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AK Steel (NYSE:AKS)

Q2 2009 Earnings Call

July 21, 2009 11:00 am ET

Executives

Albert E. Ferrara, Jr. – VP of Finance and CFO

James L. Wainscott – Chairman, President and CEO

Analysts

Brett Levy – Jefferies & Company

Michael Gambardella – JP Morgan

Mark Parr – KeyBanc Capital Markets

Sal Tharani – Goldman Sachs

Michelle Applebaum - Michelle Applebaum Research

Timna Tanners – UBS

Evan Kurtz – Morgan Stanley

Dave Martin – Deutsche Bank

John Sullivan – Citi

Luke Folta – Longbow Research

Kuni Chen – Merrill Lynch

Operator

Good morning, ladies and gentlemen, and welcome to the AK Steel second quarter 2009 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator instructions) As a reminder, this conference call is being recorded.

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 E. Ferrara, Jr.

Thank you Patty and good morning, everyone. Welcome to AK Steel’s 2nd quarter 2009 conference call and webcast. In a moment I’ll review our 2nd quarter financial results as well as provide some guidance for the third quarter of 2009. Following my remarks, Jim

Today’s call includes certain forward-looking guidance. Other than our comments on historic results, the remarks we make today constitute forward-looking statements within the meaning of section 21E of the Securities 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 that 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 or risks affecting forward-looking statements, found in our annual report on form 10-K for the year ended December 31, 2008 as updated in our most recent quarterly report on form 10Q. To the extent that 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.

Earlier today, AK Steel reported a net loss of $47.2 million for the 2nd quarter of 2009. Despite extremely difficult market conditions, the results represent a 35% improvement, compared to our 1st quarter 2009 net loss. As noted in the initial and updated guidance that we provided for the quarter, AK Steel’s results for 2Q were significantly impacted by the ongoing severe global recession. As a consequence, AK Steel experienced a lower level of customer orders and operating levels at our plants and we experienced decreased shipments and lower average selling prices than in the previous quarter. Despite these substantial obstacles, AK Steel narrowed its operating and net losses quarter-over-quarter, due primarily to effective cost-reduction measures that we implemented company-wide.

Second quarter 2009 shipments were only 740,600 tons, representing a 5% decline from the previous quarter and roughly 1 million tons below our 2nd quarter 2008 shipment level. Our average selling price for the 2nd quarter of 2009 was $1,072 per ton, which was roughly 9% lower than the prior quarter. Total revenues for the 2nd quarter were $793.6 million, or about 14% below our revenues in the first quarter. Of note, we continued to increase our business on a relative basis in the infrastructure and manufacturing market group, which rose to 40% of our revenues in the 2nd quarter of 2009. And, our non-US revenues in the 2009 2nd quarter were $191 million or about 24% of our sales for the quarter.

On the cost side, although we experienced significantly lower volumes and reduced operating rates, our results benefitted from lower raw material costs, compared to the previous quarter; a trend we expect to continue in the 2nd half of 2009. The results also reflect LIFO credit of $94 million in the 2nd quarter of 2009. We incurred planned maintenance outage expenses of approximately $16 million in the quarter. Most of the outage expense was related to maintenance work performed at the Middletown Works Blast Furnace, which began during the first quarter. Netting revenues and costs, we incurred an operating loss of $72.5 million or $98 per ton. However, that represents an improvement of $27.4 million or roughly $30 per ton, compared to our first quarter results.

Turning to the balance sheet, our continuing focus on cash and liquidity, working capital management and maintaining our financial flexibility has allowed us to sustain a strong financial position. We ended the 2nd quarter with a solid cash balance of $386 million and had $668 million in availability under our revolving credit facility, for a total liquidity of more than $1 billion.

A key to AK Steel’s business model is to maintain financial flexibility while improving the balance sheet and investing in targeted capital improvements. As such, despite the lackluster market conditions, we’ve maintained a strong liquidity position without resorting to diluted capital market transactions. Thus, our continued financial strength allows us the flexibility to take advantage of opportunities that may arise.

Let me provide an update on some of the uses of cash to enhance shareholder value.

Earlier this morning, we announced that AK Steel’s board of directors has authorized another contribution to our pension trust fund. The contribution will be made from internally-generated cash. This $110 million contribution will be double the $55 million that is required for the balance of 2009 and we expect the additional contribution to reduce our 2010 contribution obligation dollar for dollar. This will bring our total 2009 pension contributions to $210 million and our total contribution since 2005 to more than $1 billion. During the 2nd quarter, we repurchased $3.3 million in par value of our 7 ¾ % senior notes due in 2012. Since the 4th quarter of 2008, we’ve redeemed $46 million in par value of these notes.

Now let’s take a brief look at our results for the first half of 2009. Revenues for the first half were $1.7 billion, compared to revenues of $4 billion in the first half of 2008. Our non-US revenues of $371 million represented 22% of our sales for the first six months of 2009. By comparison, non-US revenues in the first half of last year totaled about 16% of our sales. Shipments for the first six months of 2009 were 1,519,400 tons; less than half our shipment level for the first six months of 2008. Our average selling price for the first half of 2009 was $1,129 per ton, which was roughly 7% lower than the first half of 2008. And, at the bottom line, we had a net loss of $121 million for the first half of 2009 or $1.10 per diluted share. This compares to net income of $246 million or $2.18 per diluted share for the same period of 2008.

