AK Steel Holding Management Discusses Q4 2013 Results - Earnings Call Transcript

Jan.28.14 | About: AK Steel (AKS)

AK Steel Holding (NYSE:AKS)

Q4 2013 Earnings Call

January 28, 2014 11:00 am ET

Executives

Douglas Mitterholzer

James L. Wainscott - Chairman, Chief Executive Officer, President and Member of Proxy Committee

Roger K. Newport - Chief Financial Officer and Vice President of Finance

Analysts

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Brett M. Levy - Jefferies LLC, Fixed Income Research

Timna Tanners - BofA Merrill Lynch, Research Division

David Adam Katz - JP Morgan Chase & Co, Research Division

David Gagliano - Barclays Capital, Research Division

Charles A. Bradford - Bradford Research, Inc.

Brian Yu - Citigroup Inc, Research Division

Luke Folta - Jefferies LLC, Research Division

Matthew Vittorioso - Barclays Capital, Research Division

Curtis Rogers Woodworth - Nomura Securities Co. Ltd., Research Division

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

David Deterding - Wells Fargo Securities, LLC, Research Division

Operator

Good morning, ladies and gentlemen, and welcome to AK Steel's Fourth Quarter and Full Year 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

With us today are Mr. James L. Wainscott, Chairman, President and Chief Executive Officer of AK Steel; Mr. Roger K. Newport, Vice President of Finance and Chief Financial Officer; and Mr. Douglas O. Mitterholzer, Assistant Treasurer. At this time, I will turn the conference call over to Doug Mitterholzer. Please go ahead, sir.

Douglas Mitterholzer

Thank you, Sam, and good morning, everyone. Welcome to AK Steel's fourth quarter and full year 2013 earnings conference call. In a moment, Jim Wainscott will offer his comments on our business. Following Jim's remarks, Roger Newport will review our fourth quarter and full year 2013 financial results, and together we will field your questions.

Our comments today will include forward-looking statements within the meaning of section 21E of the Securities Exchange Act of 1934. Included among those forward-looking statements will be any comments concerning our expectations as to future shipments, product mix, prices, costs, operating profit, EBITDA or liquidity. 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, a reconciliation information required by Regulation G is available on the company's website at aksteel.com.

With that, here's Jim for his comments. Jim?

James L. Wainscott

Thank you, Doug. Good morning, everyone, and happy New Year.

We appreciate you joining us on today's call. Let me cover 3 subjects with you this morning. First, our profits and our people; second, our products and our customers; and third, our outlook. Then I'll turn it over to Roger for his review of our financial performance for the fourth quarter and the full year 2013.

But first, let me recognize that one of the key leaders of AK Steel, John Kaloski, who will soon be ending a terrific career in the steel industry. On January 31, John will be retiring from AK Steel. As our Executive Vice President and Operating Officer, John has played a key role at AK Steel for more than a decade. For that matter, John has had a stellar career in the steel industry that spans more than 40 years. We congratulate John on a great career and offer our best wishes for a safe, healthy and long retirement.

May I also offer my congratulations to our entire team, to all of our employees at AK Steel, on a solid fourth quarter and a strong finish to the year 2013. On behalf of our shareholders and all of our constituents, we're delighted to deliver our best quarter of the year and to return to profitability in Q4. That simply would not have been possible without the hard work and dedication of all of our people.

2013 was a year of progress for AK Steel. Despite facing a number of challenges during the year, we persevered and we improved in most facets of our business. In addition to a weak start in the steel marketplace in the first half of 2013, we also experienced a significant operational disruption at our Middletown Works blast furnace, which was the result of a mechanical failure to the charging system. With that in mind, I want to take this opportunity to express our appreciation to our customers for working with us following our unplanned event in June at the Middletown blast furnace.

Production has returned to full capacity, and we're hard at work to reduce our carbon steel backlog to all of our carbon steel customers.

At AK Steel, we pride ourselves in keeping our people safe and in taking very good care of our customers. For 2013, AK Steel, once again, outperformed the steel industry from a safety standpoint. In addition, we were honored for the progress we made on our diversity initiatives and we captured first place for overall customer satisfaction among our integrated steel peers.

We also received an award for our vertical integration investments in Magnetation and AK Coal, which are coming to life as we speak. And utilizing our continuous improvement approach, we increased contract sales, cut costs, improved margins and reported net income by the end of the year. In short, in 2013, we continued to manage those things that were within our control, such as employee safety, product quality, unit productivity and controllable costs. Let me take a moment to highlight just a few of the standout performances in these areas.

On the safety front, outstanding performances were delivered by the employees located at our Rockport Works and Zanesville Works. Each plant worked the entire year without incurring a single OSHA recordable case. And Zanesville continues to set a company record of 0 OSHA recordable cases for more than 1,200 days. For that matter, 2013 was a record tying year for the entire company as we matched our lowest ever number of OSHA recordable injuries for a full year.

These results are the product of AK Steel's safety program that's focused on what I call the 3 Es: That is education, equipment and enforcement. Good education and training, proper personnel protective equipment and strong enforcement of our safety rules and procedures.

In addition, it takes employees attention to detail and proper mindset on a 24/7 basis to make our program the success that it's become. Let me offer a tip of the hard hat to all of our employees for making and keeping employee safety their highest priority.

Next, let me turn to product quality and customer satisfaction, key indicators of how we're doing for the people that are responsible for our revenues, which is the lifeblood of our or any business for that matter. From a quality standpoint, I'm pleased to report that we established an annual company record for the least amount of internally retreated product for 2013. In other words, in 2013, we made it right the first time, more times than ever before. That's progress.

In productivity and yield lines, we set numerous records at our carbon and specialty steel finishing units, with the greatest gains achieved at our Butler Works and Coshocton Works locations.

