美國鋼鐵 (X) 2009 Q2 法說會逐字稿

Welcome to the US Steel Corporation second quarter 2009 earnings conference call and webcast.

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

Later, we will conduct a question-and-answer session and instructions will be given at that time.

(Operator Instructions).

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Dan Lesnak.

Please go ahead.

Thank you, Chris.

Good afternoon, and thank you for participating in United States Steel Corporation second quarter 2009 earnings conference call and webcast.

We'll start the call with brief introductory remarks from US Steel Chairman and Chairman John Surma, and next I will provide some additional details for the second quarter.

And then Gretchen Haggerty, US Steel's Executive Vice President and CFO, will comment on the outlook for the third quarter of 2009.

Following the 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 included in our most recent annual report on Form 10-K and updated in our quarterly reports on Form 10-Q in accordance with the Safe Harbor provisions.

Here to begin the call is US Steel Chairman and CEO John Surma.

Thanks, Dan.

Good afternoon, everyone.

Thank you all for joining us.

Earlier today for the second quarter we reported a quarterly loss of $392 million or $2.92 per diluted share.

That included a $0.36 per share [variable] effect of two nonoperating items.

Before I get to the results, let me first say a word about safety, which continues to be our number one priority regardless of operating conditions.

Year to date, our global OSHA recordable rate and our global days away from work rate have continued to improve and we remain unwavering in our commitment to safety.

And we thank our employees for their shared commitment in most important of our objectives.

Second quarter was a very difficult period for the domestic steel industry and for our company, as the AISI reported industry utilization rate of less than 45% for the quarter and steel consumption in the US was at the lowest level in some decades.

Weakness in several of our major markets resulted in capacity utilization for our North American flat-rolled operations of 32.4% as demand for tubular products fell off dramatically and two of our major automotive customers worked their way through bankruptcy and restructurings.

As a result of the significant decreases in selling prices, we've incurred substantial lower cost to market inventory adjustments in recent quarters, including approximately $100 million in the second quarter.

While inventories at our flat-rolled operations in the US are not generally affected by LCM adjustments, as we have some very old LIPO inventory layers, inventories in Canada, Europe, and our Texas operations have been affected.

As we'll discuss more in a moment, we have recently experienced some improvements in order rates.

Our Granite City operation is back to work and we are making and shipping more steel, but the sustainability of this order trend remains uncertain as both the US and global economies struggle to recover.

We anticipate that we'll continue to face challenging conditions until a recovery becomes more apparent and more sustained.

Now let me turn to our results.

We reported a second quarter loss from operations of $465 million, which included pretax income of $45 million from a reversal of a litigation reserve as a result of a favorable court ruling and pretax income of $34 million associated with the recovery of federal excise taxes that were paid on coal export sales way back in the early 1990s.

Net interest and other financial costs in the second quarter of 2009 included a foreign currency gain that increased that income by about $41 million or $0.31 per diluted share due to the remeasurement of a US dollar denominated intercompany loans to our European affiliate and related Euro/US dollar derivatives activity.

Our North American flat-rolled segment had an operating loss of $362 million in the second quarter.

As a result of weak demand in our markets and a continuing destocking of inventory throughout the supply chain, our flat-rolled shipments decreased almost 15% to 1.8 million net tons, and average realized price has decreased $38 to $677 per net ton.

The flat-rolled results included approximately $285 million of continuing employee and other costs associated with our idle facilities as compared to $230 million in the first quarter as our Lake Erie plant was idled for the entire quarter and we idled additional iron ore capacity.

We had an operating loss of $53 million for the second quarter of continuing employee and other costs associated with our idle facilities, as compared to $230 million in the first quarter, as our Lake Erie plant was idled for the entire quarter and we idled additional [ironwork] capacity.

We had an operating loss of $53 million for the second quarter in our European segment, a significant improvement compared to our first quarter loss of $159 million.

Shipments were just over 1 million net tons, a 15% increase over last quarter, primarily the result of the destocking process slowing and an increase in automotive related orders in part as a result of government incentives.

While average realized prices fell $70 per ton to $602 per net ton, we realized the benefits from lower raw materials costs, a $34 million gain from sales of emissions allowances and lower inventory writedowns.

For our tubular segment, we had an operating loss of $88 million in the second quarter.

Shipments were 92,000 net tons in the second quarter, down 56% from first quarter levels, and prices fell 35% to $1,526 per net ton.

This severe downturn was primarily driven by the combination of lower demand due to reduced drilling activity and extremely high inventory levels in the tubular supply chain caused by unprecedented levels of unfairly traded and subsidized tubular imports from China.

The tubular results also reflect idle facility carrying costs of approximately $25 million and lower cost to market adjustments.

Now I'll turn the call over to Dan for some additional information about the quarterly results.

Dan.

Thank you, John.

Capital spending totaled $88 million in the second quarter and our full year capital spending plan remains at $410 million.

Depreciation, depletion, and amortization totaled $159 million in the second quarter.

We currently expect it to be approximately $630 million for the entire year.

