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AK Steel Holding Corporation (NYSE:AKS)

Q1 FY08 Earnings Call

April 22, 2008, 11:00 AM ET

Executives

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

James L. Wainscott - Chairman of the Board, President, CEO

Analysts

Aldo Mazzaferro - Goldman Sachs

Brett Levy - Jefferies & Company

Charles Bradford - Bradford Research

Michelle Applebaum - Michelle Applebaum Research

Sal Tharani - Goldman Sachs

Mark Parr - KeyBanc Capital Markets/McDonald Investments

Operator

Good morning, ladies and gentlemen, and welcome to the AK Steel's First Quarter 2008 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. - Chief Financial Officer, Vice President-Finance

Thank you, Catherine [ph], and good morning everyone. Welcome to AK Steel's first quarter 2008 conference call and webcast. In a moment, I'll review our first quarter 2008 financial results, as well as provide some data points and guidance for our second quarter. 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 profitability, 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, 2007. 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 available on our website, at aksteel.com.

Earlier today, AK Steel reported first quarter 2008 net income of $101.1 million or $0.90 per diluted share. This result represents a 60% improvement over our first quarter 2007 net income of $62.7 million, which included a $15.1 million pre-tax non-cash pension curtailment charge. During the first quarter of 2008, we shipped 1,578,000 tons, which was comparable to our shipments in the first quarter of 2007 and consistent with our guidance.

First quarter 2008 revenues were $1.79 billion, the second highest quarterly revenue in the company’s history and an increase of $71.5 million or 4% over our first quarter 2007 revenues. Our first quarter revenues were driven by record average selling price of $1,135 per ton. This was an increase of $57 per ton or 5% higher than our first quarter 2007 average selling price and was also consistent with our guidance.

Our quarterly average selling price improved due to several factors including our contract and spot market pricing and increased raw material surcharges. On the cost front during the first quarter, planned maintenance outage costs were approximately $3 million, once again in line with our guidance. During the first quarter, we continue to be negatively impacted by an unprecedented level of higher cost for raw materials. Raw material costs were a major factor in driving our first quarter LIFO charge to $59 million or $37 per ton. Netting revenues against cost, we generated first quarter 2008 operating profit of $169.7 million or $108 per ton.

Our operating profit represents a 40% increase over the year-ago first quarter and a solid improvement of $16.2 million or $10 per ton compared to the fourth quarter of 2007. Following our breakthrough performance for the year 2007, our first quarter 2008 results represent another very strong and above-expectations quarterly performance for AK Steel.

Now turning to cash, we ended the first quarter of 2008 with a very solid cash balance of $272 million. While our cash balance decreased from the 2007 year-end level of $714 million, it's important to recognize that during the first quarter we made $543 million of employee-benefit related payments. We funded $468 million for the newly established Middletown Works’ retiree VEBA and $75 million for an early-pension contribution. The impact of these actions on our balance sheet is evidenced further by the approximately $900 million decrease in our pension and OPEB obligations from $2.7 billion at the end of 2007 to $1.8 billion as of March 31st. This continues the de-leveraging process that we started at the company in 2003.

In addition during the first quarter, we made capital investments of approximately $37 million. Also we continued to place a high priority on the management of working capital. Historically, working capital has been a significant use of cash for AK Steel in the first quarter. However, we are pleased that working capital consumed only $37 million of cash during the 2008 first quarter. That's even more significant, considering the higher sales levels and increased raw material prices that we experienced. This also contributed to our total liquidity, which remains solid at over $950 million as of the end of the quarter.

AK Steel's strong liquidity position provides us with the ability to take advantage of opportunities such as the recent VEBA settlement when they arise. With that in mind, earlier this morning we announced the AK Steel's Board of Directors has authorized another early pension contribution of $75 million, which we will make in this quarter.

Based on our independent actuaries calculation, this contribution will fulfill our required pension contributions for 2008 and it will bring our total pension contributions since 2005 to more than $0.75 billion dollars. In addition our Board of Directors has declared a second quarter 2008 dividend, which was also announced earlier today. Net-net, we expect to continue to generate strong cash flows from the business during 2008. These strong cash flows will in turn provide us with solid liquidity and financial flexibility throughout the remainder of the year.