From an external quality standpoint, our customers were very happy with our overall quality performances as well. For the full year 2013, Jacobson and Associates, an independent survey of customers, showed that AK Steel maintained its #1 ranking in overall customer satisfaction compared to other integrated steel producers.

In addition, the Jacobson Survey showed that AK Steel's specialty steel customers also gave us their #1 ranking for our performance for the year 2013. On behalf of all of us at AK Steel, I want to take this opportunity to express our gratitude to our customers for their business that we continue to enjoy and for the faith and confidence they've shown in our company.

Serving our customers better than any other steelmaker with some of the finest carbon, stainless and electrical steel products produced anywhere in the world is what AK Steel is all about. We'll continue to take the best possible care of our customers as we grow profitably together.

Wherever possible, we increased profitable sales in 2013. That was most evident in the automotive sector where our shipments increased by more than 8% in 2013 compared to 2012 and this compares to overall automotive market growth of approximately 5% for the year 2013.

Now let me transition and offer a few comments on what things look like as we enter the year 2014 and what we expect to see as the year unfolds. Although we're not providing specific guidance at this time for our first quarter 2014, let me give you some sense of what we are seeing and what we expect to occur.

The automotive market, which represents approximately 50% of our sales, remains strong. Based on a continuing positive outlook for the automotive sector that shows auto builds approaching 17 million units for 2014, we anticipate higher shipments of carbon and stainless steel products in 2014.

In terms of 2014 contract pricing, we're seeking higher prices as current agreements expire, each of our sales agreements with automakers is unique, and those agreements expire at various times throughout the year.

Housing is also picked up considerably, up nearly 20% in 2013. Most economists expect another 15% to 20% increase in housing starts for 2014. And for the first time since 2007, new housing starts are expected to top the 1 million-unit mark in 2014.

Obviously, this is a positive for appliance and HVAC demand for power generation and transmission demand and for overall steel demand. The infrastructure and manufacturing, or I&M market, is gaining strength. This market is where we will benefit from improving construction activity, both residential and non-residential, as well as gains in general manufacturing.

We are especially excited to see that the non-residential construction market and, in particular, privately funded construction projects, is expected to be much more favorable in 2014 than in 2013.

Taking all of this together, our lead times are extended into May for all carbon steel products, except for hot-rolled. We have only a small amount of hot-rolled remaining to be sold for the first quarter and as a result, we're in a much stronger position at this point in the first quarter of 2014 compared to a year ago or really about as far back as we can remember. And we expect market conditions for carbon steel products to remain strong for at least the near-term.

One of the reasons for our optimism is the relatively solid level of -- and low level of steel service center inventories, in particular. In terms of service center inventories, the seasonally adjusted average month supply on-hand as of December 31, 2013, was 2.1 months. This compares to the long-term historical average of about 2.4 months of supply on-hand. These lower inventory levels have created a tighter market since production must not only support demand but also help replenish the supply chain.

Here's where stainless steel inventory stands. Seasonally adjusted stainless steel service center inventories were at 3.1 months of supply on-hand as of December 31, and that compares to a historical average. It's been closer to about 3.8 months.

With that, let me offer a few comments on what we're seeing in the electrical steel market. The electrical steel market continues to suffer from excess capacity, unfairly traded imports and relatively flat demand. As most you know, in late 2013, we filed trade cases on grain-oriented electrical steel, or GOES products, and non-GOES material against a host of global producers, including China in order to level the playing field. We're pleased with the progress of these cases to date and in each case, the International Trade Commission has made a preliminary finding in favor of the domestic industry, with respect to material injury.

The next step is for the Department of Commerce to make its preliminary determinations with regard to dumping and subsidies. Those determinations are expected in the first or perhaps the second quarter of this year, at which point the Commerce Department may impose preliminary duties.

That said, within the U.S., we expect comparable to slightly lower electrical steel shipment volumes for 2014 as compared to 2013. In addition, with the European economy still in recovery mode and with brutal pricing, we anticipate lower international electrical steel shipments for 2014 compared to the prior year.

Stainless specialty steels for a moment with some of the strongest automotive demand that we've seen in years, we are experiencing solid demand for our 400 series or autochrome stainless steel products. Similarly, we're looking for increased shipments of our specialty sheet and strip products that are produced mostly at our Coshocton Works.

From a volume standpoint, we're not a big player in the commodity chrome nickel market, which remains a very crowded place to be. Instead, we're much more focused on bringing more innovative products to market.

Moving for a moment from revenues to costs. We expect to benefit in 2014 from lower steelmaking input costs, primarily coal, coke and a few other things, but that will begin mostly in the second quarter. We are indeed currently seeing higher scrap prices and much higher natural gas costs for the first quarter of 2014.

We also expect our iron ore cost to be higher in the first quarter of '14 than the fourth quarter of '13, although we anticipate lower iron ore costs for the balance of the year 2014.

Importantly, we expect to benefit from the start up tonnage produced for Magnetation's pellet plant that scheduled to begin operations in the fourth quarter of 2014 or perhaps late in the third quarter of 2014. But in any event, it's just around corner. And when it does occur, we expect it to be meaningfully helpful to our bottom line.

So there you have it. That's a quick overview in terms of our profits and people, our products and customers and our outlook. Following 5 challenging years for the steel industry and for AK Steel, from 2009 to 2013, we now expect to emerge as a stronger company on every front in 2014.

And as we emerge from the challenges of the past 5 years, our attention at AK Steel is concentrated on that acronym E, executing our plans; and, maintaining our focus on our core values and continuously improving things like safety and quality and productivity; enhancing our earnings and cash flow; completing our raw materials' strategic initiatives, growing profitable sales and enhancing margins as we are indeed energized for our future.

Coming off a very solid fourth quarter of 2013, we'll build upon our success. We're confident that better days are ahead thanks to a combination of the qualities that differentiate AK Steel in the marketplace like great people, superior performance and world-class products, all leading to improved profitability.

