Second quarter ... 1,117 634 1,751 Third quarter ... 1,307 923 2,229 Fourth quarter ... 1,297 1,049 2,346 Year ... 1,161 875 2,036 2010 First quarter ... 1,235 1,094 2,329 Second quarter ... 1,317 1,701 3,018 Third quarter ... 1,245 1,621 2,866 Fourth quarter ... 1,213 1,696 2,909 Year ... 1,252 1,528 2,780 2011 First quarter ... 1,215 1,900 3,115 Second quarter ... 1,223 1,839 3,063 Third quarter ... 1,150 1,601 2,751 Fourth quarter ... 1,137 1,418 2,555 Year ... 1,181 1,690 2,871 2012 First quarter ... 1,185 1,466 2,651 Second quarter ... 1,182 1,434 2,616 Third quarter ... 1,155 1,370 2,525 __________
Source: CRU (German base price and alloy surcharge for 2 millimeter cold rolled 304 grade sheet).
Outokumpu’s customers are primarily distributors and processors that stock and process stainless steel to serve end users. Inoxum also has significant sales to distributors and processors. Stainless steel distributors typically make purchasing decisions based on expectations regarding raw materials price trends and stainless steel demand. When raw material prices or demand for stainless steel products are expected to increase, distributors and processors tend to increase their purchases with the goal of reselling such products at a later date and a higher price. When distributors reduce their inventories, generally in response to expected decreases in raw materials prices or stainless steel demand, it sets downward pressure on the base price that stainless steel producers are able to charge for products. Conversely, during periods when distributors restock stainless steel inventories, base prices tend to increase to reflect the increase in demand. As Inoxum has a larger proportion of direct sales to end users than Outokumpu, historically, Inoxum has not been as severely affected by the purchasing decisions of distributors as Outokumpu has. The Combined Group’s business, financial condition and results of operations are affected by the purchasing decisions of distributors.
In addition, demand volatility makes it difficult for a stainless steel producer to optimize production capacity. For instance, during periods of destocking by distributors, stainless steel producers may decide to reduce production in an attempt to counter the decline in base prices. However, such reductions of capacity utilization also decrease profitability; therefore, such reductions may not mitigate the adverse effects of destocking by distributors. Increases in costs per unit and the resulting declines in competitiveness as a result of demand volatility have affected, and may continue to affect, the Combined Group’s business, financial condition and results of operations.
With respect to HPA products produced by Inoxum, there is no alloy surcharge system and prices are generally negotiated with customers. While determining the full effective price for a product, Inoxum has price lists or calculation methods for daily metal prices, which are generated on the London Metal Exchange (the “LME”). On the LME, metals, especially nickel, are traded daily with related daily price changes. Whereas Inoxum uses the daily nickel price for pricing negotiations with customers, some of its competitors use the so-called price in effect (day of delivery) system or a one- or three-month average nickel price, which is comparable to the alloy surcharge system used in stainless steel pricing. For titanium and titanium alloys, the effective price is also negotiated with the customer. Pricing is either fixed
by single orders or in a long term agreement. In general, prices for HPAs include all raw material pricing elements, which exposes Inoxum to volatility in the price of raw materials. However, Inoxum has typically hedged the costs of raw materials for HPA products using either forwards (including for nickel) or through contractual agreements with producers of such raw materials (including for ferrochrome).
Prices of Raw Material, Energy and Supplies
The primary raw materials that Outokumpu uses to produce stainless steel products include recycled stainless steel (63.6 percent of total raw material use by volume in 2011), iron in scrap (17.1 percent of total raw material use by volume in 2011), chromium primary (6.8 percent of total raw material use by volume in 2011), nickel (2.3 percent of total raw material use by volume in 2011) and molybdenum (0.4 percent of total raw material use by volume in 2011). Inoxum uses the same primary raw materials in stainless steel production, although its production of ferritic stainless steel grades results in less nickel usage than Outokumpu’s production of primarily austenitic stainless steel grades. In addition, Inoxum uses titanium sponge and recycled titanium as raw materials in the production of titanium products. As the production of stainless steel and HPAs requires large amounts of energy, the Combined Group uses significant amounts of electricity, primarily for the operation of electric arc furnaces, as well as fossil fuels, such as propane.
The Combined Group purchases raw materials mainly under short- and long-term contracts, but also on the spot market. In addition, through its Kemi chromite mine and Tornio ferrochrome production facility, the Combined Group has access to a captive ferrochrome source, which provides it with a competitive advantage through lower sourcing and production costs. See “—Demand for, Production Capacity for and Pricing of Ferrochrome” below. Outokumpu hedges a part of its exposure to changing nickel prices and, on a case-by-case basis, molybdenum prices. However, Outokumpu does not hedge the volatility of prices for certain other raw materials, such as recycled carbon steel. Inoxum has historically hedged against price volatility for important raw materials, particularly nickel.
Prices for stainless steel and HPA raw materials are largely correlated with demand for stainless steel and can fluctuate significantly. The Combined Group sources its raw materials both locally and globally.
In the past, Inoxum has purchased raw materials as part of the ThyssenKrupp group. Following the completion of the Inoxum Transaction, Inoxum will procure its raw material needs as part of the Combined Group. For certain raw materials, such as recycled steel, Outokumpu relies on a limited number of suppliers, although its general policy is to use multiple suppliers. In addition, since most of the raw materials used by Outokumpu and Inoxum are finite resources, their prices also fluctuate in response to any perceived scarcity of reserves and the evolution of the pipeline of new exploration projects to replace depleted reserves.
Outokumpu attempts to maximize the use of recycled steel as a source of alloys in its production process. Depending on the prevailing market prices of recycled stainless steel and for its alloying elements, such as nickel, chromium and, for some grades, molybdenum, in pure form, such alloying elements can often be purchased at a discount when sourced as part of recycled stainless steel.
The following table sets forth average market prices for nickel, ferrochrome, molybdenum and recycled carbon steel for the periods indicated:
Nickel(1) Ferrochrome(2) Molybdenum(3) carbon steelRecycled (4)
(USD/t) (EUR/t) (USD/lb) (EUR/kg) (USD/lb) (EUR/kg) (USD/t) (EUR/t) 2009 First quarter ... 10,471 8,036 0.79 1.34 9.15 15.49 207 159 Second quarter ... 12,920 9,478 0.69 1.12 9.41 15.22 199 146 Third quarter ... 17,700 12,375 0.89 1.37 15.36 23.67 236 165 Fourth quarter ... 17,528 11,860 1.03 1.54 11.76 17.54 250 169 Year ... 14,655 10,507 0.85 1.34 11.42 18.05 223 160 2010 First quarter ... 19,959 14,433 1.01 1.61 16.19 25.81 323 234 Second quarter ... 22,476 17,686 1.36 2.36 16.45 28.53 346 272 Third quarter ... 21,191 16,415 1.30 2.22 15.15 25.86 346 268 Fourth quarter ... 23,609 17,382 1.30 2.11 15.86 25.74 375 276 Year ... 21,809 16,451 1.24 2.07 15.91 26.46 348 262 2011 First quarter ... 26,903 19,666 1.25 2.01 17.43 28.08 447 327 Second quarter ... 24,298 16,884 1.35 2.07 16.70 25.58 432 300 Third quarter ... 22,069 15,614 1.20 1.88 14.61 22.86 439 311 Fourth quarter ... 18,307 13,582 1.20 1.96 13.41 21.94 402 298 Year ... 22,894 16,440 1.25 1.98 15.53 24.62 430 309 2012 First quarter ... 19,651 14,991 1.15 1.93 14.26 23.97 414 316 Second quarter ... 17,146 13,385 1.35 2.32 13.80 23.72 394 308 Third quarter ... 16,319 12,741 1.25 2.20 11.87 20.93 362 238 __________
(1) Source: LME cash quotation.
(2) Source: Metal Bulletin – Quarterly contract price, Ferrochrome lumpy chromium charge, basis 52 percent chromium. (3) Source: Metal Bulletin – Molybdenum oxide, Europe.
(4) Source: Metal Bulletin – Steel scrap HMS 1&2 FOB Rotterdam.
Energy costs represent a substantial portion of the cost of the goods the Combined Group produces. In order to ensure supply of energy, Outokumpu has entered into long-term electricity supply agreements with various parties, including Vattenfall AB, Vattenfall Sähkömyynti Oy and Statkraft Energi AS. In general, Outokumpu aims to enter into long-term electricity supply agreement with terms ranging between five and ten years. Some of the agreements include fixed prices for the full term of the agreement, whereas prices under some agreements vary based on spot prices in the power markets. In nuclear power, Outokumpu has an approximately one percent (20 megawatt) indirect share in the TVO Olkiluoto 3 nuclear power plant project, which is currently under construction in Finland. It is expected that commercial operation of Olkiluoto 3 will begin in 2015. Outokumpu also has a share in the Fennovoima and TVO Olkiluoto 4 projects, both of which have been granted decisions-in-principle. As a shareholder in these projects, Outokumpu expects to be able to buy electricity at cost in return for paying its pro rata share of the operating expenses of the company. See “Risk Factors— Risks relating to the Combined Group and the Stainless Steel Industry—The Combined Group faces risks associated with nuclear power plant projects in Finland.”
