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Cliffs Natural Resources Inc. (NYSE:CLF)

Q3 2009 Earnings Call

October 30, 2009 10:00 am ET

Executives

Steve Baisden - IR

Joseph Carrabba - Chairman, President and CEO

Laurie Brlas - EVP and CFO

Analysts

Michael Gambardella - JPMorgan

Kuni Chen - Bank of America-Merrill Lynch

David MacGregor - Longbow Research

Mark Liinamaa - Morgan Stanley

Jorge Beristain - Deutsche Bank

Mark Parr - KeyBanc Capital Markets

Tim Hayes - Davenport & Co

Brian Yu - Citi

Mitesh Thakar - FBR Capital Markets

Wayne Atwell - Casimir Capital

Operator

I would like to welcome everyone to Cliffs Natural Resources 2009 Third Quarter and Nine Months Conference Call.

At this time I would like to introduce Mr. Steve Baisden, Director of Investor Relations and Corporate Communications. Thank you, Mr. Baisden, you may now begin.

Steve Baisden

Before we get started, let me remind you that certain comments made on today's call will include predictive statements that are intended to be made as forward-looking within the safe harbor protections of the Private Securities Litigation Reform Act of 1995. Although the Company believes that its forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially. Important factors that could cause results to differ materially are set forth in reports on Forms 10-K and 10-Q and news releases filed with the SEC which are available on our website.

Today's conference call is also available and being broadcast at cliffsnaturalresources.com. At the conclusion of the call, it will be archived on the website 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 Brlas. At this time, I will turn the call over to Joe for his prepared remarks.

Joseph Carrabba

Thanks, Steve and thanks to everyone for joining us today. The early signs of stabilization we discussed in our last call were further validated during the third quarter. As we stated back in July, our view that the first half of 2009 marked the low point in steel production has been reinforced as we realized notable improvements in our operations and business outlook across the board during the third quarter. Highlights during the quarter included a swing to operating income of $81 million in the quarter, compared with operating losses in each of the first two quarters. The generation of nearly $155 million in cash and nearly 6 million tons of iron ore shipped from our North American business and just is important the most iron ore tonnage shipped by our Asia Pacific business in any prior quarter, which is helping us close in on a new annual record of roughly 8.5 million tons.

Our view of long-term megatrends in the global steel making industry has always been positive. However, we have also recognized that we operate in a cyclical market. As a result, how our operating teams manage through the (inaudible) of the business cycle is crucial for Cliffs' decisive actions taken during the initial phase of the recession directly contributed to our operating results this quarter and to improvements in our balance sheet and cash flows.

As a consequence, we believe we are well positioned for what now appears to be the early stage of an industry recovery.

According to published reports between January and August 2009, global steel output was 760 million tons, 18% below the same period in 2008. Chinese production which now accounts for 49% of global production increased 5% to 370 million tons and reached a record 52 million tons in August. Global production, excluding China, declined 32% during the first eight months of this year but in August saw some improvement, coming in at 54 million tons, the highest level since October of 2008.

The industry's cautious optimism is reflected in rising steel production rates in all major areas, and has led to our increasing guidance for both iron ore and met coal volumes from our North American businesses. In Cliffs' North American iron ore segment, the improving scenario has positively impacted our operations.

Recently, capacity utilization at North American steel-making facilities reached approximately 63% from 35% at the beginning of the year. As we wrap up the year, North Shore's two largest furnaces will be operational. Empire continues to produce and Tilden and United Taconite will be running at full capacity.

We began ramping up the idle Line-1 furnace at UTAC in the third quarter after a nine-month shutdown, and the hourly workforce who had been maintaining a shortened schedule returned to a full 40 hour work week. The outstanding cooperative effort between management and the union enabled United Taconite to operate safely and efficiently with no reduction in staff during this difficult period.

While clearly we are seeing an improved environment in our business; there continues to be questions around the stability and pace of the recoveries in North America and Europe. As such we will monitor the markets closely and continue to align production with demand.

During this downturn, Cliffs' long-term sales agreements with US based integrated steel producers have helped to mitigate price declines. Combined, our North American iron ore operations achieved $90 million in positive sales margin for the quarter. While those who have settled benchmark prices for pellets in 2009 are down 48%, primarily because of our formula based pricing in North America, we expect only a modest decline of 14% to 19% in our average revenue per ton.

In other actions, just after quarter ended, Cliffs’ announced its intention to acquire full ownership of the Wabush Mines joint venture by exercising the company's right of first refusal to buy our partner's 73.2% interest. This [built-on] acquisition is consistent with our strategy to increase our exposure to steel-making markets outside of North America. The $88 million cash deal which remains subject to regulatory approvals carries no integration risk and is expected to provide approximately 4 million tons of incremental pellet capacity and more than 50 million tons of additional reserves. Wabush Mines has produced an average of 4.6 million tons annually over the past 10 years. Also, because the port at (inaudible) can accommodate most [capsized] vessels, these tons can be a 100% exportable to the seaborne market.

Cliffs has been the managing partner of Wabush since its inception and because of our long involvement we are uniquely positioned to benefit from opportunities of the operation. While overall investors have been extremely enthusiastic and complimentary about the transaction, I want to take a moment to address some of the misconceptions about Wabush in the marketplace.

