Cliffs Natural Resources, Inc. (CLV) Q4 2015 Earnings Conference Call January 27, 2016 10:00 AM ET
Kelly Tompkins - EVP & CFO
Lourenco Goncalves - Chairman, President & CEO
Timna Tanners - Bank of America Merrill Lynch
Jeremy Sussman - Clarkson
Garrett Nelson - BB&T Capital Markets
Lucas Pipes - FBR & Company
Evan Kurtz - Morgan Stanley
John Tumazos - John Tumazos Very Independent Research
Chris Haberlin - Agincourt Capital
Good morning, ladies and gentlemen. My name is Sally and I am your conference facilitator today. I would like to welcome everyone to Cliffs Natural Resources 2015 Fourth Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.
The company reminds you that certain comments made on today's call will include predictive statements that are intended to be made as forward-looking within the Safe Harbor protection 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 the company 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. The company will also discuss results excluding certain special items. Reconciliation for Regulation G purposes can be found in the earnings release which was published this morning.
At this time, I would like to introduce Kelly Tompkins, Executive Vice President and Chief Financial Officer.
Thank you, Sally, and thanks to everyone joining us on this morning's call. I am joined today by our Chairman, President, and CEO, Lourenco Goncalves. I will being our call with a review of our fourth quarter results and related financial commentary including our outlook for 2016, before turning it over to Lourenco for his remarks.
Once again our focus on cost reduction, operating efficiencies, and optimizing cash flow drove our final results for the year. The worst market environment for Cliffs in over a decade has clearly presented ample challenges but our teams at every levels have not only met our financial objectives, but in many instances beat their own aggressive targets.
There is no better example of this than looking to our USIO operating cost. Our USIO cash production cost was $45 per ton during the quarter, and $54 per ton for the full-year solidly beating our guidance of $55 per ton to $60 per ton. This quarter's USIO cash production cost represents a 23% cost reduction from the prior year's quarter.
Looking ahead into 2016, we expect our USIO cost to once again improve such that we are bringing the guidance range for both cash production cost and cash cost of goods sold down by $5 each. This performance and outlook clearly shows that despite top-line revenue pressure from weak demand and low iron ore and steel prices, plus strong operating performance has made the difference.
You will see that our Australian operation has gone toe-to-toe with the U.S. business in terms of its operating results. Despite the significant headwind of depressed seaborne iron ore prices, the focus of our Australian management team on cost and productivity delivered fourth quarter cash production cost of $26 per ton compared to $43 per ton reported in the prior year quarter.
While our APIO division, like every other Australian miner, big or small, did benefit from a weak Aussie Dollar by about $5 per ton in the quarter. These impressive production costs were driven mainly by a relentless focus on optimum mine planning, and productivity gains. This cost performance enabled APIO to maintain its status as a solid EBITDA contributor in 2015.
Looking into next year, we were expecting even further cost reductions out of APIO, with cash production cost of $25 per ton to $30 per ton down from 2015 full-year average of $31 per ton. We will continue to operate APIO with a clear bias towards cash optimization and as our consensus require, we will do everything possible to protect our EBITDA. In short, we will remain vigilant in identifying cost saving opportunities and do what is in our power to avoid sustained losses.
Let me now turn briefly to SG&A. Our fourth quarter SG&A expense was $28 million, down about 30% from the pre-discontinued operations figure of $42 million that we reported this time last year. We closed the year with a total of $110 million in SG&A expense, almost half of what we reported this time last year.
Rest assured, we have taken our focus off further cost reduction opportunities, as we expect $95 million of SG&A in 2016 which would be the first time we have expected a sub $100 million of SG&A since the Cleveland Cliffs days back in 2006.
Finally, it's also worth nothing that of this $95 million, about $29 million is non-cash items such as equity comp, accruals, and depreciation, leaving cash overhead expenses of about $65 million.
While we are understandably pleased with the cost performance of our business, which is certainly what we can directly control, our revenues have clearly been under considerable pressure both as to volume and realizations. The prices of iron ore and the seaborne market and hot-rolled steel in the U.S. have been a drag on our revenues all year, and the fourth quarter was no exception. This pricing weakness did impact our realizations in both USIO and APIO with our USIO pallets realizing $74 per ton and APIO realizing $34 per ton, both multiyear lows for each segment. Despite this top-line weakness, which was mitigated by lower cost, we reported an adjusted EBITDA of $76 million in the fourth quarter. This EBITDA result was the strongest since the first quarter, as quarter-over-quarter cost reduction more than offset the decline in realized revenues.
