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United States Steel Corporation (NYSE:X)

Q2 FY08 Earnings Call

July 29, 2008, 2:00 PM ET

Executives

W. Nick Harper - Manager of IR

John P. Surma - Chairman and CEO

Gretchen R. Haggerty - EVP and CFO

Analysts

Aldo Mazzaferro - Goldman Sachs

John Hill - Citigroup

David Lipschitz - Merrill Lynch

Timna Tanners - UBS

Michael Gambardella - J.P. Morgan

John Tumazos - Very Independent Research, LLC

Mark Parr - KeyBanc Capital Market

Michael Willemse - CIBC World Markets

Bob Richard - Longbow Research

David Martin - Deutsche Bank

Operator

Ladies and gentlemen, thank you very much for standing by and welcome to the United States Steel Corporation Second Quarter 2008 Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Instructions will be given to you at that time [Operator Instructions]. And also as a reminder, today's call is being recorded.

I would now like to turn the conference over to your first speaker, Mr. Nick Harper. Please go ahead.

W. Nick Harper - Manager of Investor Relations

Thank you, Perky. Good afternoon and thank you for participating in United States Steel Corporation's second quarter 2008 earnings conference call and webcast. We will start the call with some brief introductory remarks from U.S. Steel Chairman and CEO, John Surma. Next, I will provide some additional details for the second quarter and then Gretchen Haggerty, U.S. Steel Executive Vice President and CFO will comment on the outlook for the third quarter. Following our prepared remarks, we'll be happy to take any questions.

Before we begin, however, I must caution you that today's conference call contains forward-looking statements and that future results may differ materially from statements or projections made on today's call. For your convenience, the forward-looking statements and risk factors that could affect those statements are referenced at the end of our release and are included in our most recent annual report on Form 10-K and updated in our quarterly reports on Form 10-Q in accordance with the Safe Harbor provisions.

Now to begin the call, here is U.S. Steel Chairman and CEO, John Surma.

John P. Surma - Chairman and Chief Executive Officer

Thank you, Nick. Good afternoon everyone and thanks for joining us. Earlier today, we reported record second quarter earnings of $5.65 per share excluding the $0.03 per share effect of one item not allocated to our segment results. Our earnings were $5.68 per share, which exceeded the $5 per share high end of analysts' expectations. I understand the consensus was $3.91 per share.

Turning to our segment results, second quarter operating income of $954 million more than tripled our first quarter results as our operating group did an outstanding job running our facility this quarter. We operated in almost 93% of capability in North America and at a record 104% in Europe.

In addition, we operated at 101% of capability in Canada and achieved the highest ever quarterly production for our two Canadian plants in only our second full quarter of ownership.

Just as important as our strong operating performance, our safety performance continued to improve during the quarter. This confirms our strong belief in the alignment of world class safety performance with strong operating and financial results.

Our North American Flat-rolled segment earned record operating income of $478 million, nearly quadruple our first quarter results. Compared to the first quarter, second quarter average flat-rolled pricing increased by $131 per ton to $777 per ton, which reflected the series of spot price increases implemented during the first half of the year. The commercial improvement more than offset higher costs for raw materials, particularly purchased coke, scrap and energy, resulting in expanded margins. Overall, the North American flat-rolled end markets were largely unchanged compared to the last several quarters.

We continue to benefit from strong global steel demand and the relatively weak U.S. dollar. In addition, continued low imports and moderate inventory levels and high ocean freight rates are contributing to a balanced North American steel market. We are taking care to supply our customers' needs and supplementing our flat-rolled book with exports and slab sales to sustain a high level of operations.

In addition, our North American integrated raw material position helped insulate us from a portion of the raw material cost increases, particularly iron ore, coke and sea-borne coking coal that impact many of our global competitors.

We are dealing with cost pressures, particularly purchased coke. Currently, we are short about 2 million tons of coke in North America on an annual basis and we buy about 1.8 million tons of that from global suppliers. Sea-borne coke from China has increased from $200 per metric ton a few years ago to in excess of $700 per ton today while our average purchased coke costs are a bit more competitive than that and we have diversified our supply base. The high cost of purchased coke has made an assured cost effective supply of coke one of our top priorities.

In that regard, we are working on several major coke-related projects. Work is underway with SunCoke to construct a non-recovery coke battery and cogeneration facility at our Granite City Works and we are in the permitting process for the first of two recovery batteries at our Clairton Works and a carbon alloy process facility near our Fairfield Works in Alabama.

Once these projects are completed in the next several years, we should be in a much improved supply position for our North American coke requirements, resulting in a more favorable cost position for the long term.

Flat-rolled averaged realized prices tracked the sharp increase in spot market prices for hot-rolled coil, which, according to CRU, have increased from about $555 per ton in December of last year to over $1000 per ton today. The impact from the first half spot market increases was partially reflected in average second quarter prices and should be more fully reflected in our third quarter results.

In addition, second half contract prices will be positively affected by the realization of a full quarter of the competitive market adjustments that began in April and the renewal of several contracts at higher market-related prices. We have had success implementing contract price adjustments with a number of customers and discussions with other customers continue.

Our second quarter European segment operating income was $298 million, an 85% increase compared to the first quarter. Second quarter European average realized prices increased by nearly $200 per ton including currency effects. Cost efficiencies from record production at 104% of capability helped offset a portion of the rapid rise in raw materials costs, particularly for scrap, iron units and purchased coke.

European end markets remained stable as modern imports and good demand coupled with the surge in global raw materials costs helped drive spot steel prices to record levels.

