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WLT > SEC Filings for WLT > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for WALTER ENERGY, INC.

Form 10-Q for WALTER ENERGY, INC.


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS, FINANCIAL CONDITION AND LIQUIDITY AND CAPITAL RESOURCES

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

This report includes statements of our expectations, intentions, plans and beliefs that constitute "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to come within the safe harbor protection provided by those sections. These statements, which involve risks and uncertainties, relate to analyses and other information that are based on forecasts of future results and estimates of amounts not yet determinable and may also relate to our future prospects, developments and business strategies. We have used the words "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan," "predict," "project," "should" and similar terms and phrases, including references to assumptions, in this report to identify forward-looking statements. These forward-looking statements are made based on expectations and beliefs concerning future events affecting us and are subject to uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control, that could cause our actual results to differ materially from those matters expressed in or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to:


Deteriorating conditions in the financial markets;


Global economic crisis;


Market conditions beyond our control;


Prolonged decline in the price of coal;


Decline in global coal or steel demand;


Prolonged or dramatic shortages or difficulties in coal production;


Our customer's refusal to honor or renew contracts;


Title defects preventing us from (or resulting in additional costs for) mining our mineral interests;


Concentration of our coal and gas producing mineral interests in limited number of areas subjects us to risk;


Weather patterns and conditions affecting production;


Geological, equipment and operational risks associated with mining;


Unavailability of cost-effective transportation for our coal;


Significant increase in competitive pressures;


Significant cost increases and delays in the delivery of purchased components;


Availability of adequate skilled employees and other labor relations matters;


Greater than anticipated costs incurred for compliance with environmental liabilities or limitations on our abilities to produce or sell coal;


Our ability to attract and retain key personnel;


Future regulations that increase our costs or limit our ability to produce coal;


New laws and regulations to reduce greenhouse gas emissions that impact the demand for our coal reserves;


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Adverse rulings in current or future litigation;


Inability to access needed capital;


Availability of licenses, permits, and other authorizations may be subject to challenges;


Downgrade in our credit rating;


Our ability to identify suitable acquisition candidates to promote growth;


Our ability to successfully integrate acquisitions, including the acquisition of Western Coal Corp.;


Volatility in the price of our common stock;


Our ability to pay regular dividends to stockholders;


Our exposure to indemnification obligations; and


Other factors, including the other factors discussed in Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the year ended December 31, 2011 and as updated by any subsequent Form 10-Qs or other documents that are on file with the Securities and Exchange Commission.

You should keep in mind that any forward-looking statement made by us in this Quarterly Report on Form 10-Q or elsewhere speaks only as of the date on which we make it. New risks and uncertainties come up from time to time, and it is impossible for us to predict these events or how they may affect us. We have no duty to, and do not intend to, update or revise the forward-looking statements in this Quarterly Report on Form 10-Q after the date of this Quarterly Report on Form 10-Q, except as may be required by law. In light of these risks and uncertainties, you should keep in mind that any forward-looking statement made in this Quarterly Report on Form 10-Q or elsewhere might not occur.

ORGANIZATION

Walter Energy, Inc. ("Walter") is a leading producer and exporter of metallurgical coal for the global steel industry from underground and surface mines located in the United States, Canada and United Kingdom. Walter also produces thermal coal, anthracite coal, metallurgical coke and coal bed methane gas.

This discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto of Walter and its subsidiaries, particularly Note 14 of "Notes to Condensed Consolidated Financial Statements," which provides our revenues and operating income by reportable segment.

As fully discussed in Note 2 to the "Notes to Condensed Consolidated Financial Statements," on April 1, 2011 we completed the acquisition of Western Coal Corp. ("Western Coal"). The accompanying summary operating results include the results of operations of Western Coal since April 1, 2011.

