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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, 2013, and Item 1A. Risk Factors in this Form 10-Q. 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. -31- -------------------------------------------------------------------------------- RESULTS OF OPERATIONS Net sales by segment for the three and six months ended June 30, 2014 and 2013 are set forth in the following table: Three Months Ended Six Months Ended June 30, June 30, (Dollars in millions, excluding % % intersegment sales) 2014 2013 Change 2014 2013 Change Flat-rolled Products (Flat-rolled) $ 2,938 $ 2,876 2 % $ 5,965 $ 5,979 - % U. S. Steel Europe (USSE) 757 778 (3 )% 1,516 1,561 (3 )% Tubular Products (Tubular) 686 709 (3 )% 1,329 1,395 (5 )% Total sales from reportable segments 4,381 4,363 - % 8,810 8,935 (1 )% Other Businesses 19 66 (71 )% 38 89 (57 )% Net sales $ 4,400 $ 4,429 (1 )% $ 8,848 $ 9,024 (2 )% Management's analysis of the percentage change in net sales for U. S. Steel's reportable business segments for the three months ended June 30, 2014 versus the three months ended June 30, 2013 is set forth in the following table: Three Months Ended June 30, 2014 versus Three Months Ended June 30, 2013 Steel Products (a) Coke & Net Volume Price Mix FX (b) Other Change Flat-rolled (5 )% 6 % - % - % 1 % 2 % USSE (1 )% (5 )% - % 4 % (1 )% (3 )% Tubular (1 )% - % (2 )% - % - % (3 )% (a) Excludes intersegment sales (b) Foreign currency translation effects Net sales were $4,400 million in the three months ended June 30, 2014, compared with $4,429 million in the same three months last year. The increase in sales for the Flat-rolled segment primarily reflected an increase in average realized prices (increase of $49 per net ton) partially offset by lower shipments as a result of weather-related issues (decrease of 201 thousand net tons). The decrease in sales for the European segment was primarily due to lower average realized euro-based prices (decrease of €33 per net ton) and lower shipments (decrease of 9 thousand net tons) partially offset by the weakening of the U.S. dollar versus the euro. The decrease in sales for the Tubular segment primarily reflected lower average realized prices (decrease of $31 per net ton) and lower shipments (decrease of 7 thousand net tons) primarily as a result of continued high import levels and weather-related issues. Management's analysis of the percentage change in net sales for U. S. Steel's reportable business segments for the six months ended June 30, 2014 versus the six months ended June 30, 2013 is set forth in the following table: Six Months Ended June 30, 2014 versus Six Months Ended June 30, 2013 Steel Products (a) Coke & Net Volume Price Mix FX (b) Other Change Flat-rolled (6 )% 5 % - % - % 1 % - % USSE (1 )% (5 )% - % 3 % - % (3 )% Tubular (2 )% (1 )% (2 )% - % - % (5 )% (a) Excludes intersegment sales (b) Foreign currency translation effects -32- -------------------------------------------------------------------------------- Net sales were $8,848 million in the six months ended June 30, 2014, compared with $9,024 million in the same period last year. Sales for the Flat-rolled segment were comparable year over year as lower shipments as a result of weather-related issues (decrease of 545 thousand net tons) were offset by an increase in average realized prices (increase of $45 per net ton). The decrease in sales for the European segment was primarily due to lower average realized euro-based prices (decrease of €29 per net ton) and lower shipments (decrease of 26 thousand net tons) partially offset by the weakening of the U.S. dollar versus the euro. The decrease in sales for the Tubular segment primarily reflected lower average realized prices (decrease of $53 per net ton) and lower shipments (decrease of 16 thousand net tons) primarily as a result of continued high import levels and weather-related issues. 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 $85 million and $169 million in the three and six months ended June 30, 2014, respectively, compared to $96 million and $191 million in the comparable periods in 2013. The $11 million and $22 million decrease is primarily due to a higher discount rate, which is driving a lower amortization of unrecognized actuarial losses. Costs related to defined contribution plans totaled $12 million and $24 million in the three and six months ended June 30, 2014, respectively, compared to $11 million and $22 million in the comparable periods in 2013. Other benefit costs totaled $(15) million and $(12) million in the three and six months ended June 30, 2014, respectively, compared to $14 million and $28 million in the comparable periods in 2013. The $29 million and $40 million decrease is primarily due to a one-time $19 million curtailment gain related to the elimination of non-union retiree medical coverage after 2017. Net periodic pension cost, including multiemployer plans, is expected to total approximately $330 million in 2014. Total other benefits costs in 2014 are expected to total approximately $5 million, excluding the $19 million curtailment gain. 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) (Dollars in millions) 1% (1)% Expected return on plan assets Incremental (decrease) increase in: Net periodic pension cost $ (100 ) $ 100 Discount rate Incremental (decrease) increase in: Net periodic pension & other benefits costs $ (39 ) $ 55 Health care cost escalation trend rates Incremental increase (decrease) in: Service and interest cost components for 2014 $ 10 $ (8 ) Selling, general and administrative expenses Selling, general and administrative expenses were $143 million and $281 million in the three and six months ended June 30, 2014, respectively, compared to $151 million and $296 million in the three and six months ended June 30, 2013. The decrease is primarily related to lower pension and other benefits costs as discussed above. Restructuring and Other Charges During the fourth quarter of 2013, the Company implemented certain headcount reductions and production facility closures related to our iron and steelmaking facilities at Hamilton Works in Canada, barge operations related to Warrior and Gulf Navigation (WGN) in Alabama and administrative headcount reductions at our Hamilton Works and Lake Erie Works also in Canada. We closed our iron and steelmaking facilities at Hamilton Works effective December 31, 2013. -33- -------------------------------------------------------------------------------- Charges for restructuring and ongoing cost reduction initiatives are recorded in the period the Company commits to a restructuring or cost reduction plan, or executes specific actions contemplated by the plan and all criteria for liability recognition have been met. The Company's Canadian subsidiary U. S. Steel Canada, Inc. continues to experience losses and is exploring options to improve its performance which may include some form of restructuring. During the three months ended June 30, 