DOFASCO INC. ANNUAL REPORT 2006

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1 ANNUAL REPORT 2006

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3 TABLE OF CONTENTS 2 OVERVIEW OF THE BUSINESS Corporate overview Strategy Core businesses Corporate developments 6 SUMMARY OF QUARTERLY RESULTS 6 RESULTS OF OPERATIONS Consolidated financial results Pro forma financial results Gross income by business segment 2006 vs Gross income by business segment Fourth Quarter 2006 vs Other income statement items 15 LIQUIDITY AND CAPITAL RESOURCES Statement of cash flows Cash provided from operating activities Cash used for investment activities Cash used for financing activities Cash requirements Capital resources Contingent gain Financial instruments Off-balance sheet arrangements 18 RELATED PARTY TRANSACTIONS 18 STEEL TRADE 18 CRITICAL ACCOUNTING ESTIMATES Employee future benefits Useful lives of fixed assets Asset retirement obligations Inventory valuation 20 DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING 20 RECENT ACCOUNTING PRONOUNCEMENTS 21 SELECTED ANNUAL FINANCIAL INFORMATION 22 AUDITORS REPORT 23 MANAGEMENT S RESPONSIBILITY FOR FINANCIAL REPORTING 24 CONSOLIDATED FINANCIAL STATEMENTS 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4 Management s Discussion and Analysis Management s discussion and analysis contains certain forward-looking statements with respect to Dofasco s operations and future financial results that are subject to risks and uncertainties that may cause the results or events predicted in this discussion to differ materially from actual results or events. Consequently, all forward-looking statements made in this management s discussion and analysis or Dofasco s documents referred to herein are qualified by this cautionary statement and there can be no assurance that actual results or developments anticipated by Dofasco will be realized. This document has been reviewed by Dofasco s Board of Directors and contains information that is current as of February 8, Events occurring after that date could render the information contained herein inaccurate or misleading in a material respect. Dofasco may, but is not obligated to, provide updates to its forward-looking statements, including in subsequent news releases and its interim management s discussion and analyses filed with regulatory authorities. The following discussion and analysis should be read in conjunction with the consolidated financial statements and the accompanying notes. Additional information about Dofasco is available in the Corporation s Annual Information Form, which can be accessed from SEDAR at 1

5 MANAGEMENT S DISCUSSION AND ANALYSIS OVERVIEW OF THE BUSINESS Corporate overview Established in 1912, Dofasco Inc. is a leading North American steel solutions provider. The Corporation s steel products include hot rolled, cold rolled, galvanized and tinplate steels as well as tubular products and laser-welded blanks. Dofasco s wide range of steel products is sold to customers in the automotive, construction, energy, packaging, manufacturing, pipe and tube and steel distribution markets. The Corporation has operations in Canada, the United States and Mexico. Dofasco also owns interests in iron ore mining operations including a 98.7% interest Quebec Cartier Mining Company ( QCM ). QCM owns and operates the Mont-Wright open pit mine and a pellet plant at Port- Cartier, Quebec. On February 20, 2006 Dofasco became a wholly-owned subsidiary of Arcelor S.A. (See Corporate developments). The foundation of Dofasco s success, and a key competitive advantage, is its workforce of highly skilled and motivated employees who implement the Corporation s customer-focused Solutions in Steel strategy. Strategy Dofasco's unique Solutions in Steel strategy focuses on creating long-term sustainable growth by providing value-added products to its customers. This is accomplished through a focus on customer relationships, technology and innovation, and operational excellence. The strategy is enabled by the abilities of Dofasco employees and the Corporation s prudent financial management. Dofasco s Solutions in Steel strategy is to pursue strategic business opportunities that earn a return above its cost of capital and allow the Corporation to maintain its leadership position in the North American steel industry. During the past decade, Solutions in Steel has increasingly transformed Dofasco into a high-tech producer of innovative, value-added products that meet the immediate and future needs of its customers. Core businesses Dofasco s four key business segments are Flat Rolled Operations, Gallatin Steel, Mining Operations and Tubular Products. Effective January 1, 2006, the Corporation s Tubular Products business segment was formed, consisting of the Dofasco Tubular Products group of companies, Dofasco de Mexico and the Hamilton Tubular Division. The change was made in order to provide more useful information about the Corporation s Tubular Products and Flat Rolled Operations business segments following Dofasco s acquisition of certain assets related to Copperweld Holding Company s mechanical tubing and automotive components businesses in the fourth quarter of Dofasco s Flat Rolled Operations business segment now includes the Corporation s Hamilton facilities, excluding the Hamilton Tubular Division, as well as certain subsidiary and joint venture operations primarily engaged in the production and sale of flat rolled steel products. Hamilton operations - Dofasco's operations hub is its 750-acre steelmaking complex and head office in Hamilton, Ontario. The state-of-the-art facilities are some of the most efficient, flexible and technologically advanced in North America. These include three coke plants, two operating blast furnaces, a basic oxygen steelmaking furnace, an electric arc furnace, two slab casters, a hot strip rolling mill, pickling lines, cold rolling mills, annealing and tempering facilities, galvanizing lines and Canada's only electrolytic tinning lines. 2