Because of the mining operation's proximity to several lakes, water infiltration has been an ongoing challenge to some mining areas. To address this challenge, we continue as we always have as the operator our successful dewatering efforts of the pit. I have also read some reports that comment about manganese levels in the Wabush pellets and the impact this has on pricing for our product. In the seabourne market, the manganese content is of little operating consequence from the viewpoint of our customers around the world.

We are also exploring a project that would introduce some manganese reduction circuit to our process flowchart that would lower the manganese content. This would have two benefits; it would allow the production from additional areas of the mine while at the same time extending the life of the mine. The ability to consider a project such as this is an example of one of the benefits of being a 100% owner, compared to the joint venture partner structure which includes capital committees and differing objectives for the asset.

Turning to Cliffs' North American coal business, while the comparable sales margin loss for the third quarter increased slightly year-over-year, it continued to improve sequentially to a loss of $15.5 million for the third quarter versus respective losses of $28.8 million and $19.1 million in the first and second quarters of 2009. This also occurred despite year-over-year volume declines of 62% for the quarter. While sales volumes were deeply impacted by the past year's challenging environment, the outlook for 2010 is improving.

It's also important to understand the difference between the North American and European markets compared with Asian markets. In North America and Europe, we still have high coke inventory levels. As a result, hot idling of batteries continue in these markets. As the US and Europe (inaudible) idle capacity, we expect these inventories will continue to be worked off throughout 2010, resulting in a more gradual return of our coal volumes as we have seen in the iron ore.

In contrast, increases in seabourne trade to metallurgical coal continue. We have shipped one vessel of Pinnacle coal to a long standing Asian customer and will load another ship next month. These are direct sales and intended to be test trials to certify our Central App coal with these customers.

Should the markets tighten in 2010 and prove opportunistic for Central App producers, these trials will allow us to participate directly. As many of you have undoubtedly seen, some reports are indicating that China could import 30 million tons of metallurgical coal this year, more than 10 times the level of 2008. This translates to more than 10% of the current seabourne trade for met coal and is expected to result in a further tightening of supply to other geographies.

Cliffs' Asia-Pacific iron ore segment continued its very strong performance during the quarter and is on track to achieve record sales volume for the year. This impressive execution provides additional rationale for our long-term diversification strategy. The demand outlook in the Pacific region remains favorable with China importing nearly 65 million tons of iron ore in September alone, up 65% year-over-year, and 30% sequentially to new record levels according to one of the country's own statistics services.

In Asia-Pacific, iron ore, we continue to sell under provisional pricing to customers in China consistent with the 2009 settlements where lump and fines reached between producers of other Asian-based consumers. Looking at developments at Sonoma Coal and the Amapa iron ore projects, sales volume for our 45% economic interest in Sonoma for the third quarter 2009 was 304,000 tons versus 327,000 tons a year ago, with production currently favoring thermal coal to met coal at about a 70:30 split respectively, and higher than expected.

During the third quarter, production at Amapa was approximately 425,000 tons. Equity loss for the quarter was approximately $20 million and is expected to total $70 million to $75 million for the full year. We continue to work with our project partner, Anglo-American to improve Amapa's performance, and have looked at numerous scenarios. We’ll keep you updated on developments as we move forward.

Now, I’ll turn the call over to Laurie who’ll provide a financial review of the third quarter and nine months, as well as additional details on our operations and outlook. Then we will open the floor up for questions. Laurie?

Laurie Brlas

Consolidated revenues for the quarter were down 44% to $666 million from the all-time record quarterly level of $1.2 billion last year. Operating income improved to $81 million from the negative level recorded in the first half of 2009, but was still well below the $339 million generated last year.

Diluted earnings per share were $0.45 compared with $1.61 in last year's third quarter. Lower price realizations around the world and the reduced sales volumes in North America, both for iron ore and met coal, were at the root of the revenue and earnings declines.

We realized a 32% reduction in SG&A for the quarter and 40% year-to-date, as a result of stringent cost controls and lower employment costs. You’ll note that included in our year-to-date net income is an income tax benefit of $14.6 million. This is reflective of our current year operating tax expense rate of 24%, offset by income from discrete items of $48 million. These discrete items represent tax planning initiatives focused on maximizing our deductions for percentage depletion, and optimizing the use of foreign tax credits.

Now, turning to the business segments. We are extremely proud of the performance of our commercial and operating teams delivered in North American iron ore for the quarter, particularly considering in the first eight months of this year, US crude steel production was down approximately 49% versus a year ago.

Sales volume in the segment was 5.5 million tons, down 31% from last year, but an increase of 140% sequentially from the second quarter. This strong performance was driven by blast furnaces coming back online faster than we had expected earlier in the year. Today, 25 of the 39 furnaces in North America have either been brought online or are anticipated to be operational in the near future. This compares with the 14 furnaces online at the bottom of the cycle earlier this year.

While cost of goods sold per ton was up slightly year-over-year, this was exclusively on non-cash expenses. Cash cost per ton was $58.50, virtually flat with the third quarter last year. This is due to lowering fixed costs, the impact of our increasing volume expectations and the leverage the additional volume provides. This also allowed the business to generate $90 million in sales margin in the quarter.

In North American coal, we have restarted development efforts at both the Pinnacle and Oak Grove facilities to prepare our mines to produce 3 million tons next year and greater volume beyond that. Both mining complexes are now running five days a week with three shifts a day. Sales volume in the quarter was 343,000 tons, down significantly from last year. Despite this much lower volume compared to last year, the sales margin loss was $15.5 million. This compares with $13.3 million in sales margin loss last year.

