Q3 2012 Mechel OAO Earnings Conference Call

Dec 12, 2012 AM EST
MTLR.MZ - Mechel PAO
Q3 2012 Mechel OAO Earnings Conference Call
Dec 12, 2012 / 02:00PM GMT 

Corporate Participants
   *  Vladislav Zlenko
      Mechel OAO - Director of IR
   *  Evgeny Mikhel
      Mechel OAO - CEO
   *  Stanislav Ploshchenko
      Mechel OAO - CFO
   *  Oleg Korzhov
      Mechel OAO - SVP Economics & Management

Conference Call Participants
   *  Anton Rumanse
      Sberbank - Analyst
   *  Dan Yakub
      Citi - Analyst
   *  Dmitry Glushakov
      Credit Suisse - Analyst
   *  Alexander Sichov
      Rosbank - Analyst
   *  George Buzhenitsa
      Deutsche Bank - Analyst
   *  Vasily Kuligin
      Renaissance Capital - Analyst
   *  Maria Rachenka
      BCS Financial Group - Analyst

Operator   [1]
 Welcome to the Mechel report nine months 2012 financial results conference call. For the duration of the call, you will be on listen only, and at the end of the call, you will have the opportunity to ask questions. (Operator Instructions).

 I'll now hand over to your host, Vladislav Zlenko, to begin. Please go ahead, sir.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [2]
 Thank you, and good day, everyone. We'd like to welcome you to Mechel's conference call to discuss our nine months 2012 results, which were reported today.

 With us from management today are Mr. Evgeny Mikhel, Mechel's CEO; Mr. Stanislav Ploshchenko, Mechel's CFO; and Mr. Oleg Korzhov, Mechel's Senior Vice President for Economics and Management. After management has made their formal remarks, we will take your questions to the presentation team.

 Please note that, during this call, management will make forward-looking statements, some of which may have been made in the press release. Some of the information on this conference call may contain projections or other forward-looking statements regarding future events, or the future financial performance of Mechel, as defined in the safe harbor provisions of the US Private Securities Litigation Reform Act of 1995.

 We should caution you that these statements are only predictions, and that actual events or results may differ materially. We do not intend to update these statements. We refer you to the documents Mechel files from time to time with the US Securities and Exchange Commission, which contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

 In addition, we will be using non-GAAP financial measures, including EBITDA, in our discussion today. Reconciliations of non-GAAP financial measures to the most directly comparable US GAAP financial measures are contained in the earnings press release, which is available on our website at www.mechel.com.

 At this point, I'd like to turn the call over to Mechel's CEO. Mr. Mikhel, please go ahead.

 Evgeny Mikhel,  Mechel OAO - CEO   [3]
 (interpreted) Good afternoon and good morning, ladies and gentlemen. We are glad to welcome you to the conference call for the Company's financial results for nine months 2012.

 The third quarter proved quite successful for the Company, despite the fact that negative trends, which could be seen at Mechel's key markets since early this year, developed further. For instance, retracement of metallurgical core markets persisted, while a fairly stable situation in the domestic markets for steel products was aggravated by a further decrease of prices at key export destinations; primarily Europe.

 Nevertheless, thanks to our successful measures on cutting costs, and correcting our sales policies, where appropriate, to market realities, and optimizing our cash flow, in the third quarter, we practically managed to maintain consolidated EBITDA at the level of the second quarter, and improve it for the Mining division.

 On the whole, the results of nine months of 2012 are as follows. Mechel OAO's consolidated revenue came up to approximately $8.8 billion, EBITDA was $1.2 billion, and net income was $173 million.

 As I have noted before, in the third quarter, our key Mining division was able to improve its operational income. As prices for coal products and iron ore concentrate drove both on domestic and international markets, we focused our efforts on operational costs. As a result, in the third quarter we managed to cut Mining costs at Yakutugol by 13%, and by 7% at Southern Kuzbass.

 A sudden shift of coking coal sales from China to more profitable markets of Japan and South Korea played its part too. The share of sales to China in our total supply structure went down by 6%, while sales to Japan and South Korea went up by 8% and 3% accordingly.

 On the back of a continuing decrease in steel product prices on European markets, in the third quarter we focused on selling our Steel division's products specifically on the domestic market, where business activity and demand remained stable throughout this period.

 As a result, the share of the domestic market's steel products grew in the third quarter from 53% to 60%, which helped the Steel division to maintain a good EBITDA level, despite lower prices and sales.

 I would like to say a few words about the foundation that we established during this period for the Group's further development.

 As I have earlier announced, Mechel OAO's Board of Directors approved the Company's new strategy, as prepared by its management, focusing on our Mining business, which is the most profitable and has indisputable competitive advantages, both on the domestic and international markets.

 In accordance with this strategy, we decided to completely abandon development of our Ferroalloy and Power segments as independent business divisions, as well as to significantly reduce our steelmaking presence, limiting ourselves to the most profitable market segments and full-cycle production integrated into our mining business.

 In order to implement this strategy, we have by now largely completed preparation of all non-core assets for divestment, which allows us to say, with some confidence, that restructuring of our business will be, to a large degree, complete in the first half of the next year.

 Apart from that, we are working on minimizing the impact our loss-making enterprises negative financial results have on the Group's reports, up to completely halting them with possible shutdown to follow.

 Optimizing our production facilities, closing down loss-making enterprises, and focusing on our key markets, allowed us to increase our EBITDA margin up to 14% in the third quarter, despite negative market trends. The fact that the third quarter demonstrated the best quarter operational cash flow since the second quarter of 2009 is the best testimony to the success of the decisions we made.

 Completing our business restructuring will enable us to focus on our Mining division and free significant resources for its accelerated development. This primarily concerns the Elga project where we won new successes during the period; for example, launching a seasonal washing plant in September.

 The washing plant is currently being winterized, so that next year it could function all year round. It will bring the washing plant's annual capacity up to 3 million tonnes.

 As mining at Elga Coal Complex will reach industrial volume levels next year, we began active work on ensuring guaranteed long-term off-take of Elga coals. In September, we signed a long-term cooperation agreement with RAO Energy System of East OAO, which provides for a gradual increase in coal supplies up to a total of 60 million tonnes over 15 years.

