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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 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. The interim results are not necessarily indicative of results for the full year. 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, 2008.
The unaudited condensed consolidated financial statements include our accounts and the accounts of our wholly-owned and majority-owned subsidiaries, including the following significant subsidiaries:
Name |
Location |
Ownership Interest |
Operation |
|||
Northshore |
Minnesota |
100.0% | Iron Ore | |||
United Taconite |
Minnesota |
100.0% | Iron Ore | |||
Pinnacle |
West Virginia |
100.0% | Coal | |||
Oak Grove |
Alabama |
100.0% | Coal | |||
Asia Pacific Iron Ore |
Western Australia |
100.0% | Iron Ore | |||
Tilden |
Michigan |
85.0% | Iron Ore | |||
Empire |
Michigan |
79.0% | Iron Ore |
Intercompany transactions and balances are eliminated upon consolidation.
The following table presents the detail of our investments in unconsolidated ventures and where those investments are classified on the Statements of Condensed Consolidated Financial Position. Parentheses indicate a net liability.
(In Millions) | ||||||||||||||||
Investment |
Classification |
Interest Percentage |
June 30, 2009 |
December 31, 2008 |
||||||||||||
Amapá |
Investments in ventures |
30 | $ | 269.4 | $ | 266.3 | ||||||||||
AusQuest |
Investments in ventures |
30 | 21.8 | 19.2 | ||||||||||||
Cockatoo (1) |
Investments in ventures |
50 | 4.0 | (13.5) | ||||||||||||
Wabush (2) |
Other liabilities |
27 | (0.9) | 12.1 | ||||||||||||
Hibbing |
Other liabilities |
23 | (12.7) | (22.1) | ||||||||||||
Other |
Investments in ventures |
13.2 | 7.7 | |||||||||||||
$ | 294.8 | $ | 269.7 | |||||||||||||
(1) Recorded as Other liabilities at December 31, 2008.
(2) Recorded as Investments in ventures at December 31, 2008.
Our share of the results from Amapá and AusQuest are reflected as Equity loss from ventures on the Statements of Unaudited Condensed Consolidated Operations. Our share of equity income (loss) from Cockatoo, Hibbing and Wabush is eliminated against consolidated product inventory upon production, and against cost of goods sold and operating expenses when sold. This effectively reduces our cost for our share of the mining venture’s production to its cost, reflecting the cost-based nature of our participation in these unconsolidated ventures.
Through various interrelated arrangements, we achieve a 45 percent economic interest in Sonoma, despite the ownership percentages of the individual components of Sonoma. We own 100 percent of CAWO, 8.33 percent of the exploration permits and applications for mining leases for the real estate that is involved in Sonoma (“Mining Assets”) and 45 percent of the infrastructure, including the construction of a rail loop and related equipment (“Non-Mining Assets”). CAWO is consolidated as a wholly-owned subsidiary, and as a result of being the primary beneficiary, we absorb greater than 50 percent of the residual returns and expected losses of CAWO. We record our ownership share of the Mining Assets and Non-Mining Assets and share in the respective costs. Although SMM does not have sufficient equity at risk and accordingly is a VIE under paragraph 5(a) of FIN 46(R), Consolidation of Variable Interest Entities, we are not the primary beneficiary of SMM. Accordingly, we account for our investment in SMM in accordance with the equity method.
Summarized financial information for our significant equity method investments, as defined under Regulation S-X, for the three and six months ended June 30, 2009 and 2008 is as follows:
(In Millions) | ||||||||||||
Three Months Ended | Six Months Ended | |||||||||||
June 30, (1) | June 30, (1) | |||||||||||
Amapá |
2009 | 2008 | 2009 | 2008 | ||||||||
Revenues |
$ | 24.6 | $ | 14.3 | $ | 46.8 | $ | 20.2 | ||||
Sales margin |
(12.4) | (17.4) | (17.2) | (29.8) | ||||||||
Loss from continuing operations before
extraordinary |
(79.5) | (19.0) | (106.5) | (45.0) | ||||||||
Net loss |
(79.5) | (19.0) | (106.5) | (45.0) |
(1) |
The financial information of Amapá is recorded one month in arrears and is presented in accordance |
with U.S. GAAP.
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, 2008, included in our Annual Report on Form 10-K filed with the SEC. There have been no material changes in our significant accounting policies and estimates from those disclosed therein.
Recent Accounting Pronouncements
Effective January 1, 2009, we adopted the provisions of FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, (“SFAS 161”). SFAS 161 amends and expands the disclosure requirements of FASB Statement No. 133 to provide users of financial statements with an enhanced understanding of how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The new requirements apply to derivative instruments and non-derivative instruments that are designated and qualify as hedging instruments and related hedged items accounted for under SFAS 133. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. Refer to NOTE 7 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES for further information.
Effective January 1, 2009, we adopted the provisions of FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS 160”). SFAS 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008. SFAS 160 has been applied prospectively as of January 1, 2009, except for the presentation and disclosure requirements, which have been applied retrospectively for all periods presented.
As of the adoption date, our noncontrolling interests are primarily comprised of majority-owned subsidiaries within our North American Iron Ore business segment. The mining ventures function as captive cost companies, as they supply products only to their owners effectively on a cost basis. Accordingly, the noncontrolling interests’ revenue amounts are stated at cost of production and are offset entirely by an equal amount included in cost of goods sold, resulting in no sales margin reflected in noncontrolling interest participants. As a result, the adoption of SFAS 160 did not have a material impact on our consolidated financial statements.
We adopted FASB Statement No. 141 (revised 2007), Business Combinations (“SFAS 141(R)”), effective January 1, 2009. This Statement establishes principles and requirements for how the acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at the acquisition date fair value. SFAS 141(R) requires information to be disclosed to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of SFAS 141 (R) did not have a material impact on our consolidated financial statements.
In April 2009, the FASB issued FSP FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, to amend and clarify the initial recognition and measurement, subsequent measurement and accounting, and related disclosures arising from contingencies in a business combination under SFAS 141(R), Business Combinations. Under the new guidance, assets acquired and liabilities assumed in a business combination that arise from contingencies should be recognized at fair value on the acquisition date if fair value can be determined during the measurement period. If fair value can not be determined, companies should typically account for the acquired contingencies using existing guidance. The FSP is effective for business combinations whose acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We adopted the provisions of FSP FAS 141 (R)-1 effective January 1, 2009. The adoption of this FSP did not have a material impact on our consolidated financial statements.
Effective January 1, 2009, we adopted the provisions of EITF Issue No. 07-1, Accounting for Collaborative Arrangements (“EITF 07-1”). EITF 07-1 defines collaborative arrangements and establishes reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. EITF 07-1 is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The adoption of this Issue did not have a material impact on our consolidated financial statements.
Effective January 1, 2009, we adopted the provisions of FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. This staff position was issued in order to address whether instruments granted in share-based payment transactions are considered participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method described in FASB Statement No. 128, Earnings per Share. The guidance in this staff position is effective for fiscal years beginning after December 15, 2008 and for interim periods within such years. The adoption of FSP EITF 03-6-1 did not have a material impact on our consolidated financial statements.
In November 2008, the FASB ratified EITF Issue No. 08-6, Equity Method Investment Accounting Considerations (“EITF 08-6”). EITF 08-6 addresses certain effects associated with the impact of SFAS 141(R) and SFAS 160 on the accounting for equity method investments including initial recognition and measurement and subsequent measurement considerations. The consensus indicates, among other things, that transaction costs for an investment should be included in the cost of the equity method investment, and shares subsequently issued by the equity method investee that reduce the investor’s ownership percentage should be accounted for as if the investor had sold a proportionate share of its investment, with gains or losses recorded through earnings. EITF 08-6 is effective, on a prospective basis, for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The implementation of this standard did not have a material impact on our consolidated results of operations or financial condition.
In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. This FSP provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased and includes guidance on identifying circumstances that indicate a transaction is not orderly. This FSP emphasizes that the objective of a fair value measurement remains the same even if there has been a significant decrease in the volume and level of activity for the asset or liability and amends certain reporting requirements for interim and annual periods related to disclosure of major security types and the inputs and valuation techniques used in determining fair value. This FSP is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. We adopted and applied this staff position prospectively upon its effective date for the interim period ending June 30, 2009. The adoption of this FSP did not have a material impact on our consolidated financial statements. Refer to NOTE 8 – FAIR VALUE OF FINANCIAL INSTRUMENTS for further information.
In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. The FSP amends the existing other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. This staff position shifts the focus from an entity’s intent to hold a debt security until recovery to its intent to sell and changes the amount of an other-than-temporary impairment loss recognized in earnings when the impairment is recorded because of a credit loss. It also expands disclosure requirements related to the types of securities held, the reasons that a portion of an other-than-temporary impairment of a debt security was not recognized in earnings, and the methodology and significant inputs used to calculate the portion of the total other-than-temporary impairment that was recognized in earnings. The FSP is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. We adopted this staff position for the interim period ending June 30, 2009. Refer to NOTE 4 – MARKETABLE SECURITIES for further information.
In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. The FSP amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements, including significant assumptions used to estimate the fair value of financial instruments and changes in methods and significant assumptions, if any, during the period. This staff position also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. The FSP is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. We adopted this staff position upon its effective date for the interim period ending June 30, 2009. Refer to NOTE 8 – FAIR VALUE OF FINANCIAL INSTRUMENTS for further information.
In May 2009, the FASB issued Statement No. 165, Subsequent Events (“SFAS 165”). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Although there is new terminology, the standard is based on the same principles as those that currently exist in the auditing standards. The standard, which includes a new required disclosure of the date through which an entity has evaluated subsequent events, is effective for interim or annual periods ending after June 15, 2009. We adopted SFAS 165 for the interim period ending June 30, 2009. Refer to NOTE 20 –SUBSEQUENT EVENTS for further information.
In June 2009, the FASB issued Statement No. 166, Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140 (“SFAS 166”), which amends the guidance on transfers of financial assets in order to address practice issues highlighted most recently by events related to the economic downturn. The amendments include: (1) eliminating the qualifying special-purpose entity concept, (2) a new unit of account definition that must be met for transfers of portions of financial assets to be eligible for sale accounting, (3) clarifications and changes to the derecognition criteria for a transfer to be accounted for as a sale, (4) a change to the amount of recognized gain or loss on a transfer of financial assets accounted for as a sale when beneficial interests are received by the transferor, and (5) extensive new disclosures. SFAS 166 will be effective January 1, 2010 for calendar year-end companies. We are currently evaluating the impact adoption of this statement will have on our consolidated financial statements.
In June 2009, the FASB issues Statement No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS 167”), which amends the consolidation guidance for variable-interest entities under FIN 46(R). The statement was issued in response to perceived shortcomings in the consolidation model that were highlighted by recent market events, including concerns about the ability to structure transactions under the current guidance to avoid consolidation, balanced with the need for more relevant, timely, and reliable information about an enterprise’s involvement in a variable-interest entity. The amendments include: (1) the elimination of the exemption for qualifying special purpose entities, (2) a new approach for determining who should consolidate a variable-interest entity, and (3) changes to when it is necessary to reassess who should consolidate a variable-interest entity. SFAS 167 will be effective January 1, 2010 for calendar year-end companies. We are currently evaluating the impact adoption of this statement will have on our consolidated financial statements, financial ratios and debt covenants.
In June 2009, the FASB issued Statement No. 168, FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles — a replacement of FASB Statement No. 162 (“SFAS 168”). The FASB Accounting Standards Codification (“Codification”) will become the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. Once effective, the Codification’s content will carry the same level of authority, effectively superseding Statement 162. Therefore, the GAAP hierarchy will be modified to include only two levels of GAAP: authoritative and nonauthoritative. Statement 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We are currently evaluating the impact SFAS 168 will have on our consolidated financial statements upon adoption, but do not expect this statement to result in a material change in current practice.
In December 2008, the FASB issued FSP No. FAS 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets. The FSP requires disclosure of additional information about investment allocation, fair values of major categories of assets, the development of fair value measurements, and concentrations of risk. The FSP is effective for fiscal years ending after December 15, 2009; however, earlier application is permitted. We will adopt the FSP upon its effective date and will report the required disclosures for our fiscal year ending December 31, 2009.
NOTE 2 - SEGMENT REPORTING
Our company is organized and managed according to product category and geographic location: North American Iron Ore, North American Coal, Asia Pacific Iron Ore, Asia Pacific Coal and Latin American Iron Ore. The North American Iron Ore segment is comprised of our interests in six North American mines that provide iron ore to the integrated steel industry. The North American Coal segment is comprised of our two North American coking coal mining complexes that provide metallurgical coal primarily to the integrated steel industry. The Asia Pacific Iron Ore segment is located in Western Australia and provides iron ore to steel producers in China and Japan. 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, which is in the early stages of production. The Asia Pacific Coal and Latin American Iron Ore operating segments do not meet reportable segment disclosure requirements and therefore are not separately reported.
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, 2009 and 2008:
(In Millions) | ||||||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||||||
Revenues from product sales and services: |
||||||||||||||||||||
North American Iron Ore |
$ | 262.8 | 67% | $ | 643.4 | 64% | $ | 451.1 | 53% | $ | 922.2 | 61% | ||||||||
North American Coal |
30.8 | 8% | 61.5 | 6% | 87.3 | 10% | 155.4 | 10% | ||||||||||||
Asia Pacific Iron Ore |
73.4 | 19% | 268.2 | 27% | 240.1 | 28% | 385.7 | 26% | ||||||||||||
Other |
23.3 | 6% | 35.5 | 3% | 76.6 | 9% | 39.8 | 3% | ||||||||||||
Total revenues from product sales and services for reportable segments |
$ | 390.3 | 100% | $ | 1,008.6 | 100% | $ | 855.1 | 100% | $ | 1,503.1 | 100% | ||||||||
Sales margin: |
||||||||||||||||||||
North American Iron Ore |
$ | 33.6 | $ | 272.6 | $ | 18.6 | $ | 337.2 | ||||||||||||
North American Coal |
(19.1) | (23.0) | (47.9) | (25.5) | ||||||||||||||||
Asia Pacific Iron Ore |
(17.2) | 160.9 | 40.3 | 182.3 | ||||||||||||||||
Other |
(9.0) | 15.8 | 19.7 | 14.8 | ||||||||||||||||
Sales margin |
(11.7) | 426.3 | 30.7 | 508.8 | ||||||||||||||||
Other operating expense |
(5.6) | (16.9) | (36.6) | (56.6) | ||||||||||||||||
Other income (expense) |
70.4 | (3.2) | 61.7 | (4.8) | ||||||||||||||||
Income from continuing operations before income taxes and equity loss from ventures |
$ | 53.1 | $ | 406.2 | $ | 55.8 | $ | 447.4 | ||||||||||||
Depreciation, depletion and amortization: |
||||||||||||||||||||
North American Iron Ore |
$ | 15.1 | $ | 11.2 | $ | 32.0 | $ | 20.9 | ||||||||||||
North American Coal |
8.8 | 14.2 | 18.5 | 27.6 | ||||||||||||||||
Asia Pacific Iron Ore |
32.6 | 13.1 | 59.2 | 27.0 | ||||||||||||||||
Other |
2.7 | 1.5 | 5.0 | 2.6 | ||||||||||||||||
Total depreciation, depletion and amortization |
$ | 59.2 | $ | 40.0 | $ | 114.7 | $ | 78.1 | ||||||||||||
Capital additions (1): |
||||||||||||||||||||
North American Iron Ore |
$ | 13.9 | $ | 12.4 | $ | 21.5 | $ | 19.5 | ||||||||||||
North American Coal |
4.0 | 8.0 | 12.5 | 19.9 | ||||||||||||||||
Asia Pacific Iron Ore |
15.5 | 6.6 | 72.9 | 35.2 | ||||||||||||||||
Other |
5.4 | 7.2 | 6.9 | 11.3 | ||||||||||||||||
Total capital additions |
$ | 38.8 | $ | 34.2 | $ | 113.8 | $ | 85.9 | ||||||||||||
(1) Includes capital lease additions and non-cash accruals.
A summary of assets by segment is as follows:
(In Millions) | ||||||
June 30, 2009 |
December 31, 2008 |
|||||
Segment assets: |
||||||
North American Iron Ore |
$ | 1,939.6 | $ | 1,818.5 | ||
North American Coal |
752.8 | 773.7 | ||||
Asia Pacific Iron Ore |
1,261.3 | 1,210.9 | ||||
Other |
342.7 | 308.0 | ||||
Total assets |
$ | 4,296.4 | $ | 4,111.1 | ||
NOTE 3 - INVENTORIES
The following table presents the detail of our Inventories on the Statements of Condensed Consolidated Financial Position at June 30, 2009 and December 31, 2008:
(In Millions) | ||||||||||||||||||
June 30, 2009 | December 31, 2008 | |||||||||||||||||
Segment |
Finished Goods |
Work-in Process |
Total Inventory |
Finished Goods |
Work-in Process |
Total Inventory |
||||||||||||
North American Iron Ore |
$ | 234.7 | $ | 9.2 | $ | 243.9 | $ | 135.3 | $ | 13.5 | $ | 148.8 | ||||||
North American Coal |
6.4 | 9.9 | 16.3 | 15.0 | 6.7 | 21.7 | ||||||||||||
Asia Pacific Iron Ore |
37.5 | 46.8 | 84.3 | 30.6 | 55.1 | 85.7 | ||||||||||||
Other |
2.1 | 2.8 | 4.9 | 6.6 | 2.6 | 9.2 | ||||||||||||
Total |
$ | 280.7 | $ | 68.7 | $ | 349.4 | $ | 187.5 | $ | 77.9 | $ | 265.4 | ||||||
Our North American Iron Ore sales for the first half of the year are influenced by winter-related shipping constraints on the Great Lakes. During the first quarter, we continue to produce our products, but we cannot ship those products via lake freighter until the Great Lakes are passable, which causes inventory levels to rise during the first half of the year.
Inventory is also impacted by the timing of shipping schedules with certain customers, resulting in deferred revenue recognition until the product is delivered. In 2008, certain customers purchased and paid for approximately 1.2 million tons of pellets in order to meet minimum contractual purchase requirements under the terms of take-or-pay contracts. The inventory was stored at our facilities in upper lakes stockpiles. At the request of the customers, the ore was not shipped. Revenue recognition on these transactions, totaling $82.9 million, was deferred on the December 31, 2008 Statements of Consolidated Financial Position and will be recognized upon shipment. Of the 1.2 million tons that were deferred at the end of 2008, approximately 382 thousand tons and 432 thousand tons were delivered during the three and six months ended June 30, 2009, respectively, resulting in $25.1 million and $29.4 million, respectively, of Product revenues being recognized. The remaining undelivered tons are recorded in our inventory as of June 30, 2009.
NOTE 4 - MARKETABLE SECURITIES
Our marketable securities consist of debt and equity instruments and are classified as either held-to-maturity or available-for-sale. Securities investments that we have the positive intent and ability to hold to maturity are classified as held-to-maturity securities and recorded at amortized cost. Investments in marketable equity securities that are being held for an indefinite period are classified as available-for-sale. We determine the appropriate classification of debt and equity securities at the time of purchase and re-evaluate such designation as of each balance sheet date. In addition, we review our investments on an ongoing basis for indications of possible impairment. Once identified, the determination of whether the impairment is temporary or other-than-temporary requires significant judgment. The primary factors that we consider in classifying the impairment include the extent and time the fair value of each investment has been below cost, and the existence of a credit loss in relation to our debt securities. If a decline in fair value is judged other than temporary, the basis of the individual security is written down to fair value as a new cost basis, and the amount of the write-down is included as a realized loss. For our held-to-maturity debt securities, if the fair value is less than cost, and we do not expect to recover the entire amortized cost basis of the security, the other-than-temporary impairment is separated into the amount representing the credit loss, which is recognized in earnings, and the amount representing all other factors, which is recognized in other comprehensive income.
At June 30, 2009 and December 31, 2008, we had $40.2 million and $30.2 million, respectively, of marketable securities as follows:
(In Millions) | ||||||
June 30, 2009 |
December 31, 2008 |
|||||
Held to maturity - current |
$ | - | $ | 4.8 | ||
Held to maturity - non-current |
16.5 | 14.2 | ||||
16.5 | 19.0 | |||||
Available for sale - non-current |
23.7 | 11.2 | ||||
Total |
$ | 40.2 | $ | 30.2 | ||
Marketable securities classified as held-to-maturity are measured and stated at amortized cost. The amortized cost, gross unrealized gains and losses and fair value of investment securities held-to-maturity at June 30, 2009 and December 31, 2008 are summarized as follows:
June 30, 2009 (In Millions) | |||||||||||||
Amortized | Gross Unrealized | Fair | |||||||||||
Cost | Gains | Losses | Value | ||||||||||
Asset backed securities |
$ | 2.4 | $ | - | $ | (1.2 | ) | $ | 1.2 | ||||
Floating rate notes |
14.1 | - | (1.1 | ) | 13.0 | ||||||||
Total |
$ | 16.5 | $ | - | $ | (2.3 | ) | $ | 14.2 | ||||
December 31, 2008 (In Millions) | |||||||||||||
Amortized | Gross Unrealized | Fair | |||||||||||
Cost | Gains | Losses | Value | ||||||||||
Asset backed securities |
$ | 2.1 | $ | - | $ | (0.6 | ) | $ | 1.5 | ||||
Floating rate notes |
16.9 | - | (1.1 | ) | 15.8 | ||||||||
Total |
$ | 19.0 | $ | - | $ | (1.7 | ) | $ | 17.3 | ||||
Investment securities held-to-maturity at June 30, 2009 and December 31, 2008 have contractual maturities as follows:
(In Millions) | ||||||
June 30, 2009 |
December 31, 2008 |
|||||
Asset backed securities: |
||||||
Within 1 year |
$ | - | $ | - | ||
1 to 5 years |
2.4 | 2.1 | ||||
$ | 2.4 | $ | 2.1 | |||
Floating rate notes: |
||||||
Within 1 year |
$ | - | $ | 4.8 | ||
1 to 5 years |
14.1 | 12.1 | ||||
$ | 14.1 | $ | 16.9 | |||
The following table shows our gross unrealized losses and fair value of investment securities held-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2009 and December 31, 2008:
Less than 12 months (In Millions) | ||||||||||||
June 30, 2009 | December 31, 2008 | |||||||||||
Unrealized Losses |
Fair Value |
Unrealized Losses |
Fair Value |
|||||||||
Asset backed securities |
$ | - | $ | - | $ | - | $ | - | ||||
Floating rate notes |
- | - | 0.1 | 1.7 | ||||||||
$ | - | $ | - | $ | 0.1 | $ | 1.7 | |||||
12 months or longer (In Millions) | ||||||||||||
June 30, 2009 | December 31, 2008 | |||||||||||
Unrealized Losses |
Fair Value |
Unrealized Losses |
Fair Value |
|||||||||
Asset backed securities |
$ | 1.2 | $ | 1.2 | $ | 0.6 | $ | 1.5 | ||||
Floating rate notes |
1.1 | 13.0 | 1.0 | 14.1 | ||||||||
$ | 2.3 | $ | 14.2 | $ | 1.6 | $ | 15.6 | |||||
We believe that the unrealized losses on the held-to-maturity portfolio at June 30, 2009 are temporary and are related to market interest rate fluctuations and not to deterioration in the creditworthiness of the issuers. We expect to recover the entire amortized cost basis of the held-to-maturity debt securities, and we intend to hold these investments until maturity.
Marketable securities classified as available-for-sale are stated at fair value, with unrealized holding gains and losses included in Other comprehensive income. The amortized cost, gross unrealized gains and losses and fair value of investment securities available-for-sale at June 30, 2009 and December 31, 2008 are summarized as follows:
(In Millions) | ||||||||||||
June 30, 2009 | ||||||||||||
Amortized | Gross Unrealized | Fair | ||||||||||
Cost | Gains | Losses | Value | |||||||||
Equity securities |
||||||||||||
(without contractual maturity) |
$ | 15.8 | $ | 9.4 | $ | (1.5) | $ | 23.7 | ||||
(In Millions) | ||||||||||||
December 31, 2008 | ||||||||||||
Amortized | Gross Unrealized | Fair | ||||||||||
Cost | Gains | Losses | Value | |||||||||
Equity securities |
||||||||||||
(without contractual maturity) |
$ | 12.0 | $ | - | $ | (0.8) | $ | 11.2 |
We own 9.2 million shares of PolyMet Corp common stock, representing 6.7 percent of issued shares as a result of the sale of certain land, crushing and concentrating and other ancillary facilities located at our Cliffs Erie site (formerly owned by LTVSMC) to PolyMet. We have the right to participate in up to 6.7 percent of any future financing, and PolyMet has the first right to acquire or place our shares should we choose to sell. We classify the shares as available-for-sale and record unrealized mark-to-market changes in the fair value of the shares through Other comprehensive income each reporting period, unless the loss is deemed to be other than temporary.
We own 24.3 million shares of Golden West, a Western Australia iron ore exploration company. Golden West owns the Wiluna West exploration ore project in Western Australia, containing a resource of 126 million metric tons of ore. Our ownership in Golden West represents approximately 17 percent of its outstanding shares at June 30, 2009. We do not exercise significant influence, and the investment is classified as an available-for-sale security. Accordingly, we record unrealized mark-to-market changes in the fair value of the investment through Other comprehensive income each reporting period, unless the loss is deemed to be other than temporary.
NOTE 5 - ACQUISITIONS AND OTHER INVESTMENTS
In accordance with FASB Statement No. 141, Business Combinations (“SFAS 141”), 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.
United Taconite
The Statements of Condensed Consolidated Financial Position as of June 30, 2009 and December 31, 2008 reflect the acquisition of the remaining interest in United Taconite, effective July 1, 2008, under the purchase method of accounting in accordance with SFAS 141. The transaction constituted a step acquisition of a noncontrolling interest. As of the date of the step acquisition of the noncontrolling interest, the then historical cost basis of the noncontrolling interest balance was eliminated, and the increased ownership obtained was accounted for by increasing United Taconite’s basis from historical cost to fair value for the portion of the assets acquired and liabilities assumed based on the 30 percent additional ownership acquired.
We finalized the purchase price allocation in the second quarter of 2009 as follows:
(In Millions) | |||
Purchase price |
$ | 450.7 | |
Carrying value of net assets acquired |
$ |
25.3 |
|
Fair value adjustments: |
|||
ASSETS |
|||
Land |
7.6 | ||
Plant and equipment |
90.8 | ||
Mineral reserves |
480.6 | ||
Intangible assets |
75.4 | ||
LIABILITIES |
|||
Below market sales contracts |
(229.0) | ||
Fair value of net assets acquired |
$ | 450.7 | |
There were no significant changes to the purchase price allocation from the initial allocation performed in 2008.
Asia Pacific Iron Ore Share Repurchase and Buyout
In 2008, we acquired the remaining noncontrolling interest in Asia Pacific Iron Ore (formerly known as Portman Limited) through a series of step acquisitions. In the second quarter of 2008, our ownership interest increased from 80.4 percent to 85.2 percent as a result of a share repurchase in which we did not participate. In the fourth quarter of 2008, we completed a second step acquisition to acquire the remaining noncontrolling interest in Asia Pacific Iron Ore. In accordance with SFAS 141, we have accounted for the acquisition of the noncontrolling interest under the purchase method. In the second quarter of 2009, we finalized the purchase price allocation related to the share repurchase and made certain modifications to the key assumptions used in the valuation of net assets acquired in the buyout of the remaining interest in Asia Pacific Iron Ore. A comparison of the updated purchase price allocation to the initial allocation is as follows:
(In Millions) | |||||||||
Revised Allocation |
Initial Allocation |
Change | |||||||
Carrying value of net assets acquired |
$ | 85.6 | $ | 85.6 | $ | - | |||
Fair value adjustments: |
|||||||||
Inventory |
79.6 | 59.1 | 20.5 | ||||||
Plant and equipment |
17.3 | 18.6 | (1.3) | ||||||
Mineral reserves |
173.2 | 238.2 | (65.0) | ||||||
Intangible assets |
42.1 | 40.1 | 2.0 | ||||||
Deferred taxes |
71.3 | 58.3 | 13.0 | ||||||
Fair value of net assets acquired |
469.1 | 499.9 | (30.8) | ||||||
Goodwill |
30.8 | - | 30.8 | ||||||
Purchase price |
$ | 499.9 | $ | 499.9 | $ | - | |||
We are in the process of finalizing the net asset valuation related to the buyout of the remaining 14.8 percent interest, including the valuation of mineral reserves and the impact on deferred taxes and goodwill. Accordingly, allocation of the purchase price related to the fourth quarter 2008 step acquisition is preliminary and subject to modification in the future. We anticipate completing the purchase price allocation in the third quarter of 2009.
NOTE 6 - INTANGIBLE ASSETS AND LIABILITIES
Following is a summary of intangible assets and liabilities at June 30, 2009 and December 31, 2008:
(In Millions) | ||||||||||||||||||||
June 30, 2009 | December 31, 2008 | |||||||||||||||||||
Classification |
Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
||||||||||||||
Definite lived intangible assets: |
||||||||||||||||||||
Permits |
Intangible assets | $ | 115.6 | $ | (4.6) | $ | 111.0 | $ | 109.3 | $ | (1.8) | $ | 107.5 | |||||||
Leases |
Intangible assets | 3.1 | (1.8) | 1.3 | 3.1 | (1.0) | 2.1 | |||||||||||||
Unpatented technology |
Intangible assets | 4.0 | (1.2) | 2.8 | - | - | - | |||||||||||||
Total intangible assets |
$ | 122.7 | $ | (7.6) | $ | 115.1 | $ | 112.4 | $ | (2.8) | $ | 109.6 | ||||||||
Below-market sales contracts |
Current liabilities | $ | (30.3) | $ | - | $ | (30.3) | $ | (30.3) | $ | - | $ | (30.3) | |||||||
Below-market sales contracts |
Long-term liabilities | (198.7) | 25.2 | (173.5) | (198.7) | 15.1 | (183.6) | |||||||||||||
Total below-market sales contracts |
$ | (229.0) | $ | 25.2 | $ | (203.8) | $ | (229.0) | $ | 15.1 | $ | (213.9) | ||||||||
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 | |
Leases |
1.5 - 4.5 | |
Unpatented technology |
5 |
Amortization expense relating to intangible assets was $3.0 million and $4.8 million for the three and six months ended June 30, 2009. The estimated amortization expense relating to intangible assets for the remainder of fiscal year 2009 and each of the five succeeding fiscal years is as follows:
(In Millions) | |||
Amount | |||
Year Ending December 31 |
|||
2009 (remaining six months) |
$ | 4.0 | |
2010 |
6.4 | ||
2011 |
6.4 | ||
2012 |
6.4 | ||
2013 |
5.5 | ||
2014 |
5.5 | ||
Total |
$ | 34.2 | |
The below-market sales contracts are classified as a liability and recognized over the terms of the contracts, which range from 3.5 to 8.5 years. For the three and six months ended June 30, 2009, we recognized $10.1 million in Product revenues related to the below-market sales contracts. The following amounts will be recognized in earnings for the remainder of fiscal year 2009 and each of the five succeeding fiscal years:
(In Millions) | |||
Amount | |||
Year Ending December 31 |
|||
2009 (remaining six months) |
$ | 20.2 | |
2010 |
30.3 | ||
2011 |
30.3 | ||
2012 |
27.0 | ||
2013 |
27.0 | ||
2014 |
25.0 | ||
Total |
$ | 159.8 | |
NOTE 7 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The following table presents the fair value of our derivative instruments and the classification of each on the Statements of Condensed Consolidated Financial Position as of June 30, 2009 and December 31, 2008:
(In Millions) | ||||||||||||||||||||
Derivative Assets | Derivative Liabilities | |||||||||||||||||||
June 30, 2009 | December 31, 2008 | June 30, 2009 | December 31, 2008 | |||||||||||||||||
Derivative | Balance Sheet | Fair | Balance Sheet | Fair | Balance Sheet | Fair | Balance Sheet | Fair | ||||||||||||
Instrument |
Location | Value | Location | Value | Location | Value | Location | Value | ||||||||||||
Derivatives designated as hedging instruments under Statement 133: |
||||||||||||||||||||
Derivative liabilities |
Derivative liabilities |
|||||||||||||||||||
Interest Rate Swap |
$ | - | $ | - |
(current) |
$ | 1.9 |
(current) |
$ | 2.6 | ||||||||||
Total derivatives designated as hedging instruments under Statement 133 |
$ | - | $ | - | $ | 1.9 | $ | 2.6 | ||||||||||||
Derivatives not designated as hedging instruments under Statement 133: |
||||||||||||||||||||
Foreign Exchange |
Derivative |
Derivative |
Derivative liabilities |
Derivative liabilities |
||||||||||||||||
Contracts |
assets |
$ | 2.1 |
assets |
$ | 0.3 |
(current) |
$ | 3.4 |
(current) |
$ | 77.5 | ||||||||
Deposits and |
Deposits and |
Derivative liabilities |
Derivative liabilities |
|||||||||||||||||
miscellaneous |
0.6 |
miscellaneous |
0.6 |
(long-term) |
3.2 |
(long-term) |
34.3 | |||||||||||||
Customer Supply |
Derivative |
Derivative |
||||||||||||||||||
Agreements |
assets |
25.4 |
assets |
76.6 | - | |||||||||||||||
Benchmark Pricing |
Derivative liabilities |
Derivative liabilities |
||||||||||||||||||
Provision |
- | - |
(current) |
35.9 |
(current) |
7.7 | ||||||||||||||
United Taconite |
Derivative liabilities |
Derivative liabilities |
||||||||||||||||||
Purchase Provision |
- | - |
(current) |
29.9 |
(current) |
106.5 | ||||||||||||||
Total derivatives not designated as hedging instruments under Statement 133 |
$ | 28.1 | $ | 77.5 | $ | 72.4 | $ | 226.0 | ||||||||||||
Total derivatives |
$ | 28.1 | $ | 77.5 | $ | 74.3 | $ | 228.6 | ||||||||||||
We are exposed to certain risks related to the ongoing operations of our business, including those caused by changes in the market value of equity investments, changes in commodity prices, interest rates and foreign currency exchange rates. We have established policies and procedures, including the use of certain derivative instruments, to manage such risks.
Derivatives Designated as Hedging Instruments
Cash Flow Hedges
Effective October 19, 2007, we entered into a $100 million fixed interest rate swap to convert a portion of our floating rate debt to fixed rate debt. Interest on borrowings under our credit facility is based on a floating rate, dependent in part on the LIBOR rate, exposing us to the effects of interest rate changes. The objective of the hedge is to eliminate the variability of cash flows in interest payments for forecasted floating rate debt, attributable to changes in benchmark LIBOR interest rates. With the swap agreement, we pay a fixed three-month LIBOR rate for $100 million of our floating rate borrowings. The changes in the cash flows of the interest rate swap are expected to offset the changes in the cash flows attributable to fluctuations in benchmark LIBOR interest rates for forecasted floating rate debt. The interest rate swap terminates in October 2009 and qualifies as a cash flow hedge.
To support hedge accounting, we designate floating-to-fixed interest rate swaps as cash flow hedges of the variability of future cash flows at the inception of the swap contract. In accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities, the fair value of our outstanding hedges is recorded as an asset or liability on the consolidated statement of financial position. Ineffectiveness is measured quarterly based on the “hypothetical derivative” method from Implementation Issue G7, Measuring the Ineffectiveness of a Cash Flow Hedge of Interest Rate Risk under Paragraph 30(b) When the Shortcut Method Is Not Applied. Accordingly, the calculation of ineffectiveness involves a comparison of the fair value of the interest rate swap and the fair value of a hypothetical swap, which has terms that are identical to the hedged item. The effective portion of the cash flow hedge is recorded in Other Comprehensive Income, and any ineffectiveness is recognized immediately in income. The amount charged to Other comprehensive income for the three and six months ended June 30, 2009 was $0.8 million and $0.7 million, respectively, compared with $1.5 million and $(0.8) million, respectively, for the three and six months ended June 30, 2008. Derivative liabilities of $1.9 million and $2.6 million were recorded on the Statements of Condensed Consolidated Financial Position as of June 30, 2009 and December 31, 2008, respectively. There was no ineffectiveness recorded for the interest rate swap during the first six months of 2009 or 2008.
The following summarizes the effect of our derivatives designated as hedging instruments on Other Comprehensive Income and the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2009 and 2008:
(In Millions) | ||||||||||||||||||||||
Derivatives in Cash Flow Hedging Relationships |
Amount of Gain/(Loss) Recognized in OCI on Derivative (Effective Portion) |
Location of Gain/(Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
Amount of Gain/(Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
Location of Gain/(Loss) Recognized in Income on Derivative (Ineffective Portion) |
Amount of Gain/(Loss) Recognized in Income on Derivative (Ineffective Portion) |
|||||||||||||||||
Three months ended June 30, |
Three months ended June 30, |
Three months ended June 30, |
||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||
Interest Rate Swap |
$ | 0.5 | $ | 0.9 | Interest Income/(Expense) |
$ | - | $ | - | Non-Operating Income/(Expense) |
$ | - | $ | - | ||||||||
Foreign Exchange Contracts (prior to de-designation) |
- | 18.7 | Product Revenue | 3.5 | 4.2 | Miscellaneous - net | - | (4.2) | ||||||||||||||
Total |
$ | 0.5 | $ | 19.6 | $ | 3.5 | $ | 4.2 | $ | - | $ | (4.2) | ||||||||||
Six months ended June 30, |
Six months ended June 30, |
Six months ended June 30, |
||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||
Interest Rate Swap |
$ | 0.5 | $ | (0.5) | Interest Income/(Expense) |
$ | - | $ | - | Non-Operating Income/(Expense) |
$ | - | $ | - | ||||||||
Foreign Exchange Contracts (prior to de-designation) |
- | 32.1 | Product Revenue | 9.9 | 10.5 | Miscellaneous - net | - | (8.6) | ||||||||||||||
Total |
$ | 0.5 | $ | 31.6 | $ | 9.9 | $ | 10.5 | $ | - | $ | (8.6) | ||||||||||
Derivatives Not Designated as Hedging Instruments
Foreign Exchange Contracts
We are subject to changes in foreign currency exchange rates as a result of our operations in Australia. Foreign exchange risk arises from our exposure to fluctuations in foreign currency exchange rates because our reporting currency is the United States dollar. Our Asia Pacific operations receive funds in United States currency for their iron ore and coal sales. We use forward exchange contracts, call options, collar options and convertible collar options to hedge our foreign currency exposure for a portion of our sales receipts. United States currency is converted to Australian dollars at the currency exchange rate in effect at the time of the transaction. The primary objective for the use of these instruments is to reduce exposure to changes in Australian and United States currency exchange rates and to protect against undue adverse movement in these exchange rates. Effective July 1, 2008, we discontinued hedge accounting for these derivatives, but continue to hold these instruments as economic hedges to manage currency risk. At June 30, 2009, we had approximately $526 million of outstanding exchange rate contracts in the form of call options, collar options, and convertible collar options with varying maturity dates ranging from July 2009 to August 2011.
Upon de-designation of these cash flow hedges, the instruments are prospectively marked to fair value each reporting period through Changes in fair value of foreign currency contracts, net on the Statements of Unaudited Condensed Consolidated Operations. For the three and six months ended June 30, 2009, the mark-to-market adjustments resulted in a net unrealized gain of $79.3 million and $76.0 million, respectively, based on a spot rate of 0.81 at June 30, 2009. The amounts that were previously recorded as a component of Other comprehensive income are reclassified to earnings and a corresponding realized gain or loss is recognized upon settlement of the related contracts. For the three and six months ended June 30, 2009, we reclassified gains of $3.5 million and $9.9 million, respectively, from Accumulated other comprehensive loss related to contracts that settled during the period, and recorded the amounts as Product revenues on the Statements of Unaudited Condensed Consolidated Operations for each corresponding period. For the three and six months ended June 30, 2008, ineffectiveness resulted in a loss of $4.2 million and $8.6 million, respectively, which was recorded as Miscellaneous – net on the Statements of Unaudited Condensed Consolidated Operations. As of June 30, 2009, approximately $9.1 million of gains remains in Accumulated other comprehensive loss related to the effective cash flow hedge contracts prior to de-designation. Of this amount, we estimate $8.2 million will be reclassified to Product revenues in the next 12 months upon settlement of the related contracts.
Customer Supply Agreements
Most of our North American Iron Ore long-term supply agreements are comprised of a base price with annual price adjustment factors. These price adjustment factors vary based on the agreement but typically include adjustments based upon changes in international pellet prices, changes in specified Producers Price Indices including those for all commodities, industrial commodities, energy and steel. The adjustments generally operate in the same manner, with each factor typically comprising a portion of the price adjustment, although the weighting of each factor varies based upon the specific terms of each agreement. One of our term supply agreements contains price collars, which typically limit the percentage increase or decrease in prices for our iron ore pellets during any given year. In most cases, these adjustment factors have not been finalized at the time our product is sold; we routinely estimate these adjustment factors. The price adjustment factors have been evaluated to determine if they contain embedded derivatives. We evaluated the embedded derivatives in the long-term supply agreements in accordance with the provisions of SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities — an amendment of FASB Statement No. 133. 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 North American Iron Ore customer provide for supplemental revenue or refunds 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 an embedded derivative under the provisions of SFAS 133 and is required to be accounted for separately from the base contract price. The embedded derivative instrument, which is finalized based on a future price, is marked to fair value as a revenue adjustment each reporting period until the pellets are consumed and the amounts are settled. We recognized an increase of $5.2 million and a reduction of $21.7 million in Product revenues for the three and six months ended June 30, 2009, respectively, on the Statements of Unaudited Condensed Consolidated Operations related to the supplemental payments, compared with an increase in Product revenues of $84.3 million and $110.3 million, respectively, for the comparable periods in 2008. Derivative assets, representing the fair value of the pricing factors, were $25.4 million and $76.6 million, respectively, on the June 30, 2009 and December 31, 2008 Statements of Condensed Consolidated Financial Position.
Benchmark Pricing Provision
Certain supply agreements primarily with our Asia Pacific Iron Ore customers provide for revenue or refunds based on the ultimate settlement of annual international benchmark pricing. In accordance with SFAS 133, the pricing provisions are characterized as freestanding derivatives and are required to be accounted for separately once iron ore is shipped. The derivative instrument, which is settled and billed once the annual international benchmark price is settled, is marked to fair value as a revenue adjustment each reporting period based upon the estimated forward settlement until the benchmark is actually settled. We recognized approximately $22.3 million and $26.4 million as a reduction to Product revenues on the Statement of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2009, respectively, under these pricing provisions. As of June 30, 2009, the annual international benchmark prices have not yet settled. Therefore, we have recorded $34.1 million and $7.7 million as current Derivative liabilities on the Statements of Condensed Consolidated Financial Position at June 30, 2009 and December 31, 2008, respectively.
United Taconite Purchase Provision
The purchase agreement for the acquisition of the remaining 30 percent interest in United Taconite in 2008 contains a penalty provision in the event the 1.2 million tons of pellets included as part of the purchase consideration are not delivered by December 31, 2009. The penalty provision, which is not a fixed amount or a fixed amount per unit, is a net settlement feature in this arrangement, and therefore causes the obligation to be accounted for as a derivative instrument under the provisions of SFAS 133, which is based on the future Eastern Canadian pellet price. The instrument is marked to fair value each reporting period until the pellets are delivered and the amounts are settled. As of June 30, 2009 and December 31, 2008, approximately 0.8 million tons and 0.2 million tons, respectively, had been delivered. A derivative liability of $29.9 million and $106.5 million, representing the fair value of the pellets that have not yet been delivered, was recorded as current Derivative liabilities on the Statement of Condensed Consolidated Financial Position as of June 30, 2009 and December 31, 2008, respectively. Refer to NOTE 8 – FAIR VALUE OF FINANCIAL INSTRUMENTS for further information.
The following summarizes the effect of our derivatives that are not designated as hedging instruments, on the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2009 and 2008:
(In Millions) |
||||||||||||||
Derivative Not Designated as Hedging Instruments |
Location of Gain/(Loss) Recognized in Income on Derivative |
Amount of Gain/(Loss) Recognized in Income on Derivative |
||||||||||||
Three months ended June 30, |
Six months ended June 30, |
|||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||
Foreign Exchange Contracts |
Product Revenues | $ | 0.6 | $ | 16.5 | $ | 0.8 | $ | 32.0 | |||||
Foreign Exchange Contracts |
Other Income (Expense) | 79.3 | - | 76.0 | - | |||||||||
Foreign Exchange Contracts |
Miscellaneous - net | - | (4.2) | - | (8.6) | |||||||||
Customer Supply Agreements |
Product Revenues | 5.2 | 84.3 | (21.7) | 110.3 | |||||||||
Benchmark Pricing Provision |
Product Revenues | (24.1) | 160.6 | (28.2) | 160.6 | |||||||||
United Taconite Purchase Provision |
Product Revenues | 35.8 | - | 76.6 | - | |||||||||
Total |
$ | 96.8 | $ | 257.2 | $ | 103.5 | $ | 294.3 | ||||||
NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS
We adopted the provisions of FASB Statement No. 157 (“SFAS 157”) as of January 1, 2008, with respect to financial instruments, and as of January 1, 2009, with respect to non-financial assets and liabilities in accordance with the provisions of FSP FAS 157-2. No transition adjustment was necessary upon the adoption of SFAS 157. We have also applied the provisions of FSP FAS 157-3 and FSP FAS 157-4 in our assessment of the fair values of our financial assets and liabilities accounted for under SFAS 157.
The following represents the assets and liabilities of the Company measured at fair value in accordance with SFAS 157 at June 30, 2009 and December 31, 2008:
(In Millions) | ||||||||||||
June 30, 2009 | ||||||||||||
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 |
$ | 235.1 | $ | - | $ | - | $ | 235.1 | ||||
Derivative assets |
- | - | 25.4 | 25.4 | ||||||||
Marketable securities |
23.7 | - | - | 23.7 | ||||||||
Foreign exchange contracts |
- | 2.7 | - | 2.7 | ||||||||
Total |
$ | 258.8 | $ | 2.7 | $ | 25.4 | $ | 286.9 | ||||
Liabilities: |
||||||||||||
Interest rate swap |
$ | - | $ | 1.9 | $ | - | $ | 1.9 | ||||
Foreign exchange contracts |
- | 6.6 | - | 6.6 | ||||||||
Derivative liabilities |
- | - | 65.8 | 65.8 | ||||||||
Total |
$ | - | $ | 8.5 | $ | 65.8 | $ | 74.3 | ||||
December 31, 2008 | ||||||||||||
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 |
$ | 40.4 | $ | - | $ | - | $ | 40.4 | ||||
Derivative assets |
- | - | 76.6 | 76.6 | ||||||||
Marketable securities |
10.9 | 0.3 | - | 11.2 | ||||||||
Foreign exchange contracts |
- | 0.9 | - | 0.9 | ||||||||
Total |
$ | 51.3 | $ | 1.2 | $ | 76.6 | $ | 129.1 | ||||
Liabilities: |
||||||||||||
Interest rate swap |
$ | - | $ | 2.6 | $ | - | $ | 2.6 | ||||
Foreign exchange contracts |
- | 111.8 | - | 111.8 | ||||||||
Derivative liabilities |
- | - | 114.2 | 114.2 | ||||||||
Total |
$ | - | $ | 114.4 | $ | 114.2 | $ | 228.6 | ||||
Financial assets classified in Level 1 at June 30, 2009 and December 31, 2008 include money market funds and available-for-sale marketable securities. The valuation of these instruments is determined using a market approach, taking into account current interest rates, creditworthiness, and liquidity risks in relation to current market conditions, and 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 for substantially the full term of the financial instrument. Level 2 securities primarily include derivative financial instruments valued using financial models that use as their basis readily observable market parameters. At June 30, 2009 and December 31, 2008, such derivative financial instruments include substantially all of our foreign exchange hedge contracts and interest rate exchange agreements. The fair value of the interest rate swap and foreign exchange hedge contracts is based on a forward LIBOR curve and forward market prices, respectively, and represents the estimated amount we would receive or pay to terminate these agreements at the reporting date, taking into account current interest rates, creditworthiness, nonperformance risk, and liquidity risks associated with current market conditions.
The derivative financial asset classified within Level 3 is an embedded derivative instrument included in certain supply agreements with one of our 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 record this provision at fair value, based on an income approach when the product is consumed and the amounts are settled, as an adjustment to revenue. The fair value of the instrument is determined based on a future price of the average hot rolled steel price at certain steelmaking facilities and other inflationary indices, and takes into consideration current market conditions and nonperformance risk.
The derivative financial liabilities classified within Level 3 are comprised of various instruments. One of the instruments is a derivative included in the purchase agreement for the 2008 acquisition of the remaining 30 percent interest in United Taconite. The agreement contains a penalty provision in the event the 1.2 million tons of pellets, included as part of the purchase consideration, are not delivered by a specified date. The derivative instrument associated with the undelivered pellets is based on the future Eastern Canadian pellet price. The instrument is marked to fair value each reporting period, using a market approach, until the pellets are delivered and the amounts are settled. The fair value of the instrument is determined based on the remaining amount of tons to be delivered, the percentage of estimated iron units and the current Eastern Canadian pellet price per iron unit, and also takes into consideration current market conditions and other risks, including nonperformance risk.
Level 3 derivative liabilities also consist of freestanding derivatives related to certain supply agreements primarily with our Asia Pacific customers that provide for revenue or refunds based on the ultimate settlement of the 2009 international benchmark pricing provisions. The pricing provisions are characterized as freestanding derivatives and are required to be accounted for separately once the iron ore is shipped. The derivative instrument, which is settled and billed once the annual international benchmark price is settled, is marked to fair value as a revenue adjustment each reporting period based upon the estimated forward settlement until the benchmark is actually settled. The fair value of the instrument is determined based on the forward price expectation of the 2009 annual international benchmark price and takes into account current market conditions and other risks, including nonperformance risk.
Substantially all of the financial assets and liabilities are carried at fair value or contracted amounts that approximate fair value. We had no financial assets and liabilities measured at fair value on a non-recurring basis in accordance with SFAS 157 at June 30, 2009 or December 31, 2008.
The following 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, 2009 and 2008.
(In Millions) | ||||||||||||
Derivative Assets | ||||||||||||
Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Beginning balance |
$ | 30.1 | $ | 63.9 | $ | 76.6 | $ | 53.8 | ||||
Total gains (losses) |
||||||||||||
Included in earnings |
5.2 | 244.9 | (21.7) | 270.9 | ||||||||
Included in other comprehensive income |
- | - | - | - | ||||||||
Settlements |
(9.9) | (183.0) | (29.5) | (198.9) | ||||||||
Transfers in (out) of Level 3 |
- | - | - | - | ||||||||
Ending balance - June 30, 2009 |
$ | 25.4 | $ | 125.8 | $ | 25.4 | $ | 125.8 | ||||
Total gains (losses) for the period included in earnings attributable to the change in unrealized gains or losses on assets and liabilities still held at the reporting date |
$ | 5.2 | $ | 84.3 | $ | (21.7) | $ | 110.3 | ||||
Derivative Liabilities | ||||||||||||
Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Beginning balance |
$ | (77.5) | $ | - | $ | (114.2) | $ | - | ||||
Total gains (losses) |
||||||||||||
Included in earnings |
(24.2) | - | (25.4) | - | ||||||||
Included in other comprehensive income |
- | - | - | - | ||||||||
Settlements |
37.7 | - | 79.7 | - | ||||||||
Transfers (in) out of Level 3 |
(1.8) | - | (5.9) | - | ||||||||
Ending balance - June 30, 2008 |
$ | (65.8) | $ | - | $ | (65.8) | $ | - | ||||
Total gains (losses) for the period included in earnings attributable to the change in unrealized gains or losses on assets still held at June 30, 2008 |
$ | (21.3) | $ | - | $ | (21.4) | $ | - | ||||
Gains and losses included in earnings are reported in Product revenue on the Statements of Unaudited Condensed Consolidated Operations for the three and six months ended June 30, 2009 and 2008.
The carrying amount and fair value of our long-term receivables and long-term debt at June 30, 2009 and December 31, 2008 were as follows:
(In Millions) | ||||||||||||
June 30, 2009 | December 31, 2008 | |||||||||||
Carrying Value |
Fair Value |
Carrying Value |
Fair Value |
|||||||||
Long-term receivables (1) |
$ | 40.8 | $ | 47.7 | $ | 43.4 | $ | 46.3 | ||||
Long-term debt: |
||||||||||||
Senior notes |
$ | 325.0 | $ | 293.6 | $ | 325.0 | $ | 277.9 | ||||
Term loan |
200.0 | 200.0 | 200.0 | 200.0 | ||||||||
Customer borrowings |
4.6 | 4.6 | 5.4 | 5.2 | ||||||||
Total long-term debt |
$ | 529.6 | $ | 498.2 | $ | 530.4 | $ | 483.1 | ||||
(1) Includes current portion. |
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 percent in exchange for 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 million, recorded at a present value of $40.8 million and $43.2 million at June 30, 2009 and December 31, 2008, respectively. The fair value of the receivable of $47.7 million and $46.1 million at June 30, 2009 and December 31, 2008, respectively, is based on a discount rate of 6.4 percent, which represents the estimated credit-adjusted risk-free interest rate for the period the receivable is outstanding.
The fair value of long-term debt was determined using quoted market prices or discounted cash flows based upon current borrowing rates. The term loan and revolving loan are variable rate interest and approximate fair value. See NOTE 9 –DEBT AND CREDIT FACILITIES for further information.
NOTE 9 - DEBT AND CREDIT FACILITIES
The following represents a summary of our long-term debt as of June 30, 2009 and December 31, 2008:
($ in Millions) |
||||||||||||||
June 30, 2009 |
||||||||||||||
Debt Instrument |
Type | Average Annual Interest Rate |
Final Maturity |
Total Borrowing Capacity |
Total Principal Outstanding |
|||||||||
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) | |||||||||
Credit Facility: |
||||||||||||||
Term loan |
Variable | 1.58 % (1) | 2012 | 200.0 | (200.0) | |||||||||
Revolving loan |
Variable | - % (1) | 2012 | 600.0 | - | (2) | ||||||||
Total |
$ | 1,125.0 | $ | (525.0) | ||||||||||
December 31, 2008 |
||||||||||||||
Debt Instrument |
Type | Average Annual Interest Rate |
Final Maturity |
Total Borrowing Capacity |
Total Principal Outstanding |
|||||||||
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) | |||||||||
Credit Facility: |
||||||||||||||
Term loan |
Variable | 5.02 % (1) | 2012 | 200.0 | (200.0) | |||||||||
Revolving loan |
Variable | - % (1) | 2012 | 600.0 | - | (2) | ||||||||
Total |
$ | 1,125.0 | $ | (525.0) | ||||||||||
(1) After the effect of interest rate hedging, the average annual borrowing rate for outstanding revolving and term loans was 3.37% and 5.10% as of June 30, 2009 and December 31, 2008, respectively. |
||||||||||||||
(2) As of June 30, 2009 and December 31, 2008, no revolving loans were drawn under the credit facility; however, the principal amount of letter of credit obligations totaled $18.8 million and $21.5 million, respectively, reducing available borrowing capacity to $581.2 million and $578.5 million, respectively. |
The terms of the private placement senior notes and the credit facility each contain customary covenants that require compliance with certain financial covenants based on: (1) debt to earnings ratio and (2) interest coverage ratio. As of June 30, 2009, we were in compliance with the financial covenants in both the note purchase agreement and the credit agreement. However, if the current economic crisis continues, leading to further decline in steel demand and pricing, or we experience significant unfavorable changes in foreign currency exchange rates, it is reasonably possible that our ability to remain in compliance with these financial covenants could be impacted in the near term. Such circumstances could require the use of higher cost forms of capital.
Short-term Facilities
On February 9, 2009, Asia Pacific Iron Ore amended its A$40 million ($32.2 million) multi-option facility. The original facility provided credit for short-term working capital and contingent instruments, such as performance bonds. The amended facility includes an additional A$80 million ($64.4 million) cash facility, which matures in August 2009. The outstanding bank commitments on the A$40 million multi-option facility totaled A$26.8 million ($21.6 million) and A$27.2 million ($18.8 million) in performance bonds, reducing borrowing capacity to A$13.2 million ($10.6 million) and A$12.8 million ($8.8 million) at June 30, 2009 and December 31, 2008, respectively. As of June 30, 2009, there were no funds drawn under the cash facility. The facility agreement contains financial covenants as follows: (1) debt to earnings ratio and (2) interest coverage ratio. The amendments to the facility did not cause any change to the financial covenants in place. As of June 30, 2009, we were in compliance with the financial covenants of the credit facility agreement. We have provided a guarantee of the combined facilities, along with certain of our Australian subsidiaries.
Latin America
At June 30, 2009 and December 31, 2008, Amapá had total project debt outstanding of approximately $530 million and $493 million, respectively, for which we have provided a several guarantee on our 30 percent share. Our estimate of the aggregate fair value of the outstanding guarantee is $6.7 million as of June 30, 2009, which is reflected in Other Liabilities on the Statements of Unaudited Condensed Consolidated Financial Position. Amapá is currently in violation of certain operating and financial loan covenants contained in the debt agreements. However, Amapá and its lenders have agreed to extend the suspension of these covenants with the exception of debt to equity ratio requirements through October 2009. If Amapá is unable to either renegotiate the terms of the debt agreements or obtain further extension of the compliance waivers, violation of the operating and financial loan covenants may result in the lenders calling the debt, thereby requiring us to recognize and repay our share of the debt in accordance with the provisions of the guarantee arrangement.
Refer to NOTE 8 – FAIR VALUE OF FINANCIAL INSTRUMENTS for further information.
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 $7.0 million and $14.0 million, respectively, for the three and six months ended June 30, 2009, compared with $5.1 million and $9.9 million, respectively, for the same periods in 2008. Capital leases were $152.3 million and $73.9 million at June 30, 2009 and December 31, 2008, respectively. Corresponding accumulated amortization of capital leases included in respective allowances for depreciation were $28.6 million and $18.3 million at June 30, 2009 and December 31, 2008, respectively.
Future minimum payments under capital leases and non-cancellable operating leases at June 30, 2009 are as follows:
(In Millions) | ||||||
Capital Leases |
Operating Leases |
|||||
2009 (July 1 - December 31) |
$ | 11.2 | $ | 12.9 | ||
2010 |
22.1 | 24.0 | ||||
2011 |
21.8 | 20.4 | ||||
2012 |
21.5 | 16.0 | ||||
2013 |
20.1 | 16.1 | ||||
2014 and thereafter |
81.3 | 26.1 | ||||
Total minimum lease payments |
178.0 | $ | 115.5 | |||
Amounts representing interest |
50.4 | |||||
Present value of net minimum lease payments |
$ | 127.6 | ||||
NOTE 11 - ENVIRONMENTAL AND MINE CLOSURE OBLIGATIONS
We had environmental and mine closure liabilities of $114.9 million and $117.1 million at June 30, 2009 and December 31, 2008, respectively. Payments in the first six months of 2009 were $1.8 million compared with $6.2 million for the full year in 2008. The following is a summary of the obligations at June 30, 2009 and December 31, 2008:
(In Millions) | ||||||
June 30, 2009 |
December 31, 2008 |
|||||
Environmental |
$ | 15.7 | $ | 16.4 | ||
Mine closure |
||||||
LTVSMC |
13.3 | 13.9 | ||||
Operating mines: |
||||||
North American Iron Ore |
45.9 | 44.1 | ||||
North American Coal |
25.5 | 31.1 | ||||
Asia Pacific Iron Ore |
9.9 | 7.8 | ||||
Other |
4.6 | 3.8 | ||||
Total mine closure |
99.2 | 100.7 | ||||
Total environmental and mine closure obligations |
114.9 | 117.1 | ||||
Less current portion |
7.2 | 12.2 | ||||
Long term environmental and mine closure obligations |
$ | 107.7 | $ | 104.9 | ||
Environmental
The Rio Tinto Mine Site
The Rio Tinto Mine Site is a historic underground copper mine located near Mountain City, Nevada, where tailings were placed in Mill Creek, a tributary to the Owyhee River. Site investigation and remediation work is being conducted in accordance with a consent order between the Nevada DEP and the RTWG composed of Cliffs, Atlantic Richfield Company, Teck Cominco American Incorporated, and E. I. du Pont de Nemours and Company. As of June 30, 2009, the estimated costs of the available remediation alternatives currently range from approximately $10.0 million to $30.5 million. In recognition of the potential for an NRD claim, the parties are actively pursuing a global settlement that would include the EPA and encompass both the remedial action and the NRD issues.
During the first quarter of 2009, the parties reached agreement on the allocation percentages for a negotiated remedy, which was formalized in an allocation agreement in the second quarter of 2009. While a global settlement with the EPA has not been finalized, we expect an agreement will be reached in 2009.
We have recorded an estimated environmental liability of $10.5 million and $10.7 million on the Statements of Condensed Consolidated Financial Position as of June 30, 2009 and December 31, 2008, respectively.
Michigan Operations
In 2008 and 2009, a series of unpermitted releases of tailings and tailings water occurred at the Tilden mine. Additionally, during 2008, one such release occurred at the Empire mine. The MDEQ has issued violation notices for certain of these releases and is considering further enforcement action. We have undertaken, and will continue to undertake, certain clean-up actions and certain operational control changes at both mines, the costs for which have not been material to date. We are in discussions with the MDEQ about implementing corrective action, which we currently anticipate could result in expending $8 million to $10 million in capital, primarily for the replacement of a tailings line at Tilden during 2009 and 2010. These costs and the corrective actions are subject to change based on a number of factors, including the results of our discussions with the MDEQ regarding the planned actions. We also anticipate that we will enter into consent orders with the MDEQ resolving these violations and that the MDEQ will impose a civil penalty in an amount that cannot be reasonably determined at this time. However, we do not believe that any such civil penalty will have a material adverse effect on our results of operations, financial position or cash flows.
United Taconite Air Emissions Matter
On March 27, 2008, United Taconite received a DSA from the MPCA alleging various air emissions violations of the facility’s air permit limit conditions, reporting and testing requirements. The allegations generally stem from procedures put in place prior to 2004 when we first acquired our interest in the mine. In the interest of resolving this matter with MPCA, United Taconite signed a stipulated agreement in March 2009, which requires the facility to, among other things, install continuous emissions monitoring, evaluate compliance procedures, submit a plan to implement procedures to eliminate air deviations during the relevant time period, and retire emissions allowances. During the second quarter of 2009, United Taconite satisfied various requirements of the stipulation agreement. We do not expect this matter to have a material impact on our consolidated financial statements.
Mine Closure
The mine closure obligations are for our four consolidated North American operating iron ore mines, our two operating North American coal mining complexes, our Asia Pacific operating iron ore mines, the coal mine at Sonoma and a closed operation formerly known as LTVSMC.
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, 2009 and the year ended December 31, 2008:
(In Millions) | ||||||
June 30, 2009 |
December 31, 2008 (1) |
|||||
Asset retirement obligation at beginning of period |
$ | 86.8 | $ | 96.0 | ||
Accretion expense |
3.3 | 7.3 | ||||
Reclassification adjustments |
- | 1.0 | ||||
Exchange rate changes |
2.0 | (3.1) | ||||
Revision in estimated cash flows |
(6.2) | (14.4) | ||||
Asset retirement obligation at end of period |
$ | 85.9 | $ | 86.8 | ||
(1) Represents a 12-month rollforward of our asset retirement obligation at December 31, 2008.
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, 2009 and 2008:
Defined Benefit Pension Expense
(In Millions) | ||||||||||||
Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Service cost |
$ | 3.0 | $ | 3.3 | $ | 6.5 | $ | 6.3 | ||||
Interest cost |
8.9 | 10.4 | 19.8 | 20.5 | ||||||||
Expected return on plan assets |
(7.3) | (12.2) | (17.3) | (24.6) | ||||||||
Amortization: |
||||||||||||
Prior service costs |
0.9 | 1.0 | 1.9 | 1.9 | ||||||||
Net actuarial losses |
6.3 | 2.9 | 13.0 | 5.1 | ||||||||
Net periodic benefit cost |
$ | 11.8 | $ | 5.4 | $ | 23.9 | $ | 9.2 | ||||
Other Postretirement Benefits Expense
(In Millions) | ||||||||||||
Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Service cost |
$ | 1.1 | $ | 0.8 | $ | 2.3 | $ | 1.5 | ||||
Interest cost |
4.3 | 4.0 | 8.7 | 7.7 | ||||||||
Expected return on plan assets |
(2.2) | (2.7) | (4.5) | (5.4) | ||||||||
Amortization: |
||||||||||||
Prior service costs (credits) |
0.5 | (1.6) | 0.9 | (3.0) | ||||||||
Net actuarial losses |
2.6 | 1.5 | 5.1 | 2.9 | ||||||||
Transition asset |
- | (0.8) | - | (1.5) | ||||||||
Net periodic benefit cost |
$ | 6.3 | $ | 1.2 | $ | 12.5 | $ | 2.2 | ||||
We made OPEB contributions of $14.9 million and $4.0 million through the first six months of 2009 and 2008, respectively.
As a result of an IRS Notice issued in March 2009, which provided new guidance regarding the assumptions to be used in determining annual funding requirements under the Pension Protection Act, our estimated pension funding requirement in 2009 will be reduced by approximately $33 million, from $67 million estimated as of December 31, 2008 to approximately $34 million as of June 30, 2009.
NOTE 13 - STOCK COMPENSATION PLANS
Employees’ Plans
On March 9, 2009, the Compensation and Organization Committee (“Committee”) of the Board of Directors approved a grant under our shareholder approved 2007 ICE Plan (“Plan”) for the performance period 2009-2011. A total of 552,100 shares were granted under the award, consisting of 406,170 in performance shares and 145,930 in restricted share units. A total of 2,490,637 shares remain available for grant under the Plan at June 30, 2009.
Each performance share, if earned, entitles the holder to receive a number of common shares within the range between a threshold and maximum number of 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 restricted share units are subject to continued employment, are retention based, will vest at the end of the performance period for the performance shares, and are payable in shares at a time determined by the Committee at its discretion. The performance shares granted under the Plan vest over a period of three years and measure performance on the basis of two factors, 1) relative TSR for the period, as measured against a predetermined peer group of mining and metals companies, and 2) three-year cumulative free cash flow, and are intended to be paid out in common shares.
Determination of Fair Value
The fair value of each performance share grant is estimated on the date of grant using a Monte Carlo simulation to forecast relative TSR performance. Consistent with the guidelines of SFAS 123(R), a correlation matrix of historic and projected stock prices was developed for both the Company and its predetermined peer group of mining and metals companies. The fair value assumes that performance goals will be achieved. If such goals are not met, no compensation cost is recognized and any recognized compensation cost is reversed.
The expected term of the grant represents the time from the grant date to the end of the service period. We estimated the volatility of our common stock 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.
The following assumptions were utilized to estimate the fair value for the 2009 performance share grant:
Plan Year |
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) |
||||||||||
2009 | March 9, 2009 | $ | 12.96 | 2.81 | 85.8% | 1.43% | 2.72% | $ | 4.90 | 37.83% |
The fair value of the restricted share units is determined based on the closing price of the Company’s shares on the grant date. The restricted share units granted under the Plan vest over a period of three years.
Upon the occurrence of a change in control, all performance shares and restricted share units granted to a participant will vest and become nonforfeitable and will be paid out in cash.
Nonemployee Directors
On May 12, 2009, an annual equity grant was awarded under our Directors’ Plan to all Nonemployee Directors elected or re-elected by the shareholders as follows:
Date of Grant |
Unrestricted Equity Grant Shares |
Restricted Equity Grant Shares |
Deferred Equity Grant Shares |
|||
May 12, 2009 |
7,788 | 12,980 | 2,596 |
The Directors’ Plan provides for an annual equity grant, which is awarded at our Annual Meeting each year to all Nonemployee Directors elected or re-elected by the shareholders. The value of the equity grant is payable in restricted shares with a three-year vesting period from the date of grant. The closing market price of our common shares on our Annual Meeting date is divided into the equity grant to determine the number of restricted shares awarded. Effective May 1, 2008, Nonemployee Directors received an annual retainer fee of $50,000 and an annual equity award of $75,000. The Directors’ Plan offers the Nonemployee Director the opportunity to defer all or a portion of the Annual Directors’ Retainer fees, Chair retainers, meeting fees, and the Equity Grant into the Compensation Plan. A Director who is 69 or older at the equity grant date will receive common shares with no restrictions.
NOTE 14 - INCOME TAXES
Our tax provision for the three and six months ended June 30, 2009 was a benefit of $17.6 and $16.5 million, respectively. This includes $0.5 million and $1.0 million, respectively, of interest related to unrecognized tax benefits recorded as a discrete item. The effective tax rate for the six months of 2009 is approximately (30) percent. Our 2009 expected effective tax rate for the full year is approximately (29) percent, which reflects benefits from tax losses, deductions for percentage depletion in excess of cost depletion related to U.S. operations as well as benefits derived from operations outside the U.S., which are taxed at rates lower than the U.S. statutory rate of 35 percent.
As of June 30, 2009, our valuation allowance against certain deferred tax assets increased by $13.8 million from December 31, 2008, primarily related to ordinary losses of certain foreign operations for which future utilization is currently uncertain.
As of June 30, 2009, cumulative undistributed earnings of foreign subsidiaries included in consolidated retained earnings continue to be indefinitely reinvested in international operations. Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if we concluded that such earnings will be remitted in the future.
At January 1, 2009, we had $53.7 million of unrecognized tax benefits and there have been no significant changes through June 30, 2009. If this amount was recognized, $50.1 million would impact the effective tax rate. It is reasonably possible that an additional decrease of up to $30.2 million in unrecognized tax benefit obligations will occur within the next 12 months due to expected settlements with the taxing authorities.
NOTE 15 - CAPITAL STOCK
Common Stock
Public Offering
On May 19, 2009, we completed a public offering of our common shares. The total number of shares sold was 17.25 million, comprised of a 15 million share offering and the exercise of an underwriters’ over-allotment option to purchase an additional 2.25 million common shares. The common shares sold were out of treasury stock, and the sale did not result in an increase in the number of shares authorized or the number of shares issued. A registration statement relating to these securities was filed with and declared effective by the SEC. Net proceeds at a price of $21.00 per share were approximately $348 million.
Dividends
On May 12, 2009, our board of directors enacted a 55 percent reduction in our quarterly common share dividend to $0.04 from $0.0875 in order to enhance financial flexibility. The $0.04 common share dividend was paid on June 1, 2009 to shareholders of record as of May 22, 2009.
Euronext Listing
In March 2009, we listed our common shares on the Professional Compartment of NYSE Euronext Paris (“Euronext”). On March 31, 2009, the French Autorité des marchés financiers (AMF) approved the prospectus and correspondingly granted a visa number for admission of our common shares to listing and trading on Euronext. Our shares began trading on Euronext on April 6, 2009 under the symbol “CLF” and are denominated in Euros on the Paris venue. The cross listing does not result in changes to our capital structure, share count, or current stock-listings and is intended to promote additional liquidity for investors as well as provide greater access to our shares in Euro-zone markets and currencies.
Preferred Stock
On January 13, 2009, we announced that the trading price condition for the conversion right of our 3.25 percent redeemable cumulative convertible perpetual preferred stock had been satisfied and, as a result, holders could surrender their shares for conversion at any time. The trading price condition for the preferred shares was satisfied because the closing share price of our common shares for at least 20 of the last 30 trading days of the fiscal 2008 fourth quarter exceeded 110 percent of the then applicable conversion price of the preferred stock. The preferred stock was also convertible during each of the previous 16 fiscal quarters due to the satisfaction of the trading price condition during the applicable periods of the relevant preceding fiscal quarters.
In addition to announcing the convertibility of the shares, on January 13, 2009, we also provided the required notice of our intent to redeem the 205 convertible preferred shares that remained outstanding at December 31, 2008. As a result, holders of the preferred stock could elect to convert their shares in lieu of having them redeemed, provided that surrender for conversion occurred on or prior to February 11, 2009. The conversion rate of 133.0646 common shares per share of preferred stock equates to a conversion price of approximately $7.52 per common share, subject to adjustment in certain circumstances, including payment of dividends on the common shares.
As of February 11, 2009, all remaining preferred shares had been converted to 27,278 shares of common stock at a conversion rate of 133.0646. Total common shares were issued out of treasury.
NOTE 16 - COMPREHENSIVE INCOME
The following are the components of comprehensive income for the three and six months ended June 30, 2009 and 2008:
(In Millions) | ||||||||||||
Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Net income attributable to Cliffs shareholders |
$ | 45.5 | $ | 270.2 | $ | 38.1 | $ | 287.2 | ||||
Other comprehensive income: |
||||||||||||
Unrealized net gain on marketable securities - net of tax |
4.2 | 12.3 | 5.3 | 11.7 | ||||||||
Foreign currency translation |
130.6 | 37.1 | 129.5 | 81.0 | ||||||||
Amortization of net periodic benefit - net of tax |
5.7 | (23.9) | 17.9 | (20.8) | ||||||||
Unrealized gain on interest rate swap - net of tax |
0.5 | 0.9 | 0.5 | (0.5) | ||||||||
Unrealized gain (loss) on derivative financial instruments |
(3.5) | 14.2 | (9.9) | 19.7 | ||||||||
Total other comprehensive income |
137.5 | 40.6 | 143.3 | 91.1 | ||||||||
Total comprehensive income |
$ | 183.0 | $ | 310.8 | $ | 181.4 | $ | 378.3 | ||||
NOTE 17 - EARNINGS PER SHARE
A summary of the calculation of earnings per common share on a basic and diluted basis follows:
(In Millions) | ||||||||||||
Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Net income attributable to Cliffs shareholders |
$ | 45.5 | $ | 270.2 | $ | 38.1 | $ | 287.2 | ||||
Preferred stock dividends |
- | (0.4) | - | (1.3) | ||||||||
Income applicable to common shares |
$ | 45.5 | $ | 269.8 | $ | 38.1 | $ | 285.9 | ||||
Weighted average number of shares: |
||||||||||||
Basic |
125.1 | 98.1 | 119.1 | 94.0 | ||||||||
Employee stock plans |
0.7 | 0.5 | 0.7 | 0.4 | ||||||||
Convertible preferred stock |
- | 6.6 | - | 10.7 | ||||||||
Diluted |
125.8 | 105.2 | 119.8 | 105.1 | ||||||||
Earnings per common share attributable to Cliffs shareholders - Basic |
$ | 0.36 | $ | 2.75 | $ | 0.32 | $ | 3.04 | ||||
Earnings per common share attributable to Cliffs shareholders - Diluted |
$ | 0.36 | $ | 2.57 | $ | 0.32 | $ | 2.73 | ||||
NOTE 18 - COMMITMENTS AND CONTINGENCIES
Purchase Commitments
On July 17, 2008, Asia Pacific Iron Ore entered into an agreement to upgrade the rail line used for its operations. The upgrade is being performed to mitigate the risk of derailment and reduce service disruptions by providing a more robust infrastructure. The improvements include the replacement of 120 kilometers of rail and associated parts. As a result, we have incurred a purchase commitment of approximately $44.7 million for maintenance and improvements to the rail structure. The first phase of the project was completed during the second quarter of 2009. As of June 30, 2009, capital expenditures related to this purchase were approximately $34.7 million. Remaining expenditures of approximately $10.0 million will be made throughout the second half of 2009.
In 2008, we incurred an additional capital commitment for the purchase of a new longwall plow system for our Pinnacle mine in West Virginia. The system, which requires a capital investment of approximately $83 million, will replace the current longwall plow system in an effort to reduce maintenance costs and increase production at the mine. As of June 30, 2009, capital expenditures related to this purchase were approximately $29 million. Remaining expenditures of approximately $39 million and $15 million are scheduled to be made in 2009 and 2010, respectively. We are currently in discussions with the supplier regarding revised payment and delivery terms.
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 adverse effect on our financial position or results of operations. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. An unfavorable ruling could include monetary damages or an injunction. If an unfavorable ruling were to occur, there exists the possibility of a material adverse 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 consolidated financial statements. Refer to Part II – Item 1, Legal Proceedings, for additional information.
NOTE 19 - CASH FLOW INFORMATION
A reconciliation of capital additions to cash paid for capital expenditures for the six months ended June 30, 2009 and 2008 is as follows:
(In Millions) | ||||||
Six Months Ended June 30, | ||||||
2009 | 2008 | |||||
Capital additions |
$ | 113.8 | $ | 85.9 | ||
Cash paid for capital expenditures |
60.5 | 59.1 | ||||
Difference |
$ | 53.3 | $ | 26.8 | ||
Non-cash accruals |
$ | 5.5 | $ | 3.8 | ||
Capital leases |
47.8 | 23.0 | ||||
Total |
$ | 53.3 | $ | 26.8 | ||
Refer to NOTE 10 – LEASE OBLIGATIONS for further information.
NOTE 20 - SUBSEQUENT EVENTS
Amapá Environmental Litigation
On July 8, 2009, an order issued by the local court in the State of Amapá was published, which could require among other things, the cessation of any activities at Amapá and the neighboring operations that cause the displacement of soil into the riverbeds of nearby creeks, as well as the suspension of the use of water from or discharged into the creeks, until the completion of an environmental audit by the Ministry of the Environment. The examination would have to be completed within 180 days from notification of the order. Based on our 30 percent ownership interest, we do not have control over the operating and financial policies of Amapá, and responsibility for such decisions lies primarily with Anglo as the parent and majority owner. Amapá has retained independent environmental consultants to assess the situation and determine whether Amapá has caused environmental damages that affect the rivers, creeks and surrounding region in which it operates. The order has yet to be served on Amapá. If served, Amapá will have to temporarily suspend operations. In the event of non-compliance with the court order, a penalty of approximately $26,000 per day will be imposed. Until a complete environmental assessment has been performed, we are unable to determine the potential impact this will have on our investment in Amapá.
Settlement of 2009 Eastern Canadian Pellet Price
In July 2009, Eastern Canada reached settlement of 2009 iron ore pellet prices, reflecting a decrease of approximately 48 percent below 2008 prices. The settlement was consistent with previously reported price settlements in Europe as well as with the estimates we used during the reporting period in relation to the iron ore pellet benchmarks referenced in certain of our North American Iron Ore sales contracts. As a result, settlement of the 2009 Eastern Canadian pellet price did not have an impact on our consolidated financial statements for the period ended June 30, 2009.
Sale of Foreign Currency Exchange Contracts
As of June 30, 2009, we had outstanding exchange rate contracts with a notional amount of approximately $526 million in the form of call options, collar options, and convertible collar options with varying maturity dates ranging from July 2009 to August 2011. During July 2009, we sold approximately $132 million of the outstanding contracts and recognized a net realized loss of approximately $2.4 million based upon the difference between the contract rates and the spot rates on the date each contract was sold.
We have evaluated subsequent events through July 30, 2009, which represents the date of financial statement issuance.
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