One of the estimates we have made relates to the implementation of the Medicare Prescription Drug Improvement and Modernization Act of 2003 (“Medicare Reform Act”). As provided for under that Act, we recognized a benefit to our anticipated future prescription drug costs for retirees and their dependents in 2003 based on a coordinated implementation of the Medicare Reform Act and our existing benefit programs, including the UMWA 1992 Plan. Earlier this year the government issued regulations which make the subsidy approach the only practical alternative given our existing programs. We are currently reviewing the impact of these regulations on our total prescription drug obligation. The subsidy approach will limit our annual benefit to 28% (to a maximum of $1,330/participant) of actual costs. We expect that a revised actuarial analysis could result in a reduction of approximately $5 million in the projected net present value benefit to us from the Medicare Reform Act and a higher resultant future annual expense than we had anticipated with a coordinated benefits approach.
Asset retirement obligations primarily relate to the closure of mines and the reclamation of land upon cessation of mining. We account for reclamation costs, along with other costs related to mine closure, in accordance with Statement of Financial Accounting Standards No. 143 – Asset Retirement Obligations, or SFAS No. 143, which we adopted on January 1, 2003. This statement requires us to recognize the fair value of an asset retirement obligation in the period in which we incur that obligation. We capitalize the present value of our estimated asset retirement costs as part of the carrying amount of our long-lived assets.
The liability “Asset retirement obligations” on our consolidated balance sheet represents our estimate of the present value of the cost of closing our mines and reclaiming land that has been disturbed by mining. This liability increases as land is mined and decreases as reclamation work is performed and cash expended. The asset, “Property, plant and equipment – capitalized asset retirement costs,” remains constant until new liabilities are incurred or old liabilities are re-estimated. We estimate the future costs of reclamation using standards for mine reclamation that have been established by the government agencies that regulate our operations as well as our own experience in performing reclamation activities. These estimates may change. Developments in our mining program also affect this estimate by influencing the timing of reclamation expenditures.
We amortize our acquisition costs, development costs, capitalized asset retirement costs and some plant and equipment using the units-of-production method and estimates of recoverable proven and probable reserves. We review these estimates on a regular basis and adjust them to reflect our current mining plans. The rate at which we record depletion also depends on the estimates of our reserves. If the estimates of recoverable proven and probable reserves decline, the rate at which we record depletion increases. Such a decline in reserves may result from geological conditions, coal quality, effects of governmental, environmental and tax regulations, and assumptions about future prices and future operating costs.
Our net income is sensitive to estimates we make about our ability to use our Federal net operating loss carryforwards, or NOLs.
As of December 31, 2004 we had approximately $176 million of NOLs. These NOLs expire at various dates through 2023. When we have taxable income, we can use our NOLs to shield that income from regular U.S. Federal income tax. Our ability to use our NOLs thus depends on all the factors that determine taxable income, including operational factors, such as new coal sales, and non-operational factors, such as changes in heritage health benefit costs. Under Federal tax law, our ability to use our NOLs would be limited if we had a “change of ownership” within the meaning of the Federal tax code.
Our NOLs are one of our deferred income tax assets. We have reduced our deferred income tax assets by a valuation allowance. The valuation allowance is primarily an estimate of the deferred tax assets that may not be realized in future periods. On a quarterly and annual basis, we estimate how much of our NOLs we will be able to use to shield future taxable income and make corresponding adjustments in the valuation allowance. The estimate of future taxable income and use of the NOLs may change the valuation allowance in connection with an updated assessment of the status of the Company's business plan.
If we increase our estimated utilization of NOLs, we decrease the valuation allowance, increase our net deferred income tax assets and recognize an income tax benefit in earnings. If we decrease our estimated utilization of NOLs, we increase the valuation allowance, decrease our net deferred income tax assets and increase income tax expense. These changes can materially affect our net income and our assets. In the quarter ended June 30, 2005, for example, we increased the valuation allowance by $0.3 million because of a decrease in this quarter’s estimate of the expected amount of Federal net operating losses to be used in this and future years partially due to an expected reduction in the projected benefit to us from the Medicare Reform Act. We also made other adjustments in our net deferred tax assets. As a result of these estimates and adjustments and changes in temporary differences between book and tax accounting, our net deferred income tax assets increased from $84.7 million at December 31, 2004 to $89.3 million at June 30, 2005, and we recognized an income tax benefit of $1.6 million.
We previously reported that we expect that our alternative minimum income tax net operating loss carryforwards would be fully utilized in 2005, and that AMT payments in 2006 and beyond will increase significantly. The Energy Bill, which was signed into law on August 8, 2005, includes production tax credits available to us beginning January 1, 2006 for tons sold at our Absaloka Mine from coal reserves owned by the Crow Indians. We expect these tax credits will significantly reduce our liability for AMT in 2006 and beyond, but have not yet completed a full assessment of the value that the Company could receive.
Liquidity and Capital Resources
In 2004, Westmoreland Mining LLC borrowed an additional $35 million from its lenders pursuant to what we call the add-on facility. The add-on facility was intended to permit Westmoreland Mining to undertake certain significant capital projects in the near term without adversely affecting cash available to us. We believe that Westmoreland Mining’s add-on facility substantially improves our near term liquidity. In addition, even though the requirements, including debt service requirements, of Westmoreland Mining’s basic term loan agreement, sometimes referred to as our acquisition debt, restrict our access to some of Westmoreland Mining’s cash, Westmoreland Mining itself provides significant liquidity.
Cash provided by operating activities was $7.5 million for the six months ended June 30, 2005, compared to the cash used of $2.9 million for the six months ended June 30, 2004. Cash from operations in 2005 compared to 2004 increased primarily because of lower distributions from the ROVA project in 2004 as a result of the project’s lenders withholding cash for the Halifax County tax dispute. Working capital was $19.4 million at June 30, 2005 compared to $18.9 million at December 31, 2004. The increase in working capital resulted primarily from an increase in trade receivables, inventories and deferred overburden removal costs partially offset by an increase in trade payables due to normal timing differences and by an increase in the current portion of asset retirement obligations.
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We used $14.1 million of cash in investing activities in the six months ended June 30, 2005 and $11.3 million in the six months ended June 30, 2004. Cash used in investing activities in 2005 included $12.3 million of additions to property, plant and equipment for mine equipment and development projects and investment in our a new corporate-wide software system. Cash used in investing activities in 2005 also included an increase of $2.3 million in restricted accounts pursuant to Westmoreland Mining’s term loan agreement and required collateral for surety bonds. In 2004, additions to property and equipment using cash were $5.7 million, and increases in restricted cash accounts were $5.7 million.
Cash of $4.6 million was provided by financing activities in the six months ended June 30, 2005 primarily due to $9.5 million borrowings of revolving lines of credit reduced by $4.7 million used for the repayment of long-term debt. Cash provided from financing activities of $20.1 million in the first six months of 2004 included $18.6 million from new borrowing of long-term debt, net of debt issuance costs. We used cash of $6.0 million for repayment of long-term and revolving debt in 2004.
