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AK Steel Holding Corp. (NYSE:AKS)

Q4 FY07 Earnings Call

January 22, 2008, 11:00 AM ET

Executives

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

James L. Wainscott - Chairman, President and CEO

Analysts

Evan Kurtz - Morgan Stanley

Brett Levy - Jefferies & Company

Charles Bradford - Bradford Research

Bob Richard - Longbow Research

Michelle Applebaum - Michelle Applebaum Research

Michael Gambardella - J.P. Morgan

Mark Parr - KeyBanc Capital

Operator

Good morning ladies and gentlemen, and welcome to the AK Steel Fourth Quarter and Full-Year 2007 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder this conference call is being recorded.

With us today are Mr. James L. Wainscott, Chairman, President and Chief Executive Officer of AK Steel; and Mr. Albert E. Ferrara, Jr., Vice President of Finance and Chief Financial Officer.

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

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

Thank you, Paddy, and good morning everyone. Welcome to AK Steel's fourth quarter and full-year 2007 conference call and webcast.

In a moment, I'll review our fourth quarter and full-year 2007 financial results, as well as provide some data points and guidance for the first quarter of 2008. Following my remarks, Jim Wainscott, our Chairman, President and Chief Executive Officer, will offer his comments and field your questions.

I would like to remind you that today's conference call includes certain forward-looking guidance for 2008. Other than our comments on historical results, the remarks we make today constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements include our expectations as to our future shipments, product mix, prices, costs, operating profit, and liquidity. While we believe that our expectations are reasonable, we cannot assure you they will prove to have been correct, since they are based on assumptions and estimates that are inherently subject to risks. Such risks include economic, competitive and operational risks, uncertainties and contingencies, all of which are beyond our control and based upon assumptions with respect to future business decisions that are subject to change. Except as required by law the Company disclaims any obligation to update any forward-looking statements to reflect future developments or events.

For more detailed information, we encourage you to review the discussion of risks affecting forward-looking statements found in the managements' discussion and analysis section of our Annual Report on Form 10-K for the year ended December 31st, 2006, as updated in our most recent quarterly report on Form 10-Q. Also to the extent we refer to material information that includes non-GAAP financial measures, the reconciliation information required by Regulation G is contained in our news release that was issued earlier today and is also available on our website, at www.aksteel.com.

Earlier today, AK Steel reported fourth quarter 2007 net income of 107... $106.7 million or $0.95 per diluted share. The results are dramatic increase over our fourth quarter 2006 net income and reflect the continuing solid financial performance of AK Steel. Shipments in the fourth quarter totaled 1,568,100 tons, down slightly from the shipments in the third quarter, but about 3% higher than our fourth quarter 2006 shipments.

Fourth quarter 2007 revenues were $1.7 billion, slightly less than our revenue in the third quarter. However, our fourth quarter 2007 revenue represents an increase of more than $100 million or nearly 7% increase in revenues compared to the fourth quarter of 2006. Our average selling price for the fourth quarter of 2007 was $1079 per ton which was $5 per ton higher than in the third quarter and slightly better than our fourth quarter guidance. It also represented about a 4% increase compared to the fourth quarter of 2006.

Plant maintenance outage costs during the 2007 fourth quarter were approximately $31 million which was inline with our guidance. We benefited from a LIFO credit of approximately $37 million in the fourth quarter of 2007. We had previously anticipated the LIFO charge in the fourth quarter, however, due to a variety of factors, including reduced inventories of raw material, work-in-process and finished goods and the volatility of nickel prices, the expected LIFO charge turned out to be an actual LIFO credit. For the full year 2007 we incurred a LIFO charge totaling approximately $31 million.

Netting fourth quarter 2007 revenues against cost, we generated an operating profit of $153.5 million or $98 per ton, representing another very strong and above expectations quarterly performance for AK Steel. Excluding the $23 per ton LIFO credit, our operating profit in the fourth quarter would have been $75 per ton which was about $5 per ton ahead of our fourth quarter guidance.

Moving from earnings to cash, we ended the fourth quarter of 2007 with a very robust cash balance of $714 million, a substantial increase from our cash position of $426 million at the end of the 2007 third quarter. Our cash balance was enhanced in the fourth quarter by the receipt of nearly $43 million as a result of recapitalization of Combined Metals of Chicago. Combined Metals is a private stainless steel processing company in which AK Steel owns a 40% equity interest. Also we continue to place a high priority on working capital management. As a result working capital was a significant source of cash in the fourth quarter as it was in the previous two quarters.

Turning now to our 2007 full year results, revenues for 2007 were a company record $7 billion, an increase of 15% over 2006 revenues of $6.1 billion. Shipments for the year were also at a record level of 6,478,700 tons compared to 6,168,600 tons for 2006. For the 2007 year, we achieved an operating profit, excluding $39.8 million of curtailment charges of $664.2 million, or $103 per ton. This was a dramatic improvement from the $214.6 million, or $35 per ton, of adjusted operating profit generated during the 2006 year.

