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UNITED STATES STEEL CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Certain sections of Management's Discussion and Analysis include forward-looking statements concerning trends or events potentially affecting the businesses of United States Steel Corporation (U. S. Steel). These statements typically contain words such as "anticipates," "believes," "estimates," "expects," "intends" or similar words indicating that future outcomes are not known with certainty and are subject to risk factors that could cause these outcomes to differ significantly from those projected. In accordance with "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, these statements are accompanied by cautionary language identifying important factors, though not necessarily all such factors that could cause future outcomes to differ materially from those set forth in forward-looking statements. For discussion of risk factors affecting the businesses of U. S. Steel, see Item 1A. Risk Factors and "Supplementary Data - Disclosures About Forward-Looking Statements" in U. S. Steel's Annual Report on Form 10-K for the year ended December 31, 2012. References in this Quarterly Report on Form 10-Q to "U. S. Steel," "the Company," "we," "us" and "our" refer to U. S. Steel and its consolidated subsidiaries unless otherwise indicated by the context. RESULTS OF OPERATIONS Net sales by segment for the first quarter of 2013 and 2012 are set forth in the following table: Quarter Ended March 31, % (Dollars in millions, excluding intersegment sales) 2013 2012 Change Flat-rolled Products (Flat-rolled) $ 3,103 $ 3,300 -6 % U. S. Steel Europe (USSE) 783 815 -4 % Tubular Products (Tubular) 686 946 -27 % Total sales from reportable segments 4,572 5,061 -10 % Other Businesses 23 111 -79 % Net sales $ 4,595 $ 5,172 -11 % Management's analysis of the percentage change in net sales for U. S. Steel's reportable business segments for the quarter ended March 31, 2013 versus the quarter ended March 31, 2012 is set forth in the following table: Quarter Ended March 31, 2013 versus Quarter Ended March 31, 2012 Steel Products (a) Coke & Net Volume Price Mix FX (b) Other Change Flat-rolled -1 % -6 % 0 % 0 % 1 % -6 % USSE 1 % -4 % -2 % 1 % 0 % -4 % Tubular -18 % -10 % 2 % 0 % -1 % -27 % (a) Excludes intersegment sales (b) Foreign currency translation effects Net sales were $4,595 million in the first quarter of 2013, compared with $5,172 million in the same quarter last year. The decrease in sales for the Flat-rolled segment reflected lower average realized prices (decrease of $45 per ton) as a result of lower spot market pricing during the first quarter of 2013 as compared to the comparable period in 2012 and decreased shipments (decrease of 74 thousand - 28 - -------------------------------------------------------------------------------- tons). The decrease in sales for the European segment was primarily due to decreased average realized euro-based prices (decrease of €27 per ton). The decrease in sales for the Tubular segment reflected lower average realized prices (decrease of $171 per ton) and deceased shipments (decrease of 101 thousand tons), primarily as a result of decreased drilling activity in the first quarter of 2013 as compared to the same period in 2012. Pension and other benefits costs Pension and other benefit costs are reflected in our cost of sales and selling, general and administrative expense line items in the Consolidated Statements of Operations. Defined benefit and multiemployer pension plan costs totaled $95 million in the first quarter of 2013, compared to $100 million in the first quarter of 2012. The $5 million decrease is primarily due to the natural maturation of our pension plans and a higher market related value of assets. Costs related to defined contribution plans totaled $11 million in the first quarter of 2013 compared to $10 million in the first quarter of 2012. Other benefit costs totaled $14 million in the first quarter of 2013, compared to $30 million in the first quarter of 2012. The $16 million decrease is primarily due to program changes arising out of the 2012 Labor Agreements. Net periodic pension cost, including multiemployer plans, is expected to total approximately $385 million in 2013. Total other benefits costs in 2013 are expected to total approximately $55 million. A sensitivity analysis of the projected incremental effect of a hypothetical one percentage point change in the significant inputs used in the calculation of pension and other benefits net periodic benefit costs is provided in the following table: Hypothetical Rate Increase (Decrease) (In millions of dollars) 1% (-1%) Expected return on plan assets Incremental (decrease) increase in: Net periodic pension cost $ (103 ) $ 103 Discount rate Incremental (decrease) increase in: Net periodic pension & other benefits costs $ (58 ) $ 53 Health care cost escalation trend rates Incremental increase (decrease) in: Service and interest cost components for 2013 $ 11 $ (9 ) Selling, general and administrative expenses Selling, general and administrative expenses were $145 million in the first quarter of 2013 compared to $173 million in the first quarter of 2012. The decrease is primarily related to lower other benefit costs as noted above. - 29 - -------------------------------------------------------------------------------- Income (loss) from operations by segment for the first quarter of 2013 and 2012 is set forth in the following table: Quarter Ended March 31, % (Dollars in millions) 2013 2012 Change Flat-rolled $ (13 ) $ 183 -107 % USSE 38 (34 )(a) 212 % Tubular 64 129 -50 % Total income from reportable segments 89 278 -68 % Other Businesses 5 17 -71 % Segment income from operations 94 295 -68 % Postretirement benefit expense (56 ) (77 ) 27 % Other items not allocated to segments: Net loss on sale of assets - (310 ) Property tax settlements - 19 Total income (loss) from operations $ 38 $ (73 ) 152 % (a) Includes a loss from operations for USSK of ($17) million for the quarter ended March 31, 2012. Segment results for Flat-rolled Quarter Ended March 31, % 2013 2012 Change (Loss) income from operations ($ millions) $ (13 ) $ 183 -107 % Gross margin 5 % 11 % -6 % Raw steel production (mnt) 4,920 5,043 -2 % Capability utilization 82 % 83 % -1 % Steel shipments (mnt) 4,018 4,092 -2 % Average realized steel price per ton $ 719 $ 764 -6 % The decrease in Flat-rolled results in the first quarter of 2013 compared to the same period in 2012 resulted from a decrease in average realized prices (approximately $205 million), lower steel substrate sales to our Tubular segment (approximately $40 million), increased