Certain previously reported December 31, 2011 Condensed Consolidated Balance Sheet balances, three and nine months ended September 30, 2011 Condensed Consolidated Statements of Operations and Comprehensive Income balances and nine months ended September 30, 2011 Condensed Consolidated Statement of Cash Flows balances have been recast to include the effects of finalizing the allocation of the Western Coal purchase price. See Note 2 to the "Notes to Condensed Consolidated Financial Statements" for further information.


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OUTLOOK AND STRATEGIC INITIATIVES

Industry Overview

The weak global economy has resulted in lower steel production and lowered demand for metallurgical coal. Also, the settlement of a labor dispute in Australia has increased supply of metallurgical coal. The resulting supply-demand imbalance has reduced the benchmark for high quality coals from $225 in the third quarter to $170 in the fourth quarter with spot market pricing considerably lower than the benchmark. Recently, there have been announcements of significant reductions in production, which should help reduce overall supply. These actions are already beginning to improve the supply and demand balance, although we have not as of yet seen significant improvement in demand.

Despite the short-term challenges discussed above, we believe the long-term demand for metallurgical coal within all of our geographic markets is anticipated to be strong as industry projections indicate that global steelmaking will continue to require increasing amounts of high quality metallurgical coal, which is a limited commodity. As such, we are focused on the long-term metallurgical coal market as we anticipate strong long-term demand for the high-quality metallurgical coals we produce.

2012 Business Outlook

The challenges to the short-term market outlook discussed above resulted in the Company reviewing its operating strategy and related projects. As part of the review it was decided that the Company would reduce planned capital spending for the remainder of 2012 as well as that proposed for 2013. As a result, on August 1, 2012 the Company announced plans to reduce 2012 capital spending to approximately $400 million and on November 5, 2012 announced a preliminary 2013 capital expenditures target of approximately $220 million.

Additionally, as a result of the current weak backdrop in demand, we are reducing production at two of our three Canadian mines in the fourth quarter, in the U.S. reducing production at the Maple mine, finalizing the Brule transition and making plans to reduce inventory while we await better market conditions. We also are taking steps to reduce growth spending in our Canadian and U.K. Operations segment and filed a proposal to place the mine development of the U.K. project on hold until market conditions improve.

Due to the above factors and actions taken, we expect 2012 metallurgical coal production to be near the low end of our guidance of 11.5 million to 13.0 million metric tons, of which an estimated approximately 75% will be hard coking coal and the remainder will be low-volatile pulverized coal injection ("PCI") coal.

Acquisition of Western Coal

On April 1, 2011 we completed the acquisition of Western Coal for a total purchase price of approximately $3.7 billion. In connection with the acquisition we acquired high quality metallurgical coal mines in Northeast British Columbia (Canada), high quality metallurgical coal and compliant thermal coal mines located in West Virginia (United States), and a high quality anthracite coal mine in South Wales (United Kingdom). The acquisition of Western Coal transformed the Company into the leading, publicly traded 'pure-play' metallurgical coal producer in the world with strategic access to historic high-growth steel-producing countries in Asia, South America and Europe. We have significant reserves available for future production, the majority of which is high demand metallurgical coal, with a diverse geographical footprint.

As a result of the planned reductions in capital spending, the Company's plans to reduce mining production at certain mines in our U.S. Operations and Canadian and U.K. Operations segments and


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the significant decrease in our common stock price, the Company evaluated the potential impact of these factors on the carrying value of certain long-lived assets, including goodwill. Upon analysis, the Company determined that the undiscounted cash flows for potentially affected long-lived assets exceeded the carrying value and no further testing was necessary, except for a shale natural gas exploration project which was impaired. The Company also performed a separate interim goodwill impairment test as of July 31, 2012 and, as a result, an estimated goodwill impairment charge of $1.1 billion was recorded in the three months ended September 30, 2012 eliminating the entire carrying value of goodwill for two reporting units in the U.S. Operations segment and two reporting units in the Canadian and U.K. Operations segment. The goodwill impairment charge will not be finalized until the allocation of fair value of the reporting units to the underlying assets and liabilities contained within the individual reporting units is complete. The Company intends to finalize the goodwill impairment analysis in the fourth quarter of 2012.

