Form 10-K
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-K

ANNUAL REPORT

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 1-8944

Cleveland-Cliffs Inc

(Exact name of registrant as specified in its charter)

 

Ohio   34-1464672

(State or other jurisdiction of

incorporation)

 

(I.R.S. Employer

Identification No.)

1100 Superior Avenue,
Cleveland, Ohio
  44114-2544
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (216) 694-5700

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of Each Class

  

Name of Each Exchange on Which Registered

Common Shares, par value $.25 per share    New York Stock Exchange and Chicago Stock Exchange
Rights to Purchase Common Shares    New York Stock Exchange and Chicago Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act:

NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.      Yes  x            No   ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.      Yes  ¨            No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes  ¨            No  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of the Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.      ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer  x            Accelerated filer  ¨            Non-accelerated filer  ¨.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨        No  x

As of June 30, 2006, the aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant, based on the closing price of $39.65 per share as reported on the New York Stock Exchange — Composite Index was $1,670,340,942 (excluded from this figure is the voting stock beneficially owned by the registrant’s officers and directors).

The number of shares outstanding of the registrant’s Common Shares, par value $.25 per share, was 41,026,089 as of May 18, 2007.

 



Table of Contents

TABLE OF CONTENTS

 

         Page No.

Definitions

   2

Part I

    

Item 1.

 

Business

   5

Item 1A.

 

Risk Factors

   15

Item 1B.

 

Unresolved Staff Comments

   25

Item 2.

 

Properties

   25

Item 3.

 

Legal Proceedings

   36

Item 4.

 

Submission of Matters to a Vote of Security Holders

   40

Part II

    

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   42

Item 6.

 

Selected Financial Data

   44

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   46

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

   66

Item 8.

 

Financial Statements and Supplementary Data

   67

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

   118

Item 9A.

 

Controls and Procedures

   118

Item 9B.

 

Other Information

   119

Part III

    

Item 10.

 

Directors, Executive Officers and Corporate Governance

   120

Item 11.

 

Executive Compensation

   122

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   153

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

   157

Item 14.

 

Principal Accountant Fees and Services

   158

Part IV

    

Item 15.

 

Exhibits and Financial Statement Schedules

   159

Signatures

   160


Table of Contents

Definitions

The following abbreviations or acronyms are used in the text. References in this report to the “Company”, “we”, “us”, “our” and “Cliffs” are to Cleveland-Cliffs Inc and subsidiaries, collectively. References to “A$” refer to Australian currency, “C$” to Canadian currency and “$” to United States currency.

 

Abbreviation or acronym

  

Term

Acme

   Acme Metals Incorporated

Algoma

   Algoma Steel Inc.

AOC

   Administrative Order by Consent

APBO

   Accumulated other postretirement benefit obligation

Arcelor

   Arcelor S.A.

ARS

   Auction rate securities

BACT

   Best Available Control Technology

Bethlehem

   Bethlehem Steel Corporation

BHP

   BHP Billiton

CAL

   Cliffs and Associates Limited

CCAA

   Companies’ Creditors Arrangement Act

Centennial Amapa

   Centennial Asset Participacoes Amapa S.A.

CERCLA

   Comprehensive Environmental Response, Compensation and Liability Act

Cliffs Asia Pacific

   Cliffs Asia-Pacific Pty Limited

Cockatoo Island

   Cockatoo Island Joint Venture

CVRD

   Companhia Vale do Rio Doce

Dofasco

   Dofasco Inc

DRI

   Direct Reduced Iron

EITF

   Emerging Issues Task Force

Empire

   Empire Iron Mining Partnership

EPA

   United States Environmental Protection Agency

EPS

   Earnings per share

Eveleth Mines

   Eveleth Mines LLC

FASB

   Financial Accounting Standards Board

Ferrominera

   C.V.G. Ferrominera Orinoco C.A. of Venezuela

F.O.B.

   Free on board

FSP

   FASB Staff Position

GAAP

   accounting principles generally accepted in the United States

GAM

   Group Annuity Mortality

HAP

   Hazardous air pollutants

HBI

   Hot Briquette Iron

Hibbing

   Hibbing Taconite Company

HLE

   HLE Mining Limited Partnership

HWE

   Henry Walker Eltin

ISG

   International Steel Group Inc.

Ispat

   Ispat Inland Steel Company

JORC

   Joint Ore Reserves Code

Kobe Steel

   Kobe Steel, LTD.

Laiwu

   Laiwu Steel Group, Ltd.

LIBOR

   London Interbank Offered Rate

LTI

   Lost Time Injuries

LTIFR

   Lost Time Injury Frequency Rate

LTVSMC

   LTV Steel Mining Company

MACT

   Maximum Achievable Control Technology

 

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Abbreviation or acronym

  

Term

Mittal

   Mittal Steel Company N.V.

Mittal Steel USA

   Mittal Steel USA Inc.

MMBTU

   Million Million British Thermal Units

MSHA

   Mine Safety and Health Administration

NDEP

   Nevada Department of Environmental Protection

Northshore

   Northshore Mining Company

NRD

   Natural Resource Damages

OPEB

   Other postretirement benefits

PBO

   Projected Benefit Obligation

PCB

   Polychlorinated Biphenyl

PolyMet

   PolyMet Mining Inc.

Portman

   Portman Limited

PPI

   Producers Price Indices

PRP

   Potentially responsible party

PSD

   Prevention of Significant Deterioration

Reserve

   Reserve Mining Co.

Rouge

   Rouge Industries, Inc.

RTWG

   Rio Tinto Working Group

SEC

   United States Securities and Exchange Commission

Severstal

   Severstal North America, Inc.

SFAS

   Statement of Financial Accounting Standards

Steel Dynamics

   Steel Dynamics, Inc.

Stelco

   Stelco Inc.

Tilden

   Tilden Mining Company L.C.

Tonne

   Metric ton

United Taconite

   United Taconite LLC

USW

   United Steelworkers of America

VEBA

   Voluntary Employee Benefit Association trusts

VNQDC

   Voluntary Non-Qualified Deferred Compensation Plan

Wabush

   Wabush Mines Joint Venture

WCI

   WCI Steel Inc.

Weirton

   Weirton Steel Corporation

WEPCO

   Wisconsin Electric Power Company

 

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Explanatory Note

The filing of the Company’s Form 10-K for the year-ended December 31, 2006 was late due to a comprehensive review of the Company’s application of SFAS 133, Accounting for Derivative Instruments and Hedging Activities, in relation to its long-term North American pellet supply agreements. The filing was initially delayed due to a review undertaken in connection with a concern raised anonymously through the Company’s Ethics Hotline. The concern focused on a specific contract revenue accounting item that allegedly affected the fourth quarter of 2006. The Company’s Audit Committee, following an investigation by internal audit and outside legal counsel, found no merit or substance to the allegation.

While the Hotline allegation was found to be without merit, a review of revenue recognition policies was undertaken. The Company, with the assistance of outside consultants, conducted a detailed review of price adjustment factors contained in the Company’s North American long-term pellet supply agreements to determine whether any of those factors meet the definition of embedded derivatives that are required be accounted for as derivatives separate from the supply agreement under the provisions of SFAS 133. The identification of and accounting for derivative instruments under SFAS 133 can be extremely detailed and complex. However, it was determined after the review that price adjustment variables included in our supply agreements are clearly and closely related to the underlying sales contracts, and therefore need not be bifurcated and separately accounted for. As a result, no significant accounting adjustments were required.

 

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PART I

Item 1.    Business.

Introduction

Founded in 1847, Cleveland-Cliffs Inc is the largest producer of iron ore pellets in North America. We sell substantially all of our pellets to integrated steel companies in the United States and Canada. On April 19, 2005, Cliffs Asia Pacific, a wholly owned subsidiary of the Company, completed the acquisition of 80.4 percent of Portman, an iron ore mining company in Australia. The acquisition was initiated on March 31, 2005 by the purchase of 68.7 percent of the outstanding shares of Portman. The acquisition increased our customer base in China and Japan and established our presence in the Australian mining industry.

Prior to 2002, we primarily held a minority interest in the mines we managed, with the majority interest in the mines held by various North American steel companies. Our earnings were principally comprised of royalties and management fees paid by the partnerships, along with sales of our equity share of the mine pellet production. Faced with marked deterioration in the financial condition of many of our partners and customers, we embarked on a strategy to reposition ourselves from a manager of iron ore mines on behalf of steel company partners to primarily a merchant of iron ore through increasing our ownership interests in our managed mines.

Our successful navigation of numerous customer and partner bankruptcies and the corresponding consolidation of the industry in recent years have resulted in our emerging with new long-term supply agreements, at more favorable pricing, with steel company partners and customers that are financially stronger than their predecessors. One example is the former ISG, which consolidated several bankrupt steel companies. We entered into a 15-year term sales agreement to supply all of ISG’s pellet requirements for its Cleveland and Indiana Harbor plants. In 2002, we also invested $13.0 million in ISG to support its acquisition of bankrupt LTV Corporation’s idled steelmaking assets, receiving a seven percent stake in return. Later in 2002, we invested another $4.4 million to support ISG’s acquisition of the steelmaking assets of Acme and invested another $10.7 million of pension trust assets in 2003 to support ISG’s acquisition of Bethlehem’s assets. In conjunction with its acquisition of Bethlehem, ISG acquired Bethlehem’s 62.3 percent equity interest in Hibbing. Through these investments, we received 5.9 million shares (5.1 million shares directly-held and .8 million shares held in our pension trust) in return for our original investment. Also in 2004, ISG acquired the bankrupt assets of Weirton and Georgetown Steel Corporation. In conjunction with its acquisition of Weirton, ISG assumed our term supply agreement with Weirton with some modifications.

ISG agreed to merge with Mittal, the parent company of Ispat, in 2005, resulting in the world’s largest steel company. Effective January 3, 2006, Ispat was merged with and into Mittal Steel USA ISG Inc. and renamed Mittal Steel USA. In June 2006, Mittal further extended its position in the steel industry when it merged with Arcelor, creating a steelmaker with an estimated capacity in excess of 100 million tonnes.

In 2004, we also significantly improved our liquidity initially through our January, 2004 offering of $172.5 million of redeemable cumulative convertible perpetual preferred stock. The proceeds from the issuance were utilized to repay the remaining $25 million balance of our unsecured notes and to fund $76.1 million into our underfunded salaried and hourly pension funds and VEBAs. Additionally, the proceeds from the sale of ISG stock and cash flow from operations provided us with the liquidity for capital expenditures to maintain and expand our production capacity and to complete the acquisition of Portman.

On March 5, 2007, we acquired a 30 percent interest in MMX Amapa Mineracao LTDA., a Brazilian limited liability company developing an iron ore project (Amapa Project), through the acquisition of 100 percent of the shares of Centennial Amapa. The remaining 70 percent of the Amapa Project is owned by MMX Mineracao e Metallicos S.A., which is providing corporate and institutional support, while we will supply technical support for construction and operations. The purchase price for our 30 percent interest was $133 million, paid with cash on hand. Total capital expenditures are estimated to be $357 million, of which approximately $268 million will be funded with project debt. Capital contributions of $89.3 million were paid by Cliffs and MMX to fund the project; Cliffs 30 percent share was $26.8 million. We may be responsible for 30 percent of any additional capital contributions.

 

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The Amapa Project consists of a significant iron ore deposit, a 192-kilometer railway connecting the mine location to an existing port facility and 71 hectares of real estate on the banks of the Amazon River, reserved for a loading terminal. The Amapa Project is currently under construction and is expected to produce 6.5 million tonnes of iron ore concentrate annually once fully operational. Iron ore concentrate is expected to be sold, pursuant to a long-term supply agreement, to an operator of an iron oxide pelletizing plant in the Kingdom of Bahrain. Production is expected to begin in late 2007.

On April 18, 2007, we completed the acquisition at an effective 45 percent interest in the Sonoma Coal Project in Queensland, Australia. As of May 3, 2007, we invested $15.6 million toward the purchase of mining tenements and $19.4 million toward the construction of a washplant. We will operate and own 100 percent of the washplant and 8.3 percent of the mining leases, resulting in a 45 percent economic interest in Sonoma.

The Sonoma Coal Project is expected to initially produce two million tonnes of marketable coal annually, beginning late in 2007. Production from Sonoma will include an approximately equal mix of hard coking coal and thermal coal. Plans call for annual production to increase to between three million and four million tonnes during 2008. The Sonoma Coal Project has a current resource estimate of 107 million tonnes.

We are evaluating opportunities to proceed with development of a commercial-scale reduced iron plant, which will convert taconite into nearly pure iron in nugget form utilizing Kobe Steel’s ITmk3 technology. The high-iron-content product could be utilized to replace steel scrap as a raw material for electric steel furnaces or basic oxygen furnaces of integrated steel producers or as feedstock for the foundry industry.

We intend to continue to pursue investment and operations management opportunities to broaden our scope as a supplier of iron ore or other raw materials to the integrated steel industry through the acquisition of additional mining interests to strengthen our market position. We are particularly focused on expanding our international investments to capitalize on global demand for steel and iron ore.

Our strategic redirection and acceptance of additional risks of increased mine ownership followed by significant increases in iron ore demand and pricing culminated in record operating income in 2004, 2005 and 2006, solid financial condition, and a strong base for future growth. In the last five years, our revenues have increased over 220 percent from $.6 billion in 2002 to $1.9 billion in 2006. Our net income increased to $280 million in 2006 from a loss of $188 million in 2002.

North America

We manage and operate six North American iron ore mines located in Michigan, Minnesota and Eastern Canada that currently have a rated capacity of 37.0 million tons of iron ore pellet production annually, representing approximately 46 percent of total North American pellet production capacity. Based on our percentage ownership of the North American mines we operate, our share of the rated pellet production capacity is currently 22.9 million tons annually, representing approximately 28 percent of total North American annual pellet capacity.

 

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The following chart summarizes the estimated annual production capacity and percentage of total North American pellet production capacity for each of the North American iron ore pellet producers as of December 31, 2006:

North American Iron Ore Pellet

Annual Rated Capacity Tonnage

 

     Current Estimated Capacity
(Gross Tons of Raw Ore
in Millions)
   Percent of Total
North American Capacity
 

All Cliffs’ managed mines

   37.0    45.6 %

Other U.S. mines

     

U.S. Steel’s Minnesota ore operations

     

Minnesota Taconite

   14.6    18.0  

Keewatin Taconite

   5.4    6.6  
           

Total U.S. Steel

   20.0    24.6  

Mittal Steel USA Minorca mine

   2.9    3.6  
           

Total Other U.S. mines

   22.9    28.2  

Other Canadian mines

     

Iron Ore Company of Canada

   12.3    15.2  

Quebec Cartier Mining Co.  

   8.9    11.0  
           

Total Other Canadian mines

   21.2    26.2  
           

Total North American mines

   81.1    100.0 %
           

We sell our share of North American iron ore production to integrated steel producers, generally pursuant to term supply agreements with various price adjustment provisions.

For the year ended December 31, 2006, we produced a total of 33.6 million tons of iron ore pellets, including 20.8 million tons for our account and 12.8 million tons on behalf of steel company owners of the mines.

Australia

Portman was founded in 1925 and had undergone a number of management and business changes before establishing itself as a mineral producer in the early 1990’s. Following the sale of its Queensland-based coking coal operations in 1999, Portman focused on its Western Australia iron ore deposits at the Koolyanobbing operations and Cockatoo Island. Portman’s 100 percent owned Koolyanobbing mining operations and its 50 percent equity interest in Cockatoo Island represent Portman’s only significant operations. Portman serves the Asian iron ore markets with direct-shipping fines and lump ore. Portman’s 2006 production (excluding its .7 million tonne share of Cockatoo Island) was approximately seven million tonnes. Portman completed a $62 million project to increase its wholly owned production capacity to eight million tonnes per year in the first half of 2006. Portman’s production is fully committed to steel companies in China and Japan through 2009.

Business Segments

We primarily evaluate performance based on segment operating income, defined as revenues less expenses identifiable to each segment. We have classified certain administrative expenses as unallocated corporate expense. As a result of the Portman acquisition, we organized into two operating and reporting segments: North America and Australia. The North America segment is comprised of our mining operations in the United States and Canada. The Australia segment is comprised of our 80.4 percent Portman interest in Western Australia.

Financial information about our segments is included in Item 7 and NOTE 4 — SEGMENT REPORTING — included in Item 8 of this Annual Report on Form 10-K.

North America Segment

The North America segment is comprised of our six iron ore mining operations in Michigan, Minnesota and Eastern Canada. We produce 13 grades of iron ore pellets, including standard, fluxed and high manganese, for

 

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use in our customers’ blast furnaces as part of the steelmaking process. The variation in grades results from the specific chemical and metallurgical properties of the ores at each mine and whether or not fluxstone is added in the process. Although the grade or grades of pellets currently delivered to each customer are based on that customer’s preferences, which depend in part on the characteristics of the customer’s blast furnace operation, in many cases our iron ore pellets can be used interchangeably. Industry demand for the various grades of iron ore pellets depends on each customer’s preferences and changes from time to time. In the event that a given mine is operating at full capacity, the terms of most of our pellet supply agreements allow some flexibility to provide our customers iron ore pellets from different mines.

Standard pellets require less processing, are generally the least costly pellets to produce and are called “standard” because no ground fluxstone (i.e., limestone, dolomite, etc.) is added to the iron ore concentrate before turning the concentrates into pellets. In the case of fluxed pellets, fluxstone is added to the concentrate, which produces pellets that can perform at higher productivity levels in the customer’s specific blast furnace and will minimize the amount of fluxstone the customer may be required to add to the blast furnace. “High manganese” pellets are the pellets produced at our Canadian Wabush operation where there is more natural manganese in the crude ore than is found at our other operations. The manganese contained in the iron ore mined at Wabush cannot be entirely removed during the concentrating process. Wabush produces pellets with two levels of manganese, both in standard and fluxed grades.

It is not possible to produce pellets with identical physical and chemical properties from each of our mining and processing operations. The grade or grades of pellets purchased by and delivered to each customer are based on that customer’s preferences and availability.

Each of our North American mines is located near the Great Lakes or, in the case of Wabush, near the St. Lawrence Seaway, which is connected to the Great Lakes. The majority of our iron ore pellets are transported via railroads to loading ports for shipment via vessel to Canada, the United States or other international destinations or shipped as concentrates for sinter feed.

North American Iron Ore Customers

More than 98 percent of our North American revenues are derived from sales of iron ore pellets to the North American integrated steel industry, consisting of eight customers. Generally, we have multi-year supply agreements with our customers. Sales volume under these agreements is largely dependent on customer requirements, and in many cases, we are the sole supplier of iron ore pellets to the customer. Each agreement has a base price that is adjusted annually using one or more adjustment factors. Factors that can adjust price include measures of general industrial inflation, steel prices and international pellet prices. One of our supply agreements has a provision that limits the amount of price increase or decrease in any given year.

During 2006, 2005 and 2004, we sold 20.4 million, 22.3 million and 22.6 million tons of iron ore pellets, respectively, from our share of the production from our North American iron ore mines. Sales in 2006 were to eight North American, one European, one Japanese and four Chinese steel producers.

The following five customers together accounted for a total of 91, 93 and 94 percent of North American Revenues from product sales and services for the years 2006, 2005 and 2004, respectively:

 

    

Percent of

Sales

Revenues*

 

Customer

   2006     2005     2004  

Mittal Steel USA

   44 %   43 %   56 %

Algoma

   20     22     14  

Severstal

   13     12     13  

WCI

   9     8     6  

Stelco

   5     8     5  
                  

Total

   91 %   93 %   94 %
                  

* Excluding freight and venture partners’ cost reimbursements.

 

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Our term supply agreements expire between the end of 2010 and the end of 2018. The weighted average remaining duration is eight years.

Our sales are influenced by seasonal factors in the first quarter of the year as shipments and sales are restricted by weather conditions on the Great Lakes. During the first quarter, we continue to produce our products, but we cannot ship those products via lake freighter until the Great Lakes are passable, which causes our first quarter inventory levels to rise. Our limited practice of shipping product to ports on the lower Great Lakes and/or to customers’ facilities prior to the transfer of title has somewhat mitigated the seasonal effect on first quarter inventories and sales. At December 31, 2006, we had approximately .8 million tons of pellets in inventory at lower lakes or customers’ facilities.

In 2006, 73 percent of our North American product revenues (68 percent and 80 percent in 2005 and 2004, respectively) were derived from sales to our U.S. customers.

Mittal Steel USA

On December 17, 2004, Ispat International N.V. completed its acquisition of LNM Holdings N.V. to form Mittal. On April 13, 2005, Mittal completed its acquisition of ISG, subsequently renamed Mittal Steel USA. At the time of the acquisition of ISG, we had three different supply agreements with steel companies that became part of Mittal Steel USA:

 

   

Ispat. Ispat was a wholly owned subsidiary of Ispat International N.V. On December 31, 2002, we entered into a Pellet Sale and Purchase Agreement with Ispat (the “Ispat Contract”), which provides that we are the sole outside supplier of iron ore pellets to Ispat. The Ispat Contract runs through January 2015.

 

   

Mittal ISG. We entered into a Pellet Sale and Purchase Agreement with ISG on April 10, 2002, which runs through 2016 (the “ISG Contract”), under which we are the sole supplier of iron ore pellets for the former ISG’s Cleveland and Indiana Harbor Works. The ISG Contract was subsequently amended in December 2004.

 

   

Mittal Steel-Weirton (formerly Weirton). Prior to the acquisition of ISG by Mittal, ISG had acquired Weirton, which was in chapter 11 bankruptcy at the time. We were one of two suppliers of iron ore pellets to Weirton. At the time of ISG’s acquisition of Weirton, we entered into an Amended and Restated Pellet Sale and Purchase Agreement dated May 17, 2004, with both ISG and Weirton (the “Weirton Contract”). The Weirton Contract runs through 2018.

In December 2005, Mittal merged Ispat into Mittal Steel USA and Mittal Steel USA assumed Ispat’s obligations under the Ispat Contract. Mittal Steel USA is a 62.3 percent equity participant in Hibbing and a 21 percent equity partner in Empire.

Our North American pellet sales totaled 20.4 million, 22.3 million and 22.6 million tons in 2006, 2005 and 2004, respectively, with pellet sales to Mittal Steel USA representing approximately 45, 48 and 51 percent of North American sales volume for the respective periods.

In 2005, Mittal Steel USA shut down Mittal Steel-Weirton’s blast furnace. The Weirton Contract had a minimum annual purchase obligation and required Mittal Steel-Weirton to purchase “for the years 2004 and 2005 the greater of 67 percent of Mittal Steel-Weirton’s total annual iron ore pellet requirements, or 1.5 million tons and, for the years 2006 through and including 2018, a tonnage amount equal to Mittal Steel-Weirton’s total annual iron ore pellet tonnage requirements, with a minimum annual purchase obligation of two million tons per year, required for consumption in Mittal Steel-Weirton’s iron and steelmaking facilities in any year at Mittal Steel-Weirton”. During 2005, Mittal Steel USA advised us that the Mittal Steel-Weirton blast furnace has been permanently shut down and will not be restarted.

On March 19, 2007, we executed an umbrella agreement with Mittal Steel USA that covers significant price and volume matters under three separate pre-existing iron ore pellet supply agreements with Cliffs for Mittal Steel USA’s Cleveland and Indiana Harbor West, Indiana Harbor East and Weirton facilities. This umbrella agreement formalizes a previously disclosed letter agreement dated April 12, 2006.

 

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Under terms of the umbrella agreement, the Pellet Sale and Purchase Agreement dated as of April 10, 2002 for ISG Indiana Harbor, as previously amended, the Pellet Sale and Purchase Agreement, dated as of December 31, 2006 for Ispat Inland, and the Amended and Restated Pellet Sale and Purchase Agreement dated as of May 17, 2004 for ISG Weirton are modified to aggregate Mittal Steel USA’s purchases during the years 2006 through and including 2010 under the umbrella agreement. The pricing provisions are determined in accordance with the supply agreements for each of the covered facilities in the three agreements listed above.

During 2006 through 2010, Mittal Steel USA is obligated to purchase specified minimum tonnages of iron ore pellets on an aggregate basis. Mittal Steel USA is permitted under the umbrella agreement to transfer any of the committed volume for use at any iron and steel facility(s) owned directly or indirectly by Mittal Steel Company N.V., which enhances flexibility. The umbrella agreement also sets the minimum annual tonnage at Mittal Steel USA’s approximately budgeted usage levels through 2010, with pricing then in effect at the facility where the pellets are delivered. Beginning in 2007, the terms of the umbrella agreement allow Mittal Steel USA to manage its ore inventory levels through buydown provisions, which permit Mittal Steel USA to reduce its tonnage purchase obligation each year at a specified price per ton, and through deferral provisions, which permit Mittal Steel USA to defer a portion of its annual tonnage purchase obligation beginning in 2007. Mittal Steel USA has opted to defer the purchase of 550,000 tons from 2007 to 2008. The umbrella agreement also provides for consistent nomination procedures through 2010 across all three iron ore pellet supply agreements.

As a condition of approving Mittal’s merger with Arcelor, the U.S. Department of Justice mandated that Arcelor-Mittal sell one of its three North American steel plants in order to satisfy requirements involving antitrust concerns. On February 20, 2007, the Department of Justice announced that it would require Mittal Steel USA to divest its Sparrows Point facility, located in Baltimore, Maryland. We have not historically supplied iron ore to the Sparrows Point facility.

Algoma

Algoma is Canada’s third-largest steelmaker. We have a 15-year term supply agreement under which we are Algoma’s sole supplier of iron ore pellets through 2016 (the “Algoma Agreement”). Pricing under the Algoma Agreement is based on a formula linked to international pellet prices (the “Pricing Formula”). The Algoma Agreement also provides that in certain years either party may request a price negotiation (“Reopener Years”) if prices under the Algoma Agreement differ from a specified benchmark price. The Reopener Years are 2008, 2011, and 2014. We anticipate that Algoma will take the position that any change resulting from a requested price renegotiation would be retroactive to the beginning of the years preceding the Reopener Years, i.e., 2007, 2010, and 2013. Our position is that any price change would be retroactive to the beginning of the Reopener Years. If we are unable to reach agreement with Algoma on this issue, any dispute is likely to be resolved through binding arbitration which would occur in 2008. The amount of the variance, if any, between the Pricing Formula and the benchmark price for a particular Reopener Year depends on future events and is therefore currently not determinable. If Algoma were to prevail on the retroactivity issue, our 2007 revenues from sales to Algoma may be adversely affected. On April 15, 2007, Essar Global Limited, through its wholly owned subsidiary Essar Steel Holdings Limited, signed a definitive arrangement agreement to acquire Algoma for C$1.85 billion. We do not expect the merger to affect our term supply agreement with Algoma. We sold 3.5 million, 3.8 million and 3.3 million tons to Algoma in 2006, 2005 and 2004, respectively.

Severstal

On October 23, 2003, Rouge, a significant pellet sales customer of ours, filed for chapter 11 bankruptcy protection. On January 30, 2004, Rouge sold substantially all of its assets to Severstal. Severstal, as part of the acquisition of assets of Rouge, assumed our term supply agreement with Rouge with minimal modifications. On January 1, 2006, we entered into an amended and restated agreement whereby we will be the sole supplier of iron ore pellets through 2012, with certain minimum purchase requirements for certain years. We sold 3.7 million, 3.6 million and 3.3 million tons to Severstal in 2006, 2005 and 2004, respectively.

WCI

On September 16, 2003, WCI petitioned for protection under chapter 11 of the U.S. Bankruptcy Code. At the time of the filing, we had a trade receivable exposure of $4.9 million, which was fully reserved in the third quarter of 2003. On October 14, 2004, we and WCI reached agreement (the “2004 Pellet Agreement”) for us to

 

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supply 1.4 million tons of iron ore pellets in 2005 and, in 2006 and thereafter, to supply 100 percent of WCI’s annual requirements up to a maximum of two million tons of iron ore pellets. The 2004 Pellet Agreement is for a ten-year term, which commenced on January 1, 2005 and provided for full recovery of our $4.9 million receivable plus $.9 million of subsequent pricing adjustments. The 2004 Pellet Agreement was approved by the bankruptcy court on November 16, 2004. The receivable and subsequent pricing adjustments were to be paid in three equal annual installments of approximately $1.9 million. The first payment, due on November 16, 2005, was received and classified as Customer bankruptcy recoveries (exposures) on the Statements of Consolidated Operations.

On May 1, 2006, an entity controlled by the secured noteholders of WCI acquired the steelmaking assets and business of WCI (“New WCI”). New WCI assumed the 2004 Pellet Agreement, including the obligation to cure the remaining two unpaid installments on the bankruptcy recovery. During the third quarter of 2006, WCI paid the remaining $3.9 million balance in full, resulting in complete recovery of our reserve. We sold 1.6 million, 1.4 million and 1.7 million tons to WCI in 2006, 2005 and 2004, respectively.

Stelco

On January 29, 2004, Stelco, a Canadian corporation, applied and obtained Bankruptcy Court protection from creditors in Ontario Superior Court under the CCAA. Stelco is a 44.6 percent participant in Wabush, and U.S. subsidiaries of Stelco (which had not filed for bankruptcy protection) own 14.7 percent of Hibbing and 15 percent of Tilden. At the time of the filing, we had no trade receivable exposure to Stelco.

Throughout the fall of 2005, Stelco worked to come to agreement with key stakeholders on a reorganization plan. On December 9, 2005, the Third Amended and Restated Plan of Compromise and Arrangement (the “Plan”) was agreed. On December 10, 2005, the creditors affected by the Plan approved the Plan by substantially more than the statutorily-mandated minimum approval levels. On January 20, 2006, on motion by Stelco, the Superior Court of Ontario sanctioned the Plan as being fair and reasonable in all the circumstances. On February 14, 2006, the Superior Court of Ontario issued an order approving the proposed reorganization.

On March 31, 2006, Stelco emerged from protection from its creditors under the CCAA, which had been mandated by the Ontario Superior Court of Justice on January 29, 2004. Pursuant to Stelco’s plan of reorganization, C$350 million of new financing was invested in Stelco. The investor required, as a condition of such financing, that Stelco be reorganized into limited — partnership operating subsidiaries, one of which was a “mining” subsidiary, HLE. By way of a consent made as of March 31, 2006, our subsidiaries including Cliffs Mining Company and Wabush Iron Co. Limited, among others, consented to the transfer of Stelco’s interest in the Wabush Mines Joint Venture, and its subsidiaries’ shareholdings in the Hibbing and Tilden operations, to HLE. The Consent Order was conditional upon the completion of a number of items on or before June 30, 2006:

 

  a. the execution and delivery of a Reorganization Agreement and related documentation with respect to the joint venture operations; and

 

  b. Stelco’s execution and delivery of HLE’s obligations with respect to the joint ventures, and guarantees of HLE’s obligations by Stelco under its guarantee from each of the other limited partnerships into which Stelco’s other business interests were organized pursuant to the restructuring.

Stelco has been unable to complete the necessary documentation. If, however, the conditions are not satisfied, the Consent dictates that the consent provided therein is to be deemed not to have been given.

In December 2006, we executed a binding pellet supply term sheet with respect to a seven-year supply agreement with Stelco to provide Stelco’s Lake Erie Steel and Hamilton Steel facilities excess pellet requirements above the amount supplied from Stelco’s ownership interest at Hibbing, Tilden and Wabush. A definitive pellet sales and purchase agreement is being finalized. Pellet sales to Stelco totaled .9 million, 1.4 million and 1.2 million tons in 2006, 2005 and 2004, respectively.

