominal amount, which
may be increased or decreased by a resolution passed at a general extraordinary
shareholders’ meeting.
(b)
Comprehensive income
Comprehensive
income reported on the statement of changes in stockholders’ equity represents
the result of all of the Company’s activities during the year and includes the
following captions, which in conformity with accounting principles generally
accepted in Mexico, were applied directly to stockholders’ equity, except for
net income:
|
|
|
|
2005
|
|
|
|
2004
|
|
|
|
2003
|
|
Net
income
|
|
|
Ps.
|
|
|
1,279,898
|
|
|
Ps.
|
|
|
1,462,671
|
|
|
Ps.
|
|
|
320,522
|
|
Equity
adjustment for non- monetary assets (1)
(2)
|
|
|
|
|
|
(446,443
|
)
|
|
|
|
|
91,436
|
|
|
|
|
|
392,155
|
|
Deferred
taxes applied to the equity adjustments for non- monetary
assets
|
|
|
|
|
|
112,411
|
|
|
|
|
|
(25,527
|
)
|
|
|
|
|
(142,892
|
)
|
Fair
value of derivative financial instruments
|
|
|
|
|
|
38,652
|
|
|
|
|
|
3,379
|
|
|
|
|
|
15,646
|
|
Deferred
tax on the fair value of derivative financial instruments
|
|
|
|
|
|
(11,145
|
)
|
|
|
|
|
(1,014
|
)
|
|
|
|
|
(5,163
|
)
|
|
|
|
|
|
|
973,373
|
|
|
|
|
|
1,530,945
|
|
|
|
|
|
580,268
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest (3)
|
|
|
|
|
|
17,491
|
|
|
|
|
|
47
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
Ps.
|
|
|
990,864
|
|
|
Ps.
|
|
|
1,530,992
|
|
|
Ps.
|
|
|
580,269
|
|
|
(1)
|
In
2005, includes Cumulative Translation Adjustment of SimRep for
Ps.14,935.
|
|
(2)
|
Includes
primarily equity adjustment for non-monetary due to fixed
assets.
|
|
(3)
|
Minority
interest represents the minority share holding of Industrias CH
in SimRep
Corporation.
|
(c)
Restrictions on stockholders' equity
The
Company is required to appropriate at least 5% of the net income of each
year to
increase the legal reserve. This practice must be continued until the legal
reserve reaches 20% of capital stock issued and outstanding. At December
31,
2005, the legal reserve aggregates Ps. 21,586.
Stockholder
contributions, which are restated for tax purposes, may be refunded tax-free,
provided that the reimbursed amount is equal to or in excess of the Company’s
stockholders’ equity.
Earnings
distributed on which no income tax has been paid, as well as other stockholders’
equity account distributions, are subject to payment of income tax, payable
by
the Company, at the rate of 29%; consequently, the stockholders may only
receive
71% of such dividends.
The
variable portion of the capital stock may never exceed ten times the amount
represented by the fixed portion. The fixed portion of Simec’s capital stock may
be increased or decreased by a resolution passed at a general extraordinary
shareholders’ meeting. The variable portion of the Company’s capital stock may
be increased or decreased by a resolution passed at a general ordinary
shareholders’ meeting. Any increase or decreases in the Company’s capital stock
must be recorded in the Company’s registry of capital variations.
(a)
On
July
22, 2005, the Company and Industrias CH acquired the outstanding shares of
PAV
Republic, Inc. (Republic) through their subsidiary SimRep Corporation, a
U.S.
company. The acquisition cost amounted to USD 245 million, of which USD 229
million corresponds to the purchase price and USD 16 million, to the direct
cost
of the business combination. The Company contributed USD 123 million to acquire
50.2% of the representative shares of SimRep Corporation and Industrias CH,
the
holding company, acquired the remaining 49.8%. SimRep
then acquired all the shares from Republic through a stock purchase agreement.
Under the terms of the stock purchase agreement, the Company acquired the
right
to a portion of the reimbursement from an unresolved insurance claim. Any
receipts will change the final purchase adjustment to reflect the fair value
of
the net assets acquired (See Note 17 c). Republic has six production plants:
five in the United States and one in Canada. The Company and Industrias CH
acquired Republic to increase their presence in the US market.
The
fair
value of the assets acquired amounted to USD 474 million, which was in excess
of
the acquisition cost of USD 245 million, giving rise to a negative goodwill
of
USD 229 million, which was allocated proportionally to all non-current assets.
The factors that led to the negative goodwill include the fact that the
acquisition cost to the Company was favorable since the seller was a short-term
investor who had previously acquired Republic out of bankruptcy. The purchase
price paid for Republic was the result of the negotiations carried out with
the
previous owner based on the business expectations of Republic at that time.
This
negotiated cost was less than the sum of the net fair values of the individual
assets acquired and liabilities assumed. The fair value of the net assets
acquired, after the allocation of negative goodwill is as follows:
Current
assets
|
|
|
Ps.
|
|
|
4,405,135
|
|
Property,
plant and equipment
|
|
|
|
|
|
1,275,784
|
|
Intangibles
and deferred charges
|
|
|
|
|
|
369,505
|
|
Other
assets
|
|
|
|
|
|
61,022
|
|
Total
assets
|
|
|
|
|
|
6,111,446
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
1,703,562
|
|
Long-term
debt
|
|
|
|
|
|
695,050
|
|
Renewable
credit
|
|
|
|
|
|
748,547
|
|
Deferred
taxes
|
|
|
|
|
|
282,869
|
|
Other
long-term debt
|
|
|
|
|
|
72,296
|
|
|
|
|
|
|
|
3,502,324
|
|
Net
assets acquired
|
|
|
Ps.
|
|
|
2,609,122
|
|
As
a
result of the acquisition of Republic, an analysis of information regarding
Simec’s results of operations of 2005 and 2004, including Republic’s 6 plants,
over a twelve-month period, as if the plants had been incorporated into the
Company since the beginning of the year (unaudited information) is as
follows:
|
|
|
|
Unaudited
|
|
|
|
|
|
2005
|
|
|
|
2004
|
|
Net
sales
|
|
|
Ps.
|
|
|
22,380,726
|
|
|
Ps.
|
|
|
21,270,065
|
|
Marginal
profit
|
|
|
Ps.
|
|
|
3,824,626
|
|
|
Ps.
|
|
|
4,203,760
|
|
Majority
net income
|
|
|
Ps.
|
|
|
1,462,215
|
|
|
Ps.
|
|
|
1,989,927
|
|
Earnings
per share (pesos)
|
|
|
|
|
|
3.53
|
|
|
|
|
|
4.98
|
|
Tons
sold
|
|
|
|
|
|
2,683,312
|
|
|
|
|
|
2,612,178
|
|
|
(b)
|
On
July 20, 2005, the Company acquired all shares of Operadora de
Apoyo
Logístico, S.A. de C.V. (OAL), a subsidiary of Grupo TMM, S.A. de C.V.,
for Ps. 133 million, to make it the operating company of the three
steel
plants in Mexico. This transaction resulted in a deferred credit
of Ps.
406,731.
|
The
consolidated financial position at date of the acquisition, restated at
June 30, 2006, is as follows:
Current
assets
|
|
|
Ps.
|
|
|
1,006
|
|
Deferred
tax asset
|
|
|
|
|
|
526,753
|
|
Total
assets
|
|
|
|
|
|
527,759
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
assets acquired
|
|
|
Ps.
|
|
|
527,759
|
|
OAL
had
accumulated NOLs of Ps. 1,331,953 that could be offset against future taxable
income. However the recorded financial effect of this tax benefit is Ps.
526,753
(See Note 12). Since OAL had no operations before the acquisition, no pro
forma
results from operations are included here.
|
(c)
|
On
August 9, 2004, the Company acquired the inventories, land, buildings,
machinery and equipment and assumed the labor obligations of the
Apizaco,
Tlaxcala and Cholula, Puebla plants that were owned by Atlax, S.A.
de C.V.
and Operadora Metamex, S.A. de C.V. (the sellers). The purchase
amounted
to approximately USD 120 million. The Company began operating the
Tlaxcala
and Puebla plants on August 1,
2004.
|
A
summary
of the estimated fair value of the assets acquired and the liabilities assumed
at the acquisition date, restated for inflation through June 30, 2006 is
as
follows:
Current
assets (inventories)
|
|
|
Ps.
|
|
|
136,427
|
|
Property,
plant and equipment
|
|
|
|
|
|
1,259,592
|
|
Prepaid
technical assistance
|
|
|
|
|
|
86,537
|
|
Total
assets acquired
|
|
|
|
|
|
1,482,556
|
|
|
|
|
|
|
|
|
|
Labor
obligations
|
|
|
|
|
|
3,448
|
|
Net
assets acquired
|
|
|
Ps.
|
|
|
1,479,108
|
|
As
a
result of the above-mentioned acquisition of assets, an analysis of certain
information regarding the results of operations of the Apizaco and Cholula
plants over a twelve-month period ended December 31, 2004, as if the plants
had
been incorporated into the Company since the beginning of the year (unaudited
information) is as follows:
|
|
|
|
|
|
Net
sales
|
|
|
Ps.
|
|
|
7,205,165
|
|
Marginal
profit
|
|
|
|
|
|
2,788,234
|
|
Net
income
|
|
|
Ps.
|
|
|
1,525,374
|
|
Net
income earnings per share (pesos)
|
|
|
|
|
|
11.47
|
|
Tons
sold
|
|
|
|
|
|
978,969
|
|
The
Company and the sellers agreed to indemnify the other party for damages
resulting from (i) any false or inaccurate statement or warranty, or (ii)
failure to comply with any of the obligations of the purchase agreement.
The
claim shall be valid over a two-year period following the closure of the
sale
and for up to 4 million dollars.
In
2006
the Company’s management has changed the manner in which the business is
monitored and the decision-making process is performed. Accordingly, the
disclosures below have been changed in 2005 for comparative purposes with
2006.
The
Company segments its information by region, due to the operational and
organizational structure of its business. The Company’s sales are made primarily
in Mexico and the United States. The Mexican segment of the Company includes
the
manufacturing plants of Mexicali, Guadalajara and Tlaxcala. The United States
segment includes the seven manufacturing plants of Republic acquired on July
22,
2005. Republic’s manufacturing plants are located in the United States (six
total in Ohio, Indiana and New York) and one in Canada (Ontario). The plant
in
Canada represents approximately 5% of total sales of the segment. Both segments
manufacture and sell long steel products primarily for the construction and
automotive industries.
|
|
|
|
As
of December 31 2005 and the year then ended
|
|
|
|
|
|
As
restated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexico
|
|
United
States
|
|
Total
|
|
Results
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
Ps.
|
|
|
6,705,953
|
|
|
6,260,674
|
|
|
12,966,627
|
|
Direct
cost of sales
|
|
|
|
|
|
4,469,393
|
|
|
5,901,547
|
|
|
10,370,940
|
|
Marginal
profit
|
|
|
|
|
|
2,236,560
|
|
|
359,127
|
|
|
2,595,687
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indirect
overhead, selling, general and administrative expenses
|
|
|
|
|
|
746,865
|
|
|
271,240
|
|
|
1,018,105
|
|
Operating
income
|
|
|
|
|
|
1,489,695
|
|
|
87,887
|
|
|
1,577,582
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial
(expense) income, net
|
|
|
|
|
|
21,133
|
|
|
(36,861
|
)
|
|
(15,728
|
)
|
Foreign
exchange (loss) gain, net
|
|
|
|
|
|
(75,279
|
)
|
|
-
|
|
|
(75,279
|
)
|
Monetary
position loss
|
|
|
|
|
|
(51,656
|
)
|
|
(2,007
|
)
|
|
(53,663
|
)
|
Other
income (expense), net
|
|
|
|
|
|
44,273
|
|
|
11,216
|
|
|
55,489
|
|
Income
before taxes
|
|
|
|
|
|
1,428,166
|
|
|
60,235
|
|
|
1,488,401
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax
|
|
|
|
|
|
164,844
|
|
|
25,751
|
|
|
190,595
|
|
Statutory
employee profit sharing
|
|
|
|
|
|
417
|
|
|
-
|
|
|
417
|
|
Net
income
|
|
|
|
|
|
1,262,905
|
|
|
34,484
|
|
|
1,297,389
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
|
Ps.
|
|
|
8,565,170
|
|
|
6,023,387
|
|
|
14,588,557
|
|
Depreciation
and amortization
|
|
|
|
|
|
256,558
|
|
|
69,113
|
|
|
325,671
|
|
Capital
expenditures
|
|
|
|
|
|
130,290
|
|
|
373,445
|
|
|
503,735
|
|
For
the
year ended December 31, 2005 there were no transactions between the reportable
segments. For the years ended December 31, 2004 and 2003 the only reportable
segment was Mexico.
The
Company’s net sales to foreign or regional customers are as
follows:
|
|
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
|
Sales
|
|
Sales
|
|
Sales
|
|
Mexico
|
|
|
Ps.
|
|
|
5,885,041
|
|
|
5,279,278
|
|
|
2,698,223
|
|
United
States
|
|
|
|
|
|
6,734,518
|
|
|
626,528
|
|
|
344,444
|
|
Canada
|
|
|
|
|
|
338,076
|
|
|
-
|
|
|
-
|
|
Latin
America
|
|
|
|
|
|
8,475
|
|
|
2,444
|
|
|
2,477
|
|
Others
|
|
|
|
|
|
517
|
|
|
2,113
|
|
|
2,248
|
|
|
|
|
Ps.
|
|
|
12,966,627
|
|
|
5,910,363
|
|
|
3,047,392
|
|
(16)
|
Commitments
and Contingent Liabilities
|
Commitments
|
(a)
|
As
discussed in note 6 to the financial statements, at the end of
2003, the
Company engaged in derivative financial instruments with PEMEX
Gas y
Petroquímica Básica, for hedging purposes to cover natural gas price
fluctuations. The coverage will guarantee a portion of the Company’s
natural gas consumption from 2004 to 2006 at a fixed price of USD
4.462
per MMBtu. At the end of 2005, the Company also held in one of
its
subsidiaries in the USA, 23 open contracts for natural gas swaps,
entered
to offset the potential natural gas price volatility for the months
of
January - March 2006. These swaps resulted in the marking to market
of all
the open contracts as of December 2005 and recording a liability
for USD
1.2 million.
|
|
(b)
|
At
December 31, 2005, the Company has a number of supply contracts,
whereby
it agrees to supply certain customers with steel products during
the first
months of 2006. Should the Company fail to comply with such agreement,
the
customers have the right to reject and/or return the merchandise,
with no
liability whatsoever.
|
|
(c)
|
On
October 11, 2004, the installation of a new five-position machine
which
produces strips and ingots and the installation of related equipment
were
approved in Republic's facilities located in Canton, Ohio. The
Company
began to prepare the installation of the new equipment in December
2004.
The project was estimated to cost approximately Ps. 626.5 million,
not
including capitalized interest costs. It is expected to be in full
operation during the first quarter of 2006. At December 31, 2005,
the
Company has pending purchase agreements of Ps. 30.3 million. Furthermore,
the Company currently estimates that an additional Ps. 24.9 million
will
be needed to finish this project.
|
|
(d)
|
The
Company has certain operating lease agreements for equipment, office
space
and computer equipment, and such agreements cannot be cancelled.
The rent
will expire on different dates through 2012. In 2005, the rent
expense
related to such agreements aggregated Ps. 41.1 million. At December
31,
2005, the total minimum rental payments in accordance with such
agreements
that cannot be cancelled aggregate Ps. 41.1 million in 2006, Ps.
13
million in 2007, Ps. 10.8 million in 2008, Ps. 8.7 million in 2009,
Ps.
3.2 million in 2010 and Ps. 4.3 million in subsequent
years.
|
|
(e)
|
The
Company’s subsidiary Republic has an agreement with the USWA to manage
health insurance benefits for Republic workers of the USWA while
they
temporarily do not render their services, and to administer monthly
contribution payments to the Steelworkers' Pension Trust by local
union
officers while they work for the union. To fund this program, in
February
2004, the USWA granted an initial contribution of Ps. 27 million
in cash
to be used to provide health insurance benefits and Ps. 5.4 million
to
provide benefits for pensions for those who work in the steel industry.
At
December 31, 2005, the balance of this cash account aggregated
Ps. 30.3
million. The Company has agreed to continue managing these programs
until
the fund is completely exhausted. Republic will provide the USWA
with
periodic reports on the fund's status. At December 31, 2005, the
cash
account balance is included in Other assets and the related liability
is
included in Other long-term liabilities in the attached consolidated
balance sheets.
|
Contingent
liabilities
|
(f)
|
California
Regional Water Control
Board
|
In
1987,
Pacific Steel, Inc. (Pacific Steel), a subsidiary of Simec based in National
City in San Diego County, California, received a notice from the California
Regional Water Control Board, San Diego Region (the “Regional Board”), which
prohibited Pacific Steel from draining into the street waters from spraying
borax (waste resulting from the process of the scrap yard). This and other
subsequent requirements obligated Pacific Steel to (i) stop operations in
the
scrap yard, (ii) send an enclosure of the borax which was stored in its yards
and (iii) take samples of the soil where the borax was found. The result
of this
study was that the residual metal contents represented no significant threat
to
the quality of water.
Department
of Toxic Substances Control
In
September 2002, the Department of Toxic Substances Control inspected Pacific
Steel’s facilities based on an alleged complaint from neighbors due to Pacific
Steel’s excavating to recover scrap metal on its property and on a neighbor’s
property which it rents from a third party. In this same month, the department
issued an enforcement order of imminent and substantial endangerment
determination, which alleges that certain soil piles, soil management and
metal
recovery operations may cause an imminent and substantial danger to human
health
and the environment. Consequently, the department sanctioned Pacific Steel
for
violating hazardous waste laws and the State of California Security Code
and
imposed the obligation to make necessary changes to the location. In July
2004,
in an effort to continue with this order, the department filed a Complaint
for
Civil Penalties and Injunctive Relief in San Diego Superior Court. On July
26,
2004, the court issued a judgment, whereby Pacific Steel is obligated to
pay USD
235,000 (payable in four payments of USD 58,750 over the course of one year)
for
fines of USD 131,250, the department's costs of USD 45,000 and an environmental
project of USD 58,750. At December 31, 2005, Pacific Steel has made all of
the
payments.
In
August
2004, Pacific Steel and the Department entered into a corrective action consent
agreement. In September 2005, the Department approved the Corrective Measures
Plan presented by Pacific Steel, provided it obtains permits from the
corresponding local authorities, which are in process at date.
Due
to
the fact that the cleanliness levels have not yet been defined by the Department
and since the characterization of all the property has not yet been finished,
the allowance for the costs for the different remedy options are still subject
to considerable uncertainty.
The
Company estimated, based on experience in prior years and using the same
processes, a liability of between USD 0.8 and USD 1.7 million. Due to the
above,
at December 31, 2002, the Company created a reserve for this contingency
of
approximately USD 1.7 million. At December 31, 2005, such reserve is Ps.
15,079
million (USD 1.4 million).
The
Community Development Commission
Additionally,
the Community Development Commission of National City, California (CDC) has
expressed its intention to develop the site and is preparing a purchase offer
for Pacific Steel’s land at market value, less the cost of remediation and less
certain investigation costs incurred. Pacific Steel has informed the CDC
that
the land will not be voluntarily sold unless there is an alternate property
where it could relocate its business. The CDC, in accordance with the State
of
California law, has the power to expropriate in exchange for payment at market
value and, in the event that there is no other land available to relocate
the
business, it would also have to pay Pacific Steel the land’s book value. The CDC
made an offer to purchase the land from Pacific Steel for USD 6.9 million,
based
on a business appraisal. The expropriation process was temporarily suspended
through an agreement entered into by both parties in April 2006. This agreement
allows Pacific Steel to explore the possibility of finishing the remediation
process of the land and to propose an attractive alternative to CDC which
would
allow the Company to remain in the area.
Due
to
this situation and considering the imminent expropriation of part of the
land on
which Pacific Steel carries out certain operations, for the year ended December
31, 2002, Pacific Steel recorded its land at its estimated realizable value.
Such appraisal caused a decrease in the value of part of the land of Ps.
22,562
(19,750 historical pesos) and a charge to results of operations of 2002 for
the
same amount.
|
(g)
|
On
July 2, 2003, CSG filed a nullity suit with the Mexican Federal
Tax and Administrative Court of Justice
against an official communication issued by the Central International
Fiscal Auditing Office of the Tax Administration Service, whereby
CSG is
deemed to have unpaid taxes of Ps. 89,970 on alleged omissions
of income
taxes it should have withheld from third parties on interest payments
abroad in 1998, 1999, 2000, and for the period from January 1,
2001
through June 30, 2001. CSG is currently waiting for the authorities
to
respond it the suit. According to Company management and its legal
advisors, there
are reasonable grounds on which to obtain a favorable resolution
for
CSG
accordingly no reserve was
recorded.
|
|
(h)
|
The
Company is involved in a number of lawsuits and claims that have
arisen
throughout the normal course of business. The Company and its legal
advisors do not expect the final outcome of these matters to have
any
significant adverse effects on the Company’s financial position and
results of operations.
|
|
(i)
|
In
conformity with current tax legislation, federal, state and municipal
taxes are open to review by the tax authorities for a period of
five
years, prior to the last income tax return
filed.
|
|
(j)
|
In
accordance with the Mexican Income Tax Law, companies that do business
with related parties are subject to specific requirements in respect
to
agreed upon prices, since such prices must be comparable to those
that
would be charged in similar transactions between unrelated parties.
Should
the authorities review and reject the Company’s intercompany pricing, the
authorities may demand payment of the omitted taxes plus restatement
and
surcharges, as well as fines for an amount up to 100% of the restated
omitted taxes.
|
|
(k)
|
Republic
environmental liabilities
|
At
December 31, 2005, the Company recorded under the caption of Other Long-term
Liabilities, a reserve of Ps. 44.3 million to cover probable environmental
liabilities and compliance activities. The non-current portions of the
environmental reserve are included in the caption “Other Accounts Payable and
Accrued Expenses”, in the attached consolidated balance sheets. Republic has no
knowledge of any additional environmental remediation liabilities or contingent
liabilities related to environmental issues in regards to the facilities;
consequently, it would not be appropriate to establish an additional reserve
at
this time.
As
is the
case for most steel producers in the United States, Republic may incur in
material expenses related to future environmental issues, including those
which
arise from environmental compliance activities and the remediation of past
administrative waste practices in Republic’s facilities.
|
(a)
|
At
a Board of Directors’ meeting held on February 13, 2006, the minority
stockholders exercised their preemptive rights to subscribe and
pay for
the increase in variable capital stock declared on April 29, 2005
(see
note 12 (a) section ii), contributing Ps. 36,345 (Ps. 14.59 actual
amount
share value) and a premium for subscribing and paying shares of
Ps. 86,170
historical (Ps. 34.81 premium per share) by subscribing and paying
2,475,303 shares and canceling 252,367 shares that were neither
subscribed
nor paid in.
|
|
(b)
|
On
May 30, 2006, the Company effected a 3 for 1 stock split. After
the split
the ADS now represent 3 shares of series B common stock. Before
that stock
split was completed, each ADS represented one share of series B
common
stock. The ADSs are evidenced by American depositary receipts (“ADRs”)
issued by the Bank of New York (“Depositary”), as depositary under a
Deposit Agreement, dated as of July 8, 1993, as amended, among
Simec, the
Depositary and the holders from time to time of
ADRs.
|
|
(c)
|
In
accordance with the agreement to purchase shares of Republic mentioned
in
note 1a, the Company acquired the right to a portion of the reimbursement
of an unresolved loss claim at the time of purchase by the insurer.
A
Settlement Agreement and Release was reached on April 24, 2006.
As of
April 28, 2006, approximately Ps. 400 million, net of payment to
Predecessor’s shareholders and professional fees, has been received by the
Company. Approximately Ps. 13.1 million, net of payment to Predecessor’s
shareholders and professional fees is estimated to be received
by May 15,
2006 (see note 1a).
|
(18)
|
New
Accounting Pronouncements
|
The
following accounting bulletins issued by the Mexican Institute of Public
Accountants are obligatory as of January 1, 2005.
(a)
Business acquisitions
The
most
significant issues in Bulletin B-7 are as follows: (a) use of the purchase
method as the only alternative for valuing businesses acquired and investments
in associated companies, thus eliminating the supplementary application of
former International Accounting Standard 22, Business
Combinations,
(b)
change in the accounting for goodwill, eliminating amortization and requiring
that goodwill be evaluated for impairment, and also requiring that negative
goodwill not fully amortized at the date of adoption of Bulletin B-7 be carried
to the results of operations, as a change in accounting principle; (c)
establishment of specific rules to account for the acquisition of minority
interest and for transfers of assets or exchange of shares among entities
under
common control, and (d) accounting for intangible assets acquired in a business
combination, under Bulletin C-8, Intangible
Assets.
The
Company opted for the early adoption of this Bulletin (see note
14).
(b)
Labor obligations
The
new
accounting Bulletin D-3, Labor
Obligations,
was
issued in January 2004. The revised Bulletin replaces and nullifies the previous
Bulletin D-3, issued in January 1993 and revised in 1998. The observance
of
Bulletin D-3 is compulsory for fiscal years beginning on or after January
1
2004, except for termination payments, which will be in force as of January
1,
2005.
The
revised Bulletin incorporates the matter of remunerations for other
post-retirement benefits, thus nullifying the provisions of Circular 50,
Interest
rates to be used in the valuation of labor obligations and supplementary
application of accounting principles related to labor
obligations.
Bulletin D-3 also eliminates the subject related to unexpected payments and,
instead includes the subject related to termination payments, defining such
payments as those granted to workers at the end of their employment before
reaching the age of retirement, which include two types: (i) due to corporate
restructuring, for which the guidelines of Mexican accounting Bulletin C-9,
Liabilities,
Provisions, Contingent Assets and Liabilities and Commitments,
must be
followed, and (ii) due to reasons other than restructuring, for which the
Company must apply the valuation and disclosure rules required for retirement
pensions and seniority premiums payments, thus allowing at the time that
this
Bulletin is adopted, to immediately recognize the transition asset or liability
in results of operations, or its amortization, in conformity with the remaining
working life of the workers.
The
Company considers that the adoption of this Bulletin did not have a material
effect on its financial position or on its results of operations.
(19)
|
Differences
between Mexican and United States accounting
principles:
|
The
Company’s consolidated financial statements are prepared in accordance with
Mexican GAAP, which differ in certain significant respects from U.S.
GAAP.
The
Mexican GAAP consolidated financial statements include the effects of inflation
as provided for under Bulletin B-10, as amended. The following reconciliation
to
U.S. GAAP does not include the reversal of the adjustments for the effects
of
inflation, since the application of Bulletin B-10 represents a comprehensive
measure of the effects of price level changes in the inflationary Mexican
economy and, as such, is considered a more meaningful presentation than
historical cost-based financial reporting for both Mexican and U.S. accounting
purposes.
Other
significant differences between Mexican GAAP and U.S. GAAP and the effects
on
consolidated net income and consolidated stockholders’ equity are presented
below, in thousands of constant Mexican pesos as of December 31, 2005, with
an
explanation of the adjustments.
Reconciliation
of net income:
|
|
|
|
2005
|
|
2004
|
|
2003
|
|
Net
income as reported under Mexican GAAP
|
|
|
Ps.
|
|
|
1,297,389
|
|
|
1,462,671
|
|
|
320,523
|
|
Inventory
indirect costs
|
|
|
|
|
|
(3,958
|
)
|
|
5,858
|
|
|
(4,528
|
)
|
Depreciation
on restatement of machinery and equipment
|
|
|
|
|
|
(24,820
|
)
|
|
(24,073
|
)
|
|
(25,871
|
)
|
Others
|
|
|
|
|
|
-
|
|
|
(635
|
)
|
|
5,502
|
|
Deferred
income taxes
|
|
|
|
|
|
(5,696
|
)
|
|
(45,699
|
)
|
|
(54,176
|
)
|
Deferred
employee profit sharing
|
|
|
|
|
|
46
|
|
|
15
|
|
|
220
|
|
Pre-operating
expenses, net
|
|
|
|
|
|
26,023
|
|
|
28,650
|
|
|
28,648
|
|
Amortization
of gain from monetary position and exchange loss capitalized under
Mexican
GAAP
|
|
|
|
|
|
7,239
|
|
|
7,238
|
|
|
7,238
|
|
Minority
interest
|
|
|
|
|
|
(17,491
|
)
|
|
-
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
approximate U.S. GAAP adjustments
|
|
|
|
|
|
(18,657
|
)
|
|
(28,646
|
)
|
|
(42,968
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Approximate
net income under U.S. GAAP
|
|
|
Ps.
|
|
|
1,278,732
|
|
|
1,434,025
|
|
|
277,555
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average outstanding basic
|
|
|
|
|
|
137,929,599
|
|
|
132,972,749
|
|
|
119,052,681
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings per share (pesos)
|
|
|
Ps.
|
|
|
9.27
|
|
|
10.78
|
|
|
2.33
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average outstanding basic after split (1)
|
|
|
|
|
|
413,788,797
|
|
|
398,918,247
|
|
|
357,158,043
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings per share (pesos) after split (1)
|
|
|
Ps.
|
|
|
3.09
|
|
|
3.59
|
|
|
0.78
|
|
|
(1)
|
As
explained in Note 17 (b) the Company affected a 3 for 1 stock split
on May
30, 2006. This information presents the retrospective effect on
the
Earnings per Share after the split in accordance with US
GAAP.
|
In
2005
the Company recorded Ps. 38,467 under other expenses which were reclassified
under operating expenses for U.S. GAAP purposes.
There
are
several entries recorded in other expenses in 2004 under Mexican GAAP, which
amounts to approximately Ps. 34,581 that according to U.S. GAAP should be
presented as operating expenses.
Reconciliation
of stockholders’ equity:
|
|
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
Total
stockholders’ equity reported under Mexican GAAP
|
|
|
Ps.
|
|
|
9,628,681
|
|
|
6,847,292
|
|
|
5,061,296
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest included in stockholders’ equity under Mexican
GAAP
|
|
|
|
|
|
(1,807,684
|
)
|
|
(322
|
)
|
|
(274
|
)
|
Inventory
indirect costs
|
|
|
|
|
|
12,455
|
|
|
16,413
|
|
|
10,555
|
|
Restatement
of machinery and equipment
|
|
|
|
|
|
589,152
|
|
|
278,904
|
|
|
386,998
|
|
Accrued
vacation costs
|
|
|
|
|
|
(615
|
)
|
|
(635
|
)
|
|
-
|
|
Deferred
income taxes
|
|
|
|
|
|
(57,792
|
)
|
|
37,094
|
|
|
56,244
|
|
Deferred
employee profit sharing
|
|
|
|
|
|
748
|
|
|
701
|
|
|
686
|
|
Pre-operating
expenses
|
|
|
|
|
|
(212,400
|
)
|
|
(238,423
|
)
|
|
(274,188
|
)
|
Gain
from monetary position and exchange loss capitalized, net
|
|
|
|
|
|
(182,611
|
)
|
|
(189,851
|
)
|
|
(197,094
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
approximate U.S. GAAP adjustments
|
|
|
|
|
|
(1,658,747
|
)
|
|
(96,119
|
)
|
|
(17,073
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
approximate stockholders’ equity under U.S. GAAP
|
|
|
Ps.
|
|
|
7,969,934
|
|
|
6,751,173
|
|
|
5,044,223
|
|
A
summary
of changes in stockholders’ equity, after the approximate U.S. GAAP adjustments
described above, is as follows:
|
|
|
|
Capital
Stock and Paid-in Capital
|
|
|
|
Retained
Earnings
|
|
|
|
Fair
Value of Derivative Financial Instruments
|
|
|
|
Cumulative
Restatement Effect
|
|
|
|
Total
Stockholders’ Equity
|
|
Balances
as of December 31, 2003
|
|
|
Ps.
|
|
|
3,525,252
|
|
|
Ps.
|
|
|
506,517
|
|
|
Ps.
|
|
|
10,483
|
|
|
Ps.
|
|
|
1,001,971
|
|
|
Ps.
|
|
|
5,044,223
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
in capital stock
|
|
|
|
|
|
24,693
|
|
|
|
|
|
-
|
|
|
|
|
|
-
|
|
|
|
|
|
-
|
|
|
|
|
|
24,693
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
comprehensive income
|
|
|
|
|
|
-
|
|
|
|
|
|
1,434,025
|
|
|
|
|
|
2,364
|
|
|
|
|
|
245,868
|
|
|
|
|
|
1,682,257
|
|
Balances
as of December 31, 2004
|
|
|
|
|
|
3,549,945
|
|
|
|
|
|
1,940,542
|
|
|
|
|
|
12,847
|
|
|
|
|
|
1,247,839
|
|
|
|
|
|
6,751,173
|
|
Increase
in capital stock
|
|
|
|
|
|
230,963
|
|
|
|
|
|
-
|
|
|
|
|
|
-
|
|
|
|
|
|
(230,309
|
)
|
|
|
|
|
654
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
comprehensive income
|
|
|
|
|
|
-
|
|
|
|
|
|
1,278,732
|
|
|
|
|
|
27,507
|
|
|
|
|
|
(88,132
|
)
|
|
|
|
|
1,218,107
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
as of December 31, 2005
|
|
|
Ps.
|
|
|
3,780,908
|
|
|
Ps.
|
|
|
3,219,274
|
|
|
Ps.
|
|
|
40,354
|
|
|
Ps.
|
|
|
929,398
|
|
|
Ps.
|
|
|
7,969,934
|
|
The
cumulative difference between the amounts included under Capital Stock and
Paid-in Capital for U.S. GAAP and Capital Stock and Paid-in Capital for Mexican
GAAP arise from the following items:
Issuance
of capital stock:
During
1993 and 1994 the Company recorded Ps. 92,601 and Ps. 29,675, respectively,
corresponding to expenses related to the issuance of shares in a simultaneous
public offering in the United States and Mexico as a reduction of the proceeds
from the issuance of capital stock. In 1993 and 1994, these expenses were
deducted for tax purposes resulting in a tax benefit of Ps. 32,180 and Ps.
10,091. These tax benefits were included in the statement of operations for
Mexican GAAP purposes. For U.S. GAAP purposes these items were shown as a
reduction of cost of issuance of the shares, thereby increasing the net proceeds
from the offering.
Maritime
operations and amortization of negative goodwill:
In
1993,
Grupo Simec disposed of its maritime operations by spinning-off the two entities
acquired in 1992 to Grupo Sidek (former parent company of Grupo Simec) and
transferring its remaining maritime subsidiary to Grupo Sidek for its
approximate book value.
The
operations sold had a tax loss carryforward of approximately Ps. 197,117
which
were related to operations prior to the date the entities were acquired by
the
Company. During 1994, Ps. 4,608 of these tax loss carryforwards were realized
(resulting in a tax benefit of Ps. 1,587).
For
U.S.
GAAP purposes, the retained tax benefit of Ps. 1,587 realized in 1994, had
been
reflected as an increase to the corresponding paid-in capital rather than
in net
earnings as done for Mexican GAAP purposes.
Gain
on extinguishment:
On
February 7, 2001, the Company’s Board of Directors approved the issuance of
492,852,025 shares of Series “B” variable capital stock in exchange for the
extinguishment of debt amounting to USD 110,257,012. Under Mexican GAAP,
the
increase in stockholders’ equity resulting from the conversion or extinguishment
of debt is equal to the carrying amount of the extinguished debt. The Company
assigned a value of USD 110,257,012 to the Series “B” capital stock and,
therefore, no difference existed between the equity interest granted and
the
carrying amount of the debt extinguished. Under U.S. GAAP, the difference
between the fair value of equity interest granted and the carrying amount
of
extinguished debt is recognized as a gain or loss on extinguishment of debt
in
the statement of operations. For U.S. GAAP purposes, the fair value of the
Series “B” capital stock was determined by reference to the quoted market price
on March 29, 2001, the date the transaction was effected, and the difference
between the fair value of the Series “B” capital stock and the carrying amount
of the extinguished debt was recognized as a gain in the statement of
operations. The related restated effect as of December 31, 2005 is Ps.
584,503.
Reconciliation
of Net Income and Stockholders’ Equity:
The
Company’s consolidated financial statements are prepared in accordance with
Mexican GAAP, which differ in certain significant respects from U.S. GAAP.
The
explanations of the related adjustments included in the Reconciliation of
net
income and the Reconciliation
of stockholders’ equity are explained below:
Restatement
of prior year financial statements:
In
accordance with Mexican GAAP, prior year financial information of a foreign
subsidiary must be restated using the inflation rate of the country in which
the
foreign subsidiary is located, and then translated to pesos at the exchange
rate
as of year end. This procedure results in the presentation of prior year
amounts
representing the purchasing power of the respective currencies as of the
end of
the latest year presented.
Under
U.S. GAAP, prior year financial information of a foreign subsidiary must
be
restated in constant units of the reporting currency, the Mexican peso, which
requires the restatement of such prior year amounts using the inflation rate
of
Mexico.
This
difference will be applicable starting next year (2006), when the prior year
integrated subsidiaries needs to be restated.
Inventory:
As
permitted by Mexican GAAP, some inventories are valued under the direct cost
system, which includes material, direct labor and other direct costs. For
purposes of complying with U.S. GAAP, inventories have been valued under
the
full absorption cost method, which includes the indirect costs.
Under
Mexican GAAP, inventories include prepaid advances to suppliers. For U.S.
GAAP
purposes, the prepaid advances to suppliers are considered as prepaid
expenses.
Restatement
of property, machinery and equipment:
As
explained in note 2(g), in accordance with Mexican GAAP, imported machinery
and
equipment has been restated during 2005, 2004 and 2003 by applying devaluation
and inflation factors of the country of origin.
Under
U.S. GAAP, during 2005, 2004 and 2003 the restatement of all machinery and
equipment, both domestic and imported, has been done in constant units of
the
reporting currency, the Mexican peso, using the inflation rate of
Mexico.
Accordingly,
a reconciling item for the difference in methodologies of restating imported
machinery and equipment is included in the reconciliation of net income and
stockholders’ equity.
Deferred
income taxes and employee profit sharing:
As
explained in Note 2(k) under Mexican GAAP, the Company accounts for deferred
income tax following the guidelines of Mexican Bulletin D-4. The main
differences between SFAS No. 109 and Bulletin D-4, as they relate to the
Company, which are included as reconciling items between Mexican and U.S.
GAAP
are:
|
·
|
the
income tax effect of gain from monetary position and exchange loss
capitalized that is recorded as an adjustment to stockholders’ equity for
Mexican GAAP purposes,
|
|
·
|
the
income tax effect of capitalized pre-operating expenses which for
U.S.
GAAP purposes, are expensed when
incurred,
|
|
·
|
the
effect on income tax of the difference between the indexed cost
and the
restatement through use of specific indexation factors of fixed
assets
which is recorded as an adjustment to stockholders’ equity for Mexican
GAAP, and,
|
|
·
|
the
income tax effect of the inventory cost which for Mexican GAAP
some
inventories are valued under the direct cost system and for U.S.
GAAP
inventories have been valued under the full absorption cost
method.
|
The
cumulative deferred income tax for U.S. GAAP purposes is included under Retained
Earnings. Under Mexican GAAP such effect is included under the cumulative
deferred income taxes caption.
In
addition, the Company is required to pay employee profit sharing in accordance
with Mexican labor law. Deferred employee profit sharing under U.S. GAAP
has
been determined following the guidelines of SFAS N0. 109. Under Mexican GAAP,
the deferred portion of employee profit sharing is determined on temporary
non-recurring differences with a known turnaround time.
To
determine operating income under U.S. GAAP, deferred employee profit sharing
and
employee profit sharing expense (under Mexican GAAP included under the caption
provisions in the income statement) are considered as operating
expenses.
The
effects of temporary differences giving rise to significant portions of the
deferred tax assets and liabilities at December 31, 2005 and 2004, under
U.S.
GAAP are presented below:
|
|
|
|
2005
|
|
|
|
2004
|
|
|
|
|
|
IT
|
|
|
|
ESPS
|
|
|
|
IT
|
|
ESPS
|
|
Deferred
tax assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance
for doubtful receivables
|
|
|
Ps.
|
|
|
60,864
|
|
|
Ps.
|
|
|
-
|
|
|
Ps.
|
|
|
7,222
|
|
|
-
|
|
Accrued
expenses
|
|
|
|
|
|
117,975
|
|
|
|
|
|
748
|
|
|
|
|
|
27,980
|
|
|
-
|
|
Advances
from customers
|
|
|
|
|
|
11,186
|
|
|
|
|
|
-
|
|
|
|
|
|
21,079
|
|
|
-
|
|
Net
operating loss carryforwards
|
|
|
|
|
|
316,796
|
|
|
|
|
|
-
|
|
|
|
|
|
18,594
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recoverable
AT
|
|
|
|
|
|
103,931
|
|
|
|
|
|
-
|
|
|
|
|
|
188,017
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
gross deferred tax assets
|
|
|
|
|
|
610,752
|
|
|
|
|
|
748
|
|
|
|
|
|
262,892
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
valuation allowance
|
|
|
|
|
|
68,329
|
|
|
|
|
|
-
|
|
|
|
|
|
200,655
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
deferred tax assets
|
|
|
|
|
|
542,423
|
|
|
|
|
|
748
|
|
|
|
|
|
62,237
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventories,
net from the balance as of December 31, 1986 not yet
deducted
|
|
|
|
|
|
402,654
|
|
|
|
|
|
-
|
|
|
|
|
|
330,831
|
|
|
-
|
|
Derivative
financial instruments
|
|
|
|
|
|
11,145
|
|
|
|
|
|
-
|
|
|
|
|
|
5,708
|
|
|
-
|
|
Property,
plant and equipment
|
|
|
|
|
|
1,360,718
|
|
|
|
|
|
-
|
|
|
|
|
|
1,055,063
|
|
|
-
|
|
Others
|
|
|
|
|
|
35,319
|
|
|
|
|
|
-
|
|
|
|
|
|
124,094
|
|
|
-
|
|
Additional
liabilities resulting from excess of book value of stockholders’ equity
over its tax value
|
|
|
|
|
|
303,461
|
|
|
|
|
|
-
|
|
|
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
deferred liabilities
|
|
|
|
|
|
2,113,297
|
|
|
|
|
|
-
|
|
|
|
|
|
1,515,696
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
deferred tax liability (asset)
|
|
|
Ps.
|
|
|
1,570,874
|
|
|
Ps.
|
|
|
(748
|
)
|
|
Ps.
|
|
|
1,453,459
|
|
|
-
|
|
The
total
net deferred tax liability under U.S. GAAP includes a current portion as
of
December 31, 2005 of Ps. 93,102 with the remainder being classified as long
term.
The
deferred income taxes of Ps. 1,360,718 and Ps. 1,055,063 result from differences
between the financial reporting and tax bases of property, plant and equipment
at December 31, 2005 and 2004, respectively. Beginning in 1997 the restatement
of property, plant and equipment and the effects thereof on the statement
of
operations are determined by using factors derived from the NCPI or, in the
case
of imported machinery and equipment, by applying devaluation and inflation
factors of the country of origin. Until 1996, for financial reporting purposes,
property, plant and equipment were stated at net replacement cost and
depreciation was provided by using the straight-line method over the estimated
remaining useful lives of the assets. For income tax reporting purposes,
property, plant, and equipment and depreciation are computed by a method
which
considers the NCPI.
Domestic
operations accounted for 99% percent of the Company’s pre-tax income and IT
expense in 2004 and 2003 and 96.5% in 2005.
In
accordance with APB Opinion No. 23 it is the policy of the Company to accrue
appropriate Mexican and foreign income taxes on earnings of subsidiary companies
which are intended to be remitted to the parent company in the near future.
Unremitted earnings of subsidiaries which have been, or are intended to be,
permanently reinvested, exclusive of those amounts which if remitted in the
near
future would result in little or no such tax by operation of relevant statutes
currently in effect, aggregated Ps. 11.8 million at December 31,
2005.
Pre-operating
expenses:
For
Mexican GAAP purposes, the Company capitalized pre-operating expenses related
to
the production facilities at Mexicali, as well as costs and expenses incurred
in
the manufacturing and design of new products. For U.S. GAAP purposes, these
items are expensed when incurred.
Financial
expense capitalized:
Under
Mexican GAAP, financial expense capitalized during the period required to
bring
property, plant and equipment into the condition required for their intended
use, includes interest, exchange losses and gains from monetary position.
Under
U.S. GAAP when financing is in Mexican pesos, the monetary gain is included
in
this computation; when financing is denominated in U.S. dollars, only the
interest is capitalized and exchange losses and monetary position are not
included.
Minority
interest:
Under
Mexican GAAP, the minority interest in consolidated subsidiaries is presented
as
a separate component within stockholders’ equity on the consolidated balance
sheet. For U.S. GAAP purposes, minority interest is not included in
stockholders’ equity.
Disclosure
about Fair Value of Financial Instruments:
In
accordance with SFAS No. 107, “Disclosures about Fair Value of Financial
Instruments,” under U.S. GAAP it is necessary to provide information about the
fair value of certain financial instruments for which it is practicable to
estimate that value. The carrying amounts of cash and short-term investments,
accounts receivable and accounts payable and accrued liabilities approximate
fair values due to the short term maturity of these instruments.
