美國鋼鐵 (X) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

And welcome to the United States Steel Corporation's 2004 second quarter earnings conference call and webcast.

At this time, all participants are in a listen-only mode.

Later on, we will conduct a question-and-answer session.

Instructions will be given at that time.

If you require assistance during the call, please press star then 0.

Thank you.

I would now like to turn the conference over to the Manager of Investor Relations, Mr. Nick Harper.

Please go ahead, sir.

Thank you, David.

Good afternoon, and thank you for participating in United States Steel Corporation's 2004 second quarter earnings conference call and webcast.

We'll start the call with some brief introductory remarks from U.S.

Steel President, John Surma, then Gretchen Haggerty, U.S.

Steel's CFO will review results for the quarter and comment on the outlook for the third quarter.

Following our prepared remarks, U.S.

Steel Chairman and CEO, Tom Usher and the team will 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 actual 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 in accordance with the Safe Harbor provision.

Now to begin the call, I'd like to turn it over to U.S.

Steel President, John Surma.

Thanks, Nick, and good afternoon, everybody.

We appreciate you taking time to join us on the earnings call today.

As you saw for the quarter we reported earnings of $1.62 per share.

If you add to that the 17 cents per share effect for some charges associated with the early retirement to debt that we reviewed in some detail with you on the last quarter's call, you arrive at about $1.79 per share, exceeding the average of analyst expectations, we saw at 1.53 per share.

In fact, second quarter adjusted earnings per share was the highest recorded since we began reporting steel results separately back in 1991.

As evident from the results, U.S. steel is firing on all cylinders and firing quite well.

Domestically, our Flat-Rolled segment is really gathering steam and our Tubular segment is accelerating rapidly also.

Both segments continue to benefit considerably from the robust economic recovery that's in front of us and the resulting strong demand which we are observing across virtually all our end markets.

Our strong raw materials position which has proven to be a competitive strength, coupled with our improved cost structure and expanded asset base, we think positions our domestic operations to further leverage the current very favorable market conditions.

During the second quarter we benefited significantly from improved spot prices and from improved pricing on the portion of our contract business that's been renegotiated since the beginning of the year.

Also, our people and our plants performed exceptionally well during this period.

We see the global supply and demand dynamics supporting these favorable trends at least through year end.

Our European segment performed better than anticipated and continues to prosper with strong demand and an improving price environment.

Our European margins expanded significantly, despite higher raw material costs.

And as discussed previously, raw material costs have been a particular concern at our Serbian operation, which relies on 100% purchase coke and iron ore.

Improving our European raw materials position is one of our top priorities and we've taken some steps to reduce the financial impact through alternative sourcing of incoming materials, including shipping iron ore from our domestic operations to Serbia and taking advantage of some synergies with our operations just to the north in Slovakia.

Our involvement with LNM Holdings in an unsuccessful attempt to purchase the Ukrainian steel maker, Kryvorizhstal recently as an example of our efforts to enhance our European operations by expanding into a country which is rich in raw materials.

Those efforts are continuing.

Now I'll turn the call over to Gretchen for a thorough review of the quarter's results.

Gretchen?

Okay.

Thanks, John.

Second quarter 2004 consolidated revenues and other income totaled nearly $3.5 billion, which was an increase of $500 million from the first quarter, as our averaged realized prices increased $108 per ton, or 21% to $571 per ton on 5.5 million tons, which was 92,000 tons below the first quarter.

For the quarter, we reported net income of $211 million, $1.62 per share, which compares with net income of 58 million or 47 cents per share in the first quarter and a loss of 49 million or 51 cents per share in the second quarter of 2003.

As we noted in our release and as John referenced, our results reflect a $33 million pre-tax charge to interest and other financial costs for the redemption premium and unamortized issuance cost related to the early retirement of a portion of our senior notes.

After applying a statutory tax rate of 35%, this charge, and a minor other item not allocated to segments, reduced earnings by 17 cents per share.

Total segment income from operations before retiree benefit expenses was $454 million, or $82 per ton.

An improvement of $292 million from the first quarter, driven primarily by the Flat-Rolled segment with profits of 335 million, which was a $222 million improvement versus the first quarter of 2004.

This continued an improving trend that began in the second quarter of last year when we recorded a loss of 37 million, coinciding with the completion of the National Steel acquisition.

Looking at Flat-Rolled in particular, versus the first quarter, realized prices increased by $108 per ton or 23% to an average of 583 per ton, and Flat-Rolled profits improved by $57 per ton or 47% to $84 per ton.

Despite increased purchased raw material costs and negative LIFO inventory affects, which was due to the continued streamlining of steel inventories.

Our steel inventories have declined by 28% in the 4 quarters since the National acquisition.

Domestic results also included higher costs related to profit-based payments under the labor agreement with the USWA.

In line with our improved profitability, as well as costs related to 2 blast furnace repair outages at Gary Works.

One of these outages -- one of the outages was completed during the second quarter, the other was completed in late July.

In Europe, second quarter results improved due to a favorable pricing environment as averaged realized prices increased 17% versus the first quarter.

Partially offset by higher raw material costs.

Results were also positively affected from higher shipments in Slovakia and Serbia.

Turning to the Tubular business, second quarter results improved as the average price increased 16% from the first quarter, which was the catalyst for our improving results.

The segment posted income from operations of 25 million, an improvement of 22 million versus the first quarter.

Now, Nick Harper will provide some additional details on the quarter's results and some items for your modeling purposes.

Thanks, Gretchen.

Depreciation which totaled $93 million in the second quarter is expected to approximate $390 million for the year.

Defined benefit and multi-employer pension and OPEB costs for the quarter totaled $85 million.

And as Gretchen will discuss in a moment, we made a $50 million voluntary contribution to our main pension plan during the quarter.

In addition, in the second quarter we made cash payments of $75 million primarily for retiree healthcare costs and multi-employer pension plans.

Excluding the $33 million special charge, interest expense for the year is now expected to total approximately $184 million, which also reflects approximately $18 million of net losses due to foreign exchange affects reported today.

Currently our estimated annual effective tax rate for the year is 28%.

