1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 Commission file number 1-8491 ------------------------------------------ HECLA MINING COMPANY - ----------------------------------------------------------------- - (Exact name of registrant as specified in its charter) Delaware 82-0126240 - --------------------------------------- -------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 6500 Mineral Drive Coeur d'Alene, Idaho 83815-8788 - ---------------------------------------- -------------------- (Address of principal executive offices) (Zip Code) 208-769-4100 - ----------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for at least the past 90 days. Yes XX . No . ---- ---- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding October 30, 1998 - ---------------------------- ---------------------------- Common stock, par value 55,104,639 shares $0.25 per share
2 HECLA MINING COMPANY and SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1998 I N D E X* PAGE PART I. - Financial Information Item l - Consolidated Balance Sheets - September 30, 1998 and December 31, 1997 3 - Consolidated Statements of Operations and Comprehensive Loss - Three Months and Nine Months Ended September 30, 1998 and 1997 4 - Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1998 and 1997 5 - Notes to Consolidated Financial Statements 6 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 15 PART II. - Other Information Item 1 - Legal Proceedings 32 Item 6 - Exhibits and Reports on Form 8-K 36 *Items omitted are not applicable. -2-
3 PART I - FINANCIAL INFORMATION HECLA MINING COMPANY and SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (unaudited) (In thousands, except share data) <TABLE> <CAPTION> September 30, December 31, 1998 1997 ------------- ------------ ASSETS <S> <C> <C> Current assets: Cash and cash equivalents $ 4,085 $ 3,794 Accounts and notes receivable, net 30,664 24,445 Income tax refund receivable 1,087 793 Inventories 23,734 22,116 Other current assets 2,148 1,416 --------- --------- Total current assets 61,718 52,564 Investments 3,130 2,521 Restricted investments 7,061 7,926 Properties, plants and equipment, net 176,847 180,037 Other noncurrent assets 8,660 7,620 --------- --------- Total assets $ 257,416 $ 250,668 ========= ========= LIABILITIES Current liabilities: Accounts payable and accrued expenses $ 12,405 $12,590 Accrued payroll and related benefits 3,308 2,436 Preferred stock dividends payable 2,012 2,012 Accrued taxes 1,031 1,016 Accrued reclamation and closure costs 9,160 6,914 --------- --------- Total current liabilities 27,916 24,968 Deferred income taxes 300 300 Long-term debt 35,958 22,136 Accrued reclamation and closure costs 25,140 34,406 Other noncurrent liabilities 8,703 8,518 --------- --------- Total liabilities 98,017 90,328 --------- --------- SHAREHOLDERS' EQUITY Preferred stock, $0.25 par value, authorized 5,000,000 shares, issued and outstanding - 2,300,000 shares, liquidation preference $117,012 575 575 Common stock, $0.25 par value, authorized 100,000,000 shares; issued 1998 - 55,166,728; issued 1997 - 55,156,324 13,792 13,789 Capital surplus 374,017 373,966 Accumulated deficit (222,979) (222,143) Accumulated other comprehensive loss (5,120) (4,961) Less treasury stock, at cost; 1998 and 1997 - 62,089 shares (886) (886) --------- --------- Total shareholders' equity 159,399 160,340 --------- --------- Total liabilities and shareholders' equity $ 257,416 $ 250,668 ========= ========= The accompanying notes are an integral part of the consolidated financial statements. </TABLE> -3-
4 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (Unaudited) (Dollars and shares in thousands, except for per-share amounts) <TABLE> <CAPTION> Three Months Ended Nine Months Ended ------------------------------- ------------------------------ Sept 30, 1998 Sept 30, 1997 Sept 30, 1998 Sept 30, 1997 -------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> Sales of products $ 38,611 $ 41,204 $ 124,395 $ 129,729 --------- --------- --------- --------- Cost of sales and other direct production costs 29,904 30,032 96,918 98,192 Depreciation, depletion and amortization 5,678 5,734 15,852 15,137 --------- --------- --------- --------- 35,582 35,766 112,770 113,329 --------- --------- --------- --------- Gross profit 3,029 5,438 11,625 16,400 --------- --------- --------- --------- Other operating expenses: General and administrative 1,669 1,951 5,946 5,984 Exploration 1,396 1,738 3,348 5,530 Depreciation and amortization 100 76 293 233 Provision for closed operations and environmental matters 332 91 463 239 --------- --------- --------- --------- 3,497 3,856 10,050 11,986 --------- --------- --------- --------- Income (loss) from operations (468) 1,582 1,575 4,414 --------- --------- --------- --------- Other income (expense): Interest and other income 744 739 4,681 3,960 Miscellaneous expense (536) (383) (1,187) (1,160) Gain on investments 53 - - 1,294 - - Interest expense: Total interest cost (802) (510) (2,407) (1,930) Less amount capitalized 362 132 950 609 --------- --------- --------- --------- (179) (22) 3,331 1,479 --------- --------- --------- --------- Income (loss) before income taxes (647) 1,560 4,906 5,893 Income tax benefit (provision) 6 (625) 296 (1,386) --------- --------- --------- --------- Net income (loss) (641) 935 5,202 4,507 Preferred stock dividends (2,013) (2,013) (6,038) (6,038) --------- --------- --------- --------- Loss applicable to common shareholders (2,654) (1,078) (836) (1,531) --------- --------- --------- --------- Other comprehensive loss, net of tax: Unrealized holding losses on securities (139) (147) (97) (265) Reclassification adjustment for gain included in net loss (62) - - (62) - - --------- --------- --------- --------- Other comprehensive loss (201) (147) (159) (265) --------- --------- --------- --------- Comprehensive loss $ (2,855) $ (1,225) $ (995) $ (1,796) ========= ========= ========= ========= Basic and diluted loss per common share $ (0.05) $ (0.02) $ (0.02) $ (0.03) ========= ========= ========= ========= Cash dividends per common share $ - - $ - - $ - - $ - - ========= ========= ========= ========= Weighted average number of common shares outstanding 55,105 55,095 55,100 54,300 ========= ========= ========= ========= The accompanying notes are an integral part of the consolidated financial statements. </TABLE> -4-
5 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) <TABLE> <CAPTION> Nine Months Ended ------------------------------- Sept 30, 1998 Sept 30, 1997 ------------- ------------- <S> <C> <C> Operating activities: Net income $ 5,202 $ 4,507 Noncash elements included in net income: Depreciation, depletion and amortization 16,145 15,370 Gain on disposition of properties, plants and equipment (2,259) (1,125) Gain on investments (1,294) - - Provision for reclamation and closure costs 436 776 Change in: Accounts and notes receivable (6,219) (2,968) Income tax refund receivable (294) 405 Inventories (1,618) 2,560 Other current assets (732) 538 Accounts payable and accrued expenses (360) (4,639) Accrued payroll and related benefits 872 (212) Accrued taxes 15 219 Accrued reclamation and other noncurrent liabilities (7,271) (9,629) ---------- ---------- Net cash provided by operating activities 2,623 5,802 ---------- ---------- Investing activities: Additions to properties, plants and equipment (14,073) (16,792) Proceeds from disposition of properties, plants and equipment 3,548 1,865 Proceeds from the sale of investments 1,294 - - Decrease in restricted investments 865 13,792 Purchase of investments and increase in cash surrender value of life insurance, net (768) (1,211) Other, net (1,211) 1,588 ---------- ---------- Net cash used by investing activities (10,345) (758) ---------- ---------- Financing activities: Common stock issued under stock and stock option plans 54 46 Issuance of common stock, net of offering costs - - 23,370 Dividends on preferred stock (6,038) (6,038) Borrowing on long-term debt 33,000 46,300 Repayment of long-term debt (19,003) (70,571) ---------- ---------- Net cash provided (used) by financing activities 8,013 (6,893) ---------- ---------- Net increase (decrease) in cash and cash equivalents 291 (1,849) Cash and cash equivalents at beginning of period 3,794 7,159 ---------- ---------- Cash and cash equivalents at end of period $ 4,085 $ 5,310 ========== ========== The accompanying notes are an integral part of the consolidated financial statements. </TABLE> -5-