2014, the Company recorded severance related charges of $11 million, which were reported in restructuring and other charges in the Consolidated Statement of Operations, for additional headcount reductions related to certain of our Tubular operations in Bellville, Texas and McKeesport, Pennsylvania, within our Tubular segment, as well as headcount reductions principally at the Company's corporate headquarters in conjunction with the Carnegie Way transformation efforts. Cash payments were made related to severance and exit costs of $8 million. In addition, an asset impairment charge of $14 million was taken for certain of the Company's non-strategic assets that were designated as held for sale. Favorable adjustments for changes in estimates on restructuring reserves were made for $2 million. There were no such items for the three months ended June 30, 2013. During the six months ended June 30, 2014, the Company recorded severance related charges of $14 million, which were reported in restructuring and other charges in the Consolidated Statement of Operations, for additional headcount reductions related to our Canadian operations, within our Flat-rolled segment, certain of our Tubular operations in Bellville, Texas and McKeesport, Pennsylvania, within our Tubular segment, as well as headcount reductions principally at the Company's corporate headquarters in conjunction with the Carnegie Way transformation efforts. Cash payments were made related to severance and exit costs of $13 million. In addition, an asset impairment charge of $14 million was taken for certain of the Company's non-strategic assets that were designated as held for sale. Favorable adjustments for changes in estimates on restructuring reserves were made for $10 million. There were no such items for the six months ended June 30, 2013. Management believes its actions with regard to the Company's operations will have a positive impact on the Company's annual cash flows of approximately $50 million over the course of subsequent periods as a result of decreased payroll and benefits costs and other idle facility costs. Additionally, management does not believe there will be any significant impacts related to the Company's revenues as a result of these actions. -34- --------------------------------------------------------------------------------Income (loss) from operations by segment for the three and six months ended June 30, 2014 and 2013 is set forth in the following table: Three Months Ended Six Months Ended June 30, % June 30, % (Dollars in millions) 2014 2013 Change 2014 2013 Change Flat-rolled $ 30 $ (51 ) NM $ 115 $ (64 ) NM USSE 38 10 280 % 70 48 46 % Tubular 47 45 4 % 71 109 (35 )% Total income from reportable segments 115 4 2,775 % 256 93 175 % Other Businesses 17 43 (60 )% 30 48 (38 )% Segment income from operations 132 47 181 % 286 141 103 % Postretirement benefit expense (32 ) (54 ) (41 )% (64 ) (110 ) (42 )% Other items not allocated to segments: Loss on assets held for sale (14 ) - 100 % (14 ) - 100 % Curtailment gain 19 - 100 % 19 - 100 % Litigation reserves (70 ) - 100 % (70 ) - 100 % Total income (loss) from operations $ 35 $ (7 ) NM $ 157 $ 31 406 % Segment results for Flat-rolled Three Months Ended Six Months Ended June 30, % June 30, 2014 2013 Change 2014 2013 % Change Income (loss) from operations ($ millions) $ 30 $ (51 ) NM $ 115 $ (64 ) NM Gross margin 4 % 5 % (1 )% 7 % 5 % 2 % Raw steel production (mnt) 4,132 4,212 (2 )% 8,623 9,132 (6 )% Capability utilization(a) 75 % 70 % 5 % 79 % 76 % 3 % Steel shipments (mnt) 3,527 3,728 (5 )% 7,201 7,746 (7 )% Average realized steel price per $ 767 ton $ 774 $ 725 7 % $ 722 6 % (a) Prior to the permanent shut down of the iron and steelmaking facilities at Hamilton Works on December 31, 2013, annual raw steel production capability for Flat-rolled was 24.3 million net tons. The increase in Flat-rolled results in the three months ended June 30, 2014 compared to the same period in 2013 resulted from increased prices (approximately $145 million), lower raw materials costs (approximately $45 million) and higher steel substrate sales to our Tubular segment (approximately $10 million). These changes were partially offset by higher repairs and maintenance and other operating costs (approximately $80 million), increased energy costs, primarily due to higher natural gas costs (approximately $30 million), and higher costs for profit based payments (approximately $10 million). The increase in Flat-rolled results in the six months ended June 30, 2014 compared to the same period in 2013 resulted from increased prices (approximately $295 million), lower raw materials costs (approximately $90 million) and higher steel substrate sales to our Tubular segment (approximately $10 million). These changes were partially offset by increased energy costs, primarily due to higher natural gas costs (approximately $100 million), higher repairs and maintenance and other operating costs (approximately $60 million), decreased shipment volumes due to weather-related issues (approximately $30 million) and higher costs for profit based payments (approximately $25 million). -35- -------------------------------------------------------------------------------- During the second quarter of 2013, U. S. Steel and our partner decided to dissolve Double Eagle Steel Coating Company (DESCO), our 50-50 joint venture. DESCO operates an electrogalvanizing facility located in Dearborn, Michigan. The dissolution could take up to two years as the joint venture will continue to service customers during that period. We do not expect a significant financial impact as a result of the dissolution. The joint venture will accelerate depreciation of the fixed assets, which will reduce our investment in the joint venture, over the remaining useful life of the fixed assets. Segment results for USSE Three Months Ended Six Months Ended June 30, % June 30, 2014 2013 Change 2014 2013 % Change Income from operations ($ millions) $ 38 $ 10 280 % $ 70 $ 48 46 % Gross margin 11 % 7 % 4 % 10 % 9 % 1 % Raw steel production (mnt) 1,223 1,158 6 % 2,364 2,361 - % Capability utilization 98 % 93 % 5 % 95 % 95 % - % Steel shipments (mnt) 1,053 1,062 (1 )% 2,084 2,110 (1 )% Average realized steel price $ 700 per ton $ 691 $ 702 (2 )% $ 710 (1 )% The increase in USSE results in the three months ended June 30, 2014 compared to the same period in 2013 was primarily due to lower raw materials costs (approximately $40 million), the weakening of the U.S. dollar versus the euro in the three months ended June 30, 2014 as compared to the same period in 2013 (approximately $10 million) and decreased repairs and maintenance and other operating costs (approximately $10 million). These changes were partially offset by lower average realized prices (approximately $30 million). The increase in USSE results in the six months ended June 30, 2014 compared to the same period in 2013 was primarily due to lower raw materials costs (approximately $45 million), favorable effects