Net income for 2007 was $387.7 million or $3.46 per diluted share, an all-time record for AK Steel. Liquidity-wise we ended 2007 with no net debt, in other words our cash position exceeded our current and long-term public debt. This compares to net debt of $596 million at the end of 2006, and it is dramatically lower than our net debt at the end of 2003 which exceeded $1.2 billion.

During 2007 our combined debt redemption and pension contributions totaled $700 million. We also reinvested another $104 million in the capital projects during the year. Even with these substantial cash uses, our strong cash inflows during 2007 allowed us to increase the Company's yearend 2007 cash balance by nearly $200 million over the previous year, and I would point out that our de-leveraging and reinvestment activities were completed entirely by using internally-generated cash as opposed to accessing any external financing sources.

Finally, total liquidity increased to $1.4 billion at the end of 2007, we anticipate using a portion of our liquidity in the first quarter to meet the initial $468 million funding of a new VEBA trust agreement which is subject to approval by the Federal court in Cincinnati.

With that recap of the fourth quarter and full-year 2007 financial performances, let me provide you with some guidance for the first quarter of 2008. We expect first quarter shipments of approximately 1,565,000 tons which would be comparable to our fourth quarter of 2007 shipment level.

We anticipate plant maintenance outage cost of approximately $8 million in the first quarter compared to the 31 million we incurred in the fourth quarter of 2007. On the pricing front, we anticipate first quarter average selling prices to increase by approximately 5% to 6% in the fourth quarter. Relative to our cost, we expect to continue to see high raw material cost, particularly in the areas of carbon scrap, purchased slabs, iron-ore and purchased coke.

Let me spend a minute on our LIFO expectations for the first quarter. As a result of higher input costs we expect to incur a LIFO charge for the full year 2008. Under GAAP, we are required to recognize one-fourth of our projected full-year LIFO expense in the first quarter. Therefore, we expect to incur a LIFO charge in the first quarter of 2008. All things considered, we anticipate generating a first quarter operating profit of approximately $100 per ton which would get us off to a great start in 2008.

While we only provide guidance on a quarterly basis, let me offer a few annual data points. We anticipate total capital expenditures of about $200 million for the year 2008, roughly equal to our depreciation. While this represents a substantial increase in our capital investments compared to 2007, it highlights AK Steel's commitment to reinvest in our business to grow our niche markets and to lower our operating costs. As such, substantial portion of our 2008 capital spending is attributable to the planned expansion and upgrade of the melt shop at our Butler, Pennsylvania plant as well as major work we plan to complete on the blast furnace at our Middletown, Ohio plant.

Finally, with regard to income taxes, we're projecting a 2008 cash tax rate of less than 10% and a book tax rate of 39.5%.

Now for his comments here's James Wainscott, AK Steel's Chairman, President and CEO.

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

Thank you very much, Al. Good morning everybody, and thank you for joining us on our call today. As Al outlined in his remarks, we had an excellent fourth quarter that capped a superb year for AK Steel. In fact 2007 represents our best year of financial performance since the top management changes occurred in 2003, and it represents the finest financial performance of any year in the history of AK Steel.

Let me take a moment or two to highlight those things that got us here, then I'll give you a sense of where we intend to go from here into the future. But before talking about 2007, first you really have to look back to 2006, because 2006 was AK Steel's defining year and it really paved the way for what we believed had the potential to be a breakthrough year for us in 2007. And I am delighted to report that we executed on our plan and turned that potential this year... 2007, that is... into reality.

Despite facing many challenges last year, especially in our two largest markets: automotive and appliance, we put the pedal to the metal. Our pedal to the metal program was all about accelerating our way forward through a combination of the following items: P for profitable growth initiatives; E for enhancing shareholder value; D for de-leveraging our balance sheet; A for maximizing our assets; and L for sustaining long-term profitability.

And I have to say that we made huge progress on each of those fronts in 2007. We also improved on our already strong business basics. We took our performances up a notch in those areas that comprise our core values, namely, safety, quality and productivity, by continuing to put our employees and our customers first. We experienced our best-ever safety performance with a 44% decline in OSHA-recordable injuries year-over-year, further widening our lead versus our steel industry peers in this very important category.

Remarkably, employees at three of our seven steel plants worked the entire year without a single OSHA-recordable injury. Those locations included Mansfield, Rockport and Zanesville. And until December, Coshocton was also pitching a no-hitter, so to speak. I want to congratulate those plants and all of our other steel plants and AK Tube as well, for achieving truly outstanding safety performance for 2007.

Why do we make safety such a major concern at this company, because it is our highest priority. It is what matters to us, to our employees and to their families. And it's indicative of our tenacious approach to every aspect of our business.

We also hold product quality, delivery and customer service in high regard. For 2007, our customers gave us their highest possible honor in quality, a number one rating by carbon, stainless and electrical steel customers. That's high praise indeed from the people whose opinion matters most, our customers. And that's great work by all of our employees to earn those honors for 2007.