AK Steel

We entered into a seven-year supply agreement with AK Steel in November 2006. The agreement, which begins January 1, 2007, runs through 2013. Under the terms of the agreement, we will supply between .9 million

 

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and 1.4 million tons of pellets annually. The agreement supplants prior spot-sales agreements with AK Steel, which totaled .4 million tons of pellet sales in 2006.

Republic Engineered Products, Inc.

We entered into a five-year supply agreement with Republic Engineered Products, Inc. (“Republic”) in November 2006. The agreement, which began October 1, 2006, runs through December 31, 2011. Under the contract terms, we will supply a portion of Republic’s total annual pellet requirements. The tonnage is estimated to be between .4 million tons and .8 million tons annually. The agreement supplanted previous spot-sales arrangements. For 2006, sales to Republic totaled .4 million tons, including both spot sales and sales made under the new agreement.

Australia Segment

The Portman operations include the Koolyanobbing operations and a 50 percent equity interest in a joint venture at Cockatoo Island. These two operations supply a total of five direct shipping export products to Asia via the global seaborne trade market. Koolyanobbing produces a standard lump and fines product as well as low grade lump and fines products. Cockatoo Island produces and exports a single premium fines product. Portman lump products are directly charged to the blast furnace, while the fines products are used as sinter feed. The variation in Portman’s five export product grades reflects the inherent chemical and physical characteristics of the ore bodies mined as well as the supply requirements of the customers.

The Koolyanobbing operation is a collective term for the operating deposits at Koolyanobbing, Mt Jackson and Windarling. The Koolyanobbing Project is located 425 kilometers east of Perth and approximately 50 kilometers northeast of the town of Southern Cross. There are approximately 100 kilometers separating the three mining areas. Banded iron formation hosts the mineralization which is predominately hematite and goethite. Each deposit is characterized with different chemical and physical attributes and in order to achieve customer product quality; ore in varying quantities from each deposit must be blended together.

Blending is undertaken at Koolyanobbing, where the crushing and screening plant is located. Standard and low grade products are produced in separate campaigns. Once the blended ore has been crushed and screened into a direct shipping product, it is transported by rail approximately 575 kilometers south to the Port of Esperance for shipment to Asian customers.

Cockatoo Island is located off the Kimberley coast of Western Australia, approximately 1,900 kilometers north of Perth and is only accessible by sea and air. Cockatoo Island produces a single high iron product known as Cockatoo Island Premium Fines. The deposit is almost pure hematite and contains very few contaminants enabling the shipping grade to be above 68 percent iron. Ore is mined below the sea level on the southern edge of the island. This is facilitated by a sea wall which enables mining to a depth of 40 meters below sea level. Ore is crushed and screened to the final product sizing. Vessels berth at the island and the fines product is loaded directly to the ship. Cockatoo Island Premium Fines are highly sought in the global marketplace due to its extremely high iron grade and low gangue levels. The Cockatoo Island operation is scheduled to close in late 2007.

Australia Iron Ore Customers

A limited spot market exists for seaborne iron ore as most production is sold under long-term contracts with annual benchmark prices driven from negotiations between the major suppliers and Chinese, Japanese and other Asian steel mills. The three major iron ore producers, CVRD, Rio Tinto and BHP, dominate the seaborne iron ore trade and together account for approximately three-fourths of the global supply to the seaborne market.

Portman has long-term supply agreements with steel producers in China and Japan that account for approximately 80 percent and 20 percent, respectively, of sales. Sales volume under the agreements is partially dependent on customer requirements. Each agreement is priced based on benchmark pricing established for Australian producers.

During 2006 and 2005, we sold 7.4 million and 4.9 million tonnes of iron ore, respectively, from our Western Australia mines. (Sales for 2005 represent amounts since the March 31, 2005 acquisition). Sales in 2006

 

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were to 15 Chinese and three Japanese customers. No customer comprised more than 15 percent of Portman sales or 10 percent of our consolidated sales in 2006 or 2005. Portman’s five largest customers accounted for approximately 46 percent of Portman’s sales in 2006 (50 percent in 2005).

The iron ore and steel industries

Almost all iron ore is used in steelmaking and therefore is dependent on the steel industry. The steel industry has historically been cyclical and has recently been characterized by a period of rising production. Global crude steel production broke the 100 million tonne per month level for the first time in March 2006. Production in 2006 for the 62 countries reporting to the International Iron and Steel Institute increased approximately nine percent over 2005. The growing level of international production is largely due to the rapid industrial growth in China.

China produced approximately 418 million tonnes of crude steel in 2006, up 18 percent over 2005, accounting for approximately 34 percent of global production. Production in China has increased from approximately 12 million tonnes per month in 2001 to average nearly 35 million tonnes per month in 2006. During the first half of 2006, steel production resulted in China becoming the world’s largest steel exporting country. China’s exports of steel have grown rapidly, approximating 12 percent of Chinese production in 2006.

The rapid growth in steel production in China has only been partially met by a corresponding increase in domestic Chinese iron ore production. Chinese iron ore deposits, although substantial, are of a lower grade (less than half of the equivalent iron ore content) than the current iron ore supplied from Brazil and Australia. China has moved from a position where demand was largely satisfied by domestic supply in the early 1990’s to becoming a net importer of iron ore. Although domestic iron ore supply is expanding, it approximates only 45 percent of China’s total iron ore requirements. Chinese iron ore imports, accounting for 55 percent of its requirements, reached 326 million tonnes in 2006, increasing approximately 19 percent from 2005.

The world price of iron ore is influenced by international demand. The rapid growth in Chinese demand, particularly in more recent years, has created a market imbalance and has led to demand outstripping supply. This market imbalance has recently led to high spot prices for iron ore and increases of 19 percent and 71.5 percent in 2006 and 2005, respectively, in benchmark prices for Brazilian and Australian suppliers of iron ore. In December 2006, CVRD agreed with Baosteel, negotiating on behalf of the Chinese steelmaking industry, to a 9.5 percent increase in the annual iron ore fines price for 2007. CVRD also established a 5.28 percent increase in the price of blast furnace pellets for 2007 with their European customers. The increased demand for iron ore has resulted in the major iron ore suppliers expending efforts to increase their capacity.

Our strategic objectives are to:

Seek Additional Investment Opportunities

Much of the current increase in global demand for steel is due to industrialization in countries such as China. China is seeking foreign supplies of the raw materials it needs to produce steel to build infrastructure, factories, hotels and other buildings and to manufacture motor vehicles and appliances. China’s increased demand for materials, including iron ore and coal, has been a factor in increasing raw material prices around the globe. Currently, China is the world’s largest steel producer, with approximately one-third of global steel production, and China’s steel production is expected to continue to grow. Chinese iron ore imports rose approximately 19 percent in 2006 and are expected to further increase in 2007. China is the largest consumer of iron ore, steel and copper. We are attempting to capitalize on China’s industrial growth by acquiring well-located iron ore and/or metallurgical coal properties and obtaining agreements to supply iron ore and coal to international steel producers.

Expand Our Leadership Position as a Supplier to the North American Steel Industry

Primarily in 2002, we substantially restructured the ownership interests in our mines largely by converting mine partners into customers with term supply agreements. Under our operating strategy, royalty and management fee income has largely been replaced by profit margin on pellet sales. It is our goal to continue to expand our leadership position in the industry by focusing on high product quality, technical excellence, superior relationships with our customers and partners and improved operational efficiency through year-over-year cost

 

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savings. By developing creative solutions for our customers during the industry restructuring, we have been able to generate term supply agreements with many of these companies, which have benefited our market position. Our creative solutions included acquisition of our partners’ interests in the mines largely for the assumption of certain mine liabilities, thereby allowing partners to focus on their core steelmaking business and become our customers by entering into long term supply agreements with us.

Achieve Demonstrated Savings Through Productivity Improvements, Enterprise-Wide Cost Reductions and Strategic Sourcing

Rising costs are a threat to profits and limit our strategic flexibility. Our North American mining costs have increased 31 percent between 2004 and 2006. In particular, we have seen large increases in energy, supplies, capital and employment costs. This recent trend has affected the global mining industry as well. To mitigate the effect of these cost increases, we have implemented an aggressive business improvement and mine optimization program focusing on cost reduction, asset productivity, energy usage, alternative fuels and strategic sourcing. In building the foundation for success going forward, we are utilizing improvement processes designed around Six Sigma and Rapid Results, investments in assets and people, and through the building of bench strength and talent management.

Strive to Continuously Improve Iron Ore Pellet Quality and Develop Alternative Metallic Products

With the overall goal of achieving cost savings and quality improvements through pioneering process development at the mines that we manage, we operate a fully-equipped research and development facility.

As part of our efforts to develop alternative metallic products, we are evaluating opportunities to develop, with Kobe Steel, a commercial-scale reduced iron plant, which will convert taconite into nearly pure iron in nugget form utilizing Kobe Steel’s ITmk3 technology. This innovative technology has the potential to open new markets by offering an economically competitive supply of iron material for electric arc furnaces, which use scrap steel, pig iron and/or HBI/DRI, not iron ore pellets, in their electric arc furnaces.

Information regarding Operations, Competition, Environment, Energy, Research and Development and Employees is presented under the captions “Operations”, “Competition”, “Environment”, “Energy”, “Research and Development”, and “Employees”, respectively, all of which are included in Item 2 and are incorporated by reference and made a part hereof.

Available Information

Our headquarters are located at 1100 Superior Avenue, Cleveland, Ohio 44114-2544, and our telephone number is (216) 694-5700. We are subject to the reporting requirements of the Exchange Act and its rules and regulations. The Exchange Act requires us to file reports, proxy statements and other information with the SEC. Copies of these reports and other information can be read and copied at:

 

  

SEC Public Reference Room

100 F Street N.E.

Washington, D.C. 20549

  

Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

The SEC maintains a website that contains reports, proxy statements and other information regarding issuers that file electronically with the SEC. These materials may be obtained electronically by accessing the SEC’s home page at http://www.sec.gov.

We make available, free of charge on our website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file these documents with, or furnish them to, the SEC. These documents are posted on our website at www.cleveland-cliffs.com — under “Investor Relations”.

 

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We also make available, free of charge on our website, the charters of the Audit Committee, Board Affairs Committee, Compensation and Organization Committee, Finance Committee and Strategic Advisory Committee, as well as the Corporate Governance Guidelines and the Code of Business Conduct & Ethics adopted by our Board of Directors. These documents are posted on our website at www.cleveland-cliffs.com — under “Investor Relations”, select the “Corporate Governance” link.

References to our website do not constitute incorporation by reference of the information contained on our website and such information is not part of this Form 10-K.

Copies of the above referenced information will also be made available, free of charge, by calling (216) 694-5700 or upon written request to:

 

  

Cleveland-Cliffs Inc

Investor Relations

1100 Superior Avenue

Cleveland, OH 44114-2544

  

Item 1A.    Risk Factors

If the rate of steel consumption in China slows, the demand for iron ore and coal could decrease.

The world price of iron ore and coal are strongly influenced by international demand. The current growing level of international demand for raw materials for steel production is largely due to the rapid industrial growth in China. If the economic growth rate in China slows, which may be difficult to forecast, less steel may be used in construction and manufacturing, which could decrease demand for iron ore and coal. This could adversely impact the world iron ore and coal markets, impact the North American and Asian markets, and adversely impact our North American and Australian operations. A slowing of the economic growth rate in China could also result in greater exports of steel out of China, which if imported into North America could decrease demand for domestically produced steel, thereby decreasing the demand for iron ore supplied in North America. China became a modest net exporter of steel products in 2005 and during 2006 became the world’s largest exporter of steel.

Excess global capacity and the availability of competitive substitute materials may result in intense competition in the steel industry, which may reduce steel prices and decrease steel production and our customers’ demand for iron ore products. Increased imports of steel into the United States could also adversely impact North American steel sales.

Global overcapacity in steel manufacturing may have a negative impact on North American steel sales and reduce the production of steel and consequently the demand for North American iron ore. A weakening of certain foreign economies, particularly in Eastern Europe, Asia and Latin America, may negatively impact steel prices in those foreign economies and result in increased levels of steel imports from those countries into the United States at depressed prices. China’s domestic crude steel production is expected to climb 23 percent in 2007 from an estimated 418 million tonnes in 2006. Based on the American Iron and Steel Institute’s Apparent Steel Supply (excluding semi-finished steel products), imports of steel into the United States constituted 27.2 percent, 21.3 percent and 22.3 percent of the domestic steel market supply for 2006, 2005 and 2004, respectively. Significant imports of steel into the United States could substantially reduce sales, margins and profitability of North American steel producers, and consequently, reduce demand for North American iron ore. Further, production of steel by North American integrated steel manufacturers may be replaced, to some extent, by production of substitute materials by other manufacturers. In the case of some product applications, North American steel manufacturers compete with manufacturers of other materials, including plastic, aluminum, graphite composites, ceramics, glass, wood and concrete. Most of our term supply agreements for the sale of iron ore products are requirements-based or provide for flexibility of volume above a minimum level. Reduced demand for and consumption of iron ore products by integrated steel producers have had and may continue to have a significant negative impact on our sales, margins and profitability.

 

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The North American and global steel industries continue to undergo a restructuring process that has resulted in industry consolidation that could result in a reduction of integrated steelmaking capacity over time, and thereby reduce iron ore consumption.

The North American steel industry has undergone consolidation, and that consolidation is likely to continue as evidenced by the recently announced acquisition of Algoma Steel by Essar Global. Consolidation is also occurring globally, as evidenced by Mittal Steel’s merger with Arcelor and Tata Steel Limited’s acquisition of Corus Group plc. Consolidation in the North American and global steel industries will result in fewer customers for iron ore and coal. The restructuring process may reduce integrated steelmaking capacity, which would reduce demand for our iron ore and coal products and may adversely affect our sales.

Our sales and earnings are subject to significant fluctuations as a result of the cyclical nature of the North American steel industry.

In 2006, 2005 and 2004, 20.2 million, 21.9 million and 22.2 million tons, respectively, of our North American iron ore pellet sales were sold to North American steel manufacturers, while only ..2 million, .4 million and .4 million tons of our pellets were sold outside of North America in each year. The North American steel industry has historically been cyclical in nature, influenced by a combination of factors, including periods of economic growth or recession, strength or weakness of the U.S. dollar, worldwide demand and production capacity, the strength of the U.S. automotive industry, levels of steel imports and applicable tariffs. The demand for steel products is generally affected by macroeconomic fluctuations in North America and the global economies in which steel companies sell their products. For example, future economic downturns, stagnant economies or currency fluctuations could decrease the demand for steel products globally or increase the amount of imports of steel or iron ore into the United States.

In addition, a disruption or downturn in the oil and gas, gas transmission, construction, commercial equipment, rail transportation, appliance, agricultural, automotive or durable goods industries, all of which are significant markets for steel products and are somewhat cyclical, could negatively impact sales of steel by North American producers. These trends could decrease the demand for North American iron ore products and significantly adversely affect our North American sales, margins and profitability.

If steelmakers use methods other than blast furnace production to produce steel, or if their blast furnaces shut down or otherwise reduce production, the demand for our iron ore products may decrease.

Demand for our iron ore products is determined by the operating rates for the blast furnaces of steel companies. However, not all finished steel is produced by blast furnaces; finished steel also may be produced by other methods that do not require iron ore products. For example, steel “mini-mills,” which are steel recyclers, generally produce steel primarily by using scrap steel and other iron products, not iron ore pellets, in their electric furnaces. Production of steel by steel mini-mills was approximately 57 percent of North American total finished steel production in 2006. Steel producers also can produce steel using imported iron ore or semi-finished steel products, which eliminates the need for domestic iron ore. Environmental restrictions on the use of blast furnaces also may reduce our customers’ use of their blast furnaces. Maintenance of blast furnaces can require substantial capital expenditures. Our customers may choose not to maintain their blast furnaces, and some of our customers may not have the resources necessary to adequately maintain their blast furnaces. If our customers use methods to produce steel that do not use iron ore products, demand for our iron ore products will decrease, which could adversely affect our sales, margins and profitability.

Natural disasters, equipment failures and other unexpected events may lead our steel industry customers to curtail production or shut down their operations.

Operating levels at our steel industry customers are subject to conditions beyond their control, including raw material shortages, weather conditions, natural disasters, interruptions in electrical power or other energy services, equipment failures, and other unexpected events. Any of those events could also affect other suppliers to the steel industry. In either case, those events could cause our steel industry customers to curtail production or shut down a portion or all of their operations, which could reduce their demand for our iron ore products. For

 

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example, in 2005, Mittal Steel USA permanently shut down its Weirton blast furnaces. Mittal Steel USA also shut down the Indiana Harbor facility for 30 days in 2006 due to a molten iron spill and resultant fire. In September 2005, Steel Dynamics suspended orders for some steel products that require the use of hydrogen gas due to the effects of hurricane Katrina on its hydrogen gas supplier. Decreased demand for our iron ore products could adversely affect our sales, margins and profitability.

We operate in very competitive industries.

The iron mining and coal businesses are highly competitive, with producers in all regions where we operate. Some of our competitors may have greater financial resources than we have and may be better able to withstand changes in conditions within the steel industry than we are. In the future, we may face increasing competition. As a result, we may face pressures on sales prices and volumes of our products from competitors and large customers.

Capacity expansions could lead to lower global iron ore prices.

The increased demand for iron ore, particularly from China, has resulted in the major iron ore suppliers increasing their capacity. In 2007, CVRD’s board of directors approved a capital expenditure budget of $6.3 billion, the largest capital budget for organic growth in its history and $1.8 billion higher than the previous year’s total. In March 2007, BHP approved a second expansion project in Western Australia; and along with a current expansion project in Brazil, are increasing their iron ore capacity by a combined 54 million tonnes. An increase in our competitors’ capacity could result in excess supply of iron ore, resulting in downward pressure on iron ore prices. A decrease in pricing would adversely impact our sales, margins and profitability.

Our sales and competitive position depend on the ability to transport our products to our customers at competitive rates and in a timely manner.

Disruption of the lake freighter and rail transportation services because of weather-related problems, including ice and winter weather conditions on the Great Lakes, strikes, lock-outs or other events, could impair our ability to supply iron ore pellets to our customers at competitive rates or in a timely manner and, thus, could adversely affect our sales and profitability. Further, reduced levels of government funding may result in a lesser level of dredging, particularly at Great Lakes ports. Less dredging results in lower water levels, which restricts the tonnage freighters can haul over the Great Lakes, resulting in higher freight rates.

Portman is in direct competition with the major world seaborne exporters of iron ore and its customers face higher transportation costs than most other Australian producers to ship its products to the Asian markets because of the location of its major shipping port on the south coast of Australia. Further, increases in transportation costs, or changes in such costs relative to transportation costs incurred by our competitors, could make our products less competitive, restrict our access to certain markets and have an adverse effect on our sales, margins and profitability.

A substantial majority of our sales are made under term supply agreements, which are important to the stability and profitability of our operations.

In 2006, more than 98 percent of our North American sales volume was sold under term supply agreements. All of our Australian sales are made under existing contracts that have approximately three years remaining. If a substantial portion of our term supply agreements were modified or terminated, we could be materially adversely affected to the extent that we are unable to renew the agreements or find alternate buyers for our iron ore at the same level of profitability. We cannot be certain that we will be able to renew or replace existing term supply agreements at the same prices or with similar profit margins when they expire. A loss of sales to our existing customers could have a substantial negative impact on our sales, margins and profitability.

In North America, we depend on a limited number of customers.

Five customers together accounted for more than 90 percent of our North American sales revenues measured as a percent of product revenues for each of the past three years. If one or more of these customers

 

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were to significantly reduce their purchases of iron ore products from us, or if we were unable to sell iron ore products to them on terms as favorable to us as the terms under our current term supply agreements, our North American sales, margins and profitability could suffer materially due to the high level of fixed costs and the high costs to idle or close mines. The majority of the iron ore we manage and produce is for our own account, and therefore we rely on sales to our joint venture partners and other third-party customers for most of our revenues.

Changes in demand for our products by our customers could cause our sales, margins and profitability to fluctuate.

Our North American term supply agreements include both agreements which are requirements contracts and agreements with minimum purchase provisions, some of which provide for flexibility of volume above minimum levels. Portman sales contracts are for fixed annual tonnages with customer options to increase or decrease annual purchases. A decrease in one or more of our customers’ requirements could cause our sales to decline, as we may not be able to find other customers to purchase our iron ore products. In addition, if our customers’ requirements decline, since many of our production costs are fixed, our production costs per ton may rise, which may affect our margins and profitability. Unmitigated loss of sales would have a greater percentage impact on margins and profitability than on revenues, due to the high level of fixed costs in the iron ore mining business and the high cost to idle or close mines.

The provisions of our term supply agreements could cause our sales, margins and profitability to fluctuate.

Our term supply agreements typically contain force majeure provisions allowing temporary suspension of performance by the customer during specified events beyond the customer’s control, including raw material shortages, power failures, equipment failures, adverse weather conditions and other events. For example, one of our large customers notified us in January 2004 that it was reducing its requirements for iron ore pellets in the first quarter of 2004 by 180,000 long tons pursuant to the force majeure provisions of its term supply agreement with us. That customer invoked the force majeure provision due to a failure of its coke supplier to ship the quantity of coke that the customer had ordered due to shortages caused by a fire at a mine that supplied coal to the supplier.

Price escalators in our term supply agreements also expose us to short-term price volatility, which can adversely affect our margins and profitability. Our term supply agreements also contain provisions requiring us to deliver iron ore pellets meeting quality thresholds for certain characteristics, such as chemical makeup. Failure to meet these specifications could result in economic penalties. All of these contractual provisions could adversely affect our sales, margins and profitability.

We may have contractual disputes with our customers or significant suppliers of energy, materials, or services.

Most of our North American and Australian sales are under multi-year term supply agreements. Sales volume under these agreements is largely dependent on customer requirements, and in many cases, we are the sole supplier of iron ore pellets to the customer. Each agreement has a base price that is adjusted annually using one or more adjustment factors. Factors that could result in price adjustment include measures of general industrial inflation, steel prices and international pellet prices. One of our supply agreements has a provision that limits the amount of price increase or decrease in any given year. Australian benchmark prices are driven from negotiations between the three major iron producers, CVRD, Rio Tinto and BHP, and the Chinese and Japanese steel mills. Contractual disputes with any of our significant customers could result in lower sales volume or lower sales prices.

Additionally, we have significant contracts with suppliers of energy, materials and services in North America and Australia. Contractual disputes with significant suppliers could result in production curtailments or significant cost increases which could adversely impact our profitability.

Mine closures entail substantial costs, and if we close one or more of our mines sooner than anticipated, our results of operations and financial condition may be significantly and adversely affected.

If we close any of our mines, our revenues would be reduced unless we were able to increase production at our other mines, which may not be possible. The closure of an open-pit mine involves significant fixed closure

 

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costs, including accelerated employment legacy costs, severance-related obligations, reclamation and other environmental costs, and the costs of terminating long-term obligations, including energy contracts and equipment leases. We base our assumptions regarding the life of our mines on detailed studies we perform from time to time, but those studies and assumptions do not always prove to be accurate. We recognize the costs of reclaiming open pits, stockpiles, tailings ponds, roads and other mining support areas based on the estimated mining life of our property. If we were to significantly reduce the estimated life of any of our mines, the mine-closure costs would be applied to a shorter period of production, which would increase production costs per ton produced and could significantly and adversely affect our results of operations and financial condition. For example, we significantly decreased our ore reserve estimates for the Empire mine from 116 million tons at December 31, 2001 to 63 million tons at December 31, 2002 and further to 29 million tons at December 31, 2003. As of December 31, 2006, Empire’s estimated ore reserves decreased to approximately 13 million tons, primarily as a result of production in 2004, 2005 and 2006.

A North American mine permanent closure could significantly increase and/or accelerate employment legacy costs, including our expense and funding costs for pension and other postretirement benefit obligations. A number of employees would be eligible for immediate retirement under special eligibility rules that apply upon a mine closure. At the Tilden and Empire mines, there are Range Wide seniority rights for permanent closures that would significantly mitigate if not entirely eliminate the number of employees that would become eligible for special early retirements if only one of the mines closed. Second, all employees eligible for immediate retirement under the pension plans at the time of the permanent mine closure also would be eligible for postretirement health and life insurance benefits, thereby accelerating our obligation to provide these benefits. Third, a closure of Hibbing, Tilden or Empire would precipitate a pension closure liability significantly greater than an ongoing operation liability. Fourth, closure of United Taconite could create a withdrawal liability since it is a member of a multiemployer pension plan, but is not the plan sponsor. Finally, a permanent mine closure could trigger severance-related obligations, which can equal up to eight weeks of pay per employee, depending on length of service. No employee entitled to an immediate pension upon closure of a mine is entitled to severance. As a result, the closure of one or more of our mines could adversely affect our financial condition and results of operations.

The Cockatoo Island operation in Australia is scheduled to close in late 2007 and plans are in process to obtain all required governmental approvals. Since all of the employees are contractors, the cost of mine closure is significantly lower in Australia than in North America. Performance bonds are in place covering the estimated closure costs.

Applicable statutes and regulations require that mining properties be reclaimed following a mine closure in accordance with specified standards and approved reclamation plans. The plans address matters such as removal of facilities and equipment, regrading, prevention of erosion and other forms of water pollution, revegetation and post-mining land use. We may be required to post a surety bond or other form of financial assurance equal to the cost of reclamation as set forth in the approved reclamation plan. The establishment of the final mine closure reclamation liability is based upon permit requirements and requires various estimates and assumptions, principally associated with reclamation costs and production levels. Although our management believes, based on currently available information, we are making adequate provisions for all expected reclamation and other costs associated with mine closures for which we will be responsible, our business, results of operations and financial condition would be adversely affected if such accruals were later determined to be insufficient.

We rely on estimates of our recoverable reserves.

We regularly evaluate our iron ore reserves based on revenues and costs and update them as required in accordance with SEC Industry Guide 7. Portman has published reserves which follow JORC in Australia, which is similar to United States requirements. Changes to the reserve value to make them comply with SEC requirements have been made. There are numerous uncertainties inherent in estimating quantities of reserves of our mines, many of which have been in operation for several decades, including many factors beyond our control. Estimates of reserves and future net cash flows necessarily depend upon a number of variable factors and assumptions, such as production capacity, effects of regulations by governmental agencies and future prices for iron ore, future industry conditions and operating costs, severance and excise taxes, development costs and costs

 

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of extraction and reclamation, all of which may in fact vary considerably from actual results. For these reasons, estimates of the economically recoverable quantities of mineralized deposits attributable to any particular group of properties, classifications of such reserves based on risk of recovery and estimates of future net cash flows prepared by different engineers or by the same engineers at different times may vary substantially as the criteria change. Estimated ore reserves could be affected by future industry conditions, geological conditions and ongoing mine planning. Actual production, revenues and expenditures with respect to our reserves will likely vary from estimates, and if such variances are material, our sales and profitability could be adversely affected.

The price adjustment provisions of our North American term supply agreements may prevent us from increasing our prices to match international ore contract prices or to pass increased costs of production on to our customers.

Our North American term supply agreements contain a number of price adjustment provisions, or price escalators, including adjustments based on general industrial inflation rates, the price of steel and the international price of iron ore pellets, among other factors, that allow us to adjust the prices under those agreements generally on an annual basis. Our price adjustment provisions are weighted and some are subject to annual collars, which limit our ability to raise prices to match international levels and fully capitalize on strong demand for iron ore. Most of our North American term supply agreements do not allow us to increase our prices and to directly pass through higher production costs to our customers. An inability to increase prices or pass along increased costs could adversely affect our margins and profitability.

Our ability to collect payments from our customers depends on their creditworthiness.

Our ability to receive payment for iron ore products sold and delivered to our customers depends on the creditworthiness of our customers. In North America, we ship iron ore products to some of our customers’ yards in advance of payment for those products. Our rationale for shipping iron ore products to customers in advance of payment for, and transfer title for the product is to more closely relate timing of payment to consumption, thereby providing additional liquidity to our customers, and to reduce our financial risk to customer insolvency as title and risk of loss with respect to those products does not pass to the customer until payment for the pellets is received. Accordingly, there is typically a period of time in which pellets, as to which we have reserved title, are within our customers’ control. Several of our customers have previously petitioned for protection under bankruptcy or other similar laws. Failure to receive payment from our customers for products that we have delivered could adversely affect our results of operations.

Our change from a manager of iron ore mines on behalf of steel company owners to primarily a merchant of iron ore to steel company customers has increased our obligations with respect to those mines and has made our revenues, earnings and profit margins more dependent on sales of iron ore products and more susceptible to product demand and pricing fluctuations.

Prior to 2002, we had principally acted as a manager of iron ore mines on behalf of steel company owners, and in that capacity had been generally entitled to management fees, royalties on reserves that we have leased or subleased to the Empire and Tilden mines, and income from our sales of iron ore products to our customers, including the other mine owners. Our current business model increased ownership in our co-owned mines. In accordance with our revised business model, in 2002 we increased our ownership in (1) the Empire mine from 47 percent to 79 percent, (2) the Tilden mine from 40 percent to 85 percent, (3) the Hibbing mine from 15 percent to 23 percent, and (4) the Wabush mine from 23 percent to 27 percent. While we have gained greater control of the mines we operate, we have also increased our share of the operating costs, employment legacy costs and financial obligations associated with those mines. Our increased ownership of those mines has caused the management fees and royalties due to us from our partners in the mines to decline from $29.8 million in 2001 to $11.7 million in 2006. The decline in royalties and management fees has made our revenues, earnings and profit margins more volatile and more dependent on sales of our iron ore products to third-party customers.

We rely on our joint venture partners in our mines to meet their payment obligations.

We co-own five of our six North American mines with various joint venture partners that are integrated steel producers or their subsidiaries, including Dofasco, Mittal Steel USA, Laiwu and Stelco. While we are the

 

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manager of each of the mines we co-own, we rely on our joint venture partners to make their required capital contributions and to pay for their share of the iron ore pellets that we produce. Most of our venture partners are also our customers and are subject to the creditworthiness risks described above. If one or more of our venture partners fail to perform their obligations, the remaining venturers, including ourselves, may be required to assume additional material obligations, including significant pension and postretirement health and life insurance benefit obligations. The premature closure of a mine due to the failure of a joint venture partner to perform its obligations could result in significant fixed mine-closure costs, including severance, employment legacy costs and other employment costs, reclamation and other environmental costs, and the costs of terminating long-term obligations, including energy contracts and equipment leases.

Unanticipated geological conditions and natural disasters could increase the cost of operating our business.

A portion of our production costs are fixed regardless of current operating levels. Our operating levels are subject to conditions beyond our control that can delay deliveries or increase the cost of mining at particular mines for varying lengths of time. These conditions include weather conditions (for example, extreme winter weather, floods and availability of process water due to drought) and natural disasters, pit wall failures, unanticipated geological conditions, including variations in the amount of rock and soil overlying the deposits of iron ore, variations in rock and other natural materials and variations in geologic conditions and ore processing changes. Portman’s Cockatoo Island operation is located in an area affected by tropical storms and operates a pit below sea level that is protected by a constructed seawall. Storms in this area could affect both our operation and the operations of our major Australia competitors. These conditions could impair our ability to fulfill our plan to operate our mines at full capacity, which could materially adversely affect our ability to meet the expected demand for our iron ore products.

Many of our mines are dependent on a single-source energy supplier.