6 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. The notes to the consolidated financial statements as of December 31, 1997, as set forth in the Company's 1997 Annual Report on Form 10-K, substantially apply to these interim consolidated financial statements and are not repeated here. Note 2. The financial information given in the accompanying unaudited interim consolidated financial statements reflects all adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods reported. All such adjustments are of a normal recurring nature. All financial statements presented are unaudited. However, the balance sheet as of December 31, 1997, was derived from the audited consolidated balance sheet described in Note 1 above. Certain consolidated financial statement amounts have been reclassified to conform to the 1998 presentation. These reclassifications had no effect on the net loss or accumulated deficit as previously reported. Note 3. The components of the income tax provision (benefit) for the nine months ended September 30, 1998 and 1997 are as follows (in thousands): 1998 1997 ------ ------ Current: State $ 184 $ 229 Federal (529) (4) Foreign 49 1,161 ------ ------ Total $ (296) $1,386 ====== ====== The Company's income tax provision (benefit) for the first nine months of 1998 and 1997 varies from the amount that would have been provided by applying the statutory rate to the income before income taxes primarily due to the availability of net operating losses. -6-
7 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES Note 4. Inventories consist of the following (in thousands): Sept. 30, Dec. 31, 1998 1997 -------- -------- Concentrates, bullion, metals in transit and other products $ 7,890 $ 4,773 Industrial mineral products 7,443 9,230 Materials and supplies 8,401 8,113 -------- -------- $ 23,734 $ 22,116 ======== ======== Note 5. Contingencies - Bunker Hill Superfund Sites In 1994, the Company, as a potentially responsible party under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (CERCLA or Superfund), entered into a Consent Decree with the Environmental Protection Agency (EPA) and the State of Idaho, concerning environmental remediation obligations at the Bunker Hill Superfund Site (Bunker Hill Site) located at Kellogg, Idaho. The Consent Decree settled the Company's response-cost liability under Superfund at the Bunker Hill Site. As of September 30, 1998, the Company has estimated and accrued an allowance for liability for remedial activity costs at the Bunker Hill Site of $5.6 million. These estimated expenditures are anticipated to be made over the next three to five years. As with any estimate of this nature, it is reasonably possible that the Company's estimate of this obligation may change in the near term. Coeur d'Alene River Basin Natural Resource Damage Claims - Coeur d'Alene Tribe Claims In July 1991, the Coeur d'Alene Indian Tribe (the Tribe) brought a lawsuit, under CERCLA, in Idaho Federal District Court against the Company and a number of other mining companies asserting claims for damages to natural resources downstream from the Bunker Hill Site over which the Tribe alleges some ownership or control. The Company answered the Tribe's complaint denying liability for natural resource damages. In October 1996, following a court imposed four-year stay -7-
8 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES of the proceeding, the Tribe's natural resource damage litigation was consolidated with the United States Natural Resources Damage litigation described below. - U.S. Government Claims In March 1996, the United States filed a lawsuit in Idaho Federal District Court against certain mining companies that conducted historic mining operations in the Silver Valley of northern Idaho, including the Company. The lawsuit asserts claims under CERCLA and the Clean Water Act and seeks recovery for alleged damages to or loss of natural resources located in the Coeur d'Alene River Basin (the Basin) in northern Idaho over which the United States asserts to be the trustee under CERCLA. The lawsuit asserts that the defendants' historic mining activity resulted in releases of hazardous substances and damaged natural resources within the Basin. The suit also seeks declaratory relief that the Company and other defendants are jointly and severally liable for response costs under CERCLA for historic mining impacts in the Basin outside the Bunker Hill Site. The Company answered the complaint in May 1996, denying liability to the United States under CERCLA and the Clean Water Act and asserted a counterclaim against the United States for the federal government's involvement in mining activity in the Basin which contributed to the releases and damages alleged by the United States. The Company believes it also has a number of defenses to the United States' claims. In October 1996, the Court consolidated the Coeur d'Alene Tribe Natural Resource Damage (NRD) litigation with this lawsuit for discovery and other limited pretrial purposes. On September 30, 1998, the Federal District Court granted the Company's summary judgment motion with respect to the applicable statute of limitations and dismissed the United States' NRD claim due to the failure of EPA to comply with federal law and EPA regulations in expanding the Natural Priority List site boundaries to include the entire Coeur d'Alene River/Lake Coeur d'Alene Basin which would have the effect of extending the statute of limitations. The United States is seeking permission to appeal the Federal District Court's decision to the Ninth Circuit Court of Appeals. The case is proceeding through discovery. Summary judgment motions related to i) the -8-
9 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES extent of Federal Trusteeship over Natural Resources in the Coeur d'Alene Basin, ii) a constitutional challenge to the retroactive application of Superfund liability at the site, and iii) case management are pending before the Court. In May 1998, the EPA announced that it had commenced a remedial investigation/feasibility study under CERCLA for the entire Basin, including Lake Coeur d'Alene, in support of its response cost claims asserted in its March 1996 lawsuit. - State of Idaho Claims In March 1996, the Company entered into an agreement (the Idaho Agreement) with the State of Idaho (the State) pursuant to which the Company agreed to continue certain financial contributions to environmental cleanup work in the Basin being undertaken by a State trustees group. In return, the State agreed not to sue the Company for damage to natural resources for which the State is a trustee for a period of five years, to pursue settlement with the Company of the State's natural resource damage claims and to grant the Company credit against any such State claims for all expenditures made under the Idaho Agreement and certain other Company contributions and expenditures for environmental cleanup in the Basin. At September 30, 1998, the Company's accrual for remediation activity in the Basin, not including the Bunker Hill Site, totaled approximately $0.6 million. These expenditures are anticipated to be made over the next three years. Depending on the results of the aforementioned lawsuits, it is reasonably possible that the Company's estimate of its obligation may change in the near or longer term. Insurance Coverage Litigation In 1991, the Company initiated litigation in the Idaho State District Court in Kootenai County, Idaho, against a number of insurance companies which provided comprehensive general liability insurance coverage to the Company and its predecessors. The Company believes that the insurance companies have a duty to defend and indemnify the Company under their policies of insurance for all liabilities and claims asserted against the -9-
10 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES Company by the EPA and the Tribe under CERCLA related to the Bunker Hill Site and the Basin in northern Idaho. In 1992, the Court ruled that the primary insurance companies had a duty to defend the Company in the Tribe's lawsuit. During 1995 and 1996, the Company entered into settlement agreements with a number of the insurance carriers named in the litigation. The Company has received a total of approximately $7.2 million under the terms of the settlement agreements. Thirty percent of these settlements were paid to the EPA to reimburse the U.S. Government for past costs under the Bunker Hill Site Consent Decree. Litigation is still pending against one insurer with trial continued until the underlying environmental claims against the Company are resolved or settled. The remaining insurer is providing the Company with a partial defense in all Basin environmental litigation. As of September 30, 1998, the Company had not reduced its accrual for reclamation and closure costs to reflect the receipt of any anticipated insurance proceeds. Other Claims - George Creque, Jr. et. al. vs. Cactus Gold Mines Co., et. al. (including The Company) On October 22, 1998, Hecla Mining Company and certain affiliates were served with a lawsuit filed in Superior Court of Kern County, California. The Complaint pertains to the Cactus Gold mine located near Mojave, California. Seventy-four plaintiffs allege that during the period from 1960 through the present, the named defendants' operations and activities caused personal injury and property damage to the plaintiffs. The plaintiffs seek monetary damages of $29,600,000,000 for general negligence, nuisance, trespass, statutory violations, ultra-hazardous activities, strict liability, and other torts. The Company has provided notice and demand for defense/indemnity to its insurance carriers providing coverage for the Cactus Gold mine operation. To date, the Company has not received any response from the carriers. The Company has retained outside counsel to defend the Company in advance of any response from the insurance companies. Based on our preliminary review of the allegations in the Complaint as it relates to the historical -10-
