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Mechel OAO (NYSE:MTL)

F4Q11 Earnings Call

May 10, 2012 10:00 am ET

Executives

Yevgeny V. Mikhel – Chief Executive Officer

Stanislav A. Ploschenko – Chief Financial Officer

Oleg V. Korzhov – Senior Vice President, Economics and Management

Analysts

Dmitry Smolin – UralSib Capital

George Buzhenitsa – Deutsche Bank

Sergey Donskoy – Societe Generale

Operator

Thank you and good day everyone. We would like to welcome you to Mechel’s conference call to discuss our Full Year 2011 Results, which were reported today. With us from management today are: Mr. Yevgeny Mikhel, Mechel’s CEO, Mr. Stanislav Ploschenko, Mechel’s CFO, and Mr. Oleg Korzhov, Mechel’s Senior Vice-President for Economics and Management.

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 U.S. 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 www.mechel.com.

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

Yevgeny V. Mikhel

[Foreign Language]

Good day and good morning, ladies and gentlemen. Welcome to the conference call, where we will discuss the company’s performance in 2011.

[Foreign Language]

On the whole, 2011 was quite successful for the company. Despite an ambiguous price dynamics and high market volatility for our company’s key products, we took full advantage of the vertically integrated structure of the holding and achieved financial results that significantly surpassed those of the year before. Mechel’s consolidated revenue in 2011 increased by 29% and amounted to US$12.5 billion. EBITDA went up 19% to US$2.4 billion. Net income added 11% and amounted to $728 million.

[Foreign Language]

Strategic investment projects of the company peaked in 2011. This project aimed at upstream form in the company to make it more efficient and the leader in the industry. Today we can present concrete results of the investments made in the course of the last several years. In particular, in August 2011, we started full-scale mining of coal at Elga deposit and at the end of the year a railroad linking the deposit with Baikal-Amur Mainline was opened. That link will facilitate deliveries of cargo that is needed to increase coal production at Elga and lower transportation cost associated with shipments of coal to customers.

This year, we plan to complete construction of the seasonal coal washing facility at Elga. With it, we will be able to produce coking coal concentrate of the deposit, which will improve efficiency of the Elga coal complex and will open up new possibilities for direct delivery of Elga concentrate including its exports.

[Foreign Language]

Speaking about the performance of the Mechel’s mining division in the last year, I have to say that despite certain challenges caused by suspension of operations of the washing plant at Yakutugol for one and a half months and with a favorable market price environment since the start of the year, we spared no efforts to build out production. As a result, we raised sales of coking coal concentrate by 9% on the previous year.

We managed to achieve an even better dynamics in the sales of anthracites and PCI coal, whose sales grew respectively by 36% and [132%]. As of the end of the year, Mechel sold 16.8 million tons of metallurgical coal and entered top three of the leading global producers.

During the year, Mechel reaffirmed its leadership in reserves and resources. An audit based on JORC standards shows that the company has coal reserves and resources of 3.3 billion tons and 4.4 billion tons respectively. We look confidently into the future as the Group’s strategy aimed at strengthening its leadership in mining of metallurgical coal is supported by a strong resource base.

[Foreign Language]

Implementation of the strategic projects in the Mechel Steel Segment was no less intensive. In the last year, we made significant progress in our project for construction of the universal rolling mill at the Chelyabinsk Metallurgical Plant. By this time, we have put into operation the first stage of this unique integrated steel processing facility. Now even as we speak, the plant produces high quality billets for the universal rolling mill with all the properties that are required to manufacture 100-meter rails with increased wear resistance, surface endurance, and lower temperature robustness.

I note with pleasure that the steps that we were taking for the past two years to upgrade the Beloretsk Metallurgical Plant enabled our steel works to report record figures in hardware production in 2011. B&B has established itself firmly as the leader of the Russian hardware market. In 2011 alone, Mechel sales of hardware products increased by 17% closely approaching the level of 1 million tons.

[Foreign Language]

Our services on sales network was also developing very actively. In 2011, Mechel

Service Global shipped more than 4.7 million tons of steel product, 57% more than in the previous year. Today, Mechel Service Global has 160 offices in 16 countries, which enhances company’s flexibility and stability during seasonal fluctuations of demand for steel products in different regions.

It was demonstrated once again in the fourth quarter of last year. Given Mechel Service Global mature infrastructure and broad presence in the most appealing regions, our current priority is to start developing intensively rather than extensively. We will do that by expanding our services in treatment of rolled products at the storage facility, which will increase added value of products sold.

[Foreign Language]

Summing up the results of 2011, ladies and gentlemen, I must say a few words on how we see the development of our business. You must have already observed that in the last several years, Mechel’s production was growing at an accelerated pace in many aspects. We significantly expanded our production base in terms of our geographical presence and product diversification. In parallel with those activities, we were implementing a rather ambitious investment program aimed at laying the foundation for the Group’s successful development in the years to come.

However, the reverse side of that synchronous accelerated development was the amount in debt of the Mechel Group. This strategy was justified by the growing market. At the same time, since the first quarter of the last year, we have witnessed a lot of market volatility. There are no clear indicators that global economies grow in at the rates that we enjoyed throughout the last decade. All that made us conclude that the current leverage ratio may impose considerable constraints on the development of business. That is why one of the Group’s priorities today is reduction of debt.

In order to achieve that objective, we must remove the very driver of a further growth, extensive business development in all areas. In this connection, we decided to review the development strategy to put an emphasis on the key elements of our business’ growth, our competitive advantages, which offer the highest potential for increase of the shareholder value.

[Foreign Language]

The new strategy is based as before on the cost concept of a vertically integrated mining and metallurgic holding, which has proven its merits in the context of industrial cycles and stability in the times of turbulence in the sales market. Our focus in the vertically integrated holding will be on the following objectives.

First, prioritized development of the mining division on the basis of the coking coal reserves among the largest in the world. We believe that the unique combination of the richest resource base, geography and product diversification, closeness to the key sales markets, relatively low production costs, Group’s own logistics capabilities and enormous experience with projects in the mining industry has the great potential for higher profitability and added value for our shareholders and we must unlock that potential. There is a reason why I mentioned our own logistics.

To succeed and monetizing the reserves on which our value is built, control over transportation component including ports is a crucial factor. It will also be in the center of our attention in the context of the mining division development.

[Foreign Language]

Second, we intent to increase profitability of our business by cementing Mechel’s position as the largest play in Russia and the CIS in the market of steel products for the construction industry. Among our competitive advantages in that market are the largest service and sales network in the country and the comprehensive range of steel products for the end customer.

When the universal rolling mill is put into operation and this project has reached its final stage, our leadership in this market will become stronger. We will expand our product range even further, which will guarantee our tangible share in all major infrastructure projects in the coming decades and which will be reflective in the financial results and cash flow.

[Foreign Language]

Third, a competitive advantage of our steel division is its material share of the high value added product, primarily specialty steel, stainless rolled products and hardware. We are number one in Russian production of some of these products. This lead is founded on a sizable market share and unique technologies. If we advance those technologies, we will be able to significantly expand the product line and improve the quality, which will contribute even more to profitability of this business.

An extensive European network of Mechel Service Global allows us not only to substitute imported products of the segments into Russia, but to build up exports to Europe. We have a good understanding of the potential growth of sales in this segment, since we already sell our own and third-party products in Europe.

[Foreign Language]

This strategy will provide a focus on those areas of business that are most profitable and at the same time that secure the Group’s leading positions in the respective segments of the market. It will also have clear criteria for the structure of our business and the needs to own and manage certain assets in the context of the new strategy implementation. To that end, we have already started reviewing all our assets, their conformity to the list of criteria and contribution to the strategies execution.

We will also assess alternative costs of owning these assets. Today, they are relatively high, given the current level of debt and the investment program, which must be carried out. Assets which won’t pass the test will be divested thus reducing our gearing. We are convinced that in the present days there are abundant opportunities as well as instability in the key markets and also financial markets, and we must be ready to take bold decisions to maintain and develop vast competitive advantages.

