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Mechel OAO (NYSE:MTL)

Q1 2012 Results Earnings Call

June 20, 2012 10:00 AM ET

Executives

Vladislav Zlenko – Director, Investor Relations

Yevgeny Mikhel – Chief Executive Officer

Stanislav Ploschenko – Chief Financial Officer

Oleg Korzhov – Senior Vice-President, Economics and Management

Analysts

Sergey Donskoy – Société Générale

Anton Rumanse – Troika

Andrey Lobazov – Alfa Bank

Oleg Petropavlovsky – BCS

Bernard Zonneveld – ING Bank

Dan Yakub – Citi

Vasily Kuligin – Renaissance Capital

Andrey Kulakov – Uralsib Capital

George Buzhenitsa – Deutsche Bank

Paul Carr – Amoris Management

Operator

Welcome to the Mechel Reports Q1 2012 Financial Results. My name is Emma, and I will be your coordinator for today’s conference. For the duration of the call, you will be on listen-only. And at the end of the call, you’ll have the opportunity to ask question. (Operator Instructions)

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

Vladislav Zlenko

Thank you, and good day, everyone. I would like to welcome you to Mechel’s conference call to discuss our first quarter 2012 financial 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 mechel.com.

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

Yevgeny Mikhel

[Foreign Language]

Good morning and good day ladies and gentlemen. Welcome to conference call where we will discuss company’s performance in the first quarter of 2012.

[Foreign Language]

We have to recognize the fact that on the whole the first quarter of this year proved to be rather challenging. Significant reduction of quarterly prices on coking coal was pre-determined by prolonged weakness of the global economy and low demand from major customers.

This works against Mechel Mining financial performance. On the other side, in the first quarter steel feedstock prices were falling at a time when steel product prices were relatively stable. This contributed to high financial results of Mechel’s steel.

We succeeded in our efforts at optimizing the production of steel program with the view to reduce the inventory, which accumulated at the end of last year in Mechel Service Global and this also had positive effects. We managed the release of working capital to improve operational cash flow of the group.

[Foreign Language]

Overall, we achieved the full-end results in the first quarter of 2012. Mechel’s consolidated revenue was around $3 billion. EBITDA was $463 million, net income $218 million.

[Foreign Language]

Concerning our activities on the key areas of strategic business development especially mining, I have to note that at the end of last year, a railroad linking Baikal-Amur Mainline and Elga deposit was opened.

Early this year, we started construction of the seasonal washing plant, another infrastructure facility that is essential for Elga development. We expect to complete construction by the end of July, which will enable shipments of readymade coking coal concentrate directly from deposit already in this year, thus enhancing the project efficiency.

[Foreign Language]

We mustn’t forget that in the coming years, Mechel’s mining segment will develop not only by building up production of Elga. Coke cruisers of the Southern Kuzbass are estimated to be around 700 million pounds. From the start of the year in the Southern Kuzbass, we made progress with one of our most important current project, construction of the second line at Sibirginskaya mine.

By May, we completed funneling of the vertical shaft that took us several years and at this moment, we begin to reinforce it. We expect to work the second line at Sibirginskaya mine in 2014, thus doubling its production and bringing it to 2.4 million tonnes of coal a year.

[Foreign Language]

Considering a serious operation production of coal in the coming years, we focus on development of own port facilities to ensure efficient access to the most promising markets. From the start of the year, we manage to make progress and expand in the capacity of Port Posiet our gate to the Asia Pacific region.

Till the end of the year, we plan to increase port capacity from current 4 million tonnes to 7 million tonnes a year. (Inaudible) is down next year, the port capacity will reach 9 million tonnes. And the port will be able to receive Panamax-class vessels with deadweight of up to 60,000 tonnes, which will significantly improve the efficiency of logistics through the port.

[Foreign Language]

In the first quarter, the company also succeeded in strengthening its position in the construction of steel product. Despite the lower seasonal market, Mechel Service Global through its direct access to more than 28,000 end customers in Russia and Europe managed to raise sales and substantially reduced inventory, which at the end of they year were 1,325,000 tonnes of steel products. Between January and March, Mechel Service Global stock was more than 200,000 tonnes.

This trend continued in April and May, when Mechel Service Global scaled down its inventory by another 107,000 tonnes bringing it to just over 1 million tonnes as of June. As I have already mentioned, this had a positive impact on the working capital and group’s operational cash flow.

[Foreign Language]

In accordance with the updated strategy approved by the Board of Directors on the start of May in parallel to the development of the above mentioned priority areas will continue the process of reviewing all our assets in terms of their alignment with the fundamental parameters of the strategy.

This is done with the view to determine the most optimal ways to define the current asset structure, towards improvement of operational cash flow of the group’s enterprises. It will take some time to workout specific proposals and it would be too early now to talk about annual results.

All findings will be presented to the Board of Directors for their consideration. I’m confident that further potential for Mechel’s development is contained in key strategic projects. These will be prioritized along with measures for improvement of operational cash flow and debt reduction. Such strategy will have the most positive impact on the growth of shareholder value.

And now, I pass the floor to Stanislav Ploschenko, who will cover the details of the financial results for all segments of our business. Thank you.

Stanislav Ploschenko

Good morning and good evening, ladies and gentlemen. On this -- slightly more than a month ago, we reported a full year results of 2011, where we stated the measures the company was taking in order to adjust its operations to the volatile market environment and improve its cash flow.

