As filed with the Securities and Exchange Commission on June 27, 2007

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

Form 20-F

 

 

Commission file number 1-13368

 

 

POSCO

(Exact name of Registrant as specified in its charter)

 

 

The Republic of Korea

(Jurisdiction of incorporation or organization)

 

Finance Division

POSCO Center

892 Daechi-4-dong, Gangnam-gu

Seoul, Korea

(Address of principal executive offices)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act.

 

 

Securities registered or to be registered pursuant to Section 12(g) of the Act.

 

None

(Title of Class)

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

 

NONE

(Title of Class)

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

77,592,942 shares of common stock, par value Won 5,000 per share

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark which financial statement item the registrant has elected to follow.  Item 17 o     Item 18 þ

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes o     No o

 

 

 

TABLE OF CONTENTS

 

 

 

Any discrepancies in any table between totals and the sums of the amounts listed are due to rounding.

 

Not applicable

 

Not applicable

 

Not applicable

 

Not applicable

 

The selected financial data presented below should be read in conjunction with our Consolidated Financial Statements and related notes thereto and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report. The selected financial data as of December 31, 2005 and 2006 and for each of the three years in the period ended December 31, 2006 is derived from our Consolidated Financial Statements included elsewhere in this annual report. Our Consolidated Financial Statements are prepared in accordance with Korean GAAP, which differ in significant respects from U.S. GAAP.

 

INCOME STATEMENT DATA

 

BALANCE SHEET DATA

 

 

 

 

EXCHANGE RATE INFORMATION

 

The following table sets out information concerning the noon buying rate for the periods and dates indicated.

 

 

 

Source: Federal Reserve Bank of New York.

 

 

We have translated the Won amounts into Dollars in this prospectus solely for your convenience. We make no representation that the Won or Dollar amounts contained in this prospectus could have been or could be converted into Dollar or Won, as the case may be, at any particular rate or at all.

 

Not applicable

 

Not applicable

 

You should carefully consider the risks described below.

 

Korea is our most important market, and our current business and future growth could be materially and adversely affected if economic conditions in Korea deteriorate.

 

We are incorporated in Korea, and most of our operations and assets are located in Korea. In addition, Korea is our most important market, accounting for 67.7% of our total sales volume of steel products in 2006. Domestic demand for our products is affected by the condition of major steel consuming industries, such as construction, shipbuilding, automobile, electrical appliances and downstream steel processors, and the Korean economy in general. As a result, we are subject to political, economic, legal and regulatory risks specific to Korea.

 

From early 1997 until 1999, Korea experienced a significant financial and economic downturn, from which it is widely believed the country has now recovered to a significant extent. However, the economic indicators in recent years have shown mixed signs of recovery and uncertainty, and future recovery or growth of the economy is subject to many factors beyond our control. Events related to the terrorist attacks in the United States on September 11, 2001, recent developments in the Middle East including the war in Iraq, higher oil prices, and the general weakness of the global economy have increased the uncertainty of global economic prospects and may continue to adversely

affect the Korean economy. Any future deterioration of the Korean and global economy could adversely affect our financial condition and results of operations.

 

Developments that could have an adverse impact on Korea’s economy include:

 

 

We rely on export sales for a significant portion of our total sales. Adverse economic and financial developments in Asia in the future may have an adverse effect on demand for our products in Asia and increase our foreign exchange risks.

 

Our export sales accounted for 32.3% of our total sales volume of steel products in 2006. Our export sales volume to Asia, including China, Japan, Indonesia, Thailand and Malaysia, accounted for 63.8% of our total export sales volume for steel products in 2006, and we expect our sales to these countries, especially to China, to remain important in the future. Accordingly, adverse economic and financial developments in these countries may have an adverse effect on demand for our products. Economic weakness in Asia may also adversely affect our sales to the Korean companies that export to the region, especially companies in the construction, shipbuilding, automobile, electrical appliances and downstream steel processing industries. Weaker demand in these countries, combined with addition of new steel production capacity, particularly in China, may also reduce export prices in Dollar terms of our principal products. We attempt to maintain and expand our export sales to generate foreign currency receipts to cover our foreign currency purchases and debt service requirements. Consequently, any decrease in our export sales could also increase our foreign exchange risks.

Depreciation of the value of the Won against the Dollar and other major foreign currencies may have a material adverse effect on the results of our operations and on the price of the ADSs.

 

Depreciation of the Won may materially affect the results of our operations because, among other things, it causes:

 

 

Appreciation of the Won, on the other hand, (i) causes our export products to be less competitive by raising our prices in Dollar terms and (ii) reduces net sales and accounts receivables in Won from export sales, which are primarily denominated in Dollars. However, because of the larger positive effects of the appreciation of the Won (i.e., the reverse of the negative effects caused by the depreciation of the Won, as discussed above), appreciation of the Won generally has a positive impact on our results of operations.

 

Fluctuations in the exchange rate between the Won and the Dollar will also affect the Dollar equivalent of the Won price of the shares of our common stock on the Stock Market Division of the Korea Exchange (formerly the Korea Stock Exchange) and, as a result, will likely affect the market price of the ADSs. These fluctuations will also affect the Dollar conversion by the depositary for the ADRs of cash dividends, if any, paid in Won on shares of common stock represented by the ADSs.

 

We are dependent on imported raw materials.

 

We purchase substantially all of the principal raw materials we use from sources outside Korea, including iron ore and coal. In 2006, we imported approximately 42.6 million tons of iron ore and 19.7 million tons of coal. Iron ore is imported primarily from Australia, Brazil and India. Coal is imported primarily from Australia, China, Canada and Russia. Although we have not experienced significant unanticipated supply disruptions in the past, supply disruptions or significant increases in market prices of essential raw materials, which could be caused by political or other events in the countries from which we import these materials, could adversely affect our operations.

 

We expect global steel production capacity to continue to expand in the near future, and over-capacity in the global steel industry may return.

 

In recent years, driven in part by strong growth in steel consumption in China, the global steel industry has experienced renewed interest in expansion of steel production capacity. The International Iron and Steel Institute estimated the global crude steel production capacity to increase from 1,129 million tons in 2005 to 1,221 million tons in 2006 and expects that the production capacity to continue to increase further in 2007, primarily as a result of additions of new capacity in China, India and other Asian countries. Over-capacity in the global steel industry may return if increase in demand from developing countries that have experienced significant growth in the past several years does not meet this growth in production capacity. Over-capacity will affect our ability to expand export sales and to increase steel production in general, as well as reduce export prices in Dollar terms of our principal products.

 

Consolidation in the global steel industry may increase competition.

 

In recent years, there has been a trend toward industry consolidation among our competitors. For example, consolidation of Mittal and Arcelor in 2006 has created a company with approximately 10% of global steel production capacity. Competition from global steel manufacturers with expanded production capacity such as Mittal-Arcelor and new market entrants, especially from China and India, could result in significant price competition, declining margins and reductions in revenue. Our larger competitors may use their resources, which

may be greater than ours, against us in a variety of ways, including by making additional acquisitions, investing more aggressively in product development and capacity and displacing demand for our export products.

 

Expansion of our production operations abroad is important to our long-term success, and our limited experience in the operation of our business outside Korea increases the risk that our international expansion efforts will not be successful.

 

We conduct international trading and construction operations abroad, and our business relies on a global trading network comprised of overseas subsidiaries, branches and representative offices. Although many of our subsidiaries and overseas branches are located in developed countries, we also operate in numerous countries with developing economies. In addition, we intend to continue to expand our production operations internationally by carefully seeking out promising investment opportunities, particularly in China, India and Vietnam, in part to prepare for the eventual maturation of the Korean steel market. We may enter into joint ventures with foreign steel producers that would enable us to rely on these businesses to conduct our operations, establish local networks and coordinate our sales and marketing efforts abroad. To the extent that we enter into these arrangements, our success will depend in part on the willingness of our partner companies to dedicate sufficient resources to their partnership with us.

 

In other situations, we may decide to establish manufacturing facilities by ourselves instead of relying on partners. The demand and market acceptance for our products produced abroad are subject to a high level of uncertainty and are substantially dependent upon the market condition of the global steel industry. We cannot assure you that our international expansion plan will be profitable or that we can recoup the costs related to such investments.

 

Expansion of our trading, construction and production operations abroad requires management attention and resources. In addition, we face additional risks associated with our expansion outside Korea, including:

 

 

Several of our products have been and may become subject to anti-dumping or countervailing proceedings, which may have an adverse effect on our export sales.

 

In recent years, several of our products have been subject to anti-dumping or countervailing proceedings, including in the United States and China. Further increases in or new imposition of anti-dumping duties, countervailing duties, quotas or tariffs on our sales in these markets may have a material adverse effect on our exports to these regions in the future. Exports to these regions accounted for 15.6% of our sales volume of steel products in 2006. See “Item 4. Information on the Company — Item 4B. Business Overview — Markets — Exports.”

Cyclical fluctuations based on macroeconomic factors may adversely affect the business and performance of our engineering and construction segment.

 

In order to complement our steel operations, we engage in engineering and construction activities through POSCO Engineering & Construction Co., Ltd., a 90.9%-owned subsidiary. The engineering and construction segment, which accounted for approximately 8.2% of our consolidated sales in 2006, is cyclical and also tends to fluctuate based on macroeconomic factors. Although we believe that our strategy of focusing on high-value-added plant construction and architectural works has enabled us to be exposed to a lesser degree to general economic conditions in Korea in comparison to some of our domestic competitors, our construction revenues have fluctuated in the past depending on the level of domestic construction activity including new construction orders. Our construction operations could suffer in the future in the event of a general downturn in the construction market resulting in weaker demand and falling prices, which could adversely affect the business, financial condition and results of operations of our engineering and construction segment.

 

Fixed price construction contracts without price escalation provisions could result in losses for our engineering and construction segment in the event that unforeseen additional expenses arise with respect to the construction project.

