We maintain reserves for costs associated with mine closure, land reclamation and other environmental matters. At June 30, 2008, our reserves for these matters totaled $111.7 million, for which no contractual or commitment obligations exist. Future expenditures related to closure, reclamation and environmental expenditures are difficult to estimate, although we anticipate we will make expenditures relating to these obligations over the next 30 years. For additional information relating to our environmental obligations, see Note 6 of Notes to the Condensed Consolidated Financial Statements (Unaudited).
Off-Balance Sheet Arrangements
At June 30, 2008, we had no existing off-balance sheet arrangements, as defined under SEC regulations, that have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Critical Accounting Estimates
Our significant accounting policies are described in Note 1 of Notes to Consolidated Financial Statements in our annual report filed on Form 10-K for the year ended December 31, 2007. As described in Note 1, we are required to make estimates and assumptions that affect the reported amounts and related disclosures of assets, liabilities, revenue, and expenses. Our estimates are based on our experience and our interpretation of economic, political, regulatory, and other factors that affect our business prospects. Actual results may differ significantly from our estimates.
We believe that our most critical accounting estimates are related to future metals prices, obligations for environmental, reclamation, and closure matters, mineral reserves, and accounting for business combinations, as they require us to make assumptions that were highly uncertain at the time the accounting estimates were made, and changes in them are reasonably likely to occur from period to period. Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our board of directors, and the Audit Committee has reviewed the disclosures presented below. In addition, there are other items within our financial statements that require estimation, but are not deemed to be critical. However, changes in estimates used in these and other items could have a material impact on our financial statements.
Future Metals Prices
Metals prices are key components in estimates that determine the valuation of some of our significant assets and liabilities, including properties, plants and equipment, deferred tax assets, and certain accounts receivable. As shown below under Part II, Item 1A. Risk Factors, metals prices have been historically volatile. While average prices for all four metals we produce have performed favorably for five consecutive years, we have recorded impairments to our asset carrying value because of low prices in the past, and we can offer no assurance that prices will remain at their current levels or higher.
Processes supporting valuation of our assets and liabilities that are most significantly affected by prices include analyses of asset carrying values, depreciation, and deferred income taxes. On at least an annual basis – and more frequently if circumstances warrant – we examine the carrying values of our assets, our depreciation rates, and the valuation allowances on our deferred tax assets. In our analyses of carrying values and deferred taxes, we apply several pricing views to our forecasting model, including current prices, forward-curve prices, and historical prices (see Mineral Reserves, below, regarding prices used for reserve estimates). Using applicable accounting guidance and our view of metals markets, we use the most likely outcome to determine whether the values of our assets are fairly stated, and to determine the level of valuation allowances on our deferred tax assets. In addition, estimates of future metals prices are used in the valuation of certain assets in the determination of the purchase price allocations for our acquisitions (see Business Combinations below).
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Obligations for Environmental, Reclamation and Closure Matters
The most significant liability on our balance sheet is for accrued reclamation and closure costs. We have conducted considerable remediation work at sites in the United States for which remediation requirements have not been fully determined, nor have they been agreed between us, and various regulatory agencies with oversight over the properties. We have estimated our liabilities with counsel and in accordance with appropriate accounting guidance. On at least an annual basis – and more frequently if warranted – management reviews our liabilities with our Audit Committee. However, the range of liability proposed by the plaintiffs in environmental proceedings considerably exceeds the liabilities we have recognized. If substantial damages were awarded or remediation costs incurred in excess of our accruals, our financial results or condition could be materially adversely affected.
Mineral Reserves
Critical estimates are inherent in the process of determining our reserves. Our reserves are affected largely by our assessment of future metals prices, as well as by engineering and geological estimates of ore grade, accessibility and production cost. Metals prices are estimated at long-term averages, as described in Item 2. — Property Descriptions in our annual report filed on Form 10-K for the period ended December 31, 2007. Our assessment of reserves occurs at least annually, and periodically utilizes external audits.
