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AK Steel Holding Corp (NYSE:AKS)

October 05, 2011 11:00 am ET

Executives

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

John F. Kaloski - Executive Vice President and Operating Officer

Albert E. Ferrara - Chief Financial Officer and Senior Vice President of Finance

Analysts

Brian Yu - Citigroup Inc, Research Division

David Olkovetsky

David Katz - JP Morgan Chase & Co, Research Division

Richard Garchitorena - Crédit Suisse AG, Research Division

Kuni M. Chen - CRT Capital Group LLC, Research Division

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

Justine Fisher - Goldman Sachs Group Inc., Research Division

Luke Folta - Jefferies & Company, Inc., Research Division

David S. MacGregor - Longbow Research LLC

Evan L. Kurtz - Morgan Stanley, Research Division

Shneur Z. Gershuni - UBS Investment Bank, Research Division

David Lipschitz - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Arun S. Viswanathan - Susquehanna Financial Group, LLLP, Research Division

David S. Martin - Deutsche Bank AG, Research Division

Operator

Good morning, ladies and gentlemen, and welcome to AK Steel's Conference Call to review its strategic acquisitions of iron ore and metallurgic coal interests. [Operator Instructions] As a reminder, this conference call is being recorded. At this time, I will turn the conference call over to Mr. James L. Wainscott, Chairman, President and Chief Executive Officer of AK Steel. Please go ahead, Mr. Wainscott.

James L. Wainscott

Thank you very much, and good morning, ladies and gentlemen. Thanks to each of you for joining us today. Last evening, AK Steel announced the completion of 2 strategic transactions that we believe have the potential to unlock significant value for AK Steel and its shareholders.

Quite frankly, each of these deals holds the prospect of being game changers for our company. We're excited about these deals as they're key pieces of our vertical integration plan to enhance our raw material self-sufficiency and lower our costs in the future.

In recent years, as most of you know, AK Steel has paid a heavy price by being short when it comes to raw materials ownership. Increasing global demand for commodities such as coal and iron ore has caused the purchase prices for these and other steelmaking inputs to skyrocket. And as a result, our margins have been severely squeezed, and we've been working diligently to change that circumstance. These deals bring to fruition a lot of very hard work that will soon begin to expand our margins.

With these transactions, we've created a clear roadmap towards our goal of 50% ownership of 2 of our most critical raw materials, iron ore and metallurgical coal. On today's call, we hope to provide you with some information on each of these 2 deals on why we believe they're great deals for AK Steel and how we expect them to help transform the company and its financial performance in years to come.

Following a brief overview of each transaction, our Senior VP of Finance and CFO, Al Ferrara; together with our Executive VP and Operating Officer, John Kaloski and I would be happy to respond to your questions.

As a reminder, some information provided during this call may include forward-looking statements that are based on certain assumptions and are subject to a number of risks and uncertainties, and of course, actual future results may vary materially. Please refer to the risks described in AK Steel's SEC reports including our Form 10-K and Form 10-Q.

Let me start then with our acquisition of Solar Fuel Company, which is located in Somerset County in southwestern Pennsylvania. But first, as background, AK Steel, either directly or indirectly through our strong relationship with SunCoke, consumes about 2.5 million short tons of coal annually, consisting of various met coal grades, either low, mid or high-vol coal. These coals are used primarily at our coke battery in Middletown and the SunCoke heat recovery coke batteries located in Haverhill, Ohio and beginning later this quarter in Middletown, Ohio.

I have purposely noted that these are short, or 2,000 pound U.S. tons, simply because as you saw in our news release last evening, the iron ore joint venture was transacted using metric tonnes. Thus, to be consistent with our historic reporting and disclosure at AK Steel, which is based upon U.S. tons, we provided the short-ton equivalents of our iron ore transaction.

Currently, we purchase 100% of our coal requirements, and we've been paying increasingly higher prices for coal as global demand has exceeded supply. Our goal has been to acquire an equity interest or to hedge at least 50% of our needs. We're excited to report that with the acquisition of Solar, we're positioned to achieve this important strategic objective.

We have acquired 100% of the stock of Solar, which we're in the process of renaming AK Coal Resources, Inc. Our purchase price is $36 million, $24 million of which was paid yesterday at the closing, with the remainder to be paid over the next 3 years. In return, AK Steel has acquired certain land and mineral rights associated with more than 20 million short tons of recoverable low cost, low-vol met coal reserves.

Currently, AK Coal Resources is a passive owner of assets, with minimal income derived from royalties earned from leases. However, our vision is certainly not to lease but rather to develop a series of mines to help meet our own coal needs and/or to sell the product as a financial hedge against our coal purchases going forward.

Accordingly, we intend to immediately begin developing a mine plan and initiate the process to obtain the necessary permits. Once permitted, which may take up to 24 months, we would expect to invest an additional approximately $60 million in mining and coal preparation equipment, most of which would be expended between the years 2013 and 2015.

I would note that under this plan, we expect to begin limited mining operations in the year 2013, ramping up to nearly 1 million short tons per year in 2014, with further capabilities beyond this date.

In summary, we're confident that this is the right deal at the right time for AK Steel, and we believe this project will enhance AK Steel's future earnings and cash flow.

Next, let me switch projects and offer a few comments on our 49.9% investment in Magnetation LLC. Magnetation is an established company that has been producing iron ore concentrates since 2009. The company is run by Larry Lehtinen, a well-known and well-respected expert in the ore mining business. We are delighted to be working with Larry and his team on this joint venture.