With domestic income tax at a statutory federal rate of 35%.

However, due to management's reinvestment plans for European income and our tax credit in Slovakia, very little income tax is accrued for our European operations.

As a result, as the proportion of total income attributable to our U.S. operations increases, our tax rate will climb towards the U.S. statutory rate.

Lastly, assuming conversion of the preferred shares as dilutive, the fully diluted share count for the third quarter is expected to be approximately 130 million shares.

With that, now I would like to turn it back to Gretchen for additional comments on our results and outlook for the third quarter.

Thank you, Nick.

So far this year we've done an excellent job of generating cash.

Operating activities provided cash of 314 million after the pension fund contribution of 50 million, and we had free cash flow of about 214 million after capital spending and dividends.

We ended the quarter with a cash balance of 568 million, with total liquidity in excess of $1.5 billion.

For the balance of the year, we expect some working capital build as a result of higher steel prices, but we still anticipate healthy cash flow for the year.

Debt reduction is a very high priority for us, but because our debt structure is fairly rigid and provides somewhat limited prepayment options, as we've told you before, voluntary contributions to our pension and VEBA trust are also possibilities for the use of free cash flow.

We've been planning 75 million of voluntary cash contributions to our pension fund in 2004 as we have previously disclosed.

In the second quarter we made the $50 million contribution to the plan and we could make the remaining 25 million later this year.

In addition to these amounts, we are now authorized to make up to $250 million of voluntary contributions to either our pension plan or our VEBA trust in 2004 or 2005.

As you know, VEBA stands for Voluntary Employee Benefit Association and it's a trust which provides a tax-effective means to fund our union retiree healthcare costs.

In addition, by virtue of our agreement with United Steel Workers of America, a voluntary contribution to VEBA allows us the opportunity to reimburse ourselves from the trust for healthcare costs covering USWA retirees.

We are planning to further enhance our capital structure by reducing debt and lease obligations where we can do so cost effectively.

Our highest cost debt on an after-tax basis is the outstanding debt at USSK, which we can pre-pay at any time without penalty.

As a result, we are considering repaying a portion of this debt later this year, although I do see some philosophical advantages to maintaining some debt level at the USSK level.

In addition, we've taken steps to unwind certain lease obligations later this year and into next, although the amounts are relatively small at this point.

Finally, while it's premature to give levels of capital spending for 2005, we are considering several infrastructure projects for 2005 and later years that are designed to enhance the reliability and cost effectiveness of our facilities over the long-term, such as the potential reliance of the No. 13 blast furnace at Gary Works, as well as some market-driven projects.

As John mentioned earlier, we continued to see strong demand across virtually all end markets in our Flat-Rolled segment.

Auto production schedules remain strong, service center industry inventories remain well below historical levels and sustained strength of the nonconsumer side of the order book, which until earlier this year had lagged significantly, support our optimism for the third quarter and for the balance of the year.

Accordingly, average flat-rolled prices in the third quarter are expected to exceed second quarter levels.

As we discussed on our last quarter's call, we purchased relatively large quantity of coke in the spot market.

Mostly in the second quarter with a little in the first part of July.

As a result, third quarter coke consumption cost, which includes the benefit of a recently renegotiated sales contract that was repriced to market, should be comparable to the second quarter, depending on consumption patterns and how the high-cost purchase inventory flows through our LIFO system.

Next, I'd like to update you on the improving coke and coal supply situation.

Our major supplier of low-vol coal, PinnOak Resources, who had declared force majeure has been operating at near capacity.

But we continue to work through a number of additional force majeure situations which have plagued the coal industry in recent months.

While we are confident the worst is behind us and things are improving, we are still having difficulty getting the right quality coal in sufficient quantity to the right location.

Therefore, we continue to operate our coke facilities at less than capacity.

We're also in the process of securing our coal requirements for the next 3 to 5 years as we want to ensure sufficient coal is available to meet our future coke-making requirements.

During the second quarter at Gary Works, as we mentioned, one blast furnace repair outage was completed and a second repair outage began, which was then completed in late July.

An additional blast furnace outage is now planned for Granite City Works during the third quarter.

As a result, compared to the second quarter, third quarter flat-rolled shipments are expected to decline by approximately 200,000 tons, mostly spot hot roll tons, and we now expect full-year flat-rolled shipments of 15.8 million tons.

In addition, third quarter costs are expected to increase by approximately $20 million as a result of these outages.

We also expect continued improvement for the Tubular segment in the third quarter, due to strong demand with average prices increasing significantly, reflecting the full realization of price increases implemented during the second quarter, as well as additional third quarter price increases.

We also expect to achieve our 1 million ton annual tubular shipment target.

For U.S. steel Europe, we expect higher profit margins as higher prices will offset higher raw material costs and planned outages at a number of key units.

Third quarter shipments are expected to equal second quarter levels and shipments for full-year 2004 are estimated at 5.1 million tons.

I'd like to emphasize that we do expect worldwide steel pricing to remain strong and supplies tight as the world economy continues to recover, and as demand from developing countries, especially China, remains at very high levels.

As a result, we anticipate continued strong results for the balance of the year.

That concludes our prepared remarks.

At this time, I'd like to turn the call over to Tom Usher, U.S.

Steel Chairman and CEO for some brief remarks before we open the call for your questions.

Thank you, Gretchen.

I think as Gretchen and John and Nick have outlined, we've had a pretty good quarter here.

We look for the third quarter and fourth quarter also to be very strong.

We continue to have a very strong order book.

We continue to put a lot of emphasis on our cost reduction projects, even though the pricing has improved, we still feel this is a very cost-driven business, and we're very conscious someday in the future this will turn around.

We want to make sure we're as cost competitive as we can.

We have done a good job, I think, repositioning ourselves on the raw material during this year.

And as we exit 2004 and move into 2005, while this was a strength, I think it will even be a greater strength for us in the year 2005.

So I'd say we're still very bullish in what we see happening out there, and we look forward to continued good results.

And with that, I would turn it over to any questions that you might have.

David, if you could please queue the line for calls.

Certainly.

Ladies and gentlemen, if you wish to ask a question at this time, please press star then 1 on your touch-tone phone.

