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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED
DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 333-60599
PEN HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
TENNESSEE 62-0852576
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
5110 MARYLAND WAY, SUITE 300
BRENTWOOD, TENNESSEE 37027
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (615) 371-7300
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
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 (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates of the registrant. The aggregate market value shall be
computed by reference to the price at which the common equity was sold, or the
average bid and asked prices of such common equity, as of a specified date
within 60 days prior to the date of filing: None
Indicate the number of shares of each of the registrant's classes of common
stock as of the latest practical date: As of March 23, 1999: Class I Common
stock, $.01 par value per share, 4,290,000 shares and Class II Common stock,
$.01 par value per share, 177,550 shares.
DOCUMENTS INCORPORATED BY REFERENCE - NONE
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PEN HOLDINGS, INC.
INDEX
TABLE OF CONTENTS
<TABLE>
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PAGE
NUMBER
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PART I
<S> <C>
Item 1. Business 1
Item 2. Properties 9
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 13
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 13
Item 6. Selected Consolidated Financial Data 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16
Item 8. Financial Statements and Supplementary Data 22
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 43
PART III
Item 10. Directors and Executive Officers of the Registrant 43
Item 11. Executive Compensation 44
Item 12. Security Ownership of Certain Beneficial Owners and Management 45
Item 13. Certain Relationships and Related Transactions 45
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K E-1
Glossary of Certain Terms G-1
Kentucky-West Virginia Operations Map M-1
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PART 1.
ITEM 1. BUSINESS.
Pen Holdings, Inc. and its consolidated subsidiaries (the "Company" or
"Pen") is principally engaged in the mining, preparation, marketing and leasing
of primarily compliance coal and low-sulfur coal from mines located in the
Central Appalachian region of eastern Kentucky and southern West Virginia.
Compliance coal is coal which when burned emits less than 1.2 pounds of sulfur
dioxide per million Btu (0.72% for 12,000 Btu). This coal exceeds the sulfur
dioxide emission requirements for air quality of Phase I of the Clean Air Act
Amendments and meets the proposed sulfur dioxide emission requirements for air
quality of Phase II of such legislation without the need for flue gas
desulfurization. Throughout this report reference is made to coal reserves.
Management has used coal reserve data supplied by independent consultants as the
basis for the estimates of coal reserve data contained herein. These reserve
estimates account for mining completed on the property or other changes in the
reserve since the date of the referenced reserve study. The basis for the
Company's recoverable coal reserve estimates (other than the Company's Fork
Creek reserves) were derived from a reported dated May 1998, in which Marshall
Miller & Associates ("Marshall Miller") had audited the Company's recoverable
coal reserves as of such date (the "Marshall Miller Report"). The estimates of
the Company's recoverable Fork Creek reserves as of September 1997 have been
reviewed by Stagg Engineering Services, Inc. ("Stagg Engineering") as of such
date (the "Stagg Engineering Report"). As used herein, "reserves" means Proven
Reserves or Probable Reserves (as defined in the Glossary) which could be
economically extracted or produced at the time of the reserve determination.
Reserve estimates for all of the Company's coal properties are based on the
Marshall Miller Report and the Stagg Engineering Report, which are collectively
referred to herein as the "Reserve Studies". All references to "tons" are to
short ton unless otherwise indicated. For definition of certain coal-related
terms, see Definition of Certain Terms attached as the Glossary to this Form
10-K.
Based on the Reserve Studies, the Company estimates that it controls
the mineral rights to approximately 223 million tons of coal reserves, of which
management believes 202 million tons are owned in fee. In 1998, the Company sold
approximately 5.3 million tons of coal, approximately 74% of which was generated
from captive production with the remainder purchased from other coal mine
operators. In 1998, approximately 78% of the tonnage was sold to seven long-term
sales contract customers, with most of the remainder sold to 20 spot market
customers. The Company sells primarily to domestic public utilities, an
international government-owned utility and industrial customers. In addition to
its coal sales, the Company leases the mineral rights on approximately 66
million tons of its reserves to 24 operators who mined approximately 3.3 million
tons in 1998. The Company received an average leasing revenue per ton of coal
from its lessees of approximately $1.92 per ton in 1998. The Company's coal
leases typically have a term of five years, although some leases are for the
life of the respective reserves. For the year ended December 31, 1998, the
Company generated revenues, net income and EBITDA (EBITDA represents operating
income plus depreciation, depletion and amortization) all as adjusted to
represent only business units currently in operation, of $169.5 million, $1.4
million and $24.5 million, respectively. EBITDA may not be comparable to other
similarly titled measures of other companies. However, the Company's management
believes EBITDA is a meaningful measure of performance as substantially all of
the Company's financing arrangements contain covenants based on formulations of
EBITDA. Cash provided (used) by operating activities, investing activities and
financing activities for the year ended December 31, 1998, adjusted to represent
only business units currently operating was $16.9 million, ($12.9) million and
$10.9 million, respectively.
The Company has demonstrated a long-term record of selectively
increasing its reserves through acquisitions and consistently increasing its
production through the development of its reserves. Since 1992, reserves have
increased more than 300%, and captive production has increased at a compound
annual rate of 12% to 3.9 million tons in 1998. Beginning in 1987, Pen commenced
surface coal mining production with the purchase of approximately 49 million
tons of compliance and low-sulfur coal reserves located in southern West
Virginia ("Kiah Creek"). Prior to the purchase of Kiah Creek, the Company
fulfilled its contractual obligations through coal purchases and limited
contract mining. Approximately 82% of the Company's 1998 coal production was
from Kiah Creek, where three underground and two surface mines were operating.
In 1994, the Company acquired approximately 108 million tons of primarily
compliance and low-sulfur coal reserves located in eastern Kentucky ("Elk
Horn"). The Company's strategy for Elk Horn is (i) to lease a significant
portion of the reserves to other mining operators under long-term agreements and
(ii) to produce coal for Company sales from contract mining operations. Annual
lease payments including minimum royalties paid to the Company from Elk Horn
leases have averaged $8.8 million per year since 1994. In November 1997, the
Company acquired approximately 80 million tons of primarily compliance,
low-sulfur, and metallurgical coal reserves located in southern West Virginia
("Fork Creek"). The Company expects to have obtained the necessary permits and
completed the infrastructure at Fork Creek to commence mining operations and to
begin coal deliveries by early 2000. Management anticipates that the Fork Creek
operations will produce up to 4.0 million tons annually by 2002 with the
majority of this coal being shipped via CSX rail.
The Company's strategy has been to secure sales contracts with
customers accessible from its own loading terminals in advance of planned
increases in production. In each of the last five years, the Company's
production has been fully committed under long-term sales contracts. Management
believes that the strategy of being heavily contracted has provided the Company
with greater flexibility in managing mine development, production levels and
reserve life at Kiah Creek and, to a lesser extent, at Elk Horn. By the year
2000, management anticipates that, with the expiration of the Company's
long-term sales contract with Taiwan Power Company (the "TPC contract") and the
additional production from Fork Creek, more of its production will be sold on
the spot market until commitments can be obtained for the coal. Although
production is not scheduled to commence until early 2000, the Company has
already committed to supply from Fork Creek approximately 500,000 tons in 2000,
increasing to approximately 720,000 tons annually by 2001. With the exception of
the TPC contract, the Company's current sales contracts and spot market
agreements are primarily with domestic public
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utilities and industrial customers located in the upper Ohio River Valley and
accessible by river barge transportation from the Company's terminal on the Big
Sandy River, a navigable tributary of the Ohio River. The Company shipped only
1.3% of its tonnage sold in 1998 by rail, but it anticipates shipping up to 43%
by rail once Fork Creek is fully developed.
The Company has an integrated production, preparation and loading
operation which management believes enhances control over product quality and
consistency, storage capability and delivery scheduling for its customers. In
1990, the Company built a modern, heavy media preparation plant at Kiah Creek to
clean and size its underground coal production, which the Company believes: (i)
improved its reputation with customers by increasing the quality and quantity of
marketable compliance and low-sulfur coal production and (ii) positioned the
Company to be able to bid for more favorably priced sales contracts and spot
market agreements. The Company's development plans for Fork Creek include
construction of an additional preparation plant and a rail loadout which is
expected to extend product control over new production at Fork Creek and provide
the Company an opportunity to supply new customers in the Northeast and upper
Midwest which are primarily accessible by rail.
The Company utilizes room and pillar mining in its underground mines
and contour and point removal mining at its surface mines, which the Company
believes are the most cost-efficient methods for extracting its reserves given
their geological composition. Although a majority of the Company's production
has shifted toward underground mining, which generally can be more costly due to
preparation costs, the Company's cash production costs at the mine site have
declined from $18.81 per ton in 1993 to $17.92 per ton in 1998. Management
believes that this decline resulted from the Company's ability to improve
productivity from its mines and recovery rates at its preparation plant through
better planning, improvements to its preparation plant and more efficient use of
capital equipment.