The
fair
value of the borrowings with General Electric Capital are based on short
term
interest rates available to the Company, and the estimated fair values of
these
financial instruments approximate their recorded carrying amounts.
The
fair
values of the long term debt obligations are estimated based upon quoted
market
prices for the same or similar issues or on the current rates offered for
debt
of the same remaining maturities. As of December 31, 2005 both the carrying
value and the fair value of total debt were of Ps. 362,315.
Pension
and other retirement benefits:
The
Company records seniority premiums based on actuarial computations as described
in note 2(j).
For
purposes of determining seniority premium costs under U.S. GAAP, the Company
utilized SFAS No. 87. Adjustments to U.S. GAAP for seniority premiums were
not
individually or in the aggregate significant for any period.
SFAS
No.
106, “Employers’ Accounting for Post-retirement Benefits Other than Pensions”,
requires accrual of post-retirement benefits other than pensions during the
employment period. The Company does not provide its employees any
post-retirement benefit subject to the provisions of SFAS No. 106.
SFAS
No.
112, “Employers’ Accounting for Post-employment Benefits”, requires employers to
accrue for post-employment benefits that are provided to former or inactive
employees after employment during the employment period. For the purpose
of
determining Termination Benefits Obligations for U.S. GAAP, the Company utilized
SFAS No. 112. Adjustments to U.S. GAAP benefit were not individually or in
the
aggregate significant for any period.
For
the
year ended December 31, 1998, the Company adopted SFAS No. 132, “Employers’
Disclosures about Pensions and Other Post-retirement Benefits”, which requires
certain additional disclosures, without any changes in the measurement or
recognition of pensions and other post-retirement benefit obligations. The
additional disclosures are as follows:
|
|
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
Change
in projected benefit obligation-
|
|
|
|
|
|
|
|
Projected
benefit obligation at beginning of year
|
|
|
Ps.
|
|
|
8,093
|
|
|
6,405
|
|
Service
cost
|
|
|
|
|
|
2,859
|
|
|
593
|
|
Financial
cost
|
|
|
|
|
|
1,057
|
|
|
321
|
|
Actuarial
gain, net
|
|
|
|
|
|
11,037
|
|
|
1,644
|
|
Benefits
paid
|
|
|
|
|
|
(1,295
|
)
|
|
(870
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Projected
benefit obligation at end of year
|
|
|
Ps.
|
|
|
21,751
|
|
|
8,093
|
|
Variable
capital common stock:
Under
operation of Mexican law, stockholders holding shares representing variable
capital common stock may require the Company, with a notice of at least three
months prior to December 31 of each year, to redeem those shares at a price
equal to the lesser of either (i) 95% of the market price, based on an average
of trading prices during the 30 trading days preceding the end of the fiscal
year in which the redemption is to become effective or (ii) the book value
of
the Company’s shares approved at the meeting of shareholders for the latest
fiscal year prior to the redemption date. Although the variable capital common
stock is potentially redeemable by the terms described above, such shares
have
been classified as a component of stockholders’ equity in the consolidated
balance sheet under both Mexican GAAP and U.S. GAAP.
Company’s
management believes the variable capital common stock represents permanent
capital because the timing and pricing mechanism through which a shareholder
would exercise the option to redeem are such that a shareholder, from an
economic standpoint, would not exercise this option. At the time a shareholder
is required to give notice of redemption, the shareholder will not be able
to
know at what price the shares would be redeemed and would not expect the
present
value of the future redemption payment to equal or exceed the amount which
would
be received by the shareholder in a public sale. Such redemption also requires
approval at a shareholders’ meeting.
Statement
of cash flows:
Under
Mexican GAAP, the Company presents a consolidated statement of changes in
financial position in accordance with Bulletin B-12, which identifies the
generation and application of resources as representing differences between
beginning and ending financial statement balances in constant Mexican pesos.
It
also requires that monetary and unrealized exchange gains and losses be treated
as cash items in the determination of resources generated by
operations.
SFAS
No.
95, “Statement of Cash Flows”, requires presentation of a statement of cash
flows.
The
following presents a reconciliation of the resources generated by (used in)
operating, investing and financing activities under Mexican GAAP to the
resources generated by (used in) such activities under U.S. GAAP:
|
|
|
|
2005
|
|
|
|
2004
|
|
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income as reported under U.S. GAAP
|
|
|
Ps.
|
|
|
1,278,732
|
|
|
Ps.
|
|
|
1,434,025
|
|
|
Ps.
|
|
|
277,555
|
|
Add
charges (deduct credits) to operations not requiring (providing)
funds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
|
|
|
317,229
|
|
|
|
|
|
210,600
|
|
|
|
|
|
192,065
|
|
Unrealized
exchange loss (gain)
|
|
|
|
|
|
8,900
|
|
|
|
|
|
-
|
|
|
|
|
|
6,048
|
|
Deferred
income taxes
|
|
|
|
|
|
117,414
|
|
|
|
|
|
366,164
|
|
|
|
|
|
193,953
|
|
Deferred
employee profit sharing
|
|
|
|
|
|
(46
|
)
|
|
|
|
|
(15
|
)
|
|
|
|
|
(220
|
)
|
Minority
interest
|
|
|
|
|
|
17,491
|
|
|
|
|
|
-
|
|
|
|
|
|
1
|
|
Write-down
of idle machinery
|
|
|
|
|
|
-
|
|
|
|
|
|
14,722
|
|
|
|
|
|
45,369
|
|
Deferred
credit amortization
|
|
|
|
|
|
(67,175
|
)
|
|
|
|
|
-
|
|
|
|
|
|
-
|
|
Seniority
premiums and termination benefits
|
|
|
|
|
|
5,212
|
|
|
|
|
|
1,338
|
|
|
|
|
|
271
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds
provided by operations
|
|
|
|
|
|
1,677,757
|
|
|
|
|
|
2,026,834
|
|
|
|
|
|
715,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(investing in) financing from operating accounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade
receivables, net
|
|
|
|
|
|
(161,623
|
)
|
|
|
|
|
(553,171
|
)
|
|
|
|
|
(39,588
|
)
|
Other
accounts receivable and prepaid expenses
|
|
|
|
|
|
(234,220
|
)
|
|
|
|
|
(172,982
|
)
|
|
|
|
|
58,874
|
|
Inventories
|
|
|
|
|
|
589,674
|
|
|
|
|
|
(874,622
|
)
|
|
|
|
|
(21,600
|
)
|
Accounts
payable and accrued expenses
|
|
|
|
|
|
(151,356
|
)
|
|
|
|
|
324,845
|
|
|
|
|
|
(21,624
|
)
|
Accounts
payable to related parties
|
|
|
|
|
|
3,044
|
|
|
|
|
|
(2,699
|
)
|
|
|
|
|
(184,773
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds
provided (used in) by financing activities
|
|
|
|
|
|
45,519
|
|
|
|
|
|
(1,278,629
|
)
|
|
|
|
|
(208,711
|
)
|
Approximate
net resources generated by operations under U.S. GAAP
|
|
|
Ps.
|
|
|
1,723,276
|
|
|
Ps.
|
|
|
748,205
|
|
|
Ps.
|
|
|
506,331
|
|
Financing
activities under Mexican GAAP
|
|
|
Ps.
|
|
|
(242,412
|
)
|
|
Ps.
|
|
|
404,107
|
|
|
Ps.
|
|
|
31,489
|
|
Decrease
in debt due to restatement to constant Mexican pesos
|
|
|
|
|
|
5,246
|
|
|
|
|
|
1,213
|
|
|
|
|
|
4,319
|
|
Exchange
(loss) gain
|
|
|
|
|
|
(8,900
|
)
|
|
|
|
|
-
|
|
|
|
|
|
(6,048
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Approximate
net resources generated by (used in) financing activities under
U.S.
GAAP
|
|
|
Ps.
|
|
|
(246,066
|
)
|
|
Ps.
|
|
|
405,320
|
|
|
Ps.
|
|
|
29,760
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
resources used in investing activities under Mexican GAAP-(1)
|
|
|
Ps.
|
|
|
(1,937,578
|
)
|
|
Ps.
|
|
|
(1,357,288
|
)
|
|
Ps.
|
|
|
(10,561
|
)
|
Restatement
of non-current inventories
|
|
|
|
|
|
(2,223
|
)
|
|
|
|
|
4,986
|
|
|
|
|
|
(5,045
|
)
|
Other
non-cash investing activities
|
|
|
|
|
|
-
|
|
|
|
|
|
71,507
|
|
|
|
|
|
10,143
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Approximate
net resources used in investing activities under U.S. GAAP
|
|
|
Ps.
|
|
|
(1,939,801
|
)
|
|
Ps.
|
|
|
(1,280,795
|
)
|
|
Ps.
|
|
|
(5,463
|
)
|
Net
resources used in operating activities include cash payments for interest
and
income taxes as follows:
|
|
|
|
2005
|
|
|
|
2004
|
|
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
interest paid
|
|
|
Ps.
|
|
|
30,669
|
|
|
Ps.
|
|
|
2,183
|
|
|
Ps.
|
|
|
18,678
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
taxes paid
|
|
|
Ps.
|
|
|
300,461
|
|
|
Ps.
|
|
|
27,805
|
|
|
Ps.
|
|
|
38,668
|
|
|
(1)
|
This
caption includes the acquisition of PAV Republic (Note 1a). The
Company
acquired the outstanding shares of PAV Republic Inc. through its
subsidiary SimRep Corporation, a U.S. company. Such transaction,
paid by
the Company and ICH, was valued at USD 245 million where USD 229
million
corresponds to the purchase price and USD 16 million to the direct
cost of
the business combination. The Company contributed USD 123 million
to
acquire 50.2% of the representative shares of SimRep Corporation
and ICH,
the holding company, acquired the remaining 49.8%. SimRep then
acquired
all the shares from PAV Republic
Inc.
|
Subsequent
event: Foreign exchange rates:
The
exchange rates at June 28, 2006 were as follows (amounts in pesos):
|
|
June
28, 2006
|
|
|
|
|
|
Dollar
|
|
|
Ps.
|
|
|
11.4090
|
|
Euro
|
|
|
|
|
|
14.3239
|
|
Pound
sterling
|
|
|
|
|
|
20.7506
|
|
Recent
accounting pronouncements in the US:
In
November 2004, Statement of Financial Accounting Standards No. 151, “Inventory
Costs-an amendment of ARB No. 43, Chapter 4” (SFAS No. 151), was issued. This
Statement amends the guidance in Accounting Research Bulletin no. 43, Chapter
4,
“Inventory Pricing,” to clarify the accounting of abnormal amounts of idle
facility expense, freight, handling cost, and wasted material (spoilage).
SFAS
No. 151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. The effect on the adoption of this bulletin was not
significant because prior to the release of SFAS 151, since Mexican GAAP
already
contains similar guidance.
In
March
2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations (an interpretation of SFAS Statement No. 143) (FIN
47).
This Interpretation clarifies that the term conditional asset retirement
obligation, as used in SFAS Statement No. 143, Accounting for Asset Retirement
Obligations, refers to a legal obligation to perform an asset retirement
activity in which the timing and (or) method of settlement are conditional
on a
future event that may or may not be within the control of the entity. The
obligation to perform the asset retirement activity is unconditional even
though
uncertainty may exist about the timing and (or) method of settlement.
Accordingly, an entity is required to recognize the fair value of a liability
for the conditional asset retirement obligation when incurred and the
uncertainty about the timing and (or) method of settlement should be factored
into the measurement of the liability when sufficient information exists.
This
Interpretation is effective for fiscal years ending after December 15, 2005.
The
Company has evaluated the application of SFAS Interpretation No. 47 and
determined it has no effect on the Company’s consolidated financial
statements.
In
May
2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections” which
addresses the accounting and reporting for changes in accounting principles.
SFAS 154 replaces APB 20 and FIN 20. The adoption of SFAS 154 had no effect
on
the Company’s financial position or on its results of operations.
In
September 2005 the FASB issued SFAS 155, “Accounting for Certain Hybrid
Financial Instruments—an amendment of SFAS Statements No. 133 and 140”, that
amends SFAS Statements No. 133, Accounting for Derivative Instruments and
Hedging Activities, and No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities. This Statement resolves
issues addressed in Statement 133 Implementation Issue No. D1, “Application of
Statement 133 to Beneficial Interests in Securitized Financial Assets.” The
adoption of SFAS 155 had no material effect on the Company’s financial position
or on its results of operations.
Other
pronouncements issued by the FASB or other authoritative accounting standards
groups with future effective dates are either not applicable or not significant
to the Company’s financial statements.
GRUPO
SIMEC, S.A.B. DE C.V. AND SUBSIDIARIES
Condensed
Consolidated Balance Sheets
(Thousands
of constant Mexican pesos as of June 30, 2006)
Assets
|
|
Audited
December
31
2005
|
|
Unaudited
June
30
2006
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
|
Ps.
|
|
|
209,416
|
|
|
948,625
|
|
Accounts
receivable, net (Note 4)
|
|
|
|
|
|
2,620,377
|
|
|
2,851,746
|
|
Inventories,
net (Note 5)
|
|
|
|
|
|
3,660,501
|
|
|
4,321,500
|
|
Derivative
financial instruments (Note 6)
|
|
|
|
|
|
57,477
|
|
|
20,831
|
|
Prepaid
expenses and other current assets
|
|
|
|
|
|
230,226
|
|
|
246,147
|
|
Total
current assets
|
|
|
|
|
|
6,777,997
|
|
|
8,388,849
|
|
|
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net (Note 7)
|
|
|
|
|
|
7,114,996
|
|
|
7,443,991
|
|
Other
assets and deferred charges, net
|
|
|
|
|
|
695,564
|
|
|
606,398
|
|
Total
Assets
|
|
|
Ps.
|
|
|
14,588,557
|
|
|
16,439,238
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and stockholders' equity
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
|
Current
portion of long-term debt (Note 9)
|
|
|
Ps.
|
|
|
21,034
|
|
|
3,442
|
|
Accounts
payable and accrued liabilities (Note 8)
|
|
|
|
|
|
2,694,255
|
|
|
2,531,335
|
|
Total
current liabilities
|
|
|
|
|
|
2,715,289
|
|
|
2,534,777
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt (Note 9)
|
|
|
|
|
|
391,550
|
|
|
-
|
|
Other
long-term liabilities (Note 10)
|
|
|
|
|
|
339,958
|
|
|
117,294
|
|
Deferred
taxes (Note 11)
|
|
|
|
|
|
1,513,079
|
|
|
1,885,490
|
|
Total
long-term liabilities
|
|
|
|
|
|
2,244,587
|
|
|
2,002,784
|
|
Total
liabilities
|
|
|
|
|
|
4,959,876
|
|
|
4,537,561
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity (Note 12):
|
|
|
|
|
|
|
|
|
|
|
Capital
stock
|
|
|
|
|
|
3,476,499
|
|
|
3,512,577
|
|
Additional
paid-in-capital
|
|
|
|
|
|
845,018
|
|
|
931,110
|
|
Retained
earnings
|
|
|
|
|
|
4,519,677
|
|
|
5,865,548
|
|
Cumulative
deferred income tax
|
|
|
|
|
|
(905,828
|
)
|
|
(905,828
|
)
|
|
|
|
|
|
|
7,935,366
|
|
|
9,403,407
|
|
Other
accumulated comprehensive (loss) income items
|
|
|
|
|
|
(114,369
|
)
|
|
239,699
|
|
Total
majority stockholders' equity
|
|
|
|
|
|
7,820,997
|
|
|
9,643,106
|
|
Minority
interest
|
|
|
|
|
|
1,807,684
|
|
|
2,258,571
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
stockholders' equity
|
|
|
|
|
|
9,628,681
|
|
|
11,901,677
|
|
Total
liabilities and stockholders' equity
|
|
|
Ps.
|
|
|
14,588,557
|
|
|
16,439,238
|
|
See
accompanying notes to condensed consolidated financial
statements
GRUPO
SIMEC, S.A.B. DE C.V. AND SUBSIDIARIES
Unaudited
Condensed Consolidated Statements of Income
(Thousands
of constant Mexican pesos as of June 30, 2006, except earnings per share
figures)
|
|
Unaudited
Six
months ended June 30,
|
|
|
|
2005
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
Ps.
|
|
|
3,573,182
|
|
|
|
|
|
11,912,466
|
|
Direct
cost of sales
|
|
|
|
|
|
2,326,363
|
|
|
|
|
|
9,681,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marginal
profit
|
|
|
|
|
|
1,246,819
|
|
|
|
|
|
2,230,566
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indirect
overhead, selling, general and administrative expenses
|
|
|
|
|
|
374,630
|
|
|
|
|
|
664,093
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
|
|
|
872,189
|
|
|
|
|
|
1,566,473
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financing cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
(expense) income, net
|
|
|
|
|
|
8,454
|
|
|
|
|
|
14,842
|
|
Foreign
exchange (loss) gain, net
|
|
|
|
|
|
(35,926
|
)
|
|
|
|
|
18,598
|
|
Monetary
position (loss) gain
|
|
|
|
|
|
(7,601
|
)
|
|
|
|
|
11,574
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financial result, net
|
|
|
|
|
|
(35,073
|
)
|
|
|
|
|
45,014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expenses), net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other,
net
|
|
|
|
|
|
7,633
|
|
|
|
|
|
32,748
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expenses), net
|
|
|
|
|
|
7,633
|
|
|
|
|
|
32,748
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income tax and employee profit sharing
|
|
|
|
|
|
844,749
|
|
|
|
|
|
1,644,235
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
73,324
|
|
|
|
|
|
168,228
|
|
Deferred
|
|
|
|
|
|
24,160
|
|
|
|
|
|
(63,289
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
income tax
|
|
|
|
|
|
97,484
|
|
|
|
|
|
104,939
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
consolidated income
|
|
|
Ps.
|
|
|
747,265
|
|
|
|
|
|
1,539,296
|
|
Allocation
on net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
|
|
|
-
|
|
|
|
|
|
193,425
|
|
Majority
interest
|
|
|
Ps.
|
|
|
747,265
|
|
|
|
|
|
1,345,871
|
|
|
|
|
Ps.
|
|
|
747,265
|
|
|
|
|
|
1,539,296
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
405,209,451
|
|
|
|
|
|
419,450,541
|
|
Earnings
per share
|
|
|
Ps.
|
|
|
1.84
|
|
|
|
|
|
3.21
|
|
See
accompanying notes to condensed consolidated financial
statements
GRUPO
SIMEC, S.A.B. DE C.V. AND SUBSIDIARIES
Unaudited
Condensed Consolidated Statements of Changes in Stockholders'
Equity
(Thousands
of constant Mexican pesos as of June 30, 2006)
|
|
Capital
stock
|
|
Additional
paid-in capital
|
|
Retained
earnings
|
|
Cumulative
deferred income tax
|
|
Equity
adjustments for non-monetary assets
|
|
Translation
effect in foreign subsidiaries
|
|
Fair
value of derivative financial instruments
|
|
Total
majority interest
|
|
Minority
interest
|
|
Comprehensive
Income
|
|
Total
stockholders’ equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
at December 31, 2005
|
|
Ps. |
3,476,499
|
|
|
845,018
|
|
|
4,519,677
|
|
|
(905,828
|
)
|
|
(169,658
|
)
|
|
14,935
|
|
|
40,354
|
|
|
7,820,997
|
|
|
1,807,684
|
|
|
-
|
|
|
9,628,681
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increases
in capital stock (Note 12)
|
|
|
36,078
|
|
|
86,092
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
122,170
|
|
|
-
|
|
|
-
|
|
|
122,170
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
in Pav Republic by ICH
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
135,110
|
|
|
-
|
|
|
135,110
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income of the period
|
|
|
-
|
|
|
-
|
|
|
1,345,871
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1,345,871
|
|
|
193,425
|
|
|
1,539,296
|
|
|
1,539,296
|
|
Effect
of translation of foreign entities
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
123,335
|
|
|
-
|
|
|
123,335
|
|
|
122,352
|
|
|
245,687
|
|
|
245,687
|
|
Equity
adjustment for non-monetary assets net of deferred taxes
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
256,743
|
|
|
-
|
|
|
-
|
|
|
256,743
|
|
|
-
|
|
|
256,743
|
|
|
256,743
|
|
Effect
of market value of swaps net of deferred taxes
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(26,010
|
)
|
|
(26,010
|
)
|
|
-
|
|
|
(26,010
|
)
|
|
(26,010
|
)
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
at June 30, 2006 (unaudited)
|
|
Ps. |
3,512,577
|
|
|
931,110
|
|
|
5,865,548
|
|
|
(905,828
|
)
|
|
87,085
|
|
|
138,270
|
|
|
14,344
|
|
|
9,643,106
|
|
|
2,258,571
|
|
|
2,015,716
|
|
|
11,901,677
|
|
See
accompanying notes to condensed consolidated financial
statements
GRUPO
SIMEC, S.A.B. DE C.V. AND SUBSIDIARIES
Unaudited
Condensed Consolidated Statements of Changes in Financial Position
(Thousands
of constant Mexican pesos as of June 30, 2006, except earnings per share
figures)
|
|
|
|
Six
months ended June 30,
|
|
|
|
|
|
2005
|
|
2006
|
|
|
|
|
|
|
|
|
|
Operating
activities:
|
|
|
|
|
|
|
|
Net
consolidated income
|
|
|
Ps.
|
|
|
747,265
|
|
|
1,539,296
|
|
Add
(deduct) items not requiring the use of resources
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
|
|
|
130,940
|
|
|
201,972
|
|
Deferred
income tax
|
|
|
|
|
|
24,160
|
|
|
(63,289
|
)
|
Seniority
premiums and termination benefits
|
|
|
|
|
|
686
|
|
|
933
|
|
|
|
|
|
|
|
|
|
|
|
|
Resources
provided by operations
|
|
|
|
|
|
903,051
|
|
|
1,678,912
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivables, net
|
|
|
|
|
|
(220,488
|
)
|
|
(231,369
|
)
|
Prepaid
expenses and other current asset
|
|
|
|
|
|
2,866
|
|
|
(15,921
|
)
|
Inventories,
net
|
|
|
|
|
|
141,152
|
|
|
(615,074
|
)
|
Derivative
financial instrument
|
|
|
|
|
|
48
|
|
|
10,636
|
|
Accounts
payable, other accounts payable and accrued expenses
|
|
|
|
|
|
(171,284
|
)
|
|
(32,328
|
)
|
Other
long-term liabilities
|
|
|
|
|
|
8,351
|
|
|
(16,827
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Resources
provided operating activities
|
|
|
|
|
|
663,696
|
|
|
778,029
|
|
|
|
|
|
|
|
|
|
|
|
|
Financing
activities:
|
|
|
|
|
|
|
|
|
|
|
Increases
in capital stock
|
|
|
|
|
|
925
|
|
|
122,170
|
|
Short-term
loans repaid
|
|
|
|
|
|
(159,400
|
)
|
|
(17,592
|
)
|
Financial
debt repayment
|
|
|
|
|
|
-
|
|
|
(391,550
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Resources
used in financing activities
|
|
|
|
|
|
(158,475
|
)
|
|
(286,972
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Investing
activities:
|
|
|
|
|
|
|
|
|
|
|
Disposition
(acquisition) of property, plant and equipment
|
|
|
|
|
|
45,827
|
|
|
(285,261
|
)
|
Decrease
(increase) in other noncurrent assets
|
|
|
|
|
|
87,346
|
|
|
(9,027
|
)
|
Increase
of investment in Pav Republic by ICH
|
|
|
|
|
|
-
|
|
|
135,110
|
|
Proceeds
from insurance claim, net
|
|
|
|
|
|
-
|
|
|
407,330
|
|
|
|
|
|
|
|
|
|
|
|
|
Resources
provided by (used in) investing activities
|
|
|
|
|
|
133,173
|
|
|
248,152
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase in cash and cash equivalents
|
|
|
|
|
|
638,394
|
|
|
739,209
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
At
beginning of year
|
|
|
|
|
|
526,709
|
|
|
209,416
|
|
|
|
|
|
|
|
|
|
|
|
|
At
end of year
|
|
|
Ps.
|
|
|
1,165,103
|
|
|
948,625
|
|
See
accompanying notes to condensed consolidated financial
statements
GRUPO
SIMEC, S.A.B. DE C.V. AND SUBSIDIARIES
Notes
to
Unaudited Condensed Consolidated Financial Statements
(Amounts
in thousands of constant Mexican Pesos as of June 30, 2006, unless otherwise
indicated)
(1)
|
Significant
Accounting Policies
|
Except
as
described in the following paragraph, the accompanying unaudited condensed
consolidated financial statements are presented on the same basis of accounting
as described in the audited financial statements of Grupo Simec, S.A.B. de
C.V.
and subsidiaries (the Company) as of December 31, 2005 (the “audited financial
statements”), and have been prepared in accordance with generally accepted
accounting principles for interim financial information. Accordingly, they
do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for
the
six-month period ended June 30, 2006 are not necessarily indicative of the
results that may be expected for the year 2006.
The
unaudited condensed balance sheet as of December 31, 2005 has been derived
from
the audited financial statements at that date, but does not include all of
the
information and footnotes required by generally accepted accounting principles
for complete financial statements. For further information, refer to the
consolidated financial statements at December 31, 2005.
|
b)
|
Basis
of Consolidation
|
The
unaudited condensed consolidated financial statements include all the accounts
of Grupo Simec, S.A.B. de C.V. and its subsidiaries. All of the companies
operate in the manufacture and sale of iron and steel products primarily
for the
construction and automotive industries in the North American market (Canada,
United States and Mexico) or provide services to companies operating in such
sectors. All significant intercompany balances and transactions have been
eliminated in the consolidated financial statements.
Revenues
from the sale of products are generally recognized at the time products are
shipped and the related risks and benefits of the merchandise are transferred
to
the customer. In certain cases the company signs supply agreements with its
customers which provide the client to the right to return the merchandise
if
certain conditions established in those contracts are not met. Revenues on
these
types of agreements are recognized once all the conditions established in
the
contracts are met and when the customers accept the merchandise delivered
to
them.. The Company provides for freight expenses, returns and sales discounts
at
the time the related revenue is recognized. These provisions are deducted
from
net sales in the income statement.
|
d)
|
Recognition
of the effects of inflation on financial
information
|
The
unaudited condensed consolidated financial statement were prepared in accordance
with Bulletin B-10 (“Accounting Recognition of the Effects of Inflation on
Financial Information”) as described in the audited financial statements;
consequently, all financial statements presented herewith were restated to
constant pesos as of June 30, 2006. The June 30, 2006 restatement factors
applied to the financial statements at December 31, 2005, and June 30, 2005
were
1.0065, and 1.0318, which represent the rate of inflation from December 31,
2005
and June 30, 2005 up to June 30, 2006, respectively, based on the Mexican
National Consumer Price Index (NCPI) published by Banco de México (the Central
Bank).
|
e)
|
Basis
of translation of financial statements of foreign
subsidiaries
|
The
financial statements of foreign subsidiaries and affiliates, located in the
United States of America, are translated into Mexican pesos in conformity
with
Mexican accounting Bulletin B-15 (Foreign Currency Transactions and Translation
of Financial Statements of Foreign Operations), issued by the Mexican Institute
of Public Accountants (MIPA), as follows:
The
subsidiary SimRep was considered as a foreign entity for translation purposes;
therefore, the financial statements as reported by the subsidiary abroad
were
adjusted to conform with Mexican GAAP, which includes the recognition of
the
effects of inflation as required by Mexican accounting Bulletin B-10, applying
inflation adjustment factors derived from the U.S. Consumer Price Index (CPI)
published by the U.S. Labor Department. The financial information already
restated to include inflationary effects, is then translated to Mexican pesos
as
follows:
|
i.
|
By
applying the prevailing exchange rate at the consolidated balance
sheet
date for monetary and non-monetary assets and
liabilities.
|
|
ii.
|
By
applying the prevailing exchange rate for stockholders’ equity accounts,
at the time capital contributions were made and earnings were
generated.
|
|
iii.
|
By
applying the prevailing exchange rate at the consolidated balance
sheet
date for revenues and expenses during the reporting
period.
|
|
iv.
|
The
related effect of translation is recorded in stockholders’ equity under
the caption, “Translation effect of foreign
subsidiaries”.
|
The
subsidiaries Pacific Steel and Undershaft Investment, were considered an
“integral part of the operations” of the Company; and the financial statements
of such subsidiaries were translated into Mexican pesos as follows:
|
1.
|
By
applying the prevailing exchange rate at the consolidated balance
sheet
date for monetary items.
|
|
2.
|
By
applying the prevailing exchange rate at the time the non-monetary
assets
and capital were generated, and the weighted average exchange rate
of the
period for income statement items.
|
|
3.
|
The
related effect of translation is recorded in the statement of operations
as part of the caption, “Foreign exchange (loss)/gain,
net”.
|
The
Company’s financial statements at December 31, 2005 and June 30, 2005, were
restated to constant Mexican pesos with purchasing power at June 30, 2006
based
on the annual rate of inflation in Mexico. The effects of inflation and
variances in exchange rates were not material.
The
Company applied on a supplementary basis to Mexican GAAP, US EITF 98-11
“Accounting for Acquired Temporary Differences in Certain Purchase Transactions
that are not Accounted for as Business Combinations” to the OAL acquisition made
on July 20, 2005 (see Note 13). The deferred credit is obtained from the
difference between the amount paid and the deferred tax asset recognized
resulting from the purchase of future tax benefits from OAL.
The
deferred credit is being amortized to results of operations in the same
proportion to the realization of the tax benefits that gave rise to the deferred
credit . The deferred credit amortization in the six months period ended
June
30, 2006 was Ps. 339,555.
(2)
|
Foreign
Currency Position
|
Foreign
currency denominated assets and liabilities at December 31, 2005 and June
30,
2006 were as follows:
|
|
Thousands
of U.S. dollars
|
|
Thousands
of euros
|
|
Thousands
of
pounds
sterling
|
|
Thousands
of
deutsche
marks
|
|
|
|
2005
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
2006
|
|
Current
assets
|
|
USD |
163,318
|
|
USD |
212,394
|
|
|
-
|
|
EUR |
16
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
(180,511
|
)
|
|
(162,410
|
)
|
EUR |
(86
|
)
|
|
-
|
|
GBP |
(87
|
)
|
GBP |
(87
|
)
|
DEM |
(49
|
)
|
DEM |
(49
|
)
|
Long-term
liabilities
|
|
|
(36,095
|
)
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Total
liabilities
|
|
|
(216,606
|
)
|
|
(162,410
|
)
|
|
(86
|
)
|
|
-
|
|
|
(87
|
)
|
|
(87
|
)
|
|
(49
|
)
|
|
(49
|
)
|
Net
assets (liabilities)
|
|
|
(53,288
|
)
|
|
49,984
|
|
|
(86
|
)
|
|
16
|
|
|
(87
|
)
|
|
(87
|
)
|
|
(49
|
)
|
|
(49
|
)
|
The
exchange rates at December 31, 2005 and June 30, 2006 were as follows (amounts
in pesos):
|
|
December
31, 2005
|
|
June
30, 2006
|
|
|
|
|
|
|
|
Dollar
|
|
Ps. |
10.7777
|
|
|
11.3973
|
|
Euro
|
|
|
12.5797
|
|
|
14.3800
|
|
Pound
sterling
|
|
|
18.3570
|
|
|
20.7951
|
|
Deutsche
mark
|
|
|
6.4319
|
|
|
7.3524
|
|
The
summary of transactions carried out in U.S. dollars (in thousands) for the
six-month period ended June 30, 2005 and 2006, excluding imports of machinery
and equipment, is as follows:
|
|
2005
|
|
2006
|
|
|
|
|
|
|
|
Sales
|
|
USD |
39,355
|
|
|
767,174
|
|
Purchases
(raw materials)
|
|
|
(12,977
|
)
|
|
(543,848
|
)
|
Other
expenses (spare parts)
|
|
|
(3,353
|
)
|
|
(3,460
|
)
|
Interest
expense
|
|
|
(14
|
)
|
|
(313
|
)
|
The
exchange rate of the peso to foreign currencies used by the Company is based
on
the weighted average of free market rates available to settle its overall
foreign currency transactions.
(3)
|
Related
Party Transactions and
Balances
|
Transactions
carried out with related parties, primarily with Industrias CH, during the
six-month period ended June 30, 2005 and 2006 were as follows:
|
|
2005
|
|
2006
|
|
|
|
|
|
|
|
Sales
(1)
|
|
|
Ps.
|
|
|
24,800
|
|
|
|
|
|
-
|
|
Purchases
|
|
|
|
|
|
428
|
|
|
|
|
|
1,353
|
|
Administrative
services expenses (2)
|
|
|
Ps.
|
|
|
4,580
|
|
|
|
|
|
6,967
|
|
|
(1)
|
Primarily
this transaction relates to Intercompany sales of inventory with
Industrias CH
|
|
(2)
|
These
operations relate to Intercompany payroll services primarily with
Administración de empresas CH, S.A. de
C.V.
|
Balances
due from/to, related companies at December 31, 2005 and June 30, 2006 are
as
follows:
|
|
December
31, 2005
|
|
June
30, 2006
|
|
Accounts
receivable: (Note 4)
|
|
|
|
|
|
Industrias
CH (1)
|
|
|
Ps.
|
|
|
-
|
|
|
|
|
|
5,315
|
|
Administración
de empresas CH, S.A. de C.V. (2)
|
|
|
|
|
|
2,456
|
|
|
|
|
|
2,570
|
|
|
|
|
Ps.
|
|
|
2,456
|
|
|
|
|
|
7,885
|
|
Accounts
payable: (Note 8)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industrias
CH (1)
|
|
|
Ps.
|
|
|
460,228
|
|
|
|
|
|
155
|
|
The
account payable to Industrias CH is for an indefinite term and is a current
account that bears no interest. The balance of this payable is derived from
funds that the company received to finance the acquisition of PAV Republic.
The
amount was paid during 2006.
Accounts
receivable consist of the following:
|
|
|
|
December
31, 2005
|
|
June
30, 2006
|
|
Trade
|
|
|
Ps.
|
|
|
2,316,954
|
|
|
2,584,484
|
|
Related
parties (Note 3)
|
|
|
|
|
|
2,456
|
|
|
7,885
|
|
Recoverable
value added tax
|
|
|
|
|
|
115,703
|
|
|
99,844
|
|
Other
receivables
|
|
|
|
|
|
216,537
|
|
|
182,341
|
|
Total
|
|
|
|
|
|
2,651,650
|
|
|
2,874,554
|
|
Allowance
for doubtful accounts
|
|
|
|
|
|
(31,273
|
)
|
|
(22,808
|
)
|
Net
accounts receivable
|
|
|
Ps.
|
|
|
2,620,377
|
|
|
2,851,746
|
|
Inventories
are comprised as follows:
|
|
December
31, 2005
|
|
June
30, 2006
|
|
|
|
|
|
|
|
Finished
goods
|
|
|
Ps.
|
|
|
2,915,705
|
|
|
3,555,257
|
|
Work
in process
|
|
|
|
|
|
8,946
|
|
|
11,795
|
|
Billets
|
|
|
|
|
|
124,064
|
|
|
213,574
|
|
Raw
materials and supplies
|
|
|
|
|
|
276,183
|
|
|
155,277
|
|
Materials,
spare parts and rollers
|
|
|
|
|
|
131,425
|
|
|
94,580
|
|
Advances
to suppliers and others
|
|
|
|
|
|
147,597
|
|
|
264,459
|
|
Goods
in transit
|
|
|
|
|
|
60,581
|
|
|
30,545
|
|
|
|
|
|
|
|
3,664,501
|
|
|
4,325,487
|
|
Less:
allowance for obsolescence
|
|
|
|
|
|
4,000
|
|
|
3,987
|
|
|
|
|
Ps.
|
|
|
3,660,501
|
|
|
4,321,500
|
|
(6)
|
Derivative
Financial Instruments
|
The
Company uses derivative financial instruments primarily to offset its exposure
to financial risks related to the price of natural gas. Derivative instruments
currently used by the Company consist of natural gas swap contracts. These
contracts are recognized on the balance sheet at fair value. The swaps are
considered as cash flow hedges since the cash flow exchanges under the swap
are
highly effective in mitigating exposure to natural gas price fluctuations.
The
fair value of the swaps are recorded as part of Comprehensive income in
stockholders’ equity.
At
December 31, 2005 and June 30, 2006, the swaps gave rise to the recognition
of
an asset of Ps. 57,477 and Ps. 20,831, and a deferred tax liability of Ps.
16,669 and Ps. 6,487, as well as a net comprehensive income item in
stockholders’ equity of Ps. 40,354 and Ps. 14,344, respectively. Amounts
recorded as comprehensive loss were Ps. 101 and Ps. 26,010 (net of deferred
taxes), for the six month period ended June 30, 2005 and 2006
respectively.
Based
on
its inventory turnover, the Company believes that the natural gas burned
and
incorporated in its products during a given month is reflected in the cost
of
sales of the subsequent month.
(7)
|
Property,
Plant and Equipment
|
Property,
plant and equipment as of December 31, 2005 and June 30, 2006 are comprised
as
follows:
|
|
December
31, 2005
|
|
June
30, 2006
|
|
|
|
|
|
|
|
Buildings
|
|
|
Ps.
|
|
|
1,894,157
|
|
|
1,888,046
|
|
Machinery
and equipment
|
|
|
|
|
|
6,527,797
|
|
|
7,584,475
|
|
Transportation
equipment
|
|
|
|
|
|
48,598
|
|
|
45,797
|
|
Furniture,
fixtures and computer equipment
|
|
|
|
|
|
54,699
|
|
|
53,111
|
|
|
|
|
|
|
|
8,525,251
|
|
|
9,571,429
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
accumulated depreciation
|
|
|
|
|
|
2,516,798
|
|
|
2,878,670
|
|
|
|
|
|
|
|
6,008,453
|
|
|
6,692,759
|
|
|
|
|
|
|
|
|
|
|
|
|
Land
|
|
|
|
|
|
515,189
|
|
|
513,356
|
|
Construction
in progress
|
|
|
|
|
|
560,587
|
|
|
207,109
|
|
Idle
machinery and equipment
|
|
|
|
|
|
30,767
|
|
|
30,767
|
|
|
|
|
Ps.
|
|
|
7,114,996
|
|
|
7,443,991
|
|
Depreciation
expense for the six-month periods ended in June 30, 2005 and 2006 was
Ps.
130,940 and Ps. 192,905 respectively.
(8)
|
Other
accounts payable and accrued
expenses
|
Other
accounts payable and accrued expenses as of December 31, 2005 and June 30,
2006
consist of the following:
|
|
December
31, 2005
|
|
June
30, 2006
|
|
Accounts
payable
|
|
|
Ps.
|
|
|
1,411,813
|
|
|
1,640,252
|
|
Accruals
|
|
|
|
|
|
267,610
|
|
|
301,864
|
|
Accumulated
expenses and taxes
|
|
|
|
|
|
378,921
|
|
|
474,824
|
|
Advanced
payments from clients
|
|
|
|
|
|
44,242
|
|
|
114,240
|
|
Related
parties (Note 3)
|
|
|
|
|
|
460,228
|
|
|
155
|
|
Deferred
credit - current portion (Note 1f)
|
|
|
|
|
|
131,441
|
|
|
-
|
|
Total
|
|
|
Ps.
|
|
|
2,694,255
|
|
|
2,531,335
|
|
|
|
December
31, 2005
|
|
|
|
June
30, 2006
|
|
|
|
Currency
|
|
Items
|
|
Rate
|
|
Maturity
from 2005 to
|
|
Total
2005
|
|
Rate
|
|
Maturity
from 2006 to
|
|
Total
2006
|
|
Dollars
|
|
|
Debt
with Ohio Department of Development
|
|
|
3
|
%
|
|
2008
|
|
Ps.
|
46,994
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Dollars
|
|
|
Revolving
loan with General Electric Capital
|
|
|
|
|
|
2009
|
|
|
362,315
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Dollars
|
|
|
Medium
Term Notes
|
|
|
8
7/8
|
%
|
|
2005
|
|
|
3,275
|
|
|
8
7/8
|
%
|
|
2006
|
|
|
3,442
|
|
Total
debt
|
|
|
|
|
|
|
|
|
|
|
|
412,584
|
|
|
|
|
|
|
|
|
3,442
|
|
Less:
short term debt and current portion of long-term debt
|
|
|
|
|
|
|
|
|
|
|
|
21,034
|
|
|
|
|
|
|
|
|
3,442
|
|
Long
term debt
|
|
|
|
|
|
|
|
|
|
|
Ps.
|
391,550
|
|
|
|
|
|
|
|
|
-
|
|
(10)
|
Other
long-term liabilities
|
Other
long-term liabilities as of December 31, 2005 and June 30, 2006 consist of
the
following:
|
|
December
31, 2005
|
|
June
30, 2006
|
|
Seniority
premiums and termination benefits
|
|
|
Ps.
|
|
|
19,777
|
|
|
16,684
|
|
Other
long term liabilities
|
|
|
|
|
|
112,067
|
|
|
100,610
|
|
Deferred
credit (Note 1f)
|
|
|
|
|
|
208,114
|
|
|
-
|
|
Total
|
|
|
Ps.
|
|
|
339,958
|
|
|
117,294
|
|
(11)
|
Income
Tax, Asset Tax and Employee Profit
Sharing
|
Industrias
CH, holding company files a Consolidated Tax Return. Under Mexican Income
Tax
Law (MITL) Industrias CH does not have to allocate any tax to its subsidiaries
since each of its subsidiaries has the obligation to calculate on a stand
alone
basis its own taxes and only pay the minority part of such taxes directly
to the
Mexican Income Revenue Service (IRS). The majority tax for consolidated tax
purposes is paid through the holding company. The Company computes its tax
provision on a stand alone basis.
Under
current tax regulations, companies must pay the greater between income tax
and
asset tax. The computation of both taxes considers the effects of inflation,
although differently from accounting principles generally accepted in
Mexico.
Statutory
employee profit sharing is computed practically on the same basis as income
tax,
but excluding the effects of inflation.
The
Mexican Asset Tax Law establishes payment of a 1.8% tax on the value of restated
assets net of certain liabilities.
An
analysis of income tax charged to results of operations for the six-month
period
ended June 30, 2005 and 2006 is as follows:
|
|
|
|
2005
|
|
2006
|
|
Current
Income Tax Mexican Subsidiaries
|
|
|
Ps.
|
|
|
72,868
|
|
|
44,133
|
|
Current
Income Tax Foreign Subsidiaries
|
|
|
|
|
|
456
|
|
|
124,095
|
|
|
|
|
|
|
|
73,324
|
|
|
168,228
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
Income Tax Mexican Subsidiaries
|
|
|
|
|
|
24,160
|
|
|
143,487
|
|
Deferred
Income Tax Foreign Subsidiaries
|
|
|
|
|
|
-
|
|
|
130,586
|
|
Deferred
credit amortization (Note 1f)
|
|
|
|
|
|
-
|
|
|
(337,362
|
)
|
|
|
|
|
|
|
24,160
|
|
|
(63,289
|
)
|
Income
tax expense
|
|
|
Ps.
|
|
|
97,484
|
|
|
104,939
|
|
The
tax
effects of temporary differences that give rise to significant portions of
the
deferred tax assets and liabilities at June 30, 2006 and December 31, 2005
are
as follows:
|
|
|
|
December
31, 2005
|
|
June
30, 2006
|
|
Deferred
tax assets:
|
|
|
|
|
|
|
|
Allowance
for bad debts
|
|
|
Ps.
|
|
|
60,864
|
|
|
58,117
|
|
Liability
provisions
|
|
|
|
|
|
106,591
|
|
|
130,196
|
|
Advances
from customers
|
|
|
|
|
|
22,392
|
|
|
17,626
|
|
Tax
loss carryforward
|
|
|
|
|
|
316,796
|
|
|
7,141
|
|
Recoverable
asset tax
|
|
|
|
|
|
103,931
|
|
|
126,040
|
|
Total
gross deferred assets
|
|
|
|
|
|
610,574
|
|
|
339,120
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
valuation allowance
|
|
|
|
|
|
68,329
|
|
|
26,564
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
assets, net
|
|
|
|
|
|
542,245
|
|
|
312,556
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax liabilities:
|
|
|
|
|
|
|
|
|
|
|
Inventories
|
|
|
|
|
|
399,042
|
|
|
411,362
|
|
Derivative
financial instruments
|
|
|
|
|
|
16,669
|
|
|
6,487
|
|
Property,
plant and equipment
|
|
|
|
|
|
1,246,885
|
|
|
1,394,503
|
|
Pre-operating
expenses
|
|
|
|
|
|
89,240
|
|
|
81,830
|
|
Others
|
|
|
|
|
|
27
|
|
|
403
|
|
Additional
liabilities resulting from excess of book value of stockholders’ equity
over its tax value
|
|
|
|
|
|
303,461
|
|
|
303,461
|
|
Total
deferred liabilities
|
|
|
|
|
|
2,055,324
|
|
|
2,198,046
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax liability, net
|
|
|
Ps.
|
|
|
1,513,079
|
|
|
1,885,490
|
|
The
effective tax rate was 12% and 7% for the six month periods ended June 30,
2005
and 2006 respectively. For the six month period ended June 30, 2005 the
effective tax rate was lower than the 30% applicable tax rate in Mexico,
mainly
because in 2005 the Company determined a tax benefit due of the non-accumulation
of taxes, in the coming years, on its inventory balance at December 31, 2004
due
to a corporate restructure (spin-off of its Subsidiary COSICA) of the Company.
