Cleveland-Cliffs Inc. Q2 FY2020 Earnings Call

Good morning, ladies and gentlemen. My name is Lashana, and I am your conference facilitator today. I would like to welcome everyone to Cleveland-Cliffs Second Quarter 2020 Earnings Conference Call. All lines have been muted to prevent background noise. After the speakers' remarks, there will be a question-and-answer session. The company reminds you that certain comments made on today's call will include predictive statements that are intended to be forward-looking within the safe harbor protections of the Private Securities Litigation Reform Act of 1995. Although the company believes that its forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially. Important factors that could cause results to differ materially are outlined in reports on forms 10-K and 10-Q and news releases filed with the SEC, which are available on the company's website. Today's conference call is also being broadcast on the Cleveland-Cliffs website. After the call concludes, it will be archived on the website and available for replay. The company will also discuss results excluding certain special items. The reconciliation for Regulation G purposes can be found in the earnings release published this morning. At this time, I would like to introduce Lourenco Goncalves, Chairman, President and Chief Executive Officer.

Thanks, Lashana, and good morning to everyone. Over the past few months, our company has put on full display the strong resilience that I have highlighted in the past. Despite dealing with a period of time in which our largest end market, the automotive sector, was effectively closed, we were able to preserve and enhance our business. Very early on and ahead of any official mandates or guidelines, we implemented initiatives to protect the health and safety of our employees. We then adjusted our footprint for both the sharp reduction in demand, as well as its gradual recovery. By taking down and then restarting 15 facilities over a three-month period, at the same time, we improved our strong liquidity position and preserved our healthy balance sheet. In addition, acting as fast as only Cleveland-Cliffs can, we were able to create $181 million in equity by executing our perfectly timed liability management transaction. Fast forward to today, with the automotive sector back to more normal levels of activity, we have resumed production at all of our facilities that were temporarily idled, except the North shore, which will be back in operation next week. With that, we are back on track and ready to fulfill our vision for the new Cleveland-Cliffs, which includes our mines and pellet plants, AK Steel, AK Tube, Precision Partners, and our new HBI plant. With our HBI plant in operation later this year, we will be able to add mini mills to our portfolio of clients. This will spread our exposure to other sectors beyond automotive. As you know, Cleveland-Cliffs is essentially a supplier to the automotive industry, both directly through our subsidiary AK Steel and indirectly through our third-party clients for blast furnace pellets. While we are already at the place where other new companies would like to be, with more than 60% of our production and sales dedicated to automotive, our second quarter results were a direct consequence of the almost complete and sudden shutdown of the entire automotive sector and generating costs associated with some of our assets, as unusual and unexpected as it was. That's what happened in Q2. As the second half of the year progresses, steel shipments will continue to improve and idle expenses will fall back to zero. The second quarter did not change anything related to our strategy. Our fully integrated footprint from captive iron ore mines through high-tech carbon and stainless steels and auto parts gives us a unique technological advantage that no one else can replicate. In the demanding business of supplying steel to the automotive industry, chemical and metallurgical consistency is critical. We can do this very well. Because, among other things, we have our own iron ore production and are self-sufficient in-house. We also have the right equipment to produce the highly specified materials our automotive clients need, including blast furnaces and DRI for carbon steel, as well as electric arc furnaces and AODs for stainless steels and state-of-the-art downstream facilities for both carbon and stainless steels. Equally important, we also have the dedicated brainpower and capability to develop the skills for the future cars, something others in this market will not be able to accomplish anytime soon. Our clients know that, and so do our competitors. In the current U.S. automotive industry, our level of technical capabilities is more important to our clients than it has ever been. One unique element of automotive demand in the United States has historically been the prevalence of fleet sales, such as rental cars, which in the past have accounted for about 20% of all new vehicles sold. Different from retail clients, fleet buyers do not care as much about the quality of the car; to them, it is all about costs. So over the past three decades, we have seen costs, not quality, become the primary value for many American carmakers. However, this approach is quickly becoming outdated. Due to the pandemic, fleet sales are sharply down, whereas the retail car buyer has been largely unaffected, as sales to the American consumer have remained close to pre-COVID projections. The American automotive market is now a consumer-driven market. The pandemic has made car ownership trendy again, and while fleets buy cars because they are