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Edited Transcript of CLF earnings conference call or presentation 8-Feb-19 2:00pm GMT

Q4 2018 Cleveland-Cliffs Inc Earnings Call

CLEVELAND Feb 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Cleveland-Cliffs Inc earnings conference call or presentation Friday, February 8, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* C. Lourenco Goncalves

Cleveland-Cliffs Inc. - Chairman, President & CEO

* Timothy K. Flanagan

Cleveland-Cliffs Inc. - Executive VP & CFO

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Conference Call Participants

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* Alexander Nicholas Hacking

Citigroup Inc, Research Division - Director

* Jeremy Ryan Sussman

Clarksons Platou Securities, Inc., Research Division - Analyst

* Lucas Nathaniel Pipes

B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst

* Matthew Wyatt Fields

BofA Merrill Lynch, Research Division - Director

* Michael F. Gambardella

JP Morgan Chase & Co, Research Division - MD, Head of Global Metals & Mining Equity Research and Senior Analyst

* Seth R. Rosenfeld

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. My name is Denise, and I am your conference facilitator today. I would like to welcome everyone to the Cleveland-Cliffs 2018 Fourth Quarter and Full Year ending -- Earnings Conference Call. (Operator Instructions)

The company reminds you that certain comments made on today's call will include predictive statements that are intended to be made as forward-looking within the Safe Harbor protection of the Private Securities Litigation Reform Act of 1995. Although the company believes that its forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially. Important factors that could cause results to differ materially are set forth in reports on Forms 10-K and 10-Q and news releases filed with within the SEC, which are available on the company's website.

Today's conference call is also available and being broadcast at clevelandcliffs.com. At the conclusion of the call, it will be archived on the website and available for replay. The company will also discuss results excluding certain special items. Reconciliation for Regulation G purposes can be found in the earnings release, which was published this morning.

At this time, I'd like to introduce Tim Flanagan, Executive Vice President and Chief Financial Officer. Please go ahead.

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Timothy K. Flanagan, Cleveland-Cliffs Inc. - Executive VP & CFO [2]

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Thanks, Denise, and thanks to everyone joining us this morning. I'll kick off the call with a financial review of the fourth quarter and full year 2018 and an overview of some important outlook items for 2019.

Before getting into the results, I wanted to make sure the audience was aware of the changes we have made to the names of our business units. In order to better represent what we do now at Cliffs, and reflecting the strategic transformation of our company, the U.S. Iron Ore segment will be referred to as Mining and Pelletizing. And our HBI business will officially fall into the new Metallics segment. Until we actually produce and sell HBI, the Metallics segment will be a minor component of earnings consisting of insurance and other administrative costs.

Now for our financial results. We concluded in 2018 with a fourth quarter adjusted EBITDA of $188 million. This equated to adjusted EBITDA of $766 million for the full year, our highest market in 4 years. Our 2018 EBITDA represented a 67% increase from the prior year and more than triple what we reported 2 years ago.

Our Mining and Pelletizing segment's quarterly adjusted EBITDA of $217 million was driven by 6.5 million long tons of shipments, putting us at 20.6 million long tons of sales for the full year, a 10% increase from 2017. Shipments fell slightly short of our previous yearly guidance of 21 million long tons due to shipping constraints arising from unusually strong gale-force winds on the Great Lakes in October and early November, bringing the activity of loading and unloading vessels to a halt for several days during that time frame.

Our pellet price realization of $99 per long ton in the fourth quarter was negatively affected by the sharp fall in steel prices we saw in the United States during the latter part of the year when the index HRC benchmark fell from $830 per short ton at the beginning of Q4, down to $725 by the end of the quarter. That caused us to record an unfavorable revenue true-up adjustment in the fourth quarter. The true-up was a function of having to revalue our entire year sales at the full year average HRC rate as well as revise down the unconsumed and unpriced inventory value, negatively impacting our Q4 rate.

With all of that, our full year revenue rate was $106 per long ton, still within our expected range. Cash cost for the fourth quarter was $65 per long ton, putting us just below $63 per long ton for the full year. Our fourth quarter rate was negatively affected primarily by an unfavorable $15 million LIFO impact.

Because sales volumes were lower than expected, a significantly lower cost LIFO inventory layer was not included in the COGS mix as it was previously expected to be, thus resulting in a higher average cost. That being said, we finished the year within our initial cost guidance despite the higher royalty and profit-sharing rates we experienced throughout 2018.

And as we noted on our last cost -- our last call, our cost will be up this year effectively by just the inflation rate in the United States, which is around 3%.

Looking ahead to 2019, we expect to sell out our production capacity of 20 million long tons, including 500,000 long tons of DR-grade pellets to be delivered to our HBI plant in Toledo, Ohio. As noted previously, we do not expect these sales to take place until the third quarter and their margins will be eliminated in the consolidated level.