Consolidated cash and cash equivalents at June 30, 2005 totaled $9.1 million, including $6.5 million at Westmoreland Resources, and $2.9 million at our captive insurance subsidiary. Consolidated cash and cash equivalents at December 31, 2004 totaled $11.1 million, including $4.6 million at Westmoreland Mining, $4.1 million at Westmoreland Resources, and $2.5 million at the captive insurance subsidiary. The cash at Westmoreland Mining is available to us through quarterly distributions, as described below. The cash at Westmoreland Resources is available to us through dividends. In addition, we had restricted cash and bond collateral, which were not classified as cash or cash equivalents, of $33.1 million at June 30, 2005 and $32.7 million at December 31, 2004. The restricted cash at June 30, 2005 included $22.6 million in Westmoreland Mining’s debt service reserve and long-term prepayment accounts. At June 30, 2005, our reclamation, workers’ compensation and postretirement medical cost obligation bonds were collateralized by interest-bearing cash deposits of $11.5 million, which amounts we have classified as non-current assets. In addition, we had accumulated reclamation deposits of $57.0 million at June 30, 2005, which we received from customers of the Rosebud Mine to pay for reclamation. We also had $12.9 million in interest-bearing debt reserve accounts for the ROVA project at June 30, 2005. This cash is restricted as to its use and is classified as part of our investment in independent power projects.
Westmoreland Mining’s term loan agreement restricts Westmoreland Mining’s ability to make distributions to Westmoreland Coal Company from ongoing operations. Until Westmoreland Mining has fully paid the original acquisition debt, which is scheduled for December 31, 2008, Westmoreland Mining may only pay Westmoreland Coal Company a management fee and distribute to Westmoreland Coal Company 75% of Westmoreland Mining’s surplus cash flow. Westmoreland Mining is depositing the remaining 25% into an account that will fund the $30 million balloon payment due December 31, 2008. The add-on facility only restricts distributions to the extent funds are needed to maintain a debt service reserve equal to the next six months principal and interest payments.
Westmoreland Mining has a revolving credit facility which expires in April 2007 of $12 million. As of June 30, 2005, $10.0 million of the facility was available to borrow.
As of June 30, 2005, Westmoreland Coal Company had $6.5 million of its $14.0 million revolving line of credit available to borrow.
On July 28, 2004, we filed a registration statement for a possible rights offering. If the registration statement becomes effective, it would permit holders of our common stock to purchase additional shares of common stock. As stated in the registration statement, the additional equity capital would be used to support our growth and development strategy and for general corporate purposes.
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Liquidity Outlook
We described certain liquidity comparisons in the Liquidity Outlook section of the Annual Report on Form 10-K for the year ended December 31, 2004. All of the items described in that report continue to be important to us.
Jewett Mine Supply Contract
Texas Westmoreland Coal Co. and Texas Genco are party to a lignite supply agreement that expires in 2015 and that provides annual price redeterminations based on an equivalent cost of Southern Powder River Basin (SPRB) coal at the Limestone Electric Generating Station. In January 2004, the parties agreed to fix a price for the period 2004 through 2007, with pricing thereafter to be determined pursuant to the underlying contract. Subsequent dramatic and unexpected increases in commodity costs, including costs for diesel fuel and steel, among other items, rendered the four-year fixed price agreement uneconomic. At the same time, market prices for SPRB coal and associated rail rates have also increased dramatically. Texas Westmoreland and Texas Genco have been negotiating revisions to the fixed price agreement and potentially the underlying long-term agreement, but the Company cannot predict whether an agreement will be reached that returns the Jewett Mine to a stable and satisfactory level of financial performance. Failure to reach a new agreement with Texas Genco could have a material adverse effect on Texas Westmoreland's financial condition before the end of 2007, when substantial price increases could be expected to take effect under the terms of the current contract.
Growth and Development
We describe in Note 8 to the Consolidated Financial Statements of this Form 10-Q the possible acquisition of the ROVA interest from LG&E and the financial implications of its purchase in our Annual Report on Form 10-K for the year ended December 31, 2004 under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Implications of the ROVA Acquisition.”
Continued growth remains an important part of our strategy. The application for an air permit for our Gascoyne Project in North Dakota was filed in May 2004 and a completeness determination was received in July 2004. The North Dakota Department of Health (Department of Health) issued a draft air permit on March 29, 2005. The Department of Health started a 30 day public comment period on April 2, 2005 that included a public hearing on April 21. The public comment period concluded on May 1, 2005. The Department of Health issued the final air permit in June 2005. The Company also continues to identify and evaluate other potential growth opportunities in the coal and independent power sectors.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements within the meaning of the rules of the Securities and Exchange Commission.
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RESULTS OF OPERATIONS
Quarter Ended June 30, 2005 Compared to Quarter Ended June 30, 2004.
Coal Operations. Coal sold was 7.3 million tons in the second quarter ended June 30, 2005 compared to 6.7 million tons in the second quarter of 2004. The Rosebud and Jewett Mines increased sales while there was lower production at the Beulah Mine related to reduced sales to the Heskett Station. In the second quarter of 2004, the arbitration award for the price reopener with the owners of Colstrip Units 1&2 resulted in the recognition of additional revenue of $16.3 million for coal shipped from July 30, 2001 to May 31, 2004. Production taxes and royalties on those revenues totaled $5.1 million. Excluding the arbitration award at Colstrip Units 1&2 from the second quarter of 2004, our overall revenue has increased year over year for the second quarter due to an increase in tons sold, and higher contract prices, including the increased price under the Rosebud Mine’s contract with Colstrip Units 1&2, which was redetermined in the second quarter 2004. Revenues also increased because arrangements in place allowed the Company’s mining operations to recover portions of cost increases for commodities. The Company’s coal sales contracts generally protect our operations against cost inflation, either through direct pass-through or through index adjustments, and we are in the process of negotiating provisions to cover commodity price risk under certain contracts where such provisions have been temporary or absent. Cost of sales increased for the second quarter of 2005 compared to the comparable period in 2004 primarily as a result of more tons produced, increased commodity prices and higher stripping ratios.
The following table shows comparative coal revenues, sales volumes, cost of sales and percentage changes between the periods for actual results as reported and on a pro forma basis (which excludes the impact of the Colstrip arbitration award in second quarter 2004):
| | Quarter Ended June 30, |
|---|
| Actual | | Pro forma |
|---|
|
|
|
|
| | 2005 | | 2004 | | Change | | 2004 | | Change* |
|---|
|
|
|
| Revenues - thousands | $ | 85,701 | $ | 87,020 | | (2)% | $ | 70,720 | | 21 | % |
| |
| Volumes - millions of equivalent coal tons | | 7.252 | | 6.677 | | 9% |
| |
| Cost of sales - thousands | $ | 71,350 | $ | 66,115 | | 8% | $ | 61,015 | | 17 | % |
* Change represents change between 2005 Actual amounts and 2004 Pro forma amounts.
