Kaiser Aluminum Corporation Q1 2009 Earnings Call Transcript

Apr.30.09 | About: Kaiser Aluminum (KALU)

Kaiser Aluminum Corporation (NASDAQ:KALU)

Q1 2009 Earnings Call

April 30, 2009; 1:00 pm ET

Executives

Jack Hockema - Chairman of the Board, President & Chief Executive Officer

Dan Rinkenberger - Chief Financial Officer & Senior Vice President

Neal West - Vice President & Chief Accounting Officer

Melinda Ellsworth - Vice President, Treasurer

Analysts

Timna Tanners - UBS

Tony Rizzuto - Dahlman Rose

Mark Parr - KeyBanc Capital Markets

Lloyd O’Carroll - Davenport & Company

Operator

Good day and welcome everyone to the Kaiser Aluminum first quarter 2009 earnings results conference call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Miss. Melinda Ellsworth. Please go ahead ma’am.

Melinda Ellsworth

Thank you. Good afternoon everyone and welcome to Kaiser Aluminum’s first quarter 2009 earnings conference call. If you have not seen a copy of our earnings release, please visit the Investor Relations page on our website at www.kaiseraluminum.com. We have also posted a PDF version of the slide presentation for this call.

Joining me today are President, CEO and Chairman, Jack Hockema; Senior Vice President and Chief Financial Officer, Dan Rinkenberger; and Chief Accounting Officer, Neal West. Jack and Dan will review the results and at the conclusion of our presentation, we will open the call for questions.

Before we begin, I’d like to remind the audience that the information contained in this presentation includes statements based on management’s current expectations, estimates and projections that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include statements regarding the company’s anticipated financial and operating performance, relate to future events and expectations and involve known and unknown risks and uncertainties.

For a summary of specific risk factors that could cause results to differ materially from those expressed in the forward-looking statements, please refer to the company’s earnings release for the first quarter of 2009 and reports filed with the Securities and Exchange Commission including the company’s form 10-K for the full-year ended December 31, 2008.

All information in this presentation is as of the date of the presentation. The company undertakes no duty to update any forward-looking statement, to conform the statement to actual results or changes in the company’s expectations.

Non-run items to us are items that while they may recur from period-to-period, are particularly material to results, impacts costs as a result of external market factors and may not recur in future periods if the same level of underlying performance were to occur. These are certainly part of our business and operating environment, but are worthy of being highlighted for the benefit of the users of our financial statements.

Management’s intent is to significantly neutralize the fabricated product segment from fluctuations in underlying metal prices. We characterize metal profits and LIFO charges as non-run rate items that eventually offset to a great extent over the course of the full year.

Further, presentations including such terms as net income or operating income, before non-run rate or after adjustments are not intended to be and should not be relied on in lieu of the comparable caption under Generally Accepted Accounting Principals to which it is reconciled. Such presentations are solely intended to provide greater clarity of the impact of certain material items on the GAAP measure and are not intended to imply such items to be excluded.

I would now like to turn the call over to Jack Hockema. Jack.

Jack Hockema

Thanks Melinda and good afternoon everyone. As Melinda mentioned, you may follow our discussion by viewing the slide presentation on our website at www.kaiseraluminum.com. I will be begin with a high level review of the quarter and then turn the call over to Dan, who will review some of the financial details. I’ll then share some thoughts on our outlook before opening the call for questions.

Turning to slide five, we are pleased with our underlying fabricated product’s first quarter operating income considering the very challenging market conditions. Consistent with the outlook discussed during the fourth quarter earnings call, both shipments and value added revenues for aerospace and high-strength applications exceeded our record fourth quarter results.

In contrast, shipments for general engineering, ground transportation and industrial applications continued to decline sharply as a result of weak end user demand and continued destocking. We are also please with progress we have made toward our 2009 objectives of improving manufacturing efficiencies, while continuing to reduce inventories and strengthen our balance sheet.

During the quarter, our net cash position increased $39 million as we repaid revolver borrowings and exceeded our targeted inventory reduction plan. Our capital spending focus continues on our strategic investment in a new world class extrusion plant in Kalamazoo, Michigan and we are on schedule for launch in early 2010.

I will now turn the call over to Dan, who will go into more detail regarding the first quarter results and then I will discuss some industry trends and their implications for Kaiser.

Dan Rinkenberger

Thanks Jack. The consolidated financial highlights are shown on slide seven. As Jack mentioned, we are pleased with our first quarter underlying operating income performance, especially in light of these very challenging economic conditions. Excluding non-run rate items, consolidated operating income was $28 million for the first quarter of 2009, a decrease of approximately 27% compared to the prior year quarter.

