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Mechel OAO (NYSE:MTL)

Q3 2011 Earnings Call

December 15, 2011 9:00 AM ET

Executives

Vladislav Zlenko – Investor Relations

Yevgeny Mikhel – Chief Executive Officer

Stanislav Ploshchenko – Chief Financial Officer

Oleg Korzhov – Vice President, Business Planning and Analysis

Analysts

Dmitriy Kolomytsyn – Morgan Stanley

Sergey Donskoy – Societe Generale

Mohammed Zaidi – Martin Currie

Zaurbek Zhunisov – Troika

Vasily Kuligin – Renaissance Capital

Valentina Bogomolova – Uralsib

Denis Gabrielik – Otkritie

Erik Danemar – Deutsche Bank

Dennis Ver – Prosperity

Operator

Welcome to Mechel Reports Nine Months 2011 Financial Results. My name is Tina, and I will be your coordinator for today’s conference. For duration of the call, you will be on listen-only and at the end of the call you’ll have the opportunity to ask questions. (Operator Instructions)

I’m now handing over to your host, Vladislav Zlenko to begin. Please go ahead, sir.

Vladislav Zlenko

Thank you, and good day, everyone. I would like to welcome you to Mechel’s conference call to discuss our nine months 2011 results, which were reported today. With us from management today are Mr. Yevgeny Mikhel, Mechel’s CEO; Mr. Stanislav Ploshchenko, Mechel’s CFO; and Mr. Oleg Korzhov, Mechel’s Vice President for Business Planning and Analysis. After management has made their formal remarks, we will take your questions to the presentation team.

Please note that during this call, management will make forward-looking statements, some of which may have been made in the press release. Some of the information on this conference call may contain projections or other forward-looking statements regarding future events or the future financial performance of Mechel as defined in the Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995.

We wish to caution you that these statements are only predictions, and that actual events or results may differ materially. We do not intend to update these statements. We refer you to the documents Mechel files from time to time with the United States Securities and Exchange Commission, which contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

In addition, we will be using non-GAAP financial measures, including EBITDA in our discussion today. Reconciliations of non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures are contained in the earnings press release, which is available on our website at mechel.com.

At this point, I’d like to turn the call over to Mechel’s CEO, Mr. Mikhel. Please go ahead.

Yevgeny Mikhel

Good day and good morning to you, ladies and gentlemen. Welcome to the conference call on the company’s performance over the nine months of 2011. I will start today’s presentation with a general overview of the work done and on the current situation, and then I will pass the floor to the Senior Vice President for Finance, Stanislav Ploshchenko, who will cover financial results.

Company’s performance in the nine months of the year and in the third quarter can be said to be quite good. Key performance -- financial performance indicators in the nine months of 2011 have significantly surpassed similar indicators for the previous year. Consolidated revenue for -- Mechel for nine months of 2011 amounted to about US$9.6 billion, EBITDA at US$1.9 billion and net profit US$527 million.

The third quarter wasn’t bad either, despite the worsening of pricing environment for many products, we managed to demonstrate the growth of operational profit in comparison with the second quarter by 11% it reached US$529 million and EBITDA increased by 11% to US$678 million.

On the whole the previous quarter has seen a series of achievements which testifies to the continuous improvement of company’s quality and its consistent progress in line with the strategy for business development. At the previous conference call, we discussed the successful launch in August this year of coal production at Elga deposits.

In parallel was the gradual build-up of the production we continue the work to construct the relevant infrastructure and in the future we plan to bring the deposits to its designed capacity of 27 million tons of coal a year.

In accordance with the plans need already till the end of this year, that is to say in the remaining two weeks of the year, we will complete construction of the railway to the deposit itself. In the third quarter, we started construction of a seasonal washing plant and this way, production of coking coal concentrate of the deposit will begin in the second quarter of the next year.

In reporting periods, there were several other advancements towards higher efficiency of the Elga projects in the future. We have made considerable headway in the implementation of the programs to upgrade and expand capacities of the port Posiet, which is our export gateway to the Asia-Pacific region. Already at the end of 2012, we intend to bring the capacity of the Posiet anywhere between 7 million and 9 million tons.

In the third quarter, we have also implemented a number of measures aimed at ensuring stability of future freight traffic from Elga. In particular, a contract was made to buy 18 locomotives that will be used at the 315 kilometer railway track, Ulak-Elga that connects the Elga coal deposits with the by car and more mainline.

These locomotives will have several special features that will enable their utilization in mountainous terrain and in severe climates. We have always -- we have also made progress in supplying the Elga fleet with the special mining equipment.

We signed a long-term contract, an agreement of cooperation with one of the world leaders in production manufacturing of mine dump trucks, which provides for large scale program of acquisition of this machinery.

We are also actively implementing the program to acquire new clients and to master new prospective markets for the sale of coal products. One of such prospective markets is India. Currently, the volume of deliveries of coal into this country is sufficiently lagging behind from the volume supplies to other countries of the region, mainly China, Japan and South Korea. We know that South Asia has a lot of potential and that’s why in September in India, we established a joint venture that will be in charge of distributing metallurgic coals in this market that grows very fast.

The Steel segments did very well in the third quarter and one of the contributing factors was the delayed seasonal demand for construction loan products, as well as the reduction in the cash cost on all main items of products against the background of correction of prices on feedstock. The Blast furnace №5 at Chelyabinsk Metallurgical Plant was started in the third quarter after scheduled repair and this gave a positive effect on the financial performance of the Steel segment.

