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Cliffs Natural Resources Inc. (NYSE:CLF)

Q3 2013 Earnings Conference Call

October 25, 2013 08:45 AM ET

Executives

James F. Kirsch - Non-Executive Chairman of the Board

Terrance Paradie - EVP and CFO

P. Kelly Tompkins - EVP and CAO

Jessica Moran - Director, Investor Relations

Analysts

Michael Gambardella - JPMorgan Securities

Sal Tharani - Goldman Sachs & Co.

Brian Hsien Yu - Citigroup Global Markets Inc.

Timna Tanners - Bank of America Merrill Lynch

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

Tony Rizzuto - Cowen and Company

Mark Parr - Keybanc Capital Markets

Luke MacFarlane - Macquarie

Paul Massoud - Stifel Nicolaus & Co.

Garrett Nelson - BB&T Capital Markets

Evan Kurtz - Morgan Stanley

Harry Mateer - Barclays Capital

Operator

Good morning. My name is Marie, and I’m your conference facilitator for today. I’d like to welcome everyone to Cliffs Natural Resources 2013 Third 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, Marie. 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 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.

Joining me today are Chairman of the Board, Jim Kirsch; 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 Jim to discuss our announcements this morning on hiring Gary Halverson as President and Chief Operating Officer.

James F. Kirsch

Thank you, Jess and thanks to everyone listening on today’s call. I’m very pleased to announce the addition of Gary Halverson to Cliff’s senior leadership team. Gary joined Cliff from Barrick Gold Corporation, the world’s largest gold mining company. Gary is a proven leader with over 30 years of mining and operational experience, which includes underground and open pit mining, mineral processing and most importantly an execution track record of delivering large scale projects.

His understanding of what drives profitability and returns on capital, coupled with his breadth of experience in developing and operating assets from construction to closure, making the best candidate to lead our company. Throughout his career, he has led operations in the United States, Canada and Australia and possess deep technical expertise, operational knowledge and financial acumen. In his previous role at Barrick, Gary led their North American business unit, which is comparable to Cliffs in terms of size and complexity.

Gary will be joining Cliff as President and Chief Operating Officer and will transition to the Chief Executive Officer role over the coming months. Effective upon his arrival, I will assume the role of Executive Chairman of the Board. This structure will Gary to focus on the near-term critical operational and financial decisions ahead of us.

As Chairman, my role is to provide continuity of leadership and to refine Cliffs longer term strategy. Gary will also serve as a Director on Cliffs Board and all members of Cliffs’ executive team will report directly to him.

Over the last three months, Cliff’s management team has worked to identify opportunities, initiatives, and actions to improve the Company’s competitiveness. Gary will benefit from a tremendous amount of advanced work that has been completed on that front. Since he won’t be starting until mid November, he will not be joining us on today’s call. However, we’re looking forward to the mining experience, expertise and leadership Gary will soon bring to Cliffs.

I will now turn the call over to Kelly and Terry to discuss the quarter’s operational results. Kelly.

P. Kelly Tompkins

Thanks, Jim. During the quarter, our operations achieved lower cost per ton rates and we reduced exploration and SG&A expenses excluding special items. We’ve also lowered our expected full year CapEx spending, which Terry will cover a bit later. We were pleased to see strong and stable iron ore placing throughout the quarter, meaningfully above the bearish sentiment reflected in the street’s consensus.

Although our performance clearly benefited from pricing, our focus on reducing costs contributed substantially to the year-over-year improvement in our financial results. You will recall on our last earnings call, I noted that the office of the Chairman’s main focus was to prioritize and work on several present decisions, including chromite, Wabush and Bloom Lake. One of the key drivers influencing our decision is our belief in the value and importance of a strong balance sheet.

Looking ahead, regardless of what decisions are taken, we expect to manage our capital spending with discipline to ensure that our current debt profile is maintained or improved. We fully recognize the magnitude of the capital required for Bloom Lake and acknowledge that the Phase II decision has been pending for some time.

With Gary Halverson’s mining and project execution expertise, coupled with a strong balance sheet mandate, the Board is evaluating this decision on a value enhancing basis, stress test by multiple pricing scenarios.

On the SG&A front, we initiated an enterprise cost reduction program where we’re recalibrating our corporate footprint through early retirements as well as a voluntary and involuntary reduction in force.

Going forward, we will continue to look for ways to take cost out of the organization and minimize our outside services spending. We expect these actions will improve our 2014 SG&A expense outlook versus our 2013 expectation.

Turning to our chromite project during the quarter, the Mining and Lands Commission of Ontario ruled against our proposal for a north and south all weather road that crosses unpatented mining claims of other resource companies. This was a disappointing ruling and without prompt government intervention to address this and other critical infrastructure elements vital to the project, it will be difficult to move ahead.

Now turning to our business segments, starting with U.S iron ore. In U.S iron ore third quarter sales volume decreased 4% to 6.3 million tons from 6.6 million tons in the year-ago quarter. This was primarily driven by reduced sales from a force majeure with one customer and the expiration of another customer’s contract, all of which was partially offset by increased domestic spot and export sales. Year-to-date, we’ve exported 1.8 million tons from the lower Great Lakes into the seaborne market, successfully placing about 50% of this volume with European customers.

In recent months, we successfully negotiated and entered into new pellet supply contracts with two of our long term U.S. iron ore customers. With these agreements, we anticipate having additional incremental sales on full year 2014 and have increased our year-over-year period expected sales volume for U.S. iron ore to the 22 million and 23 million tons. With this additional secured volume, we’ll be restarting idled capacity at our North Shore mine, in Minnesota.

Further, we expect to operate our U.S. iron ore facilities at near capacity utilization rates next year. Taking this into account and assuming no year-over-year change in plats and hot band pricing, with these new agreement, our 2014 U.S. iron ore revenue realization will be inline with our current 2013 revenue per ton outlook of $110 to $115. Bottom line, we’ve secured two ten years take or pay volume contracts. We again improved fixed cost leverage and our customers are guaranteed a reliable supply of high quality pellets.