You will hear a tone indicating you've been placed in queue.

You may remove yourself from this queue at any time by pressing the pound key.

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Once again, to ask a question, please press star then 1.

One moment for the first question.

And the first question comes from the line of Cagler Somec with Credit Suisse First Boston.

Please go ahead, sir.

Good afternoon.

I was wondering what your thoughts are in terms of returning cash to shareholders later on this year or in 2005, whether you have a preference in terms of dividends or share buybacks?

This was an issue that we discuss in quite a great amount of detail with our Board every quarter.

We had a board meeting, in fact, this morning.

Certainly there was very good discussion on this.

I guess I would just say we're very sensitive as we are able to demonstrate a few quarters of this type of success, we're very sensitive to the needs of returning some of this to our shareholders.

We have good discussion on this.

And exactly what form that would take, I wouldn't want to indicate anything or anything specific would happen, but I would just say that this is something we discuss quite a bit, and we are sensitive to that.

One last question, regarding a comment that you made in the press release regarding China, what your current thoughts are regarding China, actually.

This is John.

I was in China, Shanghai, at a steel conference just a month or so ago.

There will be fits and starts and ups and downs probably in China as there have been for the foreseeable future.

But the underlying fundamentals of the large population relatively low GDP, relatively modest steel consumption for GDP, with the opportunity for strong consumption for the foreseeable future we think is very positive.

Among other things, we would see it less likely that China would become a sustained large exporter of flat roll.

I think we see a lot of focus in China.

I personally saw a lot of focus in China on construction oriented long products as you would expect given the status of that economy.

I also was advised by a number of people in the business in China, as well as senior government officials, that they really see nothing in it for their country to become a large scale exporter on a largely imported raw materials base.

That's just not a good use of national capital and they don't intend to do that.

So they're going to try to calibrate their infrastructure investment to be roughly equivalent to what they need from a consumption standpoint.

I would say in general we're very bullish on China, certainly through the Olympics and '08.

And we're also becoming more and more bullish on India as a major consumer.

Both of their steel consumption per capita are at the very, very low end of the range.

Our next question comes from the line of Mark Parr with Key McDonald.

Please go ahead, sir.

Thank you, good afternoon.

Good afternoon, Mark.

I was wondering, Tom, on the last call you had given some sense of how much you thought average selling prices would increase third quarter versus second quarter and also how much you thought costs would increase.

I was wondering if you would consider giving us the same kind of guidance this time around.

I guess I really don't know, Mark.

All I would say, we do expect prices to be up some.

But it's hard to say.

One of the things we're looking at in the third quarter is we are going to have less capacity on because of a couple of these blast furnace jobs.

The fallout there will fall primarily into some of the spot business, which certainly has been a little better business for us, as we will take care of our contractual commitments.

I would say it will be up some, but not an appreciable amount, but up some.

As far as costs, we think we've got them under control.

We've made some improvements there.

So we think there will probably be a little margin widening.

Okay.

Anything that you can share, color regarding price escalation related to contract negotiations as you head into the summer months?

I mean, you know, as you know, most of these contracts we talk about in the fourth quarter for next year, some will be renegotiated.

We will probably engage all customers, even those that we have contracts with in '05 to see what their appetite might be for renegotiation.

It's really kind of a wild card.

We haven't had this kind of market dynamics for a while.

A lot of it will depend on what their view of how long this thing will last, whether they are amenable to some renegotiation or they want to sort of ride out where they have.

So, you know, I'd love to give you better guidance, and I would if I could, but we really just don't know until we get into it.

Those discussions really are going to be October, November time frame.

Okay.

I'll go back in the queue.

Congratulations on an outstanding quarter.

Thank you, Mark.

Thanks, Mark.

Our next question comes from the line of Bruce Klein with Credit Suisse First Boston.

Please go ahead, sir.

Hi.

Good afternoon.

I was wondering on iron ore, do you guys -- I don't know the status of your union contracts or what the status is there, whether they were sent forward when you did your other union agreements last year.

Also coke, I think you mentioned you renegotiated some of your contracts.

I didn't know what was that about, and what direction you were heading there.

The iron ore.

Yeah.

Our two [inaudible] facilities are covered by the same labor contract that we signed last year, a year or so ago, that covers all our domestic facilities.

We have excellent labor relations there and we're running them hard and consuming all the pellets we make in our own facilities.

We look at that as a key competitive strength there, we think the lowest cost pellet in North America, among lowest cost in the world, probably.

On the coke side, as we described for you last quarter, we are in the process of working our way out of the merchant position that we were traditionally in.

Most of those contracts will be completed by the end of the year.

There happened to be one that because of a change in control was subject to price reopener that was completed late last quarter.

This third and fourth quarter results will reflect that.

Okay.

Maybe just -- I didn't know, just a couple other items, total debt, I think you gave us long-term debt, I'm wondering if you have total.

And secondly, if you could just help us with the -- I wasn't clear I heard you right on the pension and OPEB gross accrual cost running through the income statement in the second quarter, I think I heard what you did on the cash side.

I'll hand it over to Gretchen a second.

Just to finish the coke comment, looking forward to 2005, our domestic coke position will be much, much improved compared to 2004 by a substantial amount.

Gretchen, on the debt and pension, I'll turn it over to you.

Nick, what we were saying about the total debt?

I think we had by the end of the quarter we had reduced debt for our 259 million for the -- you know, the redemption of our senior note.

So that would probably -- that would have been out in April so that would probably put us at about a 1.6 billion or so at the end of June. 1.660 billion.

Our next question --

I'm sorry, I did forget on the pension contributions, we made a $50 million contribution in June to the pension plan.

We also paid OPEB costs of about 75 million for the quarter.

That was about 125 million in the quarter, cash.

Our next question comes from the line of Chris Olin with Longbow Research.

Please go ahead, sir.

In North America you appear to have some competitors that may be having difficulties sustaining their steel making operations in the second half related to these raw material issues, specifically the iron ore strikes, and ongoing tightness in coke.

My question is, have you begun to see any benefits from customers looking to assure steel supply going forward, given your supply in those markets?