Cash cost per ton in the third quarter was about $117, compared with $102 last year. However, I would note that cash cost per ton has improved sequentially over each of the past three quarters. Customer inquiries for 2010 contracts have begun, and we have committed to some limited volumes. We do remain approximately 90% open for next year's production.

In Asia-Pacific iron ore, we are on track for record volume of 8.5 million tons, 2.6 million of which was achieved in the third quarter. During the quarter, we deployed additional mobile equipment that when combined with some of the capital improvements made in the recent past allowed for a production increase of 44% compared with last year.

While revenue per ton of $63 in the quarter was down compared with last year as a result of lower benchmarked pricing, we did see our steel making customers in Japan begin to receive shipments of lump ore, which had a positive impact on our average selling price.

Cost of goods sold in the quarter was down 15% to $52 per ton from last year, but perhaps more impressive is that cash costs were down 18% to $44 per ton. This was attributable to the increased volume and lower mining costs, as well as favorable exchange rate variances.

Turning to the balance sheet. At September 30, 2009, cash and cash equivalents stood at $360 million versus $179 million at December 31, 2008. We had no borrowings from our $600 million revolver at either point in time. This week we also closed on an amendment to our credit agreement, and just to be clear, we did not obtain this amendment because we needed relief from our covenants.

As we have focused more and more on the international market, we found needs that our agreement did not adequately allow for it, such as the increase use of letters of credit and the ability to access foreign debt. The amendment provides this improved borrowing flexibility. We also received more liberally defined financial covenants and other benefits. In exchange, we've agreed to a modest increase in pricing of approximately 50 basis points. Even with this increase, the interest charged on our bank debt is still well below market at approximately LIBOR plus 100 basis points.

Through September 30, we used about $5 million in cash for operating activities. However, our backend weighted seasonality as it relates to cash flow will be dramatic this year, as we expect to generate $250 million to $300 million in cash from operations during the fourth quarter.

Based on our current forecast, we are likely to end the year with approximately $500 million of cash on hand, assuming the Wabush Mines transaction closes before year end. Major uses of the cash through the first nine months included $96 million in PP&E and $66 million related to investments in Amapa.

Based on the improving scenario for steelmaking raw materials, our expectation for the balance of the year and some thoughts about next year include the following. Pellet sales volume in 2009 of approximately 17.4 million tons for our North American iron ore operations. This is up from our previous guidance of 16 million tons. In addition, we anticipate collecting cash for approximately 2 million in additional tonnage related to bill-and-hold sales for 2009 that are not expected to meet revenue recognition requirements.

On a per ton basis, we expect average revenue of between $75 and $80 this year, and average cost based on 17 million tons of equity production in the range of $65 to $70. This is below our prior cost guidance of $70 to $80 per ton, and is the result of levering fixed cost over more volume.

Today we also provided 2010 sales volume expectations for our businesses. In North American iron ore, we currently expect approximately 23 million tons, including incremental tons related to the Wabush transaction with an assumption that the transaction closes on or about December 31.

In North American coal, we are now guiding to lower 2009 costs of $135 to $140 per ton, including approximately $20 per ton of depreciation, depletion and amortization for the full year. Production and sales volumes are expected to be approximately 1.8 million tons, and average per ton revenue at the mine mouth is expected to between $95 and $100.

In 2010, we currently anticipate North American coal production and sales volume of approximately 3 million tons. At our Asia-Pacific iron ore business, consistent with prior guidance, anticipated revenue per ton for 2009 is between $60 and $65, with cost per ton coming in at $50 to $55.

2010 production and sales volume is expected to be 8.5 million tons. At Sonoma, projected sales volume this year for our 45% economic interest is 1.4 million tons. Our cost per ton guidance is now slightly higher at $85 to $90 per ton, with average revenue expectations remaining unchanged at $100 to $105 per ton.

Given lower actual coal yields than originally planned for the mine ramp up, Sonoma Coal is expected to produce and sell approximately 3 million tons in 2010. The mine plan is currently been reviewed in order to optimize the mix of metallurgical to thermal coal.

Total 2009 SG&A expense is estimated to be well below last year's $189 million at $120 million. DD&A for the year is estimated to be $230 million. Capital expenditures for 2009 are expected to be about $140 million.

With that, let's open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line Michael Gambardella from JPMorgan. Please proceed with your question. Your mike is now live.

Michael Gambardella - JPMorgan

First question is on Wabush. My understanding is that Wabush had somewhat higher labor costs associated with it compared to the other North American operations. Could you give us an idea of historically what the operating results have been at Wabush, just roughly?

Joseph Carrabba

Mike, it is a high cost producer. I mean, most of the Eastern Canadian mines are. You are correct, the labor cost and also the weather. Simply the severe conditions of the weather and transporting the concentrate, the distance from the concentrator all the way down to (inaudible), certainly to where the pellet plants are and loading is certainly makes it a high cost producer. I don't have those specific numbers at hand for you. I can tell you in the last couple of years, it’s been a profitable mine for us. It has benefited from its ability to export and the people in the export market are quite used to the pellets with the manganese in them, but I don't have specific numbers for you this morning.

Laurie Brlas

It also does benefit from the international pricing more so, so we are more at market price there. So, that creates a better gap for it, and definitely we consider this to be an accretive transaction at the price it's at.

