Half Year 2015 Mechel OAO Earnings Call (US GAAP)

Sep 11, 2015 AM EDT
MTLR.MZ - Mechel PAO
Half Year 2015 Mechel OAO Earnings Call (US GAAP)
Sep 11, 2015 / 03:00PM GMT 

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

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Conference Call Participants
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   *  Nikolay Sosnovsky
      UBS - Analyst
   *  Sergey Donskoy
      Societe Generale - Analyst
   *  Barry Ehrlich
      Citibank - Analyst

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Presentation
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Operator   [1]
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 Good day and welcome to Mechel Reports the First Half 2015 Financial Results Call. Today's conference is being recorded. At this time, I would like to turn the conference over to the speakers. Please go ahead.

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 Alexey Lukashov,  Mechel OAO - IR   [2]
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 Thank you, and good day, everyone. I would like to welcome you to Mechel's conference call to discuss our first half 2015 results, which were reported today. With us from management today are Mr. Oleg Korzhov, Mechel's CEO; and Mr. Andrey Slivchenko, Mechel's CFO.

 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 provision of the US Private Securities Litigation Reform Act of 1995.

 We wish to 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 discussions today. Reconciliation of non-GAAP financial measures to the most directly comparable US GAAP financial measures are contained in the earning press release, which is available on our website at www.mechel.com.

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

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 Oleg Korzhov,  Mechel OAO - CEO   [3]
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 (interpreted) Good afternoon, and good morning, ladies and gentlemen. We're glad to welcome you to the conference call for the Company's first half 2015 financial results.

 In the first half of this year we have worked confidently and well. In comparison to the same period last year, both our financial and operational results have improved, even though our dollar-denominated revenue has slumped by 34%, primarily due to the currency exchange rate changes. EBITDA went up by 49%, which yielded us sufficient cash flow to continue operations and service our current debt.

 Consolidated revenue in the first half of this year was $2.272 billion, with consolidated EBITDA at $390 million. I would like to note in particular that in the second quarter of 2015 we managed to show net income for the first time in 11 accounting periods. This is a positive sign. But we still have a lot of work ahead of us if we want to solidify this success.

 Global commodity prices in the second and third quarters of 2015 continued to sink below historical minimum, as demand primarily from China, weakened. Nevertheless, Mechel's mining enterprises continues stable work, capitalizing on their fundamental advantages such as operational cost level, a comprehensive and streamlined supply chain, as well reliable access to our markets established over the years.

 We continue to actively work with our traditional customers. For example, we have recently signed a long-term contract for coal supplies with Japan's JFE Steel. At the same time, a number coal companies, particularly in North America, are massively closing down mines and pits and filed for insolvency. We still expect that production cut-downs from the market's most inefficient players will resolve the oversupply problem, and will ultimately bring about restoration of the prices.

 The steel division operated in less volatile conditions and demonstrated good results in this half of this year. We retained stable sales levels, increasing the share of high-value-added products in lieu of low-margin semi-finished products. In the second quarter, we increased sales of forgings, stampings, and flat rolls. The demand from construction companies became more active as summer drew closer, and supported our rebar sales.

 Our investment projects are developing successfully. We have passed certification of our rails for supplies to Russian Railways, and are currently in talks regarding their price and supply volumes. Since the beginning of this year, the Universal Rolling Ma ill has shipped off over 100,000 tonnes of high-quality products, including rails.

 The Elga project demonstrates steady growth of operational results with yet another record reached in August, as the complex shipped off 300,000 tonnes. Mining over these 8 months totaled 2.6 million tonnes of coal, which is more than double of the entire amount mined last year.

 We continue to work on restructuring the Company's debt, and have already signed agreements with Gazprombank and VTB. Negotiations with Sberbank are carrying on in a constructive manner. And I would like to offer my sincere gratitude to our colleagues in those banks that showed understanding of our situation, and gave their trust to our Company, and lent us their support. We're doing everything in our power to justify the trust of our lenders and shareholders.