Many of our mines are dependent on one source for electric power and for natural gas. For example, Minnesota Power is the sole supplier of electric power to our Hibbing and United Taconite mines; WEPCO is the sole supplier of electric power to our Tilden and Empire mines; and our Northshore mine is largely dependent on its wholly owned power facility for its electrical supply. A significant interruption in service from our energy suppliers due to terrorism, weather conditions, natural disasters, or any other cause can result in substantial losses that may not be fully recoverable, either from our business interruption insurance or responsible third parties. For example, in May 2003, we lost production when our Empire and Tilden mines were idled for approximately five weeks due to loss of power stemming from the failure of a dam in the Upper Peninsula of Michigan. One natural gas pipeline serves all of our Minnesota and Michigan mines and a pipeline failure may idle those operations. Any substantial unmitigated interruption of our business due to these conditions could materially adversely affect our sales, margins and profitability.

Our mines and processing facilities have been in operation for several decades. Equipment failures and other unexpected events at our facilities may lead to production curtailments or shutdowns.

Interruptions in production capabilities will inevitably increase our production costs and reduce our profitability. We do not have meaningful excess capacity for current production needs, and we are not able to quickly increase production at one mine to offset an interruption in production at another mine. In addition to equipment failures, our facilities are also subject to the risk of loss due to unanticipated events such as fires, explosions or adverse weather conditions. Two electrical explosions at our United Taconite facility on October 12, 2006 resulted in a temporary production curtailment as a result of a loss of electrical power. Full production did not resume until January 2007. The manufacturing processes that take place in our mining operations, as well as in our crushing, concentrating and pelletizing facilities, depend on critical pieces of equipment, such as drilling and blasting equipment, crushers, grinding mills, pebble mills, thickeners, separators, filters, mixers, furnaces, kilns and rolling equipment, as well as electrical equipment, such as transformers. This equipment may, on occasion, be out of service because of unanticipated failures. In addition, many of our mines and processing facilities have been in operation for several decades, and the equipment is aged. In the future, we may experience additional material plant shutdowns or periods of reduced production because of equipment

 

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failures. Material plant shutdowns or reductions in operations could materially adversely affect our sales, margins and profitability. Further, remediation of any interruption in production capability may require us to make large capital expenditures that could have a negative effect on our profitability and cash flows. Our business interruption insurance would not cover all of the lost revenues associated with equipment failures. Longer-term business disruptions could result in a loss of customers, which could adversely affect our future sales levels, and therefore our profitability.

We are subject to extensive governmental regulation, which imposes, and will continue to impose, significant costs and liabilities on us, and future regulation could increase those costs and liabilities or limit our ability to produce iron ore products.

We are subject to various federal, provincial, state and local laws and regulations on matters such as employee health and safety, air quality, water pollution, plant and wildlife protection, reclamation and restoration of mining properties, the discharge of materials into the environment, and the effects that mining has on groundwater quality and availability. Numerous governmental permits and approvals are required for our operations. We cannot be certain that we have been or will be at all times in complete compliance with such laws, regulations and permits. If we violate or fail to comply with these laws, regulations or permits, we could be fined or otherwise sanctioned by regulators.

Prior to commencement of mining, we must submit to, and obtain approval from, the appropriate regulatory authority of plans showing where and how mining and reclamation operations are to occur. These plans must include information such as the location of mining areas, stockpiles, surface waters, haul roads, tailings basins and drainage from mining operations. All requirements imposed by any such authority may be costly and time-consuming and may delay commencement or continuation of exploration or production operations. See Item 2. Properties. — Environment.

In addition, new legislation and/or regulations and orders, including proposals related to climate change and protection of the environment, to which we would be subject or that would further regulate and/or tax our customers, namely the North American integrated steel producer customers, may also require us or our customers to reduce or otherwise change operations significantly or incur additional costs. Such new legislation, regulations or orders (if enacted) could have a material adverse effect on our business, results of operations, financial condition or profitability. The Company’s U.S. operations are subject to MACT emissions standards for particulate matter promulgated by the EPA under the Clean Air Act effective October 31, 2006. Improved emission controls and monitoring systems have been installed at a capital cost of $4.3 million in 2006 to meet these new requirements. EPA’s decision not to regulate emissions of mercury or asbestos in the MACT Rule is the subject of a court remand, and the outcome cannot be predicted. The Company joined in a Petition to Delist the taconite emissions sources from the MACT Rule, but this has yet to be acted upon by EPA.

Further, we are subject to a variety of potential liability exposures arising at certain sites where we do not currently conduct operations. These sites include sites where we formerly conducted iron ore mining or processing or other operations, inactive sites that we currently own, predecessor sites, acquired sites, leased land sites and third-party waste disposal sites. We may be named as a responsible party at other sites in the future and we cannot be certain that the costs associated with these additional sites will not be material.

We also could be held liable for any and all consequences arising out of human exposure to hazardous substances used, released or disposed of by us or other environmental damage, including damage to natural resources. In particular, we and certain of our subsidiaries are involved in various claims relating to the exposure of asbestos and silica to seamen who sailed on the Great Lakes vessels formerly owned and operated by certain of our subsidiaries. The full impact of these claims, as well as whether insurance coverage will be sufficient and whether other defendants named in these claims will be able to fund any costs arising out of these claims, continues to be unknown. See Item 3. Legal Proceedings.

 

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Our expenditures for postretirement benefit and pension obligations could be materially higher than we have predicted if our underlying assumptions prove to be incorrect, if there are mine closures or our joint venture partners fail to perform their obligations that relate to employee pension plans.

We provide defined benefit pension plans and OPEB benefits to eligible union and non-union employees, including our share of expense and funding obligations with respect to unconsolidated ventures. Our pension expense and our required contributions to our pension plans are directly affected by the value of plan assets, the projected and actual rate of return on plan assets and the actuarial assumptions we use to measure our defined benefit pension plan obligations, including the rate at which future obligations are discounted.

We cannot predict whether changing market or economic conditions, regulatory changes or other factors will increase our pension expenses or our funding obligations, diverting funds we would otherwise apply to other uses.

We have calculated the unfunded obligation based on a number of assumptions. Discount rate, return on plan assets, and mortality assumptions parallel those utilized for pensions. If our assumptions do not materialize as expected, cash expenditures and costs that we incur could be materially higher. Moreover, we cannot be certain that regulatory changes will not increase our obligations to provide these or additional benefits. These obligations also may increase substantially in the event of adverse medical cost trends or unexpected rates of early retirement, particularly for bargaining unit retirees for whom there is currently no retiree healthcare cost cap. Early retirement rates likely would increase substantially in the event of a mine closure.

We are a related party to certain companies that were operators and are required under the Coal Industry Retiree Health Benefit Act of 1992 (the “Coal Retiree Act”) to make premium payments to the United Mine Workers Association Combined Benefit Fund (the “Combined Fund”), and our obligations to the Combined Fund could increase if other coal mine operators file for bankruptcy protection or become insolvent.

We are a related-party to certain companies that were coal mine operators. As a result we are subject to the Coal Retiree Act and are obligated to make premium payments to the Combined Fund for health and death benefits paid by the Combined Fund to retired coal miners. At December 31, 2006, the net present value of our estimated liability to the Combined Fund was $4.5 million. We are assessed premiums for unassigned or “orphan” retirees on a pro rata basis with other coal mine operators and related parties. If other coal mine operators and related parties file for bankruptcy protection or become insolvent, our pro rata portion of the liability to the Combined Fund could increase, which could have an adverse effect on our results of operations and financial condition.

Our profitability could be negatively affected if we fail to maintain satisfactory labor relations.

The USW represents all hourly employees at our Empire, Hibbing, Tilden and United Taconite mines, as well as Wabush in Canada. The USW has also been attempting to organize our employees at our Northshore mine. A four-year labor agreement was reached in August 2004 with our U.S. labor force and a five-year agreement that runs until March 2009 was reached with our Canadian work force. Hourly employees at the railroads we own that transport products among our facilities are represented by multiple unions with labor agreements that expire at various dates. If the collective bargaining agreements relating to the employees at our mines or railroad are not successfully renegotiated prior to their expiration, we could face work stoppages or labor strikes.

Our operating expenses could increase significantly if the price of electrical power, fuel or other energy sources increases.

Operating expenses at our mining locations are sensitive to changes in electricity prices and fuel prices, including diesel fuel and natural gas prices, which represent 25 percent of our North American operating costs. Prices for electricity, natural gas and fuel oils can fluctuate widely with availability and demand levels from other users. During periods of peak usage, supplies of energy may be curtailed and we may not be able to purchase them at historical rates. While we have some long-term contracts with electrical suppliers, we are exposed to

 

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fluctuations in energy costs that can affect our production costs. We enter into forward fixed-price supply contracts for natural gas and diesel fuel for use in our operations. Those contracts are of limited duration and do not cover all of our fuel needs, and price increases in fuel costs could cause our profitability to decrease significantly.

Equipment and supply shortages may impact our production.

We have recently experienced longer lead times on equipment, tires, and supply needs due to the increased demand for these resources. As the global mining industry increases its capacity, demand for these resources will increase, potentially resulting in higher prices, equipment shortages, or both.

We may encounter labor shortages for critical operational positions, which could affect our ability to produce iron ore products.

At our North American locations, many of our mining operational employees are approaching retirement age. As these experienced employees retire, we may have difficulty replacing them at competitive wages. In Western Australia, the large number of expansion projects currently in progress has created turnover principally for our contractors’ employees. As a result, wages are increasing to address the turnover.

Our profitability could be affected by the failure of outside contractors to perform.

Portman uses contractors to handle many of the operational phases of its mining and processing operations and therefore is subject to the performance of outside companies on key production areas.

Our failure to maintain effective internal control over financial reporting may not allow us to accurately report our financial results, which could cause our financial statements to become materially misleading and adversely affect the trading price of our common shares.

We require effective internal control over financial reporting in order to provide reasonable assurance with respect to our financial reports and to effectively prevent fraud. Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we cannot provide reasonable assurance with respect to our financial statements and effectively prevent fraud, our financial statements could become materially misleading, which could adversely affect the trading price of our common shares. Our management determined that we had a material weakness in our internal control over financial reporting due to the failure to maintain a sufficient complement of personnel with an appropriate level of technical accounting knowledge, experience and training to consistently perform independent secondary reviews and to appropriately interpret and apply complex accounting standards. We are enhancing our internal controls in order to remediate the material weakness. Implementing new internal controls and testing the internal control framework will require the dedication of additional resources, management time and expense. If we fail to correct the material weakness with our internal control over financial reporting, including any failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business, financial condition and operating results could be harmed.

We may be unable to successfully identify, acquire and integrate strategic acquisition candidates.

Our ability to grow successfully through acquisitions depends upon our ability to identify, negotiate, complete and integrate suitable acquisitions and to obtain necessary financing. It is possible that we will be unable to successfully complete potential acquisitions. In addition, the costs of acquiring other businesses could increase if competition for acquisition candidates increases. Additionally, the success of an acquisition is subject to other risks and uncertainties, including our ability to realize operating efficiencies expected from an acquisition, the size or quality of the resource, delays in realizing the benefits of an acquisition, difficulties in retaining key employees, customers or suppliers of the acquired businesses, difficulties in maintaining uniform controls, procedures, standards and policies throughout acquired companies, the risks associated with the assumption of contingent or undisclosed liabilities of acquisition targets, the impact of changes to our allocation of purchase price, and the ability to generate future cash flows or the availability of financing.

 

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We are subject to risks involving foreign operations.

We have a strategy to broaden our scope as a supplier of iron ore and other raw materials to the integrated steel industry in North American and international markets. The 2005 acquisition of Portman was the first step in our strategy. We completed the acquisition of Centennial Amapa, giving us a 30 percent interest in the Amapa Project in Brazil and invested in the Sonoma Coal Project in Australia. We are also pursuing other projects. As we expand beyond our traditional North American base business, we will be exposed to additional risks beyond those risks relating to our North American iron ore operations, such as fluctuations in the U.S. Dollar relative to other currencies; legal and tax limitations on our ability to repatriate earnings into the U.S. in an efficient manner; potential negative international impacts resulting from U.S. foreign and domestic policies, including government embargoes or foreign trade restrictions; the imposition of duties, tariffs, import and export controls and other trade barriers impacting the seaborne iron ore and coal markets; difficulties in staffing and managing multi-national operations; and uncertainties in the international enforcement of legal rights and remedies. If we are unable to manage successfully the risks associated with expanding our global business, these risks could have a material adverse effect on our business, results of operations or financial condition.

Item 1B.    Unresolved Staff Comments.

We have no unresolved comments from the SEC.

Item 2.    Properties.

The following map shows the locations of our North American mines:

LOGO

We directly or indirectly own and operate interests in the following six North American iron ore mines:

 

Location and Name

   Ownership interest
as of December 31,
2006, 2005 & 2004
 

Empire

   79.0 %

Tilden

   85.0  

Hibbing

   23.0  

Northshore

   100.0  

United Taconite

   70.0  

Wabush

   26.8  

Empire Mine

The Empire mine is located on the Marquette Iron Range in Michigan’s Upper Peninsula approximately 15 miles west-southwest of Marquette, Michigan and is accessed via a paved road off State Highway 35. The mine has been in operation since 1963. Over the past five years, the Empire mine has produced between 3.6 million and 5.4 million tons of iron ore pellets annually.

 

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We entered into an agreement with Ispat effective December 31, 2002, that restructured the ownership of the Empire mine and increased our ownership from 46.7 percent to 79 percent in exchange for assumption of all mine liabilities. Under the terms of the agreement, we acquired the 25 percent interest rejected by LTV Corporation in its chapter 11 bankruptcy proceedings and a 19 percent interest from Ispat. We indemnified Ispat from obligations of Empire in exchange for certain future payments to Empire and to us by Ispat of $120.0 million, recorded at a present value of $54.9 million at December 31, 2006 ($59.8 million at December 31, 2005) with $42.9 million classified as Long-term receivable with the balance current, over the 12-year life of the supply agreement. A subsidiary of Mittal Steel USA has retained a 21 percent ownership in Empire, which it has a unilateral right to put to us at the end of 2007. We are the sole outside supplier of pellets purchased under the Ispat agreement, assumed by Mittal Steel USA, for the term of the supply agreement. We manage the mine. We and Mittal Steel USA take our respective share of production pro rata; however, provisions in the partnership agreement allow additional or reduced production to be delivered under certain circumstances. We own directly approximately one-half of the remaining ore reserves at the Empire mine and lease them to Empire. The Empire mine leases the balance of its reserves from the other owners of such reserves.

Tilden Mine

The Tilden mine is located on the Marquette Iron Range in Michigan’s Upper Peninsula approximately five miles south of Ishpeming, Michigan. The main entrance to the Tilden mine is accessed by means of a paved road off of County Road 476. The Tilden mine has been in operation since 1974. Over the past five years, the Tilden mine has produced between 6.9 million and 7.9 million tons of iron ore pellets annually.

On January 31, 2002, we increased our ownership of the Tilden mine to 85 percent by acquiring Algoma’s 45 percent interest in the mine for assumption of mine liabilities and executed a term supply agreement under which we are Algoma’s sole supplier of iron ore pellets for 15 years. The acquisition increased our share of annual production capacity by 3.5 million tons. Currently, we manage the mine and have an 85 percent interest and Stelco has a 15 percent interest in the mine. Each partner takes its share of production pro rata; however, provisions in the partnership agreement allow additional or reduced production to be delivered under certain circumstances. We own all of the ore reserves at the Tilden mine and lease them to Tilden.

The Empire and Tilden mines are located adjacent to each other. The increase in ownership of our Michigan mines facilitated consolidation of operations and management, which offer operational and cost benefits that were not achievable under the previous ownership structure. These benefits include a consolidated transportation system, more efficient employee and equipment operating schedules, reduction in redundant facilities and workforce and best practices sharing.

Hibbing Mine

The Hibbing mine is located in the center of Minnesota’s Mesabi Iron Range and is approximately ten miles north of Hibbing, Minnesota and five miles west of Chisholm, Minnesota. The main entrance to the Hibbing mine is accessed by means of a paved road and is located off County Road 5. The Hibbing mine has been in operation since 1976. Over the past five years, the Hibbing mine has produced between 7.7 million and 8.5 million tons of iron ore pellets annually.

In July 2002, we acquired (effective retroactive to January 1, 2002) an eight percent interest in Hibbing from Bethlehem for the assumption of mine liabilities associated with the interest. The acquisition increased our ownership of Hibbing from 15 percent to 23 percent. This transaction reduced Bethlehem’s ownership interest in Hibbing to 62.3 percent. In October 2001, Bethlehem filed for protection under chapter 11 of the U.S. Bankruptcy Code. At the time of the filing, we had a trade receivable of $1.0 million, which has been written off. In May 2003, ISG purchased the assets of Bethlehem, including Bethlehem’s 62.3 percent interest in Hibbing. We manage the mine. Mittal Steel USA, which acquired ISG, has a 62.3 percent interest and Stelco has a 14.7 percent interest in the mine. Each partner takes its share of production pro rata; however, provisions in the joint venture agreement allow additional or reduced production to be delivered under certain circumstances.

Northshore Mine

The Northshore mine is located in northeastern Minnesota, approximately two miles south of Babbitt, Minnesota on the northeastern end of the Mesabi Iron Range. Northshore’s processing facilities are located in

 

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Silver Bay, Minnesota, near Lake Superior, on U.S. Highway 61. The main entrance to the Northshore mine is accessed by means of a gravel road and is located off County Road 20. The Northshore mine has been in continuous operation since 1990. Over the past five years, the Northshore mine has produced between 4.2 million and 5.1 million tons of iron ore pellets annually.

The Northshore mine began production under our management and ownership on October 1, 1994. We own 100 percent of the mine.

United Taconite

The United Taconite mine is located on Minnesota’s Mesabi Iron Range in and around the city of Eveleth, Minnesota, west of U.S. Highway 53. The main entrance to the United Taconite mine is accessed by means of a paved road and is located off Route 37. The mine has been operating since 1965. Over the past five years, the United Taconite mine has produced between 1.6 million and 4.9 million tons of iron ore pellets annually.

Effective December 1, 2003, United Taconite purchased the ore mining and pelletizing assets of Eveleth Mines. Eveleth Mines had ceased mining operations in May 2003 after filing for chapter 11 bankruptcy protection on May 1, 2003. Under the terms of the purchase agreement, United Taconite purchased all of Eveleth Mines’ assets for $3 million in cash and the assumption of certain liabilities, primarily mine closure-related environmental obligations. As a result of this transaction, we, after assigning appropriate values to assets acquired and liabilities assumed, recorded an extraordinary gain of $2.2 million, net of $.5 million tax and $1.2 million minority interest. In conjunction with this transaction, we and our Wabush Mines venture partners entered into pellet sales and trade agreements with Laiwu to optimize shipping efficiency. We manage the mine and hold a 70 percent interest; Laiwu holds a 30 percent interest. Sales to Laiwu under these contracts totaled .1 million tons and .3 million tons in 2006 and 2005, respectively.

Wabush Mines

The Wabush mine and concentrator is located in Wabush, Labrador, Canada, and the pellet plant is located in Pointe Noire, Quebec, Canada. The main entrance to the Wabush mine is accessed by means of a paved road and is located on Highway 530, about three miles west of the town of Wabush. The pellet plant is accessed by a paved road off Highway 138, about ten miles west of the town of Sept-Iles, Quebec. The Wabush mine has been in operation since 1965. Over the past five years, Wabush has produced between 3.8 million and 5.2 million tons of iron ore pellets annually.

In 1997, we acquired Ispat’s interest in the Wabush mine. In August 2002, we acquired our proportionate share (approximately 4.05 percent) of the 15.09 percent interest rejected by Acme in its bankruptcy proceedings. As a result of these two events, we increased our ownership in the mine from 7.7 percent to 26.83 percent. Acme had discontinued funding its Wabush obligations in August 2001. We also manage the mine. Stelco has a 44.6 percent interest and Dofasco has a 28.6 percent interest in the mine. Wabush successfully completed actions that increased annual pellet production to a 4.9 million ton rate by the end of 2006. Additionally, a C$1.4 million project was approved in 2006 to install a manganese reduction test circuit on one processing line in the Wabush concentrator. Successful operations of the test circuit could lead to the installation of manganese reduction on all Wabush processing lines. The capability to remove manganese from crude ore could allow the processing of ores previously classified as waste and potentially extend the life of the mine. Production for 2007 is estimated at 4.8 million tons of pellets.

 

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The following map shows the locations of our Australia mines:

 

LOGO

   LOGO

Koolyanobbing

The Koolyanobbing operations are located 425 kilometers east of Perth and approximately 50 kilometers northeast of the town of Southern Cross. Koolyanobbing produces lump and fine iron ore. A capacity expansion program was completed in 2006 to increase capacity from six to eight million tonnes per annum. The expansion was primarily driven by the development of iron ore resources at Mt. Jackson and Windarling, located 80 kilometers and 100 kilometers north of the existing Koolyanobbing operations, respectively. Over the past five years, the Koolyanobbing operation has produced between 4.1 million and 6.9 million tonnes annually.

Cockatoo Island

The Cockatoo Island operation is located six kilometers to the west of Yampi Peninsula, in the Buccaneer Archipelago, and 140 kilometers north of Derby in the West Kimberley region of Western Australia. The island has been mined for iron ore since 1951, with a break in operations between 1985 and 1993. Over the past five years, Cockatoo Island has produced between .3 million and 1.5 million tonnes annually at the 100 percent ownership level.

Portman commenced a beneficiation project in 1993 that was completed in mid-2000. Portman and HWE then formed a 50:50 joint venture to mine remnant iron ore deposits on mining tenements held by BHP and mined by BHP from 1951 to 1985. HWE’s interest in the operations was acquired out of receivership by Leighton in early 2006. Mining from this phase of the operation commenced in late 2000 and is expected to continue, based on current reserves, until late 2007. Studies are underway evaluating the technical and economic feasibility of developing a below-sea-level eastward resource extension of the Cockatoo deposit. Ore is hauled by haul truck to the stockpiles, crushed and screened and then transferred by conveyor to the shiploader.

Transportation

Two railroads, one of which is wholly owned by us, link the Empire and Tilden mines with Lake Michigan at the loading port of Escanaba, Michigan and with the Lake Superior loading port of Marquette, Michigan. From the Mesabi Range, Hibbing pellets are transported by rail to a shiploading port at Superior, Wisconsin. United Taconite pellets are shipped by railroad to the port of Duluth, Minnesota. At Northshore, crude ore is shipped by a wholly owned railroad from the mine to processing and dock facilities at Silver Bay, Minnesota. In Canada, there is an open-pit mine and concentrator at Wabush, Labrador, Newfoundland and a pellet plant and dock facility at Pointe Noire, Quebec. At the Wabush mine, concentrates are shipped by rail from the Scully mine at Wabush to Pointe Noire where they are pelletized for shipment via vessel to Canada, the United States and other international destinations or shipped as concentrates for sinter feed.

 

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All of the ore mined at the Koolyanobbing operations is transported by rail to the Port of Esperance, 575 kilometers to the south for shipment to Asian customers. Direct ship premium fines mined at Cockatoo Island are loaded at a local dock.

Internal Control over Reserve Estimation

We have a corporate policy relating to internal control and procedures with respect to auditing and estimating ore reserves. The procedures include the calculation of ore reserves at each mine by mining engineers and geologists under the direction of our Chief Mining Engineer and Chief Long Range Planning Engineer. Our General Manager-Resource Analysis and Engineering compiles, reviews, and submits the calculations to the Corporate Accounting department, where the disclosures for our annual and quarterly reports are prepared based on those calculations. The draft disclosure is submitted to our General Manager-Resource Analysis and Engineering for further review and approval. The draft disclosures are then reviewed and approved by our Chief Financial Officer and Chief Executive Officer before inclusion in our annual and quarterly reports. Additionally, the long-range mine planning and ore reserve estimates are reviewed annually by our Audit Committee. Furthermore, all changes to ore reserve estimates, other than those due to production, are documented by our General Manager-Resource Analysis and Engineering and are submitted to our President and Chief Executive Officer for review and approval. Finally, we perform periodic reviews of long-range mine plans and ore reserve estimates at mine staff meetings and senior management meetings.

Operations

In North America, we produced 20.8 million tons, 22.1 million tons and 21.7 million tons of pellets in 2006, 2005 and 2004, respectively, for our account and 12.8 million tons, 13.8 million tons and 12.7 million tons, respectively, on behalf of the steel company owners of the mines. In Australia, we produced 7.7 million tonnes and 5.2 million tonnes in 2006 and 2005, respectively. Portman’s 2005 total represents production since the March 31, 2005 acquisition of Portman. See Production and Sales Volume in Item 7 for further information.

Our business is subject to a number of operational factors that can affect our future profitability. A more detailed description of these risks is contained in Item 1A — Risk Factors.

Mine Capacity and Iron Ore Reserves

Reserves are defined by SEC Industry Standard Guide 7 as that part of a mineral deposit that could be economically and legally extracted and produced at the time of the reserve determination. The estimate of proven and probable reserves is of demonstrated tons. All reserve estimates are supported by scheduled life of mine plans.

Our 2007 ore reserve estimates for our iron ore mines as of December 31, 2006 were estimated from fully-designed pits developed using three-dimensional modeling techniques. These fully designed pits incorporate design slopes, practical mining shapes and access ramps to assure the accuracy of our reserve estimates. The following tables reflect expected current annual capacity and economic ore reserves for our North American and Australian iron ore mines as of December 31, 2006.

 

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Mine

 

Iron Ore

Mineralization

  Tons in Millions (1)   Mineral Rights    

Method of

Reserve

Estimation

 

Operating

Since

 

Infrastructure

   

Current

Annual

Capacity

 

Mineral

Reserves (2) (3)

       
     

Current

Year

 

Previous

Year

       
          Owned     Leased        

Empire

  Negaunee Iron   5.5   13   17   57 %   43 %   Geologic - Block   1963   Mine, Concentrator,
  Formation             Model     Pelletizer
  (Magnetite)                

Tilden

  Negaunee Iron   8.0   259   266   100 %   0 %   Geologic - Block   1974   Mine, Concentrator,
  Formation             Model     Pelletizer, Railroad
  (Hematite / Magnetite)                

Hibbing Taconite

  Biwabik Iron   8.0   152   161   3 %   97 %   Geologic - Block   1976   Mine, Concentrator,
  Formation             Model     Pelletizer
  (Magnetite)                

Northshore

  Biwabik Iron   4.8   318   310   0 %   100 %   Geologic - Block   1989   Mine, Concentrator,
  Formation             Model     Pelletizer, Railroad
  (Magnetite)                

United Taconite

  Biwabik Iron   5.2   119   123   0 %   100 %   Geologic - Block   1965   Mine, Concentrator,
  Formation             Model     Pelletizer
  (Magnetite)                

Wabush

  Wabush Iron   5.5   44   51   0 %   100 %   Geologic - Block   1965   Mine, Concentrator,
  Formation             Model     Pelletizer, Railroad
  (Hematite)                
                       
  Total   37.0   905   928          
                       

(1) Tons are long tons of pellets of 2,240 pounds.

 

(2) Estimated standard equivalent pellets, including both proven and probable reserves based on life of mine operating schedules.

 

(3) We regularly evaluate our ore reserve estimates and update them as required in accordance with the SEC Industry Guide 7.

 

Mine Project

 

Iron Ore

Mineralization

  Tons in Millions (1)   Mineral Rights    

Method of

Reserve

Estimation

 

Operating

Since

 

Infrastructure

   

Current

Annual

Capacity

 

Mineral

Reserves (2)(3)

       
     

Current

Year

 

Previous

Year

       
          Owned     Leased        

Koolyanobbing (4)

  Banded Iron Formations Southern Cross Terrane Yilgarn Mineral Field (Hematite, Goethite)   8.0   87.0   87.5   0 %   100 %   Geologic - Block Model   1994   Mine, Train Haulage Road, Crushing-Screening Plant

Cockatoo Island JV (5)

  Sandstone Yampi Formation Kimberley Mineral Field (Hematite)   1.2   .9   1.7   0 %   100 %   Geologic - Block Model   1994  

Mine,

Crushing-Screening Plant, Shiploader

                       
 

Total

  9.2   87.9   89.2          
                       

(1) Tonnes are metric tons of 2,205 pounds.

 

(2) Reported ore reserves restricted to proven and probable tonnages based on life of mine operating schedules. Koolyanobbing reserves can be derived from up to 15 separate mineral deposits over a 100-kilometer operating distance. 7.4 million tonnes of the Koolyanobbing reserves are sourced from current long-term stockpiles.

 

(3) Portman’s ore reserve estimates are regularly updated in accordance with SEC Industry Guide 7 and the 2004 Edition of the JORC code.

 

(4) An expansion project was completed in 2006 that increased annual production capacity to eight million tonnes.

 

(5) Portman has a 50 percent interest in the Cockatoo Island Joint Venture. Capacity and reserve totals represent 100 percent.

We directly own approximately one-half of the remaining ore reserves at the Empire mine and approximately three percent of the reserves at the Hibbing mine, and lease or sublease the balance of the reserves in these mines from their owners. We own all of the ore reserves at the Tilden mine. The ore reserves at Northshore, United Taconite and Wabush are owned by others and leased or subleased directly to those mines. The Koolyanobbing operations and Cockatoo Island ore reserves are derived from Crown lands owned and managed by the Western Australia state government.

In 2006, there were no changes in reserve estimates at Empire, Hibbing, Tilden or United Taconite, except for production. A new ore reserve estimate was completed in September 2006 at Northshore, along with a new

 

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pit design and production schedules. The updated ore reserve estimate calculated a four percent increase, or 13 million tons. The estimate included a complete remodeling of the mine geology, additional ore characterization data for improved definition of ore and waste, application of improved metallurgical grade cut-offs, updated financial inputs, ultimate pit design and life-of-mine scheduling.

The Wabush ore reserve has decreased by 3.5 million tons in addition to production. This is due to a reevaluation based on higher operating costs and pellet prices, a change in the manganese pellet production split from 60 percent low and 40 percent high manganese pellets to 40 percent low and 60 percent high, and decreasing the maximum pit depths due to water limitations. A new ore reserve base, completed during 2005, continues to be verified. The current estimate uses the ore reserve estimate generated in 2003, with no material changes occurring in the interim. This reserve has been scheduled to exhaustion to meet the 40/60 percent manganese pellet production mix and updated with current costs and pellet pricing. Final verification of the updated geological model and a complete ore reserve estimate is scheduled for 2007.

The 2006 Portman ore reserve estimates represent an increase of 7.6 million tonnes net of mine depletion. The increases reflect iron ore exploration success expanding the in-situ mineral resources at both the Koolyanobbing and Cockatoo operations as well as improved mining reconciliations with maturity of the operating pits. We are studying the use of existing technologies to beneficiate lower grade ores, which if successful, could increase the ore reserve base.

General Information about the Mines

Leases.    Mining is conducted on multiple mineral leases having varying expiration dates. Mining leases are routinely renegotiated and renewed as they approach their respective expiration dates.

Exploration and Development.    All mining operations are open-pit mines that are in production. Additional pit development is underway at each mine as required by long-range mine plans. Drilling programs are conducted periodically for the purpose of refining guidance related to ongoing operations. An exploration program targeting extensions to Portman’s known iron ore resources as well as regional exploration targets in the Yilgarn Mineral Field was active in 2006 and will continue in 2007. At Cockatoo Island, exploration drilling was completed in 2006 that successfully increased the resource base. Studies are underway evaluating the technical and economic feasibility of developing a below-sea-level eastward resource extension of the Cockatoo deposit.