6 MANAGEMENT S DISCUSSION AND ANALYSIS Subsidiaries - Powerlasers, a wholly-owned subsidiary, manufactures laser-welded blanks for the automotive industry at its facilities in Ontario and Ohio and operates an advanced technology centre in Kitchener, Ontario. Joint ventures - Dofasco accesses leading-edge technologies through its joint ventures, product licenses and process technology agreements with several key players in the global steel industry. For instance, the Corporation has joint venture arrangements and technology agreements with two of the world s largest steelmakers, Arcelor S.A. (at DoSol Galva) and JFE (at DJ Galvanizing), to manufacture high value-added galvanized steel for North American automotive customers. Other joint ventures are Baycoat (steel coil coating) and Sorevco (hot dip galvanizing). The Gallatin Steel business segment, which represents Dofasco s 50% ownership in the minimill joint venture located in Kentucky, is accounted for using the proportionate consolidation method. Gallatin produces flat rolled steel primarily for the construction, pipe and tube and distribution markets in the midwest United States. Gallatin s state-of-the-art compact strip production facility features a twin-shell electric arc furnace, a ladle metallurgy facility, a thin-slab continuous caster and a six-stand hot strip finishing mill, with an annual production capacity of over 1.5 million tons. The Corporation s Mining Operations business segment includes a 98.7% interest in QCM, and Wabush Resources Inc, which holds Dofasco s 28.6% interest in the Wabush Mines joint venture. QCM is a major North American producer and exporter of iron ore products with facilities in Northern Quebec and executive offices in Montreal. The company operates an open pit mine, crusher/concentrator facility, pellet plant, deep-water harbour and a railway linking the mine to the harbour in Quebec s North Shore region. The Wabush Mines joint venture, also a producer of iron ore products, has operations located in Newfoundland and Labrador and Quebec. Other investments In addition to its core businesses, Dofasco continues to hold a 27% interest in Ivara Corporation, an Ontario-based provider of advanced plant maintenance software and related services. Corporate developments Arcelor acquisition of Dofasco common shares On January 24, 2006, Dofasco and Arcelor S.A. ( Arcelor ) announced that they had reached an agreement for Arcelor to make a revised all-cash offer of $71.00 per common share or total consideration of approximately $5.6 billion, to acquire all of Dofasco s outstanding common shares. Dofasco s Board of Directors unanimously recommended to Dofasco s shareholders that they accept the offer. This announcement followed a news release issued by ThyssenKrupp AG ( ThyssenKrupp ) on January 23, 2006 announcing its decision to waive its right to match the $71.00 per share offer made by Arcelor on January 16, 2006, and the announcement on January 23, 2006 by Dofasco that it had terminated the support agreement between Dofasco and ThyssenKrupp. As a result, a break fee of $215 million was paid to ThyssenKrupp by Dofasco in the first quarter of On February 20, 2006, Arcelor took up 88.38% of Dofasco s common shares that were deposited to the offer and extended the expiry date of the offer to March 7, On the same date the Board of Directors passed a resolution rendering the Shareholder Protection Rights Plan inoperative against the Arcelor offer and any subsequent acquisition transaction resulting from that offer. On March 8, 2006, Arcelor announced that a total of 77,530,766 common shares had been deposited to date, representing 98.5% of all outstanding Dofasco common shares. Effective March 31, 2006, the Corporation s common shares were de-listed from the Toronto Stock Exchange and effective April 5, 2006, Arcelor completed the acquisition of the remaining Dofasco common shares by means of a statutory compulsory acquisition procedure under the applicable provisions of the Canada Business Corporations Act at the same price as the offer price. On April 3, 2006, Arcelor transferred 89.1% of its ownership interest in Dofasco to an independent foundation based in the Netherlands known as the Strategic Steel Stichting ( Stichting ). Under the terms 3

7 MANAGEMENT S DISCUSSION AND ANALYSIS of the foundation Arcelor retains full control over Dofasco, including all decision-making power and all economic interests relating to Dofasco, with the exception of any decision to sell Dofasco. Merger of Arcelor S.A. and Mittal Steel Company NV On January 27, 2006 Mittal Steel Company N.V. ( Mittal ) announced its intention to make a tender offer for the outstanding shares of Arcelor and that it had entered into an agreement with ThyssenKrupp to cause Arcelor to sell its investment in Dofasco to ThyssenKrupp upon the successful completion of its offer. On May 19, 2006 Mittal formally launched a tender offer for Arcelor. On June 25, 2006, Arcelor s Board of Directors resolved to unanimously recommend to Arcelor s security holders that they accept a merger of Arcelor and Mittal that would result in a combined group named Arcelor Mittal. On August 28, 2006, Mittal announced that 93.72% of Arcelor s issued share capital, on a fully diluted basis, had been tendered to Mittal s offer. On August 1, 2006 the United States of America ( the United States ) filed a civil antitrust complaint seeking to obtain equitable and other relief against Mittal to prevent its proposed acquisition of Arcelor. The complaint alleged that the likely effect of this acquisition would be to lessen competition substantially in the development, manufacture and sale of tin coated steel sheets. At the same time the complaint was filed, the United States filed a Hold Separate Stipulation and Order and a proposed final judgment ( the Final Judgment ) which was designed to remedy the anti competitive effects of the acquisition while permitting Mittal to complete its acquisition of Arcelor. Pursuant to the Final Judgment Mittal was obligated to divest of Dofasco to ThyssenKrupp within 120 calendar days of August 1, The United States was permitted to grant one or more extensions of this time period, not to exceed, in total, 60 calendar days. At its option, Mittal may elect to sell Dofasco to an alternative acquirer acceptable to the United States. In addition, Mittal agreed to use its best efforts to divest Dofasco as expeditiously as possible. The purpose of the Hold Separate Stipulation and Order was, among other things, to ensure that prior to such divestiture Dofasco would be operated as a competitively independent, economically viable, and ongoing business concern that would remain independent and uninfluenced by the consummation of Mittal s acquisition of Arcelor, and that competition would be maintained during the pendency of the ordered divestiture. Pursuant to the Final Judgment, if Mittal is unable to divest Dofasco within the aforementioned timeframe, then at the option of the United States, Mittal will be required to dispose of certain alternative assets. On November 13, 2006 Arcelor and Mittal announced that, despite requests made by both their Boards of Directors, they had been informed by the directors of the Stichting that they would not consent to the dissolution of the Stichting which would have permitted the sale of Dofasco. On or about November 28, 2006 the United States extended the time period in which Mittal was to dispose of Dofasco by 60 days, as permitted by the Final Judgment. On December 26, 2006 Mittal announced that, on December 22, 2006, ThyssenKrupp had initiated legal action against Mittal in the District Court in Rotterdam alleging that Mittal had breached its agreement with ThyssenKrupp dated January 26, 2006 with respect to the sale of Dofasco. Amongst other things, the suit sought a Court order directing MIttal to cause Arcelor to commence summary legal proceedings in the Dutch courts to force the Stichting to return the Dofasco shares to Arcelor. On January 23, 2007, the District Court of Rotterdam ruled against ThyssenKrupp. As of February 8, 2007 Mittal had not sold Dofasco to ThyssenKrupp nor had the United States made a determination of what alternative assets Mittal would be required to dispose of. In addition, the Hold Separate Stipulation and Order remains in effect. Agreement between Arcelor and Noble regarding Dofasco s investment in Powerlasers On October 27, 2006 Arcelor and Noble International Ltd. ( Noble ) announced that they had signed a binding letter of intent for the combination of Arcelor s laser-welded tailored blank business with Noble. The Form 8-K Report filed by Noble with the U.S. Securities and Exchange Commission on October 27, 4