of transactions to sell and swap a portion of our emissions allowances (approximately $20 million), the weakening of the U.S. dollar versus the euro in the six months ended June 30, 2014 as compared to the same period in 2013 (approximately $20 million) and decreased repairs and maintenance and other operating costs (approximately $10 million). These changes were partially offset by lower average realized prices (approximately $70 million). Segment results for Tubular Three Months Ended Six Months Ended June 30, % June 30, 2014 2013 Change 2014 2013 % Change Income from operations ($ millions) $ 47 $ 45 4 % $ 71 $ 109 (35 )% Gross margin 12 % 12 % - % 10 % 13 % (3 )% Steel shipments (mnt) 449 456 (2 )% 868 884 (2 )% Average realized steel price $ 1,479 per ton $ 1,479 $ 1,510 (2 )% $ 1,532 (3 )% Tubular results for the three months ended June 30, 2014 were comparable to the same period in 2013 as decreased repairs and maintenance and other operating costs (approximately $20 million) were offset by decreased average realized prices (approximately $15 million). The decrease in Tubular results in the six months ended June 30, 2014 as compared to the same period in 2013 resulted mainly from decreased average realized prices (approximately $45 million) and decreased shipping volumes (approximately $20 million) primarily due to continuing high import levels and weather-related issues, partially offset by increased repairs and maintenance and other operating costs (approximately $30 million). -36- -------------------------------------------------------------------------------- Results for Other Businesses Other Businesses had income of $17 million and $30 million in the three and six months ended June 30, 2014, compared to income of $43 million and $48 million in the three and six months ended June 30, 2013. The 2013 results included a gain of approximately $30 million from a real estate sale in the second quarter of 2013. Items not allocated to segments The decrease in postretirement benefit expense in the three and six months ended June 30, 2014 as compared to the same period in 2013 resulted from lower pension and retiree medical expenses as a result of a higher discount rate and better claims cost experience. We recorded a $14 million pretax loss on assets held for sale in the six months ended June 30, 2014 related to the write-down of non-strategic Corporate assets. We recorded a pretax gain of $19 million related to curtailments in pension and other benefit plans associated with the elimination of non-union retiree medical coverage after 2017. We recorded a pretax loss of $70 million related to litigation reserves for the Company's ongoing litigation matters. Net interest and other financial costs Three Months Ended Six Months Ended June 30, % June 30, % (Dollars in millions) 2014 2013 Change 2014 2013 Change Interest expense $ 60 $ 58 3 % $ 121 $ 143 (15 )% Interest income (1 ) (1 ) - % (2 ) (2 ) - % Other financial costs 5 11 (55 )% 14 31 (55 )% Total net interest and other financial costs $ 64 $ 68 (6 )% $ 133 $ 172 (23 )% The decrease in net interest and other financial costs in the six months ended June 30, 2014 as compared to the same period last year is primarily due to the absence of a $34 million charge that was recorded in 2013 related to the repurchases of a portion of the 2014 Senior Convertible Notes. The remaining principal amount on the 2014 Senior Convertible Notes was redeemed in May 2014 which also reduced interest expense for the six months ended June 30, 2014. The income tax benefit was $11 million and $10 million in the three and six months ended June 30, 2014 compared to a provision of $3 million and $10 million in the three and six months ended June 30, 2013. Included in the tax benefit in the first six months of 2014 is a discrete benefit related to the tentative antitrust settlement discussed in Note 20. The tax provision reflects a benefit for percentage depletion in excess of cost depletion for iron ore that we produce and consume or sell. The tax provision does not reflect any tax benefit for pretax losses in Canada which is a jurisdiction where we have recorded a full valuation allowance on deferred tax assets. The tax benefit for the six months ended June 30, 2014 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 2014 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 2014 could be materially different from the forecasted amount used to estimate the tax provision for the six months ended June 30, 2014. The net domestic deferred tax asset was $31 million at June 30, 2014 compared to $115 million at December 31, 2013. 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 that the net domestic deferred tax asset will be realized. At June 30, 2014, the net foreign deferred tax asset was $58 million, net of established valuation allowances of $1,054 million. At December 31, 2013, the net foreign deferred tax asset was $59 million, net of established valuation -37- -------------------------------------------------------------------------------- allowances of $1,028 million. 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. At both June 30, 3014 and December 31, 2013, a full valuation allowance was recorded for the net Canadian deferred tax asset primarily due to cumulative losses in Canada. 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. For further information on income taxes see Note 8 to the Consolidated Financial Statements. Net (loss) income attributable to United States Steel Corporation was $(18) million and $34 million in the three and six months ended June 30, 2014. Net loss attributable to United States Steel Corporation was $78 million and $151 million in the three and six months ended June 30, 2013. The changes between the 2014 and 2013 periods primarily reflect the factors discussed above. BALANCE SHEET Accounts receivable increased by $96 million from year-end 2013. Sales in the latter part of a quarter typically represent the majority of the receivables as of the end of the quarter. The increase in receivables primarily reflected increased average realized prices. Inventories decreased by $351 million from year-end 2013 primarily due to a larger than usual reduction in raw material inventories as a result of the weather. Income tax receivable decreased by $170 million primarily due to the receipt of a federal income tax refund related to the carryback of our 2013 net operating loss to prior years. Accounts payable and other accrued liabilities increased by $540 million from year-end 2013 primarily as a result of implementing extended vendor payment terms. Short-term debt and current maturities of long-term debt decreased by $303 million primarily due to the redemption of the remaining principal amount of our 2014 Senior Convertible Notes. Employee benefits decreased by $223 million from year-end 2013 primarily due to benefit payments made in excess of the net periodic benefit expense recognized in the first six months of 2014. Deferred income tax liabilities increased by $88 million from year-end 2013 primarily due to the valuation effects of employee related benefits. CASH FLOW Net cash provided by operating activities was $1,353 million for the six months ended June 30, 2014 compared to $384 million in the same period last year. The increase is primarily due to improved financial results, changes in working capital period over period, and the receipt of the federal income tax refund discussed above partially offset by higher employee benefit payments. 