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Executives

James Wainscot - Chairman, President and CEO

Albert Ferrara, Jr - SVP of Finance and CFO

Analysts

John Felham - Citi

Luke Folta - Longbow Research

Michael Gambardella - JPMorgan

Charles Bradford - Bradford Research

Michelle Applebaum - SMI

Mark Parr - KeyBanc Capital Markets

Evan Kurtz - Morgan Stanley

Sal Tharani - Goldman Sachs

Dave Katz - JPMorgan

Justin Fisher - Goldman Sachs

AK Steel Holding Corporation (AKS) Q4 2010 Earnings Call January 25, 2011 11:00 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to AK Steel’s fourth quarter and full year 2010 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; and Mr. Albert E. Ferrara, Jr., Senior 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 Ferrara, Jr

Thank you, Patty, and good morning, everyone. In a moment, I’ll review our fourth quarter and full year financial results as well as provide some guidance for the first quarter and full year of 2011. Following my remarks, Jim will offer his comments and 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, costs, operating profit and 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 and 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 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 Web site, at aksteeel.com.

Earlier today, AK Steel reported a net loss of $98.3 million or $0.89 per share for the fourth quarter of 2010. As previously announced our results include the impact of costs associated with the shutdown of our Ashland works coke plant along with costs related to a settlement agreement involving healthcare benefits for retirees from our Butler Works.

These pretax charges totaling $72.8 million includes $63.7 million for the Asland coke plant shutdown and $9.1 million for the Butler Works retiree settlement. Excluding the special charges AK Steel would have reported a net loss of $54.5 million or $0.49 per share.

This compared favorably to the first call consensus estimate of a loss of $0.62 per share. Our results were also impacted by unprecedented high cost for iron ore and other raw materials. In addition, our results included a less than expected LIFO surcharge of $9.3 million, due to a significant reduction in our year-end inventory levels resulting from increased shipments and strong management of our working capital.

Also, we are pleased that for the second consecutive year there were [order] charges related to the company’s retiree benefit plans.

Shipments for the fourth quarter of 2010 totaled 1.359,900 tons about 10,000 tons ahead of our guidance. Our average selling price declined to $1022 per ton from $1075 per ton in the third quarter of 2010, which was approximately 1% worse than we had anticipated.

Revenues totaled $1.391 billion, an increase of about 5% compared to the same quarter a year ago. Sales outside the U.S. continue to an important source of revenue for us, totaling approximately $190 million.

On an operating basis, we incurred and adjusted loss of $81.8 million or $60 per ton about $20 per ton better than our guidance.

Turning now to our full year results; shipments for 2010 totaled were 5.7 million tons and increase of more than 1.7 million tons or 44% compared to 2009. Revenues totaled $6 billion, a nearly 50% increase from 2009 revenues of approximately $4 billion.

Our average selling price was $1054 per ton about 2% higher than for 2009 and sales outside the U.S. totaled $823 million for 2010, an increase of $56 million or 7% compared to 2009.

Our adjusted operating loss of $61.1 million or $11 per ton for 2010 compares to an operating loss of $70.1 million or $18 per ton for 2009. Excluding a non-cash charge of $25.3 million in the first quarter of 2010 related to [indiscernible] or $59.8 million for the year 2010 or $0.54 per diluted share. That compares to a net loss of $74.6 million or $0.68 per diluted share for year 2009 and the 2009 results included $5.1 million charge related to a state tax law change.

Now turning to the balance sheet. During the fourth quarter we completed $150 million add on offering to our previously issued $400 million of senior notes. Also we generated a significant amount of working capital during the fourth quarter by strongly focusing on such items as mentioned in our inventory.

We ended the year with a cash balance of $217 million and combined with nearly $700 million of availability under our revolving credit facility, AK Steels total liquidity exceeded $900 million as of December 31st.

Our ongoing focus on the balance sheet allowed us to maintain a strong financial position even while reinvesting in the company. Capital investments for 2010 totaled $117 million, the majority of which went toward constructing a new electric arc furnace at our Butler Pennsylvania Works. The new EAF is on schedule to begin operations next months. We also contributed to our pension fund in the calendar year 2010; we contributed a total of $110 million to the pension plan.

I’m pleased to report that we achieved an investment return of more than 14% from our pension portfolio for 2010, that represented a solid performance based on our asset allocation of roughly 60% equities and 40% fixed income.

Looking forward, the funding requirements for our pension plan continue to be very manageful. For 2011, we require to make pension contributions of approximately $170 million. Of that amount, we completed $30 million contribution earlier this month and we expect to make the remaining contributions of approximately $140 million by mid-year 2011.

In 2010, we also contributed $65 million to the Middletown Works retiree VEBA trust. We have one remaining contribution of $65 million, which is due in March of 2011.

For accounting purposes once the final contribution is made, the settlement of the company’s OPEB obligations related to the group of Middletown Works retirees will be complete likely resulting in a modest non-cash gain in the first quarter of 2011.

However, it’s important to note that this potential gain will probably largely be offset in the first quarter of 2011 by non-cash charge to account for healthcare costs associated with the recently announced settlement agreement with a group of AK steel retirees from our Butler works. As part of this settlement, we will also make three annual cash payments totaling $91 million of which about $82 million will be used to fund the VEBA trust for this group of retirees.

We’ll make the first cash payment of $32 million in the third quarter of 2011; the other payments will be approximately $32 million in 2012 and $27 million in 2013. Under the terms of the agreement, AK Steel will have no further liability related to the covered Butler works retirees and their dependants for healthcare claims incurred after December 31st 2014. Following that date all such claims will be the responsibility of the VEBA trust.