The cash cost of billet at TMK in the third quarter fell by more than 10%. Given the favorable pricing environment in the Russian market, we emphasized domestic sale of the products produced by the Steel segment of the company, which contributed to improvement of the division’s economics.

Reduction in export deliveries generated an added value in terms of lower sales costs and as a result, operational process in the Steel segment in the third quarter grew by more than 241% and amounted to US$116 million.

In the Ferroalloys division, I have to say that in accordance with the previously announced plans, we started the 12-megawatt furnace at the South Urals Nickel combined plant. This was done within the framework of the schedules switching of the plants to a more efficient technology of nickel ore smelting using electrical furnaces. Migration to this technology will enable the reduction in cash cost and it will also enable the growth in the nickel production through the -- through higher recovery rate of nickel from ore.

In early December, we had a startup of the chrome builds workshop at the Tikhvin Ferroalloy plant. This will increase the capacity of the smelt furnaces and will also boost production of marketable chrome. In the near future, we will complete the reconstruction of furnace #4 at the Bratsk plant of ferroalloys within the framework of this project for its technological upgrade.

In conclusion, I would like to know that we have meet considerable progress during the year in our investment program across all divisions in the Mechel group. At the same time, given the negative phenomena that we observe now in the global economy since the middle of the year, we reviewed the volume of investment, capital investments that will have to be made till the end of this year and in the next year. There is another priority of strategic projects and one such priority projects are Elga deposits and the construction of Universal Rolling Mill and the Chelyabinsk Metallurgical Plant.

Besides in the fourth quarter, we reviewed our production plan given the current market situation. We wanted to do this to minimize the impact of the market volatility on our financial performance and cash flows. I’m sure that such measures will enable stable development of the company in the short run and will lay the basis for its dynamic growth in the future.

And now I would like to pass the floor to our Senior Vice President for Finance, Stanislav Ploshchenko, who will give you all the details about the financial performance in all segments of our business. Thank you for your attention.

Stanislav Ploshchenko

Good afternoon and good morning, ladies and gentlemen. Today we’re reporting the third quarter of 2011, which has been the biggest contributor to the Group’s financial results so far this year. Although the commodity markets remain buoyant in the reporting quarter, most of the positive dynamics came from the Steel segment whose operating results more than tripled.

However, before discussing it in greater detail, let’s traditionally review the performance of the mining segment. As reported before, the Yakutugol washing plant reached full capacity towards the end of the second quarter, which allowed us to increase shipments of low coal concentrate in Q3 by 280,000 tons.

During the same period, however, Southern Kuzbass was impacted by a loss production from the shutdown of our Sibirginskaya mine which resulted in a roughly 90,000-ton decrease in net sales quarter-on-quarter.

At Bluestone, sales decreased by about 60,000 tons due to relative decrease in export volumes during Q3. Domestic sales are generally down, FCA, whereas export sales are down on an FOB ocean port basis. The decreased volume quarter-on-quarter reflected in fact an increase in volumes and route to an ocean port.

The increase at Yakutugol along with the decreases at Southern Kuzbass and Bluestone netted to an overall increase of 150,000 tons, which delivered an additional $49 million of revenue.

The combination of higher shipments of hard coking concentrate to the seaborne market versus lower domestic sales of semi-hard and semi-soft grades also resulted in slight uptick in average realized price, whereas the contract price for the third quarter in fact as you know was lower than second one.

Sales of anthracite and PCI were almost flat quarter-on-quarter both in volume and price. The sales of thermal coal grew by around 190,000 tons, which is the period when the power generation restocks for the winter.

The realized price has, however, gone down by 6% quarter-on-quarter as a big part of that coal was slow Middle East, where output increased along with the growth of coking concentrate production. Iron ore sales edged slightly up both in volumes and price. The above factors combined for an overall 4% quarter-on-quarter increase in the revenue from sales to the third parties to $1.15 billion in Q3.

Cash cost across mining operations were generally stable except for Yakutugol, which experienced a marked improvement with a $5 per ton decrease from $37 to $32 per ton, roughly $4 of that decrease was attributable to its having re-attained most of the operating efficiency that was lost as the result of the accident at the Nerungri wash plant, which we have previously discussed.

The weakening of the ruble relative to the United States dollar benefited to our Russian mining operations as a whole by about $1 per ton.

Southern Kuzbass also experienced slightly lower maintenance expense during the period, thereby enabling it to reduce cash cost by $2 from $37 to $35 per ton, both Bluestone and Korshunov mining plants cash cost edged up by $2 per ton, which was primarily related to higher maintenance.

Overall, cost of sales increased by 10% to $613 million, which in combination was increased sales volumes of 7% led to 5% quarter-on-quarter decrease on gross profit to $785 million in Q3. The additional cost beyond the proportional increase on the back of increased production, primarily related to purchases of third-party coal of caking quality for our coke production, where the upward price trend was witnessed throughout the whole reporting period as domestic prices generally lagged behind the international benchmark indications. In December, we started test shipments of Elga’s coal to our coke plant, which in perspective may replace the third-party coal completely.

Selling and distribution expenses increased by 14% to $265 million, the increase related to additional transportation plus both rail and sea incurred as a result of a 7% volume increase quarter-on-quarter, as well as increases in coal exports to Kazakhstan on CPT and DAF terms.

General, administrative and other operating costs decreased by 25% to $76 million. The decrease was driven primarily by $20 million decrease in payroll and $9 million decrease in other operating expense as we incurred substantially fewer costs related to remediation works at Sibirginskaya and Olzherasskaya new mines.