As we look at 2016, we are expecting to sell 17.5 million tons of pellets in our USIO business, a slight improvement from 17.3 million tons sold in 2015. This is based on our current customer nominations, as well as our market intelligence.
Consistent with the usual seasonality of this business, due to the frozen lakes and lock maintenance, we are expecting just under $2 million tons of sales volumes for the U.S. in the first quarter.
You will also note from our press release that our expected production tonnage in 2016 is 16 million tons or 1.5 million tons less than our sales tonnage. With our current levels of inventory in the U.S., we will first convert that inventory into cash, and then depending on customer demand, we will look to bring back idle production.
Given the importance of liquidity, it makes sense for us to leverage our working capital to contribute positive cash flow which we anticipate should exceed $100 million. While we're still incurring idle expenses for our UTAC and North Shore mines, which is a detriment to EBITDA, we can meet forecasted sales tonnage and at the same time improve our cash position.
In APIO, our approach is very similar. Our production expectation is 11.5 million tons, with about 9 million tons actually mined, and the remainder being sold from our work-in-process inventory file. This too will improve our cash cost and lower inventory levels.
Another area where we're focused is reducing CapEx. As a result, capital expenditures for 2016 are expected to be $50 million down from $83 million in 2015 and $284 million in 2014. This 2016 CapEx expectation is mostly all USIO related and is our lowest projected CapEx spend since 2003. This is a result of a disciplined spending decision and a continued success in shedding non-core assets, including the December divestiture of our remaining coal assets, which alone carried an ongoing CapEx burden. This sale also resulted in the transfer to the buyer of substantially all liabilities, including those related to reclamation, pension, and various litigation matters, all of which would have been a significant cash drain in the future.
While the coal sale did result in about a $40 million reduction in our asset base lending facility borrowing base, the cash flow benefit of not owning these assets is quite substantial, particularly given current coal prices, and in many respects more than mitigates the loss of ABL availability.
We ended the quarter with over $450 million of total liquidity, net of outstanding letters of credit. We had $285 million of cash on hand and no borrowings on our asset based lending facility.
As I've noted before, liquidity remains a key focus of management through these difficult times. But given where we sit right now, the working capital benefits we expect to see and the reduced CapEx, I'm comfortable with our outlook for 2016.
To wrap up, let me offer a few comments about our capital structure. At the end of the quarter, we had net debt of $2.4 billion, which marks an improvement from $2.5 billion last quarter and $2.6 billion at this time last year. Even with all the challenges we've been able to accomplish meaningful debt reduction.
That said, our net debt balance of $2.4 billion and 2015 full-year EBITDA of about $300 million is not an acceptable level of leverage.
With that reality in mind, we have announced today an exchange offer utilizing our 1.5 lien secure debt capacity. For those who participate in the exchange, they will receive a premium over the current market value of their bond, and have the chance to move up in the capital structure. We see this liability management exercise as yet another step in our progress of better aligning our debt and EBITDA.
So with that, I will now turn the call over to Lourenco.
Thank you, Kelly and thanks to everyone for joining us on this morning's call. Let's just start reviewing what changed since August 2014 when I joined Cliffs as Chairman and CEO.
Iron ore prices changed a lot. The IODEX pricing for sinter feed fines sold in China went from around $100 per ton when I joined Cliffs to a recent low of $38 per ton.
The steel prices changed as well. In the United States, they are above $600 per ton average price for hot-rolled steel in place since 2010; hit a 10-year low of $360 per ton in 2015. The steel production and the massive consumption in China changed too, despite the mistaking assumption by the Australian and Brazilian iron ore majors, insisting on increasing their supply to a never growing demand of their imaginary China.
The steel production and demand of the real China peaked in 2014 and began its decline in 2015.
Last but not least, the elegant statements of the major iron ore producers are gone. Once is staking that the seaborne price in the $30 range was actually a good thing because it would make for the complete elimination of all other mining companies in the entire world. These major players are now realizing that they will bear the consequences of their own bad behavior.
At this point in time, we can no longer hear their excitement about becoming low cost per ton producers by means of investing billions of dollars to increase their tons to unnecessary levels. In fact these companies are now realizing that the returns on investments that they promise to their respective boards have not been achieved and will not materialize.