Thank you very much. Now for a review of our financial results, here's our VP of Finance and CFO, Roger Newport. Roger?

Roger K. Newport

Thank you, Jim. Earlier today, AK Steel reported net income of $35.2 million or $0.26 per diluted share for the fourth quarter of 2013. Our fourth quarter results included a noncash income tax credit of $22.7 million or $0.17 per share, as a result of the allocation of income tax expense to other comprehensive income.

Excluding this income tax credit, our adjusted net income for the fourth quarter was $12.5 million, equal to $0.09 per share, which exceeded our fourth quarter earnings guidance.

As expected, our fourth quarter results were impacted by $4.3 million or $0.03 per share as a result of costs associated with the unplanned outage at our Middletown Works blast furnace that occurred last June. Our fourth quarter results also included $2 million of costs associated with planned major maintenance outages. This was about $2 million lower than we had incurred in the third quarter for major planned outages.

Our fourth quarter results demonstrate a substantial improvement from our third quarter results, and we are pleased that we have returned to profitability.

Our shipments of 1,420,000 tons for the fourth quarter of 2013 represented an increase of 178,000 tons or about a 14% improvement compared to the third quarter of 2013. And they were slightly better than our guidance of approximately 1.4 million tons.

With the unplanned Middletown Works blast furnace outage behind us, we were able to begin to capitalize on the strong carbon steel market during the fourth quarter, including the achievement of higher shipments. However, with a higher percentage of carbon steel shipments sold into the spot market, our average selling price for the fourth quarter was $1,031 per ton, a decrease of $40 per ton, or roughly 4% compared to the third quarter but in line with our guidance.

Sales also improved in the quarter -- fourth quarter and totaled $1,465,000,000, about 10% higher than third quarter sales. In the fourth quarter, our LIFO credit was $4.3 million, down significantly from the LIFO credit of $15.8 million in the third quarter.

I would also like to provide you with a comparison of our earnings before interest, taxes, depreciation and amortization, or EBITDA, adjusted to exclude the non-controlling interests that are included in our operating results. Our non-controlling interests consist primarily of SunCoke Middletown.

Excluding the non-controlling interest, our adjusted EBITDA for the fourth quarter of 2013 was $87.2 million, which represented an improvement of $34 million or more than 63% compared to our third quarter EBITDA. On a per ton basis, our fourth quarter EBITDA improved to $61 per ton compared to $43 per ton in the third quarter, an increase of $18 per ton. Again, our fourth quarter EBITDA results represented our strongest quarter of 2013.

Moving to our results for the full year of 2013. Shipments for the year 2013 were 5,275,900 tons, a 3% decrease compared to 2012. While our shipments for the fourth quarter were at their highest levels since the second quarter of 2011, our shipments for the full year 2013 were lower than we had desired due to the combined impact of the unplanned blast furnace outage, as well as weak market conditions in the early part of the year. However, as Jim mentioned, we are pleased to have grown our automotive market shipments during 2013 compared to 2012.

Our average selling price for the year 2013 was $1,056 per ton, a decrease of $36 per ton or roughly 3% compared to the prior year, primarily due to the lower steel prices in the first part of 2013. Sales for 2013 were $5.6 billion compared to $5.9 billion in 2012.

On the operations front, we incurred expenses of $22.3 million or $0.16 per share in 2013, as a result of the unplanned Middletown Works blast furnace outage. For the full year of 2013, we incurred $29 million in planned major maintenance outage costs and this compares to roughly $31 million during 2012.

At the bottom line, for the year 2013, we reported a net loss of $46.8 million or $0.34 per share compared to a net loss of $1,027,000,000 or $9.06 per share for the year 2012. Our results for the year 2013 included a noncash income tax charge of $14.4 million or $0.10 per share as a result of the deferred tax asset valuation allowance changes.

By comparison, our results for the year 2012 included a noncash income tax charge of approximately $866 million or $7.63 per share, as a result of a change in the deferred tax asset valuation allowance, as well as a pretax pension quarter charge of $157.3 million or $0.86 per share.

Turning for a moment to the balance sheet and the cash flow statement. For the fourth quarter of 2013, our capital investments totaled approximately $15 million, roughly the same as we invested in the third quarter.

Working capital was a source of cash of approximately $99 million during the fourth quarter, as we remained intensely focused on managing working capital. As expected, for the full year, working capital was a source of cash of approximately $7 million. By comparison, in 2012, working capital was a use of $114 million of cash.

We ended the year 2013 with solid liquidity of $845 million, which represents an increase of $33 million from our September 30, 2013, liquidity level. Accordingly, we continue to be well positioned to serve the needs of our customers and our operations, as well as execute our strategic initiatives.

We also remain well positioned to continue to service our legacy liabilities. Let me take a moment to comment on our pension and VEBA funding. In the fourth quarter of 2013, we made a $41 million pension contribution, which fulfilled our pension funding requirement of $181 million for 2013. I'm pleased to report that we achieved an investment return of nearly 14% in our pension investment portfolio for 2013. That represented a solid performance for 2013 based on our asset allocation of roughly 60% equity and 40% fixed income investments.

Our pension funds' excellent investment performance in 2013 resulted in a further reduction of our estimated future pension funding requirements. For 2014, we currently expect to contribute approximately $205 million to our pension trust. Of that amount, we already contributed $41 million earlier this month and we expect to make the remaining contributions of approximately $165 million throughout the remainder of 2014.

We are also pleased to note that our pension contributions in 2015, which we previously expected to be approximately $125 million, are now expected to be approximately $105 million or $20 million lower. In 2016, our current estimate for our required pension contributions is roughly $65 million. These are very manageable pension funding levels, and they represent substantial declines from our 2013 and 2014 pension contribution levels.

