Fourth quarter 2012 results

Results of operations

In the fourth quarter of 2012, our results of operations declined, mostly driven by the weaker results of the American division.

4 quarter 20123 quarter 2012ChangeChange
in million dollarsin million dollarsin %
Sales volume (in thousand tonnes)1,0821,050323 %
Revenue1,6311,617321 %
Cost of sales(1,300)1,265143 %
GROSS PROFIT331352(35)(6) %
GROSS PROFIT MARGIN20 %22 %(20)-
Net operating expenses1(197)(204)-(3) %
Impairment of assets(8)-7(100) %
Foreign exchange gain, net513(8)(61) %
(Loss) / gain on changes in fair value of derivative financial instrument(7)1(8)-
Finance costs, net(70)(68)(8)4 %
INCOME BEFORE TAX5394(3)(43) %
Income tax expense(22)(25)(40)(13) %
NET INCOME32693(54) %
NET INCOME ADJUSTED FOR GAIN ON CHANGES IN FAIR VALUE OF DERIVATIVE INSTRUMENT23867(37)(43) %
ADJUSTED NET INCOME MARGIN32 %4 %(29)-
ADJUSTED EBITDA230243-(5) %
ADJUSTED EBITDA MARGIN14 %15 %(13)-
1 Net operating expenses include selling and distribution, general and administrative, advertising and promotion, research and development, share of profit in associate, and net other operating expenses.

2 For the purposes of this report, net income has been adjusted for the (loss) / gain on changes in fair value of the derivative financial instrument to reflect management’s opinion in respect of the treatment of the conversion option (see “Change in fair value of derivative financial instrument”). We consider it an important supplemental measure of our performance.

3 Adjusted net income margin is calculated as the quotient of Net Income adjusted for (loss) / gain on changes in fair value of derivative instrument divided by Revenue.
4 quarter 20123 quarter 2012ChangeChange
in million dollarsin million dollarsin %
Sales volume (in thousand tonnes)1,0821,050323 %
Revenue1,6311,617321 %
Cost of sales(1,300)1,265143 %
GROSS PROFIT331352(35)(6) %
GROSS PROFIT MARGIN20 %22 %(20)-
Net operating expenses1(197)(204)-(3) %
Impairment of assets(8)-7(100) %
Foreign exchange gain, net513(8)(61) %
(Loss) / gain on changes in fair value of derivative financial instrument(7)1(8)-
Finance costs, net(70)(68)(8)4 %
INCOME BEFORE TAX5394(3)(43) %
Income tax expense(22)(25)(40)(13) %
NET INCOME32693(54) %
NET INCOME ADJUSTED FOR GAIN ON CHANGES IN FAIR VALUE OF DERIVATIVE INSTRUMENT23867(37)(43) %
ADJUSTED NET INCOME MARGIN32 %4 %(29)-
ADJUSTED EBITDA230243-(5) %
ADJUSTED EBITDA MARGIN14 %15 %(13)-
1 Net operating expenses include selling and distribution, general and administrative, advertising and promotion, research and development, share of profit in associate, and net other operating expenses.

2 For the purposes of this report, net income has been adjusted for the (loss) / gain on changes in fair value of the derivative financial instrument to reflect management’s opinion in respect of the treatment of the conversion option (see “Change in fair value of derivative financial instrument”). We consider it an important supplemental measure of our performance.

3 Adjusted net income margin is calculated as the quotient of Net Income adjusted for (loss) / gain on changes in fair value of derivative instrument divided by Revenue.

Sales

Our revenue was relatively flat quarter-on-quarter. The unfavourable changes in seamless pipe pricing in our American division were offset by higher volumes of welded LD pipe in the Russian division, and the favourable currency translation effect.

Sales by reporting segments are as follows:

4 quarter 20123 quarter 2012ChangeChange
in million dollarsin million dollarsin %
Russia1,2121,132817 %
America352410(58)(14) %
Europe6775(8)(11) %
REVENUE1,6311,617141 %
in thousand tonnesin thousand tonnesin %
Russia826797294 %
America211214(3)(1) %
Europe4539615 %
TOTAL PIPE1,0821,050323 %
4 quarter 20123 quarter 2012ChangeChange
in million dollarsin million dollarsin %
Russia1,2121,132817 %
America352410(58)(14) %
Europe6775(8)(11) %
REVENUE1,6311,617141 %
in thousand tonnesin thousand tonnesin %
Russia826797294 %
America211214(3)(1) %
Europe4539615 %
TOTAL PIPE1,0821,050323 %

Sales by group of products are as follows:

4 quarter 20123 quarter 2012ChangeChange
in million dollarsin million dollarsin %
Seamless pipe99999361 %
Welded pipe568547224 %
TOTAL PIPE1,5671,540272 %
Other operations6577(13)(17) %
TOTAL REVENUE1,6311,617141 %
in thousand tonnesin thousand tonnesin %
Seamless pipe619604152 %
Welded pipe463446174 %
TOTAL PIPE1,0821,050323 %
4 quarter 20123 quarter 2012ChangeChange
in million dollarsin million dollarsin %
Seamless pipe99999361 %
Welded pipe568547224 %
TOTAL PIPE1,5671,540272 %
Other operations6577(13)(17) %
TOTAL REVENUE1,6311,617141 %
in thousand tonnesin thousand tonnesin %
Seamless pipe619604152 %
Welded pipe463446174 %
TOTAL PIPE1,0821,050323 %

Russia. The division’s revenue was up by 7% or $81 million, including a $37 million increase from the currency translation effect.

