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Edited Transcript of CLF earnings conference call or presentation 19-Jul-19 1:00pm GMT

Q2 2019 Cleveland-Cliffs Inc Earnings Call

CLEVELAND Jul 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Cleveland-Cliffs Inc earnings conference call or presentation Friday, July 19, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* C. Lourenco Goncalves

Cleveland-Cliffs Inc. - Chairman, President & CEO

* Keith A. Koci

Cleveland-Cliffs Inc. - Executive VP & CFO

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Conference Call Participants

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* Alan Henri Spence

Jefferies LLC, Research Division - Equity 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

* Nicholas Jarmoszuk

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

* Scott Schier

Clarksons Platou Securities, Inc., Research Division - Analyst

* Sean-M Wondrack

Deutsche Bank AG, Research Division - VP & Senior Credit Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. My name is Miriama, and I am your conference facilitator today. I would like to welcome everyone to Cleveland-Cliffs 2019 Second Quarter 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 protections 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 release filed with the SEC, which are available on the company 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 would like to introduce Keith Koci, Executive Vice President and Chief Financial Officer.

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Keith A. Koci, Cleveland-Cliffs Inc. - Executive VP & CFO [2]

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Thank you, Miriama, and thanks to everyone joining us this morning. Before getting into the discussion of our second quarter results and outlook, I wanted to briefly highlight the financial transaction we completed earlier in the quarter to improve our balance sheet.

Shortly after we reported our last quarter results, we issued $750 million in unsecured notes due in 2027 at a 5-handle coupon. This new issue allowed us to both retire legacy notes coming due in 2 years and reduce the size of our largest debt maturity tower in 2025 by $600 million. With the transaction closed, we have no debt coming due until the year 2024.

Also our previous $1.4 billion maturity tower in 2025 was nearly cut in half and pushed out another 2 years to 2027. We accomplished all of this without a material change to our annual debt service expense. Even though our balance sheet was already in excellent shape, we are and will always be on the lookout for opportunities like these to make it stronger.

Now to our financial results. For Q2, we reported total company adjusted EBITDA of $249 million, a dramatic increase from $21 million in the first quarter, which is typical for the seasonality of our business as it is today, pre-HBI. Our Mining and Pelletizing segment generated $281 million in adjusted EBITDA, an impressive a result driven by stronger-than-expected shipping volumes of 6.2 million long tons as our customers maintained a healthy appetite for pellets throughout the quarter.

For the full year, we were able to maintain our pellet sales forecast of 20 million long tons. Despite some reduction in nominations from one major client, our newly accomplished ability to produce and export meaningful tonnage of DR-grade pellets, coupled with better overall pricing in the seaborne market, were enough reasons for us to allow and maintain our forecast. Lourenco will discuss that in more detail later in this call. The remainder of our expected 2019 shipping volumes will be more backloaded to the fourth quarter, when the mills usually stock up before the annual winter freeze.

During the second quarter, we hit a 6-year high on pellet price realization, with an average netback selling price of $113 per long ton. That was driven by the rapid increase of iron ore prices we have seen this year, which was good enough to more than offset the negative effect of falling domestic hot-rolled coil prices throughout the quarter. With HRC index pricing reaching a low of $510 per short ton during the second quarter, we had to make a sizable negative true-up adjustment to revalue pellet sold in prior periods.

Conversely, because our sales contracts utilize full year averages as indices and some contracts have quarter lag provisions, we have not fully benefited from the latest levels of iron ore pricing in our price realizations just yet. As iron ore prices continue to average up and assuming the recent recovery in steel prices continues on its current upward trajectory, we would no longer be subject to negative true-ups and can expect even higher selling prices for our pellets in the future.

Our cash cost for the quarter was $67 per long ton, consistent with the guidance we gave last quarter where we expected to be at the high end of our outlook range, due primarily to higher royalties and higher profit sharing. As a whole, all other major cost components, including labor, energy, stripping, recoveries and materials, have remained consistent with our original forecast. We expect cash costs to remain steady at the Q2 level during the back half of the year.

Another positive item for the second quarter was that due to the completion of our Northshore plant upgrade ahead of schedule, we were able to record a small volume of intercompany DR-grade pellets to our metallic segment. Because of the early completion of the Northshore project and coupled with the anticipated, ahead-of-schedule startup of the Toledo plant, we now plan on transferring more pellets to our facility this year than previously budgeted. We are increasing our DR-grade pellet intercompany sale expectation from 500,000 to 800,000 long tons, all of which to take place in the third quarter.

Because these pellets are for intercompany use, unlike our third-party commercial arrangements, these sales are recognized immediately after they are produced instead of when delivered, explaining why all 800,000 long tons will be recognized as sales in the third quarter.

