Cleveland-Cliffs Inc.

Good morning, ladies and gentlemen. My name is Kevin, and I'm your conference facilitator today. I'd like to welcome everyone to Cleveland's first quarter 2022 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's 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 Form 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 on clevelandcliffs.com. and at the conclusion of the call, it will be archived on the website and available for replay. The company will also discuss results including certain special items. Reconciliation for Regulation G purposes can be found in the earnings release, which was published this morning. At this time, I'd like to introduce Celso Goncalves, Executive Vice President and Chief Financial Officer.

Thank you, Kevin, and thanks to everyone for joining us this morning. Let me start by summarizing the key highlights from our Q1 results, and then I'll provide some additional context around our increased outlook for the remainder of the year. Our adjusted EBITDA of $1.5 billion in Q1 of 2022 is three times higher than the year over year adjusted EBITDA in Q1 of 2021, boosting our last 12 months EBITDA to $6.2 billion, which is a record for any 12 month period in our company's history. Relative to last quarter, our sequential Q1 EBITDA was essentially steady with Q4, despite the sharp drop in spot steel prices that started around September of last year and lasted into early March of this year before rebounding higher. In late Q4 and early Q1, we also saw relatively weak service center demand due to generally elevated inventory levels. Despite this unfavorable backdrop of falling HRC prices, and weak service center demand, we were still able to maintain a steady quarterly EBITDA level from Q4 to Q1, primarily due to the magnitude of our fixed contract price increases that went into effect at the beginning of this calendar year 2022. Ultimately, more than offsetting the spot price weakness backdrop and resulting in higher overall average selling prices for cliffs quarter over quarter from Q4 to Q1. We have been foreshadowing that the strength and fixed price contract renewals would eventually materialize in our numbers, and that has now been clearly demonstrated through our Q1 results. From a volume standpoint, we also achieved a 200,000 ton sequential improvement in direct volumes to the automotive industry, our best shipment quarter to this end market since the semiconductor shortage began in the first quarter of last year. This resulted in improved sales volumes to 3.6 million tons in Q1. Going forward, as we expect the automotive sector to continue to improve and the distributors and converters market to replenish inventories, we anticipate sales volumes to increase further on a quarterly basis. During Q1, we also concluded negotiations on all of our remaining fixed-price automotive renewals that reset on April 1st. with significant further price increases executed on all 1.5 million tons of annualized volumes that matured on that date. We are already benefiting from this price increase here in Q2. Beyond that, our next round of fixed price contract renewals will be negotiated this summer and repriced on October 1st, and we look forward to continuing this favorable pricing momentum on those negotiations as well. Adding additional context around our updated favorable outlook for the remainder of the year, we are increasing our expected average selling price by $220 per ton compared to our prior guidance in February. Our expectation is now for a full year average selling price of $1,445 per ton at the current curve compared to our previous guidance two months ago of $1,225 per ton based on the curve at that time. This improved outlook is driven by three things. One, our successful fixed contract renewals, as I have just explained. Two, a higher futures curve today compared to February. And three, wider than historical spreads between hot rolled and cold rolled steel prices. On the cost side, we are better positioned than any of our competitors to mitigate pressures from the current inflationary environment, given our vertically integrated and internally sourced iron ore pellets HBI, and scrap, as well as annual fixed price contracts for met coal. Our Q1 unit costs moved up sequentially, as expected, due primarily to coal, alloys, and energy cost increases. We also took $111 million in one-time accounting charges related to some operational and financial decisions that we executed during the quarter, namely the closure of Mountain State Carbon, and the idling of the Indiana Harbor No. 4 blast furnace, as well as the redemption of our convertible notes. Looking into Q2, we expect our unit costs to increase sequentially due to our Cleveland No. 5 outage and generally higher scrap and energy costs, although these will not impact us nearly as much as others in our industry that are much more exposed to high scrap prices and need to buy slabs externally. From a cash flow standpoint, Our inventory build of $372 million during the first quarter was more reflective of costs than actual units, as our total tonnage of steel inventory actually declined over the past quarter. With this one-time inventory build out of the way, our Q1 free cash flow of $297 million should be the trough in quarterly free cash flow generation for the year, with much higher rates of EBITDA to free cash flow yield conversion in Q2, Q3, and Q4. At the current steel forward curve, we expect our total 2022 free cash flow to exceed the record that we set last year. And that is even as we become a substantial cash taxpayer this year, which we were not in 2021. Speaking of cash flow and capital allocation, we continue to clean up our capital structure and favor debt reduction over other uses of capital at this time. This year, we have already redeemed our convertible notes and our 9.875% secured notes, which we completed this week well ahead of its 2025 maturity. With this proactive approach, our most expensive bonds are now completely gone, and our annual cash interest expense is significantly reduced. Looking ahead, we have a few more tranches of debt that we can pay down with our cash flow, prioritizing our 6.75% secured notes as our next target. In a few quarters, Our debt should be so low that it will no longer even be a discussion point, and I look forward to talking about other ways of returning capital to our shareholders at that time. Our LTM EBITDA of $6.2 billion already implies leverage of 0.8 times, the lowest level for Cliffs in over 12 years. As you can also see from this morning's release, we only spent $20 million in share repurchases during Q1. executed opportunistically at very attractive prices. Other than this, we used most of our remaining free cash flow generated during the quarter toward paying down debt, as discussed. Going forward, we will continue to favor debt reduction over share repurchases in the near term, and buybacks will continue to be only opportunistic. In closing, because of our domestically sourced raw materials supply chain, as well as our heavy weighting towards fixed price contracts, Our 2022 financial outlook is very compelling, with strong margins, record levels of free cash flow, and equity value creation through a massive conversion of total enterprise value to market value via debt reduction. With that, I'll turn the call over to Lorenzo.