cheap, people buy cars because they are reliable, cool, and fun to drive. After decades of foreign competitors gaining market share in the United States by recognizing this trend, American-based car companies are starting to fight back. We finally have American car companies innovating again, after a long period of having their lunch eaten by global competitors. Tesla is the best example. Knowing that a car is essentially just one ton of steel on wheels, a theoretical $200 per ton price increase for highly specified galvanized steel would theoretically force an increase on the final price tag of the car by only $200. No consumer would choose not to buy a car just because the car is now $200 more expensive. Perhaps fleet buyers would change their minds due to a $200 price increase per car, but not individual consumers. Conversely, an equivalent price tax decrease of $200 would not be compelling enough to make anyone not planning to buy a car decide to do so, but that would certainly drive all the qualified new suppliers out of business in the United States and also in other countries such as Japan, Germany, South Korea, or France, just to name a few of the countries that are home to steel companies with technological expertise to supply all the needs and demands of the automotive industry now and in the future. Our goal with the new Cleveland-Cliffs is to regain the value lost in the supply chain over the past several years. For decades, steel companies have allowed highly specified skills, carrying a lot of technology and value to the clients, to be treated and priced as commodities, as if anyone could produce and supply the same materials. That's simply not true. To continue investing and supporting the challenges of the automotive industry of the future, steel suppliers, including Cleveland-Cliffs, must realize a return on their investment—and we will. One problem we have been fighting since we acquired AK Steel is the proliferation of gossip and deliberate attempts to influence the market—all the rumors that circulate in the steel market these days. In this parallel universe of misinformation, the steel news is always one step away from flooding the market with unnecessary and unwanted products. Prices of scrap and steel products are always going down, or at least they are expected to do so soon. And hot rolled coil (HRC) is a proxy for everything else in the steel business. Well, I am pleased to inform you that HRC, as defined by the CRUs, AMMs, and plans of the world is commodity grade steel and has nothing to do with automotive. It is a fine product for many applications, like in the energy market, but not for automotive steel. In fact, we, at Cleveland-Cliffs and AK Steel, do not care much about HRC because hot rolled is just a small fraction of the product mix we sell. As far as carbon steels, what you really care about is automotive-grade galvanized steel and other products used in high-end applications such as exposed parts. Our goal with future contract renewals will be to make it very clear that over the course of the next few years, we will start receiving the proper value for what we do for our automotive clients. We have already won the hardest battle of this war because our customers love our products, and our ability to deliver high-quality consistently and on time has been demonstrated by the awards we recently received from General Motors as Supplier of the Year for the third year in a row. The next phase is to translate this support into higher margins, which we will be implementing and accomplishing in due course. As you may recall, we did the same thing with the iron ore pricing back when I started at Cliffs. Back in 2015, the big players in Australia and Brazil were all stuck in a completely irrational race to the bottom. Iron ore pricing was forecasted by every predictor to stay below $40 per metric ton in perpetuity. We were the ones who called out the underlying observations of such a reckless attitude toward pricing. Ultimately, rationality was restored to the market. Since then, we have enjoyed appropriate prices, and the current number above $110 per metric ton is no longer a surprise. We are pleased that the recent recovery in manufacturing activity and demand has allowed us to bring our temporarily idle assets back to operation. The most exciting restart, however, is that of the construction of our Toledo HBI plant. Despite new COVID-related restrictions on the number of workers allowed on-site, we were able to come up with a solution to start producing HBI before the end of this year. Due to these restrictions, we will need another four months to complete construction and start operations, but the intensified demand for locally sourced or base metallics made finding a way to restart construction sooner rather than later a top priority for us over the last couple of months. Last but not least, I would like to provide a brief update on the achievements of the synergies we committed to when we acquired AK Steel back in March. We announced last quarter that we had already set in motion the $120 million in synergies that we expected to realize within one year. As of today, I'm pleased to announce that we have identified and set in motion a total of $151 million in synergies, exceeding our original target by $31 million. These additional synergies have come from a deeper understanding of our real needs at the overhead and operational levels, four months into the acquisition of AK Steel by Cleveland-Cliffs. I will now pass it over to Keith Koci for a discussion on our quarterly results before giving my final remarks and opening the call for Q&A.

