AK Steel reports strong third quarter, will buy back $150 million of debt

By Paul Deckelman

New York, Oct. 26 - AK Steel Corp. reported strong third-quarter earnings Tuesday and said that it would put some of its excess cash to work paring down its debt, specifically by calling $150 million of outstanding bonds. The company also touted a strong liquidity position, with ample cash on hand and unused borrowing capacity.

It was the second consecutive quarter in which the Middletown, Ohio-based supplier of specialty steel products to the automotive industry and other customers reported a profit versus a big year-ago loss, causing the company's president and chief executive officer, James L. Wainscott, to remark on the conference call for analysts and investors following release of the earnings data, "what a difference a year makes."

Still, while AK "has made solid progress, much work remains," said the AK CEO, who took the helm of a troubled company in a management shakeup a year ago following the abrupt resignations of his predecessors.

He said that while a return to profitability over two quarters after a long string of losses certainly was good, the company's real focus had to be on "sustaining profitability in the long run," even without the benefit of a currently hot steel market, which he said would eventually, inevitably, cool down.

That worldwide upturn in the steel market, driven by such factors as the U.S. economic recovery and China's seemingly insatiable demand for steel - thus absorbing output from lower-cost Asian producers that would otherwise find its way into the U.S. domestic market and undercut AK's sales - has enabled the Ohio company to sell everything that it produces, and for higher prices, fattening up both the top and bottom lines. Third quarter sales hit a record $1.337 billion, well up from $1.021 billion a year ago.

AK negotiates higher prices

Wainscott said on the call that AK has negotiated new, higher-priced deals, or has modified existing lower-priced deals, with fully two-thirds of its contract customers, the company's bread-and-butter, clients, "and we're not done yet."

An analyst on the call asked, almost incredulously, how the company was able to get customers with existing contracts that still had a year to run to renegotiate those supply pacts upward, in order to reflect both the tighter supply situation and AK's own higher input costs, such as energy and raw materials.

Wainscott quipped that it was because AK was a good negotiator, but in a more serious vein, he observed that "it's a bit of a new steel world order ... The [steel industry] world has changed, permanently, driven by China." He said the key customers who agreed to the double-digit percentage increases in contract prices for 2005 "understand and put value on AK Steel being here, being able to supply them with the highest quality steels in the market place. They want to make sure that there is availability of supply."

Income beats estimates

The booming steel market enabled the company to report net income of $83.1 million, or 76 cents per share, in the third quarter, a sharp turnaround from its year-earlier net loss of $277.5 million, or $2.56 per share. Income from continuing operations was $118.6 million, or $1.09 per share, versus a year-earlier continuing operations loss of $286 million, or $2.64 per share. Excluding a net tax benefit equal to $50.2 million, or 46 cents per share, the company's earnings from continued operations were equivalent to $68.4 million, or 63 cents per share. Wall Street had been expecting just 50 cents a share.

AK said its operating profit during the third quarter was $94.5 million, or $61 per ton, versus an adjusted operating loss of $123.8 million, or $82 per ton, a year earlier.

Rising input costs

AK, like other steel producers and most other industrial companies, faced sharp increases in its costs for energy and raw materials, such as iron ore, coal and scrap steel, which added fully $99 million to its production expenses for the quarter from year-ago levels.

Chief financial officer Albert E. Ferrara said that the energy and raw materials costs were essentially beyond the company's control, although it is negotiating with its raw materials suppliers to lock in supplies of key materials in order to assure continued production and blunt the impact of rising prices.

However, the CFO said, "for those operating and overhead costs that are within our control, we have succeeded in achieving cost reductions," to the tune of $220 million of "controllable and sustainable operating and overhead cost reductions" over the first nine months of the year, thanks to previously outlined cost-cutting initiatives. For instance, the company's employee headcount had fallen to about 8,000 at the end of the third quarter from 9,400 a year earlier.

Liquidity $775 million at quarter

Those cost-cutting moves helped to improve AK's cash position markedly; Wainscott noted that a year ago, the company had just $9 million of net cash, a figure which swelled to $314 million by the end of the third quarter. Combined with $461 million of credit line availability, the company had $775 million of total liquidity at the end of the quarter, a position which Ferrara called "solid and [which] continues to improve."

The CFO said that there had been no cash borrowing against AK's two credit lines in the third quarter, "nor do we anticipate any borrowings in the future."

Wainscott said that the company's board had decided to use $300 million of its cash cushion to take out debt, and to make an advance payment early next year on its 2006 pension obligations.

AK to call 9%, 8 7/8% notes

He said that during the fourth quarter, AK would call for redemption its $117 million of outstanding 9% senior notes due 2007 and its $33 million of outstanding 8 7/8% senior notes due 2008 (see "Tenders and Redemptions" elsewhere in this issue for full details). Following those redemptions, AK will have "no material debt maturities" coming due until 2009, he said.

Wainscott said that the company will take a $5.5 million fourth-quarter earnings charge in connection with the bond redemptions, about half of that representing the call premiums on the notes and the other half unamortized debt issuance costs. He said that the redemptions would generate $14 million annual interest cost savings.

Impact of ISG/Ispat merger

During the question-and-answer portion of the conference call following management's formal presentation, an analyst asked Wainscott what his take was on the huge steel industry merger deal announced Monday, which will see Dutch-based steel companies Ispat International NV and LNM Group NV merge to form Mittal Steel Co. and then acquire Richfield, Ohio.-based steel operator International Steel Group Inc., in a two-step deal valued at $17.8 billion in cash and stock.

The resulting company would be the largest steelmaker in the world in terms of overall production capacity. Analysts have said the combination could kick off a new round of consolidation in the steel industry, which has seen a severe shakeout over the past several years as many once-profitable producers such as Bethlehem Steel Corp., National Steel Corp., and LTV Corp. went broke and their assets were snapped up at fire-sale prices, either by existing operators like United States Steel Corp., which outbid AK for National Steel's assets last year, or by new industry players such as financier Wilbur Ross, who bought Bethlehem, LTV, Acme Steel and Weirton Steel Corp. through the bankruptcy process to create ISG over the past few years.

Wainscott called the mega-merger "an interesting transaction. We'll be watching with interest to see how it evolves and to see whether it sparks another wave of industry consolidation.

"Who knows? We'll see."

He noted that his company already competes against both ISG and against Ispat's U.S. unit, Ispat Inland; while the former, he said, is "more commodity focused," producing large quantities of lower-priced basic steel products, Ispat Inland produces more value-added specialty steels, similar to AK. Should the giant deal go through, he said, "then we will compete against Mittal Steel."

He said that whatever these other companies are doing, "our focus cannot and will not change," and his company would continue to follow the strategy that it has so far successfully ridden back to profitability.

"Even though we might become a [relatively] smaller player in a bigger global market," Wainscott concluded, "we remain a very large player in the markets we serve, and we're going to be there."

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