We continue to monitor the commercial environment to ensure that our pricing reflects European market conditions. In Europe, we're more heavily reliance on purchased raw materials and our commercial mix is more geared to the spot market, which should allow us to recover higher raw materials costs sooner.

Turning to our Tubular segment. During the second quarter, we earned $177 million, more than triple our first quarter results, or $354 per ton on shipments of 500,000 tons. Our improved second quarter results were driven by the strong tubular market environment and an increase of nearly $400 per ton in our average realized prices. The benefits from higher prices and shipments were partially offset by higher cost for semi finished steel, driven mainly by higher spot prices for hot-rolled vents.

We recently announced an $800 per ton price increase for all tubular products effective with shipments beginning July 1st, which includes the $250 per ton surcharge that was announced previously. This increase reflects the strong demand caused by higher crude oil and natural gas prices. In addition, this increase will allow us to recover the much higher operating costs we experienced since the beginning of the year, especially for the high alloy content of our product mix and the hot bands used for our welded products.

The 2008 drilling programs remain strong and in fact the rig count recently reached a 20 year high. Activity in the energy markets should continue to support good demand for our tubular products.

We are currently negotiating with the United Steelworkers for a replacement of the agreement covering most of our domestic operations. We expect to have the new agreement in place before the September 1st expiration of the current agreement.

And as you might have seen, earlier today, we announced a $0.05 or 20% increase in our quarterly common stock dividend from $0.25 to $0.30 per share. Combined with our January increase, we have increased our dividend rate 50% this year. This increase reflects our confidence in the long-term financial prospects of our company and underscores our commitment to enhancing shareholder value.

Now before I hand it off to Nick, let me take a moment to acknowledge and thank our colleague, Nick Harper, our Manager of Investor Relations for the last four years. As some of you may know, he was recently promoted to a position in our accounting organization. Nick is being succeeded by our colleague, Dan Leznak [ph], who comes from our strategic planning and business development group and is very experienced in steel investor activities. I believe that many of you have spoken with Dan already. This call represents the conclusion of Nick's outstanding tenure in this role. And Nick and Dan will work closely to ensure a smooth transaction.

Now I will turn the call over to Nick for some additional information about the quarter's results. Nick?

W. Nick Harper - Manager of Investor Relations

Thank you, John. Capital spending, which is detailed by segment in the earnings release, totaled $213 million in the second quarter. Our current plan for 2008 has total capital spending at approximately $914 million with $705 million for North American operations and $235 million for European operations.

Depreciation, depletion and amortization costs totaled $159 million in the second quarter and are expected to be about $640 million for the year. Defined benefit and multi-employer pension and OPEB costs for the quarter totaled $49 million. We made cash payments of $92 million for benefits during the second quarter, $33 million in required pension contributions and $59 million for retiring insurance plans.

Also during the second quarter, we made a $35 million voluntary contribution to our main defined benefit pension plan and a $23 million contribution to the VEBA [Voluntary Employee Benefit Association] Trust covering steelworker retiree insurance benefits. Additional details are included in our 10-Q which was filed earlier today.

Second quarter net interest and other financial expense totaled $25 million including $17 million of favorable foreign currency effects. Excluding the foreign currency effects, we expect third quarter net interest expense to be about $44 million. Our annual effective tax rate for the balance of 2008 is projected to be approximately 27%. This is a 2% increase from our prior guidance due to the increase in our North American earnings which are subject to higher tax rates than our European earnings. The catch up charge for this tax rate change applied to the first quarter income was about $6 million. Lastly, for the quarter, we averaged 118.2 million fully diluted outstanding shares.

Now Gretchen will review some additional information and the outlook for the third quarter. Gretchen?

Gretchen R. Haggerty - Executive Vice President and Chief Financial Officer

Thank you, Nick. Through the second quarter, our cash flow provided by operating activities was $463 million. Our free cash flow after capital spending and after dividend, but before external financing was $54 million.

I would like to point out that our accounts receivable has increased nearly $800 million since the end of the first quarter, reflecting the significant increase in steel prices during the same period. We anticipate the benefit of collecting these receivables will start to be reflected in our cash flow from operations in the third quarter.

We ended the second quarter with $391 million in cash and total liquidity of nearly 1.6 billion.

As noted in the earnings release, we repurchased 320,000 shares of common stock in the second quarter for a total cost of $52 million. This brings our total repurchases to 14.9 million shares, or approximately $900 million and represents more than 11% of the balance of fully diluted shares outstanding when we authorized the original repurchase program in July of 2005. As of June 30th, 5.8 million shares remain available for repurchase under the current authorization.

Turning to our outlook, we expect another excellent quarter with continued earnings improvement as price increases implemented during the second quarter and in the third quarter are expected to improve average realized prices for each of our reportable segments. For Flat-rolled, third quarter results are expected to improve substantially from the second quarter, reflecting continued realization of price increases. Raw steel capability utilization and shipments are expected to remain near the second quarter level and raw material costs are expected to increase.

Third quarter results are expected to decrease for U.S. Steel Europe. While average realized prices should be higher, raw material costs are also expected to increase and shipments and operating costs will be negatively affected by a planned blast furnace reline at U.S. Kosice that is scheduled to begin shortly and continue into the fourth quarter.

Third quarter results for Tubular are expected to increase significantly as price increases continue to be realized. Semi finished steel costs were increased and shipments are expected to be at about the second quarter level.

We are optimistic about our prospects over the longer term as our company is well positioned from an operating and commercial standpoint. Of course, the continued health of global steel markets is dependent on larger economic trends and conditions.