Now, reporting the first quarter 2012, we are proud to deliver the best results of these measures. I’ll traditionally start our discussion with the Mining segment. The overall negative price dynamics on the key product could not leave its revenue and profitability unaffected with coking concentrated FCA price down 22% quarter-on-quarter. Anthracites and PCI down 9% and iron ore concentrate down 19%.

On the steam coal realize price beat the trend with 20% quarterly rise, which was largely attributable to increase export sales. Volume wise coking coal sales to third-parties held fairly steady, down by less than 2% despite the fact that production decreased in the first quarter due to temporary hold of Sibirginskaya mine in Southern Kuzbass and idling of certain mines at Bluestone.

That was compensated by rundown on stock, which also helped to release cash. PCI and anthracites volumes were down by about 20%. Thermal coal sales down by 18% tonnage wise as internal consumption on steam coal more than doubled driven by high season power generation.

Additionally, we experienced increase demand in Turkey and Kazakhstan due to unusually cold winter. These negative variances were somewhat offset by 30% increase in iron ore sales as internal consumption decreased releasing more volumes for export sales.

That actually is reflected in a 14 quarter-on-quarter reduction in the segment sales to $226 million. It is notable though, that in comparison to the first quarter of 2011, the third-party sales of coking concentrate still showed a hefty 29% growth in physical terms while PCI and anthracites sales almost doubled largely at the expense of thermal coal where sales volume went down by 60%.

However, coming back to the reporting period, our Mining segment’s revenue from sales to third-party fell by 12% quarter-on-quarter to $933 million. The markets of our mining products continue to be quite difficult due to the cohorts from European sovereign debt crisis and the continuing slowdown in Chinese demand.

In particular, the turbulence in the euro zone was the main driver for the fall-off in PCI and anthracites shipments, which resulted in European share of sales contract to 14% as you can see on the slide number six. Demand for these types of coal however is relatively strong in the Pacific Rim and we’re intensifying our marketing efforts such to improve the geographic diversification of demand.

Additionally, we are beginning the science of practice support in the market given us reasons to be cautiously optimistic with the respect to an improved topline during the second half of the year.

Given the difficulty of the overall operating environment, we have tried to maintain and even sharp the focus in our cash cost. However, depreciating dollar and temporary mine shutdowns of Southern Kuzbass, which pushed the share fixed cost up led to $5 increase in the cash cost of our Kuzbass operations to $40 a tonne. This was combined with slightly higher shipping ratio at open pit mines incurred as we ramped up production examine to compensate for the lost underground production.

Yakutugol cash cost increased by 3% to $35 per tonne due to front loading of certain Russian payroll taxes and additional drilling at the Neryungrinsky Open Pit in order to allow us to optimize the blend going to the washing plant.

The dollar depreciation was accountable for $1 of that increase which was pretty much the case for all of our Russian operations. Korshunov Mining Plant also saw a $3 per tonne increase, $2 of which was due to higher maintenance expense.

At Bluestone, however, we were able to reduce cash cost by $13 per tonne through implementing an intensive expense management that exercise temporarily closing two of our high cost mines.

The bad factors led to 19% decrease in gross profit to $603 million. Sales and distribution expenses increased quarter-on-quarter to $249 million. The increase is explained by growth of sales to China on CIF and CFR basis. The China shaft sales grew from 23% in Q4 to 28% in Q1 as well as annual increase in rail and other transportation-related tariffs.

Growth in selling and distribution expenses was partially offset by $24 million increase in administrative and other operating expenses. Main reason for that decrease was absence of $7 million negative factor and disposal of fixed assets posted in the fourth quarter as well as less amount of repairs reformed in the first quarter over the previous one.

These factors culminated in 40% of reduction in EBITDA to $358 million in the first quarter 2012. Net interest expenses improved by 49% quarter-on-quarter to $30 million due to three factors.

Firstly, all the net debt as of the end of 2011 grew by $234 million or 3% as compared to the end of Q3. Gross debt increased by 4% or $375 million. That was the result of the management decision to drove on available credit facilities and put cash on deposits in order to protect the company’s liquid position, should the situation in the financial markets characterized by sharper increased volatility in Q4 worsen further.

This resulted in negative carry in Q1 exacerbated by general rise in interest rates leading to an increase in net interest expenses. As the situation improved in Q2 coupled with the successful re-negotiation of the covenant package and refinancing of short-term debt, the cash cushion traded in Q4 was reduced bringing the gross debt back down.

Secondly, the efforts taken by the management in Q1 and Q2 to reply short-term debt with longer term one naturally led to an increase in the average cost of debt. This rise in interest rates was further augmented by rather sharp appreciation approval during the reporting period with half of our credit portfolio denominated in Russian currency. These three factors affected all the segments.

The income tax expense in the Mining segment increased by 28%, excuse me, $28 million which was due to utilization of tax loss carried forward and the third tax benefit related mostly to change of future corporate tax rates in Bluestone recorded in Q4.

Net profit decreased by $198 million from $439 million to $241 million, driven by the factors just discussed as well as the $64 million quarter-on-quarter increase and a fixed again due to Ruble appreciation.

Now, I’ll turn to the Steel segment. I’m happy to say that the efforts taken by the company to optimize this production in the sales policy in the fourth quarter as well as reduce its inventory level bore fruit in the reported period. The third-party sales grew by 7% quarter-on-quarter to $1,649 million despite low season exacerbated by an exceptionally harsh weather conditions in February in Russia and Eastern Europe.