For full year 2013, we’re maintaining our U.S. iron ore sales volume expectation of 20 million -- 21 million tons, which includes selling approximately 2 million tons of pellets into the seaborne market. We’re also maintaining our full year production volume in U.S. iron ore of approximately 20 million tons.

Now turning to Eastern Canadian iron ore, third quarter sales volume increased 9% to 2.6 million tons from 2.4 million tons in the prior year’s comparable quarter. This was primarily driven by higher product sales from Wabush, mainly due to the timing of vessel shipments.

Year-over-year sales volumes from Bloom Lake was flat at 1.4 million tons. At Bloom Lake during the quarter, we commissioned the in pit crusher, overland conveyor belt and ore barn. Over the next few weeks we will be working to ramp up these major pieces of shared infrastructure.

On a mine development front, we are making progress but we are not where we want or frankly where we need to be. Optimizing the mine plan is stripping and blending strategy which is critical to improving Phase I production but this work will continue for the remainder of this year and well into 2014. As a result we anticipate 2014 cash cost to be in line with what we have reported this year. Naturally we are eager for Gary to start and become quickly acclimated with our mine plan and operational strategy for Bloom Lake as part of assessing the second phase expansion.

We are narrowing our full year Eastern Canadian Iron Ore sales and production volume expectations to 8.5 million to 9 million tons, up slightly from our previous range of 8 million to 9 million tons. This is comprised of 5.5 million to 6 million tons from Bloom Lake and the remainder from Wabush. For 2014 we expect Bloom Lake to produce and sell 5.5 million to 6 million tons from the Phase I operation. Even if the Board decides to proceed with Phase II over the next one to two months, as a practical matter, there would be no additional tons produced in 2014.

As for Wabush, its long-term viability is predicated on achieving a substantially lower cost structure. Although we did see improvement in volumes and costs during the quarter, significant challenges remain as we head into yearend. Due to the uncertainty and Wabush's long-term operating plan, we are currently selling Wabush's concentrate product on a spot basis and thus will not provide any anticipated 2014 sales volume expectations at this time. We do anticipate having clarity on future options for Wabush closer to yearend.

Turning to Asia Pacific Iron Ore. Third quarter sales volume decreased 8% to 2.8 million tons from 3 million tons in the prior year's comparable quarter which was driven by the absence of sales volume from Cliffs' Cockatoo Island operation, which ceased production during the third quarter of 2012, as well as the timing of vessel shipments.

Our full year 2013 expected sales and production volume remains unchanged at 11 million tons. In 2014 we expect to sell 10 million to 11 million tons from our Asia Pacific Iron Ore business comprised of approximately 50% lump and 50% fines iron ore.

Now to coal. Due largely to tough year-over-year comps, our third quarter sales volume decreased 2% to 1.6 million tons from 1.7 million tons last year, driven by lower sales tons at Oak Grove Mine. You'll recall Oak Grove had higher sales volume during last year's third quarter as we pushed to catch up on customer commitments resolving from the tornado damage and related forest [indiscernible] last year.

Oak Grove's decrease was partially offset by higher sales of the Pinnacle and Logan County mines due to strong production volumes. Production at Pinnacle Mine was exceptional during the quarter, and importantly have completed all of our development work in time for Oak Grove's fourth quarter longwall move. During the quarter we experienced good geological conditions which helped the team to deliver a solid operating performance and cash cost results which Terry will cover later on in the call.

For 2013 we are maintaining our sales and production volume expectations of approximately 7 million tons largely comprised of met coal. In 2014 Cliffs expects to sell approximately 6 million to 7 million tons from its North American coal business. Currently we have a minimal amount of our 2014 met coal volume committed but not priced. Discussions with customers are expected to take place over the next few weeks.

In closing let me reemphasize that cost cuts are gaining traction and we're carefully reviewing the major investment decisions before us, especially Bloom Lake second phase. Procuring the losses on sustainability of our core operations through long-term sales contracts and prudent capital allocation decisions is essential. Our focus on improving our cost profile across the organization will not abate as that is key to our competitiveness in times of all the pricing and we expect those efforts to continue under Gary's leadership.

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

Terrance Paradie

Thank you, Joe. A few impressive highlights to point out before I jump into the financial details. Third quarter operating income nearly tripled, year-to-date cash from operations increased 149%, year-to-date SG&A expenses are down 17% and our year-to-date EBITDA is $1.1 billion. Needless to say, things are moving in the right direction at Cliffs.

Consolidated revenues for the third quarter were $1.5 billion, slightly higher than the previous year. This was driven by a 17% increase in seaborne iron ore pricing to an average of $133 per ton for a 62% Fe fines product. Partially offsetting this was lower market pricing for met coal products and a 2% decrease in global iron ore sales volumes. Cost of goods sold decreased by 11% to $1.2 billion, primarily driven by lower cost rates across all our business segments.

Operating income for the third quarter increased 194% to $224 million. The increase was primarily driven by the higher consolidated sales margin and a significantly lower exploration expenses. During the quarter we reduced exploration spending on drilling and other professional services, as well as scale back on chromiterelated spending.

Our third quarter 2013 SG&A expenses were $71 million and reflected certain special items. These items included a $10 million litigation judgment expense and an $8 million in severance costs related to actions taken to reduce our corporate cost profile. Excluding these special items, third quarter SG&A expenses were $53 million, a 13% decrease when compared to the year-ago quarter.

During the third quarter of 2013, miscellaneous net expense increased to $44 million and included $18 million related to an oil spill. In early September approximately 1,300 gallons of bunker oil spilt into the Bay of Sept-Iles from our port in Eastern Canada. Although the cost of the cleanup negatively impacted the quarter results, we believe the appropriate insurance coverage – we have appropriate insurance coverage and have begun working with the insurance carriers on the recovery process.

