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Executives

Steve Baisden – Director, IR and Corporate Communications

Joe Carrabba – Chairman, President and CEO

Laurie Brlas – EVP and CFO

Analysts

Luke Folta – Longbow Research

Jorge Beristain – Deutsche Bank

Brian Yu – Citi

Luther Lu – FBR Capital Markets

Tony Robson – BMO Capital Markets

Mark Parr – KeyBanc Capital Markets

Tim Hayes – Davenport & Company

Wes Collins [ph] – Morgan Stanley

Wayne Atwell – Casimir Capital

Sayan Ghosh – Citadel Investment

Choi Tran [ph] – Elm Ridge Capital

Cliffs Natural Resources Inc. (CLF) Q1 2009 Earnings Call Transcript April 30, 2009 10:00 AM ET

Operator

Good morning. My name is Sarah, and I am your conference facilitator today. I would like to welcome everyone to the Cliffs Natural Resources 2009 First Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

At this time, I would like to introduce Steve Baisden, Director of Investor Relations and Corporate Communications. Mr. Baisden?

Steve Baisden

Thank you, Sarah. Before we get started, let me remind you that certain comments made on today's call will include predicative 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 CliffsNaturalResources.com. At the conclusion of the call, it will be archived and available for replay for approximately 30 days.

Joining me today are Cliffs' Chairman, President and Chief Executive Officer, Joseph Carrabba; and Executive Vice President and Chief Financial Officer, Laurie Brias. At this time, I will turn the call over to Joe for his prepared remarks.

Joe Carrabba

Thanks, Steve, and thank you to everyone for joining us today on the phone lines and on our webcast. Since October the macroeconomic environment has required Cliffs to take appropriate actions to match supply with demand in each of our businesses. In light of these conditions, I am extremely proud of the job that our management team is doing.

Cliffs has been through numerous market retrenchments throughout its history and is well positioned to manage its way through. The value of our strategic efforts have diversified Cliffs in terms of geography, minerals and end markets, as clearly demonstrated by this quarter's results.

Our Asia Pacific businesses continue to perform well and are offsetting the weaker conditions in North America and Europe. That said, unfortunately factors outside of our control are obviously having more influence on our results than the factors we can control. The steep decline in North American and European steel production that began late in 2008 continued through the first quarter impacting Cliffs' North American Iron Ore and North American Coal businesses.

In contrast, our Asia Pacific businesses selling to China, where GDP growth of 6% and higher than expected consumer spending, were recently announced. Having an exposure to this market helped us offset the demand environment and seasonally slow quarter of North America.

We continue to see reports starting North American steel production running at 40% to 45% of total capacity. This low level of production manifested itself in Cliffs' Iron Ore pellet sales volume declining 27% versus last year's first quarter. However, as a result of the unique structure of our North American Iron Ore contracts, we collected approximately $50 million from customers in this segment for sales that will be recognized in the future.

Our North American Coal business also continues to feel the effects of the difficult environment for steel making raw materials. Metallurgical coal sales volume was nearly 50% lower than the first quarter of 2008 as customers in the United States and Europe seek to delay consumption and rationalize their finished goods inventories.

In order to better match our production with demand, in addition to the actions we've already taken, we've made a decision to defer development work in North American Coal. The intent here is to mitigate sales margin losses in this segment as we navigate through the difficult period. Much of the work done to-date was necessary to stabilize our operations. The work we plan to do this year was intended to allow us to ramp up production in the future. However, we felt it prudent to suspend these investments. This deferment will allow improved results from the remaining nine months of 2009 and limit our full year sales margin losses in the segment to $50 to $70 million. Unfortunately, this will also limit our production in sales for 2010 and potentially 2011, but we feel it is the right decision at this time.

On the other side of the globe, our Asia Pacific businesses continue to perform well. Our Asia Pacific Iron Ore operation contributed $167 million in revenues and $58 million in sales margin for the quarter.

The Sonoma Coal Project added another $53 million in revenue and $29 million in sales margin to first quarter consolidated results. The bottom line for Cliffs is our strategic efforts to diversify the business in terms of geography, minerals and end markets are clearing paying off. This is especially true considering whether the businesses would be solely leveraged to the North American glass furnace market where only 14 of 38 furnaces are operating and 24 are idled.

In Brazil, we are encouraged by the progress of the new leadership team from Anglo-America is making in Amapa. In the first quarter, we witnessed a marked improvement in our operating metrics particularly in the areas of plant recovery, concentrate production and safety. While it is too early to declare the operating challenges over we are enthusiastic as ever about the project and its potential as a meaningful contributor in the future.

On a consolidated basis, each of the factors I have outlined resulted in a 6% decline in Cliffs first quarter revenues and a per share net loss of the quarter of $0.07. With our management team focused on preserving flexibility and optimizing cost, we want to maintain a balance sheet that enables us to negotiate from a position of strength and react quickly and opportunistically should long-term strategic assets become available at distressed prices.

On the operation side of our business, the leadership team in our business segments are focused on matching production with demand. This has been through curtailments, cost reductions, working capital management and ongoing scrutiny of all capital expenditure plans.

With that as a backdrop, I will turn the call over to Laurie for a closer review of the first quarter financials. Laurie?