In addition to the Company's coal operations, the Company also has a
cotton ginning and warehousing business in South Carolina which accounted for
approximately 5% of the Company's 1998 revenues. In 1996, the Company sold Pen
Cotton Tennessee, its Tennessee cotton operations, and closed Pen Cotton Company
of Alabama, Inc., its Alabama cotton merchandising activity. Approximately
19,000 bales of cotton were ginned in 1998, compared with approximately 23,000
bales in 1997. The Company receives fees for its services for ginning and
warehousing. In 1998, revenues from this operation were $8.4 million. The South
Carolina cotton operation revenues as a percentage of the Company's total
revenues and EBITDA as a percentage of the Company's total EBITDA for the period
from 1994 through 1998 were 4.3%, 7.2%, 8.1%, 5.6% and 5.0%, respectively and
1.0%, 0.6%, 2.7%, 1.6% and 1.8%, respectively. The Company also typically
purchases cottonseed from the farmer at the time of ginning. The seed is then
sold to a local oil mill who produces cottonseed oil or, more commonly, is sold
into the dairy cattle market where the seed is used as feed. Consistent with the
Company's strategy to focus on its core business, the Company may, given the
right market conditions, choose to sell its remaining cotton operations.
Pen Holdings, Inc. ("Pen Holdings") was incorporated under the laws of
Tennessee in 1971. The Company's headquarters are located at Center Court
Building, Suite 300, 5110 Maryland Way, Brentwood, TN 37027, and its telephone
number is (615) 371-7300. As of December 31, 1998, the Company had 325 full time
employees.
RISK FACTORS
The following Risk Factors are inherent in the business that the
Company is engaged in:
LEVERAGE; ABILITY TO SERVICE DEBT
The Company has, and will continue to have, substantial leverage. At
December 31, 1998, the Company had approximately $108.0 million of indebtedness,
representing approximately 64% of the Company's total capitalization.
Furthermore, subject to certain restrictions in the indenture (the "Indenture")
relating to Pen Holding's 9 7/8% Senior Notes due 2008 (the "Notes"), the
Company may incur additional indebtedness from time to time to finance
acquisitions, to provide for working capital or capital expenditures or for
other purposes.
The level of the Company's indebtedness could have important
consequences to holders of the Notes, including, but not limited to, the
following: (i) the ability of the Company to obtain additional financing for
acquisitions, working capital, capital expenditures or other purposes, if
necessary, may be impaired or such financing may not be on terms favorable to
the Company; (ii) the Company will have significant cash requirements for debt
service; (iii) financial and other covenants and operating restrictions imposed
by the terms of the Indenture and by its Amended and Restated Credit Facility by
and among Pen Holdings, certain of its subsidiaries, Mellon Bank, N.A., Canadian
Imperial Bank of Commerce, and First American Bank, N.A. (the "Credit Facility")
will limit, among other things, its ability to borrow additional funds or to
dispose of assets; (iv) a downturn in the Company's businesses will have a more
significant impact on its results of operations; and (v) the Company may,
subject to its covenants, increase indebtedness senior to the Notes immediately
following the issuance of the Notes.
The ability of Pen Holdings to satisfy its obligations will be
primarily dependent upon the future financial and operating performance of its
subsidiaries and upon its ability to renew or refinance borrowings or to raise
additional equity capital. Each of these alternatives is dependent upon
financial, business and other general economic factors affecting Pen Holdings
and its subsidiaries in particular, many of which are beyond the control of Pen
Holdings and its subsidiaries. If Pen Holdings and its subsidiaries are unable
to generate sufficient cash flow to meet their debt service obligations, they
will have to pursue one or more alternatives, such as reducing or delaying
capital expenditures, refinancing debt, including the Notes, selling assets or
raising equity capital. There can be no assurance that any such alternatives
could be accomplished or could be accomplished on satisfactory terms or that
such actions would yield sufficient funds to retire the Notes and any secured
indebtedness. While management believes that cash flow from operations will
provide an
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adequate source of long-term liquidity, a significant drop in operating cash
flows resulting from economic conditions, competition or other uncertainties
beyond the Company's control would increase the need for alternative sources of
liquidity. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Liquidity and Capital Resources."
HOLDING COMPANY STRUCTURE
Pen Holdings is a holding company that conducts substantially all of
its operations through its subsidiaries. Pen Holdings' only significant assets
are (i) the capital stock of its subsidiaries, all of which are wholly owned
(ii) the building which houses the Company's headquarters and (iii) certain
office furniture and computer equipment. As a holding company, Pen Holdings is
dependent on dividends or other distributions of funds from its subsidiaries to
meet its debt service and other obligations, including its obligations under the
Notes.
EFFECTIVE SUBORDINATION OF THE NOTES AND GUARANTEES; RESTRICTIVE DEBT COVENANTS
The Notes are senior unsecured obligations of Pen Holdings and will
rank generally the same in priority of payment with all existing and future
unsubordinated obligations of Pen Holdings and senior in right of payment to all
existing and future subordinated indebtedness of Pen Holdings. Borrowings under
the Credit Facility are secured by certain of Pen Holdings' and certain of its
subsidiaries' assets, including the stock of Pen Coal Corporation ("Pen Coal")
and The Elk Horn Coal Corporation ("Elk Horn Coal") and substantially all of the
assets of Pen Holdings' active subsidiaries (defined to include Pen Coal, Elk
Horn Coal, River Marine Terminals, Inc., Marine Terminals Incorporated and Pen
Cotton Company of South Carolina). Accordingly, while the Notes will rank
generally the same in priority of payment with borrowings under the Credit
Facility, the Notes will be effectively subordinated to the obligations
outstanding under the Credit Facility to the extent of the value of the assets
securing such borrowings. The active subsidiaries also guarantee obligations
under the Credit Facility. The guarantees of the guarantors will rank generally
the same in priority of payment with all obligations of the respective
guarantors that are not by their terms expressly subordinated to the guarantees.
In the event of a default under the Credit Facility or other secured
indebtedness (whether as a result of the failure to comply with a payment or any
covenant, a cross-default or otherwise), the lenders thereunder will have a
secured claim foreclosure right on their collateral, and, if exercised, the
Company's financial condition and the value of the Notes will be materially
adversely affected. In the event of certain asset sales, the Credit Facility
provides that net proceeds thereof not reinvested as provided therein must be
applied to the repayment of borrowings under the Credit Facility.
The Credit Facility and the Indenture contain covenants that, among
other things, limit the Company's ability to incur additional indebtedness,
prepay subordinated indebtedness, dispose of certain assets, incur liens, make
capital expenditures, make certain investments or acquisitions and otherwise
restrict corporate activities. The Credit Facility also requires the Company to
comply with certain financial ratios and tests, under which the Company is
required to achieve certain financial and operating results. The ability of the
Company to comply with such provisions may be affected by events beyond its
control. A breach of any of these covenants would result in a default under the
Credit Facility. In the event of any such default, depending on the actions
taken by the lenders under the Credit Facility, the Company could be prohibited
from making any payments on the Notes. In addition, such lenders could elect to
declare all amounts borrowed under the Credit Facility, together with accrued
interest thereon, to be due and payable, which would be an event of default
under the Indenture. As a result of the priority and/or security afforded the
Credit Facility, there can be no assurance that the Company would have
sufficient assets to pay indebtedness then outstanding under the Credit Facility
and the Indenture. Any future refinancing of the Credit Facility is likely to
contain similar restrictive covenants.
RELIANCE ON LONG-TERM SALES CONTRACTS, DEPENDENCE ON SIGNIFICANT CUSTOMERS AND
RISKS ASSOCIATED WITH PRICE ADJUSTMENT PROVISIONS
A substantial portion of the Company's coal is sold pursuant to
long-term sales contracts which are significant to the stability and
profitability of the Company's operations. In 1998, approximately 78% of the
Company's revenues from coal sales were made under long-term sales contracts
with seven customers. The Company's long-term sales contracts provided for coal
to be sold at a price which exceeds the price at which such coal could be sold
in the spot market.
The TPC contract accounted for 58%, 36%, 23%, 25% and 23% of the
Company's coal sales revenues from 1994 through 1998, respectively. The TPC
contract expires in 1999, and the Company expects that it will not be renewed or
extended due to the high transportation cost to Taiwan from the Gulf of Mexico,
as compared with other sources. The Company's long-term sales contract with
Dayton Power & Light, which expires in 2001, excluding option periods, accounted
for 15%, 23%, 21%, 24% and 23% of the Company's coal sales revenues from 1994
through 1998, respectively. The Company's long-term sales contract with American
Electric Power-Mountaineer, which expires in 2000, excluding option periods,
accounted for 9%, 15%, 18%, 17% and 17% of the Company's coal sales revenues
from 1994 through 1998. The Company continually bids on new contracts to replace
existing contracts in order to align supply requirements with its anticipated
production levels. There can be no assurance, however, that the Company will be
able to secure additional contracts to replace any expiring contract or to
replace such contract on terms favorable to the Company. As a result, the loss
of these or other of its sales contracts could have a material adverse effect on
the Company's financial condition and results of operations.
Virtually all of the Company's long-term sales contracts are subject to
price adjustment provisions which permit an increase or decrease in the contract
price at specified times during the contract term to reflect changes in certain
price or other economic indices, taxes and other governmental charges. Long-term
sales contracts also typically contain force majeure provisions allowing
suspension of performance by the Company or the customer to the extent necessary
during the duration of certain events beyond the control of the
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affected party, including labor disputes and changes in government regulations.
There can be no assurance that the Company's currently existing contracts will
remain in force for the duration of their current terms.
In addition, the TPC contract contains an annual price re-opener
provision which provides for the contract price to be adjusted upward or
downward on the basis of certain market factors. Upon establishment of the
price, any change is adjusted retroactively to apply to all tons shipped for the
subject year contract requirement, and interest is owed on any amount due to or
from the Company. If the parties fail to agree on a price for a given year, each
party has the right to require that the price be determined by binding
arbitration. Pending determination of the annual price, coal sales are made at
the prior year's price.