Thanks, Lourenco. As you noted, our second quarter results reflected the full impact of the COVID-19 pandemic on the volume and cost side of each business segment. On a positive note, due to the contracts we have in place and the value-added nature of what we supply, overall pricing for both our steel and iron ore products was not impacted by the demand environment. Our quarterly consolidated adjusted EBITDA loss of $82 million was driven by lower than typical steel shipments, as well as $150 million in cash idle costs that were incurred as a result of the several facilities that were temporarily taken down during the quarter. In the steel and manufacturing segment, as expected, the most significant impact on shipments was from our automotive carbon side, which were about 250,000 tons for the quarter, down 65% compared to last year's second quarter. However, momentum began to pick up by the end of Q2, with over 70% of the auto carbon shipments recorded in the quarter going out in June, totaling 177,000 tons. That rate has accelerated into July, as we expect to record about 210,000 tons in auto carbon shipments, further evidence that the second quarter was truly an anomaly. In addition, the bulk of the idle costs recorded for the quarter came from this segment, which will be substantially reduced in Q3 as all temporarily idled facilities, including the Dearborn blast furnace, have resumed operations. As for mining and pelletizing, sales volumes of 4.8 million long tons remains solid due to the take-or-pay arrangements we have in place and our customers' need to replenish inventories that were depleted during the winter. Pricing per long ton also held in the mid-90s as the strong IODEX performance offset weaker HRC prices and pellet premiums. Our cost per ton was impacted by idle expenses, which will be mitigated in future quarters now that Tilden has resumed operations and Northshore is slated to restart next week. Because our blast furnaces are still working through pellet inventory sold to them prior to the acquisition, most of our one million long tons of intercompany sales were eliminated from corporate EBITDA, translating to about $32 million in negative margin. Net inventory will begin to be released in the third quarter, though we will still show some eliminated margin through the end of the year. Quarterly SG&A expenses were $62 million, of which $28 million flowed through corporate EBITDA, and most of the remainder through our steel and manufacturing segment. Our full year 2020 SG&A expectation has come down substantially to about $210 million, which represents about a 50% reduction from what the combined company would have reported last year. This is a clear illustration of the synergy achievement as described by Lourenco. On the CapEx side of our $145 million in cap spend during the quarter, about $90 million were HBI payments for work done in Q1. The remainder was sustaining capital and capitalized interest. We expect another $250 million in capital spend for the remainder of the year, with about $110 million of that related to the completion of HBI. We maintained our healthy liquidity throughout the pandemic, and we currently have above $1.1 billion available to us between our cash balance and ABL availability. We received our second $60 million AMT tax refund of the year on July 14. Based on our current business projections, as well as the anticipation of over $100 million in working capital-related cash inflows, we expect to generate positive free cash flow in the second half of the year, which factors in the HBI CapEx. This would allow us to exit the year at a higher liquidity level than where we were at the end of Q2. In closing, we have weathered through the most stressful periods of the pandemic and taken the necessary actions to preserve our strong financial position, which allowed us to maintain the desired comfort necessary to restart our Toledo HBI project. We expect a fairly strong second half of the year, which should ultimately lead us to view our second quarter pandemic-driven results as a blip in history, in advance of a robust recovery.

Thank you, Keith. Just like the American economy, our company has already proven its resilience. The pandemic has changed a lot of things, but not the need for our high-end products in an increasingly discerning marketplace. We are ready to look past the impact of customer shutdowns and look into the future where our competitive advantage will always be present. With that, I'll turn it back over to Lashana for questions, please.

