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AK Steel Holding Corp. (NYSE:AKS)

Q4 2009 Earnings Call

January 25, 2009 9:30 am ET

Executives

Albert Ferrara - Vice President, Finance & Chief Financial Officer

James Wainscott - Chairman, President & Chief Executive Officer

Analysts

Michael Gambardella - JP Morgan

Luke Folta - Longbow Research

David Lipschitz - CLSA

David Gagliano - Credit Suisse

Brett Levy - Jefferies & Co.

Sal Tharani - Goldman Sachs

Michelle Applebaum - SMI

Bob Richard - Southridge

Timna Tanners - UBS

Charles Bradford - Affiliated Research

Brian Yu - Citi

Mark Parr - KeyBanc Capital

Dave Martin - Deutsche Bank

Operator

Good morning, ladies and gentlemen and welcome to the AK Steel’s fourth quarter and full year 2009 earnings conference call. At this time all participants are on a listen-only mode. (Operator Instructions)

With us today are Mr. James L. Wainscott, Chairman, President and Chief Executive Officer of AK Steel and Mr. Albert E. Ferrara Jr. Vice President of Finance and Chief Financial Officer.

At this time I would like to turn the conference call over to Mr. Ferrara please go ahead sir.

Albert Ferrara

Thank you Fannie and good morning everyone. In a moment I’ll review our fourth quarter and full year results and provide some guidance for 2010. Following my remarks Jim Wainscott will offer his comments in view of your questions. Today’s call includes certain forward-looking guidance.

Other than the comments on historical results, remarks we make today constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements include our expectations as to our future shipments, product mix, prices, costs, operating profit and liquidity.

While we believe that our expectations are reasonable, we cannot assure you that they will prove to have been correct since they are based on assumptions and estimates that are inherently subject to risks. Such risks include economic competitive and operational risks, uncertainties and contingencies all of which are beyond our control and based upon assumptions with respect to future business decisions that are subject to change.

Except as required by law of the company disclaims any obligation to update any forward-looking statements to reflect future developments or events, for more detailed information we encourage you to review the discussion of risks affecting forward-looking statements found in our Annual Report on Form 10-K for the year ended December 31, 2008, as updated in our most recent Quarterly Report on Form 10-Q.

To the extent we refer to material information that includes non-GAAP financial measures, the reconciliation information required by Regulation G is available on the company’s website at www.aksteel.com. Earlier today we reported fourth quarter 2009 results that reflect a significant improvement over the third quarter with increases in shipments, revenues, operating profit and net income.

In fact, our fourth quarter performance represents our third consecutive quarter of improved financial results and our best quarter of 2009. AK Steel reported net income of $39.8 million for the fourth quarter or $0.36 per share compared to $6.2 million or $0.06 per share in the third quarter.

Our Fourth Quarter net income was negatively impacted by a $5.1 million charge related to a tax law change by the State of Pennsylvania, which we discussed in our third quarter earnings call. Fourth quarter shipments were 1,368,300 tons an increase of 320,500 tons or 31% over the previous quarter.

Average selling prices increased quarter-over-quarter for each of our three major product groups, carbon steel, stainless and electrical steals, as well as tubular steel products. However, as expected our overall average selling price of $964 per ton was roughly 3% lower quarter-to-quarter primarily due to product mix. That is carbon steel has comprised a higher percentage of our sales during the quarter.

Total revenues for the fourth quarter were $1.320 million which was $279 million or about 27% higher than our third quarter revenues. While general market conditions remain challenging in the fourth quarter, we saw increased demand from many of our customers particularly among carbon steel buyers.

Now, looking at cost, we benefited from lower raw material costs compared to the third quarter including lower costs for pellets and purchase coke. Partially offset by higher carbon scrap, coating metals and natural gas costs. However, we do not expect the trend of overall lower raw material costs to continue in the first quarter of 2010. Netting revenues and cost, we achieved an operating profit of $87 million or $64 per ton. This represents a very solid improvement of $71.7 million or roughly $49 per ton compared to the third quarter.

Turning now to our full year results, despite the significant challenges of the great recession, AK Steel returned to solid profitability in the second half of the year, while we posted a net loss of $74.6 million or $0.68 per share for the year, we generated net income of $46 million or $0.42 per share during the second half of 2009.

Shipments for 2009 totaled 3.9 million tons with an average selling price of $1036 per ton. 2009 revenues were $4.1 billion, nearly 60% of total revenues acquired in the second half of the year, as we benefited from the early stages of an economic recovery. Our sales outside the U.S. in 2009 were $767 million, represented approximately 90% of our total sales. By comparison, sales outside the U.S. in 2008 were roughly 17% of total sales.

Our results also reflect a larger than expected LIFO credit of $417 million for 2009, due to significantly lower raw material and energy cost and a reduction in inventory levels. For the year 2009, we incurred an operating loss of $70.1 million or $18 per ton, all of which was incurred in the first half of the year before the company returned to profitability.

Turning to the balance sheet, with the difficult market conditions, we intensified our focus on cash and liquidity throughout the year. As a result we succeeded in maintaining a very solid cash position. We grew cash by more than $122 million or roughly 36% from the third quarter ending the year with $462 million. Combined with the availability under our revolver, our total liquidity stood at more than $1 billion at December 31.

Our focus on the balance sheet allowed us to maintain a strong financial position, even while making some substantial investments in the company. For example, we invested $110 million in capital improvements including the installation of a new hearth in our Middletown Works blast furnace and we contributed a total of $210 million to our pension plans along with $65 million to the Middletown retirees VEBA.

