Cleveland-Cliffs Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing; selected fourth-quarter results are identified separately. Unless noted, amounts are U.S. dollars.
Business context
Cleveland-Cliffs is a North American iron ore pellet producer, operating mines in Michigan and Minnesota. Its continuing operations are reported in Mining and Pelletizing and Metallics; the Toledo HBI plant was under construction and had not begun production. The company completed its exit from Australian iron ore operations during 2018, with those results classified as discontinued operations.
Financial and operating performance
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Revenue from product sales and services | $2,332.4 million | $1,866.0 million |
| Sales margin | $809.6 million | $467.6 million |
| Operating income | $673.2 million | $390.2 million |
| Income from continuing operations | $1,039.9 million | $360.6 million |
| Net income attributable to Cliffs shareholders | $1,128.1 million | $367.0 million |
| Diluted EPS, continuing operations | $3.42 | $1.25 |
| Net cash provided by operating activities | $478.5 million | $338.1 million |
| Cash and cash equivalents at year-end | $823.2 million | $978.3 million |
Mining and Pelletizing generated all reported segment revenue and $809.6 million of sales margin. Its realized product revenue rate rose 20% to $105.64 per long ton; cash cost of goods sold and operating expense rate increased 5.9% to $62.95 per long ton. Cliffs’ share of production was 20.3 million long tons, and sales were 20.6 million long tons. Pellet premiums and higher domestic hot-rolled coil steel prices supported realized pricing; higher sales volumes also contributed.
Capital expenditures paid, including deposits, were approximately $296.1 million, up from $151.7 million. Operating cash flow less those expenditures was approximately $182 million, a simple derived measure. The company reported $2,212.0 million of debt principal, $823.2 million of cash, and no ABL loans outstanding. ABL borrowing capacity after letters of credit and other commitments was $268.7 million; cash plus that capacity totaled $1,091.9 million. Total assets were $3,529.6 million and shareholders’ equity was $424.2 million, compared with a shareholders’ deficit of $444.3 million at year-end 2017.
The company recorded a $475.2 million income tax benefit, including a $460.5 million release of the U.S. deferred-tax valuation allowance. The net deferred tax asset was $464.8 million. These tax items materially increased reported earnings and should not be treated as operating cash generation. Discontinued operations contributed $88.2 million of income, including a $228.1 million foreign-currency translation gain reclassified on liquidation of Australian subsidiaries, partly offset by operating and exit costs and Canadian restructuring-related items.
Fourth quarter: Revenue was $696.3 million and sales margin was $202.0 million. Continuing-operations income attributable to Cliffs shareholders was $624.1 million, including the fourth-quarter U.S. valuation-allowance release. Net income attributable to shareholders was $609.5 million; diluted EPS was $2.03 from continuing operations and $1.98 in total.
Material changes versus prior period
- Revenue increased 25% and sales margin rose $342.0 million year over year, principally due to higher realized pricing and sales volumes. Sales volumes increased by about 1.9 million long tons.
- Operating cash flow increased $140.4 million, while year-end cash declined $155.1 million, reflecting investment and financing outflows.
- Debt principal was reduced by $227.4 million through redemptions and purchases; interest expense was $118.9 million versus $126.8 million in 2017. The prior-year period included a substantially larger debt-extinguishment loss.
- ASC 606 revenue recognition was adopted January 1, 2018 using the modified retrospective method. The filing estimates adoption increased 2018 reported revenue by $68.1 million and sales margin by $58.5 million versus results without adoption; comparative periods were not retrospectively revised. The standard also shifts revenue recognition toward shipment or delivery and contributes to seasonal quarterly variation.
- Australian iron ore assets were sold and operations ended. The Canadian CCAA plan was implemented, including a C$19.0 million contribution to Wabush pension plans and resolution of specified claims.
- The planned Toledo HBI plant capacity was increased from 1.6 million to 1.9 million metric tons annually; estimated construction cost rose to approximately $830 million, excluding contingencies and capitalized interest.
Outlook, risks and contingencies
For 2019, management forecast Mining and Pelletizing sales and production of approximately 20 million long tons and cash cost of $62–$67 per long ton. Revenue-rate scenarios were $102–$107 per long ton using specified January average price assumptions, or $111–$116 using February 7 spot prices; these are assumptions, not guaranteed results. Management expected approximately $120 million of SG&A, $100 million of interest expense, an effective tax rate near 10%, zero cash tax payments, and approximately $117 million of tax refunds in the third quarter.
Expected 2019 capital spending was approximately $535 million: $425 million for the Toledo HBI project, $70 million for sustaining capital, $40 million for Northshore upgrades, and $20 million of capitalized interest. Management expected HBI construction and commissioning to support production in 2020. The Northshore upgrade was intended to enable up to 3.5 million long tons of DR-grade pellet production.
- Key business risks: commodity and steel-price volatility; dependence on a small number of customers; customer and joint-venture counterparty credit/performance; energy and fuel costs; transportation disruptions; and the shift in steelmaking toward electric arc furnaces.
- Project and financing risks: HBI cost, schedule, permitting, construction, commissioning and sales-contract execution; substantial debt-service and capital commitments; and the possibility that cash generation or access to financing will weaken.
- Environmental and regulatory exposure: potential future rules on water quality, selenium, mercury, greenhouse gases and regional haze. Management stated that several potential impacts were not estimable; the Empire asset-retirement obligation included approximately $85 million related to selenium infrastructure and treatment, with additional Tilden infrastructure spending planned.
- Legal and other matters: Mesabi Metallics and Seneca-related litigation remained pending; management considered the claims against the company unmeritorious and intended to defend them. The company stated it did not believe pending proceedings would materially affect its financial position, results or cash flows. Environmental and mine-closure obligations totaled $174.9 million at year-end, including $172.4 million for mine closure.
- Capital returns: the company repurchased 5.4 million shares for approximately $47.5 million in 2018 and declared a $0.05-per-share dividend. A $200 million repurchase authorization remained effective through December 31, 2019, subject to suspension or discontinuation.
The auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management and the auditor concluded controls were effective as of year-end.
Important facts for investors to verify
- How much of 2018 earnings reflects the $460.5 million valuation-allowance release and the Australian currency-translation gain, rather than recurring operations.
- The underlying impact of ASC 606 on timing and comparability of quarterly revenue, earnings and working capital.
- Actual HBI project spending, capacity, completion timing, customer commitments and expected returns against the $830 million estimate and 2020 start-up target.
- Debt-service capacity and liquidity after planned capital expenditures, scheduled obligations, and any further repurchases or dividends.
- Whether customer concentration, steel and pellet pricing, energy costs, and environmental requirements materially diverge from management’s 2019 assumptions.