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Cliffs Natural Resources (NYSE:CLF)

Q2 2011 Earnings Call

July 28, 2011 10:00 am ET

Executives

Laurie Brlas - Chief Financial Officer and Executive Vice President of Global Finance & Administration

Joseph Carrabba - Chairman, Chief Executive Officer and President

Steven Baisden - Vice President of Investor Relations & Corporate Communications

Analysts

Paul Massoud - Stifel, Nicolaus & Co., Inc.

Jorge Beristain - Deutsche Bank AG

Mitesh Thakkar - FBR Capital Markets & Co.

Anthony Robson - BMO Capital Markets Canada

Garrett Nelson - BB&T Capital Markets

Timna Tanners - BofA Merrill Lynch

David S. MacGregor

Shneur Gershuni - UBS Investment Bank

Brian Yu - Citigroup Inc

Michael Gambardella - JP Morgan Chase & Co

Operator

Good morning. My name is LaToya, and I'm your conference facilitator today. I would like to welcome everyone to Cliffs Natural Resources' 2011 Second Quarter Conference Call. [Operator Instructions] At this time, I would like to introduce Steven Baisden, Vice President, Investor Relations and Communications. Mr. Baisden?

Steven Baisden

Thank you, LaToya. I'd like to welcome everyone to this morning's call. Before we get started, let me remind you that certain comments made on today’s call will include predicative statements that are intended to be made as forward-looking within 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.

Joining me today are Cliffs’ Chairman, President and Chief Executive Officer, Joseph Carrabba; and Executive Vice President, Global Finance and Administration and Chief Financial Officer, Laurie Brlas.

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

Joseph Carrabba

Thanks, Steve. And thanks to everyone for joining us this morning. Pricing for our iron ore products continues to be near all-time highs, which contributed to another record-breaking second quarter for Cliffs. Now that we are well into the summer months, we are seeing the typical seasonality in steel pricing and production in both the U.S. and China. However, we continue to believe North American utilization rates will remain in the mid-70s range for the remainder of the year. Today, 31 of the 39 blast furnaces in North America are running and with additional startup announced and slated for the second half of 2011.

In China, June steel production was an annualized rate of approximately 700 million tons. This production increase from 2010 is supported by China's first half 2011 GDP growth of 9.6%. I believe these data points should be considered when the industry discussions for claim increased iron ore inventories at Chinese ports signal slowing demand for steel-making raw materials.

Also in Asia, we have been encouraged by Japan's progress, which has rebounded faster than many had originally expected. Overall, during the quarter, we continued down our path of integration and execution. Our chromite project is moving ahead as planned, with prefeasibility stated to be completed in the second half of 2011. During the quarter, we submitted our project description to the Ontario government. This week, the government officially accepted the report, which initiated the critical path to permitting. Our feasibility study is expected to begin in the latter half of this year and will extend into 2012.

The Consolidated Thompson acquisition is closed, and we are well on our way to quickly integrating Bloom Lake's operations. I will talk a bit more about Bloom Lake's production ramp-up, along with updates on our other capital projects within the business segment discussion. As I'm sure you are aware in last night's release, we have reorganized our reportable business segments to now include U.S. Iron Ore, Eastern Canadian Iron Ore, Asia Pacific Iron Ore and North American Coal.

Turning to our business segment performance for the second quarter. Sales volume in U.S. Iron Ore is virtually flat at 5.8 million tons compared with 5.9 million tons sold in last quarter's -- last year's second quarter. This includes approximately 220,000 tons of pellets from our U.S. operations going into the seaborne market. Taking shipping seasonality in consideration, this puts us on track to ship over 1 million tons of pellets from our U.S. operations in the seaborne market. As we mentioned last quarter, to meet this year's increased demand for iron ore, our U.S. Iron Ore mines are running at or near capacity. During the second quarter, we produced approximately 6.2 million tons of pellets, a 25% increase over last year.

Now turning to our Eastern Canadian Iron Ore segment. This segment is comprised of our Wabush Mines and the recently acquired Bloom Lake Mine. Sales volume for the quarter was 1.7 million tons, a 122% increase over last year's second quarter. The increase was a result of additional concentrate sales from Bloom Lake. We have owned Bloom Lake for just 6 weeks and have sold approximately 900,000 tons of concentrate from the mine. Also during the same period, we produced 1 million tons of concentrate, well on our way to reaching the 8 million ton annual production rate previously indicated. During the quarter, we also experienced temporary equipment outages at Wabush Mines, which slightly lowered Wabush's production volumes when compared to last year's second quarter. We have worked through these temporary challenges, and Wabush is back into full production.

Bloom Lake's ramp-up to 16 million tons is also on track and still slated to be completed in the latter part of 2013. After additional drilling at Bloom Lake Mine was completed, we announced our Phase 3 expansion to increase production capacity to 24 million tons per year. Although we are in the early stages of planning this expansion, I believe this project has fairly low execution risk, as we will be constructing yet another mirror image of the current operations.