energy costs primarily due to higher natural gas costs (approximately $20 million), lower income from our joint ventures (approximately $15 million), increased facility repairs and maintenance and other operating costs (approximately $10 million) and a decrease in shipment volumes (approximately $10 million). These decreases were partially offset by lower raw materials costs (approximately $75 million) and lower costs for employee profit sharing (approximately $25 million). - 30 - -------------------------------------------------------------------------------- Segment results for USSE Quarter Ended March 31, % 2013 2012 Change Income (loss) from operations ($ millions)(a) $ 38 $ (34 ) 212 % Gross margin(a) 11 % 2 % 9 % Raw steel production (mnt)(a) 1,203 1,240 -3 % Capability utilization(a) 98 % 85 % 13 % Steel shipments (mnt)(a) 1,048 1,045 - Average realized steel price per ton(a) $ 718 $ 749 -4 % (a) The quarter ended March 31, 2012 includes one month of activity for USSS, which was sold on January 31, 2012 . The improvement in USSE results in the first quarter of 2013 compared to the same period in 2012 was primarily due to lower raw materials costs (approximately $80 million), the elimination of operating losses subsequent to January 31, 2012 associated with our former Serbian operations (which were approximately $15 million) and decreased other operating costs (approximately $10 million). These improvements were partially offset by a decrease in average realized prices for USSK (approximately $35 million). Segment results for Tubular Quarter Ended March 31, % 2013 2012 Change Income from operations ($ millions) $ 64 $ 129 -50 % Gross margin 14 % 17 % -3 % Steel shipments (mnt) 428 529 -19 % Average realized steel price per ton $ 1,556 $ 1,727 -10 % The decrease in Tubular results in the first quarter of 2013 as compared to the same period in 2012 resulted mainly from a decrease in average realized prices (approximately $65 million) and a decrease in shipment volumes (approximately $30 million). These decreases were partially offset by lower substrate costs (approximately $30 million). Results for Other Businesses Other Businesses had income of $5 million in the first quarter of 2013, compared to income of $17 million in the first quarter of 2012. Items not allocated to segments The decrease in postretirement benefit expense in the first quarter of 2013 as compared to the same period in 2012 resulted from lower pension expense due to the natural maturation of the pension plans and lower retiree medical expense as a result of program changes, particularly the adoption of a fully insured plan for a large number of Medicare eligible participants. We recorded a $310 million pretax net loss on the sale of assets in the first quarter of 2012 which consisted of a pretax loss of $399 million related to the sale of U. S. Steel Serbia (USSS) and a pretax gain of $89 million related to the sale of a majority of the operating assets of the Birmingham Southern Railroad. - 31 - -------------------------------------------------------------------------------- We recorded a pretax gain of $19 million related to property tax settlementsthat occurred in the first quarter of 2012. This was reflected as a reduction to our cost of sales. Net interest and other financial costs Quarter Ended March 31, % (Dollars in millions) 2013 2012 Change Interest expense $ 85 $ 49 73 % Interest income (1 ) (4 ) -75 % Other financial costs 20 5 300 % Total net interest and other financial costs (income) $ 104 $ 50 108 % The increase in net interest and other financial costs in the first quarter 2013 as compared to the same period last year was due to a $34 million charge related to the repurchases of a portion of our 4.00% Senior Convertible Notes due 2014 (see Note 13) and foreign currency remeasurement losses during the three months ended March 31, 2013 of $9 million as compared to remeasurement gains of $2 million during the three months ended March 31, 2012. The income tax provision was $7 million in the first quarter of 2013 compared to $96 million in the first quarter of 2012. The tax provision does not reflect any tax benefit for pretax losses in Canada and Serbia (USSS was sold on January 31, 2012), which are jurisdictions where we have, or had, recorded a full valuation allowance on deferred tax assets, and also does not reflect any tax provision or benefit for certain foreign currency remeasurement gains and losses that are not recognized in any tax jurisdiction. The tax provision for the first quarter of 2013 is based on an estimated annual effective rate, which requires management to make its best estimate of annual pretax income or loss. During the year, management regularly updates forecasted annual pretax results for the various countries in which we operate based on changes in factors such as prices, shipments, product mix, operating performance and cost estimates. To the extent that actual 2013 pretax results for U.S. and foreign income or loss vary from estimates used herein at the end of the most recent interim period, the actual tax provision or benefit recognized in 2013 could be materially different from the forecasted amount used to estimate the tax provision for the first quarter of 2013. The net domestic deferred tax asset was $477 million at March 31, 2013 compared to $538 million at December 31, 2012. A substantial amount of U. S. Steel's domestic deferred tax assets relates to employee benefits that will become deductible for tax purposes over an extended period of time as cash contributions are made to employee benefit plans and retiree benefits are paid in the future. We continue to believe it is more likely than not the net domestic deferred tax asset will be realized. At March 31, 2013, the net foreign deferred tax asset was $58 million, net of established valuation allowances of $1,109 million. At December 31, 2012, the net foreign deferred tax asset was $57 million, net of established valuation allowances of $1,099 million. At December 31, 2012, a full valuation allowance was recorded for the net Canadian deferred tax asset primarily due to cumulative losses in Canada in recent years. The net foreign deferred tax asset will fluctuate as the value of the U.S. dollar changes with respect to the euro and the Canadian dollar. If evidence changes and it becomes more likely than not that the Company will realize the net Canadian deferred tax asset, the valuation allowance would be partially or fully reversed. Any reversal of this amount would result in a decrease to income tax expense. - 32 - -------------------------------------------------------------------------------- For further information on income taxes see Note 8 to the Consolidated Financial Statements. Net loss attributable to United States Steel Corporation was $73 million in the first quarter of 2013, compared to a net loss of $219 million in the first quarter of 2012. The changes primarily reflect the factors discussed above. BALANCE SHEET Receivables increased by $184 million, or 9%, from year-end 2012. The increase in receivables at the end of the first quarter compared to year-end 2012 primarily reflects higher shipments during the first quarter of 2013 versus the fourth quarter of 2012. Inventories decreased by $187 million from year-end 2012 primarily due to a reduction in raw material inventories. Accounts Payable increased by $79 million from year-end 2012 primarily due to increased business volumes. Long-term debt, less unamortized discount decreased by $4 million due to the issuance of $316 million 2.75% Senior Convertible Notes due 2019 ($263 million net of unamortized discount) and the issuance of $275 million 6.875% Senior Notes due 2021, offset by the repurchase of $542 million aggregate principal amount of our 4.00% Senior Notes due 2014 (see Note 13). Employee benefits decreased by $153 million from year-end 2012 primarily due to benefit payments made in excess of the net periodic benefit expense recognized in the first quarter of 2013. CASH FLOW Net cash provided by operating activities was $233 million for the first quarter of 2013 compared to $426 million in the same period last year. The decrease is primarily due to lower financial results, excluding a net loss of $309 million on the sale of assets in the first quarter of 2012, and changes in working capital period over period. Additionally, in the first quarter of 2012, we made a $140 million voluntary pension contribution to our main defined benefit pension plan. There were no such contributions in the first quarter of 2013. Changes in working capital can vary significantly depending on factors such as the timing of inventory production and purchases, which is affected by the length of our business cycles as well as our captive raw materials position, customer payments of accounts receivable and payments to vendors in the regular course of business. Our key working capital components include accounts receivable and inventory. The accounts receivable and inventory turnover ratios for the three months and twelve months ended March 31, 2013 and 2012 are as follows: Three Months Ended Twelve Months Ended March 31, March 31, 2013 2012 2013 2012 Accounts Receivable Turnover 2.1 2.3 7.8 8.0 Inventory Turnover 1.8 1.8 7.3 7.8 Capital expenditures, in the first quarter of 2013, were $116 million, compared with $189 million in the same period in 2012. Flat-rolled capital expenditures were $96 million and included spending for - 33 - -------------------------------------------------------------------------------- construction of carbon alloy facilities (coke substitute) at Gary Works, trailing project costs primarily attributable to the completion of performance testing associated with our recently constructed, technologically and environmentally advanced coke battery at the Mon Valley Works' Clairton Plant, ongoing implementation of an enterprise resource planning (ERP) system and various other infrastructure and environmental projects. Tubular capital expenditures of $8 million related to an upgrade to the Lorain No. 4 Seamless Hot Mill, infrastructure and environmental capital projects. USSE capital expenditures of $10 million consisted of spending for infrastructure and environmental projects. U. S. Steel's contractual commitments to acquire property, plant and equipment at March 31, 2013, totaled $254 million. Capital expenditures, not including changes in accrued capital expenditures, for 2013 are expected to total approximately $750 million and remain focused largely on strategic, infrastructure and environmental projects. We have recently completed or neared completion on several key projects of strategic importance. We have made significant progress to improve our coke self-sufficiency and reduce our reliance on purchased coke for the steel making process through the application of advanced technologies, upgrades to our existing coke facilities and increased use of natural gas and pulverized coal in our operations. We have completed the construction of a technologically and environmentally advanced battery at the Mon Valley Works' Clairton Plant with a projected capacity of 960,000 tons per year. Initial start-up of the battery began in November 2012. Full production is anticipated during the second quarter of 2013. We have been constructing a two module carbon alloy facility at Gary Works, which utilizes an environmentally compliant, energy efficient and flexible production technology to produce a coke substitute product. The facility has a projected capacity of 500,000 tons per year when both modules are completed. Construction of the first module is complete, and we continue to focus on the optimization and reliability of operations of that module. We are slowing construction activities on the second module at this time based on current economic conditions, our coke requirements in North America and additional work on the first module. In an effort to increase our participation in the automotive market as vehicle emission and safety requirements become increasingly stringent, PRO-TEC Coating Company, our joint venture in Ohio with Kobe Steel, Ltd., has a new automotive continuous annealing line (CAL) that was financed at the joint venture level and began operations during the first quarter of 2013. We are also continuing our efforts to implement an ERP system to replace our existing information technology systems, which will enable us to operate more efficiently. The completion of the ERP project is expected to provide further opportunities to streamline, standardize and centralize business processes in order to maximize cost effectiveness, efficiency and control across our global operations. We are also currently developing additional projects within our Tubular segment, such as facility enhancements and additional premium connections that will further enhance our ability to support our Tubular customers' evolving needs. Over the longer term, we are considering business strategies to leverage our significant iron ore position in the United States and to exploit opportunities related to the availability of reasonably priced natural gas as an alternative to coke in the iron reduction process to improve our cost competitiveness, while reducing our dependence on coal and coke. We are considering an expansion of our iron ore pellet operations at