Revenue from sales of seamless pipe stayed relatively flat, as higher volumes of seamless OCTG were offset by lower volumes of seamless industrial pipe and worsened seamless OCTG sales mix.

Revenue from welded pipe sales was up by $36 million on higher volumes of welded LD pipe driven by our company’s involvement, among other projects, in supplies for the construction of the Russian on-shore section of the South Stream pipeline.

America. Revenue decreased by 14% or $58 million, reflecting a drop in revenue of seamless and welded pipe by $26 million and $25 million, respectively. The division’s revenue dropped mainly as a result of reduction in prices across all product lines following declining rig count and temporary drop in demand as customers increasingly used their inventory and delayed purchases of the new stock, with reduction in seamless OCTG having the most significant effect.

Europe. Throughout the year, the European market was challenging, with weak demand and growing competition. We have managed to increase sales of seamless industrial pipe, yet sales of steel billets dropped dramatically. Besides, declining prices for all our product lines adversely affected revenue. As a result, the European division’s revenue declined by 11% or $8 million. The currency translation effect was marginal.

Gross profit

Our consolidated gross profit decreased by 6% or $20 million, mostly reflecting the results of operations in our American division. Gross profit margin was 20% as compared to 22% in the previous quarter.

Gross profit results by reporting segments are as follows:

4 quarter 20123 quarter 2012Change
in million dollarsin %in million dollarsin %in million dollars
Russia27723 %28225 %(5)
America4212 %5413 %(12)
Europe1319 %1621 %(3)
GROSS PROFIT33120 %35222 %(20)
4 quarter 20123 quarter 2012Change
in million dollarsin %in million dollarsin %in million dollars
Russia27723 %28225 %(5)
America4212 %5413 %(12)
Europe1319 %1621 %(3)
GROSS PROFIT33120 %35222 %(20)

Gross profit results by group of products are as follows:

4 quarter 2012 3 quarter 2012Change
in million dollarsin %in million dollarsin %in million dollars
Seamless pipe24625 %24024 %7
Welded pipe7213 %10119 %(29)
TOTAL PIPE31820 %34122 %(23)
Other operations1320 %1013 %3
GROSS PROFIT33120 %35222 %(20)
4 quarter 2012 3 quarter 2012Change
in million dollarsin %in million dollarsin %in million dollars
Seamless pipe24625 %24024 %7
Welded pipe7213 %10119 %(29)
TOTAL PIPE31820 %34122 %(23)
Other operations1320 %1013 %3
GROSS PROFIT33120 %35222 %(20)

Russia. The division’s gross profit decreased by $5 million, while gross profit margin dropped from 25% to 23%. The effect of currency translation accounted for a $9 million increase in gross profit.

Despite higher sales volumes of welded LD pipe gross profit of welded pipe declined by $28 million mainly as result of worsened welded LD sales mix due to completion of deliveries for certain high-margin projects in CIS.

Gross profit of seamless pipe increased by $5 million on higher sales of seamless OCTG. Profitability of seamless pipe remained flat.

America. Gross profit was lower by 22%, reflecting the decrease in gross profit of seamless and welded pipe by $6 million and $3 million, respectively, as a result of the following factors: (i) lower volumes and unfavorable pricing attributed to all welded tubular products partially offset by favourable sales mix due to improved volume of higher priced welded OCTG, and (ii) unfavourable pricing across all product lines of seamless pipe, however, partially offset by higher volumes. As a result, gross profit margin declined from 13% to 12%.

Europe. Gross profit decreased by 19% or $3 million, reflecting lower gross profit of steel billets due to the weak market environment in the E.U. Gross profit of seamless industrial pipe was relatively flat. The currency translation effect was marginal. As a result, gross profit margin declined from 21% to 19%.

Net operating expenses

Net operating expenses comprise selling, general and administrative, research and development, and other income and expenses.

In the fourth quarter of 2012, net operating expenses decreased by 3% or $7 million primarily because of the decline in freight cost as a result of lower share of sales with long distance delivery terms. The share of net operating expenses, expressed as a percentage of revenue, decreased to 12% from 13%.

The currency translation effect amounted to a $4 million increase in net operating expenses.

Adjusted EBITDA

In the fourth quarter of 2012, adjusted EBITDA decreased by 5% or $13 million; adjusted EBITDA margin declined from 15% to 14%.