 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   [4]
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 Good evening, and good afternoon, and good morning, ladies and gentlemen. I'm glad you joined us today at this call.

 The second quarter of 2015 has become a breakthrough, as we have seen net profit of $34 million, regardless of the deteriorated market and ruble fluctuations. Of course the dominant factor in the second quarter financials was the appreciated ruble. It worked both ways, affecting profitability and supporting revenues.

 On the other hand, strong expectations on further currency devaluation are pushing up costs. So we have seen decrease on the gross and EBITDA margins across all the segments. Stronger ruble slightly increased our debt. But the important message today is that, as was just mentioned, we have just recently managed to sign restructuring agreements with two of our major lenders, Gazprombank and VTB.

 Revenues, both global and domestic markets this year showed no improvement, which resulted in further decline of average of 34% of sales year on year. However, in the second quarter 2015 we have seen an increase in our revenues of almost 4% across all of our segments, from $1.11 billion to $1.16 billion.

 Of all sales, mining brought almost 33% and steel contributed 56%. In mining, revenues decreased by 7% quarter on quarter, due to the world price declining trend and decrease in volumes of coking coal and iron ore sold to third parties, pushing intercompany sales up.

 Coking coal and coke sales were down by 5%. Steam coal sales were up by 9%. Sales of anthracite and PCI remain at the same level.

 Revenues in the mining segment were $363 million in the second quarter, and amounted to $753 million for the first half of the year.

 In steel revenues increased by 13%, headed by seasonal increase of long product sales, which contributed 18%, including increase in rebar sales of 21%. Second quarter revenues amounted to $682 million, up from $601 million in the first quarter.

 Exports amounted to 36% of revenues, of which 71% contributed by the mining segment.

 The level of gross margins increased across the segments from 34.4% in the first half of 2014 to 41.7% in the first half of 2015. In the second quarter, gross margins slightly shifted down by about 2%, insignificantly, due to the increased cost of raws.

 EBITDA, consolidated EBITDA in six months 2015 amounted to $390 million, a 49% increase from the same level a year ago. EBITDA margin also increased from 7.6% to 17.2% year-on-year basis. The segment contribution was almost equal, 52% from mining and 48% from the steel segment.

 In the mining segment, both decreased prices on sales of products as well inflating ruble-denominated costs led to a 9% drop in EBITDA to $96 million, although the half-year EBITDA increased by 24% to reach $202 million.

 Steel segment showed a more significant decrease of profitability of 22% in the second quarter. EBITDA amounted to $83 million for the quarter, and $188 million for six months. Cost inflation is picking up most in the steel segment, as ruble depreciates. So that is both the deferred effect of the depreciated ruble in the beginning of the year, and inflationary expectations on the market.

 Overall profitability of the segments remains high as compared to the previous year, 20.57% in the mining segment and 13.8% in the steel segment.

 Profits, the Group showed operating profit of $238 million in the six months 2015, up from $15 million a year ago. On an adjusted basis, half-year operating income amounted to $260 million in 2015, up from $46 million in 2014.

 Operating income in the second quarter of 2015 dropped by 18% from $131 million in the first quarter 2015 to $107 million in the second quarter. For the first time since 2012, the Company shows net income of $34 million for the second quarter of 2015, much due to the exchange rate fluctuations.

 Cash flows, in the first half of 2015 the Company financed its investment and financing activities using its working capital. Primarily we paid down overdue interest. Interest payments in the second quarter almost doubled from $100 million in the first quarter to $187 million in the second quarter. As a result, trading working capital decreased by another $192 million.

 As far as debt is concerned, in the first of 2015 there was no significant change in debt except for the bonds redemption and exchange rate effects. Eventually the net debt, including leasing, was down by only 1%, and totaled $6.9 billion, which is 8.3 times the EBITDA for the previous 12 months. I would remind you that last year the ratio was up at more than 15 times.