11 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES operations at the Cactus Gold mine, the Company believes the allegations are without merit. The Company is subject to other legal proceedings and claims which have arisen in the ordinary course of its business and have not been finally adjudicated. Although there can be no assurance as to the ultimate disposition of these matters and the proceedings disclosed above, it is the opinion of the Company's management, based upon the information available at this time, that the currently expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operations, financial condition or cash flows of the Company. Note 6. On September 30, 1998, the Company amended its revolving and term loan credit facility (the Bank Agreement). Under the terms of Bank Agreement, the Company may borrow up to $55.0 million on a revolving basis through December 31, 2001, repayable in eight quarterly installments beginning October 31, 2001. At September 30, 1998, there was $26.0 million outstanding under the Bank Agreement classified as long-term debt. The Company was in compliance with all restrictive covenants of the Bank Agreement as of September 30, 1998. In addition to the borrowings under the Bank Agreement, the Company also has outstanding $9.8 million aggregate principal amount of tax-exempt, solid waste disposal revenue bonds as of September 30, 1998. The amount available to borrow under the Bank Agreement is reduced by the $9.8 million amount of tax-exempt, solid waste bonds. At September 30, 1998, the Company had the ability to borrow approximately an additional $19.0 million under the Bank Agreement. -11-
12 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES Note 7. The following table presents a reconciliation of the numerators (net income or loss) and denominators (shares) used in the basic and diluted income (loss) per common share computations. Also shown is the effect that has been given to preferred stock dividends in arriving at income (loss) applicable to common shareholders for the three- and nine-month periods ended September 30, 1998 and 1997 in computing basic and diluted income (loss) per common share (in thousands). <TABLE> <CAPTION> Three Months Ended September 30, ------------------------------------------------------------- 1998 1997 ----------------------------- ------------------------------- Net Per-Share Net Per-Share Loss Shares Amount Income (loss) Shares Amount -------- ------ --------- ------------ ------ --------- <S> <C> <C> <C> <C> <C> <C> Net income (loss) $ (641) $ 935 Less: Preferred stock dividends (2,013) (2,013) -------- -------- Basic loss applicable to common shareholders (2,654) 55,105 $ (0.05) (1,078) 55,095 $ (0.02) Effect of dilutive securities - - - - - - - - - - - - -------- ------ ------- -------- ------ ------- Diluted loss applicable to common shareholders $ (2,654) 55,105 $ (0.05) $ (1,078) 55,095 $ (0.02) ======== ====== ======= ======== ====== ======= Nine Months Ended September 30, --------------------------------------------------------------- 1998 1997 ------------------------------ ------------------------------- Net Per-Share Net Per-Share Income (loss) Shares Amount Income (loss) Shares Amount ------------- ------ --------- ------------- ------ ---------- Net income $ 5,202 $ 4,507 Less: Preferred stock dividends (6,038) (6,038) -------- -------- Basic loss applicable to common shareholders (836) 55,100 $ (0.02) (1,531) 54,300 $ (0.03) Effect of dilutive securities - - - - - - - - - - - - -------- ------ ------- -------- ------ ------- Diluted loss applicable to common shareholders $ (836) 55,100 $ (0.02) $ (1,531) 54,300 $ (0.03) ======== ====== ======= ======== ====== ======= </TABLE> The foregoing calculations of diluted earnings per share for each of the three- and nine-month periods ended September 30, 1998 and 1997, exclude the effects of $115,000,000 of convertible preferred stock as such conversion would be antidilutive. For the three- and -12-
13 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES nine-month periods ended September 30, 1998 and 1997, these calculations also exclude the effects of 1,656,000 and 1,024,077 shares of common stock, respectively, issuable upon exercise of stock options as their exercise would be antidilutive. Note 8. In June 1997, Statement of Financial Accounting Standards No. 130 (SFAS 130), "Comprehensive Income," was issued. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS 130 is effective for fiscal years beginning after December 15, 1997, and requires restatement of earlier periods presented. The Company has applied this standard effective January 1, 1998. In June 1997, Statement of Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments of an Enterprise and Related Information," was issued. SFAS 131 establishes standards for the way that a public enterprise reports information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. SFAS 131 is effective for fiscal years beginning after December 15, 1997, and requires restatement of earlier periods presented. Although the Company has not yet applied this standard, the Company does not expect the adoption of this standard to have a material impact on the financial condition or results of operations of the Company. In June 1998, Statement of Financial Accounting Standards No. 133 (SFAS 133). "Accounting for Derivative Instruments and Hedging Activities" was issued. SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999, however, earlier application of all of the provisions of this Statement is encouraged as of the beginning of any fiscal -13-
14 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES quarter. The Company is presently evaluating the effect the adoption of this standard will have on the financial condition and results of operations of the Company. In April 1998, Statement of Position 98-5 (SOP 98-5) "Reporting on the Costs of Start-up Activities," was issued. SOP 98-5 provides guidance on the financial reporting of start-up costs and organizational costs. It requires costs of start-up activities and organizational costs to be expensed as incurred, as well as the recognition of a cumulative effect of change in accounting principle for retroactive application of the standard. SOP 98-5 is effective for fiscal years beginning after December 15, 1998, although earlier application is encouraged. The Company is presently evaluating the effect the adoption of SOP 98-5 will have on the financial condition and results of operations of the Company. -14-
15 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION Hecla Mining Company (Hecla or the Company) is primarily involved in the exploration, development, mining, and processing of gold, silver, lead, zinc, and industrial minerals. As such, the Company's revenues and profitability are strongly influenced by world prices of gold, silver, lead, and zinc, which fluctuate widely and are affected by numerous factors beyond the Company's control, including inflation and worldwide forces of supply and demand for precious and base metals. The aggregate effect of these factors is not possible to accurately predict. In the following descriptions, where there are changes that are attributable to more than one factor, the Company presents each attribute in descending order relative to the attribute's importance to the overall change. Except for the historical information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations, the matters discussed below are forward-looking statements that involve risks and uncertainties, including the timely development of existing properties and reserves and future projects, the impact of metals prices and metal production volatility, changing market conditions and the regulatory environment, the impact of the Year 2000 computer issue, and the other risks detailed from time to time in the Company's Form 10-K and Form 10-Qs filed with the Securities and Exchange Commission (see also "Investment Considerations" of Part I, Item 1 of the Company's 1997 Annual Report on Form 10-K). As a result, actual results may differ materially from those projected or implied. These forward-looking statements represent the Company's judgment as of the date of this filing. The Company disclaims, however, any intent or obligation to update these forward-looking statements as circumstances change or develop. The Company incurred losses applicable to common shareholders for each of the past three years in the period ended December 31, 1997. If the Company's estimates of market prices of gold, silver, lead, and zinc are realized in the fourth quarter of 1998, the -15-