8 MANAGEMENT S DISCUSSION AND ANALYSIS 2006 in connection with this proposed transaction indicated that Arcelor has agreed to cause Dofasco to sell its investments in Powerlasers Limited and Powerlasers Corporation ( Powerlasers ) to Noble in the circumstances described in the following extract taken from the Form 8-K Report: The Company has entered into a binding letter of intent with Arcelor S.A. (the LOI ) dated as of October 26, 2006, pursuant to which the Company would acquire all of the laser welded blanking properties and assets of Arcelor (all such assets, collectively, the TBA Assets ). The TBA assets to be acquired would not include the laser welded blank properties and assets of the Powerlasers business ( Powerlasers ) owned by Dofasco, Inc., of which Arcelor is a beneficiary. If, however, Arcelor is later permitted to sell Powerlasers, and subject to the Department of Justice Consent Decree, Powerlasers would be added as set forth in the LOI. Additionally, if, subject to the requirements, conditions and restrictions of the Department of Justice Consent Decree, Powerlasers may be sold to the Company, then Arcelor would cause Powerlasers to be sold to the Company within 6 months of the closing of the transaction and the Company would deliver to Arcelor a one-year, interest bearing promissory note in the aggregate principal amount of US $50 million (the Note ), subordinated in favor of the Company s senior credit facilities. The amount of the Note would be subject to downward adjustment based on the 2006 pro forma EBITDA of Powerlasers as described in the LOI. As a consequence of the Hold Separate Stipulation and Order the Corporation has been precluded, since August 1, 2006, from being a party to the negotiations between Arcelor and Noble regarding its investment in Powerlasers. Management Changes On July 21, 2006, Don Pether retired from the position of President and Chief Executive Officer, after 36 years with Dofasco. Upon his retirement, Mr. Pether became the non-executive Chair of Dofasco s Board of Directors, replacing Brian MacNeill, who resigned to help facilitate a seamless succession in the Corporation s leadership. Jacques Chabanier was appointed President and Chief Executive Officer on July 21 to succeed Don Pether. Mr. Chabanier is a 34-year veteran of the steel industry and held the position of Senior Executive Vice President at Arcelor prior to his appointment at Dofasco. On September 15, 2006 Norm Lockington announced his retirement and resigned from the position of Vice President Technology after 33 years with Dofasco. Dofasco s Board of Directors appointed Daniel Janczak as Dofasco's new Vice President Technology to succeed Mr. Lockington. Mr. Janczak held the position of Strategic Planning Downstream Technological Coordinator for Arcelor Flat Carbon Europe prior to his appointment at Dofasco. On December 18, 2006 Allen Root announced his retirement and resigned from the position of Executive Vice President and Chief Operating Officer after 33 years with Dofasco. On October 31, 2006 Guy Dufresne retired from the position of President and Chief Executive Officer of QCM. Mr. Dufresne was succeeded by Mr. Chabanier, who was appointed Chief Executive Officer of QCM effective October 31. Effective the same date, Francois Pelletier was appointed Chief Operating Officer of QCM. Mr. Pelletier joined QCM in 1976 and had been Vice President Operations Management since Changes to Dofasco Board of Directors On February 21, 2006, following the take-up of 88.38% of the Corporation s common shares by Arcelor S.A., Dofasco s Board of Directors accepted the resignations of William Coyne, William Etherington, Dezsö Horvath, Frank Logan, Thomas O'Neill, and Brian Robbins from the board. 5