Reserves are a key component in valuation of our properties, plants and equipment. Reserve estimates are used in determining appropriate rates of units-of-production depreciation, with net book value of many assets depreciated over remaining estimated reserves. Reserves are also a key component in forecasts, with which we compare future cash flows to current asset values to ensure that carrying values are reported appropriately. Reserves also play a role in the valuation of certain assets in the determination of the purchase price allocations for our acquisitions (see Business Combinations below). Reserves represent a culmination of many estimates, and are not guarantees that we will recover the indicated quantities of metals.
Business Combinations
In accordance with SFAS 141, “Business Combinations”, we are required to allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at acquisition date. We recognize the excess of an acquired business’s cost over the fair value of acquired assets, less liabilities, as goodwill. The valuation of assets acquired and liabilities assumed requires management to make significant estimates and assumptions, especially with respect to long-lived assets, including estimates of future metals prices and mineral reserves, as discussed above. In some cases, we use third-party appraisers to determine the fair values and lives of property and other identifiable assets.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
The following discussion about our risk management activities includes forward-looking statements that involve risk and uncertainties, as well as summarizes the financial instruments held by us at June 30, 2008, which are sensitive to changes in interest rates, commodity prices and exchange rates and are not held for trading purposes. Actual results could differ materially from those projected in the forward-looking statements. In the normal course of business, we also face risks that are either non-financial or non-quantifiable (see Part II, Item 1A. Risk Factors).
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Cash
Exchange control regulations in Venezuela have limited our ability to repatriate cash and receive dividends or other distributions without substantial cost. Our cash balances denominated in Bolívares that are maintained in Venezuela totaled a U.S. dollar equivalent, at official exchange rates, of approximately $1.3 million at June 30, 2008 and $30.0 million at December 31, 2007. On June 19, 2008, we entered into an agreement to sell our wholly owned subsidiaries holding our business and operations in Venezuela to Rusoro Mining, Ltd. (“Rusoro”), with the transaction closing on July 8, 2008 (see Note 5 for further discussion of the transaction). The $1.3 million held at June 30, 2008 is included in the assets of operations held for sale line of the Condensed Consolidated Balance Sheet. Pursuant to the sale agreement, Rusoro paid us $0.9 million for the U.S. dollar equivalent of Bolívares-denominated cash balances held in Venezuela at the close of the sale, converted at official rates.
Prior to the sale of our Venezuelan operations, exchanging our cash held in local currency into U.S. dollars was done through specific governmental programs, or through the use of negotiable instruments at conversion rates that are higher than the official rate (parallel rate) on which we incurred foreign currency losses. During the second quarter of 2008, we exchanged the U.S. dollar equivalent of approximately $38.7 million at the official exchange rate of 2,150 Bolívares to $1.00 for approximately $25.4 million at open market exchange rates and in compliance with applicable regulations, incurring foreign exchange losses for the difference. No such exchanges were made during the first quarter of 2008. During the second quarter and first six months of 2007, we exchanged the U.S. dollar equivalent of approximately $26.7 million and $29.8 million, respectively, at the official exchange rate of 2,150 Bolívares to $1.00 for approximately $15.2 million and $17.0 million, respectively, at open market exchange rates and in compliance with applicable regulations, incurring foreign exchange losses for the differences. All of the conversion losses discussed above were incurred on repatriations of cash from Venezuela, and are included in losses from discontinued operations, net of taxes on the Consolidated Statement of Income for those periods.
From time to time we hold various types of short-term investments that are subject to changes in market interest rates and are sensitive to those changes. We did not carry any such short-term investments as of June 30, 2008.
Commodity-Price Risk Management
At times, we use commodity forward sales commitments, commodity swap contracts and commodity put and call option contracts to manage our exposure to fluctuation in the prices of certain metals which we produce. Contract positions are designed to ensure that we will receive a defined minimum price for certain quantities of our production. We use these instruments to reduce risk by offsetting market exposures.