In terms of productivity, which together with quality, represent the key drivers of our operating cost performance, we continue to set records far too numerous to mention today. I would acknowledge, however, that the majority of our 2007 production and quality records were set at our specialty steel plants, and that was especially timely, given increased customer demand for stainless and electrical steel products.

At the top-line, we achieved record annual shipments in revenues as well as a record average selling price. And as a matter of fact our revenues topped $7 billion for the first time in Company history.

On the cost front, we made excellent progress in improving our competitiveness. Notably, we reached new competitive labor deals at Coshocton, Middletown and Rockport in 2007, and we reduced controllable cost wherever we could in the Company.

It was great team effort, as the hard work of our sales, operating and support staffs was reflected in our much improved financial performance. For the first time in our history, we achieved the long-held goal of $100 per ton in quarterly operating profit. But more importantly, we achieve this performance benchmark for the entire year as we delivered an operating profit of $103 per ton for the full year 2007. Year-over-year we tripled our operating profit, and at the bottom-line, as Al mentioned, we reported record earnings with net income of $3.46 per share.

I am very, very proud of our Company's overall performance for 2007; it was a remarkable year for us, and it's a great tribute to all of our people for rising to meet the many challenges that we faced in 2007, our employees beliefs, and together we succeeded.

Now with 2007 in the books, we transitioned to the new year, 2008, and we are very excited to do so. Notwithstanding the economic and raw material challenges that we will undoubtedly face this year, we look for even bigger and better things as a company in 2008. Why? It's because we worked very hard to get to this point. As a result, among other things, we are realizing the benefits in 2008 of our cost reduction efforts, our capital investments and higher selling prices negotiated in our contract sales agreements. In other words, our fundamentals are improving. Things, obviously, aren't perfect, but they are certainly better than they have been in a long while for AK Steel.

Recently I was speaking with someone who characterized AK Steel's management team as a group of perfectionists. Perfection is a difficult standard to obtain and harder yet to maintain. I think it's more accurate to describe our team as a group of optimizers, rather than perfectionists. We simply try to get the most out of everything, out of our plants, our equipment, our sales portfolio, and our people. To-date I think we have done a reasonably good job of taking the hand that was dealt to us and optimizing it. Having said that I believe we are still a work-in-progress and I'm certain that there is much more for us to do to optimize our earnings and to achieve our potential as a company.

For example, last fall we negotiated a groundbreaking VEBA agreement with the current Middletown Works-represented retirees, but since court approval is pending, we have not yet begun to experience its financial benefits. In terms of an update on that subject, I might add that a motion to delay the hearing to approve the settlement was recently denied. Thus we expect the hearing to proceed as scheduled on February 12, 2008, and we expect to receive court approval later in the first quarter of this year. This is an important transaction for our company, and will certainly help our balance sheet.

In addition, we have reinvested in the business to capitalize on opportunities for profitable growth and cost reduction. However, because many of those projects are still under construction and have not yet been completed, obviously, we have not yet experienced the benefits from these investments either.

That's it, we are highly confident that these and other projects and actions can meaningfully enhance shareholder value in the years ahead.

Speaking of enhancing shareholder value let me offer a comment on our 2007 stock price performance. We are delighted that AK Steel rank second in stock price performance for 2007 among all Fortune 500 companies with a 174% gain in value for the year. Incidentally that follows 113% increase in value for the year 2006. Notwithstanding the bumpy start in early 2008 for all stocks, including ours, we are happy that our shareholders have been rewarded for their support of AK Steel over the past four years and, in particular, over the past two.

It's also my pleasure to call attention to an action we announced earlier today to further enhance shareholder value, we are initiating a dividend on our common shares of $0.05 per share per quarter, or the annual equivalent of $0.20 per share. This dividend announcement is a clear indication that AK Steel's Board of Directors recognizes and values the support that our shareholders have provided during the Company's financial transformation over the past four years.

In our view, it is our focus on serving our customers better than any other steelmaker that ultimately drives the value of AK Steel for its shareholders, and that's why we have continued to capitalize on our solid market niche positions.

During 2007 we completed our third expansion of electrical steelmaking capacity and announced yet another, our fourth to be exact, electrical steel expansion project in the past three years. During 2007 we also announced the construction of a new electric arc furnace at our Butler Works that will significantly reduce our stainless and electrical steel production costs and improve our carbon steel slab self-sufficiency.

I hope that it's clear to you that we are investing to improve our competitiveness while advantaging those markets and products that we believe provide us with the greatest long-term potential for success.

So instead of resting on our past accomplishments or standing still, we are moving forward. You might say that we are forging ahead in 2008, as we look to take our performance to another higher level this year, using initials and the acronym FORGE will concentrate... in the case of F... on improving our fundamentals, that is, making our industry-leading safety, quality and productivity even better. For O, optimizing our margins, in the case of R rewarding our shareholders, G growing our profits, and finally E executing as world-class managers do. Focused on the fundamentals, optimizing, rewarding, growing and executing, I think that pretty well defines what we are all about at AK Steel.

