CLEVELAND-CLIFFS INC. annual report, FY2014

Business context and reporting period

The filing is Cliffs Natural Resources Inc.’s Form 10-K for the fiscal year ended December 31, 2014; the request metadata identifies the company as Cleveland-Cliffs Inc. The business was a major U.S. iron-ore pellet supplier, with additional iron ore operations in Australia and Canada and metallurgical coal operations in the United States. In 2014, a substantially reconstituted board and new CEO shifted strategy toward the core U.S. Iron Ore business and away from diversification.

Financial performance and key metrics

The 2014 loss was driven chiefly by $9.029 billion of goodwill and long-lived-asset impairment charges, reflecting lower long-term commodity-price assumptions and the strategic review of non-core assets. Other material charges included a $419.6 million pretax loss on the CLCC sale, a $96.3 million Worldlink arbitration judgment, $92.6 million of minimum-shipment penalties and $90.7 million of Wabush idle costs. The income-tax benefit was $1.302 billion; the company also recorded a $2.225 billion valuation allowance against deferred tax assets.

Year-end total assets fell to $3.164 billion from $13.122 billion, while total liabilities were $4.898 billion and total equity was negative $1.734 billion. Current assets were $1.449 billion and current liabilities $958.6 million. The revolving facility was undrawn at year-end; after letters of credit, reported borrowing capacity was $975.5 million under the then-$1.125 billion facility. A January 2015 amendment reduced the facility to $900 million, with a further reduction to $750 million scheduled for May 31, 2015. The company reported covenant compliance at December 31, 2014.

Operating segments

• U.S. Iron Ore: Revenue was $2.507 billion and sales margin $710.4 million, down from $901.9 million. Sales rose to 21.8 million long tons, but realized revenue per ton fell 9.5% to $102.36; cash production cost was $64.09 per ton.
• Asia Pacific Iron Ore: Revenue was $866.7 million and sales margin $121.7 million, versus $367.1 million. Realized revenue per ton declined 32.8% to $74.56, while cash production cost fell to $49.41 per metric ton.
• North American Coal: Revenue was $687.1 million and sales margin was a loss of $135.8 million, versus a $14.5 million loss. Realized revenue per ton fell 23.6% to $77.31; cash production cost was $68.64 per ton.
• Eastern Canadian Iron Ore: Revenue was $563.4 million and sales margin was a loss of $244.9 million, versus a $103.3 million loss. Wabush was idled and moved toward permanent closure; Bloom Lake ceased production in December and entered care-and-maintenance.

Material changes versus the prior comparable period

• Revenue fell 18.8%, principally due to weaker iron ore and coal pricing; management attributed approximately $1.0 billion of the decline to lower market pricing. Operating cash flow decreased by $787.0 million.
• U.S. Iron Ore production and sales improved, supported by restarted Northshore furnaces and higher customer nominations, but lower realized pricing reduced segment margin.
• Spot iron ore prices weakened sharply: the Platts 62% Fe fines price averaged $97 per ton in 2014, down 29% from 2013. The premium low-volatile hard coking coal benchmark averaged $126 per metric ton, down 21%.
• Capital spending declined as Bloom Lake Phase II was put on hold and then abandoned as a viable plan. Cash capital expenditures were $284.1 million, versus $861.6 million in 2013.
• Common equity fell from positive $6.070 billion to a deficit of $1.431 billion, largely reflecting impairment losses. Total equity, including noncontrolling interests, was a deficit of $1.734 billion.

Outlook, management commentary, risks and contingencies

Management forecast 2015 sales and production of approximately 22 million long tons for U.S. Iron Ore, 11 million metric tons for Asia Pacific Iron Ore and 5.5 million short tons of low-volatile metallurgical coal. Expected cash production costs per ton were $55–$60, $40–$45 and $65–$70, respectively. The coal outlook assumed no further divestiture; the Asia Pacific outlook assumed no sale in 2015. Capital expenditures were expected to be $125–$150 million, SG&A about $140 million, and exploration cash outflow below $5 million. Management expected U.S. steel demand to remain healthy but anticipated continued pressure on seaborne iron ore prices and cited oversupply and weaker Chinese demand.

Management said 2015 operating cash flow was expected to cover budgeted capital expenditures and described liquidity as sufficient for at least the next 12 months, subject to market conditions. The company ended its $0.15 quarterly common dividend beginning in 2015, estimating annual cash savings of about $92 million for debt reduction. It also reported approximately $159 million of additional debt reduction in January 2015. U.S. Iron Ore customer contracts provided some protection from spot-price volatility, but several began expiring at the end of 2016; customer concentration remained significant.

• Bloom Lake restructuring: Bloom Lake and certain affiliates filed for protection under Canada’s CCAA on January 27, 2015 after ceasing operations and being unable to meet obligations. Cliffs had guaranteed certain obligations totaling about $145 million; the ultimate liability and recovery from restructuring or asset sales were uncertain.
• CLCC divestiture: The sale closed December 31, 2014 for $174 million cash plus assumption of certain liabilities; $155 million had been collected by year-end. The reported pretax loss was $419.6 million.
• Legal matters: Worldlink was awarded about $71 million plus approximately $25 million interest and arbitration costs; the judgment was included in the Bloom Lake CCAA filing as an unsecured claim. In a separate Essar dispute, Cliffs sought more than $90 million and Essar counterclaimed for more than $160 million. Securities and derivative lawsuits, asbestos claims and other proceedings were also disclosed.
• Other risks: Commodity-price declines, customer and joint-venture concentration, debt and refinancing needs, mine closure costs, pension and retiree obligations, labor negotiations, energy and transport costs, and environmental permitting or compliance requirements could affect results and liquidity. The filing estimated $261.2 million of environmental and mine-closure obligations and $216.7 million of pension funding minimums in its contractual-obligations schedule.

Important facts for investors to verify

• Track the Bloom Lake CCAA restructuring, sale outcomes, creditor claims and the extent of Cliffs’ guarantee exposure.
• Reconcile cash, debt, letters of credit, borrowing availability and covenant headroom after the 2015 credit-facility reductions and subsequent debt repurchases.
• Assess whether 2015 segment volumes, realized prices and cost targets were achieved, especially U.S. Iron Ore contract pricing and the coal business’s path toward breakeven.
• Review the assumptions behind the $9.029 billion impairment, deferred-tax-asset valuation allowance and negative equity position.
• Monitor customer-contract renewals, customer concentration, environmental obligations, pension funding, and the outcome or settlement costs of material litigation.