Accounting-wise, you can begin to see how the intercompany DR-grade sales are being treated in our financials. The margin we will generated by selling DR-grade pellets to ourselves should be roughly comparable to the industry high average margin of the rest of our merchant pellets. We record the revenue and cost of goods sold associated with the transfer at the segment level, but these intercompany sales are eliminated from our consolidated results. As such, in this quarter and next quarter, our corporate consolidated revenue and cost of goods sold will be lower than that shown in the Mining and Pelletizing segment, and the eliminated margin on intercompany sales will run through the corporate line item in our segment breakdown of EBITDA.

Finally, once the HBI associated with these pellets is actually sold, you will see this margin re-included in our consolidated results and EBITDA. This will have the positive impact of removing some of the seasonality inherent in our pellet business since we will be able to sell HBI throughout the winter.

In wrapping up my remarks, with less than a year left until the major capital spend on HBI is done, we are just on the brink of our much anticipated, overwhelming cash flow generating position. It may be difficult for some to see right now, given we are still in peak capital spending mode on HBI, but in less than 12 months, we'll be looking at a business that is set up to throw off enormous amounts of free cash.

I'd like to say, with our HBI plant completed and in full production, free cash, on an annualized basis, will be EBITDA minus $220 million. Other than $100 million of sustaining capital and $120 million of debt service, all the rest of the EBITDA is free cash, since we will continue to use our NOLs and not have to disperse any cash to pay taxes for the foreseeable future. And we are not even adding to this free cash number the cash coming from our future AMT refunds, which are real as you all know.

At price levels comparable to what we've seen this year and with HBI layered in, we would expect to generate about an annualized $1 billion in EBITDA, meaning that we would have around $800 million in free cash flow to return to shareholders, primarily via stock buybacks and increased dividends.

On that positive note, I will turn it over to Lourenco.

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

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Thank you, Keith, and thanks to everyone for joining us this morning. I'm going to pick up right where I left off in the last quarterly conference call with the same exact message I had last quarter regarding the current and the future situation of supply and demand of iron ore. Welcome to the New Normal. Get used to the New Normal. There is no short-term or medium-term solution for the shortages in the seaborne iron ore market. With Cleveland-Cliffs' profitability closely tied to the iron ore markets, we have a nice future ahead of us. This is exactly what I told you in the last call when the IODEX had just passed the $90 mark on its way up.

At that price level or is likely above that number, the commodities desk of several financial institutions and other so-called experts, one after the other, had called the iron ore benchmark price at a peak. And here we are today, 3 months later, with the IODEX more than 35% higher than that at $121.85. So one more time, there is no short-term or medium-term solution for the shortages in this seaborne iron ore markets. Welcome to the New Normal. Get used to the New Normal.

Despite our prediction during last quarter's call, and despite the iron ore price increasing day after day since then, the stock market had no conviction about how much or even if our second quarter results would actually benefit from that. As always, we did not fight the tick; instead, we took advantage of the prevailing skepticism. We increased the size of the share repurchase program and bought back another $130 million dollars worth of Cliffs' shares during the second quarter, bringing the total amount spent to buy back shares to $300 million since the inception of the program just 8 months ago.

Other than HBI, there was no better use of our capital than repurchasing shares, which we did at an average of $10 per share. And now after buying back a total of 10% of our outstanding shares, our long-term shareholders own over 10% more of the company than they did just a few months ago without having to do a thing but stay long. Soon enough, when we're through big capital spend and producing HBI nameplate, these will be seen as an absolute no-brainer. As always, I thank very much all the sellers of the shares we bought back. You sold your shares very cheap. Again, thanks for your gift to Cliffs' shareholders.

Besides the New Normal for iron ore prices, the other view that drives our moves going forward is that the current weakness in the domestic steel market is temporary. Actually, we are already seeing the recently announced steel price increases sticking. And we have conviction that we have already passed the bottom for hot rolled steel prices in United States. As far as domestic steel prices, from now on, the trend is upward. Despite the low HRC price being an important part of the pricing formulas in our contracts, we were able to hit a 6-year high in pellet price realizations thanks to the IODEX performance, just as we intended when we redesigned the new pellet contracts for Cleveland-Cliffs a few years ago.

Unlike 4 or 5 years ago, we are now much better protected to weather demand reductions related to speed bumps in the domestic steel sector. If you recall, in 2015, we had several of our customers curtailing production at their blast furnaces, and we were forced to idle 2 of our mines in response. Since then, we have been actively mitigating the situation and taking preventive measures against the possibility of such problem occurring ever again.

First, with the addition of our HBI plant, we have created new demand for almost 3 million long tons of pellets per year. This new demand will, in good times, tighten the market and in bad times, provide us with volume that's certain, while paying ourselves at a healthy margin. Second, our new pellet contracts have more take-or-pay components that minimize nomination reductions, providing us with another layer of protection. Third, we now have more optionality and product flexibility. We can make standard, flux, super-flux and DR-grade pallets. We can access both the EAF metallic markets or the traditional blast furnace market with quality specs for the full spectrum of needs.

