Exhibit 20.1
AUDITORS' REPORT
To the Directors of Prudential Steel Ltd.
We have audited the consolidated statements of financial position of Prudential
Steel Ltd. as at December 31, 1999 and 1998, and the consolidated statements of
income and retained earnings and cash flows for each of the years in the three
year period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in Canada. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the Company as at December 31, 1999
and 1998 and the results of its operations and its cash flows for each of the
years in the three years period ended December 31, 1999 in accordance with
accounting principles generally accepted in Canada.
Calgary, Canada Ernst & Young LLP
Chartered Accountants
January 31, 2000 except for Note 9
which is as of August 8, 2000
<PAGE>
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
As at December
31
As At June 30 ---------------
2000 1999 1998
------------- ------- -------
(unaudited)
($000)
ASSETS
Current
Cash and cash equivalents....................... -- -- --
Accounts receivable............................. 48,879 50,936 25,491
Inventory [note 2].............................. 110,972 75,271 69,867
Prepaid expenses................................ 1,088 845 792
------- ------- -------
Total current assets.......................... 160,939 127,052 96,150
======= ======= =======
LIABILITIES
Current
Bank loans [note 4]............................. 45,360 14,529 9,387
Accounts payable and accrued liabilities........ 37,321 42,259 14,745
------- ------- -------
Total current liabilities..................... 82,681 56,788 24,132
======= ======= =======
Working capital................................... 78,258 70,264 72,018
Capital assets [note 3]........................... 62,939 58,551 57,153
Deferred pension expense [note 5]................. 247 514 1,012
------- ------- -------
Capital employed.................................. 141,444 129,329 130,183
------- ------- -------
Deduct
Post employment benefits payable [note 5]....... 770 691 482
Future income taxes............................. 1,371 1,548 1,390
------- ------- -------
Shareholders' equity.............................. 139,303 127,090 128,311
------- ------- -------
Represented by--
Share capital [note 6].......................... 42,416 41,966 41,953
Retained earnings............................... 96,887 85,124 86,358
------- ------- -------
139,303 127,090 128,311
======= ======= =======
See accompanying notes
On behalf of the Board:
J. DONALD WILSON NORMAN W. ROBERTSON
President and Chief Executive Officer Chairman of the Board
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
Six months ended June Twelve months ended
30 December 31
----------------------- -------------------------
2000 1999 1999 1998 1997
----------- ----------- ------- ------- -------
(unaudited) (unaudited)
($000s except per share amounts)
Sales....................... 173,359 68,943 210,945 175,656 352,021
Cost of sales............... 139,297 59,695 181,301 143,842 273,269
------- ------ ------- ------- -------
Gross profit.............. 34,062 9,248 29,644 31,814 78,752
------- ------ ------- ------- -------
Expenses
Selling, general and
administration........... 6,020 5,352 12,380 7,842 8,091
Interest expense (income),
net...................... 559 (69) 10 (109) (861)
Depreciation.............. 3,536 2,582 6,276 3,532 3,815
------- ------ ------- ------- -------
10,115 7,865 18,666 11,265 11,045
------- ------ ------- ------- -------
Income before income taxes.. 23,947 1,383 10,978 20,549 67,707
Income tax expense [note 7]. 9,157 1,110 6,165 7,663 24,907
------- ------ ------- ------- -------
Net income for the period... 14,790 273 4,813 12,886 42,800
Retained earnings, beginning
of period.................. 85,124 86,358 86,358 79,518 42,254
Dividends................... (3,027) (3,024) (6,047) (6,046) (5,536)
------- ------ ------- ------- -------
Retained earnings, end of
period..................... 96,887 83,607 85,124 86,358 79,518
------- ------ ------- ------- -------
Earnings per share [note 6]
Basic..................... 0.49 0.01 0.16 0.43 1.42
Fully diluted............. 0.47 0.01 0.16 0.42 1.39
------- ------ ------- ------- -------
See accompanying notes
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended June Twelve months ended
30 December 31
----------------------- ------------------------