The Company’s business is subject to weather and some seasonality. The power-generating plants that we supply typically schedule their regular maintenance for the spring and fall seasons.
Depreciation, depletion and amortization increased to $4.7 million in the second quarter of 2005 compared to $3.6 million in 2004’s second quarter. The increase is primarily related to increased capital expenditures at the mines for both continued mine development and the replacement of mining equipment and increased amortization of capitalized asset retirement costs.
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Independent Power. Our equity in earnings from independent power operations increased to $3.5 million in the second quarter 2005 from $1.7 million in the quarter ended June 30, 2004. The second quarter of 2004 included a $2.0 million charge recorded for retroactive personal property taxes contingently due to Halifax County, North Carolina, partially offset in 2005 by decreased generation and higher operating and maintenance expenses. For the quarters ended June 30, 2005 and 2004, the ROVA project produced 369,000 and 397,000 megawatt hours, respectively, and achieved average capacity factors of 81% and 87%, respectively. Both periods had scheduled maintenance outages, resulting in lower capacity factors for both periods. In addition, the second quarter of 2005 included almost 7 days of forced outages due to tube leaks in the plant which reduced the capacity factor and related revenues. We recognized $14,000 in equity earnings in second quarter 2005, compared to $23,000 in the quarter ended June 30, 2004 from our 4.49% interest in the Ft. Lupton project.
Costs and Expenses.Selling and administrative expenses increased to $8.5 million in the quarter ended June 30, 2005 compared to $7.0 million in the quarter ended June 30, 2004. The increase is primarily a result of settlement of the Entech litigation at a cost of $1.2 million plus legal fees partially offset by lower long-term incentive plan costs. Long-term incentive compensation decreased $1.1 million in second quarter 2005 compared to the three months ended June 30, 2004 because the price of the Company’s stock decreased in the second quarter of 2005 compared to our peer companies. In general, this expense increases or decreases as the market price of the Company’s common stock increases or decreases.
Heritage health benefit costs were $7.7 million in both the second quarter of 2005 and the second quarter of 2004 with both periods experiencing a decrease in the amount by which the black lung trust is overfunded as a result of increased interest rates that decreased the market value of the trust’s assets.
Interest expense was $2.6 million for both the three months ended June 30, 2005 and 2004. Interest associated with the larger amount of outstanding debt as a result of Westmoreland Mining’s add-on facility in the fourth quarter of 2004 was mostly offset by the lower interest payments due to the pay-down of the acquisition financing obtained during 2001 in connection with the purchase of the Montana Power (Entech) and Knife River coal operations and the increased use of the Company’s revolving credit lines. Interest income decreased in 2005 due to lower short-term investments earning interest although there were larger restricted cash and surety bond collateral balances that are invested.
As a result of the acquisitions we completed in the spring of 2001, the Company recognized a $55.6 million deferred income tax asset in April 2001, which assumed that a portion of previously unrecognized net operating loss carryforwards would be utilized because of the projected generation of future taxable income. That amount has grown over the years as it is estimated more net operating losses will be used. The deferred tax asset increased to $89.3 million as of June 30, 2005 from $84.7 million at December 31, 2004 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 above. Deferred tax assets are 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. The current income tax expense for the second quarter of 2005 represents income tax obligations for State income taxes and for Federal alternative minimum tax, partially reduced by the utilization of a portion of the Company’s net operating loss carryforwards, net of the impact of changes in deferred tax assets and liabilities. The deferred tax benefit of $1.6 million recognized in the second quarter of 2005 is net of a $1.0 million expense caused by an increase in the valuation allowance. This expense reflects the full estimated increase for the year 2005 resulting from a decrease in the amount of Federal net operating loss carryforwards we expect to utilize based on this quarter’s (1) financial results, (2) projections of 2005 taxable income and (3) assumptions relating to estimates of future taxable income.
Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004
Coal Operations. Coal revenues increased to $171.8 million for the six months ended June 30, 2005 from $164.2 million for the six months ended June 30, 2004 primarily as a result of an increase in tons sold from 14.1 million to 14.7 million and higher prices even including the Colstrip Units 1 & 2 arbitration award in 2004 discussed above. The increase in tons sold in 2005 came from new or extended sales contracts at the Rosebud mine. Cost of sales increased for the six months of 2005 compared to 2004 primarily as a result of increased tons produced, commodity prices and higher stripping ratios. In 2005, very difficult mining conditions at the Beulah Mine and unusually heavy rainfall there increased costs. Costs in 2004 included unplanned repairs to a primary dragline, a customer outage that extended beyond its planned duration and weather related production interruptions at the Jewett Mine.
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The following table shows comparative coal revenues, sales volumes, cost of sales and percentage changes between the periods for actual results as reported and on a pro forma basis (which excludes the impact of the Colstrip arbitration award in the first six months of 2004):
| Six Months Ended June 30, |
|---|
| Actual | | Pro forma |
|---|
|
|
|
|
| | 2005 | | 2004 | | Change | | 2004 | | Change* |
|---|
|
|
|
|
| Revenues - thousands | $ | 171,800 | $ | 164,152 | | 5% | $ | 147,852 | | 16 | % |
| |
| Volumes - millions of equivalent coal tons | | 14.699 | | 14.123 | | 4% |
| |
| Cost of sales - thousands | $ | 139,108 | $ | 126,318 | | 10% | $ | 121,218 | | 15 | % |
* Change represents change between 2005 Actual amounts and 2004 Pro forma amounts.
Depreciation, depletion and amortization increased to $9.5 million in the first six months of 2005 compared to $7.4 million in the first six months of 2004. The increase is primarily related to increased capital expenditures at the mines for both continued mine development and the replacement of mining equipment and increased amortization of capitalized asset retirement costs.
Independent Power.Our equity in earnings from the independent power projects increased to $8.6 million in the first six months of 2005 from $7.1 million for the six months ended June 30, 2004. For the six months ended June 30, 2005 and 2004, the ROVA projects produced 811,000 and 853,000 megawatt hours, respectively, and achieved capacity factors of 89% in 2005 and 93% in 2004. The lower capacity factor in 2005 was discussed above in the quarterly results. In 2004, equity in earnings was reduced by the $2.0 million charge for contested retroactive Halifax County personal property tax assessments. In 2005, the ROVA I and II plants had shorter than scheduled outages for planned repairs that improved the capacity factor, but they experienced unscheduled outages for unplanned repairs. We recognized $225,000 in equity earnings in the first six months of 2005, compared to $188,000 in the first six months of 2004 from our 4.49% interest in the Ft. Lupton project.
Costs and Expenses. Selling and administrative expenses were $14.9 million for the six months ended June 30, 2005 compared to $14.7 million for the six months ended June 30, 2004. The 2005 period included the costs of the Entech settlement and litigation previously discussed. However, as a result of a decrease in price of the Company’s common stock in the first six months of 2005, our long-term incentive performance unit plan resulted in a benefit of $2.2 million compared to an expense of $0.2 million in 2004. Legal fees associated with the Company’s legal contingencies, including the arbitration with the owners of Colstrip Units 1 & 2, were higher in 2004.
