Group review

ThyssenKrupp – global recession squeezes sales and profits

The global recession left a clear mark on ThyssenKrupp in the 1st quarter 2008 / 2009. A drastic drop in demand, unforeseeable in its severity, for carbon and stainless steel and in international materials trading had a considerable impact on our business. By contrast, our activities in capital goods and services were largely robust. Overall, ThyssenKrupp's sales in the 1st quarter 2008 / 2009 were 6% lower year-on-year. The drop in profits was much steeper. Group earnings before taxes decreased from €646 million to €240 million. This was mainly due to inventory writedowns. As in previous periods, earnings were again impacted by substantial pre-operating costs for the new plants in Brazil and the USA.

The highlights for the 1st quarter 2008 / 2009:

• Order intake was €12.9 billion, 3% down from the prior-year quarter.
• Sales decreased by 6% to €11.5 billion.
• EBITDA came to €764 million, compared with €1,083 million a year earlier.
• Earnings before taxes slipped year-on-year from €646 million to €240 million.
• Earnings per share dropped from €0.85 to €0.36.
• Net financial debt at December 31, 2008 was €3,514 million, an increase of €1,930 million compared with September 30, 2008, when we reported net financial debt of €1,584 million. On December 31, 2007, net financial debt stood at €859 million.

Outlook

We expect a significant drop in sales in fiscal 2008/2009. This will be reflected in earnings. Price and volume risks will be only partly offset by declining input material prices and an extensive additional action program to increase efficiency. In addition, measures are being taken to significantly reduce net working capital.

We expect the 2nd quarter to be more difficult than the 1st. Our expectations for the individual segments in the 2nd quarter are as follows:

• Steel – further production cuts and underutilization of core units, stabilization of shipments, largely unchanged costs for raw materials and declining prices for shorter-term deals.
• Stainless – continued production cuts and underutilization, continuing weak sales markets; further inventory writedowns cannot be ruled out.
• Technologies – high level of planning confidence for revenues and earnings in project business due to high order backlog with good earnings quality. Only the automotive business will be impacted by production cuts by OEMs.
• Elevator – sustained effect of performance programs with earnings higher year-on-year.
• Services – predominantly weak demand and continued price falls in materials business at Materials Services and Special Products; the same applies to metallurgical raw materials and coke; Industrial Services predominantly stable, construction and rail equipment activities will profit from high infrastructure spending.

Once the destocking at distributors and end-customers is over and the inventory writedowns have been absorbed we expect business and earnings to be at the level of a normal recession in the 2nd half of the fiscal year. As this happens, the earnings contributions from the materials-related businesses in the Stainless and Services segments are expected to improve. Steel faces continuing price pressure and inadequate volumes but expects lower raw material costs and positive effects from ongoing cost-reduction measures. Technologies plans to maintain its strong earnings despite a continuing difficult market environment. For the Elevator segment we expect the good earnings picture to continue.

We expect ThyssenKrupp's sales and earnings to stabilize again in 2009 / 2010. In the longer term, particularly after completion of the major investments of Steel and Stainless in North and South America and those of the other segments in other regions, we forecast earnings before taxes and major nonrecurring items of €4.0 to 5.0 billion and sales of around €65 billion.

World economy in recession

In the final months of the past year the economic situation deteriorated dramatically in almost all countries. In the 4th quarter 2008 the world economy found itself in an unexpectedly sharp downturn affecting both the industrialized countries and the previously strongly growing emerging markets. After a rise of 5% in 2007, world GDP increased by barely 3.5% in 2008, with the financial crisis intensifying the already anticipated global downturn.

The USA has been in recession since the beginning of 2008. Business spending has decreased markedly as a result of gloomier sales prospects and increasing financing difficulties. This has now impacted significantly on the labor market. Steeply rising unemployment – the unemployment rate climbed to over 7% recently – and falling property and stock prices are now affecting private consumption, which recently shrank to a level not seen since the early 1980s.

The emerging markets in Asia, Latin America and Central and Eastern Europe are feeling the effects of the financial crisis. Their previously high growth rates have slipped markedly recently. In Russia, falling energy and raw material prices have brought export revenues down, while the financial crisis has resulted in a credit squeeze. In China, export momentum has slowed due to the recession in the USA, Japan and Europe, causing overall economic growth to drop into single figures in 2008.