Miscellaneous net also included a penalty of $16 million related to minimum [indiscernible] volume commitments with the QNS&L rail lines as a result of Bloom Lake's delayed expansion. Going forward we expect to incur QNS&L penalties of roughly $15 million to $20 million per quarter. Unfavorable foreign currency remeasurements of $14 million were included in the quarter's miscellaneous net expense. These items were partially offset by $6 million in proceeds from insurance recoveries.

Third quarter 2013 results included an income tax expense of $66 million versus a benefit of $64 million reported in last year's third quarter. We increased our full year 2013 income tax effective rate to 13% from our previous expectation of 2%, including discrete items. The increase in the expected income tax effective rate was driven by higher full year taxable income due to increased iron ore pricing and lower costs. As a result of the higher expected full year tax effective rate, our third quarter's income tax expense included $38 million of expense attributed to the first half of 2013.

In spite of the number of unfavorable one-time items incurred during the quarter, we reported third quarter 2013 net income attributable to Cliffs' common shareholders of $104 million, or $0.66 per diluted share. This compares with $85 million or $0.59 per diluted share in the third quarter of 2012.

Moving on to liquidity and capital structure. In the third quarter of 2013, the business generated $297 million in cash from operations, versus generating $308 million in the third quarter of 2012. At quarter end we held $299 million in cash and cash equivalents. We invested $241 million in capital expenditures with a significant portion allocated to the Bloom Lake Mine during the quarter.

Also, we paid down our revolving credit facility by $60 million and collection $62 million in cash proceeds from equipment loan financing arrangements. These loans will go towards funding capital equipment and our Eastern Canadian Iron Ore operations. At quarter end, we had $3.3 billion in total debt including $380 million drawn under on a revolving credit facility. We intend on improving our credit profile throughout the remainder of the year by continuing to de-lever the balance sheet through repayments of our revolving borrowings. We also reported depreciation, depletion and amortization of $153 million during the third quarter of 2013.

Before I review each segments financial performance and outlook, I will remind you that we provided a full-year business segment revenue per ton guidance and related sensitivities to future iron ore pricing in the outlook section of last nights earnings release. We will use the September year-to-date average iron ore price of $135 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 U.S. iron ore revenue per ton increased to $113 from last years third quarter revenue of $111 per ton. The increase was primarily attributed to increased pricing for one customer to the reset of a contract base higher year-over-year market pricing for iron ore and a favorable true up on the estimated hot rolled steel pricing. These increases were partially offset by credits to certain customers, unfavorable customer mix and increased sales to seaborne customers.

Cash cost per ton decreased to $65 from $68 in 2012 third quarter. The decrease was primarily driven by the absence of a rightful inventory adjustment that unfavorably impacted prior-year’s third quarter results. Lower labor and repair maintenance costs also contributed to the improved year-over-year cash cost. During the quarter we also changed the power supply company that we used for our Michigan operations. We expect this strategic move to save us tens of millions of dollars in cost annually, and is the primary example of actions taken to reduce company wide cost. 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 increased to $110 up 3% when compared to last years third quarter. The higher per ton revenues were attributed to increase year-over-year seaborne iron ore pricing partially offset by lag pricing that benefited the last years third quarter. Also revenues per ton were unfavorably impacted by increased freight rates and a quarter’s product mix which was comprised of a higher proportion of iron ore concentrate versus pellets.

During the quarter Bloom Lake’s cash cost increased 5% to $92 per ton primarily due to an increase in mine development and maintenance expenses. For 2013 we are maintaining our cash cost per ton expectation at Bloom Lake of $90 to $95. Cash cost-per-ton at Wabush Mine was $108 down 18% from a year ago quarter. This was primarily due to the absence of pelletizing costs from our Point Noire pellet plant. Favorable foreign exchange variances and a decreased cost rate due to unsalable inventory and lower-of-cost market adjustments recorded in the second quarter of 2013. We are maintaining our cash cost per ton expectation at Wabush Mine of $115 to $120 for 2013. For the entire Eastern Canadian Iron Ore segment we are maintaining our full-year cash cost expectation of $100 to $105 per ton.

Turning to Asia Pacific Iron Ore, revenue increased 28% to $109 per ton from $85 per ton primarily driven by higher market pricing and the absence of low-grade tons that were sold in prior years third quarter at a significantly lower price. Revenues per ton from the third quarter of 2013 were impacted by a foreign exchange hedging loss of $3 per ton.

Cash cost decreased 22% to $59 per ton compared with $77 per ton in the year ago quarter, this was due to a favorable foreign exchange rate variances of $8 per ton and lower mining cost due to less waste movement in the third quarter of 2013 compared to last years third quarter. Also contributing to the decrease was the absence of cost from Cliffs’ Cockatoo Island operation which was a higher cost mine included in prior years third quarter results. We are maintaining our full-year Asia Pacific Iron Ore cash cost per ton expectation for 2013 of $65 to $70 per ton.

In our North American coal segment revenue was $99 per ton, down 23% from the previous year results. This was primarily driven by lower market pricing for met-coal products and customer mix. The decrease in market pricing was partially offset by favorably priced annual and carry over contracts. For full-year 2013 we have approximately 90% of our sales volume committed and we expect revenue of $100 to $105 per ton.

Our North American coal cash cost decreased 34% from last years quarter to $76 from $115 per ton. This was primarily due to improved production volumes in a resulting favorable impact on the mines cost per ton rate. Specifically at Pinnacle Mine we had a record quarter where we produced one million tons of coal and achieved the cash cost per ton in the mid-50s.

Lower maintenance and contractor spending also contributed to the improved year-over-year cost. Driven by our operating teams exceptional year-to-date performance we are again lowering our expected full-year cash cost by $5 per ton to $85 to $90 which includes a longwall move during the fourth quarter.