In light of the meaningful change in the seaborne iron ore supply/demand dynamics over the past 2 weeks, we are supplementing our historical practice of providing an indicative revenue range based on year-to-date averages with one based on recent spot pricing.

We felt this was necessary as January pricing did not reflect the long-lasting market impact of the recent catastrophic event with Vale in Brazil. Based on iron ore prices as of this morning, our revenue expectation is now a range of $113 to $118 per long ton. Compared to what -- with what was published in our press release this morning, these ranges are $11 higher than the January average and $2 higher than yesterday's indicative range.

As we always note, the figures that we've utilized do not reflect our internal view on pricing, they just represent points in time in the market.

While the seasonality of our business should be well understood by now, I want to highlight to any new analyst and investor that our first quarter is always extremely light in both tonnage and price due to the annual closure of the Soo Locks, limiting shipment on the Great Lakes and forcing us to limit our deliveries to rail only.

After the divestiture of APIO business and the adoption of the new revenue recognition standards last year, Q1 numbers became even less relevant, as they now represent less than 5% of the full year expected revenues.

On a final note, during the quarter we recorded a $490 million tax income -- income tax benefit. As our future profitability expectation has increased, our projected future taxable income has increased as well. With that, we expect to fully utilize the deferred tax assets we have on our books related to U.S. net operating losses. As such, during the quarter, we reversed our entire valuation allowance recorded against those DTAs, the primary driver of this large gain. With the ability to utilize these NOLs, we expect a 0%-cash tax rate for the foreseeable future.

In other good news, new regulatory guidance on the sequestration of AMT credits gave us an additional $15 million cash boost in our expected tax refunds. We now expect $235 million in future tax refunds related to the AMT reversal, including $117 million cash flow anticipated in the third quarter of this year.

With that, I'll turn the call Lourenco for his remarks.

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [3]

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Thank you, Tim, and good morning, everyone. Before we discuss the year ahead, I would like to reflect on what a remarkable past year we just completed.

In 2018, we linked together 3 things: a strategic vision, implemented here since my first day with the company, almost 5 years ago; our disciplined execution of the strategy every day since that day; and our undeniable financial success since then.

Thanks to the buy-in from everyone inside our company and their commitments to our strategy and to our execution, we are able to turn a messy situation into a well-protected, cash-flow-generating enterprise, with a strong balance sheet that generated over $1.1 billion in net income in 2018, something that was unimaginable not too long ago.

With the momentum we have built, it's hard to contain my excitement for how this business will look and how I will we report to you 3, 4 and 5 years into the future. As you recall a few years ago, after the billions of dollars in impairment charges we had to take related to the terrible investments made by the previous management of this company, we ended up with a balance sheet showing a negative $2 billion in equity value. As a direct result of our performance during the last 4 years, and particularly in 2018, our book value is now positive $424 million.

With that, we are able to implement 2 initiatives to return capital to our shareholders: a quarterly dividend paid for the first time this year in January; and a share repurchase program which we initiated in the fourth quarter of 2018. The share repurchase program was put in place for one simple reason: our shares were and still are ridiculously cheap. So far we have bought approximately $5.4 million of CLF shares at prices as low as $7.48 and not higher than $9.25.

Even at yesterday's closing price of $10.90, using our cash to repurchase shares is a value-accretive use of capital. We still have plenty of dry powder from the previously authorized $200 million share repurchase program, and we can easily increase the authorized amount to buy back even more stock.

In summary, until the CLF share price starts representing the real value of our company, we plan to continue to buy back our stock.

With that, let's discuss our present and future business as well as the underlying business conditions under which we will be operating in 2019. First, our Mining and Pelletizing business is coming off a year in which it [sprinted] 40% EBITDA margins. And as high as that sounds we think there is more improvement to come as only about 65% of our sales volumes are currently being sold under contracts negotiated during the years I have been running our company. Therefore, for about 35% of our pellet sales, our full leverage has not been reflected just yet.

By strategic design, we have put ourselves in a strong position to negotiate a number of pellet supply contracts. Furthermore, the HBI will produce and sell to EAF steelmakers [real commended] margins even higher than the good margins we enjoy today, selling pellets to integrated steel mills, while utilizing a significant amount of our total pellet capacity to produce a meaningful tonnage of DR-grade pellets to be consumed in Toledo.

The diversion of this tonnage of pellets from the markets to our own internal use has created the opportunity for us to be selective sellers of the remaining blast furnace pellets, and that is in the works as we speak.

Second, current steel mill capacity utilization rate at 81% in United States, which is the highest in a decade, clearly reflects a healthy demand for steel in the domestic market. As a consequence, demand for our pellets remains strong.