 The Elga project's further development includes construction of new washing facilities with an annual output of over 8 million tonnes of finished product in 2016, and over 21 million tonnes in 2021, most of which will be bound for export. Together with Yakutugol's current coal production, and increased production of coking coals and PCI at Southern Kuzbass, it will mean over 43 million tonnes of finished product in less than nine years.

 It is obvious that, with such an output of highly profitable products, it is vitally important to have uninterrupted access to all key markets, which can be guaranteed only by controlling transport logistics, including [wagon cars] and ports whose lack is acutely felt even now with the current level of coal exports from the Russian Federation.

 It is also important that all major coal terminals are controlled by our direct competitors, which makes efficient use of third-party capacities practically impossible. As a result, we endure significant costs due to lack of an efficient market of port facilities.

 In 2012, our coal export by sea will total 9.5 million tonnes, with only 5.5 million tonnes handled by our own ports. Export to the Asia Pacific will be 3.3 million tonnes, with Posyet Port handling only 4.6 million tonnes, which is to say 70%.

 To illustrate our problem, I can tell you that we are occasionally forced to use Baltic ports to export Kuzbass coals to Southeast Asia. In order to improve the situation, we are upgrading the Posyet Port, which will bring its transshipment capacity up to 9 million tonnes in two years. However, considering our Elga capacities, this will obviously not be enough.

 So as the second stage of resolving this issue, we plan to construct our own terminal in the Muchka Bay, next to the existing Vanino Port. However, this is a Greenfield-type project and is still under preparation. Implementing this project will take three to five years and cost up to RUB20 billion, as well as it will carry all risks of a Greenfield in Russia.

 Having weighed all these factors and risks that arise in the nearest future for [cash in] our stockpiles due to poor deficit in the Far East, we decided to head a consortium of Russian and foreign companies that offer the top price in the tender for prioritization of the State-held stock in the existing Vanino sea port.

 If the tender's results are approved by the Government, this will be the most important acquisition for our Company since buying Yakutugol in 2007. The factors are as follows.

 First, the port's strategic location; Port Vanino has access both to the Trans-Siberian Railway and the Baikal-Amur Mainline, and actually is the Mainline's final destination, which means that the port is one of cargo-flow regulators of that railway, with an obvious priority status.

 This is of enormous importance, considering the sweeping problem of the Russian railroad system's limited carrying capacity in the east direction. Besides, offloading our coals through Vanino will cut the delivery distance from Southern Kuzbass and Yakutugol by some 500 kilometers, saving us $3 per tonne in railway tariffs.

 The second factor is that the port's current size and development potential; the berths [and trains] in the port are four times longer than those at Posyet, while its storage space is six times wider. The port can handle Panamax-size vessels at berth and Capesize at anchorage, while Posyet will be able to handle Panamaxes only after reconstruction and not earlier than in a year.

 Posyet cannot handle Capesize vessels. With minimal investment into optimizing the port's infrastructure, we plan to bring Vanino's transshipments' capacity up to 10 million tonnes in 2013, and up to 15 million tonnes to 20 million tonnes in three to five years.

 The ability to ship coal aboard supersized ships will not only save us freight costs, but also significantly expand our supply geography, opening markets such as India, even with current global prices.

 At the same time, owning two ports in the Far East with such storage space gives us unique versatility in planning coal deliveries of entire coal grade range at the same time, which greatly expands our offer assortment. Moreover, control over two alternative export routes protects our uninterrupted supply.

 The fourth factor is that, with the existing Vanino port, we can greatly save on capital investment by postponing our project of constructing our own terminal in the Muchka Bay for an indefinite period of time.

 I'd like to highlight that, considering Mechel's high debt leverage, ensuring the neutrality of this deal regarding the Group's current loan portfolio and the pressure on the Group's cash flow was our primary task when deciding to take part in the auction.

 We managed to reach an agreement with the investor consortium, which will provide non-debt funding for this deal on condition of our administering the port. So if the Company is acknowledged winner of this auction, this acquisition will have practically no impact on the Group's existing debt leverage.

 All decisions made by the Company's management, including those aimed at optimizing our business structure and business, will, in our view, give significant positive feedback in the nearest future which will enable Mechel to go through the difficult crisis period caused by the global recession with confidence to lay the foundation for the Company's quota development in the future.

 Now I'd like to give the floor to our Chief Financial Officer, Stanislav Ploshchenko, who will give details on the financial results of all of our business segments. Thank you for your attention.

 Stanislav Ploshchenko,  Mechel OAO - CFO   [4]
 Good morning and good evening, ladies and gentlemen. We will begin the review with the Mining segment. The difficult economic headwinds faced by the global mining industry in general, and our Mining division in particular, strengthened in the third quarter. Average FCA pricing for coking coal, anthracite and PCI and iron ore were down by 6%, 17% and 22%, respectively. Until recently, pricing on PCI and iron ore had held up relatively better than coking coal prices.

 With the drop in iron ore prices experienced during the third quarter, the overall price decline since mid 2011 peaks, reached parity with the decline in coking coal prices. Anthracite and PCI prices, even with the steep reduction which we saw in Q3, have still, with a 34% reduction from 2011 peak, held up relatively better than prices for other steel-related inputs.

 Coke FCA prices were up by just 3% quarter on quarter. Peak to trough, they were down roughly in line with the price declines in feedstock. Thermal coal prices, including middlings, on the other hand ticked 1% up, due to the increase of export share tonnage-wise in sales from 18% in Q2 to 26% in Q3, as prices on export markets are traditionally higher than on the domestic one. Generally, they have held up much better than steel-related feedstock prices and are, in fact, down by just 14% from their peak in the first quarter of 2011.

 The volumes dynamics were also different. With softening of the seaborne market and decrease in realized price, we cut production in North America and decreased sales to China from Yakutugol, which is all spot, partly compensating that with higher sales to Japan and South Korea, all that resulting in a 10% reduction in coking coal physical sales volumes.

 Sales of other metallurgical coals remained flat as lower demand in Europe was offset by higher sales to Asia, while realization of thermal coal benefiting from a higher pricing and the fact that Russian power utilities are restocking for the winter season, shot up 16%.

