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Executives

Albert E. Ferrara - Senior Vice President of Corporate Strategy & Investor Relations and Member of Proxy Committee

James L. Wainscott - Chairman, Chief Executive Officer, President and Member of Proxy Committee

Roger K. Newport - Chief Financial Officer and Vice President of Finance

Analysts

Luke Folta - Jefferies LLC, Research Division

Michelle Applebaum - Michelle Applebaum Research Inc.

David Adam Katz - JP Morgan Chase & Co, Research Division

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Sam Dubinsky - Wells Fargo Securities, LLC, Research Division

Chris Brown

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Brett M. Levy - Jefferies LLC, Fixed Income Research

AK Steel Holding (AKS) Q2 2013 Earnings Call July 23, 2013 11:00 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to AK Steel's Second Quarter 2013 Earnings Conference Call. [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; Mr. Albert E. Ferrara, Jr., Senior Vice President of Corporate Strategy and Investor Relations; and Mr. Roger K. Newport, Vice President of Finance and Chief Financial Officer.

At this time, I will turn the conference call over to Mr. Ferrara. Please go ahead, sir.

Albert E. Ferrara

Thank you, Sam, and good morning, everyone. Welcome to AK Steel's Second Quarter 2013 Earnings Conference Call. In a moment, Jim Wainscott will offer his comments on our business, and following Jim's remarks, Roger Newport will review our second quarter 2013 financial results. And together, we will field your questions.

Our comments today will include forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Included among those forward-looking statements will be any comments concerning our expectations as to future shipments, product mix, prices, cost, operating profit or liquidity. Please note that our actual results may differ materially from what is contained in the forward-looking statements provided during this call.

Information concerning factors that could cause such material differences in results is contained in our earnings release issued earlier today. Except as required by law, the company disclaims any obligation to update any forward-looking statements to reflect future developments or events. 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 at aksteel.com.

And with that, I'll turn it over to Jim for his comments. Jim?

James L. Wainscott

Good morning, everybody, and thank you for joining us on today's conference call, and thank you, Al, for that introduction and for being with me on 41 of these conference calls. Right up front, I want to take this opportunity to recognize Al for his distinguished service to AK Steel for more than a decade. Al recently announced that he will be retiring from the company, effective August 31. That means that today is his final conference call with us. And on behalf of the Board of Directors, the executive officers and all of us at AK Steel, we certainly want to take this opportunity to wish Al a happy, healthy and lengthy retirement.

Turning to our business, let me offer a few thoughts on our second quarter 2013 results and our outlook. We continue to make progress at AK Steel, although that progress might not always be obvious in our numbers. But with appropriate adjustments to establish an apples-to-apples comparison, AK Steel's second quarter 2013 operating results were, in fact, slightly better than our first quarter 2013 operating performance.

Said another way, excluding the costs associated with maintenance outages at our Middletown Works blast furnace, both planned and unplanned, our second quarter results represented an improvement over our first quarter of 2013 results.

At AK Steel, continuous improvement in everything we do is our philosophy and our approach on behalf of our shareholders, our customers, and all of our other constituents. Unfortunately, however, sometimes your forward progress is halted due to events that are outside of your control, that was certainly the case in the second quarter of 2013, but there were also a number of bright spots during the quarter. At the top of the list of our second quarter bright spots was the continued strength shown by the automotive market.

We experienced our best automotive shipment quarter since the third quarter of 2007. In fact, according to published data, it was the best June for light vehicle sales in some 8 years. It appears that consumers are now better able to afford vehicles due to a combination of low interest rates, credit availability and somewhat better economic conditions. Increased household wealth from recovering home prices and a rising stock market should also provide support for more automotive sales gains down the road, you might say. Automotive, which represented 45% of our 2012 revenues, grew to 50% of our first half 2013 revenues. This market continues to be a source of strength for AK Steel, both for our carbon value-added shipments and for our autochrome shipments as well. With auto build rates expected to approach 16.2 million units for 2013, AK Steel is ready to help our automotive customers meet increasing consumer demand.

Notwithstanding the strength of the automotive market, it's fair to say that we continue to face challenging market conditions in each of our other chosen markets and especially in the commodity carbon and stainless steel markets, as well as the international electrical steel market. Increasingly, we are moving away from spot market business in favor of higher-margin contract business. Our mix of business in the first half of 2013 was approximately 70% contract and 30% spot. Longer term, our objective is to further increase contract sales while decreasing our participation in the spot market where, typically, the only thing that sets you apart from the competition is price.

While price is an important consideration, we want to continue to align our company and our products with those customers who place value not only on price but also on quality, delivery and customer service. That's because our niche is high-end, value-added products and we'll continue to align ourselves with those customers who value the total package of what we offer.

While we're not a large player in the spot market, we are indeed a participant and we make an independent assessment on a daily basis, if not hour to hour, as to our spot market pricing based on order intake rates, steelmaking input costs and a host of other factors. During the second quarter, spot market hot-rolled selling prices declined to about $560 per ton, 5-6-0. That happens to be the lowest pricing level that we've seen since the fourth quarter of the year 2010.