Pension and other benefit costs for the quarter totaled $104 million and we made cash payments for pension and other benefits of $108 million.

For the full year, we expect our pension and other benefits cost to be roughly $465 million and we expect required cash payments for pension and other benefits to be approximately $525 million.

Net interest on the financial costs totaled $9 million in the second quarter and included a foreign currency gain of $32 million.

Our effective tax benefit rate of 17% for the quarter was lower than [statuary] rate because losses in Canada and Serbia, which are jurisdictions where we have recorded a full valuation allowance on deferred tax benefits, do not generate tax benefit for accounting purposes.

Lastly, the weighted average shares used for EPS purposes for the quarter was 134.6 million shares, and the 27.1 million shares we issued in our public offering were only outstanding for about two-thirds of the quarter.

These shares will be fully reflected in the EPS calculations for the third quarter.

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

Thank you, Dan.

In the second quarter, our cash flow provided by operating activities was $52 million, including a working capital benefit of $423 million.

Cash flow used in investing activities was $131 million and cash provided from financing activities was $888 million, which includes the net proceeds from our issuance of common stocks and convertible notes of more than $840 million after we repaid $655 million in term loans with the proceeds.

The total change in cash was an increase of $819 million in the second quarter and we ended the quarter with $1.95 billion in cash and total liquidity of approximately $3.1 billion.

Turning to our outlook, while we anticipate an increase in our third quarter operating rates from the extremely low levels of last quarter, we expect each of our segments to report an operating loss in the third quarter due to continued low operating rates, idle facility carrying costs, and lower average realized prices.

There are some signs that the destocking cycle has ended in the North American and central European steel markets as increased customer orders across almost all industry segments have resulted in an extension of lead times.

We have begun to bring up idle facilities in line with customer demand and we've implemented price increases in our flat-rolled and USSE segments in the third quarter.

Despite these signs of improvement, the outlook for overall demand remains uncertain and the timing and magnitude of sustained economic recovery remains difficult to forecast.

For flat-rolled, third quarter results are expected to decrease from the second quarter, reflecting lower index-based contract prices, which tends to lag the spot market, as well as increased shipments of lower margin semi finished and hot-rolled product.

Raw steel capability utilization and shipments are expected to improve in line with increased customer orders as we restart raw materials and steel making operations.

However, the favorable effect of these items are expected to be offset by higher raw material and energy costs as well as costs to restart idle facilities at our Granite City Works and several raw material operations.

Consideration will be given to restarting other facilities if sustained customer demand supports higher production levels.

Also, we're currently negotiating with United Steelworkers for a successor to the labor agreement covering our Lake Erie Works operations, which expires on July 31, 2009.

Our third quarter results for US Steel Europe are expected to be in line with the second quarter.

Lower raw material and energy costs and higher spot market prices later in the quarter are expected to be offset by the nonrecurrence of the gain on sales of emission allowances and lower cost contract prices.

We have experienced a delay in the intended start up of our third blast furnace at US Steel Kosice, but it is expected to be operating in late September.

In the meantime, we're meeting our customers' requirements with increased production at US Steel Serbia.

Third quarter results for tubular are expected to show some improvement compared to the second quarter, mainly due to a slight increase in shipments as customers fill limited inventory needs for certain specialized products.

However, we expect an operating loss as we continue to incur idle facility carrying costs and shipments in average realized prices continue to be depressed by the inventory glut created by the surge in unfairly traded and subsidized products from China.

Dan, that's it.

Thank you, Gretchen.

Chris, can you please queue questions?

(Operator Instructions).

And our first question is from the line of Kuni Chen with Bank of America.

Hi, everybody.

Hi.

I guess to start off, obviously you have some price increases on the table for September and October.

Not going to ask you to comment on pricing, but I just want to know for your flat-rolled guidance if there's some element of higher spot prices baked into your outlook there?

And can you also give us some perspective on where your order books stand relative to September and October?

Sure.

I'll touch on both of those to the extent I can, good and fair questions.

On the order book side, as our release indicated and as Gretchen mentioned, order flow has improved, bottomed out probably in April and May and order flow in June and so far this month has been better and we're out into September at a pretty healthy clip for some of the longer lead time contract business we're probably out further than that.

But really hard to say much more about how sustained and how long that's going to be at that level.

So we're really reluctant to make any predictions.

But so far at least from the bottom, which again we think looking at our figures was in April or May, things look a bit better.

There's been lots written in the trade press and elsewhere about price moves.

We don't usually say much about it publicly, but we're trying to obtain what the market price is and right now those prices are higher than the low point in the spot pricing at least as we saw it probably in June.

We'll get, I suppose, some of that in this quarter, this current quarter.

But because we do have a good bit of business that's on indexed, either monthly, quarterly, semiannually in certain cases, I think as you saw last year when prices were moving up, it took us a quarter or so to catch what you saw in the spot market.

This year, we held on a little bit longer as the spot price came down.

That lag effect is going to be part of our business cycle now.