All of the above translated into an 8% quarter-on-quarter decrease in EBITDA to $512 million or 37% of the revenue versus 40% in the second quarter. The EBITDA margin decreased quarter-on-quarter from 40% to 37%. For the first nine months of the year, the EBITDA margin for the mining segment also stands at 37%.

Net interest expense for the mining segment increased by $15 million, mainly due to $12 million reduction in interest receipt as a result of repayment of intra-group debt, the profit tax fell by 56% to or $67 million due to high tax asset carried forward at our coke plant and lower profit of our Russian entities under national standards affected by the fixed loss, which resulted from significant fluctuation in the ruble dollar exchange rate for the period. The effect of the currency translation adjustment for the entire segment in Q3 was a negative $290 million, resulting in a net income for the segment of $14 million.

Overall for the first nine months of 2011, the mining segment’s revenue grew by 43% to the same period last year to $3.79 billion. The gross profit demonstrated the same rate of growth to $2.144 billion, the gross margin improving on a slightly from 54% to 55%. The EBITDA grew by 36% to $1.431 billion represented 37% of the revenue versus 38% last year. The net income of $631 million was only 18% higher than the last year as the segment posted a $99 million negative FX adjustment versus a $19 million positive figure for the compared period.

The realized prices in the Steel segment remained largely flat in the reported period with appearing downward trend by the end of the quarter. Thus the FCA price of both wire and stainless flat steel decreased by 7% quarter-on-quarter, whereas the price for alloyed long steel products decreased by 5%. At the same time the rebar prices went up 4%.

The sales volumes in physical terms fell by 18% quarter-on-quarter entirely at the expense of our third-party resale operations as we reduce purchases of billet from third parties. Its sales consequently fell by 57% in Q3 to 11% of the segment sale versus 23% in the previous quarter as you can see on slide number eight.

Net reduction and revenue was partly compensated by the restart of the blast furnace and the converter idled at Chelyabinsk steel plant for modernization in the second quarter. So that is demonstrated by the growth of third-party alloyed long and stainless flat steel sales which posted 20% and 19% quarter-on-quarter increase respectively.

The combination of these factors led to a 13% decrease in the segment’s revenue from third parties to $1.796 billion. Cost of sales fell by 16% at the same time, which was mostly due to the increase of production in Chelyabinsk following the re-launch of the previously idled aggregates.

The combination of cost of sale failing -- falling faster than the revenue resulted in a 6% quarter-on-quarter growth in the gross profit, which posted $334 million in the reported period or 18% of the revenue versus 15% in the previous quarter.

The reduction in sales in the third quarter entirely affected exports with direct effect on selling and distribution expenses, which fell by 25% quarter-on-quarter to $136 million or 12% of the revenue versus 13% in the previous quarter.

The administrative expenses also fell by 14% to $67 million largely as a result of payroll reduction. Net debt allowance fell by almost $6 million to only $3.3 million as some of the specific provisions made for receivables and remain in Kazakhstan in the second quarter will not increase in the third one. That all resulted in 22% quarter-on-quarter decline in operating expenses to $218 million.

The combination of high gross income and reduction in operating expenses translated into 2.3 times jump in the segment’s EBITDA to $153 million. The EBITDA margin improved from 3% in the previous quarter to over 8% in the reported one.

The net interest expenses remained virtually unchanged at $84 million, income tax expense increased by 16% to $4.8 million in line with the profitability growth. The FX loss of $22 million was not significant for the segment as most of its loan portfolio denominated in rubles which means that foreign exchange fluctuations do not affect its P&L as much as the mining one, even if the FX loss could not handle the segment return into profitability on the net basis, on the back of the growing operating result posting the net income of $18 million versus $71 million loss in Q2.

For the first nine months, the Steel segment posted the revenue from third parties of $5.6 billion at 40% growth over the similar period of 2010. The gross profit rose 19% and exceeds $1 billion. EBITDA increased by 31% to $369 million over the same period whereas the net income before the FX effect decreased three times to $21 million due to substantial increase in net interest expenses resulting from more debt incurred by or transferred to the segment from other ones, as well as high income tax expenses, that improved into 2011 due to the fact that the tax loss carried forward from the crisis year had all been used up in 2010.

The results of the Ferroalloys segment were mixed in the third quarter as we saw different dynamics in price and sales volumes in different products. The downward trend in prices was more pronounced in nickel and ferrosilicon whereas the FCA price, where the FCA price decreased by 14% and 11% respectively, whereas chrome price decreased by 6%. And the sales volumes of chrome grew in physical terms by 21% as the ramp up at Voskhod mine continued.

The nickel sales volumes were 21% lower than in the previous one due to the fact that for the second quarter, registered carry over volumes from the first one and that was not the case in the reported quarter.

The sales volumes of ferrosilicon decreased by 19% in physical terms due to the continued modernization of one of the four furnaces. The combination of lower prices and volumes despite growing chrome sales resulted in a 21% quarter-on-quarter decrease in revenue from third parties to $104 million.

Intersegment sales also decreased by 15% to $60 million. The cost base was also mixed with cash cost for nickel and chrome decreased by 14% and 12% respectively, due to fall in input prices for coke, chrome concentrate and electricity. Cash cost for chrome concentrate also went down by 5% as production at the mine ramped up.

