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Cliffs Natural Resources Inc (NYSE:CLF)

Q2 2013 Earnings Conference Call

July 26, 2013 10:00 AM ET

Executives

Joseph A. Carrabba - President and CEO

Terrance Paradie - EVP and Chief Financial Officer

P. Kelly Tompkins - EVP and CAO

Jessica Moran - Director, Investor Relations

Analysts

Michael Gambardella – JPMorgan Securities

Sal Tharani - Goldman Sachs & Co.

Mitesh Thakkar - Friedman, Billings, Ramsey & Co., Inc.

Brian Hsien Yu - Citigroup Global Markets Inc.

Timna Tanners - Bank of America Merrill Lynch

Evan Kurtz - Morgan Stanley

Curt Woodworth - Nomura

Jason Brocious - KeyBanc Capital Markets

Luke MacFarlane - Macquarie

Jorge Beristain - Deutsche Bank

Tony Rizzuto - Cowen and Company

Operator

Good morning. My name is Jonathan, and I’ll be your conference facilitator today. I’d like to welcome everyone to Cliffs Natural Resources 2013 Second 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’d like to introduce Jessica Moran, Director, Investor Relations. Ms. Moran?

Jessica Moran

Thanks, Jonathan. I’d like to welcome everyone to this morning’s call. Before I turn the call over, 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 projections of the Private Securities Litigation Reform Acts 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 on the website and available for replay.

Joining me today are Cliff’s President and Chief Executive Officer Joseph Carrabba; Executive Vice President and Chief Financial Officer Terry Paradie; and Executive Vice President and Chief Administrative Officer, Kelly Tompkins.

At this time, I’ll turn the call over to Joe for his prepared remarks.

Joseph A. Carrabba

Thanks, Jess, and thanks to everyone for joining us this morning. Before I discuss the quarter’s results, I’d like to take this opportunity to discuss our recent announcement about my retirement as CEO, which will be effective by the end of the fiscal year. Before that, let me begin by thanking Laurie Brlas for her contributions to Cliffs during her seven years of service as CFO and most recently as President of Global Operations. We wish her well in her future endeavors.

Looking back over my 10-year here at Cliff, I’m pleased with the strategic objectives that we’ve accomplished. When I began here in 2005, we’ve just began our transformation from a pure North American iron ore producer to an international mining and natural resources Company. We’ve significantly expanded and diversified our global footprint, product offering, customer base and project pipeline. In addition to these accomplishments and perhaps most importantly, we’ve embedded a focus on safety and everything we do.

I’m also very proud of the depth and breadth of the management team that we built as well as the culture and core values that have served Cliff so well for 166 years. I know the Board is confident in the executives that make up the newly formed office for the Chairman, led by our non-executive chair Jim Kirsch. I look forward to working with all of them over the next few months as our leadership transition takes place. I will continue as CEO for the remainder of the year or until the Board appoints my successor.

At this time, I’ll introduce Kelly Tompkins, who has been recently appointed Executive Vice President and Chief Administrative Officer and is part of the Office of the Chairman. Kelly will discuss the executives that make the Office of the Chairman as well as the teams priorities over the next several months. Kelly?

P. Kelly Tompkins

Thanks, Joe. Well, the Office of the Chairman is new, it is comprised of five very experienced Cliff’s executives as well our non-executive Chair of the Board, Jim Kirsch. It’s also worth noting that in conjunction with Joe’s announced retirement, we’ve separated the roles of CEO and Chairman of the Board. In the coming months our Board will evaluate whether the separation of these roles should be a permanent change to our corporate governance structure.

Joining Jim and I in the Office of the Chairman will be Terry Paradie, Executive Vice President, and Chief Financial Officer; Don Gallagher, Executive Vice President, President Global Commercial; Cliff Smith, Executive Vice President, Global Operations, who now has responsibility for U.S. iron ore, Asia Pacific iron ore and North American coal operations and Duke Vetor, Executive Vice President, Global Operations Services, who is taking responsibility for Eastern Canadian Iron Ore.

This team possesses a broad range of financial, commercial, operational and project execution expertise, not to mention deep familiarity with our business customer base and culture. Over the next few months, the groups main focus will be to prioritize and work on the most pressing challenges facing the business, namely stabilizing and lower the costs of Bloom Lake, determining whether and when to proceed with Phase 2 of Bloom Lake, assessing the long-term viability of Wabush, continuing our progress on reducing SG&A costs as well as assessing the feasibility work on our chromite project and the next steps in our early stage work on producing DR grade pellet at our Northshore facility. In the coming months, we’ll make these capital allocation recommendations to the Board with the goal of ensuring the new incoming CEO hits the ground running.

With that, I’ll turn the call back over to Joe to discuss the performance of our business segments during the quarter. Joe?

Joseph A. Carrabba

Thanks, Kelly. Globally the steel making utilization rate remains strong at 79%, with China’s crude steel production continuing to reach record levels. China’s year-to-date iron ore import data is up slightly versus 2012 comparable period. And iron ore inventories at the ports and mills continued to be at multi-year lows. These factors along with an unseasonably rainy June in parts of Western Australia supported the iron ore price during the second quarter and well into the current quarter.

Despite the favorable pricing, we recognized China’s government is in the process of orchestrating a manning slow down of their economy. This is a risk we continue to monitor along with the significant amount of iron ore supply expected to materialize later this year. In the U.S., the economy remains stable with most economic indicators pointing to slow and moderate growth.

Automotive production and sales were strong and the construction sector continues to improve. One factor that is working against us is the – in the U.S. is the stronger U.S. dollar. As many of you know, this will likely increase steel imports into the U.S. and mute the demand of domestic fuel products. Europe’s economic situation remains dismal with the consolidation and rationalization of their steel industry are likely event over the next several years.

