NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Exhibit 13(g)
Cleveland-Cliffs Inc and Consolidated Subsidiaries
ACCOUNTING POLICIES
BASIS OF CONSOLIDATION: The consolidated financial statements include the
accounts of the Company and its majority-owned subsidiaries, and references to
the "Company" include the Company and consolidated subsidiaries. "Investments in
Associated Companies" are comprised of partnerships and unconsolidated companies
("ventures") which the Company does not control. Such investments are accounted
by the equity method and include, where appropriate, capitalized interest
incurred during the construction phase of qualifying assets (see Note C). The
Company's share of earnings of mining ventures from which the Company purchases
iron ore is credited to "Cost of Goods Sold and Operating Expenses" upon sale of
the product. Pre-operating expenses incurred during construction of the Trinidad
reduced iron venture are charged to "Other Expenses" as incurred.
BUSINESS: The Company's dominant business is the production and sale of iron ore
pellets to integrated steel companies. The Company controls, develops, and
leases reserves to mine owners; manages and owns interests in mines; sells iron
ore; and owns interests in ancillary companies providing services to the mines.
Iron ore production activities are conducted in North America. Iron ore is
marketed in North America and Europe. The three largest steel company customers'
contribution to the Company's revenues were 22 percent, 15 percent and 9 percent
in 1998; 20 percent, 13 percent and 10 percent in 1997; and 15 percent, 12
percent and 11 percent in 1996.
The Company is developing a ferrous metallics business, with its initial entry
being a 46.5 percent interest in a joint venture, located in Trinidad and
Tobago, to produce and market hot-briquetted iron ("HBI"). See Note C - Ferrous
Metallics.
The Savage River Mines operation terminated production, as planned, in December,
1996 and shipped its remaining iron ore inventory during the first quarter of
1997. The Australian operation had total revenues and pre-tax earnings of $10.9
million and $4.6 million, and $58.4 million and $20.2 million, in 1997 and 1996,
respectively. On March 25, 1997, the remaining assets and all related
environmental and rehabilitation obligations were transferred to the Tasmanian
government. As a result, the Company recorded in 1997 a $3.2 million after-tax
credit ($5.0 million pre-tax), to reverse an accrual for closedown obligations
recorded in prior years.
REVENUE RECOGNITION: Revenue is recognized on sales of products when title has
transferred, and on services when services have been performed. Royalty revenue
from the Company's share of ventures' production is recognized when the product
is sold. Royalty revenue from the ventures' other participants is recognized on
production.
BUSINESS RISK: The North American steel industry had been experiencing high
operating rates and generally positive financial results in recent years.
However, strong steel production through the first half of 1998 has declined
significantly due to record levels of unfairly traded steel imports in the
second half of 1998.
The major business risk faced by the Company is the potential financial failure
and shutdown of one or more of its significant customers and partners, with the
resulting loss of ore sales and/or royalty and management fee income. If any
such shutdown were to occur without mitigation
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
through replacement sales or cost reduction, it would represent a significant
adverse financial development to the Company. The iron mining business has a
high level of fixed costs. Therefore, unmitigated loss of sales and/or royalty
and management fee income due to failure of a customer or partner would have a
greater impact on earnings than revenue.
Labor contracts at the five Company-managed mines, in which all bargaining unit
employees are represented by the United Steelworkers of America, will expire in
1999. The Wabush three year contract in Canada expires March 1, 1999. Six year
agreements at the Empire, Hibbing and Tilden mines and a five year agreement at
LTV Steel Mining Company will expire on August 1, 1999.
USE OF ESTIMATES: The preparation of financial statements, in conformity with
generally accepted accounting principles, requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from estimates.
CASH EQUIVALENTS: The Company considers investments in highly liquid debt
instruments with an initial maturity of three months or less, or with put
options exercisable in three months or less, to be cash equivalents.
INVESTMENTS: The Company determines the appropriate classification of debt and
equity securities at the time of purchase and reevaluates such designation as of
each financial statement date. Accordingly, the Company has classified its
long-term equity investment as available-for-sale. Available-for-sale securities
are carried at fair value, with the unrealized holding gains and losses, net of
tax, reported as a separate component of shareholders' equity.
DERIVATIVE FINANCIAL INSTRUMENTS: The Company does not engage in acquiring or
issuing derivative financial instruments for trading purposes. Derivative
financial instruments, in the form of forward currency exchange contracts, are
used to manage foreign exchange risks. Designated forward exchange contracts are
hedging transactions that have been entered into with the objective of managing
the risk of exchange rate fluctuations with respect to the ordinary local
currency obligations of the Company's operations. Gains and losses are
recognized in the same period as the hedged transaction.
INVENTORIES: Iron ore inventories are stated at the lower of cost or market. The
cost is determined using the last-in, first-out ("LIFO") method. The excess of
current cost over LIFO cost of iron ore inventories was $3.6 million and $2.9
million at December 31, 1998 and 1997, respectively. The cost of supplies and
other inventories are determined by the average cost method.
PROPERTIES: Properties are stated at cost. Depreciation of plant and equipment
is computed principally by the straight-line method based on estimated useful
lives, not to exceed the life of the operating unit, and is not reduced when
operating units are temporarily idled. Depreciation on buildings, mining, and
processing equipment is provided over the following estimated useful lives:
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
Buildings 45 Years
Mining Equipment 10 to 20 Years
Processing Equipment 15 to 45 Years
Depletion of mineral lands is computed using the units of production method
based upon proven mineral reserves.
On January 5, 1998, the Company sold plant and equipment of its wholly-owned
Republic Mine in Michigan, which ceased operations in 1981 and was permanently
closed in 1996. The assets, which had a recorded cost of $85.3 million and a net
book value of $1.2 million, were sold for $1.3 million.
ENVIRONMENTAL REMEDIATION COSTS: The Company has a formal code of environmental
protection and restoration. The Company's obligations for known environmental
problems at active and closed mining operations, and other sites have been
recognized based on estimates of the cost of investigation and remediation at
each site. If the cost can only be estimated as a range of possible amounts with
no specific amount being most likely, the minimum of the range is accrued. Costs
of future expenditures are not discounted to their present value. Potential
insurance recoveries have not been reflected in the determination of the
liabilities.
STOCK COMPENSATION: The Company applies the provisions of Accounting Principles
Board Opinion No. 25 ("APB 25") and related interpretations in accounting for
its stock option plans. Accordingly, compensation expense is not recognized for
stock options when the stock option price at the grant date is equal to or
greater than the fair market value of the stock.
EXPLORATION, RESEARCH AND DEVELOPMENT COSTS: Exploration, research and
development costs of mining properties are charged to operations as incurred.
INCOME PER COMMON SHARE: Basic income per common share is calculated on the
average number of common shares outstanding during each period. Diluted income
per common share is based on the average number of common shares outstanding
during each period, adjusted for the effect of outstanding stock options,
restricted stock and performance shares.
RECLASSIFICATIONS: Certain prior year amounts have been reclassified to conform
to current year classifications.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE A - ACCOUNTING AND DISCLOSURE CHANGES
The Financial Accounting Standards Board's ("FASB") Statement 130, "Reporting
Comprehensive Income," which establishes standards for the reporting and display
of comprehensive income and its components, was adopted in the first quarter of
1998. Prior financial statements have been reclassified to reflect this change
in disclosure.
FASB's Statement 131, "Disclosures About Segments of an Enterprise and Related
Information," changed the way that segment information is defined and reported
in annual and interim financial statements. The standard was adopted by the
Company in 1998.
FASB's Statement 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits," is intended to improve and standardize pension and
other postretirement benefit disclosures. The Statement, which was adopted by
the Company, does not change measurement or recognition of pensions or other
postretirement benefits.
In June, 1998, the FASB issued Statement 133, "Accounting for Derivative
Instruments and for Hedging Activities." This Statement, effective for fiscal
years beginning after June 15, 1999, provides comprehensive and consistent
standards for recognition and measurement of derivatives and hedging activities.
The Company does not expect that compliance with the Statement to have a
material effect on the Company's consolidated financial statements.
In March, 1998, the Accounting Standards Executive Committee ("AcSEC") of the
American Institute of Certified Public Accountants issued Statement of Position
("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." The Statement, effective for fiscal years beginning
after December 15, 1998, is intended to eliminate the diversity in practice in
accounting for internal-use software costs and improve financial reporting. The
Company does not expect the adoption of the Statement to have a material impact
on the Company's consolidated financial statements.
In April, 1998, AcSEC issued SOP 98-5, "Reporting on the Costs of Start-up
Activities," which requires such costs to be expensed as incurred instead of
being capitalized and amortized. The adoption of the SOP, effective for
financial statements for fiscal years beginning after December 15, 1998, is not
expected to have a material impact on the Company's consolidated financial
statements.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE B - OTHER COMPREHENSIVE INCOME
Components of Other Comprehensive Income (Loss) and related tax effects
allocated to each are shown below:
(In Millions)
---------------------------------------------------------
Pre-Tax Tax After-Tax
Amount Benefit Amount
------------------ -------------- ------------------
YEAR ENDED DECEMBER 31, 1996
Unrealized (losses) on securities $(1.6) $ .5 $(1.1)
Foreign currency translation adjustment (.2) (.2)
----- ----- -----
Total $(1.8) $ .5 $(1.3)
===== ===== =====
YEAR ENDED DECEMBER 31, 1997
Unrealized (losses) on securities $(1.7) $ .7 $(1.0)
Foreign currency translation adjustment (.1) (.1)
----- ----- -----
Total $(1.8) $ .7 $(1.1)
===== ===== =====
YEAR ENDED DECEMBER 31, 1998
Unrealized (losses) on securities $(3.5) $1.2 $(2.3)
===== ==== =====
Other Comprehensive Income (Loss) balances are as follows:
(In Millions)
-----------------------------------------------------------
Accumulated
Unrealized Foreign Other
(Losses) on Currency Comprehensive
Securities Items Income (Loss)
----------------- -------------- ---------------------
Balance December 31, 1995 $ .1 $ .3 $ .4
Change during 1996 (1.1) (.2) (1.3)
------ ----- ------
Balance December 31, 1996 (1.0) .1 (.9)
Change during 1997 (1.0) (.1) (1.1)
------ ----- ------
Balance December 31, 1997 (2.0) (2.0)
Change during 1998 (2.3) (2.3)
------ ------- ------
Balance December 31, 1998 $(4.3) $(4.3)
===== ======= =====
NOTE C - INVESTMENTS IN ASSOCIATED COMPANIES
NORTH AMERICAN IRON ORE
- -----------------------
The Company's investments in North America mining ventures consist of its 40
percent interest in Tilden Mining Company L.C., 22.5625 percent interest in
Empire Iron Mining Partnership, 15 percent interest in Hibbing Taconite Company,
and 22.78 percent (7.69 percent in 1996) interest in Wabush Mines ("Wabush").
The remaining interests in the ventures are owned by U.S. and Canadian
integrated steel companies.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
Following is a summary of combined financial information of the operating
ventures:
(In Millions)
----------------------------------------------------
1998 1997 1996
---------------- --------------- ---------------
INCOME
Gross revenue $ 1,072.4 $1,027.0 $1,043.7
========= ======== ========
Equity income $ 134.3 $ 111.1 $ 121.0
========= ======== ========
FINANCIAL POSITION
Current assets $ 187.0 $ 144.9 $ 134.6
Properties - net 691.4 713.8 745.6
Other long-term assets 30.0 29.0 28.8
Current liabilities (159.8) (143.3) (145.8)
Long-term liabilities (79.6) (74.4) (59.1)
--------- -------- --------
Net assets $ 669.0 $ 670.0 $ 704.1
========= ======== ========
Company's equity in
underlying net assets $ 194.3 $ 196.7 $ 189.2
========= ======== ========
Company's investment $ 156.0 $ 160.8 $ 147.5
========= ======== ========
The Company manages all of the ventures and leases or subleases mineral rights
to certain ventures. In addition, the Company is required to purchase its
applicable current share, as defined, of the ventures' production. The Company
purchased $253.9 million in 1998 (1997-$243.3 million; 1996-$228.0 million) of
iron ore pellets from certain ventures. During 1998, the Company earned
royalties and management fees of $49.7 million (1997-$47.5 million; 1996-$51.5
million) from ventures, of which $13.3 million in 1998 (1997-$11.8 million;
1996-$14.4 million) was the Company's share as a participant in the ventures.
Payments by the Company, as a participant in the ventures, are reflected in
royalties and management fees revenue and cost of goods sold upon the sale of
the product.
Costs and expenses incurred by the Company, on behalf of the ventures, are
charged to such ventures in accordance with management and operating agreements.
The Company's equity in the income of the ventures is credited to the cost of
goods sold and includes the amortization to income of the difference of the
Company's equity in the underlying net assets and its investment on the
straight-line method based on the useful lives of the underlying assets. The
difference between the Company's equity in underlying net assets and recorded
investment results from the assumption of interests from former participants in
the ventures, acquisitions, and reorganizations. The Company's equity in the
income of ventures was $25.6 million in 1998 (1997-$19.8 million; 1996-$19.8
million).
The Company acquired Ispat Inland Inc.'s 15.1 percent interest in Wabush for
$15.0 million effective January 1, 1997, raising the Company's interest to 22.78
percent. Depending on the magnitude of future tonnage, additional payments to
Ispat Inland may be required, but are not expected to be material in any year.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
On September 28, 1998, Acme Metals Incorporated and its wholly-owned subsidiary
Acme Steel Company (collectively "Acme"), a partner in Wabush and an iron ore
customer, petitioned for protection under Chapter 11 of the U.S. Bankruptcy
Code. The Company had a $1.2 million pre-petition trade receivable from Acme,
which has been fully provided in the allowance for doubtful accounts. Since its
filing, Acme has continued its relationship with Wabush and the Company. Sales
to Acme in 1998 and 1997 represented less than 5 percent of total sales volume.
FERROUS METALLICS
- -----------------
Cliffs and Associates Limited, a joint venture in Trinidad and Tobago, is
completing construction of a facility to produce premium quality HBI to be
marketed to the steel industry. The venture's participants, through
subsidiaries, include the Company, 46.5 percent; The LTV Corporation ("LTV"),
46.5 percent; and Lurgi AG of Germany, 7 percent, with the Company as manager
and sales agent. Project capital expenditures were $141.1 million (Company share
- - $65.6 million) through December 31, 1998. Currently estimated total capital
expenditures of $151.0 million (Company share - $70.2 million) do not include
disputed contractors' claims, which are not expected to be material to the
consolidated financial statements. Following is a summary of project
expenditures:
(In Millions)
-----------------------------------------------
COMPANY'S Total
SHARE Project
---------------------- ----------------------
Capital expenditures:
1996 $ 13.1 $ 28.2
1997 35.8 77.0
1998 16.7 35.9
------ -------
Total $ 65.6 $ 141.1
====== =======
Start-up expense:
1996 $ $ .1
1997 1.5 3.2
1998 2.3 4.8
------ -------
Total $ 3.8 $ 8.1
====== =======
Investment at December 31*:
1996 $14.4
1997 57.5
1998 79.4
Capitalized interest:
1996 $ .3
1997 2.3
1998 4.5
------
Total $ 7.1
======
* Includes the Company's capitalized interest on qualifying assets.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE D - SEGMENT REPORTING
The Company has two reportable segments offering different iron products and
services to the steel industry. Iron Ore is the Company's dominant segment. The
Ferrous Metallics segment is in the development stage, consisting mainly of the
HBI venture project in Trinidad and Tobago. "Other" includes non-reportable
segments, closed Australian operation and unallocated corporate other income and
expense.
(IN MILLIONS)
-----------------------------------------------------------------------------
IRON FERROUS SEGMENTS CONSOLIDATED
ORE METALLICS TOTAL OTHER TOTAL
------------- ------------- ------------- ------------- --------------
1998
- ----
SALES AND SERVICES TO EXTERNAL $444.1 $ $444.1 $ $444.1
CUSTOMERS
ROYALTIES AND MANAGEMENT FEES(1) 49.7 49.7 49.7
------- ------- -------- ------ --------
TOTAL OPERATING REVENUES 493.8 493.8 493.8
======= ======= ======== ====== ========
INCOME (LOSS) BEFORE TAXES 76.7 (5.5) 71.2 .6 71.8
DEPRECIATION AND AMORTIZATION(2) 20.3 20.3 20.3
EQUITY INCOME (LOSS) (2.3) (2.3) (2.3)
INVESTMENTS IN EQUITY METHOD INVESTEES 156.0 79.4 235.4 235.4
OTHER IDENTIFIABLE ASSETS 468.0 .8 468.8 19.3 488.1
------- ------ -------- ------ -------
TOTAL ASSETS 624.0 80.2 704.2 19.3 723.5
======= ======= ======== ====== ========
PROPERTY EXPENDITURES(2) 31.7 16.7 48.4 48.4
(In Millions)
-----------------------------------------------------------------------------
Iron Ferrous Segments Consolidated
Ore Metallics Total Other Total
------------- ------------- ------------- ------------- --------------
1997
- ----
Sales and services to external $381.9 $ $381.9 $ 9.5 $391.4
customers
Royalties and management fees(1) 47.4 47.4 .1 47.5
------- ------- -------- ------ --------
Total operating revenues 429.3 429.3 9.6 438.9
======= ======= ======== ====== ========
Income (loss) before taxes 66.1 (3.8) 62.3 10.3 72.6
Depreciation and amortization(2) 18.9 18.9 18.9
Equity income (loss) (1.5) (1.5) .1 (1.4)
Investments in equity method investees 160.8 57.5 218.3 218.3
Other identifiable assets 458.0 .5 458.5 17.5 476.0
------- ------- -------- ------ --------
Total assets 618.8 58.0 676.8 17.5 694.3
======= ======= ======== ====== ========
Property expenditures(2) 19.6 35.8 55.4 55.4
(In Millions)
-----------------------------------------------------------------------------
Iron Ferrous Segments Consolidated
Ore Metallics Total Other Total
-------------- ------------- ------------- ------------- -------------
1996
- ----
Sales and services to external $395.1 $ $395.1 $56.6 $451.7
customers
Royalties and management fees(1) 51.3 51.3 .2 51.5
------- ------- -------- ------ --------
Total operating revenues 446.4 446.4 56.8 503.2
======= ======= ======== ====== ========
Income (loss) before taxes 77.0 (2.4) 74.6 20.9 95.5
Depreciation and amortization(2) 17.6 17.6 17.6
Investments in equity method investees 147.5 14.4 161.9 161.9
Other identifiable assets 486.5 .3 486.8 25.0 511.8
------- ------- -------- ------ --------
Total assets 634.0 14.7 648.7 25.0 673.7
======= ======= ======== ====== ========
Property expenditures(2) 22.6 13.1 35.7 35.7
(1) Includes revenue from the Company's share of ventures' production that is
recognized when the product is sold.
(2) Includes Company's share of associated companies.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
Included in the consolidated financial statements are the following amounts
relating to geographic locations:
(In Millions)
-------------------------------------------------------
1998 1997 1996
----------------- ----------------- ----------------
Revenue(1)
- ----------
United States $444.3 $383.2 $399.2
Canada 42.1 38.9 39.1
Australia 9.5 48.1
Other Countries 7.4 7.3 16.8
------ ------- ------
$493.8 $438.9 $503.2
====== ====== ======
Long-Lived Assets(2)
- --------------------
United States $644.2 $700.3 $692.1
Canada 56.8 62.2 21.7
Trinidad and Tobago 65.6 48.9 13.1
Other Countries 2.3
------ ------- ------
$766.6 $811.4 $729.2
====== ======= ======
(1) Revenue is attributed to countries based on the location of the customer.
(2) Gross properties, before allowance for depreciation, including Company's
share of associated companies.
NOTE E - ENVIRONMENTAL RESERVES
At December 31, 1998, the Company had an environmental reserve, including its
share of ventures, of $21.5 million ($22.7 million at December 31, 1997), of
which $2.0 million was classified as current. Payments in 1998 were $.9 million
(1997 - $2.4 million and 1996 - $1.6 million). The reserve includes the
Company's obligations related to Federal and State Superfund and Clean Water Act
sites where the Company is named as a potentially responsible party, including
Cliffs-Dow and Kipling sites in Michigan and the Rio Tinto mine site in Nevada,
all of which sites are independent of the Company's iron mining operations. The
reserves are based on engineering studies prepared by outside consultants
engaged by the potentially responsible parties. The Company continues to
evaluate the recommendations of the studies and other means for site clean-up.
Significant site clean-up activities have taken place at Rio Tinto and
Cliffs-Dow. The City of Marquette, Michigan purchased the Cliffs-Dow plant site
from the Company and has assumed any future environmental responsibilities with
respect to that site. Also included in the reserve are wholly-owned active and
closed mining operations, and other sites, including former operations, for
which reserves are based on the Company's estimated cost of investigation and
remediation.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE F - LONG-TERM DEBT
Long-term debt of the Company consists of $70 million of senior unsecured notes
payable to an insurance company group. The notes, due in December, 2005, have a
fixed interest rate of 7.0 percent. The note agreement requires the Company to
meet certain covenants related to net worth ($243.5 million at December 31,
1998), leverage, and other provisions. The Company was in compliance with the
debt covenants at December 31, 1998.
The Company's $100 million revolving credit agreement was amended in June, 1998
to extend the expiration date to May 31, 2003. No borrowings are outstanding
under this agreement. Additionally, the Company has outstanding $5.9 million of
unsecured letters of credit, including its share of ventures.
NOTE G - LEASE OBLIGATIONS
The Company and its ventures lease certain mining, production, data processing
and other equipment under operating leases. The Company's operating lease
expense, including its share of ventures, was $9.1 million in 1998, $8.5 million
in 1997 and $7.5 million in 1996.
Assets acquired under capital leases by the Company, including its share of
ventures, were $9.2 million and $8.1 million, respectively, at December 31, 1998
and 1997. Corresponding accumulated amortization of capital leases included in
respective allowances for depreciation was $4.0 million and $3.3 million at
December 31, 1998 and 1997, respectively.
Future minimum payments under capital leases and noncancellable operating
leases, including the Company's share of ventures, at December 31, 1998 were:
(In Millions)
-------------------------------
Year Ending Capital Operating
December 31 Leases Leases
----------- -------------- --------------
1999 $1.9 $ 9.1
2000 1.7 7.9
2001 1.3 6.4
2002 .8 4.6
2003 .3 3.7
2004 and thereafter .3 7.6
---- -----
Total minimum lease payments 6.3 $39.3
=====
Amounts representing interest .9
----
Present value of net minimum lease payments $5.4
====
The Company's share of ventures' capital and operating lease obligations (total
minimum lease payments - $38.0 million) are largely non-recourse to the Company.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE H - PENSIONS AND OTHER POSTRETIREMENT BENEFITS
The Company and its ventures sponsor defined benefit pension plans covering
substantially all employees. The plans are largely noncontributory, and benefits
are generally based on employees' years of service and average earnings for a
defined period prior to retirement. In addition, the Company and its ventures
currently provide retirement health care and life insurance benefits ("Other
Benefits") to most full-time employees who meet certain length of service and
age requirements (a portion of which are pursuant to collective bargaining
agreements). Other Benefits are provided through programs administered by
insurance companies whose charges are based on benefits paid. The following
table presents a reconciliation of funded status of the Company's plans,
including its proportionate share of plans of its ventures, at December 31, 1998
and 1997:
(In Millions)
-------------------------------------------------------------
Pension Benefits Other Benefits
----------------------------- -----------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $293.2 $267.5 $ 17.3 $ 14.7
Actual return on plan assets 35.4 42.7 1.3 1.1
Contributions 2.8 3.5 1.3 1.5
Benefits paid (15.2) (14.3)
Dissolution of one plan (6.2)
------- ------- ------ -------
Fair value of plan assets at end of year 316.2 293.2 19.9 17.3
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year 215.5 204.9 88.4 82.7
Service cost 4.5 4.0 1.6 1.3
Interest cost 15.6 15.1 6.3 6.2
Amendments .6 .5
Actuarial losses 17.1 11.5 6.7 2.8
Benefits paid (15.2) (14.3) (5.3) (4.6)
Dissolution of one plan (6.2)
------- ------- ------ -------
Benefit obligation at end of year 238.1 215.5 97.7 88.4
------- ------- ------ -------
Funded status of the plan (underfunded) 78.1 77.7 (77.8) (71.1)
Unrecognized prior service cost 6.8 8.0 1.6 .7
Unrecognized net actuarial (gain) loss (30.0) (28.4) 2.1 (3.6)
Unrecognized net asset at date of adoption (19.7) (22.2)
------- ------- ------ -------
Prepaid (accrued) benefit cost $ 35.2 $ 35.1 $(74.1) $(74.0)
======= ======= ====== =======
ASSUMPTIONS AS OF DECEMBER 31
Discount rate 6.75% 7.25% 6.75% 7.25%
Expected long-term return on plan assets 9.00% 9.00% 6.50% 7.25%
Rate of compensation increase - average 4.30% 4.31%
(In Millions)
------------------------------------------------------------------------
Pension Benefits Other Benefits
----------------------------------- -----------------------------------
1998 1997 1996 1998 1997 1996
---------- ---------- ---------- ---------- ---------- ----------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost $ 4.5 $ 4.0 $ 3.9 $ 1.6 $1.3 $ 1.3
Interest cost 15.6 15.1 13.6 6.3 6.2 5.9
Expected return on plan assets (22.5) (20.8) (17.9) (1.3) (1.0) (.9)
Amortization and other 4.6 (.4) (.5) .1
------ ------ ------ ----- ---- -----
Net periodic benefit cost (credit) $ 2.2 $ (2.1) $ (.9) $ 6.7 $6.5 $ 6.3
====== ====== ====== ===== ==== =====
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
Annual contributions to the pension plans are made within income tax
deductibility restrictions in accordance with statutory regulations. The Company
plans to contribute $1.4 million in 1999, including its share of ventures'
funding, a decrease of $1.4 million from 1998. In the event of termination, the
sponsors could be required to fund shutdown and early retirement obligations
which are not included in the pension benefit obligations.
Other Benefits assets include deposits relating to funded life insurance
contracts that are available to fund retired employees' life insurance
obligations. Additionally, Voluntary Employee Benefits Association Trusts were
established for certain mining ventures. As a participant, the Company's minimum
annual contribution is $.7 million per year. The Company's estimated
contribution will approximate $1.4 million per year based on its share of tons
produced.
For measurement purposes, a 7.0 percent annual rate of increase in the per
capita cost of covered health care benefits was assumed for 1999, decreasing by
.5 percent per year to an annual rate of 5 percent for the year 2003 and
annually thereafter.
The assumed health care cost trend rate has a significant effect on the amounts
reported. A one percentage point change in the assumed health care cost trend
rate would have the following effects:
(In Millions)
---------------------------------
Increase Decrease
--------------- ---------------
Effect on total of service and interest cost components in 1998 $ 1.2 $ (1.0)
Effect on Other Benefits obligation as of December 31, 1998 13.3 (11.7)
NOTE I - INCOME TAXES
Significant components of the Company's deferred tax assets and liabilities as
of December 31, 1998 and 1997 are as follows:
(In Millions)
---------------------------------
1998 1997
--------------- ---------------
Deferred tax assets:
Postretirement benefits other than pensions $21.8 $22.3
Other liabilities 13.7 14.7
Product inventories 3.8 4.2
Other 16.2 10.4
------ ------
Total deferred tax assets 55.5 51.6
Deferred tax liabilities:
Investment in ventures 21.2 23.0
Properties 14.8 11.5
Other 6.8 6.4
------- -------
Total deferred tax liabilities 42.8 40.9
------ ------
Net deferred tax assets $12.7 $10.7
===== =====
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
The components of provisions for income taxes are as follows:
(In Millions)
---------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
Current $14.8 $11.9 $23.6
Deferred (.4) 5.8 10.9
----- ----- -----
$14.4 $17.7 $34.5
===== ===== =====
In the fourth quarter of 1998, a favorable tax adjustment of $3.5 million was
recorded reflecting the Company's continuing assessment of its tax obligations.
The reevaluation of the current and prior years' tax provision primarily
reflects the expected outcome of audit issues for tax years 1993 and 1994.
In 1997, the Company and the Internal Revenue Service reached agreement settling
issues raised during examination of the Company's federal income tax returns for
tax years 1991 and 1992. As a result, the Company made additional tax and
interest payments of $3.3 million and recorded a $5.6 million reversal of prior
years' tax accruals in 1997.
The provision for income taxes included Australian federal income taxes of $2.1
million and $7.5 million for the years 1997 and 1996, respectively.
Reconciliation of effective income tax rate and United States statutory rate
follows:
1998 1997 1996
---------------- --------------- ---------------
Statutory tax rate 35.0% 35.0% 35.0%
Increase (decrease) due to:
Percentage depletion in excess
of cost depletion (8.2) (5.8) (5.9)
Effect of foreign taxes .1 3.0 5.3
Prior years' tax adjustment (6.6) (10.0) (.2)
Other items - net (.2) 2.2 2.0
----- ----- -----
Effective tax rate 20.1% 24.4% 36.2%
===== ===== =====
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE J - FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amount and fair value of the Company's financial instruments at
December 31, 1998 were as follows:
(In Millions)
--------------------------------
Carrying Fair
Amount Value
--------------- ---------------
Cash and cash equivalents $130.3 $130.3
Long-term investments 4.8 4.8
Long-term debt 70.0 71.3
At December 31, 1998, the Company had .8 million shares of The LTV Corporation
Common Stock recorded as a long-term investment (included in Other Assets -
miscellaneous) and classified as available-for-sale. These shares, which had an
original cost of $11.5 million, had an estimated fair value and carrying value
of $4.8 million and $8.3 million at December 31, 1998 and 1997, respectively.
The fair value of the Company's long-term debt was determined based on a
discounted cash flow analysis and estimated borrowing rates.
The Company had $13.9 million and $22.0 million of Canadian forward currency
exchange contracts at December 31, 1998 and 1997, respectively. The market value
of the Canadian forward currency exchange contracts, which have varying maturity
dates to December 1, 1999, was estimated to be $13.9 million, based on the
December 31, 1998 forward rates.
NOTE K - STOCK PLANS
During the term of the 1987 Incentive Equity Plan, 838,144 Common Shares were
granted or awarded in the form of stock options, stock appreciation rights and
restricted or deferred stock awards. Effective April 29, 1997, no further grants
or awards may be made from this Plan.
The 1992 Incentive Equity Plan authorizes the Company to issue up to 1,150,000
Common Shares upon the exercise of Options Rights, as Restricted Shares, in
payment of Performance Shares or Performance Units that have been earned, as
Deferred Shares, or in payment of dividend equivalents paid with respect to
awards made under the Plan. Such shares may be shares of original issuance or
treasury shares or a combination of both.
Stock options may be granted at a price not less than the fair market value of
the stock on the date the option is granted, generally are not subject to
re-pricing, and must be exercisable not later than ten years and one day after
the date of grant. Stock appreciation rights may be granted either at or after
the time of grant of a stock option. Common Shares may be awarded or sold to
certain employees with restrictions as to disposition over specified periods.
The market value of restricted stock awards and Performance Shares is charged to
expense over the vesting period.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
The 1996 Nonemployee Directors' Compensation Plan authorizes the Company to
issue up to 50,000 Common Shares to nonemployee Directors. The Plan provides for
the grant of 1,000 Restricted Shares (2,000 Restricted Shares, effective January
1, 1999) to nonemployee Directors first elected after June 30, 1995. The Plan
also provides that nonemployee Directors must take at least 50 percent (40
percent, effective January 1, 1999) of their annual retainer, and may elect to
take the balance of their retainer and all other fees, in Common Shares. The
Restricted Shares vest five years from the date of award.
In accordance with the provisions of FASB Statement 123, "Accounting for
Stock-Based Compensation," ("Statement 123"), the Company has elected to
continue applying the provisions of APB 25 and related interpretations in
accounting for its stock-based compensation plans. Accordingly, the Company does
not recognize compensation expense for stock options when the stock option price
at the grant date is equal to or greater than the fair market value of the stock
at that date. However, the Company recorded $2.5 million, $3.0 million, and $2.7
million in 1998, 1997 and 1996, respectively, relating to other stock-based
compensation, primarily the Performance Share program.
Statement 123 requires pro forma disclosure of net income and earnings per share
as if the fair value method for valuing stock options, as prescribed by
Statement 123, had been applied. The Company's pro forma information follows:
1998 1997 1996
--------------- --------------- ---------------
Net income (millions) $56.5 $54.7 $61.1
Earnings per share:
Basic $5.02 $4.81 $5.27
Diluted $4.98 $4.78 $5.24
The fair value of these options was estimated at the date of grant using a
Black-Sholes option pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996:
1998 1997 1996
--------------- --------------- ---------------
Risk-free interest rate 5.47% 6.04% 6.04%
Dividend yield 3.15% 2.97% 3.00%
Volatility factor - market
price of Company's common stock .224 .221 .219
Expected life of options - years 4.31 4.31 4.22
Compensation costs included in the pro forma information reflect fair values
associated with options granted after January 1, 1995. Pro forma information may
not be indicative of future pro forma information applicable to future
outstanding awards.
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
Stock option, restricted stock award, and performance share activities under the
Company's 1987 and 1992 Incentive Equity Plans, and the 1996 Nonemployee
Directors' Compensation Plan are summarized as follows:
1998 1997 1996
-------------------------- -------------------------- --------------------------
WEIGHTED- Weighted- Weighted-
AVERAGE Average Average
EXERCISE Exercise Exercise
SHARES PRICE Shares Price Shares Price
------------ ------------ ------------ ------------ ------------ ------------
Stock options:
Options outstanding at
beginning of year 252,625 $39.00 157,425 $35.99 72,775 $23.66
Granted during the year 128,450 44.56 114,950 43.38 109,500 44.82
Exercised (18,616) 34.96 (3,000) 21.52 (6,250) 20.29
Cancelled (15,717) 44.26 (16,750) 43.95 (18,600) 45.00
------- ------- ------
Options outstanding
at end of year 346,742 41.04 252,625 39.00 157,425 35.99
Options exercisable
at end of year 138,609 36.22 96,925 31.10 72,525 25.45
Restricted awards:
Awarded and restricted
at beginning of year 49,449 39,665 10,854
Awarded during the year 5,000 13,200 30,000
Vested (2,153) (816) (1,189)
Cancelled (2,600)
------- ------- ------
Awarded and restricted
at end of year 52,296 49,449 39,665
Performance shares:
Allocated at beginning of year 161,000 145,167 88,767
Allocated during the year 73,554 63,126 57,400
Issued (58,504) (45,293)
Forfeited (2,000) (1,000)
------- ------- ------
Allocated at end of year 176,050 161,000 145,167
Required retainer and voluntary shares:
Awarded at beginning of year 4,548 3,150
Awarded during the year 6,649 4,540 3,150
Issued (4,548) (3,142)
------- ------- ------
Awarded at end of year 6,649 4,548 3,150
Reserved for future grants
or awards at end of year 520,704 718,640 339,007
Weighted-average fair value of
options granted during the year $8.86 $8.65 $8.75
Exercise prices for options outstanding as of December 31, 1998 ranged from
$20.12 to $45.00, with 84 percent of options outstanding having exercise prices
in the range of $40.00 to $45.00 per share. The weighted-average remaining
contractual life of options outstanding is 7.3 years at December 31, 1998.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE L - SHAREHOLDERS' EQUITY
On September 19, 1997, the Company adopted a new share purchase rights
("Rights") plan that replaced an expired rights plan. A Right is attached to
each of the Company's Common Shares outstanding or subsequently issued, which
entitles the holder to buy from the Company one-hundredth of one (.01) Common
Share at an exercise price per whole share of $160.00. The Rights expire on
September 19, 2007 and are not exercisable until the occurrence of certain
triggering events, which include the acquisition of, or tender or exchange offer
for, 20 percent or more of the Company's Common Shares. There are approximately
168,000 Common Shares reserved for these Rights. The Company is entitled to
redeem the Rights at one cent per Right upon the occurrence of certain events.
Through December 31, 1998, the Company has purchased 1,130,500 of its Common
Shares under its authorization to repurchase up to 1.5 million Common Shares in
open market or negotiated transactions. Following is a summary of purchases by
year since inception:
Common Cost
Shares (In Millions)
---------------------- -----------------------
1995 284,500 $10.8
1996 495,800 19.5
1997 113,100 4.9
1998 237,100 11.5
--------- -----
Total 1,130,500 $46.7
========= =====
Average cost per share $41.28
======
NOTE M - EARNINGS PER SHARE
The following table summarizes the computation of basic and diluted earnings per
share.
(In Millions, Except Per Share)
-------------------------------
1998 1997 1996
---- ---- ----
Net income $ 57.4 $ 54.9 $ 61.0
Basic weighted-average shares 11.2 11.4 11.6
Effect of dilutive shares:
Stock options/performance shares .1 .1 .1
------- ------- -------
Diluted weighted-average shares 11.3 11.5 11.7
======= ======= =======
Basic earnings per share $ 5.10 $ 4.83 $ 5.26
======= ======= =======
Diluted earnings per share $ 5.06 $ 4.80 $ 5.23
======= ======= =======
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE N - LITIGATION
The Company and its ventures are periodically involved in litigation incidental
to their operations. Management believes that any pending litigation will not
result in a material liability in relation to the Company's consolidated
financial statements.
60