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AK Steel Holding Corp  (NYSE:AKS)
Q3 2018 Earnings Conference Call
Oct. 26, 2018, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to AK Steel's Third Quarter 2018 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference call is being recorded.

At this time, I will turn the conference call over to Jaime Vasquez, Vice President, Finance and Chief Financial Officer. Please go ahead, sir.

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Thank you, Liz, and good morning everyone. I also would like to welcome you to AK Steel's conference call to review our third quarter 2018 financial and operating results. With me today are Roger Newport, Chief Executive Officer; and Kirk Reich, President and Chief Operating Officer. In a moment, Roger will offer his comments on our business and overall market conditions and following Roger's remarks, Kirk will provide an update on our progress on some of the projects and initiatives under way at AK Steel. And following Kirk's remarks, I will review our third quarter 2018 financial results, and together we will field your questions.

Please note that during today's call, we will refer to presentation materials, which were posted on AK Steel's website this morning. If you have connected to this call via the webcast, you should see those slides on your screen and for those of you, who have dialed in, the presentation slides are available at our website aksteel.com, under the Investors tab, where you can then click on Investor presentations.

As noted on slide 3, our comments today will include forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934. Included among those forward-looking statements will be any comments concerning our expectations, including among other items, margins and EBITDA. Please note that our actual results may differ materially from what is contained in the forward-looking statements provided during this call.

Information concerning factors that could cause such material differences in results is contained in our earnings release issued earlier today. Except as required by law, the Company disclaims any obligation to update any forward-looking statements to reflect future developments or events. To the extent that we refer to material information that includes non-GAAP financial measures, the reconciliation information is required by Regulation G, is available on the Company's website.

And with that, I will turn the call over to Roger.

Roger K. Newport -- Chief Executive Officer

Thank you, Jamie. Good morning, and thanks for joining us on our call. I am pleased with our third quarter results, which demonstrate the ongoing execution of our strategy. We generated net income of $67 million, which was about tripled the net income of $22 million in the year ago third quarter. We reported adjusted EBITDA of $161 million. In fact our third quarter EBITDA performance was our best third quarter performance since 2008. This provides evidence that our strategy is working, and we continue to deliver on what we said, we would do. Jamie will provide more highlights on our financial performance shortly.

Moving to Slide 5. Throughout all that we do, the safety of our employees is our highest priority. While we have seen a slight uptick in our figures, we continue to be an industry leader in safety. And once again, our team delivered good results with four of our facilities working the entire third quarter, and two of our facilities working the entire first nine months of the year without an OSHA recordable. Such results clearly demonstrate that achieving the ultimate goal of zero accident in the workplace is indeed possible. I would like to thank each of our employees for embracing safe work practices and making safety such a high priority.

As shown on Slide 6, in 2018 we continue to make solid progress in executing our strategy. Our investments to expand our growth platform are proceeding well. Our research and innovation team is working extensively with our OEM customers, as they consider the opportunity to incorporate our third generation advanced high strength steels, NEXMET 1000 and NEXMET 1200 into their vehicle design. These unique grades of steel provide opportunities for new designs for our customers lightweighting solutions that are providing exciting potential that both we and more importantly, our customers are actively working to get into vehicles in the future.

Third generation steels are actively being researched throughout the industry, as these new levels of high strength and outstanding formability represent breakthrough opportunities in lightweighting for our customers. At AK Steel, we've communicated our goal of generating at least 30% of our EBITDA from downstream revenue. Our investments in research and innovation provides strategic opportunities to help achieve this goal, as we're looking at not only the value in selling these third -- new third generation advanced high strength steels, but we are also actively developing the application solutions for customers -- that our customers will purchase.

Through our acquisition of Precision Partners, we are building prototype lightweighting solutions utilizing innovative products, such as NEXMET advanced high strength steels and researching technologies that expand the potential for these products and our customers designs. Being the first to produce these products and coupling their products with our downstream investment provides us a unique opportunity for innovation, as we are the first to research the applications of these innovative new products and actually produce parts with them showcasing the lightweighting value even before our customers stamp their first part. This provides us the opportunity to investigate the entire value of these products not only in this field, but in the value found in the final application of the lightweighting solution. This is an advantage, we expect to continue to exploit, as we're not done introducing innovative steel products.

Just last week, we announced a new $1.2 million award from the Department of Energy to explore the development of low density steels, which could ultimately be used in automotive structural applications. This is an exciting potential, new technology in which we will be collaborating with the Department of Energy, Oak Ridge National Laboratory and the Colorado School of Mines. Kirk will comment more on that in just a moment.

Now switching to the trade front on Slide 7, we support the administration's actions to address global steel overcapacity and unfair trade practices that are threatening the security and economic well-being of our country. We are pleased that the tentative deal reached between the United States, Mexico and Canada, as a replacement for NAFTA. We believe that provisions that encourage automotive production in North America are positive for our industry and our manufacturing, as a whole. But there are still opportunities to address steel trade among the NAFTA countries to ultimately achieve the underlying goals of the Section 232 remedies.