4 quarter 2012 3 quarter 2012 Change
in million dollarsin %in million dollarsin %in million dollars
Russia19516 %19017 %4
America267 %4210 %(16)
Europe914 %1014 %(1)
Adjusted EBITDA23014 %24315 %(13)
4 quarter 2012 3 quarter 2012 Change
in million dollarsin %in million dollarsin %in million dollars
Russia19516 %19017 %4
America267 %4210 %(16)
Europe914 %1014 %(1)
Adjusted EBITDA23014 %24315 %(13)

Russia. Adjusted EBITDA increased by 2% or $4 million, mainly as a result of a slight decrease in selling, general and administrative expenses. Adjusted EBITDA margin was down from 17% to 16%.

America. Adjusted EBITDA went down by 38% or $16 million mainly on lower gross profit. Adjusted EBITDA margin dropped from 10% to 7%, reflecting a higher selling, general and administrative expenses as a percentage of revenue.

Europe. Adjusted EBITDA declined by 14% or $1 million following the decrease in gross profit. Adjusted EBITDA margin remained at the level of the previous quarter, primarily on lower selling, general and administrative expenses as a percentage of revenue.

Impairment of assets

As of 31 December 2012, we determined in respect of certain non-production assets in the Russian division that the carrying value of cash-generating unit exceeded its value in use. As a result, we recognised the impairment of these assets in the amount of $8 million.

Foreign exchange movements

In the fourth quarter, we recorded a $5 million foreign exchange gain as compared to a $13 million gain recognised in the previous quarter. We also recognised a foreign exchange gain from exchange rate fluctuations in the amount of $15 million (net of income tax) in the fourth quarter as compared to a $52 million (net of income tax) in the third quarter in the statement of other comprehensive income. The amount in the statement of comprehensive income represents the effective portion of foreign exchange gains or losses on our hedging instruments.

Net finance costs

In the fourth quarter of 2012, our finance costs increased by 4% or $3 million as compared to the previous quarter substantially due to the currency translation effect. As of 31 December 2012, the weighted average nominal interest rate for our loans and borrowings decreased to 6.99%, which is a 1 basis point lower compared to the rate at 30 September 2012.

In the fourth quarter of 2012, our finance income remained flat.

As a result, our net finance costs increased by 4% or $3 million.

Cash flows

The following table illustrates our cash flows for the periods presented:

4 quarter 20123 quarter 2012ChangeChange
in million dollarsin million dollarsin %
Net cash provided by operating activities39022616472 %
Payments for property and equipment(138)(109)(29)27 %
Acquisition of subsidiaries(27)(1)(26)n/a
Dividends received36(3)(45) %
Other investments42273 %1
Free Cash Flow123212510786 %
Change in loans(75)1(76)n/a
Interest paid(60)(70)10(14) %
Other financial activities6(2)8n/a
Free Cash Flow to Equity2104544991 %
Dividends paid(8)(71)63(88) %
Effect of exchange rate changes36(2)(44) %
Cash and cash equivalents at the beginning of period127137(11)(8) %
Cash and cash equivalents at period end2251279978 %
4 quarter 20123 quarter 2012ChangeChange
in million dollarsin million dollarsin %
Net cash provided by operating activities39022616472 %
Payments for property and equipment(138)(109)(29)27 %
Acquisition of subsidiaries(27)(1)(26)n/a
Dividends received36(3)(45) %
Other investments42273 %1
Free Cash Flow123212510786 %
Change in loans(75)1(76)n/a
Interest paid(60)(70)10(14) %
Other financial activities6(2)8n/a
Free Cash Flow to Equity2104544991 %
Dividends paid(8)(71)63(88) %
Effect of exchange rate changes36(2)(44) %
Cash and cash equivalents at the beginning of period127137(11)(8) %
Cash and cash equivalents at period end2251279978 %

Net cash flows provided by operating activities substantially increased, primarily due to a $176 million decrease in working capital in the fourth quarter of 2012, as compared to the $17 decrease in the third quarter of 2012.

Cash spent for acquisition of subsidiaries in the fourth quarter of 2012 relates to the acquisition of 55% of the voting shares of Gulf International Pipe Industry LLC, a company based in the Sultanate of Oman and specialising in the manufacturing of welded steel pipes.

In the fourth quarter of 2012, we paid $8 million of the interim dividend in respect of the six months of 2012 to the shareholders of OAO TMK. In the third quarter of 2012, we paid $68 million of the final dividend in respect of 2011 to the shareholders of OAO TMK.

Net debt

With almost half of the debt portfolio denominated in the Russian rouble, our total debt is highly sensitive to exchange rates volatility. In the fourth quarter 2012 our total debt increased from $3,816 million to $3,885 million as a result of the appreciation of the Rouble against the U.S. dollar and acquisition of a subsidiary with a $98 million debt on its balance, while net repayment amounted to $75 million (including partial repayment of the acquired subsidiary’s debt). At the same time our net debt1 decreased by $30 million because of the significant growth of the cash balance at the end of the year. As a result, our Net debt-to-EBITDA ratio improved to 3.5.

1 For Net Debt and Adjusted EBITDA, please, refer to “Selected financial data”. Net-Debt-to-EBITDA ratio is defined as the quotient of Net Debt at the end of the given reporting date divided by Adjusted EBITDA for the 12 months immediately preceding the given reporting date.

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