Timothy K. Flanagan - Cliffs Natural Resources, Inc. C. Lourenco Goncalves - Cliffs Natural Resources, Inc..

Lucas N. Pipes - FBR Capital Markets & Co. Matthew Fields - Bank of America Merrill Lynch Novid Rassouli - Cowen & Co. LLC Nicholas Jarmoszuk - Stifel, Nicolaus & Co., Inc..

Good morning, ladies and gentlemen. My name is Michelle and I am your conference facilitator today. I would like to welcome everyone to Cliffs Natural Resources 2017 First Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

The company reminds you that certain comments made on today's call will include predictive statements that are intended to be made as forward-looking within the Safe Harbor 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 releases filed with the SEC, which are available on the company's website. Today's conference call is also available and being broadcast at cliffsnaturalresources.com.

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

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

Thanks Michelle, and thanks to everyone joining us on this morning's call.

Before getting into the review of our first quarter results and outlook for the remainder of this year, I will pick up where I left off on our last call with an overview of our refinancing transactions completed during the quarter, which I would describe as both successful and transformative.

The last time we spoke, Lourenco and I stressed the importance of a bulletproof balance sheet that can withstand the ever-present cyclicality in this business.

In order to get there, we made de-risking the business our number one focus, not only just reducing our overall leverage, but extending maturities, lowering our interest expense and simplifying the capital structure.

Less than three months later, I can happily and confidently say that all four of these goals were accomplished with our equity and unsecured debt issuances completed in Q1. Of the $1.2 billion we raised in February, every cent was put to work on the balance sheet.

During the first quarter alone, total debt was reduced by $600 million, the 2020 and 2021 maturity tower reduced by more than half, our annualized interest expense burden was reduced by nearly $50 million, and our layers of secured debt were reduced from three to one.

We're also very pleased with the timing of our transaction, which allowed us to minimize shareholder dilution and simultaneously lock-in a new – a low coupon, while issuing new unsecured bonds with a long-dated maturity.

As we continue to navigate this ever-cyclical commodity environment, we can now do so with the extra comfort and flexibility that comes with this much lower debt level.

That being said, our work in this regard is not done, and we'll always look for opportunities to embrace and take advantage of all parts of the cycle to improve the strength of our balance sheet. Now, moving to our quarterly results, our total company adjusted EBITDA of $92 million was a 156% increase from the prior year first quarter.

That number represents an all-around solid performance by our operating and commercial teams in what is always the lightest quarter of the year for us shipment-wise. In the United States Iron Ore, adjusted EBITDA was $64 million compared to $46 million in the prior year quarter.

The increase was attributable to higher sales volumes driven by improved market condition. As those listening are aware, the sales volume of 3.1 million long tons is a good number for the first quarter. In Q2, we expect about 3.5 million long tons of sales.

As usual, these Q2 shipment volumes will increase further in Q3 and Q4 when no shipment restrictions are in place and the steel mills look to build their tonnages ahead of the winter months. During Q1, USIO achieved lower cash costs since we did not have the negative impact of idled mines that we did in 2016.

As for our revenues per ton, we saw year-over-year realizations decline to $79 per long ton from $84 per long ton due to 2016 carryover effects. As Lourenco explained last quarter, because of our shipment schedule and our revenue recognition practices, the majority of the tons sold in the first quarter were based on 2016 pricing formulas.

In the full-year 2016, iron ore averaged $58 per metric ton and customer-realized hot-rolled steel prices averaged $450 per short ton, considerably lower than what we've averaged thus far in 2017. As a result, these 2016 full-year averages are much lower than what our 2017 prices should reflect.

Now, with all of our carryover tons worked off, we expect a substantial lift in realized prices for the remainder of the year, as the new 2017 formulas kick in.

Considering where iron ore prices, steel prices and pellet premiums have averaged through the first four months of the year even with the recent volatility, the formulaic yearly average nature of our USIO contracts should promote significantly improved EBITDA generation for the rest of 2017.

Now, moving to Australia, our $54 million adjusted EBITDA performance was more than double the $23 million we reported in the year-ago quarter. This was primarily the result of higher IODEX, which averaged $86 per metric ton during the quarter.

With another solid performance in terms of cash costs, we achieved an EBITDA margin of 33%, making our profitability in Q1 one of the highest we have seen in years in APIO.

With respect to this business, one emerging trend that really stood out, as we sold our product throughout the quarter, was a growing discount between the IODEX price and our realizations. This is primarily attributable to the price adjustments necessary to meet market competition to compensate for varying qualities of ore.

China's recent emphasis on both productivity of their mills and pollution control, combined with high quantities of sub-grade ore in the market, has widened the spread between the benchmark grade ore prices and the prices of the ore that we sell out of APIO.