Heritage health benefit costs were higher in the first six months of 2005 than in the comparable six months in 2004 due to an increase in actuarially determined costs for postretirement medical plans and a greater decrease in the market value of the black lung trust assets as a result of increased interest rates.
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Interest expense was $5.2 million and $5.0 million for the six month periods ended June 30, 2005 and 2004, respectively. Interest associated with the increased debt outstanding from the Westmoreland Mining add-on facility and borrowing using the Company’s revolving credit facilities was partially offset by the lower interest payments on the acquisition financing obtained during 2001. Interest income decreased in 2005 in spite of larger balances in our restricted cash and surety bond collateral accounts because 2004 included $700,000 in interest relating to the Colstrip Units 1 & 2 arbitration decision.
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 2005 and 2004 relate to obligations for State income taxes and Federal alternative minimum tax. During the first six months of 2005, the deferred tax benefit of $4.4 million includes a $1.5 million benefit caused by a reduction in the valuation allowance resulting from an increase in the amount of Federal net operating loss carryforwards we expect to utilize before their expiration.
Other Comprehensive Income.The other comprehensive income of $194,000, net of income taxes of $129,000, recognized during the six months ended June 30, 2005 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 the other comprehensive income of $303,000, net of income taxes of $202,000, for the six months ended June 30, 2004.
RISK FACTORS
In addition to the trends and uncertainties described in Items 1 and 3 of our Annual Report on Form 10-K for the year ended December 31, 2004 and elsewhere in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, we are subject to the risks set forth below.
Our coal mining operations are inherently subject to conditions that could affect levels of production and production costs at particular mines for varying lengths of time and could reduce our profitability.
Our coal mining operations are all surface mines. These mines are subject to conditions or events beyond our control that could disrupt operations, affect production and increase the cost of mining at particular mines for varying lengths of time and negatively affect our profitability. These conditions or events include:
| | • | | unplanned equipment failures, which could interrupt production and require us to expend significant sums to repair our capital equipment, including our draglines, the large machines we use to remove the soil that overlies coal deposits; |
| | • | | geological conditions, such as variations in the quality of the coal produced from a particular seam, variations in the thickness of coal seams and variations in the amounts of rock and other natural materials that overlie the coal that we are mining; and |
Examples of recent conditions or events of these types include the following:
| | • | | In the first quarter of 2004, electrical components on the dragline at our Savage Mine failed. This reduced overburden removal and increased costs at that mine for a period of 10 1/2 days while the dragline was being repaired. |
| | • | | In the second quarter of 2005, our Beulah Mine experienced unusually heavy rainfall and in fact had record rainfall in June that adversely impacted overburden stability and resulted in highwall and spoil sloughage, a condition in which the side of the pit partially collapses and must be stabilized before mining can continue. Unstable conditions in the pits impacted dragline operations at that mine for a period of 5 days. This resulted in a reduction in coal production during the quarter. |
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| | • | | A dragline at Jewett experienced a mechanical failure this July that will take the machine out of service for approximately two weeks. |
| | • | | In the second quarter of 2004, our Jewett Mine received approximately 93% more rain than normal, impeding production. |
Our revenues and profitability could suffer if our customers reduce or suspend their coal purchases.
In 2004, we sold approximately 98% of our coal under long-term contracts and about three-fourths of our coal under contracts that obligate our customers to purchase all or almost all of their coal requirements from us, or which give us the right to supply all of the plant’s coal, lignite or fuel requirements. Three of our contracts, with the owners of the Limestone Electric Generating Station, Colstrip Units 3&4 and with Colstrip Units 1&2, accounted for 26%, 22% and 16%, respectively, of our coal revenues in 2004. (The contract with the owners of Colstrip Units 1&2 accounted for this percentage of our 2004 revenues because we received, in 2004, an arbitration award that covered coal delivered to Colstrip Units 1&2 from July 2001.) Interruption in the purchases by or operations of our principal customers could significantly affect our revenues and profitability. Unscheduled maintenance outages at our customers’ power plants and unseasonably moderate weather are examples of conditions that might cause our customers to reduce their purchases. Four of our five mines are dedicated to supplying customers located adjacent to or near the mines, and these mines may have difficulty identifying alternative purchasers of their coal if their existing customers suspend or terminate their purchases.
Disputes relating to our coal supply agreements could harm our financial results.
From time to time, we may have disputes with customers under our coal supply agreements. These disputes could be associated with claims by our customers that may affect our revenue and profitability. Any dispute that resulted in litigation could cause us to pay significant legal fees, which could also affect our profitability.
We may not be able to complete the ROVA acquisition.
In August 2004, we agreed to acquire from LG&E the 50% interest in the ROVA Project that we do not currently own. In November 2004, Dominion Virginia Power asserted that it had a right of first refusal with respect to LG&E’s interest in this project, and in March 2005, Dominion Virginia Power filed a Petition for Declaratory Judgment in the Circuit Court of the City of Richmond, Virginia, seeking an order validating its alleged first right of refusal. In view of Dominion Virginia Power’s claim, there can be no assurance that we will be able to acquire LG&E’s interest in the ROVA Project.
Even if we are able to resolve the claim of Dominion Virginia Power, the completion of the ROVA transaction is subject to the following conditions specified in our Interest Purchase Agreement with LG&E:
| | • | | Both we and LG&E must have performed and complied with, in all material respects, the obligations and covenants that we and LG&E are required to perform and comply with prior to the closing. |
| | • | | Our representations and warranties, and the representations and warranties of LG&E, must be true and correct in all material respects on the closing date. |
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| | • | | Since August 25, 2004, there must not have been a material adverse effect on the assets, business, condition, or results of operations of the partnership that owns the ROVA Project; the condition, use, or operation of the ROVA Project itself; the payments owed to the ROVA Project by Dominion Virginia Power under the power purchase agreement; or LG&E’s 50% interest in the ROVA Project. |
| | • | | We and LG&E must have received all necessary consents to the transaction from all regulatory authorities and third parties, including the consents of the lenders to the ROVA Project. |
| | • | | We must have obtained replacement insurance that satisfies the insurance requirements of the ROVA Project’s credit agreement with its lenders. |
| | • | | LG&E and its affiliates must have been released from their obligations under the ROVA Project’s existing letters of credit, and the beneficiaries of those letters of credit must not have drawn under them. |
The closing of the ROVA acquisition is also subject to other customary conditions.
Dominion Virginia Power’s alleged right of first refusal is pending in a court proceeding, and there can be no assurance that we will prevail on this issue. In addition, many of the conditions to the closing of the ROVA acquisition are beyond our control, and there can be no assurance that those conditions will be satisfied.
We are a party to numerous legal proceedings, some of which, if determined unfavorably to us, could result in significant monetary damages.