By the way, speaking of the fundamentals, our Middletown Works recently broke its own record for casting on a dual strand caster in the western hemisphere; congratulations to our Middletown employees for getting us off to a good start in terms of production for 2008.

Looking back at a series of themes that we've used at the Company in recent years, including, believe in succeed, to the three Cs program, to the three 6s, and finally last year, the putting the pedal to the metal. Our plan is working, and we are on the right track. Our management team and our employees have given it everything they have had, and now it's gratifying to see the results of our efforts being born out and fruit for all of our constituents.

As I mentioned, 2006 was our defining year, a make-or-break-year, if you will, while 2007 represented our breakthrough year, the year that we accelerated our Company's performance to a level that frankly very, very few thought was possible, just four years ago. But thanks to the unwavering support of our Board of Directors, and by meeting our challenges head-on, I believe that we have reshaped the future of AK Steel.

Before taking your questions, let me offer a glimpse of what we see in each of our major product groups, starting with carbon steel products. In the past six months we have announced a total of five spot market price increases on carbon steel products. As a matter of fact, four of those increases have taken place since our third quarter 2007 conference call. Over that three-month period, we have raised prices on spot market carbon steel sales by combined $140 per ton.

There's a brief recap of our price increase announcements and their effective dates. We announced the $30 per ton price increase effective January 1 of 2008, another $30 per ton increase effective February 1 of this year, followed by a $50 per ton price increase also effective February 1, and just last week we announced the $30 per ton price increase for all new orders accepted for shipment on March 1st of 2008. Each of these price increases has been in response to higher demand for carbon steel products as well as the need to recover higher cost for steelmaking inputs.

The marketplace is very cognizant of the recent surge in scrap prices, and it is also anticipating higher iron ore prices as well. With that cost push, coupled with low inventory levels, there's no question that carbon steel prices are heading higher, perhaps much higher from current levels.

While the outlook for automobile on a plant's production indicates continued softness, we do see improving conditions in the service center market. Service center and distributor inventory levels are at their lowest point that they've been since September of 1999. In addition, import levels are also quite low, and as I mentioned, raw material costs are rising. Incidentally, this phenomenon is not unique to AK Steel; just about every steel producer around the world is experiencing rising input costs. But all of these factors: the low inventories, low inputs, and rising input costs, support even higher steel prices in the months ahead.

I want to also emphasize that while several steel industry research analysts have suggested that AK Steel cannot benefit significantly from higher spot market prices; well that simply is not the case. For 2008, we estimate that in excess of 40%, 4-0, of our carbon shipments will be sold into the spot market. Accordingly, we are very well positioned to capture the increases that are underway in spot market pricing.

Moving from carbon to stainless steel products, stainless steel inventories also ended 2007 at very low levels, setting the stage in 2008 for a recovery in stainless spot market volumes and prices as well. Despite announced automotive production cuts, our 400 Series stainless steel shipments for automotive exhaust customers are expected to hold up reasonably well in the first quarter of 2008, just as they did in the fourth quarter of 2007. And our specialty stainless steel shipments, primarily those from our Coshocton facility for a variety of unique customer applications, remain strong.

Finally as our recent capital investment announcements portend, electrical steel continues to be one of our strongest product lines. The outlook for electrical steels, in particular, the high-end electrical grades remain solid as demand continues to exceed supply, both in the US and abroad.

Having said that towards the end of the fourth quarter, and continuing into the first quarter of this year, we have seen some weakness in the lower end of the electrical steel market for a couple of reasons. First, the low-end of the electrical steel market is softened due to the ongoing slowdown in the housing sector, and that weakness has begun to translate into reduced demand from customers making distribution transformers, the kind that would be used, for example, in new housing subdivisions. And second, we have also faced some challenges on the low-end from imports.

Notwithstanding this, we have achieved contract pricing increases, in 2008, for our electrical steel products that are more than 20% higher than our 2007 pricing levels. We also expect that our overseas shipments of electrical steel products will increase by more than 40% in 2008, as we continue to grow this business internationally.

In terms of a domestic economic outlook for 2008, while some are espousing views of a recession, or perhaps some would argue that we are already in it, frankly, we don't subscribe to that theory, we have built our business plan anticipating a slow growth scenario with the operative word being growth not recession. I would also call attention to the fact that AK Steel has greater product diversification than any other steelmaker, because of that we are not dependent on any single segment of the economy. And with increased international sales and an active international distribution arm, we're not entirely dependant on the US economy.

We like our size; given our size, our high quality products and our flexible production capabilities, I believe that we are uniquely positioned to quickly move our products where the margins are the highest. That economic backdrop, along with the tremendous progress that we've made in recent years, provides AK Steel with the basis for what we envision to be a solidly improved year in 2008 as compared to 2007.

