Cleveland-Cliffs Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

ACQUISITIONS

ACQUISITIONS

9 Months Ended

Sep. 30, 2021

NOTE 3 - ACQUISITIONS

In 2020, we acquired two major steelmakers, AK Steel and ArcelorMittal USA, vertically integrating our legacy iron ore business with steel production. Our fully-integrated portfolio includes custom-made pellets and HBI; flat-rolled carbon steel, stainless, electrical, plate, tinplate, slabs and long steel products; and carbon and stainless steel tubing, hot and cold stamping and tooling. The AK Steel Merger combined Cliffs, a producer of iron ore pellets, with AK Steel, a producer of flat-rolled carbon, stainless and electrical steel products, to create a vertically integrated producer of value-added iron ore and steel products. The AM USA Transaction transformed us into a fully-integrated steel enterprise with the size and scale to expand product offerings and improve through-the-cycle margins.

We now have a presence across the entire steel manufacturing process, from mining to pelletizing to the development and production of finished high value steel products. The combination is expected to create significant opportunities to generate additional value from market trends across the entire steel value chain and enable more consistent, predictable performance through normal market cycles.

Acquisition of ArcelorMittal USA

Overview

On December 9, 2020, pursuant to the terms of the AM USA Transaction Agreement, we purchased ArcelorMittal USA from ArcelorMittal. In connection with the closing of the AM USA Transaction, as contemplated by the terms of the AM USA Transaction Agreement, ArcelorMittal’s former joint venture partner in Kote and Tek exercised its put right pursuant to the terms of the Kote and Tek joint venture agreements. As a result, we purchased all of such joint venture partner’s interests in Kote and Tek. Following the closing of the AM USA Transaction, we own 100% of the interests in Kote and Tek.

We incurred acquisition-related costs excluding severance costs of $1 million and $3 million for the three and nine months ended September 30, 2021, respectively, which were recorded in Acquisition-related costs on the Statements of Unaudited Condensed Consolidated Operations.

The AM USA Transaction was accounted for under the acquisition method of accounting for business combinations.

The fair value of the total purchase consideration was determined as follows:


	(In Millions)
Fair value of Cliffs common shares issued	$	990
Fair value of Series B Participating Redeemable Preferred Stock issued	738
Fair value of settlement of a pre-existing relationship	237
Cash consideration	639
Total purchase consideration	$	2,604

The fair value of Cliffs common shares issued was calculated as follows:


Number of Cliffs common shares issued	78,186,671
Closing price of Cliffs common share as of December 9, 2020	$	12.66
Fair value of Cliffs common shares issued (in millions)	$	990

The fair value of Cliffs Series B Participating Redeemable Preferred Stock issued was calculated as follows:


Number of Cliffs Series B Participating Redeemable Preferred Stock issued	583,273
Redemption price per share as of December 9, 2020	$	1,266
Fair value of Cliffs Series B Participating Redeemable Preferred Stock issued (in millions)	$	738

The fair value of the estimated cash consideration was comprised of the following:


	(In Millions)
Cash consideration pursuant to the AM USA Transaction Agreement	$	505
Cash consideration for purchase of the remaining JV partner's interest of Kote and Tek	182
Total cash consideration receivable	(48)
Total cash consideration	$	639

The cash portion of the purchase price was subject to customary working capital adjustments, and the working capital adjustments were finalized during the second quarter of 2021. We made certain elections under Section 338(h)(10) of the Internal Revenue Code of 1986, as amended, which did not change the final cash consideration.

The fair value of the settlement of a pre-existing relationship was comprised of the following:


	(In Millions)
Accounts receivable	$	97
Freestanding derivative asset from customer supply agreement	140
Total fair value of settlement of a pre-existing relationship	$	237

Valuation Assumption and Preliminary Purchase Price Allocation

We estimated fair values at December 9, 2020 for the preliminary allocation of consideration to the net tangible and intangible assets acquired and liabilities assumed in connection with the AM USA Transaction. During the measurement period, we will continue to obtain information to assist in finalizing the fair value of assets acquired and liabilities assumed, which may differ materially from these preliminary estimates. If we determine any measurement period adjustments are material, we will apply those adjustments, including any related impacts to net income, in the reporting period in which the adjustments are determined. We are in the process of conducting a valuation of the assets acquired and liabilities assumed related to the AM USA Transaction, most notably, inventories, personal and real property, mineral reserves, deferred taxes, asset retirement obligations and the final allocation will be made when completed, including the result of any identified goodwill. Accordingly, the provisional measurements noted below are preliminary and subject to modification in the future.

The preliminary purchase price allocation to assets acquired and liabilities assumed in the AM USA Transaction was:


	(In Millions)
	Initial Allocation of Consideration		Measurement Period Adjustments		Updated Allocation
Cash and cash equivalents	$	35	$	—	$	35
Accounts receivable, net	349		(5)		344
Inventories	2,115		14		2,129
Other current assets	34		(1)		33
Property, plant and equipment	4,017		372		4,389
Other non-current assets	158		7		165
Accounts payable	(758)		27		(731)
Accrued employment costs	(271)		4		(267)
Pension and OPEB liabilities, current	(109)		—		(109)
Other current liabilities	(398)		(8)		(406)
Pension and OPEB liabilities, non-current	(3,195)		—		(3,195)
Other non-current liabilities	(598)		(81)		(679)
Noncontrolling interest	(13)		13		—
Net identifiable assets acquired	1,366		342		1,708
Goodwill	1,230		(334)		896
Total net assets acquired	$	2,596	$	8	$	2,604

During the period subsequent to the AM USA Transaction, we made certain measurement period adjustments to the acquired assets and liabilities assumed due to clarification of information utilized to determine fair value during the measurement period. The measurement period adjustment related to the revaluation of the Company's previously held equity method investment, which is now being consolidated post-acquisition, resulted in a loss of $18 million, within Miscellaneous – net for the nine months ended September 30, 2021.

The goodwill resulting from the acquisition of ArcelorMittal USA primarily represents the growth opportunities in the automotive, construction, appliances, infrastructure and machinery and equipment markets, as well as any synergistic benefits to be realized from the AM USA Transaction, and was assigned to our flat steel operations within our Steelmaking segment.

Acquisition of AK Steel

Overview

On March 13, 2020, pursuant to the AK Steel Merger Agreement, we completed the acquisition of AK Steel, in which we were the acquirer. As a result of the AK Steel Merger, each share of AK Steel common stock issued and outstanding immediately prior to the effective time of the AK Steel Merger (other than excluded shares) was converted into the right to receive 0.400 Cliffs common shares and, if applicable, cash in lieu of any fractional Cliffs common shares.

The AK Steel Merger was accounted for under the acquisition method of accounting for business combinations. The acquisition date fair value of the consideration transferred totaled $1,535 million. The following tables summarize the consideration paid for AK Steel and the estimated fair values of the assets acquired and liabilities assumed at the acquisition date.

The fair value of the total purchase consideration was determined as follows:


	(In Millions)
Fair value of AK Steel debt	$	914
Fair value of Cliffs common shares issued for AK Steel outstanding common stock1	618
Other1	3
Total purchase consideration	$	1,535

1 Included as non-cash investing activities in the Statement of Unaudited Condensed Consolidated Cash Flows for the nine months ended September 30, 2020.

The fair value of Cliffs common shares issued for outstanding shares of AK Steel common stock and with respect to Cliffs common shares underlying converted AK Steel equity awards that vested upon completion of the AK Steel Merger was calculated as follows:


	(In Millions, Except Per Share Amounts)
Number of shares of AK Steel common stock issued and outstanding	317
Exchange ratio	0.400
Number of Cliffs common shares issued to AK Steel stockholders	127
Price per share of Cliffs common shares	$	4.87
Fair value of Cliffs common shares issued for AK Steel outstanding common stock	$	618

The fair value of AK Steel's debt included in the consideration was calculated as follows:


	(In Millions)
Credit Facility	$	590
7.500% Senior Secured Notes due July 2023	324
Fair value of debt included in consideration	$	914

Valuation Assumption and Purchase Price Allocation

The allocation of consideration to the net tangible and intangible assets acquired and liabilities assumed in connection with the AK Steel Merger was based on estimated fair values at March 13, 2020, and was finalized during the quarter ended March 31, 2021. The following is a summary of the purchase price allocation to assets acquired and liabilities assumed in the AK Steel Merger:


	(In Millions)
	Initial Allocation of Consideration		Measurement Period Adjustments		Final Allocation of Consideration as of March 31, 2021
Cash and cash equivalents	$	38	$	1	$	39
Accounts receivable, net	666		(2)		664
Inventories	1,563		(243)		1,320
Other current assets	68		(16)		52
Property, plant and equipment	2,184		90		2,274
Deferred income taxes	—		69		69
Other non-current assets	475		(4)		471
Accounts payable	(636)		(8)		(644)
Accrued employment costs	(94)		1		(93)
Pension and OPEB liabilities, current	(75)		(3)		(78)
Other current liabilities	(236)		9		(227)
Long-term debt	(1,179)		—		(1,179)
Pension and OPEB liabilities, non-current	(873)		2		(871)
Other non-current liabilities	(507)		72		(435)
Noncontrolling interest	—		(1)		(1)
Net identifiable assets acquired	1,394		(33)		1,361
Goodwill	141		33		174
Total net assets acquired	$	1,535	$	—	$	1,535

During the period subsequent to the AK Steel Merger, we made certain measurement period adjustments to the acquired assets and liabilities assumed due to clarification of information utilized to determine fair value during the measurement period.

The goodwill resulting from the acquisition of AK Steel was assigned to our downstream Tubular and Tooling and Stamping operating segments. Goodwill is calculated as the excess of the purchase price over the net identifiable assets recognized and primarily represents the growth opportunities in light weighting solutions to automotive customers, as well as any synergistic benefits to be realized. Goodwill from the AK Steel Merger is not expected to be deductible for income tax purposes.

The purchase price allocated to identifiable intangible assets and liabilities acquired was:


	(In Millions)		Weighted Average Life (In Years)
Intangible assets:
Customer relationships	$	77	18
Developed technology	60		17
Trade names and trademarks	11		10
Total identifiable intangible assets	$	148	17
Intangible liabilities:
Above-market supply contracts	$	(71)	12

The above-market supply contracts relate to the long-term coke and energy supply agreements with SunCoke Energy, which includes SunCoke Middletown, a consolidated VIE. Refer to NOTE 16 - VARIABLE INTEREST ENTITIES for further information.

Pro Forma Results

The following table provides unaudited pro forma financial information, prepared in accordance with Topic 805, for the three and nine months ended September 30, 2020, as if AK Steel had been acquired as of January 1, 2019:


	(In Millions)
	Three Months Ended September 30, 2020		Nine Months Ended September 30, 2020
Revenues	$	1,646	$	4,265
Net loss attributable to Cliffs shareholders	(6)		(124)

The unaudited pro forma financial information has been calculated after applying our accounting policies and adjusting the historical results with pro forma adjustments, net of tax, that assume the AK Steel Merger occurred on January 1, 2019. Significant pro forma adjustments include the following:

1.The elimination of intercompany revenues between Cliffs and AK Steel of $136 million and $395 million for the three and nine months ended September 30, 2020, respectively.

2.The 2020 pro forma Net loss was adjusted to exclude $15 million and $74 million of non-recurring inventory acquisition accounting adjustments incurred during the three and nine months ended September 30, 2020, respectively.

3.The elimination of nonrecurring transaction costs incurred by Cliffs and AK Steel in connection with the AK Steel Merger of $1 million and $29 million for the three and nine months ended September 30, 2020, respectively.

4.Total other pro forma adjustments included expense of $10 million for both the three and nine months ended September 30, 2020, primarily due to increased interest expense, offset by reduced amortization expense, depreciation expense and pension and OPEB expense.

5.The income tax impact of pro forma transaction adjustments that affect Net loss attributable to Cliffs shareholders at a statutory rate of 24.3% resulted in an income tax benefit of $6 million and $2 million for the three and nine months ended September 30, 2020, respectively.

The unaudited pro forma financial information does not reflect the potential realization of synergies or cost savings, nor does it reflect other costs relating to the integration of AK Steel. This unaudited pro forma financial information should not be considered indicative of the results that would have actually occurred if the AK Steel Merger had been consummated on January 1, 2019, nor are they indicative of future results.