our Keewatin, MN (Keetac) facility which would increase our production capability by approximately 3.6 million tons thereby increasing our iron ore self-sufficiency. The total cost of this project as currently conceived is broadly estimated to be approximately $820 million. Final permitting for the expansion was completed in December 2011. We are examining alternative iron and steel making technologies such as gas-based, direct-reduced iron and electric arc furnace (EAF) steelmaking. Our capital investments in the future may reflect such strategies, although we expect that iron and steel-making through the blast furnace and basic oxygen furnace manufacturing processes will remain our primary processing technology for the long term. - 34 - -------------------------------------------------------------------------------- The foregoing statements regarding expected 2013 capital expenditures, capital projects and expected benefits from the implementation of the ERP project are forward-looking statements. Factors that may affect our capital spending and the projects include: (i) levels of cash flow from operations; (ii) changes in tax laws; (iii) general economic conditions; (iv) steel industry conditions; (v) cost and availability of capital; (vi) receipt of necessary permits; and (vii) unforeseen hazards such as contractor performance, material shortages, weather conditions, explosions or fires. There is also a risk that the completed projects will not produce at the expected levels and within the costs currently projected. Predictions regarding benefits resulting from the implementation of the ERP project are subject to uncertainties. Actual results could differ materially from those expressed in these forward-looking statements. Restricted cash in the first quarter of 2013 primarily reflects a reduction in the use of collateralized letters of credit, which were replaced with surety bonds. Disposal of assets in the first quarter of 2012 primarily reflects proceeds from the sale of the majority of the operating assets of Birmingham Southern Railroad Company and the Port Birmingham Terminal. Borrowings against revolving credit facilities in the first quarter of 2012 reflect amounts drawn under USSK's unsecured revolving credit facilities. Repayments of revolving credit facilities in the first quarter of 2012 reflect USSK's repayment of the outstanding borrowings under its unsecured revolving credit facilities. Receivables Purchase Agreement Payments in the first quarter of 2012 reflect activity under the Receivables Purchase Agreement. Issuance of long-term debt, net of financing costs in the first quarter of 2013 reflects the issuance of $316 million of 2.75% Senior Convertible Notes due 2019 and $275 million of 6.875% Senior Notes due April 2021. U. S. Steel received net proceeds of $578 million after fees related to the underwriting discounts and third party expenses. The first quarter of 2012 reflects the issuance of $400 million of 7.50% Senior Notes due 2022. U. S. Steel received net proceeds of $392 million after fees related to the underwriting discounts and third party expenses. Repayment of long-term debt in the first quarter of 2013 reflects the repurchase of $542 million aggregate principal amount of our 4.00% Senior Convertible Notes. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes U. S. Steel's liquidity as of March 31, 2013: (Dollars in millions) Cash and cash equivalents $ 733 Amount available under $875 Million Credit Facility 875 Amount available under Receivables Purchase Agreement 625 Amount available under USSK credit facilities 280 Total estimated liquidity $ 2,513 As of March 31, 2013, $311 million of the total cash and cash equivalents was held by our foreign subsidiaries, which is indefinitely reinvested. Substantially all of the liquidity attributable to our foreign - 35 - -------------------------------------------------------------------------------- subsidiaries can be accessed without the imposition of income taxes through repayment of intercompany loans. On March 26, 2013, U. S. Steel issued $316 million of 2.75% Convertible Senior Notes due 2019 and $275 million of 6.875% Senior Notes due 2021. U. S. Steel received net proceeds of $578 million from the issuances. The net proceeds were used to repurchase $542 million aggregate principal amount of our 4.00% Senior Convertible Notes due 2014. As of March 31, 2013, there were no amounts drawn under our $875 million credit facility agreement (Amended Credit Agreement) and inventory values calculated in accordance with the Amended Credit Agreement supported the full $875 million of the facility. Under the Amended Credit Agreement, U. S. Steel must maintain a fixed charge coverage ratio (as further defined in the Amended Credit Agreement) of at least 1.00 to 1.00 for the most recent four consecutive quarters when availability under the Amended Credit Agreement is less than the greater of 10% of the total aggregate commitments and $87.5 million. As of March 31, 2013, U. S. Steel has a Receivables Purchase Agreement (RPA) that provides liquidity and letters of credit depending upon the number of eligible domestic receivables generated by U. S. Steel. As of March 31, 2013, eligible accounts receivable supported the maximum amount eligible for sale of $625 million and there were no outstanding borrowings under this facility. At March 31, 2013, USSK had no borrowings under its €200 million (approximately $256 million) unsecured revolving credit facility. At March 31, 2012, USSK had no borrowings under its €20 million unsecured credit facilities (which approximated $25 million) and the availability was approximately $24 million due to approximately $1 million of outstanding customs and other guarantees. We may from time to time seek to retire or purchase our outstanding long-term debt in open market purchases, privately negotiated transactions, exchange transactions or otherwise. Such purchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors and may be commenced or suspended at any time. The amounts involved may be material. We use surety bonds, trusts and letters of credit to provide financial assurance for certain transactions and business activities. The use of some forms of financial assurance and collateral have a negative impact on liquidity. U. S. Steel has committed $85 million of liquidity sources for financial assurance purposes as of March 31, 2013. At March 31, 2013, in the event of a change in control of U. S. Steel, debt obligations totaling $3,212 million, which includes the Senior Notes and the Senior Convertible Notes, may be declared immediately due and payable. In such an event, U. S. Steel may also