Cleveland-Cliffs Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Figures are in U.S. dollars unless stated otherwise. The company’s continuing business is one reportable segment, U.S. Iron Ore, supplying iron ore pellets to North American steelmakers. Australia’s Asia Pacific Iron Ore operations are classified as discontinued operations.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $714.3 million | $471.3 million | $894.3 million | $757.5 million |
| Sales margin | $284.5 million | $144.7 million | $346.0 million | $193.7 million |
| Operating income | $254.2 million | $115.2 million | $284.5 million | $148.6 million |
| Income from continuing operations | $229.4 million | $83.8 million | $216.0 million | $5.3 million |
| Net income attributable to Cliffs shareholders | $165.1 million | $31.8 million | $80.8 million | $3.7 million |
| Diluted EPS, continuing operations | $0.76 | $0.28 | $0.72 | $0.03 |
| Adjusted EBITDA | $275.7 million | $135.5 million | $328.0 million | $175.1 million |
- Q2 U.S. Iron Ore sales margin was $47.67 per long ton, up 42%; realized product revenue was $112.60 per long ton, up 16.4%. Six-month sales margin was $45.65 per long ton, up 75.1%; realized revenue was $110.99 per long ton, up 24.1%.
- Six-month operating cash flow was negative $49.3 million, versus positive $67.8 million a year earlier. Investing cash use was $99.8 million, including $72.3 million of deposits for property, plant and equipment. Cash declined $175.8 million to $802.5 million; cash including discontinued-operation cash was $831.9 million.
- At June 30, long-term debt was $2.297 billion; total debt principal maturities were $2.424 billion. Shareholders’ deficit was $306.3 million. The ABL Facility had no borrowings and $360.8 million available after letters of credit. Cash plus available ABL capacity was reported as $1.193 billion.
- Total assets were $3.052 billion and current liabilities were $474.9 million. Current assets were $1.547 billion, including $256.4 million of inventories and $174.7 million of derivative assets.
Changes and significant accounting effects
- Q2 revenue increased 52% year over year, reflecting higher realized prices and sales volume. Management attributed volume growth partly to two additional customer contracts and to Topic 606 revenue timing, which added a third shipping month to Q2 sales recognition versus two months in the prior-year quarter.
- Higher hot-rolled-coil steel prices and pellet premiums supported realized revenue; lower Platts 62% iron ore pricing and higher index freight rates partly offset the increase. Q2 sales volume was 5.968 million long tons versus 4.310 million.
- Topic 606 adoption added $34.0 million to opening retained deficit and increased reported Q2 revenue by $110.0 million and continuing-operations income by $48.8 million compared with balances under prior guidance. For the six-month period, it increased revenue by $47.5 million and continuing-operations income by $29.9 million. Management expects the standard to shift revenue between quarters, with first-quarter revenue generally lower and later-quarter revenue higher, but not materially change annual revenue assuming similar rates and volumes.
- Revenue included substantial derivative-related amounts: $154.7 million in Q2 and $198.5 million for the first half. The Q2 derivative gain on the customer steel-price agreement was $155.5 million. These mark-to-market estimates contributed to results and may change before final settlement.
- The company adopted a pension-cost presentation change retrospectively; it changed line-item presentation but not net income.
Outlook, commentary and risks
- Management’s 2018 U.S. Iron Ore outlook assumes iron ore prices, steel prices and pellet premiums average their respective year-to-date levels for the rest of the year: realized revenue of $105–$110 per long ton, cash cost of $58–$63 per long ton, sales volume of 21 million long tons and production of 20 million long tons.
- Other 2018 expectations: SG&A of $115 million, net interest expense of $120 million, and depreciation, depletion and amortization of approximately $80 million. The updated capital budget was $200 million for the Toledo HBI project, $75 million for sustaining capital and $50 million for Northshore upgrades.
- Management expected operating cash generation and available liquidity to cover operations, debt service and planned investment for at least 12 months, while noting exposure to steel and iron ore prices, customer demand and other changing conditions. It estimated $70–$80 million of future cash outflows for the Australian exit, mostly within six months.
- The Australian mines completed their final shipment in June. The mobile equipment sale was completed, but the sale of substantially all remaining assets to Mineral Resources Limited remained subject to closing conditions. The transaction was expected to reduce previously disclosed closure costs by approximately $65–$75 million. On liquidation, a $228.3 million cumulative currency-translation gain related to the business was expected to be recognized in earnings.
- The Canadian CCAA plan was sanctioned by the court; implementation conditions were expected by July 31, 2018, subject to amendments and tax arrangements. Cliffs and subsidiaries had contributed C$19.0 million to Wabush pension plans. The plan resolves specified claims, but remaining implementation steps were pending.
- Market risks include commodity-price volatility and concentration in one product and customer market. A $75 per net ton change in the estimated hot-rolled-coil price would change the customer-agreement derivative’s fair value by about $26 million; a $10 per dry metric ton change in Platts 62% price would change the net provisional-pricing derivative position by about $17 million. The company had no hedging program for these price exposures.
- Other exposures include a recorded $13.0 million estimated liability for Michigan electricity surcharges, with $10.8 million remaining accrued at June 30, and litigation, mine-closure, environmental, energy-supply and pension risks. Management said pending claims were not expected to be material overall, while acknowledging unfavorable outcomes could have a material effect.
Important facts for investors to verify
- How much of the improvement in reported revenue, profit and EBITDA reflects underlying pricing and operating performance versus Topic 606 timing and derivative remeasurement?
- Whether the Mineral Resources Limited asset sale and Australian closure proceed on the expected terms and timing, and whether exit cash costs remain within the $70–$80 million estimate.
- Whether 2018 sales, production, cost and capital-spending guidance is achieved, particularly under changing steel, iron ore and pellet-premium assumptions.
- Whether working-capital movements reverse and operating cash flow supports the planned HBI and Northshore investment while preserving liquidity.
- Whether the Canadian restructuring plan’s remaining conditions are completed and the Michigan electricity, litigation, environmental and mine-closure exposures change.
- The concentration of related-party sales: related parties represented 60.9% of Q2 product revenue and 56.0% for the first half.