Furthermore this major producers of iron ore have actually become major producers of dividend yields as a direct consequence of their share prices at multi-year lows. By now the pressure is only increasing on the individuals responsible for such enormous destruction of value and they should be badly regretting their previous statements. Particularly the assurance they gave to investors regarding their untouchable, ever growing dividends. To paraphrase one of them, these individuals are now hanging on by their fingernails to their respective jobs.
Now, what has not changed? 16 months ago I laid out our strategy for Cliffs predicated on one fundamental fact, China's steel demand is actually shrinking not growing. We have not deviated from our strategy, and in 2015, we were able to check many boxes in line with what was put in place on my first day at Cliffs, leaving us to a refocused and reenergized company.
All our moves were motivated by the recognition that China's appetite for iron ore was no longer increasing which was actually the opposite direction adopted by the majors and also who adopted by the old Cliffs. By insisting on their imaginary ever growing China, the iron ore majors brought iron ore prices down to a level that severely hurts themselves and their shareholders. Case in point, if we have not implemented a new U.S. centered strategy here at Cliffs in August 2014; the old way of doing business would have driven this company into bankruptcy early last year.
A very important component of our strategy was a complete divestiture of the coal business. After selling the three Logan county coal mines in December of 2014, we ended 2015 on a high note, with the closing of the sale of our two remaining coal mines Pinnacle and Oak Grove. As you may recall, we announced just last quarter that we were eliminating long haul development work at those mines which we believe provided the buyer with the necessary motivation to finalize the deal. By year-end Cliffs Natural Resources was completely out of the coal business.
Also in 2015, we took Bloom Lake out of the picture, our former restructuring proceedings in Canada under CCAA for the Bloom Lake Group and the Wabush mine made substantial progress during the year, and particularly during the fourth quarter. Interested parties entered into asset purchase agreements to acquire subject to court approval the Bloom Lake mine, some mineral claims, and related port and rail assets.
We anticipate the court to conduct their hearing this quarter and we look forward to wrapping up the CCAA process consistently with our previously stated expectations.
In addition, we're able to divest all other non-core assets including the chromite Ring of Fire and the Decar Nickel projects as well as other exploration endeavors. In each stance we selected the best exit strategy for the non-core assets and I'm pleased to have all these transactions behind us.
Another pillar of our strategy was debt reduction. We have been very successful in reducing our debt especially in light of the current commodity environment. My initial plan to take care of a big chunk of the debt was the sale of our Australian mine. During a time when iron ore was still over $100 per ton we would have been able to sell APIO for hundreds of millions of dollars. Unfortunately due to the successive maneuvers applied by the previous Board of Directors during the first half of 2014 to delay the 2014 shareholders meeting, by the time we're able to prevail in the battle and lead the company, iron ore prices had already started to slide and the trend was clear to the potential buyers which is exactly what I feared would happen. Not surprisingly APIO lost its marketability during that timeframe.
Despite this course of events, we have been able to implement several liability management exercise. Each of these moves was done in preparation for the next one. As you saw this morning, we are now offering our bondholders the opportunity to move up in the capital structure by offering them new security notes in exchange for their current holdings. By capturing the discounts available across our entire bond complex, we should be able to accomplish two goals: significantly bring down our debt balance and reduce our cash interest expense. This transaction represents another step in our strategy and should offer a similar amount of debt reduction and equity value accretion that the missed opportunity to sell APIO would have offered.
That said, let me clarify that given various legal and regulatory constraints, we will not offer any further comments nor will we address any questions about the exchange offer during the Q&A portion of this call. As we always do in our quarterly calls, the Q&A session should be focused only on our performance and business outlook.
If you're a bond investor and have questions regarding the Exchange Offer, please contact Global Bondholder Services Corporation or our lead dealer manager, Bank of America Merrill Lynch in Charlotte, North Carolina, or your BofA Merrill Lynch salesperson.
Now let's turn to the global iron ore business. Demand for steel in China which account for about half of global steel production is shrinking, as the growth of their economy is lost, prompting the Chinese steel mills to a scale back production. It has been reported that inventory levels of iron ore at the Chinese ports continue to build over the past couple months heading back to above 100 million tons.
Earlier this month, China's biggest steel producing province announced that that the steel output will be cut this year to ease pollution and help curb oversupply. Three days ago, the Chinese Premier, Li Keqiang, released target numbers for steel production cuts to the order of 100 million tons to 150 million tons. The pressure on the pollution issue in China continues to mount.