That concludes our comments, Nick.

W. Nick Harper - Manager of Investor Relations

Perky, could you please queue the line for questions? Perky?

Question And Answer

Operator

[Operator Instructions]. And our first question comes from Aldo Mazzaferro with Goldman Sachs. Please go ahead.

Aldo Mazzaferro - Goldman Sachs

Hi John, how are you?

John P. Surma - Chairman and Chief Executive Officer

Hey Aldo, we are doing great. Thank you.

Aldo Mazzaferro - Goldman Sachs

Good. I wonder if you could talk about the effect of the global markets a little bit. I can see how automotive production here is down a lot and I know you sell some to automotive. What's the effect on your business when, say, General Motors cancels a contract and you get a chance to send it to another market? What kind of impact would that have on margins?

John P. Surma - Chairman and Chief Executive Officer

Well, we have been experiencing some of that during the year, Aldo, as you can appreciate just looking at the automotive build schedule. There is not so much cancellation of the contract, but there are lesser volumes taken on certain products than there might have been in our original plans. And so far, we've been able to... and not just in automotive, but in some other markets as well... we have been able to move that product from those contract-oriented markets which include prices that date from last year into more spot markets, in some cases, exports markets. And those are at price levels that would be representative of what you see in the various indices. So that has been a net positive for our average realized prices for the year and certainly was in the second quarter as well.

Aldo Mazzaferro - Goldman Sachs

And John, speaking about contract pricing, your average selling price is still below the Harborough [ph] coke price. Can you mention more or less what impact the rollover of some of those surcharges? How much of your contract business does that affect, the surcharge rollover and what... and you mentioned you had some renewals of contracts that happened in mid year?

John P. Surma - Chairman and Chief Executive Officer

We did. We... there are sort of several different pieces there, Aldo. I guess we'll take them one by one.

Aldo Mazzaferro - Goldman Sachs

Okay.

John P. Surma - Chairman and Chief Executive Officer

As I mentioned, we have implemented some price increases on existing contracts, and some of that was in the second quarter, but more will be in the third and fourth quarters. There are other contracts that are index-related and those have been affected by the indexes as time has gone on. But there is a good bit of our contract business that has not been affected, and that's sort of an 8 million tons per year contract on our normal 50:50 blend, maybe a little bit less this year because of the lower volumes on certain customer groups. But the majority of that will be subject to renegotiation by the end of this year, so 5 to 6 million tons, I would guess, somewhere in that range.

And then the remainder probably will be subject to renegotiation in the earlier part of next year. So by mid next year, virtually all that would have had a chance to be addressed again, and we'll go through that process. I don't want to do it in this forum, but you can judge where the price indices were when those contracts were arrived at last year. And you can judge where they are today and get some appreciation for what the opportunity there might be. And on the I guess the last piece I missed was the... there are some contracts that by their terms were up for renewal during this period and those were reestablished at prices that are more representative of what was in the market at the time.

Aldo Mazzaferro - Goldman Sachs

That's great. John, just finally, the truest test of Nick's performance as an IR guy is the performance of the stock.

John P. Surma - Chairman and Chief Executive Officer

It's been okay during his tenure. Thanks Aldo.

Aldo Mazzaferro - Goldman Sachs

Thank you.

Operator

Thank you. And our next question comes from John Hill with Citigroup.

John Hill - Citigroup

Yes, good afternoon and congratulations on a great result.

John P. Surma - Chairman and Chief Executive Officer

Thank you, John.

John Hill - Citigroup

Just again, looking at the North American flat-rolled margin EBIT per ton, $99, those appear to be up strongly from the second half of '07, but those numbers themselves were depressed by Stelco. So one could argue that kind of a normalized basis were only up 40 to $50. I mean order to magnitude, do you think we can tack on another $100 or more in terms of EBIT per ton in the U.S. flat-rolled system over time?

John P. Surma - Chairman and Chief Executive Officer

I haven't done the calculation you just did there. I think in the last year comparative numbers, Stelco wasn't in until the latter part of the year. And we just had the one... really just the two months effect there and they weren't the best two months. So I think what we are seeing is margin expansion as we continue to move more and more bulk volume to the current price levels. While costs are increasing, they are increasing at lower levels and there is continued margin expansion yet to come as we see continued price improvement through both the continued utilization of spot price increases that were implemented throughout the first half of the year, including a bigger one during the second quarter. Then we had a spot price increase in July, another one in September. So we will begin to see the realization of all those as well as some of the contract adjustments. And so I am not sure I am going to give you a crisp answer except to say that we see continued improvement in profitability in our North American Flat-rolled segment.

John Hill - Citigroup

Great color. And on the subject of Stelco, obviously, some very strong production numbers coming out of there. And you talked a bit before about the slab caster and such. But what have been the source of the pleasant surprises at Stelco and what have you learned through that process?

John P. Surma - Chairman and Chief Executive Officer

I think it's been the fact that the equipment and facilities are as good as we thought they were. The employees at all levels are good as we thought they were. And with some leadership and management and taking away some of the barriers, we were able to run the facilities at much high levels and more consistently than they have ever run before. And I just think it's a great performance by every one at every level in the company in Canada and also with a lot of support from our headquarters groups at every level, at the furnaces, at the coke plants, at the steel shops and at the hot strip mill.

All the facilities are funning extremely well.

And of course the market has been pretty positive for us right now too. The fact that we have a long slab position and those direction slabs in a good place, which we are getting great results from. And the strip mill at Lake Erie is running extremely well and it's an excellent product and we wish we could have made more. So it's just been a good result. It's... the facilities are doing what we thought they could do and the people have responded extremely well.