Let me provide some guidance for the 3rd quarter now. We expect our 3rd quarter shipments to be approximately 200,000 tons higher than our shipments for the 2nd quarter and we expect our average selling price to be essentially flat quarter-to-quarter. We expect to benefit from lower operating and raw material costs and we expect a continued decline in our raw material costs for the full year 2009, compared to 2008. We expect our maintenance outage costs to decrease by approximately $6 million quarter-over-quarter due to the completion of the Middletown Works Blast Furnace outage and we anticipate another LIFO credit in the 3rd quarter. Overall, we expect a roughly break-even 3rd quarter with respect to operating profit, which would represent an improvement of approximately $70 million or about $100 per ton, compared to the 2nd quarter.

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

James L. Wainscott

Thanks very much Al and good morning everyone. Thanks to each of you for taking time to be with us today.

Continuous improvement. Perhaps nothing describes our focus at AK Steel better than that phrase. It is a way of life for us at AK Steel both in times of success and survival. Indeed we got better in the second quarter of 2009 and we expect further improvements in the second half of this year, as well.

Even though we found ourselves firmly in the grasp of the great recession, as some called it in the 2nd quarter, we made excellent progress as we dealt with an unbelievable mix of challenges. Despite setting a record for the lowest level of shipments in our company’s history and during a 10% decline in average selling prices and living through the bankruptcies of General Motors and Chrysler, AK Steel turned in a second quarter that was better than our first quarter. Years from now, we’ll look back on this past quarter and say it was one of our finest performances, I believe. It’s a remarkable achievement and I suspect that relatively few steel producers around the world will be able to say that their second quarter was better than their first quarter of this year.

Taking everything into consideration, the credit really goes to the outstanding performances of AK Steel employees. It was their efforts that enabled us to succeed in lowering our costs, which was the major driver of our improved quarterly results. While taking nothing away from our people and their extraordinary efforts, to be clear about our 2nd quarter and 1st half 2009 results, we are not happy nor are we satisfied in generating operating and net losses; that’s not our style. But, we’re encouraged that our results are headed in the right direction. In fact, we believe that the worst is behind us and that better days are ahead for AK Steel.

Our improved performance in these very challenging times speaks volumes about AK Steel’s business model. In addition, it’s a testament to the resolve of our entire team to weather this unprecedented economic downturn and emerge as an even stronger steel company.

Just to put things into perspective for a moment, though, we shipped nearly a million fewer tons in the 2nd quarter of 2009 than we did a year ago. Incredible. A nearly 60% reduction in shipments, I suppose almost qualifying us for a place in Ripley’s Believe it or Not history. But, we’re still here. We’re still standing to fight and to compete another day. After all, it’s not how high you climb; it’s how far you bounce back. And, AK Steel is bouncing back.

You need a lot of cash and liquidity to get through these times. On June 30th, as Al mentioned, our cash and liquidity were solid and remained in excess of $1 billion. We’ve not tapped our credit facility through all of this, nor do we intend to do so. And, I suppose most importantly, unlike most of our peers, we did not dilute our shareholders’ interests in order to keep the company afloat in these challenging economic times.

As I’ve said before, 2009 is not a year about being great or perhaps even being good. It’s a year that you simply have to put your head down, plough ahead and get through these very tough times. With that in mind, at AK Steel we continue to roll on. We remain focused on our core values as we strive to outperform the expectations of our customers and our shareholders, lower our costs and grow our cash position. Indeed, we’ve remained to our company’s core values in these difficult times. Our goal is to be the safest, highest quality, most productive steel maker in the world. We also want to treat our customers better than any other steel maker. And, we want to take care of our people. And, I think that we did those things very, very well in the first half of 2009. For example, in safety, we completed our best-ever first half with a total of only five, 5 OSHA-recordable injuries throughout the company.

During the 2nd quarter, AK Steel’s Middletown Works and AK Tubes Walbridge Plant each received safety recognition from entities within the state of Ohio. Of course, we’re proud of our safety performance and all of the awards, but even though our injury frequency rate is a fraction of that of our peers, we will never stop working to improve our safety performance. Our people and their families deserve nothing less.

Once again, continuous improvement is at the heart of our management approach. That certainly applies to our focus on quality and customer service, as well. During the 2nd quarter we were honored by several of our important customers including Kenwal Steel, Berg Steel and Arriva. Both Kenwal and Berg presented us with their top supplier award for our excellent and consistent quality performances, our outstanding customer service and our ability to work together through these rapidly changing market conditions.

We were also honored to be named a certified supplier by Arriva, who is one of the world’s leading producers of electric transmission and distribution products. This particular recognition is bestowed upon a select handful of Arriva suppliers that meet or exceed 25 key criteria including product quality, innovation and competitiveness. We supply grain-oriented electric steel to Arriva’s transformer and distribution division for the manufacture of energy-efficient power transformers at plants based in Europe, South America, Asia and other locations around the world.

Customer awards such as these simply confirm the results of an independent customer survey performed by Jacobson and Associates. According to the survey, for the 2nd quarter of 2009, AK Steel was once again rated number one in quality, compared to our industry peers.

Switching from sales to production, in light of the lack of orders as you might expect, we set very few production records during the 2nd quarter. Nonetheless, it was an eventful quarter for us. That’s because we successfully completed the first hearth replacement on the Middletown Works Blast Furnace in a quarter of a century. To all of those involved in the successful planning and execution of this critical maintenance job for AK Steel, I offer my thanks and kudos for a job well done. And, I’m delighted to report to all of you that the Middletown Blast Furnace ramp-up schedule is complete and it has returned to full production.

Now let me take a moment to offer a few thoughts on our chosen markets and products. These days our largest market from a standpoint of tons shipped is the distributors and converters marketplace. Service center flat roll steel inventories are now down 52% from their peak. Steel distributors now have only 2.1 months of supply of carbon flat roll steel on hand, which historically speaking is an extremely low inventory level. As the stocking programs have run their course, service centers and distributors have increased their steel purchases to match the current demand. And, as a result, we’ve seen an uptick in our recent order intake rate.