9 MANAGEMENT S DISCUSSION AND ANALYSIS These board members were replaced by six new directors nominated by Arcelor: Michel Wurth, Paul Matthys, Jacques Chabanier, Christophe Cornier, Bruno Le Forestier and Gérard Dupouy. They joined the remaining members of the previous board: Sylvia Chrominska, Roger Doe, Peter Maurice, Donald Pether and Brian MacNeill. On July 21, 2006 Dofasco s Board of Directors accepted the resignation of Brian MacNeill. At that time Donald Pether was elected the non-executive Chair of the Board. On October 31 and December 31, 2006, respectively, the Board of Directors accepted the resignations of Paul Matthys and Gérard Dupouy. Following these resignations the Board of Directors consists of Donald Pether, the non-executive Chair of the Board, Jacques Chabanier, Sylvia Chrominska, Christophe Cornier, Roger Doe, Bruno Le Forestier, Peter Maurice and Michel Wurth. As a consequence of the Hold Separate Stipulation and Order, Messrs Wurth, Cornier, Le Forestier, as well as Dupouy and Matthys, have not participated in Dofasco Board and governance activities after August 1, SUMMARY OF QUARTERLY RESULTS The following table summarizes selected financial and non-financial information for the eight most recent quarters (unaudited; in millions of dollars except where noted) Quarters First Second Third Fourth Annual Steel shipments (000s net tons) 1,318 1,353 1,238 1,096 5,005 Raw steel production 1 (000s net tons) 1,365 1,482 1,432 1,039 5,318 Net sales 1, , , , ,663.6 Gross income Net income (86.6) Quarters First Second Third Fourth Annual Steel shipments (000s net tons) 1,166 1,204 1,219 1,222 4,811 Hot band production (000s net tons) 1,414 1,304 1,391 1,374 5,483 Net sales 1, , , , ,640.0 Gross income Net income Raw steel production includes processing of purchased semi-finished steel RESULTS OF OPERATIONS Consolidated financial results Dofasco posted consolidated net income of $216.6 million for the year ended December 31, 2006 compared to $145.6 million the prior year. The 2006 results reflect the significant contribution from the Corporation s Mining Operations and Tubular Products business segments, which reflect the acquisitions of QCM and the former Copperweld mechanical and automotive tubing assets completed in the third and fourth quarters of 2005, respectively, as well as improved results at Gallatin Steel. Partially offsetting these improvements was lower net income from the Corporation s Flat Rolled Operations business segment and the impact of the $215.0 million pre-tax break fee paid to ThyssenKrupp. 6

10 MANAGEMENT S DISCUSSION AND ANALYSIS Pro forma financial results Excluding the transaction costs resulting from the change of control discussed in the section Corporate developments, which included the $215.0 million break fee paid to ThyssenKrupp and the write-off of deferred financing costs, both incurred in the first quarter of 2006, pro forma consolidated net income in 2006 was $361.1million. Pro forma net income is presented to provide more useful and comparable information on the continuing operations of the Corporation. The following table reconciles pro forma net income to net income reported in accordance with Canadian generally accepted accounting principles ( GAAP ). Year ended December (in millions) Net income, as reported $ Add: Transaction costs, including break fee paid to ThyssenKrupp AG Write-off of deferred financing costs Less: Income tax effect (74.5) Pro forma net income $ Gross income by business segment 2006 vs Effective January 1, 2006, the Corporation s Tubular Products business segment was formed, consisting of the Dofasco Tubular Products group of companies, Dofasco de Mexico and the Hamilton Tubular Division. The change was made in order to provide more useful information about the Corporation s Tubular Products and Flat Rolled Operations business segments following Dofasco s acquisition of certain assets related to Copperweld Holding Company s mechanical tubing and automotive components businesses in the fourth quarter of The change was made on a prospective basis as it was not practical to reclassify the prior year s comparative amounts to conform to the current period s presentation. Note 19 to the consolidated financial statements provides additional information about the Corporation s four reporting segments including comparable information prepared on the basis of the prior year s segmentation format. Consolidated gross income in 2006 was $914.3 million, a 67% increase over the prior year. This increase can be primarily attributed to the favourable impact of the acquisitions of QCM and Copperweld Holding Company s mechanical and automotive tubing businesses in the third and fourth quarters of 2005 and improved results at Gallatin Steel. Partially offsetting these factors was the impact of lower gross income from the Corporation s Flat Rolled Operations business segment. For the years ended December Change % Change (in millions) Steel Operations $ n/a $ $ n/a nmf Flat Rolled Operations n/a n/a nmf Tubular Products 73.7 n/a n/a nmf Gallatin Steel % Mining Operations % Intersegment eliminations 9.7 (72.4) 82.1 (113%) Consolidated gross income $ $ $ % Gross income is used by management to analyze the margins of its reporting segments. Gross income is a financial measure that is not recognized by GAAP in Canada. This measure, presented in respect of Dofasco and its business segments, may not be comparable to similar measures presented by other companies. Dofasco s method for calculating gross income is consistent with prior years, except for the presentation of short-term interest and miscellaneous financial expenses which are now excluded from the calculation of gross income and presented as part of interest expense. Previously, these amounts were included in cost of sales. These changes were made to provide users with more relevant information regarding the Corporation s operating margins and financing activities. The prior year comparative 7