Is there a market share benefit issue that you're not looking at in terms of third and fourth quarter volumes or potentially mixed.

It's sort of 2-part there.

First on the affect on our competitors.

We worry most about what we can do.

But we do see the market remaining very tight.

We think supply to some degree has been constrained, and I think the raw materials tightness, both metallics and carbon units, coal as well as coke are part of that, so I think you're on the right track there.

In a market, though, like we have in North America right now where the domestic capacity as far as we know is basically running flat out, and whatever incremental consumption is going to be met, presumably by imports to balance the market.

The market share is a hard thing to pursue, because we're making as much as we can right now.

So selectively in certain markets where we can tailor our position to track business that we think long term is better for us, we'll do that.

But in this kind of a market we're running as hard as we can to basically make as much as we can.

Okay, thanks.

One of the things we have done, Chris, is we're getting very close to moving up this second blast furnace in Serbia to get it on sooner than we had anticipated.

The Serbian operation is running very well.

And, you know, this would give us an option when we're running flat out to maybe bring some steel in here if the market is strong.

Do the contracts that you have with the union forbid any kind of exporting into North America from Europe.

In general, no, as long as what we have here is running at capacity.

I think anything that would be incremental to meet customer demand, really, because customers request it to the extent that that's more profitable business.

I think our colleagues -- our workforce and our colleagues at the union are quite fine with that.

We do have some capacity downstream we could take advantage of to finish.

We'll be looking at that as we move into '05.

That's interesting.

Thanks.

Our next question comes from the line of John Tumazos with Prudential Equity.

Please go ahead, sir.

Tom, if I could ask you a question about blast furnace practice.

Given that scrap or HBI additives for oxygen injection have grown a little more expensive and coke is expensive making PCI more attractive, and oil and gas or oxygen injectants are more expensive, is it optimal in the current environment to put a less pure burden in the furnace, more PCI at the margin, less scrap, and then less BTUs or chemical energy, oil, gas, oxygen, so the furnace temperature is a little less, maybe have 1 or 2% less throughput from the burden and a little lower speed from the temperature compared to practices in the past when all the inputs were relatively cheap.

John, this is, as you know, a very technical detailed question.

We look at it, and we have very sophisticated models that take all these different factors into account.

Pricing of each, availability of each, where the bottleneck points in a particular plant, what is the condition of the furnace compared to when we expect it to end its campaign, et cetera, et cetera.

And these are models that we have developed using best practices around the world.

We have a person who is specifically assigned just to blast furnaces across the company, it's got a group that's looking at best practices.

You know, we make these decisions really week to week depending on what happens to the price of these different commodities, what our needs are.

But in general I would say, given that the furnace is running good, and that there's not some other bottleneck downstream of that, we're trying to make as much hot metal as we can and putting in that that burden.

And given the market as it is today, that's probably our optimal mix.

But again, furnace to furnace, this will vary some depending on condition of furnace and the specific cost of those additives, whether they are tar or oxygen or gas or PCI, whatever it is going across.

Are the tons per hundred cubic foot of working volume roughly the same as they would have been a year or 2 ago.

I think we've shown some improvement on that.

We have that -- I don't have that right in front of me.

But in general that's our major productivity measure on the furnace, I think they have improved some.

Just going back, John, just to carbon units, because of the Pinnacle force majeure, we've had to scramble for a low vol, we haven't had the optimal coke blends necessarily on the batteries, and we haven't had the optimal coke stability coming out of the batteries.

So coke has been an issue in terms of overall furnace productivity to the extent we're blending purchased coke from we're not sure where with a lot of finds in it.

Those have no good result on the furnace as you would expect.

Having said all that, we're trying to make as much iron as we can.

For '05, will you try to reduce your fraction of contract sales?

Are you talking of coke?

No.

No.

Are you talking steel products?

Flat-rolled steel.

Yeah, I mean, you know, this idea that you can just walk away from all this contract business right away and go into the spot market, we're not really sure that holds up.

You know, we had talked in the past of trying to take this mix from 50-50 up to maybe 70-30.

Given the market where we're at today, we'll probably go into next year, assuming things stay as they are, about where we are today.

But over the entire cycle of this business, somewhere in that 50-60 range is probably what is we feel the optimal mix.

So, you know, as the spot market stays as hot as it is, we'll continue to take advantage of that.

But we'll probably still have in the neighborhood of 40 to 50% of our business will be longer-term contract business with people like automotive, appliance, tin plate customers, et cetera.

Next question comes from the line of Aldo Mazzaferro with Goldman Sachs.

Please go ahead, sir.

Good afternoon, can you hear me all right?

Very good, Aldo.

I had a question on 2 areas.

The cost side, you mentioned a $20 million incremental cost.

I was just wondering if that was net of any benefits you might see from the rollover of the coke sale contract?

The $20 million I think --

That was related to --

To the sort of quarter to quarter, we had sort of 1.1 outages in the second quarter and we'll have the full Granite City outage and the majority of the second Gary furnace outage in the third quarter.

So we were really dealing with that only.

So whatever happens to the coke costs relative to that new contract, that would be separate from the 20 million?

It is.

Although, when we observed that we would expect sort of coke costs to be somewhat comparable from second to third, I think is how we described it.

That takes coke, our coke business in general, including some improvements on the commercial side that I described.

Second question, on your pricing strategy in the market, I have to congratulate you from coming from a slow start I guess about 2 or 3 quarters ago to now being possibly the highest priced guy in the market.

I'm wondering if you could confirm you're pricing steel about 780 per ton on hot rolled right now, and whether that is $30 or $40 ahead of where you feel the market is right now?

We have not gone into any 4-digit sales, I'll tell you that right now.

But you're below a thousand.

We're below a thousand, but we're not going to get into specifics.

Our philosophy is to price it to market, whatever that may be.

That excludes Tubular, Aldo.

Our next question comes from the line of Daniel Roling with Merrill Lynch.

Please go ahead, sir.

Thank you.

Going back to the coke for a while, how long do you see the coke market remaining tight and metallurgical coal market remaining tight.

I know you commented on the met market earlier.

I missed, what are you doing to make sure you have adequate supplies of metallurgical coal over the next couple of years.

