Annual Report 2010

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Goals and Key Factors for Success

Management and Control of the Company, Goals and Strategy

As we operate in an environment characterized by its fast pace, we place pivotal emphasis on securing the company’s sustainable and successful performance to the benefit of all its stakeholders. This approach is reflected in our strategic goals and has been consistently implemented in recent years through an appropriate business policy and a number of measures to promote development. It is our innermost conviction that the stability and consistency of the way in which our company is managed constitutes a key success factor, that is not least reflected in the multiple increase in our share price achieved over the last decade. The alignment of Salzgitter AG towards its overriding goal – namely that of preserving its entrepreneurial independence through profitability and growth – therefore remains unchanged.

The focus over the two last years has been on securing the stability of the Group. Our intention is now to proceed with developing our company through selective, profit-oriented growth, as practiced successfully in the years preceding the most recent global economic crisis. Expanding our activities is, however, not an end in itself but is always subject to the proviso of achieving above-average profitability for our company in a peer comparison, now and in future. Return on capital employed (ROCE) is a key ratio in measuring how successful we are in this respect.

Within the context of containing entrepreneurial risk, our financial stability and a sound balance sheet are indispensable prerequisites, as they are doubtless the most important foundation for the long-term success of a company, in particular given the changeable framework conditions described above.

The strategic development of the Salzgitter Group is focused on the Steel, Trading, Tubes and Technology divisions. Along with current and planned projects aimed at promoting our organic growth, we also fundamentally review external growth options in terms of their suitability.

At the same time, we always pay special attention to the cost and technological aspects of our competitive position and work steadily on releasing new potential in all areas of the Group.

In order to achieve a top-down/bottom-up synthesis between our corporate goals and the environment in which our operating units are embedded, and to safeguard a systematic method of procedure, we use a range of tried-and-tested management tools.

We are aware that the valuable contributions of our employees in all areas of the Group are a cornerstone for the realization of our goals. This is why we view the future-oriented professional development, the systematic fostering of the qualifications of our workforce and acquisition of highly-qualified junior staff as a crucial, strategic task.

The environmental compatibility of our products and production processes, combined with the prudent use of all resources, has always been an accepted and a natural basis for all our activities.

Management and Control System

The primary objective of our company remains the preservation of our independence through profitability and growth. As a quantitative, performance-related target, the Group has set itself the goal of achieving a return on capital employed (ROCE) of at least 15% over an economic cycle, generally defined as five years.

ROCE shows the relationship of EBIT to capital employed and measures the return on capital employed:

EBIT (earnings before interest and tax) is the result before interest and tax expenses, adjusted for the interest portion of transfers to provisions. Interest income remains part of EBIT as it is considered to be part of ordinary activities and contributes to the return on capital employed.

In € m	FY 2010	FY 2009
EBT	48.9	–496.5
+ Interest expense	139.0	118.7
– Interest expenses for pension provisions	–85.0	–90.3
= EBIT	102.9	–468.1

Capital employed is interest-bearing equity and debt. This ratio is calculated by deducting pension provisions and non-interest bearing balance sheet items from the balance sheet total:

In € m	FY 2010	FY 2009
Balance sheet total	8,689	8,052
– Pension provisions	–1,926	–1,858
– Other provisions excluding tax provisions	–754	–693
– Liabilities excluding bonds, bank liabilities and notes payable, liabilities from finance leasing and forfaiting	–1,210	–915
– Deferred tax claims	–202	–129
= Capital employed	4,596	4,457

Pension provisions and related interest expenses are eliminated in the calculation of ROCE, as these components cannot be influenced by management’s decisions in the short to medium term.

The components which make up the ratios are drawn from the figures in the financial statements. The calculation is always based on figures disclosed in the financial statements as of the end of the reporting period.

Since the ROCE target (15%) is to be achieved within the Group as an average over the economic cycle, it is more of a medium-to long-term target. Specific strategic objectives are derived from this target for each individual division and company. These objectives are factored in by the medium-term plan – in their updated form whenever necessary.

Over the entire period from 2001 to 2010, we exceeded our profitability target by delivering an ROCE of 18.4%. Even in periods that were profoundly affected by the crisis we nonetheless achieved a sound 13.4%. This figure reflected the consequences of the financial and economic crisis on our company and the pressure on the margins of many products caused by the raw material price trend. ROCE stood at 2.2% in 2010 (2009: –10.5%). Upon elimination of the net cash investment held at banks, ROCE from industrial operations came to 2.7% (2009: –17.3%).

Strategy

Growth strategy

The internal and external objectives formulated in 2007 to promote the growth envisaged are still valid:

Internal goals:

Optimizing quality
Raising productivity
Eliminating bottlenecks
Enhancing the product range
Reducing our dependency on external deliveries and services in sensitive areas

External goals:

Closing gaps in the value chain
Making attractive acquisitions in areas associated with steel
Building up regional market positions on a selective basis
Supplementing and/or extending our product range
Industrial diversification

By harnessing these growth-generating building blocks, we are striving to achieve consolidated external sales in the region of between € 13 and 15 billion in the medium term. Moreover, we require each sub-project and each individual company to make a sustainable contribution to achieving an average ROCE of 15% targeted at Group level over the steel cycle, which is still the main economic cycle determined for our Group.