John Hill - Citigroup

Great job. Nice to see numbers come through there as well as on tubular, recalling all the skepticism at the time that deal was done and great numbers. So great job.

John P. Surma - Chairman and Chief Executive Officer

Thank you. Thank you very much.

Operator

Thank you. And our next question comes from David Lipschitz with Merrill Lynch.

David Lipschitz - Merrill Lynch

Thanks. Quick question on your coking coal. There has been talk some coal companies about international players coming to the U.S. to talk about coking coal earlier than normal. Have you heard about this? Have you started looking at deal earlier than you normally would?

John P. Surma - Chairman and Chief Executive Officer

You mean in terms of our supply arrangements?

David Lipschitz - Merrill Lynch

Yes, exactly.

John P. Surma - Chairman and Chief Executive Officer

No, not really. I mean the influence of other parties is always there. I think we tend to have a continuing dialogue with our customers as we continue to move our positions out forward. And we've done that; our position for 2008 is taken care of. We have a decent position already established in 2009; I would say more than half of what our North American requirements would be. And a not insignificant position, less than half, but significant position for 2010 already as well; price positions, not just volume positions. So we've had continued good success because we work with a pretty good group of coal suppliers we think and we see that as a stable situation at this point. Undoubtedly, prices have gone up. We'll get our share of that over time, but for the moment, we are in pretty good shape.

David Lipschitz - Merrill Lynch

Just to follow up. A bunch of your competitors have been buying coking coal mines here in the States. And I know you used to and have sold it off. Is that something you would want to get back into if the right opportunity presented itself?

John P. Surma - Chairman and Chief Executive Officer

I'm not sure how many have actually done that yet, but there has certainly been lots of reports about it. You're more expert than I am I suppose. But probably not as a direct owner and operator. Underground mining we think is a risky business that is best performed by those that are prepared to take that risk and get paid for it. But having said that, perhaps an equity position of some kind, which is the same kind of thought we brought to that in Europe, might be something worth exploring. But that's just conceptual at this point.

David Lipschitz - Merrill Lynch

Okay. Thanks.

John P. Surma - Chairman and Chief Executive Officer

Thank you.

Operator

Thank you. And our next question comes from Brett Levy with Jefferies & Company [ph].

Unidentified Analyst

Hey guys. As you look at all the various things that you see in terms of rising raw material costs and your strong balance sheet right now, is there any particular area where you think it would be attractive to start backward integrating kind of beyond what you've already achieved?

John P. Surma - Chairman and Chief Executive Officer

Just the things I think we talked about before Brett on the North American side. Perhaps in a modest way, the coal related matter that was just discussed by the last question. But in Europe, we've spoken on and off about wanting to have a potentially an equity position in some iron resource that would give us some stability in our cost picture. We continue to have many discussions with many parties about that, and we have never gotten the ball across the goal line yet. But we continue to see that as an aspiration. Whether it happens not is impossible to say at this point, but that we think that will be a good thing to do.

Unidentified Analyst

All right, that was my only question. Thanks guys.

John P. Surma - Chairman and Chief Executive Officer

Thank you very much.

Operator

Thank you. And our next question comes from Timna Tanners with UBS.

Timna Tanners - UBS

Yes, hi, good afternoon.

John P. Surma - Chairman and Chief Executive Officer

Hey Timna.

Gretchen R. Haggerty - Executive Vice President and Chief Financial Officer

Hi Timna.

Timna Tanners - UBS

Just wanted to ask you a little bit about the balance sheet, particularly the working capital consumption. We appreciate obviously higher costs and high realized prices would contribute to that. But days outstanding for receivables still around [ph] 56 from 48. Are you at all concerned about some of your customers in light of what we know about the auto industry or appliance industry and collecting on that? I know Grechen referred to it in here comments, but do you have any further color on working capital this quarter?

Gretchen R. Haggerty - Executive Vice President and Chief Financial Officer

Well, Timna, I think that we are very comfortable with the receivables position that we have. I mean we monitor... I don't want to comment about any specific customers or not, but we have a system of credit extension that we try to establish and live by with on a customer-by-customer basis what we are comfortable with and try and stay on top of that. So I would say, we are very comfortable with our receivables position.

Timna Tanners - UBS

Okay. And then going into the [ph] outages for the rest of the year, you highlight the blast finance in Kosice. But that's one blast furnace out of five. Can you give us any information on the size of that blast furnace and any further outages you are seeing across your production?

John P. Surma - Chairman and Chief Executive Officer

Sure. The one in Slovakia is one of three... one of five in Europe you correctly point out. I think it's making at this point, Timna, probably around 3000 a day, probably less then that, maybe it's more like 2500 tons per day. So over 90 days, it's 300,000 tons plus or minus. This will be 60 days in the upcoming quarter and then 30 days according to the schedule, we will [ph] start in the next few days. So you could take a look at what our profitability per ton was and use those numbers and come up with some kind of a ballpark for the lost volume and what the income impact might be there. And then there is direct cost with that that would be incremental, which would be about probably the same amount as what the volume impact would be. So that's just a ballpark for you. That's the only thing in Europe of consequence. Lots of small things that happen routinely.