In addition to these ramp-up projects, we recently completed some dock modifications at Point Noire. These modifications enable us to efficiently load larger capes -- Cape-class shipping vessels carrying about 180,000 tons. As we have discussed before, transportation is one of the largest synergy components we expect to achieve with the Consolidated Thompson acquisition. Through our integration process, we will continue to make logistics investments to optimize the strategic advantage of our rail and port assets.

Turning to Asia Pacific Iron Ore, second quarter sales volumes was flat at 2.2 million tons when compared to 2010 second quarter. Due to recent stoppages at the Port of Esperance during the quarter, we have reduced our Asia Pacific Iron Ore sales volume expectation to 8.8 million tons from our previous expectation of 9 million tons. Subsequent to quarter end, the Port of Esperance reached a new enterprise bargaining agreement with the unionized labor force, which we anticipate will bring an end to the work stoppages. We are maintaining our production volume expectation of 9 million tons for the full year 2011.

Construction continues on our infrastructure upgrades to increase Asia Pacific Iron Ore's annual production capacity to 11 million tons. Due to our accelerated efforts to complete this project in a timely matter, most of the major construction needed for bridges, rail passing loops, rail yard facilities and the new J1 Deposit haul road is now expected to be completed by the end of 2011.

Now turning to North American Coal. Primarily as a result of incremental tonnage acquired in the transaction of INR Energy's coal operations, we reported a sales volume increase of 76% versus 2010 second quarter. The incremental contribution from these operations more than offset year-over-year decreases in production volume of Cliffs' Pinnacle and Oak Grove Mines. Construction at Oak Grove Mine is moving along as planned after April's devastating tornado damage to the operations. The overland conveyor system is nearly complete and construction to restore the preparation plant is underway. Although this weather-related challenge hindered Oak Grove's turnaround, we are looking at the situation as an opportunity to upgrade the prep plant with more sophisticated technology. This will include better gravity flow and spiral equipment, which are expected to improve the efficiency of the plant.

Fortunately, the tornado damage at Oak Grove Mine has not significantly delayed our portal project, as we anticipate that will be completed and in use by September. Oak Grove's underground operations are fully functional, and we expect to stockpile approximately 1.5 million tons of raw coal. This will likely yield over 600,000 tons of clean coal equivalent, some of which we anticipate selling prior to year end.

Turning to Pinnacle Mine. Also during the quarter and as previously disclosed, unusual levels of carbon monoxide were detected in the mine. We are working with MSHA and other regulators to get back into longwall production as soon as possible before our current fourth quarter estimate. In early August, we expect to begin continuous minor development of coal panels that will help improve future production and efficiency. Our high vol met coal and thermal mines acquired last year from INR Energy continued to achieve record shipping levels, outperforming our plan for these assets. Lower War Eagle, one of the growth projects acquired as part of the transaction, is scheduled to commence production in November. In 2012, we expect this mine to contribute over 500,000 tons of high vol met coal to North American Coal production volume.

In summary, with the close of Consolidated Thompson, the second quarter 2011 marked a key milestone in the company's history. Although our legacy iron ore operations, which are the cornerstone of our business, performed well, we continue to be challenged by our North American Coal segment. I am however, steadfast in my belief that we will turn the corner with these operations. As many of you know, we recently hired Dave Webb, as our Senior Vice President, Global Coal. Dave's already hit the ground running in his first few weeks with Cliffs, touring the mines and completing his initial operation success.

At this time, I'd like to turn the call over to Laurie for a review of the financial highlights and our outlook for the coming year.

Laurie Brlas

Thank you, Joe. Echoing Joe's comments, the first half of 2011 has been quite eventful. We were pleased with the enthusiastic response and turnout at our recent Analyst and Investor Day in New York, and appreciated the opportunity to present our long-term strategy and plan for continuing to deliver shareholder value. As Joe indicated in his commentary earlier, our reportable segments have been reorganized. We have adjusted our prior year second quarter and year-to-date results retrospectively to reflect the new business segments.

From a financial standpoint, the second quarter of 2011 marked our fifth consecutive record-breaking quarter. Consolidated sales increased to $1.8 billion, which is 52% higher than the previous second quarter record of $1.2 billion set last year.

Increased prices for iron ore products and sales from our recently acquired Bloom Lake operations contributed to the quarter's outstanding performance.

Sales margin rose 76% to $731 million compared with $415 million in last year's second quarter. This resulted in operating income reaching $617 million up 69% from the $366 million posted in the previous year's comparable quarter. Net income improved to $408 million or $2.92 per diluted share, compared with $261 million or $1.92 per diluted share last year. I would point out that, as a result of our recent equity offering, our weighted average diluted share count increased by 4 million shares from second quarter 2010.

Turning to the business segment results. Our U.S. Iron Ore segment turned in a strong performance during the quarter. Average realized prices increased 47%, reaching $138 per ton, up from $94 last year. Costs were down slightly, primarily due to lower spending related to various large-scale maintenance projects that were in process during 2010 second quarter. Higher prices and lower cost compounded to produce a strong sales margin of $441 million or approximately $77 per ton for U.S. Iron Ore. This compares with $180 million in sales margin or $31 per ton last year.