I’m certain that the new strategy approved today by the Board of Directors will not only ensure a high value of business already in the mid term, but will also improve operational cash flow and lower Mechel’s leverage to what we believe to be the optimal level of net debt to EBITDA of not more than two to one through the sale of non-priority assets among other things.

And now I’ll pass the floor to Stanislav Ploschenko, Senior Vice President for Finance who will cover our financial results for 2011 and details of the revised strategy. Thank you for your attention.

Stanislav A. Ploschenko

Ladies and gentlemen, good morning, and good afternoon. We’ll begin the overview as usual with the results of the mining segment. The fourth quarter was quite challenging largely due to the uncertainties our customers faced from acceleration of the European Sovereign debt crisis in the second half 2011.

These uncertainties led to significant decrease in European steel production and to a less extent globally, which could not leave our key sales markets unaffected. Overall, fourth quarter coking coal sales and physical volumes remained flat quarter-on-quarter. The average FCA price decreased by 12% to $181 a ton with a $66 million negative effect on the net revenue.

Coke sales volumes were also off quarter-on-quarter by 38% while the sales price was down by 6% to $291 FCA. That reduced the revenue by another $46 million. Other met coal, that is to say Anthracites and PCI on the contrary was a bright spot as it was all year. The market notwithstanding we were to able to increase quarter-on-quarter sales volumes by 27% which along with flat FCA prices at around $104 per ton contributed $52 million to the revenue from third parties.

Steam coal sales volumes decreased by 16% although they are flat to slightly positive price dynamics due to high season, did not have a sensible impacts on the revenue. As a matter of fact, the share of thermal coal fell to just 3% of the third-party revenue in Q4, as you can see on slide number six which means it can hardly have an effect on the total picture and is fully in line with our strategy to focus on met coal.

Iron ore FCA prices decreased by 5% to $101 a ton. However, an 8% drop in sales volumes quarter-on-quarter upset the price effects on the revenue completely. Overall, mining segment revenue decreased by 7% to just $1.61 billion in Q4. The inter segments revenue on the contrary grew by 5% to $264 million. It will also be interesting to take a look at the changing geography of sales on the same slide. As you can see, the high volatility of sales in Q4 affected mostly international sales pushing the sales to Russia and CIS from 30% in Q3 to 38% of total sales in Q4.

Amongst others the sales to China were affected most of all as its share decreased from 28% to 23% with the rest of Asia growing from 13% to 18%. The total share of Asia at the same time remained unchanged at 41% of sales. This example illustrates the benefit of sell diversification, which we have been pursuing over the past several years. It fully paid off in the fourth quarter when China proved again to be probably the most volatile market for met coal.

Faced with increased volatility in our core markets and decreasing revenue in some of our mining products, the management dedicated all its efforts to keep the cash cost under control. And we are proud to say that we achieved a considerable success here. Cash cost at Southern Kuzbass Yakutugol held steady and $35 and $32 per ton respectively, despite high season for maintenance, power and fuel expenses.

Cash cost at Korshunov iron ore plant ticked up only by $1 to $42 per ton. At the same time, cash cost at our North American operations increased by $17 to $113 per ton. This was driven by 9% decrease in sales volumes quarter-on-quarter as the decreased European steel production most directly impacted our Bluestone operations.

As of the end of the year, which have two mines Spider Ridge and Job 32 temporarily offline, as it is not economical to [operate them] in the current environment. Taking these two mines offline in conjunction with other cost saving measures, we plan to get cash cost per ton bag under $100.

Overall, cost of sales in Q4 decreased relative to Q3 by 5% to [$582 million], then decrease versus a 7% fall in revenue led to the gross income quarter-on-quarter declined by 5% to $744 million. Remaining, however, the same 56% of the segment revenue as in the previous quarter protect into profitability of the segment.

Selling and distribution expense decreased by 37% to $167 million. The decrease was primarily driven by two factors, a 4% decrease in overall segment sales volumes and an increase in the portion of sales on the FCA basis as opposed to DAF and CPT.

To illustrate the fact of the shift to FCA sales in Q4, the selling and distribution expense as a percentage of third-party revenue decreased from 23% to 16%. Non-profit taxes posted a gain on $3.5 million in Q4 versus a $15 million expense in Q3 due to a $20 million correction of the mineral extraction tax for the previous periods at our Russian coal and iron ore operations. Following the recalculation of the taxable base using the production costs as oppose to the previous calculation based on the average sales prices.

Administrative and other operating expenses increased quarter-on-quarter by 11% to $84 million, primarily due to a decrease in gain from disposables of fixed assets. The cumulative effect of all of the above translated into enormous 16% quarter-on-quarter increase in the mining EBITDA to $593 million or 45% of total segments sales, up from 37% in the previous quarter and the highest since the third quarter of 2008.

It probably should go without saying that we are quite pleased with such a result given the difficult market environment prevailing during that period. The net interest expense decreased over the same period by 46% to $30 million largely due to a notable reduction in bank interest rates for the mining segment in Q4, as profitability of the segment improved and refinancing of certain debt attributed earlier to the mining segment by the steel segment.

Profit taxes were 12% down quarter-on-quarter to $46 million, the fall attributable to a combination of growth of the segment taxable income resulting in addition of $37 million of income tax, an increase of $44 million in deferred tax benefit related mostly to change our future corporate taxes in Bluestone. The segment also recorded a $39 million, fixed gain in Q3, as compared to $290 million loss in the previous quarter, given a translation difference of $329 million and I was referring to Q4, where we had $39 million FX gain.

As a result, the net profit was quarter-on-quarter up by $425 million. For the fully year, our mining segment’s realized sales to third parties of $4.140 billion, an increase of 36% over the level of 2010. The increased revenue was driven by sales growth in all our key products expect for thermal coal, the reduction of which is consistent with our stated strategy of further progressing into PCI raw coal previously sold into the thermal coal market.

In particular, coking coal sales were up by 16% in fiscal terms, despite the temporary halt of the washing plant at Yakutugol due to an accident in the December 2009. PCI and Anthracite sales were up 112%, tonnage wise and the expense of steam coal where sales volumes fell by 16%. It is also notable that price dynamics were also positive comparing 2011, 2010, with only average realized team coal price down to 22% as proportion of middlings and lower quality thermal coal in our sales increased with higher quality coal processed into PCI.

Inter-segment revenue also grew by 31% to $1.052 billion, largely through sales to the steel segment where a combination of iron ore supplies increased by over $1 million tonnes and coke supply decreased by 130,000 tonnes, coupled with growing sales prices led to $181 million inter-segments revenue growth.

Although, we managed to put cash cost under control in the fourth quarter, the average high in 2011 versus 2010 due to overall increase in input prices, electricity, fuel and labor, as well as scale effect, the temporary closure and then under capacity utilization of the washing plant at Yakutugol in the first half of the year, and closure of Sibirginsk Mine, at Southern Kuzbass in June. The combination of revenue and cost dynamics resulted in the gross income margin taken up only by 1% or 56% of the revenue.

Operating expenses grew by 28% to $1.196 billion, largely driven by selling and distribution expenses, which grew in line with sales. At the same time the share of these expenses in the segment’s revenue declined from 24% in 2010 to 23% in 2011. For the full year, EBITDA increased by 38% to $2.024 billion, or 59% of the revenue, 1% up from previous year margin.

Net interest expenses decreased by 15% to $171 million, due to an overall reduction in interest rates. The superior profitability growth of the mining segment led to a 63% increase in income tax expenses, which reached $303 million in 2011.

The ruble depreciation in 2011 resulted in $61 million loss on currency translation versus a $9 million gain in 2010. The resulting effect on the segment’s bottom line was 41% year-on-year improvement to $1.070 billion, or 21% of the revenue.

Now, let us turn to the steel segment. The downturn in the financial and commodity markets in the fourth quarter affected the steel segment’s performance most. The prices experienced correction across the entire product range. However, the long steel did not suffer as much as flat products, where down on dynamics were more pronounced.