The euro zone including Germany has also slipped into recession. According to initial estimates German GDP fell for the third time in succession in the 4th quarter 2008. Both exports and business spending decreased significantly, while private consumption provided a minor growth contribution at most.

All of the sectors of importance to ThyssenKrupp have been sucked into the recession. The picture in the individual sectors was as follows:

• Steel demand fell significantly in the final quarter of 2008. As a result, steel producers in many countries made in part substantial production cuts; corresponding measures were also taken for the first time in China as steel consumption decreased. World steel production in the 4th quarter 2008 was 20% lower than a year earlier. Towards the end of the year there were downright collapses as steel industry capacity utilization in many countries sank to extremely low levels. These massive volume drops were accompanied by steep price falls. In the 3rd quarter 2008 steel prices had reached record levels after extremely strong increases in all markets. But as demand dipped and raw material and freight costs fell, spot prices slipped considerably, falling back to the level of two years ago at the end of the year.
  The situation in the European flat carbon steel market was similar. After very strong demand growth into the summer, new orders at European flat steel producers collapsed from September 2008 as EU and particularly third-country demand slumped. Weak activity in key customer industries and existing inventory overhangs brought demand to a virtual standstill in parts. Inventory levels have still not been adequately adjusted to the low consumption levels.
• European demand for stainless steel flat products was at a very low level in the reporting period. The main reason for this were efforts by end-users, service centers and distributors to reduce their stocks due to the recession. The effects of a renewed sharp rise in imports from Asia in mid-2008, coupled with extremely weak internal demand, resulted in a significant fall in deliveries by European stainless producers, causing increasing capacity underutilization. The alloying metals used in stainless steel production suffered steep price falls. Nickel, molybdenum and chromium were particularly affected, as was ferrous scrap. The result of this was a further fall in alloy surcharges, exerting additional pressure on distributors to reduce stocks still further and limit replenishment orders to a minimum. In the other major stainless markets of North America and Asia, too, the demand collapse led to a further reduction of inventories at end-users, distributors and service centers.
  The situation in the USA was also difficult, particularly among major users of stainless steel. Demand for stainless flat products from the auto, construction and appliance industries collapsed, causing sharp falls in orders and deliveries and a significant decline in base prices.
  In Asia, almost all local producers cut their production – in some cases by more than 50%. The general economic situation coupled with falling raw material prices and resultant uncertainty over the possible postponement of major projects caused increasingly hesitant demand for nickel alloys worldwide. In the case of titanium, delays in the new Airbus and Boeing aircraft programs caused a further drop in overall market demand.
• The recession also reached the auto industry. For the first time in many years, fewer cars and trucks were sold and produced worldwide in 2008 than the year before. In the USA, sales of cars and light trucks in the last three months of 2008 slumped by 36% compared with a year earlier. New car registrations also declined in the European Union. In Germany alone, around 11% fewer cars were sold in the 4th quarter 2008 than in the prior-year quarter. Even in emerging markets like Brazil, India and China the previously high pace of growth slowed markedly in the final months of 2008.
• The mechanical engineering industry benefited from previously acquired high order backlogs for long parts of 2008. Some countries even increased their output, notably Germany. However, particularly towards the end of the year the global economic crisis and associated investment weakness resulted in a marked slowdown in orders. In Germany, new orders both from abroad and from the domestic market decreased by up to 30%. Machinery manufacturers in the USA and Japan fared even worse. Lower capital investment also made itself felt in China.
• Growth in global construction activity in 2008 was driven only by the countries of Asia and Central and Eastern Europe. In the USA, output declined due to weak private housing construction. In the German construction industry, new orders decreased in the course of 2008 but output remained relatively stable due to solid order backlogs; commercial construction in particular had a bolstering effect.

Orders and sales in decline

ThyssenKrupp in figures

				1st quarter ended Dec. 31, 2007		1st quarter ended Dec. 31 2008
Order intake		million €		13,270		12,887
Sales		million €		12,270		11,522
EBITDA		million €		1,083		764
Earnings before taxes (EBT)		million €		646		240
Employees (December 31)				193,137		197,175

The worldwide recession led to a drastic decline in demand in the materials sector in particular. However, thanks to our diversified product portfolio, Group orders and sales showed only a moderate fall.