In addition there was a decrease in the deferred assets valuation allowance
based on an improvement on the recovery of these assets. For the six month
period ended June 30, 2006 the effective tax rate was lower than the 29%
and 35%
tax rates applicable in Mexico and the United States respectively, mainly
because in 2006 the Company amortized all of its deferred credit (see Note
1f)
which is a non-taxable income.
The
current and deferred employee profit sharing for the six month periods ended
June 30, 2005 and 2006 were not significant.
(12)
|
Stockholders’
Equity
|
|
(a)
|
Structure
of capital stock
|
|
i)
|
On
May 30, 2006, the Company effected a 3 for 1 stock split. After
the split
the ADS now represent 3 shares of series B common stock. Before
that stock
split was completed, each ADS represented one share of series B
common
stock. The ADSs are evidenced by American depositary receipts (“ADRs”)
issued by the Bank of New York (“Depositary”), as depositary under a
Deposit Agreement, dated as of July 8, 1993, as amended, among
Simec, the
Depositary and the holders from time to time of ADRs. All share
and per
share information has been adjusted to reflect the three for one
split.
|
|
ii)
|
At
a regular stockholders’ meeting held on February 13, 2006, it was agreed
to increase the Company’s capital stock by Ps. 36,078 (Ps. 36,110) nominal
amount) by issuing 2,475,303 common “B” series shares and a stock premium
of Ps. 86,092 (Ps.86,169 nominal amount) that were wholly
paid.
|
Shares
outstanding as of December 31, 2005 and June 30, 2006 are as
follows:
|
|
2005
|
|
2006
|
|
Common
“B” series shares
|
|
|
137,929,599
|
|
|
421,214,706
|
|
Each
share has the right to one vote at stockholders’ meetings.
Minimum
fixed capital not subject to withdrawal is Ps. 441,786, nominal amount, which
may be increased or decreased by a resolution passed at a general extraordinary
shareholders’ meeting.
At
December 31, 2005 and June 30, 2006 the Other accumulated comprehensive (loss)
income is as follows:
|
|
December
31, 2005
|
|
June
30, 2006
|
|
Equity
adjustment for non-monetary assets
|
|
|
Ps.
|
|
|
(235,636
|
)
|
|
120,951
|
|
Translation
effect in foreign subsidiaries
|
|
|
|
|
|
14,935
|
|
|
138,270
|
|
Fair
value of derivative financial instruments
|
|
|
|
|
|
57,477
|
|
|
20,831
|
|
Deferred
tax
|
|
|
|
|
|
48,855
|
|
|
(40,353
|
)
|
Total
|
|
|
Ps.
|
|
|
(114,369
|
)
|
|
239,699
|
|
|
(a)
|
On
July 22, 2005, the Company and Industrias CH acquired the outstanding
shares of PAV Republic Inc. (Republic) through their subsidiary
SimRep
Corporation, a U.S. company. Such transaction was valued at USD
245
million where USD 229 million corresponds to the purchase price
and USD 16
million, to the direct cost of the business combination. The Company
contributed USD 123 million to acquire 50.2% of the representative
shares
of SimRep Corporation and Industrias CH, the holding company, acquired
the
remaining 49.8%. SimRep then acquired all the shares from Republic
through
a stock purchase agreement. Under the terms of the stock purchase
agreement, the Company acquired the right to a portion of the
reimbursement from an unresolved insurance claim. On April 24,
2006 a
Settlement Agreement and Release was reached and approximately
Ps. 407
million, net of payment to Predecessor’s shareholders of Ps. 211 and
professional fees has been received by the Company. Due to the
receipt,
the Company changed the final purchase accounting adjustment to
reflect
the fair value of the assets acquired and liabilities assumed.
Republic
has six production plants: five in the United States and one in
Canada.
The Company and Industrias CH acquired Republic to increase their
presence
in the US market.
|
The
total
Republic acquisition price was allocated to the assets acquired and the
liabilities assumed based on their fair values as of July 22, 2005. The
following table summarizes the fair values of the assets acquired and the
liabilities assumed in connection with the acquisition. The acquisition price
resulted in negative goodwill which was allocated proportionally to all
non-current assets. The consolidated financial position at date of the
acquisition, restated for inflation at June 30, 2006, is as
follows:
|
|
|
|
As
originally recorded
|
|
Subsequent
to Insurance Settlement
|
|
Current
assets
|
|
|
Ps.
|
|
|
4,405,135
|
|
|
4,812,907
|
|
Property,
plant and equipment
|
|
|
|
|
|
1,275,784
|
|
|
1,065,150
|
|
Intangibles
and deferred charges
|
|
|
|
|
|
369,505
|
|
|
310,169
|
|
Other
assets
|
|
|
|
|
|
61,022
|
|
|
59,116
|
|
Total
assets
|
|
|
|
|
|
6,111,446
|
|
|
6,247,342
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
1,703,562
|
|
|
1,839,458
|
|
Long-term
debt
|
|
|
|
|
|
695,050
|
|
|
695,050
|
|
Renewable
credit
|
|
|
|
|
|
748,547
|
|
|
748,547
|
|
Deferred
taxes
|
|
|
|
|
|
282,869
|
|
|
282,869
|
|
Other
long-term debt
|
|
|
|
|
|
72,296
|
|
|
72,296
|
|
|
|
|
|
|
|
3,502,324
|
|
|
3,638,220
|
|
Net
assets acquired
|
|
|
Ps.
|
|
|
2,609,122
|
|
|
2,609,122
|
|
As
a
result of the acquisition of Republic, an analysis of information regarding
Simec’s results of operations of 2005, including Republic’s 6 plants, over a
six-month period, as if the plants had been incorporated into the Company
since
the beginning of the year (unaudited information) is as follows:
|
|
|
|
Unaudited
Six-month Period ended June 30, 2005
|
|
Net
sales
|
|
|
Ps.
|
|
|
12,388,821
|
|
Marginal
profit
|
|
|
|
|
|
2,401,672
|
|
Net
income
|
|
|
Ps.
|
|
|
1,141,114
|
|
Earnings
per share (pesos)
|
|
|
|
|
|
2.33
|
|
|
(b)
|
On
July 20, 2005, the Company acquired all shares of Operadora de
Apoyo
Logístico, S.A. de C.V. (OAL), a subsidiary of Grupo TMM, S.A. de C.V.,
for Ps. 133 million, to make it the operating company of the three
steel
plants in Mexico. This transaction resulted in a deferred credit
of Ps.
406,731.
|
The
consolidated financial position at date of the acquisition, restated at
June 30, 2006, is as follows:
Current
assets
|
|
|
Ps.
|
|
|
1,006
|
|
Deferred
tax asset
|
|
|
|
|
|
526,753
|
|
Net
assets acquired
|
|
|
Ps.
|
|
|
527,759
|
|
OAL
had
accumulated NOLs of Ps. 1,331,953 that could be offset against future taxable
income. However the recorded financial effect of this tax benefit is Ps.
530,177. Since OAL had no operations before the acquisition, no pro forma
results from operations are included here.
The
Company segments its information by region, due to the operational and
organizational structure of its business. The Company’s operations are primarily
in Mexico and the United States. The Mexican segment of the Company includes
the
manufacturing plants of Mexicali, Guadalajara and Tlaxcala. The United States
segment includes the seven manufacturing plants of Republic acquired on July
22,
2005. Republic’s manufacturing plants are located in the United States (six
total in Ohio, Indiana and New York) and one in Canada (Ontario). The plant
in
Canada represents approximately 4% of total sales of the segment.
|
|
|
|
As
of June 30 and the six-month period then ended,
|
|
|
|
|
|
2005
|
|
2006
|
|
|
|
|
|
Mexico
|
|
United
States
|
|
Total
|
|
Mexico
|
|
United
States
|
|
Total
|
|
Assets
|
|
|
Ps.
|
|
|
9,246,739
|
|
|
-
|
|
|
9,246,739
|
|
|
9,113,116
|
|
|
7,326,122
|
|
|
16,439,238
|
|
Sales
|
|
|
Ps.
|
|
|
3,573,182
|
|
|
-
|
|
|
3,573,182
|
|
|
3,547,133
|
|
|
8,365,333
|
|
|
11,912,466
|
|
Income
before taxes
|
|
|
Ps.
|
|
|
844,749
|
|
|
-
|
|
|
844,749
|
|
|
1,012,060
|
|
|
632,175
|
|
|
1,644,235
|
|
The
Company’s net sales to foreign or regional customers are as
follows:
|
|
|
|
Six
months ended June 30,
|
|
|
|
|
|
2005
|
|
2006
|
|
|
|
|
|
Sales
|
|
Sales
|
|
|
|
|
|
|
|
|
|
México
|
|
|
Ps.
|
|
|
3,124,770
|
|
|
3,324,932
|
|
United
States
|
|
|
|
|
|
443,579
|
|
|
8,218,128
|
|
Canada
|
|
|
|
|
|
-
|
|
|
351,524
|
|
Latin
America
|
|
|
|
|
|
2,408
|
|
|
10,107
|
|
Others
|
|
|
|
|
|
2,425
|
|
|
7,775
|
|
|
|
|
Ps.
|
|
|
3,573,182
|
|
|
11,912,466
|
|
(15)
|
Commitments
and Contingent Liabilities
|
Commitments
|
(a)
|
As
discussed in note 6 to the financial statements, at the end of
2003, the
Company engaged in derivative financial instruments with PEMEX
Gas y
Petroquímica Básica, for hedging purposes to cover natural gas price
fluctuations. The coverage will guarantee a portion of the Company’s
natural gas consumption from 2004 to 2006 at a fixed price of USD
4.462
per MMBtu. The Company also held in one of its subsidiaries in
the USA
some contracts for natural gas swaps, entered to offset the potential
natural gas price volatility. These swaps resulted in the marking
to
market of all the open contracts as of June 30, 2006 and recording
a
liability for USD 1.1 million.
|
|
(b)
|
Regarding
the US operations, US Steel is the primary supplier of iron ore
and coke.
On March 8, 2006 the Company and US Steel entered into an agreement
which
extends the supply agreements to provide iron ore and a portion
of the
Company’s coke requirements through September 30, 2006. A renewal is
currently under negotiation. The US operations purchase coke in
the
domestic and foreign markets and are working to develop additional
sources
for both coke and iron ore.
|
|
(c)
|
On
October 11, 2004, the installation of a new five-position machine
which
produces strips and ingots and the installation of related equipment
were
approved in Republic's facilities located in Canton, Ohio. Republic
began
to prepare the installation of the new equipment in December 2004.
The
project was completed during June 2006 and the caster was put into
production. Project costs of $56.0 million were reclassified from
construction-in-progress to buildings and improvements and machinery
and
equipment upon completion. On June 30, 2006, it was decided to
temporarily
idle the caster based on sufficient alternative melt capacity.
The caster
will restart when commodity prices and business conditions warrant.
|
|
(d)
|
The
Company has certain operating lease agreements for equipment, office
space
and computer equipment, and such agreements cannot be cancelled.
The rent
will expire on different dates through 2012. In 2005, the rent
expense
related to such agreements aggregated Ps. 41.1 million. At December
31,
2005, the total minimum rental payments in accordance with such
agreements
that cannot be cancelled aggregate Ps. 41.1 million in 2006, Ps.
13
million in 2007, Ps. 10.8 million in 2008, Ps. 8.7 million in 2009,
Ps.
3.2 million in 2010 and Ps. 4.3 million in subsequent
years.
|
|
(e)
|
The
Company’s subsidiary Republic has an agreement with the USWA to manage
health insurance benefits for Republic workers of the USWA while
they
temporarily do not render their services, and to administer monthly
contribution payments to the Steelworkers' Pension Trust by local
union
officers while they work for the union. To fund this program, in
February
2004, the USWA granted an initial contribution of Ps. 27 million
in cash
to be used to provide health insurance benefits and Ps. 5.4 million
to
provide benefits for pensions for those who work in the steel industry.
At
June 30, 2006, the balance of this cash account aggregated Ps.
31.9
million. The Company has agreed to continue managing these programs
until
the fund is completely exhausted. Republic will provide the USWA
with
periodic reports on the fund's status. At June 30, 2005, the cash
account
balance is included in Other assets and the related liability is
included
in Other long-term liabilities in the attached consolidated balance
sheets.
|
Contingent
liabilities
|
(f)
|
California
Regional Water Control
Board
|
In
1987,
Pacific Steel, Inc. (Pacific Steel), a subsidiary of Simec based in National
City in San Diego County, California, received a notice from the California
Regional Water Control Board, San Diego Region (the “Regional Board”), which
prohibited Pacific Steel from draining into the street waters from spraying
borax (waste resulting from the process of the scrap yard). This and other
subsequent requirements obligated Pacific Steel to (i) stop operations in
the
scrap yard, (ii) send an enclosure of the borax which was stored in its yards
and (iii) take samples of the soil where the borax was found. The result
of this
study was that the residual metal contents represented no significant threat
to
the quality of water.
|
(g)
|
Department
of Toxic Substances
Control
|
In
September 2002, the Department of Toxic Substances Control inspected Pacific
Steel’s facilities based on an alleged complaint from neighbors due to Pacific
Steel’s excavating to recover scrap metal on its property and on a neighbor’s
property which it rents from a third party. In this same month, the department
issued an enforcement order of imminent and substantial endangerment
determination, which alleges that certain soil piles, soil management and
metal
recovery operations may cause an imminent and substantial danger to human
health
and the environment. Consequently, the department sanctioned Pacific Steel
for
violating hazardous waste laws and the State of California Security Code
and
imposed the obligation to make necessary changes to the location. In July
2004,
in an effort to continue with this order, the department filed a Complaint
for
Civil Penalties and Injunctive Relief in San Diego Superior Court. On July
26,
2004, the court issued a judgment, whereby Pacific Steel is obligated to
pay USD
235,000 (payable in four payments of USD 58,750 over the course of one year)
for
fines of USD 131,250, the department's costs of USD 45,000 and an environmental
project of USD 58,750. At December 31, 2005, Pacific Steel has made all of
the
payments.
In
August
2004, Pacific Steel and the Department entered into a corrective action consent
agreement. In September 2005, the Department approved the Corrective Measures
Plan presented by Pacific Steel, provided it obtains permits from the
corresponding local authorities, which are in process at date.
Due
to
the fact that the cleanliness levels have not yet been defined by the Department
and since the characterization of all the property has not yet been finished,
the allowance for the costs for the different remedy options are still subject
to considerable uncertainty.
The
Company estimated, based on experience in prior years and using the same
processes, a liability of between USD 0.8 and USD 1.7 million. Due to the
above,
at June 30, 2006 the Company has a reserve for this contingency of approximately
USD 1.4 million.
|
(h)
|
The
Community Development
Commission
|
Additionally,
the Community Development Commission of National City, California (CDC) has
expressed its intention to develop the site and is preparing a purchase offer
for Pacific Steel’s land at market value, less the cost of remediation and less
certain investigation costs incurred. Pacific Steel has informed the CDC
that
the land will not be voluntarily sold unless there is an alternate property
where it could relocate its business. The CDC, in accordance with the State
of
California law, has the power to expropriate in exchange for payment at market
value and, in the event that there is no other land available to relocate
the
business, it would also have to pay Pacific Steel the land’s book value. The CDC
made an offer to purchase the land from Pacific Steel for USD 6.9 million,
based
on a business appraisal. The expropriation process was temporarily suspended
through an agreement entered into by both parties in April 2006. This agreement
allows Pacific Steel to explore the possibility of finishing the remediation
process of the land and to propose an attractive alternative to CDC which
would
allow the Company to remain in the area.
Due
to
this situation and considering the imminent expropriation of part of the
land on
which Pacific Steel carries out certain operations, for the year ended December
31, 2002, Pacific Steel recorded its land at realizable value.
|
(i)
|
Nullity
suit with the Mexican Federal
Tax.
|
On
July
2, 2003, CSG filed a nullity suit with the Mexican Federal
Tax and Administrative Court of Justice
against
an official communication issued by the Central International Fiscal Auditing
Office of the Tax Administration Service, whereby CSG is deemed to have unpaid
taxes of Ps. 89,970 on alleged omissions of income taxes it should have withheld
from third parties on interest payments abroad in 1998, 1999, 2000, and for
the
period from January 1, 2001 through June 30, 2001. CSG is currently waiting
for
the authorities to respond it the suit. According to Company management and
its
legal advisors, there
are
reasonable grounds on which to obtain a favorable resolution for CSG
accordingly no reserve was recorded.
The
Company is involved in a number of lawsuits and claims that have arisen
throughout the normal course of business. The Company and its legal advisors
do
not expect the final outcome of these matters to have any significant adverse
effects on the Company’s financial position and results of
operations.
In
conformity with current tax legislation, federal, state and municipal taxes
are
open to review by the tax authorities for a period of five years, prior to
the
last income tax return filed.
In
accordance with the Mexican Income Tax Law, companies that do business with
related parties are subject to specific requirements in respect to agreed
upon
prices, since such prices must be comparable to those that would be charged
in
similar transactions between unrelated parties. Should the authorities review
and reject the Company’s intercompany pricing, the authorities may demand
payment of the omitted taxes plus restatement and surcharges.
|
(m)
|
Republic
environmental liabilities
|
At
June
30, 2006, the Company recorded a reserve of Ps. 43.3 million to cover probable
environmental liabilities and compliance activities. The non-current portions
of
the environmental reserve are included in the caption “Other long-term
liabilities”, in the attached consolidated balance sheets. Republic has no
knowledge of any additional environmental remediation liabilities or contingent
liabilities related to environmental issues in regards to the facilities;
consequently, it would not be appropriate to establish an additional reserve
at
this time.
As
is the
case for most steel producers in the United States, Republic may incur in
material expenses related to future environmental issues, including those
which
arise from environmental compliance activities and the remediation of past
administrative waste practices in Republic’s facilities.
(16)
|
Differences
between Mexican and United States accounting
principles:
|
The
Company’s consolidated financial statements are prepared in accordance with
Mexican GAAP, which differ in certain significant respects from U.S.
GAAP.
The
Mexican GAAP consolidated financial statements include the effects of inflation
as provided for under Bulletin B-10, as amended. The following reconciliation
to
U.S. GAAP does not include the reversal of the adjustments for the effects
of
inflation, since the application of Bulletin B-10 represents a comprehensive
measure of the effects of price level changes in the inflationary Mexican
economy and, as such, is considered a more meaningful presentation than
historical cost-based financial reporting for both Mexican and U.S. accounting
purposes.
Other
significant differences between Mexican GAAP and U.S. GAAP and the effects
on
consolidated net income and consolidated stockholders’ equity are presented
below, in thousands of constant Mexican pesos as of June 30, 2006, with an
explanation of the adjustments.
Reconciliation
of net income:
|
|
|
|
Six
months ended June 30,
|
|
|
|
|
|
2005
|
|
2006
|
|
Net
income as reported under Mexican GAAP
|
|
|
Ps.
|
|
|
747,265
|
|
|
1,539,296
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
GAAP adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
indirect costs
|
|
|
|
|
|
(2,817
|
)
|
|
88,403
|
|
Depreciation
on restatement of machinery and equipment
|
|
|
|
|
|
(11,951
|
)
|
|
(13,215
|
)
|
Deferred
income taxes
|
|
|
|
|
|
(4,802
|
)
|
|
(13,383
|
)
|
Deferred
employee profit sharing
|
|
|
|
|
|
47
|
|
|
(23
|
)
|
Pre-operating
expenses, net
|
|
|
|
|
|
14,326
|
|
|
14,326
|
|
Amortization
of gain from monetary position and exchange loss capitalized under
Mexican
GAAP
|
|
|
|
|
|
3,620
|
|
|
3,620
|
|
Minority
interest
|
|
|
|
|
|
-
|
|
|
(193,425
|
)
|
U.S.
GAAP adjustments on minority interest
|
|
|
|
|
|
-
|
|
|
(39,494
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total
U.S. GAAP adjustments
|
|
|
|
|
|
(1,577
|
)
|
|
(153,191
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
income under U.S. GAAP
|
|
|
Ps.
|
|
|
745,688
|
|
|
1,386,105
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average outstanding basic after split (1)
|
|
|
|
|
|
405,209,451
|
|
|
419,450,541
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings per share (pesos) after split (1)
|
|
|
Ps.
|
|
|
1.84
|
|
|
3.30
|
|
|
(1)
|
As
explained in Note 12 (a) the Company affected a 3 for 1 stock split
on May
30, 2006. This information presents the retrospective effect on
the
Earnings per Share after the split in accordance with US
GAAP.
|
Reconciliation
of stockholders’ equity:
|
|
|
|
June
30,
|
|
|
|
|
|
December
31, 2005
|
|
June
30, 2006
|
|
|
|
|
|
|
|
|
|
Total
stockholders’ equity reported under Mexican GAAP
|
|
|
Ps.
|
|
|
9,628,681
|
|
|
11,901,677
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
GAAP adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest included in stockholders’ equity under Mexican
GAAP
|
|
|
|
|
|
(1,807,684
|
)
|
|
(2,258,571
|
)
|
U.S.
GAAP adjustments on minority interest
|
|
|
|
|
|
-
|
|
|
(39,494
|
)
|
Inventory
indirect costs
|
|
|
|
|
|
12,454
|
|
|
100,857
|
|
Restatement
of machinery and equipment
|
|
|
|
|
|
589,151
|
|
|
258,403
|
|
Accrued
vacation costs
|
|
|
|
|
|
(611
|
)
|
|
(611
|
)
|
Deferred
income taxes
|
|
|
|
|
|
(57,795
|
)
|
|
27,160
|
|
Deferred
employee profit sharing
|
|
|
|
|
|
746
|
|
|
723
|
|
Pre-operating
expenses
|
|
|
|
|
|
(212,399
|
)
|
|
(198,073
|
)
|
Gain
from monetary position and exchange loss capitalized, net
|
|
|
|
|
|
(182,611
|
)
|
|
(178,991
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total
U.S. GAAP adjustments
|
|
|
|
|
|
(1,658,749
|
)
|
|
(2,288,597
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total
stockholders’ equity under U.S. GAAP
|
|
|
Ps.
|
|
|
7,969,932
|
|
|
9,613,080
|
|
A
summary
of changes in stockholders’ equity, after the approximate U.S. GAAP adjustments
described above, is as follows:
|
|
|
|
Capital
Stock and Paid-in Capital
|
|
Retained
Earnings
|
|
Fair
Value of Derivative Financial Instruments
|
|
Cumulative
Restatement Effect
|
|
Total
Stockholders’ Equity
|
|
Balances
as of December 31, 2005
|
|
|
Ps.
|
|
|
3,780,909
|
|
|
3,219,274
|
|
|
40,354
|
|
|
929,395
|
|
|
7,969,932
|
|
Increase
in capital stock
|
|
|
|
|
|
122,170
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
122,170
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
comprehensive income
|
|
|
|
|
|
-
|
|
|
1,386,105
|
|
|
(26,010
|
)
|
|
160,883
|
|
|
1,520,978
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
as of June 30, 2006
|
|
|
Ps.
|
|
|
3,903,079
|
|
|
4,605,379
|
|
|
14,344
|
|
|
1,090,278
|
|
|
9,613,080
|
|
The
cumulative difference between the amounts included under Capital Stock and
Paid-in Capital for U.S. GAAP and Capital Stock and Paid-in Capital for Mexican
GAAP arise from the following items:
Issuance
of capital stock:
During
1993 and 1994 the Company recorded Ps. 92,601 and Ps. 29,675, respectively,
corresponding to expenses related to the issuance of shares in a simultaneous
public offering in the United States and Mexico as a reduction of the proceeds
from the issuance of capital stock. In 1993 and 1994, these expenses were
deducted for tax purposes resulting in a tax benefit of Ps. 32,180 and Ps.
10,091. These tax benefits were included in the statement of operations for
Mexican GAAP purposes. For U.S. GAAP purposes these items were shown as a
reduction of cost of issuance of the shares, thereby increasing the net proceeds
from the offering.
Maritime
operations and amortization of negative goodwill:
In
1993,
Grupo Simec disposed of its maritime operations by spinning-off the two entities
acquired in 1992 to Grupo Sidek (former parent company of Grupo Simec) and
transferring its remaining maritime subsidiary to Grupo Sidek for its
approximate book value.
The
operations sold had a tax loss carryforward of approximately Ps. 197,117
which
were related to operations prior to the date the entities were acquired by
the
Company. During 1994, Ps. 4,608 of these tax loss carryforwards were realized
(resulting in a tax benefit of Ps. 1,587).
For
U.S.
GAAP purposes, the retained tax benefit of Ps. 1,587 realized in 1994, had
been
reflected as an increase to the corresponding paid-in capital rather than
in net
earnings as done for Mexican GAAP purposes.
Gain
on extinguishment:
On
February 7, 2001, the Company’s Board of Directors approved the issuance of
492,852,025 shares of Series “B” variable capital stock in exchange for the
extinguishment of debt amounting to USD 110,257,012. Under Mexican GAAP,
the
increase in stockholders’ equity resulting from the conversion or extinguishment
of debt is equal to the carrying amount of the extinguished debt. The Company
assigned a value of USD 110,257,012 to the Series “B” capital stock and,
therefore, no difference existed between the equity interest granted and
the
carrying amount of the debt extinguished. Under U.S. GAAP, the difference
between the fair value of equity interest granted and the carrying amount
of
extinguished debt is recognized as a gain or loss on extinguishment of debt
in
the statement of operations. For U.S. GAAP purposes, the fair value of the
Series “B” capital stock was determined by reference to the quoted market price
on March 29, 2001, the date the transaction was effected, and the difference
between the fair value of the Series “B” capital stock and the carrying amount
of the extinguished debt was recognized as a gain in the statement of
operations. The related restated effect as of December 31, 2005 is Ps.
584,466.
Reconciliation
of Net Income and Stockholders’ Equity:
The
Company’s consolidated financial statements are prepared in accordance with
Mexican GAAP, which differ in certain significant respects from U.S. GAAP.
The
explanations of the related adjustments included in the Reconciliation of
net
income and the Reconciliation
of stockholders’ equity are explained below:
Inventory:
As
permitted by Mexican GAAP, some inventories are valued under the direct cost
system, which includes material, direct labor and other direct costs. For
purposes of complying with U.S. GAAP, inventories have been valued under
the
full absorption cost method, which includes the indirect costs.
Under
Mexican GAAP, inventories include prepaid advances to suppliers. For U.S.
GAAP
purposes, the prepaid advances to suppliers are considered as prepaid
expenses.
Restatement
of property, machinery and equipment -
As
explained in note 1(d), in accordance with Mexican GAAP, imported machinery
and
equipment has been restated during the six months periods June 30, 2005 and
June
30, 2006, by applying devaluation and inflation factors of the country of
origin.
Under
U.S. GAAP, during the six months periods June 30, 2005 and June 30, 2006
the
restatement of all machinery and equipment, both domestic and imported, has
been
done in constant units of the reporting currency, the Mexican peso, using
the
inflation rate of Mexico.
Accordingly,
a reconciling item for the difference in methodologies of restating imported
machinery and equipment is included in the reconciliation of net income and
stockholders’ equity.
Deferred
income taxes and employee profit sharing:
Under
Mexican GAAP, the Company accounts for deferred income tax following the
guidelines of Mexican Bulletin D-4. The main differences between SFAS No.
109
and Bulletin D-4, as they relate to the Company, which are included as
reconciling items between Mexican and U.S. GAAP are:
|
·
|
the
income tax effect of gain from monetary position and exchange loss
capitalized that is recorded as an adjustment to stockholders’ equity for
Mexican GAAP purposes,
|
|
·
|
the
income tax effect of capitalized pre-operating expenses which for
U.S.
GAAP purposes, are expensed when
incurred,
|
|
·
|
the
effect on income tax of the difference between the indexed cost
and the
restatement through use of specific indexation factors of fixed
assets
which is recorded as an adjustment to stockholders’ equity for Mexican
GAAP, and,
|
|
·
|
the
income tax effect of the inventory cost which for Mexican GAAP
some
inventories are valued under the direct cost system and for U.S.
GAAP
inventories have been valued under the full absorption cost
method.
|
The
cumulative deferred income tax for U.S. GAAP purposes is included under Retained
Earnings. Under Mexican GAAP such effect is included under the cumulative
deferred income taxes caption.
In
addition, the Company is required to pay employee profit sharing in accordance
with Mexican labor law. Deferred employee profit sharing under U.S. GAAP
has
been determined following the guidelines of SFAS N0. 109. Under Mexican GAAP,
the deferred portion of employee profit sharing is determined on temporary
non-recurring differences with a known turnaround time.
To
determine operating income under U.S. GAAP, deferred employee profit sharing
and
employee profit sharing expense (under Mexican GAAP included under the caption
provisions in the income statement) are considered as operating
expenses.
The
effects of temporary differences giving rise to significant portions of the
deferred tax assets and liabilities at June 30, 2005 and 2006, under U.S.
GAAP
are presented below:
|
|
|
|
December
31, 2005
|
|
June
30, 2006
|
|
Deferred
tax assets:
|
|
|
|
|
|
|
|
Allowance
for doubtful receivables
|
|
|
Ps.
|
|
|
60,864
|
|
|
58,117
|
|
Accrued
expenses
|
|
|
|
|
|
117,975
|
|
|
130,373
|
|
Advances
from customers
|
|
|
|
|
|
11,186
|
|
|
17,626
|
|
Net
operating loss carryforwards
|
|
|
|
|
|
316,796
|
|
|
7,141
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset
Tax
|
|
|
|
|
|
103,931
|
|
|
126,040
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
gross deferred tax assets
|
|
|
|
|
|
610,752
|
|
|
339,297
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
valuation allowance
|
|
|
|
|
|
68,329
|
|
|
26,564
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
deferred tax assets
|
|
|
|
|
|
542,423
|
|
|
312,733
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax liabilities:
|
|
|
|
|
|
|
|
|
|
|
Inventories,
net from the balance as of December 31, 1986 not yet
deducted
|
|
|
|
|
|
402,654
|
|
|
417,603
|
|
Derivative
financial instruments
|
|
|
|
|
|
11,145
|
|
|
6,487
|
|
Property,
plant and equipment
|
|
|
|
|
|
1,360,718
|
|
|
1,443,554
|
|
Others
|
|
|
|
|
|
35,319
|
|
|
404
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
liabilities resulting from excess of book value of stockholders’ equity
over its tax value
|
|
|
|
|
|
303,461
|
|
|
303,461
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
deferred liabilities
|
|
|
|
|
|
2,113,297
|
|
|
2,171,509
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
deferred tax liability
|
|
|
Ps.
|
|
|
1,570,874
|
|
|
1,858,776
|
|
The
total
net deferred tax liability under U.S. GAAP includes a current portion as
of June
30, 2006 of Ps. 213,509 with the remainder being classified as long
term.
The
deferred income taxes on property plant and equipment, of Ps. 1,360,718 and
Ps.
1,443,554 result from differences between the financial reporting and tax
bases
of property, plant and equipment at December 31, 2005 and 2006, respectively.
Beginning in 1997 the restatement of property, plant and equipment and the
effects thereof on the statement of operations are determined by using factors
derived from the NCPI or, in the case of imported machinery and equipment,
by
applying devaluation and inflation factors of the country of origin. Until
1996,
for financial reporting purposes, property, plant and equipment were stated
at
net replacement cost and depreciation was provided by using the straight-line
method over the estimated remaining useful lives of the assets. For income
tax
reporting purposes, property, plant, and equipment and depreciation are computed
by a method which considers the NCPI.
Domestic
operations accounted for 99% percent of the Company’s pre-tax income and IT
expense in June 30, 2005 and 54% in June 30, 2006.
In
accordance with APB Opinion No. 23 it is the policy of the Company to accrue
appropriate Mexican and foreign income taxes on earnings of subsidiary companies
which are intended to be remitted to the parent company in the near future.
Unremitted earnings of subsidiaries which have been, or are intended to be,
permanently reinvested, exclusive of those amounts which if remitted in the
near
future would result in little or no such tax by operation of relevant statutes
currently in effect, aggregated Ps. 11.7 million and Ps. 176 million at December
30, 2006 and June 30, 2006 respectively.
Pre-operating
expenses:
For
Mexican GAAP purposes, the Company capitalized pre-operating expenses related
to
the production facilities at Mexicali, as well as costs and expenses incurred
in
the manufacturing and design of new products. For U.S. GAAP purposes, these
items are expensed when incurred.
Financial
expense capitalized:
Under
Mexican GAAP, financial expense capitalized during the period required to
bring
property, plant and equipment into the condition required for their intended
use, includes interest, exchange losses and gains from monetary position.
Under
U.S. GAAP when financing is in Mexican pesos, the monetary gain is included
in
this computation; when financing is denominated in U.S. dollars, only the
interest is capitalized and exchange losses and monetary position are not
included.
Minority
interest:
Under
Mexican GAAP, the minority interest in consolidated subsidiaries is presented
as
a separate component within stockholders’ equity on the consolidated balance
sheet. For U.S. GAAP purposes, minority interest is not included in
stockholders’ equity. In addition, minority interest is not deducted in the
income statement under Mexican GAAP; therefore, for U.S. GAAP purposes it
has
been excluded in the income statement reconciliation.
U.S.
GAAP adjustments on minority interest
The
U.S.
GAAP inventory indirect cost adjustment is calculated on a consolidated basis.
Therefore, the minority interest effect is presented as a separate line item,
in
order to obtain net income and stockholders’ equity.
Disclosure
about Fair Value of Financial Instruments:
In
accordance with SFAS No. 107, “Disclosures about Fair Value of Financial
Instruments,” under U.S. GAAP it is necessary to provide information about the
fair value of certain financial instruments for which it is practicable to
estimate that value. The carrying amounts of cash and short-term investments,
accounts receivable and accounts payable and accrued liabilities approximate
fair values due to the short term maturity of these instruments.
Pension
and other retirement benefits:
The
Company records seniority premiums based on actuarial computations.
For
purposes of determining seniority premium costs under U.S. GAAP, the Company
utilized SFAS No. 87. Adjustments to U.S. GAAP for seniority premiums were
not
individually or in the aggregate significant for any period.
SFAS
No.
106, “Employers’ Accounting for Post-retirement Benefits Other than Pensions”,
requires accrual of post-retirement benefits other than pensions during the
employment period. The Company does not provide its employees any
post-retirement benefit subject to the provisions of SFAS No. 106.
SFAS
No.
112, “Employers’ Accounting for Post-employment Benefits”, requires employers to
accrue for post-employment benefits that are provided to former or inactive
employees after employment during the employment period. For the purpose
of
determining Termination Benefits Obligations for U.S. GAAP, the Company utilized
SFAS No. 112. Adjustments to U.S. GAAP benefit were not individually or in
the
aggregate significant for any period.
Statement
of cash flows:
Under
Mexican GAAP, the Company presents a consolidated statement of changes in
financial position in accordance with Bulletin B-12, which identifies the
generation and application of resources as representing differences between
beginning and ending financial statement balances in constant Mexican pesos.
It
also requires that monetary and unrealized exchange gains and losses be treated
as cash items in the determination of resources generated by
operations.
SFAS
No.
95, “Statement of Cash Flows”, requires presentation of a statement of cash
flows.
The
following presents a statement of cash flows under U.S. GAAP:
|
|
|
|
Six
months ended June 30,
|
|
|
|
|
|
2005
|
|
2006
|
|
|
|
|
|
|
|
|
|
Net
Income under U.S. GAAP
|
|
|
Ps.
|
|
|
745,688
|
|
|
1,386,105
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and Amortization
|
|
|
|
|
|
124,946
|
|
|
197,241
|
|
Deferred
income taxes
|
|
|
|
|
|
28,962
|
|
|
(49,883
|
)
|
Minority
Interest
|
|
|
|
|
|
-
|
|
|
193,426
|
|
U.S.
GAAP Adjustment on minority interest
|
|
|
|
|
|
-
|
|
|
39,494
|
|
Seniority
premiums and termination benefits
|
|
|
|
|
|
686
|
|
|
933
|
|
Trade
receivable, net
|
|
|
|
|
|
(228,339
|
)
|
|
(246,130
|
)
|
Prepaid
expenses
|
|
|
|
|
|
1,408
|
|
|
(6,071
|
)
|
Inventories
|
|
|
|
|
|
134,759
|
|
|
(727,118
|
)
|
Accounts
payable and accrued expenses
|
|
|
|
|
|
(151,051
|
)
|
|
(8,850
|
)
|
Other
long-term liabilities
|
|
|
|
|
|
(2,404
|
)
|
|
(16,827
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Funds
provided by operating activities
|
|
|
|
|
|
654,655
|
|
|
762,320
|
|
|
|
|
|
|
|
|
|
|
|
|
Financing
activities
|
|
|
|
|
|
|
|
|
|
|
Notes
payable to banks, net
|
|
|
|
|
|
(159,401
|
)
|
|
(17,592
|
)
|
Decrease
in financial debt
|
|
|
|
|
|
-
|
|
|
(391,550
|
)
|
Increase
in Common Stock and Paid-In Capital stock
|
|
|
|
|
|
926
|
|
|
122,170
|
|
Others
|
|
|
|
|
|
8,353
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
resources used in financing activities
|
|
|
|
|
|
(150,122
|
)
|
|
(286,972
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Investing
activities
|
|
|
|
|
|
|
|
|
|
|
Disposition
(Acquisition) of property, plant and equipment
|
|
|
|
|
|
45,668
|
|
|
(285,261
|
)
|
Others
|
|
|
|
|
|
86,911
|
|
|
(496
|
)
|
Increase
of investment in Pav Republic by ICH
|
|
|
|
|
|
-
|
|
|
135,110
|
|
Proceeds
from insurance claim in Pav Republic
|
|
|
|
|
|
-
|
|
|
618,748
|
|
Payment
of insurance proceeds to Predecessor Shareholders
|
|
|
|
|
|
|
|
|
(211,418
|
)
|
Funds
provided by investing activities
|
|
|
|
|
|
132,579
|
|
|
256,683
|
|
|
|
|
|
|
|
|
|
|
|
|
Effects
of inflation accounting
|
|
|
|
|
|
1,248
|
|
|
7,178
|
|
Increase
in cash
|
|
|
|
|
|
638,360
|
|
|
739,209
|
|
Cash
beginning of the year
|
|
|
|
|
|
526,743
|
|
|
209,416
|
|
Cash
end of the year
|
|
|
Ps.
|
|
|
1,165,103
|
|
|
948,625
|
|
Recent
accounting pronouncements in the US:
In
November 2004, Statement of Financial Accounting Standards No. 151, “Inventory
Costs-an amendment of ARB No. 43, Chapter 4” (SFAS No. 151), was issued. This
Statement amends the guidance in Accounting Research Bulletin no. 43, Chapter
4,
“Inventory Pricing,” to clarify the accounting of abnormal amounts of idle
facility expense, freight, handling cost, and wasted material (spoilage).
SFAS
No. 151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. The effect on the adoption of this bulletin was not
significant because prior to the release of SFAS 151, since Mexican GAAP
already
contains similar guidance.
In
March
2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations (an interpretation of SFAS Statement No. 143) (FIN
47).
This Interpretation clarifies that the term conditional asset retirement
obligation, as used in SFAS Statement No. 143, Accounting for Asset Retirement
Obligations, refers to a legal obligation to perform an asset retirement
activity in which the timing and (or) method of settlement are conditional
on a
future event that may or may not be within the control of the entity. The
obligation to perform the asset retirement activity is unconditional even
though
uncertainty may exist about the timing and (or) method of settlement.
Accordingly, an entity is required to recognize the fair value of a liability
for the conditional asset retirement obligation when incurred and the
uncertainty about the timing and (or) method of settlement should be factored
into the measurement of the liability when sufficient information exists.
This
Interpretation is effective for fiscal years ending after December 15, 2005.
The
Company has evaluated the application of SFAS Interpretation No. 47 and
determined it has no effect on the Company’s consolidated financial
statements.
In
May
2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections” which
addresses the accounting and reporting for changes in accounting principles.
SFAS 154 replaces APB 20 and FIN 20. The adoption of SFAS 154 had no effect
on
the Company’s financial position or on its results of operations.
In
September 2005 the FASB issued SFAS 155, “Accounting for Certain Hybrid
Financial Instruments—an amendment of SFAS Statements No. 133 and 140”, that
amends SFAS Statements No. 133, Accounting for Derivative Instruments and
Hedging Activities, and No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities. This Statement resolves
issues addressed in Statement 133 Implementation Issue No. D1, “Application of
Statement 133 to Beneficial Interests in Securitized Financial Assets.” The
adoption of SFAS 155 had no material effect on the Company’s financial position
or on its results of operations.
In
July
13, 2006 the FASB released an interpretation, FIN 48, Accounting for Uncertainty
in Income Taxes - An Interpretation of FASB Statement 109. This Interpretation
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. This Interpretation prescribes a recognition
threshold and measurement attribute for the financial statement recognition
and
measurement of a tax position taken or expected to be taken in a tax return.
This Interpretation also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. The Company has not assessed the impact of this standard on its
financial statements.
Other
pronouncements issued by the FASB or other authoritative accounting standards
groups with future effective dates are either not applicable or not material
to
the Company’s financial statements.
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
The
Board
of Directors
PAV
Republic, Inc.:
We
have
audited the accompanying consolidated balance sheet of PAV Republic and
subsidiaries as of December 31, 2004, and the related consolidated statements
of
operations, stockholders’ equity and comprehensive income, and cash flows for
the year ended December 31, 2004. These consolidated financial statements
are
the responsibility of the Company’s management. Our responsibility is to express
an opinion on these consolidated financial statements based on our
audits.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present
fairly,
in all material respects, the financial position of PAV Republic and
subsidiaries as of December 31, 2004, and the results of their operations
and
their cash flows for the year ended December 31, 2004, in conformity with
U.S.
generally accepted accounting principles.