This development, combined with higher freight rates and some unfavorable timing impacts we felt during the quarter, drove our realizations lower relative to the IODEX. We believe that these discounts are cyclical and should ultimately normalize to historical levels.

That said, at this time, in our outlook for 2017, we're adopting a similar realized price discount that we saw in Q1 for the remainder of 2017. As for corporate overhead, SG&A expenses of $26 million were down $2 million year-over-year and $10 million quarter-over-quarter. We remain on track to achieve our lowest SG&A levels in nearly a decade.

In addition, we recorded a $72 million loss related to the repurchase of certain of our senior notes and the full redemption of our 1.5 lien notes and second lien notes, which had a $0.27 impact on our earnings per share. Let's move on to liquidity.

We ended the quarter with about $450 million of total liquidity, including nearly $295 million of cash, plus the ABL availability. Liquidity was down quarter-over-quarter, as typical for Q1. In addition, CapEx ticked up to $29 million the quarter, as we head towards the completion of the Mustang Project next month.

As inventory begins to be released and we enter into much more favorable 2017 pricing formulas, our free cash flow generation should drive liquidity higher through the end of the year. As such, we certainly do not anticipate borrowing on the ABL this year.

Turning to the 2017 full-year outlook, other than our major interest expense reduction, all other controllable drivers remain unchanged, including sales volume, operating cost, SG&A and CapEx.

That said, we've revised our full-year adjusted EBITDA outlook due to the changes in pricing for iron ore and domestic steel, as well as updated assumptions surrounding APIO revenue realizations, including higher discounts and lower lump premiums.

Applying April's month-to-date IODEX average price of $71 per metric ton and the AMM hot-rolled coil price of $648 per short ton for the remainder of the year, we would expect a 2017 adjusted EBITDA of approximately $700 million. With that, I'll turn the call over to Lourenco..

Thank you, Tim, and thanks to everyone joining us on the call this morning.

Many of you listening on the call have been here for the whole ride and observed the heavy-lifting that we have done during the last two-and-a-half years, cutting cost across the board, exiting all operations that weren't making us money, taking on and defeating all potential threats, and securing sales volumes by means of multi-year contracts with our clients, which will continue to be in place through the best part of the next decade.

In a business environment where our margins for error were so small, our success on all of these things would have been impossible without the perfectly coordinated work of all my team members from the Executive Committee to each one of our USIO employees in Michigan and Minnesota, our entire Asia Pacific team in Australia, Beijing and Tokyo, and to those here at our headquarters in Cleveland.

To each one of these Cliffs' employees across the entire company, thank you very much for embracing the strategy, for believing we could overcome all the challenges and for working together to make everything happen. Since joining Cliffs in August of 2014, I have been working very diligently to reduce our debt and to improve our balance sheet.

The most visible part of this work has been a series of liability management exercises. Each transaction took advantage of what the market gave us and each transaction was done in preparation for the next one.

As we've begun this year, we saw the opportunity in February to execute a big bank transaction, including new equity issuance, redemption of old bonds, retirement of other tranches and issuance of unsecured bonds.

This was actually a complex series of transactions that was flawlessly executed within a 24-hour timeframe using two separate lead-left bookrunners, one for equity, Goldman Sachs, and another one for bonds, Bank of America Merrill Lynch.

As a consequence of the big bank, we substantially de-risked the company with a big reduction of debt, extension of maturities, lowering of interest expense and simplification of our capital structure. As I said in the last quarterly conference call, I do take dilution seriously, and I am a big shareholder of this company myself.

This being said, the February transaction not only gives more upside to the equity holders, as we're set for a massively improved 2017 with $700 million of adjusted EBITDA and nearly $450 million of free cash flow generation, but our much improved debt profile also gives our shareholders far more downside protection in the cyclical environment that Cliffs knows so well how to navigate.

Now, with the carryover tons from 2016 behind us in Q1, our results for the balance of 2017 will benefit from positive development in all three of the factors influencing the USIO numbers, hot-rolled steel domestic prices, pellet premiums in Europe and the underlying IODEX price. Let me explain each one of these three factors.

First, hot-rolled domestic prices. Current demand for steel in the United States is healthy, and that's pretty much across all sectors. Recent weaknesses made clear during this current Q1 earnings season by a few companies are not indication of any underlying problem with the steel business in the United States.

These weaknesses are actually company-specific, and we are glad to inform you that Cliffs and the steel mills that we serve are doing very well.

Actually, based on their actual pellet demand and nominations, the steel mills that are clients of Cliffs are running at higher rates than in the recent past and there are no signs ahead that this trend will change anytime soon.