I think we've tried to work with our customers to have a little more sustainable pricing mechanism that doesn't have as many ups and downs in it.

So the price move is in the right direction.

Begin to see some, but it will take it longer to work through the system.

Okay.

And then just as a follow-up, can you give us an update on the potential for permanent capacity shots and really go through how your thought process has evolved here over the past one or two months?

And then also for Gretchen, can you walk through some of the major cash costs associated with any permanent potential closures?

There's not a whole lot we can say about that.

We, of course, are looking at our configuration all the time in good markets and in not so good markets.

It's a question really of what we foresee in the market and how long and what course the market will take to get to a level that would sustain our configuration at a reasonably high and profitable level of utilization.

Things are just so opaque in the market that it's really hard for us to reach a current conclusion on that right now.

We're looking at it, studying it, considering what the effects are one way or the other.

I remind people from time to time that in 2003 everyone said we should shut down Granite City.

We didn't and then the ensuing seven or eight years, we made -- or six or seven years we made $1 billion.

So I think there's a risk in waiting and a risk in going too soon, and we're going to try to make the right decision with with better information than we have today, because today we just don't have a good view of how long and where the market is going to go.

We think there's a pretty good chance that the level of consumption, which was implied by what the shipments were for the industry back in the middle part of the year, was unsustainably low.

We're probably moving back into something that's more aligned with what real end use demand is, but we don't have any idea what that demand is until we have a little more time to assess it.

I don't think for the long term it's likely that the US steel consumption per capita will be one half of what it's been for the last 20 years.

That seems unlikely, but it's possible.

So we want to get a better fix on that before we do anything that would be longer term.

Gretchen.

As far as cash costs, if we were to consider some shutdown of facilities, the near-term costs would tend to be more from the employment side, cash comps there.

There would be some longer term, I guess, that we would have to consider -- environmental costs, for example, depending on what location we would be looking at that might not entail immediate cash, but it would have to be in consideration in lieu of all costs of a potential shutdown.

And there's probably some contractual commitments, too, for suppliers of one kind or another.

If you dug way back in our history in 1979, 1983, 1987, 1991, you would see those kind of actions were taken, we had to do it, and those would be the elements of what we had to contend with back then.

Okay.

Thanks.

Thank you.

And next we'll go to the line of Timna Tanners with UBS.

Please go ahead.

Hi, good afternoon.

Hi, Timna.

Wonder if you can give us a status report on the restarts of capacity that have been discussed?

I was surprised that you mentioned that there would be more of a impact of semi finished production and the flat-rolled US operations if the new demand is considered to be more high-end auto.

So could you explain that, please?

I'm not sure what -- can you just clarify, Timna, about semi finished?

I am not sure I understand what you said.

Sorry.

You talked about on the third quarter the mix shift would be more low end, and I was confused by that because I did think the restarts of capacity were meant to meet some of the auto related demand.

I understand.

We're trying to meet every piece of demand we can find, we're trying to keep our facilities running.

In recent years, when we've had more of a semi finish capability, beyond what we needed for our own finishing, we have done some semi finish sales from time to time.

And those have been up and down -- this particular quarter looking ahead is likely to have a bit more, and when you look at the realized price number we'll disclose at the end of the third quarter, there will be an impact there.

And we just thought we would draw that to your attention.

I would say that's really separate and apart from our overall demand, although it certainly helps to keep the facilities loaded.

The order flow is coming from a variety of sectors -- automotive would be one of them.

And we're looking at what's being ordered and what we can make where and what the capabilities are and we've arrived at a configuration that has, I think as was noted in the release and as Gretchen pointed out, I mentioned that Granite City is back up and operating.

I think both furnaces are online at this point and most of the facilities are operating quite well, and we're going to let the market tell us whether there's more that needs to be done.

We haven't decided that yet and we don't normally talk much about it, although others seem to.

And we'll try to make sure we have enough capacity on to satisfy our customers, but we're not in the business of laying slabs on the ground to wait for someone to show up and take them.

That's not what we do.

So we've described what we're doing in Granite City.

We do have a little more ironwork coming on to keep things in place, although we'll continue to draw inventories down from an [iron] standpoint.

We have what need at this point.

We may need to do more.

We'll let the market tell us that and we look forward to doing it if we can.

Okay.

Can I just ask about tubular inventories?

I know the data we get from MSCI doesn't cover it entirely.

Can you give us an update maybe incorporating the broader inventory that you know of maybe at the ports and other sources?

Sure.

We look at a number of sources for tubular inventory.

The MSCI tends to be more on structural and other things that aren't part of our tubular segment directly, although we sell to those, flat-rolled, and those markets are doing pretty well right now.

But on the OCTG, which is of more importance to us, the inventories are quite high, although recent reports that we get from a couple of sources plus our look into our distributors, which gives us a pretty good view and I think we get pretty good data there, it might suggest that the inventory drawdown has started, not in a huge amount, but it looks like maybe we're over the peak.