Looking at our CapEx, we are decreasing our expectation by $50 million to approximately $915 million driven by lower spending in Eastern Canada. While our decision on Bloom Lake second phase is pending, we intend to minimize our capital spending as much as possible. Also we expect full-year 2014 Capital expense to be significantly lower than our 2013 guidance.

Turning to our overhead expenses; we are maintaining our full-year SG&A expense expectation of approximately $215 million which excludes severance related costs. We anticipate severance related cost to be approximately $12 million for the full-year of which $8 million was incurred during the third quarter. As Kelly mentioned earlier we expect our SG&A expenses to be sustainably lower in 2014.

We are lowering our 2013 exploration expenses by $10 million to $65 million for the full-year. This is comprised of approximately $15 million related to exploration and $50 million related to our chromite project. Overall we had a great quarter. We are making the right decisions and taken the necessary steps to increase our competitiveness and enhance our balance sheet strength. We’re all enthusiastic about Gary joining in the Cliffs’ team and we welcome his mining expertise and his leadership experience. I’m excited for the opportunity to work with Gary over the coming months to refine our capital allocation strategy and we look forward to him leading the yearend conference call.

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

Jessica Moran

Marie, can you please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Michael Gambardella from JPMorgan. Your line is open.

Michael Gambardella - JPMorgan Securities

Yes, thank you and congratulations on your third quarterly earnings peak this year and the good work on the costs particularly for Bloom Lake and coal this quarter. My question is about Bloom Lake in terms of the pricing for the quarter it seemed a bit weaker; are you still discounting any pricing out of Bloom Lake for trial orders with potential new customers?

Terrance Paradie

No, I don’t think we’re having a lot of discounts on a trial new order. What we have really is -- what we’re managing is that the freight costs that are going over to China that’s having an impact on our realized price, and that’s really the main driver of pricing as well as the mix of pellet price premiums that are coming because we have a higher mix of concentrate versus pellets this quarter versus last year.

Michael Gambardella - JPMorgan Securities

And then on the chromite project; if you can’t get this approval on this all weather road, north-south road, what are the options for what to do with the chromite projects?

P. Kelly Tompkins

Yeah, Mike this is Kelly; we’ve got a couple of near term options, one of which is we file an appeal but we also recognize that that’s going to take time to work through. So we’ll be discussing with the board at the upcoming meeting not only what this ruling means to the overall project but as well the uncertainty of some of the other infrastructure elements and we’ll move forward based on those inputs. But most importantly we’ve lowered the expense profile of the project; now a result of the land ruling, but just to overall lower our expense’s as part of the exploration and chromite related spend and we’ll continue to do that.

Michael Gambardella - JPMorgan Securities

Okay. Thanks a lot guys and congratulations again on the quarter.

P. Kelly Tompkins

Thank you.

Operator

Thank you. Our next question comes from Sal Tharani from Goldman Sachs. Your line is open.

Sal Tharani - Goldman Sachs & Co.

Thank you. Good morning.

P. Kelly Tompkins

Good morning.

Terrance Paradie

Good morning.

Sal Tharani - Goldman Sachs & Co.

I just wanted to understand the status of Empire Mine; you said next year you will most likely be running at full utilization rate. What rate is Empire Mine running and how long of the life is left in that mine?

P. Kelly Tompkins

The Empire Mine's life is expected to end at the end of 2014. Historically that mine could do I think up to 3 million to 4 million tons a year and for next year we're obviously working through the nomination with our Board, with our customers but that's built into our guidance for U.S. iron ore of 22 million to 23 million for next year.

Sal Tharani - Goldman Sachs & Co.

Got you. And also in the U.S. you have one more customer with whom you have a contract some of – most of it which is expiring over the next couple of years. I was wondering if there are discussions going on, on that front as well to get into longer term or extending to longer term contract?

P. Kelly Tompkins

Yes. We are in discussions constantly with our customers and certainly recognize the importance of that particular customer. So the short answer is yes, we are in discussions and it's really part of our overall U.S. iron ore strategy which is a very holistic approach to really secure our leading position in the marketplace with long-term agreements that we think over time notwithstanding the normal ups and downs of pricing, lock-in, secure volume give us greater fixed cost leverage and really again are key to preserving that leading market franchise. So that customer you were referring to was absolutely a key part of that building block strategy.

Sal Tharani - Goldman Sachs & Co.

Okay. Thank you very much.

Operator

Thank you. Our next question comes from Brian Yu from Citi. Your line is open.

Jessica Moran

Marie, can you move on to the next caller please?

Operator

Yes. Our next question comes from Mark Parr from KeyBanc Capital Markets. Your line is open.

P. Kelly Tompkins

Marie, the caller is not coming through.

Operator

One moment please. Brian Yu, your line is open.

Brian Hsien Yu - Citigroup Global Markets Inc.

Great, thanks. Can you hear me?

P. Kelly Tompkins

Yes, we can hear you now, Brian.

Brian Hsien Yu - Citigroup Global Markets Inc.

Okay, great. So my question is could you comment on the 2014 U.S. iron ore cost outlook with Northshore which I believe is a little bit higher cost mine but then you've also got the fixed cost leverage?

Terrance Paradie

Yes, I think from a cost perspective we're probably looking at something not too soon dissimilar from where we are this year. I think again we're in the preliminary stages of setting our budget for next year. I think there will be some opportunities to reduce our cost, but we'll continue to focus on things that we have control over. So one thing that was good is from a power rate standpoint we're going to see some benefits from our mission and operations with recent contract that we just executed.

Brian Hsien Yu - Citigroup Global Markets Inc.

Got it. And what's the export tonnage baked into that 22 million, 23 million ton assumption?

Terrance Paradie

Yes. I think we still got some preliminary numbers on that but right now I think it would be about 1.5 million to 2 million tons for the year. But we'll finalize and disclose that more in our next conference call.