The progress of companies towards greater growth always entails entrepreneurial risk, as far-reaching decisions for the future are made on the basis of empirical data, insights and experience and the commitment of considerable financial resources. The repercussions of the global financial and economic crisis were still exerting considerable influence on general market conditions in the financial year 2010. This was reflected above all in changes at short notice and wide variations in the parameters influencing decisions, which greatly hampered predictability. For this reason, and as in 2009, we gave precedence to measures geared to securing the future of the Group over our external growth targets.

It is our fundamental intention to use potential processes of consolidation to actively shape developments in our core businesses of steel, trading, tubes and technology in the future as well, without being pressured into action. We will, however, not be taking part in “bidding wars” and will not pay unrealistically high prices for acquisitions.

Our foresighted building up of liquidity reserves enabled us to forge ahead with extensive investment. There was only one exception where we decided to delay investment and, having achieved clarity as to the relevant market conditions, we subsequently moved ahead swiftly with the implementation of work planned. Having made very good progress with all our undertakings in 2010, we have set our sights on completing the remaining projects by the financial year 2012.

The examination and assessment of the Group’s investment measures are always subject to conservative assumptions and standards. We are therefore confident that the internal growth initiatives expedited in our core businesses of steel, trading, tubes and technology have left us well equipped and able to achieve the goals envisaged, even if there is a delay in some instances. Once the macro-economic situation has sustainably returned to normal levels, the large majority of our projects will serve to promote our long-term growth objectives.

Within the current five-year period, groupwide projects worth € 2.0 billion in total have already been partly completed or will have been implemented by 2012.

Groupwide Investment Volume 1996/1997 – 2012

Strategy of the divisions

In 2010, the strategic focus was on raising the competitive ability of all units forming part of the Group. To this end, stringent measures such as closing down locations and reducing personnel were initiated (see “Divisions” in the section entitled “Profitability, Financial Position and Net Assets” starting on page 102).

The Steel Division concentrated on proceeding with implementing the extensive investment program launched in 2007, the volume of which will have reached an amount of approximately € 1.7 billion by the year 2012. The investment measures initiated or already completed in our three steel locations will enable us to:

supplement our product range,
reduce our costs due to enhanced facilities efficiency and
significantly lower the volume of input material purchased externally and scale back outsourced processing in the Steel and Tubes divisions.

For more detailed explanations please see the “Investments” section on page 66. In addition, decisive improvement potential is to be released through the restructuring program now under way at Peiner Träger GmbH (PTG).

The Trading Division will coordinate its stockholding distribution of steel closely with the export business of our production companies in order to release synergies through a joint development of the market. In addition, its position in the strategic growth segment of higher quality grades is to be reinforced and its pre-processing capacity expanded in line with the market. International Trading will concentrate on strengthening its customer relationships and continue to support the steel mills in purchasing input material.

The Tubes Division’s business is largely geared to infrastructure projects, which means that it is in essence late in the economic cycle. This is explained by its proximity to the energy sector which, in turn, is geared towards long-term changes in energy requirements. In addition to their advantageous competitive position, the Group’s subsidiaries, which deliver to the markets for the transportation of agents (media such as gas) reliant on pipelines, are set to benefit from the fact that access to energy and water are indispensable prerequisites underpinning society’s prosperity. The Tubes Division will continue to sharpen its profile by rounding off its product range and optimizing its existing activities.

The aim of the strategy pursued by the companies belonging to the Technology Division is to offer customers all over the world solution expertise from a single source and the opportunity of benefiting from a seamless and coordinated product portfolio. In future, even greater emphasis will be placed on providing customers with comprehensive solutions encompassing the entire production cycle of plants and facilities, from planning right through to final decommissioning and recycling. Furthermore, the restructuring process initiated to optimize internal workflows is being consistently implemented.

The primary task of the Services Division is to support the Group’s producing companies. As before, the aim is to enhance the efficiency of its services on an ongoing basis and also to field these services and compete on external markets, thereby optimizing the division’s business success wherever possible.

Management and Control Instruments

In order to manage the process geared to our objective of boosting the competitiveness of the Salzgitter Group, the company deploys a range of management and control instruments, alongside the regular coordination of goals at Executive Board level, flanked by the respective reporting to the supervisory and controlling bodies:

Profit Improvement Program (PIP),
“5P Management”, as well as
agreeing individual goals for executives and non-tariff employees.

Profit Improvement Program (PIP)

We view the ongoing optimization of value-added processes as an important management task which makes a major contribution to conserving the Group’s sustainable competitive edge. It entails the systematic and consistent leverage of the existing potential in all our divisions.