Regarding the automotive sector, our current sales to automotive customers continued to decline in the 2nd quarter, as a percentage of total sales and for Q2 represented about 30% or so of our total sales directly to the automotive market. By comparison for the year ’07, that figure was about 40% and for all of 2008 it was about 32%. In addition, our automotive sales portfolio continues to be well diversified among the Detroit three and the transplant automotive manufacturers who continue to favor purchasing their steel from domestic steel producers.

From our perspective, the automotive market appears to have stabilized at an annual sales rate for 2009 of about 10 million units. And, with inventories of unsold vehicles now much more in line with sales levels, North American light vehicle production schedules are increasing for the 2nd half of 2009. Based on what our customers tell us in the automotive segment, it’s possible that AK Steel’s 2nd half automotive shipments could grow by as much as 40%, compared to the first half of this year.

Let me make a brief comment on where we stand with the amounts that were owed to AK Steel by General Motors and Chrysler when each filed for bankruptcy protection. At the times of filings, the press had reported the size of the amounts that were owed to AK Steel by GM and Chrysler. I’m happy to report that we have collected 100 cents on the dollar of all of our GM and Chrysler pre-bankruptcy receivables. We look forward to working closely with the new GM and the new Chrysler, each of which emerged from bankruptcy after a period of only 40 days. For that matter, we look forward to working in concert with all of our fine customers for years to come. Early on, this management team proclaimed that we were entirely focused on our customers. That was true then, and it is especially true today. Make no mistake; customers remain our focal point, our reason for being here at AK Steel.

Let me move from the automotive market to our infrastructure and manufacturing market. This market covers a broad range of customers and their markets, including the areas of appliance construction and manufacturing. From the standpoint of consumer durables for the 1st half of 2009, appliance sales are down by about 14%, compared to the year ago period. But, by comparison, that decline is far less steep than the 35% year-to-date decline experienced in automotive. Of late, we’ve seen an increase in the production schedules of our appliance customers and we’re also benefitting from an increased share of the appliance market for our products.

There are few signs of improvement in the construction market, which is one of our smallest end markets, thank goodness at this point. In fact, non-residential construction appears to be declining further as completed projects are not replaced by new ones.

Having said all of that, as a result of overall increased demand and higher steel-making input costs, especially for scrap which has risen by more than $100 per ton in the past couple of months, we’ve increased our spot market prices. We’ve now had a series of three spot market price increases on carbon steel products and two price increases on stainless steel products. Speaking of stainless steel, we’ve seen increased buying recently on the part of service centers and it appears that with rising nickel costs, many service centers have been trying to get a jump on expected higher surcharges in the months ahead.

Finally, on the subject of electrical steel, we have seen a recent reduction in demand, both from NAFTA and overseas customers. We expect this to be relatively short-lived as we believe it’s a function of two things: the continuing global economic recession and the desire by transformer manufacturers to reduce their inventories. As the global economic recovery takes shape, and as customer inventories are, in fact, reduced we’re confident that we’ll see a recovery in electrical steel demand.

In fact, we think that this could occur as early as the 4th quarter of this year and longer-term, as construction markets recover, stimulus projects are finally funded and the US electricity grid is modernized and the developing world restarts a number of energy projects that were delayed, we remain very positive about our global position in the electrical steel business.

Beginning in the 3rd quarter of this year, which we’re in, we’ll benefit in a very meaningful way from substantially lower steel making input costs that largely arise out of the decline in iron ore pellet prices. The European benchmark for iron ore finds, lump or in pellets has been set and the pellet price decline is slightly in excess of 48%. While Canadian benchmark prices have not yet been finalized, all in, we expect that AK Steel’s iron ore pellet prices will decline by an amount or percentage approaching the decline in the European benchmark that I just mentioned.

Having worked through our higher priced pellet inventory in the first inventory in the first half of 2009, we expect to benefit in a meaningful way from lower pellet costs in the 2nd half. On the strength of lower costs, both input and operating, higher spot market pricing and higher production and shipment volumes, we expect a substantial improvement - $100 a ton I think is what Al talked about – in our operating profitability and our net results for the 3rd quarter of 2009 as compared to the 2nd quarter.

Before taking your questions, let me simply say that despite our optimism for the future, and our guidance for a much better 3rd quarter and 2nd half of 2009, the economic recovery is likely going to be a protracted one. We have bounced off the bottom, but we’re not here to call the end of the great recession. Because of that, we will continue to focus on our three-C’s program: taking care of our customers while lowering costs and conserving cash. Our three-C’s program is one that we initiated nearly six years ago. It has and will continue to serve us well at this extraordinary time.

Frankly, it’s a good time to be a good company with the characteristics of AK Steel, including our relatively smaller size and niche market focus, our diverse product mix, our roughly 80/20 US and non-US sales mix, flexible labor agreements, a balanced raw materials position, solid balance sheet and excellent cash and liquidity positions.

In closing let me say that despite significant near term challenges, I remain very confident in the long term prospects for AK Steel. With our continuous improvement approach, we intend to be here to serve our customers better than any other steel maker and to continue to take care of our people as well. Both groups are counting on us. They tell me that every day. And, we have absolutely no intention of letting them down.

Thanks again to all of you for joining us today. With that, we’d be happy to field your questions.

Question-and-Answer Session

Operator

Thank you Mr. Wainscott. We will now begin the question and answer portion of our conference call. (Operator Instructions). Our first question comes from Brett Levy of Jeffries & Company.