Now let me provide some guidance for the first quarter 2011. We expect shipments of approximately 1,450,000 tons an increase of roughly 100,000 tons compared to the fourth quarter 2010 and indicative of the general strengthening in the most of the markets we serve.

In addition, we expect our average selling price to increase by approximately 8% quarter- -over - quarter or $80 per ton due to higher contract of spot market prices and an improved product mix. We expect higher cost for raw materials including scrap, iron ore and coal of roughly $65 million, or $45 per ton compared to the fourth quarter.

It’s important to note that we’ve completed our coal contracts for 2011 prior to the extensive flooding in Australia that has impacted global markets for metallurgical coal. We expect our maintenance outage cost to be essentially flat quarter-to-quarter. Overall we expect to breakeven at the operating level for the first quarter representing a substantial improvement of about $60 per ton quarter-over-quarter.

Finally as we typically do at this time of year, let me offer few data points for the full year 2011. We anticipate total capital investments of approximately $85 million which is less than 2010, now that some of our major capital projects are nearing completion.

We expect interest expense of roughly $45 million in 2011 and excluding special charges related to the shutdown of the ash and coke plant and the Middletown and Butler, retiree settlements pension and OPEB expense will decrease by approximately $20 million in 2011, largely due to the better than expected pension investment returns for 2010 that I referenced earlier.

And finally with respect to income taxes, while we are projecting a book tax rate for 2011 of roughly 40%, we estimate our cash tax rate will be less than 5%.

Now for his comments, here’s Jim.

James Wainscott

Thanks very much Al. Good morning everybody and thank you for interest in AK Steel and for joining us on today’s call. A K Steel’s fourth quarter of 2010 wrapped up one of the most challenging years in the 111 year history of our company.

However, in spite of lower shipments and pricing and enduring the full brunt of our 90-80.65% increase in the benchmark price for our iron ore pellets, we exceeded our fourth quarter guidance.

Our growth expectation 4Q was attributable to lower operating cost and reduced spending, that’s a credit to all of the employees of AK Steel, who met our latest quarterly challenge head on.

Despite exceeding expectations for the fourth quarter, as I will mention, we lost money at both the operating profit and net income line, and I suffice it to say that no one around here is pleased about that, least of all me.

But I am pleased about the way we come through the quarter and through the year for that matter with our heads held high, having done a good job on those items that were within our control.

When the history books are written on the year 2010, it will be remembered as the year in which items, outside of our control, dominated the headlines. In particular, higher raw material costs and a slower economic recovery than expected overshadowed the gains we made in other aspects of our business.

We were certainly ready for the economy to recover in 2010; however, with a benefit of hindsight, it is clear that the recovery is a longer and slower one than we had originally thought.

While our operating units were in a much higher capacity utilization rates in 2010 than in 2009, selling prices for 2010 were under pressure for most of the year. But once again, our biggest challenge was the fact that raw material prices soared to record high as global demand hit a peak.

From a big picture standpoint, we currently find ourselves somewhere between recession and recovery, nonetheless, I believe that AK Steel is firmly on the road to recovery. In 2010, we continue to roll on. Thanks special attention to our customers’ needs, our cost performance and our cash position. I believe we focused on the right things and we’re headed in the right directions as a result.

We continue to do everything possible to look after our people and take good care of our customers. In 2010 we stayed true to our company’s core values of safety, quality and productivity. Among other things, taking care of our people means keeping them safe when they’re at work. I’ve said many times before we have no higher priority than the safety of our people at AK Steel.

Each of our two coke plants, the one located in Ashland, Kentucky and the other one located in Middletown, Ohio, worked the entire year of 2010 without experiencing a single OSHA recordable injury.

In addition, the main steel making plants at Ashland also work the entire year without incurring a single OSHA recordable injury. These are fantastic accomplishments and I offer my sincere thanks and congratulations to the employees at these locations and to all of our employees for placing safety first.

Speaking of our employees in December, we announced that we had reached an early agreement with the United Steelworkers Union, on a three-year labor contract extension at our Mansfield Works. This agreement replaced the existing contract that was set to expire on March 31, 2011. It was one of three labor contracts that were successfully negotiated during 2010, well ahead of their expiration dates.

The two other labor agreements included the Ashland Works main plants and our Coshocton Works. Each of these deals offers competitive wages and benefit for the employees at those plants while providing the company with the kind of operating flexibility that we absolutely need going forward.

For 2011, the only expiring labor agreement that we have is in Middletown Works with the International Association of Machinists. The current labor agreement is set to expire around September 15th and we are hopeful of reaching a new deal, well ahead of the current contract expiration date.

I feel remissive I did not mention the settlement agreement that was recently reached with out Butler Works retirees regarding their healthcare. As with our Middletown works retirees, we were successful in reaching an equitable settlement for retiree healthcare.

It’s a real win-win deal for the company and the Butler retirees. Elements in some of the near-term costs associated with this settlement, longer term the company has transferred the obligation for retiree healthcare costs to the retirees.

Their VEBA will help secure their future healthcare costs, and importantly this is one more agreement that enables us to focus more of our attention on our core business and what we do best; making and finishing some of the world’s finest steel for our customers.

Speaking of our customers; let me offer a few updates on how we’re doing in service to them. Taking care of our customers involves things that mean making great quality products first and then delivering those products on time and serving customers better than any other steel maker. I am pleased to report that again in 2010 we succeeded on this front

Our performance for our customers continues to lead the league and it is one of the most important ways in which AK Steel is differentiated from its peers. Despite operating in a very challenging economic environment, 2010 was AK Steels’ best year ever from a quality performance standpoint.

Our rates were internally rejections and retreated products were at their lowest levels in company history and our customers while we did a pretty good job for them on the quality front as well. An independent customer survey was performed by Jacobson & Associates that compared A K Steel to our most direct competitors and we are delighted to share those results with you.

Our carbon and specialty steel customers rated AK Steel number one in overall customer satisfaction, in addition they’ve rated us number one in quality and delivery for the fourth quarter and full year 2010. We’re thrilled to continue to be atop the league in the eyes of the incredibly important constituent group namely our customers.

So there you have it on safety and quality two of our company’s three core values. Now, let me take just a moment to comment briefly on the third key focus area, productivity.

As I alluded to earlier, productivity-wise our average capacity utilization rate across all of our plants last year rose to about 84% from about 58% in 2009.

In steel making we set a world record in 2010 for casting sequence at Middletown works at 2156 heats. Middletown and our other locations set numerous other production records. In fact, dozens of such records were set in our Coshocton works as the demand for brighter new product by auto and appliance makers increased greatly during the year.

Also prog reports that during the fourth quarter, A K Steel received Honda's Green Factory Environmental Achievement Award for our environmental effort at our Coshocton Works. We’re honored to receive this prestigious award from Honda which reflects our company’s commitment to operate in an environmentally responsible manner at all of our plant locations.

Now let me share some observations on what we’re seeing in the markets that we serve and after that, I'll offer a few comments on the raw materials front, then following a few closing remarks, we would happy to take your questions.

Over the past couple of months, we’ve experienced an increased order intake rate for carbon steel products. Due to this higher level of demand and the need to recover much higher steel making input costs, we'd been raising our prices.

Fact since November 1st, we've announced a total of six spot market price increases for carbon steel products, totaling about $250 per ton.

Compared to historical averages, service centers have reduced their inventories to very low levels to about 2.2 months of supply on hand as of December, for carbon flat-rolled products compared to a historical average of about 2.4 months.

In addition, as of December 31st, the level of inventory on hand at service centers was about 27% below the level of inventory at the peak of this cycle. As a result, a number of service center customers are quickly trying to secure product to meet the growing needs of their customer base.

Automotive customers are also experiencing increased sales levels. 2010 North American sales of cars and light trucks represented the first annual increase since the beginning of the great recession.

New car and truck sales for 2010 totaled about 11.6 million units, which represented an 11% gain over 2009.

Granted the automotive market still has a long way to go to reach the 16 million to 17 million annual level of automotive sales that we experienced before the great recession but the trend for automotive sales is certainly a positive one. And AK Steel continues to benefit from this positive trend.

Incidentally for 2011, the consensus expectation is worth a sale of about 13 million vehicles. We’re encouraged by this outlook and hope that like 2010, this forecast proves to be a bit conservative as well.

Let me offer a few comments on contract sales pricing for 2011 at various times throughout the year, we have contract business that comes out for price re-negotiation. Today, we’ve been successfully in negotiating higher base prices with most of our contract customers.

We’ve also been successfully in expanding the coverage of raw material variable pricing mechanisms to help recover a portion of our substantially increased raw material costs.

Prospectively, as the raw material market evolves, especially the market for iron ore, we will modify future contract pricing agreements to ensure that we recover the major cost drivers in our business. Again, not just scrap and natural gas but iron ore as well.

Moving from carbon to specialty steels, commodity chrome, nickel, stainless steel orders from service centers declined a bit in the fourth quarter as nickel-driven surcharges increased. As a result, following a record setting third quarter shipment level customers bought less stainless steel in Q4 as they reduced their inventories.

We expect commodity stainless steel volumes to improve in Q1 of 2011 as customers begin to restock. We also expect stainless steel pricing to rise in the first quarter in part due to further nickel price escalation.

With anticipated strong automotive build rates and inventory replenishment, we expect our auto chrome stainless business to improve by more than 10% in the first quarter of 2011 compared to the fourth quarter of 2010. And for specialty stainless steel products such as those we produced at our Coshocton Works, we’ve seen solid demand and are sold out for the first quarter and well into the second.

Our current lead times are as I say, well out into Q2 and demand appears very strong for that product as far out as we can see.

On the electrical steel front, we’ve seen things stabilize both domestically and abroad in terms of sales volumes. Demand is steady to slightly higher, especially outside of the U.S. from customers value, high efficiency electrical steel products like the ones we make.

AK Steel experienced a 5% increase in grain-oriented electrical steel shipments in 2010 compared to 2009 and we anticipate an additional 5% to 10% increase in electrical steel sales volumes in 2011 compared to the year just completed.

The lag in residential construction continues to hamper domestic growth opportunities for electrical steel, while the forecast for housing starts in 2011 is about a 15% increase to about 680,000 units just indicate that would still be the third lowest level in the past 50 years.

At the present time global supply for electrical steel product exceeds demand and as a result while we expect to increase our 2011 shipments year-over-year. We’re anticipating lower prices in about to 10% range for our contract and stock market sales of electrical steel.

Still making input costs were a major part of the story for our company in 2010 and they are likely to be an important story as well in 2011 and beyond. Simply put, with increased global demand for raw materials the cost of those raw materials rose to record levels last year. While sluggish demand especially domestically prevented a recovery of most of those costs here in the states.