Additionally, the clear commitment of the current administration to enforce our trade laws and keep illegally traded foreign steel out of our domestic marketplace will bring a lot of support to what should be a strong performance for the domestic steel industry in 2017.

On top of all that, the steel service centers sector is currently carrying less than two months of inventory on hand, as recently reported by the MSCI.

As a consequence of such a depleted level of inventory, service centers, distributors and plate flippers (16:01) are setting themselves up to pay more for steel in the near future, particularly now that Commerce has declared the self-initiation of a trade case based on Section 232 of the Trade Expansion Act of 1962.

Section 232 allows the President of the United States to impose restrictions on imports for reasons of national security.

During the Q&A portion of the call today, if you wish to further discuss this point, I will be glad to explore the potential of serious consequences of a Section 232 trade case for U.S.-based service centers, distributors, traders, plate flippers (16:51) and all other recipients of legal steel. Second, pellet premiums in Europe.

First World countries need high-quality steel and produce that steel via blast furnaces, but they do not tolerate pollution. That's why the utilization of high-quality pellets is prevalent as the basic source of iron units for blast furnaces in Europe and in United States.

However, with the Samarco disaster in November of 2015, the availability of high-quality pellets in the international market has been reduced by approximately 30 million metric tons per year.

The production of pellets in Brazil from other sources is restricted to a limited amount from Vale, and it's almost all earmarked for world-class mills in Japan, South Korea and Europe, as well as DR-grade pellets to the Middle East and the Caribbean.

Most importantly, the major iron ore producers in Australia, Rio Tinto, BHP, Fortescue and Roy Hill, are all located in the water-constrained Pilbara region, and therefore, they do not produce pellets. These Australians only produce a lot of sinter feed fines and some lump, but not a single pellet.

With that, pellet premiums in the Atlantic Basin went up and have stayed high.

Even in the unlikely event that the owners of Samarco, BHP and Vale, pay the several billions of dollars that they must pay in Brazil and then bring Samarco back to operation sometime in the future, there is no easy way Samarco would be able to go back to its previous full production capacity anytime soon or maybe ever.

Knowing that other traditional pellet suppliers, such as the Swedish LKAB and the Eastern Canadians IOC and AMMC, were sold-out to their respective clients in Europe and in the Middle East even before the Samarco fiasco, and with other pellet producers located in countries like India, Ukraine and Russia unable to produce the high-quality pellets needed in the First World, pellet premiums in Europe will continue to be high for the foreseeable future.

That's a very positive fact for Cliffs and our contracts in the United States. Third item, the underlying IODEX price. During the last year, both Rio Tinto and Vale have gone back to practicing and preaching the value-over-volume supply discipline that has made them successful and profitable throughout their history and were vocal about that.

BHP, however, remained the outlier and has not embraced the value-over-volume approach. BHP has actually elected to continue to play by the 2015 playbook of producing more tons and reporting lower cash costs per ton.

Looking at the recent sharp drop in the IODEX, the beginning of such drop seems to coincide with the March 9 speech by the CFO of BHP when he publicly said that the fundamentals in the iron ore market "points to a softening" and that – paraphrasing him – his company was prepared for much lower iron ore prices.

Over the following month or so, the iron ore price dropped from – over $30 from $93 per ton on March 16 to $62 per ton on April 18. Of course, the BHP CFO's speech was not the only cause to make the market change direction.

But it clearly sent a message similar to the one so common in 2014 and 2015 when BHP and Rio Tinto, at that time, were so proud of their strategy of self-destruction based on volume for volume's sake.

Now, tell me, in what other business is this speech okay from any CEO and particularly from a CFO? For example, how would the shareholders of a tech company react if the CFO of one of them would make a prediction like that? Or what would be the consequence of such a speech if that were given by, let's say, the CFO of a car manufacturer? Something like this, based on current levels of car inventory at the dealers' lots, our company believes that car prices are going down significantly.

However, you should not worry, because our production costs are so low, and therefore, we are fine. Do you agree that such a statement would have an impact in the market? I will give you 10 seconds of silence for you to think about. All things considered, I find it's very natural and almost predictable that an activist shareholder has emerged for BHP.

Also, I find it hard to believe that the only motives of the activists are to force the spin-off of a business unit and to delist the company from one stock exchange.

I really wish that BHP will have as much fun as Arconic has been having as we speak in dealing with the same activist, Elliott Management, or the enjoyment that I brought to the previous board of Cliffs Natural Resources when I came to their door in 2014 and took the company from their hands with the support of the majority of the Cliffs shareholders.