be required to either repurchase the leased Fairfield slab caster for $20 million or provide a letter of credit to secure the remaining obligation. The maximum guarantees of the indebtedness of unconsolidated entities of U. S. Steel totaled $29 million at March 31, 2013. In the event that any default related to the guaranteed indebtedness occurs, U. S. Steel has access to its interest in the assets of the investees to reduce its potential losses under the guarantees. Our major cash requirements in 2013 are expected to be for capital expenditures, employee benefits and operating costs, including purchases of raw materials. We finished the first quarter of 2013 with - 36 - -------------------------------------------------------------------------------- $733 million of cash and cash equivalents and $2.5 billion of total liquidity. Available cash is left on deposit with financial institutions or invested in highly liquid securities with parties we believe to be creditworthy. U. S. Steel management believes that U. S. Steel's liquidity will be adequate to satisfy our obligations for the foreseeable future, including obligations to complete currently authorized capital spending programs. Future requirements for U. S. Steel's business needs, including the funding of acquisitions and capital expenditures, scheduled debt maturities, contributions to employee benefit plans, and any amounts that may ultimately be paid in connection with contingencies, are expected to be financed by a combination of internally generated funds (including asset sales), proceeds from the sale of stock, borrowings, refinancings and other external financing sources. Our opinion regarding liquidity is a forward-looking statement based upon currently available information. To the extent that operating cash flow is materially lower than recent levels or external financing sources are not available on terms competitive with those currently available, future liquidity may be adversely affected. Off-balance Sheet Arrangements U. S. Steel did not enter into any new material off-balance sheet arrangements during the first quarter of 2013. Environmental Matters, Litigation and Contingencies U. S. Steel has incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures as a result of environmental laws and regulations. In recent years, these expenditures have been mainly for process changes in order to meet Clean Air Act (CAA) obligations and similar obligations in Europe and Canada, although ongoing compliance costs have also been significant. To the extent that these expenditures, as with all costs, are not ultimately reflected in the prices of our products and services, operating results will be reduced. U. S. Steel believes that our major North American and many European integrated steel competitors are confronted by substantially similar conditions and thus does not believe that our relative position with regard to such competitors is materially affected by the impact of environmental laws and regulations. However, the costs and operating restrictions necessary for compliance with environmental laws and regulations may have an adverse effect on our competitive position with regard to domestic mini-mills, some foreign steel producers (particularly in developing economies such as China) and producers of materials which compete with steel, all of which may not be required to incur equivalent costs in their operations. In addition, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities and its production methods. U. S. Steel is also responsible for remediation costs related to our prior disposal of environmentally sensitive materials. Many of our competitors do not have similar historical liabilities. Our U.S. facilities are subject to the U.S. environmental standards, including the CAA, the Clean Water Act (CWA), the Resource Conservation and Recovery Act (RCRA) and the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), as well as state and local laws and regulations. U. S. Steel Canada (USSC) is subject to the environmental laws of Canada, which are comparable to environmental standards in the United States. Environmental regulation in Canada is an area of shared responsibility between the federal government and the provincial governments, which in turn delegate certain matters to municipal governments. Federal environmental statutes include the federal Canadian Environmental Protection Act, 1999 and the Fisheries Act. Various provincial statutes regulate - 37 - -------------------------------------------------------------------------------- environmental matters such as the release and remediation of hazardous substances; waste storage, treatment and disposal; and releases to air and water. As in the United States, Canadian environmental laws (federal, provincial and local) are undergoing revision and becoming more stringent. USSK is subject to the environmental laws of Slovakia and the European Union (EU). A related law of the EU commonly known as Registration, Evaluation, Authorization and Restriction of Chemicals, Regulation 1907/2006 (REACH) requires the registration of certain substances that are produced in the EU or imported into the EU. Although USSK is currently compliant with REACH, this regulation is becoming increasingly stringent. Slovakia is also currently considering a law implementing an EU Waste Framework Directive that would more strictly regulate waste disposal and increase fees for waste disposed of in landfills including privately owned landfills. The intent of the waste directive is to encourage recycling and because Slovakia has not adopted implementing legislation, we cannot estimate the full financial impact of this prospective legislation at this time. The EU's Industry Emission Directive will require implementation of EU determined best available techniques (BATs) to reduce environmental impacts as well as compliance with BAT associated emission levels. It contains operational requirements for air emissions, wastewater discharges, solid waste disposal and energy conservation, dictates certain operating practices and imposes stricter emission limits. Producers will be required to be in compliance with the iron and steel BAT by March 8, 2016. We are currently evaluating the costs of complying with BAT, but our most recent broad estimate of likely capital expenditures is $300 million to $400 million over the 2013 to 2016 period. We are currently investigating the possibility of obtaining EU grants to fund a portion of those capital expenditures. We also believe there will be increased operating costs, such as increased energy and maintenance costs, but we are currently unable to reliably estimate this