This management team and our Board of Directors at AK Steel have great confidence in the future of this Company. As evidence of this, we are continuing to put the Company's strong cash position to work right here in the first quarter of this year. In addition, to our dividend announcement, our Board has taken another proactive step to enhance our pension funding with our most recent $75 million early pension contribution announcement. And pending court approval, we stand ready to fund, later this quarter, the initial $468 million of the Middletown VEBA settlement.

All of these actions are possible because in a span of a little more than four years we have made dramatic progress in turning around one of America's premier steel company.

In closing, let me assure you that this management team remains extremely determined to deliver improved results for the owners of this Company, achieve sustained profitability, and realize our Company's potential. 2008 has the potential to be great for AK Steel. It's our job as managers to execute, to turn that potential into reality, and to make 2008 truly great, and that's exactly what we intend to do.

Thanks again for joining us today. That concludes my prepared remarks, and I would be happy to respond to your questions.

Question And Answer

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 Evan Kurtz of Morgan Stanley.

Evan Kurtz - Morgan Stanley

Hi. Good morning gentlemen, and congratulations on a great quarter.

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

Thank you, good morning.

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

Good morning, Evan.

Evan Kurtz - Morgan Stanley

Just a couple of questions on 1Q '08. Given that your 20% boost in electrical steel pricing, 5% to 6% in your overall ASPs. You are obviously facing a significant amount of cost inflation, something you can... provide some more color on that. What are some of the bigger items? Is it coke palates outages, your ability to pass to alloy, any sort of information will be useful.

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

Maybe I will take a shot at that in terms of the selling price guidance. First I would tell you that our guidance comprehends our entire shipment mix, and we are delighted that we are up 5% to 6% quarter-over-quarter, and I think the rest of the year is really going to play out. Much depends on the timing of the various spot market price increases that we've just announced versus how much we had left.

Frankly, our order book is very tight right now. We are full through January; essentially, full through February, and have a small amount of tonnage left for March. In addition... so that's a spot market environment. We will continue to realize more of those announcements as we get into Q2 and beyond as conditions remain tight. Similarly with respect to contract pricing, fair amount of our contract business will come due later this year. And with this kind of a tailwind we would certainly expect to see significant increases in that environment. So, no apologies for being up 5% to 6% in Q1; we think the best is yet to come.

On the cost front, clearly we are seeing all of the rhetoric that's out there with respect to raw material prices. Unfortunately, we and few others have a seat at the table, but we have read things, and you have read things. And the one thing we know for sure is that scrap prices are up, they are up about 95 bucks a ton, recently, and they are remaining high. Iron ore prices are going to be higher, the question is, obviously, how high. And I, really, hesitate to get into a lot of discussion about percentage increases, because these things have intend to become self-fulfilling prophecies, but certainly the pressures are there, given the supply and demand in the world for iron ore and for other inputs such as coal and coke.

Evan Kurtz - Morgan Stanley

Okay. Well, maybe just talking about LIFO and planned outages in Q1 versus Q4. So, we are expecting a LIFO charge easily to provide some sort of magnitude to that, is there any additional guidance on LIFO?

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

We are probably looking, Evan, at that impacting us, approximately around $10 a ton.

Evan Kurtz - Morgan Stanley

Okay.

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

In the first quarter which, again, keeping in mind that we had a $23 per ton credit gives you something of a jumping off point. And keep in mind our outage expense is expected to be somewhere in the $7 million area or down from $31 million in the fourth quarter.

Evan Kurtz - Morgan Stanley

Got it, thanks.

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

I would just emphasize, Evan... and we had a fair amount of discussion on the last conference call on LIFO... that we take an estimate based on our estimated input cost levels and our inventory levels at the end of 2008. And under GAAP we are required to record a quarter of that in the first quarter, that's how Al arise at the $10 per ton charge as compared to a $23 per ton credit. So, it is pretty huge delta quarter-to-quarter.

Evan Kurtz - Morgan Stanley

Right. My last question is other income. There is almost a five-fold increase in 4Q

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

Right.

Evan Kurtz - Morgan Stanley

What's the nature of that?

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

Well, we disclosed in our third quarter 10-Q the Combined Metals' recapitalization which, as I mentioned in my remarks, generated almost $43 million in cash and almost $30 million of income. In addition, we had higher cash balances which generated more cash. We witnessed going from the 400-ish up to about 4... or excuse me, $740 million. And we had a just a touch of some foreign exchange gains in there, rolling all those together comes to your $22 million.

Operator

Our next question comes from Brett Levy of Jefferies & Company.

Brett Levy - Jefferies & Company

Hey guys. I know that you guys have moved a significant chunk of the sheet sales into the spot markets. Can you talk a little bit about contract discussions, and where they went, how close to done you are and the kind of, maybe what particular products you're moving more into the spot market?

