Cliffs Natural Resources Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. The filing’s registrant is Cliffs Natural Resources Inc. (Ohio); the company’s continuing operations were U.S. Iron Ore and Asia Pacific Iron Ore. The former Canadian and North American coal businesses are reported as discontinued operations.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $496.2 million | $498.1 million | $801.7 million | $944.1 million |
| Sales margin | $91.5 million | $57.3 million | $122.4 million | $138.1 million |
| Sales margin rate | 18.4% | 11.5% | 15.3% | 14.6% |
| Operating income | $74.7 million | $25.7 million | $74.4 million | $97.6 million |
| Income from continuing operations | $29.9 million | Loss of $38.2 million | $144.2 million | $128.6 million |
| Net income (loss) attributable to Cliffs shareholders | $12.8 million | $60.2 million | $120.8 million | Loss of $699.6 million |
| Diluted EPS from continuing operations | $0.07 | Loss of $0.28 | $0.67 | $0.70 |
| Adjusted EBITDA | $101.6 million | $64.9 million | $137.8 million | $153.9 million |
Q2 revenue was nearly unchanged year over year, while first-half revenue fell 15.1%, chiefly from lower U.S. Iron Ore shipments and weaker realized pricing. Q2 sales margin improved by $34.2 million, principally on cost reductions and favorable exchange rates, partly offset by mine-idling costs. First-half sales margin declined $15.7 million as lower volume and pricing and higher idle costs outweighed cost savings. First-half earnings included a $182.4 million gain on debt extinguishment/restructuring; the comparable 2015 period included a $313.7 million gain. The 2015 net loss also reflected substantial discontinued-operation losses.
- Segments: Q2 U.S. Iron Ore revenue was $361.7 million and sales margin $70.0 million, versus $369.7 million and $49.0 million. Asia Pacific Iron Ore revenue was $134.5 million and sales margin $21.5 million, versus $128.4 million and $8.3 million. First-half segment sales margins were $83.2 million for U.S. Iron Ore and $39.2 million for Asia Pacific, compared with $129.0 million and $9.1 million.
- Cash flow: First-half operating cash use was $19.3 million, improved from $248.2 million used in 2015. Investing cash use was $14.3 million, including $20.2 million of capital spending; financing cash use was $142.5 million, including $95.6 million to repay equipment loans. Cash declined $177.0 million to $108.2 million.
- Debt and liquidity: Debt carrying value was $2.507 billion at June 30, compared with $2.699 billion at year-end 2015. Long-term debt on the balance sheet was $2.490 billion. No ABL loans were drawn; after letters of credit, ABL borrowing capacity was $312.8 million. Cash plus available ABL capacity provided about $421 million in liquidity. The company reported compliance with ABL liquidity requirements; its springing fixed-charge-coverage covenant was not then applicable.
- Balance sheet: Current assets were $779.2 million and current liabilities $376.1 million. Total liabilities were $3.530 billion, against a total deficit of $1.679 billion. These figures reflect a substantial leverage and negative-equity position.
Material changes, outlook and management commentary
- In March, the company issued $218.5 million principal of 8% 1.5-lien notes in exchange offers. It accounted for the exchange as a troubled debt restructuring and recognized a $174.3 million gain; the notes’ reported carrying amount reflects the restructuring accounting. Separately, debt-for-equity exchanges generated gains of $3.6 million in Q2 and $4.5 million in Q1.
- Preferred shares mandatorily converted in February into 26.5 million common shares, including shares issued in lieu of the final preferred dividend. Common shares outstanding increased materially year over year.
- Management expected to generate operating cash and meet anticipated capital spending and debt-service needs for the next 12 months, but warned that a prolonged decline in customer demand or iron ore and steel prices could pressure liquidity. Further asset sales, cost reductions, or secured-note issuance might be considered, and could prove insufficient in a severe downturn.
- 2016 guidance: U.S. Iron Ore sales of 18 million long tons and production of 16.5 million long tons; cash production cost of $50–$55 and cash cost of goods sold of $55–$60 per long ton. Asia Pacific Iron Ore sales and production were each forecast at 11.5 million metric tons; cash production cost of $25–$30 and cash cost of goods sold of $30–$35 per metric ton. Full-year capital expenditures were expected at $75 million, SG&A at $100 million, interest expense at about $200 million (about $170 million cash), and depreciation, depletion and amortization at about $120 million.
- Management raised U.S. Iron Ore volume guidance after additional U.S. Steel Canada business and lowered expected idle costs to $55 million following earlier-than-expected restarts. United Taconite was scheduled to restart in August 2016. Outlook assumed full-year customer hot-rolled steel realizations of about $480 per short ton; revenue-per-ton guidance varied with Platts IODEX assumptions. At a $50 IODEX average for July–December, indicated full-year realized revenue ranges were $75–$77 per long ton for U.S. Iron Ore and $38–$40 per metric ton for Asia Pacific.
- Key commercial developments included a ten-year ArcelorMittal pellet-supply agreement, effective October 2016, with minimum purchases of 7 million long tons annually and purchases up to 10 million; and the reinstatement of the Essar agreement from January 2017 through 2024. Essar remained under creditor protection.
Risks, contingencies and unusual items
- Iron ore prices, Chinese and global steel demand, customer furnace idlings, contract pricing formulas, foreign exchange, energy costs, and customer or joint-venture-partner performance could materially affect results. A customer steel-price-linked derivative produced a $19.5 million Q2 revenue gain; its June 30 fair value was a $23.7 million asset. A $75 per-short-ton change in the estimated hot-rolled steel price could change its fair value by roughly $22–$25 million.
- Canadian entities remained in CCAA proceedings. The company recorded $70.2 million of loans and receivables from them at estimated fair value; ultimate recovery depends on liquidation proceeds and creditor claims. Management said additional losses beyond accrued amounts could be material but could not reasonably estimate a range.
- Potential retroactive electricity-system charges affecting the Empire and Tilden mines were estimated at approximately $19 million; the company continued to challenge the charges. The Essar agreement’s future sales remained subject to uncertainty because Essar was in creditor protection. A putative noteholder class action challenging the 2016 exchange offers was pending, and the company said it would defend the claims.
- The company settled two shareholder securities actions for $84 million and $10 million, funded by insurance, and related derivative suits were also settled or dismissed. Management said these settlements had no operating impact. It stated that other pending litigation was not expected to create a material liability, while acknowledging adverse rulings could have material effects.
Important facts for investors to verify
- Whether the forecast mine restarts, sales volumes and cost reductions were achieved, and whether U.S. steel demand and iron ore prices supported guidance.
- Actual liquidity, ABL borrowing-base availability, covenant compliance, debt maturities and the effects of additional debt or equity transactions.
- Cash conversion and working-capital trends, given first-half operating cash outflow and the fall in cash to $108.2 million.
- Recovery of Canadian-entity receivables and the ultimate cost of CCAA-related guarantees, claims and proceedings.
- Essar’s ability to perform under the reinstated agreement and the impact of customer concentration and related-party sales.
- The extent to which reported earnings depend on debt-restructuring gains and fair-value adjustments rather than recurring operating performance.