While we are encouraged with the trade progress, we remain concerned the electrical steel downstream products such as laminations, cores and core assemblies, the power of our nation's electrical grid have yet to be included in the Section 232 remedies. Including these products is important because certain transformer manufacturers and foreign electrical steel producers are working to circumvent the tariffs. Some parties are directly seeking exclusions from the Section 232 for foreign electric steel, even though there is adequate domestic supply. Those requests should be denied by the Department of Commerce.

Other parties are importing more downstream transformer products from Canada and Mexico that are simply making minor modifications to steel that we believe is dumped or subsidized to avoid the Section 232 tariffs. These efforts to evade the 232 tariffs are threatening the domestic electrical steel infrastructure supply chain. We remain steadfast in our belief that the Section 232 remedies must be extended to downstream electrical transformer products, in order to prevent circumvention and to protect our nation's security.

To recognize the importance of a strong domestic supply chain for electrical power generation and distribution, one need to only look at the recent severe weather events involving Hurricane, Florence and Michael. In the immediate aftermath of these devastating events, millions were left without power. Safety stocks of finished transformers were quickly depleted and major transformer producers turn to AKS Steel to rapidly supply high quality grain-orient electrical steel to meet the desperate surge in demand. Having a domestic source capable of such an immediate response is critical to protecting the health and well-being of our fellow citizens, and in being the long process of recovery from such tremendous natural disasters.

Turning to Slide 8, I would now like to discuss what we are seeing in the markets that we serve. Our core automotive market is exhibiting continued strength with North American light vehicle production forecasted to be roughly 17.1 million vehicles in 2018. This would essentially tie with 2017, as the third highest automotive production level in the history of the industry. Automakers ended the third quarter with a 65 day supply of dealer inventory, which is down approximately four days since the start of September.

Likewise, we continue to see strength in the areas of residential and commercial construction. New housing starts are presently expected to finish the year around 1.28 million units, which represents an increase of 6.4% versus the prior year. And inventories at steel distributors remain well balanced with seasonally adjusted inventories currently estimated at 2.3 months for carbon and 3 months for stainless products. In short, demand for our products remain strong overall and market conditions remain favorable.

Before turning it over to Kirk, I want to share our enthusiasm about the future of AK Steel. We had a very solid performance in the third quarter, while we were negatively impacted by two major operational issues in 2018, those are now behind us, and we are focused on the future and the execution of our strategy. We are presently very busy with our 2019 customer contract negotiations with many of our key annual contracts, which cover the full breadth of our product portfolio. About 75% of our annual automotive volume will be negotiated prior to year-end. Our goal is to enhance our margins, and this means at least capturing our inflationary cost increases, We bring significant value to our customers, in terms of technical support, inventory programs, and new product development, and need to earn a fair return, in order to continue to develop these products that they desire.

Now, I would like to turn the call over to Kirk to provide an update on our steel operations, our downstream progress, and the exciting developments on the new product front. Kirk?

Kirk W. Reich -- President and Chief Operating Officer

Thanks, Roger. I'd like to touch on a few items, beginning with our third quarter operations. Starting with an update on our Middletown Works temper mill fire that occurred in the second quarter, I am happy to report that we have completed the necessary repairs and have taken the opportunity to make some mill upgrades as well. The mill was back up and operating at full capacity. During the rebuild, we utilized our other temper mills to ensure our customers were not impacted. Those workarounds have now ended and we have returned the mill to its most efficient operation. Thanks to our engineering, operating, and contractor teams for their tireless efforts to bring the mill back online, so quickly and better than ever before.

Expenses in the quarter totaled $11 million for both the repairs and additional product transportation costs. Overall, our operations have returned to expected performance levels, and we continue to make capital investments to improve our efficiencies and lower our costs. Suffice it to say that we have learned from the events of earlier this year, and we will be better going forward for it.

Switching gears to the performance of our Downstream businesses. As summarized on Slide 10, we continue to make very good progress with collaboration among our steel tubing and stamping operations. A particular interest in the industry is our NEXMET family of third generation advanced high strength steels, where we are actively working with our OEM customers on new steel solutions and lightweight designs, as we progress through the qualification process. We are securing new business awards in the area of advanced high strength steel tubing, as automakers continuing their efforts to lightweight their vehicle designs.

On the financial side, we expect to realize improved EBITDA performance at both Precision Partners and AK Tube in 2018. Precision Partners had a challenging quarter, as certain automotive programs they served experienced volume reductions. But we expect the fourth quarter of 2018 to be the strongest quarter of the year for Precision, as a result of new business we secured, which began in the fourth quarter. Also at Precision Partners, as I mentioned during the last call, we continue our program to optimize margin and have identified a number of components produced at one particular facility, which are simply not profitable.

We are in the process of shutting those parts to improve both the product mix and the overall financial returns of the company. This transition is expected to occur in the fourth quarter as well. I'm certainly excited about the growth opportunities at Precision Partners, and we have a number of new programs in the sales funnel, and I look for continuous improvement in our performance in the coming years beginning in 2019.

