The acquisitions completed in the second quarter of 2001 have significantly affected the Company’s financial and operating results since their effective date. The operations of Westmoreland Mining LLC (“WML”), the Company’s acquisition entity, have contributed the following:
These results may not necessarily be indicative of the results to be realized in future periods.
The acquisitions, described in Note 2 to the Consolidated Financial Statements, also affected the Company’s balance sheet on the acquisition date by:
While the acquisitions are generating significant positive operating cash flows, the term loan and revolving credit agreements include certain conditions with respect to the use of such cash flows that affect the amount of WML’s cash flows available for general use by the Company. As of June 30, 2002 WML has $9,951,000 of operating cash and $11,160,000 of restricted cash which is dedicated to debt service and funding of the debt service reserve required by the term loan and revolving credit agreements. Until the initial debt service reserve account was fully funded, WML could not distribute any earnings to the Company with the exception that WML was permitted to distribute $1,250,000 per quarter to the Company for quarters ending on or before December 31, 2001. This $1,250,000 distribution was in addition to the $500,000 management fee that WML has paid and will continue to pay the Company each quarter. The debt service reserve account was fully funded in March 2002. As a result, 75% of surplus cash, as defined in the debt agreement, not including the required debt service reserve amount, is now distributable to Westmoreland and 25% is required to be used to fund a debt prepayment account.
The final purchase price for the acquisition of Montana Power’s coal business is subject to adjustment. As discussed in Item 3 - Legal Proceedings of the Company’s Annual Report on Form 10-K for the year ended December 31, 2001 and updated in Part II, Item 1 - Legal Proceedings of this Quarterly Report, the Company and Montana Power were not able to agree on either the amount of the purchase price adjustment or the methodology to calculate the adjustment within the time frame provided for under the Purchase Agreement. The Company initiated an action in the Supreme Court of New York on November 26, 2001, seeking specific performance of the purchase price methodology provided for under the Purchase Agreement. Any change in the purchase price will cause a change to the preliminary purchase price allocation. If the purchase price is reduced, the Company and WML may be required to use the proceeds received from Entech and Montana Power to pay the indebtedness described in Note 3 to the Consolidated Financial Statements. In the unlikely event an additional purchase price payment is required it would likely be funded by the use of WML’s revolving credit facility. Although there can be no assurance as to the ultimate outcome, the Company believes its claims are meritorious and intends to pursue its rights vigorously.
The income being generated by the acquisitions is allowing the Company to use at least a portion of its net operating loss carryforwards. As a result of the expectation of the generation of taxable income by the acquisitions and as required by generally accepted accounting principles, the Company recognized a $55,600,000 deferred tax asset on the acquisition date. As taxable income is generated in each period and in future periods, the net operating loss carryforwards are utilized; the tax asset is reduced; a non-cash deferred income tax expense is recognized; and, no regular Federal income taxes are paid. Under purchase accounting for the acquisitions, recognition of the deferred tax asset reduced the Company’s basis in the property, plant and equipment acquired, thus reducing future depreciation and depletion expense. This accounting treatment has no effect on cash flows, which will reflect the full benefit to the Company of using its tax loss carryforwards.
Liquidity and Capital Resources
Cash provided by operating activities was $25,904,000 and $18,575,000 for the six months ended June 30, 2002 and 2001, respectively. The increase in cash from operations in 2002 compared to 2001 is attributable to the acquisitions completed in the second quarter of 2001 which contributed $22,013,000 and $13,481,000 to operating cash flow during the six months ended June 30, 2002 and 2001, respectively. Cash provided by operating activities in 2001 included $8,949,000 from the Company’s three Virginia independent power projects which were sold on March 23, 2001.
Cash used in investing activities was $1,880,000 for the six months ended June 30, 2002, compared to cash used of $141,501,000 for the six months ended June 30, 2001. In 2002, additions to property and equipment using cash totaled $3,551,000 and proceeds of $504,000 from sales of used equipment provided cash. Also, during the first six months of 2002, WML deposited $2,977,000 into required restricted cash accounts for debt service and security deposits and earned interest income of $138,000. The $6,000,000 refund of collateral under the UMWA Master Agreement which was received during the second quarter of 2002 provided cash and reduced restricted cash. The primary use of cash in 2001 was $162,730,000 paid for acquisitions; and cash of $9,368,000 was received from the recoupment of collateral required for long-term security deposits and bond obligations. Cash used by investing activities in 2001 benefited by $15,166,000 in proceeds from the sale of the Company’s interests in the three Virginia independent power projects.
Cash used in financing activities was $14,726,000 for the six months ended June 30, 2002 compared to cash provided of $127,310,000 for the six months ended June 30, 2001. Cash used in financing activities in 2002 represented repayment of long-term debt of $9,000,000, the net repayment of revolving debt of $5,500,000 and dividends paid to WRI’s minority shareholder of $400,000. Cash in the amount of $174,000 was provided by the exercise of stock options in the first six months of 2002, compared to $604,000 in the corresponding period in 2001. Cash provided by financing activities during the six months ended June 30, 2001 included the net proceeds from the issuance of long-term debt and net borrowings under WML’s revolving line of credit.
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Consolidated cash and cash equivalents at June 30, 2002 totaled $14,531,000 (including $9,951,000 at WML and $3,937,000 at WRI). At December 31, 2001, cash and cash equivalents totaled $5,233,000 (including $624,000 at WML and $3,449,000 at WRI). The cash at WML is available to the Company through quarterly distributions as described below in Liquidity Outlook. The cash at WRI, an 80%-owned subsidiary, is available to the Company only through dividends. In addition, the Company had restricted cash and bond collateral, which were not classified as cash or cash equivalents, of $16,101,000 at June 30, 2002 and $18,423,000 at December 31, 2001. The restricted cash at June 30, 2002 included $11,160,000 in the WML debt service reserve accounts described above and $563,000 deposited in an escrow account pursuant to an agreement between WRI and WGI. The Company’s workers’ compensation and post retirement medical cost obligation bonds were collateralized by interest-bearing cash deposits of $4,378,000, which amount was classified as a non-current asset. In addition, the Company has reclamation deposits of $48,783,000, which were funded by certain customers to be used for payment of reclamation activities at the Rosebud Mine. The Company also has $4,600,000 in interest-bearing debt reserve accounts for certain of the Company’s independent power projects. This cash is restricted as to its use and is classified as part of the investment in independent power projects.