When it comes to our raw material short position, we’re in the process of improving things at AK Steel. We remain very focused on becoming more of self-sufficient and on lowering our costs.

Reducing our costs was the major factor behind our decision in late December of 2010 to permanently close our Ashland Kentucky coke plant. This was difficult, but a necessary choice that enhanced the long-term viability of the main steel also known as the West Works at Ashland.

Coke is the fuel for our blast furnaces and for us to produce slabs at Ashland at a competitive cost level we determined, given the age of the coke batteries and impending increased environmental constraints that it was much cheaper to buy rather than to make coke at Ashland. Accordingly we have secured other sources of coke for the near-term at a substantial cost savings compared to what our cost would be at Ashland. Longer term we are reviewing all of our options for sourcing coke to meet the needs of our Ashland blast furnace.

We intend to complete the shutdown of the two Ashland coke batteries during the first half of 2011 and we are committed to finding a job for as many of the 263 displaced employees there. Many of the folks its possible at the Ashland West Works or elsewhere within our company.

Let me also take a moment to add that the decision to permanently close the Ashland coke plant is unrelated to the construction in start of this fall of the SunCoke, Middletown coke plant. It always intended that the SunCoke, Middletown plant will serve the coke needs of AK Steel’s Middletown blast furnace and that has not changed.

In addition to coke, we are also very focused these days on implementing our strategies for coal and iron ore. We’d expect to have more to say on the strategic front on these subjects in the near future, but in the meantime, let me offer a few thoughts on the present situation.

We have secured our coal and pellet requirements for 2011 from a variety of suppliers. In the case of coal we will be paying substantially more in 2011 than 2010, since the number of our coal contracts expired at the end of 2010. The good news is as Al mentioned earlier that our deals were done prior to the recent floods in Australia.

Regarding iron ore pellets, we have assumed that we will be paying higher prices for 2011. However, at this early point in the year, it's difficult to be much more specific than that regarding pricing.

Having said that, I do believe that we are moving towards quarterly pricing and I am hopeful that we can conclude our iron ore contract negotiations much earlier this year than last, as you will recall last year that did not get done until October.

Lastly, but also related to raw materials, I am pleased to report that we are less than a month away from the start of our new electric arc furnace at our Butler Works. This new, modern technology and more energy efficient EAF will replace our three existing EAF at Butler, which are smaller in capacity and 1960s lineage. We expect the new EAF to lower our operating cost and it will provide us with improved slab making flexibility as well.

So, AK Steel, despite the twist and turns of the market cycle, we are on the road to recovery, using the acronym ROAD in 2011, we'll remain focused on our key values as we seek to outperform expectations, aggressively control our cost and deliver great value for our shareholders.

We come through the most difficult downturn ever and we are on the front end of an economic recovery. Our management team with it's continuous improvement approach, looks forward to improving on every aspect of our business this year.

Our 2011 production and shipment volumes will be higher. Our average selling prices will be higher as well. Wherever possible, we are reducing our controllable costs but as was the case in 2010, the wild card remains steel making input costs, and our ability to recover those higher costs in 2011.

I am very fortunate to lead a great management team and have the tremendous support of our great Board of Directors, our team has a proven track record of success and we’re excited and ready to tackle our challenges in 2011 and beyond. At AK Steel, that’s our focus each and everyday. On behalf of our shareholders and all of our constituents.

Once again, thanks to all of you for participating on today’s conference call and at this time, let’s open the telephone lines for questions.

Question-and-Answer Session

Operator

Thank you Mr. Wainscott. We will now begin the question-and-answer portion of our conference call. (Operator instructions). Our first question comes from Brian Yu of Citi.

John Felham - Citi

Hi, this is actually John Felham calling here for Brian. I just a have a quick question on steel pricing. I was wondering how much of the recent price increases would flow through in Q1 versus Q2?

James Wainscot

John, good morning. You will see more of them in Q2 than Q1 simply because by the time that all of them were announced, we had booked a substantial amount of business already. In fact, there’s a very small portion of our quarter book that remains to be filled a little bit of hot rolled and cold rolled product.

Secondly, a number of our deals are tied to the CRU Index, which has a bit of a lag effect, so while Al mentioned that we’re pleased to report that our first quarter average pricing will be up pretty substantially, should look even better as we look out to the second quarter.

John Felham - Citi

Okay thanks.

Operator

Thank you. Our next question comes from Luke Folta of Longbow Research

Luke Folta - Longbow Research

Hey good morning guys. Quick questions first on met coal units that you are seeing substantial increases year-over-year. Can you get any more specific on what you are paying and what the year over year delta would be?

James Wainscott

I think Luke, what we’ve tried to do is capture in Al’s $65 million guidance, really a number of things. What’s going with scrap, what’s going on with coal, what’s going on with iron ore and while we wouldn’t necessarily break each of those out right now.

I think each of them shares a pretty substantial piece of the $65 million bucks. I think as you know and as I mentioned, we were favored with our coal deals last year. And we expect to pay more this year, but that guidance was really incorporated in that $65 million or about $45 a ton.

We are fortunate to have gotten and done when we did. I think that the spot market has continued to move higher but will avoid much of that going forward.

The other thing I just emphasize is that we are not happy being 100% exposed to the coal market and are working hard to remedy that situation. I don’t have a solution for it today on the call, but we hope to in the not too distant future.