In North America, really nothing planned at all in North America in the third quarter of any consequence; small, routine things. We do have a couple of things that we need to do in the U.S. market... the U.S. furnaces. In the fourth quarter, there is a couple of weeks outage at our Mon Valley Works... nothing to do with the blast furnaces... but on our caster, there is a certain bearing on the turret that need to get replaced every once in a while. This is the once in a while right now. And they are planning for it for quite a while. It will be a few weeks down. The furnaces will be banked and will be back up in a couple of weeks. But we'll lose 100,000 tons plus or minus there probably. And then just smaller week or two Short Creek jobs, trough [ph] jobs, that kind of stuff in Granite City, one or two in Gary. But small items, in total a couple of hundred thousand tons. And that's just routine stuff we have in plan, they've been planned, engineering prepared, materials scheduled, that sort of stuff. But they'll happen routinely. But that's really about it; nothing big.

Timna Tanners - UBS

Okay. So finally, if I could ask your export opportunities that you might be seeing. I know you are not as well positioned maybe geographically as some of your competitors, but how do you see your export opportunities?

John P. Surma - Chairman and Chief Executive Officer

We are pretty well positioned in Canada. And that's been one of the real positives there as well. Export opportunities are there and we've been exporting in the second quarter... we always export of course some material to both Canada and Mexico routinely. But we would view your question, I would take it, is more non-traditional, non-NAFTA kind of exports.

In the second quarter, we did slab as well as mostly hot band, a few hundred thousand tons and we'll do at least that much, probably a little bit more, maybe in total up to 4 or 500,000 tons at the maximum I would think at this point in the third quarter. But we have been able to reach a decent logistics position with our Canadian position and we have slabs that are going into export markets and also into non flat-rolled markets that would be a little closer to home that doesn't affect our flat-rolled business. So we have been able to take advantage of the strong global demand and we have sent our hot-rolled product to a lot of places that I never thought we would be shipping to.

Timna Tanners - UBS

Okay. Great, thanks.

John P. Surma - Chairman and Chief Executive Officer

Thank you.

Operator

Thank you. And our next question comes from Michael Gambardella with J.P. Morgan.

Michael Gambardella - J.P. Morgan

Yes, good afternoon John.

John P. Surma - Chairman and Chief Executive Officer

Hey Mike.

W. Nick Harper - Manager of Investor Relations

Hey Mike.

Michael Gambardella - J.P. Morgan

Congratulations would be an understatement, but great work.

John P. Surma - Chairman and Chief Executive Officer

Sure. Our folks did a good job. Thank you.

Michael Gambardella - J.P. Morgan

I have a question for you on this automotive question you get at lot. If you had some tonnage under an auto contract that you had signed at the beginning of the year and the auto customer came back to you and said we don't need as much tonnage as we thought, how much more money would you make on those tons, putting them either into the export market even as a slab or just in the spot market?

John P. Surma - Chairman and Chief Executive Officer

Well, it depends on the price and the customer and where we would divert it to. But that would be in the hundreds of dollars per ton difference probably. Again, just looking at the hot-rolled reference price that was in the market when those contracts were set in the third quarter, I would guess last year, early fourth quarter, which was... I am remembering... 500 plus or minus. And you look at the spot market today, $1000 or plus, that probably gives you a pretty decent bracket on what the kind of numbers are we are looking at.

Michael Gambardella - J.P. Morgan

But the point here is that on automotive weakness and demand, you are actually making more money by diverting it to a higher price market.

John P. Surma - Chairman and Chief Executive Officer

I think that's a reasonable conclusion.

Michael Gambardella - J.P. Morgan

Okay. And then second question, on the Tubular business, can you give us an idea of how much of the $800 price increase that you announced for July 1st you effectively have gotten already in this second quarter by getting some of the price adjustments like $250 that would be kind of a deduction from the 800?

John P. Surma - Chairman and Chief Executive Officer

I would say a decent piece of it, but no more than a 250.

Michael Gambardella - J.P. Morgan

Right, right.

John P. Surma - Chairman and Chief Executive Officer

So it's probably at least that amount, and there was some we didn't get the 250 on for one reason or another. So there is a pretty good opportunity there for a much higher proceed in the third quarter.

Michael Gambardella - J.P. Morgan

Okay, great. Thank you very much.

Operator

Thank you. And our next question comes from John Tumazos and please state your company.

John Tumazos - Very Independent Research, LLC

Congratulations again. You earned a couple of good years in the last three months.

John P. Surma - Chairman and Chief Executive Officer

Thanks John.

Gretchen R. Haggerty - Executive Vice President and Chief Financial Officer

Thank you, John.

John Tumazos - Very Independent Research, LLC

Two questions. First, could you describe the opportunities to increase you land position? And I know your reserves already are great in Minnesota, but the geologic structure, I believe is much bigger than the ground you own.

John P. Surma - Chairman and Chief Executive Officer

Right.

John Tumazos - Very Independent Research, LLC

Or even take it public, even a few percent of it to focus the market's attention on the value of that franchise. And second question, given all the gyrations in coal and scrap and iron ore and product prices, going forward, will your structure, your strategy to have less contracts for inputs and products to be able to adapt to change or as, the world gets volatile, how do you plan going forward?

John P. Surma - Chairman and Chief Executive Officer

Both good questions, John. On the first point, just on the iron resources development prospects, we do have a variety of land positions and opportunities to perhaps increase those through lease or outright purchased land positions. And we are working on those all the time as we develop our mining plans at both Keetac and Minntac and now indirectly through some of the equity interest that we own.

But at the moment, I think the limiting factor is more just the time of permitting, and we understand that we need to do permitting, we understand it takes time. But the gating factor for us on the expansion we have at Keewatin, which will be several million tons by restarting an idle line, is really governed more by the permitting process. And we are underway there and we have a target date for I think September of next year, something like that. I think that will likely be the thing that would perhaps slow us down or provide some temper to how quickly we can do that versus having additional resource to develop. I think we've got sufficient resource and I think we are confident we could keep a sufficient resource in front of the mines.

