Cleveland-Cliffs Inc. (filed as Cliffs Natural Resources Inc.) — Q2 2017 Form 10-Q
Business context and reporting period
The unaudited filing covers the three and six months ended June 30, 2017. Continuing operations comprise U.S. Iron Ore, supplying North American steelmakers, and Asia Pacific Iron Ore, operating in Western Australia. The company also announced development of a Toledo, Ohio, hot briquetted iron (HBI) plant, targeted to begin production by 2020.
Financial performance and liquidity
| Metric (USD millions, except per-share amounts) | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Revenue | 569.3 | 496.2 | 1,030.9 | 801.7 |
| Sales margin | 145.1 | 91.5 | 240.8 | 122.4 |
| Sales margin as % of revenue | 25.5% | 18.4% | 23.4% | 15.3% |
| Operating income | 114.6 | 74.7 | 196.5 | 74.4 |
| Income from continuing operations | 76.5 | 29.9 | 46.2 | 144.2 |
| Net income attributable to Cliffs shareholders | 31.8 | 12.8 | 3.7 | 120.8 |
| Diluted EPS, continuing operations | $0.26 | $0.07 | $0.17 | $0.67 |
| Diluted EPS, total | $0.11 | $0.07 | $0.01 | $0.68 |
- Q2 adjusted EBITDA was $137.0 million, up from $101.6 million; first-half adjusted EBITDA was $229.2 million, up from $137.8 million. These are non-GAAP measures.
- First-half operating cash flow was $67.8 million, compared with cash used of $19.3 million in 2016. Cash used in investing was $48.3 million, including $49.4 million of cash capital expenditures.
- Cash and cash equivalents were $321.5 million at June 30, versus $323.4 million at year-end 2016. ABL borrowing capacity available was $214.1 million; there were no ABL borrowings. Cash plus available ABL capacity totaled $535.6 million.
- Long-term debt was $1,611.8 million, down from $2,175.1 million at year-end. Total debt principal maturities shown, excluding the ABL, were $1,652.5 million, including $715.7 million due in 2020. Total deficit was $666.7 million.
Material changes versus prior comparable periods
First-half revenue increased 28.6%, and sales margin nearly doubled, driven by higher realized prices and greater U.S. Iron Ore sales volumes, including the return to full operation at United Taconite and Northshore after prior-year idling. Q2 U.S. Iron Ore sales margin rose to $144.2 million from $70.0 million. In contrast, Q2 Asia Pacific Iron Ore sales margin fell to $0.9 million from $21.5 million, primarily due to lower sales volumes and realized revenue rates.
First-half net income and EPS were sharply lower year over year despite improved operating performance. Results included a $76.8 million loss on debt extinguishment/restructuring in 2017, versus a $182.4 million gain in 2016, and a $45.9 million discontinued-operations loss in 2017. Interest expense improved to $74.2 million from $107.5 million for the first half.
In February, the company issued $661.3 million net from a common-share offering and $500 million of 5.75% senior notes due 2025. It used offering proceeds to redeem or repurchase $1,154 million of debt principal during the first half. The transactions reduced debt but increased shares outstanding.
Outlook, commentary, risks and unusual items
- Management forecast approximately $310 million of 2017 net income and $650 million of adjusted EBITDA, assuming iron ore and steel prices for the rest of the year average their respective year-to-date levels. These are estimates, not guarantees.
- 2017 U.S. Iron Ore sales and production volume guidance remained about 19.0 million long tons; cash cost guidance was $55–$60 per long ton. Asia Pacific production guidance remained 11.5 million metric tons, while sales guidance was reduced by 0.5 million to 11.0 million metric tons; cash cost guidance was $34–$39 per metric ton.
- Full-year SG&A guidance rose by $10 million to $110 million, reflecting HBI pre-feasibility spending and higher incentive compensation. 2017 capital expenditure guidance rose by $10 million to $115 million. The company separately expected about $200 million of capital spending over the next 12 months, including HBI development and Northshore upgrades.
- Management cited stronger global steel production and demand for higher-grade iron ore, while warning of continued commodity-price volatility. It noted that iron ore and U.S. steel prices, Chinese steel activity, trade measures, customer demand and major producers’ supply decisions could affect results.
- Pricing adjustments are a material source of earnings volatility. Q2 product revenue included a $51.9 million gain related to customer supply agreements and a $35.4 million decrease from provisional pricing arrangements. At June 30, related derivative assets were $72.5 million and liabilities were $20.8 million.
- The company recorded a $50.0 million contingent liability related to a potential claim in Canadian CCAA proceedings and recognized a $46.4 million Q2 discontinued-operations loss. The Monitor may assert a claim exceeding the recorded amount; recovery of company claims against the Canadian entities is uncertain.
- Subsequent to quarter-end, a July 18 sale of Wabush Scully Mine assets was completed. Replacement environmental assurance is expected to eliminate a $38.5 million guarantee liability and produce an approximately $30 million gain in Q3 2017.
- Other exposures include a potential $13.6 million liability tied to Michigan electricity/SSR cost allocation proceedings, unresolved legal matters, environmental and mine-closure obligations, energy-price and supply risks, and the company’s substantial debt. Management said it expected sufficient liquidity for the next 12 months; the ABL springing fixed-charge covenant was not applicable at quarter-end. Disclosure controls were assessed as effective.
Most important facts for investors to verify
- Whether realized iron ore and steel prices, customer pricing adjustments and shipment volumes support the assumptions behind 2017 earnings and adjusted EBITDA guidance.
- Whether the company delivers the reduced Asia Pacific sales-volume outlook and manages higher operating costs, including energy and mining costs.
- Debt repayment, maturities, interest costs, ABL availability and cash generation relative to the HBI, Northshore and other capital commitments.
- The outcome and timing of Canadian CCAA claims and recoveries, the expected release of the $38.5 million guarantee liability, and the Q3 gain from the Wabush Scully sale.
- Progress, total funding needs and execution risks for the HBI plant and Northshore upgrades, alongside commodity-price, regulatory and litigation exposures.