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

First of all, I'd just say that we're taking an increasingly closer look at what it costs us to make the near-perfect steel that we make and provide to the contract arena. And it's been a bit of an eye-opening experience, and we consider, sort of, the profitability per minute, or lack thereof, as the case may be. So, that has really caused us to step back. And, obviously, we want to be there for all of our customers, but if we're not there in a profitable way then they can't count on us for the long run. So, hence the recent shift.

I suppose there was a point when we were about 75%, 25% contract to spot; and as I said, this year that's going to be very different, below 60% contract and more than 40% spot. So, what's driving us there is really the opportunity to serve our customers but also to do so profitably.

As far as the contract business is concerned, again we have contracts across the spectrum, we have contracts in electrical steel which we've talked about, we have autochrome contracts, and then we have contracts with our automotive customers. And I think, probably the better question than asking what did we get, is really, what do we expect to get as the year evolves, because we have a variety of contracts that come due throughout the year.

And I guess... I would just offer the following: The upward direction of steelmaking input cost is going to have a lot to do with all of this. And the recent substantial rise in the spot market prices, which we've clearly been a part of with our announcements, we would certainly anticipate negotiating higher contract prices as those deals come due, and it's reasonable to assume that we'll be seeking double-digit percentage price increases.

We are not shy about seeking higher prices, because we have to. The fact of the matter is that we've seen, probably as a company, over the last five years, about $2 billion in higher steelmaking input costs hit us. And without the ability to pass those through, either in the form of higher fixed or base prices or variable prices, which is effectively surcharge mechanisms, I mean we wouldn't be here having this conference call. So it's essential that we continue to do that and the market and our customers, I think, are getting the message.

Brett Levy - Jefferies & Company

Got it. Pro forma for the 468 VEBA trust contribution, and your pension contributions, what were the new levels of post retirement health and pension liabilities be for the Company? And then, can you talk a little bit in terms of the cash impact of post retirement health liabilities before and after?

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

Let me address, first, the issue of what it does to the balance sheet. This particular deal, as we disclosed in our third quarter 2007 Q, the deal that we've negotiated has the effect, over time, of reducing by about $1 billion our OPEB liability. So, it's meaningful, it's really transformational with respect to our balance sheet. And much in terms of the accounting is going to depend on the successful ruling that we seek and expect to get in February, and I think it's fair to say that after that comes out we will have more to say about it.

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

We will. I think prior to that, Brett, we prefer not to get into too many details with respect to OPEB.

Operator

Our next question comes from Chris Olin of Cleveland Research.

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

Good morning, Chris.

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

Good morning, Chris.

Unidentified Analyst

Hello.

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

Hi Chris.

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

Hi Chris.

Unidentified Analyst

Hey this is Billy Hercley, Gotenberg [ph] Research. I have got a couple of questions. Congratulations, James, on a solid quarter, you always seem to do real well each year. Can you talk about what your operational improvement initiatives are regards to lean, TPM, six sigma, and how you guys improving the throughput throughout the entire company going into '08?

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

I would say that our programs really haven't been defined as six sigma and so forth, but we really engage in, at AK Steel, is a continuous improvement process, whether we are talking about safety or quality or productivity. In essence, we load all of our lines, we don't have redundant facilities, we do it, I think, more productively than anyone if you look at our headcount and the tons produced and the revenues produced, we really standalone in that regard.

One of the key initiatives for us going forward, though, is to continue to take cost out of the system, continue to take cost out of our slab production, and our overall process. And it's the one thing that I continue to have; really, daily discussion with our management team about is our need to continue to reduce our cost. Despite the fact that we have regained the leadership in our industry in operating profit per ton, certainly amongst the integrators, and that's a tremendous compliment to our team, we got to reduce our cost more. We are doing it through a series of things, operationally, maintenance wise, and also in terms of capital investments, the benefits of which we should see for years to come.

Unidentified Analyst

You guys have always seemed to be very metric-oriented. What metrics are you guys using in the manufacturing and handle all contingent [ph] they were going like OEE arona [ph] are those important to arona [ph]?

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

They are all important, but again what we try and do is take the previous year and set a new bar such that our records that we set internally are repeatedly broken throughout the year. And this year that will depend, really, on how strong the market is, but as we are amongst the most productive... if not the most productive, whether you are talking about per cubic feet of working volume of blast furnaces or hot strip mills or coating lines, nobody does it like we do it. I'll reference the galvanized line of Rockport again, which was estimated to make somewhere in the range of 800,000 tons when we announced it. We can do 1.2 million tons now depending on product mix.

So, we look at ourselves, and really we've never sort of etched and stoned any particular numbers, because they tend to be limiting. We free our mind of that and we continue to move forward into territory that few have imagined.

Operator

Our next question comes from Charles Bradford of Bradford Research.

Charles Bradford - Bradford Research

Hey, good morning.

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

Good morning, Chuck.