In terms of different financial techniques, we've looked at a lot of things over the years, John, and have stayed with the current position. I think to focus the market's attention on the value of our resource position, I would just direct them look at our income per ton of our Flat-rolled segment for this quarter and to maybe keep looking at it for the next few quarters because I think we're going to begin to see, as we saw it on the second quarter, some pretty good results where margins can expand because our costs will increase perhaps as much as some others have. So I would say, I think that's going to be helpful to achieve the end that your question implies.

On how to deal with input costs, it is a very turbulent period and we're looking how to deal with inputs. And I think there we tend to be moderate and have some balance between shorter term purchase commitments and longer term to provide some stability but not getting locked into a particular risk that's way behind or way in front of the market. So I think we would continue there to be moderate and balanced as we have been, but also looking forward into the customers as we get into establishing new contract terms really right about now. I don't want to get into too much of this because we are doing it right now. But I think the time of the fixed price contract into our customers might begin to change. And there will begin to be some degree of ability to manage that relationship in a more flexible way for the benefit of both us and our customers over time.

So I think the overall allocation of value along the supply chain from the mine pits all the way to the end use application is being reconsidered right now. I have no doubt that both, with our good suppliers and our good customers we'll come to a good solution of that. But I think that's really the question, and we are working on both ends of that right now with some success, but we will have to wait and see how it works out.

John Tumazos - Very Independent Research, LLC

John, if I could follow up, there is there Minnesota Steel and Steel Dynamics, Mesabi Nugget steel and iron making projects and the [ph] taconite range. Given the extraordinary $375 premium for clean scrap today, one would think that you could make iron two-thirds of that cost if you wanted to up in Minnesota and sell it for a wonderful profit. Do you have any thoughts about merchant iron making? That could be a better business than those folks that want to build blast furnaces in the swamp in Louisiana.

John P. Surma - Chairman and Chief Executive Officer

I am not to up to date on the latter items, so I will let that one go. But just in general, John, again, from our standpoint, we think the highest value we can create ultimately for our shareholders is to develop our resource base as quickly as we can, consistent with good environmental principles and convert that in our Midwest blast furnaces and get it into an undersupplied market at a high margin. But that captures not just the resource value, but also the conversion value including the iron making value. And that's going to be valued against scrap-based material. So we are going to get that value. We think that's the best way to go. Actually getting into some new iron making activity in and around the range would bring other permitting issues with it that I think we are best addressing the ones we know how to work on now. But it's a good question.

Operator

And our next question comes from Mark Parr with KeyBanc Capital. Mark, your line is open.

Mark Parr - KeyBanc Capital Market

Well, hey, thanks very much.

John P. Surma - Chairman and Chief Executive Officer

Hi Mark.

Gretchen R. Haggerty - Executive Vice President and Chief Financial Officer

Hi Mark.

Mark Parr - KeyBanc Capital Market

Hey, how are you this afternoon?

John P. Surma - Chairman and Chief Executive Officer

Great, thank you.

Mark Parr - KeyBanc Capital Market

I bet you've had better days, but not very many?

John P. Surma - Chairman and Chief Executive Officer

It's just a pretty successful quarter, thank you.

Mark Parr - KeyBanc Capital Market

Congratulations, really, absolutely, very successful. I was wondering John, and I don't know if you've addressed this, could you comment a little bit on how much progress you are making with the spot price increase announcements that the trade press has talked about for September?

John P. Surma - Chairman and Chief Executive Officer

I didn't address it directly, but we did have... we don't necessarily do announcements, but we inform our customers and that find its way into the press, I suppose. But we did intend to move our spot pricing by $40 a ton in general in September. And that's working its way through the system. We don't try things out for size; we do things when we think it's the right thing to do and the market will sustain it. And we think it has, to some agree, and it will.

Mark Parr - KeyBanc Capital Market

Right. Is there any corresponding upside opportunity in Europe?

John P. Surma - Chairman and Chief Executive Officer

Could be. There were some recent price moves that are just being digested, and I think we are in a period of hiatus here. This is traditionally a fairly slow time in Europe as you may know; I am sure you do know. So I think that will be probably a subject more for September discussion than right now.

Mark Parr - KeyBanc Capital Market

Okay. And then one last question. On the slab situation that you talked about related to your export opportunity, is there any reason to think that pricing that you are getting for slabs is any different than what we are hearing about being quoted FOB Black Sea?

John P. Surma - Chairman and Chief Executive Officer

No, I am assuming you convert for metric and do those sort of things.

Mark Parr - KeyBanc Capital Market

Sure.

John P. Surma - Chairman and Chief Executive Officer

No, that's generally the kind of prices we are seeing.

Mark Parr - KeyBanc Capital Market

Okay. Terrific. Well, hey, can't wait for the next quarter. That's all I could say.

John P. Surma - Chairman and Chief Executive Officer

Well we have a lot of steel to make and a lot of orders to take. But we think it's going to be a reasonably successful quarter. Thank you.

Mark Parr - KeyBanc Capital Market

I certainly hope so. All right, look forward to it. Thanks again.

John P. Surma - Chairman and Chief Executive Officer

Thank you.

Operator

Thank you. And our next question comes from Michael Willemse with CIBC World Markets. Your line is open

Michael Willemse - CIBC World Markets

Great, thank you. John, early on, you talked a bit about your met coke negotiation for 2009. Do you have any sense now on how much the increases could be on some of the longer-term net call contracts, are we talk on lets say some of your run a few years are we looking at $10 to $20 a ton or do a lot of contracts get renewed of the end of 2008?