We test goodwill for impairment using a fair value approach at the reporting unit level. We perform our goodwill impairment test in two steps. Step one compares the fair value of each reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit determined in step one is lower than its carrying value, we proceed to step two, which compares the carrying value of goodwill to its implied fair value. In estimating the implied fair value of goodwill at a reporting unit, we assigned the fair value of the reporting unit to all of the assets and liabilities associated with the reporting unit as if the reporting unit had been acquired in a business combination. Any excess of carrying value of goodwill over its implied fair value at a reporting unit is recorded as impairment.

The valuation methodology utilized to estimate the fair value of the reporting units in step one was performed using a market approach. The market approach is based on a guideline public company methodology. Under the guideline public company method, certain operating metrics from a selected group of publicly traded guideline companies that have similar operations to the Company's reporting units were used to estimate the fair value of the reporting units.

The valuation methodology utilized to allocate the estimated fair value of the reporting units to the underlying assets and liabilities contained within the individual reporting units in step two of the goodwill impairment test was primarily based on an income approach. The income approach is dependent upon a number of significant management estimates about future performance including sales volumes and prices, costs to produce, income taxes, capital spending, working capital changes and the after-tax weighted average cost of capital. Changes in any of these assumptions could materially impact the estimated fair value of the underlying assets and liabilities contained within the individual reporting units. Our forecasts of coal prices generally reflect a long-term outlook of market prices expected to be received for our coal. If actual coal prices are less than our expectations, it could have a material impact on the fair value of the underlying assets and liabilities contained within the individual reporting units. Our forecasts of costs to produce coal are based on our operating forecasts. If actual costs are higher, it could have a material impact on the fair value of the underlying assets and liabilities contained within the individual reporting units. For additional details of the impairment charge see Note 3 of "Notes to Condensed Consolidated Financial Statements".


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RESULTS OF OPERATIONS

                       Summary Operating Results for the
                 Three Months Ended September 30, 2012 and 2011

                                       For the three months ended September 30, 2012
                                                    Canadian
                                      U.S.          and U.K.
(in thousands)                     Operations      Operations       Other        Total
Sales                              $   485,720     $    126,790   $       -   $    612,510
Miscellaneous income (loss)             (2,105 )          1,115         454           (536 )

Revenues                               483,615          127,905         454        611,974
Cost of sales (exclusive of
depreciation and depletion)            320,716          128,049           -        448,765
Depreciation and depletion              44,789           37,305         466         82,560
Selling, general and
administrative                          12,732            6,807      12,947         32,486
Postretirement benefits                 13,325                -        (112 )       13,213
Impairment charges                     114,281          992,434           -      1,106,715

Operating (loss)                   $   (22,228 )   $ (1,036,690 ) $ (12,847 )   (1,071,765 )

Interest expense, net                                                              (30,432 )
Other loss                                                                            (943 )
Income tax benefit                                                                  41,184

Net loss                                                                      $ (1,061,956 )

                                 For the three months ended September 30, 2011 Recast
                                                 Canadian
                                 U.S.            and U.K.
(in thousands)                Operations        Operations          Other          Total
Sales                        $     468,735     $     214,861     $         134   $ 683,730
Miscellaneous income                 2,420             2,473               124       5,017

Revenues                           471,155           217,334               258     688,747
Cost of sales (exclusive
of depreciation and
depletion)                         280,483           140,008               199     420,690
Depreciation and
depletion                           43,546            13,408               190      57,144
Selling, general and
administrative                      16,944            11,557            14,621      43,122
Postretirement benefits             10,104                 -              (340 )     9,764
Impairment charges                       -                 -                 -           -

Operating income (loss)      $     120,078     $      52,361     $     (14,412 )   158,027

Interest expense, net                                                              (27,602 )
Other loss                                                                         (13,143 )
Income tax expense                                                                 (30,202 )