 Interest burden was also down from $479 million in the first half of 2014 to $394 million in the first half of 2015. Quarterly interest expense net of fines and penalties was $143 million in the second quarter, versus $193 million in the second quarter of 2014.

 Accrued fines and penalties for overdue payments amounted to $186 million for the first half of 2015, and are expected to be written off as a result of the signed restructuring agreements, subject to fulfillment of the conditions subsequent of such agreements.

 That's it I have to point out today, and welcome with your questions.

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Questions and Answers
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 Alexey Lukashov,  Mechel OAO - IR   [1]
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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 a translation. So you may ask your questions in Russian also, and we will translate.

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Operator   [2]
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 (Operator Instructions). Nikolay Sosnovsky, UBS

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 Nikolay Sosnovsky,  UBS - Analyst   [3]
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 Hi. It's Nikolay Sosnovsky from UBS. Thanks a lot for the presentation. Actually I've got several questions. First of all on the recent market developments and with regards to domestic steel prices, what we've been seeing in September is significant divergence between hot rolled coil and domestic rebar prices. Basically it reached like more than $60. And we haven't seen such a difference in many months. What do you think about the sustainability of this situation, and what would you expect in terms of prices in the remainder of the year, especially given the ruble weakness? That's the first question.

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 Alexey Lukashov,  Mechel OAO - IR   [4]
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 The question will be answered by Oleg Korzhov.

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 Oleg Korzhov,  Mechel OAO - CEO   [5]
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 (interpreted) As you might know that our niche in the steel segment falls into the construction projects and fasteners. And so as far as the pricing for these particular types of products throughout the year are concerned, we have been observing a certain volatility during Q1 where prices were sufficiently high. There was quite a hectic demand for it. Then in Q2 prices leveled off. And so during the third quarter there is a bit of a volatility in prices because of the seasonal nature, because of the dollar exchange rates changes. But overall, this particular market segment, as I stated, the construction products and fasteners, remained in a more or less well-balanced situation. So prices didn't really change throughout this period.

 Before the end of the year, we do not see any particular prerequisites for these fluctuations to be stronger, so quite I would say that the possibility for prices to be changed in the market can come only from the exchange rate differences. While the rest of them will stay as is.

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 Nikolay Sosnovsky,  UBS - Analyst   [6]
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 Okay, thank you. And the second question is regarding your financials, actually. I wanted to ask you to help me reconciliate your interest expense payments in terms of what we see in your profit and loss statement, which is like roughly $0.5 billion, how it splits into, let's say regular interest and these penalties and what exactly would be cancelled as a result of the negotiation. And the cash flow statement, where we see actually only insignificant cash expenditures in terms of financial activities. And also in the balance sheet we see that accrued taxes and other liabilities increased quite significantly over the first half.

 So actually what went into the actual cash payments, and what was accrued and then still to be paid during the second half or at a later stage?

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 Andrey Slivchenko,  Mechel OAO - CFO   [7]
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 (interpreted) So in answer to this question is that in the P&L you do see $491 million in terms of our expenses, out of which as I said, about $186 million are the fines and penalties for the overdue interest payments. So respectively we count that we will be in a position to meet the terms of restructuring. And so these fines and penalties are going to be written off.

 So as far as the accruals are concerned in terms of there is -- and the cash flow, it won't be possible to give you a quick answer in terms of which kind of interest comes from where. The [200 and 227] respectively are the tax and other liabilities in terms of what you can see. Out of which, I would guess that approximately $90 million is the tax liability. Whereas the rest of it, which is $280 million, would contain within itself the fines and penalties that I mentioned about, which is $186 million.

 And next is the accruals that you may -- the one that you're asking about, which is $100 million. And the $305 million as separate items, which would require some more labor time in order to give you an explanation. So there is another aspect to it which is the interest capitalization, so as to understand the differences better in between different line items. But with your permission, we would prepare this reconciliation for you as a separate [piece] of information, and would make it available at a later point in time.