The Company believes that it has reached an agreement in principle with
Taiwan Power Company on a price for 1999 under the TPC contract. This agreement,
which is subject to Taiwan Power Company board approval, would maintain the
price under the TPC contract for 1999 at the price paid in 1998 (currently coal
is being shipped to Taiwan Power Company at the price agreed to by the parties
for 1998). Under this agreement the required 1999 tonnage to be shipped under
the contract would be reduced by approximately 265,000 tons. The Company has
also pre-shipped approximately 174,000 tons of the required 1999 tonnage during
1998. If the current agreement in principle is finalized, it would not have a
material adverse affect on the Company.
Although the Company believes it has reached an agreement in principle
with Taiwan Power Company, until there is a definitive agreement, there can be
no assurance concerning the actual price or tonnage shipped under the contract.
In the event that the price and/or tonnage were to ultimately be different from
the agreement in principle, it could have a material adverse effect on the
Company's EBITDA for 1999.
The operating profit margins realized by the Company under its
long-term sales contracts depend on a variety of factors, including production
costs, transportation costs, delivered coal qualities and quantities and various
general macro-economic indices, many of which are beyond the Company's control.
In addition, price adjustment, price re-opener and other provisions may reduce
the insulation from short-term coal price volatility provided by such contracts
and may adversely impact the Company's operating profit margins. If any of the
Company's long-term sales contracts were modified or terminated, the Company
could be adversely affected to the extent that it is unable to find alternate
customers at the same level of profitability. See Item 7-"Management's
Discussion and Analysis of Financial Condition and Results of Operations."
RELIANCE ON LONG-TERM MINERAL LEASES
A portion of the Company's revenues is derived from the leasing of its
coal reserves pursuant to long-term (longer than one year) mineral lease
agreements. Although under such leases the lessees are required to pay certain
minimum royalties upon production by a lessee, they will generally be obligated
to pay the Company royalties based on the level of its production from the
leased reserve. In 1998, approximately 15.2% of the Company's gross profits were
derived from the leasing of its mineral reserves. See "Selected Consolidated
Financial Data." As of December 31, 1998, the Company had 34 mineral leases with
a weighted average remaining life of approximately 16.3 years.
The amount of gross profit the Company derives from long-term mineral
leases is subject to the production of its lessees. The Company evaluates each
prospective lessee to determine its ability to efficiently and productively mine
the leased reserves based in large part upon past performance of the particular
prospective lessee. Beyond this evaluation, however, the ability of the lessee
to generate royalties for the Company is beyond the Company's control. There can
be no assurance that the companies which lease the Company's mineral reserves
will continue to have production levels from the Company's reserves at the same
levels they have been in the past.
The revenues generated by the Company's leases depends upon a variety
of other factors, including the long-term viability of the lessees and the
Company's ability to renew these leases as they approach termination or find
other willing and suitable lessees. If a number of the leases are terminated due
to the lessee ceasing operations, or the leases are not renewed upon expiration
of their term, the Company's results of operations could be adversely affected
to the extent that it is not able to find suitable alternate lessees.
HIGHLY COMPETITIVE INDUSTRY
The U.S. coal industry is highly competitive, with numerous producers
in all coal producing regions. The Company competes with other large producers
and hundreds of small producers in the United States and abroad. Many of the
Company's customers also purchase coal from its competitors. The markets in
which the Company sells its coal are highly competitive and affected by factors
beyond the Company's control. Demand for coal and the prices that the Company
will be able to obtain for its coal are closely linked to coal consumption
patterns of the domestic electric utility industry, which accounted for
approximately 89.5% of domestic coal consumption in 1997. These coal consumption
patterns are influenced by the demand for electricity, coal transportation
costs, environmental and other governmental regulation, technological
developments and the location, availability and price of competing sources of
coal, alternative fuels such as natural gas, oil and nuclear, and alternative
energy sources such as hydroelectric power. In addition, during the mid-1970's
and early 1980's, a growing coal market and increased demand attracted new
investors to the coal industry and spurred the development of new mines and
added production capacity throughout the industry. As a result of the increased
development of large surface mining operations, particularly in the western
United States, and more efficient mining equipment and techniques, the industry
has developed excess coal production capacity in the United States. Competition
resulting from excess capacity encourages producers to reduce prices and to pass
productivity gains through to customers. Moreover, because of greater
competition in the domestic electric utility industry and increased pressure
from customers and regulators to lower electricity prices, public utilities are
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lowering fuel costs by buying higher percentages of spot coal through a
competitive bidding process and by only buying the amount of coal necessary
under existing contracts to meet their contractual requirements. There can be no
assurance that the Company will continue to be able to obtain long-term sales
contracts with reliable customers as its reserves expand and as existing
contracts expire. If a lower percentage of its revenues are generated pursuant
to long-term sales contracts, the Company will be increasingly affected by
changes in prices for coal in the spot market.
RISKS INHERENT TO MINING
The Company's mining operations are subject to conditions beyond the
Company's control which can negatively affect the cost of mining at particular
mines for varying lengths of time. These conditions include weather and natural
disasters such as heavy rains and flooding, unexpected maintenance problems,
variations in coal seam thickness, variations in the amount of rock and soil
overlying the coal deposit, variations in rock and other natural materials and
variations in other geological and other conditions. See "Item 7-Management's
Discussion and Analysis of Financial Condition and Results of Operations."
IMPORTANCE OF ACQUISITIONS AND RELATED RISKS
The Company has grown, in part, through the acquisition of coal
companies, coal properties, coal leases and related assets, and management
believes such acquisitions will continue to be important to the Company.
Acquisitions involve a number of special risks, including possible adverse
effects on the Company's operating results, diversion of management's attention,
failure to retain key acquired personnel, risks associated with unanticipated
events or liabilities and difficulties in the assimilation of the operations,
technologies, services and products of the acquired companies, some or all of
which could have a material adverse effect on the Company's financial condition
and results of operations. There can be no assurance that the Company will be
successful in the development of such acquisitions or that the acquired
companies or other businesses acquired in the future will achieve anticipated
revenues and earnings. See "Item 7-Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources."
GOVERNMENT REGULATION OF THE MINING INDUSTRY
The coal mining industry is subject to regulation by federal, state and
local authorities on matters such as employee health and safety, permitting and
licensing requirements, air quality standards, water pollution, plant and
wildlife protection, reclamation and restoration of mining properties after
mining is completed, the discharge of materials into the environment, surface
subsidence from underground mining and the effects that mining has on
groundwater quality and availability. Numerous governmental permits and
approvals are required for mining operations. The Company believes all material
permits required to conduct its present mining operations have been obtained.
The Company may be required to prepare and present to federal, state or local
authorities data pertaining to the effect or impact that any proposed
exploration for or production of coal may have upon the environment, including
the development of Fork Creek. All requirements imposed by any such authority
may be costly and time-consuming and may delay commencement or continuation of
exploration or production operations. The possibility exists that new
legislation and/or regulations and orders may be adopted which may materially
adversely affect the Company's mining operations, its cost structure and/or its
customers' ability to use coal. New legislation, including proposals related to
the protection of the environment which would further regulate and tax the coal
industry, may also require the Company or its customers to change their
operations significantly or incur increased costs. Such factors and legislation
(if enacted) could have a material adverse effect on the Company's financial
condition and results of operations.
RECLAMATION AND MINE CLOSURE ACCRUALS
The federal Surface Mining Control and Reclamation Act of 1977
("SMCRA") and similar state statutes require that mine property be restored in
accordance with specified standards and an approved reclamation plan. The
Company accrues for the costs of final mine closure over the estimated useful
mining life of the property. These costs relate to reclaiming the pit and
support acreage at surface mines and sealing portals and contour reclamation at
underground mines, scrap removal, and contour reclamation at the preparation
plant. Other costs common to both types of mining are related to reclaiming
refuse and slurry ponds. The Company accrues for current mine disturbance which
will be reclaimed prior to final mine closure. The establishment of the final
mine closure reclamation liability and the current disturbance is based upon
permit requirements and requires various estimates and assumptions, principally
associated with costs and production levels. Although the Company's management
believes it is making adequate provisions for all expected reclamation and other
costs associated with mine closures, the Company's financial condition and its
future operating results would be adversely affected if such accruals were later
determined to be insufficient.
IMPACT OF CLEAN AIR ACT AMENDMENTS ON COAL CONSUMPTION
The federal Clean Air Act ("Clean Air Act") and amendments to the Clean
Air Act ("Clean Air Act Amendments"), and corresponding state laws which
regulate the emissions of materials into the air, affect coal mining operations
both directly and indirectly. Coal mining and processing operations may be
directly affected by Clean Air Act permitting requirements and/or emissions
control requirements relating to particulate matter (e.g., "fugitive dust").
Coal mining and processing may also be impacted by future regulation of fine
particulate matter measuring 2.5 micrometers in diameter or smaller. Regulations
relating to fugitive dust and coal combustion emissions may restrict the
Company's ability to develop new mines or could require the Company to modify
its existing operations. The Clean Air Act indirectly affects coal mining
operations by extensively regulating the air emissions of coal-fueled utility
power plants. Such regulations directly impact a coal producer's ability to sell
coal to its customers. Title IV if the Clean Air Act Amendments places limits on
sulfur dioxide emissions from electric power generation plants. These limits set
baseline emission standards for such facilities.