Meanwhile, at AK Tube. AK Tube continues to perform very well and is exceeding our heightened expectations for improved results in 2018. As Roger commented, we are actively expanding our research and innovation effort into developing new steels that hold design potential beyond anything our customers have seen before. We're particularly encouraged in these efforts, as the Department of Energy has recognized the potential of our innovation by granting us two awards to support our technology development.

The DOE first recognized us in May of last year with an award to develop the next generation of advanced non-oriented electrical steels for motors used in a wide variety of industrial and automotive applications, including hybrid and electric vehicles. We are now moving into the second phase of that project with plant trials to develop a high-alloy non-oriented electrical steel product, targeting improved motor design efficiency of more than 30% compared to existing motor designs.

And I'm pleased to inform you that just two weeks ago, we announced our second award from the Department of Energy to explore the development of low-density steels for lightweighting in automotive applications. This is also a three year project to conduct alloy design, laboratory validation, and testing of low-density steels that are alternatives to currently available advanced high strength steels, and other lightweight materials. These low density steels are expected to provide further mass reduction opportunities for our customers bringing further efficiencies in the reduction of greenhouse gas emissions through steel solutions. We're excited about these awards, as they demonstrate and underscore our commitment to being a leader in next generation steel development and processes.

Finally, as Roger mentioned, demand in the automotive market remain strong, and we have begun negotiations on a portion of our contracts that represents approximately 75% of our total annual automotive volume. We expect to benefit from improved pricing, although it's too early in the negotiations to provide any additional color. As we've stated in the past, we have positioned ourselves well with our new products, our continued exemplary to delivery performance and customer service and being on the right platforms with our differentiated products and solutions.

With that, I will now turn the call over to Jaime. Jaime?

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Thank you, Kirk. As Roger mentioned, the third quarter was our best since 2008. Adjusted EBITDA was $160.8 million and was essentially in line with our guidance, as lower than expected shipments were offset by higher than expected selling prices and higher than expected margins.

To review our results in more detail, let me begin with shipments and sales using Slide 12 as a backdrop. For the third quarter, flat-rolled steel shipments of 1.4 million tons were down about 1% from the second quarter and up 4% from the third quarter a year ago. Shipments into the automotive market were down about 5% from the second quarter reflecting lower seasonal production levels at many OEMs. This was mostly offset by increased sales into the spot and distributor and converter markets.

Sales of $1.7 billion in the third quarter were about the same, as the previous quarter and $241 million or 16% higher than a year ago. The large year-over-year sales increase was driven by stronger pricing environment, including carbon hot-rolled spot market pricing that was on average about $285 per ton higher in the third quarter than a year ago. Additionally, the recent third quarter included a full quarter of sales from Precision Partners, which was acquired in early August of last year. The full quarter inclusion of Precision Partners contributed to about $40 million of the year-over-year sales increase. Our third quarter average selling price of flat-rolled steel products increased slightly to $1,114 compared to the previous quarter. The selling prices in most product categories were on the rise.

And turning to Slide 13, you can see the sequential change in our reported third quarter adjusted EBITDA from the previous quarter. The selling price environment remained strong during the third quarter and for AK Steel increased shipments into the spot and distributor and converter markets benefited our adjusted EBITDA by $33 million. Volume and mix were $10 million negative impact, as total shipments were down from the second quarter. This was mostly due to the seasonal slowdown in automotive and when combined with increased sales into distributor and converter market resulted in a weaker sales mix.

Raw materials and energy costs were a negative $15 million, mostly reflecting higher cost inventory flowing through cost of goods sold in the third quarter. $8 million benefit in operations, primarily reflected lower planned outage expense compared to the second quarter. And other, primarily includes $11 million of expense from the second quarter fire at the temper mill that Kirk mentioned, offset by roughly an $8 million insurance recovery.

I will now turn to the balance sheet and cash flow items, which we highlight on Slide 14. Working capital was a $40 million use of cash during the quarter, due primarily to higher accounts receivable balance and an increase in iron ore inventory, as we begin to take additional shipments to prepare for the winter months. Our capital investments in the third quarter totaled $37 million, which compares to $26 million in the second quarter. For the full year, we expect capital investments to be less than $160 million.

Total net debt at the end of the third quarter was about $80 million lower than at the beginning of the year. I Also want to mention that as part of our continued focus to derisk the balance sheet, we completed another transfer of pension liabilities to a highly rated insurance company in early October. This annuitization included a transfer of just over $280 million in projected benefit obligations from our pension plan for a similar amount of assets. The annuitization is expected to result in a non-cash settlement charge of around $3 million in the fourth quarter. This was our third annuity transaction in the last two years covering over 15,000 pensioners and transferring almost $500 million in projected benefit obligations, and a similar amount of assets to a highly rated insurance companies.

Let me conclude my remarks by providing you with some insight on our current outlook for the fourth quarter, as highlighted on Slide 15. We also include some full year guidance estimates on Slide 16. Specifically, we estimate that our fourth quarter flat-rolled steel shipments will be essentially flat compared to the third quarter, as the seasonal slowdown in automotive shipments is offset by strong demand from the distributor and converter market, which includes spot market opportunities. Due to the shift in mix, we expect that our average selling price will decline by about 2% to 3%, increased shipments into the spot and distributor and converter markets will reduce our average selling price, as products sold into those markets typically have a lower average selling price than most of our other products.