11 MANAGEMENT S DISCUSSION AND ANALYSIS amounts for cost of sales, gross income and interest expense have been reclassified to conform to the current period s presentation. Sales, cost of sales and gross income, excluding the results of the sale of by-products, are divided by tons shipped in the period to calculate the per ton metrics. Flat Rolled Operations gross income Dofasco s Flat Rolled Operations business segment contributed $219.9 million of gross income in 2006, a significant decline from $295.8 million posted by the Steel Operations business segment in The 2005 Steel Operations business segment includes the results of the operations now included in the Flat Rolled Operations business segment as well as the results of the Hamilton Tubular Division, Dofasco Marion and Dofasco de Mexico that have been included in the Tubular Products business segment in 2006, the sum of which is not significant. For the years ended December * Change % Change (in millions) Net sales $ 3,519.2 $ 3,771.7 $ (252.5) (7%) Cost of sales 3, ,475.9 (176.6) (5%) Gross income $ $ $ (75.9) (26%) * Reflects the results of the Steel Operations business segment As in previous years, the results of the Flat Rolled Operations business segment are largely driven by the Corporation s Hamilton operations. Hamilton operations gross income Hamilton s results for the year reflect the continued volatility experienced in the North American pricing environment. In 2004, robust global flat rolled steel demand led to a rapid escalation of U.S. hot rolled spot market selling prices over the first three quarters of the year, reaching a record level of US $740 per ton as published by CRU International Inc. in September Increased levels of imports into North America in the second half of 2004 resulted in higher inventories throughout the supply chain which led to a decline in industry-reported prices of approximately US $100 per ton during the fourth quarter. In 2005, the high inventory levels, combined with softening end-user demand, resulted in a further decline in published hot rolled spot prices of more than US $200, reaching a low of US $425 per ton in August before recovering to US $550 per ton for the fourth quarter, as reported by CRU. Following two consecutive quarters in which pricing averaged US $550 per ton, strong demand coupled with declining supply chain inventories led to a significant increase in spot market pricing through the second and third quarters of Beginning in the third quarter of 2006 spot market pricing, as reported by CRU, began to decline as a result of announced automotive production cutbacks and a substantial increase in the level of imports into the North American market U.S. Midwest hot rolled spot price Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 US$ per net ton, quarterly average For the years ended December * Change % Change Steel shipments (000s net tons) 4,232 4, % Raw steel production 1 (000s net tons) 4,540 4,708 (168) (4%) Revenue per ton $ 782 $ 826 $ (44) (5%) Cost per ton $ 738 $ 760 $ (22) (3%) Gross income per ton $ 44 $ 66 $ (22) (33%) 1 Raw steel production includes purchased semi-finished steel * 2005 amounts include the results of the Hamilton Tubular Division Steel shipments from Hamilton operations increased by 5% over 2005 levels. Shipments in 2006 were strong into the third quarter but declined over the balance of the year due to automotive production 8

12 MANAGEMENT S DISCUSSION AND ANALYSIS cutbacks and a substantial increase in service centre inventory levels driven in large part by very high import levels. By comparison, shipments through the first half of 2005 were negatively impacted by very high inventory levels through the supply chain at the beginning of the year. Hamilton operations average revenue per ton shipped in 2006 was $782, a decrease of $44 per ton from the prior year. This decline reflects lower market prices in the fourth quarter of 2005 when most 2006 contract pricing was established. Average hot band spot pricing in the fourth quarter of 2005, as published by CRU, was US $550 per ton compared to U.S. $658 per ton in the fourth quarter of In addition, the stronger Canadian dollar, averaging U.S. $0.88 in 2006 compared to US $0.83 in 2005, had an unfavourable impact on sales denominated in U.S. dollars as well as on Canadian dollar denominated contracts which reflect U.S. dollar pricing. Average revenue per ton was also negatively impacted by a lower value product mix due to the commissioning and ramp up of the #2 Coupled Pickle Line Cold Mill ( #2 CPCM ) throughout the year and lower shipments of higher value add product, primarily galvanized steels, to the automotive market in the later part of the year. Hamilton operations average cost per ton shipped decreased by $22 over the levels experienced in The lower cost per ton can be primarily attributed to significantly lower prices for purchased slabs and a lower value product mix. The impact of these factors was partially offset by significantly higher costs for zinc, iron ore and other raw materials and higher cost opening inventories resulting from production interruptions at steelmaking operations in the fourth quarter of Tubular Products gross income The Tubular Products business segment contributed $73.7 million to Dofasco s consolidated results in 2006 of which $58.3 million was attributable to the former Copperweld operations. Gross income per ton for the segment in 2006 was $100. For the years ended December Change (in millions) Sales $ $ n/a $ n/a Cost of sales n/a n/a Gross income $ 73.7 $ n/a $ n/a Shipments (000s net tons) Revenue per ton $ 1,349 $ n/a $ n/a Cost per ton 1,249 n/a n/a Gross income per ton $ 100 $ n/a $ n/a Total shipments in 2006 were 733,000 tons, 310,000 tons higher than in This significant increase is primarily due to the acquisition of the Copperweld assets in October In 2006, sales by the Tubular Products business segment were $989.0 million, of which $662.8 million was attributable to the former Copperweld operations. Average revenue and cost per ton for the segment in 2006 was $1,349 and $1,249 respectively. Gallatin Steel gross income Gallatin Steel contributed $138.6 million to Dofasco s consolidated results in 2006 compared to $123.7 million in

13 MANAGEMENT S DISCUSSION AND ANALYSIS For the years ended December Change % Change (50%, Cdn $ millions) Net sales $ $ $ 3.4 1% Cost of sales (11.5) (3%) Gross Income $ $ $ % (000s net tons at 100%) Steel shipments (000s net tons) 1,546 1, % Raw steel production (000s net tons) 1,556 1, % (US $) Revenue per ton $ 591 $ 555 $ 36 6% Cost per ton % Gross income per ton $ 159 $ 133 $ 26 20% Shipments in 2006 were a record 1,546,000 tons an increase of 17,000 tons over levels achieved in Average revenue per ton in 2006 was US $591, an increase of US $36 over 2005 reflecting higher average spot market pricing in Average cost per ton shipped in 2006 increased by US $10 compared to the prior year primarily due to higher scrap and maintenance costs. These factors were partially offset by the impact of lower alloy and electricity costs. Mining Operations gross income The Corporation s Mining Operations business segment, consisting of QCM and Wabush Resources, contributed $472.4 million of gross income in 2006, compared to the $199.1 million posted in The 2005 results included only Wabush Resources until the acquisition of QCM on July 22, For the years ended December Change % Change (in millions) Net sales $ 1,172.4 $ $ % Cost of sales % Gross Income $ $ $ % (000s tonnes) Pellet shipments 10,451 5,302 5,149 97% Concentrate shipments 4,713 1,839 2, % Total iron ore shipments 15,164 7,141 8, % Concentrate production 15,309 7,330 7, % Revenue per tonne $ 77 $ 80 $ (3) (4%) Cost per tonne (6) (12%) Gross income per tonne $ 31 $ 28 $ 3 11% Total iron ore shipments in 2006 were 15,164,000 tonnes compared to 7,141,000 tonnes in The increase in shipments can be primarily attributed to the acquisition of QCM in July 2005 and the fact 2005 shipments at QCM were impacted by an eight-week labour disruption. Mining Operations average revenue per tonne in 2006 decreased by $3 over the prior year reflecting a lower value product mix attributable to the impact of QCM concentrate shipments, lower market prices for pellets and the unfavourable impact of the stronger Canadian dollar on US dollar denominated sales. These factors were partially offset by higher market prices for concentrate. The average cost per tonne of iron ore shipped in 2006 was $46, down from $52 in Cost per tonne in 2005 was impacted by non-cash purchase price allocation adjustments of approximately $46.5 million 10