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Reductions in such emissions will occur in two phases: the first began in 1995
("Phase I") and applies only to certain identified facilities; and the second is
currently scheduled to begin in 2000 ("Phase II") and will apply to most
remaining facilities, including those subject to the 1995 restrictions. The
affected utilities have been and may be able to meet these requirements by,
among other ways, switching to lower sulfur fuels, installing pollution control
devices such as scrubbers, reducing electricity generating levels or purchasing
or trading "pollution credits." Specific emission sources will receive these
credits which utilities and industrial concerns can trade or sell to allow other
units to emit higher levels of sulfur dioxide. In addition, the Clean Air Act
Amendments require a study of utility power plant emission of certain toxic
substances and their eventual regulation, if warranted.
The effect of the Clean Air Act Amendments on the Company cannot be
completely ascertained at this time. The Company believes that implementation of
Phase II will likely exert a downward pressure on the price of higher sulfur
coal, as additional coal-burning utility power plants become subject to the
restrictions of Title IV. This price effect is expected to result after the
large surplus of pollution credits which has accumulated in connection with
Phase I has been reduced and before utilities electing to comply with Phase II
by installing scrubber sulfur-reduction technologies are able to implement such
a compliance strategy. If the price of compliance coal rises as Phase II is
implemented, scrubber compliance strategies may become more attractive to
utility customers, thereby lessening the downward pressure on the price of high
sulfur coal which could adversely affect the Company's prices for its compliance
and low-sulfur coal. Currently, approximately 75% of the Company's coal reserves
are estimated to be composed of compliance or low-sulfur coal and 25% of the
Company's reserves are estimated to be composed of medium-sulfur coal.
The Clean Air Act Amendments also require that utilities that currently
are major sources of nitrogen oxides in moderate or higher ozone non-attainment
areas install reasonably available control technology ("RACT") for nitrogen
oxides, which are precursors of ozone. In addition, stricter ozone standards are
expected to be implemented by the U.S. Environmental Protection Agency (the
"EPA") by 2003. The Ozone Transport Assessment Group ("OTAG"), formed to make
recommendations to the EPA for addressing ozone problems in the eastern United
States, submitted its final recommendations to the EPA in June 1997. Based on
the OTAG's recommendations, the EPA recently announced a proposal (the "SIP
call") that would require 22 eastern states, including states in which the
Company's customers are located, to make substantial reductions in nitrous oxide
emissions. The EPA expects that states will achieve these reductions by
requiring power plants to reduce their nitrous oxide emissions by an average of
85%. Installation of RACT and additional control measures required under the SIP
call will make it more costly to operate coal-fired utility power plants and,
depending on the requirements of individual state attainment plans and the
development of revised new source performance standards, could make coal a less
attractive fuel alternative in the planning and building of utility power plants
in the future. Any reduction in coal's share of the capacity for power
generation could have a material adverse effect on the Company's financial
condition and results of operations. The effect such legislation or regulation,
or other legislation that may be enacted in the future, could have on the coal
industry in general and on the Company in particular cannot be predicted with
certainty. Although a large portion of the Company's coal reserves are comprised
of compliance and low-sulfur coal, there can be no assurance that the
implementation of the Clean Air Act Amendments or any future regulatory
provisions will not materially adversely affect the Company.
POTENTIAL IMPACT OF KYOTO PROTOCOL
On December 11, 1997, U.S. government representatives at the climate
change negotiations in Kyoto, Japan, agreed to reduce the emissions of
greenhouse gas (including carbon dioxide and other gas emissions that are
believed to be trapping heat in the atmosphere and warming the Earth's climate)
in the United States. The adoption of the requirements of the Kyoto protocol by
the United States are subject to conditions which may not occur, and are also
subject to the protocol's ratification by the U.S. Senate. The U.S. Senate has
indicated that it will not ratify an agreement unless certain conditions, not
currently provided for in the Kyoto protocol, are met. At present, it is not
possible to predict whether the Kyoto protocol will attain the force of law in
the United States or what is impact would be on the Company. Further
developments in connection with the Kyoto process could adversely affect the
Company's financial condition and results of operations.
REPLACEMENT AND RECOVERABILITY OF RESERVES
The Company's future success depends, in part, upon its ability to
find, develop or acquire additional coal reserves. The reserves of the Company
will generally be depleted as mining operations are conducted, except to the
extent that the Company conducts successful exploration and development
activities or acquires properties containing reserves. To increase reserves and
production, the Company must continue its development, exploration and
acquisition activities or undertake other replacement activities. The Company's
current strategy includes increasing its reserve base through acquisitions of
producing properties and by continuing to exploit its existing properties. There
can be no assurance, however, that the Company's planned development and
exploration projects and acquisition activities will result in significant
additional reserves or that the Company will have continuing success developing
additional mines. Most of the Company's mining operations are conducted on
properties owned or leased by the Company. Because title to most of the
Company's leased properties and mineral rights is not thoroughly verified until
a permit is obtained to mine the property, the Company's right to mine certain
of its reserves may be adversely affected if defects in title or boundaries
exist. In addition, there is no assurance that the Company can successfully
negotiate new leases or mining contracts for properties containing additional
reserves or maintain its leasehold interest in properties on which mining
operations are not commenced during the term of the lease. See "Item
2-Properties."
PRICE FLUCTUATIONS AND MARKETS
The Company's results of operations are highly dependent upon the
prices received for the Company's coal. Any significant decline in prices for
coal could have a material adverse effect on the Company's financial condition,
results of operation and quantities of
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reserves recoverable on an economic basis. Should the industry experience
significant price declines from current levels or other adverse market
conditions, the Company may not be able to generate sufficient cash flow from
operations to meet its obligations and make planned capital expenditures. See
"Item 7-Management's Discussion and Analysis of Financial Condition and Results
of Operations-Liquidity and Capital Resources."
To the extent the Company is unable to sell its coal under long-term
sales contracts, it would be forced to cease production or to sell its
production into the spot market. The prices for spot coal sales are typically
below the price received under long-term sales contracts. The Company estimates
that, on average, spot sales for coal shipped through the Big Sandy River
district in 1998 averaged approximately $2.50 less per ton (for comparable
quality coal) than the amount received by the Company under long-term sales
contracts.
RELIANCE ON ESTIMATES OF RECOVERABLE RESERVES
There are numerous uncertainties inherent in estimating quantities of
reserves, including many factors beyond the control of the Company. The coal
reserve data set forth in this report are based on the Reserve Studies.
Estimates of coal reserves and future net cash flows necessarily depend upon a
number of variable factors and assumptions, such as historical production from
the area compared with production from other producing areas, the assumed
effects of regulations by governmental agencies and assumptions concerning
future coal prices, future operating costs, severance and excise taxes,
development costs and reclamation costs, all of which may in fact vary
considerably from actual results. For these reasons, estimates of the
economically recoverable quantities of coal attributable to any particular group
of properties, classifications of such reserves based on risk of recovery and
estimates of future net cash flows expected therefrom prepared by different
engineers or by the same engineers at different times may vary substantially.
Actual production, revenues and expenditures with respect to the Company's
reserves will likely vary from estimates, and such variances will likely be
material. As a result, potential investors should not place undue reliance on
the coal reserve data included herein. See "Item 2-Properties."
RISKS ASSOCIATED WITH CURRENT IRS AUDIT
The IRS is currently examining the Company's federal tax returns for
the years 1990 through 1993. The Company has received various preliminary
notices of proposed adjustments from the IRS proposing substantial adjustments
to taxable income reported on the Company's income tax returns for these years.
As the IRS has not yet concluded its examination or issued its examination
report, management does not yet know what issues the IRS will pursue and is
unable to estimate the likely outcome of the audits for these years. The Company
is continuing to meet with the IRS to discuss the preliminary proposed
adjustments in an attempt to resolve these issues. Although management believes
that most of the preliminary proposed adjustments from the IRS are likely to be
eliminated or substantially reduced prior to any necessary appeal, there can be
no assurance as to the ultimate outcome of the ongoing examination by the IRS.
If, after exhaustion of all administrative and judicial remedies and appeals
that are available to the Company, issues currently raised in the preliminary
proposed adjustment were decided substantially in favor of the IRS positions,
the result could impact the Company's financial results.
DEPENDENCE ON KEY MANAGEMENT AND CONTROL BY PRINCIPAL SHAREHOLDER
The Company's business is managed by a number of key personnel, the
loss of any of whom could have a material adverse effect on the Company. In
addition, as the Company's business develops and expands, the Company believes
that its future success will depend greatly on its continued ability to attract
and retain highly skilled and qualified personnel. See "Item 10-Directors and
Executive Officers of the Registrant."
William E. Beckner beneficially owns 90.4% of the outstanding voting
securities of the Company. Accordingly, Mr. Beckner is able to control the
election of the Company's directors and to determine the corporate and
management policies of the Company, including decisions relating to any mergers
or acquisitions by the Company, sales of all or substantially all of the
Company's assets and other significant corporate transactions, which
transactions may result in a Change of Control under the Indenture and Credit
Facility. See "Item 12-Security Ownership of Certain Beneficial Owners and
Management."
