DOFASCO INC. ANNUAL REPORT 2005

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1 ANNUAL REPORT 2005

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3 TABLE OF CONTENTS 2 OVERVIEW OF THE BUSINESS Corporate overview Strategy Core businesses Corporate developments 4 SUMMARY OF QUARTERLY RESULTS 5 RESULTS OF OPERATIONS Consolidated financial results Gross income by business segment 2005 vs Gross income by business segment Fourth Quarter 2005 vs Other income statement items 12 LIQUIDITY AND CAPITAL RESOURCES Statement of cash flows Cash requirements Guarantees and other commitments Capital resources Contingent gain Financial instruments Off-balance sheet arrangements 15 CRITICAL ACCOUNTING ESTIMATES Employee future benefits Useful lives of fixed assets Asset retirement obligations 17 DISCLOSURE CONTROLS AND PROCEDURES 17 SELECTED ANNUAL FINANCIAL INFORMATION 18 AUDITORS REPORT 19 MANAGEMENT S RESPONSIBILITY FOR FINANCIAL REPORTING 20 CONSOLIDATED FINANCIAL STATEMENTS 23 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 March 20, 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 one of North America's most progressive and consistently profitable steelmakers, and a market leader in an industry that continues to be a cornerstone of the Canadian manufacturing economy. As Canada s largest manufacturer of flat rolled steels, the Corporation s products include hot rolled, cold rolled, galvanized and tinplate as well as tubular products, laser-welded blanks and Zyplex, a proprietary laminate. Dofasco supplies these products to the automotive, construction, packaging, manufacturing, pipe and tube and steel distribution markets. Dofasco also has iron ore mining interests, to ensure the supply of one of the critical raw materials to its advanced steelmaking process. Dofasco completed the acquisition of Quebec Cartier Mining Company (QCM) on July 22, 2005, and now holds a 98.7% interest in the company. Together with Dofasco s 28.6% ownership position in Wabush Mines, Dofasco maintains a significant market position in the Canadian iron ore industry. In addition, on October 3, 2005, Dofasco completed the acquisition of certain assets related to Copperweld Holding Company s mechanical tubing and automotive components businesses. These assets are used in the manufacture of specialized tubular steel products suitable for niche mechanical and automotive market applications. Integration of the acquired Copperweld businesses with Dofasco s existing tubular steel business is expected to accelerate Dofasco s growth to become a North American leader in the supply of specialty tube products for both mechanical and automotive customers. 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 intimacy, 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. The strategy continues to differentiate Dofasco from its competitors, giving it a competitive advantage in the markets it serves. 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 key operating segments, described below, are Steel Operations, Gallatin Steel and Mining Operations: Steel Operations Dofasco s Steel Operations segment includes the Corporation s core Hamilton facilities as well as certain subsidiary and joint venture operations primarily engaged in the production and sale of flat rolled steel and tubular 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 2

6 MANAGEMENT S DISCUSSION AND ANALYSIS 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, Canada's only electrolytic tinning lines and two tube mills. Subsidiaries Dofasco s Tubular Products division manufactures specialized tubular steel products for customers in the automotive and machinery manufacturing industries across North America, with operating facilities in Ontario, Ohio, Kentucky and Monterrey, Mexico. Another wholly-owned subsidiary, Powerlasers, 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 (at DoSol Galva) and JFE (at DJ Galvanizing), to manufacture high valueadded galvanized steel for North American automotive customers. Other joint ventures are Baycoat (steel coil coating) and Sorevco (hot dip galvanizing). Gallatin Steel Dofasco owns 50% of Gallatin Steel, a low-cost minimill in Kentucky which 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 mid-west 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. Mining Operations Dofasco s Mining Operations segment includes Quebec Cartier Mining Company, 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 segment also includes Dofasco s subsidiary, Wabush Resources Inc., which holds Dofasco s 28.6% interest in the Wabush Mines joint venture. Wabush Mines, 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 Shareholder Protection Rights Plan On January 6, 2006 Dofasco's Board of Directors approved deferring the separation of the Rights under the terms of the Shareholder Protection Rights Plan in respect of the Arcelor Offer for Dofasco's common shares announced on December 23, On February 20, 2006, the Board of Directors passed a resolution rendering the Shareholder Protection Rights Plan inoperative against the Arcelor Offer and any subsequent acquisition transaction flowing from that offer. Arcelor acquisition of Dofasco common shares On January 24, 2006, Dofasco Inc. and Arcelor S.A. announced that they had reached an agreement for Arcelor to make a revised all-cash offer for $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 had resolved to unanimously recommend to Dofasco shareholders that they accept the offer. This announcement followed a news release issued by ThyssenKrupp AG on January 23, 2006 announcing its decision to waive its right to match the $71.00 per share offer made by Arcelor on January 3