14 MANAGEMENT S DISCUSSION AND ANALYSIS or $7 per tonne related to the fair value of QCM s finished goods and work in process inventories on hand at the acquisition date. These inventories, which are sold under long-term take-or-pay contracts, were revalued at market value less costs to sell and a reasonable profit margin for the future selling effort. The fair value increment is recognized in cost of sales in the third quarter of 2005 as this inventory was shipped to customers subsequent to the acquisition date. Additional information regarding the purchase price allocation is provided in note 3(a) to the consolidated financial statements. Gross income by business segment Fourth Quarter 2006 vs Consolidated gross income for the fourth quarter of 2006 was $220.3 million, a 67% increase over gross income of $131.6 million for the same quarter of This increase reflects improved results at the Corporation s Flat Rolled Operations business segment which were partially offset by lower results at Gallatin Steel. For the three months ended December Change % Change (in millions) Steel Operations $ n/a $ 12.8 $ n/a nmf Flat Rolled Operations 57.6 n/a n/a nmf Tubular Products 11.9 n/a n/a nmf Gallatin Steel (16.2) (50%) Mining Operations (2.7) (2%) Intersegment eliminations 8.6 (42.3) 50.9 (120%) Consolidated gross income $ $ $ % Flat Rolled Operations gross income For the quarter ended December 31, 2006, Flat Rolled Operations gross income was $57.6 million, a significant improvement over the $12.8 million generated in the fourth quarter of 2005 by the Steel Operations business segment. The 2005 Steel Operations business segment includes the results of the operations now included in the Flat Rolled Operations business segment as well as the results of the Hamilton Tubular Division, Dofasco Marion and Dofasco de Mexico that have been included in the Tubular Products business segment beginning in 2006, the sum of which is not significant. For the three months ended December * Change % Change (in millions) Net sales $ $ 1,030.8 $ (239.8) (23%) Cost of sales ,018.0 (284.6) (28%) Gross income $ 57.6 $ 12.8 $ % *Reflects the results of the Steel Operations business segment As in previous quarters, the results of the Flat Rolled Operations business segment are largely driven by the Corporation s Hamilton operations. Hamilton operations gross income At the Corporation s Hamilton operations, shipments were 938,000 tons in the fourth quarter, a decrease of 82,000 tons from shipments in the fourth quarter of The decrease can be attributed to lower overall market demand in the automotive market and the impact of high service centre inventories primarily resulting from a substantial increase in the level of imports into the North American market. In response to the lower overall market demand experienced in the quarter, production levels at Hamilton operations hot strip mill and finishing facilities were reduced, consistent with a reduction in overall capacity utilization within the North American steel industry. 11

15 MANAGEMENT S DISCUSSION AND ANALYSIS For the three months ended December Change % Change Steel shipments (000s net tons) 938 1,020 (82) (8%) Raw steel production 1 (000s net tons) 892 1,169 (277) (24%) Revenue per ton $ 770 $ 785 $ (15) (2%) Cost per ton $ 722 $ 778 $ (56) (7%) Gross income per ton $ 48 $ 7 $ % 1 Raw steel production includes purchased semi-finished steel Average revenue per ton of steel shipped from Hamilton in the fourth quarter of 2006 was $770 per ton, $15 per ton lower than in fourth quarter of The decrease can be attributed to a lower value product mix, reflecting a decrease in the shipments of higher value add product to the automotive market, and the impact of a stronger Canadian dollar, averaging $0.88 in the fourth quarter of 2006 versus $0.85 in the fourth quarter of These factors were partially offset by higher average selling prices for galvanize and hot rolled products. Average cost per ton for the fourth quarter was $722 per ton, a decrease of $56 per ton from the level experienced in the same period in This decrease was mainly due to the impact of the lower cost of purchased slabs and the elimination of dumping duties applicable to certain shipments of galvanize products into the United States (see Steel Trade). In addition, cost per ton in the fourth quarter of 2005 was negatively impacted as a result of production interruptions at steelmaking operations and additional outside processing and other costs incurred in preparation for the production shutdown associated with the #2 CPCM project that commenced in January Partially offsetting these factors was higher variable compensation expense and higher costs for zinc, natural gas and electricity in As a result of these factors, gross income from Hamilton operations increased to $45.7 million in the fourth quarter compared to $6.7 million in the fourth quarter of Tubular Products gross income During the fourth quarter of 2006 the Tubular Products business segment contributed $11.9 million of gross income of which $9.6 million was attributable to the former Copperweld operations. Gross income per ton for the segment in the fourth quarter of 2006 was $73. For the three months ended December Change (in millions) Sales $ n/a n/a Cost of sales n/a n/a Gross income $ 11.9 n/a n/a Shipments (000s net tons) (9) Revenue per ton $ 1,401 n/a n/a Cost per ton 1,328 n/a n/a Gross income per ton $ 73 n/a n/a Total shipments in the fourth quarter of 2006 were 164,000 tons, down slightly from 173,000 ton shipped in the same period in The decrease can be attributed primarily to a reduction in shipments to certain automotive customers. In fourth quarter of 2006, sales by the Tubular Products business segment were $229.8 million. Average revenue and cost per ton in the fourth quarter were $1,401 and $1,328 respectively. Gallatin Steel gross income Gallatin Steel contributed $16.0 million of gross income in the fourth quarter of 2006, lower than the $32.2 million of gross income reported in same period of the prior year. The decline in gross income was mainly a result of significantly lower production and sales volumes and the impact of a weaker U.S. dollar on the translation of Gallatin s results. These factors were partially offset by higher average selling prices. 12