2000 1999 1999 1998 1997
----------- ----------- ------ ------- -------
(unaudited) (unaudited)
($000s except per share amounts)
OPERATING ACTIVITIES
Net income for the period.... 14,790 273 4,813 12,886 42,800
Add (deduct) items not
affecting cash
Depreciation............... 3,536 2,582 6,276 3,532 3,815
Future income taxes........ (177) (361) 158 (520) (344)
Deferred pension expense... 267 187 498 851 (271)
Accrued post employment
benefits.................. 79 18 209 17 19
(Gain) loss on sale of
capital assets............ -- -- (41) -- 37
------- ------ ------ ------- -------
18,495 2,699 11,913 16,766 46,056
Net change in non-cash
working capital............. (38,825) 10,675 (3,388) (14,226) (10,093)
------- ------ ------ ------- -------
Cash (used in) provided by
operating activities........ (20,330) 13,374 8,525 2,540 35,963
------- ------ ------ ------- -------
FINANCING ACTIVITIES
Bank loans................... 30,831 (855) 5,142 9,387 --
Dividends paid............... (3,027) (3,024) (6,047) (6,046) (5,536)
Common shares issued......... 449 -- 13 91 578
------- ------ ------ ------- -------
Cash provided by (used in)
financing activities........ 28,253 (3,879) (892) 3,432 (4,958)
------- ------ ------ ------- -------
INVESTING ACTIVITIES
Expenditures on capital
assets...................... (7,923) (4,573) (7,921) (32,251) (7,246)
Proceeds from sale of assets. -- -- 288 -- 49
------- ------ ------ ------- -------
Cash used in investing
activities.................. (7,923) (4,573) (7,633) (32,251) (7,197)
------- ------ ------ ------- -------
Net (decrease) increase in
cash........................ -- 4,922 -- (26,279) 23,808
Cash position, beginning of
period...................... -- -- -- 26,279 2,471
------- ------ ------ ------- -------
Cash position, end of period. -- 4,922 -- -- 26,279
------- ------ ------ ------- -------
See accompanying notes
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information at June 30, 2000 and for the six months ended June 30, 2000 and
1999 is unaudited
(all dollar amounts in thousands except per share and option amounts)
Prudential Steel Ltd. (the "Company"), was continued under the Business
Corporations Act (Alberta) on May 24, 1983. The Company is a steel fabricator of
tubular goods for sale to the energy and construction sectors in Western Canada
and the United States Pacific Northwest.
1. ACCOUNTING POLICIES
These consolidated financial statements, which include the accounts of the
Company and its wholly owned subsidiaries, have been prepared by management in
accordance with accounting principles generally accepted in Canada, consistently
applied. Significant accounting policies are summarized below.
Inventory
Inventories of raw materials, work in process, finished goods and stores are
valued at the lower of cost and net realizable value. Cost for all categories is
determined on a moving average basis.
Capital Assets
Capital assets are recorded at cost. Depreciation is computed generally on the
straight-line method applied to the cost of the assets used in operations at
rates based on their estimated useful lives as follows:
Buildings................................... 5%
Plant Equipment............................. 5%-20%
Yard Equipment.............................. Based on machine operating hours
Office furnishings and equipment............ 10%-50%
Leasehold improvements...................... Over the life on the lease
Income Taxes
Effective January 1, 2000 the Company adopted the liability method of accounting
for income taxes as recommended by The Canadian Institute of Chartered
Accountants. Under the liability method, future tax assets and liabilities are
determined based on differences between financial reporting and tax basis of
assets and liabilities and measured using substantively enacted tax rates and
laws that will be in effect when the differences are expected to reverse.
This change has been applied prospectively and results in no changes to the
Company's consolidated statement of financial position or net income.
Prior to January 1, 2000 the Company followed the deferral method in providing
for income taxes. Deferred income taxes resulted primarily from timing
differences between depreciation of capital assets and capital cost allowance,
and the differences between pension expense and pension payments.