In U.S. iron ore second quarter sales volume increased 5% to 5.7 million tons from 5.4 million tons in the year-ago quarter. This was primarily driven by increased demand and higher export sales related to pellet contracts assumed from Cliff’s Wabush mine. Year-to-date we’ve exported approximately 800,000 tons of pellets from the lower Great Lakes into the seaborne markets. We’ve been successful in placing about half of this volume with European customers.

With the year-to-date results, we’re on track to meet our full-year 2013 expectation of exporting between 1.5 million to 2 million tons of U.S. Iron Ore pellets into the seaborne market.

As announced during the quarter, we entered into an agreement with Essar Steel Algoma to extend our iron ore pellet sale and purchasing agreement to 2024. The previous agreement was expected to expire in 2016. This agreement includes Essar's minimum volume iron ore pellet purchases from Cliffs beyond 2016 and pricing for 2013 through 2024. We are pleased to continue to supply Essar with high quality products throughout the next decades.

In early April, we executed a planned curtailment at Empire Mine in Michigan. We expect to restart Empire's production during mid third quarter. At Northshore Mine we are conducting additional tests on the DR-grade pellets we successfully produced earlier this year. Our next step is to perform industrial scale engineering work to refine our cost estimates to potentially modify Northshore Mine for DR-grade pellet production.

As I mentioned last quarter, our ability to produce DR-grade pellets and potentially enter into a new market is an exciting new development for Cliffs. For full year 2013 we are maintaining our U.S. Iron Ore sales and production volume expectation of 21 million tons and 20 million tons respectively.

Turning to Eastern Canadian Iron Ore, sales volume decreased 18% to 1.9 million tons from 2.4 million tons in the prior year's comparable quarter. This was comprised of 1.5 million tons of concentrate and approximately 475,000 tons of iron ore pellets. The year-over-year decrease was primarily driven by lower pellets availability from Wabush Mine.

At Bloom Lake we continued to experience variability in the ore characterization. This variability drives lower throughput and recovery rates through the mill. As we've previously discussed, adjusting the ore blend to include additional crude ore from the West Pit is expected to improve our operating metrics for the longer term.

At this point, we have not reached the optimal ore blend primarily due to the availability of equipment and labor on site. That being said, we expect to conduct additional mining work in the West Pit during the second half of the year versus the first half. As a result, our strip ratio will increase as well as our cash cost per ton. To reflect this, we are increasing our full year cash cost per ton expectation at Bloom Lake by $5 to $90 to $95.

Also, due to the lower throughput recovery rates we've experienced to-date and in an effort to derisk our forecast, we are lowering the range of our full year expected sales volume from Bloom Lake by 1 million tons to 5.5 million to 6 million tons.

For the remainder of this year, we are focused on a number of projects including some of the shared infrastructure and permission to operate investments. We expect to commission the new in-pit crusher overland conveyor system and ore barn in the next few months. In addition to these projects, we still have a significant amount of work to complete in our tailing facilities.

As disclosed in the outlook in last night's earnings release, we are increasing our full year 2013 CapEx expectation by approximately $20 million. The increase reflected additional tailings construction required to be completed this year. Later in the call, Terry will discuss how we intend to finance the additional CapEx required.

The decision to restart the construction of phase two's concentrator and load-out facility is still under review. We are currently evaluating several scenarios to determine the most appropriate plan for this project going forward.

On the marketing front, our customer diversification strategy for Bloom Lake's concentrate continues to gain momentum. During the quarter, we were successful in signing a one-year supply agreement with a Japanese mill. Due to our lower revised forecast for Bloom Lake's full year expected sales volume, we are now fully committed for 2013. We expect to resume our trial cargo shipments to new customers in the beginning of 2014.

At Wabush we idle the Point Noire pellet plant at the end of June and we have switched over to processing and marketing of concentrate-only product. Thus far, we have several trial cargos scheduled for the second half of the year to customers in Europe, Japan and China.

At the end of June, forest fires caused burning close to Wabush's operations cost us to temporary idle production at Scully Mine. During the natural disaster, Cliff’s employees stabilized and protected the mining operation. In addition, the company worked in partnership with Wabush authorities to provide volunteer systems and heavy equipment to create a firebreak for the town at a safe distance from the fire. There was no damage to our operations and production has resumed.

With our revised outlook for Bloom Lake, we are decreasing our full year Eastern Canadian iron sales and production volume expectations to 8 million to 9 million tons from our previous expectations of 9 million to 10 million tons. This is comprised of 5.5 million to 6 million tons for Bloom Lake and the remainder from Wabush.

Turning to Asia-Pacific Iron Ore, second quarter sales volume decreased to 3 million tons from 3.1 million tons sold in last year's comparable quarter. The decrease was attributed to the absence of sales volume from our Cockatoo Island operation that ceased production in the third quarter of 2012.

Sales volumes for the quarter were slightly better than anticipated due to the Port of Esperance, only executing one 10-day shutdown versus our expectation of two 10-day shutdowns during the quarter. We expect the second shutdown to take place later this year. Our full-year 2013 expected sales and production volume remains unchanged at 11 million tons.

Now turning to coal. Our second quarter sales volume increased 36% to 2.1 million tons from 1.5 million tons last year, another record quarter and tremendous performance by our operating and commercial teams. Production at Pinnacle Mine was exceptional during the quarter. In addition to good geological conditions, the team also executed Pinnacle's planned longwall move in seven days compared to our previous best record. This was 100% improvement.

In addition to increased production volumes in North American coal, the team continues to work on lowering the cost structure. I think it's important to highlight this especially considering the price environment all coal producers are facing today. We recognized our ability to move less on the cost curve will enable us to supply existing and new customers with quality met coal.

That being said, during the second quarter, we were successful in adding new tier 1 customers to our order book. These included two customers in Europe and one in South America. Currently, we do not have any met coal volume price for 2014. However, we are experiencing a strong demand for our products. For 2013 we are maintaining our sales and production volume expectations of approximately 7 million tons largely comprised of metallurgical coal.

