Q1 2015 Mechel OAO Earnings Call

Jun 23, 2015 AM EDT
MTLR.MZ - Mechel PAO
Q1 2015 Mechel OAO Earnings Call
Jun 23, 2015 / 03:00PM GMT 

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Corporate Participants
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   *  Oleg Korzhov
      Mechel OAO - CEO
   *  Andrey Slivchenko
      Mechel OAO - CFO
   *  Alexey Lukashov
      Mechel OAO - IR

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Conference Call Participants
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   *  Sergey Donskoy
      Societe Generale - Analyst
   *  Barry Ehrlich
      Citibank - Analyst
   *  Nikolay Sosnovskiy
      UBS - Analyst
   *  Alexander Drobushas
      Iyonka Capital - Analyst

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Presentation
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 Oleg Korzhov,  Mechel OAO - CEO   [1]
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 (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 of the first quarter 2015.

 In the first quarter of 2015, the Group worked in economic conditions that differ drastically from last year, and I think worked successfully. Consolidated revenue amounted to $1.113 billion, consolidated EBITDA, $211 million.

 Despite a beneficial effect that the weakening of the Russian national currency had on the Company's results, the situation on most markets for our products continued to be difficult and volatile. Global prices for raw materials for steelmaking stayed in the downward trend. This was due not only to competition between major coal producers, but also weaker demand from the key consumers, China, for example.

 At the same time, the domestic market was more stable. Ruble prices went up, as did the dollar exchange rate, while dollar-denominated costs went down. In our current situation, with dollar sales taking up over 80% share of our mining segment's revenue and with production costs mainly denominated in rubles, the mining segment demonstrated a drastic growth of operating income.

 On the whole, there is a feeling that prices at the coal market have reached their bottom. Even though there is still more supply than demand, lately, there are more and more reports of coal assets being halted or cutting down production.

 With this in mind, by this year's end, we may see an upward trend for coal prices. This growth will not come in [bounce]. It will most likely be gradual. But, even such a change will definitely have a positive effect on our facility's economics, as their production costs are among the lowest in the industry.

 For the Russian steel market, the quarter began with an upsurge of demand and price growth as the ruble weakened. Unfortunately, this growth was short lived, with the trend taking a downturn due to a decrease in effective demand as loan costs grew and state project financing volumes decreased.

 Nevertheless, the weaker ruble helped cut down dollar-denominated production costs in the steel segment as well. This has helped us to alleviate the negative impact on our financial results, though it must be admitted that, in rubles, the situation appeared otherwise. Growing ruble prices for incoming raw materials could not but have a negative impact on ruble-denominated production costs.

 Despite market volatility in the first quarter, our facilities maintained their key production results, coal mining and steelmaking, at the previous period's level.

 Our key investment projects have had their effect on the figures as well. Elga Coal Complex is actively increasing mining volumes. In January-May, Elga mined nearly 1.5 million tons of coal, which is more than was mined at the complex in the entire 2014.

 At Chelyabinsk Metallurgical Plant Universal Rolling Mill, new products are being mastered as production grows, and so do rolled supplies. Moreover, Chelyabinsk Metallurgical Plant's rails are at the final stage of certification and will very shortly be able to begin supplying the Russian railways.

 Due to our increased operating income, we managed to overcome the liquidity crisis and reach debt restructuring agreements with our two major lenders, Gazprom Bank and VTB. We continued talks with Sberbank and fully intend to reach a compromise. The conditions of the agreements we made with our lenders include paying the outstanding debt arrears. Though we can service our current debt, paying the arrears made last year will require extra effort. We consider these a priority issue and do all we can to resolve it.

 Considering the perspectives for a speedy attainment of debt restructuring arrangements, with production volumes maintained at a stable level and our keen understanding of the market, we are confident about our future and expect the Company's financials to improve further.

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

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 Andrey Slivchenko,  Mechel OAO - CFO   [2]
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 Thank you. Ladies and gentlemen, welcome to our call. In the interest of time, as usual, I will speak English.

