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AK Steel Holding Corp. (NYSE:AKS)

Q4 2008 Earnings Call

January 27, 2009 11:00 am ET

Executives

James Wainscott - Chairman, President and CEO

Albert Ferrara - VP of Finance and CFO

Analysts

Sal Tharani - Goldman Sachs

Evan Kurtz - Morgan Stanley

Mark Parr - KeyBanc Capital

Michelle Applebaum - Michelle Applebaum Research

Luke Folta - Longbow Research

Brett Levy - Jeffries & Company

Charles Bradford - Bradford Research

Kuni Chen - Banc of America

Operator

Good morning, ladies and gentlemen, and welcome to the AK Steel's Fourth Quarter and Full Year 2008 Earnings Call. (Operator Instructions).

With us today are Mr. James L. Wainscott, Chairman, President and Chief Executive Officer of AK Steel, and Mr. Albert E. Ferrara Jr., Vice President of Finance and Chief Financial Officer. At this time I would like to turn the conference call over to Mr. Ferrara. Please go ahead, sir.

Albert Ferrara

Thank you Patty, and good morning everyone. Welcome to AK Steel's fourth quarter and full year 2008 conference call and webcast. In a moment I'll review our fourth quarter and full year financial results as well as provide some data points and guidance for 2009. Following my remarks Jim Wainscott, our Chairman, President and Chief Executive Officer will offer his comments and field with your questions.

Today's call includes certain forward-looking guidance. Other than our comments on historical results, the remarks we make today constitute forward-looking statements within the meaning of the section 21E of the Securities and Exchange Act of 1934. These statements include our expectations as to our future shipments, product mix, prices, costs, operating profit, and liquidity.

While we believe that our expectations are reasonable, we cannot assure you they will prove to have been correct, since they are based on assumptions and estimates that are inherently subject to risks. Such risks include economic, competitive and operational risks, uncertainties and contingencies, all of which are beyond our control and based upon assumptions with respect to future business decisions that are subject to change, except as required by law, the company disclaims any obligation to update any forward-looking statements to reflect future developments or events.

For more detailed information, we encourage you to review the discussion of risks affecting forward-looking statements found under management's discussion and analysis section of our Annual Report on Form 10-K for the year ended December 31st, 2007 as updated in our most recent Quarterly Report on Form 10-Q.

To the extent, we refer to material information that includes non-GAAP financial measures. The reconciliation information required by Regulation G is available on the company's website aksteel.com.

Let me begin by reviewing AK Steel's fourth quarter 2008 results, which along with our results for the full year were reported earlier today. During the fourth quarter of 2008, AK Steel's results were impacted by the sudden and dramatic downturn in the US and global economies. However, despite the significant challenges posed by recessionary economic conditions worldwide, we reported adjusted pre-tax income of $600,000 for the fourth quarter of 2008.

The adjusted income number excludes $699.5 million in pre-tax, non-cash charges related to our pension plans. These charges include first, a quarter charge of $660.1 million for actuarial losses associated with our pension plans. Under our unique method of employee benefits accounting, these charges are required to be recognized immediately instead of being amortized over time.

Second, a curtailment charge of $39.4 million associated with locking and freezing the defined benefit pension plans of our salaried employees, which was announced during the fourth quarter of 2008. I want to emphasize that these charges, while certainly large are of the non-cash nature.

Turning to our operations, shipments in the 2008 fourth quarter totaled 1.073 million tons, representing a 27% decrease from the previous quarter and a 32% decrease from the fourth quarter of 2007. Our average selling price for the fourth quarter of 2008 was $1,359 per ton, which was 7% lower than the prior quarter. However, it represented an increase of $280 per ton or 26% compared to pricing for the fourth quarter of 2007.

Our average selling price in the 2008 fourth quarter was negatively impacted by lower spot market prices and lower surcharges, which were partially offset by a richer shipment mix. Total revenues for the fourth quarter were nearly $1.5 billion, which was 32% below our revenue in the third quarter. Revenues in the 2008 fourth quarter were lower by $233 million or 14% as compared to our fourth quarter 2007 revenue levels.

On the cost side of the equation, planned maintenance outages during the 2008 fourth quarter totaled approximately $7.3 million, most of which was related to projects completed at our Butler, Pennsylvania plant. Due to a significantly lower volume of customer orders, our quarterly financial results were meaningfully impacted by reduced operating rates. However our operations did benefit from lower scrap, alloy and natural gas cost compared to the previous quarter. In addition our fourth quarter LIFO charges of $60 million or $15 per ton was slightly lower than we had expected.

Netting revenues and costs, our fourth quarter adjusted operating profit was $10.3 million or $10 per ton. Given the severe economic challenges we faced, we were pleased to generate an adjusted operating profit for the quarter.

Turning now for our full year 2008 results despite the dramatic downturn in the global economy during the fourth quarter, 2008 was a record setting year for AK Steel. For 2008, we established all time records for revenues, average selling price and adjusted operating profits.

We generated adjusted pre-tax income of $692.6 million for the year 2008 excluding the fourth quarter corridor and curtailment charges I previously discussed. Shipments for 2008 were 5.9 million tons compared to 6.5 million tons in 2007. Our average selling price for 2008 was a record $1,303 per ton, an increase of $222 per ton or more than 20% higher compared to 2007.