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. We improved cash provided by operating activities by extending vendor payment terms consistent with industry standards. 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 June 30, 2014 and 2013 are as follows: Three Months Ended Twelve Months Ended June 30, June 30, 2014 2013 2014 2013 Accounts Receivable Turnover 2.1 2.0 8.2 7.9 Inventory Turnover 1.7 1.8 6.9 7.2 Capital expenditures, for the six months ended June 30, 2014, were $186 million, compared with $221 million in the same period in 2013. Flat-rolled capital expenditures were $102 million and included spending for the ongoing -38- -------------------------------------------------------------------------------- implementation of an enterprise resource planning (ERP) system, the Granite City Steel Shop Tap and Charging Emission Control System, the Mon Valley Blast Furnace No. 1 reline and various other infrastructure and environmental projects. Tubular capital expenditures of $47 million related to an upgrade to the Lorain No. 4 Seamless Hot Mill and various other infrastructure, environmental and strategic capital projects. USSE capital expenditures of $35 million consisted of spending for infrastructure and environmental projects. U. S. Steel's contractual commitments to acquire property, plant and equipment at June 30, 2014, totaled $224 million. Capital expenditures for 2014 are expected to total approximately $600 million and remain focused largely on strategic, infrastructure and environmental projects. In recent years, we have 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 steelmaking 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 capacity of 960,000 tons per year. Initial start-up of the battery began in November 2012 and the battery has reached full production capacity. We have been constructing a two module carbon alloy facility at Gary Works, which was designed to utilize an environmentally compliant, energy efficient and flexible production technology to produce a coke substitute product. The facility targeted a projected capacity of 500,000 tons per year if both modules were completed. Construction of the first module is complete, and we continue to focus on the optimization and reliability of operations of that module. We continue to evaluate our coke requirements in North America and the performance of the first module. We are 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 improve our ability to support our Tubular customers' evolving needs. With reduced pricing for iron-ore, management is considering its options with respect to the Company's 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 examining alternative iron and steelmaking technologies such as gas-based, direct-reduced iron (DRI) and electric arc furnace (EAF) steelmaking. We are currently in the permitting process for the installation of an EAF at our Fairfield Works in Alabama. We submitted air and water permit applications to the Jefferson County Department of Health and the Alabama Department of Environmental Management, respectively, in February 2014. The DRI process requires iron pellets with a lower silica content than blast furnace pellets. We have verified that our iron ore reserves are suitable for direct reduced (DR) grade pellet production and are examining the capital and engineering design process requirements to produce DR grade pellets at our Minntac operations for use internally by the Company if we were to construct a DRI facility or for sale to external third parties with DRI facilities. Our capital investments in the future may reflect such strategies, although we expect that iron and steelmaking through the blast furnace and basic oxygen furnace manufacturing processes will remain our primary processing technology for the long term. The foregoing statements regarding expected 2014 capital expenditures, capital projects, emissions reductions and expected benefits from the implementation of the ERP project are forward-looking statements. Factors that may affect our capital spending and the associated 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; (vii) unforeseen hazards such as contractor performance, material shortages, weather conditions, explosions or fires; (viii) our ability to implement these projects; and (ix) the requirements of applicable laws and regulations. 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. Disposal of assets in the first six months of 2014 primarily reflects cash proceeds from transactions to sell and swap a portion of the emissions allowances at USSK. Restricted cash in the first six months of 2013 primarily reflects a reduction in the use of cash collateralized letters of credit, which were replaced with surety bonds. -39- -------------------------------------------------------------------------------- Issuance of long-term debt, net of financing costs in the second 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. Repayment of long-term debt in the first six months of 2014 reflects the redemption of the remaining $322 million principal amount of our 2014 Senior Convertible Notes. The aggregate price, including accrued and unpaid interest, for the 2014 Senior Convertible Notes redeemed was approximately $327 million and the redemptions were paid with cash. Repayment of long-term debt in the first six months of 2013 reflects the repurchase of $542 million aggregate principal amount of our 2014 Senior Convertible Notes. -40- --------------------------------------------------------------------------------LIQUIDITY AND CAPITAL RESOURCES The following table summarizes U. S. Steel's liquidity as of June 30, 2014: (Dollars in millions) Cash and cash equivalents $ 1,471 Amount available under $875 Million Credit Facility 875 Amount available under Receivables Purchase Agreement 575 Amount available under USSK credit facilities 313 Total estimated liquidity $ 3,234 As of June 30, 2014, $522 million of the total cash and cash equivalents was held by our foreign subsidiaries. A significant portion of the liquidity attributable to our foreign subsidiaries can be accessed without the imposition of income taxes. Additionally, as part of our Carnegie Way initiative to remain competitive and drive world class growth, we are implementing extended vendor payment terms to be better aligned with other large industrial companies and our peers in the metals and mining sector. On July 15, 2014, we commenced a consent solicitation directed to the holders of the Company's 2.75% Senior Convertible Notes due 2019 (2019 Senior Notes) to amend certain covenant provisions to exclude an event of default on indebtedness in excess of $100 million by subsidiaries of U. S. Steel organized in Canada. The consent solicitation expired on July 28, 2014 without receiving the requisite level of consent. As of June 30, 2014, 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. Since availability was greater than $87.5 million, compliance with the fixed charge coverage ratio covenant was not applicable. On July 23, 2014, the Company amended its Amended Credit Agreement to designate USSC and each subsidiary of USSC formed under the laws of Canada or any province thereof as an excluded subsidiary and to waive any event of default that may occur as a result of the Company's 2019 Senior Notes being accelerated or caused to be accelerated as a result of specified actions of USSC. 