Cleveland,
Ohio
March
18,
2005
KPMG
LLP
PAV
Republic, Inc. and Subsidiaries
Consolidated
balance sheet
(In
thousands of dollars, except per share information)
|
|
December
31, 2004
|
|
ASSETS
|
|
|
|
Current
assets:
|
|
|
|
Cash
and cash equivalents
|
|
$
|
3,748
|
|
Accounts
receivable, less allowance of $11,246
|
|
|
140,091
|
|
Inventories
(note 5)
|
|
|
243,351
|
|
Deferred
income taxes (note 11)
|
|
|
2,295
|
|
Prepaid
expenses and other current assets
|
|
|
17,114
|
|
Total
current assets
|
|
|
406,599
|
|
|
|
|
|
|
Property,
plant, and equipment:
|
|
|
|
|
Land
and improvements
|
|
|
683
|
|
Buildings
and improvements
|
|
|
1,669
|
|
Machinery
and equipment
|
|
|
13,947
|
|
Construction-in-progress
|
|
|
3,983
|
|
Total
property, plant, and equipment
|
|
|
20,282
|
|
Accumulated
depreciation
|
|
|
(918
|
)
|
Net
property, plant and equipment
|
|
|
19,364
|
|
|
|
|
|
|
Deferred
costs, net of accumulated amortization of $821 (note 6)
|
|
|
7,975
|
|
Deferred
income taxes (note 11)
|
|
|
1,545
|
|
Other
assets (note 9, 15)
|
|
|
6,143
|
|
|
|
|
|
|
Total
assets
|
|
$
|
441,626
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
Current
portion of long-term debt
|
|
$
|
668
|
|
Accounts
payable
|
|
|
50,378
|
|
Accrued
compensation and benefits
|
|
|
34,550
|
|
Accrued
interest
|
|
|
540
|
|
Accrued
income taxes (note 11)
|
|
|
21,198
|
|
Other
accrued liabilities
|
|
|
13,101
|
|
Total
current liabilities
|
|
|
120,435
|
|
Long-term
debt (note 8)
|
|
|
77,027
|
|
Revolving
credit facility (note 8)
|
|
|
142,219
|
|
Accrued
environmental liabilities (note 14)
|
|
|
3,647
|
|
Other
long-term liabilities (note 15)
|
|
|
3,644
|
|
Total
liabilities
|
|
|
346,972
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
Common
stock, $0.01 par value. Authorized 60,000 shares, issued, and outstanding
50,000 shares and authorized
|
|
|
1
|
|
Additional
paid in capital
|
|
|
55,923
|
|
Retained
earnings
|
|
|
38,568
|
|
Other
comprehensive income (note 18)
|
|
|
162
|
|
Total
stockholders’ equity
|
|
|
94,654
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
441,626
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Consolidated
statements of operations
(In
thousands of dollars, except per share amounts)
|
|
Year
ended December 31, 2004
|
|
Net
sales
|
|
$
|
1,190,673
|
|
Cost
of goods sold
|
|
|
1,070,841
|
|
Gross
profit
|
|
|
119,832
|
|
Selling,
general, and administrative expense
|
|
|
53,350
|
|
Depreciation
and amortization expense
|
|
|
910
|
|
Other
operating income
|
|
|
(382
|
)
|
Operating
Income
|
|
|
65,954
|
|
Interest
expense
|
|
|
18,957
|
|
Interest
income
|
|
|
(251
|
)
|
Income
before income taxes
|
|
|
47,248
|
|
Provision
for income taxes (note 11)
|
|
|
18,084
|
|
Net
income before extraordinary gain
|
|
$
|
29,164
|
|
Extraordinary
gain, net of tax, due to purchase price accounting (notes 4,
9)
|
|
|
10,162
|
|
Net
Income
|
|
$
|
39,326
|
|
Basic
net income per share:
|
|
|
|
|
Income
before extraordinary gain
|
|
$
|
688.65
|
|
Extraordinary
gain
|
|
|
239.95
|
|
Basic
net income per share
|
|
$
|
928.60
|
|
Weighted
average shares outstanding
|
|
|
42,350
|
|
Diluted
net income per share:
|
|
|
|
|
Income
before extraordinary gain
|
|
$
|
683.13
|
|
Extraordinary
gain
|
|
|
238.03
|
|
Diluted
net income per share
|
|
$
|
921.16
|
|
Weighted
average diluted shares outstanding
|
|
|
42,692
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Consolidated
statements of stockholders’ equity and comprehensive income
(In
thousands of dollars, except per share amounts)
|
|
Common
Shares
|
|
Additional
|
|
Accumulated
|
|
Accumulated
Other
|
|
|
|
|
|
Number
|
|
Par
Value
|
|
Paid-In
Capital
|
|
Retained
Earnings
|
|
Comprehensive
Income
|
|
Total
|
|
Balance,
December 31, 2003
|
|
|
30,000
|
|
$
|
-
|
|
$
|
30,000
|
|
$
|
(758
|
)
|
$
|
-
|
|
$
|
29,242
|
|
Issuance
of 20,000 shares
|
|
|
20,000
|
|
|
-
|
|
|
20,000
|
|
|
-
|
|
|
-
|
|
|
20,000
|
|
Common
Stock, $.01 par value
|
|
|
-
|
|
|
1
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1
|
|
Compensation
Expense (note 3)
|
|
|
-
|
|
|
-
|
|
|
5,923
|
|
|
-
|
|
|
-
|
|
|
5,923
|
|
Comprehensive
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
39,326
|
|
|
-
|
|
|
39,326
|
|
Currency
Translation Adjustment
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
162
|
|
|
162
|
|
Total
Comprehensive Income
|
|
|
|
|
|
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
39,488
|
|
Balance,
December 31, 2004
|
|
|
50,000
|
|
$
|
1
|
|
$
|
55,923
|
|
$
|
38,568
|
|
$
|
162
|
|
$
|
94,654
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic,
Inc. and Subsidiaries
Consolidated
statements of cash flows
(In
thousands of dollars)
|
|
Year
Ended December 31, 2004
|
|
Cash
flows from operating activities:
|
|
|
|
Net
income
|
|
$
|
39,326
|
|
Adjustments
to reconcile net income to net cash provided by (used in) operating
activities:
|
|
|
|
|
Extraordinary
gain, net of tax, due to purchase price accounting (notes 4,
9)
|
|
|
(10,162
|
)
|
Depreciation
and amortization
|
|
|
918
|
|
Amortization
of deferred costs
|
|
|
1,332
|
|
Write
off of deferred costs
|
|
|
1,123
|
|
Deferred
income taxes
|
|
|
(3,709
|
)
|
Issuance
of stock options and restricted stock (note 3)
|
|
|
5,924
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
Increase
in accounts receivable
|
|
|
(75,184
|
)
|
Increase
in inventory
|
|
|
(110,411
|
)
|
Decrease
in prepaid and other assets
|
|
|
42,026
|
|
Increase
in accounts payable
|
|
|
41,712
|
|
Increase
in accrued compensation and benefits
|
|
|
14,631
|
|
Increase
in accrued income tax payable
|
|
|
14,571
|
|
Increase
in other current liabilities
|
|
|
2,376
|
|
Decrease
in long-term liabilities
|
|
|
(1,308
|
)
|
Net
cash used in operating activities
|
|
|
(36,835
|
)
|
Cash
flows from investing activities:
|
|
|
|
|
Capital
expenditures
|
|
|
(18,354
|
)
|
Net
cash used in investing activities
|
|
|
(18,354
|
)
|
Cash
flows from financing activities:
|
|
|
|
|
Proceeds
from revolving credit facilities
|
|
|
528,336
|
|
Repayment
of revolving credit facilities
|
|
|
(478,021
|
)
|
Proceeds
from long-term debt
|
|
|
70,165
|
|
Repayments
of long-term debt
|
|
|
(78,418
|
)
|
Equity
contribution
|
|
|
20,000
|
|
Deferred
costs
|
|
|
(8,959
|
)
|
Net
cash provided by financing activities
|
|
|
53,103
|
|
Effect
of exchange rate changes on cash
|
|
|
162
|
|
Net
decrease in cash and cash equivalents
|
|
|
(1,924
|
)
|
Cash
and cash equivalents—beginning of period
|
|
|
5,672
|
|
Cash
and cash equivalents—end of period
|
|
$
|
3,748
|
|
Supplemental
cash flow information:
|
|
|
|
|
Cash
paid for interest
|
|
$
|
16,198
|
|
Cash
paid for income taxes
|
|
$
|
7,244
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Notes
to
consolidated financial statements
(In
thousands of dollars, except as otherwise noted)
(1)
Nature of operations, organization and other related information
PAV
Republic, Inc. (PAV Republic or the Company) is a Delaware corporation, which
owns 100% of the outstanding stock of Republic Engineered Products, Inc.
Republic
Engineered Products, Inc., (Republic Inc.), a Delaware corporation, which
was
incorporated on December 15, 2003, produces special bar quality steel products.
Special bar quality steel products are high quality hot-rolled and cold-finished
carbon and alloy steel bars and rods used primarily in critical applications
in
automotive and industrial equipment. Special bar quality steel products are
sold
to customers who require precise metallurgical content and quality
characteristics. Special bar quality steel products generally contain more
alloys, and sell for substantially higher prices, than merchant and commodity
steel bar and rod products. The Company produces a wide range of special
bar
quality steel products and supplies a diverse customer base that includes
leading automobile and industrial equipment manufacturers and their first
tier
suppliers.
Republic
Machine, LLC and Republic N&T Railroad, Inc. and Republic Canadian Drawn are
wholly owned subsidiaries of Republic Inc. Republic Machine, LLC is a Delaware
limited liability company and its sole assets include all assets associated
with
operations at 4135 Commerce Drive SW, Massillon, Ohio 44646. Republic N&T
Railroad, Inc. is a Delaware corporation and operates the railroad assets
located at the Company’s Canton and Lorain Ohio facilities. Republic Canadian
Drawn, Inc. is an Ontario, Canada corporation which operates the cold-finishing
plant located in Ontario, Canada.
The
Company commenced operations on December 19, 2003 after acquiring substantially
all of the operating assets of REPH LLC (formerly known as Republic Engineered
Products Holdings LLC) in a sale of assets under Section 363 of the United
States Bankruptcy Code. The Company also acquired the following property:
assets
located on the premises of REPH LLC’s machine shop located in Massillon, Ohio;
assets located on the premises of REPH LLC’s corporate headquarters located in
Akron, Ohio; all permits used in the business in conjunction with the purchased
assets; all intellectual property used in connection with the business; certain
contracts; books, files and records used in the business; all inventory wherever
located; all accounts receivable; and an option to purchase certain assets
for
nominal consideration and assume certain liabilities associated with Republic
Technologies International LLC’s (RTI or Republic Technologies) cold-finishing
plant located in Ontario, Canada. This option was exercised on January 29,
2004.
The
Company, through a wholly owned subsidiary Republic Inc., incurred significant
indebtedness in connection with the consummation of the acquisition. The
indebtedness included $60.0 million aggregate principal amount, $80.0 million
face amount of 10% Senior Secured Notes (senior notes), $21.0 million aggregate
principal amount of 10% Senior Bank Notes (bank notes), and initial borrowings
of $74.9 million (which included $1.5 million in deferred loan fees) under
Republic Inc.’s revolving working capital agreement.
On
May
20, 2004, Republic Inc. entered into a new $200.0 million revolving credit
facility with General Electric Capital Corporation, as lender and agent for
lenders, (GE Capital), a new $61.8 million senior secured promissory note
with
Perry Principals Investments, L.L.C. and a new $8.4 million senior subordinated
promissory note with Perry Principals Investments, L.L.C. Republic Inc. repaid
its outstanding revolving working capital agreement (Perry credit facility)
and
exercised its option to redeem its $60.0 million aggregate principal 10%
Senior
Secured Notes. On May 20, 2004, Perry Partners LP and Perry Partners
International, Inc. made a $20.0 million equity contribution to PAV Republic,
Inc. Under the terms and conditions of the General Electric Capital corporate
credit facility (GE credit facility), PAV Republic, Inc. increased its equity
investment in Republic Inc. by $20.0 million. On November 10, 2004, Republic,
Inc. and GE Capital amended the revolving credit facility to expand the
borrowing capacity under the revolving credit facility from $200.0 million
to
$250.0 million.
PAV
Republic’s five largest customers accounted for 33.0% of total sales for the
year ended December 31, 2004. For this period, two customers, on an individual
basis, each accounted for more than 10% of the Company’s total sales. Direct
sales to US Steel and American Axle & Manufacturing accounted for 10.6% and
10.3% of sales, respectively, for the year ended December 31, 2004.
(2)
Basis of presentation and principles of consolidation
In
the
accompanying consolidated financial statements of the Company, transactions
and
balances are presented on a new cost basis reflecting purchase accounting
adjustments. All significant intercompany balances and transactions have
been
eliminated in consolidation.
(3)
Summary of significant accounting policies
(a)
Cash and cash equivalents
The
Company considers all short-term investments with maturities at the date
of
purchase of three months or less to be cash equivalents.
(b)
Inventories
As
of
December 31, 2004, the Company valued inventories at the lower of cost or
market
applied on a last-in, first-out (LIFO) method of inventory costing which
was
adopted by the Company as of January 1, 2004. As of December 31, 2004,
approximately 99% of inventories were valued under this method.
(c)
Derivative Instruments
The
Company is exposed to fluctuations in natural gas prices. PAV Republic may
employ the use of call options to manage its exposure to natural gas price
fluctuations when practical. Our policies include establishing a risk management
philosophy and objectives designed to cap our exposure to the extreme price
volatility of natural gas and thereby limiting the unfavorable effect of
price
increases on our operating costs. The Company does not enter into call options
for the purpose of speculation. The Company accounts for these derivative
instruments in accordance with FASB Statement of Financial Accounting (SFAS)
No.
133, Accounting for Derivative Instruments and Hedging Activities.
(d)
Property, plant, and equipment
The
Company’s property, plant, and equipment are stated at cost and include
improvements that significantly extend the useful lives of existing plant
and
equipment. The Company provides for depreciation of property, plant, and
equipment on the straight-line method based upon the estimated useful lives
of
the assets. The ranges of estimated useful lives of the Company’s assets are as
follows:
Building
and improvements
|
|
|
10
- 25 years
|
|
Land
improvements
|
|
|
5
- 25 years
|
|
Machinery
and equipment
|
|
|
|
|
(the
vast majority of lives are from 10 - 20 years)
|
|
|
5
- 20 years
|
|
Computer
equipment
|
|
|
3-5
years
|
|
Repairs
and maintenance costs are expensed as incurred. Capital expenditures that
cannot
be put into use immediately are included in construction-in-progress. As
these
projects are completed, they are transferred to depreciable assets. Net gains
or
losses related to asset dispositions are recognized in the Company’s operating
results in the period in which the disposition occurs.
(e)
Goodwill
Goodwill
represents the excess of costs over fair value of assets of businesses acquired.
Pursuant to SFAS No. 142, Goodwill
and Other Intangible Assets,
goodwill and intangible assets acquired in a purchase business combination
and
determined to have an indefinite useful life are not amortized, but instead
tested for impairment at least annually in accordance with the provisions
of
Statement 142. Statement 142 also requires that intangible assets with estimable
useful lives be amortized over their respective estimated useful lives to
their
estimated residual values, and reviewed for impairment in accordance with
SFAS
No. 144, Accounting for Impairment or Disposal of Long-Lived Assets.
Negative
goodwill is created when the fair values of net assets of businesses acquired
exceed the purchase prices. Accordingly, the negative goodwill created should
be
first allocated to the remaining non-current assets acquired which are
principally property, plant and equipment. Any remaining unallocated negative
goodwill is written off as an extraordinary gain.
(f)
Impairment of long-lived assets
Long-lived
assets, consisting of property, plant, and equipment and intangible assets,
are
reviewed by the Company for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by
a
comparison of the carrying amount of an asset to future undiscounted net
cash
flows expected to be generated by the asset. If such assets are considered
to be
impaired, the impairment to be recognized is measured by the amount by which
the
carrying amount of the assets exceed the recovery amount or fair value of
the
assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less cost to sell and are no longer depreciated.
(g)
Income taxes
The
Company accounts for income taxes under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts
of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax
rates is recognized in income in the period that includes the enactment date.
(h)
Environmental costs
The
Company and other steel companies have in recent years become subject to
increasingly stringent environmental laws and regulations, including
requirements relating to environmental remediation. It is the policy of the
Company to comply with applicable environmental laws and regulations. The
Company established a liability for an amount which the Company believes
is
appropriate, based on information currently available, to cover costs of
environmental remediation it deems probable and reasonably estimable.
The
recorded amounts represent an estimate of the environmental remediation costs
associated with future events triggering or confirming the costs that, in
management’s judgment, are probable. These estimates are based on currently
available facts, existing technology and presently enacted laws and regulations,
and it takes into consideration the likely effects of inflation and other
societal and economic factors. The precise timing of such events cannot be
reliably determined at this time due to the absence of detailed deadlines
for
remediation under the applicable environmental laws and regulations pursuant
to
which such remediation costs will be expended; hence we do not discount the
recorded amounts to the present value of estimated future payments. No claims
for recovery are netted against the stated amount.
(i)
Revenue recognition
The
Company recognizes revenue when products are shipped and the customer takes
ownership and assumes risk of loss, collection of the relevant receivable
is
probable, persuasive evidence of an arrangement exists and the sales price
is
fixed and determinable. The Company’s customers have no rights to return
product, other than for defective materials. As sales are recognized, reserves
for defective materials are recorded as a percentage of sales. This percentage
is based on historical experience. The adequacy of reserve estimates is
periodically reviewed by comparison to actual experience.
(j)
Allowances for doubtful accounts
Allowances
for doubtful accounts are maintained to provide for estimated losses resulting
from the inability of customers to make required payments. If the financial
condition of these customers deteriorates, resulting in their inability to
make
payments, additional allowances may be required. The Company also records
allowance for accounts receivable for all other customers based on a variety
of
factors, including pricing adjustments, length of time the receivables are
past
due, and historical experience.
(k)
Cost of goods sold
The
Company expenses inbound and outbound freight charges, purchasing and receiving
costs, inspection costs, warehousing costs, and internal transfer costs as
cost
of goods sold.
(l)
Selling, general and administrative expense
The
Company includes overhead expenses not directly associated with the manufacture
or delivery of goods, administrative salaries, rent, utilities, telephone,
travel, property and casualty insurance and expenses related to order taking
and
product sales in selling, general and administrative expense.
(m)
Compensation costs
Incentive
compensation costs are significant expense categories that are highly dependent
upon management estimates and judgments, particularly at each interim reporting
date. In arriving at the amount of expense to recognize, management believes
it
makes reasonable estimates and judgments using all significant information
available. Incentive compensation costs are accrued on a monthly basis, and
the
ultimate determination is made after our year-end results are finalized.
(n)
Use of estimates
The
preparation of consolidated financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts
of
assets and liabilities and disclosure of contingent assets and liabilities
at
the date of the financial statements and the reported amounts of revenues
and
expenses during the reporting period. Actual results could differ from those
estimates.
The
Company has made significant accounting estimates with respect to the
preliminary allocation of the purchase price of the acquisition of assets
from
REPH LLC, the valuation allowances for receivables, inventories, long-lived
assets, deferred income tax assets and liabilities, environmental liabilities,
obligations related to employee health care and incentive and stock based
compensation.
(o)
Income per share
Basic
income per share for PAV Republic is calculated by dividing net income
attributable to common shareholders by the weighted average number of shares
of
common stock outstanding during the period. Diluted earnings per share is
calculated by including the restricted stock and stock options issued using
the
weighted average number of shares outstanding during the period.
On
January 21, 2004, the articles of incorporation were amended to increase
the
total number of shares from 100 to 30,000. On January 21, 2004, the Company’s
Board of Directors approved the issuance of a 300 for 1 stock split. All
share
information has been adjusted to reflect the 300 for 1 stock split. As of
December 31, 2003, there were 30,000 shares issued and outstanding of PAV
Republic, Inc. stock.
On
May
20, 2004, the articles of incorporation were amended and the Company increased
the total number of shares which the company has the authority to issue to
50,000 shares. On May 20, 2004, Perry Partners LP and Perry Partners
International, Inc. made a $20.0 million equity contribution to PAV Republic,
Inc. and 20,000 shares were issued. As of May 20, 2004, there were 50,000
shares
issued and outstanding.
On
October 1, 2004 the articles of incorporation were amended and the Company
increased the total number of shares which the Company has the authority
to
issue to 60,000 shares.
(p)
Stock-based compensation
The
Company accounts for stock based compensation under the fair value method
as
permitted under Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock Based Compensation. Compensation expense is measured
at
fair value at the grant date using the Black-Scholes option pricing model
and
recognized over the vesting period. On October 1, 2004, PAV Republic’s Board of
Directors adopted the 2004 Equity Incentive Plan. The 2004 Equity Incentive
Plan
provides for the grant of incentive stock options, nonqualified stock options,
stock appreciation rights, or ‘‘SARs,’’ restricted stock, and performance awards
based on PAV Republic’s performance, the performance of one of PAV Republic’s
subsidiaries or the performance of the participant. PAV Republic’s directors,
officers and employees, and other individuals performing services for PAV
Republic’s subsidiaries, may be selected by the compensation committee to
receive benefits under the plan. A total of 5,556 shares of our common stock
may
be issued pursuant to the 2004 Equity Incentive Plan. On October 1, 2004,
options to purchase 4,167 shares were issued to key employees and on October
5,
2004, 60 shares of restricted stock were issued to three outside directors.
The
restrictions on the stock issued to the outside directors will lapse upon
the
achievement of continued service on May 3, 2005. The following table represents
the equity incentive plan as of December 31, 2004.
|
|
Securities
|
|
Options
granted
|
|
|
4,167
|
|
Restricted
stock
|
|
|
60
|
|
Securities
available for future issuance
|
|
|
1,329
|
|
Total
authorized
|
|
|
5,556
|
|
The
stock
options granted in October 2004 generally become exercisable over a three-year
graded vesting period, provided that the participant remains a director or
employee at such a time. The stock options expire 10 years from the date
of
grant. We measure the total cost of each stock option grant at the date of
grant
using the Black Scholes option pricing model. We recognize the cost of each
stock option using straight-line over the stock options vesting period. The
stock option based compensation expense, included in selling general and
administration expense, was $5.9 million for the year ended December 31,
2004.
The
following table summarizes the stock option activity for the year ended December
31, 2004.
|
|
Shares
subject to option
|
|
Exercise
price
|
|
Balance
at December 31, 2003
|
|
|
-
|
|
$
|
-
|
|
Options
granted
|
|
|
4,167
|
|
|
1,000
|
|
Options
exercised
|
|
|
-
|
|
|
-
|
|
Options
terminated
|
|
|
-
|
|
|
-
|
|
Balance
at December 31, 2004
|
|
|
4,167
|
|
$
|
1,000
|
|
The
following table sets forth information about the fair value of each option
grant
on the date of grant using the Black-Scholes option-pricing model and the
weighted average assumptions used for such grants:
Average
fair value of option granted
|
|
$
|
2,521
|
|
Expected
dividend yield
|
|
|
-
|
|
Expected
volatility
|
|
|
40.1
|
%
|
Risk-free
interest rates
|
|
|
2.6
|
%
|
Expected
lives
|
|
|
3
|
|
The
following table summarizes information about stock options outstanding at
December 31, 2004:
Total
unvested shares
|
|
|
2,779
|
|
Total
vested shares
|
|
|
1,388
|
|
|
|
|
|
|
Average
life
|
|
|
10
|
|
Outstanding
average exercise price
|
|
$
|
1,000
|
|
Exercisable
average exercise price
|
|
$
|
1,000
|
|
The
fair
market value of each share of restricted stock on the date of grant was $3,436.
(q)
Foreign currency translation
Asset
and
liability accounts of the Company’s foreign operations are translated into U.S.
dollars using current exchange rates in effect at the balance sheet date
and for
revenue and expense accounts using a weighted average exchange rate during
the
period. Translation adjustments are reflected as a component of other
comprehensive income included in stockholders equity.
(r)
Other postretirement benefits
Accounting
for other postretirement benefits requires the use of actuarial techniques
and
assumptions including, among others, assumptions about employees’ future
retirement decisions, mortality of participants, future increases in wages
and
health care costs, discount and interest rates and plan continuation. Changing
these assumptions would have an impact on our disclosed obligation and annual
expense for other postretirement benefits. Actuarial gains and losses are
deferred and amortized over future periods.
(s)
New accounting pronouncements
In
June
2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations,
which requires recognition of the fair value of liabilities associated with
the
retirement of long-lived assets when a legal obligation to incur such costs
arises as a result of the acquisition, construction, development and/or the
normal operation of a long-lived asset. Upon recognition of the liability,
a
corresponding asset is recorded and depreciated over the remaining life of
the
long-lived asset. SFAS No. 143 defines a legal obligation as one that a party
is
required to settle as a result of an existing or enacted law, statute,
ordinance, or written or oral contract or by legal construction of a contract
under the doctrine of promissory estoppel. SFAS No. 143 is effective for
fiscal
years beginning after December 15, 2002. The adoption of SFAS No. 143 did
not
have any impact on the Company’s consolidated financial statements.
In
July
2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or
Disposal Activities. SFAS No. 146 addresses significant issues regarding
the
recognition, measurement and reporting of costs that are associated with
exit
and disposal activities, including restructuring activities. The scope of
SFAS
No. 146 includes (1) costs to terminate contracts that are not capital leases;
(2) costs to consolidate facilities or relocate employees; and (3) termination
benefits provided to employees who are involuntarily terminated under the
terms
of a one-time benefit arrangement that is not an ongoing benefit arrangement
or
an individual deferred-compensation contract. The provisions of this Statement
became effective for exit or disposal activities initiated after December
31,
2002, with early application encouraged. The adoption of SFAS No. 146 did
not
have any impact on the Company’s consolidated financial statements.
In
December 2002, the FASB issued SFAS No. 148 Accounting for Stock-Based
Compensation-Transition and Disclosure—an amendment of FASB Statement No. 123.
SFAS No. 148 provides alternative methods of transition from a voluntary
change
to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements
of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The adoption
of SFAS No. 148 did not impact the Company’s consolidated financial statements.
In
January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable
Interest Entities. Interpretation No. 46, as revised in December 2003, requires
existing unconsolidated variable interest entities to be consolidated by
their
primary beneficiaries if the entities do not effectively disperse risk among
parties involved. It is based on the concept that companies that control
another
entity through interests other than voting interests should consolidate the
controlled entity. Interpretation No. 46 and its revision did not impact
the
Company’s consolidated financial statements.
In
April
2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities. SFAS No. 149 amends and clarifies the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 149
is
generally effective for contracts entered into or modified after June 30,
2003
and for hedging relationships designated after June 30, 2003. The adoption
of
SFAS No. 149 did not have an effect on the Company’s consolidated financial
statements.
In
May
2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity. SFAS No. 150 requires
that
certain financial instruments, which under previous guidance were accounted
for
as equity, must now be accounted for as liabilities. The financial instruments
affected include mandatory redeemable stock, certain financial instruments
that
require or may require the issuer to buy back some of its shares of stock
in
exchange for cash or other assets and certain obligations that can be settled
with shares of stock. SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at
the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have an effect on the Company’s consolidated
financial statements.
In
December 2003, the FASB revised SFAS No. 132 (revised 2003), Employers’
Disclosures about Pensions and Other Postemployment Benefits. SFAS No. 132
(revised 2003) requires additional disclosure on the assets, obligations,
cash
flows and net periodic benefit cost of defined benefit pension plans and
other
defined benefit postretirement plans in the notes to consolidated financial
statements. The disclosures include describing the types of plan assets,
investment strategy, measurement dates, plan obligations, cash flows, and
components of net periodic benefit cost recognized during interim periods.
The
Company adopted SFAS No. 132 (revised 2003) in the fourth quarter of 2003.
This
Statement requires changes in disclosure only.
In
November 2004, Statement of Financial Accounting Standards No. 151, ‘‘Inventory
Costs-an amendment of ARB No. 43, Chapter 4’’ (SFAS No. 151), was issued. This
Statement amends the guidance in ARB No. 43, Chapter 4, ‘‘Inventory Pricing,’’
to clarify the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage). SFAS No. 151 is
effective for inventory costs incurred during fiscal years beginning after
June
15, 2005. We do not expect adoption of this standard to have a material impact
on our consolidated financial statements.
In
December 2004, the FASB revised SFAS No. 123 (revised 2004), Share Based
Payment. SFAS No. 123 (revised 2004) requires a public entity to measure
the
cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award (with limited
exceptions). That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award—the requisite
service period (usually the vesting period). This statement is effective
for
public entities that do not file as small business issuers-as of the beginning
of the first interim or annual reporting period that begins after June 15,
2005;
for public entities that file as small business issuers as of the beginning
of
the first interim or annual reporting period that begins after December 15,
2005; and for nonpublic entities as of the beginning of the first annual
reporting period that begins after December 15, 2005. The Company will adopt
SFAS No. 123 (revised 2004) during the year ended December 31, 2005.
(4)
Acquisitions
On
December 19, 2003, the Company through a wholly owned subsidiary, acquired
all
of the operating assets of REPH LLC and its subsidiaries. The total adjusted
purchase price was $184.4 million (consisting of $101.3 million paid to REPH
LLC, $2.1 million in acquisition fees and expenses, the issuance of $60.0
million in senior secured notes and the issuance of $21.0 million in bank
notes). The total purchase price was allocated to the assets acquired and
liabilities assumed based on their respective fair values.
The
following table summarizes the fair values of the assets acquired and
liabilities assumed at December 19, 2003. The Company adjusted the initial
purchase price allocation during the year ended December 31, 2004. The more
significant adjustments were a result of the fair value of the senior secured
notes issued and the option acquired related to the Ontario, Canada location
and
for $34.2 million in insurance proceeds received (see Note 10). This resulted
in
negative goodwill which was initially allocated to non-current assets and
the
remainder resulted in the recognition of $10.2 million in extraordinary gain,
net of tax of $6.5 million.
Current
assets
|
|
$
|
202,964
|
|
Rights
to insurance proceeds
|
|
|
48,273
|
|
Other
assets
|
|
|
1,006
|
|
Total
assets
|
|
|
252,243
|
|
Current
liabilities
|
|
|
40,447
|
|
Long-term
liabilities
|
|
|
10,760
|
|
Total
liabilities
|
|
|
51,207
|
|
Net
assets acquired
|
|
|
201,036
|
|
Adjusted
purchase price
|
|
|
184,377
|
|
Extraordinary
gain, pre-tax
|
|
$
|
16,659
|
|
On
December 19, 2003 the Company purchased an option to acquire certain assets
for
nominal consideration and assume certain liabilities associated with Republic
Technologies International LLC’s cold-finishing plant located in Ontario,
Canada. The Company exercised this option on January 29, 2004. The total
value
of the option was $1.3 million. The total value of the option was allocated
to
the assets acquired and the liabilities assumed.
The
following table summarizes the estimated fair values of the assets acquired
and
liabilities assumed at January 29, 2004.
Current
assets
|
|
$
|
144
|
|
Property,
plant and equipment
|
|
|
1,814
|
|
Total
assets
|
|
|
1,958
|
|
Current
liabilities
|
|
|
643
|
|
Long-term
liabilities
|
|
|
50
|
|
Total
liabilities
|
|
|
693
|
|
Net
assets acquired
|
|
$
|
1,265
|
|
(5)
Inventories
The
components of inventories as of December 31, 2004 are as follows:
Raw
materials
|
|
$
|
88,522
|
|
Semi-finished
|
|
|
76,077
|
|
Finished
goods
|
|
|
131,323
|
|
|
|
|
295,922
|
|
LIFO
reserve
|
|
|
(52,571
|
)
|
Total
|
|
$
|
243,351
|
|
The
Company has elected to change its method of accounting for inventory to last-in,
first-out (LIFO) effective January 1, 2004 because the Company has experienced
inflation in raw material prices for the commodities it purchases and uses
to
produce steel products. The Company has adopted the LIFO method to more
accurately match revenues with current costs.
On
December 31, 2004, inventories are valued at the lower of cost or market
applied
on a last-in, first-out (LIFO) method of accounting for inventory. This
inventory method is used to value approximately 99% of the Company’s inventory.
The
Company believes the impact of the change in its method of accounting for
inventory from FIFO to LIFO is minimal from the date of acquisition, December
19, 2003 to December 31, 2003. All of the Company’s inventories were valued at
market prices under purchase price accounting at the time of acquisition.
The
Company’s inventory carrying values and product mix at December 31, 2003 was
approximately the same as December 19, 2003, indicating only negligible price
fluctuations during that period. The adoption of LIFO as of January 1, 2004
resulted in the reduction of pre-tax income by $52.6 million for the year
ended
December 31, 2004.
(6)
Deferred costs
On
December 31, 2004, the Company’s deferred costs consisted of $7.0 million in
deferred loan fees, net of accumulated amortization and $1.0 million in fees
related to our planned initial public offering. The deferred fees were incurred
in relation to the new debt items discussed in note 8 and the planned initial
public offering (IPO) discussed in note 20. The Company amortizes these assets
associated with the debt agreements over their term, which will expire in
May
and August of 2009. The Company will net the fees associated with the IPO
with
the proceeds of the offering.
The
deferred costs as of December 31, 2003 consisted of $1.5 million in deferred
loan fees; net of accumulated amortization, relating to Republic Inc.’s
revolving working capital credit agreement with Perry Partners L.P. (Perry
credit facility). The asset was to be amortized over the term of the agreement,
which would have expired December 19, 2004, but was extended to March 31,
2005.
However, in May 2004, the Perry credit facility was repaid in full and Republic
Inc. entered into a new agreement with GE Capital (Note 8). Concurrent with
the
repayment of the Perry credit facility, the remaining $1.1 million of these
assets were written off by the Company.
The
components of deferred costs are as follows:
Net
deferred costs as of December 31, 2003
|
|
$
|
1,471
|
|
Amortization
of deferred costs
|
|
|
(1,332
|
)
|
Write-off
of deferred costs
|
|
|
(1,123
|
)
|
Fees
related to new debt items (note 8)
|
|
|
7,998
|
|
Fees
related to IPO (note 20)
|
|
|
961
|
|
Net
deferred costs as of December 31, 2004
|
|
$
|
7,975
|
|
(7)
Goodwill
The
fair
value of identifiable net assets of REPH LLC exceeded the purchase price.
Accordingly, this difference was proportionately allocated to reduce the
value
of acquired non-current assets, which were principally property, plant, and
equipment (see Note 4).
(8)
Revolving credit facilities, long-term debt and capital lease obligations
Revolving
credit facility
On
May
20, 2004, the Company, through a wholly owned subsidiary, Republic Inc.,
entered
into a $200.0 million revolving credit facility with GE Capital. This facility
matures on May 20, 2009. On May 20, 2004, Perry Partners LP and Perry Partners
International, Inc. made a $20.0 million equity contribution to PAV Republic,
Inc. Under the terms and conditions of the General Electric Capital corporate
credit facility (GE credit facility), PAV Republic, Inc. increased its equity
investment in Republic Inc. by $20.0 million. Republic Inc. repaid its
outstanding Perry credit facility. On November 10, 2004, Republic Inc. and
GE
Capital amended the revolving credit facility to expand the borrowing capacity
under the revolving credit facility from $200.0 million to $250.0 million.
At
December 31, 2004, Republic Inc. had $142.2 million outstanding and had issued
$3.3 million in letters of credit under our revolving credit facility. The
Company is required to maintain a borrowing availability of at least $25.7
million. The amount available under the GE credit facility was approximately
$78.7 million in excess of the $25.7 million minimum availability requirement
at
December 31, 2004. Republic Inc. is required to pay an unused facility fee
of
one-half of one percent per annum on the average daily unused total commitment.
Advances under the GE credit facility is limited by the borrowing base, as
defined in the credit facility as the sum of 85% of eligible accounts receivable
plus 65% of eligible inventory.
Borrowings
under the GE credit facility are secured by a first priority perfected security
interest in all of Republic Inc.’s presently owned and subsequently acquired
inventory and accounts receivable. The obligations under the GE credit facility
are secured and are unconditionally and irrevocably guaranteed jointly and
severally by Republic Inc.’s subsidiaries.
Borrowings
under the credit facility bear interest, at Republic Inc.’s option, at either an
index rate equal to the higher of the ‘‘prime rate’’ announced from time to time
by The Wall Street Journal, plus the applicable margin, or the federal funds
rate plus 50 basis points per annum, plus the applicable margin; or a LIBOR
rate, plus the applicable margin. The applicable margin on index rate loans
initially is 1.0% and on LIBOR loans is 2.75%. Commencing on April 1, 2005,
the
margins may be adjusted based on the average availability quarterly on a
prospective basis. The base rate margins may be reduced to an amount between
0.00% and 1.00%, and the LIBOR margins may be adjusted to an amount between
1.75% and 2.75%. As of December 31, 2004, borrowings under the GE credit
facility are accruing interest at the rate of 6.25% per year for index rate
loans and 5.11% for LIBOR loans.
The
revolving credit facility contains customary representations and warranties
and
customary covenants restricting Republic Inc.’s and its subsidiaries’ ability
to, among other things and subject to various exceptions, alter the nature
of
its business, engage in mergers, acquisitions and asset sales, permit the
creation of any security interests on any of its assets, incur additional
indebtedness, declare dividends, make distributions or redeem or repurchase
capital stock, prepay, redeem or repurchase other debt, make loans and
investments or conduct transactions with affiliates. Our revolving credit
facility also contains the following covenants:
|
·
|
restrict
unfinanced capital expenditures during any fiscal year that exceeds
$40.0
million in the aggregate
|
|
·
|
a
minimum fixed charge coverage ratio not less than 1.25:1.0 for
each
12-months most recently ended
|
|
·
|
minimum
borrowing availability of $25.7 million
|
Events
of
default under the credit agreement include, but are not limited to, failure
to
pay principal, interest, fees or other amounts under the credit agreement
when
due or after expiration of a grace period, covenant defaults, any representation
or warranty proving to have been materially incorrect when made, the revocation
or purported revocation of any guarantee by any of the guarantors, unsatisfied
final judgments over a threshold, bankruptcy events, the invalidity or
impairment of any loan document or any security interest, a cross default
to
certain other debt, a change of control and certain ERISA defaults. In the
event
of default, there are provisions for remedies from the agent of the revolving
credit facility.
The
Company violated the indebtedness covenant in the GE Credit facility. The
company has incurred $0.4 million in debt relating to a promissory note and
$0.6
million in debt relating to capital lease financing, which it failed to disclose
to GE Capital. On February 25, 2005 the Company was granted a waiver. As
of
February 25, 2005, we were in compliance with all covenants under our revolving
credit facility.
Revolving
working capital agreement with Perry Partners L.P.
On
May
20, 2004 Republic Inc. repaid the Revolving working capital agreement with
Perry
Partners L.P. (Perry credit facility). Prior to the repayment, Republic Inc.
maintained the credit facility, which was entered into on December 19, 2003
with
Perry Partners L.P. Under the terms of the agreement, the facility was to
mature
on December 19, 2004. The Perry credit facility consisted of a senior secured
credit facility with a commitment of up to $150.0 million. In March 31, 2004
the
facility was amended to increase the commitment to $165.0 million and extend
the
maturity date to March 31, 2005.
Republic
Inc. was required to pay an unused facility fee of one-half of one percent
per
annum on the average daily unused total commitment. The amount available
to be
borrowed at any time was limited by a borrowing base, as defined in the Perry
credit facility as the sum of 85% of eligible accounts receivable plus 60%
of
eligible inventory.
Borrowing
under the Perry credit facility were secured by a first priority perfected
security interest in all of Republic Inc.’s presently owned and subsequently
acquired inventory and accounts receivable. The obligations under the Perry
credit facility were secured and were unconditionally and irrevocably guaranteed
jointly and severally by Republic Inc.’s subsidiaries.
Borrowings
under the Perry credit facility bore interest, at Republic Inc.’s option, at
either a base rate equal to the higher of the ‘‘prime rate’’ announced from time
to time by Citibank, N.A. at its principal office in New York, New York or
the
weighted average of rates on overnight federal funds transactions with members
of the Federal Reserve System arranged by federal funds brokers, plus the
applicable margin; or a libor rate on deposits for one or three month periods,
plus the applicable margin. The applicable margin on base rate loans initially
was 1.5% and on Eurodollar loans was 4.5%.
The
Perry
credit facility contained negative covenants and provisions that restricted,
among other things, the ability to incur additional indebtedness or guarantee
the obligations of others, grant liens, make investments, pay dividends,
repurchase stock or make other forms of restricted payments, merge consolidate
and acquire assets or stock, engage in sale and leaseback transactions or
dispose of assets, make capital expenditures in excess of $19.4 million for
2004, engage in transactions with Republic Inc.’s affiliates, and prepay or
amend Republic Inc.’s senior secured notes.
Long-term
debt
11%
Senior Secured Promissory Notes due 2009
On
May
20, 2004, Republic Inc. issued a $61.8 million senior secured promissory
note
under a senior secured note purchase agreement among Republic Engineered
Products, Inc., as borrower, and Perry Principals Investments, LLC, as Term
2
Note holder. In the absence of an Event of Default, interest on the notes
would
accrue at the rate of 11% per annum and is payable on the last day of each
calendar month until the loan matures on August 20, 2009. The notes require
a 3%
prepayment penalty and are secured by personal property and other assets
of
Republic Inc. as set forth by the security agreement to the senior secured
promissory note. The outstanding principal balance of the 11% Senior Secured
promissory notes was $61.8 million as of December 31, 2004.
May
2004 Senior Subordinated Note due 2009
On
May
20, 2004, Republic Inc. issued an $8.4 million senior subordinated promissory
note under a senior secured note purchase agreement among Republic Engineered
Products, Inc., as borrower, and Perry Principals Investments, LLC, as Term
1
Note holder. In the absence of an Event of Default, interest on the notes
will
accrue at the rate of 7% per annum and is payable on the last day of each
calendar month until the loan matures on August 20, 2009. This debt was repaid
during July of 2004. The note was secured by personal property and other
assets
of Republic Inc. as set forth by the security agreement to the senior secured
promissory note.
10%
Senior Secured Notes due 2009
On
December 19, 2003, in connection with the acquisition, Republic Inc. issued
$21.0 million of 10% senior secured bank notes (bank notes). Republic Inc.’s
bank notes require quarterly interest payments on March 31, June 30, September
30 and December 31 of each year. The note purchase agreement in respect to
the
bank notes requires Republic Inc. to redeem the notes with certain proceeds
from
asset sales of any collateral that secures the notes. The note purchase
agreement also contains significant affirmative and negative covenants including
separate provisions imposing restrictions on additional borrowings, certain
investments, certain payments, sale or disposal of assets, payment of dividends
and change of control provisions, in each case subject to certain exceptions.
As
of December 31, 2004, Republic Inc. was in compliance with all of these
covenants. The bank notes are secured, subject to exceptions and limitations,
by
(1) a first priority lien on, and security interest in real estate and fixtures
related to the Canton C-RTM facility and (2) fifty percent of any proceeds
greater than $5.0 million but less than $25.0 million received by the Company
after December 5, 2003 for business interruption coverage relating to the
loss
events experienced by REPH LLC at the Lorain, Ohio facility in 2003; provided
that such security interests in business interruption insurance proceeds
shall
in no event exceed $10.0 million in the aggregate. During the year ended
December 31, 2004 Republic Inc. received $34.2 million in insurance proceeds.
As
of October, 2004 Republic Inc. had fulfilled this repayment requirement.
Republic Inc. was required, on December 31, 2003 and on the last day of each
calendar quarter until maturity or until a maximum amount of $1.0 million
in the
aggregate is paid, to prepay 0.25% of the original principal amount or such
lesser principal amount as shall then be outstanding. This requirement was
discharged for all future periods during June 2004 as a result of the payment
from insurance proceeds discussed above. Republic Inc.’s obligations under the
bank notes are unconditionally and fully guaranteed jointly and severally
by
each of Republic Inc.’s subsidiaries. The outstanding principal balance of the
bank notes as of December 31, 2004 was $10.9 million.
Ohio
Department of Development Loan
On
December 19, 2003, in connection with the acquisition, Republic Inc. assumed
from REPH LLC a $5.0 million loan from the Ohio Department of Development.
This
loan accrues interest at the rate of 3% per annum payable on the first day
of
each calendar month until the loan matures in July 2008. Principal payments
are
required in the amount of $0.67 million, $1.64 million, $1.69 million and
$1.00
million in the years 2005 to 2008, respectively. As of December 31, 2004
$.67
million is included in current portion of long-term debt. The loan is
collateralized by the 20‰ mill modernization project at Lorain on a pari passu
basis with the 10% senior secured notes.
Long
term debt related to December 2003 acquisition
Prior
to
their early redemption in whole on May 20, 2004, Republic Inc.’s 10% senior
secured notes were senior secured obligations of Republic Inc. and certain
of
its subsidiaries, aggregating $60.0 million of principal amount, $80.0 million
face amount, and were scheduled to mature on December 19, 2009.
On
December 19, 2003, the 10% senior secured notes were issued under an indenture
among Republic Engineered Products, Inc., as issuer, PAV Republic, Inc.,
PAV
Railroad, Inc., and PAV Machine, LLC, as guarantors, and U.S. Bank National
Association, as trustee and collateral agent. These 10% senior secured notes
were issued in connection with the acquisition of the operating assets of
REPH
LLC. The indenture governing these notes required Republic Inc. to redeem
the
senior secured notes with certain proceeds from asset sales of any collateral
that secures the notes and contained significant affirmative and negative
covenants including separate provisions imposing restrictions on additional
borrowings, certain investments, certain payments, sale or disposal of assets,
payment of dividends and change of control provisions, in each case subject
to
certain exceptions. The notes were secured, subject to exceptions and
limitations, by a first priority lien on, and secured interest in, substantially
all of Republic Inc.’s existing assets other than the Canton C-RTM facility,
inventory, accounts receivable and intellectual property and related assets,
and
a first priority interest in Republic Inc.’s capital stock and other equity
interests. Republic Inc.’s obligations under the senior secured notes were
unconditionally and fully guaranteed jointly and severally on a senior secured
basis by each of its direct subsidiaries.
The
Bondholders’ priority lien on Republic Inc.’s existing assets, entitled them to
a security interest in the $13.9 million of property insurance proceeds received
by REPH LLC in October 2003. As a result of the redemption on May 20, 2004,
this
interest was released and the encumbered funds became available to the Company.
Capital
lease obligations
On
December 31, 2004 the amount included in property, plant and equipment for
various equipment and computer capital leases was $0.8 million, net of $0.2
million of accumulated amortization. These various capital leases require
minimum payments in 2005 of $0.4 million and 2006 of $0.3 million, which
is
included in other accrued liabilities and other long-term liabilities,
respectively.
(9)
Insurance proceeds
In
2003,
REPH LLC’s operations were negatively impacted by the loss of one of two blast
furnaces located in Lorain, Ohio. As a result, REPH LLC has filed business
interruption and property damage insurance claims. The Company acquired the
right to reimbursement from insurance claims for damage incurred to the #3
blast
furnace under the terms of the asset purchase agreement. During the year
ended
December 31, 2004, the Company received $34.2 million of insurance proceeds.
The
Company recorded the receipt of the insurance proceeds and reduced non current
assets by $16.4 million, and the remainder resulted in the recognition of
$10.2
million in extraordinary gain, net of tax of $6.5 million. Reimbursements
from
the business interruption insurance claims up to $25.0 million were subject
to
the security interest maintained by Republic Inc.’s bank note holders as
discussed in note 8. The Company, as of October, 2004, paid $10.0 million
to
satisfy in full this security interest. The Company will continue to seek
reimbursement on the full amount of the business interruption and property
damage insurance claims.
(10)
Benefit plans
In
August
2002 REPH LLC implemented a new collective bargaining agreement with the
United
Steelworkers of America (USWA). The Company assumed this labor agreement
in
connection with the acquisition of the operating assets of REPH LLC. The
USWA
labor agreement covers the vast majority of our hourly employees. The USWA
supported the acquisition and assumption of the labor agreement. The labor
agreement expires on August 15, 2007.