Michael Gambardella - JPMorgan

Has Wabush been 100% export or have they sent some material into the Mid-West?

Joseph Carrabba

We do send some occasionally down the Eastern Seaboard. As always, nothing is a 100% Mike, but it is primarily an export market driven product.

Michael Gambardella - JPMorgan

On the North American iron ore business with the new higher guidance, are you getting pretty good indications from the mills in terms of their requirements for 2010?

Joseph Carrabba

Not really. We don't have visibility all the way through. We are working off of the utilization and capacity of the mills versus looking through into the order books and seeing what they have in the mills, but basically working off of mill utilization capacity rates and what are anticipated into the New Year.

Michael Gambardella - JPMorgan

Was the biggest change the middle Cleveland operations?

Joseph Carrabba

That was certainly a very pleasant surprise that we hadn't anticipated, but we are seeing uplift pretty much across the board in North America, but Cleveland was a very nice surprise for us.

Operator

Thank you. Our next question comes from the line of Kuni Chen with Bank of America-Merrill Lynch. Please proceed with your question. Your mike is now live.

Kuni Chen - Bank of America-Merrill Lynch

I guess just first question on North American iron ore. Obviously, your guidance implies a big sequential increase in shipments here in the fourth quarter. Can you just comment on where you see both your inventory levels and also customer inventories in iron ore and how that should progress over the next quarter or two, certainly as we get through the winter months? I just want to get a sense as to your comfort level that certainly the high inventories have now run their course.

Joseph Carrabba

We think they certainly have and you can see that as they are coming down from when we discussed stockpile sales early in the year of something around 6 million tons, and now I think the guidance was around 2 million. That is a very strong indication of where we are coming. More or less back in line with our year-on-year stockpile sales, still a little bit higher than year-on-year, but starting to get more in the realm of reason, if you will.

As you know, in North America, we are always backend loaded in our shipping due to the locks closing down, primarily in the first quarter. So, you see these shipment pickups and we do an inventory build usually in the summer, and we work it off as we get into the heavy shipping in the third and fourth. It’s come late, obviously, but we do have Great Lake capacity to move the volumes that are required to get them into the lower lakes in the fourth quarter, barring weather events.

Kuni Chen - Bank of America-Merrill Lynch

On the met coal side of the business, obviously it’s been seeing losses in that business for a number of quarters now. Based on your guidance, it looks like margins could be positive now in the fourth quarter and going forward. So, I just want to get your views on that.

Laurie Brlas

I don't think we will see that in the fourth quarter but when we move into next year with the increase in volumes and assuming some pricing improvement, I think that you will begin to see some positive results then.

Kuni Chen - Bank of America-Merrill Lynch

Can you just walk us through how you get to the 3 million tons? Is that sort of a gradual sequential ramp up process or do you plan to be producing at that run rate early on in the year? Then can you also just talk about where you see your costs in that business going, as you get up to 3 million tons?

Laurie Brlas

It is a little backend loaded, but it won't be as backend loaded as our iron ore business typically is, because of the shipping constraints.

Operator

Thank you. Our next question comes from the line of David MacGregor with Longbow Research. Please proceed with your question. Your mike is now live.

David MacGregor - Longbow Research

Laurie, you talked a little bit about some of the blast furnace activity and some furnaces coming back on. I guess I am trying to get a sense of given the blast furnace rationalizations that have occurred, what is the full recovery volume from your existing customers that investors should expect as we get back to normalize operating levels?

Joseph Carrabba

That is in the million-dollar question, isn't it, David, that we would all like to know. Warren continues to be down and Wheeling-Pittsburgh continues to be down as well as you know. We didn't have a lot of exposure into either one of those mills as they went down. Our thoughts are, as you know, the US stays at about 70 million tons of steel that we can produce and use annually; that that volume from those mills just gets pushed into other customers and helps their utilization and capacity which we supply. So, I wish I had that answer for you, but my crystal ball just doesn't go out that far.

David MacGregor - Longbow Research

You were talking about 23 million tons next year. Should we think about 4 million tons of pick up from Wabush so that it's really kind of a 19 million apples-to-apples number?

Laurie Brlas

No, I would say that the Wabush pick up isn't forecasted to be quite that high next year, yet that is kind of at full capacity. We are going to do some capital investing and so forth. I think you are probably looking more like 2.5 million to 3 million.

David MacGregor - Longbow Research

2.5 million to 3 million incremental?

Joseph Carrabba

Right.

David MacGregor - Longbow Research

Then you talked about the capital expenditures up there. Presumably that is the manganese circuit. What is the capital cost and is it about a 5% discount on the manganese ore?

Joseph Carrabba

We haven't defined the capital cost. We’ve got one line up there that has been running in a test production mode, and we've had very favorable results. Again, being in the partnership, if you will, there wasn't a desire to go forward with that. They were satisfied with the manganese results that they had versus the capital output that we had to lay. We will bring that forward as we get those numbers, David from there.

The discount that is quoted around is really because we sell on iron unit basis, so it is the displacement of iron versus the quality implication. As we have the ability now, again, subject to regulatory approvals, we can move this volume around particularly to our customers in China, it gets a dilution effect of the ships that go in with the rest of the ores and the manganese. Many of the mills over there actually becomes favorable because it prevents them from having to put manganese into their circuits. So, it is more of a displacement of iron units than it is a discount due to quality of high manganese.