FCA price carbon and low alloy sheet moved 10% stainless led 12% down. At the same time, long steel semi-finish products and hardware, which constituted 74% of the segment’s fourth quarter sales, experienced a much less pronounced turbulence with prices for rebar and wire down 8% and 7% respectively billet and engineering steel, 8% and 6% respectively, alloyed long steel 4% down.

The pressure in our key products was partly alleviated by the construction in sales volumes as MSG was restocking for the winter season. The supply demand situation was also different in Russia and Europe, which are our key sales markets.

The downturn in European demand was more pronounced fueled by distressed financial markets, whereas in Russia despite the seasonal slowdown in sales to the construction sector, the downward movement in price halted in the end of November and remarkably stayed at that level through the entire winter, which was exceptionally harsh both in Russia and Eastern Europe.

The physical sales volumes of higher value-added products with longer cash conversion cycle were also affected more as stainless flat volumes went down by 14%, engineering steel by 16%, alloyed long products by 13%. In comparison, the physical sales volumes of rebar reduced only by 8% and stampings by 6%, the only item where realized price grew by 3% in the reported period.

In order to counter the reduction in cash flow resulting from lower sales, we increased the trade-in built where sales volumes grew by 18%, mostly the account of sales of third-party product supplied by Russian steel mills. The combination of the volumes and price dynamics described above led to the third-party revenue decreasing by 14% to $1.541 billion.

Despite a reduction in cash costs due to similar downward trend in input prices, the cost of rebar at Chelyabinsk went down by 13% to $511 a tonne. The gross income fell by 64% to $119 million, or 7.3% of the revenue. The selling and distribution expenses grew by 8% to $147 million due to substantial increase in export sales of billet mentioned above.

In the environment, which imposed a significant stress on the cash flows, the company took certain measures to improve the collection of receivables, which led to reverse in the doubtful accounts provision by almost $9 million as compared to the third quarter. The administrative expenses were also cut by 19% to $54 million, going from 4% to just 3% of the segment’s revenue, largely due to a reduction in pension liability as a result of a pension plan amendments. Despite these measures, the segment’s fourth quarter EBITDA fell by $203 million to a positive $50 million negative figure.

The FX loss of $22 million was almost equal to that positive in the previous quarter. Income tax expense grew more than four times quarter-on-quarter to $20 million as a result of an adjustment of the effective tax rate at Izhstal, as well as FX income realized at a number of subsidiaries due to repayment of dollar denominated loans. The result was a $194 million net loss in the fourth quarter versus an $18 million profit for the previous periods.

Comparing the full year 2011 with the previous one, we still see a considerable 28% growth in top line to a record $7.154 billion, fueled by the expansion of sales in Russia and Europe along with other increase in sales prices.

Despite a contraction of Europe’s share in Q4 revenues to 22%, as you can observe on the slide number eight, in the annual sales, Europe’s share improved from 18% in 2010 to 23% in 2011. That is explained by two factors. The fast growing distribution network of MSG in Europe supported by gross share in finished products in the segment’s revenue, which rose from 73% to 79%, as our previously completed investment began to bear fruit.

The Russian prices for raw feed, however, in particular coal and iron ore did not allow the gross profits to grow at the same rate as the revenue, the former having increased by only $20 million over the figure of 2010, posting $1.127 billion.

The operating costs grew by 16% to over $127 million, largely due to a 17% growth in selling and distribution expenses, which increased to $614 million, as our sales grew dramatically year-on-year.

Within the margins we have seen in 2011 and the market downturn in the last quarter resulted in negative EBITDA dynamics, which decreased by 23% year-on-year to $319 million. The net interest expense of the segment grew by sensible 59% to $306 million mostly on the account of inter-segment expenses, which increased by $70 million year-on-year.

That was largely due to different allocation of loans between segments as the loans previously attributed to the ferroalloy segment and as related to the acquisition of Oriel Resources were repaid in the second half of 2010 through a refinancing largely allocated to the steel segment.

The $81 million FX loss in 2011 can be compared to only $7 million in 2010, as ruble depreciated faster during the reported year. That all resulted in net loss of $233 million in 2011 versus $91 million income in the previous year. The quarterly revenue dynamics in the ferroalloy segment were influenced by a combination of a slowdown with price trend across all the products and an increase in sales volumes in nickel and chrome accounted by a temporary decrease in ferrosilicon sales.

The ferronickel realized price experienced the biggest quarterly decrease 15% to almost $18,000 FCA. The third-party sales volumes grew on a contrary to 46% to 3.5 thousand tonnes. That was all at the expense of decreased inter-segment sales as the ferronickel stock accumulated and our steel segment in the third quarter was sufficient to last until the fourth one.

The chrome third-party sales volumes grew by almost 18% to 14.5000 tonnes. Intersegment sales volumes also increased by 65% as production of chrome concentrated was hot and consequently chrome Smelting Tikhvin continue to grow.

The realized price edged only by slight 4% down to $2180. A similar price dynamics was observed for ferrosilicon, down 5% quarter-on-quarter to $1363 a tonne at a time when third-party physical sales volumes fell by 17% to 9.9000 tonnes due to a halt of the one of the four furnaces for modernization in August 2011, partly compensated by high inter-segment sales volumes. The furnace was subsequently relaunched in March 2012.

As increase of third-party physical sales volumes led by nickel sales outpaced the price consolidation. The third-party revenue grew by 12% to almost $116 million in Q4. At the same time a sharp decrease in inter-segment nickel sales by 73% to only $16 million led to the overall segment’s revenue fell by 19% quarter-on-quarter.

The cash cost of ferrochrome decreased by 5% to $2047 a tonne, as a 9% increase in the cash cost of chrome concentrate attributable to seasonal factors was more than offset by ruble depreciation and overall increase in production in the fourth quarter.

Nickel cash cost remains flat at $20,600; a seasonal increase in the use of coke was offset by a slight decrease in coke prices and ruble depreciation. At the same time, cash cost of ferrosilicon production grew slightly by 4% to $912 a tonne due to temporary decrease in production.

The combination of these factors led to 6% decrease in cost of sales lower than revenue, resulting in a thin gross profit margin the third quarter reversed to a $9 million, $10 million negative figure on gross basis in Q4.

The selling expenses decreased by 52% to $3.5 million in Q2 the reclassification of the inter-segment transportation costs to the cost of sales. If that effect is stripped off, the selling expenses would have stayed at the level of the third quarter as share of revenue rising from 4.4% to 5.6% as the third-party revenue decreased.

This is due to the effect of high export sales of nickel and chrome volume wise, as prices for these products were on a contrary decreasing. Consequently, the operating expenses fell by 23% to less than $17 million in Q4. This, however, did not help to offset a fall in the gross item, which led to the fourth quarter EBITDA posting negative figure of a $11 million versus $2.8 million income in the preceding periods.

Net interest expenses fell quarter-on-quarter by almost 18% to just $1.5 million, largely due to a change of allocation of external loans between the segments as discussed above in the steel segment analysis. The FX effect in the ferroalloy segment posted a $2.6 million negative figure as dollar appreciated versus $15.6 million gain in the third quarter.

The income tax expense of $1.4 million, compared to an asset of $1.3 million in the third quarter. That increase was mostly due to additional $4.1 million income tax at Voskhod accrued following into the full utilization of tax laws carried forward.

Comparing the year 2011, 2010, the third-party revenue from ferroalloy segment grew only by 4% to $475 million. Inter-segment sales improved more, having demonstrated a 15% growth to almost $200 million. While the price dynamics year-on-year were not dramatic, nickel and ferrosilicon SA prices rising by 9% and 6%, respectively, while chrome prices remaining flat at 15% increase in chrome physical sales was balanced off by a 14% reduction in ferrosilicon sales due to temporary hault of one of the four furnaces in the second half of the year for modernization.

