Interview with

President of U. S. Steel Kosice, s.r.o.

November 30th, 2001

U. S. Steel Kosice, s.r.o. (U. S. Steel Kosice) is made up of the core steel business of the former VSZ a.s. (VSZ), which was bought last year by the U. S. Steel Group of USX Corporation (USX). Can you tell us what was U. S. Steel’s strategic interest in investing in Slovakia?

In late 1996, VSZ was considering an expansion of their tin product facilities that would increase the capacity of the plant by 200,000 tons.  U. S. Steel’s subsidiary, USX Engineers and Consultants, Inc. (UEC), of which I was president at the time, came on board to manage the construction of the project for VSZ.  We were impressed with their facility and, as the project progressed, we asked them if they would be interested in having us as an equity partner in the tinning facility.  U. S. Steel was also interested in exploring a similar arrangement related to an  automotive galvanizing line.  We had already conducted some market studies and knew this was generally an emerging market with increasing consumer demand, and the market study we conducted on tin products showed there would be additional demand for those products.  This convinced us that we had to seize the opportunity to invest here.

U. S. Steel has a global strategy and is always looking for new markets to move in to.  We have a number of U.S. customers in that market base who have been telling us for years that they wanted us to globalize and follow them into Central Europe, as well as other parts of the world.  We felt as though we could get a fair return on investment (ROI).  That was another significant reason for us to come here.

What countries, besides Slovakia, were you considering at that time?

We had looked at opportunities in various countries in Asia, such as China, Taiwan, Malaysia and Thailand.  We had looked in Australia.  We considered Brazil and Venezuela in South America.  In Europe, we looked into Romania.  Our main concern, though, was to invest in tinning facilities that were tied to a quality steel producer, and this is what we found when we investigated the facilities in Kosice, Slovakia.  We also evaluated the political risk, and we judged it acceptable given our ROI estimates.

In 1998, we created a joint venture tinning facility with VSZ, which turned out to be an excellent investment.  We invested about $65 million in that project and virtually attained our projected profit in the first year.  There was also a $120 million to $130 million capital expansion program. The idea was to put in cash and finance the balance of the project. Our parent company financed the construction period. Then, once the facility started operating, most of the banks would allow the joint venture company to underwrite the loan.

However, when it was time to get the loan for the expansion of our facilities, VSZ started to reveal their financial difficulties. That was in October 1998. We already had some significant construction under way and had gotten closer to VSZ.  They came to us and asked if we were interested in making an equity investment in the company.  The transaction would be difficult since there were many stakeholders’ interests that had to be protected. There were several primary owners and 80,000 individual shareholders.

The banks believed that they needed to be involved in the negotiations since they had loaned about $400 million to the company. Also, the government wanted to be involved in the negotiations in order to protect their investment, which I believe was 24 to 28 percent of the company, and to ensure that this part of the country did not suffer from an increase in its already high unemployment rate. VSZ employed 25,000 people, and 236,000 people from Kosice directly or indirectly made their living from this organization, or from companies that service it. 

How long did the negotiations take?

Two years. When VSZ was experiencing these financial difficulties in 1998, we began to explore the possibility of purchasing the entire facility. Our first meeting with the owners and executives took place in November 1998, and we signed the agreement on November 24, 2000. We never thought it would take that long, but it took considerable time to get all of the parties together, figure out what everybody wanted, and make sure everybody would be satisfied.

What guarantees did U. S. Steel finally offer to all different parties?

VSZ owned 140 companies and U. S. Steel was only interested in the steel-related assets of VSZ itself and about 31 of its companies. We agreed that we would absorb $325 million of debt and give them the equivalent of $95 million in cash.  Additionally, we are legally obligated to provide two more cash payments based on the company’s performance in 2001.  These payments could range from $25 million to $75 million, part of which is due in July 2002, and the rest in 2003.  We did very well during the first nine months, but the fourth quarter is not going to be as good.  So, we believe that we are going to have a reasonable payout – close to the maximum amount – on our legal obligation.

Is the development of the market actually living up to your expectations?

We did not take over the balance sheet until November 24, 2000. The company is performing as we expected and the market is developing as we thought it should, despite the fact that the steel market has been deteriorating. In the past, there have been a significant number of individual traders here who sold steel.  They had good bargains – they took steel out of the marketplace and sold it to anybody they could sell it to. U. S. Steel has been more selective, however, and to a certain extent, we would decide to whom we would sell our steel. We have developed different philosophies through our service centers and have established a market price on our own. Since we have eliminated most of the traders, they no longer establish a market price for us.

A few isolated areas remain where we use traders, but in those cases we have a sales person who determines the price and the kind of service our customer needs, and conveys that information to the trader. The trader processes the documents, expedites the material and makes sure the customer gets the product.  If the customer has a complaint with that product, he does not contact the trader, he contacts us.

What are your main export markets?

Although we export about 42 percent of our production to Western Europe, about 47 percent of our production remains in the Central European market, mainly in the Czech Republic, Poland and Hungary.  We ship the remaining 11 percent of our steel to countries outside of Europe.  In total, we ship to about 40 different countries. 

Where do your main resources, such as iron ore and coke, come from?

Our iron ore primarily comes from the Ukraine and Russia. Our coal comes from Russia, Poland and the Czech Republic.  However, we are re-evaluating our coal suppliers since they do not want to negotiate with us.  We are now considering importing part of our coal from countries like Canada and Australia. The message we are trying to send our suppliers is that if our business is good, we are going to share our profitability with you; but if our business is down, we expect lower prices from you. That is how we can all maintain the profit level, otherwise we all share the pain.

Over the fourth quarter of 2001, the steel market in Central Europe experienced a recession. How is this going to influence U. S. Steel Kosice’s medium-term development strategy?

There are various reasons for this recent downturn. Western European markets are heading towards a crisis.  Their economies are still growing but not at the rate

originally projected. And the global steel market suffers from an overcapacity of around 300 million tons. Even with the current global situation, we believe we will be able to maintain our shipment levels at around 3.5 million tons of finished product. We have seen pricing pressure, particularly over the second half of 2001, and we try to respond by modifying our product mix and being innovative. We try to shift our strategy to adapt to growing markets, such as the energy sector. However, we believe that the first half of 2002 is going to look very much like the fourth quarter of 2001. 

We focus on six business drivers: safety, environment, customer service, quality, productivity and manufacturing cost. We are exploring every way possible to drive down our manufacturing cost so we can remain profitable over this downturn. We do have an obligation for stable employment. We have today around 16,300 employees and we can only reduce the employment level through natural attrition, such as retirements. In 2001, we hired 130 people in the operations section, and we want to continue to attract talented people. We have found it beneficial to hire young people right out of the universities and train them according to our procedures.  Focusing on our six drivers, we believe we can improve the quality of our products and services and still reduce our manufacturing cost.

Will this reduction in manufacturing cost involve some prior investment into new facilities?

There are two ways to reduce costs: you can either reduce your expenses or you can improve what you have and reduce costs through better efficiency. We want to put our money into value-added equipment which will enable us to operate more efficiently. A year ago, for example, if you had come into our steel shops where our basic oxygen furnaces are, an average vessel lining would last about 1,400 heats. Since relines are costly, ranging from $400,000 to $500,000, we changed our operating practices to extend the life of vessel linings. The last basic oxygen furnace vessel we relined lasted through 6,150 heats. That is a significant improvement, and just this year we saved $2 million through this operating change. This has also permitted us to change the way we make sinter in our sinterplant, eliminating the use of dolomite. These are just a couple of examples, among hundreds, of cost reduction projects that we employ.

Two weeks after U. S. Steel took over the plant, we assembled a group of engineers, operators and accountants.  Their job was to sit down with everyone in each area and develop cost reduction projects, then follow up on the development of those projects every month. We have recently started a continuous improvement program, beginning with our management organization, whom we are training, appraising and evaluating. It is extremely disciplined.  As American managers, we look at a number of details, and people here are just amazed at the things we look at.  Most of us have had enough experience that there is almost nothing we have not seen or done before. I have 31 and one-half years with U. S. Steel. I think the average number of years of

service of our executive team is 23 and one-half years.  We know what works and what does not work. Of course, we also make our share of mistakes.  While it is not a crime to make a mistake, it is a crime not to recognize it and fix it. We also want our employees to try new things, take calculated risks and think it through. And, if something goes wrong, be sure to have a back up plan and know how to recover from it. To make a mistake is okay, as long as you are prepared to move on and try something else.

Following the acquisition of VSZ, U. S. Steel was to invest $700 million over a ten-year period. Given the current situation in the steel making industry, what are the main projects you plan to allocate those funds to?

We had a capital plan based on specific projects to which we decided to commit $700 million over a ten-year period. Part of that money was dedicated to infrastructure, including new facilities, new vessels, etc. Some generators had been down for a long time; VSZ never put the money into their rehabilitation. We want to generate more of our own power as it is significantly cheaper than buying it. We know that we have to do something with industrial gasses such as oxygen, hydrogen and nitrogen. We want to build a new air separation plant. It is taking us longer to negotiate our contracts and find the right equipment. I do not want to build a 1,500-ton-per-day plant, because if we have a problem with it, we would be down completely. So, we changed our strategy and said let’s initially build a 700-ton-per- day plant and take some of our current units and rehabilitate them. Obviously, these projects are not only production related: they have an environmental/conservation impact. Regarding other issues related to the environment, we have planned to build one precipitator at our sinter plant each year for the next four years. We put one precipitator on this year, which will come on line next week. By 2003, the project will be completed, which means that we should be a year ahead of schedule. As for investments in value-added facilities, we have spotted a growing market for electrical sheets and we have decided to invest in facilities to serve that market. This is an entirely new project and one we didn’t anticipate pursuing until recently.

You recently launched the final phase of the tinning plant expansion project that you mentioned earlier. When should this expansion be completed, and to what extent will you increase your annual production capacity?

We will add 200,000 tons of tin to the annual capacity, giving us a total capacity of 340,000 tons. The expansion includes a continuous annealing line, a new electrolytic tinning line and a second sheet line. The continuous annealing line we are implementing will allow us to manufacture a complete line of tin products, and enable us to reach new market segments. One of the projects we completed in the fourth quarter of last year was the conversion of our tin temper mill into a double cold reduction and tin temper mill, which allows us to get significantly lighter gauges of material. We are optimistic, because we now believe that the potential of that market is twice as high as our original projections. In March 2002, we will also launch our new vacuum degasser, which will allow us to get into some cold rolled electrical sheet applications that we cannot get into today. We should start testing in March and bring it on line in April 2002. We have just installed roll cooling on our hot strip mill. This is one of the main projects we discussed in 1998. One of the first projects we conducted after we took over was the implementation of the new cooling system, including a new cooling tower and new sand filters. We have completely revamped the way we handle scrap by developing models of how to buy scrap based on what we are expecting to make.  We have models that allow us to use significantly cheaper scrap while improving our steel quality. We now blend the scrap ourselves. We probably have 10 or 15 new scrap suppliers, and we have spent about $10 million on this project. We started investing in this project in February 2001 and it should start to pay off soon.

Through its Economic Development Centre, U. S. Steel has launched a few programs to make the Kosice region more attractive to foreign investors. What has been the result of such initiatives?

Our job here is more than just running the plant; we also have an obligation to help develop the community. We try to promote the country and its economic development. The Economic Development Centre is there to attract additional businesses to the area so employment in the region will grow faster. We have been directly involved in three economic development seminars: Brussels, Berlin and Oslo, but also in London and Vienna during 2001. The one in Vienna was actually organized by the Austrian government and they asked us to come over and speak. A total of 208 prospective investors showed up at the conference. Out of those 208, 13 people were interested in moving to the next stage. Some additional seminars are being conducted in order to assist investors in carrying out the proper research. But it may take some time to get investors to come here as the steel industry is in a slowdown. There is a worldwide recession and people generally do not make decisions to expand during a recession. However, we are still confident that new investors will come soon. We are planning to have additional conferences next year. We are not focusing on industrial parks to encourage investment. There are a lot of people in Slovakia who believe that it is necessary to have industrial parks before investors come in. I believe that there are enough industrial sites here with the necessary infrastructure and, in many cases, it may not be necessary to spend the amount of money that is required to build an industrial park. Generally, such projects need a strong investor in order to attract others. A good example might be Volkswagen in Bratislava, which more or less forced companies to locate there. But we believe that in Eastern Slovakia, with a very small investment, there are a fair number of industrial sites that could easily attract investors. If a new industrial park is going to be built, I believe it is important to have the tenant first.

To what extent do you actually get involved into the integration process of those foreign investors?

One of the advantages we have is the experience we gained from our own transaction. Anything that could come up, came up in our transaction. The other advantage we have is our position in the country. If an investor has a question that involves tax issues, for example, we can arrange a meeting with the Minister of Finance to help get answers. We have been happy with the cooperative attitude we’ve seen from the customs authorities. In the beginning, the customs process was frustrating. The customs authority came in and would spend half an hour telling us exactly what the law said. It takes a lot of time but, in the end, it is just a matter of sitting down with the right people to simplify the process.

The government fully supports the economic development of the region. And they rely on us. We are currently rehabilitating the children’s oncology wing at a new hospital and they are sharing a minor portion of the cost. We prefer providing the goods and services rather than giving money, because it helps us get around problems of possible misuse. At an elementary school in Saca, we did some roof repairs, replaced some windows and did some painting.. We donated SKK 250,000 to a school for the handicapped in Medzilaborce. We made a significant contribution to a hockey club where there are a significant number of young kids that we wanted to help. We are also doing a Christmas program for the elderly people now. In the hockey club, we have two of our people on the executive committee and our chief financial officer reviews their financials. Deloitte & Touche also contributes to the auditing so that we know that our money is being spent wisely.

How would you evaluate Slovakia’s chances to join the EU in 2004?

Entry into the EU will bring economic growth and stability to Slovakia. But Slovakia needs to make sure that it is not an entry into the EU at any cost. Everybody in the government is eager to make sure that all chapters are closed on time. There are some people here who believe that if this happens in 2004, they will see an immediate difference in Slovakia. But I don’t believe they will see significant change until 2010 or 2015. It will take a while for this country to develop economically and reach the competitive level of Germany, France or the USA.

Today, how would you evaluate Slovakia as a potential investment destination in comparison with its neighbouring countries?

As an investor in Slovakia, I want to promote this country. The major asset here is the people. We have an exceptionally well-trained work force and any company that comes here would benefit from this excellent resource. Slovakia also has an excellent educational system with several universities and colleges. You can study a wide range of subjects including medicine, veterinary medicine, mechanical engineering and biology.  We have hired several young people and they are excellent. You don’t find that everywhere. I’ve traveled around the world, and kids here are different. They do like their free time, but when they are at work, they really work for you. Some of the older people had trouble adjusting to the way we do things.  They had been taught to work a certain way for 35 or 40 years and suddenly the Americans came in and asked them to do it another way. But the kids and the government officials who have been in contact with us want the country to grow, they want to be cooperative, they want to encourage investors to come here. They don’t always know the right way to do it, but they do want that to happen.

One of the problems that the government has with economic development is that it has yet to designate one person to be responsible for foreign investment and to help entrepreneurs. The opportunity to attract 10 to 20 small-sized manufacturers, rather than one very large investor, is significantly higher and in the long term, it will be better for the region.  When we were working on our transaction, there were days when things got frustrating.  But after you successfully complete the transaction and see the company performing well, you tend to forget about the problems. As we were doing the transaction, there were many days when we laughed wondering what are we doing here. But now it is amazing how efficiently things get done.

Besides being the President of U. S. Steel’s largest plant outside the U.S. you have also been General Manager of U. S. Steel’s largest plant in the U.S. (Gary Works). How would you compare those two different experiences?

In general, I had fun at both places. The job at Gary was somewhat different: the General Manager’s job is really to run the operation, to make sure that the equipment runs, you have some strategy and capital engineering, but no commercial responsibility. You have some contact with government officials, you have some contributions or philanthropic work, but it is really a minor part of the job. This is a significantly bigger job because the scope of responsibility is significantly broader. U. S. Steel is giving us a great deal of responsibility here. We take care of everything; we have a public affairs department, a commercial organization, engineering, and strategic planning. We are like a major company, and whether our projects succeed or fail, the final result is attributable to all of us. So, I probably get more personal satisfaction from my job here in Kosice.