Cleveland-Cliffs Inc. (filed as Cliffs Natural Resources Inc.) — Q1 2014 Form 10-Q
Period: Three months ended March 31, 2014. Financial statements are unaudited. Amounts are in U.S. dollars unless noted.
Business context
The company produces iron ore and metallurgical and thermal coal for the steelmaking industry. Its reportable segments are U.S. Iron Ore, Eastern Canadian Iron Ore, Asia Pacific Iron Ore, and North American Coal. Management cited weaker commodity prices, lower shipments in some operations, and operating challenges at Wabush and Bloom Lake.
Financial results and liquidity
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Revenue | $940.0 million | $1,140.5 million |
| Sales margin | $63.2 million; 6.7% of revenue | $237.9 million; 20.9% of revenue |
| Operating income (loss) | $(50.7) million | $168.3 million |
| Net income (loss) attributable to Cliffs common shareholders | $(83.1) million | $97.1 million |
| Diluted EPS | $(0.54) | $0.66 |
| Cash from operating activities | $(82.0) million | $(25.4) million |
| Cash used in investing activities | $(90.7) million | $(228.4) million |
- Revenue fell 17.6%; management attributed $172.6 million of the decline to lower market pricing. Iron ore and coal pricing, as well as lower sales volumes, weighed on results.
- Cash and cash equivalents were $364.0 million at March 31, versus $335.5 million at year-end. Current assets were $1.672 billion and current liabilities $1.043 billion.
- Balance-sheet debt was approximately $3.292 billion, including $96.9 million classified as short-term or current debt; long-term debt was $3.195 billion. The company had $175 million drawn on its revolving facility and reported $1.555 billion of available borrowing capacity.
- Cash capital expenditures were $103.3 million, down from $230.4 million. Financing activities provided $197.9 million, including $225 million in borrowings, partly offset by common and preferred dividends.
- Cash flow from operations was negative despite a $28.5 million increase in cash for the quarter. Working-capital movements included a $214.5 million use from product inventories.
Segment performance and material changes
- U.S. Iron Ore: Sales margin fell to $95.0 million from $157.3 million. Lower realized revenue per ton and sales volume, including Great Lakes shipping disruption from severe weather, contributed to the decline.
- Eastern Canadian Iron Ore: Sales margin shifted to a $49.7 million loss from $19.4 million income. Lower prices and sales volumes, inventory write-downs, and high costs affected the segment. The Scully mine at Wabush was idled during March.
- Asia Pacific Iron Ore: Sales margin increased to $66.3 million from $61.3 million, supported by higher sales volume and lower costs, though realized revenue per ton declined.
- North American Coal: Sales margin shifted to a $48.4 million loss from $1.8 million income. Lower metallurgical-coal prices and volumes, higher unit costs, and $22.1 million of inventory charges contributed.
- Miscellaneous net expense was $58.6 million, compared with $1.5 million of income in Q1 2013. It included $33.3 million of Wabush idling-related costs and $15.7 million for failure to meet minimum Bloom Lake shipment requirements. Management cited an additional adverse foreign-exchange remeasurement impact.
- The Platts 62% Fe iron ore spot price averaged $120 per ton, down 19% from Q1 2013. The premium low-volatile coking-coal benchmark averaged $143 per metric ton, down 13%.
Outlook, management commentary, and risks
- Management maintained 2014 volume expectations: U.S. Iron Ore 22–23 million long tons; Eastern Canadian Iron Ore 6–7 million metric tons; Asia Pacific Iron Ore 10–11 million metric tons; North American Coal 7–8 million short tons.
- At a $120-per-ton iron ore base-price assumption, expected realized revenue ranges were $100–$105 per ton for U.S. Iron Ore and $95–$100 for each Canadian and Asia Pacific iron ore segment. North American Coal revenue guidance was reduced to $80–$85 per short ton from $85–$90.
- Management expected 2014 cash costs per ton of $65–$70 for U.S. Iron Ore, $85–$90 for Eastern Canadian Iron Ore (Bloom Lake operating cash cost), $60–$65 for Asia Pacific Iron Ore, and $85–$90 for North American Coal. These are non-GAAP measures as defined by the filing.
- Full-year expectations included approximately $375–$425 million in capital expenditures, $600 million in depreciation, depletion and amortization, $185 million in SG&A excluding severance, and $15 million in exploration cash outflows. Wabush idling costs were estimated at approximately $100 million for 2014.
- Bloom Lake Phase II remained on hold; Cliffs was exploring strategic alternatives and planned to operate Phase I with reduced tailings and water-management capital. Management said the operation could be temporarily idled if pricing and costs warranted.
- Management stated liquidity was sufficient for at least the next 12 months under current assumptions and that the company complied with revolving-credit covenants at March 31. The filing cautions that prolonged weak demand or prices could prompt production reductions, delayed capital spending, asset sales, or overhead cuts.
- Key risks include iron ore and coal price volatility, China’s economic and steel-demand outlook, operating costs and production performance, foreign-exchange and energy costs, Bloom Lake asset recoverability, and the ability to maintain liquidity and meet debt covenants.
Contingencies and unusual items
- The company disclosed an active shareholder proxy contest by Casablanca Capital, which held approximately 5.2% of common shares and sought board changes and strategic actions. The filing warns of potential costs, management distraction, stock volatility, and possible change-in-control severance costs.
- Arbitrations included a dispute with Esperance Port Sea and Land over port capacity and charges, and a pellet-pricing dispute with Severstal. A hearing in the Severstal arbitration was proceeding in April 2014; the Esperance arbitration hearing had been adjourned to September 2014.
- EPA Region 5 issued Notices of Violation to Empire, Tilden, and United Taconite regarding alleged historical Taconite MACT and permit violations. The company was reviewing the notices and did not then expect a material business impact.
- Management said pending litigation was not expected to have a material effect based on information then available, while noting that unfavorable rulings could have a material impact in the period incurred.
- Cliffs extended its iron ore pellet supply agreement with ArcelorMittal through January 2017, with a mutual option for a further year, and extended the Empire Mine partnership, preventing its previously anticipated 2014 closure.
Most important facts for investors to verify
- Whether weaker iron ore and coal prices, shipment volumes, and segment margins persist, and how actual results compare with the stated 2014 assumptions.
- Wabush’s total idling costs and any operational or closure liabilities, and whether Bloom Lake Phase I remains economic without Phase II.
- Bloom Lake’s asset carrying value and impairment sensitivity; the filing cited approximately $4.9 billion in long-lived assets at December 31, 2013 and sensitivity to price, cost, and capital assumptions.
- Available revolver capacity and covenant compliance as operating performance changes, given substantial debt and negative Q1 operating cash flow.
- Outcomes and financial effects of the shareholder proxy contest, the port and customer arbitrations, and the EPA notices.
- Reliability of derivative-based customer pricing estimates and exposure to commodity, steel-price, foreign-exchange, and energy-cost changes.