Revenues for 2008 were $7.6 billion, also a company record compared to the previous record revenues of $7 billion set in the prior year. Our non-US revenues in 2008 of nearly $1.3 billion represented approximately 17% of our sales. That was an increase of more than $300 million compared to 2007.

Adjusted operating profit for 2008 was a record $727.5 million equal to a record $124 per ton. That compares to adjusted operating profit of $664.2 million or $103 per ton for 2007, each of which previously have been records.

Given the difficult market conditions during the final quarter of the year, we increased our focus on cash and liquidity. As a result, our year-end 2008 cash position remained very solid. We grew cash sequentially by more than a $121 million or roughly 27% from the third quarter ending the year with a cash balance of $562.7 million.

Combining our year-end cash balance with $682 million and availability under our revolving credit facility, AK Steel's total liquidity stood at $1.25 billion at December 31st. Our ongoing focus on cash and liquidity, working capital management and maintaining our financial flexibility allowed us to make substantial investments in the company during 2008.

We invested $167 million in capital improvements to sustain and grow our business. We fulfilled the initial funding of our Middletown retirees VEBA with $468 million in cash, which will reduce our OPEB liabilities by roughly $1 billion and we made $225 million in early pension contributions.

Our net debt at the end of 2008 was less than a $100 million and I think it's worth noting that we have no significant debt maturities until the year 2012. During the fourth quarter of 2008, we utilized some of our cash to directly benefit our shareholders. We expended $14.4 million to repurchase roughly 1,650,000 shares of AK Steel's common stock at an average cost of $8.73 per share.

Also during the fourth quarter, we repurchased 19.6 million in par value of our 7.75% senior notes at a cost of roughly $14.2 million. We will continue to do everything we can to enhance shareholder value and will capitalize on opportunities as they become available.

I'd also like to take a moment to provide you with a brief update on our pension fund investment performance. Just as it was for most investors, 2008 was certainly a challenging year for our Pension Trust. However, the conservative and diverse asset allocation that we employ in investing our Pension Trust assets served us well.

Although we experienced a loss of about 17% in our pension portfolio for the calendar year 2008, we believe that our performance in 2008 compares favorably to many financial markets and indices Despite this challenging investment environment, the future funding requirements for a pension plans remained very manageable. We expect that our pension contribution will be approximately $150 million for calendar year 2009.

Before turning it over to Jim, let me offer some initial guidance for 2009. Given current market conditions and uncertainties, we are going to depart from our customary guidance methodology.

Normally at this time of year, we would provide specific guidance for the first quarter only. Today we will provide directional guidance over the first half of 2009.

For the first quarter of 2009, we expect shipments to be in the range of between 850,000 tons and 900,000 tons. While we expect a substantial decline in raw material costs for the year, we do not expect to enjoy much of these benefits in the first quarter of 2009 as we work through higher priced raw material inventory that was carried forward from 2008 to 2009.

In addition, given the current depressed business conditions, we believe it's prudent to initiate some maintenance work during the first quarter at our Middletown with blast furnace. Including this work, we expect to incur planned maintenance outage costs of approximately $13 million in the first quarter.

Given the lower shipment level and operating volume scenario, we expect to incur a significant operating loss in the first quarter of 2009. However, as we look out for the second quarter of 2009, at this time we expect to generate a modest operating profit. We expect our shipments to increase as the market begins to rebound and we expect to realize lower cost in the second quarter.

Finally, as we typically do, let me offer a few data points for the full year 2009. We anticipate total capital investments of around $180 million in 2009, which will be roughly $30 million less than our depreciation.

A substantial portion of our 2009 capital budget is designated for the planned expansion and upgrade of the melt shop at our Butler works, as well as the work on the blast furnace at Middletown works.

We expect interest expenses to be approximately $11 million per quarter in 2009. We expect pension and OPEB expenses to increase by approximately $25 million in 2009.

Finally with respect to income taxes, while we are projecting a book tax rate for 2009 of approximately 40%. We estimate a cash tax rate of less than 10%.

Now, for his comments, here's Jim Wainscott, AK Steel's Chairman, President and CEO. Jim?

James Wainscott

Thank you, Al. Good morning, everyone. Thank you for joining us today. 2008 was another year of solid progress for AK Steel and while our fourth quarter was clearly the toughest we have faced in recent memory. Taken as a whole, 2008 will go down on history as AK Steel's finest year yet.

Facing severe adversity late in the year with a quarterly shipment rate at the lowest level we have seen in more than a decade, I'm really delighted that we generated an adjusted operating profit for the fourth quarter of 2008.

It shows me that we were up to the challenge and that we have reacted quickly and appropriately to the circumstances we faced and that we are well positioned to weather the economic storm ahead

Looking back for a moment at the full year 2008, it was a record setting year. As Al reviewed, in terms of our business basics, the things that define AK Steel, including safety, quality, productivity, as well as profitability. This focus on the fundamentals arises out of our desire to put our employees and our customers first.

At AK Steel, we have no higher priority than the safety of our people, and for 2008, we exceeded our company's specific safety goals and we continued to lead the entire steel industry by a wide margin and safety performance.

We also hold our customers in high regard that is why we focus so much of our attention on making great quality products, delivering them on time and providing superior customer service. Our performance for our customers continues to differentiate AK Steel from the peer group.

From an overall quality standpoint, we believe that 2008 was our best year ever. That opinion was validated by the results of an independent customer survey performed recently by Jacobson & Associates. According to the Jacobson's survey, we received our highest ever quality scores and we achieved best ever quality performances at a number of our largest customers.

