AK Steel's (AKS) CEO James Wainscott on Q2 2014 Results - Earnings Call Transcript

Jul.29.14 | About: AK Steel (AKS)

AK Steel Holding Corporation (NYSE:AKS)

Q2 2014 Earnings Conference Call

July 29, 2014 11:00 AM ET

Executives

Douglas O. Mitterholzer – General Manager, Investor Relations and Assistant Treasurer

James L. Wainscott – Chairman, President and Chief Executive Officer

Roger K. Newport – Senior Vice President, Finance and Chief Financial Officer

Kirk W. Reich – Senior Vice President-Manufacturing

Analysts

Evan L. Kurtz – Morgan Stanley & Co.

Nathan Littlewood – Credit Suisse

Timna Tanners – Bank of America Merrill Lynch

Aldo J. Mazzaferro – Macquarie Research

Charles A. Bradford – Bradford Research, Inc.

Sal Tharani – Goldman Sachs & Co.

Jorge Beristain – Deutsche Bank

Brian Yu – Citigroup Inc.

Philip Gibbs – KeyBanc Capital Markets Inc.

Anthony Rizzuto, Jr. – Cowen and Company

Operator

Good morning, ladies and gentlemen, and welcome to AK Steel’s Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (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. Roger K. Newport, Senior Vice President of Finance and Chief Financial Officer; Mr. Kirk W. Reich, Senior Vice President of Manufacturing; and Mr. Douglas O. Mitterholzer, General Manager, Investor Relations and Assistant Treasurer.

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

Douglas O. Mitterholzer

Thanks you, Sam, and good morning, everyone. Welcome to AK Steel’s second quarter 2014 earnings conference call. In a moment, Jim Wainscott will offer his comments on our business. Following Jim’s remarks, Roger Newport will review our second quarter 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 the future shipments, product mix, prices, costs, operating profit, EBITDA or liquidity or any comments that may be made regarding our pending acquisition of Severstal Dearborn. 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 are 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 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 at aksteel.com.

With that, here’s Jim for his comments. Jim?

James L. Wainscott

Thank you, Doug. Good morning, everyone. Thank you for being a part of today’s conference call. I’m very pleased to report that AK Steel’s second quarter of 2014 showed marked improvement in just about every area compared to our first quarter results.

We were well-positioned for a much improved second quarter of 2014 and deliver a much improved second quarter is exactly what we did. While our second quarter was not without its challenges for sure, our performance proved to be significantly better than the first quarter in terms of shipments, revenues and production among a host of other items and each of those factors contributed to improve margins on a much better bottom line.

Excluding the negative mark-to-market impact on certain hedges that were out of the money at the end of second quarter, AKS Steel generated adjusted net income for the second quarter. On an adjusted basis, we earned a profit of $0.02 per share in 2Q compared to a loss of $0.40 per share in 1Q. That is terrific progress. But our future looks even brighter with our recently announced acquisition of Severstal Dearborn.

Let me take a few minutes to follow-up on last week’s historic announcement of this transformative deal for AK Steel. On July 21, we announced the acquisition of Severstal North America’s Dearborn plant located in Dearborn, Michigan. I’d take just a few moments this morning to, first, reiterate a couple of key points from last week’s conference call, but more importantly, offer some additional details, provide more insight into our thinking on this deal.

AK Steel’s acquisition of Dearborn will provide us with increased scale and enhanced operating flexibility. The acquisition will also allow us to better serve our customers. And serving customers better than any other steelmaker is what we’re all about at AK Steel.

It’s expected to generate cost-based synergies of about $50 million per year of which approximately $25 million are expected to be realized in the first full year after closing the deal. The synergies come from making more, better and safer opportunities for meaningful productivity improvements, quality enhancements, purchasing and transportation savings, have all been identified and we’re eager to get to work to realize these synergies.

Finally, the transaction will be accretive. We expect it to improve our earnings and cash flow, be credit enhancing and enhance shareholder value. The price we’re paying is $700 million in cash. That price is roughly $1 billion less than the original purchase price and subsequent investments to upgrade the facility. And at least, in my opinion, it’s at least $5 billion less than replacement cost.

Let me add that the $700 million purchase price includes $300 million of working capital. Upon closing the deal, if working capital is lower than $300 million, the price paid for the asset will be reduced accordingly.

Now, let me offer a comment on depreciation when we apply purchase accounting to this transaction. We expect the fixed assets to go on our books and a value of between $400 million to $500 million. This is between $900 million to $1 billion below the caring value currently on service tools books.

As a result we expect depreciation expense to be much lower for AK Steel than was the case for several stalls. Upon completion of the acquisition we estimate that annual depreciation and amortization expense will be in a range of $30 million to $40 million.

As I mentioned we expect higher earnings resulting from this acquisition since AK Steel has substantial net operating loss carry forwards. We do not expect to pay income taxes on these additional earnings for the foreseeable future.

So it’s important to keep this in mind when forecasting future cash taxes and cash flow. Over the years AK Steel has generated NOLs of about $1.8 billion with a b dollars. The Severstal acquisition will allow us to more quickly utilize our net operating loss carry forwards or NOLs offset taxable income. In other words this is another benefit of the Debron acquisition.

In terms of both taxes except for changes in our LIFO reserve AK Steel currently does not report any tax expense or any tax benefit. After the Dearborn acquisition we expect to continue this practice.

Now let me shift focus to how and when we intend to finance the transaction. Under the Hart-Scott-Rodino act we’re required to provide certain information to the department of justice to obtain antitrust clearance for the transactions.

We’re currently preparing that information expect to submit to the DoJ within the current or next week. We expect the initial regulatory reviewed to be completed within 30 days after our HSR filing. We’ll be clear to proceed at that point unless we received, their request. Upon completion of this review, we intent to move forward immediately with capital market transactions to finance the acquisition. Once again to be clear, we did not currently intend to come to the markets to finance the transaction until we successfully complete the HSR review process.

In financing the acquisition of the Dearborn we expect to issue a prudent combination of debt and equity securities. We cannot say at this time with certainly what the final financial structure will be because of variety of factors, including our consideration of the capital market conditions at the time of the offerings, but here is our current thinking on this subject.