ThyssenKrupp's order intake in the 1st quarter 2008 / 2009 reached a value of €12.9 billion, 3% less than in the corresponding prior-year period. There were sharp falls in the Steel and Stainless segments, reflecting weaker volume demand as well as lower prices. Declining demand for materials, above all in North America and Europe, also impacted the Services segment. By contrast, new orders at Technologies and Elevator were higher year-on-year. Several large projects were secured, particularly in our shipbuilding and plant technology businesses.

Group sales fell by 6% to €11.5 billion in the 1st quarter 2008 / 2009. A significant drop in shipments led to lower sales in the Steel segment; however, the segment's high proportion of long-term contracts had a stabilizing effect. At Stainless, the demand slump and lower alloy surcharges and base prices were the main reasons for the fall in sales. Sales at Technologies were higher year-on-year thanks to the good performance of the plant technology and shipbuilding units. The biggest sales growth was achieved by Elevator, where new installations and service business was positive above all in America and the Asia/Pacific region. Declining prices and demand for materials pushed down sales at Services.

Profits down in the 1st quarter 2008/2009

ThyssenKrupp's earnings declined in the 1st quarter 2008 / 2009. After €646 million in the 1st quarter of the prior year, the Group achieved earnings before taxes (EBT) of €240 million in the reporting quarter. This includes inventory writedowns of €250 million and pre-operating costs for the new plants in Brazil and the USA of €83 million.

With the exception of Stainless, all segments generated a profit. At Stainless, already weak market demand slipped further, resulting in capacity underutilization and a substantial drop in prices. The fall in prices for nickel, chromium and molybdenum also led to significant writedowns. Steel recorded lower profits as a result of declining deliveries, particularly to the auto industry. Technologies almost equaled its pleasing prior-year earnings, notably due to the strong performance of the plant technology unit. Elevator increased its earnings mainly thanks to high profits in its American operations. Profits at Services were lower year-on-year due to declines in the materials business.

Net sales in the reporting period were €748 million or 6% lower than in the corresponding prior-year quarter. The cost of sales decreased by €436 million or 4% and therefore to a lesser extent than sales; a major reason for this was a €170 million year-on-year increase in inventory writedowns which partly offset the decline in other costs of sales. Overall, gross profit decreased by €312 million, combined with a decline in gross margin from 17% to 16%.

The rise in selling and general and administrative expenses by a total of €25 million was mainly the result of increased personnel expense. Higher provisions for restructuring in the personnel area in the Steel segment's Auto business unit in the amount of €9 million were a major factor in the €11 million increase in other operating expense. The €30 million decrease in income from companies accounted for by the equity method was due to the overall drop in earnings at the companies concerned compared with the corresponding prior-year quarter. The €65 million deterioration in net interest was connected with the higher net financial debt compared with the prior-year quarter. The €53 million improvement in other financial income was primarily due to the €35 million year-on-year increase in capitalized interest cost, mainly relating to construction progress on the steel mill in Brazil.

After deducting taxes on income, net income for the period was €163 million, down €272 million from the prior year. Taking into account minority interest in losses of €5 million, earnings per share was €0.36, compared with €0.85 in the comparable prior-year quarter.

Net financial debt and capital expenditures

On December 31, 2008, net financial debt stood at €3,514 million. The increase of €1,930 million compared with September 30, 2008 is due to capital spending – especially for our major projects – and the effects of the economic downturn on day-to-day operations.

ThyssenKrupp invested a total of €1,106 million in the 1st quarter 2008 / 2009, 19% more than in the first three months of the prior year. €1,095 million was spent on property, plant and equipment and intangible assets, and €11 million on the acquisition of businesses, shareholdings and other financial assets.

Construction of new plants in Brazil and the USA

The Steel segment is pressing ahead with the implementation of its transatlantic growth strategy. Of central importance is the construction of the steel mill in Rio de Janeiro/Brazil, which will produce up to 5 million metric tons of steel per year at low cost and to high quality standards. More than 20,000 people are currently working on the construction site. The project is now making good progress after previous delays. As things stand, the core blast furnace and melt shop units will go into operation at the end of 2009.

In November 2008 the Supervisory Board approved an increase in the investment budget to around €4.5 billion. Now included in this figure is the economically justified insourcing of energy supplies and slab logistics as well as the optimization of the technical design for future capacity expansion. Also included are cost increases for supplies and services, higher interest costs, and exchange-rate differences. The profitability of the project in combination with the construction project in Alabama and the expansion program in Europe is not jeopardized by this increase. Recruitment of personnel for the future production phase is at an advanced stage: At the end of December 2008, ThyssenKrupp CSA had 1,129 employees in Brazil.

In parallel with the investments in Brazil we have expanded our plants in Europe. Steel intends to strengthen its position in its core European market by expanding and modernizing its processing and coating facilities in Germany. Around 40% of the slabs produced in Brazil in the future are to be shipped across the Atlantic to Germany to be processed into high-quality finished products for demanding customers. The investment projects to facilitate slab handling at Walsum port and increase capacity at four hot-dip coating lines have been completed. The Bochum and Beeckerwerth hot strip mills have also been partially modernized. Further investments to increase capacity in the hot-rolled area have been scheduled.

Begun in fall 2007, construction of the new joint steelmaking and processing plant of the Steel and Stainless segments near Mobile in Alabama/USA is also continuing apace. The Steel segment intends to start production in Alabama in spring 2010. In November 2008 the Supervisory Board approved an increase in the investment budget for Steel to USD3.25 billion. The profitability of the project remains assured.

At the Mobile plant the Steel segment will operate hot- and cold-rolling and coating lines to process slabs produced in Brazil into high-quality flat products. Total hot-rolling capacity will be over 5 million tons per year.

As at December 31, 2008 the value of contracts placed by the Steel segment totaled USD2.6 billion, around 80% of the investment volume. The main work being carried out at present is concreting of buildings and machine foundations. Erection of structural steel has already begun in the shipping bays for cold-rolled and hot-dip galvanized products. Construction of infrastructure facilities is making good progress. These include the river terminal and training center.

In parallel, Steel's sales and marketing experts are continuing their work on a sales strategy for the North American market. With the involvement of technical experts, strong relationships are being built with potential key customers. Target groups include the auto industry, electrical goods manufacturers, steel service centers, appliance manufacturers and the tube industry, particularly for the energy sector.

As well as premium carbon steel, the Mobile plant will also supply important stainless steel products to American customers in the future. Construction of the Stainless plant is proceeding on schedule. The structural steel has been erected for a large part of the production buildings of the cold rolling mill and roofing has begun. The first foundations for machinery in the cold rolling stand area and cold-rolled annealing and pickling line are under construction. In November 2008 the Supervisory Board approved an increase in the investment budget to USD1.4 billion. Here too, the profitability of the project remains assured.

After ramp-up, the Stainless segment's production lines for stainless flat products will have an annual capacity of around 350,000 tons of cold-rolled and 450,000 tons of hot-rolled. A large portion of the hot-rolled will be supplied to the ThyssenKrupp Mexinox stainless steel plant in Mexico.

Against the background of the current weakness on the North American stainless steel market, coupled with a massive fall in demand, Stainless intends to delay its investments. However we believe that the stainless market in the NAFTA region will recover and resume its growth in the foreseeable future. For this reason we are not cutting back on the scale of the project. We will begin cold-rolled production with the startup of the first units of the cold rolling mill in October 2010 and start operation of the melt shop at the beginning of 2012. Until the melt shop commences operation, starting material will be supplied from our European mills. In view of the extensive investment funds budgeted for the current and the next fiscal year, this will give the Group additional room for maneuver.

Award-winning communications

Our "Discovering Future Technology" initiative to promote dialogue on technology across all areas of society and all age groups, particularly through our Ideas Parks, won two awards in the reporting quarter. It came first in the large companies category of the "Freedom and Responsibility" competition, run under the patronage of Federal President Horst Köhler and sponsored by German business associations and the business magazine WirtschaftsWoche. In addition, the ThyssenKrupp Ideas Park won the "Politik-Award" as the "most coherent, effective and best-communicated concept" in the area of corporate responsibility. This award was for "outstanding social commitment" and was presented by the magazine politik&kommunikation.

The Ideas Park is a popular technology exhibition at the center of our "Discovering Future Technology" initiative. Visitors can look behind the scenes of research and development, experiment for themselves and get to know researchers personally. The most recent Ideas Park in Stuttgart in May 2008 was visited by more than 280,000 young people and adults, who were thrilled by the exhibits on show. Together with the previous events in Gelsenkirchen in 2004 and Hanover in 2006, the total number of visitors is now over 550,000. The next Ideas Park is currently being planned; it is to be held in North Rhine-Westphalia in 2011.