Luke Folta - Longbow Research

Okay and then when you think about the $65 million, I imagine at least from a point you probably have some time that just was carrying over from last year at last year’s price. And then for iron ore I mean the increase we’re seeing is that just an increase in the average inventory cost as being 98.65% increase is fully imposed, or you are assuming some sort of incremental increase in the iron ore prices year over year

James Wainscott

We are assuming Luke, an incremental increase in our prices year-over-year but we are not in position right now obviously to discuss that. What we’re talking about is what’s going to hit our P&L in the first quarter, namely the $65 million and $45 per ton.

I wouldn’t point that our consumption of coal and coke is somewhat more ratable over the year whereas of course as you know pellets certainly in the first quarter we consume few of those as the year goes on. In other words, our consumption will be greater in the second and third quarter of pellets being purchased.

Luke Folta - Longbow Research

Okay. And then second question on your coke facility closure, can you just remind us after that closure how much of your coke are you sourcing internally versus externally and then if you could what the pricing is like on those external contracts?

James Wainscott

We’ll go from what was about 70% probably down to 25% or 30%, somewhere in that kind of range on a go forward basis post closure at Ashland. The savings I don’t that we have quantified that publicly but it’s, I don’t know, in the range of $50 million a year.

This was a very meaningful decision for us and we would have had a similar amount of capital to put into the facilities which didn’t make sense when you’re still going to be not cost competitive. So, those were the deals that we’ve cut into next couple of years here to sort of buy sometime as we evaluate the bigger picture.

There’s number of things that we could do and we want to explore all those options. We have some alliances in the past with Sun Coke, certainly that might be an avenue that we would pursue but there are other avenues that we’re looking at as well to ensure ultimately the cost competitiveness and the viability of the blast furnace at Ashland, that’s really behind all of us.

Luke Folta - Longbow Research

Right. Great. Thanks guys. I’ll turn it over.

Operator

Thank you. Our next question comes from Michael Gambardella of JPMorgan.

Michael Gambardella - JPMorgan

Hi, Jim. Hi, Al

James Wainscot

Good morning, Mike.

Albert Ferrara, Jr

HI, Mike.

Michael Gambardella - JPMorgan

Good morning. Happy New Year. Just a couple questions on the raw materials. So, just to confirm, on the met coal and your coke, you've lined up all of your requirements for 2011?

James Wainscot

That’s correct.

Michael Gambardella - JPMorgan

Okay. And then, on the pellet side, in the fourth quarter, did you have anymore additional true-ups, like you had in the previous quarters in the year?

James Wainscot

We did not, Michael. No, it was essentially the 98.65. It ran through the P&L on net basis.

Michael Gambardella - JPMorgan

Okay. And then going forward, most of your iron pellet requirements will be based on the seaborne price on the quarterly seaborne price?

James Wainscot

We, I think Mike, you know and we've tried to convey to all of you that we have a variety of suppliers primarily, its ArcelorMittal mining company, formerly QCM Iron Ore Company, Canada, plus natural resources and time to time little bit with our friends in Brazil, Bali. And each of them has a bit of different pricing mechanism.

We are in discussions with all of them, as we are on the call here today, we have had a number of them here. We have gone to see them, about trying to accelerate the process of pricing arrangements for 2011.

As I said, my prepared remarks, I think we are moving towards and I believe it's their desire, as in most cases, to move towards some sort of quarterly pricing, but the Devil's in the details, Mike, as you know. What's the quarter, what's the rolling period before than, what are the component pieces and so, all of that you are referring to, the seaborne would be one measure. But there are other measures and we're looking at all of that.

And importantly, what we want to do is more closely matched our revenues and costs as you can guess in our business or any business it doesn’t do us any good not to price our products to be able to recover our cost. Last year we really got whacked, it’s not about technical accounting term but our cost for raw materials rose exponentially and the fact that we didn’t get our iron ore deals done until very late in the year actually in the fourth quarter really precluded us from the opportunity from recovering much of those cost.

So we are about that this year and making sure that we have arrangements with our customers that give us the opportunity to recover that on a more real-time basis.

Michael Gambardella - JPMorgan

Okay. Last question on the CRU link contracts; are they largely what you’d refer to us quarterly? The CRU contracts were, you take the average CRU price and the fourth quarter would be what you get in the first quarter?

James Wainscot

Depends on the customers and again we’re a little dangerous when we start going into this territory because as you might guess our customers really don’t want to talk about this publicly but it depends on the customers and their desires. In some cases they are quarterly as you would suggest, in other cases there are more often, namely monthly. I suppose one could argue that with prices changing as frequently as it had been here recently, may be they should be weekly, but predominantly they’re quarterly and monthly, Mike.

Operator

Our next question comes from Charles Bradford of Bradford Research.

Charles Bradford - Bradford Research

Hi good morning. Al.

Albert Ferrara, Jr

Good morning, Charles.

Charles Bradford - Bradford Research

Hi. One of the major iron work company seems to be going towards a monthly price. Have your suppliers, I know you said you’d be doing quarterly but has that come up in the negotiations at all.

James Wainscot

Most of our discussions have been centered around either same with annual or more frequently the quarterly Chuck. We really haven’t gotten in to monthly and again its important, if we move in these directions to make sure that we are aligned. You really don’t want to have the mismatched situation.

But so it could have evolve in that direction I suppose, given the volatility of raw materials and pricing generally, but the short answer is no we haven’t really entertained serious discussion of our monthly pricing mechanism.

Charles Bradford - Bradford Research

Okay a lot of the Cliffs contract have us tie into the price of either hot-rolled coils or a couples of cases, cold-rolled. Would your arrangement with them be relatively conventional?

James Wainscot

I’d just say again I would guess if Cliff didn’t want us going into great detail, we can understand that. I think our deals by and large are fairly conventional but we take a look at those things and to the extent that you have some sort of embedded derivative business, which is something that the auditors and our accountants sort of have disdain for.

We try and stay away from that sort of things. So there are a number of other factors that tend to be weighted far more.

Charles Bradford - Bradford Research

Some of the people in the industry have been looking at derivative contracts and other ways to try to hedge either their cost or their selling prices. Have you done on any work in that area?

James Wainscot

Well we’d love to entertain some of that discussion. I mean we do hedge other commodity inputs. Certainly in the energy arena we look at natural gas and then to hedge a pretty significant position there.

We look at things like Zinc and other coating metals and to the extent that a similar mechanism existed for ore or other steel making inputs, we would entertain that and at the end of the day though, I think what’s most important is to develop meaningful, long-lasting supply arrangements and hopefully in our case, equity arrangements that position us well to endure the ebbs and flows of the market.

Charles Bradford - Bradford Research

Good Luck. Thank you.

James Wainscott

Thank you, Doug [ph]

Operator

Our next question comes from Michelle Applebaum of SMI

Michelle Applebaum - SMI

Hi,

James Wainscott

Good morning Michelle.

Michelle Applebaum - SMI

First, I have to say I am knocked off by the first quarter guidance, the kind of business and market conditions that we are in right now; a breakeven at the operating level is very impressive.

James Wainscott

Thank you very much.

Albert Ferrara, Jr

Thanks

Michelle Applebaum - SMI

And second, I have a few questions. Did you mention purchase slabs at all, I haven’t anything and I was curious to know if you’ve been able to avail yourself opportunistically from that?

Albert Ferrara, Jr

We’ve bought a few slabs throughout last year, we may buy a few this year. We continue to evaluate on an all in basis, so we better to make or to buy and we certainly favor making whenever possible, but in certain instances we bought a few slabs. I don’t it’s a big number or anything that we would brag about. But we will be opportunistic when it makes sense.

Michelle Applebaum - SMI

How many slabs do you have in your first quarter guidance? Is it anything --?

James Wainscott

I don’t know if we’re buying 50,000 tons or something like that could be, its about 100 [ph] that be higher of that, okay

Michelle Applebaum - SMI

100,000 tons?

James Wainscott

About 100,000 tons for sure.

Michelle Applebaum - SMI

Okay. And when was the last time you had that many slabs in your mix?

James Wainscott

We were probably half of that number for most each of the quarter last year, so we are trying a bit

Michelle Applebaum - SMI

Okay. And would those slabs be available again for the second quarter?

James Wainscott

We’ll see. Again, we hope so at reasonable prices but that’s the tradeoff we continue to look at as we try and envision selling prices and costs and availability from a number of suppliers around the globe.

Michelle Applebaum - SMI

That is great that you are able to be that opportunistic and flexible. That indeed a part of your model. On iron ore --

James Wainscot

Sorry to interrupt, the other comment I would just offer is this that with the startup for the number 5 EAF at Butler, that may change the flavor of things just a bit, depending on scrap prices. But one of the reasons that we embarked on constructing that facility was to give us the kind of flexibility that if we wanted to, we could meet all our needs for slabs, carbon slabs i.e. internally. This adds effectively 400,000 - 500,000 tons of capacity which could take us out of the slab market, if we want to. So, the idea here is to have flexibility to turn it on and off when it makes business sense.

Michelle Applebaum - SMI

Okay. The other question on iron ore. I know that you don’t want to be specific, but I remember last year, this time, when we were talking about first quarter iron ore cost. Because of the way the lakes freeze in the winter, you had accumulated iron ore at the year-ago price so that your first quarter guidance had the old price in it and I just wanted to make sure what apples and oranges here. The first quarter guidance that you are giving us, at breakeven, that is not -- that compensates the 2010 iron ore cost.

James Wainscott

Michelle, our first quarter guidance comprehends what our expected pellet cost will be in the first quarter. A component of that certainly is a carry over from 2010. But there is an incremental part of that, that reflects 2000 or expect 2011 pricing for pellets. And so, consequently, it’s kind of a blend in number and the $65 million or $45 per ton comprehends not only that but also changes in coal as well as straps.

Albert Ferrara, Jr

To say it in another way, it's conceivable that our iron ore costs could be higher, beyond the first quarter but it’s also highly conceivable because we’re booking tons at increased prices and we also have these sales arrangements that I alluded too earlier that will recover not just scrap and natural gas and some of the other inputs but also higher iron ore cost.

That was critical to our ongoing approach with our customers and so I'm hopeful that the second quarter will be substantially improved from the first quarter and everything I see would lead us in that direction just as the first quarter is substantially better than the fourth quarter.

As you know we only give quarter-to-quarter guidance but our outlook is for a substantially improved not just first quarter but year as a whole and hopefully that is something we can confirm when we get together three months from now.

Operator

Our next question comes from Mark Parr of KeyBanc Capital Markets.

Mark Parr - KeyBanc Capital Markets

Hey, thanks very much. Good morning.

James Wainscott

Good morning Mark.

Mark Parr - KeyBanc Capital Markets

I have a just a couple of questions and Jim and Al, I want to thank you for all the color that you’ve given on this call. It’s been very helpful. So thank you for that. You guys have got a lot on your plate and you continue to manage it extremely well. So…

James Wainscott

I appreciate it.

