10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

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

 

LOGO

CLIFFS NATURAL RESOURCES INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Ohio

  34-1464672

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

200 Public Square, Cleveland, Ohio

  44114-2315

(Address of Principal Executive Offices)

  (Zip Code)

Registrant’s Telephone Number, Including Area Code: (216) 694-5700

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  x                                         NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES  x                                         NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x             Accelerated filer  ¨    Non-accelerated filer   ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES  ¨                                         NO  x

The number of shares outstanding of the registrant’s Common Shares, par value $0.125 per share, was 142,492,567 as of July 23, 2012.

 

 


Table of Contents

TABLE OF CONTENTS

 

Page No.

              
1       Definitions

PART I – FINANCIAL INFORMATION

3       Item 1 – Financial Statements
        

Statements of Unaudited Condensed Consolidated Operations for the Three and Six Months Ended June 30, 2012 and 2011

4         

Statements of Unaudited Condensed Consolidated Comprehensive Income for the Three and Six Months Ended June 30, 2012 and 2011

5         

Statements of Unaudited Condensed Consolidated Financial Position as of June 30, 2012 and December 31, 2011

6         

Statements of Unaudited Condensed Consolidated Cash Flows for the Six Months Ended June 30, 2012 and 2011

7         

Notes to Unaudited Condensed Consolidated Financial Statements

36      

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

63       Item 3 – Quantitative and Qualitative Disclosures About Market Risk
64       Item 4 – Controls and Procedures

PART II – OTHER INFORMATION AND SIGNATURES

64       Item 1 – Legal Proceedings
65       Item 1A – Risk Factors
66       Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
67       Item 4 – Mine Safety Disclosures
68       Item 6 – Exhibits
68       Signatures
69       Exhibit Index


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 Cliffs Natural Resources Inc. and subsidiaries, collectively. References to “A$” or “AUD” refer to Australian currency, “C$” to Canadian currency and “$” to United States currency.

 

Abbreviation or acronym        

  

Term

Algoma

   Essar Steel Algoma Inc.

Amapá

   Anglo Ferrous Amapá Mineração Ltda. and Anglo Ferrous Logística Amapá Ltda.

ArcelorMittal

   ArcelorMittal (as the parent company of ArcelorMittal Mines Canada, ArcelorMittal USA and ArcelorMittal Dofasco, as well as, many other subsidiaries)

ArcelorMittal USA

   ArcelorMittal USA LLC (including many of its North American affiliates, subsidiaries and representatives. References to ArcelorMittal USA comprise all such relationships unless a specific ArcelorMittal USA entity is referenced)

ATO

   Australian Taxation Office

AusQuest

   AusQuest Limited

Bloom Lake

   The Bloom Lake Iron Ore Mine Limited Partnership

C.F.R.

   Cost and Freight

CLCC

   Cliffs Logan County Coal LLC

Cliffs Chromite Far North Inc.

   Entity previously known as Spider Resources Inc.

Cliffs Chromite Ontario Inc.

   Entity previously known as Freewest Resources Canada Inc.

Cockatoo Island

   Cockatoo Island Joint Venture

Consolidated Thompson

   Consolidated Thompson Iron Mining Limited (now known as Cliffs Quebec Iron Mining Limited)

CQIM

   Cilffs Quebec Iron Mining Limited

CSAPR

   U.S. Cross-State Air Pollution Rule

DEP

   U.S. Department of Environment Protection

Dodd-Frank Act

   Dodd-Frank Wall Street Reform and Consumer Protection Act

Empire

   Empire Iron Mining Partnership

EPA

   U.S. Environmental Protection Agency

Exchange Act

   Securities Exchange Act of 1934

FASB

   Financial Accounting Standards Board

Fe

   Iron

FIP

   Federal Implementation Plan

FMSH Act

   U.S. Federal Mine Safety and Health Act 1977

F.O.B.

   Free on board

GAAP

   Accounting principles generally accepted in the United States

GHG

   Green house gas

Hibbing

   Hibbing Taconite Company

IASB

   International Accounting Standards Board

ICE Plan

   Amended and Restated Cliffs 2007 Incentive Equity Plan, As Amended

Ispat

   Ispat Inland Steel Company

LCM

   Lower of cost or market

LIBOR

   London Interbank Offered Rate

LTVSMC

   LTV Steel Mining Company

MMBtu

   Million British Thermal Units

MPCA

   Minnesota Pollution Control Agency

MRRT

   Minerals Resource Rent Tax

MSHA

   Mine Safety and Health Administration

NO2

   Nitrogen dioxide

Northshore

   Northshore Mining Company

NOV

   Notice of Violation

NPDES

   National Pollutant Discharge Elimination System, authorized by the U.S. Clean Water Act

Oak Grove

   Oak Grove Resources, LLC

OCI

   Other comprehensive income

OPEB

   Other postretirement benefits

 

1


Table of Contents

Abbreviation or acronym        

  

Term

Pinnacle

   Pinnacle Mining Company, LLC

renewaFUEL

   renewaFUEL, LLC (now known as Cliffs Michigan Biomass, LLC)

SEC

   United States Securities and Exchange Commission

Silver Bay Power

   Silver Bay Power Company

SO2

   Sulfur dioxide

Sonoma

   Sonoma Coal Project

Tilden

   Tilden Mining Company

TSR

   Total Shareholder Return

United Taconite

   United Taconite LLC

U.S.

   United States of America

Wabush

   Wabush Mines Joint Venture

WISCO

   Wugang Canada Resources Investment Limited, a subsidiary of Wuhan Iron and Steel (Group) Corporation

2012 Equity Plan

   Cliffs 2012 Incentive Equity Plan

 

2


Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

CLIFFS NATURAL RESOURCES INC. AND SUBSIDIARIES

STATEMENTS OF UNAUDITED CONDENSED CONSOLIDATED OPERATIONS

 

     (In Millions, Except Per Share Amounts)  
                     Three Months Ended                                           Six Months Ended                       
     June 30,      June 30,  
     2012      2011      2012      2011  

REVENUES FROM PRODUCT SALES AND SERVICES

           

Product

     $ 1,546.6           $ 1,705.0           $ 2,747.5           $ 2,838.0     

Freight and venture partners' cost reimbursements

     79.4           100.8           143.2           151.0     
  

 

 

    

 

 

    

 

 

    

 

 

 
     1,626.0           1,805.8           2,890.7           2,989.0     

COST OF GOODS SOLD AND OPERATING EXPENSES

     (1,176.7)          (1,074.2)          (2,137.9)          (1,657.9)    
  

 

 

    

 

 

    

 

 

    

 

 

 

SALES MARGIN

     449.3           731.6           752.8           1,331.1     

OTHER OPERATING INCOME (EXPENSE)

           

Selling, general and administrative expenses

     (83.5)          (69.4)          (146.5)          (115.1)    

Consolidated Thompson acquisition costs

     -             (18.0)          -             (22.9)    

Exploration costs

     (29.1)          (18.2)          (47.9)          (28.8)    

Miscellaneous - net

     28.6           (8.2)          38.0           (4.4)    
  

 

 

    

 

 

    

 

 

    

 

 

 
     (84.0)          (113.8)          (156.4)          (171.2)    
  

 

 

    

 

 

    

 

 

    

 

 

 

OPERATING INCOME

     365.3           617.8           596.4           1,159.9     

OTHER INCOME (EXPENSE)

           

Changes in fair value of foreign currency contracts, net

     -             50.4           0.3           106.7     

Interest expense

     (47.1)          (81.3)          (94.4)          (119.7)    

Other non-operating income (expense)

     (0.5)          2.9           3.0           5.9     
  

 

 

    

 

 

    

 

 

    

 

 

 
     (47.6)          (28.0)          (91.1)          (7.1)    
  

 

 

    

 

 

    

 

 

    

 

 

 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND EQUITY LOSS FROM VENTURES

     317.7           589.8           505.3           1,152.8     

INCOME TAX (EXPENSE) BENEFIT

     (42.9)          (150.4)          167.9           (292.6)    

EQUITY LOSS FROM VENTURES

     (0.5)          (11.3)          (7.4)          (8.3)    
  

 

 

    

 

 

    

 

 

    

 

 

 

INCOME FROM CONTINUING OPERATIONS

     274.3           428.1           665.8           851.9     

LOSS FROM DISCONTINUED OPERATIONS, net of tax

     -             (0.7)          (0.1)          (1.1)    
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INCOME

     274.3           427.4           665.7           850.8     

LESS: INCOME ATTRIBUTABLE TO

           

NONCONTROLLING INTEREST

     16.3           18.3           31.9           18.3     
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INCOME ATTRIBUTABLE TO CLIFFS SHAREHOLDERS

     $ 258.0           $ 409.1           $ 633.8           $ 832.5     
  

 

 

    

 

 

    

 

 

    

 

 

 

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CLIFFS SHAREHOLDERS - BASIC

           

Continuing operations

     $ 1.81           $ 2.95           $ 4.45           $ 6.07     

Discontinued operations

     -             (0.01)          -             (0.01)    
  

 

 

    

 

 

    

 

 

    

 

 

 
     $ 1.81           $ 2.94           $ 4.45           $ 6.06     
  

 

 

    

 

 

    

 

 

    

 

 

 

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CLIFFS SHAREHOLDERS - DILUTED

           

Continuing operations

     $ 1.81           $ 2.93           $ 4.44           $ 6.04     

Discontinued operations

     -             (0.01)          -             (0.01)    
  

 

 

    

 

 

    

 

 

    

 

 

 
     $ 1.81           $ 2.92           $ 4.44           $ 6.03     
  

 

 

    

 

 

    

 

 

    

 

 

 

AVERAGE NUMBER OF SHARES (IN THOUSANDS)

           

Basic

     142,380           139,000           142,303           137,243     

Diluted

     142,814           139,783           142,762           137,987     

CASH DIVIDENDS DECLARED PER SHARE

     $ 0.63           $ 0.14           $ 0.91           $ 0.28     

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Table of Contents

CLIFFS NATURAL RESOURCES INC. AND SUBSIDIARIES

STATEMENTS OF UNAUDITED CONDENSED CONSOLIDATED COMPREHENSIVE INCOME

 

      (In Millions)  
     Three Months Ended
June  30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

NET INCOME ATTRIBUTABLE TO CLIFFS SHAREHOLDERS

     $ 258.0         $ 409.1           $  633.8         $ 832.5     

OTHER COMPREHENSIVE INCOME, NET OF TAX

           

Pension and OPEB liability

     7.1           0.8           13.3           9.5     

Unrealized net loss on marketable securities

     (2.8)          (19.0)          (0.5)          (19.2)    

Unrealized net gain (loss) on foreign currency translation

     (17.4)          42.9           (6.5)          57.5     

Unrealized net gain (loss) on derivative financial instruments

     (4.4)          1.7           (0.6)          3.2     
  

 

 

    

 

 

    

 

 

    

 

 

 

OTHER COMPREHENSIVE INCOME (LOSS)

     (17.5)          26.4           5.7           51.0     
  

 

 

    

 

 

    

 

 

    

 

 

 

LESS: OTHER COMPREHENSIVE LOSS ATTRIBUTABLE TO THE NONCONTROLLING INTEREST

     (1.5)          (0.4)          (3.0)          (0.9)    
  

 

 

    

 

 

    

 

 

    

 

 

 

TOTAL COMPREHENSIVE INCOME ATTRIBUTABLE TO CLIFFS SHAREHOLDERS

     $ 239.0         $ 435.1           $ 636.5         $   882.6     
  

 

 

    

 

 

    

 

 

    

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Table of Contents

CLIFFS NATURAL RESOURCES INC. AND SUBSIDIARIES

STATEMENTS OF UNAUDITED CONDENSED CONSOLIDATED FINANCIAL POSITION

 

     (In Millions)  
     June 30,
2012
     December 31,
2011
 
ASSETS      

CURRENT ASSETS

     

Cash and cash equivalents

     $ 159.2           $ 521.6     

Accounts receivable

     310.8           304.2     

Inventories

     741.0           475.7     

Supplies and other inventories

     237.0           216.9     

Derivative assets

     74.8           82.1     

Other current assets

     219.8           190.2     
  

 

 

    

 

 

 

TOTAL CURRENT ASSETS

     1,742.6           1,790.7     

PROPERTY, PLANT AND EQUIPMENT, NET

     10,882.1           10,524.6     

OTHER ASSETS

     

Investments in ventures

     531.2           526.6     

Goodwill

     1,166.1           1,152.1     

Intangible assets, net

     137.9           147.0     

Deferred income taxes

     522.2           209.5     

Other non-current assets

     212.2           191.2     
  

 

 

    

 

 

 

TOTAL OTHER ASSETS

     2,569.6           2,226.4     
  

 

 

    

 

 

 

TOTAL ASSETS

     $ 15,194.3           $ 14,541.7     
  

 

 

    

 

 

 
LIABILITIES      

CURRENT LIABILITIES

     

Accounts payable

     $ 385.2           $ 380.3     

Accrued expenses

     402.1           386.3     

Taxes payable

     49.2           324.5     

Current portion of debt

     369.7           74.8     

Deferred revenue

     123.4           126.6     

Other current liabilities

     204.7           200.8     
  

 

 

    

 

 

 

TOTAL CURRENT LIABILITIES

     1,534.3           1,493.3     

POSTEMPLOYMENT BENEFIT LIABILITIES

     634.2           665.8     

ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS

     231.4           222.0     

DEFERRED INCOME TAXES

     1,143.7           1,062.4     

LONG-TERM DEBT

     3,614.1           3,608.7     

BELOW-MARKET SALES CONTRACTS, NET

     98.5           111.8     

OTHER LIABILITIES

     330.6           338.0     
  

 

 

    

 

 

 

TOTAL LIABILITIES

     7,586.8           7,502.0     

COMMITMENTS AND CONTINGENCIES

     
EQUITY      

CLIFFS SHAREHOLDERS' EQUITY

     

Common Shares - par value $0.125 per share

     

Authorized - 400,000,000 shares (2011 - 400,000,000);

     

Issued - 149,195,469 shares (2011 - 149,195,469 shares);

     

Outstanding - 142,488,633 shares (2011 - 142,021,718 shares)

     18.5           18.5     

Capital in excess of par value of shares

     1,759.6           1,770.8     

Retained earnings

     4,929.4           4,424.3     

Cost of 6,706,836 common shares in treasury (2011 - 7,173,751 shares)