Wage
and
benefit provisions under this collective bargaining agreement are specified
until expiration of the agreement and will be subject to negotiations at
that
time. The labor agreement provides for the creation of a defined contribution
program for retirement healthcare and pension benefits. The Company is required
to make a contribution for every hour worked. The contribution amount was
$3.00
for every hour worked through August 16, 2004. At that time, the contribution
amount increased to $3.50 for every hour worked. Effective August 16, 2005
and
until the expiration of the labor contract, the contribution increases to
$3.80
for every hour worked. Contributions are directed by the USWA to provide
either
pension benefits and/or retiree medical coverage for future eligible employees
of Republic Inc. and for retirees of REPH LLC. (However, no contributions
may be
used for the purpose of providing medical coverage for the retirees of REPH
LLC
if they create, or result in, any liability whatsoever on the part of the
Company for any obligation of REPH LLC, or any independent obligation to
the
retirees of REPH LLC.) Republic Inc.’s contributions to the benefits trust
constitute its sole obligation with respect to providing these benefits.
The
Company recorded expense of $12.5 million in expense related to this provision
of the labor contract for the year ending December 31, 2004.
The
labor
agreement also establishes a profit sharing plan to which the Company is
required to contribute 15% of its quarterly pre-tax income, as defined in
the
labor agreement, in excess of $12.5 million. Twenty-five percent of these
contributions will be divided among USWA-represented employees who are covered
by the labor agreement based on the numbers of hours worked and the remaining
75% will be contributed to the benefits trust described above. Contributions,
if
any, will be distributed to employees and the benefits trust within 45 days
of
the end of each fiscal quarter. The Company recorded expense of $9.7 million
for
the year ending December 31, 2004 for the profit sharing obligation under
this
plan.
The
Company has a defined contribution retirement plan that covers substantially
all
salary and nonunion hourly employees. This plan is designed to provide
retirement benefits through company contributions and employee deferrals.
The
Company funds contributions to this plan each pay period based upon the
participants age and service as of January 1st of each year. The amount of
the
Company’s contribution is equal to the monthly base salary multiplied by the
appropriate percentage based on age and years of service. The contribution
becomes 100% vested upon completion of 5 years of service. In addition,
employees are permitted to make contributions into a 401(k) retirement plan
through payroll deferrals. The Company provides a 25% matching contribution
for
the first 5% of an employee’s contributions. Employees are 100% vested in both
their and the Company’s matching contributions. The Company recorded expense of
$2.4 million under this plan for the year ending December 31, 2004.
In
2004,
Republic Inc. adopted a profit sharing plan for salary and non-union hourly
employees excluding a select group of managers and executives. The Company
is
required to contribute 3% of its quarterly pre-tax income, as defined in
the
plan, in excess of $12.5 million. During the year-ended December 31, 2004
the
Company incurred a $2.0 million profit sharing obligation under this plan.
In
2004,
Republic Inc. adopted a management incentive plan for a select group of managers
and executives. Incentives are based upon achievement of specific corporate
and
individual objectives which include financial results, product yield
improvement, energy utilization, quality, safety, and delivery reliability.
During the year ended December 31, 2004 the Company recorded a liability
and
expense of $2.5 million in connection with this plan. In addition, the Board
of
Directors approved incentive compensation for Joseph F. Lapinsky, Chief
Executive Officer, of $1.1 million for the year ended December 31, 2004,
which
we expensed and accrued in 2004.
In
2004,
the Company assumed a deferred compensation plan covering certain key employees.
This plan was adopted by REPH LLC and became effective on August 1, 2003.
The
plan allows for the employee to make annual deferrals of base salary and
provides for a fixed annual contribution by the Company based on a percentage
of
salary. The Company incurred $0.3 million of expense associated with this
plan
for the year ended December 31, 2004.
(11)
Income taxes
The
components of the income tax provision (benefit) for the Company for the
year
ended December 31, 2004 are as follows (in thousands):
Current:
|
|
|
|
Federal
|
|
$
|
17,996
|
|
State
and local
|
|
|
3,183
|
|
Foreign
|
|
|
614
|
|
Total
current
|
|
|
21,793
|
|
Deferred:
|
|
|
|
|
Federal
|
|
|
(3,328
|
)
|
State
and local
|
|
|
(381
|
)
|
Total
deferred
|
|
|
(3,709
|
)
|
Total
|
|
$
|
18,084
|
|
The
following is a reconciliation of the Company’s effective income tax rate to the
Federal statutory rate for the year ended December 31, 2004:
|
|
|
|
Statutory
rate
|
|
|
35.0
|
%
|
Provision
for state and local taxes, net of federal effect
|
|
|
4.0
|
%
|
Valuation
allowance and other
|
|
|
(0.7
|
)%
|
Effective
income tax rate
|
|
|
38.3
|
%
|
Deferred
tax assets and liabilities as of December 31, 2004 are presented below (in
thousands):
|
|
|
|
Deferred
tax assets:
|
|
|
|
Capitalized
inventory costs
|
|
$
|
8,562
|
|
Compensation
and benefits
|
|
|
6,026
|
|
Accrued
expenses
|
|
|
3,271
|
|
Allowance
for doubtful accounts
|
|
|
299
|
|
Total
deferred tax assets
|
|
|
18,158
|
|
Deferred
tax liabilities:
|
|
|
|
|
Inventory
|
|
|
(9,114
|
)
|
Property,
plant, and equipment
|
|
|
(2,871
|
)
|
Prepaid
expenses
|
|
|
(2,333
|
)
|
Total
deferred tax liabilities
|
|
|
(14,318
|
)
|
Net
deferred tax assets
|
|
$
|
3,840
|
|
The
fair
values of the net assets of REPH LLC acquired by the Company on December
19,
2003 exceeded the purchase price. Accordingly, this difference was
proportionately allocated to reduce the tax values otherwise assigned to
prepaid
expenses, property, plant, equipment, and other assets. The deferred tax
assets
and liabilities as of December 31, 2004 reflect adjustments to the original
purchase price allocation.
Deferred
taxes are provided on the differences between the tax basis of assets and
liabilities and their reported amounts in the Company’s consolidated financial
statements. As of the date of acquisition there were differences between
the tax
basis of certain assets and liabilities and their reported amounts. The
differences between the tax basis of the acquired assets and their reported
amounts were equal to the differences between the tax basis of the liabilities
assumed and their reported amounts. Therefore, the net deferred tax assets
and
liabilities at the date of acquisition were zero.
During
the period from January 1, 2004 to December 31, 2004, certain deferred tax
assets and liabilities reversed, resulting in a net deferred tax asset at
December 31, 2004 of $3.8 million. Management believes it is more likely
than
not that all of the deferred tax assets will be realized due to generating
sufficient amounts of taxable income in the future, and accordingly, no
valuation allowance is required at December 31, 2004.
(12)
Related party transactions
PAV
Republic, Inc. and certain of its stockholders have entered into a stockholders
agreement. Under the terms of such stockholders’ agreement, if Perry and Perry
International propose to transfer any shares of stock, each stockholder of
PAV
Republic may participate in such transfer on a pro rata basis. In the event
Perry and Perry International propose and the Board of PAV Republic approves
of
a transfer of a majority of assets or a majority of the Company’s outstanding
stock to an unaffiliated third party, each stockholder will be obligated
to sell
its shares in connection with such transaction.
On
May
20, 2004, the Company agreed to pay a transaction fee of $1.8 million to
Perry
Principals Investments, L.L.C, an affiliate of Perry, in connection with
its
$61.8 million senior secured promissory note and guaranty agreement between
Republic Engineered Products, Inc. and Perry Principals Investments, L.L.C.
(see
Note 8)
On
May
20, 2004, the Company agreed to pay a transaction fee of $0.2 million to
Perry
Principals Investments, L.L.C., an affiliate of Perry, in connection with
its
$8.4 million senior subordinated promissory note and guaranty agreement between
Republic Engineered Products, Inc. and Perry Principals Investments, L.L.C.
(see
Note 8). This note was repaid in full in July 2004.
During
the year ended December 31, 2004, the Company made a payment of $0.3 million
to
Perry Partners LP to reimburse Perry Partners LP for expenses it incurred
in
connection with the acquisition in December 2003 and other expenses.
On
December 31, 2004, Perry Principals, L.L.C., an affiliate of Perry Capital,
the
Company’s principal stockholder, was the holder of $1.3 million of the
outstanding 10% Senior Secured Notes due August 31, 2009.
On
December 31, 2004, Contrarian Funds LLC, a stockholder of the Company, was
the
holder of $1.9 million of the outstanding 10% Senior Secured Notes due August
31, 2009.
(13)
Commitments and contingencies
The
Company, in the ordinary course of business, is the subject of or party to
various pending or threatened legal and environmental actions. The Company
provides for the costs related to these matters when a loss is probable and
the
amount is reasonably estimable. Based on information presently known to the
Company, management believes that any ultimate liability resulting from these
actions will not have a material adverse affect on its consolidated financial
position, results of operations or cash flows.
US
Steel
is the Company’s primary supplier of iron ore and coke. The Company was informed
by US Steel that it did not intend to renew its current supply agreement,
which
expired at the end of December 2004. On October 22, 2004, the Company and
U.S.
Steel finalized transition supply agreements which will provide iron ore
and a
portion of the Company’s coke requirements from January 1, 2005 through June 30,
2005. The Company is working to develop additional sources for these raw
materials.
On
October 11, 2004 our Board of Directors approved the installation of a new
five-strand combination billet/bloom caser and associated equipment at our
Canton facility. We began the preparation for installation of the new equipment
in December 2004. We anticipate the project to cost approximately $50.0 million
to complete and will become fully operational by the fourth quarter of 2005.
At
December 31, 2004 the Company had executed contracts relating to this project
in
the amount of $24.2 million. The anticipated expenditures associated with
this
project are expected to be funded using cash from operations and borrowings
under our revolving credit facility.
The
Company leases certain equipment, office space and computer equipment under
non-cancelable operating leases. These leases expire at various dates through
2012. Rental expense on operating leases amounted to $8.9 million for the
year
ended December 31, 2004. At December 31, 2004, total minimum lease payments
under noncancelable operating leases are $2.9 million in 2005, $1.3 million
in
2006, $1.0 million in 2007, $0.8 million in 2008 and $1.2 million thereafter.
(14)
Environmental matters
As
is the
case with most steel producers, the Company could incur significant costs
related to environmental issues in the future, including those arising from
environmental compliance activities and remediation stemming from historical
waste management practices at the Company’s facilities acquired in December 2003
from REPH LLC. The reserve to cover environmental remediation liabilities
that
the Company considers probable and reasonably estimable, based on current
information and existing laws and regulations, was $4.9 million as of December
31, 2004. The reserve includes estimated costs associated with (i) the current
investigation and cleanup underway at our Canton plant pursuant to an
administrative order on consent with EPA, issued pursuant to the federal
agency’s corrective action authority under the Resource Conservation and
Recovery Act (RCRA); (ii) the potential for similar investigation/cleanup
obligations associated with historic operations and on-site waste management
practices at our Lorain, Lackawanna and Massillon plants; and (iii) several
smaller environmental remediation items, each less than $100,000. The Company
is
not otherwise aware at this time of any material environmental remediation
liabilities or contingent liabilities relating to environmental matters with
respect to our facilities for which the establishment of an additional reserve
would be appropriate at this time. To the extent the Company incurs any such
additional future costs, these costs will most likely be incurred over a
number
of years. However, future regulatory action regarding historical waste
management practices at the Company’s facilities and future changes in
applicable laws and regulations may require the Company to incur significant
costs that may have a material adverse effect on the Company’s future financial
performance.
(15)
Obligation to administer USWA benefits
In
2004
the Company entered into an agreement with the USWA to administer health
insurance benefits to the Company’s USWA employees while on layoff status and to
administer payment of monthly contributions to the Steelworker’s Pension Trust
on behalf of local union officials while on union business. To fund this
program
the USWA provided a cash contribution of $3.0 million. As of December 31,
2004,
the balance of this cash account totaled $2.8 million. Expenditures from
this
account were used to provide health insurance to laid off USWA employees.
The
Company has agreed to continue to administer this program until the fund
is
exhausted. The Company will provide the USWA with periodic reports regarding
the
financial status of the fund. The cash account of $2.8 million is recorded
as an
other asset and the related liability is recorded as an other long-term
liability.
(16)
Disclosures about fair value of financial instruments and significant group
concentration of credit risk
The
following methods and assumptions were used to estimate the fair value of
each
class of financial instruments for which it is practicable to estimate that
value:
(a)
Cash and cash equivalents
The
carrying amount approximates fair value because of the short maturity of
these
investments.
(b)
Revolving credit facilities
Since
these borrowings are based on short-term interest notes available to the
Company, the estimated fair values of these financials instruments approximate
their recorded carrying amounts.
(c)
Long-term debt
The
fair
value of the Company’s long-term debt obligations are estimated based upon
quoted market prices for the same or similar issues or on the current rates
offered for debt of the same remaining maturities.
The
estimated fair values of the Company’s financial instruments as of
December 31, 2004 are as follows:
|
|
|
|
|
|
|
|
Carrying
amount
|
|
Fair
Value
|
|
Cash
and cash equivalents
|
|
$
|
3,748
|
|
$
|
3,748
|
|
Revolving
credit facilities
|
|
|
142,219
|
|
|
142,219
|
|
Long-term
debt
|
|
|
77,027
|
|
|
77,027
|
|
(17)
Derivative instruments and hedging activities
The
Company purchases natural gas under short term supply contracts. In an effort
to
manage the risks associated with fluctuations in market prices, we periodically
use hedging instruments including options on natural gas. We purchase options
for a portion of our natural gas requirements. These options are designed
to cap
our exposure to extreme price volatility thereby limiting the unfavorable
effect
of price increases on our operating costs. Changes to the fair value of the
premiums paid for these option contracts are recorded as a change in the
value
of prepaid assets and as an increase or offset to cost of goods sold.
(18)
Comprehensive income
Other
comprehensive income consists of foreign currency translation adjustments.
At
December 31, 2004, the Company recognized $0.2 million in other comprehensive
income relating to foreign currency translation adjustments.
(19)
Other Postretirement Benefits
In
connection with the acquisition of the operating assets of REPH LLC, the
Company
assumed a defined retiree health care plan covering approximately 14 union
hourly employees. These benefits are provided under the terms of the collective
bargaining agreement with the Bricklayers & Allied Craftsman International
Union and are based upon years of service and age. Health care benefits that
are
provided include comprehensive hospital, surgical, major medical and drug
benefit provisions. Participation in the plan requires the retiree to contribute
50% of the cost of the benefit plan. Currently there are no plan assets and
the
Company funds the benefits as claims are paid.
The
postretirement benefit obligation was determined by application of the terms
of
the health care provided together with relevant actuarial assumptions and
healthcare cost trends. The Company uses a December 31 measurement date.
Fiscal
year ending:
|
|
December
31, 2004
(dollars
in thousands)
|
|
Change
in Accumulated Postretirement Benefit Obligation
|
|
|
|
Accumulated
postretirement benefit obligation at beginning of year
|
|
$
|
537
|
|
Service
cost
|
|
|
14
|
|
Interest
cost
|
|
|
33
|
|
Actuarial
loss/(gain)
|
|
|
26
|
|
Benefits
paid
|
|
|
(21
|
)
|
Accumulated
postretirement benefit obligation at end of year
|
|
|
591
|
|
Change
in Plan Assets
|
|
|
|
|
Fair
value of plan assets at beginning of year
|
|
|
—
|
|
Employer
contribution
|
|
|
21
|
|
Benefits
paid
|
|
|
(21
|
)
|
Fair
value of assets at end of year
|
|
|
—
|
|
Information
on Funded Status
|
|
|
|
|
Funded
status
|
|
|
(591
|
)
|
Unrecognized
net actuarial loss (gain)
|
|
|
26
|
|
Net
amount recognized
|
|
|
(564
|
)
|
Components
of Net Periodic Postretirement Benefit Cost
|
|
|
|
|
Service
cost
|
|
$
|
14
|
|
Interest
cost
|
|
|
33
|
|
Net
periodic postretirement benefit cost
|
|
|
47
|
|
Assumptions
|
|
|
|
|
Weighted-average
assumptions used to determine accumulated postretirement benefit
obligation as of December 31
|
|
|
|
|
a.
Discount rate
|
|
|
6.00
|
%
|
b.
Rate of compensation increase
|
|
|
N/A
|
|
Weighted-average
assumptions used to determine net periodic postretirement benefit
cost for
years ended December 31
|
|
|
|
|
a.
Discount rate
|
|
|
6.25
|
%
|
b.
Rate of compensation increase
|
|
|
N/A
|
|
c.
Expected return on plan assets
|
|
|
N/A
|
|
Assumed
health care cost trend rates at end of year
|
|
|
|
|
a.
Assumed health care cost trend rate for the coming year
|
|
|
10.00
|
%
|
b.
Rate that the cost trend gradually declines to
|
|
|
5.00
|
%
|
c.
Year that the rate reaches the rate it is assumed to remain
at
|
|
|
2009
|
|
Sensitivity
Analysis
|
|
1-percentage
point Increase
|
|
Effect
on total of service and interest cost components
|
|
$
|
11
|
|
Effect
on postretirement benefit obligation
|
|
|
131
|
|
Estimate
Future Benefit Payments
|
|
|
|
|
2005
|
|
$
|
22
|
|
2006
|
|
|
22
|
|
2007
|
|
|
19
|
|
2008
|
|
|
20
|
|
2009
|
|
|
18
|
|
2010
- 2014
|
|
$
|
108
|
|
In
December 2003, the Medicare Prescription Drug, Improvement and Modernization
Act
of 2003 (the Act) became law in the United States. The Act introduces a
prescription drug benefit under Medicare as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that
is at
least actuarially equivalent to the Medicare benefit. In accordance with
FASB
Staff Position (FSP) FAS 106-1 (issued January 2004), ‘‘Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003,’’ the Company elected to defer recognition of the
effects of the Act in any measures of the benefit obligation or cost in 2003
and
2004. FSP FAS 106-2 (issued May 2004), ‘‘Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization
Act of
2003’’ will require the Company to determine whether its plan is at least
actuarially equivalent to the Medicare benefit as at January 1, 2005 and
account
for the effects of the Act, if any, beginning in 2005. The Company is currently
assessing whether the benefits provided by its plan are actuarially equivalent
to the Medicare benefit.
(20)
Subsequent event
The
Company announced in November 2004 its intent for an initial public offering
(IPO) of PAV Republic Inc. The Company plans to sell approximately 30% to
35% of
its equity in the IPO and expects to complete the IPO in the first half of
2005,
subject to market conditions and receipt of various regulatory approvals.
On
March
15, 2005, the Company amended its 2004 Equity Incentive Plan in order to
bring
it into compliance with new Section 409A of the Internal Revenue Code. In
addition, outstanding stock options issued to certain executives were also
amended in response to new Section 409A of the Code. As amended, the stock
options are exercisable only on the earliest of (i) a fixed date or pursuant
to
a fixed schedule, (ii) death, (iii) disability, or (iv) in certain
circumstances, the executive’s separation from employment with the Company
and/or its subsidiaries. The repurchase provisions with respect to shares
received on the exercise of the outstanding options were also modified so
that
after this offering (i) the Company will have no contractual right to repurchase
shares held by Mr. Lapinsky upon termination of his employment with the Company
and (ii) the Company’s right to repurchase shares held by the other executives
shall be limited to a contractual repurchase right entitling the Company
to
repurchase shares held by executives only if that executive’s employment is
terminated for Cause for a price per share equal to the lesser of its original
cost or fair market value. The Company has granted to each executive in 2005
an
additional grant exercisable for a number of shares of the Company equal
to five
percent of the shares of the Company executive would have received upon exercise
in full of his or her 2004 grant, assuming such 2004 grant had been exercisable
in full at the time of the subsequent 2005 grant.
(21)
Segment information
The
Company is primarily engaged in one line of business that produces and sells
engineered steel bars. Our products include hot rolled bars, cold finished
bars,
semi-finished seamless tube rounds and other semi-finished trade products.
On
December 19, 2003, Republic Engineered Products, Inc., our wholly-owned
subsidiary, acquired substantially all of the operating assets and assumed
certain liabilities of REPH LLC. Upon completion of the acquisition the company
implemented a strategy to manage our product mix by focusing on higher
value-added bar product with more engineering content and metallurgical
specificity, which command premium margins. Our product lines are marketed
to a
common customer base. Our customers include automotive and industrial equipment
manufacturers, first tier suppliers to automotive, forgers and tubular and
pipe
product manufacturers. We differentiated the Company from its predecessor
by
exiting the lower commodity business. The transition to a single segment
culminated in the fourth quarter of 2004.
The
manufacturing process for all our engineered products begins with steel being
melted in either Canton or Lorain, Ohio. The molten steel is then poured
into
either a four, five or six-strand continuous caster through which the steel
flows and cools. The cooled blooms or billets solidify, then are cut to length
before further processing. The casters produce round blooms and billets that
are
feedstock for hot-rolled seamless tube products or rectangular blooms or
square
billets that are transported to one of three bar rolling mills.
At
the
rolling mill, blooms and billets are converted to hot rolled bars by reheating,
then rolling the products through a series of continuous roll stands. The
steel
is reduced in cross-section and elongates through this process. The completed
hot-rolled products are either coiled or are placed on a cooling bed and
then
cut into required lengths. The items are then stacked into coils or bundles
and
placed in warehouses from which they are shipped directly to the customer
or to
one of our cold finishing mills for further processing.
Our
product lines include:
Hot
rolled bar products.
Hot
rolling changes the internal physical properties, size, and shape of the
steel.
As a direct cast billet or bloom is reduced in size, the strength and integrity
of the resulting bar or rod product is increased. Since blooms have larger
cross-sectional area than billets, a greater reduction to finished size occurs.
Accordingly, a bar or rod product rolled from a cast bloom is generally stronger
than a direct cast billet product of the same size and metallurgical content.
Typically customers concerned about product quality and strength as related
to
reduction of area require bloom based hot-rolled bar products. Direct cast
billet products are generally used for smaller bar product sizes and for
less
demanding end-use applications.
Cold
finished bar products.
Cold
finishing improves the physical properties of hot-rolled products through
value-added processes. Cold finishing processes generate products with more
precise size and straightness tolerances as well as a surface finish that
provides customers with a more efficient means of producing a number of end
products by often eliminating the first processing step in the customer’s
process.
Semi-Finished
Seamless Tube Rounds.
In
connection with our current supply arrangement with US Steel Corporation,
we
produce semi-finished seamless rounds at our Lorain, Ohio facility for purchase
by US Steel’s Lorain, Ohio and Fairfield, Alabama facilities. Seamless tubes are
used in oil and gas drilling and exploration applications.
Other
Semi-Finished Trade Products.
We also
sell semi-finished trade products to trade customers that are cast or rolled
into round cornered squares. These products are typically sold for forging
applications or to rolling mills operated by competitors that do not have
melt
shop facilities or to steel service centers or distributors, for further
processing before they reach the ultimate end user.
The
following table presents the sales of our product lines as a percentage of
our
total sales, for the year ended December 31, 2004.
Product
|
|
|
|
Hot-rolled
bars
|
|
|
70.1
|
%
|
Cold-finished
bars
|
|
|
13.8
|
%
|
Semi-finished
seamless tube rounds
|
|
|
10.8
|
%
|
Other
semi-finished trade products
|
|
|
5.3
|
%
|
Total
|
|
|
100.0
|
%
|
Foreign
sales for all product lines were 6.3% of the Company’s total sales for the year
ended December 31, 2004. The Company’s foreign long-lived assets, located in
Ontario, Canada, represent 0.5% of the Company’s total assets. The Company did
not own any foreign long-lived assets until the acquisition of Republic Canadian
Drawn, Inc. on January 29, 2004.
Report
of Independent Registered Public Accounting
Firm
Board
of
Directors and Stockholders
PAV
Republic, Inc. and Subsidiaries
Akron,
Ohio
We
have
audited the accompanying consolidated balance sheet of PAV Republic, Inc.
and
Subsidiaries (the “Company”) as of July 22, 2005 and the related
consolidated statements of operations, stockholders’ equity and comprehensive
income, and cash flows for the period January 1, 2005 through July 22,
2005. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required
to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting.
Our
audit
included consideration of internal control over financial reporting as a
basis
for designing audit procedures that are appropriate in the circumstances,
but
not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
as
well as evaluating the overall financial statement presentation. We believe
that
our audit provide a reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present
fairly,
in all material respects, the financial position of PAV Republic, Inc. and
Subsidiaries at July 22, 2005, and the results of its operations and its
cash flows for the period January 1, 2005 through July 22, 2005 in
conformity with accounting principles generally accepted in the United States
of
America.
September
15, 2006
BDO
SEIDMAN LLP
PAV
Republic, Inc. and Subsidiaries
Consolidated
Balance Sheet
As
of
July 22, 2005
(in
thousands of dollars)
Assets
|
|
|
|
Current
assets:
|
|
|
|
Cash
and cash equivalents
|
|
$
|
1,398
|
|
Accounts
receivable, less allowance of $21,735
|
|
|
108,281
|
|
Inventories
(note 4)
|
|
|
213,733
|
|
Deferred
income taxes (note 9)
|
|
|
6,951
|
|
Prepaid
expenses and other current assets
|
|
|
4,631
|
|
Total
current assets
|
|
|
334,994
|
|
Property,
plant and equipment
|
|
|
|
|
Land
and improvements
|
|
|
827
|
|
Buildings
and improvements
|
|
|
1,750
|
|
Machinery
and equipment
|
|
|
16,610
|
|
Construction-in-progress
(note 11)
|
|
|
43,977
|
|
Total
property, plant and equipment
|
|
|
63,164
|
|
Accumulated
depreciation
|
|
|
(2,288
|
)
|
Net
property, plant and equipment
|
|
|
60,876
|
|
Intangible
assets and deferred costs, net of accumulated amortization (note
5)
|
|
|
6,207
|
|
Other
assets (notes 7 and 13)
|
|
|
4,891
|
|
Total
assets
|
|
$
|
406,968
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
Current
portion of long-term debt (note 6)
|
|
$
|
1,617
|
|
Accounts
payable
|
|
|
78,515
|
|
Accrued
compensation and benefits
|
|
|
31,048
|
|
Accrued
interest
|
|
|
418
|
|
Accrued
income taxes (note 9)
|
|
|
7,994
|
|
Other
accrued liabilities
|
|
|
7,392
|
|
Total
current liabilities
|
|
|
126,984
|
|
Long-term
debt (note 6)
|
|
|
65,183
|
|
Revolving
credit facility (note 6)
|
|
|
70,200
|
|
Accrued
environmental liabilities (note 12)
|
|
|
3,315
|
|
Deferred
income taxes (note 9)
|
|
|
1,329
|
|
Other
long-term liabilities (notes 6 and 13)
|
|
|
3,465
|
|
Total
liabilities
|
|
|
270,476
|
|
Stockholders’
equity:
|
|
|
|
|
Common
stock, $0.01 par value, 60,000 shares authorized, 50,074 issued
and
outstanding
|
|
|
1
|
|
Additional
paid-in capital
|
|
|
61,495
|
|
Retained
earnings
|
|
|
74,839
|
|
Accumulated
other comprehensive loss (note 15)
|
|
|
157
|
|
Total
stockholders’ equity
|
|
|
136,492
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
406,968
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Consolidated
Statement of Operations
For
the
Period January 1, 2005 to July 22, 2005
(in
thousands of dollars)
|
|
|
|
Net
sales
|
|
$
|
858,694
|
|
Cost
of goods sold
|
|
|
747,023
|
|
Gross
profit
|
|
|
111,671
|
|
|
|
|
|
|
Selling,
general and administrative expense
|
|
|
47,948
|
|
Depreciation
and amortization expense
|
|
|
1,330
|
|
Other
operating income, net
|
|
|
(768
|
)
|
Operating
income
|
|
|
63,161
|
|
Interest
expense
|
|
|
8,521
|
|
Interest
income
|
|
|
(96
|
)
|
Income
before income taxes
|
|
|
54,736
|
|
|
|
|
|
|
Provision
for income taxes (note 9)
|
|
|
20,526
|
|
|
|
|
|
|
Net
income before extraordinary gain
|
|
|
34,210
|
|
|
|
|
|
|
Extraordinary
gain, net of tax (note 17)
|
|
|
2,061
|
|
|
|
|
|
|
Net
income
|
|
$
|
36,271
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Consolidated
Statement of Stockholders’ Equity and Comprehensive Income
For
the
Period January 1, 2005 to July 22, 2005
(in
thousands of dollars)
|
|
Common
Shares
Par
Value
|
|
Additional
Paid-in
Capital
|
|
Accumulated
Retained
Earnings
|
|
Accumulated
Other
Comprehensive
Loss
|
|
Total
|
|
Balance,
December 31, 2004
|
|
$
|
1
|
|
$
|
55,923
|
|
$
|
38,568
|
|
$
|
162
|
|
$
|
94,654
|
|
Stock-based
compensation expense (note 7)
|
|
|
-
|
|
|
5,572
|
|
|
-
|
|
|
-
|
|
|
5,572
|
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
-
|
|
|
-
|
|
|
36,271
|
|
|
-
|
|
|
36,271
|
|
Currency
translation adjustment (note 15)
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(5
|
)
|
|
(5
|
)
|
Total
comprehensive income
|
|
|
|
|
|
-
|
|
|
36,271
|
|
|
(5
|
)
|
|
36,266
|
|
Balance,
July 22, 2005
|
|
$
|
1
|
|
$
|
61,495
|
|
$
|
74,839
|
|
$
|
157
|
|
$
|
136,492
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Consolidated
Statement of Cash Flows
For
the
Period January 1, 2005 to July 22, 2005
(in
thousands of dollars)
Cash
flows from operating activities:
|
|
|
|
Net
income
|
|
$
|
36,271
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
Depreciation
and amortization
|
|
|
1,330
|
|
Amortization
of deferred financing costs
|
|
|
807
|
|
Write
off of deferred costs
|
|
|
2,027
|
|
Stock-based
compensation expense
|
|
|
5,572
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
Decrease
in accounts receivable
|
|
|
31,810
|
|
Decrease
in inventory
|
|
|
29,618
|
|
Decrease
in prepaid and other assets
|
|
|
13,735
|
|
Increase
in accounts payable
|
|
|
28,137
|
|
Decrease
in accrued compensation and benefits
|
|
|
(3,502
|
)
|
Decrease
in accrued interest
|
|
|
(122
|
)
|
Decrease
in accrued income tax - accrued and deferred
|
|
|
(14,986
|
)
|
Decrease
in other accrued liabilities
|
|
|
(5,888
|
)
|
Decrease
in accrued environmental liabilities
|
|
|
(332
|
)
|
Net
cash provided by operating activities
|
|
|
124,477
|
|
Cash
flows from investing activities:
|
|
|
|
|
Capital
expenditures
|
|
|
(42,842
|
)
|
Net
cash used in investing activities
|
|
|
(42,842
|
)
|
Cash
flows from financing activities:
|
|
|
|
|
Proceeds
from revolving credit facilities
|
|
|
184,290
|
|
Repayment
of revolving credit facilities
|
|
|
(256,309
|
)
|
Repayments
of long-term debt
|
|
|
(10,895
|
)
|
Deferred
financing costs
|
|
|
(1,066
|
)
|
Net
cash provided by financing activities
|
|
|
(83,980
|
)
|
Effect
of exchange rate
|
|
|
(5
|
)
|
Net
decrease in cash and cash equivalents
|
|
|
(2,350
|
)
|
Cash
and cash equivalents - beginning of period
|
|
|
3,748
|
|
Cash
and cash equivalents - end of period
|
|
$
|
1,398
|
|
Supplemental
cash flow information:
|
|
|
|
|
Cash
paid for interest
|
|
$
|
8,130
|
|
Cash
paid for income taxes
|
|
$
|
37,153
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Notes
to
consolidated financial statements
(In
thousands of dollars, except as otherwise noted)
(1)
|
Nature
of Operations, Organization and Other Related
Information
|
PAV
Republic, Inc. (the Company or PAV) commenced operation on December 19, 2003
after acquiring substantially all of the operating assets of REPH LLC (formerly
known as Republic Engineered Products Holdings LLC) in a sale of assets under
Section 363 of the United States Bankruptcy Code. PAV also acquired assets
located on the premises of REPH LLC’s machine shop located in Massillon, Ohio;
assets located on the premises of REPH LLC’s corporate headquarters located in
Akron, Ohio.
PAV
is a
Delaware corporation, which owns 100% of the outstanding stock of Republic
Engineered Products, Inc. (Republic Inc). PAV has no substantial operations
or
assets, other than its investment in Republic Inc. Republic Inc, a Delaware
corporation, produces special bar quality steel products. Special bar quality
steel products are high quality hot-rolled and cold-finished carbon and alloy
steel bars and rods used primarily in critical applications in automotive
and
industrial equipment. Special bar quality steel products are sold to customers
who require precise metallurgical content and quality characteristics. The
Company’s products include hot-rolled bars, cold-finished bars, semi-finished
seamless tube rounds and other semi-finished trade products. The Company’s
customers include automotive and industrial equipment manufacturers, first
tier
suppliers to automotive, forgers, and tubular and pipe product
manufacturers.
Republic
Machine, LLC, Republic N&T Railroad, Inc. and Republic Canadian Drawn, Inc.
are wholly owned subsidiaries of Republic Inc. Republic Machine, LLC is a
Delaware limited liability company which operates the machine shop located
in
Massillon, Ohio. Republic N&T Railroad, Inc. is a Delaware corporation and
operates the railroad assets located at the Company’s Canton and Lorain, Ohio
facilities. Republic Canadian Drawn, Inc. is an Ontario, Canada corporation
which operates the cold-finishing plant located in Ontario, Canada.
The
manufacturing process for the Company’s products begins with steel melted in
either the Canton or the Lorain, Ohio facilities. The molten steel is then
poured into a four, five or six-strand continuous caster through which the
steel
flows and cools. The cooled blooms or billets solidify, and then are cut
to
length before further processing. The casters produce round blooms and billets
that are feedstock for hot-rolled seamless tube products or rectangular blooms
or square billets that are transported to one of three bar rolling
mills.
At
the
rolling mill, blooms and billets are converted to hot-rolled bars by reheating,
then rolling the products through a series of continuous roll stands. The
steel
is reduced in cross-section and elongates through this process. The completed
hot-rolled products are either coiled or are placed on a cooling bed and
then
cut into required lengths. The bars are bundled and banded, then placed in
warehouses from which they are shipped directly to the customer or to one
of the
Company’s cold-finishing plants for further processing.
The
Company’s product lines include:
Hot-rolled
bar products.
Hot-rolling changes the internal physical properties, size, and shape of
the
steel. As a direct cast billet or bloom is reduced in size, the strength
and
integrity of the resulting bar or rod product is increased. Since blooms
have
larger cross-sectional area than billets, a greater reduction to finished
size
occurs. Accordingly, a bar or rod product rolled from a cast bloom is generally
stronger than a direct cast billet product of the same size and metallurgical
content. Typically customers concerned about product quality and strength
as
related to reduction of area require bloom based hot-rolled bar products.
Direct
cast billet products are generally used for smaller bar product sizes and
for
less demanding end-use applications.
Cold-finished
bar products.
Cold-finishing improves the physical properties of hot-rolled products through
value-added processes. Cold-finishing processes generate products with more
precise size and straightness tolerances as well as a surface finish that
provides customers with a more efficient means of producing a number of end
products by often eliminating the first processing step in the customer’s
process.
Semi-Finished
Seamless Tube Rounds.
In
connection with the Company’s current supply arrangement with United States
Steel Corporation (US Steel), the Company produces semi-finished seamless
rounds
at the Company’s Lorain, Ohio facility for purchase by US Steel’s Lorain, Ohio
and Fairfield, Alabama facilities. Seamless tubes are used in oil and gas
drilling and exploration applications.
Other
Semi-Finished Trade Products.
We also
sell semi-finished trade products to trade customers that are cast or rolled
into round cornered squares. These products are typically sold for forging
applications or to rolling mills operated by competitors that do not have
melt
shop facilities or to steel service centers or distributors, for further
processing before they reach the ultimate end user.
The
following table presents the sales of the Company’s product lines as a
percentage of the Company’s total sales for the periods indicated:
Hot-rolled
bars
|
|
|
63.7
|
%
|
Cold-finished
bars
|
|
|
13.4
|
%
|
Semi-finished
seamless tube rounds
|
|
|
14.9
|
%
|
Other
semi-finished trade products
|
|
|
8.0
|
%
|
|
|
|
100.0
|
%
|
(2)
|
Basis
of Presentation and Principles of
Consolidation
|
The
accompanying consolidated financial statements include the accounts of PAV
Republic, Inc. and Subsidiaries for period from January 1, 2005 to July 22,
2005. All significant intercompany balances and transactions have been
eliminated in consolidation.
(3)
|
Summary
of Significant Accounting
Policies
|
|
(a)
|
Cash
and Cash Equivalents
|
For
purposes of the consolidated statement of cash flows, the Company considers
all
short-term investments with maturities at the date of purchase of three months
or less to be cash equivalents.
The
Company values inventories at the lower of cost or market applied on a last-in,
first-out (LIFO) method of inventory costing.
|
(c)
|
Derivative
Instruments
|
The
Company is exposed to fluctuations in natural gas prices. The Company has
a
hedging policy to manage its exposure to natural gas price fluctuations when
practical. The Company’s policy includes establishing a risk management
philosophy and objectives designed to cap the Company’s exposure to the extreme
price volatility of natural gas and thereby limiting the unfavorable effect
of
price increases on the Company’s operating costs. The Company does not enter
into contracts for the purpose of speculation. The Company accounts for these
derivative instruments in accordance with Statement of Financial Accounting
Standards (SFAS) No. 133, “Accounting for Derivative Instruments and
Hedging Activities.”
|
(d)
|
Property,
Plant, and Equipment
|
The
Company’s property, plant, and equipment are stated at cost and include
improvements that significantly increase productive capacity or extend the
useful lives of existing plant and equipment. The Company provides for
depreciation of property, plant, and equipment on the straight-line method
based
upon the estimated useful lives of the assets. The range of estimated useful
lives of the Company’s assets is as follows:
Buildings
and improvements
|
|
|
10-25
years
|
|
Land
improvements
|
|
|
5-25
years
|
|
Machinery
and equipment (the vast majority of lives are from 10-20
years)
|
|
|
5-20
years
|
|
Computer
equipment
|
|
|
3-5
years
|
|
Repair
and maintenance costs that significantly increase productive capacity or
extend
the useful lives of existing plant and equipment are capitalized. All other
repair and maintenance costs are expensed as incurred. Capital expenditures
for
projects that cannot be put into use immediately are included in
construction-in-progress. As of July 22, 2005, PAV estimated $13.5 million
of
costs associated with completion of current approved projects, excluding
the
five-strand combination billet/bloom caster and associated equipment discussed
in note 12. Interest is capitalized in connection with major capital projects.
The capitalized interest is recorded as part of the asset to which it relates
and is amortized over the asset’s estimated useful life. During the period
January 1, 2005 to July 22, 2005, interest costs of $0.5 million were
capitalized. When construction-in-progress projects are completed, they are
transferred to depreciable assets. Net gains or losses related to asset
dispositions are recognized in the Company’s operating results in the period in
which the disposition occurs.
|
(e)
|
Impairment
of Long-Lived Assets
|
Long-lived
assets, consisting of property, plant, and equipment, are periodically reviewed
by the Company for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset, or related group of assets,
may
not be recoverable. Recoverability of assets to be held and used is measured
by
a comparison of the carrying amount of an asset to future undiscounted net
cash
flows expected to be generated by the asset. If such assets are considered
to be
impaired, the impairment to be recognized is measured by the amount by which
the
carrying amount of the assets exceeds the lesser of the recovery amount or
the
fair value of the assets. Measurement of fair value may be based upon
appraisals, market values of similar assets or discounted cash flows. Assets
to
be disposed of are reported at the lower of the carrying amount or the fair
value less cost to sell and are no longer depreciated.
The
Company accounts for income taxes under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts
of
existing assets and liabilities and their respective tax bases and operating
losses and tax credit carryforwards. Deferred tax assets and liabilities
are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax
rates is recognized in income in the period that includes the enactment
date.
The
Company and other steel companies have, in recent years, become subject to
increasingly stringent environmental laws and regulations. It is the policy
of
the Company to endeavor to comply with applicable environmental laws and
regulations. The Company established a liability for an amount which the
Company
believes is appropriate, based on information currently available, to cover
costs of environmental remediation it deems probable and estimable.
The
recorded amounts represent estimates of the environmental remediation costs
associated with future events triggering or confirming the costs that, in
management’s judgment, are probable. These estimates are based on currently
available facts, existing technology and presently enacted laws and regulations,
and take into consideration the likely effects of inflation and other societal
and economic factors. The precise timing of such events cannot be reliably
determined at this time due to the absence of any deadlines for remediation
under the applicable environmental laws and regulations pursuant to which
such
remediation costs will be expended. No claims for recovery are netted against
the stated amount.
The
Company recognizes revenue when products are shipped and the customer takes
ownership and assumes risk of loss, collection of the relevant receivable
is
probable, persuasive evidence of an arrangement exists and the sales price
is
fixed and determinable. The Company’s customers have no rights to return
product, other than for defective materials. As sales are recognized, reserves
for defective materials are recorded as a percentage of sales and are charged
against such sales. This percentage is based on historical experience. The
adequacy of reserve estimates is periodically reviewed by comparison to actual
experience and adjusted as appropriate.
|
(i)
|
Allowances
for Doubtful Accounts
|
Allowances
for doubtful accounts are maintained to provide for estimated losses resulting
from the inability of customers to make required payments. If the financial
condition of these customers deteriorates, resulting in their inability to
make
payments, additional allowances may be required. Actual losses could differ
from
these estimates. The Company also records an allowance for accounts receivable
for customers based on a variety of factors, including pricing adjustments,
length of time receivables are past due, and historical experience. After
all
attempts to collect a receivable have failed, the receivable is written off
against the allowance.
The
Company expenses outbound freight charges, purchasing and receiving costs,
inspection costs, warehousing costs, and internal transfer costs as cost
of
goods sold.
|
(k)
|
Selling,
General and Administrative
Expense
|
The
Company includes overhead expenses not directly associated with the manufacture
or delivery of goods, administrative salaries, rent, utilities, telephone,
travel, property and casualty insurance and expenses related to order taking
and
product sales in selling, general and administrative expense.
|
(l)
|
Incentive
Compensation Costs
|
Incentive
compensation costs are significant expense categories that are highly dependent
upon management estimates and judgments. In arriving at the amount of expense
to
recognize, management believes it makes reasonable estimates and judgments
using
all significant information available. Incentive compensation costs are accrued
on a monthly basis, and the ultimate determination is made after the Company’s
year-end results are finalized.
The
preparation of consolidated financial statements, in conformity with U.S.
GAAP,
requires the Company’s management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
The
Company has made significant accounting estimates with respect to the valuation
allowances for receivables, inventories, long-lived assets, deferred income
tax
assets and liabilities, environmental liabilities and obligations related
to
employee health care.
|
(n)
|
Stock-based
Compensation
|
The
Company accounted for stock based compensation under the fair value method
as
permitted under Statement of Financial Accounting Standard No. 123,
“Accounting for Stock Based Compensation.” Compensation expense was measured at
fair value at the grant date using the Black-Scholes option pricing model
and is
recognized over the vesting period.
|
(o)
|
Foreign
Currency Translation
|
Asset
and
liability accounts of the Company’s foreign operations are translated into U.S.
dollars using current exchange rates in effect at the balance sheet date
and for
revenue and expense accounts using a weighted average exchange rate during
the
period. Translation adjustments are reflected as a component of other
comprehensive income included in stockholders’ equity.
|
(p)
|
Other
Post-Retirement
Benefits
|
Accounting
for other post-retirement benefits requires the use of actuarial methods
and
assumptions including, among others, assumptions about employees’ future
retirement decisions, mortality of participants, future increases in health
care
costs, discount and interest rates and plan continuation. Changing these
assumptions would have an impact on the Company’s disclosed obligation and
annual expense for other post-retirement benefits. Actuarial gains and losses
are deferred and amortized over future periods.
|
(q)
|
New
Accounting
Pronouncements
|
In
November 2004, Statement of Financial Accounting Standards No. 151,
“Inventory Costs-an amendment of ARB No. 43, Chapter 4” (SFAS
No. 151), was issued. This Statement amends the guidance in Accounting
Research Bulletin No. 43, Chapter 4, “Inventory Pricing,” to clarify
the accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material (spoilage). SFAS No. 151 is effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
The Company does not expect any financial statement implications related
to the
adoption of this Statement.
In
March
2005, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
No. 47, “Accounting for Conditional Asset Retirement Obligations, an
interpretation of FASB Statement No. 143.” This Interpretation clarifies that an
entity is required to recognize a liability for the fair value of a conditional
asset retirement obligation if the fair value of the liability can be reasonably
estimated. Uncertainty about the timing and (or) method of settlement of
a
conditional asset retirement obligation should be factored into the measurement
of the liability when sufficient information exists. This Interpretation
is to
be effective no later than December 31, 2005, with early adoption encouraged.
The Company has evaluated the application of FASB Interpretation No. 47 and
determined it has no effect on the Company’s consolidated financial statements.