In Eastern Canadian Iron Ore, second quarter revenues were $298 million, compared with $111 million in the second quarter of 2010. This increase was driven by higher year-over-year pricing and the additional incremental tons sold from Bloom Lake that Joe discussed earlier. Sales prices averaged $177 per ton, up 20% from $147 last year.

Cash cost per ton averaged $90, which was slightly lower than last year's cash cost of $93 per ton. We normally don't break down cost by mine, but due to the change in segments and the recent acquisition of CT, it is helpful to understand these results to look at it by mine. Wabush cash cost increased versus last year due to maintenance and stripping. During the 6 weeks we've owned CT, cash cost averaged $66, as we had a significant number of contractors on-site to complete the construction and to increase production. This is expected to be in the mid-50s by fourth quarter and under $50 per ton by year end.

Also during the quarter, costs were unfavorably impacted by noncash expenses of approximately $48 million related to the purchase of Consolidated Thompson. This is the inventory step-up in valuation of approximately 1 million tons of Bloom Lake Mine concentrates, which is required under purchase accounting. It translates to $29 per ton for this segment.

Turning to the Asia Pacific Iron Ore operation. Average revenue per ton in the quarter increased 41% to $173 from last year's $123. Average cash cost per ton was up 56% to $69, compared with $44 last year, due to unfavorable currency exchange rates, higher royalty expense and accelerated mining cost related to our capacity expansion. Sales margin per ton increased 53% to $93 from $61 in last year's second quarter. We do hedge against the Australian dollar, which mitigates the impact of currency changes. However, because the hedge is against revenue, it doesn't change the increase in cost, which are in Aussie dollars, it just protects the margin.

Now turning to North American Coal. Average revenue per ton decreased 18% to $119. The decrease was driven by a change in our current product sales mix from 2010. Last year's second quarter results were comprised exclusively of premium low vol met coal, which is sold at a much higher selling price. Cash cost for the quarter increased 18% to $114 per ton. This is primarily driven by the production challenges at Pinnacle and Oak Grove that Joe mentioned earlier. Although this segment was not profitable on a book basis, our year-to-date cash margin is nearly $10 per ton.

Sonoma Coal continued to post positive results in the second quarter. Sales volume for equity interest was 481,000 tons, which contributed $83 million to Cliffs' revenue and $32 million to consolidated sales margins. Amapá continues to ramp up production and contributed to earnings per share during the quarter, generating approximately $8 million in after-tax equity income. In addition, production volume for the second quarter was 1.2 million tons. I'd also point out that during the quarter, we recorded an $18 million impairment adjustment for our investment in AusQuest, which accounts for the equity loss reported in our income statement. This noncash charge relates to an investment we've held for several years.

Looking to the balance sheet. Cliffs had a busy quarter transitioning our capital structure for the longer-term. In June, we priced a 10.3 million share equity offering at $85.63, which netted us just over $850 million. At June 30, we held $238 million in cash and equivalents and long-term debt of $3.9 billion. During the quarter, we produced over $600 million in cash from operations versus about $170 million last year, an absolutely significant improvement. We're very comfortable with the condition of our balance sheet and overall financial condition, particularly given our cash from operations outlook of $2.6 billion, which is double 2010's record-breaking year. Based on this outlook, Cliffs' Board of Directors recently declared a 100% increase to our quarterly cash dividend, which brings our payout more in line with our peers.

Looking ahead to the balance of the year, we'll direct our focus on integrating recently acquired assets and working to bring the ongoing capacity expansions online as expected. Please note that we provided a detailed discussion of our outlook assumptions within last night's press release. We will use as our working assumption that iron ore pricing for the remainder of 2011 remains flat at the June 30 Platts 62% iron ore spot price of $171 per ton, as we provide our expected revenue per ton by segment.

For our U.S. Iron Ore business, 2011 sales volume is expected to be 25 million tons and anticipated per ton revenue is expected to be in the range of $130 to $135. We expect pellet production volume in U.S. iron ore to be about 23 million tons in 2011, with average cash cost per ton between $55 and $60. DD&A for the full year is expected to be $3 per ton.

Full year 2011 sales volume in Eastern Canadian Iron Ore is expected to be approximately 9 million tons and production volumes are expected to be 8.8 million tons. Revenue is anticipated to be approximately $170 to $175 per ton. Average cash cost per ton is expected to be between $85 and $90. In addition for full year 2011, we anticipate noncash inventory step-up cost of approximately $5 to $10 per ton and DD&A of approximately $15 per ton.

As Joe mentioned earlier, we've lowered our Asia Pacific Iron Ore sales volume expectation to 8.8 million tons from 9 million tons due to constraints at the port related to work stoppages.

