Cleveland-Cliffs Inc. (Cliffs Natural Resources Inc.) — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010; unaudited. Dollar amounts are in millions unless noted. Comparisons are with the corresponding 2009 periods. Results include acquired businesses only from their respective acquisition dates.
Business context
Cliffs was an international mining and natural-resources company focused on iron ore, coal, and emerging chromite operations. Management cited stronger steel production, demand, and commodity prices during 2010. The company completed or advanced acquisitions of Wabush, Freewest, Spider, and INR’s coal operations (CLCC), expanding its iron ore, coal, and chromite footprint.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue from product sales and services | $1,346.0 | $666.4 | $3,258.0 | $1,521.5 |
| Sales margin | $476.5 | $103.2 | $1,041.2 | $133.9 |
| Sales margin as % of revenue | 35.4% | 15.5% | 32.0% | 8.8% |
| Operating income | $389.2 | $80.5 | $868.4 | $74.6 |
| Net income attributable to Cliffs shareholders | $297.4 | $58.8 | $626.6 | $96.9 |
| Diluted EPS | $2.18 | $0.45 | $4.60 | $0.78 |
- Revenue more than doubled year over year in both periods, driven by higher prices and volumes, especially in North American iron ore, and by acquired operations. Costs also rose with higher volumes, foreign exchange, acquisition accounting, and higher labor, royalties, and benefit costs.
- Operating cash flow was $631.0 for nine months, versus cash used of $5.4 in 2009. Investing used $1,292.6, primarily reflecting acquisitions and investments; financing provided $1,112.6, chiefly from senior-note offerings. Cash increased $466.7 to $969.4.
- At September 30, current assets were $2,022.9 and current liabilities $690.0; long-term debt was $1,713.0. Cash exceeded current liabilities. The $600 credit facility was undrawn, with $536.9 of borrowing capacity after letters of credit. The company reported compliance with its financial covenants.
- Capital expenditures paid were $150.1 for nine months. The quarterly dividend rose to $0.14 per share in 2010.
Material changes and unusual items
- Cliffs acquired the remaining Wabush interest in February, acquired Freewest in January, took majority control of Spider in July (85% at quarter-end; 100% after the quarter), and bought CLCC in July for $774.5 cash and working-capital consideration. CLCC contributed $45.5 of revenue and $2.5 of sales margin after acquisition; Wabush contributed $329.6 of revenue and $180 of sales margin after acquisition.
- Nine-month results included a $28.4 gain on acquisition of controlling interests. Wabush purchase-price allocation revisions were recorded retrospectively and reduced first-quarter pre-tax income by $34.3, shareholder net income by $25.0, and EPS by $0.18.
- North American iron-ore shipments were partly recorded at provisional prices amid the industry shift from annual benchmark pricing to shorter-term or spot-linked pricing. Nine-month provisional-pricing revenue was $960.7; $455.7 had been realized through settlements by quarter-end. The company recorded a $136.6 current derivative asset for estimated final pricing, plus $1.8 classified in receivables.
- Q3 results included $12.7 of retroactive iron-ore price adjustments, adding $8.3 to shareholder net income and $0.06 to diluted EPS. The reported nine-month tax provision was $278.0; management cited a 31% effective rate, including discrete items.
Outlook, risks, and contingencies
- For 2010, management expected North American Iron Ore sales of about 27 million tons, revenue per ton of $98–$103, and cost per ton of $65–$70. Revenue guidance was lowered from $107–$112, primarily reflecting the expected timing of an arbitration outcome.
- North American Coal guidance was reduced to 3.6 million tons from 3.9 million; revenue per ton remained $115–$120 while cost per ton rose to $120–$125. Management cited adverse geology and lower fixed-cost leverage. Pinnacle’s production was disrupted by geological conditions; management expected improvement after installation of a new longwall machine.
- Asia Pacific Iron Ore guidance rose to 9.0 million tonnes for sales and production; revenue per tonne was expected at $115–$120 and cost at $55–$60. Management expected more than $1.3 billion of 2010 operating cash flow, approximately $275 of capital expenditures, and a roughly 30% full-year tax rate.
- Two North American iron-ore pricing arbitrations and ongoing contract negotiations could alter realized prices and cause material retroactive adjustments. A 25% change in estimated provisional settlement prices was estimated to affect the derivative value and revenue by about $54.4.
- Other risks included volatile iron-ore, coal, energy, and foreign-exchange markets; mine geology and operating execution; acquisition integration and preliminary purchase-price allocations; customer concentration; and a proposed Australian minerals resource rent tax whose impact was uncertain. Environmental and mine-closure obligations totaled $201.6. Management said pending litigation was not expected to create a material liability, while acknowledging adverse rulings could have a material effect.
Important facts for investors to verify
- Final outcomes and timing of the iron-ore pricing arbitrations, and the settlement of provisional sales prices.
- Whether the company delivered on segment volume, price, and cost guidance, particularly North American Coal’s production recovery.
- Acquisition integration, final purchase-price allocations for Wabush, Freewest, Spider, and CLCC, and the returns on acquisition spending.
- Cash generation and capital spending relative to the substantial acquisition program, debt burden, and planned growth projects.
- Developments in Australia’s proposed MRRT and their potential effect on the company’s operations and investment plans.