Interest-Rate Risk Management
At June 30, 2008, we had $360 million in debt associated with the acquisition of the remaining 70.3% of the Greens Creek mine. The debt consists of a $140 million three-year amortizing term facility and a $220 million bridge facility, which matures on October 15, 2008. The term loan requires the company to hedge the floating rate interest rate exposure and on May 5, 2008, the Company entered into an interest rate swap, which converted the interest rate to a 3.38% fixed rate plus an additional marginal rate ranging from 1.25% to 2.00%, over the term of the loan. With regard to the bridge facility, the interest rate fluctuates based on the current London Interbank Borrowing Rate. A hypothetical 100 basis-point change in the variable interest rate for the bridge facility would change our monthly interest expense by an estimated $0.2 million. For additional information regarding our credit facility, see Note 11 of Notes to the Condensed Consolidated Financial Statements (Unaudited).
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In May 2008, we entered into a interest rate swap agreement that has the economic effect of modifying the LIBOR-based variable interest obligations associated with the $140 million term facility maturing on March 31, 2011 so that the interest payable on the note effectively became fixed at a rate of 5.005% until maturity on March 31, 2011. The terms of the interest rate swap agreement and the notes that the swap agreement pertains to match, including the notional amounts, interest rate reset dates, and maturity dates. The fair value of the swap totaled an unrealized gain of $75,000 at June 30, 2008. We are accounting for this swap as a hedge pursuant to FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities . The unrealized gain is included in accumulated other comprehensive income and the corresponding fair value receivable is included in other current assets in our condensed consolidated balance sheet.
An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures as required by Exchange Act Rules 13a-15(e) and 15d-15(e) as of the end of the period covered by this report. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of June 30, 2008, in ensuring them in a timely manner that material information required to be disclosed in this report has been properly recorded, processed, summarized and reported. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2008, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
On January 1, 2008, we implemented a new business system at our corporate office to facilitate automation of our accounting processes. We believe the new system will enhance existing controls over financial reporting by decreasing manual controls inherent in our prior system.
On April 16, 2008, we acquired the remaining 70.3% interest in the Greens Creek Joint Venture, of which we previously held 29.7%. Prior to our ownership of 100% of the joint venture, we excluded Greens Creek from our assessment of internal control over financial reporting, as we did not have the ability to dictate or modify the controls at Greens Creek. We have commenced the process of assessing the effectiveness of our internal control over financial reporting at Greens Creek, using criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). We plan to include Greens Creek in our assessment of internal controls as of December 31, 2008.
Internal control systems, no matter how well designed and operated, have inherent limitations. Therefore, even a system which is determined to be effective cannot provide absolute assurance that all control issues have been detected or prevented. Our systems of internal controls are designed to provide reasonable assurance with respect to financial statement preparation and presentation.
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Part II - Other Information
Hecla Mining Company and Subsidiaries
For information concerning legal proceedings, refer to Note 6 of Notes to the Condensed Consolidated Financial Statements (Unaudited), which is incorporated by reference into this Item 1.
Item 1A (“Risk Factors”) of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 sets forth information relating to important risks and uncertainties that could materially adversely affect the Company’s business, financial condition or operating results. Except as set forth in the next following paragraph, those risk factors continue to be relevant to an understanding of the Company’s business, financial condition and operating results. Certain of those risk factors have been updated in this Form 10-Q to provide updated information, as set forth below. References to “we”, “our” and “us” in these risk factors refer to the Company.
Subsequent to the filing of our Form 10-K for the year ended December 31, 2007 and Form 10-Q for the period ended March 31, 2008, we sold our business and operations in Venezuela. As a result of that sale, we are no longer directly subject to any risks from conducting business in Venezuela as previously disclosed in our Form 10-K for the year ended December 31, 2007 and our Form 10-Q for the period ended March 31, 2008.