In addition, according to the survey, our carbon, stainless, and electrical steel customers rated us number one in overall customer satisfaction for the year 2008. That's high praise indeed from the people whose opinion matters most, our customers, the ones who buy our steel.

In terms of productivity for the first three quarters of the year, our units were operating at excellent productivity rates with numerous records being set in particular at our specialty steel plants.

Subject to full year profitability, we certainly forged ahead in 2008 and delivered our best ever adjusted financial results in the history of the company, including a record top line with $7.6 billion in revenues, a record adjusted operating profit of $728 million or $124 a ton and a record pre-tax income level of $693 million.

So once again, we forged ahead as we improved on the fundamentals of safety, quality and productivity, optimized our margins, rewarded our shareholders, grew our profits and executed on our business plan very well. It's clear that our business model works at high levels of sales and production, but does it work when volumes suffer, as in the current severe economic downturn?

In the fourth quarter, we demonstrated that our business model does in fact work at much lower shipment operating rates. That was evidenced as we generated an operating profit. Again, on an adjusted basis and essentially broke even at the bottom-line by that same measure.

That said, as Al indicated, as we look ahead, our first quarter of 2009 will be negatively impacted by a host of factors including even lower production and shipment volumes than Q4, lower average selling prices as well. High cost raw materials that are carrying over from 2008 and increased maintenance costs.

We are reacting, of course, to one of the swiftest and most severe economic downturns in our country's history. Many economists and others have opined that this economic downturn may be second only to the great depression itself. We certainly hope, and we have some reason for optimism that the worst of it will be behind us in the first half of this year, if not towards the tail end of the first quarter.

Accordingly, we look for shipment volumes and pricing to pickup beginning in the second quarter.

We believe that our optimism is well founded as we take our lead from our customers. For example, in the automotive sector more vehicles are currently being sold than are being produced. Accordingly, we are seeing a slight up tick in our automotive shipment rate and expect it to continue each month going forward.

Let me give you just a couple of numbers. In December of 2008 only 773,000 vehicles were manufactured in North America, while sales of vehicles built here topped 812,000 units.

The January and February 2009 automotive production levels are expected to be even lower than the December pace, but automotive sales are expected to remain comparable to December's sales rates.

So as you can see, while it will take some time, things are slowly coming back into balance. On top of that, auto sales are likely to get some help from improved credit availability with direct infusions of cash to GMAC and Chrysler Financial, and a bit more interest being shown by banks in providing lease financing.

Another reason we think for optimism is that there is no inventory overhang for the service centers to work through. In fact, carbon flat-rolled service center inventory levels are at their lowest point since the year 2002. For all steel products, inventories are at their lowest point since 1996.

Past experience has shown that these cycles have a tipping point, when it becomes apparent to buyers that prices have bottomed and others are moving back into the market to buy more steel. Our sense is that we could see this begin to occur in the March and April timeframe of 2009.

Finally, while it will take a bit longer to be realized, we believe that the large infrastructure spending program that is being signaled by President Obama, once approved and implemented is going to be a significant positive for our overall economy.

In AK Steel's case as we get into the second quarter in the second half of 2009, we also expect to fully enjoy the benefits of lower raw material pricing and particular lower prices for iron ore. As many of you know, the price we paid for iron ore pellets tripled in recent years. However, given current global supply and demand conditions, we believe that iron ore pellet prices could decline by as much as 50% or more in 2009. In addition, with major maintenance expenditures behind us in the first half of this year, we expect to be poised to capitalize on opportunities as the markets begin to rebound.

As we go through this downturn, we have been and continue to align our production requirements with the level of incoming orders. I want to take this opportunity to compliment our operating and manufacturing planning personnel for the great job they are doing adjusting production schedules and I also want to thank our hourly and salaried personnel, many of whom have been laid off. I also want to thank their families for hanging in there as we go through this economic cycle.

Kudos as well to our human resources and labor relations people, who have done an excellent job reducing our headcount to match the lower production levels. AK Steel employees are as tough as steel and we look forward to welcoming our laid-off employees back to work just as soon as market conditions sufficiently improve.

In a moment, I'll provide an update on market conditions, but first let me comment on our blast furnace maintenance job at Middletown Works, which is planned to begin later this quarter. By way of background, we operate two blast furnaces at AK Steel, one at our Ashland Works and one at our Middletown Works.

When commercial conditions dictate, we run these blast furnaces as productively as anyone in the world for furnaces of their size. In addition to operating our blast furnaces well, I think that we have also maintained them quite well. Having said that, the time has come to perform some major maintenance at the Middletown furnace and given current market conditions, it's an excellent time to do so.

We expect to perform this maintenance job, which involves replacing the hearth beginning in March and the job will continue into April. Successful completion of this outage, should position us very well, to meet increased customer demands, when we see an up-tick in the marketplace.

Accordingly, having previously idled the Ashland Works blast furnace, we are preparing for restart of that facility in early February. In addition to performing the necessary repairs on the Middletown blast furnace, we will also be doing a number of things that will improve future furnace reliability and lower ongoing maintenance costs. While it will burden an already difficult first quarter with additional costs, we are convinced that it's the right thing to do, and it's the right time to do it.

With that, let me offer a glimpse of what we see in each of our major product groups, carbon, stainless and electrical steels. Starting with carbon steel products. Demand for carbon steel products remains depressed as the automotive, housing and capital goods sectors are all experiencing historic record low sales activity.