David MacGregor - Longbow Research

Just on Amapa, you talk a little bit about some of the scenarios; you are exploring other scenarios. I wonder if you could just elaborate on that and give us a sense of how committed you are there?

Joseph Carrabba

Sure, I would be happy to. Let me just start by saying I am very committed to Amapa, as you know, and all of the listeners today know. During the big uptick, very few projects came on in the iron ore business. So, to go out and find another 5 million or 6 million ton mine that fits our diversification strategy, that has a rail and port in place, that's actually owned by the project is a rather difficult thing to do.

David MacGregor - Longbow Research

It has a pretty favorable economic potential, right?

Joseph Carrabba

It’s very favorable, yes. We quoted first quartile cost when we got into this. We still believe that is going to happen. The scenarios we are looking at are to get into some different types of specifications for the material that the mine can handle on a life-of-mine average and also going upstream this mine will need some capital infusion. The rock strength and hardness is a little stronger than expected, and we think we are going to need a little more crushing and grinding on the front end so that we can optimize those circuits and get the efficiencies up with where they need to be.

So, those are the discussions we are in with Anglo right now. As you know, Anglo holds 70% and is managing partner of this project and we are trying to influence the technical discussions. We are committed, one, to the project until proved differently, but I think more importantly, we are committed to bring this thing to resolution on the ramp up side of this, David.

David MacGregor - Longbow Research

So as we look at 2010, how much more capital are we really talking about, at least according to the plans you have in place today?

Joseph Carrabba

We are still having technical discussions and flow sheet discussions and all of that good stuff between engineers and the metallurgists as it is right now. If we do get to a spot of agreement on the technical solutions due to lead time items, 2010 will be the rebuild, ordering of equipment and the rebuild and you would see the emergence in 2011.

David MacGregor - Longbow Research

Is it really just some of those engineering issues that are the gating factor at this point or are there other gating factors too?

Joseph Carrabba

We believe those are the biggest ones when it comes to plant performance. As you know, all of these just like the coal business is very so volume sensitive. You got to move the coal up. We are very pleased. We are getting a 67% iron off of process that we are getting and we are quite pleased with the release of iron units that we are getting out of the mill, but we've got to get the efficiencies up and it is primarily in that technical arena.

Operator

Thank you. Our next question comes from the line of Mark Liinamaa with Morgan Stanley. Please proceed with your question. Your mike is now live.

Mark Liinamaa - Morgan Stanley

Joe, in your commentary you cited some weaker conditions in North America and Europe relative to the Asia-Pacific with met coal. Regarding your contracting strategy, are you actively trying to place the 3 million tons now or are you willing to let the market come to you? Also, maybe just a little bit of commentary on how much of a spread there is between the two markets.

Joseph Carrabba

No, Mark. We definitely want to wait for the market to develop later into 2010. I think as we commented, we’ve got about 10% of the volume committed going into the new year, but we are more than willing to wait and watch the tightness of the met coal market, see where benchmark settlement comes out in the New Year with the Japanese mills, and watch like everybody this Chinese story develop.

We believe it could be a good spot business for us. We don't think it is a business you would build on given the variability of freight rates versus coal that is coming out of Queensland and Western Canada, but it could be a good spot business and we are just trying to get ourselves in position right now with a few of our customers that we already have within China particularly, and get that material in, certified, tested and through their coke and blast furnace. So, it takes a long process and we want to get all of that out of the way in case there is some spot business in the New Year.

Mark Liinamaa - Morgan Stanley

Sure. As you think about placing the tonnage, would the 165 spot give or take, would that be the starting point for negotiations?

Joseph Carrabba

It would be nice, but again, we will have to wait and see. I think it's just a little too early Mark to make the call on the pricing. I get the same numbers out of market you are. We have not seen those numbers to-date coming through, but we just need to wait and watch this market tighten up.

Mark Liinamaa - Morgan Stanley

So, if it did tighten up substantially, how much higher than the 3 million tons could you do in 2010?

Joseph Carrabba

We wouldn't push the mines past that. As you know, we are not going to get ourselves in developmental problems again and have to shut those longwalls down for long periods of time while development catches up. We want to get into a balance and equilibrium in 2010 of around 3 million tons. We will start on the shaft in Oak Grove, that capital project, but that will take it through 2010 and then do a gradual ramp up over the next couple of years as we bring the capital projects on to support that, and then the new longwall in Pinnacle as well. We would pretty much limit ourselves on the production side at 3 million tons so we don't mess up the future.

Mark Liinamaa - Morgan Stanley

The 23 million tons of production guidance in iron ore, would you be willing to share what that would roughly correlate to as far as a blast furnace utilization rate in 2010 in your mind?

Joseph Carrabba

I think we are staying right along industry standards right now. I mean, it is everything that you read, that we read, that 70%, 75% outlook that people are looking at as the blast furnaces get up and stabilize. Again, we don't use a precise science and work it back. Each mill and customer is very, very different, but we are working within the guidelines of what the industry is putting out.

Mark Liinamaa - Morgan Stanley

Roughly a low mid-70 operating range with that range consistent with that volume?

Joseph Carrabba

Yes. We still think 2010 is a rebuilding, revamping year in North America and Western Europe, our natural markets, and we're trying to put our plans in place in the rebuilding year.

Operator

Thank you. Our next question comes from the line of Jorge Beristain with Deutsche Bank. Please proceed with your question. Your mike is now live.