In all fairness, BHP is not alone make the business more complicated than it should be. Other big companies such as Fortescue and Roy Hill are also major contributors. Like BHP and their massive sales of lower grade iron ore to China, Fortescue also sells massive amounts of lower Fe content iron ore.

And Roy Hill does the same and also sells lump ore with high percentage of residual elements. Despite being cheaper, these lower quality ores are no longer favored by the Chinese steel mills, which are these days a lot more concerned about pollution control, value in use (25:00) and productivity.

Due to this clear change on the purchasing behavior of the Chinese steel mills, this low-quality ore, and that being predominantly sold to Chinese traders, and that makes for a very important portion of the ore that goes straight to the piles of inventory accumulated port side in China waiting for better ores to blend with.

As they overproduce and oversell, these Australian iron ore producers artificially reduced their respective cash costs per ton by adding more tons. They are also able to brag about how low their costs per ton are. Remember, the easiest way to reduce costs per ton is actually adding tons.

However, they lose a lot more money in overall profitability per ton and in the aggregate. The result of this anti-value-over-volume activity is a high level of iron ore inventories at the Chinese ports filled mostly with low-grade and high impurities (26:19) ore.

This low-quality iron ore accumulate port side, waiting for higher Fe content ores to blend with, combined with the Chinese steel mills' new focus on productivity and pollution control have driven a much bigger gap between the price of 62% Fe content ore and the price of lower grades of iron ore.

The Chinese mills are demanding more 62% iron content ore, which is exactly what our pricing formulas in our USIO contracts are based on when calculating price. The good news for Cliffs is why we are clearly negatively impacted in our APIO realizations. This development has been a net average positive for USIO as for Cliffs overall.

With that, we expect significantly improved USIO realizations this year. We do expect discounts to remain greater than their historical averages, as the market progressively absorbs all of the low-grade products out there, mainly through blending with higher Fe content, lower impurity (27:39) ores.

This reality is contemplated within our latest full-year EBITDA forecast, which bakes in greater discounts and a low IODEX number, basically assuming that BHP will not change its behavior.

However, if the other majors, Rio Tinto and Vale, stay the course and something positive happens at BHP either with the help of Elliott, the activist, or just with them seeing the light, very unlikely, our current forecast of $700 million for 2017 adjusted EBITDA will prove itself conservative.

Also, while last time, we used year-to-date figures to frame our guidance, in this case, we used April month-to-date averages to be more in line with the recent price trend. If we had instead applied the year-to-date iron ore average, our EBITDA forecast will be similar to what we provided in our outlook last quarter.

Looking at the domestic steel market as of now, we recognize that our primary customer base, the blast furnace integrated steel industry, makes up for less than half of the total steel output in United States.

And while blast furnaces continue to be efficient and competitive in this market from a quality and specification standpoint, the larger portion of the domestic steel market, the EAFs, are still largely unserved by Cliffs.

This evolution of the steel business has a lot of call-backs to Cliffs pioneering the pelletizing process 70 years ago, and it must continue to evolve. Over the past two years, we have had a lot of success selling DR-grade pellets to new clients. And we're now getting ready to expand our role in serving the EAFs.

With the significant cash flow we expect to generate over the next couple years, we are currently in the process of evaluating the best course for a more substantial entry into this market.

We have a number of options, some of which are not incredibly capital-intense and would position us to feed the EAFs with what they desire, high-quality virgin iron units. Whether HBI and/or DRI, this is what the (30:38) need and want, and Cliffs will be the one supplying them.

This certainly is no reflection of a lesser commitment to our blast furnace core customer base. One of our top priority remains protecting and enhancing this core business. We'll continue to deliver high-quality custom-made pellets that allow our customers to remain competitive in both quality and efficiency.

We will also identify and consider opportunities to improve, expand or extend the life of our pellet-making operations in the United States. The perfect example of this is our recent upgrade to the UTAC facility, where soon we will be delivering the specialized custom-made super-flux pellets to our largest customer, ArcelorMittal.

This upgrade was for Cliffs, a no-brainer. Like we did with the Mustang Project, we must evaluate all of these opportunities very seriously and apply high hurdles when it comes to return on investment.

While we now have the luxury of having a much improved capital structure, we must recognize what gave Cliffs the debt problems of the recent past, a poor allocation of capital by previous management. The beauty of this current scenario is that there is no gun to our head and we can be patient in evaluating opportunities.

As volatility persists, even better opportunities may arise later. We know what we want, but we are patient. One thing we'll always be confident in is the resilience of the U.S. economy, and by extension, the health of the domestic steel industry.