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 Alexey Lukashov,  Mechel OAO - IR   [8]
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 Next question, please?

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Operator   [9]
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 Sergey Donskoy, Societe Generale

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 Sergey Donskoy,  Societe Generale - Analyst   [10]
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 Yes. Thank you. I had a few questions, actually. Number one, and I apologize if this was covered during the presentation. I missed the first part of it. What -- actually the new terms agreed with the banks as a result of the restructuring, what will be your interest payments now and starting from what period? And what is the debt repayment schedule, at least in broad strokes? And I have a few more questions.

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 Andrey Slivchenko,  Mechel OAO - CFO   [11]
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 (interpreted) So in answering the first question, the terms and conditions for the restructuring that we have signed with the above mentioned two banks are almost the same in terms of the repayment schedule. It has a grace period until April 2017. And then in the course of the following three years, the repayments will be done in even installments. As far as interest payments are concerned, the interest level will be dependent upon the key interest plus the margin.

 In one case we have an interest capitalization term above a certain fixed rate. In the other case there is no condition like that. So respectively as far as both restructuring arrangements are concerned, we are supposed to be paying the interest payments in accordance with the schedule.

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 Sergey Donskoy,  Societe Generale - Analyst   [12]
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 Could you maybe give some indication of what these payments on the new agreements will be in dollar terms, and again, starting from what period? I mean sorry, not just for these payments, but your total interest payments on all outstanding debt, taking into consideration these new agreements.

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 Andrey Slivchenko,  Mechel OAO - CFO   [13]
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 (interpreted) I am not in a position at this point in time to quote to the total amount. Because about 47% of our credit portfolio is still subject to restructuring and specifically with Sberbank, and all of the foreign lenders. So I'm not going to give you this total amount, since it has to be done with these payments in mind.

 The only thing that I can note in terms of what we see right now, is that EBITDA exceeds the amount of interest payment -- I mean the current interest payments.

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 Sergey Donskoy,  Societe Generale - Analyst   [14]
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 Okay, thank you. And two more questions, first could you give me the amount of capitalized interest in Q1 and Q2, and give us your current CapEx target for the year, excluding capitalized interest.

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 Andrey Slivchenko,  Mechel OAO - CFO   [15]
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 (interpreted) The amount of capitalized interest in the second quarter amounted to approximately $53 million.

 As far as the question about the CapEx target was concerned, during H1 2015 these amount to about $50 million, including for maintaining operations about $20 million, and to pay our investment projects about $30 million.

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 Alexey Lukashov,  Mechel OAO - IR   [16]
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 Next question, please?

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Operator   [17]
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 (Operator Instructions). Barry Ehrlich, Citibank

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 Barry Ehrlich,  Citibank - Analyst   [18]
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 Yes. I have two questions please. Should we assume that third quarter EBITDA will be lower than second quarter?

 And second question, the run-of-mine production in the first half was higher. But coal sales, met coal and steam combined, fell it looks by about 1 million tonnes. What explains that gap? Is it lower yielding coal? Is it some stockpiling, or another factor?

 Can I just rephrase the first question please? Just to clarify that I'm asking about third quarter EBITDA, and confirming that it will be lower than the second quarter.

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Unidentified Company Representative   [19]
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 (interpreted) It is difficult to either confirm or not say that EBITDA is going to be higher or lower. We are hoping to see the same level of EBITDA overall. Because there are quite a few factors which are always moving in the modeling and in the outlook. And one of the uncertainty factors is the exchange rate, which defines the way prices and expenditures are going to be changing in the domestic market.

 And so in terms of the external sales, this is also dependent upon it. But nevertheless we are hoping to see the same level.