With regard to our balance sheet, we saw significant improvement in our pension liability. As a result of the performance of our pension assets in 2013, as well as an increase in the discount rate from 2013 of 68 basis points, our pension liability as of December 31, 2013, narrowed to $572 million, representing a reduction of $596 million or more than a 50% reduction since December 31, 2012.

Turning to other post-retirement benefits. We completed the third and final payment to the Butler VEBA in 2013. As a result, effective January 1, 2015, all the future other post-retirement employee benefit, or OPEB obligations related to the Butler retirees, will become the responsibility of the Butler VEBA trust. In 2013, we also completed the first of 3 annual payments of $3 million each to fund the Zanesville VEBA and effective January 1, 2016, all future OPEB obligations related to the Zanesville retirees will become the responsibility of the Zanesville VEBA trust.

Similar to the pension liability, as a result of the increase in the discount rate during 2013 of 71 basis points, the OPEB liability on our balance sheet at the end of 2013 declined to $470 million, a reduction of $123 million or more than 20% since the end of 2012.

In total, between the end of 2012 and the end of 2013, our combined pension and OPEB liabilities declined by $719 million or more than 40%.

Now turning to our outlook. As is our practice, we plan to provide detailed guidance for the first quarter of 2014 in March. While we're not providing financial guidance at this time, we would like to provide a few data points for 2014.

As Jim mentioned, we expect coal and coke cost to decline in 2014 starting in the second quarter. For the full year 2014, we expect a decline of roughly $70 million in our coke and coal costs compared to 2013. We also expect to be impacted in the early part of 2014 by the rising cost of natural gas, which is being driven by the extreme cold weather conditions in the United States.

Turning to capital investments. We anticipate total capital investments of approximately $60 million in 2014. In addition, we expect to complete our strategic iron ore investment with a payment of $100 million into our Magnetation joint venture. We expect to contribute the full amount prior to the start up of the pellet plant that Jim discussed earlier.

We intend to take a planned outage at our Ashland Works Blast Furnace in the first half of 2014, most likely in the second quarter.

We anticipate that our pension and OPEB will be a combined credit of approximately $105 million in 2014 compared to a credit of $69 million in 2013. The increase in the size of the credit is primarily the result of the substantial increase in the pension plan assets and the amortization of gains and the significant decrease in our pension liability.

Finally, with regard to income taxes, our book tax rate for 2014 attributable to AK Steel, excluding SunCoke, will again primarily be a function of the tax effect of our LIFO charge or credit. For example, if we incur a LIFO credit, we will incur a tax expense for the year. And if we incur a LIFO charge, we will incur a tax benefit for the year. While we do not provide specific guidance on LIFO, we currently do not expect a large LIFO credit like the one we incurred in 2013. The actual LIFO charge or credit will primarily be driven by raw materials and energy costs. We also expect that our cash taxes will continue to be very minimal given our NOL tax carryforward position.

Let me conclude my comments by saying thank you for your interest in AK Steel. At this time, we would be happy to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Sohail Tharani of Goldman Sachs, please go ahead with your question.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

First question on the new iron ore contracts you -- contract you signed last year with Cliffs, can you give us the time line when would that start to roll in? And if it is a beneficial contract than what you had been paying in the past considering iron ore prices globally remain the same as 2013?

Roger K. Newport

Sal, the contract would kick in roughly in the second quarter this year. And as you know, we have a couple providers of iron ore to us. We don't get into the specifics of our -- each of our contracts with our suppliers as we try to protect that information.

James L. Wainscott

Just on for -- Sal, a couple of other thoughts. First off, we're buying fewer pellets, right? In the near-term, we'll be getting about 3 million tons of pellets every year for Magnetation. They're going to be great pellets and feed our blast furnaces. But when you are able then to tell all those suppliers that Roger referred to that you need half of what you used to need, I think that really gets everybody focused, everyone sharpens their pencils and it winds up being a little bit better situation to be in and we've been in for a long time, maybe ever just in the history of AK Steel. I'd say our deal is a good deal for us. We'd like to believe that Cliffs thinks it's a good deal for them. I think it's a normal course deal, so we really don't get into the great details except to say we're very, very happy with it. It's a long-term deal. We're building on our relationship and really between what we're doing at Magnetation and with Cliffs, truly, it's a game changer for our company in terms of iron ore costs for AK Steel. It's a wonderful thing. Can't have it fast enough.

Sohail Tharani - Goldman Sachs Group Inc., Research Division

Is Cliffs the only provider after Magnetation to satisfy your 6 million tons requirement, which you have on normalized basis?

James L. Wainscott

I would say there may still be some opportunity for others to play to a smaller extent. But our primary providers will be Magnetation and Cliffs.

Operator

Our next question comes from Brett Levy of Jefferies.

Brett M. Levy - Jefferies LLC, Fixed Income Research

Can you talk a little bit, it sounds like the pellet plant is coming on faster than expected at Magnetation. And then also, it's my understanding that something about the contract at Magnetation, it looks a little bit more like coaling[ph] than something iron ore-driven? Can you talk a little bit about kind of how the contract for pelletizing works at that part of the business?

James L. Wainscott

Let me start with the timing of things. Of course, Magnetation is already about a year ahead of where we thought they were going to be. Construction schedule is moving along well, I mean, even though it's frigid here in the Midwest, this sort of feels like summer conditions to a lot of the folks from Minnesota who are coming down and building this thing. They've done an outstanding job so far. All the equipment's arrived on time, we're ahead of schedule. And everything we see continues to give us hope. Magnetation, I believe, has its own disclosure with respect to the timing of these things. We're comfortable saying second half, hopefully late third quarter, who knows, it's a little bit of luck and hard work it could be sooner than that. But we're very excited about it.

As I said, it couldn't happen fast enough. Could it be 6 months from now? That would be wonderful and I suppose that's a possibility. So clearly, everything continues to be ahead of schedule and on budget. And that's all good news. I don't know, you want to talk, Roger, a little about the financial side of things?