Although sales declined approximately 33% from the prior year, we had a good leverage on an operating income basis as we flexed our costs to adjust to significantly lower fabricated product shipments for general engineering and ground transportation products.

Our Primary Aluminum segment includes our earnings related to Anglesey, as well as our metal hedging activities. Operating income excluding non-run rate items for this segment was $9 million, primarily due to realized gains on hedge positions.

As background, the pricing mechanism for our purchases of metal from Anglesey differs from that price at which we sell that same metal externally and we periodically hedge that difference to align our purchase and sale prices. That’s what happened in the first quarter; in a sharply declining metal pricing environment of the fourth and first quarters we locked in a hedging gain.

As previously announced, Anglesey is expected to fully curtail its smelting operations in September. Although we will continue to assess the situation at each quarter end, at this time we do not expect to realize our share of Anglesey earnings in the form of dividend payments to Kaiser and as such during the quarter, we fully impaired our share of Anglesey’s reported income, representing approximately $600,000.

The decline in net sales was driven in part by the lower fabricated product shipments I mentioned previously, but also due to the impact of significantly lower metal prices in 2009 compared to the prior year quarter. For reference, the London Metal Exchange price at March 31, 2009 was $0.62 per pound. That was exactly 0.5 LME price of $1.24 per pound at March 31, 2008.

Although the impact of metal price fluctuations more directly affects net sales of our primary aluminum segment, which did decline 50% during the quarter on approximately the same shipments as compared to the prior year, dramatically lower metal prices also reduce fabricated product sales.

As a reminder, since we manage our fabricated products business to be neutral to fluctuations in metal prices, passing the underlying metal price onto customers, we do not have a correspondingly negative impact of metal prices on our operating income for fabricated products.

Reported net income was approximately $4 million or $0.19 per share fully diluted. Adjusted for the non-run rate items which I will discuss on the next slide, first quarter net income would have been approximately $16 million or $0.81 per share fully diluted.

Our effective tax rate for the first quarter was 45%; however, cash taxes were only $300,000 reflecting the usage of NOLs and other tax attributes, which apply against pre-tax U.S. income. As of the end of the quarter, these tax attributes totaled approximately $900 million. Although we anticipate the effective income tax rate in 2009 will be approximately 40%, we do expect potential variation to that rate quarter-by-quarter. The cash tax income rate however, is expected to remain in the single digit percentages.

On slide eight, we review the non-run rate items. While important to mention, these non-run rate charges are predominantly non-cash and we believe they do not reflect the true underlying operating performance of the company. As we continue our discussion in later slides, the presentation will focus on operating performance excluding these non-run rate items.

On a consolidated basis, non-run rate charges for the first quarter of 2009 totaled approximately $20 million. This compares to non-run rate gains of $30 million in the first quarter of 2008. Mark-to-market gains and losses on our derivative positions drove the majority of the difference in non-run rate items between these two quarters. The non-cash mark-to-market loss of $4 million in the first quarter of 2009 was driven by further declines in metal prices as of March 31, 2009 as compared to December 31 of last year.

By contrast, in the first quarter of 2008, metal prices increased during the quarter generating $33 million mark-to-market gain. This results in a quarter-over-quarter change of $37 million in non-cash mark-to-market gains and losses between the two periods.

The further decline in metal prices from December 31 2008 to March 31 ‘09 also resulted in a $9 million lower of cost of market charge to reduce our inventory value. This is substantially smaller than the $66 million lower of cost or market charge recorded in the fourth quarter of last year, which reflected the precipitous drop in metal prices during the latter part of 2008.

The mark-to-market and lower cost of market items comprised the majority of the $50 million change in non-run rate items between the first quarters of 2009 and 2008. Other smaller non-run rate items cover the balance and these are presented in the appendix on slide 26 and in greater detail in our 10-Q.

Slide nine focuses on Fabricated Product segment excluding non-run rate items. Fabricated Products operating income excluding non-run rate items was $28 million in the first quarter of 2009. This was an increase of $3 million sequentially, compared to the fourth quarter of 2008, despite lower shipments as we leveraged our cost improvements.

Operating income excluding non-run rate items declined 31% in the first quarter as compared to the first quarter of last year, roughly in proportion to the decline in shipments during the period. Net sales in the first quarter declined as compared to both the first and fourth quarters of 2008 due to lower shipments and as previously mentioned, due to the lower underlying hedged metal price.

On slide nine, we present Fabricated Products sales analysis by end market application. As we previously discussed and introduced during our fourth quarter earnings call, we believe that value added revenue, which is our revenue less the hedged cost of alloyed metal, is an important metric to monitor overall performance. We have included quarterly shipment volumes and value-added revenue by end use category for the periods 2007 through the first quarter of 2009 on slide 28 in the appendix.