That will be affected not just by what's being produced in the imports, both of which are down probably, but also by how much consumption there is and I guess the drilling rig rate is back over 900, if I saw the last figure that I saw, and that's certainly good news.

It's not 2,000, where it was last year, but that's probably good news.

So I think we're in the drawdown phase, but that could take some time.

But inventories seem like they're on the way down.

Okay.

Thank you.

Thank you.

Next we'll go to the line of Luke Folta with Longbow Research.

Please go ahead.

Good afternoon everybody.

Hi, Luke.

Couple of questions.

First off, regarding the percentages of shipments you have under the quarterly contract reset pricing, can you give us an estimate of how much that would be as a percentage of your business in North America and in Europe as well?

Well, in Europe our total contract business is on the order of 30%, so it would be some piece of that and not a huge piece necessarily.

I think on the North American piece, that's somewhat flexible and fluid because we're going through those revisions all the time.

But if I just looked out through this year, the amount that would be on some kind of index base probably would be -- on the order of 20% of our contract business might be on an index base, something like that.

And then there would be a financial index.

We also would have some indexation going on against cost-based imports -- that's probably another 15% to 20%.

So a meaningful part of our contract business is on some kind of adjustment based on index, either cost inputs or our financial index.

Okay.

And if you hypothetically were able to run full out now, now that you have Granite City back online, how much could you ship at maximum in the third quarter if you want to?

You mean with our current configuration?

With Granite City back online with your current configuration.

Oh, it would be on the order of -- it wouldn't be a lot more than we shipped in the second quarter, but probably at least 2.5 million tons, maybe a bit more than that.

And then just one quick one if you could regarding how much of the idled facility carrying costs you have in the third quarter and how much you think is going to impact results there?

Well, I think the third quarter idle facility costs should be lower for two reasons.

One, Granite City is running and we'll have some more raw materials operations running and, therefore, they'll be absorbing their share of costs.

And that's a positive, but also with the facilities that are still idle, our operators are doing a good job of continuing to whack the costs down and find ways to cut off the energy requirements and reduce the staffing that's required for whatever purpose and reduce the amount of OpEx services.

So we should have that moving in the right direction for both of those regions.

Thanks a lot, guys and very good luck.

Thank you.

Next we'll go to the line of David Lipschitz with CLSA.

Please go ahead.

Thank you.

Good afternoon, everyone.

Question for you on your coke and coal inventories.

Where do you stand on that?

Have you gone to any negotiations yet for next year or where do you stand on that?

Well, we're always in negotiations.

We have reduced the amount of coal that we're going to take this year to a level that we're agreed with our several suppliers is something both we and they can live with, a lot less than we needed.

We've in some ways reduced that by operation of the contract terms we have.

In other cases we've negotiated outright reductions.

In other cases we've moved it into later years, a variety of price discussions around that, usually with callers and some indexes, in some cases just to be negotiated.

So as a result, we have all we need this year, I'm sure, and we have some volumes of some significant amount in one form of contract or another through 2012, even 2013, meaningful volumes.

Not everything, but meaningful.

So we have a fairly good position with suppliers that we've, I think, established a good position with over periods of time.

And also, have you hedged any natural gas for next year?

No, not -- not of any consequence.

We have some cogeneration facilities that we buy forward for where we know against what the electricity price would be, which is usually too high.

We just go ahead and buy what we need to lock in what that savings on the rate would be.

But beyond that for our operating units, not very much.

Back up on the coal question, so on coke inventories, where do you stand versus your normal inventory levels?

I guess you have to look at normal in context of what we are operating.

If we were operating full, our inventory might be a tad on the high side, but not really for what we're operating now.

We have more than we need.

But our plans are to continue to draw down all of our raw materials as much as we can.

Coal and coke are difficult because we have commitments to take coal and it's probably better to store coke than coal.

We're trying to move the materials, the coal and coke, to locations where we need it including in some cases to Europe.

So I think our coke inventories will be about what we targeted them for.

We would make them lower if we could, but that's not going to be easy to achieve.

Okay.

Thank you.

Thank you.

Next we'll go to the line of Brian Yu with Citi.

Please go ahead.

Thank you.

John, in your European operations, how much of the drop in the pellet sale mix will be flowing through in the third quarter?

Oh, it's going to flow.

We've, I think, used up virtually everything.

It's not impossible we've got a pile of something somewhere, but I think virtually everything has been pretty well consumed, so the lower -- not just pellets, but [seaborne] ore and everything we're buying metallics wise.

The prices have come down substantially across the whole group.

So we'll see that pretty clearly in the third quarter.

We had a good bit of it in the second quarter.

Of course, the change in the spot prices in the second quarter didn't allow us to enjoy as much of it, but those lower costs will start coming through.

Okay.

And then sticking with the input side, where we're looking at metallurgical coast costs going out to 2010 -- I know it's very early, but it seems like seaborne spot prices might be moving up a little bit.

At the same time you're paying a much higher price this year than last year, and how should we think about seaborne dynamics versus -- and what types of cost position you have?

Well, we had a -- we do have higher coal costs this year.