amount. A Memorandum of Understanding was signed in March of 2013 between U. S. Steel and the government of Slovakia. The Memorandum of Understanding outlines areas in which the government and U. S. Steel will work together to help create a more competitive environment and conditions for USSK. Some of the incentives the government of Slovakia agreed to provide, as an effort to reduce USSK's cost structure, include participation in a renewable energy program that provides the opportunity to reduce electricity costs as well as the potential for government grants and other support concerning investments in environmental control technology that may be required under the recently implemented BAT requirements. The ultimate economic value of these actions is subject to many developments and uncertainties but based on current electricity tariffs, management estimates annual energy savings of approximately €15 million, which are expected to begin in 2016. There are many conditions and uncertainties regarding the grants, including matters controlled by the EU, but the value could be as much as €75 million. In return, U. S. Steel agreed to achieve employment level reduction goals at USSK only through the use of natural attrition, except in cases of extreme economic conditions, as outlined in the current Collective Labor Agreement. Additionally, U. S. Steel agreed to pay the government of Slovakia specified declining amounts should U. S. Steel sell USSK within five years of signing the Memorandum of Understanding. U. S. Steel has incurred and will continue to incur substantial capital, operating and maintenance and remediation expenditures as a result of environmental laws and regulations, which in recent years have been mainly for process changes in order to meet CAA obligations and similar obligations in Europe and Canada. In the future, compliance with carbon dioxide (CO2) emission requirements may include substantial costs for emission allowances, restriction of production and higher prices for coking coal, natural gas and electricity generated by carbon based systems. Since it is difficult to predict what requirements will ultimately be imposed in the United States, Canada and Europe, it is difficult to estimate the likely impact on U. S. Steel, but it could be substantial. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of U. S. Steel's products and services, - 38 - -------------------------------------------------------------------------------- operating results will be reduced. U. S. Steel believes that our major North American and many European integrated steel competitors are confronted with substantially similar conditions and thus does not believe that its relative position with regard to such competitors will be materially affected by the impact of environmental laws and regulations. However, if the final requirements do not recognize the fact that the integrated steel process involves a series of chemical reactions involving carbon that create CO2 emissions, our competitive position relative to mini mills will be adversely impacted. Our competitive position compared to producers in developing nations, such as China and India, will be harmed unless such nations require commensurate reductions in CO2 emissions. Competing materials such as plastics may not be similarly impacted. The specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities and its production methods. U. S. Steel is also responsible for remediation costs related to former and present operating locations and disposal of environmentally sensitive materials. Many of our competitors, including North American producers, or their successors, that have been the subject of bankruptcy relief have no or substantially lower liabilities for such matters. Greenhouse Gas Emissions Regulation The current and potential regulation of greenhouse gas emissions remains a significant issue for the steel industry, particularly for integrated steel producers such as U. S. Steel. The regulation of greenhouse gases such as CO2 emissions has either become law or is being considered by legislative bodies of many nations, including countries where we have operating facilities. In the United States, the Environmental Protection Agency (EPA) has published rules for regulating greenhouse gas emissions for certain facilities and has implemented various reporting requirements as further described below. In Utility Air Regulatory Group v. EPA, No. 11-1037 (consolidating various challenges); and Texas v. EPA, No. 10-1425, the U.S. Court of Appeals for the District of Columbia issued an opinion essentially upholding the EPA's greenhouse gas authority. The court rejected challenges to the endangerment finding, giving the EPA authority to regulate greenhouse gases under the CAA on the basis that they pose a risk to human health. The court also rejected arguments by petitioners to dismiss inclusion of greenhouse emissions under the tailpipe rule, giving the EPA the authority to regulate greenhouse gas emissions from mobile sources and triggering regulation for stationary sources. The court dismissed challenges to the timing and tailoring rules citing that it lacked jurisdiction to decide the case on its merits since none of the petitioners had legal standing to challenge the timing and tailoring rules. Finally, the court declined to decide challenges to other State Implementation Plan (SIP) related rules issued by the EPA regarding greenhouse gas, stating that it also lacked jurisdiction over these SIP related rules. The rules are being challenged in different tribunals. The EU has established greenhouse gas regulations for the EU member states, while in Canada, a regulatory framework for greenhouse gas emissions has been published, details of which are discussed below. International negotiations to supplement and eventually replace the 1997 Kyoto Protocol are ongoing. Since 2009, the federal government has committed to reducing Canada's total greenhouse gas emissions by 17 percent from 2005 levels by 2020. The Ontario government has committed to its own greenhouse gas emission reduction targets for the province. This plan announced greenhouse gas emission reduction targets of six percent below 1990 levels by 2014, 15 percent below 1990 levels by 2020 and 80 percent below 1990 levels by 2050. The Ontario government is currently seeking input from stakeholders, including industry, on the development of a greenhouse gas emission reduction program for Ontario. - 39 - -------------------------------------------------------------------------------- If federal or provincial greenhouse gas reduction legislation for the steel sector becomes law in Canada, it could