We had record shipments of aerospace and high strength products in the first quarter of 2009, as a result of continued robust demand in aerospace and defense products, the ramp-up of commitments under several key long term sales contracts and the additional heat treat plate capacity in our Trentwood facility, which came online during 2008. Aerospace and high strength shipments were up approximately 17% and 5% respectively over the first and fourth quarters of last year.

End user demand for ground transportation in industrial applications remained at recessionary lows, however. With weak demand, exacerbated by aggressive distributor destocking, our shipments of these product were down dramatically, 44% and 19% compared to the first and fourth quarters of last year respectively.

While total shipments were down in the first quarter, value-added pricing per pound held relatively steady in each end use category. Overall, however, the weighted average value-added price per pound improved with a higher percentage of aerospace and high strength shipments.

Turning to slide 11, during the first quarter, EBITDA and working capital improvements funded capital spending our normal quarterly dividend, our annual VEBA contribution and repayment of $36 million borrowed under our revolving credit facility at year end 2008. At March 31, our borrowing base on a revolver supported $171 million of additional borrowing availability, net of $10 million reserved for letters of credit.

We continue to right-size our inventory levels with current demand and have made significant progress generating $24 million of incremental cash flow through inventory reductions during the first quarter. We maintained our quarterly dividend and paid $0.24 per share or approximately $5 million to shareholders during the quarter and on April 14; we announced that our board declared the next quarterly dividend of $0.24 per share, which will be paid on May 15.

Jack Hockema

Okay, Dan just turned the call over to me. I’ll finish his slide here. We will continue to proactively and conservatively manage our liquidity to preserve our financial strength and flexibility during this period of economic uncertainty and to ensure that we are well positioned to pursue other growth initiatives as such opportunities arise. I’ll now turn to slide 13, which begins an extensive discussion of our outlook as we go forward here.

Slide 13, provides context and outlook for aerospace and high strength applications, which an important context is that this includes plate, sheet and coil, cold finish rod and bar and drawn tube products. Consistent with our previous outlook, the long term fundamentals are good.

Kaiser is a well positioned supplier to the defense industry for aerospace and armor applications and we are closely following actions on defense spending by the new administration and Congress. In particular, the highly publicized cuts in the F-22 program will have little impact on demand four or products while funding for the F-35 joint strike fighter is expected to generate significant long term demand for aluminum sheet and plate products.

Although commercial airframe manufacturers have a strong and well diversified order backlog, the near term outlook for build rates is softening. Because deliveries of our products precede airframe deliveries, we are beginning to experience some weakening in demand.

One area of extreme weakness is business jets where the near term outlook is bleak. While it’s a relatively small portion of our served market for aerospace and high strength applications, demand in this area has fallen off a cliff. The graphs on the right-hand side of this slide capture the strong growth in shipments for overall aerospace and high strength applications to successive records in the fourth quarter and again in the first quarter.

As Dan mentioned, this growth has been generated by Trentwood’s customer contracts and the expanded capacity and capability for aerospace plate. As we look forward, our shipments for these applications are trending down from the record fourth quarter and first quarter rate and are currently on a pace similar to mid-2008.

There are several storylines to explain this trend. First, demand for these applications is weakening in line with the outlook for modest reductions in commercial airframe builds and the dramatic cuts in demand for business jets.

Destocking for these products has now begun in earnest and the effect is especially evident at service centers where inventories had grown substantially during four years of very robust demand for aerospace applications. Although aerospace plate shipments are experiencing some negative impact from service center destocking, the overall pace for aerospace plate shipments continues at a rate substantially higher than a year ago.

Offsetting the strong underlying growth from aerospace plate is a downturn in shipments of the aerospace and high strength sheet and coil, cold finish and drawn tube products, approximately 80% of these shipments are to service centers and aggressive service center destocking is multiplying the impact of demand weakness.

In addition, the sharp decline in demand for business jet applications has a significant impact on our sheet and coil shipments to service centers. It should also be noted that the value-added revenue per pound for the portfolio of aerospace and high strength products is likely to continue to decline as the mix shifts away from higher value-added sheet and coil, cold finish, drawn tube and non-contract plate products.

Slide 14 addresses the trends and outlook for general engineering, automotive and industrial applications. Our first quarter shipments for these applications reflected continued deterioration and end use demand and destocking throughout the supply chain.

To illustrate the cyclic impact of service center demand and destocking and restocking cycles, we have added slide 30 in the appendix with eight years of quarterly data aluminum rod and bar. Demand from service centers for general engineering products was very weak in the first quarter and destocking continued.