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. Domestic trade accounts receivables are sold, on a daily basis, without recourse, to U. S. Steel Receivables, LLC (USSR), a consolidated wholly owned special purpose entity used only for the securitization program. As U. S. Steel accesses this facility, USSR sells senior undivided interests in the receivables to a third-party and a third-party commercial paper conduit, while maintaining a subordinated undivided interest in a portion of the receivables. The third-parties issue commercial paper to finance the purchase of their interest in the receivables and if any of them are unable to fund such purchases, two banks are committed to do so. U. S. Steel has agreed to continue servicing the sold receivables at market rates. The RPA may be terminated on the occurrence and failure to cure certain events, including, among others, failure by U. S. Steel to make payments under our material debt obligations and any failure to maintain certain ratios related to the collectability of the receivables. The maximum amount of receivables eligible for sale is $625 million and the facility expires in July 2016. As of June 30, 2014, eligible accounts receivable supported $625 million of availability under the RPA, and there were no receivables sold to third-party conduits under this facility. The subordinated retained interest at June 30, 2014 was $625 million with availability of $575 million due to approximately $50 million of letters of credit outstanding. On July 23, 2014, the RPA was amended to (a) modify a termination event so that if USSC and any of its subsidiaries organized in Canada failed to pay any principal of or premium or interest on any of its debt that is outstanding in a principal amount of at least $100 million, and (b) to waive any termination event occurring as a result of the acceleration by the holders of the Company's 2019 Senior Notes due to the acceleration of any debt of USSC or any of its subsidiaries but only if the notes are promptly paid in full. -41- -------------------------------------------------------------------------------- At June 30, 2014, USSK had no borrowings under its €200 million (approximately $273 million) unsecured revolving credit facility (the Credit Agreement). The Credit Agreement contains certain USSK financial covenants (as further defined in the Credit Agreement), including maximum Leverage, maximum Net Debt to Tangible Net Worth, and minimum Interest Cover ratios. The covenants are measured semi-annually for the period covering the last twelve calendar months. USSK may not draw on the Credit Agreement if it does not comply with any of the financial covenants until the next measurement date. The Credit Agreement expires in July 2016. At June 30, 2014, USSK had no borrowings under its €20 million and €10 million unsecured credit facilities (collectively approximately $41 million) and the availability was approximately $40 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 cash collateral have a negative impact on liquidity. U. S. Steel has committed $160 million of liquidity sources for financial assurance purposes as of June 30, 2014. Increases in these commitments which use collateral are reflected in restricted cash on the Consolidated Statement of Cash Flows. If there is a change in control of U. S. Steel, the following may occur: (a) debt obligations totaling $2,891 million as of June 30, 2014 (including the Senior Notes and Senior Convertible Notes) may be declared immediately due and payable; (b) the Amended Credit Agreement, the RPA and USSK's €200 million revolving credit agreement may be terminated and any amounts outstanding declared immediately due and payable; and (c) U. S. Steel may be required to either repurchase the leased Fairfield slab caster for $37 million or provide a cash collateralized 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 June 30, 2014, which includes a $23 million current liability related to a guarantee of debt of an unconsolidated equity investment for which payment by U. S. Steel is probable. The $23 million is the maximum amount U. S. Steel would be obligated to pay as the guarantor and represents the fair value of the obligation at June 30, 2014. If 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 2014 are expected to be for capital expenditures, employee benefits, and operating costs, including purchases of raw materials. We finished the second quarter of 2014 with $1,471 million of cash and cash equivalents and $3.2 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 second quarter of 2014. -42- -------------------------------------------------------------------------------- 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, Russia, Ukraine and India) and producers of materials which compete with steel, all of which may not be required to incur equivalent costs in their operations. The specific impact on each competitor may vary depending on several things such as the age and location of their operating facilities and production methods. Some of U. S. Steel's facilities were in operation before 1900. Although management believes that U. S. Steel's environmental practices have either led the industry or at least been consistent with prevailing industry practices, hazardous materials may have been released at current or former operating sites or delivered to sites operated by third parties. This means U. S. Steel is responsible for remediation costs associated with the disposal of such materials and 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 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 (BAT) to reduce environmental impacts as well as compliance with BAT associated emission levels. This directive includes operational requirements for air emissions, wastewater discharges, solid waste disposal and energy conservation, and 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, unless specific extensions are granted by the Slovak environmental authority. We are currently evaluating the costs of complying with BAT, but