7 MANAGEMENT S DISCUSSION AND ANALYSIS 16, 2006, and the announcement on January 23, 2006 by Dofasco that it had terminated the support agreement between Dofasco and ThyssenKrupp. On February 20, 2006, Arcelor took up 88.38% of Dofasco s common shares that were deposited to the offer and extended the expiry time of the offer to March 7, 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. Arcelor indicated that it intends, as soon as permitted, to acquire 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. Upon acquiring a sufficient number of Dofasco common shares, Arcelor intends to de-list the Corporation s shares from the Toronto Stock Exchange. 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 E. Coyne, William A. Etherington, Dezsö J. Horvath, Frank H. Logan, Thomas C. O'Neill, and Brian A. Robbins from the board. These board members have been replaced by six new directors nominated by Arcelor: Michel Wurth, Paul Matthys, Jacques Chabanier, Christophe Cornier, Bruno LeForestier and Gérard Dupouy. They join the remaining members of the previous board: Sylvia D. Chrominska, Roger G. Doe, Brian F. MacNeill, Peter C. Maurice, and Donald A. Pether. Mr. MacNeill continues as the Chair of the Board. Status of QCM In accordance with the Support Agreement between Arcelor S.A. and Dofasco Inc. dated January 23, 2006, the Corporation has agreed not to proceed with the sale of any of its subsidiaries. As a result, the initial public offering of QCM Income Fund securities contemplated in the amended and restated preliminary prospectus dated November 16, 2005 has not been completed and the prospectus became stale-dated on March 17, 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 per share amounts and where noted) Quarters First Second Third Fourth Annual Steel shipments (000s net tons) 1,166 1,204 1,219 1,222 4,811 Raw steel production 1 (000s net tons) 1,414 1,304 1,391 1,374 5,483 Net sales 1, , , , ,562.9 Gross income Net income Earnings per common share: Basic Diluted Quarters First Second Third Fourth Annual Steel shipments (000s net tons) 1,317 1,284 1,194 1,207 5,002 Raw steel production 1 (000s net tons) 1,390 1,409 1,413 1,288 5,500 Net sales , , , ,224.9 Gross income Net income Earnings per common share: Basic Diluted Raw steel production includes processing of semi-finished steel purchased 4

8 MANAGEMENT S DISCUSSION AND ANALYSIS RESULTS OF OPERATIONS Consolidated financial results Dofasco posted consolidated net income of $145.6 million or $1.88 per share for the year ended December 31, 2005, a significant decline from the previous year s record earnings. The 2005 results were adversely impacted by continued high input costs, weaker demand in the first half of the year, declining spot market pricing and the stronger Canadian dollar. Partially offsetting these factors in 2005 were the significant contribution from QCM since the date of acquisition and improved results at Wabush Resources. For the year ended December 31, 2004, excellent operating performance, a record high pricing environment and robust North American flat rolled steel demand resulted in consolidated net income of $376.9 million or $4.92 per share. These results reflect the recent 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 $550 per ton for the fourth quarter, as reported by CRU U.S. Midwest hot rolled spot price Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 US$ per net ton, quarterly average Gross income by business segment 2005 vs Effective July 1, 2005, Dofasco s subsidiary, Wabush Resources Inc., which holds Dofasco s 28.6% interest in the Wabush Mines joint venture, was reclassified from Steel Operations and is now aggregated with QCM in the Mining Operations business segment. The change was made in order to provide financial statement users with more useful information about the Corporation s steel and mining businesses. The prior year comparative amounts have been reclassified to conform to the current period s presentation. Consolidated gross income in 2005 was $536.2 million, a 36% decrease from the record gross income of $836.2 million reported in This decrease was driven by significantly lower results at both the Corporation s Steel Operations and Gallatin Steel segments, partially offset by the impact of improved results from the Mining Operations segment. For the years ended December Change % Change (in millions) Steel Operations $ $ $ (362.8) (55%) Gallatin Steel (68.3) (36%) Mining Operations (9.6) nmf Intersegment eliminations (72.4) (0.2) (72.2) nmf Consolidated gross income $ $ $ (300.0) (36%) Additional information about the Corporation s three reporting segments is provided in note 20 to the consolidated financial statements. 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 generally accepted accounting principles (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. 5