Thank you, Celso, and good morning, everyone. I will start addressing the most significant development we are facing at this time The Russian invasion of Ukraine is a barbaric act. Its impact on the civilian population of Ukraine has made this event, above all else, a human tragedy. As a matter of fact, Russia and Ukraine have been at war since Putin invaded the Crimean Peninsula in February of 2014, a few months before we began the turnaround process at Cleveland Cliffs. Our business at that time was to supply raw materials to North American steelmakers, and we identified the massive share of pig iron coming to the United States from Russia and Ukraine as unreliable and at risk. Representing two-thirds of all U.S. imports of pig iron at the time, it was pretty remarkable that no one was really concerned about it. for working to reduce their dependence on both Ukraine and Russia. This helped us formulate our decision made in 2017 after we had already fixed the financial situation of the company to build a domestic source of virgin metallics with our Toledo direct reduction HDI plans. That was an attempt to provide the U.S. electric arc furnace market with a more reliable and carbon-friendly source of metallics, which they absolutely need to make higher specs of flat-rolled steel. In the seven years following the invasion of Crimea, we were the only company to act on this potential to reshore or base metallic supply back to the United States. Fast forward, now that we are a steel producing company, we are better off using our HBI in-house. That has allowed us to reduce our blast furnace footprint from eight to seven units while maintaining similar level of the steel production output following our recent idol of the Indiana Harbor number four blast furnace. This has also created a huge competitive advantage for us. With our own in-house pellets and relatively cheap natural gas, our cost to produce HBI has been just over $200 a ton. And that compares very favorably to the $1,000 per ton price tag for pig iron imported into the United States these days. The ongoing importance we placed on prime metallics did not stop with HBI. In November of last year, we acquired FPT, the leading prime scrap company in the United States. Since acquiring FPT just five months ago, we have already increased our access to another 400,000 tons of prime scrap per year, elevating our market share in merchant prime scrap from 15% at the time of the acquisition to 20% now. Both of these strategic moves, FPT and HBI, each underscored by our forward-looking view on the necessity of domestically sourced, high-quality iron units, have paid off in very short order. These actions were based on our view of the world, and we are benefiting now. Iron metallics are absolutely necessary to make high-quality flat-walled steel. We at Cleveland Cliffs are long on metallics in a country that is short of them. EAFs cannot make high-quality flat-walled steel just by melting scrap. They need metallics. That's why they import so much pig iron, vast majority from Russia and Ukraine. However, imported pig iron comes from some of the least environmentally friendly plants in the world, generating a level of CO2 emissions that will put them out of business here in the United States. But that is scope three emissions for the American importers of pig iron. And so far, that important piece is ignored when a company reports emissions. We at Cleveland Cliffs will continue to educate investors, members of Congress, and government officials on the importance of accounting for Scope 3 emissions. If you are serious about emissions, Scope 3 can no longer be ignored. As a result of the invasion of Ukraine by Russia on February 24, more than 4 million tons per year of imported pig iron supply have been disrupted. While the new situation hit very late in Q1, particularly due to vessels already sailing and material already unloaded on domestic grounds, 4 million tons out of a total of little more than 6 million tons is a full-blown disaster. for companies depending on imported pig iron. For these folks, Q2 should be very challenging. Supply from Ukraine will likely be out of the market for a very long time due to the significant damage to blast furnaces, oak batteries, and other equipment that cannot be fixed quickly. As far as Russian pig iron, well... we are sure that production will not be discontinued. Due to outdated trade laws and powerful lobbying efforts, pig iron from Russia can still come into our country with effectively zero restrictions, even after Russia losing the NTR, permanent normal trade relations status, with the United States. The revocation of PNTR status came with heft tariffs