Cliffs Natural Resources Inc. — FY 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011; quarterly figures are included for the fourth quarter. The filing’s registrant is Cliffs Natural Resources Inc.
Business context and results
Cliffs was an international iron ore and metallurgical coal producer, with operations in the U.S., Canada and Australia and interests in Brazilian iron ore and Canadian chromite development. Results benefited from stronger steel demand, higher iron ore prices and increased production, as well as acquisitions. The May 2011 acquisition of Consolidated Thompson added a 75% interest in Bloom Lake and materially expanded Eastern Canadian Iron Ore.
| Metric | FY 2011 | FY 2010 |
|---|---|---|
| Revenue | $6.794 billion | $4.682 billion |
| Sales margin | $2.689 billion; 39.6% of revenue | $1.527 billion; 32.6% of revenue |
| Operating income | $2.349 billion | $1.270 billion |
| Income from continuing operations | $1.831 billion | $1.023 billion |
| Net income attributable to Cliffs shareholders | $1.619 billion | $1.020 billion |
| Diluted EPS | $11.48 total; $11.61 continuing operations | $7.49 total; $7.51 continuing operations |
| Cash from operating activities | $2.289 billion | $1.320 billion |
| Cash and cash equivalents at year-end | $521.6 million | $1.567 billion |
| Long-term debt, including current term-loan portion | Approximately $3.683 billion | Approximately $1.713 billion |
Revenue increased 45.1% year over year. Sales margin is the company’s segment performance measure, not a GAAP gross margin. Operating margin was approximately 34.6% in 2011. Cash paid for capital expenditures was $862.1 million; operating cash flow less this amount was approximately $1.427 billion. Current assets were $1.791 billion and current liabilities $1.493 billion at year-end. The company reported $1.727 billion of available borrowing capacity under its revolving facility and stated it was in compliance with its financial covenants.
Production increased at U.S. Iron Ore (31.0 million tons versus 28.1 million), Eastern Canadian Iron Ore (6.9 million metric tons versus 3.9 million, including acquired Bloom Lake production) and North American Coal (5.0 million short tons versus 3.2 million). Asia Pacific Iron Ore production declined to 8.9 million metric tons from 9.3 million.
Material changes and unusual items
- Higher realized iron ore pricing was a major earnings driver. U.S. Iron Ore’s average realized price increased 40% per ton versus 2010, or 28% excluding the ArcelorMittal USA settlement; Asia Pacific realized prices increased 38% for lump and 24% for fines.
- The ArcelorMittal USA settlement added $280.9 million of 2011 U.S. Iron Ore revenue for 2009–2010 pricing and shipment matters. Cliffs reported receiving a $275 million true-up payment in April 2011. Algoma pricing finalization added a further $23.4 million of revenue.
- Consolidated Thompson was acquired for reported consideration of approximately $4.554 billion. Its contribution since acquisition included $571.0 million of revenue; purchase-accounting inventory step-up added $59.8 million to costs. The acquisition’s purchase-price allocation remained preliminary and subject to refinement.
- North American Coal’s segment sales margin loss widened to $58.4 million from $28.6 million. Operational disruption included tornado damage at Oak Grove, elevated carbon monoxide and other interruptions at Pinnacle, and shipping constraints.
- A $27.8 million goodwill impairment was recorded for CLCC, reflecting the coal-price outlook and higher expected development and sustaining costs. The renewaFUEL business was classified as discontinued operations; 2011 loss was $18.5 million, including a $16.0 million impairment.
- Interest expense rose to $216.5 million from $70.1 million, reflecting higher debt and $38.3 million of bridge-facility issuance costs written off. The effective tax rate declined to 18.7% from 22.5%, with acquisition-related and other discrete tax effects.
- Fourth-quarter revenue was $1.663 billion, sales margin $496.2 million and net income attributable to shareholders $185.4 million, compared with third-quarter figures of $2.143 billion, $861.3 million and $601.2 million, respectively. Diluted EPS was $1.30 in Q4 versus $4.15 in Q3.
