美國鋼鐵 (X) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the United States Steel Corporation fourth quarter 2006 earnings conference call and webcast. [OPERATOR INSTRUCTIONS] I would like to turn the conference over to the Manager of Investor Relations, Mr. Nick Harper. Please go ahead, sir.

Thank you, John. Good afternoon, and thank you for participating in United States Steel Corporation's fourth quarter 2006 earnings conference call and webcast. We will start the call with some brief introductory remarks from US Steel Chairman and CEO, John Surma. Next, I will provide some additional details for the fourth quarter and then Gretchen Haggerty, US Steel Executive Vice President and CFO, will comment on the outlook for the first quarter. Following our prepared remarks, we 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 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 quarterly report on Form 10-Q in accordance with the Safe Harbor provision. Now to begin the call here is US Steel Chairman and CEO, John Surma.

Thank you, Nick. Good afternoon, everyone. Thanks for joining us. Last evening we reported good fourth quarter results with earnings of $2.50 per diluted share, which you may have noted includes a pre-tax charge of 32 million for debt retirement. That item and two other items, which were not allocated to segment results, reduced that income by $33 million or $0.28 per diluted share. If you exclude those charges, our results were $2.78 per diluted share, well ahead of the average of analysts' expectations, which I understand was $2.21 per share. Looking back at 2006 in total for a moment, U.S. Steel had an outstanding year with record revenue of $15.7 billion. Record earnings of $11.18 per share. Record operating income of nearly $1.8 billion and record net income of nearly $1.4 billion. We also demonstrated the value of our well balanced operating position and each of our three main business segments earned operating income of at least $600 million.

Our record financial performance and strong cash generation provided us with the opportunity to increase our shareholder returns and improve our capital structure during the year, as we doubled our quarterly dividend rate, paying $70 million in total common dividends during the year. We also repurchased 7.2 million common shares for $442 million. We made $190 million in voluntary contributions to our domestic benefit plans. We invested $612 million in our capital base and retired nearly $600 million of debt. We now have less than $1 billion of debt outstanding as of today and our pension plans are again fully funded on a PBO basis. One of the most frequently asked questions on these quarterly calls of late has been what will you do with your strong cash flow. Our actions in 2006 provide a clear answer to that question. While the financial results and shareholder returns are gratifying, we are particularly proud of the improved safety performance we had in 2006, which is a key core value in our Company's top priority.

In 2006 we continued our quest to become a global leader in safety performance. Not just among steel producers, but compared to leading global manufacturers. In fact, our 2006 safety performance and global recordable cases rate exceeded that of one of our key benchmark companies, a feat that only a few years ago most of us here at the Company would have thought to be impossible. In 2006, on a global basis, our OSHA recordable rate improved by 30% and we achieved a 29% reduction in the days away from work cases. Our managers, employees and union colleagues deserve the credit for this extraordinary improvement, which has been facilitated by ongoing cooperation with union leadership both in the US and in Europe. I want to thank all of our employees for their contribution to making 2006 a much safer year for everybody. Now turning to our operations, we reported fourth quarter segment results of $414 million, a much stronger quarter than the fourth quarter of 2005 when we earned $313 million.

Our three main operating segments performed well under different market conditions as strong results in Europe and Tubular offset a weaker North American Flat-rolled business. There have been other quarters in which our Flat-rolled segment was a source of strength, while the other segments were not. We believe this operating balance provides U.S. Steel with a competitive advantage. Our Flat-rolled segment earned $31 million or $10 per ton in the fourth quarter, reflecting the combination of much lower shipments, lower spot prices and higher outage costs compared to the third quarter of 2006, along with the cost and efficiencies associated with operating at 67% of capability. Given this difficult environment, which was similar to that experienced in the third quarter of 2005, our Flat-rolled segment performed reasonably well, reflecting improvements in our cost structure over the last several years. With the fourth quarter behind us, things look somewhat brighter on the horizon. The domestic service center inventory bulge that began in earnest last spring, seems to have leveled off and has started to decline.

Flat-rolled imports have moderated over the last few months, which seems to reflect price imparity across most major steel consuming regions. As a result, we recently experienced an uptick in our order rate from very low levels in the fourth quarter and we restarted one furnace at our Mon Valley works earlier this month and one of our smaller Gary works furnaces just last week. We will continue to ensure that our operations are aligned with our customer needs and we are prepared to increase or decrease production based on customer order rates. In Tubular, we earned $144 million or $531 per ton as shipments declined 32,000 tons or 11% compared to the third quarter. The effect of lower shipments was partially offset by higher pricing on a better mix compared to third quarter. These results reflect continued good demand from the energy sector, partially offset by the effects of higher imports and distributor inventory levels.

Our European segment had another tremendous quarter, earning $182 million or $117 per ton. These results were fueled by continued strong steel demand from the fast growing central European corridor. The somewhat lower results compared to the third quarter was mostly due to higher costs, partially offset by higher prices. At our steel plant in Slovakia we are beginning to commission our new 350,000 annual metric ton automotive quality galvanizing line and we are on pace to begin coating strip in the next few weeks. Gretchen will review our outlook more specifically in just a moment, but I will make a couple of general comments. As I mentioned earlier, business conditions seem to be moving in the right direction. Whether a decline in North American service center inventory levels occurs in earnest depends on import levels and more specifically Chinese imports. We will have to wait and see if additional pressure on China, but only from the U.S. government but also from the European union, will facilitate resolution of the Chinese over production issue.