our most recent broad estimate of likely capital expenditures is $200 million to $250 million over the 2014 to 2016 period. We also believe there will be increased operating costs, such as increased energy and maintenance costs, but we are currently unable to reliably estimate them. We are currently investigating the possibility of obtaining EU grants to fund a portion of these capital expenditures. The EU has various programs under which funds are allocated to member states to implement broad public policies. These are being implemented in two campaigns, Operational Program 1 which covered the years 2007 - 2013 (OP1) and Operational Program 2 which will cover the years 2014 - 2020 (OP2). Each member state legislates its own framework for implementing the operational programs and administers its allocation of funds under the operational programs by offering these funds to government units and private entities for qualifying projects. USSK submitted two BAT projects under the last call of OP1. Both projects were approved for funding by the Ministry of Environment of -43- -------------------------------------------------------------------------------- the Slovak Republic in May in an amount not to exceed €8.8 million (approximately $12 million). The actual amount of the grant funding received will be based on 35% of the identified eligible costs as defined in OP1 actually incurred on the projects. We plan to submit several additional BAT projects for EU grants as well. However, all future projects will be submitted under calls governed by OP2. The specific legislation governing OP2 has not yet been finalized by the Slovak Republic, so we are not able to accurately estimate at this time the amount of additional grant funding that we may receive, if any. Due to other EU legislation, we will be required to make changes to the boilers at our steam and power generation plant in order to comply with stricter air emission limits for large combustion plants. In January of 2014, the operation of USSK's boilers was approved by the European Commission (EC) as part of Slovakia's Transitional National Plan (TNP) for bringing all boilers in Slovakia into BAT compliance no later than 2020. The TNP establishes parameters for determining the date by which specific boilers are required to reach compliance with the new air standards, which has been determined to be October 2017 for our boilers. This gives us the flexibility of delaying the completion of the project to upgrade our boilers to no later than that date, although we may choose to accelerate the implementation of this project in order to qualify for supplementary support payments as part of Slovakia's renewable energy program. The project should result in reduced electricity, operating, maintenance and waste disposal costs once completed. The current projected cost to reconstruct one existing boiler and build one new boiler to achieve compliance is broadly estimated at $170 million. A Memorandum of Understanding (MOU) was signed in March of 2013 between U. S. Steel and the government of Slovakia. The MOU 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 include potential 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. There are many conditions and uncertainties regarding the grants, including matters controlled by the EU, but the value as stated in the MOU 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 USSK's current collective labor agreement. U. S. Steel also agreed to pay the government of Slovakia specified declining amounts should U. S. Steel sell USSK within five years of signing the MOU. Since the signing of the MOU, USSK has received cooperation from the government of Slovakia in fulfilling the terms of the MOU. Broad legislative changes were made to extend the scope of support for renewable sources of energy, which have the effect of allowing USSK to participate in the renewable energy program once the upgrade to our boilers is completed. The government of Slovakia also provided general guidance as we prepared two applications for EU grants under the last call of OP1. Both projects were approved in May for EU funding grants. We will continue to work closely with the government of Slovakia to achieve the incentives described in the MOU. 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, 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 fixed and irreducible 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, Russia, Ukraine 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. -44- -------------------------------------------------------------------------------- Greenhouse Gas Emissions Regulation The current and potential regulation of greenhouse gas (GHG) 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 GHG 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 authority to regulate GHGs. The court rejected challenges to the endangerment finding, giving the EPA authority to regulate GHGs 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 GHG emissions under the tailpipe rule, giving the EPA the authority to regulate GHG 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 GHGs, stating that it also lacked jurisdiction over these SIP related rules. This decision was ultimately argued in Utility Air Regulatory Group v. EPA, No. 12-1146 in the Supreme Court on February 24, 2014. A decision on the case was issued on June 23, 2014 that will significantly effect how the EPA implements any GHG permits. We are currently evaluating the practical implications of the decision. The final effects on any expenditures are unknown at this time. The EPA re-proposed it's New Source Performance Standards (NSPS) for GHG emissions from Power Plants in September 2013 after missing the original April 2013 deadline to publish the first rule it had proposed a year earlier. The re-proposed NSPS imposes separate intensity based greenhouse gas limits for new coal fired and new natural gas fired power plants. Although the September 2013 proposal would only affect new electric generating units, the potential impacts of the rule's issuance extends beyond these sources, because the agency is obligated under Section 111(d) of the CAA to promulgate guidelines for existing sources within a category when it promulgates GHG standards for new sources. Accordingly, the EPA proposed guidance for regulating GHGs from existing sources on June 2, 2014. The guidance imposes a two-part goal structure for existing power generation in each state. The structure is composed of an interim goal for states to meet on average over the ten-year period from 2020-2029, and a final goal that a state must meet at the end of that period in 2030 and thereafter. The final goal is to achieve a 30 percent reduction of greenhouse gases by 2030 from 2005 levels. The EPA proposal lists state-specific carbon intensity rates from its power sector that are necessary to meet a state's final goal. The carbon intensity goal is defined as the total CO2 emissions from fossil fuel-fired