- The filing describes an Empire mine noncontrolling-interest accounting adjustment: an $84.0 million increase in noncontrolling interest reduced Cliffs shareholders’ net income by $67.9 million in the third quarter. Management judged the prior-quarter error immaterial and recorded the adjustment prospectively; its effects should be considered when comparing quarterly results.
Outlook, risks and contingencies
Management’s 2012 outlook assumed an average seaborne 62% Fe iron ore spot price of approximately $150 per ton, CFR China, and forecast more than 45 million tons of global iron ore sales. Segment guidance is stated on differing tonnage bases as indicated in the filing.
| 2012 segment outlook | Sales volume | Revenue per ton | Cash cost per ton |
|---|---|---|---|
| U.S. Iron Ore | Approximately 23 million long tons | $115–$125 | $60–$65 |
| Eastern Canadian Iron Ore | Approximately 12 million metric tons | $135–$145 | $70–$75 |
| Asia Pacific Iron Ore | Approximately 11 million metric tons | $135–$145 | $65–$70 |
| North American Coal | Approximately 7.2 million short tons | $140–$150 | $105–$110 |
Management also forecast 2012 operating cash flow of approximately $1.9 billion, capital expenditures of approximately $1.0 billion, DD&A of approximately $620 million, SG&A of approximately $325 million and an effective tax rate of approximately 25%. Planned growth spending included approximately $90 million for exploration and $75 million for the Ontario chromite project. Bloom Lake’s planned expansion is intended to increase annual concentrate capacity from 8 million to 16 million metric tons; approximately $600 million of project spending was expected in 2012.
- Market and customer exposure: Results depend on global steel demand, China’s growth, commodity prices and contract renewals. ArcelorMittal accounted for 21% of 2011 product revenue; the filing also identifies concentration in a limited set of customers and related-party sales.
- Pricing uncertainty: Some U.S. and Eastern Canadian iron ore contract prices remained subject to final settlement. At year-end, the company reported $1.2 million of related derivative assets, $19.5 million of liabilities and $83.8 million classified in receivables; management estimated a 25% change in settlement prices could affect revenue by about $90 million.
- Operating and cost risks: Mine interruptions, logistics, energy and foreign-exchange movements, geological conditions, labor relations and contractor performance could affect output and margins. Management estimated that a 10% change in natural gas and diesel prices could change annual 2012 energy costs by about $22 million.
- Regulatory and environmental exposure: Potential climate, air-quality, water, coal-mining and selenium rules could require added costs or constrain permits. Michigan selenium treatment was estimated at $35 million over 2012–2015. Environmental and mine-closure obligations totaled $235.7 million at year-end; the company disclosed a $10.0 million reserve for its 32.5% share of the Rio Tinto mine-site remediation allocation.
- Other contingencies: Litigation includes maritime asbestos claims and mine-permit matters. A Northshore air-quality settlement provided for an approximately $240,000 civil penalty and at least $80,000 of environmental work. The company stated that pending litigation was not expected to have a material impact, while acknowledging unfavorable rulings could be material.
- Accounting and audit scope: The auditors issued unqualified opinions on the financial statements and internal control. Management and the auditor excluded Cliffs Quebec Iron Mining Limited from the 2011 internal-control assessment; it represented 51.3% of consolidated assets, 8.9% of revenue and 8.9% of net income. The company said it would include the acquired business in its 2012 assessment.
Most important facts for investors to verify
- Whether iron ore pricing settlements and the provisional-pricing balances ultimately reconcile to amounts recognized in 2011.
- Whether Bloom Lake achieves its planned ramp-up and expansion within the stated cost, schedule and production assumptions.
- Whether coal operations recover from 2011 disruptions and meet 2012 sales, production and cost guidance.
- How much of 2011 earnings and cash flow reflects nonrecurring settlements, foreign-exchange gains, acquisition accounting and other unusual items.
- Debt repayment capacity and liquidity after the acquisition and planned approximately $1 billion of 2012 capital expenditures, including execution of the expected $1.9 billion operating cash flow.
- Any changes in environmental, mine-closure, pension and OPEB obligations, customer concentration, legal contingencies or internal-control coverage.