16 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES Company expects to record a loss in the range of $4.0 million to $6.0 million after the expected dividends to preferred shareholders totaling approximately $8.1 million for the year ending December 31, 1998. Due to the volatility of metals prices and the significant impact metals price changes have on the Company's operations, there can be no assurance that the actual results of operations for 1998 will be as projected. The variability of metals prices requires that the Company, in assessing the impact of prices on recoverability of its metals segment assets, exercise judgment as to whether price changes are temporary or are likely to persist. The Company performs a comprehensive evaluation of the recoverability of its assets on a periodic basis. This evaluation includes a review of estimated future net cash flows against the carrying value of the Company's assets. Moreover, a review is made on a quarterly basis to assess the impact of significant changes in market conditions and other factors. Asset write-downs may occur if the Company determines that the carrying values attributed to individual assets are not recoverable given reasonable expectations for future production and market conditions. During the first nine months of 1998, the Company produced approximately 95,000 ounces of gold compared to approximately 130,000 ounces of gold production in the first nine months of 1997. The decrease in gold production in 1998 is the result of the suspension of operations at the Grouse Creek mine in April 1997 and decreased gold production at the La Choya mine in 1998, partly offset by increased gold production at the Rosebud mine where operations commenced in April 1997. The Company's gold production in the first nine months of 1998 was from the following sources: the Rosebud mine - approximately 51,000 ounces; the La Choya mine - approximately 29,000 ounces; the Greens Creek mine - approximately 13,000 ounces; and an additional 2,000 ounces from other sources. For the year ending December 31, 1998, the Company expects to produce between 125,000 and 130,000 ounces of gold compared to actual 1997 gold production of approximately 174,000 ounces of gold. The 1998 estimated gold production includes 63,000 to 65,000 ounces from the Company's interest in the Rosebud mine, 42,000 to 44,000 ounces from the Company's La Choya mine, 16,000 to 17,000 -16-
17 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES ounces from the Company's interest in the Greens Creek mine, and 4,000 ounces from other sources. In the first nine months of 1998, the Company produced approximately 5.4 million ounces of silver compared to approximately 3.9 million ounces in the first nine months of 1997. The increase in silver production in 1998 is principally the result of increased silver production at the Lucky Friday mine due to mining in the higher silver grade expansion area in the 1998 period. The Company's silver production in the first nine months of 1998 was principally from the Lucky Friday mine - approximately 3.0 million ounces, the Greens Creek mine - approximately 2.2 million ounces, and the Rosebud mine - approximately 0.2 million ounces. The Company's share of silver production for 1998 is expected to be between 7.2 million and 7.4 million ounces compared to 1997 production of approximately 5.1 million ounces. The 1998 estimated silver production includes 4.1 to 4.2 million ounces from the Lucky Friday mine, 2.8 to 2.9 million ounces from the Company's interest in the Greens Creek mine and an additional 0.3 million ounces from other sources. The Company's shipments of industrial minerals, including ball clay, kaolin, feldspar, and specialty aggregates, are expected to increase in 1998 to approximately 1,112,000 tons compared to 1,026,000 tons in 1997. Additionally, the Company expects to ship approximately 1,049,000 cubic yards of landscape material from its Mountain West Products operation in 1998 compared to 891,000 cubic yards in 1997. RESULTS OF OPERATIONS FIRST NINE MONTHS 1998 COMPARED TO FIRST NINE MONTHS 1997 The Company reported net income of approximately $5.2 million, or $0.09 per share, in the first nine months of 1998 compared to net income of approximately $4.5 million, or $0.08 per share, in the same period of 1997. After $6.0 million in dividends to shareholders of the Company's Series B Cumulative Convertible Preferred Stock, the Company's loss applicable to common shareholders for the first nine months of 1998 was $0.8 million, or $0.02 per common share, compared -17-
18 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES to a loss of $1.5 million, or $0.03 per common share, in the comparable 1997 period. The change in income in the first nine months of 1998 was attributable to a variety of factors the most significant of which are discussed below in descending order of magnitude. Comparing the average metal prices for the nine months of 1998 with the comparable 1997 period, gold decreased by 13% to $294 per ounce from $339 per ounce, silver increased by 20% to $5.73 per ounce from $4.77 per ounce, lead decreased by 16% to $0.245 per pound from $0.292 per pound, and zinc decreased by 23% to $0.475 per pound from $0.617 per pound. During the first nine months of 1998, the Company's realized gold price per ounce decreased 18% from $366 per ounce in the first nine months of 1997 to $301 per ounce in 1998. Sales of the Company's products decreased by approximately $5.3 million, or 4%, in the first nine months of 1998 as compared to the same period in 1997. The decreased product sales resulted from lower sales totaling approximately $19.1 million from gold operations due to decreased production at the Grouse Creek and La Choya mines, and a lower gold price. The decrease in sales from gold operations was partly offset by increased sales from the industrial minerals segment of $8.7 million where sales improved at both Kentucky-Tennessee (K-T) clay and MWCA, and increased sales from silver operations of $5.1 million due to increased production and a higher silver price, partly offset by lower zinc, gold, and lead prices. Cost of sales and other direct production costs decreased approximately $1.3 million, or 1%, from the first nine months of 1997 to the comparable 1998 period primarily due to (1) decreased production costs of $10.2 million at the Grouse Creek mine where operations were suspended in April 1997; (2) decreased production costs at the La Choya mine of $5.1 million, due to decreased production; and (3) decreased costs at other operations totaling approximately $1.1 million. These decreases in costs were partially offset by increases in operating costs at other operations including (1) increased production costs of $7.8 million at the industrial minerals segment resulting from increased sales of products, a litigation settlement at K-T Clay, and organizational restructuring costs at MWCA; (2) increased production costs at the Rosebud mine totaling -18-
19 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES $4.7 million due to the commencement of operations in April 1997; and (3) increased production costs at the Lucky Friday mine of $2.6 million resulting from increased production and sales from the newly developed expansion area. Cost of sales and other direct production costs as a percentage of sales increased from 75.7% in the first nine months of 1997 to 77.9% in the comparable 1998 period. The increase is primarily due to decreased production and sales in 1998 at the low cost La Choya mine, combined with the lower gold price in the 1998 period. Depreciation, depletion and amortization increased $0.7 million, or 5%, from the first nine months of 1997 to the comparable 1998 period primarily due to (1) increased depreciation at the Rosebud mine ($1.9 million) the result of operating nine months in 1998 versus six months in 1997; (2) increased depreciation at the Lucky Friday mine ($0.7 million) due to increased production in the 1998 period; and (3) increased depreciation at the industrial minerals segment ($0.2 million). These increases were partly offset by decreased depreciation, depletion, and amortization at (1) the La Choya mine ($1.9 million), as a result of the majority the current property, plant, and equipment being fully depreciated as of December 31, 1997, and (2) the Greens Creek mine ($0.2 million). Cash operating cost, total cash cost and total production cost per gold ounce increased from $167, $175 and $237 for the first nine months of 1997 to $173, $185 and $249 for the comparable 1998 period, respectively. The increase in the cash operating cost, total cash cost, and total production cost per gold ounce is primarily attributable to increased per ounce costs at both the La Choya mine, the result of decreased production, and the Rosebud mine, the result of higher milling costs and mining of lower grade gold ore. Cash operating cost, total cash cost and total production cost per silver ounce increased from $3.36, $3.36 and $5.23 in the first nine months of 1997 to $3.88, $3.88 and $5.30 in the comparable 1998 period, respectively. The increases in the cost per silver -19-