We currently expect to finance this transaction, including the associated fees and expenses, with approximately 60% debt securities and about 40% equity securities. We believe this type of financing structure will result a transaction that is both accretive to our earnings per share and credit-enhancing using traditional credit metrics.

As we indicated on last week’s conference call, we expect double-digit percentage accretion. And that statement is based on comparing our outlook to the current 2015 consensus earnings estimates for AK Steel. Subject to the conclusion of the regulatory review process, we expect to close this transaction late in the third quarter or sometime in the fourth quarter of 2014.

In summary, AK Steel’s acquisition of Severstal Dearborn will make us a better company. It will further strengthen our position as a premier North American steel manufacturer and complement our existing carbon steel operations. It’s a business we know well and we believe we’re buying it at a good price. Hence, it’s an attractive investment opportunity for AK Steel.

Now, I’d like to take a moment to highlight some standout performances in those areas that we hold near and dear at our Company, our core values, if you will of safety, quality and productivity. Safety remains our Company’s highest priority and we do our best to live it every day. During the second quarter, AK Steel’s Coshocton Works was recognized by the Ohio Bureau of Workers’ Compensation, Division of Safety and Hygiene for working nearly 2 million man-hours without a lost-time injury. That is an amazing accomplishment. Congratulations to them.

And AK Tube’s Columbus, Indiana and Walbridge, Ohio plants each received the Safety Award of Merit from the Fabricators and Manufacturers Association for great safety performance relative to their peers, again job well done. On the quality front, we performed well internally, that is in terms of both internal rejects and retreated products. Once again we generated only about 2% of secondary or non-prime products, a fine job by our operators.

But our customers are really the best judges of our performance when it comes to quality. And according to Jacobson customer surveys, we continue to be rated number one in quality in both carbon and specialty steel markets, which is just terrific.

Productivity-wise, I’m delighted to report that our blast furnaces ran much better in Q2 than in Q1. That said, we continue to experience operational issues at our Ashland Works blast furnace, some of which are continuing and we’re assessing the possible need and timing for a larger maintenance job at that furnace.

I’m delighted to report though that Middletown’s blast furnace is running exceptionally well and speaking of Middletown during the second quarter, we reached a new 42 month labor agreement at our Middletown Works with Local 1943 of the International Association of Machinists and Aerospace Workers, so prior Middletown contract was set to expire on September 15, 2014 and we’re pleased that we reached a neutrally beneficial agreement with the Machinists well in advance of the scheduled expiration day.

And my remaining prepared remarks I would like to focus my comments on three subjects in particular. First, raw materials including Magnetation’s near-term startup of plant.

Secondly, automotive markets it’s strengthen our progress in terms of light weighting. And third the electrical steel market and particular its recovery. Then following Roger’s recap of our financial performance we will be happy to take your questions.

In recent years, lowering cost and improving our raw materials and energy self sufficiency have been key strategic initiatives for AK Steel, suffice it to stay that these initiatives are coming to life. Given the fact that we are currently buying 100% of our iron ore pallets in the open market the steep decline and iron prices will lower our third quarter still making input costs and enhance our margins in a meaningful way.

We are also tremendously excited about the imminent startup of Magnetation’s pellet plant in Reynolds, Indiana. Since we announced our joint venture with Magnetation Inc. in October of 2011, we’ve been looking forward to this important milestone. Magnetation is in the final stages of construction of its new state-of-the-art iron ore pellet plant again that is in Reynolds, Indiana.

Also, Magnetation is more than a year ahead of its original schedule and is now expected to begin operating either in August or September of this year. That’s a credit to Larry Lehtinen and his entire team at Magnetation. Soon Magnetation will be producing its first iron ore pellets and begin to provide what will become a steady diet of pellets to feed AK Steel’s blast furnaces located Middletown, Ohio and Ashland, Kentucky.

Our current 6 million tons of annual pellet needs for our Middletown and Ashland blast furnaces we’ll look to Magnetation to provide at least 3 million tons or about 50% of our current requirements with the remaining 50% of our needs are supplied by ECLIPSE and others.

The pellet plant is expected to ramp up production and began delivery of pellets this fall in 2015, we expect the Magnetation will be at a full production run rate of about 3 million tons of pellets annually.

Now, let we switch gears and comment on a strong and growing automotive market. I’ll just say that the automotive market is very strong, especially for AK Steel.

The light vehicle build rate has increased by about 5% from 2013 to 2014. However, AK Steel’s growth rate has been more than double that amount. From the depths of the great recession more than five years ago, this year’s auto builds are expected to reach or exceed some 17 million units and continue to grow steadily in the years ahead.

Light vehicle sales continue to exceed expectations and for the month of June achieved a seasonally adjusted annualized rate of approximately 17 million units, the highest level since July of 2006. For AK Steel second quarter shipments to automotive customers represented the highest auto shipment quarter in seven years since the second quarter of 2007 to be exact.

Increasingly, automakers are coming to North America or expanding their production capabilities here. And that’s really great news for AK Steel, for all the American manufacturers and it’s great news for the United States as well as Canada and Mexico. We continue to talk and mostly listen to our automotive customers on the subject of light weighting, a topic that has gained a lot of press this year with aluminum’s penetration on particular platform.

As automakers continue to search for new ways to enhance fuel efficiency, I strongly believe that Steel is and will remain the material of choice. As a company and as an industry through our trade association, The American Iron and Steel Institute, we’ve been interested in light weighting for many, many years. And AK Steel is ready to complete the win and this latest and this very serious challenge to keeping its steel.

We already offer highly innovative and competitive solutions. For example, AK Steel currently produces advanced high-strength steel products including our dual phase and both bare and aluminum-coated pressed hardened steels that make vehicles stronger and lighter. In addition to producing carbon steel products needed to meet CAFE Standards, our stainless and electrical steel products are also up to the task.

So if you’re a steel buyer, user or consumer of steel products, here are three things to keep in mind. First, if cost matters to you then steel is the material of choice for you. Steel is less expensive than aluminum. Using steel results in a less expensive vehicle to producers and as we know the consumers who will also pay lower insurance rates and repair costs with vehicles made from steel. And steel allows automakers to lightweight their vehicles without retooling their plants and spending billions of dollars to do so.