Laurie Brlas

Thank you, Joe, and good morning everyone. As Joe just touched on, the revenue and margin contributions from our operations serving the Asian markets were a definite bright spot, but unable to completely offset the sharp drop in revenues and margins from the North American businesses. This led to the 6% decline in consolidated revenue to $465 million versus last year's $494 million. Net loss in the quarter was $7.4 million or $0.07 per diluted share compared with net income of $17 million or $0.16 per diluted share for the year-ago period.

While the current demand environment resulted in a net loss, I do think it's extremely important to focus on the cash flow performance of the business. As the first quarter is seasonally slow, it has historically resulted in a use of cash from operations, but we reduced that use from last year's $120 million to a use of $45 million in Q1 2009.

As Joe mentioned, we received approximately $50 million in cash from customers in our North American Iron Ore segment for sales that will be recognized in the future. Because of a limited ability to ship on the Great Lakes, we always build inventory in the first quarter. However, this year the inventory build resulted in a use of cash of $67 million compared with $131 million in the same period last year. D&A expense was $55 million for the quarter. Each of these helped drive a $75 million improvement year-over-year in net cash used from operating activities in the first quarter and illustrate our operating teams focus on cash generation, collection and preservation.

In light of the current environment, I also want to provide an update around Cliffs' pension and OPEB liability. On our year-end call, I indicated that our total liability was approximately $1 billion, and of that amount we were funded at $548 million. At that time we expected we would have to make an estimated cash contribution of approximately $67 million in order to reach our minimum funding level this year. As a result of an amendment published by the IRS in March, the assessment will be reduced by approximately $33 million to $34 million, which is less than our $45 million in 2008 funding. The bottom line is that it will result in a reduced cash outlay.

Turning to the business segment results for the quarter, North American Iron Ore reported a sales margin loss of $15 million compared with positive margin of $70 million for first quarter 2008. This decrease reflected lower sales volume of 2 million tons versus 2.7 million tons last year and the resulting lack of leverage over fixed cost.

Per ton revenues in North American Iron Ore decreased 2% to about $77 compared with last year's number of $78 when adjusted for the Iron Ore settlement that occurred in the second quarter of 2008.

Our first quarter revenue per ton average was adversely affected by the sales factors that determine pricing as they are included in our supply agreement. In particular, a drop in hot band steel prices resulted in estimated $14 per ton reduction of an expected payment as part of the supply agreement with one of our North American Iron Ore customers. This reflected the extremely steep drop in the quarter and this level of impact is not expected to recur in 2009's subsequent quarters. What that means is going forward we will be profitable at the sales margin line in this business even at the current volume level.

As a result of lower fixed cost leverage due to the lower sales volume, cost per ton in the quarter was about $84. I'd also note that decreases in steel and energy costs of approximately $18 million for North American Iron Ore compared with the first quarter last year were offset by idle expense of about $31 million related to the production curtailments we've enacted along with increases in labor rates which totaled $13 million as a result of the United Steel Workers agreement that was entered into last year.

In North American Coal, average realized revenue for the quarter was about $95 per ton, an increase of 18% compared with the $81 per ton realized in the previous year's first quarter. However, much higher average cost of goods sold of approximately $154 per ton led to the $58 per ton sales margin loss for this segment.

Similar to the North American Iron Ore segment, our lower volumes have resulted in very little leverage over fixed cost. We also incurred expense of approximately $30 million related to production curtailment and delays associated with Longwall development in the quarter. As Joe mentioned, we have suspended development efforts at this operation, which have been significantly weighing on our reported unit cost in recent periods, and expect this action to mitigate the level of negative margin in future quarters.

Now for some thoughts around our businesses that are operating in a more robust environment than North America. In our Asia Pacific Iron Ore business, first quarter revenue per ton averaged about $76. This was down from last year's first quarter when sales per ton were adjusted for the 2008 settlement for Australian Lump and Fines Ore. We are very proud of the Asia Pacific team's performance including the 5% increase in sales volume, which got us to a record 2.2 million tons for that business for the quarter.

Our marketing team has concentrated sales efforts on Chinese customers who absorbed additional shipments in lieu of some of our Japanese customers that have been experiencing relatively weaker demand. We like many others in the industry are operating under various provisional pricing scenarios that resulted in decreased pricing that will be trued up upon any settlement being reached.

On the cost side, average per ton cost of goods sold increased just 4% to about $50. Perhaps more impressive is that on a cash basis, costs declined to about $38 or 9% from last year. This excludes the non-cash DD&A impact of our 2008 acquisition of the remaining 20% of Portman.

Cliffs' 45% economic interest in its other Asia-focused business, Sonoma Coal, generated $29 million in sales margin on $53 million in revenues. This project has been performing very well and continues to ramp up on plan. We lowered our full year cost estimates for this project to between $75 and $85 per ton from our previous guidance of $85 to $95 per ton. This is due to lower than previously expected contract mining costs and royalty payments.

Amapa generated an equity loss of $9.1 million during the quarter. However, as Joe mentioned, we are encouraged by the progress the new team from Anglo-American is making on the project.

Turning to the balance sheet, our liquidity position remains very strong. At first quarter end 2009, cash and cash equivalent stood at $97 million versus $179 million at December 31, 2008. Major uses of cash during the period included approximately $67 million in product inventories and $30 million in PP&E.

Long-term debt was $525 million including the $325 million private placement we closed last year and our $200 million term loan. At March 31st, nothing was drawn on our revolver, leaving the full $600 million available. Moreover, none of our long-term debt is due prior to 2012 and our debt to total capital is an extremely low 23%. I should note that while we used cash in the first quarter, which is typical due to the seasonality of our North American Iron Ore business, as we sell through pellet inventory in the remaining three quarters, we expect to generate cash from operations for the full year.