We are a party to several legal proceedings, which are described more fully in our Annual Report on Form 10-K for the year ended December 31, 2004 under Item 3 – “Legal Proceedings”, and in Note 7 (“Contingencies”) to our Consolidated Financial Statements in this Quarterly Report on Form 10-Q. Adverse outcomes in some or all of the pending cases could result in substantial damages against us or harm our business.
We currently own a 50% interest in the ROVA Project, which is located in Halifax County, North Carolina, and we have agreed to purchase the 50% interest that we do not currently own. Halifax County asserts that the ROVA Project owes $8.6 million in back taxes, penalties and interest. If we complete the ROVA acquisition, LG&E has agreed to indemnify the ROVA Project for one-half of this amount.
We may not be able to manage our expanding operations effectively, which could impair our profitability.
At the end of 2000, we owned one mine and employed 31 people. In the spring of 2001, we acquired the Rosebud, Jewett, Beulah and Savage Mines from Entech and Knife River Corporation, and at the end of 2004, we employed 943 people. This growth has placed significant demands on our management as well as our resources and systems. One of the principal challenges associated with our growth has been, and we believe will continue to be, our need to attract and retain highly skilled employees and managers. In the second quarter of 2005, we hired a new Chief Financial Officer, General Counsel, Controller, and Assistant Controller. Eight of the eleven professional positions in our corporate-level finance and accounting department and both of the positions in our legal department are or will be filled by individuals who have joined the Company since the beginning of 2005. To manage our financial, accounting and legal matters effectively, these individuals must absorb considerable, necessary background information on the Company and we must successfully integrate them into our ongoing activities. In the second quarter of 2005, we began to implement a new Company-wide computer system. The start-up of this new system has imposed increased demands on employees, particularly our finance and accounting staff. If we are unable to attract and retain the personnel we need to manage our increasingly large and complex operations, if we are unable to integrate successfully our new officers and employees, and if we are unable to complete successfully the implementation of our new computer system, our ability to manage our operations effectively and to pursue our business strategy could be compromised.
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The implementation of a new enterprise resource planning system could disrupt our internal operations.
We are in the process of implementing a new company-wide computer system to replace the various systems that have been in place at our corporate offices, at the operations we owned in 2001, and at the operations we acquired in 2001. Once implemented, we expect this system to help establish standard, uniform, best practices and reporting in a number of areas, increase productivity and efficiency, and enhance management of our business. Certain aspects of our information technology infrastructure and operational activities have and may continue to experience difficulties in connection with this transition and implementation. Such difficulties can cause delay, be time consuming and more resource intensive than planned, and cost more than we have anticipated. There can be no assurance that we will achieve the cost savings and return on investment intended from this project.
Our growth and development strategy could require significant resources and may not be successful.
We regularly seek opportunities to make additional strategic acquisitions, to expand existing businesses, to develop new operations and to enter related businesses. We may not be able to identify suitable acquisition candidates or development opportunities, or complete any acquisition or project, on terms that are favorable to us. Acquisitions, investments and other growth projects involve risks that could harm our operating results, including difficulties in integrating acquired and new operations, diversions of management resources, debt incurred in financing such activities and unanticipated problems and liabilities. We anticipate that we would finance acquisitions and development activities by using our existing capital resources, borrowing under existing bank credit facilities, issuing equity securities or incurring additional indebtedness. We may not have sufficient available capital resources or access to additional capital to execute potential acquisitions or take advantage of development opportunities.
Our expenditures for postretirement medical and life insurance benefits could be materially higher than we have predicted if our underlying assumptions prove to be incorrect.
We provide various postretirement medical and life insurance benefits to current and former employees and their dependents. We estimate the amounts of these obligations based on assumptions described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates and Related Matters” herein. We accrue amounts for these obligations, which are unfunded, and we pay as costs are incurred. If our assumptions change, the amount of our obligations could increase, and if our assumptions are inaccurate, we could be required to expend greater amounts than we anticipate. We estimate that our gross obligation for postretirement medical and life insurance benefits was $259.8 million at December 31, 2004. We had an accrued liability for postretirement medical and life insurance benefits of $137.7 and $134.2 million at June 30, 2005 and December 31, 2004, respectively, and we expect to accrue an additional $122.1 million over the next ten years, as permitted by Statement of Financial Accounting Standards No. 106. We regularly revise our estimates, and the amount of our accrued obligations is subject to change.
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We have a significant amount of debt, which imposes restrictions on us and may limit our flexibility, and a decline in our operating performance may materially affect our ability to meet our future financial commitments and liquidity needs.
As of June 30, 2005, our total indebtedness was approximately $122 million, which included Westmoreland Mining’s obligations under its term loan agreement, including the add-on facility described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.” We will assume significant non-recourse debt upon completion of the ROVA acquisition, we may incur additional indebtedness to finance the ROVA acquisition and we may incur additional indebtedness in the future, including indebtedness under our two existing revolving credit facilities.
Westmoreland Mining’s term loan agreement restricts its ability to distribute cash to Westmoreland Coal Company through 2011 and limits the types of transactions that Westmoreland Mining and its subsidiaries can engage in with Westmoreland Coal Company and our other subsidiaries. Westmoreland Mining executed the term loan agreement in 2001 and used the proceeds to finance its acquisition of the Rosebud, Jewett, Beulah and Savage Mines. The final payment on this indebtedness, which we call Westmoreland Mining’s acquisition debt, is in the amount of $30 million and is due on December 31, 2008. After payment of principal and interest, 25% of Westmoreland Mining’s surplus cash flow is dedicated to an account that is expected to fund this final payment. The $35 million add-on facility is scheduled to be paid-down from 2009 through 2011. Westmoreland Mining has pledged or mortgaged substantially all of its assets and the assets of the Rosebud, Jewett, Beulah and Savage Mines, and we have pledged all of our member interests in Westmoreland Mining, as security for Westmoreland Mining’s indebtedness. In addition, Westmoreland Mining must comply with financial ratios and other covenants specified in the agreements with its lenders. Failure to comply with these ratios and covenants or to make regular payments of principal and interest could result in an event of default.
A substantial portion of our cash flow must be used to pay principal of and interest on our indebtedness and is not available to fund working capital, capital expenditures or other general corporate uses. In addition, the degree to which we are leveraged could have other important consequences, including:
| | • | | increasing our vulnerability to general adverse economic and industry conditions; |
| | • | | limiting our ability to obtain additional financing to fund future working capital, capital expenditures or other general corporate requirements; and |
| | • | | limiting our flexibility in planning for, or reacting to, changes in our business and in the industry. |
If our or Westmoreland Mining’s operating performance declines, or if we or Westmoreland Mining do not have sufficient cash flows and capital resources to meet our debt service obligations, we or Westmoreland Mining may be forced to sell assets, seek additional capital or seek to restructure or refinance our indebtedness. If Westmoreland Mining were to default on its debt service obligations, a note holder may be able to foreclose on assets that are important to our business.