FINANCIAL RISKS
A substantial or extended decline in metals prices would have a material adverse effect on us.
The majority of our revenue is derived from the sale of silver, gold, lead and zinc and, as a result, our earnings are directly related to the prices of these metals. Silver, gold, lead and zinc prices fluctuate widely and are affected by numerous factors, including:
| • | relative exchange rates of the U.S. dollar; |
| • | global and regional demand and production; |
| • | recession or reduced economic activity; and |
| • | other political and economic conditions. |
These factors are largely beyond our control and are difficult to predict. If the market prices for these metals fall below our production or development costs for a sustained period of time, we will experience losses and may have to discontinue exploration, development or operations, or incur asset write-downs at one or more of our properties.
On April 16, 2008, we completed the acquisition of the companies owning 70.3% of the Greens Creek mine (see Note 14 of Notes to Condensed Consolidated Financial Statements (Unaudited) for further discussion of the acquisition). The acquisition was partially funded by a $380 million debt facility, which includes a $140 million three-year term facility and a $240 million bridge facility, which matures in six months. We utilized $220 million from the bridge facility at the time of closing the Greens Creek transaction (see Note 11 of Notes to Condensed Consolidated Financial Statements (Unaudited) for more information on the debt facility). If the market prices for the metals we produce fall below our production or development costs for a sustained period of time, our ability to service our debt obligations associated with this transaction may be adversely affected.
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The following table sets forth the average daily closing prices of the following metals for the year ended December 31, 1995, 2001 and each year thereafter through 2007, and for the six months ended June 30, 2008.
| | 2008 | | 2007 | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | | | 1995 | |
Silver (1) (per oz.) | | $ | 17.43 | | $ | 13.39 | | $ | 11.57 | | $ | 7.31 | | $ | 6.66 | | $ | 4.88 | | $ | 4.60 | | $ | 4.37 | | $ | 5.20 | |
Gold (2) (per oz.) | | $ | 911.36 | | $ | 696.66 | | $ | 604.34 | | $ | 444.45 | | $ | 409.21 | | $ | 363.51 | | $ | 309.97 | | $ | 272.00 | | $ | 384.16 | |
Lead (3) (per lb.) | | $ | 1.18 | | $ | 1.17 | | $ | 0.58 | | $ | 0.44 | | $ | 0.40 | | $ | 0.23 | | $ | 0.21 | | $ | 0.22 | | $ | 0.29 | |
Zinc (4) (per lb.) | | $ | 1.03 | | $ | 1.47 | | $ | 1.49 | | $ | 0.63 | | $ | 0.48 | | $ | 0.38 | | $ | 0.35 | | $ | 0.40 | | $ | 0.47 | |
______________
(3) | London Metals Exchange — Cash |
(4) | London Metals Exchange — Special High Grade — Cash |
On August 4, 2008, the closing prices for silver, gold, lead and zinc were $17.37 per ounce, $905.75 per ounce, $0.95 per pound and $0.82 per pound, respectively.
Failure to comply with debt covenants could adversely affect our financial results or condition.
In September 2005, we entered into a $30.0 million revolving credit agreement that includes various covenants and other limitations related to our indebtedness and investments that require us to maintain customary measures of financial performance. The revolving credit agreement was replaced on April 16, 2008 by a restated and amended credit agreement in connection with our acquisition of the companies owning 70.3% of the Greens Creek mine, as discussed below.
Our acquisition of the companies owning 70.3% of the Greens Creek mine (see Note 14 of Notes to the Condensed Consolidated Financial Statements for further discussion) was partially funded by a $380 million debt facility, which includes a $140 million three-year term facility and a $240 million bridge facility, which matures in six months. We utilized $220 million from the bridge facility at the time of closing the Greens Creek transaction. The debt facility includes various covenants and other limitations related to our indebtedness and investments that require us to maintain customary measures of financial performance. We believe we will be able to comply with such requirements in the future, although failure to do so could adversely affect our results or financial condition and may limit our ability to obtain financing. See Note 11 of Notes to Condensed Consolidated Financial Statements (Unaudited) for more information on the debt facility
The retirement of our bridge facility may materially adversely affect us.