Liquidity Outlook
The major factors impacting the Company’s liquidity outlook are its significant heritage health benefit costs, its acquisition debt repayment obligations, and its ongoing business requirements. The Company’s principal sources of cash flow are dividends from WRI, distributions from independent power projects and distributions from WML subject to its debt agreement provisions. These items are discussed in detail in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001 along with the Company’s contractual obligations and commitments.
The detailed discussion of health benefit and retirement obligations contained in the 2001 Annual Report on Form 10-K will not be repeated here. However, it does bear reiteration that retiree health benefit costs continue to rise as a result of nationwide increases in medical service and prescription drug costs. Actuarial valuations of future obligations now indicate that these costs will continue to increase in the near term and then decline to zero over the next approximately thirty-five years as the number of eligible beneficiaries declines. In fact, the estimated liability for post retirement medical costs increased approximately $3 million between December 31, 2001 and June 30, 2002 due to an increase in the actuarially determined expense recognized. The Company currently expects to incur cash costs in excess of $19,000,000 for post-retirement medical benefits in 2002. The Company expects to incur cash costs of approximately $3,000,000 for workers’ compensation benefits in 2002, and expects that amount to steadily decline to zero over the next approximately nineteen years. There were no workers’ compensation obligations assumed in conjunction with the 2001 acquisitions as all the acquired operations are fully insured for that potential liability.
The Coal Industry Retiree Health Benefit Act of 1992 (“Coal Act”) authorized the Trustees of the 1992 UMWA Benefit Plan to implement security provisions for the payment of future benefits. The Trustees set the level of security for each company at an amount equal to three years’ benefits. The bond amount and the amount to be secured are reviewed and adjusted on an annual basis. The Company secured its obligation in 2001 by posting a bond for $21 million. The bond was collateralized by U.S. Government-backed securities in the amount of $7,968,000 at March 31, 2001 which amount the Company withdrew during second quarter 2001 in connection with a change of bonding agents. The Company’s previous bonding agent required collateral equal to approximately 40% of the bonded amount. The Company’s bond amount increased to approximately $25 million in early 2002 but was then reduced to approximately $22 million during the second quarter of 2002 by the Trustees of the 1992 UMWA Plan. The Company’s bonding agent required cash collateral of $300,000 to support the increased bond amount, which amount was deposited in June 2002. The amount of the bond collateral is periodically reviewed by the bonding agent and may be increased back to prior levels of approximately 40% of the bonded amount.
23
In connection with its dismissal from Chapter 11 in 1998, the Company agreed to secure its obligations under the Master Agreement for a period of six years by providing a Contingent Promissory Note (“Note”). The original principal amount of the Note was $12 million. The Company collateralized its obligations under the Note by posting $6 million in an escrow account. The Note is payable only in the event the Company does not meet its Coal Act obligations, fails to meet certain ongoing financial tests specified in the Note, or failed to maintain a required balance of $6 million in an escrow account through 2001. The Company met all of these requirements through 2001 and, accordingly, in January 2002, the principal amount of the Note was reduced to $6 million and the $6 million collateral was returned to the Company on May 1, 2002.
A Medicare prescription drug benefit that covers Medicare-eligible beneficiaries covered by the Coal Act could reduce one of the Company’s largest costs. Of the over $19 million per year paid for retirees’ health care costs, more than 50% is for prescription drugs. Provision of such a benefit continues to be debated on the national level, and although both Republicans and Democrats proposed new bills in the most recent Congress, neither of the bills passed before Congress recessed in August 2002. There is no assurance at this time what, if any, new proposal will be enacted into law or what effect that it may have on the Company’s obligation.
The Company expects that there will be continued upward pressure on corporate insurance and surety bonding rates as a result of insurers’ world-wide loss experiences over the past several years, the terrorist attacks in September 2001 and ongoing threats around the world. Property and casualty premiums are increasing by extraordinary amounts and some companies face limitations on the amount of coverage and bonding capacity available to them. Westmoreland was able to maintain all required insurance coverage and capacity as of July 1, 2002 but at higher premiums. The Company plans to form an offshore-based captive insurance company to help mitigate the effect of escalating premiums. The captive insurance company will elect to be a U.S. tax paying entity.
The Company’s acquisitions in 2001 greatly increase revenues and operating cash flow, and have returned the Company to profitability, but the cash used and financing arranged to make those acquisitions could also create short-term liquidity issues which must be managed. The Company used $39 million of available cash in the second quarter of 2001 to complete the acquisitions, knowing that short-term liquidity would be temporarily reduced by doing so. The terms of the acquisition financing facility also restricted distributions to the Company from WML, particularly through March 2002 while the required debt service reserve account was being initially funded. Distributions available from WML increased in the second quarter of 2002 when a one-time reduction in the debt service reserve account of approximately $2 million was realized after the $20 million Term A Notes were fully repaid at June 28, 2002. However, the debt financing requires that 25% of excess cash flow, as defined, be used to fund the balloon payment due in 2008. Therefore, only 75% of WML’s excess cash flow is available to the Company until the debt is paid off.
The Company’s ongoing and future business needs may also affect liquidity. The Company does not anticipate that its coal and power production will on average diminish materially as a result of the current economic downturn because the independent power projects in which the Company owns interests and the power plants that purchase coal mined by the Company produce relatively low-cost, baseload power. In addition, almost all of the Company’s production is sold under long-term contracts, which help insulate the Company from unfavorable reductions in tons sold. However, contract price reopeners and market competition could affect future price and production levels. Also, the Company’s largest customers include two utilities which have recently had subsidiaries suffer downgraded credit ratings which may later affect the customers as the entire energy industry is impacted by tighter liquidity. The Company invoices its customers for coal sales either semi-monthly or monthly and limits its credit exposure by closely monitoring its accounts receivable.
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Effective July 1, 2002, the Company reached an agreement with Reliant Energy, Inc. on the price and tons of lignite committed to the Limestone Station from the Jewett Mine for the second half of 2002 through December, 2003 under the Amended Lignite Supply Agreement (“ALSA”) which expires in 2015. Sales to Reliant represented approximately 40% of the Company’s total coal revenues for the first six months of 2002. As reported previously, the ALSA, entered into by the Jewett Mine’s prior owner in 1998, called for a change beginning July 1, 2002 from a cost-plus fees contract to one with an annually determined market-based pricing mechanism. As expected, the transition to an equivalent price determined in large part by reference to, among other things, market prices for higher Btu Southern Powder River Basin coal will result in revenues and profit at the Jewett Mine that will be less than historical cost-plus levels beginning in the third quarter of 2002 and for at least the next 18 months. However, our settlement with Reliant for this first period provides price and tonnage which should assure that the Jewett Mine is profitable for at least the next year and a half. Under the terms of the ALSA, which preserved Jewett’s right to supply 100% of Limestone’s fuel requirements, so long as the equivalent price is met, the price for the Jewett Mine’s lignite will be renegotiated annually for each twelve-month period after 2003. Higher market prices for coal could benefit Jewett in the future. Another important element of the settlement reached by the parties in July is that Jewett will have the opportunity to work with Reliant on Limestone’s NOx compliance strategy, which could also affect the value and demand for Jewett’s coal beginning in 2004. Reliant is obligated under the settlement to make best efforts to achieve NOx compliance with a blend of fuel that includes a minimum of 7 million tons per year of lignite.
In previous years, WRI expended approximately $4,100,000 to repair the dragline at WRI. All of these expenditures assure the productive life of the dragline and therefore, were capitalized. The Company believes that, under the terms of WRI’s agreements with WGI, WGI is responsible for all of these expenditures. WRI expended these amounts to assure continued, uninterrupted production at WRI, and has demanded reimbursement from WGI for the full cost of the repair. WGI has reimbursed WRI for approximately $530,000 of these costs. On March 7, 2000, WRI commenced litigation against WGI in the United States District Court for the District of Montana seeking, among other things, payment by WGI of approximately $3.6 million of dragline repair costs paid by WRI, plus accrued interest. The Company has not recorded any amounts that may be recoverable from WGI in its Consolidated Financial Statements. On March 2, 2001, WGI announced that it was facing a severe near-term liquidity problem due to a delay in resolving purchase price adjustments in connection with an acquisition and in May 2001, WGI sought protection in the bankruptcy court in Reno, Nevada. WRI filed claims against WGI to recover the cost of repairing the dragline tub, for overcharges on mining costs, potential royalty underpayment as alleged by the Minerals Management Service in a recent demand letter and seeking adequate assurances that WGI will perform its contractual obligations regarding reclamation. In addition, WRI objected to the assumption of existing contract mining agreements between WRI and WGI. While WGI’s plan of reorganization has been approved, WRI’s issues remain unresolved and pending in the bankruptcy court. The bankruptcy court lifted the automatic stay and will allow the tub litigation to proceed in the United States District Court in Billings, Montana. It is expected that some or all of these issues will be resolved this year; however, the Company cannot currently determine what impact, if any, the reorganization may have on its operations or this litigation.
The final purchase price for the acquisition of Montana Power’s coal business is subject to adjustment as discussed above in the section “Impact of Acquisitions.” The outcome of this matter will affect the Company’s outstanding debt and liquidity.
The Company has certain contract contingencies, which may impact future sales, prices received and cost of operations. These include, but are not limited to:
| • | WRI’s dispute with WGI regarding both past and current pricing for contract mining services. As described in Note 8 to the Consolidated Financial Statements, the dispute regarding pricing for contract mining services constrains the earnings of WRI (and the Company) and may continue to limit the amount of dividends from WRI to the Company, consistent with historical dividend levels, until the dispute is resolved. A favorable outcome would decrease cost of coal sales and could increase net earnings, dividends, and cash flow to the Company. |
| • | Replacement or extension of the current coal supply agreement with WRI’s largest customer which expires at the end of 2002. The impact of any new agreement with Xcel can not be determined without the resolution of a new contract mining agreement with WGI. |
| • | A price reopener triggered in July 2001 under WECO’s Coal Supply Agreement with Colstrip Units 1 and 2. The Company believes that the price reopener will ultimately result in an increase in the overall value of the Coal Supply Agreement to the Company. |
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In addition, there are other issues regarding royalty payments and reclamation obligations, which may affect the Company but their impact is not known at this time.
DTA is being utilized at less than capacity and is incurring operating losses due to the continued softness of the export market for U.S. coal. Alternatives for this facility and steps to lower operating losses are being pursued.
The Company has a 4.49% interest in the Ft. Lupton power project. No distributions have been received from that project since 1999 and are not expected to resume until 2005.
The Company is mindful of the need to manage costs with respect to the timing of receipts, and variations in distributions or expected performance. Therefore, the Company continues to take steps to conserve cash wherever possible. The Company has in place a $7 million revolving line of credit for general corporate purposes, of which $3.5 million was available as of June 30, 2002.
The Company also aims to increase its sources of profitability and cash flow. Given possible future demand for new power generating capacity, stronger energy pricing, the need for stabilizing fuel and electricity costs, and pressure to reduce harmful emissions into the environment, the Company believes that its strategic plan positions it well for potential further growth, profitability, and improved liquidity.
The Company’s growth plan is focused on acquiring profitable businesses and developing projects in the energy sector which complement the Company’s existing core operations and where America’s dual goals of low cost power and a clean environment can be effectively addressed. The Company has sought to do this in niche markets that minimize exposure to competition, maximize stability of long-term cash flows and provide opportunities for synergistic operation of existing assets and new opportunities. A key to the Company’s strategy is the availability of approximately $181 million in NOLs at the end of 2001. The availability of these NOLs can shield the Company’s future taxable income from payment of regular Federal income tax and thereby increase the return the Company receives from profitable investments (as compared to the return a tax-paying entity would receive that cannot shield its income from federal income taxation).
Sources of potential additional future liquidity also include the sale of non-strategic assets, reimbursement of amounts paid to the 1974 UMWA Pension Plan, increased cash flow from existing operations and collection of approximately $1.0 million if the pending Ft. Drum dispute with the U.S. Army is awarded as described in Item 1, “Legal Proceedings”.
In conclusion, there are many factors which can both positively or negatively affect the Company’s liquidity and cash flow. Management believes that cash flows from operations, along with available borrowings, should be sufficient to pay the Company’s heritage health benefit costs, meet repayment requirements of the debt facilities, and fund ongoing business activities as long as currently anticipated surplus cash distributions from WML are received. At the same time, the Company continues to explore contingent sources of additional liquidity on an ongoing basis and to evaluate opportunities to expand and/or restructure its debt obligations and improve its capital structure.
Preferred Dividends and Stock Repurchase Plan
The Board of Directors regularly reviews the subjects of reinstating the preferred stock dividend and satisfying the accumulated unpaid dividends on the preferred stock, and is committed to meeting its obligations to the preferred shareholders in a manner consistent with the best interests of all shareholders. On August 9, 2002 the Board of Directors declared a dividend of $0.15 per depositary share payable on October 1, 2002 to holders of record as of September 17, 2002. Each depositary share represents one-quarter of a share of the Company’s Series A Convertible Exchangeable Preferred Stock.
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Westmoreland’s Board of Directors also authorized the repurchase of up to 10% of the outstanding depositary shares on the open market or in privately negotiated transactions with institutional and accredited investors. The timing and amount of depositary shares repurchased will be determined by the Company’s management based on its evaluation of the Company’s capital resources, the price of the depositary shares offered to the Company and other factors. The program will expire at the end of 2004. Any acquired shares will be converted into shares of Series A Convertible Exchangeable Preferred Stock and retired. The repurchase program will be funded from working capital which may be currently available, or become available to the Company.
Resumption of a dividend payment and the repurchase plan reflect the reestablishment of profitability as a result of the Company’s successful initial implementation of its strategic plan for growth and the Company’s continuing commitment to preferred shareholders.
RESULTS OF OPERATIONS
Quarter Ended June 30, 2002 Compared to Quarter Ended June 30, 2001.
Coal Operations.The increase in coal revenues to $81,888,000 in the second quarter of 2002 from $51,792,000 in 2001‘s second quarter is the result of including a full three months of contributions from acquired mines in 2002 compared to two months in 2001. Almost all of the tons sold in 2002 were sold under long-term contracts, primarily to owners of power plants located adjacent to the mines. Equivalent tons sold include petroleum coke sales which continued through June 2002. Costs as a percentage of revenues increased to 76% in 2002 compared to 75% during the second quarter of 2001. In addition, the change from a cost-plus fees contract to an annually determined market-based price after July 1, 2002 at NWR’s Jewett Mine will reduce revenues and profit on its annual production of seven to eight million tons through 2003. Tons and prices will be renegotiated annually for each twelve-month period after 2003 through expiration of the contract in 2015.
The second quarter of 2002 results from coal operations were negatively impacted by reduced power plant demand due to the continued mild weather which particularly reduced tons sold at the Jewett Mine. An unplanned outage at the Colstrip Station also occurred in June 2002 and continued into July. This significantly reduced sales from the Rosebud Mine during the second quarter. Mining operations were adjusted to the extent possible to minimize costs during the outage. It is anticipated that some of the tons not sold in the quarter due to the outage will be made up later in the year.
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The following table shows comparative coal revenues, sales volumes, cost of sales and percentage changes between the periods:
| | Quarter Ended | |
| | June 30, | |
| | 2002 | | 2001 | Change |
|
|
|
|
|
|
| | | | | | |
| Revenues – thousands | $ | 81,888 | $ | 51,792 | 58% |
| | | | | | |
| Volumes – millions of equivalent coal tons | | 6.283 | | 4.648 | 35% |
| | | | | | |
| Cost of sales – thousands | $ | 62,617 | $ | 38,872 | 61% |
Depreciation, depletion and amortization increased to $3,039,000 in second quarter 2002 compared to $2,880,000 in 2001’s second quarter as a result of the full impact of the acquisitions.
Independent Power. Equity in earnings from independent power projects was $1,795,000 in the second quarter 2002 compared to $1,936,000 in the quarter ended June 30, 2001. Both periods had scheduled maintenance outages which resulted in an expected lower capacity factor. For the quarters ended June 30, 2002 and 2001, the ROVA projects produced 360,000 and 362,000 megawatt hours, respectively, and achieved average capacity factors of 79% in both quarters.
Terminal Operations.Losses at Westmoreland Terminal Company (“WTC”), a wholly-owned subsidiary of the Company, continue due to low throughput volume at Dominion Terminated Associates (“DTA”) as a result of continued weakness in the export market and cost-sharing obligations. WTC owns a 20% interest in DTA. WTC is dependent upon its customers’ coal export business to maintain an acceptable level of throughput. The coal export business has experienced a significant decline due to a decline in worldwide demand for metallurgical as well as steam coal and intense competitive pressure from coal suppliers in other nations. The Company does not believe that those competitive pressures will abate in the near term. The Company is pursuing several alternatives to reduce or eliminate losses at DTA.
Costs and Expenses.Selling and administrative expenses were $7,023,000 in the quarter ended June 30, 2002 compared to $5,555,000 in the quarter ended June 30, 2001. The amount for the second quarter of 2002 and 2001 includes $4,573,000 and $3,103,000, respectively, incurred by the four mines acquired effective April 30, 2001. The increase was partially reduced by a decrease in non-cash compensation expense for the Company’s 2000 Performance Unit Plan, which provided a credit of $650,000 in the second quarter of 2002 compared to a $647,000 expense during the second quarter of 2001. Of the $650,000 credit, $84,000 was a non-cash expense for performance units granted in 2001 and $734,000 was a non-cash credit for performance units granted in 2000. The long-term incentive plan is designed to link management interests with those of shareholders by tieing long-term incentive compensation directly to appreciation in value of the Company’s common stock. Performance units were granted in 2000 and 2001 because the Company did not have adequate numbers of qualified stock options available for award. The expense for these plans (performance units, unlike stock options, are expensed) fluctuates with changes in the market value of the Company’s common stock. Vesting occurs over three years, but none of the performance units granted in 2000 will be paid until 2003 and none of the performance units granted in 2001 will be paid until 2004, and all can be paid by issuing Company stock, if approved by shareholders, and at the discretion of the Board of Directors. The amount payable for the performance units granted in 2001 is capped to limit the potential amount of variable expense. A similar long-term incentive plan was adopted effective June 1, 2002. The overall increase in selling and administrative expenses in 2002 is due to annual salary increases and the addition of employees associated with the Company’s growth.
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Heritage health benefit costs increased 4%, or $236,000, in the second quarter 2002 compared to second quarter 2001 as a result of increased actuarially determined costs for postretirement medical plans partially offset by a favorable actuarial valuation adjustment to the pneumoconiosis benefit obligation.
Interest expense was $2,729,000 and $2,219,000 for the three months ended June 30, 2002 and 2001, respectively. The increase was due to the full impact of the acquisition financing. Interest income decreased in 2002 due to lower rates despite the larger deposit accounts acquired in the acquisitions.
As a result of the recent acquisitions, the Company recognized a $55,600,000 deferred income tax asset in April 2001 which assumes that a portion of previously unrecognized net operating loss carryforwards will be utilized because of the projected generation of future taxable income. The asset increased to $56,783,000 as of June 30, 2002 because of temporary differences (such as accruals for pension and reclamation expense, which are not deductible for tax purposes until paid) arising during the intervening period and due to a reduction of the deferred income tax valuation allowance discussed below and is comprised of both a current and long-term portion. When taxable income is generated, the deferred tax asset relating to the Company’s net operating loss carryforwards is reduced and a deferred tax expense (non-cash) is recognized although no regular Federal income taxes are paid. Income tax expense for 2002 represents a current income tax obligation for State income taxes, the utilization of a portion of the Company’s net operating loss carryforwards and the impact of changes in deferred tax assets and liabilities. The Federal Alternative Minimum Tax regulations were changed to allow 100% utilization of net operating loss carryforwards in 2001 and 2002 thereby eliminating the Company’s current Federal income tax expense. During the second quarter of 2002, an additional deferred tax benefit of $600,000 was recognized by reducing the valuation allowance associated with unused Federal net operating loss carryforwards which are expected to be utilized. This benefit reduced the deferred tax expense for the quarter.
Other Comprehensive Income. The other comprehensive loss of $218,000 (net of income taxes of $145,000) recognized during the quarter ended June 30, 2002 represents the change in the unrealized loss on an interest rate swap agreement on the ROVA debt caused by changes in market interest rates during the period. This compares to other comprehensive loss of $2,321,000 (net of income taxes of $1,547,000) for the quarter ended June 30, 2001. If market interest rates continue to decrease prior to repayment of the debt, additional comprehensive losses will be recognized. Conversely, increases in market interest rates would result in comprehensive gains.
Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001
Coal Operations. Coal revenues increased to $160,304,000 for the six months ended June 30, 2002 from $62,208,000 for the six months ended June 30, 2001. This increase is primarily the result of the acquisitions completed during 2001. Costs, as a percentage of revenues, were 76% in 2002 and 2001.
The coal operations results for the first six months of 2002 were negatively impacted by reduced power plant demands at LEGS which is supplied by the Jewett Mine and unplanned outages at the Colstrip Station, affecting shipments from the Rosebud Mine during the first quarter as discussed above.
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The following table shows comparative coal revenues, sales volumes, cost of sales and percentage changes between the periods:
| | Six Months Ended | |
| | June 30, | |
| | 2002 | | 2001 | Change |
|
|
|
|
|
|
| | | | | | |
| Revenues – thousands | $ | 160,304 | $ | 62,208 | 158% |
| | | | | | |
| Volumes – millions of equivalent coal tons | | 12.859 | | 6.137 | 110% |
| | | | | | |
| Cost of sales – thousands | $ | 121,482 | $ | 47,262 | 157% |
Independent Power.Equity in earnings from the independent power projects was $6,592,000 and $8,265,000 for the six months ended June 30, 2002 and 2001, respectively. For the six months ended June 30, 2002 and 2001, the ROVA projects produced 803,000 and 809,000 megawatt hours, respectively, and achieved capacity factors of 88% in both periods. The 2001 period includes $1,286,000 in equity in earnings from the three Virginia projects that were sold in March 2001.
Costs and Expenses. Selling and administrative expenses were $15,708,000 for the six months ended June 30, 2002 compared to $9,200,000 for the six months ended June 30, 2001. The increase includes $9,651,000 incurred by the Company’s four new mines for the full six months in 2002 compared to $3,104,000 for the two months included in 2001. There was a decrease in 2002 in the non–cash compensation expense for the Company’s Performance Unit Plan which was $577,000 in the first six months of 2002 compared to $2,378,000 in 2001. The design and vesting of this plan is discussed in the quarter-to-quarter comparison above.
Heritage health benefit costs increased 14%, or $1,594,000, in the 2002 six-month period compared to 2001 as a result of increased actuarially determined costs for postretirement medical plans.
During the first six months of 2002, there was a $40,000 gain from the sale of used mine equipment. For the first six months of 2001 there was a loss of $123,000 related to the Ft. Drum independent power project and a $669,000 loss related to the sale of the Company’s interest in the three Virginia independent power projects.
Interest expense was $5,534,000 and $2,433,000 for the six months ended June 30, 2002 and 2001, respectively. The increase was mainly due to the acquisition financing obtained during the second quarter of 2001. Interest income decreased in 2002 due to lower rates earned and despite the larger deposits acquired in the acquisitions.
When taxable income is generated, the deferred tax asset relating to the Company’s net operating loss carryforwards is reduced and a deferred tax expense (non-cash) is recognized although no regular Federal income taxes are paid. Current income tax expense in both 2002 and 2001 relate to state income tax obligations. During the first six months of 2002, the deferred tax expense of $421,000 is net of a $1,100,000 benefit recognized for the reduction of the valuation allowance associated with unused Federal net operating loss carryforwards which are expected to be utilized.
Other Comprehensive Income.The other comprehensive income of $58,000 (net of income taxes of $39,000) recognized during the six months ended June 30, 2002 represents the change in the unrealized loss on an interest rate swap agreement on the ROVA debt caused by changes in market interest rates during the period. This compares the other comprehensive loss of $2,321,000 (net of income taxes of $1,547,000) for the six months ended June 30, 2001.
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2002 Second Quarter Compared to 2002 First Quarter
Although not required, the following information provides a basis for comparative evaluation of performance, by segment, between the second quarter and the first quarter of 2002. This information is being provided in this filing in an effort to help investors follow the Company’s performance after the 2001 acquisitions until next quarter when the financial information that compares one quarter to the corresponding quarter in the prior year becomes more comparable because the acquired operations will have been included in the results of both quarters in each year.
| | Coal |
| | Quarter
ended | | Quarter
ended |
| | 6/30/2002 | | 3/31/2002 |
|
|
|
|
|
| | (in thousands) |
| | | | | |
| Revenues – coal | $ | 81,888 | $ | 78,416 |
| | | | | |
| Costs and expenses: | | | | |
| Cost of sales – coal | | 62,617 | | 58,865 |
| Depreciation, depletion | | | | |
| and amortization | | 3,012 | | 3,123 |
| Selling and administrative | | 5,301 | | 5,391 |
| Gains on sales of assets | | - | | (40) |
| Doubtful account recoveries | | (271) | | (46) |
|
|
|
|
|
| | 70,659 | | 67,293 |
| | | | | |
| Operating income | $ | 11,229 | $ | 11,123 |
|
|
|
|
|
| | Revenues increased during the second quarter as a result of increased sales tonnage and a higher price per ton at the Jewett Mine. This increase was partially offset by an unscheduled outage at Colstrip Unit 3, which is supplied by the Company’s Rosebud Mine. |
| | Cost of sales – coal increased primarily due to the increased reclamation and stripping costs at the Jewett Mine. |
| | Independent Power | | Terminal Operations |
| | Quarter ended | | Quarter ended | | Quarter ended | | Quarter ended |
| | 6/30/2002 | | 3/31/2002 | | 6/30/2002 | | 3/31/2002 |
|
|
|
|
|
|
|
|
|
| | (in thousands) |
| Revenues - | | | | | | | | |
| equity in earnings | | | | | | | | |
| (share of losses) | $ | 1,795 | $ | 4,797 | $ | (534) | $ | (530) |
| | | | | | | | | |
| Costs and expenses: | | | | | | | | |
| Depreciation, depletion | | | | | | | | |
| and amortization | | 3 | | 2 | | - | | - |
| Selling and administrative | | 214 | | 232 | | 93 | | 18 |
|
|
|
|
|
|
|
|
|
| | 217 | | 234 | | 93 | | 18 |
| | | | | | | | | |
| Operating income (loss) | $ | 1,578 | $ | 4,563 | $ | (627) | $ | (548) |
|
|
|
|
|
|
|
|
|
| | Independent Power: | The first quarter benefited from higher utilization at the ROVA projects compared to the second quarter which had a scheduled outage at the ROVA I plant. |
31
| | Terminal Operations: | Terminal operations losses reflect low throughput volumes. Selling and administrative expenses increased as a result of legal fees incurred during the second quarter. |
| | Corporate |
| | Quarter
ended | | Quarter
ended |
| | 6/30/2002 | | 3/31/2002 |
|
|
|
|
|
| | (in thousands) |
| | | | | |
| Revenues | $ | - | $ | - |
| | | | | |
| Costs and expenses: | | | | |
| Depreciation, depletion | | | | |
| and amortization | | 24 | | 24 |
| Selling and administrative | | 1,415 | | 3,205 |
| Heritage health benefit costs | | 6,286 | | 6,726 |
|
|
|
|
|
| | 7,725 | | 9,955 |
| | | | | |
| Operating loss | $ | (7,725) | $ | (9,955) |
|
|
|
|
|
| | Selling and administrative costs decreased in the second quarter of 2002 due to a non-cash credit of $650,000 for the Performance Unit Plan as a result of the decrease in stock price and vesting compared to a $1,168,000 non-cash expense recognized during the first quarter of 2002 as a result of the increase in stock price and vesting. Also, costs were higher in the first quarter 2002 due to the accrual of annual bonuses approved in 2002 for 2001 performance. |
| | Heritage health benefit costs decreased in the second quarter compared to the first quarter primarily as a result of an increase in the overfunding of the pneumoconiosis benefit obligation caused by an increase in the fair value of trust assets due to decreased long-term interest rates, offset by an increase in the obligation for post retirement medical costs. |
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued SFAS No. 143,Accounting for Asset Retirement Allocations.SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset and is effective for fiscal years beginning after June 15, 2002. Management is currently assessing the impact, if any, of SFAS 143 on the Company’s consolidated financial statements for future periods.
32
ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risk, including the effects of changes in commodity prices and interest rates as discussed below.
Commodity Price Risk
The Company, through its subsidiaries Westmoreland Resources, Inc. and Westmoreland Mining LLC, produces and sells coal to third parties from coal mining operations in Montana, North Dakota and Texas, and through its subsidiary Westmoreland Energy, Inc. produces and sells electricity and steam to third parties from its independent power projects located in North Carolina and Colorado. Nearly all of the Company’s coal production and all of its electricity and steam production is sold through long-term contracts with customers. These long-term contracts can help to reduce the Company’s annual exposure to market changes in commodity prices. The Company has not entered into derivative contracts to manage its exposure to changes in commodity prices, and was not a party to any such contracts at June 30, 2002.
Interest Rate Risk
The Company is subject to interest rate risk on its revolving lines of credit, which have variable rates of interest indexed to either the prime rate or LIBOR. Interest rates on these instruments approximate current market rates as of June 30, 2002. Based on the balances outstanding as of June 30, 2002, a one percent change in the prime interest rate or LIBOR would increase interest expense by $55,000 on an annual basis. The Company’s heritage health benefit costs are also impacted by interest rate changes because its pension, pneumoconiosis and post-retirement medical benefit obligations are recorded on a discounted basis.
33
PART II - OTHER INFORMATION
ITEM 1
LEGAL PROCEEDINGS
Washington Group International, Inc. ("WGI") has filed a petition in the U.S. Bankruptcy Court in Reno, Nevada. WRI has asserted various claims and has objected to WGI’s assumption of the mining contract between WRI and WGI. All of the claims and the objection to the contract assumption are pending. See Note 8 "Contingencies" to the Consolidated Financial Statements, which is incorporated by reference herein.
As described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, “Item 3 - Legal Proceedings,” the Company has other litigation which is still pending. As discussed in Note 8 “Contingencies” of the Notes to Consolidated Financial Statements, on July 5, 2002 the New York Appellate Division affirmed the decision of the New York Supreme Court in the purchase price adjustment litigation. However, on August 8, 2002, the Company received notice that Entech has petitioned the New York Court of Appeals, the highest court in the State of New York, to exercise its judicial discretion and accept an appeal of the decisions of the Appellate Division and Supreme Court granting Westmoreland’s petition to compel compliance with the terms of the Stock Purchase Agreement. The Company will respond to the petition in the next several weeks.
When Westmoreland Energy’s interest in the Ft. Drum Project was sold, the Company retained its rights to any award in a pending dispute with the U.S. Army over its unilateral decision to reduce the contract price paid for high temperature water produced by the Ft. Drum power project. On April 5, 2002, the administrative procedures associated with a review of the U.S. Army decision to reduce the contracted price has resulted in a favorable verdict. It is not known if the U.S. Army will appeal this decision. If the judgement is not appealed and becomes final the Company expects to receive approximately $1.0 million.
ITEM 3
DEFAULTS UPON SENIOR SECURITIES
See Note 4 “Capital Stock” to the Consolidated Financial Statements, which is incorporated by reference herein.
34
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An Annual Meeting of Shareholders was held on May 23, 2002. Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934. Three proposals were voted upon at the meeting.
The first proposal was the election by the holders of Common Stock of seven members of the Board of Directors. The tabulation of the votes cast with respect to each of the nominees for election as a Director is set forth as follows:
|
|
|
| Name | Votes For | Votes Withheld |
|
|
|
| Pemberton Hutchinson | 6,731,466 | 514,424 |
| William R. Klaus | 6,732,042 | 513,848 |
| Thomas W. Ostrander | 6,734,847 | 511,043 |
| Christopher K. Seglem | 6,572,372 | 673,518 |
| Thomas J. Coffey | 6,734,246 | 511,644 |
| Robert E. Killen | 6,734,246 | 511,644 |
| James W. Sight | 6,733,746 | 512,144 |
|
|
|
Messrs. Hutchinson, Klaus, Ostrander, Seglem, Coffey, Killen and Sight were elected.
There were no abstentions or broker non-votes.
The second proposal was the election by the holders of Depositary Shares of two members of the Board of Directors. Each Depositary Share represents one-quarter of a share of the Company’s Series A Convertible Exchangeable Preferred Stock (“Series A Preferred Stock”), the terms of which entitle the holders to elect two directors if six or more Preferred Stock dividends have accumulated. The tabulation of the votes cast with respect to each of the nominees for election as a Director, expressed in terms of the number of Depositary Shares, is as follows:
|
|
|
| Name | Votes For | Votes Withheld |
|
|
|
| Michael Armstrong | 745,267 | 53,278 |
| William M. Stern | 745,267 | 53,278 |
|
|
|
Messrs. Armstrong and Stern were elected.
There were no abstentions or broker non-votes.
The third proposal was the approval of the 2002 Long-Term Incentive Stock Plan (the “Plan”). The Plan provides for the grant of incentive stock options, non-qualified stock options and stock awards by a committee or sub-committee of the Company’s Board of Directors to executives, managers and key employees of the Company and designated subsidiaries of the Company. Holders of Common Stock and Depositary Shares voted together on this proposal. The tabulation of votes is as follows:
| Votes For | Votes Against | Abstentions |
| 2,489,664 | 1,973,193 | 20,202 |
There were no broker non-votes.
35
ITEM 6
EXHIBITS AND REPORTS ON FORM 8-K
| | a) | Exhibits |
| | | |
| | | 10.1 Letter Agreement dated June 18, 2002 between Reliant Energy – HL&P and Northwestern Resources Co. (confidential treatment has been requested as to certain portions, which portions have been omitted and filed separately with the Securities and Exchange Commission) |
| | | (1) | On July 31, 2002, the Company filed a report on Form 8-K regarding its press release on July 31, 2002 providing an earnings estimate for the second quarter ended June 30, 2002. |
| | | | |
| | | (2) | On August 9, 2002, the Company filed a report on Form 8-K announcing its Board of Directors has authorized a dividend of $0.15 per depository share payable on October 1, 2002 to holders of record as of September 17, 2002. Each depository share represents one-quarter of a share of the Company’s Series A Convertible Exchangeable Preferred Stock. The Company’s Board of Directors also authorized the repurchase of up to 10% of the outstanding depository shares on the open market or in privately negotiated transactions with institutional and accredited investors. |
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| WESTMORELAND COAL COMPANY |
| | |
| Date: August 14, 2002 | /s/ Ronald H. Beck |
| Ronald H. Beck |
| Vice President - Finance and |
| Treasurer |
| (A Duly Authorized Officer) |
| | |
| | /s/ Thomas S. Barta |
| Thomas S. Barta |
| Controller |
| (Principal Accounting Officer) |
| | |
STATEMENT PURSUANT TO 18 U.S.C.§1350
Pursuant to 18 U.S.C. § 1350, each of the undersigned certifies that this Quarterly Report on Form 10-Q for the period ended June 30, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in this report fairly presents, in all material respects, the financial condition and results of operations of Westmoreland Coal Company.
| Dated: August 14, 2002 | /s/ Christopher K. Seglem |
| Christopher K. Seglem |
| Chief Executive Officer |
| | |
| Dated: August 14, 2002 | /s/ Robert J. Jaeger |
| Robert J. Jaeger |
| Chief Financial Officer |
37
Exhibit Index
10.1 Letter Agreement dated June 18, 2002 between Reliant Energy-HL&P and Northwestern Resources Co. (confidential treatment has been requested as to certain portions, which portions have been omitted and filed separately with the Securities and Exchange Commission)
Exhibit 10.1
Confidential Materials omitted and filed separately with the Securities and Exchange
Commission. Asterisks denote omissions.
Reliant Energy – HL&P Letterhead
June 18, 2002
Mr. Todd A. Myers
Vice President - Sales & Marketing
Northwestern Resources Co.
P.O. Box 915
Jewett, Texas 75846-0915
Re: Letter agreement regarding Lignite Supply Agreement
Dear Mr. Myers:
This letter agreement is intended to memorialize certain agreements regarding the Settlement Agreement and Amendment of Existing Contracts dated August 2, 1999 (“Agreement”), between Reliant Energy – HL&P (“Reliant Energy”) and Northwestern Resources Co. (“NWR”). All capitalized terms shall have the meaning used in the Agreement. The parties mutually agree as follows:
| 1. | For the period of July 1, 2002 to December 31, 2003, the Redetermined Price for the Commitment volumes (refer to commitment letter from NWR to Reliant Energy dated June 22, 2000) shall be [**] per mmbtu ($[**]/mmbtu). |
| 2. | NWR waives its Right of First Refusal for the Remaining Anticipated Fuel Requirements under section D.18 for the July 1, 2002 to [**], 2002 period only. |
| 3. | Reliant Energy may burn up to [**] tons of PRB coal ("Test Burn") from June 1, 2002 to [**] 2002. |
| 4. | Reliant Energy agrees to employ testing protocols and provide sufficient notice to NWR to assure that NWR representatives are able to be present and to observe and monitor all test burns and their results. Reliant Energy also agrees to provide NWR, on a confidential basis, the results and analysis of such test burns, and all related data, as they become available to Reliant Energy. |
| 5. | If the burn of the [**] tons of PRB coal causes the Limestone Plant to require less than the Commitment volume of lignite during the period July 1, 2002 to [**], 2002, Reliant Energy shall provide Shortfall Compensation to NWR at the rate of $[**]/MMBtu on all volumes shipped per each [**] tons below the [**] million ton Commitment for the second half of 2002, up to a total of [**] tons (i.e, (i) [**] ton reduction in Committed volume increases the price on all quantities shipped by $[**]/mmBtu; (ii) [**] ton reduction in committed volume increases the price on all quantities shipped by $[**]/mmBtu; (iii) [**] ton reduction in Committed volume increases the price on all quantities shipped by $[**]/mmBtu; and (iv) [**] ton reduction in Committed volume increases the price on all quantities shipped by $[**]/mmBtu). In the event the shortfall exceeds [**] tons, the Parties shall revert to the existing contract for remedies, if any. Reliant Energy and NWR understand and agree that the Test Burn may extend into the [**]. No later than thirty (30) days after the Test Burn is completed, Reliant Energy will commit to lignite deliveries scheduled for the years [**] and [**]. |
| 6. | During the period from July 1, 2002 through [**], REI shall use its best efforts to establish the Limestone Energy Generating Station’s (“LEGS”) capability to comply with NOx regulations via a lignite-to-PRB blend of at least 7 million tons per year of lignite. |
| 7. | Reliant Energy agrees to purchase from NWR a target of [**] tons per month of [**] to be delivered by NWR from [**] to [**]. |
| 8. | NWR shall stay all litigation through February 28, 2003. The Parties may extend this period by mutual agreement. The parties understand that the Court may not stay the litigation for the period of time desired by the parties. In that event, NWR agrees to dismiss the litigation without prejudice to refiling the same. |
| 9. | After Reliant Energy files a Motion to Transfer Venue and its Original Answer, Reliant Energy will refrain from taking any legal action, either original or in response to the NWR suit, until at least February 28, 2003. Reliant Energy and NWR shall jointly seek a Stay of the pending litigation. Parties agree that this delay will not constitute a waiver of any rights currently available to either Party, including, but not limited to, Reliant Energy’s position that the matters raised in the pending lawsuit are subject to arbitration. |
| 10. | Notwithstanding the foregoing, Reliant Energy & NWR agree to use their best efforts to continue working together to select an arbitrator as soon as possible. |
If you agree to the terms of this letter agreement, please sign below and return to me by June 18, 2002.
| | Sincerely, |
| | |
| | /s/ David G. Tees |
| | David G. Tees |
| | Sr. Vice President Generation Operations |
ACCEPTED AND AGREED this 18th day of June, 2002
NORTHWESTERN RESOURCES CO.
By: /s/ Todd A. Myers
Todd A. Myers