Second, consumers of these steel are the safest choice, thus giving steel an advantage over aluminum. Consumers know and they trust steel and indeed steel is one of the strongest materials in the world. And third against the environment matters to you then steel is the right choice for you, over the course of a vehicle’s life cycle. Steel produces fewer ignitions than aluminum. Steel is also the single most re-cycle product in the world, it’s 100% recyclable. In the year 2012, steel achieved a re-cycling rate of 88%. This compares to aluminum’s re-cycling rate of only 67% for 2012, in fact more steel is re-cycled every year than paper, plastic glass and aluminum combined.

My final thought on this subject is that, sometimes no news is good news. And what I mean by that is that, our customers rarely announce that they keep a vehicle in steel, but that is exactly what is happening almost everywhere you look. At the time when the perception is that we’re losing business to aluminum, we’re actually growing our automotive position at AK Steel, in fact, at AK Steel we provide a full complement of sheet steels that are used by our automotive customers to achieve their energy efficiency and light weighting objectives.

On the carbon steel front, we’re developing third-generation advanced high-strength steels that are significantly stronger and that demonstrate incredible formability when compared to current product offerings. Let me emphasize one thing, the products that we are developing at AK Steel are not simply extensions of existing products that are being touted as next-generation.

I fully expect there our research efforts at our company will deliver true third generation, advanced high-strength steels that can be produced with minimal or perhaps even no capital investment. Our stainless steels have been developed to be used in highest temperature exhaust systems for the engines that are being developed to meet ever increasing efficiency standards.

These steels provide improved corrosion resistance and the strength needed in order allow our customers to produce exhaust systems that will enable new light weighting application stand. Finally, our electrical steels are used for high-efficiency motors needed for the growing electrical and hybrid vehicle market segment.

AK Steel happens to be the only steel producer in the United States offering a full range of carbon and specialty flat-roll steel products needed by our customers, to achieve light weighting. We offer these products today and will offer the products of the future, to serve our automotive and other customers, as well. That is what real innovation is all about.

And finally, let me take a couple of minutes to provide you an idea what we’re seeing in terms of the recovery in the electrical steel market. After a multi-year decline, the tide, thankfully, is beginning to turn. As evidence, our second quarter grain-oriented logical steel shipments were more than 10% higher than the first quarter for naphtha and for export shipments. Several things are causing the ship beginning with inventory levels, unlike 2013 customer inventories are in line, commercial construction is recovering and importantly, housing starts are expected to exceed 1 million units in 2014 which would be the first time it’s done so, where the level of housing starts has occurred since the year 2007.

With the very harsh winter weather conditions behind them naphtha customers are more bullish now than they have been in quite some time, in addition they are preparing for a seasonal weather related growth. So, the improved domestic picture appears to be one that is demand driven and that’s very encouraging. Similarly after a long drought, we’re finally seeing some optimism regarding electric steel in Europe. The economy of Europe continues to recover and the new energy efficiency standards have become effective in 2015 and 2016, also appear to be having a positive effect.

Once again, while all of this is a positive for AK Steel, I would add that there remains significant excess global capacity for electrical steel. When the playing field is level, we are capable of competing effectively on a global basis and with that in mind we have applaud the final ruling that the U.S. Department of Commerce issued earlier this week against three countries we identified in our freight case forgoes products. These rulings upheld the preliminary antidumping margins on goes in force into the United States. And as the facts are examined we remain confident that a favorable ruling will ensue in late September against the remaining four countries involved in this trade case.

To be clear, we are not seeking exclusion or special treatment, we are simply seeking fair trade on electrical steel or for that matter on any flat-rolled steel products that is imported into the United States of America.

Before turning the call over to Roger to cover our results and outlook, let me say that I believe AK Steel is well positioned for a much improved second half of 2014. the first half of this year with all of its weather related challenges operating stability issues and mark-to-market hedges frankly played havoc with our financial results for a variety of reasons including lower cost raw materials, further gains on the auto market and a continuing electrical steel recovery as well as the acquisition of Severstal Dearborn, we are very excited about the future of AK Steel.

Thank you all very much for your attention. And now to recap of our second quarter results, here is our Senior VP of Finance and CFO, Roger Newport. Roger.

Roger K. Newport

Thank you Jim. Earlier today we were pleased to report adjusted net income of $2.9 million for a profit of $0.02 per diluted share. For the second part which exceeded our guidance of an adjusted net loss ranging from $0.02 to $0.06 per share.

Our adjusted second quarter results exclude the mark-to-market charge of $20 million or $0.15 per share related primarily to derivatives used to hedge the cost of iron ore that were out of the money at end of second quarter. We are adjusting our results to exclude those mark-to-market hedges because we believe that provides a more consistent and accurate quarter-to-quarter comparison of our financial performance.

Charges for mark-to-market hedges are largely a matter of timing. In this instance, the cost impact of our second quarter charges for mark-to-market hedges will be mostly offset in the second half of 2014. The offset will occur either in the form of a lower purchase for the related steel making inputs or by an offsetting gain should the mark-to-market loss on derivatives reverse before settlement.

Our adjusted net income for the second quarter 2014 represents a significant improvement over our first quarter results. In fact, our results were $57 million or $0.42 per share better than our adjusted net loss for the first quarter of 2014. In addition to the previously discussed mark-to-market charge, our second quarter financial results were also negatively impacted by the lingering effect of the severe winter weather we experienced, which reduced our iron ore deliveries, slowed our blast furnace production and caused an increase in our transportation costs.

The weather related cost impact in our second quarter results totaled approximately $15 million or $0.11 per diluted share. Our planned outage expenses for the second quarter were $2.5 million, a reduction of nearly $27 million when compared to the first quarter.

Second quarter shipments of 1,397,500 tons represent an increase of 135,000 tons or about 11% compared to the first quarter. And I might add that our shipments for the second quarter were slightly better than our guidance. The increase in shipments for the second quarter was primarily due to the recovery from the unplanned outage at the Ashland Works blast furnace in the first quarter. This improvement was partially offset by the impact to our operations due to the extreme winter weather conditions.