20 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES ounce are due primarily to increased cost per ounce amounts at the Greens Creek mine due to the impact of lower gold, zinc, and lead prices on by- product credits, partly offset by decreased cost per ounce amounts at the Lucky Friday mine resulting from increased silver production, which offset was also impacted by lower by-product metal prices. Gold, lead, and zinc are by-products of the Company's silver production, the revenues from which are netted against production costs in the calculation of production cost per ounce of silver. Other operating expenses decreased $1.9 million, or 16%, from the 1997 period to the 1998 period, due principally to decreased exploration expenditures of $2.2 million, most notably at Mexican exploration properties. This decrease was partly offset by an increase in provision for closed plants and environmental matters of $0.2 million and decreased depreciation expense of $0.1 million. Other income was $3.3 million in the first nine months of 1998 compared to $1.5 million in the comparable 1997 period. The $1.8 million increase was primarily due to (1) a $1.3 million gain on sale of investments in the 1998 period, and (2) an increase in interest and other income of $0.7 million resulting from a gain on sale of land located near the Coeur d'Alene office of $2.3 million, partly offset by a 1997 gain on sale of an 8% interest in the Buckhorn Joint Venture, in Nevada, of $1.1 million, and decreased royalty income of $0.5 million. Total interest cost increased approximately $0.5 million due to higher interest and fees associated with the Company's tax- exempt solid waste disposal bonds and the revolving and term loan credit facility. Capitalized interest costs increased $0.3 million principally due to increased capitalized interest costs associated with the Lucky Friday expansion project, partly offset by decreased capitalized interest associated with the Rosebud mine. THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1997 The Company incurred a net loss of approximately $0.6 million, or $0.01 per share, in the third quarter of 1998 compared to net income of approximately $0.9 million, or $0.02 per share, in the same period of -20-
21 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES 1997. After $2.0 million in dividends to shareholders of the Company's Series B Cumulative Convertible Preferred Stock, the Company's loss applicable to common shareholders for the third quarter of 1998 was $2.7 million, or $0.05 per common share, compared to $1.1 million, or $0.02 per common share, in the comparable 1997 period. The change in income in the third quarter of 1998 was attributable to a variety of factors the most significant of which are discussed below in descending order of magnitude. Sales of the Company's products decreased by approximately $2.6 million, or 6%, in the third quarter of 1998 as compared to the same period in 1997. The decreased product sales resulted from lower sales totaling approximately $6.8 million from gold operations resulting from decreased production at the La Choya and Grouse Creek mines, combined with a lower average gold price. The decreased sales at the gold operations were partially offset by increased sales from the industrial minerals segment of $2.2 million where sales improved at K-T Clay and MWCA, and increased sales from silver operations of $1.9 million due to increased production and sales at the Lucky Friday mine, the favorable impact of a higher silver price, partly offset by decreased shipments at the Greens Creek mine, and by lower zinc, lead, and gold prices. Comparing the average metals prices for the third quarter of 1998 with the comparable 1997 period, gold decreased by 11% to $289 per ounce from $324 per ounce, silver increased by 15% to $5.22 per ounce from $4.53 per ounce, lead decreased by 15% to $0.242 per pound from $0.284 per pound, and zinc decreased by 36% to $0.464 per pound from $0.728 per pound. During the third quarter of 1998, the Company's realized gold price per ounce decreased 16% from $352 per ounce in the third quarter of 1997 to $297 per ounce in the 1998 period. Cost of sales and other direct production costs decreased slightly from the third quarter of 1997 to the comparable 1998 period primarily due to (1) decreased production costs at the La Choya mine totaling approximately $2.2 million due to decreased production; (2) decreased costs at the Greens Creek mine due to decreased shipments during the third -21-
22 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES quarter of 1998 ($1.9 million); (3) decreased costs at the Grouse Creek mine ($1.0 million) due to the suspension of operations in 1997; and (4) decreased costs at the American Girl mine ($0.3 million). These production cost decreases were partially offset by increased production costs at (1) the Lucky Friday mine of $2.7 million due to increased production and shipments from the Lucky Friday expansion area; (2) the industrial minerals segment of $1.9 million resulting from increased sales; and (3) the Rosebud mine of $0.7 million due to increased tons mined and milled combined with an increased milling cost per ton in the third quarter of 1998. Cost of sales and other direct production costs as a percentage of sales from products increased from 72.9% in the third quarter of 1997 to 77.4% in the comparable 1998 period, primarily due to the decreased production and sales from the La Choya mine, the impact of the lower gold price, and increased costs in the 1998 period at the Rosebud mine. Depreciation, depletion and amortization decreased by approximately $0.1 million, or 1%, from the 1997 period to the 1998 period, primarily the result of decreased depreciation, depletion, and amortization at (1) the La Choya mine ($0.6 million) due to fully depreciating the majority of the current property, plant, and equipment at the end of 1997, and (2) the Greens Creek mine ($0.1 million). These decreases were partially offset by increases in depreciation, depletion, and amortization at (1) the Lucky Friday mine of $0.4 million as a result of increased production in 1998, and (2) the Rosebud mine of $0.2 million as a result of higher gold production in 1998. Cash operating cost, total cash cost and total production cost per gold ounce increased from $160, $171 and $239 for the third quarter of 1997 to $181, $195 and $273 for the third quarter of 1998, respectively. The increase in the cash operating, total cash and total production cost per gold ounce is mainly attributed to the decreased production at the La Choya mine combined with higher unit costs at the Rosebud mine due to mining of lower grade ore and higher milling costs. -22-
23 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES Cash operating and total cash cost per silver ounce increased from $3.21 and $3.21 in the third quarter of 1997 to $3.59 and $3.59 in the third quarter of 1998, respectively. The increases in the cash cost per silver ounce are due primarily to lower by product metal prices, including gold, lead, and zinc. Total production cost per silver ounce decreased from $5.06 in the third quarter of 1997 to $4.93 in the third quarter of 1998 principally due to lower per ounce depreciation charges at both Lucky Friday and Greens Creek in the 1998 period, partially offset by the increased total cash costs per ounce. Gold, lead, and zinc are by-products of the Company's silver production, the revenues from which are netted against production costs in the calculation of production cost per ounce of silver. Other operating expenses decreased by $0.4 million, or 9%, from the 1997 period to the 1998 period, due principally to (1) a decrease in exploration expenditures of $0.3 million due to decreased Mexican exploration expenditures, and (2) decreased general and administrative costs of $0.3 million. These decreases were partly offset by an increased provision for closed operations and environmental matters totaling approximately $0.2 million. Other expense was $0.2 million in the 1998 period compared to nil in the 1997 period. The $0.2 million increase was primarily due to increased miscellaneous expense of $0.2 million most notably due to increased foreign exchange losses. Total interest cost increased $0.3 million due to increased borrowing in 1998 under the Company's revolving and term loan facility than in 1997. Capitalized interest costs increased $0.2 million principally due to increased capitalized interest costs associated with the Lucky Friday expansion project. FINANCIAL CONDITION AND LIQUIDITY A substantial portion of the Company's revenue is derived from the sale of products, the prices of which are affected by numerous factors beyond the Company's control. Prices may change dramatically in short periods of time and such changes have a significant effect on revenues, profits and liquidity of the Company. The Company is subject to many of the same -23-