Charles Bradford - Bradford Research

Hi. Could you talk a bit about the timing of some of these raw material cost increases? It's my recollection that you guys... for iron ore, for example, take effect the beginning of the year even though the contract prices are really as of April 1st, and there is some retroactivity in it. Is that true or what is the timing?

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

Chuck let me give that a stab. Our iron ore contracts, really, all reset this year, that is, 1-1-2008, even though as you've accurately pointed out, those deals may not get done even this quarter. There is a chance they will, there is a chance that they will go forward. Whatever does ultimately gets negotiated, will be retroactive to the first of the year. We've obviously assumed something in our plan, we try to incorporate that into our guidance, the extent that we're high or low, we will have some sort of impact going forward, and we will talk about that more as we know more.

Charles Bradford - Bradford Research

And as far as coking coal, lot of people have brick contracts where something like third turns over every year. What's your situation at the moment?

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

This point we've got agreements in place, they go out beyond this year and... but what we have continued to see is, obviously, a shortage in that segment of the market as well. We later... we tend to stagger the contracts as we look out. But I think there has been particular tightness in the low-vol end of the marketplace and we've had to buy through a couple of force majeure situations that has increased our cost. I think that market is probably a bit more imbalanced than most, nonetheless it's likely to incur some price increases as well.

Charles Bradford - Bradford Research

On the stainless side, obviously most of the 409... most of your business is 409, but you do have some nickel grades, what are you currently seeing now. I know what the LME prices are, but what about stainless scrap for the nickel content and those kind of things. Are those coming down still?

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

I think we've seen a leveling off, really, which is delightful. In the last couple of months it was probably the most volatile year anyone of us can remember in terms of nickel prices. We look back at 2007, peaking, I think, at one point to $54,000 a ton. And we are back into that range of about 27,000 or so as we speak, or about half of that peak.

I think the real key in the $0.05-based product arena in stainless is our customers getting confidence that there is some sort of stability in pricing, otherwise they try and sort of buy ahead or get out of the way of increases. And we've seen that, we've seen the stability, we've seen an improving scenario, and I think that not unlike what we've talked about with the market dynamics and inventory levels of carbon, we'll see a pick-up in stainless. We haven't seen as much just yet, but the conditions are certainly in place for that, but the key, again, is nickel pricing.

Operator

Our next question comes from Bob Richard of Longbow Research.

Bob Richard - Longbow Research

: Good morning, and thanks for taking my call.

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

Good morning, Bob. How are you?

Bob Richard - Longbow Research

Good. Hey, Al you'd spoken a few calls before a possibility of setting up a strategic slab plan with a third-party. How is that going and can you give us any update on that? Thanks.

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

Let me give it a shot, I don't know that Al said that, maybe he did. I would just tell you that one of the things that we announced on our last conference call in terms of one of the reasons that we wanted to move ahead with the number 5 EAF off the Butler was to help improve our self efficiency. In a typical year we might buy 700,000 tons of slabs, that's about what we bought last year. This year it's probably going to be a little bit less as we make more ourselves. We could be in the 0.5 million ton, kind of range, roughly speaking. We will supplement a substantial amount of that when we bring number 5 EAF online in 2009.

We are always looking at assets that are available in the market that might improve our portfolio, our production portfolio, our sales portfolio. There are a few out there and we pay close attention to those things.

Bob Richard - Longbow Research

Thank you very much.

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

Thank you.

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

Thank you.

Operator

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

Michelle Applebaum - Michelle Applebaum Research

Hi, I have a couple of questions, I was wondering if you could talk about the... on the electrical steel side. I didn't hear you answer the question on timing of your production increases. You may have, and I may have missed it?

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

In terms of our electrical steel production, we... those took effect, really, the first of this year, in fact, some came up late in 2007, this was for expansion Phase III, we're in the midst of expansion Phase IV, that will come up in 2009 as well. So, we added about 35,000 tons, round figures, to the fold of electrical steel products for 2008.

Michelle Applebaum - Michelle Applebaum Research

So, the 5% to 6% guidance includes their chunk at 20% and the extra tons too.

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

Our overall pricing guidance incorporates our total portfolio, so it would have those new tons in there, yes.

Michelle Applebaum - Michelle Applebaum Research

Is there any potential, I'm sorry if I sound greedy, but is there any potentials for further increases in the first quarter? If you

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

We've not booked a 100% of our business. It will depend on what kind of prices that we transact at, so certainly that potential is there. I think we've guided to a comfortable level today.

Michelle Applebaum - Michelle Applebaum Research

I have noticed that your secondary levels tend to run about 3% of your mix the last couple of years. In a market like this, do you think you'll have any secondary; and what could that do? Or would you budgeting the same level of secondary?

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

I think if you look at our supplemental data. I believe we incorporate that into our release. It shows that we've gotten secondary down to about 4% change about 4.1% for last year. I think that's a very, very good level. We try not to make any more than we have to, obviously because it means that we didn't make the product right in the first place, and it typically carries a lower margin. So I think we'll do everything we can to boost production and get to higher prices and reduce those costs and secondary is really a byproduct of that process.