Our average selling price for the second quarter was $1,095 per ton, virtually identical to our average selling price for the first quarter and in line with our guidance. Sales for the second quarter totaled $1,531 million, about $147 million or 11% higher than the first quarter. Improved selling prices in the second quarter for many of the company’s products were offset by less value-added mix of products as more shipments during the second quarter were made to the carbon steel spot market.

Our second quarter results included a LIFO credit of $3.3 million compared to a LIFO credit of $1.5 million for the first quarter of 2014. 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 interest that are included in our operating results. As a reminder our non-controlling interest, consist primarily of SunCoke, Middletown. Excluding the non-controlling interest our adjusted EBITDA for the second quarter of 2014 was $64.5 million or $46 per ton. This represents an improvement of $67.3 million or $48 per ton, compared to the first quarter of 2014.

Moving to our results for the first six months of 2014, revenues for the first half were more than $2.9 billion, an increase of approximately $140 million or 5% compared to the first half of 2013.

Shipments for the first six months of 2014 were 2,659,600 tons, roughly 2% increase compared to the first six months of 2013. And we are pleased to have achieved higher automotive market shipments, during the first half of 2014, as compared to the same period, in 2013.

Our average selling price for the first half of 2014 was $1,096 per ton, an increase of $35 per ton or roughly 3% compared to the first half of last year.

Moving from sales to our operations, we incurred approximately $50 million in planned and unplanned major maintenance outage calls during the first half of 2014, compared to $29 million in the first six months of 2013. The extreme winter weather conditions resulted in higher cost of approximately $45 million in the first six months of 2014 for items such as electricity, natural gas, transportation and operating costs, compared to the same period in 2013.

At the bottom line, for the first six months of 2014, we reported a net loss of $103.2 million, compared to a net loss of $50.3 million in the first half of 2013. Also included in our first half 2014 results, we are $23.4 million in mark-to-market charges on hedging derivatives, which I discussed previously, as well as a $5.8 million charge related to a legal settlement.

Turning to the balance sheet and cash flow for the second quarter of 2014, our capital investments totaled $13.5 million, represents the same amount as we invested in the first quarter of 2014.

On a strategic front, in the second quarter we invested the $45 million in our iron ore joint venture with Magnetation sounds good. As expected working capital consumed $148 million of cash during the second quarter, partially reflecting the normal seasonal fluctuation in inventories as well as the normal quarterly fluctuations related to interest payments.

In addition, we ended the quarter with strong sales, which increased our receivables at the end of the second quarter. Our working capital usage in the first half of 2014 of $162 million was slightly better than our recent historical average. We continue to be focused on working capital needs of our business and we expect just as we have got historically, to achieve a significant reduction in working capitals, as we move through the remainder of 2014 primarily in the fourth quarter.

In the second quarter, we also made a $71 million contribution to our pension fund. Looking ahead, fundamental change is on the way in terms of our future pension contributions. We expect our pension contributions to decrease by about one-half, to approximately $100 million of 2015, and by one-half again to approximately $15 million in 2016. On the liquidity front, we ended the second quarter of 2014 with solid liquidity of $539 million. Accordingly, we continue to be well positioned to serve the needs of our customers and our operations and our operations, as well as execute our strategic initiatives.

As we look forward to the closing of the acquisition of Severstal Dearborn, we anticipate incorporating Dearborn’s inventory receivables into the collateral base for our revolving credit facility. While we remain intently focused on managing our working capital needs, we do expect to increase the size of our revolving credit facility in conjunction with the acquisition which will further enhance our liquidity position. Further, as we anticipate regulatory approval and accessing the capital markets for permanent financing of the Dearborn acquisition, it is important to remember that we already have in place committed bridge financing.

Now turn its our outlook as is our practice, we plan to provide detailed guidance for the third quarter of 2014 in September. While we are not providing financial guidance at this time as mentioned, we expect our results in the third quarter of 2014 to be much better than the second quarter. Among the reasons for this improvement is that we expect to benefit in a meaningful way from declining iron ore cost.

Let me conclude my prepared comments by saying, thank you for interest in AK Steel. And at this time, we would be happy to take your questions.

Question-and-Answer Session

Operator

Thank you, Mr. Newport. We will now begin the question-and-answer portion of our conference call. (Operator Instructions) One moment please for our first question. Evan Kurtz of Morgan Stanley, please go ahead with your question.

Evan L. Kurtz – Morgan Stanley & Co.

Hi. Good morning, guys.

James L. Wainscott

Good morning, Evan.

Evan L. Kurtz – Morgan Stanley & Co.

It was interesting you bought up the electrical steel use in hybrids. I was wondering if you could maybe delve in a little bit more detail and give us a size of that market, where it is today, where you think it could go maybe over the next decade or so?

Roger Newport

I don’t know that we’d be the experts in being able to give you the facts and figures or except to say that, I think we all realize it’s a growing market. We’re working closely with all of our automotive customers, make sure they know what we can do for them. And I’d tell you that there is an awful lot of interest.

Evan L. Kurtz – Morgan Stanley & Co.

Are you actively selling actually what’s non-oriented product to the auto today?

Roger Newport

Yes, indeed.

Evan L. Kurtz – Morgan Stanley & Co.

Great. And then one other question, just on mix. I was a little surprised to see that you had a slight offset from higher spot carbon sales in the quarter just given that you had some operational issues. How should we think about that in the second half? Is that going to revert more back towards the first quarter mix?

Roger Newport

I would say the first quarter we were impacted from the outages and then we had the cold weather in the second quarter. So here in the third and fourth quarters, we don’t see a material swing market conditions will drive how much we put into the stock market more than anything.

Evan L. Kurtz – Morgan Stanley & Co.

Okay. And then, maybe just one on stainless. Nickel seem to flatten out here a little bit and I’m just wondering if that’s impacted your order books at all going forward?

Roger Newport

I think what stainless for us – our primary focus is on the 400 series, the autochrome business. That’s been remarkably strong, and we expect it to continue to remain that way. We’ve also great strength with the kind of products we produce out of the Coshocton Works to meet certain special needs there. But commodity chrome nickel market again is not a big one for AK Steel, but we’ve been opportunistic and we’ll continue to be, I think that the upward move with respect to nickel prices, and then sort of holding there has been favorable to us and we will continue to take advantage of that as it makes sense.