The Biwabik, Negaunee, and Wabush Iron Formations are classified as Lake Superior type iron-formations that formed under similar sedimentary conditions in shallow marine basins approximately two billion years ago. Magnetite and/or hematite are the predominant iron oxide ore minerals present, with lesser amounts of goethite and limonite. Chert is the predominant waste mineral present, with lesser amounts of silicate and carbonate minerals. The ore minerals readily liberate from the waste minerals upon fine grinding.

The mineralization at the Koolyanobbing operations is predominantly hematite and goethite replacements in greenstone-hosted banded iron-formations. Individual deposits tend to be small with complex ore-waste contact relationships. The Koolyanobbing operations reserves are derived from 15 separate mineral deposits distributed over a 100-kilometer operating radius. The mineralization at Cockatoo Island is predominantly friable, hematite-rich sandstone that produces premium high grade, low impurity direct shipping fines.

Geologic models are developed for all mines to define the major ore and waste rock types. Computerized block models are then constructed that include all relevant geologic and metallurgical data. These are used to generate grade and tonnage estimates, followed by detailed mine design and life of mine operating schedules.

 

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Mine Facilities and Equipment.    Each of the North American mines has crushing, concentrating, and pelletizing facilities. There are crushing and screening facilities at Koolyanobbing and Cockatoo Island. The facilities at each site are in satisfactory condition, although they require routine capital and maintenance expenditures on an ongoing basis. Certain mine equipment generally is powered by electricity, diesel fuel or gasoline. The total cost of the property, plant and equipment, net of applicable accumulated amortization and depreciation as of December 31, 2006, for each of the mines is set forth in the chart below.

 

     (In Millions)  

Location and Name

   Total Historical Cost of Mine
Plant and Equipment (Excluding
Real Estate and Construction in
Progress), Net of Applicable
Accumulated Amortization and
Depreciation
 

Empire

   $ 92.8 (1)

Tilden

     201.3 (2)

Hibbing

     467.5 (3)

Northshore

     83.1  

United Taconite

     61.8  

Wabush

     317.3 (3)

Portman

     160.9  

(1) Includes capitalized financing costs of $9.6 million, net of accumulated amortization.

 

(2) Includes capitalized financing costs of $19.2 million, net of accumulated amortization.

 

(3) Does not reflect depreciation, which is recorded by the individual venturers.

Competition

We compete with several iron ore producers in North America, including Iron Ore Company of Canada, Quebec Cartier Mining Company and U.S. Steel, as well as other steel companies that own interests in iron ore mines that may have excess iron ore inventories. In addition, significant amounts of iron ore have, since the early 1980s, been shipped to the United States from Brazil and Venezuela in competition with iron ore produced by us.

As the North American steel industry continues to consolidate, a major focus of the consolidation is on the continued life of the integrated steel industry’s raw steelmaking operations, i.e., blast furnaces and basic oxygen furnaces that produce raw steel. Some steelmakers are importing semi-finished steel slabs as an alternative to using blast furnaces and basic oxygen furnaces to produce steel because of the costs associated with relining blast furnaces and maintaining coke ovens. These imported steel slabs can be converted and finished in the steelmaker’s downstream finishing facilities. In addition, other competitive forces have become a large factor in the iron ore business. Electric furnaces built by mini-mills, which are steel recyclers, generally produce steel by using scrap steel, not iron ore pellets, in their electric furnaces.

Competition among the sellers of iron ore pellets is predicated upon the usual competitive factors of price, availability of supply, product performance, service and transportation cost to the consumer.

Portman exports iron ore products to China and Japan in the world seaborne trade. Portman competes with major iron ore exporters from Australia, Brazil and India.

Environment

North America

In the construction of our facilities and in their operation, substantial costs have been incurred and will continue to be incurred to avoid undue effect on the environment. Our North American capital expenditures relating to environmental matters were $10.9 million, $8.3 million and $7.3 million in 2006, 2005 and 2004, respectively. It is estimated that approximately $10.5 million will be spent in 2007 for capital environmental control facilities.

 

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Various legislative bodies and federal and state agencies are continually promulgating new laws and regulations affecting us, our customers, and our suppliers in many areas, including waste discharge and disposal, hazardous classification of materials and products, air and water discharges, and many other environmental, health and safety matters. Although we believe that our environmental policies and practices are sound and do not expect that the application of any current laws or regulations would reasonably be expected to result in a material adverse effect on our business or financial condition, we cannot predict the collective adverse impact of the expanding body of laws and regulations.

The iron ore industry has been identified by the EPA as an industrial category that emits pollutants established by the 1990 Clean Air Act Amendments. These pollutants included over 200 substances that are now classified as hazardous air pollutants (“HAP”). The EPA is required to develop rules that would require major sources of HAP to utilize MACT standards for their emissions. Pursuant to this statutory requirement, the EPA published a final rule on October 30, 2003 imposing emission limitations and other requirements on taconite iron ore processing operations. On December 15, 2005, we and Ispat-Inland Mining Company filed a Petition to Delete as a source category regulated by Section 112 of the Clean Air Act. EPA requested additional information, and a supplement was submitted to the EPA on August 22, 2006. A response is pending.

We were in compliance with the requirements of MACT as of the October 31, 2006 deadline. Our capital expenditures in 2006 to meet the MACT standards were $4.3 million. On January 23, 2004, the National Wildlife Federation, Minnesota Conservation Federation, Lake Superior Alliance and Save Lake Superior Association filed a petition for review of the EPA’s final MACT rule in the United States Court of Appeals for the District of Columbia. This petition challenges the EPA’s decision not to impose standards for mercury and asbestos and monitoring of formaldehyde from taconite indurating furnaces. We filed a petition to intervene in this case. Typically, the EPA’s consideration of a petition is an iterative process extending over several months, with a longer period for controversial subjects. Subsequently, the Court remanded to EPA the asbestos and mercury rules. The National Wildlife Federation, the Minnesota Conservation Federation and Save Lake Superior Association also voluntarily dismissed the petition with respect to the formaldehyde rules. The EPA has yet to respond to the remand.

On December 16, 2006, we submitted an administrative permit amendment application to the MPCA with respect to Northshore’s Title V operating permit. The proposed amendment requested the deletion of a 30 year old “control city” monitoring requirement which was used to assess the adequacy of air emission control equipment installed in the 1970s. MPCA had discontinued use of control city monitoring in the early 1980s, but had recently reinstituted monitoring. The control city monitoring compared ambient fiber levels in St. Paul, Minnesota to levels at Northshore and the surrounding area. The amendment application argued that the control city monitoring requirement is an obsolete and redundant standard given Northshore’s existing emission control equipment and applicable federal regulations, state rules, and permit requirements.

We have received a letter dated February 23, 2007 from the MPCA notifying us that our request for an administrative permit amendment has been denied. We have appealed the denial to the Minnesota Court of Appeals. We are also currently in negotiations with the MPCA on a compliance schedule. Subsequent to the filing of our appeal, the MPCA advised Northshore that the MPCA considered Northshore to be in violation of the control city standard. Without conceding MPCA’s allegations, we have entered into discussions with the MPCA with respect to the terms of a compliance schedule in which we would agree to take certain actions in settlement of the alleged violation. Discussions with the MPCA are currently ongoing. In addition, the Minnesota Center for Environmental Advocacy has since filed a motion with the Court of Appeals to intervene in our appeal of the denial of an administrative amendment to our Title V operating permit. If either our appeal is unsuccessful or if we are unable to negotiate an acceptable compliance schedule, Northshore could be subject to future enforcement actions with respect to its Title V permit if we are unable to meet the control city requirement as interpreted by MPCA.

Australia

Portman achieved significant progress in environmental management during 2005 and 2006. As production activity from the new operations at Mt. Jackson and Windarling consolidated, the emphasis in environmental

 

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management shifted from control of mine establishment and construction activities to implementation and ongoing development of the Koolyanobbing Project Environmental Management System and conservation initiatives.

The key elements of a number of environmental management plans that were required under governmental approvals were consolidated into one system manual in 2005. The environmental management system was reviewed in October 2005 and determined to be on schedule to achieve certification to the ISO 14001 Standard within the following 18 months.

On May 14, 2007, the Australian Environmental Protection Authority (“AEPA”) published a study in which the AEPA recommended the establishment of “A class reserves” for the protection of certain allegedly environmentally sensitive areas of Western Australia. Some of the proposed A class reserves overlap with mining tenements granted to Portman (the “Overlapping Areas”). The AEPA study has been submitted to the Minister for the Environment and Heritage.

Portman originally received governmental approval to mine in the Overlapping Areas in June 2003. Since that time, Portman has met all applicable environmental requirements. Although we are currently reviewing the study and the effects of the designation of the Overlapping Areas as A class reserves, such categorization may have a material effect on Portman’s operations. It is unknown at this time whether the Minister for the Environment and Heritage will accept the recommendations of the AEPA. If the recommendations of the AEPA are accepted, Portman will challenge any such decision.

For additional information on our environmental matters, see Item 3. Legal Proceedings and NOTE 5 — ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS.

Energy

Electricity.    The Empire and Tilden mines each have electric power supply contracts with WEPCO that are effective through 2007 and include an energy price cap and certain power curtailment features. We have resolved our dispute with WEPCO regarding certain pricing provisions of our contract. The Empire and Tilden mines also recently entered into settlement with WEPCO on tariff rates that will apply beginning in 2008. See Item 3. Legal Proceedings for further information.

Electric power for the Hibbing mine and the United Taconite mine is supplied by Minnesota Power, Inc., under agreements that continue to December 2008 and October 2008, respectively.

Silver Bay Power Company, an indirect wholly owned subsidiary of ours, with a 115 megawatt power plant, provides the majority of Northshore’s energy requirements, has an interconnection agreement with Minnesota Power, Inc. for backup power, and sells 40 megawatts of excess power capacity to Northern States Power Company under a contract that extends to 2011.

Wabush owns a portion of the Twin Falls Hydro Generation facility that provides power for Wabush’s mining operations in Newfoundland. We have a 20-year agreement with Newfoundland Power, which continues until December 31, 2014. This agreement allows an interchange of water rights in return for the power needs for Wabush’s mining operations. The Wabush pelletizing operations in Quebec are served by Quebec Hydro on an annual contract.

Koolyanobbing and its associated satellite mines draw power from independent diesel fuelled power stations and generators. Temporary diesel power generation capacity has been installed at the Koolyanobbing operations, allowing sufficient time for a detailed investigation into the viability of long-term options such as connecting into the Western Australian South West Interconnected System or provision of natural gas or dual fuel (natural gas and diesel) generating capacity. These options are not economic for the satellite mines, which will continue being powered by diesel generators.

Electrical supply on Cockatoo Island is diesel generated. The powerhouse adjacent to the processing plant powers the shiploader, fuel farm and the processing plant. The workshop and administration office is powered by a separate generator.

Process Fuel.    We have contracts providing for the transport of natural gas for our United States iron ore operations. The Empire and Tilden mines have the capability of burning natural gas, coal, or, to a lesser extent, oil. The

 

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Hibbing and Northshore mines have the capability to burn natural gas and oil. The United Taconite mine has the ability to burn coal, natural gas and coke breeze. Although all of the U.S. mines have the capability of burning natural gas, with higher natural gas prices, the pelletizing operations for the U.S. mines utilize alternate fuels when practicable. Wabush Mines has the capability to burn oil and coke breeze.

Research and Development

We have been a leader in iron ore mining technology for more than 150 years. We operated some of the first mines on Michigan’s Marquette Iron Range and pioneered early open-pit and underground mining methods. From the first application of electrical power in Michigan’s underground mines to the use today of sophisticated computers and global positioning satellite systems, we have been leaders in the application of new technology to the centuries-old business of mineral extraction.

We maintain research facilities in Ishpeming, Michigan at our Cliffs Technology Center. It was at these facilities that the current concentrating and pelletizing process was developed in the 1950s. This successful development allowed for what was once considered millions of tons of useless rock to be turned into an iron ore reserve that provides the basis for our operations today. Today our engineering and technical staffs are engaged in full-time technical support of our operations and improvement of existing products.

As part of our efforts to develop alternative metallic products, we are evaluating opportunities to develop, with Kobe Steel, a commercial-scale reduced iron plant, which will convert taconite into nearly pure iron in nugget form utilizing Kobe Steel’s ITmk3 technology. This innovative technology has the potential to open new markets by offering an economically competitive supply of iron material for electric arc furnaces.

Portman does not have any material research and development projects.

Employees

As of December 31, 2006, there were a total of 4,189 employees:

 

Mining Operations

   Salaried    Hourly    Total

Empire

   115    496    611

Tilden

   117    585    702

LS&I Railroad

   13    121    134

Hibbing

   145    572    717

Northshore

   154    358    512

Wabush

   174    615    789

United Taconite

   90    396    486

Portman

   70    10    80

Corporate/Support Services

   156    2    158
              

Total (1)

   1,034    3,155    4,189
              

(1) Includes our employees and the employees of the North American joint venturers

Hourly employees at our North American mining operations (other than Northshore) are represented by the USW under collective bargaining agreements. The USW advised the Company with a “Written Notification” that they initiated an organizing campaign effective April 1, 2006 at Northshore. Under the terms of our collective bargaining agreements with the USW, we are required to remain neutral during the organizing campaign. Based upon subsequent conversations with USW representatives, the organizing campaign was postponed pending resolutions of issues related to the neutrality commitment in the collective bargaining agreement. Those issues were not resolved by discussion, and the Union has filed suit in Federal District Court in Minnesota to compel arbitration of the issues. The Company has filed a charge with the National Labor Relations Board seeking its intervention in the matter to clarify its requirements and prohibit any unlawful actions by the USW. At this time, the timing of when a campaign may begin and the outcome of the campaign, when and if it proceeds, cannot be predicted. Previous efforts to organize Northshore employees have not been successful.

 

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In August 2004, employees at the Empire and Tilden mines in Michigan and the Hibbing Taconite and United Taconite mines in Minnesota, represented by the USW, ratified four-year labor agreements that were comparable to other USW contracts in the industry. The agreements provided employees three separate three percent wage increases over the four-year term and for us and our partners to increase funding into pension plans and VEBAs during the term of the contracts. Accelerated funding of these plans will better secure employee retiree benefits and reduce our future years’ employment legacy cost contribution requirements. The agreements also provide that, for employees retiring on or after September 1, 2004, our share of retirees’ healthcare premiums is capped at 2008 levels for 2009 and beyond. In addition, the union agreed to certain workforce flexibility provisions and other work rule modifications to improve productivity. These agreements will expire on September 1, 2008.

On July 5, 2004, the USW initiated a strike that idled Wabush mining and concentrating facilities in Labrador, Newfoundland and pelletizing and shipping facilities in Pointe Noire, Quebec. As a result of the work stoppage, Wabush lost approximately 1.7 million tons of production (our share .5 million tons). On October 10, 2004, a five-year labor agreement was ratified by employees who are represented by the USW. The expiration of the agreement is March 1, 2009. The agreement provides for increases in wages and benefits and increased worker flexibility provisions to allow for higher productivity. Operations resumed on October 11, 2004.

Item 3.    Legal Proceedings.

Wisconsin Electric Power Company.    Two of the Company’s mines, Tilden and Empire (“the Mines”), currently purchase their electric power from WEPCO pursuant to the terms of special contracts specifying prices based on WEPCO’s “actual costs”. Effective April 1, 2005, WEPCO unilaterally changed its method of calculating the energy charges to the Mines. It was the Mines’ contention that WEPCO’s new billing methodology was inconsistent with the terms of the parties’ contracts and on September 20, 2005, the Mines filed a Demand for Arbitration with the American Arbitration Association with respect to the dispute. Pursuant to the terms of the relevant contracts, disputed amounts were deposited into an interest-bearing account maintained by a bank. An interim agreement was entered into effective May 5, 2006, between WEPCO and the Mines. Under the terms of the agreement, we received a net amount of $67.5 million, representing a rebate of amounts in excess of certain contractual caps paid either to WEPCO or placed in escrow. The agreement also temporarily adjusted the billing and payment provisions of the contracts during the pendency of the arbitration, without affecting the final outcome of the dispute. As of December 31, 2006, a total of approximately $32 million remained in the escrow accounts which represents a portion of WEPCO’s 2005 and 2006 billings, plus accrued interest. On May 3, 2007, the Mines and WEPCO settled their dispute. Under the terms of the Settlement Agreement and Release (the “Settlement”), the Mines received $32.5 million from escrow and paid $9.0 million to WEPCO. Additionally, WEPCO paid the Mines a rebate for over-the-cap payments of $2.6 million. As a result of the settlement, we will recognize a $10.3 million pre-tax gain in the second quarter of 2007. In addition, under the Settlement, the Mines will be billed for electric service from April 1, 2007 at the same rate as provided in the interim agreement. Upon termination of the special contracts on December 31, 2007, the Mines will be subject to the then applicable tariffs approved by the Michigan Public Service Commission.

In anticipation of the termination of these two power supply contracts, on September 8, 2006, the Mines filed a Complaint and Application for Emergency Relief with the Michigan Public Service Commission (the “Commission”), Case No. U-15039 (the “Application”), under which the Mines requested a special transitional rate equivalent to the midpoint between the rates payable under the current power agreements and the applicable industrial tariff rate. The Mines requested that the special transitional rate be available for ten years. On September 28, 2006, prior to the Commission taking any action on the Application, WEPCO filed a rate case with the Commission, MPCS Case No. U-15071 (the “Rate Case”), which included an industrial rate that would be applicable to the Mines. Subsequently, on October 12, 2006, the Commission issued an Order Combining Dockets, under which the Mines’ Application was combined with WEPCO’s rate case. The Order Combining Dockets also established a nine-month schedule for the combined proceedings, with a final order to be issued in July 2007.

On April 30, 2007, the Mines and WEPCO entered into a Settlement Agreement for Final Rate Relief and Tariff Approvals (the “Tariff Agreement”). Under the Tariff Agreement, the Mines and WEPCO reached an

 

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agreement as to the tariff rate to be charged to the Mines under the industrial tariff. Any impact from the results of the combined proceeding will not occur until 2008, when the Power Supply Contracts terminate and it is anticipated that the Mines will be on an industrial tariff.

Maritime Asbestos Litigation.    As has been previously disclosed, The Cleveland-Cliffs Iron Company and/or The Cleveland-Cliffs Steamship Company have been named defendants in 485 actions brought from 1986 to date by former seamen (or their administrators) in which the plaintiffs claim damages under federal law for illnesses allegedly suffered as the result of exposure to airborne asbestos fibers while serving as crew members aboard the vessels previously owned or managed by our entities until the mid-1980s. All of these actions have been consolidated into multidistrict proceedings in the Eastern District of Pennsylvania, whose docket now includes a total of over 30,000 maritime cases filed by seamen against ship-owners and other defendants. All of these cases have been administratively dismissed without prejudice, but can be reinstated upon application by plaintiffs’ counsel. The claims against our entities are insured, subject to self-insured retentions by the insured in amounts that vary by policy year; however, the manner in which these retentions will be applied remains uncertain. Our entities continue to vigorously contest these claims and have made no settlements on these claims.

In April 2007, a lawsuit was filed naming the Company, The Cleveland-Cliffs Iron Company, The Cleveland-Cliffs Steamship Company and other subsidiaries as defendants in a maritime asbestos lawsuit brought in the Court of Common Pleas in Cuyahoga County, Ohio. The plaintiff has alleged exposure to asbestos while serving as a crew member aboard vessels previously owned or managed by our entities between 1967 and 1971. Unlike previously referenced cases, this case is not subject to the multidistrict proceedings in the Eastern District of Pennsylvania and accordingly, is not subject to the administrative dismissal applicable to actions brought in Federal Court. The claim against our entities is insured, subject to self-insurance retentions by the insured in amounts that vary by policy year; however the manner in which these retentions will be applied remains uncertain. Our entities intend to vigorously contest this claim.

Milwaukee Solvay Coke.    In September 2002, we received a draft of a proposed Administrative Order by Consent from the EPA, for clean-up and reimbursement of costs associated with the Milwaukee Solvay coke plant site in Milwaukee, Wisconsin. The plant was operated by a predecessor of ours from 1973 to 1983, which predecessor we acquired in 1986. In January 2003, we completed the sale of the plant site and property to a third party. Following this sale, an Administrative Order by Consent (“Solvay Consent Order”) was entered into with the EPA by us, the new owner and another third party who had operated on the site. In connection with the Solvay Consent Order, the new owner agreed to take responsibility for the removal action and agreed to indemnify us for all costs and expenses in connection with the removal action. In the third quarter of 2003, the new owner, after completing a portion of the removal, experienced financial difficulties. In an effort to continue progress on the removal action, we expended $.9 million in the second half of 2003, $2.1 million in 2004 and $.4 million in 2005 secured by a mortgage on the property. In September 2005, we received a notice of completion from the EPA documenting that all work had been fully performed in accordance with the Solvay Consent Order.

On August 26, 2004, we received a Request for Information pursuant to Section 104(e) of CERCLA relative to the investigation of additional contamination below the ground surface at the Milwaukee Solvay site. The Request for Information was also sent to 13 other PRPs. On July 14, 2005, we received a General Notice Letter from the EPA notifying us that the EPA believes we may be liable under CERCLA and requesting that we, along with other PRPs, voluntarily perform clean-up activities at the site. We have responded to the General Notice Letter indicating that there had been no communications with other PRPs but also indicating our willingness to begin the process of negotiation with the EPA and other interested parties regarding a Consent Order. Subsequently, on July 26, 2005, we received correspondence from the EPA with a proposed Consent Order and informing us that three other PRPs had also expressed interest in negotiating with the EPA. At this time, the nature and extent of the contamination, the required remediation, the total cost of the clean-up and the cost sharing responsibilities of the PRPs cannot be determined, although the EPA advised us that it incurred $.5 million in past response costs, which the EPA will seek to recover from us and the other PRPs.

On August 25, 2006 we completed the sale of our mortgage on the site to East Greenfield Investors, LLC, a successor to Kinnickinnic Development Group LLC (“East Greenfield”). East Greenfield acquired our mortgage on the site in consideration for the assumption of all our environmental obligations with respect to the site and a

 

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cash payment of $2.25 million. In addition, East Greenfield deposited $4.5 million into an escrow account to fund any remaining environmental clean-up activities on the site and to purchase insurance coverage with a $5 million limit.

Rio Tinto.    The Rio Tinto Mine Site is a historic underground copper mine located near Mountain City, NV, where tailings were placed in Mill Creek, a tributary to the Owyhee River. Site investigation and remediation work is being conducted in accordance with a Consent Order between the NDEP and the RTWG composed of the Company, Atlantic Richfield Company, Teck Cominco American Incorporated, and E. I. du Pont de Nemours and Company. The Consent Order provides for technical review by the U.S. Department of the Interior Bureau of Indian Affairs, the U.S. Fish & Wildlife Service, U.S. Department of Agriculture Forest Service, the NDEP and the Shoshone-Paiute Tribes of the Duck Valley Reservation (collectively, “Rio Tinto Trustees”). The Consent Order is currently projected to continue with the objective of supporting the selection of the final remedy for the Site. Costs are shared pursuant to the terms of a Participation Agreement between the parties of the RTWG, who have reserved the right to renegotiate any future participation or cost sharing following the completion of the Consent Order.

The Rio Tinto Trustees have made available for public comment their plans for the assessment of NRD. The RTWG commented on the plans and also are in discussions with the Rio Tinto Trustees informally about those plans. The notice of plan availability is a step in the damage assessment process. The studies presented in the plan may lead to a NRD claim under CERCLA. There is no monetized NRD claim at this time.

During 2006, the focus of the RTWG was on development of alternatives for remediation of the mine site. A draft of an alternatives study was reviewed with NDEP, EPA and the Rio Tinto Trustees and as of December 31, 2006, the alternatives have essentially been reduced to two: (1) tailings stabilization and long-term water treatment; and (2) removal of the tailings. The estimated costs range from approximately $10 million to $27 million. In recognition of the potential for an NRD claim, the parties are actively pursuing a global settlement that would encompass both the remedial action and the NRD issues and thereby avoid the lengthy litigation typically associated with NRD and any such settlement would include the EPA. We increased our reserve by $4.1 million in the third quarter of 2006 to reflect our estimated costs for completing the work under the existing Consent Order and our share of the eventual remediation costs based on a consideration of the various remedial measures and related cost estimates, which are currently under review. The expense was included in Miscellaneous-net in the Statements of Consolidated Operations. During the fourth quarter of 2006, the RTWG retained a team of geochemical consultants to assist with the assessment of remediation alternatives and also initiated a mediation process to determine an equitable allocation of costs for the remediation.

KHD Humboldt Wedag International Ltd. (“KHD”).    On June 20, 2006, KHD and Cade Struktur Corporation (“Cade”) submitted an Arbitration Notice, Appointment of Arbitrator and Request to Appoint Arbitrator to the participants in the Wabush Mines Joint Venture in connection with a dispute over the calculation of royalties under the terms of an Amended and Consolidation of Mining Leases dated September 2, 1959, as amended, between Wabush Iron Co. Limited and Canadian Javelin Limited (a predecessor to KHD and Cade). KHD and Cade have claimed that the Wabush Mines Joint Venture has underpaid royalties since 1991 and claim underpayments in excess of C$15 million. An arbitration panel has been selected and the participants are currently in the discovery phase of the arbitration. The participants in the Wabush Mines Joint Venture have denied the existence of any royalty underpayments and plan to defend the arbitration vigorously. The Company currently owns 26.83 percent of the Wabush Mines Joint Venture.

Deer Lake.    Deer Lake is a reservoir located near Ishpeming, Michigan that historically provided water storage for the Carp River Power Plant that was razed in 1972. Elevated concentrations of mercury in Deer Lake fish were noted in 1981. Three known sources of mercury to the lake were atmospheric deposition, historic use of mercury in gold amalgamation on the west side of the lake, and releases of mercury to the City of Ishpeming sewer system, including waste assay solutions from a laboratory operated by Cliffs. The State of Michigan filed suit in 1982 alleging that we had liability for the mercury releases. A Consent Agreement was entered in 1984 that required certain remediation and mitigation, which was performed, and by 2003 mercury concentrations in fish had declined significantly. Subsequently, we engaged in negotiations with the State to comprehensively and completely resolve our liability for mercury releases. An amendment to the Consent Agreement between the Company and the State was

 

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entered by the Court on November 7, 2006. The agreement provides for additional remedial measures, long-term maintenance and provisions for public access to various water bodies which we own or control. In the fourth quarter of 2006, the reserve was reduced by $1.6 million to reflect our reduced liability.

Northshore Notice of Violation.    On February 10, 2006, our Northshore mine received a Notice from the EPA. The alleged violations related to the restarts of Furnaces 6, 11 and 12. Following a thorough investigation, Northshore met with the EPA, Region V, and submitted a documented response to the allegations. In December 2006, the Minnesota Pollution Control Agency (“MPCA”) advised Northshore that the EPA would not pursue any further action.

Northshore Administrative Permit Amendment.    On December 16, 2006, we submitted an administrative permit amendment application to MPCA with respect to Northshore’s Title V operating permit. The proposed amendment requested the deletion of a 30 year old “control city” monitoring requirement. The MPCA denied our application on February 23, 2007. We have appealed the denial to the Minnesota Court of Appeals.

Subsequent to the filing of our appeal, the MPCA advised Northshore that the MPCA considered Northshore to be in violation of the control city standard. Subsequently, without conceding MPCA’s allegations, we entered into discussions with the MPCA with respect to the terms of a compliance schedule in which we would agree to take certain actions in settlement of the alleged violation. Discussions with the MPCA are currently ongoing. In addition, the Minnesota Center for Environmental Advocacy has since filed a motion with the Court of Appeals to intervene in our appeal of the denial of an administrative amendment to our Title V operating permit. If either our appeal is unsuccessful or if we are unable to negotiate an acceptable compliance schedule, Northshore could be subject to future enforcement actions with respect to its Title V permit if we are unable to meet the control city requirement as interpreted by MPCA.

American Steamship Litigation. One of our subsidiaries, Cliffs Sales Company, currently contracts with American Steamship Company for the transportation of iron ore pellets from various ports on the Great Lakes to a blast furnace ore dock in Cleveland, Ohio. There are ten years remaining on that contract. We filed suit against American Steamship on February 21, 2007, in the United States District Court for the Northern District of Ohio alleging breach of contract and unjust enrichment claims for damages in connection with overcharges by American Steamship for fuel adjustments under the contact. We also requested declaratory relief regarding the fuel adjustment provisions of the contract as well as with respect to American Steamship’s obligation to shuttle iron ore down the Cuyahoga River during the winter.

On May 18, 2007, American Steamship filed its own action in United States District Court for the Northern District of Ohio against Cliffs Sales and adding Northshore Mining Company and Oglebay Norton Marine Services Company, LLC, as parties. American Steamship requested declaratory relief stating that its fuel adjustment charges were proper and that it had no obligation to shuttle iron ore during the winter. American Steamship also requested damages in connection with an alleged anticipatory breach of the contract based on our objection to paying the alleged overcharges as well as declaratory relief regarding the parties’ rights and obligations regarding all agreements that govern the parties’ shipping arrangements.

To date the Company has paid and expensed the alleged overcharges to American Steamship. If the court determines that ASC is not obligated to make certain shuttle movements of iron ore during the winter, the Company will need to reach an agreement with American Steamship or another carrier to make such movements, if such movements are required for us to meet our obligations to our customer. We believe that it will be able to make such arrangements for winter shuttles, should we need to do so, and that such arrangements would not have a material impact on the Company.

Carl’s Tire Retreading Superfund Site. In July 2006 we received a Request for Information pursuant to Section 104(e) of CERCLA relating to contamination of the Carl’s Tire Retreading Superfund Site in Grawn, Grand Traverse County, Michigan resulting from a fire that began at the site in December 1995. The site was a tire recycling business to which the Tilden and Empire Mines shipped tires before the fire. In November 2006 we received a letter from the U.S. Department of Justice notifying us that the EPA is seeking about $3.1 million in response costs associated with releases of hazardous substances from the fire. EPA brought suit against PRPs that have not entered into tolling agreements with the EPA. On November 13, 2006, The Cleveland-Cliffs Iron Company signed a tolling agreement with the EPA on behalf of itself and its corporate affiliates. On April 18,

 

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2007, we, along with 25 other PRPs, received a group settlement demand for approximately $2.3 million. We are currently in the process of determining how to respond to the EPA’s offer. If the matter does not settle, we (along with the other non-settling parties) would face joint and several liability if the EPA is successful in the lawsuit, meaning that we could be held responsible to the U.S. for the entire amount of any judgment.

Item 4.    Submission of Matters to a Vote of Security Holders.

None.

EXECUTIVE OFFICERS OF THE REGISTRANT

 

Name

  

Position with Cleveland-Cliffs Inc as of May 24, 2007

     Age  

J.A. Carrabba

   Chairman, President and Chief Executive Officer    54

D.H. Gunning

   Vice Chairman    64

L. Brlas

   Senior Vice President-Chief Financial Officer and Treasurer    49

D.J. Gallagher

   President, North American Iron Ore    55

W.R. Calfee

   Executive Vice President — Commercial, North American Iron Ore    60

W.A. Brake Jr.

   Executive Vice President — Cliffs Metallics and Chief Technical Officer    47

R.L. Kummer

   Senior Vice President — Human Resources    50

J.A. Trethewey

   Senior Vice President — Business Development    62

W.C. Boor

   Senior Vice President — Business Development    41

G.W. Hawk, Jr.  