Our revenue per ton has decreased to approximately $160 to $165, which is in line with the lower spot prices since we last provided guidance. Cash cost per ton at Asia Pacific Iron Ore is in line with our previous estimate of $60 to $65. DD&A per ton is expected to be approximately $12 for the full year.

Expected sales volume at our North American Coal segment has been reduced to 4.5 million tons as a result of the production challenges addressed by Joe. We expect to sell approximately 1.4 million tons of high vol met coal and 1.8 million tons of low vol met coal, with the balance being thermal coal. Average revenue for the full year is now expected to be $120 to $125 per ton. Cash cost per ton in North American Coal is projected to be between $110 and $115. Full year DD&A per ton is expected to be approximately $20 per ton.

At Sonoma Coal, we're maintaining our sales volume estimate of 1.2 million tons but increasing our production volume to 1.4 million tons. Sonoma's sales mix will be comprised of 1/3 met coal and 2/3 thermal coal. Full year 2011 cash cost is expected to be approximately $90 to $95 per ton and full year DD&A per ton is expected to be approximately $14. From Amapá, we anticipate generating over $35 million in equity income for the full year 2011. Based on our current expectations, we expect to generate about $2.6 billion in cash from operations in 2011.

Our CapEx budget remains unchanged at $1 billion, which is roughly $300 million in sustaining capital and $700 million related to growth capital projects, including spend for our Bloom Lake expansion, Asia Pacific Iron Ore expansions and bringing on the Lower War Eagle metallurgical coal mine.

We've made considerable progress over the last few years in our quest for expanding and diversifying Cliffs' revenue base and product mix. Our current capital projects, along with the close of our Consolidated Thompson acquisition, will only add to our cash flow generation momentum and financial strength.

We thank our employees and shareholders for their continuing support in the execution of our strategy, and most recently, in seeing our Bloom Lake acquisition to a successful close.

Steve, with that, let's open the call for questions now.

Steven Baisden

LaToya, could you give the instructions for asking a question?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Brian Yu of Citi.

Brian Yu - Citigroup Inc

Joe, Laurie, cost has been a major theme throughout the earnings season for others besides yourself. Can you touch on that just in terms of iron ore? We calculate about a $4 per ton increase in cost estimates in the current guidance. What's driving that? And then also on the coal side, too, if you could break out the delta between the production -- load production versus just industry-wide cost escalation, that would be great.

Joseph Carrabba

Let me start with the overall cost inflation. And I'm sure, again, not only through the theme of the earnings season but also the articles we've written, it certainly looks like shades of the last mining boom that we had from '04 to '08, where certainly pressures on cost are going to increase. We are not seeing the inflationary piece of that yet, as evidenced particularly in North America. Now a lot of the North American costs are due to maintenance timing, and we had an awful lot of heavy maintenance last year. If you remember the kiln ring we replaced at Tilden and the rotary car dump at Northshore. However, we continue to look for these inflationary pressures, Brian, that come on. But to date, the lag time hasn't caught up with us in North America. If you turn to Australia, you look at the costs that you see at this point in time, where they've increased. A lot of that is FX, that effect that you see coming in at this point in time. There is some effect on inflation in diesel fuels, obviously with the mines being run on diesel out there. But the other big piece of ours is the accelerated stripping that we're involved in, as we advance the mines into stripping and the ore uncovered as we get into 2011, when we move from '09 to '11. So it's a generic answer. We think inflation and cost pressures are coming in the back half of the year. But there's a lag time between what we have in inventories and the parts that will come through the system. But we really can't define that number and we maintain our guidance that you saw with the cost parameters. Laurie, do you have anything to add to that?

Laurie Brlas

Yes, I think on your question on the coal, about $30 per ton is really related to the recent challenges that we've had. So you can think about that on the coal side. On the iron ore side, as Joe said, we've certainly been challenged by the currency in Australia. In North America, we did bring our Consolidated Thompson costs up for the year, probably a little bit over what we had initially thought. We definitely still see ourselves getting to the guidance number by the end of the year, but we had to do a little bit of work in this first 6 weeks, and that certainly is impacting things. And then the other thing is sort of depends a little bit on the point within the ranges that we provide people, that where we end up and where you take the assumption is going to actually have a surprisingly large effect on how you think about that.

Brian Yu - Citigroup Inc

Okay. And then my second question is just on pricing. You used to provide sensitivities around seaborne price assumptions. And I don't think I saw that this time around. Is that something that you can disclose?

Joseph Carrabba

Yes, Brian, I think really the meaningful sensitivity would be in the U.S. Iron Ore business. I mean, most of our business has moved to a higher correlation with the Platts price outside of the U.S. Iron Ore. But we would estimate for every $10 increase in Platts, we'd see probably in 2012, an impact of about $4 a ton in our U.S. Iron Ore business.

Laurie Brlas

For the other businesses, you can just take -- we provided if it stays flat, here's what you get. You can look at what you think is going to happen to Platts over the back half of the year and adjust our number up or down with a pretty direct correlation.

Operator

Our next question comes from Jorge Beristain of Deutsche Bank.