We utilized $220 million of a $240 million six-month bridge debt facility established in connection with our April 16, 2008 acquisition of the companies owning 70.3% of the Greens Creek mine. During the next several months, we will be evaluating various alternatives to meet our obligation for the bridge loan, which may include potential refinancing arrangements, equity issuances, deferment of capital investing activities, and/or divestitures of properties. It is currently uncertain to us which of, and to what extent, these financial sources for retiring the bridge facility will be used, and there can be no assurance that such financing will be available to us, or that our financial position and results of operations will not be materially adversely affected as a result.
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OPERATION, DEVELOPMENT, EXPLORATION AND ACQUISITION RISKS
We may be subject to a number of risks and uncertainties if our announced acquisition agreement fails to close.
In February 2008, we announced an agreement to purchase substantially all of the assets of Independence Lead Mines Company (“Independence”). For more information, see Note 14 of Notes to Condensed Consolidated Financial Statements (Unaudited). Failure to complete this transaction could negatively impact our stock performance and future operations. For example:
| • | The price of our common stock may decline to the extent that the current market price reflects an assumption that the transactions will be completed. |
| • | We must pay expenses related to the transaction, including substantial legal and accounting fees, even if the transaction is not completed. This could affect the results of our operations for the period during which the fees are incurred. |
| • | We would continue to own our current interest, rather than the entire future interest in the Lucky Friday mine. |
We may not realize the cost savings and other benefits we currently anticipate due to challenges associated with integrating the operations, personnel and other aspects of the companies owning 70.3% of the Greens Creek mine.
Our acquisition of the companies owning 70.3% of the Greens Creek mine reflects our expectation that the transaction will result in increased metals production, earnings and cash flow. These anticipated results will depend in part on whether we can successfully integrate the acquired companies’ operations in an efficient and effective manner. This will present significant challenges to management, including integration of systems and personnel, unanticipated liabilities and costs, and the potential loss of key personnel. There can be no assurance that there will be operational or other synergies realized, or that the integration of the companies’ operations, management and cultures will be timely or effectively accomplished. In addition, the integration of the companies may subject us to liabilities existing at the acquired companies, some of which may be unknown. While we have conducted due diligence on the operations of, and have participated in the Greens Creek Joint Venture with the acquired companies, there can be no guarantee that we are aware of any and all liabilities of the acquired companies. These liabilities, and any additional risks and uncertainties related to the acquisition not currently known to us or that we may currently deem immaterial, could negatively impact our business, financial condition and results of operations.
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| Item 4. | Submission of Matters to a Vote of Security Holders |
At the annual meeting of shareholders held on May 16, 2008, the following matters were voted on by Hecla’s shareholders:
| A. | Election of Three Directors: |
| | Votes For | | Votes
Withheld | | Percentage of Outstanding
Shares Entitled to Vote | | Percentage of Shares
Present at Meeting | |
| | | | | | | | | |
Phillips S. Baker, Jr. | | 96,337,634 | | 1,650,328 | | 78.3% | | 98.32% | |
David J. Christensen | | 95,338,007 | | 2,649,955 | | 77.5% | | 97.30% | |
Dr. Anthony P. Taylor | | 96,144,724 | | 1,843,238 | | 78.1% | | 98.12% | |
See the exhibit index to this Form 10-Q for the list of exhibits.
Items 2, 3 and 5 of Part II are not applicable and are omitted from this report.