In the past, Inoxum has purchased electricity, to a large extent, as part of the ThyssenKrupp group. In June 2012, ThyssenKrupp and Inoxum entered into an energy procurement and cooperation agreement by which they agreed to continue the sourcing of electricity for the German subsidiaries of Inoxum through ThyssenKrupp until December 31, 2014 and of natural gas until September 30, 2013. In the energy procurement and cooperation agreement, ThyssenKrupp and Inoxum also agreed to continue their cooperation on emission allowance trading on the basis of existing commission agreements until December 31, 2013. Further, an addendum agreement was concluded between ThyssenKrupp and Inoxum regarding the cooperation on electrical energy procurement for 2012 and 2014. See “Material Agreements— Inoxum Transaction—Inoxum Separation—Procurement and Cooperation Agreement Regarding Energy.”
Demand for, Production Capacity for and Pricing of Ferrochrome
The Combined Group produces ferrochrome using chromite sourced from its mine in Kemi, Finland. The Combined Group’s ferrochrome production facility is located in Finland, where it has access to sufficient electricity and is close to the Combined Group’s Tornio integrated production facility. For the years ended December 31, 2011, 2010 and 2009, Outokumpu produced 231,000 tonnes, 238,000 tonnes and 123,000 tonnes, respectively, of ferrochrome, of which 173,000 tonnes, 170,000 tonnes and 92,000 tonnes, respectively, were used by Outokumpu to produce stainless steel and 58,000 tonnes, 68,000 tonnes and 31,000 tonnes, respectively, were sold on the global market.
The Combined Group’s ability to source ferrochrome internally and at the cost of production mitigates the impact of ferrochrome price volatility on the Combined Group’s sourcing and production costs, although the Combined Group is subject to price volatility in its sales of ferrochrome to third parties. In addition, ferrochrome production at the Combined Group’s Tornio integrated production facility is adjacent to the melt shops, which allows molten ferrochrome, the product of ferrochrome smelting, to be transferred directly to the melt shops. This provides significant energy savings not only because the ferrochrome does not need to be re-melted, but also because the molten ferrochrome does not need to be cooled and crushed for transportation, a process that requires significant amounts of electricity.
The Combined Group is currently finalizing the approximately EUR 410 million investment program to double its annual ferrochrome production capacity to 530,000 tonnes at its Tornio ferrochrome production facility as well as increase the annual production capacity of the Kemi chromite mine. The increased production capacity resulting from this investment is scheduled to be operational in 2013, with operations scheduled to be ramped up to full production capacity by 2015. Outokumpu believes that an increase in global demand for stainless steel would result in a similar increase in the global demand for ferrochrome, a key raw material in stainless steel production. Outokumpu expects that the increased capacity will allow the Combined Group to maintain cost competitiveness in ferrochrome production and position the Combined Group as a competitive and reliable ferrochrome supplier for both internally and to external customers. However, global supplies of ferrochrome currently exceed demand and Outokumpu’s profit margin on ferrochrome sales has decreased in recent years.
Product and Geographic Mix
Product mix has affected, and will continue to affect, the Combined Group’s profitability. General stainless steel products are typically produced in large volumes and provide lower profit margins as compared to specialty stainless steel products and HPAs, which typically have higher margins. In general, a higher percentage of higher value-added product sales impact the Combined Group’s results of operations favorably, as such products tend to have higher prices and profit margins than other products.
Stainless steel applications are sold to different types of end users with specific product and grade requirements; therefore, the demand for stainless steel products may vary significantly. For example, Outokumpu has more sales to capital goods industries, whereas Inoxum has more customers in more consumer driven industries. As different grades and products are sold to end users operating in different industries, the underlying trends in different industries impact sales of different grades and products, which could affect the Combined Group’s profitability.
Geographic mix has also affected, and will continue to affect, the Combined Group’s profitability. Sales of stainless steel products to certain regions, such as the Nordic region and Western Europe, generally tend to have higher margins than sales to other regions, such as Asia. In general, a higher percentage of sales to regions with generally higher margins has a positive effect on the Combined Group’s results of operation.
Implementation of Planned and Future Efficiency Measures
In recent years, Outokumpu has taken a number of measures in response to the challenging market conditions and in order to improve the efficiency of its operations. Total provisions recognized relating to the below mentioned measures amounted to EUR 13 million as at September 30, 2012.
In April 2011, Outokumpu began implementing actions to improve its profitability and efficiency and remove overlapping activities in sales, supply chain and supporting functions in Europe. The implemented actions resulted in the reduction of approximately 300 jobs. In addition, the outsourcing of some IT services was developed further and an agreement on IT infrastructure services was signed with Tieto Corporation before the end of 2011. As a result of the agreement, approximately 20 employees were transferred to Tieto Corporation as of March 1, 2012. In May 2012, Outokumpu entered into an outsourcing agreement with Accenture related to certain IT services. The estimated annual operational cost savings after the transition are approximately EUR 29 million.