We've talked about that in this forum a number of times.

And that's in part because we did a really good job of buying our coal in 2007 for 2008 and we were well below the big numbers you read about on the seaborne settlements.

We were nowhere near that.

I think our average costs delivered in North America were $125 million or $121 million, somewhere in that zone, delivered.

This year I think we've guided it towards about $160 million, maybe a little bit more than that.

That's probably a good number, which was lower than we were initially thinking when we were seeing the big price tags that you were referring to.

I don't know really how the seaborne settlement figures will affect that.

We're buying mostly from local sources, Appalachian sources.

We're got pretty good logistics and I think we're generally a pretty good customer because of where we are and how we transport things.

So my sense is our coal costs, we'll have to wait and see how it turns out, but we have a pretty good handle on that for next year, and I think our coal cost will be less affected by whatever the seaborne settlements are later and more affected by what we've accomplished this year in establishing positions with our suppliers for the longer term.

Okay.

Thanks.

Thank you.

Next we'll go to the line of Michelle Applebaum with Steel Market Intelligence.

Please go ahead.

Hi.

Hi, Michelle.

Hi.

I just wanted to compliment you on -- you got your 10-Q filed about an hour ago, and you do that almost every quarter where you get the 10-Q out within 48 hours of releasing.

That's very impressive.

Thank you, Michelle.

What we've discovered is waiting an additional 10 days or so doesn't make the numbers look any better.

Okay.

Okay.

I like that.

All right.

I wanted to ask you a little bit about trade.

You had an event that you're -- I think at the Mon Valley Works a couple of weeks ago.

We did.

Can you talk about that?

And there was some discussion of alternatives to trade suits, I think, that came out of that that I'd heard and I was wondering if you could talk a little bit about what we might be able to see on that?

Well, you're referring to the visit that Ambassador Kirk, the US trade rep, paid us at Edgar Thompson Works at their request.

We were delighted to make our plan available.

We do that pretty routinely for public officials if they wish.

And he made a very important presentation that covered a wide range of issues.

And I can't recall vividly, Michelle, what the one item is you're referring to, but I think he talked about trying to engage both his office and the appropriate commerce department folks in trying to spot problems early and try to work through those in some way other than waiting the long time it takes under our system to have a trade case go through from start to finish, during which time the industry that's affected like us can be damaged severely before any relief is granted.

So I think that was what he was describing, but I really can't tell you much more than that.

I'll defer to the experts on that.

Okay.

So you don't know if there might be alternatives to trade cases given the past -- ?

I don't recall the word alternative.

Again, my recollection of it was to try to spot and engage in discussions about problematic practices earlier, and I don't recall anything real definitive beyond that.

I'm sorry, I just don't remember.

Okay.

And then can you talk a little bit about the WTO case with China, the resource case?

Because that's different and I don't have a precedent for understanding that.

We don't have a lot either, but it's a matter that the industry, AISI, and member companies have been working with, supplying information and ideas to the USTR for quite some time.

It goes back a year or two probably and there are a number of inputs there that are of interest to us.

Other industries are affected well, coke and magnesium and zinc and a few other things that are important to us.

And the USTR decided to take that case to the WTO -- the technical term as I understand it is to ask for consultations -- and I think the EU at about the same time did about the same thing.

I have no idea if it was coordinated or not, but it happened about the same time and I think there's a process under the WTO of consultation.

I guess it's a discussion, I don't understand how that works.

If that doesn't lead to a satisfactory response, then a WTO adjudication process begins and that's about as much as I know about it.

But we were pleased to see the USTR taking that action early in the new administration.

We think it portends good things for trying to ensure that the trading rules that apply to everyone in the world are respected and that the rules must be complied with.

We think it's good.

Okay.

Thank you.

Thank you.

Thank you.

Next we'll go to the line of Michael Gambardella with JPMorgan.

Good afternoon John, Gretchen.

Got a question.

You're almost booked now in the US flat-rolled business.

You're almost booked through this third quarter.

So you have a pretty good handle on what that looks like.

In the second quarter, US flat-rolled you mentioned operated at 32% of capacity.

Where would you say you're going to operate in the third quarter?

Well, we have a lot of steel yet to make, Mike, but I think if just with our existing configuration that I described, just looking at raw steel, we would be somewhere north of 50%.

Okay.

So pretty meaningful increase, obviously.

Yes.

But -- and what kind of penalty do you think you take on these index link contracts on the pricing side in the third quarter?

Well, I'm reluctant to call it a penalty.

I mean if we could have our choice of making sure we always got the benefit and the customers always didn't, that would be a system that probably wouldn't work too well.

But I think it's just a lag, and we had it on the way up last year and on the way down this year, and we'll have it on the way up again assuming we do go up.

But if you look at our total average realized price thing, it's not a small number.

It could be $20 to $30 a ton, something in that range.

Okay.

Thank you very much.

You're welcome.

Thank you.

And next we'll go to the line of Mark Parr with KeyBanc Capital.

Please go ahead.

Thanks very much.