John P. Surma - Chairman and Chief Executive Officer

Well, some will get that would the end of the year between we now the end of the year and we have about half of RD in for next year at prices were comfortable with and presently we are surprise well the prices is during the market place today are much higher then they were this time last year. So I am sure we'll be facing some increases; it's really too early me to say whether the number do you mention would a kind of increases but secondary will be the case, I don't think that we're necessarily going to experience some of the really headline prices that the sea born number had on just a few months ago I don't think that case but if you I am negotiate that at this point but my guess there will be more likely numbers you talk about.

Michael Willemse - CIBC World Markets

Okay. Also, can you us a sense of how much your North America shipments were slab in the second quarter?

John P. Surma - Chairman and Chief Executive Officer

I am going to get... it was 100,000 I think, somewhere in that range.

Michael Willemse - CIBC World Markets

Okay. Is that a good number to kind of think about going forward?

John P. Surma - Chairman and Chief Executive Officer

It probably will be a little bit more than I was thinking... were making the lot more know and we have some customers in fine very desirable so we are going to try sure we serve the interest. So I would just say the sum of slab and export non-traditional, non as to export, if it was through the 300,000 is probably going to be more or like 4 to 500,000. Sort of a net --

Michael Willemse - CIBC World Markets

Okay. And then just one more question on the U.S. Steel Canada, when you purchased Stelco, I think you commented the capacity there been over 5 million tons. You still its 5 million tons or do you think it might be more?

John P. Surma - Chairman and Chief Executive Officer

It could be more. We're asking our self some of those question right now, it's really too early of might... to re-change conclusion. I think we'll have to let the facilities for a while and some of the things it went into that are involving outages and what your ordinary annualized capacity with these. I think it's possible, but it's going to take a lot for figure that out.

Michael Willemse - CIBC World Markets

Okay, great. Thanks very much.

John P. Surma - Chairman and Chief Executive Officer

Thank you.

Operator

Thank you. And our next question comes from Bob Richard with Longbow Research. Your line is open.

Bob Richard - Longbow Research

Thanks for taking our call.

John P. Surma - Chairman and Chief Executive Officer

Thanks Bob.

Bob Richard - Longbow Research

Again, not to beat Stelco to death, but can you... the utilization is pretty impressive. Can you give some flavor to what... was it a mix change, more intercompany, more slabs, more... is a lot of that going to trade? Can you... whatever detail you can give would be appreciated.

John P. Surma - Chairman and Chief Executive Officer

No, it wasn't necessarily mix. I think the mix is largely as it was. I mean we did lot of work to refine the mix. But it's just the people running the facilities more consistently at higher levels than they might have thought was possible and we knew was possible. So I would say it's just a excellent effort by the employees, good direction by the management and some technical assistance that allowed us to prove the burdens, maybe change some of the technology and tweak it a bit. But we always knew... we can take it away. It's just a matter of making the iron and making the steel and getting the supply chains where they could supply all the things we need all the time. We just worked our way through that and had the logistics supporting all that to take it out. I would just say it was a great effort by the entire team. And once they knew what they could do, they set about doing it. So just a good effort by the team. No sort of magic discovery. We didn't uncover a furnace that we didn't know was there. Just running the things that we were there at the levels we thought we could do it.

Bob Richard - Longbow Research

It is a correct assumption to say most of your intercompany comes out Stelco?

John P. Surma - Chairman and Chief Executive Officer

You mean intercompany transfers to Tubular, for example?

Bob Richard - Longbow Research

Yes, slabs and hot band?

John P. Surma - Chairman and Chief Executive Officer

No, the hot band that we are sending to Tubular operations would be primarily Granite City, not exclusively, but primarily Granite City. Some of that could potentially be coming from Great Lakes, some of that could theoretically be coming out of Hamilton slabs. It's not a steady diet, but if we have done all those things. All the trade slab sales, or virtually all of it comes out of Hamilton just because of the way we are configured. But the way we really have things laid out now, we've got this nice steady demand in Texas with the tube mills and we run everything back up. But really, the excess steel is going out in Hamilton and that's teed up then to either get it finished in Great Lakes or Granite City or Lake Erie if we have the extra space, or sell it as a slab. And for today's market, it's a pretty good configuration.

Bob Richard - Longbow Research

Hey, I appreciate all that color. One quick follow up. Utilization in Tubular, pretty impressive. Any concern on imports? They've kind of gone straight up, a 45 degree trend here since the beginning of the year. Any concern on your pricing increases have on traction [ph] in then in Harmon [ph]

John P. Surma - Chairman and Chief Executive Officer

In order, yes and no. I think yes, we are concerned about imports. We always are... not if they are fairly traded imports, then let the best pipe win. But when they are coming from regions, in particular China that we all know, everyone on this call and everyone on the world knows, has one of the highest cost structures in the world, selling their product in our market at prices well below their cost is against the rules. And when we see that happening, we draw that for the appropriate authorities' attention. We do have a line pipe case going on right now. There were two other import cases that have had some success at the IPC.

So are we concerned? Yes. Is it affecting the overall business and our ability to generate the kind of margins we think we can? Not in a big way right now.

Bob Richard - Longbow Research

Okay, thanks very much and great quarter.

Operator

And our next question comes from Wayne Atwell with Pontis Capital Management.

Unidentified Analyst

Thank you. And at the risk of being redundant, I have... congratulations on a great quarter.