In the second quarter, we announced 2 carbon steel spot market price increases that were eventually realized, and we're currently quoting new sales opportunities at $650 per ton for hot-rolled bands. As we speak, our lead times for carbon steel products have lengthened. For example, hot-rolled lead times are extended to late August, spot market cold-rolled and coated availability is even tighter, with lead times extended to late September.

In what is known as the 300 series or commodity stainless steel market, which is a relatively small portion of our stainless and overall sales at AK Steel, market conditions remain brutal. A market, already characterized by overcapacity has not been helped by the entrance of Outokumpu and its new capacity from Alabama. I might add that declining nickel prices have not been helpful either. Where possible, we are opportunistic in the 300 series market, but we're mostly focused on increasing 400 series production to serve the increasing needs of our automotive customers.

Now let me offer a few thoughts on the grain-oriented electrical steel or what we call the GOES market. Our second quarter shipments of GOES products increased, on a sequential quarterly basis, by nearly 10%. We've gained market share and we've benefited from a housing recovery within the United States. Housing starts are projected to total nearly 1 million units for the year 2013, compared to 781,000 units for the year 2012. But analyzing the details behind the numbers yields some interesting insight. For the first 5 months of this year, the data on housing starts shows that single-family home starts increased by 23%, but multifamily home starts rose by a whopping 38%. Why is that relevant? It's relevant because AK Steel has little participation in the multifamily home starts business since these developments typically use a dry type of transformer, which uses a lower-grade product, and where we have less participation.

On the export GOES front, oversupply continues to be a very significant issue. The European debt crisis and slower economic growth in China, in India and in South America put downward pressure on both sales volumes and selling prices. Speaking of export GOES, one bright spot looms, however. This October, India is expected to implement the long-awaited BIS minimum international quality standards. This should spur demand for prime as opposed to secondary GOES products and represents an opportunity for AK Steel to increase our sales into this growing market. Our GOES product quality delivery and customer service are all excellent, both at home and abroad. But until a better supply-and-demand balance comes to pass, we'll continue to slug it out for market share in the global, grain-oriented electrical steel space.

Whining about the markets is -- well, it's what losers do. Winners find a way to win in spite of market conditions. At AK Steel, we're not sitting around here lamenting less-than-perfect market conditions. What we are doing is finding a way to win by focusing on doing a great job on those things over which we have control, namely safety, quality and productivity, our business basics, if you will, and by bringing to successful completion and to fruition our strategic raw material investments, which are expected to substantially improve our competitive cost position.

In terms of our business basics, our first priority remains keeping our employees safe while they are in our employ. In the second quarter, our Coshocton works was recognized by the state of Ohio for outstanding safety performance, having received the 100% award for safety for operating the entire year of 2012 without any lost-time injuries or illnesses. AK Tube's Walbridge facility was also recognized in the quarter by the state of Ohio with this very same award. And I'd be remiss if I didn't mention that employees at our Zanesville Works plant have now worked more than 1,000 days, more than 1,000 days without experiencing an OSHA recordable injury. I'm going to take this opportunity to congratulate our employees at those locations on achieving these milestones, and encourage our entire workforce to remain vigilant when it comes to safety, every day, every shift, every hour and every minute.

Moving from employees to customers, at AK Steel, we make every effort to serve our customers better than any other steelmaker with a combination of things, including superior product quality, on-time delivery and outstanding customer service. Over the years, based on these metrics, we've performed quite well, in the eyes of our customers and they're the ones that matter. Utilizing the Jacobson independent survey of our customers as a measuring device, we continued that tradition in the second quarter of 2013. Compared to our carbon steel integrated competitors, AK Steel was ranked #1 in quality, in customer service and in on-time delivery for the second quarter. Together, these performances translated into a #1 rating in overall customer satisfaction in our carbon steel market.

On specialty steel front, which encompasses both stainless and electrical steel, we were ranked #1 in quality and on-time delivery and those performances translated into a #1 rating in overall customer satisfaction in our specialty steel markets. These outstanding performances, in service to our great customers, are the result of the fantastic team effort by all of our employees. I congratulate our entire workforce on a job very well done.

We continued to serve our customers well in the past month, despite a significant production disruption. Let me take a moment or 2 to provide you with an update on the status of our Middletown Works blast furnace. On June 22, we experienced an unplanned outage at that location due to a mechanical failure. We took the furnace down in a controlled fashion, made the necessary repairs and have been in the process of restarting the blast furnace for roughly the past week or 10 days.

I'm delighted to report that we're making iron steel again at Middletown Works and that the ramp up to full production is more than 90% complete as I speak to you today. Take a moment to express my gratitude for the extraordinary efforts of our engineers, operators, manufacturing planners and our purchasing and transportation organization, as well as our primary repair contractor, Graycor, to get us back in this mode as safely and as quickly as possible. I'd also like to acknowledge the efforts of our sales organization and the assistance and support of our customers during this unplanned outage. Our customers represent the lifeblood of AK Steel and we greatly appreciate their understanding and cooperation.