Brian Hsien Yu - Citigroup Global Markets Inc.

Got it, great. Congrats on the quarter.

P. Kelly Tompkins

Thank you.

Jessica Moran

Thanks, Brian.

Operator

Thank you. Our next question comes from Timna Tanners from Bank of America. Your line is open.

Timna Tanners - Bank of America Merrill Lynch

Hi. Good morning, everyone.

P. Kelly Tompkins

Good morning.

Terrance Paradie

Good morning.

Jessica Moran

Good morning.

Timna Tanners - Bank of America Merrill Lynch

I just want to drill down – maybe I'm the only one confused on Bloom Lake Phase II and what it all means, but on the one hand you're saying that CapEx guidance is lower and for the next year but does that mean that if Bloom Lake Phase II doesn't go ahead or either way? And then there were a lot of talk last quarter on the call about the tailings costs. I want to know if you have any updated information on that if about misfit? And then just a little bit more if you could on the take or pay, what makes it 15 versus 20 per quarter? Are there any options around that? Should we expect that to continue until the mine, the second phase starts up? And along the same lines Bloom Lake Phase I, I thought was 7.4 million tons, so just confused around the guidance on that? Thanks.

P. Kelly Tompkins

Timna, we'll try to get through a four-part multiple question but maybe start with the last one first. We guided, as you recall on our last quarter, 5.5 million to 6 million tons. Yes, we had earlier guided to 7 million, but this is all part of our focus on really stabilizing and optimizing the mine. And as I said in my opening comments, Phase I is not there yet. And so we are continuing to work on that, hence the constant volume outlook [indiscernible] higher at this point. In terms of next year's CapEx, even if we were to proceed with Phase II and have the Phase II CapEx impact 2014, we would still be looking at an overall lower CapEx number than '13. We're not in a position to give you definitive guidance on '14 but that lower than 2013 does contemplate either or with Phase II. Obviously it will be lower if we didn't go forward with Phase II.

Terrance Paradie

On the tailings standpoint I think we said something about $200 million for next year. The team's working hard on reducing that number. Again, from a capital standpoint we want to continue to focus on reducing capital across the board and obviously tailings is a big piece of that. I think from a Phase II and just from a capital standpoint going forward, we want to schedule this capital and spend this capital to ensure that we have maintained the strength in the balance sheet that we have now with the cash balances and keep our debt profile to where it kind of is now and the range where we're at today and that's a critical point of view that we have as an organization going forward.

P. Kelly Tompkins

Timna, I think the fourth question not necessarily in that order was on QNS&L penalty and as we referenced in our comments and in the release, it's all volume driven. So to the extent that we are operating at the volumes that we guided to for next year you should assume a quarterly penalty impact of around $16 million. So it's all about volume and not absorbing that full [indiscernible].

Jessica Moran

That will go on to delay…

Timna Tanners - Bank of America Merrill Lynch

Okay. Thanks very much.

P. Kelly Tompkins

Sure.

Operator

Thank you. Our next question comes from Mitesh Thakkar from FBR Capital. Your line is open.

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

Good morning, everybody.

P. Kelly Tompkins

Good morning.

Terrance Paradie

Good morning, Mitesh.

Jessica Moran

Good morning.

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

Congratulations on the quarter. Just a few clarifying questions. One is on the 2014 U.S. iron ore volume guidance, you mentioned about 55% is seaborne linked which is roughly 12 million tons and about 2 million tons of export tonnage. Of the remaining 10 million tons, is there any tonnage which is like 100% linked to spot price or something like that which doesn't have any other contract movements?

Jessica Moran

Yes, there are. There are definitely. Some of our contracts would reference either the valid [ph] price settlement or the flat pricing settlement.

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

Is it possible for you to disclose that or you're still in the preliminary phase, you would like to wait?

Jessica Moran

Yes, I mean we're comfortable with the current disclosures.

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

Okay. Just on the CapEx question, if we – my understanding was that the maintenance CapEx is about 300 million and then 200 million related to tailings management. The Bloom Lake Phase II CapEx which was spending I think was mentioned as 450 million before. Can you just provide an update; I know the 450 million could move here or there depending on what you do with Phase II? Is it possible for you to kind of give us an update on those numbers?

Terrance Paradie

Yes, I think Mitesh you're in the ballpark from a sustaining capital standpoint as well as the tailings capital, so 500 million sounds in the ballpark. From a Phase II standpoint, again as I mentioned a little bit earlier depending on our decision, we will execute to ensure that we keep our strength in balance sheet. So we'll manage our costs, manage our cash outflows so that we can essentially pay for this if we move ahead forward with our current balance sheet profile.

Terrance Paradie

I would just add, the $450 million which was really the construction related CapEx to finish is still a good estimate, but obviously if that decision is pushed out there could be an inflation impact on moving that number up. But as we’ve said I think on prior calls a substantial amount of the work and the equipment and what needs to be done is well in hand, so there’s pretty good visibility and predictability on that number except to the extent it gets pushed out in time and again inflation could have impacted.

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

Okay, this is great. Thank you very much guys and good luck.

Terrance Paradie

Thank you.

Operator

Thank you. Our next question comes from Tony Rizzuto from Cowen and Company. Your line is open.

Tony Rizzuto - Cowen and Company

Thank you very much. Hi, folks and good to see movement in the right direction. I was very pleased to see the cash cost improvements in U.S, Asia Pacific and North American coal, it was much better than we were looking for. I guess on a bit surprise though that the full-year cash cost guidance is maintained, I know there’s a lot of moving parts here. Are you expecting fourth quarter cost to increase or is it just maybe a bit of conservatism on your part?

P. Kelly Tompkins

Yeah, I think that Tony we’re looking at our cost to be -- continue to focus on cost control and reducing our costs in the fourth quarter. So I think that there’s some upside to the cost profile both from a USIO and an APIO stand point.