 

Most domestic and international construction projects are carried out on a fixed price basis according to a predetermined timetable, pursuant to the terms of a fixed price contract. The pricing of fixed price contracts is crucial to the profitability of a contractor, as is the ability of the contractor to quantify risks to be borne by it and to provide for contingencies in the contract accordingly. If unforeseen additional expenses arise, for example due to increases in the cost of raw materials or supplies or because the property underlying a structure requires unforeseen remedial treatment in order for it to support the structure, such expenses are usually borne by the contractor, whose profit from the project will be correspondingly reduced or eliminated. If we experience significant unforeseen additional expenses with respect to our fixed price construction projects, we may incur losses on such projects, which could adversely affect the business, financial condition and results of operations of our engineering and construction segment.

 

The Korean housing construction market fluctuates based on the Government’s real estate policies.

 

The performance of the housing construction business of POSCO Engineering & Construction is affected by a variety of factors, many of which are beyond our control. In particular, the housing market in Korea is influenced by the Government’ s real estate policies. In recent years, the Government has introduced a variety of new measures to mitigate increases in housing prices in Korea, which include constraints on the amount of mortgage loans, imposition of higher real estate and capital gains taxes and disclosure of construction project costs. The Government has also discouraged redevelopment of apartment complexes in certain parts of Seoul. In part due to such policies, the real estate market for new housing in Korea has experienced a slowdown in recent months. Additional changes in the Government’ s real estate policies may further reduce demand for new housing in Korea, which would negatively affect the business, financial condition and results of operations of our engineering and construction segment.

 

Escalations in tension with North Korea could have an adverse effect on us and the market value of our securities.

 

Relations between Korea and North Korea have been tense throughout Korea’s modern history. The level of tension between the two Koreas has fluctuated and may increase abruptly as a result of current and future events. In recent years, there have been heightened security concerns stemming from North Korea’s nuclear weapon and long-range missile programs and increased uncertainty regarding North Korea’s actions and possible responses from the international community. In December 2002, North Korea removed the seals and surveillance equipment from its Yongbyon nuclear power plant and evicted inspectors from the United Nations International Atomic Energy Agency. In January 2003, North Korea renounced its obligations under the Nuclear Non-Proliferation Treaty. Since the renouncement, Korea, the United States, North Korea, China, Japan and Russia have held numerous rounds of six party multi-lateral talks in an effort to resolve issues relating to North Korea’s nuclear weapons program.

In addition to conducting test flights of long-range missiles, North Korea announced in October 2006 that it had successfully conducted a nuclear test, which increased tensions in the region and elicited strong objections worldwide. In response, the United Nations Security Council passed a resolution that prohibits any United Nations member state from conducting transactions with North Korea in connection with any large scale arms and material or technology related to missile development or weapons of mass destruction and from providing luxury goods to North Korea, imposes an asset freeze and travel ban on persons associated with North Korea’s weapons program, and calls upon all United Nations member states to take cooperative action, including through inspection of cargo to or from North Korea. In response, North Korea agreed in February 2007 at the six-party talks to shut down and seal the Yongbyon nuclear facility, including the reprocessing facility, and readmit international inspectors to conduct all necessary monitoring and verifications. In return, the other five parties in the six-party talks agreed to provide emergency energy assistance to North Korea in the initial phase of 50,000 tons of heavy fuel oil.

 

There can be no assurance that the February 2007 accord will be implemented as agreed or the level of tension on the Korean peninsula will not escalate in the future. Any further increase in tension, including a breakdown of high-level contacts between Korea and North Korea or occurrence of military hostilities, could have a material adverse effect on our operations.

 

If you surrender your ADRs to withdraw shares of our common stock, you may not be allowed to deposit the shares again to obtain ADRs.

 

Under the deposit agreement, holders of shares of our common stock may deposit those shares with the ADR depositary’s custodian in Korea and obtain ADRs, and holders of ADRs may surrender ADRs to the ADR depositary and receive shares of our common stock. However, under current Korean laws and regulations, the depositary bank is required to obtain our prior consent for the number of shares to be deposited in any given proposed deposit that exceeds the difference between (i) the aggregate number of shares deposited by us for the issuance of ADSs (including deposits in connection with the initial and all subsequent offerings of ADSs and stock dividends or other distributions related to these ADSs) and (ii) the number of shares on deposit with the depositary bank at the time of such proposed deposit. It is possible that we may not give the consent. As a result, if you surrender ADRs and withdraw shares of common stock, you may not be able to deposit the shares again to obtain ADRs. See “Item 10. Additional Information — Item 10D. Exchange Controls.”

 

You may not be able to exercise preemptive rights for additional shares of common stock and may suffer dilution of your equity interest in us.

 

The Commercial Code of Korea and our articles of incorporation require us, with some exceptions, to offer shareholders the right to subscribe for new shares in proportion to their existing ownership percentage whenever new shares are issued. If we offer any rights to subscribe for additional shares of our common stock or any rights of any other nature, the ADR depositary, after consultation with us, may make the rights available to you or use reasonable efforts to dispose of the rights on your behalf and make the net proceeds available to you. The ADR depositary, however, is not required to make available to you any rights to purchase any additional shares unless it deems that doing so is lawful and feasible and:

 

 

We are under no obligation to file any registration statement. If a registration statement is required for you to exercise preemptive rights but is not filed by us, you will not be able to exercise your preemptive rights for additional shares and may suffer dilution of your equity interest in us.

 

This annual report contains “forward-looking statements” that are subject to various risks and uncertainties.

 

This annual report contains “forward-looking statements” that are based on our current expectations, assumptions, estimates and projections about our company and our industry. The forward-looking statements

are subject to various risks and uncertainties. Generally, these forward-looking statements can be identified by the use of forward-looking terminology such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “project,” “should,” and similar expressions. Those statements include, among other things, the discussions of our business strategy and expectations concerning our market position, future operations, margins, profitability, liquidity and capital resources. We caution you that reliance on any forward-looking statement involves risks and uncertainties, and that although we believe that the assumptions on which our forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and, as a result, the forward-looking statements based on those assumptions could be incorrect. The uncertainties in this regard include, but are not limited to, those identified in the risk factors discussed above. In light of these and other uncertainties, you should not conclude that we will necessarily achieve any plans and objectives or projected financial results referred to in any of the forward-looking statements. We do not undertake to release the results of any revisions of these forward-looking statements to reflect future events or circumstances.

 

We were established by the Government on April 1, 1968, under the Commercial Code of the Republic of Korea, to manufacture and distribute steel rolled products and plates in the domestic and overseas markets. The Government owned more than 70% of our equity until 1988, when the Government reduced its ownership of our common stock to 35% through a public offering and listing our shares on the Stock Market Division of the Korea Exchange. In July 1998, the Government announced its intention to sell all of our common stock owned directly by it or indirectly through The Korea Development Bank. In December 1998, the Government sold all of our common stock it owned directly, and The Korea Development Bank completed the sale of our shares that it owned in September 2000. The Government no longer holds any direct interest in us, and our outstanding common stock is currently held by individuals and institutions. See “Item 7. Major Shareholders and Related Party Transactions — Item 7A. Major Stockholders.”

 

Our legal and commercial name is POSCO. Our principal executive offices are located at POSCO Center, 892 Daechi-4-dong, Gangnam-gu, Seoul, Korea, and our telephone number is (822) 3457-0114.

 

The Company

 

We are the largest and the only fully integrated steel producer in Korea, and one of the largest steel producers in the world, based on annual crude steel production in 2006. We produced approximately 31.2 million tons of crude steel in 2006, a substantial portion of which was produced at Pohang Works and Gwangyang Works. Currently, Pohang Works has 13.3 million tons of annual crude steel and stainless steel production capacity, and Gwangyang Works has an annual crude steel production capacity of 16.7 million tons. We manufacture and sell a broad line of steel products, including hot rolled and cold rolled products, plates, wire rods, silicon steel sheets and stainless steel products.

 

We sell primarily to the Korean market, with domestic sales accounting for 67.7% of our total sales volume of steel products in 2006. We believe that we had an overall market share of approximately 42.3% of the total sales volume of steel products sold in Korea in 2006.

 

Our exports in 2005 and 2006 accounted for 26.5% and 32.3% of our total sales volume of steel products, respectively. Our major export market is Asia, with China accounting for 25.1%, Japan 19.4% and the rest of Asia 18.8% of our total steel export sales volume in 2006.

 

Business Strategy

 

Our goal is to maintain and strengthen our position as one of the leading steel producers in the world. In recent years, the global steel industry has undergone significant consolidation, resulting in the emergence of steel companies with expanded production capacity. We seek to achieve continued global excellence in this era of

consolidation through a renewed emphasis on growth and innovation. We are currently pursuing the following business strategies.

 

Continue to Seek Investment Opportunities Abroad and Establish Global Production Base

 

We carefully seek out promising investment opportunities abroad, primarily in China, India and Vietnam, in part to prepare for the eventual maturation of the Korean steel market. We believe that China, India and Vietnam will continue to offer substantial growth opportunities, and we plan to selectively seek additional investment opportunities and expand our production base in these countries. In November 2003, we launched POSCO China Holding Corporation, a holding company for our investments in China. In June 2005, we entered into a memorandum of understanding with Orissa State Government of India for the construction of an integrated steel mill and the development of an iron ore mine in Orissa state. We estimate the aggregate costs of the initial round of construction and mine development to be approximately $3.7 billion and additional costs of approximately $8.3 billion in order to increase the annual production capacity to 12 million tons of slab and hot rolled products. We also obtained an approval from the Government of Vietnam in November 2006 to construct steel mills with annual production capacities of 1.2 million tons of cold rolled products and 3.0 million tons of hot rolled products, pursuant to which we plan to invest $196 million and finance the remainder to start construction of a $491 million cold rolling mill in November 2007 with target completion in December 2009. We also entered into a memorandum of understanding with Vina-shin Group in May 2007 to jointly study feasibility of construction and operation of an integrated steel mill in Vietnam. We will continue to seek investment opportunities abroad.

