Cleveland-Cliffs Inc.

Good morning, ladies and gentlemen. My name is Kevin, and I am your conference facilitator today. I'd like to welcome everyone to Cleveland Cliffs' second 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 Protection's 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 within the SEC, which are available on the company website. Today's conference call is also available and being broadcast at clevelandcliffs.com. At the conclusion of the call, it will be archived on the website and available for replay. The company will also discuss results excluding certain special items. Reconciliation for Regulation G purposes can be found in the earnings release, which was published this morning. At this time, I'd like to introduce Celso Gonsalves, Executive Vice President and Chief Financial Officer.

Good morning, everyone. Our second quarter marked the continued execution of our key capital allocation objectives, including the largest free cash flow driven debt reduction in company history. During the quarter, we generated $633 million in free cash flow on $1.1 billion of adjusted EBITDA. This cash generation in Q2 is more than double what we generated in Q1, even after paying around $300 million of cash taxes in the second quarter. Consistent with our stated priorities, we used this cash to aggressively pay down debt and opportunistically buy back stock. During the quarter, we fully redeemed the remaining $607 million of our most expensive secured notes well in advance of its maturity and took advantage of volatility in the debt markets to attack other tranches of bonds in the open market, repurchasing another $307 million in principal outstanding notes at an average discount of 8% to par. These repurchases focused on our 2029 and 2031 guaranteed unsecured bonds, as well as our 2026 secured notes. On the revenue front, our volumes and selling prices were both up sequentially from Q1 to Q2, leading to a record quarterly sales revenue of $6.3 billion. Our Q2 steel selling price averaged $1,487 per net ton, representing an over $40 quarter over quarter increase. primarily driven by substantially higher slab prices sold to other steel mills and favorable April fixed price sales contract renewals, as well as continued robust spreads for cold rolled, coated, and plate products sold on an index basis. Looking ahead, in the third quarter, although pricing will likely be impacted by falling commodity index prices, lower spot prices will be heavily mitigated by our industry-leading use of fixed price contract rule arrangements. Our next round of fixed price contract resets will occur on October 1st, with roughly 1.7 million annualized tons up for renewal. Given our unique product offering and technical capabilities, we expect to see continued substantial increases in fixed contract prices in this upcoming renewal, even with the recent downtrend in commodity steel prices as a backdrop. From an operating standpoint, our Q2 adjusted EBITDA was down sequentially quarter over quarter, primarily due to the increased cost that we foreshadowed on our last earnings call. With over 200 million MMBTUs of annual consumption, Cleveland Cliffs is one of the largest direct consumers of natural gas in the U.S. Even though we're meaningfully hedged at all times, we still experienced a substantial impact from elevated natural gas prices throughout the entire quarter. Other rising input costs included electricity, scrap and alloys, as well as higher repair and maintenance spending. Cost increase was also driven by higher idle costs, up nearly $200 million from Q1, which was driven in large part by the expanded scope of the outage at our Cleveland Works facility. Along with the reline of blast furnace number five in Cleveland, which is generally only done once every 20 years, we took advantage of the downtime to perform other important repairs and maintenance in related areas of Cleveland Works, including the wastewater treatment plant and the on-site powerhouse. With the additional work being done, we now plan to have Cleveland Works back at full capacity in August, aligning with improved automotive steel demand. With the bulk of the work behind us, we expect our excess and idle costs to decline meaningfully in the third quarter. In terms of working capital, while our gross inventory values increased as a result of higher costs during Q2, our total steel inventory volumes were actually reduced by 230,000 tons in the second quarter and has declined about 400,000 tons so far this year. As costs for several of our primary inputs have declined recently since the end of Q2, and with Cleveland Works back in full operation in Q3, we expect working capital to be a meaningful source of cash in the second half of the year. Even with the current lower price of commodity grade steel in the market, we expect to continue generating strong free cash flow for the remainder of the year. There are several factors that will continue to support our cash generation going forward under the current environment. One, the fixed price nature of nearly half of our order book will keep our average selling price elevated despite lower spot prices. Two, fixed price contract resets occurring on October 1st are going up, not down. Three, Lower operating repair and maintenance and idle costs going forward. Four, the expected release of working capital that we have built up over the past 18 months. And five, lower cap-back spending as we have no major capital projects on the horizon for the foreseeable future. This will all allow for continued robust free cash flow generation, opportunistic share buybacks, and aggressive debt reductions. With net debt well below one time in our last 12 months adjusted EBITDA, we continue to be focused on maintaining conservative leverage levels going forward. With that, I'll now turn the call over to our CEO, Lorenzo Goncalves.