I have said this before, and I will state it again, China will resolve its pollution problem and it cannot do so without a major impact on its steel production, and a significant reduction of the consumption of sinter feed fines. One of the root causes of pollution in China is environmentally unfriendly characteristics of the production of sinter from iron ore clients. Differently from the United States and Europe, the vast majority of the blast furnaces in China use sinter as feedstock and not pellets. Making matters worse, a good number of Chinese sintering plants utilize lower grade iron ore sinter feed fines purchased from the iron ore majors, as well as from their own domestic mines.
Over time, the Chinese steel mills will find it difficult to overcome the environmental issues associated with the use of sinter as feedstock for their blast furnaces and that will naturally impact all the market players who are coming in to their flawed assumption that China will continue to buy what they sell just because it is apparently cheap. Mainly because the major producers of iron ore finds have kept defeating a level of Chinese demand that no longer exist. Iron ore prices are now well established into the price range that was once called Fantasy land. At this point, every other iron ore miner should have been long gone.
Once again, they were wrong, and just for the record, Cliffs APIO achieved in 2015, a record year in production and cash cost per ton and that was accomplished using as we approach the end of life of our mine in Australia.
We know that with the constant deterioration of the seaborne price levels, our Australian business was not a good fit for the U.S. centric pellet focused fleets. However at today's IODEX our expected cash production cost are still lower than what our price realizations are.
With that said, we will keep a close watch on conditions with this business and we'll act appropriately if and when we need to. In some, we will not allow APIO to become a drag on Cliffs EBITDA.
Now turning to the United States the most adverse condition we've dealt with here in the U.S. was not iron ore price but rather the demand for pellets from our domestic clients. The price of steel in the U.S. has been hammered by record levels of imports that vast majority of that unfairly priced and dumped in our domestic steel markets. The price of steel in the United States not only directly affects our realized prices, but also affects the utilization of the steel mills we serve.
As a result, we sold far fewer pellets than we had originally anticipated. While of course this illegal is still trade situation must and will be fixed. So far I have been generally pleased with the preliminary duties coming from Washington on the steel trade case, especially the extremely punitive percentages placed on China. That has already started to positively affect the order books of our clients.
While seaborne iron ore prices continue to be low, domestic steel prices in the United States are up substantially from their bottoms. As the preliminary rulings for hot-rolled and cold-rolled steel are released by the Department of Commerce in the next couple of months, domestic steel prices and steel demand should continue to recover for our clients in turn Cliffs profitability should improve as well.
With that as a backdrop, let's move on to USIO and its performance. The very first thing I would like to point out is the adjusted EBITDA of the USIO business segment. For the fourth quarter, USIO adjusted EBITDA was $98 million, with $352 million for the full year. We continued to reduce cost quarter-over-quarter and year-over-year for this segment, achieving cash production cost of $45 per ton in the fourth quarter.
The USIO management team worked very well in 2015 to implement a production plan to address current customer demand and also to work down product inventory levels. Our operators made sure that our equipment was operating reliably and in top working order, all being done safely and responsibly from an environmental standpoint, why we are spending a lot less in CapEx.
During 2015, we also had very good cooperation from our partners, customers, rail providers, shipping companies, and last but for sure not least, the United Steel workers, as we made difficult but necessary decisions related to our production plans to respond to evolving market conditions and fluid customer demands.
I would like to recognize our USIO team led by Terry Fedor and our General Managers, Jack Croswell at Hibbing, Dean Kochevar at Michigan, Ed LaTendresse at North Shore and Santi Romani at UTAC. This group had an incredible 2015 and every aggressive target I set for them they not only reached but beat. I assure those listening on the call that these mines are in great hands.
Now to address the status of our idle mines, United Taconite and North Shore both in Minnesota. Based on our clients' nominations the winter season and our current inventory levels, this mine will remain temporarily idle during Q1 2016. As Kelly mentioned, the idling of this mines is not totally optimal from a cost perspective. But that has allowed us to recoup the cash from the inventory we produced in 2015. We expect domestic steel production and our inventory tonnage to be back to normal levels sometime in 2016 so we can bring this mine back to operation sometime this year.
