Labrador Iron Ore Royalty Corporation - 2020 Results of Operations

Labrador Iron Ore Royalty Corporation ("LIORC") (TSX: LIF) announced the results of its operations for the year ended December 31, 2020 .

To the Holders of Common Shares of Labrador Iron Ore Royalty Corporation

The Directors of Labrador Iron Ore Royalty Corporation ("LIORC" or the "Corporation") present the Annual Report for the year ended December 31, 2020 .

83 Years in Labrador West

Labrador Iron Ore Royalty Corporation has been involved in Labrador West for 83 years. Under a Statutory Agreement with Newfoundland made in 1938, a predecessor company, Labrador Mining and Exploration Limited, was granted extensive exploration and mining rights in Labrador West. LM&E found the iron ore bodies that now constitute the mine operated by Iron Ore Company of Canada . LM&E received grants of leases and licences under the Statutory Agreement. It also received a grant of surface rights to establish the town site that became Labrador City . LM&E sublet the leases to IOC and IOC, with major steel companies as original shareholders, built the infrastructure, mine, railway and port. Under the sublease, LIORC receives a 7% gross overriding royalty on iron ore products produced and sold by IOC.

In April 2020 , the Government of Newfoundland and Labrador granted renewals of all 12 of LIORC's mining leases in accordance with their terms for an additional 30 years.

Financial Performance

The COVID-19 global pandemic impacted IOC operations, as well as the global demand and supply of iron ore products. Despite the pandemic, from a financial perspective 2020 was a very good year for LIORC.  Net income per share for the year ended December 31, 2020 was $3.55 per share, which was an 11% increase over 2019. The adjusted cash flow per share for 2020 was $3.09 per share, which was 5% lower than in 2019 as a result of IOC's decision to pay lower shareholder dividends in 2020 in order to retain a higher cash balance due in part to concerns that the COVID-19 pandemic may adversely affect IOC's operations. In 2020, IOC paid dividends to its shareholders of US$450 and had a year-end net working capital balance of US$184.6 million , compared to dividends of US$550 and a year-end net working capital balance of US$52.0 million in 2019. The financial results for LIORC in 2020 benefited from higher iron ore prices and increased sales tonnages.

The demand for iron ore by steel producers outside of China was reduced in 2020 because of the COVID-19 global pandemic. For example, the World Steel Association has reported that steel production in the European Union, Japan and the United States was lower in 2020 year over year by 12%, 16% and 17%, respectively. However seaborne iron ore prices increased throughout the year, as steel production in China was unexpectedly 5% higher in 2020 year over year. IOC sells concentrate for sale ("CFS") based on the Platts index for 65% Fe, CFR China ("65% Fe index"). In 2020, the 65% Fe index increased throughout the year from an average US$106 per tonne in January to an average of US$168 per tonne in December. The average price for 2020 was US$122 per tonne, an increase of 16% year over year. The monthly Atlantic Blast Furnace 65% Fe pellet premium index as quoted by Platts (the "pellet premium"), on average was 49% lower in 2020 year over year, predominantly as a result of the weaker demand from European and other steel producers outside of China , who have been the traditional purchasers of pellets. As a result, IOC took advantage of stronger market conditions in Asia in the first half of the year and switched its product mix, prioritising CFS over pellets, and then returned to higher pellet production as European demand recovered. Overall, the average price realized by IOC for CFS and pellets, FOB Sept-Îles, net of selling costs was approximately C$155 per tonne in 2020, an increase of 5% year over year.

Iron Ore Company of Canada Operations

Operations
In order to protect IOC's people and to prevent COVID-19 outbreaks within IOC's operations which could affect IOC's capacity to operate, IOC took measures early in March 2020 to limit the exposure risk at different levels. Main actions taken by IOC included limiting on-site presence of personnel to essential operational activities (remote work for administration and supports) and reduction of contractors on-site (favouring local rather than out-of-province when possible). In parallel, several protocols were put in place including strict approval processes for all travel between sites and out-of-province contractors, mandatory on-line health questionnaires linked to gate access, COVID-19 screening for all out-of-province contractors and employees and daily temperature checks at all site access points. As a result of these and other procedures and protocols, IOC was able to continue operations throughout 2020. The IOC saleable production (CFS plus pellets) of 17.7 million tonnes in 2020 was 1% lower than 2019, and slightly below the lower end of Rio Tinto's guidance of 17.9 to 20.4 million tonnes, predominantly because of the impact of COVID-19 and unplanned maintenance at the processing facilities in the third and fourth quarters.

