Cleveland-Cliffs Inc. — 2017 Third-Quarter Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and nine months ended September 30, 2017. Cleveland-Cliffs produces iron ore pellets for North American steelmakers and operates an iron ore business in Western Australia. Continuing operations are reported in U.S. Iron Ore and Asia Pacific Iron Ore. The company also described plans to develop a hot briquetted iron (HBI) plant in Toledo, Ohio.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $698.4 million | $553.3 million | $1,729.3 million | $1,355.0 million |
| Sales margin | $160.2 million; 22.9% | $85.4 million; 15.4% | $401.0 million; 23.2% | $207.8 million; 15.3% |
| Operating income | $129.7 million | $34.7 million | $326.2 million | $109.1 million |
| Income from continuing operations attributable to Cliffs shareholders | $21.1 million | $(23.1) million | $70.7 million | $95.6 million |
| Net income attributable to Cliffs shareholders, including discontinued operations | $53.4 million; diluted EPS $0.18 | $(25.8) million; diluted EPS $(0.12) | $57.1 million; diluted EPS $0.19 | $95.0 million; diluted EPS $0.51 |
| Adjusted EBITDA | $154.4 million | $61.9 million | $383.6 million | $199.7 million |
Q3 revenue increased 26% year over year; nine-month revenue increased 28%. Margin improvement was primarily attributable to higher realized prices across operations and greater U.S. Iron Ore sales volumes. Results also included substantial debt-extinguishment losses: $88.6 million in Q3 and $165.4 million for the nine months. By comparison, the nine months of 2016 included a $164.1 million debt-extinguishment gain. Q3 discontinued operations contributed $32.3 million after tax, including a gain related to the Wabush Scully Mine sale; the nine-month discontinued-operations result was a $13.6 million loss.
- Segments: U.S. Iron Ore sales margin rose to $157.2 million in Q3 from $66.5 million and to $349.8 million for nine months from $149.7 million. Asia Pacific Iron Ore margin fell to $3.0 million in Q3 from $18.9 million and to $51.2 million for nine months from $58.1 million.
- Cash flow: Nine-month operating cash flow was $206.7 million, compared with $72.1 million in 2016. Investing cash outflow was $84.4 million, including $78.9 million for property, plant and equipment. Financing cash outflow was $188.6 million. Cash declined $62.6 million to $260.8 million.
- Liquidity: Current assets were $791.1 million and current liabilities $417.5 million at September 30. ABL borrowing capacity available after letters of credit was $209.2 million; combined cash and available capacity was approximately $470 million. No ABL loans were drawn.
- Debt and equity: Long-term debt carrying value was $1,689.4 million, down from $2,175.1 million at year-end 2016; no current debt portion was reported at September 30. The company issued $1.075 billion of 5.75% senior notes due 2025 and used equity-offering proceeds and note proceeds to refinance and retire debt. It reported total shareholders’ deficit of $833.1 million. Common shares outstanding were approximately 296.5 million at September 30.
Material changes, outlook and risks
- In 2017 the company issued 63.25 million common shares for net proceeds of $661.3 million and issued $1.075 billion principal of 5.75% notes. It reported that refinancing reduced total debt by $503.2 million and its average interest rate to 5.71%, while extending maturities. Interest expense was $103.1 million for the first nine months, versus $156.2 million a year earlier.
- Cliffs acquired U.S. Steel’s remaining 15% interest in Tilden for $105 million and obtained 100% ownership. It also agreed to pay ArcelorMittal $132.7 million for the remaining interest in Empire; approximately $44.2 million was paid initially, with installments due in 2018 and 2019. Tilden ownership is expected to add 1.2 million long tons of annual pellet capacity beginning in 2018.
- 2017 guidance: U.S. Iron Ore sales and production were forecast at 18.5 million long tons each, with cash cost of goods sold and operating expense of $55–$60 per long ton. Asia Pacific sales were forecast at 10.5 million metric tons and production at 11.0 million metric tons, with cash cost of $36–$41 per metric ton. Both segments’ volume outlooks were reduced by 0.5 million tons. The company maintained expected SG&A of $110 million, interest expense of approximately $130 million, and capital expenditures of $115 million.
- Investment plans: Management expected approximately $270 million of capital expenditures over the next 12 months, including about $130 million for the Toledo HBI plant and $40 million for Northshore upgrades. Estimated total project spending through 2020 was approximately $700 million for HBI and $75 million for Northshore upgrades. Management said operating cash flow was expected to cover existing operations and debt service, but not the additional HBI investment; potential funding sources included cash, ABL availability, capital markets or project partners.
- Market and operating risks: Results are exposed to iron ore and hot-rolled coil prices, steel demand, Chinese production and policy, customer nominations, product quality and mix, fuel and energy costs, Australian-dollar exchange rates, and supply interruptions. The company cited possible price pressure if Chinese steel output declines without matching supply reductions, and said it had no hedges for iron ore, steel-price or currency exposure. It estimated a $15 million revenue impact from a $75 change in the relevant hot-rolled-coil estimate for a customer supply agreement.
- Contingencies: Cliffs recorded a $50 million liability for a probable preference claim in the Canadian CCAA proceedings, while disputing liability; the filing says a future change in the estimate is possible. The amount recoverable on its $51.9 million of Canadian-related loans and receivables remains uncertain. A $13.6 million accrual relates to Michigan electricity cost-allocation proceedings. Mesabi Metallics also filed a lawsuit seeking unspecified damages and injunctive relief; Cliffs said it would defend the claims. Management stated that other pending legal matters were not expected to be material, while noting litigation uncertainty.
- Management reported effective disclosure controls. The filing also notes that U.S. Iron Ore revenue recognition was expected generally to occur upon delivery under the new revenue standard effective in 2018, with total annual revenue expected to remain substantially unchanged.
Important facts for investors to verify
- Whether iron ore and steel prices, customer nominations and shipment volumes support the improved margins and the revised 2017 segment volume forecasts.
- Whether the $50 million Canadian CCAA claim liability, recovery of Canadian receivables and any other CCAA claims or distributions change materially.
- Whether the 2025-note refinancing delivers the expected lower interest burden and whether debt maturities and liquidity remain manageable.
- How the HBI project will be financed, whether planned spending and commissioning remain on schedule, and whether project economics justify the investment.
- How much reported earnings and revenue depend on mark-to-market customer supply-agreement derivatives, including the $84.8 million derivative asset at September 30, 2017.
- Whether higher operating costs, energy prices, currency movements, environmental obligations or the Michigan electricity proceedings create additional cash or earnings exposure.