Evan L. Kurtz – Morgan Stanley & Co.

Great. I’ll hand it over. Thanks, guys.

James L. Wainscott

You bet.

Operator

Thank you. Our next question comes from Nathan Littlewood of Credit Suisse. Your line is now open.

Nathan Littlewood – Credit Suisse

Good morning, and thanks, guys. Just had a couple of questions on iron ore first of all. Could you tell us what your inventories of iron ore were at the beginning and also at the end of the quarter? And how do they compare to what you consider normal levels?

James L. Wainscott

Let me just take a stab at that and if Kirk wants to jump in that’s fine. My sense is that we are still – in fact I know that our company is still well below its normal levels of inventory. At midway point of the year we suspect that that will rectify itself between now and year end. So we’ll go into the winter season in good shape again, but I think frankly that the entire marketplace is still catching up from the severe winter weather conditions.

Most have underestimated the effect of that in our case will probably cost us something like, I don’t know, 75,000 tons of production, in the quarter simply because we had to travel our glass furnaces back. I don’t know that I give you specific number need other than to say, we are in better shape today, we’re not down to single days we’re in two weeks. In terms of our own inventories, I suspect that that’s similar for most, because there’s only so many cargo ships that can deliver the product and deliver the product and so forth. So the world is still catching up and we’re in that world.

Nathan Littlewood – Credit Suisse

Okay, thank you. The other one was just on this Magnetation JV. So I appreciate the uptake there, but could you talk a little bit about, when and how you expect to actually see the cash savings, or cash returns for that? I mean assume initially you will be paying some sort of the great market price with Magnetation. The earnings and cash will be getting accumulated in Magnetation, but it might be some period before it actually start, [securely] (ph) paying a dividend back to you and you realizing those cash benefits.

So could you talk about what the cash return profile looks like?

Roger Newport

And there is a variety of ways that we benefit obviously our 50% ownership, as well as the discounted price that we get, and it’s very competitive cost even relative to today’s lower IODEX Index. And the key benefits that you begin to see in 2015 and beyond, just because it’s obviously going to be in bit of a startup mode here for the balance of this year. I don’t you can give a number in terms of how much we’ll see. But again going forward on full run rate basis it’ll will be about 300 million tons and even if you assume, nay, then IODEX price of say $100, a ton, that’s probably a $16 million are so benefit to the company. I don’t know why did you refer [ph].

Roger K. Newport

I kind of comment on that. This three components of the benefits related to Magnatation, one, is the discounted the market so basically the volumes that we’re purchasing from them are 49.9% of the earnings, which will have some more is just because of their restrictions on their ends. And the other one is lower transportation cost that we will benefit from. And those, so this [started marking] (ph) a lower transportation cost directly to us and how we’re purchasing a commodity and how we’re transporting it.

James L. Wainscott

Yes one other thing here that would I just emphasize to Roger’s point on the transportation, imagine how much better off we would have been this year 2014, how much more we have been able to produce and sell at Magnatation had been up a year ago. So we’re delighted that we are year ahead of schedule, but it can happen fast enough in terms our long term strategy, just take us out of really the really the sort of eggs in one basket with the northern facilities. Hopefully we’ll never another winner like we did first time in 40 years but one never knows and so the geographical diversification the transportation savings are meaningful towards as well.

Nathan Littlewood – Credit Suisse

Absolutely, certainly just for background on the project that 49% of earnings the cash return of that. Is that expect to be a 2015 event as well or could that be a bit later?

Roger Newport

There could be some. There’s certain restrictions that they would have under their covenants if they have to live by, there could be some but again that I would say when you look at the benefits it’s across the three components that I mentioned early.

Nathan Littlewood – Credit Suisse

Okay, great, thanks for turning out to someone else.

Unidentified Company Representative

Thank you, (indiscernible).

Operator

Thank you. Our next question comes from Timna Tanners of Bank of America Merrill Lynch. Your line is now open.

Timna Tanners – Bank of America Merrill Lynch

Hi, good morning

James L. Wainscott

Good morning, Timna

Timna Tanners – Bank of America Merrill Lynch

Thanks for the further detail that was helpful on the deal. I’m curious about what’s going on with that front. What’s the problem there .Why is that not fixed? What’s is it running out at? Is that a volume cascades you were both, that’s my first question?

James L. Wainscott

So we’ve been playing close attention to our blast furnace there. There’s likely a longer term if not intermediate term maintenance sharp that will need to do.

Over the course of last week, we had an event that we typically refer to as a (indiscernible), it’s when excess water gets in the furnace and so we’ve been going through a process of recovering there, really should not have any meaningful impact at all over quarter with respect to shipments as we have purchase slabs and also can supplement our own carbon make it Ashland and Middletown with Buffer #5 VAF, so no issues there but I think the furnace is talking to us and we are listening intently and we are known for and we’ll continue to pay close attention to what’s happening and put into maintenance and operating practice there.

So that’s what’s going on in terms of the comment in my prepared remarks.

Timna Tanners – Bank of America Merrill Lynch

By the time you can offset the volume with other production butler at the minimum but as well as get to something that keep (indiscernible) in terms of elevated thoughts relative to running, that’s what you’re saying?

James L. Wainscott

There is a cost impact but again to really quantify that one has to know the extent of repairs the length and so forth. That was a big deal we probably say more about it now we’re really right in the midst of it, in terms of its recovery we’ll have more to say perhaps either in our Q or when we give guidance but again, we know blast furnace is pretty well we maintain them and operate them humbly pretty well. This is just one of those things that you run into with them and we’re working through it.

Timna Tanners – Bank of America Merrill Lynch

Okay, thank you. One other question I have is on NOL, we just want to make sure we understand if there is any limits to their application on the acquisition sometimes there is some parameters around that. so just want to little bit more color there, please.

James L. Wainscott

Timna, short answer there is no. there is no limitations.

Timna Tanners – Bank of America Merrill Lynch

Okay, excellent thanks again.

