UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

Commission file number 1-31926

 

MITTAL STEEL USA INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

(312) 899-3400

(Registrant’s Telephone Number Including Area Code)

 

 

The Registrant meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form with the reduced disclosure format.

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated Filer  o          Accelerated Filer  o          Non-Accelerated Filer  þ

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of November 14, 2006, the Registrant had 120.81658 shares of common stock, par value $0.01 per share, all of which are ultimately owned by Mittal Steel Company N.V., a company organized under the laws of The Netherlands (Mittal).

 

TABLE OF CONTENTS

 

 

MITTAL STEEL USA INC.

Consolidated Statements of Operations
(Unaudited)
(Dollars in millions)

 

 

See accompanying notes to consolidated financial statements.

MITTAL STEEL USA INC.

 

Consolidated Balance Sheets

(Dollars in millions except share and per share amounts)

 

 

See accompanying notes to consolidated financial statements.

MITTAL STEEL USA INC.

Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in millions)

 

 

See accompanying notes to consolidated financial statements.

MITTAL STEEL USA INC.

 

Notes to Financial Statements

(Unaudited)
(Dollars in millions)

 

 

Effective December 31, 2005, Mittal Steel USA ISG Inc. (Mittal ISG) merged with another indirect wholly owned subsidiary of Mittal Steel Company N.V. (Mittal), Ispat Inland Inc. (Inland). Mittal ISG was the surviving subsidiary and was renamed Mittal Steel USA Inc. (MSUSA or the Company). On April 15, 2005, Mittal acquired International Steel Group Inc. (ISG) which was renamed Mittal Steel USA ISG Inc. The business combination was accounted for under the purchase method. See Note 2, ISG Acquisition for a description of the acquisition.

 

The merger of Mittal ISG and Inland was accounted for as a merger of net assets under common control. The existing book values of the companies were combined without remeasuring the assets and liabilities at the business combination date. The additional paid in capital of Mittal ISG and Inland were combined as of the date of the merger. Although Mittal ISG was the surviving entity, Mittal was the controlling party and the merger between Mittal ISG and Inland was accounted for as a reverse acquisition, with Inland as the accounting acquirer. These financial statements present the combined company for 2006. These financial statements include the results of Mittal ISG and Inland since they have been under the control of Mittal for all periods presented for Inland and since April 15, 2005 for Mittal ISG.

 

These interim financial statements are unaudited and include only selected notes. They do not contain all information required for annual statements under United States generally accepted accounting principles and should be read together with the audited financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. In the opinion of management, these interim financial statements reflect all adjustments that are necessary to fairly present the results for the interim periods presented. Certain prior period amounts have been reclassified to conform to the current presentation.

 

The preparation of financial statements in conformity with United States generally accepted accounting principles requires that management make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The results of operations for the interim periods shown in this report are not necessarily indicative of the results to be expected for a full year.

 

 

On April 15, 2005, ISG became a wholly owned subsidiary of Mittal. ISG’s stockholders received $2,072 in cash and 60,891,883 shares of Mittal Class A common shares valued at $1,922. Mittal accounted for the acquisition under SFAS No. 141, Business Combinations.

 

Assets recorded in the purchase include $384 assigned to favorable supply and sales contracts that are being amortized over the term of the associated contracts ranging from one to six years (two year weighted average). The fair value of $1,095 assigned to unfavorable supply and sales contracts is being amortized over the term of the associated contracts ranging from one to 15 years (three year weighted average). We recognized income of $112 and $304 during the three and nine month periods ended September 30, 2006 related to the net amortization of these items.

 

In connection with this acquisition, we identified certain facilities we are no longer operating. We permanently idled the iron and steel producing operations at our Weirton plant, our hot briquette iron plant in Trinidad, and our AK-ISG joint venture. This will affect about 1,000 employees. We recorded a $180 liability comprised of $113 for contract termination costs, including lease obligations, and $67 for severance and other employee benefits. See Note 9, Other Long-Term Liabilities for a summary of spending against these liabilities.

 

MITTAL STEEL USA INC.

 

Notes to Financial Statements — (Continued)

We would have recorded sales of $2,637 and net income of $45 for the three month period ended September 30, 2005 and sales of $9,227 and net income of $542 for the nine month period ended September 30, 2005 on a pro forma basis, if the merger had been consummated at the beginning of the period. The pro forma adjustments include the effects of the increased value of property, plant and equipment, amortization of intangibles and other acquisition costs. This pro forma data is based on historical information and does not necessarily reflect the actual results that would have occurred, nor is it indicative of future results of operations.

 

 

SFAS No. 151 — In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, Inventory Costs. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight handling costs, and wasted material (spoilage). SFAS No. 151 requires that those items be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. There was no material impact to our financial statements upon the adoption of SFAS No. 151 on January 1, 2006.