 Sales of iron ore also grew by 9%, mostly on behalf of the domestic market. That compensated the negative dynamics in coking coal sales and negative met coal price dynamics to a certain extent, but still led to a 12% drop in the overall third-party revenue in our Mining segment to $777 million in the reported period.

 Intra-Group sales decreased overall by 17% to $172 million, with a double increase in iron ore sales volumes, and a 5% increase in coke sales volumes to the steel segment offset by a 94% decrease in coke sales volumes to the ferroalloy segment. Due to the work stoppage at Southern Urals Nickel Plant, coke shipments to it ceased altogether.

 However, we are proud to report that the negative dynamics in sales volumes and prices were more than compensated by our successful efforts to reduce cash costs almost across the board. Bluestone was a marginal exception with costs per tonne up $1 to $89 per tonne, due to cuts in production.

 As for the rest, the cash costs were down $2 per tonne to $39 for Southern Kuzbass, $4 per tonne to $28 at Yakutugol, and $2 per tonne to $43 at Korshunov Mining Plant. That achievement is even more remarkable against the background of growing ruble/dollar exchange rate. And that resulted in the cost of sales down 14% to $490 million, driving the gross margin 1% up to 84% of the revenue -- to 48%, excuse me.

 Sales and distribution expenses decreased over the quarter by 13%. This reduction was primarily driven by a decrease in sales to Ukraine, and an increase in the percent of coking coal sold domestically on FCA basis. As a percent of revenue, S&D expenses were basically flat quarter on quarter. Operating and other G&A expenses decreased during the period by 30%, due primarily to an $18 million reduction in payroll.

 For the quarter, the lower revenue was completely offset by our operating cost containment efforts, and the lack of a variety of one-off charges and accruals which were booked during Q2. The net result was a $3 million increase in EBITDA quarter on quarter to $305 million, pushing the EBITDA margin 4% up to 32% of the revenue.

 Net interest expense decreased by $6 million, due to an increase in capitalized interest. The appreciating ruble led to an FX gain of $94 million, which can be compared to a $198 million loss in the previous quarter.

 Profit tax increased by $66 million, due to a $14 million deferred tax increase at Bluestone, and a $50 million increase in statutory profit tax at our Russian operations, due to an FX gain with respect to US denominated debt.

 Overall, for the nine months of 2012, the Mining segment recorded $3.2 billion of revenue, including intersegment, down 17% to the same period of last year. The EBITDA fell by 33% to $965 million, or 30% of the revenue. The net income fell to $428 million from $631 million in the compared period, affected by $2 million FX loss versus a $99 million loss a year ago.

 In the Steel business, the third quarter continued with robust sales, albeit with a graduate slowdown towards the end of the construction season in Russia, and the background of weak demand in Europe. The fact that we had undertaken a massive destocking in the first half of the year, which could not be continued at the same pace in the third one, also affected the sales.

 The sales prices were stable with a slight downward pressure, coming from the factors just mentioned. The average sales price change ranged from 0% for rebar, to minus 7% for engineering steel and alloy long products on the FCA basis. At the same time, the sales volumes of rebar also remained virtually unchanged as this product is exposed to the stronger domestic market more than the others.

 The sales of billet and wire rod fell by 31% and 15% in physical terms, respectively. This was due to the fact that the production in Donetsk Plant was reduced, and we also decreased purchases of semi-finished steel from Estar for resale in the third quarter on weak export prices.

 Sales volumes of flat products, including stainless, fell by 23% as demand for flat steel, especially from Europe, continued to weaken, unlike the demand for long steel products, including stainless. At the same time, we increased sales volumes of high value-added hardware products such as wire and rods by 3% and 12%, respectively. The combination of these factors resulted in a 10% reduction in the segment's third-party revenue quarter on quarter to $1.7 billion.

 Intersegment sales fell by 25%, largely due to restructuring of the Group's Repair and Maintenance business, which was previously outsourced by other segments to the Steel one. In the third quarter, we put all the maintenance arms back to the respective segments.

 The continuing weakness in coal and iron ore prices in the reported period, slightly offset by stronger ruble, resulted in a further decrease in cash costs, which fell to $409 a tonne of billet, and $450 a tonne of rebar, on average.

 However, this decline was not enough to compensate for a steeper reduction of revenue, resulting in a 31% decrease in gross profit. That also affected the gross margin, which went to 13% in Q3, down from almost 17% in Q2.

 The decline in export sales mostly accounted for by sales of semi-finished and flat steel could not leave sales and distribution expenses unaffected, and they fell by 24%, representing only 8% of the revenue versus 9% in the previous quarter. The segment did not incur any impairment of goodwill and long-lived assets in Q3.

 Provision of $202 million created in Q2 for debt from related parties, which was represented by the loan to Estar, was further increased by $75 million in the reported period, reflecting our expectations of recoverability of that loan in the current market of depressed margins.

 The provision for other doubtful accounts, which was increased by $14 million in Q2, was reversed by $7 million income in Q3 as we cancelled the provisions for receivables from [Cogna] following its consolidation in the reported period. No new bad debt provision was created either.

 These factors resulted in a 17% quarter-on-quarter decrease in the segment's EBITDA to $75 million, or 4.3% of the revenue, a slight decline from the previous quarter.

 Net interest expenses grew by 4% to $96 million, reflecting overall increase in the cost of debt.

 FX loss of $160 million posted in the second quarter reversed to $48 million gain in Q3, due to stronger ruble. In Q2, we posted a $32 million income tax gain, largely attributable to reduction of deferred tax liability due to an adjustment of tax book value of fixed assets in Chelyabinsk, and impairment of long-lived assets in our Romanian plants.

 No such adjustment or impairment took place in Q3. On the contrary, FX gain on appreciating ruble increased income tax expenses which total $13 million in the reported period. As a result, the segment posted a $111 million net loss for the period, which can be compared to $625 million loss in the previous financial quarter.

 Overall for the first nine months, the Steel segment posted $5.441 billion of revenue, including intersegment, 7% lower than for the comparable period of 2011; $215 million of EBITDA, a 42% decrease; and $752 million net loss compared to $38 million loss in nine months of 2011. $594 million of that loss is accounted for by impairments of goodwill and long-lived assets and bad debt provision for a related party loan incurred in 2012.