James L. Wainscott

Thank you, Timna.

Operator

Thank you, our next question comes from Aldo Mazzaferro of Macquarie. Your line is now open.

Aldo J. Mazzaferro – Macquarie Research

Yes, hi, Jim how are you?

James L. Wainscott

I’m doing well.

Aldo J. Mazzaferro – Macquarie Research

I’m wondering if you could just help us a little bit on the other facilities that you required with Dearborn. you talked about how the Dearborn plant itself is a scale up and quality and issues like that. But you also have the Double Eagle, Spartan and Coke battery.

Could you talk about what the capital cost may have been for those and whether they are operating profitably at the moment?

James L. Wainscott

I’ll start maybe with the coke complex where Kirk will be tomorrow but you wanted this comment and I think that would sure blossom what we got there.

Roger Newport

Sure, it’s a very nice larger battery, there is several smaller batteries that are on highlight with the larger batteries is running pretty well. Was a large capital investment made several years ago. And it’s a very nice asset that we intend to run harder to be very profitable there.

James L. Wainscott

Just on that point, although I think to produce what they have got there- I don’t know $0.5 billion or so I mean big money, obviously and three are sort of an idled, the one is going. It’s not operating full because there has been a need for it, the real benefit comes when we burn it full. And we looked around everything fall out so of course finding solutions for that’s great.

You may have seen recently where through the resolution of the RG Steel bankruptcy, Severstal actually paid for the remaining other half but they didn’t have some $30 million or so came out of their pockets not ours. So we will own 100% of Mountain State it has a significant potential from there then the other facilities as you mentioned Double Eagle where we will be a partner with United States Steel. We’ve really not had dialog at this point to say what the future of that facility is. But as you know it burned down, it was rebuilt, I think a very good facility the question is what can we do there together.

And then as Gartner our good friends at Worthington are great customer and processor that we use, we have had dialog and really looked to capitalize further on that tickle.

Any details beyond that by the way just comes a percentage ownerships were 50:50 owner Double Eagle and a 48% owners Sparton steel coating. Enormous opportunity collectively with all of those things and more. All I would say, but we don’t own the facilities yet, we really had just what I would call due diligence initial looks at these things, but tremendous outside potential.

Roger Newport

Right and then net working capital $300 million of working capital seems kind of a heavy number for our company with 2.5%, does that strike you with heavy – $300 million here.

James L. Wainscott

Though future judgment calls it’s part of the deal, it’s the reason why I mention it, I think when we took a look at historic levels, that they have operated under it has been in that ball park. And it’s a little bit below that with respect to the iron ore issues that they had this winter. So, all that will get trued up when the deal closes. We would hope although that there’s opportunity in every aspect of the operations for significant efficiency improvements, bringing some of the practices and procedures for maintenance and operations that we bring as well as good working capital management. So hopefully there is more to be had, but the deal will simply be adjusted plus/minus to that $300 million level I was making.

Aldo J. Mazzaferro – Macquarie Research

Yes, very nice trade on that asset, Jim, by the way. If I could just ask one more question. We’re hearing a little bit about the electrical steel market in Asia seeing some price increase. I think it may be related to some trade action Japan maybe talking against China. You commented on how the demand seems to be getting better. Are you seeing any pricing on the electrical steel?

James L. Wainscott

I think we’ve seen demand pick up generally, which has been the main driver. I think that the trade case certainly had an impact in terms of sort of sending the tide perhaps of some imported levels and just putting up a floor on things here. In terms of your specific question, I don’t know that I can add a whole lot of color with respect to the Asian market. As you know, we were zoned out of China and remain largely zoned out. That was a very important opportunity for us. We are anxiously awaiting the implementation of the plan there, so that we can get back in and serve our customers there. But specific to Japan, I cannot comment today.

Operator

Thank you. (Operator Instructions) Our next question comes from Charles Bradford of Bradford Research. Your line is now opened.

Charles A. Bradford – Bradford Research, Inc.

Thank you. Good morning,

James L. Wainscott

Hi, Charles.

Charles A. Bradford – Bradford Research, Inc.

Hi. Questions about the JV. So my understanding is that both of the Double Eagle and the Spartan has slide up first refusal on a change in ownership. Have you had any indications from your partners on how they’re going to do handle it?

James L. Wainscott

Again, I think I’d mentioned in the response to all those questions. I don’t know if you heard that or not that we’ve had good dialogue, very encouraging dialogue with respect to Worthington as it relates to the Spartan Steel Coating Facility. We intend to run that together and to optimize the opportunity there. There’s no intend on their part to do anything. We’ve had less conversation, in fact, no conversation with a partner in Double Eagle at this point. We’re very interested in saying what that could bring. So we’ll leave it at that for now, Chuck.

Charles A. Bradford – Bradford Research, Inc.

Okay. Are there any provisions in Cliffs contract that Severstal has about change in ownership?

James L. Wainscott

Nothing I’m aware of. It’s a great method we will step into and we’ll obviously need to have some conversation with Cliffs. We’ll be a more important customer to them and they’ll be a more important supplier to us. We have a good relationship with them. We know today it’s a big day for them. So we won’t bother them today, but we’ll certainly be in touch.

Obviously steel making input cost and quality matter greatly when you’re making steel and again when you’re finishing steel. So that’s an important discussion that needs to occur. Again, it has not taken place, but it will.

Charles A. Bradford – Bradford Research, Inc.

The rumor now has it that there will be a change in ownership, at least a change in management, say, tomorrow.

James L. Wainscott

I don’t know, but I’d comment on that rumor any more than any other rumor. We value our relationship with them and we’ll see how that plays out and look forward to our dialogue.

Operator

Thank you. Our next question comes from Sal Tharani of Goldman Sachs. Your line is now opened.

Sal Tharani – Goldman Sachs & Co.

Good morning.

James L. Wainscott

Hi, Sal.

Sal Tharani – Goldman Sachs & Co.

Sorry. I missed most of the comment. I want to ask you if you have touched upon. How you’ve been utilizing the Butler plant in terms of slab for your other systems? And I know with Dearborn acquisition you will be further long on the rolling side. Would Butler play a role in there you think?