Thank you, Celso, and good morning, everyone. Cleveland Leafs became a steel company on March 13, 2020, the day we completed our acquisition of AK Steel. Two of our favorite things about AK Steel were its industry-leading weighting toward the automotive end market and its leading capabilities in research and development. Automotive not only consumes a lot of highly customized flat-robed steel, but also demands strict specifications and a long approval process to qualify materials. there is no such a thing as commodity steel in automotive. That's true in Europe, in Japan, in South Korea, and obviously here in the United States as well. That being said, the supplier base of steel to automotive clients everywhere in the entire world is limited to few steel companies really able to support all the specs the car manufacturers need, usually one per country or geographic region. That background aside, within a week of the completion of our AK steel acquisition in March of 2020, the entire automotive production ecosystem shut down for the first time ever in its century-plus long history. After a three-month-long interruption, automotive production began to resume but not nearly to the levels we had seen for the prior decade, despite a very strong demand for cars associated with the restrictions imposed by COVID-19. While the automotive sector was slowly coming back to life, we acquired ArcelorMittal USA, the other major steel player in the automotive space, making Cleveland Cliffs, the largest supplier of automotive steel in North America by a very wide margin. Next, a wave of supply chain issues began to hit the sector, with widespread shortage of microchips being the most visible problem. That reversed the initial pace of recovery and has hampered automotive production to this day. In the six years leading up to 2020, North American light vehicle production averaged more than 17 million units per year. Comparably, in the past two years, the industry has only produced 13 million units per year, a 24% decline at a time when consumers' demand for cars was growing. During this time period, other still-consuming markets have grown, most notably construction, and we have benefited from that, as evidenced by our record earnings results in 2021. That said, our mini-milk peers are much more leveraged to the construction market than we are, and they have benefited from that more than we have, particularly in their downstream businesses. This is now about to change. As we read through the current economic conditions in the country, which include 40-year high inflation levels and rising interest rates, yet consistently low unemployment, we have all the ingredients for the dynamics of the past two years to shift in our favor. It has been over two years of construction, outpacing automotive. But that's no longer the case. The North American automotive industry could have produced 8 to 10 million more vehicles than they actually did over the past two years. And as a result, a relentlessly growing pent-up demand for cars, trucks, and SUVs has developed. The best indicator of this trend is the main high used car price index, which has nearly doubled in that time period and remains near all-time highs. On top of that, the average age of a light vehicle on the road in the U.S. has grown to 12.2 years, the highest it has ever been. Also, very importantly, the unemployment rate has remained low at 3.6%, about the lowest it has been in 53 years. This means that individuals not only have the income to buy a new car, but in most cases, they also need that car to commute to work. A car is not a house. and a loan to buy a car is less sensitive to interest rates than that of a mortgage. If you have a paycheck, you can buy or lease a car and make the monthly payments. Unless the fight against inflation leads into high levels of unemployment, every car that can be produced over the next several years has a buyer. It's just a matter of having the materials needed to produce the cars. The most prevalent material in a car is steel, which makes up roughly half the weight of the vehicle. Over the past two years, we at Cleveland Cliffs have made the investments necessary to meet this coming onslaught of demand. And we are ready with the most advanced technical capabilities the industry can offer, including a brand new black furnace at our Cleveland Works operation. All of our automotive customers have indicated to us that their supply chain issues are easing, and we are seeing tangible proof of this trough on our own channel checks. The production pace of the first half of this year has been nowhere near its full potential, let alone the prior decade average. Starting the second half of 2022, we expect to get more automotive volume, and with more volume and base load for our mills, our costs should naturally improve. The incoming volume improvement comes from both internal combustion engine vehicles and electric vehicles. We are not only the largest supplier of steel to the automotive sector, but we're also the largest supplier of each one of the individual car manufacturers currently transitioning from ICE vehicles to EVs. Higher fuel prices have only increased the consumer's appetite for EVs. If you as an investor believes in this EV transition, Cleveland Cliffs is who you need to be with. That's not just because of the long-standing quality products we have historically supplied for ICE vehicles, but also because our broad offerings of advanced high strength steels is the perfect solution for battery-powered EVs. In addition, We are the only domestic producer of non-oriented electric steel in the United States, where roughly 150 pounds are required per vehicle for using the motor. Because of the growing demand of these steels, we are investing $30 billion in our Zanesville, Ohio facility, a small investment, to allow us to add another 70,000 tons of production of non-oriented electrical steels, NOS, effectively doubling our NOS capacity without impacting our industry-leading capability on gross grain-oriented electrical steels. With that, we will also be generating another 100 good paying middle-class union jobs at Zanesville when this addition comes online in 2023. Going forward, these are the types of low-dollar, high-impact capital projects we will be focused on. That's a clear differentiation between Cleveland Cliffs and other companies in our space in their multi-year commitments to massive CapEx Each one of these other companies has announced several billions of dollars to build new mills, steel mills and even aluminum mills. Cleveland Cliffs did not and will not announce any of these mega investments. When we acquired ArcelorMittal USA, and based on our experience immediately after we acquired AK Steel, we knew we would have to spend significant money to bring in the assets to our own higher standards. That has been done and done very well. By now, we have all the equipment and technology in place to meet the needs of our most demanding customers in automotive and other sectors. Actually, our capital spending in 2023 should decline when compared to 2022. Our last big capital project was the Cleveland Works revamp, and we do not have any other capital project of this magnitude until at least 2025. Outside of automotive, it's clear that the stocking activity is underway at service centers. and they simply will let their inventories go very low. Other still-consuming sectors have peaked for now, but automotive has not. A significant 45% of our sales are on fixed prices, and those prices are not directly correlated with the latest market prices. We have the leading market share in automotive, not because of price, but rather because of our technical capabilities and ability to deliver on time. This is why we expect more price increases in our upcoming renewal cycle, where we can get closer to a proper value for the full service and solution package we provide the automotive industry. These fixed prices will keep our cash flow strong through the rest of the year. along with the release of at least a portion of the $2 billion in working capital we have built over the past 18 months. This working capital release should come not just from lower input costs, but also from our own proactive management of raw materials. For example, we are now extending the ongoing idle at our North Shore swing facility to at least April of next year. With the increased use of scrap company-wide in our steelmaking operations made possible by the acquisition of FPT last year, the pellets from North Shore are not needed at this time. Rather than deplete this finite resource for the benefit of the MESABI Trust and its so-called unit holders, We will keep North Shore idle until we decide otherwise. On a final note, we have begun our union negotiations with the United Steelworkers to renew our current labor agreement. The agreement expires September 1st, and it covers approximately half of our company-wide workforce. We have always valued the relationship with our unions. It made it clear that we appreciate working together with them. Differently from others in our industry, we remain committed to our existing plant sites and to our unionized workforce. With all that, we expect the negotiation process to result in a fair and equitable agreement for both parties. Cleveland Cliffs is about more than just making steel. Our mission is deeper, to revitalize manufacturing in the United States, and through that, support and enable a vibrant American middle class. We are not a steel company of the past. We are the present and the future of our industry. And we have the right people, equipment, and capabilities to prove that out. I will now turn it back to the operator for Q&A.