Also, because of the structure of our contracts to sell pellets, the drop in steel prices we saw earlier this year, not 2019, has been more than offset by increases in both IODEX and Atlantic Basin pellet premium, as reported by Platts in January. Regarding the latter, it is important to notice that the Atlantic Basin pellet premium negotiations have not been finalized for 2019 just yet.

Even before the horrible disaster of January 25 with Vale operations in Brazil, the expect outcome of these negotiations once concluded, was for a higher pellet premium than the $67.50 reported by Platts in January.

Third, the full impact to the iron ore market of the catastrophic events with Vale has not been properly quantified yet. Once that happens, we expect both IODEX and pellet premiums to increase further, and this increase should both be significant.

Fourth, with all this inflationary pressure coming from the cost of iron ore feed stock, in China and everywhere else Vale sells sinter feed and pellets, including Japan, South Korea, Europe, among others, steel prices in these countries will have to increase accordingly in order to preempt a huge profit margin squeeze. With that, we expect steel prices in the United States to increase in 2019 as well.

Finally, the boost in profitability we expect to see from HBI is at best under-appreciated by outside investors. And at worst, not factored in at all in their valuation models. The recent news flow coming from this new industry has represented further validation of our strategy and proof that we were ahead of the curve when we made the HBI plant site announcement in June of 2017.

In just the last 3 months, we have seen many announcements of new electric arc furnaces and capacity expansions. This new EAF capacity, will be competing for feedstock, and some will pursue the higher quality, higher-margin end of the steel value chain. In order for these EAFs to have any chance of competing on high-end steel specs and on higher quality market sectors, they need one thing, they need high-quality iron feed stock, exactly what we are getting set to supply from our Toledo plant.

With pig iron being imported from unreliable countries, like Venezuela, Brazil, and Russia, and domestic scrap diminishing in quality, Cliffs HBI is exactly what the EAF steelmakers need, particularly the newer, financially stronger and more technologically developed ones.

In light of these developments and based on the technical and commercial discussions we continue to have with our future HBI customers -- over the past months, we made the decision to increase the capacity of our HBI plant from 1.6 million to 1.9 million metric tons per year.

We have explored, identified and implemented some significant project modifications, to allow us to reach this new annual capacity number of 1.9 million metric tons of HBI. With that, we now expect to spend approximately $830 million instead of the former price tag of $700 million for the original 1.6 million metric tons of capacity.

Furthermore, with this capacity expansion, we now expect the HBI plants to consume 2.8 million long tons of DR-grade pellets, instead of the original number of 2.4 million long tons. This will further constrain the supply of pellets within the Great Lakes, and should, therefore, enhance our competitive strength and our ability to be even more selective in negotiating with our blast furnace pellet clients.

Even with this scope change in our HBI project, we still remain slightly ahead of schedule. We continue to receive materials and deploy construction work within the proper time frame to allow for a mid-2020 startup. So far, manpower has been harder and more expensive to come by than originally anticipated, but that has not affected our progress. As of today, we have approximately 350 workers on-site and expect to peak at around 900 people on-site during the summer months.

Wrapping up my prepared remarks, we have a lot to be happy about in 2018: $1.1 billion in net income; 67% EBITDA growth; HBI plant ahead of schedule as we have more capacity than originally projected; our exit from Australia; the payoff of multiple tranches of debt; and reaching a financial comfort level that allowed us to start returning capital to our shareholders using 2 different avenues, buying back shares and paying a meaningfully yielded quarterly dividend.

As we compare our Cleveland-Cliffs of today with what we had here 4.5 years ago, we are very proud of our accomplishments, and we enjoy seeing how much our company has improved since August 2014. However, we absolutely believe that in 4 more years Cleveland-Cliffs will be even stronger and even more profitable than it is today.

A few years ago, in a quarterly call with investors like this one, I suggested that you should invest along with me in this great business and in this great company. If you did just that at that time, you made a lot of money. Actually a lot more than what you would have made investing in fancier or trendier companies. Or if you had invested in a fund replicating the S&P 500.

I actually encourage each one of our shareholders, if you haven't done so yet, to compare our stock price performance during the last year, or in the last 3 years for that matter, against the S&P 500 or against our peer companies in steel and mining or against the fancy stocks the press loves to talk about. You will be shocked with how much better CLF performance is against virtually all these other stocks.

Moving forward, we'll continue to work very hard and very smartly to reward your investment exactly as we have done so far. During the next 4 years, we plan to continue to surprise each one of you with a lot of upside. At this time, I would like to renew my suggestion in you to be good for the next 4 years. Invest along with LG and enjoy the ride.

With that, I will turn it over to Denise for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Michael Gambardella with JP Morgan.