 

SFAS No. 123R — In December 2004, the FASB issued SFAS No. 123R, Share Based Payment, which replaces SFAS No. 123, and supersedes APB No. 25. SFAS No. 123R 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. We started expensing stock options from 2003 using the prospective method. In March 2005, the SEC staff issued Staff Accounting Bulletin (SAB) No. 107, Share-Based Payment regarding the SEC’s interpretation of SFAS No. 123R and the valuation of share-based payments for public companies. The adoption of SFAS No. 123R on January 1, 2006 had no impact on our financial statements.

 

SFAS No. 153 — In December 2004, the FASB issued SFAS No. 153, Exchange of Non-monetary Assets. SFAS No. 153 is based on the principle that exchange of non-monetary assets should be measured based on the fair market value of the assets exchanged. SFAS No. 153 eliminates the exception of non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. For MSUSA, SFAS No. 153 was effective for non-monetary asset exchanges in 2006 and thereafter. This statement will only impact our financial statements to the extent we have non-monetary exchanges in the future. None are presently contemplated.

 

SFAS No. 154 — In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections that replaces APB No. 20 Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application to the earliest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. We have had no changes in accounting methods or error corrections that have required restatement since we adopted the pronouncement on January 1, 2006.

 

SFAS No. 155 — In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. This statement eliminates a restriction on the passive derivatives instruments that a qualifying special-purpose entity (SPE) may hold 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. We do not expect the adoption of this pronouncement to have an impact on our financial statements.

 

SFAS No. 156 — In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets. We have a consolidated SPE that purchased certain of our receivables. This entity previously had a financing arrangement with a group of banks. That arrangement is no longer in place, but the SPE still exists. See Note 7 Debt (l) — Former Credit Facilities in our financial statements contained in our Annual Report filed on Form 10-K for the year ended December 31, 2005 for further details. We are currently evaluating

 

MITTAL STEEL USA INC.

 

Notes to Financial Statements — (Continued)

whether SFAS No. 156 will impact the accounting for our SPE and our consolidated financial statements. This statement is effective January 1, 2007.

 

FIN No. 48 — In June 2006, the FASB issued Financial Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, which applies to all tax positions related to income taxes. FIN No. 48 prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN No. 48 provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact, if any, this statement will have on our financial statements.

 

SAB No. 108 — In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 108 (Topic 1N), Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. This SAB addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB 108 requires registrants to quantify errors using both the balance sheet and income approaches and to evaluate whether either approach results in quantifying a misstatement as material in light of relevant quantitative and qualitative factors. When the effect of initial adoption is determined to be material, the SAB allows registrants to record that effect as a cumulative effect adjustment to beginning of the year retained earnings. SAB 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006. We have not had any misstatements requiring restatement. The SAB will only impact us to the extent we identify errors in the future.

 

SFAS No. 157 — In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact, if any, this statement will have on our financial statements.

 

FSP No. AUG AIR-1 — In September 2006, the FASB issued FASB Staff Position (FSP) No. AUG AIR-1, Accounting for Planned Major Maintenance Activities. This FSP prohibits companies from recognizing planned major maintenance costs under the “accrue-in-advance” method that allowed the accrual of a liability over several reporting periods before the maintenance is performed. FSP AUG AIR-1 is applicable to all entities in all industries for fiscal years beginning after December 15, 2006, and must be retrospectively applied. We do not use the “accrue-in-advance” method so the FSP will not have an impact on our financial statements.

 

SFAS No. 158 — In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. This statement requires recognition of the funded status of the benefit plan in the balance sheet. The Statement also requires recognition in other comprehensive income certain gains and losses that arise during the period but are deferred under current pension accounting rules, as well as modifies the timing of reporting. SFAS No. 158 provides recognition and disclosure elements to be effective for fiscal years ending after December 15, 2006, and measurement elements to be effective for fiscal years ending after December 15, 2008. We presently recognize a minimum liability for pensions. That liability will now be recognized based on the projected benefit obligation instead of the accumulated benefit obligation. This will increase the liability recognized on our balance sheet slightly. At the end of 2005, because we had an unrecognized net prior service credit, our recorded liability for other postretirement benefits was greater than the unfunded amounts, meaning we would have reduced our recorded liability with an offsetting entry to stockholder’s equity. Until we remeasure our plan assets and liabilities at our next remeasurement date, we will not be able to determine the impact on our balance sheet. The adoption of SFAS No. 158 will have no impact on our statement of operations or statement of cash flows. We now use a

 

MITTAL STEEL USA INC.

 

Notes to Financial Statements — (Continued)

November 30 measurement date. At this point we have not made the determination as to when we will change our measurement date to December 31 or which transition method we will use.