From 2007 to 2008, light vehicle sales declined by about 3 million units from 16.2 million to 13.2 million units and another 3 million unit drop is expected for 2009. North American automotive producers have done aggressively reducing production schedules to balance their inventory levels with consumer buying patterns.

Over the years we have reduced AK Steel's automotive exposure and diversified our customer base within the automotive market group, for example, in 2008 direct automotive shipments represented about 32% of our total sales. That compares to 58% of total sales five years ago in 2003.

From a sales portfolio standpoint, we think it is a far more prudent place to be going forward. If there is a silver lining in all of the economic chaos, it's the fact that carbon service center inventories are at extremely low levels, as I mentioned before, in fact they are lowest since 2002. This will be a very strong positive when demand returns.

With declining inventories and announced capacity reductions, a case can be made for a modest favorable demand cycle to develop later in the first quarter and certainly in the first half of 2009.

Stainless steel demand is also depressed in terms of commodity stainless, auto chrome and specialty strip and with a recessionary economy and falling nickel prices, fires have been reluctant to purchase product at this time. Adding to the weakness in stainless has been a surge of imported stainless steel from Asian countries primarily Korea, Japan and China.

On the electrical steel front, 2008 marked another record year for us in terms of shipments of high end grain oriented electrical steels, but even this product line which has been in high demand around the globe for the past few years is not immune from the global economic slowdown.

In the US continued weakness in housing starts has diminished demand for distribution transformers and globally further slowing in the European economies and in China is not helping things either as construction projects have been delayed. As a result, we would currently project that our electrical steel shipments may be down by 10% to 15% in 2009 compared to the year 2008.

However, this softness may be short lived as planned economic stimulus packages both here at home and abroad, target infrastructure investments that should stimulate future electrical steel demand. In other words, longer term, we expect electrical steels to be a very strong product for AK Steel.

So in terms of the markets we serve, the situation is not pretty at present, but from our perspective we think that they are at or very near the trough of the recession. Now the question is when and how fast will the recovery take hold. Obviously, we cannot forecast with any meaningful degree of precision when the recession will end and positive economic growth returns.

Having said that, we do know this, it will depend in large measure on credit availability and consumer confidence and the sooner the better, in terms of the return of both of those things. Let's all hope that President Obama's administration working in tandem with the new Congress takes immediate steps to inject capital into the system to hold institutions that receive TARP funds accountable for loaning the money to credit worthy consumers.

Let's all hope that all Americans are more confident about their employment situation and more comfortable, as a result buying a home and buying a new car or truck. I'd just offer this that manufacturing is the backbone of our economy and for a healthy manufacturing sector, we need to make things in America. But the road to recovery in manufacturing also requires people to buy things, big ticket items that in most cases require funding assistance..

So let's keep America and American manufacturing moving forward, safe in our future and strong leadership which is what made America great. Let's get back to those principles, whether it's in government, in the financial sector or in industry. So we can soon look at this recession, in the rearview mirror.

In the meantime, AK Steel will continue to react quickly and prudently to these extraordinary times. Having an extraordinary management team and Board of Directors will certainly help us capably navigate this storm. Together the Board and the management team are focused on continuing to enhance shareholder value and in that regard; we really made excellent progress in 2008 by posting record adjusted earnings in cash flow, initiating the common stock dividend and instituting a share buyback program. We have great confidence in the future of AK Steel.

Frankly, we believe it's a great time to be a company with our makeup, intensely focused, smaller and more nimble with great product quality, unique product diversity, solid cash and liquidity positions, a great balance sheet and no debt maturing until the year 2012. In other words, thanks to all the progress we have made over the past five years, we are well positioned to weather the current storm and to capitalize on market opportunities, in the days ahead.

Last year we forged ahead for 2009 our theme is to roll on. As we work through the economic challenges of the day, we intend to remain focused on our core values, in order to outperform expectations of our customers and our shareholders, while lowering our costs and lifting or growing our cash position.

In essence, it's a return to our three C's program; our focus on Customers, Cost and Cash. The things that matter most at this time, those things will drive our priorities. Our management team has a track record of overcoming adversity. We have all played through downturns during the course of our careers. Although this particular recession is a bit different in terms of its pace and its depth will draw on our past experiences.

Despite all of the near-term gloom and doom at AK Steel, we expect to return to making an operating profit for the second quarter of 2009.

Once again, thank you for being with us today on the call and this concludes our prepared remarks.

With that, we'd be happy to respond to your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Sal Tharani of Goldman Sachs.

Sal Tharani - Goldman Sachs

Good afternoon.

Albert Ferrara

Good morning, Sal. How are you?

James Wainscott

Good morning, Sal.

Sal Tharani - Goldman Sachs

Good. Can you just give us some more color on the pension side? You said, the expense will be $25 million higher than last year.

Albert Ferrara

Right.

Sal Tharani - Goldman Sachs

What was for last year about?

Albert Ferrara

Last year, Sal, if you look at pension and OPEB, last year we had no pension expenses and we had $7 million of OPEB expenses, so a total of seven. This year we expect our pension expenses to go from zero to 55, and we expect our OPEB to go from a $7 million charge to a $23 million credit.