Your first question comes from the line of Lucas Pipes with B. Riley FBR.

Hey. Good morning, everyone.

Good morning, Lucas.

So Lourenco, I appreciated your comments on commodity grade steel versus your highly specialized steel products. And I guess we will see your second quarter carbon price in the 10-Q pretty soon. But would you be able to walk us through your carbon steel prices and costs in the second quarter? And where you would expect them to go in the second half of the year? Thank you very much.

Well, we do not have a lot of exposure to commodity-type pricing because, as you know, Lucas, our contracts are set in stone for one-year time frames. Therefore, the prices that we are basically selling to the automotive clients these days—and I'm talking two-thirds of our business—were set in place a long time ago in a different price environment. So we're not going to forecast any numbers for the second half of the year, but the prices are still good and still in good shape. What happened in Q2 was all demand-related; the shutdown was unprecedented. The last time we had something similar to what happened in the automotive industry was during World War II, just to give you an idea. So it was a complete shutdown that came without a lot of anticipation or advice. However, we are past that. June, the last month of the second quarter, was positive. We have stainless in the mix; that was not very negatively affected. We have electrical steels in the mix; even those were not very affected. We have a lot of positive aspects, but automotive was really bad. Going forward, we are seeing automotive very close to normal levels. The common factor is that we are in three shifts, and production levels in the second half will be back to normal, which will change the dynamic drastically. We’re going to be able to show the power of the combination of Cleveland-Cliffs.

Thank you for that, Lourenco. And honing in on the second half, it’s great to hear that there will be cash flow positive. Are you able to, at this point, provide some sort of range? Are we talking $50 million more or less than that kind of rough ballpark? And I believe Keith mentioned the ATM refinance was obtained in July; are there any other kind of discreet cash items that we should consider for the second half of this year to get to that free cash flow positive number? Thank you.

I will let Keith answer that. Keith, please.

Yes, Lucas. The $60 million is part of it. We're also anticipating about $100 million release out of inventory during the second half of this year. That's going to contribute positively to the free cash flow. We're not going to disclose the exact amount, but your $50 million to $100 million is probably about right on what we're looking at right now for positive free cash flow in the second half. We will wait to see how things go, and there’s definitely some potential for some upside as the automotive market recovers.

That's very helpful. I appreciate that, and best of luck. Thank you.

Thanks, Lucas.

Your next question comes from the line of Scott Schier with Clarksons.

Hi. Good morning, everyone.

Good morning, Scott.

Following up on a few of Lucas’s questions. Could you provide any kind of color or commentary around your auto contracts and any early talks or expectations for how 2021 is shaping up?

We are in an ongoing process—because we supply so much to automotive, we are always in an ongoing process of negotiating with automotive. We, of course, do not supply any color or detail on any commercial endeavors that we are taking care of with clients. But overall, it's very positive. The clients understand our position. The clients are getting more and asking for more, not for less from AK Steel. We are the one-stop shop. We can produce great structural steels directly through AK Steel and indirectly through AK Tube. We can provide auto parts to PPHC, Precision Partners. We can provide carbon steels, galvanized, electro-galvanized, and exposed parts. So they like that a lot. So we are in great shape as far as conversations with our great clients, and we are adding new ones. It's not just the traditional ones. We have been very upfront and open to entertain conversations and deals with the likes of Tesla and Nikola and Rivian, along with several other new names that are emerging. We are very happy also that our traditional customer base, like General Motors, Toyota, Ford, and Volkswagen, are heading in the same direction. We look forward into the future, and it's not a month-by-month or quarter-by-quarter basis. This is strategic. That’s where we are at. Not all car manufacturers will survive, but some will. One thing I will tell you, we from Cleveland-Cliffs and AK Steel will be there with all these folks—particularly those that are not price-driven. Typically, those that understand that if they really want to compete and win in the marketplace, they need to partner with us. They need to make money, and we need to make money. The times of imposing price decreases on steel mills are over in the United States. We are not going to allow that to happen through Cleveland-Cliffs and AK Steel. We don't want to go out of business like several mills in Europe are going out of business. We're not going to do the same with ourselves. The good news is that the new wave of cars coming in, and the new wave of car builders that are starting to gain momentum here in the United States, have this technological mindset. That’s exactly where we are.