Also the weaker dollar versus most other currencies tends to work in our favor as a weaker dollar helps make our customers more competitive on a global basis. How well we do in 2007 ultimately depends on how well our customers do, which in turn depends on the overall economy. So if the economy continues to do reasonably well then we should do just fine in 2007. With that, I will turn the call back to Nick for some additional information about the quarter's results. Nick.

Thanks, John. Capital spending, which is detailed by segment in the earnings release, totaled $215 million in the fourth quarter resulting in full year capital spending of $612 million. Our current plan for 2007 has total capital spending at approximately $750 million, with $545 million for domestic operation and $205 million for European operations. Domestic capital projects for 2007 include coke battery through wall repairs at our Clairton coke operation, mining equipment at our iron ore operations and energy related projects at Granite City. In Europe, 2007 capital spending will consist of completion of the new galvanizing line in Slovakia, a blast furnace reline in Serbia and a number of environmental projects in both Slovakia and Serbia. Depreciation totaled $102 million in the fourth quarter and $441 million for the year. Depreciation is expected to be about $460 million for 2007. Defined benefit and multi-employer pension and OPEB costs for the quarter totaled $76 million. During the quarter we made cash payments of $71 million for benefits, primarily for retiree healthcare and contributed $20 million to our retiree Life Trust for salaried employees.

Our annual actuarial remeasurement indicated that due to good market returns on plan assets and a revised discount rate, for our pension plans -- our pension plans were overfunded as of December 31, 2006, and therefore the $1.4 billion after tax additional minimum liability established at the end of 2005 was no longer required. Also in the fourth quarter, we were required to adopt a new accounting standard governing accounting for benefit plans. FAS 158 has the objective of fully recognizing the funded status of benefit plans on the balance sheet. The required AML entries, combined with the adoption of this accounting standard for pension and other benefit plans, resulted in a $186 million net charge to equity. For 2007, we expect our pension and OPEB costs to be approximately $237 million compared to $312 million in 2006. Excluding voluntary contribution, we expect our 2007 cash pension and OPEB payments to be approximately $328 million compared to $332 million last year. Additional detail will be included in our 10K, which should be filed late next month.

Excluding the $32 million charge associated with the early redemption of our 10.75% senior notes, net interest income totaled $7 million in the fourth quarter. We expect first quarter interest expense to be about $20 million before the effective interest income on cash balances and foreign currency remeasurement gains or losses. Our 2006 tax rate ended lower than we had projected at the end of the third quarter. This rate change resulted in a $58 million reduction to our fourth quarter tax accrual to adjust the tax provision for the first three quarters to the final rate. This reduced annual tax rate mainly related to, one, a higher proportion of annual income generated from Europe where our tax rate is lower and two, changes in deferred tax items triggered by reversal of the $2.3 billion AML established at the end of 2005 as our pension plans are now over funded. The latter is a complex calculation that includes the impact on deferred state income taxes caused by reduction in income tax rates since the deferred tax asset was initially established.

Our 2007 estimated annual effective tax rate will be determined based on domestic results taxed at the statutory rate of about 38% and Slovakian earnings tax at a flat 9.5%. Lastly, for the quarter we averaged 119 fully diluted shares. Now Gretchen will review some additional information and the outlook for the first quarter.

Thanks, Nick. Cash flow was very strong in 2006, with our cash provided by operating activities reaching nearly $1.7 billion, even after $190 million of voluntary funding for our employee benefit plan. Our free cash flow after capital spending and dividends but before external financing was just over $1 billion. So we ended the year with over $1.4 billion of cash and about $2.6 billion of total liquidity. As we've highlighted before, we do continue to accrue a profit based payment liability to be used to assist National Steel retirees with healthcare costs that have not yet been paid because the Associated Trust has not been established. As of the end of the year we had recorded a liability of $360 million for this purpose. As noted in the earnings release, we repurchased 700,000 shares of common stock in the fourth quarter for a total cost of $46 million. This brings our total repurchases to 13.1 million shares, or nearly $700 million and represents about 10% of the balance of fully diluted shares outstanding when we authorized the original repurchase program in July of 2005.

As John mentioned earlier, we retired nearly all of our 10.75% senior notes during the fourth quarter. Our balance sheet debt at year-end stands at 1.025 billion. With the redemption of 49 million of our senior quarterly income debt securities on January 2, our debt is now below $1 billion. The funded status of our pension plans is now over 200 million overfunded for accounting purposes as compared to 600 million underfunded at December 31, 2005. Our OPEB funded status on a projected benefit obligation basis is about 2.2 million underfunded, slightly better than last year. With these reductions, our debt-to-total book capital improved from 33% at year-end 2005, to 19% at year-end 2006. Our adjusted debt-to-total book capital ratio, which is more like how certain rating agencies and investors tend to look at it, and includes after tax underfunded employee benefit obligation, also improved from approximately 51% to 35% year-over-year. These ratios, as well as other relevant credit metrics, have improved markedly over the last few years to what we and some others view to be investment grade levels.

They are consistent with our desire to be a modest investment grade Company and still have the flexibility to continue our balanced approach to capital allocation by growing the Company, meeting our debt and employee obligations, and returning capital to our shareholders. Since our ratings dropped to below investment grade in 2001, we've had an objective of regaining those ratings. In November, Fitch raised our rating two notches to a triple B minus investment grade rating. Earlier this month, S&P also took positive action, raising our rating by one notch to double B plus. Our objective is to continue to produce ratios consistent with an investment grade rating through the cycles. Our financial accomplishments from 2004 through 2006 have been many, including averaging 1.6 billion of income per year and 1.1 billion of net income per year. Over this 2004 to 2006 period, we have also spent 1.9 billion of capital. We've reduced debt by almost $1 billion. We've voluntarily funded our employee benefit obligations by almost $700 million.