And finally, with the New Normal in iron ore pricing, we have the export market as another high-margin outlet for our pellets. While we continue to first meet the obligations under our local supply agreements, in the event of nomination reductions, we can now sell to buyers overseas and still make decent money. Although the pellet premium hasn't moved much since the beginning of the year, pellets are much more expensive in the seaborne market by virtue of the increased IODEX. Remember, the pellet premium is the sum of the iron ore price with the pellet premium. Just doing simple math on the IODEX and pellet premium and assuming current freight charges to ship out of the Seaway, in today's spot markets, we would be able to enjoy price realizations in the seaborne market similar to what we currently get from our long-term domestic clients. That effectively provides us with another accretive alternative source of demand for Cliffs' pellets outside of the United States.

In fact, over the past months, we saw one of our customers pulling forward planned maintenance into this year and lowering its pellet nomination as a result. So far, we are offsetting these revisions by sending more pellets to our Toledo facility, which is actually necessary given the accelerated startup date of the HBI plant. We are also scheduling a few vessels to the export market, including sales of both blast furnace and DR-grade pellets to seaborne customers.

As you can see from our consistent cost results, we will continue to produce these pallets in reliable, safe and environmentally friendly manner and should be able to accommodate revised pellet nominations without complication. Also we can always assume that a portion of the demand not being served by this one steelmaker is actually being covered by another Cliffs customer as we actually saw some incremental demand from another client.

In any event, our strategic foresight to be ready for these scenarios is the reason why we are heading toward our fifth consecutive year of EBITDA growth, even with low domestic steel prices, offset by a New Normal of robust IODEX and scarcity of pellets in the seaborne market.

We will be even more protected next year and going forward with the addition of HBI to our portfolio. With the conclusion of our Northshore upgrade project in the second quarter and the initial production of the DR-grade pellets ahead of schedule, we were also able to push the conclusion of our Toledo HBI plant construction to an earlier startup. With that, we are now aiming to start commercial production of HBI no later than June 2020 or 2 months ahead of the original schedule.

At this time, I would like to personally thank and congratulate Craig Filizetti and all involved in the completion of the Northshore upgrade for their hard -- I'm sorry, Steve Pause and all involved in the completion of the Northshore upgrade for their hard work, first, for delivering a DR-grade pellet on spec in the very first batch, and second, for making possible an earlier startup in Toledo. On that note, this past quarter was a productive one for us in Toledo. Among other accomplishments, we finished this sticky build portion of the reactor tower, which is currently -- which currently stands 200 feet tall. From now on and over the next few months, we will be using the largest crane currently in operation in America to finish the remainder of the tower and to complete the 450-foot tower structure.

We are also moving our General Manager of Construction in Northshore, Steve Pause, to help the General Manager of Toledo, Craig Filizetti, and I have a combination of Batman and Batman taking care of the very end of the construction of Toledo, which we're very excited with.

With project completion and commercial production now less than a year away, we have reached a spot where we have certainty and visibility on total spend. We have always been working with a 20% construction contingent expectation, which is the usual standard for a project of this size. Now that we have clarity on completion, we are pleased to report that we only need to allocate about 13% as contingency. The primary items making up this allocation are additional infrastructure and additional soil stability work necessary to facilitate a bigger and more automated plant than originally planned and, most important, the extra labor costs driven by the advanced construction schedule.

After allocating the contingency and assuming a busheling scrap price environment going forward, consistent with the last 2 years, the final IRR of the project calculates at a very good number of 26%. Private equity would kill for a 26% internal rate of return. That's our number.

The rewards of our HBI plant are not just financial. Those that closely follow the industry are well aware that the transition from blast furnaces to EAFs further enhances our already pristine environmental and emissions profile in the United States. The steel is present in virtually everything. Despite several centuries of effort, the world has yet to identify a viable replacement for steel, while producing and consuming steel at a pace that continues to accelerate. However, I made this point before and I'll do it again, the world needs more steel, but the world also needs less pollution.

I really hope that the current move we have been seeing in the capital markets toward environmental, social and governance compliance to be real. If that proves to be the case, in the not-so-distant future, only ESG-compliant companies like Cleveland-Cliffs and countries like the United States will deserve the allocation of capital from sensible investors. When that happens, China and others steelmaking countries like India will not be able to continue to pollute the world environment as they do now almost completely unchecked. Particularly in our space, once clean steelmaking is finally embraced worldwide, the future will be high-grade iron units, meaning, high iron content ore, pellets and metallics. This is what Cleveland-Cliffs is about. And any initiative we explore in the future will be centered on these core products, predicated by what we feel is an undeniable trend.