   General Counsel and Secretary    50

There is no family relationship between any of our executive officers, or between any of our executive officers and any of our Directors. Officers are elected to serve until successors have been elected. All of the above-named executive officers were elected effective on the dates listed below for each such officer.

The business experience of the persons named above for the past five years is as follows:

 

J.A. Carrabba   

Chairman, President and Chief Executive Officer, Cleveland-Cliffs Inc,
May 8, 2007 to date.

  

President and Chief Executive Officer, Cleveland-Cliffs Inc,
September 1, 2006 to May 7, 2007.

  

President and Chief Operating Officer, Cleveland-Cliffs Inc,
May 23, 2005 to August 31, 2006.

  

President and Chief Operating Officer, Diavik Diamond Mines,
April 21, 2003 to May 22, 2005.

  

General Manager, Weipa Bauxite Operation, Comalco Aluminum
March 1, 2000 to April 20, 2003.

D.H. Gunning   

Vice Chairman, Cleveland-Cliffs Inc, April 16, 2001 to date.

L. Brlas   

Senior Vice President-Chief Financial Officer

and Treasurer, Cleveland-Cliffs Inc,
December 11, 2006 to date.

  

Senior Vice President-Chief Financial Officer, STERIS Corporation,
April 2000 to December 8, 2006.

D.J. Gallagher   

President, North American Iron Ore, Cleveland-Cliffs Inc,
December 11, 2006 to date.

  

President, North American Iron Ore, and Chief Financial Officer and
Treasurer, Cleveland-Cliffs Inc, July 12, 2006 to December 8, 2006.

  

Executive Vice President, Chief Financial Officer and Treasurer,
Cleveland-Cliffs Inc, May 10, 2005 to July 11, 2006.

  

Senior Vice President, Chief Financial Officer and Treasurer,
Cleveland-Cliffs Inc, July 29, 2003 to May 9, 2005.

  

Vice President — Sales, Cleveland-Cliffs Inc,
August 1, 1998 to July 28, 2003.

 

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W.R. Calfee   

Executive Vice President — Commercial, North American Iron Ore,

Cleveland-Cliffs Inc,
July 12, 2006 to date.

  

Executive Vice President — Commercial, Cleveland-Cliffs Inc,
October 1, 1995 to July 11, 2006.

W.A. Brake Jr   

Executive Vice President — Cliffs Metallics and Chief Technical Officer,

Cleveland-Cliffs Inc,
April 16, 2007 to date.

  

Executive Vice President — Operations, Mittal Steel USA,
January 2006 to August 2006.

  

Executive Vice President — Operations East, Mittal Steel USA,
March 2005 — January 2006.

  

Vice President & General Manager, International Steel Group,
March 2003 to March 2005.

  

Division Manager — Hot Rolling, International Steel Group,
April 2002 to March 2003.

R.L. Kummer   

Senior Vice President — Human Resources, Cleveland-Cliffs Inc,
January 1, 2003 to date.

  

Vice President — Human Resources, Cleveland-Cliffs Inc,
September 5, 2000 to December 31, 2002.

J.A. Trethewey   

Senior Vice President — Business Development, Cleveland-Cliffs Inc,
June 1, 2004 to date.

  

Senior Vice President — Operations Improvement, Cleveland-Cliffs Inc,
April 24, 2003 to May 31, 2004.

  

Senior Vice President — Business Development, Cleveland-Cliffs Inc,
March 15, 2001 to April 23, 2003.

W.C. Boor   

Senior Vice President — Business Development, Cleveland-Cliffs Inc,
May 21, 2007 to date.

  

Executive Vice President — Strategy and Development, American Gypsum Co,
(a subsidiary of Eagle Materials Inc.) February 15, 2005 to April 30, 2007

  

Senior Vice President — Corporate Development and Investor Relations,
Eagle Materials Inc. May 1, 2002 - February 14, 2005.

G.W. Hawk, Jr.   

General Counsel and Secretary, Cleveland-Cliffs Inc, January 1, 2005 to date.

  

Assistant General Counsel and Secretary, Cleveland-Cliffs Inc,
August 1, 2003 to December 31, 2004.

  

Assistant General Counsel, Cleveland-Cliffs Inc,
February 17, 2003 to July 31, 2003.

  

Deputy General Counsel, Lincoln Electric Holdings, Inc., 1998 to 2003.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Stock Exchange Information

Our Common Shares (ticker symbol CLF) are listed on the New York Stock Exchange. The shares are also listed on the Chicago Stock Exchange.

Common Share Price Performance and Dividends

All per-share information has been adjusted retroactively to reflect the two-for-one stock splits effective June 30, 2006 and December 31, 2004.

 

     2006    2005
     High    Low    Dividends    High    Low    Dividends

First Quarter

   $ 55.18    $ 40.25    $ .100    $ 44.18    $ 23.40    $ .05

Second Quarter

     50.43      31.39      .125      37.75      25.57      .05

Third Quarter

     40.10      33.16      .125      44.34      28.43      .10

Fourth Quarter

     49.47      36.83      .125      49.63      35.45      .10
                         

Year

     55.18      31.39    $ .475      49.63      23.40    $ .30
                         

At May 18, 2007, we had 1,193 shareholders of record.

Shareholder Return Performance

The following graph shows changes over the past five-year period in the value of $100 invested in: (1) Cliffs’ Common Shares; (2) S&P Stock Index; and (3) S&P Steel Group Index. The values of each investment are based on price change plus reinvestment of all dividends.

LOGO

 

     Value at December 31
     2001    2002    2003    2004    2005    2006

Cliffs’ Common

   $ 100.00    $ 108.48    $ 278.57    $ 570.50    $ 989.14    $ 1,105.15

S&P 500

     100.00      77.95      100.31      111.22      116.68      135.11

S&P Steel

     100.00      76.37      129.51      207.42      253.90      457.73

 

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Unregistered Sales of Equity Securities and Use of Proceeds

On October 15, 2006, November 15, 2006, and December 15, 2006, pursuant to the Cleveland-Cliffs Inc VNQDC Plan, we sold a total of 125 shares of common stock, par value $.25 per share, of Cleveland-Cliffs Inc Common Shares for an aggregate consideration of $5,537.90 to the Trustee of the Trust maintained under the VNQDC Plan. These sales were made in reliance on Rule 506 of Regulation D under the Securities Act of 1933 pursuant to an election made by two managerial employees under the VNQDC.

Purchases of Common Shares by the Company

 

Period

  

(a)

Total Number of
Shares (or Units)
Purchased

   

(b)
Average Price Paid
per Share

(or Unit)

$

  

(c)

Total Number of
Shares (or Units)
Purchased as Part
of Publicly
Announced Plans
or Programs (1)

    (d)
Maximum
Number (or
Approximate
Dollar Value) of
Shares (or
Units) that may
Yet be Purchased
Under the Plans
or Programs

October 1 — 31, 2006

   48,859 (2)   38.2533    30,000 (3)   1,582,700

November 1 — 30, 2006

   110,000     43.2679    110,000     1,472,700

December 1 — 31, 2006

   180,000     47.0779    180,000     1,292,700
                 

Total

   338,859     44.5687    320,000     1,292,700

(1) On July 11, 2006, we received the approval by the Board of Directors to repurchase up to an aggregate of two million Common Shares.

 

(2) On October 2, 2006, we acquired 18,859 shares from a retired employee in connection with a distribution from the Company’s VNQDC to satisfy tax withholding obligations.

 

(3) The share transactions reported for October 2006 were initiated in late September and settled after October 1, 2006.

 

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Item 6.    Selected Financial Data.

Summary of Financial and Other Statistical Data

Cleveland-Cliffs Inc and Consolidated Subsidiaries

 

     2006     2005 (a)     2004     2003 (e)     2002 (e)  

Financial data (in millions, except per share amounts and employees)

          

Operating income (loss) from continuing operations (pre-tax)

          

Revenue from product sales and services

   $ 1,921.7     $ 1,739.5     $ 1,203.1     $ 825.1     $ 586.4  

Cost of goods sold and operating expenses

     (1,507.7 )     (1,350.5 )     (1,053.6 )     (835.0 )     (582.7 )

Other operating income (expense)

     (48.3 )     (32.5 )     (31.9 )     (38.4 )     (65.4 )
                                        

Operating income (loss)

     365.7       356.5       117.6       (48.3 )     (61.7 )

Income (loss) from continuing operations

     279.8       273.2       320.2       (34.9 )     (66.4 )

Income (loss) from discontinued operations

     .3       (.8 )     3.4         (108.5 )
                                        

Income (loss) before extraordinary gain and cumulative effect of accounting changes

     280.1       272.4       323.6       (34.9 )     (174.9 )

Extraordinary gain

           2.2    

Cumulative effect of accounting changes income
(loss) (b)

       5.2           (13.4 )
                                        

Net income (loss)

     280.1       277.6       323.6       (32.7 )     (188.3 )

Preferred stock dividends

     (5.6 )     (5.6 )     (5.3 )    
                                        

Income (loss) applicable to common shares

     274.5       272.0       318.3       (32.7 )     (188.3 )

Earnings (loss) per common share — basic (c) (d)

          

Continuing operations

     6.52       6.16       7.39       (.85 )     (1.64 )

Discontinued operations

     .01       (.02 )     .08         (2.68 )

Cumulative effect of accounting changes and extraordinary gain

       .12         .05       (.33 )
                                        

Earnings (loss) per common shares

     6.53       6.26       7.47       (.80 )     (4.65 )

Earnings (loss) per common share — diluted (c) (d)

          

Continuing operations

     5.19       4.92       5.84       (.85 )     (1.64 )

Discontinued operations

     .01       (.02 )     .06         (2.68 )

Cumulative effect of accounting changes and extraordinary gain

       .09         .05       (.33 )

Earnings (loss) per common share — diluted (c) (d)

     5.20       4.99       5.90       (.80 )     (4.65 )

Total assets

     1,939.7       1,746.7       1,232.3       881.6       718.1  

Debt obligations effectively serviced (f)

     47.2       49.6       9.1       34.6       67.4  

Net cash from (used by) operating activities

     428.5       514.6       (141.4 )     42.7       40.9  

Redeemable cumulative convertible perpetual preferred stock

     172.3       172.5       172.5      

Distributions to preferred shareholders cash dividends

     5.6       5.6       5.3      

Distributions to common shareholders cash dividends

          

- Per share (c) (d)

     .475       .30       .05      

- Total

     20.2       13.1       2.2      

Repurchases of common shares

     121.5         6.5      

North American iron ore production and sales statistics (tons in millions — North America; tonnes in millions - Australia)

          

Production tons — North America

     33.6       35.9       34.4       30.3       27.9  

Tonnes — Australia

     7.7       5.2        

Company’s share of iron ore production—North America (tons)

     20.8       22.1       21.7       18.1       14.7  

Sales tons — North America

     20.4       22.3       22.6       19.2       14.7  

Tonnes — Australia

     7.4       4.9        

Common share outstanding (millions) (c) (d)

          

- Average for year

     42.1       43.4       42.6       41.0       40.4  

- At year-end

     40.9       43.8       43.2       42.0       40.4  

Employees at year-end (g)

     4,189       4,085       3,777       3,956       3,858  

(a) On April 19, 2005, we completed the acquisition of 80.4 percent of Portman, an iron ore mining company in Australia. The acquisition was initiated on March 31, 2005 by the purchase of approximately 68.7 percent of Portman’s outstanding shares. Results for 2005 include Portman’s results since the acquisition.

 

(b) Effective January 1, 2005, we adopted EITF 04-6, “Accounting for Stripping Costs Incurred during Production in the Mining Industry”. Effective January 1, 2002, we adopted SFAS No. 143, “Accounting for Asset Retirement Obligations”.

 

(c)

On May 9, 2006, the Board of Directors of the Company approved a two-for-one stock split of its common shares. The record date for the stock split was June 15, 2006 with a distribution date of June 30, 2006. Accordingly, all

 

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common shares and per share amounts have been adjusted retroactively to reflect the stock split. Additionally, all diluted per share amounts reflect the “as-if-converted” effect of our convertible preferred stock as required by EITF 04-8.

 

(d) On November 9, 2004, the Board of Directors of the Company approved a two-for-one stock split of its common shares. The record date for the stock split was December 15, 2004, with a distribution date of December 31, 2004. Accordingly, all common shares and per share amounts have been adjusted retroactively to reflect the stock split.

 

(e) In 2003, we recognized a $2.2 million extraordinary gain in the acquisition of the assets of Eveleth Mines; $3.3 million acquisition and startup costs for this same mine, renamed United Taconite and $8.7 million of restructuring charges related to a salaried employee reduction program. Results for 2002 include $95.7 million and $52.7 million for impairment charges relating to discontinued operations and impairment of mining assets, respectively.

 

(f) Includes our share of unconsolidated ventures and equipment acquired on capital leases; includes short-term portion.

 

(g) Includes employees of managed mining ventures.

 

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Cleveland-Cliffs Inc is the largest producer of iron ore pellets in North America. We sell the majority of our pellets to integrated steel companies in the United States and Canada. We manage and operate six North American iron ore mines located in Michigan, Minnesota, and Eastern Canada that currently have a rated capacity of 37.0 million tons of iron ore pellet production annually, representing approximately 46 percent of the current North American pellet production capacity. The other iron ore mines in the U.S. and Canada have an aggregate rated capacity of 44.1 million tons. Based on our percentage ownership in the mines we operate, our share of the rated pellet production capacity is currently 22.9 million tons annually, representing approximately 28 percent of total North American annual pellet capacity.

On April 19, 2005, Cliffs Asia Pacific, a wholly owned subsidiary of the Company, completed the acquisition of 80.4 percent of Portman, an iron ore mining company in Australia. The acquisition was initiated on March 31, 2005, by the purchase of 68.7 percent of the outstanding shares of Portman. As a result of the acquisition, we operate in two reportable segments: the North America segment and the Australia segment, also referred to as Portman.

Portman serves the Asian iron ore markets with direct-shipping fines and lump ore from two iron ore projects, both located in Western Australia. Portman’s full-year 2006 production (excluding its .7 million tonne share of the 50 percent-owned Cockatoo Island Joint Venture) was 7.0 million tonnes. Portman completed a $62 million project to increase its wholly owned production capacity to eight million tonnes per year in the first half of 2006. The production is committed to steel companies in China and Japan through 2009.

The Portman acquisition represents a significant milestone in our long-term strategy to pursue investment and management opportunities to broaden our scope as a supplier of iron ore or other raw materials to the integrated steel industry through the acquisition of additional mining interests to strengthen our market position. We are particularly focused on expanding our international investments to capitalize on global demand for steel and iron ore.

The global mining environment is changing to meet the needs of today’s market. While this is an environment that has allowed Cliffs to reach record sales and earnings over the past several years, it also highlights challenges to our traditional business and the limited growth potential of the North American market. We have developed and are executing strategies to capitalize on the new trends, to grow the business and to deliver competitive returns to our shareholders in a changing environment for mining and iron ore.

On March 5, 2007, we acquired a 30 percent interest in MMX Amapa Mineracao LTDA., a Brazilian company developing an iron ore project (Amapa Project), through the acquisition of 100 percent of the shares of Centennial Amapa. The remaining 70 percent of the Amapa Project is owned by MMX Mineracao e Metallicos S.A., which is providing corporate and institutional support, while we will supply technical support for construction and operations. The purchase price for our 30 percent interest was $133 million, paid with cash on hand. Total capital expenditures are estimated to be $357 million, of which approximately $268 million will be funded with project debt. Capital contributions of $89.3 million were paid by Cliffs and MMX to fund the project; Cliffs 30 percent share was $26.8 million. We may be responsible for 30 percent of any additional capital contributions.

The Amapa Project consists of a significant iron ore deposit, a 192-kilometer railway connecting the mine location to an existing port facility and 71 hectares of real estate on the banks of the Amazon River, reserved for a loading terminal. The Amapa Project is currently under construction and is expected to produce 6.5 million tonnes of iron ore concentrate annually once fully operational. Iron ore concentrate is expected to be sold, pursuant to a long-term supply agreement, to an operator of an iron oxide pelletizing plant in the Kingdom of Bahrain. Production is expected to begin in late 2007.

On April 18, 2007, we completed the acquisition of an effective 45 percent interest in the Sonoma Coal Project in Queensland, Australia. As of May 3, 2007, we invested $15.6 million toward the purchase of mining tenements and $19.4 million toward the construction of a washplant. We will operate and own 100 percent of the washplant and 8.3 percent of the mining leases, resulting in a 45 percent economic interest in Sonoma.

 

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The Sonoma Coal Project is expected to initially produce two million tonnes of marketable coal annually, beginning late in 2007. Production from Sonoma will include an approximately equal mix of hard coking coal and thermal coal. Plans call for annual production to increase to between three million and four million tonnes during 2008. The Sonoma Coal Project has a current resource estimate of 107 million tonnes.

We have also realigned our management roles and have created a business unit corporate structure to support our ongoing growth strategy. Under this new organizational model, each unit will be responsible for its own operational activities with shared support from our central service and corporate groups. As we continue our growth, this structure will provide the flexibility to align the organization to potential new opportunities.

In North America, we are engaged with expanding our leadership position in the industry by focusing on high product quality, technical excellence, superior relationships with our customers and partners and improved operational efficiency through cost saving initiatives. We operate a fully-equipped research and development facility in Ishpeming, Michigan. Our research and development group is staffed with experienced engineers and scientists and is organized to support the geological interpretation, process mineralogy, mine engineering, mineral processing, pyrometallurgy, advanced process control and analytical service disciplines. Our research and development group is also utilized by iron ore pellet customers for laboratory testing and simulation of blast furnace conditions.

We will continue to investigate opportunities to expand our leadership position in the North American iron ore market. We were not able to reach agreement on terms with the other participants in the Mesabi Nugget Project to move forward with the construction of a reduced iron plant. However, we are evaluating opportunities with Kobe Steel to proceed with the development of a commercial-scale reduced iron plant, which will convert taconite into nearly pure iron in nugget form utilizing Kobe Steel’s ITmk3 technology. See Strategic Investments — Mesabi Nugget Project for further information.

A consequence of the expanding industry has been significant increases in capital, supply, energy and employment costs as suppliers attempt to meet increasing demand. Rising costs could threaten our margins and limit our strategic flexibility. Our challenge is to improve performance at all of our mining operations. To minimize the threat of increasing mining costs, we have developed initiative teams to focus on business improvement, asset productivity, energy usage, alternative fuels and strategic sourcing. We have also initiated comprehensive personnel plans that will address current talent needs, meet future hiring requirements and identify specific succession plans for key management positions.

We have taken a balanced approach to allocation of our capital resources and free cash flow. We have made strategic investments both domestically and internationally, increased our capital expenditures, strengthened our balance sheet, increased funding of our employee benefit obligations, increased our common stock dividends, repurchased our common stock and increased our borrowing capacity.

Our strategic redirection and acceptance of additional risks of increased mine ownership followed by significant increases in iron ore demand and pricing culminated in record operating income in 2004, 2005 and 2006, solid financial condition, and a strong base for future growth. In the last five years, our revenues have increased over 220 percent from $.6 billion in 2002 to $1.9 billion in 2006. Our net income increased to $280 million in 2006 from a loss of $188 million in 2002.

Our operating objectives are to maximize safe production, efficiency and productivity at our mines. Unfortunately, during the year we experienced three very serious incidents resulting in fatalities. We achieved a reportable incident rate, as defined by MSHA, of 2.26 in North America. According to MSHA, the industry frequency rate for total reportable incidents for U.S. mines, mills and shops (excluding coal) was 3.35 per 200,000 employee hours worked in 2006. Our frequency rate for lost-time incidents in 2006 was 1.40 per 200,000 employee hours worked, compared with an MSHA lost-time incident rate of 2.20.

At the Koolyanobbing operation, the LTIFR for the year was 3.5, which is slightly below the Western Australian Metalliferous surface mining industry average of 3.8 incidents per million man-hours. During 2006, five LTI’s were recorded at the Koolyanobbing operation. At Cockatoo Island, two LTI’s were incurred, resulting in a LTIFR of 7.87 for the year. Portman’s safety statistics include employees and contractors.

 

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Recent Accounting Pronouncements

Refer to NOTE 1 — BUSINESS SUMMARY AND SIGNIFICANT ACCOUNTING POLICIES — of the Consolidated Financial Statements for a description of recent accounting pronouncements, including the respective dates of adoption and effects on results of operations and financial condition.

Two-for-One Stock Splits

On June 30, 2006 and December 31, 2004, the Company completed two-for-one stock splits of its common shares with corresponding decreases in par value from $.50 to $.25 and from $1.00 to $.50, respectively. Accordingly, all common shares, per-share amounts, stock compensation plans and preferred stock conversion rates have been adjusted retroactively to reflect the stock splits. Additionally, all diluted per-share amounts reflect the “as-if-converted” effect of our convertible preferred stock as required by EITF 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings per Share.

Key Operating and Financial Indicators

Following is a summary of our key operating and financial indicators for the years 2006, 2005 and 2004:

 

     (In Millions, Except EPS)
     2006    2005     2004

North American pellet sales (tons)

     20.4      22.3       22.6

Australian iron ore sales (tonnes)

     7.4      4.9    

North American pellet production (tons)

       

Total

     33.6      35.9       34.4

Company’s share

     20.8      22.1       21.7

Australian iron ore production (tonnes)

     7.7      5.2    

Revenues from iron ore sales and services*

   $ 1,921.7    $ 1,739.5     $ 1,203.1

Operating income

     365.7      356.5       117.6

Income from continuing operations

       

Amount

     279.8      273.2       320.2

Per diluted share

     5.19      4.92       5.84

Income (loss) from discontinued operations

       

Amount

     .3      (.8 )     3.4

Per diluted share

     .01      (.02 )     .06

Cumulative effect of accounting change

       

Amount

        5.2    

Per diluted share

        .09    

Net income

       

Amount

     280.1      277.6       323.6

Per diluted share

     5.20      4.99       5.90

* Includes revenues of $252.6 million, $227.3 million and $208.1 million in 2006, 2005, and 2004, respectively, related to freight and venture partners’ cost reimbursements.

2006 Versus 2005

North American Iron Ore

Following is a summary of North American sales margin for 2006 versus 2005:

 

     (In Millions)  
               Increase (Decrease) Due To:  
     2006    2005    Rate     Volume     Total  

Sales revenue*

   $ 1,308.1    $ 1,307.7    $ 111.6     $ (111.2 )   $ .4  

Cost of goods sold and operating expenses*

     980.7      949.1      112.3       (80.7 )     31.6  
                                      

Sales margin*

   $ 327.4    $ 358.6    $ (.7 )   $ (30.5 )   $ (31.2 )
                                      

* Excludes freight and venture partners’ cost reimbursements.

 

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Revenues from Iron Ore Sales and Services

Sales revenue increased $.4 million. The increase in sales revenue was due to higher sales prices, $111.6 million, partially offset by a sales volume decrease of 1.9 million tons, or $111.2 million. The 9.3 percent increase in sales prices primarily reflected the effect of contractual base price increases, higher term supply agreement escalation factors including higher steel pricing, higher PPI and lag-year adjustments, partially offset by the impact of lower international benchmark pellet prices. The price of blast furnace pellets for Eastern Canadian producers decreased 3.5 percent. Included in 2006 revenues were approximately 1.3 million tons of 2006 sales at 2005 contract prices and $21.6 million of revenue related to pricing adjustments on 2005 sales.

Cost of Goods Sold and Operating Expenses

Cost of goods sold and operating expenses increased $31.6 million or approximately three percent. The increase primarily reflected higher unit production costs of $112.3 million. Lower sales volume reduced costs $80.7 million. On a per-ton basis, cost of goods sold and operating expenses increased approximately 13 percent, primarily due to higher maintenance activity, increased energy and supply pricing, increased stripping and higher employment costs. Production costs were also impacted by an approximate $15 million cost effect related to production curtailments caused by the October 12, 2006 explosions at the United Taconite processing plant. See Production and Sales Volume for further information regarding production volumes.

Sales Margin

The sales margin decrease of $31.2 million or approximately nine percent was primarily due to higher production costs and lower sales volume, partially offset by an increase in sales prices.

Australia Iron Ore

Following is a summary of Australia sales margin for 2006 versus 2005:

 

     (In Millions)
               Increase (Decrease) Due To:
     2006    2005    Rate    Volume*    Total

Sales revenue

   $ 361.0    $ 204.5    $ 51.5    $ 105.0    $ 156.5

Cost of goods sold and operating expenses

     274.4      174.1      10.9      89.4      100.3
                                  

Sales margin

   $ 86.6    $ 30.4    $ 40.6    $ 15.6    $ 56.2
                                  

* Volume for 2005 includes Portman’s results since the March 31, 2005 acquisition.

Revenues from Iron Ore Sales and Services

Sales revenue increased $156.5 million or approximately 77 percent. The increase in sales revenue was due to higher volume, $105.0 million and higher sales prices, $51.5 million. The 2.5 million tonne volume increase reflected the expansion of the Koolyanobbing operations in 2006 and the exclusion of sales prior to the March 31, 2005 acquisition. Portman’s sales prices include the effects of a 19 percent increase in the international benchmark price of iron ore fines and lump.

Cost of Goods Sold and Operating Expenses

Cost of goods sold and operating expenses increased $100.3 million or approximately 58 percent. The increase primarily reflected the effect of higher volume and an increase in unit production costs, primarily higher contract labor.

Sales Margin

The sales margin increase of $56.2 million was primarily due to higher sales volume and prices, partially offset by higher unit production costs.

 

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Other Operating Income

The pre-tax earnings changes for 2006 versus 2005 also included:

 

   

A recovery in 2005 of $12.3 million related to a five-week production curtailment at the Empire and Tilden mines in 2003 due to the loss of electric power as a result of flooding in the Upper Peninsula of Michigan. We expect to recover a portion of our deductible in the second quarter of 2007, totaling $3.0 million;

 

   

Higher administrative, selling and general expenses of $6.7 million reflecting increased outside professional services and full-year expense at Portman, partially offset by lower incentive compensation;

 

   

Higher customer bankruptcy recoveries in 2006 reflected complete recovery of our $3.9 million reserve related to WCI’s 2003 bankruptcy filing. See Customers — WCI — in PART I for further information; and,

 

   

Lower miscellaneous-net expense of $2.6 million, primarily reflecting higher mark-to-market currency gains at Portman of $5.3 million, partially offset by the $3.0 million property damage insurance deductible associated with the electrical explosions at United Taconite.

Other Income (Expense)

 

   

Lower gain on sales of assets to PolyMet. We realized an $8.4 million gain on a 2006 sale, compared with a $9.5 million gain in 2005. See PolyMet for further information;

 

   

Increased interest income of $3.3 million reflected higher average cash balances and higher interest rates; and,

 

   

Lower other-net expense of $6.7 million primarily reflected $9.8 million of currency hedging costs associated with the Portman acquisition in the first quarter of 2005, partially offset by $1.7 million of expense in 2006 related to the accelerated write-off of debt issuance costs due to the replacement of our unsecured revolving credit facility. See NOTE 6 — CREDIT FACILITIES for further information.

Income Taxes

During 2005, an $8.9 million adjustment to reverse a valuation allowance on net operating losses attributable to pre-consolidated separate return years of one of our subsidiaries was recognized. Excluding the $8.9 million reversal in 2005, income tax expense of $90.9 million in 2006 was $2.8 million lower than the comparable amount last year. The decrease was due to a lower effective tax rate, partially offset by higher pre-tax income in 2006. See NOTE 9 — INCOME TAXES — for further information.

Minority Interest

Minority interest increased $7.0 million, or almost 70 percent from the prior year. Minority interest represents the 19.6 percent minority interest in Portman’s earnings.

Discontinued Operations

Our arrangements with Ferrominera, a government-owned company responsible for the development of Venezuela’s iron ore industry, to provide technical assistance in support of improving operations of a 3.3 million tonne per year pelletizing facility, were terminated in the third quarter of 2005. We recorded after-tax income of $.2 million related to this contract in 2006, compared with 2005 after-tax expense of $1.7 million, which included our exit costs.

On July 23, 2004, CAL, an affiliate of the Company jointly owned by a subsidiary of the Company (82.3945 percent) and Outokumpu Technology GmbH (17.6055 percent), a German company (formerly known as Lurgi Metallurgie GmbH), completed the sale of CAL’s HBI facility located in Trinidad and Tobago to Mittal Steel USA. Terms of the sale included a purchase price of $8.0 million plus assumption of liabilities. Mittal Steel USA closed this facility at the end of 2005. We recorded after-tax income of $.1 million in 2006, compared with after-tax income of $.9 million in 2005.

 

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The results of discontinued operations for CAL and Ferrominera were recorded under Income (Loss) from Discontinued Operations in the Statements of Consolidated Operations.

2005 Versus 2004

North American Iron Ore

Following is a summary of North American sales margin for 2005 versus 2004:

 

     (In Millions)
               Increase (Decrease) Due To:
     2005    2004    Rate    Volume     Total

Sales revenue*

   $ 1,307.7    $ 995.0    $ 328.0    $ (15.3 )   $ 312.7

Cost of goods sold and operating expenses*

     949.1      845.5      116.6      (13.0 )     103.6
                                   

Sales margin*

   $ 358.6    $ 149.5    $ 211.4    $ (2.3 )   $ 209.1
                                   

* Excludes freight and venture partners’ cost reimbursements.

Revenues from Iron Ore Sales and Services

Sales revenue increased $312.7 million or approximately 31 percent. The increase in sales revenue was due to higher sales prices, $328.0 million, partially offset by a sales volume decrease of $15.3 million. The 33 percent increase in sales prices primarily reflected the effect on Cliffs’ term supply agreement price adjustment factors of an approximate 86 percent increase in international pellet pricing, higher steel pricing, higher PPI and other contractual increases, including base price increases and lag-year adjustments. Included in 2005 revenues was approximately .9 million tons of 2005 sales at 2004 contract prices and $2.4 million of price adjustments on 2004 sales.

Cost of Goods Sold and Operating Expenses

Cost of goods sold and operating expenses increased $103.6 million, or approximately 12 percent. The increase primarily reflected higher production costs of $116.6 million. Lower sales volume of .3 million tons reduced costs $13.0 million. The increase in unit production costs principally reflected higher energy pricing, increased maintenance costs, higher supply prices, and higher royalty rates due to increased pellet sales pricing.

Sales Margin

The sales margin improvement of $209.1 million in 2005 was principally due to an increase in sales price, partially offset by higher production costs and lower volume.

Australia Iron Ore

Revenues from Iron Ore Sales and Services

Sales revenue of $204.5 million on 4.9 million tonnes of Portman’s sales reflected results since the March 31, 2005 acquisition.

Cost of Goods Sold and Operating Expenses

Cost of goods sold and operating expenses of $174.1 million for the nine-month period included $38.6 million of basis adjustments to inventory and mineral rights due to the preliminary allocation of the $433.1 million purchase price.

Sales Margin

The sales margin of $30.4 million on 4.9 million tonnes of Portman’s sales reflected results since the March 31, 2005 acquisition.