Magnetation does not mine iron ore per se. Instead, Magnetation utilizes a unique mineral recovery process, removing the tailings from formerly mined iron ore deposits in the Mesabi Oil Range in Minnesota to produce iron ore concentrate or fines. By way of background, again, AK Steel's 2 blast furnaces typically consume between 6 million and 6.5 million short tons of iron ore pellets annually, depending on market conditions. Today, we purchase 100% all of our iron ore requirements from 3 or 4 global iron ore pellet producers, and we have indeed been paying increasingly higher prices for iron ore as global demand has exceeded supply.

Our goal has been to acquire an equity interest in an iron ore producer to meet and/or to hedge at least 1/2 of our iron ore needs. We're excited to report that with our acquisition of nearly 50% of the Magnetation LLC joint venture, we are positioned to achieve this important strategic objective for our company.

Although we will not realize the full benefits of this investment for a few years, we expect our investment in Magnetation will be accretive to our 2012 earnings.

There are 2 phases to AK Steel's investment in Magnetation so let me take a moment to comment on what's involved with each phase. Our Phase 1 investment consists of $147.5 million, $100 million of which was made yesterday at closing. Over the next year, Magnetation's existing annual production capacity will be expanded to approximately 1.4 million metric tonnes, or about 1.5 million short tons, with the addition of a second operation near its existing plant.

Accordingly, AK Steel will make an investment in the second half of 2012, likely in the third quarter timeframe of next year, of about $47.5 million. During Phase 1, we will share the financial benefits of Magnetation's existing production and sale of iron ore concentrate, which will serve as a natural hedge to help offset volatile iron ore prices.

Phase 2 involves the installation of 2 additional, for a total of 4, concentrate plants of 1 million metric tonnes each, equivalent to about 1.1 million short tons each, and a pelletizing plant with annual capacity of 3 million metric tonnes, or about 3.3 million short tons. To construct the additional concentrate plants and a pellet plant operation, we expect to invest an additional $150 million, likely between the years 2013 and 2016.

Our Phase 2 investment is contingent primarily upon obtaining the necessary operating permits, but we believe that this will be accomplished in due course. Following the completion and startup of the pellet plant, AK Steel will have access to lower-cost pellets, which can be consumed in our own blast furnaces. With the installation of the pellet plant, AK Steel could procure about 50% of our annual requirements, or more than 3 million short tons of low-cost, high-quality iron ore pellets directly from Magnetation.

Not only is the Magnetation process low cost, it is also very environmentally friendly. Magnetation's process reclaims previously abandoned iron units from existing tailing basins. Once the iron units are removed from the basins, the mining properties can be transformed into valuable wetlands.

As with the coal acquisition, we are confident that our investment in Magnetation is absolutely the right deal at the right time with the right partner for AK Steel.

In terms of financing these deals in the short term, that is between now and the end of 2012, we expect gross cash requirements totaling about $175 million. To meet this need, we intend to utilize our cash on hand and our revolving credit facility. We have sufficient liquidity to finance these transactions and meet the ongoing needs of the business.

Longer term, however, it would be our intention to access the capital markets when conditions warrant and subject, of course, to approval by the AK Steel Board of Directors. That's because these are long-term investments for our company and accordingly, when the financial markets are more receptive, we believe it's appropriate, and we plan to utilize long-term financing vehicles to implement these important strategic initiatives.

In order to improve our cost position, we have been looking to vertically integrate for quite some time. In fact, over the years, we have considered numerous other possible deals, but we waited for the deals that made the most sense for AK Steel. Again, the right deals with the right partners at the right price. With the creation of AK Coal Resources and our investment in Magnetation, we believe we've found those deals, great deals, right here in the United States of America.

Importantly, these investments will also lead to the creation of new manufacturing and mining jobs. Again, here in these United States at a time when our country needs to increase its manufacturing base and the jobs that go along with it.

So in summary, it's a new and it's an exciting day for AK Steel. With that, I'd like to thank all of you again for joining us on the call. And at this point, let's open up the telephone lines for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Justine Fisher of Goldman Sachs.

Justine Fisher - Goldman Sachs Group Inc., Research Division

The first question that I have is just on the cost of production for Magnetation. I think most of us -- are you still looking at iron ore mines? And so if we're going to judge the margin benefit, can you talk about what the expected -- I guess what the current cost of producing concentrate is and then maybe what the expected cost of all in pelletizing would be?

James L. Wainscott

Justine, let me take a shot of that. First of all, I would say we've modeled both our anticipated costs with respect to iron ore and coal. These are terrific deals for us, almost no matter what happens to the future direction of those items in the marketplace. But I would just offer that we have signed a confidentiality agreement with our JV partner not to disclose specific cost information for obvious reasons. And so we don't want to violate that agreement or even the spirit of it. But let me attempt to be as responsive as possible to your question. I suspect it's a question that others have as well. We believe that our production costs at Magnetation will be among, if not the lowest of all producers who produce iron ore on the range. And that's really a great place to be. The Achilles' heel really for our company has been our cost position has not been among the lowest, and this positions us in a very, very different light, and we are delighted about that. So I think you have a sense of what others can produce more for. We are confident that this process is at least as competitive, if not more competitive than that.

Justine Fisher - Goldman Sachs Group Inc., Research Division

Okay. And then also on realizing the cash flow benefit over the near term from selling the concentrate as a way to hedge your iron ore cost, how exactly will those cash flows work? I mean, you guys will own 49.9% of the JV. Will you -- should we literally be thinking that you would sell that into the market and then AK gets half the cash? Or how should we be thinking that from a modeling perspective?

James L. Wainscott

Al, do you want to take that?

Albert E. Ferrara

In effect, that's right, Justine, that under the LLC agreement is the cash benefits, if you will, will flow through to each of the partners.