At the end of 2009, our net debt was less than $150 million. Our debt was favorably impacted by the repurchase during the year of $26.4 million in par value of our 7.75% senior notes at a cost of roughly $23 million. In the past two years, we have repurchased a total of $46 million in par value of these notes for an average purchase price of about $0.80 on the dollar.

Other actions in 2009 to enhance shareholder value included the repurchase of more than 1.6 million shares of AK Steel’s common stock at an average price of $6.13 per share. In the past two years, we have repurchased nearly 3.3 million shares at an average price of $7.43 per share, well below the current market value.

Turning to the pension fund, in the calendar year 2009, we enjoyed an investment gain of more than 17% from our investment portfolio, a solid performance based on an asset mix of roughly 60% equities and 40% fixed income.

Looking forward, funding requirements for our pension plans continue to be very manageable with approximately $105 million required in 2010. As we announced this morning, our Board of Directors has approved a contribution of $75 million this quarter, which will meet a significant portion of the companies 2010 funding requirements.

Now for some guidance for the first quarter of 2010, we expect shipments to be essentially flat compared to the fourth quarter of 2009. As is typically the case, we expect our first quarter to be the lowest shipment quarter of the year. We expect our average selling price to increase by 4% to 5% quarter-over-quarter.

We expect lower operating costs in the first quarter due to improved operating rates and continuous improvements in all areas of our business. In addition, we expect maintenance outage costs will be lower than in the previous quarter and while we experienced a significant LIFO credit in 2009, we do not expect that will be the case for 2010.

Netting the positive and negatives including moving from a LIFO credit to a LIFO charge, we expect to report an operating profit of approximately $35 per ton for the first quarter of 2010. As we look for the remainder of the year, we expect our quarterly shipment levels and average selling prices to be higher than during the first quarter. Finally, as we typically do, let me offer a few data points for the full year 2010. We anticipate total capital investments of about $200 million in 2010, essentially equal to depreciation.

We expect interest expense to be roughly flat year-over-year, but pension and OPEB expense will decrease by approximately $40 million in 2010, largely due to better than expected pension investment returns in 2009, and finally, with regard to income taxes, while we are projecting a book tax rate for 2010 of roughly 39%, we estimate our cash tax rate will be less than 5%.

Now, for his comments, here is Jim Wainscott.

James Wainscott

Thank you very much, Al. Good morning, everyone and thank you for joining us today. We finished the year 2009 in strong fashion with higher shipments and lower costs than we had expected and I’m proud of the fact that, with each successive quarter in 2009, our results continued to improve. As we concluded one of the most challenging years in the 110 year history of AK Steel, our fourth quarter performance represented our strongest quarter of 2009 and that is a credit to all of the employees of AK Steel who responded to the challenges of one of the most severe economic downturns in our country’s history.

Not only did we conclude a very challenging year, but 2009 also represented the end of a rather adventurous decade for AK Steel and the steel industry for that matter. It was certainly a timeframe during which the Board of Directors and the Management team of AK Steel repositioned the company for success in the coming decade, but in 2009 we did what we had to do in order to survive what economists called the great recession. That’s what great leadership is all about, managing through tough times.

As we look ahead to 2010, it’s our intent at AK Steel to move from the great recession to the great recovery. That’s because our production has returned to about 85% of capacity for our first quarter of 2010, compared to our low point in the second quarter of last year when we were operating on average at only 45% of capacity. These higher current operating rates are great for a number of reasons, not the least of which is the fact that they put our people back to work. In fact we’ve recently been hiring new employees at our Ashland Works.

Things are certainly better, recall as I mentioned in the second quarter of 2009, we experienced record low quarterly shipments of only 740,000 tons, but we’ve recovered nicely from that low point reporting fourth quarter 2009 shipments as Al mentioned of nearly 1,370,000 tons some 85% higher. While we’re still not where we want to be, back to pre-recession production and shipment levels, we are absolutely moving in the right direction.

As a company, we made solid progress throughout the year with each successive quarter better than the previous one, both in terms of operating and net profitability. It’s really a testament once again to the can do spirit of the employees of AK Steel. Throughout our company, we have a resilient group of people who simply refuse to lose. We may get knocked down, but we get right back up and we get after it.

Speaking of our people, I’m pleased that late in the fourth quarter, we attained a three year labor contract extension at our Keshakan Works with the United Auto Workers union. This agreement replaced the existing contract that was set to expire on April 1 of 2010. While we’re on the subject of labor, it’s worth noting that our only other labor agreement expiring this year is with the united steel workers at the Ashland Works main plant. That agreement is set to expire on September 1.

Take care of your customers and your people and all things are possible. That has been our approach at AK Steel for quite a while now and I’m confident that a high degree of our success is due to following that approach. As a Management team, we are most proud of the way we treated our customers and our people in 2009 and through it all, we stayed true to our core values of safety, quality, and productivity.

At AK Steel we have no higher priority than the safety of our people. For 2009 we exceeded our company specific safety goals and we continued to lead the entire steel industry once again by a wide margin in terms of safety performance. We set a new company record of only 15, 15 OSHA-recordable injuries.

While that’s the best that we’ve ever done, our goal is and must always be zero and guess what? Employees at two of our plants, Rockport and Zanesville actually delivered zeros. They work the entire year without a single recordable injury. That is a terrific achievement by everyone at those two locations.

Also during Q4, the Columbus, Indiana plant of our AK Tube subsidiary was recertified by the Department of Labor under the DOL’s voluntary protection program for having safety programs that go above and beyond OSHA requirements. Congratulations to our AK Tube Columbus employees.