Tony Rizzuto - Cowen and Company

Okay. And if I could just a little bit update on Bloom Lake with regard to the strip ratio profile and you indicated that you’ve now commissioned the in-pit crush convey in the overland conveyor and what impact is that likely to have on cost very specifically?

P. Kelly Tompkins

Well I think those, the impact of those are going to actually make us more efficient and improve our cost profile. From a stripping standpoint as Kelly mentioned in some of his opening remarks we continue to, we need to improve what we’re doing now, get more tons out. We’re starting to get the right utilization of our mobile equipment and our all profiles are from a tonnage standpoint are increasing. So, but we still have to focus in on opening up these pits and reducing our costs and getting our cost down and further in enhancing the performance of Bloom Lake Phase I and that’s what we’re focused in for next year.

Tony Rizzuto - Cowen and Company

Thank you very much.

P. Kelly Tompkins

Welcome.

Operator

Thank you. Our next question comes from Mark Parr from Keybanc. Your line is open.

Mark Parr - Keybanc Capital Markets

Hi, thanks very much. Good morning.

Terrance Paradie

Good morning, Mark.

P. Kelly Tompkins

Good morning, Mark; good to have you back.

Mark Parr - Keybanc Capital Markets

Yeah, well the first time I was like talking to some kind of empty space, I don’t know what that was.

Terrance Paradie

Yeah, we didn’t take it personally, so go ahead.

Mark Parr - Keybanc Capital Markets

All right, well, thanks. I wanted to see if there was any chance about a reenergizing, reengaging Empire, I know there was kind of a development opportunity perhaps that might have been very expensive, I mean, I don’t know if that’s even on the table right now. And then also; and again I missed part of the prepared comments but from a CapEx perspective is there anything that you’ve allocated at this point as far as production of DR grade pellets?

P. Kelly Tompkins

Mark, this is Kelly.

Mark Parr - Keybanc Capital Markets

Hey, Kelly.

P. Kelly Tompkins

How are you?

Mark Parr - Keybanc Capital Markets

Long time no hear man.

P. Kelly Tompkins

Yeah, exactly. Good to hear you and see you.

Mark Parr - Keybanc Capital Markets

And Cliffs’ is a long way from where we used to get together.

P. Kelly Tompkins

We did -- we did and we’ll talk about that offline but, anyway in terms of the overall CapEx guidance it does not really contemplate any capital at this point allocated with DR. I think as we talked before we’ve done testing at our Northshore facility and feel comfortable and confident that we can produce a low silicate DR grade pellet. But until we see the evolution of a customer there’s no point in allocating capital, but to that at this point in time more importantly we’re bringing up the two Northshore furnaces just because of our overall core USIO volume increase expectation for next year.

Jessica Moran

And really to Empire, I mean yeah you’re right Mark in 2008 I think it was July we announced I think an extension of that life and then as the market collapsed we pulled back on those plans, but the thing that Mark to note there is we’ve got a partner in Empire so the decision to expand the life will be a much more complicated decision, it's not a sole decision. But certainly we’ve considered it, but I think our plans right now are for it to reach its end of life in 2014.

P. Kelly Tompkins

Yeah, we have to assume that as the base case Mark, and that’s the current outlook.

Mark Parr - Keybanc Capital Markets

Okay, thanks guys. Good luck.

P. Kelly Tompkins

Okay.

Terrance Paradie

Hey, Mark we understand that you maybe retiring here at the end of this week so I just want to congratulate you and thank you for your very objective coverage over the years.

Mark Parr - Keybanc Capital Markets

Oh no – thank you for the nice thoughts, and it's truly been a pleasure to have been able to be part of the saga that is Cliffs’ Natural Resources, and I really would wish you all the best and look forward to some really good things in the upcoming years.

Terrance Paradie

Same to you, Mark. Thanks.

Jessica Moran

Thank you, Mark.

Operator

Thank you. Our next question comes from Luke MacFarlane from Macquarie. Your line is open.

Luke MacFarlane - Macquarie

Yeah, hi guys. Congratulations on the quarter.

Jessica Moran

Thanks.

P. Kelly Tompkins

Thank you.

Luke MacFarlane - Macquarie

So, what I was interested in is your coal business mainly. Looking into 2014, I mean how many -- well do you have any sort of percentages of how many of your contracts are priced on annual contracts and how you think that will change between 2013 and 2014?

Jessica Moran

Yeah, the way to think about it, we normally would export about half of the volume in U.S. Iron Ore -- oh sorry, to our North American coals to the export market and that’s typically on a Japanese fiscal year, so that’s on a lagging kind of mechanism. Right now as Kelly mentioned we don’t have anything priced. We do have some tons committed. Usually we would have about, I don’t know, 60% to 70% of our volume committed and priced by the first quarter or mid April timeframe.

P. Kelly Tompkins

Yeah, usually what happens right now is the domestic coal producer or coal users where we’ll start negotiating today lock those contracts in and then the international stuff is through the first quarter. So by the time we get to the second quarter call we’ll have a pretty good idea of what the commitments are.

Luke MacFarlane - Macquarie

Awesome. And then I noticed that your coal production this quarter was quite a lot higher than your sales, I mean is that something to do with timing or is that more of the fact that you sort of ramped your production to sort of lower base cash cost a little bit as much as you could I suppose.

P. Kelly Tompkins

Yeah, just the high fix cost business and our Pinnacle Mine actually did very well and this quarter they had a record as I mentioned on some of the comments and that’s exactly it and then our expectation is we’ll be able to move these cons during the rest of the year.

Luke MacFarlane - Macquarie

Okay. Thanks.

P. Kelly Tompkins

Yeah.

Operator

Thank you. Our next question comes from Paul Massoud from Stifel Nicolaus. Your line is open.

Paul Massoud - Stifel Nicolaus & Co.

