Hecla Mining Company — 2018 Q3 Form 10-Q Summary
Business context and reporting period
Hecla Mining Company is a precious- and base-metals producer of silver, gold, lead and zinc. The filing covers the three and nine months ended September 30, 2018. Operations comprised Greens Creek, Lucky Friday, Casa Berardi, San Sebastian and, beginning July 20, 2018, Nevada Operations acquired through the Klondex Mines transaction.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Sales of products | $143.6 million | $140.8 million | $430.6 million | $417.7 million |
| Gross profit | $6.6 million | $43.0 million | $80.4 million | $106.1 million |
| Income (loss) from operations | $(30.4) million | $20.3 million | $(14.7) million | $37.2 million |
| Net income (loss) | $(23.2) million | $0.3 million | $(2.9) million | $0.4 million |
| Loss applicable to common shareholders | $(23.3) million | $0.2 million | $(3.3) million | $0.03 million |
| Diluted loss per share | $(0.05) | $0.00 | $(0.01) | $0.00 |
| Cash provided by operating activities | Not provided for the quarter | Not provided for the quarter | $75.2 million | $74.1 million |
Q3 gross margin was approximately 4.6%, versus approximately 30.5% in the prior-year quarter. Nine-month gross margin was approximately 18.7%, versus approximately 25.4% in the prior-year period. Cost of sales and depreciation, depletion and amortization increased materially, including $43.5 million of Q3 DDA expense versus $29.5 million in Q3 2017.
- Cash and cash equivalents were $60.9 million at September 30, 2018, compared with $186.1 million at December 31, 2017. Cash, cash equivalents and restricted cash totaled $61.9 million.
- Total current assets were $198.3 million and current liabilities were $132.5 million, implying a current ratio of approximately 1.5x.
- Long-term debt was $534.1 million, while total debt including current and non-current capital leases was approximately $548.8 million. Senior Notes had principal of $506.5 million and mature in May 2021; the Series 2018-A Notes had principal of CAD$40 million and also mature in May 2021.
- The revolving credit facility was $200 million at September 30, 2018, with $3.0 million of letters of credit outstanding and no drawn balance. The facility was subsequently increased to $250 million in November 2018.
- Nine-month capital expenditures were $83.3 million. Net cash used in investing activities was $184.6 million, including $139.3 million for the Klondex acquisition. Net cash used in financing activities was $15.7 million.
- Total assets increased to $2.71 billion from $2.35 billion at year-end 2017, principally reflecting the Klondex acquisition. Shareholders’ equity increased to $1.72 billion from $1.46 billion.
Material changes versus the prior comparable period
- Sales increased 2.0% in Q3 and 3.1% for the first nine months, but profitability deteriorated substantially because of higher production costs, DDA, suspension costs, acquisition costs and weaker performance at San Sebastian and the newly acquired Nevada Operations.
- Klondex added three producing Nevada gold mines, the Aurora mill and exploration properties. The acquisition consideration was $414.2 million, consisting of $161.7 million cash, $242.4 million of Hecla stock and $10.2 million of warrants. Nevada Operations contributed $11.5 million of sales and a $10.1 million net loss from the acquisition date through September 30.
- Q3 included a $7.2 million write-down of Nevada Operations inventory to net realizable value and a $7.8 million gross loss at Nevada Operations.
- San Sebastian gross profit declined by $19.1 million in Q3 and $38.9 million year to date as the mine transitioned from higher-grade open-pit ore to lower-grade, higher-cost underground production. Its Q3 gross loss was $0.2 million.
- Lucky Friday remained affected by the union strike that began in March 2017. Q3 sales were negligible, and nine-month suspension-related costs were $18.3 million, including $3.7 million of non-cash depreciation.
- Base-metal derivative activity was unusually favorable: the company recognized a $19.5 million Q3 gain and a $40.3 million nine-month gain, compared with losses in the 2017 periods. The company received approximately $32.8 million from early settlement of contracts during Q3.
- The company identified and revised prior-period depreciation and depletion errors at Casa Berardi. Management concluded the errors were immaterial to previously issued financial statements; the revisions did not affect sales or operating cash flow.
Guidance, outlook, commentary and risks
Management stated that available cash, investments, projected operating cash flow and financing availability were expected to be adequate for the next 12 months. The company estimated 2018 capital expenditures of $140 million to $145 million, exploration and pre-development expenditures of approximately $40 million, and research and development expenditures of $6 million to $10 million. These estimates remained subject to metals prices, operating performance, liquidity and other factors.
- Management’s priorities included integrating Klondex, improving Nevada Operations, maintaining and expanding reserves, advancing Rock Creek and Montanore permitting, and continuing exploration.
- Key operating risks include volatile silver, gold, lead and zinc prices; foreign exchange exposure; integration and performance risks at Klondex; continued disruption at Lucky Friday; and the transition to underground mining at San Sebastian.
- Environmental and reclamation liabilities totaled approximately $105.9 million, with future expenditures expected over approximately 30 years. The company had $181.6 million of surety bonds supporting reclamation, closure, self-insurance and employee-benefit obligations.
- Potentially material environmental matters include the Johnny M site, for which the company accrued $5.6 million but stated liability could be higher, and EPA matters involving the San Mateo Creek Basin, Carpenter Snow Creek and Barker-Hughesville sites for which liability could not be reasonably estimated.
- Litigation related to the Klondex acquisition remained outstanding, including shareholder lawsuits and a Canadian lawsuit alleging that warrants issued to Waterton were undervalued.
- Rock Creek and Montanore face permitting, environmental and legal challenges. In October 2018, a Montana court entered a $3.325 million trespass verdict related to the Montanore access adit; the company planned to appeal.
- The board declared a $0.0025-per-share common dividend payable in December 2018. No silver-price-linked dividend was declared because Q3 realized silver pricing was $14.68 per ounce, below the policy threshold.
Important facts for investors to verify
- Verify the sustainability of liquidity after the Klondex cash acquisition, reduced cash balance and substantial 2021 debt maturities.
- Assess whether Nevada Operations can improve from its Q3 gross loss, inventory write-down and reported AISC of $1,932 per gold ounce.
- Monitor the duration and resolution of the Lucky Friday strike and the potential for impairment of its approximately $428.8 million carrying value.
- Evaluate San Sebastian’s underground transition, expected grades, mining costs and ability to restore profitability.
- Separate recurring operating performance from the $40.3 million derivative gain, acquisition costs, suspension costs and other unusual items.
- Review the preliminary Klondex purchase-price allocation, integration costs, acquired deferred tax liabilities and the Nevada mine reserve and production assumptions.
- Track environmental, reclamation and litigation exposures, including matters where the company cannot reasonably estimate a potential loss.
- Confirm the impact of the Casa Berardi accounting revisions and the company’s conclusion that prior-period errors were immaterial.