     (322.6)          (336.0)    

Accumulated other comprehensive loss

     (89.9)          (92.6)    
  

 

 

    

 

 

 

TOTAL CLIFFS SHAREHOLDERS' EQUITY

     6,295.0           5,785.0     
  

 

 

    

 

 

 

NONCONTROLLING INTEREST

     1,312.5           1,254.7     
  

 

 

    

 

 

 

TOTAL EQUITY

     7,607.5           7,039.7     
  

 

 

    

 

 

 

TOTAL LIABILITIES AND EQUITY

     $   15,194.3           $ 14,541.7     
  

 

 

    

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Table of Contents

CLIFFS NATURAL RESOURCES INC. AND SUBSIDIARIES

STATEMENTS OF UNAUDITED CONDENSED CONSOLIDATED CASH FLOWS

 

     (In Millions)  
     Six Months Ended
June 30,
 
     2012      2011  

CASH FLOW FROM CONTINUING OPERATIONS

     

OPERATING ACTIVITIES

     

Net income

       $ 665.7           $ 850.8     

Adjustments to reconcile net income to net cash provided (used) by operating activities:

     

Depreciation, depletion and amortization

     249.4           186.6     

Derivatives and currency hedges

     9.0           (89.8)    

Equity loss in ventures (net of tax)

     7.4           8.3     

Deferred income taxes

     (259.2)          75.9     

Changes in deferred revenue and below-market sales contracts

     (23.2)          (98.1)    

Other

     (40.7)          10.1     

Changes in operating assets and liabilities:

     

Receivables and other assets

     (86.4)          7.1     

Product inventories

     (265.9)          (196.8)    

Payables and accrued expenses

     (288.9)          (29.1)    
  

 

 

    

 

 

 

Net cash provided (used) by operating activities

     (32.8)          725.0     

INVESTING ACTIVITIES

     

Acquisition of Consolidated Thompson, net of cash acquired

     -             (4,423.4)    

Purchase of property, plant and equipment

     (517.0)          (244.5)    

Settlements in Canadian dollar foreign exchange contracts

     -             93.1     

Cost of Canadian dollar foreign exchange option

     -             (22.3)    

Investment in Consolidated Thompson senior secured notes

     -             (125.0)    

Investments in ventures

     (11.9)          (1.3)    

Proceeds from sale of assets

     8.0           2.6     
  

 

 

    

 

 

 

Net cash used by investing activities

     (520.9)          (4,720.8)    

FINANCING ACTIVITIES

     

Net proceeds from issuance of common shares

     -             853.7     

Net proceeds from issuance of senior notes

     -             998.1     

Borrowings on term loan

     -             1,250.0     

Borrowings on bridge credit facility

     -             750.0     

Repayment of bridge credit facility

     -             (750.0)    

Repayment of term loan

     (25.0)          -       

Debt issuance costs

     -             (47.7)    

Borrowings under revolving credit facility

     550.0           -       

Repayment under revolving credit facility

     (225.0)          -       

Repayment of Consolidated Thompson convertible debentures

     -             (337.2)    

Contributions by (to) joint ventures, net

     31.5           (3.0)    

Common stock dividends

     (128.8)          (38.0)    

Other financing activities

     (11.1)          (16.5)    
  

 

 

    

 

 

 

Net cash provided by financing activities

     191.6           2,659.4     

EFFECT OF EXCHANGE RATE CHANGES ON CASH

     (0.3)          7.8     
  

 

 

    

 

 

 

DECREASE IN CASH AND CASH EQUIVALENTS

     (362.4)          (1,328.6)    

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

     521.6           1,566.7     
  

 

 

    

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

     $ 159.2           $    238.1     
  

 

 

    

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

See Note 20 - Cash Flow Information.

 

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Table of Contents

CLIFFS NATURAL RESOURCES INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

NOTE 1 – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with SEC rules and regulations and in the opinion of management, contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly, the financial position, results of operations, comprehensive income and cash flows for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. 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. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of results to be expected for the year ended December 31, 2012 or any other future period. These unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2011.

The unaudited condensed consolidated financial statements include our accounts and the accounts of our wholly owned and majority-owned subsidiaries, including the following operations:

 

        Name        

       Location            Ownership Interest             Operation    

 Northshore

    Minnesota      100.0   Iron Ore

 United Taconite

    Minnesota      100.0   Iron Ore

 Wabush

    Labrador/Quebec, Canada      100.0   Iron Ore

 Bloom Lake

    Quebec, Canada      75.0   Iron Ore

 Tilden

    Michigan      85.0   Iron Ore

 Empire

    Michigan      79.0   Iron Ore

 Koolyanobbing

    Western Australia      100.0   Iron Ore

 Pinnacle

    West Virginia      100.0   Coal

 Oak Grove

    Alabama      100.0   Coal

 CLCC

    West Virginia      100.0   Coal

Intercompany transactions and balances are eliminated upon consolidation.

Also included in our consolidated results are Cliffs Chromite Ontario Inc. and Cliffs Chromite Far North Inc., which have a 100 percent interest in the Black Label and Black Thor chromite deposits and a 72 percent interest in the Big Daddy chromite deposit, all located in Northern Ontario, Canada.

The following table presents the detail of our investments in unconsolidated ventures and where those investments are classified in the Statements of Unaudited Condensed Consolidated Financial Position as of June 30, 2012 and December 31, 2011. Parentheses indicate a net liability.

 

                    (In Millions)  

Investment    

   Classification              Accounting  
Method
   Interest
  Percentage  
     June 30,  
2012
    

  December 31,  
2011

 

Amapá

   Investments in ventures    Equity Method    30      $         493.4           $ 498.6     

Cockatoo

   Other liabilities    Equity Method    50      (16.7)          (15.0)    

Hibbing

   Other liabilities    Equity Method    23      (5.8)          (6.8)    

Other

   Investments in ventures    Equity Method    Various      37.8           28.0     
           

 

 

    

 

 

 
              $ 508.7           $ 504.8     
           

 

 

    

 

 

 

 

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Immaterial Errors

In September 2011, we noted an error in the accounting for the 21 percent noncontrolling interest in the Empire mine. In accordance with applicable GAAP, management quantitatively and qualitatively evaluated the materiality of the error and determined the error to be immaterial to the quarterly reports previously filed for the periods ended March 31, 2011 and June 30, 2011 and also immaterial for the quarterly report for the period ended September 30, 2011. Accordingly, all of the resulting adjustments were recorded prospectively in the Statements of Unaudited Condensed Consolidated Operations for the three and nine months ended September 30, 2011 and the Statements of Unaudited Condensed Consolidated Financial Position as of September 30, 2011. The impact of the immaterial error in the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2011 would have resulted in an increase in Income from Continuing Operations of $7.7 million and $16.1 million, respectively, and a decrease in Net Income Attributable to Cliffs Shareholders of $30.4 million and $67.9 million, respectively, or $0.22 and $0.49, respectively, to basic and diluted earnings per common share. These adjustments should be considered when comparing the operating results for the three and six months ended June 30, 2012 to the reported results for the three and six months ended June 30, 2011, as such adjustments are not reflected in the operating results reported for the three and six months ended June 30, 2011.

Discontinued Operations

On September 27, 2011, we announced our plans to cease and dispose of the operations at the renewaFUEL biomass production facility in Michigan. As we continued to successfully grow our core iron ore mining business, the decision to sell our interest in the renewaFUEL operations was made to allow our management focus and allocation of capital resources to be deployed. On January 4, 2012, we entered into an agreement to sell the renewaFUEL assets to RNFL Acquisition, LLC. The results of operations of the renewaFUEL operations are reflected as discontinued operations in the accompanying unaudited condensed consolidated financial statements for all periods presented. We recorded a loss of $0.1 million as Loss From Discontinued Operations in the Statements of Unaudited Condensed Consolidated Operations for the six months ended June 30, 2012. This compares to losses of $0.7 million and $1.1 million for the three and six months ended June 30, 2011.

Significant Accounting Policies

A detailed description of our significant accounting policies can be found in the audited financial statements for the fiscal year ended December 31, 2011, included in our Annual Report on Form 10-K filed with the SEC. There have been changes in our significant accounting policies from those disclosed therein. As disclosed in the March 31, 2012 Form 10-Q, the following significant accounting policies have been included within the disclosures below.

Revenue Recognition and Cost of Goods Sold and Operating Expenses

U.S. Iron Ore, Eastern Canadian Iron Ore and Asia Pacific Iron Ore

We sell our products pursuant to comprehensive supply agreements negotiated and executed with our customers. Revenue is recognized from a sale when persuasive evidence of an arrangement exists, the price is fixed or determinable, the product is delivered in accordance with F.O.B. terms, title and risk of loss have transferred to the customer in accordance with the specified provisions of each supply agreement and collection of the sales price reasonably is assured. Our U.S. Iron Ore, Eastern Canadian Iron Ore and Asia Pacific Iron Ore supply agreements provide that title and risk of loss transfer to the customer either upon loading of the vessel, shipment or, as is the case with some of our U.S. Iron Ore supply agreements, when payment is received. Under certain term supply agreements, we ship the product to ports on the lower Great Lakes or to the customers’ facilities prior to the transfer of title. Our rationale for shipping iron ore products to certain customers and retaining title until payment is received for these products is to minimize credit risk exposure.

 

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Iron ore sales are recorded at a sales price specified in the relevant supply agreements resulting in revenue and a receivable at the time of sale. Upon revenue recognition for provisionally priced sales, a freestanding derivative is created for the difference between the sales price used and expected future settlement price. The derivative, which does not qualify for hedge accounting, is adjusted to fair value through Product revenues as a revenue adjustment each reporting period based upon current market data and forward-looking estimates determined by management until the final sales price is determined. The principal risks associated with recognition of sales on a provisional basis include iron ore price fluctuations between the date initially recorded and the date of final settlement. For revenue recognition, we estimate the future settlement rate; however, if significant changes in iron ore prices occur between the provisional pricing date and the final settlement date, we could be required to either return a portion of the sales proceeds received or bill for the additional sales proceeds due based on the provisional sales price. Refer to NOTE 3 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES for further information.

In addition, 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 a derivative instrument 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. Refer to NOTE 3 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES for further information.

Revenue from product sales also includes reimbursement for freight charges paid on behalf of customers in Freight and venture partners’ cost reimbursements separate from Product revenues. Revenue is recognized for the expected reimbursement of services when the services are performed.

Costs of goods sold and operating expenses represents all direct and indirect costs and expenses applicable to the sales and revenues of our mining operations. Operating expenses within this line item primarily represent the portion of the Tilden mining venture costs for which we do not own; that is, the costs attributable to the share of the mine’s production owned by the other joint venture partner in the Tilden mine. The mining venture functions as a captive cost company; it supplies product only to its owners effectively on a cost basis. Accordingly, the noncontrolling interests’ revenue amounts are stated at cost of production and are offset by an equal amount included in Cost of goods sold and operating expenses resulting in no sales margin reflected in the noncontrolling partner participant. As we are responsible for product fulfillment, we act as a principal in the transaction and, accordingly, record revenue under these arrangements on a gross basis.

Where we have joint ownership of a mine, our contracts entitle us to receive royalties and/or management fees, which we earn as the pellets are produced.

Recent Accounting Pronouncements

In May 2011, the FASB amended the guidance on fair value as a result of the joint efforts by the FASB and the IASB to develop a single, converged fair value framework. The amended fair value framework provides guidance on how to measure fair value and on what disclosures to provide about fair value measurements. The significant amendments to the fair value measurement guidance and the new disclosure requirements include: (1) the highest and best use and valuation premise for nonfinancial assets; (2) the application to financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risks; (3) premiums or discounts in fair value measurement; (4) fair value of an instrument classified in a reporting entity’s shareholders’

 

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equity; (5) for Level 3 measurements, a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, a description of the valuation process in place, and a narrative description of the sensitivity of the fair value to changes in the unobservable inputs and interrelationships between those inputs; and (6) the level in the fair value hierarchy of items that are not measured at fair value in the Statement of Financial Position but whose fair value must be disclosed. The new guidance is effective for interim and annual periods beginning after December 15, 2011. We adopted the amended guidance as of January 1, 2012. Refer to NOTE 8 – FAIR VALUE OF FINANCIAL INSTRUMENTS for further information.

NOTE 2 SEGMENT REPORTING

Our Company’s primary operations are organized and managed according to product category and geographic location: U.S. Iron Ore, Eastern Canadian Iron Ore, North American Coal, Asia Pacific Iron Ore, Asia Pacific Coal, Latin American Iron Ore, Ferroalloys and our Global Exploration Group. The U.S. Iron Ore segment is comprised of our interests in five U.S. mines that provide iron ore to the integrated steel industry. The Eastern Canadian Iron Ore segment is comprised of two Eastern Canadian mines that primarily provide iron ore to the seaborne market for Asian steel producers. The North American Coal segment is comprised of our five metallurgical coal mines and one thermal coal mine that provide metallurgical coal primarily to the integrated steel industry and thermal coal primarily to the energy industry. The Asia Pacific Iron Ore segment is located in Western Australia and provides iron ore to the seaborne market for Asian steel producers. There are no intersegment revenues.

The Asia Pacific Coal operating segment is comprised of our 45 percent economic interest in Sonoma, located in Queensland, Australia. The Latin American Iron Ore operating segment is comprised of our 30 percent Amapá interest in Brazil. The Ferroalloys operating segment is comprised of our interests in chromite deposits held in Northern Ontario, Canada and the Global Exploration Group is focused on early involvement in exploration activities to identify new projects for future development or projects that add significant value to existing operations. The Asia Pacific Coal, Latin American Iron Ore, Ferroalloys and Global Exploration Group operating segments do not meet reportable segment disclosure requirements and therefore are not reported separately.

We evaluate segment performance based on sales margin, defined as revenues less cost of goods sold and operating expenses identifiable to each segment. This measure of operating performance is an effective measurement as we focus on reducing production costs throughout the Company.