 The price dynamics in the Ferroalloy segment continued to be negative for nickel, which fell 11% on FCA basis, and chrome down 13%, as markets continued to be weak in Q3. Only the price for ferrosilicon grew by 6%, mainly due to the increase of prices on the Russian market.

 The continued softening of the key markets resulted in our decision to halve production at Tikhvin Chrome Smelter, and idle Southern Urals Nickel Plant in Q3 altogether. That decision resulted in a 48% fall in third-party sales of chrome, and a 36% fall in sales of nickel quarter on quarter.

 The sales of ferrosilicon, which remains to be the most profitable product of the segment, grew by 39%, largely due to a more robust domestic market as production continued to grow after the modernization of one of the four furnaces, topped up by carryover volumes from the second quarter posted in the reported one.

 The growth of ferrosilicon sales, however, could not compensate for the decline in sales of nickel and chrome, which resulted in a 31% drop in the third-party revenue quarter on quarter to $91 million.

 Intersegments revenue increased only by 4% to $23 million. Cash costs of all the products remained flat quarter on quarter. Thus, cost of sales fell only by the volume of sold products, resulting in a reduction of the gross loss by half, to only $6.5 million.

 Selling and distribution expenses decreased by 23%, to $6 million, as export sales of nickel and chrome fell. That reduction was partly offset by growing share of [these] expenses per tonne of chrome by higher custom clearance charges, due to a higher number of [export] parties, as we were selling smaller volumes of chrome to a higher number of customers in order to adapt to a weak market.

 There was no impairment of goodwill and long-lived assets in Q3. As a result of production volume adjustment, we managed to decrease the segment EBITDA loss by 57% quarter on quarter, to only $3 million in Q3, which is a good result, taking into account that all these adjustments were made towards the end of the quarter.

 Net interest expenses changed insignificantly. The segment traditionally posted an FX loss on appreciating ruble, $15 million versus $22 million gain in Q2. That was due to the fact that most of the liabilities of the segment, including intra-Group, are denominated in rubles, whereas the reporting currencies, apart from ruble, are British pound, US dollar, and Kazak tenge.

 The income tax expense of $3 million in Q2 reversed with a gain of $3.6 million in Q3, as deferred income tax expense for the nickel plant was reduced, due to building up tax loss. And there was no effective deferred current income tax expense recognized in the second quarter.

 All that resulted in a $42 million net loss in Q3, which can be compared to $107 million loss in the previous period. All in all, the Ferroalloys segment generated $421 million revenue, including intersegment, in the first nine months of 2012, which was 22% down from the same period of 2011. Depressed nickel and chrome prices were largely responsible for an $18 million negative EBITDA, versus $57 million positive one for the compared period.

 The segment's net loss of $205 million, nearly half of that coming from impairment of goodwill and long-lived assets, plus a $42 million negative difference in the FX effect, can be compared to $32 million loss in the first nine months of 2011.

 The third quarter is traditionally the weakest for the Power segment, due to seasonal factors. The year 2012 was not an exception. The revenue from third parties fell by 16%, to $147 million. Intersegment revenues dynamics were less pronounced, with only 4% decline to $109 million. Decrease in sales led to lower variable costs by higher fixed [part]. That resulted in more subdued cost of sales dynamics, which dropped only by 6% quarter on quarter.

 The gross income consequently fell by 27%, to $45 million, or 18% of the revenue, versus 22% in Q2. Selling and distribution expenses declined by 10% to $50 million, as a result of lower sales. The almost zero EBITDA of the second quarter turned into a negative $6.6 million in Q3, but the net interest expense changed insignificantly. The FX effect was negligible.

 The result was a $14 million net loss, down from $60 million loss in the previous quarter, due to absence of impairment charges on Toplofikatsia Rousse's goodwill posted in the Q2.

 For the first nine months of the year, the Power segment generated $924 million revenue, including intersegment, down 2% period on period. The $21 million EBITDA is 37% down for the same period. The zero net result of the first nine months of 2011 turned into a $62 million loss in the reported period, almost all of it coming from the impairment of Toplofikatsia Rousse.

 On a consolidated basis, the revenue declined by 12% quarter on quarter, to $2.750 billion. The gross profit was 18% down, to $730 million, or 27% of the revenue, versus 29% in Q2. The consolidated EBITDA was only 3% down quarter on quarter, to $375 million, as positive EBITDA dynamics in the Mining and Ferroalloys segments offset the downward pace in the Steel and Power ones.

 The relatively robust sales in the Mining and Steel segments, despite weakening markets, which were more than enough to offset negative dynamics in the Ferroalloys and Power divisions, augmented by successful efforts to reduce cash costs and production in loss-making businesses, resulted in an improvement in EBITDA margin from 12% to 14% in the reported period.

 The net interest expenses remained virtually unchanged, despite growing cost of funds, are largely due to redemption of high-coupon bonds issued in 2009, and at a higher yield than the current funding we are able to get from the marketplace. The $292 million currency translation loss, in the second quarter, reversed to $127 million gain in Q3.

 The income tax expense posted $69 million versus $36 million gain in the previous period, largely due to the absence of one-off tax gains in the Steel segment recorded in Q2, due to asset impairment charges, as well as higher taxable income, due to positive FX effect.

 For the first nine months of 2012, the consolidated revenue was 9% down versus the same period of 2011, to $8.751 billion. The gross income down 23%, to $2.594 billion, or 30% of the revenue, down from 35% in the first nine months of 2011. The Group's EBITDA of $1.224 billion was 34% down over the same period on a margin of 14%, versus 19% a year ago.

 The $550 million net loss, almost the mirror image of the income posted for the first nine months of 2011, was affected by $471 million impairment charges, as well as $300 million of provision for doubtful accounts from the related parties.

 Let's now turn to the cash flow statements. I am proud to say that this is the item where we can claim the biggest achievement in the reported period, flagging the success of all our previous and present efforts to adjust the working capital to the present requirements, adapt our business to enhance its profitability, and improve the structure of our sales to generate maximum cash flow.

 All these efforts that we have been exerting since the beginning of the year, materialized in Q3 more than ever increasing cash flow from operations to the record $458 million, despite the fact that the cash flow, before changes in working capital, decreased by 36% quarter on quarter. Reduction in accounts receivables and divesting inventory alone brought over $90 million. Another $93 million came through a reduction of our trade position with related parties.

 As the construction season started to draw to an end, we began to divest our net receivables from Estar, inflated during the high season. In addition, we received $25 million in dividends from our cost method investments, and recorded a $35 million decrease in taxes receivable in our major production subsidiaries, due to utilization of prepayments for income tax made in the previous quarters, against the growing income tax accruals of the third quarter.

 Thus, changes in working capital in Q3 summed up to a record $284 million. At the same time, Q3 saw only $223 million spent on investments, less than the working capital release in the same period. Another $195 million was paid in dividend for the year 2011, which, combined with the investments, still result in less cash outflow than the cash generated by operations, leaving the balance for debt reduction.

 Financing activities contributed another $440 million resulted in an increase in cash position by $431 million, after $242 million negative effect of the exchange rate changes.

 Overall, for the first nine months 2012, our operations generated over $1.1 billion of cash, which is a record for the last three years. $435 million of that came from working capital adjustment. $997 million was spent on investments and dividends to our shareholders, leaving over $100 million, the rest for debt reduction.

 Despite superior operating cash flow in the third quarter, net debt increased to $9.6 billion, largely as a result of exchange rate fluctuations. The ruble-denominated debt share in the Group's loan portfolio increased from 48% to 54% in third quarter, as foreign debt was being amortized out of long-term credit lines opened with Russian banks.

 This exacerbated the effect the appreciating ruble made on the balance sheet. For the first nine months, net debt increased by $352 million, or 4%, despite the fact that the operating cash flow exceeded the expenditure on CapEx, acquisitions and dividends, entirely due to relative ruble appreciation, augmented by change in currency structure of the loan portfolio in favor of ruble during the reported period.

 Although the Group still faces significant repayments in 2013, totaling $2.2 billion, we have recently made the first important step in addressing this issue. Four days ago, we completed the restructuring of the $1 billion syndicated facility with international banks. This resulted in an additional 12 months' grace period in the facility, which previously was in the monthly amortization stage, saving us $600 million in next year repayments.

 The voluntary nature of this restructuring was also a sign of trust our Group continues to enjoy with international banking community, proved by the fact that four new institutions entered the facility in the course of syndication.

 Taking comfort from the fact that, after the successful restructuring, around 51% of next year repayments fall on Russian debt, we are convinced that we will be successful in reducing our short-term debt to the targeted $1 billion within the next few months. We expect that that will be helped with the divestment of non-strategic businesses which is underway.

 To recap, ladies and gentlemen, I am proud that our business demonstrated its ability to adapt quickly and generate enough cash to go on with its key investment projects, and service debt even in challenging volatile markets.

 Despite softening commodity prices in the reported period, we were able not only to deliver a relatively stable performance in terms of the EBITDA, but improve the operating profitability of the business, and increase cash flow.

 Not the last in this achievement was the right course for operating adjustments we set on in the beginning of the year, and concentration on those parts of our business which we have the biggest competitive advantage.

 Obviously, a lot yet has to be done, but being on the right track I'm convinced that, in the next 12 months, we will bring the business to the level of profitability and income generation where it deserves to be.

 Thank you for your attention, ladies and gentlemen. We are ready to take your questions.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [5]
 Thank you. We will now take questions. We would ask that participants please state their name and company before asking their question, and allow some time after for translation. When questions are answered in Russian, they will be followed by a translation, so you may ask your question in Russian also, and we will translate. Please go ahead.

Questions and Answers
Operator   [1]
 (Operator Instructions). Anton Rumanse, Sberbank.

 Anton Rumanse,  Sberbank - Analyst   [2]
 I have two questions on your recent Vanino acquisition, which is actually yet to be completed. But the first one, actually could you please provide some details on actually what is the reason for this consortium of investors to participate in this deal, and where they will make money? So if they will make money on port charges, or maybe you will provide them with some coal off-take agreement. Because it's just very interesting, because the price tag for the port is very high, and the benefits of this consortium of investors should be also pretty huge.

 And the second thing is that you stated that you will manage the port, and that's why the question is, do you plan to consolidate it? And if you are consolidating it, how the investors are participating. Do they receive some stake in Mechel, or one of the subsidiaries, namely Mechel Mining? Maybe you will just give some more details how the deal will be structured. Thank you.

 Stanislav Ploshchenko,  Mechel OAO - CFO   [3]
 (interpreted) Since the results of the tender have not been approved yet, and the deal itself has not been closed, we cannot provide comments on all the details of the agreements with the consortium of investors. Nevertheless, we are ready to provide some comments.

 As for the consortium of investors, they're going to make money on the port's economics, and the increased value of the port in the future. The consolidation is planned to be performed through management, and since the port doesn't have any debt, it will not increase the debt portfolio.

 We will have an option, but not a liability, to buy the port, and the consortium of investors is not going to get a share or any other participation in the Company.

 Anton Rumanse,  Sberbank - Analyst   [4]
 Okay. Thank you.

Operator   [5]
 Dan Yakub, Citi.

 Dan Yakub,  Citi - Analyst   [6]
 A follow-up question on Vanino Port, and a couple of other questions related to the cash flow statement, and a final question will be on your attempts to divest some of the assets that were -- to find a strategic partner for the development of the Mechel Mining division.

 First of all, in terms of Vanino Port, there was approximately $0.5 billion price tag mentioned for a majority stake in the share capital of Vanino Port. I just want to try and understand who'll actually pay that, whose balance sheet, whose cash flow statement this $0.5 billion will appear on? Is that ever going to appear on your cash flow statement as participation in the share capital of that entity?

 Second, in terms of the working capital release; we've seen that close to 63% of the operating cash flow in the third quarter was actually working capital release. Do you think that you have more capacity to release working capital in the fourth quarter? And if you do have more capacity, can you elaborate a little bit on what is the potential for the working capital release in the fourth quarter of this year?

 And finally, maybe you can provide some more details, if you have any, on the potential start date for the search of a partner to develop Mechel Mining division. You mentioned up to 25% of Mechel Mining division can be divested to a third party. Just trying to see, maybe you can elaborate a little bit on whether you have had any concrete proposals, or when is the start date for that search process?

 And on, maybe on the Ferroalloy division maybe you have some understanding and the EAF -- some of your EAF investments, maybe you have reached any progress in trying to divest some of the assets that you identified as non-core? Thank you.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [7]
 We will start answering from the last question; Evgeny Mikhel will take it. Evgeny Mikhel will take the final question of the asked ones, so this question regards the possible sellout of non-core and some core assets.

 Evgeny Mikhel,  Mechel OAO - CEO   [8]
 (interpreted) We are quite active in this domain, and we have already distributed teasers and investment memorandums concerning these assets. And all these procedures require time to prepare documents and to set off some in-Group streams, and this took a bit more time than we had anticipated.

 Anyway, in the first half of 2013, we'll be able to close most of the deals indicated, and some of the deals are already at a higher level of readiness. Sure, we have tried to speed up the process to deliver some of the results this year, but we all know that speeding up the selling process makes the buyers willing to reduce the prices. That's why we take a reasonable approach to the timeframe for the best interests of the Company and their shareholders, so as to get the best market price for the things we have to sell.

 Anyway, I'll say again that, in the first half 2013, there will be ready and closed deals. The results will be available and made public to the investors accordingly.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [9]
 The question on working capital release in the fourth quarter will be answered by Oleg Korzhov.

 Oleg Korzhov,  Mechel OAO - SVP Economics & Management   [10]
 (interpreted) As mentioned in quarter 3, we were able to reveal a big share of our working capital, and this procedure had been planned and announced. As for quarter 4, we are likely to repeat this thing, due to some seasonal factors and the way our facilities and distribution parts operate in quarter 4.

 As for the production facilities in quarter 4, they generate stockpiles for winter to minimize the technical risks, while the distribution parts, on the contrary, increase their stockpiles to minimize the risks related to sales needs of the customers. So we have a goal to minimize the working capital outflow for these two events and activities, so we are not going to have a share of working capital released in quarter 4. But at the same time, working capital will not decrease due to the seasonal factors.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [11]
 The remaining first and third questions will be answered by Stanislav Ploshchenko.

 Stanislav Ploshchenko,  Mechel OAO - CFO   [12]
 (interpreted) As for the Vanino Port deal, it has been mentioned that it has not been approved yet. And we can say anyway that it will not go to our balance, or to the balance of Mechel, or to the cash flow statement of Mechel. We, at the same time, cannot comment on the financial reports and financial documents of our co-investors; that's why we cannot say on whose balance sheet or cash flow statement these funds will go.

 As for the private placement of a part of Mechel Mining, we can say that the process has been already launched and it enjoys a lot of demand from the investors. We believe that, by the first half of 2013, the deal will be closed.

Operator   [13]
 [Yuri Stensky, Credit Suisse].

 Dmitry Glushakov,  Credit Suisse - Analyst   [14]
 (interpreted) This is Dmitry Glushakov, Credit Suisse. There are three questions.

 First question regarded cash cost, and it was indicated that, for Mining, it reduced by 13% to 15% in quarter 3. The question is, how sustainable this reduction is, because quarter 2 and quarter 3 are usually best for Mechel in terms of costs. Then the costs usually increase. So could you please comment on this situation?

 And the second question related to the debt, and I looked at the debt maturity schedule and saw that, for September 1, there was more than $1 billion in renewable working capital loan and trade finance fund, but for December 1, this figure was lower than $0.5 billion. So why the difference?

 And the third question concerns the Estar. The previous presentation it was said that the debt had been restructured and now Estar is to sell assets to pay the debt. So is there any progress in this domain, and what are the expectations?

 Vladislav Zlenko,  Mechel OAO - Director of IR   [15]
 The first question will be answered by Oleg Korzhov.

 Oleg Korzhov,  Mechel OAO - SVP Economics & Management   [16]
 (interpreted) We don't expect any miracles to happen, and our Company operates in the climate zones where seasonal fluctuations are of great importance. And this weights to the cost of heat, electricity and winter fuel we are to endure, and it has been rightly mentioned, historically quarter 4 has an increase in cash costs. And we believe that it will happen this year as well, but do not think it will be considerable. We expect it to be about 2% to 3% increase of cash cost in quarter 4, compared to quarter 3.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [17]
 Next question will be answered by Stanislav Ploshchenko.

 Dmitry Glushakov,  Credit Suisse - Analyst   [18]
 [I also have] a follow-up question.

 Stanislav Ploshchenko,  Mechel OAO - CFO   [19]
 (interpreted) The Group is continuously restructuring and refinancing its debt portfolio and changing the instruments applied. For instance, we are shifting from the working capital financing to long-term financing so as to shift from short-term to long-term debt. And some of the work was done between September 1 and December 1, illustrated by the graph.

 And, for instance, we attained a five-year loan from Sberbank worth RUB24 billion, which was used to cover short-term debt, including revolvers.

 Dmitry Glushakov,  Credit Suisse - Analyst   [20]
 (interpreted) The follow-up question to Stanislav is as follows. So you are replacing the short-term debt by long-term debt, and you have refinanced some of the loans. The question is as follows; what is the average interest rate for the debt? How has it changed, compared to the previous figures?

 Stanislav Ploshchenko,  Mechel OAO - CFO   [21]
 (interpreted) For sure, the debt interest is increasing with time, and this is largely due to the fact that the cost of funding coming from the western banks to the Russian banks is also increasing, which increases the rates of the Russian banks.

 This happens not to the worst estimates of the risks of the loan taken, but rather due to this funding price. And for sure, we have done restructuring refinancing but, at the same time, we haven't seen a considerable increase in the rate.

 As for an example, for instance, this $1 billion [western bank] syndicated loan rate has not increased, and we have received a 12-month grace period. And the structure of this loan has been improved, because the rate will be reduced due to the changes in the net debt to EBITDA ratio. So this structure is even better than the previous one.

 As for the Estar question, as far as I know, the Estar assets are being sold out. And we believe that this will be done by the end of the grace period we provided to Estar; that is by the end of the first half 2013.

Operator   [22]
 [Alexander Sichov, Rosbank].

