Investor Presentaiton
Foreign exchange loss/gain, net
Management's Discussion and Analysis
Nine months ended September 30, 2011
In the first nine months of 2011, a foreign exchange loss was recognised in
the amount of U.S.$5 million as compared to a U.S.$16 million gain in the
corresponding period of 2010. In addition, we recognised a foreign
exchange loss from exchange rate fluctuations in the amount of
U.S.$56 million in the first nine months of 2011 compared to a U.S.$6
million loss in the corresponding period of 2010, in the statement of other
comprehensive income. They represent the effective portion of foreign
exchange gains or losses on our hedging instruments. At the date of
acquisition of controlling interests in NS Group, Inc. and
IPSCO Tubulars, Inc. we hedged our net investment in these operations
against foreign currency risk using US dollar denominated borrowings made
by Russian entities of TMK. Hedging is used to eliminate the foreign
currency exchange rate risk associated with a repayment of these liabilities
resulting from changes in the US dollar/Russian rouble spot rates.
Gain on changes in fair value of derivative financial instrument
In February 2010, we issued U.S.$413 million 5.25% convertible bonds due
2015, convertible into TMK's GDRs. The bonds are convertible into GDRs
at a conversion price of U.S.$23.075 per GDR. The convertible bonds
represent a combined financial instrument containing two components: (i) a
bond liability and (ii) an embedded derivative representing a conversion
option in foreign currency combined with an issuer call. In accordance with
IFRS, a bond liability of U.S.$368 million (net of transaction costs of
U.S.$9 million) was recognised and the liability under the embedded
conversion option of U.S.$35 million at the initial recognition date.
As of September 30, 2011, the bond liability and the liability under the
embedded conversion option were U.S.$384 million and U.S.$4 million,
respectively. As of 31 December, 2010, the liability under the embedded
conversion option was U.S.$48 million. Consequently, we recognised a gain
of U.S.$44 million on changes in the fair value of the derivative financial
instrument in the first nine months of 2011.
Management nevertheless believes that the IFRS accounting treatment of
the conversion option of the bond does not reflect the expected outflow of
resources under the conversion rights. The conversion option, whether
exercised or expired, will not result in cash outflows. In the event of the
bond not being converted, the liability under the conversion option will be
recognised as a gain in our income statement. In the event of the exercise of
the option, the liability will be transferred to equity (together with the
carrying value of the converted bonds); no gain or loss will be recognised
on the transaction. Additionally, the accounting treatment of the conversion
option requires that changes in the fair value of the embedded instrument be
recognised in the income statement. The price and volatility of TMK's
GDRs have significant impact on the fair value of the embedded derivative.
In the event the GDRs perform well, the liability under the conversion
option will increase and result in losses in the income statement. The
changes in the fair value may be material in comparison to our net income
and may cause distortions in the income statement.
As such, for the purposes of this report, in addition to net income as
reflected in the consolidated income statement for the first nine months of
2011 and 2010, it has been decided to present, in this report, an adjusted net
income so that it does not reflect gains in changes in the fair value with
respect to the embedded derivative component of the convertible bond. The
adjusted net income is an alternative performance measure that is not
reflected in our consolidated financial statements and has not been audited
or reviewed in accordance with ISA.
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