Operating expenses grew by 8% to $78 million along with growing export sales of chrome. In 2011, this segment contributed $46 million of EBITDA to the consolidated number versus $94 million in the previous year. The reduction is largely due to higher cost per tonne of nickel and ferrosilicon effect and the profitability of the entire segment. The former due to a substantially higher average price of coke, while the latter affected by lower production and sales volumes in the second half of the year due to the modernization of the furnace that I just mentioned.

The net loss, however, more than halved year-on-year from $186 million to $71 million. The decrease in the gross profit of $62 million was offset by a similar decrease in income tax expense due to revaluation of the income tax liability at Voskhod overall recognizing a cancellation of the statutory tax reduction from 22% to 15% that’s we reported in our 2010 accounts

The decrease in interest expenses added another $78 million to the bottom line. However, $70 million of that decrease was transferred to other segments primarily steel due to change of inter-company loans allocation.

The FX effect added $41 million to the net income as the year 2011 posted a $24 million gain versus a $17 million loss in the previous one. The fourth quarter was traditionally good for the Power segment and due to high season for electricity and heat consumption. The revenue grow by 28% quarter-on-quarter to $211 million, the cost of sales in the country decreased by 7% largely due to substantial increase in heat and electricity generation.

In Southern Kuzbass Power Plant, the cash cost per megawatt hour decreased from $50 in the third quarter to $34 only. And the segment sales also grew by 12% to $126 million, driven by the same factors. As a result, the gross profit showed 87% up to almost $90 million. The gross margin improved from 17% in the third quarter to almost 27% in the fourth one.

Not surprisingly, selling and distribution expenses increased by 19% quarter-on-quarter to $67 million due to higher transmission charges as sales grew significantly. Administrative expenses also increased by $19 million largely due to a $4.7 million provision for asset retirement obligation at Southern Kuzbass Power Plant and an $8.5 million difference between the preliminary value of emission rights at Toplofikatsia Rousse posted as of the end of the third quarter and the result of the power plants final appraisal for accounting purposes, down in the fourth one.

The combination of higher gross profit and operation expenses affected by mentioned above one-off effect on administrative expenses summed up to a $3 million of EBITDA for the fourth quarter of a $7 million negative figure in the previous one. The FX effect on the segment’s P&L was negligible. The net interest expense of $4.1 million remains virtually unchanged.

The income tax expense grew by $4 million quarter-on-quarter as profitability significantly improved due to the high season. As a result, net loss more than halved quarter-on-quarter to just $5.9 million. For the full year 2011, the segment increased its revenue from third parties by 19% to $778 million has a slight [dip] in physical sales volumes due to maintenance was more than compensated by the growth in tariffs.

The inter-segment sales also increased by 24% to $507 million. However, due to similar increase in costs as coal price demonstrated a superior growth in 2011 versus 2010 levels, the gross income grew only by 3% to $308 million. Therefore a 13% growth in operating expenses are largely driven by growth in transmission tariff, not unexpectedly led to 40% reduction in the segment’s EBITDA to just under $37 million. This coupled with two times increase in administrative expenses driven entirely by the fourth quarter one-off’s described earlier were the reason behind the reversal of the net income performance of $17 million in 2010 into $5.8 million loss in 2011.

It will be fair to say that despite electricity tariff growth in 2011, the economics of the power segment were transferred to the mining one through the increase of the market price for thermal coal.

The combined segments results led to 9% quarter-on-quarter decrease in the consolidated revenue to $2.9 billion, which on almost flat cost of goods sold resulted in 21% reduction of the gross income to $934 million, or 32% of the revenue versus 37% in Q3.

The EBITDA decreased by 21% quarter-on-quarter to $536 million. The $296 million FX loss posted in the third quarter reversed into a $14 million gain in the fourth one. The income tax expense increased by 30% largely due to the factors described in the Steel segment discussion. All that resulted in a $201 million net income for the fourth quarter, which can be compared with only $26 million in the previous one.

Overall, for the full year 2011, the business increased the revenue by almost 30% to $12.5 billion and gross profit by 20% to $4.3 billion, or 35% of sales. The consolidated EBITDA also rose by almost 20% to a near $2.4 billion, that growth entirely attributable to the Mining segment. The net interest expense remained virtually unchanged at $544 million.

The depreciating throughout the reporting period ruble led to an eight times increase in FX loss to $117 million, which coupled with a 30% growth in income tax as profitability improved, could not offset the superior dynamics in the operating result and ended up in a 11% year-on-year increase in the net income to $728 million.

Now, let us turn to the cash flow and balance sheet analysis. The volatility in our coal markets in Q4 and uncertainty about further market development substantially increased the risks of the business, which had been growing very rapidly in the previous financial periods. Having enjoyed almost two years of positive market dynamics in a post-crisis recovery, we have invested substantial efforts and resources and taken advantage of our superior position in coal and steel markets, having amongst others capitalized on our strong presence in long steel market and the biggest steel distribution platform in Russia.

The latter has been allocated a significant part of our investment in the working capital, having grown its European operations almost non-existent prior to the 2008 crisis to the same size as its Russian operations in sales volumes.

The investments in the distribution also gave us another advantage. Being a Tier 1 producing and selling company in this segment, we have successfully used our position to increase our market share at the expense of small and weaker players, which have suffered more during the crisis. However, these achievements were paid for with a significant investment in the working capital, which totaled $1.423 billion in 2010 and another $1.272 billion for the first nine months of 2011.

This strategy was justified in a rapidly growing market, where a sharp improvement in competitive advantage in a struggle for market share, which in its turn would guarantee stable sales and cash flow was worth the investments made.

However, the abrupt change in the market environment and significant decrease in market visibility witnessed in Q4, made it clear that the investments in a rapid growth of business we have been making are becoming excessively costly and become a direct competitor for funds to the investments that we have been making in the fixed assets and new projects like Elga and Universal Rolling Mill.

This competition has become very narrow as our net debt grew to almost $9.3 billion and the consolidated EBITDA decreased by 21% in Q4. Our net debt to EBITDA ratio shot up to 3.9 times, entailing negotiations of our account and bridge with our banks and limitation on further debt raising.

Faced with this choice in the fourth quarter, we have carried out a rethink of our global strategy and laid out the three pillars, which have been mentioned by Mr. Mikhel and measures to be taken short to medium-term in order to dramatically improve our financial position and return our market capitalization to the level where it will reflect the true value of our business.

These measures will concentrate around two targets we will be pursuing in the next at least two years. Number one, improvement in the cash flows; in the fourth quarter 2011, we halted the expansion of MSG, which had been our main cash consumer lately. We believe we have grown a significant in our franchise to comfortably retrench and dedicate our efforts to improve the economics of its corporation without producing assets and other market players without the need to struggle too in the higher market share, which will require more resource.

We have also taken a few measures to curb inventory build-up in the volatile market and lay a path for their gradual reduction. We changed the production plan, so that our production fully reflects current sales including any of over investments in the working capital.

We further improve the management of receivables and payables in Q4, 2011 and Q1, 2012. Despite the fact that any change in the production profile takes two or three months to be visualized in sales, all these efforts led to dramatic improvement in the Group’s cash flow already in the fourth quarter 2011.

The working capital excluding change in settlements with related parties, consumed only $62 million of cash versus $202 million in Q3, and $984 million for the entire first nine months of last year. This figure looks even more impressive if we remember that Q4 is usually a low season for steel when inventory builds up before the year-end and Christmas holidays.

Looking ahead I'm proud to say that we achieved an even more visible success in 2012 to this date in managing the inventory. The stock at MSG’s warehouses has been reduced from around 1.33 million tonnes as of the end of December 2011 to 1.1 million tonnes as of to date or almost by 20% during the period, most of which was low season with exceptionally harsh winter both in Russia and Europe. It is even more impressive having the average realized price not changing much over this period implied we have not been subsidizing volumes from pricing.

We plan to take this stock down by at least 150,000 tonnes more for the second half 2012. This reduction seems the beginning of the year is expected to release approximately $350 million of cash. Apart from inventory and payables management, we took certain measures to protect our P&L and cash flow from further deterioration in the marketplace, which would affect not only the group but our partners, which are beyond our control, but only through market instruments.