Let me sort of take it bit by bit.

On the coal side, and we already have in place a number of multi-year contracts at pretty competitive prices that have been entered from time to time in the last several years and they extend 1, 2, 3 years out, maybe a couple even beyond that.

They are pretty competitive prices.

We are more well fixed on the low-vol side than high-vol side.

Low-vol has been a problem more recently.

We're comfortable on the low-vol side and we'll continue to try to sign up longer-term contracts as time goes on.

And then we're moving into the high-vol contract season, signing up business that we can count on with suppliers that we can count on, into the next year to 2 to 3.

We're taking a layered position where we're trying to sign up coal supplies from here out, to 2 to 3, maybe to 5 years the furthest out, maybe a little bit beyond that.

Just philosophically, there's a lot of coal in the Appalachian metallurgical mines, but I don't think at 30 bucks at a ton, it's not much at 50 or 60 or 70 where they are now, there's probably plenty.

I think it's going to be a question of having the right price to coax that amount of supply in.

I think a lot of the net coal that will produced is going to be in some of the more difficult to access deposits, it's probably going to be more continuous mining less long wall.

But there will be a sufficient amount of coke, we think to balance the market, but it's going to be a fairly competitive price.

Then on coke, I know that American Metal Market has a fairly extensive story on that in the print edition, full of testimony by a lot of experts, so I won't try to second-guess them.

Except the consensus in that story and most of the experts we look at seem to say that we wouldn't expect coke to recede back to the $100ish kind of price it was just a few short years ago or less.

We would see coke, maybe not in the 450 range where it flirted with back in the second quarter, but easily above $200 a ton for the foreseeable future.

Okay.

So basically what you're saying is that you are able to get contracts -- multi-year contracts and you're out as far as 5 years.

Are you seeing the quality of that metallurgical coal deteriorate versus where it was a year or 2 ago.

Not per se.

I mean, on the [inaudible], we can work with what we get.

The problem has been the reliability of supply and delivery, and having the consistent blend that the furnace -- that the batteries like.

We don't like having to switch blends and switch coals.

And we have had, count them, 10 force majeure declarations by our suppliers, 10.

So that doesn't bode well for continuity and stability of coal supply on the batteries themselves.

So it's not so much quality as it is consistent stable supply.

And the execution of some of these agreements we've entered into now is allowing the coal supplier to have a source for this coal, so it's going to allow them to get a little more stability to their operation.

Lastly, just what you said I find interesting in that we're not hearing from the major coal companies that they are signing those 3, 5-plus year contracts.

Since you're implying you're getting 5-plus year contracts.

Are you more with the small independents or with the majors?

We have -- not everything I described did we do in the last month.

Some of this is practice we've had over a period of time, since some of our longer-term contracts we've had for quite some time.

Some are with large companies and some are with small companies.

It's not our practice to be bad sports and talk about specific companies.

We do business with a variety of companies large and small.

Most of which we've done business with for a long time.

The next call comes from the line of Wayne Atwell with Morgan Stanley.

Please go ahead, sir.

Thank you.

Am I to understand that all of your iron ore is coming from your own mines and you're not acquiring any iron ore that's subject to a labor negotiation in the near future.

Not any to speak of.

Domestically you're correct, in both Kosice and Serbia we're buying iron over there, but not -- domestically, we're getting it all from our own mines.

That's conceivably a very nice strength for you.

I feel good about it.

I would say we have the best metallics cost.

In fact, our metallics cost this year is probably a little bit lower than it was last year in North America.

There can't be too many people saying that.

Right.

By the way, congratulations for a great quarter.

Thank you.

It's nice to see that.

In terms of contracts, I know you've already gone over this once or twice.

But dealing with some of your contract customers has been a bit challenging and not very profitable.

It seems like maybe if they are not willing to pay up, and seems like some of them aren't, maybe they should get the steel but on the spot basis, seems like that might be a commercial decision that makes sense.

Can you sort of discuss that?

You know, this is a difficult challenge, obviously.

We've had relationships with these customers for a number of years and they honor what they have done, and we've honored what we've done.

As I said, we will enter into discussions with them over the next few months as we enter the fall.

And to a degree, those people that are having things run out in '05, may be amenable, depending on how they see the long-term supply situation.

So you know, it's hard for us to say in advance.

But I guess I would just say philosophically that if we have commitments to customers, we are going to honor those commitments through the contract term.

Having said that, you know, this business while it is not as rich as some of the spot business that we see currently, it's still very profitable business.

We make a very good return on this business, and it is business that, you know, we've had during some lean times.

We have it now.

You know, we will continue with sort of that philosophy and do not intend to renege on those contract commitments that we have.

Okay.

If we could move into coke.

I know this has been beat to death here a little bit.

I'm trying to figure out how to model this in.

Basically, what I think I've heard is your cost will probably be sort of flat second to third quarter.

But how about pricing?

Obviously, you've renegotiated 1 contract with the change of control.

So your pricing should be better on part of your volume.

I assume that's maybe 200,000 tons a quarter.

Can you help us out sort of figuring out cost and price.

Sounds like cost the same but pricing should be better?

Is that realistic?

When we indicated that our overall coke cost ought to be comparable.

I think that's the way we described it, we were speaking in a comprehensive way, that's kind of our net coke cost, whatever we produce, whatever we buy, less what we sell, whatever margin we make on that will be fairly consistent second to third.

We would expect the position to improve then third to fourth.

This depends on how the coke actually gets consumed, and how our LIFO calculation works, which is a bit of our accounting that we shouldn't get into.

But assuming that it gets consumed and runs through our cost system in the third quarter, we would expect most of the higher cost purchased coke that we really bought in the either the second quarter or earlier this month to be consumed or run through the system in the third quarter, and the fourth quarter coke net costs which would reflect lower cost purchases, fewer purchases to begin with, lower cost purchases to begin with, then better pricing on our commercial transactions, we should have approved coke costs in the fourth quarter and then a substantial, substantial improvement in '05 from '04 in total.

So should I interpret that to mean that your margins would be more or less unchanged between the second and third quarters.