With that recap of our first quarter financial performance, let me now provide you with some guidance for our 2008 second quarter. We expect the second quarter shipments to increase to approximately 1.7 million tons, up nearly 8% from the first quarter. On the pricing front, we expect our second quarter average selling price to be another record quarter for AK Steel. We expect average selling prices to increase by approximately $100 per ton over the first quarter. Relative to our cost, we expect to continue to see higher raw material and energy costs, particularly in the areas of carbon scrap, iron ore, and natural gas. We expect the impact of raw material and energy costs to increase quarter-over-quarter by approximately $70 per ton.

During the second quarter, as Jim will detail, we also anticipate increased maintenance outage cost compared to the first quarter of approximately $40 million or about $25 per ton. This is primarily due to a planned maintenance outage that we are taking at our Middletown Works blast furnace. As was the case in the first quarter, we expect to incur a substantial LIFO charge in the second quarter of 2008.

And finally to update our previous guidance, we now expect our 2008 book tax rate to be approximately 38%. This is slightly lower than we had previously expected, due largely to the re-valuation of our OPEB liabilities following the VEBA settlement. I should note that the guidance we gave regarding our cash tax rate are being less than 10% has not changed. All things considered, we anticipate generating a second quarter operating profit of approximately $125 per ton, which would represent the best quarter in the history of AK Steel and conclude our best first half ever.

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

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Thank you very much, Al, and thanks to each of you for joining us in this earning season on AK Steel's conference call today. AK Steel is off to a great start in 2008, despite much higher cost for steel making inputs than we had expected, really delighted that we delivered the better than expected first quarter performance and that's because we have a great group of employees at AK Steel who continue to rise to meet just about any challenge that we place in front of them. At $108 per ton, our first quarter 2008 operating profit ranks us the best ever first quarter in the history of the company, best ever. That's a big achievement for us and so I want to take this opportunity to say thank you to all of our people to the men and women of AK Steel for achieving record setting quarterly results in which we can all take pride.

Our first quarter was aided by a richer shipment mix, which help drive the record average selling price that Al referred to you in his remarks; in addition, we achieved solid cost performance in our operations and excellent product quality as well.

In fact during the first quarter, we set a monthly production record on the Middletown hot strip mill of more than 575,000 tons ... and mind you, we are not just rolling carbon slabs on that hot mill, we are also rolling stainless slabs on that mill, which significantly lowers the overall throughput. Already one of the most productive hot mills in the world, it simply got better than ever in the first quarter of this year. That's great work by a talented group of employees at our Middletown Works. Speaking of first quarter production records, we also set our fair share of them at our Butler, Zanesville, and Coshocton facilities. This was very timely performance indeed in support of our efforts to increase our high value added stainless and electro steel shipments.

Thanks to all of our employees at each of those locations for a job well done. And while we are on the subject of manufacturing excellence, I would be remised if I did not congratulate all of our employees throughout the company on recently receiving a MANNY award from Cincy magazine, a leading business publication in Greater Cincinnati. This award for manufacturing distinction is greatly appreciated and I believe it's richly deserved by our people for their breakthrough performances in 2007.

In addition to the MANNY award, I am pleased to report that during the first quarter, AK Steel was named by Fortune magazine as one of America's Most Admired Companies for 2008. Being recognized as one of America's Most Admired Companies by Fortune is really a terrific honor and we are especially proud of our number one ranking in the metal sector in two key categories, the quality of our products and the best use of our assets.

Importantly, our customers, the people who we are in business to serve continued to appreciate the job that we are doing for them. According to the Jacobson & Associates independent survey of our carving stainless and electrical steel customers for the initial quarter this year, AK Steel was ranked first in quality, first in on-time delivery, and first in overall satisfaction. And in addition to our top rankings in this world recognized broad customer survey, we received specific reorganization from an important customer during the first quarter. AP specialty metals presented AK Steel with its Superior Service award. We sincerely appreciate this tribute from our fine specialty steel customer. So, although performing well in the areas of productivity and quality two of our three fundamental operating measures.

The third and our most important fundamental focus area is safety. During the first quarter, we were honored for our 2007 safety performance. For the third consecutive year, our Ashland coke plant earned the Max Eward Safety Award for operating the safest coke plant in America. In fact our company's coke plants in Ashland and Middletown have now won this prestigious award intend of the past 11 years. Our Zanesville Works received two safety awards during the first quarter from the Ohio Bureau of Workers' Comp for its 2007 performance and one of these awards was for working 2.3 million hours without a single loss-time injury, that is truly what it’s all about.