In a moment, Roger will quantify the costs associated with this event, that is those costs that were incurred in the second quarter, as well as those costs that will be incurred in the second half of 2013. Let me emphasize, however, that the unplanned outage at Middletown Works that took place in June, to the best of our knowledge, is unrelated to the successful planned outage that took place at the same blast furnace in April. The planned outage was successfully completed on time and on budget, but it added about $20 million in cost to our second quarter performance.

The bottom line is this: With our steelmaking facilities located in Middletown, Ohio; Ashland, Kentucky; Butler, Pennsylvania; and Mansfield, Ohio, we are well positioned to serve our customers for the rest of 2013 and beyond. Most of you know, at AK Steel, we manufacture some of the finest carbon, stainless and electrical steel products in the world. And thanks to our capital investments and new-era labor agreements, we have excellent operational flexibility when it comes to where we make our products. And that flexibility paid off in a big way recently, as we challenged our Butler Works and Ashton Works to step up at a time of need, and they did exactly that. In the process, Butler's #5 electric arc furnace set new monthly and quarterly production records. Again, let me offer my thanks to all of our employees for a job well done in overcoming adversity.

Speaking of our employees, let me take just a moment to highlight the excellent progress that our employees are making at AK Coal. On June 21, we obtained our permit to operate the North Fork mine in Southwestern Pennsylvania, and mining activities commenced some 3 days later. The ramp up is progressing as planned, additional permit applications have been submitted and we expect to see receive those permits in 2014, as we ramp up to full production in the year 2015.

Moving to our iron ore joint venture with Magnetation, they have all of their significant permits in hand, and construction activities for the pellet plant are accelerating in Reynolds, Indiana. They remain on, if not,\ ahead of schedule for a startup by the end of 2014, and a ramp up to full production in the year 2015.

In June of this year, in recognition of the importance of AK Coal and Magnetation to AK Steel's future, we received the Best Mergers and Acquisitions Award from American Metal Market. We appreciate receiving this honor, and we remain very excited about the value these investments can bring to AK Steel, starting in the very near future and continuing for many years to come.

We're building long-term cost competitiveness through our strategic raw material investments. And when fully ramped up, we expect that they will be among the lowest-cost producers of low-vol coal met coal and iron ore pellets in North America. And when the ramp ups are complete, we will have achieved our goal of being 50% self-sufficient in our key steelmaking inputs of met coal and iron ore pellets. On top of that, we have a host of other opportunities, significant opportunities at that, to further reduce costs and enhance our margins at AK Steel.

In closing, let me say that the first half of 2013 was tougher than we've expected, but we responded to the challenges. And while we expect the second half to be better, it won't be easy. Then again, this is the steel business, it's never easy. And that's just fine with us, it's the life we've chosen, because we love making things in America. And we'll continue to make our way from here to there, taking care of our employees, serving our customers better than any other steelmaker and lowering our costs where possible, just as fast as we can. I remain confident that our best days are ahead of us at AK Steel. And thank you, all, very much for your attention.

With that, here's Roger Newport. Roger?

Roger K. Newport

Thank you, Jim. Earlier today, AK Steel reported a net loss of $40.4 million, or $0.30 per share, for the second quarter 2013. As Jim mentioned, our second quarter results were impacted by substantial planned, as well as unplanned, outage costs at our Middletown Works blast furnace. As we expected, our results for the second quarter included $22 million in planned major maintenance outage costs, which was about $21 million higher than in the first quarter. However, our second quarter results were also impacted by approximately $6 million for costs related to the unplanned outage at our Middletown blast furnace. Thus, the impact of these outages dampened our second quarter performance. Even with this unplanned blast furnace outage, our shipments for the second quarter of 2013 increased by 34,000 tons, or about 3%, to 1,323,700 tons, compared to the first quarter of 2013. This was slightly lower than our guidance for the second quarter, as a result of the unplanned blast furnace incident.

While we experienced lower shipments to the carbon steel spot market and electrical steel market in the second quarter compared to first quarter, we did achieve higher shipments to the automotive market. Our average selling price for the second quarter was $1,061 per ton, virtually identical to our average selling price in the first quarter and slightly better than our guidance for the second quarter. The average selling price in the second quarter reflects the improvement in value-added shipments which was offset by lower spot market prices for carbon steel products compared to the previous quarter.

Revenues for the second quarter totaled $1,405,000,000, roughly 3% higher than the prior quarter. In the second quarter, we benefited from a LIFO credit of $12.4 million, reflecting the continued decline in raw material cost. This compares to a LIFO credit of $6 million in the first quarter.

I would also like to provide you with a comparison of our earnings before interest, taxes, depreciation and amortization, or EBITDA, adjusted to exclude the non-controlling interests which are included in our operating results. Our non-controlling interests consist primarily of SunCoke Middletown. Excluding the non-controlling interest, our adjusted EBITDA for the second quarter of 2013 was $47.5 million or $36 per ton. This compares to an adjusted EBITDA of $66.8 million or $52 per ton in the first quarter. I believe it is important to note that the decline in our adjusted EBITDA was primarily the result of the planned and unplanned outages, which resulted in costs that were $27 million higher than the first quarter. Thus, without these outages, we would have had an improvement in adjusted EBITDA in the second quarter compared to the first quarter.

