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| Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
Management's Discussion and Analysis of Financial Condition and Results of Operations is designed to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and other factors that may affect our future results. We believe it is important to read our Management's Discussion and Analysis of Financial Condition and Results of Operations in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2021, as well as other publicly available information.
Overview
Cliffs is the largest flat-rolled steel producer in North America. Founded in 1847 as a mine operator, we are also the largest manufacturer of iron ore pellets in North America. We are vertically integrated from mined raw materials, direct reduced iron and ferrous scrap to primary steelmaking and downstream finishing, stamping, tooling and tubing. We are the largest supplier of steel to the automotive industry in North America and serve a diverse range of other markets due to our comprehensive offering of flat-rolled steel products. Headquartered in Cleveland, Ohio, we employ approximately 27,000 people across our operations in the United States and Canada.
Economic Overview
Steel market conditions in 2022 have been marked by notable volatility, driven by disruptions due to the war in Ukraine, continued supply chain issues, significantly higher energy prices and demand declines as a result of recessionary fears. The price for domestic HRC, the most significant index impacting our revenues and profitability, averaged $1,119 per net ton for the first nine months of 2022, 27% lower than the same period last year, but well above the prior ten-year average of $712 per net ton. HRC prices climbed to an all-time high of $1,958 per net ton in September 2021 and averaged approximately $1,500 per net ton from January 2021 through June 2022. HRC prices have since receded below $800 per net ton, the lowest level since December 2020. The large decline in spot price has been driven by service center destocking, interest rate hikes driving caution on new business and declining metallics prices driven by lower domestic steel production and excess raw material inventory. Continued automotive supply chain difficulties have also limited the demand for steel from automotive manufacturers. Looking forward, we expect domestic steel demand to normalize as imports have become less attractive, service centers begin to restock inventory, automotive supply chain issues continue to ease and incremental steel demand from the Infrastructure and Jobs Act of 2021 is realized.
The Federal Reserve has pushed interest rates to the highest level in almost 15 years in an attempt to slow demand and reduce inflation. Rising interest rates could cause a significant economic downturn and impact various end markets that we serve and overall domestic steel demand. While we believe there is strong pent-up demand for light vehicles in the U.S., automotive sales could be negatively impacted due to higher interest rates. With mortgage rates near 7%, the highest level since 2002, new builds in the residential housing market could be adversely impacted, which could also impact the appliance market. The non-residential construction market could see delays in construction as increased rates drive caution on new business. As unemployment remains low at 3.5% at the end of September 2022, the current expectation is that the U.S. central bank will continue to increase interest rates. If continued rising rates in the U.S. result in a recession, end-user demand for steel intensive products could be negatively impacted as a recession would likely result in higher unemployment, lower wages and less disposable income for consumers.
The recently passed CHIPS Act and Inflation Reduction Act should provide meaningful support for overall domestic steel demand in the coming years. Our extensive portfolio of products should result in increased steel demand from some of our end markets. The CHIPS Act promotes semiconductor manufacturing in the U.S., which should help support non-residential construction. Additionally, on-shoring manufacturing in the U.S. should reduce risk of supply chain issues in the future. The Inflation Reduction Act provides a tax credit for consumers who buy new electric vehicles, which further incentivizes consumers to purchase vehicles in an environment where pent-up demand is still very strong from recent supply chain issues and low dealer inventory levels. In addition, the Inflation Reduction Act provides incentives for the use of domestic steel for investments in clean energy projects, including wind and solar projects, which consume a substantial amount of steel. Additional projects from the legislation could create incremental demand for our galvanized, GOES, NOES and other steel products. We expect to start seeing benefits from the spending related to the recently passed legislation beginning in 2023.
The largest market for our steel products is the automotive industry in North America, which makes light vehicle production a key driver of demand. In the first nine months of 2022, North American light vehicle production was approximately 10.8 million units, the highest production volume through the first nine months of a year since the first nine months of 2019. While we have seen modest improvement, automotive production continues to be adversely affected by the global semiconductor shortage, as well as other material shortages and supply chain disruptions. This has caused several outages amongst light vehicle manufacturers. The long-term outlook for the automotive industry remains positive as pent-up demand is strong due to ongoing production and supply chain issues. Additionally, the average age of cars on the road in the U.S. reached an all-time high during 2022, which should support demand as older vehicles need to be replaced. As the largest supplier of automotive-grade steel in the U.S., we expect to benefit from the increased production in coming years.
During the first nine months of 2022, light vehicle sales in the U.S. saw an average seasonally adjusted annualized rate of 13.6 million units sold, with 2.8 million passenger cars and 10.8 million light trucks sold, representing a 13% decrease compared to the average of the first nine months of 2021, primarily due to decreased availability. Inventory levels have recently reached the highest level since May 2021 with 1.4 million units of gross stock at the end of September 2022, but remain significantly below historical average inventory levels of 2.5 to 3.0 million units of gross stock.
The ongoing conflict between Russia and Ukraine has disrupted raw material sourcing for our minimill competitors and has further increased the volatility in their steelmaking input costs. Approximately two-thirds of all U.S. imported pig iron, an important feedstock for flat-rolled steel producing minimills, is sourced from Russia and Ukraine. Imported pig iron prices peaked at $1,045 per metric ton in April 2022, the highest level since Fastmarkets AMM began assessing the pig iron market in September 2017, before declining to $535 per metric ton at the end of the third quarter of 2022. Imported pig iron prices averaged $731 per metric ton for the first nine months of 2022, which is significantly above the historical average of $440 per metric ton from September 2017 to December 2021. The recent decline from record levels in pricing is primarily due to lower domestic steel production and surplus raw material inventory as competitors purchased excess raw materials at the beginning of the conflict between Russia and Ukraine to ensure sufficient supply in a time of uncertainty. Higher than historical imported pig iron costs should continue to support a higher HRC price. Unlike other flat-rolled producers, we are not reliant on imported pig iron as we produce it in-house at our blast furnaces, using our own iron ore as the primary raw material.
The price for busheling scrap, a necessary input for flat-rolled steel production in EAFs in the U.S., has remained at or above the historical ten-year average of $380 per long ton. The Fastmarkets AMM Cleveland busheling price averaged $611 per long ton for the first nine months of 2022. Pricing retracted to $420 per long ton at the end of the third quarter, as domestic steel capacity utilization rates declined below 80% and competitors worked through excess raw material inventory. As prime scrap is a replacement to imported pig iron, we expect the busheling scrap price will remain at or above historical levels as the availability of imported pig iron from Russia and Ukraine remains disrupted. We expect the supply of busheling scrap to further tighten due to decreasing prime scrap generation from original equipment manufacturers and the growth of EAF capacity in the U.S., along with a push for expanded scrap use globally. As we are fully integrated and have primarily a blast furnace footprint, increased prices for busheling scrap in the U.S. bolster our competitive advantage, as we source the majority of our iron feedstock from our stable-cost mining and pelletizing operations in Minnesota and Michigan.
As for iron ore, the Platts 62% price averaged $127 per metric ton in the first nine months of 2022, which is 30% higher than the historical ten-year average. While higher iron ore prices play a role in increased steel prices, we also directly benefit from higher iron ore prices for the portion of iron ore pellets we sell to third parties.