Brett Levy – Jefferies & Company

Hey guys. Excellent progress. Can you talk a little bit about the Ashland situation and if it’s forced to stay open is it something that is a source of significant cash burn or - given the improved outlook - do you think you can kind of run it pretty close to neutral or better?

James L. Wainscott

Great question Brett. Thanks for asking it. Let me just give a little bit of background. First of all, we have what we feel are the best labor agreements in the steel business. One of the great aspects of the deals that we’ve negotiated is the flexibility that we have in those deals to run our operations in a way that makes sense to do so, which is really the same approach we were applying in the case of Ashland. Due to the extraordinarily low order intake rate that we were experiencing, previously it was our intention to idle the Ashland Blast Furnace, gave appropriate notices and really the timing of that idling was to coincide with the ramp-up of the Middletown Furnace.

Of course, the answer to all of this, to run both of our blast furnaces and other facilities at higher rates, is more orders. That’s how we spell relief at the end of the day. So it certainly was nothing personal; we were simply trying to take opportunity to reduce our costs, avoid transportation costs and so forth.

The critical issue at stake here is some language that is in the agreement. The steel workers filed a grievance alleging that we had contractually agreed that subject to customer demand, the company would operate the Ashland Blast Furnace. So really, the issued turned on, what does that mean? The arbitrator in this case interpreted the language to mean that so long as there is demand for products that can be produced at Ashland, that those products must be produced at Ashland until it’s operating at full capacity. I’d say that we disagree strongly with that interpretation. We’re studying the arbitrator’s ruling to evaluate our options. The good news is that, as I’ve said in my prepared remarks, we have seen an increase in orders recently. And, because of that, we had intended in any event to run Ashland through most of if not all of August.

And, beyond that, the market will determine what we need to make. I will just offer a couple of final thoughts on it. First, flexibility is key; certainly for the long term. We’ve worked through a lot of other challenges and issues. We’re working to do this from a manufacturing, planning and scheduling standpoint. We’ve already incorporated it into our guidance that Al provided for the 3rd quarter, in terms of any cost impacts. And, to the extent that there will be other impacts beyond that, we’ll take a look at that as we go forward. Hopefully the market will solve this for us. If not, we’ll evaluate all of our other options.

Brett Levy – Jefferies & Company

Alright. And the for the 2nd half of ’09, can you guys talk a little bit about where you’re going to be spot vs. contract, two half vs. one half and whether or not there’s actually been that kind of the start of any contract negotiations for 2010 yet?

Albert E. Ferrara, Jr.

I’ll just take a stab at it as follows. Again, we’re happy to see the increase in orders. Those orders are coming both from automotive customers, from appliance customers as I mentioned and from the service centers. I don’t know that our percentages will change substantially. We’re probably a little bit more contract than spot, but that can change pretty quickly. Again, the economy has got a lot to do with all of this. At the end of the day, I think short term we are seeing an improvement as restocking occurs. But, I don’t think anybody is going to get ahead of this. I think that the service centers are too smart. I think the auto guys have a big dose of reality now. The mix will be probably 55/45 contract to spot; somewhere in that kind of range. But the key for us is not so much the mix as it is really the increases in volume and the increases in prices that we’re pushing through. As far as the new deals that we’ve got, we have been involved in discussion and dialogue with both GM and Chrysler and we hope to profitably grow those parts of our business.

Brett Levy – Jefferies & Company

Thanks very much guys and a good 2nd Q.

Albert E. Ferrara, Jr.

Thank you, Brett

Operator

Our next question comes from Michael Gambardella of JP Morgan.

Michael Gambardella – JP Morgan

Yes, good morning. Congratulations on the hard work and all the results.

Albert E. Ferrara, Jr.

Good morning, Michael.

Michael Gambardella – JP Morgan

I have a question on the iron ore pellet situation and your costs going forward. I know you get most of your pellets from the Eastern Canadian mills, which you mentioned are basically tied to the sea born price, which was down 48%. But, I believe those contracts start on April 1st, so that your pellet suppliers will have to true up or either cut you a check for what they overcharged you in the 2nd quarter or lower the price even more than the 48% to make up for that differential for the 3rd quarter, maybe even the 2nd half. How does that work and how does that benefit filter into your numbers in the 2nd half?

James L. Wainscott

Michael, actually the contracts start January 1st, but we really don’t get any deliveries until the 2nd quarter. We have made provisional payments to them, based on individual discussions that we’ve had with each of the mines. But, we’ve made an assumption if you will, and have since we’ve received those pellets, as to what our expectation would be with respect to that pricing.

Now, we would probably benefit somewhat, cash wise, in the 3rd quarter when it’s trued up, but in effect we’ve been assuming a certain level of pricing which we’re very comfortable with and will continue to assume that until the price is set. We’ve expected and would expect to get a benefit in the second half of the year substantially more than in the first half with respect to pellets, keeping in mind in the first half of the year we benefitted significantly from scrap, nickel and alloys that benefitted us. Overall, we expect to see an overall reduction in our raw material costs, in the second half vs. the first half. In other words, we’ll get more of a benefit in the second half than in the first half.

Michael Gambardella – JP Morgan

Right but, in terms of the almost $100 per ton operating improvement, which is coming largely from cost reduction, how much second and in the third quarter – could we view as a non-recurring thing that’s really the true-up component?

James L. Wainscott

Well, really not much of that is true-up, Michael. What we’re talking about in the third quarter vs. the second quarter is you have really three things at work there. One, we have increased volume of 200,000 tons which will benefit us from an operating performance perspective, as well as the fact that we continue to take costs out of the business. You do have the raw material price decreases that we’ll be tasting more of in the third quarter and subsequently into the fourth quarter, as well. In addition, we have lower outage costs in the third quarter vs. the second quarter. So all three of those, if you will, factors are in effect improving us to the extent of about $70 million or $100 per ton. We wouldn’t see that as non-recurring. It’s not a question really of any significant sort of true-up, so to speak.

Michael Gambardella – JP Morgan

Okay. And last question, just on your pricing guidance for the third quarter. Is a good way to interpret your guidance to basically think about it as okay, the first month of the quarter – July – the prices were still going down in the marketplace because those were prices from June and maybe even earlier? And, the August month is probably relatively flat pricing and the September month is probably up a little bit and the net effect is a flat pricing for the quarter?

James L. Wainscott

I think Michael there are a lot of things submitting pieces and parts here. We may have still been dipping down as we entered into the third quarter, but the direction is upward. As we mentioned earlier, we’ve announced the three increases. We’ve got a relatively small amount of tonnage to book, really as we look out into September. There’s more there I suppose if it’s profitable to bring more on. It really is as much a mix issue as it is a price issue. Really in stating that as we talk, we may have a bit less in terms of electrical steel sales, which tend to carry a little bit higher price tag. And, that average if you will, is moving down more as a result of that than it is kind of your thesis.

Michael Gambardella – JP Morgan

Okay. Thank you very much.

James L. Wainscott

Okay, thank you.

Operator

Our next question comes from Mark Parr of Key Banc.

Mark Parr – KeyBanc Capital Markets

Thanks very much.

Albert E. Ferrara, Jr.

Good morning, Mark.

Mark Parr – KeyBanc Capital Markets

Good morning guys. I was wondering if you could give a little color on the impacts of LIFO? I don’t know if you’ve quantified that for the 2nd quarter, but could you talk about the 2Q, 3Q LIFO impact related to your guidance?

Albert E. Ferrara, Jr.

Well, the thing is in the 2nd quarter we benefitted about $66 million up to $94 million in terms of our LIFO impact. What came about as a consequence was a determination for the full year that we expected our LIFO credit to be about $320 million. So, $160 million is what we needed to book for the first half of the year and the 2nd half represented a portion of a true-up. We don’t give specific guidance as to the 3rd quarter, but by implication we would expect to book about $160 of LIFO for the second half of the year. But to be perfectly candid, that number is obviously going to fluctuate based on our expectation of prices and inventory levels at the end of the year.

Mark Parr – KeyBanc Capital Markets

So the 2nd quarter LIFO credit was, if you annualized that it would be more than $320 million.

Albert E. Ferrara, Jr.

That is correct. And, the reason for that Mark is that we booked half of our expected LIFO credit for the year in the 2nd quarter.

Mark Parr – KeyBanc Capital Markets

Okay. So if you were to take it sequentially, the 3rd quarter LIFO credit will be lower than the 2nd quarter, assuming no change in the full year outlook.

Albert E. Ferrara, Jr.

Assuming that, but I’ll have to say this, we would certainly have an expectation that due to a number of factors, fluctuating commodity prices as well as possible changes in inventory levels, that you could see a change in that. But, we’ve learned not to project LIFO, simply because it’s very problematic to do that. But, your analysis is correct.

Mark Parr – KeyBanc Capital Markets

Okay, fine. Just another thing, if I could get some color on the pickup in demand you’re seeing on the stainless side. If you could, talk about that relative to what you’re seeing on the carbon side that would be helpful as well.

Albert E. Ferrara, Jr.

Again, as I mentioned Mark, it’s really the underlying cost of the price of nickel that’s been moving here. I think we’ve seen virtually a doubling of that since the beginning of the year. And, I think as smart buyers of stainless products look out and try and hedge their bets, if you will, against the rising surcharges, the order intake rate is picking up pretty substantially for us. Percentage-wise it may have been leading carbon for a while. But again, in the last few weeks or so, we’ve seen a pretty large increase in carbon, as well. So I think it’s fair to say that the uptick is something that’s being shared both in carbon and stainless.

Mark Parr – KeyBanc Capital Markets

Okay, because you had mentioned your automotive business could be up as much as 40%, second half. Part of your stainless business is automotive, but could the stainless business be up that much?

Albert E. Ferrara, Jr.

It could be. It’s been a little bit stronger, so the percentage might be a little bit less. But certainly the 400 series stainless which we make primarily out of our Mansfield location, has probably been hid hardest in this first half. We're still not looking for a huge recovery there in the third quarter. But, as the rest of the year goes on and if that 40% or so comes to pass, we’ll certainly see a benefit of the auto-chrome stainless 400 series.

Operator

Our next question comes from Sal Tharani of Goldman Sachs.

Sal Tharani – Goldman Sachs

Good morning guys.

Albert E. Ferrara, Jr.

Good morning, Sal.

James L. Wainscott

Good morning, Sal.

Sal Tharani – Goldman Sachs

You mentioned that the non-US revenue contributed about ¼ of the total earnings or revenue?

James L. Wainscott

No, just the revenue, Sal. We don’t break out the earnings, but that is correct. It was about 24%.

Sal Tharani – Goldman Sachs

Is that increase in any particular products you’ve been shipping too much outside?

James L. Wainscott

No, I think as we’ve indicated in our public disclosures, we’ve had a – the preponderance of our increase has been certainly on the electrical and stainless side. I will point out though, Sal, that even though our percentage is up, clearly our revenues are down internationally. If you look at it on a revenue basis, we’re down from $650 million to $370 million. But as a percentage of our overall sales, it has increased.

Sal Tharani – Goldman Sachs

Got you. Also, can you give us what utilization rates you are running at the moment at your Middletown mill and also Ashland?

Albert E. Ferrara, Jr.

Again, we’ve been coming up ever so slightly. We were probably operating at about 40% or so at the first quarter and are flat company-wide now. We were still less than half in the 2nd quarter and we’re going to break through the 50% mark here in the 3rd quarter, thank goodness. At Middletown, we’re essentially back to full production. We’re running full-out. We were down for the entire 2nd quarter, in terms of the steel shop there. It’s been an extraordinarily good start up and ramp-up curve and we’re running at its top level.

Sal Tharani – Goldman Sachs

And at Ashland you are running at lower utilization rate now that Middletown has come up?

Albert E. Ferrara, Jr.

You know, we’re balancing Ashland to really meet the needs there and we’re certainly complying with the arbitrator’s ruling in that regard. We continue to look at what the order book requires. But, Ashland’s been running at very high rates and so has Middletown and that’s really to catch up for the recent order intake rate as we significantly reduced our inventories and we’ll continue to balance that very closely. We don’t want to get out of whack here in terms of how much steel we produce versus the orders that are coming in.

Operator

Our next question comes from Michelle Applebaum of Michelle Applebaum Research.

Michelle Applebaum – Michelle Applebaum Research

Hi.

James L. Wainscott

Good morning, Michelle.

Michelle Applebaum – Michelle Applebaum Research

Hi. First, wow. Pretty impressive. I wanted to ask you a question. You said that there was a true-up. You said $37 a ton of LIFO credit in the 2nd quarter. How much of that was first quarter patch up?

James L. Wainscott

Well Michelle, if you assume that we have on an expected basis $320 million, if we had in the 2nd quarter a LIFO credit of $94 million, you would assume $160 million being the number; it would be $80 million per quarter. So the true-up, in effect, would be $14 million.

Michelle Applebaum – Michelle Applebaum Research

Okay. So that’s nominal, a couple of pennies.

James L. Wainscott

Right.

Michelle Applebaum – Michelle Applebaum Research.

Okay. And my other question for you, I was curious about this stuff on Ashland and the labor contract. Have you talked about that yet?

Albert E. Ferrara, Jr.

We did.

Michelle Applebaum – Michelle Applebaum Research.

What I was curious about is that, is this a labor contract, is this how the judge is reading the labor contract or do you think that this is more of a political thing or can’t you comment on that at all?

James L. Wainscott

I think it would be safest not to comment on it. The arbitrator has ruled. We’re evaluating and trying to interpret and understand that. You know, I don’t know whether politics are involved or not involved. Certainly our approach has been one of let’s do what makes the best sense for the company. What is the economically most efficient thing to do? We’d love to run everything full – both at Ashland and Middletown and Mansfield and Butler. But obviously, in this environment it can’t be done. We didn’t create the economic situation we’re all in but we have to react to it. That’s really what we’ve tried to do in the best fashion for the company. The arbitrator’s finding is disappointing, as I said before. But we’ll play through that as we have many, many other things.

Michelle Applebaum – Michelle Applebaum Research

Okay. We haven’t been talking as much these last six or nine months and there have suddenly become available from integration opportunities for you in this country and perhaps abroad. Should we start thinking about you looking to be opportunistic in acquiring upstream?

James L. Wainscott

I’d say we’re certainly in a very different position as a company, a much stronger, much healthier position – with enormous flexibility – than we’ve ever been. And, I think that we’re positioned to look at a lot of things, really consider all of the available opportunities and determine what might have the most value for our shareholders. We have continued to look backwards at raw materials, energy self-sufficiency, improving our cost position. We’ve continued to invest in profitable market niches like electrical steel. We’ve done four of those. We continue, as Al said in his prepared remarks, a lot of money we’ve reinvested in the company and improving the balance sheet. I think we’ve done a good job in all of those respects and the board has been really very wise in their stewardship of our cash. But, to your question, it’s a very interesting and very good question; that we’re positioned very well to compete these days. So the question is how do we best maximize shareholder value going forward? We’re mindful of all of the opportunities that I think you’re referring to.

Operator

Our next question comes from Timna Tanners of UBS.

Timna Tanners – UBS

Yes, hi, good morning.

Albert E. Ferrara, Jr.

Hello.

James L. Wainscott

Good morning, Timna.

Timna Tanners – UBS

I wanted ask – I’ll just keep it to two, easy hopefully. One is CapEx. If you can, just give us an update there. I think run rate so far is higher than I think you’ve guided to, or is that going to change?

Albert E. Ferrara, Jr.

The run rate is around 76 but we’re expecting to be right around $100 million for the year.

Timna Tanners – UBS

So that should taper off?

James L. Wainscott

Yeah, we’ll taper off in the 2nd half of the year, for sure.

Timna Tanners – UBS

Okay. Then on electrical steel, in particular I was interested in the guidance. Are there any grades in particular that are seeing a difference? Is that in the TCH, is that in the non-grain? Grain? If you could give us a little bit more color. And then, if you could describe a little bit why it should be a one to two quarter phenomenon in your view, that would be helpful.

James L. Wainscott

I’ll just take it in reverse Timna, if I can. I think what we’re seeing is sort of the same thing that happened in the service center arena, albeit that took a little bit longer, two to three quarters to sort of work through inventory levels where things were a lot worse. I think the electrical steel purchasers are very mindful of what’s going on in the world and there’s no year-long or six month overhang here. I think these are minor modifications that, as we talk to them, they’ll work through largely in the third quarter.

The products that remain in the highest demand are really the most efficient grades of electrical steel. For us, it’s TCH, it’s high-D as some refer to it around the world. We really have not seen any sort of meaningful deterioration with respect to that product line. It is some of the lesser efficient, if you will, still within a very strong category of efficiency, nonetheless. But, some of the lesser grades, if you will, within that product have also faced some additional competition globally from imports. But it’s also just a slowdown relative to the overall economy, lack of construction projects, in particular non-residential. Again, it will take some time to work through that more on the lower end.

Timna Tanners – UBS

So you’re saying that more of the deterioration in sales of late has been in the non-grain oriented? Is that right?

James L. Wainscott

It’s more on the grain oriented, but on the lower end of that.

Timna Tanners – UBS

Oh, okay. Understood. Can you give us any suggestions then on how we can try to track that on our own? I mean, how much – are there any particular sources that you look to that are public that we could try to gauge the electrical steel consumption or inventory on?

James L. Wainscott

It would be a little challenging to do that. Again, we take our leads in speaking directly with our customers and I think they’re a little shy about sharing a lot of that publicly as well. I’ve probably said about as much in that regard as they would be comfortable with me doing.

Operator

Our next question comes from Evan Kurtz of Morgan Stanley.

Evan Kurtz – Morgan Stanley

Good morning and congratulations on a tough quarter and tough environment.

James L. Wainscott

Good morning Evan.

Evan Kurtz – Morgan Stanley

You mentioned that you might see auto ships up by 40% in the 2nd half of ’09 and I just wanted to get a sense of how much of that uptick are you already seeing in your order books and whether or not you have a sense of what auto steel inventories are right now at the auto plants?

James L. Wainscott

Well, I don’t know that I’d go to the auto inventory question except to say that it is dramatically more in line with where it needs to be and I think they’re still working through the strategies of the new GM and the new Chrysler with the new dealerships and all that sort of thing. You know, as they effectively got out of making the vehicles for quite a long period of time here in the 2nd quarter, as you might guess, things are far back in line. We’ve seen a pick up. I don’t know that we’re all the way through the 35-40% level, but it’s certainly double-digits at this point; substantial double-digits.

Things are heading higher, is what we’re hearing. That’s good, I think for everybody. I think it’s very good for our economy. Maybe the clunkers for cash or cash for clunkers program– albeit that would be a one-time shot in the arm – could be helpful in that regard, as well. But, I think that the managements of the automotive companies and the boards of those companies are going to stay very, very close to inventory levels and match supply and demand. I just say 40% sounds like a big number. I think JP Morgan’s auto analyst, for example, has estimated that the 2nd half will be 54%. So, we may be conservative, we may be aggressive. I think it’s about right. But, that comes off an incredibly low base in the first half of 2009, so I say just keep that in mind, as well.

Evan Kurtz – Morgan Stanley

Okay. Secondly, you mentioned briefly when you were speaking of Arriva that you might be able to target distribution transformers that go into Asia, among some other places. I was wondering if you could just provide some more color on what the real appetite throughout Asia for high-efficiency distribution transformers. Do you see an opportunity for some of your higher end products there?

James L. Wainscott

We’re already shipping – I think to an earlier question that was asked maybe from Sal to Al about our increase in non-US revenues – while the US has been on its back in terms of the economy and the rest of the world hasn’t been much better, we’ve been taking advantage trying to capitalize on the chaos by continuing to move product around the world, whether that is into Europe, into Asia, into South America or other parts. We’ll continue to do that. So even though we are viewed as a domestic steel player, when it comes to electrical steel and some of our specialty steel products, we’re already present in a very big way around the world.

Evan Kurtz – Morgan Stanley

Okay, thank you.

Operator

Our next question comes from Dave Martin of Deutsche Bank.

Dave Martin – Deutsche Bank

Yes, thanks for the update. I just wanted to come back first to CapEx spending. Could you give us an update on the Butler expansion permitting and startup, given what you said about CapEx being $100 million this year? Will that expansion be available if the market dictates next year?

James L. Wainscott

We are still working through the challenging process of obtaining a permit. It’s a difficult process. Just broadly speaking, it’s difficult to be a manufacturer in America these days, with things like permitting and global climate change legislation and tax policy and I could go on, on that subject. But to your specific point, we do not yet have a permit to construct and operate our new number five EAF in Butler, Pennsylvania. It is much less of an issue for us now, than we had previously envisioned, given market demand. But, we’re obviously disappointed with the lack of progress. We are hard at it in terms of all of the doors that we can knock on, and we’re hopeful that later this year we will have the permit in hand and can proceed, which would position us to complete the project sometime in 2010, hopefully as the market begins to recover.

Dave Martin – Deutsche Bank

Okay. Then, lastly, coming back to electrical steels – I think back in April you had noted that you think ’09 shipments were to fall somewhere between 10% and 15%, although that target would be difficult to achieve. Can you give us an update on that range?

James L. Wainscott

It’s obviously widened a bit. I don’t know that we have specific new percentages for you. And again, think it’s more of a quarterly phenomenon, as our sense of things as we talk to customers and evaluate the outlook going forward. You know, we’re already booking business for 2010. We’re doing those deals and in many cases people are concerned again about making sure that they get in the cue, that they can get all of the electrical steel that they want and in particular in the grades that they want. So, we take that as a positive sign. If 10-15% was before, perhaps its 15-20% or a little bit in excess of that now.

Dave Martin – Deutsche Bank

Okay. Then coming back to Timna’s question, do you have an assessment of what global demand for electrical steels or electrical steel shipments would have fallen year-to-date or a forecast for this year, as compared to your range?

James L. Wainscott

We really do not. Again, there are components within this – we talk about stainless steel – there’s 300 series, there’s 400 series, there’s various other products. When we talk about electrical steel, similarly, it runs the gamut. So, for the highest efficiency electrical steel products, that decline would be far less; for some of the less efficient it would be greater. I don’t know that I have a feel really, overall, of what that might be. That kind of data is very difficult to come by. There’s no electrical steel service center institute, if you will, that sort of tracks that product line as they do stainless and carbon. It’s down. I would just say that I think it’s taken a pause as the world has taken a pause. But longer term, the world wants what we have in America. They want running water and they want electricity and they want to be able to use appliances. And for that, you need efficient power generation. So at a time when we are as a globe and certainly as a nation very focused on energy conservation, energy efficiency, the environment, I think that we have absolutely the perfect product at the perfect time.

Operator

Our next question comes from Kuni Chen of Bank of America.

James L. Wainscott

Good morning, Kuni.

Operator

Please check your mute button.

Kuni Chen – Bank of America

Hi, good afternoon everybody. It’s Kuni Chen.

James L. Wainscott

Kuni, how are you?

Albert E. Ferrara, Jr.

Hi Kuni.

Kuni Chen – Bank of America

Thanks. Just a question on where iron ore pellet inventory stands. Can you give us a sense as to how quickly you’re working down the stock piles and when you’ll start to flow through some of the lower pellet costs?

Albert E. Ferrara, Jr.

I think Kuni, as we’ve indicated, we’ve obviously reduced our purchases this year, commensurate with our expected lower consumptions levels. But, we went into the year really as part of the overall working capital management program with what we thought were very reasonable inventories. As Jim has indicated, we’ve chewed through a lot of the higher priced inventories and will continue to benefit as the year goes on with more and more of the lower-priced product coming through. So, we feel very comfortable with the inventory levels, both from an operational perspective as well as from a working capital point of view.

Kuni Chen – Bank of America

Great. Then just sequentially as far as the profit per ton improvement, can you help break that down between how much of the roughly $100 improvement is higher volume and how much is attributed to iron ore and raw material costs and other factors?

Albert E. Ferrara, Jr.

The thing is, very much in terms of – in a rough way – if you look at where we are from an operational point of view, we see operations contribute probably about $30 a ton of that amount. And the other, there’s probably another $5 and so about $65 shows up in what we call raw materials or related activities.

Kuni Chen – Bank of America

Okay. I’ll turn it over. Thank you.

Albert E. Ferrara, Jr.

Thank you.

Operator

Our next question comes from Bryan Yu of Citi.

John Sullivan – Citi

Hi, this is actually John Sullivan filling in for Brian. I just had a quick question. I was wondering if you could comment on mill lead times, particularly on the carbon side?

James L. Wainscott

They’re certainly picking up, but I don’t know that we’ve really seen a dramatic move yet. I think that’s all going to depend on the order intake rates that are coming in. But, I would say that they’re shortening. They’ve been pretty tight already and they remain pretty tight.

John Sullivan – Citi

Got it, thanks.

James L. Wainscott

I’m getting a signal from someone inside the room here. The point being we can service our customers largely out of inventory now, but I think the reality is that as our book is filling up on us, for us to produce a product and deliver it – we’re out into September at this point, if that’s really more your question.

John Sullivan – Citi

Okay, great.

James L. Wainscott

Thank you.

Operator

Our final question comes from Luke Folta or Longbow Research.

James L. Wainscott

Luke, how are you?

Luke Folta – Longbow Research

I’m not bad, you?

James L. Wainscott

Just fine, thanks.

Luke Folta – Longbow Research

Most of my questions have been answered; I just have one last one. Just if the outlook for shipments isn’t as good as expected for the 2nd half of the year, I’m just curious, is the most likely response that you would bring Middletown back down in that case?

James L. Wainscott

We’ll see. I don’t mean to be flippant with that response, but we’ll look at all of our options. The reason, just if I can Luke, the reason that we advantaged Middletown to begin with was not of any particular love or hate for either group of unions or locations, it was purely economics. And, the fact is that when we produce slabs at Ashland and have to transport them up to Middletown at a cost of $10 or so, when we run a larger, more efficient, newly-hearthed furnace at Middletown, there is an operating cost advantage to that. So, it was purely and simply a function of making the right business decision for the company. And, we can’t run the company with really competing factions or plants who really want to dominate one over the other. That will get us nowhere fast. So I guess we will see. We’ll try and advantage the company, as we always have, with the most economical decisions. And, I think the battle or feud may have been waged and won, but certainly not the war at this point.

Luke Folta – Longbow Research

Are you able to give us kind of ballpark what the cost advantage you do have over Middletown is over Ashland?

James L. Wainscott

I think I’ve kind of just done that. Again, you’ve got a transportation piece and then you’ve got an operating efficiency piece. Middletown runs a larger, more efficient and a bit more modern now operation. So, it would be enough to cause us to make the decision that we previously made and again, we’ll work through all of that. Perhaps, as I’ve said before, the market helps solve this issue for us. Not too long ago, in fact just about a year ago, we were at a point where we were operating both furnaces at their max and we were also buying foreign slabs. Maybe we’ll be back there and that will solve this. But, perhaps it won’t happen as quickly as we would like and we’ll have to work through this. But, we prefer to do that mostly off-line rather than on the conference call.

Luke Folta – Longbow Research

Okay, thanks a lot guys and congratulations.

James L. Wainscott

Thank you.

Operator

This concludes our question and answer session. I would now like to ask Mr. Wainscott for his closing comments

James L. Wainscott

Thank you much, Patty. Before signing off today ladies and gentlemen, let me just close by saying thank you. Thank you for your interest in and your continuing support of our company, AK Steel. In about three months, we hope you’ll join us again on our 3rd quarter 2009 conference call. In the meantime, have a great day and terrific summer.

Operator

Ladies and gentlemen, this concludes our conference call for today. Thank you for participating and you may disconnect at this time.

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Source: AK Steel Holding Corporation Q2 2009 Earnings Call Transcript
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