Also during the first quarter of 2008, Ashland Works continued its great safety performance by setting new first quarter records of zero OSHA recordable injuries and zero first-aid cases. However, tragically during the first quarter one of our Coshocton Works employees suffered the first fatality in the history of our Coshocton plant. We express our deepest sympathy and our thoughts and prayers are with the family, friends, and the co-workers of our fallen employee. Both as a management team and a workforce we rededicate ourselves each and everyday to doing everything we can to make sure that our employees return home to their loved ones in the same condition in which they came to work.

So with our focus on the fundamentals of our business solidly intact, we forecast in 2008. Much of our [inaudible] program for this year has to do with creating even more value for our shareholders as we optimize our margins, reward our shareholders, and grow our profits, that's all part of our objective that execute as world-class managers. And we’re off to our best ever start. On the heels of our best first quarter in the company's history, we expect to follow that with our best ever second quarter. Our second quarter, as Al mentioned, will however be impacted by an 18-day planned blast furnace outage at the Middletown Works. This is about a week longer than our typical 10- to 12-day campaign for a blast furnace outage; in addition of performing normal gunite [ph] refractory work, we're also doing some work on the tap holes, which have not been repaired in a decade. At AK Steel, we take a proactive approach to maintenance. We prefer to maintain equipment before it breaks down. As a result, we plan for maintenance outage, outages in this case on a preventative basis, and we take them when it's necessary to do so regardless of market conditions.

I recently had the opportunity to visit with the leadership of the outage team at Middletown Works and I have to say that they are doing a great job for us. Notwithstanding the extensive nature of our blast furnace outage, which is well underway and expected to be successfully completed later this week, we anticipate shipping more not less steel in the second quarter compared to the first quarter. And when finished, this outage will put us in an excellent position to make steel well into the future at that facility, but we are required to take the associated costs of about $40 million as a current quarter charge.

Accordingly, if it were not for the roughly $25 per ton cost penalty associated with our second quarter maintenance outage, our 2Q operating profit per ton guidance would be $150 per ton instead of the $125 per ton. Incidentally, we have no other planned blast furnace outages in the year 2008. Suffice it to say that despite the unprecedented increase cost of steel-making inputs and the current economic doldrums in which the U.S. economy finds itself, we have continued to find ways not just to sustain our profitability but to excel.

I would take just a moment though to expand on the subject of raw materials, the prices of which have been rising to historic levels this year. Simply put the prices we pay for iron ore, scrap, and purchase slabs are at their highest levels in history period. And as the least integrated of the integrated steel producers, we are receiving a forefront result from these extraordinary cost increases. The world price of iron ore pellets for example increased by nearly 90% this year compared to 2007 and to a significant extend, our iron ore agreements are tied to the world price index.

The price of number one scrap bundles has climbed to more than $550 per ton. Once again, we are a buyer at this price so much we can locate the substitute a lower grade of scrap. Purchase slabs are in tight supply and currently selling for more than $800 a ton. Natural gas is selling for $10 to $11 per Mcf and most of our coding materials remain at very, very high levels historically speaking. So I think you are getting the picture. These are extraordinarily costly times for us and our selling prices must reflect this.

Because of the need to recover the unprecedented increases in the cost for steel making inputs and in response to continued strong demand and limited supply for carbon steel products, AK Steel has announced a series of carbon steel spot market price increases. Since the beginning of 2008, we have announced total of seven carbon steel spot market price increases for a combined total of more than $400 per ton.

We realized the small portion of this increase in the first quarter and we expect to realize substantially more of it in the second quarter. However to the extent that a large percentage of our spot market business had already been sold before several of the more recent price increase announcements that we've made, it's fair to say that the forward trajectory of our pricing is even higher from here. Obviously what happens with future pricing will depend in part on the value of the dollar, the forward cost curve for steel making inputs and a host of other factors, not the least of which is demand. That said, at this point what we see in terms of forward pricing is very encouraging. While automotive and appliance markets are quite weak, we are seeing strong demand from carbon products, before carbon products from sectors, including energy, commercial construction, large equipment manufacturers and OEMs that are experiencing high levels of export activity.

Like it's also worth noting that Metal Service Center inventories are at their lowest levels since November of 1997 and inventory levels are down by nearly 20% from the year-ago March levels. The tight supply situation is expected to continue for the foreseeable future due to limited domestic supply and limited steel import availability.