In particular, we manage to increase sales of engineering steel by 22%, carbon flat steel by 31%, tonnage wise both on the domestic and export markets. At the same time, the biggest fall in physical sales volume was demonstrated by long steel, down by 17%, all the expense of the domestic market were down was traditionally subdued due to the seasonal factors and smaller number of sales based in the reported period.

The same factors stood behind the 11% fall in stainless flat and the 9% reduction in wire sales volume wise. The similar situation was expectedly observed on the domestic market for rebar, where physical sales volumes went down by 8%. However, as the factors affecting the Russian market for long steel were less pronounced in Europe, our efforts to unload this stock and release working capital led to almost a two-fold growth in the European rebar sales, which more than compensated the full out in Russian sales.

As input cost outpaced downward price dynamics of semis, we took advantage of the situation by rapidly increasing sales of billet prices from third parties largely from Estar which improved by 23% quarter-on-quarter in physical terms, adding $46 million to the segments revenue.

The scale of success can be better as we would compare the first quarter of 2012 to the same period of 2011 where market conditions were sensibly better. The physical sales volumes of rebar improved by 30%, carbon flat by 14%, engineering steel by 18%.

At the same time, sales of semis finished product like billet and wire rod despite a quarter-on-quarter increase in Q1 2012 fell by 37% of the same period of last year as more processing capacity was being added at our own facilities and output of finished goods improved.

To add the final patch to the achievements of the first quarter of 2012, I need to know that we managed to bring about that increase in sales in spite of the low season for our product, avoiding an impact on pricing. The SA price on our products remained largely flat quarter-on-quarter. Only wire rod and engineering steel notching down by 8% and 4% respectively.

To a large extent that was achievement of Mechel Service Global which demonstrated its pricing resilience and sales capacity using sizable distribution network in Russia and Europe. Despite growth in revenue, the cost of sales decreased by 1% as prices for raw materials consolidated.

Extra efforts were taken to minimize the cost of raw material by increasing the share of own center replacing more expensive billets following to the increase of productivity of the center plant at Chelyabinsk, which together with the lower process for coke and iron ore led to fall in billets cash cost to $497 per tonne.

Cash cost of rebar did not change much as a decrease in price of input materials was offset by increased share of fixed cost as some of the rolling facilities were temporarily idle in order to reduce the stock of products for sale.

The combination of higher sales and lower cost doubled the gross income quarter-on-quarter to $249 million with the same effect on gross margin that increased to over 14% of the revenue. The selling and distribution expenses grew by 10% to $162 million as sales of semis on CIF and CFR basis for Eastern Asia grew.

The share of these expenses in the revenue stated about 10% as in the previous period. The administrative expenses grew by 16% quarter-on-quarter to $63 million due to the absence in Q1 of one-off income from reduction of pension liabilities posted in Q4 2011.

The efforts taken by the company to improve the performance of the steel segment resulted in the negative EBITDA of $50 million posted in Q4 of 2011 reverse into earnings of $49 million in the reported period. Net interest expenses grew by 18% quarter-on-quarter to $84 million due to the factors described above as well as one that relate in particular to the Steel segment.

In the first quarter, we posted an additional $5 million approved expense resulting from discounting the long-term payable for the Donetsk plant acquired in the end of Q4, where not such expense was accrued.

The income tax expense increased by almost $11 million quarter-on-quarter largely due to the utilization of tax loss carried forward at Chelyabinsk plant as well as absence of almost $3 million tax income at Mechel Service Russia posted in Q4 due to a sharp decrease in profitability as compared to the first nine months, resulting in the tax write back.

The segment posted a $91 million, a fixed gain in Q1 due to sharp depreciation of dollar versus ruble which can be compared to a $22 million loss in the previous quarter. That all led to a 92% quarter-on-quarter decrease in the segments net loss to just $16 million, a significant improvement even despite the fixed gain, will that factor stripped off the bottom line still shows a 38% quarterly improvement.

The Ferroalloy segment demonstrates better revenue dynamics in the first quarter as compared to the previous one. FCA sales price of nickel were up 6% and flat on chrome quarter-on-quarter. At the same time, the relaunch of the refurbished furnace at Bratsk in March, as well as lowest sales to the steel segment led to 9% rise in third-party sales of ferrosilicon.

Sales of nickel and chrome grew by 4% and 2% respectively in physical times. In combination it was slightly higher FCA prices driving segmental revenue from third-parties up almost 8% to $125 million. And the segment revenue increased dramatically by almost 74% to $28 million, largely as a result of almost doubled quarter-on-quarter sales of nickel, which had fallen sharply in Q4 is more than sufficient stock was traded with our steel plants in Q3.

That stock was consumed in the following quarter and then replenished in Q1 resulting in share price in the sales to the steel business. Cash cost was largely under control, changing only and significantly with the nickel up 4% due to higher gas and electricity consumption, ferrosilicon down the same 4% as output grew after the furnace return to production, chrome flat while cash cost of return from concentrate down 7% due to growth of output.

However, growth of the topline driven largely by increased sales of nickel led to 20% -- 22% rise in the cost line. That was just enough to decrease the gross loss by 20% over the previous quarter to just $15 million. Operating expenses grew by 10% mirroring sales growth. Administrative expenses as over almost 22% down quarter-on-quarter largely due to the absence of write-offs on fixed assets posted in Q4.

The combination of better gross result and slightly higher operating expenses still resulted in the reduction of the negative EBITDA over the segment by one-third to just $7.5 million indicating that the segment is well on the path to recovery.