Jorge Beristain - Deutsche Bank

Just wanted to follow-up on the Amapa question earlier. Amapa has been a bit of a headwind for you guys and I was wondering if you could provide any kind of guidance as to when you think that due to higher utilization that operation might actually get into the black? Secondly, were the current capital contributions something that was forecasted in your CapEx budget for this year?

Laurie Brlas

I will start with the financial question there, Jorge. The cash contributions are very much in line with what we had forecasted for the full year, not much different at all. The earnings impact is a little bit higher. We actually had about $8.5 million negative impact of currency in that number for the quarter. So, that’s really what pushed us up compared to where we thought we were at last quarter. We thought we might even be running slightly ahead because we had absorbed a couple of write-offs in the last quarter, so the currency there having an effect. As Joe mentioned earlier, we are working on a lot of scenarios with Anglo, and there very well managed. There may be some capital infusion. If that is the case, next year would be kind of a rebuilding year, but we really don't have a definitive timeline and plan, and we are committed to letting you know as soon as we do have that. At this point, everything is really in a discussion phase.

Jorge Beristain - Deutsche Bank

in terms of Portman, we’ve recently seen a nice spread open up in the spot markets internationally. I understand you guys have those contracts out there committed on the standard contract which was for pellets, down 48%. Would you have any optionality out there, given that it does seem that even some of the major global producers are now starting to sell on either spot or C&F basis? So if the large players are able to sort of take advantage of spot market pricing, is that something that you would consider out in Australia?

Joseph Carrabba

Well, we would always consider if we had the tonnage, Jorge. I guess our business model is a little bit different, and it has certainly helped carry us through the difficult times. As you know, we sell into the secondary mills primarily into China. These are mills that don't have large stockpiles in front of them. It's more of a cash tied business, and where on both sides we've to kind of stay together through this thing and we've got some very loyal customers that set out there and work within these frameworks. They've got to stay profitable so that we can sell the products and go forward. If we had an overhang of volume, we would certainly try and maximize that and get into the spot market and sell some cargoes. At this point in time, we don't have any extra or additional volume to bring on to get into the spot market, but we always consider things as they go forward.

Jorge Beristain - Deutsche Bank

Lastly, on the North American coal that you quoted could be around 3 million tonnes. Given that you would be prepared to sell a lot more internationally next year, could you dimension what amount of that tonnage could ultimately be sold internationally just based on known logistics constrains? And does it make sense at this point to begin, at least, purchasing options for potential freight contracts, given that if we see spot coal go up a lot, we're also going to see spot freight rates go up a lot?

Joseph Carrabba

Well, the old Pinnacle mine out of West Virginia and particularly the Oak Grove coal out of Alabama has always been widely accepted in the export markets, that is the natural markets of Western Europe and Brazil. It is traditionally traded at around 60% export, 40% domestic. So selling into the export markets and the natural markets is a pretty accepted practice and a long-standing practice for those types of coals, right out through the last few years before we owned the mines. So we would continue with that exposure. I really don't have a (inaudible) or a particular ratio in mind as to where we sell on an export/domestic type of a ratio, but we do want to maximize, obviously, the pricing that comes out with it and goes from there.

We've had discussions around freight, particularly with our counterparts in Perth, who are very much more attuned to the freight business and freight rates. There is a lot of conflicting information of volume goes up, freight rates go up, but there is also, as we understand it, a lot of additional freight capacity really coming on and going to hit the market in the next couple of years as well. So we are exploring some different ideas, not just being, if you will, victims to the freight, and trying to get a little more sophisticated as we go out into the freight market, but really haven't made any moves at this point in time.

Jorge Beristain - Deutsche Bank

Just to put a hard number on that, would you have a theoretical maximum for exports of 1.5 million or 2 million tonnes of that call?

Joseph Carrabba

Not at all. If it was all exported, I don't think there would be any angst within the group at all. Again, wherever we can maximize the pricing.

Operator

Our next question comes from the line of Mark Parr with KeyBanc Capital Markets. Please proceed with your question. Your mike is now live.

Mark Parr - KeyBanc Capital Markets

.

I was wondering if you had any guidance you could share as far as North American iron ore cost per ton in 2010?

Joseph Carrabba

We haven't given any guidance on other than the volumes, Mark. We are in the midst of our planning sessions right now, as I am sure everybody else is, and we are just not prepared to give any further guidance today.

Mark Parr - KeyBanc Capital Markets

In the absence of any final number, I mean are there some puts and takes that you might be able to talk about say in terms of cost reduction programs, productivity enhancement initiatives, forward contracts on natural gas purchases, union labor rates, I mean any sort of just general discussion that might give us some sense of what direction thinks might be moving?

Joseph Carrabba

I will just give you some general discussions. As you know, we've worked very hard like every other company probably in the downturn to cut not only variable costs, but look at our fixed cost base. We certainly don't want to give all that back on the way up. Volume certainly helps us, as any mineral processing business cure a lot of ills. On the other stuff, we are coming off of hedges of natural gas and we are going into the market pretty clean next year, and we should get some favorable gas prices. On the other side, we are facing higher oil prices now of over $80, and there is some negating there. So the labor contract is set. We signed that. We're just starting the second year of our labor contract. So labor rates are set, not a lot of surprises that will come from there. Just a lot of factors of, again, going through the planning session of one offsetting the other and we don't have any final answers, yet, at this point in time.

