CLEVELAND Jun 24, 2015 (Thomson StreetEvents) -- Edited Transcript of Cliffs Natural Resources Inc earnings conference call or presentation Wednesday, April 29, 2015 at 2:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Lourenco Goncalves Cliffs Natural Resources Inc. - Chairman, President and CEO * Kelly Tompkins Cliffs Natural Resources Inc. - EVP and CFO ================================================================================ Conference Call Participants ================================================================================ * Michael Gambardella JPMorgan - Analyst * Aldo Mazzaferro Macquarie Research - Analyst * Kevin Cohen Imperial Capital - Analyst * Brian Yu Citigroup - Analyst * Nathan Littlewood Credit Suisse - Analyst * Jeremy Sussman Clarkson Capital Markets - Analyst * Jorge Beristain Deutsche Bank - Analyst * Evan Kurtz Morgan Stanley - Analyst * Timna Tanners BofA Merrill Lynch - Analyst * Gordon Johnson Wolfe Research - Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good morning, ladies and gentlemen. My name is Shannon and I am your Conference Facilitator today. I would like to welcome everyone to Cliffs Natural Resources' 2015 first-quarter conference call. (Operator Instructions) At this time, I would like to introduce Lourenco Goncalves, Chairman, President and Chief Executive Officer. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [2] -------------------------------------------------------------------------------- Thanks, Shannon, and thanks to everyone for joining us this morning. Before we start, I would like to introduce our new Executive Vice President and Chief Financial Officer, Kelly Tompkins. Many of the participants on the call today already know Kelly from Cliffs or from his previous experience as CFO of another publicly traded company. Since my first day at Cliffs, Kelly has been my most valuable player and second in command. With Kelly's move to the CFO spot, Cliff Smith moved to Kelly's previous position as Head of Business Development. And the reduction of one Executive level position in our organization chart, I feel very comfortable we have the right players in the right positions to execute our USIO centric strategy. With that, I will now turn it over to Kelly Tompkins for the financial overview portion of today's call. -------------------------------------------------------------------------------- Kelly Tompkins, Cliffs Natural Resources Inc. - EVP and CFO [3] -------------------------------------------------------------------------------- Thank you, Lourenco, and thanks to everyone for joining us on this morning's call. As I take the helm as Cliffs CFO, I do so very mindful of the challenges ahead of us. Cliffs has shown resiliency throughout its long history and now that we are strategically focused and fully aligned on our financial and operating priorities, I am very confident we will manage through the current cycle. With that, let me remind you that certain comments made on today's call will include predictive statements that are intended to be made as forward-looking within the Safe Harbor Protections of the Private Securities Litigation Reform Act of 1995. Although the Company believes that its forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially. Important factors that could cause results to differ materially are set forth in reports on Forms 10-K and 10-Q and news releases filed with the SEC, which are available on our website. Today's conference call is also available and being broadcast at www.cliffsnaturalresources.com. At the conclusion of the call, it will be archived on the website and available for replay. We will also discuss our results excluding certain special items. Reconciliation for Reg G purposes can be found in our earnings release, which was published after the market yesterday. In addition to briefly reviewing the results of our first-quarter financial performance, I'll briefly recap our recently completed refinancing efforts. Beginning with our first quarter results, including coal, we achieved revenue of $574 million and adjusted EBITDA of $94 million. Despite significant decreases in pricing for iron ore, steel and metallurgical coal, we were able to generate positive EBITDA from all of our businesses. In the face of a tough macro environment, we have and will continue to respond aggressively by taking cost out of the business, methodically allocating capital, aligning corporate overhead with the changing footprint of our business and pushing to further reduce expenses wherever possible. Across all three of our reported business segments, we achieved strong results for the quarter. In USIO we generated $105 million of adjusted EBITDA. During the quarter the USIO business achieved a realized price of $93 per ton. As expected, the blast furnace pellets we produce and deliver to our domestic clients and our long-term customer contracts continue to provide us with pricing stability in an otherwise volatile global iron ore market with a spot price for sinter feeds that recently hit 10-year lows. Also as a point of clarification that was also noted in last year's first quarter, in both Q1 of this year and last year our cash production costs were higher than our cash cost of goods sold. This is primarily due to inventory effects. Because our production costs are typically higher in Q1 due to seasonality, the product that we sell is at a lower cost than what we currently are producing at and that difference comes through in the non-cash production line as inventory effects. This amount should return to positive levels as we progress into the second half of the year. In Asia-Pacific iron ore, we were able to generate $6 million of adjusted EBITDA, even with the extremely depressed seaborne pricing environment and a much lower realized pricing in the quarter of $43 per ton, APIO was still profitable in Q1. As seaborne iron ore pricing has declined, sales margins at APIO have tightened, which will have and continue to address with our relentless push to cut costs. Given the updated cost guidance that we provided last night, our objective will continue to be keeping this asset cash flow positive in what will likely be a depressed near-term pricing environment. And finally our North American coal business outperformed in the first quarter reporting $6 million in adjusted EBITDA. This is a direct consequence of a very successful cost-cutting plan implemented in our coal mines, as well as good execution by our commercial team to sell the low vol met coal preduced in both Pinnacle and Oak Grove for the best prices we can get, taking advantage of the high quality of our product. Nevertheless, North American coal's realized price of $71 per ton shows that met coal prices remain under pressure, which means cost discipline must remain a priority so we continue achieving our EBITDA neutral objective for these operations. Let me remind everyone that while we reported coal in our earnings release, the business is now considered from an accounting standpoint to be non-core, non strategic and an asset that the Company expects to sell. Accordingly, all current and historical North American Coal operating segment results are now included in the Company's financial statements but classified within discontinued operations. In effect going forward our coal group's financial results will be reflected in the discontinued operations line of the P&L. That said, let me be very clear that we are not shutting down these operations, we will continue operating these mines throughout the sale process, which is well underway. Let's now turn to our capital expenditures and SG&A expenses during the first quarter. Including our coal operations, capital spending dropped to $16 million for this quarter, an 85% reduction when compared to last year's first quarter. Looking ahead, we are further reducing our capital expenditure budget range from -- to $100 million to $125 million, representing a $25 million reduction for our previous guidance. Our first quarter SG&A expenses were $29 million, down 22% from the prior year first-quarter expense of $38 million. We continue to reduce staffing, minimize the use of outside services and consolidate office space at our corporate headquarters. During the first quarter, we further reduced our corporate headcount by 25%. Our peak headcount for the corporate office was 338 people. We are now operating with 139 people at our corporate office. Our updated SG&A outlook for 2015 is now $120 million, down from our previous expectation of $140 million. We will continue to adjust our overall SG&A expense to make sure it matches our US iron ore strategy and operating footprint. A significant undertaking during the first quarter was the successful refinancing of the Company. We established three overarching goals for the refinancing. First, we wanted to capture available market discounts on our various bonds to reduce our net debt. By capturing some of the discount on our bonds with secured note exchange offers, we were able to reduce our net debt by $130 million, well above our original expectation when we launched the exchange. This discount capture from the exchange offers, in addition to the $70 million of discount that we captured through open market repurchases executed during January -- December and January, gave us a total of over $200 million in proceeds from debt extinguishment in a four-month period. At the end of the quarter, we had net debt of $2.5 million compared to $2.9 million of net debt at the end of the first quarter of 2014. The results of these debt reduction efforts are reflected on the balance sheet. And as we transition out of the cash consuming season for our USIO business, we expect to continue to reduce our net debt by increasing our available cash balances. Our second goal is to remove the onerous financial covenants previously tied to our old revolving credit facility by replacing it with a new asset based lending facility. Because the ABL is substantially on our borrowing base of working capital, the size of the facility is smaller than the size of our previous revolver. That said, a larger revolver geared to a far different irrelevant growth strategy of the past burdened with restrictive covenants is not as valuable as a flexible ABL that we can more readily access to enhance our available cash. The benefit of eliminating the revolver-based covenants, which were a major source of unneeded management distraction for the last two years, was a key accomplishment. At the end of the first quarter and as of today we have nothing drawn on the ABL facility, despite the first and second quarter challenges from a liquidity perspective due to the seasonality of our US iron ore business. As the seasonal Great Lakes freeze comes to an end, cash receipts will be stronger and we intend to manage the business for the remainder of the year without tapping our ABL. Finally, our third goal was to supplement our ABL-based liquidity by putting additional cash on the balance sheet. Despite a very difficult debt market for the mining industry, we successfully completed a first lien note offering that netted us nearly $500 million in cash. With this new cash on our balance sheet, we have not needed to draw on the ABL, even with about $240 million of net working capital usage in the first quarter when there are essentially no shipments on the Great Lakes. With this three-step refinancing completed and the beginning of the Great Lakes shipping season upon us, we are very comfortable with our current liquidity position, but we will continue to monitor it closely as industry conditions dictate. As Cliffs CFO, I can assure you my eye will be looking forward to next winter when cash flows are naturally tight and preserving liquidity is a must. With that, I'll turn the call back over to Lourenco for his prepared remarks. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [4] -------------------------------------------------------------------------------- Thanks, Kelly, and thanks to everyone joining the call this morning. Since we took office in August last year and implemented a new USIO centric strategy, we have been executing with discipline and making progress on all fronts. Among the several steps taken, the most relevant one was the CCAA filing by the Bloom Lake Group. Had we not stopped the bleeding at Bloom Lake, this Q1 conference call would certainly be a lot different. This CCAA process has so far developed in a very smooth and even predictable way. All of the expected disagreements, lawsuits, threats of lawsuits and general statements from creditors of the Bloom Lake entities are being addressed within the scope of the process under the supervision of the monitor, and ultimately subject to the power of the court. The main highlights of the CCAA process are the following. Claims from the creditors of the Bloom Lake entities have been stayed as part of the court process. Unfavorable contracts, including the take or pay rate contract have been disclaimed. The sale of assets has been approved by the court, and the process is well underway. The Bloom Lake Group currently has a cash balance of about $45 million, and their average expected outflow per week is only a little over $1 million. Additionally, with the stay periods going through the end of July, and with the majority of the proceeds of the recently announced sale of the chromite assets going to fund the CCAA process, we maintain our expectation that no additional finance will be needed. And last but not least, we confirm our previous statement that we do not anticipate any Cliffs exposure to the Bloom Lake creditors throughout the entire CCAA process. Our liability exposure number for such creditors, which was estimated to be $650 million to $700 million pre CCAA is indeed a zero. Kelly and I will be more than happy to clarify any questions you still have regarding CCAA. Moving to our USIO business, we achieved a 38% EBITDA margin in the first quarter. Driven by contract structure and the value-added product that we sell, our pellet business in the US continues to prove its reliable profitability. Despite the irrationally low prices imposed by the two Australian majors to the seaborne trade of iron ore fines, our USIO business realized a price of $93 per ton in the first quarter. Now, why is that? First, we sell custom-made blast furnace ready pallets, not sinter feed fines. Second, due to the lack of existence of sintering plants available in the United States and obvious environmental restrictions, sinter feed fines cannot be sold in the US market. And third, Cliffs has in place and in full force long-term contracts that substantially protect us from pricing volatility. None of these contracts will expire in the next seven quarters. And we expect to renew the two contracts expiring in December 2016 in January 2017, with good terms for both Cliffs and the clients and way ahead of the expiration date. In what is always a seasonally cost heavy quarter due to weather conditions and increase the major maintenance spend, we saw USIO Q1 cash production costs decrease 20% to $65 per ton compared to $80 per ton in last year's first quarter. Also important, CapEx spend in the USIO during the quarter was only $8 million. Going forward, we have revised our 2015 sales tonnage guidance to 20.5 million tons from 22 million tons originally and adjust our production accordingly. Even though this decision may prove itself too conservative in light of recent news surrounding other Great Lakes pellet producers, and also because we expect a stronger [astute] business for our clients in the second half of the year, we believe it is prudent to adopt a cautious attitude at this time. Despite the reduction in production tonnage, we are aggressively managing costs and are maintaining our previously guided cost expectations. Holding costs with lower volumes is always difficult. But just as the sales margins on our contracts are not all equal, our production tonnage is not create equally either. We have the ability to idle some higher costs production that will offset some of the lost fixed cost leverage. We also continue to optimize our operating and maintenance practices. As well as further reducing manpower and driving cost out of our three main energy components, electricity, natural gas and diesel fuel. In sum, our USIO team under Terry Fedor's leadership is comprised of an accomplished group of very experienced general managers and operators. And they have succeeded on every challenge I have given them so far. I have full confidence that this one will be no different. Again, as we maintain our unit cost guidance with the overall better customer mix from our remaining US sales tons and other cost reduction initiatives, we expect a neutral to positive impact of this production reduction on our profitability. As unfairly traded imports ultimately step aside and the steel production normalized for our clients, we will bring back our pellet production and adjust our sales volume guidance accordingly. Separately, and very importantly, we continue to develop various entry options for the electric arc furnace market. Near term, we are focused on securing a trial order for DR pellets to confirm under actual operating conditions what we have already demonstrated in smaller batch trials. As a market leader in value added iron ore pellets, these will open up a new opportunity for us to diversify our product mix and add new customers to USIO beyond the traditional blast furnace clientele. Now, let's discuss our Asia Pacific iron ore business. In the first quarter, we reported cash production costs of $37 per ton, a 28% reduction from last year's first quarter and a 14% sequential reduction from Q4 2014. Since I started with Cliffs, the APIO business achieved cash production cost per ton of $53 per ton in Q3, $43 in Q4 and $37 in Q1. With our very limited CapEx requirements of less than $1 per ton through the rest of APIO's mine life, we believe we have been operating in the same breakeven ZIP code as the two Australia majors, when we add their very low cash cost to their very high CapEx needs. As one of the two Australian majors has already demonstrated with the recently announced postponement of a big CapEx investment, the two Australian majors will have to make a decision the next few quarters. Give up their massive CapEx deployments due to lack of funds or allow iron ore prices to increase in order to generate the funds they need for CapEx deployment. While how to price the products is a typical decision made by Management, the deployment of billions of dollars is a Board decision. And Board members are usually cautious about the decisions they make and the consequences of those decisions. In the long run, when real metrics come back to play like return on invested capital, or return on assets, the story can be a lot different, especially in a country like Australia which is so dependent on how well or how badly the natural resources are taken care of. If I were a Board member of either one of the two Australian iron ore majors, I would really think hard a lot more about the consequence of what they have been enabling their respective companies to do so far and how they will proceed going forward. Similarly, the Brazilian major, Vale, will have to make the same decision as its two Australian peers. If iron ore prices don't increase, it may not have the money for its multi billion-dollar 90 million-ton per year expansion. In sum, none of the three majors can continue to support their massive CapEx needs without allowing iron ore price to increase, and if they still decide to keep iron ore prices artificially low as they have been doing so far, their advertised massive capacity increases will not materialize due to insufficient cash flow generation. In the meantime, Cliffs continues to optimize the APIO operation and we continue to improve our cost position. One of the projects we are implementing right now is the idling of one of our three pits. Our Koolyanobbing Mine in Australia formerly operated out of three pits, Koolyanobbing, Mount Jackson and Windarling. Because Windarling's higher Street ratio, and thus higher cost established in the portfolio, mining out of this pit has been discontinued. And the operation is now concentrated on the remaining two pits, Kooly and Mount Jackson. This will deliver us further savings on resources and has already led to a nearly 20% reduction on our fly in, fly out workforce. In addition, we have completely eliminated all exploration activity. We are confident that these actions will maintain Cliffs' APIO as an EBITDA generator and as a free cash flow generator, not even considering any additional benefit we may see from the always-helpful Australian dollar exchange rate. Finally, let's discuss our North American Coal business. As Kelly noted earlier, we will continue to operate the business during the sale process. But due to the accounting treatment as an asset held for sale, this will be the last quarter that we will be reporting and commenting on coal as a business segment. In the first quarter, North American Coal achieved $6 million of EBITDA which is a lot better than our EBITDA neutral growth. Our operational team under Dave Webb's leadership continues to deliver impressive cost-cutting results quarter over quarter. Until a sale is finalized, we will continue to do all we can to operate safely and profitably. At this time, I would like to commend the North American Coal operational and commercial teams for all of their exceptional efforts in doing whatever it takes to keep this business achieving remarkable results, to the point of attracting the interest of potential buyers. In conclusion, we are focused on executing our strategic plan which will enable Cliffs to weather the current business climate and emerge from the cycle as a stronger Company. I continue to be impressed by the team's ability to deliver year-over-year cost savings during a challenging business environment. Looking ahead, we will continue to be focused on cost cutting, asset optimization, debt reduction and the sale of non-core assets as well as the conclusion of the CCAA process in Canada. We have surely covered a lot on this call already. And Kelly and I very much look forward to answering any questions you may have. With that, I'll turn it over to the Operator to direct the Q&A part of the call. Shannon? ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Michael Gambardella of JPMorgan. -------------------------------------------------------------------------------- Michael Gambardella, JPMorgan - Analyst [2] -------------------------------------------------------------------------------- I just want to say before I ask my question, I just want to say congratulations on all the hard work in making all these tough decisions that are under your control. I know there's a lot of uncontrollable factors that have been going against you, but I applaud you for all of your efforts to cut costs and make the hard decisions like up in Canada and so forth. So congratulations on great work so far. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [3] -------------------------------------------------------------------------------- Thank you very much, Mike, appreciate your kind words. -------------------------------------------------------------------------------- Michael Gambardella, JPMorgan - Analyst [4] -------------------------------------------------------------------------------- My question is with the seaborne price plummeting for the last year or so, the silver lining I think of lower seaborne prices is that a number of people were projecting that there'd be increases in US iron ore capacity to compete against you. And I would think with these low prices that all of those people have fallen by the wayside whether it's US Steel, Essar and now Magnetation, which looks like it may cease operations soon. So with that elimination of supply that some people have expected, AK Steel will need, may need some more iron ore for their US operations. ArcelorMittal who had expected to get some material from Essar may need some more iron ore from you. Because the alternative as everyone knows ( technical difficulty) is just cost prohibitive with a $30 per ton freight rate on a $55 product. So when you're approaching some of these contracts that are coming up at the end of next year, how do you balance trying to get a better price because you know the premium that these people have to pay to go through the Saint Lawrence Seaway and keeping them somewhat happy? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [5] -------------------------------------------------------------------------------- Again, thanks for great comments and appreciate your support and encouragement. Michael, believe it or not we have a lot more control over things that people say they don't control. So let's -- you gave me a lot of things here to work with, and to answer your question about the context. But let me start bringing back things to the right size. People talk a lot about the world being flooded with iron ore. That's a true statement at this point. But the biggest problem for iron ore price at this point is not even the fact that the world is being flooded with iron ore. It's the fact that the market and the press and the investors are being flooded with bad information about the expansion plans of three companies. And these three companies are Rio Tinto, BHP and Vale. Their current prices of iron ore fine sinter feed in the seaborne market are being depressed at this point, not by the fact that these guys produce a lot of iron ore sinter feed but by the fact that they are saying that they will produce a lot more. So you have for example just to give you a good number, and easy one to understand, you have Vale saying we produced 310 million tons a year but I'm going to 460 million. So that's another Fortescue on top of what they have right now. You have currently Rio Tinto producing something like 250 million tons but saying that they are going to produce 360 million, that's two Roy Hills on top of the existing production. You have Roy Hills producing nothing because Roy Hill is Hancock property, they are just the landlord of Rio Tinto. But saying that we're starting September we are going to add 55 million tons to the trade. So these news are the ones that are destroying the future view of iron ore sinter feed fines in the world. But we have to consider this thing in the context of how these things are being played. Especially Rio Tinto and BHP, more Rio Tinto than BHP, they're playing the game of scaring everybody else. And some people are getting really scared. Some others are not. Some others are asking, I put myself in Cliffs in the side of the ones that to take these things at face value, that it is what it is, so this seaborne market is dormant, is cursed, it is a place not to be in, I can't wait to get out of Australia. That is the bottom line, because I already shut down completely in Canada and as soon as I get to the end of life of mine in Australia, I'm out of there. And now by shutting down Windarling I'm going to expedite that by a year. So instead of 4.5 years, I have 3.5 years of life of mine left in Australia. I can't wait to get out of the seaborne trade and let the Australians take that horrible business on their own hands. Another point to consider is that there is not enough CapEx for these guys to do what they are doing under the current cash flow generation. I really would like to see analogies on that. Where is the money coming from for the massive CapEx deployment that's necessary for BHP, Rio Tinto and Vale? Serra Sul, the S11D project alone we are talking upwards something like $20 billion. They don't have that money, period, full stop. So they are scrambling to make ends meet right now at Vale. I'm a Brazilian guy as you know, I know what's going on there, a lot more than they believe. So they can talk a good game but the reality is completely different. So long story short these big projects are not coming. When the rubber meets the road, you are going to see a lot more of these BHP decisions of postponing the debottlenecking project and this and that just to save meager $600 million, not billion, millions. So they are starting to count the money. That's a good thing. How long it will take for everyone to perceive the game, I don't know. I'm in the business of clarifying that as much as I can because it's affecting me. I couldn't care less about them, but it's affecting Cliffs. We are having to reduce our footprint in Australia because of that. I know that the Western Australian Government is not happy with the way they are handling their natural resources over there. So there's a lot going on and a lot can change between now and next year for example. As far as the United States, look US Steel, you mentioned US Steel, I have never seen US Steel as a competitor. US Steel is a steel [baker]. They are integrated backwards and they have upstream pellet production. They produce a good product, US Steel has been affected by unfairly traded imports to the United States. I hope this thing subsides and US Steel recovers their business and goes back to produce pellets in Minnesota, they are a big player in the region. We look forward to see US Steel coming back at full force and in full capacity. They are not a competitor of Cliffs Natural Resources. I do understand AK Steel's investment in Magnetation. They were left by the old Cliffs' Management and Board unattended. They were left under the rain. When they needed Cliffs badly, Cliffs turned their back to AK Steel and put them in ignore, saying my growth strategy is all about growing the seaborne market. I don't care about the United States, I don't care about AK Steel. So I even understand not only their investment with Magnetation, especially at those crazy high iron ore prices of the time. But I even understand their reluctance in coming back to Cliffs and develop a solution together. They know that we will be here when they need us, if they need us, when they need us. If they never come back, I have a plan to take care of Cliffs without growing the business with integrated use. I came to Cliffs and we ousted an entire board with the support of the shareholders because we had a plan to grow this business towards the electric arc furnace business. Electric arc furnace in this country is 60% of steel production. Integrated is only 40%. So we are just catering to the smaller portion of the business. I'm going to the bigger portion. I'm going to the electric arc furnace business. We are going to produce DR pellets. Depending on how the DR pellet thing pans out, we may also pursue the production of DRI. We are working very closely with the State of Minnesota to put in place the first DRI facility in the State of Minnesota to supply the Midwest many mills with DR pellets. So we are not sitting still here. We're not just cutting costs, we're not just reducing the size of the footprint. We have a strategy, we have a plan, we are implementing the plan. How long it will take for us to receive recognition? I don't know. What I know is that why we don't get recognition, why are bondholders trading my bond at a discount, I would be there to grab that discount and reduce our net debt. Why are shareholders are not giving me credit in the stock price, I will be always ready to use any cash available that I have to buy back stock. And we will continue to pursue every single point in our strategic plan, one by one. We are not going to be derailed. My biggest surprise when I got to Cliffs is that this Company has a very, very strong Management team. It's amazing how badly the Board was handling this Company. This has been fixed, was fixed nine months ago, since then we have been working hard and we will continue to work. I hope I answered your question. I did not talk about the sub because I don't talk about [SI] Minnesota because I don't talk about stuff that don't exist. I only talk about reality. Any other question Michael? -------------------------------------------------------------------------------- Michael Gambardella, JPMorgan - Analyst [6] -------------------------------------------------------------------------------- No that's good. Thank you, Lourenco, for that comprehensive answer. -------------------------------------------------------------------------------- Operator [7] -------------------------------------------------------------------------------- Aldo Mazzaferro of Macquarie. -------------------------------------------------------------------------------- Aldo Mazzaferro, Macquarie Research - Analyst [8] -------------------------------------------------------------------------------- I had two separate questions. First if I could talk about DRI for a second, Lourenco, if you had your success in penetrating that market, would you be able to supply at all out of the US iron ore mining or would you need to expand your mines a little bit? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [9] -------------------------------------------------------------------------------- Actually we have a plan here that works supplying DRI out of US iron ore and working out of only four mines instead of five. So we cannot only supply from USIO but we can also optimize the footprint in order to further reduce costs while we are doing that. -------------------------------------------------------------------------------- Aldo Mazzaferro, Macquarie Research - Analyst [10] -------------------------------------------------------------------------------- So how much -- in your plan going forward, how much volume do you think you would be mining then compared to the 21 million or 22 million you do today. Would it be much higher, a few million tons higher, or would it be roughly the same you think? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [11] -------------------------------------------------------------------------------- Look it's very premature to say that because we don't have enough discussion with potential buyers of DRI to know the depth of their needs. But when we start digging you'll find interesting stuff. For example, one company that already buys HBI, that's HBI, we're talking about the same thing, HBI in the international market, and I believe -- I don't know, but I believe I would have a serious chance to supply would be AK Steel. Because as far as I know they buy from Venezuela and Venezuela is not a reliable supplier of absolutely anything. And AK Steel is an integrated mill, they do have electric arc furnace. So there's a lot of potential, a lot of potential. So we may be talking in an initial moment about let's say 5 million tons, but this 5 million can become 10 million very quickly. So our target of 10 million tons in three years, 10 million tons of DRI supply is not crazy, is not impossible. -------------------------------------------------------------------------------- Aldo Mazzaferro, Macquarie Research - Analyst [12] -------------------------------------------------------------------------------- I like the idea, Lourenco, of the merchant facility, it's a very novel idea. But I had a second question too on your pricing trend. The $93 a ton was very impressive in the first quarter and I'm wondering there must be somewhat of a lag effect on what the IODEX is doing in future quarters. Could you say roughly if iron ore prices were to say bottom out around here, would you think that your selling price stays around $90 or $85 or so as you get through the middle of the year? What do you think the price outlook would be in a flat IODEX environment? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [13] -------------------------------------------------------------------------------- Look, we give in our press release we give the guidance on the price. I would refer you to the table that we provided in the press release yesterday evening. So that's some good guidance. The fact that they got $93 in Q1 is just because the things are not as square as they look on paper. So some quarters have lags, some quarters have carryovers, some of our clients did not take all the tonnage of 2014 contracts and then we got a carryover in Q1. Some others are ahead of the game. So it's a mix of a bunch of things. But a good middle of the road guidance is the table that we provided in our press release yesterday. -------------------------------------------------------------------------------- Aldo Mazzaferro, Macquarie Research - Analyst [14] -------------------------------------------------------------------------------- Okay, thank you. And any update on the timing of a coal sale? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [15] -------------------------------------------------------------------------------- We are getting a lot closer than we were last quarter. That's the reason we moved coal to the category of assets held for sale. And so we are getting close. We are not done yet, we are negotiating with multiple buyers at this point. There's no assurance that any one will close before some other research analysts say that my credibility is in check. Because I'm saying that I will sell coal. So for the record there is no assurance that I will sell coal, but also there's no assurance that you that say that will be alive tomorrow. You can die tonight. So nobody knows the future. So we believe we are going to sell. We do believe we're going to sell as we sold Logan County. So we are working, stay tuned. -------------------------------------------------------------------------------- Aldo Mazzaferro, Macquarie Research - Analyst [16] -------------------------------------------------------------------------------- Right, thanks very much, Lourenco. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [17] -------------------------------------------------------------------------------- And thank you for being the only research analyst with a buy recommendation on my stock. It pays off to know the history of a CEO. And you know me for close to 17 years now, so I appreciate the vote of confidence on what we are doing here. -------------------------------------------------------------------------------- Aldo Mazzaferro, Macquarie Research - Analyst [18] -------------------------------------------------------------------------------- It's all you. Thank you. -------------------------------------------------------------------------------- Operator [19] -------------------------------------------------------------------------------- Kevin Cohen of Imperial Capital. -------------------------------------------------------------------------------- Kevin Cohen, Imperial Capital - Analyst [20] -------------------------------------------------------------------------------- Very nice quarter overall. Lourenco, a couple things. First as it relates to the Mittal contract renewals that you alluded to, you mentioned it would likely be on good terms from the perspective of both Cliffs and Mittal. I'm wondering if you could elaborate a little bit on what that might mean for Cliffs? Whether it's relative to the first quarter ASP or anything directionally that you could allude to on that? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [21] -------------------------------------------------------------------------------- Thanks, Kevin, I appreciate the kind words. Regarding the two contracts with ArcelorMittal, we are talking about a total of close to 10 million tons of pellets. In theory, everything is possible, everything is possible. The contract cannot be renewed so we don't have a contract after December 2016. The contract can be partially renewed, so just half of the tonnage and the other tonnage will come from somewhere else and for some other supply. Or we can renew the entire contract. We have been supplied this muse that occurred by this contract for several decades. Let's face it. So there's a history of first Cleveland-Cliffs and the muse under other denominations and now there's a long history between Cliffs Natural Resources and ArcelorMittal USA. We are partners at Hibbing, we own Hibbing together among other mines. So we know each other costs extremely well. We know each other products extremely well. We know how the performance of the pellets go and blast furnaces A, B, C, D, E, F, G, we know everything about each other. So when I say with a high degree of conviction that we are going to renew this contract in a way that would be good for Cliffs and good for ArcelorMittal USA, I'm basing my conclusion on what is going on right now and what happened the last several years. So there is absolutely no indication right now that anyone including Cliffs or ArcelorMittal USA will act in an unexpected way. Even because we all know that even though the world has a lot of sinter feed available, the world does not have a lot of pellets available let alone here in the United States. Here in the United States we for some years, we have been living with the perspective of newcomers. But at the end of the day, these newcomers haven't materialized yet. And as the clock ticks and time goes by, the likelihood of this competition to materialize diminishes by the day. So that's pretty much what we have at this point. I don't know what else to say. The worst case scenario for us, Kevin, is that this contract doesn't get renewed. If this contract doesn't get renewed, it will be a different ballgame for Cliffs Natural Resources. And certainly it will be a different life for ArcelorMittal USA as well. I don't see at this point, none of us betting the farm on this type of outcome. That's the way I see it. But that's my own assessment. There's no track on that, there's no bad feelings, it's the other way around. We -- actually we feel very comfortable with the current management of ArcelorMittal USA and we believe that we work very well together. We have Terry Fedor working for me, he's my Executive Vice President US Iron Ore. He used to work for Andy Harshaw at the predecessor company of ArcelorMittal and at ArcelorMittal. So we have a lot more in common and a lot more goes to pursue together helping each other than trying to take meager advantage of the small things here and there. That's the way I see it. But again, this being said, I also understand why ArcelorMittal USA in the past embarked in this crazy experience with Essar Minnesota. Cliffs is the reason. Cliffs was the one that led ArcelorMittal USA down. Cleveland-Cliffs, Cliffs Natural Resources was the one that told ArcelorMittal USA that they were not important. They were not the core business. They were not their main client. They would like to pursue a different strategy to sell iron ore in the seaborne market. I'm telling them exactly the opposite. We replaced the Board, the shareholders put me here because I believe in the US iron ore business. I believe that supporting the clients in the United States is the reason why this business exists. And we are working day by day with ArcelorMittal USA to develop the product that will take us to the next 10 years. So that's what we're doing at this point. -------------------------------------------------------------------------------- Kevin Cohen, Imperial Capital - Analyst [22] -------------------------------------------------------------------------------- And then two other really quick financial questions. I know in the past the Company has alluded to the desire to capture secondary market discounts. To the extent you think about where we are today, there's been a nice rally in the bonds, but how do you think about the 2018s at this point? I now that you did do an interview and did allude to those on March 26, and where's your head at on those today in the low 80s%? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [23] -------------------------------------------------------------------------------- Look, we continue to pursue the debt reduction through liability management exercise. There's one thing that I believe that I brought to this Company, that I can do very well. I have done before, especially at Metals USA we took advantage of the opportunities that the leveraged finance market gave us. And we took advantage of that, we bought bonds at a discount. In 2018, we will be taking care of at the right time. I haven't done that, I know you have a different opinion. I respect your opinion as a very knowledgeable high yield person, but we decided not to take care of the 2018s yet because we are waiting for the right moment with the right transaction. It's coming, we are not going to ignore the 2018s, we will take care of those bonds. -------------------------------------------------------------------------------- Kevin Cohen, Imperial Capital - Analyst [24] -------------------------------------------------------------------------------- And then the last question, Lourenco, as it relates to the tax receivable on the balance sheet, any update in terms of how much cash that should convert into late this year? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [25] -------------------------------------------------------------------------------- I'll let Kelly Tompkins reply that to you, Kevin. -------------------------------------------------------------------------------- Kelly Tompkins, Cliffs Natural Resources Inc. - EVP and CFO [26] -------------------------------------------------------------------------------- Yes I think, Kevin, you'll see on the balance sheet reflected about $165 million and we would expect -- certainly expect to get that before year end. We're pushing to get it in middleway Q3 by certainly by Q4. It's a significant component of our anticipated cash this year. -------------------------------------------------------------------------------- Kevin Cohen, Imperial Capital - Analyst [27] -------------------------------------------------------------------------------- That's very helpful. Thanks and good luck as always, guys. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [28] -------------------------------------------------------------------------------- Thank you so much. -------------------------------------------------------------------------------- Operator [29] -------------------------------------------------------------------------------- Brian Yu from Citi. -------------------------------------------------------------------------------- Brian Yu, Citigroup - Analyst [30] -------------------------------------------------------------------------------- Lourenco, on the US volume, if I annualize the first-quarter production it's coming in about 21.5 million tons, and I know you've cut the numbers there. Can you speak to, one, does that mean you're going to have to slow down production? And two, does the volume plug relate to customers having revised their nomination or are you taking out numbers in anticipation of that? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [31] -------------------------------------------------------------------------------- Look I'm based, Brian, to the information and I'm based on how our decision here on information that we have available and the input that the clients have given to us. So at this point, without putting any optimism into our forecast, I am assuming that none of the blast furnaces that are now shutdown will come back to operation. So with that, we will reduce our output accordingly, so -- especially in Q2 and Q3. We are going to reduce production that's for sure. As we speak right now, I have my guys inform me the folks in Michigan that we are going to take one mine down. So that's the consequence of the current requirements of the clients. This being said, I do believe that they are being true conservatives. But I have to act on the information that I have. As soon as they revise up their intentions in terms of production, we will revise ours accordingly. And we will be ready. But that's what we have so far. Did I miss something in your question, Brian? -------------------------------------------------------------------------------- Brian Yu, Citigroup - Analyst [32] -------------------------------------------------------------------------------- No, you did answer it. So let's say that things improve and we talked about earlier, maybe AK needing some additional tons. How quickly can you turn the volume back up? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [33] -------------------------------------------------------------------------------- It's quick, it's quick. We -- the comparison would be a pellet plant like ours would react as quickly as an electric arc furnace in steel mill. So we basically can turn on and off very quickly. -------------------------------------------------------------------------------- Brian Yu, Citigroup - Analyst [34] -------------------------------------------------------------------------------- Okay, can I get one more question in on reclamation? You pulled in the end of life for Australia, are there any cash expenses towards the tail end of that? And then a similar question with Bloom Lake, I don't know if it was accidental or not but you didn't mention reclamation at Bloom Lake as part of the CCAA, would that be fully covered too? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [35] -------------------------------------------------------------------------------- I'll let Kelly answer the reclamation questions, but just a clarification based on what you wrote in your report that you said that you believe that we are going to idle APIO. We are not going to idle APIO, okay, Brian. We are going to continue to pursue the costs adding cash cost to CapEx. We are going to pursue BHP and Rio. If they continue to go down, I'll continue to go down. The difference is that I have no commitment to stay in Australia and they have the full commitment to stay in Australia. So everything that they do will have consequences. Everything that we'll do I will only do to replicate what they're doing. So I will be their worst nightmare. Because I know that their game plan is not to shutdown Cliffs' Koolyanobbing. They couldn't care less about Cliffs' Koolyanobbing. Their game plan is to shut down Fortescue, which they will not be able to accomplish based on what I have seen so far. But what I'm saying is that I will be like that firefly that we'll continue to be there sucking their blood to the very end. We are not going to shut down APIO. We'll continue to drive costs down because we know how to do it. We know how to push the buttons. Three quarters I'm here, that's exactly what I have been doing. I will drive costs until everyone will give up, say yes, this guy knows how to drive costs down. So until everyone will say that, I'll be relentless. So APIO is not going to shutdown. You can continue to say that but you should know that you are wrong on that. Kelly, please. -------------------------------------------------------------------------------- Kelly Tompkins, Cliffs Natural Resources Inc. - EVP and CFO [36] -------------------------------------------------------------------------------- The other consideration relating to APIO that I had alluded to and then I'll comment on Bloom Lake, not only the merits of continuing to run APIO given the aggressive cost reduction we've already done and will continue to do is that it also plays into our APIO borrowing capacity as well. So that's a consideration. But absolutely the focus is running not idling, and at the end of mine life we'll deal with whatever reclamation or closure costs would be there. Secondly on Bloom Lake reclamation is part of the overall CCAA equation. So just consider that part of the package of liabilities that are being addressed as part of the CCAA process. -------------------------------------------------------------------------------- Brian Yu, Citigroup - Analyst [37] -------------------------------------------------------------------------------- (multiple speakers) Yes, if you have a reclamation estimate because you pulled in the mine life now that 3.5 years left. And I know you said you'd address it when you get there, but the timeline has come in and curious if -- what that might be? -------------------------------------------------------------------------------- Kelly Tompkins, Cliffs Natural Resources Inc. - EVP and CFO [38] -------------------------------------------------------------------------------- Yes, no at this point we're not in a position to provide that kind of estimate. As we get closer, we certainly -- we will see that kind of detail reflected in our SEC filings, but not at this point. -------------------------------------------------------------------------------- Brian Yu, Citigroup - Analyst [39] -------------------------------------------------------------------------------- Okay, thanks. -------------------------------------------------------------------------------- Operator [40] -------------------------------------------------------------------------------- Nathan Littlewood from Credit Suisse. -------------------------------------------------------------------------------- Nathan Littlewood, Credit Suisse - Analyst [41] -------------------------------------------------------------------------------- Appreciate the opportunity, guys, and the clarification on APIO just now was certainly useful. I had a couple of questions on USIO pricing. It was my understanding that Essar Algoma had a prefixed price last year. From memory it was $114 or $117 a ton or something. But they carried over some tons into the beginning of this year. And if you were selling tons to Essar Algoma today, there would be somewhere in the $50 a ton range. So there's a pretty big difference in the price you realize between the two. Wondering if you might be able to help us with what the magnitude of that was in the March quarter numbers? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [42] -------------------------------------------------------------------------------- Nathan, I don't discuss pricing client by client. The fact that you know a price or believe you know a price is very a matter of serious concern for me. Because this would be a violation of the confidentiality clause of the contract between Cliffs Natural Resources and Essar Algoma. And you just mentioned that you know the price, so you will eventually be subpoenaed in the lawsuit that I am moving against Essar Algoma based on breach of confidentiality. So I'm not going to discuss this subject. What was your next question? -------------------------------------------------------------------------------- Nathan Littlewood, Credit Suisse - Analyst [43] -------------------------------------------------------------------------------- No problems, fair enough, Lourenco. The other one was just on the embedded guidance. I believe at least your public disclosure in the past has been fairly clear that the HRC price is a driver of the inland steel contracts that you have with Mittal. Could you clarify what HRC price is embedded in the current USIO pricing guidance? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [44] -------------------------------------------------------------------------------- Well when we talk about hot rolled prices, the price are not linked to any index. They are based on the actual prices that the clients execute with their clients. So our relationship with these clients, and I'm not nominating any specific ones, is so open that we have access to their actual hot rolled prices, realized prices. And they are checked in the -- and the input is into the price going forward. That's the way it works. So they -- of course the indexes are loosely guidance for that but the actual prices that they practice are much higher than the spot or the index or anything that you may use as a general number for HRC prices. -------------------------------------------------------------------------------- Nathan Littlewood, Credit Suisse - Analyst [45] -------------------------------------------------------------------------------- Yes, absolutely and I was aware of that, Lourenco. But when I look at what AK Steel and US Steel have done recently or reported recently I should say, they've obviously got a lot of contracts in their order book and the analysis that we've done suggests that those guys are realizing HRC prices which might be $50 or $60 above the actual spot price. So eventually the contract price that these customers are selling at is going to have to catch up to spot price reality. And I'm wondering what the embedded expectations are on that curve be it either the index price or Mittal's average realized price? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [46] -------------------------------------------------------------------------------- Look, the expectations that prices will continue to go back up because of my expectations that imported steel unfairly traded into the United States will go away. And they're steel mills, AK Steel included, ArcelorMittal included, US Steel included, Essar Algoma included. We'll be able to recover their sales prices to a decent level because that's just fair and just. So that's my expectation at this point. -------------------------------------------------------------------------------- Nathan Littlewood, Credit Suisse - Analyst [47] -------------------------------------------------------------------------------- Okay and I would certainly agree with that too. But at the beginning of the year you'd talked about I think an embedded assumption of [570] or [580] or somewhere in that neighborhood. I assume that we're a bit lower than that now. Is it possible to give us that number or is that not something you want to discuss? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [48] -------------------------------------------------------------------------------- We are a bit lower but at this point we're not going to provide that detail. You'll see further disclosure in our Q, but it is slightly lower than what you embedded in your assumption. -------------------------------------------------------------------------------- Nathan Littlewood, Credit Suisse - Analyst [49] -------------------------------------------------------------------------------- Okay, no problems. Thanks, guys, appreciate it. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [50] -------------------------------------------------------------------------------- Nathan before you go just a reminder, you have an EBITDA target for Cliffs Natural Resources for the year of $170 million. In Q1 alone, and Q1 is the frozen quarter. Is the quarter that we are not shipping because you can't walk between here and your home country in Canada. You know that. So even with this difficulties, we are able to generate $94 million in Q1. So now based on your EBITDA target, I am $76 million away from reaching your EBITDA target and I have three quarters to do it. Just a reminder. -------------------------------------------------------------------------------- Nathan Littlewood, Credit Suisse - Analyst [51] -------------------------------------------------------------------------------- No problems, we will take another look at the model. Thanks for the feedback, Lourenco. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [52] -------------------------------------------------------------------------------- Yes take a look at the -- your price target as well. Because you went from 10 to 1 [baked into] your report the assumption that Cliffs Natural Resources by now would be bankrupt, so you were wrong. I'm not bankrupt, I'm not heading into bankruptcy. Your assumptions are all wrong and the outcome has been bad so far. -------------------------------------------------------------------------------- Nathan Littlewood, Credit Suisse - Analyst [53] -------------------------------------------------------------------------------- Thanks Lourenco, appreciate the feedback. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [54] -------------------------------------------------------------------------------- You are very welcome. -------------------------------------------------------------------------------- Operator [55] -------------------------------------------------------------------------------- Jeremy Sussman from Clarkson. -------------------------------------------------------------------------------- Jeremy Sussman, Clarkson Capital Markets - Analyst [56] -------------------------------------------------------------------------------- I have one follow up on coal. Lourenco, in terms of Oak Grove and Pinnacle, is this something that you want to sell together or would you consider selling each separately? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [57] -------------------------------------------------------------------------------- I would -- Jeremy, thank you very much for the question. I would take any deal, and we have different parties right now and I will disclose that not all of the ones that are [busy] at this point and negotiating with us are buying all the assets altogether. We have a different transactions being considered right now. Our only goal is to optimize the results and get to Cliffs the best we can get. -------------------------------------------------------------------------------- Jeremy Sussman, Clarkson Capital Markets - Analyst [58] -------------------------------------------------------------------------------- Thank you very much and it sounds like we have something to look forward to soon on that front. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [59] -------------------------------------------------------------------------------- Yes, you are right about that. Thank you. -------------------------------------------------------------------------------- Operator [60] -------------------------------------------------------------------------------- Jorge Beristain from Deutsche Bank. -------------------------------------------------------------------------------- Jorge Beristain, Deutsche Bank - Analyst [61] -------------------------------------------------------------------------------- Good morning, Lourenco, and again congrats on a strong quarter. My question really was twofold. If you could clarify a little but what's going on with the unit cost, because you admitted it is hard given lower fixed cost absorption to lower cost sequentially, but there was some mention about freight costs being lower. Could you walk us through how the lower freight costs help your unit cost sequentially? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [62] -------------------------------------------------------------------------------- Directionally, the US iron ore costs are being cut because we are working toward improving the utilization of our lower cost operational basis. That's the bottom line. You guys all know that we have one mine that has higher costs and that's Empire. Empire for the ones that have visited Empire [in person], you know that Empire is right now a big hole in the ground. It's at the end of the life of mine, we're approaching the end of life of mine. We actually -- we are working overtime over there, the mine should have been shut down two years ago. If I were here two years ago I would have shut down that mine at the time and I would not have brought that mine back. It has been a very good operation over the course of several decades, but it is coming to an end. So we are refocusing our operations and refocusing our ability to produce the products that we produce out of four mines instead of five. That's the main thing. The next big thing is that based on my background as an operator in the steel mill side and also in the service center side, and tied together with Terry Fedor's extremely deep experience doing more or less the same thing that I have been doing for my entire career. We are working very seriously in expanding maintenance cycles, in optimizing the utilization of equipment, and changing their practice on the supply chain of spare parts. We are cutting costs in serious things. And it goes without saying that we are applying to the seller to work for us at the mine sites the same logic that we are applying here at the headquarters in Cleveland. If you are not really doing something that will bring EBITDA to the Company, chances are that your position is irrelevant. So we continue to cut people at the top of the organization in our operations. So our cost targets are achievable, are challenging but very much achievable, and I have every single person involved in the effort completely committed to get it done and they know why they are doing that. On top of that, we have the energy rates that we continue to work very seriously to bring those costs down. We just finished recently to renegotiate our entire energy electricity situation in Michigan with an extremely helpful work together with the office of the Michigan Governor. And I believe we've cut an excellent long-term deal, we're back to buying electricity from the press -- WI Energy, WI is Wisconsin Energies, the utility supply in the Upper Peninsula. We also in the meantime, we resolved the program of the electricity rates in the entire Upper Peninsula even for the households over there. So creating a lot of goodwill within the community and again with invaluable support from Governor Snyder. So we are working all fronts to cut this cost, and we'll continue to account for all of our [growth]. -------------------------------------------------------------------------------- Jorge Beristain, Deutsche Bank - Analyst [63] -------------------------------------------------------------------------------- Great and then second question I had was on the volume outlook, how should we think about the optionality now on the outlook of some of your clients, AK Steel particularly with the problems at Magnetation? Is there something that you're already in discussions with them about possibly supplying volumes that they would have otherwise taken in-house? Could you comment about that and if you have the optionality to meet that demand? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [64] -------------------------------------------------------------------------------- Look, we have so few clients here at Cliffs at this point, that we are always talking to the clients. We have only four. I don't know how much you followed me at Metals USA, I don't remember anymore. I think you did, but you had thousands of clients over there. I still used to talk to clients. So here with only four, I talk with clients all the time and so we talk about a lot of things. So yes we are talking, but it doesn't mean a thing because it takes two to dance, and there's a lot of history, recent history between AK and Cliffs and we believe that the right things, we will always happen at the right time. So I'm not an issues guy, I tend to plan ahead, I tend to execute very disciplined -- in a very disciplined way. I always had my own thoughts about Magnetation, but I always understood why AK initiated the Magnetation investment. And I can't say that I was surprised with the outcome. This being said, if AK who buys labs, if AK will buy pellets from timbuktu corporation, I have no idea if they came to see them. If they come to Cliffs, they know what they'll get. And they even know how much they will pay. And they even know how good the quality of our product is, how superior our product is in comparison, not only with their in-house supplier, but with any pellet supplier in the world. -------------------------------------------------------------------------------- Jorge Beristain, Deutsche Bank - Analyst [65] -------------------------------------------------------------------------------- Okay, thank you. -------------------------------------------------------------------------------- Operator [66] -------------------------------------------------------------------------------- Evan Kurtz from Morgan Stanley. -------------------------------------------------------------------------------- Evan Kurtz, Morgan Stanley - Analyst [67] -------------------------------------------------------------------------------- I had a question if you look at a few years from now, it seems like Cliffs will be a US only business, it will be involved in one commodity, and much more simple than the business that you have today. And you cut SG&A about $120 million this year. Where do think you could go if we look out a few years? What do you think the sustainable long-term SG&A costs will be for a USIO-only company? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [68] -------------------------------------------------------------------------------- Yes there were $120 million, still have the influence of people and the work that's done related to both APIO that is here probably to stay for the next 3.5, 4 years. And also North American coal. So we can further reduce these numbers going forward. How much I don't know at this point, Evan. I don't have the number here from the top of my head. At the right time we will inform, at the right time you'll be able to plug in your model. And maybe at that time my numbers will look a little better in your model. Because you already guided as a low price -- stock price estimate. But you always have the higher estimate in terms of our profitability. So we will always -- you always challenge me a lot. But I got a modest beat, right, you said that I got a modest beat. So modest beat in Q1 is a very good thing in a model like yours that is designed for me to lose. So it's not designed for me to beat, I still beat, so that was not a good -- that was not a bad thing. -------------------------------------------------------------------------------- Evan Kurtz, Morgan Stanley - Analyst [69] -------------------------------------------------------------------------------- Okay well believe it or not, I'm actually rooting for you, Lourenco, so hopefully you continue to do so. Similar question actually on the CapEx side, you've cut pretty significantly here, how sustainable is that if you go out three years again? Is there some CapEx that has to come back into the equation to keep those four mines running optimally or as some of the other businesses fall off, how do we think about where that number moves to? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [70] -------------------------------------------------------------------------------- Yes, look, if we materialize and I believe, I fully believe that we will do -- materialize our production of DRI in Minnesota. If we do that, of course a DRI, a new DRI facility in Minnesota is not baked into our CapEx numbers. On the other hand, there is more investments that we need to deploy in order to give Northshore the capability to produce DR pellets are not only baked into the number but they're also being authorized, there are already in the process of being deployed. So it's a mix. At this point, we have our CapEx number that is limited to the footprint that we have and the short-term plans that we have ahead of us. Of course as we go bigger into the electric arc furnace side of the business, I'm fully confident that we will -- we are going to revise these CapEx numbers up. And all of these numbers will be calculated based on return on assets, return on invested capital in the right metrics. Will not be decisions taken based on how our stock price is doing. Actually because if I use the stock price as a reference I would be in trouble. I can't buy lunch, I have to sell lunch to buy dinner. So -- but I use the real metrics. Got to really use the real returns and the ones that pay off over time, the ones that pay off to real investors. And that's the way we do business here. -------------------------------------------------------------------------------- Evan Kurtz, Morgan Stanley - Analyst [71] -------------------------------------------------------------------------------- Great, thanks for that, Lourenco. -------------------------------------------------------------------------------- Operator [72] -------------------------------------------------------------------------------- Timna Tanners of Bank of America. -------------------------------------------------------------------------------- Timna Tanners, BofA Merrill Lynch - Analyst [73] -------------------------------------------------------------------------------- So gosh, every single question I was going to ask has been addressed and with great answers, really thorough detail. So I thought I could -- the only thing I thought might be helpful is really to hear a little bit more on the really nice cost savings in USIO and making sure we're confident we're getting as much detail as possible on the sustainability. If we do forecast longer term prices recovering, should we assume that this cost structure is permanent or are there variables that would have to go up over time? Thanks. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [74] -------------------------------------------------------------------------------- All right, Timna, let me introduce you to a person that you don't know yet, that's Mr. Kelly Tompkins, my second in command, my most valuable player here at the Company, and I'm extremely happy that I finally have my Management team all placed with the right players in the right spots. So Kelly please, this is Timna Tanners, a research analyst at Bank of America Merrill Lynch. -------------------------------------------------------------------------------- Timna Tanners, BofA Merrill Lynch - Analyst [75] -------------------------------------------------------------------------------- Nice to meet you. -------------------------------------------------------------------------------- Kelly Tompkins, Cliffs Natural Resources Inc. - EVP and CFO [76] -------------------------------------------------------------------------------- Yes, likewise. I think we've met at one of my other capacities, Timna. Of course I think Lourenco touched on some of these earlier, he talked about the maintenance practices that we're implementing. I know there's been some question are we just simply differing maintenance, no, we're improving our maintenance practices so it's sustainable. We're continuing to rationalize the salaried workforce for example, irrespective of what we might do to idle and taking out rank-and-file, we're being equally disciplined with the Management team. Lourenco talked about the aggressive work we've done on the energy side. So there is a constant pursuit of operational improvements, productivity initiatives. And when we reaffirmed our cost guidance for USIO, that was not Lourenco and I sitting in a room making that up ourselves. This is the operating guys, a complete buy-in from the top down to the bottom of the organization. So we feel very confident as we mentioned before we've got a very experienced team that knows exactly how to stay at this. So we are very confident these are sustainable. -------------------------------------------------------------------------------- Timna Tanners, BofA Merrill Lynch - Analyst [77] -------------------------------------------------------------------------------- Okay that's helpful. And then, Lourenco, I know when I saw you last time, you had just come from a conference in Australia and you were saying that the Australians seem to have a different view than the Chinese about steel production and that they were targeting a higher number. But maybe your tone has changed a little bit and you seem to be -- you sound a little bit more confident at least that maybe their changing their viewpoint are going to produce a little less. Can you give us a little bit more color around your change in thinking? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [78] -------------------------------------------------------------------------------- Sure, I'll be glad. In order to deploy massive amounts, billions of dollars of CapEx, you need two things. One is return on invested capital. And two, a market to sell the product. If you have the return on invested capital, you have a chance. If you have a market for a product, then you put one plus one together, get a two and there you go. In the case of the deployment of CapEx from Australia, it's a lot more lip service and empty threats and bad advertisement and is scaring the (expletive) out of everybody than anything else. Think about the port bottlenecking of BHP. They said that they could optimize without the bottleneck and without deploying their money, they said whatever they like to say. But at the end of the day, they did not pony up $600 million of investment just to go from $270 million or $290 million in 2017. So there's a lot -- money talks and other stuff walks. There is a lot of posturing going on over there trying to take one big one out of the picture because [you is] not part of the original party. Remember through 2009, iron ore prices were negotiated with the Japanese and the with the Chinese and also with the Europeans based on the benchmark negotiations. And the benchmark negotiations used to be more or less like Vale speaking on behalf of the three with the Europeans and Rio Tinto is speaking on behalf of the three with the Japanese. And then the Chinese became bigger and the Chinese said I'm not going to follow the Japanese, I'm going to do my own thing. And then Vale Steel was negotiated on behalf of the Chinese and then Stern Hu went to jail in 2009. The guy that was the head of the Rio Tinto office in Shanghai, he was arrested and accused of taking bribes and he was accused of stealing government secrets or his two company secrets in order to sell positions based on the allocation of iron ore under the benchmark system. And then the benchmark system was replaced with the IODEX, with an index that is very easy to move around not by Cliffs, not by Fortescue, not by Mount Gibson, not by Ferrous Natural Resources in Brazil or not by [San Marco] but easily manipulated by Rio Tinto, BHP and Vale. So in other words if one of the three decides that they will sell iron ore this afternoon, $10 above the IODEX, with the tonnage that they sell already, they can move the IODEX. So when the board members of these three companies realize that, and I promise you, very few of them if any know that, when they realize that, that these three companies can move the IODEX around, you are going to see a lot of Monday morning quarter-backing going on in these companies. And these Board members will not have the ability or the courage or the [craziness] to approve the deployment of billions of dollars just to bury money, good money, in a market that can't pay for their return or pay any return for their investment of capital. That's my thesis. My thesis is that -- I'm not okay, I'm not done yet. My thesis is that they are threatening capital expansion that they are not planning to deploy. Because I can't believe -- I do believe in stupidity, but I do not believe in this stupidity for a long period of time. Example, Cliffs Natural Resources. Here in this Company, they buried close to $9 billion in bad investments and I'm sure that during the time that the previous Board was deploying billions and billions of dollars of capital here using as the only metric the share price, they were extremely happy and they were tapping each other on the back and telling each other how great they were, until the outcome was a disaster. So I don't think that BHP, Rio Tinto or Vale will do the same thing. I believe that common sense will come back and we are going to start looking at the size of that things really have. So and the size that things really have is Rio Tinto is the biggest supplier of Australia, with 200 and something million tons and that's pretty much it. And Vale is the biggest one among all with close to 300 million tons. And BHP is a 200 million tons supplier. And Fortescue is 125 million tons and Roy Hill may come and may not, they'd be 55 -- they will come, but maybe 55 or 40 or 25 and Hancock Properties will continue to collect a lot of royalties from Rio Tinto and life is good. And the IODEX will go to the right direction because the right IODEX is an index that can be moved by three companies, Vale, BHP and Rio Tinto. If they don't move the IODEX it's because they do not want. But if these three companies do not want to move the IODEX, they are basically taking money away from their shareholders and their Board members need to know that. Did I answer your question? -------------------------------------------------------------------------------- Timna Tanners, BofA Merrill Lynch - Analyst [79] -------------------------------------------------------------------------------- Yes, thanks. I was wondering incrementally it sounds like as things remain difficult, you're more convinced that rational behavior given it's a rationalized market will prevail. Is that what you're saying? -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [80] -------------------------------------------------------------------------------- I am convinced that as soon as the Board members of Rio Tinto, BHP and Vale realize that they are enabling their management teams to do something that goes against their shareholders, at least one or two or three or five will get scared because their fiduciary duties are associated to that. That's what I believe. -------------------------------------------------------------------------------- Timna Tanners, BofA Merrill Lynch - Analyst [81] -------------------------------------------------------------------------------- Okay, got you. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [82] -------------------------------------------------------------------------------- I also believe that the ACCC, the antitrust authority is fair competition authority in Australia should be taking a serious look about their behavior already, instead of looking about what Mr. A or Mr. B or Mr. C said under this or that circumstances. Because what people say is not as important as what people do. I believe that what they are doing is on purpose and I believe that what they are doing is not right. And I believe that they are generating a lot of unemployment in Australia and that should have serious consequence for the years to come. -------------------------------------------------------------------------------- Timna Tanners, BofA Merrill Lynch - Analyst [83] -------------------------------------------------------------------------------- Okay, thank you for sharing that. That's interesting. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [84] -------------------------------------------------------------------------------- One more question then we are done, Shannon. -------------------------------------------------------------------------------- Operator [85] -------------------------------------------------------------------------------- Gordon Johnson from Wolfe Research. -------------------------------------------------------------------------------- Gordon Johnson, Wolfe Research - Analyst [86] -------------------------------------------------------------------------------- My question and Lourenco congratulations on the execution thus far, impressive execution. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [87] -------------------------------------------------------------------------------- Thanks. -------------------------------------------------------------------------------- Gordon Johnson, Wolfe Research - Analyst [88] -------------------------------------------------------------------------------- The first question is on the rationality of the large iron ore producers. I remember back in 2012 when some of these plans were announced, we had heard a lot that a lot of the plans are going to be delayed and indeed these guys executed on the ramp plans. So given where their cash costs and manufacturing costs are at least that they're reporting, can you comment on how long you think it'll take them to be more rational? Could it be a year, could it be two years, or do you think it'll happen sooner? And then secondly could you comment on your operating cash flow this quarter? It looks like it was the lowest it's ever been. Is that something that we should expect as a one-time dynamic? Was there something maybe that happened this quarter that caused it to be so low versus where your net income was? Thank you. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [89] -------------------------------------------------------------------------------- Everything related to the cash flow is related to seasonality, Gordon. You haven't been in this business long enough and there's a lot of things that you don't know. I'm looking forward to our dinner tomorrow here in Cleveland when I really plan to spend time explaining to you that Cliffs is not a high-cost producer. We are actually a producer of value-added product called pellets. And that pellets go into blast furnaces and not sinter feed fines that go into sinter plants. But we will talk about that tomorrow. But the cash flow thing is all about the seasonality and the Q1 is completely different from Q2 and Q3 and Q4. And even Q2 and Q3 and Q4 are not exactly the same. There's a lot of seasonality associated to our business. As far as rational behavior, I don't believe in rational behavior. I really believe in Board members when they really -- it's a come to Jesus thing, a moment of truth, when the Board members say oh my God, what have I been doing? Because it happened here at Cliffs. So it happened here at Cliffs, but then the guys were so committed with their bad strategy that they did not know how to get out of the hole. So I was the guy that helped them out at the end of the day. And they went out a lot better than for example the former President, CEO of Rio Tinto that was ousted in January of 2013, that left with no severance after a write-off of $14 billion. So things in this business, Gordon, they are not exactly the way they look like. Of course they are big, of course they have a lot of capacity, but that's not the point. Because they always had a lot of capacity. They always were big, but they never really went on a rant to basically terrorize everyone else saying, I produce a lot, but I will produce a lot more. And that's what's pushing prices down. Price is not going down because Rio Tinto is big or Vale is big or BHP is big. Prices are going down -- prices are not going down even because they we are doing expansions. Because that's -- they are in their rights to do that. But prices are going down because they advertise every day that they are doing the expansions. It's a tactics of scaring everyone else. It's a tactics that plays well for the future markets that are based on the IODEX and that is manipulation of an index. If it were the LIBOR, people would go to jail. But because it's the IODEX, people don't go to jail. But shareholders that realize what's going on, they may take action. And that's what I am talking about. So when are they going to be rational? When they get scared. When are they going to get scared? I don't know. Did I answer your question? -------------------------------------------------------------------------------- Gordon Johnson, Wolfe Research - Analyst [90] -------------------------------------------------------------------------------- That does answer my question, that's very helpful. One more question, if I could, and it goes to the rationality question somewhat. In Q1 if you look at the big four producers, Rio, Vale, BHP, FMG, their overall production of iron ore was down I think more than a lot of people expected. I think it was down roughly 30 million metric tons, yet iron ore prices fell Q4 to Q1 roughly 12% on average. And I think for the first time since I think the 1990s in Q1 demand actually for iron ore in China was down. So could it possibly be if demand in China is down this year, which would mark the first time since the 80s, that maybe demand is also having an effect on iron ore prices? And thanks again for the questions. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [91] -------------------------------------------------------------------------------- Look Gordon, that's exactly my point. You nailed it on this one. Because demand is down. If demand is down, there is no point in announcing expansions. Even if you are doing -- if you believe that with your expansions you are going to displace in the future, you are going to displace what you call the higher cost producers. When you compare bananas with bananas of course. We are not comparing with Cliffs USIO, we produce pellets here. We'll address that tomorrow at dinner. But when you're talking about producers of sinter feed fines, displacing producers of sinter feed fines that's exactly what happened. So you are completely right, demand is going down, so that's the wrong moment to be trying to create or trying to announce more capacity because that would have a deleterious effect. On the other hand, at a very minimal announcement that we are not doing it, we are not deploying this capital, we are not doing this thing, that's what happened with BHP in a very sympathetic way, told everyone that they were not willing to deploy $600 million in CapEx because that was not the right decision to make. So the only factor -- the simple fact that they announced that and iron ore price went up despite all the Chinese demand that's going down. Despite of everything that you said. So it's all about perception. It's not about reality. It's not about what Cliffs --I'm sorry, about what Vale or Rio Tinto or BHP or Fortescue are producing now. The market is okay for what they are producing now. What the market is not okay is for this thing, you know what, I'm going to double this, I'm going to produce a lot more. But China is going down production, I don't care. I'm going to flood China with more products. That's wrong. That's absolutely wrong. It can't not end up well. And the consequences will be paid, all of them will be paid in Australia. It's already starting, especially in WA. WA is Western Australia is where the iron ore basically is. So the consequences there are unbearable. And I'm not talking about Cliffs Koolyanobbing, we're small. We're in the paper today because we changed our fly in, fly out because their no longer exploring the Windarling Peak. So we're in the newspaper over there. And I gave you the number of unemployment there, we're taking down 170 people. Fortescue is in the paper as well, they didn't give the number. BHP is firing people, Rio Tinto is firing people. So they think there is [stinking], and I'm not talking about the guys that already shut down like [Aerial], or Mount Gibson, like several others, Atlas. So what they are doing with Australia is some things that they'll be responsible for and they are doing that on purpose. They are basically terrorizing the market with the prospect of CapEx that at the end of the day will not be deployed. Do you know why it will not be deployed? Because Board members are a lot more responsible than CEOs. They're not bullish. They have fiduciary duties and they are responsible for what the actions they take. If they do, they will be responsible. All right? -------------------------------------------------------------------------------- Gordon Johnson, Wolfe Research - Analyst [92] -------------------------------------------------------------------------------- Very helpful, thank you. -------------------------------------------------------------------------------- Lourenco Goncalves, Cliffs Natural Resources Inc. - Chairman, President and CEO [93] -------------------------------------------------------------------------------- Thank you, Gordon. Thank you very much for joining the call and staying with me for so long. Kelly and I are looking forward to continuing our conversation with each of you, and we'll speak again in three months. Thanks a lot. Bye now. -------------------------------------------------------------------------------- Operator [94] -------------------------------------------------------------------------------- This concludes today's conference call. You may now disconnect.
|