And with that, I will turn the call back to Joe.

Joe Carrabba

Thanks, Laurie. Before we take your questions, I will discuss our current outlook for 2009 as best I can from our vantage point. The continuing production cuts made by steel producers with low capacity utilization rates makes it extremely difficult to provide realistic pricing and therefore market guidance. Moreover, negotiations for benchmark iron ore settlements are still ongoing and will have a meaningful impact on our per ton revenue. As such, we are limited in the amount of reliable guidance we can provide at this time.

We are conforming that we have contractual obligations for 18 million tons of sales volume in North American Iron Ore. This combined with the 1.2 million tons deferred in 2008 totals approximately 19 million tons of sales volume. However, I do think it's important for all of you on the call to understand that the current environment is extremely uncertain. There are practical implications of stockpiling physical inventories throughout the supply chain for both Cliffs and our customers.

On a consolidated basis, our mines are producing at an annualized rate of approximately 50% of their 38 million tons of rated capacity. However, Cliffs' equity production is down to 58% of our 25.5 million ton equity share compared with 35% of the 12.6 million tons of non-equity production we manage.

Cost per ton for 2009 at a current 15 million ton production rate for the year is expected to be $70 to $80. With the high fixed portion of our cost, unit cost increases realized in 2009 will primarily be from reductions in operating leverage, and of course future production is always predicated on what unfolds on the demand front.

North American Coal is now expected to produce and sell approximately 2 million tons and we are expecting revenue per ton of approximately $100. Given that we have deferred our long-term mine development activities at our North American Coal mines, we anticipate full year unit cost to be between $125 and $135. Our full year Asia Pacific Iron Ore sales volume estimate is about 8 million tons with per ton cost of between $45 and $55.

At Sonoma, we are projecting a sales volume of 3.3 million tons, and as Laurie just commented, slightly lower cost per ton of between $75 and $85. Costs are expected to increase sequentially from the first quarter as a result of increased stripping cost at the mine in the second and third quarters.

Before we open the call for questions, I want to take a moment to commend the business unit teams, who in a very difficult environment with environment different than just six months ago, when we were asking in for every incremental ton of production they could get, have really turned on the dime to focus on cash conservation and capital spend. In an industry as capital intensive as mining and natural resources, it's not easy to find ways to cut $70 million from your capital plans and maintain your production capabilities. But, as you can see from our 2009 CapEx guidance of $130 million, down from the $200 million that is exactly what we've done.

With that, I will open the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of David MacGregor from Longbow Research. Your line is now open.

Luke Folta – Longbow Research

Good morning, guys. This is actually Luke Folta sitting in for David. How are you doing?

Laurie Brlas

Good morning.

Joe Carrabba

Hi Luke.

Luke Folta – Longbow Research

My first question is related to your deferred development plan over at PinnOak. Can you give us what the production capacity is there excluding the curtailment and also what the implications are for 2009 and 2010 CapEx?

Joe Carrabba

Well, we certainly pulled back on the development. Luke, it's once again a tail of two cities. A year ago, nobody could get an equipment to do the development including ourselves and/or manpower to man the new equipment that we couldn't get. Obviously there is plenty of that now. So, we pulled back on the development drifts to go through with that.

The timing to give you specific numbers would be impossible Luke because if things were to turn tomorrow, we haven't really damaged our development plan at this point, if you will, because we are not producing. But as we go through the year and continue to produce, we would have a less of an ability to move that 2 million tons forward in a very quick and rapid pace.

Again, the same logic will apply if you flip it over into the next year. It will really depend on the sales rate going forward from an annual basis and as we get later in the year, we will be able to answer the questions more firmly.

Luke Folta – Longbow Research

Okay. And just second question regarding the equity loss over Amapa. If you annualize the number, it comes out to about $36 million for the year, which it seems like quite a bit ahead of your prior guidance of $50 to $60 loss. Was it one quarter, the first quarter better than you had expected and what do you think the implications are for the remainder of the year?

Joe Carrabba

Well, as we discussed in the past, the biggest difficult that we've all suffered with Amapa is just a year's delay in the ramp up. If you remember it was a year ago January when the deal was announced between Anglo and MMX. However that deal didn't close until August. So for eight months during the most critical part of this project, which was the project was being completed and in ramp up, there really wasn't the new management in place.

Anglo since they took control in August have established a new management team. You can imagine that took some time to really turn things around and we are seeing mass recoveries and production rate starting to move up the ramp up curve as we had thought they would.

Laurie Brlas

But at this time it's just too early for us to really bank on making a projection and change our guidance that we've given you. Yet, we just don't know enough about being certain of the balance of the year.

Joe Carrabba

While it's good news and it's encouraging, we would like to get a few months under our belt of solid performance before we go forward and declare that we are back on line with Amapa.

Luke Folta – Longbow Research

And that's understandable and just one last one, regarding your hot band price for 2009, it has declined. Are you able to provide for us what your prior guidance was and what the revised guidance is as well?

Laurie Brlas

Yeah, we are probably assuming around $500 now, which is down from probably around $700 range at the end of the year.

Luke Folta – Longbow Research

Great. Thanks a lot guys and good luck.

Joe Carrabba

Thanks, Luke.