Net income                                                                       $  87,080


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                             Dollar variance for the three months ended September 30,
                                                 2012 versus 2011
                                              Canadian
                             U.S.             and U.K.
(in thousands)            Operations         Operations           Other          Total
Sales                    $      16,985     $        (88,071 )   $      (134 ) $    (71,220 )
Miscellaneous income
(loss)                          (4,525 )             (1,358 )           330         (5,553 )

Revenues                        12,460              (89,429 )           196        (76,773 )
Cost of sales
(exclusive of
depreciation and
depletion)                      40,233              (11,959 )          (199 )       28,075
Depreciation and
depletion                        1,243               23,897             276         25,416
Selling, general and
administrative                  (4,212 )             (4,750 )        (1,674 )      (10,636 )
Postretirement
benefits                         3,221                    -             228          3,449
Impairment charges             114,281              992,434               -      1,106,715

Operating income
(loss)                   $    (142,306 )   $     (1,089,051 )   $     1,565     (1,229,792 )

Interest expense, net                                                               (2,830 )
Other income (loss)                                                                 12,200
Income tax benefit
(expense)                                                                           71,386

Net income (loss)                                                             $ (1,149,036 )

Summary of Third Quarter Consolidated Results of Operations

Our net loss for the three months ended September 30, 2012 was $1.1 billion, or $16.97 per diluted share, which compares to income of $87.1 million, or $1.39 per diluted share for the three months ended September 30, 2011. The net loss is primarily due to a goodwill impairment charge of $1.1 billion and an impairment of a capitalized shale natural gas exploratory project of $40.0 million pre-tax and $25 million after tax as well as lower metallurgical coal pricing and reduced sales volume. Earnings before interest expense, interest income, income taxes, depreciation, depletion and amortization ("EBITDA") for the third quarter of 2012 decreased $1.2 billion as compared to the third quarter of 2011 due to the impairment charges. A reconciliation of net income to EBITDA is presented in the Liquidity and Capital Resources section below.

Revenues for the three months ended September 30, 2012 were $612.0 million, representing a decrease of $76.8 million from $688.7 million in the same period in 2011. The decrease in revenues was primarily due to a decrease in metallurgical coal pricing due to weaker worldwide demand.

Cost of sales, exclusive of depreciation and depletion, increased $28.1 million to $448.8 million as compared to the third quarter of 2011 and was primarily the result of increased hard coking coal sales volumes, partially offset by a reduction in the average cost per ton.

Selling, general and administrative expense decreased $10.6 million to $32.5 million, as compared to $43.1 million in the third quarter of 2011, primarily attributable to non-recurring professional, legal, and severance expenses incurred with the acquisition of Western Coal and the relocation of our corporate headquarters from Tampa, FL to Birmingham, AL in the third quarter of 2011.

The $0.9 million and $13.1 million other loss for the three months ended September 30, 2012 and 2011, respectively, is primarily attributable to losses on the sale and remeasurement to fair value of equity investments.

The Company recognized an income tax benefit of $41.2 million for the three months ended September 30, 2012, compared to a tax provision of $30.2 million for the three months ended September 30, 2011. In the current quarter, the Company determined the current year income tax provision for Canada, U.K. and West Virginia operations using actual year-to-date financial results as compared to the estimated annual effective tax rate method utilized in 2011 resulting in a tax benefit.


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The current year income tax provision for the Alabama operations continues to be based on an estimated annual effective tax rate method. The decrease in income tax expense as compared to 2011 is primarily due to the pretax operating loss for the three months ended September 30, 2012 as compared to pretax operating income for the same period in 2011. The level of ordinary income in 2012 decreased substantially from 2011, leading to income tax benefits in excess of income tax expense. Additionally, the Company recorded a preliminary impairment charge on $1.1 billion of nondeductible goodwill during the three months ended September 30, 3012. The loss generated from the impairment of goodwill is not deductible for income tax purposes.