power plants in pounds for a given time period divided by a state's total electricity generation in megawatt hours for the same period. States are said to be given flexibility in terms of how to achieve their goal, and what measures to implement. State plans must be submitted by no later than June 30, 2016. The impact these rules will have on the supply and cost of electricity to industrial consumers, especially the energy intensive industries, is being evaluated. We believe there will be increased operating costs, such as increased energy and maintenance costs, but we are currently unable to reliably estimate them. The EU has established GHG regulations for the EU member states, while in Canada, a regulatory framework for GHG 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, in Canada, the federal government has committed to reducing the country's total GHG emissions by 17 percent from 2005 levels by 2020. The Ontario government has committed to its own GHG emission reduction targets for the province. This plan announced GHG 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. Both the federal and Ontario governments are currently seeking input from stakeholders, including industry, on the development of GHG emission reduction programs. No timelines have been finalized for the implementation of federal and provincial GHG reduction programs for the steel sector. If federal or provincial GHG 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 GHGs, such as CO2, as harmful gases. Under this premise, it has implemented a GHG emission monitoring and reporting requirement for all facilities emitting 25,000 metric tons or more per year of CO2, methane -45- -------------------------------------------------------------------------------- and nitrous oxide in CO2 equivalent quantities. In accordance with EPA GHG emissions reporting requirements, reports for the year 2013 were completed and submitted for all required facilities by the March 31, 2014 deadline. Consistent with prior year's reporting, fourteen U. S. Steel 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 because its emissions were well below the 25,000 ton reporting threshold. New requirements were adopted in 2011 related to monitoring and reporting of GHG emissions for vacuum degassing (decarburization), and methane emissions from on-site landfills. Facilities for which GHG 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 also completed 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 GHG emissions from on-site landfills starting in 2011. In 2013, the EPA significantly expanded its reporting requirements to include inputs to the calculations that 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 GHG 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. Effective January 1, 2014, EPA revised the Global Warming Potentials (GWPs) of certain GHGs used in its monitoring and reporting program. The new GWPs agree with the most recent report by the Intergovernmental Panel on Climate Change. The revisions to the GWPs will change not only the amount of CO2 equivalent emissions reported but also potentially increase the number of facilities that are subject to the rule. As a result, some facilities that were exempted from reporting previously may now meet the 25,000 CO2 equivalent ton threshold and be required to report. U. S. Steel is currently determining what impact if any this would have on our own reporting requirements. The EC has created an Emissions Trading System (ETS) and starting in 2013, the ETS began to employ centralized allocation, rather than national allocation plans, that are more stringent than the previous requirements. The ETS also includes a cap designed to achieve an overall reduction of GHGs for the ETS sectors of 21% 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 transferring their production to other countries with lesser constraints on greenhouse gas emissions, or what is more commonly referred to as 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 ETS is still expected to lead to additional costs for steel companies in Europe. The EU has imposed limitations under the ETS for the period 2013-2020 (Phase III) that are more stringent than those in NAP II, reducing the number of free allowances granted to companies to cover their CO2 emissions. In September of 2013, the EC issued EU wide legislation further reducing the expected free allocation for Phase III by an average of approximately 12% for the Phase III period. USSK's final allocation for the Phase III period that was approved by the EC in January is approximately 48 million allowances. Based on 2013 emission intensity levels and projected future production levels and as a result of carryover allowances from the NAP II period, we do not currently expect to need to purchase credits until 2019 and currently estimate a shortfall of 14 million allowances for the Phase III period. However, due to a number of variable factors such as the future market value of allowances, future production levels and future emission intensity levels, we cannot reliably estimate the full cost of complying with the ETS regulations at this time. U. S. Steel entered into transactions to sell and swap a portion of our emissions allowances and recognized a gain of $17 million during the six months ended June 30, 2014. There were no such similar transactions for the six months ended June 30, 2013. -46- -------------------------------------------------------------------------------- Environmental Remediation In the United States, U. S. Steel has been notified that we are a potentially responsible party (PRP) at 20 sites under CERCLA as of June 30, 2014. In addition, there are 9 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 or make any judgment as to the amount thereof. There are also 37 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 six months of 2014, U. S. Steel recorded a net decrease of $6 million to our accrual balance for environmental matters for U.S. and international facilities. The total accrual for such liabilities at June 30, 2014 was $227 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. -47- --------------------------------------------------------------------------------OUTLOOK We expect operating income for our reportable segments and Other Businesses to increase significantly over the second quarter, as we return to normal operating levels. We continue to earn the right to grow as the Carnegie Way transformation allows us to better meet our customers' needs and improves our earnings power. Results for our Flat-rolled segment are expected to improve significantly from the second quarter. Shipments are projected to increase as we return to normal operations while average realized prices are expected to remain consistent with the second quarter. The absence of the weather related and operational challenges experienced during the second quarter is expected to generate a favorable impact of approximately $150 million from reduced repairs