So whatever happened in the second quarter, you'd have a very similar performance in the third quarter in the coke area.

In the coke area?

Right.

I think that's what we were trying to say, Wayne.

If I could just maybe repeat a little bit of what I said.

In the second quarter, that's when we bought the higher cost coke.

We bought a larger quantity there that we consumed.

We'll be consuming some of that in the third quarter, so you'll see that in our result.

But we also, if you take that affect and you add in the benefit that we expect to realize in the third quarter from this renegotiated coke contract, then our costs should be comparable to the second quarter.

And there may be some changes because of consumption.

And John just tried to take us through it again, there may be some differences depending on how it runs through our LIFO system.

But basically, the guidance we're giving is that looking at coke, it's comparable quarter-to-quarter.

Okay?

The other cost information we gave you is that we do expect cost to be 20 million higher in the third quarter for these outages, quarter-to-quarter change in our outage cost.

We're affected by scrap and after gas as everybody else is.

You can absorb the cost of that in the metal market as easily as we can.

Right.

Our next question comes from the line of Brian Rayle with FTN Midwest Research.

Please go ahead, sir.

Good afternoon and congratulations.

Thanks, Brian.

One quick question with the iron ore mining.

Did you guys say that you were flat out production, so there would not be an opportunity for you to -- or would there be an opportunity to increase production and maybe supply some of the domestic market with some of the excess iron ore or is that sort of not a possibility?

We're making really everything we can right now.

To the extent we can make more, we have 4 or 5 very hungry furnaces in central Europe, that the way the economics are in the world right now, that would probably be our preference.

One other follow-up question, in the outlook statement of the press release, I just noticed that of the 3 business segments you discuss, USSE is the only one where you explicitly say profit margins are expected to increase from the second quarter.

Am I sort of reading too much into that or is there something else going on there?

I think we wanted to be a little bit clear there because we did have some very significant price moves in the early part of this month, and we wanted to just give you the view that from our point of view, that despite some materials increases that the pricing movements have been successful there and we expect margins to be a little wider in the quarter.

The absence of it from the other 2 doesn't imply anything?

No, although I think it would be more pronounced in Slovakia, in Europe, because of -- Tubular is also doing very well, was not intended to slight that business, Tubular has had a perfect turnaround and we see strong price movements there as well.

But because we had, I think, 100 to 130 euro dollar a ton price announcement early in July, we wanted to make it clear that we thought that has every expectation from our point of view of giving us better margins.

Thank you very much.

Our next question comes from the line of Michelle Applebaum.

Please go ahead.

Hi.

Couple questions.

At the very start of the conference, you said that your spot prices and renegotiated contract prices rose during the quarter.

I'm just wondering, did we talk about renegotiated contract prices yet?

I think what I said were spot prices went up.

That was probably not a surprise.

But we have had, and we talked about this last quarter, too.

We have had during the year for a variety of reasons some contract business where we got into a discussion with a customer and ended up having improved pricing.

So we look at our internal information, we've seen improvement on both contract and spot.

But as you would expect the improvement on spot has been far more dramatic.

Okay.

So you have renegotiated contracts that would have been up at the end of the year?

John actually said that we had improved pricing on the portion of our contract business that was renegotiated since the beginning of the year.

We had contracts coming up then which we then renegotiated and extended at higher prices.

The other thing I'd say, we're not just sort of sitting still on this business.

To the extent we're not able to change a price, we're not holding any more inventory than we need to.

We're being in good form, making sure that we try to fashion the overall relationship, be it credit or delivery or shipping terms or processing obligations or administrative obligations.

We're trying to make sure that we make the relationship as favorable as the market dictates it should be for us now.

Okay.

Great.

I just want to get that clarified.

A.K. came out and gave us a figure of $500 million, what the difference between spot and contract was, because I think it's pretty widely known that spot is actually higher than contract, which I don't think has happened maybe '95, but I don't think it's happened before.

Can you venture a guess, either dollars or percentage basis, how much higher spot is than kind of your average mix of contracts or similar products?

No.

We really wouldn't do that.

I'm not even sure I know, Michelle.

I couldn't give you a number there.

Okay.

And your SG&A dropped to 160 million in the quarter from 190 million, which is quite impressive given the sales increase.

Wanted to ask if there was anything specific in there that I should pay attention to and why it dropped, or is it just great management?

We can agree on that.

We already know that.

Well, I mean, it does reflect some of the ongoing --

Michelle, this is Nick, there was also a $10 million reclass that was made during the quarter that reflected the first quarter SG&A numbers as well.

The change isn't as dramatic as it appears.

Okay.

Aside from that, is there anything else unusual?

It should reflect some of the ongoing impacts of our cost reduction effort, but also a change in the stock appreciation rights.

I guess that would flow through there also.

Yeah, the other expense.

We have taken a big whack out of our administrative cost structure.

We have compared to combined salary, if I could use that as a crude reference, employment at the date of the National acquisition, we have about 1,500 fewer salaried management kinds of workers around the Company today than we had then, largely in administrative functions.

Okay.

That's really terrific.

One more question.

I haven't heard you talk about this in a while, but I know you talked about it a few years ago, which was spinning off Tubular, was kind of the pet project I guess the tubular bubble didn't last long enough to do more than kind of dust it off.

What are your thoughts on that right now?

Does it make sense?

I would say we've done a lot of work to get it in a position to spin it off.

We're now starting to see them actually generate some results.

I think a few quarters of good results, I think will make some type of a strategic move with the Tubular business easier.

But this is a business that we're looking for what will best enhance our shareholder value for this business, and there are potentials anywhere from spinnoffs to some type of association with others in this business.

We're open for a whole host of things.

We are, I would say -- we've had discussions with others in the past.

This is something that strategically we're just trying to maximize its value.

Currently it's doing very well.

We're looking, as John indicated, strong pricing improvement in the third quarter, our costs are under control.

But down the road, if the right situation presented itself, this is an asset that I would put in the noncore category and that we would be looking at something that might enhance the value of this business.

Our next question comes from the line of Charles Bradford from Bradford Research.

Please go ahead, sir.

Good afternoon.

Chuck.

Clearly, you had a pretty large flat-rolled price increase, about 108 per ton.

But an operating profit gain of only 57.

I think, Gretchen, you identified a couple of different items, and maybe 3 that were cost increases.

And I was wondering if you could put a little bit of meat on -- you said negative LIFO, higher raw material costs and profit sharing.

Can you put some numbers on what these might have amounted to?

I'll just give you some general direction.

I guess the most significant thing would be materials and scrap and alloying other furnace additives, electrolytic [inaudible] those kinds of things, we use a lot of because of our contract book.

Those together would be the single largest cost increase period to period.

Natural gas would be among the other high-cost increase items.

And then coke, which we talked about before, net-net had some upward pressure on cost as well.

Then profit sharing, I'm not sure exactly how to express that.

Certainly some portion of that profit flows to the various streams we have, and I guess that would be 10 or 15% of the gross number to some degree at the higher level.

So those would be the headline items in probably order of significance.

Okay.

Can you also talk a bit about the prices, you alluded to significant price increases in the last quarterly conference call, you were a little bit more specific about how much that could be on the Flat-Rolled and on the Tubular side.

Could you do that again?

I think this last quarter we were coming off of the first quarter where we had just begun to move prices.

I think we were able to look out and see what the affect of that ramp up would be pretty clearly.

I think the relative rate to move up this time would not be anywhere near what we experienced between the first and second.

We'll continue to have some favorable price increases.

But not knowing where the surcharge scrap team is going, I'm don't think we want to get much more specific than saying we expect realized prices to be better in the third quarter than they were in the second.

Thank you.

Our next question comes from the line of Bob LaGaipa with CIBC World Markets.

Please go ahead, sir.

Thank you.

Good afternoon.

Hi, Bob.

I just had a few brief questions for you.

One to get back to coke just for a moment.

I was interested just from a volume perspective how much coke was actually purchased in the quarter year-to-date and what you expect the coke purchases to be for the remainder of this year.

If, in fact, you'll actually be, given your outlook, a net purchaser next year.

To give you the last answer first, we, in all probability, will not purchase coke of any consequence next year for domestic production.

It's possible that opportunistically in the south, for example, there's a couple of merchant producers that are quite nearby one of our plants.

Just for logistics reasons occasionally we might do something like that.

In terms of needing to in quantity in '05, the answer is not of any significance.

Let me just go over the numbers one more time.

I've done this several times.

I'll try to do it quickly.

We'll produce about 7 million tons.

We need to consume about 6.5, which gives us a slight overage of about a half a million tons.

We sell 2.8, we buy 2.3.

I think those are the same numbers I reviewed with you all back in the last quarter.

Most of that 2.3 buy has already been completed or is under contract.

In fact, from here to the end of the year, most of it was under contract late last year.

Really the spot buy, which we disclosed last quarter in this call was about 700,000 tons of spot buy.

Most of that has been purchased and received for that matter.

I wouldn't want you to think when we purchase it and receive it also goes through the P&L, because there is some accounting that goes on there with our overall accounting system and LIFO calculations.

So we had a short position of 700,000 tons to cover I think I described last time.

That is either physically purchased or it's in a boat somewhere or we have contracts that give us some good insurance.

We're covered commercially at this point.

Terrific.

I just had two other quick questions for you.

One, in terms of your order book, how far out actually are you booked out at this point?

There's a little bit of proprietary information in an absolute complete answer to that question.

I would just tell you that in general we have been keeping our order book relatively short and during this kind of market that has served us well.

Okay.

And also in the European operations, in terms of the contract business, if I recall, the contract business there was about 20%.

I was just interested in maybe getting a little additional color as to what kind of penetration you're getting in Europe, especially given these price gains.

Contract business would be 15 to 20% at the highest.

It would be largely -- tin would be our single biggest amount, 10 to 15, maybe some of the dynamo stuff.

Those I think we'll be able to improve our position there nicely through the rest of the year.

But that won't happen until a little bit later.

Most of our business there, indeed most of the business in Europe, for that matter, is done on the spot trade.

As I said earlier, we made a big move, followed a big move, made our own big move early in this month and we're doing quite nicely with it.

You mentioned the other blast furnace potentially coming up to speed, depending what the demand would be.

How quickly would you be able to physically do that?

It takes some time, because we have to order controls and refractories and those kind of things.

We were just there recently and had a look at it.

If we fast track it, it could be some period of months, not a month or a week, it could be 6 months or 8 months, something like that, depending on how long we actually get after it.

Terrific.

Just final question, the pension and OPEB cost given the contributions, I was just interested in what you expect the remaining overall cost, not just the cash cost to be for the remainder of this year.

The pension OPEB cost that we described in our outlook in the last MD&A or 10-K or whatever should be relatively stable.

The contributions won't really begin to affect the accounting costs until next year sometime.

The actual P&L impact for both pension and OPEB should be -- I would think, Gretchen?

About 300 million.

Yeah, but it should be consistent.

Whatever we said it was is what it should be.

Right.

Suffice it to say it should be much less than next year, given the contributions.

That's a fairly complicated subject as well, it really depends on -- it's going to be a discount rate and then as the assets perform we drop off the third oldest year and bring in the most recent year, last year was a pretty big year.

So until you really grind through the calculation it's really hard to see.

This year's asset performance will make a difference.

Terrific.

Thanks very much.

I guess the only other thing I'd add to that is that our current forecast 2004 cost didn't really reflect the impact of the Medicare legislation.

We did have it disclosed in our footnotes what the affects of the obligation would be, but that could reduce the expense going forward.

Our next question comes from the line of David Tupper with Appaloosa.

Please go ahead, sir.

How is it going, guys?

Actually just to clarify it's Mike Lucas.

I just want to ask a few questions.

You said that the spot market in the U.S.

I'm trying to understand price realizations and you're saying that quarter-over-quarter for the third quarter the margins wouldn't be up that much.

I just want to a make sure my notes are correct here to start off.

Basically, we're talking about a tubular market.

Can you give me where you see that market right now?

I've seen it with a couple of your competitors, Maverick and Lone Star looks like 1,000.

Is that fair?

My comments were really on the Flat-Rolled business.

On the Tubular business there's been substantial price moves and we ought to continue to see improvements on the Tubular business.

I'm not sure you can compare our prices directly to some of the competitors, it's going to be different materials, different size ranges, different applications.

But the direction is going to be the same, which is up.

Okay.

Actually, I wanted to touch on the Flat-Rolled.

Even in the Flat-Rolled I'm a little bit struggling with that.

Let's just say you do 1.7 million tons spot in a quarter and we're talking about a market that's up probably 130 bucks, is that right?

That's base plus surcharges, to which I've seen several prices, saying you guys get 750 to 780 on that market.

I'm trying to understand why you say flat.

The only thing I would say is, not every ton is for the quarter is going to be priced at what the highest price we've seen.

Okay?

So that's -- we don't have a whole lot more yet to book for the quarter.

A lot of our sales have already been taken care of because we have lower production, because of 2 furnace outages, as Gretchen pointed out, we're going to have 200,000 tons less tons to sell, that's going to be largely spot hot roll, which would have been a very higher margin, I wish we had it, but we've got to get the furnace taken care of.

So when you boil all that together and look at the average price for the quarter, including mix affects because a lot of people do less buying in July than they otherwise would have, and you put all that together we would see prices being higher in the third quarter versus the second, but not at the same rate of increase that we saw in the second quarter compared to the first.

That's one of the reasons why John is keeping this order book in tight, so that as these kind of prices do improve and we go into the fourth quarter we're not out already booked out at that.

Okay.

Let me ask this a different way.

Is there any way you can me what your realized price was on spot price market transactions in the second quarter?

I can't give it to you in one number.

I mean, we sell spot market in a lot of different grades and industries and there's a lot of different price structures that prevail, one for hot roll.

I can't give you one easy number on that I'm afraid, Mike.

Our next question comes from the line of Alex Latzer with Merrill Lynch.

Please go ahead, sir.

Thanks Following up on an earlier question regarding some of the cost savings you're getting on National acquisition.

I was wondering if you could just go into more detail on how you're proceeding with the cost savings, whether you are still targeting the quarter million by year end.

To what extent are those cost savings helping you with respect to some of your raw materials cost increases?

We've really run through the tape we think on our objective of 400 million.

A big chunk of that was administrative, as I said before.

We really have basically eliminated the entire total National administrative cost structure and taken on all the duties now with U.S.

Steel administrative cost structure and reduced that even further.

The big chunk of that was the represented labor through the new steel worker contract with large reductions in elimination of job classes, et cetera, et cetera.

That sort of 20% job production, roughly 3,000 people, they're virtually all out of the plants now, just a few that might be here or there because of some training requirement or otherwise.

Lots of the easier things like mapping customers through the local plant that reduce transportation by consolidating caster runs, by loading facilities, changing facilities from galvoline to galvonized, all these things have been in process.

We're now into the third or fourth derivative of cost savings.

I'm confident that we've run through the tape of the 400 million we set for ourselves and we analyze that and report to our Board on it quite regularly.

On the raw materials in particular, I mentioned our iron ore operations in Minnesota, both world class operations, Minntac and Kee-tac we had substantial employment reductions, we have far fewer people, they're extremely hardworking people, talented, very dedicated, fewer job classes, doing a lot of different jobs they didn't do before, safely, I'm pleased to note.

We have a very competitive low-cost facility now at Minntac.

It's not as easy to see because we've had such huge increases in natural gas and in scrap and things like that that we can't control.

But on our period-to-period hot band cost comparison, the things we said we could control as a result of our cost reductions, we got those, we can't control the scrap price or natural gas prices.

Okay.

All right.

Thank you for that.

And then lastly, I had a question on demand.

The rate of change that you're seeing in European demand, if you characterize it against the U.S., one would get the impression the U.S. demands -- rate of change demand remains strong overall, but that it's neither increasing but perhaps softening a bit from a very high rate.

In Europe one gets a sense that maybe we've bottomed and things are picking up a bit.

Do you get any sense in Europe that as we head into a relatively seasonally slow period, what you're seeing from a cyclical standpoint, whether you're seeing a fall in character with the seasonal period or a slight pickup related perhaps to a cyclical recovery there?

In general I think the vital signs are that Europe is improving.

We see some -- we look at Paresh and Disha in Germany and western Europe and in southern Europe.

But I would say in general, we see Europe as improving by all accounts the normal seasonal doldrums are upon us, and order flows slows down and shipments slow down.

We've been there long enough now that we expect that and have seen it enough that it doesn't really worry us.

We see Europe moderately improving.

But I think your overall assessment is correct, at a lesser rate than what we observed in North America.

Our last question is the follow-up question from the line of Mark Parr with Key McDonald.

Please go ahead, sir.

Okay.

Thank you very much.

If I was going to try to summarize what you said regarding the third quarter outlook, you're going to see significant improvement in Europe on the bottom line, significant improvement in Tubular's on the bottom line and perhaps some modest improvement on Flat-Rolled domestic on the bottom line.

Is that what I'm hearing you say?

In general, the last point, modest improvement.

We might do better depending on how the outage goes.

We have a furnace outage that we are finishing in Gary today as a matter of fact.

And then how the outage actually goes in Granite City, it's the first time we've done this furnace, so we don't know it well, assuming all that goes okay, and that our price expectations are met, then the scrap doesn't go in a direction we aren't prepared for, assuming all that happens, we may well do better in the third quarter.

Okay.

So then on the Flat-Rolled side, I sense a tone of conservatism with bias toward the upside.

I think that's what you're trying to suggest.

We're sort of congenitally conservative [Laughter].

All right.

One last question, I know this coke situation has been beaten to death.

Is there any number that you want to try to share with us looking into '05 as far as the delta on coke costs relative to '04, looking at a full-year scenario?

No.

The only thing I observe is I said earlier we had to fill a spot buy at about 700,000 tons or so and we won't have to do that next year.

You can make your own guess at the difference between what the cost of that was and what our own production cost might be, and do some multiplication and you'll come up with a number that's at least 3 digits.

And that now concludes our question-and-answer session for this call.

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