Hi, good morning. Thanks for taking my questions. I just got a couple of questions on Bloom Lake and then maybe just a follow-up on the coal. First on Bloom Lake, the 5 to 6 million ton guidance that you put out there; originally Bloom Lake’s at least Phase I was supposed to hit 65%, 66% Fe content, I mean is that still the target. And how much of the tonnage reduction has to do with hitting that mark and if that is the case are you still seeing a percentage of premium on that product?

P. Kelly Tompkins

Yeah, Paul we are still getting a premium, it's a high quality Fe product. I think what you’re referring to earlier and I’ll ramp up the Phase I reaching up the silica spec that had a bit of an impact on volume, but that’s not really the driver right now where our largest off take customer WISO is extremely pleased with the quality and the consistency of the product. And while the Phase I is indeed below the main price capacity at this point again it's back to focusing on stabilizing and optimizing that and there’s no point in trying to ramp up the volume if we don’t have the blending and all the development work we’re shipping.

Paul Massoud - Stifel Nicolaus & Co.

And are you still targeting $65 cash cost?

P. Kelly Tompkins

Yes.

Terrance Paradie

Long-term.

P. Kelly Tompkins

Long-term, absolutely. And that will require us to bring on Phase II.

Paul Massoud - Stifel Nicolaus & Co.

Okay. And then as far as the transport cost as you had indicated might have had an impact or had an impact on what your ultimate realized price was. How much of that is between the mine and the port and is there a potential for some optimization there?

Jessica Moran

Yeah, it's normally 30 or 40 bucks a ton between -- for the coal business is that what you’re referring to?

Paul Massoud - Stifel Nicolaus & Co.

No, no. This is for Bloom Lake.

Jessica Moran

Okay, Bloom Lake, okay. Yeah, right now the current freight rates from Eastern Canada, China is $37 a ton. We’ve seen them spike in the fourth quarter which will impact our realization. In the current quarter and the third quarter 2013 they were about $30 per ton that was baked into our realization. So that could impact us slightly next quarter, but they have been moving down.

Terrance Paradie

Your comment I think was around also from the mine to the port and we have a contract with QNS&L for the minimum standpoint at a set rate that we're locked into. So it's a matter of us thinking of getting the tons to the port or ship.

P. Kelly Tompkins

The rates stood, it's just the volumes out there.

Paul Massoud - Stifel Nicolaus & Co.

Understood. And then finally on the coal business, as just a follow-up I think to Luke's question, he said you really didn't have anything priced. I'm assuming that's just on the met coal side. For the thermal coal, do you have contracts priced?

P. Kelly Tompkins

Those are minimal. Yes, our thermal coal business is probably maybe 0.5 million tons a year [indiscernible] in that coal.

Paul Massoud - Stifel Nicolaus & Co.

All right, I think that's all. Thank you.

P. Kelly Tompkins

Thank you.

Operator

Thank you. Our next question comes from Garrett Nelson from BB&T Capital Markets. Your line is open.

Garrett Nelson - BB&T Capital Markets

Hi. Thanks for taking my questions and congratulations on another strong quarter.

P. Kelly Tompkins

Thanks.

Garrett Nelson - BB&T Capital Markets

Have you considered transactions that can bring in cash to fund Bloom Lake Phase II such as monetizing non-core assets, bringing in JV partners of some of the operations or either divesting some of your pellet pricing or processing securities? Have you thought about that and would that make sense?

P. Kelly Tompkins

Yes, let me – Garrett, yes, I think the way to answer that is really as we framed it earlier in our comments, it's two key components. We've talked a lot about Phase I and getting that optimized but the other key point of criteria is our balance sheet and our debt profile and so we've got to derisk the capital, so sure there could be a lot of different options on the table. We do have an existing partner in the mine, but that maintaining our current debt profile and protecting the strength of our balance sheet will go into that. So the extent there are options that could help derisk the capital, we'll look at a lot of different things.

Garrett Nelson - BB&T Capital Markets

Okay, great. And then on the coal side, volume gains of 6 million to 7 million tons next year but a little bit of a step down from this year if you use the midpoint of that range. Are you planning on running Pinnacle and Oak Grove at full capacity and then maybe taking down some of the high-vol in thermal mines?

P. Kelly Tompkins

I think our guidance is actually pretty consistent to what we've guided this year, so I think there's not been any real changes there to be honest with you.

Garrett Nelson - BB&T Capital Markets

Okay, thank you.

Terrance Paradie

But this could be timing from your midpoint calculation and I think it's just timing of our expectation as to same as last year for 2014.

Garrett Nelson - BB&T Capital Markets

Great. And then on the commitment side, how many tons do you currently have commitment price for 2014 for coal?

P. Kelly Tompkins

Yes, we just actually covered that in a prior question. It's too early at this point. We're just in the early stages and discussions in terms of 2014 as we go into the yearend and typically those start to come together in the first quarter.

Garrett Nelson - BB&T Capital Markets

Okay, so that's it from me [ph].

P. Kelly Tompkins

Did you have a follow-up? I didn't catch the…

Operator

Thank you. Our next question comes from Evan Kurtz from Morgan Stanley. Your line is open.

Evan Kurtz - Morgan Stanley

Hi. Good morning, guys. Thanks for taking my question.

P. Kelly Tompkins

Sure.

Evan Kurtz - Morgan Stanley

I just want to make sure I heard you right at the beginning of the call. I think you said that North American pellet realizations would be preferably kind of flat in the 110 to 115 range next year assuming flat year-on-year C.F.R. iron ore prices and [indiscernible]. If that's correct – we've heard recently from both AK and SR and kind of put press releases out there. They've renegotiated contracts and they seem to be fairly happy that pricing might come down for them. What are some of the offsets to that if you're able to keep pricing flat?

