Cleveland-Cliffs Inc.

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

Thank you, Maria, and thanks to everyone for joining us this morning. Before going through our Q3 results, let me start by highlighting the $1.8 billion improvement to our balance sheet that was outlined in our earnings release this morning. During the quarter, we signed two new labor agreements covering approximately 14,000 USW-represented employees, encompassing more than half of our workforce. These agreements also cover benefits for over 22,000 retirees. The ratification of these labor agreements triggered a re-measurement for the associated pension and OPEB plans, essentially requiring a refresh to all assumptions that go into calculating the value of those liabilities, including primarily interest rates, asset returns, and most importantly, the premiums that we pay for retiree health care expenses. With interest rates higher this year and asset returns lower, those two first factors effectively offset each other. But the third factor, the updated healthcare premiums, resulted in a significant reduction to our overall liabilities. Using our size and scale to our advantage, we were able to proactively renegotiate significantly lower premiums with our health insurance providers at much lower costs. All in all, these updates reduce our net pension and OPEB liabilities on our books by $1.8 billion relative to the end of 2021, a 63% reduction. Our pro forma net liability for pension and OPEB is now only $1.1 billion compared to $2.9 billion at the end of 2021 and $4.2 billion at the end of 2020 after we acquired ArcelorMittal USA. In less than two years, we have reduced this liability by over $3 billion. As you may recall, the pension and OPEB liabilities we assumed were by far the largest piece of the enterprise value of the AMUSA acquisition, and now most of those liabilities have moved over to equity on our balance sheet. Going forward, these changes will also reduce our OPEB cash funding obligations by more than $100 million per year, cutting this use of cash by more than half. Since the larger of the two labor agreements was not ratified until October 12th, meaning after the end of Q3, the full impact of this change was not reflected on the actual 930 balance sheet. That's why we provided the pro forma calculation in our press release this morning. Furthermore, the impact of these renegotiated healthcare premiums is also applicable to other plans that will not be remeasured until December 31st. As a result, When we report the Q4 and year-end 2022 financials, we expect these liabilities to be even lower on the 1231 balance sheet. Also, to be clear, the benefit we have gotten just comes from reduced premiums from healthcare providers and does not reflect any reduced benefits for our retirees. This was truly a win-win for both the company and the union, and we thank the USW for their partnership to make it happen. Now, moving on to our results. In Q3, we generated $5.7 billion of revenues, $452 million of adjusted EBITDA, and $288 million of free cash flow. On the revenue front, steel sales volumes of 3.6 million net tons held roughly steady with the prior two quarters, as lower demand from service centers and distributors was offset by higher automotive volumes. Very importantly, Q3 of 2022 was our best quarter to the automotive market since the semiconductor shortage began, but is still well below what we would consider normalized compared with the period from 2014 to 2019. Going forward, in Q4, we expect total volumes to increase as a result of further improved automotive, service center, and slab demand. On the pricing side, Our sequentially lower average selling price was driven by the index-linked portion of our business, with declines in the hot-rolled, cold-rolled, and slab indices. We also had declines in EBITDA for our third-party pellet and scrap businesses as a result of lower pricing. Looking into the fourth quarter, the improvements we achieved on the contractual fixed prices that reset in October will help to mitigate the lagged impact of continued falling index prices. but a product mix heavier in slabs and HRC will be a negative factor on our realized price. Our adjusted EBITDA performance was also impacted by higher reported operating costs, which on a unit basis trended upward in Q3 due to the lagged effects of higher cost inventory that we foreshadowed on our previous call. Compared to 2021, our 2022 costs have been up meaningfully due to inflationary pressures on input and energy costs, as well as lower production volume and higher repair and maintenance spending. From a cash cost standpoint, though, these costs peaked in Q2, but the impact on our results was not fully flushed through EBITDA until Q3, a dynamic that can be seen when comparing the Q3 and Q2 cash flow statements. With all big repairs behind us, our repair and maintenance expenses have begun to decline rapidly here in Q4. Going forward, increased production volumes will also further dilute our fixed costs. From a free cash flow standpoint, we generated almost $300 million of free cash flow in Q3, largely driven by a significant amount of working capital released during the quarter. Price declines combined with lower cost of inventory should lead to continued release of working capital in Q4 and into next year, supporting strong free cash flow generation and partially offsetting the cash flow impact of declining EBITDA. Also, our capital expenditures should decline in Q4 and even further into next year, where we expect total capex to be between $700 and $800 million in 2023. We also expect cash taxes to be negligible for the rest of this year, with a substantial refund coming in early 2023. And, of course, pension and OPEB cash needs will decline substantially, as discussed earlier. Consistent with our previously stated capital allocation priorities, we continue to use the majority of our free cash flow to pay down debt. During Q3, we reduced net debt by $200 million and on a year-to-date basis through today, we have reduced our net debt by $1 billion, bringing our current net debt level below where it was before we completed the acquisition of Arsenal Middle USA. Our capital allocation priority remains to continue reducing our overall debt, and beyond that, we still have around $800 million remaining under our current share repurchase authorization. With almost $2.5 billion of liquidity, a much cleaner balance sheet with meaningfully reduced pension and OPEB obligations, lower operating costs going forward, less capex next year, minimal cash taxes for the remainder of this year, cash coming in from working capital, and no major bond maturities until 2026, we are in great shape to navigate any potential recessionary environment. Very importantly, our automotive shipment levels in Q3 have indicated that our largest end market has been counter-cyclical due to the massive backlog from lower production over the past two years. The strength of our automotive franchise with our unique product offering and ability to lock in fixed price contracts will reduce volatility, especially now that our major maintenance, repair, and capital expenditures are behind us and costs begin to trend meaningfully lower. I will now turn the call over to our CEO, Lourenço Gonçalves.