Now the pension expense is going up, because obviously our assets have declined so our expected rate of return on our assets is going to decline. Our OPEB is going to improve because we are going to get the full-year benefit of the Middletown retiree VEBA that we put in place last March. And so net-net what you are having is a net benefit on the OPEB side of 30, a net increase on the pension side of 55 and so that comes to an increase of 25.

Sal Tharani - Goldman Sachs

Great. Thanks. And do you know what is the pension underfunding at the end of the year is?

Albert Ferrara

The pension underfunding, last year it was $0.8 billion or $800 million. This year it's up to $1.3 billion. In other words, our pension assets have gone from about 2.8 down to 2.2, our pension liabilities have gone from 3.6 down to 3.5. So an increase of $500 million, but keep in mind that at the same time our OPEB, which was last year about $1.8 billion is now down to about $900 million, so we have improved that $900 million, so net-net, our overall obligations have improved by about $400 million.

Sal Tharani - Goldman Sachs

And you expect $150 million funding, which I think you had a guidance last year, also for 2009, so it hasn't changed much even though you pensioned?

Albert Ferrara

What we said in the 10-Q, to be clear, is we expect pension funding over the period 2009 to 2011 to be to average between $200 million and $225 million over those three-year period of time with the $150 million in 2009, which hasn't changed. We would expect our funding in 2010 and 2011 to be in the area of around 250.

So again, the average funding during that period of time is what we said back in our third quarter 10-Q, 200 to 225, if you will, bifurcated just a bit. Indicate that 2009 is going to be a certainly not (onerous) at all and we continue to indicate that our pension funding over the long-term is certainly manageable.

Sal Tharani - Goldman Sachs

And one more thing on the furnaces, Ashland is coming up in early February; Middletown is going down early March. So you will have two furnaces running at the same time. Apparently both will be running at much lower utilization rate that's probably your cost is rising too much in the first quarter, but once Ashland comes back, what utilization rate you expect on Ashland post March?

James Wainscott

We have been obviously pacing the Middletown furnace because of the lack of orders. We will ramp it down as we ramp the Ashland furnace back up. And again, it will run at a level that is consistent with the order intake rate. We hope that's a stronger rate than we have seen lately.

Sal Tharani - Goldman Sachs

And how much inventory of raw material you have at the current utilization rate on hand?

James Wainscott

We are obviously long on pellets. We are long on some other raw materials as well. We will work through that largely as we get through the first quarter here, perhaps in some cases into the second quarter as well.

Albert Ferrara

We'll say that in the fourth quarter our inventories actually were a source of cash, if you look at our working capital, it was a source of cash of over $183 million, inventories were about $240 million of that. We would expect that number to continue to come in our favor and we see that as being a nice source of cash for us in 2009.

Operator

Our next question comes from Evan Kurtz of Morgan Stanley.

Evan Kurtz - Morgan Stanley

Hi. Good morning.

Albert Ferrara

Good morning, Evan. How are you?

Evan Kurtz - Morgan Stanley

Good. Just wanted to ask a couple of questions on electrical steel. You had mentioned that, shipments you expect now to be down about 10% in 2009. The backlog is being little impacted by some cancellations. Just wondering if some of the customers are pushing back on pricing as well and whether you still expect the kind of double-digit increases that you talked about last quarter?

James Wainscott

Let me just offer a couple of thoughts. Again, it is really still a very terrific product line for AK Steel for the global economy. It's really the right product at the right time to help the world meet its needs for electricity generation and transmission efficiently.

We did as we mentioned on the previous conference call and would affirm today to negotiate successfully higher base prices in 2009. Overall prices are really a function, of course, of the base price that's negotiated, as well as surcharges, which are expected to be a bit lower in 2009 due to the decline in raw material costs that's expected.

The demand factor, which, again, we put at 10% to 15%, which is still the best market that we are going to participate in as other markets may be down 30% to 40%, at least in the near term, is really a function of deferrals rather than cancellations.

I think that the growth rates that we are seeing around the globe in non-U.S. economies, primarily the bricks are still mid-single digits to high-single digits, but not at the 10% to 12% rates that they saw before.

So prudently I think that they are pairing back some of their near-term spending. We are also very excited about the electric grid plan in the U.S. That could be a major plus for us and we will have to wait and see what the stimulus package includes in that regard.

Evan Kurtz - Morgan Stanley

Actually that was my follow-up. They are kind of kicking around a number now of about 1000 miles of power lines. What does that actually mean as far as tons of electrical steel? Is there any sort of rough kind of rule of thumb that you might be able to provide as far as tons per mile?

James Wainscott

I don't know that I've got that math readily available, but I would just say that it would tighten things up right away and I'm not sure that we'd be able to make enough.

Evan Kurtz - Morgan Stanley

Okay. Great, thanks.

James Wainscott

Thank you.

Operator

Our next question comes from Mark Parr of KeyBanc Capital.

Mark Parr - KeyBanc Capital

Okay. Thanks very much. Good morning.

James Wainscott

Good morning, Mark.

Albert Ferrara

Good morning, Mark.

Mark Parr - KeyBanc Capital

Could you give a little more color on the raw material pricing situation. You had mentioned on the iron ore that you thought pricing could be down as much as 50% so if you could provide some color on that, and I don't know if you have made any comment specifically related to metallurgical coal, but would like to get your comment on that as well to the extent you are comfortable.

James Wainscott

I don't know if there were any better forecasters or anyone else. We read a lot of material and some of you opine as to what's going to happen with iron ore and I'm sure the producers have their views as well, but you can't have it both ways.

It seems to me that when the steel industry was cranking out record volumes of steel products and prices for iron ore, in our case iron ore pellets tripled. Now with really operating rates around the world at probably something less than 50% it just stands to reason to us that some of that has got to come back.

We've seen numbers as low as 10 we have seen numbers in excess of 50. We don't know where it is going to settle out, but we certainly think it's coming down and has to come down in a big way. Again if relationships are real and not one sided, in other words if you're going to have a real relationship with the iron ore producers over time, then it's in their best interest, it seems to me, to look at this on a longer term basis and I suspect that's what they are doing, painful as they may be.

So we certainly expect to see a significant decline in iron ore prices. It's a little bit unclear to us as to when and how that negotiations process will occur this year. It's never been an exact science and it's probably going to be even less than that this year.

But I would tell you this, that we are excited again not only to be a company of our size but to be raw material short at this point in time, it seems like it's a great place to be and that once we exhaust our inventory of the higher price pellets, that we obviously didn't consume in the fourth quarter, as we had hoped to and planned to before the economic tsunami hit us and everyone.

Once we work through that, I think we will be in great shape. The other things that we consume, things like HBI, again will move in our direction as that price is largely tied to scrap. I think your other question was on coal.

Mark Parr - KeyBanc Capital

Yes.

James Wainscott

The majority of our coal requirements, are under contracts that expire at the end of this year and those agreements have within them a collar provision that limit both the upside and downside movements in pricing, and when we sort of take a hard look at that, it's our sense that, we may incur a modest increase in our 2009 coal cost just given the way those agreements have priced out.

So those would be the comments that we would offer at this point in time. Obviously, there is a lot of discussion and negotiations that have to go on and I think it's really recognition on everyone's part that the world has changed dramatically.

Albert Ferrara

Just to be clear, Mark, the coal contracts are negotiated in 2007 so that was the base upon which they were going rather than 2008. So the callers if you were predicated on it on sort of lower price.

Mark Parr - KeyBanc Capital

Okay terrific, thanks very much.

James Wainscott

Thank you, Mark.

Operator

Our next question comes from Michelle Applebaum of Michelle Applebaum Research. Michelle, your line is open. Please check your mute button.

Michelle Applebaum - Michelle Applebaum Research

Hi. Can you hear me?

James Wainscott

We can hear you now.

Albert Ferrara

Hi, Michelle.

Michelle Applebaum - Michelle Applebaum Research

Hey. Congratulations, Jim, on the AISI.

James Wainscott

Thank you very much.

Michelle Applebaum - Michelle Applebaum Research

I think they are having new blood in there, it is a good thing and I'm thrilled that you guys have reinvolved yourselves in that effort. I think they do good work.

James Wainscott

I would just comment on that. First off, thank you for mentioning that. I want to first of all appreciate the service of all those who came before me to the industry trade association, especially Keith Busse, the outgoing coming Chairman who did a great job for us.

It's an honor for me to serve in that capacity after 27, 28 years in the business to give a little bit back particularly at this critical time. I'm going to do everything I can to make sure that our legislators understand the importance of a strong steel industry in North America that is central to a healthy manufacturing sector and strong economy.

As you know, we have got a lot of issues that this administration has inherited and that mattered to us, whether it's the broad economy, the environment, energy policy, trade policy, healthcare, et cetera, and I will just say this, that AISI's voice and ideas need to be heard and they will be heard as these issues are debated.

Michelle Applebaum - Michelle Applebaum Research

Great. Okay. Glad I gave you that opportunity. We chewed it up well. We will practice a little bit more next time.

James Wainscott

We didn't plan that but --

Michelle Applebaum - Michelle Applebaum Research

We didn't plan that, no, but I think there's macro things going on that kind of dominate the dialogue right now. Speaking of which, could you give me your perspective from your new platform about the whole by America flap.

I know we talk a lot about enforcement of trade laws, but I think a lot of you guys take for granted that we the people understand the trade laws and why they are there, because, we don't go back and redefine that very often. So what if somebody else dumps or subsidized, why don't we take advantage of that. And I was hoping you might have thoughts on that to share.

James Wainscott

I know that this has been a bit of a hot button. I would just offer the following. We are obviously very interested in what the stimulus package contains and what it looks like, but to the extent of the stimulus packages we understand that is intended to create American jobs, and if the projects within that stimulus package include items made of steel like bridges and roads and other structures, then I say buy America, because to do so was going to create those jobs and that's going to really fuel the economy. I want to take this opportunity as well, since I'm on my perch and you gave me that perch to applaud my fellow --

Michelle Applebaum - Michelle Applebaum Research

And don't forget this in the future. I'm going to need to take the favor back.

James Wainscott

So noted, but Peter Visclosky of the Gary area is proposing to amend the economic stimulus plan to support the American steel industry, which we think makes really a terrific sense. But this really is not about protectionism for those who would argue that it is I would beg to differ. It really is about continuing to do what we need to do in this country which is get this economy moving again, get credit, get confidence headed in the right direction and get manufacturing back on its feet.

Michelle Applebaum - Michelle Applebaum Research

Okay. And unrelated question more in case specific. You may have shared this I was having a little bit of distractions earlier. You know, you guys were really unfair what you did to us today. It's going to take weeks for us to deal with this, with all of you reporting on the same day back-to-back, very clever, by the way. My question was and your conference call in the third quarter, I think you refer to a billion dollars of cost savings for '09 and I'm not sure that I heard that today and I was just wondering, is it just too bizarre a moving target to even think about quantifying?

James Wainscott

Well, let me take your points in the order you made them. First of all, we have forever come out on this day and this time.

Michelle Applebaum - Michelle Applebaum Research

I know.

James Wainscott

So please talk to our peers.

Michelle Applebaum - Michelle Applebaum Research

We are joking. It's a joke.

James Wainscott

All right but --

Michelle Applebaum - Michelle Applebaum Research

We need jokes today.

James Wainscott

To the more substantive point, I think we talked in 2009, excuse me in 2008 first of all that our input costs for making steel were going to go up around a billion dollars. They came in slightly below that given, some lower costs in the fourth quarter and the fact that we didn't consume as much and I think that billion dollars that we threw out as a potential savings in 2009 was obviously predicated on some assumptions and some volume assumptions as well.

Having said all that, I think that we could see something that approaches a billion dollars when it's all said and done, so we will stand by that. It might be closer to $800 million in terms of lower input costs this year but it's going to be a big number. It has to be a big number to reflect the fact that spot market selling prices have come off by about 50%.

Operator

Our next question comes from Luke Folta of Longbow Research.

Luke Folta - Longbow Research

Good afternoon I guess its afternoon now, gentlemen. How are you doing?

James Wainscott

Hi, Luke, how are you?

Luke Folta - Longbow Research

Well, not bad. Most of my questions have been answered. I just had one more regarding your guidance for the first quarter. I know you guys really don't report it this way, but would you expect that you'd be profitable in your specialty business? I understand carbon is going to be difficult, but can you give some color on that?

James Wainscott

Well, again, internally we obviously look at margin contribution those sorts of things and we would hope that we would have positive margin contribution in a number of areas, but it is not something we report, it is not the way we run the company. Really what we are trying to do is size of the company, in terms of production, in terms of people, in terms of our cost to get to the point we're at around a million tons a quarter of shipments, which is down from 1.6 million to 1.7 million where we love to be at, but haven't been there and may not be there for a while, that we are still generating and operating if not a net income level. That's the direction that we are moving in and again we expect to be there by the second quarter.

Luke Folta - Longbow Research

Okay, just one more follow-up on the met coal contracts. So shall we assume that your met coal pricing is pretty much set in stone at this point or is there room for that to change?

James Wainscott

No. In large measure it's pretty much set in stone, Luke. That again, within the coalers that we have negotiated that the numbers that we will be producing for -- or the numbers we will be using for 2009 are pretty much fixed.

Luke Folta - Longbow Research

Okay, great. Thanks a lot.

Albert Ferrara

Thank you, Luke.

Operator

Our next question comes from Brett Levy of Jeffries & Company.

Brett Levy - Jeffries & Company

As you go into 2009, can you give a little bit of guidance in terms of your target ratio of spot to contract and then talk a little bit about, any form of range of price reductions or anything like that in the contract pricing?

Albert Ferrara

Brett, good morning. Our contract to spot ratio is likely to remain around 50-50, 50 contract and 50 spot. In addition, I would just emphasize that the vast majority of our contracts contain some form of variable pricing, whether it's tied to an index or there is a surcharge mechanism reflecting steel making input costs. So as spot market selling prices rise, we certainly intend to participate in a meaningful way in the form of substantially higher revenues.

We talked a little bit about electrical steel contracts. We really did not talk about automotive contracts. The vast majority of those renew later in 2009, again they will have a base component, a surcharge component to them as well. Timing is everything. But it's important to recognize that in most of those cases as well our input costs have risen, spot market selling prices have actually risen above where a number of those deals were negotiated.

So we will see how that all plays out. Just impossible at this point to give great guidance in light of all of the issues that are out there in the automotive and appliance arena and in light of some of the uncertainties as far as the cost side. But we won't be shy about seeking prices that allow us to make a reasonable return to survive and prosper.

Brett Levy - Jeffries & Company

And with respect to kind of first quarter outlook and that kind of thing, you are not going to bump into, I assume, any covenant issues or anything along those lines and would there be anything that would in your bank covenants impair your ability to buy back bonds in the future?

Albert Ferrara

Absolutely not, Bruce or…

Brett Levy - Jeffries & Company

Brett.

Albert Ferrara

Brett. I'm sorry. We have no covenants that will impact us in any way that would stop us from reacquiring debt. I would point out that the debt we have reacquired has been offered to us. We are not out soliciting the debt but we do accept offers as they come to us.

Brett Levy - Jeffries & Company

And last question on the $45.5 million distribution for minority interest in the fourth quarter, can you give some color on that?

Albert Ferrara

Yes, that's our SunCoke operation, essentially under FIN 46. It's a unique accounting methodology that requires us to consolidate our Middletown coke operation, which is what we call our SunCoke.

Even though we don't own it, essentially we have to consolidate that on our books. We will be reporting that separately. It's not our cash, it's not our operation, but the thing is it does have to be consolidated and that's where that amount is.

It's essentially expenditures that have been made on our behalf that will be running through our cash flow statements, but again it doesn't affect cash or obligations.

Brett Levy - Jeffries & Company

Thanks very much. You guys have got to be proud of the years you've put into preparing the company to weather this kind of thing and the fact that you look very well positioned to do so.

Albert Ferrara

Thank you very much.