And we repurchased 13.1 million shares for $700 million, while raising our dividend four times, all while we ended this period with strong credit ratios and significant liquidity. In announcing the upgrades, the agencies noted our strong financial performance, our improved balance sheet and cited the permanent improvement to our assets and capital structure. Now turning to our outlook. For the first quarter of 2007, while we expect first quarter results to decline from the fourth quarter, we are beginning to see some recovery in the domestic flat-rolled market and we are adjusting production accordingly, as John mentioned. In the Flat-rolled segment our first quarter shipments are expected to improve from the fourth quarter level, while average realized prices should remain near fourth quarter levels as higher contract prices are expected to offset lower spot prices. Our costs are expected to be in-line with fourth quarter levels for the Flat-rolled segment.

In Europe, first quarter shipments are expected to increase and averaged realized prices are expected to be slightly lower as the result of increased import product availability on the European market. Again, our costs are expected to be in-line with fourth quarter levels. In Tubular, first quarter shipments and averaged realized prices are expected to decrease as import levels and customer inventories remain high. And our costs are also expected to remain in-line with fourth quarter levels. Finally, first quarter results for other businesses are expected to be consistent with our historical first quarter results for that -- for those businesses, but will decline substantially compared to the fourth quarter due to normal seasonal effects at our iron ore operations in Minnesota and not the non-recurrence of the fourth quarter land sales that we mentioned in our release. With that, Nick.

John, please queue the line for questions.

[OPERATOR INSTRUCTIONS] First go to the line of Kuni Chen with Banc of America Securities. Please go ahead.

Good afternoon, everyone. My first question ties into CapEx spending and growth, kind of on a longer term basis. Can you give us a breakdown of some of the projects or projects under consideration that provide either growth or cost savings. Obviously, you talk about the galv line in Slovakia. But if you look at most of your peers, I think people tend to talk about a backlog of growth projects that now stretch into the 2008 and 2009 time frame. I just want to see what you are thinking on that basis.

I can't speak for our peers, of course, but speaking for us I think there will be two broad categories. In Europe we have a good number of market facing growth opportunities, Serbia in particular we are still exploring the upper-end of what our production capabilities there and we will be doing work on one of the blast furnaces and beginning to -- or continuing to work out the bottlenecks that allow us to hit the run rate we think that plant can hit, which is well beyond what it has hit so far. And not only that, we also have a chance to improve our product mix in Serbia and Slovakia with the new galv line. We are going to be using a lot of what are called world market facing opportunities are, so we have got to think about doing things on -- particularly in cold roll capacity to continue to meet those growth markets in Europe.

So lots and lots of market facing opportunities in Europe, including potentially another galv line that may be more construction oriented. Those are decisions we haven't made yet. They are good decisions to make and it's a choice among what the best opportunities are. I think in North America we have quite a lot of opportunities on the cost improvement side around energy efficiency and that would be more in the hot end coke making opportunities, co-gen opportunities, things that would improve energy efficiency given the higher energy price structure, even though it's come off a bit now. Those would be a couple of broad categories that come to mind.

Quick follow-up on pricing. You mentioned that flat-rolled prices should be about flat sequentially. If spot prices are down, I calculate roughly 35 a ton, implies that contract should be up 35 a ton? Is that the right way to look at it or is are any mix differences as you go from the fourth quarter to the first quarter?

That's not a bad analysis. There will no doubt be some mix and that really is going to depend on how strong the more spot oriented industries come on or how good the man is. I shouldn't say strong necessarily. But I think your analysis is directionally pretty accurate.

And I'll turn it over. Good luck.

Next go to Michelle Applebaum with [Marr] Research. Please go ahead.

Hi. Congratulations on a pretty decent performance in a difficult environment. Would you have ever thought you could run at 67% and make well over $2?

The last time, Michelle, this is John, the last time we ran at 67%, I looked back this morning, was the fourth quarter in 2001 and our Flat-rolled segment lost $152 million.

Wow. That's just incredible. It's just amazing. I have a bunch of questions and I guess I'm excited about what you are doing in Europe. Could you just talk about how the timing of the galvanizing line will come through this year and how that will impact sort of prices and spreads?

Well, as I said, we have to go through the startup process, which we are working our way through right now. I was over there just -- we were over there just a few weeks ago and the line looks terrific and it's been, I think, a good construction project. Operators are being trained. We are trained here at our Pro-Tec Joint Venture and training at the mill that the last line like this was installed, so we are taking all the right steps, we think, to have a smooth startup. And there is a startup curve that has physical start, of course, but then market penetration over the course of the year will beginning a couple different markets. Some into the construction service center market earlier and then eventually into automotive and appliance.

Then throughout the next two years expectations of qualifying on additional automotive opportunities as they are presented to us. I think it will be like most other startups and market projects, we have got to get qualified on the higher end products for the customers that are looking for it. We think there is plenty of demand for it, we just have to work our way through it. In the totality of the European segments, pricing and mix and spreads, I don't know that they will have a huge impact this year. They will be positive wherever they are but probably not a huge impact this year.

And a bigger impact next year?

Should be, yes.

And then the other question was, I guess I have seen a lot of commentary that Newcor raised sheet prices for March orders last week. I haven't seen anything specific about U.S. Steel's activity in that arena. Do you want to comment on that?