Roger K. Newport

Yes, Brett, as you are aware, we have a substantial financial benefit that we expect. This is a game changer for us with Magnetation. And as we talked about it, the IODEX saves us about $120 per ton that we expect about a $90 million improvement annually. There's a couple of components that we have in regards to our relationship with Magnetation in the contract and you're talking about being a tolling agreement. It's really not a tolling agreement. We have a 49.9% interest in Magnetation. So we will get 49.9% of their earnings. In addition, there is pricing, the way it's determined, it has 2 factors. One, there is a discount to the marketplace; and there is also the fluctuation based on what happened with the IODEX. So those are the drivers for the benefits. So as the IODEX goes up, the IODEX goes down, that will affect what our earnings are related to that. And I'd also remind you that whether the IODEX goes up or down, that also affects the other half of the iron ore that I'm buying. So we either get impacted there negatively or get the benefits, if any, if iron ore is going up or down.

Operator

Our next question comes from Timna Tanners of Bank of America.

Timna Tanners - BofA Merrill Lynch, Research Division

I was just hoping you could provide a little bit more color on the electrical steel market in light of the dumping case. I thought that maybe there'd be more domestic market capture? And then along those same lines, the second part of the question is, if you could comment on the report that was out yesterday talking -- how the impact paper is talking about market share losses actually and some customers defecting as a result of the dumping case? If you could answer those questions.

James L. Wainscott

I think the cases were absolutely essential. Again, we can fight or compete, if you will, with anyone on any given day so long as there's a level playing field. One of the things that happened really over recent years is the supply of product. And one of the things that we find, whether it's with these cases or earlier cases that we're still working through with respect to electrical steel, is it just takes so long to get through the system. We've shared those thoughts with those who govern our country to make sure that we can expedite this process because in the meantime, one does tend to lose opportunity if not market share. So I would just offer that as sort of a big picture thought. The fact of the matter is we continue to provide great quality product to our domestic customers and to our international customers, albeit there are fewer these days internationally. The key longer-term, we believe, once we get through the trade cases and we believe they'll have a positive effect, they've already had a positive effect, will be for us to continue to innovate and provide great quality products both here and abroad that allow for the efficient movement of electrons. That's really the game changer for us in that space. Again, customers, I think, are wanting to make sure that the product they're buying meets their quality standards, and that it's at a price that will allow them to compete. We're continuing to work with them. We've got great relationships. I don't know that we've seen anything in any meaningful way in terms of market share losses or that we'd have anything to impart from a wisdom standpoint on that subject. Except to just reiterate, as I said in my prepared remarks, that we expect roughly comparable perhaps slightly lower shipments domestically in 2014 versus '13. And probably still tough sledding overseas for a while as those markets recover.

Operator

Our next question comes from Dave Katz of JPMorgan.

David Adam Katz - JP Morgan Chase & Co, Research Division

I heard you guys detail the beneficial movement in the pension contribution that you expect over the next couple of years. And obviously, you detailed the fall in total in between pension and OPEB. But I was hoping that you could break it down and just kind of detail what the pension underfunding by itself moved to? And then a refresh of what you would expect at this point for, let's say, a 50-basis-point movement in rates?

Roger K. Newport

Well, I'd comment 2 things there. As we said in total, our total pension and OPEB liabilities went down well over $700 million. As you're seeing on our balance sheet, the discount rate is starting to move up. From a funding perspective, the discount rate is not as big of a deal because there's a 25-year smoothing that's done for the interest rate. So with the movement in interest rates from a funding perspective, not material moves as you've seen there with our numbers that we've given as guidance for both 2014, which went down about $5 million to 2015, which went down about $20 million. That is really reflecting the benefit of the improved asset returns as the biggest driver. A smaller piece of that is related to the increase in the discount rate. One thing I would comment is that when you see it on our balance sheet, that a 1% change in the discount rate is about a $300 million reduction in our liability.

David Adam Katz - JP Morgan Chase & Co, Research Division

Okay. And then on the natural gas headwind that you said that you might see early this year, is there any way to quantify what that could be?

James L. Wainscott

We buy in any given year or consume 40 Bcf, 45 Bcf in that sort of range. We will hedge a portion of that if we believe it's appropriate to do so. We've hedged some of that, so we got ahead of the recent rise. Of course, it's understandable what's been going on with natural gas and spending time here in the Midwest or even up in the East Coast. These are really some of the coldest temperatures that we've seen ever. Ohio River may even freeze again. It hasn't done that in about 30 or 40 years. But so we certainly see that. Our view longer-term, that is later this year, perhaps even later this month, which would be later this week, is that gas will come back down. But $1 movement in gas is worth about $40 million to us. We do have some of our agreements that carry a surcharge but there's also different provisions within each of those. So it's not a perfect hedge kind of situation. So again, I don't know that I'd quantify it just yet. It's probably hurt us a few million dollars more than we thought at this point in the quarter. But it's not anything that we're getting too excited about but we're watching it carefully. And I think that the 4s work better than the 5s, and the 3s are even better than the 4s. You get the point.

David Adam Katz - JP Morgan Chase & Co, Research Division

Okay. And on the 40 to 45 that you talked about, you said you'd have some of that early in the year. I guess that would be 10 to 12 per quarter. How much of that was hedged in the first quarter?

James L. Wainscott

I don't know that we've disclosed really our hedge position historically. I think we might have had something less than 20% hedged for the full year is what I would say.

Operator

Our next question comes from David Gagliano of Barclays.

David Gagliano - Barclays Capital, Research Division

I just have a couple of sort of detailed questions with regards to the savings on the coal and the coke side for full year 2014. First of all, I was wondering if you could just tell us why it really doesn't kick in til Q2 versus Q1? I'm guessing it's inventory, I just want to clarify that. And then secondly, what was the year-over-year average decline in your coal price, the contracts that you signed for '14 versus '13?