In closing, I am pleased with the quarter's result. As I mentioned in my opening remarks, over the last several years we've been successful in our diversification strategy. It's been a privilege to lead this company through some of the most challenging and exciting time commodity companies have faced in recent history. I look forward to working with the offices of the Chairman during the leadership transition period.

With that, I'll turn the call over to Terry for his review of the financial highlights. Terry?

Terrance Paradie

Thank you, Joe. Consolidated revenues for the second quarter were $1.5 billion, 6% lower than the previous year. This was driven by an 11% decrease in seaborne iron ore pricing to an average of $126 per ton for a 62% Fe fines product.

Cost of goods sold increased 7% to $1.2 billion, driven by higher sales volumes in North American Coal and U.S. Iron Ore, unfavorable inventory adjustments and higher idle costs. This was partially offset by lower sales volumes in Eastern Canadian Iron Ore.

Operating income for the second quarter decreased 28% to $262 million. The decrease was primarily driven by lower consolidated sales margin, partially offset by a significant decrease in year-over-year SG&A and exploration expenses. This was driven by an overall focus on cost management as well as lower spending on drilling and professional services for certain projects.

The lower operating income was partially offset by a significant increase in miscellaneous net, which was primarily comprised of a $39 million benefit related to foreign exchange remeasurements. Results of a $19 million non-cash gain related to the final transfer of our Cockatoo Island operation and the purchaser's assumption of certain asset retirement obligation liabilities.

Second quarter 2013 results also included an income tax expense of $9 million versus $42 million reported in the previous year's comparable quarter. The decrease was driven by our expected full year 2013 income tax effective tax rate of 2%, which includes discrete items.

Additionally, we recorded a $68 million asset impairment charge related to the write-down of our Amapa investment. We reported second quarter 2013 net income attributable to Cliffs' common shareholders of $133 million, or $0.82 per diluted share. This compares to $258 million or $1.81 per diluted share in the second quarter of 2012.

Moving on to liquidity and capital structure; in the second quarter of 2013 the business generated $114 million in cash from operations versus generating $96 million in the second quarter of 2012. The improvement was driven by favorable working capital primarily related to inventory and payables. At quarter end we held $263 million in cash and cash equivalents. Also during the quarter we paid down $110 million in borrowings from our revolving line of credit reducing our debt to $3.3 billion. At quarter end we had $440 million drawn under $1.75 billion revolving credit facility. We intent to improve our credit profile through the remainder of the year by continuing to de-lever the balance sheet through repayments of the revolver borrowings.

Before I review each segments financials performance and outlook, I will remind you that we provided a full-year business segment revenue per ton guidance and related sensitivities to future in iron ore pricing in the outlook section of last nights earnings release. We will use the June year-to-date average iron ore price of $137 per ton as a proxy for our full-year average price. It's important for me to stress that this is not our internal iron ore price outlook for the year.

In the U.S. Iron Ore revenues per ton decreased to $110 from last years second quarter revenue of $120 per ton. The decrease was due to lower market pricing for iron ore the year-over-year increase in volume exported to seaborne customers which has lower realized pricing due to increased freight costs. Lower year-over-year hot-rolled steel pricing also contributed to decreased realized revenue rate in the second quarter of 2013.

Cash cost per ton increased to $68 from $63 in 2012 second quarter. The year-over-year increase was primarily driven by higher cost related to the planned temporary production curtailments at Cliffs' Northshore and Empire mines as well as increased energy costs. This was partially offset by lower employment-related expenses and maintenance and supplies spending. We are maintaining our 2013 cash cost per ton expectation in U.S. Iron Ore of $65 to $70 per ton.

In Eastern Canadian Iron Ore, revenue per ton decrease to $111 down 14% when compared to the prior-year’s second quarter. This was attributed to 11% year-over-year decrease in seaborne iron ore pricing. Also due to lack of pellet availability at Wabush, the segment sale’s mix was comprised of a higher proportion of iron ore concentrate which realizes a lower revenue rate due to lack of pellet premium. A more favorable freight rate of $26 per ton partially offset the year-over-year decrease in realized revenue per ton.

During the quarter Bloom Lake’s cash cost decreased 4% to $87 per ton which was due to improved production volumes in a resulting favorable impact on mine cost-per-ton rate as well as lower maintenance and contractor spending. Due to the increased mining cost, Joe discussed earlier, we are raising our cash cost per ton expectation at Bloom Lake by $5 to $90 to $95. Cash cost-per-ton at Wabush Mine was $200 up 51% from a year ago quarter primarily driven by unfavorable inventory adjustments totaling $55 per ton. Due to the fact these inventory adjustments would have been recognized later this year when the respective inventory was sold, we are maintaining our cash cost-per-ton expectation at Wabush Mine of $115 to $120. For the entire Eastern Canadian Iron Ore segment we expect the full-year cash cost to be $100 to $105 per ton up from our previous expectation primarily driven by Bloom Lake.

Turning to Asia Pacific Iron Ore, revenue decreased 7% to $109 per ton from $118 per ton primarily driven by lower market pricing partially offset by the absence of low-grade tons that we included in the 2012 second quarter. Cash cost increased 12% to $64 per ton compared with $57 per ton in the year ago quarter. The increase was due to the absence of the low-grade tons that were sold in last year’s second quarter which were produced at a lower cash cost rate. This was partially offset by the absence of cost from Cockatoo Island which was a higher cost mine. Due to favorable foreign exchange rates realized to date we are lowering our full-year cash cost per ton expectation for 2013 to $65 to $70 per ton from our previous expectation of $70 to $75 per ton.

In North American Coal segment revenue was $105 per ton down 13% from previous year results, primarily driven by lower year-over-year spot pricing for metallurgical coal. This was partially offset by favorably priced annual and carryover contracts as well as product mix that comprises of certain higher quality metallurgical coal products. Due to the pricing weakness in the metallurgical coal market, we are lowering our expected revenue per ton to $100 and $105 from our previous expectation of $110 to $115 per ton. Our North American Coal cash cost decreased 20% from last years second quarter to $88 from $111 per ton.