TRANSPORTATION
The U.S. coal industry depends on rail, trucking and river barge
transportation to deliver shipments of coal to customers. Disruption of these
transportation services could temporarily impair the Company's ability to supply
coal to its customers and thus adversely affect the Company's financial
condition and operating results. Transportation costs are a significant
component of the total cost of supplying coal to customers and can affect
significantly the Company's competitive position and profitability. Increases in
the Company's transportation costs, or changes in such costs relative to
transportation costs incurred by providers of competing coal or of other fuels,
could have an adverse effect on the Company's financial condition and operating
results. In addition, the Company may be adversely affected by labor or other
disruptions throughout the transportation industry as a whole.
In the past, the Company has experienced delays in transporting coal
from its mine sites near the Kentucky-West Virginia border due to temporary
cessations of operations at its Big Sandy River loading terminals. In the past,
the Big Sandy River has flooded or water levels have risen after sustained
periods of adverse weather conditions, forcing the terminals to cease loading
barges. These terminals were unable to load barges 69 days during the five year
period ending December 31, 1998. Delays in transporting its coal to customers
increases the Company's cost of production and decreases customer satisfaction
and, if prolonged, could have a material adverse effect on
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the Company. It is anticipated that coal production from Fork Creek will be
shipped on rail via CSX and, as a result, the Company will be dependent upon CSX
to transport this coal.
UNIONIZATION OF LABOR FORCE
The Company is not currently a party to any collective bargaining
agreement and considers its relations with its employees to be good. If some or
all of the Company's currently non-union operations were to become unionized,
the Company could incur higher labor costs and an increased risk of work
stoppages. There can be no assurance that the Company's workforce will not
unionize in the future. In addition, even if the Company remains non-unionized,
its operations may still be adversely affected by work stoppages at unrelated
unionized companies.
NEW TECHNOLOGY
The coal mining industry is increasingly affected by advances in
technology. The ability of the Company to compete successfully may depend on the
extent to which it is able to implement and exploit such technological changes.
The failure of the Company to develop, anticipate or respond to such changes
could have a material adverse effect on the Company. The development of new and
better technologies by the Company's competitors could have a material adverse
effect on the Company's financial condition and results of operations.
FRAUDULENT CONVEYANCE STATUTES
Under applicable provisions of federal bankruptcy law or comparable
provisions of state fraudulent transfer law, if a court were to find that, among
other things, at the time Pen Holdings incurred the indebtedness evidenced by
the Notes or a guarantor executed its guaranty, Pen Holdings or the guarantor,
as the case may be: (i) (a) was or is insolvent or rendered insolvent by reason
of such occurrence, (b) was or is engaged in a business or transaction for which
the assets remaining with Pen Holdings or such guarantor constituted
unreasonably small capital, or (c) intended or intends to incur, or believed or
believes that it would incur, debts beyond its ability to pay such debts as they
mature; and (ii) received or receives less than reasonably equivalent value or
fair consideration for the incurrence of such indebtedness, then the Notes or
guarantee, as the case may be, could be voided, or claims in respect of the
Notes or guarantees could be subordinated to all other debts of Pen Holdings, as
the case may be. In addition, the payment of interest and principal by Pen
Holdings pursuant to the Notes could be voided and required to be returned to
the person making such payment, or to a fund for the benefit of the creditors of
Pen Holdings.
The measures of insolvency for purposes of the foregoing considerations
will vary depending upon the law applied in any proceeding with respect to the
foregoing. Generally, however, Pen Holdings or a Guarantor would be considered
insolvent if (i) the sum of its debts, including contingent liabilities, were
greater than the salable value of all of its assets at a fair valuation or if
the present fair salable value of its assets were less than the amount that
would be required to pay its probable liability on its existing debts, including
contingent liabilities, as they become absolute and mature or (ii) it could not
pay its debts as they become due.
On the basis of historical financial information, recent operating
history and other factors, the Company believes that, as a result of the
indebtedness incurred in connection with the Notes and the establishment of the
Credit Facility, it was not rendered insolvent, did not have unreasonably small
capital for the business in which it is engaged and did not incur debts beyond
its ability to pay such debts as they mature. There can be no assurance,
however, as to what standard a court would apply in making such determinations
or that a court would agree with the Company's conclusions in this regard.
POTENTIAL INABILITY TO FUND A CHANGE OF CONTROL OFFER
Upon a change of control, the Company will be required to offer to
repurchase all outstanding Notes at 101% of the principal amount thereof plus
accrued and unpaid interest, if any, to the date of repurchase. However, there
can be no assurance that sufficient funds will be available at the time of any
change of control to make any required repurchases of Notes tendered or that
restrictions in the Credit Facility will allow the Company to make such required
repurchases.
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ITEM 2. PROPERTIES.
Mining Operations
For reference, the Company has included on Page M-1, a small scale
map illustrating the Company's coal operation. See "Page M-1 - Kentucky-West
Virginia Operation".
Captive Coal Production. The Company currently conducts mining
operations at three underground mines and one surface mine at its Kiah Creek
reserves located in Wayne, Lincoln and Mingo counties in southern West Virginia
and six underground mines and two surface mines at its Elk Horn reserves located
in Floyd, Johnson, Knott, Letcher, Magoffin, Martin and Pike counties in eastern
Kentucky. Approximately 70% of the Company's 1998 production originated from its
underground mines, and approximately 30% originated from its surface mines. Coal
seam thickness, location and the amount of overburden required to be removed,
among other conditions, are factors utilized by the Company to determine the
appropriate mining method. Over the last five years, the Company has shifted a
greater percentage of its production to underground mines to maximize its
reserve utilization. In 1994, 43% of the Company's production was from
underground mines, compared to 70% in 1998. Contract miners, under the terms of
contract mining agreements with the Company, have operated in nine underground
mines and two surface mines on the Company's Elk Horn reserves and one
underground mine on the Company's Kiah Creek reserves during 1998. Contract
mining has represented 11%, 21%, 17%, 22% and 16% of the Company's coal
production in the periods 1994 through 1998, respectively.
The following table presents the Company's total captive coal
production for the previous five years for its regions:
<TABLE>
<CAPTION>
REGION 1994 1995 1996 1997 1998
------ ---- ---- ---- ---- ----
(IN THOUSANDS OF TONS)
<S> <C> <C> <C> <C> <C>
Kiah Creek (West Virginia) 2,068 2,161 2,746 2,947 3,244
Elk Horn (Kentucky) (1) 612 896 552 557 707
----- ----- ----- ----- ------
Total 2,680 3,057 3,398 3,504 3,951
===== ===== ===== ===== =====
</TABLE>
(1) Includes the production of a Company operated mine in Kentucky known as
Big River Mining which produced 330,000 tons and 255,000 tons in 1994
and 1995, respectively. Excludes production by The Elk Horn Coal
Corporation, which the Company acquired in August 1994, prior to the
Company's purchase of the Elk Horn reserves. Production from Elk Horn
was (exclusive of leased production) 466,000 tons during 1994.
Kiah Creek. The Company's major mining operations are located at Kiah
Creek. These reserves were purchased by the Company in 1987 for $16.5 million,
and mining operations commenced shortly thereafter with surface mining and,
later, underground mining. This property consists of approximately 45,000 acres
of surface area. In 1995 and 1996, the Company acquired by lease approximately
26 million tons of reserves which are contiguous to Kiah Creek. Management
estimates that the Company currently owns in fee approximately 27 million tons
of reserves and currently controls, primarily through leases, an additional
approximately 24 million tons of reserves on this property. Management estimates
that the quality of its production at Kiah Creek has averaged 10 to 14% ash, and
11,500 to 12,500 Btu per pound, and that its remaining reserves at Kiah Creek
are 73% compliance coal, 17% low-sulfur and 10% medium sulfur.
At Kiah Creek, four underground mining units in three underground mines
are currently operating. The Company operates two underground mining units in
its Mine #3 in the Coalburg seam, one underground mining unit in its Mine #4 in
the 5-Block seam and one underground mining unit in its Mine #5 in the 5-Block
seam. In addition, for the first half of 1998, a contract mining company had
operated one underground mining unit at the Company's Mine #2 in the Coalburg
seam. Mining is now complete at Mine #2. Approximately 0.9, 1.0, 1.5, 1.9 and
2.0 million tons of coal were produced from the Company's Kiah Creek underground
mines in the years from 1994 through 1998, respectively.
The Company also operates one surface mine in the 5-Block seam at Kiah
Creek. The Company utilizes contour and point removal and area mining techniques
in its surface mining operations. Approximately 1.2, 1.2, 1.3, 1.1 and 1.2
million tons of coal were produced from the Company's Kiah Creek surface mines
in the years from 1994 through 1998, respectively.
The Company owns and operates a computer-controlled, 600 tons-per-hour
heavy media preparation plant on the Kiah Creek property where the coal from all
of its underground mines on this property and a small percentage of its surface
mined coal is processed. The preparation plant sizes the raw product, then
directs the sized product to one of three circuits: heavy media vessel, heavy
media cyclones or spirals. Each of these circuits utilizes gravity separation to
separate coal from rock and other impurities. This preparation plant is also
capable of producing stoker coal. The preparation plant has a storage capacity
of approximately 50,000 tons of raw and washed coal and a processing capacity of
approximately four million raw tons per year. This plant processed 0.9, 1.0,
1.5, and 1.9 and 2.0 million tons of clean coal in the years from 1994 through
1998, respectively, and has averaged recovery rates of 47%, 42%, 54%, 51% and
53% in the years 1994 through 1998, respectively. The preparation plant
currently operates 24 hours per day, seven days a week.