Moving to our results for the first 6 months of 2013, revenues for the first half were nearly $2.8 billion, compared to approximately $3 billion in the first half of 2012. Shipments for the first 6 months of 2013 were 2,613,500 tons, a 2% decrease compared to the first 6 months of 2012. We are pleased to have achieved higher automotive market shipments during this time frame as compared to the same period in 2012. However, the higher automotive shipments were more than offset by lower spot market carbon and electrical steel shipments. The decline in spot market prices has resulted from continuing challenges -- challenging conditions in both the domestic and global marketplace. Our average selling price for the first half of 2013 was $1,061 per ton, a decrease of $83 per ton, or roughly 7%, compared to the first half of last year.

In regards to our operations, we incurred $23 million in planned major maintenance outage costs during the first half of 2013, compared to roughly $2 million during the 6 months of 2012. In addition, as previously mentioned, we incurred $6 million in unplanned outage costs. At the bottom line, for the first 6 months of 2013, we reported a net loss of $50.3 million, compared to a net loss of $736 million for the first half of 2012. Our results for the first 6 months of 2012 included a noncash income tax charge of approximately $736 million, as a result of a change in the deferred tax asset valuation allowance recorded in the second quarter of 2012.

Now turning to the balance sheet and the cash flow statement. For the second quarter of 2013, our capital investments totaled $15.5 million, about the same amount as in the first quarter. As expected, working capital consumed approximately $53 million of cash during the second quarter, reflecting the normal seasonal fluctuation in inventories and our semiannual interest payments that primarily occur in the second and fourth quarters.

It is important to note that our continued focus on working capital management resulted in a significant improvement, compared to what we have typically experienced in the first half of the year. In the first half of 2013, working capital consumed $63 million. In comparison, in the first half of both 2011 and 2012, working capital consumed more than $230 million in each of those periods. The primary driver of this improved performance is related to our continued efforts to lower our raw material inventory levels.

On the investment front, in the second quarter, we contributed $50 million to our strategic investment in Magnetation. Taking all these factors into account, we ended the second quarter of 2013 with very strong liquidity of more than $900 million. With this solid level of liquidity, we continue to be well positioned to serve the needs of our customers and our operations, as well as execute our strategic initiatives.

Let me take a moment to comment on our pension plan. Our 2013 pension funding requirements remained at about $180 million. In the second quarter, we completed a $41 million pension contribution. In addition, earlier this month, we contributed $69 million to the pension fund, and we will be making the final pension contribution for 2013 in the fourth quarter of this year of roughly $41 million.

Now turning to our outlook. As is our practice, we plan to provide detailed guidance for the third quarter of 2013 in September. In advance of that guidance, we do expect our second half financial results to be impacted by the recent unplanned Middletown blast furnace outage. While we continue to refine our estimate for the total impact of this loss, we currently expect that the uninsured portion of the losses in the second half of 2013 will be between $12 million and $17 million. We are already working with our property and business insurance underwriters on the claim. The timing of their recognition of our insurance recovery will depend on the timing of reaching agreement with our insurance underwriters.

Let me conclude by saying thank you for your interest in AK Steel. At this time, Jim, Al and I would be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Luke Folta, of Jefferies, please go ahead with your question.

Luke Folta - Jefferies LLC, Research Division

I guess the biggest question out there I have is if you look at free cash flow generation over the last few years, say, I don't know, 2011 and forward, it's been kind of oscillating around, let's say, a negative $240-ish million sort of number. And looking forward, if I look at what you think you can earn out of your raw material investments, just based on the estimates that you provided for contribution at various price level, if I run $120 iron ore through there and $130 met coal, I get sort of a positive $130 million number, which would only be, sort of, a partial offset to the free cash flow at its current run rate. So I guess what I'm trying to understand is if the market remains as competitive as it has been, going forward, is there any -- what are the other levers that you have that you could pull, basically, to kind of make up for the gap between kind of current run rate, free cash flow and what sort of benefits you expect from the raw material investments?

James L. Wainscott

Luke, you hit on a very critical item for us. It's something that we talk about a lot as a management team. Our board, obviously, is focused on it as well. I think, Roger, I would just start with the comment that we believe our liquidity, currently, is in excellent shape. And don't take our opinion only, I would also look to our S&P rating here. Recently, S&P reaffirmed our credit rating and also ranked our liquidity as strong. So -- but to your question, we have been consumers, and we'll likely be consumers again this year, of cash for all the reasons that Roger mentioned: pension funding interest, strategic investments, capital investments and so on. And again, I think we continue to ramp up and crank up. The biggest lever, probably, in our items that we have would be the strategic investments. And one can put one's own view on that. Obviously, we went either way in our perspective because it's a bit of a hedge bet, so if raw material prices go up or go down, we're going to win. If you want to put some kind of number like you talked about, that's certainly a significant move forward. There are a whole host of other things, initiatives that we have going on within the company, some of which I'm free to chat about and others which I'm really not, but all of which really derive benefit from lowering our costs. Clearly, in the long run, we believe that the markets that we serve will get better. But we can't continue to wait on that. It's been 5 long, tough years of slogging it out. We are growing profitable sales. I mentioned automotive, a host of other areas. Sort of a long answer to your question, but there's no one silver bullet. We know we've got to get back to cash generation, EBITDA generation north of $500 million, and probably get usage in the $400 million-plus range. And I think we're probably 1 year or 2 out from doing that. That's sort of our forward look at things with all of the initiatives that we have underway.

Roger K. Newport

Jim, I would just add, of course, that of course, our pension contributions will peak in 2014, again subject to mortality interest rates, investment performance, as well as the fact that our strategic investment commitment will finalize in 2014, 2015. So we think there's certainly better days ahead, Luke.

Luke Folta - Jefferies LLC, Research Division

Okay. And just a follow-up on that. I mean in your -- in the last investor presentation that you have out there, you had forecasted that -- I mean, obviously, it's tough to make the call today what it's going to be in 2015, but in your numbers, it looks like you expect cash out the door for pension in total to be [indiscernible] benefits to be about $100 million less in '15 than it is today. Is that a function of an expectation of higher improved interest rates or is that just the plan fundamentals themselves?

Roger K. Newport

It's a combination of 2 items. One of them is as we put the assets in, you'll get the return on those assets. And as Al mentioned, our peak of our funding and our pension plan is next year. And then also, as we continue to settle on our VEBAs, we settle with our, as you're aware, Butler and our Middletown and our Zanesville, we have another $30 million we'll put in this year to the Butler VEBA, but then we'll be getting out from under those payments and paying any retired health care benefits for that group in the future too.

Albert E. Ferrara

So it's meaningful, Luke. I think your $100 million is a pretty good benchmark to see coming our way. The other thing is, again, we'll be complete with our funding of our strategic investments. As we get into next year, all of our VEBA deals will be done and so on. So there's a whole host of things that are moving in our direction, if you will, on the cash flow front.

Operator

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

Michelle Applebaum - Michelle Applebaum Research Inc.

I particularly want to actually highlight, Jim and the board of AK Steel, you're to be congratulated for having had someone of Al's training, experience, caliber, integrity in a communications position for as long as you've had, he has made a huge difference, and the company having a senior person in this clearly has been invested in communications. And I want to say that a lot of people would look at the market that we're in right now and say, "Well, there's no good news, there's no great story here." And they would not have somebody like that in the job and you guys realize in a tougher market, the way it's been the last few years, where things have been so complicated and so many moving parts, having somebody like that in the job has been so important. So I want to congratulate you all and say, job well done to you and the board, Jim, as well.

James L. Wainscott

Thank you.

Albert E. Ferrara

Thank you very much, Michelle.

Michelle Applebaum - Michelle Applebaum Research Inc.

And big shoes to fill here. My next question is, so you had an outage that looks like it cost about 150,000 tons. Is that a fair number?

James L. Wainscott

I think it's in the zip code. We -- there's probably 25,000 tons, Michelle, of shipment opportunities that we lost in the second quarter. There's some number, 100,000 plus, maybe a little more than that, 150,000, that is probably not available to us in the third quarter. But what we have done, if I can just -- and then I'll let you ask your question. What we've certainly tried to do is to increase our production capabilities at Ashland. As you recall, the new EAF that we put in really hadn't been challenged, but with Butler we're challenging it now. And for some selective grade applications, we've gone ahead and purchased a few merchant slabs. So we'll be doing everything we can to make up for that loss production, but some of it has probably gotten away from us.

Michelle Applebaum - Michelle Applebaum Research Inc.

Okay. So -- and you've seen that the market has kind of taken off on your outage, and I'm just wondering now that you're back, is it fair to say that perhaps your outage was just sort of a catalyst as opposed to a cause here?

James L. Wainscott

I think it may have been one of the things. It's never -- as you know as well or better than anybody, one item that typically causes these things to move. I think the other thing we pay close attention to is what's been going on with service center inventories, which again moves prices a fair amount as well as the input costs. On the service center side of things, flat-rolled inventories down for the fifth consecutive month, at their lowest level in the past 2 years since June of '11, adjusted month supply on hand down to 2.1 months. Things are pretty tight, those are really positive trends for spot market pricing. And we saw scrap head up by almost $40 a ton here, recently. So I think it's a combination, maybe, of our event and those items that have bolstered pricing. And, as I said, we're quoting 650 and evaluating if another increase is warranted.

Michelle Applebaum - Michelle Applebaum Research Inc.

And you're -- so can you tell me how much wiggle room do you think we have before we make an invitation to more import?

James L. Wainscott

I'll leave that to those that look at the bigger picture a bit more than we do. But maybe there's another $20 to $30, or something like that, per ton if I was to be a prognosticator.

Operator

Our next question comes from Dave Katz of JPMorgan.

David Adam Katz - JP Morgan Chase & Co, Research Division

I'm curious, for a while now, you guys have stated that the benefit from the coal and iron ore holdings will provide the company with 50% vertical integration to each material. Looking at iron ores, the company owns 50% of Magnetation which is going to produce 50% of the company's iron ore. To me, that would imply about 25% iron ore integration. I was curious what I'm missing there?

Roger K. Newport

Well, if you look at it, we consume approximately 6 million tons of iron ore. They'll provide us roughly 3 million tons out of their pellet plant. So we'll be buying from them half of our iron ore. And then also, we do get the benefit of the iron ore that we're buying, the financial benefit that Magnetation gets, we do get half the benefit from Magnetation. But we will be getting our iron ore at a reduced price at a very – it'll be a very cost-competitive pellet once it starts up.

David Adam Katz - JP Morgan Chase & Co, Research Division

So the 50% that you're buying that you're not directly exposed to through your ownership, is the right way to think about that, is that you're purchasing it at below-market prices and that's the benefit that's provided?

Roger K. Newport

Yes. Because we are taking all the offtake of that pellet plant. So the 3 million tons is coming to us, and then if you look at it by getting the financial benefit back, you're getting that -- you're getting the benefit of it as a lower-cost pellet.

James L. Wainscott

The other thing I would just add, David, is it's important to realize, and I know you know this, but what goes around comes around with respect to raw materials. And again, we saw raw materials escalate fourfold over the period of the last 5 years or so. But I think that we're seeing a little change in conditions there. We recently held a forum for a number of producers of raw materials and energy and transportation, and really had some pretty positive results. We don't have any announcements to make today, but I would say that we would expect that both from the Magnetation benefit, as well as our purchases in the open market should be beneficial to us as well going forward.

David Adam Katz - JP Morgan Chase & Co, Research Division

Okay. And then on the pension and OPEB expense and other post-retirement benefit and payment line items which both show up in the cash flow statement, they've been running between $30 million to $35 million per quarter. Is that a fair assumption of how they're going to move in the future, at least through, let's say, 2014?

Roger K. Newport

In terms of pension and OPEB, the pension credit?

David Adam Katz - JP Morgan Chase & Co, Research Division

Well, it shows up as -- if you add the Q up, they shows up as about $30 million use of cash on the cash flow statement.

Roger K. Newport

Yes, if you aggregate the 2 of those. In other words, a component of that is our pension and OPEB credit which is running around $16 million per quarter. And then the noncash pension and OPEB, essentially, are payments to retirees, have actually been running a little less, but probably, they'll probably be in the $65 million to $70 million range for the year, which translates into about a $16 million or $17 million payment. So aggregating those 2, that would be essentially a deduct from EBITDA, so your calculation is correct.

Operator

[Operator Instructions] Our next question comes from Phil Gibbs of KeyBanc Capital.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Jim, I had a question about ultra-high-strength steel and what your potential capacity is there right now, and how that business has evolved over the last couple years?

James L. Wainscott

I guess I'd start with sort of the broader picture of things. Again, materials continue to evolve. We continue to believe, at AK Steel, that steel is indeed the material of choice, particularly for automobiles, and we're part of the solution, rather than part of the problem when it comes to lightweighting of vehicles. As we all know, trying to get the 54.5 mpg is a long way from where we're currently at. But if you care about things like safety and cost and repairability and sustainability, then steel is for you. And that's certainly the message that we continue to carry forward to our OEMs in the automotive business. Aluminum certainly made in-roads, will continue to make in-roads, mostly they've made it, though, as you know, in engine blocks and occasional parts for lightweighting. But they have made some progress, we wouldn't dismiss that. I think to your point, we already have certain products, including ultra-loom [ph] product, and we are spending a fair amount of time in our research organization, in our sales and customer service group to really listen to customers, to assess the market. This is the kind of thing where, again, you don't want to get too far ahead, but you don't want to be behind. In our case, we're producing advanced high-strength steels today. And we're focused mostly on the next-generation, what we call the third generation of advanced high-strength steels. Really want to have a very good handle from our customers on what their needs are, try and secure the business before we sort of go forward from here. But in all likelihood, for us to participate in a significantly bigger way, it will require some sort of a capital investment, location to be determined and exact form to be determined, in order to meet our customers' future needs in the future.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Okay. And then -- I appreciate that. And on your contract business, you mentioned it was 70% of where you are today. How much of that is reset quarterly? How much of that, outside of the grain-oriented business, is reset annually? Can you give us a feel for how some of that business goes to the market?

James L. Wainscott

Virtually, all of the automotive business is reset annually. From time to time, we'll have discussion about longer term. We're currently engaged in some of those negotiations, as we speak. Unlike in the past, however, where most of those deals came up for renewal on or about January 1, now they're really spread throughout the year, on the various quarters. And oftentimes it depends on when the participants or the customers have their year ends and so forth. And really, to their credit, they're trying to stagger the expiration of their deals so as not to have everything kind of come due at a given point. So yes, we have negotiations that were done and take effect July 1, others are still in progress and others will follow from there. And the same is true when you get outside of automotive, into appliance and into a number of our other markets, including electrical steel. It's really all over the board.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

Is there like an annual base price with a surcharge, or is that just largely a fixed price that you'd be going out with?

James L. Wainscott

It's a really good question. Over the years, what we've tried to do is introduce the concept of a variable price, to take into account the things that cause us problems on the cost front, namely things like natural gas and raw materials, iron ore and scrap and so forth. With some of the specialty steel business, for years, we've had a nickel component and on some of the coated products we'll have a zinc component. But it really does depend. It's a matter of sharing of the risk, and if certain customers want a fixed price because that's the way they want to build their business plan and report to their management, we can do that. But in most cases, it's usually a base price with those variable components on top of it.

Operator

Our next question comes from Sam Dubinsky of Wells Fargo.

Sam Dubinsky - Wells Fargo Securities, LLC, Research Division

Just a few quick ones. Other than hot-rolled, what are the product segments should we expect to be most impacted by the Middletown outage?

James L. Wainscott

I think it's primarily the spot market which would include hot-rolled, some cold-rolled, to a lesser extent, coated products. That's sort of the variety. And really in that order, those are the less profitable, from a margin standpoint, products for us. Having said that, we like more volume in a high-fixed cost business, that's a good thing for us. But we like profitable volume. So there'll be an impact. We should recover nicely from that as we look out into the fourth quarter, although we're not giving forward guidance. We'll kind of work our way through Q3 with the challenges that we've got, and look to do better and to do more in Q4.

Sam Dubinsky - Wells Fargo Securities, LLC, Research Division

Okay. Great. I'm sorry if I missed this, but what percent of your business in Q3 is based purely on spot market, post outage? And also, what is the link to the spot market?

James L. Wainscott

Roger, you want to give that a shot?

Roger K. Newport

Well, in 2Q, it was a little bit higher with the -- less of hot-rolled and cold-rolled, as you saw on our shipments that we gave. So we were a little bit more higher value-added. Our automotive had grown. So we were a little bit north of the 70% range for the second quarter.

Sam Dubinsky - Wells Fargo Securities, LLC, Research Division

And for the third quarter, with the product mix? I'm just try to figure out, given that the spot market has increased, how much of that actually trickles to your pricing?

James L. Wainscott

There's a lot of moving pieces and parts. I would just offer, Sam, including the automotive shutdowns, even though they're less than they typically are this year. You've got that moving pieces and part in the equation. So if we were at 70-something, we might be high 60s. It's sort of shades of gray here moving a little bit towards a bit more in the spot market.

Sam Dubinsky - Wells Fargo Securities, LLC, Research Division

Okay, great. My last question is just how should we think about minority interest for Q3 with your relationship with SunCoke? Because you may be producing [indiscernible]?

Roger K. Newport

If you look at the bottom line for our net income, it's a 0 impact to our net income. So the minority interest, while it's affecting operating income and then you have the minority interest down below, the bottom line is, it's a 0 impact, basically, to our earnings.

Operator

Our next question comes from Chris Brown of Merrill Lynch.

Chris Brown

Could you maybe provide us a little bit more color on the electrical steel market? Why were shipments down year-over-year when the housing market is better, you guys are gaining market share? Sort of what's going on there? Is it mostly just international weakness or maybe something else?

James L. Wainscott

Yes, I think the aftermarket, I would characterize as okay, if not pretty good, relatively speaking, versus international, which is really not good at all. And so it's the combination of those 2 things: growth, then opportunity of growth in market share in the NAFTA region. But, really, internationally, things are much tougher. Really, too much steel internationally, chasing too few orders, which has driven pricing down. Asian producers, in particular, seem to have contributed to the over capacity problem, and so pricing environment there has been really, really poor. That's caused us, in turn, to reduce exports, so you're seeing that in our shipments. And I might add that it's also caused the foreigners to look to America, the land of the free and the home of the brave, and we're seeing, absolutely seeing, an influx of imports into our country.

Chris Brown

And then as a follow-up, should we still be sort of thinking about lower shipments, year-over-year, for electrical steels? Or given second quarter was up 10% sequentially, could that maybe be flat on a year-over-year basis for 2013?

James L. Wainscott

It's probably a bit of wishful thinking on our part at this point, as we look out, that it would be flattish and maybe down somewhat from year-over-year.

Operator

Our next question comes from Sal Tharani of Goldman Sachs.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Roger, this unplanned outage cost, $12 million to $15 million, will this be more on the third-- in the third quarter or is it going to be evenly distributed between third and fourth?

Roger K. Newport

What I'd tell you there, Sal, is that we plan to have additional costs -- most of the costs will be incurred in the third quarter, as that's when most of the outage occurred. The question will be what the timing is of getting the insurance proceeds and getting agreement with the insurance company, and at this point I can't really give guidance of whether that would be in third quarter or fourth quarter. But it will be -- our intent is that -- and plan,] is that would be in the second half.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

And of the $6.5 million in the first quarter – in the second quarter, will a part of it be recoverable from insurance or was it your part, uninsured part you took?

Roger K. Newport

Well, as we said, we incurred $6 million, so that was -- we took that as an expense. And then we said we incurred another $12 million to $17 million of additional cost in the second half of the year. So that's the total that we would -- we expect to incur, which is roughly in the $18 million to $22 million range.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Okay. And do you have any planned shutdown in the -- or idling in third quarter at all? Maintenance, I mean to say.

Roger K. Newport

Our outages in the third quarter are very minimal.

Unknown Executive

It's only $1 million or $2 million, Sal, in the third quarter.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Okay. And, Jim, on your overall contract to spot, 70-30 you mentioned this year, how would you break it down in stainless steel? Is stainless steel more contract or less contract than that ratio?

James L. Wainscott

It's a very similar sort of ratio when you look at the big picture. And again, Sal, while you know, maybe others don't have a full appreciation, you really have to understand that we've got sort of 3 or maybe 4 components within stainless. You've got that commodity 300 series, which largely is a spot sort of feel. You've got the 400 series, the autochrome business which is largely contract, if not entirely. And then you've got some sort of specialty products, the kinds of things that we make out of Coshocton which are mostly contract. And then you've got, of course, electrical steel, which, domestically, is largely contract and internationally, or non-NAFTA, is a spot business. So I think sort of putting all those pieces together, and that's sort of dissecting and then bring it back together, we're somewhere in that same sort of range, maybe 70%, 75% would be my best estimate.

Operator

Our final question comes from Brett Levy of Jefferies.

Brett M. Levy - Jefferies LLC, Fixed Income Research

Can you guys talk a little bit about sort of how you see this whole ThyssenKrupp Alabama transaction impacting the competitive environment? I mean ThyssenKrupp was fairly disruptive, it looks like they're winning bidders, at least in the press, and may not believe what you can. Or CSA and with Vale, they're also interlopers into, sort of, the United States, at least for the moment. Do you see them as being more disruptive, have you bumped into them, thus far, in any of your contract business, spot business, et cetera? And then, I mean, do you have a sense as to sort of how full they are now, and if they were to ramp up additionally, either in stainless or carbon, would that pose a threat to you that you could perceive?

James L. Wainscott

Okay. For the next hour, we'll be covering the ThyssenKrupp. Right, those are fantastic questions. Let me sort of, first, thank you for your comments about Al, all of you -- for those, and also for your question. Let me first start off by saying we've learned over the years not to believe everything we read in the press, and we've been hearing for months and quarters, I guess 1.5 years, various scenarios about TK. We, like everybody else, kicked at tires. We, like everybody else, has looked very carefully at the competitive landscape there. And for us, it's sort of doubly important because it's not only producing carbon, it's also producing stainless down there. So we're pretty well aware of what they're doing. I would say that there's an awful lot of steel that they brought to market. And there's, perhaps, additional capacity that could come. One of the things that is not well understood is that about half of the carbon steel production that could come out of that plant, and really most all of what's been coming out of there so far, has been affecting the spot marketplace, which has been a very crowded marketplace, as we know. I guess from our standpoint at AK Steel, we could offer a scenario, and would be happy to do so, whereby we come out in good shape no matter who owns it. And part of that goes to who we are, how we run the company, what we stand for. And if you're the industry leader, as we are, in product quality and delivering customer service, we look forward to competing successfully with whoever winds up putting a new name on the door, whether that's a foreigner or whether that's a domestic player. So I think all of them know our reputation. We remind our customers, and they remind us, frankly, with their votes every quarter, about the job that we're doing for them. So candidly, a lot of steel has come to market, whether it's carbon steel or stainless steel already, and we'll wait perhaps not with bated breath, but we'll wait to see if in the next few weeks or months here a solution is found. But we look forward to the challenge of competing with whoever it is that owns it.

Brett M. Levy - Jefferies LLC, Fixed Income Research

And then the last one is just sort of a double check. My sense is that with respect to the revolver, it's fully available, there's not any sort of maintenance issues. If you wanted to draw it down tomorrow and run negative spreads, that you could. Just double check that I'm correct in assuming this.

Roger K. Newport

Yes, you are correct in that.

Brett M. Levy - Jefferies LLC, Fixed Income Research

No maintenance covenants, no nothing?

James L. Wainscott

Not unless [indiscernible]...

Unknown Executive

[indiscernible] $137 million, which frankly isn't going to happen. It's found in our sites.

Roger K. Newport

And that comment that if you look at it, from the first quarter, the second quarter, there was a decline in liquidity, but $53 million of that was related to working capital. And as we indicated earlier this year, we expect working capital to be a source of cash for us for the year. So we'll get that back. It's a normal seasonality that occurred in the second quarter. And also, in the second quarter, we put $50 million in the Magnetation. So of the decline, $103 million of it was just related to those 2 items alone.

James L. Wainscott

Brett, thanks to you. Thanks to everyone who joined us on today's call. We hope you'll have a good balance of the summer. We appreciate your ongoing interest in AK Steel. Have a great day and a better tomorrow.

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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