CLF

Cleveland-Cliffs Inc. 10-Q Summary: Period Ended June 30, 2007

Business Context and Reporting Period

Cleveland-Cliffs Inc. (Cliffs) is an international mining company and the largest producer of iron ore pellets in North America. The company operates mines in Michigan, Minnesota, and Eastern Canada, and holds significant interests in iron ore operations in Australia (Portman) and Brazil (Amapa). This report covers the quarterly period ended June 30, 2007, and the six-month period ended on the same date. During this period, Cliffs executed major strategic moves, including the acquisition of a 30% interest in the Amapa Project (Brazil), a 45% economic interest in the Sonoma coal project (Australia), and the acquisition of 100% of PinnOak Resources (U.S. metallurgical coal producer) on July 31, 2007.

Key Financial Metrics

Note: Operating cash flow for the six months ended June 30, 2007, was negative $37.7 million, primarily due to a $159.0 million increase in product inventories.

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 13% in Q2 and 10% for the six-month period compared to 2006, driven by higher sales volumes in North America and Asia-Pacific, as well as favorable price realizations in the first half.
• Profitability: Net income increased 4.6% in Q2 ($86.9M vs $83.1M) despite flat pre-tax income, largely due to lower income tax expense and a reduced minority interest allocation. For the six-month period, net income decreased slightly by 1.3% ($119.4M vs $121.0M).
• Segment Performance: North America segment operating income increased to $112.9M in Q2 from $100.2M in 2006. Asia-Pacific operating income decreased to $20.6M from $27.8M in the prior year quarter due to higher costs and volume mix, though it improved year-to-date.
• Capital Deployment: Significant cash outflows occurred for investments in ventures ($223.7M for six months), primarily for the Amapa ($160.1M) and Sonoma ($56.7M) projects. Capital expenditures for property, plant, and equipment were $46.2M for the six months.
• Liquidity: Cash and cash equivalents decreased by $222.4 million during the first half of 2007. The company drew $125 million on its $500 million revolving credit facility.

Guidance, Outlook, and Risks

• Production Outlook: Cliffs-managed 2007 North American pellet production is estimated at 35 million tons (Cliffs share ~22 million tons). Portman's 2007 production is expected to be 8.4 million tonnes.
• Cost and Price Guidance: North American revenue per ton is expected to increase ~3% for the full year. Unit production costs are expected to rise ~1% year-over-year. Portman's unit costs are expected to increase ~11% due to labor and exchange rates.
• Acquisition Impact: The PinnOak acquisition is expected to have minimal impact on 2007 earnings due to integration costs. The Sonoma and Amapa projects are expected to negatively impact full-year earnings due to development costs.
• Legal and Environmental Risks:
  • Northshore Permit: The Minnesota Pollution Control Agency (MPCA) denied a permit amendment regarding a "control city" monitoring requirement. Cliffs has appealed and is facing potential enforcement actions.
  • Portman Tenements: Portman received notice that mining rights under two leases with Polaris Metals NL would not be extended, potentially affecting 4.5 million tonnes of reserves. Portman disputes this.
  • Environmental Liabilities: Total environmental and mine closure obligations were $106.5 million. Specific sites include the Rio Tinto mine in Nevada and the Carl's Tire Retreading Superfund Site in Michigan.
• Internal Controls: Management concluded that disclosure controls and procedures were not effective as of June 30, 2007, due to a material weakness identified in December 2006 regarding insufficient personnel with technical accounting knowledge for independent secondary reviews.

Investor Verification Checklist

• Inventory Build-up: Verify the rationale and marketability of the $159 million increase in product inventories, which drove negative operating cash flow.
• Internal Control Remediation: Assess the progress made in addressing the material weakness in internal controls over financial reporting.
• Acquisition Integration: Monitor the financial impact and integration progress of the PinnOak, Amapa, and Sonoma acquisitions.
• Legal Proceedings: Track the resolution of the Northshore permit appeal and the Portman lease dispute with Polaris Metals NL.
• Debt Covenants: Confirm continued compliance with financial covenants on the $500 million revolving credit facility and the new $150 million PinnOak term loan.