24 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES inflationary pressures as the U.S. economy in general. The Company continues to implement cost- cutting measures in an effort to reduce per unit production costs. Management believes, however, that the Company may not be able to continue to offset the impact of inflation over the long term through cost reductions alone. However, the market prices for products produced by the Company have a much greater impact than inflation on the Company's revenues and profitability. Moreover, the discovery, development and acquisition of mineral properties are in many instances unpredictable events. Future metals prices, the success of exploration programs, changes in legal and regulatory requirements, and other property transactions can have a significant impact on the need for capital. At September 30, 1998, assets totaled approximately $257.4 million and shareholders' equity totaled approximately $159.4 million. Cash and cash equivalents increased by $0.3 million to $4.1 million at September 30, 1998 from $3.8 million at the end of 1997. During the first nine months of 1998, approximately $8.0 million of cash was provided by financing activities. The major source of cash was borrowings of long-term debt of $33.0 million. This source was partially offset by uses of cash, including repayments of long-term debt of $19.0 million, and payment of preferred stock dividends totaling $6.0 million. Operating activities provided approximately $2.6 million of cash during the first nine months of 1998. The primary sources of cash were from the industrial minerals segment, the Rosebud mine, the Greens Creek mine, and the La Choya mine. Partially offsetting these sources were (1) decreases, totaling $7.3 million, in accrued reclamation and other noncurrent liabilities principally for reclamation and closure activities at Grouse Creek, the Bunker Hill Superfund site, the Coeur d'Alene River Basin, the Republic mine, the Cactus mine, the Yellow Pine mine, and the Durita site; (2) a $6.2 million increase in accounts receivable, most notably at the Lucky Friday mine due to increased production and sales, the industrial minerals segment resulting from increased sales, and the Greens Creek mine due to the timing of shipments, partly offset by decreased accounts receivable at La Choya and Rosebud; -24-
25 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES and (3) a $1.6 million increase in inventories most notably at the La Choya mine due to deferral of costs associated with the push back of the pit wall at La Choya, and the Lucky Friday mine due to increased production. Principal noncash charges included depreciation, depletion, and amortization of approximately $16.1 million and provision for reclamation and closure costs of $0.4 million. The Company's investing activities used $10.3 million of cash during the first nine months of 1998. The most significant uses of cash were (1) additions to properties, plants, and equipment totaling $14.1 million, including significant additions at the Lucky Friday mine of $5.7 million, the industrial minerals segment of $3.5 million, the Greens Creek mine of $2.1 million, capital expenditures at the Noche Buena project of $1.1 million including the purchase of the minority interest in the mining concessions, in-fill, and definition drilling, and other additions, including capitalized interest of $1.7 million; (2) other net uses of $1.2 million; and (3) the purchase of investments and increase in cash surrender value of life insurance required cash of approximately $0.8 million. These uses of cash were partly offset by (1) proceeds from disposition of properties, plants, and equipment during the first nine months of 1998 totaling approximately $3.5 million, principally from the sale of land located near the Company's corporate headquarters; (2) proceeds from the sale of investments of $1.3 million; and (3) the release of restricted investments of $0.9 million. The Company estimates that capital expenditures to be incurred during the fourth quarter of 1998 will be approximately $5.2 million. These capital expenditures consist primarily of (1) approximately $1.8 million at the Company's Industrial Mineral operations; (2) approximately $1.7 million at the Noche Buena project; (3) the Company's share of expenditures at the Greens Creek mine totaling approximately $1.4 million; (4) approximately $0.2 million at the Lucky Friday mine; and (5) other capitalized expenditures of $0.2 million. These planned capital expenditures are anticipated to be funded from operating activities, and amounts available under the Company's revolving term loan credit facility. -25-
26 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES The Company's estimate of its capital expenditure requirements assumes, with respect to the Greens Creek and Rosebud properties, that the Company's joint venture partners will not default with respect to their portion of development costs and capital expenditures. Pursuant to a Registration Statement filed with the Securities and Exchange Commission and declared effective in the third quarter of 1995, the Company can, at its option, issue debt securities, common shares, preferred shares or warrants in an amount not to exceed $100.0 million in the aggregate. To date, the Company has issued $48.4 million of the Company's common shares under the Registration Statement. On September 30, 1998, the Company amended its revolving and term loan credit facility (as amended, the Bank Agreement). Under the terms of the Bank Agreement, the Company may borrow up to $55.0 million on a revolving basis through December 31, 2001, repayable in eight quarterly installments beginning October 31, 2001. At September 30, 1998, there was $26.0 million outstanding under the Bank Agreement classified as long-term debt. The Company was in compliance with all restrictive covenants of the Bank Agreement as of September 30, 1998. In addition to the borrowings under the Bank Agreement, the Company also has outstanding $9.8 million aggregate principal amount of tax-exempt, solid waste disposal revenue bonds as of June 30, 1998. The amount available to borrow under the Bank Agreement is reduced by the $9.8 million amount of tax-exempt, solid waste disposal bonds. At September 30, 1998, the Company had the ability to borrow approximately an additional $19.0 million under the Bank Agreement. The Company's planned environmental and reclamation expenditures during the fourth quarter of 1998 are expected to be approximately $5.0 to $5.7 million, principally for environmental and reclamation activities at the Bunker Hill Superfund site, the Republic mine, the Grouse Creek mine, the Coeur d'Alene River Basin, the American Girl mine, the Durita property, and the Cactus mine. Exploration expenditures during the fourth quarter of 1998 are estimated to be approximately $1.9 million. The Company's exploration strategy is to focus further -26-
27 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES exploration at or in the vicinity of its currently owned domestic and foreign properties. Accordingly, domestic exploration expenditures will be incurred principally at the Greens Creek, Rosebud, and Lucky Friday mines. Foreign exploration efforts in 1998 center primarily on targets in Mexico and South America. In the normal course of its business, the Company uses forward sales commitments and commodity put and call option contracts to manage its exposure to fluctuations in the prices of certain metals which it produces. Contract positions are designed to ensure that the Company will receive a defined minimum price for certain quantities of its production. Gains and losses, and the related costs paid or premium received, for contracts which hedge the sales prices of commodities are deferred and included in income as part of the hedged transaction. Revenues from the aforementioned contracts are recognized at the time contracts are closed out by delivery of the underlying commodity or when the Company matches specific production to a contract. For contracts where the net position is settled in cash, revenues are recognized on the original settlement date of the contracts. The Company is exposed to certain losses, generally the amount by which the contract price exceeds the spot price of a commodity, in the event of nonperformance by the counterparties to these agreements. At September 30, 1998, the Company had forward sales commitments through June 30, 1999 for 6,000 ounces of gold at an average price of $354 per ounce. The estimated fair value of these forward sales commitments was $353,000 as of September 30, 1998. The London Final gold price at September 30, 1998, was $294. Additionally, at September 30, 1998, the Company had forward sales commitments through June 30, 1999 for 1,100,000 ounces of silver at an average price of $6.18 per ounce. If the Company's forward silver sales commitments were closed on September 30, 1998, the estimated fair value of these commitments was approximately $857,000. The Handy & Harman silver price at September 30, 1998 was $5.29. The nature and purpose of the forward sales contracts, however, do not presently expose the Company to any significant net loss. All of the aforementioned contracts were designated as hedges as of September 30, 1998. -27-