Jorge Beristain - Deutsche Bank AG

Just wanted to clarify a little bit again some of the accounting issues related to Bloom Lake. If I understand, is the step-up for the inventory revaluation of $29 per ton, is that included in the new unified Eastern Canadian Iron Ore costs?

Laurie Brlas

It's a noncash. So when we give you cash costs, we are not including the inventory step-up in that number. And the inventory step-up has a very significant effect on this quarter. You'll still see a little bit of it come through in Q3, and then that will be gone, but it's all non-cash. It's related to the inventory that was on the ground at the time we purchased the asset.

Jorge Beristain - Deutsche Bank AG

So the main driver then of the lower sequential cost of Bloom Lake, if you highlight it, would be the deceleration in the excess labor that you're paying and sort of the start-up costs?

Laurie Brlas

Right. Yes, the numbers that I talked about were the cash costs. So if you look at the book numbers, you'll see a double benefit because you'll see the inventory step-up come off. You'll also see the cash costs come down.

Jorge Beristain - Deutsche Bank AG

Okay. And on your balance sheet, could you just clarify the impact of the equity raised then is included already in your net debt position as of the close of 2Q?

Laurie Brlas

Yes, that's correct because we paid off the bridge loans in June.

Jorge Beristain - Deutsche Bank AG

Okay. I was just a little bit surprised, though, that your interest expense was a bit higher than expected, and perhaps just because you took the money out a little bit ahead of time. But could you give us any color on what you forecast third quarter normalized interest expense would be? I'm not sure you reflected a full quarter in 2Q.

Laurie Brlas

There is certainly -- there is some noise in terms of fees with the bridge loan and so forth in the second quarter. There's quite a bit of noise on that. So we'll get back to you on exactly the interest number.

Jorge Beristain - Deutsche Bank AG

Okay. And then maybe just lastly on the coal business. If I understood what you were saying about the $30 sort of extraordinary cost per unit per ton down there. If you kind of strip that out over your most recent $97 -- I'm sorry, to $114 and you strip that out of your -- the $114 you subtract the $30, that kind of puts you in the ballpark of the sort of $80 cash cost guidance range that you guys have been talking about for a while. So it would seem that you're kind of already achieving that this year.

Joseph Carrabba

We're getting closer and closer as we go. As we said at Oak Grove, I think in the last quarter, that we really felt we were turning the corner at Oak Grove before the tornado hit with production results there. Again, we've got the new longwall in and running -- or will be running once we go through the regulatory process, and the new upgrades. So yes, we are starting to get into the numbers once we get up and running again at both mines that we projected, Jorge.

Jorge Beristain - Deutsche Bank AG

And then, sorry, just lastly on equity income. Again, a bit of a negative surprise there on that one-off charge you took, and now I understand that Amapá, in fact, did have profitability. And just quickly checking the numbers versus guidance, it would seem to imply you're looking for maybe $12 million or $13 million per quarter now of equity income from Amapá in 3 and 4Q.

Laurie Brlas

Yes.

Jorge Beristain - Deutsche Bank AG

Would there be any other kind of extraordinary equity losses that could offset that in the second half?

Laurie Brlas

We don't have anything on the horizon, no.

Operator

Our next question is from Shneur Gershuni of UBS.

Shneur Gershuni - UBS Investment Bank

I guess, my first question, because some have been asked and answered, but I was wondering if you could sort of walk us through kind of how you expect the sales to play out for the back half of the year. Based on your guidance, it seems the second quarter deliveries were kind of light and suggest that the back half is going to be quite a bit higher and so forth. I was wondering if you could sort of walk us through which quarter it's going to hit and what the logistics are involved.

Joseph Carrabba

Well, as you know, if you follow our business in North America, you know it is a very seasonal business, and it's always back half-loaded, as far as shipments go. If you look at the back half and off the outlook we've given of 25 million tons, we've shipped 11.3 million through the first half. It's always a slow first quarter, given where the locks are shut down. That's about 14 million tons we have to ship or about 7 million tons for the rest of the year in each quarter. If you look at 2Q of last year, we shipped 7.6 million tons, and we've exceeded those rates in numerous quarters in the past. So it's always a heavy shipping back half for us, as we get ready for winter once again and backload it. But again the shipping numbers that we're looking at are well within the range that we've produced in the past.

Shneur Gershuni - UBS Investment Bank

Okay. And then if I can shift over to the Canadian operation for a second, it kind of appears that there's clearly a different cost structure between Bloom Lake and the legacy Cliffs assets. The expansion that you're taking upon yourselves over the next couple of years, where can we expect those costs to lay out? I mean, is it going to be closer to Bloom Lake where you've got cost kind of in the 60s, or is it going to be closer to how Wabush has been playing out as of late?

Laurie Brlas

Yes, the costs for Bloom Lake for the additional expansion should be fairly consistent with what we've seen at Bloom Lake to date and what we expect for the current year. So basically, if you look at the total costs for the segment on a per ton basis, that will dilute the higher impact of Wabush. And also Bloom Lake is concentrate, Wabush is pellets, so there's always going to be a difference between those. So the short answer is I would suggest you think about it as just more tons at the Bloom Lake rate.