Mark Parr - KeyBanc Capital Markets

Just good luck on continuing this good work. I think Jim you had mentioned you thought the savings from Ashland would be around $50 million and could you give some color on the timing of actual achievement on those savings?

James Wainscott

That should be clear, it wouldn’t be necessarily from our incurred costs in 2010 but as we looked at the ongoing operating cost because we were going to be able to produce less at higher costs and with all of the additional requirement from an environmental standpoint where we envision cost going versus what we are able to buy. In other words, the make versus buy on a pro forma basis really is in that magnitude that I mentioned.

As I said before, we’re intending to shut down the two batteries at Ashland in the first half of the year, which would imply that the savings begin to be experienced in the second half of this year, Mark, by March.

Mark Parr - KeyBanc Capital Markets

Okay, that’s helpful. And then secondly how on your electrical steel could you provide some color on the mixed lead business domestic versus international in 2010 versus 09 and also I know that you’ve been dissuaded from shipping into China because of the unfortunate outcome of some anti-dumping allegations. But which countries should we look to in 2011 as the largest consumers of AK’s electrical steel products?

James Wainscot

Well we could spend the whole conference call on that, but let me give you a sort of couple of high points. I guess, first of all, there are couple of things happening domestically that will affect what we do outside of the U.S. One of the things that’s happening is we expect to see fewer imports in 2011 than we saw in 2010 and part of that is due to fact that there is no longer a pricing disparity.

Global prices are really compatible with domestic prices, we expect to number of those imports to stay away. Demand is improving; domestically to some extent we are looking for replacement transformer growth of about 3% this year and for new distribution transformers, which is as I mentioned in my remarks closely tied to the housing market. The housing is going to be up 15% to 20% this year, some 90,000 homes and that will certainly bring with it need for distribution transformers in neighborhoods, etcetera.

Our overall volumes is going to be up 8% to 10%, split roughly equally between here and abroad I suppose and NAFTA might be up as much as 10% and international somewhere in the 6% to 8% as we continue to grow our international footprint.

Contracts and spots probably more like 80/20, 80 contract and 20 spot as we continue to increase that side of things. I think we continue to advantage where possible, international opportunities and for 2011 if I had to guesstimate we are probably low 50s for international, that will grow to about 55% this year, 45% domestically to give you some feel.

As far as countries, I don’t know that we’d tick off individual names except to say that Europe has consumed a fair amount, we’ll be serving customers there and also other growing markets, India, Turkey etcetera.

We certain wish and continue to hope that we can breakthrough back in to China, our Chinese customers want us back, but at this point given the unfair practices there, with the trade case, we’ve been unsuccessful. We hope we have better news to share there very, very soon.

Operator

Our next question comes from Evan Kurtz of Morgan Stanley.

Evan Kurtz - Morgan Stanley

Hi, good morning Jim and Al.

James Wainscot

Hi, Evan, how are doing?

Evan Kurtz - Morgan Stanley

Pretty good. Most of my questions have been asked but just some quick clarification I hope on some of your sales contracts versus spot. Just wandering on the carbon side, what the mix is right now and within contract just roughly how much of those have passes at this point?

James Wainscot

Yeah. I would say that Evan that we're growing our contract business again, that is something that we favor and that’s not to say that they're won't be a seat at the table quite contrary. We have been roughly 50-50, may be a little bit more than 50% contract business. But where it makes sense for us to grow that we will buy a few percentage points or so.

Sorry the your second part of the question?

Evan Kurtz - Morgan Stanley

Is the raw material pass through about 90?

James Wainscot

You have to kind get into a couple of numbers on that whole thing. But I would say that we are not doing any deals with any customers, any contract customers, certainly that do not include some sort of variable pricing mechanism. That is an essential for us going forward.

So we have that and the deals that have been cut and for the deals that are to come which there is a lot of those particularly in the automotive sector later this year. That will be a critical element and we will not do a deal without capturing a variable pricing agreement there. So it gives the opportunity once again to more closely match our cost and revenues.

Evan Kurtz - Morgan Stanley

Thanks, that's helpful.

Operator

Our next question comes from Sal Tharani of Goldman Sachs.

Sal Tharani - Goldman Sachs

Good morning, Al and Jim. How are you?

James Wainscot

How are you doing, Sal?

Sal Tharani - Goldman Sachs

The guidance you gave, we appreciate it because you are the only steel company which actually give the guidance and despite the fact that there is volatility in steel prices and raw materials. And we went through this last year if you recall, you even show final prices to use.

Is there any sensitivity you can provide us which you did actually in the middle of last year that for some certain percentage of iron ore we can assume XYZ dollar impact? So we can have a better idea how to manage the model over here?

James Wainscott

The other answer is we could but we won't. It’s just simply too early, Sal. To do that, I think, if we were interested in doing that, we would have provided it. We run the sensitivities all the time here, but there’s just simply too many deals to be cut, probably too many variables and too many sales pricing agreements to be had.

And you can’t just look at it, last year it was all about if the client scale up then here’s to be incremental impact. But this year, if the costs go up, here is that impact and then here’s the sale impact. What we’re really interested in is managing our margins better and the bottom line better and we intend to do that, we have more to say about it. I’m sure you’d be among the first to know.

Sal Tharani - Goldman Sachs

Okay and one more questions, you mentioned that at best you have solved almost in your open books until March. Based on the pricing that you’re getting do you think that the incremental dollar per ton pricing for the Q2 will be higher than the $80 you’re getting in Q1?