Operator

Your next question comes from the line of Jorge Beristain from Deutsche Bank. Your line is now open.

Jorge Beristain – Deutsche Bank

Yeah, good morning Joe, Laurie and Steve. Jorge Beristain with Deutsche Bank. Just two things I guess. I wanted to follow-up on the statements that you made last quarter when I asked the same question about the North American coal business and you had answered that you would not be selling coal or commit to selling coal at a loss.

Now it seems if I heard the number right, you are committing to sell at a lower revenue per ton than your cost per ton and I think you did mention an estimated $70 million or $60 million of potential EBITDA losses at those businesses. Could you just clarify why you are bound to make these sales, is it just because of contracts and would there be any further sort of sequential stepdown that you would envision in unit cost of that business because that seems to be the only leverage you would have to turn the coal business around?

Laurie Brlas

Yeah, the tough thing there is volume and so we are not, you are right, we said and we still haven't and wouldn't enter into any new contracts for pricing that we know is below our cost. But we are dealing with some carryover tonnage from last year at lower prices, so that drives the revenue side of that equation and then actually our cost per ton is higher because we've reduced the volume. So we've got the two numbers moving away from each other. But we still and by evidence of our cutting development is that we do not want to go out and try to sell that extra tonnage would be lower prices this year. We'd rather keep that tonnage in the ground and save it for next year or the year after when we expect prices will go up.

Jorge Beristain – Deutsche Bank

And how will the cuts for the CapEx affect your '010 and '011 projections for coal. I know that Joe said you couldn't really comment, but would you expect if you sell 2 million tons this year that 3 million tons is feasible for next year or will that just be off the cards because or off the table just because of the cuts you are making right now?

Joe Carrabba

Most of the capital cuts, Jorge, are actually over on the iron ore side, that's where we spend the big intensive capital. We had actually received most of the continuous miners which are, I don't know, $2 million to $3 million a shot as they come in. So we do have the development capacity to put back in place if the ramp up and then the profitability of this business does return. We could bring this back on. So, I don't really see the capital effects damaging the ramp up if it were to be profitable.

Jorge Beristain – Deutsche Bank

Great. And so if I could just on iron ore business I had one more question. Just could you help us understand, because we've seen this impact a bit in the steel industry, where the downtime I think you quantified that the downtime you are taking in North American iron ore was causing you on a gross basis something like $31 million your idle expense. If we divide that by the tonnage you sold around 4 million tons, that's about $7 a metric ton of idled iron ore expense.

Do you see this reversing, would this immediately sort of dissipate in the second half if you saw 20% uptick in iron ore throughput? And would there be any further cutting that you could do in your North American ops because it seems that generally you are keeping across the board a lot of your mines open, but particularly the ones that your non-equity production at 35% utilization, that's got to be very painful in terms of lack of fixed cost dilution?

Joe Carrabba

Let me answer the second part of the question first is we still have room to go as far as cutting in the North American Iron Ore operations and we will continue to do that. We just recently extended the North Shore shut if you will that we have a 100% ownership from a four week to a six week shut and throughout the year, Jorge, we will continue to manage the production inventories and do have the ability to shutter these mines up and down as need be particularly to manage the product inventory. We will continue to be diligent on that.

Laurie Brlas

So a couple of things Jorge first your math. We sold 2 million tons. So you have to kind of have to take that idle cost over the 2 million to get the impact on the current quarters ton and if you see we sold $84 per ton in the quarter and we are expecting $70 to $80 for the full year. So that shows you how it will ramp down over the rest of the year as we do increase our sales a bit over the course of the year.

Jorge Beristain – Deutsche Bank

Okay. Thank you.

Operator

Your next question comes from the line of Brian Yu from Citi. Your line is now open.

Brian Yu – Citi

Good morning.

Joe Carrabba

Good morning, Brian.

Laurie Brlas

Good morning, Brian.

Brian Yu – Citi

Hi. Laurie, I want to get a clarification on the North American pricing comments. So, we should really be working off of an adjusted price in Q1 of closer to $90 assuming that this $14 is some sort of a retroactive adjustment?

Laurie Brlas

Yeah, that's right. If you think about our contracts as we end every year and this happens every year, the factors within those are still subject to adjustment and most years in the first quarter there is some level of adjustment related to the factors for iron ore sold in the last year. So if nothing changes going forward and of course that's always something that's not going to be true. But if nothing changes from this point forward, the balance of the year we would be in the $90, $91 a ton revenue range.

Brian Yu – Citi

Okay. And I assume that you are also making some assumptions about your contracts that are tied to the seaborne settlements. Can you give us a sense of what your underlying assumptions are so that we can make our own estimates about the potential true-up depending on wherever those oversea contracts?

Laurie Brlas

In the first quarter because of the minimal shipments on the Great Lakes and because of the lag year factors in our contracts, we really didn't have any need to make an assumption on the world settlement there.

In Asia Pacific as we mentioned, we are doing some provisional pricing and that varies across the few numbers, but it's generally in line with what the analysts are saying on any given week. So that varies from week to week depending on what spot pricing and different things are doing over in the Asia Pacific market.

Brian Yu – Citi

Okay. So in Asia Pac you are looking at potentially maybe only 30% to 40% decline in seaborne trades?

Laurie Brlas

That might be a little aggressive. I think we are doing a little better than that.