And lastly, we expect our adjusted EBITDA margin will decline by about 150 basis points from the third quarter. And the third quarter was our highest adjusted EBITDA margin for the year, while the fourth quarter is typically our seasonally weakest quarter of the year, reflecting the normal seasonality in the automotive market. But I will say, we expect that the fourth quarter will be one of the strongest fourth quarters in many years.

In closing, I would like to thank the entire AK Steel team for their continued efforts in helping to implement positive change within our company.

And at this time, we would be happy to take your questions.

Questions and Answers:

Operator

Thank you, Mr. Vasquez. We will now begin the question-and-answer portion of our conference call. (Operator Instructions) Timna Tanners of Bank of America. Please go ahead with your question.

Timna Tanners -- Bank of America -- Analyst

Yeah. Good morning, guys. How are you?

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Good morning.

Roger K. Newport -- Chief Executive Officer

Good morning.

Timna Tanners -- Bank of America -- Analyst

I know you mentioned that it was too early to provide a lot of color on auto negotiations, but I figured, I would ask anyway since it's a hot topic. We get a lot of questions about how -- you have any pricing power in that market. And I just wanted to know, if you could talk a little bit about the competitive landscape as you see it. Is there anything changing year-over-year with significant new entrants, I know, you talk about your greater capabilities and offerings. But you know, year-over-year, can you give us a little bit more information about how many competitors you have and what you think the direction of volume is that you're getting from your customers so far?

Roger K. Newport -- Chief Executive Officer

Yeah. I guess I'd answer that by saying I don't think there's anything significantly different from the landscape, as far as number of competitors or in general, the competitive landscape. It's certainly a competitive space, as you well know, a lot of folks want to be in that area. But we don't see a whole lot of penetration by new players or anything along those lines. We've been able to maintain our volumes, and in some cases, grow our share, particularly on some of the newer truck SUV and CUV platforms, that's where we've focused our attention and we've continued to gain share on those particular platforms. And really with every new sourcing, we continue to gain share, as far as the allocation within that shares or the product mix is toward more and more advanced high strength steels, and our ultra-loom (ph) hot stamped product as well. And so, we're in a good spot from that standpoint. We don't see the landscape being too much different, Timna.

Kirk W. Reich -- President and Chief Operating Officer

And I comment, you know, most customers do not quickly move tons around, as you look at, you get on a platform, and you're usually serving that platform and it's not a quick moves there. And also, I note that we are heavier in the auto or in the light truck side, so the SUVs, the crossover vehicles et cetera, which have been going very strong.

Timna Tanners -- Bank of America -- Analyst

Okay, thanks. And then a follow-up on that. So just when you think about striking a balance between maintaining your volume, as you said that somewhat sticky, but you have to be competitive, you have to recoup costs, but also spot market is up significantly and you didn't get a lot of that last year. So how do you -- how do you maintain that balance? And then along the same lines, you've been reportedly doing some tolling of Brazilian slabs lately. And I figured that might be a temporary phenomenon, as you mentioned because auto has been weaker. But is that something that you consider an important part of your business going forward or is that something you take advantage of temporarily? Thanks?

Kirk W. Reich -- President and Chief Operating Officer

Yeah. Sure. Let me help you a little bit with the balance piece of it. It's certainly, we want to maintain our book of business and grow and the products, where we want to grow and -- and recognize higher pricing, as a result of the CRU change. A lot of folks talk about the delta in CRU year-over-year. If you look at the hot-rolled different, it's around $250 a ton CRU year-over-year delta and it's about $160 a ton year-over-year delta in cold-rolled and coated.

Keep in mind the most of what we sell to the automotive world is cold-rolled and coated from that standpoint. And so we use those numbers, as do our OEM customers and try to strike some kind of a balance based on those numbers. And so we recognize as you stated, we've to stay within a competitive band, but we also recognize that our costs have certainly gone up, the CRU has gone up, and we haven't been the full recipient of that this year and we intend to get those price increases. So yes, that's all part of what we do and how we do our business. So hopefully that gives you the color there.

As far as tolling Brazilian Slabs yeah, we're doing a little bit of that. We have done that from time-to-time Timna over the course of the years that's really not a new book of business for us or not a new piece, it's not a substantial piece of our business. We have time available on our hot strip mill in Middletown, as a result of the temporary idling of our Ashland works, as you know. And as a result of that we look for -- from time-to-time opportunities, where it makes sense that we are not the importer on those slabs, we are simply toll-rolling them and processing them. We know the markets they're going into, they're not going to compete with -- with our material. And so we take advantage of those situations, where we see him to make a little bit of margin, fill one of our -- one of our less utilized units and -- and make some money do it.