The cash cost of ferrosilicon on the contrary, inflated by 5% due to higher fixed cost resulting from idling one of the four furnaces for modernization as announced previously in our CapEx program. The resulting picture was a 12% decrease in cost of sales, which in combination with a higher fall in revenue ended up in a gross profit of only $2 million versus $19 million in the previous quarter.

The selling and distribution expenses grew by 29% to $7 million all due to growth in chrome and ferrosilicon export sales, in a latter case at the expense of the domestic market, offsetting lower nickel export sales.

The administrative expenses decreased by 19% mostly due to decrease in payroll. However, that was not significant to compensate for the growth in selling expenses, which resulted in operating expenses going up 11% quarter-on-quarter to $22 million. Consequently, the segment’s EBITDA went down to just to $2.9 million versus $19 million in the previous quarter.

Net interest expenses halved in the third quarter into just $8 million as some of the external debt was repaid including the financing trace back to the acquisition of ferroalloy resources and allocated to the Ferroalloy segment.

In the third quarter, the segment posted an FX gain of $16 million due to resolution of dollar-denominated intra-group loans extended throughout the segments of the Group. The FX gain helped to reduce the net loss to $9.7 million from the reported period from $20 million in the second quarter.

For the first nine months of 2011, the Ferroalloy segment increased its revenue from third parties by 9% over the same period last year to $359 million whereas intersegment sales grew by 47% to $183 million.

The gross profit for the same period posted $52 million versus $57 in 2010 as improvement in ferrochrome business was not able to offset inflating prices for coke, for nickel production and loss of additional income from ferrosilicon sales due to the plant modernization.

The EBITDA improved by 5% to $57 million for the same period or 11% of the revenue versus 12% in 2010. The pre-FX net result improved by 43%, reducing the last period’s loss to $59 million, adjusted for FX effect, net loss for the first nine months of 2011, posted only $32 million versus $120 million for the same period last year.

The performance of the Power segment in the third quarter was expectedly typical for that time of the year, characterized by the lowest heat and electricity consumption. The revenue from third parties went down by 7% to $164 million, intersegment revenue also decreased by 9% to $113 million. The cost of sales decreased albeit by lesser rate, 5%, which resulted in a $22 fall in the gross income to $48 million, or 17% of the revenue versus 20% in the second quarter.

The lower sales also resulted in a 5% fall in operating expenses to $58 million. It allowed EBITDA reversing to $7 million lost in the reported quarter versus $5 billion profit in the previous one. With no significant FX effect and despite a 20% reduction in net interest expenses to $4 million, the net loss increased from $7 million in the second quarter to $13 million in the reported one.

Overall, the nine months results demonstrated significant year-on-year improvement in third-party sales, up 21% to $566 million, 26% of that increase is attributable to the consolidation of Rousse power plant acquired in December 2010.

The intra-group sales grew by 25% to $380 million. The gross profits remained flat at $290 million, with gross margin decreasing from 28% to 23%, due to higher input prices and lower output at South Kuzbass power plant, due to extensive maintenance in the first quarter, as well as relatively low profitability and we consolidate, hope we consolidated asset.

At the same time, the operating expenses picked only slightly up by $3 million over the same period to $196 million. The growing electricity distribution tariff, which added $21 million to operating cost base, was compensated by $10 million reduction in bad debt provision, as well as almost $5 million income from unutilized CO2 emission quarter sales by Rousse power plant.

As a result, the segment’s nine months EBITDA decreased by 14% to $34 million versus the same period last year or 3.5% of the revenue versus 5% for the previous period. The net income fell to almost zero versus $8.6 million for the same period last year.

Now, let’s take a look at the consolidated picture. The segmental results combined in the revenue of $3.2 billion for the third quarter of 2011, 8% lower than in the previous one, mostly due to lower steel sales. The gross income remained unchanged at $1.185 billion or 37% of the revenue versus 34% in the previous three months period, which is a notable improvement.

The EBITDA grew 11% to $678 million as operating expenses fell by 7%, reflecting lower steel exports and absence of one-off payroll accruals made in the second quarter. The sharp depreciation of the ruble versus American dollar resulted in a $296 million FX loss for the period as compared to $11 million gain in the second quarter.

Net interest expenses grew only by 4% to $158, excuse me, $154 million, as more debts raising was offset by the company’s successful efforts to lower interest rates. The FX loss resulted in a net income of only $26 million.

The revenue for the first nine months of 2011 has risen by 38% over the same period of last year to $9.6 billion. The gross profit grew by 31% at the same time to $3.4 billion. The EBITDA grew in a similar way by 32% to $1.857 billion, despite such superior growth, the net income has grown by 14% largely as a result of $132 million FX loss in 2011 this is virtually new in 2010.

Now, let’s turn to the cash flow analysis. The third quarter saw growth in both mining and steel sales with the exception of third-party billet as noted above, as production at Yakutugol fully recovered and the construction season was in full swing.

However, by the end of the quarter we witnessed the slowdown in steel market especially in Europe, fueled by the political instability in the eurozone and contraction of dollar lending, which coupled with increased funding cost for the European banks, started to affect the demand for steel products.

After an accelerated growth of sales and expansion of MSGs operations that resulted in a highly -- higher inventory as of the end of the reported period and at least 70% of that inventory growth in the third quarter is accounted for by our Steel segment the rest attributable to mining.

We stopped another rate increase from 60 to 80 days in Russia as well. As the market turbulence in Europe spilled over into our home market, remained at this level through the months of October and November. The slowdown in the steel market also affected our related parties, whose products we sell through our distribution network that also resulted in extended settlements. Another $63 million of working capital were attributable to the growing VAT and other tax receivables.

