Cost of Sales

In 2010, the cost of sales increased by 48% or by U.S.$1,380 million from U.S.$2,905 million in 2009 to U.S.$4,285 million in 2010 representing 84% and 77% of total revenue in 2009 and 2010, respectively. The improvement was achieved mainly due to better production capacity utilisation and cost saving efforts.

The following table sets out TMK’s cost of sales for the twelvemonth periods ended 31 December:

  2010 2009 Change Change
  in millions of U.S. dollars in %
Russia 3,065 2,101 964 46%
America 1,023 668 355 53%
Europe 197 136 61 45%
TOTAL COST OF SALES 4,285 2,905 1,380 48%

Russia. The cost of sales growth in the Russian division in 2010 was substantially affected by the demand recovered from its main customers and significantly expanded sales volumes of large diameter pipe. Increasing prices for goods and services consumed in production and changes in the product mix also significantly affected cost of sales. The effect of translation from functional to presentation currency led to an increase of U.S.$128 million in cost of sales.

America. The increase in cost of sales (53%) resulted from the 125% growth in the volume of sales, improved by changes in product mix and in cost per tonne. Production cost per tonne decreased due to considerable improvements in the utilisation of production capacity resulting in a strong improvement in the fixed production costs absorption ratio.

Europe. The cost of sales change in the European division was mainly the result of growing purchase prices and sales volumes as well as the changes in the product mix. The effect of translation from functional to presentation currency resulted in a reduction of U.S.$9 million in the cost of sales.

The table below provides a breakdown of TMK’s cost of sales for the twelve-month periods ended 31 December:

  2010 2009 Change Change
  in millions of U.S. dollars in %
Raw materials and consumables 2,972 1,660 1,312 79%
Staff costs 540 388 152 39%
Energy and utilities 336 216 120 56%
Depreciation 218 193 25 13%
Other costs 313 170 143 84%
TOTAL PRODUCTION COST 4,379 2,627 1,752 67%
Change in finished goods and work in progress (171) 244 (415) (170)%
Cost of externally purchased goods and obsolete stock and write offs 77 34 43 126%
TOTAL COST OF SALES 4,285 2,905 1,380 48%

The main components of TMK’s cost of sales are discussed below.

Raw materials and consumables

The costs of raw materials and supplies include the costs of metal scrap, coils, steel sheets, pig iron, ferrous alloys, billets and other consumables.

The significant production volumes growth due to the recovery of the economy after the crisis contributed U.S.$929 million to the increase of cost of raw materials and consumables. Increased prices for raw materials consumed in the production as well as changes in product mix resulted in U.S.$301 million of the total growth.

The increased share of large diameter pipe in TMK’s product mix had an impact on cost of raw materials as purchase prices of steel plates and coil used in production of this type of pipe are higher than raw material costs of other pipe products. Prices for certain types of raw materials and supplies varied depending on the region. In 2010, in the Russian division, the average purchase cost of metal scrap increased by 16%, average price for coils increased by 28% and the average purchase price for pig iron increased by 57% as compared to 2009. The average purchase cost of metal scrap and coils in the American division increased by 59% and 28%, respectively, as compared to 2009. Average purchase costs for metal scrap in the European division were higher by 53% in 2010 than those in 2009.

The effect of translation from the functional to presentation currency accounted for a U.S.$82 million increase in these types of costs.

Labour costs

Labour costs include wages and related taxes for employees directly engaged in the production.

Labour cost growth was mainly driven by increased payroll rates and bonuses resulting in a U.S.$121 million increase. The greatest part of the increase derived from the American division where outstanding operational performance resulted in higher payroll rates and bonuses growth. Changes in labour costs by U.S.$16 million occurred due to the headcount increase, particularly in the American division. The effect of translation from the functional to presentation currency accounted for a U.S.$15 million increase.

Energy and utilities

The costs of energy and other utilities include the costs of gas, electricity, heat energy, water and other utilities.

Significant production volumes increase resulted in U.S.$97 million of the costs of energy and utilities growth.

Growing prices for energy and utilities consumed in the production as well as the changes in product mix resulted in U.S.$14 million of the energy and other utilities expenses growth.

Prices for certain types of energy and other utilities varied depending on the region. In 2010, in the Russian division, the average electricity purchase costs increased by 18% and natural gas purchase costs increased by 26% as compared to 2009. The average electricity and gas purchase cost in the American division decreased by 9% and 32%, respectively, as compared to 2009 due to regressive tariffs that decreases as the volume of energy used grow. In 2010, average purchase costs for electricity and gas in the European division were lower by 5% and 6% respectively as compared to those in 2009.

The effect of translation from the functional to presentation currency accounted for a U.S.$9 million increase.

Depreciation

The increase in depreciation expenses by U.S.$19 million was principally the result of the overall growth attributable to new equipment put into operation during 2010 as part of TMK’s capital expenditure program. The effect of translation from the functional to presentation currency accounted for a U.S.$6 million increase.

Other costs

Other costs include repair and maintenance, contracted manufacture, transportation, taxes and other expenses. Growth of other costs correlates with production volumes and increased by U.S.$136 million primarily because of the production volumes dynamics. The American division contributed the majority to the total change. The outstanding production and sales growth in the American division resulted in additional outsourced processing services, repair and maintenance and extensive usage of more expensive transportation means for the transportation of semi-finished products between production and finishing capacities. The effect of translation from the functional to presentation currency accounted for a U.S.$7 million increase.

Change in own finished goods and work in progress

Managing the consequences of economic crisis and decreased production in 2009 TMK put its efforts on optimising the size and structure of working capital through reducing balances of finished goods and work in progress. However in 2010 as a result of growing operating activity TMK significantly increased its finished goods and work in progress.

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