Competitive Strengths
As the largest flat-rolled steel producer in North America, we benefit from having the size and scale necessary in a competitive, capital intensive business. Our sizeable operating footprint provides us with the operational leverage, flexibility and cost performance to achieve competitive margins throughout the business cycle. We also have a unique vertically integrated profile from mined raw materials, direct reduced iron, and ferrous scrap to primary steelmaking and downstream finishing, stamping, tooling and tubing. This positioning gives us both lower and more predictable costs throughout the supply chain and more control over both our manufacturing inputs and our end product destination.
One of our main competitive strengths is our ability to source our primary feedstock domestically and internally. This model reduces our exposure to volatile pricing and unreliable global sourcing. The current Russia-Ukraine conflict has displayed the importance of our U.S.-centric footprint, as our minimill competitors rely on imported pig iron to produce flat-rolled steel. The best example is our legacy business of producing iron ore pellets, which is
our primary steelmaking raw material input. By controlling our iron ore pellet supply, our primary steelmaking raw material feedstock can be secured at a more stable and predictable cost and not be subject to as many factors outside of our control.
The FPT Acquisition has given us a competitive advantage in sourcing prime scrap, as we have started leveraging our long-standing flat-rolled automotive and other customer relationships into recycling partnerships to further grow our prime scrap presence. In the short period of time since the FPT Acquisition was completed, we have already seen success in our strategy by increasing our prime scrap presence. FPT has 22 facilities located primarily in the Midwest near our steel facilities, which gives us an increased advantage in logistics. The strategic importance of these assets for securing additional access to prime scrap is now even further elevated as a result of the Russia-Ukraine conflict.
We are also the largest supplier of automotive-grade steel in the U.S. Compared to other steel end markets, automotive steel is generally higher quality and more operationally and technologically intensive to produce. As such, it often generates higher through-the-cycle margins, making it a desirable end market for the steel industry. We were able to significantly improve our fixed price contract portfolio for 2022, with the trend continuing through the most recent renegotiation cycle for contracts resetting October 1, 2022. Demand for our automotive-grade steel is expected to increase in the coming years from pent-up automotive demand as a result of supply chain issues. With our continued technological innovation, as well as leading delivery performance, we expect to remain the leader in supplying this industry.
We are the only producer of both GOES and NOES in the U.S. The recently passed Infrastructure and Jobs Act of 2021 in the U.S. provides funding to be used for the modernization of the electrical grid and the infrastructure needed to allow for increased electric vehicle adoption, both of which require electrical steels. As a result, with increased demand for both transformers and motors for electric vehicles, we expect to benefit from this position in what is currently a rapidly growing market.
We believe we offer the most comprehensive flat-rolled steel product selection in the industry, along with several complementary products and services. A sampling of our offering includes advanced high-strength steel, hot-dipped galvanized, aluminized, galvalume, electrogalvanized, galvanneal, HRC, cold-rolled coil, plate, tinplate, GOES, NOES, stainless steels, tool and die, stamped components, rail, slab and cast ingot. Across the quality spectrum and the supply chain, our customers can frequently find the solutions they need from our product selection.
Since the acquisition of our steelmaking assets, we have dedicated significant resources to maintain and upgrade our facilities and equipment. The quality of our assets gives us a unique advantage in product offerings and operational efficiencies. In 2022, we brought our facilities and equipment up to the standard required to maintain and improve our supply to the automotive industry. The necessary resources that we have invested in our footprint will keep our assets at automotive-grade quality and reliability for years to come.
We are the first and the only producer of HBI in the Great Lakes region. Construction of our Toledo direct reduction plant was completed in the fourth quarter of 2020 and reached full run-rate nameplate annual capacity of 1.9 million metric tons during the middle of 2021. From this modern plant, we produce a high-quality, low-cost and low-carbon intensive HBI product that can be used in our blast furnaces as a productivity enhancer, or in our BOFs and EAFs as a premium scrap alternative. We use HBI to stretch our hot metal production, lowering carbon intensity and reliance on coke. As a result of our internal usage of HBI, coupled with our ongoing evaluation of coke use strategies, we idled our coke facility at Middletown Works during the third quarter of 2021 and permanently closed our Mountain State Carbon coke plant in the first quarter of 2022. We also sell a portion of our HBI to a third party under a long-term agreement. With increasing tightness in the scrap and metallics markets combined with our own internal needs, we expect our Toledo direct reduction plant to continue to support healthy margins for us going forward.
Strategy
Maximize Our Commercial Strengths
We offer a full suite of flat steel products encompassing all steps of the steel manufacturing process. We have an industry-leading market share in the automotive sector, where our portfolio of high-end products delivers a broad range of differentiated solutions for this highly sought after customer base.
As a result of our exposure to these high-end markets, we have the highest fixed-price contractual volumes in our industry. Approximately 45% of our volumes are sold under these contracts. These contracts reduce volatility and allow for more predictable through-the-cycle margins. The pricing in our fixed-price contracts has dramatically improved in 2022 compared to 2021. We expect contract values to remain above historical averages as
fundamentals remain strong and the HRC price remains above historical averages. In addition to our fixed price contracts, we anticipate having more volumes under index-linked contracts in the coming years, which will reduce our reliance on spot sales and allow us to improve our efficiency with increased volumes.
Our unique capabilities, driven by our portfolio of assets and technical expertise, give us an advantage in our flat-rolled product offering. We offer products that have superior formability, surface quality, corrosion resistance and paintability for the automotive industry. We are also the only producer of GOES and NOES in the U.S. In addition, our state-of-the-art Research and Innovation Center in Middletown, Ohio gives us the ability to collaborate with our customers and create new products and develop new steel manufacturing processes. These unique product offerings and customer service capabilities enable us to remain the leading supplier to the automotive industry.
Take Advantage of our U.S.-Centric, Internally Sourced Supply Chain
The conflict between Russia and Ukraine has displayed the unique advantage of our vertically integrated business model. Two-thirds of U.S. imports of pig iron, a critical raw material for flat-rolled minimills, has historically been sourced from Russia and Ukraine. This supply remains largely disrupted, driving volatility in input costs and reducing availability for our competitors’ ferrous inputs. We, on the other hand, produce our pig iron in-house in the U.S., supported by internally sourced iron ore and HBI and supplemented with internally sourced scrap. While competitors are forced to scramble for materials, we are able to take advantage of our vertically integrated footprint.
We began construction of our HBI plant in 2017, in part because of the uncertainty of the industry sourcing metallics from Russia and Ukraine. Russia had previously invaded the Crimea peninsula in 2014, and we felt it necessary to on-shore more metallics capacity to the U.S. HBI, which is a lower-carbon alternative to imported pig iron, has now become a critical component of our decarbonization strategy.
Optimize Our Fully-Integrated Steelmaking Footprint
We are a fully-integrated steel enterprise with the size and scale to achieve margins above industry averages for flat-rolled steel. Our focus remains on both maintaining and enhancing our cost advantage while also lowering carbon emissions. The combination of our ferrous raw materials, including iron ore, scrap and HBI, allows us to do so relative to peers who must rely on more unpredictable and unreliable raw material sourcing strategies.
With our acquisition of FPT, we have ample access to scrap along with internally sourced HBI. The use of higher amounts of these raw materials in our blast furnaces ultimately boosts liquid steel output, reduces coke needs and lowers carbon emissions from our operations. As a result of the successful operational improvements, we announced the indefinite idle of the Indiana Harbor #4 blast furnace in the first quarter of 2022. The indefinite idle reduced our operational blast furnaces from eight to seven.
We used 2022 as an opportunity to optimize our steelmaking footprint by dedicating significant resources to bring our facilities and equipment up to the standard required to maintain and improve our supply to the automotive industry. The necessary resources that we have invested in our footprint will keep our assets at automotive-grade quality and reliability for years to come. With our facilities and equipment in the best shape since the acquisition of our steelmaking assets and no major investments needed until at least 2025, we are well positioned to benefit from operating efficiencies and improved capabilities in the coming years.
Expand our Ferrous Scrap Recycling Presence
Throughout our entire footprint, we consume a very significant amount of scrap in our EAFs and BOFs, more than half of which can now be obtained through internal sources. Prime scrap is a byproduct of industrial manufacturing. As manufacturing in the U.S. has moved offshore and yields have improved, prime scrap supply has been shrinking for the last 50 years. As the U.S. steel industry brings new flat-rolled EAF capacity online over the next five years, and the global metallics market remains disrupted as a result of the Russia-Ukraine conflict, securing additional access to prime scrap will continue to be an important strategic initiative.
Our expansion in this area began with the FPT Acquisition and has continued to grow by pairing FPT's processing capabilities with our long-standing customer relationships. As the largest supplier of flat-rolled steel in North America, we are the largest source of the steel that generates prime scrap in manufacturing facilities. Based on this, we have grown our prime scrap presence by leveraging our long-standing flat-rolled automotive and other customer relationships and expanding them into recycling partnerships. The FPT Acquisition allows us to optimize productivity at our existing EAFs and BOFs, as we have no current plans to add additional steelmaking capacity.
Advance our Participation in the Green Economy
We are seeking to expand our customer base with the rapidly growing and desirable electric vehicle market. At this time, we believe the North American automotive industry is approaching a structural inflection point, with the adoption of electrical motors in passenger vehicles. As this market grows, it will require more advanced steel applications to meet the needs of electric vehicle producers and consumers. With our unique technical capabilities and leadership in the automotive industry, we believe we are positioned better than any other North American steelmaker to supply the steel and parts necessary to fill these needs.
We also have the right products to meet the growing demand for renewable energy as well as for the modernization of the U.S. electrical grid. We offer plate products that can be used in windmills, which we estimate contain 130 tons of steel per megawatt of electricity. In addition, panels for solar power are heavy consumers of galvanized steel, where we are a leading producer. We estimate solar panels consume 40 tons of steel per megawatt of electricity.
We are currently the sole producer of electrical steel in the U.S., which can facilitate the modernization of the U.S. electrical grid. Along with charging networks, electrical steels are also needed in the motors of electric vehicles.
Enhance our Environmental Sustainability
Our commitment to operating our business in a more environmentally responsible manner remains constant. One of the most important issues impacting our industry, our stakeholders and our planet is climate change. In early 2021, we announced our commitment to reduce GHG emissions 25% from 2017 levels by 2030. This goal represents combined Scope 1 (direct emissions) and Scope 2 (indirect emissions from purchased electricity or other forms of energy) GHG emission reductions across all of our operations. On a per ton basis, we reduced our blast furnace and BOF Scope 1 and Scope 2 GHG intensity from 1.82 per ton in 2020 to 1.67 per ton in 2021.
Prior to setting this goal with our newly acquired steel assets, we exceeded our previous GHG reduction target at our legacy facilities six years ahead of our 2025 goal. In 2019, we reduced our combined Scope 1 and Scope 2 GHG emissions by 42% on a mass basis from 2005 baseline levels. Our goal is to further reduce those emissions in coming years.
Our future GHG emissions reductions are expected to be driven by the use of direct reduced iron in blast furnaces, the stretching of hot metal with additional scrap, driving more productivity out of fewer blast furnaces, natural gas technologies, including natural gas injection, carbon capture, clean energy and energy efficiency projects.
Improve Financial Flexibility
Given the cyclicality of our business, it is important to us to be in the financial position to easily withstand any negative demand or pricing pressure we may encounter. Throughout the first nine months of 2022, we have shown our ability to generate healthy free cash flow and use it to reduce substantial amounts of debt, return capital to shareholders through our share repurchase program and make investments to both improve and grow our business. We have also been able to take advantage of volatility in the debt markets to redeem bonds in the open market at a discount. Through the first nine months of 2022, we have made open market repurchases of $348 million aggregate principal amount of assorted series of notes at an average price of 92% of par.
We expect to have ample opportunities to reduce our debt with our own free cash flow generation in the coming years. During the first nine months of 2022, we reduced the outstanding principal of our long-term debt by $834 million.
Recent Developments
Labor Agreements
On September 30, 2022, a new 47-month labor agreement with the USW was ratified. The contract covers approximately 2,000 USW-represented employees at our legacy mining operations, and is effective from October 1, 2022 through August 31, 2026. Refer to NOTE 10 - PENSIONS AND OTHER POSTRETIREMENT BENEFITS for further information.
On October 12, 2022, we announced the ratification of a new 4-year labor agreement with the USW. The contract covers approximately 12,000 USW-represented employees at 13 operating locations, and is effective from September 1, 2022 through August 31, 2026. Refer to NOTE 19 - SUBSEQUENT EVENTS for further information.
Results of Operations
Overview
Our total revenues, net income, diluted EPS and Adjusted EBITDA for the three and nine months ended September 30, 2022 and 2021 were as follows:
See "— Results of Operations — Adjusted EBITDA" below for a reconciliation of our Net income to Adjusted EBITDA.
Revenues
During the three and nine months ended September 30, 2022, our consolidated Revenues decreased by $351 million and increased by $2,847 million, respectively, compared to the prior-year periods. Both the three and nine months ended September 30, 2022 were positively impacted by the incremental revenue associated with the FPT Acquisition, which occurred on November 18, 2021. The three months ended September 30, 2022 were also positively impacted by an increase in the average steel product selling price of $26 per net ton. These positives were more than offset by the 518 thousand net ton reduction of steel shipments from our Steelmaking segment period over period. The nine months ended September 30, 2022 were also positively impacted by an increase in the average steel product selling price of $309 per net ton, partially offset by a decrease of 1,589 thousand net tons of steel shipments from our Steelmaking segment.
Revenues by Product Line
The following represents our consolidated Revenues by product line for the three months ended:
The following represents our consolidated Revenues by product line for the nine months ended:
The increase in Revenues from our Other product line for the three and nine months ended September 30, 2022, as compared to the prior-year periods, is primarily related to the inclusion of results for the FPT Acquisition in 2022.
Revenues by Market
The following table represents our consolidated Revenues and percentage of revenues attributable to each of the markets we supply:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (In Millions) |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Revenue | | % | | Revenue | | % | | Revenue | | % | | Revenue | | % |
| Automotive | $ | 1,847 | | | 33 | % | | $ | 1,254 | | | 21 | % | | $ | 5,344 | | | 30 | % | | $ | 3,883 | | | 26 | % |
| Infrastructure and manufacturing | 1,476 | | | 26 | % | | 1,615 | | | 27 | % | | 4,662 | | | 26 | % | | 3,922 | | | 26 | % |
| Distributors and converters | 1,483 | | | 26 | % | | 2,465 | | | 41 | % | | 5,199 | | | 29 | % | | 5,721 | | | 38 | % |
| Steel producers | 847 | | | 15 | % | | 670 | | | 11 | % | | 2,740 | | | 15 | % | | 1,572 | | | 10 | % |
| Total revenues | $ | 5,653 | | | | | $ | 6,004 | | | | | $ | 17,945 | | | | | $ | 15,098 | | | |
Operating Costs
Cost of goods sold
During the three and nine months ended September 30, 2022, Cost of goods sold increased by $1,076 million and $3,529 million, respectively, as compared to the prior-year periods. Both the three and nine months ended September 30, 2022 were impacted by the incremental Cost of goods sold associated with the FPT Acquisition, which occurred on November 18, 2021. The increases for both the three and nine months ended September 30, 2022, as compared to the prior-year periods, were also impacted by higher raw materials and utility costs, including natural gas, coal, coke, alloys and scrap, coupled with increased investment in maintenance, excess and idle costs and labor costs.
Selling, general and administrative expenses
During the three and nine months ended September 30, 2022, Selling, general and administrative expenses increased by $8 million and $24 million, respectively, as compared to the prior-year periods. The increases primarily relate to the inclusion of results for the FPT Acquisition in 2022. Additionally, there were increases related to external service costs and charitable contributions, offset by lower incentive compensation.
Miscellaneous – net
During the three and nine months ended September 30, 2022, Miscellaneous – net increased by $27 million and $66 million, respectively, as compared to the prior-year periods. The increase in miscellaneous expense for the three months ended September 30, 2022 was primarily related to an increase in idle expenses and the loss on disposal of assets. The nine months ended September 30, 2022 were also impacted by a $29 million asset impairment charge associated with the permanent closure of Mountain State Carbon.
Other Income (Expense)
Interest expense, net
During the three and nine months ended September 30, 2022, Interest expense, net decreased by $17 million and $53 million, respectively, as compared to the prior-year periods. The decrease was primarily due to debt restructuring activities during 2021 and 2022, which reduced interest expense on our senior notes.
Gain (loss) on extinguishment of debt
The loss on extinguishment of debt of $76 million for the nine months ended September 30, 2022 primarily resulted from the redemption of all $607 million aggregate principal amount of our outstanding 9.875% 2025 Senior Secured Notes in April 2022 and the redemption of all $294 million aggregate principal amount of our outstanding 1.500% 2025 Convertible Senior Notes in January 2022. The losses were partially offset by the net gain on extinguishment for the repurchase of $414 million aggregate principal amount of our outstanding IRBs and senior notes of various series.
The loss on extinguishment of debt of $88 million for the nine months ended September 30, 2021 primarily resulted from the redemption of all $396 million aggregate principal amount outstanding of our 5.750% 2025 Senior Notes and the repurchase of $25 million aggregate principal amount of our outstanding 9.875% 2025 Senior Secured Notes. The nine months ended September 30, 2021 were also impacted by the repurchase of $535 million in aggregate principal amount of our outstanding senior notes of various series in the first quarter of 2021.
Refer to NOTE 8 - DEBT AND CREDIT FACILITIES for further details.
Income Taxes
Our effective tax rate is impacted by permanent items, primarily state income tax expense and depletion. It also is affected by discrete items that may occur in any given period but are not consistent from period to period. The following represents a summary of our tax provision and corresponding effective rates:
| | | | | | | | | | | | | | | | | | | | | | | |
| (In Millions) |
| Three Months Ended
September 30, | Nine Months Ended
September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Income tax expense | $ | (10) | | | $ | (334) | | | $ | (404) | | | $ | (559) | |
| Effective tax rate | 6 | % | | 21 | % | | 20 | % | | 21 | % |
The decreases in income tax expense for the three and nine months ended September 30, 2022, as compared to the prior-year periods, are directly related to the decreases in pre-tax income.
Our 2022 estimated annual effective tax rate before discrete items at September 30, 2022 is 20%. This estimated annual effective tax rate is less than the U.S. statutory rate of 21% due to the percentage depletion in excess of cost depletion. The 2021 estimated annual effective tax rate before discrete items at September 30, 2021 was 21%. The decrease in the estimated annual effective tax rate before discrete items is driven by the change in income and the percentage depletion in excess of cost depletion.
Adjusted EBITDA
We evaluate performance on an operating segment basis, as well as a consolidated basis, based on Adjusted EBITDA, which is a non-GAAP measure. This measure is used by management, investors, lenders and other external users of our financial statements to assess our operating performance and to compare operating performance to other companies in the steel industry. In addition, management believes Adjusted EBITDA is a useful measure to assess the earnings power of the business without the impact of capital structure and can be used to assess our ability to service debt and fund future capital expenditures in the business.
The following table provides a reconciliation of our Net income to Adjusted EBITDA:
| | | | | | | | | | | | | | | | | | | | | | | |
| (In Millions) |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Net income | $ | 165 | | | $ | 1,282 | | | $ | 1,580 | | | $ | 2,134 | |
| Less: | | | | | | | |
| Interest expense, net | (64) | | | (81) | | | (205) | | | (258) | |
| Income tax expense | (10) | | | (334) | | | (404) | | | (559) | |
| Depreciation, depletion and amortization | (237) | | | (239) | | | (788) | | | (664) | |
| Total EBITDA | $ | 476 | | | $ | 1,936 | | | $ | 2,977 | | | $ | 3,615 | |
| Less: | | | | | | | |
EBITDA of noncontrolling interests1 | $ | 22 | | | $ | 17 | | | $ | 57 | | | $ | 60 | |
| Asset impairment | — | | | — | | | (29) | | | — | |
| Gain (loss) on extinguishment of debt | 4 | | | — | | | (76) | | | (88) | |
| Severance costs | (2) | | | (3) | | | (9) | | | (15) | |
| Acquisition-related costs excluding severance costs | — | | | (1) | | | (1) | | | (3) | |
| Acquisition-related loss on equity method investment | — | | | — | | | — | | | (18) | |
| Amortization of inventory step-up | — | | | (11) | | | — | | | (129) | |
| Impact of discontinued operations | — | | | 1 | | | 2 | | | 2 | |
| Total Adjusted EBITDA | $ | 452 | | | $ | 1,933 | | | $ | 3,033 | | | $ | 3,806 | |
| | | | | | | |
1 EBITDA of noncontrolling interests includes the following: |
| Net income attributable to noncontrolling interests | $ | 13 | | | $ | 8 | | | $ | 31 | | | $ | 39 | |
| Depreciation, depletion and amortization | 9 | | | 9 | | | 26 | | | 21 | |
| EBITDA of noncontrolling interests | $ | 22 | | | $ | 17 | | | $ | 57 | | | $ | 60 | |
The following table provides a summary of our Adjusted EBITDA by segment:
| | | | | | | | | | | | | | | | | | | | | | | |
| (In Millions) |
| Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Adjusted EBITDA: | | | | | | | |
| Steelmaking | $ | 436 | | | $ | 1,934 | | | $ | 2,967 | | | $ | 3,796 | |
| Other Businesses | 9 | | | 6 | | | 58 | | | 25 | |
Eliminations1 | 7 | | | (7) | | | 8 | | | (15) | |
| Total Adjusted EBITDA | $ | 452 | | | $ | 1,933 | | | $ | 3,033 | | | $ | 3,806 | |
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1 In 2022, we began allocating Corporate SG&A to our operating segments. Prior periods have been adjusted to reflect this change. The Eliminations line now only includes sales between segments. |
Adjusted EBITDA from our Steelmaking segment for the three and nine months ended September 30, 2022 decreased by $1,498 million and $829 million, respectively, as compared to the prior-year periods. The decreases were primarily attributable to lower gross margins of $1,427 million and $705 million for the three and nine months ended September 30, 2022, respectively, as compared to the prior-year periods. Our Steelmaking Adjusted EBITDA included Selling, general and administrative expenses of $117 million and $331 million for the three and nine months ended September 30, 2022, respectively, and $106 million and $301 million for the three and nine months ended September 30, 2021, respectively.
Steelmaking
The following is a summary of our Steelmaking segment operating results for the three months ended September 30, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
September 30, | | | | |
| 2022 | | 2021 | | % Change | | | | | | |
| Steel shipments (in thousands of net tons) | 3,635 | | | 4,153 | | | (12) | % | | | | | | |
| Average selling price per net ton of steel products | $ | 1,360 | | | $ | 1,334 | | | 2 | % | | | | | | |
| | | | | | | | | | | |
| Revenues (in millions) | $ | 5,511 | | | $ | 5,869 | | | (6) | % | | | | | | |
| Cost of goods sold (in millions) | $ | (5,167) | | | $ | (4,098) | | | 26 | % | | | | | | |
| Gross margin (in millions) | $ | 344 | | | $ | 1,771 | | | (81) | % | | | | | | |
| Gross margin percentage | 6 | % | | 30 | % | | | | | | | | |
| Adjusted EBITDA (in millions) | $ | 436 | | | $ | 1,934 | | | (77) | % | | | | | | |
Gross margin decreased by $1,427 million, or 81%, during the three months ended September 30, 2022, as compared to the prior-year period, primarily due to:
•A decrease in sales volumes (approximately $300 million impact) predominantly driven by lower shipments to the distributors and converters end market due to weaker demand; and
•Increased costs of production (approximately $1.0 billion impact) driven by higher raw materials and utility costs, including natural gas, coal, coke, alloys and scrap, coupled with increased investment in maintenance and labor costs.
•This was partially offset by an increase in selling prices (approximately $150 million impact) driven by favorable renewals of annual sales contracts.
The following is a summary of our Steelmaking segment operating results for the nine months ended September 30, 2022 and 2021:
| | | | | | | | | | | | | | | | | |
| Nine Months Ended
September 30, | | |
| 2022 | | 2021 | | % Change |
| Steel shipments (in thousands of net tons) | 10,913 | | | 12,502 | | | (13) | % |
| Average selling price per net ton of steel products | $ | 1,431 | | | $ | 1,122 | | | 28 | % |
| | | | | |
| Revenues (in millions) | $ | 17,481 | | | $ | 14,710 | | | 19 | % |
| Cost of goods sold (in millions) | $ | (14,948) | | | $ | (11,472) | | | 30 | % |
| Gross margin (in millions) | $ | 2,533 | | | $ | 3,238 | | | (22) | % |
| Gross margin percentage | 14 | % | | 22 | % | | |
| Adjusted EBITDA (in millions) | $ | 2,967 | | | $ | 3,796 | | | (22) | % |
Gross margin decreased by $705 million, or 22%, during the nine months ended September 30, 2022, as compared to the prior-year period, primarily due to:
•A decrease in sales volumes (approximately $1.1 billion impact), predominantly driven by lower shipments to the distributors and converters end market due to weaker demand; and
•Increased costs of production (approximately $3.3 billion impact) driven by the highly inflationary environment, which has resulted in higher raw materials and utility costs, including natural gas, coal, coke, alloys and scrap, coupled with increased investment in maintenance, excess and idle costs and labor costs.
•This was partially offset by an increase in selling prices (approximately $3.5 billion impact) driven primarily by favorable renewals of annual sales contracts and favorable lagged index-linked contract prices.
Liquidity, Cash Flows and Capital Resources
Our primary sources of liquidity are Cash and cash equivalents and cash generated from our operations, availability under the ABL Facility and other financing activities. Our capital allocation decision-making process is focused on preserving healthy liquidity levels while maintaining the strength of our balance sheet and creating financial flexibility to manage through the inherent cyclical demand for our products and volatility in commodity prices. We are focused on maximizing the cash generation of our operations, reducing debt, and aligning capital investments with our strategic priorities and the requirements of our business plan, including regulatory and permission-to-operate related projects.
The recent market environment has provided us opportunities to reduce our debt with our own free cash flow generation. We also continue to look at the composition of our debt, as we are interested in both extending our average maturity length and increasing our ratio of unsecured debt to secured debt, which can be accomplished with cash provided by operating activities. During 2022, we took action in alignment with these priorities. In the first quarter of 2022, we redeemed all $294 million in aggregate principal amount outstanding of our 1.500% 2025 Convertible Senior Notes and all $66 million aggregate principal amount outstanding of the IRBs due 2024 to 2028. In April 2022, we redeemed all $607 million remaining aggregate principal amount outstanding of our 9.875% 2025 Senior Secured Notes. Additionally, during the second and third quarters of 2022, we repurchased $348 million in aggregate principal amount of our outstanding senior notes of various series at an average price of 92% of par.
Additionally, we have been able to return capital to shareholders through our share repurchase program. During 2022, we repurchased 10.5 million common shares at a cost of $210 million in the aggregate.
Based on our outlook for the next 12 months, which is subject to continued changing demand from customers and volatility in domestic steel prices, we expect to have ample liquidity through cash generated from operations and availability under our ABL Facility sufficient to meet the needs of our operations, service and repay our debt obligations and return capital to shareholders.
The following discussion summarizes the significant items impacting our cash flows during the nine months ended September 30, 2022 and 2021 as well as expected impacts to our future cash flows over the next 12 months. Refer to the Statements of Unaudited Condensed Consolidated Cash Flows for additional information.
Operating Activities
Net cash provided by operating activities was $1,934 million and $1,648 million for the nine months ended September 30, 2022 and 2021, respectively. The period-over-period improvement was driven by a reduction in cash used for working capital, offset by a decrease in net income. The working capital changes were primarily driven by lower increases in accounts receivable, which were higher in 2021 due to the unwind of the ArcelorMittal USA factoring agreement as well as rising revenue. Additionally, we had lower pension contributions as a result of improvements to our pension plans' funded status.
We expect the cash flow impacts over the next 12 months relating to the newly ratified labor agreements with our USW-represented employees to be immaterial. The cash requirements for the increased wages and other benefits are expected to be offset by the cash savings relating to our OPEB plans. Separate from the labor agreements, we negotiated favorable Medicare Advantage Prescription Drug healthcare rates, which will go into effect January 1, 2023. The reduction in retiree healthcare rates and pause on the Cleveland-Cliffs Steel LLC VEBA funding requirements due to the plan's funded status is expected to reduce our use of cash by over $100 million in the aggregate in 2023 compared to the 2022 cash spend.
Investing Activities
Net cash used by investing activities was $727 million and $414 million for the nine months ended September 30, 2022 and 2021, respectively. We had capital expenditures of $716 million and $473 million for the nine months ended September 30, 2022 and 2021, respectively, primarily relating to sustaining capital spend. Sustaining capital spend includes infrastructure, mobile equipment, fixed equipment, product quality, reliability, environment, health and safety.
We anticipate total cash used for capital expenditures during the next 12 months to be between $700 and $800 million.
Financing Activities
Net cash used by financing activities was $1,199 million and $1,304 million for the nine months ended September 30, 2022 and 2021, respectively. Cash outflows from financing activities for the nine months ended September 30, 2022 included $1,355 million for repayments of debt and $210 million for the repurchase of common shares. In the nine months ended September 30, 2022, we used available liquidity to redeem all $607 million remaining aggregate principal amount outstanding of our 9.875% 2025 Senior Secured Notes, all $294 million aggregate principal amount outstanding of our 1.500% 2025 Convertible Senior Notes and all $66 million aggregate principal amount outstanding of our IRBs due 2024 to 2028. We also repurchased $348 million in aggregate principal amount of our outstanding senior notes of various series. Cash inflows from financing activities for the nine months ended September 30, 2022 included net borrowings of $481 million under our ABL Facility.
Net cash used by financing activities for the nine months ended September 30, 2021 included the redemption of all 583,273 shares outstanding of our Series B Participating Redeemable Preferred Stock at a redemption price of $1.3 billion during the third quarter of 2021, along with $1.3 billion for repayments of debt. We used available liquidity to redeem all $396 million aggregate principal amount of our 5.750% 2025 Senior Notes. We used the net proceeds from the issuance of 20 million common shares, and cash on hand, to redeem $322 million in aggregate principal amount of 9.875% 2025 Senior Secured Notes. We used the net proceeds from the issuances of the 4.625% 2029 Senior Notes and 4.875% 2031 Senior Notes to redeem all of the outstanding 4.875% 2024 Senior Secured Notes, 6.375% 2025 Senior Notes, 7.625% 2021 AK Senior Notes, 7.500% 2023 AK Senior Notes and 6.375% 2025 AK Senior Notes, and pay fees and expenses in connection with such redemptions, and reduce borrowings under our ABL Facility.
Cash inflows from financing activities for the nine months ended September 30, 2021 included the issuances of $500 million aggregate principal amount of 4.625% 2029 Senior Notes, $500 million aggregate principal amount of 4.875% 2031 Senior Notes and 20 million common shares for proceeds of $322 million, along with net borrowings of $193 million under credit facilities.
We anticipate future uses of cash for financing activities during the next 12 months to include the reduction of borrowings under our ABL Facility balance, as well as opportunistic transactions, including other debt repayments.
Capital Resources
The following represents a summary of key liquidity measures:
| | | | | |
| (In Millions) |
| September 30,
2022 |
| Cash and cash equivalents | $ | 56 | |
| |
| |
| |
Available borrowing base on ABL Facility1 | $ | 4,500 | |
| Borrowings | (2,090) | |
| Letter of credit obligations | (166) | |
| Borrowing capacity available | $ | 2,244 | |
| |
1 As of September 30, 2022, the ABL Facility had a maximum borrowing base of $4.5 billion. The available borrowing base is determined by applying customary advance rates to eligible accounts receivable, inventory and certain mobile equipment. |
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Our primary sources of funding are cash and cash equivalents, which totaled $56 million as of September 30, 2022, cash generated by our business, availability under the ABL Facility and other financing activities. The combination of cash and availability under the ABL Facility gives us $2.3 billion in liquidity entering the fourth quarter of 2022, which is expected to be adequate to fund operations, letter of credit obligations, capital expenditures and other cash commitments for at least the next 12 months.
As of September 30, 2022, we were in compliance with the ABL Facility liquidity requirements and, therefore, the springing financial covenant requiring a minimum fixed charge coverage ratio of 1.0 to 1.0 was not applicable.
Off-Balance Sheet Arrangements
In the normal course of business, we are a party to certain arrangements that are not reflected on our Statements of Unaudited Condensed Consolidated Financial Position. These arrangements include minimum "take or pay" purchase commitments, such as minimum electric power demand charges, minimum coal, coke, diesel and natural gas purchase commitments, minimum railroad transportation commitments and minimum port facility usage commitments; and financial instruments with off-balance sheet risk, such as bank letters of credit and bank guarantees.
Information about our Guarantors and the Issuer of our Guaranteed Securities
The accompanying summarized financial information has been prepared and presented pursuant to SEC Regulation S-X, Rule 3-10, “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered,” and Rule 13-01 "Financial Disclosures about Guarantors and Issuers of Guaranteed Securities and Affiliates Whose Securities Collateralized a Registrant's Securities." Certain of our subsidiaries (the "Guarantor subsidiaries") have fully and unconditionally, and jointly and severally, guaranteed the obligations under (a) the 5.875% 2027 Senior Notes, the 7.000% 2027 Senior Notes, the 4.625% 2029 Senior Notes and the 4.875% 2031 Senior Notes issued by Cleveland-Cliffs Inc. on a senior unsecured basis and (b) the 6.750% 2026 Senior Secured Notes issued by Cleveland-Cliffs Inc. on a senior secured basis. See NOTE 8 - DEBT AND CREDIT FACILITIES for further information.
The following presents the summarized financial information on a combined basis for Cleveland-Cliffs Inc. (parent company and issuer of the guaranteed obligations) and the Guarantor subsidiaries, collectively referred to as the obligated group. Transactions between the obligated group have been eliminated. Information for the non-Guarantor subsidiaries was excluded from the combined summarized financial information of the obligated group.
Each Guarantor subsidiary is consolidated by Cleveland-Cliffs Inc. as of September 30, 2022. Refer to Exhibit 22, incorporated herein by reference, for the detailed list of entities included within the obligated group as of September 30, 2022. The guarantee of a Guarantor subsidiary with respect to Cliffs' 6.750% 2026 Senior Secured Notes, the 5.875% 2027 Senior Notes, the 7.000% 2027 Senior Notes, the 4.625% 2029 Senior Notes and the 4.875% 2031 Senior Notes will be automatically and unconditionally released and discharged, and such Guarantor subsidiary’s obligations under the guarantee and the related indentures (the “Indentures”) will be automatically and unconditionally released and discharged, upon the occurrence of any of the following, along with the delivery to the trustee of an officer’s certificate and an opinion of counsel, each stating that all conditions precedent provided for in the applicable Indenture relating to the release and discharge of such Guarantor subsidiary’s guarantee have been complied with:
(a) any sale, exchange, transfer or disposition of such Guarantor subsidiary (by merger, consolidation, or the sale of) or the capital stock of such Guarantor subsidiary after which the applicable Guarantor subsidiary is no longer a subsidiary of the Company or the sale of all or substantially all of such Guarantor subsidiary’s assets (other than by lease), whether or not such Guarantor subsidiary is the surviving entity in such transaction, to a person which is not the Company or a subsidiary of the Company; provided that (i) such sale, exchange, transfer or disposition is made in compliance with the applicable Indenture, including the covenants regarding consolidation, merger and sale of assets and, as applicable, dispositions of assets that constitute notes collateral, and (ii) all the obligations of such Guarantor subsidiary under all debt of the Company or its subsidiaries terminate upon consummation of such transaction;
(b) designation of any Guarantor subsidiary as an “excluded subsidiary” (as defined in the Indentures); or
(c) defeasance or satisfaction and discharge of the Indentures.
Each entity in the summarized combined financial information follows the same accounting policies as described in the consolidated financial statements. The accompanying summarized combined financial information does not reflect investments of the obligated group in non-Guarantor subsidiaries. The financial information of the obligated group is presented on a combined basis; intercompany balances and transactions within the obligated group have been eliminated. The obligated group's amounts due from, amounts due to, and transactions with, non-Guarantor subsidiaries and related parties have been presented in separate line items.
Summarized Combined Financial Information of the Issuer and Guarantor Subsidiaries:
The following table is summarized combined financial information from the Statements of Unaudited Condensed Consolidated Financial Position of the obligated group:
| | | | | | | | | | | |
| (In Millions) |
| September 30, 2022 | | December 31, 2021 |
| Current assets | $ | 7,876 | | | $ | 6,539 | |
| Non-current assets | 9,950 | | | 12,753 | |
| Current liabilities | (3,786) | | | (3,222) | |
| Non-current liabilities | (8,294) | | | (9,081) | |
| | | |
The following table is summarized combined financial information from the Statements of Unaudited Condensed Consolidated Operations of the obligated group:
| | | | | |
| (In Millions) |
| Nine Months Ended |
| September 30, 2022 |
| Revenues | $ | 16,658 | |
| Cost of goods sold | (14,216) | |
| Income from continuing operations | 1,347 | |
| Net income | 1,349 | |
| Net income attributable to Cliffs shareholders | 1,349 | |
As of September 30, 2022 and December 31, 2021, the obligated group had the following balances with non-Guarantor subsidiaries and other related parties:
| | | | | | | | | | | |
| (In Millions) |
| September 30, 2022 | | December 31, 2021 |
| Balances with non-Guarantor subsidiaries: | | | |
| Accounts receivable, net | $ | 494 | | | $ | 199 | |
| Accounts payable | (812) | | | (186) | |
| | | |
| Balances with other related parties: | | | |
| Accounts receivable, net | $ | 9 | | | $ | 3 | |
| | | |
| Accounts payable | (12) | | | (7) | |
| | | |
Additionally, for the nine months ended September 30, 2022, the obligated group had Revenues of $118 million and Cost of goods sold of $89 million, in each case, with other related parties.
Market Risks
We are subject to a variety of risks, including those caused by changes in commodity prices and interest rates. We have established policies and procedures to manage such risks; however, certain risks are beyond our control.
Pricing Risks
In the ordinary course of business, we are exposed to market risk and price fluctuations related to the sale of our products, which are impacted primarily by market prices for HRC, and the purchase of energy and raw materials used in our operations, which are impacted by market prices for electricity, natural gas, ferrous and stainless steel scrap, chrome, metallurgical coal, coke, nickel and zinc. Our strategy to address market risk has generally been to obtain competitive prices for our products and services and allow operating results to reflect market price movements dictated by supply and demand; however, we make forward physical purchases and enter into hedge contracts to
manage exposure to price risk related to the purchases of certain raw materials and energy used in the production process.
Our financial results can vary for our operations as a result of fluctuations in market prices. We attempt to mitigate these risks by aligning fixed and variable components in our customer pricing contracts, supplier purchasing agreements and derivative financial instruments.
Some customer contracts have fixed-pricing terms, which increase our exposure to fluctuations in raw material and energy costs. To reduce our exposure, we enter into annual, fixed-price agreements for certain raw materials. Some of our existing multi-year raw material supply agreements have required minimum purchase quantities. Under adverse economic conditions, those minimums may exceed our needs. Absent exceptions for force majeure and other circumstances affecting the legal enforceability of the agreements, these minimum purchase requirements may compel us to purchase quantities of raw materials that could significantly exceed our anticipated needs or pay damages to the supplier for shortfalls. In these circumstances, we would attempt to negotiate agreements for new purchase quantities. There is a risk, however, that we would not be successful in reducing purchase quantities, either through negotiation or litigation. If that occurred, we would likely be required to purchase more of a particular raw material in a particular year than we need, negatively affecting our results of operations and cash flows.
Certain of our customer contracts include variable-pricing mechanisms that adjust selling prices in response to changes in the costs of certain raw materials and energy, while other of our customer contracts exclude such mechanisms. We may enter into multi-year purchase agreements for certain raw materials with similar variable-price mechanisms, allowing us to achieve natural hedges between the customer contracts and supplier purchase agreements. Therefore, in some cases, price fluctuations for energy (particularly natural gas and electricity), raw materials (such as scrap, chrome, zinc and nickel) or other commodities may be, in part, passed on to customers rather than absorbed solely by us. There is a risk, however, that the variable-price mechanisms in the sales contracts may not necessarily change in tandem with the variable-price mechanisms in our purchase agreements, negatively affecting our results of operations and cash flows.
Our strategy to address volatile natural gas rates and electricity rates includes improving efficiency in energy usage, identifying alternative providers and utilizing the lowest cost alternative fuels. If we are unable to align fixed and variable components between customer contracts and supplier purchase agreements, we use cash-settled commodity price swaps to hedge the market risk associated with the purchase of certain of our raw materials and energy requirements. Additionally, we routinely use these derivative instruments to hedge a portion of our natural gas and zinc requirements. During 2022, we initiated hedging programs for electricity and tin. Our hedging strategy is designed to protect us from excessive pricing volatility. However, since we do not typically hedge 100% of our exposure, abnormal price increases in any of these commodity markets might still negatively affect operating costs.
The following table summarizes the negative effect of a hypothetical change in the fair value of our derivative instruments outstanding as of September 30, 2022, due to a 10% and 25% change in the market price of each of the indicated commodities:
| | | | | | | | | | | | | | |
| | (In Millions) |
| Commodity Derivative | | 10% Change | | 25% Change |
| Natural gas | | $ | 75 | | | $ | 187 | |
| Electricity | | 3 | | | 8 | |
| Zinc | | 1 | | | 3 | |
| Tin | | — | | | 1 | |
Any resulting changes in fair value would be recorded as adjustments to AOCI, net of income taxes, or recognized in net earnings, as appropriate. These hypothetical losses would be partially offset by the benefit of lower prices paid for the related commodities.
Valuation of Goodwill and Other Long-Lived Assets
We assign goodwill arising from acquired companies to the reporting units that are expected to benefit from the synergies of the acquisition. Goodwill is tested on a qualitative basis for impairment at the reporting unit level on an annual basis (October 1) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or
sale or disposition of a significant portion of a reporting unit. As necessary, should our qualitative test indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we perform a quantitative test to determine the amount of impairment, if any, to the carrying value of the reporting unit and its associated goodwill.
Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units and if a quantitative assessment is deemed necessary in determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated using a discounted cash flow methodology, which considers forecasted cash flows discounted at an estimated weighted average cost of capital. Assessing the recoverability of our goodwill requires significant assumptions regarding the estimated future cash flows and other factors to determine the fair value of a reporting unit, including, among other things, estimates related to forecasts of future revenues, expected Adjusted EBITDA, expected capital expenditures and working capital requirements, which are based upon our long-range plan estimates. The assumptions used to calculate the fair value of a reporting unit may change from year to year based on operating results, market conditions and other factors. Changes in these assumptions could materially affect the determination of fair value for each reporting unit.
Long-lived assets are reviewed for impairment upon the occurrence of events or changes in circumstances that would indicate that the carrying value of the assets may not be recoverable. Such indicators may include: a significant decline in expected future cash flows; a sustained, significant decline in market pricing; a significant adverse change in legal or environmental factors or in the business climate; changes in estimates of our recoverable reserves; and unanticipated competition. Any adverse change in these factors could have a significant impact on the recoverability of our long-lived assets and could have a material impact on our consolidated statements of operations and statement of financial position.
A comparison of each asset group's carrying value to the estimated undiscounted net future cash flows expected to result from the use of the assets, including cost of disposition, is used to determine if an asset is recoverable. Projected future cash flows reflect management's best estimate of economic and market conditions over the projected period, including growth rates in revenues and costs, and estimates of future expected changes in operating margins and capital expenditures. If the carrying value of the asset group is higher than its undiscounted net future cash flows, the asset group is measured at fair value and the difference is recorded as a reduction to the long-lived assets. We estimate fair value using a market approach, an income approach or a cost approach. We concluded that there were no additional triggering events resulting in the need for an impairment assessment except for the announcement of the permanent closure of Mountain State Carbon, which resulted in a $29 million asset impairment charge for the nine months ended September 30, 2022.
Interest Rate Risk
Interest payable on our senior notes is at fixed rates. Interest payable under our ABL Facility is at a variable rate based upon the applicable base rate plus the applicable base rate margin depending on the excess availability. As of September 30, 2022, we had $2,090 million outstanding under the ABL Facility. An increase in prevailing interest rates would increase interest expense and interest paid for any outstanding borrowings from the ABL Facility. For example, a 100 basis point change to interest rates under the ABL Facility at the September 30, 2022 borrowing level would result in a change of $21 million to interest expense on an annual basis.
Supply Concentration Risks
Many of our operations and mines rely on one source each of electric power and natural gas. A significant interruption or change in service or rates from our energy suppliers could materially impact our production costs, margins and profitability.
Forward-Looking Statements
This report contains statements that constitute "forward-looking statements" within the meaning of the federal securities laws. As a general matter, forward-looking statements relate to anticipated trends and expectations rather than historical matters. Forward-looking statements are subject to uncertainties and factors relating to our operations and business environment that are difficult to predict and may be beyond our control. Such uncertainties and factors may cause actual results to differ materially from those expressed or implied by the forward-looking statements. These statements speak only as of the date of this report, and we undertake no ongoing obligation, other than that imposed by law, to update these statements. Investors are cautioned not to place undue reliance on forward-looking statements. Uncertainties and risk factors that could affect our future performance and cause results to differ from the forward-looking statements in this report include, but are not limited to:
•continued volatility of steel, iron ore and scrap metal market prices, which directly and indirectly impact the prices of the products that we sell to our customers;
•uncertainties associated with the highly competitive and cyclical steel industry and our reliance on the demand for steel from the automotive industry, which has been experiencing a trend toward light weighting and supply chain disruptions, such as the semiconductor shortage, that could result in lower steel volumes being consumed;
•potential weaknesses and uncertainties in global economic conditions, excess global steelmaking capacity, oversupply of iron ore, prevalence of steel imports and reduced market demand, including as a result of inflationary pressures, the prolonged COVID-19 pandemic, conflicts or otherwise;
•severe financial hardship, bankruptcy, temporary or permanent shutdowns or operational challenges, due to the ongoing COVID-19 pandemic or otherwise, of one or more of our major customers, including customers in the automotive market, key suppliers or contractors, which, among other adverse effects, could disrupt our operations or lead to reduced demand for our products, increased difficulty collecting receivables, and customers and/or suppliers asserting force majeure or other reasons for not performing their contractual obligations to us;
•disruptions to our operations relating to the ongoing COVID-19 pandemic, including the heightened risk that a significant portion of our workforce or on-site contractors may suffer illness or otherwise be unable to perform their ordinary work functions;
•risks related to U.S. government actions with respect to Section 232, the United States-Mexico-Canada Agreement and/or other trade agreements, tariffs, treaties or policies, as well as the uncertainty of obtaining and maintaining effective antidumping and countervailing duty orders to counteract the harmful effects of unfairly traded imports;
•impacts of existing and increasing governmental regulation, including potential environmental regulations relating to climate change and carbon emissions, and related costs and liabilities, including failure to receive or maintain required operating and environmental permits, approvals, modifications or other authorizations of, or from, any governmental or regulatory authority and costs related to implementing improvements to ensure compliance with regulatory changes, including potential financial assurance requirements;
•potential impacts to the environment or exposure to hazardous substances resulting from our operations;
•our ability to maintain adequate liquidity, our level of indebtedness and the availability of capital could limit our financial flexibility and cash flow necessary to fund working capital, planned capital expenditures, acquisitions, and other general corporate purposes or ongoing needs of our business;
•our ability to reduce our indebtedness or return capital to shareholders within the currently expected timeframes or at all;
•adverse changes in credit ratings, interest rates, foreign currency rates and tax laws, including adverse impacts as a result of the Inflation Reduction Act of 2022;
•the outcome of, and costs incurred in connection with, lawsuits, claims, arbitrations or governmental proceedings relating to commercial and business disputes, environmental matters, government investigations, occupational or personal injury claims, property damage, labor and employment matters, or suits involving legacy operations and other matters;
•uncertain cost or availability of critical manufacturing equipment and spare parts;
•supply chain disruptions or changes in the cost, quality or availability of energy sources, including electricity, natural gas and diesel fuel, or critical raw materials and supplies, including iron ore, industrial gases, graphite electrodes, scrap metal, chrome, zinc, coke and metallurgical coal;
•problems or disruptions associated with transporting products to our customers, moving manufacturing inputs or products internally among our facilities, or suppliers transporting raw materials to us;
•uncertainties associated with natural or human-caused disasters, adverse weather conditions, unanticipated geological conditions, critical equipment failures, infectious disease outbreaks, tailings dam failures and other unexpected events;
•cybersecurity incidents relating to, disruptions in, or failures of, information technology systems that are managed by us or third parties that host or have access to our data or systems, including the loss, theft or corruption of sensitive or essential business or personal information and the inability to access or control systems;
•liabilities and costs arising in connection with any business decisions to temporarily or indefinitely idle or permanently close an operating facility or mine, which could adversely impact the carrying value of associated assets and give rise to impairment charges or closure and reclamation obligations, as well as uncertainties associated with restarting any previously idled operating facility or mine;
•our ability to realize the anticipated synergies and benefits of our recent acquisition transactions and to successfully integrate the acquired businesses into our existing businesses, including uncertainties associated with maintaining relationships with customers, vendors and employees and known and unknown liabilities we assumed in connection with the acquisitions;
•our level of self-insurance and our ability to obtain sufficient third-party insurance to adequately cover potential adverse events and business risks;
•challenges to maintaining our social license to operate with our stakeholders, including the impacts of our operations on local communities, reputational impacts of operating in a carbon-intensive industry that produces GHG emissions, and our ability to foster a consistent operational and safety track record;
•our ability to successfully identify and consummate any strategic capital investments or development projects, cost-effectively achieve planned production rates or levels, and diversify our product mix and add new customers;
•our actual economic mineral reserves or reductions in current mineral reserve estimates, and any title defect or loss of any lease, license, easement or other possessory interest for any mining property;
•availability of workers to fill critical operational positions and potential labor shortages caused by the ongoing COVID-19 pandemic or otherwise, as well as our ability to attract, hire, develop and retain key personnel;
•our ability to maintain satisfactory labor relations with unions and employees;
•unanticipated or higher costs associated with pension and OPEB obligations resulting from changes in the value of plan assets or contribution increases required for unfunded obligations;
•the amount and timing of any repurchases of our common shares; and
•potential significant deficiencies or material weaknesses in our internal control over financial reporting.
For additional factors affecting our business, refer to Part II – Item 1A. Risk Factors of this Quarterly Report on Form 10-Q. You are urged to carefully consider these risk factors.
Forward-looking and other statements in this Quarterly Report on Form 10-Q regarding our GHG reduction plans and goals are not an indication that these statements are necessarily material to investors or required to be disclosed in our filings with the SEC. In addition, historical, current and forward-looking GHG-related statements may be based on standards for measuring progress that are still developing, internal controls and processes that continue to evolve and assumptions that are subject to change in the future.