CLF

Cleveland-Cliffs Inc. 10-Q Summary: Quarter Ended March 31, 2005

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2005, for Cleveland-Cliffs Inc., a leading supplier of iron ore products to the steel industry. The reporting period is significantly impacted by the acquisition of a 68.7% interest in Portman Limited, an Australian iron ore mining company, on March 31, 2005. While Portman's balance sheet is consolidated as of the quarter-end, its operating results are not included in the first-quarter income statement due to the acquisition date.

Key Financial Metrics

Liquidity and Debt: The company funded the Portman acquisition using existing cash, marketable securities, and a new $350 million revolving credit facility. As of April 27, 2005, $175.0 million was outstanding on this facility. Cash flow from operating activities was $194.4 million, while investing activities used $376.3 million, primarily due to the Portman investment.

Material Changes vs. Prior Period

• Revenue Growth: Iron ore revenues increased to $219.2 million from $163.9 million, driven by a 34% increase in sales prices (approx. 86% increase in international pellet pricing) despite a 7% decrease in sales volume (4.0 million tons vs. 4.3 million tons).
• Profitability Surge: Operating income improved by $36.7 million, turning a loss into a profit. This was primarily due to a $37.1 million increase in sales margin.
• Cost Increases: Cost of goods sold increased by $18.2 million due to higher unit production costs ($28.0 million increase) driven by maintenance timing, energy prices, and royalties, partially offset by lower volume.
• Accounting Change: The company adopted EITF No. 04-6 regarding stripping costs, resulting in a $4.2 million after-tax cumulative effect adjustment to net income.
• Asset Base: Total assets increased by $331.3 million, largely due to the consolidation of Portman's assets ($592.6 million preliminary allocation).

Guidance, Outlook, and Risks

Outlook: Management forecasts total-year North American sales of approximately 24 million tons and production of 37.0 million tons (Company share 22.8 million tons). Full-year 2005 unit production costs are expected to increase approximately 9% compared to 2004. Capital expenditures are estimated at $200 million for 2005, including $60 million for Portman expansion.

Management Commentary: The acquisition of Portman establishes a presence in the Australian mining industry and expands the customer base in China and Japan. The company continues to benefit from strong international pellet pricing.

Risks and Contingencies:

• Customer Bankruptcy: WCI Steel Inc. remains in Chapter 11 reorganization; confirmation of a plan by June 30, 2005, is unlikely, which may delay full recovery of a $5.8 million receivable. Stelco Inc. is also under court protection in Canada, though it continues to meet cash call requirements.
• Environmental Liabilities: Total environmental and mine closure obligations are $101.9 million. Specific sites like Milwaukee Solvay and Kipling Furnace face ongoing regulatory scrutiny and potential cost increases.
• Market Risks: Exposure to energy costs (approx. 25% of production costs), currency fluctuations (AUD/USD for Portman, CAD/USD for Wabush), and steel industry consolidation.

Investor Verification Checklist

• Portman Integration: Verify the final purchase price allocation and the timeline for Portman's production expansion to 8.0 million metric tons.
• Customer Solvency: Monitor the status of WCI Steel's bankruptcy plan confirmation and Stelco's restructuring to assess receivable collectibility.
• Cost Inflation: Track actual energy and maintenance costs against the forecasted 9% increase in unit production costs for 2005.
• Debt Covenants: Review compliance with the new $350 million revolving credit facility covenants, particularly regarding earnings and fixed cost coverage.
• Environmental Reserves: Assess potential increases in reserves for the Milwaukee Solvay and Kipling Furnace sites based on regulatory developments.