Service center inventories for general engineering products are currently at low levels, but an end to the current destocking cycle ultimately depends upon stabilization of end use demand. We expect that armor programs will continue as previously discussed with strong demand in 2009 and 2010, but not as robust as the exceptional demand experienced in 2007 and 2008.

Automotive, truck and truck trailer builds continue at depressed levels and there is little indication of the improvement in the near term. Recent announcements of extended summer shutdowns at several GM plants will have some impact on our second quarter. However, in considering news regarding GM and Chrysler strategic plans, it’s important to note that demand for our products is driven more by total build rate than by individual manufacturer. It’s also important to reiterate that automotive represents less than 10% of our total value-added revenue.

Taking a step back to review the outlook for this group of applications, we are encouraged that our shipments early in the second quarter are on a pace similar to the first quarter level. Hopefully, this is a sign that demand is stabilizing. However, visibility is limited and the situation can change in either direction without notice. Current pricing for these applications is generally stable except for some competitive price pressure on general engineering plate.

Slide 15 summarizes the overall trends and outlook for fabricated products. Shipments for aerospace and high strength applications are trending downward towards levels similar to mid-2008, while the shipping pace for general engineering automotive and other applications is currently stabilizing at a level similar to the first quarter.

Overall fabricated products value-added revenue per pound is expected to trend down as a consequence of a weaker mix due to proportionally less high value-added aerospace and high strength products and to competitive price pressure on general engineering plate products.

We expect that low energy costs and continuing gains in manufacturing efficiency will offset to some extent the effects of declining shipments in a weaker mix. In addition, we are reducing overhead costs including the recent action to streamline the fabricated products organization by consolidating operational leadership under Pete Bunin. Pete has considerable experience with all of our operations and we’re confident that he will do an excellent job in his expanded responsibility.

Turning to slide 16, our financial and competitive strength provide a solid foundation to manage through this uncertain economic climate and to further prosper upon the eventual economic rebound.

As we discussed during our previous earnings call, our primary emphasis in 2009, is to improve underlying cost performance to achieve results during the second half of this year equivalent to the record 2007 base line. We made progress in the first quarter with approximately $4 million improvement compared to the second half 2008 run rate and we expect to continue the progress in the second quarter.

Also as we shared with you on the last call, we had targeted a reduction in inventory of $20 million by mid-year 2009. We have exceeded that goal having reduced inventory by $24 million during the first quarter and we expect to achieve further reductions in the second quarter.

Our net cash position increased $39 million as we reduced working capital and repaid revolver borrowings. This challenging market environment adds urgency to further differentiate our products and services as we pursue our commitment to provide best in class customer satisfaction.

Reinforcing this priority is our new portfolio of Kaiser select heat treat plate products that we are launching in the second quarter. These products were developed to address customers’ needs for superior metallurgical characteristics that lower their processing cost and improve their product quality.

We continue to position the company for strategic income growth. During the first quarter, we invested $22 million in capital projects designed to improve our operating efficiencies and the new Kalamazoo plant is on schedule to become fully operational in early 2010.

Slide 17 summarizes today’s prepared remarks. We have strong underlying first quarter results despite a very challenging market environment and we’ve made significant progress reducing inventory and improving manufacturing efficiency. The short term outlook is for weakening shipments and product mix for aerospace and high strength applications, but we expect to reap some offsetting benefit from lower energy costs and continuing improvements in manufacturing efficiency.

Our long term business fundamentals are sound and we are confident that Kaiser is well positioned with financial and competitive strength to manage through ongoing economic uncertainty. Our capital investment strategy remains focused on opportunities that will provide improved profitability. The Kalamazoo project represents the next step change in our cost structure as we strengthen the value strain for rod and bar, general engineering applications.

Overall, our focus in 2009 is to preserve our financial strength and to prioritize tactical and strategic initiatives on opportunities to generate manufacturing efficiencies and profitable long term sales growth. We will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Timna Tanners with UBS.

Timna Tanners – UBS

Hello everyone.

Jack Hockema

Good afternoon Timna.

Timna Tanners - UBS

Good afternoon, good morning to you. I wanted to ask a little bit more specifics on the guidance. The comments are as I understand it, so please correct me, but as I understand it, the higher value add products are seeing further weakness in price and volume and you’re listing some signs of stability in the lower value add products, but you also say that you see some cost benefit.

So, could I ask you to maybe specifically talk about your EBIT guidance or how you see those two measures flushing out? I appreciate visibility is difficult, but can you give us a little better sense of how those two can offset one another.