As a result the operating cash flow remains near zero or a mere $15 million negative figure. That also means that all our investments which totaled $612 million in this third quarter, all of that being property, plant, equipment and mineral licenses, as well as $210 million of dividend payment were financed by debt, all of which was long-term. The net debt however increased only by 5% or $416 million due to devaluation of ruble-denominated debt as ruble depreciated against the dollar in the third quarter.

At the same time, the maturity structure of the debt portfolio improved as the company attracted over $1 billion of long-term debt part of which was used to repay short-term debt. We don’t have debt covenants in our loans on nine months results, nevertheless net debt to EBITDA ratio stood at 3.5 times as of the end of the period, the maximum allowed by our loan agreements. We are aware that we need to maintain at this level or below till the end of the year, therefore the management has undertaken certain measures to comply with that.

Firstly, the investment program for the fourth quarter has been revised down significantly in size with certain payments deferred till the first quarter of 2012.

Secondly, we have changed the focus of production on sales policy, having reduced the output of products especially in low and negative margin in a current month environment, while concentrating on the products with higher sales turnover rate.

And thirdly, we are targeting a reduction in the working capital in the current quarter, which will help to improve the operating cash flow.

Thank you, ladies and gentlemen, for your attention. We are ready to take your questions.

Operator

Thank you.

Vladislav Zlenko

We’ll now take questions. We’d ask that participants please state their name and company before asking their question and allow some time after for translation. When questions are answered in Russian, they’ll be followed by translation. So you may ask your question in Russian also and we will translate for you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question is coming from the line of Dmitriy Kolomytsyn from Morgan Stanley. Please go ahead.

Dmitriy Kolomytsyn – Morgan Stanley

Yeah. Good evening. I have three questions. First, the debt repayment in 2012 looks massive. Just was wondering how you’re planning to deal with that and how much has been done in terms of refinancing which transfer you’re working on right on? And also, can you please explain, I know you’ve touched upon this several times? But can you again maybe summarize the nature of those ForEx losses and that would be actually two questions that I have?

And one other question that I have, what sort of losses or gains do you expect in the fourth quarter, now that we’re almost done with the fourth quarter, you probably have a good understanding of that. And what sort of revenue breakdown do you expect in the fourth quarter, if that’s possible? That’s it for me.

Vladislav Zlenko

Stanislav Ploshchenko will answer the questions.

Stanislav Ploshchenko

To answer your first question, if you’re looking at slide 14 of the presentation, you’ll see that in 2012 about US$2.5 billion must be repaid, in fact you should look into the breakdown of the figure $1.100 billion out of $2.5 billion is the committed revolving line, which is used to finance the working capital. Therefore, we will only have to rebate next year $1.200 billion or around that amount.

As to the bonds and again if you’re looking at the slides you will see the figure of US$348 million. All these bonds have loans we didn’t offer, so unless the bonds market close all together, all these bonds can be refinanced by assigned coupons in the market. So we don’t see any problems. We don’t expect any problems or challenges in implementing this debt repayment program. Thank you.

And we have always been the supporters of the yield having cushioned or sometimes to fall back on so if you take our the money on the accounts that we have put it together with the great lines that are still open to us then we have approximately US$2.1 billion which is sufficient to repay the debt.

So your second question, about the nature of FX losses, if you look at our consolidated assets and you will see that all of them are basically denominated in rubles and if you look at slide 14, you will see that about the half of our debt is denominated in foreign currency and mainly its U.S. dollars. So whenever the ruble is falling relative to the U.S. dollar, we have a foreign exchange loss, whenever the ruble is appreciating against the dollar we have a gain.

As to our P&L items for the fourth quarter that our FX is by currency exchange rates then everything will depend on the exchange rates between the ruble and the dollar as of 31st of December this year. Right now, today, the exchange rate is 31.9 rubles per $1, which is somewhat higher than 38.87 rubles per dollar that we have at the start of the fourth quarter. So if the exchange rate remains the same then there will be revaluation, slightly exit revaluations so there will be a slight loss but not a big one.

As your third question about the revenue breakdown, I guess you were asking about the breakdown between the national segments. But actually we don’t have any figures right now and the year is not over yet, so I don’t want to make any guesses. Thank you.

Dmitriy Kolomytsyn – Morgan Stanley

Okay. Thank you very much.

Vladislav Zlenko

We’re ready for the next question, please.

Operator

Thank you. The next question is coming from the line of Sergey Donskoy from Societe Generale. Please go ahead.

Sergey Donskoy – Societe Generale

There are three questions from Societe Generale. The first question is about the growing debt that comes from transactions with related parties against the background of declining accounts receivable. What is the reason for this and what is the trend that you expect for the fourth quarter?

The second question asks for details about the sales of Yakutugol in the second and the third quarters, how did the prices and the volumes change across your main markets including China and Ukraine?

And the third question is, could you please provide figures for coal production at your main sites in the second and the third quarter?

Vladislav Zlenko

The first question will be answered by Stanislav Ploshchenko, the second and the third one by Oleg Korzhov.

Stanislav Ploshchenko

Regarding your first question about our relations with the related parties, as a matter of fact, we sell products of our several plants in Russia and in Europe who also sponsors to us and we also supply to those plants -- to those production sites and to be able to look at the big picture, we should be considering the whole year and not just one quarter.