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Michael F. Gambardella, JP Morgan Chase & Co, Research Division - MD, Head of Global Metals & Mining Equity Research and Senior Analyst [2]

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Just a couple of questions. You mentioned that you have about 35% of your contracts that have not been renegotiated since you've been at the company. Can you give us an idea when they're coming due? And also what the pricing is, say relative to the current contracts, just in general terms?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [3]

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Yes, in general terms, you know that I don't review individual contracts, Mike. But they are clearly lower than what I have already renegotiated. They represent fewer tons because we -- being very clear, we have already renegotiated our most important and most relevant contract with ArcelorMittal. We combined the contract -- the different contracts we had before into a very good contract that supports Cliffs supports ArcelorMittal extremely well.

But I still have stuff that came from the previous regime that is coming due very quickly, and we are starting to talk with these folks. Because as you know, Michael, I don't have pellets for everybody. So even before we increased the size of our HBI facility, which by the way we are ecstatic, we are very, very happy with that, we are already running short on pellets to serve everybody.

So at this point, it's even more clear that I don't have. So I'm seeing who is going to have it -- who is going to go be the have -- who are going to be the haves, and who are going to be the have-nots. That's pretty much what's happening as we speak.

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Michael F. Gambardella, JP Morgan Chase & Co, Research Division - MD, Head of Global Metals & Mining Equity Research and Senior Analyst [4]

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Okay. And you mentioned that the market is under-appreciating the results of the Vale disaster. Can you explain what you see that the market's not appreciating, and why you think that's so?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [5]

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Too much of a spreadsheet reaction to things. So when the news first popped, the businesses said well the dam -- is related to an operations that is 8 million tons. 8 million tons is nothing. So Vale will shut down 8 million tons here and open 8 million tons in Carajas. And that was the first reaction.

I even got a call from Platts asking to clarify, trying to pick out my brain. Because as you know well, I'm Brazilian, and I'm very familiar with mining in Minas Gerais, I used to run one when I was with CSN. So I know the area, I know the terrain. I know how they view the dams over there. I also know how we do here in the United States, so I can compare.

So I gave Platts my honest opinion, it's published in the -- I think it was on January 26 or January 27, saying that what they were seeing was not the real size of things. And now we're seeing every day, a new thing happens. And this morning, we heard that ArcelorMittal mine in Brazil was under the threat of a -- hitting a town, and they had to evacuate the town. Vale had a problem with another mine.

So they are now starting to wake up for what they have there. They don't have a great situation over there. That's for sure. And that's very unfortunate. But that's the way it is. So I'm not trying to (technical difficulty) the internal details of Vale, I wish them well. I feel bad as a Brazilian to see more than 300 people dead based on that, but that's the nature of our business, Michael.

Like I have been telling people for more than 4 years, this is not a cost-driven business. This is serious stuff. This is serious on operations. This is a series on safety. This is serious on value and use. These are the drivers, not cost, not cost. We need to stop behaving like bots, miss and beat and this. This might be good for websites, but it's not good for the mining business.

We have rain. We have soil movement. We deal with dynamite. We deal with real stuff, and that's Cleveland-Cliffs. We have been around for 172 years. We are the benchmark technologically. And I'm already going way off. So I'll try to behave today, Michael. So I'll stop.

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Michael F. Gambardella, JP Morgan Chase & Co, Research Division - MD, Head of Global Metals & Mining Equity Research and Senior Analyst [6]

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Okay. Final question. On the HBI project, you increased your capacity from 1.6 million metric ton to 1.9 million metric tons. Could you give us a feel -- what does that do -- I'm assuming you have a lower cost structure with the increased capacity, and can you review where you stand on the key fundamentals for the HBI project on an operating basis?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [7]

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Yes. Look, we envisioned -- first of all, we are receiving a lot of interest, a lot more than we'll be able to handle. So that situation we have for pellets, we are going to have for HBI. The situation of producing less than the market would be able to absorb. So we saw a very simple solution to increase our capacity by adding equipment to the handling and of the plants to increasing the diameter of pipes, things like that. So simple changes that increase the process, increase the size of the plant, and we increase output.

And obviously, the fact that we are going to produce 300,000 tons more than initially anticipated will have a positive impact in our costs. Internal rate of return of the project now is going to start this year. Because you add 300,000 tons more to 1.6 million tons, the increase is phenomenal for IRR. So it's all positive. So we are extremely excited.

And last but not least, we are the only ones that can do that because we are the only ones that can produce DR-grade pellets, without DR-grade pellets there's no HBI. Another thing that you're going to see, Michael, in the world as this consequences of Vale's problems in Brazil will unfold, is that we are going to see not only a shortage of iron ore but a shortage of pellets. And we think pellets -- a shortage of DR-grade pellets -- and we have countries in the Middle East and some others that rely on Vale in order to get fed with DR-grade pellets. So you should anticipate that as well.

