AK Steel touts Q2 profit, "solid" liquidity; cut debt $142 million in quarter

By Paul Deckelman

New York, July 20 - AK Steel Corp. posted strong second-quarter numbers Tuesday - proof that the recovery strategy that the Middletown, Ohio-based specialty steelmaker has been following for much of the past year seems to have been working.

But as impressive as the numbers were - especially measured against big year-ago losses - company executives noted that they come at a time when the steel market is booming, a situation that might not necessarily continue. They said that "a lot of heavy lifting" is still needed - in terms of further concessions from its unions, its long-term contract customers and its raw-materials suppliers - to position AK to remain competitive with its sector peers at home and abroad over the long-term.

AK's second-quarter performance was "dramatically improved," the company's chief financial officer, Albert E. Ferrara, told analysts and investors on a mid-morning conference call following the release of the second-quarter results.

Second-quarter net income was $92.7 million (85 cents per share) - a sharp turnaround from the company's year-earlier net loss of $78.2 million (72 cents per share).

The latest results included several large positive items - an after-tax gain of $44.2 million on the sale this spring of the company's Houston industrial park and a $27.2 million tax benefit related to discontinued operations.

Excluding those special items, AK reported an operating profit of $56.4 million versus a year-ago operating loss of $115.2 million and income from continuing operations of $20.2 million (18 cents per share) versus a continuing operations loss of $86.6 million (80 cents a share), in the second quarter of 2003.

The net profit from continuing operations in the latest quarter, said Ferrara, broke a string of eight consecutive quarters in the red.

AK Steel's president and chief executive officer, James L. Wainscott, noted that when he took over the company not quite a year ago following the abrupt resignations of his predecessors in those two positions AK had "the opportunity, the ability and the will" to put the company back on a solid footing - and has now done so, first becoming cash-flow positive, then producing operating profits, and now showing net income for the quarter.

"We went from losing big money, on both an operating and a net basis for the third quarter of 2003, to making a solid operating profit and net income for the second quarter of 2004," he declared.

Liquidity "solid"

CFO Ferrara said that AK's liquidity picture "continues to be very solid." As of the end of the second quarter, on June 30, the company had $735 million of total liquidity, consisting of $267 million in cash and $468 million of availability under the company's two credit facilities.

He said that there had been no cash borrowings under either of the company's revolving credit facilities, although AK did utilize its credit lines for $153 million of letter of credit. The CFO said that outstanding letters of credit did actually increase during the quarter by $62 million due to the issuance in June of industrial revenue bonds through the Ohio Air Quality Development Authority. That financing came at what Ferrara called "very attractive variable rates," currently around 1.2%. It gives the company "added financial flexibility going forward," he said. The funds will be used to cover capital expenditures for a project at the company's Middletown works, slated for completion by May 2006.

Ferrara said that during the quarter AK had also entered into a new $300 million multi-year accounts receivable credit facility to replace the existing credit facility that was slated to expire on Sept. 30.

He said that excluding the $62 million of newly issued industrial revenue bonds, AK repaid $142 million of debt during the quarter, including the repayment of $80 million under the credit revolvers and the early redemption of $62.5 million of senior secured notes slated to mature in December. Having taken those steps, he said, the company has no scheduled debt maturities before 2007 and, additionally, no pension funding requirements till 2006.

Further paydowns up to board

However, when asked by an analyst during the question-and-answer portion of the proceedings whether there were any more debt repayments on the company's agenda, Ferrara again noted the $142 million debt paydown in the second quarter, but said only that: "As we look at options, the board [of directors] will consider this from time to time and at the appropriate time they'll give us some direction."

Wainscott added that: "Obviously, the board takes a look at everything." Deferring to the board, the CEO said "they obviously have within their purview, as Al mentioned, the ability to look at a lot of things, including paying down debt. And as our cash balances hopefully improve this is a high-class problem that we haven't had for a while that our board can consider."

Wainscott, speaking generally, said that being back in the black was "encouraging" - but he added that the company's position "is still not where we used to be or, more importantly, it's not where we must be for the longer term."

AK's 3 Cs

He said that the company's recovery strategy that it has been pursuing over the past year, and certainly since last year's third quarter when Wainscott took the reins of power, has emphasized what he called "the three Cs" - get customers to return, cut costs and increase the company's cash position.

With that recovery phase "essentially complete," the company moves onto the second phase, which he calls the turnaround phase, emphasizing what he termed "the three fixes" - meaning necessary adjustments in the company's labor costs, its raw materials costs, and its contracts with its long-term customers, including many automobile and appliance companies, AK's two biggest markets.