9 MANAGEMENT S DISCUSSION AND ANALYSIS Steel Operations gross income Dofasco s Steel Operations segment contributed $291.3 million of gross income in 2005, a significant decline from the excellent results posted in For the years ended December Change % Change (in millions) Net sales $ 3,699.1 $ 3,645.9 $ % Cost of sales 3, , % Gross income $ $ $ (362.8) (55%) As in previous years, the results of the Steel Operations segment are largely driven by the Corporation s Hamilton operations. Hamilton operations gross income Steel shipments from Hamilton operations declined by 5% from the record 2004 levels, reflecting lower flat rolled steel demand, particularly in the construction and distribution markets as well as a decline in delivery performance attributable to operational problems affecting steelmaking and finishing production. Hamilton s record shipments in 2004 were driven by robust market demand and were enabled by record production levels. Hamilton operations average revenue per ton shipped in 2005 was $808, a slight increase from $803 per ton in the prior year. Average revenue per ton declined steadily quarter over quarter in 2005 from $864 in the first quarter to $758 in the fourth quarter. The impact of contract price increases and strong spot market selling prices in the first half of 2005 was mostly offset by the impact of the continued strengthening of the Canadian dollar on sales denominated in U.S. dollars as well as on Canadian dollardenominated contracts that reflect U.S. dollar pricing. For the years ended December Change % Change Steel shipments (000s net tons) 4,047 4,244 (197) (5%) Raw steel production 1 (000s net tons) 4,708 4,729 (21) 0% Revenue per ton $ 808 $ 803 $ 5 1% Cost per ton $ 743 $ 661 $ 82 12% Gross income per ton $ 65 $ 142 $ (77) (54%) 1 Raw steel production includes purchased semi-finished steel Hamilton operations average cost per ton shipped increased by $82 over the levels experienced in The higher cost per ton was driven by the significantly higher cost for purchased slabs, iron ore, coal, energy and other raw materials as well as the impact of significantly lower production levels. The impact of these factors was partially offset by a significant decrease in scrap prices from the unprecedented levels in 2004 and by the impact of the strengthening of the Canadian dollar on the raw materials purchased in U.S. dollars. In 2004, the high average cost per ton was driven primarily by record high scrap prices and increased cost of other raw materials, partially offset by the strengthening of the Canadian dollar and higher production levels. 6

10 MANAGEMENT S DISCUSSION AND ANALYSIS Gallatin Steel gross income Gallatin Steel contributed $123.6 million to Dofasco s consolidated results in 2005, down 36% from the record annual gross income contributed in This decline was driven by a decline in the average selling price to scrap price spread, from US $360 per ton in 2004 to US $320 per ton in 2005, as well as the impact of the strengthening Canadian dollar compared to 2004 on the translation of Gallatin s results. For the years ended December Change % Change (50%, Cdn $ millions) Net sales $ $ $ (63.0) (11%) Cost of sales % Gross Income $ $ $ (68.3) (36%) (000s net tons at 100%) Steel shipments 1,529 1, % Raw steel production 1,549 1, % (US $) Revenue per ton $ 555 $ 587 $ (32) (5%) Cost per ton % Gross income per ton $ 133 $ 195 $ (62) (32%) Shipments in 2005 were a record 1,529,000 tons, surpassing the previous high set in Average revenue per ton declined by 5% from the prior year levels due to lower average U.S. spot market selling prices during the year. Average cost per ton shipped in 2005 increased by 8% compared to the prior year, led by continued high costs for scrap, alloys and energy and the impact of higher value opening inventory in These factors were partially offset by the impact of higher production and shipments in Mining Operations gross income The Corporation s Mining Operations segment, consisting of QCM and Wabush Resources, contributed $193.7 million of gross income in 2005, compared to the $9.6 million loss posted in The 2005 results reflect both Wabush Resources and QCM s results net of consolidation adjustments for the period following the acquisition date. The 2004 results reflect only Wabush Resources, which reported a loss at the gross income level, reflecting lower production and shipments at the mine as unionized employees were on strike from July 5 to October 10, Of the Mining Operations gross income reported in 2005, $71.6 million has been eliminated on consolidation, reflecting the change in unrealized intercompany profit remaining in Dofasco s pellet and steel inventories during the year. For the years ended December Change % Change (in millions) Net sales $ $ 55.2 $ % Cost of sales % Gross Income $ $ (9.6) $ nmf (000s tonnes) Pellet shipments 5,302 1,067 4, % Concentrate shipments 1,839-1,839 nmf Total iron ore shipments 7,141 1,067 6, % Concentrate production 7,330 1,066 6, % Revenue per tonne $ 79 $ 52 $ 27 52% Cost per tonne (10) (16%) Gross income per tonne $ 27 $ (10) $ 37 nmf 7

11 MANAGEMENT S DISCUSSION AND ANALYSIS Total iron ore shipments in 2005 were 7,141,000 tonnes, including 5,808,000 tonnes from QCM since the July 22, 2005 date of acquisition. The QCM shipments were below the 2004 pace on a pro-rated basis due to the low inventory levels in July 2005 following the settlement of a labour disruption in the second quarter. On June 3, 2005, QCM and its unionized employees reached a new six-year collective bargaining agreement, ending an eight-week strike during which production was interrupted and all available inventories were shipped to meet customer requirements. Wabush Resources shipped 1,333,000 tonnes of iron ore pellets in 2005, compared to 1,067,000 tonnes during 2004, which was impacted by a fourteen-week strike. Mining Operations average revenue per tonne in 2005 increased by $27 or 52%, over the prior year period primarily due to the significant increase in iron ore market prices resulting from increased global demand for the commodity, partially offset by the impact of the stronger Canadian dollar. The average cost per tonne of iron ore shipped in 2005 was $52, down from $62 in the prior year mainly due to the higher production and shipment levels in Cost per tonne in 2005 was impacted by noncash purchase price allocation adjustments of approximately $46.5 million 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 as this inventory was shipped to customers subsequent to the acquisition date. Additional information regarding the purchase price allocation is provided in note 2(a) to the consolidated financial statements. Gross income by business segment Fourth Quarter 2005 vs Consolidated gross income for the fourth quarter of 2005 was $123.6 million, a 44% decline from gross income of $219.7 million for the same quarter of This decrease is mainly the result of significantly lower results at Steel Operations and lower results at Gallatin Steel. On the positive side, the results of the Corporation s Mining Operations segment increased significantly as a result of the impact of the acquisition of Quebec Cartier Mining Company and improved results at Wabush Resources. For the three months ended December Change % Change (in millions) Steel Operations $ 9.9 $ $ (163.2) (94%) Gallatin Steel (18.0) (36%) Mining Operations (4.3) nmf Interesegment eliminations (42.3) 0.8 (43.1) nmf Consolidated gross income $ $ $ (96.1) (44%) Steel Operations gross income For the quarter ended December 31, 2005, Steel Operations gross income was $9.9 million, a significant decrease from the $173.1 million generated in the fourth quarter of For the three months ended December Change % Change (in millions) Net sales $ 1,003.1 $ $ % Cost of sales % Gross income $ 9.9 $ $ (163.2) (94%) As in previous quarters, the results of the Steel Operations segment are largely driven by the Corporation s Hamilton operations. 8

12 MANAGEMENT S DISCUSSION AND ANALYSIS Hamilton operations gross income At the Corporation s Hamilton operations, shipments were 1,020,000 tons in the fourth quarter, virtually unchanged from the 1,019,000 tons shipped in the fourth quarter of For the three months ended December Change % Change Steel shipments (000s net tons) 1,020 1, % Raw steel production 1 (000s net tons) 1,169 1, % Revenue per ton $ 758 $ 870 $ (112) (13%) Cost per ton $ 755 $ 717 $ 38 5% Gross income per ton $ 3 $ 153 $ (150) (98%) 1 Raw steel production includes purchased semi-finished steel Average revenue per ton of steel shipped from Hamilton in the fourth quarter of 2005 was $758 per ton compared to $870 per ton in the fourth quarter of 2004 driven by a substantial decrease in selling prices across all products and the impact of a stronger Canadian dollar, averaging $0.85 in the fourth quarter of 2005 versus $0.82 in the fourth quarter of As well, various short-term operating interruptions in the third quarter caused some shipments to be delayed until the fourth quarter. As a result, revenue per ton in the fourth quarter was negatively impacted because these shipments were sold at the third quarter spot market prices which were well below the fourth quarter levels. Average cost per ton for the fourth quarter was $755 per ton, an increase of $38 per ton over the level experienced in the same period in This increase was mainly due to the impact of the higher cost of purchased slabs in the quarter, which was approximately $26 per ton shipped higher than in the fourth quarter of Costs were also higher due to production interruptions at steelmaking operations and additional outside processing and other costs incurred in preparation for the January 2006 shutdown associated with the #2 Coupled Pickle Line Cold Mill (#2 CPCM) project, the total of which contributed approximately $20 to the higher cost per ton. Increased costs for raw materials and energy were partly offset by lower scrap costs, the impact of higher hot mill and finishing production as well as lower variable compensation expense versus the fourth quarter of As a result of these factors, gross income from Hamilton operations declined to $3.0 million in the fourth quarter compared to $158.0 million in the fourth quarter of Gallatin Steel gross income Gallatin Steel contributed $32.1 million of gross income in the fourth quarter of 2005, lower than the excellent results of $50.1 million reported in the fourth quarter of The decline in gross income was mainly a result of significantly lower average revenue per ton and the impact of a weaker U.S. dollar on the translation of Gallatin s results. For the three months ended December Change % Change (50%, Cdn $ millions) Net sales $ $ $ (25.9) (17%) Cost of sales (7.9) (7%) Gross Income $ 32.1 $ 50.1 $ (18.0) (36%) (000s net tons at 100%) Steel shipments (000s net tons) % Raw steel production (000s net tons) % (US $) Revenue per ton $ 546 $ 682 $ (136) (20%) Cost per ton (53) (11%) Gross income per ton $ 135 $ 218 $ (83) (38%) 9

13 MANAGEMENT S DISCUSSION AND ANALYSIS Shipments were 406,000 tons in the fourth quarter, the second highest ever, and 32,000 tons higher than in the fourth quarter of This was enabled by record hot band steel production of 406,000 tons in the fourth quarter of Gallatin s average revenue per ton in the fourth quarter of 2005 was US $546 per ton compared to US $682 per ton in the fourth quarter of 2004, a decrease of US $136 per ton reflecting considerably lower U.S. spot market selling prices. The average cost per ton shipped in the fourth quarter decreased by US $53 over the same period in 2004, primarily driven by lower average scrap costs in the quarter. Mining Operations gross income Gross income for the Corporation s Mining Operations segment, consisting of QCM and Wabush Resources, was $123.9 million for the quarter ended December 31, 2005, of which $117.7 million was contributed by QCM, compared to a loss of $4.3 million in the fourth quarter of 2004, which included only Wabush Resources. For the three months ended December Change % Change (in millions) Net sales $ $ 16.8 $ ,642 % Cost of sales % Gross Income $ $ (4.3) $ nmf (000s tonnes) Pellet shipments 2, , % Concentrate shipments 1,097-1,097 nmf Total iron ore shipments 3, , % Concentrate production 3, , % Revenue per tonne $ 78 $ 49 $ % Cost per tonne (17) (27%) Gross income per tonne $ 33 $ (13) $ % Mining Operations average revenue per tonne for pellets and concentrate in the period was $78, reflecting the higher market pricing for both pellets and concentrate in 2005, partially offset by the unfavourable impact of the stronger Canadian dollar on sales which are denominated in U.S. dollars. Average cost per tonne shipped in the quarter was $45. Of the Mining Operations gross income reported in the fourth quarter, $41.9 million has been eliminated on consolidation, reflecting the change in the unrealized intercompany profit in the quarter. The unrealized intercompany profit at the end of each period relates to Mining Operations profit remaining in Dofasco s pellet and steel inventories. 10

14 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 $ $ $ (300.0) (36%) Depreciation and amortization (1.7) (1%) Operating income (298.3) (50%) Transaction costs nmf Interest on long-term debt (5.3) (13%) Investment and other income (7.8) (10.5) 2.7 (26%) Foreign exchange loss (0.2) (3%) Income before income taxes (334.0) (59%) Income tax expense (102.3) (56%) (231.7) (61%) Minority interest (0.4) (8%) Net income $ $ $ (231.3) (61%) Depreciation and amortization Consolidated depreciation and amortization decreased by $1.7 million compared to The additional depreciation and amortization associated with the acquisition of QCM and the Copperweld assets in 2005 was more than offset by the impact of certain facilities in Hamilton becoming fully depreciated during 2004 and by $13.0 million of non-cash adjustments in 2004 for obsolete equipment and assets no longer in service. Transaction costs 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 on long-term debt Interest on long-term debt decreased by $5.3 million, reflecting lower outstanding long-term debt in 2005 due to scheduled repayments at Hamilton and DJ Galvanizing throughout 2004 and Interest on short-term borrowings of $5.0 million in 2005 has been classified in cost of sales. Foreign exchange The consolidated foreign exchange loss in 2005 was $5.7 million, comparable to the $5.9 million loss in The impact of the weakening of the U.S. dollar during the year ($1.20 to $1.17) was less significant than the weakening in 2004 ($1.29 to $1.20) on a larger US dollar working capital base. Income taxes The consolidated effective tax rate of 35% for the year ended December 31, 2005 was comparable to the Corporation s Canadian manufacturing and processing effective statutory rate of 34%. The effective tax rate of 32.5% for the year ended December 31, 2004 was slightly lower than the Corporation s Canadian manufacturing and processing effective statutory rate of 34%. The lower effective rate reflects an $11.6 million reduction of income tax expense due to the reversal of the valuation allowance against U.S. future income tax assets. 11