have economic and operational consequences for U. S. Steel. At the present time, it is not possible to estimate the timing or impact of these or other future government actions on U. S. Steel. The EPA has classified greenhouse gases such as CO2 as harmful gases. Under this premise, it has implemented a greenhouse gas emission monitoring and reporting requirement for all facilities emitting 25,000 metric tons or more per year of carbon dioxide, methane and nitrous oxide in CO2 equivalent quantities. In accordance with EPA greenhouse gas emissions reporting requirements, reports for the year 2012 were completed and submitted for all required facilities by the April 1, 2013 deadline. As with previous year's reporting, fourteen facilities submitted reports including Gary Works, East Chicago Tin, Midwest Plant, Clairton Plant, Edgar Thomson Plant, Irvin Plant, Fairless Plant, Fairfield Sheet, Fairfield Tubular, Granite City Works, Great Lakes Works, Lorain Tubular, Minntac and Keetac. The Texas Operations is the only significant operation not required to report as its emissions were well below the 25,000 ton reporting threshold. New requirements were adopted in 2011 related to monitoring and reporting of greenhouse gas emissions for vacuum degassing (decarburization), and methane emissions from on-site landfills. Facilities for which greenhouse gas emissions from decarburization were determined and reported included Gary Works, Great Lakes Works, and the Edgar Thomson Plant. Calculation of landfill methane emissions from U. S. Steel facilities were completed earlier this year. New provisions for incorporating electronic reporting of on-site landfill methane emissions were added in 2012 enabling those subject to the rule to report greenhouse gas emissions from on-site landfills for 2011. In 2013, the EPA significantly expanded its reporting requirements to include inputs to the calculation, primarily related to methane emissions from landfills, which had previously been deferred. This meant that in addition to the 2012 reports, the 2010 and 2011 reports also had to be re-submitted for many of our facilities. New requirements were also imposed for the monitoring and reporting of greenhouse gas emissions from industrial landfills, including reporting specific categories and historical quantities of materials sent to our on-site landfills. As with previous year's reports, the EPA intends to make this information publicly available from all facilities. The European Commission (EC) has created an Emissions Trading System (ETS) and subsequent to 2012, the ETS will employ centralized allocation, rather than national allocation plans, that are expected to be more stringent than the previous requirements. The new ETS also includes a cap designed to achieve an overall reduction of greenhouse gases for the ETS sectors of 21 percent in 2020 compared to 2005 emissions and auctioning as the basic principle for allocating emissions allowances, with some transitional free allocation provided on the basis of benchmarks for manufacturing industries under risk of carbon leakage. Manufacturing of sinter, coke oven products, basic iron and steel, ferro-alloys and cast iron tubes have all been recognized as exposing companies to a significant risk of carbon leakage, but the new ETS is still expected to lead to additional costs for steel companies in Europe. Because the final scheme has not yet been published, we cannot reliably estimate the future market value of CO2 emission allowances and the cost of complying with the new ETS at this time. Environmental Remediation In the United States, U. S. Steel has been notified that we are a potentially responsible party (PRP) at 22 sites under CERCLA as of March 31, 2013. In addition, there are 12 sites related to U. S. Steel where we have received information requests or other indications that we may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability - 40 - -------------------------------------------------------------------------------- or make any judgment as to the amount thereof. There are also 38 additional sites related to U. S. Steel where remediation is being sought under other environmental statutes, both federal and state, or where private parties are seeking remediation through discussions or litigation. At many of these sites, U. S. Steel is one of a number of parties involved and the total cost of remediation, as well as U. S. Steel's share thereof, is frequently dependent upon the outcome of investigations and remedial studies. U. S. Steel accrues for environmental remediation activities when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. As environmental remediation matters proceed toward ultimate resolution or as additional remediation obligations arise, charges in excess of those previously accrued may be required. See Note 20 to the Consolidated Financial Statements. For discussion of relevant environmental items, see "Part II. Other Information-Item 1. Legal Proceedings-Environmental Proceedings." During the first quarter of 2013, there was no change in our accrual balance for environmental matters for U.S. and international facilities. The total accrual for such liabilities at March 31, 2013 was $203 million. These amounts exclude liabilities related to asset retirement obligations, disclosed in Note 14 to the Consolidated Financial Statements. U. S. Steel is the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments involving a variety of matters, including laws and regulations relating to the environment. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the financial statements. However, management believes that U. S. Steel will remain a viable and competitive enterprise even though it is possible these contingencies could be resolved unfavorably. OUTLOOK We expect total reportable segment and Other Businesses operating results to be near breakeven for the second quarter. Results for our Tubular segment are projected to be comparable with the first quarter; however we expect lower results from our Flat-rolled and European segments. While we project North American flat-rolled market conditions for the second quarter to be comparable to the first quarter, we expect an operating loss for our Flat-rolled segment primarily due to higher operating costs. Operating costs are projected to increase due primarily to higher repairs and maintenance costs as well as higher natural gas costs offset by lower raw materials costs. Repairs and maintenance costs are projected to be $75 million higher in the second quarter due to maintenance projects already largely completed at Gary Works and Lake Erie Works. Average realized prices, including the effect