28 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES The Company is subject to legal proceedings and claims which have arisen in the ordinary course of its business and have not been finally adjudicated (see Part II Item 1. Legal Proceedings). Although the ultimate disposition of these matters and various other pending legal actions and claims is not presently determinable, it is the opinion of the Company's management, based upon the information available at this time, that the expected outcome of these suits and proceedings will not have a material adverse effect on the results of operations, financial condition and cash flows of the Company and its subsidiaries. YEAR 2000 The Company utilizes software and related technologies throughout its business that will be affected by the "Year 2000 computer problem," which is common to many corporations and governmental entities, and concerns the inability of information systems, primarily computer software programs, to recognize and process date-sensitive information properly as the Year 2000 approaches. Absent corrective actions, a computer program that has date sensitive software may recognize a date using "00" as the year 1900 rather than 2000. This could result in system failures or miscalculations causing disruptions to various activities and operations. The Company has established thirteen teams to identify and correct Year 2000 compliance issues. The Company's primary information systems (IS) with non- compliant code are expected to be modified or replaced with systems that are Year 2000 compliant. The Company is also evaluating its non-IS applications, primarily systems embedded in processing and other facilities. Additionally, the teams are responsible for evaluating the Company's critical suppliers and vendors as to their state of readiness for the Year 2000. The Company's primary IS was originally evaluated in 1996, and out of 2,300 programs, 850 programs were identified that required modification. All of the 850 programs have been modified, installed and tested by the Company's information services department. End- user testing is approximately 25% complete with expected completion by December 31, 1998. The -28-
29 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES Company's other IS's are currently being evaluated, and progress is being made in identifying non-compliant systems. Plans are also being made to remediate the non-compliant systems. The Company currently anticipates completing its evaluation of the other IS's, along with plans for remediating non- compliant systems by December 31, 1998. Inventories and assessments of non-IS systems have been completed by all thirteen teams. Remediation plans are currently being documented and implemented, where necessary. Contingency plans will be developed for all major components in case of system failures surrounding the year 2000. The Company is utilizing independent consultants to oversee the Year 2000 project as well as to perform certain remediation efforts. In addition, progress on the Year 2000 project is also monitored by senior management, and reported to the Company's Audit Committee and Board of Directors at each respective meeting. The Company has identified critical suppliers, as well as other essential service providers, and has surveyed their Year 2000 compliancy. Based on expected compliance dates expressed by some of these critical suppliers and other service providers, additional follow-up will be required to fully assess their state of readiness for the Year 2000. These follow-up activities will occur during the fourth quarter of 1998 and throughout 1999. For other suppliers and service providers, risk assessments and contingency plans, where necessary, will be finalized by mid-year 1999. The Company has taken the above described steps to address issues surrounding suppliers and service providers; however, the Company has no direct ability to influence their compliance actions. The Company believes it has taken the necessary actions to mitigate the effect of Year 2000 risks, although the Company is not able to eliminate the risks or to estimate the ultimate effect Year 2000 will have on the Company's operating results and financial condition. Contingency plans for Year 2000 related business interruptions are being developed and will include, but not limited to, the development of emergency backup and recovery procedures, replacing automated processes with -29-
30 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES manual processes, identification of alternate suppliers, and increasing raw material supplies and finished goods inventory prior to December 31, 1999. All plans are expected to be completed by the end of the second quarter of 1999, but ongoing monitoring will continue throughout 1999. The Company's most likely potential risk is a temporary inability to process and ship its products, as well as the inability of some customers to order and pay on a timely basis. Incremental costs directly related to Year 2000 issues are estimated to be $265,000 from 1998 to 2000, of which approximately $91,000 has been spent to date. The Company's current estimate of expected costs is based upon work performed to date, and depending on the results of future work, the cost estimate may increase. This estimate assumes that the Company will not incur significant Year 2000 costs on behalf of its suppliers or customers. The Company's Year 2000 efforts are ongoing and its overall plan, as well as the consideration of contingency plans, will continue to evolve as new information becomes available. While the Company is taking steps it believes to be necessary to prevent any major interruption to its business activities, that will be dependent in part, upon the ability of third parties to be Year 2000 compliant. ACCOUNTING PRONOUNCEMENTS In June 1997, Statement of Financial Accounting Standards No. 130 (SFAS 130), "Comprehensive Income," was issued. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS 130 is effective for fiscal years beginning after December 15, 1997, and requires restatement of earlier periods presented. The Company has applied this standard effective January 1, 1998. In June 1997, Statement of Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments of an Enterprise and Related Information," was issued. SFAS 131 establishes standards for the way that a public enterprise reports information about -30-
31 PART I - FINANCIAL INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. SFAS 131 is effective for fiscal years beginning after December 15, 1997, and requires restatement of earlier periods presented. The Company does not expect the adoption of this standard to have a material impact on the financial condition or results of operations of the Company. In April 1998, Statement of Position 98-5 (SOP 98-5) "Reporting on the Costs of Start-up Activities," was issued. SOP 98-5 provides guidance on the financial reporting of start-up costs and organizational costs. It requires costs of start-up activities and organizational costs to be expensed as incurred, as well as the recognition of a cumulative effect of change in accounting principle for retroactive application of the standard. SOP 98-5 is effective for fiscal years beginning after December 15, 1998, although earlier application is encouraged. The Company is presently evaluating the effect the adoption of SOP 98-5 will have on the financial condition and results of operations of the Company. In June 1998, Statement of Financial Accounting Standards No. 133 (SFAS 133). "Accounting for Derivative Instruments and Hedging Activities" was issued. SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999, however, earlier application of all of the provisions of this Statement is encouraged as of the beginning of any fiscal quarter. The Company is presently evaluating the affect the adoption of this standard will have on the financial condition and results of operations of the Company. -31-