James Wainscott

Absolutely. Yeah, let me just add a little emphasis to that. We’re in a very good position right now and, of course, I think there are a lot of high analyst perhaps yourself included and others who are a little skittish about the second half and again our visibility is in a whole lot better perhaps than yours as we look out beyond Q2.

But we think this thing has some lights. There are enough economic under underpinnings of all this and really one of the main drivers here has been the cost to push. We are once again seeing record prices for iron ore, we’re seeing higher scrap, we’re seeing, obviously, higher coal and coke. And so we’re really almost full for the first quarter at a very early stage in the quarter.

We’re booking carbon business out into late March and we are open for April which was really the basis of our most recent $50 ton price increase and we’re booking tons there and stainless we’re out to mid to late March and electrical we’re out about six weeks as well.

So we have some pretty good visibility in the second quarter and we certainly expect higher average selling prices in Q2 relative to Q1.

Operator

Our next question comes from Dave Katz of JPMorgan.

Dave Katz - JPMorgan

Hi guys, I’m hoping that you could come back to the electric arch furnace at Butler that’s going to come online. You said that it would lower your overall costs, I was hoping that you could perhaps quantify a little bit

James Wainscott

Well, again I don’t know that we’ve put an actual number on it. We’ve sold the project internally and I think we’re going to have about $150 million in it and hopefully its got a couple of year payback or so for us.

Anytime you can sort of replace three existing blast furnaces with one and get all the efficiencies out of that and other cost savings. It’s fairly significant but again, part of that benefit will depend on are we displacing purchase of slabs, are we doing a number of other things.

So there is a bit of a variable there. That’s incorporated in our guidance’s in our 2011 business plan. I think it’s meaningful and again the payback is probably in the two to three year time frame for us.

Dave Katz - JPMorgan

Okay and then from the point of view of your customers, if you ever were to move to 100% cost indexing where all costs were passed through, what would be your incentive to keep your costs down?

James Wainscott

Well if you want to keep your customers, it really is important that not only you provide them with great quality product on time and service them perfectly. We got to have a competitive cost. So, we certainly recognize that there are competitors, direct competitors of AK Steel who have an advantage of over us if you will. While you may not always see it in their bottom-line, the fact of the matter is did they have a substantial advantage if they own their coal or their iron ore. Maybe it’s a $100 a ton or so.

So, look at our customers value what it is that we do for them, but they won’t pay us whatever price we ask. It has to be an all in competitive deal. And so, there is a clearly an incentive for us to manage our cost.

Operator

Our final question comes from Justin Fisher of Goldman Sachs.

Justin Fisher - Goldman Sachs

Good morning.

James Wainscott

Good morning, Justin.

Justin Fisher - Goldman Sachs

Quick question on the impact of the Butler VEBA settlement, I saw that your overall pension and OPEB liabilities on the balance sheet were down by about $150 million from last year to this year. Was that reflective of Butler or what sort of balance sheet impact we expect from this VEBA settlement as you move those liabilities away?

James Wainscott

What’s going to happen there Justin, its two fold. We reflected the $9 million in our cost settlement cost in the fourth quarter, but what you’ll see in the first quarter is a $14 million increase in our liability and that will be followed really and that will be in the first quarter, and then that will be followed if you will, by an additional $16 million, the total will be $30 million.

We’ll take the charge for $14 million in the first quarter and that $16 million will be amortized over the remaining lives of the individuals over the next five years. So, what you’ll see in effect will be our liability go up for the Butler settlement for about $30 million

Justin Fisher - Goldman Sachs

Are there any other actions that AK can take in terms of reducing that overall that OPEB liability? I think you remember that the positive balance sheet impact from Middletown was much greater. Is there anything else that you guys can do to whittle that down over the next couple of years let’s say?

Albert Ferrara, Jr

Well, I think the thing is in this particular transaction as you know; it’s actually an increase rather than a decrease. But longer term it’s going to materially impact our OPEB liability. And if you look at it it’s been dropping, our OPEB obligation had been dropping about $80 million per year over the last several years and that’s a function, really, of the caps ticking in and things like that.

To the extent that this other transactions are available, we have the financial flexibility to pull them off. We'll continue to pull this down but I think the trends is certainly our friend in this area and will continue to be so going forward.

James Wainscot

Justin, we are proud of what we have done here. There is always more that can be done and I think, companies that have been around for a while like AK Steel, and have done a very good job, if I do say so, meeting the obligations of our retirees, but for them, guys like Al and I, really aren’t running steel companies.

So, we are tremendously appreciative of that and we are delighted we have been able, unlike a number of other steel companies, to meet those obligations.

We'll continue to look at ways though to move our company back to what we do best, which is producing some of finest steel in the world and getting more and more out of the employee benefits, administration business. That’s just the right thing to do.

We have capped all of our pension plans, we have capped all of our retiree healthcare costs, but there is still more we can do and when it makes meaningful sense for us to exit certain aspects of the population, we will continue to look at that carefully.

Justin Fisher - Goldman Sachs

All right, thank you very much.

James Wainscot

Yes. Thank you, Justin. I want to take this opportunity, again to thank all of you for participating in the call. I know this is earnings season, not just for AK Steel, but for many other companies that you all follow. We appreciate what you do genuinely, and offer our sincere thanks for your continuing interest and support of AK Steel.

We hope that you will be able to join us in about three months for our first quarter 2011 conference call, where we hope to impart even more wisdom and certainly better results. Until then, we wish you a great quarter and a much better year in 2011.

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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