James Wainscott

Thanks, Brett.

Brett Levy - Jeffries & Company

Okay, great.

Operator

Our next question comes from Charles Bradford of Bradford Research.

Charles Bradford - Bradford Research

Hey, good afternoon.

James Wainscott

Hello, Charles.

Albert Ferrara

Hello, Chuck, how are you?

Charles Bradford - Bradford Research

Couple of questions. First of all on the Butler expansion, is that still going on or has it been delayed a bit?

James Wainscott

The Butler expansion really involves the new number five electric arc furnace. It is on schedule both from a construction standpoint and a permitting standpoint. We do not yet have the permit in hand. We hope to receive it very soon, but that project, I think as you know, Chuck, is really central to our profitable growth and cost reduction initiatives. It will give us ability to make more electrical steel, which we will need longer term.

So it give us more capacity to make more the carbon steel slabs we need, as well and it's got to replace some 1960s EAF technology with state of the art 21st century equipment, so it's going to be much more efficient cost-effective and cost effective for us, so wherever we want to be in that regard.

Charles Bradford - Bradford Research

What's the current timing? When do you think you'll actually have it up and running?

James Wainscott

Should be late this year.

Charles Bradford - Bradford Research

Even if though, you don't have the permit?

James Wainscott

It won't take long, once we get what we need and we hope that, that happens here very soon, perhaps this quarter.

Charles Bradford - Bradford Research

What's the current situation in regard to the coke plant in Middletown? I saw when they got the last of the needed permits, but it also sounds like there are still people trying to slow you down.

James Wainscott

There has been some local resistance in particular from the city of Monroe, which is frankly not even where the facility will be built, but I'd also add that there has been very strong support for the project starting with the International Association of Machinists and its Local Lodge 1943.

The local Building Trades unions and many local businesses and citizens, as well as Butler County officials and the Middletown City Council has shown great leadership as well.

It really comes down to the location of facility is especially important to us, because given the landlocked nature of the Middletown Plant, our transportation cost for raw materials already put us at a competitive disadvantage.

So we are underway now with construction since we have got all the permits in hand and we hope to work through with the centers, any issues that may still be out there. It's really, again, an issue for SunCoke, although we are obligated to take the off-take of that facility for the next couple of decades.

Charles Bradford - Bradford Research

There had been some talk that if you didn't get or they didn't get that plant done by the end of the year, you were going to run into major coke shortage problems. Where does that stand?

James Wainscott

At this point, again, we make about 70% to 75% of our own Coke requirements. We have been buying the remainder, nearly all of our other coke requirements from Shenango. The Shenango, which by the way was bought by DTE, our deal with Shenango expires at the end of this year.

We are obviously in a coke long standpoint right now given the production levels that we are operating at. If market conditions return to more normal levels, we might be short. Frankly, given the worldwide coke situation right now, we are not too concerned about that.

Having said all of that, we would like to get this built and up and operating as quickly as possible. We were hopeful that that would occur by the end of 2009. It's likely going to go into early 2010 at this point.

Operator

Our final question comes from Kuni Chen of Banc of America.

Kuni Chen - Banc of America

. Good day, everybody.

Albert Ferrara

Hi, Kuni.

Kuni Chen - Banc of America

Can you just clarify for me the $700 million of non-cash pretax charges, what is the after-tax amount there?

Albert Ferrara

The after tax amount is about $400 million.

Kuni Chen - Banc of America

Okay, great. And then just as far as Middletown goes, you mentioned $13 million of maintenance outages in the first quarter. It looks like you get about half of it done if you start in early March. So should we assume that you have another $13 million that flows into the second quarter?

Albert Ferrara

We would expect our outage expense in the second quarter to be somewhat similar overall to the first quarter. It might be up a million or two, but generally speaking it should be flat.

Kuni Chen - Banc of America

Okay.

Albert Ferrara

Couple of million dollars.

Kuni Chen - Banc of America

All right, great. And then just lastly, as far as the outlook for an improving second quarter. Is that just more based on your macro views or are your customers saying anything specific that does give you more confidence that that volume trend should improve in the second quarter?

James Wainscott

We expect to see and we are already seeing higher volume levels in terms of sales, not dramatically so, but certainly an uptick from the level that we are seeing in the first quarter. We also expect to enjoy the lower cost, so it's really a function of the two things at the end of the day that should move us directionally in a positive fashion.

But I think we are still some time-off from seeing the kinds of volume levels that we would really like to see. Having said that, these are levels that we'll adjust to and that we can ensure that the company remains sustainable and viable for the long-term at, because even though we are seeing some signs, it's a little early to confirm that the recession is over, that the worst is behind us, but we are seeing a bit more interest both in terms of sales orders and volumes and certainly we expect to enjoy the lower cost.

Kuni Chen - Banc of America

Okay, great. Good luck.

James Wainscott

Thank you very much.

Albert Ferrara

Thank you, Kuni.

James Wainscott

Before signing off, let me again take the opportunity to thank all of you who joined us on this busy earnings reporting day. Thank you for your interest in AK Steel and your continuing support on our company.

We look forward to having you join us on our first quarter 2009 conference call in about three months, same time, same place. We wish you a great day and a better 2009 and God bless you and God bless our country.

Operator

Ladies and gentlemen, this concludes our conference call for today. Thank you for participating.

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Source: AK Steel Holding Corp. Q4 2008 Earnings Call Transcript
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