32 PART II - OTHER INFORMATION HECLA MINING COMPANY and SUBSIDIARIES ITEM 1. LEGAL PROCEEDINGS - Bunker Hill Superfund Sites In 1994, the Company, as a potentially responsible party under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (CERCLA or Superfund), entered into a Consent Decree with the Environmental Protection Agency (EPA) and the State of Idaho, concerning environmental remediation obligations at the Bunker Hill Superfund Site (Bunker Hill Site) located at Kellogg, Idaho. The Consent Decree settled the Company's response-cost liability under Superfund at the Bunker Hill Site. As of September 30, 1998, the Company has estimated and accrued an allowance for liability for remedial activity costs at the Bunker Hill Site of $5.6 million. These estimated expenditures are anticipated to be made over the next three to five years. As with any estimate of this nature, it is reasonably possible that the Company's estimate of this obligation may change in the near term. Coeur d'Alene River Basin Natural Resource Damage Claims - Coeur d'Alene Tribe Claims In July 1991, the Coeur d'Alene Indian Tribe (the Tribe) brought a lawsuit, under CERCLA, in Idaho Federal District Court against the Company and a number of other mining companies asserting claims for damages to natural resources downstream from the Bunker Hill Site over which the Tribe alleges some ownership or control. The Company answered the Tribe's complaint denying liability for natural resource damages. In October 1996, following a court imposed four-year stay of the proceeding, the Tribe's natural resource damage litigation was consolidated with the United States Natural Resources Damage litigation described below. - U.S. Government Claims In March 1996, the United States filed a lawsuit in Idaho Federal District Court against certain mining companies that conducted historic mining operations in the Silver Valley of northern Idaho, including the Company. The lawsuit asserts claims under CERCLA and the Clean Water Act and seeks recovery for alleged damages to or loss of natural resources located in the -32-
33 PART II - OTHER INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES Coeur d'Alene River Basin (the Basin) in northern Idaho over which the United States asserts to be the trustee under CERCLA. The lawsuit asserts that the defendants' historic mining activity resulted in releases of hazardous substances and damaged natural resources within the Basin. The suit also seeks declaratory relief that the Company and other defendants are jointly and severally liable for response costs under CERCLA for historic mining impacts in the Basin outside the Bunker Hill Site. The Company answered the complaint in May 1996, denying liability to the United States under CERCLA and the Clean Water Act and asserted a counterclaim against the United States for the federal government's involvement in mining activity in the Basin which contributed to the releases and damages alleged by the United States. The Company believes it also has a number of defenses to the United States' claims. In October 1996, the Court consolidated the Coeur d'Alene Tribe Natural Resource Damage (NRD) litigation with this lawsuit for discovery and other limited pretrial purposes. On September 30, 1998, the Federal District Court granted the Company's summary judgment motion with respect to the applicable statute of limitations and dismissed the United States' NRD claim due to the failure of EPA to comply with federal law and EPA regulations in expanding the Natural Priority List site boundaries to include the entire Coeur d'Alene River/Lake Coeur d'Alene Basin which would have the effect of extending the statute of limitations. The United States is seeking permission to appeal the Federal District Court's decision to the Ninth Circuit Court of Appeals. The case is proceeding through discovery. Summary judgment motions related to i) the extent of Federal Trusteeship over Natural Resources in the Coeur d'Alene Basin, ii) a constitutional challenge to the retroactive application of Superfund liability at the site, and iii) case management are pending before the Court. In May 1998, the EPA announced that it had commenced a remedial investigation/feasibility study under CERCLA for the entire Basin, including Lake Coeur d'Alene, in support of its response cost claims asserted in its March 1996 lawsuit. -33-
34 PART II - OTHER INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES - State of Idaho Claims In March 1996, the Company entered into an agreement (the Idaho Agreement) with the State of Idaho (the State) pursuant to which the Company agreed to continue certain financial contributions to environmental cleanup work in the Basin being undertaken by a State trustees group. In return, the State agreed not to sue the Company for damage to natural resources for which the State is a trustee for a period of five years, to pursue settlement with the Company of the State's natural resource damage claims and to grant the Company credit against any such State claims for all expenditures made under the Idaho Agreement and certain other Company contributions and expenditures for environmental cleanup in the Basin. At September 30, 1998, the Company's accrual for remediation activity in the Basin, not including the Bunker Hill Site, totaled approximately $0.6 million. These expenditures are anticipated to be made over the next three years. Depending on the results of the aforementioned lawsuits, it is reasonably possible that the Company's estimate of its obligation may change in the near or longer term. Insurance Coverage Litigation In 1991, the Company initiated litigation in the Idaho State District Court in Kootenai County, Idaho, against a number of insurance companies which provided comprehensive general liability insurance coverage to the Company and its predecessors. The Company believes that the insurance companies have a duty to defend and indemnify the Company under their policies of insurance for all liabilities and claims asserted against the Company by the EPA and the Tribe under CERCLA related to the Bunker Hill Site and the Basin in northern Idaho. In 1992, the Court ruled that the primary insurance companies had a duty to defend the Company in the Tribe's lawsuit. During 1995 and 1996, the Company entered into settlement agreements with a number of the insurance carriers named in the litigation. The Company has received a total of approximately $7.2 million under the terms of the settlement agreements. Thirty percent of these settlements were paid to the EPA to reimburse the U.S. Government for past costs under the Bunker Hill Site Consent Decree. Litigation is still pending against one insurer with trial -34-
35 PART II - OTHER INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES continued until the underlying environmental claims against the Company are resolved or settled. The remaining insurer is providing the Company with a partial defense in all Basin environmental litigation. As of September 30, 1998, the Company had not reduced its accrual for reclamation and closure costs to reflect the receipt of any anticipated insurance proceeds. Other Claims - George Creque, Jr. et. al. vs. Cactus Gold Mines Co., et. al. (including The Company) On October 22, 1998, Hecla Mining Company and certain affiliates were served with a lawsuit filed in Superior Court of Kern County, California. The Complaint pertains to the Cactus Gold mine located near Mojave, California. Seventy-four plaintiffs allege that during the period from 1960 through the present, the named defendants' operations and activities caused personal injury and property damage to the plaintiffs. The plaintiffs seek monetary damages of $29,600,000,000 for general negligence, nuisance, trespass, statutory violations, ultra-hazardous activities, strict liability, and other torts. The Company has provided notice and demand for defense/indemnity to its insurance carriers providing coverage for the Cactus Gold mine operation. To date, the Company has not received any response from the carriers. The Company has retained outside counsel to defend the Company in advance of any response from the insurance companies. Based on our preliminary review of the allegations in the Complaint as it relates to the historical operations at the Cactus Gold mine, the Company believes the allegations are without merit. The Company is subject to other legal proceedings and claims which have arisen in the ordinary course of its business and have not been finally adjudicated. Although there can be no assurance as to the ultimate disposition of these matters and the proceedings disclosed above, it is the opinion of the Company's management, based upon the information available at this time, that the currently expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operations, financial condition or cash flows of the Company. -35-
36 PART II - OTHER INFORMATION (Continued) HECLA MINING COMPANY and SUBSIDIARIES ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1(a) First Amendment to Credit Agreement dated September 30, 1998 12 - Fixed Charge Coverage Ratio Calculation 13 - Third Quarter Report to Shareholders for the quarter ended September 30, 1998, for release dated November 3, 1998. 27 - Financial Data Schedule (b) Reports on Form 8-K None Items 2, 3, 4, and 5 of Part II are omitted from this report as inapplicable. -36-
37 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: November 12, 1998 By /s/ Arthur Brown -------------------------------- Arthur Brown, Chairman, President and Chief Executive Officer Date: November 12, 1998 By /s/ Stanley E. Hilbert -------------------------------- S. E. Hilbert, Corporate Controller (Chief Accounting Officer) -37-
38 EXHIBIT INDEX Exhibit No. Description - --------- ------------------------- 10.1(a) First Amendment to Credit Agreement dated September 30, 1998 12 Fixed Charge Coverage Ratio Calculation 13 Third Quarter Report to Shareholders for the quarter ended September 30, 1998, for release dated November 3, 1998 27 Financial Data Schedule -38-