In
June
2005, the FASB issued Statement of Financial Accounting Standards No. 154,
“Accounting Changes and Error Corrections”
(SFAS No.
154).
SFAS
No.
154
replaces
APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting
Changes in Interim Financial Statement.” SFAS No.
154
requires
that a voluntary change in accounting principle be applied retrospectively
with
all prior period financial statements presented as if the new accounting
principle had always been used unless it is impractical to do so. SFAS No.
154
also
requires that a change in method of depreciating or amortizing a long-lived
nonfinancial asset be accounted for prospectively as a change in estimate,
and
correction of errors in previously issued financial statements should be
termed
a “restatement”. SFAS No.
154
is
effective for accounting changes and correction of errors made in fiscal
years
beginning after December 15, 2005. The Company does not expect any financial
statement implications related to the adoption of this Statement.
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments - and amendment of FASB Statements No. 133 and 140.” This
Statement resolves issues addressed in Statement 133 Implementation Issue
No.
D1, “Application of Statement 133 to Beneficial Interests in Securitized
Financial Assets,” and is effective for all financial instruments acquired or
issued after the beginning of an entity’s first fiscal year that begins after
September 15, 2006. The Company does not expect any financial statement
implications related to the adoption of this Statement.
In
December 2004, the FASB issued Statement No. 123 (R) (revised 2004) “Share-Based
Payment”, which is a revision of SFAS No. 123, “Accounting for Stock-Based
Compensation”. Statement 123 (R) supersedes APB No. 25, and amends SFAS
No. 95, Statement of Cash Flows. Generally, the approach to accounting in
Statement 123 (R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the financial statements
based on their fair values. Statement 123 (R) is effective for the Company
beginning January 1, 2006. The Statement offers several alternatives for
implementation. The Company does not expect any financial statement
implications related to the adoption of this Statement due to the subsequent
termination of the plan due to the acquisition of PAV Republic by SimRep
(note
20).
The
components of inventories as of July 22, 2005 are as follows:
Raw
materials
|
|
$
|
87,431
|
|
Semi-finished
|
|
|
75,518
|
|
Finished
goods
|
|
|
109,924
|
|
|
|
|
272,873
|
|
Reduction
to LIFO value
|
|
|
(59,140
|
)
|
Total
inventories at LIFO
|
|
$
|
213,733
|
|
On
July
22, 2005, inventories are valued at the lower of cost or market applied on
a
last-in, first-out (LIFO) method of accounting for inventory. This inventory
method is used to value approximately 98% of the Company’s
inventory.
(5)
|
Deferred
Financing Costs
|
As
of
July 22, 2005, the Company’s deferred financing fees relating to the revolving
credit facility with General Electric Capital Corporation were $1.0 million,
net
of accumulated amortization of $0.2 million.
The
Company uses the effective interest method to amortize the costs associated
with
its debt agreements over their term. The current revolving credit facility
loan
agreement will expire in May 2009.
The
components of deferred financing costs are as follows:
Net
deferred financing costs as of December 31, 2004
|
|
$
|
7,975
|
|
Amortization
|
|
|
(807
|
)
|
Fees
related to IPO incurred in 2005
|
|
|
1,066
|
|
Write-off
of IPO fees
|
|
|
(2,027
|
)
|
Net
deferred financing costs as of July 22, 2005
|
|
$
|
6,207
|
|
During
the period January 1, 2005 through July 22, 2005, the Company incurred initial
public offering (IPO) fees of $1.1 million. In June 2005, the IPO was abandoned
and $2.0 million of associated fees were charged to expense.
(6)
|
Revolving
credit facility, long-term debt and capital lease
obligations
|
Revolving
credit facility
On
May
20, 2004, PAV, through its wholly-owned subsidiary Republic Inc, entered
into a
$200.0 million Senior Secured Credit with General Electric Capital Corporation
(GE capital). This facility matures on May 20, 2009. The termination date
of the
facility can be extended until May 20, 2010 at the option of the Company
upon
providing timely written notice. On November 10, 2004, Republic Inc and GE
Capital amended the revolving credit facility to expand the borrowing capacity
from $200.0 million to $250.0 million.
At
July
22, 2005, Republic Inc had $70.2 million in outstanding borrowings and had
issued $3.34 million in letters of credit under the GE credit facility. The
amount available under the facility was approximately $176.5 million at July
22,
2005. The Company is required to maintain a borrowing availability of at
least
$25.7 million. The amount available under the GE credit facility was
approximately $150.8 million in excess of the $25.7 million minimum
availability requirement at July 22, 2005. Republic Inc is required to pay
an
unused facility fee of 0.50% per annum. The advances under the GE credit
facility are limited by the borrowing base, as defined in the GE credit facility
as the sum of 85% of eligible accounts receivable plus 65% of eligible
inventory.
Borrowings
under the GE credit facility are secured by a first priority perfected security
interest in all of Republic Inc’s presently owned and subsequently acquired
inventory and accounts receivable. The obligations under the GE credit facility
are secured and are unconditionally and irrevocably guaranteed jointly and
severally by Republic Inc’s subsidiaries.
Borrowings
under the GE credit facility bear interest, at Republic Inc’s option, at an
index rate equal to the higher of the “prime rate” announced from time to time
by The Wall Street Journal, plus the applicable margin, or the federal funds
rate plus 50 basis points per annum, plus the applicable margin; or LIBOR
plus
the applicable margin. The applicable margin on index rate loans initially
was
1.0% and on LIBOR loans was 2.75%. On April 1, 2005, the margins were
adjusted based on the average availability quarterly on a prospective basis.
The
base rate margins are adjusted to a rate between 0.00% and 1.00%, and the
LIBOR
margins are adjusted to a rate between 1.75% and 2.75%. As of July 22, 2005,
$65.0 million of the Company’s revolving credit facility balance was accruing
interest at a rate of 7.25% per year as an index rate loan and $5.2 million
was
accruing interest at a rate of 5.43% per year as a LIBOR loan.
The
GE
credit facility contains customary representations and warranties and covenants
including restrictions on the amount of capital expenditures, maintenance
of a
minimum fixed charge coverage ratio. Capital expenditures for any fiscal
year
are limited under the GE credit facility to $40.0 million, excluding capital
expenditures financed by proceeds of any insurance recoveries received. The
Company was in compliance with all its covenants under the GE credit facility
as
of July 22, 2005.
Long-term
debt
A
summary
of long-term debt outstanding as of July 22, 2005 is as follows:
Senior
Secured Promissory Note due 2009
|
|
$
|
61,800
|
|
Ohio
Department of Development Loan
|
|
|
5,000
|
|
|
|
|
66,800
|
|
Less
current portion of long-term debt - Ohio Department of Development
Loan
|
|
|
1,617
|
|
Debt
classified as long-term
|
|
$
|
65,183
|
|
11%
Senior Secured Promissory Note due 2009
On
May
20, 2004, Republic Inc issued a $61.8 million senior secured promissory note
under a senior secured note purchase agreement among Republic Engineered
Products, Inc., as borrower, and Perry Principals Investments, LLC, as note
holder. In the absence of an Event of Default, interest on the notes would
accrue at the rate of 11% per annum and is payable on the last day of each
calendar month until the loan matures on August 20, 2009. The notes require
a 3%
prepayment penalty and are secured by personal property and other assets
of
Republic Inc as set forth by the security agreement to the senior secured
promissory note.
10%
Senior Secured Notes
On
December 19, 2003, Republic Inc issued a $21.0 million of 10% senior secured
bank notes (Bank Notes). Republic Inc’s Bank Notes require quarterly interest
payments on March 31, June 30, September 30 and December 31 of each year.
The
note purchase agreement in respect to the Bank Notes requires Republic Inc
to
redeem the notes with certain proceeds from asset sales of any collateral
that
secures the notes. The note purchase agreement also contains significant
affirmative and negative covenants including separate provisions imposing
restrictions on additional borrowings, certain investments, certain payments,
sale or disposal of assets, payment of dividends and change of control
provisions, in each case, subject to certain exceptions. The Bank Notes are
secured, subject to exceptions and limitations, by (1) a first priority lien
on,
and security interest in real estate and fixtures related to the Canton
C-RTM
facility
and (2) fifty percent of any proceeds greater than $5.0 million but less
than
$25.0 million received by PAV after December 5, 2003 for business interruption
coverage relating to the loss events experienced by PAV at the Lorain Ohio
facility in 2003; provided that such security interests in business interruption
insurance proceeds shall in no event exceed $10.0 million in the aggregate.
As
of October, 2004 Republic Inc had fulfilled this repayment requirement. The
note
purchase agreement in respect of the Bank Notes contained significant
affirmative and negative covenants. This note was repaid early by PAV in
July
2005.
Ohio
Department of Development Loan
Republic
Inc has a loan outstanding from the Ohio Department of Development which
was
utilized to modernize the Lorain, Ohio facility. The project was completed
in
2003. The initial amount of the loan was $5.0 million and it accrues interest
at
the rate of 3% per annum payable on the first day of each calendar month
until
the loan matures in July 2008. Principal payments are required in the amount
of
$1.6 million, $1.7 million and $1.0 million during the years
2006, 2007 and 2008, respectively. The loan is collateralized by the 20"
mill
modernization project at Lorain.
Capital
lease obligations
On
July
22, 2005, the amount included in property, plant and equipment for various
equipment and computer capital leases was $0.4 million. The Company’s capital
leases at July 22, 2005 require future minimum payments of $0.1 million in
the
period from July 22, 2005 to December 31, 2005 and $0.3 million in 2006.
The
current and noncurrent portions of the capital lease obligations are included
in
other accrued liabilities and other long-term liabilities, respectively,
in the
accompanying consolidated balance sheet.
(7)
|
Stock-based
Compensation
|
The
Company’s Board of Directors adopted the 2004 Equity Incentive Plan on October
1, 2004. The 2004 Equity Incentive Plan provides for the grant of incentive
stock options, nonqualified stock options, stock appreciation rights or “SARs,”
restricted stock, and performance awards based on PAV Republic’s performance,
the performance of one of the PAV Republic’s subsidiaries or the performance of
the participant. PAV Republic’s directors, officers and employees, and other
individuals performing services for PAV Republic’s subsidiaries, may be selected
by the compensation committee to receive benefits under the plan. A total
of
5,556 shares of our common stock may be issued pursuant to the 2004 Equity
Incentive Plan. On October 1, 2004, options to purchase 4,167 shares were
issued
to key employees and on October 5, 2004, 60 shares of restricted stock were
issued to three outside directors. The restrictions on the stock issued to
the
outside directors lapsed upon the achievement of continued service on May
3,
2005. On March 14, 2005, options to purchase 208 shares were issued to key
employees.
The
following table represents the 2004 Equity Incentive Plan as of July 22,
2005:
|
|
Securities
|
|
Options
granted
|
|
|
4,375
|
|
Restricted
stock
|
|
|
60
|
|
Securities
available for future issuance
|
|
|
1,121
|
|
Total
authorized
|
|
|
5,556
|
|
The
stock
options granted in October 2004 and March 2005 generally become exercisable
over
a three-year graded vesting period, provided that the participant remains
a
director or employee at such time. The stock options expire 10 years from
the
date of grant. The Company measures the total cost of each stock option grant
at
the date of grant using the Black Scholes option pricing model. The Company
recognizes the cost of each stock option using the straight-line method over
the
stock option vesting period. The stock option based compensation expense,
included in selling, general and administrative expense was $5.6 million
for the
period January 1, 2005 to July 22, 2005. The following table summarizes the
stock option activity for the period from January 1, 2005 to July 22, 2005
(in
actual amounts):
|
|
Shares
subject to option
|
|
Exercise
price
|
|
Balance
at December 31, 2004
|
|
|
4,167
|
|
$
|
1,000
|
|
Options
granted
|
|
|
208
|
|
|
1,000
|
|
Options
exercised
|
|
|
-
|
|
|
-
|
|
Options
terminated
|
|
|
-
|
|
|
-
|
|
Balance
at July 22, 2005
|
|
|
4,375
|
|
$
|
1,000
|
|
The
following table summarizes information about the fair value of each option
grant
on the date of grant using the Black-Scholes option-pricing
model
and the weighted average assumptions used for such grants:
Average
fair value of option granted
|
|
$
|
3,744
|
|
Expected
dividend yield
|
|
|
-
|
|
Expected
volatility
|
|
|
40.1
|
%
|
Risk-free
interest rates
|
|
|
2.6
|
%
|
Expected
lives
|
|
|
3
|
|
The
following table summarizes information about stock options outstanding at
July
22, 2005:
Total
unvested shares
|
|
|
2,431
|
|
Total
vested shares
|
|
|
1,944
|
|
Average
life
|
|
|
10
|
|
Outstanding
average exercise price
|
|
$
|
1,000
|
|
Exercisable
average exercise price
|
|
$
|
1,000
|
|
The
vast
majority of the Company’s production workers are covered by a collective
bargaining agreement with the United Steelworkers of America (USWA). The
collective bargaining agreement expires on August 15, 2007 (labor
agreement).
The
labor
agreement provides for a defined contribution program for retirement healthcare
and pension benefits. The Company is required to make a contribution for
every
hour worked. The contribution amount was $3.50 for every hour worked through
August 16, 2005 and $3.80 for every hour worked thereafter until the expiration
of the labor agreement. For the period from January 1, 2005 to July 22, 2005,
the Company recorded expense of $8.1 million.
The
labor
agreement includes a profit sharing plan to which the Company is required
to
contribute 15% of its quarterly pre-tax income, as defined in the labor
agreement, in excess of $12.5 million. For the period from January 1, 2005
to July 22, 2005, the Company recorded expense of $7.4 million.
The
Company has a defined contribution retirement plan that covers substantially
all
salary and nonunion hourly employees. This plan is designed to provide
retirement benefits through company contributions and voluntary deferrals
of
employees’ compensation. The Company funds contributions to this plan each pay
period based upon the participants age and service as of January first of
each
year. The amount of the Company’s contribution is equal to the monthly base
salary multiplied by the appropriate percentage based on age and years of
service. The contribution becomes 100% vested upon completion of five years
of
service. In addition, employees are permitted to make contributions into
a
401(k) retirement plan through payroll deferrals. The Company provides a
25%
matching contribution for the first 5% of payroll that an employee elects
to
contribute. Employees are 100% vested in both their and the Company’s matching
401(k) contributions. For the period from January 1, 2005 to July 22, 2005,
the
Company recorded expense of $1.4 million.
In
2004,
Republic Inc adopted a profit sharing plan for salary and non-union hourly
employees excluding a select group of managers and executives. The Company
is
required to contribute 3% of its quarterly pre-tax income, as defined in
the
plan, in excess of $12.5 million. For the period from January 1, 2005
to July 22, 2005, the Company recorded expense of $1.5 million.
In
2004,
Republic Inc also approved a management incentive plan for a select group
of
managers and executives. Incentives are based upon achievement of specific
corporate and individual objectives which include financial results, product
yield improvement, energy utilization, quality, safety, and cash flow. For
the
period from January 1, 2005 to July 22, 2005, the Company recorded expense
of
$0.9 million. In addition, the Company’s Board of Directors approved incentive
compensation for Joseph F. Lapinsky, Chief Executive Officer, of $0.5 million
for the period January 1, 2005 to July 22, 2005. The incentives, totaling
$1.4
million, were paid during February 2006.
The
Company has a deferred compensation plan covering certain key employees.
The
plan allows for the employee to make annual deferrals of base salary and
provides for a fixed annual contribution by the Company based on a percentage
of
salary. For the period from January 1, 2005 to July 22, 2005, the Company
recorded expense of $0.2 million.
The
Company is primarily engaged in one line of business that produces and sells
engineered steel bars. The Company’s products include hot-rolled bars,
cold-finished bars, semi-finished seamless tube rounds and other semi-finished
trade products. The Company’s product lines are marketed to a common customer
base. The Company’s customers include automotive and industrial equipment
manufacturers, first tier suppliers to automotive, forgers and tubular and
pipe
product manufacturers.
For
the
period January 1, 2005 to July, 22, 2005, the five largest customers accounted
for 37.7% of the Company’s total sales. During this period one customer, on an
individual basis, accounted for 15.1% of total sales.
The
components of the income tax provision are presented below for the period
January 1, 2005 to July 22, 2005:
Current:
|
|
|
|
Federal
|
|
$
|
20,027
|
|
State
and local
|
|
|
1,998
|
|
Foreign
|
|
|
282
|
|
Total
current
|
|
|
22,307
|
|
Deferred:
|
|
|
|
|
Federal
|
|
|
(1,619
|
)
|
State
and local
|
|
|
(162
|
)
|
Total
deferred
|
|
|
(1,781
|
)
|
Total
|
|
$
|
20,526
|
|
The
following is a reconciliation of the Company’s effective income tax rate to the
Federal statutory rate for the period January 1, 2005 to July 22,
2005:
Statutory
rate
|
|
|
35.0
|
%
|
Provision
for state and local taxes, net of federal effect
|
|
|
3.5
|
%
|
Federal
manufacturing deduction and other
|
|
|
(1.0
|
)%
|
Effective
income tax rate
|
|
|
37.5
|
%
|
Deferred
tax assets and liabilities as of July 22, 2005 are presented below:
Deferred
tax assets:
|
|
|
|
Capitalized
inventory assets
|
|
$
|
7,761
|
|
Allowance
for doubtful accounts
|
|
|
4,943
|
|
Compensation
and benefits
|
|
|
4,401
|
|
Accrued
expenses
|
|
|
2,793
|
|
Total
deferred tax assets
|
|
|
19,898
|
|
Deferred
tax liabilities:
|
|
|
|
|
Inventory
|
|
|
(8,998
|
)
|
Property
and equipment
|
|
|
(2,780
|
)
|
Prepaid
expenses and other
|
|
|
(2,498
|
)
|
Total
deferred tax liabilities
|
|
|
(14,276
|
)
|
Net
deferred tax assets
|
|
$
|
5,622
|
|
Deferred
taxes are provided on the difference between the tax basis of assets and
liabilities and their reported amounts in the Company’s consolidated financial
statements.
During
the period from January 1, 2005 to July 22, 2005 certain deferred tax assets
and
liabilities reversed. The net result is a deferred tax asset at July 22,
2005 of
$5.6 million.
(11)
|
Related
party transactions
|
Perry
Principals, L.L.C., an affiliate of Perry Capital, was the holder of $1.3
million of the Company’s outstanding 10% senior secured notes that were repaid
in July 2005.
Contrarian
Funds LLC, a stockholder of PAV, was the holder of $1.9 million of the
outstanding 10% senior secured notes that were repaid in July 2005.
(12)
|
Commitments
and contingencies
|
The
Company, in the ordinary course of business, is the subject of, or party
to,
various pending or threatened legal and environmental actions. The Company
provides for the costs related to these matters when a loss is probable and
the
amount is reasonably estimable. Based on information presently known to the
Company, management believes that any ultimate liability resulting from these
actions will not have a material adverse affect on its consolidated financial
position, results of operations or cash flows.
United
States Steel Corporation (U.S. Steel) is the Company’s primary supplier of iron
ore and coke. On March 8, 2006, the Company and U.S. Steel entered into an
agreement which extends the supply agreements to provide iron ore and a portion
of the Company’s coke requirements through September 30, 2006. The Company also
purchases coke in the domestic and foreign markets and is working to develop
additional sources for both coke and iron ore.
On
October 11, 2004, the installation of a new five-strand combination
billet/bloom caster and associated equipment at the Company’s Canton, Ohio
facility was approved. Republic Inc began the preparation for installation
of
the new equipment in December 2004. Republic Inc anticipates the project
to cost
approximately $58 million, exclusive of capitalized interest costs. At July
22, 2005, the Company has outstanding purchase contracts in the amount of
$13.8
million. The caster was put into production during June 2006. The caster
was
installed to allow flexibility in melt capability to take advantage of volatile
raw material prices and to capture potential semi-finished business. On June
30,
2006, it was decided to temporarily idle the caster based on sufficient
alternative melt capacity.
The
Company leases certain equipment, office space and computer equipments under
noncancelable operating leases. These leases expired at various dates through
2012. During the period January 1, 2005 to July 22, 2005, rental expense
relating to operating leases amounted to $4.6 million. At July 22, 2005,
total
minimum lease payments under non-cancelable operating leases were $1.9 million
for the period from July 22 to December 31, 2005, $3.7 million in 2006, $1.2
million in 2007, $1.0 million in 2008, $0.8 million in 2009, $0.7 million
in
2010 and $0.4 million thereafter.
In
2003,
REPH, LLC’s (the predecessor to PAV) operations were negatively impacted by the
loss of one of two blast furnaces located in Lorain, Ohio. As a result, REPH,
LLC filed business interruption and property damage insurance claims. See
Note
17.
(13)
|
Environmental
matters
|
As
is the
case with most steel producers, the Company could incur significant costs
related to environmental issues in the future, including those arising from
environmental compliance activities and remediation stemming from historical
waste management practices at the Company’s facilities. The reserve to cover
probable environmental liabilities as well as anticipated compliance activities
totaling $4.6 million was recorded as of July 22, 2005. The current and
noncurrent portions of the environmental reserve are included in other accrued
liabilities and accrued environmental liabilities, respectively in the
accompanying consolidated balance sheet. The Company is not otherwise aware
at
this time of any material environmental remediation liabilities or contingent
liabilities relating to environmental matters with respect to the Company’s
facilities for which the establishment of an additional reserve would be
appropriate at this time. To the extent the Company incurs any such additional
future costs, these costs will most likely be incurred over a number of years.
However, future regulatory action regarding historical waste management
practices at the Company’s facilities and future changes in applicable laws and
regulations may require the Company to incur significant costs that may have
a
material adverse effect on the Company’s future financial
performance.
(14)
|
Obligation
to administer USWA
benefits
|
The
Company has an agreement with the USWA to administer health insurance benefits
to the Company’s USWA employees while on layoff status and to administer payment
of monthly contributions to the Steelworker’s Pension Trust on behalf of local
union officials while on union business. In February 2004, to fund this program,
the USWA provided an initial cash contribution of $2.5 million to be used
to
provide health insurance benefits and $0.5 million to provide steelworkers
pension benefits. As of July 22, 2005, the balance of this cash account totaled
$2.8 million. The Company has agreed to continue to administer these programs
until the fund is exhausted. The Company will provide the USWA with periodic
reports regarding the financial status of the fund. At July 22, 2005, the
cash
account balance is included in other assets and the related liability is
included in other long-term liabilities in the accompanying consolidated
balance
sheet. The Company has no liability beyond the administration of the funds
in
the cash account.
(15)
|
Financial
instruments and concentration of credit
risk
|
The
following methods and assumptions were used to estimate the fair value of
each
class of financial instruments for which it is practicable to estimate that
value:
The
carrying amount approximates fair value because of the short maturity of
these
investments.
|
(b)
|
Revolving
credit facilities
|
Since
these borrowings are based on short-term interest rates available to the
Company, the estimated fair values of these financials instruments approximate
their recorded carrying amounts.
The
fair
values of the Company’s long-term debt obligations are estimated based upon
quoted market prices for the same or similar issues or on the current rates
offered for debt of the same remaining maturities.
|
(d)
|
Concentration
of credit risk
|
The
Company is engaged primarily in the manufacture and sale of special bar quality
steel principally in the United States of America. Trade accounts are stated
at
the amounts management expects to collect from outstanding
balances.
(16)
|
Derivative
instruments and hedging
activities
|
The
Company uses natural gas cash-flow exchange contracts or swaps to manage
fluctuations in the cost of natural gas. Contracts generally do not extend
beyond one year. The Company recognizes the fair value of these instruments
either as liabilities or assets and records the changes in fair value within
other comprehensive loss as a component of stockholders’ equity. When the
transaction is settled, the realized gain or loss is recognized in the results
of operations as a cost of goods sold. During the period ended July 22, 2005,
all contracts were treated as undesignated hedges and therefore the fair
value
adjustment of $0.8 million was recorded as a reduction of cost of goods sold
in
the period.
(17)
|
Comprehensive
income
|
Other
comprehensive income consists of foreign currency translation adjustments
and
cash flow hedge valuation. At July 22, 2005, the other comprehensive income
relating to foreign currency translation adjustments was insignificant. Total
comprehensive income for the Company was $36.3 million for the period January
1
to July 22, 2005.
(18)
|
Other
post-retirement benefits
|
The
Company has a defined retiree health care plan covering approximately 14
union
hourly employees. These post-retirement benefits are provided under the terms
of
the collective bargaining agreement with the Bricklayers & Allied Craftsman
International Union and are based upon years of service and age. Health care
benefits that are provided include comprehensive hospital, surgical, major
medical and drug benefit provisions. Participation in the plan requires the
retiree to contribute 50% of the cost of the benefits provided.
Currently,
there are no plan assets and the Company funds the benefits as claims are
paid.
As of July 22, 2005, the Company accrued $0.6 million which is included as
a
component of other long-term liabilities. The following provides the components
of net periodic benefit cost for the periods indicated.
|
|
Year
Ended December 31, 2004
|
|
Change
in Accumulated Benefit Obligation:
|
|
|
|
Accumulated
postretirement benefit obligation at beginning of period
|
|
$
|
539
|
|
Service
cost
|
|
|
14
|
|
Interest
cost
|
|
|
33
|
|
Actuarial
loss
|
|
|
26
|
|
Benefits
paid
|
|
|
(21
|
)
|
Accumulated
postretirement benefit obligation at end of period
|
|
|
591
|
|
Change
in Plan Assets:
|
|
|
|
|
Fair
value of plan assets at beginning of period
|
|
|
-
|
|
Employer
contributions
|
|
|
21
|
|
Benefits
paid
|
|
|
(21
|
)
|
Fair
value of plan assets at end of period
|
|
|
-
|
|
Funded
Status - (underfunded)
|
|
|
(591
|
)
|
Unrecognized
net actuarial loss
|
|
|
26
|
|
Net
amount recognized
|
|
$
|
(565
|
)
|
|
|
|
|
|
Components
of Net Periodic Postretirement
|
|
|
|
|
Benefit
cost:
|
|
|
|
|
Service
cost
|
|
$
|
14
|
|
Interest
cost
|
|
|
33
|
|
Net
periodic postretirement benefit cost
|
|
$
|
47
|
|
|
|
|
|
|
Assumptions:
|
|
|
|
|
Weighted-average
assumptions used to determine accumulated postretirement benefit
obligations at period end:
|
|
|
|
|
Discount
rate
|
|
|
6.00
|
%
|
Rate
of compensation increase
|
|
|
N/A
|
|
Expected
return on plan assets
|
|
|
N/A
|
|
Weighted-average
assumptions used to determine accumulated postretirement benefit
costs
during the period:
|
|
|
|
|
Discount
rate
|
|
|
6.25
|
%
|
Rate
of compensation increase
|
|
|
N/A
|
|
Expected
return on plan assets
|
|
|
N/A
|
|
Assumed
health care cost trend rates at end of period:
|
|
|
|
|
Assumed
health care cost trend rate for the year
|
|
|
10.00
|
%
|
Rate
that cost trend gradually declines to
|
|
|
5.00
|
%
|
Year
that the rate reaches the rate it is assumed to remain at
|
|
|
2009
|
|
|
|
|
|
|
Sensitivity
analysis:
|
|
|
|
|
Effect
on total of service and interest cost components
|
|
$
|
11
|
|
Effect
on postretirement benefit obligation
|
|
|
131
|
|
|
|
Year
Ended December 31, 2004
|
|
|
|
|
|
Estimated
future benefit payments:
|
|
|
|
2006
|
|
$
|
22
|
|
2007
|
|
|
22
|
|
2008
|
|
|
19
|
|
2009
|
|
|
20
|
|
2010
|
|
|
18
|
|
2011
and beyond
|
|
|
490
|
|
|
|
$
|
591
|
|
In
2003,
REPH LLC’s operations were negatively impacted by the loss of one of two blast
furnaces located in Lorain, Ohio. As a result, REPH LLC filed business
interruption and property damage insurance claims. PAV acquired the right
to
reimbursement from insurance claims for damage incurred to the #3 blast furnace
under the terms of the asset purchase agreement in connection with acquisition
of REPH LLC by PAV effective December 19, 2003.
During
the period January 1, 2005 to July 22, 2005, the Company recorded an
extraordinary gain of $2.1 million, net of tax of $1.2 million and associated
fees of $1.1 million. Gross insurance proceeds recorded totaled $4.4
million.
Effective
July 22, 2005, SimRep Corporation (SimRep) acquired 100% of the outstanding
stock of PAV for a cash purchase price of $229.0 million (the PAV acquisition).
Industrias CH, S.A. de C.V (Industrias CH), Controladora Simec, S.A. de C.V.
(Controladora) and Pacific Steel, Inc. (Pacific) own 49.8%, 47.6% and 2.6%,
respectively, of the stock of SimRep. The stock purchase agreement provides
that, in the event the Company receives future reimbursement from the insurance
claim relating to damage incurred to a blast furnace located at the Lorain,
Ohio
facility in 2003, a portion will be paid to PAV’s shareholders.
On
April
24, 2006, a Settlement Agreement and Release was reached for approximately
$58.0
million. Approximately $38.4 million, net of the $19.8 million payment to
PAV’s
former shareholders, were received by SimRep as a result of the Settlement
Agreement and Release.
The
GE
credit facility (see note 6) was amended, effective during July 2005, to
obtain
the lenders consent for the acquisition of PAV by SimRep and for certain
other
related changes. Effective November 1, 2005, the GE credit facility was amended
to reduce the borrowing capacity from $250.0 million to $150.0 million to
eliminate unnecessary liquidity and to provide for certain other changes.
Also
as part of the November 1, 2005 amendment and through the end of 2005, the
base
rate margins were fixed at 0.00% for Index Margins and 1.00% on LIBOR margins.
Commencing on January 1, 2006, the applicable margins were adjusted from
0.00%
to 0.25% for index rate loans and from 0.875% to 1.25% for LIBOR loans based
on
the average daily availability in the prior quarter. The new agreement also
varied the margins on the unused facility fee from 0.50% to 0.375%. Based
on the
fourth quarter 2005 average daily availability, the initial margins for 2006
are
0.00% for the index margin, 0.875% for the LIBOR margin, 0.500% for the unused
facility fee margin, and 0.875% for the applicable letter of credit margin.
The
capital expenditures limit was increased to $100.0 million with the amendment
dated November 1, 2005.
PAV
Republic, Inc. and Subsidiaries
Consolidated
Balance Sheet
As
of
June 30, 2004
(unaudited)
(in
thousands of dollars)
Assets
|
|
|
|
Current
assets:
|
|
|
|
Accounts
receivable, less allowance of $11,662
|
|
$
|
132,621
|
|
Inventories
(note 4)
|
|
|
146,998
|
|
Deferred
income taxes (note 9)
|
|
|
2,327
|
|
Prepaid
expenses and other current assets
|
|
|
15,917
|
|
Total
current assets
|
|
|
297,863
|
|
Property,
plant and equipment:
|
|
|
|
|
Land
and improvements
|
|
|
300
|
|
Buildings
and improvements
|
|
|
2,003
|
|
Machinery
and equipment
|
|
|
9,134
|
|
Construction-in-progress
|
|
|
2,003
|
|
Total
property, plant and equipment
|
|
|
13,440
|
|
Accumulated
depreciation and amortization
|
|
|
(520
|
)
|
Net
property, plant and equipment
|
|
|
12,920
|
|
Deferred
financing costs, net of accumulated amortization (note 5)
|
|
|
7,430
|
|
Deferred
income taxes (note 9)
|
|
|
1,574
|
|
Other
assets (note 13)
|
|
|
5,541
|
|
Total
assets
|
|
$
|
325,328
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
Accounts
payable
|
|
$
|
29,945
|
|
Accrued
compensation and benefits
|
|
|
25,773
|
|
Accrued
interest
|
|
|
496
|
|
Other
accrued liabilities
|
|
|
7,854
|
|
Total
current liabilities
|
|
|
64,068
|
|
Long-term
debt (note 6)
|
|
|
92,363
|
|
Revolving
credit facility (note 6)
|
|
|
107,487
|
|
Accrued
environmental liabilities (note 12)
|
|
|
5,121
|
|
Other
long-term liabilities (notes 6 and 13)
|
|
|
3,621
|
|
Total
liabilities
|
|
|
272,660
|
|
Stockholders’
equity:
|
|
|
|
|
Common
stock, $0.01 par value, authorized 60,000 shares, issued and outstanding
50,000 shares
|
|
|
-
|
|
Additional
paid in capital
|
|
|
50,000
|
|
Retained
earnings
|
|
|
2,668
|
|
Total
stockholders’ equity
|
|
|
52,668
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
325,328
|
|
See
accompanying notes to consolidated financial statements.
Consolidated
Statement of Operations
For
the
Six Months Ended June 30, 2004
(unaudited)
(in
thousands of dollars)
Net
sales
|
|
$
|
541,111
|
|
Cost
of goods sold
|
|
|
502,246
|
|
Gross
profit
|
|
|
38,865
|
|
Selling,
general and administrative expenses
|
|
|
22,589
|
|
Depreciation
and amortization expense
|
|
|
286
|
|
Other
operating income, net
|
|
|
(178
|
)
|
Operating
income
|
|
|
16,168
|
|
Interest
expense
|
|
|
10,558
|
|
Interest
income
|
|
|
(6
|
)
|
Income
before income taxes
|
|
|
5,616
|
|
Provision
for income taxes (note 9)
|
|
|
2,190
|
|
Net
income
|
|
$
|
3,426
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Consolidated
Statement of Stockholders’ Equity
For
the
Six Months Ended June 30, 2004
(unaudited)
(in
thousands of dollars)
|
|
Common
Shares
|
|
Additional
Paid-in
|
|
Accumulated
Retained
(Deficit)
|
|
|
|
|
|
Number
|
|
Par
Value
|
|
Capital
|
|
Earnings
|
|
Total
|
|
Balance,
December 31, 2003
|
|
|
30,000
|
|
$
|
-
|
|
$
|
30,000
|
|
$
|
(758
|
)
|
$
|
29,242
|
|
Issuance
of common shares:
|
|
|
20,000
|
|
|
-
|
|
|
20,000
|
|
|
|
|
|
20,000
|
|
Net
income
|
|
|
|
|
|
|
|
|
-
|
|
|
3,426
|
|
|
3,426
|
|
Balance,
June 30, 2004
|
|
|
50,000
|
|
$
|
-
|
|
$
|
50,000
|
|
$
|
2,668
|
|
$
|
52,668
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Consolidated
Statement of Cash Flows
For
the
Six Months Ended June 30, 2004
(unaudited)
(in
thousands of dollars)
Cash
flows from operating activities:
|
|
|
|
Net
income
|
|
$
|
3,426
|
|
Adjustments
to reconcile net income to net cash used in operating
activities:
|
|
|
|
|
Depreciation
and amortization
|
|
|
286
|
|
Amortization
of deferred financing costs
|
|
|
526
|
|
Write-off
deferred financing costs
|
|
|
1,123
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
Increase
in accounts receivable
|
|
|
(68,036
|
)
|
Increase
in inventories
|
|
|
(14,058
|
)
|
Decrease
in prepaid expenses and other assets
|
|
|
26,881
|
|
Increase
in accounts payable
|
|
|
22,326
|
|
Increase
in accrued compensation and benefits
|
|
|
6,179
|
|
Decrease
in income taxes - accrued and deferred
|
|
|
(5,985
|
)
|
Decrease
in other current liabilities
|
|
|
(4,350
|
)
|
Increase
in long-term liabilities
|
|
|
194
|
|
Net
cash used in operating activities
|
|
|
(31,488
|
)
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
Capital
expenditures
|
|
|
(8,574
|
)
|
Net
cash used in investing activities
|
|
|
(8,574
|
)
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
Proceeds
from revolving credit facilities
|
|
|
297,276
|
|
Repayment
of revolving credit facilities
|
|
|
(281,693
|
)
|
Proceeds
from long-term debt
|
|
|
70,165
|
|
Repayments
of long-term debt
|
|
|
(63,750
|
)
|
Equity
contribution
|
|
|
20,000
|
|
Deferred
financing costs
|
|
|
(7,608
|
)
|
Net
cash provided by financing activities
|
|
|
34,390
|
|
|
|
|
|
|
Net
decrease in cash and cash equivalents
|
|
|
(5,672
|
)
|
|
|
|
|
|
Cash
and cash equivalents - beginning of period
|
|
|
5,672
|
|
|
|
|
|
|
Cash
and cash equivalents - end of period
|
|
$
|
-
|
|
|
|
|
|
|
Supplemental
cash flow information:
|
|
|
|
|
Cash
paid for interest
|
|
$
|
9,071
|
|
Cash
paid for income taxes
|
|
$
|
7,000
|
|
See
accompanying notes to consolidated financial statements.
PAV
Republic, Inc. and Subsidiaries
Notes
to
Consolidated Financial Statements
(in
thousands of dollars)
(1)
|
Nature
of Operations, Organization and Other Related
Information
|
PAV
Republic, Inc. (the Company or PAV) commenced operation on December 19, 2003
after acquiring substantially all of the operating assets of REPH LLC (formerly
known as Republic Engineered Products Holdings LLC) in a sale of assets under
Section 363 of the United States Bankruptcy Code. PAV also acquired assets
located on the premises of REPH LLC’s machine shop located in Massillon, Ohio
and assets located on the premises of REPH LLC’s corporate headquarters located
in Akron, Ohio.
PAV
is a
Delaware corporation, which owns 100% of the outstanding stock of Republic
Engineered Products, Inc. (Republic, Inc.). PAV has no substantial operations
or
assets, other than its investment in Republic Inc. Republic Inc, a Delaware
corporation, produces special bar quality steel products. Special bar quality
steel products are high quality hot-rolled and cold-finished carbon and alloy
steel bars and rods used primarily in critical applications in automotive
and
industrial equipment. Special bar quality steel products are sold to customers
who require precise metallurgical content and quality characteristics. The
Company’s products include hot-rolled bars, cold-finished bars, semi-finished
seamless tube rounds and other semi-finished trade products. The Company’s
customers include automotive and industrial equipment manufacturers, first
tier
suppliers to automotive, forgers, and tubular and pipe product
manufacturers.
Republic
Machine, LLC, Republic N&T Railroad, Inc. and Republic Canadian Drawn, Inc.
are wholly owned subsidiaries of Republic Inc. Republic Machine, LLC is a
Delaware limited liability company which operates the machine shop located
in
Massillon, Ohio. Republic N&T Railroad, Inc. is a Delaware corporation and
operates the railroad assets located at the Company’s Canton and Lorain, Ohio
facilities. Republic Canadian Drawn, Inc. is an Ontario, Canada corporation
which operates the cold-finishing plant located in Ontario, Canada.
(2)
|
Basis
of Presentation and Principles of
Consolidation
|
The
accompanying consolidated financial statements include the accounts of PAV
Republic, Inc. and Subsidiaries as of and for the six months ended June 30,
2004. All significant intercompany balances and transactions have been
eliminated in consolidation.
These
financial statements have been prepared in accordance with U.S. generally
accepted accounting principles for interim financial information. Accordingly,
they do not include all of the information and footnotes required by U.S.
generally accepted accounting principles for complete financial statements.
In
the opinion of management, all adjustments (consisting of normal recurring
adjustments and accruals) considered necessary for a fair presentation of
the
financial position of the Company as of June 30, 2004, and the results of
its
operations, cash flows and changes in stockholders’ equity for the six months
ended June 30, 2004 have been included.
(3)
|
Summary
of Significant Accounting
Policies
|
|
(a)
|
Cash
and Cash Equivalents
|
For
purposes of the consolidated statement of cash flows, the Company considers
all
short-term investments with maturities at the date of purchase of three months
or less to be cash equivalents.
The
Company valued inventories at the lower of cost or market applied on a last-in,
first-out (LIFO) method of inventory costing.
An
actual
valuation of inventory under the LIFO method can be made only at the end
of each
year based on the inventory levels and costs at that time. The Company’s interim
accounting for LIFO is based on an estimated year-to-date calculation.
Accordingly, interim LIFO calculations are based on managements’ estimates of
expected year-end inventory levels and costs. These estimates are subject
to
many factors beyond managements’ control. Interim results are subject to the
final year-end LIFO inventory valuation. Actual results could differ from
those
estimates.
|
(c)
|
Property,
Plant, and Equipment
|
The
Company’s property, plant, and equipment are stated at cost and include
improvements that significantly increase productive capacity or extend the
useful lives of existing plant and equipment. The Company provides for
depreciation of property, plant, and equipment on the straight-line method
based
upon the estimated useful lives of the assets. The range of estimated useful
lives of the Company’s assets is as follows:
Buildings
and improvements
|
|
|
10-25
years
|
|
Land
improvements
|
|
|
5-25
years
|
|
Machinery
and equipment (the vast majority of lives are from 10-20
years)
|
|
|
5-20
years
|
|
Computer
equipment
|
|
|
3-5
years
|
|
Repair
and maintenance costs are expensed as incurred. Capital expenditures that
cannot
be put into use immediately are included as construction-in-progress. As
these
projects are completed, they are transferred to depreciable assets. Net gains
and losses related to asset dispositions are recognized in the Company’s
operating results in the period in which the disposition occurs.
|
(d)
|
Impairment
of Long-Lived Assets
|
Long-lived
assets, consisting of property, plant, and equipment and deferred costs,
are
periodically reviewed by the Company for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset, or related
group
of assets, may not be recoverable. Recoverability of assets to be held and
used
is measured by a comparison of the carrying amount of an asset to future
undiscounted net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds
the
lesser of the recovery amount or the fair value of the assets. Measurement
of
fair value may be based upon appraisals, market values of similar assets
or
discounted cash flows. Assets to be disposed of are reported at the lower
of the
carrying amount or the fair value less cost to sell and are no longer
depreciated.
The
Company accounts for income taxes under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts
of
existing assets and liabilities and their respective tax bases and operating
losses and tax credit carry-forwards. Deferred tax assets and liabilities
are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax
rates is recognized in income in the period that includes the enactment
date.
The
Company and other steel companies have in recent years become subject to
increasingly stringent environmental laws and regulations. It is the policy
of
the Company to endeavor to comply with applicable environmental laws and
regulations. The Company established a liability for an amount which the
Company
believes is appropriate, based on information currently available, to cover
costs of environmental remediation it deems probable and estimable.
The
recorded amounts represent estimates of the environmental remediation costs
associated with future events triggering or confirming the costs that, in
management’s judgment, are probable. These estimates are based on currently
available facts, existing technology and presently enacted laws and regulations,
and take into consideration the likely effects of inflation and other societal
and economic factors. The precise timing of such events cannot be reliably
determined at this time due to the absence of any deadlines for remediation
under the applicable environmental laws and regulations pursuant to which
such
remediation costs will be expended. No claims for recovery are netted against
the stated amount.
The
Company recognizes revenue when products are shipped and the customer takes
ownership and assumes risk of loss, collection of the relevant receivable
is
probable, persuasive evidence of an arrangement exists and the sales price
is
fixed and determinable. The Company’s customers have no rights to return
product, other than for defective materials. As sales are recognized, reserves
for defective materials are recorded as a percentage of sales and are charged
against such sales. This percentage is based on historical experience. The
adequacy of reserve estimates is periodically reviewed by comparison to actual
experience and adjusted as appropriate.
|
(h)
|
Allowances
for doubtful accounts
|
Allowances
for doubtful accounts are maintained to provide for estimated losses resulting
from the inability of customers to make required payments. If the financial
condition of these customers deteriorates, resulting in their inability to
make
payments, additional allowances may be required. Actual losses could differ
from
these estimates. The Company also records an allowance for accounts receivable
for customers based on a variety of factors, including pricing adjustments,
length of time receivables are past due, and historical experience. After
all
attempts to collect a receivable have failed, the receivable is written off
against the allowance.
The
Company expenses outbound freight charges, purchasing and receiving costs,
inspection costs, warehousing costs, and internal transfer costs as cost
of
goods sold.
|
(j)
|
Selling,
general and administrative
expense
|
The
Company includes overhead expenses not directly associated with the manufacture
or delivery of goods, administrative salaries, rent, utilities, telephone,
travel, property and casualty insurance and expenses related to order taking
and
product sales in selling, general and administrative expense.
|
(k)
|
Incentive
compensation costs
|
Incentive
compensation costs are significant expense categories that are highly dependent
upon management estimates and judgments, particularly at each interim reporting
date. In arriving at the amount of expense to recognize, management believes
it
makes reasonable estimates and judgments using all significant information
available. Incentive compensation costs are accrued on a monthly basis, and
the
ultimate determination is made after the Company’s year-end results are
finalized.
The
preparation of consolidated financial statements, in conformity with U.S.
GAAP,
requires the Company’s management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
The
Company has made significant accounting estimates with respect to the valuation
allowances for receivables, inventories, long-lived assets, deferred income
tax
assets and liabilities, environmental liabilities and obligations related
to
employee health care.
|
(m)
|
Foreign
currency translation
|
Asset
and
liability accounts of the Company’s foreign operations are translated into U.S.
dollars using current exchange rates in effect at the balance sheet date
and for
revenue and expense accounts using a weighted average exchange rate during
the
period. Translation adjustments are reflected as a component of other
comprehensive income included in stockholders’ equity. At June 30, 2004, the
foreign currency translation adjustment was immaterial to the Company’s
consolidated financial statements.
|
(n)
|
New
accounting
pronouncements
|
In
November 2004, Statement of Financial Accounting Standards No. 151,
“Inventory Costs-an amendment of ARB No. 43, Chapter 4” (SFAS
No. 151), was issued. This Statement amends the guidance in Accounting
Research Bulletin No. 43, Chapter 4, “Inventory Pricing,” to clarify
the accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material (spoilage). SFAS No. 151 is effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
The Company elected to adopt the provisions of SFAS No. 151 effective on
July
22, 2005.