Michelle Applebaum - Michelle Applebaum Research

Okay. Is there any kind of contemplation of separating the two... the carbon business and the specialty business from a business line reporting perspective?

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

You know, Michelle, we've been asked that from time-to-time over the years, it's a very good question, but we really don't run our business that way. When you look at the fact that we will melt stainless steel in Butler and will hot-roll it in Middletown, we'll finish it in Rockport, it becomes a matter of sort of allocating cost that, and it tends to lose its significance and its meaningfulness. But it's a good point, and as I think you can sense here with our capital investments, we're advantaging those product lines that we believe provide us with the highest margins, but it's unlikely you'll see a change in our reporting on those parts of the business.

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

Michelle, we manage our business as a single segment, and so consequently we report on that basis on the same way.

Operator

Our next question comes from Michael Gambardella of J.P. Morgan.

Michael Gambardella - J.P. Morgan

Yes, good morning.

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

Hi Michael.

Michael Gambardella - J.P. Morgan

I have a question on the iron ore contracts you have. You have... can you go through the sources of your iron ore. I know IOC is a big one, but where... and you get a little bit from CVRD, I think, up the river, but where else do you get your ore?

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

We have four primary providers. I don't know that we get into how much from each, but we've got the two Canadian outfits, we've got our fellow Buckeye, Cleveland Cliffs up in Cleveland, and CVRD. So, it's Quebec RDA and IOC, are the other two providers.

Michael Gambardella - J.P. Morgan

But QCM and IOC, and where do you get it from Cliffs, which mine?

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

I think it might be Tilden, yeah.

Michael Gambardella - J.P. Morgan

Okay, and are all... are the QCM and the IOC, is the price geared off of a 100% of the international contract prices?

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

I would say that each of the deals that we have, have a little bit different flavor to them, but as a rule of thumb, a benchmark would be sort of jumping off of world price as of 1-1-08.

Michael Gambardella - J.P. Morgan

Alright. Well, Cliffs is one-third of the world price, but the other two I had thought were a 100%.

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

We generally, Michael, don't get into specific details of each contract, and consequently, I think, Jim's point, and I would reintegrate it, is that we use a world price metric for IOC and QCM, and Cleveland Cliffs have some variations to it, but we try not to get into specifics on each particular contract.

Michael Gambardella - J.P. Morgan

Okay, and then on the slab side, how much are you expecting to import this year on slabs?

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

I think I mentioned in an earlier remark about a 1.5 million tons. Much of that will come I think in the first half of the year, as we plan for what is an anticipated outage, our only planned blast furnace outage which is currently scheduled to take place in the second quarter at our Middletown Works. So we are planning ahead for that.

Michael Gambardella - J.P. Morgan

Okay, and that the slab price just... it fluctuates every quarter?

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

I think the sellers of slabs... it's an interesting group, obviously, we've got a number of relationships around the world that's become a more challenging environment as the assets have come into pure hands, and as some of those players have encountered some operational difficulties recently. So it's a function of availability, obviously, and I suppose they are other drivers as well, not the least of which is what they can sell it for based on the market prices. So that's it, it moves back and forth, and the other factor, of course, is the transportation and where we can get it from. We obviously seek to minimize cost, including transportation cost, wherever possible.

Michael Gambardella - J.P. Morgan

Alright, thanks much, Jim.

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

Thank you.

Operator

We have time for one more question. Our final question comes from Mark Parr of KeyBanc Capital.

Mark Parr - KeyBanc Capital

Hey, thanks very much. I was just getting into the slab issue again, Jim. If you look at the upgrade to Middletown and the new furnace at Butler, will you be essentially slab independent in '09?

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

Depends on what our product mix is, and what we want to do. The potential is there, but if there is opportunity in the marketplace, we have got a strip mill that can run very, very well; number one or two in this country depending on the product mix. And we are not going to leave any stone unturned. If there is opportunity to move product profitability, we will continue to buy slabs and convert it. If the opportunity isn't there then we may be defined as being self-sufficient. But we continue to make good progress, it really is a function of reliability, stability and taking up the capability of our furnaces. And the EAF that I mentioned is going to be very helpful as well, but that's another year, year-and-a-half out.

Mark Parr - KeyBanc Capital

Okay, terrific. Congratulations on the great results.

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

Yeah, thanks very much.

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

Thank you, Mark.

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

Let me just say, again, thank you all, and as we wrap-up here today, for joining us. We know that it's been an extraordinary morning, and for that matter maybe a very interesting year for all of us. But we are delighted to kick-off the year with these great results, the positive outlook. We sincerely want to say thank you for your interest in and your continuing support of AK Steel. And we certainly hope that you'll have the opportunity to join us on our first quarter 2008 conference call in about three months.

Have a great day and a great 2008.

Operator

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

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Source: AK Steel Holding Corp. Q4 2007 Earnings Call Transcript
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