This quarter cash cost-per-ton benefited from improved fixed cost leverage from the increased sales volume, lower maintenance and spending and employment related expenses when compared to prior-year’s quarter. Even with the lower market pricing for coal we delivered positive cash margin and positive sales margin which included $14 per ton of DVA in the quarter. Due to the operating teams outstanding performance we are lower our expected full-year cash cost by $5 per ton to $90 to $95. Included in our lower cash cost expectation is a longwall move at Oak Grove Mine scheduled for the end of the third quarter.

Now turning to our revised full-year CapEx budget. As Joe indicated in his Bloom Lake remarks we are increasing our 2013 CapEx budget by approximately $200 million to a total of approximately $1 billion for the full-year. The increase in spending is primarily related to additional tailings in water management work required at Bloom Lake. We intend to fund the increase from available liquidity and borrowing arrangements. This will likely include lease financing which is expected to be at a low interest rate and neutral debt level profile. For 2013 our full-year effective tax rate is expected to be 2% and we are maintaining our depreciation, depletion and amortization expense of approximately $565 million.

Turning to our overhead expenses; we are lowering our expected full-year SG&A expense outlook to approximately $215 million from $230 million driven by our overall focus on improving the cost structure of the business. We are also lowering our expected exploration expense by $10 million, this is primarily driven by our previously announced delay in the chromite projects environmental assessment activities. Our revised full-year exploration expense is expected to be approximately $75 million; this is comprised of approximately $25 million related to exploration and $50 million related to the chromite project.

Overall the business results for the quarter were good, a large part driven by our operating performance. Looking ahead its part of our initiative we would be more financially flexible, we will continue to aggressively focus on ways to reduce our overall cost profile. We have some key decisions to make over the next few months as we work to ensure the incoming CEO can hit the ground running. We look forward to updating you on our progress later this year.

With that Jess, I think we’re ready to open the call for questions.

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) Our first question comes from the line of Michael Gambardella from JPMorgan. Your question please.

Michael Gambardella – JPMorgan Securities

Yes, good morning.

Terrance Paradie

Hi, Mike.

Michael Gambardella – JPMorgan Securities

I just want to know, you’ve had some good results in the quarter on working capital reductions; how much more do you have in the pipeline?

Joseph A. Carrabba

Well we’ve got quite a few programs Mike, just like everybody else has with that. We are really just beginning on the SG&A. We’ve got a very structured program to go back through and look at not only headquarters, but also look out in the regions as well and see where we can combine some of that work. So we are -- again we’re just in the early stages of our SG&A work, so we see we’re going to make more strives there. Exploration I would think we’re pretty much finished with the year, a lot of that is just to wrap up with the drilling, a lot of the near mine drilling that we have from there. And I think also the $50 million has been slated for the completion of the feasibility study and the optionality of the FerroChrome’s is pretty much there, but I still think there’s some good ways to go in the SG&A.

Terrance Paradie

And Mike, from a working capital standpoint I think again we’re going to continue to focus in on reducing our working capital primarily related to the inventory and supply inventories at the sites.

Michael Gambardella - JPMorgan Securities

Okay. Last question. Can you give us any details on this new Essar contract extension beyond 2016?

Joseph A. Carrabba

Sorry, Mike, as much as I know the industry and the analysts are looking for that kind of information. We do hold that confidential with all of our customers and we're delighted with the customer, we're delighted with the extension of the customer, particularly on a contract that we thought would end at 2016. And obviously we think it's favorable to ourselves, but more importantly it was fair to both parties and we continue to deliver a quality product to Essar.

Michael Gambardella - JPMorgan Securities

Thanks, Joe.

Operator

Thank you. Our next question comes from the line of Sal Tharani from Goldman Sachs. Your question please.

Sal Tharani - Goldman Sachs & Co.

Good morning.

Joseph A. Carrabba

Morning.

Terrance Paradie

Morning.

Sal Tharani - Goldman Sachs & Co.

I'm still struggling with your CapEx guidance. I thought that when you took the – postpone the phase two, you reduced it a couple of $100 million and then now we back to 1 billion, but we still are talking about phase two concentrator and tailing postponed. So is this the additional stuff you found out while you were working on the project that you need to do even though you have still postponed the concentrator and the tailings for the second phase?

Joseph A. Carrabba

It's a little bit of everything that you've talked about, Sal, in there. I think we've been a bit consistent with the conversations that we've had that as we build the tailings bond and as we expand the stripping and the Western Pit, those are all being build in mine for the potential of a phase two expansion, it would be kind of silly to build that at a phase one level and then have to go back and re-modify it from there. On the tailings side and the enhancement of tailings, as you know, we did get some different water management regulations that came in which increased the expenses of the water management system but also this is more of just the refinement of our CapEx, the definitive capital was we continue to get into the property. We thought it was appropriate to go ahead and expand and spend the money this year in that tailings bond in light if we did have an unusual storm event in particular in the spring. And that will allow us and the Board to make the decision in the future. If they choose to, if the market conditions are right and there's a good IRR on the remaining portion of that capital to go forward. So, the tailings expansion is more dependant with engineering but its still [irregardless] sets us up for phase two if the Board chooses to approve the decision.

Sal Tharani - Goldman Sachs & Co.

Okay. And the last question on Wabush, you had mentioned in the past that if Wabush doesn't breakeven by the end of this year, you may consider some alternatives and I was wondering if that is still on the plate because it doesn't look like that Wabush cost is getting any better compared to where this iron ore prices are?