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Operator [8]

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Your next question comes from Lucas Pipes with B. Riley FBR.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [9]

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Lourenco, I wanted to follow up on the increase in HBI capacity. It sounded like you had encouraging indicators from customers to take this step. But can you refresh us on kind of what the commercial strategy is from here on out? When should we be looking forward to contract and maybe even some prices associated with that?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [10]

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Lucas, we -- first and foremost, we are developing the technical side of the business with each one of our main anchor clients because introducing HBI in a massive scale in their [burden] will change their melting practices. So that precedes everything. And we are working on that with these clients.

Once we are done with that, then we are going to go to more detailed contract language. But keep in mind, we're not going to be delivering our first recast before June or July of 2020. So we are in January of 2019, we have plenty of time to get to that point.

Before we are in a hurry and have done project finance for this, HBI, I would be paying a lot more than the way I financed with the high yield and converts. The converts are fantastic. The converts attract good shorts, and it kicked out the bad shorts. The high yield, the way we did was fantastic. The combined cost to build this plant was just perfect.

And so far, so good, everything we did was proper at the right time and done the best way we could. And commercial is no different. But just generating a piece of paper, just to tell everybody else that I have a contract, that's not me. I do things my way, and my way works. So far, so good. We are discussing technically. We are going to finalize this shortly. Commercial comes next, and price will come when they have to pay the [dues] much later.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [11]

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That's very helpful. And then my second question is more on the modeling side, unfortunately. But when I look at the kind of pricing indications for the North American mining business, at $76 iron ore mid-point is about $104.5 and then at $90 -- at $90.50 of iron ore, I'm looking at a mid-point of roughly $113.05. So a lot of sensitivity there to higher iron ore prices.

First I wanted to ask, is there something unique in regards to the sensitivity when iron ore prices increase to that $90 level? Or is -- are there maybe some other moving parts that I overlooked? I would appreciate your thoughts on that.

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [12]

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You know well, we have 3 main drivers of our price, hot rolled price in the United States, iron ore prices in the international markets translated by the IODEX and Atlantic Basin pellet premium, as published by Platts for the 62% iron content. So I'll let Tim Flanagan explain the sensitivities, and let's see if we can resolve your question.

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Timothy K. Flanagan, Cleveland-Cliffs Inc. - Executive VP & CFO [13]

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So Lucas, I think to your question about the $90 threshold. No there's nothing unique or special about $90 that increases that sensitively. I think if you look at what we previously guided to versus today, our sensitivity for HRC and iron ore is about $3 on a $50 or $5 move, respectively, and about $2.50 on the Atlantic basin pellet premium.

Those are slightly higher than what we had in 2018, predominantly driven by customer mix and the contracts Lourenco was just referencing before. So if you use those as kind of a benchmark, or a guidepost, you should be able to get right to that midpoint of the range we gave on the call.

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Operator [14]

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Your next question comes from Seth Rosenfeld from Jefferies.

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Seth R. Rosenfeld, Jefferies LLC, Research Division - Equity Analyst [15]

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I had a couple on the HBI side, again, and then wanted to run back to the simple guidance for shipment and production, please.

With regards to HBI, obviously, you're going to be pulling a lot of material out of the pellet market, as you start feeding this internally. How have you considered any opportunities to expand your internal mining operations and pelletizing operations in order to limit the downside to supply for some of your kind of long-term blast furnace customers? Is that attractive or simply something that you think is less attractive then tightening the market as you pull material away?

And then secondly, when it comes to shipment and production guidance, can you just confirm how we should think about the 0.5 million ton of shipment that seems to be delayed from Q4 into Q1, given that you're targeting both production shipments this year. 20 million tons does imply you're building about 0.5 million tons of inventory, and why would that be the case?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [16]

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Thanks, Seth, and good morning. Thanks for the questions. Both are very good questions. I'll start with HBI. The answer is yes. We are seriously considering increasing our pellet output. We have opportunities. We have one that's actionable as we speak, and that's Empire. We are finalizing our studies to bring back Empire.

Remember, we never shut down Empire. We put Empire on indefinite idle, and that means that at -- under the right circumstances, we would bring Empire back. So we still have a few i's to dot, few t's to cross. But I am very pleased to inform for the first time actually in a public forum that we are close to announce the resurgence of Empire.

And that should be great news for Michigan and for the great people of Michigan to know that Empire has a great chance of being brought back into operations in not so long future down the road because Empire would really mitigate a big portion of the hole that we are going to create in our supply of blast furnace pellets, as we supply DR-grade pellets to HBI.

That other opportunity for expansion even though it would take longer and it doesn't depend only on Cleveland-Cliffs, is Nashwauk. We own half of the land of the pit. We own pretty much all of the land surrounding the pit. Governor Tim Walz has been making very intelligent and very precise moves to get rid of that thing that has been infecting Minnesota called [the SAR], so that virus is going away hopefully, soon.

And as soon as this virus is eradicated from Minnesota, we are ready to step in and take care of Nashwauk. But these things take long. I might not be able to do Nashwauk ahead of Empire. Actually, Empire is ahead of Nashwauk at this point.

But the good thing is that from both states, Michigan and Minnesota, we have the support of the workforce. We have the support of my employees. We have the support of the people in the land. We have the phenomenal support of United Steelworkers.

I can't thank the President -- the local president of the USW, Chris Johnson, Joe Fredrickson; the USW, Michigan, Leo Gerard, Tom Conway. These guys are partners, and we are partners for life with the USW. We are going to bring back Empire. And hopefully, we are going to own Nashwauk. So for the next 10 years, we're going to be busy, bringing more production to the United States of America.

Oh, the other question was the tons that we could not ship in Q4. Well in this world, that's not controlled by spreadsheets. In this world that's controlled by real life. We have stuff like wind. So we have gale force winds in the Great Lakes, even above gale force.

We had winds above 50 knots in the Great Lakes, late October, early November. So carriers could not dock to get the ore. We had the ore. We produced the ore. The ore was available. And they could not put in the vessel. The vessel had to be moved towards the center of the lake to wait for more convenient weather conditions to start loading. So we missed the shipment that we did not have enough days left in the quarter, in the 92 days of Q4 to ship.

Fortunately, we were able to enjoy better and nicer weather during the very first few days of January. And a portion of what we did not ship in Q4, we shipped it before the closure of the Soo Locks. So roughly 150 tons -- 150,000 tons of the missed shipments were sent to the clients in a timely fashion. So they're all good for the winter. They are not missing ore for their needs during the times that we can't ship at all during the winter months.

On the other hand, the balance, 400 -- 350,000 tons or so will be sold in 2019 and will be priced at 2019. That's the beauty about pellets, they don't deteriorate. So we could not ship in 2018, but we ship in 2019. The only difference is that they will cost a little more. But the clients can pay. They're in good shape. They'll increase steel prices, so they'll make a lot of money, and we are going to make money as well. You got it?

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Seth R. Rosenfeld, Jefferies LLC, Research Division - Equity Analyst [17]

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Just to clarify, given that you have the extra 0.5 million tons of material available and production is still 20 million tons, why are your shipments not 20.5 million tons? And I apologize if it's that's simplistic.

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [18]

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Yes, first of all, like I said, I don't have the 500,000 tons available because 150,000 tons are gone because I shipped between the beginning of the year, and so it's already done in January. So it will count against January. And the reason why I did not add that is because we're already dipping into inventory. So that is already accounted for in 2019. I don't know if I answered your question.

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Seth R. Rosenfeld, Jefferies LLC, Research Division - Equity Analyst [19]

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Yes. That's helpful. So you're basically rebuilding some inventory that were to draw down early.

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [20]

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Exactly, absolutely. That's correct. So the 20 million already includes the tonnage not shipped in the fourth quarter. So it's already part of the entire thing.

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Operator [21]

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Your next question comes from Jeremy Sussman with Clarksons.

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Jeremy Ryan Sussman, Clarksons Platou Securities, Inc., Research Division - Analyst [22]

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Lourenco, congratulations on a very successful year at cliffs. So if I think about the current pellet premium for February, it remained flat versus January at $67.50 a ton. And I think you noted that it was sort of a rollover and didn't really yet reflect any impact from the Vale tragedy.

And Vale has publicly said they will lose at least 11 million tons of pellet supply from the tragedy, which I'd estimate is almost 10% of the seaborne market. So given these dynamics, I guess how much further do you think pellet premiums could go when the market digests everything?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [23]

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Jeremy, I'll give a very honest answer to you. I don't know. If I were negotiating, first of all, these negotiations has already been concluded. And I don't know why they took so long, and now I understand why they can't finish because they are busy with much more serious stuff.

But the fact of the matter is that we're going to have a double problem in the international market. One is what we have just mentioned. There's capacity lost. And you're saying 11 million tons. In my own calculation, based on what I know about the Vale mines, it will be at least double that.

But the other thing is that Brazil is demanding that the domestic news are taken care of first. So we're going to probably see Vale having to deliver to the news in Brazil and leaving the international news unattended for the most part. So it will be a mess. But I don't know where the pellet premiums will land, it will be a lot higher.

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Jeremy Ryan Sussman, Clarksons Platou Securities, Inc., Research Division - Analyst [24]

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That's fair, certainly a moving situation. And just -- I want to follow up on the Empire comment, which was helpful earlier. So I guess just roughly speaking, what type of CapEx would it take to bring back the mine? And would the output be sort of similar to the 3 million tons or so annually that we saw the last year or 2 before the mine was idle?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [25]

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Jeremy, the numbers that we have right now are not refined yet, but we are talking something in the order of $600 million over the course of 3 years, and the production levels would be between 3.2 million and 3.5 million tons of pellets per year.

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Jeremy Ryan Sussman, Clarksons Platou Securities, Inc., Research Division - Analyst [26]

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And just to clarify, is there anything -- is it shovel-ready? Or are there permits or anything like that that you need to wait on?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [27]

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We are good for permits. That's the beauty about going Empire because we are good for permits. But again, it's not an act. It's not a -- we are not producing yoga pants here like lululemon. So we are producing iron ore. We use dynamite things like that. So we have to remove a lot of overburden from where the iron ore is located. That's why it takes 3 years.

So when you say shovel-ready, yes, the overburden is shovel-ready. But I need to shovel the overburden out and then get to the ore. So it's 3 years of digging. And then we start reproducing pellets after that.

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Operator [28]

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Your next question comes from Alex Hacking with Citi.

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Alexander Nicholas Hacking, Citigroup Inc, Research Division - Director [29]

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Sorry, I was on mute. I wanted to ask on the pellet premium. Firstly, Vale was obviously looking to move the contract to the 65% benchmark from 62%. How mechanically would that affect Cliffs? Would your contracts potentially roll over to 65%? And then how would you bridge the GAAP between 65% and 62% because the price differential between those 2 indexes has varied very widely over the past few years? So I guess how do you settle that in the short term?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [30]

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Look, first of all, we don't rely on what Vale does. We rely on what Platts does. We use the very reliable indexes produced on a daily basis by Platts, and Platts has been extremely good in terms of keeping up with the market's needs. I commend them for that.

So whatever Vale would do, it's Vale's decision. But we will continue to follow the 62% pellet premium that -- or what's called the Atlantic Basin pellet premium, that's calculated over the 62% iron ore content. So I don't have anything to do with what Vale's doing. I only have to do with the indexes, and the indexes are as reliable as, for example, the LIBOR. It's an international index, and that's how we treat our contracts.

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Alexander Nicholas Hacking, Citigroup Inc, Research Division - Director [31]

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Okay. And then, you mentioned that pellet premiums directionally could well head higher from here. And it certainly seems like that when you look at supply/demand. But how do you -- when you're making capital allocation decisions and so on -- how do you think about what should be more of a normalized level?

Are you aware of any swing supply of pellets into the seaborne market? And how do you think about steel mills potentially reconfiguring their feedstock to use less pellets if premiums get too high? So I'd be curious on your views on that.

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [32]

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Well let's start with from the end. Mills are reconfiguring their way of doing business. Let's think about the steel mills in United States -- the integrated steel mills in the United States. Let's assume that they decide not to use pellets. They'll have a big problem because they can't comply with environmental regulation for even 5 minutes. They will be out of business in a New York minute.

So in order to be able to continue to play with environmental compliance, integrated steel mills in the United States must use pellets, and they know that. So much so that there are only 3 sinter plants in the United States, and they are barely utilized. It's just marginal operation, going further from the 60%, and they use more mill scale than iron ore sinter feed as their feedstock.

So it's not an option for first world countries like the United States. Is this an option for China? Absolutely. That's a country that has absolutely no commitment with anything civilized just yet, including pollution controls. They are followed by the second largest in the world, that's India.

India is the second largest producer in the world, and they have a big similarity with China. They also don't care about the environment, but they are both signatories of the Paris Accord. Don't forget that. Because they like to pretend that they are civilized, and they like to play for the audiences.

But here in the United States, we are for real. We have PM 2.5 less than 10, which is green in the back in the Earth picture that you can see every day on the Internet. We have it every day. In these countries, they don't. So that's the difference between using pellets and not using pallets. It's not a cost thing, Alex. It's a real-life thing.

China is polluted, among other things, because they do not use pellets, and our air here in Cleveland, Ohio, is clean because ArcelorMittal uses pellets. The air in Chicago is clean because all the mills in the surrounding areas of Chicago use pellets. And that's the nature of the business. It's not a cost thing, it's not a spreadsheet thing, it's real life. When you talk about the environment, you are talking about lives. You're talking about people breathing. That's what pellets are about.

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Alexander Nicholas Hacking, Citigroup Inc, Research Division - Director [33]

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Yes, can I just follow up on that? So if Vale then is going to sell 20 million tons less pellets, they sell very little into China. In your opinion then you would have to see an equivalent amount of steel production closing?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [34]

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I didn't say that. They sell very little into China because China will give you lip service about the environment, but they don't do anything about it. But they sell a lot into Japan. They sell a lot into South Korea. They sell a lot into Germany. They sell a lot into France. They sell a lot into Belgium. They sell a lot into Luxembourg.

And these are all countries that produce a lot of steel through the blast furnace route. What are they going to do with their blast furnace? I don't know. I don't know. Let's see how the Europeans that are so serious about the environment will react. If mills in Germany or mills in Luxembourg or in Belgium, they start to say, "I don't have pellets. I'll have to use more lump. I'll have to more sinter feed." Let's see, that would be interesting to watch.