P. Kelly Tompkins

Well, the main offset of course is we're managing our cost and we've alluded to the full year impact of the new power deal that we have. But I think the more important thing to kind of keep in mind on this is we're looking at our U.S. IO business on a very holistic basis, on a long-term basis. It's the annuity business for Cliffs and so our primary objective at this point is then to secure long-term agreements, to secure agreements that have a positive impact on volume for 2014. You alluded to the comparability of pricing we expect to see in '14 and bring out Northshore, get just further fixed cost leverage. So we're not focused on any one or two particular contracts. It's really looking at the overall business and from our standpoint; we're very pleased with both these contracts and hope we can lock in some other long-term ones as well.

Evan Kurtz - Morgan Stanley

Got you. And then just maybe one more on Bloom Lake. I think you said on the last call that you're opening up several faces in the pit and trying to work on the sequencing issue between the magnetite and hematite no feed problem. I wanted to then sort of update there. Did you learn anything new or are you getting a little bit closer to maybe solving that issue?

P. Kelly Tompkins

From our operational standpoint, again, we either focus in on opening up these pits and get the right spot, pile the right blend to be able to fill – feed the first mill Phase I [indiscernible] our yields out of that mill. But from a standpoint of that's it really around the mine blend at this point in time, I think the concentrators offer and as expected bring volatile sort of mixes into it, you're going to have a mixed performance. But right now I think the team's doing a good job of getting the maximum yield out of the mill.

Terrance Paradie

This is an area too where we look forward to Gary coming on board and have an opportunity with his – the extensive operating background, experience particularly in Canada that he has – we think he'll be able to take a real objective, critical look at what we're doing and see areas for improvement. So that's another key factor.

Evan Kurtz - Morgan Stanley

Got you. And maybe just one last one quickly on coal, if I could. I know a bunch of questions have been asked on pricing already for 2014 but if you look in the 10-K, I think you said last year that you did about two-thirds on the export market and one-third domestic contracts. Is that still a pretty good number that we should think about going forward?

P. Kelly Tompkins

I think historically we are probably more of a 50-50 one for domestic and international and I think that's sort of what we're thinking for 2014 as well.

Evan Kurtz - Morgan Stanley

Great. That's really helpful. Thanks a lot guys.

Operator

Thank you. Our next question comes from Harry Mateer from Barclays. Your line is open.

Harry Mateer - Barclays Capital

Hi, guys. Thanks. A couple of questions. I guess first, so when you said you want to maintain your current debt profile, should we take that to mean that you'll not finance a potential gap between operating cash flow and CapEx with that?

Terrance Paradie

I think we have to deal with the situation as it occurs. We have some seasonality in our business in the first quarter with the Great Lakes being closed, but our ideal goal is to essentially fund our CapEx through operating cash flow. That's essentially where we want it as sort of our goal going forward.

Harry Mateer - Barclays Capital

Okay. And then if the [indiscernible] goes ahead and I guess what I'm trying to get at is what you mean when you say maintaining current debt profile? Is that maintaining like a debt to EBITDA ratio or keeping your debt balance flat or improving it?

Terrance Paradie

I think it's a combination. We look at all the metrics. Of course pricing has definitely an impact on our debt to EBITDA ratio. As you know we're in the first quarter next year, a holiday from a debt to covenant standpoint [ph] expires. So we often manage through that, but ultimately we'd like to keep our debt closer to the $3 billion mark.

Harry Mateer - Barclays Capital

Okay. In terms of maintenance CapEx, is there any sense you can give us for how that breaks down across the businesses?

Terrance Paradie

We'll provide some more outlook on that going into next call.

P. Kelly Tompkins

I think the key message was – yes, our CapEx we'll expect to be lower but we're not at a point yet to really get granular about our guidance for '14.

Harry Mateer - Barclays Capital

Okay. And then in terms of the revenue per ton guidance for next year and U.S. iron ore, you indicated you're kind of expecting roughly in line number for 2014 relative to 2013. Can you just lock the mechanics of that a little bit more given my understanding that on the contracts you guys assigned, there were some price concessions there?

P. Kelly Tompkins

Yes, all the – mainly it's about the mix and volume overall, so again as I said earlier we're not looking at our U.S. IO business let alone our price guidance for '14 through the lens of two customers. We're looking at it through the entire business and the portfolio of customers that we have and there's obviously a mix there depending on nomination. So it's a very holistic view to get us to that guidance.

Harry Mateer - Barclays Capital

Okay. Thanks very much.

P. Kelly Tompkins

You’re welcome.

Operator

Thank you. This concludes our Q&A session for today. I’d like to turn the conference back to Mr. Jim Kirsch for closing remarks.

James F. Kirsch

Thank you, Marie. I will just make a couple of quick comments. What we should be all about and we’re all about is improving and optimizing shareholder returns. In our mind we do that through a better and more efficient allocation of our capital and improved cost profile and ultimately better sales margins, which should lead to those enhanced returns. And as I think about the third quarter, which the guys have done a nice job of profiling for you, I call a good start. We’ve gotten a great start to improving those returns, a couple of other key accomplishments obviously Gary Halverson is on Board. He starts in November 18th. However, the onboarding process has already begun. I’m looking forward to his skill set and particularly his financial acumen and leadership helping us achieve our goals of improved returns.

Cost reductions, again a good start, continuous improvement, some other activities we’ve got going will enable us to continue to improve there. We’ve made good steps in protecting the U.S. franchise. We look at that very holistically and we like where we’re going in that direction. And then finally, the focus in recentering ourselves in terms of our capital allocation returns and focus on Bloom in terms its improvement and moving forward.

So again, third quarter is a good start. Our expectations are to enhance that and report that back to you in due course, and I appreciate and thank you for taking the time to join us on the call this morning. Thank you.

Jessica Moran

Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect at this time.

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Source: Cliffs Natural Resources' Management Discusses Q3 2013 Results - Earnings Call Transcript
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