Wrapping up, we are already benefiting from the New Normal with a shortage in the iron ore market, particularly for pellets. And soon enough, we should benefit from the next trend, an overdue push to environmentally friendly steelmaking worldwide.

With that, I'll turn the call back over to the operator for 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 Lucas Pipes with B. Riley FBR.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [2]

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Congratulations on another very good quarter. Lourenco, I first wanted to ask on the CapEx side. So there were a couple of moving pieces. You mentioned the lower contingency of 13% averages to 20% previously, but then, you increased this year -- well, I mean the way I understood it, maintaining the total CapEx guidance for the project. Could you just kind of walk us through it, what are we expect -- what should we expect for 2020 in terms of capital spending? And where would we see the benefit of the lower contingency?

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

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Okay. Lucas, thanks. Look, the budget continues to be $830 million, and we are actually giving a few good news -- we're delivering a few number of good news regarding the project. First, we are now less than 1 year away from conclusion. With that, with the fact that we anticipate at least 2 months the conclusion of the project and the startup of the plant, it's time to allocate contingency. Based on our best estimate at this point, we don't need the entire 20% that we have been working with since the beginning of the project, only 13%. So if you calculate the number, it would be something like $110 million on top of the $830 million that we are talking now.

And the fact that we're spending more this year than we previously anticipated is very easy to understand. We are spending money this year that we're supposed to spend only next year. So things that were in January or February of next year are now in December, November, October of this year. So we need to bring up these expenses upfront because we are ahead of schedule. So that's the difference in 2019 CapEx. And as far as 2020, it'll be the balance. So calling the $830 million plus the contingency as the number for completion. No matter if we do a little more in 2019 or -- and a little less in 2020, we're still doing the same thing. So that's the entire story.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [4]

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Got it. Okay. That's helpful. And then the 26% IRR, does that include any of the benefit that you would capture on the mining and pelletizing sites? So you mentioned you're going to tighten the pellet market as well. And then I see opportunities for higher prices when you sell intercompany versus some of the contracts you have out there. Would that benefit be captured in the 26% IRR?

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

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Yes. Thanks for the asking the clarification. And the answer is no. We are considering the 26% -- we are calculating the 26% IRR after paying for the DR-grade pellets that we're delivering from Northshore to Toledo at market price. If you include the benefit of the production of DR-grade pellet at -- and you account for the DR-grade pellet cost, the IRR would be way above 30%, but that would be in general, Lucas, because we also spent $91 million or $92 million at Northshore to create that capability. So I don't have, from the top of my head, the IRR combined, including those projects. But I assume that it will be in the low 30s -- 30%, 31%. But then I need to add the CapEx that was spent there as well. So I'm just staying with the CapEx of Toledo. And I'm considering the price of its stock paid at market price, that -- not at cost, includes profit.

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Operator [6]

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Your next question comes from Alan Spence with Jefferies.

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Alan Henri Spence, Jefferies LLC, Research Division - Equity Analyst [7]

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First on CapEx. I'm wondering how quickly, after you reach commercial production, you think you can get that to reaching kind of nameplate capacity.

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [8]

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Nameplate will be a target for 2021. 2020 will be the year that we're going to finish the plant. We're going to do a lot of trials with the clients that we continue to discuss where the clients will progressively fall in love with the product. We know that, that will happen. That would be the first step. The second step they'll get rid of pig iron from Russia, pig iron from Ukraine, these exotic countries that are enemies of United States by and large, like Russia. So we can't wait to take these guys out of their market very quickly. So that's the route we're going to do, and that's the work we're going to do in 2020. And we plan to do all that during 2020 to a point that when we hit January 1, 2021, we'll be in nameplate pace already. So you should consider that 2020 will be whatever it will be, and 2021 will be nameplate.

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Alan Henri Spence, Jefferies LLC, Research Division - Equity Analyst [9]

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Okay. Understood. And more near term obviously a very strong set of sales volumes for this quarter. And I think Keith made the comments earlier about kind of being, the remainder of the year, a little bit more back half, back end weighted. How should we think about sales volumes in Q3 versus Q4?

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

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We are expecting Q3 volume at 5.5 million or more. In Q4, something above 6 million, let's call between 6 million and 6.2 million. So these are the numbers and that is all but they are not adding up to 20 million because we -- at the same talking that we are expecting the number just to mention to you in Q3, whether staying the way where it is right now, we should do better than that. And Q4 is always an unknown because we never know when winter will hit.

I think that the biggest point to consider right now, Alan, if you allow me, is that any dramatic drop of nomination that the clients put on us right now -- by the way, abundantly clear full disclosure so far, no dramatic decline in the nomination, only a decreasing nomination from one client, partially offset for another -- by another client that increased their nomination. So so far so good. But the biggest change with this company right now from the client's perspective is they start dropping the nomination, right now, when the sun is up in the sky and the weather is good and the lakes are actually -- we have so much water in the lakes that we can load the boats above and beyond what was a draft line before. And we're really taking advantage of that because we have depths in the lakes that are favoring transportation.

Dropping nomination right now can be a suicidal move because I'm going to start moving pellets into Toledo, I'm going to start moving pellets to Québec City to export. And we will comply with all nomination arrangements and all commitments that we have with our clients. I'm just not going to be as fast as in the past to go back when they have a change of mind. So they might need to wait and that is a problem. I don't know if you follow the complete convoluted explanation. But I'm just showing you that at this point, we're a lot more protected against fluctuations in nominations within the contracts. But the clients are more exposed and they need to take that into consideration when making their decisions on change in nominations.

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Alan Henri Spence, Jefferies LLC, Research Division - Equity Analyst [11]

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That's very clear. And just a quick clarification. The Q3 number, is that inclusive of the 800,000 tons you'll sell internally?

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

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Yes, sir. Yes. Because physically, we need to use the same fleet, the same port, the same handling equipment. So yes, that's correct.

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Operator [13]

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

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [14]

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Congratulations, again, on the progress on Toledo. A couple things -- I just wanted to ask about -- jump all over, I'm sorry, but -- so you're exporting a few pellets, both sort of regular pellets and DR-grade pellets out of Québec City. What's your sort of netback math on getting that to Europe?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [15]

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That's very similar to the current of the freight, the current in the domestic market. If we -- pricing is factored into the range. So we -- because of the current favorable conditions to export price-wise, we can netback more or less the same thing, even though we're paying extra freight.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [16]

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So if iron ore is, give or take, $120 million, the pellet premiums, give or take, $65 million or $70 million and your freight is x, netting back to you, you're getting about $110 million or $112 million on your netback for realizations?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [17]

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Yes. We have -- the range that we provided stands regardless of selling everything domestically or selling a portion exporting.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [18]

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Okay. Great. And then you mentioned that your capital allocation is kind of going to be -- once we're at nameplate in 2021 and beyond, capital allocation will be primarily for dividends and share buybacks. Does that mean kind of the current debt value and your current level of debt, which is $2.2 billion roughly, is that the right level of debt for Cliffs going forward once Toledo is up and running? Or do you want to see it a little higher or a little lower?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [19]

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Okay. This thing of a right level of debt is very tricky. And in the past, when we had to really clean up the balance sheet and do things that put a target of $1 billion, which we kind of got to because I got to $1.3 billion, but I spent $300 million buying out my partners at 2 of the operations and buying land in Nashwauk, if you recall that, Matt. And now we also spent another $300 million with share buyback. So it's a moving target. The fact of the matter is, we are -- what Keith Koci was explaining. We're extremely comfortable at this point because as soon as we have HBI up and running, our EBITDA minus $220 million is free cash.

And what do you do with free cash in a company like Cliffs? You give it back to the shareholders through share buybacks, through increased dividends, through special dividends. So that's what we're heading to here. We are not going to spend more than $100 million in CapEx a year after we have HBI done and up and running. And remember, HBI needs a -- the HBI plant needs a lot less CapEx than a concentrating pelletizing pellet plants in the mine. So it's a different animal as far as maintenance CapEx. So $100 million a year is actually rich, but let's consider $100 million. And then we have $120 million in interest expense that's pretty much it and -- for the foreseeable future. Remember, we don't have anything to address until 2024. So EBITDA minus $220 million, that's the money that you have available to pretty much give back to the shareholders every year.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [20]

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And there's no M&A or other expansion plans that you'd allocate cash to on the top of the mind?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [21]

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Well, not today. I can't say never. We are always looking for opportunities, but these opportunities are far -- few and far between. It's very difficult to exceed the returns of that and share repurchase at this point. Remember, we made an economical decision to buy back stock. That was our -- I explained that before I started. So we are always analyzing this M&A thing, M&A possibilities. We are always analyzing against alternative uses of capital. We're not going to grow just to be bigger. I'm comfortable with the size, I'm comfortable with what I'm doing, I'm comfortable with my industrial bases, and I'll be more than comfortable, I'm super excited about the fact that very soon we're going to be producing HBI.

So I don't need size to feel better. I feel very good the way we are. And I will feel even better if I start returning money to the shareholders in a more massive way. We are returning a lot, $300 million. One research analyst called today the buyback of another company much bigger than us. They acquired back $127 million. He called that strong execution. I did not even know that buying back stock was execution, but execution for me is operating and selling stock. But anyway, if $127 million for debt, huge company, is strong execution, $134 million of this, miraculous execution. So we are returning a lot money for the shareholders on that. Our dividend increased 20%.