The following table presents a summary of our reportable segments for the three and six months ended June 30, 2012 and 2011:

 

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Table of Contents
     (In Millions)  
     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Revenues from product sales and services:

                       

U.S. Iron Ore

     $ 705.0           43%         $ 885.2           49%         $   1,146.7           40%         $   1,395.3           47%   

Eastern Canadian Iron Ore

     303.9           19%         297.6           16%         524.6           18%         424.9           14%   

North American Coal

     209.2           13%         159.7           9%         399.2           14%         324.7           11%   

Asia Pacific Iron Ore

     361.3           22%         381.6           21%         721.1           25%         727.0           24%   

Other

     46.6           3%         81.7           5%         99.1           3%         117.1           4%   
  

 

 

       

 

 

       

 

 

       

 

 

    

Total revenues from product sales and services for reportable segments

     $   1,626.0           100%         $   1,805.8           100%         $   2,890.7           100%         $   2,989.0           100%   
  

 

 

       

 

 

       

 

 

       

 

 

    

Sales margin:

                       

U.S. Iron Ore

     $ 286.1              $ 441.1              $ 452.9              $ 802.4        

Eastern Canadian Iron Ore

     11.7              68.0              (2.6)             102.5        

North American Coal

     (9.6)             (14.8)             5.0              (17.7)       

Asia Pacific Iron Ore

     146.8              205.0              271.9              400.8        

Other

     14.3              32.3              25.6              43.1        
  

 

 

       

 

 

       

 

 

       

 

 

    

Sales margin

     449.3              731.6              752.8              1,331.1        

Other operating expense

     (84.0)             (113.8)             (156.4)             (171.2)       

Other expense

     (47.6)             (28.0)             (91.1)             (7.1)       
  

 

 

       

 

 

       

 

 

       

 

 

    

Income from continuing operations before income taxes and equity loss from ventures

     $ 317.7              $ 589.8              $ 505.3              $ 1,152.8        
  

 

 

       

 

 

       

 

 

       

 

 

    

Depreciation, depletion and amortization:

                       

U.S. Iron Ore

     $ 23.8              $ 22.2              $ 47.0              $ 39.5        

Eastern Canadian Iron Ore

     38.6              31.5              76.5              41.3        

North American Coal

     24.3              20.8              44.4              42.4        

Asia Pacific Iron Ore

     39.8              24.9              69.8              48.9        

Other

     5.6              7.4              11.7              14.5        
  

 

 

       

 

 

       

 

 

       

 

 

    

Total depreciation, depletion and amortization

     $ 132.1              $ 106.8              $ 249.4              $ 186.6        
  

 

 

       

 

 

       

 

 

       

 

 

    

Capital additions (1):

                       

U.S. Iron Ore

     $ 28.1              $ 55.7              $ 62.9              $ 87.3        

Eastern Canadian Iron Ore

     177.3              60.7              307.9              64.2        

North American Coal

     32.7              28.5              71.8              56.0        

Asia Pacific Iron Ore

     16.9              58.0              126.2              83.3        

Other

     11.1              3.5              50.7              6.6        
  

 

 

       

 

 

       

 

 

       

 

 

    

Total capital additions

     $ 266.1              $ 206.4              $ 619.5              $ 297.4        
  

 

 

       

 

 

       

 

 

       

 

 

    

(1) Includes capital lease additions and non-cash accruals. Refer to NOTE 20 – CASH FLOW INFORMATION

 

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A summary of assets by segment is as follows:

 

     (In Millions)  
     June 30,
2012
     December 31,
2011
 

Segment assets:

     

U.S. Iron Ore

     $ 1,915.4           $     1,691.8     

Eastern Canadian Iron Ore

     8,138.3           7,973.1     

North American Coal

     1,908.2           1,814.4     

Asia Pacific Iron Ore

     1,859.4           1,511.2     

Other

     1,045.2           1,017.6     
  

 

 

    

 

 

 

Total segment assets

     14,866.5           14,008.1     

Corporate

     327.8           533.6     
  

 

 

    

 

 

 

Total assets

     $         15,194.3           $   14,541.7     
  

 

 

    

 

 

 

NOTE 3 DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The following table presents the fair value of our derivative instruments and the classification of each in the Statements of Unaudited Condensed Consolidated Financial Position as of June 30, 2012 and December 31, 2011:

 

     (In Millions)  
     Derivative Assets      Derivative Liabilities  
     June 30, 2012      December 31, 2011      June 30, 2012      December 31, 2011  

Derivative

Instrument

   Balance Sheet
Location
  Fair
Value
     Balance Sheet
Location
  Fair
Value
     Balance Sheet
Location
   Fair
Value
     Balance Sheet
Location
   Fair
Value
 

Derivatives designated as hedging instruments under ASC 815:

                     

Foreign Exchange Contracts

   Derivative
assets
(current)
    $ 10.1         Derivative
assets
(current)
    $ 5.2         Other
current
liabilities
     $ 9.5         Other
current
liabilities
     $ 3.5     
    

 

 

      

 

 

       

 

 

       

 

 

 

Total derivatives designated as hedging instruments under ASC 815

       $ 10.1             $ 5.2              $ 9.5              $ 3.5     
    

 

 

      

 

 

       

 

 

       

 

 

 

Derivatives not designated as hedging instruments under ASC 815:

                     

Foreign Exchange Contracts

   Derivative
assets
(current)
    $ -           Derivative
assets
(current)
    $ 2.8              $ -                $ -       

Customer Supply Agreements

   Derivative
assets
(current)
    61.4         Derivative
assets
(current)
    72.9              -                -       

Provisional Pricing Arrangements

   Derivative
assets
(current)
    3.3         Derivative
assets
(current)
    1.2         Other
current
liabilities
       15.8         Other
current
liabilities
     19.5     
   Accounts

receivable

    19.2         Accounts
receivable
    83.8              -                -       
    

 

 

      

 

 

       

 

 

       

 

 

 

Total derivatives not designated as hedging instruments under ASC 815

       $   83.9             $   160.7              $   15.8              $   19.5     
    

 

 

      

 

 

       

 

 

       

 

 

 

Total derivatives

       $   94.0             $   165.9              $   25.3              $   23.0     
    

 

 

      

 

 

       

 

 

       

 

 

 

 

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Derivatives Designated as Hedging Instruments

Cash Flow Hedges

Australian and Canadian Dollar Foreign Exchange Contracts

We are subject to changes in foreign currency exchange rates as a result of our operations in Australia and Canada. With respect to Australia, foreign exchange risk arises from our exposure to fluctuations in foreign currency exchange rates because the functional currency of our Asia Pacific operations is the Australian dollar. Our Asia Pacific operations receive funds in U.S. currency for their iron ore and coal sales. The functional currency of our Canadian operations is the U.S. dollar; however the production costs for these operations primarily are incurred in the Canadian dollar.

We use foreign currency exchange derivatives to hedge our foreign currency exposure for a portion of our Australian dollar sales receipts and our Canadian dollar operating costs. For our Australian operations, U.S. dollars are converted to Australian dollars at the currency exchange rate in effect during the period the transaction occurred. For our Canadian operations, U.S. dollars are converted to Canadian dollars at the exchange rate in effect for the period the operating costs are incurred. The primary objective for the use of these instruments is to reduce exposure to changes in Australian and U.S. currency exchange rates and U.S. and Canadian currency exchange rates, respectively, and to protect against undue adverse movement in these exchange rates. These instruments qualify for hedge accounting treatment, and are tested for effectiveness at inception and at least once each reporting period. If and when any of our hedge contracts are determined not to be highly effective as hedges, the underlying hedged transaction is no longer likely to occur, or the derivative is terminated, hedge accounting is discontinued.

As of June 30, 2012, we had outstanding Australian and Canadian foreign currency exchange contracts with notional amounts of $425.0 million and $558.0 million, respectively, in the form of forward contracts with varying maturity dates ranging from July 2012 to June 2013. This compares with outstanding Australian foreign currency exchange contracts with a notional amount of $400.0 million as of December 31, 2011. There were no outstanding Canadian foreign currency exchange contracts as of December 31, 2011, as we did not begin entering into Canadian foreign currency exchange contracts until January 2012.

Changes in fair value of highly effective hedges are recorded as a component of Accumulated other comprehensive loss in the Statements of Unaudited Condensed Consolidated Financial Position. Any ineffectiveness is recognized immediately in income and as of June 30, 2012 and 2011, there was no material ineffectiveness recorded for these foreign exchange contracts. Amounts recorded as a component of Accumulated other comprehensive loss are reclassified into earnings in the same period the forecasted transaction affects earnings. Of the amounts remaining in Accumulated other comprehensive loss related to Australian hedge contracts and Canadian hedge contracts, we estimate that losses of $5.6 million and $5.2 million, respectively, will be reclassified into earnings within the next 12 months.

The following summarizes the effect of our derivatives designated as hedging instruments in Accumulated other comprehensive loss and the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2012 and 2011:

 

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     (In Millions)  
Derivatives in Cash Flow    Amount of Gain (Loss)
Recognized in OCI on
Derivative
     Location of Gain
(Loss) Reclassified
from Accumulated OCI
into Income
   Amount of Gain
(Loss) Reclassified
from Accumulated
OCI into Income
 

Hedging Relationships

   (Effective Portion)      (Effective Portion)    (Effective Portion)  
     Three months ended
June 30,
          Three months ended
June 30,
 
     2012     2011           2012     2011  

Australian Dollar Foreign

Exchange Contracts

(hedge designation)

   $ 2.1      $ 3.0       Product revenue    $ (0.4   $ 0.8   

Canadian Dollar Foreign Exchange Contracts (hedge designation)

     (5.9     —         Cost of goods sold
and operating
expenses
     (0.2     —     

Australian Dollar Foreign

Exchange Contracts

(prior to de-designation)

     —          —         Product revenue      —          0.5   
  

 

 

   

 

 

       

 

 

   

 

 

 

Total

   $ (3.8   $ 3.0          $ (0.6   $ 1.3   
  

 

 

   

 

 

       

 

 

   

 

 

 
     Six months ended
June 30,
          Six months ended
June 30,
 
     2012     2011           2012     2011  

Australian Dollar Foreign

Exchange Contracts

(hedge designation)

   $ 5.1      $ 4.9       Product revenue    $ 2.7      $ 1.0   

Canadian Dollar Foreign Exchange Contracts (hedge designation)

     (5.2     —         Cost of goods sold
and operating
expenses
     0.3        —     

Australian Dollar Foreign

Exchange Contracts

(prior to de-designation)

     —          —         Product revenue      —          0.7   
  

 

 

   

 

 

       

 

 

   

 

 

 

Total

   $ (0.1   $ 4.9          $ 3.0      $ 1.7   
  

 

 

   

 

 

       

 

 

   

 

 

 

Interest Rate Risk Management

Interest rate risk is managed using a portfolio of variable- and fixed-rate debt composed of short- and long-term instruments, such as U.S. treasury lock agreements and interest rate swaps. From time to time these instruments, which are derivative instruments, are entered into to facilitate the maintenance of the desired ratio of variable- and fixed-rate debt. These derivative instruments are designated and qualify as cash flow hedges. These instruments did not have a material impact on our financial statements as of and for the three and six months ended June 30, 2012.

Derivatives Not Designated as Hedging Instruments

Australian Dollar Foreign Exchange Contracts

Effective July 1, 2008, we discontinued hedge accounting for foreign exchange contracts entered into for all outstanding contracts at the time and continued to hold such instruments as economic hedges to manage currency risk as described above. The outstanding non-designated foreign exchange contracts with a notional amount of $15.0 million as of December 31, 2011, matured as of January 2012.

As a result of discontinuing hedge accounting, the instruments were marked to fair value each reporting period through Changes in fair value of foreign currency contracts, net in the Statements of Unaudited Condensed Consolidated Operations. For the six months ended June 30, 2012, the change in fair value of the foreign currency contracts resulted in net gains of $0.3 million based on the Australian to U.S. dollar spot rate change until maturity. This compares with the net gains of $7.0 million and $11.4 million for the three and six months ended June 30, 2011, respectively, based on the Australian to U.S. dollar spot rate of 1.07 at June 30, 2011. The amounts that previously were recorded as a component of Accumulated other comprehensive loss were reclassified to earnings with a corresponding realized gain or loss recognized in the same period the forecasted transaction affected earnings.

 

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Canadian Dollar Foreign Exchange Contracts and Options

On January 11, 2011, we entered into a definitive agreement with Consolidated Thompson to acquire all of its common shares in an all-cash transaction, including net debt. We hedged a portion of the purchase price on the open market by entering into foreign currency exchange forward contracts and an option contract with a combined notional amount of C$4.7 billion. The hedge contracts were considered economic hedges, which do not qualify for hedge accounting. The forward contracts had various maturity dates and the option contract had a maturity date of April 14, 2011.

During the first half of 2011, swaps were executed in order to extend the maturity dates of certain of the forward contracts through the consummation of the Consolidated Thompson acquisition and the repayment of the Consolidated Thompson convertible debentures. These swaps and the maturity of the forward contracts resulted in net realized gains of $41.5 million and $93.1 million, respectively, recognized through Changes in fair value of foreign currency contracts, net in the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2011.

Customer Supply Agreements

Most of our U.S. Iron Ore long-term supply agreements are comprised of a base price with annual price adjustment factors, some of which are subject to annual price collars in order to limit the percentage increase or decrease in prices for our iron ore pellets during any given year. The price adjustment factors vary based on the agreement but typically include adjustments based upon changes in international pellet prices and changes in specified Producer 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 based upon the specific terms of each agreement. The price adjustment factors have been evaluated to determine if they contain embedded derivatives. 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 U.S. Iron Ore customer provide for supplemental revenue or refunds to the customer based on the customer’s average annual steel pricing at the time the product is consumed in the customer’s blast furnace. The supplemental pricing is characterized as a freestanding derivative and is required to be accounted for separately once the product is shipped. The derivative instrument, which is finalized based on a future price, is adjusted to fair value as a revenue adjustment each reporting period until the pellets are consumed and the amounts are settled. We recognized $42.6 million and $82.0 million, respectively, as Product revenues in the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2012, related to the supplemental payments. This compares with Product revenues of $46.5 million and $71.1 million, respectively, for the comparable periods in 2011. Derivative assets, representing the fair value of the pricing factors, were $61.4 million and $72.9 million, respectively, in the June 30, 2012 and December 31, 2011 Statements of Unaudited Condensed Consolidated Financial Position.