James L. Wainscott

Well, Butler has been a magnificent addition really in terms of the investor. We made the Number 5 EAF. It’s primarily meant to replace three less efficient sort of 1960’s-vintage EAFs and it’s done that very effectively, very cost effectively and quality effectively to make our electrical steels and certain stainless products. But it also supplements our carbon needs and it’s opportunistic and particular when we have an issue related to a planned or unplanned outage. It probably has something upwards of 4,000, 5,000 tons of carbon capability slab wise for us in addition to meeting all of our other needs.

In terms of exactly how we’re playing to the Dearborn structure and outlook remains to be determined. One of the things that we look to do when we get our hands on the wheel is to really optimize everything. And a point I made before that I’d just emphasize again is, we have no intention of shutting down anything that we operate today at AK Steel, nothing at Butler, nothing at Ashland, nothing at any of our other facilities. And the same is true for Dearborn.

We’re looking to take things to the max, really get everything out of these facilities that we can get. And the same is true also for optimization of the people. It’s really putting together the very best team that would be able to compete effectively and to win on the global steel marketplace. So that’s that. Anything more specific with respect to Number 5 or Butler?

Sal Tharani – Goldman Sachs & Co.

No, that’s it. Thank you.

James L. Wainscott

Okay.

Operator

Thank you. Our next question comes from Jorge Beristain of Deutsche Bank. Your line is now opened.

Jorge Beristain – Deutsche Bank

Good morning. My question is just more of a strategic one, I guess, for Jim. Just to your earlier comments about how steel will be the natural choice for the auto industry in the future and you guys through technology will have rebuttal products. I was just wondering if you could comment. When we talk to the aluminum processors, they’re talking about getting the auto OEMs to switch over for a life of platform. So, just wondering. It seems to be like a one-way substitution win and if they do switch to aluminum. So I was wondering if you could talk to that point and how long your current durations are for your existing auto steel supply contract.

James L. Wainscott

Historically it’s been steel. That doesn’t mean it will always be steel, but we understand the space pretty well and we know that typically when you get on a platform you stay on that platform. So I think what you’re hearing is consistent with what we have experienced being steelmakers and suppliers to automotive companies.

I think we’re all going to see together just how successful this network is. And so, for us to make a call on it – we’re not going to do that today. In fact, I just emphasized it. We have wonderful relationship with all of our automakers. We want them to be profitable. We want to be profitable as well and we’ll continue to try and serve their needs. Could there be some sort of midstream change? Those things do happen from time to time, but by and large when a platform is bid out, it tends to stay with a particular supplier and a particular material. But we’re all going to find out together.

Jorge Beristain – Deutsche Bank

And if you could also comment a little bit on profitability. There’s been some examples that you guys have raised about how parts done in aluminum have gone back to steel. But could you comment? Is this a kind of thing where the OEMs are expecting sort of flat pricing, but just better quality steel, higher strength steels? And, so I’m just wondering if you could talk a little bit to the potential profitability impact of having to be with aluminum down to a product-by-product level if you’re seeing any cut in the margin when a product is back into steel?

James L. Wainscott

I don’t know that we’ve won a whole lot of products back. So it’s a little early to really sense that. I would tell you that we continue to bring not just a price to the party, but the total value equation. Again, I know that sounds a little fuzzy and furry, but the reality is we sell a value proposition here. We are not the biggest and we don’t show all the commodity products and great volumes. We’re really focused on the very high. We love to serve automotive customers, give them great product on time, great delivery, great customer service and over the years that’s started as a very good position. We take number one position with them.

So, obviously, we’re watching. We’re paying very close attention to the larger scenario type of issues and questions, but we’re growing at a time, as I mentioned, before 10% or 11% over the last year and we expect to continue to grow. We’re taking market share and we think that will continue. There has certainly been instances where certain pieces and parts, certain products have come back to steel because the light weighting and the cost factors enter into all of it.

I would just tell you that aluminum remains a multiple of higher cost than steel. And so, it’s going to be challenging I think from a cost standpoint purely to compete. And again, there are a variety of objectives that OEMs are seeking. And I would just emphasize that steel, and particularly AK Steel, we are part of the solution rather than sort of being due as part of the problem and that’s the way we’ll continue to go at this.

Operator

Thank you. Question comes from Brian Yu of Citi. Your line is now opened.

Brian Yu – Citigroup Inc.

Great, thanks. Jim, a question on iron ore, and you’ve kind of given us an outlook that the iron ore pressure – your costs were expected to climb. That makes spot sense. Would you also provide some sensitivity? I know Cliff, so for them every $10 change in the benchmark iron ore price reduces or that changes their real life price by about $1. So it’s $0.10, not $1. Would you be able to give us a sense of how your iron ore purchase cost changed relative to the IODEX?

James L. Wainscott

It’s a really good question, Brian. I’d say it’s not just as simple as that because some of our deals relate directly to the IODEX and others do not. But I think the IODEX has probably fallen per $20 quarter-over-quarter. If that was a straight shot, consuming 3 million tons in the second half of the year one can do that math. However, a portion of that of course we’ve hedged, right. So you can’t really do that math and I don’t know that I’d be able to give with a great certainty here. It’s tens of millions of dollars. Let’s say that.

We think our raw materials and energy in total will be a multiple of that for the second half, but I think (indiscernible) has it today, Brian, to give sort of a piecemeal guidance if you will, just sort of picking out the iron ore piece or raw materials and energy piece without sort of giving volume and pricing and other components that might affect the third or fourth quarter, but, please, no. It is a very meaningful move. What has happened here to iron ore and what’s happened to natural gas and other inputs should serve us very well both in the third quarter and in the second half.

Brian Yu – Citigroup Inc.

Okay. Same question on stainless. I think your date has been a lot of nickel-based stainless steel pricing. To my knowledge very few of them have stuck for your auto-chrome. That seems to be much stronger to speak to the base prices for that particular product line and whether you’ve been able to boost those?

James L. Wainscott

Our auto-chrome deals are done typically on an annual basis and will be in those dialogues some are undergoing right now. Similar to our regular automotive contracts they expire at various times throughout the year. And I think, again, as with everything, supply and demand plays a great role in it. And the job that we’ve done for our customers matters as well, but we’re never shy about seeking to obtain a price that will allow us to obtain a return for our shareholders and to reinvest in the business to be there for the long run and this year will be no exception.