It's 21%, some may say -- try to dismiss our dividend, saying, "Oh, it's only $0.05, oh, it's just $0.06." Well, it's -- at $10 that was the prevailing stock price until the stock corrected -- finally corrected to a number that is still very low, but it's a lot better than $10. Our yield is 2.4%. So yes. How many companies in our space delivers a 2.4% yield on dividends? And this is growing. This will continue to grow. This money belongs to the shareholders, the long shareholders. And especially the company like ours, with 0 chance of having a balance sheet problem or like we have 5 years ago, risk of bankruptcy and things like that. 70 million share short, oh my gosh, I have a ready source of free money from these shorts. It's right there. They probably don't realize, but I continue to boil them like frogs in a pan full of water. It's as low, but one day they'll realize that it's not a warm pool, it's their death bed.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [22]

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Fair enough. One last one for me, please, just bigger picture. With IODEX kind of at $120, like you said, and the pellet premium up to $67.5, are European steelmakers really paying $185, $190 a ton for pellets? Are they demanding concessions? At what point do they start to really push back or even sort of idle blast furnaces?

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

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Look, I don't have an answer for you on that. I haven't sold pellets to any European steelmaker in a long time. So I don't know. But -- and actually, the export opportunities that we're envisioning at right now are not even in Europe. I believe, honestly, Matt, that Europe is the next playground for China. They like a lot of -- they love free trade. They are the free traders. So they believe that tariffs should not exist to protect the domestic market against the bad players, like China and others. So now that we have protection here in United States, the Chinese steel that continues to grow and continues to increase the Chinese output needs a home. And apparently, they're finding a home in Europe, right place, because they love free trade. So I'm enjoying seeing Chinese steel going to Europe. So I don't know the answer to your question.

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Operator [24]

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Your next question comes from Scott Schier with Clarksons.

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Scott Schier, Clarksons Platou Securities, Inc., Research Division - Analyst [25]

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Congratulations on a very strong quarter. Lourenco, could you talk a little bit more about your outlook for the pellet premium going forward? We have seen such a compression to quality spread recently. I'd be interested to hear your thoughts on when this will return to a more normal level.

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [26]

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Yes. Look -- that's a very good question. Look, you should never lose track to the fact that the pellet price is not the pellet premium. The pellet price is the sum of the IODEX with the -- or the sum of the price of ore no matter if it's IODEX 62% or the benchmark price for 65%, plus a pellet premium. The way we envision here in our quarter is this 62% plus correction for iron content plus pellet premium, that's a price. So if the IODEX appreciated from $90 to $121.85, let's call it $120, just to facilitate my calculation, so appreciated $30. The pellet premium directly could go down $30, and I'm still in the same spot. And of course, the pellet premium doesn't go down $30, the pellet premium went down $3. So plus $30, minus $3 is a plus $27, so we're good. So it's not a pellet premium thing, and people get really stuck in these details of how the prices are calculated and this and that. At the end of the day, other than China, that's -- all is faking, all is lying, all is pretending, all is polluting everybody else that buy pellets. They pay a lot more for pellets because they must comply with environmental regulations that does not allow them to use crap as feedstock. Like here in the United States, like in Canada and a few other countries like Japan, like in others. So they pay more. Did I answer your question?

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Scott Schier, Clarksons Platou Securities, Inc., Research Division - Analyst [27]

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Yes. That was very helpful. Just to follow that up on iron ore pricing in general. Do you expect supply/demand conditions to ease from here and pricing to move lower? Or do you see the $120-ton level as the New Normal?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [28]

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Yes, I had to call it this New Normal for some time. I'm surprised that I'm still kind of the only one. That makes my life really easy because I just need to execute that quarterly to what I say, and I have been executing our quarter to what I say. So look, with the -- we'll go back 4 months, 5 months, we are in July right now. So go back 4 months. At that time, any steelmaker in the world should have a moment of reckoning and say, "Oh my gosh, iron ore pricing are going up, and my steel prices are not great." Then find a way to increase the steel prices. Final, this you make a -- they preferred to get stuck with that thing of, "I control what I can control, I don't control what I cannot control." Okay, so now in Q2, you're going to enjoy your own inability to see reality. And going forward, welcome to the New Normal. Get used to the New Normal. We are not going to do any Amazon Prime Day. We are going to continue to charge full price for the pellets. So if you don't increase your prices, you are going to be squeezed. That's my message to my clients and to the clients of other iron ore miners because they don't talk to their clients like that. They are lot more politically correct than me. But anyway, that's a different conversation.

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Operator [29]

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Your next question comes from Nick Jarmoszuk with Stifel.

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Nicholas Jarmoszuk, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [30]

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Question -- north -- with the Northshore project, what is the DR pellet production capacity now?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [31]

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3.5 million long tons per year.