The coal from the Kiah Creek surface mine and from the Kiah Creek
preparation plant is sent by truck via Company roads and state highways
approximately 50 miles to the Company's Wayne County River Terminal located in
West Virginia along the Big Sandy River, a navigable tributary of the Ohio
River. The Company built its Wayne County facility in 1988 at an initial cost of
approximately
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$3.5 million and has made additional capital expenditures on this facility of
$3.8 million. This river terminal, which is approximately 15 miles from
Huntington, West Virginia, has blending capabilities and a loading capacity of
approximately 6 million tons annually.
The Company's coal is delivered by barge to its domestic customers
along the Ohio River and Mississippi River, and to its international and Gulf of
Mexico customers through International Marine Terminals, an ocean vessel loading
facility south of New Orleans on the Mississippi River which is one-third owned
by the Company. Either an independent barge operator or the Company's customers
transport the coal after it has been loaded into the river barges. In April
1998, the Company ceased operations at its smaller river terminal in Kentucky
located along the Big Sandy River since all of the Company's barge loading needs
can be more efficiently met at the Company's Wayne County River Terminal. The
Kentucky dock facility is currently being marketed for sale.
The Company shipped 3.8, 4.1, 4.4, 4.5 and 4.7 million tons from its
terminals on the Big Sandy River from 1994 through 1998, respectively. According
to the Big Sandy River Committee, an organization of shipping facilities on the
Big Sandy River, including 10 coal-loading facilities, the Company shipped more
tonnage than any other operator on this river in 1996, 1997 and 1998.
Generally, the Company undertakes and controls all permitting and
permit maintenance under the SMCRA requirements and similar state requirements
in West Virginia for its captive production. The Company provides surety bonds
for these SMCRA permits.
Elk Horn. In 1994, the Company acquired the Elk Horn properties through
its purchase of all of the outstanding capital stock of The Elk Horn Coal
Corporation for $71 million in cash. This acquisition made the Company one of
the largest private owners of coal reserves in Central Appalachia. The Company
produces coal through the use of contract mining companies and leases to other
coal companies the mineral rights to a portion of the coal from its Elk Horn
reserves. The Company's Elk Horn reserves include approximately 142,000
non-contiguous surface acres of coal bearing lands in eastern Kentucky, all of
which is owned in fee. Based on the Reserve Studies, the Elk Horn reserves are
estimated to contain more than 92 million tons of coal.
The Company believes that due to the location and geological
composition of its Elk Horn reserves, it is more economically attractive to
either contract with other mining companies or lease to other coal companies
than for the Company to mine. However, the Company continually reevaluates its
reserves and production to determine whether the Company can cost-effectively
extract coal through its own mining operations. Therefore, given the appropriate
economic and geological factors, the Company could determine to mine the
reserves at Elk Horn itself.
Elk Horn's contract mines include both underground and surface mines.
Because of the reserve's geological composition, Elk Horn's contract underground
miners currently utilize conventional mining techniques which generally result
in less volume and productivity per man hour versus utilizing continuous mining
units. However, conventional mining tends to produce coal with less ash content
which reduces the requirement to wash the coal at a preparation plant. As a
result, the Company does not maintain a preparation plant on the Elk Horn
reserve.
Under these contract mining arrangements, the Company contracts with
independent mining companies to extract coal in exchange for a predetermined
per-ton fee. Contract mining fees at the Elk Horn operations have averaged
approximately $14.99 per ton from 1995 through 1998. Contract mining fees
typically exclude taxes and royalties. The relationships between the Company and
its contract miners are generally governed by the Company's standard contract
mining agreement (the "Contract Mining Agreement"). The Contract Mining
Agreement is for a term of one year which is automatically renewed from year to
year, although either party may elect not to renew upon 60 days' notice. Several
of the Contract Mining Agreements allow either party to terminate upon 30 days'
notice for virtually any reason. Each Contract Mining Agreement provides that
the independent contractor meet certain minimum daily and monthly production
requirements and minimum coal quality standards. Contractors are given premiums
or charged penalties based on delivered coal quality. The Contract Mining
Agreement is not assignable by the contractor without the express permission of
the Company nor is a significant change in ownership of the contractor
permitted. The Contract Mining Agreement requires the contractor to provide all
of the equipment, manpower and other resources necessary to mine the coal. The
contractor must provide all required insurance coverage to its employees and
liability insurance for its operation. The Contract Mining Agreement provides
that the contractor will hold the Company harmless from any environmental or
health and safety liability incurred by the contractor as a result of its
mining. The Company in conjunction with the contractor, determines the most
efficient mining plan for the coal reserve in order to maximize the use of the
resources.
The Company generally undertakes and controls all permitting and permit
maintenance under SMCRA requirements and similar state requirements in Kentucky
(including providing the surety bonds for the SMCRA permits for these contract
mine sites). Each contract miner fulfills the site maintenance requirements for
the SMCRA permits as part of its contract with the Company. All federal Mine
Safety Health Act requirements are also the sole responsibility of the contract
miner.
The coal produced for the Company from Elk Horn is transported to the
Company's Wayne County River Terminal on the Big Sandy River for delivery to
customers along the Ohio River and Mississippi River systems and to the Gulf of
Mexico.
From the date of acquisition in August 1994 through 1998, contract
mining operations at Elk Horn produced 282,000, 641,000, 552,000, 557,000 and
707,000 tons, respectively. The average raw coal quality produced by these
contract mining operations has consistently exceeded the Company's sales
contract requirements.
Fork Creek. In November 1997, the Company acquired a 28,000-acre
contiguous tract located in Kanawha, Boone and Lincoln counties in West
Virginia. Based on the Reserve Studies, Fork Creek contains approximately 80
million tons of coal reserves. The Fork
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<PAGE> 13
Creek acquisition is consistent with the Company's strategy to focus its
operations on large contiguous properties located in the Central Appalachia
region. The purchase price for this property was $16 million.
The Fork Creek reserves are a large contiguous tract of mineral
reserves analogous in size to the Kiah Creek reserves. Unlike Kiah Creek,
however, the geological conditions of the Fork Creek reserves have led the
Company to plan primarily underground mining operations to extract the mineral.
The Company intends to develop Fork Creek for its own production while
selectively contracting with other miners where such contracts are commercially
attractive. Based upon data received from core-hole drilling done on the
property, management estimates that the quality of the reserves at Fork Creek
will generally be between 5% to 13% ash and 12,150 to 13,250 Btu per pound and
the reserves are 25% compliance coal, 41% low-sulfur and 34% medium sulfur.
The Company expects to invest approximately $65 million over the next
several years to develop this property, including the construction of an
upgradable 900 tons per hour coal preparation plant and a 150 car, four hour,
batch weigh, fast feed rail loadout adjacent to a CSX rail line and an access
road to the heart of the property. This expected investment for development of
Fork Creek is larger than the investment previously planned because management
believes the income from the property can be significantly increased with a
larger preparation plant and other infrastructures. The Company anticipates that
the construction of the preparation plant and the rail loadout will take
approximately twelve months to complete. A portion of the proceeds from the
Notes are intended to be used to fund a portion of the Fork Creek development,
and in particular to fund the construction of the preparation plant and rail
loadout. In addition to rail transportation, coal from this property may also be
cost-effectively transported by truck to river terminals located on the nearby
Kanawha River and loaded into river barges for shipment along the Ohio River and
Mississippi River systems. The Fork Creek reserves are accessible by truck via a
state highway and an access road which is now under construction. The Company
believes that flexibility in transporting coal by rail or river barge will
provide it with a competitive advantage in increasing the number of potential
customers for coal from this property. All material permits for road access,
rail access, the preparation plant, the loadout and the underground facility
will be submitted by the end of the second quarter of 1999.
Leasing Operations
Elk Horn Coal Leasing. The primary use of the Company's Elk Horn
property has involved the leasing of its mineral rights to independent coal
producers in exchange for revenue-based lease royalties. The Company's strategy
has been to lease attractive coal reserves to reliable coal producers under
financially sound leases. As noted above, the Company owns the mineral rights on
approximately 142,000 acres in eastern Kentucky and has approximately 92 million
tons of reserves, which are generally characterized as high-volatility
bituminous with low-sulfur content. The Elk Horn coal reserves are strategically
located in eastern Kentucky, with access to major markets on the CSX rail
system, and by barge via the Big Sandy and Ohio Rivers. Much of these reserves
are adjacent to numerous mining companies' operations. As a result, it often is
cost-effective for such mining companies to continue mining in such areas,
including on reserves leased from the Company for a fee, rather than to cease
mining operations at such locations and redeploy equipment to other locations or
idle or dispose of equipment. All of these factors make the Company's Elk Horn
reserves attractive lease property to independent producers and coal operators.