and maintenance costs and increased operating efficiencies along with the increased shipments described above. Inventory levels are expected to increase during the balance of the year as we work to replenish our supply chain. We expect results for our European segment to decrease as compared to the second quarter. Scheduled caster and blast furnace maintenance along with the normal impact of the European holiday season is expected to result in lower shipments and higher repairs and maintenance costs related to the planned outages. These negative impacts are expected to be partially offset by a decrease in raw materials costs, primarily for iron ore. Averaged realized prices are projected to be in line with the second quarter. Tubular results are expected to improve slightly as compared to the second quarter. Shipments are expected to decrease, due to the indefinite idling of the McKeesport and Bellville facilities, while average realized prices are projected to increase due to improved pricing and mix. Because the International Trade Commission (ITC) ruling on the OCTG trade case is expected in mid-August, we do not anticipate any benefit for the third quarter. INTERNATIONAL TRADE U. S. Steel remains active in its efforts to ensure that competitors are not participating in unfair trade practices. In recent years, a significant number of steel imports have been found to violate United States or Canadian trade laws. Under these laws, antidumping duties (AD) can be imposed against dumped products, which are products sold at a price that is less than fair value. Countervailing duties (CVD) can be imposed against products that have benefited from foreign government assistance for the production, manufacture, or exportation of the product. For many years, U. S. Steel, other producers, customers and the United Steelworkers have sought the imposition of duties and in many cases have been successful. As in the past, U. S. Steel continues to monitor unfairly traded imports and is prepared to seek appropriate remedies against such importing countries. On July 2, 2013, U. S. Steel and eight other domestic producers filed AD and CVD petitions against imports of oil country tubular goods (OCTG) from India and Turkey, along with AD petitions against imports of OCTG from the Philippines, Saudi Arabia, South Korea, Taiwan, Thailand, Ukraine, and Vietnam. These petitions allege that unfairly-traded imports from the subject countries are both a cause and a threat of material injury to United States producers of OCTG. On August 16, 2013, the U.S. International Trade Commission (ITC) made affirmative determinations in the preliminary phase of its injury investigations. The U.S. Department of Commerce (DOC) announced its preliminary determinations in the CVD investigations of OCTG from India and Turkey on December 17, 2013, and it announced its preliminary determinations in the AD investigations of India, South Korea, Philippines, Saudi Arabia, Taiwan, Thailand, Turkey, Ukraine, and Vietnam on February 18, 2014. On July 11, 2014, the DOC announced its final determinations in both the CVD investigations of OCTG from India and Turkey and the AD investigations of India, South Korea, Philippines, Saudi Arabia, Taiwan, Thailand, Turkey, Ukraine and Vietnam. The DOC made an affirmative determination that exporters and producers in all nine countries, including South Korea, were importing OCTG into the United States at less than fair value. The DOC calculated AD margins ranging from 2.05% up to 118.32% against producers and exporters from all nine countries, and CVD margins ranging from 2.53% up to 19.11% against producers and exporters from India and Turkey. As a result of the final determinations, the DOC will "suspend liquidation" and require cash deposits of AD and/or CVD duties for imports of OCTG from those producers and exporters with dumping margins and/or subsidy rates equal to or greater than 2% ad valorem. The ITC is currently expected to make its final determinations of injury in August. If the ITC also makes an affirmative final determination, the DOC will issue AD and CVD orders. While U. S. Steel strongly agrees with the DOC that the imports in question were traded unfairly, and that relief is fully justified under United States law, the outcome of such litigation remains uncertain. AD and CVD orders are generally subject to "sunset" reviews every five years and U. S. Steel actively participates in such review proceedings. In May 2014, the United States government completed the five-year sunset review of the -48- -------------------------------------------------------------------------------- AD and CVD orders on welded line pipe from China. The United States government decided to keep the welded line pipe from China AD and CVD orders in place. In January 2014, the United States government completed five-year sunset reviews of: (i) AD orders on hot-rolled steel from China, Taiwan, and Ukraine; and (ii) AD and CVD orders on hot-rolled steel from India, Indonesia and Thailand. In each of those reviews, the United States government decided to keep the orders in place. Steel sheet imports to the United States accounted for an estimated 15 percent of the steel sheet market in the United States in 2013, 14 percent in 2012 and 13 percent in 2011. Increases in future levels of imported steel could reduce future market prices and demand levels for steel produced in our North American facilities. Imports of flat-rolled steel to Canada accounted for an estimated 35 percent of the Canadian market for flat-rolled steel products in 2013, 34 percent in 2012 and 35 percent in 2011. Total imports of flat-rolled carbon steel products (excluding quarto plates and wide flats) to the 28 countries currently comprising the EU were 14 percent of the EU market in 2013, 13 percent in 2012 and 17 percent in 2011. 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 49 percent of the U.S. domestic market in 2013, 52 percent in 2012 and 47 percent in 2011. U. S. Steel expects to continue to experience competition from imports and will continue to closely monitor imports of products in which U. S. Steel has an interest. Additional complaints may be filed if unfairly-traded imports adversely impact, or threaten to adversely impact, U. S. Steel's financial results. 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 at least 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. Sovereign debt issues and the resulting economic uncertainties also adversely affect markets in the EU. USSE is subject to market conditions in those areas, which are influenced by many of the same factors that affect United States 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, end users and by the level of new capacity and imports in the markets U. S. Steel serves. NEW ACCOUNTING STANDARDS See Note 2 to the Consolidated Financial Statements in Part I Item 1 of this Form 10-Q. -49--------------------------------------------------------------------------------- |