The current and prior year period results also include the impact of factors discussed in the following segment analysis.

Segment Analysis

U.S. Operations

Hard coking coal sales totaled 1.9 million metric tons for the three months ended September 30, 2012 compared to 1.2 million metric tons during the same period in 2011. Our hard coking coal production totaled 1.7 million metric tons in the third quarter of 2012, an increase of 31.7% from the same period in the prior year as a result of higher production at the Alabama underground operations that resulted from improved mining conditions. The average selling price of hard coking coal in the third quarter of 2012 was $196.41 per metric ton, representing a 25.0% decrease from the average selling price of $261.76 per metric ton for the same period in 2011. The decrease in the average selling price of hard coking coal reflects current weaker market conditions.

Thermal coal sales totaled 0.9 million metric tons for the three months ended September 30, 2012 compared to 1.3 million metric tons during the same period in 2011. The average selling price of thermal coal for the third quarter of 2012 was $67.00 per metric ton, down 5.9% from the average selling price of $71.17 per metric ton for the same period in 2011. The decrease in thermal coal sales volumes and prices during the 2012 third quarter as compared to the same period last year was attributable to the continued softening of demand for thermal coal, offset in part by the majority of our thermal coal being sold under long-term price and volume contracts. Thermal coal production totaled 0.8 million metric tons for the three months ended September 30, 2012, as compared to 1.3 million metric tons during the same period in 2011. The decrease in production was primarily due to lower production at our West Virginia operations as a result of idling a thermal coal surface mine in the second quarter of 2012 due to the lower demand and prices.

Statistics for U.S. Operations are presented in the following table:

                                                                Three months ended
                                                                  September 30,
                                                                 2012         2011
 Tons of hard coking coal sold(1) (in thousands)                    1,880      1,232
 Tons of hard coking coal produced (in thousands)                   1,721      1,307
 Average hard coking coal selling price(1) (per metric ton)    $   196.41   $ 261.76
 Tons of thermal coal sold (in thousands)                             927      1,302
 Tons of thermal coal produced (in thousands)                         805      1,329
 Average thermal coal selling price (per metric ton)           $    67.00   $  71.17


--------------------------------------------------------------------------------
    (1)
    Includes sales of both produced and purchased coal.


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Our U.S. Operations segment reported revenues of $483.6 million for the three months ended September 30, 2012, representing an increase of $12.5 million from the same period last year. The increase in revenues during the third quarter of 2012 as compared to the 2011 third quarter was primarily attributable to higher hard coking coal sales volumes at the Alabama underground operations as mining conditions improved compared to that of the third quarter 2011, partially offset by the decline in the average selling price of both hard coking and thermal coal.

Cost of sales, exclusive of depreciation and depletion, in our U.S. Operations segment increased $40.2 million to $320.7 million as compared to the 2011 third quarter. The increase in cost of sales was primarily attributable to the increase in hard coking coal sales volumes and an increase in the proportion of sales from Alabama Mine No. 4, which has higher production costs than Alabama Mine No. 7. Mine No. 4 not only represented a greater proportion of third quarter sales, it also represented a slightly greater proportion of third quarter production, as Mine No. 7 had one week of miners' vacations during the period. These increases in cost of sales were partially offset by lower cost of sales for the West Virginia operations due to idling a thermal coal surface mine during the second quarter of 2012.

Our U.S. Operations segment reported an operating loss of $22.2 million for the three months ended September 30, 2012, compared to operating income of $120.1 million in the same period in 2011. The $142.3 million decrease in operating income was primarily due to a goodwill impairment charge of $74.3 million, an asset impairment of a capitalized shale natural gas exploratory project of $40.0 million, and reduced coal selling prices.

Canadian and U.K. Operations

Metallurgical coal sales for the three months ended September 30, 2012 totaled 303,000 metric tons of hard coking coal at an average selling price of $204.82 per metric ton and 440,000 metric tons of low-volatile PCI coal at an . . .

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