15 MANAGEMENT S DISCUSSION AND ANALYSIS LIQUIDITY AND CAPITAL RESOURCES Statement of cash flows For the years ended December Change % Change (in millions) Net income $ $ $ (231.3) (61%) Cash provided from operations before changes in working capital $ $ $ (259.3) (41%) Cash provided from operating activities $ $ $ (185.5) (43%) Cash used for investment activities $ $ $ % Cash used for financing activities $ $ $ % Cash provided from operating activities In 2005, consolidated cash provided from operations before changes in non-cash working capital was $373.7 million, a 41% decline from the record $633.0 million generated in 2004, reflecting the significantly lower net income in The $123.1 million increase in non-cash working capital in the year was primarily due to a considerable increase in inventories and a decrease in income and other taxes payable. The increase in inventories of $84.8 million is the result of the higher cost and quantity of raw materials and 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 Changes in other working capital items resulted in a net cash increase of $17.8 million as lower accounts receivable were partially offset by an increase in other current assets. In 2004, non-cash working capital increased by $196.9 million, primarily caused by a significant increase in the cost of virtually all inventories. An increase in accounts receivable was caused by higher sales in the fourth quarter of 2004 compared to the same period in These increases were partially offset by an increase in accounts payable due to higher 2004 accruals for profit sharing and employee performance-based compensation, as well as higher income taxes payable reflecting the higher final tax installment for 2004 payable in the first quarter of Cash used for investment activities Consolidated capital expenditures in 2005 were $382.2 million, a 20% increase over the $318.0 million of capital expenditures in The increase in capital spending was mainly due to the continued investment in the Finishing Division Improvement Program (FDIP) in Hamilton and the No. 2 Blast Furnace rebuild, which was completed late in the second quarter of The final activity in Phase I of FDIP, the coupling of a new pickle line to an existing upgraded cold rolling mill (#2 CPCM), was completed in the first quarter of Capital expenditures for 2006 are expected to be approximately $395 million, including the continued investment in the Finishing Division in Hamilton and upgrades to the computer systems and infrastructure in Hamilton as well as approximately $80 million of capital investment at QCM. Cash used for investing activities included $399.4 million to fund strategic acquisitions in 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 2 to the consolidated financial statements. Short-term investments decreased by $106.0 million in 2005 compared to an increase of $51.5 million during As at December 31, 2005, the Corporation did not hold any term deposits with maturities greater than 90 days at acquisition. This decrease reflects the use of cash and short-term investments during the year to fund acquisitions, for continued investment in capital projects and for required payments on the maturity of long term debt. 12

16 MANAGEMENT S DISCUSSION AND ANALYSIS Cash used for financing activities Short-term borrowings increased by $216.2 million in 2005, representing the utilization of available credit facilities to fund the QCM and Copperweld acquisitions and for the continued investment in capital projects. In 2004, repayment of short-term borrowings totaled $7.3 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, The notes will mature on June 15, 2017, with interest payable semi-annually on June 15 and December 15. The principal will be repayable over four years in equal amounts of $62.5 million commencing June 15, The proceeds from the Series A note issue have been used to repay long-term debt maturing in the year, to fund capital expenditures and for general corporate and working capital purposes. 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 $226.8 million in 2005, including a $175.0 million repayment of the 7.5%, 5-year Medium Term Notes that matured on June 1, In 2004, scheduled long-term debt repayments totaled $54.8 million. In 2004, the Corporation redeemed all of the outstanding 4¾% Cumulative Redeemable Preferred Shares, Series A for $11.5 million. On October 15, 2004, registered holders of Series A shares received $101 per share plus $0.98 per share representing accrued and unpaid dividends up to the redemption date. The Series A shares were de-listed from the Toronto Stock Exchange effective on the redemption date. Cash proceeds of $14.2 million were received in 2005 relating to the exercise of 476,700 common share stock options, compared to proceeds of $26.2 million received on the exercise of 980,400 options in Dofasco paid $101.9 million in dividends in 2005, compared to $94.5 million in The increase reflects the 10% increase in the dividend payable on common shares to 33 cents per share per quarter, effective October 1, 2004, and a higher average number of common shares outstanding during As at March 10, 2006, there were 78,708,481 common shares issued and outstanding, of which 77,530,766 were indirectly held by Arcelor S.A. following its acquisition of 98.5% of the Corporation s outstanding common shares. Additional details regarding this transaction are provided in note 21 to the consolidated financial statements. 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 $ 43.8 $ 43.2 $ $ 0.1 $ 0.1 $ $ Capital lease obligations Operating leases Long-term purchase contracts Total cash requirements $ $ $ $ $ 29.3 $ $ 1,557.3 Dofasco s scheduled payments under long-term debt agreements summarized above include $125.0 million of 7.55% medium-term notes and $137.0 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 and coal, as well as natural gas, electricity and other utilities. 13