The steel prices in the United States are at their highest since I have been with Cliffs, and all signs point to a sustained healthy year. The noise about Chinese and domestic steel price arbitrage is irrelevant now with the trade cases we have in place and a strong commitment to enforce them.

The reality is demand for steel in the United States is good. Our clients are doing well in their markets, and the measures to curb illegally traded imports have been put in place. The coming years appear promising for both the blast furnaces and EAFs.

And with our current market position, as well as the opportunities we have to expand our customer base, the future is bright for Cliffs. With that, I will now turn it back to the operator for the Q&A portion of the call.

Michelle?.

Thank you. [Operator Instruction] Your first question comes from Lucas Pipes, FBR & Company. Your line is open..

Hey. Good morning, everybody..

Morning..

Morning, Lucas..

Good job in, of course, navigating this market and cleaning up the balance sheet. And my first question is kind of longer term, especially as it relates to your earnings power. So, I think your stock is pricing in lower levels of iron ore prices. If I were to assume, let's say, $60 IODEX in 2018, I would still estimate about $600 million of EBITDA.

Do you think that's the right ballpark? Is that reasonable or would you say maybe higher or lower than that? I would appreciate your thoughts..

Okay. Lucas, longer term earnings power of this company is great, because our core business sits in a market that's a lot more inelastic than any other market, the United States of America.

On top of that, we have contracts in place with all the big clients that are performing well in the United States, ArcelorMittal and AK Steel mainly, and others that are working hard to get better like Algoma (35:23). These are multi-year contracts that are not going away anytime soon.

Another interesting thing is that the fact that we had quarter one average price of $86 per ton and year-to-date IODEX at $83 per ton have already gave me my 2017 EBITDA here in the United States. I am done for 2017 only with these four months.

What if the IODEX continues to be at, like today, $66 or $70 like the April average IODEX? We're going to be okay. We're going to make a lot of money, because our contracts work with yearly averages. So, the yearly average has already been pumped up by the actuals in Q1. People fail to realize that.

They're looking at the results of Q1, even though we said so many times that we had carryover tons. Very few caught that in their models. You are probably – based on the Q1 forecast, probably the only one that really understood this thing.

So – and unfortunately, your number for some strange reason was not part of the consensus, and that pretty much made me miss consensus. And we are all gauged against consensus. So, anyway, you're right, but your number was not part of the consensus. But I hope you understand the formula is based on yearly averages.

So, here in United States, no matter what happens from now on, I only see upside, because we are done. Q1 is in the bag. April's in the bag. Life is good. We are going to see pellet prices going sharply up in Q2. So, we're going to be in great shape. As far as APIO, it all depends on sanity of people over there.

BHP is insane, but they have a lot to deal with right now. They have their hands full with Elliott. If you want to kind of anticipate what's coming for BHP, take a look on what already happened at Arconic, and it's going to happen as the proxy comes to an end over there, the proxy fight. Rio Tinto changed direction last year. They know what they want.

Vale is doing everything in terms of being responsible.

And the more they produce S11D to blend with the crap that sits at the port in China and the more they introduce new products like the low alumina sinter feed fines blend that they announced a couple days ago, the better we will see these inventories at the ports to disappear, because these are good products to blend with the low-quality materials sitting at the port.

But you know I'm paid to be conservative here. I have to bring my guidance down. I have to assume the worst-case scenario. I can't assume the easiest case.

So, if everything continues to be – or if everything continues to go in the wrong direction, let's put like this, as far as IODEX and nothing changed over there, that's it, we're going to make only $700 million. I'm sorry, only $700 million, only double EBITDA from last year, instead of tripling.

We are going to generate only $450 million of cash flow, only $450 million of cash flow. That's my worst-case scenario. Sorry for the long answer..

No, that's – I appreciate long answers, and that was very insightful. You certainly recommended yourself for giving good advice when it comes to activist situations..

Thanks for recognizing that. I know how these guys think..

A quick second question. There have been some rumblings about the revival of Essar Steel Minnesota maybe under new ownership. Do you have any thoughts on that and where do you think that asset fits in domestically at this time? Thank you..

Well, the process is still ongoing. So, I can't comment too much. What happened yesterday was an auction that we elected not to show up for. Our offer was made. It was public, so I can talk about, was $75 million. And then, I increased that offer to $100 million and that's also public information, so I can talk about.

And our offer was all cash, just writing a check. And my offer would also make all the contractors and vendors 50% hold on their money as soon as the process – the bankruptcy process would end. So, they would recover $0.50 on each $1 that were owned (41:00) at that point.

The squatters that are there for – at this point for 10 years would get zip, would get a goose egg, as well as all the other parties that helped them to continue to be there. I would only do this 50% for the vendors and contractors. It's cash.

Yes, we are competing against our plan (41:26) from a very powerful trading house in London, which I forgot the name. A company that was just formed Chewbacca Steel and, Chewbacca? No. Chippewa? Chippewa (41:39) sounds so bad in Portuguese. It sounds almost like a bad word.

So, I tried to say Chewbacca Steel (41:51), and a bunch of other well-known unknown people. So, let's see how this thing will go. The game is ongoing. My offer is cash. The other is Monopoly money or (42:05). So, we'll see how it goes..

Well, that's a helpful update and appreciate your color, and best of luck with everything. Thank you..

Thank you very much..

Your next question comes from Matthew Fields from Bank of America. Your line is open..

Hey, Lourenco. Hey, everybody. Congratulations on the great balance sheet work you did in the quarter..

Thanks Matt..

Thanks Matt..

I think Tim might have mentioned something about this, but I may have missed it or would like some more detail, a little bit on the difference between maybe realized price that you state and the sort of overall revenue per ton and the cash cost of freight in there.

Can you sort of flush that out and why the discrepancy in 1Q and sort of how that's expected to normalize over the rest of the year?.

Yes, sir. I will have Tim answering that. Please, Tim..

Yeah. I think if you look at a couple things, while iron ore prices were up year-over-year and certainly we realized – we saw that realization come down, the biggest piece of that is that price adjustment, the discounts that we referred to. But then you also have the timing impact, and timing's really two pieces.

One, when the product gets discharged at the port and the way the price is moving at quarter-end into the quarter, so we had an impact there, as well as lag pricing.

So, certain of our Australian customers are on a one month – or a full quarter and one month lag, and certainly that impacted us, as the 2017 lag pricing was about $22 lower than that $86 IODEX for the quarter average. Freight, Fe content and all the other adjustments to the IODEX relatively flat year-over-year, quarter-over-quarter.

Not much of a big difference there..

Okay.

So, maybe the biggest content – the discrepancy is just that lag and APAC pricing?.

The lag and the discounts that we're seeing. I think second quarter discounts priced out 20%..

Yeah. Look, the discounts between the ore we produce, that's below 62%, as you know, both lump and fines..

Right..

And the IODEX 62% will depend on how much BHP and Fortescue and Roy Hill will continue to overproduce. What do I expect? I expect that BHP will get religion one way or another. Fortescue, they don't have a lot of options, because that's the ore they have. They can always control the output, but I don't see that coming.

And Roy Hill, well, it's just a time bomb at this point. One day, it – I can hear it tick, tick, ticking, but it hasn't exploded yet. So, I don't give much credence to what they are doing or not doing. So, short-term, same thing. Mid-term, it will improve, that's for sure.

As Vale picks up and Rio Tinto picks up with better ores and blending continues to improve and put into use the ore that sits on the port, this thing will continue to be reduced. I just don't want to see the discount reduced for the wrong reason, because IODEX goes down, then the discounts go down. That's bad.

I would rather have the IODEX stay where it is than going up and the discounts increase. We make more money, and we make money in dollars. We don't make money in percentages, so..

Thanks. And then, given the already tight sheet market in U.S. Steel and maybe compounded or caused by U.S.

Steel's – the company's decision to take a bunch of assets down for the year and the next few years, have you seen an increase in activity for your other blast furnace customers for sort of maybe more entry into the spot market to try to fill that gap?.

Well, you know well that we don't have any business with U.S. Steel. So, we don't sell pellets to U.S. Steel. But we sell pellets to the U.S. Steel competitors. From where I sit here, it's clear to me that our clients are benefiting from the current domestic scenario here, and they are benefiting from the retraction, let's call that, retraction of U.S.

Steel from the domestic market of steel. Where are they going to sell the pellets, if that is part of your question? I have no idea, because the clients are taking. I will sell to them in 2017, 2018, 2019, 2020, 2021, 2022, and then 2023, one contract of one client will end. And then, 2024, a second contract and then – and it's too far away.

By that time, I'll be very old. So, that's the status. So, we're good. Our clients are good, and we are here to support them for more. They should go take business from U.S. Steel. That's probably what they are doing as we speak. So, anyway, I'm happy with that.

What else can I tell you?.

Okay, good. And then, I just kind of wanted to follow-up on Lucas' question about the other Minnesota assets. And I think Chippewa might have been the word you were searching for, Chippewa Capital Partners, put in a bid, and we read it was pretty significant.

We read $350 million plus another $1 billion pledge to finish the plant, which seems kind of a lot. And this is the group that's related to the – I think the group that took over the Magnetation assets as well.

So, given sort of where we are, sort of a tight pellet market in the U.S., can you comment on what do you think this guy's strategy is?.

Look, if you combine a blind with a handicapped, you are not going to make for an MMA fighter, right. You are going to make for a handicapped and blind men. So, you are combining Magnetation with all their success in the past with Essar Minnesota that has also been extremely successful.

So, you combine those two stories of success, you pair with someone that offer $250 million of equity and then increase to $350 million that said that they are going to put a DRI facility for 3 million tons of pellets and they will start up in three years.

Their 3 million tons mega model for that type of size does not exist yet, and they are going to start talking to you, that sounds like a great combination of everything. And the other thing is where is the money.

Although they (49:20) have an underwritten letter of commitment from a big financial institution like Goldman Sachs, like Bank of America or JPMorgan or Morgan Stanley or something like that or they have come with Bank of Timbuktu. So, these are things that we all see in court. That's the maximum amount of color that I can give to you.

I just feel bad for the Minnesota people that – you fool me once, shame on me. But fool me twice, blame me (49:53). That's my assessment of the situation with Chewbacca Steel (49:56). That's the word I'd use..

All right. Thanks very much, Lourenco..

All right. Nice talking to you, Matt..

Your next question comes from Novid Rassouli from Cowen & Company. Your line is open..

Hey, guys. Novid Rassouli at Cowen. Thanks for taking my questions. Lourenco, you mentioned that you do not think Chinese HRC spreads matter at this point. What global spreads do you think are more important to focus on now and what is your view of the U.S.

HRC prices throughout the remainder of 2017?.

Well, I said that it doesn't matter because at this point in time, we have trade case in place. And in order to increase the spread, you have to do two things. One is China needs to keep pushing prices down. The other one is having United States pushing prices up. And the only third option is both come together. So, if U.S.

Iron Ore prices continue to go up based on the absence or the reduction or the enforcement of the trade laws and the absence of imported steel here in this country, it is kind of expected, right, at this point. China coming down, I don't see how come, because they are now entering the second five-year for President Xi Jinping.

Usually, in China, this is the time when things get really done. He knows that he needs to continue to fuel the beast over there. So, consumption in China seems to be healthy and continue to grow. And that is a clear message coming from CISA, from Mr.

Li Xinchuang, and he is repeating that since 2015, we are not growing indefinitely, we are reducing, we are being more focused, we are controlling pollution. They are going to have to shut down capacity and they will need steel.

So, these massive amounts of Chinese steel available to do all kinds of stuff go to Vietnam and then come to the United States or go to other Asian countries and that will displace material that come to the United States.

That's all been taken care of already with the antidumping and countervailing against hot-rolled, cold-rolled, galvanized and plate. And on top of that, there is a self-initiated Section 232 trade case that was initiated by Secretary of Commerce Wilbur Ross. Just to give an idea, Mr.

Wilbur Ross was the guy that put together Bethlehem Steel and LTV Steel just after the debacle of the two companies around 2001, 2002. And that was a result of trade case. So, Wilbur Ross knows trade cases very well. So, I don't know what you're concerned about.

Can you be a little more specific on your views?.

Yeah, I....

So, then I could probably answer better..

Yeah. No, Lourenco, I was just curious – I actually agree with you on the Chinese spreads. But I'm curious what part of the world now you think is more important to be focused on when thinking about HRC prices in the U.S. and what's a reasonable spread, essentially..

Okay. I'm glad we agree. So, now to the second one. The part of the world that you should be focused on at this point is the United States of America, because our economy is growing. All sectors are in good shape. Some sectors are surprisingly strong at this point like agriculture, like non-residential construction. Automotive has not come down.

Actually, we are seeing automotive turning back up. And we have a limited amount of domestically generated steel available for all these uses. And that's why I'm trying to guide you, Novid, that our nominations (54:21) are good, our clients are in good shape.

If there is any perceived weaknesses in the marketplace, certainly, they are not related to any of our clients. So, we should be in great shape..

Great..

But then, our price would be a lot higher than the international price (54:41). Yes, of course. This is our market. This is how it works. It has been like that – I'm in this business for 37 years. It has been like that during the last 30 years that I have been paying attention to that, because the first seven, I was still learning..

Got it..

I'm still learning as of today, but I was not dealing with international trade. So, our prices are higher, have always been. Take a look when that was different, when the gap was different from the gap that we have today. Another point to consider, Novid, let's assume just for you and me like two guys talking about. Like you said, I'm curious.

I like when an analyst starts like that the question – I'm curious. You should be curious. So, let me try to placate your curiosity.

Let's assume that we have a war in the Korean Peninsula, and then we have a big disruption on the flow of iron ore to China, the flow of iron ore to Japan, the flow of iron ore to South Korea, the flow of products out of the Asia Pacific area. That's a possibility at this point.

Finally, the (56:03) is right there, watching that guy with the crazy hair just to see what he's going to do. So, there is a real possibility of war. Nobody is baking in that. I'm not, you are not, nobody is, but you can't deny that.

So, I don't see a negative scenario, no matter how you skin the cat, no matter how much the shorts (56:28) want you to write a report to support (56:31). Another point, I have been showing loud and clear that if bond (56:41) prices are up, we take advantage. If bond (56:43) prices are down, we take advantage. If stock prices are up, we take advantage.

If stock prices are low, I take advantage. So, I spent this half an hour after the prepared remarks of this call only with one purpose, to try to share my views with you. If you're going to take, great. If you don't take, great. (57:04). But we are going to be okay no matter what.

What else can I do for you, Novid?.

Just one more, Lourenco. Thanks. On entering the DR-grade pellet market in a more substantial form, I just wanted to see if you're able to divulge some of the options that you might be weighing, and then maybe just a potential timeline of when you might be targeting moving into that market in a more substantial way. Thanks Lourenco..

Novid, the move that we will define – a change in direction for Cliffs will be when we decide on a site to put our first DRI production facility. We have already proved ourselves as a capable producer of DR-grade pellets. We have already proved ourselves as able to deliver high-quality pellets to the ones that produce DRI as we speak.

Now, it's our turn to have our own facility to produce our own DRI. Our first facility will be 1.5 million tons of DRI/HBI per year, and that will demand around 2 million tons of our own pellets that we already have and can produce, so we know where we're going to get.

So, the next visible step will be the definition of which site we are going to build our DR-grade pellets. Depending on the outcome of the situation in Minnesota, it can be Minnesota. I still believe that it will be Minnesota, but can be somewhere else.

And we have a couple of other options that we are actually extremely developed in moving in that direction. All these things considered, we are not going to spend any meaningful capital this year, because time is passing and we are already pretty much in May, and we are not going to break ground just before snow comes to the ground.

So, I don't see how we are going to spend money on that project in 2017. In other words, 2017 will be fully dedicated to continue to pay down debt, and we are going to end 2017 substantially below $1 billion in debt, more or less like 1 time EBITDA leverage. That's our goal for this year.

And then, next year, we're going to start spending on our first DRI facility. We will continue to be very, very disciplined, and paying down debt continues to be our priority for 2017. And we're going enter 2018 with – we are already with an extremely good balance sheet. And coming January 1, 2018, we are going to be even better.

Today is a little more than 1 time EBITDA, close to 2 times EBITDA. We'll be below 1 time or around 1 time coming January 1, 2018.

Is that okay?.

That's perfect. Thanks Lourenco. Appreciate it..

Thanks..

And your final question today will come from Nick Jarmoszuk from Stifel. Your line is open..

Hi. Good morning, Lourenco. I wanted to ask you a little more on the....

Hi, Nick. Good morning. Good morning..

Good morning. A little more on the DRI facility. I know previously you talked about using someone else's balance sheet.

Is this something now that Cliffs would look to do on its own?.

Yes. Right now, that's the only change actually. We've got the only change that we made to our plans. Until the big bank transaction in February of this year, I was considering the – in order to be able to move forward, I was considering using somebody else's money. So, that need is no longer present.

Like I said, we are already in a great balance sheet situation. And by the end of the year, we'll be in a better – even better position to do on our own. So, now, I prefer to decide things alone here with me – myself and my management team and my board, instead of sharing decision-making with a financial partner.

That's not always will be totally aligned with Cliffs. So, we are going to do on our own. That's a perfect conclusion. But it will be next year, not this year..

Okay.

So, with the $450 million of cash flow, how should we think about what potential debt repayments could be versus cash build to pre-fund the DRI plant? And then, what's the CapEx associated with it?.

With the DRI facility?.

Yeah..

We don't have a final number yet. We do not. But we are discussing with both suppliers of the technology. They both understand that that will be the first one of a series of potential DRI facilities in United States.

We are going to show the way, and that will be very positive for Cliffs, but it will also be very positive for either one of the suppliers of the technology that will work with us. So, we are still in negotiation time. So, we can't talk about numbers yet..

Okay. That's all I have. Thank you..

Thanks..

And we have no further questions at this time. I turn the call back to our presenters..

Thank you very much. We will be here in three months, and you should expect Q2 to be a very strong quarter in terms of pellet price realization, in terms of EBITDA, in terms of net income. Our EBITDA in Q2 will be above $200 million. That's what we expect. Thank you very much. I'll see you soon. Bye..

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