Operator

Our next question comes from the line of Tim Hayes with Davenport & Co. Please proceed with your question. Your mike is now live.

Tim Hayes - Davenport & Co

On the North American iron ore, you had a nice improvement in unit cost going down about $21 a ton. Was that all due to the higher iron ore sales or did you actually reduce the level of fixed costs?

Laurie Brlas

Looking at specifically the quarter compared to last quarter, there is a very big impact of the fact that our volume went up. Now the team has been doing a lot of work throughout the year overall, just reducing costs and so forth. We did have a very significant step change in our volume expectations with the 17.4 now compared to where we were three months ago.

Tim Hayes - Davenport & Co

In terms of the level of fixed costs going down, can you give us a range by how much sequentially?

Joseph Carrabba

No, we don't really have that at our fingertips, and the difference on fixed and variable is always a very tricky slope to go down. So no, we don't have that info.

Tim Hayes - Davenport & Co

Then also when we look at some of the details, we came up with an unusual number for estimated freight and reimbursement. I know that's a number that's no longer disclosed, but it seems like there was something odd going on in the quarter. Was there such an issue with that line item?

Laurie Brlas

Yes, that has to do with the relationship between our partners and moving some of the tonnes around, and it is kind of a quarterly anomaly.

Tim Hayes - Davenport & Co

So we'll just treat that as unusual, but that will go away presumably in Q4?

Laurie Brlas

Yes.

Tim Hayes - Davenport & Co

Then in some of the volume guidance for 2010 for North American iron ore, the 23 million tonnes, does that assume 2 million of bill and hold sales from '09?

Laurie Brlas

Yes, that would be rolling into that.

Tim Hayes - Davenport & Co

Then could you remind me, what was the '08 bill and hold sales?

Steve Baisden

1.2.

Laurie Brlas

1.2.

Tim Hayes - Davenport & Co

All of that was shipped in '09, yes?

Laurie Brlas

Yes, that's correct. It was shipped in '09.

Operator

Our next question comes from the line of Brian Yu with Citi. Please proceed with your question. Your mike is now live.

Brian Yu - Citi

My question relates to the 2010 iron ore commitment. Can you remind us what your minimum contract levels are and how that is impacting your preliminary estimates?

Laurie Brlas

Our contract for 2010, we really don't want to get into all of the individual contracts. I think that we'll probably have materially similar numbers rolling into 2010 than we had in 2009.

Brian Yu - Citi

So we are looking at maybe around 18 million tonnes and then plus the 2 million of carryover; that gets to the 20 million excluding the Wabush acquisition?

Laurie Brlas

You are probably not too far out of the ballpark.

Brian Yu - Citi

Then the other question, just going back to the early one about costs, if we look at your actual production out of the total North American operations, it really didn't improve much in the third quarter, even though selling levels did. So in terms of the costs, it really is just an estimate on where you think back-half costs will be and not actually what was incurred in 3Q based on the production, right?

Laurie Brlas

You are right, Brian.

Brian Yu - Citi

Then with the metallurgical coal expansion, it sounds like you are now moving forward, and Joe earlier you talked about putting in that new shaft at Oak Grove?

Joseph Carrabba

Yes.

Brian Yu - Citi

Okay.

Laurie Brlas

We plan to ramp up that production over the course of the next couple years.

Brian Yu - Citi

If I recall correctly, that met coal expansion to bring it up to about 5 million tonnes, the CapEx total for that project is about $120 million?

Joseph Carrabba

No, I think there is a combination in there, Brian. Over the next few years, we think 5 million tonnes is realizable, and it really hinges on the two projects. One is the Oak Grove shaft, which is simply moving the miners closer to the face after 20 years of production down there. They travel some pretty long distances and lose a lot of production time as they go forward. That is about $30 million, $31 million. The other piece, I think, that you are referring to is the longwall down at Pinnacle that we are putting in place. If memory serves me correct, that is about $83 million that goes in. So I think that is where you are getting your $120 million, but it is a combination of both projects coming in.

Brian Yu - Citi

All right. Pinnacle longwall is that project is moving forward or undecided?

Joseph Carrabba

It is moving forward. We did delay everything through this financial upheaval that we just went through, but actually some of the shields are on the water. The guys were just in Austria inspecting the equipment, and it is all moving forward again.

Steve Baisden

Brian, our intention is to continue through our capital planning process in the next couple of months, and then eventually provide a 2010 comprehensive capital plan.

Brian Yu - Citi

Then last question here back on met coal. I think you said you have 10% committed for next year, and if you wait for the Japanese settlement, that doesn't occur until the end of Q1. So it seems like there is a volume gap in there, in terms of what would actually carry you through Q1. How should we think about it? Would the Q1 pricing essentially reflect the current-year settlement?

Laurie Brlas

Well, and it's only October. That doesn't mean that that's what we'll have committed by the time we roll into the new year.

Joseph Carrabba

Domestic settlements, because coal business settles all over the place, Brian. The domestic settlements are usually by year-end. Some of them are settled outright, some of are based on the benchmark that comes forward. Then you go into the Asian settlements of April 1, and I think even Brazil has a different date of July 1, if memory serves me correct. So you have got settlement dates all over the map, and we just work through those pricing equations. We don't stop selling coal in the quarter to wait for the pricing settlements. We work through those with agreements.

Operator

Our next question comes from the line of [Mitesh Thakar] with FBR Capital Markets. Please proceed with your question. Your mike is now live.