While Wainscott called the currently sizzling steel market "the best of times" in terms of increased demand and shipments, he said that it was also the worst of times in terms of being hit with escalating energy and raw materials costs.

"At AK Steel, this hits especially hard, since we are among the least integrated of the integrated steel producers," the CEO lamented. While the company does produce 75% of its coke needs, it owns no coal properties or iron ore facilities and must buy about 15% of its carbon-slab steel needs from other producers.

While a raw material-and-energy surcharge mechanism put in place earlier in the year has helped to offset a portion of AK's increased costs in these areas, it has primarily come from the company's spot market customers, who only comprise about 25% of sales, albeit at considerably higher prices than the long-term customers pay.

Most contracts "too one-sided"

While many of AK's contract customers have begun to work with the company on adjustments to their contracts to help AK defray some of the added costs, he said, "unfortunately, at least to date, some of our largest contract customers have either ignored or simply refused to deal with this issue."

Most of the long-term agreements with the contract customers come up for renewal in the next 12 to 18 months. Wainscott called most of the agreements as currently structured "far too one-sided" in the customers' favor, leaving the company unable to recover many of its own increased costs.

He said that the kind of uncooperative response that AK has so far gotten from many of its big customers, as well as the fact that it can make much more money selling its product on the spot market to non-contract customers on an ad hoc basis, "calls for a reevaluation of the percentage of business that we desire in each category." He said that industry-watchers could certainly expect AK to "rebalance at least a portion of our sales portfolio from the contract sales arena, to the spot market sales arena."

Fewer, more flexible jobs

Besides hinting that AK plans to play some hardball with some of its less cooperative contract customers to get them to give the company more help in meeting its escalating energy and raw materials costs, the CEO also indicated that it would look to its labor unions to go along with company plans for "fewer and more flexible jobs" as it tries to cut what Wainscott said was a $30 per ton cost disadvantage that AK had against some of its sector peers.

He envisions a 20% headcount reduction among hourly workers - matching a prior 20% cut in the number of salaried, non-union employees - and said most of this could be accomplished through attrition.

The executive said that while some progress in cutting costs and headcount and giving the company more flexibility in the use of its workers has been made at several plants, much remains to be done - and here again some of its union locals at the remaining facilities have proven to be uncooperative, giving "no response to our proposal, no new proposal from them - and not even a commitment to negotiate."

Seeking to gain control of the negotiating process by invoking an emotional issue close to the hearts of many union members, Wainscott said such tactics were not productive for the company, "or the many constituents that depend upon us, not the least of which are AK Steel's 32,000 retirees."

Wainscott asserted that the company has "no intention of doing away with legacy costs" - i.e. the legal obligation a company has under collective bargaining agreements to continue to provide pensions and benefits for retired employees. "We will continue to have them. However, we are looking for other ways to continue to pay for those costs."

Tackling legacy costs

He said the legacy cost burden accounts for the $30 a ton disadvantage AK has vis-à-vis other steelmakers, some of whom have managed to negotiate better deals with their unions and some of whom managed to shed much of their legacy obligations by restructuring in Chapter 11. Over the past several years, many formerly formidable American steel producers such as Bethlehem Steel, LTV Corp., National Steel Corp. and Weirton Steel Corp., to name just a few, were forced into bankruptcy by steel industry problems, and their assets were bought at what amounted to fire-sale prices by other steelmakers, such as the relatively recently formed International Steel Group. Those surviving producers got the cooperation of labor unions in lowering their legacy costs and other operating costs as the price for keeping plants open and preserving current jobs.

Wainscott took a veiled verbal shot at such rivals, noting that "unlike most competitors, AK Steel has not failed in the marketplace ... As a result we've not walked away from pension and healthcare promises as many others have and every month we continue to honor our promises to more than 32,000 retirees. It's the right thing to do."

He said that AK has "every intention" of continuing to honor its obligations in this area "if - and it's a big if - if we can obtain the help of all of our unions."

He said that the legacy cost disadvantage could be offset and the company's competitive standing could be improved by reducing the size of the workforce and adjusting the benefits package.

Responding to an analyst who wondered whether AK seemed to be making a threat - that it would continue meeting its legacy obligations only if it got union cooperation - Wainscott answered that "it's difficult to imagine a scenario where indefinitely, forever we continue to do all of this with the $30 per ton disadvantage."

He said that right now, "we're living in one of the hottest steel markets ever," but "inevitably, the downturn will come, [though] we don't foresee it any time soon. We want to prepare ourselves for the future, to sustain profitability and [keep] those promises.

"We want to continue to do the right thing," he concluded. "It's not a threat - but it's a reality that it will be increasingly difficult, particularly as things turn south one day down the road, if we don't fix this."

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