The dynamics of relations in the second quarter and the dynamics of the market also in the second quarter resulted in the decline of our settlements with the third parties by almost $140 million, while the positive dynamics of the market in the third quarter made us invest more into our relations with them.

The third quarter started very well and then in September we have seen a decline in the demand and the growing volatility of the market. Therefore, the sale of steel products in the market decelerated. We were affected by this process, as well as other producers in that field and our warehouses, as well as the warehouses of other companies in that field have started to grow.

So the investment was made into production but since the stock was growing and it hasn’t been sold yet, that’s why we have seen an increase in our payments to third parties.

Oleg Korzhov

Now you requested the structure of sales at Yakutugol for the coking coal concentrate. Let’s look at Ukraine first, the volumes of shipments in the Ukraine was 360,000 tons in the second quarter and 225,000 tons in the third quarter. The prices were $310, $320 on the DDO basis in the third quarter and $280, $290 on the same basis in the fourth quarter.

Southeast Asia, the second quarter, overall deliveries 500,000 tons, third quarter 310,000 tons. The prices in the third quarter was US$310 FOB basis for that and the fourth quarter same basis $270, $275.

The prices for the second quarter were around US$210, US$230.

Now let’s take China. In the second quarter, our shipments to China were 294,000 tons, in the third quarter they increased significantly to 790,000 tons. The sales price in the second quarter to China was $220, $230 same basis and we are not selling K-9 pure we were selling it in the mix. And in the third quarter, the prices were approximately at the same level $220, $230.

And also in the second and in the third quarter, we shipped approximately 40,000 tons of coking coal concentrate to India and the prices there were more or less on par with the prices for Southeast Asia.

The overall production of coal in the third quarter was 7.3 million tons from South Kuzbass came 3.6 million tons, Yakutugol delivered 2.2 million and Bluestone 1.5 million. In the second quarter, the total production was 6.5 million tons, 3.3 million were coming from the Southern Kuzbass, 1.8 from Yakutugol and 1.3 from Bluestone.

Vladislav Zlenko

We’re now ready for the next question.

Operator

Thank you. The next question is coming from the line of Mohammed Zaidi from Martin Currie. Please go ahead.

Mohammed Zaidi – Martin Currie

Yeah. Thank you. Just two questions. Going back to the debt issues, just wanted to find out what are the implications of a potential breach of covenants if that were to occur? And the second question is if the current weakness that you talks about in the market continues into the first half of 2012 then what further steps will the company have to take to manage its debt position, given its debt covenants get reset to a lower level for 2012?

Vladislav Zlenko

Stanislav Ploshchenko will answer the questions.

Stanislav Ploshchenko

To answer your first question, you know that the covenants per se, they don’t mean anything terrible, it’s just the level at which the company should address the banks to discuss the future steps and there are other companies that operate quite normally and whose net debt to EBITDA ratio is higher than 3.5%.

We understand that the higher is this ratio, the less possibilities the company has to invest in its own development. So if we fail to observe the covenants, then well first of all should this happen, I’m absolutely sure that our -- that we will not violate them dramatically, it will just be a slight violation and then we’re absolutely sure that we will be able to come to an agreement with the bank syndicate and change them if necessary, and besides there won’t be any serious implications for the financial policy of the company.

Yeah. We realize that. It may involve higher debt servicing fees or it will also curtail our opportunity, our possibilities and capability to invest into the company’s projects. But we have already reviewed our CapEx program for the next year and we are sure that the steps company has already undertaken will enable it to first of all service the debt and to also maintain its key projects. Thank you.

And if the bad -- this bad environment in the markets persists into 2011, that Mechel is not a mono-producer, we don’t just have one product and we don’t service just one market, we are a diversified holding and we will be able to adjust our production and sales policy in such a way as to first of all support our debt and also to support our priority projects.

Vladislav Zlenko

Next question, please.

Operator

Thank you. The next question is coming from the line of Zaurbek Zhunisov from Troika. Please go ahead.

Zaurbek Zhunisov – Troika

Good evening, gentlemen. I have four questions if I may. First of all, in your presentation, you say that the adjusted net debt is $8.7 billion, but I’m getting $9 billion and by dividing this EBITDA, I’m getting 3.6% debt-to-EBITDA ratio. Could you please comment on this, how are you getting $8.7 billion?

And second question is you said that you might revise your CapEx for next year to leave only important projects. Could you just comment how much you need to finish these important projects for next year giving a breakdown for Elga and Universal Rolling Mill?

And third question is, if situation worsens in the global steel market and coking coal market and banks impose tough position, could you or will you revise your dividend payments on preferred shares? Could you potentially cancel them?

And my last question is, what’s your current working capital and what is the optimal level of working capital you see in the breakdown for your mining division and steel business and Mechel Service Global? Thank you.

Vladislav Zlenko

Stanislav Ploshchenko will answer the questions.

Stanislav Ploshchenko

I will answer your questions one, three and four and Oleg Korzhov will take questions here about CapEx. Now speaking about the adjusted net debt indicator, we have an agreement with the banks to include into the calculation of net debt not just the amount on the account, not just the cash, but also all bank deposits roughly 180 days, that’s the time of preparing this reports. We had US$250 million on such deposits. So that’s how we arrived at $8.7 billion.

As you repurchase and the dividends, it’s not the decision of the management, it’s the shareholders’ meeting that instructs the Board of Directors -- it’s the Board of Directors discusses that matter with the shareholders’ meeting and this events are just take place around April and May 2012.