 

Develop Leading Technology to Increase Sales of Higher Margin, Higher Value-Added Products and Enhance Quality of Our Products

 

We plan to continue to invest in developing leading technology necessary to produce higher margin, higher value-added products and enhance the overall quality of our products. We will continue to refine FINEX, a low cost, environmentally friendly steel manufacturing process that we believe optimizes our production capacity by utilizing non-agglomerated iron ore fines and using non-coking coal as an energy source and a reducing agent. We believe that FINEX offers considerable environmental and economic advantages through elimination of major sources of pollution such as sinter and coke plants, as well as decreasing operating and raw material costs. We completed the construction of our first FINEX plant with an annual production capacity of 1.5 million tons in May 2007. We are also incorporating a new technology called strip casting, which eliminates most of the existing slab casting and hot rolling process and transforms molten steel directly into steel sheets with 1.6 mm to 3.0 mm in thickness. We completed construction of a testing plant with an annual production capacity of 600 thousand tons that utilizes strip casting technology, which we expect to start operating late this year.

 

We have also sought to enhance the quality of our products through continued modernization and rationalization of our facilities. Through our strategic alliance with Nippon Steel, we also participate in jointly sponsored research. Leveraging our leading technology, we plan to further increase the proportion of our sales of higher margin, higher value-added products such as cold-rolled products (including automotive steel sheets), silicon steel sheets and stainless steel products.

 

Enhance Efficiency of Operations and Cost-Effectiveness through Company-Wide Process Innovation

 

We continue to refine our Six Sigma programs as part of our company-wide process for innovation and enhancing efficiency of operations. We reoriented our business transaction processes, including purchase of raw materials and sale of goods, to focus on our customers and established a computerized resource management system. The company-wide inventory and product classification and data standardization system have substantially cut operational inefficiencies and enhanced our cost-effectiveness. In addition, by sharing inventory and cost information in real time, we have shortened the period required to prepare monthly financial accounting data. In recent years, we have also implemented aggressive cost savings programs, including implementation of the Mega Y project to reduce raw material costs and steel production costs related to sintering and coking processes. In addition to improving the efficiency of our production, we also strive to create an innovative corporate culture. Under the slogan of “improve and practice everyday,” the POSCO Six Sigma Model extends to business process management

which enables us to monitor and control our performance. We will continue to seek new opportunities to implement our company-wide process innovation and increase our efficiency and cost-effectiveness.

 

Continue to Expand Our Export Customer Base

 

Although supplying the Korean domestic market is our priority, we intend to continue to supply a significant amount of our products to customers in overseas markets. Our export and overseas sales volume represented 32.3% of our total sales volume of steel products in 2006, with 63.8% of our export and overseas sales volume of steel products to customers in nearby Asian markets in 2006. We intend to further strengthen our global market position by cultivating relationships with our existing overseas customers and assertively seeking out prospective new customers in the emerging markets for high value steel products. Our export sales provide a foreign currency hedge by generating foreign currency that can be used to service our foreign currency debt and to purchase key raw materials, most of which we source from overseas. Maintaining strong relationships with major export customers also provides us with the flexibility to reallocate sales to foreign markets in periods when domestic demand is weak.

 

Secure Procurement of Raw Materials through Strategic Investments and Long-Term Contracts

 

We purchase substantially all of the principal raw materials we use, including iron ore and coal, from sources outside Korea. Import prices of these raw materials have increased in recent years. To secure adequate procurement of principal raw materials, we have invested and will continue to explore additional investment opportunities in various raw material development projects abroad, as well as enter into long-term contracts with leading suppliers of raw materials, principally in Australia, Brazil and Canada.

 

Selectively Seek Opportunities in Growth Industries

 

Our first priority is to maximize revenues and profits from our steel operations. We also selectively seek opportunities in growth industries, in part to prepare for the eventual maturation of the Korean steel market. When determining our diversification projects, we consider attractiveness of the industry and its future growth potential, as well as our capabilities to become competitive in such an industry. New businesses related to our steel operations include liquefied natural gas production, logistics and magnesium coil and sheet production. New businesses not related to our steel operations in which we intend to focus our efforts for diversification include power generation, advanced materials and alternative energy development. For example, we purchased a 50.0% interest in POSCO Power Corporation for Won 291 billion in July 2005 and the remaining 50.0% interest for Won 306 billion in March 2006. POSCO Power Corporation is the largest private power generation company in Korea that operates power plants with total power generation capacity of 1,800 megawatts. In order to meet the increasing demand for clean and renewable sources of energy, POSCO Power Corporation signed a strategic partnership agreement in February 2007 with FuelCell Energy, a global leader in molten carbonate fuel cell technology, pursuant to which POSCO Power Corporation will explore opportunities to expand into the stationary fuel cell market.

 

Major Products

 

We manufacture and sell a broad line of steel products, including the following:

 

 

The tables below set out our sales revenues and sales volume by major steel product categories for the periods indicated.

 

 

 

The sales revenues and sales volumes in the tables above represent the steel product sales of our consolidated entities which are steel-related companies but do not include the non-steel product sales of these entities. They include sales by our consolidated sales subsidiaries of steel products purchased by these subsidiaries from third parties, including trading companies to which we sell steel products. The sales of steel products purchased from third parties amounted to approximately 1.2 million tons in 2002, 1.4 million tons in 2003, 1.0 million tons in 2004, 1.0 million tons in 2005 and 0.8 million tons in 2006, accounting for Won 511 billion in 2002, Won 679 billion in 2003, Won 699 billion in 2004, Won 807 billion in 2005 and Won 470 billion in 2006, respectively.

 

Hot Rolled Products

 

Hot rolled coils and sheets have many different industrial applications. They are used to manufacture structural steel used in the construction of buildings, railway rolling stocks, industrial pipes and tanks, and automobile chassis. Hot rolled coil is also manufactured in a wide range of widths and thickness as the feedstock for higher value-added products such as cold rolled products and silicon steel sheets.

 

Our deliveries of hot rolled products amounted to 9.6 million tons in 2006, representing 31.0% of our total sales volume of steel products. The Korean market accounted for 7.1 million tons or 74.2% of our hot rolled product sales in 2006, representing a domestic market share of approximately 51.3%. The largest customers of our hot rolled products are downstream steelmakers in Korea who use the products to manufacture pipes and cold rolled products.

 

Hot rolled products constitute one of our two largest product categories in terms of sales volume. In 2006, our sales volume of hot rolled products decreased by 7.0% compared to 2005 primarily due to a decrease in demand from the construction industry and an increase in the quantity set aside for use in the production of cold rolled products.

Plates

 

Plates are used in shipbuilding, structural steelwork, offshore oil and gas production, power generation, mining, and the manufacture of earth-moving and mechanical handling equipment, boiler and pressure vessels and other industrial machinery.

 

Our deliveries of plates amounted to 3.6 million tons in 2006, representing 11.7% of our total sales volume of steel products. The Korean market accounted for 3.4 million tons or 93.7% of our plate sales in 2006, representing a domestic market share of approximately 37.2%. The Korean shipbuilding industry, which uses plates to manufacture chemical tankers, rigs, bulk carriers and containers, and the construction industry are our largest customers of plates.

 

In 2006, our sales volume of plates increased by 13.2% compared to 2005 primarily due to an increase in demand from the shipbuilding and industrial machinery industries.

 

Wire Rods

 

Wire rods are used mainly by manufacturers of wire, nails, bolts, nuts and welding rods. Wire rods are also used in the manufacture of coil springs, tension bars and tire cords in the automobile industry.

 

Our deliveries of wire rods amounted to 2.2 million tons in 2006, representing 6.9% of our total sales volume of steel products. The Korean market accounted for 1.7 million tons or 76.9% of our wire rod sales in 2006, representing a domestic market share of approximately 52.7%. The largest customers for our wire rods are manufacturers of wire and nails.

 

In 2006, our sales volume of wire rods decreased by 9.0% compared to 2005 primarily due to a decrease in demand from the construction industry, which more than offset an increase in demand from the automobile industry.

 

Cold Rolled Products

 

Cold rolled coils and further refined galvanized cold rolled products are used mainly in the automobile industry to produce car body panels. Other users include the household goods, electrical appliances, engineering and metal goods industries.

 

Our deliveries of cold rolled products amounted to 10.9 million tons in 2006, representing 35.1% of our total sales volume of steel products. The Korean market accounted for 6.1 million tons or 56.1% of our cold rolled product sales in 2006, representing a domestic market share of approximately 52.3%.

 

Cold rolled products constitute one of our two largest product categories in terms of sales volume and revenue. Sales of cold rolled products in recent years have experienced growth due to the launching of a sixth continuous galvanizing line at Gwangyang Works and an increase in demand from the automobile industry. In 2006, our sales volume of cold rolled products increased by 3.8% compared to our sales volume in 2005.

 

Silicon Steel Sheets

 

Silicon steel sheets are used mainly in the manufacture of power transformers and generators and rotating machines.

 

Our deliveries of silicon steel sheets amounted to 686 thousand tons in 2006, representing 2.2% of our total sales volume of steel products. The Korean market accounted for 318 thousand tons or 46.3% of our silicon steel sheet sales in 2006, representing a domestic market share of approximately 85.0%.

 

In 2006, despite an increase in demand from manufacturers of power transformers and generators, our sales volume of silicon steel sheets decreased by 6.9% compared to 2005 due to a temporary suspension of a production plant for revamping from April to June in 2006.

Stainless Steel Products

 

Stainless steel products are used to manufacture household goods and are also used by the chemical industry, paper mills, the aviation industry, the automobile industry, the construction industry and the food processing industry.

 

Our deliveries of stainless steel products amounted to 2.3 million tons in 2006, representing 7.3% of our total sales volume of steel products. The Korean market accounted for 1.0 million tons or 44.9% of our stainless steel product sales in 2006, representing a domestic market share of approximately 53.9%.

 

Stainless steel products constitute our second largest product category in terms of revenue. Although sales of stainless steel products accounted for only 7.3% of our total sales volume in 2006, they represented 25.8% of our total revenues from sales of steel products in 2006. Our sales volume of stainless steel products increased by 17.8% in 2006 compared to 2005 due to an increase in demand from the stainless steel products industry and stabilization of production from China.

 

Others

 

Other products include lower value-added semi-finished products such as pig iron, billets, blooms and slab.

 

Markets

 

Korea is our most important market. Domestic sales represented 67.7% of our total sales volume of steel products in 2006. Exports and overseas sales represented 32.3% of our total sales volume of steel products in 2006. Our sales strategy has been to devote our production primarily to satisfy domestic demand, while seeking export sales to utilize capacity to the fullest extent, to expand our international market presence and to earn foreign exchange.