In June 2011, Outokumpu instituted a turnaround plan to improve efficiency and profitability at the Kloster thin strip production facility. Actions taken during the nine months ended September 30, 2012 included reducing production shifts, optimizing both the product mix and material flows and reducing cost levels. In addition, overall price increases were implemented. If the turnaround does not proceed at the expected pace, Outokumpu has announced that it would consider taking further action, including possibly forming a joint venture of, divesting or closing the Kloster thin strip production facility. Outokumpu will make decisions regarding the Kloster thin strip production facility as part of the overall strategy for the Combined Group.
In October 2011, Outokumpu began implementing a cost reduction program targeting savings of EUR 100 million by the end of 2012 to reach sustainable profitability, improve cash generation and strengthen the balance sheet. The planned and
implemented measures include reducing the number of production shifts, streamlining Outokumpu’s organization, divesting certain of Outokumpu’s stock locations and its remaining Brass operations, outsourcing some support functions and implementing improvements in overall efficiency. In total, the planned measures correspond to a reduction of up to 1,300 jobs globally. The cost savings are showing a gradual impact throughout the year 2012, with full effects expected from the beginning of 2013. As at the date of these listing particulars, the program is progressing as planned.
In October 2011, Outokumpu also began implementing plans to improve the inventory turnover in Outokumpu’s entire supply chain in order to reduce Outokumpu’s working capital by EUR 250 million. Compared to the number of inventory days of approximately 110 during the second quarter 2011, Outokumpu aims to bring inventory days closer to 90 by mid- 2013. This target was achieved in the first quarter of 2012 and, in the third quarter of 2012, inventory days increased slightly and were close to 100. In 2011, Outokumpu’s working capital was reduced significantly partly as a result of lower inventories and lower metal prices, but also as a result of positive development in managing of accounts receivables and accounts payables. In 2012, Outokumpu divested certain of its stock operations in Europe. Outokumpu expects that the streamlining and consolidation its distribution network in Europe to contribute to this inventory reduction target and enable the most cost-efficient routes to market that match customer needs. Outokumpu plans to serve the markets from these key locations and utilize its existing processing capacity in the markets efficiently.
Inoxum has also taken a number of measures to reduce its costs and to improve its operating efficiencies. In 2009, Inoxum launched its operational excellence program, which focuses on profitable growth, higher operating efficiency and optimization of capital employed.
Completion of Ongoing and Future Investment Programs
In recent years, Outokumpu has undertaken a number of initiatives to promote growth within its existing operations. Outokumpu’s main ongoing investment programs are:
● A EUR 410 million investment program (EUR331million spent as at September 30, 2012) to double the annual ferrochrome production capacity of its Tornio ferrochrome production facility to 530,000 tonnes as well as increase the production capacity of the Kemi chromite mine. The increased production capacity resulting from this investment is scheduled to be operational in 2013, with operations scheduled to be ramped up to full production capacity by 2015. It is expected that the Combined Group would consume a significant portion of the additional ferrochrome production volumes, which would reduce sales costs and risks associated with expanded external sales as well as allow the Tornio integrated production facility to continue to benefit from the reduced energy and transportation costs resulting from its integrated ferrochrome production. It is also expected that the Combined Group would continue to sell its surplus ferrochrome volumes on the global market.
● A EUR 104 million investment program (EUR 63 million spent as at September 30, 2012) to expand quarto plate production capacity and capability at the Degerfors quarto plate production facility in Sweden. This investment program is expected to enable the Combined Group to broaden its product offering in higher margin special grades. The annual quarto plate production capacity of the Degerfors production facility is expected to increase to 150,000 tonnes in 2014, bringing Outokumpu’s total annual quarto plate production capacity to 220,000, including the New Castle production facility in the United States.
Inoxum’s main ongoing investment programs are:
● A EUR 1.2 billion investment (EUR 1 billion spent as at September 30, 2012) in the Calvert integrated production facility in the United States, which is scheduled to be completed by the end of 2012 and ramped up to full production capacity in 2014. It is expected that upon its completion, the Calvert integrated production facility, combined with the Combined Group’s cold rolling facility in Mexico, would provide the Combined Group with a platform from which to expand sales to certain Latin American countries.
● An approximately EUR 244 million investment program (EUR 8 million spent as at September 30, 2012) in the Krefeld cold rolling production facility. The investment program is expected to increase the total ferritic grades cold rolling capacity at the Krefeld production facility by relocating cold rolling equipment from the Düsseldorf- Benrath cold rolling facility in Germany to the Krefeld production facility as well as upgrading or replacing certain equipment used in the cold rolling process. This investment program is expected to deliver significant annual cost savings through the closure of the Düsseldorf-Benrath cold rolling facility and through increased efficiencies in production. Originally, the investment program was scheduled to be completed by 2015. Given