 

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Other Operating Income

The pre-tax earnings changes for 2005 versus 2004 also included:

 

   

The previously noted business interruption insurance recovery in 2005 of $12.3 million;

 

   

Higher royalties and management fee revenue of $1.8 million, primarily reflecting higher Wabush management fees due to the approximate 86 percent increase in Eastern Canadian pellet prices;

 

   

Higher administrative, selling and general expense of $14.8 million reflecting higher stock-based compensation and the inclusion of $5.5 million of Portman’s expense since the acquisition;

 

   

Lower impairment of mining asset charges, $5.8 million. Due primarily to the significant increase in 2005 pellet pricing, we determined, based on a cash flow analysis, that our Empire mine was no longer impaired; accordingly, capital additions at Empire in 2005 were not charged to expense;

 

   

Lower provision for customer bankruptcy exposures, $3.6 million. Results for 2005 included a $1.9 million recovery from WCI. Results for 2004 included a first-quarter charge related to a subsidiary of Weirton, $1.6 million; and

 

   

Miscellaneous — net expense, $9.1 million higher than the same period in 2004. Miscellaneous-net included $5.2 million to clean a PCB spill at the Tilden mine in November 2005, and $1.9 million of expense at Portman since the acquisition.

Other Income (Expense)

 

   

Year 2004 results included a $152.7 million gain on the sale of directly-held ISG common stock;

 

   

A 2005 gain of $9.5 million on the sale of certain assets to PolyMet. See PolyMet for further information;

 

   

Increased interest income of $2.4 million reflecting higher average cash and short-term marketable securities balances and slightly higher rates;

 

   

Increased interest expense of $3.7 million included $2.0 million of interest expense at Portman since the acquisition and interim borrowings (repaid within 100 days) under Cliffs’ $350 million revolving credit facility to supplement funds required for the Portman acquisition; and

 

   

Higher other-net expense of $11.5 million primarily reflected $9.8 million of currency hedging costs associated with the Portman acquisition.

Income Taxes

We entered 2005 with a valuation allowance to reduce a deferred tax asset related to $25.4 million of net operating losses attributable to pre-consolidation years of one of our subsidiaries. In the fourth quarter of 2005, we determined, based on the existence of sufficient evidence, that we no longer required this valuation allowance. During 2005, an $8.9 million adjustment to reverse this valuation allowance was recognized.

In the fourth quarter of 2004, we determined, based on the existence of sufficient evidence that we no longer required a previously established valuation allowance other than $8.9 million related to net operating loss carryforwards described above. During 2004, a $113.8 million adjustment to reduce the valuation allowance was recognized.

Excluding the $8.9 million and $113.8 million valuation reversals in 2005 and 2004, respectively, income tax expense of $93.7 million in 2005 was $14.9 million higher than the comparable amount in 2004. The increase was due to higher pre-tax income in 2005, partially offset by a lower effective tax rate.

Minority Interest

Minority interest was $10.1 million for 2005 and represented the 19.6 percent minority interest in Portman’s earnings.

 

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Discontinued Operations

We recorded after-tax income of $.9 million related to CAL in 2005, compared with after-tax income of $3.1 million in 2004.

We recorded after-tax expense of $1.7 million related to our contract with Ferrominera in 2005, compared with after-tax income of $.3 million in 2004.

Cash Flow and Liquidity

Following is a summary of our cash flows for 2006, 2005 and 2004:

 

     (In Millions)  
     2006     2005     2004  

Net cash from (used by) operating activities

   $ 428.5     $ 514.6     $ (141.4 )

Capital expenditures

     (132.9 )     (106.3 )     (60.7 )

Investment in Portman (net of $24.1 million cash acquired)

       (409.0 )  

Proceeds from sale of ISG common stock

         170.1  

Repurchases of common stock

     (121.5 )    

Dividends on common and preferred stock

     (25.8 )     (18.7 )     (6.1 )

Proceeds from convertible preferred stock

         172.5  

Other

     10.3       (2.5 )     7.7  
                        

Increase (decrease) in cash and cash equivalents from continuing operations

     158.6       (21.9 )     142.1  

Cash from (used by) discontinued operations

     .3       (2.2 )     7.0  
                        

Increase (decrease) in cash and cash equivalents

   $ 158.9     $ (24.1 )   $ 149.1  
                        

Net cash from operating activities (“operating cash flows”) included $79.2 million and $68.3 million related to Portman in 2006 and 2005, respectively. The decrease in operating cash flows in 2006 compared with 2005 was primarily due to lower cash provided from changes in operating assets and liabilities. Operating cash flows in 2006 include $62.6 million relating to 1.2 million tons of pellets purchased by two customers for which revenue has been deferred until the product is delivered in 2007. Operating cash flows in 2005 included the proceeds from the sale of $182.7 million of highly liquid marketable securities used in connection with our acquisition of Portman, net of $9.9 million purchases of ARS. Operating cash flows in 2006 compared with 2005 also reflected higher cash flows resulting from higher payables and accrued expenses.

At December 31, 2006, there were 3.8 million tons of pellets in inventory at a cost of $129.5 million, ..5 million tons higher than last year, an increase of $24.2 million. The increase in pellet inventory was primarily due to lower sales volume, partially offset by lower production. See Production and Sales Volume for further information regarding North American production. At December 31, 2006, Portman had .9 million tonnes of finished product inventory at a cost of $20.8 million, .3 million tonnes higher than last year, or an increase of $7.0 million. The increase in inventory is primarily due to increased production attributable to the expansion of the Koolyanobbing operations.

Net cash from operating activities in 2006 and 2005 also reflected $95.7 million and $86.2 million of income tax payments and $64.2 million and $55.8 million of contributions to pension plans and VEBAs, respectively. In 2006, we received a $67.5 million refund from the WEPCO escrow account. See Wisconsin Electric Power Company Dispute for further information.

Capital expenditures included $39.6 million and $37.2 million related to Portman in 2006 and 2005, respectively. We anticipate that total cash used for investments and capital expenditures in 2007 will be approximately $460 million, including $240 million associated with the Amapa Project and $96 million with the Sonoma Coal Project. The Amapa Project investment is comprised of the $133 million initial investment, $26.8 million for our share of Amapa’s 2007 capital expenditures and $84 million of construction expenditures financed by project-level debt. Capital expenditures at our North American and Portman operations are estimated

 

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at $123 million. Included in the 2007 capital spending estimate is $19 million related to the .8 million ton capacity expansion at the Northshore mine. We expect to fund our capital expenditures from available cash, current operations and borrowings under our credit facility.

Common stock repurchases in 2006 reflected the purchase of 3.2 million shares of 4.5 million shares authorized under two 2006 repurchase programs. Also, we increased our quarterly common share dividend to $.125 per share from $.10 per share effective on June 1, 2006 and to $.10 per share from $.05 per share effective on September 1, 2005.

Following is a summary of key liquidity measures:

 

     At December 31
     (In Millions)
     2006     2005     2004

Cash and cash equivalents

   $ 351.7     $ 192.8     $ 216.9
                      

Marketable securities — trading

     $ 9.9     $ 182.7
                      

Debt

   $ (6.9 )   $ (7.7 )  
                      

Working capital

   $ 407.4     $ 273.3     $ 474.3
                      

Cash and cash equivalents included $97.6 million and $54.7 million at Portman in 2006 and 2005, respectively.

In June 2006, we entered into a five-year unsecured credit agreement with a syndicate of 16 financial institutions. The new facility provides $500 million in borrowing capacity under a revolving credit line, with no scheduled maturities other than the five-year term of the agreement; loans are made with a choice of interest rates and maturities, subject to the terms of the agreement. The new credit agreement replaced an existing $350 million unsecured revolving credit facility, which was scheduled to expire in March 2008. The current facility has financial covenants based on earnings, debt and fixed cost coverage. Interest rates are either (1) a range from LIBOR plus .75 to LIBOR plus 1.50 percent, based on debt and earnings, or (2) the prime rate. Borrowings outstanding under the credit agreement were $135 million at May 16, 2007. We were in compliance with the covenants in the credit agreement as of December 31, 2006 and March 31, 2007. Per the terms of the credit agreement, we are required to deliver annual financial statements to the lenders within 90 days of fiscal year-end. On April 18, 2007, we received a waiver extending the requirement to 180 days following fiscal year-end.

During the fourth quarter of 2006, Portman reduced its A$40 million multi-option credit facility to A$11.8 million, which represents the outstanding commitments under performance bonds. Portman entered into a new A$40 million multi-option credit facility in April 2007. Borrowings outstanding under Portman’s facility totaled A$13.3 million at March 31, 2007.

In 2005, Portman secured five-year financing from its customers in China to assist with the funding of the expansion of its Koolyanobbing mining operation. The borrowings, totaling $6.9 million at December 31, 2006, accrue interest annually at five percent. The borrowings require an approximate $.8 million principal payment plus accrued interest to be made each January 31 for the next three years with the remaining balance due in full on January 31, 2010.

 

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Contractual Obligations and Off-Balance Sheet Arrangements

Other than operating leases primarily utilized for certain equipment and office space, we do not have any off-balance sheet financing. Following is a summary of our contractual obligations at December 31, 2006:

 

     Payments Due by Period (1) (In Millions)

Contractual Obligations

   Total    Less Than
1 Year
   1 - 3
Years
   3 - 5
Years
   More Than
5 Years

Long-term debt

   $ 6.9    $ .8    $ 1.5    $ 4.6   

Capital lease obligations

     39.4      6.3      9.4      7.3    $ 16.4

Operating leases

     49.5      13.0      19.1      15.0      2.4

Purchase obligations

              

Open purchase orders

     142.4      117.9      24.5      

Minimum “take or pay” purchase commitments (2)

     574.7      168.0      173.1      155.8      77.8
                                  

Total purchase obligations

     717.1      285.9      197.6      155.8      77.8

Other long-term liabilities

              

Pension funding minimums

     148.0      35.5      50.7      30.6      31.2

OPEB claim payments

     172.8      37.3      57.5      52.1      25.9

Mine closure obligations

     104.4      3.5      19.9      15.8      65.2

Coal industry retiree health benefits

     5.4      .6      1.2      1.1      2.5

Personal injury

     16.5      4.3      5.2      1.7      5.3

Other (3)

     183.6            
                                  

Total other long-term liabilities

     630.7      81.2      134.5      101.3      130.1
                                  

Total

   $ 1,443.6    $ 387.2    $ 362.1    $ 284.0    $ 226.7
                                  

(1) Includes our consolidated obligations and our ownership share of unconsolidated ventures’ obligations.

 

(2) Includes minimum electric power demand charges, minimum coal and natural gas obligations, and

minimum railroad transportation obligations.

 

(3) Primarily includes deferred income taxes payable and other contingent liabilities for which payment

timing is non-determinable.

Production and Sales Volume

Production

Following is a summary of production tonnage for 2006, 2005 and 2004:

 

     Production (In Millions)
     Company Share    Total Production

Mine

   2006    2005    2004    2006    2005    2004

North America (1)

                 

Empire

   3.8    3.8    4.3    4.9    4.8    5.4

Tilden

   5.9    6.7    6.6    6.9    7.9    7.8

Hibbing

   1.9    2.0    1.9    8.3    8.5    8.3

Northshore

   5.1    4.9    5.0    5.1    4.9    5.0

United Taconite

   3.0    3.4    2.9    4.3    4.9    4.1

Wabush

   1.1    1.3    1.0    4.1    4.9    3.8
                             

Total

   20.8    22.1    21.7    33.6    35.9    34.4
                             

Australia (2)

                 

Koolyanobbing

            7.0    4.7   

Cockatoo Island

            .7    .5   
                     

Total

            7.7    5.2   
                     

(1) Long tons of pellets of 2,240 pounds.

 

(2) Metric tonnes of 2,205 pounds. Totals reflect production since the March 31, 2005 acquisition. Cockatoo production reflects our 50 percent share.

 

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Production at Tilden in 2006 was lower than the previous year due to unplanned equipment repairs and a change in mix to produce more magnetite pellets to fulfill customer requirements. Magnetite pellets have lower productivity than hematite pellets.

The decrease in United Taconite production was due to the electrical explosions at the United Taconite processing plant on October 12, 2006. Production at the United Taconite plant was temporarily curtailed as a result of the loss of electrical power resulting from the explosions. Repairs to the plant’s Line 2 were completed and full production resumed in January 2007.

The decrease in Wabush production in 2006 was due to continued mining difficulties. Crude ore mining was significantly impacted by pit de-watering difficulties, which adversely impacted production and costs. Wabush successfully completed actions that increased annual pellet production to a 4.9 million ton rate by the end of 2006. Additionally, a C$1.4 million project was approved in 2006 to install a manganese reduction test circuit on one processing line in the Wabush concentrator. Successful operations of the test circuit could lead to the installation of manganese reduction on all Wabush processing lines. The capability to remove manganese from crude ore could allow the processing of ores previously classified as waste and potentially extend the life of the mine. Production at Wabush for 2007 is estimated at 4.8 million tons of pellets.

During 2004, we initiated capacity expansion projects at our United Taconite and Northshore mines in Minnesota. An idled pellet furnace at United Taconite was restarted in the fourth quarter of 2004, which added approximately 1.0 million tons (our share .7 million tons) to annual production capacity. In 2006, we reinitiated construction activity to restart an idled furnace at Northshore. The project, which will increase Northshore’s capacity by ..8 million tons, is expected to be completed in the first quarter of 2008. The furnace, idled since 1982, initially was scheduled to restart in late 2005; however the restart had been put on hold due to market conditions.

Portman’s 2005 production reflects results since the March 31, 2005 acquisition. An expansion of the Koolyanobbing facility was completed in 2006 that increased the Portman’s wholly-owned production capacity from six to eight million tonnes per annum.

Sales

Our pellet sales for the year 2006 were 20.4 million tons, compared with 22.3 million tons in 2005. The decrease in pellet sales was primarily due to lower consignment sales as a result of customers’ inventory requirements and programmed contractual changes with customers. Our sales are largely committed under term supply agreements, which are subject to changes in customer requirements.

Portman sold 7.4 million tonnes of fines and lump ore in 2006, compared with 4.9 million tonnes in 2005. The increase in fines and lump ore sales principally reflect nine months of sales in 2005 since the acquisition. Production is fully committed to steel companies in China and Japan through 2009.

Pensions and Other Postretirement Benefits

Defined benefit pension expense totaled $26.4 million and $20.7 million for 2006 and 2005, respectively. The increase in defined benefit pension expense was due primarily to a decrease in discount rates.

OPEB expense totaled $11.2 million and $17.9 million for 2006 and 2005, respectively. The decrease in OPEB expense was due to higher expected asset returns and lower loss amortization. The higher asset returns mainly reflect additional VEBA contributions agreed to under the existing labor agreement with the USW. The decrease in loss amortization is due to longer amortization periods reflecting increased remaining service lives of employees.

See Employee Retirement Benefit Obligations under Critical Accounting Policies in Item 7 and NOTE 8 — RETIREMENT RELATED BENEFITS — for further information.

Wisconsin Electric Power Company Dispute

Two of our mines, Tilden and Empire (the “Mines”), currently purchase their electric power from WEPCO pursuant to the terms of special contracts specifying prices based on WEPCO’s “actual costs”. Effective April 1,

 

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2005, WEPCO unilaterally changed its method of calculating the energy charges to the Mines. It was the Mines' contention that WEPCO's new billing methodology was inconsistent with the terms of the parties' contracts and on September 20, 2005, the Mines filed a Demand for Arbitration with the American Arbitration Association with respect to the dispute. Pursuant to the terms of the relevant contracts, disputed amounts were deposited into an interest-bearing account maintained by a bank. An interim agreement was entered into effective May 5, 2006, between WEPCO and the Mines. Under the terms of the agreement, we received a net amount of $67.5 million, representing a rebate of amounts in excess of certain contractual caps paid either to WEPCO or placed in escrow. The agreement also temporarily adjusted the billing and payment provisions of the contracts during the pendency of the arbitration, without affecting the final outcome of the dispute. As of December 31, 2006, a total of approximately $32 million remained in the escrow accounts which represents a portion of WEPCO’s 2005 and 2006 billings, plus accrued interest. On May 3, 2007, the Mines and WEPCO settled their dispute. Under the terms of the Settlement Agreement and Release (the “Settlement”), the Mines received $32.5 million from escrow and paid $9.0 million to WEPCO. Additionally, WEPCO paid the Mines a rebate for over-the-cap payments of $2.6 million. As a result of the settlement, we will recognize a $10.3 million pre-tax gain in the second quarter of 2007. In addition, under the Settlement, the Mines will be billed for electric service from April 1, 2007 at the same rate as provided in the interim agreement. Upon termination of the special contracts on December 31, 2007, the Mines will be subject to the then applicable tariffs approved by the Michigan Public Service Commission.

In anticipation of the termination of these two power supply contracts, on September 8, 2006, the Mines filed a Complaint and Application for Emergency Relief with the Michigan Public Service Commission (the “Commission”), Case No. U-15039 (the “Application”), under which the Mines requested a special transitional rate equivalent to the midpoint between the rates payable under the current power agreements and the applicable industrial tariff rate. The Mines requested that the special transitional rate be available for ten years.

On September 28, 2006, prior to the Commission taking any action on the Application, WEPCO filed a rate case with the Commission, MPCS Case no. U-15071 (the “Rate Case”), which included an industrial rate that would be applicable to the Mines. Subsequently, on October 12, 2006, the Commission issued an Order Combining Dockets, under which the Mines’ Application was combined with WEPCO’s rate case. The Order Combining Dockets also established a nine-month schedule for the combined proceedings, with a final order to be issued in July 2007.

On April 30, 2007, the Mines and WEPCO entered into a Settlement Agreement for Final Rate Relief and Tariff Approvals (the “Tariff Agreement”). Under the Tariff Agreement, the Mines and WEPCO reached an agreement as to the tariff rate to be charged to the Mines under the industrial tariff. Any impact from the results of the combined proceeding will not occur until 2008, when the Power Supply Contracts terminate and it is anticipated that the Mines will be on an industrial tariff.

Environmental and Mine Closure Obligations

The iron ore industry has been identified by the EPA as an industrial category that emits pollutants established by the 1990 Clean Air Act Amendments. These pollutants included over 200 substances that are now classified as HAP. EPA is required to develop rules that would require major sources of HAP to utilize MACT standards for their emissions. Pursuant to this statutory requirement, the EPA published a final rule on October 30, 2003 imposing emission limitations and other requirements on taconite iron ore processing operations. We complied with the new requirements by the October 31, 2006 deadline. Our capital expenditures in 2006 to meet the MACT standards were $4.3 million.

At December 31, 2006, we had environmental and mine closure obligations, including our share of the obligations of ventures, of $122.2 million ($115.4 million at December 31, 2005), of which $13.6 million is current. Payments in 2006 were $15.6 million ($5.6 million in 2005). The obligations at December 31, 2006 include certain responsibilities for environmental remediation sites, $12.9 million, closure of LTVSMC, $28.2 million, and obligations for closure of our six North American operating mines, $68.3 million, and $12.8 million for Portman. See NOTE 5 — ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS — for more information.

 

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Strategic Investments

We intend to continue to pursue investment and operations management opportunities to broaden our scope as a supplier of iron ore and other raw materials to the integrated steel industry through the acquisition of additional mining interests to strengthen our market position. We are particularly focused on expanding our investments to capitalize on global demand for steel, iron ore and coal. Our innovative United Taconite joint venture with Laiwu and our Portman acquisition are examples of our ability to expand geographically, and we continue to pursue similar opportunities in other regions. In the event of any future acquisitions or joint venture opportunities, we may consider using available liquidity or other sources of funding to make investments.

Sonoma Coal Project

On April 18, 2007, we completed the acquisition of an effective 45 percent interest in the Sonoma Coal Project in Queensland, Australia. As of May 3, 2007, we invested $15.6 million toward the purchase of mining tenements and $19.4 million toward the construction of a washplant. We will operate and own 100 percent of the washplant and 8.3 percent of the mining leases, resulting in a 45 percent economic interest in Sonoma.

The Sonoma Coal Project is expected to initially produce two million tonnes of marketable coal annually, beginning late in 2007. Production from Sonoma will include an approximately equal mix of hard coking coal and thermal coal. Plans call for annual production to increase to between three million and four million tonnes during 2008. The Sonoma Coal Project has a current resource estimate of 107 million tonnes.

Centennial Amapa

On March 5, 2007, we acquired a 30 percent interest in MMX Amapa Mineracao LTDA., a Brazilian company developing an iron ore project (Amapa Project), through the acquisition of 100 percent of the shares of Centennial Amapa. The remaining 70 percent of the Amapa Project is owned by MMX Mineracao e Metallicos S.A., which is providing corporate and institutional support, while we will supply technical support for construction and operations. The purchase price for our 30 percent interest was $133 million, paid with cash on hand. Total capital expenditures are estimated to be $357 million, of which approximately $268 million will be funded with project debt. Capital contributions of $89.3 million were paid by Cliffs and MMX to fund the project; Cliffs 30 percent share was $26.8 million. We may be responsible for 30 percent of any future capital contributions.

The Amapa Project consists of a significant iron ore deposit, a 192-kilometer railway connecting the mine location to an existing port facility and 71 hectares of real estate on the banks of the Amazon River, reserved for a loading terminal. The Amapa Project is currently under construction and is expected to produce 6.5 million tonnes of iron ore concentrate annually once fully operational. Iron ore concentrate is expected to be sold, pursuant to a long-term supply agreement, to an operator of an iron oxide pelletizing plant in the Kingdom of Bahrain. Production is expected to begin in late 2007.

Mesabi Nugget Project

In November 2006, we announced that the participants, principally Cliffs, Steel Dynamics and Kobe Steel, were unable to reach agreement on terms necessary to move forward with construction of a reduced iron plant. Cliffs and the other principal parties suspended efforts to jointly develop the Mesabi Nugget Project at our Cliffs Erie site in Hoyt Lakes, Minnesota. However, the Company and Kobe Steel are evaluating opportunities to proceed with development of a commercial-scale reduced iron plant, which will convert taconite into nearly pure iron in nugget form utilizing Kobe Steel’s ITmk3 technology. The high-iron-content product could be utilized to replace steel scrap as a raw material for electric steel furnaces or basic oxygen furnaces of integrated steel producers or as feedstock for the foundry industry.

Portman Acquisition

On April 19, 2005, Cliffs Asia Pacific completed the acquisition of 80.4 percent of the outstanding shares of Portman, a Western Australia-based independent iron ore mining and exploration company. The acquisition was

 

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initiated on March 31, 2005 by the purchase of approximately 68.7 percent of the outstanding shares of Portman. The assets consist primarily of iron ore inventory, land, mineral rights and iron ore reserves. The purchase price of the 80.4 percent interest was $433.1 million, including $12.4 million of acquisition costs. Additionally, we incurred $9.8 million of foreign currency hedging costs related to this transaction, which were included in Other-net in the first-quarter 2005 Statements of Consolidated Operations. The acquisition increased our customer base in China and Japan and established our presence in the Australian mining industry. Portman’s full-year 2006 and 2005 production (excluding its share of the 50 percent-owned Cockatoo Island joint venture) was 7.0 million tonnes and 6.0 million tonnes, respectively. Portman completed a $62 million project that increased its wholly owned production capacity to eight million tonnes per year in the first half of 2006. The production is fully committed to steel companies in China and Japan through 2009. Portman’s reserves total approximately 88 million tonnes at December 31, 2006, and it has an active exploration program underway to increase its reserves.

The acquisition and related costs were financed with existing cash and marketable securities and $175 million of interim borrowings under a three-year $350 million revolving credit facility. The outstanding balance was repaid in full in July 2005. See NOTE 6 — CREDIT FACILITIES.

The Statements of Consolidated Financial Position of the Company as of December 31, 2006 and 2005 reflect the acquisition of Portman, effective March 31, 2005, under the purchase method of accounting. Assets acquired and liabilities assumed have been recorded at estimated fair values as of the March 31, 2005 initial acquisition date as determined by the results of an appraisal, which was finalized in the first quarter of 2006. See NOTE 2 — PORTMAN ACQUISITION — for further information regarding the final purchase price allocation.

PolyMet

On November 15, 2005, we reached an agreement with PolyMet regarding the terms for the early exercise of PolyMet’s 2004 option to acquire land, crushing and concentrating and other ancillary facilities located at our Cliffs Erie site (formerly owned by LTVSMC) and closed the sales transaction resulting in a $9.5 million pre-tax gain. PolyMet’s parent company, Polymet Mining Corporation (“PolyMet Corp”) is a non-ferrous mining company located in Vancouver, B.C. Canada. PolyMet Corp’s stock trades on the AMEX in the U.S. under the symbol PLM. Under the terms of the agreement, we received cash of $1.0 million and approximately 6.2 million common shares of PolyMet Corp, which closed that day at $1.25 per share. ($3.14 per share at December 31, 2006). The $9.5 million gain included recognition of a $.7 million deferred gain from 2004. The additional PolyMet Corp shares received in this transaction are classified as available-for-sale in Other assets on our Statements of Consolidated Financial Position. We expect to receive additional cash proceeds of $2.4 million in quarterly installments of $.25 million by and according to the terms of the contract for deed executed by the parties, which installments will be recognized as received.

In December 2006, Cliffs Erie sold to PolyMet additional owned or leased real property, various mining, railroad and service facilities and associated service permits. The sale included, but is not limited to, a 120-car rail fleet, locomotive fueling and railway maintenance buildings, railway track and rights, an administration building, pump houses, pipelines, power lines and support equipment. Proceeds from the transaction were:

 

   

$1.0 million in cash;

 

   

Two million shares of the common stock of PolyMet Corp, valued at $3.09 per common share at December 20, 2006, which are valued at $3.14 at December 31, 2006;

 

   

$7.0 million in cash payable in quarterly installments of $.25 million commencing December 31, 2006, with the balance payable upon receipt of PolyMet’s commercial finance. Interest will be payable quarterly from December 31 at the Wall Street Journal Prime Rate; and

 

   

$7.0 million in cash payable in quarterly installments of $.25 million commencing on December 31, 2009, with a balloon payment of the remaining amount due December 31, 2011, plus interest on the unpaid balance from December 31, 2009, which installment will be recognized as received.

We recognized a $7.4 million pre-tax gain in the fourth quarter of 2006 as a result of the December 2006 transaction. As a final component of the purchase price, PolyMet will assume from Cliffs certain on-going site

 

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related environmental and reclamation obligations. See Mine Closure in NOTE 5 — ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS. We also recognized a $1.0 million pre-tax gain resulting from the 2006 receipt of four quarterly installments of $.25 million associated with the November 2005 PolyMet transaction. Cliffs now owns 9.2 million shares of PolyMet Corp common stock, representing 7.7 percent of issued shares. We intend to hold our shares of PolyMet Corp indefinitely. Cliffs has the right to participate in up to 7.7 percent of any future financing and PolyMet has the first right to acquire or place Cliffs shares should it choose to sell. The two million shares received in the December 2006 transaction could not be sold, transferred or traded in Canada until April 21, 2007. Sales of the unregistered shares in the United States are subject to the trading volume restrictions outlined in Rule 144 of the Securities Act of 1933. It has been determined that the shares are appropriately classified as Marketable securities on the Statements of Consolidated Financial Position and valued (marked-to-market) at the current trading price. There are no restrictions related to the 7.2 million shares previously owned.

Market Risk

We are subject to a variety of market risks, including those caused by changes in market value of equity investments, commodity prices, foreign currency exchange rates and interest rates. We have established policies and procedures to manage risks; however, certain risks are beyond our control.

Our investment policy relating to cash and cash equivalents is to preserve principal and liquidity while maximizing the return through investment of available funds. The carrying value of these investments approximates fair value on the reporting dates.

At December 31, 2005, we held investments in highly liquid auction rate securities in order to generate higher than typical money market investments. ARS typically are high credit quality, generally achieved with municipal bond insurance. Credit risks are eased by the historical track record of bond insurers, which back a majority of this market. Although rare, sell orders for any security traded through a Dutch auction process could exceed bids. Such instances are usually the result of a drastic deterioration of issuer credit quality. Should there be a failed auction, ARS holders may be unable to liquidate their positions in the securities in the near term.

The rising cost of energy is an important issue for us as it comprises approximately 25 percent of our North American production costs. Our North American mining ventures consumed approximately 15.1 million mmbtu’s of natural gas and 25.2 million gallons of diesel fuel (our share 11.0 million mmbtu’s and 15.9 million gallons of diesel fuel) in 2006. In 2006, the average price paid by the North American mining ventures was $8.32 per mmbtu for natural gas and $2.15 per gallon for diesel fuel. Recent trends indicate that electric power, natural gas and oil costs can be expected to increase over time, although the direction and magnitude of short-term changes are difficult to predict. Our strategy to address increasing energy rates includes improving efficiency in energy usage and utilizing the lowest cost alternative fuel. We also use forward purchases of natural gas and diesel fuel to stabilize fluctuations in near-term prices.

Our mining ventures enter into forward contracts for certain commodities, primarily natural gas and diesel fuel, as a hedge against price volatility. Such contracts, which are in quantities expected to be delivered and used in the production process, are a means to limit exposure to price fluctuations. At December 31, 2006, the notional amounts of the outstanding natural gas and diesel forward contracts were $80.0 million (our share — $72.5 million), with an unrecognized fair value loss of $12.6 million (our share — $11.3 million) based on December 31, 2006 forward rates. The natural gas contracts mature at various times through October 2007 and the diesel fuel contracts mature at various times through December 31, 2009. For 2007, we purchased or have forward purchase contracts for 6.3 million mmbtu’s of natural gas at an average price of $8.69 per mmbtu and 8.7 million gallons of diesel fuel at $2.07 per gallon for our North American mining ventures. If the forward rates were to change 10 percent from the year-end rate, the value and potential cash flow effect on the contracts would be approximately $6.7 million (our share — $6.1 million).

Our share of Wabush Mines operation in Canada represented approximately five percent of our North American pellet production. This operation is subject to currency exchange fluctuations between the U.S. and Canadian dollars; however, we do not hedge our exposure to this currency exchange fluctuation. Between 2003 and 2006, the value of the Canadian dollar rose against the U.S. dollar from $.64 U.S. dollar per Canadian dollar

 

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at the beginning of 2003 to $.86 U.S. dollars per Canadian dollar at December 31, 2006, an increase of 34 percent. The average exchange rate increased to $.88 U.S. dollar per Canadian dollar in 2006 from an average of $.77 U.S. dollar per Canadian dollar for 2004, an increase of 14 percent.

We are subject to changes in foreign currency exchange rates in Australia as a result of our operations at Portman, which could impact our financial condition. Foreign exchange risk arises from our exposure to fluctuations in foreign currency exchange rates because our reporting currency is the United States dollar. We do not hedge our exposure to this currency exchange fluctuation. A hypothetical 10 percent movement in quoted foreign currency exchange rates could result in a fair value change of approximately $55 million in our net investment.

Portman hedges a portion of its United States currency-denominated sales in accordance with a formal policy. The primary objective for using derivative financial instruments is to reduce the earnings volatility attributable to changes in Australian and United States currency fluctuations. The instruments are subject to formal documentation, intended to achieve qualifying hedge treatment, and are tested at inception and at each reporting period as to effectiveness. Changes in fair value for highly effective hedges are recorded as a component of other comprehensive income. Ineffective portions are charged to operations. At December 31, 2006, Portman had outstanding hedges totaling A$268.2 million in the form of call options, collar options, convertible collar options and forward exchange contracts. The contracts have varying maturity dates ranging from January 2007 to June 2009, and a fair value gain based on the December 31, 2006 exchange rate of A$9.9 million. A one percent increase in rates from the month-end rate would increase the fair value and cash flow by A$1.9 million and a one percent decrease would decrease the fair value and cash flow by A$1.5 million.

Outlook

North America

Although production schedules are subject to change, all of our operations are expected to operate at or near capacity in 2007, with the exception of Hibbing. In late February 2007, Hibbing was forced to shut down production operations due to severe weather conditions that caused significant buildup of ice in the basin supplying water to the processing facility. The operation resumed limited production in late March, with full production in early April. Production loss totaled approximately .8 million tons (Company share .2 million tons). Cliffs’ total North American pellet production is expected to be approximately 35 million tons with our share approximately 22 million tons. Our 2007 North American sales volume is projected to be approximately 22 million tons.