Shneur Gershuni - UBS Investment Bank

Okay. And one final question, if I may, kind of your cash flow from operations guidance. I was wondering if you can sort of present to us your kind of assumptions with respect to working capital drawdowns. Is that part of the calculation?

Laurie Brlas

Yes, we certainly do. If you look at our production and sales guidance, we expect to bring inventory down pretty significantly by year-end, so there is some involvement in that. We really haven't changed our guidance a whole lot since the last time we reported in total cash from operations. We've actually lowered our expectations out of our North American Coal business, added some significant cash generation from Bloom Lake, and the rest of it stayed pretty consistent.

Steven Baisden

Shneur, we've built quite a bit of inventory in the U.S. Iron Ore segment. We probably have about 6 million tons on the ground. As Joe alluded to, as we sell through quite a bit of tonnage in the second half, that should come down significantly.

Shneur Gershuni - UBS Investment Bank

So at this point in time, you feel fairly comfortable with that number?

Laurie Brlas

Yes, we do, yes. We actually don't have working capital in total being drawn down at all.

Operator

Our next question is from David MacGregor of Longbow Research.

David S. MacGregor

Any middle settlements in this quarter? Or was that all in the first quarter?

Laurie Brlas

Well, the middle settlement, it was -- it happened in the first quarter and what we included in the first quarter were some retroactive effects that really related to tons that were sold in 2010. We certainly had some tons that the pricing of those tons was impacted by the settlement, but they were tons that were just sold in the quarter and are priced in the quarter, not specifically differentiated by the settlement. In fact, the tons under that will continue to increase, we expect, in terms of the pricing that we get over the next couple of quarters and next year.

David S. MacGregor

Got it. The SG&A, up about 20% in your guidance, $240 million increase. I guess, there's a lot going on in your model this year, obviously. But are there some big pieces in there you can really highlight for us to help us understand that increase?

Laurie Brlas

Sure. There's a small piece that would've been the base increase, but that's very small. We had significant, as you can imagine, expenses involved in the acquisition of CT, lawyer fees, bank fees and various types of things like that, which probably account for about $20 million. There's another about $10 million that is related to the Montreal operations, that the SG&A that we essentially acquired from CT. So part of that would not recur next year, part of it is still likely to be recurring next year.

David S. MacGregor

And then just finally, I wondered if you could just give us a sense to where the spot pellet price would be today. I know the Platts number everybody refers to as a finds price, but just in terms of the pellet premium. And where is that market today, FOB, the Northshore, the St. Lawrence?

Steven Baisden

Yes, David, you've heard a lot of kind of commentary in the media around the pellet premium shrinking. I think FOBs in Canada, you'd be looking for pellets around $180 a ton right now.

David S. MacGregor

$180. And can you give us concentrate price as well?

Steven Baisden

Yes, it's about the same as the Platts price, but you have to back up the $30 for freight, so probably $140, $150, something like that.

Operator

Our next question is from Tony Robson of BMO Capital Markets.

Anthony Robson - BMO Capital Markets Canada

Couple of, obviously, one-off costs in your results, rather nice. One of them is, from a previous question, was interest at $81 million. And I heard, Laurie, you said you'd come back to us on that. But can you remind us what your weighted average interest rate is for your debt, please?

Laurie Brlas

About 5%.

Anthony Robson - BMO Capital Markets Canada

Okay, so obviously, a strong cash flow, you'll be paying that down?

Laurie Brlas

We certainly do have the option to pay some of it down. That's the way we actually structured the mixture of the term loan and some of the public debt so the term loan, we have the opportunity to pay down if we choose to do so with no penalty or anything. So that'll be the first piece we look at.

Anthony Robson - BMO Capital Markets Canada

Right, okay, great. In terms of your profit and loss statement, you said -- well, sorry, your expenses -- sorry, your spending, I should say, $65 million to $70 million on Global Exploration. Will you expense that in your P&L or capitalize it?

Laurie Brlas

It's actually a mixture. It depends on the types of investments that the team makes. It's historically been a mix, probably 50% to 60%, 70% of it is expense and the rest becomes capitalized or investment from the balance sheet. It depends on the nature. We kind of give them budget and don't expect them to do accounting and understand the differences.

Anthony Robson - BMO Capital Markets Canada

Sure, I understand. And a final question for Joe, if I may. Thank you for the additional explanation on Wabush being a little low for the quarter, can we assume normal run rate at about 5 million to 5.5 million tons a year?

Joseph Carrabba

I think we're around 5 million tons, Tony, would be a more accurate number. They did work through their problems of the quarter, and they're back up and running and moving forward. So I think 5 million would be more accurate.

Anthony Robson - BMO Capital Markets Canada

And that again for 2012?

Joseph Carrabba

Yes.

Operator

Our next question is from Timna Tanners of Bank of America.