Mitesh Thakar - FBR Capital Markets

Congratulations on the quarter. My question is just on the North American iron ore operations, you are guiding about 23 million tonnes, as some of the guys have pointed out earlier, 2.5 million if you strip out Wabush, 2 million from deferred tonnes in 2009, and your guidance for 2010 would be about 18.5 million tonnes. Now you've got steel capacity utilization sequentially improving from '09 average of say about 50% to 70%, 75%; that is in your number. Why is this number not going high?

Joseph Carrabba

Well, there are just numerous factors that go into this number. I wish it was a linear equation, but it doesn't work that way. We have different customers in different states of capacity utilization. The numbers I quoted were industry capacities, which I think even include VAF furnaces, which we don't supply to, and it gets a little more complicated than that. You are right on straight up, that is the way it should look, but it gets a little more complicated as we go down through customers and blast furnaces that we supply.

Laurie Brlas

It still is a pretty significant increase over our 2009 expectations.

Mitesh Thakar - FBR Capital Markets

So is there some upside to this number? That is what I am coming to.

Laurie Brlas

It is still October of 2009. I hope there is, absolutely.

Joseph Carrabba

There is downside given the economic state of the country.

Laurie Brlas

If this steel utilization continues to decline, certainly there is, but as we said earlier, we are cautiously optimistic and I think you've heard the steel producers report, and they are cautious as well in their commitment. So, a lot of news to unfold before the end of 2010.

Mitesh Thakar - FBR Capital Markets

My second question is on your Asia-Pacific coal operations. What kind of steam to met mix are you expecting for 2010?

Joseph Carrabba

I would think right now looking at the geological models and where we are at the mine, I think you can anticipate pretty much the same, the 70/30 split as we go forward into 2010.

Mitesh Thakar - FBR Capital Markets

I mean is there any sort of discount toward benchmark price settlements for the met prices which you realize, or is that the working number?

Joseph Carrabba

The coking coal aspect, in the thermal coal aspect as well is pretty much in line with the benchmarks.

Mitesh Thakar - FBR Capital Markets

If I can, I would like to go back to Latin American iron ore operations. When do you see those operations to become more like cash breakeven? I know you touched upon your plans for 2010 and really your (inaudible) phase would be more of an '11 phenomenon.

Joseph Carrabba

That would be, at least, 2011 in our opinions. We think there is some capital that has to be spent in that mine to move it forward. Again, it is based on long lead time items of some capital in the grinding and crushing equipment, once we reach agreement with the partners and move forward.

Laurie Brlas

That is realistically what we were probably looking at, but we want to get our own detailed plan and then hopefully we can share that with you after we get comfortable with that plan.

Operator

Our next question comes from the line of Wayne Atwell with Casimir Capital. Please proceed with your question. Your mike is now live.

Wayne Atwell - Casimir Capital

Can you share your thoughts in terms of how much upside there might be at Wabush; how much you might be able to add to your resource base there?

Joseph Carrabba

I don't have a number. We are optimistic. The next step from this test circuit is to install another full line of the manganese reduction circuits. I don't have a number for you, but the reserve base would increase as we go forward. It wouldn't be huge, Wayne, as far as tripling or quadrupling the reserve, but it would be a nice addition to it. I don't have the numbers at hand, but it would be a nice enhancement if the numbers play out on the capital and the operating cost versus the gains.

Wayne Atwell - Casimir Capital

Do you have an early estimate of CapEx for 2010?

Joseph Carrabba

We do not. Still working through it.

Wayne Atwell - Casimir Capital

Which leads me to a question about your cash reserves; you have pretty strong cash position here. What are your thoughts in terms of how you are going to deploy that?

Joseph Carrabba

Well, we still want to stay with our strategy. We think it has certainly paid off. The dividends are coming through this quarter and they have through the year of diversifying product lines and going out into the marketplace and to different markets. With our Portman acquisition we would continue to look for both, diversity of minerals. We would look more iron ore, obviously, if we could get that, and scale that everybody needs in this business to carry the big projects forward. Again, as we've always said, we are not going to be cavalier about how we spend the money or just for growth sake. We will continue to look at projects and evaluate them appropriately as we go forward. That is our number one desire to use the cash.

Wayne Atwell - Casimir Capital

Now, you mentioned diversification, would you move outside of coal and iron ore into nickel or copper or something else?

Joseph Carrabba

Well, as we have always said in all of the presentations, our strategy is certainly, we want to stay within the steel space and look at other mineral diversification within the steel space. But as generally Mother Nature isn't perfect, they are going to carry some different minerals with them. So moly might have some copper with it. Different minerals might carry some nickel with it, but we would like to stay within the steel space first. We may get some opportunities as they arise to have one of these polymetallic deposits.

Steve Baisden

At this point we are past the top of the hour. So we are going to go head and end the call. I am going to be available all afternoon to talk with people through their models and answer any additional questions. So with that, on behalf of Joe and Laurie, I thank everyone for joining us today and we look forward to reporting to you in the future.

Joseph Carrabba

Thanks, everyone.

Laurie Brlas

Thanks.

Operator

Ladies and gentlemen, that does conclude today's conference call. You may disconnect your lines at this time. And we thank you all for your participation. Have a wonderful day.

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Source: Cliffs Natural Resources Inc. Q3 2009 Earnings Call Transcript
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