SIM

Business Context and Reporting Period

Company: GRUPO SIMEC, S.A.B. De C.V. (Grupo Simec)
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2015
Accounting Standards: International Financial Reporting Standards (IFRS)
Business Overview: Grupo Simec is a diversified manufacturer, processor, and distributor of Special Bar Quality (SBQ) steel and structural steel products. Operations are conducted across Mexico, the United States (via Republic Steel), Canada, and Brazil. The company operates 15 facilities with a combined crude steel capacity of 4.6 million tons.

Key Financial Metrics (Year Ended Dec 31, 2015)

Note: USD amounts are translated at the period-end rate of Ps. 17.3398 per USD 1.00.

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 9% to Ps. 24.5 billion, driven by a 1% decrease in average price per ton and an 8% decrease in shipment volume (2.026 million tons vs. 2.197 million tons in 2014).
• Significant Impairment: The company recognized a non-cash impairment charge of Ps. 2,072 million (approx. USD 120 million) related to the Lorain, Ohio facility. This was triggered by the idling of the facility due to the downturn in the energy exploration sector.
• Segment Performance:
  • Mexico: Remained profitable with net income of Ps. 2.1 billion, driven by a 53% increase in gross profit due to lower raw material costs.
  • United States: Recorded a net loss of Ps. 4.1 billion, primarily due to the Lorain impairment, a 27% drop in shipments, and an inventory valuation allowance of Ps. 681 million.
  • Brazil: Operations began in late 2015, resulting in a net loss of Ps. 553 million, largely attributed to foreign exchange losses from the depreciation of the Brazilian Real.
• Foreign Exchange: Recorded a net foreign exchange loss of Ps. 382 million, compared to a gain of Ps. 474 million in 2014, reflecting the 17.7% depreciation of the Mexican Peso and 47% depreciation of the Brazilian Real against the USD.
• Tax Provision: Income tax expense increased significantly to Ps. 771 million, including a Ps. 1,333 million payment related to a tax authority review of fiscal year 2010 regarding the deduction of losses on U.S. Treasury bond disposals.

Guidance, Outlook, and Risks

• Outlook: Management expects the U.S. segment to return to profitability in the near future as it tackles the cost curve. The company is committed to supporting the U.S. segment. A new steel facility in Tlaxcala, Mexico, is under construction with an estimated budget of USD 600 million, expected to be operational in 2017.
• Internal Controls: The company and its auditors identified material weaknesses in internal controls over financial reporting for the fifth consecutive year (2011-2015). Key issues include inadequate segregation of duties, insufficient internal audit resources, lack of an appropriate consolidation system, and failure to remediate previous deficiencies. The auditors issued an adverse opinion on the effectiveness of internal controls.
• Operational Risks:
  • Idled Capacity: The Lorain, Ohio facility remains idled with no near-term plans to restart, dependent on market conditions in the oil and gas industry.
  • Raw Materials: Prices for scrap metal and ferroalloys are volatile; the company may not be able to pass cost increases to customers.
  • Environmental: Ongoing environmental remediation liabilities exist, particularly at the Pacific Steel facility in California, with potential future costs for soil removal and monitoring.
  • Legal/Regulatory: Pending anti-dumping duty reviews in the U.S. regarding rebar exports from Mexico.

Investor Verification Checklist

• Internal Control Remediation: Verify the specific progress and timeline for remedying the material weaknesses in internal controls identified for five consecutive years.
• Lorain Facility Status: Confirm the current status of the Lorain, Ohio facility and the specific market conditions required for its restart, given the significant impairment charge.
• Tax Liability Resolution: Verify the final status of the Ps. 1,333 million tax payment related to the 2010 Treasury bond deduction review and any potential for future tax assessments.
• U.S. Segment Turnaround: Assess the specific cost-reduction measures and revenue drivers management cites for the U.S. segment's return to profitability.
• Environmental Reserves: Review the adequacy of the USD 2.9 million reserve for environmental liabilities at Republic facilities and the potential costs associated with the Pacific Steel soil remediation.