Looking more broadly at our market position in the Great Lakes, what a difference a year makes. In short, the so-called competitive threats that were present in this market have all but faded the way. Moreover, as a result of the Samarco tragedy in Brazil, there is now a shortage of pellets in the seaborne market, I will repeat that. Moreover, as a result of the Samarco tragedy in Brazil, there is now a shortage of pellets in the seaborne market. This has created opportunities for Eastern Canadian pellet supplier for example to supply additional pellets to Europe and to the Middle East which are low cost voyages for them. We are seeing this take shape already, as December shipment data has shown major increases in vessels loaded with pellets in Eastern Canada, to fill the void of steel makers previously supplied by Samarco in the seaborne market for iron ore pellets.
In addition, potential threats from inside the Great Lakes are now effectively gone or very close to fold. I would be happy to elaborate more but I have already discussed this so-called threat at length, and all but a few uninformed observers, can see the handwriting on the wall. We also don't believe that any steelmaker with a temporary availability of their in-house produced pellets due to their own particularly weak steel order book would supply cheap pellets to other steel makers in a permanent basis. The steel companies don't give their competitors a cost advantage. Now what does this mean for Cliffs? We have the opportunity to solidify our market leading position and improve our profitability all while being mindful of our customers costs and their need to be competitive.
Turn to our new business as a supplier of DR-grade pellets to DRI producers; we have reached a significant milestone in our tests, with very positive early results coming from the successful full scale operational trial of our DR pellets in the customer's actual production process. At this point, we can comfortably state that DR-grade pellets has been added to our portfolio of custom made pellets available to be produced and sold to our clients.
While we are still in the early stages of our DR-grade pellets business, it's nice to have the stamp of approval, our foot in the door, if you will, to make DR-grade pellets an important portion of our product mix.
In closing my prepared remarks, let those of you that I still skeptical about the Cliffs turnaround story we have been writing every day since August 7, 2014. You will point to our debt lows and the challenges we face in this industry. I hope that I have given you the proper commentary that has shown you the roadmap to our future financial success.
First, maintaining our non-stop focus on cost reduction; second, using our technical expertise and strong market position in United States to increase our product offering and foster improved profitability; and third, promoting debt reduction through liability management exercises.
We are entering 2016 to conclude the implementation of our strategy as we execute the final steps of our action plan. At the same time, in 2016, the major producers of iron ore will have no option other than acknowledging that the strategy of self-destruction has led them to the urgent need of actions not very different from the ones we have already implemented here at Cliffs.
At the time these major players start to endure the pain, they signed up for the Cliffs turnaround chapter will have being successfully completed.
With that I will turn it over to the operator to direct the Q&A part of the call.
Thank you. [Operator Instructions].
Your first question comes from the line of Timna Tanners with Bank of America Merrill Lynch. Your line is open.
I want to drill down on your volume guidance because I just wanted to understand the commentary it sounded like was that in first quarter you're keeping some of the mines that are closed, closed with the intention of being able to potentially restart them later on through the year, as I believe you said the U.S. have returned to historical utilization levels. So did I assume that some of your customers restart idle blast furnaces or is that just assuming they go from taking the minimum to a more normal level or can you give a little bit more color about what that -- what your volume guidance assumes for your customers?
Sure. Our guidance is based substantially on nominations that we get. We have already got them from our clients and it is also based on our marketing challenges. We have options outside of our two main clients at this point. And I mentioned during my prepared remarks the substantial impact that we expect from DR-grade pellets.
So there's a lot happening here in the U.S. iron ore market and even more important it has become very clear that in the domestic steel market we have a clear differentiation between the steel mills that are focused on automotive and the high end of the market, more towards the cold-rolled and galvanize the steel and the ones that are more leveraged to help in. Fortunately we serve the ones that are more leveraged to the markets that are performing well like I provide the best example is the automotive market. So I will leave it at that but that's the way we're seeing our market developing in 2016.
Okay. So I understand about a million tons probably supplied to Nucor on the DRI side and they're happy having you as the supplier and your existing customers hold on to their current operating model. I just understood from your comments that you're expecting return to more normal operating levels and I just want to know if that was embedded in your guidance or is that potential upside and are you assuming that it comes equally from integrated mini mills to be able to give you a full benefit on your integrated customer base?
Yes, look your comment about 1 million tons of pellets to a specific client is your comment. I'm not endorsing or negating the comment. But you are absolutely right; we are expecting a much more normal situation. And as far as operations in United States mainly because the impact of the trade case will be real and it has already been started to be realized by the order books of the clients, our clients at least, and we expect that only to improve.
Your next question comes from the line of Jeremy Sussman with Clarkson. Your line is open.
