U.S. Steel Canada Inc. (formerly Stelco), Sep 21, 2015

September 21, 2015

On September 21, 2015, we filed an urgent motion for an interim “stand still” order against USS requiring it to immediately cease and desist from moving the automotive production out of USSC pending the final disposition of the main motions that we and USW filed, which are scheduled for a hearing on September 29,2015. As of this writing, we are awaiting a response from the Court office for the time for a hearing on September 21, 2015. To view our motion materials, please click here.

Update on recent actions by USS and the response of USSC

On August 31, 2015, the Monitor announced that USS would be transferring high revenue automotive steel production from USSC to USS facilities. USS did not obtain court approval for its intention to transfer this production out of USSC, nor did it agree to the Monitor’s request to wait before transferring the production so that the Monitor can better assess the impact of such a transfer on USSC. The relevant portions of the Monitor’s 12th Report are set out below:

Since the commencement of the CCAA, the Monitor has been monitoring activities performed by USS on behalf of USSC. Such monitoring procedures were detailed in the Pre-Filing Report at paragraphs 39, 42, 51, 55 and 61.
As noted in paragraph 40 of the Pre-Filing Report, although it is not formalized in a written agreement, USS centrally plans the loading of its North American steel mills, including USSC’s Hamilton Works and Lake Erie Works. The production generated at USSC’s mills is ultimately one of the key drivers generating revenue and cash flow, as semi-finished or finished mill products are ultimately sold to Canadian and U.S.-based customers, or to other USS mills for further processing. The current mill loading and production allocation process has been followed for a number of years. Although there is no written agreement between USS and USSC with respect to USS’s allocation of production, there is a structured process that is understood among the parties and followed. This process is referred to herein as “plant loading”.
As part of the monitoring of plant loading, the Monitor has participated in weekly calls with USS’ Enterprise Planning department. This department is responsible for allocating production to each of the mills in the USS group.

Plant loading processes

Paragraph 41 of the Pre-Filing Report summarized the plant loading process in greater detail and is reproduced in Appendix “A” to this Twelfth Report.
Pursuant to the plant loading process, USS has been loading USSC’s plants with particular products to be produced at Lake Erie Works and Hamilton Works during the course of the CCAA proceedings. Any significant changes in production since the Filing Date have been largely due to market conditions and generally challenging steel demand in the North American steel market and not as a result of reallocation to U. S. mills of automotive steel currently being manufactured by USSC.
As set out in the Pre-Filing Report, a large proportion of Hamilton Works’ production is ultimately sold to North American automotive customers. Such steel is produced at Lake Erie Works and then further processed at Hamilton Works’ cold mill and Z-line (which is a zinc coating line). As set out in the Monitor’s Second Supplemental Report to the Seventh Report dated May 4, 2015, automotive contracts represented a significant proportion of steel processed at the Hamilton Works plant in fiscal 2014.

Recent plant loading developments

USSC and the Monitor have recently received notification from USS that approximately 15,000 tons of monthly production scheduled for customer delivery in early October will be redirected to USS mills in the United States rather than being allocated to and produced at Lake Erie Works and finished at Hamilton Works. On an annualized basis this represents 180,000 tons, which compares to total tonnage produced at Hamilton Works in fiscal 2014 of approximately 735,000 tons (and a total of approximately 381,000 tons for the seven month year-to-date period in fiscal 2015). The parts being diverted to the U.S.-based mills represent relatively higher gross margin production for Hamilton, so the impact on Hamilton’s revenue, earnings and cash flow will be significant.
As a result of the proposed reduction of production in Canada, it will be necessary for USSC to layoff approximately 17 employees and re-deploy a further 10 employees into other work, assuming the production is not replaced from other sources. Given the lesser impact to Lake Erie Works’ operations (on a proportionate basis), USSC is not contemplating layoffs at that facility as a result of the shift in production.
USSC has advised the Monitor that it expects it will not, on a timely basis and at the same pricing, be able to find alternate customers to make up for all the business expected to be lost in 2015 and 2016 due to the proposed change in plant loading. As stated previously, USS is USSC’s primary sales agent for automotive steel, and USSC does not have its own automotive sales staff. USSC has a smaller sales group that services certain non-automotive customers in the Canadian marketplace. USSC has advised the Monitor that it may be able to replace some of the lost tonnage referred to in the previous paragraph, but it is not certain and finding new customers could take up to a year.
As a result of the proposed mill loading reallocation, USSC has forecast that production at each of Lake Erie Works and Hamilton Works will be reduced by approximately 45,000 tons for the remainder of 2015 and approximately 180,000 tons for 2016. Without the replacement of this tonnage through new customer orders, USSC estimates that the move of production will result in a reduction of approximately $40 million of revenue for the last three months of 2015 and approximately $162 million of revenue for 2016. Further, USSC estimates that the impact on its forecast EBITDA will be a reduction of approximately $8.8 million for the remainder of 2015 and approximately $35.1 million for 2016.
Although this does not represent all of Hamilton Works’ automotive production the above tonnage loss represents approximately 27% of total Hamilton Works total production, based on current production levels.
USS has informed the Monitor that the decision to reallocate production to plants in the United States was made on a basis that it believe is consistent with past practice, and that USS took into consideration:

(a) Lower shipping costs – due to proximity between the new proposed production location in the U.S. and the customer, there will be lower shipping costs on an enterprise-wide basis;

(b) Concentration of production – USS has historically concentrated production at facilities with open production capacity, to enable fully booked facilities to seek out potential additional volumes. Hamilton Works is currently fully booked on its galvanizing lines, whereas at least one of USS’ U.S.-based plants is not;

(c) Historical production of the part in the U.S. – USS has informed the Monitor that over 85% of the volumes subject to the proposed change were previously produced at a U.S. facility in 2013. USSC has informed the Monitor that certain of these parts were originally produced in Canada and were moved to U.S.-based plants during a labour dispute at Lake Erie Works in 2013; and

(d) Higher opportunity for replacement business at Hamilton Works – the Hamilton Works Z-line produces a wide range of products for non-automotive customers compared to the U.S.-based plant where production is being moved; therefore, Hamilton Works has a greater opportunity to replace tons moved versus the U.S.- based plant.

After learning of the plant loading reallocation decision from USS, the Monitor requested further details and information from USS. USS advised the Monitor that the information requested was confidential business information of USS and that it would not be provided to the Monitor unless the Monitor executed a non-disclosure agreement. A form of non-disclosure agreement has been agreed to (which, among other things, precludes the Monitor from providing any information received from USS to USSC or its stakeholders). USS has provided the Monitor with certain details and is in the process of providing the Monitor with further requested information. The Monitor is currently reviewing the plant loading decision and the information provided by USS to assess the consistency with past practice and the rationale for the plant loading decision in light of current exchange rates, customer requirements and trends in the steel industry and will further update the Court upon completing its review of that information and any follow-up information requested by the Monitor.
While the Monitor will update the Court on its views regarding whether the plant loading reallocation decision is consistent with past practices in due course, USS has informed the Monitor that it has initiated the plant loading changes for customer deliveries in early October and does not intend to await any conclusions of the Monitor in that regard.
The CRO has advised the Monitor that he has spoken with counsel to USS and asked that the decision to transfer production be delayed until January 1, 2016 so that it will not negatively impact the cash flow forecast of USSC during the pendency of these proceedings. USS has advised the CRO that such a shift cannot be accommodated. The Monitor notes that the process to shift production to the U.S.-based mills has begun in the last week for certain of the parts.

On September 15, 2015, the CCAA Judge ordered the main stakeholders to participate in a mediation of all the issues with a view to reaching a “comprehensive agreement”. The mediator is retired Associate Chief Justice Douglas Cunningham and the mediation will commence on September 24, 2015. To view the Judge’s mediation order, please click here.

On September 17, 2015, following further case conferences with the CCAA Judge, we filed a motion for a court order to stop USS from moving the automotive steel from USSC. To view our motion record, click here. The USW filed a similar motion.‎ The motions are scheduled to be heard on September 29, 2015.

Also on September 17, 2015, USSC responded to the USS action by filing its “Cash Conservation Business Preservation” motion. To view the USSC motion, please click here.

USS also filed a motion on September 17, 2015 for various other court orders relating to its intention to transfer the steel production. To view the USS motion record, please click here.

We are very concerned with the above-noted actions of USS and the response of USSC. Throughout the CCAA proceeding we have asserted that the pension plan members have a statutory priority over all other creditors for amounts owing to the pension plans by operation of the deemed trust provisions in the Ontario Pension Benefits Act, which was confirmed by the Supreme Court of Canada in the Indalex case. ‎The exchange of correspondence we have sent to USS regarding the pension plan members’ statutory priority can be viewed below.

We will continue to post new developments as they occur.

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