Justine Fisher - Goldman Sachs Group Inc., Research Division

And is there -- are there buyers and an export capacity for that? Are you looking to sell it domestically? Is there a strategy for selling that concentrate now?

James L. Wainscott

Again, we'll leave that to Larry and the team up at Magnetation. They've done a terrific job. And the short answer is there are buyers, they are both domestic and foreign.

Operator

Our next question comes from Dave Martin of Deutsche Bank.

David S. Martin - Deutsche Bank AG, Research Division

Just coming back to the question on consumers. Can you at least tell us who the consumer is or consumers are of the current output for magnetite?

James L. Wainscott

I don't know that naming customers are necessarily customary to do, and I wouldn't necessarily want to do that without chatting with our JV partner except to say that there are current active customers, good relationships there, and others being pursued. And we think that's a good thing.

David S. Martin - Deutsche Bank AG, Research Division

Okay. And then also I'm clearly not familiar with the Magnetation type process. Can you comment a little bit on the life cycle on an operation like this?

James L. Wainscott

Let me ask John Kaloski maybe to take a shot at that. John?

John F. Kaloski

The life cycle of the process, there's really no limits on the process and processing equipment itself. Normal repair and maintenance keeps it going. We're anticipating that there's a 20-year life span in this right now though.

James L. Wainscott

Hopefully, there's a lot more. There's certainly tailings that have been accumulating for decades or longer. And so I think we would be comfortable saying 20 years is conservative, and we hope it's a lot more.

David S. Martin - Deutsche Bank AG, Research Division

Okay. And then lastly, I just had a question on the coal operation. Can you comment on the production history of these reserves if there was any and whether there's any infrastructure in place?

Albert E. Ferrara

David, at the present time, there's some very minor leases as Jim mentioned. But essentially, it's been -- it has not produced coal for a number of years going back 15, 20 years or so. The infrastructure in place there, there really is not any significant infrastructure at the time. That's one of the things we'll be putting together with the mine plan and making the necessary investments to get it up to a production phase, as Jim mentioned, in the next 24 months or so.

David S. Martin - Deutsche Bank AG, Research Division

And would this be a continuous mining operation?

Albert E. Ferrara

This would be primarily upper trail but would be deep mines. That's the expectation at this particular time and continuous miners would likely be used.

Operator

Our next question comes from Evan Kurtz of Morgan Stanley.

Evan L. Kurtz - Morgan Stanley, Research Division

I'll try to limit myself to one on coal and one on iron ore. Just going back to coal, could you talk a little bit about what sort of quality and geological conditions we're dealing with as far kind of seam thickness, CSR impurities go?

John F. Kaloski

Commenting on the coal quality itself, it's a low-vol coal. Most of the reserves are low vol. It's about 1% sulfur, about an 80% ash, and our reflectants pre-coking coal, good for blending and good for the type of coke covenants we'll be servicing with these resources.

James L. Wainscott

I should mention, Evan, that we have purchased coal not from these reserves per se, but we've purchased coal from the Somerset area in the past and have had good results from it.

Evan L. Kurtz - Morgan Stanley, Research Division

And seam thickness?

James L. Wainscott

We have an awful lot of information that we've gotten from our mining third parties, but I don't know that we'd get into that...

John F. Kaloski

Well, there are 5 different things there. There's Freeport and Kittanning seams and frankly, the seam thickness varies and like I said. But the seams themselves have been very actively mined by others. And like I said, we like our position, we like where the coal is and where this is going to take us.

Evan L. Kurtz - Morgan Stanley, Research Division

Got it, okay. And then one on iron ore. Could you break down perhaps the $297.5 million into CapEx versus just the buy into the JV?

James L. Wainscott

Well we've really done that. I think most of the money is going to actually go into the operation to expand. As we understand it, the additional facilities bring it up at 4 and the pellet plant. So there's not a whole lot of money to be distributed here. This is going into building this business, is how I would characterize it.

Operator

Our next question comes from Michael Gambardella of JPMorgan.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

I have just questions on the Magnetation, the iron ore process. I just want to understand. So the grade that they are mining is somewhere in the 30% iron content. Is that about right?

John F. Kaloski

There are concentrations, so they're in the 30%. It varies both ways though, Mike.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

And Magnetation, because they're taking their processing tailings from previous mining campaigns of other companies, are they going into properties of other miners? And are they getting a processing feed to do their work? Or how does that work? Because you don't own the tailings, right?

John F. Kaloski

The source is what the State of Minnesota refers to as stockpiled minerals. And you go in and get the minerals off the surface that have been stockpiled. The stockpiled minerals are in essence to tailings and the iron that they contain.

James L. Wainscott

But you pay up the state and of course they have the rights to do this. And again, this is where John's comment earlier, the deals that have been arranged through Magnetation management, go out again for many years to come, and many more deals are available to be lined up. So it's not so much that you have to own the tailings so long as you have the ability to get your access to the tailings for which you pay a fee as you reclaim these materials.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

And you, AK Steel, won't be able to use any of the material until you build the pelletizing plant. Is that correct?

James L. Wainscott

Yes, we don't have a center plant as you know, Mike, so it's really not in a format that we can consume today at our 2 blast furnaces. We'll get about that pelletizing operation just as quickly as we can. Again, not unlike the coal operation, there's a permitting process. There's a bit of planning that has to go into that. And so we've been very upfront. This is a long-term investment. It's probably 2016 or thereabouts before we're really able to consume this output. But in the meantime, it serves as a wonderful hedge for us.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

And the pelletizing plant -- I think you said the 4 concentrators in the pelletizing plant were going to cost about $150 million?