 The first quarter of 2015 was to become a breakthrough. However, due to highly volatile exchange rates bouncing from 56 to 70 and back to 58, again, the performance turned out to be less [cheery] than expected.

 Firstly, profitability kept increasing on the difference between the more quickly growing ruble prices pushed up by the ruble depreciation and more slowly, but still growing costs accompanied by the lower sales volumes.

 Second, the depreciating trend in the ruble was -- has turned around after bringing more cash to the Company's operations in the fourth quarter and in the beginning of the first quarter and allowing to get back to the debt servicing schedules, though not in full.

 And third, we have managed to start servicing the debt and repay overdue interest and made certain progress in restructuring arrangements with our major lenders.

 Now, revenues, over the first quarter, we have seen an increase in our revenues of almost 5% across all the segments. However, ruble devaluated by 31% quarter on quarter, which led to a 20% drop in revenues in dollar denomination.

 The revenues amounted to $1.1 billion, down from $1.4 billion a quarter ago. In mining, dollar price declined by another 7% on average, and volumes added 13% to the revenue's decrease.

 Coking coal sales were down by 22%. And PCI, anthracites, and steam coal, sales were up by 8% to 13%. Nevertheless, revenues were down to $390 million. Intercompany sales increased, but remained at the same dollar revenue level of about $100 million.

 In metals, ruble prices failed to catch up with ruble depreciation. And thus, a 15% increase in ruble price turned into 12% decrease in dollar prices. The structure of sales was not affected. But, the volume suffered from the weakening payable demand.

 Long product sales were down 18% and contributed most to the total revenues, which were down to $600 million from $740 million in the fourth quarter of 2014.

 [Extras] amounted to 40% of revenues, up from the previous year's level of 35%. Of that, mining brought almost 30%.

 Now, profitability, regardless of the enormous devaluation of ruble, the Group EBITDA was only 3.8% lower than in the fourth quarter of 2014 and, as mentioned, amounted to $211 million. The segment contribution was almost equal, 49% from mining and 48% from steel segment, approximately $106 million each.

 In mining, EBITDA grew on the weakening exchange rate by 22%. And the margin increased from 15% in the fourth quarter to 22% in the first quarter of this year. In steel, EBITDA was down by 12% on higher cost inflation. And the margin added only 1%.

 The Group showed operating profit of $113 million after losses in the previous year. In the first quarter, before impairments of [loan] debt provisions and other write-offs and accruals, the operations earned $152 million, slightly less, approximately 3%, than in the previous quarter.

 Net loss amounted to $273 million, of which $154 million was the effect due to ForEx fluctuations.

 As far as the cash flows are concerned, although operating cash flow available for debt service was 26% lower in dollar terms than in the fourth quarter, due to the devaluated ruble, we increased our interest payments in ruble denomination by 52% and paid down significant amount of the overdue interest. Interest payments in the first quarter were $107 million.

 Nevertheless, the Company was short of cash. And the deficit of about $130 million from operating, financing, and investment activities was financed from the working capital, which decreased by another $124 million.

 Debt, in the first quarter, there were no significant repayments of debt, except for the offers on the publicly traded bonds coupled with slight change in the exchange rate as at the end of the period and the beginning of the period. So, this brought net debt down by only 3% and totaled to $6.8 billion, which is 8.2 times the EBITDA for the previous 12 months.

 Interest burden was slightly down. And about 60% of the loan portfolio is still denominated in foreign currencies. However, the quarterly interest expenses now amounts to about $175 million versus $280 million, which was the average for the first three quarters of last year, and $160 million for the fourth quarter of 2014.

 In the first quarter, the Company managed to keep effective its working capital credit lines with Gazprom Bank and VTB Factoring as well as with several other Russian international banks. Further, the short-term financing was brought down from 24% as a result of increased cost of capital on the market to 15.5% in annual rates.

 During the first quarter, we also managed to restructure certain loans with Raiffeisen Bank and VTB Factoring.

 Finally, I would like to mention that we keep -- we continue talks with our major lenders on restructuring of our debt and now in the process of implementation of the agreed arrangements and fulfillment of the conditions precedent.

 Thank you very much. And now, we are in position to take your questions. Thank you.

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 Alexey Lukashov,  Mechel OAO - IR   [3]
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 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 translation. So, you may ask your question in Russian also, and we will translate.

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Questions and Answers
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Operator   [1]
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 (Operator Instructions). Sergey Donskoy, Societe Generale.

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 Sergey Donskoy,  Societe Generale - Analyst   [2]
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 Yes, thank you very much. I have two questions. One, if you could please provide some update on the coal price dynamics in the first quarter and in the second quarter on the export and on the domestic market and if you have some outlook for the third quarter as well, as we know that coal prices have been quite volatile this year in ruble terms, speaking about the domestic market.

 And second question, I might have missed your explanations. Could you please comment again on the increase in your interest expense? In the first quarter, it was significantly above the last year's level at $256 million. How much of that was a one-off? And what was it caused by? Thank you.

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 Alexey Lukashov,  Mechel OAO - IR   [3]
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 The question will be answered by Oleg Korzhov.

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 Oleg Korzhov,  Mechel OAO - CEO   [4]
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 (interpreted) To talk about, so, the [SKS] call in the domestic market in the first quarter, we sold at approximately RUB4,050, RUB4,400 per ton [as CA]. Second quarter saw a slight growth, and so RUB4,500, RUB4,900 per ton.

 Now, [Yakutin] call, the basic sales destination are the Asia-Pacific, China, Korea, and Japan. To China in Q1, we sold at $95, $100 CIF, in the second quarter, $92, $88. Now, Japan and Korea were shipping FOB. Sales prices in Q1 were $97, $105 approximately, in Q2, $95, $91.

 Apart from it, we've got quite a product range in terms of the volume that we're shipping of the PCI, no call, to Japan and Korea were shipped as call and during Q1 at $95, $92 FOB, in Q2, $86, $88 per ton, similar calls to China, which shipped and sold at $97, $99 CIF, during Q2, $85, $87.

 Now, and as far as the current environment in rubles is concerned, as you may noted in Q2, there was a slight decline dynamics in terms of our sale prices. And at present, there is a bit of positive news related to a spot price growing for coking concentrate by about $3, $5. One shouldn't really describe it as any major improvement in terms of the price and growth.

 But, nevertheless, this kind of dynamics is something we see in June, we view as a positive one, while we don't think that, in the immediate future, like towards the Q3 and during Q3, the coal prices may show any dramatic growth.

 Like I stated in my presentation, we're expecting that, by the end of the year, there will be a positive trend, which won't have a fits-and-starts kind of a nature, but would rather simply manifest itself in a slight growth towards the end of the year.

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 Alexey Lukashov,  Mechel OAO - IR   [5]
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 The next question will be answered by Andrey Slivchenko.

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 Andrey Slivchenko,  Mechel OAO - CFO   [6]
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 (interpreted) Now, if I understood correctly, the question was about the difference between the regular interest, which has been accrued, and the interest that we cite in our expenditures during Q1 in the amount of $256 million.

 Now, in terms of considerable difference between the accruals of fines and penalties for being overdue, which are currently being the subject of the discussion and possible restructuring and a possible writing off with our main lenders, the amount of such fines and penalties approximately equals $100 million.

 So, respectively, out of $256 million, somewhere about $114 million and constitute a regular interest, which has accrued itself during Q1.

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 Sergey Donskoy,  Societe Generale - Analyst   [7]
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 (interpreted) Now, a follow-up question, if at all possible, could you describe the domestic coal price dynamics that you expect during third quarter? There is an understanding amongst many market watchers that, in the domestic market, the prices for the coking coal during Q3 most probably would demonstrate weakening after showing growth during Q2. So, what do you think about this?

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Unidentified Company Representative Mechel OAO   [8]
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 (interpreted) We've got the same kind of an understanding, i.e. that, during Q3 in the domestic market, there will be slight adjustment of prices for coking coal.

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 Sergey Donskoy,  Societe Generale - Analyst   [9]
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 Thank you.

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 Alexey Lukashov,  Mechel OAO - IR   [10]
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 Next question, please.

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Operator   [11]
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 (Operator Instructions). Barry Ehrlich, Citibank.

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 Barry Ehrlich,  Citibank - Analyst   [12]
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 Yes, hello. I have three questions. First question, you sold 2 million tons of coking coal concentrate in the first quarter. And that level looks low compared to your output. When will you get back to a higher level of 2.3 million or maybe even 2.5 million tons?

 Second question is the penalties on the overdue loans that you just discussed, do those penalties have an impact on the balance sheet, for example, within the accrued expenses and other current liabilities line?

 And that line in the balance sheet is now almost $1 billion. Can you help us understand what portion of that $1 billion you actually have to pay over the coming 12 months and whether that entire $1 billion in that line is somehow related to penalties?

 And then a final question, you've given some outlook statements. For example, realized coking coal prices are expected to be stronger in the second quarter. The ruble is stronger, though. And I assume volumes will be higher in the second quarter.

 In your outlook statement, it indicates that you expect improving profitability over the course of the year. But, is that really the case that the second quarter EBITDA will be above the first quarter level? Thank you.

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 Alexey Lukashov,  Mechel OAO - IR   [13]
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 The first question will be answered by Oleg Korzhov.

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 Oleg Korzhov,  Mechel OAO - CEO   [14]
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 (interpreted) Indeed, during the first quarter, the amounts of sales in our two third parties were not really standing out well, two basic reasons, because basically, throughout the first quarter, the Lenin Mine didn't operate. We had to stop it because of subjective reasons. And at present, the mine has been relaunched. And so, we will renew the volumes of output that we have at the mine.

 Now, the second reason was that, during the first quarter, more of the coking concentrate we took to our entities, Mechel coke and [Moscow], substituting the coke acquired from the third parties, trying to use as much as we can from our own capacities.

 Speaking about the sales, apart from it, we are finishing the assembly at the [Olzherassk] Mine with an access to the design capacity. Additionally, on a monthly basis, we'll be producing about 150,000, 180,000 tons. So, approximately, by third quarter, we will be able to come up to our standard volume of output and sale of the coking concentrate.

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Unidentified Company Representative Mechel OAO   [15]
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 (interpreted) As far as the second part of the question is concerned, related to the accrued expenses and other short-term liabilities, I would describe it this way. The amount is approximately $1 billion. More than half of it are the structured liabilities with the repayments scheduled in relationship to the nonfinancial liability.

 And here, we are maintaining our schedule. And principally speaking, this is the debt which has been reclassified from long term into a short-term one because of the state of default.

 Now, in as far as the -- our interest obligations are concerned, which are contained within this figure, by the end of Q1, that is approximately $300 million. We have partially paid it in Q1 -- in Q2, sorry. So, I am not in a position to give you an exact figure in terms of what we will ultimately have to pay. But, this is the amount of repayment that is gradually going down or might be partially restructured if we are able to come to an agreement with our lenders.

 And the third part within this line item are the fines and penalties amounting to approximately $138 million, which is the amount I previously mentioned because of the overdue payment that the banks have either accrued or we have respectively accrued the fines and penalties for the overdue payment, which might be subject to either a write-off or a certain restructuring, considering the way our negotiations with the banks end.

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Unidentified Company Representative Mechel OAO   [16]
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 (interpreted) Now, as far as the third part of the question's concerned, I am afraid that I won't be in a position to correctly assess the results of the second quarter, well, first of all, because this would be a forward-looking approach.

 Secondly, we are continuing to witness three very much diverse trends in the market right now, first one being the changing prices; second, the changing volumes and the changing demand in the market, as well as the changing national currency exchange rate.

 Now, what will be the result that all these three trends may evolve into is hard to predict, although I would expect it not to be any worse or any better than what we've seen as the result of Q1.

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 Alexey Lukashov,  Mechel OAO - IR   [17]
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 Next question, please.

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Operator   [18]
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 Nikolay Sosnovskiy, UBS.

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 Nikolay Sosnovskiy,  UBS - Analyst   [19]
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 Yes, hello. Thanks a lot for the presentation. I've got a couple of follow ups. First of all, on your steel division, basically, you reported half of your EBITDA derives from steel segment. And already in first quarter, you reported quite significant deterioration in construction product sales.

 What do you see right now, like in two months of second quarter? Have you seen any, like, extension of this deterioration in terms of domestic demand? That's my first question.

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 Alexey Lukashov,  Mechel OAO - IR   [20]
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 The question will be answered by Oleg Korzhov.

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 Nikolay Sosnovskiy,  UBS - Analyst   [21]
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 And then the -- .

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 Oleg Korzhov,  Mechel OAO - CEO   [22]
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 (interpreted) -- So, as far as the steelmaking segment is concerned, we expect that, during second quarter, our amount of steel output will remain at the level of the first quarter. Here, we do not see any deterioration particularly. I would describe that, in the steel product, which is a base one in terms of the product category, we're even able to increase the amount of sales as opposed to Q1, not significantly, but still.

 And we were able to see that, indeed, during the second quarter, the market for the construction [steel] (inaudible) product, was volatile to a certain extent. And in a number of items, we noted the decrease of the amount of sales as well as the demand went down. But, in as far as our sales was concerned, it was not a factor. Even in some of the construction segment, we were able to sell more than during the first quarter.

 As far as the sale prices are concerned, we've went through a bit of an adjustment during 2Q because the prices of Q1 were very positive in terms of the forming trend. And during the second quarter, there was a bit of an adjustment in prices. But, as of right now, prices have stabilized. And I would even say that, in certain number of categories, we are noting an increase of sale prices, for example, like for the rolled products in the domestic market.

 So, principally speaking, I shall summarize. We didn't notice any [fact over us] during the second quarter. And the price situation for us is quite stable.

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 Nikolay Sosnovskiy,  UBS - Analyst   [23]
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 Yes, then if it's possible, would be really good to have a clarification on this. What's been helping you to really buck the trend on the domestic market and increase your sales in second quarter opposing to the overall declining trend?

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Unidentified Company Representative Mechel OAO   [24]
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 (interpreted) Well, I would attribute it to possibly the art of our marketeers and salespeople because, as we used to say at our rail mill, we are enhancing the categories of products that we are shipping to new markets. And we're looking for ways to enhance our overall sales.

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 Nikolay Sosnovskiy,  UBS - Analyst   [25]
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 Thank you. And my second question is on your debt restructuring negotiations. Can you please clarify, if possible, what are exact terms achieved between you and VTB, Gazprom Bank? And what's the point of discussion in the remaining case with Sberbank? Thank you.

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Unidentified Company Representative Mechel OAO   [26]
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 (interpreted) With respect to the first two lenders that you have mentioned, specifically VTB and Gazprom Bank, we are currently in the process of acting on the agreements that we have achieved some time ago. And effectively, we are now working on a new loan documentation.

 Alongside with that, we are trying to negotiate with Sberbank, although I should expect you to be better -- knowing better the response from Sberbank out of the open media sources. So far, we haven't reached any finalization with the Sberbank. But, we're very much hopeful to achieve it.

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 Nikolay Sosnovskiy,  UBS - Analyst   [27]
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 And are you able to disclose the exact agreements that have been already achieved between you and VTB, Gazprom Bank?

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Unidentified Company Representative Mechel OAO   [28]
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 Unfortunately, no, we're covered by the confidentiality agreements.

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 Nikolay Sosnovskiy,  UBS - Analyst   [29]
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 Okay. Thanks a lot.

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 Alexey Lukashov,  Mechel OAO - IR   [30]
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 Thank you. Next question, please.

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Operator   [31]
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 [Alexander Drobushas], [Iyonka Capital].

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 Alexander Drobushas,  Iyonka Capital - Analyst   [32]
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 (interpreted) The first question, if we heard it correctly, is whether Mechel is planning to divest from any additional assets. And will there be any arrangement achieved in this sense with the Russian railroads? And it would be great to understand, what is the timeframe within which you might be able to achieve any outcome of your situation with Sberbank? Thank you.

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 Alexey Lukashov,  Mechel OAO - IR   [33]
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 Oleg Korzhov will answer.

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 Oleg Korzhov,  Mechel OAO - CEO   [34]
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 (interpreted) So, without doubt, if we do have any technical possibility to use such an instrument as the government support, we will definitely resort to it, but so far, there is no government support that is being considered because we are going through the restructuring and various issues that we're having with our lending banks.

 So, first of all, we'll have to sort things out with the lenders. And then possibly, we might ask the government to provide us with any support necessary.

 Now, as far as the Russian railroad possible deal is concerned, we undertook several attempts to divest from that infrastructure project. But, unfortunately, we are where we are right now. And in terms of any sources to finance the acquisition by the Russian railroad or any other entity are not visible. So, we're currently at the point where we are, which is that this line is part of the Elga infrastructural project.

 Nevertheless, we are not standing still. We are actively looking for possible financial instruments, which would enable us in as far as this project is concerned to achieve certain financial resources in exchange for this railroad line.

 As far as the negotiations with Sberbank are concerned, we're very much interested in being able to find any compromise. We are applying all possible efforts in order to find it. We have an understanding as to where we should go and how we should go about it.

 But, it's difficult for me to give you any specific timeframe because we're originally planning to achieve a certain kind of an arrangement by this point in time in terms of the principle restructuring. But, we don't have it.

 So, we are very much hopeful that, sometime by the end of summer, we'll be able to identify this compromise and would be moving into the homestretch in terms of our restructuring with Sberbank.

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 Alexey Lukashov,  Mechel OAO - IR   [35]
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 Next question, please.

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Operator   [36]
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 (Operator Instructions). Barry Ehrlich, Citibank.

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 Barry Ehrlich,  Citibank - Analyst   [37]
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 Yes, hello, I have a follow-up question. I'm going to refer to the cash flow statement, where you show cash provided by operating activities positive $111 million and cash from investment activities negative $49 million. So, putting those together, it appears that free cash flow was around positive $60 million during the first quarter.

 I wanted to ask whether that is reflective of the, let's say, backing out any one-off or nonrecurring components related to interest payments, whether that is really reflective of the current cash flow into the Company in the first quarter, whether that level is sustainable going forward, assuming your CapEx remains low. And I understand you may increase your CapEx at some time. But, assuming it remains low, is that sustainable? Thank you.

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 Alexey Lukashov,  Mechel OAO - IR   [38]
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 The question will be answered by Andrey Slivchenko.

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 Andrey Slivchenko,  Mechel OAO - CFO   [39]
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 (interpreted) Now, in as far as the sustainability of the operational cash flow is concerned, I would say that it would largely depend upon the sustainability of EBITDA. So, if we do believe that $200 million plus on the EBITDA side is sustainable, then I would call it as the proper level that we should follow in the course of the year.

 And as far as the investment cash flow is concerned, we used to say it previously, and we continue to state that, in terms of any material investments, we're not going to make them that we will be spending our money primarily into maintaining and sustaining the current operations.

 And as far as any specific figures are concerned, they do reflect the real state of affairs you find within one-off accruals and payments. But, it would be more proper to follow EBITDA, again, as far as it's concerned because it contains in itself both the accruals of fines and penalties that I've mentioned previously. And most probably, there will be written off as well here. You may find certain other amounts of the accruals that would be continuing to be part of it in the foreseeable future.

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Operator   [40]
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 There is no further question.

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 Alexey Lukashov,  Mechel OAO - IR   [41]
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 Ladies and gentlemen, thank you for taking the time to join Mechel's first quarter 2015 financial results conference today. The replay of the call will be available on Mechel's Website. If you have any further questions, please contact the Investor Relations Office. Thank you, again, from all the team here.

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Editor   [42]
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 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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