Timna Tanners - BofA Merrill Lynch

I wanted to just touch base with you. I think we've talked about the costs in the North American market and on the Asia Pacific side, you talked more about cost pressure into the second half of the year. But full year guidance only went up $1 per ton and the second quarter was pretty -- was steeper. So I'm just wondering if I'm missing something that was one-off in the second quarter, if there's risk for more cost pressure further into the second half.

Joseph Carrabba

Well, as I said, Timna, there's probably a lag effect. I mean, everybody is concerned about inflationary pressures in the mining business right now, which in an up-cycle is to be expected. We haven't seen them to date at this point in time. As they come forward, we continue to look for that. Our procurement team has a lot of our expenses, going forward, locked in. Our wage rates are locked in for the most part for the balance of the year as well. So but we do -- we are very concerned about cost pressures in the second half, but we don't have anything to report at this time.

Timna Tanners - BofA Merrill Lynch

Okay, that makes more sense. And then I know you talked about this on your Investor Day, but I wanted to hear a little bit more. You upped the amount of exploration expense, and can you talk a little bit more about any progress, insights, or where you're kind of focused on right now?

Joseph Carrabba

Well, we're focusing mainly in -- we've got several areas in Canada that we're focusing on in that part of the world. And we've got some focus down in South America at this point in time in some of our regional areas. We haven't stepped out really beyond the areas that we've discussed in the past. We're not in Africa doing an exploration or anything of that nature. And exploration opportunity comes and goes as the deals flow in and out. So that's where the numbers are coming from.

Timna Tanners - BofA Merrill Lynch

Okay. And then one last one, if I could. On the stockpiled coal, just trying to get a sense of what prices those might sell at. Are you committed to selling at the contracted price or at a price prevailing when you were first expected to have shipped those tons? Or can you offer those more on a price that may be prevailing by the time you can ship them? So in a rising coal price environment, can you get the increase or not, I guess, is the question?

Steven Baisden

Yes, Timna. Generally speaking for the force majeure tonnage, it will be repriced at whatever the prevailing market price is. I mean, we do have some obligation to supply coal under some of the contracts at the previous rate. But for the lion's share of it, it would get repriced.

Operator

Our next question is from Michael Gambardella of JPMorgan.

Michael Gambardella - JP Morgan Chase & Co

I have a question on your release, the chart where you have 2011 outlook summary. On the cost side, the cash cost side, under Eastern Canadian Iron Ore, do you refer to Eastern Canadian Iron Ore as Wabush and Bloom?

Laurie Brlas

Yes, it's the 2 added together, yes.

Michael Gambardella - JP Morgan Chase & Co

Right. So like I'm trying to figure out how you go from -- how you get up to $85 to $90 per ton cash cost for 2011 when Wabush and Bloom, in terms of volumes, are about 50-50?

Laurie Brlas

Yes, that's correct.

Michael Gambardella - JP Morgan Chase & Co

And Bloom you're saying that since you've owned it, it's about the cash costs are around $66 a ton. And in the fourth quarter, Bloom, you're going to see cash costs in the mid-50s, and you've just said that Wabush cash costs were $90 a ton.

Laurie Brlas

It was $93 last year because last year's segment was only Wabush. And they were up this year from what they were last year. So you're going down the right path. Wabush cash costs are pretty high.

Michael Gambardella - JP Morgan Chase & Co

So your Wabush cash costs, what is the increase from the $90? I mean, that you must have cash costs up near around $140 then.

Laurie Brlas

You're right. It's about half and half, Wabush and Bloom Lake. The number we provided is essentially the average of the 2, and we said that Bloom Lake is about $55.

Michael Gambardella - JP Morgan Chase & Co

But how could Wabush cash costs go from $90 to $140, $145?

Steven Baisden

It's probably currency-related, Mike, the Canadian dollar strengthening. Part of it is...

Michael Gambardella - JP Morgan Chase & Co

Not that much.

Steven Baisden

Right, well, portions of it. Part of it is increased stripping costs and maintenance costs at Wabush. And there's probably some other things in there that I can follow-up with you on after the call.

Michael Gambardella - JP Morgan Chase & Co

Okay. But on the Bloom side, you're confident you're going to see costs go down below the mid-50s beyond this year.

Laurie Brlas

That is our full year guidance, yes. We're going to see them go down to the mid-50s. We're going to end the year looking at around $50. I think you're probably looking at Wabush being in there at about $110, $150. It's not quite as high as you're thinking. It's probably $115 or so.

Joseph Carrabba

Right, right.

Michael Gambardella - JP Morgan Chase & Co

Okay, so then as you ramp up Bloom, obviously, you'll take down that iron ore, that Eastern Canadian Iron Ore cash cost component?

Joseph Carrabba

Yes. And again in the second quarter, Wabush did have its struggles in the second quarter. It's unfortunate that in our first reporting and breakout that Wabush went the other way. But they've worked through some pretty big maintenance problems that they had up there in the second quarter. And we do anticipate them getting back on track for the rest of the year.