James L. Wainscott

In regards to the coal and coke, you're exactly right, the key driver is working through inventory. There's 2 things there. With our unplanned blast furnace outage, we had a little bit higher raw materials when it came to coal and coke because you cannot stop running a blast or a coke plant. You got to keep that running, so we had a little bit higher inventory levels. And it's just the normal uptime to work through the inventories also. So we see that benefit really coming in, really kicking in, in the second quarter for us. In regards to specifics, per ton in that, we don't get into the details. We buy from a lot of different coal providers. We are always looking at which blend changes we can do to lower our cost, what's the impact on that on our blast furnace and coke plant operations to get the lowest cost that we can through our operations. So we really don't get into specifics of each coal provider or in total. But we do buy a little over 2 million tons of coal a year and as we indicated, we expect about a $70 million reduction. So that kind of gives you a ballpark range.

David Gagliano - Barclays Capital, Research Division

Okay, that's actually helpful. And then the -- just so we can tighten up our numbers for the upcoming 3 months, obviously, we got higher nat gas, we've got higher iron ore sequentially. In terms of order of magnitude, based on what you see in your order books right now, would you expect those cost increases to offset improvements in pricing, i.e. [indiscernible]?

James L. Wainscott

I think we'll stay with -- David, I appreciate the question. Certainly understand it. I think that we'll let a few things kind of play out here and we'll give our more precise guidance with respect to the outlook in the month of March. Our objective, of course, as a management team, as a company is to have a better year. And that means having a great quarter every quarter. But there are a few moving pieces and parts here in Q1 that we've just outlined. But to be any more precise than that, I think, we'd be giving you guidance. We said we'd do that in the month of March.

Operator

Our next question comes from Charles Bradford of Bradford Research.

Charles A. Bradford - Bradford Research, Inc.

Could you talk a bit about anything you might have heard about the ThyssenKrupp sale situation? Clearly, the announcement was the end of November. On the Hart-Scott-Rodino, there should have been a -- some kind of a comment in 30 days to somebody. Haven't heard a word. We've also heard that the plant has been having a lot of trouble with quality. Any comments that you might have heard about that also?

James L. Wainscott

Well, we certainly read the announcement and we're paying close attention to that. We're really already competing with most of the product that's come out of that facility. We're already competing with ArcelorMittal today as well. I don't know that we can really attest to quality issues. I think the issue has been and will continue to be qualifications and when can they get on new parts and so forth. I guess, it remains to be seen, a, whether the deal will get done and if so, sort of what the requirements of getting the deal done are, which is to say that we'll leave it in the hands of the esteemed lawyers regarding the DOJ review and whether or not to satisfy a restraint of trade issues they have to divest of anything. But look, at the end of the day, what we like is the fact that 73%, 75% of our business is with contract customers. We've grown substantially with automotive because they like what we do, they like the relationships that we have. We expect to continue to grow. And I think if you're rated #1 in terms of things like quality, delivery, service, overall customer satisfaction, it positions you well. That's really the field that we have, the 4 things. We have weighed in on this subject matter, as I suppose other competitors and customers have and will and all of that, I think, is being considered. But we'll see where it all comes out. It's going to be very interesting.

Operator

Our next question comes from Brian Yu of Citi.

Brian Yu - Citigroup Inc, Research Division

Jim, it seems like auto is becoming a more and more important part of your business and that tends to be more fixed price in nature, or at least fixed base price in nature, if I understand correctly. Could you help us understand what your sensitivity to just changes in commodity hot-rolled coal prices are now given that more of your mix is fixed versus more variable pricing?

James L. Wainscott

Well, again, I'd first start, Brian, with the fact that we really built the company, invested in our equipment, have a mindset and a focus to serve the very demanding aspects that it takes to serve automotive. And not just any automotive, it's exposed automotive as well. So it's nice to kind of get back to where we were and even get beyond where we were. We had an excellent quarter in terms of automotive shipments but if I look back into the 2008 and prior time frame, we were doing this every quarter. It's taken us about 5 years to sort of get back here. And by no means are we done. We continue to gain market share. And we think that's a very, very good thing for us with the Detroit Three, with all the foreign automotive manufacturers. And one of the trends that's happening in this country that I think is often overlooked is not just the sales rate, not just the consumption by American consumers, but rather the build rate and what is being manufactured in America and sent overseas. That's really music to my ears, to our company's ears, to make things in America for consumption worldwide. So that's great. I think you're also seeing continued expansions by the producers into our country, and I think a lot of that has gone to the south and our locations serve that extraordinarily well. It is, indeed, more of a fixed-price situation but I would remind you that many of our contracts, if not most, have a variable pricing feature associated with them to help recover certain input costs that may get out of hand from time-to-time. So that's there. But we're going to price our products in order to return a margin that allows us to meet the day to day needs of the business and invest for the long term. Look, we want to be there producing the products that our automotive customers need, whether it's exposed coated products, whether it's advanced high-strength steels and so forth. To the issue of how all that relates to costs and so forth, again, we consider costs one of the things that was really eroding our position in the marketplace from a financial standpoint, was the fact that we were not integrated at all in terms of things like coal and iron ore. We're well on our way to solving that to the extent we want to solve that, which is about 50% of our needs. So that will help. And I think all of this, the growth in contract business, securing supply at costs that are favorable to the marketplace, gives us great confidence in our ability to sort of forecast and deliver future results that will be better and more reliable going forward is how I'd answer that.

Brian Yu - Citigroup Inc, Research Division

Okay. I guess, I was just trying to get a sense, if we look at 3Q to 4Q, overall profitability improved by about $18 per ton. I know there are some adjustments in there with the Middletown outage. So I'm trying to better model if HRC prices start moving around by $10, $20, how should we think about that impact on profit, taking into consideration all these costs indexes?

James L. Wainscott

Want to give it a go?

Roger K. Newport

Yes. To comment, as you know, on our contract versus spot, we're probably about 3/4 to contract, 1/4 spot, so that will give you a little bit of a sensitivity as pricing moves, what can happen to our bottom line on pricing. As Jim mentioned and I mentioned on the call here, that we see a couple of things rising here in the first quarter, scrap is up. We expect natural gas to be up, and iron ore to be up because of the timing of how the Vale model works, the 4 month lag of how it flows through. So -- and we won't see the benefits of the coal and coke until the second quarter. So hopefully, that gives you a little bit of flavor. As Jim mentioned, we're not going to give real specific guidance on the fourth quarter -- the first quarter but we're trying to give directionally what we see happening both kind of short-term and longer-term for 2014.

Operator

Our next question comes from Luke Folta of Jefferies.

Luke Folta - Jefferies LLC, Research Division

First question I have, when we look around at mostly other mills, it seems like your lead times are way ahead of where most others are, even on the integrated side. And I wanted to understand, is that a function of your sales strategy? Or is it a function of you being perhaps backed up on orders in some way because of the Middletown outage? How do we think about that?

James L. Wainscott

Well, again, as I said, we are -- as full as we've been in a long time, we are hoping to ship, well, hopefully, better numbers than we have recently and we have very little left to sale. I think that's a function of 2 things. One, customers like what we're selling them; and two, we did dig ourselves a little bit of a hole. I think there were some rumblings in the marketplace with respect to delinquency. That's a very unusual situation for us, but it occurred for a reason that was outside of our control and we have brought it under control, we believe. This all relates back to the Middletown blast furnace that we talked about, the event, occurring in June. There's some of that for the tightness, particularly in, I would say, cold-rolled product but it's one of the reasons why cold-rolled is probably out to about mid-May for us. We got a little bit of hot-rolled and we can take orders into the second quarter and we're considering appropriate pricing there. Coated products for us continues to be very tight because, again, most of that offering goes to our contract customers. So I think it's a combination of things but it's mostly what we see is a pretty tight market out there, I have to say. And that's a good thing. Very good for pricing.

Luke Folta - Jefferies LLC, Research Division

Okay. And I think historically, you've been willing to comment on what the changes have been in electrical steel and perhaps auto contracts in terms of year-on-year. Any color you can give us in terms of '14 on those items?

James L. Wainscott

I think we've commented to the extent we're really comfortable commenting in terms of the volumes. Pricing has been under pressure. We're meeting competitive situations there, but still good business for us, just challenging business right now.

Operator

Our next question comes from Matt Vittorioso of Barclays.

Matthew Vittorioso - Barclays Capital, Research Division

Just taking a step back on the cost front, looking across the last couple of years, you've been able to take out, it looks like more than $100 per ton of cost on the cost of goods sold line. Could you break that out between raw materials and other sort of operational improvements? And maybe talk about some of those operational improvements and what they might be?

James L. Wainscott

Let me just kind of give you a few thoughts. This is Jim, and, Roger, you're welcome to chime in. I would say at AK Steel, lowering costs is sort of a way of life. We don't have a name for it, but the fact of the matter is that we have been doing more with less, fewer facilities and fewer peoples -- people, rather, setting safety and quality and productivity records for years, if not decades. And so it's something that we live and breathe every day. We target initiatives in any number of areas, whether it's yields or productivity improvement, or maintenance spending, lower costs, metallic burdens, transportation costs and of course, all of the things that are yet to come in terms of Magnetation and AK Coal. I'd also add that our labor agreements have given us tremendous flexibility. We think they're the best in the industry. So there is no one thing. Really, at the end of day in the steel business, if you make a lot of it, you make it right the first time, those are the biggest drivers. But then these input costs that become very, very important, things like scrap and coal and coke, gas, iron ore. Certainly, I would say in our case, input costs have probably come to the point where they're more than half of our costs. They might be 60% of our costs these days. So that's why we focus so much attention on those things. But to say that we have a certain initiative or a certain project or put a name on it or anything of that sort. The fact of the matter is it is a way life, it is the AK way and we live it every day.

Roger K. Newport

And I'd add to that. If you look at where our secondary shipments have been as showing what's happening on our quality front, we've had great operating performance, great quality and you'll see that our secondary shipments were actually less than 2% of our shipments. So drastic improvement there and that's where you see those reduced shipments add right to the bottom line.

Matthew Vittorioso - Barclays Capital, Research Division

And that's very helpful. Can I just add one last cash flow question? You talk about the OPEB benefit to EBITDA in 2014 being something like $120 million. What's the cash outflow associated with that? Would that continue to be around that $60 million level?

Roger K. Newport

Yes, it's probably about $65 million to $70 million in that range.

Operator

Our next question comes from Curt Woodworth of Nomura Securities.

Curtis Rogers Woodworth - Nomura Securities Co. Ltd., Research Division

I guess, back to the contract question, Jim. Can you give us a sense for kind of the progression of when those contracts roll off? Is it heavier in the first part of the year or the second part of the year? And then what percent of your contract business would you say is linked to some sort of spot index, like crude or plats?

James L. Wainscott

I think we view our contract business as you or your portfolio managers might view an investment portfolio, which is to say that you want some of these things to roll off at various times and they do. Some producers prefer earlier in the year, some prefer later, some prefer 9 months or 12 months or 18 months. I would say if I had to come down on one side or the other, it's probably a little heavier in the second half of the year and a little less heavy in the first half of the year. And in terms of the percentage of those that have some sort of variable mechanism, again, it's the majority. But again, there's also kind of something that's been negotiated. Each deal is unique and we always hesitate in getting into many details on these because our customers have cautioned us about this, but I would just say this that each deal has different components, things that matter to one or the other in an effort to sort of balance the risk equation. And there's sort of a, I'll call it a no blood zone, in some cases above and beyond which there is a charge or a credit but within that zone, sort of nothing happens. So that's sort of a long-winded answer to say that that's when they come up and sort of what they come. But everyone is unique and different and special, just that is the agreements, just as our customers are.

Curtis Rogers Woodworth - Nomura Securities Co. Ltd., Research Division

Okay, that's helpful. And then just a follow-up on Magnetation. Have you provided any guidance on what you think your cost to pelletize is going to be and then transportation call outs if there's any further funding requirements for that payment in the Magnetation post this year?

James L. Wainscott

I just offer that, while we haven't given specific numbers, we expect them to be very, very competitive, very competitive. Obviously, we would not have invested, made this sort of strategic decision if we did not think it was going to be meaningfully beneficial to the shareholders of AK Steel long-term. It will be among the lowest-cost, highest-quality pellets produced in America. And I think if you are familiar with some others who have given information, well, you can sort of ferret that out. But it's not producing pellets yet. We're close but we're not there. So we'll be a little hesitant as far as giving exact numbers. But I just reiterate, I guess, for the third or fourth time on this call, this is a game changer for AK Steel. It's a big deal. It's hugely important to us. We're counting on it. We have every reason to believe it's going to be soon and a really positive financial impact to the company.

Operator

Our next question comes from Henry [indiscernible] of Deutsche Bank.

Unknown Analyst

My question was actually answered.

Operator

Our next question comes from Phil Gibbs of KeyBanc Capital.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

How are you thinking about strategic capital priorities or debt reduction as you move out maybe into second half of '15 or '16? When do you really envision generating free cash flow given what you're looking at as far as your pension requirements and market conditions?

James L. Wainscott

I would just offer, Phil, a couple of thoughts. We, obviously, are looking 2014 squarely in the eye and seeing even though it's down a bit $205 million of pension contributions, $100 million due to Magnetation to complete that requirement. So it's a bit of an unusual year in that regard. The pension contributions go down by half the next year. Magnetation's investment goes away. So 2015, everything looks great. 2014, again, we'll deal with the very, very best that we can. Continuing to look at everything very carefully, starting with generating solid results from the company and good cash flow there. Also, continue to manage working capital very carefully and our capital investment program. But there's no question that 2014, things will be tight again, as they have been as we work our way to 2015. In terms of the capital structure and debt reduction and all those sorts of things, I think all those things come in due time. We're mindful of what we had to do to get through really the great recession to make investments that we've made to position the company for future success. And we look forward to the day when we're generating that cash flow where we can do some meaningful things to reduce debt and then reinvest in the business.

Philip Gibbs - KeyBanc Capital Markets Inc., Research Division

And then, Roger, how does it work from just real simplistically from an accounting standpoint for your pension credit through the P&L to grow so aggressively? I think you had mentioned something around $40 million year-over-year. Really, what drives such a meaningful benefit even from what you experienced last year?

Roger K. Newport

Yes, the biggest benefit there is driven by 2 factors. One is the favorable return on our pension assets, which we resulted in a gain, which lowered our liabilities, our net liabilities; and the other one is the rise in the discount rate. So with those gains that we had, we had numerous gains that lowered our liabilities and you amortize those over time. So that's why you're seeing the increase in the pension and OPEB credit.

Operator

Our final question comes from David Deterding of Wells Fargo.

David Deterding - Wells Fargo Securities, LLC, Research Division

I just had one quick question. If you could just give us a quick update on where we stand with AK Coal? And then as a follow-up to that, does the $60 million capital spending that you guys have laid out for this year, does that include your -- the spending that you have related to the coal projects?

James L. Wainscott

I'll take the second one first. That's easier. The $60 million does, in fact, include what we're going to invest at AK Coal. AK Coal is doing fine, coming along well. But we have made a decision to sort of slowdown in light of really tough market conditions in the coal business, which sort of yields great cost savings, which Roger talked about before, combining coal and coke, $70 million in savings for this year. I think we said when it's all said and done, it should produce about 1 million tons of what we need. We're probably on a path to roughly 0.5 million-ton level. And we've got the right focus and really the right approach there. We still think in the long run, it makes great strategic sense for us so that we're not exposed in this world that continues to bring heavy focus in regulation on that segment of the marketplace. So it's there. I would say that we've slowed it down just to reflect what is going on in the marketplace and to take advantage of the lower cost opportunities that are there.

Just, ladies and gentlemen, I want to comment on one other thing. It wasn't a question asked. I thought it might be in light of the -- all of the buzz that was created in Detroit over the aluminum vehicle, the Ford F-150. I'd just offer about 30 seconds of comments there. We would just offer, and I know it's on everybody's mind, that steel, in our view, remains the material of choice for automotive design and utilization for a variety of reasons, not the least of which is cost, paintability, repairability and really a host of other reasons, including life cycle and environmental concerns.

I don't know that the cost advantage and the life cycle advantages of steel are sufficiently understood. I think our industry and our company will try and do a better job of that. But consumers really need to be mindful of the -- not only the increase in purchase price because of the fact that aluminum is 2 to 4x as expensive as steel, but also the cost of repairs, repair shops are really ready to go for this and insurance cost. So we'll protect our product and really this space vigorously. We are delighted to continue to grow with automotive and it's a big bet by certain people but we wish them well. But we just want to emphasize that our product remains a wonderful product for making automobiles, particularly if you want to put your family in that vehicle and keep them safe.

With that, ladies and gentlemen, again, we want to thank you for your interest in AK Steel. And as we sign off on today's call, for your continuing support of our company. 2013 was a year of progress and improvement. We expect more of the same this year. We hope that you will join us in about 3 months for our first quarter 2014 conference call. And until then, we wish you a great quarter and a safe, healthy and prosperous 2014. Thank you very much.

Operator

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

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