Roger K. Newport -- Chief Executive Officer

I also add to Kirk's comments in regards to the automotive contracts, as we negotiate them. We look at as you mentioned Timna what's happened in the spot market, but we also look at input costs and driving to recover those and also freight costs. We've been impacted. We adhere to our contracts. We honor our contracts with our customers, and we've had some negative impacts in 2018, as freight costs have risen and other costs have risen. So our goal is to recover those, as we move forward. And we're currently in negotiations with many of them and we're focused on improving our pricing.

Timna Tanners -- Bank of America -- Analyst

Okay. Thank you very much.

Operator

Our next question comes from Curt Woodworth of Credit Suisse.

Curt Woodworth -- Credit Suisse -- Analyst

Hi, good morning, guys.

Roger K. Newport -- Chief Executive Officer

Good morning.

Curt Woodworth -- Credit Suisse -- Analyst

I'm just trying to square the ASP guidance for 4Q relative to what happened in the third quarter? Last quarter, you talked about more volume going into spot and clearly that happened this quarter, yet your ASP was better than you thought. And then going into the fourth quarter, you talked about continuation of that fact, but you're guiding to a level that seems to imply that you're not getting much shift on your contract book. So can you just help us understand the mechanics around the ASP guide for 4Q? Maybe if you could just help us quantify either what your pricing would be if you held the mix constant? And then could you also just confirm that I -- we were under the (ph) understanding that about 20% of your order book repriced October 1? Did that happen and can you comment on that outcome?

Roger K. Newport -- Chief Executive Officer

Yeah. So I guess, I'll start with the auto piece, and then let Jaime answer the selling price piece. But the -- as far as the auto book at 20% those contracts have not been finalized yet. We're still negotiating those. So we're continuing in that discussion, Kurt and so we don't have anything to report from that standpoint. We've -- we've built into the fourth quarter forecast what we think is an appropriate increase, but those have not been finalized. Those will -- when we get those contracts done, they will be retroactive to the start of the quarter. And that's not atypical that they -- those discussions will continue perhaps the end of the deadline.

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Yeah. And just in terms of the average selling price, going back to our guidance for the third quarter, I think that delta was really driven by the mix within. We also had slightly lower automotive shipments than expected. So that did tamper the average selling price, but it's really the mix within caused us to exceed our guidance. And going from the third quarter to the fourth quarter, it's really the delta in automotive shipments, I mean it's seasonally weaker. And so that's going to put little bit more pressure on the average selling price.

Curt Woodworth -- Credit Suisse -- Analyst

What is the just rough numbers, the differential between your contract book ASP versus the spot market ASP?

Roger K. Newport -- Chief Executive Officer

We're not going to tell you that.

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

But they're not -- they're not comparable numbers necessarily because they include a lot of process (inaudible) sweating and blanking (ph) and a lot of other things besides -- versus spot market, you're just shipping typically an entire coil and you're doing a lot of other services too. It could be blanked parts (ph) there's a lot of things. So they're not really in comparable.

Roger K. Newport -- Chief Executive Officer

Yeah and the contracts were booked at the end of the third quarter last year, at the end of the year last year, at the end of the first quarter of this year. The CRUs at all different pricing level when that happens, the competitive landscape is different when each of those happens, each of them have their own particular details to them. So those are -- you just can't -- that's apples and oranges, you can't put those together and match them to one another.

Curt Woodworth -- Credit Suisse -- Analyst

Okay. And just one final follow-up. What percent of your shipments in the fourth quarter, do you expect to be contract or spot?

Roger K. Newport -- Chief Executive Officer

The mix shouldn't change too much. I mean, we're 70% fixed. With the decline in automotive, there could be a percentage point or two delta, but that mix doesn't typically change that much.

Curt Woodworth -- Credit Suisse -- Analyst

Okay. Thanks, guys.

Operator

Our next question comes from Nick Jarmoszuk of Stifel.

Nicholas Jarmoszuk -- Stifel -- Analyst

Hi, good morning. Thanks for taking the questions. There was a domestic met producer that was discussing their 2019 book and they're saying that some of the domestic mills are having more appetite for index linked met tons. I was hoping you comment on how your met contracts are going? And whether you guys are looking for fixed or putting pricing?

Roger K. Newport -- Chief Executive Officer

By met tons, what are you referring to met coal?

Nicholas Jarmoszuk -- Stifel -- Analyst

Met coal, yeah.

Roger K. Newport -- Chief Executive Officer

Yeah. Met coal, we do the same way we've done it every year. And Nick, we book those as annual contracts and those were all are already done for next year. We did see an increase due to the increase in coal prices, as you've seen and somewhat due to the increase in transportation costs as well. So those costs are up year-over-year, but we book those as annual contracts.

And then as you know, we have AK Coal, our own coal mine with the (ph) 15% or so of the coal that we consume. We produce ourselves out of that lowball mine. We've actually recently elected to expand into an additional seam in that mine. So we'll go through in the same portal, but in a different seam that will get us a little bit lower cost of coal and a better quality from the blend between those two. And it really puts us in a position that if coal prices remain high, we could decide to increase our production out of that mine as well. And so nothing has changed from that perspective for us, Nick, from the annual contract standpoint.