Net interest expenses grew by $6 million all due to the factors described in the mining segment discussion. The income tax show the $7 million gain in the reported period. This is $1 million expense in the previous one due to a $9.5 million tax assets carry forward, almost cold refinery resulting from the loss recorded in Q1.

The ferroalloy segment was the only one showing an FX loss, which amount as a $23 million in the first quarter at the time when ruble appreciated against other currencies. That largely resulted from the revaluation of ruble-denominated in the company loans received by the entities who is reporting currencies, Kazakh tenge or British Pounds such as Voskhod Chrome and the holding company Oriel Resources.

The fixed loss was the dominating factor the behind the net loss of $56 million. Fixed effect is tripped from analysis, the bottom line was still improved by 9%.

Now, let’s turn to the power segment. For the first quarter despite the fourth one a traditionally high season for power sales, no surprise then that the increase in electricity and heat consumption led to 16% quarter-on-quarter growth in the revenue from third-parties to $203 million and another 8% growth in revenue from internal consumption to $136 million.

The cost of sales grew inline with revenue, which resulted in a flat gross margin of 27%, the gross income rise in 14% to $102 million. Selling and distribution expenses grew by 9% to $73 million to reflecting high sales. Administrative expenses fell dramatically quarter-on-quarter by almost $80 million.

The biggest contributor to that difference was $7 million loss realized in Q4 due to the reassessment of the financial result of quarters for a mission right sales by Toplofikatsia Rousse in the financial period, and the precious price allocation of the power plant was finalized.

Another $3, $5 million were recorded as a provision for environmental claim in Southern Kuzbass Power Plant in Q4. In Q1, all the site has been absent. There was an additional $1.5 million income realized on disposal of fixed asset. The effect of this economics on the segment EBITDA was a dramatic nine times increase to $28 million or 7% of the revenue versus just 1% in the previous quarter.

Net interest expenses grew by $1.5 million, the fixed effect was negligible as usual. The income tax rose by $4 million due to overall increase in the segments profitability. The bottom line results from a $6 million loss in the fourth quarter to $12 million income in Q1.

On the consolidated level, the reduction in the topline of the Mining segment was compensated by growth in all other segments resulting in just 1% quarter-on-quarter growth, also inline with the results of the first three months of 2011. Gross margin also improved by 1% to 33% of the revenue, which can be compared to almost 35% in Q1, 2011. SG&A expenses increased by 19% to $661 million driven largely by the mining segment as discussed above.

It is notable though, that administrative expenses remains flat if compared to the first quarter 2011. Downward trend in the Mining segment economics could not be fully granted by improvements in other segments driving the consolidated EBITDA 14% down quarter-on-quarter to $463 million.

The EBITDA margin contracted to 16% of the revenue. The net interest expenses grew by 33% to $142 million due to the factors discussed above. Income tax expense grew by 49% quarter-on-quarter to $103 million largely due to the mining segment. The fixed transaction posted to $171 million gain on the consolidated level, this is only $14 million in Q4, 2011 pushing the net income to $218 million in the reported period.

I said at the beginning of our discussion, the first quarter visibility demonstrated the successful results of the measures taking by the company in the fourth quarter 2011 aimed at adjusting the production to match current demand and optimization of working capital in order to release cash back into the business.

Despite uneasy market environment and generally down with price trend in commodity markets, these measures resulted in operating cash flow growing by 28% to $345 million quarter-on-quarter. If we takeaway the effect on the cash flow in Q4 coming from the settlement through a loan through Estar.

It is notable that $118 million of operating cash flow came from release of working capital. In particular, the reduction in inventory resulted in the release of $176 million where $137 million came from the Steel segment and $40 million from Mining, partly offset by increased receivables as sales in the Steel segment grew.

Investments consumed $276 million almost entirely for the purchase of fixed assets. The balance of $69 million between cash flow from operations and investments went to debt reduction top -- topped with repayment of debt from the cash balance resulting in $305 million of gross debt reduction.

On the balance sheet side, however, the net debt has risen by $458 million to a $9.7 billion that’s why it is entirely attributable to ruble appreciation versus dollar and the fact ruble eliminated loans represented 51% of our gross debt portfolio.

The trailing net debt-to-EBITDA ratio deteriorated to 2 to 4.2 times hold you to Q1 EBITDA reduction, but still very comfortably within the renegotiated current level of 5.5 times for the year 2012.

Net interest expenses was 3.3 times EBITDA covered, which was also well within the new covenants.

To recap ladies and gentlemen, the first quarter proves, despite challenging market conditions, the company has been able to turnaround a separations to counter the downward trend in its key commodity markets and significantly improved its cash generation capacity through better production planning and working capital management.

The flexibility and adaptability of our vertically integrated business model has demonstrated that even in the current volatile market environment the company is capable not only to continue with its key investment projects but to use its debt along with it.

The steps that the company is going to take in order to optimize its business structure in line with the new strategy announced at the last conference call, will help it to further improve its cash generating capacity, which will be translated into higher profitability and return to our shareholders.

Thank you, ladies and gentlemen for your attention. The team is ready to take your questions.

Vladislav Zlenko

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question is come from the line of Sergey Donskoy, Société Générale. Please go ahead Sergey.

Sergey Donskoy – Société Générale

Good evening, everyone. Thank you for the call. I have two questions at this point. First of all, according to your statement of cash flows, you have repaid during the quarter about $280 million of debts. While I look at balance sheet, I find that gross debts actually increased by approximately $230 million, which results in, well, like $500 million discrepancy. Could you somehow comment on this? Have you consolidated some external loans during the quarter or something else happened?

And second question is speaking of the working capital reduction during first quarter. It was a positive achievement, but perhaps, not quite enough given the rising level of financial leverage. Do you have any internal target of working capital reduction you want to achieve this year? Should we expect, saying, a higher lower reduction in the working capital next quarter? And what is the likely amount that you plan to release for the entire year? Thank you.

[Foreign Language]

Vladislav Zlenko

Stanislav Ploschenko will answer the question.

Stanislav Ploschenko

The reason behind the discrepancy between the balance sheet and cash flow statement is that, the items in the balance sheet are translated using the currency exchange rate as of the beginning and the end of the reporting period. Whereas in the cash flow statements the average exchange rate is taken throughout the period. Therefore, during the time of high currency exchange rate fluctuation these discrepancies are very common. As -- and obviously, no additional or no any kind of internal loans or external loans were consolidated. It’s purely effect of raising ruble dollar rates.

As far as the second question is concerned, in order to asses the groups efforts to reduce its working capital, we need to take into account the factor that, the measures that led to working capital release were being worked out and implemented during the fourth quarter and partly during the first one. So a lot of the effect is yet to come.

And another very important factor which I mentioned few times in the discussion is that, most of the reduction came from the steel segment where we have high stocks of finished product, and of course, in the first quarter, as well as fourth quarter is a low season for steel market, especially for the construction market. Therefore, this factor is very important to take into account whether it will be result from measures taken in order to optimize working capital.

We certainly expect that as the construction season began in the second quarter there will be more capital -- working capital release. In the present condition, we expect that at least $0.5 billion of working capital should be release this year and obviously that will depend on the market trends and the situation in the financial market as well.

Sergey Donskoy – Société Générale

Thank you.

[Foreign Language]

Vladislav Zlenko

We are ready for the next question please.

Operator

Thank you. Our next question is coming from the line of Anton Rumanse from Troika. Please go ahead Anton.

Anton Rumanse – Troika

Good evening, gentlemen. Thank you for very detailed presentation. I’ve got several questions. The first one is the follow up question on Sergey’s question on debt. So, in the presentation you had shown that your current debt is due $9 billion and just -- I just wanted to ask, what was the reasons of this decrease, was it solely the ruble depreciation or you have been, you have continued to repay your debt?

And the second question is, what’s sales dynamics can we expect in mining division for in the second quarter. So do you plan to increase sales of coking concentrate PCI and anthracites? And actually what dynamics -- what prior dynamics do you currently see for these products? Thank you.

[Foreign Language]

Vladislav Zlenko

The first question will be answered by Stanislav Ploschenko.

Stanislav Ploschenko

Yeah. Indeed most of the reduction of net debt in the second quarter came as a result of the reverse dynamics of ruble and dollar exchange rate. But we continue to repay some of debt out of the operating cash flow as well.

[Foreign Language]

Vladislav Zlenko

The second question will be answered by Oleg Korzhov.

Oleg Korzhov

[Foreign Language]

The pricing policy very much depends on the consumer, so when you -- you would say consumer is at respective product separately, let’s start working on nine grade coals which come primarily from Yakutugol. In the second quarter the sales price dynamics depends on the destination for those products. Those coals are shipped to Ukraine, China and Japan and Korea.

For Ukraine, the sale price in the second quarter was $200 on the basis of DDU, the DDU rate was $57. In first quarter the prices were above 30% high, so in the second quarter the price was lower.

As to China, we are shipping a slightly different grade of coal to China and in the first quarter the prices were $185, $190 on the basis of CIS. In the second quarter, the price was more or less the same and the shipment rate to China is $55, $57.

Japan and Korea, in the first quarter the prices were $215, $220 on basis of FOB, delivery through Port Posiet. In the second quarter the prices went down somewhat to $185, $190 on the basis of FOB and the same, FOB to Posiet is $41, $42.

Now if we take PCI coals and anthracites, PCI goes to Japan and Korea and to China. In the second quarter prices were more or less the same as in the first quarter and amounted to $140, $150 on the basis of FOB. To China, the shipments are made on the CIS basis, in the first the price was $166, $165 and the second quarter $150, $160.

Anthracites is shipped to Europe through Port Vysotsk. The delivery rate is $60 while the sales price is $145, $150. As to our expectation of the third quarter, the company’s pricing policy goes much in the same direction as the global trend.

We are currently actually contracted that for instance and the America has already agreed their prices with coke and as the coal, in coal concentrate we expect that in the third quarter the prices will add another $10 to $15. Thank you.

Vladislav Zlenko

Next question please.

Operator

Thank you. Our next question is coming from the line of Andrey Lobazov from Alfa Bank. Please go ahead, Andrey.

Andrey Lobazov – Alfa Bank

Hello. First of all thank you for the presentation. One of my questions about average realized prices has been answered already. So I have only one question left about production costs. Given significant global devaluation, how do you see mining cash cost in the second quarter, specifically at Southern Kuzbass and Yakutugol as compared to the first quarter of this year? Thank you.

[Foreign Language]

Vladislav Zlenko

Oleg Korzhov will answer the question.

Oleg Korzhov

[Foreign Language]

Andrey Lobazov – Alfa Bank

Thank you.

Oleg Korzhov

We expect that in the second quarter the cash cost for the company were below where it had been in the first quarter and our reasoning goes in the following way. There are three main factors basically. Factor number one is the season factor that mainly our production is located in the northern regions and traditionally our cost in the second quarter have always been lower than in the first quarter.

The second factor is that we plan to add another 10% to our production in the second quarter, you know that in the South Kuzbass there was an accident in May and now…

Vladislav Zlenko

In May we relaunched.

Oleg Korzhov

… and now Southern Kuzbass mine is relaunched and we expect that it will contribute of course to mining production.

And the third factor is related to the salaries and the taxes imposed, and the salaries the way the taxes are calculated, indeed our company is subject to regressive and grew a scale for the taxes and that’s why we expect once again our cash cost in the second quarter to be lower than that in the first quarter.

Vladislav Zlenko

Next question please.

Operator

Thank you. Next question is coming from the line of Oleg Petropavlovsky from BCS. Please go ahead, Oleg.

Oleg Petropavlovsky – BCS

Good evening, gentlemen. Thank you for your presentation and couple of questions from me. When are you going to finish the audit and announce your divestment plans? And the second question is, what are your expectations on the 2Q and 3Q steel prices environment?

[Foreign Language]

Vladislav Zlenko

The first question will be answered by Yevgeny Mikhel.

Yevgeny Mikhel

[Foreign Language]

Yeah. We have already explained, currently we are undertaking a review of all our assets and we plan to complete this process in the beginning of the first quarter. We already have an understanding regarding certain assets that can be subject to divestment, but anyway, it is too early to give any specific information on main names so to say. We will present our findings to the Board of Directors and the Board of Directors will take a final decision.

Vladislav Zlenko

The second question will be answered by Oleg Korzhov.

Oleg Korzhov

[Foreign Language]

You know that construction products are coal products for our company and construction industry is extremely seasonal. In the second quarter the dynamics, price dynamics was more or less flat, the prices stayed at more or less the same level as they were in the first quarter. However, towards the end of the second quarter, the prices started growing and historically, the third quarter has always seen some peak prices on the construction product.

And again, if we rely on the historical dynamics then the prices -- we expect the prices to grow by 5% to 7% in the third quarter. The situation in the external markets is less optimistic especially the prices of square billet are at an extremely low level at the moment. And in the second quarter there was some improvement on those prices on square billet. But I think that right now these prices are important and we expect that in the short-term the prices will recover and reach the level of $570, $580 FOB.

Vladislav Zlenko

Next question please.

Operator

Thank you. The next question is coming from the line of Bernard Zonneveld from ING Bank. Please go ahead.

Bernard Zonneveld – ING Bank

Thank you very much. First of all, we are looking a very difficult time and if you then see the first quarter results of metal, I think they are very reasonable good results and therefore, I think big compliment to the senior management of Mechel that they did an excellent work in these difficult times.

Having said that, I have two questions, my questions are the following, with regard and I’m a typical banker saw forward looking. I don’t want to look so much backwards. So we see that last year you had an average adjusted EBITDA margin of 19%, 18%, 21% and 18% per quarter. We are now at 16% in the first quarter based on your figures of the second quarter or let say, your estimate of the second quarter. Can you tell us a little bit about your outlook for, let say, the EBITDA margin for the full year 2012, so will it in the end be higher than the 16% represented now?

And second question had to do with, let say your total debt position, probably now net around $9.2 billion, if I see your presentation of June on page 14, I see there was mentioning the total debt reduced in quarter two to date to under $9 billion. Can you please clarify that as well? Thank you very much.

[Foreign Language]

Vladislav Zlenko

Stanislav Ploschenko will answer.

Stanislav Ploschenko

Thanks Bernard for the questions. With regard to the first one, unfortunately it is the company’s policy not give forward looking statements with regard to its financial metrics. But the company has review on the development of its EBITDA and with that review, which hasn’t change so far, we approach the syndicate banks to negotiate the debt covenants a few months ago, as you know and we are pretty certain that the room that we have agreed with the banks for the fluctuation in the net debt-to-EBITDA metric is still very comfortable for the company through the end of this year.

The second question most of the reduction of -- most of the difference between debt as of the end of the first quarter, and last Friday, which is the date as of which we put this number into the presentation has happened due to a rather sharp dollar appreciation versus ruble in the second quarter. But on top of that we are continuing to use excessive operating cash flow to repay debt.

Vladislav Zlenko

Thank you. Next question please.

Operator

Thank you. Our next question is coming from the line of Dan Yakub…

Vladislav Zlenko

Operator, we haven’t translated.

Operator

Please go ahead with your translation please. Thank you.

[Foreign Language]

Vladislav Zlenko

Now we are ready for the next question.

Operator

And our next question is coming from the line of Dan Yakub from Citi. Please go ahead, Dan.

Dan Yakub – Citi

Guys thanks a lot for the presentation. I have couple of questions. The -- first relates to the Elga coal deposit, production guidance, there was a published production guidance which suggest that you will be achieving [2] million tonnes of one of the mine coal already in 2012, and 1.3 million tonnes of clean washed or concentrated coal in 2012, and that was growing to 6 million by 2014, which was -- which is growing to 4.5 million tonnes of washed coal in 2014. Can you provide an understanding of whether this guidance is still in place and what will be the washed or concentrated split between thermal and metallurgical coals in the first couple of years of production?

Second question relates to the ruble denominated exchange traded bonds. I understand that the pretty significant portion of the US$9 billion equivalent of the net debt is actually ruble bonds, 25% of the total debt profile is in ruble bonds. Can you elaborate little bit on the covenants that pertain to these ruble bonds? And maybe you can disclose who is the main holders -- who are the main holders of these bonds, would this be Russian financial institutions, is there one financial institutions, is there many financial institutions, who would actually hold these ruble bonds.

And finally to finish of the debt question, just wanted to understand what kind of collateral Sberbank who is among the major lenders, do you work with collateral Sberbank is holding against the debt that is extended to you. These are the debts and Elga question?

And I might have one more markets, steel market related question, if I may. Once we have gone through these three questions. Thank you.

[Foreign Language]

Vladislav Zlenko

Oleg Korzhov will answer the first question.

Oleg Korzhov

[Foreign Language]

As you know in 2007, we had to adjust our brands for Elga as there is a certain continuous factor that exists there, which has our washing capacities. We do -- we plan to produce million tonnes in 2012 but because of the commissioning of the seasonal washing factory, we had to adjust our brands of production to 1 million tonnes.

This project of the seasonal washing factory is almost finished. We plan to commission this facility in July but we have always insisted that we need to produce only as much we can wash.

So there are several factors at play here. First of all, our production very much depends again on the launch of this seasonal washing factory then we will need to build up the capacity branch, the design capacity. Then we are currently considering different options of turning that washing factory rather if you extend these funds during which this washing factory can operate in the year and there is another factory which doesn’t really depend on us, which is winter, in our (inaudible) when winter will come this year.

So again, we plan only to produce as much as we can wash. And as there were plans for subsequent years, in the next year, we plan to produce 2 million, 3 million tonnes of coal. Again it will depend -- the final figure will depend on the launch of additional washing facilities according to our plans and we have not made any adjustments here to our plans beyond 2013.

Now, to the split between the coking coals and the thermal -- steam coals, we -- in the current year, in the next year, we plan to produce 30%, 35% of coking coal with subsequent increase of its share in overall productions. So when our Elga deposit production site reaches its design production of 9 million tonnes, we believe that the split between the coking coals and thermal coals will be 50,50.

[Foreign Language]

And when I said that there will be a split of 50,50, I meant finished products, ready products, not the run-of-mine coal but the readymade products.

Vladislav Zlenko

The remaining questions will be answered by Stanislav Ploschenko.

Stanislav Ploschenko

The first question was about the ruble denominated bonds, which constitute 25% of our debt portfolio and the attractiveness of this instrument is exactly the fact that its covenant free completely and unsecured and which is why we envisage further utilization of this instrument and the future should be public debt capital markets in Russia allow. This 25% consists of number of tranches, another species of different nominal value issued in the course of the last three years.

It’s a widely distributed instrument across the investment community in Russia, of course, including banks but I would not say that a huge number of this instrument is concentrated by one particular investor.

As far as the second question is concerned, in particular, for the collateral under Sberbank allows the usual collateral that -- with the Sberbank, we had unsecured loans largely working capital facility. As far as long-term facilities are concerned, we have five-year loan which is already halfway through its maturity to let them plant secured with 25% plus loan share in Beloretsk metallurgical plant. Now, the significant security is attributed to Sberbank relationship.

Vladislav Zlenko

Next question, please.

Dan Yakub – Citi

Just one follow-up question, it’s a very quick one on the different -- well, there is quite a significant premium opened up between rebar and billets. So the premium of realized price of rebar rose its stability in the first quarter of this year with 27% versus approximately 17% in the preceding two quarters, first quarter of 2011, fourth quarter of 2011. Can you comment on why the premium was so large in specialized increasing the premium of the first quarter, is that the result of much lower billet prices or a result of particularly strong rebar markets? Thank you.

[Foreign Language]

Vladislav Zlenko

Please allow us some time for prepare the answer. Stanislav Ploschenko will answer the question.

Stanislav Ploschenko

As a matter of fact, there is always a difference between the price on rebar and billets because those are two different products and two different markets. The fluctuation of the billet or the change in the difference that happens from time to time, when one looks at that, one should take into account that we operate in different markets.

So we use billet sales as a commodity, which is highly sensitive to the commodity market changes whereas the rebar is a -- that's a finished product market is driven by slightly different factors. And we also should take into account that most of our rebar sales are domestic where we fully utilize the selling capacity of Mechel Service.

And one of the illustration was that in fourth quarter and the first quarter, while the billet prices were volatile, the rebar prices as a matter of fact did not change at all.

[Foreign Language]

Vladislav Zlenko

Next question, please.

Operator

Thank you. We currently have no further questions coming through. (Operator Instruction) And we have a question coming from the line of Vasily Kuligin from Renaissance Capital. Please go ahead.

Vasily Kuligin – Renaissance Capital

Good evening. Thank you for your presentation. Two short questions from me. The first one is regarding Estar Group. What is the timing of consolidation of Estar Group on your billets. For example, if we assumed that they really default on their loan closer to September, what will be the first quarter of your consolidated results including Estar Group Financial?

And second question is regarding SG&A, it’s more general question. Usually, your SG&A expenses account for about 20%, 22% of revenue, which is far above the average level of global peers, which is 4%, 5%, not more. Does this happens due to Mechel Service separation or there is some of recent [for this]?? Thanks.

[Foreign Language]

Vladislav Zlenko

Stanislav Ploschenko will answer.

Stanislav Ploschenko

Well, first of all, it is too early to assume that Estar will default on the debt and the group does not have an intention to consolidate Estar. This is the mentality of the final default and we count on Estar’s Management or on its ability to repay debt.

As far as the SG&A expenses are concerned, it is difficult for me to compare to the global peers as we mentioned. I would doubt that the average share of SG&A expenses in revenue is 4% or 5%. It looks more like only administrative expenses, and certainly not in our industry and our country.

As you know, the group is selling or first of all there is a big transportation lag from our operations to our core markets and the group sells a lot of its goods not on the FCA basis but on the final delivery base, sometimes that will be, sometimes CIF and CFR and those full delivery basis sales represent bulk of sales of Mechel Mining, which in their turn represent the bulk of the consolidated group sales. So, no surprise that commercial expenses take a significant part in our revenue and the same goes for Mechel Service, yeah, here your assumption is also right.

[Foreign Language]

Vladislav Zlenko

Next question, please?

Operator

Thank you. Our next question comes from the line of Andrey Kulakov, Uralsib Capital. Please go ahead.

Andrey Kulakov – Uralsib Capital

Hi. Thank you for presentation. I have a small follow-up question regarding your debt. So as I can find from your presentation, there is a graph showing your loans or payment schedule and according to that in 2012, you have about $153 million of commercial papers and ruble bond that should be redeemed.

Well, but it looks strange to me, maybe I missed something but as I can’t find information public resources, you have free relevant issues one of them should be redeemed, it’s 5 billion rubles but as far as 1.5 billion rubles outstanding. And two bond issues of 10 billion rubles totally that have put options and you say that you include put options in this schedule. So holding should be approximately $470 million, whereas rates -- may be, sorry, bought back starting from their market -- from the open market tool. Can you just comment on that? Thanks.

[Foreign Language]

Vladislav Zlenko

Stanislav Ploschenko will answer.

Stanislav Ploschenko

We will double check the information and if there is an error, it will be posted on the website.

[Foreign Language]

Andrey Kulakov – Uralsib Capital

Okay. Thanks.

Vladislav Zlenko

Next question, please?

Operator

Thank you. The question comes 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 a question on your debt. Can you please tell us, how is the debt calculated, the net debt is calculated for the purpose of covenant testing and could you also remind, what are the new covenants?

[Foreign Language]

Vladislav Zlenko

Stanislav Ploschenko will answer.

Stanislav Ploschenko

The net debt is calculated by adding debt by adding financial lease to debt and tracking cash and cash equivalents including deposits up to six months. The net debt-to-EBITDA level set for this year’s five to five -- 5.5 times and EBITDA interest expense is 3.3 times, excuse me, 2.6 times.

[Foreign Language]

Vladislav Zlenko

Next question please?

Operator

Thank you. Our next question is coming from the line of [Paul Carr from Amoris Management]. Please go ahead, Paul.

Paul Carr – Amoris Management

Thank you for taking my call. I don’t know, if you can actually comment on this. Because I know your spokesperson said that you might not be able to comment until the time period expires. But progress that you’re making in addressing the ministry is concerned at the Yakutugol subsidiary?

[Foreign Language]

Vladislav Zlenko

Yevgeny Mikhel will answer the question.

Yevgeny Mikhel

[Foreign Language]

As you probably always know in the beginning of May 2012, there was a meeting of the Special Commission within the Ministry, which considered our case and made -- gave us certain instructions. We are complying with those instructions. They gave us six months to fix all the problems that they found at the site and we believe that currently we are on schedule. We have a plan of action and we are pursuing it. And when this timeframe comes to the end, we will be able to give you all the details about that process. Thank you.

Paul Carr – Amoris Management

Thank you.

Vladislav Zlenko

Next question, please?

Operator

Thank you. We have a follow-up question from the line of Dan Yakub from Citi. Please go ahead, Dan.

Dan Yakub – Citi

Thanks so much for taking the follow-up question. It really relates to the 15% increase in the interest expenses quarter-over-quarter in the first quarter. What is your feeling for the year interest expense dynamics in the third quarter? I know it would -- it constituted probably financial guidance, but maybe you have a -- I’m just spending over the interest expenses are going to remain the same or may change in the subsequent quarters? Thank you.

[Foreign Language]

Vladislav Zlenko

Stanislav Ploschenko will answer.

Stanislav Ploschenko

At the moment, we did not see any significant volatility in dollar interest rates in the markets. But of course, it will -- it’s always easier to test the water when you step into it since it’s the company’s strategy for this year to continue debt optimization with aim to expand the maturity, which may probably entail certain refinancing including in foreign currency that may lead, if the market continues to be tied to and increase in the interest rate.

But obviously, we will not sacrifice the economic just to get longer tenure. We will look at the all the factors at the same time. And I would also like to return to the question, which was asked before about the ruble bonds. The figures that are in this schedule on the page number 14 represent the maturity of the bonds, but not the put options. The put options are seemed to be -- to rollover in today’s market since we see the capacity of the market to do that.

In case, there is a shortage in the markets for rolling over the bonds or even for any refinancing. We still feel very comfortable with the cash position of the company and the available credit lines especially after the reduction of short-term debt or repayment of short-term working capital facilities, which took place in the last two months following raising long-term debt with the Russian Banks amount to approximately $2 billion.

[Foreign Language]

Vladislav Zlenko

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 it back to your host to wrap up today’s call.

Vladislav Zlenko

Ladies and gentlemen, thank you for taking the time to join Mechel’s first quarter 2012 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.

Operator

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

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