CLF

Cleveland-Cliffs Inc. 10-Q Summary: Q1 2007

Business Context and Reporting Period

This report covers the quarterly period ended March 31, 2007. Cleveland-Cliffs Inc. is the largest producer of iron ore pellets in North America, with operations in North America, Australia (Portman), and a new development project in Latin America (Amapa). The filing was delayed due to a comprehensive review of derivative accounting (SFAS 133) related to long-term supply agreements. As of June 7, 2007, there were 41,020,105 common shares outstanding.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 6.2% to $325.5 million, driven by a 66.4% surge in Australian segment revenues ($100.3M vs $60.2M) due to higher prices and volume. North American revenues declined 8.5% ($225.2M vs $246.2M) due to lower sales volume caused by winter shipping constraints on the Great Lakes.
• Profitability Decline: Net income decreased 14.2% to $32.5 million. This was primarily due to higher income tax expenses ($13.5M vs $9.9M) and increased minority interest allocations ($4.5M vs $2.4M), reflecting the strong performance of the Australian subsidiary (Portman) which is subject to a higher tax rate.
• Cash Flow Deterioration: Net cash used by operating activities widened significantly to $96.6 million (from $5.3 million used in 2006). This was largely driven by a $129.2 million increase in product inventories due to seasonal shipping delays and a $133.3 million cash outflow for the acquisition of a 30% interest in the Amapa project in Brazil.
• Segment Performance: North American sales margin decreased $8.3 million due to volume declines. Conversely, Australian sales margin increased $14.7 million due to higher prices and volume.

Guidance, Outlook, and Risks

• Production Outlook: Full-year 2007 North American production is expected to approximate 35 million tons (Cliffs share ~22 million tons), despite a temporary shutdown at the Hibbing mine due to ice buildup. Portman production is expected to reach 8.4 million tonnes.
• Cost and Price Guidance: North American revenue per ton is expected to increase ~2% for 2007. Unit production costs are projected to rise ~2% to ~$48.17/ton. Portman revenue per tonne is expected to rise ~6%, with unit costs increasing ~8%.
• Strategic Acquisitions: The company acquired a 30% interest in the Amapa iron ore project in Brazil for $133.3 million and a 45% interest in the Sonoma coal project in Australia. Total expected investment for Amapa is $160 million.
• Subsequent Event: On June 6, 2007, the company agreed to sell its 26.8% interest in the Wabush Mines Joint Venture for approximately $24.1 million in cash plus warrants, expecting to record a gain upon closing.
• Legal and Regulatory Risks:
  • Internal Controls: Management identified a material weakness in internal controls due to insufficient personnel with technical accounting knowledge, leading to a delay in the 10-K filing.
  • Environmental: Ongoing remediation obligations at the Rio Tinto mine site in Nevada (estimated costs $10M-$27M) and potential regulatory challenges in Western Australia regarding "A class reserves" overlapping with Portman's tenements.
  • Energy Costs: Rising energy costs (approx. 25% of North American production costs) pose a risk, though the company has hedged a portion of natural gas and diesel requirements.

Investor Verification Checklist

• Verify the impact of the material weakness in internal controls on future financial reporting accuracy and the timeline for remediation.
• Monitor the Wabush Mines sale closing conditions, specifically the 90-day right of first refusal held by Dofasco, to confirm the expected gain recognition.
• Assess the inventory buildup ($279.5M in product inventories) and its effect on working capital and future cash flows as shipping constraints ease.
• Review the Amapa project capital expenditure schedule and the company's ability to fund the remaining $80 million share of construction costs via project debt.
• Track the resolution of the WEPCO power dispute settlement and the transition to industrial tariffs in late 2007 to understand future cost structures.