16 MANAGEMENT S DISCUSSION AND ANALYSIS For the three months ended December Change % Change (50%, Cdn $ millions) Net sales $ $ $ (29.5) (23%) Cost of sales (13.3) (14%) Gross Income $ 16.0 $ 32.2 $ (16.2) (50%) (000s net tons at 100%) Steel shipments (000s net tons) (88) (22%) Raw steel production (000s net tons) (116) (28%) (US $) Revenue per ton $ 559 $ 546 $ 13 2% Cost per ton % Gross income per ton $ 89 $ 135 $ (46) (34%) Shipments in the fourth quarter were 316,000 tons, 88,000 tons lower than the fourth quarter of Market demand for Gallatin s products was significantly lower in the fourth quarter of 2006 than in the same period in In response to lower market demand, Gallatin made appropriate adjustments to its production levels and during this period successfully completed a 10 day planned outage to complete several capital and maintenance projects. As a result, raw steel production in the fourth quarter of 2006 was 116,000 tons lower than in the fourth quarter of Gallatin s average revenue per ton in the fourth quarter of 2006 was US $559 per ton compared to US $546 per ton in the fourth quarter of 2005, an increase of US $13 per ton reflecting higher spot market pricing. The average cost per ton shipped in the fourth quarter increased by US $59 over the same period in 2005, primarily driven by the impact of significantly lower production volumes, higher maintenance costs and higher scrap costs. Mining Operations gross income Gross income for the Corporation s Mining Operations business segment, consisting of QCM and Wabush Resources, was $126.2 million for the quarter ended December 31, 2006 compared to $128.9 million in the fourth quarter of For the three months ended December Change % Change (in millions) Net sales $ $ $ 3.3 1% Cost of sales % Gross Income $ $ $ (2.7) (2%) (000s tonnes) Pellet shipments 2,705 2, % Concentrate shipments 1,035 1,097 (62) (6%) Total iron ore shipments 3,740 3, % Concentrate production 4,055 3, % Revenue per tonne $ 80 $ 80 $ - 0% Cost per tonne % Gross income per tonne $ 34 $ 35 $ (1) (3%) Mining Operations average revenue per tonne in the fourth quarter of 2006 was $80, unchanged over the previous year as higher market pricing for concentrate in 2006 and an increased proportion of pellets sold were offset by the unfavourable impact of the stronger Canadian dollar on sales which are denominated in U.S. dollars and lower market prices for pellets. Average cost per tonne shipped in the fourth quarter of 2006 was $46, essentially unchanged from the same period in the prior year. 13

17 MANAGEMENT S DISCUSSION AND ANALYSIS Other income statement items The following table outlines the changes in the consolidated income statement line items below gross income compared to the prior year. For the years ended December Change % Change (in millions) Gross income $ $ $ % Depreciation and amortization % Operating income % Transaction costs % Interest expense % Investment and other income (13.8) (7.8) (6.0) 77% Foreign exchange loss (4.0) (39%) Income before income taxes % Income tax expense % % Minority interest % Net income $ $ $ % Depreciation and amortization Consolidated depreciation and amortization increased by $31.4 million compared to The higher depreciation and amortization in 2006 reflects the impact of the acquisitions of QCM and the Copperweld assets in 2005 which was partially offset by the impact of certain facilities in Hamilton becoming fully depreciated in 2005 and Transaction costs Transaction costs of $215.8 million incurred in 2006 include payment of the $215.0 million break fee to ThyssenKrupp AG on January 27, 2006 following termination by Dofasco of the support agreement between Dofasco and ThyssenKrupp AG, as well as other costs ancillary to the acquisition of Dofasco by Arcelor. Transaction costs of $38.5 million expensed in 2005 included advisory fees related to fairness opinions provided with respect to the offers received during the acquisition process described in the section Corporate developments. Interest expense Interest expense in 2006 increased by $19.4 million compared to 2005 reflecting higher short term borrowings and higher average long term borrowings under the $150.0 million, three year revolving term facility at Hamilton operations. In addition, interest expense increased as a result of the acquisition of QCM in the third quarter of 2005 and an increase in the principal amount of capital leases at QCM during Investment and other income Interest and other income in 2006 was $13.8 million, $6.0 million higher than in the prior year. The increase is attributable to a gain on the sale of land at Hamilton operations and higher investment income at QCM. Foreign exchange loss The consolidated foreign exchange loss in 2006 was $ 6.2 million, comparable to the $10.2 million loss in The decrease in the amount of the foreign exchange loss can be primarily attributed to a reduction in the foreign exchange loss at QCM. The foreign exchange loss at QCM in 2005 was higher than in 2006 mainly due to a more significant weakening of the US dollar from the date of acquisition until the end of the 2005 compared to the nominal weakening of the US dollar which occurred during

