Cleveland-Cliffs Inc. (filed as Cliffs Natural Resources Inc.) — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; financial statements are unaudited. Unless otherwise stated, amounts are in U.S. dollars and millions. The filing cautions that quarterly results are not necessarily indicative of full-year results.
Business context and key results
The company is an international iron ore and coal producer. Its reportable segments are U.S. Iron Ore, Eastern Canadian Iron Ore, North American Coal, and Asia Pacific Iron Ore. The May 2011 Consolidated Thompson acquisition expanded Eastern Canadian Iron Ore, including Bloom Lake.
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue from product sales and services | $1,264.7 | $1,183.2 | Up 6.9% |
| Sales margin | $303.5 | $599.5 | Down $296.0 |
| Sales margin percentage | 24.0% | 50.7% | Down 26.7 percentage points |
| Operating income | $231.1 | $542.1 | Down $311.0 |
| Income from continuing operations | $391.5 | $423.8 | Down $32.3 |
| Net income attributable to Cliffs shareholders | $375.8 | $423.4 | Down $47.6 |
| Diluted EPS from continuing operations | $2.63 | $3.11 | Down $0.48 |
Revenue growth was primarily due to higher Eastern Canadian Iron Ore volumes following the acquisition. Lower iron ore pricing and higher costs sharply reduced sales margin. Q1 2011 also included significant nonrecurring customer settlements and pricing true-ups, including $105.1 of ArcelorMittal USA settlement revenue and $54.1 of related cost reimbursements.
- Segment sales margin: U.S. Iron Ore $166.9 (prior year $361.3); Eastern Canadian Iron Ore $(14.3) ($34.5); North American Coal $14.5 ($(2.9)); Asia Pacific Iron Ore $125.0 ($195.8).
- Cash flow: Operating cash flow was $(129.0), versus $106.9 provided in Q1 2011. Capital expenditure cash outflow was $241.1, versus $65.7. Investing cash flow was $(252.0); financing cash flow was $(21.2).
- Liquidity and debt: Cash was $122.3 at quarter-end, down from $521.6 at year-end 2011. Current assets were $1,587.3 and current liabilities $1,384.6. Balance-sheet debt comprised $87.2 current term loan and $3,583.8 long-term debt. The $1.75 billion revolving facility had $1,726.5 available at March 31; the company disclosed $425.0 drawn by April 26 for general operations.
- Other: Interest expense rose to $47.3 from $38.4. The declared quarterly dividend was $0.28 per share in Q1; the board subsequently raised it to $0.625, payable June 1, 2012.
Material changes, outlook, and management commentary
Iron ore prices softened from 2011 levels while operating costs increased. Eastern Canadian Iron Ore’s sales volume rose 171.4% year over year, but its margin turned negative amid lower realized prices, increased costs, and operating challenges at Wabush and Bloom Lake. Asia Pacific Iron Ore margin declined on lower prices, higher stripping costs, and unfavorable currency effects. North American Coal returned to a positive margin as volumes and production improved.
The Australian Minerals Resource Rent Tax (MRRT) was enacted in March, with commencement scheduled for July 1, 2012. It generated a $210.8 income tax benefit in Q1, including a $334.6 increase in deferred tax assets and a $19.9 valuation allowance. Management estimated a 2012 effective tax rate of approximately 5% including discrete items, and approximately 23% excluding the MRRT and other discrete items. It expects MRRT to raise the consolidated effective tax rate by about 3–4 percentage points annually over the affected mines’ lives.
2012 guidance: Management expected approximately $1.7 billion operating cash flow, reduced from $1.9 billion; approximately $1 billion capital expenditures; and about $585 million depreciation, depletion and amortization. It forecast average seaborne 62% Fe iron ore at about $150 per ton. Segment guidance included U.S. Iron Ore sales of 23 million long tons at $115–$120 revenue per ton and $60–$65 cash cost; Eastern Canadian Iron Ore sales of 12 million metric tons at $140–$145 revenue per ton and $80–$85 cash cost; Asia Pacific Iron Ore sales of 11.4 million metric tons at $140–$145 revenue per ton and $70–$75 cash cost; and North American Coal sales of 7.2 million short tons at $130–$135 revenue per ton and $105–$110 cash cost. Eastern Canadian production guidance was reduced to 11.2 million metric tons, and its cash-cost outlook increased; North American Coal revenue-per-ton guidance was reduced.
Management cited a stable long-term demand outlook, planned continued investment in organic growth, and expected operating cash flow to exceed budgeted investment and other cash requirements. Major projects included the Bloom Lake Phase II expansion, intended to raise annual capacity from 8 to 16 million metric tons, and the Koolyanobbing expansion. The company said it was in compliance with financial covenants at March 31.
Risks, contingencies, and unusual items
- Bloom Lake/WISCO dispute: WISCO challenged minimum distributions and expansion cash calls. An interim arbitration order barred dilution tied to a disputed March cash call pending the merits hearing; final determinations were reserved. The company said it would defend the matter.
- Regulatory matters: Northshore received a draft proposed $0.3 million penalty concerning coal-ash landfill leachate. Pinnacle faced a proposed $1.0 million penalty related to alleged discharge-permit violations; the company disputed some allegations.
- Legal exposure: Management believed pending litigation would not materially affect the statements, while cautioning that an unfavorable ruling could have a material impact.
- Operating and market risks: Risks include weaker global or Chinese demand and prices, customer contract pricing disputes, cost inflation, foreign exchange and interest-rate movements, energy supply interruptions, weather, mine performance, and the ability to fund growth while maintaining liquidity.
- Pricing and estimates: Some customer sales are provisionally priced or include supplemental revenue linked to steel prices. At March 31, the company recorded a $65.1 derivative asset for a customer steel-price provision; a $75 change in estimated hot-rolled steel price could change its fair value by about $16.0.
- Comparability issue: The filing disclosed an immaterial prior-period Empire noncontrolling-interest accounting error. Had the adjustment been reflected in Q1 2011, continuing-operations income would have increased $8.4, while net income attributable to Cliffs shareholders would have decreased $37.5, or $0.28 per share. The filed Q1 2011 results were not restated.
Important facts for investors to verify
- How lower commodity prices, realized sales prices, and higher unit costs affect margins and whether segment guidance remains achievable.
- The assumptions, recoverability, and tax-authority review of the MRRT-related deferred tax asset, and the resulting cash-tax outlook.
- Bloom Lake expansion spending, production ramp-up, cost performance, and the outcome of the WISCO arbitration.
- Whether forecast operating cash flow and available borrowing capacity are sufficient for the approximately $1 billion capital program, debt service, and increased dividend.
- The impact of the disclosed unadjusted Q1 2011 accounting error when comparing historical earnings and per-share results.