Retirement Plans
The Company's defined benefit pension plan covers substantially all of its
employees. The Company also has a defined benefit supplemental pension plan
which covers certain of its officers. The cost of pension benefits is determined
on an actuarial basis using the projected benefits method prorated on services
and is charged to income annually. Actuarial valuations reflect management's
best estimates of investment yields, salary escalation and other cost factors.
Adjustments resulting from benefit amendments, experience gains and losses and
changes in assumptions are amortized over the remaining service life of active
employees. Pension assets are valued on a four-year average market valuation.
The Company accrues for other post-employment benefits to retired employees and
their surviving spouses, including medical benefits (supplementary to government
benefits), dental care, vision care and life insurance for both active and
retired employees, on a basis similar to that used for pension costs.
On January 1, 2000 the Company adopted the new recommendations of The Canadian
Institute of Chartered Accountants with respect to accounting for employee
future benefits. The recommendations established new standards for the
measurement and recognition of pension and other post-employment benefit
obligations as liabilities. Employee future benefit assets and liabilities must
be valued using current market interest rates. Previously, long-term averages
were used.
This change has been applied prospectively and results in an approximate $8,000
employee future benefit asset that will be amortized on a straight line basis as
a reduction in pension expense over the expected remaining service life of
employees, which is approximately 14 years.
Foreign Currency Translation
Monetary assets and liabilities denominated in foreign currencies are translated
at exchange rates in effect at the balance sheet date. Revenue and expenses are
translated at rates of exchange prevailing on the transaction date. Gains and
losses on translation are reflected in income as incurred.
The Company's U.S. operations have been accounted for using the temporal method
which results in monetary items being translated at the current rate in effect
at the year end; non-monetary items being translated at the historic rates; and
revenue and expense items being translated at the exchange rates in effect at
the date of the underlying transactions. Gains and losses on translation are
reflected in income as incurred.
The Company periodically enters into forward contracts for the purchase of U.S.
dollars to reduce its exposure to foreign exchange fluctuations on purchases of
materials and supplies denominated in U.S. currency. Gains and losses on these
contracts that constitute effective hedges, and the related costs of the hedges,
are deferred and recognized as a component of the related transactions. At June
30, 2000 no forward exchange contracts were outstanding. At December 31, 1999 an
option dated forward exchange contract was outstanding for $3,000 USD at a rate
of 1.44995 or $4,350 CAD, exercisable not before January 10, 2000 and no later
than January 31, 2000 [December 31, 1998--nil, December 31, 1997--nil].
Financial Instruments
Financial instruments of the Company consist mainly of accounts receivable, bank
loans, and accounts payable and accrued liabilities. As at June 30, 2000,
December 31, 1999, and 1998, there were no significant differences between the
carrying amounts of these financial instruments reported on the balance sheet
and their estimated fair values.
2. INVENTORY
June 2000 1999 1998
--------- ------ ------
$ $ $
Raw materials........................................... 28,500 31,123 20,509
Work in process......................................... 415 613 235
Finished goods.......................................... 79,991 41,635 47,648
Stores.................................................. 2,066 1,900 1,475
------- ------ ------
110,972 75,271 69,867
======= ====== ======
3. CAPITAL ASSETS
June 30, 2000
---------------------------
Net
Accumulated Book
Cost Depreciation Value
------- ------------ ------
$ $ $
Land and land improvements......................... 6,635 -- 6,635
Buildings.......................................... 18,693 7,472 11,221
Plant and yard equipment........................... 90,963 46,615 44,348
Office furnishings, equipment and leasehold
improvements...................................... 4,216 3,481 735
------- ------ ------
120,507 57,568 62,939
======= ====== ======
1999
---------------------------
Net
Accumulated Book
Cost Depreciation Value
------- ------------ ------
$ $ $
Land and land improvements......................... 6,632 -- 6,632
Buildings.......................................... 18,474 6,908 11,566
Plant and yard equipment........................... 83,388 43,852 39,536
Office furnishings, equipment and leasehold
improvements...................................... 4,089 3,272 817
------- ------ ------
112,583 54,032 58,551
======= ====== ======
1998
---------------------------
Net
Accumulated Book
Cost Depreciation Value
------- ------------ ------
$ $ $
Land and land improvements......................... 6,020 -- 6,020
Buildings.......................................... 19,173 6,414 12,759
Plant and yard equipment........................... 77,095 39,488 37,607
Office furnishings, equipment and leasehold
improvements...................................... 3,683 2,916 767
------- ------ ------
105,971 48,818 57,153
======= ====== ======
4. OPERATING CREDIT FACILITY
The Company has two forms of credit facilities available for its use. A $50
million unsecured demand operating credit facility is available through a
Canadian chartered bank, and a US$10 million credit facility is available
through a U.S. financial institution for use in funding the working capital
requirements of the Longview, Washington operation. The US$10 million facility
is secured by letters of credit drawn on the Canadian bank line and any
borrowings on the U.S. line reduce the amount available on the Canadian line.
Funds can be borrowed in a variety of forms and bear interest at either Canadian
prime, U.S. base rate, Libor plus 0.5 per cent, or Bankers' Acceptances rates
plus stamping fees. At June 30, 2000 there is $45,360 outstanding [December 31,
1999--$14,529, December 31, 1998--9,387]. The effective interest rate on the
amount outstanding at June 30, 2000 is 6.78 per cent [December 31, 1999--6.27
per cent, December 31, 1998--5.70 per cent]. Interest paid to June 30, 2000 was
$643 (1999--$411, 1998--$383).
5. RETIREMENT PLANS
Deferred pension expense is the excess of the cumulative contributions made to
fund the pension plan over the cumulative estimated pension expense charged to
income. The Deferred Pension Expense amount recorded on the Consolidated
Statements of Financial Position is net of an unfunded supplemental pension
obligation of $1,845 at December 31, 1999 [1998--$1,379, 1997--$1,031].
The obligation for pension benefits, based on amounts determined by independent
actuaries, was $31,115 at December 31, 1999 [1998--$29,447, 1997-- $25,871],
including a supplemental pension obligation of $2,195 at December 31, 1999
[1998--$1,770, 1997--$1,410]. The market-related valuation of pension assets,
was $36,824 at December 31, 1999 [1998--$32,471, 1997--$29,508].
Post-employment benefits payable are based on amounts determined by independent
actuaries. The Company does not fund post employment benefits in advance.
6. SHARE CAPITAL
Authorized
An unlimited number of common shares without par value
An unlimited number of preferred shares issuable in series
June 2000 1999 1998
----------------- ----------------- -----------------
Number Amount Number Amount Number Amount
---------- ------ ---------- ------ ---------- ------
$ $ $
Common Shares Issued
Balance, beginning of
period.................. 30,239,106 41,966 30,235,572 41,953 30,213,138 41,862
Exercise of options...... 80,328 450 3,534 13 22,434 91
---------- ------ ---------- ------ ---------- ------
Balance, end of period... 30,319,434 42,416 30,239,106 41,966 30,235,572 41,953
========== ====== ========== ====== ========== ======
Stock-based Compensation Plans
Under the Company's stock option plan, the Company may grant stock options to
its management and directors for the purchase of up to 2,680,567 common shares.
Options vest on a one-third basis starting on the first anniversary from the
date of each grant and have a maximum term of ten years subject to reduction
under certain circumstances. The exercise price of each option equals the market
price of the Company's shares on the date of the grant. No compensation expense
is recognized for this plan when stock options are issued or exercised and
consideration paid on exercise is credited to share capital.