Now let me shift gears from safety to quality, a subject that matters a great deal to our customers. At AK Steel we’ve built our reputation based upon making great quality products, delivering them on time and providing superior customer service.

This is only possible when the entire organization, sales, customer technical services, research, operations, and all of the staff functions, realize that without our customers, there is no need for AK Steel, and speaking of research we continue to do everything we can to meet the needs of our customers for the finest quality, most energy efficient carbon stainless and electrical steel.

During the fourth quarter the hard work that AK Steel’s researchers performed got some well deserved recognition. Our researchers were the recipients of the 42 annual Outstanding Author Award from the Galvanizers Association. This honor was presented in connection with a technical paper on the subject of furnace atmosphere monitoring at our coating lines.

By the way this marked the tenth time that AK Steel has received this very prestigious recognition. Once again in our company our focus is on serving our customers better than any other steelmaker, and our performance on that front continues to differentiate AK Steel from its peers. Despite operating in a very, very difficult environment in 2009, last year was one of our best years ever in terms of quality.

That opinion of mine was recently validated by the annual results of an independent customer survey performed by Jacobson & Associates. According to the Jacobson survey, our carbon and specialty steel customers rated AK Steel number one in overall customer satisfaction as well as number one in quality and delivery for the year 2009.

Ladies and gentlemen, that is about as good as it gets. For 2009 in short, we rolled on, as we worked through the very tough economic challenges of the day, we remain focused on our core values as we outperformed the expectations of our customers and shareholders, in addition, we lowered our cost and we lifted or grew our cash position.

In essence, we returned to our three C’s approach of focusing on customers, costs, and cash, the things that matters very much last year, those were the items that really drove our priorities and at the bottom line although we reported net income as Al mentioned for the third and fourth quarters of 2009.

We did report a net loss for the full year 2009 excluding special charges, it’s our first annual loss since the year 2003. Let me assure you that we have no intention of a repeat performance of this sort for 2010, quite contrary; AK Steel expects to be solidly rather profitable for the year 2010.

As was the case in 2009, we expect sequential quarterly improvement in our results throughout 2010 as we enjoy the benefits of higher production and shipments as well as higher pricing. That’s it from a profitability standpoint.

We expect the first quarter to be our weakest; given product lead times we came into 2010 with a portion of our sales already in the order book for the first quarter. These sales were made prior to our recently announced spot market price increases; thus as a result much of the steel that will ship in the first quarter will be at prices below the current pricing levels.

Accordingly, we’ll have what I term a bit of a mismatch between our first quarter sales prices and our costs. It’s because our costs will reflect the real time increases that are going on in scrap and the expected increases for iron ore prices, whereas our selling prices for most of our first quarter shipments will not fully comprehend these cost increases until next quarter.

Let’s take a moment to expand on this thought. It’s important to realize that the higher iron ore prices that we anticipate, once in fact the deals are settled are retroactive to January 1 of this year. In contrast most of our selling prices have already been set for the first quarter, hence the mismatch situation of which I spoke; having said that, as we look to future quarters and to the full year, we expect a much improved 2010, as compared to 2009.

Our annual sales volumes for 2010 should be about 40% higher than 2009. We are seeing an improvement in overall demand from our customers, but the biggest change that we’re seeing is that customers are once again purchasing steel in quantities that are equal to their sales levels. It’s a big change from a year ago and even a couple of quarters ago when customers were selling product from their stock of inventory.

Our average selling prices are expected to improve as well as a function of the increased demand and the need to recover higher costs. Let me confirm that we are indeed now booking new spot market sales at increasingly higher sales prices. We have to because again our costs are rising rapidly.

On the subject of steel making input costs, we have experienced a large increase recently and a price we pay for steel scrap. Scrap prices in 2010 have already risen by about 18% from early December of 2009. Matter of fact, scrap prices are now pre-recession price levels. In terms of iron ore, most analysts who cover the raw material sector now forecast that iron ore prices are likely to rise by 20% to 25% in 2010 as compared to 2009.

Given the current supply and demand conditions and in particular increased demand from China, we too expect iron ore prices to be on the rise again in 2010. Accordingly as has been the case in recent years, steel producers, including AK Steel will be under significant cost pressures this year from higher prices for raw materials.

In response to these cost pressures, we’ve announced a series of spot market price increases in recent months for carbon and stainless steel products, as well as the related surcharges for these products and once again, the price increases are reflective of increases in input costs and increased order intake rates for us.

Speaking of orders, our lead times for carbon products are lengthening with hot rolled out to the first half of March and cold rolled and coated products out to the second half of March, and depending on the product some of our stainless steel lead times are now out into April.

With that, let me take a couple of minutes before taking your questions to comment on what we’re seeing in the markets for each of our products. In general we see the year 2010 as one of gradual recovery in the markets that we serve. In terms of the automotive market, according to our customers and several forecasters, we look for an auto build rate in 2010 of about 10.6 million vehicles, compared to an estimated 8.5 million units for 2009.

On the sales side, the numbers climb to about 12 million units for 2010, compared to an estimated 10.4 million units for 2009. Auto inventories are in much better shape now than they were a year ago, 2009 auto inventories finished at 53 days of supply, compared to 93 days at the end of 2009.

Now let me turn to service centers and distributors whereby historical measures inventory levels also remain low. Based on the December 31, 2009, MSCI report, carbon flat roll steel inventories stood at 2.6 months of supply on hand, by comparison, this figure was 3.6 months of supply on hand a year ago. Using MSCI seasonally adjusted numbers, the December 2009 inventories represented 2.2 months of supply compared, to 2.1 months of supply on hand at the end of November.

On a tonnage basis, total carbon flat-rolled steel inventories, stood at 3.5 million tons at the end of 2009, which represented a 24% reduction compared, to 4.7 million tons on hand at the end of 2008. Importantly, the MSCI data also showed the December shipments of carbon flat-rolled steel were up by about 4% compared to a year ago.

Turning to stainless, stainless steel inventories stood at 2.9 months of supply on hand at the end of 2009, and that compared to 3.2 months of supply at the end of 2008. On a tonnage basis, total stainless steel inventories stood at 287,000 tons at the end of ‘09, which was 20% below the 359,000 tons of stainless at the end of 2008.

We take our lead from our customers and what they’re telling us is that, business conditions continue to improve, but to-date except for automotive the pace of that recovery remains relatively slow in comparison to previous recessions.

Speaking of automotive, our auto chrome business has strengthened as automotive production and sales have picked up. This business rose by more than 20% in the fourth quarter compared to the third quarter, and when you compare the fourth quarter to the second quarter, our auto chrome business nearly doubled. We look for continued strong demand in 2010.

On the electrical steel front, the fourth quarter of 2009, continued the recent trend of weaker demand from both NAFTA and export customers. As we look ahead to the year 2010, we expect a slow, but steady recovery in demand for electrical steals. In light of the depressed NAFTA and export market conditions not surprisingly our electrical steel contract selling prices have declined.

However, we expect that an increase in our 2010 sales volumes of this product coupled with the richer product mix will more than offset the lower selling prices. We believe that the gradually recovering economy here at home as well as recovering economies abroad will spur increases in consumption of electrical steel. We will continue to be advantaged by our products and our approach.

In other words, we’re well positioned to serve the high end of the electrical steel market, and we believe that our approach to Customer Service and the overall strength of our relationships will result in increased market share for AK Steel going forward. The U.S. and the world will continue to have a growing need for new and more efficient electrical power. That is a need that AK Steel is perfectly suited to fill.

As most of you know, AK Steel is one of the largest suppliers in the world, the manufacturers of power generation and distribution transformers. In the United States beginning this month, federal law now mandates higher energy efficiency standards for distribution transformers. Our electrical steel will be used to help transformer manufacturers meet those higher standards for both replacement technology and to modernize our nation’s electricity grid.

With a weak US dollar, we’ll also continue to capitalize on export opportunities where possible. However with respect to sales of electrical steel in China, our ability to capitalize on export opportunities has been hampered by a recent decision by the Chinese Ministry of Commerce. This organization which is known as MOTHCON ruled preliminary to impose duties of about 22% on our electrical steel imported into China.

We’re very disappointed by that decision, but we’re cooperating with the MOTHCON officials in this ongoing trade proceeding. We’ll continue to try to impress upon them that their preliminary findings lacked any factual or legal basis. We anticipate a final determination by the Chinese Ministry with respect to the duties sometime this spring if they continue to impose duties on our electrical steel products, we would expect to file an appeal to the WTO, vigorously challenging the imposition of those duties.

As we enter the New Year and the new decade, we are ready for the recovery at AK Steel. Accordingly in 2010, we’ll remain focused on our core values; we’ll execute with world class precision, we’ll aggressively control those costs that we can, as we strive to deliver shareholder value, and work to achieve year long continuous improvement in every way.

Not only are we ready for the recovery, but we are experiencing the early stages of a recovery and positioning the company to compete and win in the global steel marketplace as the recovery takes hold. Thanks to all of the progress that we’ve made over the past six years at AK Steel.

We were well positioned to weather the severe economic storm, to capitalize on the chaos and to secure market opportunities that will serve us well in the days ahead. Our Management team has a track record of overcoming adversity and we did so once again during the great recession of 2008 and 2009. Now, we’ve positioned the company for economic recovery in 2010 and for continued prosperity beyond that.

Once again thank you for being with us today. This concludes my prepared remarks and at this time, we’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Gambardella - JP Morgan.

Michael Gambardella - JP Morgan

Two brief questions. One, can you give us the LIFO credit in the fourth quarter and the LIFO charge that you’re assuming in your guidance for the first quarter?

Albert Ferrara

The LIFO credit in the fourth quarter, Michael, is $151 million. That’s up from the $106 million in the third quarter, and we haven’t assumed a specific number. We’ve just said it will probably be a modest charge in the first quarter. We’ve been had some very large numbers in LIFO the last couple years, large credit this year. If you remember back in 2008, we had a charge of $281 million, but the year before that only $30 million. We would think that it would be very modest in the first quarter looking forward.

Michael Gambardella - JP Morgan

Second question, on the electrical steel, are you saying, Jim, your sales in electrical steels in 2010 should be about the same as in 2009, that the volumes and product mix better volumes product mix 2010 kind of offsets the price decline?

James Wainscott

Mike, let me just give a little bit of color with respect to electrical steel. The volume for 2009 was continually under fire and probably came in roughly 30% or so down year-over-year that is when we compare it to 2008. As we look to the question of volume for 2010, we expect at least a 30% increase in our volumes compared to 2009, so that’s obviously very, very good news, a function of the quality of our product and the value of our relationships.

On the pricing front, again as I mentioned in light of global supply and demand conditions, right now, we expect our average pricing for this product line in 2010 to be less, but less by something less than double digit, so less than a 10% decline. We will benefit from a richer product mix, probably our richest mix ever in this product line as customers that we have continue to seek the highest efficiency grades of electrical steel. So pricing will be down, mix will be up, volume will be up and overall, it will be a better year for us in terms of electrical steel.

Operator

Your next question comes from Luke Folta - Longbow Research.

Luke Folta - Longbow Research

Just a quick question here, your modest expectation for LIFO charge in the first quarter, I assume that charge you’re expecting assumes the 20% to 25% increase in iron ore that you’re expecting for the full year?

James Wainscott

We have assumed the increase in the iron ore price. That is correct.

Luke Folta - Longbow Research

Just secondly, on the mismatch you’re referring to as far as your selling prices and the lagging contract for carbon. Can you give us a feel for, what sort of impact that is in dollars or…?

James Wainscott

We’ve announced a serious of price increases that totaled more than $100 of ton. We obviously have experienced some of that, but the most recent $60 a ton would not be in our results largely for the quarter, so we’ll continue to book at those higher levels.

We’re not here to guide to the second quarter yet, but again, to Al’s point the LIFO charge, the higher expected whether it’s scrap or iron ore or other input costs will be reflected in our first quarter, but again, we’re already booking out into March and April as we speak, so we won’t be able to go back and recoup those higher costs at this point.

I think prices per scrap, prices for iron ore have been going up, if you believe the trade press almost weekly and we’re trying to stay current with that but in a rising cost environment we’re a little bit behind the curve. We’ll catch up and I think it will be meaningful.

Luke Folta - Longbow Research

Is it fair to say that the full impact or roughly 10% decline in electrical steel is reflected in the first quarter?

James Wainscott

Yes, I think it will be our weakest quarter. Again, we’ve been commenting for the last couple of quarters that we thought the destocking program was occurring. I think it has occurred. It may still be occurring to some extent. I would imagine that there are a number of producers or users of electrical steel, transformer producers who have a fair amount of inventory still on hand.

That’s our sense anyhow, so I think we’ll be working through this over the next quarter or two. We need to see a little bit better of a construction marketplace and we need to see the emerging economies bring projects that were set aside really back front and center. I think that will continue to occur as economies will continue to improve.

Operator

Your next question comes from David Lipschitz - CLSA.

David Lipschitz – CLSA

A question on your mix in terms of you said auto was good, other stuff wasn’t as good, where do you stand in terms of where you think 2010 is from a mix perspective and also where do you stand coming into the year on a contract perspective with the automakers and others?

James Wainscott

From a mix standpoint again we’re well positioned to serve really all of the markets, but I think we’re able to capitalize early on here in terms of automotive. Automotive last year, haven’t seen all of the numbers and we’re probably 36% I think we’ll be all of that this year and I think it’s probably a pretty good place to be again, all things considered, given that a lot of the economic turmoil has passed in that regard.

In terms of the outlook for pricing and such, I’d just offer that given the increased demand profile that we’re experiencing in that particular sector and the higher steel making input costs that we’ve spoken of here, we certainly expect to negotiate higher prices as our contracts expire at various times in that particular market during 2010. A lot of our deals will expire in the first half and I think that will be very, very helpful.

We still have a very significant place at the table though, I want to emphasize, for appliance manufacturers, for infrastructure and manufacturing participants and certainly the service centers and distributors and all of our specialty steel that customers, so again, I think our mix will be looking to increase volumes, particularly in the carbon arena as that market seems to be increasing particularly in the automotive sector. You should mention the I&M will be about 31% and PNC 33 so very good mix looking for this year as well?

David Lipschitz – CLSA

Just one quick follow up on the electrical steel, you said volumes will be up but you also said your customers have some inventory on the ground. Do you think they will work through that in order for the second half or where are your increases of 30% shipments going to go, overseas or US? What are you thinking there?

Albert Ferrara

Again I think it really does get to how you treat your customers, we try to listen to them, and we sort of share the same concerns that they have. I don’t know that’s always true in every relationship, but in our case as they work through some of this in the first and second quarter we look for stronger second followed by a stronger third and a stronger fourth again the sequential improvement being there.

In terms of the NAFTA, non-NAFTA, I would say roughly we’re half and half in terms of our exposures there and I think that’s a good thing. We’ll continue to advantage ourselves overseas and there’s probably a bit more growth opportunity there and we would love to get the China thing behind us so that we can continue to ship back into that market.

Operator

Your next question comes from David Gagliano - Credit Suisse.

David Gagliano - Credit Suisse

I just back on this volume comment. Of the expected 30% increase in the electrical and I think you said a 40% increase in overall volume versus ‘09 how much of both electrical and total volumes are actually tied up under fixed volume contracts at this point for the full year?

James Wainscott

The majority of our NAFTA business is under contract, but a greater percentage of our non-NAFTA business would be in the spot market, so got another, I’d give you a percent, but a significant portion we have a good idea of what those prices are going to be.

David Gagliano - Credit Suisse

In terms of the portion is that for the electrical business, is that the basis for the 10% decline in prices, or is there a different price for the portion that’s being committed at this point?

James Wainscott

That drives the majority of the decline in pricing, but we’re making some assumptions again about volumes and pricing here that we expect to play out given all of the customer input that we’ve gotten, but the comments we’ve given reflect what we’ve been able to negotiate with respect to contract business on the NAFTA side.

David Gagliano - Credit Suisse

Just last question, for Al, did you quantify the LIFO charge that’s within the $30 to $35 per ton assumption?

James Wainscott

When you say $30 to $35 assumption for the first quarter?

David Gagliano - Credit Suisse

I’m just saying $35 assumption for the first quarter, right.

James Wainscott

No, we did not. What we have going on in the first quarter is, essentially we have some higher selling prices, and obviously higher raw material prices, but all we’ve said is, we have a major headwind there with the reversal of the $150 million LIFO credit that we won’t be seeing in the first quarter.

David Gagliano - Credit Suisse

There is an assumed charge already embedded?

James Wainscott

There is a modest charge, yes.

David Gagliano - Credit Suisse

What was assumed to credit heading into Q4?

James Wainscott

We went into the quarter, we had $105 million in a credit in Q3, and we were looking at something slightly in excess of that, and obviously it turned out a bit higher, because our customers pulled a lot more inventory than we had expected and so consequently, we had a larger credit of $150 million.

I’d just offer that, the LIFO is what it is. Even taking the additional LIFO credit out from what we thought it might be, it was a better than expected quarter for us for the reasons that I mentioned before. LIFO is a function of the cost of those steel making inputs, which headed down, but it’s also a function of the inventories.

Again, when the customers came calling in the fourth quarter, we far exceeded even the high end of our shipment guidance, that drove the inventory levels down and we have to true-up the LIFO calculation at the end of the year. As Al mentioned, this can go and has gone either way. We benefited for the first time in six or seven years on the LIFO front and if you exclude 2009 for a moment, our LIFO charges have been cumulative.

Albert Ferrara

About $800 million.

James Wainscott

Anyhow, it is what it is. We wish it wasn’t going to be a quite so high this year, but again that’s a function of the markets and we’ll do, we can to pass along those cost increases.

Operator

Your next question comes from Brett Levy - Jefferies & Co.

Brett Levy - Jefferies & Co.

What are you thinking from here? Would you buy, would you build, do you want to stay in your core businesses, go international? There are a lot of things to think about, but you owe a multitude of options. As you look at sort of growth strategies going forward, what things feel compelling to you?

James Wainscott

Well I think, all of the above are being examined. I don’t know that any one is compelling at this moment, but we certainly are in a better position from a standpoint of financial flexibility than we’ve been. Having just weathered the great recession and maybe we aren’t completely out of that I think we have a number of alternatives and options to think about and we’re doing that. I don’t know that we would announce today exactly, what direction we’ll be heading in, but I like where we’re at.

Brett Levy - Jefferies & Co.

The second one is more specific. With respect to the auto contracts this year, are you gaining market share, losing market share, any key wins? Can you talk about the pricing mechanism? Is there used to be scrap adjustments, are there other adjustments as well now in the new contracts for your auto customers?

Albert Ferrara

I would say overall, we’re winning and that is really a function of how we do business and the kind of product that we’re bring into the marketplace. It’s a really tough year to come through 2009. We’ve talked about that a lot on the conference call, but the significance of it is that you get through together. You get through it with your customers and relationship, everybody can talk about a great relationship when times were wonderful as they were in recent years, but those relationships really get tested.

In our view this isn’t about a quarter-to-quarter, year-to-year, this is about a decade-to-decade and we think that, we’ve got the strongest relationships in the group. That is paying dividends for us. We’re able to get some business that we’ve been seeking and I think that our volumes this year will reflect that. I don’t know what others are doing. We make independent production and pricing decisions, but I can tell you that our outlook is a positive one, because that’s reflective of the orders and the pricing that we’re getting.

We’ve attempted in all cases once again to try and get surcharge or pass through mechanisms and they vary. They either have to do with raw materials or they are reset by various indices and again in some cases there’s a one to three month lag with respect to those surcharges as well.

I think again in a rising environment, we’ll catch up a bit as the year goes on, but we certainly have helped ourselves in this down market to build on relationships to get a bit of market share, and I suppose we’ve also benefited from the fact that some others from time-to-time have had some issues. We’re not immune from that, but I think we’ve been able to capitalize on some of the operating difficulties others have had as well.

Operator

Your next question comes from Sal Tharani - Goldman Sachs.

Sal Tharani - Goldman Sachs

Jim, you mentioned iron ore prices in the first quarter guidance, you have already taken it. Is that what you mentioned the consensus is 20%, 25%?

James Wainscott

I know that’s about half of where Goldman is at, but I think from what I can see in terms of the range of estimates that appears to be on the high side. I sometimes think that the marketing firms for some of the iron ore concerns do an absolutely marvelous job with the analyst community convincing them to publish things like that, but if one simply looks at the supply and demand demographics, we are seeing it more in that 20%, 25% range. That’s consistent with how we’ve built our plan.

Sal Tharani - Goldman Sachs

Also the electrical steel, thanks for clarifying all of the comments on electrical steel, just want to make sure the price decline of 10%, is that the base or is it overall with surcharge you expect the price decline of 10%?

James Wainscott

It’s an overall comment and I’d just say that I’ve probably said as much as I need to say about that, but again we suspect that the price declines net-net will be more than offset by the increase to volume.

Sal Tharani - Goldman Sachs

Last question on volume guidance, are you a little conservative at this point because if I add the 40% last year volume and exclude the first quarter guidance that implies mostly flattish to 1% up volume. Do you think there’s an opportunity to do better than that?

James Wainscott

You know, Sal, if I said that I’d have to revise my guidance and I think our guidance is our guidance, we always look to meet or exceed guidance and that remains the case for 2010.

Operator

Your next question comes from Michelle Applebaum - SMI.

Michelle Applebaum - SMI

I know we talked so much about LIFO, but here I still have a question. $150 million LIFO credit in the fourth quarter, how much of the $150 million was due to the true up that you mentioned you do at year end and there for not attributable to the fourth quarters results?

Albert Ferrara

No, I think as we’ve talked about, Michelle, we booked three quarters of our expected LIFO credit through the first three quarters and I think as Jim noted that as we went into the fourth quarter, we true up every quarter if you will. In this particular instance, we had sharply higher shipments than we expected and when we compared that against the indexes that we had we generated that credit. So it was a really a function of a number of things, not the least of which are falling commodity prices but also the fact that the inventory levels were lower which generated LIFO credit.

James Wainscott

We never really know what it will be until we know what it will be. I just offer one other color commentary if I can to this whole discussion. When I kind of look at the fourth quarter to the first quarter, we did $64 a ton in Q4, we’ve guided to $35, but keep in mind, more than $100 a ton delta on the subject of LIFO. So when one sort of backs that out of the equation, just for purposes of thinking about things, we feel pretty good about our start here to 2010 and again, I’d reiterate we think that will be the low point.

Michelle Applebaum – SMI

Confuse because you’re having us back out the LIFO charge in the first quarter or LIFO credit in the fourth quarter? What are you referring to when you say backing out?

Albert Ferrara

Well if we were $100 plus a ton, $110 I think round figures in the fourth quarter, and then you compare that to the, so that would take you negative, all other things being equal and then if you jump off of that into a positive 35 guidance, which incorporates a LIFO charge, it just seems to me that it speaks for itself that we’re headed in the right direction here.

Michelle Applebaum – SMI

Okay, well see what I don’t understand is that when I study inflation accounting in college 30 years ago, I was told that the LIFO credit or the LIFO charge is that you take it out, you’re adjusting the companies results to FIFO. It isn’t an unusual item so I don’t understand that.

Then the other thing is that I was under the impression that most companies in the fourth quarter will have a typical LIFO creditor charge that will be attributable to the current quarter and then a piece would be attributable to the nine months, but you’re telling me that you actually true up your inventory value every single quarter is actually a true up and so you don’t do an estimate every quarter. You actually do a true up, so the 150 was entirely fourth quarter.

James Wainscott

So what we’re saying Michelle, the way you book your LIFO and I’m sure we do it just like everybody else in the sense that you make an expectation in the first quarter with respect to what your annual charge is going to be and consequently you take one fourth of that charge in the first quarter, you do the same thing in the second quarter and you calculate it for the year if you will and you take one half of that charge in the first half.

Now, notionally, that’s your charge in the second quarter and that wouldn’t necessarily comprehend a true up if you will for the first half of the year because you’re truing up your first half LIFO charge, which of course will include the first quarter charge or credit and to the second quarter and similarly with respect to the third quarter, you do exactly the same thing, namely that you take three quarters of your expected charge or credit for the full year and that will comprehend the first half of what you’ve taken and then you additionally add what’s going on in the third quarter, so I think we’re saying the same thing, maybe just in different ways.

Operator

Your next question comes from Bob Richard – Southridge.

Bob Richard - Southridge

Just real quick CapEx meeting depreciation in 2010 would that be mostly maintenance in nature, Al or are there some selective investments you’re going to make there?

Albert Ferrara

Quite the contrary our maintenance CapEx is around $50 million a year. We have five EAF that we’re looking to spend some money on in 2010, and like I said so there are some real initiatives there it’s not just simply maintenance CapEx. Our maintenance CapEx number, Bob, has come down because of the way we’re doing our business as well as the fact that with our different labor agreements we’re far more efficient. We used to talk about $70 million to $80 million we think its numbers closer to $40 million to $50 million right now.

James Wainscott

Bob the three big items that are coming back online if you will for us in 2010 as Al mentioned the number five EAF it Butler, the SunCoke Middletown project and then the completion of really our fourth electrical steel expansion all of which were either hung up in permitting and still are to some extent or we simply just said, let’s put it on ice for a while, but that’s really what causes the doubling of our CapEx in 2010.

Bob Richard - Southridge

I appreciate that and your electrical steel expansion is here, right?

James Wainscott

Yes, it is.

Bob Richard - Southridge

One quick follow up, your carbon spot versus contract in the fourth quarter, did you offer that or can you?

James Wainscott

I don’t know that we offered it. I would tell you that spot contract last year, we were probably 55, 45 and that kind of a range and I think it was approaching 60. It might have been plus or minus 5% in the fourth quarter, on the contract.

Operator

Your next question comes from Timna Tanners - UBS.

Timna Tanners - UBS

It’s been very thorough wanted to just follow up on the comment on the call about sequential improvement in volume and talking about how that’s normally the case and when I look back I don’t see a really clear trends. I just hoping you could elaborate on why you expect volumes to move higher throughout the year.

James Wainscott

I think it’s a general comment. It’s consistent obviously with how we’ve built our plan as the economies continue to recover here and abroad, it’s consistent with how we see business coming in.

The quarter already has strengthened since the beginning of the year and I think that’s the modus operandi that we will employ. The typical seasonal effects that we see in the first quarter and I guess we really haven’t seen them to a great extent as we’re capitalizing on opportunities that are out there.

I don’t know that it will be monumental huge improvement, but largely the point we’re trying to make is not just from a shipment volume standpoint, but from a bottom line standpoint. That’s really driving really our focus at the company. We continue to focus not just on sales or sales prices, but really margins and driving those margins to the bottom line.

Timna Tanners - UBS

So that’s the volume is a little smaller, but margins will be expanding in your view, and would you expect the volumes across the Board, across your three major product lines to be improving?

Albert Ferrara

We’re counting on that.

Operator

Your next question comes from Charles Bradford - Affiliated Research.

Charles Bradford - Affiliated Research

A question for you about coking coal, the other big component, I know you’ve got a lot on the contract, but can you spell out for us just how well fixed you are because we’re hearing about some pretty large increases in the world markets, in the neighborhood of 50%?

James Wainscott

Chuck, I think we might have commented on this, but I’d just reiterate not necessarily in today’s call, but previously. In early 2009 taking advantage of coal prices at the time we negotiated agreements to the effect of which is really for us a very minimal price increase in 2010. So we’ve avoided that which you have just referred to.

Charles Bradford - Affiliated Research

Then a question about possible outages, do you have anything significant scheduled for 2010?

James Wainscott

We’ll knock wood as we answer that just for superstition purposes. The short answer is, we’ll have our regular outages, but given the extensive work that we did last year on blast furnaces, we have no planned blast furnace outage at either Middletown or at Ashland. So we are ready to rock and roll in terms of making steel.

Operator

Your next question comes from Brian Yu - Citi.

Brian Yu - Citi

I just got a couple questions left on my list here. First, with regards to pension requirement, I think you said $105 million this year. Any updates to your pension requirements for next couple years?

James Wainscott

We are looking, Brian, next year at about $275 million and probably something similar to that in 2011.

Brian Yu - Citi

Then going back to your fourth quarter results in terms of the volume upside, which particular end market did that come from? Is it auto or service centers elsewhere?

Albert Ferrara

I would say, we had a very strong pull in the automotive sector.

James Wainscott

Brian, just back to the pensions again the numbers Al gave for the out years are really anybodies guess. There are so many moving pieces and parts now. We have an assumed rate of return, we have an assumed mortality experience, we have an assumed discount rate and as those things move and some cases with great volatility if not violently, those numbers can change rapidly.

So whereas this year’s numbers a little more than 100 and the next couple are out some number that maybe will triple that we’ll see is sort of the bottom line. The key point I would just say is that with respect to pension contributions, we feel that they’re very manageable for our company.

Albert Ferrara

I think that’s the point that we’ve been making actually since 2003 that the pension contributions that we have are manageable and frankly, we’ve had a pretty consistent approach with them going forward.

Operator

Your next question comes from Mark Parr - KeyBanc Capital.

Mark Parr - KeyBanc Capital

It’s nice to see you take advantage of the volume recovery in the market in particular. I had a couple of questions, first related to utilization. You talked about, I think an 85% utilization rate expectation for the first quarter; is that right?

James Wainscott

Correct.

Mark Parr - KeyBanc Capital

Could you give some more color for that around your blast furnace, BOF operations as opposed to EAF and also is that steel making utilization or is that rolling utilization rates?

James Wainscott

Those are a lot of questions, but let me try. First off, just to give some context, as we looked at first half of 2009, overall as a company, we were operating at about 50%, of capacity and that grew to 60% in Q3 and to about 70% in the fourth quarter and as I say now, we’re about 85%.

Without getting into a whole lot of details, that’s an average number for the company. Our blast furnaces are running pretty much full out and we haven’t, if you will, juiced them up as much as we might, that’s something that we’re looking at doing if demand continues to strengthen. We’re running at somewhat less than full capacity at Mansfield, and also Butler in terms of steel making.

Finishing really is dependent really on the products that are moving, but again, I think as an overall indicator substantially up from where we were in the first part of last year, we like that for a number of reasons as I said. It helps our costs and it helps our people.

Mark Parr - KeyBanc Capital

In your current outlook, do you envision reengaging slab purchases to any great degree this year?

James Wainscott

Yes.

Mark Parr - KeyBanc Capital

One last question if I could, just on iron units, were there any significant backlog of iron units that you had that you could carryover into 2010?

James Wainscott

Quite contrary, we came into 2009 with a bit of a backlog and that weigh down our first quarter, first half results. We’d like to buy a few more iron units as we crank things up in 2010.

Operator

Your final question comes from Dave Martin - Deutsche Bank.

Dave Martin - Deutsche Bank

Had a couple questions, I think maybe the first one, you partially answered, but can you just comment on your coal and iron ore inventories? I think it’s typical this time of year that you have a few months of supply given the seasonality of the business. Are your coals and iron ore inventories characteristic of that today, or are they not normal?

James Wainscott

I think our ore inventories are consistent really with what we’ve done in the past. We’ve maintained levels of inventories clearly, because of the lakes freezing up and things like that, but we certainly have ample inventories to operate on a planned basis through the first quarter when the shipments start to pick up a little bit later in the quarter, but no issues with respect to either iron ore or coal.

Dave Martin - Deutsche Bank

Then my last question would be coming back to electrical steel in China. Can you give us some color on the tons you shipped or the percent of business that you did in China in the electrical steel business in 09?

James Wainscott

I don’t know that we’ve said that publicly. I would say that it’s an important part of our business, but it’s not the dominating part of our business. It’s double digit of our total percentage of electrical steels, but importantly, it also represents a great growth prospect for us. So I think, clearly is an area that we’d want to continued to sell into and we have continued to sell into, but not nearly at the levels that we would like.

I’d reference again my prepared remarks that we think it’s really a baseless situation, factual and legally, we will continue to pay close attention. We hope to hear something in the spring and we’ll continue to fight the case, but in the meantime, activity there has largely stalled out.

We’re here really as a company, whether it’s in electrical steel or stainless steel or carbon steel for one reason and that’s to serve our customers, serve them very, very well, hopefully better than any other steelmaker and I think it does a disservice to our Chinese customers to have done what they’ve done, at least in the short run.

Let me just again close by saying to all of you, thank you, thank you for your interest and your continuing support of AK Steel. We certainly hope that you will join us on our first quarter 2010 conference call in about three months. Have a great day and a much better 2010. Bye now.

Operator

Ladies and gentlemen, this concludes our conference call for today. Thank you for participating. You may disconnect at this time.

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Source: AK Steel Holding Corp. Q4 2009 Earnings Call Transcript
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