Yes, hi thanks for taking my call. Lourenco, very good job on costs in the fourth quarter and nice to see it flowing through to next year or I guess this year anyhow. Along those lines one piece that did go up a bit, is the non-production cash cost which I believe includes idling. Can we just get a sense of kind of how much of the increase in '15 was idling related and kind of may be what the right level of that component is going forward?
Sure. I will let Kelly take this one. Go ahead Kelly.
Yes, Jeremy, you're right. We're going to idle expense again in 2016. We're looking to say roughly somewhere in the $55 million range of total idle expense for the year just based on our, again looking at our sales ton forecast, looking at kind of how we see production evolving over the course of the year based on market conditions, and in customer demand. We tend to have -- we're going to have a little higher amount of idle expense in the first quarter simply because we've got some continuation of sub pay and some other elements of the idle expense that are higher in the first quarter and those will start to decline and more normalize over the course of the year.
So and obviously there are number of elements that go into the idle expense everything from take or pay requirements to maintain energy to the facilities and scalable crews to make sure that facilities under good care and maintenance et cetera. So obviously that could change and be lower if we're able to bring back facilities sooner than we expect at this point.
I would just one additional comment it’s more like a win we bring back production, not if, we will bring back production. This is United States of America, we're not going anywhere. We're going to continue to have a resilient economy, domestic steel production, domestic steel consumption, and we're going to continue to sell pellets.
And Jeremy just one other point the idle expense that we're looking at is baked into our COGS guidance. So you got that kind of picked out for modeling purposes.
Right. No that's helpful. So I guess just may be along those lines when you do bring back production, I mean there has been a pretty substantial reduction in your -- the cash cost of production kind of before the line item of the non-producing cash cost. So I guess I mean do you envision this as sort of a two-fold benefit greater volumes but also once you get the idle component of cost out of the way that you should also see margin expansion on back of that? Thanks very much.
Absolutely, you're right about that. Yes. Thanks Jeremy.
Your next question comes from the line of Garrett Nelson with BB&T Capital Markets. Your line is open.
Hi with the closing of Oak Grove and Pinnacle transaction last month, is that the final asset sale we should be expecting or you still considering selling the Asia-Pacific assets and/are your terminal there at Esperance?
That’s a very good question, Garrett, and the answer is no, this is not our last transaction. We are always looking for opportunities of doing better and divesting -- the opportunity to divest assets that may be divested and doing transactions that may make sense and the most clear one is absolutely the complex Koolyanobbing port of Esperance. It's a dedicated port, we are the own users of that port, it's a deepwater port; there was one in that area of Australia that can accommodate capsized vessels. So we have a very good asset in the port and we're going to continue to discuss opportunities related to the Koolyanobbing Esperance complex. Of course Koolyanobbing that continues to be reduced because not only the seaborne prices are going nowhere but down but also because we are really approaching the end of life of mine.
But even for other companies, out of the iron ore business the port of Esperance may represent a value proposition and we have some discussions ongoing but they are too premature at this point to be discussed in detail but a good question.
Okay. Great and then one more you’re expecting to produce 16 million tons from U.S. iron ore this year. What's your annual production capacity and how quickly could you ramp up if domestic steel fundamentals were to improve?
To run past this quick, we can run past in less than a quarter we can to back to full production any mine that we have. Our production capacity is sub 20 million at this point not at this point because we still have Empire, but when Empire reached the end of life of mine, we took the sub 20 million. With Empire we got little more than 20 million. But keep in mind the 16 million is production but shipments will be 17.5 million which is an increase in compared with 2015.
Your next question comes from the line of Lucas Pipes with FBR & Company. Your line is open.
Lourenco in the past you were providing details on kind of new entrants to the USIO market and today I think you made some comments but it would be helpful to have more granular update on what you think is happening in terms of competitors coming to the U.S. market. Where do you think that stands right now, how is the supply situation going to change?
Well you're absolutely right because in the past this was important. At this point, it’s no longer important because not but short of a miracle from God the one that's last being built in Minnesota will not be able to start in the next quarter or two quarters or three quarters or two years or three years. So it’s gone, it’s able. So all that talk, all that great predictions about a competitor establishing himself, first to produce steel and DRI and belts, then to produce only DRI and belts, then to produce only belts. Now they're producing just disappointment, sadness, unemployment, lack of respects, lots of great things over there. So it's gone, so that's a reason I did not even bother commenting.
The other one is still grasping the last straws of their existence. We are really standing by respecting the legal process that's going on over there and we will wait and see how we're going to address. It's so great, it's all positive. Even for the current guide in funds bankrolling their existence continues to put good money after that that's their decision not mine.
We have a situation in the USIO that can be profitable and that can generate good revenues and return on investments for our investors, well established, and they are the ones not doing the same thing it's operating under Chapter 11 and continuing to struggle day after day after day after just relying on legal opinions to stay afloat and to stay supplying our client that doesn't like them. So that's the current situation.
I don't know if I missed something but if want to ask a more specific question I'll give you a more specific answer.
No, no this was exactly what I was looking for. Thank you for that and just to make sure I understood your prior comments on USIO outputs from Cliffs at current steel capacity utilization factors where would that shake out if kind of things stay at the status quo, what sort of volume should we be looking at for 2016?
17.5 million tons, 16 from mill production and 1.5 from inventory.
At current utilization rate?
At current utilization, exactly at current utilization rates, exactly right.
Okay, great. Well, good luck.
Which I -- Lucas, which I truly believe it will improve during the year by the way for the record. We tend to build our worst case scenario in our forecast to protect the downside.
Got it. That's great. Well good luck with everything. I appreciate your color.
Your next question comes from the line of Evan Kurtz with Morgan Stanley. Your line is open.
So first one good work on controlling what you can control, looking at cost coming down and continuing into next year certainly a positive. So I was trying to take your guidance and kind of back into what the seaborne price for iron ore would be for Cliffs to be free cash flow breakeven and at least on my math and this is not including that $100 million in the working capital that you had mentioned at the beginning of the call. I was shaking out somewhere near $50 a ton or so. And I was wondering you're about $10 a ton away from free cash flow breakeven at this point. What do you see or what can you do footprint wise or to get there over the next year to two?
Evan, look, here's the thing. The number that would be the answer to your question would be very relevant for iron ore mining companies that are fighting to be cash cost breakeven in the seaborne iron ore market, that's not my goal.
My goal is to profitable in the United States, helping our clients to continue to be profitable in the United States, enhance the product mix in the United States, and last but not least as kind of the tail of the dog, not be generating any negative EBITDA out of Australia. So far, so good, so you have the answer in the number that we have already realized. And then you plug your own price assumptions for seaborne iron ore and then you see if you're going to be cash flow positive, cash flow neutral, or Australia will have to drop out of the picture that will be the three options that we will have as far as Australia.
So I don't have an answer for the number because here in United States this number is totally irrelevant at $42 per ton, seaborne iron ore prices. The seaborne iron ore price can only down $42 and the seaborne iron ore prices go down $42 this will not mean anything for the United States market because our market is driven by the steel prices not seaborne iron ore prices. It was driven by seaborne iron ore price when we were in the 70, 80, 90, 100 plus IODEX price. At these IODEX price, these numbers totally irrelevant for the U.S. iron ore price.
But now that you're talking here I have a question for you Evan Kurtz, why you're still calling Cliffs high cost reducer, if you're saying that we have been cutting cost so much. Our last report still costs are high, cost produce like, if you're writing above Cliffs on 2014 we're in 2016.
Okay. Well taking into account your new guidance we will see where you shake out in the cost curve and revisit that?
Say it again.
Taking into account of your new guidance we will see where you shake out on the cost curve again we will refresh that?
Yes, cost is my guidance; cost is numbers that we publish every quarter. We did it in Q3 2014, Q4 2014, Q1 2015, Q2 2015, Q3 2015, Q4 2015; you are still calling me high cost producer. So it’s hard to confuse people when they don’t want to be confused. Have a nice day Evan Kurtz.
Your next question comes from the line of John Tumazos with John Tumazos Very Independent Research. Your line is open.
Congratulations on all the progress. Two questions if I may.
Thank you very much, John. Always nice hearing from my old friend.
Good, good. The flow of ferrous scrap for publicly traded companies has falling about 20% and many of the private scrap yards have closed, so the companies that are down 20% probably are gaining share. First question is if the mini-mills are short 10 million tons to 15 million tons due to the lower scrap flows, do you think that they will hit the 12 million tons of scrap exports into the domestic market or simply stop producing the products to have the lowest price like hot-rolled sheets? Or bid up scrap you can’t give them iron units fast enough for them to build DRI plants given how quickly the scrap was falling? How do you think that plays out?
It plays out John in a way that the mini-mills of today are not the mini-mills of the early 90s. The mini-mills of the early 90s were really low cost scrap, easily available driven big reservoir, nobody tapping to produce flat roll. That was when Crawford sued can [ph] corporation in 1989 and then Hickman, then the Steel Dynamics plants, and so on and so forth, you and I saw that happening real time.
Fast forward we are in 2016 we have a much more material market a bigger huge presence, majority presence of mini-mills in the marketplace they have done a phenomenal job in improving the quality of their steel and their ability to produce high end materials and to be competitive against the Esperance producers, including some markets that were not the markets that were designed for as high as automotive.
So at this point in time, what the mini-mills, I have problem calling them mini-mills at this point -- but the producers are aiming when they go to DRI, HBI or any other iron sub institute is to be able to cater to a clientele that they would not be no matter how cheap, no matter how available, no matter how simple life would be by using only scrap. So DRI or HBI or any iron sub institute, yes, gives the mini-mills -- the [indiscernible] producers the ability to compete in markets that they were able to compete before and that is like MasterCard.
Thank you. I will ask the second question Lourenco --
Yes, go ahead.
Fluctuations on the debt exchange which looks like it will create at least $1 billion of fresh equity on your balance sheet, if accepted without issuing any dilutive stock, it's really you should get to know about price, you're trying to preserve shareholder value. Thank you.
I appreciate the congratulations but I had to stop you, John. I will not discuss the debt exchange I can't, that is a legal.
Excuse me, if that was a legal, Lourenco. Thank you.
Thanks, John. Appreciate, thanks a lot. I will take the last question operator.
Your next question comes from the line of Chris Haberlin with Agincourt Capital. Your line is open.
Hi, Lourenco thanks for taking the question. On your inventory reduction, can you just kind of talk about how you expect that to go through the year, I know at some point you mentioned that you expect some of it to happen in the first quarter, is that the whole 1.5 million tons and then how should we think about the working capital benefit of that reduction is it just simply kind of looking at the $71 to $78 iron ore realizations and just multiplying that by the volume or is there some other math that I'm missing there?
I will let Kelly take this one.
Chris, your math isn't really wrong. I don’t think you should look at the working capital benefit which will be substantially driven by USIO inventory obviously a lot of other elements contributing the working capital, but that will be the main driver, it should follow largely our seasonal patterns maybe a little bit more in the first quarter than the normal but I think you can just look at it pretty typical to our normal seasonality. And we finished last year with about $2 million tons -- of $2 million tons higher inventory than I will say more normal levels. So we got an opportunity to work it down and so that is a very significant driver of our cash flow operations this year.
And then just the second question here on your volume guidance for USIO, I guess I was a little bit surprised to see it increasing from 2015 just given that you had six plus months of the SR contract that was terminated. And I know you've talked about this quite a bit but is this all I guess it implies if your shipping increased volumes to other customers. Is that indeed the case?
Look we're not going to breakdown our shipping forecast for you but it's a combination of new clients and old, new, getting more pellets than they got last year. That's pretty much it.
I know that's not the answer you would like to get but I'm not going to go beyond that. So no matter how many times you ask the question so I'm feeling sorry.
That's fair. And just one last question can you just kind of update on where you stand with the middle contracting and how you expect that to play out over the balance of the year.
Yes, we look we have two contracts with ArcelorMittal and one expires in December of 2016 was the last month of this year and the other expires in January of 2017 which first month of next year. So we still have 11 month left in one contract and throughout in the other one. So that's the status of both contracts. The renewal will come at the right time and I’m 100% sure that the contract will be renewed in a situation that would be very good for Cliffs and very good for ArcelorMittal. That’s all I can tell you right now.
I appreciate the call. With that we are going to wrap up the call. We are really at the last stages of implementation of our strategy but we still have a lot to do here in this company. The U.S. domestic market for steel and consequently for pellets should improve in 2016 especially for the clients that are focused on the higher end of the U.S. domestic steel market.
We have a lot of hope and the hope is probably not even the right word, but a lot of conviction that the U.S. Department of Commerce will do the right thing to fix the legal trade of steel that we have been subjected to especially in 2015 and we continue to feel that our decision to refocus Cliffs into a USIO pellet center company was the right thing to do.
We look forward to continue the dialogue with you all and we will stand in fact as needed. Thank you very much and have a great day. Bye now.
Thank you, ladies and gentlemen for your participation today. This concludes today's conference call. You may now disconnect.
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