 

Domestic Market

 

The total Korean market for steel products amounted to 49.6 million tons in 2006. We sold a total of 21.0 million tons of steel products in Korea in 2006, maintaining an overall domestic market share of 42.3% for such period.

 

The table below sets out sales of steel products in Korea for the periods indicated.

 

 

 

 

Total domestic sales increased by 3.8% in 2003, primarily resulting from an increase in demand from the construction industry which more than offset decreases in demand from the automobile industry and the consumer appliance industry. Imports from foreign competitors, primarily from Japan, China and Russia, showed strong growth as import sales volume increased by 30.9% in 2003 to 6.4 million tons. Growth in domestic sales volume of other Korean steel companies in 2003 slowed to 0.6% in 2003 while our domestic sales volume remained stable with a 0.1% increase in 2003 to 21.1 million tons. Accordingly, our market share dropped to 46.6% in 2003 from 48.2% in 2002.

 

In 2004, total domestic sales increased by 4.0%, primarily due to an increase in demand from the automobile, consumer appliance, and shipbuilding industries which more than offset a decrease in demand from the construction industry. Imports from foreign competitors, primarily from Japan, China, and Russia, showed strong growth as import sales volume increased by 18.5% in 2004 to 7.6 million tons. Growth in domestic sales volume of other Korean steel companies decreased by 10.5% in 2004 while our domestic sales volume increased by 11.7% in 2004 to 23.6 million tons. Accordingly, our market share increased to 50.0% in 2004 from 46.6% in 2003.

In 2005, total domestic sales decreased by 0.1%, primarily due to a decrease in demand from the construction industry, which more than offset an increase in demand from the automobile and shipbuilding industries. Imports from foreign competitors, primarily from Japan, China, and Russia, showed strong growth as import sales volume increased by 9.1% in 2005 to 8.3 million tons. Growth in domestic sales volume of other Korean steel companies decreased by 0.1% in 2005 while our domestic sales volume decreased by 3.0% in 2005 to 22.9 million tons. Accordingly, our market share decreased to 48.5% in 2005 from 50.0% in 2004.

 

In 2006, total domestic sales increased by 5.3%, primarily due to an increase in demand from the shipbuilding and automobile industries, which more than offset a decrease in demand from the construction industry. Imports from foreign competitors, primarily from Japan, China, and Russia, showed strong growth as import sales volume increased by 27.8% in 2006 to 10.6 million tons. Growth in domestic sales volume of other Korean steel companies increased by 13.1% in 2006 while our domestic sales volume decreased by 8.3% in 2006 to 21.0 million tons. Accordingly, our market share decreased to 42.3% in 2006 from 48.5% in 2005.

 

We sell in Korea higher value-added and other finished products to end-users and semi-finished products to other steel manufacturers for further processing. Local distribution companies and sales affiliates sell finished steel products to low-volume customers. We provide service technicians for large customers and distributors in each important product area.

 

For a discussion of our domestic sales of steel products and factors that may affect domestic sales in the future, see “Item 5. Operating and Financial Review and Prospects — Item 5.A. Operating Results.”

 

Exports

 

Our exports and overseas sales volume represented 32.3% of our total sales volume of steel products in 2006, 63.8% of which was generated in exports and sales to Asian countries. Our exports in terms of sales volume increased by 21.4% to 10.0 million tons in 2006. The tables below set out our exports and sales of steel products in terms of sales volume by geographical market and by product for the periods indicated.

 

 

The table below sets out our total sales, including non-steel sales, by geographic region for the periods indicated.

 

 

The above tables include sales by our consolidated sales subsidiaries of steel products purchased by these subsidiaries from third parties, including trading companies to which we sell steel products.

 

The table below sets out the world’s apparent crude steel use for the periods indicated.

 

 

 

Source: International Iron and Steel Institute.

 

In recent years, driven in part by strong growth in steel consumption in China, the global steel industry has experienced renewed interest in expansion of steel production capacity. The International Iron and Steel Institute estimated the global crude steel production capacity to increase from 1,129 million tons in 2005 to 1,221 million tons in 2006 and expects the production capacity to increase further in 2007, primarily as a result of additions of new capacity in China, India and other Asian countries. Over-capacity in the global steel industry may return if increase in demand from developing countries that have experienced significant growth in recent years does not meet this growth in production capacity.

 

We distribute our export products mostly through Korean trading companies and our overseas sales subsidiaries. Our largest export market in 2006 was China, which accounted for 25.3% of our export volume of steel products, including sales by our overseas subsidiaries. The principal products exported to China are cold rolled products and stainless steel products. Our exports to China amounted to 3.1 million tons in 2004, 2.6 million tons in 2005 and 2.5 million tons in 2006. Exports to China decreased by 10.6% in 2004 and 15.9% in 2005 primarily due to our decision to focus on meeting increased domestic demand. Our exports to China further decreased in 2006 by 4.4% primarily due to an adjustment of our sales volume from China to other countries with more favorable market price conditions. Our exports to Japan recovered from 1.7 million tons in 2004 to 1.8 million tons in 2005 and 2.0 million tons in 2006 primarily due to a general increase in the Japanese market price for our products. Sales volume to Asian countries other than China and Japan increased from 1.5 million tons in 2004 to 1.6 million tons in 2005 and increased further to 1.9 million tons primarily due to an adjustment of our sales volume from China to other Asian countries with more favorable market price conditions.

 

In 2004 and 2005, our exports to the United States and Europe remained at relatively low levels primarily due to our decision to export to Asian countries other than Japan that have higher profit margins. However, our sales volume to the United States and Europe increased from 0.8 million tons in 2005 to 1.3 million tons in 2006, primarily due to favorable market price conditions in these regions during the first half of 2006.

 

A significant part of our sales in North America are made to USS-POSCO Industries (“UPI”), a 50-50 joint venture between U.S. Steel Corporation and us. We sell hot rolled products to UPI, which uses such products to manufacture cold rolled and galvanized steel products for sale in the United States. Our sales to UPI were 639

thousand tons in 2004, 572 thousand tons in 2005 and 730 thousand tons in 2006, accounting for approximately 87% of our sales to North America in 2004, 75% in 2005 and 76% in 2006.

 

In the United States, a number of our products have been subject to anti-dumping and countervailing proceedings since 1992. As a result of these proceedings, our sales of corrosion resistant steel are subject to a countervailing duty of 0.07% and an anti-dumping duty of 0.35%, our sales of stainless steel plates are subject to an anti-dumping duty of 1.19% and our sales of stainless steel sheets are subject to an anti-dumping duty of 0.92%.

 

In China, we are subject to an anti-dumping duty of 11.0% on our sales of stainless cold rolled steel since December 2000. However, we entered into a suspension agreement in December 2000 with China and agreed to certain price undertakings. Since then, we have been exporting certain types of stainless cold rolled steel products to China that are exempt from such anti-dumping duty.

 

Our products that have been subject to anti-dumping or countervailing proceedings in the aggregate have not accounted for a material portion of our total sales in recent years. Consequently, the anti-dumping or countervailing duties imposed on our products have not had a material adverse effect on our total sales. However, there can be no assurance that further increases in or new imposition of dumping duties, countervailing duties, quotas or tariffs on our sales in the United States, China or elsewhere may not have a material adverse effect on our exports to these or other regions in the future.

 

Pricing Policy

 

We determine the sales price of our products based on market conditions. In setting prices, we take into account our costs, including those of raw materials, supply and demand in the Korean market, exchange rates, and conditions in the international steel market.

 

Our export prices can fluctuate considerably over time, depending on market conditions and other factors. The export prices of our higher value-added steel products in the largest markets are determined considering the prices of the similar products charged by our competitors. Export prices in Dollar terms increased in 2004 and the first half of 2005, primarily as a result of general recovery of the global economy and continued increase in steel consumption in China, as well as increases in transportation cost and price of raw materials. However, our export prices in Dollar terms decreased in the second half of 2005 due to excessive supply of steel products from China. Our export prices in Dollar terms rebounded in the first half of 2006 due to the recovery of the global steel markets resulting primarily from an increase in demand from the United States and Europe starting in the second quarter, but decreased in the second half of 2006 as such demand slowed. Our export prices in Dollar terms have rebounded and stabilized in the first half of 2007 as demand from Japan remained strong and various steel producers in China, the United States and Europe increased their sales prices.

 

Raw Materials

 

Steel Production

 

The principal raw materials used in producing steel through the basic oxygen steelmaking method are iron ore and coal. We import all of the coal and virtually all of the iron ore that we use. In 2006, we imported approximately 42.6 million tons of iron ore and 19.7 million tons of coal. Iron ore is imported primarily from Australia, Brazil and India. Coal is imported primarily from Australia, China, Canada and Russia.

 

In 2006, we purchased most of our iron ore and coal imports pursuant to long-term contracts. We purchased approximately 15.4% of our iron ore and coal imports in 2006 from foreign mines in which we have made an investment. The long-term contracts generally have terms of three to ten years and provide for periodic price adjustments to the then-market prices. The long-term contracts require us to purchase certain fixed amounts of relevant raw materials each year, and we typically have an option to increase or decrease such fixed amounts up to 5% or 10% each year. We or the suppliers may cancel the long-term contracts only if performance under the contracts is prevented by causes beyond our or their control and these causes continue for a specified period.

 

The prices of coal and iron ore increased substantially in recent years. The average price of coal per ton (including all associated costs such as customs duties and transportation costs) increased from $72.00 in 2004 to

$114.40 in 2005 and stabilized at $111.30 in 2006. The average price of iron ore per ton (including all associated costs such as customs duties and transportation costs) increased from $32.00 in 2004 to $44.60 in 2005 and increased further to $55.10 in 2006. We currently do not depend on any single country or supplier for our coal or iron ore.

 

In April 2002, we entered into an agreement with BHP Billiton, Itochu Corporation and Mitsui Corporation and invested A$16.3 million to establish the largest iron ore development project in Australia. We have a 20% interest in the project, while BHP Billiton, Itochu and Mitsui have 65%, 8% and 7% interests, respectively. We are obligated under the agreement to purchase 3.0 million tons of iron ore each year, representing approximately 8% of our total annual iron ore procurement amount, for twenty-five years starting in 2003. The purchase price is determined based on the global market price at the time of purchase. We purchased 2.4 million tons of iron ore from this development project in 2004, 3.2 million tons in 2005 and 2.9 million tons in 2006.

 

Since 2004, we have made the following investments in Australia: (i) A$51 million to acquire a 20% interest in a coal mine project in Foxleigh, Australia, securing 1.5 million tons of coal per year, (ii) A$10 million to acquire a 3.6% interest in a coal mine in Glennies Creek, NSW, Australia, securing 0.5 million tons of coal per year, (iii) A$12.5 million to acquire a 5% interest in a coal mine in Carborough Downs, Queensland, Australia, securing 50 thousand tons of coal per year, (iv) A$18 million to acquire 40 million shares of Murchison Metals Ltd. to develop iron ore mines in the western region of Australia, and (v) A$30 million to acquire a 10% interest in a coal mine in Newpac, NSW, Australia, to secure 0.5 million tons of coal per year. In addition, we invested approximately $25 million to acquire a 2.5% stake in a coal mine project in Elkview, Canada, securing an additional 0.5 million tons of coal per year. We continue to seek opportunities to enter into additional strategic relationships that would enhance our ability to meet our requirements for high quality raw materials.

 

Stainless Steel Production

 

The principal raw materials for the production of stainless steel are wrought nickel, ferrochrome, stainless steel scrap and carbon steel scrap. We purchase a substantial portion of our requirements for wrought nickel from leading producers in Australia, Indonesia, New Caledonia, Russia and Japan, as well as Korea. A substantial portion of requirements for ferrochrome are purchased from producers in South Africa, India and Kazakhstan. Most of the requirements for stainless steel scrap are sourced from domestic and overseas suppliers in Japan, United States and Southeast Asian countries. As for the requirements for carbon steel scrap, scrap from the Pohang Steelworks is also utilized. The average nickel price per ton increased from $13,852 in 2004 to $15,230 in 2005, and further to $21,654 in 2006.

 

In April 2005, we executed a joint venture agreement with Société Minière du Sud Pacifique, a New Caledonian nickel mining company, to procure nickel ore deposits in New Caledonia and operate a ferro-nickel production plant in Korea with annual production capacity of approximately 30,000 metric tons of nickel. Pursuant to the joint venture agreement, two joint venture companies were established in Korea and New Caledonia in May 2006 and June 2006, respectively. We have ownership interest of 49% in each joint venture company and our aggregate investment amount in the joint venture companies is $352 million. The joint venture company in New Caledonia will own the nickel mines and assets relating to nickel mining operations. We plan to purchase all of the ferro-nickel produced by the joint venture company in Korea using the nickel ore supplied from the joint venture company in New Caledonia starting in 2009 and use it for our stainless steel production.

 

Transportation

 

Since 1983, we have retained a fleet of dedicated bulk carriers to transport our raw materials through long-term contracts with shipping companies in Korea. These dedicated bulk carriers transported approximately 75% of our coal and iron ore in 2006, with the remaining 25% transported by other vessels through chartering contracts. All imported raw materials are unloaded at our port facilities in Pohang and Gwangyang. Costs of transportation of iron ore and coal represented approximately 18% and 9% of the total cost of such materials in 2006.

The Steelmaking Process

 

Our major production facilities, Pohang Works and Gwangyang Works, produce steel by the basic oxygen steelmaking method. The stainless steel plant at Pohang Works produces stainless steel by the electric arc furnace method. Continuous casting improves product quality by imparting a homogenous structure to the steel. Pohang Works and Gwangyang Works produce all of their products through continuous casting.

 

Steel — Basic Oxygen Steelmaking Method

 

First, molten pig iron is produced in a blast furnace from iron ore, which is the basic raw materials used in steelmaking. Molten pig iron is then refined into molten steel in converters by blowing pure oxygen at high pressure to remove impurities. Different desired steel properties may also be obtained by regulating the chemical contents.

 

At this point, molten steel is made into semi-finished products such as slab, blooms or billets at the continuous casting machine. Slab, blooms and billets are produced at different standardized sizes and shapes. Slab, blooms and billets are semi-finished lower margin products that we either use to produce our further processed products or sell to other steelmakers that produce further processed steel products.

 

Slab are processed to produce hot rolled coils products at hot strip mills or to produce plates at plate mills. Hot rolled coils are an intermediate stage product that may either be sold to our customers as various finished products or be further processed by us or our customers into higher value-added products, such as cold rolled sheets and silicon steel sheets. Blooms and billets are processed into wire rods at wire rod mills.

 

Stainless Steel — Electric Arc Furnace Method

 

Stainless steel is produced from stainless steel scrap, chrome, nickel and steel scrap using an electric arc furnace. Stainless steel is then processed into higher value-added products by methods similar to those used for steel production. Stainless steel slab are produced at a continuous casting mill. The slab are processed at hot rolling mills into stainless steel hot coil, which can be further processed at cold strip mills to produce stainless cold rolled steel products.

 

Competition

 

Domestic Market

 

We are currently the only fully integrated steel producer in Korea. As we had an overall market share of 42.3% of the total sales volume of steel products sold in Korea in 2006, we generally face fragmented competition in the domestic market. In hot rolled products, where we had a market share of approximately 51.3% in 2006, we face competition from a Korean operator of mini-mills, which produces lower quality products, and from various foreign producers, primarily from China and Japan. In cold rolled products and stainless steel products, where we had a market share of approximately 52.3% and 53.9% in 2006, respectively, we compete with smaller specialized domestic manufacturers and various foreign producers, primarily from China and Japan.

 

We may face increased competition in the future from new specialized or integrated domestic manufacturers of steel products in the Korean market. Our biggest competitor in Korea is Hyundai Steel, an electric-furnace steel producer with annual crude steel production of 9.3 million tons in 2006.

 

The Korean Government does not impose quotas on or provide subsidies to local steel producers. As a World Trade Organization signatory, Korea has also removed all steel tariffs.

 

Export Markets

 

The competitors in our export markets include all the leading steel manufacturers of the world. In recent years, there has been a trend toward industry consolidation among our competitors, and smaller competitors in the global steel market today may become larger competitors in the future. For example, Mittal Steel’s takeover of Arcelor in 2006 created a company with approximately 10% of global steel production capacity. Competition from global steel manufacturers with expanded production capacity such as Mittal-Arcelor, and new market entrants, especially from China and India, could result in a significant increase in competition. Major competitive factors include range of

products offered, quality, price, delivery performance and customer service. Our larger competitors may use their resources, which may be greater than ours, against us in a variety of ways, including by making additional acquisitions, investing more aggressively in product development and capacity and displacing demand for our export products.

 

Various export markets currently impose tariffs on different types of steel products. However, we do not believe that tariffs significantly affect our ability to compete in these markets.

 

Joint Venture and Other Investments

 

In September 1996, we entered into an agreement with Sagang Group Co. to establish Zhangjiagang Pohang Stainless Steel Co., Ltd., a joint venture company in China for the manufacture and sale of stainless cold rolled steel products. We have a 82.5% interest in the joint venture (including 23.9% interest of POSCO China Holding Corporation). The plant commenced production of stainless cold rolled steel products in December 1998. The joint venture also completed the construction of new mills in July 2006 with additional annual production capacity of 600 thousand tons of stainless hot rolled products. Zhangjiagang Pohang Stainless Steel produced 458 thousand tons of stainless steel products in 2006.

 

We established POSCO Specialty Steel Co., Ltd. as a wholly-owned subsidiary in Korea in February 1997. POSCO Specialty Steel produces high-quality steel for automobiles, machinery, nuclear power plants, ship-building, aeronautics and electronics industries. The plants operated by POSCO Specialty Steel have an aggregate annual production capacity of 835 thousand tons of wire rods, round bars, steel pipes and semi-finished products. POSCO Specialty Steel Co., Ltd. produced 831 thousand tons of such products in 2006.

 

We currently hold an 80.0% interest in Qingdao Pohang Stainless Steel Co., Ltd. (including 10.0% interest of POSCO China Holding Corporation), a joint venture set up to manufacture and sell stainless cold rolled steel products in China. Construction of the plant operated by Qingdao Pohang Steel began in August 2003 and became operational in December 2004, with an annual production capacity of 180 thousand tons of stainless cold rolled steel products. Qingdao Pohang Steel produced 171 thousand tons of such products in 2006.

 

In August 2003, we entered into a joint venture agreement with Benxi Iron and Steel Group in China to establish Benxi Steel POSCO Cold Rolled Sheet Co., Ltd. and build a cold rolling mill with annual production capacity of 1.8 million tons. The cold rolling mill became operational in March 2006 and produced 506 thousand tons of such products in 2006. We currently hold a 10.0% interest in this joint venture.

 

In November 2003, we launched POSCO China Holding Corporation, a wholly-owned holding company for our investments in China. POSCO China Holding Corporation also provides support to our Chinese investment projects and affiliated companies with their marketing efforts in China and solidify their business relationships with clients and suppliers.

 

In addition to the above investments, we are carefully seeking out additional promising investment opportunities abroad. In June 2005, we entered into a memorandum of understanding with Orissa State Government of India for the construction of an integrated steel mill and the development of an iron ore mine in Orissa state. We estimate the aggregate costs of the initial round of construction and mine development to be approximately $3.7 billion and an additional cost of approximately $8.3 billion in order to increase the annual production capacity to 12 million tons of slab and hot rolled products. We are currently obtaining the necessary regulatory approvals for the construction of the mill and the development of an iron ore mine.

 

We also obtained an approval from the Government of Vietnam in November 2006 to construct steel mills with annual production capacities of 1.2 million tons of cold rolled products and 3.0 million tons of hot rolled products, pursuant to which we plan to invest $196 million and finance the remainder to start construction of a $491 million cold rolling mill in November 2007 with target completion in December 2009. We also entered into a memorandum of understanding with Vina-shin Group in May 2007 to jointly study feasibility of construction and operation of an integrated steel mill in Vietnam.

 

In Mexico, we are planning to build an automotive steel sheet plant to supply automobile manufacturers in Mexico and Southwestern United States. We plan to invest $84 million and finance the remainder to start

construction of a $210 million automotive steel sheet plant with an annual capacity of 0.4 million tons in September 2007 with target completion in June 2009.

 

Subsidiaries

 

In order to complement our steel operations, we also engage in engineering and construction activities through POSCO Engineering & Construction Co., Ltd., a 90.9%-owned subsidiary, and steel products trading activities through POSCO Steel Service & Sales Co., Ltd., a 95.3%-owned subsidiary.

 

POSCO Engineering & Construction

 

Our engineering and construction activities include the planning, designing and construction of: (1) plant construction, which involves the construction and enhancement of iron and steel works, power generation facilities, sewage treatment plants and other industrial facilities; (2) civil engineering, which involves the construction of roads and bridges, reservoirs and transportation facilities, land reclamation and other infrastructure projects; (3) architectural works, involving the construction of office and commercial buildings and educational and cultural facilities, as well as urban planning and redevelopment; (4) housing, which involves the construction or reconstruction of apartment buildings; and (5) overseas business, which includes a broad range of construction projects for both public and private sector clients outside Korea, primarily in Asia and the Middle East.

 

Major construction projects that we have been involved in recent years include steel plant construction projects in India and the Middle East and a power plant construction project in Chile, as well as urban planning and development for An Khanh new city project in Vietnam. In addition, we are involved in various construction projects for the Incheon Songdo international city development project.

 

POSCO Steel Service & Sales Co., Ltd.

 

Our trading activities consist of exporting and importing a wide range of steel products that are both obtained from and supplied to POSCO, as well as between other suppliers and purchasers in Korea and overseas. Our trading activities are coordinated through a global trading network comprised of overseas subsidiaries, branches and representative offices. Such subsidiaries and offices support our trading activities by locating suitable local suppliers and purchasers on behalf of customers, identifying business opportunities and providing information regarding local market conditions.

 

Diversification

 

Our first priority is to maximize revenues and profits from our steel operations. In addition, we selectively seek opportunities in growth industries, in part to prepare for the eventual maturation of the Korean steel market. When determining our diversification projects, we consider attractiveness of the industry and its future growth potential, as well as our capabilities to become competitive in such an industry.

 

New businesses related to our steel operations include liquefied natural gas production, logistics and magnesium coil and sheet production. We completed the construction of a liquefied natural gas terminal in July 2005. In January 2003, we also entered into a joint venture with Mitsui Corporation of Japan for a 51.0% interest in POSCO Terminal Co., Ltd. which provides logistics services related to storage and transportation of raw materials used in steel production and other industries. Facilities operated by POSCO Terminal Co., Ltd. currently have an annual handling capacity of 6.3 million tons and enable us to transport raw materials on behalf of third parties, including electric power companies, cement companies and overseas steel manufacturers. In February 2004, we launched a research and development program with Research Institute of Science and Technology on magnesium sheet production using the strip casting and coil rolling technologies. We expect to complete our first magnesium coil and sheet plant with annual capacity of 3,000 tons in July 2007.

 

New businesses not related to our steel operations in which we intend to focus our efforts for diversification include power generation, development of alternative energy and advanced materials, information and technology related consulting services and Wireless broadband Internet access service, or WiBro. We purchased a 50.0% interest in POSCO Power Corporation for Won 291 billion in July 2005 and purchased the remaining 50% interest

for Won 306 billion in March 2006. POSCO Power Corporation is the largest private power generation company in Korea that operates power plants with total power generation capacity of 1,800 megawatts. In order to meet the increasing demand for clean and renewable sources of energy, POSCO Power Corporation signed a strategic partnership agreement in February 2007 with FuelCell Energy, a global leader in molten carbonate fuel cell technology, pursuant to which POSCO Power Corporation will explore opportunities to expand into the stationary fuel cell market. As for production of advanced materials, we plan to utilize our proprietary steel rolling and strip casting technologies and to develop additional technologies and manufacturing capabilities. Through POSDATA, a 61.9%-owned subsidiary, we also engage in information and technology consulting and system network integration and outsourcing services, as well as WiBro service under the “FLYVO” brand name. POSDATA also manufactures electronic toll collection terminals, Internet protocol phones and digital video recorders.

 

Insurance

 

As of December 31, 2006, our property, plant and equipment are insured against fire and other casualty losses up to Won 9,729 billion. In addition, we carry general insurance for vehicles and accident compensation insurance for our employees to the extent we consider appropriate.

 

The following table sets out their jurisdiction of incorporation and our ownership interests of our significant subsidiaries:

 

 

Our principal properties are Pohang Works, which is located at Youngil Bay on the southeastern coast of Korea, and Gwangyang Works, which is located in Gwangyang City in the southwestern region of Korea. We expect to increase our production capacity in the future when we increase our capacity as part of our facilities expansion or as a result of continued modernization and rationalization of our existing facilities. For a discussion of major items of our capital expenditures currently in progress, see “Item 5. Operating and Financial Review and Prospects — Item 5B. Liquidity and Capital Resources — Liquidity — Capital Expenditures and Capital Expansion.”

 

Pohang Works

 

Construction of Pohang Works began in 1970 and ended in 1983. Currently, Pohang Works has an annual crude steel and stainless steel production capacity of 13.3 million tons. Pohang Works produces a wide variety of steel products. Products produced at Pohang Works include hot rolled sheets, plates, wire rods and cold rolled sheets, as well as specialty steel products such as stainless steel sheets and silicon steel sheets. These products can also be customized to meet the specifications of our customers.

 

Situated on a site of 8.9 million square meters at Youngil Bay on the southeastern coast of Korea, Pohang Works consists of 40 plants, including iron-making, crude steelmaking and continuous casting and other rolling facilities. Pohang Works also has docking facilities capable of accommodating ships as large as 250,000 tons for unloading raw materials, storage areas for up to 45 days’ supply of raw materials and separate docking facilities for ships carrying products for export. Pohang Works is equipped with an up-to-date computerized production-management system allowing constant monitoring and control of the production process.

The following table sets out Pohang Work’s capacity utilization rates for the periods indicated.

 

 

 

 

Gwangyang Works

 

Construction of Gwangyang Works began in 1985 on a site of 13.5 million square meters reclaimed from the sea in Gwangyang City in the southwestern region of Korea. Production capacity is currently 16.7 million tons per year. Gwangyang Works specializes in high volume production of a limited number of steel products. Products manufactured at Gwangyang Works include both hot and cold rolled types.

 

Gwangyang Works is comprised of 43 plants, including iron-making plants, steelmaking plants, continuous casting plants, hot strip mills and thin-slab hot rolling plants. The site also features docking and unloading facilities for raw materials capable of accommodating ships of as large as 300,000 tons for unloading raw materials, storage areas for 40 days’ supply of raw materials and separate docking facilities.

 

We believe Gwangyang Works is one of the most technologically advanced integrated steel facilities in the world. Gwangyang Works has a completely automated, linear production system that enables the whole production process, from iron-making to finished products, to take place without interruption. This advanced system reduces the production time for hot rolled products to only four hours. Like Pohang Works, Gwangyang Works is equipped with an up-to-date computerized production-management system allowing constant monitoring and control of the production process.

 

Capacity utilization has kept pace with increases in capacity. The following table sets out Gwangyang Works’ capacity utilization rates for the periods indicated.

 

 

 

 

The Environment

 

We believe we are in compliance with applicable environmental laws and regulations in all material respects. Our levels of pollution control are higher than those mandated by Government standards. We established an on-line environmental monitoring system with real-time feedback on pollutant levels and a forecast system of pollutant concentration in surrounding areas. We also undergo periodic environmental inspection by both internal and external inspectors in accordance with ISO 14001 standards to monitor execution and maintenance of our environmental management plan. We recently invested in comprehensive flue gas treatment facilities at some of sinter plants, dust collector at steelmaking plants and coke wastewater treatment facilities. In addition, we recycle most of by-products from the steelmaking process. We also have been developing environmentally friendly

products such as chrome-free steel sheets in an effort to compete with products from the European Union, the United States and Japan and meet strengthened environmental regulations. Anticipating the trend toward increasing regulation of chrome in various steel products, we have introduced chrome-free steel products meeting international environment standards in 2006 that are used to manufacture automobile oil tanks.

 

We plan to continue to invest in developing more environmentally friendly steel manufacturing processes. We commenced research and development for a new steel manufacturing technology called FINEX in 1992 jointly with the Research Institute of Industrial Science and Technology and VOEST Alpine, an Australian company, and we completed the construction of our first FINEX plant with an annual production capacity of 1.5 million tons in May 2007. We will continue to refine FINEX, a low cost, environmentally friendly steel manufacturing process that we believe optimizes our production capacity by utilizing non-agglomerated iron ore fines and using non-coking coal as an energy source and a reducing agent. We believe that FINEX offers considerable environmental and economic advantages by eliminating major sources of pollution such as sinter and coke plants, as well as decreasing operating and raw material costs.

 

POSCO spent Won 145.5 billion in 2004, Won 127.0 billion in 2005 and 194.0 billion in 2006 on anti-pollution facilities.

 

We do not have any unresolved comments from the Securities and Exchange Commission staff regarding our periodic reports under the Exchange Act of 1934.

 

Our results of operations are affected by sales volume, unit prices and product mix, costs and production efficiency and exchange rate fluctuations.

 

Overview

 

Sales Volume, Prices and Product Mix

 

In recent years, our net sales have been affected by the following factors:

 

 

Domestic demand for our products is affected by the condition of major steel consuming industries, such as construction, shipbuilding, automobile, electrical appliances and downstream steel processors, and the Korean economy in general.

 

Our sales volume decreased by 2.1% in 2005 and further decreased by 0.4% in 2006. While our crude steel output increased from 31.1 million tons in 2004 to 31.4 million tons in 2005, sales volume decreased from 31.8 million tons in 2004 to 31.1 million tons in 2005 due to an increase in our inventory in the second half of 2005 resulting from adverse Chinese market conditions. In 2006, our crude steel output decreased to 31.2 million tons and sales volume decreased to 31.0 million tons due to a temporary suspension of the second blast furnace and the second hot rolled mill at Pohang Works for revamping from March to May 2006. For a discussion of our sales volume and revenues by major products and markets from 2002 to 2006, see “Item 4. Information on the Company — Item 4.B. Business Overview — Major Products” and “— Markets.”

 

Unit sales price in Won for all of our principal product lines increased in 2005 despite an appreciation of the Korean Won against the Dollar. The weighted average unit prices for our products increased by 10.6% in 2005 compared to 2004. Unit sales price of plates, which accounted for 10.3% of total sales volume, increased by 20.2%

in 2005. Unit sales price of wire rods, which accounted for 7.6% of total sales volume, increased by 19.7% in 2005. Unit sales price of hot rolled products, which accounted for 33.2% of total sales volume, increased by 14.5% in 2005.

 

In 2006, unit sales price in Won for all of our principal product lines other than silicon steel sheets and stainless steel products decreased, and the weighted average unit prices for our products decreased by 4.8%, partially due to appreciation of the Korean Won against the Dollar in 2006 that contributed to a decrease in our export prices in Won terms. The average exchange rate of the Korean Won against the Dollar appreciated from Won 1,023.2 per Dollar in 2005 to Won 954.3 per Dollar in 2006. Unit sales price of hot rolled products, which accounted for 31.0% of total sales volume, decreased by 14.9% in 2006. Unit sales price of cold rolled products, which accounted for 35.1% of total sales volume, decreased by 13.4% in 2006. Unit sales price of wire rods, which accounted for 6.9% of total sales volume, decreased by 10.6%. Unit sales price of plates, which accounted for 11.7% of total sales volume, decreased by 6.7% in 2006. These decreases were partially offset by a 7.5% increase in unit sales price of stainless steel products, which accounted for 7.3% of total sales volume in 2006 and also by a 6.2% increase in unit sales price of silicon steel sheets, which accounted for 2.2% of total sales volume in 2006.

 

Export prices in Dollar terms increased in 2004 and the first half of 2005 primarily as a result of general recovery of the global economy and continued increase in steel consumption in China, as well as increases in transportation cost and price of raw materials. However, our export prices in Dollar terms decreased in the second half of 2005 due to excessive supply of steel products from China. Our export prices in Dollar terms rebounded in the first half of 2006 due to the recovery of the global steel markets resulting primarily from an increase in demand from the United States and Europe starting in the second quarter, but decreased in the second half of 2006 as such demand slowed during this period. Our export prices in Dollar terms have rebounded and stabilized in the first half of 2007 as demand from Japan remained strong and various steel producers in China, the United States and Europe increased their sales prices. See “Item 4. Information on the Company — Item 4.B. Business Overview — Markets — Exports.”

 

The table below sets out the average unit sales prices for our semi-finished and finished steel products for the periods indicated.

 

 

 

 

Costs and Production Efficiency

 

Our major costs and operating expenses are raw material purchases, depreciation, labor and other purchases.

 

The table below sets out a breakdown of our total costs and operating expenses as a percentage of our net sales for the periods indicated.

 

 

 

 

Our production efficiency in recent years has continued to benefit from operation near or in excess of stated capacity levels. Production capacity represents our maximum production capacity that can be achieved with an optimal level of operations of our facilities. We expect to increase our production capacity in the future when we increase our production capacity as part of our facilities expansion or as a result of continued modernization and rationalization of our existing facilities. See “Item 4. Information on the Company — Item 4.D. Property, Plants and Equipment.”

 

The table below sets out certain information regarding our efficiency in the production of steel products for the periods indicated.

 

 

 

 

Exchange Rate Fluctuations

 

Exchange rate fluctuations also have affected our results of operations and liquidity in recent years. Foreign exchange translation gains and losses arise as a result of fluctuations in the rates of exchange of Won to the foreign currencies in which some of our assets and liabilities are denominated (primarily Dollars and Yen). Depreciation of the Won may materially affect the results of our operations because, among other things, it causes:

 

 

Appreciation of the Won, on the other hand, (i) causes our export products to be less competitive by raising our prices in Dollar terms and (ii) reduces net sales and accounts receivables in Won from export sales, which are primarily denominated in Dollars. However, because of the larger positive effects of the appreciation of the Won (i.e., the reverse of the negative effects caused by the depreciation of the Won, as discussed above), appreciation of the Won generally has a positive impact on our results of operations. In terms of the average noon buying rate, the Won appreciated against the Dollar from Won 1,035.1 to US$1 as of December 31, 2004 to Won 930.0 to US$1 as of December 29, 2006. See “Item 3. Key Information — Exchange Rate Information.”

 

We attempt to minimize our exposure to currency fluctuations by attempting to maintain export sales, which result in foreign currency receipts, at a level that covers foreign currency obligations to the extent feasible. As a result, a decrease in our export sales could increase our foreign exchange risks. From time to time we also enter into cross currency swap agreements in the management of our interest rate and currency risks and currency forward contracts with financial institutions to reduce the fluctuation risk of future cash flows. As of December 31, 2006, we had entered into one option contract and seven currency forward contracts. The net valuation gain of the above contracts was approximately Won 1.0 billion and the net transaction loss was Won 24.9 billion in 2006. We may incur losses under our existing contracts or any swap or other derivative product transactions entered into in the future. See Note 22 of Notes to Consolidated Financial Statements.

 

Impairment Loss on the No. 2 Mini-mill at Gwangyang Works

 

We started the construction of the no. 2 mini-mill at Gwangyang Works in 1997. Our board of directors decided in May 1998 to temporarily suspend the construction of the mini-mill due to the unstable economic condition in Korea and the Asia Pacific Region. Due to the continuing unstable economic condition and related decrease in the selling price of products, which in turn resulted in the deterioration in profitability, the management’s operations committee decided in April 2002 to cease the construction of the No. 2 mini-mill. We recognized impairment losses on the construction-in-progress in Gwangyang No. 2 mini-mill amounting to Won 469.6 billion in 2003 and 2004 and reclassified related machinery held to be disposed of in the future as other investment assets as of December 31, 2004. We entered into a contract with Al-Tuwairqi Trading and Contracting Establishment of Saudi Arabia in June 2006 to sell the no. 2 mini-mill equipment for $96 million. The book values of property, plant and equipment held for sale amounted to Won 64 billion and are classified as other investment assets as of December 31, 2006.

 

Reportable Operating Segments

 

We have three reportable operating segments — a steel segment, an engineering and construction segment and a trading segment. The steel segment includes production of steel products and sale of such products. The engineering and construction segment includes planning, designing and construction of industrial plants, civil engineering projects and commercial and residential buildings, both in Korea and overseas. The trading segment consists of exporting and importing a wide range of steel products that are both obtained from and supplied to POSCO, as well as between other suppliers and purchasers in Korea and overseas. The operations of all other entities which fall below the reporting thresholds are included in the “others” segment, and include power generation, liquefied natural gas production, logistics and magnesium coil and sheet production. See Note 29 of Notes to Consolidated Financial Statements.

 

Inflation

 

Inflation in the Republic, which was 3.6% in 2004, 2.8% in 2005 and 2.2% in 2006 has not had a material impact on our results of operations in recent years.

 

Critical Accounting Estimates

 

Our financial statements are prepared in accordance with Korean GAAP and reconciled to U.S. GAAP. The preparation of these financial statements under Korean GAAP as well as the U.S. GAAP reconciliation requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and

expenses during the reporting period. Actual results could differ from those estimates. We have identified the following areas where we believe assumptions and estimates are particularly critical to the financial statements:

 

Allowance for Doubtful Accounts

 

We maintain an allowance for doubtful accounts for exposures in our receivable balances that represent our estimate of probable losses in our short-term and long-term receivable balances. Determining the allowance for doubtful accounts requires significant management judgment and estimates including, among others, the credit worthiness of our customers, experience of historical collection patterns, potential events and circumstances affecting future collections and the ongoing risk assessment of our customers’ ability to pay. Unforeseen circumstances such as adverse market conditions that deviate significantly from our estimates may require us to change the timing of and make additional allowances to our receivable balances.

 

Valuation of Investment Securities and Derivatives

 

We invest in various financial instruments including debt and equity securities and derivatives. Depending on the accounting treatment specific to each type of financial instrument, an estimate of fair value is required to determine the instrument’s effect on our consolidated financial statements.

 

If available, quoted market prices provide the best indication of fair value. We determine the fair value of our securities using quoted market prices when available, including quotes from dealers trading those securities. If quoted market prices are not available, we determine the fair value based on pricing or valuation models, quoted prices of instruments with similar characteristics or discounted cash flows. The fair value of unlisted equity securities held for investment (excluding those of affiliates and subsidiaries) is based on the latest obtainable net asset value of the investees, which often reflects cost or other reference events. These fair values based on pricing and valuation models, discounted cash flow analysis, or net asset values are subject to various assumptions used which, if changed, could significantly affect the fair value of the investments.

 

When the fair value of a listed equity security or the net equity value of an unlisted equity security declines compared to acquisition cost and is not expected to recover (impaired investment security), the value of the equity security is adjusted to its fair value or net asset value, with the valuation loss charged to current operations. When the fair value of a held-to-maturity or an available-for-sale investment debt security declines compared to the acquisition cost and is not expected to recover (impaired investment security), the carrying value of the debt security is adjusted to its fair value with the resulting valuation loss charged to current operations.

 

As part of this impairment review, the investee’s operating results, net asset value and future performance forecasts as well as general market conditions are taken into consideration. If we believe, based on this review, that the market value of an equity security or a debt security may realistically be expected to recover, the loss will continue to be classified as temporary. If economic or specific industry trends worsen beyond our estimates, valuation losses previously determined to be recoverable may need to be charged as a valuation loss in current operations.

 

Significant management judgment is involved in the evaluation of declines in value of individual investments. The estimates and assumptions used by our management to evaluate declines in value can be impacted by many factors, such as the financial condition, earnings capacity and near-term prospects of the company in which we have invested, the length of time and the extent to which fair value has been less than cost, and our intent and ability to hold the related security for a period of time sufficient to allow for any recovery in market value. The evaluation of these investments is also subject to the overall condition of the economy and its impact on the capital markets. Any changes in these assumptions could significantly affect the valuation and timing of recognition of valuation losses classified as other than temporary.

 

Impairment of Long-lived Assets

 

The depreciable lives of long-lived assets are estimated and the assets are reviewed for impairment if events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. The recoverable amount is measured at the greater of net selling price or value in use. When the book value of long-lived asset

exceeds the recoverable value of the asset due to obsolescence, physical damage or a sharp decline in market value and the amount is material, the impairment of assets is recognized and the asset’s carrying value is reduced to its recoverable value and the resulting impairment loss is charged to current operations. Such recoverable value is based on our estimates of the future use of assets that is subject to changes in market conditions.

 

Our estimates of the useful lives and recoverable values of long-lived assets are based on historical trends adjusted to reflect our best estimate of future market and operating conditions. Also, our estimates include the expected future period in which the future cash flows are expected to be generated from continuing use of the assets that we review for impairment and cash outflows to prepare the assets for use that can be directly attributed or allocated on a reasonable and consistent basis. If applicable, estimates also include net cash flows to be received or paid for the disposal of the assets at the end of their useful lives. As a result of the impairment review, when the sum of the discounted future cash flows expected to be generated by the assets is less than the book value of the assets, we recognize impairment losses based on the recoverable value of those assets. We made a number of significant assumptions and estimates in the application of the discounted cash flow model to forecast cash flows, including business prospects, market conditions, selling prices and sales volume of products, costs of production and funding sources. Further impairment charges may be required if triggering events occur, such as adverse market conditions, suggesting deterioration in an asset’s recoverability or fair value. Assessment of the timing of when such declines become other than temporary and/or the amount of such impairment is a matter of significant judgment. Results in actual transactions could differ from those estimates used to evaluate the impairment of such long-lived assets. A percentage difference in cash flow projections or discount rate used would not likely result in an impairment write-down.

 

Operating Results

 

2006 Compared to 2005

 

Our sales in 2006 decreased by 1.7% to Won 25,842 billion from Won 26,302 billion in 2005, primarily due to a decrease of 4.8% in the average unit sales price per ton of our steel products, as discussed in “— Overview — Sales Volume, Prices and Product Mix” above, and a 0.4% decrease in the sales volume of our steel products, which were offset in part by recognition of sales of Won 413 billion from POSCO Power Corporation and Won 198 billion from POSCO-Foshan Steel Processing Center Co., Ltd., our newly consolidated subsidiaries in 2006.

 

Sales volume of wire rods, which accounted for 6.9% of total sales volume, showed the greatest decrease among our major steel product categories in 2006 with a decrease of 9.0%. Sales volume of hot rolled products, which accounted for 31.0% of total sales volume, decreased by 7.0%. In addition, sales volume of silicon steel sheets, which accounted for 2.2% of total sales volume, decreased by 6.9%. These decreases in sales volume were partially offset by increases in sales volume of stainless steel products and plates. Sales volume of stainless steel products, which accounted for 7.3% of total sales volume, showed the greatest increase among our major steel product categories in 2006 with an increase of 17.8%. Sales volume of plates, which accounted for 11.7% of total sales volume, increased by 13.2%. See “Item 4. Information on the Company — Item 4B. Business Overview — Major Products.”

 

Our domestic sales in 2006 decreased by 7.1% in terms of total sales revenues and decreased by 8.3% in terms of sales volume of steel products compared to 2005. In 2006, our domestic sales accounted for approximately 67.7% of our total sales volume of steel products, compared to 73.5% in 2005. The decrease in domestic sales revenues in 2006 compared to 2005 was attributable primarily to a decrease in domestic sales volume, as well as a decrease in the price of steel products sold in Korea.

 

Our export sales in 2006 increased by 11.1% in terms of sales revenues and by 21.4% in terms of sales volume compared to 2005. Exports as a percentage of total sales volume increased to 32.3% of our total sales volume of steel products in 2006 compared to 26.5% in 2005. The increase in export sales in terms of sales revenues in 2006 compared to 2005 was primarily attributable to an increase in export sales volume, which more than offset a decrease in the price of steel products sold abroad and the reduction in net sales in Won from export sales caused by appreciation of the Won against the Dollar.

Gross profit in 2006 decreased by 21.1% to Won 5,946 billion from Won 7,535 billion in 2005. Gross margin in 2006 decreased to 23.0% from 28.6% in 2005 due to a 6.0% increase in cost of goods sold in 2006 to Won 19,897 billion from Won 18,767 billion in 2005, as well as a 1.7% decrease in sales discussed above. The increase in cost of goods sold was attributable primarily to an increase in raw materials costs, which more than offset the impact from our cost savings programs, including implementation of the Mega Y project to reduce raw material costs and steel production costs related to sintering and coking processes. Raw materials costs in 2006 increased primarily as a result of a general increase in unit costs of iron ore and nickel, the impact of which was offset in part by a decrease in our production of crude steel to 31.2 million tons in 2006 compared to 31.4 million tons in 2005, as well as recognition of gain from disposition of scrap metal as a partial offset to raw material costs starting in 2006. The average price of iron ore per ton (including all associated costs such as customs duties and transportation costs) increased by 23.5% to $55.10 in 2006 from $44.60 in 2005, and the average price of nickel per ton (including all associated costs such as customs duties and transportation costs) increased by 42.2% to $21,654 in 2006 from $15,230 in 2005. Depreciation and amortization increased by 10.5% to Won 1,783 billion in 2006 from Won 1,613 billion in 2005, primarily due to an increase in capital investment in our facilities for production of higher value-added products.

 

Operating income in 2006 decreased by 27.8% to Won 4,389 billion compared to Won 6,083 billion in 2005. Operating margin decreased to 17.0% in 2006 from 23.1% in 2005, as selling and administrative expenses increased by 7.2% in 2006 to Won 1,556 billion compared to Won 1,451 billion in 2005. The increase in selling and administrative expenses resulted principally from increases in transportation and storage expenses and sales commissions, the impact of which were offset in part by a significant decrease in fees and charges. Transportation and storage expenses increased by 9.5% to Won 540 billion in 2006 compared to Won 493 billion in 2005 primarily due to an increase in our total export volume. Our sales commission expenses increased by 82.2% to Won 43 billion in 2006 compared to Won 23 billion in 2005 primarily due to reclassification of claim-related expenses as sales commissions starting in 2006. Our fees and charges in 2006 decreased by 48.8% to Won 63 billion compared to Won 122 billion in 2005, primarily as a result of a decrease in charges related to construction projects of POSCO Engineering & Construction. Our labor-related expenses included in selling and administrative expenses, which consist of salaries, welfare expenses and provisions for severance benefits, increased by 2.2% to Won 322 billion in 2006 from Won 315 billion in 2005, primarily as a result of a Won 15 billion increase in salaries resulting from the addition of POSCO Power Corporation and POSCO-Foshan Steel Processing Center Co., Ltd. as consolidated subsidiaries.

 

Our net income in 2006 decreased by 17.6% to Won 3,314 billion compared to Won 4,022 billion in 2005 primarily due to decreases in operating income, non-operating income-others and gain on foreign currency translation, as well as increases in other bad debt expense and interest expense, the aggregate impact of which were partially offset by a decrease in non-operating expenses-others. Our non-operating income-others decreased by 36.9% to Won 133 billion in 2006 from Won 211 billion in 2005 primarily due to recognition of gain from disposition of scrap metal as a partial offset to raw material costs instead of non-operating income starting in 2006. Our gain on foreign currency translation decreased by 43.3% to Won 84 billion in 2006 from Won 149 billion in 2005 primarily due to a decrease in the magnitude of appreciation of the Korean Won against the Dollar in 2006 compared to such appreciation in 2005. Other bad debt expense increased by 133.4% to Won 70 billion in 2006 from Won 30 billion in 2005 primarily due to allocation of Won 31 billion in bad debt expenses relating to accounts receivable for the construction expenses of POSCO Engineering & Construction. Interest expense increased by 22.7% to Won 183 billion in 2006 from Won 149 billion in 2005 primarily due to an increase in long-term borrowings, as well as a general increase in market interest rates in Korea. Our non-operating expenses-others decreased by 76.0% to Won 205 billion in 2006 from Won 854 billion in 2005 due to a significant decrease in special subsidies granted to 1,672 employees who were transferred to outsourcing companies in 2006 compared to such subsidies paid out to 23 employees who were transferred to outsourcing companies in 2005, as well as payment of additional income taxes of Won 179 billion in 2005 assessed following a regular audit conducted by the National Tax Service of our corporate income tax returns for 2000 to 2004; we have commenced an administrative action to challenge such assessment.

 

Our effective tax rate in 2006 was 21.5% compared to 26.9% in 2005. The statutory income tax rate applicable to us, including resident tax surcharges, remain the same in 2006 to 27.5% as in 2005. See Note 25 of Notes to Consolidated Financial Statements.

Segment Results — Steel

 

Our sales to external customers decreased by 4.7% to Won 23,728 billion in 2006 from Won 24,887 billion in 2005, primarily as a result of the reasons discussed above. After adjusting for inter-segment transactions, our net sales decreased by 5.6% to Won 19,743 billion in 2006 from Won 20,912 billion in 2005.

 

Operating profit decreased by 30.6% to Won 4,079 billion in 2006 from Won 5,880 billion in 2005, primarily as a result of the reasons discussed above. Depreciation and amortization increased by 6.8% to Won 1,713 billion in 2006 from Won 1,604 billion in 2005, primarily due to an increase in capital investment in our facilities for production of higher value-added products.

 

Segment Results — Engineering and Construction

 

Our sales to external customers decreased by 6.1% to Won 3,752 billion in 2006 from Won 3,994 billion in 2005, primarily due to a decrease in our plant construction activities. After adjusting for inter-segment transactions, our net sales decreased by 1.3% to Won 2,121 billion in 2006 from Won 2,148 billion in 2005.

 

Operating profit increased by 15.3% to Won 282 billion in 2006 from Won 245 billion in 2005, primarily due to an increase in profit margins of our construction projects.