CLEVELAND-CLIFFS INC. annual report, FY2017

Cleveland-Cliffs Inc. — 2017 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2017; comparisons are primarily with fiscal 2016. The company mines and sells iron ore pellets in the U.S. and iron ore in Australia. Its continuing operations are U.S. Iron Ore and Asia Pacific Iron Ore.

Financial performance and liquidity

Metric	2017	2016
Revenue from product sales and services	$2,330.2 million	$2,109.0 million
Sales margin	$501.7 million; 21.5%	$389.3 million; 18.5%
Operating income	$423.6 million	$240.8 million
Income from continuing operations	$381.8 million	$219.2 million
Net income attributable to Cliffs shareholders	$367.0 million	$174.1 million
Diluted EPS attributable to Cliffs common shareholders	$1.26	$0.87
Adjusted EBITDA	$504.9 million	$373.5 million
Cash from operating activities	$338.1 million	$303.0 million
Capital expenditures	$151.7 million	$69.1 million

Operating cash flow less capital expenditures was approximately $186.4 million in 2017, calculated from the reported figures. Fourth-quarter 2017 revenue was $600.9 million, sales margin was $100.7 million, net income attributable to Cliffs shareholders was $309.9 million, diluted EPS was $1.03, and Adjusted EBITDA was $121.3 million.

At year-end, cash and cash equivalents were $1,007.7 million; principal debt was $2,439.4 million. The ABL Facility had no loans drawn, $273.2 million of borrowing-base availability and $226.7 million available after letters of credit and other commitments. Cash plus available borrowing capacity totaled $1,234.4 million. The balance sheet reported a shareholders’ deficit of $444.3 million. No common dividends were paid in 2017.

Business trends and changes versus 2016

• Revenue rose about 10.5%, while sales margin increased $112.4 million. Higher U.S. realized prices and sales volumes drove the improvement; U.S. Iron Ore sales margin rose to $465.4 million from $275.7 million.
• U.S. Iron Ore realized revenue per long ton rose 16.3% to $88.03. U.S. sales volume increased to 18.7 million long tons; production for Cliffs’ account increased to 18.8 million long tons as previously idled mines resumed or operated at higher levels.
• Asia Pacific sales margin fell to $36.3 million from $113.6 million. Sales volume declined 15.7% to 9.8 million metric tons, and cash cost per metric ton rose 18.3% to $40.15. Management expected Australian mining to cease during 2018, subject to market economics.
• Adjusted EBITDA improved, but reported EBITDA declined to $330.4 million from $503.0 million, principally because 2017 included a $165.4 million debt-extinguishment loss while 2016 included a $166.3 million gain.
• Operating cash flow increased, but investing outflows rose with higher capital spending. Year-end cash increased from $323.4 million to $1,007.7 million, supported substantially by financing transactions.

Financing, outlook, and notable items

• During 2017, Cliffs issued 63.25 million common shares, raising $661.3 million net, and issued $1.075 billion of 5.75% senior notes. It used proceeds and other financing to retire or repurchase approximately $1.611 billion principal of debt, recording a $165.4 million loss on extinguishment. It also issued $400 million of 4.875% secured notes due 2024 and $316.25 million of 1.50% convertible notes due 2025.
• The share offering materially increased outstanding common shares, from 233.1 million at year-end 2016 to 297.4 million at year-end 2017. Management reported a reduced effective interest rate and extended maturities following the debt restructuring.
• Management’s 2018 U.S. Iron Ore outlook: approximately 20 million long tons of sales and production; realized revenue of $97–$102 per long ton; and cash cost of goods sold and operating expense of $58–$63 per long ton. Estimates assume iron ore prices, steel prices and pellet premiums average their year-to-date levels for the rest of 2018.
• 2018 guidance also included approximately $115 million of SG&A, $130 million of interest expense and $100 million of depreciation, depletion and amortization. Planned capital spending was approximately $85 million sustaining, $250 million for the Toledo HBI project and $50 million for Northshore upgrades. Total HBI plant investment was estimated at $700 million, plus $80 million for Northshore upgrades, through 2020, excluding contingencies and capitalized interest.
• The Toledo HBI plant was planned for production in 2020 at 1.6 million metric tons annually, with expected additional demand for 2.5 million long tons of Cliffs DR-grade pellets. Project completion, permitting, construction costs, customer contracts and returns remain uncertain.
• The Tax Cuts and Jobs Act produced a significant 2017 income tax benefit of $252.4 million and reduced the U.S. corporate tax rate beginning in 2018. The company reported $235.3 million of refundable alternative minimum tax credits, expected to be received between 2019 and 2022; it also maintained a $2,238.5 million valuation allowance against deferred tax assets.
• Cliffs recorded a $55.6 million contingent liability for a probable preference claim expected to be asserted in the Canadian CCAA proceedings. The company disputes liability; the eventual claim and recovery from the Canadian estates remain uncertain. Sale of the Wabush Scully mine and release from related guarantees generated a $31.4 million gain in discontinued operations.
• After its January 2018 earnings release, the company recorded an adjustment to increase the Asia Pacific asset retirement obligation. The 10-K reports full-year net income attributable to shareholders of $367.0 million and Adjusted EBITDA of $504.9 million, versus the earnings release figures of $374.9 million and $512.8 million, respectively. The reported fourth-quarter figures were likewise revised; investors should use the 10-K amounts.

Key risks and contingencies

• Customer concentration is substantial: ArcelorMittal represented 38% and AK Steel 23% of consolidated product revenue in 2017. Results depend on a small group of North American steelmakers and their production, creditworthiness and contract nominations.
• Iron ore and steel prices, pellet premiums, energy costs, transportation availability and foreign exchange can materially affect revenue and margins. The Australian operation faced low-grade ore discounts and possible closure costs.
• Environmental permitting and standards—including water quality, selenium, mercury and greenhouse-gas rules—could require additional investment or restrict operations. Environmental and mine-closure obligations totaled $200.1 million at year-end.
• Other disclosed matters include the Mesabi Metallics adversary proceeding, the Bluestone litigation, Michigan electricity cost-allocation appeals and continuing Canadian insolvency proceedings. Management generally disputes the claims; outcomes may differ from estimates.
• Debt service, pension and postretirement obligations, mine closure costs and the large HBI investment compete for cash. Total contractual obligations were reported at $4,888.1 million, including debt principal, interest, purchase commitments and benefit obligations.

Important facts for investors to verify

• Whether 2018 U.S. Iron Ore sales volumes, realized prices and cash costs meet guidance, and how contract pricing responds to iron ore, steel and pellet-premium changes.
• Whether the Australian mine closes as expected, and the final asset-retirement and closure costs.
• HBI and Northshore project spending, schedule, permits, customer commitments, financing sufficiency and expected returns.
• The resolution and potential additional exposure from the $55.6 million Canadian contingent claim, and the recoverability of $51.6 million in Canadian receivables.
• Debt maturities, liquidity availability, dilution from issued and potentially convertible securities, and the timing of the $235.3 million AMT credit refunds.
• Whether the 2017 earnings-release revisions and the accounting transition to ASC 606 affect comparability; the filing expects a $30–$35 million opening retained-deficit adjustment and a changed quarterly revenue pattern beginning in 2018, with substantially unchanged full-year revenue.