17 MANAGEMENT S DISCUSSION AND ANALYSIS Cash payments required in the first quarter of 2006 include $215.0 million relating to a break fee paid to ThyssenKrupp AG, as well as approximately $38.5 million for advisory fees related to fairness opinions provided with respect to the offers received during the acquisition process described in the section Corporate developments. Further details regarding these two items are provided in note 21 to the consolidated financial statements. The cost to complete capital projects authorized as at December 31, 2005 was $282.2 million, the majority of which will be incurred in Guarantees and other commitments During 2005, Dofasco was released from its obligation to provide $17.5 million of letters of credit in support of QCM s credit facility as the underlying obligation has been fully repaid by QCM. In addition, the Corporation was released from its obligation to provide letters of credit in the amount of US $4.0 million in support of QCM s equipment leases. Following the acquisition of QCM, the Corporation was released from its contingent obligation to provide continuing support of future mine development at QCM to a maximum of $34.5 million between 2005 and No support payments were required under this arrangement. Capital resources Dofasco s capital resources at December 31, 2005 included cash and cash equivalents amounting to $122.4 million, compared to $368.2 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. These credit facilities include a new unsecured revolving term loan entered into subsequent to year end, with a maximum availability of $300.0 million. The facility bears interest at variable rates based on bankers acceptances and expires on July 31, On January 27, 2006, $215.0 million was drawn on this credit facility to pay the break fee owing to ThyssenKrupp. In addition, at December 31, 2005 the Corporation s other credit facilities had additional remaining availability totaling $204.6 million as well as an additional $122.7 million available to its joint ventures and subsidiaries under existing credit facilities. As a result of the financing activities discussed above, Dofasco s ratio of debt to debt plus equity increased to 27.8% at December 31, 2005 from 17.2% at the end of 2004, in line with the Corporation s long-term target range of 20% to 30%. The Corporation received an A (low) rating from Dominion Bond Rating Service (DBRS) in respect of notes issued under its Medium Term Note program. On November 23, 2005, DBRS placed a rating of Under Review with Negative Implications on Dofasco following the announcement of Arcelor s takeover bid for all outstanding shares of Dofasco. On February 21, 2006, Standard & Poor s (S&P) lowered its ratings on Dofasco to BBB from A- after it was announced that Arcelor had acquired control of the Corporation s shares. The ratings on Dofasco are now equalized with those on its parent company. At the same time, S&P revised its CreditWatch on Dofasco to developing from negative pending the outcome of the unsolicited bid by Mittal Steel Co N.V. for Arcelor and the possible subsequent sale of Dofasco to ThyssenKrupp AG. Contingent gain Effective August 30, 2004, the Corporation gave notice to a customer of the termination of a contractual steel supply arrangement, in accordance with the terms of the supply agreement. The 2004 results reflect a $10.0 million liquidation payment related to the termination of this contract. To ensure that the supply chain is not disrupted, Dofasco is continuing to ship steel to the customer at a price that is reflective of current market conditions. The right of Dofasco to terminate the arrangement is being disputed by the customer through arbitration proceedings, which were initiated in the fourth quarter of As a result of the dispute, a provision against sales and accounts receivable has been recorded as the amount equal to the difference between the invoice price and the original contract price. The cumulative provision increased from approximately $37 million at December 31, 2004 to approximately $100 million as at December 31, The amount and timing of realization of the potential gain to date, if any, is not determinable at this time as it is dependent on the resolution of the dispute with the customer. Future revenues will be impacted by such resolution, by future market conditions and by the volume of future purchases by the customer. 14

18 MANAGEMENT S DISCUSSION AND ANALYSIS Financial instruments In order to manage the risk associated with fluctuations in foreign exchange rates on anticipated transactions, Dofasco periodically enters into foreign currency forward purchase contracts for the purpose of limiting exposure to exchange rate fluctuations on certain U.S. dollar-denominated purchase transactions, including committed purchases of steel slabs and major capital expenditures, as well as on purchases denominated in euros and other currencies. In accordance with the Corporation s Commodity Risk Management Policy, the maximum period for these contracts cannot exceed twenty-four months, except as specifically approved by Dofasco s Commodity Risk Oversight Committee. In addition, QCM regularly enters into foreign currency forward sales contracts for the purpose of limiting exposure to exchange rate fluctuations on its U.S. dollar-denominated sales of iron ore, based on anticipated sales transactions. These contracts provide for a fixed rate conversion of approximately 20% to 60% of its anticipated sales denominated in U.S. dollars over a three year period. Neither the Corporation nor any of its subsidiaries or joint venture operations holds or issues derivative financial instruments for trading or speculative purposes. Under Canadian GAAP, qualifying derivative financial instruments designated as effective hedges are not recorded on the balance sheet. Consequently, unsettled forward contracts are not recognized in Dofasco s consolidated financial statements, as these instruments are designated as cash flow hedges for accounting purposes. Any of Dofasco s gains or losses arising from settled hedge transactions related to slab or commodity purchases are deferred as a component of inventory until the product containing the hedged item is sold, at which time both the underlying hedged item and the related hedge deferral are recorded as cost of goods sold. With respect to the QCM foreign currency forward sales contracts, any gains or losses arising from settled hedge transactions are recorded in sales since the hedged item is a forecasted sale in a foreign currency. The net unrealized gain or loss on unsettled foreign exchange forward purchase contracts at December 31, 2005 were not significant (December 31, 2004 nil). At the Corporation s QCM subsidiary, there were unrealized gains on foreign exchange forward sales contracts of $15.4 million, of which $6.7 million are included in other current assets and $0.3 million, are included in investments and other assets. These amounts, included on the consolidated balance sheet at December 31, 2005 represent the remaining balances of the fair value of the U.S. dollar forward sales contract assets included in the purchase price allocation at the acquisition date of QCM. Off-balance sheet arrangements Dofasco does not engage in off-balance sheet accounting to structure any of its financial arrangements. Off-balance sheet activities are limited to matters such as guarantees, which are discussed above. CRITICAL ACCOUNTING ESTIMATES Dofasco s significant accounting policies are described in note 1 to the consolidated financial statements. Some of these accounting policies involve estimates that require management s judgment in the use of assumptions about matters that are uncertain at the time the estimate is made. Different estimates, with respect to key variables used for the calculations, or changes to estimates, could potentially have a material impact on Dofasco s financial position or results of operations. In its review of major accounting policies with the Corporation s Audit Committee and independent auditors, management has discussed the development and selection of the critical accounting estimates described below. 15

19 MANAGEMENT S DISCUSSION AND ANALYSIS Employee future benefits The Corporation s pension plans provide eligible employees with pension benefits based on a number of criteria including earnings, years of service, retirement age and specified benefit levels, and include both final average earnings formulae and minimum benefit formulae. The Corporation s other benefit plans provide post-employment coverage for health care benefits including prescription drugs, hospital, and other medical, dental and vision benefits for eligible retired employees, their spouses and eligible dependents. Other benefit plans also provide for post-employment life insurance and compensated absences for eligible current employees, including vacation to be taken before retirement, if certain age and service conditions are met. The determination of the obligation and expense for defined benefit pensions and post-employment benefits is dependent on the selection of certain assumptions used by actuaries in calculating such amounts. Those assumptions are disclosed in note 15 to the Corporation s consolidated financial statements, the most significant of which are the discount rate, the expected long-term rate of return on plan assets, the rates of increase in compensation costs and the rates of increase in the cost of health care and dental benefits. The significant actuarial assumptions adopted are internally consistent and reflect the long-term nature of employee future benefits. Significant changes in assumptions could materially affect the Corporation s employee benefit obligations and future expense. Useful lives of fixed assets The Corporation s fixed assets related primarily to its steelmaking facilities represent a significant portion of the consolidated total assets. Fixed assets are stated at historical cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. The Corporation reviews the estimated useful lives of its fixed assets on a regular basis. Evaluating the reasonableness of the estimated useful lives requires judgment on the part of management and is based on current information and past experience. Significant changes in business circumstances, including major technological advancements, changes to strategy, changes to business conditions and outlook or changes in laws and regulations may result in the useful lives of fixed assets differing from the estimates. Estimated useful lives are reviewed on an on-going basis to ensure they continue to be appropriate in light of significant changes in business circumstances. Amendments to the useful lives result in a change to the depreciation rates and are treated as changes in accounting estimates, which are accounted for on a prospective basis. Asset retirement obligations Effective January 1, 2004, the Corporation adopted the new recommendations contained in CICA Handbook Section 3110 Asset retirement obligations, on a retroactive basis. The asset retirement obligations represent the legal and contractual obligations associated with the eventual closure of the Corporation s iron ore mining operations at the end of their productive lives. These obligations consist of costs associated with reclamation and monitoring activities and the removal of tangible assets at QCM, with mining and related operations located in Mont-Wright and Port-Cartier, Quebec, and at the Corporation s Wabush Mines joint venture, with mining and related operations located near Labrador City, Newfoundland and Labrador, and in Pointe Noire, Quebec. The fair value of the future asset retirement obligations is recognized in the period in which they are incurred when a reasonable estimate of the fair value can be made. The fair value of the obligations has been determined as the sum of the estimated discounted future cash flows of the legal obligations associated with the future retirement of these mining assets. These asset retirement costs are capitalized and amortized over the assets useful lives, while changes to the present value of the obligations are charged to income. The key assumptions on which the fair value of the asset retirement obligations are based include the estimated future cash flows, the timing of those cash flows and the credit-adjusted riskfree rate or rates on which the estimated cash flows have been discounted. The amount of the liability is subject to re-measurement at each reporting period if there has been a change to certain of the key assumptions. 16