Okay. That's very helpful. I appreciate that color. Switching gears, are you able to provide any expectations around second half EBITDA, especially on the AK Steel side? Specifically in terms of volumes for the second half, since some auto manufacturers are getting back to three shifts or expecting a return to a more normal run rate of volumes by the end of the year?

Yes. I think we've provided a lot of color regarding what's happening in the second half, but Keith, do you want to elaborate a little bit on the numbers?

Sure. Yes, we won't disclose an EBITDA forecast, but we are counting on about 85% of normal in terms of automotive volume for Q3, and we're looking for 100% of normal by Q4. That’s what we've got baked into that free cash flow assumption.

Okay. Great. I appreciate that, and thanks for taking my questions. Looking forward to seeing the rest of the year.

Thank you so much, Scott.

Thanks, Scott.

Your next question comes from the line of Matthew Fields with Bank of America.

Hey, Lourenco and Keith. Lourenco, your comments on the fleets were interesting earlier in your prepared remarks. Obviously, we're seeing problems with rental cars, and Hertz has had a big issue with trying to reject their fleet contracts through their restructuring. How do you view the consumer being able—or not—to make up for the lack of their buying this year and maybe next year? How does that sort of play out into the overall SAR picture?

Yes. We have to see how these things will play out, Matt, because despite all these new trends, the overall consequence for us as steel suppliers has been positive. The demand is very strong, with many operating at or very close to full capacity in several cases, and even at full capacity in some cases. They are unaffected so far. We are not the only suppliers in the automotive industry. So I can only give you the perspective of equivalent lifts from the point of view of milestones this year for AK Steel. So far, so good. The ones we are selling to are buying and asking for more, and things are picking up positively. I'm not so sure about competition because I don’t know. That's not my focus. We brought capacity back at the right time. For instance, we were able to bring the Dearborn platforms back to 22 years, and we did it very smoothly. The technological capabilities of our people in Dearborn and from our media accounts have permitted this. Outstanding work was performed by our blast furnace team, enabling us to ensure this smooth restart. That said, we made changes in our footprint already, like the definitive idling of the hot strip at Dearborn. Now, we have only one integrated company. We are going to have hot strip in Middletown in the second half; it hasn’t run at full nominal capacity for a long time. So, we have already adjusted our footprint to supply the market. However, keep in mind that the overall market is not solely dependent on AK Steel; others participate. As far as the situation is concerned, we have been in good shape.

Alright, thanks. And then, Keith, you mentioned that the SG&A levels are significantly down from the combined company. I guess, is that a big part of the additional synergies you've been able to find? Can you give us sort of a little breakdown of that $150 million of synergies by category? What are the major chunks of that number?

Yes, sure, Matt. The $151 million synergy number includes about $69 million that would be in the SG&A category. The remainder consists of $82 million in cost of goods sold. The synergies come from several sources: $81 million is related to public company duplicate overheads; $56 million from asset optimization; and another $14 million is from improvements in the supply chain. The actual reductions in SG&A are quite substantial. The synergy piece is really probably only about half of it. There are a couple of other factors contributing to that. We do have some accounting classification changes on the expense side. So a significant portion of the SG&A costs that were charged to SG&A last year by AK Steel are now recorded under the Cliffs methodology and categorized as part of the cost of goods sold. So, you'll also see a factor contributing to this. Additionally, other cost reductions are simply due to the fact that costs came down because of this past year where profits are lower. So you’ve got lower incentive compensation and travel costs as a direct result of COVID. Did that clarify things for you, Matt?

Yes, that's great. And then is there any additional pull-through through Precision Partners included in that number? Or is that still yet to come?

Yes, we are starting to see some movement in that direction. But Q2 was definitely not the moment to execute on that because, as you know well, Matt, the end market was shut down. Actually, Precision Partners was the first one to shut down and the first one to come back. But the work has been done. I'll give an example: Tesla, which was not a traditional client of AK Steel in the past is now working with us on components for Precision Partners. So we're working steadily together. I'm mentioning Tesla because everybody is interested in Tesla, but we’re seeing similar engagement with other manufacturers as well. So we are very excited about executing the plan that we have set together for this combined company, and we will be delivering results a lot sooner than people expect.

Okay, great. Thank you. And then finally for me, assuming you have no more secured capacity— which hopefully you can confirm—what’s the plan or outlook on any debt reductions in the second half of the year, if you have cash coming in from AMT or working capital releases? Do you think there’s a target or strategy in place to potentially buy back more unsecured debt at a discount during the second half of 2020?

First of all, we have now what lets us continue to reduce debt without necessarily buying back debt on the market. That’s ABL. I’m sure you noticed we paid down the ABL in Q2. Despite all the difficulties, we were able to use cash to pay down the ABL. Any excess cash flow generated will be used primarily to continue paying down the ABL. That’s the first point. Secondly, as far as the security capacity you mentioned, keep in mind that 2024 secured will start to be available for us to redeem come January, very close to par at 102.5. That’s our next target and not in our treasury portfolio, to address outside of the ABL. We have a plan and we will continue executing it. We’ve created the five-year discussion that I normally engage in in my companies dealing with metals—Cleveland-Cliffs and now the new Cliffs. So we have a plan, and we will continue executing it. Everything is lined up, and we will restore the security capacity as soon as we take down the '24 at the right time. We will do that when it's right. But again, I would like to insist on this: the primary source of debt reduction right now is paying off the ABL, and that’s where the cash will go.

Alright. That’s very helpful. Thank you, and good luck in the back half, guys.

Thanks a lot, Matt.

Thanks, Matt.

Your next question comes from the line of Alex Hacking with Citi.

Yes. Good morning. I have a couple of questions on Toledo. Could you remind us of your expectations for sales there next year? And then also kind of remind us where you stand in terms of offtake with customers? I know you had a lot of previous discussions and then also in terms of how those discussions have evolved regarding the potential pricing structure? Thank you.

Toledo next year, we'll be running to achieve nominal capacity. If we are able to achieve that by the end of the year remains to be seen. Remember, when we were planning to start in June, ramping up in the second half of the year and achieving nominal capacity by 2021 was the goal. Now, we are going to be starting at the very end of the year, so more likely in December. To ensure we do everything correctly and avoid any missteps, we can’t assure that we will be running at 1.9 million tons next year. But we will get pretty close, and I don’t feel the ramp-up will be a lengthy process. We have enough knowledge about our plant and processes to ensure a smooth ramp-up. Regarding offtake with clients, I have already explained that we have determined that HBI sells into the metallics market, into the scrap-based market, and that’s not the model our clients operate by. I addressed that matter back in 2017 when I chose not to cut long-term deals to support project finance. The route of issuing bonds and other financial instruments was key, and we have 100% confidence regarding selling that product at the right price. More than that, Alex, we have already developed procedures for using HBI as a coolant in the BOFs, particularly for the off-spec material that will be generated as we ramp up the plant; we will use that both in Middletown and our other facilities, where the material will be on-spec. So off-spec will be used in BOF, and on-spec will go to our EAF. We have procedures in place, and we can even work with clients to develop the right way to melt HBI. We are going to be incredibly successful with that. As for pricing levels, you'll see them when it's the right time; it will be very profitable, and HBI will be a substantial contributor to our EBITDA.

Okay, thanks, Lourenco. And just a follow-up if I may. Thanks for the insights. How much of that 1.9 million could you potentially consume internally?

250,000 to 300,000 in a steady-state year would be a conservative number. We will do that not just to make the material disappear, but because as you may know, we still buy scrap. Thus, we will save money by doing this, not jeopardizing our ability to generate EBITDA. Therefore, we will not have the same negative impact on the HBI side, but rather a positive impact on the cost side of the AK Steel facilities that I mentioned, putting us in the ballpark of generating 250,000 tons. The rest of it will be sold in the marketplace. We have a lot of interest from the usual consumers in the EAF side. We won’t be selling to the blast furnace side because we don’t want to give our competition the advantage that we will enjoy in our costs by using the HBI.

Okay, perfect. Thank you so much, and good luck in the second half.

Thanks.

Your next question comes from the line of Matt Vittorioso with Jefferies.

Good morning. Thanks for taking the question, and thanks for the color on the plan regarding AK Steel not treating your product as commodities. I'm curious, how do you think about pushing prices on your steel products at AK Steel relative to some of the aluminum competition? How do Novelis and some of the other aluminum firms factor into that equation?

Aluminum has been trying to become a mainstream material in vehicles for a long time. Except for the F-150, they have never succeeded in practically anything else they have tried. The biggest problem with aluminum is consumer preference. Consumers may prefer the F-150 with aluminum, but not others. We have evidence that this trend is valid; thus, aluminum has not progressed significantly beyond the F-150. Another example is that Tesla’s S was aluminum, while the Model 3 is primarily steel. So no matter how we approach this, aluminum will continue to be just what it is. No matter what the aluminium companies assert, they will always be on the periphery. Technological advancements in steel continue to improve our offerings relative to aluminum, while from a cost standpoint, steel is much more favorable for vehicle manufacturers. Therefore, I don’t have any concerns regarding aluminum entering the automotive market.

Okay. Also, on the iron ore side, just a question about the competition. A lot of the great work you did on the iron ore contracts seems to be a function of your position in the market in North America. How do you think about U.S. steel iron ore pellets freeing up as they close some of their blast furnaces and look to market their iron ore more broadly? Do you have any comments on the implied valuation of that deal with Stelco that was announced a little while ago?

I have no opinion on their deal with Stelco, and it wouldn't be appropriate to comment on that. However, regarding the pellet market in the United States, everything is playing exactly as we planned at Cleveland-Cliffs. Let me recap: Our contract with our biggest client, ArcelorMittal, goes through 2026, so it’s totally secure for Cleveland-Cliffs. The contract is extremely well-done, and we are pleased with it; they are pleased as well. The second biggest client is AK Steel, and I don’t need to comment on that. I’ll just emphasize that we are not going to consume many pellets outside of our Cleveland-Cliffs operations. Our third client is Algoma. Algoma is letting some deals expire by 2020 because we need the pellets to feed our HBI plant. This is happening as planned. One contract will continue until 2024, and through other contracts, we will expire by the end of the year because we have a more profitable use for the pellets feeding our HBI plant in Toledo. Again, everything is functioning as planned. In addition, we have replaced the bottom line: we replaced our bond with Nucor, which was a significant achievement for us. We are transitioning our exposure from Algoma in Canada to high-grade coated pellets for Nucor in Trinidad, which is fantastic.

Okay. Lastly, a big-picture question about the domestic steel market: how do you see the share shifting between EAFs and blast furnaces over the coming decade? It seems that EAFs shot up to two-thirds of the market quite quickly, but maybe it's plateauing a bit. Any high-level thoughts on how you foresee that playing out going forward? Your HBI product may assist the EAF producers as well, correct? They could potentially produce better products with your pure iron inputs.