James L. Wainscott

That's our share. We're going to be $150 million, and there's $147.5 million on the front end. So all in, it's about $297.5. Round figures, $300 million for our half share.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

And then -- okay, so that's your share. Because my understanding was pelletizing plants were extremely expensive, a lot more than that.

James L. Wainscott

I guess I'd look to John for this, but my own experience is it depends on what you want to do with them and all the bells and whistles. And some can cost more. It really depends on the expectations and how well-managed it is.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

And when you say 3 million tons of pellets, is that your share? Or is that the whole company?

James L. Wainscott

The pellet facility will be capable of producing about 3 million -- again, it's not up and running, but it's anticipated to be designed to produce about 3 million metric tonnes annually, or about 3.3 million short tons. Again, we consume between 6 million and 6.5 million tons of pellets at AK Steel with our 2 blast furnaces. So if we elected to do so, we could provide ourselves with roughly 1/2 of our annual pellet requirements once that's fully operational.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

But don't you just own half of that? Or 1.5 million?

James L. Wainscott

We would have access to all of it, and we have arrangements, offtake arrangements in place and at appropriate discount levels that we felt was necessary to do the deal.

John F. Kaloski

Our intention, Mike, would be to take all the output of the pellet plant.

James L. Wainscott

Yes, it's about it.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

But I mean, I'm just thinking, your partner's not going to give you the pellets at the -- 1.5 million tons of their pellets at the same price, right? It's got to be pretty much a market pricing I would think, right?

John F. Kaloski

We have an arrangement in place with the partner, and it's covered under the confidentiality.

James L. Wainscott

It's fair to say that we've negotiated a price that we are comfortable with. It's at a bit of a discount, and so we'll enjoy the benefit of that, and we'll also enjoy 49.9% of the benefits of the earnings of the JV. So it's a win-win for both parties.

Operator

Our next question comes from Arun Viswanathan of Susquehanna.

Arun S. Viswanathan - Susquehanna Financial Group, LLLP, Research Division

First thing, on the coal operation. You guys detailed out a little bit on the plans for Magnetation. But on the coal side, how does the progression work? I mean, how much of your internal needs would be met over the next couple of years? And if you can just help us with the trajectory?

James L. Wainscott

Again, Arun, we've commented that we could use 2.5 million tons through our own existing battery and the SunCoke facilities, although that would be a blended need of low, mid and high vol. Obviously, what we're mining here is all low vol. So we will not be able, at any point, to consume all of the capacity here. So we will be, in all likelihood, marketing a portion of this high quality, low-cost, low-vol coal. But I think, again, it gives us really a great opportunity to be able to produce between 1 million and 2 million tons or whatever we decide to produce over this period of time to offset the cost and really -- that have been going up, up and away and really lessen the volatility associated with this input cost. But that which we will use, will be great for us, and we will not be out buying it anymore. But there could be some trading, there could be some mixing. There could be a number of things that happen to find a home per ton.

John F. Kaloski

And as you understand, we're in the -- the low vol, generally speaking, has the highest unit value among the coals that we purchase.

Arun S. Viswanathan - Susquehanna Financial Group, LLLP, Research Division

Right. So specifically, you did outline that the iron ore transaction could be accretive in 2012. Do you expect to see similar benefits from the coal operation? Or when do you expect to see similar benefits from the coal operation?

James L. Wainscott

I think we're probably out a couple years. It could be, I don't know, 2013?

Albert E. Ferrara

2013, 2014, which is when most production would kick in. But we would expect it to be accretive at that point in time.

James L. Wainscott

It's not to say, Arun, that there won't be any benefit associated with this, as Al had mentioned before, I think, and we'd commented that there are certain leases that pay royalties. I would say they're not of a material nature that would significantly move the needle. So we're out a couple years on the investment as well.

Arun S. Viswanathan - Susquehanna Financial Group, LLLP, Research Division

The other question I had was, you did mention that there would be some further expensing involved. I guess, on both sides, is it fair to assume that it's not just capital investment here, that you do have some expense involved in these projects? Or...

James L. Wainscott

I don't think we intended to imply that if we said. But no, these are -- the numbers we've laid out are the completed closed deals. That's what we expect to expend, and they're all going into building these businesses for us.

Operator

Our next question comes from Brian Yu of Citi.

Brian Yu - Citigroup Inc, Research Division

More questions on the metallurgical coal. First off, what do you think is a reasonable cash cost estimate for these operations? And then secondly, do you plan on mining these on your own, or employing the services of contractors?

James L. Wainscott

Well, Brian, let me say, again, on the cost side of things, we have assumed and again, remember, this is all part of the plan, we've utilized third-party experts. We've utilized our own internal knowledge and putting all this together and modeling the what-ifs. But we've assumed that our cost to mine the coal is at least $100 a ton better than, I'll say, the current spot market. We'd hope it's a lot better than that. We think it's at least of that order of magnitude. So you can begin to see that that's significant money coming our way. And for those who -- I might just offer for those who say, "Well, geez, I'm at the peak of the market." Short answer is we don't know. We had hoped against hope for years that the peak of the market had come and gone, only to see the market continue to rise. Recently, we've seen a bit of a drop. We hope that that continues, and if it does, frankly, that's a great thing for our company because we'll continue to be short in the raw materials area for years to come. But it is, among other things, an opportunity for us to really balance things here. We don't want to be 100% self-sufficient, but we can no longer afford to be 100% spot-market takers. So cost is a major driver of why we would get into each of these transactions and each of these deals. But we're confident that as with the case of iron ore, similarly on coal, our production cost will be very, very competitive and low cost.