 Alexander Sichov,  Rosbank - Analyst   [23]
 I've got number of questions on your coal assets. First one, can you give us the breakdown of your Q3 coking coal sales by subsidiary?

 Next, what's your coal production plans for 2013? Please provide the breakdown by type of coal and subsidiary.

 Next, what was the average realized price of coking coal at Bluestone, specifying the delivery basis?

 Lastly, one small follow up; in your cash flow statement there is a $17 million gain on forgiveness of accounts payable. Could you please elaborate on what's that and where is it included in G&A expenses, or anywhere else? Thank you.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [24]
 We'll start answering from the fourth question. Stanislav Ploshchenko will answer.

 Stanislav Ploshchenko,  Mechel OAO - CFO   [25]
 (interpreted) As for the $17 million, this is forgiven receivables from one of our construction department units, and we had an agreement with one of the creditors, and we also had some questions to them. And as we all settled this -- settled all these issues, we came to an agreement that we are going to pay $17 million less. This is recognized by the Other income line in the P&L statement.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [26]
 The remaining questions will be answered by Oleg Korzhov.

 Oleg Korzhov,  Mechel OAO - SVP Economics & Management   [27]
 (interpreted) The first question related to the coking coal concentrate shipments. The overall amount was 2.6 million tonnes, and Southern Kuzbass shipped 900,000 tonnes; Bluestone provided 200,000 tonnes; and Yakutugol shipped 1.4 million tonnes.

 As for the plans for 2013 concerning the coking coal concentrate, we are going to produce 31 million tonnes to 31.5 million tonnes coal, and we are going to ship 25.5 million tonnes to 26 million tonnes coal products. As for coking coal concentrate, this will amount to 12.5 million tonnes to 13 million tonnes. As for steam coal, this will be 8.5 million tonnes, and as for anthracite and PCI, this will be 4.6 million tonnes to 4.8 million tonnes.

 As for the units' split, these 25.5 million tonnes to 26 million tonnes will split the following way. [Southern] Kuzbass will ship 12.5 million tonnes to 13 million tonnes; Yakutugol will provide 10.5 million tonnes to 10.7 million tonnes; and Bluestone will provide 2.5 million tonnes.

 As for the sales of our US asset, Bluestone, the question [that we] got was for quarter 4. So we contracted two types of coal, high-vol and low-vol coal. And as for high-vol coal, it was $120 (inaudible), with a $55 tariff. And as for low-vol coal, this was $140 to $150 with a $55 tariff for (inaudible).

Unidentified Participant   [28]
 (interpreted) Could you please specify the prices for Bluestone quarter 3?

 Oleg Korzhov,  Mechel OAO - SVP Economics & Management   [29]
 (interpreted) For sure, we can provide this information. For quarter 3, for high volume coal, we started with $150, and over to the end of quarter 3 it was $120. As for low-vol coal, the dynamic was also decreasing. We started with $205 and ended with $140. This is also [non-FOB] approach $55.

Operator   [30]
 George Buzhenitsa, Deutsche Bank.

 George Buzhenitsa,  Deutsche Bank - Analyst   [31]
 (interpreted) Regarding Port Vanino, and as far as I got the presentation, there is a planned increase of the Port throughput which implies some CapEx. The question is, due to the structure of the deal, who is going to finance the CapEx; what is the estimate of the CapEx?

 Another part of the question is that to take part in the bid, $100 million worth of bank guarantee was necessary. The question is, who provided this bank guarantee; was it Mechel or the investors' consortium?

 Another part of the question is the presentation mentioned that Mechel would have an option for buying a stake from the investors' consortium share in this port. What type of share will it be? Will it be a controlling stock or not controlling stock, and will Mechel have share in the Vanino Port or not at the initial part of the deal?

 Another question pertains to the Universal Rolling Mill. I would like to know the launch date, the planned capacity, and the production output planned for 2013.

 Another question is concerning the increase of provisions for debt. Is it going to happen or not?

 Vladislav Zlenko,  Mechel OAO - Director of IR   [32]
 Stanislav Ploshchenko will answer the first question.

 Stanislav Ploshchenko,  Mechel OAO - CFO   [33]
 (interpreted) As for the increased capacity of the Vanino Port, it will be capable of shipping up to 10 million tonnes next year, and this will require virtually no CapEx. This implies optimization of the warehouses and of the Port infrastructure, which leads to virtually no CapEx.

 And as for the increase up to 15 million tonnes to 20 million tonnes for the future, we have just considered this possibility, and it's premature to provide any figures because we have not related the CapEx required for this.

 As for the bank guarantee question, it was provided to Mechel and it expires when the deal on purchasing the Vanino Port is closed. And the buying party to the agreement is Mechel Trans, which took part in the bid.

 And as for the further deals with the investment consortium, we wouldn't like to provide any details because, until the bid results are announced, we are subject to a confidentiality agreement. But anyway, we can say that Mechel will have a right to obtain a controlling stock of the port.

 As for the question concerning the provisions for the Estar loan, this loan underwent the same testing for repayment as goodwill and assets do, and this is the testing for impairments. So these provisions will be determined by the market conditions.

 The provisions can both grow and decline, and they can decline unlike the impairment in this case. It's premature to talk about the market conditions at the time when we make it go into our reports.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [34]
 And the remaining question will be answered by Oleg Korzhov.

 Oleg Korzhov,  Mechel OAO - SVP Economics & Management   [35]
 (interpreted) As for the Universal Rolling Mill, we plan to complete the installment procedures in December and start the commissioning procedures afterwards.

 As for the commissioning procedures, we have already started some of them. For instance, we have done it for the heating furnace, which is a big unit of this mill, and we are going to complete commissioning in first quarter and follow with hot testing and test production. By the end of the summer, we are going to produce rails and to send them for the Russian railroads for testing.

 As for the production figures for 2013, we wouldn't like to provide any specific numbers, because we understand that this Universal Rolling Mill is quite a sophisticated unit which is high tech and quite new to us. So we would like to see how it goes, and many things will depend on how the results of the tests we have and the hot test results. And there are many things we have to test, together with the Danieli company.

Operator   [36]
 Vasily Kuligin, Renaissance Capital.

 Vasily Kuligin,  Renaissance Capital - Analyst   [37]
 (interpreted) What is the Company's covenant for debt to EBITDA, and what is the official figure for quarter 4? Do you think that you can go beyond this figure, due to the reduced EBITDA figures?

 The second question pertains to quarter 1 price for coking coal. Since BHP has contracted some coking coal sales for quarter 1 with a $5 reduction to the current price, so do you anticipate similar reduction in coking coal price for your Company?

 Vladislav Zlenko,  Mechel OAO - Director of IR   [38]
 Stanislav Ploshchenko will answer the first question.

 Stanislav Ploshchenko,  Mechel OAO - CFO   [39]
 (interpreted) We agree that, under the current market conditions, the debt covenants can be exceeded, but we have already started our preparation for this, and while we have agreed with the western banks for a restructuring of the syndicate, and now the restructured syndicate deals do growth for Mechel Mining and the ratio there is 3.5 debt to EBITDA. Given the fact that Mechel Mining is the most profitable of our units, we believe that we have already sorted out the issue as for the international syndicate.

 There is a risk in this domain mainly for the Russian banks and bilateral loans with western banks, and if things like that start, we cannot see any problem because, even if their covenants are exceeded, we should consider that, in the current market conditions, which are quite tough, we show record-setting cash flow and we are not increasing our debt. These two factors are the most important ones for any bank, while it considers the loan taker as for its risk.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [40]
 Next question will be answered Oleg Korzhov.

 Oleg Korzhov,  Mechel OAO - SVP Economics & Management   [41]
 (interpreted) As for the question relating to the first quarter contract prices, Mechel traditionally sells and ships coking coal of K-9 grade to two regions; one is China and the other is Japan and Korea.

 As for China, we have already contracted for January and February, and we have not reduced the price compared to December figures. And there it is, [say, for] $155 with a tariff of $55 and we hope that, [call this] at the end of quarter 1, the prices are going to show growing dynamics.

 As for Japan and Korea, we have not contracted our first quarter shipments yet, but we are going to maintain the quarter 4 prices.

Operator   [42]
 [Maria Rachenka, BCS Financial Group].

 Maria Rachenka,  BCS Financial Group - Analyst   [43]
 (interpreted) [I would like to ask] a clarification question concerning the covenants for the syndicated deal. I would like to clarify whether these covenants which went to Mechel Mining pertain to the $1 billion syndicated loan, and whether the previous covenant state for the new syndicated loan of $2.7 billion it was 5.5 debt to EBITDA by the end of 2012.

 Stanislav Ploshchenko,  Mechel OAO - CFO   [44]
 (interpreted) As for the first part of the question for the syndicate of $1 billion, you are right. As for the second syndicate of $2.7 billion, there might be some confusion here because we don't have this syndicate.

 If you meant the $2.7 billion to be paid back, as we had indicated as of September 1, has been reduced to $2.2 billion, for these figures for most of the sum we have the ratio of -- the covenant of 5.5 which is the Mechel covenant.

Operator   [45]
 Anton Rumanse, Sberbank.

 Anton Rumanse,  Sberbank - Analyst   [46]
 Now just several small follow-up questions from me. The first one is, could you please give us an update if your CapEx plans for 2012 and 2013 have changed somehow? If I remember correct, you plan to spend something like $1.2 billion for 2012, and if this target is still in place.

 The second question is maybe just in ballpark figures, could you please tell us what average decline of coking coal prices do you expect in the fourth quarter? Maybe on FCA basis, because there are pretty different types of shipments of your coal.

 And the third question is, in the third quarter we have seen a quite significant reduction of your sales, general and administrative expenses. Do you think that the amount will reduce in the fourth quarter, or you will be able to keep them at the current levels? Thank you very much.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [47]
 Oleg Korzhov will answer the question.

 Oleg Korzhov,  Mechel OAO - SVP Economics & Management   [48]
 (interpreted) For 2012, as for the investment figures, we had $900 million, and $150 million was to be spent on maintaining our facilities on rebuilding equipment, and $750 million was allocated for the investment projects.

 For 2013, we initially had a plan of $1.2 billion of investment but, given the market condition and the conditions of our current facilities, we decided to reduce the figure to $500 million to $600 million and, out of this, $150 million, $160 million, the same as last year, would be spent on maintaining the facilities, and the remainder of $400 million, $450 million will be earmarked for the investment projects; we have two of them remaining. One of them is completing the construction of the Universal Rolling Mill, and the other one is the Elga development project.

Unidentified Company Representative   [49]
 (spoken in Russian).

 Anton Rumanse,  Sberbank - Analyst   [50]
 Yes, just to clarify, I just interested in the overall trend so, for example, the prices -- we expect the prices to decline by 3% or 5%, because there were a lot of questions asked about some specific prices, but overall trend in the fourth quarter was not mentioned, that's why I just decided to clarify it.

 Oleg Korzhov,  Mechel OAO - SVP Economics & Management   [51]
 (interpreted) The question was about the [FCA] price of coal and it was said that there are two major markets again in China and Japan and Korea. And for China for quarter 4, FCA, the price was $85 to $100; it started with $85 and then go to the end of quarter 4 it was $100. As for Japan and Korea, the price was $110 FCA, and there we have quarterly contracts. And also in quarter 4 we sold to Ukraine, and there it was $105 FCA.

 And as for the overall reduction trend for the coal price for quarters 3 and 4, in Ukraine and Korea the reduction was about $50. And as for China, the quarter 3 and quarter 4 prices were within the same band, and in quarter 3 they started a bit higher and ended a bit lower, and in quarter 4 they started a bit lower and ended higher. But overall, quarter 3 and quarter 4 prices were close.

Operator   [52]
 We currently have no questions coming through. (Operator Instructions). We have no further questions coming through, so I hand you back to your host to wrap up today's call.

 Vladislav Zlenko,  Mechel OAO - Director of IR   [53]
 Ladies and gentlemen, thank you for taking time to join Mechel's nine month 2012 financial results conference call today. The replay of the call will be available on Mechel's website. If you have any further questions, please contact the IR office. Thank you again from all the team here. Bye.

Operator   [54]
 Ladies and gentlemen, thank you for joining. You may now disconnect your lines.

Editor   [55]
 Portions of this transcript that are marked (interpreted) were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.

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