CLEVELAND-CLIFFS INC. quarterly report, Q2 FY2019

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Cleveland-Cliffs Inc. — Q2 2019 Form 10-Q

Reporting period: Three and six months ended June 30, 2019. The company’s continuing operations comprised Mining and Pelletizing and Metallics; the Toledo HBI plant remained under construction. Financial amounts are in U.S. dollars.

Financial performance

  • Q2 revenue: $743.2 million, up 4.0% from $714.3 million. Sales margin was $263.0 million, down from $284.5 million; operating income was $226.8 million versus $254.2 million.
  • Q2 earnings: Net income was $160.8 million ($0.57 diluted EPS), compared with $165.1 million ($0.55 diluted EPS). Income from continuing operations fell to $161.4 million from $229.4 million ($0.57 versus $0.76 diluted EPS). The prior-year quarter included a $64.3 million discontinued-operations loss.
  • First-half revenue and earnings: Revenue was $900.2 million versus $894.3 million. Sales margin declined to $293.9 million from $346.0 million; operating income to $226.0 million from $284.5 million. Net income rose to $138.7 million from $80.8 million, while continuing-operations income fell to $139.3 million from $216.0 million. The comparison reflects substantially smaller discontinued-operations losses in 2019.
  • Margins and non-GAAP results: Sales margin was about 35.4% of revenue in Q2 versus 39.8% a year earlier, and 32.7% for the first half versus 38.7%. Adjusted EBITDA was $248.5 million for Q2 and $269.6 million for the first half, down from $275.7 million and $328.0 million, respectively.
  • Cash flow: First-half operating cash flow was $151.1 million, versus cash use of $49.3 million in 2018. Investing used $292.4 million, principally reflecting capital spending; financing used $307.9 million. Cash and cash equivalents ended June at $377.2 million, down from $823.2 million at year-end.
  • Debt and liquidity: Long-term debt carrying value was $2.105 billion; principal maturities totaled $2.238 billion. The company issued $750 million of 5.875% notes due 2027 and used proceeds and cash to redeem its 2021 notes and repurchase $600 million principal of 2025 notes. It had no ABL borrowings and $388.9 million of available ABL capacity after letters of credit. Including cash classified with discontinued operations, management reported $775.3 million of liquidity.
  • Other balance-sheet items: Current assets were $1.119 billion and current liabilities $437.4 million. Property, plant and equipment, net, increased to $1.597 billion from $1.286 billion, primarily amid project investment. Environmental and mine-closure obligations were $179.5 million.

Changes and management commentary

  • In Q2, sales volume rose by 0.3 million long tons, supporting revenue, but sales margin per ton declined 10.9% to $42.49. For the first half, margin per ton fell 16.8% to $38.00.
  • Management attributed pressure on margins to higher royalties and labor, commodity and transportation costs, maintenance and stripping costs, and the nonrecurrence of prior-year LIFO layer liquidation benefits. Q2 production was lower, mainly because of unplanned maintenance at Tilden.
  • Higher Platts iron-ore prices and pellet premiums supported realized pricing, but lower hot-rolled-coil steel prices offset much of that benefit under customer pricing arrangements. Management cited the 2019 Vale dam failure and resulting supply disruptions as contributing to favorable iron-ore market conditions.
  • Derivative revenue was $74.8 million in Q2 and $80.3 million in the first half, versus $154.7 million and $198.5 million in the corresponding 2018 periods. These market-linked estimates are subject to later settlement and can make reported revenue volatile.
  • The company repurchased 24.4 million shares for $252.9 million in the first half under its $300 million authorization, leaving approximately $0.2 million available at June 30. It paid $28.9 million in dividends during the period.

Outlook, risks and contingencies

  • For 2019, management maintained expected Mining and Pelletizing sales and production of 20 million long tons each, and cash cost of goods sold of $62–$67 per long ton. Assuming relevant indices average their year-to-date levels for the rest of the year, expected revenue rates were $109–$114 per long ton.
  • Other 2019 estimates included SG&A of $120 million, net interest expense of $100 million, depreciation, depletion and amortization of about $85 million, and an effective tax rate of 12%–14%. Cash tax payments were expected to be zero due to the company’s net operating loss position.
  • Management revised total 2019 capital expenditure expectations to $650–$700 million. Toledo HBI commercial production was expected ahead of schedule, in the first half of 2020; the project’s expected total spend was about $830 million plus contingency of up to 20%. The company also expected roughly $680 million of capital spending over the next 12 months.
  • Management expected cash from operations, subject to changing steelmaker demand and commodity prices, to meet operating needs, debt service and dividends. It stated that cash and ABL availability should be adequate for at least the next 12 months.
  • Key risks include iron-ore, pellet-premium and steel-price volatility; dependence on steelmaking customers and energy suppliers; project execution and HBI start-up; production interruptions; regulation, permits and environmental obligations; liquidity and indebtedness; and legal or contractual disputes. A customer hot-rolled-coil-linked derivative asset was valued at $102.4 million; a $75-per-net-ton change in the estimated steel price was estimated to change its value by about $36.8 million. The filing says pending claims were not expected to have a material effect based on information then available. The Bluestone litigation settlement was finalized with a full release.
  • Management reported disclosure controls and procedures were effective as of quarter-end and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  • Whether iron-ore prices and pellet premiums sustain realized pricing, and how lower steel prices affect customer contract settlements and derivative values.
  • Whether operating costs, production reliability and sales margins improve after the first-half decline, including the effects of Tilden maintenance and cost inflation.
  • HBI construction progress, final project cost and contingency, planned 2020 start-up, and associated capital-funding needs.
  • Cash generation and liquidity after substantial share repurchases, capital spending, debt refinancing and planned dividends.
  • Debt principal and interest obligations, including the economics of the 2027 issuance and the tendered 2025 notes; the filing reports $2.1045 billion debt carrying value and $2.238 billion principal maturities.
  • How much reported earnings depend on market-sensitive derivative revenue and non-GAAP adjustments; compare GAAP continuing-operations results with Adjusted EBITDA.