Brian Yu - Citigroup Inc, Research Division

And then the other part of the question about whether you plan to take on the mining yourself or outsource it to contractors?

James L. Wainscott

There may be a mixture there. That is still to be determined. The reality is we are engaged and very close to employing an individual on our staff who would put the mine plan together, help us develop that and then construct and to begin operations at the mine. It's an individual who believes as we do and the values that we have, particularly about employee safety and not cutting any corners and really instilling the philosophy of AK Steel's industry-leading safety program in the steel business, translating that into the coal business, which is really a requirement for us. So we'll have more to say about that soon, but I think we feel very good about where we're at right now.

Brian Yu - Citigroup Inc, Research Division

And then just a last one. Is there a resource number there? Or is that the 20 million tons of reserves?

Albert E. Ferrara

The 20 million is all reserves. There is a resource number that right now is about 5 million or 6 million tons. But like I said, we focus really on the SEC reserves and, like I said, through further drilling and analysis so that number could rise. But at the present time, we're very comfortable with the SEC reserves that we have.

Operator

Our next question comes from Charles Bradford of Bradford Research.

Charles A. Bradford

A couple of questions. I understood that Cargill had the exclusive worldwide rights to the Magnetation product. Whatever happened to that contract, which was only signed several months ago?

John F. Kaloski

Magnetation, Inc., Chuck, is in an agreement with Cargill. This is excluded from that and covers mostly outside North America.

James L. Wainscott

Said another way, I think that they are looking to perhaps market this process outside of the U.S., and that is certainly within their purview to do. Our deal is not in any sort of violation with whatever they're doing with Cargill.

Charles A. Bradford

And so the Cargill contract is the process that they would market, not the product?

James L. Wainscott

Again, I think you'd have to check with our friends up there. We're really not going to speak on that. We just know what we've done here, and it makes great sense for us.

Charles A. Bradford

Yes, I know those guys pretty well, they're good guys. On the coal side, you've talked about reserves of 20 million tons. Is that recoverable reserves?

Albert E. Ferrara

Yes, sir. That's recoverable SEC reserves.

James L. Wainscott

Yes. Chuck, you know the distinction between recoverable and not. We've had a lot of discussion. We've talked about a lot of other numbers, higher numbers. I think Al just talked about some other reserves that may or may not be recoverable. But the reality is, no, these are indeed SEC verified reserves in excess of 20 million tons.

Charles A. Bradford

Because it's very common when you run met coal through a washer plant, you're going to lose 20% or more.

Albert E. Ferrara

Well, Chuck, these are reserves that are out of the ground, that are sellable reserve under current mining techniques, current economics, current existing mining laws.

Operator

Our next question comes from Luke Folta of Jefferies.

Luke Folta - Jefferies & Company, Inc., Research Division

First question I had is I imagine most of the concentrate that you'll be producing will end up on the export market. And I'm just trying to get a sense of what -- do you know what current transportation costs would be to get that product out on the East Coast?

James L. Wainscott

I don't know that we're prepared to really speak to that, and I think it will be a mix. Our sense is that the deals that are being done are domestic and foreign, but there certainly could be a foreign component, some of which might not necessarily have to be seaborne. It's conceivable some of that could go to Mexico.

Luke Folta - Jefferies & Company, Inc., Research Division

Okay. And then on the coal side, is there a thermal component to this? Or is it all met coal?

Albert E. Ferrara

No. This is all met coal, low vol, and that was one of the real attractions to this transaction, Luke, was the fact that -- very targeted, very focused on the met side. As you know, a lot of transactions that are done on the coal space are a mixture of thermal and met. We only use met. That's what we want, and that's what we got.

Luke Folta - Jefferies & Company, Inc., Research Division

And just to clarify your earlier comments, you're saying the cost is in excess of $100 below current spot. I assume you were talking about seaborne coal on a metric tonne basis?

John F. Kaloski

Yes, that would be a lot more competitive, as published probably.

James L. Wainscott

Yes. Fair interpretation. But thanks for clarifying, Luke.

Luke Folta - Jefferies & Company, Inc., Research Division

Sure. And last question was just in regards to the financing. You had mentioned that longer term, you're looking to put some longer term financing in place for these projects. And I was just interested in knowing, do you expect that to be entirely debt-financed projects? Or you think this could have some equity components to it?

James L. Wainscott

We'll leave to our esteemed finance committee and our board and to our board and their vision. We have been very cautious, as you know, over the years. In fact, all of our other capital investments, pension funding, other activities, have been really utilizing AK-generated cash. We have no great intention then or now to dilute our shareholders or to relever the company. Having said that, I think it's fair to say, and I think you'd agree with me, that when you do deals of this sort that have returns for the next 5, 10 years or beyond, it's unlikely, most times, that you'd use credit facilities or things of that sort or existing cash to do those deals, even though we think the cash generated from these deals will go a long way towards paying for them. So I don't wish to create an overhang on any of our securities in the marketplace, but I think because we're considering that, because our board will take action when it's appropriate, we just want to share with you our current thinking.

Operator

Our next question comes from David Lipschitz of CLSA.

David Lipschitz - Credit Agricole Securities (USA) Inc., Research Division

Can you guys walk me through the production ramp in terms of -- I know they have, like you said, other deals you're doing with other people, other JVs. Can you just walk me through right now what their producing for you versus what they're doing for other people? And is there a play already in construction that would be yours, that would go to your profits? Or is that totally separate?

James L. Wainscott

David, I'd presume you're speaking about Magnetation?

David Lipschitz - Credit Agricole Securities (USA) Inc., Research Division

Yes.

James L. Wainscott

Okay, I'm going to ask John to maybe comment on what -- just to repeat on sort of what they're doing today, when more comes on. And maybe you want to address John, maybe part of David's question is he may have heard about something they're doing with steel dynamics, maybe just touch on that as well.

John F. Kaloski

The current Plant 1 is in operation and has been for the last few years, and it's pretty much up to speed and operating. The current -- the Plant 2 is currently under construction and is permitted. That will be the extent of the production necessary for the Phase 1. The additional 2 plants will come in later on, and they'll come in pretty much with the pellet plant as they will be needed to supply the pellet plant. There is a portion of the production that is going to the partners through another arrangement, and that is something that's probably better left to the partner to discuss.

David Lipschitz - Credit Agricole Securities (USA) Inc., Research Division

Is that totally separate then, the Plant 1 and Plant 2?

John F. Kaloski

I'm sorry?

James L. Wainscott

The arrangement with SDI is totally separate, Plant 1 and Plant 2?

John F. Kaloski

Yes, it is.

James L. Wainscott

Yes.

David Lipschitz - Credit Agricole Securities (USA) Inc., Research Division

And then my second -- my follow-up question is your contracts with your sources now. When do they actually run out from a volume perspective?

James L. Wainscott

With respect to iron ore? Coal?

David Lipschitz - Credit Agricole Securities (USA) Inc., Research Division

Yes, Iron ore. Iron ore.

James L. Wainscott

They expire at various times. We stagger them intentionally, so some would expire over the course of the next, I would say, 3 years, round figures. And again, we'll be chatting with them. This is new news to those suppliers. We'll be chatting with them about our ongoing relationship. I think it's fair to say that you'll find out in times like this sort of whether you have a real relationship or you don't. And we'll build on those strong relationships and continue to do some business. We're still going to be needing to buy, longer term, about half of what we used to, and those that value the things we do, we'll continue to do business with.

David Lipschitz - Credit Agricole Securities (USA) Inc., Research Division

Okay and just one more. In terms of the -- I know somebody asked about the cost of the pelletizing plant. So the cost of the pelletizing plant is $150 million?

James L. Wainscott

No. I wouldn't interpret it that way. Again, let me just remind you that we're buying a 49.9%, round figure is 50% interest that a large expenditure associated with the pellet plant and other activities will incorporate our $150 million. That's not to say that the actual price of the pellet plant will be $300 million, but I think one could infer that it's in that neighborhood.

David Lipschitz - Credit Agricole Securities (USA) Inc., Research Division

So basically $100 a ton then?

Albert E. Ferrara

Yes, that's correct, yes, doing the math.

David Lipschitz - Credit Agricole Securities (USA) Inc., Research Division

Okay, just because I've been up in Minnesota and talking to people up there, and your competitor is saying it's $200 a pellet or so. I talked to somebody else who's building a facility up there, and that's $200 a ton. So I'm just -- is this a different type of pelletizing plant?

John F. Kaloski

We feel that $300 million is sufficient to cover the $300 million plant, or the 3 million-ton plant. It's more than enough.

Operator

Our next question comes from Kuni Chen of CRT Capital Group.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Most of my questions have been answered. I just wanted to circle back to the pellet offtake agreement. If you could just talk to us structurally about that. You did a discount to the world price. Does that reset quarterly or annually? If you could just kind of just talk around some of those issues?

John F. Kaloski

The pricing mechanism would be reset quarterly, and it's functionally related to what is now the IODEX. There's a discount for market, and then the rest of the proceeds to us would come from the entity.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Okay. And then can you talk about the capital structure for the JV and what that looks like down the road?

Albert E. Ferrara

Well, the capital structure for the JV is set up at the present time. It's essentially funded by contributions by the partners, if you will. It's not intended to be leveraged. But frankly, on an ongoing basis, the joint venture will make the appropriate decisions with respect to funding. At the present time, it's thought that the investments that we will be making will be sufficient, if you will, to get us to where we need to be with the 4 plants, as well as the pelletizing plant. On an ongoing basis, things like capital structure, dividend policy, will all be part of the discussion between the partners going forward.

Operator

Our next question comes from David MacGregor of Longbow Research.

David S. MacGregor - Longbow Research LLC

I'm sorry, I got dropped off the call, but I'm back on. I'm just wondering, could you address just how accretive it would be in 2012?

James L. Wainscott

No, we really did not and I don't know that we'll do that on today's call, except to say that we would confirm the statement, and we'll look to try and improve on that. And again, I think that primarily comes from our investment in Magnetation as opposed to what's going on with the coal business, simply because it's not up and running just yet. We'll only get a bit of income from coal. And again, the other reason why we would be a little bit hesitant to give a specific number is that the amount of that return from Magnetation next year will depend, in large part, on just in fact what the spot market is. And so one would have to make a number of assumptions. But I think given the sense that we've given about its low-cost position that they're already producing and continuing to produce more, and that the IODEX is still, I think, this morning, we're around 170 or so, 169. That's a really big number. I think that positions us very well in terms of the accretion for next year.

David S. MacGregor - Longbow Research LLC

Okay. And you're talking about 1 million ton for your production rate on the coal. How much would it cost you to expand beyond that? Is there a run rate we should think about?

James L. Wainscott

We've talked a lot about that. I think we're probably being a bit conservative there. At 1 million tons, obviously, we think you could produce for 20 years. If you want to amp that up to 1.5 million, it lowers the years. And a lot will depend really on market conditions, on the price of the product in the marketplace. But there's really probably not a whole lot of physical things that hold us back from doing that, and we could probably do as much as 2 million tons a year once we're up and going.