Nicholas Jarmoszuk -- Stifel -- Analyst

Okay. And then just another approach on the auto contracts. Are you able to discuss whether the gross profit per ton is going to be flat? Or whether you think it's going to be up for 2019? Basically, are there going to be more profitable?

Roger K. Newport -- Chief Executive Officer

From an automotive standpoint, we should be more profitable. Yes, we expect the increases to exceed the raw material increases. That's correct.

Nicholas Jarmoszuk -- Stifel -- Analyst

Can you put any quantification on that $5 per ton, $10 per ton, $15 bucks per ton?

Roger K. Newport -- Chief Executive Officer

No, we're still in negotiation with some. As we indicated for fourth quarter, we're still negotiating that expired October 1st and we're in early discussions right now with those in 2019 and we don't want to set any expectations. We don't want to communicate anything at this point, as we are negotiating with our customers.

Nicholas Jarmoszuk -- Stifel -- Analyst

Okay. That's all I had. Thank you.

Operator

Our next question comes from Arjun Chandar of J.P. Morgan.

Arjun Chandar -- J. P. Morgan -- Analyst

Hi, good morning. Thank you. Which is on the balance sheet, where do you see an idea of leverage target for your business long-term? And does that target include pension liabilities?

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Yeah. The -- the target we set out right now is to be less than four times and that's kind of just a landing spot. I mean ultimately in the cyclicality of this industry, you like to be down to two to one. So we have a long way to go. But our dedication of any free cash flow is to reduce debt at this point. So ultimately, we want to drive it to give us a lot of flexibility to do more things strategically. But as we've said in the past, the balance sheet and reducing debt at this point is kind of the focal point from the finance side.

Roger K. Newport -- Chief Executive Officer

I also add is we've made progress in our deleveraging and derisking our balance sheet with what our team did here in October to move more of our pension assets and liabilities off of our balance sheet, which takes away risk and we've done over $400 million since we started this and we just did $280 million in October. So that is a -- we think another step, as you know of our focus to derisk our balance sheet given the volatile markets because the volatility is not in the liability, the volatility is in the asset -- pension assets.

Arjun Chandar -- J. P. Morgan -- Analyst

Right. Thanks. And just following up on that your latest thoughts around both the 2019 converts and the 2021 notes, which stepped down to a par call next October. I mean, I know you've got about $950 million of liquidity on your -- on your balance sheet today mostly in the revolver. But what are your plans to address both of those -- those instruments coming up?

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Yeah. Needless to say, the 2019 converts, we will be addressing sometime in 2019 in the -- in the early part of 2019. And then 2021, we continue to look at market conditions. It's got to make sense to push up the duration for the costs we want to incur. So it's something, we are constantly looking at.

Arjun Chandar -- J. P. Morgan -- Analyst

Great. And then finally, can you just give us a little bit more color around the evolution of flat-rolled shipments in the quarter? You mentioned the weakness in auto shipments versus your internal expectations. Was that the primary driver of where flat-rolled shipments played out versus guidance? Or was there -- were there other -- other factors in play?

Roger K. Newport -- Chief Executive Officer

Yeah. No, it was predominantly on the automotive side. Yeah. There we have a little less control. It really depends how kind of the tier ones or the OEMs are pulling from the inventory programs. So I would say that was probably the primary driver.

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

And it's the timing of those two, when you see the auto industry has kept their vehicle inventories in line when they -- what levels they produce at, we we know basically week-to-week. So ability to adjust quickly will be dependent on how quickly we see it from the auto customers. But we're pleased the auto customers out there are keeping their inventories in check, with today's of inventory actually going down in September down to 65 days, which is a great level to be at and supports the production going forward some.

Arjun Chandar -- J. P. Morgan -- Analyst

Great. Thank you.

Operator

Our next question comes from Phil Gibbs of KeyBanc Capital Markets.

Philip Gibbs -- KeyBanc Capital Markets, Inc. -- Analyst

Hi, good morning.

Roger K. Newport -- Chief Executive Officer

Good morning.

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Good morning.

Philip Gibbs -- KeyBanc Capital Markets, Inc. -- Analyst

Real interesting comments, I think on the pension derisking, is there any change to the cash flow obligations, as we look out the next couple of years?

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Yeah. I would say the one change that's in our 10-Q is in 2020 and that is -- that is about an $80 million contribution requirement at this point. It really broken out on the delta previously was about $10 million that was reported in the December 10-K and the delta is really about $25 million to -- little bit more than $25 million was driven by the annuitization. And then the -- another probably $25 plus million is just kind of our expectations, where the performance of the plan, which is really driven by the equity markets and to some degree, the bond markets will end up, the delta between the expected return and where we think we'll end up. And then there were some other changes in kind of the Department of Labor mortality tables that also affected that contribution rate.

Philip Gibbs -- KeyBanc Capital Markets, Inc. -- Analyst

So you're just talking about the pension here, Jaime, well -- what was it before you're saying, what was it before the $80 million.

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

It was $10 million for -- then this is for 2020. So that was the significant change in contributions. Next year's contributions are relatively the same, as we previously reported.