Thank you, Celso, and good morning, everyone. Throughout my several years with Cliffs, our company has transformed and adapted to several different challenges, but two elements have remained constant throughout. Our commitment and full support to manufacturing in the United States is one, and the importance we place on our people is the other. This is not just a speech. We have backed this up with actions. Our latest labor agreement with our USW-represented workforce is the most recent demonstration of that. The deal provides increased wages, offers better insurance, gives improved pension benefits, and enhances vacation and holiday provisions. We also agreed to continue to invest in our facilities, at $4 billion over four years, combining CAPEX and OPEX, which is consistent with typical spending on these types of investments for our footprint. We also kept the retiree benefits strong and were able to negotiate lower rates across the board, as Celso has already explained it. Together with our union partners, we have integrated Four stand-alone companies, in a span of just two years, overcame a difficult pandemic, completed the construction of a state-of-the-art direct reduction plant, invested to keep our meals at an automotive level standard, paid down a significant amount of debt, and drastically reduced our pension and OPEB liabilities. which we assumed two years ago in order to make the entire transformation possible. Our third quarter results were unique in that they reflect abnormally elevated costs, the largest portion of which was incurred in the second quarter, but did not flow all the way through until Q3. We have been pre-opening since day one that the set of assets we acquired particularly those from AM USA, were a bit underinvested and at some point would need some catch-up repair and maintenance. We got great value on these assets, on these two acquisitions, and in fact, over the past two years, we have already paid ourselves back with profits from the business, even with the persistent underperformance of the automotive industry during that time frame. That said, embedded in the low acquisition price was an implied catch-up repair and maintenance cost. That is now behind us. As a major supplier to the automotive sector, the quality standards for our equipment must be pristine. We ramped up repairs beginning in the fourth quarter of last year, reinvesting a portion of our record profits earned throughout the year. It was around that time that we were signing new fixed contracts with our automotive customers at higher prices. So it was even more important that our equipment capability was taken care of. As our spending picked up, both CAPEX and OPEX, in many cases we found more work to do than we initially anticipated. The best example of this was the origin of our Cleveland Works facility. which lasted from March through August. The original scope of the blasphemous reliant expanded to effectively include a rebuild of the wastewater treatment plant and the powerhouse located on site, as well as several other smaller jobs. Fast forward to the present moment. We are now at the point where the major maintenance cycle has been concluded. Due to the work we have done, our equipment is in great shape and we are primed to meet the unique needs of our customers, particularly in automotive. The most common feedback we consistently hear from these automotive customers is about our perfect steel quality and our ability to keep them in steel during a time that the entire automotive sector has been deeply affected by underperformance from several suppliers throughout their supply chain. Not the case with what they buy from Cleveland Cliffs. And these clients know that. Throughout this year, and particularly during the big repairs, we have seen the negative impact of lower production volume, reducing our ability to dilute our fixed costs. In the first nine months of 2021, we sold 12.5 million tons of finished steel, compared to 10.9 million tons of finished steel so far this year. That being said, automotive steel demand has started to improve in Q3, and we expect our volumes to increase further in Q4. That will result in improved costs going forward. The remaining drivers of higher costs, including increases in natural gas, electricity, and alloys, are not unique to us. And we have also seen some relief in these areas. All in, based on our inventory status and current outlook for input costs, we expect our reported unit cost in Q4 to fall at least $80 per ton, compared to Q3. with further reductions into the first half of 2023, even after factoring the increased wages in the USW labor agreements that were recently ratified. As for demand, we were encouraged by the 100,000 tons volume improvement from our automotive customers from Q2 to Q3, and while they're still not back to normalized levels, the worst impact of the cheap shortage seems to be behind us. In our view, automotive is now in position to carry the market. Despite the Fed's best efforts to damage the job market, unemployment at 3.5% is at a 50-year low, and that means people both need cars to go to work and can't qualify to buy cars because they have jobs and paychecks. Inventory levels at car dealers remain so remarkably low that even if there is a consumer slowdown at the end user level, there will still be a lag acting as a buffer until a slowdown in the production of cars, SUVs, and trucks eventually falls. The current average age of light vehicles on the road of over 12 years is the highest on record. Also, for those of you that have rented a car in the past year, there is clear evidence that fleet inventories need to be replenished as well, a meaningful 20% of the light vehicle market with a healthy backlog. Our October fixed contract renewals were another success, and the weighted average of the price increase we achieved would represent the second best October renewal cycle in our legacy company's history, only behind last year. As we come to the table for our renewal cycle in January, our customers are being reminded that what we offer them cannot be compared to a CRU spot price. The difference between what makes up a CRU price and how we do business in automotive is night and day. We manage our production schedules based on the auto OEM's needs. We have to reserve our available capacity to align with their production forecast and we hold their inventory if they have production issues, which, by the way, happens a lot. We have a fully dedicated customer service group that manages this complicated, just-in-time inventory system to the point that our customers don't even have to think about steel. It's there when they need, automatic. And it is all before we even considered the constant technical support, research and development, and of course quality of materials that we provide In some, in the United States, automotive steel means clips. Now that they have microchips, we want each one of our automotive clients to be successful in 2023. They have a unique opportunity in 2023 as automotive may be the only sector with pent-up demand to be taken care of. The last thing they need now is not having access to all the specks of steel they need to produce cars. That can be a lot more devastating than not having microchips. On the distributor and service center portion of the business, customers have been following the typical herd mentality and buying hand-to-mouth in recent months. The strengthening of the dollar has not helped the price either, but the economics of overseas imports no longer make sense, supporting demand from domestic suppliers as we close out the year. Our August price increase announcement brought some buyers off the sidelines, and we secured additional Q4 orders as a result. As long as underlying demand stays this way in the coming quarters, a restock will need to happen. Our grain-oriented and non-oriented electrical steels continue to see very strong demand, and we anticipate record price increase in the fixed price for those products. We have an infrastructure bill that should finally start to drive steel demand in the next year. We expect automotive taking up more steel share, and we have manufacturing being reshort. When this thing turns around, it will turn around sharply. With an ongoing war, multi-decade highs in inflation, rapidly rising interest rates, and a focus on mitigating climate change, we are living in a difficult time in the world in transition. But we have already proven that Cleveland Cliffs is capable of overcoming difficulties. The key to that is having the right people. People is the foundation of ESG. You cannot pretend to care about the environment if you neglect your people. And Cleveland Cliffs will never do that. Several companies, the vast majority actually, fight their ESG challenges with MOUs, letters of intent, and press releases, while Cleveland Cliffs, and very few others, take concrete action. We built a direct reduction plant before it was trendy. We adopt HBI using blast furnaces, and we will remain on the cutting edge. Next for us will be the use of hydrogen, first in our direct reduction plant, and then in our blast furnaces. Blast furnaces have always been on the forefront of technological innovation in ironmaking and steelmaking, and our current utilization of HBI as part of the burden in our blast furnaces is further confirmation of that. The future use of hydrogen and carbon capture will be the next examples of American blast furnaces in the vanguard of CO2 emissions reduction. Other companies in the United States and abroad are building new plants. And new plants add CO2 emissions, regardless of the process utilized. Cleveland Cliffs is not adding capacity and will not add capacity. we are reducing emissions within our existing historic capacity. And that's the ultimate goal. After we completed two years ago a transformation of once in a generation consolidation of the American steel industry, some outsiders were fixated on the resulting pension and OPEB liabilities. Fast forward in less than two years, Those liabilities have been made irrelevant. With our major repair and maintenance impacts behind us, no ongoing or planned new construction project, an improving automotive sector, and most importantly, labor peace throughout our organization, we are ready to continue to execute like we have been doing for eight years. With that, I will turn it over to Maria for Q&A.