Brian Yu – Citi

Okay. And then, one last follow-up in North American pricing. So there is some sort of a contract mix shift during Q1 and as we look at the rest of the year and more of the seaborne settlement type contracts flow through, we are still looking at somewhere close to $90 holding all else equal?

Laurie Brlas

Yes. If I understand your question, once there is a world settlement that would flow through, and if it is a decline it would reduce that $90, but because of the contract obviously the full amount of any reduction wouldn't flow through.

Brian Yu – Citi

Thank you.

Operator

Your next question comes from the line of Luther Lu from FBR Capital Markets. Your line is now open.

Luther Lu – FBR Capital Markets

Good morning Joe and Laurie.

Joe Carrabba

Good morning, Luther.

Laurie Brlas

Good morning, Luther.

Luther Lu – FBR Capital Markets

My first question is related to North American coal business. Certainly you are showing revenue in the $100 and then cost at $134. I am just wondering is there any flexibility in terms of purchasing the coal from the market either from your nearby other coal companies to satisfy the contracts and to create some win-win situation?

Joe Carrabba

Not really with this type of coal, there has been a low-vol coal. It has some very tight and specific specifications around it. That's why in a good market it makes this coal so valuable. But, no, there really isn't any coal in the surrounding area that could match up the specification for this coal.

Laurie Brlas

And the other things is, we wouldn't be able to get rid of all those costs because there is a lot of fixed costs involved in our operations and so it's not that you could go out and buy the coal for less and to completely eliminate that $134.

Luther Lu – FBR Capital Markets

Okay, got it. Just want to get some color on the international market. In China, they've really haven't cut back their iron ore production and yet they are increasing their iron ore imports significantly. Just wanted to get a sense of what is exactly going on in China and where do you think the eventual settlement price would end up with?

Joe Carrabba

Well, I think they have quite a dilemma now in China, Luther, and that the iron ore producers over there, it's a very large business with a lot of jobs entailed. So as spot prices drop, the iron ore producers in China become uneconomical, which is everybody is looking at stimulus and jobs at this point in time. So I think they've got a real dilemma of what do they do with this pricing now versus the jobs that the iron ore producers in China are putting out and buying iron ore on the spot markets. So I don't know the answer to it, but that's certainly I will frame the dilemma that they have.

Luther Lu – FBR Capital Markets

Okay. And since you are not involved, just wondering if you can comment on the iron ore settlement price, what's your expectation?

Joe Carrabba

I wish I could. I am no closer as you know than anyone else here. We are selling to our customers, which are primarily the secondary market and primarily produce construction based materials, which seems to be going well in the stimulus package in China. We are using provisional pricing in line with what you've read in the press over there with the other producers. But when and what it's going to be, I really don't have any more idea at this point than anybody on this call.

Luther Lu – FBR Capital Markets

Okay. And switching back to North American iron ore, we are at the end of April. What are the steel customers telling you in terms of volume going forward for the second quarter perhaps versus second half?

Joe Carrabba

I think there is not a lot of upside this year in the steel business, no different than you probably heard on the calls. I think people are looking for maybe a little more robustness in the industry in the second half, but not a whole lot from moving past the 40% to 45% that we are seeing now. I mean some de-stocking is taking place obviously as inventories go down, but I think it will be very sluggish as well throughout the year.

Luther Lu – FBR Capital Markets

But, at least 90 million tons should be, I mean they should at least take that 90 million tons, right?

Joe Carrabba

I don't know whether they will take it or not. We have contracts on a take or pay basis, Luther, for this material as we said in the discussion we had earlier. The physical practicalities of where these tons go is something we'll have to workout with the customers throughout the year, but we have contracts in place that are being honored.

Luther Lu – FBR Capital Markets

Okay.

Laurie Brlas

And consistent with what you saw at year end where we had collected cash for tons that we didn't ship and as we mentioned in the quarter we collected $50 million for sales in the future. Our contracts are holding, our customers are paying. The challenge is what we all do with the iron ore.

Luther Lu – FBR Capital Markets

Okay, great. Thank you.

Joe Carrabba

Thank you, Luther.

Laurie Brlas

Thanks.

Operator

Your next question comes from the line of Tony Robson from BMO Capital Markets. Your line is now open.

Tony Robson – BMO Capital Markets

Good morning.

Laurie Brlas

Good morning, Tony.

Joe Carrabba

Good morning, Tony.

Tony Robson – BMO Capital Markets

Hi. Clearly on your cuts in CapEx as Laurie pointed out previously, you guys got a pretty good balance sheet even accounting for the fact that you consumed cash in the first quarter and then sort of free it up in the subsequent quarters.

Your cut in CapEx from $200 million doubles to $130, does that sort of indicate you are expecting tough times to continue or you are just taking, in other words it's very-very cautious approach because on my numbers you can certainly continue to run at the higher CapEx rate?

Joe Carrabba

This is very cautious approach, Tony, from just the type of company we are and we don't have an outlook as we said before either on the pricing or the duration of this downfall that we are in right now, we are just being extremely cautious in all the things we do.

Tony Robson – BMO Capital Markets

Okay. All my other questions have already been asked, so thank you.

Joe Carrabba

Great, thanks Tony.

Laurie Brlas

Thanks, Tony.

Operator

Your next question comes from the line of Mark Parr from KeyBanc Capital Markets. Your line is now open.

Mark Parr – KeyBanc Capital Markets

Yes, good morning guys.

Joe Carrabba

Good morning, Mark.

Laurie Brlas

Good morning, Mark.

