Cleveland-Cliffs Inc. (Cliffs Natural Resources Inc.) — Q2 2010 Form 10-Q
Business context and reporting period. Unaudited results cover the quarter and six months ended June 30, 2010. The company produces iron ore and coal, with operations in North America, Australia and Brazil and developing chromite interests. Management attributed the recovery from 2009’s downturn to stronger steel production, customer demand, sales volumes and commodity pricing. The filing was made under the name Cliffs Natural Resources Inc.
Financial performance
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Revenue from product sales and services | $1,184.3 million | $390.3 million | $1,912.0 million | $855.1 million |
| Sales margin | $414.7 million | $(11.7) million | $564.7 million | $30.7 million |
| Operating income (loss) | $365.8 million | $(17.3) million | $479.2 million | $(5.9) million |
| Net income attributable to Cliffs shareholders | $260.7 million | $45.5 million | $354.2 million | $38.1 million |
| Diluted EPS | $1.92 | $0.36 | $2.60 | $0.32 |
| Sales margin as a percentage of revenue | 35.0% | (3.0)% | 29.5% | 3.6% |
Cash flow and liquidity. First-half operating cash flow was $235.7 million, versus cash use of $160.3 million a year earlier. Investing activities used $357.2 million, including acquisitions, venture investments and capital spending; cash capital expenditures were $63.0 million. Cash increased to $527.5 million from $502.7 million at year-end 2009. Long-term debt was $725.0 million, up from $525.0 million; cash less reported debt implies net debt of about $197.5 million. The $600 million revolver had $537.8 million available after letters of credit. The company reported compliance with financial covenants.
Margins and segments. North American Iron Ore sales margin rose to $208.5 million from $33.6 million in Q2; North American Coal improved to $23.0 million from a $19.1 million loss; Asia Pacific Iron Ore rose to $169.1 million from a $17.2 million loss. Higher volumes and prices drove the improvement. North American Iron Ore sales nearly tripled in the quarter, while North American Coal sold 719,000 tons versus 289,000.
Material changes and notable items
- First-half sales increased by $1,056.9 million year over year, reflecting increased volumes, higher prices and the consolidation of Wabush. Cost of goods sold also rose substantially with activity; reported costs included $21.7 million of inventory step-up and purchase-price amortization, primarily associated with Wabush.
- First-half results included a $60.6 million noncash gain from remeasuring prior interests in Wabush and Freewest when control was obtained. The company acquired the remaining Wabush interest in February and Freewest in January.
- Provisional iron ore pricing materially affected reported revenue: the company recorded $389.3 million in Q2 and $731.5 million in the first half as increases to product revenue under provisional pricing arrangements. These amounts depend on final pricing settlements. Q2 also included a $36.7 million favorable settlement adjustment for earlier Asia Pacific shipments.
- Foreign-currency contract fair-value changes were losses of $10.0 million in Q2 and $7.7 million in the first half, compared with gains of $79.3 million and $76.0 million, respectively, in 2009.
- The first-half tax provision included $23.1 million of discrete expense, primarily related to health-care legislation; the filing identifies a $16.1 million noncash deferred-tax charge from reduced deductibility of prescription-drug benefits.
Outlook, risks and contingencies
Management’s 2010 outlook assumes steel utilization remains stable for the rest of the year and is subject to unsettled pricing mechanisms and arbitrations. Guidance was 27 million tons of North American Iron Ore sales at $107–$112 per ton, with production of about 26 million tons and costs of $65–$70 per ton; 3.4 million tons of North American Coal sales at $140–$145 per ton and costs of $110–$115; and 8.8 million tonnes of Asia Pacific Iron Ore sales at $110–$115 per tonne and costs of $55–$60. North American Coal guidance excludes INR. Management estimated 2010 operating cash flow above $1.5 billion, contingent on final North American pricing and resolution of arbitrations, and capital expenditures of about $250 million. It expected a full-year tax rate of approximately 30%; elsewhere, it gave an expected 28.5% rate before discrete items.
- Two North American Iron Ore customer pricing arbitrations remained pending. The filing warns outcomes could materially affect realized prices and revenue; a stated risk to the 2010 North American Iron Ore price outlook was about $11 per ton if one arbitration did not settle by year-end.
- After quarter-end, Cliffs reported owning about 85% of Spider by July 26, 2010. It also signed an agreement to acquire INR’s coal operations for $757 million, expected to close July 30 and to be funded from liquidity, including cash and the revolver. Both transactions increase execution and financing requirements.
- Other disclosed exposures include a proposed Australian minerals resource rent tax, potentially applying a 30% rate to iron ore and coal profits from July 2012 if enacted; currency and energy-price movements; customer concentration; and environmental, mine-closure and litigation matters. Management said pending litigation was not expected to result in material liability overall, while noting unfavorable outcomes could be material. A KHD royalty arbitration was estimated to result in about C$11 million plus interest and costs; Cliffs had accrued approximately $2.8 million for its share.
- The company reported effective disclosure controls at period-end and no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Check final North American Iron Ore pricing settlements and arbitration outcomes against the provisional revenue recognized and the $107–$112 per-ton guidance.
- Verify the closing, funding and integration of the Spider and INR transactions, including their effects on debt, liquidity and segment results.
- Track operating cash generation and working-capital movements against management’s conditional estimate of more than $1.5 billion for 2010.
- Reconcile the tax outlook, including discrete charges, health-care impacts and the difference between the stated approximately 30% full-year rate and 28.5% before discrete items.
- Monitor the proposed Australian tax, customer concentration, energy and currency exposures, and material litigation or mine-closure developments.