A summary of the status of the Company's stock option plan as at June 30, 2000,
December 31, 1999, 1998, and 1997 and changes during the years then ended is
presented below:
Weighted
Number of Average Exercise
Options Price/Share
--------- ----------------
Outstanding at January 1, 1998...................... 902,954 $ 5.83
Exercised........................................... (22,433) $(4.06)
--------- ------
Outstanding, December 31, 1998...................... 880,521 $ 5.87
Granted............................................. 432,537 $ 5.97
Exercised........................................... (3,534) $(3.67)
--------- ------
Outstanding, December 31, 1999...................... 1,309,524 $ 5.91
Granted............................................. 111,569 $14.50
Exercised........................................... (80,328) $ 5.59
--------- ------
Outstanding, June 30, 2000.......................... 1,340,765 $ 6.64
========= ======
The following table summarizes information about stocks outstanding at June 30,
2000:
Option Price Options Options Options
Per Share Outstanding Exercisable Expire
------------ ----------- ----------- -------
$ 3.33 145,000 145,000 2004
$ 4.00 173,341 173,341 2005
$ 3.67 242,545 242,545 2006
$ 8.00 134,047 134,047 2007
$14.00 121,667 80,001 2007
$ 5.25 302,318 94,145 2009
$ 6.75 7,778 2,593 2009
$ 7.90 102,500 65,000 2009
$14.50 111,569 -- 2010
An additional 1,339,802 shares are reserved for future issue under the terms of
the plan.
Fully diluted earnings per share reflect the dilutive effect of the conversion
of the stock options outstanding at the end of the year, as if they had been
exercised at the beginning of the year. The number of shares used for the
calculation of the fully diluted earnings per share is 31,613,177 (1999--
31,453,784, 1998--31,110,551, 1997--30,923,632).
7. INCOME TAXES
Income tax expense varies from the amount that would result from applying the
combined Canadian federal and provincial income tax rate to income before taxes.
The reason for these differences are as follows:
June June
2000 1999 1999 1998 1997
------ ----- ------ ------ ------
$ $ $ $ $
Basic rate applied to pre-tax income.... 10,685 617 4,898 9,169 30,210
(Decrease) increase in taxes resulting
from Manufacturing processing
deduction.............................. (2,064) (334) (1,337) (1,674) (5,449)
Other................................... 27 149 135 168 146
U.S. tax losses not yet recognized...... 509 678 2,469 -- --
------ ----- ------ ------ ------
9,157 1,110 6,165 7,663 24,907
====== ===== ====== ====== ======
Cash payments made to June 30, 2000 for income taxes were $3,010 (1999-- $6,420,
1998--$20,712, 1997--$19,769).
8. SEGMENTED INFORMATION
The Company has two segments for financial reporting purposes based on
geographical location. The Canadian operation, serving primarily western Canada,
is based in Calgary, Alberta. The U.S. operation, serving primarily the U.S.
Pacific Northwest is based in Longview, Washington. Both segments fabricate
steel tubular goods. Information about segment profits, assets and capital
expenditures prior to 1998 is not provided as the U.S. operations did not
commence until late December 1998.
The accounting policies of the segments are the same as those described in Note
1--Accounting Policies. The Company accounts for intersegment sales as if the
sales were to third parties, at current market prices.
Geographic information
Canada U.S. Total
------- ------ -------
$ $ $
June 30, 2000
Revenue............................................... 160,098 13,261 173,359
Segmented profit (loss)............................... 16,811 (2,021) 14,790
Capital Assets--Cost.................................. 82,105 38,402 120,507
Capital Assets--NBV................................... 28,552 34,387 62,939
June 30, 1999
Revenue............................................... 67,624 1,319 68,943
Segmented profit (loss)............................... 1,293 (1,020) 273
Capital Assets--Cost.................................. 78,805 31,730 110,535
Capital Assets--NBV................................... 28,153 30,983 59,136
1999
Revenue............................................... 199,591 11,354 210,945
Segmented profit (loss)............................... 10,110 (5,297) 4,813
Capital Assets--Cost.................................. 78,363 34,220 112,583
Capital Assets--NBV................................... 26,681 31,870 58,551
1998
Revenue............................................... 176,656 -- 176,656
Segmented profit...................................... 12,886 -- 12,886
Capital Assets--Cost.................................. 77,378 28,593 105,971
Capital Assets--NBV................................... 28,560 28,593 57,153
Revenues have been allocated to country based on the location where the products
were produced. To June 30, 2000, U.S. revenues exclude $10,472 of sales to the
Canadian parent (six month ended June 30, 1999--$35, 1999--$2,960, 1998--nil).