Jack Hockema

Yes, well Timna, we don’t provide guidance other than just general terminology or general indications of how the business climate is changing. I think you captured the essence of it there in your question. It’s not that pricing is deteriorated in the high strength applications. It’s that the mix is getting a little bit leaner.

As we’ve said many times on these calls and in investor meetings in the past, in the aerospace and high strength segment of our business, the contract plate business is actually the lowest value added product compared to non-contract plate and sheet and coil and drawn tube and cold finish and it’s in those non-contract areas where we are seeing weakening demand, primarily as a consequence of destocking, but not weakening prices.

The rest of what you said, right now we see some stabilization, knock on wood, in the other aspects of the business, so hopefully that means demand is stabilizing and we are seeing continuing improvements in our cost performance. How rapidly we continue to ramp that down is tough, that’s why we continue to chase the volume, but we’ve had good success in the first quarter and we’re optimistic about the second quarter.

Timna Tanners – UBS

Okay. So, what you’re saying is on the non-contract tons for heat treated plate maybe is where there’s more weakness or would that be like some of the armored plate for armored vehicles?

Jack Hockema

Actually armored plate is in general engineering. When we talk about the aerospace and the high strength sector, most of our plate business is contract business. There’s a small portion that’s non-contract that goes through service centers.

In the aerospace and high strength or applications as we describe, it’s really the service center portion of the business where we’re seeing significant weakness and demand and that’s what’s pushing the shipments down at this point, trending to where we were in mid-2008 and I’ll reiterate that our shipments of aerospace plate are up substantially, compared to where we were the first nine months of last year.

Timna Tanners – UBS

Okay. So, when you give guidance about the weakness in the higher margin products, are you talking about a structural problem or something that might be more short term, then?

Jack Hockema

Well, it’s tough to read right now. This really just started in the last three or four weeks, but it’s typical of what happens. We’re service centers and similar to what we’ve seen through all the general engineering and the other products here over the last six to nine months is this very severe destocking, and we’ve seen it especially in drawn tube and cold finish and in sheet and coil and then the sheet and coil situation is further exacerbated by business jets, all of the fiasco that went on around Washington and folks flying into Washington earlier this year, has basically shut down the business jet business and much of our sheet and coil goes into distributors or service centers for the business jet business.

Timna Tanners – UBS

So, it maybe a little bit of both, it sounds like?

Jack Hockema

Yes, but at some point this destocking will run its course. It’s just hard to tell when that happens.

Timna Tanners - UBS

Sure of course. Okay, the last question for me is, trying to understand that better obviously your balance sheet as you say is a great distinguishing factor, but we’ve just been seeing a lot of headlines from some of your competitors like Indalex and Aleris struggling.

So, I’m wondering if you could talk to us about how that’s impacting your business. Are you seeing them and try to undercut prices, are you seeing any impact on the general and environment, because of some of the weakness of some of your competitors?

Jack Hockema

As we said in the remarks, from a pricing standpoint, across the board prices are pretty stable. The only exception is in general engineering plate and that’s one that I’ve been signaling for at least one and maybe two prior calls; that we expected we were going to see pressure there as demand began to soften from the sold out position that we had for the four prior years. So, really generally prices are stable with that one exception where we’re seeing pressure in general engineering plate.

Timna Tanners - UBS

So, you don’t see there are any liquidation issues or any desperate kind of activity from some of the more financially weak competitors?

Jack Hockema

Can’t speak to what they’re doing. All I can speak to what our pricing is doing and right holding and some of you may have heard me say in the past that I was a little surprised during the last recession back in ‘01 through ‘03 that prices held much better than they had in prior recessions. So, it looks like generally we’re seeing the same kind of scenario repeat here, but we’re not seeing severe price degradation despite the weak demand.

Timna Tanners – UBS

Thank you.

Operator

We will take our next question from Tony Rizzuto with Dahlman Rose.

Tony Rizzuto - Dahlman Rose

Thank you very much. Hello everyone.

Jack Hockema

Hi, Tony.

Dan Rinkenberger

Hi Tony.

Tony Rizzuto - Dahlman Rose

Hello guys. I’ve got a couple questions here. First of all, when I look at the MSCI inventory data for aluminum plate and I’ve seen quite an increase here and I think we were averaging about 3.5 months of supply on land last year and then we probably jumped up to about, 5.7, 5.8. Is this really the general engineering plate that this would be obviously the service center, the general engineering, that we’ve clearly seen a build in the last couple of months here.

Jack Hockema

There may be some of that in there, although I’d be surprised Tony if there is. Frankly, I don’t even look at the MSCI plate numbers, because it gets contaminated with so many products that we don’t supply.