We are also experiencing robust worldwide demand for electrical steel products. We are capitalizing on export opportunities what makes good business sense to do so. The global outlook for electrical steel remains very positive, especially for our high-end electrical steel products. And in light of the demand strength of this particular product line, we have already begun contract negotiations for 2009 business.

In the area of commodity stainless steel, our first quarter shipment activity indicates to us that the bulk of the service center de-stocking program is behind us. The fundamentals appear to be improving and we are encouraged that customers seem to be returning to their normal buying patterns. We continue to do what we can to position AK Steel for future success. We are reinvesting heavily in the business to reduce our cost and improve our self-sufficiency. For example, construction of our number five electric arc furnace and ladle [inaudible] of Butler Works is underway and slightly ahead of schedule.

Upon completion in the follow 2009, this new EAF will provide us with a 40% increase in melting capacity at our Butler Works, lower our production cost, and it has the potential to essentially take our company out of the market for purchased carbon slabs. We have also begun to address our other long-term raw material requirements. In the first quarter, our Board authorized an agreement with SunCoke to build, own, and operate a new heat-recovery coke battery adjacent to our Middletown Works. We continue to work through some permitting and other contingencies, but upon completion this new state-of-the-art coke battery will produce about 550,000 tons of coke annually and 50 megawatts of electricity exclusively for the use of AK Steel.

This will allow us to be self-efficient in terms of our company-wide coke requirements and it will further reduce our cost. In addition it enables us to do so in both an environmentally-friendly and energy-efficient manner. As well as investing for cost reduction and improved self efficiency, we are also investing for future growth. We are in the midst of our fourth electric steel expansion phase at Butler and Zanesville to meet the growing global demand for high quality, high value-added electrical steels.

And I hope as you listen to all this, you get the sense that AK Steel is a company on the move, with the crowd-pass [ph] and a very promising future we are forging ahead.

Before closing, I want to take just a moment to publicly thank an individual and a friend who played a key role on our company's recovery and resurgence, and that is Tom McKenna. At end of March, Tom retired as our Vice President of Labor Relations. Thanks to Tom's leadership and the support of a number of others, both inside and outside of the company. We obtained state-of-the-art labor deals with each of our unions and that has had and going forward, it will continue to have a hugely positive impact on improving our overall competitive position.

Our innovative labor agreements that we negotiated over the past several years serve as the new standard in terms of flexibility and cost reduction in the steel business. Unlike our integrated competitors, we have long-term competitive labor agreements in place at each of our steel locations. And we are positioned to deliver steel on an uninterrupted basis to our customers throughout 2008. That is worth noting that the only labor agreement in our company that's up for negotiation this year is that our Ashland Works coke plant. That deal with the United Steelworkers covers about 240 individuals and it expires on October 31st.

Speaking of people make no mistake, our greatest asset at AK Steel is our people. We have an exceptional group of employees that continue to do more with less, that is produce more and better steel products with fewer people faster and safer than ever before. With approximately 30% fewer employees than we had just five years ago, we are now shipping greater than 50% more steel per employee, and that ladies and gentlemen, is what it takes to compete and to win in today's globally competitive steel business. We have a great group of employees that make keep proving that quarter-after-quarter, year-after-year in that regard the second quarter and the year 2008 should be no exception.

As I said earlier, we expect the second quarter to be an even better quarter than our record setting first quarter. Higher shipments and selling prices, coupled with improved cost performance on those items within our control should more than offset higher input cost and the costs associated with our planned maintenance work. As a matter of fact, our second quarter has the potential to be our best ever of any quarterly performance and that is in the history of our company, frankly I would be disappointed if it wasn't.

Before taking your questions, let me say that 2008 is the year that we intend to forge ahead at AK Steel. 2008 has the potential to be great and it will be if we execute, as we know we are capable, and I fully expect that we will do just that. Thanks again for joining us today. Now we'd be happy to field 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 Aldo Mazzaferro of Goldman Sachs.

Aldo Mazzaferro - Goldman Sachs

Well hi, good morning, Al and Jim.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Hi, Aldo. Good morning, Aldo.

Aldo Mazzaferro - Goldman Sachs

On the input costs, you mentioned $70 of ton would be the sequential increase quarter-to-quarter. I am wondering, could you break this down a little bit on what the various inputs would be of that and whether those fully accrue for what you expect for the year? Do you expect more to come third quarter or so?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Let me take a shot at it, Aldo. Obviously it’s a big deal for us as it is for everybody. We would ballpark our 2008 raw material and energy cost increase to be about a $1 billion. And I would add that that's on top of the roughly $2 billion and steel-making input costs that we've endured for the period 2003 through 2007. The biggest hitters are things that are obvious iron ore pellets, carbon scraps, in our case, chrome, some steel additives and really natural gas. All of those things are moving to higher levels in most cases to record setting levels. And again, hopefully we've seen the branch of that, but I think the second half is likely to be at more the same with respect to those high costs.

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

We would only point out although that as you know that we've been impacted by close to $2 billion of input cost increases since 2003, and during that period of time our operating cost has grown by $1 billion. So we've been able to sustain those investors through high independence [ph].

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

And one last point, Aldo, I would made with respect to the overall raw materials category, most of the slabs that we need to buy this year, we've purchased thankfully, we will not be a heavy buyers in the slab market in the second half of the year, and we continue to do everything we can as I mentioned in my prepared remarks to do two things, improve our self-sufficiency and reduce our costs. We're well underway with that when you talk about the future slab making with the Number 5 EAF and also in terms of coke self-sufficiency with the Senco project. So we're continuing to look at this area and it's a very important strategic focus for us.

Aldo Mazzaferro - Goldman Sachs

Great. And if I just quickly, does that include your coal expectations like, one of you if you could just update us on how you stand in terms of purchase coal for the coke advent?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

The numbers that we gave do comprehend what we are seeing in coal again like all of our other steel making inputs, our cost for coal this year will be higher. We buy about 2 to 2.2 million tons a year of met coke, we have got long-term agreements in place that do contain certain cost escalators which we’ve factored in to our guidance here and those deals are in place through 2009. Clearly, the world price for coking coal is sky rocketed recently due to a number of reasons and it's fair to say that we've not yet sold before run-off of that or will we this year nor next.

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

Do you mention met coke, you really meant met coal, I'm sorry.

Aldo Mazzaferro - Goldman Sachs

Right. I got that. Okay, thanks very much. I'll get back in queue.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Okay, thank you.

Operator

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

Brett Levy - Jefferies & Company

Hi, gentlemen, excellent quarter. And just wanted to tick in, you guys have talked about having contract volume down below 60%. It’s strange as you know when we talked to some of the automotive guys, they are not guiding to contract cost being up nearly as high as maybe some of the profitability numbers would suggest. What percentage automotive does it look like you guys are going to be at 2008 and where you are kind of... for the quarter, where you see that going and just talk a little bit about the escalators you've got in place for your contract business?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Well, first let me just say that for the past several years, our company, Brett, has been taking a portfolio management approach to our sales we chose to rebalance and diversify our portfolio to maximize margin opportunities. And in the process of that, we moved away from what had been about 75% or so contract business down to, I think, I guided in the first quarter, Al, our year-end conference call about 55%.

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

Right?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

And as the auto companies have endured the American Axle strike and cut back on production, obviously we've been able to take some of those tons into the spot market. So we were less than the 55% and I suspect that we were to venture, I guess, for second quarter mix of contract, the spot it might be 50-50 and that's a place that right now given the current market environment, we are very, very comfortable with and we'll see things or how things go going forward. I just want to say this about the auto companies, obviously our view has been continues to be that we need to make things in America and for strong economy, we need a strong manufacturing base and we need to make cars and appliances, we need steel to support that. We are in it, as they are. We are going to do everything we can to help them out, but obviously this is a challenging time. Really the toughest environment to date have been for a decade and we're going to work with them, but we're also advantaging ourselves, given some of the other dynamics of the end marketplace right now.

Brett Levy - Jefferies & Company

And just to follow-up. What escalators have you guys basically negotiated, a fixed price, a fixed price with scrap surcharges, talk a little bit about the dynamic that you have with the 50% of the business that you have in the contract market?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Most but not all of our contract sales agreements, we have a variable pricing mechanism that takes into account, again most but not all of the costs of steel-making inputs. For example, things like scrap and gas and zinc. Unfortunately it doesn't comprehend iron ore at this point. And in the spot market, we are obviously issuing price increases to comprehend the recent activities there. I would just say that upon the expiration of the various agreements, which in our case occur throughout the year, we will be truing up pricing to comprehend both cost and the current market situation. And the other point that I would make is that I think that it is fair to say that fixed-price agreements will soon be a thing of the past. Steel companies have really had allowed you one-sided business model and where we accepted all of the risk on commodity inputs, including iron ore and that simply will not work going forward.

Brett Levy - Jefferies & Company

All right. And then it looks like you guys are doing a lot to take care of some of the raw material cost. At this point, given a free cash flow positive you guys seem to be… any expansion plans on the horizon in terms of total output?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Well, we continue to make more of our own and continue to ship more as you've heard. We try not to stencil in limitations in terms of our thinking in that regard. If you're talking about acquisitions, we look at everything, haven't found anything just yet that really fits adding value for our shareholders and that really… that's the only thing that we are interested in at those deals that might make sense for AK Steel shareholders. And we continue to look to capitalize on those profitable market niches that we have both within the states and around the world. So I would just say stay tuned.

Operator

Our next question comes from Bob Richard of Longbow Research.

Unidentified Analyst

Hi, this is Luke Fulton [ph] for Bob. Thanks for taking our call this morning.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

No problem, Luke.

Unidentified Analyst

Within your guidance for 2Q, I'm curious what you're assuming for stainless steel volumes and pricing there?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Stainless steel volumes and pricing should not be dramatically different from where they've been. As I've mentioned in my prepared remarks, we're beginning to see a bit of a recovery with respect to the stainless market. Demand has improved somewhat, I think as some of the analyst committees noted the fundamentals are better but maybe not great. End user demand has improved. Certainly the imports have moderated, given the weak dollar. The MSCI inventories in the case of commodities, stainless are at low-levels historically speaking following the de-stocking process for 2007. For us, stainless also comprehends auto chrome business and that's largely going to depend on what happens in the automotive sector. And we certainly hope that towards the end of the quarter, things start to turn up there. But with respect to some of the specialty stainless business and the electrical steel business again those remain very robust for us, and we hope to continue to push more tons out the door.

Unidentified Analyst

And thanks for the detail there. And also with regarding your iron ore purchases, could you quantify how much of that's going to be based on formula pricing versus how much will fluctuate at the [inaudible] price?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

We have got four different deals, they are all just a little bit different, in other words, we don't buy from any one individual provider. We have got two deals with Canadian producers, one here in the States and one with a Brazilian producer, each is a little bit different, I guess you can say in some respect they are all formulae. But as I indicated in my prepared comments, they are largely tied to the world price and the best guidance we can give you is that in AK Steel's case, we are going to see iron ore pellet prices up about 90% year-over-year. And I would just put one asterisk on that Luke and that is this that we have not received sort of formal, final, and official notification. That's all based on the announcements that were made, I guess back in March with respect to the deals that have been cut in Europe.

Operator

Our next question comes from Charles Bradford of Bradford Research.

Charles Bradford - Bradford Research

Hi, good morning.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Good morning, Chuck.

Charles Bradford - Bradford Research

Could you talk a bit about the slabs you did buy, how many did you use in the quarter? What do you expect to do in the second quarter? And what are you seeing in regard to pricing. I know you said you wouldn't be buying much in the second quarter, but $700 kind of prices that I've been hearing, I can understand that pretty readily?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

It's not a particularly attractive price, Chuck. And only that makes us feel all the smarter with respect to our decision to increase capacity above the worse and make more of our own. In fact, we have even made some slabs at Mansfield lately, carbon slabs to their office out there. We bought a little bit more than a couple of 100,000 tons. In the first quarter, we will buy about 250,000, in the second quarter and maybe for the year we will approach 0.5 million. If we can make more, we will even avoid that remaining purchase. As far as prices go again, we are several hundred dollars below the current level, could be $300 to $400 below that in terms of what we bought.

Charles Bradford - Bradford Research

Okay. On the iron ore side, I know your contracts tend to be retroactive to the beginning of the year, have you taken into account the full 90% for the first quarter?

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

Chuck, the iron ore affects us really in two ways. In that first of all, first through cost of goods sold, due to the time that the ore is delivered. We really are not going to see much of that, so the newly priced ore in the first quarter. In fact we did not see very much of it in the first quarter. But it will affect us from a LIFO perspective. In other words, what we expect the price to be at the end of the year. So as a result we did have an impact to us LIFO wise in the first quarter, not as much from a cost-of-goods sold perspective. We would see the cost-of-goods sold impact to be greater in the second, third and fourth quarter going forward.

Charles Bradford - Bradford Research

I'm sure you are well aware of the ArcelorMittal announcement of the $250 surcharge. And I saw you had someone from your shops commenting about the situation. Do you think they are going to be successful at all, and why not go along with what they are doing, since your automobile customers in the past haven't been terribly good to you all when they were doing well and you weren't?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

But we certainly remember Senor Lopez and other situations, but we have moved on from a lot of the old days, Chuck. I think we've spent an awful lot of our last several years rebuilding and initiating new relationships and I guess that's really what it comes down to. We're certainly not shy about raising prices, having been a participant or having led seven stock market price increases up to now, And as I mentioned we've got other deals that come up throughout the year and some of those negotiations are underway. But I’d just offer the following that notwithstanding the fact that our costs are up $1 billion for 2008, we honor our sales agreements with customers, we value our customer relationships for the long run, and frankly we value those relationships too much to arbitrarily impose a raw material surcharge upon them without their consent. What goes around tends to come around, and I think that we will be well served and they will be well served by working through these things together. We've got to continue to improve on the variable pricing mechanism, we have got to introduce iron ore, we've got to away from the fixed-price contracts that we’ve talked about before. And I can assure you for AK Steel shareholders we won't leave a single dollar on the table, but we’ll go about it in their own way.

Operator

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

Michelle Applebaum - Michelle Applebaum Research

Hey, Jim, make a note of the day because I just want to say I agree with Chuck about these fixed-price contracts that were fixed-price ceilings for a long time. You are saying that you are not going to follow the surcharge because of your relationships?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

We're getting every dollar we can of our pricing power and we have our own discussions. We have not issued a press release and don't really have any further comment today than what I’ve just made.

Michelle Applebaum - Michelle Applebaum Research

Okay. So you're not saying that you are not going to, you are just saying you haven't yet?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

I don't know that I can be any more clear. We will continue to seek every dollar revenue for AK Steel shareholders.

Michelle Applebaum - Michelle Applebaum Research

A question on fabs.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Yes.

Michelle Applebaum - Michelle Applebaum Research

You're not going to be buying fabs in the second half of the year you're saying.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

We hope to buy very few, it’s conceivable if we need them to meet customer orders so we can do so profitably that we might buy both, both typically is 40,000 tons, 45,000 tons delivered and we've yet to make that decision, but at $800 a ton we were trying to make more on our own.

Michelle Applebaum - Michelle Applebaum Research

If you eliminate the fab tons in second quarter, how will that impact your volume in the third?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

We are well positioned really for the year at this point. We are not providing third quarter guidance today nor fourth quarter guidance for that matter and we'll tend to play it one quarter at a time. But it shouldn't have a huge impact with respect to our third quarter activities.

Michelle Applebaum - Michelle Applebaum Research

So I might infer that you already have the fabs that you need for third and fourth quarter for you are just not going to be using them?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

We're going to be making more as we come out of the Middletown outage. We obviously took our outage at Ashland last fall and that's running... that facility is running very, very well. We are making more at Butler and we are making some material out of Mansfield as I mentioned. And we will evaluate opportunities in the marketplace to supplement our own needs.

Michelle Applebaum - Michelle Applebaum Research

Okay. One more, for… I've noticed Harbinger has bought a bunch of shares recently. Can you just give me an update on how many shares they own and whether or not they've talked to you about what their intent is?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

We have good relationship with Harbinger as we do with all our shareholders. I think our shareholders are frankly quite happy with the progress of the company and how they've been rewarded. We are encouraged as they’ve bought, at recent levels I think they are 15%, 16% ownership.

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

16,100,000 million is the most recent public filing we've seen.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

But all we know is what we read in their filings and we have regular dialog and Al

and his staff have regular dialog with them and we believe their aim is to be friendly.

Operator

Our next question comes from Sal Tharani of Goldman Sachs.

Sal Tharani - Goldman Sachs

Hi, guys how are you?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Good morning, Sal.

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

Good morning, Sal.

Sal Tharani - Goldman Sachs

Al, can you… just as a couple of housekeeping questions, can you breakdown the pension and OPEB liabilities you have lumped up in your balance sheet?

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

The pension and OPEB is… right now it's about 16 million…. in total it, Sal, was 16 million [ph]. That's broken down about 800 million in pension and around 800 million on the OPEB side.

Sal Tharani - Goldman Sachs

Okay. And can you tell us about what was your expense of pension OPEB, which went to P&L this time?

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

Right, the pension and OPEB expense, let me break that down. It's going to be substantially down in 2008 versus 2007 for a couple of reasons. First on the pension side, we expect our pension expense for the year to be down to about $1 million, down from about $13 million last year and that's due to our aggressive funding as well as the full impact of our locking and freezing of our represented employees. That expense reduction will be down ratably during the year and you will probably see in the first quarter our pension expense, Sal, will be around $200,000 versus $5 million if you eliminate the curtailment charge year-to-year.

On the OPEB side, you sort of have to talk about the liability first in that our liability will be reduced by about $1 billion versus what it was on the balance sheet, and that's broken down in two components, really the $468 million that we paid, if you will, as the settlement as well as the $339 million that is the… essentially the plan amendment, which comes with determination of the plan. And the reason those numbers are relevant, Sal, is that the $339 million will be amortized over the next 11 years, essentially $30 million a year as a reduction in expense. And then since our liability has dropped by about $800 million, you will see that we will be down to… the amount of interest on that 6% of the 800 million, will give you about $48 million of reduction. So those two will reduce your OPEB expense by about $78 million year-to-year on an… on a complete 12-month basis. Offsetting that somewhat is the interest income that we are giving out on the $468 million, which amounts to about $18 million. So your net benefit is about $60 million, but the numbers you will see on your OPEB is about $78 million reduction, coupled with the $12 million reduction. So you're going to see about $90 million reduction year-to-year on your pension and OPEB expense year-to-year, but the net benefit will be about $5 million a month when you factor in the interest income. Is that clear?

Sal Tharani - Goldman Sachs

That's clear. Thank you very much, very clear. And lastly, on LIFO assumption for 2Q, is it same as 1Q right now?

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

Right now, it is. Let me just make sure that if I said 1.6, what I meant was 1.6 billion rather than 16 million. I was giving that clarity, hope you’ve got that, but our overall pension and OPEB obligations are 1.6 billion.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

And on the LIFO question, the best guidance we’d have at this point is really to annualize that LIFO review.

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

Right. Our 59, call it, $60 million, if you annualize that, that would give a LIFO expense for the full year of $240 million and that's what we’re comfortable with right now.

Operator

And final question comes from Mark Parr of KeyBanc Capital Market.

Mark Parr - KeyBanc Capital Markets/McDonald Investments

Hey, good afternoon, or I guess it's still morning.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Still morning, Mark.

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

God morning, Mark.

Mark Parr - KeyBanc Capital Markets/McDonald Investments

Yes, I had… there has been a lot of really good commentary and congratulations on the great number.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Thank you, sir.

Mark Parr - KeyBanc Capital Markets/McDonald Investments

I had one question though about the expansion you're doing at Butler. Do you have any plans to vertically integrate that from a raw material input perspective or could you talk a little about your raw material strategy for the expansion of Butler?

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Well obviously, given that it is an electric arc furnace that we are feeding it with scrap, we're continuing to be mindful of what's going on in the scrap market. Obviously, it hit new highs as well. It's coming under new ownership. Don't know that we've seen a big change just yet, but we are sensitive to that. We are sensitive to the fact that whether you're talking about slabs or scrap or iron ore, the world is becoming a smaller place and we'll continue to look for opportunities to build relationships, perhaps do joint ventures or other things that might move us on the path of vertical integration. In some cases, it takes money to do that, it takes relationships to do that. And I would say that we're in a much better position today than we were a few years ago to pursue those kinds of things. It's something that we as a senior management team and the Board talk about frequently, but really don't have any insights to share with you today, Mark, other than we're considering a lot of alternatives.

Mark Parr - KeyBanc Capital Markets/McDonald Investments

Okay. I won't try to expand the conversation, and just congratulations on the great progress.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

Well, thanks very much.

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

Thank you, Mark.

James L. Wainscott - Chairman of the Board, President, Chief Executive Officer

And let me just say that in signing off, I'd like to thank all of you for being a part of today's call and for your continuing interest in AK Steel. We're off to an excellent start in 2008 and our outlook is improving. But also I want to say that you should rest assured that we take nothing for granted at this company. Our team remains hungry. We are focused as we look to create even more value for AK Steel's shareholders. We have made enormous progress, and we are proud to say that AK Steel is once again one of the premier steel makers in America, but I firmly believe that our best days are yet to come. Have a great day and a better tomorrow.

Operator

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

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Source: AK Steel Holding Corp. Q1 2008 Earnings Call Transcript
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