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Nicholas Jarmoszuk, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [32]

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Okay. And all of that will be consumed by the Toledo plant?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [33]

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No. The Toledo plant is 1.9 million metric tons a year, and we need at that plant something like 2.7, 2.8 million long tons of pellets taking use into consideration. So we well had have, if you produce Northshore at capacity with DR-grade pellets, we'll all had have like 700,000 to 800,000 tons a year of DR-grade pellets that we plan to sell to select clients that we have ongoing relationships. We're not going to supply anyone that will produce it. We have to compete against us. So that's not going to happen. Though I am going to supply someone that will put -- I already told Midrex and Tenova, "Go sell in another territory because right here in the United States, we have a problem." I'm not going to supply any DR-grade pellet to anyone in the Midwest. So it's not going to happen, but I will supply other companies. Like in the past, we supplied Nucor in Trinidad, we supplied ArcelorMittal in Canada, so these are the ones. So we are looking for -- always looking for long-term partnerships that could be good for us like North Africa, Middle East, places like that. Places that are basically -- that were left in the rain with the problems that happened in Brazil. So there is an opportunity there right now.

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Nicholas Jarmoszuk, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [34]

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And with the tons that the company is exporting, can you give us what the volumes are between regular blast furnace pellets? And if there are any HBI pellets in there as well?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [35]

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We don't have this breakdown just yet because we just started moving pellets to Québec City, and we started moving DR grade. So at this point, we haven't moved any blast furnace pellets just yet, just DR-grade. So we'll see. Look, if there is no cancellation, there's no reduction in nomination. Going forward, that would stop and redirected the pellets to the domestic market. Domestic market will always be my first priority, but we are just preparing ourselves to the event that nomination cuts will come, and then I will not come here and say, "Oh, no keep quiet. I can only control what I can control." No, I can't control stuff like that. I can't control what they will do, but I can control what I will do depending on what they do. So that's called the strategy and execution. We do that a lot here.

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Nicholas Jarmoszuk, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [36]

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As of today, what are you expecting the export volumes to be?

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

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As of today, 300,000 tons. But if you ask me tomorrow, I might say 500,000. In one week, could be 100,000, or 1 million. I don't know yet.

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Nicholas Jarmoszuk, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [38]

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These pellets are transported from like Lake Superior through the locks and through Québec City. Are they damaged? Is the quality degraded any from all the handling or no?

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

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Pellets don't like handling. So every time you unload a pellet and you load it again, you generate fines who create issues. So pellets don't like to be moved from point A to point B and then loaded again. That's not a thing that we like to do. But that's the -- actually the nature of the beast. All these pellets that move in the seaborne market, they move a lot. I will give an example. A Brazilian producer will produce pellets that in the minute they arrive, they move the pellets to the port and then load on a vessel. Then the vessel go through seaborne, and then it will get to the port in China and unloaded and put in a storage at the port and then someone will grab that pellet and move to a closer storage to the mill, then to be sold for a mill. So how many times this pellet was loaded and unloaded, generating fines and generating problems. So ours will not be different, but the good thing is that our pellets are high quality, so they resist a lot more to this type of deterioration. But you're right, the pellets in general don't like that.

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Nicholas Jarmoszuk, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [40]

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And then last question on the AMT refund, could you remind us what the refund schedule is over the next several years?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [41]

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I'll let Keith answer that, Nick.

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Keith A. Koci, Cleveland-Cliffs Inc. - Executive VP & CFO [42]

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We have got another $117 million coming, and it's broken out over the next 3 years. So you can see like $58 million will come in 2020 and then following after that, we've got like $28 million each year after that. So...

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Michael F. Gambardella, JP Morgan Chase & Co, Research Division - MD, Head of Global Metals & Mining Equity Research and Senior Analyst [43]

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Okay. So that's the balance of it?

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Keith A. Koci, Cleveland-Cliffs Inc. - Executive VP & CFO [44]

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Right. Correct.

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Operator [45]

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Your next question comes from Sean Wondrack with Deutsche Bank.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [46]

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Nice quarter, and I was impressed to see that you have accelerated time line on the HBI plan. Just a couple from me this morning. You mentioned earlier something about having not fully benefited from the iron ore price realization. Can you just clarify what you mean by that?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [47]

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Yes. Look, each contract is different. Each contract with a different client is different. For example, there's one client that has a lag in their contract. So this client hasn't seen any huge price increase because he is still being charged based on the price of iron ore back in March, April, May. So very soon, he will be paying April, May and June and so on and so forth. So -- and that's one client that has this lag. So all things considered, things will continue to improve for us. And we believe that as steel prices recover, we should also have help from that. So that's how we see it.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [48]

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Right. And the steel price recovery, that should help offset even if there is a little bit of weakening in the iron ore price, just given where steel prices are. Just a quick question…?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [49]

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Hold on, hold on, Hold on. Are you expecting weakness in iron ore pricing?