Hi, Mark.

Hey, good afternoon, John.

A couple of questions.

We know that met coal is up versus last year.

Could you rank order other raw material pressures that you're seeing for the second half of the year?

Well, scrap, which all of it is not a huge influence for is, is meaningful and that is certainly up from the low lows we had earlier in the year.

So I would say scrap is one that would be noteworthy for us.

Coal to some degree, although I think we've described that and we've essentially had those kind of coal prices in the system.

In the third quarter, we may have a slightly different blend that in and of itself is going to give us a slightly higher cost, but it's not a huge effect.

We will have some higher iron input costs in the third quarter because we're going to be consuming some materials and we have to reposition -- there's extra freight on it and we think that's an appropriate thing to do from a cash conservation standpoint.

We won't overdo that, but I think that will give us a little bit more cost in the near term, but I think there'll be some cash effect.

Beyond that, nothing that would really be significant.

Everything else is relatively stable.

Natural gas, you can see the strip the way we do.

The numbers are relatively low, but the strip is up.

So I mean we'll probably have higher gas costs, is but I think you can see that as well as we can.

Those would be the high points.

Okay.

Can you quantify at all the magnitude of the extra freight associated with the iron inputs?

Not specifically.

I think in general if you're talking about moving a ton of that kind of material, it's going to be $20 to $30, depending on what, where you have to move it, handle it more than once.

But it's in that zone probably.

So this is material that's moving from one mill to another?

Right.

Again, we're thinking of doing -- we've done some of that, we may do more.

It really depends on what we're running and what the configuration is and it's a long way from here to the end.

I have two more questions for you if I could and I'll just leave it open for you.

One is I was wondering if you could give us an update on some of the operational challenges that -- I think there have been some at Gary Works, I was wondering if there was an update there, any changes?

And, also, to what extent are you looking at engaging the export markets between now and the end of the year and thanks very much.

Good.

Both good questions.

Well, at Gary, it was widely reported earlier in the year we did have a refractory lining failure that took us offline for a while.

It's been repaired and the furnace is back in operation.

We've not been running it at full out levels, out of care and caution, and we have a longer term repair plan in mind and that may take place later this year, it may go into next year, depending on getting the materials we need.

It's a fairly specialized process.

Some important design, a lot of technology is this, and we want to make sure we get it right.

So in the meantime we've been running that furnace at a somewhat lower level than it produced at in the last several years when it was fairly new and in operation.

So I think there we're going to take that step by step in being very careful, thinking about the long-term importance of that facility to us and at some point likely we'll have a repair job later this year or early next year.

And that of course goes into our planning as to what our configuration is going to be as well.

Export sales, given where the dollar is going and if the experts are right, I'm not one that if the dollar continues to weaken a bit, that by definition makes that a bit more attractive.

We've had some export sales of hot band, we've had some export slab sales.

Most of the slab business has been domestic, but export potential is also there.

And for the right price and if it's our configuration those are attractive markets, we'll take those.

We've worked hard the last few years to establish those positions.

So we're not in and out.

We're trying to have positions that are fairly consistent, and customers at the other end, you know who we are and where we are.

We find that to be attractive, but only if the price is right.

Okay.

Thank you very much.

Thank you.

Thank you and next we'll go to the line of Tony Rizzuto with Dahlman Rose.

Please go ahead.

Thank you.

I wondered, John, if you could address the lawsuit in Canada.

I see the investment in Canada and they're requiring you to run the legacy Stelco operations.

I was just wondering what you see as the different possibilities of how this could be resolved?

And I've got another smaller question, too.

Well, in the -- our 10-Q, which was pointed out was just filed, has some I think disclosure in there on that.

Tony, I won't try to improve on that except to say that that's current and there's also, as I understand it around this whole investment Canada process, some pretty strict confidentiality requirements which we at least intend to respect and won't get into argument with them about it.

But I just observed that when we made the acquisition, we got off to a pretty good start and we were meeting all the requirements and I think there's like 31 of them or something like that, and we were running quite well and the employees and we were very pleased with all of that.

And lo and behold, we have an unprecedented and severe economic downturn and the most severely affected sector in the global economy has been steel, even though auto gets most of the news about it.

And I can only guess that the news of that economic downturn hasn't reached Ottawa, but I'm confident that over time we'll do what we have to do.

We know how to defend ourselves.

We'll do so vigorously, and at the end we look forward to running our facilities in a way that best fits our company's objectives and benefits our employees.

Very good, and the other question I have and you might have also covered this in the Q is was wondering if you could quantify the emissions credits that you received at US Steel Europe?

That was $34 million, Tony.

$34 million.

Okay.

And I think you refer to it in a text that it's not likely to be as large in 3Q, is that correct?

Well, I think we're saying to anticipate the nonrecurrence of that in the third quarter.

So we aren't anticipating any sales at this point.

Okay.

And just a follow-up on the tubular question earlier, I think I heard you indicate that there are some special -- more specialized products that you're seeing, maybe somewhat lower inventories.