Segment profit has been measured exclusive of intersegment sales. The benefit of
the tax losses in the U.S. operation has not been recorded on these financial
statements.
Major Customers
In 1999, four customers account for approximately 48 per cent (1998--47 per
cent, 1997--47 per cent) of the revenue of the Canadian segment.
9. SUBSEQUENT EVENT
On June 11, 2000 the Company and Maverick Tube Corporation ("Maverick") entered
into a combination agreement whereby each common share of the Company would
ultimately be exchanged for 0.52 of a common share of Maverick. The transaction
is subject to shareholder approval by the Company and Maverick shareholders and
regulatory approval.
10. UNITED STATES ACCOUNTING PRINCIPLES
Reconciliation of Accounting Principles Generally Accepted in the United States:
June 2000 June 1999 1999 1998 1997
--------- --------- ------ ------ ------
$ $ $ $ $
Net income in accordance with
Canadian basis.................... 14,790 273 4,813 12,886 42,800
Add (Deduct) adjustments for start
up costs (1)...................... 157 (342) (185) (1,150) --
------ ------ ------ ------ ------
Net income (loss) using United
States basis...................... 14,947 (69) 4,628 11,736 42,800
------ ------ ------ ------ ------
Net income per share using United
States basis
Basic............................ 0.49 -- 0.15 0.39 1.42
Fully diluted (2)................ 0.48 -- 0.15 0.39 1.40
------ ------ ------ ------ ------
Balance sheet items in accordance
with United States basis
Capital assets................... 61,761 57,644 57,216 56,003 28,434
Retained earnings................ 95,709 82,115 83,789 85,208 79,518
====== ====== ====== ====== ======
U.S. GAAP requires that all start up costs be expensed as incurred. Canadian
GAAP allows capitalization of start up costs if certain criteria are satisfied.
In accordance with U.S. GAAP the number of shares used for the calculation of
the fully diluted earnings per share for June 30, 2000 is 31,184,231 (June 30,
1999--30,647,027, 1999--30,953,182, 1998--30,366,357, 1997--30,592,637).
Under U.S. GAAP, the Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" ("SFAS 123") requires that companies
with stock-based compensation plans either recognize compensation expense based
on new fair-value accounting methods or continue to apply the provisions of
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" ("APB 25") and disclose pro forma net earnings (loss) per share
assuming the fair-value method had been applied. The Company has elected to
follow APB 25 and related interpretations in accounting for employee stock
options.
For June 30, 2000, the SFAS 123 pro forma calculation includes those options
under the Company's Stock Option Plan that were granted and vested during this
period plus options granted in 1999, 1998 and 1997. A total of 193,677 vested
during this period (1999--231,993, 1998--282,031, 1997--280,866).
Options are issue at the market price on date of grant and therefore, under APB
25, no compensation expense has been recorded.
Under SFAS 123, the Company's pro forma net income (loss) under U.S. GAAP would
be $14,521 for the six months ended June 30, 2000 (June 30, 1999--($424);
1999--$3,851; 1998--$11,118; 1997--$42,410) and pro forma net income (loss) per
common share would be $0.48 for the six months ended June 30, 2000 (June 30,
1999--($0.01); 1999--$0.13; 1998--$0.37; 1997--$1.40).
For disclosure purposes, the fair value of each stock option grant is estimated
on the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for stock options granted in 2000,
1999 and 1997, respectively: expected dividend yield of 2 per cent, 2 per cent
and 1 per cent; expected volatility of 49.6 per cent, 49.6 per cent and 40.7 per
cent; risk-free interest rate of 7 per cent, 6 per cent and 5 per cent; and
expected life of 7 years. The weighted average fair value of the stock options
granted in 2000, 1999 and 1997 was $7.20, $2.90 and $4.89 respectively.