Revenue per ton from iron ore sales and services (excluding freight and venture partners’ cost reimbursements), which is expected to increase approximately two percent per ton for full year 2007, is dependent upon several price adjustment factors included in our term sales contracts, primarily the percentage change from 2006 to 2007 in the international pellet price for blast furnace pellets, PPI and actual 2007 steel pricing for one of our customers.

Following is the estimated impact to our average North American revenue per ton from iron ore sales and services (excluding freight and venture partners’ cost reimbursements) based on 2006 realization of $64.25 per ton:

 

   

The settlement of the World Pellet Price in 2007 is expected to increase our average pellet sales realization by $.63 per ton;

 

   

Each one percent change in the PPI — Industrial Commodities less fuel and PPI — Fuel and Related Products indices is anticipated to result in $.12 per ton and $.07 per ton, respectively;

 

   

Each $10 increase from $560 per ton in the average hot rolled steel price at certain steelmaking facilities will result in a $.26 per ton increase in our 2007 average realization; and

 

   

Known year-over-year increases representing a combination of contractual base price increases, lag-year adjustments and capped pricing on one contract will result in a $.92 per ton increase in our 2007 average realization.

In March 2007, Eastern Canadian 2007 pellet prices, which are the predominant international prices affecting our North American contracts, increased 5.80 percent.

 

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We are currently in a contractual dispute with Algoma over the timing of the price reopener in our 15-year term supply agreement. Algoma maintains that the price reopener is effective for 2007 sales, while our position is that the reopener is effective in 2008. We have agreed to resolve the issue through binding arbitration, which is anticipated to be completed in 2008. Resolution of this issue could adversely affect our revenues related to sales to Algoma in 2007.

North American production costs per ton are expected to increase approximately two percent from the 2006 cost of goods sold and operating expenses (excluding freight and venture partners’ cost reimbursements) of $48.17 per ton.

Australia

Portman’s estimate of 2007 production is 8.4 million tonnes, including .6 million from Cockatoo Island. Feasibility studies have concluded that mining and shipments from the current operations at Cockatoo Island can be continued until late 2007. Portman’s estimate of 2007 sales is 8.2 million tonnes, compared with 7.4 million tonnes in 2006. In December 2006, settlements between a number of the major sea-borne iron ore producers and the Chinese steel industry resulted in a 9.5 percent increase for 2007. Sales of lump and fines ore from Portman will reflect that negotiated increase, and combined with other factors, is expected to result in an approximate six percent increase on a Cliffs basis. Unit production costs are expected to increase approximately eight percent from 2006, due primarily to higher contract labor.

Critical Accounting Policies

Management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. Preparation of financial statements requires management to make assumptions, estimates and judgments that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and the related disclosures of contingencies. Management bases its estimates on various assumptions and historical experience, which are believed to be reasonable; however, due to the inherent nature of estimates, actual results may differ significantly due to changed conditions or assumptions. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are fairly presented in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. Management believes that the following critical accounting estimates and judgments have a significant impact on our financial statements.

Revenue Recognition

Revenue is recognized on the sale of products when title to the product has transferred to the customer in accordance with the specified terms of each term supply agreement and all applicable criteria for revenue recognition have been satisfied. Generally, our North American term supply agreements provide that title transfers to the customers when payment is received. In December 2006, two customers purchased and paid for 1.2 million tons of pellets in upper lakes stockpiles to meet 2006 contractual requirements. At the request of the customers, the ore was not shipped. The Company considered whether revenue should be recognized on these sales under the “bill and hold” guidance discussed in SEC Staff Accounting Bulletin No. 101 Topic No. 13, but because a fixed shipment schedule was not established prior to year-end, revenue recognition on these transactions, totaling $62.6 million, has been deferred until the product is delivered.

Most of our North American long-term supply agreements are comprised of a base price with annual price adjustment factors. These price adjustment factors vary from agreement to agreement but typically include adjustments based upon changes in international pellet prices, changes in specified Producers Price Indices including those for all commodities, industrial commodities, energy and steel. The adjustments generally operate in the same manner, with each factor typically comprising a portion of the price adjustment, although the weighting of each factor varies from agreement to agreement. One of our term supply agreements contains price collars, which typically limit the percentage increase or decrease in prices for our iron ore pellets during any one year. In most cases, these adjustment factors have not been finalized at the time our product is sold; we routinely

 

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estimate these adjustment factors. The price adjustment factors have been evaluated as embedded derivatives. We evaluated the embedded derivatives in the supply agreements in accordance with the provisions of SFAS 133, Accounting for Derivative Instruments and Hedging Activities. The price adjustment factors share the same economic characteristics and risks as the host contract and are integral to the host contract as inflation adjustments; accordingly they have not been separately valued as derivative instruments. Certain supply agreements with one customer include provisions for supplemental revenue or refunds based on the customer’s annual steel pricing for the year the product is consumed in the customer’s blast furnaces. We account for this provision as derivative instruments at the time of sale and record this provision at fair value until the year the product is consumed and the amounts are settled as an adjustment to revenue.

Under some North American term supply agreements, we ship the product to ports on the Great Lakes and/or to the customer’s facilities prior to the transfer of title. Our rationale for shipping iron ore products to some customers in advance of payment for the products is to more closely relate timing of payment by customers to consumption, which also provides additional liquidity to our customers. Generally, our North American term supply agreements specify that title and risk of loss pass to the customer when payment for the pellets is received. This is a practice utilized to reduce our financial risk to customer insolvency. This practice is not believed to be widely used throughout the balance of the industry.

Revenue is recognized on services when the services are performed.

Where we are joint venture participants in the ownership of a North American mine, our contracts entitle us to receive royalties and management fees, which we earn as the pellets are produced.

Portman’s sales revenue is recognized at the F.O.B. point, which is generally when the product is loaded into the vessel. Foreign currency revenues are converted to Australian dollars at the currency exchange rate in effect at the time of the transaction.

See Accounting Policies in Item 8 for a complete discussion of our revenue recognition policy.

Litigation Accruals

We are subject to proceedings, lawsuits and other claims. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as the potential ranges of probable losses. A determination of the amount of accrual required, if any, for these contingencies is made after careful analysis of each matter. The required accrual may change in the future due to new developments in each matter or changes in approach, such as a change in settlement strategy in dealing with these matters. We do not believe that any such matter will have a material adverse effect on our financial condition or results of operations.

Tax Contingencies

Domestic and foreign tax authorities periodically audit our income tax returns. These audits include questions regarding our tax-filing positions, including the timing and amount of deductions and allocation of income among various tax jurisdictions. At any time, multiple tax years are subject to audit by the various tax authorities. In evaluating the exposures associated with our various tax-filing positions, we record reserves for exposures on a probable basis. A number of years may elapse before a particular matter, for which we have established a reserve, is audited and fully resolved. When facts change or the actual results of a settlement with tax authorities differs from our established reserve for a matter, we adjust our tax contingencies reserve and income tax provision in the period in which the facts changed or the income tax matter is resolved.

Iron Ore Reserves

We regularly evaluate our economic iron ore reserves and update them as required in accordance with SEC Industry Guide 7. The estimated ore reserves could be affected by future industry conditions, geological conditions and ongoing mine planning. Maintenance of effective production capacity or the ore reserve could require increases in capital and development expenditures. Generally as mining operations progress, haul lengths and lifts increase. Alternatively, changes in economic conditions, or the expected quality of ore reserves could decrease capacity or ore reserves. Technological progress could alleviate such factors, or increase capacity or ore reserves.

 

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We use our ore reserve estimates combined with our estimated annual production levels, to determine the mine closure dates utilized in recording the fair value liability for asset retirement obligations. See NOTE 5 — ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS — for further information. Since the liability represents the present value of the expected future obligation, a significant change in ore reserves or mine lives would have a substantial effect on the recorded obligation. We also utilize economic ore reserves for evaluating potential impairments of mine assets and in determining maximum useful lives utilized to calculate depreciation and amortization of long-lived mine assets. Decreases in ore reserves or mine lives could significantly affect these items.

Asset Retirement Obligations

The accrued mine closure obligations for our active mining operations provides for contractual and legal obligations associated with the eventual closure of the mining operations. Our obligations are determined based on detailed estimates adjusted for factors that an outside party would consider (i.e., inflation, overhead and profit), which were escalated (at an assumed three percent) to the estimated closure dates, and then discounted using a credit-adjusted risk-free interest rate of 10.25 percent (12.0 percent for United Taconite and 5.5 percent for Portman) for the initial estimates. The estimates at December 31, 2006 and 2005 were revised using incremental increases in the closure cost estimates and minor changes in estimates of mine lives. The closure date for each location was determined based on the exhaustion date of the remaining iron ore reserves. The estimated obligations are particularly sensitive to the impact of changes in mine lives given the difference between the inflation and discount rates. Changes in the base estimates of legal and contractual closure costs due to changed legal or contractual requirements, available technology, inflation, overhead or profit rates would also have a significant impact on the recorded obligations. See NOTE 6 — ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS — for further information.

Asset Impairment

We monitor conditions that indicate that the carrying value of an asset or asset group may be impaired. We determine impairment based on the asset's ability to generate cash flow greater than its carrying value, utilizing an undiscounted probability-weighted analysis. If the analysis indicates the asset is impaired, the carrying value is adjusted to fair value. Fair value can be determined by market value and also comparable sales transactions or using a discounted cash flow method. The impairment analysis and fair value determination can result in significantly different outcomes based on critical assumptions and estimates including the quantity and quality of remaining economic ore reserves, future iron ore prices and production costs.

Environmental Remediation Costs

We have a formal policy for environmental protection and restoration. Our obligations for known environmental problems at active and closed mining operations and other sites have been recognized based on estimates of the cost of investigation and remediation at each site. If the estimate can only be estimated as a range of possible amounts, with no specific amount being most likely, the minimum of the range is accrued. Management reviews its environmental remediation sites quarterly to determine if additional cost adjustments or disclosures are required. The characteristics of environmental remediation obligations, where information concerning the nature and extent of clean-up activities is not immediately available, or changes in regulatory requirements, result in a significant risk of increase to the obligations as they mature. Expected future expenditures are not discounted to present value unless the amount and timing of the cash disbursements are readily known. Potential insurance recoveries are not recognized until realized.

Employee Retirement Benefit Obligations

The Company and its mining ventures sponsor defined benefit pension plans covering substantially all North American employees. These plans are largely noncontributory, and benefits are generally based on employees’ years of service and average earnings for a defined period prior to retirement. Portman does not have employee retirement benefit obligations.

 

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Additionally, the Company and its ventures provide postretirement medical and OPEBs to most full-time employees who meet certain length-of-service and age requirements. For several years prior to 2003, our pension and medical costs (including OPEB) had increased substantially. Lower interest rates, lower asset returns and continued escalation of medical costs had been the predominant causes of the increases. We have since taken actions to control pension and medical costs which have helped to maintain current pension expense levels and decrease postretirement welfare expense amounts. On July 1, 2003, we implemented changes to U.S. salaried employee plans that reduced costs by more than an estimated $8.0 million on an annualized basis. Benefits under the current defined benefit formula were frozen for affected U.S. salaried employees and a new cash balance formula was instituted. Increases in affected U.S. salaried retiree healthcare co-pays became effective for retirements after June 30, 2003. A cap on our share of annual medical premiums was also implemented for existing and future U.S. salaried retirees. Pursuant to the four-year U.S. labor agreements reached with the USW, effective August 1, 2004, OPEB expense for 2004 and the APBO decreased $4.9 million and $48.0 million, respectively, to reflect negotiated plan changes, which capped our share of future bargaining unit retirees’ healthcare premiums at 2008 levels for the years 2009 and beyond. The agreements also provide that the Company and its partners fund an estimated $220 million into bargaining unit pension plans and VEBAs during the term of the contracts.

On September 12, 2006, the Company’s Board of Directors approved modifications to the pension benefits provided to salaried participants. The modifications retroactively reinstated the final average pay benefit formula (previously terminated and replaced with a cash balance formula in July 2003) to allow for additional accruals through June 30, 2008 or the continuation of benefits under an improved cash balance formula, whichever is greater. The change increased the PBO by $15.1 million and pension expense by $1.1 million in 2006. Following is a summary of our defined benefit pension and OPEB funding and expense for the years 2004 through 2007:

 

     (In Millions)
     Pension    OPEB
     Funding    Expense    Funding    Expense

2004

   $ 63.0    $ 23.1    $ 30.9    $ 28.5

2005

     40.6      20.7      31.8      17.9

2006

     46.2      26.4      33.1      11.2

2007 (Estimated)

     39.2      23.3      23.9      8.2

Assumptions used in determining the benefit obligations and the value of plan assets for defined benefit pension plans and postretirement benefit plans (primarily retiree healthcare benefits) offered by the Company and its unconsolidated ventures are evaluated periodically by management. Critical assumptions, such as the discount rate used to measure the benefit obligations, the expected long-term rate of return on plan assets, and the medical care cost trend are reviewed annually. At December 31, 2006, we increased our discount rate for U.S. plans to 5.75 percent from 5.50 percent at December 31, 2005, and kept our discount rate for Canadian plans at 5.00 percent, unchanged from December 31, 2005. Additionally, on December 31, 2005, we adopted the 1994 GAM table to determine the expected life of our plan participants, replacing the 1983 GAM table. Following are sensitivities on estimated 2007 pension and OPEB expense of potential further changes in these key assumptions:

 

    

Increase in 2007

Expense

(In Millions)

         Pension            OPEB    

Decrease discount rate .25 percent

   $ 1.9    $ .6

Decrease return on assets 1 percent

     6.3      1.3

Increase medical trend rate 1 percent

     N/A      4.2

 

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Changes in actuarial assumptions, including discount rates, employee retirement rates, mortality, compensation levels, plan asset investment performance, and healthcare costs, are selected by us. Changes in actuarial assumptions and/or investment performance of plan assets can have a significant impact on our financial condition due to the magnitude of our retirement obligations. See NOTE 8 — RETIREMENT RELATED BENEFITS — for further information.

Accounting for Business Combinations

During 2005, we completed the acquisition of 80.4 percent of Portman. We allocated the purchase price to assets acquired and liabilities assumed based on their relative fair value at the date of acquisition, pursuant to SFAS No. 141, Business Combinations. In estimating the fair value of the assets acquired and liabilities assumed, we consider information obtained during our due diligence process and utilize various valuation methods, including market prices, where available, appraisals, comparisons to transactions for similar assets and liabilities and present value of estimated future cash flows. We are required to make subjective estimates in connection with these valuations and allocations.

Forward-Looking Statements

This report contains statements that constitute “forward-looking statements.” These forward-looking statements may be identified by the use of predictive, future-tense or forward-looking terminology, such as “believes,” “anticipates,” “expects,” “estimates,” “intends,” “may,” “will” or similar terms. These statements speak only as of the date of this report, and we undertake no ongoing obligation, other than that imposed by law, to update these statements. These statements appear in a number of places in this report and include statements regarding our intent, belief or current expectations of our directors or our officers with respect to, among other things:

 

   

trends affecting our financial condition, results of operations or future prospects;

 

   

uncertainty relating to contractual disputes with any of our customers;

 

   

our business and growth strategies;

 

   

uncertainties relating to our ability to identify and consummate any strategic investments;

 

   

adverse changes in currency values;

 

   

uncertainty relating to contractual disputes with any of our significant energy, material or service providers;

 

   

the success of cost-savings efforts;

 

   

our financing plans and forecasts; and

 

   

the potential existence of significant deficiencies or material weaknesses in internal controls over financial reporting that may be identified during the performance of testing under Section 404 of the Sarbanes-Oxley Act of 2002.

You are cautioned that any such forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties, and that actual results may differ materially from those contained in the forward-looking statements as a result of various factors, some of which are unknown. For additional factors affecting the business of Cleveland-Cliffs Inc, see Item 1A. Risk Factors.

You are urged to carefully consider these risk factors. All forward-looking statements attributable to us are expressly qualified in their entirety by the foregoing cautionary statements.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

Information regarding our Market Risk is presented under the caption Market Risk, which is included in Item 7 and is incorporated by reference and made a part hereof.

 

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Item 8.    Financial Statements and Supplementary Data

Statements of Consolidated Financial Position

Cleveland-Cliffs Inc and Consolidated Subsidiaries

 

    

December 31

(In Millions)

 
     2006     2005  

ASSETS

    

CURRENT ASSETS

    

Cash and cash equivalents

   $ 351.7     $ 192.8  

Marketable securities

       9.9  

Trade accounts receivable — net

     28.3       35.1  

Receivables from associated companies

     4.0       5.4  

Product inventories

     150.3       119.1  

Work in process inventories

     50.6       56.7  

Supplies and other inventories

     77.5       70.5  

Deferred and refundable taxes

     9.7       12.1  

Deferred power receivable

     15.6       73.0  

Derivative asset

     32.9       19.2  

Other

     61.7       42.2  
                

TOTAL CURRENT ASSETS

     782.3       636.0  

PROPERTIES

    

Plant and equipment

     638.1       557.5  

Land rights and mineral rights

     469.2       421.8  
                
     1,107.3       979.3  

Allowances for depreciation and depletion

     (222.4 )     (176.5 )
                

NET PROPERTIES

     884.9       802.8  

OTHER ASSETS

    

Prepaid pensions — salaried

     2.2       80.4  

Long-term receivables

     43.7       48.7  

Deferred income taxes

     107.0       66.5  

Deposits and miscellaneous

     83.7       53.8  

Other investments

     7.0       34.0  

Intangible pension asset

       13.9  

Marketable securities

     28.9       10.6  
                

TOTAL OTHER ASSETS

     272.5       307.9  
                

TOTAL ASSETS

   $ 1,939.7     $ 1,746.7  
                

See notes to consolidated financial statements.

 

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Statements of Consolidated Financial Position

Cleveland-Cliffs Inc and Consolidated Subsidiaries

 

    

December 31

(In Millions)

 
     2006     2005  

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

CURRENT LIABILITIES

    

Accounts payable

   $ 139.0     $ 122.9  

Accrued employment costs

     48.0       47.4  

Pensions

       45.3  

Other postretirement benefits

     18.3       36.6  

Income taxes

     29.1       29.1  

State and local taxes

     25.6       22.2  

Environmental and mine closure obligations

     8.8       13.4  

Accrued expenses

     28.1       28.9  

Payables to associated companies

     3.4       7.7  

Deferred revenue

     62.6       .2  

Other

     12.0       9.0  
                

TOTAL CURRENT LIABILITIES

     374.9       362.7  

POSTEMPLOYMENT BENEFIT LIABILITIES

    

Pensions

     140.4       119.6  

Other postretirement benefits

     139.0       85.2  
                

TOTAL POSTEMPLOYMENT BENEFIT LIABILITIES

     279.4       204.8  

ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS

     95.1       87.3  

DEFERRED INCOME TAXES

     117.9       116.7  

OTHER LIABILITIES

     68.5       79.4  
                

TOTAL LIABILITIES

     935.8       850.9  

MINORITY INTEREST

     85.8       71.7  

3.25% REDEEMABLE CUMULATIVE CONVERTIBLE PERPETUAL PREFERRED STOCK — ISSUED 172,500 SHARES 172,300 AND 172,500 OUTSTANDING IN 2006 AND 2005

     172.3       172.5  

SHAREHOLDERS’ EQUITY

    

Preferred stock - no par value

    

Class A — 3,000,000 shares authorized and unissued

    

Class B — 4,000,000 shares authorized and unissued

    

Common Shares — par value $.25 a share

    

Authorized — 112,000,000 shares;

    

Issued — 67,311,764 shares

     16.8       16.8  

Capital in excess of par value of shares

     103.2       100.5  

Retained Earnings

     1,078.5       824.2  

Cost of 26,406,414 Common Shares in treasury (2005 — 23,480,770 shares)

     (282.8 )     (164.3 )

Accumulated other comprehensive loss

     (169.9 )     (125.6 )
                

TOTAL SHAREHOLDERS’ EQUITY

     745.8       651.6  
                

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 1,939.7     $ 1,746.7  
                

See notes to consolidated financial statements.

 

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Statements of Consolidated Operations

Cleveland-Cliffs Inc and Consolidated Subsidiaries

 

    

Year Ended December 31

(In Millions, Except Per Share
Amounts)

 
     2006     2005     2004  

REVENUES FROM PRODUCT SALES AND SERVICES

      

Iron Ore

   $ 1,669.1     $ 1,512.2     $ 995.0  

Freight and venture partners’ cost reimbursements

     252.6       227.3       208.1  
                        
     1,921.7       1,739.5       1,203.1  

COST OF GOODS SOLD AND OPERATING EXPENSES

     (1,507.7 )     (1,350.5 )     (1,053.6 )
                        

SALES MARGIN

     414.0       389.0       149.5  

OTHER OPERATING INCOME (EXPENSE)

      

Royalties and management fee revenue

     11.7       13.1       11.3  

Casualty recoveries

       12.3    

Administrative, selling and general expenses

     (54.6 )     (47.9 )     (33.1 )

Impairment of mining assets

         (5.8 )

Customer bankruptcy recoveries (exposures)

     4.0       2.0       (1.6 )

Miscellaneous — net

     (9.4 )     (12.0 )     (2.7 )
                        
     (48.3 )     (32.5 )     (31.9 )
                        

OPERATING INCOME

     365.7       356.5       117.6  

OTHER INCOME (EXPENSE)

      

Gain on sale of ISG common stock

         152.7  

Gain on sale of assets

     9.1       9.5    

Interest income

     17.2       13.9       11.5  

Interest expense

     (3.6 )     (4.5 )     (.8 )

Other — net

     (.6 )     (7.3 )     4.2  
                        
     22.1       11.6       167.6  
                        

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND MINORITY INTEREST

     387.8       368.1       285.2  

INCOME TAX CREDIT (EXPENSE)

     (90.9 )     (84.8 )     35.0  

MINORITY INTEREST (net of tax $7.3 million in 2006 and $5.4 million in 2005)

     (17.1 )     (10.1 )  
                        

INCOME FROM CONTINUING OPERATIONS

     279.8       273.2       320.2  

INCOME (LOSS) FROM DISCONTINUED OPERATIONS

      

(net of tax $.2 million in 2006, $.4 million in 2005 and $1.8 million in 2004)

     .3       (.8 )     3.4  
                        

INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE

     280.1       272.4       323.6  

CUMULATIVE EFFECT OF ACCOUNTING CHANGE (net of tax $2.8 million)

       5.2    
                        

NET INCOME

     280.1       277.6       323.6  

PREFERRED STOCK DIVIDENDS

     (5.6 )     (5.6 )     (5.3 )
                        

INCOME APPLICABLE TO COMMON SHARES

   $ 274.5     $ 272.0     $ 318.3  
                        

EARNINGS PER COMMON SHARE — BASIC

      

Continuing operations

   $ 6.52     $ 6.16     $ 7.39  

Discontinued operations

     .01       (.02 )     .08  

Cumulative effect of accounting changes

       .12    
                        

EARNINGS PER COMMON SHARE — BASIC

   $ 6.53     $ 6.26     $ 7.47  
                        

EARNINGS PER COMMON SHARE — DILUTED

      

Continuing operations

   $ 5.19     $ 4.92     $ 5.84  

Discontinued operations

     .01       (.02 )     .06  

Cumulative effect of accounting changes

       .09    
                        

EARNINGS PER COMMON SHARE — DILUTED

   $ 5.20     $ 4.99     $ 5.90  
                        

AVERAGE NUMBER OF SHARES (In thousands)

      

Basic

     42,072       43,456       42,616  

Diluted

     53,827       55,673       54,845  

See notes to consolidated financial statements.

 

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Statements of Consolidated Cash Flows

Cleveland-Cliffs Inc and Consolidated Subsidiaries

 

    

Year Ended December 31

(In Millions, Brackets

Indicate Cash Decrease)

 
     2006     2005     2004  

CASH FLOW FROM CONTINUING OPERATIONS

      

OPERATING ACTIVITIES

      

Net income

   $ 280.1     $ 277.6     $ 323.6  

(Income) loss from discontinued operations

     (.3 )     .8       (3.4 )

Cumulative effect of accounting change

       (5.2 )  
                        

Income from continuing operations

     279.8       273.2       320.2  

Adjustments to reconcile net income from continuing operations to net cash from (used by) operations:

      

Depreciation and amortization:

      

Consolidated

     73.9       48.6       25.0  

Share of associated companies

     9.4       4.2       4.3  

Minority interest

     17.1       10.1    

Share-based compensation

     4.9      

Pensions and other postretirement benefits

     (40.3 )     (35.2 )     (48.0 )

Gain on sale of assets

     (9.9 )     (11.3 )     (4.2 )

Derivatives and currency hedges

     (8.0 )     36.7    

Deferred income taxes

     (4.8 )     (4.4 )     (86.7 )

Environmental and closure obligation

     (1.6 )     6.0       4.6  

Excess tax benefit from share-based compensation

     (1.2 )    

Proceeds from business interruption insurance recovery

       12.3    

Impairment of mining assets

         5.8  

Provision for customer bankruptcy exposures

         1.6  

Gain on sale of ISG common stock

         (152.7 )

Casualty recoveries

       (12.3 )  

Other

     (.2 )     5.4       5.1  

Changes in operating assets and liabilities:

      

Payables and accrued expenses

     56.4       63.5       20.4  

Receivables & other assets

     34.0       1.0       (50.7 )

Sales of marketable securities

     13.6       182.8    

Inventories and prepaid expenses

     9.1       (56.0 )     (3.4 )

Purchases of marketable securities

     (3.7 )     (10.0 )     (182.7 )
                        

Net cash from (used by) operating activities

     428.5       514.6       (141.4 )

INVESTING ACTIVITIES

      

Purchase of property, plant and equipment:

      

Consolidated

     (119.5 )     (97.8 )     (54.4 )

Share of associated companies

     (13.4 )     (8.5 )     (6.3 )

Proceeds from sale of assets

     5.5       4.4       4.4  

Investment in Portman Limited

       (409.0 )  

Payment of currency hedges

       (9.8 )  

Proceeds from sale of ISG common stock

         170.1  

Proceeds from steel company debt

         10.0  

Proceeds from Weirton investment

         3.8  
                        

Net cash from (used by) investing activities

     (127.4 )     (520.7 )     127.6  

FINANCING ACTIVITIES

      

Repurchases of Common Stock

     (121.5 )       (6.5 )

Common Stock dividends

     (20.2 )     (13.1 )     (2.2 )

Preferred Stock dividends

     (5.6 )     (5.6 )     (3.9 )

Repayment of capital leases

     (3.1 )    

Issuance cost — Revolving credit

     (1.0 )     (2.7 )  

Repayment of long-term debt

     (.8 )       (25.0 )

Contributions by minority interest

     1.9       2.1       9.7  

Excess tax benefit from share-based compensation

     1.2      

Proceeds from stock options exercised

     .7       5.7       17.9  

Repayments under revolving credit facility

       (175.0 )  

Borrowings under revolving credit facility

       175.0    

Proceeds from Convertible Preferred Stock

         172.5  

Issuance cost — Convertible Preferred Stock

         (6.6 )
                        

Net cash from (used by) financing activities

     (148.4 )     (13.6 )     155.9  

EFFECT OF EXCHANGE RATE CHANGES ON CASH

     5.9       (2.2 )  
                        

CASH FROM (USED BY) CONTINUING OPERATIONS

     158.6       (21.9 )     142.1  

CASH FROM (USED BY) DISCONTINUED OPERATIONS — OPERATING

     .3       (5.2 )     .3  

  — INVESTING

       3.0       6.7  
                        

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     158.9       (24.1 )     149.1  

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

     192.8       216.9       67.8  
                        

CASH AND CASH EQUIVALENTS AT END OF YEAR

   $ 351.7     $ 192.8     $ 216.9  
                        

Taxes paid on income

   $ 95.7     $ 86.2     $ 57.1  

Interest paid on debt obligations

   $ 2.7     $ 2.0     $ .2  

See notes to consolidated financial statements.

 

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Statements of Consolidated Shareholders’ Equity

Cleveland-Cliffs and Consolidated Subsidiaries

 

    (In Millions)  
    Common
Shares
  Capital
in
Excess
of Par
Value of
Shares
  Retained
Earnings
    Common
Shares
in
Treasury
    Accumulated
Other
Compre-
hensive
Income
(Loss)
    Total  

January 1, 2004

  $ 16.8   $ 72.8   $ 255.7     $ (173.6 )   $ 56.4     $ 228.1  

Comprehensive income

           

Net income

        323.6           323.6  

Other comprehensive income

           

Unrealized gain on securities

            .2       .2  

Minimum pension liability

            7.3       7.3  

Reclassification adjustment — included in net income

            (144.9 )     (144.9 )
                 

Total comprehensive income

              186.2  

Stock options exercised

      8.1       9.8         17.9  

Stock and other incentive plans

      11.4       .9         12.3  

Issuance cost — Convertible Preferred Stock

        (6.5 )         (6.5 )

Repurchases of Common Stock

          (6.5 )       (6.5 )

Preferred Stock dividends

        (5.3 )         (5.3 )

Common Stock dividends

        (2.2 )         (2.2 )
                                           

December 31, 2004

    16.8     92.3     565.3       (169.4 )     (81.0 )     424.0  

Comprehensive income

           

Net income

        277.6           277.6  

Other comprehensive income

           

Minimum pension liability

            (19.5 )     (19.5 )

Unrealized gain on securities

            1.5       1.5  

Unrealized loss on Foreign Currency Translation

            (24.7 )     (24.7 )

Hedge reserve

            (1.9 )     (1.9 )
                 

Total comprehensive income

              233.0  

Stock options exercised

      3.2       2.4         5.6  

Stock and other incentive plans

      5.0       2.7         7.7  

Preferred Stock dividends

        (5.6 )         (5.6 )

Common Stock dividends

        (13.1 )         (13.1 )
                                           

December 31, 2005

    16.8     100.5     824.2       (164.3 )     (125.6 )     651.6  

Comprehensive income

           

Net income

        280.1           280.1  

Other comprehensive income

           

Minimum pension and OPEB liability

            17.9       17.9  

Unrealized gain on marketable securities

            7.9       7.9  

Unrealized gain on Foreign Currency Translation

            34.3       34.3  

Unrealized gain on derivative instruments

            6.3       6.3  
                 

Total comprehensive income

              346.5  

Effect of implementing SFAS 158

            (110.7 )     (110.7 )

Stock options exercised

      .3       .4         .7  

Stock and other incentive plans

      2.3       2.5         4.8  

Repurchases of Common Stock

          (121.5 )       (121.5 )

Conversion of Preferred Stock

      .1       .1         .2  

Preferred Stock dividends

        (5.6 )         (5.6 )

Common Stock dividends

        (20.2 )         (20.2 )
                                           

December 31, 2006

  $ 16.8   $ 103.2   $ 1,078.5     $ (282.8 )   $ (169.9 )   $ 745.8  
                                           

See notes to consolidated financial statements.

 

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Notes to Consolidated Financial Statements

NOTE 1 — BUSINESS SUMMARY AND SIGNIFICANT ACCOUNTING POLICIES

Two-for-One Stock Splits

On June 30, 2006 and December 31, 2004, we completed two-for-one stock splits of our common shares with corresponding decreases in par value from $.50 to $.25 and from $1.00 to $.50, respectively. The record dates for the stock splits were June 15, 2006 and December 15, 2004, respectively. Accordingly, all common shares, per-share amounts, stock compensation plans and preferred stock conversion rates have been adjusted retroactively to reflect the stock splits. Additionally, all diluted per-share amounts reflect the “as-if-converted” effect of our convertible preferred stock as required by EITF 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings per Share.