The total cost of goods sold, excluding depreciation, was higher in 2020 than in 2019 by 7%, predominantly due to higher sales. The unit cost of goods sold, excluding depreciation, in 2020 was comparable to 2019.

Revenue from third party haulage by the Québec North Shore and Labrador Railway Company, Inc. ("QNS&L") in 2020 was 15% higher than in 2019, predominantly from increased shipments of iron ore concentrate from the Scully Mine, owned by Tacora Resources.

Sales as Reported for the LIORC Royalty
Total iron ore sales tonnage by IOC (CFS plus pellets) of 18.3 million tonnes in 2020 was 7% higher than the total sales tonnage in 2019 as a result of timing differences and breakdowns in reclaiming and ship loading equipment at the terminal that negatively affected sales and increased inventory levels in 2019.  In 2020, IOC also started selling limited quantities of CFS to Rio Tinto's port side trading operations in China . These sales are made on arm's length commercial terms and provide IOC with additional demand for its product.

Capital Expenditures
Capital expenditures for IOC of $288 million in 2020 were 2% lower than in 2019 and 18% lower than IOC had forecasted for 2020, mainly because of the decision by IOC at the early stages of COVID-19 to defer some projects to 2021 and 2022 because the impact of COVID-19 on the market for high grade iron ore was unknown at that time. Capital expenditures were also lower due to the difficulty in getting contractors to site because of COVID-19 restrictions and protocols.

Outlook

Rio Tinto's 2021 guidance for IOC's saleable production tonnage (CFS plus pellets) is 17.9 million to 20.4 million tonnes. This compares to 17.7 million tonnes of saleable production in 2020. Pellet production of 9.6 million tonnes in 2020 was 5% lower than 2019 mainly because of IOC's strategic decision to change its product mix in response to lower pellet demand.  In response to strengthening demand for pellets IOC reverted to maximizing pellet production in the fourth quarter of 2020.

IOC and its shareholders are committed to improving operations, which includes increased investment in IOC's capital assets. The capital expenditures for 2021 at IOC are forecasted to be approximately $460 million , as compared to $288 million in 2020. The 2021 forecast includes approximately $165 million of growth and development projects, as compared to $51 million of growth and development projects in 2020.  Significant capital expenditure projects scheduled for 2021 include implementation of the Mill 11 circuit redesign to increase weight yield, redesign of the tailings system to increase the life of use and reduce electricity and water usage, replacement of the dumper cages and refurbishment of the dumper auxiliary system at Sept-Îles, and replacement of a number of locomotives on the mainline between Labrador City and Sept-Îles and on the Automatic Train Operation which delivers ore from the mine to the primary crushers located near the concentrator.

In December 2020 , IOC signed a Reconciliation and Collaboration Agreement with the Innu communities of Uashat mak Mani-utenam and Matimekush-Lac John laying the groundwork for a mutually beneficial relationship based on dialogue, collaboration and trust between IOC and the two communities over the coming decades, and ending the legal action initiated by the two communities against IOC.

The price outlook for seaborne iron ore remains robust.  Global steel production outside of China is expected to revert to pre-COVID-19 levels, and as governments look to re-establish their domestic economies, new infrastructure spending is expected to drive additional demand for steel.  Thus far in 2021 ( January 1, 2021 to February 23, 2021 ), the average price of the 65% Fe index has been US$189 , which is 55% higher than the average of the 65% Fe index for 2020.   In addition, thus far in 2021 the average pellet premium has averaged US$42 compared to an average of US$29 for 2020.  Given current iron ore prices and pellet premiums, as well as the positive outlook for steel production in 2021, LIORC is well positioned to benefit from increased revenues and cashflow generated by IOC.

On February 18, 2021 , IOC declared a dividend payable to shareholders on March 25 , 2021.  The Corporation's portion is US$15.1 million or about CDN$0.30 per share.

I would like to take this opportunity to thank our Shareholders for their interest and loyalty and my fellow Directors for their wisdom and support.

Respectfully submitted on behalf of the Directors of the Corporation,

John F. Tuer
President and Chief Executive Officer
March 4, 2021

Corporate Structure

LIORC is a Canadian corporation formed to give effect to the conversion of the Labrador Iron Ore Royalty Income Fund (the "Fund") into a corporation under a plan of arrangement completed on July 1, 2010 . LIORC is also the successor by amalgamation of a predecessor of LIORC with Labrador Mining Company Limited, formerly a wholly-owned subsidiary of the Fund, that occurred pursuant to the plan of arrangement.

LIORC, directly and through its wholly-owned subsidiary Hollinger-Hanna, holds a 15.10% equity interest in IOC and receives a 7% gross overriding royalty and a 10 cent per tonne commission on all iron ore products produced, sold and shipped by IOC.  Generally, LIORC pays cash dividends from its net income to the maximum extent possible, subject to the maintenance of appropriate levels of working capital. The common shareholders receive quarterly dividends on the common shares on the 25th day of the month following the end of each quarter.

Eight Directors are responsible for the governance of the Corporation and also serve as directors of Hollinger-Hanna. The Directors, in addition to managing the affairs of the Corporation and Hollinger-Hanna, oversee the Corporation's interests in IOC. The Audit, Compensation and Nominating Committees are composed of five independent Directors.

Taxation

The Corporation is a taxable corporation. Dividend income received from IOC and Hollinger-Hanna is received tax free while royalty income is subject to income tax and Newfoundland royalty tax. Expenses of the Corporation include administrative expenses. Hollinger-Hanna is a taxable corporation.

Income Taxes

Dividends to a shareholder that are paid within a particular year are to be included in the calculation of the shareholder's taxable income for that year. All dividends paid in 2020 were "eligible dividends" under the Income Tax Act.

Review of Operations

Iron Ore Company of Canada

The income of the Corporation is entirely dependent on IOC as the only assets of the Corporation and its subsidiary are related to IOC and its operations. IOC is one of Canada's largest iron ore producers, operating a mine, concentrator and pellet plant at Labrador City, Newfoundland and Labrador , and is among the top five producers of seaborne iron ore pellets in the world.  It has been producing and processing iron ore concentrate and pellets since 1954.  IOC is strategically situated to serve markets throughout the world from its year-round port facilities at Sept-Îles, Québec.

IOC has ore reserves sufficient for approximately 24 years at current production rates with additional resources of a greater magnitude.  It currently has the nominal capacity to extract around 55 million tonnes of crude ore annually. The crude ore is processed into iron ore concentrate and then either sold or converted into many different qualities of iron ore pellets to meet its customers' needs. The iron ore concentrate and pellets are transported to IOC's port facilities at Sept-Îles, Québec via its wholly-owned QNS&L, a 418 kilometer rail line which links the mine and the port.  From there, the products are shipped to markets throughout North America , Europe , the Middle East and the Asia-Pacific region.

IOC's 2020 sales totaled 18.6 million tonnes, comprised of 10.2 million tonnes of iron ore pellets and 8.4 million tonnes of iron ore concentrate.   Production in 2020 was 9.6 million tonnes of pellets and 8.1 million tonnes of CFS. IOC generated ore sales revenues (excluding third party ore sales) of $2,915 million in 2020 (2019 - $2,558 million ).

Selected IOC Financial Information

IOC Royalty

The Corporation holds certain leases and licenses covering approximately 18,200 hectares of land near Labrador City . IOC has subleased certain portions of these lands from which it currently mines iron ore. In return, IOC pays the Corporation a 7% gross overriding royalty on all sales of iron ore products produced from these lands. A 20% tax on the royalty is payable to the Government of Newfoundland and Labrador . For the five years prior to 2020, the average royalty net of the 20% tax had been $107.7 million per year and in 2020 the net royalty was $160.1 million (2019 - $140.4 million ).

Because the royalty is "off-the-top", it is not dependent on the profitability of IOC. However, it is affected by changes in sales volumes, iron ore prices and, because iron ore prices are denominated in US dollars, the United States - Canadian dollar exchange rate.

IOC Equity

In addition to the royalty interest, the Corporation directly and through its wholly owned subsidiary, Hollinger-Hanna, owns a 15.10% equity interest in IOC.  The other shareholders of IOC are Rio Tinto Limited with 58.72% and Mitsubishi Corporation with 26.18%.

IOC Commissions

Hollinger-Hanna has the right to receive a payment of 10 cents per tonne on the products produced and sold by IOC. Pursuant to an agreement, IOC is obligated to make the payment to Hollinger-Hanna so long as Hollinger-Hanna is in existence and solvent.  In 2020, Hollinger-Hanna received a total of $1.8 million in commissions from IOC (2019 - $1.7 million ).

Quarterly Dividends

Dividends of $3.05 per share including special dividends of $0.50 per share were declared in 2020 (2019 – dividends of 4.00 per share including special dividends of $3.00 ). These dividends were allocated as follows:

The quarterly dividends are payable to all shareholders of record on the last day of each calendar quarter and are paid on or after the 26th day of the following month.

Management's Discussion and Analysis

The following is a discussion of the consolidated financial condition and results of operations of the Corporation for the years ended December 31, 2020 and 2019. This discussion should be read in conjunction with the consolidated financial statements of the Corporation and notes thereto for the years ended December 31, 2020 and 2019.  This information is prepared in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB") and all amounts are shown in Canadian dollars unless otherwise indicated.

Overview of the Business

The Corporation is a Canadian corporation resulting from the conversion of the Fund into a corporation under a plan of arrangement completed on July 1, 2010 . LIORC is also the successor by amalgamation of a predecessor of LIORC with Labrador Mining Company Limited, formerly a wholly-owned subsidiary of the Fund, that occurred pursuant to the plan of arrangement.

The Corporation is dependent on the operations of IOC. IOC's earnings and cash flows are affected by the volume and mix of iron ore products produced and sold, costs of production and the prices received. Iron ore demand and prices fluctuate and are affected by numerous factors which include demand for steel and steel products, the relative exchange rate of the US dollar, global and regional demand and production, political and economic conditions and production costs in major producing areas.

Financial Highlights

The higher revenue, net income and equity earnings achieved in 2020 as compared to 2019 were mainly due to (i) higher iron ore prices as a result of continued demand from China , and (ii) higher sales of pellets and CFS. While saleable production in 2020 was 1% lower than in 2019 due to unplanned maintenance at the processing facilities in the third and fourth quarters, sales were 7% higher as IOC took advantage of higher inventory levels that had accumulated in 2019.

Capital expenditures for IOC in 2020 were $288 million in total as compared to $294 million in 2019.  At the beginning of 2020 IOC forecasted that capital expenditures for 2020 would be approximately $350 million . Capital expenditures were lower than forecasted mainly because of the decision by IOC at the early stages of COVID-19 to defer some projects to 2021 and 2022 because the impact of COVID-19 on the market for high grade iron ore was unknown at that time. Capital expenditures were also lower due to the difficulty in getting contractors to site because of COVID-19 restrictions and protocols.

Fourth quarter 2020 sales (pellets and CFS) were lower year-over-year by 4% despite higher saleable production due to timing differences in the sales process. However, this was offset by an increase in the realized sales price of pellets and CFS, resulting in royalty income of $53.9 million for the quarter as compared to $38.9 million for the same period in 2019. Fourth quarter 2020 cash flow from operations was $116.0 million or $1.81 per share compared to 2019 of $79.1 million or $1.24 per share. LIORC received an IOC dividend in the fourth quarter of 2020 in the amount of $86.6 million or $1.35 per share (2019 - $44.5 million or $0.70 per share). Equity earnings from IOC amounted to $37.8 million or $0.59 per share in the fourth quarter 2020 compared to $23.7 million or $0.37 per share for the same period in 2019.

Operating Highlights

IOC sells CFS based on the 65% Fe index. The average price for the 65% Fe index increased 16% to US$122 per tonne in 2020 compared to the average price in 2019 of US$104 per tonne. Despite the COVID-19 global pandemic and the resultant reduced demand for iron ore by steel producers outside of China , seaborne iron ore prices increased throughout the year as a result of strong demand from China . In 2020, the 65% Fe index started the year at US$105 per tonne and ended at US$174 per tonne.  The premium for the 65% Fe index compared to the Platts index for 62% Fe, CFR China ("62% Fe index"), which had been expanding over the last few years, remained at 12% in 2020 as compared to 2019. The 62% Fe index averaged US$109 per tonne in 2020 compared to US$93 per tonne in 2019. The pellet premium, as quoted by Platts, averaged US$29 per tonne in 2020, compared to an average in 2019 of US$57 . Pellet premiums were lower in 2020 predominantly as a result of weaker demand from European and other steel producers outside of China , who have been the traditional purchasers of pellets.

The average price realized by IOC for CFS and pellets, FOB Sept-Îles, net of selling costs was approximately C$155 per tonne in 2020 compared to C$148 per tonne in 2019. The increase in the average realized price FOB Sept-Îles in 2020 was a result of higher CFS prices, partially offset by lower pellet premiums.

Liquidity and Capital Resources

The Corporation had $106.1 million (2019 - $77.9 million ) in cash as at December 31, 2020 with total current assets of $164.4 million (2019 - $114.0 million ). The Corporation had working capital of $31.0 million (2019 - $28.2 million ). The Corporation's operating cash flow was $175.4 million (2019 - $224.6 million ) and dividends paid during the year were $147.2 million , resulting in cash balances increasing by $28.2 million during 2020.

Cash balances consist of deposits in Canadian dollars and US dollars with Canadian chartered banks. Accounts receivable primarily consist of royalty payments from IOC. Royalty payments are received in U.S. dollars and converted to Canadian dollars on receipt, usually 25 days after the quarter end. The Corporation does not normally attempt to hedge this short-term foreign currency exposure.

Operating cash flow of the Corporation is sourced entirely from IOC through the Corporation's 7% royalty, 10 cents commission per tonne and dividends from its 15.10% equity interest in IOC. The Corporation normally pays cash dividends from its net income to the maximum extent possible, subject to the maintenance of appropriate levels of working capital. The Corporation has a $30 million revolving credit facility with a term ending September 18, 2022 with provision for annual one-year extensions.  No amount is currently drawn under this facility leaving $30 million available to provide for any capital required by IOC or requirements of the Corporation.

Selected Consolidated Financial I   nformation

The following table sets out financial data from a Shareholder's perspective for the three years ended December 31, 2020 , 2019 and 2018.

The following table sets out quarterly revenue, net income,  cash flow and dividend data for 2020 and 2019. Due to seasonal weather patterns the first and fourth quarters generally have lower production and sales. Royalty revenues and equity earnings in IOC track iron ore spot prices, which can be very volatile. Dividends, included in cash flow, are declared and paid by IOC irregularly according to the availability of cash.

Standardized Cash Flow and Adjusted Cash Flow

For the Corporation, standardized cash flow is the same as cash flow from operating activities as recorded in the Corporation's cash flow statements as the Corporation does not incur capital expenditures or have any restrictions on dividends. Standardized cash flow per share was $2.74 for 2020 (2019 - $3.51 ).  Cumulative standardized cash flow from inception of the Corporation is $33.72 per share and total cash distributions since inception are $33.39 per share, for a payout ratio of 99%.

The Corporation also reports "Adjusted cash flow" which is defined as cash flow from operating activities after adjustments for changes in amounts receivable, accounts payable and income taxes recoverable and payable. It is not a recognized measure under IFRS.  The Directors believe that adjusted cash flow is a useful analytical measure as it better reflects cash available for distributions to Shareholders.

The following reconciles standardized cash flow from operating activities to adjusted cash flow (in '000's).

Disclosure Controls and Internal Control over Financial Reporting

The President and CEO and the CFO are responsible for establishing and maintaining disclosure controls and procedures and internal control over financial reporting for the Corporation.  Two directors serve as directors of IOC and IOC provides monthly reports on its operations to them.  The Corporation also relies on financial information provided by IOC, including its audited financial statements, and other material information provided to the President and CEO and the CFO by officers of IOC.  IOC is a private corporation, and its financial statements are not publicly available.

The Directors are informed of all material information relating to the Corporation and its subsidiary by the officers of the Corporation on a timely basis and approve all core disclosure documents including the Management Information Circular, the annual and interim financial statements and related Management's Discussion and Analyses, the Annual Information Form, any prospectuses and all press releases.  An evaluation of the design and operating effectiveness of the Corporation's disclosure controls and procedures was conducted under the supervision of the CEO and CFO.  Based on their evaluation, they concluded that the Corporation's disclosure controls and procedures were effective in ensuring that all material information relating to the Corporation was accumulated and communicated for the year ended December 31, 2020 .

The President and CEO and the CFO have designed internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS.  An evaluation of the design and operating effectiveness of the Corporation's internal control over financial reporting was conducted under the supervision of the CEO and CFO.  Based on their evaluation, they concluded that the Corporation's internal control over financial reporting was effective and that there were no material weaknesses therein for the year ended December 31, 2020 .

The preparation of financial statements requires the Corporation's management to make estimates and assumptions that affect the reported amounts of the assets, liabilities, revenue and expenses reported each period. Each of these estimates varies with respect to the level of judgment involved and the potential impact on the Corporation's reported financial results. Estimates are deemed critical when the Corporation's financial condition, change in financial condition or results of operations would be materially impacted by a different estimate or a change in estimate from period to period. By their nature, these estimates are subject to measurement uncertainty, and changes in these estimates may affect the consolidated financial statements of future periods.

No material change in the Corporation's internal control over financial reporting occurred during the year ended December 31, 2020 .

Forward-Looking Statements

This report may contain "forward-looking" statements that involve risks, uncertainties and other factors that may cause the actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Words such as "may", "will", "expect", "believe", "plan", "intend", "should", "would", "anticipate" and other similar terminology are intended to identify forward-looking statements. These statements reflect current assumptions and expectations regarding future events and operating performance as of the date of this report. Forward-looking statements involve significant risks and uncertainties, should not be read as guarantees of future performance or results, and will not necessarily be accurate indications of whether or not such results will be achieved. A number of factors could cause actual results to vary significantly, including iron ore price and volume volatility, exchange rates, the performance of IOC, market conditions in the steel industry, mining risks and insurance, relationships with indigenous groups, natural disasters, severe weather conditions and public health crises, changes affecting IOC's customers, competition from other iron ore producers, estimates of reserves and resources, government regulation and taxation and cybersecurity.  A discussion of these factors is contained in LIORC's annual information form dated March 4, 2021 under the heading, "Risk Factors". Although the forward-looking statements contained in this report are based upon what management of LIORC believes are reasonable assumptions, LIORC cannot assure investors that actual results will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this report and LIORC assumes no obligation, except as required by law, to update any forward-looking statements to reflect new events or circumstances. This report should be viewed in conjunction with LIORC's other publicly available filings, copies of which can be obtained electronically on SEDAR at www.sedar.com .

Additional information

Additional information relating to the Corporation, including the Annual Information Form, is on SEDAR at www.sedar.com . Additional information is also available on the Corporation's website at www.labradorironore.com .

John F. Tuer
President and Chief Executive Officer
Toronto, Ontario
March 4, 2021

The complete consolidated financial statements for the year ended December 31, 2020 , including the notes thereto, are posted on sedar.com and labradorironore.com .

SOURCE Labrador Iron Ore Royalty Corporation

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