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [50]

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No, I'm not saying that. I am just saying that like as an investor when you're thinking about it, coming off this very low steel price should only provide you additional upside, basically price...

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [51]

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But you said that it could offset weaker iron ore prices, and the -- it would be very comfortable for me to just agree with you, but I have to call you out on that because I spent -- I have been spending a lot of time in these calls, explaining why there's no weakness ahead in iron ore pricing, but people disagree. That's why we buy cheap stock in the marketplace. Deutsche Bank -- I haven't checked the commodity deck of Deutsche Bank these days, but do you know the price deck of your bank?

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [52]

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I am not even 100% sure, but -- excuse me, Lourenco, I don't think the price of iron ore is going down. That's not what I am trying to say here.

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [53]

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Okay. All right. Okay. So we are on the same page.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [54]

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I apologize if I was confusing.

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [55]

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No, no. No need to apologize.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [56]

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Okay. Cool. The freight advantage. When you think about supplying new customers around the Midwest with HBI. Could you just, big picture, what is your freight advantage of supplying them versus Russia or Venezuela or any of these other countries that have been shipping DRI or pig iron to those clients as of now?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [57]

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Look, let's take -- depends on -- advantages varies with the client. But let's take one that's really easy to understand, North Star BlueScope. North Star BlueScope will be a big why of our HBI. We are in Toledo, Ohio. They are in Delta, Ohio. They will be receiving our HBI continuously by truck. So they will not have to carry any inventory on their site because we're going to deliver pretty much just in time. And the only freight that they will pay is truck freight. If they were buying from Russia, that material would have to be transported from point of production to port in Russia, then loaded in a vessel, then sailed to the United States, unloaded in Québec City, and then -- or New Orleans, then loaded in a vessel to bring to the site that would be a barge up the Mississippi or a train from ports to Delta, Ohio. And you keep adding these things, they don't compare with a freight truck. So it's huge freight advantage. And our plan is to share this advantage with the client. Not to pay their way, but to share with the client. So the client will not have to pay the humongous freight to bring big iron from exotic places.

And on the other hand, we are not going to give the entire advantage. We share a lot with the client. So we are going to be very price competitive. We are going to be very quality competitive. Our HBI is not the HBI of the past, it's not HBI -- historical HBI. It has a lot more mechanical resistance. It have 3% carbon content with pretty close to pig iron. So it will be like pig iron, just better. And it will have a logistics advantage that is second to none. And as far as quality, one thing that we're going to have, we're going to have HBI being produced from iron ore from 1 mine, that's the Babbitt mine. And 1 pellet plant, that's the Northshore plant. So only [4 persons] out of Northshore will be producing DR-grade pellets for Toledo. So that's the type of narrow quality that we are looking for. So the operators of the EAFs will have something as far as feedstock that they don't know yet. As soon as they start receiving material for trial, they will become excited the same way the operators of blast furnace are always excited about our blast furnace pellets.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [58]

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Great, that's very helpful. And my last question, just to -- you are coming into a position of strength like you've never seen before, guiding to roughly $1 billion of EBITDA against cash needs of only $222 million. You are basically going to have cash to do whatever you want in terms of dividend, share buybacks, debt reduction. Given that kind of backdrop and the lack of supply security for iron ore in the U.S., are you worried about Cliffs as a company becoming an acquisition candidate? And have you seen any kind of M&A interest towards Cliffs over the past few months?

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C. Lourenco Goncalves, Cleveland-Cliffs Inc. - Chairman, President & CEO [59]

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Look, we are for sale in the stock exchange every day, and our price, our stock price has been absurdly low for an extended period of time. In the meantime, the ones that could, theoretically, balance-sheet wise, could make a move and make an offer to buy Cliffs, they were all involved in what I used to call the Brazilian/Australian championship of stupidity. They are very interesting being the low-cost producer of the world. And now they are paying the price for that. Instead of being looking into buying a company like Cliffs, they are concerned about fixing the disaster that was made first by Samarco and then by Vale. They are also coping with a few problems at the port and fire and lots of stuff that are all a consequence of a cost-cutting environment that I have been, throughout the 5 years, explaining. Mining business is not a cost-base business. It's a different ball games. Value use, it's margin. It's using money to maintain your facilities and mines. So focus on cost is important, but can't be the main focus. So the answer to you is no. So despite the opportunity, the ones that could buy Cliffs, they are not going to pay the price that I would demand to sell the company because they are busy taking care of their own problems at this point.

And with that we are going to turn the call back to the operator to wrap up, and I appreciate the interest, and we will keep in touch. Thanks a lot.

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Operator [60]

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This concludes today's conference call. Thank you for joining us today. You may now disconnect.