Operator

Thank you. Our next question comes from Philip Gibbs of KeyBanc Capital Markets. Your line is now opened.

Philip Gibbs – KeyBanc Capital Markets Inc.

Good morning.

Roger Newport

Good morning.

James L. Wainscott

Good morning, Phillip.

Philip Gibbs – KeyBanc Capital Markets Inc.

I had a question largely just on how you think about hedging the iron ore exposure. You said you got about 3 million tons that you’ve got coming in that you obviously used for the steel making. So how do we think about that hedging piece going forward and how you just view it strategically?

James L. Wainscott

The biggest hedge that we have, Philip, is of course Magnetation, the fact that we have taken 50% off the table, if you will. We could no longer afford to be 0% hedged or 0% ownership and have 100% at risk. Having said that, one can never call the direction with great accuracy or success certainly over the long run. And so, we think being about at that 50% level of self-sufficiency is a very good strategic position to be in whether prices go up or down. So it offer that as sort of the first point.

Then that leaves us in the open market for about half of our needs. And, again, this year as iron ore prices were following, we were putting in hedges along the way. They fell further and faster, I think than most expected. But I think we’re systematic about it. We’re strategic about it, so that we’re not placing big bets. These are indeed defensive positions to sort of lock in at levels that we think makes sense and preserve and protect our business plans. So I’d offer that business in terms of the approach.

Philip Gibbs – KeyBanc Capital Markets Inc.

Okay. And then, just a follow-up on the grain-oriented piece. Any color you could give us on what you may anticipate the volume growth to be this year relative to last year given the solid second quarter that you had?

James L. Wainscott

It’s certainly going to be up, but it’s not going to be up anywhere near where we’d like and certainly nowhere near the record levels that we’ve seen before. We’ll continue and talk to customers. Delighted that for the first time in about seven years we are going to be that back to that million tons of housing starts which really drives the after production don’t know we would be able to give you a percentage increase today but we are looking for more this year and even more next year.

Philip Gibbs – KeyBanc Capital Markets Inc.

Thank, Jim. Good luck.

James L. Wainscott

Thank you, Buck.

Operator

Thank you and our final question comes from Tony Rizzuto of Cowen and Company. Your line is now open.

Anthony Rizzuto, Jr. – Cowen and Company

Hi, good morning gentlemen.

James L. Wainscott

Hi, Tony.

Anthony Rizzuto, Jr. – Cowen and Company

Hey, Jim got a follow-up question here on the investments at Dearborn and it seems like lot of the investments have been at the hard end and the finishing in coating side relatively little it seem in the hot strip mill I was just wondering can you comment us to the condition of the hot strip mill there or there any significant investments that you see that would be required there over the medium term?

James L. Wainscott

Now I’ll let Kirk think about that. Let me first just sort of way into remind everybody that since 2007 alone, this excludes the comments we made earlier about Mountain State, coke investment is over but $1.2 billion. $1.2 billion invested in upgrades since 2007 that’s effectively what we spent to built Rock Fort Worth that’s effectively what Allegheny technologies are spent and it’s new our pickle facility I mean that is a unbelievable amount of money and in the process re-align the blast furnace in our new coal mill complex, triple coal tunnel and new hot-dip galvanizing facility. This is the facility that largely has reinvented itself and has enormous opportunity like other even on our call last week sort of appointed hot strip mill and there are things we are drilling there or let me ask Kirk maybe just way in.

Kirk W. Reich

There are earlier investment aside from the big dollars that keep being throwing out that have been made the steel shop has the new vessel the hot strip mill has new re-heat furnace burner, burner utilization project that they spend $30 million on, so there has been fair amount of investment there, they are based on due diligence, the right number of spares, the right amount of equipment there and then it become a maintenance and operation again and we intent to reduce the convergence cost by operating more efficiently and applying some of the same techniques we use in our current operation.

James L. Wainscott

So frequently Tony there is never a perfect hand so perfect game, we have now significantly more business or in life, you play the hand and you drill, there are some pretty good hands, not perfect hand, but pretty good hand we will maximize the opportunity we think again it’s a business we know well we have now significantly more flexibility and we are getting at a very good price all those things we thing, that made for very, very good investment.

Anthony Rizzuto, Jr. – Cowen and Company

That’s look good Jim. Just one further question so what the capabilities you guys with Rock Fort and other facilities now much more operational flexibility. And it seems like there is clearly a decided swift going away from electro gal to more hot dip. You guys think it’s no longer necessary as some others think that you got to have a continuous new line. Is that not so necessary as you guys see the market pulling out?

James L. Wainscott

That’s a really good question. Tony, we’d ask you to sort of hold that question as we finalize our evaluation. I think one of things that we’ll able to do in terms of competing more effectively by putting Severstal Dearborn and AK together is each of this have done some work and so accessing the needs of the customer in the future and really looking with limited capital as to how to best solve that.

As I mentioned, we’re providing all the products we need to today. The key is, how do you best align with the customers in the future. We don’t want to get ahead of them. We don’t want to behind them. We want to be just with them. Is a [catalog] (ph) the answer or is there some other product or facilities. I guess that is to be determined, but it is a front set setting for us. It’s certainly on the list of what’s next for AK Steel in the post Dearborn era. So we just ask you to take, put that to the side, but please understand that we’re working very, very hard on that question and solving it quickly for our customers and to serve them well in the future. Thank you.

Anthony Rizzuto, Jr. – Cowen and Company

Thanks for the color on that, Jim. Appreciate it, guys.

James L. Wainscott

So, ladies and gentlemen, again, we want to take this opportunity to thank you for joining us today and for your continuing interest and these exciting times for AK Steel. On behalf of all of us at the Company, I wish you a great day, a better tomorrow and a terrific second half of 2014. Bye for now.

Operator

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

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AK Steel (NYSE:AKS): Q2 EPS of $0.02 beats by $0.07. Revenue of $1.53B (+9.3% Y/Y) beats by $20M.