Operator

Our next question is from Mitesh Thakkar of FBR & Company.

Mitesh Thakkar - FBR Capital Markets & Co.

Can you talk a little bit about just the end market demand, what you are seeing more so domestically and a little bit on the Chinese side? If you look at the spot prices of where the finds are on the ore side, and Asia seems pretty strong. So can you talk a little bit more about the U.S. guys, what you are seeing from them?

Joseph Carrabba

Sure, in the U.S. again, we've still -- through our guidance, what we look at is blast furnace utilizations. We plan the year in the mid-70s and we still see that and maintain that outlook as we go forward in the U.S. industry. We now have 31 of the 39 blast furnaces in North America that are up and running. The L furnace has been blowing back in over at Sparrows Point, as you know, under the new ownership. So there's -- we still maintain, not an uptick in North America, but we see steady as she goes in the second half of the year with blast furnace capacity. In China, as you see, the projections coming off are 700 million tons, another increase again this year in steel capacity and prices are being maintained, if you will, rather strong through the summer. So we still see China running at a very strong rate. And we see Japan starting to come back into the market once again, as they're really starting to accelerate in that country, we're bring back manufacturing plants back on play. So it bodes well for some strength in Japan in the latter half of the year.

Mitesh Thakkar - FBR Capital Markets & Co.

And are you seeing any -- in your discussion with your domestic customer, are you seeing any intention from them to kind of defer that over into the first quarter or something like that?

Joseph Carrabba

There's always quarter-to-quarter activity. There's always maintenance shuts that makes sense to the customers to move them up or move them back. We've got the normal noise and seasonality, if you will, that comes with that, but nothing dramatic to report in today's call.

Mitesh Thakkar - FBR Capital Markets & Co.

Okay, great. And one final question. You are generating some very solid operating cash flow. I know a couple of quarter down the lane, you'll be starting to look at options. Is paying down debt a better option at this point, as well you feel or expanding, maybe look at some assets outside or something like that?

Joseph Carrabba

Well, we continue, as we've said all year, we're going to integrate and execute this year, and that's the track that we're taking. If you look at the growth profile that we showed during the Analyst Day of just the organic work we have in place, we really don't have a need to go external at this point in time. Paying off the debt is always something that the financial folks will take into consideration, looking at all the external environment of the world as it stands right now. We're going to keep a healthy balance sheet as we go forward, given the volatility of the world economy as it stands. But basically, it's integrate and execute this year.

Operator

Our next question is from Paul Massoud of Stifel, Nicolaus.

Paul Massoud - Stifel, Nicolaus & Co., Inc.

The 1.8 million tons of low vol met, how much of that has already been sold this year? And how much are you modeling for the fourth quarter? I mean, is it safe to assume there's a significant portion that's expected to be sold in the fourth?

Steven Baisden

Yes, I mean, we don't -- we would only have...

Laurie Brlas

It's already sold.

Paul Massoud - Stifel, Nicolaus & Co., Inc.

Most of it is already sold?

Laurie Brlas

Yes.

Steven Baisden

I mean, Paul, if you consider that we're anticipating only starting up Pinnacle in the fourth quarter and we don't anticipate washing any coal at Oak Grove until December, most of those sales have already occurred.

Paul Massoud - Stifel, Nicolaus & Co., Inc.

And are you still expecting -- I think at the Analyst Day, you had said you were expecting about 5 million tons of low vol next year. I mean, is that still the case?

Laurie Brlas

Yes.

Joseph Carrabba

Yes, that's right, Paul.

Paul Massoud - Stifel, Nicolaus & Co., Inc.

Okay. And then just thinking about the seaborne U.S. Iron Ore sales that you had, the 220,000 tons in the second quarter, can you give us a sense of where that went globally? I mean, did it all go into Asia? Or did you see some go into Europe, for example? I mean, where exactly was that sold?

Joseph Carrabba

It all went into Asia.

Paul Massoud - Stifel, Nicolaus & Co., Inc.

It all went into Asia. And right now, it's about $30 a ton to ship it out there?

Joseph Carrabba

That's right.

Operator

Our next question is from Garrett Nelson of BB&T Capital Markets.

Garrett Nelson - BB&T Capital Markets

My iron ore-related questions have been answered. But on the coal business, you're expecting production to outpace shipments by about 900,000 tons this year. Can we assume that delta is all Oak Grove low vol met?

Joseph Carrabba

Yes, that's almost where it all is. We will ship everything else we make from the small production we're getting from the development at work down at Pinnacle. We've got the small CM sections that are running down there and everything will be shipped minus the raw coal that's on the ground at Oak Grove.

Operator

[Operator Instructions]

Steven Baisden

LaToya, if there's no further questions, we can go ahead and wrap up the call.

I'd like to thank everyone for joining us today, on behalf of the entire Cliffs management team, we appreciate your interest in the company. Both Jessica Moran and I will be available for the rest of the day if you have follow-up questions, so feel free to give us a call. Thanks.

Joseph Carrabba

Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Thank you.

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