At June 30, 2005, the ROVA Project had total debt of approximately $194 million. The ROVA Project’s credit agreement restricts its ability to distribute cash, contains financial ratios and other covenants, and is secured by a pledge of the project and substantially all of the project’s assets. If the ROVA Project fails to comply with these ratios and covenants or fails to make regular payments of principal and interest, an event of default could occur. A substantial portion of the ROVA Project’s cash flow must be used to pay principal of and interest on its indebtedness and is not available to us. If the ROVA Project were to default on its debt service obligations, a creditor may be able to foreclose on assets that are important to our business.
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If the cost of obtaining new reclamation bonds and renewing existing reclamation bonds continues to increase, our profitability could be reduced.
Federal and state laws require that we provide bonds to secure our obligations to reclaim lands used for mining. We must post a bond before we obtain a permit to mine any new area. These bonds are typically renewable on a yearly basis and have become increasingly expensive. Bonding companies are requiring that applicants collateralize a portion of their obligations to the bonding company. In 2004, we paid approximately $2.5 million in premiums for reclamation bonds and posted approximately $3.2 million in collateral, in addition to the collateral that we had previously posted, for those bonds. Any capital that we provide to collateralize our obligations to our bonding companies is not available to support our other business activities. If the cost of our reclamation bonds continues to increase, our profitability could be reduced.
Our financial position could be adversely affected if we fail to maintain our Coal Act bonds.
The Coal Act established the 1992 UMWA Benefit Plan, or 1992 Plan. We are required to secure three years of our obligations to that plan by posting a surety bond or a letter of credit or collateralizing our obligations with cash. We presently secure these obligations with two bonds, one in an amount of approximately $21.3 million and one in an amount of approximately $5.0 million. In December 2003, the issuer of our $21.3 million bond indicated a desire to exit the business of bonding Coal Act obligations. In February 2004, this company renewed our Coal Act bond. Although we believe that the issuer of this bond must continue to renew the bond so long as we do not default on our obligations to the 1992 Plan, the issuer of this bond filed a Complaint for Declaratory Judgment on May 11, 2005 to force our payment of $21.3 million and to cancel the bond. If either of the companies that issue our Coal Act bonds were to cancel or fail to renew our bonds, we may be required to post another bond or secure our obligations with a letter of credit or cash. At this time, we are not aware of any other company that would provide a surety bond to secure obligations under the Coal Act. We do not believe that we could now obtain a letter of credit without collateralizing that letter of credit in full with cash. The Company does not currently have $21.3 million in cash available.
We face competition for sales to new and existing customers, and the loss of sales or a reduction in the prices we receive under new or renewed contracts would lower our revenues and could reduce our profitability.
Approximately one-third of the coal tonnage that we will produce in 2005 will be sold under long-term contracts to power plants that take delivery of our coal from common carrier railroads. All of the Absaloka Mine’s sales are delivered by rail and about 20% of the Rosebud Mine’s and Beulah Mine’s sales are delivered by rail. Contracts covering 90% of those rail tons are scheduled to expire between December 2006 and December 2008. As a general matter, plants that take coal by rail can buy their coal from many different suppliers. We will face significant competition, primarily from mines in the Southern Powder River Basin of Wyoming, to renew our long-term contracts with our rail-served customers, and for contracts with new rail-served customers. Many of our competitors are larger and better capitalized than we are and have coal with a lower sulfur and ash content than our coal. As a result, our competitors may be able to adopt more aggressive pricing policies for their coal supply contracts than we can. If our existing customers fail to renew their existing contracts with us on terms that are at least equivalent to those in effect today, or if we are unable to replace our existing contracts with contracts of equal size and profitability from new customers, our revenues and profitability would be reduced.
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Approximately two-thirds of the coal tonnage that we will sell in 2005 will be delivered under long-term contracts to power plants located adjacent to our mines. We will face somewhat less competition to renew these contracts upon their expiration, both because of the transportation advantage we enjoy by being located adjacent to these customers and because most of these customers would be required to invest additional capital to obtain rail access to alternative sources of coal. Our Jewett Mine is an exception because our customer has already built rail unloading and associated facilities that are being used to take coal from the Southern Powder River Basin as permitted under our contract with that customer.
Stricter environmental regulations, including regulations recently adopted by the EPA, could reduce the demand for coal as a fuel source and cause the volume of our sales to decline.
Coal contains impurities, including sulfur, mercury, nitrogen and other elements or compounds, many of which are released into the air when coal is burned. Stricter environmental regulation of emissions from coal-fired electric generating plants could increase the costs of using coal, thereby reducing demand for coal as a fuel source generally, and could make coal a less attractive fuel alternative in the planning and building of utility power plants in the future. The U.S. Environmental Protection Agency, or EPA, has recently adopted regulations that could increase the costs of operating coal-fired power plants, including the ROVA Project. Congress has considered legislation that would have this same effect. At this time, we are unable to predict the impact of these new regulations on our business. However, we expect that the new regulations may alter the relative competitiveness among coal suppliers and coal types. The new regulations could also disadvantage some or all of our mines, and notwithstanding our coal supply contracts we could lose all or a portion of our sales volumes and face increased pressure to reduce the price for our coal, thereby reducing our revenues, our profitability and the value of our coal reserves.
In March 2005, the EPA issued the Clean Air Interstate Rule (“CAIR”) and Clean Air Mercury Rule (“CAMR”). The CAIR will reduce emissions of sulfur dioxide and nitrogen oxide in 28 eastern States and the District of Columbia. Texas and Minnesota, in which customers of the Jewett and Absaloka mines are located, and North Carolina, where the ROVA Project is located, are subject to the CAIR. The CAIR requires these States to achieve required reductions in emissions from electric generating units, or EGUs, in one of two ways: (1) through participation in an EPA-administered, interstate “cap and trade” system that caps emissions in two stages, or (2) through measures of the State’s choice. Under the cap and trade system, the EPA will allocate emission “allowances” for nitrogen oxide to each State. The 28 States will distribute those allowances to EGUs, which can trade them. To control sulfur dioxide, the EPA will reduce the existing allowance allocations for sulfur dioxide that are currently provided under the acid rain program established pursuant to Title IV of the Clean Air Act Amendments.EGUs may choose among compliance alternatives, including installing pollution control equipment, switching fuels, or buying excess allowances from other EGUs that have reduced their emissions. Aggregate sulfur dioxide emissions are to be reduced from 2003 levels in two stages, a 45% reduction by 2010 and a 57% reduction by 2015. Aggregate nitrogen oxide emissions are also to be reduced from 2003 levels in two stages, a 53% reduction by 2009 and a 61% reduction by 2015.
The CAMR applies to all States. The CAMR establishes a two-stage, nationwide cap on mercury emissions from coal-fired EGUs. Aggregate mercury emissions are to be reduced from 1999 levels in two stages, a 20% reduction by 2010 and a 70% reduction by 2018. The EPA expects that, in the first stage, emissions of mercury will be reduced in conjunction with the reductions of sulfur dioxide and nitrogen oxide under the CAIR. The EPA has assigned each State an emissions “budget” for mercury, and each state must submit a State Plan detailing how it will meet its budget for reducing mercury from coal-fired EGUs. Again, States may participate in an interstate “cap and trade” system or achieve reductions through measures of the State’s choice. The CAMR also establishes mercury emissions limits for new coal-fired EGUs (new EGUs are power plants for which construction, modification, or reconstruction commenced after January 30, 2004).