However, in our agreements with the banks there are no limitations or constraints on the payout of dividends on preferred shares. And in the current market environment, we do not see any needs to change our policy in this respect.

And your last question about the working capital and the optimal level for the working capital, we could be speaking about the optimal level or working capital if it were a mono company, a company that produces just one product. However, in a diversified holding, this is a rather flexible notion. It depends very much on the market situation on any given segment.

It is declining in the Steel segment where our inventories are high, they went up. It is also going down in the Mining segment, although the market situation is better there. But in terms of sparing the working capital, I think that we could discuss several hundreds of millions of dollars. There is this potential in the company.

Oleg Korzhov

Now to answer your question about our investment program on 2012, right now all the figures that we have are not final. They are still being discussed. But we are looking at for 2012 investment program is roughly US$1 billion to US$1.1 billion and the main attention will be paid to our chief projects, the Universal Rolling Mill and the Elga projects.

Actually here, we exercised two approaches. One of them is the revision of the investment plan and all the secondary projects for the company were postponed until the middle of 2012. They haven’t been cancelled but they were postponed by six months.

And the second approach that we use is cost optimization. In case of the Universal Mill, we have reviewed the technology and it will allow us to save in terms of our CapEx there and in Elga, we are actively doing the construction, using our own labor, our own means of forces. We have established a company (inaudible) that will allow us to reduce the involvement of contractors and sub-contractors.

As to how much we will need to fully finance this project. That the Universal Rolling Mill project must be completed in 2012 and the total investment that will go into the project is about US$300 million. As to Elga, very difficult to say now because it’s a multi-staged project and our estimate for the first stage, for the first phase of the Elga project was $2.8 billion.

As of the beginning of 2011, $720 million have been already invested into the project. By the end of 2012, we expect that it will be around $750, $780 million. In 2012, we plan to invest into Elga around 10 to 15 billion rubles, which is about $450, $500 million. And we expect that investment into Elga in 2013 will be at the same level, more or less as was in 2012 or as will have been in 2012.

Vladislav Zlenko

Next question, please.

Operator

Thank you. The next question is coming from the line of Vasily Kuligin, Renaissance Capital. Please go ahead.

Vasily Kuligin – Renaissance Capital

There are four questions from Renaissance Capital. The first one is about the Elga deposit, how much coal do you expect to mine there in 2012 and 2013 and you have told us about the washing plant, will it be started in the first quarter next year?

The second question is about the volume of port, when do you expect to announce construction there and what is the expected CapEx into this project?

Question three is related to the falling EBITDA in the mining complex? What are the main factors? What are the main assets that are contributing to this decline?

And question four, the first Yakutugol and its recovering production, is it already running at full capacity?

Vladislav Zlenko

Oleg Korzhov will answer the questions.

Oleg Korzhov

I’ll start with the last question, because it’s the easiest one to answer. The washing plant there was running at full capacity since July, so it has been operating in the last six months no problems.

To answer your first question about expected production of coal at Elga in 2012 and ‘13, we have made these announcements previously and we still stick to them. We expect to mine up to 2 million tons at Elga in 2012, up to 3 million in 2013, up to 6 million in 2014 and so on and so forth. These are the same plans that we announced in the past and we are on track. We believe that they will be realized.

To answer about -- to answer your question about the washing plant, again we only have to repeat the plans that we announced previously. In the middle of 2011, we entered into a contract for the delivery of recruitment for this slides, by now the design of the infrastructure has been completed and also we build the schedule for construction work there.

In December, we started the work on the foundations. In the first quarter we expect the shipment of the equipment and the assembly of this equipment on site. And in the second quarter of 2012, the washing plants should be put to its capacity, the design capacity is 1 million tons a year. I’m sorry, it’s 3 million tons.

About the volume report, right now there is work going on. On the feasibility studies, there are no cost estimates and we believe that all this preparatory work will be finished around the first or second quarter of 2012 and we will decide on the future of this project in the second quarter of 2012.

As to the EBITDA, foreign EBITDA in the mining segments, you know that in -- recently in the fourth quarter especially the market was down, especially the market of coking coal, so it’s only logical that EBITDA would be falling, but we can’t really say how much it will decline and besides, it’s not the financial policy of our company to make any forward-looking statements.

Now as to the differences in EBITDA level in the third and the second quarters, the -- we have seen the most decline in EBITDA for the Southern Kuzbass. In the second quarter, we have to suspend the Chelyabinsk mine. Another contributing asset was the Korshunovsk mining complex and our coking plant. But at the same time EBITDA went up by 25% in Yakutugol and by 60% at the Bluestone.

Vladislav Zlenko

We’re now ready for the next question, please.

Operator

Thank you. The next question is coming from the line of Dmitry Kolomytsyn from Morgan Stanley. Please go ahead.

Dmitriy Kolomytsyn – Morgan Stanley

Yeah. Hi again. Just a quick question on your inventories breakdown. I don’t know if that question was asked before but if you could give some breakdown what the $2.4 billion really consists of, that will be great. Thank you.

Vladislav Zlenko

Well, since we need some time to check out the data, we’ll do it and in the meanwhile we’ll take the next question please and then comes to this one after that.

Operator

Thank you. The next question comes from the line of Sergey Donskoy, Societe Generale. Please go ahead.

Sergey Donskoy – Societe Generale

Question from Societe Generale. Could you please discuss the change in fuel prices of Bluestone in the second and third quarters?

Vladislav Zlenko

Oleg Korzhov will answer the question.