I would comment that you are not likely to see anything from us in that arena. I think, Michelle, our view is, of course, that we want to try to have an appropriate commercial strategy to get the most the market has to give us within the construct of what we have available. And just given the way the markets move, it is entirely possible, including the fact that scrape has remained fairly high, that there could be some opportunities for improved pricing on spot business that we would be placing in March. I think that's a likely prospect. An opportunity we'll do our best to take advantage of, but that's what we think our market allows us.

Okay, but you don't announce your price increases, correct?

Not normally, no. We think that's between us and our customers.

Okay, great. Thanks a lot.

Thank you.

Our next question is from Chris Olin with Cleveland Research. Please go ahead.

Hi.

Hi, Chris.

I was just hoping to get a little bit more color on your guidance. When you say down sequentially, does that -- is that looking at a pretax number or are you looking EPS basis?

We tend to talk about segment -- on a segment basis, Chris. It's really before tax.

Great. Secondly, does it make sense to bring on all this steel making supply so quickly? I recognize orders are improving, but it seems like it is coming off a very low number. I'm wondering what's the thought process in putting all this supply into the market so early?

If you are talking about us, all we are trying to do is to make sure that we produce and supply what our customers order. And the order rates have picked up a bit. We are not interested in producing for inventories, we said quarter after quarter. On the other hand, we're not interested in getting our customers upset by having lead time and delivery time problems either. So we aren't anxious to get behind. Trying to keep it within a decent quarter. There is a lot of guesswork in all that, of course, but we think the amount of supply we have coming on right now is geared nicely to what our market expectations are and what our customers ordered.

We are being disciplined about it and we can pull back.

As my comment said earlier, if necessary we will add capacity or reduce it, as the case may be, to keep in-line with our customer orders.

Finally, I just want to know if you can discuss some of the demand trends that you are seeing in the tubular marketplaces, excluding the inventory situation. Are you seeing any orders drying up for specific product categories right now?

No, not really. I think the underlying fundamentals are still pretty good. The level of results we had in the last quarter and what we expect in the coming quarter by historical perspective are still quite good. There is pretty heavy inventory, if you look at the various market analysis that are public, there is pretty heavy inventory levels and pretty heavy import penetration as well. Until those two things flatten out a bit, we are likely to have a little bit of choppy water. But still the underlying fundamentals, drilling and the amount of holes being drilled and the amount of pipe that is being laid are still pretty good.

How long until you can work out or work through that inventory out there?

On the tubular side? I don't really want to hazard a guess as our guidance kind of suggests. We don't necessarily expect a big change in the first quarter, could happen. But it's really hard to say until we see the fundamental change on the import level and perhaps some change in the business activity beyond pretty good levels we are at right now.

Thanks a lot.

Thank you.

And our next question is from the line of Edings Thibault with Morgan Stanley. Please go ahead. Edings, your line is open. Please go ahead. Mr. Thibault, your line is open. Do you have any questions?

No, thank you.

We will move on to David MacGregor with Longbow Research. Please go ahead.

Good afternoon, everyone. Can you hear me okay?

Yes, David.

John, third quarter your flat-rolled product average price realization was 651. In the fourth quarter it fell by $3 to $648. Now I realize there was a fairly substantial mix development there. Can you just talk a little bit about sort of that quarter over quarter delta in pricing, how much of it was mix and if you can provide any more granularity on the mix story that would be helpful. And then obviously your contract versus spot ratio changes a little bit as well. Can you talk a little bit about that. Just help us better understand some of these pricing dynamics.

David, you're comparing the third quarter average realized of 651 to the fourth quarter of 648?

Correct.

As you can see it came out fairly close. I think during the fourth quarter spot prices were moderating and, of course, our participation in the spot market dropped off in our contract business, even though some of that dropped off was probably a little more resilient. What you see are some reductions in spot price realizations offset a little bit by heavier contract participation in total.

What was your spot contract mix in the fourth quarter? Can you help me with that?

I don't -- I would only be guessing but instead of saying 50/50 it was probably more like 45/55. Or something along those lines.

45/55. And then can you talk a little bit about the mix within your various flat-rolled product lines?

You mean by industry or product?

Yes. When you are curtailing operations to that extent, how does that influence the mix? You break it down between hot rolled, cold rolled and coated sheets.

We were doing that. We are producing what the customers order. It all depends on what the order intake was. The biggest product that got cut probably was straight hot roll. I think that's what the bigger product mix at the service center market and the converters would be. So more of our -- the utilization rates in our higher end finishing facilities were probably higher than what the overall capability rates would otherwise have indicated.

I think that's fair, John. I would say that quarter to quarter change in shipments, more than half would be hot roll related.

Okay. Just a couple other quick questions. I'm sorry, your European business, that's typically been about 30% contract sales. Did that change at all heading into '07 and with decoding line, how does that -- what does that number look like for '07?

It's fairly similar. Maybe a little bit higher than that for '07. The new line doesn't have a lot of contract business attached to it yet. It may during the course of the year and we would very much expect it to next year. A little bit higher as we ramp up some tin volumes in Serbia that typically would be contract. So that's just bringing along a little bit more volume on some of the same contracts. And we have been successful in placing a little more of our Slovak production in some good contract businesses as well. So, I'd say it's up a little bit but not a lot. The biggest step change will come, I expect, next year when we have a full year capacity under our belt on the new automotive galvanized line.

Good luck with that. What is your forward visibility on your tax rates for '08 and '09?

We are essentially a full taxpayer domestically and we are 9.5% rate taxpayer in 2007 in Europe. So our overall average tax rate will depend upon the contribution to income from either of those businesses. Obviously that's shifted throughout 2006. That's part of the story on our tax rate in the fourth quarter. So I think those are really the rule of thumb that you should use, David. And when you develop your forecast for domestic you can use a full federal rate and 9.5% in Europe.

You did say '08 and '09. I'd encourage you that when our 10K gets filed we will have a little more color around the tax situations in Slovakia, our tax credits, how long the reduce rate lasts, and all that. Usually do that update in the 10K and rather than doing it here, I'd encourage you to have a good look at that because we will have a little more information in the longer term outlook there.

Yes, I think that's enough.

Last question is just on the Tubular business. You don't really have a presence in western Canada right now. How do you address that going forward? Is that an area where you'd like to be positioned and if so how do you establish that presence?

Well, we have some product which gets there through distribution, but probably not very much and our existing facilities serve an existing market that has been a pretty good market for the last few years, so we aren't looking to necessarily reposition into that market right now. So I don't really have any specific plans to offer that we are trying to get there. We think our existing markets have plenty of growth in them and plenty of opportunities for us, but to try and completely reposition and penetrate that market in a big way is not something that is in our current Tubular commercial strategy.

Okay, good. Thanks very much, guys.

Okay, thanks, David.

Our next question is from Aldo Mazzaferro with Goldman Sachs. Please go ahead.

Hi, John, and congratulations on the balance sheet improvement, it's tremendous.

Thank you, Aldo, we appreciate that.

I'm wondering about two things. In the domestic market, I'm wondering as you bring back capacity here, as you see your order book improving, I'm wondering if you could give us some ballpark guidance as to what you think your operating rate might be in the first quarter, maybe second quarter. And also how you balanced the options you might have on pricing. As Newcor brought on the $20 in March, I am wondering whether you feel the market can accept a little price and a little volume at the same time?

There's a lot of signs and arc and all that, Aldo, and I don't have a good answer for you on the latter question but I will come to it. On the capability question, it will be, I expect, unless something very unusual happens, higher than it was in the fourth quarter, that's an easy statement to make. And probably not as high as it was during most of last year. So whether it's 70s or 80s, I really don't know, but that depends on really how the rest of the quarter plays out. It is still early enough that we have decisions we have to make and the decisions involve the kind of access of analysis you just described about what we are bringing on, what our order rates are and where we are commercially in the marketplace. Lead times are getting a little bit more stretched out.

Our anecdotal conversations with customers, particularly in the important service center and tube conversion and sheet conversion markets suggest that they are working away on inventories, but how much. Until the numbers come out, it's really hard to tell. We have, as you saw in our outlook, some cautious optimism that things are improving because that's what our order rate tells us. And we think that the capacity that we've committed to, that I commented in my earlier remarks, can well be absorbed by the order rates we've already experienced. And we think, as I also said, given a strong scrape price environment, that there probably is some opportunity for a price response.

And I think, Aldo, at a investor conference that I attended not too long ago, I did observe just in a conjecture more or less that when and if imports began to move off, when and if inventories in the service center sector begin to come down, if scrape prices remain strong, there probably was an opportunity for some price response pretty quickly. That may well be what's happening, too early to tell yet, but that may well be what we are seeing here.

We do have some planned outages in the first quarter, as well. But we don't expect it to be a big swing quarter to quarter in outage costs, so we really didn't say anything about that. So you'll expect to have some furnace down.

And we are going to be running at something less than full capacity through the quarter. We are not running full out, there is no doubt about that.

The next question is from the line of Michael Willemse with CIBC World Market. Please go ahead.

Just on your first quarter guidance, you are looking for a cost per ton to be flat sequentially in North America and Europe. In North America with the pension and OPEB expense down year-over-year, and also with your operating rate increase, I would have thought your cost per ton would come down. Is there an offset there that is bringing it up in the first quarter?

Most of that pension and OPEB expense decline falls out in retiree benefit expenses below the segment results, Michael. So we were talking about segment results quarter to quarter. That's where that will -- most of that will fall there.

That's a good point. Another category of cost that I think has offered pressure for us in the first quarter is coal and coke. Our coal cost will likely be up $7 per ton, not a lot but five or less probably per ton. But we do burn up a lot of coal and make a lot of coke. So I think that's one cost pressure that we are dealing with. And while zinc has been high, we expect it to stay high. We use a lot of zinc for coating, of course, and that's another cost category that has some pressure. And then even though we don't use as much scrape as those in electric furnace model, we do use some scrape and we expect to pay more for that, too.

And in Europe, you have been operating pretty much full capacity for quite a few quarters now, since third quarter 2005. When do you think you might have another major outage at one of your blast furnaces in Europe?

We probably will have some work to do in Serbia later in the year, as I quickly alluded to earlier. When the job gets set up, if indeed it's set up, it probably would be in the second half of the year and of course those aren't our biggest furnaces but they are important to us. If there is one to happen it would be more likely in Serbia, more likely in the second half of the year. We have maybe some smaller things to do on one or two of the furnaces throughout the year. That is not necessarily any different than it has been (technical difficulties).

So in Slovakia you can still go with current rates easily for all of '07?

Yes, we have one furnace which is nearing the need for some more significant work, but I'm not so sure that we are prepared to talk about when or how long it might take at this point. We're not ready yet from an engineering standpoint.

Lastly, on the Cap Ex projects, there is a number of them listed for the U.S., new mining equipment, new coke batteries, there is some work at the coke batteries. Is there a cost savings associated with that that you could kind of suggest?

You get better production when you do through-all work on the battery.

It will improve our performance compared to where the batteries were when they last operated, but I'm reluctant to give you any kind of a number per ton because I think it's the amount of through-all work we are doing and the totality of our coke production probably is not going to be all that significant.

Our next question is from Michael Gambardella with JP Morgan. Please go ahead.

Good afternoon, John, and congratulations on transforming U.S. Steel and also assisting in transforming the whole global steel industry. I wanted to ask you a question. We have been talking about a re-rating of U.S Steel and other steel stocks, what we think is much higher earnings power. And I tell you, the one push, big pushback I seem to get from people who want to be negative on that is just how is U.S. Steel going to react on a sustained demand downturn. Can you address that? We have seen how you've led the Company in say the fourth quarter operating at 67% and still generating over $2 of earnings. Could you talk how you would envision operating under a demand scenario that would be weak for say a prolonged period of time?

Well, Mike, we unfortunately have a lot of experience in that. First, let me thank you for your very kind comments on behalf of our 44,000 employees who did all the hard work. We appreciate that. You are very, very generous with your comments. We have had some experience in it. I think the performance that we had in the fourth quarter and the conduct you observed by us in the fourth quarter could easily carry on for an extended period. It's not fun and we would much rather be working in a hot market with a growth oriented environment. But if we need to curtail operations and maintain cash and draw inventories down and we know how to do that and we would not mind doing that. Would rather be in a strong market but if we had to in a market that was not able to sustain a higher production level, we are prepared to do that.

The fact that our cost structure allows us to do that and be profitable, not wildly so, but profitable at a very, very low level gives us the confidence to say that we are prepared to do that. And we have been saying that, as you know, every quarter, even when we were very high operating rates. The reason we say that is we are trying to make it clear that that's our policy and we're not just into seasonal thing. That's what we do. We intend to keep doing it that way and if we have to do it for a longer period, that's what we will do. Now, at some point in time there is pressures on capital and other things and could we curtail capital if necessary for cash purposes, of course we could. We know how to do that. We know how to spend $300 million, we know how to spend $600 million. We can do that if necessary. We think we have the capability and the expertise to do that if called upon, if necessary that's what we will do.

That's great. One last question. Any progress in looking at a iron ore position in Europe?

No. I would say we continue to look and have discussions, but nothing that I would categorize as progress. That's important. Having said that, we have excellent relationships with our suppliers and they have been reliable and reasonable even though we have tough negotiations over that matter and our profitability in Europe has been strong. It's not that we're handicapped and would like to improve that position, but the dynamics in the marketplace haven't been supportive of that so far. So nothing specific to report.

Thanks, John.

Thank you, Mike.

Next from the line of Mark Parr with KeyBanc Capital Markets. Please go ahead.

I would just like to add my congratulations, too. The change in your financial performance and your market positioning is just amazing. It's really wonderful.

Thank you.

One of the things I was wondering, I don't -- I think there was somebody else who already asked this question one way. I would like to ask it a little different. With the 900 plus million of CapEx projects you have for this year, could you talk a little bit about how you go about improving CapEx or do you have financial hurdle rates or what sort of a return do you expect on CapEx on a go-forward basis?

Actually I think we were saying $750 [MULTIPLE SPEAKERS] expectation. Well, we have got a formal approach to projects that start from the ground up at every location, they'll build develop projects that they know will improve their costs, take advantage of market opportunities, maintain their infrastructure. I mean and we will -- every project gets written up, described, it goes through a review process. But we start with a budget which is approved by our board and then we go through and cull through the projects as the year goes on and we will approve them. This year -- we do have a lot of infrastructure spending and we have had a lot of infrastructure spending. Those, by definition, don't have a return assigned to them. And we have to make a judgment about which ones need to be done based upon a particular -- what shape our facilities are in and our priorities. We will go through that. But then we will look for market opportunities. That's how we get the high dip line. A lot of our customers were heading towards Europe with automotive facilities and we rather quickly moved that up the list of potential projects in the future to take advantage of it, come together very quickly.

On the -- just one quick follow-up, Mark, on the -- particularly on the market facing stuff and particularly in Europe, we are probably more constrained just by developing the projects, assessing where we think the market is going to be and then developing our plans as to how to address it, doing the engineering, getting the project together. We are willing to spend the capital on those kind of things because they are high return projects. As you have seen on the galvanizing line, we committed to it and we are just about finished with it. My guess is there is a good number of those yet to come behind it.

If I could just ask a follow-up on European operation. Could you share approximately what the output at Smederevo was in '06 and what you think the potential is for it? And is there a potential to add a third furnace there?

A third blast furnace?

Yes.

I guess there is always the potential, Mark. I don't know that that's anything that we -- it's not anything I have given any serious thought to, I know that. My colleagues may have, but I don't know about it. But the infrastructure there really isn't designed to support a third furnace. And we are sort of getting limited now on materials on the input side and product on the output side, transportation, logistics. A third furnace would be a heck of a challenge and that would have to be a long ways away and have a lot more infrastructure around it before you could do that.

More opportunities to maximize production there and then maybe market stuff down.

We talked about Smederevo when we first got involved there that it was sort of a nameplate, 2 million ton per year capacity plant. And we are closing on that number this year, should be depending on the outer schedules, et cetera. The one thing I can tell you is it has got a really nice hot strip mill, which is what John Goodish and I first saw when we walked through that plant in a very dark day in 2002 and a strip mill's got capability to have another stand, roughing stand put in that could juice it a little bit. It has got a foundation for a third [reede] and for a third down quarter. So there is a lot of potential in that strip mill.

That's kind of where I was coming from. It seems like the steel making side of that operation was really undersized for the rolling capacity that's there.

It is. It's a first class strip mill that's gotten better every year. I think we also have opportunities to take slab from Slovakia down to Serbia and we haven't really explored the upper reaches yet of what we can do in the blast furnace [indiscernible] in Slovakia. So we have more steel we can make in Europe.

Just one last question, what's your natural gas assumption for the first quarter relative to the fourth.

It's too high. I don't know that I have a specific assumption we can mention.

Our assumption is going to be basically what you can see on the curve.

We just take the strip and work with that.

Okay, terrific. Thanks again. Congratulations.

I should say we have locked in some but not 100%.

Okay. Terrific. Thank you.

Thanks, Mark.

Next one is John Tumazos with Prudential. Please go ahead.

Congratulations. Not only on the earnings, but on spending every penny wisely.

Thanks, John.

All the acquisitions you didn't do this year. British Steel, Wheeling Pitt, and all these things. Your cost of sales in the Flat-rolled division appeared artificially high because of mix in the low operating rate. It's 638, not cost of sales but all the cost other than operating profit?

Yes.

I don't know if the right number adjusted for the operating rate or mix was 575 or 600. If you could talk a little bit about what the normalized cost was and then looking back three years to an unusually good quarter in the fourth quarter of '03 for cost of 422? Shouldn't we just look at the business as we're here where the costs are $200 more? Or are there opportunities to lower it?

John, if you are looking back that far, I think compared to '03, earlier '04, I think the current cost structure for the industry is probably up $200. I think you are in that zone and that's metallics, it's carbon, it's energy, it's zinc, those things are all up substantially, additives, everything that goes into the furnace additions. Everything is up probably double from where we were back in those days. I think the cost structure is up and not likely to change a lot, at least from what we can see in the near future. That doesn't mean that John Goodish and the operating team aren't out slugging away and trying to take out $5 or $10 a ton every quarter, every year because we do and they do a great job of that.

But, $50 or $100 ton kind of change, that only is going to come if there is some major change in the underlying structures for the various raw materials I talked about. The way you might also look at it would be what was the operating income per ton back then and how is our operating income per ton effected in the fourth quarter versus the third quarter. If the cost were higher because we did have a higher proportion of coded product and zinc costs were particularly high and that increase cost would also increase the prices, of course, to some degree as well. There is a lot of moving parts there. Your basic premise is the costs are a lot higher, I think you right.

Just as a minor example, zinc has been running about $0.50, as much as $0.90 more than aluminum. For construction products can you change coating lines to aluminum from zinc.

We can and we have lines that produce both. We have some dual lines that can produce galvalume and galvanized and indeed there have been some customers who were exploring that change. They have to get their process to where they can use it for whatever they are using for deck or roof or whatever. And A, we had customers changing. In fact our galvalume capacity is probably getting a little bit on the tight side right now and typically galvalume would be a little bit more costly to make because of what change has to happen more often, a little more costly to process. Then we have a line that we used to make both on and we switched to galvanized only that we would have to look at moving to galvalume if in fact zinc stayed so high that our customers really wanted to move that way. So that's sort of playing out in the market place right now. It is something we are watching very carefully. It's a good point.

Thank you.

Our next question is from Don MacDougall with Adage Capital. Please go ahead.

Good afternoon. My congratulations as well. Most of my questions have been asked already. But I didn't hear what the change in the discount rate assumption was for the pension.

We increased it a quarter of -- 25 basis points to 575 at year-end '06.

And maybe while I have you if I could maybe just get a little bit more color, the commentary on pricing in Europe and particularly with respect to imports. Was that across the entire fourth quarter? Was that a late in the quarter phenomena? What is the outlook for imports and pricing momentum in Europe here in the first quarter?

I think the import flow into and particularly southern Europe was pretty consistent in the fourth quarter and maybe it was a little more severe a little bit later in the quarter. Of course, our mix in Europe is still largely spot oriented. We would be more effected by that than perhaps others who are more contract oriented on Europe and a lot of our market, particularly out of Serbia, is more in the southern European market so we might also be effected more by it then compared to others. A lot of the imports have been from China. The European Union and Eurofair and others are trying to cause some attention to be placed on that. We have not observed any further deterioration in the first quarter, moving into the first quarter in Europe and we are trying to work with what we have. It's sort of the same pattern we see here in North America maybe playing out just a tad behind where we are here. How quickly things may consolidate to where there could be stability and maybe an opportunity for increase in spot pricing. I don't know. That could happen in the first quarter, could happen in the second quarter.

John, is it your sense that the import volume you are seeing in Europe is coming from North America now that pricing is kind of normalized a little bit more here.

Not from here, but it's probably some volume that could have come here that's now -- .

No, that's what I mean, redirect.

I think that's very possible. I think probably -- in fact it's quite likely.

Thank you.

Our next question is from David Gagliano with Credit Suisse. Please go ahead,

Most of my questions have already been asked. I was just wondering if you could frame the magnitude of the expected decline in volume and prices in the Tubular business in the first quarter. Is it similar? Should we be expecting a similar type of decline that we saw in Q4?

Well, I -- actually I think Q4 probably ended up a little bit better than we were expecting because of some opportunities we were able to take advantage of. And we really don't see that -- it could materialize in the first quarter because Tubular is pretty much on a spot basis anyway. But I think we are looking at something a little more than Q3 to Q4.

Okay. Fair enough. And then just in terms of the end markets in the U.S. I'm just curious if you could give us a little more visibility into specifically what end markets you have seen or which end markets where you have seen the strengthening lately.

It's almost consistent across all of the markets that we are selling into. The inventories got heavy in the fourth quarter and that's not just the intermediate service center and the pipe and two conversion and sheet conversion. Even the construction markets, the metal building folks, automotive, appliance, electrical equipment. Everybody that we sell to, the specific industry groups, be they distribution processing, early ins had heavier inventories, little bit of a hiccup in the economy, bit of a slow down, reduced order rates late in the quarter, and many of the customers we speak with now are beginning to clear the inventory out. They foresee higher operating rates later in the quarter, certainly later in the year. And began to see some holes in inventory and they are beginning to order again.

That same drama has played out over almost every market that we sell to. And it's common now, I think, in the service center sector those that we sell to that the service center customer's beginning to see some holes in their inventory and therefore they are working with us. I just think it is a cycle we have gone through and it's not been particularly pronounced in any one market, the service centers in particular, because they hold so much inventory, saw it probably the most severely, but almost everybody else saw it. But that same pattern had a brief hiccup and then a consolidation and now moving off to a, we hope, a better start for the year and a decent second half of the year. That sort of where we see things right now in the marketplace.

That sounds -- obviously sounds like it's across the board. So based on what you know today, do you think your operating rates will continue to trend higher in the second quarter versus the first quarter?

We don't know much about the second quarter today. We know our contract positions or at least we know what denominations are. But that the economy does reasonably well that could likely be the outcome because we have furnaces that have not been on during some of the first quarter that we will have on during part of the quarter if we continue to operate at the same level throughout the second quarter then by definition our capability rates will be higher. I'm reluctant to look out that far because we can't see that far just yet.

Thanks very much.

Next we will do to Robert Richard with FTN Midwest. Please go ahead.

Thank you very much but my questions have been answered. Thank you.

Thank you.

And we will go to Tony Rizzuto with Bear Stearns. Please go ahead.

Thanks very much. Good afternoon. Congrats again on all of the excellent progress across the board.

Thanks, Tony.

All my questions for the most part have been answered. But two things that come to mind. Are you guys seeing any softening at all in your European markets because there seem to be some of the leading indicators appear to be flattening out, maybe turning down a little bit. And secondly, John, if you can just update us on what your current mix is with automotive here in North America between big three and the NAMs.

The first point in Europe, we had some softening in prices because of, we think, import particularly in southern Europe and particularly from China. But the overall Euro zone is doing pretty well, in particular the central European quarter that we sell into, the growth rates there have been consistently ahead of the rest of Europe and the peripheral countries around our marketplace, Germany, France, et cetera have all had decent economic performance. I would say we see things in Europe as looking pretty good. Not perfect. Not great but pretty good. In your second question about automotive. We tend to think and you can think of our position with each of the manufacturers is roughly equivalent to what their market position is for the U.S. market. If you would just look at the overall manufacturers and look at -- and prove them anyway you want to, our participation with them is about what their participation is in the total market.

Thank you.

Our final question will be from the line of [Basim Molick] with Neuberger. Please go ahead.

I have one quick question. You talked about what you have done with your free cash flow in '06. And said that that could be the template for '07, but you have paid down a lot of debt and you have shown some production discipline to do at 67% operating rate that you are profitable and were able to manage your supplies and production. Does that give you more confidence that you can direct more of your free cash flow toward buyback?

I think we have done a pretty good job of directing free cash flow to buybacks and that's certainly an option that we have available to us with our board authorization. So I just think we feel confident about that and we probably have some debt reduction opportunities to look at as well. And we have some funding of our OPEB. But I think we are looking at more of the same in '07. We've got heavier capital spending planned but we've got plenty of financial flexibility to take advantage of opportunities that present themselves.

Can you elaborate on the opportunities in terms of how something John Tumazos sort of mentioned in terms of deals not done. How you can approach that.

Well, you know, I think what John is saying is that we've exercised some discipline on the acquisition front and we will continue to do that. But I do think we have got plenty of financial flexibility to take advantage of opportunities if they are the kind that we want to take advantage of, that's all. That's really what I mean in terms of opportunities.

Got you.

Our financial position has improved so markedly over the last three years that we can just be -- we can take advantage of a lot more things that are balancing a lot of opportunities that we weren't able to do three years ago.

I would just like to comment as a shareholder that to the extent that you practice operating restraint in the face of overcapacity or oversupply industry. Your stock will be valued a lot more on normalized earnings and return on capital rather than on trough earnings or the tendency of companies running flat-out in oversupply. And I think that to the extent that you take that free cash flow and buyback shares it does the same thing to the earnings leverage and I think it long term increases the value of the enterprise.

Thank you.

Thank you, It's good advice.

Thank you.

Presenters, any closing comments?

I would like to thank everyone for participating and we will talk to you next quarter.

Ladies and gentlemen, this conference is available for replay. It starts today at 5:30 P.M. eastern, will last until February 6 at midnight. You may access the replay at any time by dialing 320-365-3844. The access code is 857571. That number again, 320-365-3844. The access code 857571. That does conclude your conference for today. Thank you for your participation. You may now disconnect.