Joseph A. Carrabba

Absolutely. We're being consistent with the message through the year. The management team and our workforce up there knows and by the way we're all pulling together on this and the targets they have is to be below the $100 a ton mark in the fourth quarter with that. As we said through, we did schedule the Point Noire. We successfully scheduled that down, had a lot of redundant folks that came out of that at Point Noire. We've got enough material to go ahead and fulfill our customer contracts. And I'm very pleased to think that after over 50 years of operating the pellet plants that our commercial guys in these tough markets are finding a home for this product. I mean you have to remember this is a relatively low silica, so it has a bit of a high magnesium – thanks, I always forget that term. But the low silica is finding its way into the marketplace as well. So I think when you back out the exceptional items that were discussed in the press release last night, we are going to shrink the footprint from six mills to five mills and the mine footprint as well. The guys have got a good fighting chance in it and now they've got six months to really operate in the method of concentrate-only after the pellet plants have been shut.

Sal Tharani - Goldman Sachs & Co.

Great. Thank you very much.

Operator

Thank you. Our next question comes from the line of Mitesh Thakkar from FBR Capital Markets. Your question please.

Mitesh Thakkar - Friedman, Billings, Ramsey & Co., Inc.

Good morning, gentlemen.

Joseph A. Carrabba

Morning.

Mitesh Thakkar - Friedman, Billings, Ramsey & Co., Inc.

Congratulations on the quarter.

Joseph A. Carrabba

Thank you.

Terrance Paradie

Thank you.

Mitesh Thakkar - Friedman, Billings, Ramsey & Co., Inc.

Just a question about the Essar contract without getting into specifics, can you help us understand what would be the [price] overall on your portfolio for 2014 versus 2013 without any change in iron ore price?

Jessica Moran

Hi, Mitesh. You kind of broke up a little bit. Can you repeat your question, please?

Mitesh Thakkar - Friedman, Billings, Ramsey & Co., Inc.

Yeah, I'm sorry. So without getting into the details of the Essar contract, can you help us – how should we think about 2014 pricing versus 2013 pricing if there is no change in iron ore price?

Terrance Paradie

Well, I don't think we ever commented that there would not be a change in iron ore prices. With all of our pricing mechanisms throughout all of our contracts, and Essar is no different, it all has unique features on lead and lag, it's got some world pricing components in it. It's got the CPI index as it goes in and out. So, the pricing will continue to move as well as the elements within the contract. So, the pricing will move and it will move within the designated piece of that move around in that contract.

Joseph A. Carrabba

Yeah. Mitesh, as you know because of the way we have those contracts structured, it makes us less sensitive to all the price changes during each quarter and the year.

Mitesh Thakkar - Friedman, Billings, Ramsey & Co., Inc.

Okay. And this will not allow that sensitivity to go higher; it would probably be the similar sensitivity?

Joseph A. Carrabba

Yeah, that number should be similar.

Mitesh Thakkar - Friedman, Billings, Ramsey & Co., Inc.

Okay. And just one follow-up question. When you think about your Australian costs, obviously a very good job there, how much of that was a currency-related tailwinds and how much of that was productivity and how much of that is sustainable? Can we sustain cost at these line of levels for next couple of years are – of course I understand that if iron ore prices go higher, inflation will walk into it but just all else equal?

Terrance Paradie

Yeah, the currency change in Australia has just occurred, if you will, I would say even within the quarter to see those drops, so there's not a lot of currency fluctuation in this quarter. Certainly if it holds up, it will have a different effect on the cost that they go in Australia. We did hit the higher stripping ratios last year that we talked about that we think we can maintain or even lower. So that was the big bump up in the costs from a year ago and we think we've also got the great stabilize now into the 60% to 60.5% Fe as well and we don't see further decline at this point coming out of the deposits. It won't be to 62.5 that we delivered in the past and I think we discussed that in our previous calls and on our tours with the analysts, but we think we can sustain with inside of inflation the costs that you currently see through the remaining life of the mine.

Mitesh Thakkar - Friedman, Billings, Ramsey & Co., Inc.

Great. Thank you very much, guys.

Terrance Paradie

Thank you.

Operator

Thank you. Our next question comes from the line of Brian Yu from Citi. Your question please.

Brian Hsien Yu - Citigroup Global Markets Inc.

Yeah, thanks and congrats on a good quarter too.

Joseph A. Carrabba

Thank you.

Brian Hsien Yu - Citigroup Global Markets Inc.

My first question is with the West Pit, you talked about ore availability. Could you elaborate on that a little bit more in terms of is this access to the West Pit hematite or are you seeing variability in that section of it too?

Joseph A. Carrabba

We are seeing a little more variability in that section than we saw. I mean the good news is it's a much more friable than it goes through, so it crushes very well and the mill throughput works very well with it. But on the other nuances of the chemistry in the iron, it is a little more variable than we had anticipated when we went into it and that's why we need to strip a little more. Even in the West Pit we've got to get a couple more open spaces so that we can blend even the West Pit in with the other two pits. So, we're working our way through it. We're giving ourselves as much optionality in those pits with open places for blending as we run into it and we're still learning through all the modeling and now putting it through the mill as to which characteristics work best.

Brian Hsien Yu - Citigroup Global Markets Inc.

Yeah, okay. And is it fair to assume that until that you get this ore variability under control or resolve that and that phase two is the concentrator is unlikely to proceed?

Joseph A. Carrabba

No, I wouldn't say that at all. I would think – again our teams are very confident they're going to get this ore variability under control. That's what we do. I mean these ore grades in this pit are no more complex than the pits we have in Michigan or Minnesota or certainly the blending challenges we have in Western Australia if you've ever seen that operation, it just takes some time to work out. I think more of the phase two type of decision will be more on the marketplace and where we think it is where we think future pricing will be when we do the outlook and then the overall IRR that's left – with some capital left on the project. So I would put it lesser on debt and I would put it more on the external environment in the marketplace.

Brian Hsien Yu - Citigroup Global Markets Inc.

Okay. That’s helpful. Thanks.

Operator

Thank you. Our next question comes from the line of Timna Tanners from Bank of America. Your question please.

Timna Tanners - Bank of America Merrill Lynch

Hi. Thank you. I know it’s been a long weekend, maybe these are dense questions, but I just wanted to know in terms of the additional CapEx, how much if any additional volume might come from that and how much is left to decide on Phase 2 for the completion of the project, how much is up in the air?

Joseph A. Carrabba

Well, as we said Timna, with this whole – the increased hitting in additional volume this year on the outlook that we just gave where we’ve lowered the volume that goes with it. We think that’s the right place to be. We don’t anticipate an uptick obviously or we’d change the outlook. Again it’s more just getting that stripping well ahead of us on the cash side, so that we can get the product go out of the mine and goes with it from there. I think the – in round numbers the finishing of the concentrator and the load out are around $450 million or so to finish that segment up if again we decided to go forward with the completion of Phase 2.

Timna Tanners - Bank of America Merrill Lynch

Okay. And then as a follow-up, Terry in his final comments was making the point that there is a lot of decisions to come in the next couple of months; so I was wondering if you could describe for us what those balls are up in the air and how to think about the decisions? Will they be primarily about the market view and about priorities? I know again with the change in management that they will not be decisions of the current management team, but what are those balls in the air and what do you think will be the deciding factors? Thanks.

Joseph A. Carrabba

Well, I think certainly the market, we all continue to assess that as we could too and make sure we have operating plans and contingency plans in place for if pricing is to go into consensus where the analysts are that are putting the reports out to go with it. Balls in the air, certainly Phase 2 as you just mentioned from there, the Wabush decision based on the operating strategy and the implementation that goes with it. We certainly have the FerroChrome decisions after we finish the feasibility, and once we work through our governmental issues with both road funding and power supply that goes with that and getting the MOU that goes with it. And on the upside of it is certainly the DR type of work that we continue to talk about, about Northshore. We continue to be in early stage conversations with a number of potential folks to supply for DR, and that continues on with the natural gas. And I think those are some decisions we will need to – hopefully we’ll need to make on the very upside on DR production in the remaining part of this year.

Timna Tanners - Bank of America Merrill Lynch

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Evan Kurtz from Morgan Stanley. Your question please.

Evan Kurtz - Morgan Stanley

Hi. Good morning, everyone.

Joseph A. Carrabba

Good morning.

Jessica Moran

Good morning.

Evan Kurtz - Morgan Stanley

I just wanted to get some color on how currency might have helped you out in Australia this quarter, if you could break that out as far as cost declines and just maybe an update on your hedging position for the Australian dollar?

Terrance Paradie

Yes, so from the way we’re looking at it for the quarter and year-to-date essentially with maybe a couple of dollar benefit in the cost structure. The way I will look at it going forward from a hedging standpoint is we do have an active hedging policy where we will take a certain portion of our costs and hedge the currency. But from a sensitivity standpoint, I kind of look at in our plan going forward we essentially have the currency for Australian dollar and U.S. dollar at parity. So any sort of percentage change after that sensitivity would be probably $0.50 to $0.75 on a per ton basis going forward for rest of year.

Evan Kurtz - Morgan Stanley

Great. That’s helpful. Thanks. And then maybe just a question on CapEx; could you maybe just -- I know you’re probably not ready to give 2014 guidance, but just talk about some of the big moving pieces to think about for next year on CapEx, with this incremental $200 million being spend at Bloom Lake this year on tailings, is that the entire cost of the tailings project or is some of that going to bleed into next year and may be some of the other pieces there? Thanks.

Joseph A. Carrabba

It will continue to bleed in the sustaining capital portion of Bloom Lake, it’ll probably run at about $200 million a year and that will probably be over a time period of the next five years. I would suspect sustaining capital will probably run more in the $500 million range in the future when you put that $200 million into what we typically run in a sustaining capital range, an area that goes from there. So the big kicker on the rest of the capital outside of sustaining is really around Phase 2.

We don’t have any other expansion plans the best point in time. The early indicators on Northshore if we were to go into a DRI, a conversion number one is the building of a DRI facility with these several years out before we would even think about spending the capital. There’s no reason to convert in 2014, I wouldn’t think it would be a nice thing to do if we could, but the capital is pretty the minimus that we see right now at Northshore. So, not a lot of growth capital out there, other than the opportunity of Phase 2 if that were to come over the top of the sustaining capital.

Evan Kurtz - Morgan Stanley

Great. Thanks for taking my question.

Operator

Thank you. Our next question comes from the line of Curt Woodworth from Nomura. Your question please.

Curt Woodworth - Nomura

Yes, hi, good morning everyone.

Terrance Paradie

Good morning.

Joseph A. Carrabba

Good morning.

Curt Woodworth - Nomura

I just had a question more on the Bloom Lake cash cost progression. Joe, I know that earlier in this year you had talked about $15 per ton headwind from deep ripping water management and some other activities and it seemed like part of the ability to get that headwind down was leveraging Phase 2. So, I guess my question is, is if the – to kind of keep it at the current 7 million ton target, what do you think the normal headwind or cash cost estimate should look like going forward in the next year?

Joseph A. Carrabba

So, Curt I think we talked in the past with 7 million ton just Phase 1 that we would be looking at a range of $70 to $75 cash cost. I think with, what we are looking at now we’re probably going to have to increase that a little bit probably to the mid 70’s versus the $70 to $75 based on so what we expect from a performance standpoint in that now.

Jessica Moran

But that would only be Terry, if we’re at lower volumes, but today’s volumes are like 6 million tons, $70 to $75 is still intact …

Joseph A. Carrabba

6 to 7 million tons, right.

Jessica Moran

So, no change from that, Curt.

Curt Woodworth - Nomura

So in terms of taking the cost guidance up right now versus what you think is going to happen next year; what are the current moving pieces that would get you down to that $75 level for next year?

Joseph A. Carrabba

Well the biggest part was again, we increased the stripping once again just to get further ahead of it. So that is the moving piece to bring it down, and the guys continue to manage the contractors better and get those moving parts out of the way. The overland conveyor, the ore-barn and the in-pit crusher when that comes on in the very last part of the year we’ll cut down on trucking and cut some haulage cost down as it comes from there and again looked even with the tailing facility we’ll do a lot more pumping and be more efficient than we were with trucking. So there’s two or three pieces that will fundamentally bring that down and of course when we get rid of the excess stripping go to a normal strip rate that will combine also to bring the cost-per-ton down.

Curt Woodworth - Nomura

And then, are there any other kind of additional costs for either Phase 2 or other issues that would cause the kind of aggregate number to be higher than that for the Bloom Lake segment next year?

Joseph A. Carrabba

Non that we see, I mean the concentrator is at about a 65% completion rate, the load out is identical to the one that’s on Phase 1, and it does not have to be put in sequence to start the concentrator up. It can be blended in as it ramps up from there. And the new ship loader is intact to come on in 2014 as well which will lower demurrage as we can improve our -- both the weight of what we can put on the vessel as well as our loading times.

Jessica Moran

There might be just some spikes in cash cost in a particular quarter it's just related to ramp up, volume obviously the first quarter you start, you’re not pretty using your targeted run rate of 1.8 million tons a quarter. So there could be a little spike related to that.

Joseph A. Carrabba

Yeah, and I think also the stripping ratio is going to be higher than the life of the mine, next year it's going to roll into next year for a period as well.

Curt Woodworth - Nomura

Okay. And what's the expectation on getting to the targeted volume level time wise?

Joseph A. Carrabba

Well, we’re looking at evaluating that, the ramp up of Phase 2 and we’ll let you guys know on the future quarters as we kind of look through those strategic priorities right now.

Curt Woodworth - Nomura

Okay. Thanks a lot.

Operator

Thank you. Our next question comes from the line of Jason Brocious from KeyBanc Capital Markets. Your question please.

Jason Brocious - KeyBanc Capital Markets

Hi. Good morning, guys.

Joseph A. Carrabba

Good morning.

Jason Brocious - KeyBanc Capital Markets

I just wanted a little clarity around the sustaining CapEx comment you made, Joe. So regardless of any decision to go forward on phase two, it's now expected that sustaining capital would be at the $500 million level?

Joseph A. Carrabba

I think that's a range for 2014. Again, as the previous caller asked if – again, we're just beginning our planning into the new year with that and that number will get refined as well. So I wouldn't just check it off, if you will. I'm trying to give you as sensible a range as I possibly can. Obviously the management team is going to work everything within their power to continue to lower even sustaining capital. But if you want a benchmark to start with, that's what I would use. There would be a lot of discussions between now and year end before the Board signs off and finalizes our capital plan, but that's a good range that you could use to get started with.

Jason Brocious - KeyBanc Capital Markets

Okay, all right. And any update you can give on the – I know last quarter you talked about a proposed extraction tax in Québec and I was wondering if you can give any update on that?

Terrance Paradie

Yeah, that extraction, they call it Québec mining tax is – it's been implemented but it has not been enacted yet. We think the impact to us is going to be pretty minimal, clearly immaterial to us going forward based on how we understand it's going to work.

Jason Brocious - KeyBanc Capital Markets

Okay, so it's no longer 5% of revenue type arrangement?

Terrance Paradie

No, it's a percentage off of the profits at the mine, so you get the – your expenses, depreciation essentially becomes a pretty de minimis tax for us.

Jason Brocious - KeyBanc Capital Markets

Okay, all right. And then just a couple modeling questions too. Could you give us just the cost of freight from Eastern Canada to China during the quarter and then also to Europe, just to get a handle on what those levels were?

Terrance Paradie

The cost to China was around $26 and to Europe was…

Jessica Moran

Probably in the range of $12 to $15…

Terrance Paradie

$12 to $15.

Jason Brocious - KeyBanc Capital Markets

Okay, all right. And what does that compare to last year at this time, 2Q '12?

Jessica Moran

Last year it was on 28 – I think it was $28. I think our 12 months trailing, Jason, is on Eastern Canada, so China – north China's around $28, $29.

Joseph A. Carrabba

Yeah. We'd like that $30 kind of what I recall.

Jason Brocious - KeyBanc Capital Markets

Okay, all right. And then to Europe, it's generally stable at 12 to 15 over time?

Jessica Moran

Yeah, it's pretty stable in Europe.

Jason Brocious - KeyBanc Capital Markets

Okay, great. Well, thank you very much, guys.

Joseph A. Carrabba

Thank you.

Operator

Thank you. Our next question comes from the line of Luke MacFarlane from Macquarie. Your question please.

Luke MacFarlane - Macquarie

Hi, guys. How are you?

Joseph A. Carrabba

Hi there.

Luke MacFarlane - Macquarie

Hi. So, I just wondering can you talk about the level of contract liability that you've got at Bloom Lake currently? And then how that will change in the second half as you ramp-up these additional works?

Joseph A. Carrabba

I'm sorry; I don't have numbers for you, Luke. As they go forward from there, I can tell you we – again, when we made the decision to delay Bloom Lake, obviously we pulled a lot of those contractors out and we continue to bring more of our own workforce in to do the different parts of the work as you would in any new facility. But I don't have any numbers for you.

Terrance Paradie

Yeah, Luke, but I can tell you though that we're actually very focused in on a number of contracts what they're working on to continue to make sure that they're working efficiently and effectively. So we've taken real dollars out of the cost profile as a result of that improved process, if you will.

Luke MacFarlane - Macquarie

Sure, but in general, do you think – you obviously expect that to go up in the back half? I'm not eyeing a specific number, but I mean you think it will increase as opposed to being out or bring your own people in?

Joseph A. Carrabba

No, I don't think outside of our guidance. I think it will stay right within the guidance and what we gave with the increase in the guidance in Bloom.

Luke MacFarlane - Macquarie

Sure. Okay, cool. And then just another question on your coal business. Are you exporting any of that? And if so, how much and what percentage of met and high vol are you exporting?

Joseph A. Carrabba

So we generally – rule of thumb we export about 50-50, 50% domestically and for the most part we stay in the Atlantic Basin. Europe is the biggest export market. We do, do a little bit to South America. But our primary export market is Europe. I don't think we've done any boats to China this year. We did a couple last year but none to China this year. It's just not favorable for us and we're able to sell in our domestic market. Again, the mix on the high vol, we just don't have that much of it. I couldn't give you percentages of high vol to low vol, but I would expect most of the tonnage because Oak Grove is all – almost all exported and low vol that the majority of the material would be low vol going to the export market.

Luke MacFarlane - Macquarie

And then lastly if I can, what sort of impact would be the abolishment of the Australian, natural resources tax down there to with your Australian operation?

Terrance Paradie

It’s been very little impact to us so far. I could tell you that we’ve had very little MRRT tax paid this year or even accrued from that standpoint, a couple of million bucks at the more or so, that with the – sort of the opening value of that, that we’ve a quite a few allowances that we don’t we think – we don’t expect to pay any of that tax in the near-term.

Luke MacFarlane - Macquarie

Okay, great. Thanks.

Operator

Thank you. Our next question comes from the line of Jorge Beristain from Deutsche Bank. Your question please.

Jorge Beristain - Deutsche Bank

Hi guys. Jorge with Deutsche Bank. Sorry, I joined a bit late. But my question Joe, if you could kind of give us any guidance as to the 2014 volume outlook for the U.S. legacy operations where of some potential mine shutdowns and I just wanted to know if you could kind of give us a ballpark if we’re looking at maybe 2 million tons of attrition into 2014?

Joseph A. Carrabba

We are just not there yet. We haven’t given any guidance Jorge. Unfortunately, sorry about that, but as nominations come in, which is much later in the year partnership meetings take place. I mean, there is a design formula that goes with 2014. We’re just not prepared to give the guidance yet.

Jorge Beristain - Deutsche Bank

Okay. But the Empire Mine, when is that slated to close?

Joseph A. Carrabba

It’s slated at the end of ’14. So it will have another production year, next year and again as you know our partner in that, the minority partners ArcelorMittal, so we will work through the remaining life of that mine on scheduling the tonnage just like we did this year. We said, we expect to restart Empire, the middle of this quarter and probably run it through the year and if their demand keeps up, we will just keep it running. But in this last year of going into the production, we will have to work with the scheduling of it with Arcelor.

Jorge Beristain - Deutsche Bank

Okay. And just in terms of a kind of top level question. How should we think about your portfolio management going forward? You’ve had some non-performing assets, such as in the coal business for some time and clearly you’ve a high net debt load now. What’s the thought process at the Board in terms of how Cliffs is going to look going forward? Do they want to maintain the current portfolio that you have of coal and iron ore or is there some thought process to streamline the Company back to your core iron ore competencies?

Joseph A. Carrabba

I think we’re constantly and in conjunction with the Board. Management is constantly looking at scenarios based on the future of the marketplace and what it looks like and where pricing estimates go with as well as operating parameters go in. And as you know, I don’t think anything is off the table. We try and keep a very open mind around this Company and the most effective way possibly we can for the shareholders as it goes forward. But I don’t think there is anything that’s been cast in stone and I don’t think anybody wants to roll us back to just a North American Iron Ore operation either Jorge, but we’re constantly looking at our operations and the future as well to see what’s the appropriate thing to do.

Jorge Beristain - Deutsche Bank

Okay, great. Thanks, Joe.

Jessica Moran

Jonathan, we think we have time for one last call or question.

Operator

Certainly. Our final question comes from the line of Tony Rizzuto from Cowen and Company. Your question please.

Tony Rizzuto - Cowen and Company

Hi to everybody.

Joseph A. Carrabba

Hi. Good morning, Tony.

Tony Rizzuto - Cowen and Company

Just a couple of questions, and thanks so much for all the color today. I just want to find out where your strip ratios are today and where are they likely to be in 2014 and what are your targeted levels at Bloom Lake? And then I have a follow-up question too.

Jessica Moran

Yeah, I think I can take you through that detail offline Tony.

Tony Rizzuto - Cowen and Company

Thank you, Jessica. All right, offline?

Joseph A. Carrabba

Yes.

Jessica Moran

Yeah, I will take you – yeah.

Tony Rizzuto - Cowen and Company

All right. Thanks for that. Then the other question I had is that Quebec mining tax is there a sliding scale, typically these taxes do have some variable nature relative to the commodity prices. Is that part of that too?

Terrance Paradie

Yeah. It’s a little bit. There is actually – there is two calculations we do, and I won’t get into the detail, I guess we can get in the detail offline, but there is two calculations and you take the greater of, and it’s based on your profits at the mine that which will be impacted by pricing of course.

Joseph A. Carrabba

I think like all these factors Tony there, none of them are simple. There is some complicated language in the computations that Terry is talking about and since we’re just into it, it hasn’t even quite been implemented yet. We’re still working through those details, but sure just would be happy to give you the color around that as well.

Tony Rizzuto - Cowen and Company

All right. I just wanted to – I think on the stripping, you guys have previously talked about that the stripping, the higher stripping has added pretty significantly your costs and I think the number you’ve used in the past I think may be its been about $10 to $15 a ton, is that correct.

Joseph A. Carrabba

That’s correct, yes.

Tony Rizzuto - Cowen and Company

Okay. All right. Thanks very much.

Joseph A. Carrabba

Okay. Thanks.

Jessica Moran

Thank you everybody for joining us for today’s call. As always, I’ll be available throughout the day for any follow-up questions that you may have.

Joseph A. Carrabba

Thank you.

Operator

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day

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Source: Cliffs Natural Resources Inc (CLF) CEO Discusses Q2 2013 Results - Earnings Call Transcript

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