During the year ended December 31, 1998, the Company had 19 operators
who were actively mining on leased coal reserves, including MC Mining, Inc.,
Bull Creek Coal Corporation, Locust Grove, Inc., Johns Creek Coal Company, Maple
Ridge Inc., Industrial Fuels Minerals Company, Richardson Fuel, Inc., Kris-Coal
Mining, Inc., Turner Elkhorn Mining Company, Pike-Letcher Land Company, and
Mineral Resources, Inc. Generally, the lease terms provide the Company with a
royalty fee of up to 10% of the sales price of the coal with a minimum of $1.75
to $2.50 per ton. The length of such leases generally varies from three to five
years with five years being the most common term. The Company has a limited
number of longer term leases which have terms of 35 years to the exhaustion of
the reserve. Under these longer term leases the royalties range from 4% to 7% of
the coal sales price. A minimum royalty is required whether the property is
mined or not. If sufficient coal is not mined such that the property does not
meet the minimum, the lessee pays the deficiency. Such deficiency (or minimum
royalty) can be recouped by the lessee as a credit against royalties owed on
mined coal if there is production within a period of time after a deficiency is
paid. This system motivates the lessee to maximize production of the property
during the term of the lease. The Company's credit experience with its lessees
has historically been favorable, with minimal bad debt write-offs for the period
from 1995 through 1998 of $27,000, $3,000, $111,000 and $0, respectively. The
Company has subsequently recouped $86,000 of the $111,000 written off in 1997.
In the period from 1994 through 1998, independent coal producers mined
approximately 4.0, 3.7, 3.4, 3.0 and 3.3 million tons, respectively, of coal
under leases (the information provided prior to the Company's acquisition of the
Elk Horn reserves has been derived from amounts reported by Elk Horn's previous
owner). Management believes that the amount of leased coal mined in 1998
increased from 1997 levels due to several new lessees' mines starting production
in late 1997 and during 1998. Leasing contributed an average of $8.8 million per
year in revenues since 1995 and management believes leasing will continue to
generate significant revenues based on existing leases and indications of future
mining activity by these operators.
The main activities include new lease development, cubication for
lessee extraction verification, continuing reserve analysis and mapping,
acquisitions and dispositions of properties, lease compliance, environmental
oversight on unleased properties, and related matters.
In recent years, Elk Horn's internal engineering and mapping group has
identified and prioritized the coal reserves which are favorable for
development. Management has proactively sought lessees for these identified
areas. The Company has also leased in response to inquiries about mining
opportunities in specific seams, areas, or boundaries. The Company's objective
is to acquire by purchase or lease properties contiguous to its Elk Horn
properties in order to offer additional lease tracts to coal operators.
-11-
<PAGE> 14
Transportation Operations
Wayne County River Terminal. The Company's coal is currently
transported to its customers primarily by barges loaded at this river terminal
on the Big Sandy River and, to a much lesser extent, by truck and rail. The
Company generally pays truck charges to deliver coal from its preparation plant
or mine site to its Wayne County River Terminal and incurs costs to load it onto
a barge. Customers typically pay the transportation costs from the barge to the
customer's ultimate destination of delivery. The average annual per ton cost
incurred by the Company for transporting its coal from the preparation plant or
mine site to its river terminals during the period from 1994 through 1998 was
$3.84.
The Company currently contracts with 9 independent trucking companies
to haul its coal from the mine site or preparation plant to the Wayne County
River Terminal. These hauling arrangements typically consist of a term of three
years and are based on a fixed fee per ton. The Company believes it can replace,
if necessary, any of its independent trucking relationships with other
independent trucking companies upon relatively short notice.
International Marine Terminals. For the Company's export customers, the
Company incurs additional charges related to the cost of barging the coal
downriver and for transloading the coal from river barges to ocean-going
vessels. The Company has a one-third partnership interest in International
Marine Terminals ("IMT"). IMT owns and operates an ocean marine loading facility
located in Louisiana south of New Orleans along the Mississippi River. IMT (i)
transloads coal from river barges into gulf barges or ocean going vessels to
Gulf Coast coal customers and international markets; (ii) transloads petroleum
coke for domestic producers (or their sales brokers); and (iii) provides
transloading services for the U.S. steel industry with imported iron ore and
other ferro alloys.
Cotton Operations
Pen Cotton Company of South Carolina. The Company has a cotton ginning
and warehousing business in South Carolina which accounted for approximately 5%
of the Company's 1998 revenues. In 1996, the Company sold Pen Cotton Tennessee,
its Tennessee cotton operations, and closed Pen Cotton Company of Alabama, Inc.,
its Alabama cotton merchandising activity. Approximately 19,000 bales of cotton
were ginned in 1998, compared with approximately 23,000 bales in 1997. The
Company receives fees for its services for ginning and warehousing. In 1998,
revenues from this operation were $8.4 million. The South Carolina cotton
operation revenues as a percentage of total revenues and EBITDA as a percentage
of total EBITDA for the period from 1994 through 1998 were 4.3%, 7.2%, 8.1%,
5.6% and 5.0%, respectively and 1.0%, 0.6%, 2.7%, 1.6% and 1.8%, respectively.
The Company also typically purchases cottonseed from the farmer at the time of
ginning. The seed is then sold to a local oil mill who produces cottonseed oil
or, more commonly, is sold into the dairy cattle market where the seed is used
as feed. Consistent with the Company's strategy to focus on its core business,
the Company may, given the right market conditions, choose to sell its remaining
cotton operations.
Administrative Offices
The Company maintains administrative offices in Brentwood (located near
Nashville), Tennessee; Kenova, Dunlow, and Alum, West Virginia; and
Prestonsburg, Kentucky.
-12-
<PAGE> 15
ITEM 3. LEGAL PROCEEDINGS.
On September 22, 1998, a Floyd County, Kentucky Circuit Court jury
found in favor of Cheyenne Resources, Inc. and its wholly owned subsidiary, PC&H
Construction, Inc. (collectively "Cheyenne") in a suit brought against Elk Horn
Coal, a wholly owned subsidiary of the Company, on a breach of contract and
fraud case relating to a coal lease that was entered into prior to the Company's
purchase of Elk Horn. Elk Horn has appealed the verdict on liability. On
September 24, 1998, Cheyenne first elected its remedies and specified that as
relief it sought over $18 million in compensatory damages and punitive damages.
On October 1, 1998, the jury awarded damages in favor of Cheyenne of $4.5
million attributable to the fraud claim and $5.0 million attributable to the
breach of contract claim. No punitive damages were awarded. Elk Horn's
litigation counsel and management believe that there are numerous meritorious
grounds for reversal and/or modification of these verdicts on appeal on the
issue of liability as well as the issue of damages. Currently, the case is in
appeals in the Kentucky Court of Appeals. However, the Company cannot determine
whether the resolution of this matter will have a material adverse impact on the
Company's financial position or results of operations.
In 1995, the Company filed a petition in U.S. Tax Court requesting a
determination on the issues raised by the IRS in its examinations for the years
1982 through 1989. In January 1999, the Company reached a settlement of this
matter with IRS. In addition to settling the Tax Court case, the settlement also
includes the years 1990 through 1994 on one central issue that had been before
the Tax Court. See "Item 7-Management's Discussion and Analysis of Results of
Operations and Financial Position--Liquidity and Capital Resources."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders of the
Company through the solicitation of proxies or otherwise during the fourth
quarter of 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company does not have a class of equity securities which are
registered under the Securities Exchange Act of 1934. No equity securities were
sold by the Company during the year ended December 31, 1998.
-13-
<PAGE> 16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data as of and for each
of the five years ended December 31, 1998 have been derived from the
consolidated financial statements of the Company which have been audited by
PricewaterhouseCoopers LLP, independent accountants. The information presented
below is qualified in its entirety by, and should be read in conjunction with,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the audited consolidated financial statements of the Company and
related notes included elsewhere in this document. For purposes of this
presentation, depreciation, depletion, and amortization have been reclassified
into a separate component of operating expenses from cost of sales and selling,
general and administrative. The balance sheet items as of December 31, 1994,
1995 and 1996 and the statement of operations data and other data for the years
ended December 31, 1994 and 1995 have been derived from audited consolidated
financial statements not included herein.