Tony Rizzuto - Dahlman Rose

Okay, so it’s not really a good indicator of where you guys play?

Jack Hockema

No.

Tony Rizzuto - Dahlman Rose

The other question I have is, you talked to us last quarter about controllable costs and in 2008 they were, I think about 20 million higher than where they should have been. Again, because of a lot of the inefficiencies being created by the modernization efforts on and so forth; could you describe for us where you are along and I think I saw a number or heard a number that indicated something about a $4 million improvement versus last year. Was that in relation to that and can you kind of update us where you guys are?

Jack Hockema

Yes. Good question, Tony. You’re correct that the year-over-year cost performance issue ‘08 versus ‘07 was a little more than $20 million and what I said in the prepared remarks is that the first quarter improved $4 million compared to the second half run rate; and the second half was worse than the first half of last year. So, if you annualize that four times four is 16, we’re less than two thirds of the way there. We need to basically double that. We need another $4 million or $5 million a quarter to get to that 2007 target.

Tony Rizzuto - Dahlman Rose

Now you indicated, I think in the earlier call from last quarter, that it would be more of a, kind of midyear to second half weighted time of improvement. Has the deterioration in the business environment, is that going to affect the way that you’re able to bring those cost savings to the bottom line?

Jack Hockema

Well, the good news is we’re stabilizing in the area that had been falling like a knife, so those plants have really been chasing volume down. Although with the last Friday’s announcement by GM, we’ve got two or three plants that are looking at what the impact on their order book will be. So, they may have to do some chasing here over the next few weeks, just because of extended shutdowns at GM.

Now, all of a sudden we’ve seen a vacuum in the service center orders in aerospace and high strength type products, so now those plants are adjusting. All that he’s saying that we’re continuing to chase the volume down, rather than having the volume stabilize so that makes it a little more difficult, but Pete and I both are committed and confident that we’re going to get those costs by the second half, pretty much in line with where we were in 2007.

Tony Rizzuto - Dahlman Rose

Alright, that’s great, and just to talk about the GM situation a little bit. It’s been my understanding that most of your exposure there has been more with the higher technology areas in automotive and therefore I’ve always kind of thought you’re kind of more transplant or more European and maybe Asian manufacture there. Can you kind of break down for us what is kind of domestic in terms of the little two I guess?

Jack Hockema

We’re slightly underweighted with “transplants.” We don’t call them transplants any more so I’m going back to my 1980s vintage in automotive, but we are slightly underweighted with those and slightly over weighted with the Detroit three, but your characterization that we’re in specialty is correct. I mean the real core products there are antilock brake systems, bumper beams and drive shaft tubing.

Tony Rizzuto - Dahlman Rose

I looked at your allowance for doubtful accounts I think in the Q and I didn’t really see any increase there in terms of reserve for bad debts or anything like that. Could you describe that a little bit, what you’re seeing out there at this point?

Jack Hockema

Well Tony, we don’t have any change that we made in a material way on the allowance for doubtful accounts and actually we feel like we’ve mitigated our exposure over the last several months to any issues that would be happening, not to say there couldn’t be any losses, but we think that we’ve certainly mitigated that exposure.

Tony Rizzuto - Dahlman Rose

Okay, and the final question I have is more big picture Jack, and I’d be interested in your views on this. You’ve talked to us before about this environment and you’ve looked at previous cycles and we saw 30% decline from say, peek to trough in terms of build rates, if you will. Could you describe for us how your thoughts may be changing on the cycle as we see it play out?

Jack Hockema

Well, the cycle is pretty tough right now. I’ll just contrast it to what we saw in ‘01 through ’03, and let me start with the general engineering and ground transportation type products.

Slide 30 gives an illustration of what’s happened to service center demand for rod and bar, which is a surrogate for most of the general engineering products that we supply and you can see that the first quarter when you combine the effect of end use demand for the service centers, with the significant destocking, the first quarter was lower than any quarter we experienced during the 2001 through 2003 recession. So, that’s a little bit stiffer and the destocking has been more severe than it was in the prior recession.

The other thing that’s different from a ground transportation standpoint, while the truck and the trailer are similar to what we saw in ‘01 through ‘03, automotive didn’t really have a severe downturn in ‘01 to ‘03. Off the top of my head, I think it was only down maybe 10% or so, while this time we’re looking at build rates declining 40% or may even more. It’s hard to tell where we’re going to end up this year, with everything that’s going on with GM and with Chrysler here.

So the automotive is more severe. One quarter worth of general engineering is more severe, but again a lot of that is the destocking, it’s hard to tell. In the aerospace side and high strength side, this is nothing compared to what we saw in the ‘01 through ‘03. The September 11, basically took the air out of aerospace and it was a dramatic decline. So as I said from a plate standpoint, we’re a much different company now than we were six or seven years ago.

If we look at our plate shipments, the current internal forecast we have in the second quarter and compare that to where we were in the depth of the ‘01 to ‘03 recession, it is multiples of where we were in 2001 to 2003.

So, aerospace and defense is much stronger than it was in the last recession and Kaiser’s participation in that is multiplied positively from what it was in the past. So, in terms of the impact on us, it’s not anything like what we’ve seen in the past, because of the end use markets but also because of how we’ve repositioned ourselves.

Tony Rizzuto - Dahlman Rose

Thank you, Jack. I’m just wondering if I may, just a follow-on; the general engineering, I mean we’ve been in this destocking at the service center level for some time now and I’m wondering what your senses of that? If we saw at the end of this destocking, what would that do to say the operating rate if you could?

Jack Hockema

Well, again I’ll refer you to that slide, slide 30 in the presentation and it shows it very dramatically. I’ve put a chart in there and I’ve used the 2001 through 2008 and I’m using rod and bar as a surrogate, because it applies directly to us, but it illustrates really what’s happening here.

I’ve compared each quarter shipments for eight years and a quarter, so there are 33 bars on there that compare each quarter’s service center shipments, what they shipped to their customers, compared to the average trend line for the eight-year period and then I show how much was restocked or destocked each quarter as a percentage of those average shipments.

Then I show a third chart that illustrates how much they received, how much the service centers received, which is a reflection of their end use demand and how much they restocked. So, what they received is a reflection of what the mills were shipping to them. So, I think if you look at that chart, it shows vividly what’s happening and it shows that the fourth quarter and the first quarter were disastrous. Part of that is very weak end use demand, but a big part of it is destocking as well.

Tony Rizzuto - Dahlman Rose

Clearly far outpacing the actual shipments and inventory changes.

Jack Hockema

Another point that I should make here is that those charts show service center destocking, but when you look at their shipments, they’re experiencing destocking by their customers as well. So, there’s a combined destocking impact through the entire supply chain that flows through all those statistics.

I mean, we would expect service center steady state to pretty much reflect industrial production and industrial production is not down 30% or 40% from a year ago, it’s down more like 10% or so and I ascribe most of the difference between service center shipments or mill shipments to the service centers and the index of industrial production; virtually all of that is destocking throughout the entire supply chain.

Tony Rizzuto - Dahlman Rose

What’s your best guess is to when it’ll be complete?

Jack Hockema

Well, I read some of Dan Dimego’s comments and I agree with him. As I said in my prepared remarks, right now it looks like it’s stabilizing, those inventories are at very low levels and it looks like demand is stabilizing, but until demand really does stabilize, that destocking won’t stabilize.

I mean rod and bar, we know we’ve got good stats there. Their inventories are the lowest they’ve ever been since they were recorded and began recording in early 2001. So, the inventories are extremely low but the service centers aren’t going to stop taking inventory out until they see that their demand has steadied.

Tony Rizzuto - Dahlman Rose

Thank you so much. Great insight.

Jack Hockema

Okay. Thank you.

Operator

We’ll take our next question from Mark Parr with KeyBanc Capital Markets.

Jack Hockema

Hello, Mark.

Mark Parr - KeyBanc Capital Markets

Good morning.

Dan Rinkenberger

Hello Mark

.

Mark Parr - KeyBanc Capital Markets

Hey, thanks for having me on today; it’s nice to be with you. I wanted to ask a question; kind of follow-on to Tony’s comments and hey Tony, we haven’t talked for a while, we got to get together, it’s been a while, but that’s just a shout out to Tony Rizzuto.

The industry dynamic; and one of the things that we’ve seen in carbon steel emerge is everybody seems to be I think as you characterize it Jack. You’re kind of chasing down orders; you’re not really maintaining production and a weakening demand environment. They’re really keeping their production in line with demand.

You’ve had an awful lot of experience in this industry and I’m wondering if you could provide some perspective to us on how the industry is responding to this demand destruction that we’re seeing now and the destocking that we’re seeing versus previous downturns.

Jack Hockema

Well, unlike the steel industry, we don’t have that much visibility in terms of what everyone else is doing, but as Timna mentioned, I think you’ve got the Aleris situation and the Indalex situation, and obviously they’re really battening down the hatches and I presume that other folks in our industry are as well.

I think the best indication, I really hadn’t thought about your question, but perhaps if you go back to my remarks regarding pricing, the fact that we’ve not seen severe degradation in pricing with some very, very limited exceptions, is a very good clue that the industry is adjusting production rather than running for volume and slashing prices and maybe that’s where you were directing me but…

Mark Parr - KeyBanc Capital Markets

Yes, that’s kind of what I was trying to get at, exactly.

Jack Hockema

Yes.

Mark Parr - KeyBanc Capital Markets

Okay, and you had indicated that some of these, like the specialty aerospace, the destocking has just really begun say in the last month or so. So, I mean is it premature to really make a call on whether pricing is going to hold up better than it has in the last downturns, than previous downturns?

Jack Hockema

Yes, it could be. I mean there’s no way to predict as you know; this market is so dynamic, there’s no way to predict, but at this point the prices are holding, that’s not the issue. It’s really just all of a sudden this destocking has cropped up.

Mark Parr - KeyBanc Capital Markets

Okay. Well good luck working through that and congratulations on all the progress that you’re making here over the last couple of years with your company.

Jack Hockema

Great. Thanks Mark.

Operator

(Operator Instructions) We will go next to Tim Hayes with Davenport and Company.

Lloyd O’Carroll - Davenport & Company

Well, this is Lloyd on Tim’s phone; his office is bigger than mine, he’s got a better view. To clarify the destocking, you’re saying on aerospace is primarily cold finish, hard alloy tube and a small amount of plate?

Jack Hockema

Yes, it’s actually cold finish, sheet and coil and drawn tube.

Lloyd O’Carroll - Davenport & Company

And very little plate?

Jack Hockema

Yes, some of the service center non-contract plate, but most of our plate goes direct to OEMs but there’s some portion that does go through service centers and we’re seeing some destocking there as well.

Lloyd O’Carroll - Davenport & Company

Okay. I mean, that’s certainly consistent with what people were talking about at the EMM conference with supply chains stuffed all the way through. On your contract business, I understand that your customers have to give you significant forward notice before volumes are adjusted. Have any customers given you that kind of notice or indications?

Jack Hockema

Well, it depends contract by contract what the situation is. You’re talking about contracts where there would be mid-maxes and where they do have to give us some notice. We’ve not seen significant degradation in any of those, but again the build rates, as you look at commercial aerospace which is the big portion of this, the build rates have been pretty much holding at the high levels that we had.

Most of the forecast is that the build rates will start to turn down some later this year and next year. So, there could be some additional degradation there and that’s part of what we are seeing I think in the non-contract businesses; the service center is anticipating what’s going to happen to demand there.

Lloyd O’Carroll - Davenport & Company

Okay. But thus far, no one is giving you the high sign in an official manner?

Jack Hockema

Yes, we’ve not seen any severe degradation in the significant portion of our contract business.

Lloyd O’Carroll - Davenport & Company

Yes. Are any significant contracts, you say modest declines in contracts or is it material at this point?

Jack Hockema

Let me just answer it this way. The fourth quarter and first quarter aerospace plate shipments were up substantially from where we were running the first nine months of last year and the second quarter too will be substantially higher than where we were in the first nine months of last year.

Lloyd O’Carroll - Davenport & Company

Okay. I think that helps, and then the final question is on the stretcher. Are you qualified all the way up to the gauges that you were anticipating and is there any meaningful volume in the thick plate coming through thus far?

Jack Hockema

I’m going to put a caveat on it. I believe that we’re qualified on virtually everything. There may be a couple of remnants out there that we’re still working through, but basically we’re close to 100% qualified on everything that we expected and the second part of your question, the answer is yes and I would attribute virtually all of that substantial increase currently compared to where we were in the first nine months of last year is the fact that we are qualified on heavy plate.

Lloyd O’Carroll - Davenport & Company

Okay, thank you.

Operator

And it appears there are no further questions at this time. Mr. Hockema, I’d like to turn the conference back over to you for any additional or closing remarks.

Jack Hockema

Okay, thank you. I want to reiterate some important points that we did make today. The first quarter 2009 underlying results were solid. Our financial position remains strong and we’re confident that we’re well positioned to manage through the market cycles with financial and competitive strength to capitalize on opportunities as the market recovers.

We are continuing to prudently invest in projects such as the world class extrusion plant in Kalamazoo, to improve our long term growth in profitability and finally despite near term economic challenges, the long term business fundamentals remain very positive for Kaiser.

We also want to take the opportunity to let you know that we will be hosting an investor day in New York City on Wednesday, or May 20. Will also be conducting a live webcast of the presentation and we will provide additional details in the weeks ahead.

Thanks for joining us on the call today and we look forward to updating you again on our second quarter 2009 call.

Operator

This concludes today’s conference. We thank everyone for their participation.

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