John P. Surma - Chairman and Chief Executive Officer

Thank you, Wayne.

Unidentified Analyst

The steel market is probably the best it's been in 30 or 40 years. You had a great quarter and you're likely to have a pretty good next one to two years with a lot of cash flow. You have bought some companies and built facilities. You are working on coke. But taking a look at your income and what you spend on your share repurchase program, you are going to have a lot of surplus cash here over the next one or two years. Could you sort of... and I can figure out just like everybody else what you might spend it on... but could you give us a list by priority, share buyback, acquisition, asset accumulation? How are you going to spend your money and could you do that by the most exciting, the least exciting?

John P. Surma - Chairman and Chief Executive Officer

Sure. I'll let Gretchen comment. That isn't usually the parameters we use, but we'll try to do it that way. In general, I would say that in the future, we would be doing things the way we have done them in the past. And if you look at our recent record, we would run on that record. That's the way we'll tend to operate. And the things we have done will be indicative of what we'll likely like do in the future. And we would do it responsibly and balanced, not to extremes, in a way that tends to favor shareholder value. So with those, parameters, Gretchen, go right ahead and comment.

Gretchen R. Haggerty - Executive Vice President and Chief Financial Officer

Yes. And I guess from the most favorite to... the most exciting to least exciting, it probably changes over time. And I think that the approach that we have tried to take reflects that. And so, we think about it all the time and what we should be doing about using excess cash flows. So we do have significant capital opportunities which we're pursing that will also help address some of the risks that we've identified in our business on the coke side for example. And so you can expect that we will be spending higher capital as a result of that.

We've done a pretty good job with out balance sheet, but there is probably a little bit more that we could be doing there. And as we generate cash flow, we do have the flexibility to reduce some of the debt that we have; we can get our hands on it pretty easily. We've been funding our employee obligations very steadily, and I think I'm pretty comfortable with what we have been doing there and don't see huge changes with our approach. But we could have some opportunities where it might be a very tax efficient thing to do to fund some additional amounts and we would consider that.

But then that gets us back to dividends, and I think we gave you an answer today on our dividend and increased it the second time this year. And then... and we've been continuing our share repurchase program. And I'd just say that we would do more the same and we would do more where we think we have to do more.

John P. Surma - Chairman and Chief Executive Officer

And I think just to finish on that. Thanks Gretchen. We do have some things internally with internal capital that I think qualify as exciting, being able to develop additional 3 to 4 to 5 million tons of resource and iron ore pellets per year coming out of our equity operations and into our blast furnaces for conversion. Those were exciting things. I think we have resource value and conversion value into a pretty good world market. We think that's pretty exciting and can create a lot of value. It weighs out, but we think it's exciting.

Unidentified Analyst

Okay. And just one last question as a follow up. You've done a great job of buying when other people weren't interested and have gotten some great values in Europe and elsewhere. But... and obviously, you can't mention their names, but one would guess knowing what's available and what's been bought, there aren't as many exciting opportunities like you found in Europe and up north of the border. But are you finding... and obviously, you can't mention the names, but are you finding interesting acquisition targets that... like you've had in the past?

John P. Surma - Chairman and Chief Executive Officer

Well, I mean you are quite right, Wayne. Most of the good countries have been discovered. So I think the likelihood of us developing another opportunity like we had in Slovakia is quite unlikely in the near term. But we do have a lot of things that we are looking at in terms of development in each of our business initiatives that could add real value, some smaller, some larger. On the tubular sector, I think we have opportunities there to improve our business by adding elements to it that may not be there now. So I think we've got a lot of opportunities. But it's a different world today than it was back in 2002 and 2003. There is no doubt about that. I think you are quite right.

Unidentified Analyst

Great. Well, thanks and keep up the good work.

John P. Surma - Chairman and Chief Executive Officer

Thank you.

Operator

Thank you. And we do have time for one more question. And that goes to Dave Martin with Deutsche Bank. Your line is open

David Martin - Deutsche Bank

Thank you. I just had a couple of remaining items. First one is a clarification John I think earlier on the Q&A you mentioned 5 to 6 million tons of contract business, was this fixed price contract that can't reset until '09?

John P. Surma - Chairman and Chief Executive Officer

Yes, it's... that number was I think related to the contracts that are currently in place that will likely be adjusted and renegotiated, reset for business effective one way '09, right.

David Martin - Deutsche Bank

Okay. And then secondly, focusing on Europe can you quantify or give us some estimate of what additional cost increases you will see in the third quarter on a per ton basis. In the second quarter, I think costs were up maybe about $100 a ton. I would have thought they would have been up a bit more than that. I guess what I am asking is what additional cost increases will you see from what we've seen going on with global prices for both iron ore and coal?

John P. Surma - Chairman and Chief Executive Officer

Sure. Well I think there will be continued steady increases. And I guess my number... well similar to that, I am just looking to make sure I have got the right number, probably similar to that. But in the third quarter, it will look a little bit different because we will have fewer tons because of the blast furnace outage we mentioned and some direct costs related to the outage. So it will appear to be a higher cost increase in the third quarter than the second quarter. But other than that, I think it's fairly steady cost increases like everybody has.

David Martin - Deutsche Bank

Okay, thank you much.

John P. Surma - Chairman and Chief Executive Officer

Okay, thank you.

Operator

Thank you. There no further questions. If you have any closing remarks?

W. Nick Harper - Manager of Investor Relations

Thank you for participating and we'll talk to you soon.

Operator

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Source: United States Steel Corp. Q2 2008 Earnings Call
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