18 MANAGEMENT S DISCUSSION AND ANALYSIS Income taxes The consolidated effective tax rate of 41% for the year ended December 31, 2006 was higher than the Corporation s Canadian manufacturing and processing effective statutory rate of 34% primarily due to the higher proportion of consolidated net income before income taxes contributed by QCM and certain foreign subsidiaries which have higher effective income tax rates. The effective tax rate of 35.1% for the year ended December 31, 2005 was comparable to the Corporation s Canadian manufacturing and processing effective statutory rate of 34%. LIQUIDITY AND CAPITAL RESOURCES Statement of cash flows For the years ended December Change % Change (in millions) Net income $ $ $ % Cash provided from operations before changes in working capital $ $ $ % Cash provided from operating activities $ $ $ % Cash used for investment activities $ $ $ (432.0) (64%) Cash used for (provided from) financing activities $ $ (287.4) $ (178%) Cash provided from operating activities In 2006, consolidated cash provided from operations before changes in non-cash working capital was $522.5 million, a 39% increase over 2005, reflecting higher net income in The $58.4 million increase in non-cash working capital in the year was primarily due to a $86.1 million decrease in accounts payable and accrued liabilities resulting from the payment of obligations at December 31, 2005 in respect of advisory fees associated with the change of control of the Corporation (see Corporate developments) and the Corporation s stock based compensation plans and the impact of lower purchases in the later part of 2006 compared to In 2005, non-cash working capital increased by $125.7 million, primarily due to a significant increase in inventories and a decrease in income and other taxes payable. The increase in inventories of $84.8 million was the result of higher cost and quantities of raw materials, work in process and finished goods partially offset by a decrease in purchased slabs. The $56.1 million decrease in income and other taxes payable reflects the payment of the final 2004 income tax installments in the first quarter of Cash used for investment activities Consolidated capital expenditures in 2006 were $248.4 million compared to $382.2 million of capital expenditures in The reduction in capital expenditures of $133.8 million was primarily due to lower spending in respect of the #2 CPCM project, which was completed in the first quarter of 2006, and the completion of the #2 Blast Furnace rebuild project in These reductions were partially offset by higher capital expenditures at QCM which were primarily in respect of mining and processing equipment upgrades. In 2005 cash used for investing activities included $399.4 million to fund strategic acquisitions. Of this amount, $227.9 million was related to the acquisition of QCM on July 22, 2005, consisting of the $307.4 million cash purchase price less $79.5 million of QCM cash acquired. In addition, $171.5 million was used to finance the Copperweld asset purchase completed on October 3, Additional details regarding Dofasco s business acquisitions in 2005 are provided in note 3 to the consolidated financial statements. Cash used for financing activities Short-term borrowings decreased by $79.0 million in During the first quarter of the year the Corporation borrowed $347.3 million by utilizing available credit facilities to fund the payment of the $215.0 million break fee to ThyssenKrupp, the continued investment in capital projects and general 15

19 MANAGEMENT S DISCUSSION AND ANALYSIS working capital requirements. Subsequent to the first quarter, the Corporation made repayments of its short-term borrowings aggregating $426.3 million. In 2005, Dofasco issued $250.0 million of 4.961% Series A senior unsecured, non-redeemable notes under its $300.0 million Medium Term Note program pursuant to a Short Form Shelf Prospectus dated November 24, In addition, $137.0 million was drawn on the $150.0 million three-year revolving term facility and has been included in long-term debt. On any of its anniversaries, Dofasco may request that the three-year term facility be extended for an additional year. Scheduled repayments of long-term debt were $51.1 million in In addition, the Corporation made repayments aggregating $60.5 million on the $150.0 million revolving term facility. In 2005, scheduled long-term debt repayments totaled $226.8 million including a $175.0 million repayment of the 7.5%, 5- year Medium Term Notes that matured on June 1, Cash proceeds of $14.2 million were received in 2005 relating to the exercise of 476,700 common share stock options. Dofasco paid $25.5 million in dividends in 2006 compared to $101.9 million in Cash requirements The following table summarizes contractual obligations and other cash payments required over the next five years and in total. For the years ended December Thereafter Total (in millions) Long-term debt $ 43.2 $ $ 76.6 $ 0.1 $ 0.1 $ $ Capital lease obligations Operating leases Long-term purchase contracts ,251.6 Total cash requirements $ $ $ $ $ $ $ 1,927.6 Dofasco s scheduled payments under long-term debt agreements summarized above include $125.0 million of 7.55% medium-term notes maturing in 2008 and $76.5 million on the three-year revolving term facility maturing in Long-term purchase contracts include contracts for fixed or minimum quantities of raw materials such as iron ore, coal and scrap, as well as natural gas, electricity and other utilities. The cost to complete capital projects authorized as at December 31, 2006 was $183.4 million, the majority of which will be incurred in Capital resources Dofasco s capital resources at December 31, 2006 included cash and cash equivalents amounting to $118.9 million, compared to $122.4 million including short-term investments at the end of This cash position, together with ongoing strong cash flow from operations and available credit facilities, is expected to enable the Corporation to satisfy the anticipated cash requirements described above. At December 31, 2006, the Corporation had additional remaining availability totaling $639.2 million as well as an additional $123.2 million available to its joint ventures and subsidiaries under existing credit facilities. Dofasco s ratio of debt to debt plus equity was 22.2% at December 31, 2006, down from 27.8% at the end of Dominion Bond Rating Service ( DBRS ) maintained its rating on Dofasco at A (low) and Under Review with Negative Implications when it issued its report on June 26, 2006 following Arcelor s announcement that its Board of Directors had unanimously recommended the proposed merger between Arcelor and Mittal. DBRS has not made any changes to the rating since that time. On February 26, 2006 Standard & Poor s ( S&P ) lowered its rating on Dofasco to BBB from A- after it was announced that Arcelor had acquired control of the Corporation s shares. On July 26, 2006 S&P affirmed its "BBB" rating on Dofasco with a stable outlook following the announcement by Mittal Steel that approximately 92% of 16