To this end, we introduced the concept of our Profit Improvement Program (PIP) as a groupwide, uniform management instrument into the Salzgitter Group back in 1996. PIP combines all the explicitly defined measures designed to improve the performance and results of Group’s companies, the impact of which are assessable and measurable based on a set of financial ratios. All projects are subject to a stringently systematic procedure for measuring success to which binding and identical assessment criteria are applicable.

Employees play an active part in PIP

In contrast to pure top-down approaches, the commitment of all involved under the PIP concept ensures the successful implementation of the steps agreed. Accordingly, our employees’ suggestions for improvement are also incorporated into PIP. The acceptance of the program, which relies mainly on our employees’ initiative rather than being driven by consultants, and their willingness to use the structures and mechanisms established to consistently improve the profitability of their own projects therefore remains very high. Consequently, we regard PIP as an ongoing task that permeates all levels of management.

Successful project contributions

To date, the relaunch aspect and the resulting limited time horizon of four years has been a core PIP feature. The year 2010 saw the scheduled completion of the third PIP relaunch (PIP 3) which commenced in 2007.

New ideas and sustainably effective measures were once again integrated into the project catalog, provided that they stood the stringent test of the PIP criteria. With 329 active projects and 81 ideas the number of measures was comparable with that of the previous year. The full-year effect (FYE) of € 175 million also stayed at the 2009 level.

This overall effect results from a number of different areas: activities in sales markets based on products with a higher value added and the extension of the network of sales channels delivered an FYE of € 187 million. Moreover, in the course of improving process workflows in production and administration and streamlining the use of materials and external services, we have identified a potential of € 86 million.

A precondition for achieving the goals set for the Group partly involves an increase in expenses, such as those incurred by investments. An annual amount of € 98 million was therefore taken into account to cover depreciation and amortization, interest and other expenses.

Current Status of PIP 3

In € m	FYE
Increase in overall operating performance	187
Savings on expenses	86
Depreciation and amortization/interest/non-personnel expenses	–98
Profit-related effect before tax	175

Launch of the new PIP

In response to the economic environment of recent years, the subsidiaries have meanwhile launched additional programs with structures similar to PIP, which, however, have not yet been incorporated into PIP given the input involved in the necessary double entry and associated administration.

The completion of the Group’s third PIP relaunch now presents an opportunity to optimize and create a standardized catalog of criteria for use by all companies. Key aspects include a flexible base year and the implementation of a continuous program with no time restriction. In order to provide additional support, we will be moving away from our current IT system to create an IT environment more suited to the new conditions. In the process, the name PIP will not be changed, as the core criteria will be retained and the three letters have become anchored in the Group’s corporate culture. They are synonymous with efficient and sustainable business conducted with initiative.

Immediate action program for securing profit and liquidity in the short term

As a measure to supplement PIP, we launched an immediate action program in 2009 designed to secure profit and liquidity in the short term so as to counteract the impact of a notable downturn in capacity utilization. The effectiveness of this measure has convinced us to retain a number of components in 2010. Indeed it proved to be a thorough success in 2010 as shown by the practically full realization of an effect on profits worth € 235 million. Around half of the measures under the program are likely to have a permanent effect.

“5P Management”

In connection with “5P Management” goals are formulated whose impact may be difficult to ascertain in financial terms, but which nonetheless exert a positive influence on the company’s performance. The structure of the “5P corporate guideline dimensions” comprises goals such as supplying customers by the respective deadline and in the right quality, ensuring that production processes are up and running seamlessly with minimum unscheduled interruption, as well as promoting the continuous professional development of employees in all areas of the company.

“5P Management”, a balanced scorecard system based on our corporate guidelines and in place since 2004, has meanwhile been implemented in the majority of companies belonging to the Salzgitter Group. This tool enables the identification and pursuit of operational goals and measures derived from the respective corporate strategy for the individual organization units. The structure mirrors the “5P” corporate guideline dimensions defined as “Partners”, “Processes”, “Products”, “Personnel” and “Profit”. Examples of goals which are measurable on the basis of defined criteria and ultimately designed to exert a positive impact on overall company profit are as follows:

raising the proportion of premium specification integrity across all production levels on an ongoing basis,
guaranteeing necessary precautions for occupational safety and
assessing and analyzing customer satisfaction.

These operational goals constitute the basis for formulating agreements on objectives between superiors and executives and non-tariff employees in the relevant area of responsibility.

Agreeing Individual Objectives for Executives and Non-tariff Employees

Agreements on objectives serve to transmit corporate goals and cascade them down to the level of each individual employee’s personal endeavors. Salzgitter AG divides these objectives up into individual targets for executives and non-tariff employees and a collective, quantitative component reflecting the Group’s goal of achieving a return on capital employed (ROCE) of at least 15%. Part of this process is to define a target for each individual subsidiary. Individual objectives are agreed between a superior and his staff and derived from the goals of the next organization unit up in the hierarchy. Beyond this, we take care to ensure that the interaction between the various targets of the employees in their entirety has a positive impact on achieving the overriding objective of our company, which is “preserving our independence through profitability and growth”.

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