Cleveland-Cliffs Inc. 10-Q Summary: Quarter Ended March 31, 2006
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 2006. Cleveland-Cliffs Inc. is the largest producer of iron ore pellets in North America. Following the acquisition of Portman Limited in late 2005, the Company now operates in two reportable segments: North America (mining operations in the U.S. and Canada) and Australia (Portman operations in Western Australia). The North American segment accounted for approximately 80% of consolidated revenues in the quarter.
Key Financial Metrics
| Metric (in millions, except per share) | Q1 2006 | Q1 2005 |
|---|---|---|
| Total Revenues | $306.4 | $271.2 |
| Operating Income | $46.2 | $34.1 |
| Net Income | $37.9 | $26.2 |
| Income from Continuing Operations | $37.7 | $20.9 |
| Diluted EPS (Continuing Ops) | $1.36 | $0.76 |
| Diluted EPS (Total) | $1.37 | $0.95 |
| Cash and Cash Equivalents | $136.7 | $108.5 |
| Net Cash Used by Operating Activities | ($5.3) | $194.9 |
| Capital Expenditures | $43.3 | $19.1 |
Liquidity and Debt: As of March 31, 2006, the Company had no outstanding borrowings under its $350 million revolving credit facility. Portman had A$28.8 million of availability under its A$40 million credit facility. Total cash and cash equivalents were $136.7 million.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 13% to $306.4 million, driven by the inclusion of Portman's results (which were not consolidated in Q1 2005) and higher North American sales prices.
- Profitability: Net income increased 45% to $37.9 million. This was primarily due to Portman's earnings contribution and higher North American sales margins, partially offset by a $5.2 million after-tax cumulative effect of an accounting change in 2005 that did not recur.
- Cash Flow: Net cash used by operating activities was ($5.3) million, a significant decrease from the $194.9 million generated in Q1 2005. The 2005 figure was anomalously high due to the sale of $182.7 million in marketable securities (auction rate securities) which were fully liquidated in Q1 2006. Additionally, inventory build-up in Q1 2006 consumed $95.9 million in cash.
- Segment Performance: North American sales margins increased to $45.6 million due to higher price realizations, despite a 1.1 million ton reduction in sales volume. Australian sales revenue was $60.2 million on 1.5 million tonnes.
Guidance, Outlook, and Risks
- Production Outlook: North American pellet production is expected to be approximately 35 million tons in 2006 (Cliffs' share ~22 million tons). Portman expects to produce 7.5 million tonnes in 2006, with sales of 7.6 million tonnes, following the completion of its expansion project.
- Cost Outlook: North American unit production costs are expected to increase approximately 13% in 2006 due to higher energy, supply, and labor costs. Portman's unit costs are expected to increase less than 5%.
- Accounting Changes: The Company adopted SFAS 123R (Share-Based Payment) effective January 1, 2006, resulting in $2.4 million of share-based compensation expense in Q1 2006.
- Legal and Environmental Risks:
- WEPCO Dispute: A dispute exists with Wisconsin Electric Power Company regarding billing methodology. $75.8 million has been deposited in escrow, with the Company asserting a right to recover $73.0 million against 2006 invoices.
- Environmental Liabilities: Total environmental and mine closure obligations are $110.3 million. Specific sites include the Milwaukee Solvay site (negotiating a liability transfer) and the Rio Tinto mine site in Nevada.
- Customer Bankruptcies: WCI Steel emerged from bankruptcy with a confirmed plan assuming the Company's pellet supply agreement. Stelco emerged from creditor protection, and the Company is working to finalize the transfer of Stelco's joint venture interests.
Key Facts for Investor Verification
- Inventory Build-up: Verify the sustainability of the $95.9 million cash outflow for product inventories, which increased significantly due to winter shipment curtailments on the Great Lakes.
- Portman Expansion: Confirm the timeline for Portman reaching its 8 million tonne production rate, currently expected in Q3 2006, and the impact of the finalized purchase price allocation on future depletion costs.
- WEPCO Escrow: Monitor the resolution of the WEPCO arbitration and the potential release of the $73.0 million escrow offset against future invoices.
- Energy Hedging: Review the exposure to energy price volatility, noting that the Company has hedged approximately 70% of its 2006 natural gas consumption but faces rising diesel and power costs.
- Customer Concentration: Assess the impact of the Mittal Steel USA agreement modification and the status of the Algoma Steel pricing arbitration regarding "Reopener Years."