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 Barry Ehrlich,  Citibank - Analyst   [20]
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 Okay. And my second question, just to rephrase it please, that run-of-mine production rose. Coal sales fell in the first half by a substantial amount. Why did that occur?

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Unidentified Company Representative   [21]
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 (interpreted) So in terms of the figures of sales that you've seen and the shipment of coal that were due was going to the third parties. And if you take a look at the overall amount that we shipped, based on the results of H1 2015, it is similar to the results we showed last year in 2014. Last year during the six months, we've shipped about 10.2 million tonnes. And so this year, we've demonstrated the same figures in the first half. So the kind of devaluation that you've noted dedicated to the third parties was compensated for by the amounts we shipped. And the needs for coal within the enterprise in the group, which was Mechel (inaudible).

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 Barry Ehrlich,  Citibank - Analyst   [22]
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 Yes. Then can I have a follow-up question please? Where do we see that in steel production or steel sales? Where did those internal volumes go to?

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Unidentified Company Representative   [23]
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 (interpreted) Not all of the coal types that we consume previously have been produced by us. So with the commissioning into operation of the Elga Project, what we do is we are substituting the G-gauges of coal with the coals that we produce ourselves. You won't see it in steel. Because our iron production has reached a full capacity. And we previously were trying to buy it from a site whereas currently we are reaching the capacity to support our own needs with our own production of coal.

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 Alexey Lukashov,  Mechel OAO - IR   [24]
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 Next question, please?

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Operator   [25]
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 Sergey Donskoy, Societe Generale

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 Sergey Donskoy,  Societe Generale - Analyst   [26]
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 Yes. I'm not sure that one of my questions was answered in full. So I was wondering, what is your CapEx forecast for the full year, excluding capitalized interest? And one follow-up to what I asked before, if I understood correctly, the amount of interest capitalized in the second quarter was $53 million. At the same time, the CapEx including capitalized interest was, I think, about $58 million. So if I subtract one from the other, it appears that your total capital expenditure during Q2, including sustaining CapEx was something like $5 million. I'm wondering if this math is correct, and this number it seems quite small, given the amount of capital in the fixed assets you employ. Thank you.

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 Andrey Slivchenko,  Mechel OAO - CFO   [27]
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 (interpreted) So as far as the second part of the question is concerned. I'd rather touch up on this first, because I can't see where do you get the figure of $58 million as the total one including both for the investment spending and the capitalized interest. Could you possibly explain how did you come up the $58 million, because the $53 million of capitalized interest, is not reflected as far as cash flow is concerned, as far as investment spending is concerned. That is something that increases our debt burden and as far as the interest due are concerned. But if you take a look at the cash flow, that reflects the already paid for investment expenses.

 So the kind of questions that you are trying to raise with respect to the investments, which we plan for next year, that these are definitely the investments which do not include the capitalized interest. And so these are the two notions which are not directly related to each other.

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 Alexey Lukashov,  Mechel OAO - IR   [28]
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 The second part of the question will be answer by Oleg Korzhov.

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 Oleg Korzhov,  Mechel OAO - CEO   [29]
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 (interpreted) And as far as the current plans for the capital expenditure is concerned, our CFO will give you an explanation with the capitalized expenses. For this year, we had a plan for about $150 million. And so about $40, $42 million is what we're going to spend for sustaining purposes, and about $110 million will be our investment spending.

 And as we've previously stated more than once, these are not any kind of new expenses related to any new projects. But this is either related to the payables that we have, or the completion of the investment projects, which we had been working on previously.

 Now considering the results of H1 at RUB150 million we have funded out about RUB50 million, as I previously stated. And so our sustaining CapEx is something that we are able to maintain in full. We've planned RUB40 million for the full year. We've spent RUB20 million of them during the first half. And as far as our investment projects are concerned, we are lagging behind slightly. But as I said, this is not being reflected largely speaking, about the way these investment projects are being completed. Primarily these are the payables. And so we are taking care of it as we can. And out of RUB110 million, we should plan to pay out this year, as I've previously stated.

 During the first half, we've been able to spend about $30 million. Thank you.

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 Andrey Slivchenko,  Mechel OAO - CFO   [30]
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 (interpreted) As far as the first part of the question is concerned, I have been able to sort it out. And I understand what you were after. And you are indeed correct in estimating out of $58 million, which were paid as investment in Q2, $53 million is capitalized interest and $5 million of it, which was in the P&E line.

 So there are slight methodological discrepancies. So if you would like to, we can spend some separate time on it offline. But generally speaking, your calculations were correct.

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 Sergey Donskoy,  Societe Generale - Analyst   [31]
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 (interpreted) And the follow-up question is about the $40 million for sustaining purposes, which is approximately 10 times less than what for the same kind of sustaining CapEx that's being spent by your major competing colleagues in the industry, which are major integrated steel companies. Taking into account the size of the business, I would assume that this particular figure could be 3 times less. But 10 times less is what gives me the reason to question the extent to which this could be considered as sustainable long term. And will the Company be able to perform all of the necessary investments to sustain its operations, having just $40 [million] dedicated to it? And won't this create any major risk in terms of the long-term future of business operations?

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 Oleg Korzhov,  Mechel OAO - CEO   [32]
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 (interpreted) And so as you correctly stated, it is difficult to cast a philosophical glance over it, because it is difficult for me to understand what are the specific companies you're trying to compare us with as far as sustaining CapEx is concerned. In our particular case, in the case of the Mechel Company, approximately 70% is what we spend on the mining facilities that we have.

 So there are certain aspects in this overall issue. As the amounts that are being produced through the open pit or closed pit methodology. So it's difficult to make an apple-to-apples comparison. Because you have to bear in mind the composition equipment, when it was bought, its selective service and its utility in terms of the periods. So I would approach this particular issue as well philosophically, but from a different angle.

 Because during the more comfortable years, when we didn't have any big problems with our debt burden, we would spend approximately twice as much as you are seeing right now. And that was a more positive kind of characteristic. And back during 2012-2011, we have spent some considerable amount of money, specifically for sustaining CapEx into our mining operations.

 And so bearing in mind the fact that the equipment that we bought in 2011 and 2012, it doesn't work for just three years. Its utility would extend for almost 10 years. So that is a long period of time. So at this point in time, we do have certain issues in terms of its quality, of which is not of a very critical nature.

 So speaking about the longer term, it's definite that we won't be able limit ourselves to this particular level. In about two to three years, we would have to spend more. But again looking at the current year and next year, the kind of spending that we have in the sustaining purposes are enough for us to maintain a good output of coal, as well as in the rest of our operations, so as to keep up with the kind of output levels that we've demonstrated during a few previous years.

 But still thinking additionally about the nature of what you might be seeing, when I would talk about the reduction of the sustaining CapEx in absolute terms, one should also note that we've gone through very considerable business structure changes. Because compared to 2008 and 2009, even 2011 and 2012, when Mechel inner structure had different (inaudible) assets in Bluestone, with its capacities as well as Romanian entities in quite big numbers; all of those assets distracted a sizeable amount for sustaining CapEx.

 Now with us having them no more and following just the logics and arithmetics, we are able to operate right now without the need to spend as much money as we had to in the past.

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 Alexey Lukashov,  Mechel OAO - IR   [33]
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 Next question, please?

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Operator   [34]
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 There are no further questions in the queue. As there are no further questions, this will conclude today's question-and-answer session. I would now like to turn the call back to the speakers for any additional or closing remarks.

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 Alexey Lukashov,  Mechel OAO - IR   [35]
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 Ladies and gentlemen, thank you for taking the time to join Mechel's first half 2015 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 Investor Relations office. Thank you again from all the team here.

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Operator   [36]
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 Thank you. That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.

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Editor   [37]
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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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