As you know, we have extensively cooperated with a number of independent steel mills in Russia and abroad which brought us a substantial advantage in terms of market share and complementary product range enabling us to extract better terms including pricing in the post-crises years.

Our biggest partner so far has been Estar Group which we accounted for as related party transactions in our financial since 2009. However, in return we invested over $1 billion in our relationship through working capital, Estar being by far the largest industry with $880 million exposure as of the end of 2011 up from $420 million, 12 months before.

Having faced a changed market environment and curbing our expansion in steel, we decided that in the new circumstances we can not afford to keep investing in our relationships as we so even the present exposure be at risk should the market volatility continue.

Consequently, we took steps to ensure that in the worst scenario, the Group’s cash flow will not be riskier further; at best it would recover this exposure fully. In order to realize this opportunity, we entered the loan agreement for $945 million with the owners of Estar secured with shares and guarantees from essentially all its assets. The proceeds of this loan were used to repay the related party receivables just enough to keep our exposure to them at the current working level.

The loan expires on September 30, 2012. Should the loan be not repaid, we will recover it through entering into position of Estar assets of around 2.3 million tonnes of smelting and 2.7 million tonnes of rolling capacity.

As the settlement of receivables with Estar continues into 2012, the settlements with related parties item reflected $679 million in our cash flow statements, pushing cash flow from operations to a remarkable $937 million in the fourth quarter. It is notable though that even stripping the related party effect, the operating cash flow rose to $258 million. This impressive achievement was largely due to the measures I mentioned above.

This was all related to the target number one, improvement in cash flows. Target number two that we will be pursuing in the next two years and that will take significantly more efforts helping to improve the cash flow is significant deleverage of our business. Our net debt rose 7% quarter-on-quarter to $9.3 billion as of the end of 2011, or 3.9 annual backward look in EBITDA, the level that we regard an acceptable in the medium to long run for our business especially having a very high volatility in the operating result.

Although, we have managed to service our debt from the operating cash flow and meet all the repayments having seen even higher relative indebtedness levels in 2009-2011. The present size and structure of debt impose a significant limitations on our ability to invest in the key projects and hence on our growth in the selected business segments.

We therefore adopted since the beginning of the year, policy of balanced cash flow from operations and investments, which would limit our gross debt at the current levels. We revised our investment program and to respond all the projects, which were either in the start-up stage or not our key priorities, actual limit in our CapEx is only 3.

The completion of the universal rolling mill in Chelyabinsk this year, further development of Elga, and completion of the modernization of Port Posiet, where capacity increase is essential from an acquisition of all mining assets.

If you turn to Q4 numbers, we see that investment cash flow demonstrated a substantial increase to $1.2 billion, however clean of the loan to EFTA, it was $496 million, $76 million thereof attributable to new acquisitions, most of it to the acquisition of DEMZ. That leaves on the $436 million to purchase of property plant and equipment, 29% down versus Q3, which was the result of the CapEx cutting program, we’ll begin to implement in the fourth quarter.

Although we had planned to larger reduction, we made a decision to complete the projects which were near completion in order to minimize their CapEx and move the project into the payback phase, most importantly, the railroad to Elga, which we had to finalize by the year-end. Now that the project is done, we have more leeway on our investment program.

The CapEx has already been reduced to $1.2 billion for 2012. Subsequently, we planned to spend no more than $1.2 billion in 2013, and $900 million in 2014. All this CapEx will be subject to the operating cash flow balancing policy described above, which will ensure that the net debt will not exceed the current levels.

The experience since the beginning of the year has demonstrated that we have been successful in following this path so far. As previously completed investments payback and as equipment begins to generate cash, we plan the operating cash flow to exceed the investments by $900 million over the next four years including 2012.

As you can see on the slide number 13, even if the market trends remain flat for the forecast period, all the delta directed had debt reduction. That estimate is done on the basis of a basic scenario where working capital will continue to grow, fueling expansion of sales, and the markets remaining relatively volatile as we are today.

However, as you can see on this slide under a more optimistic scenario, where the working capital is kept at a normalized level, if the market conditions improve, it’s cash release capacity gives an additional resource to decrease the debt by [$70] billion over the same period. That will limit future sales volume growth, especially in the Steel segment, but help to deliver faster, should the circumstances require.

Nonetheless, although, we expect to gradually de-leverage for the superior operating cash flow, on the debt we’ll not bring us to the target of 2:1 in terms of net debt to EBITDA in a medium term, which is the level where we feel enough room for further less investment, and new growth projects. In order to achieve that, we will be taking unconventional for our group steps, suggested by the strategy we highlighted above.

As Mr. Mikhel stated, by grouping our assets around we said three pillars of our competitive advantage, little bit considering all assets, which do not exceed the core of our strategy, a way opportunity cost of operating them exceed the incremental economics they contribute to the group as subject for divestment.

As far as the structure of the debt and covenant package are concerned, we have taken certain measures which led to remarkable improvement on this front, which we’re proud to deliver. As we recently announced, we successfully finalized negotiations with all our creditors which resulted in a significant amendment of our covenant package.

The net debt to EBITDA covenant has been lifted to 5.5 times through the end of the year 2012, coming down to 4.75 times and 4.4 times as of June 30 and December 31, 2013 respectively, at the end 3.75 and 3.5 as of the end of June and end of December 2014; 3.25 times at the end of June 2015, and finally, to the run rate of 3:1 starting from the year-end 2015. These new levels were to provide for a high escalation in the group’s EBITDA should market volatility increase again.

The maturity structure of our debt also experienced a significant revamp to-date. Since the beginning of the year, we completed several transactions. A $500 million of five-year loan from Gazprombank has another $460 million VTB debt was extended by five years. $167 million worth of ruble-denominated bond and another $500 million worth of ruble commercial paper placed with VTB; all together $1.6 billion of long-term debt.

All these funds have fully been utilized to meet current repayments and repay short-term debt. Our most recent achievements was sign off RUB 22 billion worth of three to five year facilities with Gazprombank, which we will be utilizing to repay the debt with short-term maturities in May and June.

These has brought the amount of debts repayable till the end of 2012 to just $1.6 billion, which is more than manageable having currently $2 billion worth of cash and utilize bank limits to our disposal as you can see on the slide number 15. Additionally, our investment program is insured by $531 million of committed projects related long-term facilities.

Our further actions are aimed at diversification of long-term instruments after stabilization of our credit rating, which is now the one of the negative outlook replanted type Eurobond markets, which could be towards the year end or in the first half of 2013, after we have demonstrated certain de-leveraging.

We also plan to continue to use ruble bonds and commercial paper, which was proven to be an efficient instrument to diversify from bank debt into an unsecured covenant free long-term public debt.

To sum up ladies and gentlemen, the results demonstrated by our business in 2011 reflects significant growth achieved in the previous years and the potential yet to be realized, in order to do that we need to undertake significant changes in our business combination, dramatically, reduce debt and concentrate in our key competitive advantages.

Having put it on our agenda, we are confident that we will be able to achieve it in the short to medium term, which will help us to realize our flagship projects monetize our high quality results, and so that bring a significant improvements to the shareholder value.

And now, we are ready to ask your questions ladies and gentlemen, thank you.

Question-and-Answer Session

Unidentified Company Representative

Thank you. We’ll now take questions. We’d ask that participants please state their name and company before asking their question. And I’ll ask for sometime after for translation, when questions are answered in Russian, they will be followed by translation, so you may ask your question in Russian also, and we will translate. Thank you.

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Dmitry Smolin, UralSib Capital. Please go ahead.

Dmitry Smolin – UralSib Capital

Good afternoon, thank you for the call and very detailed presentation. I have three questions, first on your new strategy given that almost all of your segments apart from mining, you’re also making in the first quarter, should we expect that the company could sell its steel always in Power segment, as well as some loss making (inaudible). Beyond that I don’t believe that it’s possible to sell in this tough market and still has it, but I guess that you can find some bidders for ferroalloys and power segment. Then, according to some steel traders, we are hearing that steel demand was deteriorating on export markets and due to turbulence on financial markets.

Do you see any weakness in demand or softening in prices from your key customers now in May? And also, do you consider any other options for reducing your debt apart from the sale of business, I mean, maybe IPO of mining assets this year or any other options available at the moment? Thank you.

[Foreign Language]

Yevgeny V. Mikhel

But we want some time to prepare the question. Stanislav Ploschenko will answer the first question.

Stanislav Ploschenko

Good afternoon. Since the question was asked in English, I will reply in English as well. We stated to the main principles of our strategy and, we although deleveraging is one of the points of the strategy, it would be a little bit superficial to say that we will sell everything apart from the mining segment. As you’ve noticed two elements of our strategy concern the steel segment as well.

We will definitely be reviewing the asset base and look at the assets, first of all, the ones which generate loss or generate a very thin margin. And this analysis will continue for a few months. So it wouldn’t be fair to say, it wouldn’t be fair to gauge our ability to deleverage judging by today’s market circumstances.

By all means, we will be looking not at a particular segment, but at particular assets within the segment, including the ferroalloy segment as well. Ferroalloy segment has very profitable assets like brass ferroalloys plant for example. And we will be considering not only the possibility to sell an entire segment, but selling certain assets and retaining certain assets as well.

I will repeat, this process will take a few months to be completed because we need to be absolutely sure, and to present to our Board the suggestions by highlighting all the factors and proving that we have evaluated all the factors. And we have substantial proof, both for the Board and for our investors that we consider and we recommend to get rid of certain assets. And this is the answer to the question number one.

The question number three, early on we considered an IPO of Mechel Mining, and although in these market circumstances it would be very challenging to do that. Because of that we have postponed this project for the time being. I don’t want to use the word indefinitely, but certainly for a long time until the market recovers. But we are never associated in IPO of Mechel Mining with a deleveraging. We associated the IPO with the attraction of funds to serve the developed, the reserve base of Mechel Mining.

That notwithstanding, we are prepared to look at partnerships and minority investments in our key assets, the ones which fit into our strategy and the ones which we are going to retain and develop further, if that helps not only deleveraging, but also bringing in new experience, know-how technology.

[Foreign Language]

Operator

The second question will be answered by Oleg Korzhov.

Unidentified Analyst

[Foreign Language]

Unidentified Company Representative

To answer the second question we’ll have to say that with respect to the sale of steel products in May we do not, right now, conceive any obstacles or constraints in the market. In terms of sales, our shipments of steel products in May will be higher than in the same period of last year and perhaps this should be attributed to a very mature, very well developed network of distribution and sales that the company has.

Yevgeny V. Mikhel

We are now ready for the next question please.

Operator

Thank you. Our next question is coming from the line of (inaudible). Please go ahead.

Unidentified Analyst

Good evening, gentlemen. Thank you for your presentation. I have got several questions. The first one, could you please tell me if I am right that in the fourth quarter the additional weakness in steel division performance was due to the sale of expensive stocks by Mechel Service Global because I think that there should be some live stocks accumulated in the previous quarters when the prices for steel had been high and by the end of the year Mechel Service Global, I think that they should have realized them at a lower price, maybe even lower than they have purchased.

And the next question is about the recent media speculations about Rosprirodnadzor and Rosnedra and a review of violations on the Yakutugol, of mining licenses’ violations on the Yakutugol. Could you please tell us what the current status of this, actually of the whole situation is and how the company plans to act in this situation? And my third question is, could you please give us some breakdown of your reduced CapEx in 2012 and also, if I’m right that you will now postpone the development of Sibirginskaya and Erunakovsk-1 underground mines and to concentrate only on [that] development. Thank you.

Unidentified Company Representative

[Foreign Language]

Stanislav A. Ploschenko

[Foreign Language]

Operator

First question will be answered by Stanislav Ploschenko.

Stanislav A. Ploschenko

If we talk about the inventory of Mechel Service Global in the fourth quarter, there is no direct effect from the inventory dynamics in the reported period and the fallen profitability. As a matter of fact, the inventory in the fourth quarter grew because the efforts we’ve taken to balance the production in line with the sales took two to three months, as I said previously, to materialize. And we were replacing one product with another one and which suggest for the absence again, of inventory write-down in the fourth quarter that most of the effect on the profitability was simply coming from the falling prices across the market. As simple as that

[Foreign Language]

Operator

The second question will be answered by Yevgeny Mikhel.

Yevgeny V. Mikhel

[Foreign Language]

I’ll answer the second question. In the fourth quarter and over the last year and in the first quarter of this year there were indeed scheduled orders in the South Kuzbass and Yakutugol. These orders were conducted by Rosnedra and Rosprirodnadzor with the Advisory Authority. With respect to the compliance with the license terms and Rosprirodnadzor reported to Rosnedra that there were some violations of the license identified. However, most of these violations were related to the technology of the development of the technology of the works, and there is a special commission within Rosnedra by the official meeting of this commission on the 3rd of May.

Both enterprises have removed most of the concerns of the Supervisory Boards and submitted further plans of action with supervisory authorities. On the 3rd of May, Rosnedra decided that there are no grounds to revoke. The licenses with respect to Yuzhny Kuzbass, the Southern Kuzbass that one-off action was noticed and with respect to Yakutugol, they received a special notice listing the measures and the timeline during which the still remaining violations must be fixed. So at the moment there is no token, there are no reasons to even discuss the possibility of a license revocation.

Operator

The third question will be answered by Oleg Korzhov.

[Foreign Language]

Unidentified Analyst

Okay. Thank you very much.

Unidentified Company Representative

To answer the third question, with respect to our CapEx budget in 2012, the overall CapEx budget is $1.2 billion. $200 million is for maintenance of existing facilities, $1 billion is our investment program. We decided to focus on our priority projects that, first of all, are in high stages of readiness and also that are vital for Mechel’s future and we identified five priority investment projects for ourselves, which will consummate 5% of the CapEx budget.

First one is Elga. It will take $350 million than the construction of the universal rolling mills, $320 million, construction of the Posiet Port, $85 million, the grinding and mixing complex, $40 million, and Sibirginskaya construction, on the Sibirginskaya mine $25 million. In Sibirginskaya we will construct and reinforce the vertical shaft and with respect to Voskhod Mine, there we are currently conducting preparatory work and this project will be fully realized in the next year. That’s when we plan to continue construction.

Yevgeny V. Mikhel

We are now ready for the next question please.

Operator

Thank you. Our next question is coming from the line of (inaudible). Please go ahead.

Unidentified Analyst

Guys, thanks for the presentation. I have a coupe of questions, some of them are more of follow-up questions. The first question is on the Elga CapEx, you mentioned $350 million that will be spent on that. What are the main cost items in Elga given that however this will now fully completed, what will be spend, is it a seasonal factor that’s taking $350 million or is that the remainder of infrastructure (inaudible) what’s the main CapEx component in that $350 that will spend at this year and maybe if you have a number, ballpark number for 2013 in terms of the CapEx for Elga?

And then second question is on production variables, you produced 27.6 million tons of run-of-mine coal in 2011 and I would say approximately a third of that was for steam coal, remainder two thirds was coking coal. So what’s the first of all production guidance for 2012 in terms of run-of-mine coal?

And second what is the break down between steam and coking. It’s going to look like in 2011 and 2012, I think there are really just some significant shift in the first couple of months of 2012 in favors of steam coals. Maybe you can expand a little bit on that change in the product mix? These will be the two questions and I may have one follow-up question. Thank you.

[Foreign Language]

Unidentified Company Representative

I like (inaudible) answer the questions.

[Foreign Language]

Unidentified Company Representative

To answer your first question about Elga and 350 million, approximately one half of that amount will go into completing, fully completing finalizing the construction of the railway link. Right now we have a like that connects the deposits with back, our main line, but we still need to build 27 bridges, 20 of them will be constructed in 2012 and seven will be build in the first six months of 2013. The fact that, right now we don't have this bridges does not affect the shipments from the deposits and the throughput capacity of that link whatsoever.

The second half of our investment into Elga this year will be broken down into two parts approximately $7 million will be consumed by the seasonal washing factory and the remaining part will be spent on the development of the infrastructure bridges and equipment and building the camp for the workers.

After the power, the electricity this investment is fully carried by the Federal Grid Company. Now with regard to our investment guidance for 2013 for Elga, at the moment we plan to invest about $600 million. Thank you.

Unidentified Analyst

[Foreign Language]

Unidentified Company Representative

[Foreign Language]

Unidentified Analyst

[Foreign Language]

Unidentified Company Representative

We will go to the second question, the production of shipment guidance for 2012, Remember, Michael we plan to produce about 30 million to 31 million tons and speaking about the finished products that will be about 27 million tons of those including 13 million tons of coking concentrate, 10 million tons of steam coal and 4 million tons of anthracite and PCI.

There was an additional question how much of that production will be done in Russia and how much in the U.S? Out of the 30 million or 31 million tons, 4.1 million is U.S. production everything else is Russian.

Unidentified Analyst

Thanks a lot.

Unidentified Company Representative

We'll go to the next question please.

Operator

Thank you. The next question is coming from the line of George Buzhenitsa from Deutsche Bank. Please go ahead.

George Buzhenitsa – Deutsche Bank

Good evening gentlemen, thank you for the presentation. I have one question on your Astor transactions. Can you please clarify is that correct that, investor does not repay the loan that you provided them then you will be consolidating all from Astor assets in your balance sheet. And if so how do you think your debt balance will change? Is there any debt on those assets?

[Foreign Language]

Unidentified Company Representative

Stanislav Ploschenko will answer.

Stanislav A. Ploschenko

Yes indeed, if the loan is not repaid we will enforce the security, which is the clash of shares of essentially all Astor assets guarantees from them, and having done that, having enter to deposition of the Astor we will according to US GAAP consolidate the assets.

Yes our assets altogether have about $1 billion debt outstanding, but it's important to note two things with respect to that debt, first of all our analysis and experience of deal with the Astor, shows that even in the present market environment they have been capable of servicing the debt from their own operations.

Secondly all the debt is structurally subordinated to Mechel, which means that none of the creditors to Astor has recourse to Mechel through a security or guarantee. So our creditors will be privileged in that sense to the creditors of Astor. And even consolidation of additional debt from Astor will not entail any common bridge because the revision of the new covenant package. It was the front taken into account possible consolidation at first time, there was a significant room on top of that to provide for any negative volatility in the company’s operational result.

And if the eventualities that we have to consolidate Astor and entering into position of smelts and consequently technically that will be tough time to increase of debt. Our first and foremost task will be to bring the situation back to normal meaning to reduce debt by selling part of the assets. By that time, we will have formed analogies of our own asset base and the broad Astor will follow the same rule as our own operations.

[Foreign Language]

Unidentified Company Representative

And I would like to ask with respect to Astor indebtedness, short-term indebtedness substantially all indebtedness is in seven years to 10 years settlement agreements reached signed with our creditors when they were going through bankruptcy procedure. So it’s pretty much short-term debt zero interest bearing.

[Foreign Language]

Unidentified Company Representative

Thank you. We are ready for the next question please.

Operator

Thank you. The next question is coming from the line of (inaudible) HSBC. Please go ahead.

Unidentified Analyst

Good evening everyone. Small questions. I try to understand the production guidance, the corporation guidance for this year implies a reduction from the previous one, which was available year-on-year (inaudible) side is part of a sort of medium term production strategy. If you have understanding now, what – of production volumes going into say 2013 and 2014, can you please provide those figures, say total production co-production volume. So it just lead between thermal and coking coal.

Second question, what is our outlook for cash growth for this year, given that you are going to have the higher production volume, does it imply lower production costs or at least slight production costs year-on-year.

And question number three, given you said that you said, you’re considering number of options in terms of raising capital to reduce debt, would you consider selling the perhaps some treasury? Thank you.

[Foreign Language]

Stanislav A. Ploschenko

This is Stanislav Ploschenko, I’ll answer the third question and then Oleg Korzhov with follow with number one and two. No, we did not consider sale of preferred stock held in treasury, because the preferred stock even in today’s market conditions with entries cost of debt is a much more expensive source of financing. We follow here purely arithmetical approach, the preferred share are basically too expenses, more expensive than debt.

Unidentified Company Representative

[Foreign Language]

Unidentified Company Representative

The first question will be answered by Oleg Korzhov.

Oleg V. Korzhov

[Foreign Language]

Unidentified Company Representative

There are three factors, of course the direction of the production guidance that we gave earlier for 2012, in fact, number one is the lower production in Elga regionally, we looked up 2 million tons a day while we get 1 million tons, this is explained by our – at the moment limited washing capacities there at the schedule of putting the new washing factory into [alteration]. We decided that we’re going to produce there only as much as will be able to wash and to ship and to sell consequently.

The second factor is Bluestone, technically all capabilities are there to produce more broad to market in the first and the second quarter made us a suspend production in some of our sites there whether the net result was negative for us.

The third factor is the South Kuzbass that were also lowered our production, again physically it is possible to produce more there, but for this we need to purchase some rather expensive pieces of equipment, and this equipment is needed for open mine production.

At the moment we decided to return to this issue around the middle of 2012. We will review the market, the market situation and our financial capacity to buy that equipment and then maybe a different decision will be taken. As to production in 2013 and 2014, for 2013 we're looking at 39 million tons and 41 million tons in 2014. Thank you.

Unidentified Company Representative

Next question please.

Operator

Thank you. Next question is come from the line of (inaudible), Renaissance capital. Please go ahead.

Unidentified Analyst

Good evening ladies and gentlemen. Thanks very much for the presentation. I’ve got two short questions. First of all about Bluestone on the page 5 of your presentation, I see that the cash cost on Bluestone it hit sharply nearly 17% quarter on quarter. What's the nature of this sharp growth and can we expect the same growth further in 2012?

And the second question is about your operating results in first quarter [wells] operating results. What's the current level of your core inventories in your warehouse and can you please provide the split of cooking and thermal coal inventory if it's possible? Thanks.

[Foreign Language]

Unidentified Company Representative

Stanislav Ploschenko answer the first question.

Stanislav A. Ploschenko

As I mentioned in my presentation, the increase in (inaudible) on a fourth quarter vis-à-vis the third one was largely due to contraction of sales by 9% in the fourth quarter as Bluestone is largely an exporter and most of it exports goes to Europe, the volatility in the European market in contraction of (inaudible) Europe as large steel produces began to cap their production in the fourth quarter effected the exports of Bluestone which together coupled with the decreased production increase the cash costs because of the scale effect.

Already in the fourth quarter and probably in the first quarter of this year which suggest us to bring the cash cost further down below $100 a ton by closing two most costly mines temporary until the pricing environment and demand situation recovers. So we expect that the cash cost at the end of the first quarter especially in the second one would be restored to the normal level.

[Foreign Language]

Unidentified Company Representative

The second question will be answered by Aleksandrovich.

Stanislav A. Ploschenko

[Foreign Language]

As far as understanding the second question that refers to the product that is really it to be sold as of the beginning – at the beginning of the year and one of the coating figures that begin to come the coal, in the warehouse of our own enterprises and also in reports. That figure is 2 million tons. At the moment that was at the beginning of the year. At the moment, is 1.4 million tons it means, that we manage to reduce our inventory, by 600,000 tons. Our sales today are 2.3 million tons a month, it means that our inventory is 20 days. We believe that 20 days is an optimal figure, it’s an optimal period for our company.

As to the break down for the first quarter, you will find this information on the press release, overall we produce 6.4 million tons. We sold 3.2 million tons of coking coal 500,000 of PCIs, 614,000 the anthracites, and 1.5 million of steam coal.

Unidentified Company Representative

Next question please.

Operator

Thank you. Next question is coming from the line of (inaudible) from Citi. Please go ahead.

Unidentified Analyst

Guys, just one additional question, one follow-up question, additional question is on projected or expected net interest rate, net interest expense that you expect to incur as a result of negations for maturity, [expenses], et cetera. So, in one of your scenarios you have $9.5 billion of debt, but the year-end, 2012 another scenario $9.2 billion. If somewhere between that scenario and that will actually materialize, what's the average or weighted average net interest expense that you expect to pay, but you negotiated for that leverage. And just wanted to stop question on production, you mentioned 4.2 million tons of [cement] production, cement goods production in the United States. It is possible to give some guidance for 2012 in terms of the one of the mine coal production in 2012 for Bluestone Group assets. Thank you.

Unidentified Company Representative

[Foreign Language]

Operator

The first question will be answered by Stanislav Ploschenko.

Stanislav A. Ploschenko

Answering the first question, first of all I have to say that the company’s policy is not to give financial forecast and forecasting one of the items on the P&L, easy financial forecast. So I will try to answer your question indirectly. There was no revision to the interest rate as a result of renegotiation of the covenant package. There was an increase on overall interest rates in the first quarter when the Russian financial markets was still affected by the, if whether I can use the word crisis in the European financial market, so the turbulence in the European financial markets. And in the presence of liquidity concerns, the interest rates and the Russian market increased because for both international and Russian banks the cost of funding rose. The increase of those interest rates can be tracked by the public market instruments for example, the yield on the ruble-denominated bond of Mechel.

The situation in the second quarter became easier, there is no concern about the liquidity so the situation started to improve, it is not in our place to give forecasts about the macroeconomic measures, especially the development in the liquidity position and the global financial industry, but this is a situation which we have had for the part of the year, that we leap through.

[Foreign Language]

Unidentified Analyst

And just one follow-up question. What is the average interest rate, net interest rate that you were paying in 2011, so just dividing net interest expense by the average net debt? Do you have that ballpark number at your disposal?

[Foreign Language]

Stanislav A. Ploschenko

I will answer that question after Mr. Korzhov replies to the other one.

[Foreign Language]

Oleg V. Korzhov

What I mention the figure of 4.1 million tons, Bluestone that was done in the context of the overall guidance production for nature of 30 million tons and speaking about, so that was actually run of Mechel. So once again in 2012, we expect to produce 4.1 million tons of run of Mechel at Bluestone and 3 million tons of finished products all we shipped.

Stanislav A. Ploschenko

Answering the question about the average interest rates, we did not drive the average interest rates for the entire debt portfolio, but if you can follow up on our financial statements issued today. The average interest rates for rubles denominate long-term debt in 2011 was 9.1%, the U.S. dollar denominated long-term debt was 5.6% and Euro denominated long-term 4.2%. With respect to the short-term debt, the Ruble denominated stood at 7.2%, the Dollar denominated 4% flat and Euro denominated, 4.9%.

[Foreign Language]

Stanislav A. Ploschenko

Next question please.

Operator

Thank you. Next question is coming from the line of Alexander Moran (inaudible). Please go ahead.

Unidentified Analyst

Good evening guys. I have some questions just what is your expected target level on EBITDA margin for 2020? And second question is do you plan to reduce production in metal system if some global markets continue reduction? Thank you.

[Foreign Language]

Unidentified Company Representative

Stanislav will answer the first one.

Stanislav A. Ploschenko

Unfortunately, I have to return to my early comment that we don’t give financial forecast especially for such very long period 2012-20. But I would like to refer to the outlines of the strategy that Mr. Mikhel and myself discussed earlier on the conference call. The all these strategic initiatives that we have described they have only one target improvement and dramatic improvement in the profitability of the business, which will be translated into the improvement of the shareholder value and since you given us time till 2020, we believe we have sufficient room to improve it considerably.

[Foreign Language]

Unidentified Company Representative

The next question will be answered by Oleg Korzhov

[Foreign Language]

Oleg Korzhov

May I translate the answer to the second question first?

Unidentified Analyst

Yes, yes.

Oleg Korzhov

Thank you very much. Now regarding our production of steel products you have already heard about our strategy, our strategy is to produce only as much as were capable of selling, we’ll not produce to make a loss for the company or we’ll not produce for the production shake. So every time a decision was taken as economics is calculated and every time decision is made regarding the feasibility of this or that move. So if the calculation is demonstrate that the decrease of production is feasible and it is necessary then of course actually decision will be taken but I hope that the market conditions will not deteriorate and demand will restore we’ll now have to take that steps. Thank you.

[Foreign Language]

Oleg Korzhov

It’s a follow-up question to the first one. Regarding the forecast, all the EBITDA margin target in 2012, the question is really not about the absolute figure but it’s rather about an upwards or downwards trend what does the company expects with respect to the EBITDA margin.

Unidentified Analyst

I have to clarify, am I right as we’re talking about 2012, not 2020.

[Foreign Language]

Stanislav A. Ploschenko

Well then we’re talking about two short-term projection, which is difficult to make in the volatile market, precisely to provide for high volatility in the operating results. We for example introduced or we have kept our debt in the financial covenants with our banks at $11 billion net, which was a measure to ensure that the debt, according to the or due to the volatile markets the financial metrics may isolate significantly. Therefore, I would stay short of making any projection for the financial results, but the measures that Mr. Korzhov just described we’ll ensure that even if the market remains volatile we are affected at least by these events and now our financial results stays or is affected to the minimum extent.

[Foreign Language]

Unidentified Company Representative

Next question please.

Operator

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

Sergey Donskoy – Societe Generale

Hello, everyone. I have two short questions but before I ask one follow up on your loan to Estar. Just to clarify was this loan to Estar itself or through the company’s shareholders?

[Foreign Language]

Sergey Donskoy – Societe Generale

It was loan to the shareholders of Estar otherwise the shares in the plants could not have been pledged.

[Foreign Language]

Sergey Donskoy – Societe Generale

Understood, thank you and then two questions. First of all on the profitability of your mining division. I think that you touched upon it in your presentation, but just again to clarify. So far as I understand the sales volumes in the division were flat quarter-on-quarter. Keep close they were also flat or slightly up, prices flat or down. How, was it possible that the mining division achieved a 16% increase in EBITDA quarter-on-quarter. That’s question number one. And question number two, looking at your working capital dynamics in Q4. I notice that there was an approximately $608 million inflow, cash inflow from settlement with related parties. Could you please clarify what was the nature of this transaction? Thank you.

[Foreign Language]

Yevgeny V. Mikhel

Stanislav Ploschenko will answer the questions.

Stanislav A. Ploschenko

If you look at the segmental analysis and the segment’s financials in the mining, we had a significant improvement in the items below the gross income in particular the selling and distribution expenses decreased by 37%, largely, not only due to the overall decrease in sales which was not significant, but most importantly due to increase of the share of sales on the FCA basis oppose to longer-term delivery like CPT or DAF. Last we had an improvement in the administrative expense. Excuse me in the non-profit taxes due to recalculation of the mineral-extraction tax. And from other reasons these are probably the two main ones that led to the improvement in profitability.

Answering your second question, when I described the relationship the origins of the Estar loan or I mentioned that loan was extended to the Estar shareholders precisely in order to repay the net receivables we had extended to Estar when the market was growing and we were relying on larger scale of operations.

Our task was to protect the P&L by attaining the unsecured receivables into asset secured loan, to repay those receivables. Since the settlement with Estar continued into the first quarter of 2012. We only reflected $679 million of net inflow from Estar in settlement of those receivables. So basically, the money revolved from the loan to Estar back to our group through the repayment of receivables.

Sergey Donskoy – Societe Generale

Thank you.

[Foreign Language]

Stanislav A. Ploschenko

Next question please.

Operator

Thank you. We currently have no further questions coming through. (Operator Instructions) We’ve got no further questions coming through. Now I hand you back to your host to wrap up today’s call.

Vladislav Zienko

Ladies and gentlemen, thank you for taking the time to join Mechel’s full year 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.

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