In
December 2004, the Financial Accounting Standards Board (FASB) revised Statement
of Financial Accounting Standards No. 123 (revised 2004), “Share Based
Payment” (SFAS No. 123R). SFAS No. 123R requires a public entity to measure
the cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award (with limited
exceptions). That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award—the requisite
service period (usually the vesting period). This statement was to be effective
for public entities that do not file as small business issuers—as of the
beginning of the first interim or annual reporting period that begins after
June 15, 2005; for public entities that file as small business issuers as
of the beginning of the first interim or annual reporting period that begins
after December 15, 2005; and for nonpublic entities as of the beginning of
the first annual reporting period that begins after December 15, 2005. The
Company does not expect any financial statement implications related to the
adoption of this Statement due to the subsequent termination of the plan
due to
the acquisition of PAV Republic by SimRep (see note 16).
In
March
2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional
Asset Retirement Obligations, an interpretation of FASB Statement No. 143.” This
Interpretation clarifies that an entity is required to recognize a liability
for
the fair value of a conditional asset retirement obligation if the fair value
of
the liability can be reasonably estimated. Uncertainty about the timing and
(or)
method of settlement of a conditional asset retirement obligation should
be
factored into the measurement of the liability when sufficient information
exists. This Interpretation is to be effective no later than December 31,
2005,
with early adoption encouraged. The Company has evaluated the application
of
FASB Interpretation No. 47 and determined it has no effect on the Company’s
consolidated financial statements.
In
June
2005, the FASB issued Statement of Financial Accounting Standards No. 154,
“Accounting Changes and Error Corrections” (SFAS No. 154). SFAS No. 154 replaces
APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting
Changes in Interim Financial Statement.” SFAS No. 154 requires that a voluntary
change in accounting principle be applied retrospectively with all prior
period
financial statements presented as if the new accounting principle had always
been used unless it is impractical to do so. SFAS No. 154 also requires that
a
change in method of depreciating or amortizing a long-lived nonfinancial
asset
be accounted for prospectively as a change in estimate, and correction of
errors
in previously issued financial statements should be termed a “restatement”. SFAS
No. 154 is effective for accounting changes and correction of errors made
in
fiscal years beginning after December 15, 2005. The Company has evaluated
the
application of SFAS No. 154 and determined it has no effect on the Company’s
consolidated financial statements.
The
components of inventories as of June 30, 2004 are as follows:
Raw
materials
|
|
$
|
31,898
|
|
Semi-finished
|
|
|
48,560
|
|
Finished
goods
|
|
|
90,913
|
|
|
|
|
171,371
|
|
LIFO
reserve
|
|
|
(24,373
|
)
|
Total
|
|
$
|
146,998
|
|
On
June
30, 2004, inventories are valued at the lower of cost or market applied on
a
last-in, first-out (LIFO) method of accounting for inventory. This inventory
method was used to value 99% of the Company’s inventories.
(5)
|
Deferred
financing costs
|
As
of
June 30, 2004, the Company’s deferred financing costs were $7.4 million, net of
accumulated amortization of $0.2 million. The deferred financing costs were
incurred in relation to the new debt items discussed in note 6. The Company
uses
the effective interest method to amortize the costs associated with its debt
agreements over their term (see Note 6). Concurrent with the repayment of
the
revolving working capital agreement with Perry Partners L.P. in May 2004,
the
remaining $1.1 million of these assets were written off by the
Company.
The
components of deferred financing costs are as follows:
Net
deferred financing costs as of December 31, 2003
|
|
$
|
1,471
|
|
Amortization
of deferred financing costs
|
|
|
(526
|
)
|
Write-off
of deferred financing costs
|
|
|
(1,123
|
)
|
Costs
related to new debt (note 6)
|
|
|
7,608
|
|
Net
deferred financing costs as of June 30, 2004
|
|
$
|
7,430
|
|
(6) |
Revolving
credit facilities, long-term debt and capital lease
obligations
|
Revolving
credit facility
On
May
20, 2004, PAV, through a wholly-owned subsidiary, Republic Inc., entered
into a
$200.0 million Senior Secured Credit Agreement with General Electric Capital
Corporation (GE Capital). This facility matures on May 20, 2009. The termination
date of the facility can be extended until May 20, 2010 at the option of
the
Company upon providing timely written notice. On November 10, 2004, Republic
Inc. and GE Capital amended the revolving credit facility to expand the
borrowing capacity from $200.0 million to $250.0 million. The GE credit facility
was also amended effective during July 2005 to obtain the lenders consent
for
the July 2005 stock purchase (see Note 16) and for certain other related
changes.
At
June
30, 2004, Republic Inc. had $107.5 million outstanding and had issued
$0.1 million in letters of credit under the GE credit facility. The Company
is required to maintain a borrowing availability of at least $25.7 million.
The amount available under the GE credit facility was approximately $92.4
million in excess of the $25.7 million minimum availability requirement at
June 30, 2004. Republic Inc. is required to pay an unused facility fee of
one-half of one percent per annum on the average daily unused total commitment.
Advances under the GE credit facility are limited by the borrowing base,
as
defined in the GE credit facility as the sum of 85% of eligible accounts
receivable plus 65% of eligible inventory.
Borrowings
under the GE credit facility are secured by a first priority perfected security
interest in all of Republic Inc.’s presently owned and subsequently acquired
inventory and accounts receivable. The obligations under the GE credit facility
are secured and are unconditionally and irrevocably guaranteed jointly and
severally by Republic Inc.’s subsidiaries.
Borrowings
under the GE credit facility bear interest, at Republic Inc.’s option, at an
index rate equal to the higher of the prime rate announced from time to time
by
The Wall Street Journal, plus the applicable margin, or the federal funds
rate
plus 50 basis points per annum, plus the applicable margin; or LIBOR plus
the
applicable margin. The applicable margin on index rate loans initially is
1.0%
and on LIBOR loans is 2.75%. Commencing on April 1, 2005, the margins may
be adjusted based on the average availability quarterly on a prospective
basis.
The base rate margins may be reduced to an amount between 0.00% and 1.00%,
and
the LIBOR margins may be adjusted to an amount between 1.75% and 2.75%. As
of
June 30, 2004, borrowings under the GE credit facility are accruing interest
at
the rate of 5.25% per year for index rate loans and 4.18% for LIBOR
loans.
The
GE
credit facility contains customary representations and warranties and covenants
including restrictions on the amount of capital expenditures, maintenance
of a
minimum fixed charge coverage ratio and maintenance of a minimum borrowing
availability of $25.7 million. The Company was in compliance with all covenants
under the GE revolving credit facility as of June 30, 2004.
Long-term
debt
A
summary
of long-term debt outstanding as of June 30, 2004 was as follows:
11%
Senior Secured Promissory Note due 2009
|
|
$
|
61,800
|
|
10%
Senior Secured Notes due 2009
|
|
|
17,198
|
|
7%
Senior Secured Subordinated Note due 2009
|
|
|
8,365
|
|
Ohio
Department of Development Loan
|
|
|
5,000
|
|
Total
long-term debt
|
|
$
|
92,363
|
|
11%
Senior Secured Promissory Note
On
May
20, 2004, Republic Inc. issued a $61.8 million senior secured promissory
note under a senior secured note purchase agreement among Republic Engineered
Products, Inc., as borrower, and Perry Principals Investments, LLC, as Term
2
Note holder. The note, which matures on August 20, 2009, bears interest at
11%
and requires monthly interest payments. The note requires a 3% prepayment
penalty and is secured by personal property and other assets of Republic
Inc. as
set forth by the security agreement to the senior secured promissory
note.
7%
Senior Subordinated Note
On
May
20, 2004, Republic Inc. issued an $8.4 million senior subordinated promissory
note under a senior secured note purchase agreement among Republic Engineered
Products, Inc., as borrower, and Perry Principals Investments, LLC, as Term
1
Note Holder. In the absence of an Event of Default, interest on the notes
will
accrue at the rate of 7% per annum and is payable on the last day of each
calendar month until the loan matures on August 20, 2009. This debt was repaid
during July of 2004. The note was secured by personal property and other
assets
of Republic Inc. as set forth by the security agreement to the senior secured
promissory note.
10%
Senior Secured Notes
In
December 2003, Republic Inc. issued $21.0 million of 10% senior secured
bank notes (Bank Notes) that were scheduled to mature August 31, 2009. The
Bank
Notes required quarterly interest payments. The Bank Notes were secured,
subject
to exceptions and limitations, by (1) a first priority lien on, and
security interest in real estate and fixtures related to the Canton C-R™
facility and, (2) fifty percent of any proceeds greater than
$5.0 million but less than $25.0 million received by the Company after
December 5, 2003 for business interruption coverage relating to the loss
events experienced by REPH LLC at the Lorain, Ohio facility in 2003; provided
that such security interests in business interruption insurance proceeds
shall
in no event exceed $10.0 million in the aggregate. As of October 2004,
Republic Inc. had fulfilled this repayment requirement. The note purchase
agreement in respect of the Bank Notes contained significant affirmative
and
negative covenants. As of June 30, 2004, Republic Inc. complied with all
of
these covenants. This note was repaid early by PAV in July 2005.
Ohio
Department of Development Loan
Republic
Inc. has a loan outstanding from the Ohio Department of Development which
was
utilized to modernize the Lorain, Ohio facility. The project was completed
in
2003. The initial amount of the loan was $5.0 million and it accrues interest
at
the rate of 3% per annum payable on the first day of each calendar month
until
the loan matures in July 2008. Principal payments are required in the amount
of
$0.7 million, $1.6 million, $1.7 million and $1.0 million
during years 2005, 2006, 2007 and 2008, respectively, beginning August 2005.
The
loan is collateralized by the 20" mill modernization project at
Lorain.
Capital
lease obligations
On
June
30, 2004, the amount included in property, plant and equipment for various
equipment and computer capital leases was $0.8 million, net of
$0.2 million of accumulated amortization. These various capital leases
require minimum payments during the last six months of 2004 of
$0.1 million, $0.4 million during 2005 and $0.3 million during 2006.
The current and non-current portions of the capital lease obligations are
included in other accrued liabilities and other long-term liabilities,
respectively, in the accompanying consolidated balance sheet.
The
vast
majority of the Company’s production workers are covered by a collective
bargaining agreement with the United Steelworkers of America (USWA). The
collective bargaining agreement expires on August 15, 2007 (labor
agreement).
The
labor
agreement provides for a defined contribution program for retirement healthcare
and pension benefits. The Company is required to make a contribution for
every
hour worked. The contribution amount was $3.00 for every hour worked through
August 16, 2004, $3.50 for every hour worked through August 16, 2005 and
will be
$3.80 for every hour worked thereafter until the expiration of the labor
agreement. The Company recorded expense of $5.5 million related to this
provision of the labor agreement for the six months ended June 30,
2004.
The
labor
agreement includes a profit sharing plan to which the Company is required
to
contribute 15% of its quarterly pre-tax income, as defined in the labor
agreement, in excess of $12.5 million. During the six months ended June 30,
2004, the Company recorded expense of $0.7 million to recognize the profit
sharing obligation under this plan.
The
Company has a defined contribution retirement plan that covers substantially
all
salary and nonunion hourly employees. This plan is designed to provide
retirement benefits through company contributions and voluntary deferrals
of
employees’ compensation. The Company funds contributions to this plan each pay
period based upon the participants age and service as of January first of
each
year. The amount of the Company’s contribution is equal to the monthly base
salary multiplied by the appropriate percentage based on age and years of
service. The contribution becomes 100% vested upon completion of five years
of
service. In addition, employees are permitted to make contributions into
a
401(k) retirement plan through payroll deferrals. The Company provides a
25%
matching contribution for the first 5% of payroll that an employee elects
to
contribute. Employees are 100% vested in both their and the Company’s matching
401(k) contributions. The Company recorded expense of $2.1 million under
this plan for the six months ended June 30, 2004.
Republic
Inc. has a profit sharing plan for salary and non-union hourly employees
excluding a select group of managers and executives. The Company is required
to
contribute 3% of its quarterly pre-tax income, as defined in the plan, in
excess
of $12.5 million. During the six months ended June 30, 2004, the Company
recorded expense of $0.2 million to recognize the profit sharing obligation
under this plan.
Republic
Inc. has a management incentive plan for a select group of managers and
executives. Incentives are based upon achievement of specific corporate and
individual objectives which include financial results, product yield
improvement, energy utilization, quality, safety, and cash flow. During the
six
months ended June 30, 2004, the Company recorded expense of $1.3 million in
connection with this plan.
The
Company has a deferred compensation plan covering certain key employees.
The
plan allows for the employee to make annual deferrals of base salary and
provides for a fixed annual contribution by the Company based on a percentage
of
salary. There was no deferred compensation expense recorded during the six
months ended June 30, 2004.
The
Company is primarily engaged in one line of business that produces and sells
engineered steel bars. The Company’s products include hot-rolled bars,
cold-finished bars, semi-finished seamless tube rounds and other semi-finished
trade products. The Company’s product lines are marketed to a common customer
base. The Company’s customers include automotive and industrial equipment
manufacturers, first tier suppliers to automotive, forgers and tubular and
pipe
product manufacturers.
For
the
period January 1, 2004 to June 30, 2004, the five largest customers accounted
for 33.1% of the Company’s total sales. During this period, two customers, U.S.
Steel and American Axle & Manufacturing, accounted for 11.5% and 10.7%,
respectively, of total sales.
The
components of the income tax provision for the Company for the six months
ended
June 30, 2004 is as follows:
Current:
|
|
|
|
Federal
|
|
$
|
4,702
|
|
State
and local
|
|
|
889
|
|
Foreign
|
|
|
369
|
|
Total
current
|
|
|
5,960
|
|
Deferred:
|
|
|
|
|
Federal
|
|
|
(3,170
|
)
|
State
and local
|
|
|
(600
|
)
|
Total
deferred
|
|
|
(3,770
|
)
|
Total
|
|
$
|
2,190
|
|
The
following is a reconciliation of the Company’s effective income tax rate to the
Federal statutory rate for the six months ended June 30, 2004:
Statutory
rate
|
|
|
35.0
|
%
|
Provision
for state and local taxes, net of federal effect
|
|
|
4.0
|
%
|
Effective
income tax rate
|
|
|
39.0
|
%
|
Deferred
tax assets and liabilities as of June 30, 2004 are presented below:
Deferred
tax assets:
|
|
|
|
Compensation
and benefits
|
|
$
|
4,696
|
|
Accrued
expenses
|
|
|
1,997
|
|
Capitalized
inventory assets
|
|
|
338
|
|
Allowance
for doubtful accounts
|
|
|
260
|
|
Deferred
costs
|
|
|
16
|
|
Total
deferred tax assets
|
|
|
7,307
|
|
Deferred
tax liabilities:
|
|
|
|
|
Prepaid
expenses and other
|
|
|
(2,747
|
)
|
Property,
plant and equipment
|
|
|
(659
|
)
|
Total
deferred tax liabilities
|
|
|
(3,406
|
)
|
Net
deferred tax assets
|
|
$
|
3,901
|
|
During
the six months ended June 30, 2004, certain deferred tax assets and liabilities
reversed, resulting in a net deferred tax asset of $3.9 million. Management
believes it is more likely than not that all of the deferred tax assets will
be
realized due to generating sufficient amounts of taxable income in the future,
and accordingly, no valuation allowance is required at June 30, 2004.
(10) |
Related
party transactions
|
On
May
20, 2004, the Company agreed to pay a transaction fee of $1.8 million to
Perry
Principals Investments, L.L.C., in connection with $61.8 million senior secured
promissory note and guaranty agreement between Republic Engineered Products,
Inc. and Perry Principals Investments, L.L.C. Perry Principals Investments,
L.L.C. is an affiliate of Perry Partners LP and Perry Partners International,
Inc. who own substantially all of the Company’s capital stock (Perry Capital).
The note is included in long-term debt as of June 30, 2004 (see Note
6).
On
May
20, 2004, the Company agreed to pay a transaction fee of $0.2 million to
Perry
Principals Investments, L.L.C., an affiliate of Perry Capital, in connection
with its $8.4 million senior subordinated promissory note and guaranty agreement
between Republic Engineered Products, Inc. and Perry Principals Investments,
L.L.C. This note was repaid in full in July 2004.
On
May
20, 2004, Perry Partners LP and Perry Partners International, Inc. made a
$20.0
million equity contribution to PAV Republic, Inc. Under the terms and conditions
of the Senior Secured Credit Agreement with General Electric Capital
Corporation, PAV Republic, Inc. increased its equity investment in Republic
Inc.
by $20.0 million. The proceeds were used by Republic Inc. to repay its
outstanding Perry credit facility.
(11)
|
Commitments
and contingencies
|
The
Company, in the ordinary course of business, is the subject of, or party
to,
various pending or threatened legal and environmental actions. The Company
provides for the costs related to these matters when a loss is probable and
the
amount is reasonably estimable. Based on information presently known to the
Company, management believes that any ultimate liability resulting from these
actions will not have a material adverse affect on its consolidated financial
position, results of operations or cash flows.
United
States Steel Corporation (U.S. Steel) is the Company’s primary supplier of iron
ore and coke. U.S. Steel, under various supply agreements, supplied the Company
with iron ore and coke for the years 2004, 2005 and 2006. Under the current
coke
agreement, effective November 30, 2006, U.S. Steel has agreed to supply the
Company with coke through 2007. An agreement with U.S. Steel for iron ore
for
the first quarter of 2007 was reached on August 30, 2006. The Company is
currently working to develop additional sources for these raw materials.
On
October 11, 2004 the Company’s Board of Directors approved the installation
of a new five-strand combination billet/bloom caster and associated equipment
at
the Canton, Ohio facility. The Company began the preparation for installation
of
the new equipment in December 2004. The caster was installed to allow
flexibility in melt capacity to take advantage of volatile raw material prices
and to capture potential semi-finished business. The project was completed
during June 2006 and the caster was put into production. Project costs of
$56.0
million were reclassified from construction-in-progress to buildings and
improvements and machinery and equipment upon completion. On June 30, 2006,
the
Company decided to temporarily idle the caster based on sufficient alternative
melt capacity. The caster will restart when commodity price and business
conditions warrant.
In
2003,
REPH, LLC’s (the predecessor to PAV) operations were negatively impacted by the
loss of one of two blast furnaces located in Lorain, Ohio. As a result, REPH,
LLC filed business interruption and property damage insurance claims. See
note
16.
(12)
|
Environmental
matters
|
As
is the
case with most steel producers, the Company could incur significant costs
related to environmental issues in the future, including those arising from
environmental compliance activities and remediation stemming from historical
waste management practices at the Company’s facilities. The reserve to cover
probable environmental liabilities, as well as anticipated compliance
activities, totaling $5.1 million was recorded as of June 30, 2004. The
current and non-current portions of the environmental reserve are included
in
other accrued liabilities and accrued environmental liabilities, respectively,
in the accompanying consolidated balance sheet. The Company is not otherwise
aware at this time of any material environmental remediation liabilities
or
contingent liabilities relating to environmental matters with respect to
the
Company’s facilities for which the establishment of an additional reserve would
be appropriate at this time. To the extent the Company incurs any such
additional future costs, these costs will most likely be incurred over a
number
of years. However, future regulatory action regarding historical waste
management practices at the Company’s facilities and future changes in
applicable laws and regulations may require the Company to incur significant
costs that may have a material adverse effect on the Company’s future financial
performance.
(13)
|
Obligation
to administer USWA
benefits
|
The
Company has an agreement with the USWA to administer health insurance benefits
to the Company’s USWA employees while on layoff status and to administer payment
of monthly contributions to the Steelworker’s Pension Trust on behalf of local
union officials while on union business. To fund this program, the USWA provided
an initial cash contribution of $3.0 million. As of June 30, 2004, the balance
of this cash account totaled $2.8 million. Expenditures from this account
are
used to provide health insurance to laid-off USWA employees. The Company
has
agreed to continue to administer this program until the fund is exhausted.
The
Company will provide the USWA with periodic reports regarding the financial
status of the fund. At June 30, 2004, the cash account balance is included
in
other assets and the related liability is included in other long-term
liabilities in the accompanying consolidated balance sheet.
(14)
|
Disclosures
about fair value of financial instruments and significant group
concentration of credit
risk
|
The
following methods and assumptions were used to estimate the fair value of
each
class of financial instruments for which it is practicable to estimate that
value:
The
carrying amount approximates fair value because of the short maturity of
these
investments.
|
(b)
|
Revolving
credit facilities
|
Since
these borrowings are based on short-term interest rates available to the
Company, the estimated fair values of these financials instruments approximate
their recorded carrying amounts.
The
fair
values of the Company’s long-term debt obligations are estimated based upon
quoted market prices for the same or similar issues or on the current rates
offered for debt of the same remaining maturities. The estimated fair value
approximates the carrying value of the long-term debt.
In
2003,
REPH LLC’s operations were negatively impacted by the loss of one of two blast
furnaces in Lorain, Ohio. As a result, REPH LLC filed business interruption
and
property damage insurance claims. PAV acquired the right to reimbursement
from
insurance claims for damage incurred to the #3 blast furnace under the terms
of
the asset purchase agreement in connection with acquisition of REPH LLC by
PAV
effective December 19, 2003.
During
the period January 1, 2004 to June 30, 2004, $13.6 million of insurance proceeds
were received. The Company recorded the receipt of the insurance proceeds
and
reduced non-current assets by $13.6 million.
Effective
July 22, 2005, SimRep Corporation (SimRep) acquired 100% of the outstanding
stock of PAV for a cash purchase price of $229.0 million (the PAV acquisition).
Industrias CH, S.A. de C.V (Industrias CH), Controladora Simec, S.A. de C.V.
(Controladora) and Pacific Steel, Inc. (Pacific) own 49.8%, 47.6% and 2.6%,
respectively, of the stock of SimRep. The stock purchase agreement provides
that, in the event the Company receives future reimbursement from the insurance
claim relating to damage incurred to a blast furnace located at the Lorain,
Ohio
facility in 2003, a portion will be paid to PAV’s shareholders.
On
April
24, 2006, a Settlement Agreement and Release was reached for approximately
$58.0
million. Approximately, $38.4 million, net of the $19.8 million payment to
PAV’s
former shareholders, were received by SimRep as a result of the Settlement
and
Release.
The
GE
credit facility (see note 6) was amended, effective during July 2005, to
obtain
the lenders consent for the acquisition of PAV by SimRep and for certain
other
related changes. Effective November 1, 2005, the GE credit facility was amended
to reduce the borrowing capacity from $250.0 million to $150.0 million to
eliminate unnecessary liquidity and to provide for certain other changes.
Also
as part of the November 1, 2005 amendment and through the end of 2005, the
base
rate margins were fixed at 0.00% for Index Margins and 1.00% on LIBOR margins.
Commencing on January 1, 2006, the applicable margins were adjusted from
0.00%
to 0.25% for index rate loans and from 0.875% to 1.25% for LIBOR loans based
on
the average daily availability in the prior quarter. The new agreement also
varied the margins on the unused facility fee from 0.50% to 0.375%. Based
on the
fourth quarter 2005 average daily availability, the initial margins for 2006
are
0.00% for the index margin, 0.875% for the LIBOR margin, 0.500% for the unused
facility fee margin, and 0.875% for the applicable letter of credit margin.
The
capital expenditures limit was increased to $100.0 million with the amendment
dated November 1, 2005.
Unaudited
Pro Forma Condensed Combined Statements of
Operations
On
July
22, 2005, the Company and Industrias CH acquired the outstanding shares of
PAV
Republic Inc. (Republic) through the Company’s subsidiary SimRep Corporation, a
U.S. company. Such transaction was valued at USD 245 million where USD 229
million corresponds to the purchase price and USD 16 million, to the direct
cost
of the business combination. The Company contributed USD 123 million to acquire
50.2% of the representative shares of SimRep Corporation and Industrias CH,
the
holding company, acquired the remaining 49.8%. SimRep then acquired all the
shares from Republic through a stock purchase agreement. Under the terms
of the
stock purchase agreement, the Company acquired the right to a portion of
the
reimbursement from an unresolved insurance claim. On April 24, 2006 a Settlement
Agreement and Release was reached and approximately Ps. 407 million, net
of
payment to Predecessor’s shareholders of Ps. 211 and professional fees, has been
received by the Company. Due to the reimbursement, the Company changed the
final
purchase accounting adjustment to reflect the fair value of the assets acquired
and liabilities assumed.
The
unaudited proforma condensed combined statements of income for the six months
ended June 20, 2005, and for the year ended December 31, 2005, give effect
to
Republic’s acquisition as if it had occurred on January 1, 2005. Each are
reconciled from Mexican GAAP to US GAAP.
As
a
result of the acquisition of Republic, an analysis of information regarding
Simec’s results of operations for 2005, including Republic’s six plants, over a
six-month period and for the full year, as if the plants had been incorporated
into the Company since the beginning of the year (unaudited information)
is as
follows:
Unaudited
Pro Forma Condensed Combined Statements of Income
For
the Six Months Ended June 30, 2005
(Thousands
of Constant Mexican pesos as of June 30, 2006, except earnings per share
figures)
|
|
|
|
Simec
as reported
|
|
PAV
Republic(1)
|
|
Proforma
adjustments
|
|
Simec
Pro Forma
|
|
Net
sales
|
|
|
Ps.
|
|
|
3,573,182
|
|
|
8,815,639
|
|
|
-
|
|
|
12,388,821
|
|
Direct
Cost of Sales
|
|
|
|
|
|
2,326,363
|
|
|
7,660,786
|
|
|
-
|
|
|
9,987,149
|
|
Marginal
Profit
|
|
|
|
|
|
1,246,819
|
|
|
1,154,853
|
|
|
-
|
|
|
2,401,672
|
|
Indirect
overhead, selling, general and administrative expenses
|
|
|
|
|
|
374,630
|
|
|
453,069
|
|
|
23,491
|
(2)
|
|
851,190
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
|
|
|
872,189
|
|
|
701,784
|
|
|
(23,491
|
)
|
|
1,550,482
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financing cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense income , net
|
|
|
|
|
|
8,454
|
|
|
(90,201
|
)
|
|
4,984
|
(3)
|
|
(76,763
|
)
|
Foreign
exchange loss, net
|
|
|
|
|
|
(35,926
|
)
|
|
-
|
|
|
|
|
|
(35,926
|
)
|
Monetary
position loss
|
|
|
|
|
|
(7,601
|
)
|
|
-
|
|
|
|
|
|
(7,601
|
)
|
Comprehensive
financial result, net
|
|
|
|
|
|
(35,073
|
)
|
|
(90,201
|
)
|
|
4,984
|
|
|
(120,290
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income, net
|
|
|
|
|
|
7,633
|
|
|
26,583
|
|
|
-
|
|
|
34,216
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income tax, statutory employee profit sharing and minority
interest
|
|
|
|
|
|
844,749
|
|
|
638,166
|
|
|
(18,507
|
)
|
|
1,464,408
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
73,324
|
|
|
245,400
|
|
|
-
|
|
|
318,724
|
|
Deferred
|
|
|
|
|
|
24,160
|
|
|
(12,650
|
)
|
|
(6,940
|
)
(4)
|
|
4,570
|
|
Total
income tax
|
|
|
|
|
|
97,484
|
|
|
232,750
|
|
|
(6,940
|
)
|
|
323,294
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
consolidated income
|
|
|
Ps.
|
|
|
747,265
|
|
|
405,416
|
|
|
(11,567
|
)
(5)
|
|
1,141,114
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation
of net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
|
|
|
-
|
|
|
201,816
|
|
|
(5,758
|
)
(6)
|
|
196,058
|
|
Majority
interest
|
|
|
Ps.
|
|
|
747,265
|
|
|
203,600
|
|
|
(5,809
|
)
(6)
|
|
945,056
|
|
|
|
|
Ps.
|
|
|
747,265
|
|
|
405,416
|
|
|
(11,567
|
)
|
|
1,141,114
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
405,209,451
|
|
|
|
|
|
|
|
|
405,209,451
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share (pesos)
|
|
|
Ps.
|
|
|
1.84
|
|
|
|
|
|
|
|
|
2.33
|
|
Unaudited
Pro Forma Condensed Combined Statements of Income
For
the Year Ended December 31, 2005
(Thousands
of Constant Mexican pesos as of June 30, 2006, except earnings per share
figures)
|
|
|
|
Simec
as
reported
|
|
PAV
Republic(1)
|
|
Proforma
adjustments
|
|
Simec
Pro
Forma
|
|
Net
sales
|
|
|
Ps.
|
|
|
12,966,627
|
|
|
9,414,099
|
|
|
|
|
|
22,380,726
|
|
Direct
Cost of Sales
|
|
|
|
|
|
10,370,940
|
|
|
8,185,160
|
|
|
|
|
|
18,556,100
|
|
Marginal
Profit
|
|
|
|
|
|
2,595,687
|
|
|
1,228,939
|
|
|
|
|
|
3,824,626
|
|
Indirect
overhead, selling, general and administrative expenses
|
|
|
|
|
|
1,018,105
|
|
|
540,268
|
|
|
26,362
|
(2)
|
|
1,584,735
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
|
|
|
1,577,582
|
|
|
688,671
|
|
|
(26,362
|
)
|
|
2,239,891
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financing cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
(expense) income , net
|
|
|
|
|
|
(15,728
|
)
|
|
(97,114
|
)
|
|
5,593
|
(3)
|
|
(107,249
|
)
|
Foreign
exchange (loss) gain, net
|
|
|
|
|
|
(75,279
|
)
|
|
-
|
|
|
|
|
|
(75,279
|
)
|
Monetary
position loss
|
|
|
|
|
|
(53,663
|
)
|
|
2,007
|
|
|
|
|
|
(51,656
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financial result, net
|
|
|
|
|
|
(144,670
|
)
|
|
(95,107
|
)
|
|
5,593
|
|
|
(234,184
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expenses), net
|
|
|
|
|
|
55,489
|
|
|
(10,398
|
)
|
|
|
|
|
45,091
|
|
Income
before income tax, statutory employee profit sharing and minority
interest
|
|
|
|
|
|
1,488,401
|
|
|
583,166
|
|
|
|
|
|
2,050,798
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
79,294
|
|
|
152,759
|
|
|
|
|
|
232,053
|
|
Deferred
|
|
|
|
|
|
111,718
|
|
|
54,394
|
|
|
(7,792
|
)
(4)
|
|
158,320
|
|
Total
income tax
|
|
|
|
|
|
191,012
|
|
|
207,153
|
|
|
(7,792
|
)
|
|
390,373
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
consolidated income
|
|
|
Ps.
|
|
|
1,297,389
|
|
|
376,013
|
|
|
(12,977
|
)
(5)
|
|
1,660,425
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation
of net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
Ps.
|
|
|
17,491
|
|
|
187,179
|
|
|
(6,460
|
)
(6)
|
|
198,210
|
|
Majority
interest
|
|
|
|
|
|
1,279,898
|
|
|
188,834
|
|
|
(6,517
|
)
(6)
|
|
1,462,215
|
|
|
|
|
Ps.
|
|
|
1,297,389
|
|
|
376,013
|
|
|
(12,977
|
)
|
|
1,660,425
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
413,788,797
|
|
|
|
|
|
|
|
|
413,788,797
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share (pesos)
|
|
|
|
|
|
3.09
|
|
|
|
|
|
|
|
|
3.53
|
|
(1)
This
column shows the income statement of Pav Republic for the six-month period
ended
June 30, 2005 and for the period from January 1, 2005 to July 22,
2005.
(2)
The
increase in the expenses is driven by two components; the first one is the
decrease of the stock compensation expense of $60,053 that was recorded during
the period January 1, 2005 through July 22, 2005 and $53,512 during the period
January 1, 2005 through June 30, 2005. The company terminated the stock
compensation plan at the time of the purchase and provided no additional
compensation to employees to replace this lost benefit. The Company made
the
assumption that the stock compensation recognized during the period January
1,
2005 - July 22, 2005 would not be recorded if the purchase would have taken
place on January 1, 2005. The second component is an increase in depreciation
and amortization expense of $86,415 and $77,003 for the periods January 1,
2005
through July 22, 2005 and January 1, 2005 through June 30, 2006 respectively,
due to the purchase price allocation to intangibles related to Republic’s Union
Agreement, Kobe Tech, Customer Relationships and Republic trade name being
recorded at the time of purchase, the Company made the assumption that Republic
would have booked this entry as of January 1, 2005 and the Company recorded
an
additional seven months of amortization expense. Also, the depreciation
expense was adjusted as if the allocation of the purchase price would have
taken
place on January 1, 2005. The value of the plant, property and equipment
increased and depreciation expense increased accordingly.
(3)
Due to
the allocation of the purchase price to the deferred financing costs related
to
the Perry Note and the GE revolver (both items were subject to a decrease
in the
cost basis) as of July 22, 2005, the Company adjusted the amortization expense
to reflect the decrease in cost basis as if the purchase would have occurred
on
January 1, 2005.
(4)
The
Company adjusted the income tax expense to reflect the change in net income
due
to the decrease in selling, general and administrative expenses, increase
in
depreciation and amortization and decrease in interest expense described
above
at a rate of 37.5% which was the effective income tax rate of the
company.
(5)
The
effect in the net income reflects the change due to the decrease in selling,
general and administrative expenses, increase in depreciation and amortization,
decrease in interest expense and decrease in the income tax expense, described
above.
(6)The
adjustment in the minority interest reflecting Industrias CH’s 49.8% interest in
Republic.
SUPPLEMENTAL
UNAUDITED PRO FORMA CONDENSED RECONCILIATION OF MEXICAN GAAP NET INCOME TO
US
GAAP NET INCOME
For
the Six Months Ended June 30, 2005
(Thousands
of Constant Mexican pesos as of June 30, 2006, except earnings per share
figures)
|
|
|
|
Simec
as
reported
|
|
PAV
Republic
|
|
Proforma
adjustments
|
|
Simec
Pro
Forma
|
|
Net
income as reported under Mexican GAAP
|
|
|
Ps.
|
|
|
747,265
|
|
|
405,416
|
|
|
(11,567
|
)
|
|
1,141,114
|
|
U.S.
GAAP Adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
indirect costs
|
|
|
|
|
|
(2,817
|
)
|
|
|
|
|
|
|
|
(2,817
|
)
|
Depreciation
on restatement of machinery and equipment
|
|
|
|
|
|
(11,951
|
)
|
|
|
|
|
|
|
|
(11,951
|
)
|
Deferred
income taxes
|
|
|
|
|
|
(4,802
|
)
|
|
|
|
|
|
|
|
(4,802
|
)
|
Deferred
employee profit sharing
|
|
|
|
|
|
47
|
|
|
|
|
|
|
|
|
47
|
|
Pre-operating
expenses, net
|
|
|
|
|
|
14,326
|
|
|
|
|
|
|
|
|
14,326
|
|
Amortization
of gain from monetary position and exchange loss capitalized under
Mexican
GAAP
|
|
|
|
|
|
3,620
|
|
|
|
|
|
|
|
|
3,620
|
|
Minority
interest
|
|
|
|
|
|
|
|
|
(201,816
|
)
|
|
5,758
|
|
|
(196,058
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
U.S. GAAP adjustments
|
|
|
|
|
|
(1,577
|
)
|
|
(201,816
|
)
|
|
5,758
|
|
|
(197,635
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income under U.S. GAAP
|
|
|
Ps.
|
|
|
745,688
|
|
|
203,600
|
|
|
(5,809
|
)
|
|
943,479
|
|
Weighted
average outstanding basic after split
|
|
|
|
|
|
405,209,451
|
|
|
|
|
|
|
|
|
405,209,451
|
|
Net
earnings per share (pesos) after split
|
|
|
Ps.
|
|
|
1.78
|
|
|
|
|
|
|
|
|
2.25
|
|
SUPPLEMENTAL
UNAUDITED PRO FORMA CONDENSED RECONCILIATION OF MEXICAN GAAP NET INCOME TO
US
GAAP NET INCOME
For
the Year Ended December 31, 2005
(Thousands
of Constant Mexican pesos as of June 30, 2006, except earnings per share
figures)
|
|
|
|
Simec
as
reported
|
|
PAV
Republic
|
|
Proforma
adjustments
|
|
Simec
Pro
Forma
|
|
Net
income as reported under Mexican GAAP
|
|
|
Ps.
|
|
|
1,297,389
|
|
|
376,013
|
|
|
(12,977
|
)
|
|
1,660,424
|
|
U.S.
GAAP adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
indirect costs
|
|
|
|
|
|
(3,958
|
)
|
|
|
|
|
|
|
|
(3,958
|
)
|
Depreciation
on restatement of machinery and equipment
|
|
|
|
|
|
(24,820
|
)
|
|
|
|
|
|
|
|
(24,820
|
)
|
Deferred
income taxes
|
|
|
|
|
|
(5,696
|
)
|
|
|
|
|
|
|
|
(5,696
|
)
|
Deferred
employee profit sharing
|
|
|
|
|
|
46
|
|
|
|
|
|
|
|
|
46
|
|
Pre-operating
expenses, net
|
|
|
|
|
|
26,023
|
|
|
|
|
|
|
|
|
26,023
|
|
Amortization
of gain from monetary position and exchange loss capitalized under
Mexican
GAAP
|
|
|
|
|
|
7,239
|
|
|
|
|
|
|
|
|
7,239
|
|
Minority
interest
|
|
|
|
|
|
(17,491
|
)
|
|
(187,179
|
)
|
|
6,460
|
|
|
(198,210
|
)
|
Total
approximate U.S. GAAP adjustments
|
|
|
|
|
|
(18,657
|
)
|
|
(187,179
|
)
|
|
6,460
|
|
|
(199,376
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Approximate
net income under U.S. GAAP
|
|
|
Ps.
|
|
|
1,278,723
|
|
|
188,834
|
|
|
(6,517
|
)
|
|
1,461,048
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average outstanding basic after split
|
|
|
|
|
|
413,788,797
|
|
|
|
|
|
|
|
|
413,788,797
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings per share (pesos) after split
|
|
|
Ps.
|
|
|
3.09
|
|
|
|
|
|
|
|
|
3.53
|
|
GRUPO
SIMEC, S.A. DE C.V. ( PARENT COMPANY ONLY)
Condensed
Balance Sheets
December
31, 2005 and 2004
(Thousands
of constant Mexican pesos as of June 30, 2006)
Assets
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
1,864
|
|
|
18,584
|
|
|
|
|
|
|
|
|
|
Accounts
receivable:
|
|
|
|
|
|
|
|
Related
parties
|
|
|
433,110
|
|
|
240,338
|
|
Other
receivables
|
|
|
441
|
|
|
493
|
|
|
|
|
|
|
|
|
|
Total
accounts receivable, net
|
|
|
433,551
|
|
|
240,831
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
435,415
|
|
|
259,415
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long
term account receivables to subsidiary companies
|
|
|
881,114
|
|
|
1,742,189
|
|
|
|
|
|
|
|
|
|
Investment
in subsidiary companies
|
|
|
6,343,251
|
|
|
4,691,414
|
|
|
|
|
|
|
|
|
|
Property,
net
|
|
|
177,975
|
|
|
181,089
|
|
|
|
|
|
|
|
|
|
Deferred
Income Tax
|
|
|
10,445
|
|
|
18,645
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
7,848,200
|
|
|
6,892,752
|
|
|
|
|
|
|
|
|
|
Liabilities
and stockholders' equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Current
installments of long-term debt
|
|
$
|
3,276
|
|
|
3,538
|
|
Other
accounts payable and accrued expenses
|
|
|
19,380
|
|
|
19,917
|
|
Accounts
payable to related parties
|
|
|
4,547
|
|
|
971
|
|
Deferred
revenue for leasing
|
|
|
-
|
|
|
21,356
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
27,203
|
|
|
45,782
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity:
|
|
|
|
|
|
|
|
Capital
stock
|
|
|
3,476,499
|
|
|
3,408,488
|
|
Additional
paid-in-capital
|
|
|
845,018
|
|
|
682,066
|
|
Contributions
for future capital stock increases
|
|
|
-
|
|
|
230,310
|
|
Retained
earnings
|
|
|
4,519,677
|
|
|
3,239,778
|
|
Cumulative
deferred income tax
|
|
|
(905,828
|
)
|
|
(905,828
|
)
|
Equity
adjustment for non-monetary assets
|
|
|
(154,723
|
)
|
|
179,309
|
|
Fair
value of derivative financial instruments
|
|
|
40,354
|
|
|
12,847
|
|
|
|
|
|
|
|
|
|
Total
stockholders' equity
|
|
|
7,820,997
|
|
|
6,846,970
|
|
|
|
|
|
|
|
|
|
|
|
$
|
7,848,200
|
|
|
6,892,752
|
|
See
accompanying notes to consolidated financial statements.
GRUPO
SIMEC, S.A. DE C.V. ( PARENT COMPANY ONLY)
Condensed
Statements of Income
Years
ended December 31, 2005, 2004 and 2003
(Thousands
of constant Mexican pesos as of June 30, 2006)
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
Income:
|
|
|
|
|
|
|
|
Equity
in results of subsidiary companies
|
|
$
|
1,186,601
|
|
|
1,390,990
|
|
|
261,005
|
|
For
leasing
|
|
|
21,074
|
|
|
10,821
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
of income
|
|
|
1,207,675
|
|
|
1,401,811
|
|
|
261,005
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
4,759
|
|
|
2,240
|
|
|
-
|
|
Administrative
|
|
|
4,606
|
|
|
1,467
|
|
|
3,401
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
costs and expenses
|
|
|
9,365
|
|
|
3,707
|
|
|
3,401
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
1,198,310
|
|
|
1,398,104
|
|
|
257,604
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financing result:
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
(321
|
)
|
|
(388
|
)
|
|
(719
|
)
|
Interest
income
|
|
|
157,734
|
|
|
170,709
|
|
|
166,682
|
|
Foreign
exchange (loss) gain, net
|
|
|
(167
|
)
|
|
4,606
|
|
|
423
|
|
Monetary
position loss
|
|
|
(60,610
|
)
|
|
(131,048
|
)
|
|
(99,580
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financial result, net
|
|
|
96,636
|
|
|
43,879
|
|
|
66,806
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
(expenses) income, net:
|
|
|
(190
|
)
|
|
7,554
|
|
|
(2,003
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income tax
|
|
|
1,294,756
|
|
|
1,449,537
|
|
|
322,407
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax
|
|
|
6,658
|
|
|
0
|
|
|
0
|
|
Deferred
income tax
|
|
|
8,199
|
|
|
(13,134
|
)
|
|
(1,884
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
1,279,899
|
|
|
1,462,671
|
|
|
324,291
|
|
See
accompanying notes to consolidated financial statements.
GRUPO
SIMEC, S.A. DE C.V. ( PARENT COMPANY ONLY)
Condensed
Statement of Changes in Financial Position
Years
ended December 31, 2005, 2004 and 2003
(Thousands
of constant Mexican pesos as of June 30, 2006)
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
Operating
activities:
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
1,279,899
|
|
|
1,462,671
|
|
|
320,522
|
|
Add
(deduct) items not requiring the use of resources
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
4,759
|
|
|
2,240
|
|
|
-
|
|
Equity
in net results of subsidiary companies
|
|
|
(1,186,601
|
)
|
|
(1,390,990
|
)
|
|
(261,005
|
)
|
Deferred
income tax
|
|
|
8,199
|
|
|
(13,134
|
)
|
|
1,886
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds
provided by operations
|
|
|
106,256
|
|
|
60,787
|
|
|
61,403
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
Short
term of subsidiaries companies, net
|
|
|
(189,196
|
)
|
|
208,939
|
|
|
67,558
|
|
Other
accounts receivable, net
|
|
|
52
|
|
|
(375
|
)
|
|
(6
|
)
|
Other
accounts payable and accrued expenses
|
|
|
(537
|
)
|
|
5,838
|
|
|
(433
|
)
|
Deferred
revenue for leasing
|
|
|
(21,356
|
)
|
|
21,356
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds
(used in) provided by operating activities
|
|
|
(104,781
|
)
|
|
296,545
|
|
|
128,522
|
|
|
|
|
|
|
|
|
|
|
|
|
Financing
activities:
|
|
|
|
|
|
|
|
|
|
|
Increases
in capital stock
|
|
|
0
|
|
|
24,693
|
|
|
392,351
|
|
Contributions
for future capital stock increases
|
|
|
-
|
|
|
230,310
|
|
|
-
|
|
Tax
on assets
|
|
|
-
|
|
|
(1,715
|
)
|
|
170
|
|
Long
term account receivables to subsidiary companies
|
|
|
861,075
|
|
|
548,921
|
|
|
(496,809
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Funds
provided by financing activities
|
|
|
861,075
|
|
|
802,209
|
|
|
(104,288
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Investing
activities:
|
|
|
|
|
|
|
|
|
|
|
Acquisition
of property
|
|
|
(1,645
|
)
|
|
(183,329
|
)
|
|
-
|
|
Investment
in subsidiary companies
|
|
|
(771,369
|
)
|
|
(917,922
|
)
|
|
(3,307
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Funds
used in investing activities
|
|
|
(773,014
|
)
|
|
(1,101,251
|
)
|
|
(3,307
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in cash and equivalents
|
|
|
(16,720
|
)
|
|
(2,497
|
)
|
|
20,927
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and equivalents:
|
|
|
|
|
|
|
|
|
|
|
At
beginning of year
|
|
|
18,584
|
|
|
21,081
|
|
|
154
|
|
|
|
|
|
|
|
|
|
|
|
|
At
end of year
|
|
$
|
1,864
|
|
|
18,584
|
|
|
21,081
|
|
See
accompanying notes to consolidated financial statements.