Also, the countries in the Middle East that rely 100% on DR-grade pallets from the international market will probably have trouble getting fed. And they don't have scrap because they are in the middle of the desert. They are in the middle of a manufacturing country like the United States. So scrap is not an easy thing to go by. So scrap should go up as well.

So we are entering unchartered territories, interesting times. But it's something that we here at Cleveland-Cliffs are absolutely prepared for. So what's going to happen in the United States with all this mess, nothing because we are the suppliers for the steel mills, and we are good for the long, long haul. Nothing's going to change our course of business here.

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Operator [35]

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Your next question comes from Matthew Fields with Bank of America Merrill Lynch.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [36]

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Lourenco and Tim, congratulations on a lot accomplished this year. I have another sort of tricky modeling question. In the quarterly cadence, should we expect 1Q '19 to be similar low-volume quarter? I think was 8% of your total volume last year. Should we expect similar in 2019?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [37]

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Yes. Look, Matthew, first quarter, it's rail only because we added in the 150,000 tons that we were able to ship that have come in previously. The rest is rail, and the net debt on the rail contract is not as good for us as when we ship through vessels. So Q1 is almost a write-off in terms of the contribution to the year.

So no matter what number, we are going to put in your model, probably when we release results the bots that work for Associated Press and Reuters and these folks and we will say that we missed and then everybody else will repeat after this. So with Q1 I'm going to miss again. So no worries. But for the year we are very good, we're doing very well, and we'll do great.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [38]

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Okay. Great. And then just looking at CapEx for the fourth quarter, you sort of were averaging about $65 million of CapEx a quarter and then 4Q was really low like $18 million. Did something happen? Did construction pause at the pellet plant while you were making these decisions to expand? Or what sort of -- what happened with the down tick in CapEx in 4Q?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [39]

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The answer is no in terms of the deployment of work on the field. But as far as the deployment of money, I will see if Tim Flanagan can help with that.

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Timothy K. Flanagan, Cleveland-Cliffs Inc. - Executive VP & CFO [40]

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Not sure where that number's coming from. We actually spent just over $100 million in the fourth quarter, and it actually was the highest quarter of spend we had on the year for HBI. I mean we continue to pick up the volume and then the work done on the project in Toledo, and that will continue into next year as next year will be a peak CapEx year for us.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [41]

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Okay. And then just on the HBI plant expansion, I know you probably don't want to name names and whatnot, but like is the increased sort of demand that you saw to make this decision from some of the new capacity expansions announced this year? Are these kind of old -- or not old but existing facilities that just sort of wanted more due to the compelling economics?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [42]

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It's a combination. It's a combination of both because we have been receiving input from the usual suspects to deliver more but we also -- we are seeing the announcement and seeing what's going to happen within the United States as we go forward.

And we have these folks that have a much stronger balance sheet, and they have a long-term view for the business announcing mills that will really be built, and they will be real, and they will be competing for high-speccing materials. So it's a combination of both, Matthew, frankly.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [43]

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Okay. And then, maybe just a bigger picture question on -- I know you sort of said that the market's probably underestimating how many tons of iron ore and pellet supply may be affected by the dam problems.

Given your insight into Brazil, how many upstream dams do you think may be affected by these problems? And bigger picture, where do you think this sort of shakes out, where everybody is kind of starting to look at their tailings dams?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [44]

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I think that it's happening as we speak, frankly. Unfortunately, it's happening more than 2 years -- actually, more than 3 years after it should have happened. When the Samarco thing hit, I thought that they would do a much more thorough job in terms of reviewing their situation and not just one company but everybody.

Actually we here from the United States, even though we have a lot of serious things in terms of constantly undertaking a never-ending loop of testing, field monitoring, reporting, assessment. We have [peer] review. We have extensive third-party audits, and we perform real-time drills in terms of the situation of each one of our dams.

After Samarco, we humbly reassessed everything here at Cliffs. We said let's pretend that we don't know nothing. That we are rookies here. We are [SR]. We are arriving to the business right now and trying to learn how to do things, and we assessed everything. We didn't find much. But very honestly, we implemented some improvements. So to see that happening again, it makes me sick of my stomach. So -- but I hope that this 300-plus lives will not be lost in vain, and Brazil will move in the right direction.

And look we are actually ahead of the cut-off time, so I will wrap up here. And I really appreciate you participating in our call and being with us for this 4.5 years. For the ones that have been long with me since the day I said the investor along with the Lourenco, and you're going to be happy. You should be happy now.

But for the ones that are not happy, you still can be happy. So happiness starts every day, including today. We are good for the next 4 to 5 years. So invest along with LG and make a lot of money. Or short my stock and have pain. Thank you very much, and have a great day. Bye now.

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Operator [45]

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This concludes today's conference call. You may now disconnect.