of a more favorable product mix, are expected to be comparable to the first quarter while shipments are projected to decrease slightly. The labor agreement covering our Lake Erie Works expired on April 15, 2013 and a successor agreement has not been reached. U. S. Steel Canada implemented a lockout of represented employees effective April 28, 2013. Second quarter results for our European segment are projected to decline compared to the first quarter due to higher raw materials costs, primarily iron ore. Shipments and average realized euro-based prices are expected to be comparable to the first quarter as decreases in spot market prices are expected to be offset by the positive effect of a higher volume of value-added shipments. We expect second quarter results for our Tubular segment to be comparable to the first quarter. Shipments are expected to increase compared to the first quarter to support a higher level of drilling activity while average realized prices are projected to be slightly lower, mainly due to increased shipments of welded product. Operating costs are expected to decrease due to operating efficiencies related to higher production volumes. - 41 - -------------------------------------------------------------------------------- Operating profit from Other Businesses is expected to increase approximately $30 million due to a real estate sale expected to occur in the second quarter. We expect a minimal tax provision/benefit in the second quarter primarily due to the full valuation allowance on deferred tax assets in Canada. INTERNATIONAL TRADE Demand for flat-rolled products is influenced by a wide variety of factors, including but not limited to macro-economic drivers, the supply-demand balance, inventories, imports and exports, currency fluctuations, and the demand from flat-rolled consuming markets. The largest drivers of North American consumption have historically been the automotive and construction markets, which make up more than 50 percent of total sheet consumption. Other sheet consuming industries include appliance, converter, container, tin, energy, electrical equipment, agricultural, domestic and commercial equipment and industrial machinery. USSE conducts business primarily in Europe. Like our domestic operations, USSE is affected by the cyclical nature of demand for steel products and the sensitivity of that demand to worldwide general economic conditions. The sovereign debt issues and the resulting economic uncertainties are adversely affecting markets in the EU. We are subject to market conditions in those areas, which are influenced by many of the same factors that affect U.S. markets, as well as matters specific to international markets such as quotas, tariffs and other protectionist measures. Demand for energy related tubular products depends on several factors, most notably the number of oil and natural gas wells being drilled, completed and re-worked, the depth and drilling conditions of these wells and the drilling techniques utilized. The level of these activities depends primarily on the demand for natural gas and oil and expectations about future prices for these commodities. Demand for our tubular products is also affected by the continuing development of shale oil and gas resources, the level of production by domestic manufacturers, inventories maintained by manufacturers, distributors, and end users and by the level of new capacity and imports in the markets we serve. In recent years, a significant number of steel imports have been found to violate U.S. or Canadian trade laws. Under these laws, duties can be imposed against dumped products, which are products sold at a price that is below that producer's sales price in its home market or at a price that is lower than its cost of production. Countervailing duties (CVD) can be imposed against products that benefited from foreign government financial assistance for the production, manufacture, or exportation of the product. For many years, U. S. Steel, other producers, customers and the United Steel Workers have sought the imposition of duties and in many cases have been successful. Such duties are generally subject to review every five years and we actively participate in such review proceedings. As in the past, U. S. Steel continues to monitor unfairly traded imports and is prepared to seek appropriate remedies against such imports. The following international trade orders of interest to U. S. Steel are currently undergoing five-year (sunset) reviews in the United States: (i) an AD order on welded large-diameter line pipe from Japan; (ii) an AD order on hot-rolled steel from China; (iii) AD and CVD orders on hot-rolled steel from India; (iv) AD and CVD orders on hot-rolled steel from Indonesia; (v) an AD order on hot-rolled steel from Taiwan; (vi) AD and CVD orders on hot-rolled steel from Thailand; and (vii) an AD order on hot-rolled steel from Ukraine. Steel sheet imports to the United States accounted for an estimated 15 percent of the U.S. steel sheet market in 2012 and 13 percent of the U.S. steel sheet market in 2011 and 2010. Increases in future levels of imported steel could reduce future market prices and demand levels for steel produced in our North American facilities. - 42 - -------------------------------------------------------------------------------- Imports of flat-rolled steel to Canada accounted for an estimated 34 percent of the Canadian market for flat-rolled steel products in 2012, 35 percent in 2011 and 40 percent in 2010. Total imports of flat-rolled carbon steel products (excluding quarto plates and wide flats) to the 27 countries currently comprising the EU were 11 percent of the EU market in 2012, 17 percent of the EU market in 2011 and 14 percent in 2010. Increases in future levels of imported steel could reduce market prices and demand levels for steel produced by USSE. Energy related tubular products imported into the United States accounted for an estimated 52 percent of the U.S. domestic market in 2012, 47 percent in 2011 and 46 percent in 2010. Increases in future levels of imported steel could reduce future market prices and demand levels for steel produced in our North American facilities. We expect to continue to experience competition from imports and will continue to closely monitor imports of products in which we have an interest. Additional complaints may be filed if unfairly-traded imports adversely impact, or threaten to adversely impact, our financial results. NEW ACCOUNTING STANDARDS See Note 2 to the Consolidated Financial Statements in Part I Item 1 of this Form 10-Q. - 43 - -------------------------------------------------------------------------------- |