Oleg Korzhov

Based on in the second quarter, the sale prices were $320, $330 FOB north of U.S. in the thirds quarter more or less the same level, $310, $320.

Vladislav Zlenko

Now we can come back to the previous question. Stanislav Ploshchenko will answer that.

Stanislav Ploshchenko

Now the breakdown for our inventories as of the 30th of September 2011 more, approximately 60% was finished product, 30% feedstock and materials, and 10% work in progress.

Vladislav Zlenko

We’re ready for the next question, please.

Operator

(Operator Instructions) We’ve got a question coming from the line of Valentina Bogomolova of Uralsib. Please go ahead.

Valentina Bogomolova – Uralsib

There are two questions. On the same subject about the expected performance in the Steel segment and Ferroalloys segment in the fourth quarter, whether the increase in performance that was achieved in the Steel segment is sustainable and as to the Ferroalloys segment there, the costs are going up while the prices are going down. So what is your vision for quarter four?

Vladislav Zlenko

Stanislav Ploshchenko will answer the questions.

Stanislav Ploshchenko

I can only give you a general answer to this question because, of course, we observe the trends in pricing, but we will not be able to give you any final figures at this time. The price environment in the Steel segment has been marked by downward trend. But things are not as bad as they were in 2008 when the market almost disappeared.

Now we have a market and we are selling 7, 8 or even 9,000 tons through Mechel service in Russia alone. The prices are going down but not dramatically slow and the physical prices are going down as well, so these items -- few items move in parallel.

In the Ferroalloy segment, nickel prices are also down in the fourth quarter in comparison with the third quarter, but the prices of coke coal also going down although at a slower pace. So the profitability of this segment is expected to shrink somewhat and as to the ferrochrome and ferrosilicon there the prices and the costs have not changed much in those quarters.

And when I spoke about the 9,000 tons of Mechel service itself, I meant, 9,000 tons a day, of course.

Vladislav Zlenko

We’re ready for the next question.

Operator

Thank you. The next question is coming from the line of Denis Gabrielik from Otkritie. Please go ahead.

Denis Gabrielik – Otkritie

There are few questions from Otkritie, both of them are about the CapEx program. One of them is actually, I want to clarification if my understanding is correct that in 2012 your overall CapEx program will amount to about $1.1 billion just wanted to confirm that? And the second one, what other projects that you postponed for the next year?

Stanislav Ploshchenko

As for your first question, yeah, we confirm that figure $1 to $1.1 billion of investment in 2012. As to your second question was actually very difficult to answer it because our company has about 200 projects of different sizes and skills. So probably it would be best if I just listed the ones that we consider to be a priority and that will remain in our investments program.

Those includes the Universal Rolling Mill, the Elga project, the reconstruction of the furnace at the Bratsk Ferroalloys Plant, the development of the Posiet port, the washing plant at the second stage of the Chelyabinsk mine, the grinding and mixing complex and the development of underground mining at Bluestone.

Vladislav Zlenko

Next question, please.

Operator

We currently have no further questions coming through. So just a final reminder (Operator Instructions) And we have a question coming from the line of Erik Danemar from Deutsche Bank. Please go ahead.

Erik Danemar – Deutsche Bank

Yeah. Hello. One question with regards if there’s any -- been any uptake with regards to your intension for the Donetsk Electrometallurgical Plant, what are your strategic assessments there? Thank you.

Vladislav Zlenko

Stanislav Ploshchenko will answer the question.

Stanislav Ploshchenko

This deal has not been closed yet. We are still very interested in this asset. But the market has changed and that’s why we are currently negotiating new terms of acquisition before the regional agreement provided for, this was a payment till the first quarter of 2014. But now we would like to extend that period.

Vladislav Zlenko

And we’re ready for the next question, please.

Operator

Thank you. Next question is coming from the line of [Dennis Ver] from Prosperity. Please go ahead.

Dennis Ver – Prosperity

Prosperity would like to get the breakdown of coal sales from the three main assets that Mechel has and also the information about the prices is requested?

Vladislav Zlenko

Oleg Korzhov will answer the question.

Oleg Korzhov

I’d like to translate the first part of the answer? So what Mechel suggest is for all interested parties to subtract the cost of transportation from the prices that have been already provided to you in answer to the previous questions.

So if we take [it include all] then shipments to Ukraine, in those shipments, the transportation cost is about $54, the shipments through Posiet have the transport component of above $40. Deliveries from Bluestone, there the transportation cost is about $50.

Now production at the South Kuzbass, the coking coal from South Kuzbass on the FCA basis, second quarter, 62,000, I’m sorry, these are the prices in rubles, 6,200 to 6,400 in the second quarter, third quarter 6,400 to 6,500 and the fourth quarter 5,300 to 5,500.

As it is rather difficult for us to give you the answers to the volumes of sales from different assets because, again, we have several assets and we also use coal from them, and we’ll blended with coal from other assets. So if you really want to get the answer to this question then we would need time to prepare and then we will get back to you with the answer.

Vladislav Zlenko

We are now ready for the next question.

Operator

We’ve got no further questions coming through. I’ll hand it back to your host to wrap up today’s call.

Vladislav Zlenko

Ladies and gentlemen, thank you for taking the time to join Mechel’s nine months 2011 financial results conference call today. The replay of the call will be available on Mechel’s website. If you have any further questions please contact the IR office. Thank you again from all the team here. Good bye.

Operator

Ladies and gentlemen, thank you for joining. You may now disconnect your line.

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