 

(4)  Inventories

 

Inventories are stated at the lower of cost determined as Last-in, First-out (LIFO) or market, which approximates replacement cost. Costs include the purchase costs of raw materials, conversion costs, and an allocation of fixed and variable production overhead. The LIFO reserve increased by $21 and $64 for the three and nine months ended September 30, 2006. The following table presents the components of inventories:

 

 

Effective January 1, 2005, MSUSA (previously Inland) changed its accounting policies for valuing inventory from FIFO to LIFO. We believe the LIFO method is preferable to the FIFO method because it provides better matching of current revenues and costs in the income statement, primarily as a result of the volatility in the key steel related energy and commodity markets and because it provides better comparability to the LIFO method used by many of the Company’s competitors. We accounted for the change in accounting method under APB No. 20, Accounting Changes. APB No. 20 requires reporting a change in accounting principle (with certain exceptions) in the year of adoption with the cumulative effect on prior periods shown in the income statement in the current year. The cumulative effect of implementing LIFO on prior periods and the pro forma effects of retroactive application is not determinable primarily because the necessary accounting records since the inception of the Company in 1998, which would be required to compute the cumulative effect, are no longer available. The effect of changing from FIFO to LIFO would have resulted in a reduction of net income of $51 for the nine months ended September 30, 2005 had the change been made during the quarter ended March 31, 2005.

 

(5)  Debt

 

On April 20, 2005, MSUSA entered into definitive agreements as borrower with respect to a new $1 billion term loan facility and a new $700 term loan facility. Mittal Steel US Finance LLC, a wholly owned subsidiary of Mittal is the lender under each of the term loan facilities. These intercompany borrowings were entered into as part of the financing arrangements to pay the cash portion of the merger consideration to ISG’s former stockholders. The term loan facilities represent an intercompany loan to the Company that another subsidiary of Mittal borrowed under a credit agreement, dated as of April 7, 2005 among Mittal and certain subsidiaries of Mittal as original borrowers, and ABN AMRO Bank N.V., Citigroup Global Markets Limited, Credit Suisse First Boston International, Deutsche Bank AG London, HSBC Bank Plc and UBS Limited, as lead arrangers, certain other lenders signatory to the credit agreement and HSBC Bank Plc, as facility agent.

 

MSUSA drew down on each of the term loan facilities in the principal amounts of $1 billion and $700 on April 21, 2005. Each of the term loan facilities will mature on April 21, 2010. Each term loan facility contains general undertakings which principally requires that all of the Company’s transactions with affiliates be conducted on an arms length basis and limits our ability to incur additional indebtedness, consummate certain extraordinary business transactions such as mergers, and create liens on its properties.

 

MITTAL STEEL USA INC.

 

Notes to Financial Statements — (Continued)

MSUSA is required to pay interest on each of the term loan facilities at an annual rate for each applicable interest period equal to the sum of (i) a margin, initially set at 0.475% and then subject to adjustment based on Mittal’s unsubordinated unsecured debt rating plus 0.125%, and (ii) the London Interbank Offering Rate (LIBOR) for the applicable interest period. The initial interest period for each of the term loan facilities is six months and then shall be agreed upon between borrower and lender for subsequent periods not to exceed six months.

 

MSUSA has $500 of senior, unsecured debt securities due 2014. The debt bears interest at a rate of 6.5% and is paid semi-annually. In addition, in 2004, an indirect subsidiary of Mittal, Ispat Inland, ULC (Borrower) issued $800 principal amount of senior secured notes: $150 of floating rate notes bearing interest at LIBOR plus 6.75% due April 1, 2010 and $650 of fixed rate notes bearing interest at 9.75% (issued at 99.212% to yield 9.875%) due April 1, 2014 (the Senior Secured Notes). Also in 2004, the Company issued $800 principal amount of First Mortgage Bonds (Series Y, in a principal amount of $150, and Series Z, in a principal amount of $650) to Ispat Inland Finance, LLC, an affiliate of the Borrower, which, in turn, pledged them to the trustee for the Senior Secured Notes as security. On April 1, 2006, the Company redeemed all of its $150 outstanding floating rate Senior Secured Notes at a redemption price equal to 103% of the outstanding principal amount, plus accrued interest.

 

The Senior Secured Notes are also secured by a second position lien on the inventory of the Company. As further credit enhancement, the Senior Notes are fully and unconditionally guaranteed by the Company, certain subsidiaries of the Company, Mittal and certain other affiliates of the Borrower. The Company is obligated to pay interest on the Series Y Bonds at the rate paid on the floating rate Senior Secured Notes, plus one-half of one percent per annum, and on the Series Z Bonds at a rate of 10.25%.

 

MSUSA had a $35 convertible note with the Pension Benefit Guaranty Corporation (PBGC) that bore interest at 6.0% and required semi-annual interest payments. On April 20, 2006, the PBGC note was converted into 1,268,719 class A common shares of Mittal. On April 25, 2006 an inter-group payable was created between Mittal and MSUSA for $48 which represented the fair value of the shares on the date of conversion. The difference of $12 was a recorded as a reduction to additional paid-in capital. The $48 inter-group payable was repaid by MSUSA during the third quarter 2006.