I wonder if you can be a little bit more -- if you can provide a little bit more clarity to me in terms of which products those are.

Is it certain diameter ranges or is it some other type of quality?

No.

It would be -- and again, we're seeing holes that need to be filled, our Fairfield plant has a very responsive configuration, so we can respond quickly when a hole does come up in a customer's inventory.

And it would probably be focused mostly on the middle-sized range, 4 or 5 inch sort of stuff, higher alloy casing.

I think that would be the bread and butter of what we're seeing.

Fantastic.

Thanks very much, everyone.

Thank you.

Thank you.

Next we'll go to the line of John Tumazos with Very Independent Research.

Please go ahead.

I guess sometimes business is just rough, but there's a carbon rolling mill in Alabama that Thyssen is building, and in their literature they list four coating lines -- galvanized, galvanized, galvannealed, aluminized, and galvalume.

And given the importance of the auto market, I was wondering if US Steel has any plans to improve upon or renovate or invest in the coating operations?

It's a fair question, John.

We have been spending some capital.

We've added a number of facilities over the years.

When we acquired National, we got a couple of good lines in that transaction.

So we're aware of the potential new competition.

We don't fear it.

We'll take it head on, and if we do a good job for our customers, we'll do just fine.

We don't really have any projects to announce today, but we're looking at what the longer range requirements are for the auto sector.

We just talked today about some of those internally, and that's a key sector for us and we intend to remain competitive.

And if it takes capital, we know how to do that, but nothing specific that we can tell you that would be designed to deal with that competitor -- future competitor you mentioned or any other one.

Do any of the market share shifts with some of the traditional US companies -- smaller and nontraditional companies, bigger, Fiat entering into Chrysler's mix, do any of those change the preferences toward coating technologies?

I wouldn't even limit it to coating.

I think there are preferences that could emerge from some of those developments that would affect metallurgy as well and we're aware of those.

And I think longer term trends have been away from certain products and towards others and we've got to make sure we stay with or in front of that.

There are changes and they're not just today, they're three to four to five years out depending on what the configurations are for the cars that are being made here.

So I think the answer is yes.

I don't want to get into that detail, because it's really confidential information from our standpoint, but the answer is yes and we're aware of it.

Thank you.

Thank you.

Thank you.

Next we'll go to the line of Charles Bradford with Affiliated Research Group.

Please go ahead.

I've got a couple of questions.

First of all, generally, your operating rates have been pretty close to the industry average, which was 43.5% in the second quarter, but you reported 32%.

Was there anything that caused you to keep the rate lower or was it trying to hold pricing, was it mechanical problems, or what was behind it?

Well, it wasn't for any of those reasons, I can assure you.

We made everything that our customers ordered from us.

And I think I tried to mention this in my remarks, I might have been too subtle about it, but the two things appear to us to be one reason potentially for that would be that we're pretty heavily configured towards tubular, not just the tube rounds we make, but also the flat-rolled that would be otherwise going to our welded operations, which last year was 1 million tons, this year was virtually zero.

So the tubular business being so far off, I think, affected us maybe more than the broad industry average that you saw.

And then from an auto standpoint, that's an important sector for us.

We have strong positions with two of our large customers who went through a restructuring and had an interruption of operations of a variety of durations and those two things would be the two biggest things probably that we were affected by.

I would think that AK Steel would be hit especially hard by the latter even more than you would.

I guess you'll have to ask them.

Their rate was much better.

Okay.

Another area, you were building a spiral weld, a large diameter pipe mill in California with a couple of Asian partners.

What's the status?

The -- you're correct.

It's with POSCO, our long-term partner on the West Coast, and SeAH, who's in their line of business.

And we're just in the commissioning phase right now and testing and running trial orders, those kind of things.

So it's just in the commissioning phase and sometime later in the year we hope to be making pipe.

Are there any orders out there?

It seems like things have dried up quite a bit.

Everything has been slow.

I think the credit availability has been quite constraining in that regard for new projects, but it seems like line pipe orders are moving ahead at a slightly better rate recently, just slight.

And, again, everything from our standpoint is from a really low base, so I'm seeing some slight improvement from a very low base.

But I think there's a great need for additional transmission lines all across the country and I think eventually that market's going to be strong.

Thank you.

Thank you.

Next we'll go to the line of Sal Tharani with Goldman Sachs.

Please go ahead.

Good afternoon, guys.

Sal.

Hi, Sal.

Just wanted to get some color on the shipment levels in Europe.

You had a nice 15% increase sequentially and you also mentioned some government incentives.

Is that sustainable how you're seeing the market right now over there?

The general order flow in Europe has followed a similar pattern to what I described here in North America.

In April or May, things were bottoming out, been some improvement since then.

Some of that was from auto and I think it reflected in some degree the incentive programs that the governments had over there.

They were not nearly as constrained as the one that the US Congress passed recently and I think that's had a positive affect on our order flow.

There has been some written in Europe by analysts and other experts about whether that is just pulling forward demand and there will be a falloff.

Some of the same questions used to be asked about incentive programs in the North American market.

I just don't know that, Sal.

In the near term, the effect was pretty positive.

Whether or not that will be sustained, it's impossible for us to say.

And you are seeing an increase -- you didn't give a guidance in the shipment volume number for the USSE.

Do you expect a flattish, higher, lower?

Did we indicate in our outlook?

I thought we indicated somewhat higher shipments, which I think would be pretty likely.

Great.

Thank you very much.

I think slightly.

That was tubular.

I think we were silent on Europe because it's -- if it is somewhat improved, it's not going to make that much of a difference, so we talked about other things.

Okay.

Thank you.

Thank you.

Next we'll go to the line of Zack Schreiber with Duquesne Capital.

Please go ahead.

Hi.

Just a quick question.

In terms of the order books and their increase, I think your comment was that some of your products -- you're foreseeing them extend out to September, some of them you're seeing them extend a little bit further out.

Just wondering if you can elaborate on how much the order books are extending by and for what kind of products?

And what the length of those order books is relative now to where they were at the trough?

That's a good question.

I think the -- one way to look at it is what the promise front is or what the order input dates would be.

And those were in very, very short promise fronts.

Lead times were a couple of weeks time probably for hot roll and I think their -- at least ours are extended out now into the four or five to six week range, which is four or five probably much more customary.

And the other products would follow that.

Some of the coded products for us at least are out maybe even further than that.

Some of the demand pickup in some of the coated markets has been pretty positive for us.

So I would say we're -- for our current configuration, we're out at about an average level of lead time and promise front.

And that's pretty normal if you look back in recent cycles, that that would maybe lead to some opportunity to improve our position pricewise.

And, of course, that's what we were trying to do.

So from very short to about average is about where we would be.

And can you just talk about what implied utilizations your forward order books support, or I know that you've been saying quite religiously that you're only going to make that which your customers demand.

So should we just assume that, whatever the utilization you're running is, that's exactly what is being demanded, but is there some sort of utilization creep embedded in the forward order books as well?

It's hard to say and I'm reluctant to predict because of the way things are these days, the volatility is so extreme.

But I think as I mentioned before, with our current configuration, our implied utilization rate today is about 50%, maybe it's 51% to 52%, something like that probably.

And if we would maintain a stronger order book for a period, we might need to go a bit higher than that.

How far and how soon, impossible to say, but it is certainly better, meaningfully better than what we experienced during the very, very difficult second quarter.

All right.

And then just on the operating cash flow and the working capital benefit, the $423 million benefit, are we going to continue to have working capital benefits throughout the course of the balance of this year or are we sort of done with that?

And then the cash flow profile is going to be much more driven by core operating cash flows?

I can probably just talk a little bit more in the near term.

In the third quarter, we probably still have more room to run on inventories and we'll keep working on that.

We -- so I would expect still some favorable working capital effects from that.

But as we -- as our orders increase, notably, and start coming in, we'll be replenishing inventory and receivables.

So it will be a negative effect there, which is, I think, a welcome change, certainly.

But we still do have some room on inventories on the raw materials side and I can see probably at least a quarter's worth of release on that.

And then it's going to really depend on what we see on the order book and how we brought our facilities back.

And if we have a working capital build, I'll look forward to that.

Got it.

And in terms of the third quarter, should it be equal in magnitude or a little bit less than what we just saw in the second quarter?

I think we've run the course on receivables, so we're going to start seeing some effect on that.

So I would expect it to be less then in the second quarter.

Thank you.

And next we'll go to the line of Dave Katz with JPMorgan, please go ahead.

Hi.

I was hoping that you guys could talk about specifically what you would have to see in the market just by moving ahead with some of the deferred projects like in Q1?

Obviously you're operating conservatively.

What would it take to take those off of deferral?

Well, I think we would need to have a much firmer view of the longer term trend.

Given what we've been through in the last six to eight months, it's really premature for us to do that.

Besides, we have sufficient materials capability to supply nearly any configuration we can think of in today's world for some time.

So I know these projects take a long time and we think that's an excellent project in the world we had last year, but in the world we have this year, it doesn't have quite have the same degree of necessity to it.

So we know how to do the project.

It's got pretty good development prospects, we've got plenty of rocks to blow up, there's no problem there.

The real question is do we have a place to take the pellets and do we have orders to justify melting them?

And that's the question we're not really prepared to answer yet.

And would you be able to talk about the JV you have with JFE for the exchange of technical expertise and any updates there?

No.

It -- I think it's not so much a JV, it's really an agreement to exchange information and we have a variety of visits and our scientists and technologists and metallurgists focus on different projects of mutual interest.

They're very useful to us on a lot of cost savings and quality things that we worked on, but it's a technical collaboration and largely research oriented.

So really nothing more to say about it than that.

It's a relationship we value, but it's really a technology -- it's a technical research oriented relationship.

Okay.

Thank you very much.

Thank you.

There are no additional questions.

All right.

Thank you for joining us.

We'll talk to you next quarter.

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