Business Summary

We are the largest supplier of iron ore pellets to integrated steel companies in North America. We manage and own interests in North American mines and own ancillary companies providing transportation and other services to the mines.

On April 19, 2005, Cliffs Asia Pacific, our wholly owned subsidiary, completed the acquisition of 80.4 percent of Portman’s common stock. Portman is an iron ore mining company in Australia, serving the Asian iron ore markets with direct-shipping fines and lump ore. The acquisition was initiated on March 31, 2005 by the purchase of 68.7 percent of the outstanding shares of Portman. Our Statements of Consolidated Financial Position as of December 31, 2006 and December 31, 2005 reflect the acquisition of Portman under the purchase method of accounting. Results include revenue and expenses of Portman since the March 31, 2005 date of acquisition. See NOTE 2 — PORTMAN ACQUISITION for further discussion.

Accounting Policies

We consider the following policies to be beneficial in understanding the judgments that are involved in the preparation of our consolidated financial statements and the uncertainties that could impact our financial condition, results of operations and cash flows.

Basis of Consolidation:    The consolidated financial statements include our accounts and the accounts of our majority-owned subsidiaries, including:

 

Name

  

Location

   Ownership Interest  

Empire

   Michigan    79.0 %

Tilden

   Michigan    85.0  

United Taconite

   Minnesota    70.0  

Northshore

   Minnesota    100.0  

Portman

   Western Australia    80.4 *

* Consolidated since March 31, 2005 when we acquired 68.7 percent ownership. We increased our ownership to 80.4 percent on April 19, 2005.

Intercompany accounts are eliminated in consolidation.

Other investments on the Statements of Consolidated Financial Position include our 26.83 percent equity interest in Wabush and related entities that we do not control, which are carried at the lower of cost or market. Our 23 percent equity interest in Hibbing, an unincorporated joint venture in Minnesota, was a net liability and accordingly was classified as Other liabilities. Portman’s 50 percent non-controlling interest in Cockatoo Island, which was carried in Other investments at December 31, 2005, was recorded as a net liability at December 31, 2006 and accordingly classified in Other current liabilities. CAL and Ferrominera results are included in the Statements of Consolidated Operations under Discontinued Operations. See NOTE 3 — DISCONTINUED OPERATIONS.

 

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Investments in joint ventures in which our ownership is 50 percent or less, or in which we do not have control but have the ability to exercise significant influence over operating and financial policies, are accounted for under the equity method. Our share of equity income (if any) is eliminated against consolidated product inventory upon production, and against cost of goods sold and operating expenses when sold. This effectively reduces our cost for our share of the mining venture’s production to its cost, reflecting the cost-based nature of our participation in non-consolidated ventures.

Revenue Recognition:    Revenue is recognized on the sale of products when title to the product has transferred to the customer in accordance with the specified terms of each term supply agreement and all applicable criteria for revenue recognition have been satisfied. Generally, our North American term supply agreements provide that title transfers to the customer when payment is received. Under some term supply agreements, we ship the product to ports on the lower Great Lakes and/or to the customer’s facilities prior to the transfer of title. Certain supply agreements with one customer include provisions for supplemental revenue or refunds based on the customer’s annual steel pricing for the year the product is consumed in the customer’s blast furnaces. We account for this provision as derivative instruments at the time of sale and record this provision at fair value until the year the product is consumed and the amounts are settled as an adjustment to revenue. Estimated supplemental payments (on .2 million tons), which at current pricing would have amounted to approximately $3.3 million, related to sales in 2005 to one of the customer’s indefinitely idled facilities, have not been included in revenue. Supplemental payments related to the pellets sold to this facility are due and will be recognized when the pellets have been consumed or upon other disposition. Revenue for the year from product sales includes reimbursement for freight charges ($70.4 million-2006; $70.5 million-2005; $71.7 million-2004) paid on behalf of customers and cost reimbursements ($182.2 million-2006; $156.8 million-2005; $136.4 million-2004) from venture partners for their share of mine costs.

We do not recognize revenue on North American iron ore products shipped to some customers until payment is received. Generally, our North American term supply agreements specify that title and risk of loss pass to the customer when payment for the pellets is received. This is a practice utilized to reduce our financial risk due to customer insolvency. This practice is not believed to be widely used throughout the balance of the industry.

Where we are joint venture participants in the ownership of a mine, our contracts entitle us to receive royalties and/or management fees, which we earn as the pellets are produced. Revenue is recognized on the sale of services when the services are performed.

Portman’s sales revenue is recognized at the F.O.B. point, which is generally when the product is loaded into the vessel.

Deferred Revenue:    Two of our North American customers purchased and paid for a total of 1.2 million tons of pellets in December 2006 under terms of take-or-pay contracts. The inventory is stored at our facilities in upper lakes stockpiles. At the request of the customers, the ore was not shipped. The Company considered whether revenue should be recognized on these sales under the “bill and hold” guidance discussed in SEC Staff Accounting Bulletin No. 101 Topic No. 13, but because a fixed shipment schedule was not established prior to year-end, revenue recognition on these transactions, totaling $62.6 million, has been deferred until the product is delivered in 2007.

Use of Estimates:    The preparation of financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from estimates.

Cash Equivalents:    We consider investments in highly liquid debt instruments with an initial maturity of three months or less at the date of purchase to be cash equivalents.

 

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Marketable Securities:    We determine the appropriate classification of debt and equity securities at the time of purchase and re-evaluate such designation as of each balance sheet date. At December 31, 2005, we had $9.9 million in highly-liquid ARS, classified as trading with changes in market value, if any, included in income, which were sold in 2006. We invested in ARS to generate higher returns than traditional money market investments. Although these securities had long-term stated contractual maturities, they were presented for redemption at auction when rates are reset which is typically every 7, 28 or 35 days. As a result, we classified these securities as current assets. We had no realized or unrealized gains or losses related to these securities during the years ended December 31, 2006 and 2005. All income, including any gains or losses related to these investments, was recorded as interest income. In accordance with our investment policy, we only invest in ARS with high credit quality issuers and limit the amount of investment exposure to any one issuer.

At December 31, 2006 and 2005, we had $28.9 million and $10.6 million, respectively, of non-current marketable securities, classified as “available for sale,” which are stated at fair value, with unrealized holding gains and losses included in Other comprehensive income. See NOTE 14 — FAIR VALUE OF FINANCIAL INSTRUMENTS for further information.

Derivative Financial Instruments:    Portman, an Australian company wholly owned by Cliffs, receives funds in United States currency for its iron ore sales. Portman uses forward exchange contracts, call options, collar options and convertible collar options, designated as cash flow hedges, to hedge its foreign currency exposure for a portion of its sales receipts denominated in United States currency. United States currency is converted to Australian dollars at the currency exchange rate in effect at the time of the transaction. The primary objective for the use of these instruments is to reduce the volatility of earnings due to changes in the Australian and United States currency exchange rates, and to protect against undue adverse movement in these exchange rates. The instruments are subject to formal documentation, intended to achieve qualifying hedge treatment, and are tested at inception and at each reporting period as to effectiveness. Portman’s policy is to hedge no more than 90 percent of anticipated sales up to 12 months, no more than 30 percent of anticipated sales from 13 to 24 months and no more than 15 percent of anticipated sales from 25 to 36 months. In 2006 and 2005, $2.7 million and $9.8 million, respectively, of hedge contracts were settled and recognized as a reduction of revenues. Changes in fair value for highly effective hedges are recorded as a component of Other comprehensive income. In 2006 and 2005, ineffectiveness resulting in a $2.7 million gain and $2.6 million loss, respectively, were charged to Miscellaneous-net on the Statements of Consolidated Operations. We estimate $4.7 million of cash flow hedge contracts will be settled and reclassified into earnings in the next 12 months.

At December 31, 2006, Portman had outstanding $268.2 million in the form of call options, collar options, convertible collars and forward exchange contracts with varying maturity dates ranging from January 2007 to June 2009, and a fair value gain based on the December 31, 2006 spot rate of $9.9 million. We had $6.3 million and $.6 million of hedge contracts recorded as Derivative assets on the December 31, 2006 and 2005 Statements of Consolidated Financial Position, respectively and $3.6 million of hedge contracts recorded as long-term assets as Deposits and miscellaneous on the Statements of Consolidated Financial Position at December 31, 2006. Hedge contracts payable totaling $1.3 million were included as Other Liabilities on the December 31, 2005 Statements of Consolidated Financial Position.

Most of our North American long-term supply agreements are comprised of a base price with annual price adjustment factors. These price adjustment factors vary from agreement to agreement but typically include adjustments based upon changes in international pellet prices, changes in specified Producers Price Indices including those for all commodities, industrial commodities, energy and steel. The adjustments generally operate in the same manner, with each factor typically comprising a portion of the price adjustment, although the weighting of each factor varies from agreement to agreement. One of our term supply agreements contains price collars, which typically limit the percentage increase or decrease in prices for our iron ore pellets during any one year. In most cases, these adjustment factors have not been finalized at the time our product is sold; we routinely estimate these adjustment factors. The price adjustment factors have been evaluated as embedded derivatives. We evaluated the embedded derivatives in the supply agreements in accordance with the provisions of SFAS 133,

 

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Accounting for Derivative Instruments and Hedging Activities. The price adjustment factors share the same economic characteristics and risks as the host contract and are integral to the host contract as inflation adjustments; accordingly they have not been separately valued as derivative instruments.

Certain supply agreements with one of our North American customers include provisions for supplemental revenue or refunds based on the customer’s annual steel pricing for the year the product is consumed in the customer’s blast furnace. The supplemental pricing is characterized as an embedded derivative instrument and is required to be accounted for separately from the base contract price. The derivative, which is finalized based on a future price, is marked to fair value as a revenue adjustment each reporting period until the year the pellets are consumed and the amounts are settled. The amounts, totaling $107.9 million, $65.9 million, and $115.7 million, were recognized as Iron Ore revenues in the Statements of Consolidated Operations, in 2006, 2005 and 2004, respectively. Derivative assets, representing the fair value of pricing factors, were $26.6 million and $18.6 million on the December 31, 2006 and December 31, 2005 Statements of Consolidated Financial Position, respectively.

In the normal course of business, we enter into forward contracts designated as normal purchases, for the purchase of commodities, primarily natural gas and diesel fuel, which are used in our North American operations. Such contracts are in quantities expected to be delivered and used in the production process and are not intended for resale or speculative purposes.

Inventories:    North American product inventories are stated at the lower of cost or market. Cost of iron ore inventories is determined using the LIFO method. The excess of current cost over LIFO cost of iron ore inventories was $60.4 million and $39.9 million at December 31, 2006 and 2005, respectively. During 2005, the inventory balances declined resulting in liquidation of LIFO layers; the effect of the inventory reduction decreased Cost of goods sold and operating expenses by $.9 million in 2005. At December 31, 2006 and 2005, we had approximately .8 million tons and 1.2 million tons, respectively, stored at ports on the lower Great Lakes to service customers. We maintain ownership of the inventories until title has transferred to the customer, usually when payment is made. Maintaining iron ore products at ports on the lower Great Lakes reduces risk of non-payment by customers, as we retain title to the product until payment is received from the customer. It also assists the customers by more closely relating the timing of the customer’s payments for the product to the customer’s consumption of the products and by providing a portion of the three-month supply of inventories of iron ore the customers require during the winter when product shipments are curtailed over the Great Lakes. We track the movement of the inventory and verify the quantities on hand. Supplies and other inventories reflect the average cost method. North American finished product, work-in-process and supplies inventories as of December 31, 2006, were valued at $220.9 million, of which $129.5 million, or 59 percent (54 percent in 2005), was finished product.

At acquisition, the fair value of Portman’s iron ore inventory was determined utilizing estimated selling price less costs of realization and an appropriate margin for selling efforts and costs to complete, with the exception of lower grade stockpiles. The net realizable value was discounted to present value using a weighted average cost of capital, where appropriate. Optimal use of the lower grade stockpiles of high phosphorous ore is dependent on future production of standard ore for blending into saleable product. These stockpiles are scheduled to be utilized in the mine plan progressively over the life of the mine. Given the nature of these stockpiles and their dependence on future production, they have been assessed on the same basis as mineral rights associated with mining operations adjusted for the costs incurred to date to extract the ore and to reflect the benefits to Portman of having this ore available as an alternative to in-ground reserves. We maintain ownership of the inventories until title has transferred to the customer at the F.O.B. point, which is generally when the product is loaded into the vessel. Finished product, work-in-process and supplies inventories as of December 31, 2006, were valued at $57.5 million, of which $20.8 million, or 36 percent (26 percent in 2005), is finished product.

Deferred Power Receivable:    Our Empire and Tilden mines purchase their electric power from WEPCO pursuant to the terms of special contracts. The $15.6 million balance at December 31, 2006 represents payments

 

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into an escrow account for billings above the contractual cap in the first three months of 2006. The $73.0 million balance at December 31, 2005 were payments above the contractual cap in 2005 which were refunded in the second quarter of 2006. The escrow account was established in 2005 for the deposit of disputed billings for capped and auxiliary power.

Iron Ore Reserves:    We review the iron ore reserves based on current expectations of revenues and costs, which are subject to change. Iron ore reserves include only proven and probable quantities of ore which can be economically mined and processed utilizing existing technology. Asset retirement obligations reflect remaining economic iron ore reserves.

Properties:    North American properties are stated at cost. Depreciation of plant and equipment is computed principally by the straight-line method based on estimated useful lives, not to exceed the estimated economic iron ore reserves. Depreciation expense of $42.7 million, $32.7 million and $25.0 million in 2006, 2005 and 2004, respectively, was recorded on the Statements of Consolidated Operations. Depreciation is provided over the following estimated useful lives:

 

Asset Class

  

Life

Buildings

   45 Years

Mining equipment

   10 to 20 Years

Processing equipment

   15 to 45 Years

Information technology

   2 to 7 Years

Depreciation is not curtailed when operations are temporarily idled.

Portman’s properties were valued under purchase accounting using the depreciated replacement cost (“DRC”) approach as the primary valuation methodology. This method was utilized as it recognizes the value of specialized equipment and improvements as part of an ongoing business. When assessing the DRC of an asset, the expected remaining useful life was determined based on the shorter of the estimated remaining life of the asset and the life of the mine. Depreciation at Portman is provided over the following estimated useful lives:

 

Asset Class

  

Basis

   Life

Plant and equipment

   Straight line    5 - 13 Years

Plant and equipment and mine assets

   Production output    12 Years

Motor vehicles, furniture & equipment

   Straight line    3 - 5 Years

 

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Notes to Consolidated Financial Statements — (Continued)

 

The following table indicates the value of each of the major classes of our consolidated depreciable assets as of December 31, 2006 and 2005:

 

     (In Millions)
December 31
 
     2006     2005  

Land rights and mineral rights

   $ 469.2     $ 421.8  

Office and information technology

     34.9       29.4  

Buildings

     51.1       32.4  

Mining equipment

     101.0       80.8  

Processing equipment

     214.8       175.8  

Railroad equipment

     96.4       75.4  

Electric power facilities

     30.2       28.9  

Port facilities

     42.9       37.4  

Interest capitalized during construction

     19.0       19.0  

Land improvements

     10.0       11.1  

Other

     10.5       5.3  

Construction in progress

     27.3       62.0  
                
     1,107.3       979.3  

Allowance for depreciation and depletion

     (222.4 )     (176.5 )
                
   $ 884.9     $ 802.8  
                

Amortization of interest capitalized during construction is at the rate of approximately $2 million per year.

The costs capitalized and classified as Land rights and mineral rights on the Statements of Consolidated Financial Position represent lands where we own the surface and/or mineral rights. The value of the land rights is split between surface only, surface and minerals, and minerals only.

Portman’s interest in iron ore reserves and resources was valued using a discounted cash flow method. Fair value was estimated based upon the present value of the expected future cash flows from iron ore operations over the economic lives of the mines.

The net book value of the land rights and mineral rights is as follows:

 

     (In Millions)
December 31
     2006    2005

Land rights

   $ 4.9    $ 4.8
             

Mineral rights:

     

Cost

     464.3      417.0

Less depletion

     52.1      19.3
             

Net mineral rights

   $ 412.2    $ 397.7
             

Accumulated depletion relating to mineral rights, which was recorded using the unit-of-production method, is included in Allowances for depreciation and depletion on the Statements of Consolidated Financial Position.

Goodwill:    Based on our final purchase price allocation for our Portman acquisition, we identified $8.4 million of excess purchase price over the fair value of assets acquired. At December 31, 2006 the amount of goodwill recorded on the Statements of Consolidated Financial Position related to Portman was $8.7 million. The increase is attributable to foreign exchange rate changes. Goodwill also includes $2.1 million related to our acquisition of Northshore in 1994.

 

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As required by SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142), goodwill related to Portman was allocated to the Australia segment and goodwill related to Northshore was allocated to the North America segment. SFAS 142 requires us to compare the fair value of the reporting unit to its carrying value on an annual basis to determine if there is potential goodwill impairment. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than the carrying value of its goodwill.

We evaluate goodwill for impairment in the fourth quarter each year. In addition to the annual impairment test required under SFAS 142, we assessed whether events or circumstances occurred that potentially indicate that the carrying amount of these assets may not be recoverable. We concluded that there were no such events or changes in circumstances during 2006 and 2005, and determined that the fair value of reporting units was in excess of our carrying value as of December 31, 2006 and 2005. Consequently, no goodwill impairment charges were recorded in either year.

Preferred Stock:    In January 2004, we issued 172,500 shares of redeemable cumulative convertible perpetual preferred stock, without par value, issued at $1,000 per share. The preferred stock pays quarterly cash dividends at a rate of 3.25 percent per annum and can be converted into our common shares at an adjusted rate of 65.5068 common shares per share of preferred stock. The preferred stock is classified as “temporary equity” reflecting certain provisions of the agreement that could, under remote circumstances, require us to redeem the preferred stock for cash. See NOTE 10 — PREFERRED STOCK for more information.

Asset Impairment:    We monitor conditions that may affect the carrying value of our long-lived and intangible assets when events and circumstances indicate that the carrying value of the assets may be impaired. We determine impairment based on the asset’s ability to generate cash flow greater than the carrying value of the asset, using an undiscounted probability-weighted analysis. If projected undiscounted cash flows are less than the carrying value of the asset, the asset is adjusted to its fair value.

Repairs and Maintenance:    The cost of major power plant overhauls is amortized over the estimated useful life, which is the period until the next scheduled overhaul, generally five years. All other planned and unplanned repairs and maintenance costs are expensed when incurred.

Insurance Recoveries:    Potential insurance recoveries can relate to property damage, business interruption (including profit recovery) and expenditures to mitigate loss. We account for insurance recoveries under the guidelines established by SFAS No. 5, Accounting for Contingencies (SFAS 5) and EITF 01-10 which indicate that the proceeds from property damage insurance claims are to be recognized only when realization of the claim is probable and only to the extent of loss recoveries. Insurance recoveries that result in a gain, and proceeds from business interruption insurance are recognized when realized in Other operating income (expense) in the Statements of Consolidated Operations.

Pensions and other postretirement benefits:    Cliffs and its unconsolidated ventures offer defined benefit pension plans, defined contribution pension plans and other postretirement benefit plans, primarily consisting of retiree healthcare benefits, to most employees in North America as part of a total compensation and benefits program. Portman does not have employee retirement benefit obligations.

Under the provisions of SFAS 158 (effective December 31, 2006), we recognized the funded status of our postretirement benefit obligations on our December 31, 2006 Statement of Consolidated Financial Position based on the market value of plan assets and the actuarial present value of our retirement obligations on that date. On a plan-by-plan basis, we determine if the plan assets exceed the benefit obligations or vice-versa. If the plan assets exceed the retirement obligations, the amount of the surplus is recorded as an asset; if the retirement obligations exceed the plan assets, the amount of the underfunded obligations are recorded as a liability. Year-end balance sheet adjustments to postretirement assets and obligations are charged to other comprehensive income.

 

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The market value of plan assets is measured at the year-end balance sheet date. The PBO is determined based upon an actuarial estimate of the present value of pension benefits to be paid to current employees and retirees. The APBO represents an actuarial estimate of the present value of OPEB benefits to be paid to current employees and retirees.

The actuarial estimates of the PBO and/or APBO retirement obligations incorporate various assumptions including the discount rates, the rates of increases in compensation, healthcare cost trend rates, mortality, retirement timing and employee turnover. The discount rate is determined based on the prevailing year-end rates for high-grade corporate bonds with a duration matching the expected cash flow timing of the benefit payments from the various plans. The remaining assumptions are based on our estimate of future events incorporating historical trends and future expectations.

The amount of net periodic cost that is recorded in the Consolidated Statements of Operations consists of several components including service cost, interest cost, expected return on plan assets, and amortization of previously unrecognized amounts. Service cost represents the value of the benefits earned in the current year by the participants. Interest cost represents the cost associated with the passage of time. In addition, the net periodic cost is affected by the anticipated income from the return on invested assets, as well as the income or expense resulting from the recognition of previously deferred items. Certain items, such as plan amendments, gains and/or losses resulting from differences between actual and assumed results for demographic and economic factors affecting the obligations and assets of the plans, and changes in plan assumptions are subject to deferred recognition for income and expense purposes. The expected return on plan assets is determined utilizing the weighted average of expected returns for plan asset investments in various asset categories based on historical performance, adjusted for current trends. See NOTE 8 — RETIREMENT RELATED BENEFITS — for further information.

Income Taxes:    Income taxes are based on income (loss) for financial reporting purposes and reflect a current tax liability (asset) for the estimated taxes payable (recoverable) for all open tax years and changes in deferred taxes. In evaluating any exposures associated with our various tax filing positions, we record liabilities for exposures on a probable basis. Deferred tax assets or liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax laws and rates. A valuation allowance is provided on deferred tax assets if it is determined that it is more likely than not that the asset will not be realized. See NOTE 9 — INCOME TAXES.

Environmental Remediation Costs:    We have a formal policy for environmental protection and restoration. Our mining and exploration activities are subject to various laws and regulations governing protection of the environment. We conduct our operations to protect the public health and environment and believe our operations are in compliance with applicable laws and regulations in all material respects. Our environmental liabilities, including obligations for known environmental remediation exposures at active and closed mining operations and other sites, have been recognized based on the estimated cost of investigation and remediation at each site. If the cost can only be estimated as a range of possible amounts with no specific amount being most likely, the minimum of the range is accrued in accordance with SFAS 5. Future expenditures are not discounted unless the amount and timing of the cash disbursements are readily known. Additional environmental obligations could be incurred, the extent of which cannot be assessed. Potential insurance recoveries have not been reflected in the determination of the liabilities. See NOTE 5 — ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS.

Share-Based Compensation:    Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, Share-Based Payment (SFAS 123R) using the modified prospective transition method. Because we elected to use the modified prospective transition method, results for prior periods have not been restated. Under this transition method, share-based compensation expense for 2006 included compensation expense for all share-based compensation awards granted prior to January 1, 2006 based on the grant date estimated fair value, which are being amortized on a straight-line basis over the remaining service periods of the awards.

 

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Notes to Consolidated Financial Statements — (Continued)

 

Effective January 1, 2006, we made a one-time election to adopt the transition method described in FSP No. FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. This election resulted in the reclassification of excess tax benefits as presented in the Statements of Consolidated Cash Flows, from operating activities to financing activities.

Prior to the adoption of SFAS 123R, we recognized share-based compensation expense in accordance with SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123). As prescribed in SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure (SFAS 148), we elected to use the prospective method. The prospective method required expense to be recognized for all awards granted, modified or settled beginning in the year of adoption. In accordance with SFAS 123 and SFAS 148, we provided pro forma net income or loss and net income or loss per share disclosures for each period as if we had applied the fair value recognition provisions to all awards unvested in each period.

In March 2005, the SEC issued SAB 107, which provided supplemental implementation guidance for SFAS 123R. We have applied the provisions of SAB 107 in our adoption of SFAS 123R. See NOTE 11 — STOCK PLANS for information on the impact of our adoption of SFAS 123R and the assumptions we used to calculate the fair value of share-based compensation.

Research and Development Costs:    Research and development costs, primarily relating to the Mesabi Nugget project at the Northshore mine in Minnesota and international projects located in Australia and Brazil, are expensed as incurred. Business development costs of $5.6 million, $3.2 million and $1.2 million in 2006, 2005 and 2004, respectively, were included in Miscellaneous — net. Mine development costs, primarily stripping and development drilling, are included in the cost of production as incurred.

Earnings Per Share:    We present both basic and diluted EPS amounts. Basic EPS are calculated by dividing net income by the weighted average number of common shares outstanding during the period presented. Diluted EPS are calculated by dividing net income by the weighted average number of common shares, common share equivalents and convertible preferred stock outstanding during the period, utilizing the treasury share method for employee stock plans. Common share equivalents are excluded from EPS computations in the periods in which they have an anti-dilutive effect. See NOTE 15 — EARNINGS PER SHARE.

New Accounting Standards:

In February 2007, FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Liabilities Including an Amendment of FASB Statement No. 115, (SFAS 159). This Statement permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The Statement also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted. We are evaluating the impact, if any, of the adoption of this standard on our consolidated financial statements.

On September 29, 2006, FASB issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS 158). SFAS 158 requires an entity to recognize on its balance sheet the funded status of its defined benefit postretirement plans, measured as the difference between the fair value of the plan assets and the benefit obligation. Changes in the funded status of a defined benefit postretirement plan will now be recognized, net of tax, in comprehensive income, effective for fiscal years ending after December 15, 2006. SFAS 158 also requires an employer to measure the funded status of its plans as of the date of its year-end balance sheet, effective for fiscal years ending after December 15, 2008. We have adopted the requirements of SFAS 158 in December 2006. The effect on our consolidated financial statements is shown in NOTE 8 — RETIREMENT RELATED BENEFITS.

 

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Notes to Consolidated Financial Statements — (Continued)

 

In September 2006, FASB issued FSP No. AUG AIR-1, Accounting for Planned Major Maintenance Activities, which prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim periods. This FSP is effective for fiscal years beginning after December 15, 2006. Retrospective application is required unless it is impracticable. We have evaluated the provisions of this Staff Position and have determined that adoption of this standard is not expected to have a material impact on our consolidated financial statements.

In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their impact on each of our financial statements and related disclosures and is effective for fiscal years ending after November 15, 2006. A one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006 is allowed for errors that were not previously deemed material, but are material under the guidance in SAB 108. The adoption of SAB No. 108 in the fourth quarter of 2006 did not impact our consolidated financial statements.

In September 2006, FASB issued Statement No. 157, Accounting for Fair Value Measurements (SFAS 157). SFAS 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, with early adoption permitted. We do not expect adoption of this Statement to have a material impact on our consolidated financial statements.

In June 2006, FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that we recognize the impact of a tax position in our financial statements, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The application of this Statement will reduce our retained earnings on January 1, 2007 by approximately $8 million to increase reserves for uncertain tax positions.

On February 16, 2006, FASB issued Statement No. 155, Accounting for Certain Hybrid Instruments (SFAS 155), which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133) and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities (SFAS 140). SFAS 155 allows financial instruments that have embedded derivatives to be accounted for as a whole, (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. This Statement is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The adoption of this Statement is not expected to have a material impact on our consolidated financial statements.

On March 17, 2005, the EITF reached consensus on Issue No. 04-6, Accounting for Stripping Costs Incurred during Production in the Mining Industry, (EITF 04-6). The consensus clarified that stripping costs incurred during the production phase of a mine are variable production costs that should be included in the cost of inventory. The consensus, which was effective for reporting periods beginning after December 15, 2005, permitted early adoption. At its June 29, 2005 meeting, FASB ratified a modification to EITF 04-6 to clarify that the term “inventory produced” means “inventory extracted.” We elected to adopt EITF 04-6 in 2005. As a result, we recorded an after-tax cumulative effect adjustment of $5.2 million or $.09 per diluted share, and increased product inventory by $8.0 million effective January 1, 2005.

 

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Notes to Consolidated Financial Statements — (Continued)

 

NOTE 2 — PORTMAN ACQUISITION

On April 19, 2005, Cliffs Asia Pacific completed the acquisition of 80.4 percent of the outstanding shares of Portman, a Western Australia-based independent iron ore mining and exploration company. The acquisition was initiated on March 31, 2005 by the purchase of 68.7 percent of the outstanding shares of Portman. The assets consist primarily of iron ore inventory, land and mineral rights, and iron ore reserves. The purchase price of the 80.4 percent interest was $433.1 million, including $12.4 million of acquisition costs. Additionally, we incurred $9.8 million of foreign currency hedging costs related to this transaction, which were included in Other-net in the Statements of Consolidated Operations. The acquisition increased our customer base in China and Japan and established our presence in the Australian mining industry. Portman’s full-year production (excluding .7 million tonnes in 2006, and .6 million tonnes in 2005 representing the 50 percent-owned Cockatoo Island joint venture) was approximately 7.0 million tonnes for 2006 and 6.0 million tonnes for 2005. Portman completed a $62 million project in the first half of 2006 that increased its wholly owned production capacity to eight million tonnes per year. The production is fully committed to steel companies in China and Japan through 2009. Portman’s reserves total approximately 88 million tonnes at December 31, 2006, and it has an active exploration program underway to increase its reserves.

The acquisition and related costs were financed with existing cash and marketable securities and $175 million of interim borrowings under a three-year $350 million revolving credit facility. The outstanding balance was repaid in July 2005. See NOTE 6 — CREDIT FACILITIES.

Our Statements of Consolidated Financial Position as of December 31, 2006 and 2005, reflected the acquisition of Portman, under the purchase method of accounting. Assets acquired and liabilities assumed have been recorded at fair values as of the acquisition date as determined by results of an appraisal of assets and liabilities finalized in the first quarter of 2006.

 

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Notes to Consolidated Financial Statements — (Continued)

 

The adjustment since our initial allocation of the 80.4 percent interest in Portman increased Portman’s iron ore inventory values by $46.5 million to reflect a market-based valuation. Of the $46.5 million inventory basis adjustment, $23.1 million was allocated to product and work-in-process inventories, of which approximately $19.9 million was included in cost of goods sold in 2005 and the $3.2 million remaining product and work-in-process inventory basis adjustment was recognized in the first quarter of 2006. The remaining $23.4 million inventory basis adjustment, which was allocated to the long-term stockpiles, will be realized over the mine life. Additionally, a long-term lease was classified as a capital lease resulting in an increase in plant and equipment, and current and other long-term liabilities, of $26.7 million. The valuation also resulted in a $13.6 million increase in the value of our 50 percent interest in our investment in Cockatoo Island and assignment of $8.4 million of goodwill, which is not deductible for tax purposes. The increase in the value of Cockatoo Island was based upon a discounted cash flow analysis over the remaining life of its iron ore reserves. Feasibility studies have concluded that mining and shipments from current operations at Cockatoo Island can be continued until late 2007. The value assigned to Portman’s iron ore reserves decreased by $82.4 million. The $.7 million reduction in purchase price was attributable to the re-allocation of transaction costs to debt acquisition costs, which were being initially amortized over the three-year term of the credit facility and recorded as Other-net on the Statements of Consolidated Operations upon replacement of the $350 million credit facility in June 2006. A comparison of the final