 

MSUSA has $84 in various unsecured Industrial Development Revenue Bonds that bear interest at rates that range from 5.75% to 7.25% and maturity dates that range from 2007 to 2014.

 

MSUSA fully redeemed all of its remaining $17 Pollution Control Series 1977, 5.75% Bonds due February 2007 during the first quarter 2006 and fully redeemed the $38 Pollution Control Project Number 13, 7.25% Bond due November 2011 during the third quarter 2006. Mittal repaid these on the behalf of MSUSA and reduced inter-group promissory notes owed MSUSA by an equivalent amount.

 

As part of the acquisition of our AK-ISG joint venture, MSUSA assumed $15 of capital lease obligations during the third quarter 2006.

 

(6)  Income Taxes

 

The income tax provision for the first nine months of 2006 is based on an estimated annual effective rate of 37.1% for ordinary operations before consideration of discreet items. The estimated annual effective rate after consideration of discreet items approximates 36.2%. The income tax provision for the nine month period ending September 30, 2006 includes a one-time benefit of $14 related to changes in Indiana and Pennsylvania tax law less a one-time cost of $4 to establish a valuation allowance against a capital loss carry forward.

 

SFAS No. 109, Accounting for Income Taxes, requires that we record a valuation allowance for a deferred tax asset when it is “more likely than not” (a likelihood of more than 50%) that some portion or all of the deferred tax asset will not be realized based on available “positive and negative evidence.” The realization of

 

MITTAL STEEL USA INC.

 

Notes to Financial Statements — (Continued)

the deferred tax asset is ultimately dependent upon the Company’s generation of sufficient future taxable income during periods in which those net temporary differences become deductible and before the expiration of the NOL carryforwards. The valuation allowance at September 30, 2006 is $63.

 

 

 

MSUSA is exposed to fluctuations in interest rates and the prices of certain commodities such as natural gas, fuel oil, coke, steel scrap, iron ore and various non-ferrous metals. Management is authorized to use various financial instruments where available to manage the exposures associated with these fluctuations. MSUSA may employ the use of futures, forwards, collars, options and swaps to manage certain exposures when practical. By policy, MSUSA does not enter into such contracts for the purpose of speculation. MSUSA’s policies include establishing a risk management philosophy and objectives, providing guidelines for derivative usage and establishing procedures for control and reporting of derivative activity. For certain transactions MSUSA may elect to account for these transactions as hedges. In this case, the change in value of the effective portion of financial instruments used to hedge certain exposures is reported as a component of other comprehensive income and is reclassified into earnings in the same period during which the hedged transactions affect earnings. Because of the extensive documentation requirements necessary to elect hedge treatment for derivative instruments, we did not elect this accounting during 2005 and all unrealized gains and losses in the market value of these instruments were recognized in the period in which the change in value occurred. Effective January 2006, we implemented the appropriate documentation requirements and elected hedge treatment for certain qualifying derivative instruments.

 

 

Under our labor agreement with the United Steelworkers of America (USW), the Company and the USW established defined contribution benefit trusts (VEBA) to fund retiree medical and death benefits for retirees and dependents from certain bargaining units formerly represented by the USW. We have a similar agreement with the Independent Steel Workers Union (ISU) at our Weirton facility. We have contributed $105 so far in 2006.

 

We provide a non-contributory defined benefit pension plan covering substantially all USW represented employees at our Hibbing Taconite joint venture and our Indiana Harbor East facility. Hibbing’s non-represented salaried employees and certain non-represented salaried employees of the former Inland also receive defined pension benefits. Employees at other facilities are not covered by a defined benefit pension plan. We contributed $50 million to the Inland trust in 2006. There are no PBGC or ERISA funding requirements in 2006.

 

MITTAL STEEL USA INC.

 

Notes to Financial Statements — (Continued)

Substantially all USW represented employees are covered under postretirement life insurance and medical benefit plans that require deductible and co-insurance payments from retirees. For most employees, the Company’s share of the healthcare costs are capped at 2008 levels for years 2010 and beyond. The postretirement life insurance benefits are primarily specific amounts for hourly employees. We are not required to pre-fund any amounts under the defined benefit postretirement plans and expect the benefits to be paid in 2006 to be about $76. Our prorated required contribution to the Hibbing plan for other benefits based on tons produced in 2005 and expected benefit payments is $10 in 2006.

 

ISG’s labor contract with the USW provided defined benefit retiree medical and death benefit plans covering employees who are eligible to retire under the current labor agreements. We do not intend to provide similar retiree medical benefits for employees who retire after the current labor agreement expires, but as required by accounting rules, have recognized a healthcare obligation for all active employees, including those expected to retire after the expiration of the current agreement.

 

The details of our period pension and other postretirement expense follows:

 

 

 

We are subject to various legal actions and contingencies in the normal course of conducting business. We accrue liabilities for such matters when a loss is probable and the amount can be reasonably estimated. The effect of the ultimate outcome of these matters on future results of operations and liquidity cannot be predicted with any certainty. While the resolution of these matters may have a material effect on the results of operations of a particular future quarter or year, we believe that the ultimate resolution of such matters in excess of liabilities recorded will not have a material adverse effect on our competitive position or financial position.

 

MITTAL STEEL USA INC.

 

Notes to Financial Statements — (Continued)

The activity associated with these liabilities including environmental, asset retirement obligations (ARO) and those recorded in connection with the facilities that are no longer being operated (see note 2, ISG Acquisition) follows:

 

 

 

The table below summarizes related party transactions (see Note 5, Debt for a discussion of long term related party debt). Included in payables to related parties shown on the balance sheet are advances between MSUSA and Mittal which are treated as short term promissory notes in addition to amounts owed for management fees. During the first quarter 2006, Mittal paid $95 to MSUSA for promissory notes entered into during 2005. The payment of $95 included $17 that was a reduction of inter-company debt related to Mittal’s redemption of the Pollution Control Series Bonds on behalf of MSUSA. In addition, Mittal advanced $70 to MSUSA under a new promissory note during the first quarter 2006.

 

During the second quarter 2006, MSUSA repaid $70 to Mittal for promissory notes entered into during the first quarter 2006. In addition, MSUSA advanced $158 to Mittal under a new promissory note during the second quarter of 2006. MSUSA redeemed the $150 Series Y First Mortgage Bond, plus paid an early redemption fee of $5 to Ispat Inland Finance LLC. The $35 convertible note with the PBGC was converted into 1,268,719 class A common shares of Mittal. An inter-group payable was created between Mittal and MSUSA for $48 which represented the fair value of the shares on the date of conversion.

 

During the third quarter 2006 MSUSA advanced $7 to Mittal. Mittal repaid $158 advanced by MSUSA in the second quarter of 2006 and $7 advanced by MSUSA in the third quarter 2006. This payment of $165 included $38 that was a reduction of inter-company debt related to Mittal’s redemption of the Pollution Control Project Number 13 Bond on behalf of MSUSA. MSUSA also repaid $48 to Mittal for the inter-group payable created by the conversion of the $35 PBGC note to 1,268,719 class A common shares of Mittal in the second quarter of 2006.

 

 

MITTAL STEEL USA INC.

 

Notes to Financial Statements — (Continued)

 

 

For the three months ending September 30 we recorded $15 and $14 for 2006 and 2005 for our share of earnings in the joint ventures as a reduction of cost of sales. For the nine months ending September 30 we recorded $36 and $35 for 2006 and 2005 for our share of earnings in the joint ventures as a reduction of cost of sales.

 

A summary of combined financial information of our unconsolidated joint ventures follows:

 

 

 

Most of these joint ventures provide services to our operations. They bill for these services at cost or some other contractual rate that may not reflect the market rate for these services.

 

 

On August 1, 2006, the U.S. Department of Justice (DOJ) announced that it had concluded that the acquisition by Mittal Steel Company N.V., our parent company, of Arcelor, a Luxembourg-based steelmaker, which closed on August 1, was likely to substantially lessen competition in the market for tin mill products in the Eastern United States, and filed in the U.S. District Court in Washington, D.C. a consent decree, which Mittal Steel had previously signed with the DOJ on May 11, 2006. The consent decree requires the divestiture of Dofasco Inc., a Canadian-based steel producer acquired by Arcelor in February 2006 or, if Dofasco cannot be sold, the divestiture of whichever of two identified, alternative assets is selected by DOJ. The two alternative assets identified in the consent decree are Mittal Steel’s Sparrows Point facility located near Baltimore, Maryland and Mittal Steel’s Weirton facility located in Weirton, West Virginia. In the twelve months ended December 31, 2005, the Sparrows Point facility, which primarily serves the construction, tin and distribution markets, represented approximately 15% of the Company’s total production volume and 11% of

 

MITTAL STEEL USA INC.

 

Notes to Financial Statements — (Continued)

total sales volume, and the Weirton facility, which primarily operates finishing facilities for tin products but does not currently produce liquid steel, represented approximately 6% of the Company’s total sales volume, in each case on a pro forma basis assuming that the acquisition of ISG had occurred on January 1, 2005. In April 2006, Arcelor announced that it had transferred its Dofasco holdings to S3, an independent Dutch foundation, in order to prevent any sale of Dofasco for five years, unless S3’s board of directors decides to dissolve S3 earlier. After the consent decree was filed in federal court, the boards of both Mittal Steel Company N.V. and of Arcelor SA requested the directors of S3 to dissolve the foundation in order to allow the sale of Dofasco. Arcelor Mittal has been informed that the directors of the S3 decided on November 10, not to dissolve the foundation, which would have permitted the sale of Dofasco. Arcelor Mittal announced on November 13, 2006 that Arcelor Mittal is currently reviewing the situation and will be in contact with the DOJ.

 

 

MSUSA incurred three insurable events in the second quarter of 2006: (1) a fire at the Indiana Harbor West steelmaking shop, (2) a motor failure at the Conshohocken plate mill, and (3) a lighting strike that resulted in an outage at the Sparrows Point blast furnace. We made insurance claims for property damage, business interruption, and extra expenses of about $138. The amounts the insurance carriers are willing to pay for business interruption is net of any mitigating actions we may take to minimize the impact of business interruptions.

 

The insurers have committed to date, an acceptance of claims amounting to $45 comprised of $23 for Indiana Harbor and $22 for Sparrows Point. We have recognized this amount in cost of sales in the third quarter of 2006. We received $32 of this $45 on September 30, 2006, and the balance in October, 2006.

 

 

The Company has announced on October 5, 2006, that it will be idling two of its blast furnaces to bring production capabilities in line with reduced level of demand for light flat rolled products. The west furnace in Cleveland has already been idled.

ITEM 2.  MANAGEMENT’S NARRATIVE ANALYSIS — RESULTS OF OPERATIONS

 

Forward-Looking Statements

 

The Company and its representatives may from time to time make forward-looking statements in reports filed with the Securities and Exchange Commission (SEC), reports to stockholders, press releases, other written documents and oral presentations. These forward-looking statements may be identified by the use of predictive, future-tense or forward-looking terminology, such as “believes,” “anticipates,” “expects,” “estimates,” “intends,” “may,” or similar terms. These statements speak only as of the date of such statements and the Company will undertake no ongoing obligation, other than that imposed by law, to update these statements. These statements appear in a number of places in this report and include statements regarding the Company’s intent, belief or current expectations of its directors, officers or advisors with respect to, among other things:

 

 

Any such forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties, and actual results may differ materially from those contained in the forward-looking statements as a result of various factors, some of which are unknown. The factors that could adversely affect the Company’s actual results and performance include, without limitation:

 

 

Results of operations

 

On April 15, 2005, Mittal Steel Company N.V. (Mittal) acquired International Steel Group Inc. (ISG). The business combination was accounted for under the purchase method. See Note 2, ISG Acquisition in our financial statements for a description. Effective December 31, 2005, Mittal Steel USA ISG Inc. (Mittal ISG) merged with Ispat Inland Inc. (Inland). The merger of Mittal ISG and Inland was accounted for as a merger of net assets under common control. The existing book values of the companies were combined without remeasuring the assets and liabilities at the business combination date. Although Mittal ISG was the surviving entity, Mittal was the controlling party and the merger between Mittal ISG and Inland was accounted for as a reverse acquisition, as if Inland was the surviving entity. These financial statements include the results of Mittal ISG and Inland since they have been under the control of Mittal for all periods presented for Inland and since April 15, 2005 for Mittal ISG.

 

To facilitate the discussion of the three and nine month periods ended September 30, 2006 against the results of operations for the same periods in 2005, the historical operations of Inland, ISG and MSUSA ISG

have been combined even though they were separate reporting entities under different control. No pro forma adjustments have been made and we have simply combined their respective results.

 

 

 

Third Quarter 2006 Compared with Third Quarter 2005

 

Net income in the third quarter of 2006 rose by $171 million, or 380%, to $216 million from $45 million in the third quarter of 2005. The sales revenue in the third quarter of 2006 increased by 24% to $3.3 billion from $2.7 billion in the third quarter of 2005. The major drivers of this increase were the 12% increase in steel shipments in the third quarter 2006 as well as higher prices, higher realization of about $75 per ton over the third quarter of 2005 (12%). The higher volumes were generally across the board in all product markets reflecting a strong apparent demand for steel in the economy.

 

Cost of goods sold, exclusive of depreciation, increased in the third quarter of 2006 by 13% to $2.7 billion from $2.4 billion in the comparable period of 2005. This increase in cost was the result of higher sales volume, higher input prices, and the impact of outages in the operations at two of our facilities. The Conshohocken plate mill suffered volume outages due to the motor failure that occurred mid-June 2006. The repaired motor was commissioned in the first week of September. The blast furnace outage from a lightning strike in June 2006 at Sparrows Point resulted in loss of production of about 300,000 tons of hot metal in this quarter and the furnace came to normal operations in September. An insurance recovery of $45 million was recorded in this quarter by way of a partial commitment for losses arising out of the outages in the second and third quarter of 2006.

 

Credit insurance coverage premiums for trade receivables effective June 2006, higher legal fees, and others increased selling and general administrative expenses by $16 million in this quarter over the corresponding quarter of 2005.

 

Depreciation expense increased by $11 million in the third quarter of 2006 to $89 million compared to $78 million in the third quarter of 2005. Our final valuation of property, plant and equipment acquired from

ISG recorded in 2006 was higher than the preliminary valuation used in 2005. Net interest expense was higher for the third quarter 2006 compared to the same period in 2005 due to higher interest rates.

 

The income tax provision for the three months ended September 30, 2006 is higher than the tax provision for the three months ended September 30, 2005 because of a benefit recorded by Inland in the third quarter of 2005 for an adjustment of an uncertain tax position

 

First Nine Months 2006 Compared with First Nine Months 2005

 

Net income in the nine months of 2006 increased by $87 million to $556 million from $469 million in the first nine months of 2005. Sales revenue increased by 8% to $10.0 billion in the nine months of 2006 from $9.3 billion in the first nine months of 2005. Despite outages in operations which cost the company approximately 600,000 tons by way of lost production, shipments were 15.0 million tons in 2006 compared to 13.8 million tons in 2005. Average net sales price was $669 per ton in the nine months ended September 30, 2006 compared to $671 per ton in the nine months ended September 30, 2005.

 

Cost of goods sold, exclusive of depreciation, increased in the nine months ended September 30, 2006 by 8% to $8.5 billion from $7.9 billion in the comparable period of 2005. This cost increase was the result of substantially higher input prices for all raw materials and energy in 2006, and also from the additional costs resulting from the outages.

 

Selling and general administrative expenses decreased by $68 million to $231 million in the nine months ended September 30, 2006 from $299 million in the nine months ended September 30, 2005, primarily due to the merger related expenses which were incurred at the time of the acquisition of ISG.

 

Depreciation expense increased by $60 million in the nine months ended September 30, 2006 to $272 million compared to $212 million in the nine months ended September 30, 2005 due to higher valuation of land property and equipment as part of purchase accounting. Net interest expense was also higher for the nine month period ended September 30, 2006 compared to the same period in 2005 due to higher interest rates in 2006 over 2005.

 

The income tax provision for the nine months ended September 30, 2006 is slightly higher when compared to the nine months ended September 30, 2005 due to the recognition of discrete state tax benefits in both periods and an increase in the provision for a valuation allowance in 2006.

 

Liquidity

 

The Company’s cash balance at September 30, 2006 was $18 million ($55 million as on December 31, 2005). Cash provided by operating activities for the nine months ended September 30, 2006 was $359 million. During the nine months ended September 2006, the Company’s net payments to related parties for notes entered into prior to 2006 were $71 million. In addition, Mittal advanced $70 million to the Company under a new promissory note during the first quarter 2006, which was repaid in the second quarter 2006. The Company has advanced Mittal $165 million during the second and third quarters, which was entirely repaid in the third quarter.

 

EVALUATION OF DISCLOSURE CONTROLS

 

Management is responsible for establishing and maintaining a system of disclosure controls and procedures and a system of internal control over financial reporting for Mittal Steel USA. “Disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time period specified in the SEC’s rules and forms. “Internal control over financial reporting” includes those policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation

of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of their inherent limitations, systems of disclosure controls and procedures and internal control over financial reporting, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and may not prevent or detect misstatements. Further, because of changes in conditions (including staffing and operations integration, as discussed in more detail below), effectiveness of disclosure controls and procedures and internal control over financial reporting may vary over time.

 

 

Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13 (a)-15 (e) and 15 (d)-15 (e) under the Exchange Act as of September 30, 2006 (Evaluation Date). Based on this evaluation, for the reasons discussed in the following paragraphs, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were, as of the Evaluation Date, effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms. We reached this conclusion despite the past identification of three material weaknesses, discussed below, in our internal control over financial reporting. As we discussed in our Quarterly Report on Form 10-Q for the quarters ended March 31 and June 30, 2006, we have taken extraordinary steps to improve our disclosure controls, including a detailed review of several of our accounting practices, which we believe mitigate the potential effect of the previously identified material weaknesses in our internal control over financial reporting.

 

In preparing our Exchange Act filings, we utilized processes and procedures to provide reasonable assurance that information relating to the Company that was required to be disclosed in such filings was recorded, processed, summarized and reported within the time periods specified by applicable SEC rules and was accumulated and communicated to the Company’s management as appropriate to allow timely decisions regarding required disclosure. These processes and procedures are designed to, among other things, mitigate the effect of any deficiencies in our internal control over financial reporting on information relating to the Company that is required to be disclosed in our Exchange Act filings.

 

 

Mittal Steel USA applied for and was granted approval to exit from accelerated filer status in December 2005 and is therefore not currently subject to certain reporting requirements of Section 404 of the Sarbanes-Oxley Act of 2002. The Company has, however, prepared the following update on internal controls over financial reporting.

 

As noted in our Annual report on Form 10-K for the year ended December 31, 2005, our predecessor company (ISG) and its external auditor concluded that the Company’s system of internal controls over financial reporting was not effective as of December 31, 2004, as a result of the following three material weaknesses: deficiencies in policies and procedures in the inventory and cost of goods sold process, excessive access to significant spreadsheets, and inadequate segregation of duties in the revenue cycle. In addition, in the course of management’s work to finalize the Company’s financial statements for the fiscal year ended December 31, 2005, we agreed, in consultation with our external auditors, that we must strengthen our controls over accounting for deferred taxes and for derivative instruments for financial reporting.

Recent Review of Internal Control Over Financial Reporting

 

Management has not identified any additional material weaknesses in internal controls over financial reporting in the first, second or third quarter of 2006.

 

Remediation Activities

 

Management has taken actions in 2005 and 2006 to improve its internal controls over financial reporting, as discussed in our Annual Report on Form 10-K for the year ended December 31, 2005 and our quarterly Reports of Form 10-Q for the quarters ended March 31 and June 30, 2006. As a result of these actions, management believes that the internal controls around all of the issues that we and our auditors have previously commented on have been addressed. Our external auditors are in the process of testing the internal controls and as of this date have not noted any material weakness in internal control over financial reporting. We continue to assess our internal controls over financial reporting and will make all necessary improvements identified by our ongoing review process.

 

Environmental Matters

 

The Company’s operations are subject to a broad range of laws and regulations relating to the protection of human health and the environment. The prior owners of the Company’s facilities expended in the past, and the Company expects to expend in the future, substantial amounts to achieve or maintain ongoing compliance with U.S. federal, state, and local laws and regulations, including the Resource Conservation and Recovery Act (RCRA), the Clean Air Act (CAA), and the Clean Water Act (CWA). These environmental expenditures are not projected to have a material adverse effect on the Company’s consolidated financial position or on the Company’s competitive position with respect to other similarly situated U.S. steelmakers subject to the same environmental requirements.

 

The following describes material changes that have occurred during the reporting quarter.

 

CAA, CWA and Other Matters

 

Clean Air Act

 

In April, 2006 the Maryland Department of Environment (MDE) notified the Company’s Sparrow’s Point facility of alleged violations of emissions limitations on volatile organic compounds from the facility’s sinter plant. The company negotiated and entered into a Consent Order Agreement with MDE which resolved the matter through payment of a monetary penalty of $75 thousand. The Company paid the penalty in October 2006.

 

The Indiana Department of Environmental Management (IDEM) issued the Company’s Indiana Harbor (West) facility a Notice of Violation (NOV) on October 30, 2006 alleging visible emission opacity limit excursions at H3 Blast Furnace. The Company is evaluating the NOV and will be in discussions with IDEM to effect a resolution of this matter. It is possible that IDEM may seek a civil penalty with respect to the allegations; however such penalty is not expected to be material.

 

The United States Department of Environmental Protection (USEPA) issued the Company’s Burns Harbor Facility a Notice of Violation (NOV) on August 8, 2006 alleging that in early 1994 the facility commenced a major modification of its #2 Coke Battery without obtaining a PSD permit and has continued to operate without the appropriate PSD permit. The Company met with USEPA in early October to obtain a preliminary understanding of the allegations, as well as on November 7, at which time the USEPA provided information regarding the technical bases for the NOV. Further communication and discussion with the USEPA is planned. It is possible that USEPA may seek a civil penalty or other forms of injunctive relief with respect to the allegations, however the cost cannot be reasonably estimated at this time.

Clean Water Act

 

On September 1, 2006, the Company entered in to an Administrative Order of Consent with the United States Environmental Protection Agency (USEPA) to resolve a historic problem involving floating oils reaching the surface waters of the channel at the Indiana Harbor (West) facility. The order requires among other things the installation of a sheet pile containment wall with an underflow weir across the Indiana Harbor Intake plume. The cost to resolve this legacy matter of about $1 million, has been previously recorded in the financials since 2001.

 

Other

 

In addition to the above matters, the Company receives notices of violation relating to minor environmental matters from time to time in the ordinary course of business. The Company does not expect any material unrecorded reclamation requirements, fines or penalties to arise from these items and, other than as previously disclosed, none of these involve potential individual monetary sanctions in excess of $100 thousand.

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

MITTAL STEEL USA INC.

 

Name: Vaidya Sethuraman

Chief Accounting Officer

Mittal Steel USA Inc.

 

Date: November 14, 2006

EXHIBIT INDEX

 

QUARTERLY REPORT ON FORM 10-Q

 

MITTAL STEEL USA INC.

FOR THE QUARTER ENDED SEPTEMBER 30, 2006