Matt, you’ve already answered your own question. They—their blast furnace operations have done an incredible job over the last 30 years to capture available market share. They have executed well by taking advantage of flexibility and keeping costs low. Now, when we push comes to shove, we are getting to that last stretch where technology matters. The R&D support matters, and the ability to produce specialized steel that the equipment can't make matters. We are going to continue to defend that. Let’s take a step back and analyze what types of steels we are talking about. We’re considering steels that we cannot produce through the EAF route. Some can, and they are doing a good job, thus increasing their participation. But limits exist. In Japan, blast furnaces still prevail at Nippon Steel and JFE despite their availability of scrap. South Korea’s POSCO, for the automotive business, remains a blast furnace operation, even with our involvement at AK Steel. Things are not as simplistic as they are presented in the gossip press. Let’s evaluate what kinds of steels we are discussing. We are discussing steels we cannot produce through the EAF route. Some can and are finding success, but there are good operators, and not everyone under that umbrella is good. When we examine the automotive footprint globally, we see that some markets are saturated. We are across the world from good operations. As for the automotive space in the U.S., there are operations in Japan, such as Nippon Steel and JFE, that are predominantly blast furnace-based. Why is that? They have plenty of scrap, but they can't make EAFs competitive in the automotive arena. The same holds true for South Korea with POSCO. Technology remains the king, and we will continue to leverage our relationships with these clients.

Helpful, Lourenco. Thank you.

Thank you, Matt.

Your final question comes from the line of Phil Gibbs with KeyBanc Capital.

Hey, Lourenco, Keith. Good morning.

Good morning, Phil.

Thanks for taking my question. I apologize if you talked about this already, but the synergy number, I think, was north of $150 million. How much of that did you achieve in the second quarter? And how much, relative to that number on an annualized basis, do you still have to go?

Yes, we achieved a run rate of $84 million in June; we picked up $7 million alone that month. For the quarter, it was around $17 million. By the beginning of Q4, we should be at the $120 million target we discussed on the last call, and the full $151 million will kick in by January 1, 2021.

You were going to say something.

No, no.

So when we think about it, you've got a full $150 million next year. Given what you've realized so far and what you expect to realize in the second half, would that get you somewhere around $50 million, plus or minus?

Yes, that's pretty close, Phil. Let’s say $65 million or so.

A little more than that; we should be in the range of $65 million to $70 million.

$65 million to $70 million. So you're gaining that extra juice in next year's numbers due to the synergies having them for a full year and also stepping up?

That's correct.

Where did you find more?

The more we integrate and comprehend, the more we can develop our business model with AK inside our footprint. The more we can execute successfully. I'll give an example that was not part of our original plan: AK Tube is now integrated 100% into the AK Steel commercial effort and was previously regarded as a separate company. We are also in the process of doing the same thing with Precision Partners, making it not just a separate entity but more like a department of AK Steel, similar to how AK Tube operates now. As we continue integrating, our knowledge enhances, and the synergies naturally unfold. Another point I need clarification on is that when we combined AK Steel and Cleveland-Cliffs, we were able to redo several big contracts with significant monetary advantages. This has also contributed greatly to this boosted number, as we now have a much larger operational footprint. For instance, our railroad transportation costs have reduced, making it much easier without needing the hot-strip rolling from Dearborn to Middletown.

And just as a follow-up—again, I apologize if I missed this—in terms of your pellet shipments this year, was there an update on what you expect that to be? Then sub-question: assuming $450 in hot-band and $110 iron ore in the current pellet premium, where does that put you for pricing in the back half as well? Thanks.

Keith, do you want to take that?

Yes. We really didn’t give guidance on pellets so far, but we see the pellet shipments being very similar to Q2, maybe slightly improved for Q3, and we should see a pickup in Q4 as we historically see, when blast furnaces need to stock up before the lots close for the winter. Regarding pricing, if it stays where it is today, we’d end the year probably in the low $90s on a pellet price, with a true-up in Q3; it may be a little lower, but the full-year average will settle at low $90s if the prices hold.

Very helpful. I appreciate it. Thanks so much.

You bet.

Thank you, Phil. Operator?

There are no additional questions at this time.

Alright. Thank you very much. I appreciate it, and it was a pleasure to be with you all on the phone today. It is an exciting time for Cleveland-Cliffs. Thanks for your interest, and let's keep in touch. You all have a great day. Thank you. Bye now.

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect.