Cleveland-Cliffs Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Amounts are in U.S. dollars; financial statements are unaudited. Cliffs reported one continuing segment, U.S. Iron Ore, after classifying its Asia Pacific Iron Ore business as discontinued operations.
Financial performance and position
- Q3 revenue: $741.8 million, up 24% from $596.7 million. Sales margin was $261.6 million (35.3% of revenue), versus $157.8 million (26.4%) a year earlier. Operating income was $225.5 million, versus $128.7 million.
- Q3 earnings: Continuing-operations income was $199.8 million, or $0.64 diluted per share, compared with $22.3 million, or $0.08, in Q3 2017. Net income was $437.8 million, or $1.41 diluted per share; it included $238.0 million from discontinued operations.
- First nine months: Revenue was $1.636 billion, up 21%; sales margin was $607.6 million (37.1% of revenue), versus $351.5 million (26.0%). Operating income was $510.0 million. Continuing-operations income was $415.8 million, or $1.37 diluted per share; net income was $518.6 million, or $1.71 diluted per share, including $102.8 million from discontinued operations.
- Adjusted EBITDA: $250.3 million in Q3 versus $150.8 million; $578.3 million for nine months versus $325.9 million. These are non-GAAP measures; Q3 reported EBITDA also included discontinued-operations effects.
- Cash flow: Nine-month operating cash flow was $188.7 million, down from $206.7 million. Investing used $173.7 million, including $111.4 million of PP&E purchases and $83.3 million of capital deposits. Financing used $107.7 million. Cash and cash equivalents were $897.1 million at quarter-end, down from $978.3 million at year-end 2017.
- Debt and liquidity: Long-term debt was $2.30 billion. The company had no ABL borrowings and $330.7 million of availability after letters of credit. Management reported total cash, including discontinued operations, plus available ABL capacity of $1.243 billion. Total liabilities exceeded assets by $86.2 million, leaving a shareholders’ deficit.
Changes and notable items
- U.S. Iron Ore sales margin improved substantially, reflecting higher realized prices and sales volumes. Q3 realized product revenue was $105.65 per long ton, up 16.7%; sales volume increased to 6.481 million long tons from 5.863 million. Nine-month realized revenue was $108.53 per long ton, up 20.7%.
- Higher hot-rolled coil steel prices and pellet premiums supported realized pricing; higher freight rates and a lower estimated Platts 62% iron ore price partly offset the benefit. Cost rates also rose.
- Q3 discontinued-operations income included a $228.1 million foreign-currency translation gain reclassified to earnings following the Australian asset sale, as well as a $16.8 million net gain on that sale. The Australian operation completed its final shipment in June and sold substantially all remaining assets in August.
- Topic 606 adoption increased nine-month 2018 revenue by $57.2 million and income from continuing operations by $35.3 million versus what would have been reported without adoption; comparative periods were not restated. The filing says the change primarily affects timing, not expected annual revenue in the long term.
- After quarter-end, Cliffs redeemed approximately $211 million principal amount of 2020 notes for approximately $218 million including premiums and accrued interest. It also ratified a four-year union contract and declared a $0.05-per-share dividend payable in January 2019.
Outlook, risks and contingencies
- 2018 guidance maintained: U.S. Iron Ore sales volume of 21 million long tons; production of 20 million long tons; realized revenue of $105–$110 per long ton; and cash cost of goods sold and operating expense of $58–$63 per long ton. Revenue guidance assumes iron ore, steel and pellet prices for the rest of the year average their year-to-date levels.
- Full-year expectations included $115 million of SG&A, $120 million of net interest expense and approximately $80 million of depreciation, depletion and amortization. Capital budgets were $175 million for the Toledo HBI project, $75 million for sustaining capital and $50 million for Northshore upgrades. The company expected approximately $510 million of capital expenditures over the next 12 months.
- Management expected available liquidity to fund operations, debt service, capital projects and dividends for at least 12 months, while noting sensitivity to steelmaker demand and iron ore and domestic steel prices. It cited favorable pellet-premium supply-demand conditions but acknowledged that commodity prices could move in either direction.
- Key exposures include iron ore, hot-rolled coil steel, fuel and energy prices, customer and joint-venture performance, production and project execution, regulation, mine closure and environmental obligations, and debt and dividend capacity. A $75-per-net-ton change in estimated hot-rolled coil steel price would change the customer-supply-agreement derivative’s fair value by about $19.5 million. Related-party customers generated 57.3% of Q3 product revenue.
- Cliffs estimated $13.0 million of potential Michigan electricity surcharges; $8.8 million remained accrued at September 30, 2018. The filing describes other litigation and regulatory matters, including Mesabi Metallics and Seneca disputes, but says management did not expect pending claims collectively to create a material liability based on information then available. It cautions that unfavorable rulings could still have a material impact.
Investor verification priorities
- Separate recurring U.S. Iron Ore performance from discontinued-operation gains, especially the $228.1 million translation release, when assessing reported net income.
- Check the cash conversion and timing of provisional and supplemental pricing: derivative assets were $190.8 million at quarter-end, and nine-month revenue included $334.4 million of derivative revenue.
- Track completion costs, schedule and returns for the HBI project and Northshore upgrade, alongside the stated capital-spending plan.
- Reconcile post-quarter-end redemption costs and remaining debt maturities with cash, borrowing availability and dividend commitments.
- Monitor the stated commodity, customer-concentration, legal, environmental and mine-closure risks, including the remaining electricity surcharge estimate.