Provisional Pricing Arrangements

Certain of our U.S. Iron Ore, Eastern Canadian Iron Ore and Asia Pacific Iron Ore customer supply agreements specify provisional price calculations, where the pricing mechanisms generally are based on market pricing, with the final sales price to be based on market inputs at a specified point in time in the future, per the terms of the supply agreements. The difference between the provisionally agreed-upon price and the estimated final sales price is characterized as a derivative and is required to be accounted for separately once the revenue has been recognized. The derivative instrument is adjusted to fair value

 

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through Product revenues each reporting period based upon current market data and forward-looking estimates provided by management until the final sales price is determined. We have recorded $2.0 million as current Derivative assets and $4.2 million as derivative liabilities included in Other current liabilities in the Statements of Unaudited Condensed Consolidated Financial Position at June 30, 2012 related to our estimate of final sales price with our U.S. Iron Ore, Eastern Canadian Iron Ore and Asia Pacific Iron Ore customers. At December 31, 2011, we did not have any derivative assets or liabilities recorded due to these arrangements. These amounts represent the difference between the provisional price agreed upon with our customers based on the supply agreement terms and our estimate of the final sales price based on the price calculations established in the supply agreements. As a result, we recognized a net $2.2 million as a decrease in Product revenues in the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2012 related to these arrangements. There were no amounts recognized related to these arrangements for the three and six months ended June 30, 2011.

In some instances we are still working to revise components of the pricing calculations referenced within our supply agreements to incorporate new market inputs to the pricing mechanisms. As a result, in the current period we recorded certain shipments made to one of our U.S. Iron Ore customers based on an agreed-upon provisional price. The shipments will continue to be recorded based on the provisional price until settlement of the market inputs to the pricing mechanisms are finalized. The lack of agreed-upon market inputs results in these pricing provisions being characterized as derivatives. The derivative instrument, which is settled and billed or credited once the determinations of the market inputs to the pricing mechanisms are finalized, is adjusted to fair value through Product revenues each reporting period based upon current market data and forward-looking estimates determined by management. During the three and six months ended June 30, 2012, we had shipments to one U.S. Iron Ore customer under a supply agreement in which components of the pricing calculations are still being finalized. We recognized $96.1 million as an increase in Product revenues in the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2012, under these pricing provisions for certain shipments to the U.S. Iron Ore customer. For the three and six months ended June 30, 2011, $289.4 million and $309.4 million, respectively, were realized due to provisional pricing settlements. At June 30, 2012, we have recorded a $1.3 million Derivative asset and an $11.6 million derivative liability included in Other current liabilities, in the Statements of Unaudited Condensed Consolidated Financial Position related to this arrangement. As of June 30, 2012, we also have derivatives of $19.2 million classified as Accounts receivable in the Statements of Unaudited Condensed Consolidated Financial Position to reflect the amount we have provisionally agreed upon with the U.S. Iron Ore customer until a final price settlement is reached. At December 31, 2011, we recorded $1.2 million Derivative assets, $19.5 million derivative liabilities included in Other current liabilities and $83.8 million Accounts receivable in the Statements of Unaudited Condensed Consolidated Financial Position related to these type of provisional pricing arrangements with various U.S. Iron Ore and Eastern Canadian Iron Ore customers.

The following summarizes the effect of our derivatives that are not designated as hedging instruments in the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2012 and 2011:

 

(In Millions)

 

Derivatives Not Designated as Hedging

                 Instruments

   Location of Gain Recognized in
Income on Derivative
  Amount of Gain
Recognized in Income
on Derivative
 
         Three Months Ended
June 30,
     Six Months Ended
June 30,
 
         2012      2011      2012      2011  

Foreign Exchange Contracts

   Product Revenues   $ -         $ 2.6       $ -         $ 3.2   

Foreign Exchange Contracts

   Other Income (Expense)     -           48.5         0.3         104.5   

Customer Supply Agreements

   Product Revenues     42.6         46.5         82.0         71.1   

Provisional Pricing Arrangements

   Product Revenues     98.3         289.4         98.3         309.4   
    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     $ 140.9       $ 387.0       $ 180.6       $ 488.2   
    

 

 

    

 

 

    

 

 

    

 

 

 

Refer to NOTE 8 – FAIR VALUE OF FINANCIAL INSTRUMENTS for additional information.

 

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NOTE 4 INVENTORIES

The following table presents the detail of our Inventories in the Statements of Unaudited Condensed Consolidated Financial Position as of June 30, 2012 and December 31, 2011:

 

      (In Millions)  
     June 30, 2012      December 31, 2011  

Segment

   Finished
    Goods    
     Work-in
    Process    
     Total
    Inventory    
     Finished
    Goods    
     Work-in
    Process    
     Total
    Inventory    
 

U.S. Iron Ore

     $ 290.8           $ 36.8           $ 327.6           $ 100.2           $ 8.5           $ 108.7     

Eastern Canadian Iron Ore

     103.6           50.8           154.4           96.2           43.0           139.2     

North American Coal

     61.7           90.2           151.9           19.7           110.5           130.2     

Asia Pacific Iron Ore

     27.2           57.2           84.4           57.2           21.6           78.8     

Other

     21.5           1.2           22.7           18.0           0.8           18.8     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     $ 504.8           $ 236.2           $ 741.0           $ 291.3           $ 184.4           $ 475.7     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At our North American Coal operating segment, we recorded lower of cost or market inventory charges of $8.6 million and $9.9 million in Cost of goods sold and operating expenses in the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2012, respectively, due to the softening in the market prices for coal. No lower of cost or market inventory adjustments were recorded for the three and six months ended June 30, 2011.

NOTE 5 PROPERTY, PLANT AND EQUIPMENT

The following table indicates the value of each of the major classes of our consolidated depreciable assets as of June 30, 2012 and December 31, 2011:

 

     (In Millions)  
     June 30,
2012
     December 31,
2011
 

Land rights and mineral rights

     $ 7,964.1           $ 7,918.9     

Office and information technology

     63.9           67.0     

Buildings

     144.7           132.2     

Mining equipment

     1,123.2           1,323.8     

Processing equipment

     1,998.3           1,441.8     

Railroad equipment

     241.5           164.3     

Electric power facilities

     58.2           57.9     

Port facilities

     125.0           64.1     

Interest capitalized during construction

     27.6           22.5     

Land improvements

     31.8           30.4     

Other

     32.5           43.2     

Construction in progress

     667.0           615.4     
  

 

 

    

 

 

 
     12,477.8           11,881.5     

Allowance for depreciation and depletion

     (1,595.7)          (1,356.9)    
  

 

 

    

 

 

 
     $ 10,882.1           $   10,524.6     
  

 

 

    

 

 

 

We recorded depreciation and depletion expense of $125.8 million and $237.2 million in the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2012, respectively. This compares with depreciation and depletion expense of $98.4 million and $170.1 million for the three and six months ended June 30, 2011.

 

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NOTE 6 – ACQUISITIONS

Acquisitions

We allocate the cost of acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. Any excess of cost over the fair value of the net assets acquired is recorded as goodwill.

Consolidated Thompson

On May 12, 2011, we completed our acquisition of Consolidated Thompson by acquiring all of the outstanding common shares of Consolidated Thompson for C$17.25 per share in an all-cash transaction, including net debt, pursuant to the terms of an arrangement agreement dated as of January 11, 2011. Upon the acquisition: (a) each outstanding Consolidated Thompson common share was acquired for a cash payment of C$17.25; (b) each outstanding option and warrant that was “in the money” was acquired for cancellation for a cash payment of C$17.25 less the exercise price per underlying Consolidated Thompson common share; (c) each outstanding performance share unit was acquired for cancellation for a cash payment of C$17.25; (d) all outstanding Quinto Mining Corporation rights to acquire common shares of Consolidated Thompson were acquired for cancellation for a cash payment of C$17.25 per underlying Consolidated Thompson common share; and (e) certain Consolidated Thompson management contracts were eliminated that contained certain change of control provisions for contingent payments upon termination. The acquisition date fair value of the consideration transferred totaled $4.6 billion. Our full ownership of Consolidated Thompson has been included in the unaudited condensed consolidated financial statements since the acquisition date, and the subsidiary is reported as a component of our Eastern Canadian Iron Ore segment.

The acquisition of Consolidated Thompson reflects our strategy to build scale by owning expandable and exportable steelmaking raw material assets serving international markets. Through our acquisition of Consolidated Thompson, we now own and operate an iron ore mine and processing facility near Bloom Lake in Quebec, Canada that produces iron ore concentrate of high quality. WISCO is a 25 percent partner in the Bloom Lake mine. We also own additional development properties, primarily Lamêlée and Peppler Lake, in Quebec. All of these properties are in proximity to our existing Canadian operations and will allow us to leverage our port facilities and supply this iron ore to the seaborne market. The acquisition also is expected to further diversify our existing customer base.

The following table summarizes the consideration paid for Consolidated Thompson and the estimated fair values of the assets acquired and liabilities assumed at the acquisition date. We finalized the purchase price allocation for the acquisition of Consolidated Thompson during the second quarter of 2012.

 

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     (In Millions)  
     Initial
Allocation
     Final
Allocation
     Change  

Consideration

        

Cash

     $ 4,554.0           $ 4,554.0           $ -       
  

 

 

    

 

 

    

 

 

 

Fair value of total consideration transferred

     $ 4,554.0           $ 4,554.0           $ -       
  

 

 

    

 

 

    

 

 

 

Recognized amounts of identifiable assets acquired and liabilities assumed

        

ASSETS:

        

Cash

     $ 130.6           $ 130.6           $ -       

Accounts receivable

     102.8           102.4           (0.4)    

Product inventories

     134.2           134.2           -       

Other current assets

     35.1           35.1           -       

Mineral rights

     4,450.0           4,825.6           375.6     

Property, plant and equipment

     1,193.4           1,193.4           -       

Intangible assets

     2.1           2.1           -       
  

 

 

    

 

 

    

 

 

 

Total identifiable assets acquired

     6,048.2           6,423.4           375.2     

LIABILITIES:

        

Accounts payable

     (13.6)          (13.6)          -       

Accrued liabilities

     (130.0)          (123.8)          6.2     

Convertible debentures

     (335.7)          (335.7)          -       

Other current liabilities

     (41.8)          (47.9)          (6.1)    

Long-term deferred tax liabilities

     (831.5)          (1,041.8)          (210.3)    

Senior secured notes

     (125.0)          (125.0)          -       

Capital lease obligations

     (70.7)          (70.7)          -       

Other long-term liabilities

     (25.1)          (32.8)          (7.7)    
  

 

 

    

 

 

    

 

 

 

Total identifiable liabilities assumed

     (1,573.4)          (1,791.3)          (217.9)    
  

 

 

    

 

 

    

 

 

 

Total identifiable net assets acquired

     4,474.8           4,632.1           157.3     

Noncontrolling interest in Bloom Lake

     (947.6)          (1,075.4)          (127.8)    

Goodwill

     1,026.8           997.3           (29.5)    
  

 

 

    

 

 

    

 

 

 

Total net assets acquired

     $ 4,554.0           $ 4,554.0           $ -       
  

 

 

    

 

 

    

 

 

 

Included in the changes to the initial purchase price allocation for Consolidated Thompson, which was performed during the second quarter of 2011, are changes recorded in the first quarter of 2012, when we further refined the fair value of the assets acquired and liabilities assumed. The acquisition date fair value was adjusted to record a $16.4 million increase related to pre-acquisition date Quebec mining duties tax. We recorded $6.1 million and $10.3 million as increases to current and long-term liabilities, respectively. This resulted in a reduction of our calculated minimum distribution payable to the minority partner by $2.6 million. These adjustments resulted in a net $13.8 million increase to our goodwill during the period. As our fair value estimates remained materially unchanged from December 31, 2011, the immaterial adjustments made to the initial purchase price allocation during the first quarter of 2012 were recorded in that period. All other changes to the initial allocation were recorded retrospectively to the acquisition date. During the second quarter of 2012, no further adjustments were recorded.

During 2011, subsequent to the initial purchase price allocation for Consolidated Thompson, we adjusted the fair values of the assets acquired and liabilities assumed. Based on this process, the acquisition date fair value of the Consolidated Thompson mineral rights, deferred tax liability and noncontrolling interest in Bloom Lake were adjusted to $4,825.6 million, $1,041.8 million and $1,075.4 million, respectively, in the revised purchase price allocation during the fourth quarter of 2011. The change in mineral rights was caused by further refinements to the valuation model, most specifically as it related to potential tax structures that have value from a market participant standpoint and the risk premium used in determining the discount rate. The change in the deferred tax liability primarily was a result of the movement in the mineral rights value and obtaining additional detail of the acquired tax basis in the acquired assets and liabilities. Finally, the change in the noncontrolling interest in Bloom Lake was due to the change in mineral rights and a downward adjustment to the discount for lack of control being used in the valuation. A complete comparison of the initial and revised final purchase price allocation has been provided in the table above.

 

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The fair value of the noncontrolling interest in the assets acquired and liabilities assumed in Bloom Lake has been allocated proportionately, based upon WISCO’s 25 percent interest in Bloom Lake. We then reduced the allocated fair value of WISCO’s ownership interest in Bloom Lake to reflect the noncontrolling interest discount.

The $997.3 million of goodwill resulting from the acquisition has been assigned to our Eastern Canadian Iron Ore business segment through the CQIM reporting unit. Management believes the goodwill recognized primarily is attributable to the proximity to our existing Canadian operations and potential for future expansion in Eastern Canada, which will allow us to leverage our port facilities and supply iron ore to the seaborne market. None of the goodwill is expected to be deductible for income tax purposes. Refer to NOTE 7 – GOODWILL AND OTHER INTANGIBLE ASSETS AND LIABILITIES for further information.

The following unaudited consolidated pro forma information summarizes the results of operations for the three and six months ended June 30, 2011 as if the Consolidated Thompson acquisition and the related financing had been completed as of January 1, 2010. The pro forma information gives effect to actual operating results prior to the acquisition. The unaudited consolidated pro forma information does not purport to be indicative of the results that actually would have been obtained if the acquisition of Consolidated Thompson had occurred as of the beginning of the periods presented or that may be obtained in the future.

 

     (In Millions, Except
Per Common Share)
 
     Three Months      Six Months  
     Ended June 30,      Ended June 30,  
     2011      2011  

REVENUES FROM PRODUCT SALES AND SERVICES

     $ 2,065.0           $ 3,343.8     

NET INCOME ATTRIBUTABLE TO CLIFFS SHAREHOLDERS

     $ 418.4           $ 810.1     

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CLIFFS SHAREHOLDERS - BASIC

     $ 3.01           $ 5.90     

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CLIFFS SHAREHOLDERS - DILUTED

     $ 2.99           $ 5.87     

NOTE 7 GOODWILL AND OTHER INTANGIBLE ASSETS AND LIABILITIES

Goodwill

The following table summarizes changes in the carrying amount of goodwill allocated by operating segment for the six months ended June 30, 2012 and the year ended December 31, 2011:

 

    (In Millions)  
    June 30, 2012     December 31, 2011 (1)  
    U.S.    

Eastern

Canadian

   

North

American

    Asia Pacific                 U.S.    

Eastern

Canadian

   

North

American

   

Asia

Pacific

             
    Iron Ore     Iron Ore     Coal     Iron Ore     Other     Total     Iron Ore     Iron Ore     Coal     Iron Ore     Other     Total  

Beginning Balance

   $   2.0          $ 986.2          $   -           $   83.0          $   80.9          $   1,152.1          $ 2.0          $   3.1          $   27.9           $   82.6         $   80.9          $   196.5     

Arising in business combinations

    -            13.8           -            -            -            13.8           -            983.5           (0.1)           -          -            983.4     

Impairment

    -            -            -            -            -            -            -            -            (27.8)           -          -            (27.8)    

Impact of foreign currency translation

    -            -            -            0.2           -            0.2           -            -            -            0.4          -            0.4     

Other

    -            -            -            -            -            -            -            (0. 4)           -            -          -            (0.4)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $   2.0          $ 1,000.0          $   -           $   83.2          $   80.9          $   1,166.1          $   2.0          $   986.2          $   -           $   83.0         $   80.9          $   1,152.1     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(1) Represents a 12-Month rollforward of our goodwill by reportable unit at December 31, 2011.

 

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Goodwill is not subject to amortization and is tested for impairment annually or when events or circumstances indicate that impairment may have occurred.

Other Intangible Assets and Liabilities

Following is a summary of intangible assets and liabilities as of June 30, 2012 and December 31, 2011:

 

    

(In Millions)

 
          June 30, 2012      December 31, 2011  
    

Classification

   Gross
Carrying
Amount
     Accumulated
Amortization
     Net
Carrying
Amount
     Gross
Carrying
Amount
     Accumulated
Amortization
     Net
Carrying
Amount
 

Definite-lived intangible assets:

                    

Permits

   Intangible assets, net      $ 134.5           $ (26.8)          $ 107.7           $ 134.3           $ (23.2)          $ 111.1     

Utility contracts

   Intangible assets, net      54.7           (26.9)          27.8           54.7           (21.3)          33.4     

Leases

   Intangible assets, net      5.5           (3.1)          2.4           5.5           (3.0)          2.5     
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total intangible assets

        $ 194.7           $ (56.8)          $ 137.9           $ 194.5           $ (47.5)          $ 147.0     
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Below-market sales contracts

   Other current liabilities      $ (46.0)          $ -           $ (46.0)          $ (77.0)          $ 24.3           $ (52.7)    

Below-market sales contracts

   Below-market sales contracts      (250.7)          152.2           (98.5)          (252.3)          140.5           (111.8)    
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total below-market sales contracts

     $ (296.7)          $ 152.2           $ (144.5)          $ (329.3)          $ 164.8           $ (164.5)    
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The intangible assets are subject to periodic amortization on a straight-line basis over their estimated useful lives as follows:

 

Intangible Asset

   Useful Life (years)

Permits

   15 - 28

Utility contracts

   5

Leases

   1.5 - 4.5

Amortization expense relating to intangible assets was $4.5 million and $9.3 million, respectively, for the three and six months ended June 30, 2012, and is recognized in Cost of goods sold and operating expenses in the Statements of Unaudited Condensed Consolidated Operations. Amortization expense relating to intangible assets was $4.7 million and $9.6 million, respectively, for the comparable periods in 2011. The estimated amortization expense relating to intangible assets for the remainder of 2012 and each of the five succeeding years is as follows:

 

     (In Millions)  
     Amount  

Year Ending December 31

  

2012 (remaining six months)

     $ 9.0     

2013

     17.9     

2014

     17.9     

2015

     6.0     

2016

     6.0     

2017

     6.0     
  

 

 

 

Total

     $ 62.8     
  

 

 

 

The below-market sales contracts are classified as a liability and recognized over the terms of the underlying contracts, which have remaining lives ranging from two to five years. For the three and six months ended June 30, 2012, we recognized $14.7 million and $16.6 million, respectively, in Product revenues related to the below-market sales contracts, compared with $16.6 million and $23.7 million, respectively, for the three and six months ended June 30, 2011. The following amounts are estimated to be recognized in Product revenues for each of the five succeeding fiscal years:

 

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     (In Millions)  
     Amount  

Year Ending December 31

  

2012 (remaining six months)

     $ 29.4     

2013

     46.0     

2014

     23.1     

2015

     23.0     

2016

     23.0     

2017

     -         
  

 

 

 

Total

     $       144.5     
  

 

 

 

NOTE 8 FAIR VALUE OF FINANCIAL INSTRUMENTS

The following represents the assets and liabilities of the Company measured at fair value at June 30, 2012 and December 31, 2011:

 

     (In Millions)  
     June 30, 2012  

Description

   Quoted Prices in Active
Markets for Identical
Assets/Liabilities
(Level 1)
     Significant Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
    Total  

Assets:

          

Cash equivalents

     $ 25.0           $   -             $   -            $ 25.0     

Derivative assets

       -               -             83.9   (1)      83.9     

International marketable securities

     25.0             -               -            25.0     

Foreign exchange contracts

       -             10.1             -            10.1     
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     $ 50.0           $ 10.1           $ 83.9          $ 144.0     
  

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities:

          

Derivative liabilities

     $   -             $   -             $ 15.8          $ 15.8     

Foreign exchange contracts

       -             9.5             -            9.5     
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     $                     -             $                     9.5           $                     15.8          $                     25.3     
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     (In Millions)  
     December 31, 2011  

Description

   Quoted Prices in Active
Markets for Identical
Assets/Liabilities
(Level 1)
     Significant Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
    Total  

Assets:

          

Cash equivalents

     $ 351.2           $   -             $   -            $ 351.2     

Derivative assets

       -               -             157.9   (1)      157.9     

International marketable securities

     27.1             -               -            27.1     

Foreign exchange contracts

       -             8.0             -            8.0     
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     $ 378.3           $ 8.0           $ 157.9          $ 544.2     
  

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities:

          

Derivative liabilities

     $   -             $   -             $ 19.5          $ 19.5     

Foreign exchange contracts

       -             3.5             -            3.5     
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     $                     -             $                     3.5           $                     19.5          $                     23.0     
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1)

Derivative assets includes $19.2 million and $83.8 million, respectively, classified as Accounts receivable in the Statement of Unaudited Condensed Consolidated Financial Position as of June 30, 2012 and December 31, 2011. Refer to NOTE 3 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES for further information.

 

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Financial assets classified in Level 1 at June 30, 2012 and December 31, 2011 include money market funds and available-for-sale marketable securities. The valuation of these instruments is based upon unadjusted quoted prices for identical assets in active markets.

The valuation of financial assets and liabilities classified in Level 2 is determined using a market approach based upon quoted prices for similar assets and liabilities in active markets, or other inputs that are observable. Level 2 securities primarily include derivative financial instruments valued using financial models that use as their basis readily observable market parameters. At June 30, 2012 and December 31, 2011, such derivative financial instruments included our existing foreign currency exchange contracts. The fair value of the foreign currency exchange contracts is based on forward market prices and represents the estimated amount we would receive or pay to terminate these agreements at the reporting date, taking into account creditworthiness, nonperformance risk and liquidity risks associated with current market conditions.

The derivative financial assets classified within Level 3 at June 30, 2012 and December 31, 2011 include a freestanding derivative instrument related to certain supply agreements with one of our U.S. Iron Ore customers. The agreements include provisions for supplemental revenue or refunds based on the customer’s annual steel pricing at the time the product is consumed in the customer’s blast furnaces. We account for this provision as a derivative instrument at the time of sale and adjust this provision to fair value as an adjustment to Product revenues each reporting period until the product is consumed and the amounts are settled. The fair value of the instrument is determined using a market approach based on an estimate of the annual realized price of hot-rolled steel at the steelmaker’s facilities, and takes into consideration current market conditions and nonperformance risk.

The Level 3 derivative assets and liabilities at June 30, 2012 also consisted of derivatives related to certain supply agreements with our U.S. Iron Ore, Eastern Canadian Iron Ore and Asia Pacific Iron Ore customers. These customer supply agreements specify provisional price calculations, where the pricing mechanisms generally are based on market pricing, with the final sales price to be based on market inputs at a specified point in time in the future, per the terms of the supply agreements. The difference between the provisionally agreed-upon price and the estimated final sales price is characterized as a derivative and is required to be accounted for separately once the revenue has been recognized. The derivative instrument is adjusted to fair value through Product revenues each reporting period based upon current market data and forward-looking estimates provided by management until the final sales price is determined.

In the second quarter of 2011, we revised the inputs used to determine the fair value of these derivatives to include 2011 published pricing indices and settlements realized by other companies in the industry. Prior to this change, the fair value primarily was determined based on significant unobservable inputs to develop the forward price expectation of the final price settlement for 2011. Based on these changes to the inputs used in the determination of the fair value, we transferred $20.0 million of derivative assets from a Level 3 classification to a Level 2 classification within the fair value hierarchy in the second quarter of 2011.

The Level 3 derivative assets and liabilities at December 31, 2011 also consisted of derivatives related to certain supply agreements with our U.S. Iron Ore and Eastern Canadian Iron Ore customers. In some instances we are still working to revise components of the pricing calculations referenced within our supply agreements to incorporate new market inputs to the pricing mechanisms as a result of the elimination of historical benchmark pricing. As a result, we record certain shipments made to our U.S. Iron Ore and Eastern Canadian Iron Ore customers based on an agreed-upon provisional price with the customer until final settlement on the market inputs to the pricing mechanisms are finalized. The lack of agreed-upon market inputs results in these pricing provisions being characterized as derivatives. The derivative instrument, which is settled and billed or credited

 

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once the determinations of the market inputs to the pricing mechanisms are finalized, is adjusted to fair value through Product revenues each reporting period based upon current market data and forward-looking estimates determined by management. During the three and six months ended June 30, 2012, we had certain shipments to customers under supply agreements in which components of the pricing calculations are still being finalized. As a result, we have recorded certain shipments made during 2012 on a provisional basis until final settlement is reached. The pricing provisions are characterized as freestanding derivatives and are required to be accounted for separately once product is shipped. The derivative instrument, which is settled and billed once final pricing settlement is reached, is marked to fair value as a revenue adjustment each reporting period.

The following table illustrates information about quantitative inputs and assumptions for the derivative assets and derivative liabilities categorized in Level 3 of the fair value hierarchy:

 

Quantitative Information About Level 3 Fair Value Measurements  

($ in millions)

   Fair Value at
6/30/12
     Balance Sheet
Location
     Valuation
Technique
     Unobservable
          Input           
  Range
(Weighted
Average)
 

Provisional Pricing Arrangement

   $             3.3         Derivative Assets         Market Approach       Managements
Estimate of 62% Fe
    $140-$160 ($148)   
   $ 19.2         Accounts receivable           
   $ 15.8         Other current liabilities           

Customer Supply Agreement

   $ 61.4         Derivative Assets         Market Approach       Hot-Rolled Steel

Estimate

    $650-$775 ($675)   

The significant unobservable input used in the fair value measurement of the reporting entity’s provisional pricing arrangements is management’s estimate of 62% Fe price that is estimated based upon current market data, including historical seasonality and forward-looking estimates determined by management. Significant increases or decreases in this input would result in a significantly higher or lower fair value.

The significant unobservable input used in the fair value measurement of the reporting entity’s customer supply agreements is the future hot-rolled steel price. Significant increases or decreases in this input would result in a significantly higher or lower fair value measurement, respectively.

These significant estimates are determined by a collaboration of our commercial, finance and treasury departments and are reviewed by management.

Substantially all of the financial assets and liabilities are carried at fair value or contracted amounts that approximate fair value. We had no material financial assets and liabilities measured at fair value on a non-recurring basis at June 30, 2012 or December 31, 2011.

There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the first half of 2012 or 2011. As noted above, there was a transfer from Level 3 to Level 2 in the second quarter of 2011, as reflected in the table below. The following table represents a reconciliation of the changes in fair value of financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2012 and 2011.

 

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     (In Millions)  
     Derivative Assets (Level 3)  
         Three Months Ended    
June 30,
         Six Months Ended    
June 30,
 
     2012      2011      2012      2011  

Beginning balance

     $ 69.2           $ 68.1           $ 157.9           $ 45.6     

Total gains

           

Included in earnings

     61.4           46.5           104.7           91.1     

Included in other comprehensive income

       -               -               -               -       

Settlements

     (46.7)          (30.6)          (178.7)          (52.7)    

Transfers into Level 3

       -               -               -          

Transfers out of Level 3

       -             (20.0)            -             (20.0)    
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance - June 30

     $ 83.9           $ 64.0          $ 83.9           $ 64.0     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total gains for the period included in earnings attributable to the change in unrealized gains on assets still held at the reporting date

     $         61.4           $         46.5           $         104.7           $         91.1     
  

 

 

    

 

 

    

 

 

    

 

 

 
     (In Millions)  
     Derivative Liabilities (Level 3)  
         Three Months Ended    
June 30,
         Six Months Ended    
June 30,
 
     2012      2011      2012      2011  

Beginning balance

     $ (1.1)          $   -             $ (19.5)          $   -       

Total losses

           

Included in earnings

     (14.7)            -             (15.8)            -       

Included in other comprehensive income

       -             -               -             -       

Settlements

       -             -             19.5             -       

Transfers into Level 3

       -                -        

Transfers out of Level 3

       -             -               -             -       
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance - June 30

     $ (15.8)          $ -             $ (15.8)          $ -       
  

 

 

    

 

 

    

 

 

    

 

 

 

Total losses for the period included in earnings attributable to the change in unrealized losses on assets still held at the reporting date

     $         (14.7)          $         -             $         (15.8)          $         -       
  

 

 

    

 

 

    

 

 

    

 

 

 

Gains and losses included in earnings are reported in Product revenues in the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2012 and 2011.

The carrying amount for certain financial instruments (e.g. Accounts receivable, Accounts payable and Accrued expenses) approximate fair value and, therefore, have been excluded from the table below. A summary of the carrying amount and fair value of other financial instruments at June 30, 2012 and December 31, 2011 were as follows:

 

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            (In Millions)  
            June 30, 2012      December 31, 2011  
     Classification      Carrying
Value
     Fair Value      Carrying
Value
     Fair Value  

Receivables:

              

Customer supplemental payments

     Level 2       $ 11.1       $ 10.5       $ 22.3       $ 20.8   

ArcelorMittal USA—Receivable

     Level 2         23.0         26.2         26.5         30.7   

Other

     Level 2         10.1         10.1         10.0         10.0   
     

 

 

    

 

 

    

 

 

    

 

 

 

Total receivables

      $ 44.2       $ 46.8       $ 58.8       $ 61.5   
     

 

 

    

 

 

    

 

 

    

 

 

 

Long-term debt:

              

Term loan—$1.25 billion

     Level 2       $ 847.3       $ 847.3       $ 897.2       $ 897.2   

Senior notes—$700 million

     Level 2         699.4         753.8         699.3         726.4   

Senior notes—$1.3 billion

     Level 2         1,289.3         1,526.4         1,289.2         1,399.4   

Senior notes—$400 million

     Level 2         398.1         461.5         398.0         448.8   

Senior notes—$55 million

     Level 2         55.0         62.1         325.0         348.7   

Revolving loan

     Level 2         325.0         325.0         —           —     
     

 

 

    

 

 

    

 

 

    

 

 

 

Total long-term debt

      $ 3,614.1       $ 3,976.1       $ 3,608.7       $ 3,820.5   
     

 

 

    

 

 

    

 

 

    

 

 

 

The fair value of the long-term receivables and debt are based on the fair market yield curves for the remainder of the term expected to be outstanding.

The terms of one of our U.S. Iron Ore pellet supply agreements require supplemental payments to be paid by the customer during the period 2009 through 2013, with the option to defer a portion of the 2009 monthly amount up to $22.3 million in exchange for interest payments until the deferred amount is repaid in 2013. Interest is payable by the customer quarterly and began in September 2009 at the higher of 9 percent or the prime rate plus 350 basis points. As of June 30, 2012 and December 31, 2011, a receivable of $11.1 million and $22.3 million, respectively, have been recorded in Other non-current assets in the Statement of Unaudited Condensed Consolidated Financial Position reflecting the terms of this deferred payment arrangement. The fair value of the receivable of $10.5 million and $20.8 million at June 30, 2012 and December 31, 2011, respectively, is based on a discount rate of 3.29 percent, which represents the estimated credit-adjusted risk-free interest rate for the period the receivable is outstanding.

In 2002, we entered into an agreement with Ispat that restructured the ownership of the Empire mine and increased our ownership from 46.7 percent to 79.0 percent in exchange for the assumption of all mine liabilities. Under the terms of the agreement, 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 $23.0 million and $26.5 million at June 30, 2012 and December 31, 2011, respectively. The fair value of the receivable of $26.2 million and $30.7 million at June 30, 2012 and December 31, 2011, respectively, is based on a discount rate of 2.12 percent, which represents the estimated credit-adjusted risk-free interest rate for the period the receivable is outstanding.

The fair value of long-term debt was determined using quoted market prices or discounted cash flows based upon current borrowing rates. The term loan and revolving loan are variable rate interest and approximate fair value. See NOTE 9 – DEBT AND CREDIT FACILITIES for further information.

 

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NOTE 9 DEBT AND CREDIT FACILITIES

The following represents a summary of our long-term debt as of June 30, 2012 and December 31, 2011:

 

($ in Millions)

 

June 30, 2012

 

Debt Instrument

   Type    Annual Effective
Interest Rate
     Final
Maturity
     Total Face
Amount
    Total Debt  

$1.25 Billion Term Loan

   Variable      1.37 %           2016       $ 947.0   (1)      $     947.0  (1) 

$700 Million 4.875% 2021 Senior Notes

   Fixed      4.88 %           2021         700.0          699.4  (2) 

$1.3 Billion Senior Notes:

             

$500 Million 4.80% 2020 Senior Notes

   Fixed      4.80 %           2020         500.0          499.1  (3) 

$800 Million 6.25% 2040 Senior Notes

   Fixed      6.25 %           2040         800.0          790.2  (4) 

$400 Million 5.90% 2020 Senior Notes

   Fixed      5.90 %           2020         400.0          398.1  (5) 

$325 Million Private Placement Senior Notes:

             

Series 2008A - Tranche A

   Fixed      6.31 %           2013         270.0          270.0     

Series 2008A - Tranche B

   Fixed      6.59 %           2015         55.0          55.0     

$1.75 Billion Credit Facility:

             

Revolving Loan

   Variable      1.20 %           2016         1,750.0          325.0   (6) 
           

 

 

   

 

 

 

Total debt

              $     5,422.0          $     3,983.8     
           

 

 

   

Less current portion

                369.7     
             

 

 

 

Long-term debt

                $     3,614.1     
             

 

 

 

 

December 31, 2011

 

Debt Instrument

   Type    Annual Effective
Interest Rate
    Final
Maturity
     Total Face
Amount
    Total Debt  

$1.25 Billion Term Loan

   Variable      1.40  %        2016         $ 972.0  (1)      $     972.0  (1) 

$700 Million 4.875% 2021 Senior Notes

   Fixed      4.88  %        2021         700.0          699.3  (2) 

$1.3 Billion Senior Notes:

            

$500 Million 4.80% 2020 Senior Notes

   Fixed      4.80  %        2020         500.0          499.1  (3) 

$800 Million 6.25% 2040 Senior Notes

   Fixed      6.25  %        2040         800.0          790.1  (4) 

$400 Million 5.90% 2020 Senior Notes

   Fixed      5.90  %        2020         400.0          398.0  (5) 

$325 Million Private Placement Senior Notes:

            

Series 2008A - Tranche A

   Fixed      6.31  %        2013         270.0          270.0     

Series 2008A - Tranche B

   Fixed      6.59  %        2015         55.0          55.0     

$1.75 Billion Credit Facility:

            

Revolving Loan

   Variable      -          2016         1,750.0          -   (6) 
          

 

 

   

 

 

 

Total

             $     5,447.0          $     3,683.5     
          

 

 

   

Less current portion

               74.8     
            

 

 

 

Long-term debt

               $     3,608.7     
            

 

 

 

(1) As of June 30, 2012 and December 31, 2011, $303.0 million and $278.0 million, respectively, had been paid down on the original $1.25 billion term loan and, of the remaining term loan, $99.7 million and $74.8 million, respectively, was classified as Current portion of debt. The current classification is based upon the principal payment terms of the arrangement requiring principal payments on each three-month anniversary following the funding of the term loan.

(2) As of June 30, 2012 and December 31, 2011, the $700 million 4.88 percent senior notes were recorded at a par value of $700 million less unamortized discounts of $0.6 million and $0.7 million, respectively, based on an imputed interest rate of 4.89 percent.

(3) As of June 30, 2012 and December 31, 2011, the $500 million 4.80 percent senior notes were recorded at a par value of $500 million less unamortized discounts of $0.9 million and $0.9 million, respectively, based on an imputed interest rate of 4.83 percent.

(4) As of June 30, 2012 and December 31, 2011, the $800 million 6.25 percent senior notes were recorded at par value of $800 million less unamortized discounts of $9.8 million and $9.9 million, respectively, based on an imputed interest rate of 6.38 percent.

 

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(5) As of June 30, 2012 and December 31, 2011, the $400 million 5.90 percent senior notes were recorded at a par value of $400 million less unamortized discounts of $1.9 million and $2.0 million, respectively, based on an imputed interest rate of 5.98 percent.

(6) As of June 30, 2012 and December 31, 2011, $325.0 million and no revolving loans were drawn under the credit facility, respectively, and the principal amount of letter of credit obligations totaled $23.1 million and $23.5 million for each period, respectively, thereby reducing available borrowing capacity to $1.4 billion and $1.73 billion for each period, respectively.

The terms of the private placement senior notes, term loan and credit facility each contain customary covenants that require compliance with certain financial covenants based on: (1) debt to earnings ratio (Total Funded Debt to EBITDA, as those terms are defined in the credit agreement, as of the last day of each fiscal quarter cannot exceed (i) 3.5 to 1.0, if none of the $270 million private placement senior notes due 2013 remain outstanding, or otherwise (ii) the then applicable maximum multiple under the $270 million private placement senior notes due 2013) and (2) interest coverage ratio (Consolidated EBITDA to Interest Expense, as those terms are defined in the amended credit agreement, for the preceding four quarters must not be less than 2.5 to 1.0 on the last day of any fiscal quarter). As of June 30, 2012 and December 31, 2011, we were in compliance with the financial covenants related to both the private placement senior notes and the credit facilities. The terms of the senior notes due in 2020, 2021 and 2040 contain certain customary covenants; however, there are no financial covenants.

Short-term Facilities

Asia Pacific Iron Ore maintains a bank contingent instrument facility and cash advance facility. The facility, which is renewable annually at the bank’s discretion, provides A$40.0 million ($41.0 million) in credit for contingent instruments, such as performance bonds and the ability to request a cash advance facility to be provided at the discretion of the bank. As of June 30, 2012, the outstanding bank guarantees under this facility totaled A$24.9 million ($25.5 million), thereby reducing borrowing capacity to A$15.1 million ($15.4 million). We have provided a guarantee of the facility, along with certain of our Australian subsidiaries. The facility agreement contains certain customary covenants that require compliance with certain financial covenants: (1) debt to earnings ratio and (2) interest coverage ratio, both based on the financial performance of the Company. As of June 30, 2012, and December 31, 2011, we were in compliance with these financial covenants.

Letters of Credit

In conjunction with our acquisition of Consolidated Thompson, we issued standby letters of credit with certain financial institutions in order to support Consolidated Thompson’s and Bloom Lake’s general business obligations. In addition, we issued standby letters of credit with certain financial institutions during the third quarter of 2011 in order to support Wabush’s obligations. As of June 30, 2012 and December 31, 2011, these letter of credit obligations totaled $95.3 million and $95.0 million, respectively. All of these standby letters of credit are in addition to the letters of credit provided for under the amended and restated multicurrency credit agreement.

Debt Maturities

Maturities of debt instruments, excluding borrowings on the revolving credit facility, based on the principal amounts outstanding at June 30, 2012, total approximately $49.8 million in 2012, $369.7 million in 2013, $124.6 million in 2014, $428.8 million in 2015, $299.1 million in 2016 and $2.4 billion thereafter.

NOTE 10 LEASE OBLIGATIONS

We lease certain mining, production and other equipment under operating and capital leases. The leases are for varying lengths, generally at market interest rates and contain purchase and/or renewal options at the end of the terms. Our operating lease expense was $6.2 million and $12.5 million, respectively, for the three and six months ended June 30, 2012, compared with $7.9 million and $13.7 million, respectively, for the same periods in 2011.

 

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Future minimum payments under capital leases and non-cancellable operating leases at June 30, 2012 are as follows:

 

     (In Millions)  
     Capital
Leases
    Operating
Leases
 

2012 (July 1 - December 31)

     $     40.2          $     11.7     

2013

     72.1          23.5     

2014

     66.7          19.6     

2015

     55.5          12.7     

2016

     39.9          9.5     

2017 and thereafter

     123.0          30.2     
  

 

 

   

 

 

 

Total minimum lease payments

     $     397.4          $     107.2     
    

 

 

 

Amounts representing interest

     90.5       
  

 

 

   

Present value of net minimum lease payments

     $     306.9   (1)   
  

 

 

   

 

  (1)

The total is comprised of $53.4 million and $253.5 million classified as Other current liabilities and Other liabilities , respectively, in the Statements of Unaudited Condensed Consolidated Financial Position at June 30, 2012.

NOTE 11 ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS

We had environmental and mine closure liabilities of $244.1 million and $235.7 million at June 30, 2012 and December 31, 2011, respectively. The following is a summary of the obligations as of June 30, 2012 and the year ended December 31, 2011:

 

     (In Millions)  
     June 30,
2012
     December 31,
2011
 

Environmental

     $ 14.5         $     15.5     

Mine closure

     

LTVSMC

     16.9           16.5     

Operating mines:

     

U.S Iron Ore

     77.9           74.3     

Eastern Canadian Iron Ore

     71.5           68.0     

North American Coal

     37.5           36.3     

Asia Pacific Iron Ore

     16.8           16.3     

Other

     9.0           8.8     
  

 

 

    

 

 

 

Total mine closure

     229.6           220.2     
  

 

 

    

 

 

 

Total environmental and mine closure obligations

     244.1           235.7     

Less current portion

     12.7           13.7     
  

 

 

    

 

 

 

Long term environmental and mine closure obligations

   $     231.4         $ 222.0     
  

 

 

    

 

 

 

Mine Closure

Our mine closure obligations are for our four consolidated U.S. operating iron ore mines, our two Eastern Canadian operating iron ore mines, our six operating North American coal mines, our Asia Pacific operating iron ore mine, the coal mine at Sonoma and a closed operation formerly known as LTVSMC.

 

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The accrued closure obligation for our active mining operations provides for contractual and legal obligations associated with the eventual closure of the mining operations. The accretion of the liability and amortization of the related asset is recognized over the estimated mine lives for each location. The following represents a rollforward of our asset retirement obligation liability related to our active mining locations for the six months ended June 30, 2012 and the year ended December 31, 2011:

 

     (In Millions)  
     June 30,
2012
     December 31,
2011(1)
 

Asset retirement obligation at beginning of period

   $ 203.7       $ 168.3   

Accretion expense

     8.9         16.1   

Exchange rate changes

     0.1         0.1   

Revision in estimated cash flows

     -           5.9   

Payments

     -           (0.7 )   

Acquired through business combinations

     -           14.0   
  

 

 

    

 

 

 

Asset retirement obligation at end of period

   $ 212.7       $ 203.7   
  

 

 

    

 

 

 

 

(1)

Represents a 12-month rollforward of our asset retirement obligation at December 31, 2011.

NOTE 12 PENSIONS AND OTHER POSTRETIREMENT BENEFITS

The following are the components of defined benefit pension and OPEB expense for the three and six months ended June 30, 2012 and 2011:

Defined Benefit Pension Expense

 

     (In Millions)  
     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Service cost

     $ 8.0           $ 5.2           $ 16.0           $ 11.0     

Interest cost

     12.3           12.2           24.3           25.8     

Expected return on plan assets

     (15.0)          (13.7)          (29.8)          (29.2)    

Amortization:

           

Prior service costs

     0.9           1.0           1.9           2.2     

Net actuarial loss

     7.6           4.8           15.0           10.0     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net periodic benefit cost

     $ 13.8           $ 9.5           $ 27.4           $ 19.8     
  

 

 

    

 

 

    

 

 

    

 

 

 

Other Postretirement Benefits Expense

 

     (In Millions)  
     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Service cost

     $ 3.9           $ 2.3           $ 7.5           $ 4.7     

Interest cost

     5.4           5.3           10.6           11.2     

Expected return on plan assets

     (4.3)          (3.7)          (8.6)          (8.0)    

Amortization:

           

Prior service costs

     0.8           0.2           1.5           0.8     

Net actuarial loss

     2.7           2.9           5.6           5.8     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net periodic benefit cost

     $ 8.5           $ 7.0           $ 16.6           $ 14.5     
  

 

 

    

 

 

    

 

 

    

 

 

 

We made pension contributions of $7.6 million and $24.9 million for the three and six months ended June 30, 2012, respectively, compared to pension contributions of $3.5 million and $27.3 million for the three and six months ended June 30, 2011, respectively. OPEB contributions were $21.9 million for each of the six months ended June 30, 2012 and 2011.

 

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NOTE 13 STOCK COMPENSATION PLANS

Employees’ Plans

On March 12, 2012, the Compensation and Organization Committee (“Committee”) of the Board of Directors approved a grant under our shareholder-approved ICE Plan for the performance period 2012 – 2014. A total of 426,610 shares were granted under the award, consisting of 312,540 performance shares and 114,070 restricted share units.

For the outstanding ICE Plan award agreements, each performance share, if earned, entitles the holder to receive a number of common shares or cash within the range between a threshold and maximum number of our common shares, with the actual number of common shares earned dependent upon whether the Company achieves certain objectives and performance goals as established by the Committee. The performance share or unit grants vest over a period of three years and are intended to be paid out in common shares or cash in certain circumstances. Performance for the 2010 – 2012 performance period and 2011 – 2013 performance period is measured on the basis of two factors: 1) relative TSR for the period, and 2) three-year cumulative free cash flow. The relative TSR for the 2010 – 2012 performance period is measured against a predetermined peer group of mining and metals companies and for the 2011 – 2013 performance period is measured against the constituents of the S & P Metals and Mining ETF Index on the last day of trading of the incentive period. Performance for the 2012 – 2014 performance period is measured on the basis of relative TSR for the period and measured against the constituents of the S & P Metals and Mining ETF Index on the last day of trading of the incentive period. The final payout for the 2010 – 2012 performance period will vary from zero to 150 percent of the original grant. The final payouts for the 2011 – 2013 performance period and the 2012 – 2014 performance period will vary from zero to 200 percent of the original grant. The restricted share units are subject to continued employment, are retention based, will vest at the end of the respective performance period for the performance shares, and are payable in common shares or cash in certain circumstances at a time determined by the Committee at its discretion.

Upon the occurrence of a change in control, all performance shares, restricted share units, restricted stock, performance units and retention units granted to a participant will vest and become nonforfeitable and will be paid out in cash.

Our Board of Directors approved the new 2012 Equity Plan on March 13, 2012 and our shareholders approved it on May 8, 2012 effective as of March 13, 2012. The new 2012 Equity Plan replaced the ICE Plan. The maximum number of shares that may be issued under the 2012 Equity Plan is 6,000,000. A total of 11,425 shares were granted under the 2012 Equity Plan as of June 30, 2012.

The ICE Plan was terminated on May 8, 2012 and no shares will be issued from the ICE Plan as of this date. Upon termination of the ICE Plan, all awards previously granted under the ICE Plan shall continue in full force and effect in accordance with the terms of the award.

Determination of Fair Value

The fair value of each grant is estimated on the date of grant using a Monte Carlo simulation to forecast relative TSR performance. A correlation matrix of historic and projected stock prices was developed for both the Company and our predetermined peer group of mining and metals companies. The fair value assumes that performance goals will be achieved.

The expected term of the grant represents the time from the grant date to the end of the service period for each of the three plan-year agreements. We estimate the volatility of our common shares and that of the peer group of mining and metals companies using daily price intervals for all companies. The risk-free interest rate is the rate at the grant date on zero-coupon government bonds, with a term commensurate with the remaining life of the performance plans.

 

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The following assumptions were utilized to estimate the fair value for the first quarter of 2012 performance share grants:

 

Grant Date

   Grant Date
Market
Price
     Average
Expected
Term
(Years)
     Expected
Volatility
    Risk-Free
Interest
Rate
    Dividend
Yield
    Fair Value      Fair Value
(Percent of
Grant Date
Market Price)
 

March 12, 2012

   $ 63.62         2.80         56.0     0.45     3.93     77.78         122.26

The fair value of the restricted share units is determined based on the closing price of the Company’s common shares on the grant date. The restricted share units granted under either the ICE Plan or 2012 Equity Plan vest over a period of three years.

NOTE 14 INCOME TAXES

The estimated annual effective tax rate is affected by recurring items, such as depletion, tax rates in foreign jurisdictions and the relative amount of income we earn in our various jurisdictions with tax rates that differ from the U.S. statutory rate. It is also affected by discrete items that may occur in any given year, but are not consistent from year to year. In the first quarter of 2012 the Australian government enacted the MRRT. The impact of this legislation was recorded as a discrete item and had a net financial statement tax benefit of $314.7 million and was a 20.7% benefit to the estimated annual effective tax rate. Additionally, currency elections made in the first quarter of 2012 impacted the remeasurement of deferred tax assets and liabilities and a discrete item was recorded that resulted in a net tax expense of $60.5 million. Finally, an agreement was reached with the taxing authorities in the current period resulting in a reversal of a prior liability for an uncertain tax position, the financial statement impact of which was an income tax benefit of $26.9 million.

NOTE 15 CAPITAL STOCK

Dividends

A $0.14 per share cash dividend was paid on March 1, 2011 and June 1, 2011 to shareholders of record as of February 15, 2011 and April 29, 2011, respectively. On July 12, 2011, our Board of Directors increased the quarterly common share dividend by 100 percent to $0.28 per share. The increased cash dividend was paid on September 1, 2011 and December 1, 2011 to shareholders of record as of the close of business on August 15, 2011 and November 18, 2011, respectively. Additionally, the increased cash dividend was paid on March 1, 2012 to shareholders of record as of the close of business on February 15, 2012. On March 13, 2012, our Board of Directors increased the quarterly common share dividend by 123 percent to $0.625 per share. The increased cash dividend was paid on June 1, 2012 to shareholders of record as of the close of business on April 27, 2012.

Public Offering

On June 13, 2011, we completed a public offering of our common shares. The total number of shares sold was 10.35 million, comprised of the 9.0 million share offering and the exercise of an underwriters’ over-allotment option to purchase an additional 1.35 million shares. The offering resulted in an increase in the number of our common shares issued and outstanding as of June 30, 2011. We received net proceeds of approximately $853.7 million at a closing price of $85.63 per share.

Amendment to the Second Amended Articles of Incorporation

On May 25, 2011, our shareholders approved an amendment to our Second Amended Articles of Incorporation to increase the number of authorized Common Shares from 224,000,000 to 400,000,000, which resulted in an increase in the total number of authorized shares from 231,000,000 to 407,000,000. The total number of authorized shares includes 3,000,000 and 4,000,000 shares of Class A and Class B, respectively, of unauthorized and unissued preferred stock.

 

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NOTE 16 – SHAREHOLDERS’ EQUITY

The following table reflects the changes in shareholders’ equity attributable to both Cliffs and the noncontrolling interests primarily related to Bloom Lake, Tilden and Empire of which Cliffs owns 75 percent, 85 percent and 79 percent, respectively, for the six months ended June 30, 2012 and June 30, 2011:

 

     (In Millions)  
     Cliffs
Shareholders’
Equity
    Noncontrolling
Interest
    Total Equity  

December 31, 2011

   $ 5,785.0      $ 1,254.7      $       7,039.7   

Comprehensive income

      

Net income

     633.8        31.9        665.7   

Other comprehensive income

     2.7        3.0        5.7   
  

 

 

   

 

 

   

 

 

 

Total comprehensive income

     636.5        34.9        671.4   

Stock and other incentive plans

     2.3        -          2.3   

Common stock dividends

     (128.8     -          (128.8

Undistributed gains to noncontrolling interest

     -          8.6        8.6   

Capital contribution by noncontrolling interest to subsidiary

     -          22.3        22.3   

Acquisition of controlling interest

     -          (8.0     (8.0
  

 

 

   

 

 

   

 

 

 

June 30, 2012

   $ 6,295.0      $ 1,312.5      $ 7,607.5   
  

 

 

   

 

 

   

 

 

 
     (In Millions)  
     Cliffs
Shareholders’
Equity
    Noncontrolling
Interest
    Total
Equity
 

December 31, 2010

   $ 3,845.9      $ (7.2   $       3,838.7   

Comprehensive income

      

Net income

     832.5        18.3        850.8   

Other comprehensive income

     50.1        0.9        51.0   
  

 

 

   

 

 

   

 

 

 

Total comprehensive income

     882.6        19.2        901.8   

Equity offering

     853.7        -          853.7   

Purchase of additional noncontrolling interest

     0.3        -          0.3   

Stock and other incentive plans

     3.1        -          3.1   

Common stock dividends

     (38.0     -          (38.0

Purchase of subsidiary shares from noncontrolling interest

     -          4.5        4.5   

Undistributed gains to noncontrolling interest

     -          9.6        9.6   

Capital contribution by noncontrolling interest to subsidiary

     -          0.2        0.2   

Acquisition of controlling interest

     -          947.6        947.6   
  

 

 

   

 

 

   

 

 

 

June 30, 2011

   $ 5,547.6      $ 973.9      $ 6,521.5   
  

 

 

   

 

 

   

 

 

 

The following table reflects the changes in Accumulated other comprehensive income (loss) related to Cliffs shareholders’ equity for June 30, 2012 and June 30, 2011:

 

     (In Millions)  
     Postretirement
Benefit
Liability
     Unrealized
Net Gain
(Loss) on
Securities
     Unrealized
Net Gain
(Loss) on
Foreign
Currency
Translation
     Unrealized
Net Gain
(Loss) on
Derivative
Financial
Instruments
     Accumulated
Other
Comprehensive
Income (Loss)
 

Balance December 31, 2011

   $  (408.9)       $ 2.6        $  312.5        $ 1.2        $  (92.6)   

Change during 2012

     10.3          (0.5)         (6.5)         (0.6)         2.7    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance June 30, 2012

   $ (398.6)       $ 2.1        $ 306.0        $ 0.6        $ (89.9)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     (In Millions)  
     Postretirement
Benefit
Liability
     Unrealized
Net Gain
(Loss) on
Securities
     Unrealized
Net Gain
(Loss) on
Foreign
Currency
     Net Gain
on
Derivative
Financial
Instruments
     Accumulated
Other
Comprehensive
Income
 

Balance December 31, 2010

     $ (305.1)          $ 33.6           $ 314.7           $ 2.7           $ 45.9     

Change during 2011

     8.6           (19.2)          57.5           3.2           50.1     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance June 30, 2011

     $ (296.5)          $ 14.4           $ 372.2           $         5.9           $ 96.0     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

NOTE 17 RELATED PARTIES

Three of our five U.S. iron ore mines and one of our two Eastern Canadian iron ore mines are owned with various joint venture partners that are integrated steel producers or their subsidiaries. We are the manager of each of the mines we co-own and rely on our joint venture partners to make their required capital contributions and to pay for their share of the iron ore pellets and concentrate that we produce. The joint venture partners are also our customers. The following is a summary of the mine ownership of these iron ore mines at June 30, 2012:

 

Mine

   Cliffs Natural
Resources
     ArcelorMittal      U.S. Steel
Canada
     WISCO  

Empire

     79.0         21.0         -           -     

Tilden

     85.0         -           15.0         -     

Hibbing

     23.0         62.3         14.7         -     

Bloom Lake

     75.0         -           -           25.0   

ArcelorMittal has a unilateral right to put its interest in the Empire mine to us, but has not exercised this right to date.

Product revenues from related parties were as follows:

 

     (In Millions)  
     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Product revenues from related parties

   $ 465.4      $ 610.7      $ 797.3      $ 924.3   

Total product revenues

       1,546.6          1,705.0          2,747.5          2,838.0   

Related party product revenue as a percent of total product revenue

     30.1     35.8     29.0     32.6

Amounts due from related parties recorded in Accounts receivable and Derivative assets, including customer supply agreements and provisional pricing arrangements, were $134.0 million and $180.4 million at June 30, 2012 and December 31, 2011, respectively. Amounts due to related parties recorded in Other current liabilities, including provisional pricing arrangements and liabilities to minority parties, were $24.9 million and $43.0 million at June 30, 2012 and December 31, 2011, respectively.

NOTE 18 EARNINGS PER SHARE

The following table summarizes the computation of basic and diluted earnings per share attributable to Cliffs’ shareholders:

 

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     (In Millions)  
     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012      2011     2012     2011  

Net income from continuing operations attributable to Cliffs shareholders

   $ 258.0       $ 409.8      $ 633.9      $ 833.6   

Loss from discontinued operations

     -             (0.7     (0.1     (1.1
  

 

 

    

 

 

   

 

 

   

 

 

 

Net income attributable to Cliffs shareholders

   $ 258.0       $ 409.1      $ 633.8      $ 832.5   
  

 

 

    

 

 

   

 

 

   

 

 

 

Weighted average number of shares:

         

Basic

     142.4         139.0        142.3        137.2   

Employee stock plans

     0.4         0.8        0.5        0.8   
  

 

 

    

 

 

   

 

 

   

 

 

 

Diluted

     142.8         139.8        142.8        138.0   
  

 

 

    

 

 

   

 

 

   

 

 

 

Earnings per common share attributable to
Cliffs shareholders - Basic:

         

Continuing operations

   $ 1.81       $ 2.95      $ 4.45      $ 6.07   

Discontinued operations

     -             (0.01     -            (0.01
  

 

 

    

 

 

   

 

 

   

 

 

 
   $ 1.81       $ 2.94      $ 4.45      $ 6.06   
  

 

 

    

 

 

   

 

 

   

 

 

 

Earnings per common share attributable to
Cliffs shareholders - Diluted:

         

Continuing operations

   $ 1.81       $ 2.93      $ 4.44      $ 6.04   

Discontinued operations

     -             (0.01     -            (0.01
  

 

 

    

 

 

   

 

 

   

 

 

 
   $ 1.81       $ 2.92      $ 4.44      $ 6.03   
  

 

 

    

 

 

   

 

 

   

 

 

 

NOTE 19 COMMITMENTS AND CONTINGENCIES

Purchase Commitments

In 2011, we incurred capital commitments related to the expansion of the Bloom Lake mine. The expansion project requires a capital investment of over $1.3 billion for the Phase II expansion of the mine and the mine’s processing capabilities. The capital investment also includes common infrastructure necessary to sustain current operations and support the expansion. Through June 30, 2012, approximately $819 million of the total capital investment required for the Bloom Lake expansion project had been committed, of which a total of approximately $369 million had been expended. Of the remaining committed capital, expenditures of approximately $450 million are expected to be made during the remainder of 2012 and in 2013.

In 2011, we entered into an agreement with the rail service provider for the rail lines used by our Koolyanobbing operations to upgrade the existing rail line. The upgrade is being performed to enhance safety and improve functionality of the rail. The improvements include the replacement of rail and associated parts. As a result, our portion of the related purchase commitment is approximately $33 million for replacements and improvements to the rail structure. Through June 30, 2012, our capital expenditures related to this purchase were approximately $17 million. Remaining expenditures of approximately $16 million are expected to be made throughout 2013 and 2014.

We incurred capital commitments related to an expansion project at our Empire and Tilden mines in Michigan’s Upper Peninsula in 2010. The expansion project requires a capital investment of approximately $245 million, of which $203 million has been committed as of June 30, 2012, and is expected to allow for production capacity at the Empire mine to produce at three million tons annually through 2014 and increase Tilden mine production capacity by an additional two million tons annually over this same period. Through June 30, 2012, total capital expenditures related to this commitment were approximately $169 million. Of the committed capital, expenditures of approximately $32 million and $2 million are scheduled to be made during the remainder of 2012 and in 2013, respectively.

 

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Table of Contents

Contingencies

Litigation

We are currently a party to various claims and legal proceedings incidental to our operations. If management believes that a loss arising from these matters is probable and can reasonably be estimated, we record the amount of the loss, or the minimum estimated liability when the loss is estimated using a range, and no point within the range is more probable than another. As additional information becomes available, any potential liability related to these matters is assessed and the estimates are revised, if necessary. Based on currently available information, management believes that the ultimate outcome of these matters, individually and in the aggregate, will not have a material effect on our financial position, results of operations or cash flows. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. An unfavorable ruling could include monetary damages, additional funding requirements or an injunction. If an unfavorable ruling were to occur, there exists the possibility of a material impact on the financial position and results of operations of the period in which the ruling occurs, or future periods. However, we believe that any pending litigation will not result in a material liability in relation to our unaudited condensed consolidated financial statements.

NOTE 20 CASH FLOW INFORMATION

A reconciliation of capital additions to cash paid for capital expenditures for the six months ended June 30, 2012 and 2011 is as follows:

 

     (In Millions)  
     Six Months Ended June 30,  
     2012      2011  

Capital additions

   $ 619.5       $ 297.4   

Cash paid for capital expenditures

     517.0         244.5   
  

 

 

    

 

 

 

Difference

   $ 102.5       $ 52.9   
  

 

 

    

 

 

 

Non-cash accruals

   $ 53.1       $ 52.9   

Capital leases

     49.4         —     
  

 

 

    

 

 

 

Total

   $ 102.5       $ 52.9   
  

 

 

    

 

 

 

NOTE 21 SUBSEQUENT EVENTS

Cliffs Australia Coal Pty Ltd entered into a definitive share and asset sale agreement on July 10, 2012 to sell its 45% economic interest in the Sonoma joint venture coal mine located in Queensland, Australia. The assets to be sold include Cliffs’ interests in the Sonoma mine along with its ownership of the affiliated wash plant. Upon completion of the transaction, Cliffs expects to collect approximately AUD$141 million in cash proceeds. We do not expect the disposal to have a material impact on the Statements of Consolidated Operations, Statements of Consolidated Comprehensive Income, Statements of Consolidated Financial Position or the Statement of Consolidated Cash Flows.

We have evaluated subsequent events through the date of financial statement issuance.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and other factors that may affect our future results. We believe it is important to read our MD&A in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2011 as well as other publicly available information.

 

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Table of Contents

Overview

Cliffs Natural Resources Inc. traces its corporate history back to 1847. Today, we are an international mining and natural resources company. A member of the S&P 500 Index, we are a major global iron ore producer and a significant producer of high- and low-volatile metallurgical coal. Our Company’s operations are organized according to product category and geographic location: U.S. Iron Ore, Eastern Canadian Iron Ore, North American Coal, Asia Pacific Iron Ore, Asia Pacific Coal, Latin American Iron Ore, Ferroalloys and our Global Exploration Group.

We have been executing a strategy designed to achieve scale in the mining industry and focused on serving the world’s largest and fastest growing steel markets. In the U.S. we operate five iron ore mines in Michigan and Minnesota, five metallurgical coal mines located in West Virginia and Alabama and one thermal coal mine located in West Virginia. We also operate two iron ore mines in Eastern Canada that provide iron ore to the seaborne market for Asian steel producers. Our Asia Pacific operations primarily are comprised of two iron ore mining complexes in Western Australia, serving the Asian iron ore markets with direct-shipping fines and lump ore, and a 45 percent economic interest in a coking and thermal coal mine located in Queensland, Australia, which is expected to be sold in the fourth quarter of 2012. In Latin America, we have a 30 percent interest in Amapá, a Brazilian iron ore operation, and, in Ontario, Canada, we have a major chromite project that entered into the feasibility stage of exploration during May 2012. In addition, our Global Exploration Group is focused on early involvement in exploration activities to identify new world-class projects for future development or projects that add significant value to existing operations.

Our 2011 results were driven by increased steel production, higher demand and rising prices. Global crude steel production has remained stable in the first half of 2012 from the comparable period in 2011, with an increase of approximately one percent in China and an increase of nine percent in the U.S., which are the two largest markets for the Company. China produced approximately 296 million metric tons of crude steel in the first half of 2012, representing approximately 46.6 percent of global production. Although global crude production has remained strong, the demand for iron ore has softened in the first half of 2012. World pricing of iron ore is influenced heavily by international demand, and spot market prices for iron ore have reflected this trend.

Our consolidated revenues for the three and six months ended June 30, 2012 decreased to $1.6 billion and $2.9 billion, respectively, with net income from continuing operations per diluted share of $1.81 and $4.44, respectively. This compares with revenues of $1.8 billion and $3.0 billion and net income from continuing operations per diluted share of $2.92 and $6.03, respectively, for the comparable periods in 2011. Revenues during the three and six months ended June 30, 2012 were impacted by a decrease in market pricing during the first half of 2012 in comparison to the historically high prices of 2011, due to the weakening of market demand for our steelmaking raw materials. This partially was offset by incrementally higher iron ore concentrate sales volumes at our Eastern Canadian Iron Ore operating segment that were made available through our acquisition of Consolidated Thompson during May 2011. Our net income from continuing operations also was impacted favorably during the six months ended June 30, 2012 by discrete tax items, primarily due to the enactment of the MRRT in Australia.

Results in the first six months of 2012 reflect increased production and sales volumes at our operations around the world offset by increased costs and a decrease in pricing for our products compared to the first six months of 2011. Our cash flow generation and positive outlook for our business allow us to continue our focus on investments in our assets, which enable us to continue to pursue strategic objectives and enhance our long-term operating performance, while also providing us with the increased ability to return cash to shareholders. We also continued to align our balance sheet and enhance our financial flexibility to achieve our long-term financial growth goals and objectives.

 

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Table of Contents

Growth Strategy and Strategic Transactions

Through a number of strategic acquisitions executed over recent years, we have significantly increased our portfolio of assets, including our production profile and growth project pipeline. In 2012, we are committed to executing our announced organic expansion plans with a focus on driving top-quartile TSR. Our new capital allocation strategy is designed to prioritize all potential uses of future cash flows in a manner that is most meaningful for shareholders. While we plan on using future cash flows to reduce debt over time, we also intend to deploy capital to finance organic growth projects and dividend distributions. Maintaining financial flexibility as commodity pricing changes throughout the business cycle is imperative to executing our strategic initiatives.

As we continue to expand our operating scale and geographic presence as an international mining and natural resources company, we intend to shift our strategy from a merger and acquisition-based strategy to one that primarily focuses on organic growth and expansion initiatives. As such, in January 2012, our Board of Directors approved the additional capital investment for Bloom Lake’s Phase II expansion. We also own additional development properties, primarily Lamêlée and Peppler Lake, in Quebec that potentially could allow us to leverage parts of our existing infrastructure to supply additional iron ore into the seaborne market.

In March 2012, the Board of Directors announced the approval of a 123 percent increase to our quarterly cash dividend rate to $0.625 from the previous quarterly rate of $0.28. This meaningful increase reinforces our belief in our ability to generate future cash flow and management’s commitment to driving top-quartile TSR.

Our Chromite Project, located in Northern Ontario, advanced into the feasibility stage of development during May 2012, where we will build further on the technical and economic evaluations and continue evaluating realistic options for the mining, processing and transportation of future products from this asset. In addition to this large greenfield project, we expect to achieve additional growth through early involvement in exploration and development activities by partnering with junior mining companies. This potentially provides us low-cost entry points to significantly increase our reserve base and growth production profile.

Segments

Our Company’s primary operations are organized and managed according to product category and geographic location: U.S. Iron Ore, Eastern Canadian Iron Ore, North American Coal, Asia Pacific Iron Ore, Asia Pacific Coal, Latin American Iron Ore, Ferroalloys and our Global Exploration Group. The Asia Pacific Coal, Latin American Iron Ore, Ferroalloys and our Global Exploration Group operating segments do not meet the criteria for reportable segments.

Results of Operations – Consolidated

2012 Compared to 2011

The following is a summary of our consolidated results of operations for the three and six months ended June 30, 2012 and 2011:

 

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Table of Contents
     (In Millions)     (In Millions)  
     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     Variance
Favorable/
(Unfavorable)
    2012     2011     Variance
Favorable/
(Unfavorable)
 

Revenues from product sales
and services

     $   1,626.0        $   1,805.8        $    (179.8     $   2,890.7        $   2,989.0        $ (98.3

Cost of goods sold and operating expenses

     (1,176.7     (1,074.2     (102.5     (2,137.9     (1,657.9     (480.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Sales Margin

     $ 449.3        $ 731.6        $ (282.3     $ 752.8        $ 1,331.1        $   (578.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Sales Margin %

     27.6%        40.5%        (12.9)%        26.0%        44.5%        (18.5)%   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Revenue from Product Sales and Services

Sales revenue for the three and six months ended June 30, 2012 decreased $179.8 million and $98.3 million, respectively, or 10.0 percent and 3.3 percent, respectively, from the comparable period in 2011. The decrease in sales revenue in the first half of 2012 resulted primarily from lower market pricing for our products compared to the first half of 2011 and the recording of negotiated settlements in 2011 which were non-recurring in 2012. The decrease in revenue partially was offset by higher sales volumes across all operating segments.

Our realized sales price for our U.S. Iron Ore operations during the first half of 2012 was 19.3 percent lower per ton compared with the same period of 2011, or a 10.2 percent decrease per ton, excluding the impact of 2011 arbitration settlements. The realized sales price for our Eastern Canadian Iron Ore operations was on average a 30.1 percent decrease per metric ton for the first half of 2012, over the comparable prior year period in 2011. The decrease in our realized price for the six months ended June 30, 2012 at our Asia Pacific Iron Ore operating segment was on average a 22.3 percent and 24.7 percent decrease for lump and fines, respectively, over the comparable prior year period. Our realized price for the six months ended June 30, 2012 at our North American Coal operating segment was on average an 8.3 percent decrease, a 3.0 percent increase and a 5.0 percent increase for low-volatile, high-volatile and thermal coal, respectively, over the comparable prior year period.

In the first half of 2011, an additional $105.1 million of revenue was recognized at our U.S. Iron Ore operating segment related to the negotiated settlement we reached with ArcelorMittal USA with respect to our previously disclosed arbitrations and litigation regarding price re-opener entitlements for 2009 and 2010 and pellet nominations for 2010. In addition, during the first half of 2011, revenues included the impact of $23.4 million related to the finalization of pricing on sales for Algoma’s 2010 pellet nomination.

The decreases in revenue were offset partially by higher sales volumes of 77.4 percent, 32.1 percent, and 16.4 percent at our Eastern Canadian Iron Ore, Asia Pacific Iron Ore and North American Coal operating segments, respectively, in the first half of 2012 as compared to the first half of 2011.

Refer to “Results of Operations – Segment Information” for additional information regarding the impact of specific factors that impacted revenue during the period.

Cost of Goods Sold and Operating Expenses

Cost of goods sold and operating expenses for the three and six months ended June 30, 2012 was $1,176.7 million and $2,137.9 million, respectively, which resulted in an increase of $102.5 million and $480.0 million, or 9.5 percent and 29.0 percent, respectively, over the comparable prior year periods. The increase primarily was attributable to higher sales volumes at our Eastern Canadian Iron Ore operations as a result of the

 

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acquisition of Consolidated Thompson in May 2011. The increase in the sales volumes at Eastern Canadian Iron Ore resulted in $162.2 million of additional costs in the first half of 2012. Cost of goods sold and operating expenses for the first six months of 2012 also were impacted by sales volume increases of $104.8 million, and $45.9 million, respectively, at our Asia Pacific Iron Ore and North American Coal segments.

Refer to “Results of Operations – Segment Information” for additional information regarding the impact of specific factors that impacted our operating results during the period.

Other Operating Income (Expense)

Following is a summary of other operating income (expense) for the three and six months ended June 30, 2012 and 2011: