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 which the Company does not control. Such investments are accounted by
the equity method (see Note C). The Company's share of earnings of mining
partnerships and companies from which the Company purchases iron ore production
is credited to cost of goods sold upon sale of the product.
BUSINESS: The Company's dominant business is the production and sale of iron
ore pellets. 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 the United States, Canada and Australia. The
wholly-owned Australian operations had total revenues and pre-tax operating
profit of $45.8 million and $13.0 million, $43.5 million and $5.4 million, and
$41.9 million and $4.4 million, in 1995, 1994 and 1993, respectively. Total
Australian assets, including long-term investments ($4.6 million, 1995, and
$12.9 million, 1994) to fund eventual shutdown cost, were $31.8 million at
December 31, 1995 (1994 - $38.8 million).
Iron ore is marketed in North America, Europe, Asia, and Australia. The three
largest steel company customers' contributions to the Company's revenues were
17%, 11% and 10% in 1995; 14%, 14% and 12% in 1994; and 14%, 12% and 11% in
1993.
BUSINESS RISK: The North American steel industry experienced high operating
rates and generally positive financial results in 1995 and 1994. The Company's
integrated steel company partners and customers have generally improved their
financial condition over the two-year period as a result of continued earnings
and increased equity capital.
The improvement in most steel companies' financial positions has significantly
reduced the major business risk faced by the Company in recent years, i.e., the
potential financial failure and shutdown of significant customers or partners
with a resulting unmitigated loss of ore sales or royalty and management fee
income.
If any such shutdown were to occur without mitigation through replacement sales
or cost reduction, it would represent a significant adverse financial
development to the Company. The iron mining business has high operating
leverage because "fixed" costs are a large portion of the cost structure.
Therefore, loss of sales or other income due to failure of a customer or
partner would have an adverse income effect proportionately greater than the
revenue effect (see Note E - McLouth Bankruptcy).
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Cleveland-Cliffs Inc and Consolidated Subsidiaries
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 those estimates.
CASH EQUIVALENTS: The Company considers investments in highly liquid debt
instruments with an initial maturity of 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.
Securities are classified as held-to-maturity when the Company has the intent
and ability to hold the securities to maturity. Held-to-maturity securities are
stated at cost and investment income is included in earnings.
The Company classifies certain highly liquid securities as trading securities.
Trading securities are stated at fair value and unrealized holding gains and
losses are included in income.
Securities that are not classified as held-to-maturity or trading are
classified 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.
FORWARD CURRENCY EXCHANGE CONTRACTS: The Company had $4.5 million and $6.0
million of Australian forward currency exchange contracts at December 31, 1995
and 1994, respectively, and $4.8 million and $6.0 million of Canadian forward
currency exchange contracts at December 31, 1995 and 1994, respectively. These
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 Australian
and Canadian operations. Gains and losses are recognized in the same period as
the hedged transaction. The fair value of these currency exchange contracts,
which have varying maturity dates to December 30, 1996, is estimated to be $4.7
million for the Australian contracts and $4.8 million for the Canadian
contracts, based on the December 31, 1995 forward rates.
The Company's exposure to risk associated with derivatives is limited to the
above forward currency exchange contracts.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Cleveland-Cliffs Inc and Consolidated Subsidiaries
INVENTORIES: Product inventories, primarily finished products, are stated at
the lower of cost or market. The cost of product inventories is determined
using the last-in, first-out ("LIFO") method. The excess of current cost over
LIFO cost of product inventories was $1.2 million and $.9 million at December
31, 1995 and 1994, respectively. The cost of other inventories is determined by
the average cost method.
PROPERTIES: Depreciation of plant and equipment is computed principally by the
straight-line method based on estimated useful lives. Depreciation is not
reduced when operating units are temporarily idled. Depletion of mineral lands
is computed using the units of production method based upon proven mineral
reserves.
EXPLORATION, RESEARCH AND DEVELOPMENT COSTS: Exploration, research and
continuing development costs of mining properties are charged to operations as
incurred. Development costs which benefit extended periods are deferred and
amortized over the period of benefit. At December 31, 1995, deferred
development costs were less than $1.0 million. Startup costs of major new
facilities are deferred and amortized over five years from commencement of
commercial production.
INCOME PER COMMON SHARE: Income per common share is based on the average
number of common shares outstanding during each period.
RECLASSIFICATIONS: Certain prior year amounts have been reclassified to
conform to current year classifications.
NOTE A - ACCOUNTING AND DISCLOSURE CHANGES
In March, 1995, the Financial Accounting Standards Board issued Statement 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of," which requires the review for impairment of long-lived
assets and certain identifiable intangibles whenever significant events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Although Statement 121 is effective for years beginning after
December 15, 1995, the Company has elected to adopt the provisions of this
standard for the year ended December 31, 1995. The Company has determined that
no event or change in circumstance occurred in 1995 to indicate that a review
for asset impairment was required.
In October, 1995, the Financial Accounting Standards Board issued Statement
123, entitled, "Accounting for Stock-Based Compensation," which establishes
financial accounting and reporting standards for stock-based employee
compensation plans. The standard is effective for years that begin after
December 15, 1995. Management is evaluating the accounting and disclosure
alternatives; however, no significant financial statement effect is expected.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE B - NORTHSHORE MINE AND POWER PLANT ACQUISITION
On September 30, 1994, Cliffs Minnesota Minerals Company, a subsidiary of
Cleveland-Cliffs Inc, acquired Cyprus Amax Minerals Company's iron ore
operation and power plant (renamed Northshore Mining Company or "Northshore")
in Minnesota. The principal Northshore assets acquired were 4 million annual
tons of active capacity for production of standard pellets (equivalent to 3.5
million tons of flux pellet capacity), supported by 6 million tons of active
concentrate capacity, a 115 megawatt power generation plant, and an estimated
1.2 billion tons of magnetite crude iron ore reserves, leased mainly from the
Mesabi Trust. Northshore has a long-term contract to sell 40 megawatts of
excess capacity to an electric utility with approximately 16 years remaining at
December 31, 1995.
The acquisition has been accounted for as a purchase transaction. Pro forma
results of the Company's operations, assuming the acquisition had occurred at
the beginning of 1993, are shown in the following table.
ProForma
(Unaudited)
---------------
1994 1993*
------ ------
Total Revenues (Millions) $466.7 $415.0
====== ======
Net Income
----------
Amount (Millions) $ 47.0 $ 36.5
====== ======
Per Common Share $ 3.89 $ 3.04
====== ======
* Year 1993 results exclude the Company's $35.7 million before-tax ($23.2 million after-tax or $1.93 per share) recovery on the
settlement of the Company's bankruptcy claim against LTV Steel Company, Inc. (an integrated steel company subsidiary of The LTV
Corporation, or collectively "LTV").
The pro forma results have been prepared for illustrative purposes only and do
not purport to be indicative of what would have occurred had the acquisition
actually been made at the beginning of 1993, nor of results which may occur in
the future. Actual results could be significantly different under the Company's
ownership due to, among other matters, differences in marketing, operating and
investment actions which have been or may be taken by the Company.
In June 1995, a $6.0 million pellet expansion project, at Northshore, which
involved the re-commissioning of an idled pelletizing unit, was completed. On
an annualized basis, the expansion added approximately .9 million tons of
pellets, a 23 percent expansion of Northshore production.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE C - INVESTMENTS IN ASSOCIATED COMPANIES
The Company's investments in associated mining companies ("ventures") are
accounted by the equity method and consist primarily of its 22.5625% interest
in Empire Iron Mining Partnership ("Empire"), 15% interest in Hibbing Taconite
Company ("Hibbing"), 40% interest in Tilden Mining Company L.C. ("Tilden";
formerly 33.33% interest in Tilden Magnetite Partnership and 60% interest in
Tilden Mining Company), and 7.69% (7.01% in 1994) interest in Wabush Mines
("Wabush"). These ventures are managed by the Company in North America. The
other interests are owned by U.S. and Canadian integrated steel companies.
Following is a summary of combined financial information of the operating
ventures.
(In Millions)
--------------------------------------
1995 1994 1993
--------------------------------------
INCOME
Gross revenue $1,025.9 $ 968.2 $ 896.5
Equity income 143.3 99.5 82.2
FINANCIAL POSITION
Properties - net $ 761.5 $ 774.5 $ 812.4
Other assets 138.6 107.1 95.8
Debt obligations (22.5) (39.8) (61.0)
Other liabilities (163.9) (147.4) (123.1)
-------- ------- -------
Net assets $ 713.7 $ 694.4 $ 724.1
======== ======= =======
Company's equity in
underlying net assets $ 185.1 $ 253.6 $ 266.8
Company's investment $ 152.0 $ 151.7 $ 152.2
The Company manages and operates 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 production decided by
the venture participants. The Company purchased $217.8 million in 1995
(1994-$212.5 million; 1993-$196.0 million) of iron ore from certain ventures.
During 1995, the Company earned royalties and management fees of $49.5 million
(1994-$44.7 million; 1993-$39.5 million) from ventures, of which $13.7 million
in 1995 (1994-$12.7 million; 1993-$10.7 million) was paid by the Company as a
participant in the ventures.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
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 excess of
the Company's equity in the underlying net assets over 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 the Tilden reorganization. The Company's equity
in the income of ventures was $24.3 million in 1995 (1994-$19.5 million;
1993-$23.5 million).
In February, 1994, the Company reached agreement with Algoma Steel Inc.
("Algoma") and Stelco Inc. to restructure and simplify the Tilden Mine
operating agreement effective January 1, 1994. The principal terms of the
agreement are (1) the participants' tonnage entitlements and cost-sharing are
based on a 6.0 million ton target normal production level instead of the
previous 4.0 million ton base production level, (2) the Company's interest in
Tilden has increased from 33.33% to 40.0% with an associated increase in the
Company's obligation for its share of mine costs, (3) the Company is receiving
a higher royalty, (4) the Company has the right to supply any additional iron
ore pellet requirements of Algoma from Tilden or the Company, and (5) any
partner may take additional production with payment of certain fees to Tilden.
The parties implemented the general agreement effective January 1, 1994 and
finalized the detailed provisions of the definitive agreement on September 30,
1995. The agreement has not had a material effect on the Company's consolidated
financial statements.
The Company's effectively serviced share of long-term obligations of ventures,
including current portion, was $6.3 million as of December 31, 1995 (1994-$9.2
million). In addition, the Company guaranteed $6.6 million of Empire long-term
obligations which are effectively serviced by LTV and Wheeling-Pittsburgh Steel
Corporation. The fair value of the guarantees is nominal because advances
against the guarantees would be supported by ownership interests in Empire. The
Company's share of the final principal payment, due in 1996, of the Empire
long-term obligation is $3.9 million. The Company's share of plant and
equipment and other property interests which secure the effectively serviced
obligations was $45.0 million at December 31, 1995.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE D - INVESTMENTS
Following is a summary of investment securities:
(In Millions)
--------------------------------------------
Gross Estimated
Unrealized Fair
Cost Gains (Losses) Value
---- -------------- ---------
December 31, 1995
- -----------------------------------
Long-Term Investments
- ---------------------
Available-for-Sale
------------------
Debt Securities $ .1 $ -- $ .1
LTV Common Stock 11.5 .1 11.6
----- ---- -----
11.6 .1 11.7
Held-to-Maturity
-----------------
Australian Government Securities 4.6 .3 4.9
----- ---- -----
Total Long-Term Investments $16.2 $ .4 $16.6
===== ==== =====
Marketable Securities
- ---------------------
Trading
-------
Debt Securities $ 8.9 $ -- $ 8.9
===== ==== =====
December 31, 1994
- -----------------------------------
Long-Term Investments
- ---------------------
Available-for-Sale
-------------------
Debt Securities $ .7 $ -- $ .7
LTV Common Stock 11.2 2.3 13.5
----- ---- -----
11.9 2.3 14.2
Held-to-Maturity
-----------------
Australian Government Securities 12.9 (.3) 12.6
----- ---- -----
Total Long-Term Investments $24.8 $2.0 $26.8
===== ==== =====
Marketable Securities
- ---------------------
Available-for-Sale
------------------
Debt Securities $ .8 $ -- $ .8
===== ==== =====
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
The contractual maturities of the Available-for-Sale and Held-to-Maturity
securities at December 31, 1995 and 1994 are shown below.
December 31, 1995 December 31, 1994
(In Millions) (In Millions)
----------------------------- -----------------------
Estimated Estimated
Fair Fair
Cost Value Cost Value
----- --------- ----- ---------
Available-for-Sale
- ------------------
Debt Instruments:
Due in one year or less $ .1 $ .1 $ .8 $ .8
Due after three years -- -- .7 .7
----- ----- ----- -----
.1 .1 1.5 1.5
LTV Common Stock 11.5 11.6 11.2 13.5
----- ----- ----- -----
$11.6 $11.7 $12.7 $15.0
===== ===== ===== =====
Held-to-Maturity
- ----------------
Debt Instruments:
Due in one year or less $ 3.9 $ 4.1 $ 8.7 $ 8.6
Due after one year through three years .7 .8 4.2 4.0
----- ----- ----- -----
$ 4.6 $ 4.9 $12.9 $12.6
===== ===== ===== =====
In 1995, $8.3 million of Australian government securities matured and were
converted to cash and cash equivalents. The redemption of these investments,
previously classified as held-to-maturity securities, did not result in the
recognition of gain or loss.
NOTE E - MCLOUTH BANKRUPTCY
On September 29, 1995, McLouth Steel Products Company ("McLouth"), a
significant customer, petitioned for protection under Chapter 11 of the U.S.
Bankruptcy Code. The Company has periodically extended credit to McLouth. At
the time of the bankruptcy filing, the Company had an unreserved receivable
from McLouth of $5.0 million, secured by liens on certain McLouth fixed assets.
A $2.7 million reserve against the receivable was recorded in September, 1995
resulting in a $1.8 million after-tax charge. Since the petition, McLouth has
maintained operations and the Company has continued pellet shipments. McLouth's
liquidity is limited, and there is no assurance that McLouth will continue to
operate. Future operating results would be adversely affected if the Company's
total sales declined due to McLouth developments. The extent of such effect
would be dependent on the timing and degree of replacement sales to other
customers.
Sales to McLouth totaled 1.3 million tons for the year 1995 representing 12.5
percent of the Company's sales volume. Included in the Company's December 31,
1995 inventory was .1 million tons (which increased to a peak .2 million tons
in January, 1996) consigned to McLouth in accordance with long-standing
practice.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE F - RESERVE FOR CAPACITY RATIONALIZATION
The Company initially established a reserve of $70 million in 1983 to provide
for expected costs of reorienting its mining joint ventures and facilities to
adjust to changed market conditions. During 1990, the Company increased the
reserve by $24.7 million as a result of a restructuring of Savage River Mines
under which the previous participants in the venture paid $19.0 million to the
Company for closedown obligations. In 1993, $5.6 million, was charged to the
reserve. During 1994 and 1995, $3.8 million and $.5 million, respectively, were
credited to the reserve. The balance at December 31, 1995 was $34.8 million,
with $7.1 million classified as a reduction of other current assets.
The reserve balance is principally for the planned shutdown of Savage River
Mines in the first quarter of 1997 and the permanent shutdown of the Republic
Mine. The Republic Mine shutdown was announced on January 30, 1996. The Savage
River Mines shutdown provision has been funded.
NOTE G - ENVIRONMENTAL RESERVES
The Company has a formal code of environmental conduct which promotes
environmental protection and restoration. The Company's obligations for known
environmental problems at active mining operations, idle and closed mining
operations and other sites have been recognized based on estimates of the cost
of required investigation and remediation at each site. If the cost can only be
estimated as a range of possible amounts with no specific amount being most
likely, the minimum of the range is accrued in accordance with generally
accepted accounting principles. Estimates may change as additional information
becomes available. Actual costs incurred may vary from the estimates due to the
inherent uncertainties involved. Any potential insurance recoveries have not
been reflected in the determination of the financial reserves.
In the second quarter of 1995, the Company provided $9.9 million of additional
environmental reserves which resulted in a $6.7 million special after-tax
charge. The additional provision reflected a comprehensive review of available
information on all known sites. Additional environmental reserves of $3.3
million were provided in other quarters as a result of other environmental
reviews and determinations. Net payments in 1995 were $2.4 million.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
At December 31, 1995, the Company had an environmental reserve of $22.9 million
($12.0 million at December 31, 1994), of which $4.4 million was current. The
reserve includes the Company's obligations for:
o Federal and state Superfund and Clean Water Act sites where the
Company is named as a potential responsible party, including the
Cliffs-Dow and Kipling sites in Michigan, the Arrowhead Refinery
site in Minnesota, the Summitville mine site in Colorado, 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
potential responsible parties. The Company continues to evaluate
the recommendations of the studies and other means of site
clean-up. Significant site clean-up activities have taken place at
Cliffs-Dow since late 1993. A Consent Decree has been reached
among the federal and state governments and approximately 224
individuals and companies with respect to the Arrowhead site.
Clean-up began in 1995 with significant funding provided by the
federal and state governments. The Consent Decree has been entered
by the U.S. District Court. The Company's share of Arrowhead costs
totaled approximately $149,000, which included $23,000 of funded
remediation costs and $126,000 of incurred legal and other costs.
o Wholly-owned active and idle operations, including the Northshore
mine and Silver Bay power plant in Minnesota, acquired on
September 30, 1994. The Northshore/Silver Bay reserve is based on
an environmental investigation conducted by the Company and an
outside consultant in connection with the purchase. Expenditures
in 1995 totalled $.6 million.
o Other sites, including former operations, for which reserves are
based on the Company's estimated cost of investigation and
remediation of sites where expenditures may be incurred.
Estimated environmental expenditures under current laws and regulations are not
expected to materially impact the Company's consolidated financial statements.
NOTE H - LONG-TERM OBLIGATIONS
(In Millions)
December 31
---------------------
1995 1994
----- -----
Term notes $70.0 $75.0
Less current portion -- 5.0
----- -----
$70.0 $70.0
===== =====
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
In December, 1995, the Company completed a private placement of $70.0 million
of senior unsecured notes to an insurance company group. The proceeds were used
to retire existing notes in the same amount, held by another group of insurance
companies. The new notes due in December, 2005, have a fixed interest rate of
7.0 percent, and replace the existing notes, which had an average interest rate
of 8.77 percent and remaining annual principal payments of $12.1 million per
year in the years 1996 through 1999 and $7.2 million in the years 2000 through
2002. The retiring of the existing notes resulted in an extraordinary charge
of $3.1 million after-tax ($4.8 million before-tax).
The senior unsecured note agreement requires the Company to meet certain
covenants related to net worth ($200.0 million at December 31, 1995), leverage,
and other provisions. The Company was in compliance with the debt covenants at
December 31, 1995.
Effective March 1, 1995, the Company terminated its $75 million three-year
revolving credit agreement, which was scheduled to expire on April 30, 1995,
and entered into a five-year, $100 million agreement. No borrowings are
outstanding under the agreements.
NOTE I - RETIREMENT BENEFITS
Pensions
- --------
The Company and its managed ventures sponsor defined benefit pension plans
covering substantially all employees. The plans are noncontributory and
benefits generally are based on employees' years of service and average
earnings for a defined period prior to retirement.
Pension costs, including the Company's proportionate share of the costs of
ventures, were credits of $1.2 million and $2.7 million, in 1995 and 1993,
respectively, and a cost of $ .2 million in 1994. The (credits) cost included
credits of $3.6 million, $3.4 million, and $3.2 million in 1995, 1994, and
1993, respectively, related to a shutdown operation which increased the
Capacity Rationalization Reserve and were not credited to income. Components of
the pension (credits) costs were as follows:
(In Millions)
------------------------------------------
1995 1994 1993
-------- -------- --------
Service cost $ 3.4 $ 3.7 $ 3.0
Interest cost 15.3 14.4 13.4
Actual loss (return) on plan assets (42.6) 1.5 (27.7)
Net amortization and deferral 22.7 (19.4) 8.6
------ ------ ------
$ (1.2) $ .2 $( 2.7)
====== ====== ======
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
Most of the Company's pension funds are held in diversified collective trusts
with the funds contributed by partners in the ventures. Plan assets principally
include diversified marketable equity securities and corporate and government
debt securities, which are selected by professional asset managers.
The following table presents a reconciliation of the funded status of the
Company's plans, including its proportionate share of the plans of ventures, at
December 31, 1995 and 1994.
(In Millions)
------------------------
1995 1994
---------- ---------
Plan assets at fair value $ 249.1 $ 228.4
Actuarial present value of benefit
obligation:
Vested benefits 187.9 156.7
Nonvested benefits 22.4 23.4
------- --------
Accumulated benefit obligation 210.3 180.1
Effect of projected compensation levels 23.3 13.3
------- -------
Projected benefit obligation 233.6 193.4
------- -------
Plan assets in excess of projected
benefit obligation 15.5 35.0
Unrecognized prior service costs 8.3 11.1
Unrecognized net asset at date of adoption
of FAS 87, net of amortization (26.2) (34.1)
Unrecognized net loss 25.9 9.0
------- -------
Prepaid cost $ 23.5 $ 21.0
======= =======
At December 31, 1995, the Company recorded an additional liability of $1.6
million for certain plans where the fair value of plan assets was less than the
accumulated benefit obligation. The minimum liability recognition resulted in
the recording of a $1.6 million intangible asset.
The discount rate and weighted average rate of increase in compensation levels
used in determining the actuarial present value of the projected benefit
obligation were 7.25% and 4.1% at December 31, 1995 (8.5% and 4.0% at December
31, 1994), respectively. The expected long-term rate of return assumption
utilized for determining pension (credit) cost for the years 1995, 1994 and
1993 was 8.5%, 8% and 9%, respectively. The assumption was changed to 8.75% on
December 31, 1995 for year 1996 pension cost (credit) determination.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
The Company has increased pension plan funding to the maximum amount deductible
for income tax purposes. For Plan Year 1995 (largely funded in calendar year
1996), the Company expects to contribute $5.1 million, including its share of
ventures' funding, an increase of $3.5 million from Plan Year 1994. In the
event of plan termination, the sponsors could be required to fund shutdown and
early retirement obligations which are not included in the accumulated benefit
obligation.
Other Postretirement Benefits ("OPEB")
- ------------------------------------
In addition to the Company's defined benefit pension plans, the Company and its
managed ventures currently provide retirement health care and life insurance
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). These benefits are provided through programs administered by
insurance companies whose charges are based on the benefits paid during the
year. If such benefits are continued, most active employees would become
eligible for these benefits when they retire.
The following table presents a reconciliation of the funded status of the
Company's OPEB obligations, including its proportionate share of the
obligations of ventures, at December 31, 1995 and 1994.
(In Millions)
-----------------------------
1995 1994
------ ------
Accumulated postretirement benefit obligation:
Retirees $ 67.5 $ 46.7
Fully eligible active plan participants 3.2 2.2
Other active plan participants 24.8 16.8
------ ------
95.5 65.7
Plan assets (12.1) (10.4)
------ ------
Accumulated postretirement benefit cost
obligation in excess of plan assets 83.4 55.3
Unrecognized prior service credit (cost) (.1) .1
Unrecognized gain (loss) (9.2) 17.3
------ ------
Accrued postretirement benefit cost $ 74.1 $ 72.7
====== ======
Net periodic postretirement benefit cost, including the Company's
proportionate share of the costs of ventures, includes the following components:
(In Millions)
-----------------------------------
1995 1994 1993
----- ----- -----
Service cost $ 1.2 $ 1.1 $ 1.2
Interest cost 5.8 5.6 5.7
Return on plan assets (.6) (.5) --
Net amortization and deferral (.4) .1 --
----- ----- -----
Net periodic postretirement benefit cost $ 6.0 $ 6.3 $ 6.9
===== ===== =====
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
As a result of recent experience, the Company has changed the medical cost
trend rate assumption used in the calculation of its OPEB obligation at
December 31, 1995. The new assumption reflects medical cost growth of 8.5% in
1996 decreasing by .5% per year to a growth rate of 5% for the year 2003 and
annually thereafter. The previous assumption reflected medical cost growth of
13% in 1993, 11% in 1994, 9% in 1995, 7% in 1996, 5% in 1997 and annually
thereafter. The medical cost trend rate assumption has a significant effect on
the amounts reported. For example, changing the assumed medical cost trend rate
by one percentage point in each year would change the accumulated
postretirement benefit obligation, as of December 31, 1995 by $20.4 million,
and the aggregate of the service and interest cost components of net periodic
postretirement benefit cost for 1995 by $1.3 million. Amounts include the
Company's proportionate share of the costs of ventures.
Plan assets include $9.3 million of deposits, relating to funded life insurance
contracts, at January 1, 1994, that the Company determined were available to
fund retired employees' life insurance obligations. As part of the 1993 labor
contracts at Empire, Hibbing, and Tilden, Voluntary Employee Benefit
Association Trusts ("VEBAs") have been established. Funding of the VEBAs began
in 1994 to cover a portion of the postretirement benefit obligations of these
ventures. As a participant, the Company's minimum annual contribution is $.8
million per year. The Company's estimated actual contribution will approximate
$1.4 million per year based on its share of tons produced. The discount rate
used in determining the accumulated postretirement benefit obligation was 7.25%
at December 31, 1995 (8.5% and 7.25% at December 31, 1994 and 1993,
respectively). The expected long-term rate of return on life insurance contract
deposits was increased to 8.0% at December 31, 1995 from 5.5% at December 31,
1994 to reflect contract provisions. The expected return on VEBAs remained at
5.5%.
NOTE J - INCOME TAXES
Significant components of the Company's deferred tax assets and liabilities as of December 31, 1995 and 1994 are as follows:
(In Millions)
------------------
1995 1994
------ -----
Deferred tax assets:
Postretirement benefits other than pensions $20.9 $21.4
Other liabilities 20.1 19.3
Deferred development 9.2 9.4
Reserve for capacity rationalization 7.3 6.7
Current liabilities 6.7 4.4
Product inventories 3.6 2.5
Other 2.4 7.4
----- -----
Total deferred tax assets 70.2 71.1
Deferred tax liabilities:
Investment in associated companies 24.5 26.2
Other 20.4 21.5
----- -----
Total deferred tax liabilities 44.9 47.7
----- -----
Net deferred tax assets $25.3 $23.4
===== =====
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Cleveland-Cliffs Inc and Consolidated Subsidiaries
The components of provisions for income taxes before the extraordinary item are as follows:
(In Millions)
--------------------------------
1995 1994 1993
------ ------ -----
Current $11.9 $16.5 $19.0
Deferred (1.2) (1.8) 2.1
----- ----- -----
$10.7 $14.7 $21.1
===== ===== =====
In 1995, the Company and the Internal Revenue Service reached agreement on
several issues raised during the examination of the Company's federal income
tax returns for the tax years 1986 through 1988. The income tax settlement
favorably resolved a number of audit issues primarily arising from the
Company's restructuring program in the late 1980s when mining partnerships were
reorganized to cope with steel company bankruptcies and non-core businesses
were divested. During that period, the Company had reserved the potential tax
liabilities. Accordingly, a tax credit of $12.2 million was recorded in the
second quarter of 1995. As a result of the settlement and its related impact on
the tax years 1989 through 1993, the Company made additional tax and interest
payments of $11.8 million in the third quarter of 1995 and is entitled to tax
and interest refunds of $5.3 million. Additional cash benefits of the tax
settlement will be realized for the tax year 1994 and thereafter.
The provision for income taxes included Australian federal income taxes of $3.7
million, $1.9 million, and $.9 million for the years 1995, 1994 and 1993,
respectively.
The reconciliation of effective income tax rate before the extraordinary item
and United States statutory rate is as follows:
1995 1994 1993
---- ---- ----
Statutory tax rate 35.0% 35.0% 35.0%
Increase (decrease) due to:
Percentage depletion in excess
of cost depletion (7.8) (7.9) (4.5)
Effect of foreign taxes 1.7 .2 --
Prior years' tax adjustment (15.2) (1.5) (3.0)
Corporate dividends received -- (1.0) (1.0)
Other items - net 1.3 .8 1.3
----- ----- -----
Effective tax rate 15.0% 25.6% 27.8%
===== ===== =====
Prior years' tax adjustment in 1995 includes the effect of the $12.2 million
tax credit.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE K - BANKRUPTCY SETTLEMENT
Following a 1986 filing, LTV emerged from bankruptcy in June, 1993. In final
settlement of its allowed claim, the Company received 2.3 million shares of LTV
Common Stock and 4.4 million Contingent Value Rights, valued at $31.6 million
and $4.1 million, respectively, resulting in a total gain in 1993 of $35.7
million ($23.2 million after-tax, or $1.93 per share). On July 13, 1993, the
Company distributed to its common stockholders, a special dividend of 1.5
million shares of LTV Common Stock, valued at $20.4 million, and $12.0 million
($1.00 per share) cash.
On March 20, 1995, the Company received a second and final distribution of
22,689 shares of LTV Common Stock. The Company has retained the approximately
842,000 shares as an investment.
NOTE L - FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amount and fair value of the Company's financial instruments at
December 31, 1995 are as follows:
(In Millions)
-----------------------
Carrying Fair
Amount Value
-------- ------
Cash and cash equivalents $139.9 $139.9
Marketable securities:
Available-for-Sale 11.7 11.7
Held-to-Maturity 4.6 4.9
Trading 8.9 8.9
------ ------
Total securities 25.2 25.5
Long-term debt 70.0 71.9
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 also has forward currency contracts at December 31, 1995 of $9.3
million with a fair value of $9.5 million.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE M - STOCK PLANS
The 1987 Incentive Equity Plan authorizes the Company to make grants and awards
of stock options, stock appreciation rights and restricted or deferred stock
awards to officers and key employees, for up to 750,000 Common Shares (plus an
additional 89,045 Common Shares reserved for issuance, but not issued, under
the Company's 1979 Restricted Stock Plan). The 1992 Incentive Equity Plan
authorizes the Company to issue up to 595,000 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 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. Option prices were adjusted in 1991 and 1993 to recognize the
effect of special dividends to shareholders. Stock option, restricted stock
award, and performance share activities are summarized as follows:
1995 1994 1993
------------------------ ----------------------- -----------------------
Shares Price Shares Price Shares Price
-------- ------------ -------- ------------ -------- -----------
Stock options:
Options outstanding
beginning of year 82,182 $ 8.51-37.13 105,125 $ 8.51-34.80 160,650 $6.68-37.50
Granted 5,000 39.44-40.56 5,500 35.50-37.13 5,000 32.56
Exercised (14,407) 8.51-35.50 (27,943) 8.51-34.80 (60,525) 6.68 26.31
Cancelled -- -- (500) 35.50 -- --
------- ------- -------
Options outstanding at end of year 72,775 8.51-40.56 82,182 8.51-37.13 105,125 8.51-34.80
Options exercisable at end of year 72,775 8.51-40.56 82,182 8.51-37.13 105,125 8.51-34.80
Restricted awards:
Awarded and restricted at beginning
of year 13,264 20,218 10,990
Awarded during the year -- 8,000 15,277
Vested (2,410) (14,954) ( 6,049)
Cancelled -- -- --
------- ------- -------
Awarded and restricted at end of year 10,854 13,264 20,218
Performance shares:
Allocated at beginning of year 41,317 --
Allocated during the year 47,450 42,067
Forfeited -- (750)
------- -------
Allocated end of year 88,767 41,317
Reserved for future grants or awards at end
of year 469,457 521,907 576,224
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Cleveland-Cliffs Inc and Consolidated Subsidiaries
NOTE N - SHAREHOLDERS' EQUITY
As of December 31, 1995, the Company is authorized to issue up to 500,000
shares of Class A voting preferred stock, without par value, and up to
4,000,000 shares of Class B non-voting preferred stock, without par value.
A share purchase right ("Right") is attached to each of the Company's Common
Shares outstanding as of December 31, 1995, or subsequently issued. Each Right
entitles the holder to buy from the Company eleven one-thousandths (.011) of
one Common Share at an exercise price per whole share of $39.11. The Rights
become exercisable if a person or group acquires, or tenders for, 20% or more
of the Company's Common Shares. The Company is entitled to redeem the Rights at
5 cents per Right at any time until ten days after any person or group has
acquired 20% of the Common Shares and in certain circumstances thereafter. If a
party owning 20% or more of the Company's Common Shares merges with the Company
or engages in certain other transactions with the Company, each Right, other
than Rights held by the acquiring party, entitles the holder to buy $78.22
worth of the shares of the surviving company at a 50% discount. The Rights
expire on September 18, 1997 and are not exercisable until the occurrence of
certain triggering events, which include the acquisition of, or a tender or
exchange offer for, 15% or more of the Company's Common Shares. There are
approximately 185,000 Common Shares reserved for these Rights.
In January, 1995, the Company announced a program to repurchase up to 600,000
of its Common Shares in the open market or in negotiated transactions. Under
the continuing program, the Company repurchased 284,500 shares at an average
price of $37.71 per share in open market transactions throughout 1995. The
shares will initially be retained as Treasury Stock.
NOTE O - LITIGATION
The Company and its managed 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.
61