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Hecla Mining Company and Subsidiaries
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.
| | HECLA MINING COMPANY
(Registrant) |
Date: August 6, 2008
| | By | /s/ Phillips S. Baker, Jr. |
| | | Phillips S. Baker, Jr., President and
Chief Executive Officer |
| | |
Date: August 6, 2008
| | By | /s/ James A. Sabala |
| | | James A. Sabala, Vice President and
Chief Financial Officer |
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Hecla Mining Company and Wholly Owned Subsidiaries
Form 10-Q – June 30, 2008
Index to Exhibits
| 2.1 | Stock Purchase Agreement dated as of June 19, 2008, by and among Rusoro Mining Ltd., Rusoro MH Acquisition Ltd., and Hecla Limited. Filed as exhibit 2.1 to Registrant’s Current Report on Form 8-K filed on June 25, 2008 (File No. 1-8491), and incorporated herein by reference.* |
| 2.2 | Letter agreement by and among Hecla Limited, Rusoro MH Acquisition Ltd., and Rusoro Mining. Ltd. dated June 27, 2008. Filed as exhibit 2.1 to Registrant’s Current Report on Form 8-K (File No. 1-8491) filed on July 3, 2008, and incorporated herein by reference. |
| 3.1 | Certificate of Incorporation of the Registrant as amended to date. Filed as exhibit 3.1 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 (File No. 1-8491), and incorporated herein by reference. |
| 3.2 | Bylaws of the Registrant as amended to date. Filed as 3.1 to Registrant’s Current Report on Form 8-K filed on December 6, 2007 (File No. 1-8491), and incorporated herein by reference. |
| 4.1(a) | Form of Certificate of Designations. Filed as exhibit 3.1 to Registrant’s Current Report on Form 8-K filed on December 14, 2007 (File No. 1-8491), and incorporated herein by reference. |
| 4.1(b) | Certificate of Designations, Preferences and Rights of Series A Junior Participating Preferred Stock of the Registrant. Filed as exhibit 4.1(a) to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 (File No. 1-8491), and incorporated herein by reference. |
| 4.1(c) | Certificate of Designations, Preferences and Rights of Series B Cumulative Convertible Preferred Stock of the Registrant. Filed as exhibit 4.1(b) to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 (File No. 1-8491), and incorporated herein by reference. |
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| 10.1 | Stock Purchase Agreement dated as of June 19, 2008, by and among Rusoro Mining Ltd., Rusoro MH Acquisition Ltd., and Hecla Limited. Filed as exhibit 2.1 to Registrant’s Current Report on Form 8-K filed on June 25, 2008 (File No. 1-8491), and incorporated herein by reference.* |
| 10.2 | Letter agreement by and among Hecla Limited, Rusoro MH Acquisition Ltd., and Rusoro Mining. Ltd. dated June 27, 2008. Filed as exhibit 2.1 to Registrant’s Current Report on Form 8-K (File No. 1-8491) filed on July 3, 2008, and incorporated herein by reference. |
| 10.3 | Amended and Restated Bank Credit Agreement dated as of April 16, 2008, by and among Hecla Mining Company, various Lenders, The Bank of Nova Scotia, as the Administrative Agent for the Lenders, and Scotia Capital as Sole Lead Arranger and Sole Bookrunner. Filed as exhibit 10.1 to Registrant’s Current Report on Form 8-K (File No. 1-8491) filed on April 22, 2008, and incorporated herein by reference. |
| 10.4 | Guaranty, dated as of April 16, 2008, by Hecla Mining Company. Filed as exhibit 10.2 to Registrant’s Current Report on Form 8-K (File No. 1-8491) filed on April 22, 2008, and incorporated herein by reference. |
| 31.1 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. ** |
| 31.2 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. ** |
| 32.1 | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ** |
| 32.2 | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ** |
___________________
* | The agreements filed or incorporated by reference contain a brief list identifying the contents of all omitted schedules, which schedules Hecla Mining Company agrees to furnish supplementally to the Securities and Exchange Commission upon its request. |
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