Philip Gibbs -- KeyBanc Capital Markets, Inc. -- Analyst

Okay. Got it. And I think you'd mentioned that the strongest quarter of the year is -- for Precision Partners is going to be for Q4, and I think we calculated some of your non -- call it flat-rolled revenue in Q3 about, call it $150 million or so. Should we expect that to increase then to $160 million, $170 million just trying to get a gauge of that?

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

No, there would be more margin improvement. The revenues coming from the Downstream businesses are relatively stable. They're typically in that $140 million to $150 million range per quarter. So we'll see (multiple speakers) margin improvement.

Philip Gibbs -- KeyBanc Capital Markets, Inc. -- Analyst

Okay. So pretty stable. Thanks so much.

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Okay.

Operator

(Operator Instructions) Our next question comes from Matt Vittorioso at Jefferies.

Matt Vittorioso -- Jefferies -- Analyst

Yeah. My balance sheet questions have been answered. Maybe if you can just comment on free cash flow generation for 2019. Just trying to think about what CapEx might be -- will remain in that sort of $160 million context. Any other big cash movement -- movements in '19, just trying to get a picture of how much you could delever the balance sheet in the coming year? Thanks.

Roger K. Newport -- Chief Executive Officer

Sure. Yeah. The big component, obviously, capital expenditures, we're going through the process right now. Yeah, I would say a good proxy is $160 million, but that could deviate plus or minus a few million, as we go through our process. But there's really nothing major on the horizon from a CapEx needs.

Free cash flow generation, we'd like to think that it's going to be better than this year, just based on our expectations for the automotive contract renewals. And I do caution everybody that even though we'll capture some meaningful price increases on the automotive contract renewals, you have to look at where spot market pricing is going as well because there's an offset there, as you know 30% of our business is still exposed to kind of the CRU index. But overall, I think we'll see some continued debt reduction through free cash flow generation.

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Yeah. Matt, I would add one thing that we're doing next year as we've got a Dearborn blast furnace and steel shop outage that will be a bit kind of above the norm if you will from an outage cost standpoint or replacing some tap holes and doing quite a bit of work in this steel shop there just normal routine every X number of years we've got to do that, but that will be different from what it was in 2018, where we didn't have that.

Matt Vittorioso -- Jefferies -- Analyst

Great. And then just one quick follow-up on, I know you've talked about some raw materials, met coal and whatnot. But on the iron ore front, the stuff that you buy from Cliffs, HRC spot prices have come down. How does that look for you guys in 2019? Would you expect to pay more based on the current contract structure and current commodity prices in 2019 less or somewhat something similar anyway to sort of bracket that?

Roger K. Newport -- Chief Executive Officer

Yeah. There -- it'll be a bit more, as a result of exactly, where you were going with that Matt is not because of the iron ore, the IODEX piece of it, but because of the indices, pieces of that and each of the contracts we have are a bit different and it gets really in the weeds. But some are, yes, you're right a piece of it is a hot-rolled or cold-rolled piece and it depends on when it was that time period to time period some of them are annual, some of them adjust on a quarterly basis and so, if you could imagine each of the contracts will have a little different flavor to them. But in general, we think that iron ore price that we will pay will be elevated a bit because of those indices being up year-over-year net-net.

Matt Vittorioso -- Jefferies -- Analyst

Okay.

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

And I -- I comment also that we do hedge the IODEX. We have a routine and a very disciplined process of hedging the IODEX, which is a component of the iron ore. And we go out as far as two years in hedging that.

Matt Vittorioso -- Jefferies -- Analyst

Yeah. Okay. Thank you.

Operator

Our next question comes from Karl Blunden of Goldman Sachs.

Karl Blunden -- Goldman Sachs -- Analyst

Hi guys, thanks for taking the time. On the Downstream contracts that you discussed as being off market, is there a way you could give us a sense of the size of those, how much the termination of those could add to cash flow next year?

Roger K. Newport -- Chief Executive Officer

Yeah. You're talking specifically at Precision Partners, where I mentioned a few of those components. I don't know that we'll go to the specifics of what that is, but those are certainly negative for us, and we intend to resolve that here in the fourth quarter. We said about getting that operation more efficient. We were successful of doing that. Then its analyze the components. There's a few that just don't make sense, and so we're resolving that this quarter.

And then within the long-term forecast for Precision Partners, there is nothing, but better as a result of hot stamp and our 3,000 ton press, those were the assets that we've got to get better utilize. And I'm happy to say that the 3,000 ton press is 100% utilized now that is up significantly from last year and the hot stamp presses are in the low 80s, as far as a percent utilization and that's up significantly year-over-year. We expect that to continue. We're landing new platforms that will in the future '19, 2021 have those assets full and have us spending a bit of capital to build more hot stamp cells (ph) that's where we anticipate that business to expand and that expands the margins, as Jaime referred to earlier.

Karl Blunden -- Goldman Sachs -- Analyst

Got you. Then just on the balance sheet side, you've mentioned some liability management actions here. You've done with the pension and planning to take cash flow and pay down some debt. Probably it's about a year ago, you spoke about potential accelerated debt reduction, maybe some additional cash coming in through the form of equity, the stock is now down from levels it was earlier in the year. How do you think about the the option or potential to do that? Or is that now squarely on the back burner?

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Yeah. I would say it's on the back burner. I mean we've been saying throughout this year that we came into the year feeling like, we were going to generate some pretty good free cash flow generation and we've, and so we've reduced debt and we feel like the same thing for 2019. We've issued quite a few shares in the past. And so we do look at our equity shareholders. They've been patient. So I think we can -- we can do a good job knocking down some debt through free cash flow generation over the next year.

Karl Blunden -- Goldman Sachs -- Analyst

Got it. Thanks very much.

Operator

Our next question comes from Derek Hernandez of Seaport Global. Mr. Hernandez, your phone maybe muted. Our final question comes from the line of Matthew Fields of Bank of America Merrill Lynch.

Matthew Fields -- Bank of America Merrill Lynch -- Analyst

Hey, guys. Just a quick clarification and then another one. The Dearborn outage that you said maybe more significant this year. When -- when is that scheduled to take place?

Roger K. Newport -- Chief Executive Officer

Yeah. It's in 2019 and is scheduled to take place fourth quarter is what we currently have in (inaudible).

Matthew Fields -- Bank of America Merrill Lynch -- Analyst

4Q '19?

Roger K. Newport -- Chief Executive Officer

That's correct.

Matthew Fields -- Bank of America Merrill Lynch -- Analyst

Okay. And then just trying to square up some comments that you've made despite the increases in met coal, despite the increases in iron ore and transport costs, you've kind of said that the automotive shipments should be more profitable in '19. But then earlier in the call, you kind of made an allusion to at least capturing inflationary cost increases. Does that mean did the non-auto business is forecast to be like less profitable on a gross margin basis?

Roger K. Newport -- Chief Executive Officer

What -- what I comment there on the automotive business, there is a couple of factors. Their annual contracts. We saw for example, rising freight costs in 2019 or in 2018 that was not in our contracts. So we had to absorb some of that. Also as you've seen, raw material costs have gone up. So and where you have annual calendar year contracts, we've incurred higher costs without seeing the benefit of the price hike. And as Kirk mentioned of improved margins and just recovering those costs alone would be beneficial to margins going forward and that's our focus is to capture those.

Matthew Fields -- Bank of America Merrill Lynch -- Analyst

Yeah. But -- but you're going after non-automotive though as well?

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Yeah. I mean -- I mean the ones that are more exposed to spot -- you commented earlier in the call that they are trying to capture at least inflationary annual cost increases presumably, your annual met contracts, your annual iron ore contracts. Just -- just squaring (multiple speakers). This part of the business is going to be more profitable, but overall we're going to try to just keep up.

Kirk W. Reich -- President and Chief Operating Officer

Yeah. If we haven't finalized any of those contracts, so we're just leaving that up in the air, but we expect the auto contracts will certainly be up. Non-automotive, we really ride with where the spot price goes. And so you know, who knows, where that is, is going to be -- if you look at CRU, the forwards would say or the CRU projection would say, it's going to be down $100 year-over-year, who knows whether that's right or wrong. And so you have to -- you have to adjust according to what those prices become and how much we make and all of that we'll adjust accordingly. So we just -- we just -- it's too early to tell any of those kind of things.

Matthew Fields -- Bank of America Merrill Lynch -- Analyst

All right. Thanks very much.

Operator

This concludes our question-and-answer session. I would now ask Mr. Newport for his closing comments.

Roger K. Newport -- Chief Executive Officer

Appreciate your questions and comments and we'd like to leave you with the following thoughts.

I'm pleased with our progress over the past couple of years, as we execute on our strategic objectives to build a stronger foundation for our company. Slide 18 illustrates our actions to-date. While we have made good progress, we still have more work to do, and we remain focused on enhancing shareholder value.

Let me close by saying that we are optimistic about the future and the continued strength in the markets, which is currently expected to continue well into next year. We remain committed to driving results, as we work hard to reward our investors. We are focused on three pillars of our corporate strategy, which include commercialization of our new innovative products and services, transforming our operations to significantly improve our competitive position and driving future growth both organically and through acquisitions into new markets and downstream businesses. We are confident that these actions will create long-term value for our shareholders.

Thank you for joining us today. We appreciate your continued interest in AK Steel, and we look forward to updating you on our progress in January.

Operator

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

Duration: 50 minutes

Call participants:

Jaime Vasquez -- Vice President, Finance and Chief Financial Officer

Roger K. Newport -- Chief Executive Officer

Kirk W. Reich -- President and Chief Operating Officer

Timna Tanners -- Bank of America -- Analyst

Curt Woodworth -- Credit Suisse -- Analyst

Nicholas Jarmoszuk -- Stifel -- Analyst

Arjun Chandar -- J. P. Morgan -- Analyst

Philip Gibbs -- KeyBanc Capital Markets, Inc. -- Analyst

Matt Vittorioso -- Jefferies -- Analyst

Karl Blunden -- Goldman Sachs -- Analyst

Matthew Fields -- Bank of America Merrill Lynch -- Analyst

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