These new rules are likely to affect the market for coal for at least three reasons:
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| | • | | Different types of coal vary in their chemical composition and combustion characteristics. For example, the lignite from our Jewett and Beulah mines is inherently higher in mercury than bituminous and sub-bituminous coal, and sub-bituminous coal from different seams can differ significantly. |
| | • | | Different EGUs have different levels of emissions control technology. For example, the ROVA Project has “state of the art” emissions control technology that reduces its emissions of sulfur dioxide, nitrogen oxide and, collaterally, mercury. |
| | • | | The CAIR is likely to affect the existing national market for sulfur dioxide emissions allowances, thereby indirectly affecting coal producers and consumers that are not directly subject to the CAIR. |
For all the foregoing reasons, and because it is unclear how States will allocate their emissions budgets, we are unable to predict at this time how these new rules will affect the Company.
The Company’s contracts protect our sales positions, including volumes and prices, to varying degrees. However, we could face disadvantages under the new regulations that could result in our inability to renew some or all of our contracts as they expire or reach scheduled price reopeners or that could result in relatively lower prices upon renewal, thereby reducing our relative revenue, profitability, and/or the value of our coal reserves.
New legislation or regulations in the United States aimed at limiting emissions of greenhouse gases could increase the cost of using coal or restrict the use of coal, which could reduce demand for our coal, cause our profitability to suffer and reduce the value of our assets.
A variety of international and domestic environmental initiatives are currently aimed at reducing emissions of greenhouse gases, such as carbon dioxide, which is emitted when coal is burned. If these initiatives were to be successful, the cost to our customers of using coal could increase, or the use of coal could be restricted. This could cause the demand for our coal to decrease or the price we receive for our coal to fall, and the demand for coal generally might diminish. Restrictions on the use of coal or increases in the cost of burning coal could cause us to lose sales and revenues, cause our profitability to decline or reduce the value of our coal reserves.
Demand for our coal could also be reduced by environmental regulations at the state level.
Environmental regulations by the states in which our mines are located, or in which the generating plants they supply operate, may negatively affect demand for coal in general or for our coal in particular. For example, Texas passed regulations requiring all fossil fuel-fired generating facilities in the state to reduce nitrogen oxide emissions beginning in May 2003. In January 2004, we entered into a supplemental settlement agreement with Texas Genco II pursuant to which the Limestone Station must purchase a specified volume of lignite from the Jewett Mine. In order to burn this lignite without violating the Texas nitrogen oxide regulations, the Limestone Station is blending our lignite with coal, produced by others in the Southern Powder River Basin, and using emissions credits. Considerations involving the Texas nitrogen oxide regulations might affect the demand for lignite from the Jewett Mine in the period after 2007, which is the last year covered by the four- year fixed price agreement. Texas Genco II might claim that it is less expensive for the Limestone Station to comply with the Texas nitrogen oxide regulations by switching to a blend that contains relatively more coal from the Southern Powder River Basin and relatively less of our lignite. Other states are evaluating various legislative and regulatory strategies for improving air quality and reducing emissions from electric generating units. Passage of other state-specific environmental laws could reduce the demand for our coal.
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We have significant reclamation and mine closure obligations. If the assumptions underlying our accruals are materially inaccurate, or if we are required to honor reclamation obligations that have been assumed by our customers or contractors, we could be required to expend greater amounts than we currently anticipate, which could affect our profitability in future periods.
We are responsible under federal and state regulations for the ultimate reclamation of the mines we operate. In some cases, our customers and contractors have assumed these liabilities by contract and have posted bonds or have funded escrows to secure their obligations. We estimate our future liabilities for reclamation and other mine-closing costs from time to time based on a variety of assumptions. If our assumptions are incorrect, we could be required in future periods to spend more on reclamation and mine-closing activities than we currently estimate, which could harm our profitability. Likewise, if our customers or contractors default on the unfunded portion of their contractual obligations to pay for reclamation, we could be forced to make these expenditures ourselves and the cost of reclamation could exceed any amount we might recover in litigation, which would also increase our costs and reduce our profitability.
We estimate that our gross reclamation and mine-closing liabilities, which are based upon permit requirements and our experience, were $315.5 million (with a present value of $144.4 million) at June 30, 2005. Of these liabilities, our customers have assumed a gross aggregate of $187.3 million and have secured a portion of these obligations by posting bonds in the amount of $50 million and funding reclamation escrow accounts that currently hold approximately $57.0 million, in each case at June 30, 2005. We estimate that our gross obligation for final reclamation that is not the contractual responsibility of others was $128.1 million at June 30, 2005, and that the present value of our net obligation for final reclamation that is not the contractual responsibility of others was $55.6 million at June 30, 2005.
Our profitability could be affected by unscheduled outages at the power plants we supply or own or if the scheduled maintenance outages at the power plants we supply or own last longer than anticipated.
Scheduled and unscheduled outages at the power plants that we supply could reduce our coal sales and revenues, because any such plant would not use coal while it was undergoing maintenance. We cannot anticipate if or when unscheduled outages may occur.
Our profitability could be affected by unscheduled outages at the ROVA Project or if scheduled outages at the ROVA Project last longer than we anticipate. For example, the ROVA I unit is scheduled to be out of service for 20 days in September and early October 2005. Also, the ROVA II unit is scheduled to be out of service for 28 days in October and November 2005. The ROVA Project’s contract with Dominion Virginia Power is structured so that our annual revenues will not be adversely affected by this outage. However, if maintenance uncovers matters beyond those anticipated, the outage could be prolonged beyond the scheduled period, which could reduce the ROVA Project’s profitability and our revenues. In addition, if the maintenance uncovers a matter that must be remedied or repaired, the cost of those repairs may also adversely affect the ROVA Project’s profitability.
Increases in the cost of the fuel, electricity and materials we use to operate our mines could affect our profitability.
Under several of our existing coal supply agreements, our mines bear the cost of the diesel fuel, lubricants and other petroleum products, electricity, and other materials and supplies necessary to operate their draglines and other mobile equipment. The prices of many of these commodities have increased significantly in the last year, and continued escalation of these costs would hurt our profitability or threaten the financial condition of certain operations in the absence of corresponding increases in revenue.
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If we experience unanticipated increases in the capital expenditures we expect to make over the next several years, our profitability could suffer.
Over the next several years, we anticipate making significant capital expenditures, principally at the Rosebud and Jewett Mines, in order to add to and refurbish our machinery and equipment and prepare new areas for mining. We also began implementing a new company-wide computer system in 2005. The costs of any of these expenditures could exceed our expectations, which could reduce our profitability and divert our capital resources from other uses.