Mark Parr – KeyBanc Capital Markets

I didn't change my last name contrary to.

Laurie Brlas

We didn't think so.

Mark Parr – KeyBanc Capital Markets

It doesn't sound too bad, I might think about it.

Laurie Brlas

Whatever works.

Mark Parr – KeyBanc Capital Markets

Whatever works. I had a couple of questions if I could. First, I'd like to kind of get back to this physicality issue related with your shipping, 19 million tons of pellets and I guess maybe the one way to start would be how much additional stock piling capability do you have in your own yards and then based on your canvassing of available places, all the usual places I guess. I mean how much, and assuming no change in utilization rates, say if we stay at 50% or less utilization rate for North American integrator producers in '09, I mean what does that do to your ability to actually ship 19 million tons?

Joe Carrabba

Well, let me start.

Mark Parr – KeyBanc Capital Markets

Or you book the revenue I guess, if you store it in your place you can't book the revenues, right?

Laurie Brlas

It depends on how soon the customers are going to take possession of the inventory. We've got a clear schedule that says they are taking it very quickly and they've already paid for it, then we probably could book the revenues. But that gets to a lot of new nuances that we'll deal with at year end.

Joe Carrabba

Yeah. Let me address the physical piece of this thing Mark is stocks in the normal locations in the lower lakes and all the shipping points are certainly at very high levels of inventory as consumption is slow and many of the mills are idled. Our traditional places, if we had to in our minds, will fill up very quickly.

However, if we needed to continue to produce those pellets for the customers, I have a lot of mobile equipment that's sitting idle and we have a lot of open ground in all of these mines where if we needed to stop these pellets, well we could to do that.

Mark Parr – KeyBanc Capital Markets

Okay. So there's no worry about having a place to put the pellets I guess, as a constraint to the production process?

Joe Carrabba

It's not a worry, no. I mean mines can always find places to put stockpiles of finished goods and WIPs and all that, but they would not be in traditional places right off of our most convenient and effective places to put the materials in.

Mark Parr – KeyBanc Capital Markets

Can you talk a little bit about how many tons you have on the ground right now, or at the end of March how many you had on the ground and what you've got on the ground now?

Joe Carrabba

They are looking (inaudible) quarter numbers.

Steve Baisden

I have that number, hold on one second Mark. We had about almost 6 million tons of inventory in our North American Iron Ore segment at the end of the quarter, which isn't extremely high considering in the first quarter of 2008 we had 5.8 million tons.

Mark Parr – KeyBanc Capital Markets

Okay.

Joe Carrabba

We are trying very hard, Mark, at this point to match the production with the shuts coming out of the winter that we've had and we are keeping a pretty close eye on the stock. So we are okay for now and certainly through the second quarter we'll just have to watch the later half of the year.

Mark Parr – KeyBanc Capital Markets

Okay, terrific, all right. I had a couple other questions. So first I just wanted to get some more clarification on your balance sheet. You noted $180 some million liability for below market contracts. Could you give you a little more color on that?

I was looking up in the K. I got kind of a real brief description of that, but I'd just like to get some more better description of what that entails and what it means from a P&L standpoint?

Laurie Brlas

Well, that would be purchase accounting related to UTEC primarily. So what that means from a P&L standpoint is as we ship those, we work down that liability and the credit comes through the P&L of income.

Mark Parr – KeyBanc Capital Markets

Okay, all right. So, again going back to the K, it says you are going to book $30 million in earnings in '09, so that would take that $180 would take it down to $150?

Laurie Brlas

Yep.

Mark Parr – KeyBanc Capital Markets

Is that the right way to think about that?

Laurie Brlas

Yes, that is.

Mark Parr – KeyBanc Capital Markets

Okay, all right. So that's helpful. And then, Joe, I also just like to get back to addressing the issue of production costs on coal. I know that there is a fixed charge issue that hit you in the first quarter and I know you had an awful lot of detail early in the call. But are there any specific things or can you quantify any sort of magnitude in potential reduction in mining costs over the next couple of quarters for your domestic operations?

Joe Carrabba

Well, I think at this point, just as we've been talking to you folks and to our investors since the purchase of PinnOak. We've spent a lot of time in the maintenance and bringing those mines both in West Virginia and Alabama back up to snuff and where we thought they should be to produce. We felt we were really ready to turn the corner this year with those, Mark, we've put in a, as you know, a lot of effort, time and money into those processes. And I think when the volume rebounds we'll be able to see the fruits of the labor. But unfortunately at this point in time with that low volume that we are looking at in these mines, you just can't overcome the fixed cost portion of these mines.

Laurie Brlas

One way to think about it, Mark, we said about 2 million tons for the year, which means if we did about 500,000 or kind of run at the correct current run rate and we lost about just under $30 million in the quarter and as Joe said our changes are to limit our losses to a $50 million to $70 million range, so obviously we've got some improvement in the loss per quarter projected into that for the balance of the year.

Mark Parr – KeyBanc Capital Markets

Okay. Was another part of the loss in the first quarter perhaps an unusually large mix of carryover business from last year of lower numbers?

Joe Carrabba

It certainly was, yes. We had quite a bit of carryover tonnage going through the first quarter.

Laurie Brlas

We've got revenue per ton of $95 and we are projecting to get closer to $100 for the full year.

Mark Parr – KeyBanc Capital Markets

Okay, alright, that's terrific. Thanks for all that help.

Joe Carrabba

Thanks, Mark.

Mark Parr – KeyBanc Capital Markets

Good luck in the second quarter.

Joe Carrabba

Thank you.

Laurie Brlas

Thank you.

Operator

Your next question comes from the line of Tim Hayes from Davenport & Company. Your line is now open.

Tim Hayes – Davenport & Company

Hey, good morning.

Joe Carrabba

Good morning, Tim.

Laurie Brlas

Good morning, Tim.

Tim Hayes – Davenport & Company

Just a couple questions on the North American Iron Ore. Your assumption of the steel price, I think we heard it correctly, is $500 per ton, is that for the year?

Joe Carrabba

Approximately, yes.

Laurie Brlas

Yeah.

Tim Hayes – Davenport & Company

Yeah. And then your sensitivity to steel prices, has that changed?

Laurie Brlas

What do you mean by has that changed?

Tim Hayes – Davenport & Company

Yeah, it was I think previously for every $10 per ton change in steel prices, you had a $24 to $25...

Joe Carrabba

Cent.

Tim Hayes – Davenport & Company

Yeah, cent change in pricing realizations.

Laurie Brlas

About the same.

Tim Hayes – Davenport & Company

About the same?

Laurie Brlas

Little bit more.

Tim Hayes – Davenport & Company

Okay.

Laurie Brlas

Not materially different from that.

Tim Hayes – Davenport & Company

Okay. That's all my questions. Thanks.

Laurie Brlas

Okay.

Joe Carrabba

Okay. Thanks Tim.

Operator

Your next question comes from the line of Wes Collins [ph] from Morgan Stanley. Your line is now open.

Wes Collins – Morgan Stanley

What was the impact of lower contract mining costs in 1Q and what is embedded in the $10 a ton reduction in the full year guidance?

Laurie Brlas

Are you talking about Sonoma?

Wes Collins – Morgan Stanley

Yeah.

Laurie Brlas

Okay.

Joe Carrabba

I am sorry. I think we missed the first part of your question, Wes. Would you say that again so that we can hear it?

Wes Collins – Morgan Stanley

Yeah, at Sonoma, the impact of lower contract mining costs in 1Q and what was embedded in the $10 a ton reduction in the full year guidance?

Joe Carrabba

The lower mining costs, we were hit one with some pretty heavy rain up there, so the contractors were literally down for most of that period or two or three weeks out of that period I should say. So we worked through the stockpiles. What you'll also see coming through the year are the lower diesel fuel rates and things of that nature that are pass-throughs with the contractors as the mining goes forward with that. And we are also adding a micro-cell into the prep plant there that we think we'll get a couple of points of recovery on. So you add all that together and it will be very helpful through the year.

Wes Collins – Morgan Stanley

And do you think that's what about the $10 a ton reduction in your guidance, is that a couple dollars?

Joe Carrabba

I really don't have a number for you, Wes. We can get it for you, but I don't have it here at the tip of my tongue.

Steve Baisden

Yeah, Wes, why don't I follow up with you after the call? I mean part of it is some of the contract mining impact and then part of it is the royalty.

Laurie Brlas

We don't know the split between those two factors. We'll get that.

Wes Collins – Morgan Stanley

Okay. And regarding the royalty payments, could you comment about the expected timing the royalty payments to QCoal I am speaking about, can you talk about the expected timing of those payments and how that's changed versus your prior expectations?

Laurie Brlas

Well, those are a function of return. And as pricing has come down a bit in coal, that lowers the requirement to make that royalty payment, similar to a lot of the royalty payments we have in North America. So that isn't a timing change. That means we don't have to pay a piece of it just because revenues have come down.

Wes Collins – Morgan Stanley

So it's not based on a full year for our performance, metric ton?

Joe Carrabba

It is based on a full year, but in current projections we don't see the catch-up.

Laurie Brlas

Revenues in per ton are less than we had originally projected them because coal prices have come down.

Wes Collins – Morgan Stanley

Yes. At Amapa, were you selling concentrates during the quarter at last year's contract prices or at a provisional price?

Joe Carrabba

It's a last year's contract price through this with GIC.

Wes Collins – Morgan Stanley

Okay. And lastly, if I may, given the cuts in North American Iron Ore CapEx, what's your expected maximum capacity going out in 2010 and 2011 and where do you see Empire going forward?

Joe Carrabba

Well, I think this won't have any damage on North American production going forward. We'll be able to ramp right back up to capacity, if need be.

The run rate, we have suspended on Empire, the run rate is still going pretty heavy. That just happens to be the furnace that also matches up with Mittal's furnace in Burns Harbor, as well we would still project that to go down I think in 2013-2014 as we had originally thought. But we've suspended all activity because of the poor visibility we've got right now, Wes.

Wes Collins – Morgan Stanley

Okay. Thank you very much, guys.

Joe Carrabba

Thank you.

Laurie Brlas

Thanks, Wes.

Operator

Your next question comes from the line of Wayne Atwell from Casimir Capital. Your line is now open.

Wayne Atwell – Casimir Capital

What do you think you could bring your cost down to PinnOak? If you were operating under ideal circumstances flat out, how much could you bring your cost down to?

Joe Carrabba

Well, I think we'd get below $100 now, Wayne, with where we are in the current environment. But if we could push back into a 4 million ton environment, I think we could start seeing costs below $100.

Wayne Atwell – Casimir Capital

And what's the spot market for that coal or if you were to book it today what would you get for that?

Joe Carrabba

There is no spot market, Wayne, that's the problem. And I am being serious, there is no demand for metallurgical grade coal whatsoever at this point in time. So lowering the price or going out on a spot market would have no material impact other than a negative of selling your coal again at a very low price.

Wayne Atwell – Casimir Capital

Okay. And I was surprised your costs in North America for iron ore were as high as they were. Obviously you've cut back your production. What can you bring those costs down to under ideal circumstance when you're operating flat out?

Joe Carrabba

When we are operating flat out, well I think we'd move right back into the range that we were last year. Obviously we are going pick up some efficiencies like everybody else in these downturns and we would get a favorable impact right now of the natural gas in particular, which is a very high cost for us in the in duration process of these pellets, and there is some diesel fuel that would flow through as well, but it would certainly be back in line with where we were a year ago.

Steve Baisden

Yeah. Wayne, just to be a little more pointed, we had cost of sales in 2008 of about $57 a ton and that was on a sales volume base of about 23 million tons.

Wayne Atwell – Casimir Capital

Okay. So you could get back into that level?

Laurie Brlas

Yeah, if you took that piece we mentioned as idle cost and took that off, you'd see we are pretty much in that range this year.

Wayne Atwell – Casimir Capital

Okay. And then lastly can you remind us of your formula, if I am not mistaken your North American Iron Ore is tied to steel index in the international price. Could you give us those percentages again?

Laurie Brlas

Well, we like to think of it roughly, and this is going to be a rough guideline if you will, that a third of our pricing in North American Iron Ore is tied to the world pellet price settlement. So that's the Eastern Canadian pellet price settlement, I am sorry. So that's kind of a European-Canadian version, not Australian Lump and Fine. A third of it is going to be tied in some way to steel. It could be a customer's hot band. It could be a PPI of cold rolled, something like that. And then a third is tied in someway to our cost inputs, could be a PPI of commodities, PPI of fuel and related, so we think of those three components.

Wayne Atwell – Casimir Capital

Thank you.

Joe Carrabba

Okay. Thanks, Wayne.

Operator

Your next question comes from the line of Sayan Ghosh from Citadel Investment. Your line is now open.

Sayan Ghosh – Citadel Investment

My questions did get asked, but just to reconfirm, pricing that you are recognizing on iron ore, what you're seeing on North American Iron Ore is that ex this adjustment for one of your customers pricing should revert to $90, $91 per ton, but that there might be a potential downwards adjustment subject to the settlement of that Canadian benchmark pellet price, right?

Laurie Brlas

That's a very good way to look at it.

Joe Carrabba

That's correct, Sayan.

Sayan Ghosh – Citadel Investment

And the $90, $91 is basically assuming (inaudible) versus '08 that international pellet price sort of whatever that number was?

Laurie Brlas

Flat.

Joe Carrabba

Yes, flat pricing.

Sayan Ghosh – Citadel Investment

Okay. And on Amapa, again just to reconfirm, you are saying that as of Q1 '09 you are still recognizing pricing based on last year's seaborne benchmark?

Joe Carrabba

That's right. We didn't sell a lot on that contract.

Sayan Ghosh – Citadel Investment

Right.

Joe Carrabba

In the first quarter of this year. GIC is also taking lower shipments out of the mine and there wasn't a recognition.

Sayan Ghosh – Citadel Investment

Okay. So whenever these seaborne benchmark settlements are made, say between Valley and the Europeans or otherwise, you are going to be putting in a retroactive adjustment to this price for the relevancy of applicable from Jan 1?

Laurie Brlas

Yes, some of our contracts have some lag factors. So there may be an adjustment on how much of that flows through, but generally speaking that's right.

Sayan Ghosh – Citadel Investment

Okay, got it. Thanks.

Steve Baisden

Sarah, after this question we are going to ahead and finish up the call. So we'll take one more question as we are approaching the top of the hour.

Operator

Your last question comes from the line of Choi Transaction [ph] from Elm Ridge Capital. Your line is now open.

Choi Tran – Elm Ridge Capital

Just a couple questions on your North American ore, just to understand the caps and collars a little bit better for me.

Laurie Brlas

Could you speak up a little more?

Choi Tran – Elm Ridge Capital

Sure. Just a couple of questions on your North American Iron Ore, is that a little bit better?

Laurie Brlas

Yes.

Joe Carrabba

Yes, it's better.

Choi Tran – Elm Ridge Capital

Yeah, just so that I can understand it a bit better, how much of your volume is subject to the caps and collars? And at this point if everything stays flat, how much could the caps and collars move going from 2009 into 2010.

Laurie Brlas

Well, virtually all of our production is under long-term contracts, which means it does have some type of formula cap, what have you, on it that limits the volatility. So that's a general statement. Now if any of these factors change, there will be some flow-through of that. And as I went through the one-third, one-third, the way we think about the formula, if those numbers are extremely large, then the caps and collars would come into effect a little bit more.

Steve Baisden

And if you'd like, I can spend some time with you actually walking you through the North American Iron Ore business model and how we contract our business in that segment offline.

So with that, we'll go ahead and end today's call. We'd like thank everyone for joining us and I will be available for the rest of the day to answer any follow-up questions. Thanks everyone.

Joe Carrabba

Thanks all.

Laurie Brlas

Thanks.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Cliffs Natural Resources Inc. Q1 2009 Earnings Call Transcript
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