David S. MacGregor - Longbow Research LLC

Okay. Last question, just on the pellet line. It does sound a little inexpensive given what everybody else talks about. Is there something different about this line from a technology standpoint or from the standpoint of maybe using a little less infrastructure than others might be talking about with respect to their lines? Can you just help us understand the difference a little more?

James L. Wainscott

In a moment, I'll let John comment, but I just want you to know that all of the questions that you're asking, whether it's about the pellet plant, whether it's about the cost of production, whether it's about how we run it, how we structure it, we've had those discussions in spades. So please understand, but it's a very fair question. We are not skimping. We're not looking to build a sub-par pellet operation. The appetite that our blast furnaces have is for a very high-quality pellet, and we're going to produce that out of this operation. So probably the better question, I would say, and then I'll let John comment, is you might want to ask the others why they're spending so much money. John?

John F. Kaloski

Well, we feel that the price is representative of what's going to take to put the plan in. And there are certain pieces of logistics that are already in place at some of the sites that we're considering. And that would be a little bit very slight advantage. But we feel the $300 million is representative of what we'll need to spend.

Operator

Our next question comes from Richard Garchitorena of Credit Suisse.

Richard Garchitorena - Crédit Suisse AG, Research Division

My first question in regards to the coal acquisition. You're changing the name to AK Coal Resources, and you'd mentioned that this is primarily going to be just low-vol coal. You do consume mid and high and other blends. Is it fair to say that you look -- you're probably going to look at further additions to this part of the business to either supplement your current needs or maybe sell to third parties?

James L. Wainscott

I think, and I go back to our stated goals with each of these areas, is not to be 100% self-sufficient nor 0%, and we wanted to be somewhere around 50% by taking an equity interest. And really, each of these deals, when they're fully, at the point where we're realizing what we expect to realize, really moves us right around that 50%, plus or minus, slightly. So I think we'll continue to keep our eyes open, Richard, to opportunities. But I think we're going to go about executing these deals, getting our permits, making these things happen and enjoying the benefits of them. Indeed, as you say, with respect to coal, we like the low vol, we think it's the right space for us, but we're not going to consume all of that. So there will be some other activities going there. But I wouldn't imply from that, that we're going to be out actively seeking other properties. But we'll keep an open mind about that.

Richard Garchitorena - Crédit Suisse AG, Research Division

Great. And just to follow-up on that, when you did look at your various options, was there any reason why you went with this specific deposit and reserves as opposed to ones that may have existing operations that could also -- that you could use production from immediately?

James L. Wainscott

Let me just say this, that we looked at everything. And we looked all around the world, and we talked to all kinds of people. A lot of them wanted a big chunk of the company, and we were not about to give away what we think is a fantastic company with great people, great products. And we just simply needed to fix the cost side of the equation. And so we've done that without sacrificing AK Steel's future. A lot of folks had very grandiose views about what they thought their properties or their existing entities were worth, and we obviously didn't see eye-to-eye with that. We think this is, in each of these cases, for us, of course, it's in the eye of the beholder, these are absolutely perfect solution. The glove fits in each case. They work. We've got some execution risk. We'll work through that the best we can, as quickly as we can. But we like what we've done today.

Richard Garchitorena - Crédit Suisse AG, Research Division

And one more question on the -- how does this impact, I guess, your CapEx plans for the rest of the business? I know you've shut in your coke battery plant and asset earlier this year. What are your thoughts on the rest of the business?

James L. Wainscott

Yes, we'll comment -- I'll just offer, for many of you who may have questions about our third quarter results or fourth quarter outlook of the business more broadly, just as a reminder, we'll have our third quarter conference call, and that will take place on October 25 at 11:00, and we'll cover a variety of things at that point including liquidity, capital investments and so forth. I'd just offer, in general, we've been talking capital numbers this year, Al. I think about...

Albert E. Ferrara

$85 million.

James L. Wainscott

$85 million, and that's what we've said probably there. I don't know that we've given any guidance beyond that. These are separate and distinct investments from any of that, anything we're doing this year, anything we're doing in future years. But again, more to follow.

Albert E. Ferrara

And just to be clear, the $85 million won't be impacted by these investments. This year, obviously.

Operator

Our next question comes from Shneur Gershuni of UBS.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Most of my questions have been asked and answered, but when you were evaluating the purchase price for these transactions, can you kind of share with us your thought process with respect to long-term normalized pricing for both iron ore and for met coal in terms of how you evaluated it? What's below the 2010 average pricing and so forth? If you can just sort of give us a bit of flavor for that?

James L. Wainscott

Let me start, if I can, Shneur, and then the other guys are welcome to join in. And I think, might be a little careful here regarding specifics, but I would say, in general, consistent with what most of the so-called experts predict, our sense is that over time, as additional capacity comes on and as things balance out, it's likely, and we don't know whether we'd peak this year or next year, whenever, but it's likely that over time, the cost of what we consume, iron ore, pellets and coal will come down. We don't know how much, we don't know how fast, and we certainly don't know when. So we have tried to do sort of a stress test, if you will, on all of these investments, to make sure that even if they fall fairly precipitously, that as market prices, that these still make sense. And the short answer is they do. And again, we take comfort in this fact, Shneur, that these are low-cost, high-quality properties. Low-cost, high-quality investments. So almost no matter where things go, we're going to be in good shape. And again, I'd remind you, we wouldn't be able to make that statement if we were 100% vertically integrated. We would be making a much bigger bet than it appears we're making here. So I think we'd be just fine if the prices of those commodities came down. On the other hand, if they go up, we now have the way to offset a fair amount of that.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Fair enough. In one of the earlier questions, you talked about how you're going to look at permanent financing and so forth. Is there any thought about hybrid securities at all, kind of converts and so forth, where shareholders aren't diluted as much and so forth? Has that been part of the discussion at all or not at this time?

James L. Wainscott

I think it's fair to say we think about everything or we try to, that's in the best interest of our shareholders, our noteholders and all of our constituents. But to really get into any other specifics about what and when and how much, we're simply not there.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Okay. And one final question if I may. You talked about -- there's going to be a permitting process with respect to the coal side. How far down the path are you at this point right now? Or was the existing operations -- or are you starting fresh at this point right now? And if you can give us some guidance in terms of the timeline as to how it's likely to progress?

James L. Wainscott

Yes, again, just as a reminder, we closed on each of these transactions yesterday and issued the press release shortly thereafter, and we're holding our call today. And as soon as we're done with the call, we'll begin to get about executing all these things. There is the permitting process, and there's the construction process, the startup and ramp-up. And so I would say that with respect to coal, we believe that the permits can be obtained within a couple of years. We hope to be able to do better than that, but I think that's realistic. And we acknowledge that there is a regulatory process involved and all that goes with that. And I think, similarly, there are permits that are required in particular for constructing and operating a pelletizing plant that is of similar, potentially similar duration. So those are sort of critical path items for us. We'll get about them just as soon as we're done with this call and hopefully can get them through the process faster than we previously thought.

Operator

Our next question comes from Brett Levy of Jefferies.

David Olkovetsky

It's actually Dave Olkovetsky I work with Brett. Just a couple questions. First, in terms of your liquidity, at the end of the last quarter, you guys were at $467 million, you just spent $124 million, that leaves you with about $343 million. What's the minimum level of liquidity that you're comfortable at? And have you spoken with your banks about your increasing the revolver or some other sort of financing?

James L. Wainscott

Well, let me first just say that we, as I said in my prepared remarks, are confident that our current level of liquidity is sufficient to do a couple things to finance these transactions, certainly the first portion of them, while also allowing us to meet the ongoing cash needs of the business. Some of you may recall that earlier in 2011, we expanded our credit facility to $1 billion from, I think it was $850 million. Among other reasons, this was done to provide us with the financial flexibility that we need to move our company forward and to be able to capitalize on strategic transactions such as what we've talked about here today. Finally, I think as we've disclosed, we were consumers, significant consumers of working capital in the first half of 2011. We haven't sold as much as we've procured and built inventories in anticipation thereof. So in the second half of this year, we've said and we'll say here that we expect to generate a significant amount of cash from working capital. So really, that's what I'd be comfortable and confident in saying about working capital. Rather than getting to specific levels that we're comfortable with or not, I think the short answer is we are in a position and have indeed met the needs of the business and these deals.

Albert E. Ferrara

The only thing I'd point out, the number you mentioned for June 30 was incorrect. Our liquidity was $615 million on June 30. You may not be comprehending the increase in the credit facility that Jim referenced, the $150 million increase.

David Olkovetsky

Possibly. Okay, great. And then the second question I have relates to just the pricing of the iron ore concentrate. How exactly does that work? I think an earlier caller mentioned that it was something like 30% iron. Would it basically be looking at the world price level for 59% fines, cutting that about in half and then adding a small discount because it's concentrated as opposed to pellets? Or how does that work exactly?

James L. Wainscott

Good question. I'm going to quickly pass that over to John Kaloski. John?

John F. Kaloski

The price -- the mechanism in the price that would move it up and down is the IODEX, the published world price. And from there, we have various adds and subtractions that bring us to the final price to us.

David Olkovetsky

So that's somewhere in line with the IODEX price? Or how do I think about that?

John F. Kaloski

It's based on that IODEX price, and we'll move with it.

Operator

Our final question comes from Dave Katz of JPMorgan.

David Katz - JP Morgan Chase & Co, Research Division

I was just hoping that -- I know you've talked about the iron ore and the way those contracts were lost over the next couple of years. Where do you stand with your present coal purchases?

John F. Kaloski

Coal purchases, generally speaking, David, are on a yearly basis. We have some that extend out longer than a year. But generally speaking, the bulk of our coal is purchased on an annual basis so to speak.

David Katz - JP Morgan Chase & Co, Research Division

And you've completed those purchases for the 2012 year?

John F. Kaloski

We're going to -- we'll probably talk more about that on the conference call in October.

David Katz - JP Morgan Chase & Co, Research Division

Okay. And then just coming back to the permitting. I know you said that you haven't obviously undertaken the permitting as of yet or started that process. You indicated though that you did have a good handle that the iron ore should not be that difficult to get permitting in your opinion. Would you feel the same way about the coal, especially given the more rigorous process that the EPA set up recently with regard to coal?

James L. Wainscott

One of the things I've continued to say is that we need reasonable regulation in America. We certainly hope that at a time when our economy is so much in need of increasing its manufacturing base and the creation of jobs that, that will be taken into account. But having said that, there is a process, we'll get about it. I don't know that we can predict with any more certainty than what we've said today, how long that will take. But we acknowledge, as you've indicated, that there's a process and it's going to take a while.

Well, thank you, and let me take this opportunity to really, on behalf of all of us at AK Steel, say thank you. Thank you for joining us on today's conference call, especially on a short notice. The investments that we announced last evening and discussed today provide AK Steel with a clear plan for integrating backwards. But more importantly, and I don't want to make any mistake about this, we're not moving backwards as a company. Indeed, we are moving the company forward to position us much better, to compete more effectively for the long term. Thank you again for joining us. Have a great day, and we'll see you in a few weeks.

Operator

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

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Source: AK Steel Holding Corporation, Magnetation, Inc., Solar Fuel Company, Inc - M&A Call
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