GRUPO
SIMEC, S.A. DE C.V. (Parent Company Only)
Condensed
statements of changes in financial position
Years
ended December 31, 2005, 2004 and 2003
(Thousands
of constant Mexican pesos as of June 30, 2006)
1
|
Organization
of the Company and certain other
information:
|
The
accompanying condensed financial statements reflect the results of operations
of
the Company since its incorporation in August 1990.
Information
with respect to the Company's material contingencies are presented in note
16 of
the consolidated financial statements.
Exhibit
I
UNAUDITED
FINANCIAL INFORMATION AS OF AND FOR THE NINE MONTH PERIODS
ENDED SEPTEMBER 30, 2006 AND 2005
Set
forth
below is our unaudited financial information as of September 30, 2006 and
for
the three months and nine months ended September 30, 2006 and 2005. This
financial information has been prepared in accordance with Mexican GAAP and
is
presented in constant pesos with purchasing power as of September 30, 2006.
This
unaudited financial information includes all adjustments, consisting of only
normally recurring adjustments, necessary for a fair presentation of this
financial information. You should read this unaudited financial information
together with our audited consolidated financial statements as of December
31,
2005 and 2004 and for each of the three years in the period ended December
31,
2005, which are included elsewhere in this prospectus. Since this unaudited
financial information is presented in constant Mexican pesos with purchasing
power as of September 30, 2006, it is not directly comparable to the financial
information presented elsewhere in this prospectus, which, unless otherwise
stated, is presented in constant Mexican pesos with purchasing power as of
June
30, 2006. The financial information presented elsewhere in this prospectus
stated in constant Mexican pesos with purchasing power as of June 30, 2006
would
require the application of a restatement factor of 1.018 for such financial
information to be comparable with this unaudited financial information. We
do
not believe that the application of such factor represents a material change
in
the purchasing power of the Mexican peso during this period. The NCPI increased
2.47% from December 31, 2005 to September 30, 2006 and increased 1.8% from
June
30, 2006 to September 30, 2006.
This
information does not contain all the information and disclosures normally
included in interim financial statements prepared in accordance with Mexican
GAAP. We have not undertaken a U.S. GAAP reconciliation as of September 30,
2006
or the three months or nine months ended September 30, 2006 and 2005.
The
financial information includes the consolidation of Republic from July 22,
2005.
Period to period comparison of our results of operation is made more difficult
as a result of the inclusion of financial information relating to the
acquisition of Republic only from July 22, 2005.
Summary
Consolidated Unaudited Financial Information
|
|
Three
months ended
September
30,
|
|
Nine
months ended
September
30,
|
|
|
|
2005
|
|
2006
|
|
%
Change
|
|
2005
|
|
2006
|
|
%
Change
|
|
|
|
(Millions
of constant pesos with purchasing power as of September 30,
2006)
(except
per share data, percentages and ratios)
|
|
Income
Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
4,677
|
|
|
5,561
|
|
|
18.9
|
%
|
|
8,315
|
|
|
17,688
|
|
|
112.7
|
%
|
Direct
cost of sales
|
|
|
3,890
|
|
|
4,420
|
|
|
13.6
|
%
|
|
6,259
|
|
|
14,276
|
|
|
128.1
|
%
|
Marginal
profit
|
|
|
787
|
|
|
1,141
|
|
|
45.0
|
%
|
|
2,056
|
|
|
3,412
|
|
|
65.9
|
%
|
Indirect
manufacturing, selling, general and administrative
expenses
|
|
|
214
|
|
|
200
|
|
|
(6.5
|
%)
|
|
463
|
|
|
671
|
|
|
44.9
|
%
|
Depreciation
and amortization
|
|
|
94
|
|
|
109
|
|
|
15.9
|
%
|
|
227
|
|
|
314
|
|
|
38.3
|
%
|
Operating
income
|
|
|
479
|
|
|
832
|
|
|
73.7
|
%
|
|
1,366
|
|
|
2,427
|
|
|
77.7
|
%
|
Comprehensive
financing (cost) income
|
|
|
(53
|
)
|
|
(55
|
)
|
|
3.8
|
%
|
|
(89
|
)
|
|
(9
|
)
|
|
(89.9
|
%)
|
Other
income (expense), net
|
|
|
8
|
|
|
(6
|
)
|
|
(175.0
|
%)
|
|
16
|
|
|
27
|
|
|
68.7
|
%
|
Income
before taxes and employee profit sharing
|
|
|
434
|
|
|
771
|
|
|
77.6
|
%
|
|
1,293
|
|
|
2,445
|
|
|
89.1
|
%
|
Income
tax expense and employee profit sharing
|
|
|
56
|
|
|
236
|
|
|
321.4
|
%
|
|
155
|
|
|
343
|
|
|
121.3
|
%
|
Net
income
|
|
|
378
|
|
|
535
|
|
|
41.5
|
%
|
|
1,138
|
|
|
2,102
|
|
|
84.7
|
%
|
Allocation
of net income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
31
|
|
|
56
|
|
|
80.6
|
%
|
|
31
|
|
|
253
|
|
|
716.1
|
%
|
Majority
interest
|
|
|
347
|
|
|
479
|
|
|
38.0
|
%
|
|
1,107
|
|
|
1,849
|
|
|
67.0
|
%
|
Net
income per share
|
|
|
0.84
|
|
|
1.14
|
|
|
35.7
|
%
|
|
2.71
|
|
|
4.40
|
|
|
62.4
|
%
|
Net
income per ADS (1)
|
|
|
2.52
|
|
|
3.41
|
|
|
35.3
|
%
|
|
8.14
|
|
|
13.21
|
|
|
62.2
|
%
|
Weighted
average shares outstanding (thousands)(2)
|
|
|
413,789
|
|
|
421,215
|
|
|
|
|
|
408,101
|
|
|
420,045
|
|
|
|
|
Weighted
average ADSs Outstanding (thousands)
|
|
|
137,930
|
|
|
140,405
|
|
|
|
|
|
136,034
|
|
|
140,015
|
|
|
|
|
Operational
information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual installed
capacity (thousands of tons)
|
|
|
2,847
|
|
|
2,902
|
|
|
|
|
|
2,847
|
|
|
2,902
|
|
|
|
|
Tons
shipped (thousands of tons)
|
|
|
592
|
|
|
680
|
|
|
|
|
|
1,115
|
|
|
2,050
|
|
|
|
|
Mexico
|
|
|
247
|
|
|
250
|
|
|
|
|
|
695
|
|
|
712
|
|
|
|
|
United
States, Canada and others
|
|
|
345
|
|
|
430
|
|
|
|
|
|
420
|
|
|
1,337
|
|
|
|
|
SBQ
steel
|
|
|
385
|
|
|
488
|
|
|
|
|
|
554
|
|
|
1,485
|
|
|
|
|
Structural
and other steel products
|
|
|
207
|
|
|
193
|
|
|
|
|
|
561
|
|
|
565
|
|
|
|
|
Per
ton (Ps.):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales price per ton
|
|
|
7,900
|
|
|
8,178
|
|
|
|
|
|
7,457
|
|
|
8,628
|
|
|
|
|
Cost
of sales per ton
|
|
|
6,571
|
|
|
6,500
|
|
|
|
|
|
5,613
|
|
|
6,964
|
|
|
|
|
Operating
income per ton
|
|
|
809
|
|
|
1,224
|
|
|
|
|
|
1,225
|
|
|
1,184
|
|
|
|
|
Adjusted
EBITDA per ton(3)
|
|
|
968
|
|
|
1,384
|
|
|
|
|
|
1,429
|
|
|
1,337
|
|
|
|
|
Number
of employees
|
|
|
4,433
|
|
|
4,303
|
|
|
|
|
|
4,433
|
|
|
4,303
|
|
|
|
|
_________________________
(1)
|
Following
our three-for-one stock split effective May 30, 2006, one ADS represents
three series B shares; previously one ADS represented one series
B
share.
|
(2)
|
For
U.S. GAAP and Mexican GAAP purposes, the weighted average shares
outstanding were calculated to give effect to the stock split described
in
Note 13(a) to the audited financial statements
at
December 31, 2005.
|
(3)
|
Adjusted
EBITDA is not a financial measure computed under Mexican or U.S.
GAAP.
Adjusted EBITDA derived from our Mexican GAAP financial information
means
Mexican GAAP net income (loss) excluding (i) depreciation and
amortization, (ii) financial income (expense), net (which is composed
of
net interest expense, foreign exchange gain or loss and monetary
position
gain or loss), (iii) other income (expense) and (iv) income tax
expense
and employee statutory profit-sharing
expense.
|
We
believe that adjusted EBITDA can be useful to facilitate comparisons of
operating performance between periods and with other companies in our industry
because it excludes the effect of (i) depreciation and amortization, which
represents a non-cash charge to earnings, (ii) certain financing costs, which
are significantly affected by external factors, including interest rates,
foreign currency exchange rates, and inflation rates, which have little or
no
bearing on our operating performance, (iii) other income (expense) that are
not
constant operations and (iv) income tax expense and employee statutory
profit-sharing expense. However, adjusted EBITDA has certain material
limitations, including that (i) it does not include taxes, which are a necessary
and recurring part of our operations; (ii) it does not include depreciation
and
amortization, which, because we must utilize property, equipment and other
assets in order to generate revenues in our operations, is a necessary and
recurring part of our costs; (iii) it does not include comprehensive cost
of
financing, which reflects our cost of capital structure and assisted us in
generating revenue; and (iv) it does not include other income and expenses
that
are part of our net income. Therefore, any measure that excludes any or all
of
taxes, depreciation and amortization, comprehensive cost of financing and
other
income and expenses has material limitations.
Adjusted
EBITDA does not represent, and should not be considered as, an alternative
to
net income, as an indicator of our operating performance, or as an alternative
to cash flow as an indicator of liquidity. We believe that adjusted EBITDA
provides a useful measure for investors and analysts to evaluate our performance
and compare it with other companies. In making such comparisons, however,
you
should bear in mind that adjusted EBITDA is not defined and is not a recognized
financial measure under Mexican GAAP or U.S. GAAP and that it may be calculated
differently by different companies and must be read in conjunction with the
explanations that accompany it. Adjusted EBITDA as presented in this table
does
not take into account our working capital requirements, debt service
requirements and other commitments.
Adjusted
EBITDA should not be considered in isolation or as a substitute for net income,
net cash flow from operating activities or net cash flow from investing and
financing activities. Reconciliation of net income to adjusted EBITDA is
as
follows:
|
|
Three
months ended
September
30,
|
|
Nine
Months ended
September
30,
|
|
|
|
2005
|
|
2006
|
|
2005
|
|
2006
|
|
Net
income
|
|
|
378
|
|
|
535
|
|
|
1,138
|
|
|
2,102
|
|
Depreciation
and amortization
|
|
|
94
|
|
|
109
|
|
|
227
|
|
|
314
|
|
Financial
income (expense)
|
|
|
(53
|
)
|
|
(55
|
)
|
|
(89
|
)
|
|
(9
|
)
|
Income
tax expense and employee profit sharing
|
|
|
56
|
|
|
236
|
|
|
155
|
|
|
343
|
|
Other
income (expense)
|
|
|
8
|
|
|
(6
|
)
|
|
16
|
|
|
27
|
|
Adjusted
EBITDA
|
|
|
573
|
|
|
941
|
|
|
1,593
|
|
|
2,741
|
|
Comparison
of Nine Months Ended September 30, 2006 and 2005
Net
Sales
Our
net
sales increased 113% to Ps. 17,688 million in the nine-month period ended
September 30, 2006 (including net sales of Ps. 11,942 million generated by
Republic), compared to Ps. 8,315 million in the same period of 2005 (including
net sales of Ps. 2,943 million generated by Republic from July 22 to September
30, 2005). Net sales, excluding sales of Republic increased 7% from Ps. 5,372
million to Ps. 5,746 million due to higher prices for our basic steel products
(the average price increased 10% in real terms in the nine-month period ended
September 30, 2006 compared to the same period in 2005). Sales in metric
tons of
steel products increased 84% to 2,049,646 metric tons in the nine-month period
ended September 30, 2006 (including 1,258,429 metric tons generated by Republic)
compared to 1,115,054 metric tons in the same period of 2005 (including 308,719
metric tons generated by Republic since its acquisition). Sales outside of
Mexico (including sales by U.S. subsidiaries) of basic steel products increased
219% to 1,338,029 metric tons in the nine-month period ended September 30,
2006
(including 1,258,429 metric tons generated by Republic) compared to 420,052
metric tons in the same period of 2005 (including 308,719 metric tons generated
by Republic since its acquisition). We sell billet only when we cannot use
it in
our steel production process. We sold 1,388 metric tons of billet in the
nine-month period ended September 30, 2006, compared to 13,305 tons of billet
in
the same period of 2005. The average price of steel products increased 17%
in
real terms in the nine-month period ended September 30, 2006 compared to
the
same period in 2005. We attribute this increase to higher prices prevailing
in
the Mexican steel markets.
Direct
Cost of Sales
Our
direct cost of sales increased 128% to Ps. 14,276 million in the nine-month
period ended September 30, 2006 (including Ps. 10,731 million relating to
Republic) compared to Ps. 6,259 million in the same period of 2005 (including
Ps. 2,726 million relating to Republic since its acquisition). Direct cost
of
sales, excluding Republic, remain substantially unchanged reflecting Ps.
3,545
million in the nine-month period ended September 30, 2006 compared to Ps.
3,533
million in the same period of 2005. The average cost of raw materials used
to
produce a ton of steel products increased 3% in real terms in the nine-month
period ended September 30, 2006 compared to the same period of 2005. Direct
cost
of sales as a percentage of net sales was 81% in the nine-month period ended
September 30, 2006 compared to 75% in the same period of 2005. We attribute
the
higher cost of sales in the nine-month period ended September 30, 2006 primarily
to additional direct cost of sales at Republic. The average cost of raw
materials used to produce a ton of steel products increased 25% in real terms
in
the nine-month period ended September 30, 2006 compared to the same period
of
2005, primarily resulting from increased raw materials costs at
Republic.
Marginal
Profit
Our
marginal profit increased 66% to Ps. 3,412 million in the nine-month period
ended September 30, 2006 (including Ps. 1,211 million relating to Republic)
compared to Ps. 2,056 million in the same period of 2005 (including Ps. 217
million relating to Republic since its acquisition). As a percentage of net
sales, marginal profit was 19% in the nine-month period ended September 30,
2006
compared to 25% in the same period of 2005. This decrease is the result of
the
higher cost of sales prevailing at our Republic facilities.
Indirect
Manufacturing, Selling, General and Administrative Expenses
Our
indirect manufacturing, selling, general, and administrative expenses (which
include depreciation and amortization) increased 43% to Ps. 985 million in
the
nine-month period ended September 30, 2006 (including Ps. 439 million relating
to Republic) from Ps. 690 million in the same period of 2005 (including Ps.
120
million relating to Republic since its acquisition). Republic’s indirect
manufacturing, selling, general and administrative expenses (which include
depreciation and amortization) included in our consolidated results increased
266% from Ps. 120 million to Ps. 439 million, due to the consolidation of
Republic’s results for the full nine-month period ended September 30, 2006,
whereas in the same period of 2005 we consolidated Republic’s results from July
22 to September 30, 2005. Depreciation and amortization expense, in the
nine-month period ended September 30, 2006 increased to Ps. 314 million
(including Ps. 113 million relating to Republic) compared to Ps. 227 million
in
the same period of 2005 (including Ps. 29 million relating to Republic).
We
attribute this increase to operating expenses from our Republic facilities,
which we acquired in July of 2005.
Operating
Income
Our
operating income increased 78% to Ps. 2,427 million in the nine-month period
ended September 30, 2006 (including Ps. 771 million relating to Republic)
compared to Ps. 1,366 million in the same period of 2005 (including Ps. 97
million relating to Republic). Republic’s operating income included in our
consolidated results increased 695% to Ps. 771 million from Ps. 97 million
reflecting the consolidation of Republic’s results for the full nine-month
period ended September 30, 2006, whereas in the same period of 2005 we
consolidated Republic’s results only from July 22 to September 30, 2005. As a
percentage of net sales, operating income decreased from 16% in the nine-month
period ended September 30, 2005 to 14% in the nine-month period ended September
30, 2006. We attribute the decrease as a percentage of net sales to the higher
cost of sales prevailing at our Republic facilities.
Financial
Income (Expense)
We
recorded financial expense of Ps. 9 million in the nine-month period ended
September 30, 2006 compared to financial expense of Ps. 89 million in the
same
period of 2005. We recorded an exchange loss of approximately Ps. 16 million
in
the nine-month period ended September 30, 2006 compared to an exchange loss
of
Ps. 72 million in the same period of 2005, reflecting a 2.2% decrease in
the
value of the peso compared to the dollar in the nine-month period ended
September 30, 2006 compared to a 3.7% increase in the value of the peso versus
the dollar in the same period of 2005. Net interest income was Ps. 28 million
in
the nine-month period ended September 30, 2006 versus net interest income
of Ps.
1 million in the same period of 2005. We recorded a loss from monetary position
of Ps. 21 million in the nine-month period ended September 30, 2006 compared
to
a loss from monetary position of Ps. 18 million in the same period of 2005,
reflecting the domestic inflation rate of 2.47% in the nine-month period
ended
September 30, 2006 as compared to a 1.72% inflation rate in the same period
of
2005. We attribute the decrease in financial income less exchange loss due
to a
decrease in the value of the Mexican peso relative to the dollar and to higher
net interest income due in part to our low level of debt.
Other
Income (Expense), Net
We
recorded other income, net, of Ps. 27 million in the nine-month period ended
September 30, 2006 compared to other income, net, of Ps. 16 million in the
same
period of 2005.
Income
Tax and Employee Profit Sharing
We
recorded an income tax provision of Ps. 343 million for income tax and employee
profit sharing in the nine-month period ended September 30, 2006 (including
a
decrease in the provision of Ps. 160 million with respect to deferred income
tax) compared to a provision of Ps. 155 million in the same period of 2005
(including an increase in the provision of Ps. 91 million with respect to
deferred income tax). This provision increased due to higher net sales,
operating income and financial income.
Our
effective tax rate was 12% and 14% for the nine-month periods ended September
30, 2005 and 2006, respectively. For the nine month period ended September
30,
2005, our effective tax rate was lower than the 30% applicable tax rate in
Mexico. Our effective tax rate was lower mainly because in 2005 we recognized
a
tax benefit from future non-accumulation of our inventory balance at December
31, 2004 due to the spin-off of our subsidiary, COSICA. In addition, our
2005
effective tax rate was lower due to a decrease in our deferred assets valuation
allowance resulting from an improved recovery of these assets. For the nine
month period ended September 30, 2006, our effective tax rate was lower than
the
29% and 35% tax rates applicable in Mexico and the United States, respectively,
mainly because in 2006 we amortized all of our deferred tax credit which
constituted non-taxable income.
Net
Income
As
a
result of the foregoing, we recorded net income of Ps. 1,849 million in the
nine-month period of 2006 compared to net income of Ps. 1,108 million in
the
same period of 2005. We attribute this increase primarily to net income from
our
Republic facilities and higher net income at our facilities in
Mexico.
Liquidity
and Capital Resources
Net
resources provided by operations were Ps. 1,359 million in the nine-month
period
ended September 30, 2006 versus Ps. 1,242 million of net resources provided
by
operations in the same period of 2005. Net resources used in financing
activities were Ps. 114 million in the nine-month period ended September
30,
2006 (which amount includes the prepayment of Ps. 399 million (U.S. $37.7
million) of Republic’s bank debt and a capital contribution of certain of our
minority shareholders of Ps. 124 million) versus Ps. 1,604 million of net
resources provided by financing activities in the same period of 2005. Net
resources provided by investing activities (to acquire property, plant and
equipment, other non-current assets and liabilities and proceeds from insurance
claim) were Ps. 190 million in the nine-month period ended September 30,
2006
versus net resources used in investing activities of Ps. 2,816 million in
the
same period of 2005 including the acquisition of Republic
facilities
The
following pages contains Condensed Consolidated Financial Information of
Grupo
Simec, S.A.B. de C.V. and Subsidiaries as of December 31, 2005 and September
30,
2006 and for the three-month and nine-month periods ended September 30, 2005
and
2006.
Unaudited
Condensed Consolidated Balance Sheets
(Thousands
of constant Mexican Pesos with purchasing power as of September 30,
2006)
Assets
|
|
|
|
Audited
December
31,
2005
|
|
Unaudited
September
30,
2006
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
|
Ps.
|
|
|
213,185
|
|
|
1,648,802
|
|
Accounts
receivable, net
|
|
|
|
|
|
2,667,544
|
|
|
2,673,682
|
|
Inventories,
net
|
|
|
|
|
|
3,726,390
|
|
|
4,652,439
|
|
Derivative
financial instruments
|
|
|
|
|
|
58,512
|
|
|
20,831
|
|
Prepaid
expenses and other current assets
|
|
|
|
|
|
234,370
|
|
|
142,306
|
|
Total
current assets
|
|
|
|
|
|
6,900,001
|
|
|
9,138,060
|
|
|
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
|
|
|
7,243,066
|
|
|
7,289,715
|
|
Other
assets and deferred charges, net
|
|
|
|
|
|
708,084
|
|
|
579,373
|
|
Total
Assets
|
|
|
Ps.
|
|
|
14,851,151
|
|
|
17,007,148
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and stockholders' equity
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
|
Current
portion of long-term debt
|
|
|
Ps.
|
|
|
21,413
|
|
|
181,790
|
|
Accounts
payable and accrued liabilities
|
|
|
|
|
|
2,742,752
|
|
|
2,704,831
|
|
Total
current liabilities
|
|
|
|
|
|
2,764,165
|
|
|
2,886,621
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
|
|
|
398,598
|
|
|
-
|
|
Other
long-term liabilities
|
|
|
|
|
|
346,077
|
|
|
105,177
|
|
Deferred
taxes
|
|
|
|
|
|
1,540,314
|
|
|
1,773,359
|
|
Total
long-term liabilities
|
|
|
|
|
|
2,284,989
|
|
|
1,878,536
|
|
Total
liabilities
|
|
|
|
|
|
5,049,154
|
|
|
4,765,157
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity
|
|
|
|
|
|
|
|
|
|
|
Capital
stock
|
|
|
|
|
|
3,539,076
|
|
|
3,575,911
|
|
Additional
paid-in-capital
|
|
|
|
|
|
860,228
|
|
|
947,917
|
|
Retained
earnings
|
|
|
|
|
|
4,601,031
|
|
|
6,449,767
|
|
|
|
|
|
|
|
9,000,335
|
|
|
10,973,595
|
|
Other
accumulated comprehensive (loss) income items
|
|
|
|
|
|
(1,038,561
|
)
|
|
(967,668
|
)
|
Majority
stockholders' equity
|
|
|
|
|
|
7,961,774
|
|
|
10,005,927
|
|
Minority
interest
|
|
|
|
|
|
1,840,223
|
|
|
2,236,064
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
stockholders' equity
|
|
|
|
|
|
9,801,997
|
|
|
12,241,991
|
|
Total
liabilities and stockholders' equity
|
|
|
Ps.
|
|
|
14,851,151
|
|
|
17,007,148
|
|
GRUPO
SIMEC, S.A.B. DE C.V. AND SUBSIDIARIES
Unaudited
Condensed Consolidated Statements of Income
(Thousands
of constant Mexican Pesos with purchasing power as of September 30, 2006,
except
earnings per share figures)
|
|
|
|
Unaudited
Three
months ended
September
30,
|
|
|
|
|
|
2005
|
|
2006
|
|
Net
sales
|
|
|
Ps.
|
|
|
4,677,464
|
|
|
5,561,063
|
|
Direct
cost of sales
|
|
|
|
|
|
3,890,433
|
|
|
4,420,046
|
|
Marginal
profit
|
|
|
|
|
|
787,031
|
|
|
1,141,017
|
|
|
|
|
|
|
|
|
|
|
|
|
Indirect
overhead, selling, general and administrative expenses
|
|
|
|
|
|
308,391
|
|
|
308,587
|
|
Operating
income
|
|
|
|
|
|
478,640
|
|
|
832,430
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financing result:
|
|
|
|
|
|
|
|
|
|
|
Interest
(expense) income, net
|
|
|
|
|
|
(6,972
|
)
|
|
13,298
|
|
Foreign
exchange loss, net
|
|
|
|
|
|
(35,240
|
)
|
|
(35,245
|
)
|
Monetary
position loss
|
|
|
|
|
|
(10,782
|
)
|
|
(33,217
|
)
|
Comprehensive
financing cost, net
|
|
|
|
|
|
(52,994
|
)
|
|
(55,164
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense), net
|
|
|
|
|
|
7,955
|
|
|
(6,238
|
)
|
Income
before income tax and employee profit sharing
|
|
|
|
|
|
433,601
|
|
|
771,028
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax:
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
(10,503
|
)
|
|
331,597
|
|
Deferred
|
|
|
|
|
|
66,252
|
|
|
(95,174
|
)
|
Total
income tax
|
|
|
|
|
|
55,749
|
|
|
236,423
|
|
Net
consolidated income
|
|
|
Ps.
|
|
|
377,852
|
|
|
534,605
|
|
Allocation
of net income:
|
|
|
|
|
|
|
|
|
|
|
Majority
interest
|
|
|
Ps.
|
|
|
346,929
|
|
|
478,641
|
|
Minority
interest
|
|
|
|
|
|
30,923
|
|
|
55,964
|
|
|
|
|
Ps. |
|
|
377,852
|
|
|
534,605
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
413,788,797
|
|
|
421,214,706
|
|
Earnings
per share
|
|
|
Ps.
|
|
|
0.84
|
|
|
1.14
|
|
GRUPO
SIMEC, S.A.B. DE C.V. AND SUBSIDIARIES
Unaudited
Condensed Consolidated Statements of Income
(Thousands
of constant Mexican Pesos with purchasing power as of September 30, 2006,
except
earnings per share figures)
|
|
|
|
Unaudited
Nine
months ended
September
30,
|
|
|
|
|
|
2005
|
|
2006
|
|
Net
sales
|
|
|
Ps.
|
|
|
8,314,963
|
|
|
17,687,953
|
|
Direct
cost of sales
|
|
|
|
|
|
6,258,671
|
|
|
14,276,220
|
|
Marginal
profit
|
|
|
|
|
|
2,056,292
|
|
|
3,411,733
|
|
|
|
|
|
|
|
|
|
|
|
|
Indirect
overhead, selling, general and administrative expenses
|
|
|
|
|
|
689,764
|
|
|
984,634
|
|
Operating
income
|
|
|
|
|
|
1,366,528
|
|
|
2,427,099
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financing result:
|
|
|
|
|
|
|
|
|
|
|
Interest
income, net
|
|
|
|
|
|
1,634
|
|
|
28,407
|
|
Foreign
exchange loss, net
|
|
|
|
|
|
(71,813
|
)
|
|
(16,312
|
)
|
Monetary
position loss
|
|
|
|
|
|
(18,520
|
)
|
|
(21,435
|
)
|
Comprehensive
financing (cost) income, net
|
|
|
|
|
|
(88,699
|
)
|
|
(9,340
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other
income, net
|
|
|
|
|
|
15,725
|
|
|
27,099
|
|
Income
before income tax and employee profit sharing
|
|
|
|
|
|
1,293,554
|
|
|
2,444,858
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax:
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
64,141
|
|
|
502,853
|
|
Deferred
|
|
|
|
|
|
90,847
|
|
|
(159,602
|
)
|
Total
income tax
|
|
|
|
|
|
154,988
|
|
|
343,251
|
|
Net
income
|
|
|
Ps.
|
|
|
1,138,566
|
|
|
2,101,607
|
|
Allocation
of net income:
|
|
|
|
|
|
|
|
|
|
|
Majority
interest
|
|
|
Ps.
|
|
|
1,107,643
|
|
|
1,848,736
|
|
Minority
interest
|
|
|
|
|
|
30,923
|
|
|
252,871
|
|
|
|
|
Ps. |
|
|
1,138,566 |
|
|
2,101,607 |
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
408,100,659
|
|
|
420,045,057
|
|
Earnings
per share
|
|
|
Ps.
|
|
|
2.71
|
|
|
4.40
|
|
EXHIBIT
I
Unaudited
Pro Forma Condensed Combined Statements of Income
The
unaudited proforma condensed combined statements of income for the nine months
and three months ended September 30, 2005, give effect to Republic’s acquisition
as if it had occurred on January 1, 2005.
|
|
Three
months-ended
September
30,
|
|
Nine
months ended
September
30,
|
|
|
|
Pro
Forma
|
|
|
|
|
|
Pro
Forma
|
|
|
|
|
|
|
|
2005
|
|
2006
|
|
%
Change
|
|
2005
|
|
2006
|
|
%
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexican
GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
5,412
|
|
|
5,561
|
|
|
2.8
|
%
|
|
18,024
|
|
|
17,688
|
|
|
(1.9
|
%)
|
Direct
cost of sales
|
|
|
4,574
|
|
|
4,420
|
|
|
(3.4
|
%)
|
|
14,741
|
|
|
14,276
|
|
|
(3.2
|
%)
|
Marginal
profit
|
|
|
838
|
|
|
1,141
|
|
|
36.2
|
%
|
|
3,283
|
|
|
3,412
|
|
|
3.9
|
%
|
Indirect
manufacturing, selling, general and administrative
expenses
|
|
|
316
|
|
|
200
|
|
|
(36.7
|
%)
|
|
1,036
|
|
|
671
|
|
|
(35.2
|
%)
|
Depreciation
and amortization
|
|
|
96
|
|
|
109
|
|
|
13.5
|
%
|
|
243
|
|
|
314
|
|
|
29.2
|
%
|
Operating
income
|
|
|
426
|
|
|
832
|
|
|
95.3
|
%
|
|
2,004
|
|
|
2,427
|
|
|
21.1
|
%
|
Financial
(expense)
|
|
|
(47
|
)
|
|
(55
|
)
|
|
17.0
|
%
|
|
(170
|
)
|
|
(9
|
)
|
|
(94.7
|
%)
|
Other
income (expense), net
|
|
|
11
|
|
|
(6
|
)
|
|
(154.5
|
%)
|
|
46
|
|
|
27
|
|
|
(41.3
|
%)
|
Income
before taxes employee profit sharing
|
|
|
390
|
|
|
771
|
|
|
97.7
|
%
|
|
1,880
|
|
|
2,445
|
|
|
30.1
|
%
|
Income
tax expense and employee profit sharing
|
|
|
29
|
|
|
236
|
|
|
713.8
|
%
|
|
358
|
|
|
343
|
|
|
(4.2
|
%)
|
Net
income
|
|
|
361
|
|
|
535
|
|
|
48.2
|
%
|
|
1,523
|
|
|
2,102
|
|
|
38.0
|
%
|
Minority
interest
|
|
|
30
|
|
|
56
|
|
|
86.7
|
%
|
|
230
|
|
|
253
|
|
|
10.0
|
%
|
Majority
interest
|
|
|
331
|
|
|
479
|
|
|
44.7
|
%
|
|
1,293
|
|
|
1,849
|
|
|
43.0
|
%
|
Net
income per share
|
|
|
0.80
|
|
|
1.14
|
|
|
42.5
|
%
|
|
3.17
|
|
|
4.40
|
|
|
38.8
|
%
|
Net
income per ADS (1)
|
|
|
2.40
|
|
|
3.41
|
|
|
42.1
|
%
|
|
9.50
|
|
|
13.21
|
|
|
38.9
|
%
|
Weighted
average shares outstanding (thousands)(2)
|
|
|
413,789
|
|
|
421,215
|
|
|
|
|
|
408,101
|
|
|
420,045
|
|
|
|
|
Weighted
average ADSs Outstanding (thousands)
|
|
|
137,930
|
|
|
140,405
|
|
|
|
|
|
136,034
|
|
|
140,015
|
|
|
|
|
Operational
information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual installed
capacity
|
|
|
2,847
|
|
|
2,902
|
|
|
|
|
|
2,847
|
|
|
2,902
|
|
|
|
|
Tons
shipped
|
|
|
678
|
|
|
680
|
|
|
|
|
|
2,078
|
|
|
2,050
|
|
|
|
|
Mexico
|
|
|
247
|
|
|
250
|
|
|
|
|
|
695
|
|
|
712
|
|
|
|
|
United
States, Canada and others
|
|
|
431
|
|
|
430
|
|
|
|
|
|
1,383
|
|
|
1,337
|
|
|
|
|
SBQ
steel
|
|
|
471
|
|
|
488
|
|
|
|
|
|
1,517
|
|
|
1,485
|
|
|
|
|
Structural
and other steel products
|
|
|
208
|
|
|
193
|
|
|
|
|
|
561
|
|
|
565
|
|
|
|
|
Per
ton:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales per ton
|
|
|
7,982
|
|
|
8,178
|
|
|
|
|
|
8,674
|
|
|
8,628
|
|
|
|
|
Cost
of sales per ton
|
|
|
6,746
|
|
|
6,500
|
|
|
|
|
|
7,094
|
|
|
6,964
|
|
|
|
|
Operating
income per ton
|
|
|
628
|
|
|
1,224
|
|
|
|
|
|
964
|
|
|
1,184
|
|
|
|
|
Adjusted
EBITDA per ton(3)
|
|
|
770
|
|
|
1,384
|
|
|
|
|
|
1,081
|
|
|
1,337
|
|
|
|
|
Number
of employees
|
|
|
4,433
|
|
|
4,303
|
|
|
|
|
|
4,433
|
|
|
4,303
|
|
|
|
|
(1)
|
Following
our stock split effective May 30, 2006, one ADS represents three
series B
shares; previously one ADS represented one series B
share.
|
(2)
|
For
U.S. GAAP and Mexican GAAP purposes, the weighted average shares
outstanding were calculated to give effect to the stock split described
in
Note 13(a) to the audited financial statements at December 31,
2005.
|
(3)
|
Adjusted
EBITDA is not a financial measure computed under Mexican or U.S.
GAAP.
Adjusted EBITDA derived from our Mexican GAAP financial information
means
Mexican GAAP net income (loss) excluding (i) depreciation and
amortization, (ii) financial income (expense), net (which is composed
of
net interest expense, foreign exchange gain or loss and monetary
position
gain or loss), (iii) other income (expense) and (iv) income tax
expense
and employee statutory profit-sharing
expense.
|
We
believe that adjusted EBITDA can be useful to facilitate comparisons of
operating performance between periods and with other companies in our industry
because it excludes the effect of (i) depreciation and amortization, which
represents a non-cash charge to earnings, (ii) certain financing costs, which
are significantly affected by external factors, including interest rates,
foreign currency exchange rates, and inflation rates, which have little or
no
bearing on our operating performance, (iii) other income (expense) that are
not
constant operations and (iv) income tax expense and employee statutory
profit-sharing expense. However, adjusted EBITDA has certain material
limitations, including that (i) it does not include taxes, which are a necessary
and recurring part of our operations; (ii) it does not include depreciation
and
amortization, which, because we must utilize property, equipment and other
assets in order to generate revenues in our operations, is a necessary and
recurring part of our costs; (iii) it does not include comprehensive cost
of
financing, which reflects our cost of capital structure and assisted us in
generating revenue; and (iv) it does not include other income and expenses
that
are part of our net income. Therefore, any measure that excludes any or all
of
taxes, depreciation and amortization, comprehensive cost of financing and
other
income and expenses has material limitations.
Adjusted
EBITDA does not represent, and should not be
considered as, an alternative to net income, as an indicator of our operating
performance, or as an alternative to cash flow as an indicator of liquidity.
We
believe that adjusted EBITDA provides a useful measure of our performance
that
is widely used by investors and analysts to evaluate our performance and
compare
it with other companies. In making such comparisons, however, you should
bear in
mind that adjusted EBITDA is not defined and is not a recognized financial
measure under Mexican GAAP or U.S. GAAP and that it may be calculated
differently by different companies. Adjusted EBITDA as presented in this
table
does not take into account our working capital requirements, debt service
requirements and other commitments.
Adjusted
EBITDA should not be considered in
isolation or as a substitute for net income, net cash flow from operating
activities or net cash flow from investing and financing activities.
Reconciliation of operating income to adjusted EBITDA is as follows:
|
|
Three
months ended
September
30,
|
|
Nine
Months ended
September
30,
|
|
|
|
2005
|
|
2006
|
|
2005
|
|
2006
|
|
Net
income
|
|
|
361
|
|
|
535
|
|
|
1,523
|
|
|
2,102
|
|
Depreciation
and amortization
|
|
|
96
|
|
|
109
|
|
|
243
|
|
|
314
|
|
Financial
income (expense)
|
|
|
(47
|
)
|
|
(55
|
)
|
|
(170
|
)
|
|
(9
|
)
|
Income
tax expense and employee profit sharing
|
|
|
29
|
|
|
236
|
|
|
358
|
|
|
343
|
|
Other
income (expense)
|
|
|
11
|
|
|
(6
|
)
|
|
46
|
|
|
27
|
|
Adjusted
EBITDA
|
|
|
522
|
|
|
941
|
|
|
2,248
|
|
|
2,741
|
|
Unaudited
Pro Forma Condensed Combined Statements of Income
On
July
22, 2005, the Company and Industrias CH acquired the outstanding shares of
PAV
Republic Inc. (Republic) through the Company’s subsidiary SimRep Corporation, a
U.S. company. Such transaction was valued at $245 million where $229 million
corresponds to the purchase price and $16 million, to the direct cost of
the
business combination. The Company contributed $123 million to acquire 50.2%
of
the representative shares of SimRep Corporation and Industrias CH, the Company’s
parent, acquired the remaining 49.8%. SimRep then acquired all the shares
from
Republic through a stock purchase agreement. Under the terms of the sock
purchase agreement, the Company acquired the right to a portion of the
reimbursement from an unresolved insurance claim. On April 24, 2006 a Settlement
Agreement and Release was reached and approximately Ps. 414 millions, net
of
payment to the predecessor’s shareholders of Ps. 215 million and professional
fees, has been received by the Company. Due to the receipt, the Company changed
the final purchase accounting adjustment to reflect the fair value of the
assets
acquired and liabilities assumed.
The
unaudited proforma condensed combined statements of income for the nine months
ended September 30, 2005, give effect to Republic’s acquisition as if it
occurred on January 1, 2005.
Unaudited
Pro Forma Condensed Combined Statements of Income
For
the Nine Months Ended September 30, 2005
(Thousands
of Constant Mexican pesos as of September 30, 2006, except earnings per share
figures)
|
|
|
|
Simec
as
reported
|
|
|
|
PAV
Republic
(1)
|
|
|
|
Proforma
adjustments
|
|
|
|
Simec
Pro
Forma
|
|
Net
sales
|
|
|
Ps.
|
|
|
8,314,963
|
|
|
Ps.
|
|
|
9,708,973
|
|
|
Ps.
|
|
|
-
|
|
|
Ps.
|
|
|
18,023,936
|
|
Direct
Cost of Sales
|
|
|
|
|
|
6,258,671
|
|
|
|
|
|
8,481,988
|
|
|
|
|
|
-
|
|
|
|
|
|
14,740,659
|
|
Marginal
Profit
|
|
|
|
|
|
2,056,292
|
|
|
|
|
|
1,226,985
|
|
|
|
|
|
-
|
|
|
|
|
|
3,283,277
|
|
Indirect
overhead, selling, general and administrative expenses
|
|
|
|
|
|
689,764
|
|
|
|
|
|
562,363
|
|
|
|
|
|
26,836
|
|
|
(2
|
)
|
|
1,278,963
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
|
|
|
1,366,528
|
|
|
|
|
|
664,622
|
|
|
|
|
|
(26,836
|
)
|
|
|
|
|
2,004,314
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
financing cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
(expense) income , net
|
|
|
|
|
|
1,634
|
|
|
|
|
|
(102,615
|
)
|
|
|
|
|
5,694
|
|
|
|
|
|
(95,287
|
)
|
Foreign
exchange (loss) gain, net
|
|
|
|
|
|
(71,813
|
)
|
|
|
|
|
16,077
|
|
|
|
|
|
|
|
|
|
|
|
(55,736
|
)
|
Monetary
position loss
|
|
|
|
|
|
(18,520
|
)
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
(18,520
|
)
|
Comprehensive
financial result, net
|
|
|
|
|
|
(88,699
|
)
|
|
|
|
|
(86,538
|
)
|
|
|
|
|
5,694
|
|
|
(3
|
)
|
|
(169,543
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expenses), net
|
|
|
|
|
|
15,725
|
|
|
|
|
|
30,399
|
|
|
|
|
|
-
|
|
|
|
|
|
46,124
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income tax, statutory employee profit sharing and minority
interest
|
|
|
|
|
|
1,293,554
|
|
|
|
|
|
608,483
|
|
|
|
|
|
(21,142
|
)
|
|
|
|
|
1,880,895
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
64,141
|
|
|
|
|
|
148,777
|
|
|
|
|
|
-
|
|
|
|
|
|
212,918
|
|
Deferred
|
|
|
|
|
|
90,847
|
|
|
|
|
|
62,290
|
|
|
|
|
|
(7,932
|
)
|
|
(4
|
)
|
|
145,205
|
|
Total
income tax
|
|
|
|
|
|
154,988
|
|
|
|
|
|
211,067
|
|
|
|
|
|
(7,932
|
)
|
|
|
|
|
358,123
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
consolidated income
|
|
|
|
|
|
1,138,566
|
|
|
|
|
|
397,416
|
|
|
|
|
|
(13,210
|
)
|
|
(5
|
)
|
|
1,522,772
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allocation
on net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
|
|
|
30,923
|
|
|
|
|
|
197,834
|
|
|
|
|
|
(6,576
|
)
|
|
|
|
|
222,181
|
|
Majority
interest
|
|
|
|
|
|
1,107,643
|
|
|
|
|
|
199,582
|
|
|
|
|
|
(6,634
|
)
|
|
|
|
|
1,300,591
|
|
|
|
|
Ps.
|
|
|
1,138,566
|
|
|
|
|
|
397,416
|
|
|
|
|
|
(13,210
|
)
|
|
(6
|
)
|
|
1,522,772
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
408,100,659
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
408,100,659
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share (pesos)
|
|
|
|
|
|
2.71
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3.19
|
|
|
(1)
|
This
column shows the income statement of Pav Republic for period from
January
1, 2005 to July 22, 2005.
|
|
(2)
|
The
increase in the expenses is driven by two components; the first
one is the
decrease of the stock compensation expense of $61,134. The company
terminated the stock compensation plan at the time of the purchase
and
provided no additional compensation to employees to replace this
lost
benefit. The company made the assumption that the stock compensation
recognized during the period January 1, 2005 - July 22, 2005 would
not be
recorded if the purchase would have taken place on January 1, 2005.
The
second component is an increase in depreciation and amortization
expense
of $87,970, due to the purchase price allocation to intangibles
related to
Republic’s Union Agreement, Kobe Tech, Customer relationships and Republic
trade name being recorded at the time of purchase. The Company
made the
assumption that Republic would have booked this entry as of January
1,
2005 and the Company recorded an additional seven months of amortization
expense. Also the depreciation expense was adjusted as if the allocation
of the purchase price would have taken place on January 1, 2005.
The value
of the plant, property and equipment increased and depreciation
expense
increased accordingly.
|
|
(3)
|
Due
to the allocation of the purchase price to the deferred financing
costs
related to the Perry Note and the GE revolver (both items were
subject to
a decrease in the cost basis) as of July 22, 2005, the Company
adjusted
the amortization expense to reflect the decrease in cost basis
as if the
purchase would have occurred on January 1,
2005.
|
|
(4)
|
The
company adjusted the income tax expense to reflect the change in
net
income due to the decrease in selling, general and administrative
expenses, increase in depreciation and amortization and decrease
in
interest expense described above at a rate of 37.5% which was the
effective income tax rate of
Republic.
|
|
(5)
|
The
decrease in the net income reflects the change due to the decrease
in
selling, general and administrative expenses, increase in depreciation
and
amortization, decrease in interest expense and decrease in the
income tax
expense, described above.
|
|
(6)
|
The
adjustment in the minority interest reflecting Industrias CH’s interest in
Republic.
|
Grupo
Simec, S.A.B. de C.V.
52,173,915
series B shares
Grupo
Simec, S.A.B. de C.V.
PROSPECTUS
February
8,
2007
Citigroup
Co-Manager
Morgan
Stanley