Our ability to operate effectively and achieve our strategic goals could be impaired if we lose key personnel.
Our future success is substantially dependent upon the continued service of our key senior management personnel, particularly Christopher K. Seglem, our Chairman of the Board, President and Chief Executive Officer. We do not have key-person life insurance policies on Mr. Seglem or any other employees. The loss of the services of any of our executive officers or other key employees could make it more difficult for us to pursue our business goals.
Provisions of our certificate of incorporation, bylaws and Delaware law, and our stockholder rights plan, may have anti-takeover effects that could prevent a change of control of our company that you may consider favorable, and the market price of our common stock may be lower as a result.
Provisions in our certificate of incorporation and bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders. Provisions of our bylaws impose various procedural and other requirements that could make it more difficult for stockholders to effect some types of corporate actions. In addition, a change of control of our Company may be delayed or deterred as a result of our stockholder rights plan, which was initially adopted by our Board of Directors in early 1993 and amended and restated in February 2003. Our ability to issue preferred stock in the future may influence the willingness of an investor to seek to acquire our company. These provisions could limit the price that some investors might be willing to pay in the future for shares of our common stock and may have the effect of delaying or preventing a change in control of Westmoreland.
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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, Texas and North Dakota, and through its subsidiary, Westmoreland Energy, LLC, 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 are sold through long-term contracts with customers. These long-term contracts serve to reduce the Company’s exposure to changes in commodity prices although some of the Company’s contracts are adjusted periodically based upon market prices and some contracts provide for fixed pricing. 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, 2005.
Interest Rate Risk
The Company and its subsidiaries are subject to interest rate risk on its debt obligations. Long-term debt obligations have fixed interest rates, and the Company’s revolving lines of credit have a variable rate of interest indexed to either the prime rate or LIBOR. Based on balances outstanding on these instruments as of June 30, 2005, a one percent change in the prime interest rate or LIBOR would increase or decrease interest expense by $95,000 on an annual basis. Westmoreland Mining’s Series D Notes under its term debt agreement have a variable interest rate based on LIBOR. A one percent change in the LIBOR would increase or decrease interest expense by $146,000 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.
ITEM 4
CONTROLS AND PROCEDURES
The Company’s management, with the participation of the Company’s chief executive officer and chief financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of June 30, 2005. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of the Company’s disclosure controls and procedures as of June 30, 2005, the Company’s chief executive officer and chief financial officer concluded that, as of such date, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.
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No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended June 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II — OTHER INFORMATION
ITEM 1
LEGAL PROCEEDINGS
As described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, “Item 3 — Legal Proceedings,” the Company has litigation which is still pending. For developments in these proceedings, see Notes 7 and 8 to our Consolidated Financial Statements, which are incorporated by reference herein.
Purchase Price Adjustment
On June 24, 2005, Westmoreland Coal Company reached a settlement with Entech LLC of all disputes relating to Westmoreland’s acquisition of Entech’s coal business in 2001. Entech is currently in bankruptcy. Under the terms of the settlement, Westmoreland will pay $1,150,000 to Entech for a full and final settlement of claims either party may have against the other. This amount was accrued as an expense in the quarter ended June 30, 2005. The settlement is subject to the approval of the bankruptcy court having jurisdiction over Entech’s bankruptcy proceeding. This approval is expected.
As background, the final purchase price for Westmoreland’s 2001 acquisition of the coal business of Entech was subject to certain adjustments to reflect changes in net assets and net revenues of the acquired operations between January 1, 2001 and the closing date. In June 2001, Entech submitted proposed adjustments that would have increased the purchase price by approximately $9.0 million. In July 2001, Westmoreland objected to Entech’s proposed adjustments and submitted its own adjustments which would have resulted in a substantial decrease in the original purchase price. The Stock Purchase Agreement required that the parties’ disagreements be submitted to an independent accountant for resolution. Westmoreland also submitted a claim for indemnification by Entech.
In November 2004, the independent accountant issued findings that showed a net amount due to Westmoreland of $587,000. However, the independent accountant’s findings did not include a $5 million adjustment that represented an initial purchase price reduction at the time of closing. Entech requested that the independent accountant revise his findings to include this $5 million adjustment. Prior to the settlement, the independent accountant had not revised his findings. Westmoreland’s claims against Entech for indemnification were set for trial in December 2005 in the U.S. District Court for the District of Delaware, but all legal proceedings have been brought to an end because of the settlement.
The dispute with Entech involved two separate proceedings, one relating to purchase price adjustments and one to indemnification of the Company by Entech related to the representations and warranties by Entech in the purchase and sale agreement. As a result of Entech having filed for bankruptcy after these proceedings commenced, a significant risk emerged that any judgment in favor of the Company in the indemnification proceeding would be subordinated to the claims of unsecured creditors in the Entech bankruptcy proceeding, and thus not only uncollectable, but unavailable to offset any potential purchase price adjustment in favor of Entech. In light of these circumstances and the cost of continuing litigation it was concluded that a negotiated settlement was the best way to resolve this four-year-old dispute. The Company believes the settlement is fair and in the best interests of shareholders.
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ITEM 3
DEFAULTS UPON SENIOR SECURITIES
See Note 4 “Capital Stock” to our Consolidated Financial Statements, which is incorporated by reference herein.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An Annual Meeting of Shareholders was held on May 19, 2005. Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934. Two 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 | | 7,169,276 | | 166,186 | |
| Thomas W. Ostrander | | 7,184,114 | | 151,348 | |
| Christopher K. Seglem | | 7,213,886 | | 121,576 | |
| Thomas J. Coffey | | 7,177,893 | | 157,569 | |
| Robert E. Killen | | 7,219,551 | | 115,911 | |
| James W. Sight | | 7,220,551 | | 114,911 | |
| Donald A. Tortorice | | 7,219,151 | | 116,311 | |
|
| |
Messrs. Hutchinson, Ostrander, Seglem, Coffey, Killen, Sight and Tortorice 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 | | 668,163 | | 5,903 | |
| William M. Stern | | 668,163 | | 5,903 | |
|
Messrs. Armstrong and Stern were elected.
There were no abstentions or broker non-votes.
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ITEM 6
EXHIBITS
Exhibit
Number | | Description |
|---|
| | | | |
| 31 | | Rule 13a-14(a)/15d-14(a) Certifications. | |
| | | |
| 32 | | Certifications pursuant to 18 U.S.C. Section 1350. | |
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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 9, 2005 | /s/ David J. Blair |
| David J. Blair |
| Chief Financial Officer |
| (A Duly Authorized Officer) |
| | |
| | /s/ Diane M. Nalty |
| Diane M. Nalty |
| Controller |
| (Principal Accounting Officer) |
| | |
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EXHIBIT INDEX
Exhibit
Number | | Description |
|---|
| | | | |
| 31 | | Rule 13a-14(a)/15d-14(a) Certifications. | |
| | | |
| 32 | | Certifications pursuant to 18 U.S.C. Section 1350. | |
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