of 25% or above on most steel products from Russia. But the tariff on pig iron is still a meaningless $1 per net. This dates back to the 1930s, when pig iron was not even a product imported by the United States, and certainly not from Russia. Russia's predecessor, the Soviet Union. Again, as far as Russian pig iron, production will not be discontinued. Even if American companies decide to stop buying Russian pig iron as early as right now, in Q2, Russia's next move on the international trade arena is very predictable. Transshipment of Russian pig iron through Russian-friendly business-as-usual type of countries, such as China, India, Brazil, and a few others. Cleveland Clips will be watching the current developments around the international trade of Russian pig iron in Q2, and we fully expect the U.S. government to be on the lookout to block such predictable moves on transshipments of pig iron from Russia through third-party countries. Take one step back and learn from current events. The impact on supply chains should have been a lot worse if we're talking about the invasion of Taiwan by China. But the ongoing invasion of Ukraine by Russia should be enough for a clear call for the end of globalization. We call it deglobalization. I believe deglobalization is the most important game changer of this decade in the United States and for the American people. De-globalization is not just relevant for our industry, but for our customers as well. If the automotive OEMs had not set themselves up to be so reliant on imported semiconductors, they would have the demand to support the production of 18 million cars, both last year and this year, rather than the 14 to 15 million units they are currently able to produce. We are encouraged by investments made in onshoring this production, including a major $20 billion factory down the road in Columbus, Ohio. Cleveland Cliffs is an automotive supplier, first and foremost, by far the largest supplier of steel to this sector. It's also noted Q1 was our best shipment quarter to the automotive sector in a year. But we will be able to do much more in a fully utilized business environment. That day is coming, and the amazing results we have shown Over the past year, we will only be further amplified once we get there. Looking ahead to the rest of the year, based on the rationale I have tried to lay out today, we are set to benefit from our perfectly constructed business model. There are seven real producers of flat-rolled steel in the United States, and we are the only one among the seven that does not rely on imported pig iron or its labs. In simple terms, the high cost that our competitors are facing from sourcing these materials will force them to keep steel prices elevated, and we will benefit through higher margins. Our cost structure is not nearly as impacted. Also very important, new flat-rolled mini-mules ramping up capacity will only exacerbate their current issues with sourcing prime scrap and metallics, which will just further widen the competitive advantage we have. While I have focused the majority of my remarks on raw materials and substrate, the Russia-Ukraine conflict removed a lot of finished steel from the global marketplace as well, including its labs re-rolled in Europe. The war-induced steel shortage has pushed global steel prices up, making imports less appealing in the United States. We continue to read the same headlines about inflation, rising rates, rising lower growth, and the increasing likelihood of a recession. We long for the days that Fed officials will just keep quiet and do their job rather than giving doomsday interviews on Zoom almost every day. For us, underlying demand is good. Customer inventories have begun to decline, and issues related to sourcing labor or critical materials are showing signs of easing. The panic buying of 2021 is behind us. but we still have a lot of hungry mouse to feed and that will only increase as the same conductor shortages gets progressively better. Wrapping up, we did not wish for the current Russia-Ukraine situation and want to see peace soon. Russia should be punished for their vicious attacks and the steel industry around the world, particularly the American steel industry, can play an important role in inflicting maximum pain to the perpetrators of this despicable act against the civilian population of Ukraine. We have geared our strategy around the importance of a domestic supply chain, and it's unfortunate that it took this situation to be the wake-up call for the ones that were not paying attention. We are proud to provide our customers with steel free of association with Russia. With that, I will turn it over to Kevin for a question.

Thank you. Now, they're conducting a question and answer session. If you'd like to be placed in the queue, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to move your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star one. Our first question today is coming from Lucas Pipes from B. Reilly Securities. Your line is now live.

Thank you very much, and good morning, everyone. Lorenzo and team, great, great quarter. Lorenzo, there's a lot of concern in your prepared remarks. You touched on this, that 2022 will be another challenging year for automakers from the supply chain VOS. And kind of as the largest automotive steel supplier, how are you engaging with your customers to manage these product flows and inventory? Thank you very much.

Thanks, Lucas. Look, as we showed, numbers are numbers. You can't deny numbers. Q1 was better, was our best quarter of automotive delivers since the problem started. So since COVID. So we are in better shape now than we were in Q4. That's a good sign. So we are moving in the right direction. They are moving in the right direction. Another thing is that I have been in direct discussions with the CEOs of each one of these companies, these big clients of us. We are the biggest supplier of each one of them. You name it, we are the biggest supplier. And we are in direct discussions with them about how we're going to do next. Each one of them is also on the brink of developing new products in the EV arena, in the EV space, in the electric vehicles space. And this is very important to them. We are the sole suppliers of non-oriented electrical steels for the engines of these cars. We are developing the body and the exposed parts of these cars. We are improving the quality of these materials for these cars. So we are seeing their effort. We appreciate their effort. And we are working together with them to improve their own ability to forecast to us. When you deliver the amount of tons that we deliver every quarter, there's no other way to go. So we appreciate the interaction. We are seeing improvements. And the numbers, the shipment numbers are starting to show.

That's terrific to hear. Thank you for that detail. Lorenzo, you have been prophetic about the vulnerable supply chains of the North American steel industry and appreciated your detailed comments and your prepared remarks, but I wondered if you could speak on the numbers for both metallics and steel imports in a little bit more detail. What amount of Pig iron is still coming to the U.S. today. What are the sources? How do you expect that to change over the course of this year? And on the finished steel side or slab side, a similar question, what are the levels of imports today and how would you expect the impacts there on European suppliers, for example, to ricochet back to the U.S. over the course of this year? Thank you very much.

Lucas, first of all, there's no such a thing as ready, available, and made to order pig iron everywhere in the world. That's not true. There's an integrated competitor of us that needs pig iron, and now they are importing pig iron and buying other iron substitutes from third parties, and now they are going to supply it on pig iron. You take them one year to be able to produce pig iron. So there's no such a thing as someone or several parties will be ready to chime in to replace Russia and Ukraine in pig iron. So let's go to the numbers. The importation of pig iron in the United States has been above 6 million tons a year, give or take. And more than four come from Russia and Ukraine. Ukraine counted out Of course, we'd like Ukraine to continue to be able to produce and provide for their people. But that's not the case when you have bombarded plants. So Ukraine is out. And Russia should be out. But knowing Russia, of course, they're not going to be out. They're going to sell these things to Brazil, to India, to China, to South Africa, to Middle Eastern countries. And this pig iron will come here. So it's up to us to not allow the Russians to do that and not to turn a blind eye, to pretend that these big irons are coming from a different country. It's not. So we'll see. I will be watching. Q2 will be interesting.

Thank you. And on the steel side?

Well, on the steel side, the biggest impact is in Europe. in these labs, because Russian labs are part of the picture. And Europe now is finally acknowledging the fact that they made themselves dependent on Russia with gas and with steel. There's a lot of steel being re-rolled in Western Europe that really comes from Russia. We were able to educate the the administration on that thing, and it was reflected in the trade agreement that we cut with Europe. But again, it's a lot of steel that's no longer available. It's a lot of steel that needs to be replaced in Europe. So overall, in the international trade, in the merchant market for steel, this is out. So I believe that the pressure on import steel into the United States will decrease based on the fact that Russia is now outlawed in Europe.

Lorenzo, thank you very much and continue best of luck. Really appreciate it.

Appreciate it.

Thanks, Lucas.

Thank you. Our next question today is coming from Michael Glick from J.P. Morgan. Your line is now live.

Morning. Just on the raw material side, do you guys have interest in pursuing incremental third-party sales of pellets since it looks like Europe's going to need a lot of those? And then on scrap specifically, how much do you think you can grow the closed-loop process with some of your larger customers on the auto side?

Michael, first on the sale of pellets. We produce pellets. We have spare capacity. We are treating North Shore in Minnesota as our swing producer. We are not planning to run North Shore at this time because we feel that that would not be the right thing to do. This being said, I sell pellets to third parties. I sell pellets to two companies. I'm not committed to sell beyond what we have contracted, but at this point, we still sell pellets to clients. So it's not like we already do that. We could be selling more. Yes, absolutely. Do you have a compelling reason to do that? No. I don't. It's a finite resource. I keep saying that. There's no point in selling just to beef up a quarter. I run this company for the long run. And shareholders, after, you know, eight years that I'm doing the same way, they are now understanding. So... I can make another buck, yes. Do I want to make another buck?

No.

So that's on pellets. The other question was about what? I'm sorry, I missed the other one.

Just closed-loop recycling on scrap, which you're auto-oes.

Yeah, closed-loop is, you know, bushling scrap, prime scrap, is extremely relevant for Cleveland Cliffs. We believe and we are proving that every day and showing to our clients every day that we can improve the environment, we can absolutely reduce emissions, and we can use a lot less carbon-intensive raw materials if we use more bushling scrap. So for the clients that understand that, and the vast majority understand this right away, it's easy. for us to gain control over that prime scrap, that bushling scrap that is generated inside their facilities. And remember, the biggest source of bushling scrap is automotive. We are by far the biggest supplier of automotive. So it's not a big stretch to realize that our conversations and our negotiations with our automotive clients go through scrap. And I don't believe that any car manufacturer in this country would deny access to Prime Scrap. So far, so good. We are growing our access to Prime Scrap. I said in my prepared remarks, when we acquired FPT, FPT was already the biggest leader in Prime Scrap with 15% market share. Now it's 20%. So it's good to know that my competition doesn't care about Prime Scrap. I heard this week that they are decreasing the use of prime scrap in their own furnaces. So I will continue to use even these arguments to continue to convince my clients to give me more and more prime scrap. So we'll continue to grow our prime scrap. We'll continue to grow the use of HBI in our glass furnaces, reduce coke rate, reduce emissions, do all the right things. One day, scope three emissions will be accounted for. And this day is coming, and we are ready. Others are not.

Understood. And then from a capital allocation perspective, it's been very clear that debt is the key priority near term. But could you also just remind us your thinking on building an EAF versus doing a blast furnace realign in the future?

Look, at this point, building an EAF is a possibility for the future. And we will analyze when the time is right. We are right now relining Cleveland No. 5 last month. So the process is ongoing. So we are fully committed to supply steel to the automotive industry. We are not a supplier of steel for the construction market. We are a supplier of steel for the automotive market. That's the biggest difference between us and our competitors. It's not EAS against vice presidents. It's the market that we serve. We are designed to supply automotive. Automotive has been not so great, but it's getting better. That's us. That's Cleveland Cliffs. So the future is bright for us. Competition is geared toward construction, and construction has been phenomenal. I'm not sure with inflation and stuff like that if – construction will be good in the near and mid-term future. So therefore, there's no incentive for me to do EAFs, to build an EAF and try to nibble in construction. I don't have that confidence that the EAF type of market that's basically construction would be a good one for us. We have enough scrap to produce wide-flange beams to produce rebar, that's easy. Melting scrap to produce rebar, so I walk in the park. The difficult thing in steel making is producing automotive steel to expose parts. That's Cleveland Cliffs, and the clients know.

Understood, and thanks for all the candor. Thank you.

Thank you. Our next question is coming from Emily Chang from Goldman Sachs. Her line is now live.

Good morning, Lorenzo and Celso, and thank you for taking my question. My first one is just around the contract renegotiation process. Are you able to provide some color around the contract renewals that were reset in April? Perhaps how did they compare relative to your previous contracts that were reset late last year and earlier this year in terms of both contract length and pricing to the extent that you can provide color there? And any early indication ahead of recontracting season over the summer as to what themes are particularly important, as you discussed, do globalization, shortening of supply chains.

Good morning, Emily. Thanks for the question. First of all, the April contracts were a big success. We were able to achieve everything that we are planning for, and we are very thankful that our clients that were at the other side of the negotiating table understood our proposals and our good intentions. So we're all good, and we are in partnership going into not just to help them navigate their own problems with the supply chains, but also to help them go into electric vehicles. That's the biggest challenge that they have. As far as the negotiations that will come in the summer toward the ones that we have to negotiate, on October 1st, This is something that for us now is an ongoing thing. We believe, based on what we have been in a daily basis discussing with these clients, it will be a no-brainer. It will be a no-problem type of situation. In other words, the same level of high success that we got in the April 1st contract, we believe we're going to get in the October 1st contract. With the addition that now the story and the proposition around Prime Scrap has been completely understood. Even now, even more now than the competitions telling out loud that they don't need Prime Scrap. We do, and we do in order to provide the closed loop to improve the environmental impact of our work together with them. You understand? And things will be fine.

Understood. That's very clear. And my second question is just around supply discipline. There's certainly been a lot of news from you and your peers as well around, you know, being more disciplined around not putting tons into the market for the sake of putting volume out. And you also had the island of Indiana Harbor for a couple months ago. Could you perhaps talk about the cost benefit you could potentially see here and perhaps how you think about the broader suite of domestic assets being sustainably run at much higher utilization rates going forward?

Yeah, there are two things in your question. The one is the supply discipline. The other one is Indiana Harbor 4. Indiana Harbor 4 being taken out of operations, was not to produce fewer tons it was because now we have a lot of scrap a lot of hbi we can produce the same amount of steel with the world fewer blast points which is a remarkable accomplishment in terms of emissions keep in mind pig iron has four and a half percent carbon with four and a half percent carbon you produce a certain amount of co2 Steel has 0.3% carbon, the steel, the bushling scrap that we load in our BOFs. So it's 10 times less or more than 10 times less carbon. So that's a lot less CO2 as well. So using more scrap in the BOF is the right thing as far as emissions. And it stretches our liquid pig iron and makes us able to shut down a blast pump. And for the remaining blast furnaces, because we're using a lot of HDI, that's pre-reduced iron inside the blast furnace, we use a lot less coke. And coke is carbon. And carbon produces CO2. So less coke or lower coke rates, lower levels of CO2. So that's the Indiana Harbor 4 thing. It was an environmental decision, and it was our way to produce fewer emissions with the same amount of steel with the use of less pig iron than we could save on costs by reducing one blast furnace. As far as supply discipline, we appreciate what pretty much everybody is doing in terms of not overproducing. I think it's the right thing, so I applaud my competition to at least say that they are doing what we are doing You check our volumes against our own volumes in previous quarters, you'll see that we really have supply discipline. Would you have been selling more tonnage? Absolutely. But we'd be selling more tonnage for lower prices. Look at our results. So tonnage is not the answer. The answer is profitability. The answer is cash flow. The answer is generating shareholder value. That's what we're doing at Cleveland Clips.

Very clear. Thanks, Lorenzo.

Thanks, Emily.

Thank you. Next question is coming from Seth Rosenfeld from BNP Parabyte. Your line is now live.

Hi. Good morning, Lorenzo and Celso. Thanks for taking our question today. My name is Seth. I have a follow-up, please, with regards to supply discipline and the shipment outlook. Obviously, Q1 shipment volumes are quite modest, down very sharply year over year. By how much do we expect shipment volumes to potentially recover in coming quarters? Is it reasonable to assume that by Q2 you could return to stable year-over-year run rates with respect to more gradual rebound in volume as you need to push better discipline to support higher prices? Start there, please.

Well, supporting higher prices for us is better negotiation of our contracts. That's what supports higher prices. So I believe, I really believe, Seth, that the way things are set right now, we have a chance that spot prices will fluctuate. It will go up, it will go down. But what I do know is that our contract prices will continue to go higher. And that's our business model. So we do not go based on our massive participation of automotive. And the way we are dealing, even with the clients outside of automotive, that we are going to be exposed to these fluctuations as much as we were in the past. What others will do, you'll see. Another thing that will be influential in terms of price, one is the shortage of pig iron throughout the entire world, which I tried to explain during my prepared remarks. And the other one is the fact that more capacity of EAFs in the United States will force more people to buy more pig iron, to buy more bushling scraps, to buy more scrap in general, and this will have an impact on the price of feedstock. And that's a positive for steel price. It's not a problem for us because we have our ironwork less fixed, so we're in good shape.

Yeah, and maybe, this is Celso, let me, Seth, if I may, maybe to add some numbers to what Lorenzo explained, just so you have them. You know, our volume, just to clarify on the volume point, our volume picked up from 3.4 million to 3.6 million in Q1. And looking into Q2, we do expect another increase in Q2 of at least another 100,000 to 200,000 here in Q2, particularly as automotive continues to recover. But as Lorenzo stated, we're still taking a disciplined approach on price. But just wanted to add some numbers around that 100,000 to 200,000 going into Q2 and potentially higher for Q3 and Q4.

Great. Thank you very much. On the significant investment in inventory values and working capital in Q1, can you give us a bit of color on how we should expect that to progress throughout the course of the year? Obviously, 2021 saw very meaningful investment over the 12 months. On your current forecast and your guidance, would you expect working capital to be a source of cash in 2022? I'll state that.

Yeah, sure, so just I guess to comment on Q1 first, the working capital build in Q1 was largely driven by inventory, and that's cost, not units. Going forward, receivables and payables will generally kind of trend with prices as you would expect, but we do expect that going forward we will see a meaningful release of working capital from the inventory standpoint. And that's baked into our guidance of free cash flow for the year.

Great. Thank you very much.

Thank you. Our next question today is coming from Carlos de Aldo from Morgan Stanley. Your line is now live.

Thank you very much. Good morning, Lorenzo and Celso and other members of the team. So the first question is, you spoke quite significantly about auto sector, but I wonder if you can give us more color on the other end markets that you also serve. Particularly distribution is an important share of your volumes. What are you seeing there? What are the conversations that you're having with them, given the sort of stocking that they went through in Q1 that impacted volumes? Is that changing? How are they reacting to the increase in prices that we have seen recently? And then a second question would be on your balance sheet. Clearly, significant free cash flow generation this quarter and improving throughout the year. You have been buying back your debt, the most expensive debt. Is there a level of net debt or net debt to EBITDA where you might pause and maybe start to consider more cash going to other uses of cash and return to shareholders?

Yeah, let me start from the second one. I'll address the other markets beyond automotive. Look, we are already at 0.8 leverage. So we are... very comfortable level, we will continue to pay down debt. So this number will continue to be reduced toward the end of the year. And at a certain point, we are going to seriously consider reinstituting a dividend. At this point, a dividend is not being instituted right now because we feel like we are getting more bang for the buck by paying down debt, as simple as that. Our goal of generating shareholder value is easily accomplished by continuing to pay down debt, as Celso explained so well during his prepared remarks. We'll continue to do that. And in a certain moment that I'm not going to commit right now, we are going to be reinstituting a dividend. We still have the buyback authorization in place, which will be used as an insurance policy. We are not trying to prioritize share buybacks over paying down debt. Pay down debt is the priority. And after that, after we get to a level that we are getting there. Well, we are not there yet. I want to pay more debt down before we institute a dividend. We will do what we were talking here in terms of the dividend. As far as the analogies on other markets, the OEMs outside of automotive, they are going through the same process as automotive. We treat them the same way. We want their scrap. We are getting their scrap. We are trying to work on fixed prices like automotive has. It's working well. We are making progress on that. they are starting to see the benefits of having a fixed price and not be worrying every day what's going to be published on CRU and if things are going up or down in Timbuktu and what impact we're going to have here. That's not the way it should work. It's benefiting very few, not the broad market. So we are going toward that. Everybody can make money in an environment that we have a stability in high prices. As far as service centers go, Some decide not to buy. And their strategy was waiting for lower prices. They are now confronting the tough reality that prices are not going down. And what we have been saying about scrap is materializing. It's starting to shrink. What we have always been concerned about in terms of metallics is happening. There's a shortage in the world. So the backdrop, the underlying conditions for higher prices is totally in place. So they're coming back and buying. So things are getting better in these other sectors. That's all I can tell you at this point.

All right. Fair enough. Thank you very much. Good call. Thank you.

Thank you. Our next question today is coming from Tim Natanis from Wolf Research. Your line is now live.

Hey, good morning, guys.

Good morning.

I wanted to ask a little bit more about the right inventory levels and then ask about your footprint. On inventory, obviously prices are higher, input costs are higher, but can you remind us how much tonnage you have in inventory and how to think about what that can look like, even if we have flat prices from here, how that unwinds and how that contributes to volumes?

Yeah, we are not growing inventories in Q1. The value of the inventory increased, but not the tonnage of inventory. So we are low the tons in Q1. We will continue to do that. We are no longer taking the forecast of our clients at face value. We are negotiating with them their own forecasts, and that has been good for us and good for them. So we are not adding tons on the ground that they are not taking. And aged inventory is moving faster because we are pushing them to take those aged tons, and the numbers show that. So we're not adding tons to inventory. As they continue to improve their performance, as we continue to fine-tune their inventory, forecast with our own input on what we are taking, the tendency is to continue to reduce inventories. But one more time, we did not increase inventories in Q1. The value of the inventory increased.

Gotcha. That's helpful. But you don't have a ton of data you can share with us on how much is there and how that should reduce over the year? No.

No. It's got to be lower. Lower is good. The trend is good. The number will just put you in a straight jacket and will make people comfortable. When they get to the number, they believe that they accomplished something. They didn't. They can always do better. That's why I don't have numbers.

Okay. Understood. Fair enough. The second question is just that since we saw an application come through for an electric arc furnace permit, I think in Middletown, I think you've said that that would be a long-term strategy, but just wanted a little more color around how you're thinking about your current footprint, if you're satisfied with it, and what it would take to think about converting to an EAF down the road?

I'll give a very objective answer. Let's see how many of my clients will be really doing what they are saying they are going to do in terms of electric vehicles. If they are very successful, all of them, and we need a lot more no oriented electrical steels to supply the engines of electric vehicles that electric car furniture will materialize. For now, it's just a permit. For now, it's just the preparation for something that might happen only if clients perform as they are saying that they are going to perform. Remember, we are the sole producers of electrical steels in the Americas, and we are seeing Every single car manufacturer is saying they're going in that direction. I don't believe that all of them will be successful. One of the things that I'm discussing with the CEOs that I'm talking to is to gauge how much they are real, how much they are really controlling what they are talking about. If this thing starts to materialize, we're going to be the first ones to jump in. But that's what the EAF is about.

So the EAF is for electrical steel, or is it for EVs?

Mainly to increase our ability to produce more electrical steels. We are sold out right now. We are starting to auction electrical steels. We are selling electrical steels, both grain-oriented and no-oriented, through auctions. So the ones that pay the highest price will take, because I don't have capacity for more.

And Russia was a big supplier of that, too. Okay. All right. Thank you.

I'm sorry?

Say it again? Russia is a big electrical steel supplier historically as well.

No, they're not. They're not. They're not. They're not. The biggest supplier of that type of steel that I'm talking about is South Korea. South Korea, among the friends, is the biggest enemy.

Hmm.

Okay. Thanks again. But that's a different ballgame. But Russia, on electrical steels, they're not really... that relevant because they are better with the lower quality stuff. Okay.

Thanks again.

Thank you.

Thank you. Our final question today is coming from Matthew Fields from Bank of America. Your line is now live.

Hey, Lorenzo. Hey, Sal. Good morning.

Morning, Matt.

I know you sort of outlined the change to your guidance with kind of three aspects about the forward curve, the new auto contract, and current sort of hot-rolled, cold-rolled spreads. But I just wanted to sort of drill down. The guidance is up on sales price 220 a ton from last quarter, but the hot-rolled curve is up, you know, well over 300 a ton. So, you know, not to sound – not meaning to be a brown-noser or anything, but is this baking some conservatism to your guide, or is there something else there that's sort of the mix of the contracts implying that, you know, the spot – the contracting is sort of dragging down your average realized price due to not participating in the spot market?

No, look, it's all blended. It's all blended on the curve, on the reality of the contracts that we have already renewed, the very concrete expectation on the contracts that we're about to renew. So it's all in. But, you know, at the end of the day, we are not sent back if that's your concern. We are being as realistic as we can, like I'm always am. I'm always very realistic. I always am very realistic about these things. I try to give you guys and ladies the best approach, the best view on how the business is taking care in our company. I think the takeaway of this conversation new price guidance is that, well, the curve changed and they disciplined it. In a disciplined way, they reassessed the curve. So that's one point to consider. Second, the contracts that were renewed are better than much better than the numbers that they had at home when they supplied the previous guidance. So that helped increase as well. If it changes, we'll change accordingly. But that's our best view at this point. I don't know if Celso has any points to add, but that's pretty much it.

Yeah, no, sure. I think the important thing to note, too, Matt, is the lagged impact of our pricing contracts. So Q1 benefited from contracts and the pricing that was happening in Q4. And, you know, going forward, prices suffered a little bit in Q1, and that's going to impact the results in Q2. But five months of actuals are already set in our new full-year guide. This conservative curve that we're using has pricing trending down a little bit, too, in the second half. So even though Q2 is going to have this negative impact from lower Q1 pricing, the $220 per ton increase, the way to think about it, is basically $3.5 billion in revenues in addition with very limited cost offsets. So that's kind of the best way to think about it.

Okay, great. That's very helpful. And then last question for me. I know you've spent a lot of time talking about global metallics sourcing, and your insights there are very valuable. On the other side of the coin for blast furnaces, Have you thought more about maybe vertically integrating more on the coal side with prices the way they are now? Does that change your thinking about being more of a vertically integrated, you know, having more sort of domestic supply chain in-house for coal?

Not really. Not really. Actually, because we are going the opposite direction, we continue to privilege The use of HBI, which is reduced through natural gas, that's a godsend for the United States. We have it. Europe doesn't have it. Japan doesn't have it. South Korea doesn't have it. Only Russia has. But Russia is Russia. So we are in a differentiated position as far as decarbonization here in the United States because we have natural gas. So because we have natural gas, my priority has been direct reduction. HBI is a great product. High quality metallics. High quality metallics. Only the ones that haven't got good HBI cannot appreciate the benefit of HBI. There are several types of HBI. Our HBI so far has been used at home at Cleveland Cliffs. It is phenomenal. It has been allowing us to reduce coke rates and increase the the productivity of the blast furnace while reducing CO2 emissions. That's just perfect. But if I'm reducing coke rate, going into coke would be going the wrong direction. So I believe in natural gas as an environmentally friendly reductant. And we are going to try hydrogen just to prove that the plant works with hydrogen. And then I'll go back to natural gas because there is no economical feasibility to use hydrogen at this point in time. But we are going in that direction, not toward coal.

Okay. Fair enough. Thanks very much, and good luck the rest of the year. Thanks, Matt. Appreciate it.

Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to management for any further or closing comments.

Thank you so much for being with us today. We look forward to speaking with you in three months. Keep up the work with us, and we believe that we'll continue to reward the good long shareholders of Cleveland. Thanks a lot, and have a great day. Bye now.

Thank you. That does conclude today's teleconference webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.