SELECTED CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER TON DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
Coal sales $ 161,744 $ 147,169 $ 154,205 $ 161,462 $ 154,908
Leased coal 4,198 10,738 9,348 8,235 6,121
Other 19,738 28,136 18,916 12,592 8,522
--------- --------- --------- --------- ---------
Total revenues 185,680 186,043 182,469 182,289 169,551
Cost of sales:
Coal sales 136,614 127,890 134,267 138,948 130,516
Leased coal 657 1,355 1,179 1,171 1,706
Other 17,170 24,443 15,370 9,906 8,206
--------- --------- --------- --------- ---------
Total cost of sales 154,441 153,688 150,816 150,025 140,428
Gross profit:
Coal sales 25,130 19,279 19,938 22,514 24,392
Leased coal 3,541 9,383 8,169 7,064 4,415
Other 2,568 3,693 3,546 2,686 316
--------- --------- --------- --------- ---------
Total gross profit 31,239 32,355 31,653 32,264 29,123
Selling, general and administrative 5,573 5,540 5,013 5,445 4,407
Depreciation, depletion, and amortization 11,397 13,975 14,742 15,290 15,270
--------- --------- --------- --------- ---------
Operating income 14,269 12,840 11,898 11,529 9,446
Interest expense (1) 6,173 10,340 9,186 7,906 9,682
Other income 1,725 1,698 2,884 6,125 3,216
--------- --------- --------- --------- ---------
Income from continuing operations before income taxes 9,821 4,198 5,596 9,748 2,980
Income taxes 2,497 1,137 1,463 2,246 (213)
--------- --------- --------- --------- ---------
Net income before discontinued operations 7,324 3,061 4,133 7,502 3,193
Income (loss) from discontinued operations (2) 152 70 (1,448) (35) 28
--------- --------- --------- --------- ---------
Net income before extraordinary items $ 7,476 $ 3,131 $ 2,685 $ 7,467 $ 3,221
========= ========= ========= ========= =========
OPERATING DATA:
Coal sold (in thousands of tons) 5,010 4,734 5,051 5,317 5,340
Coal production (in thousands of tons) (3) 2,680 3,057 3,298 3,504 3,951
Leased coal production (in thousands of tons) (4) 3,988 3,739 3,406 2,952 3,300
Average sales price per ton of coal (5) $ 32.28 $ 31.09 $ 30.53 $ 30.37 $ 29.01
Average cash cost per ton of coal shipped (FOB barge) (6) 24.07 25.46 23.05 23.22 22.58
Average leasing revenue per ton of coal (7) 2.53 2.87 2.74 2.79 1.85
STATEMENT OF CASH FLOW DATA:
Net cash provided (used) by operating activities $ (4,851) $ 23,176 $ 18,974 $ 17,502 $ 16,883
Net cash provided (used) by investing activities (67,158) (801) 2,440 14,900 (12,940)
Net cash provided (used) by financing activities 67,032 (19,409) (27,689) (28,136) 10,918
</TABLE>
-14-
<PAGE> 17
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
BALANCE SHEET ITEMS:
Cash and cash equivalents 5,194 8,160 1,885 6,151 21,012
Working capital (8) 30,751 4,412 12,953 11,895 9,289
Total debt 129,217 109,374 96,873 86,371 108,003
Mandatorily redeemable preferred stock (9) 0 13,650 15,344 17,097 14,115
Total shareholders' equity 61,272 34,793 35,786 41,486 45,823
OTHER DATA:
EBITDA (10) 25,666 26,815 26,640 26,819 24,487
Capital Expenditures (11) 7,181 5,902 9,542 7,969 17,098
</TABLE>
- ----------
(1) Excludes capitalized interest expense of $97 for the year ended December
31, 1997 and $1,417 for the year ended December 31, 1998. There was no
capitalized interest expense for any prior periods.
(2) Represents the earnings (loss) of Pen Cotton Alabama, Pen Hardwood and
Pen California (collectively, the "Discontinued Operations"), which were
discontinued or disposed of in 1996 and 1995.
(3) Coal production includes contract mining production of 282, 641, 552,
770, and 844 tons (in thousands) for the years ended December 31, 1994,
1995, 1996, 1997 and 1998, respectively.
(4) The Company acquired its Elk Horn coal operations in August 1994. Data
for 1994 prior to the acquisition was obtained from the previous owner of
these properties and the Company makes no representation as to the
accuracy of such data. Included in such data is 2,330 tons (in thousands)
produced by lessees in 1994 prior to the Company's acquisition of Elk
Horn.
(5) In the five years ended December 31, 1998, the average sales price per
ton of coal includes per-ton costs of approximately $5.41, $2.71, $1.97,
$1.98, and $1.54, respectively, for the shipment of coal sold to Taiwan
Power Company from the Company's loading facility on the Big Sandy River
until loaded into a vessel at a transloading facility along the
Mississippi River near the Gulf of Mexico.
(6) Average cash cost per ton of coal shipped includes all cash costs of coal
production, transportation of the coal to the loading facility, loading
of the coal into barges, and selling expenses.
(7) Represents average leasing revenue per ton of coal for coal produced by
lessees subsequent to the Company's acquisition of Elk Horn.
(8) Equal to current assets (excluding cash and cash equivalents) less
current liabilities (excluding current portion of long-term debt, current
maturities of capital leases and revolving credit loans).
(9) The Company's outstanding Convertible Preferred Stock was issued in
connection with the Company's Recapitalization in December, 1995. The
Convertible Preferred Stock which had an original liquidation preference
of $13,650,000 does not pay cash dividends and no dividends accrue from
the date of issuance through December 2000; beginning in January 2001,
dividends will accrue on the then liquidation preference at an annual
rate of 25.25% for a five-year period. The aggregate amount of dividends
which will accumulate from 2001 to 2006 is being recorded evenly from the
date of issuance in 1996 through the redemption date in 2006. The
Convertible Preferred Stock is mandatorily redeemable in January 2006 and
is redeemable with the issuance of a note equal to the liquidation
preference which equally amortizes over the 10 years following the
redemption at an interest rate 2.25% above the rate on five-year U.S.
Treasury obligations. Accumulated dividends will be payable on the same
terms over the same period. The liquidation preference of the Convertible
Preferred Stock, as well as the amounts owed upon redemption of the
Convertible Preferred Stock, are to be reduced by any tax deficiencies or
settlements (including interest and penalties) paid or payable for all
tax periods beginning prior to December 29, 1995. The liquidation
preference of the convertible preferred stock was reduced to $10,238,000
in December 1998 for the January 1999 settlement of the Company's
1982-1989 tax court matters. See "Item 3-Legal Proceedings-IRS
Proceedings." The Convertible Preferred Stock is convertible, at the
option of the holder, into 2,950,000 shares of Class I Common Stock. The
conversion feature is exercisable from January 2001 until January 2002,
and immediately prior to certain fundamental transactions.
(10) EBITDA represents operating income plus depreciation, depletion and
amortization. EBITDA is not intended to represent cash flow from
operations as defined by generally accepted accounting principals and
should not be used as an alternative to net income or as an indicator of
operating performance or to cash flows as a measure of liquidity. EBITDA
may not be comparable to other similarly titled measures of other
companies. However, the Company's management believes EBITDA is a
meaningful measure of performance as substantially all of the Company's
financing arrangements contain covenants based on formulations of EBITDA.
(11) Includes capital additions financed through capital lease transactions
amounting to $155, $1,287, $7,221, $4,098 and $2,156 for the years ended
December 31, 1994 through 1998.
-15-
<PAGE> 18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND
RESULTS OF OPERATIONS
The statements contained in this report that are not historical facts
are "forward looking statements" (as such term is defined in the Private
Securities Litigation Reform Act of 1995), which statements can be identified by
the use of forward looking terminology such as "believes," "expects," "may,"
"will," "should," "intends" or "anticipates" or the negative thereof or other
variations thereon or comparable terminology, or by discussions of strategy that
involve risks and uncertainties. Management cautions the reader that these
forward looking statements are only predictions. No assurance can be given that
future results will be achieved; actual events or results may differ materially
as a result of risks facing the Company. Such risks include, but are not limited
to the ultimate resolution of the Cheyenne litigation and the pending Internal
Revenue Service's examination of certain tax returns of the Company, the
Company's reliance on long-term sales contracts, the Company's reliance on
long-term mineral leases, the competitive environment in which the Company
operates, the risks inherent to the mining industry, acquisitions, government
regulation, reclamation and mine closure accruals, the effects of Clean Air Act
Amendments on the coal industry, replacement and recoverability of coal
reserves, economic conditions in the coal industry generally and technological
developments. Such risks are described in more detail in "Item 1-Business-Risk
Factors". Such risks could cause actual results to vary materially from the
future results indicated, expressed or implied, in such forward looking
statements.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
operating and other data of the Company presented as a percent of revenues.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
OPERATING DATA:
Revenues 100.0% 100.0% 100.0%
Operating expenses:
Cost of sales 91.5 90.3 90.4
Selling, general and administrative 3.0 3.4 3.1
----- ----- -----
Operating income 5.6 6.3 6.5
Interest expense 5.7 4.3 5.0
Other income 1.9 3.4 1.6
----- ----- -----
Income from continuing operations before income taxes 1.8 5.4 3.1
Provision for income taxes (0.1) 1.3 0.8
----- ----- -----
Income from continuing operations 1.9 4.1 2.3
Loss on disposal of discontinued
operations, net of taxes and minority
interest 0.0 0.0 0.8
----- ----- -----
Net income before extraordinary
item 1.9 4.1 1.5
Extraordinary item, net of taxes (1.1) 0.0 0.0
----- ----- -----
Net income 0.8% 4.1% 1.5%
===== ===== =====
</TABLE>
YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997
REVENUES
Coal sales. Coal sales revenues were $154,908,000 for the year ended
December 31, 1998 compared to $161,462,000 for the year ended December 31, 1997,
a decrease of 4.1%. Although overall coal sales volume was substantially the
same for the year ended December 31, 1998 and 1997, the decreased revenue is
primarily attributable to a reduction of 112,000 tons in shipments to an
international government owned foreign utility with which the Company has a
long-term sales contract. Sales prices on this contract are higher than domestic
sales prices because they include the additional cost of transportation and
handling included with international shipments. The reduced tonnage to this
customer is the result of a concession made with the customer during annual
price renegotiations.
Coal leasing. Coal leasing revenues were $6,121,000 for the year ended
December 31, 1998 compared to $8,235,000 for the year ended December 31, 1997, a
decrease of 25.7%. Production from lessees' mining operations was 3.3 million
tons for the year ended December 31, 1998 compared to 3.0 million tons for the
year ended December 31, 1997, an increase of 11.8%. The reduction in revenue is
primarily attributable to minimum royalties which were recognized in prior
periods, and are now being credited to lessees as production is generated from
the lessee mines.
-16-
<PAGE> 19
Other. Other revenues primarily include revenues from cotton ginning,
cotton warehousing and sales of cottonseed for the year ended December 31, 1998
and cotton ginning, cotton warehousing, sales of cottonseed, and barge revenue
for the year ended December 31, 1997. Other revenues were $8,522,000 for the
year ended December 31, 1998 compared to $12,593,000 for the year ended December
31, 1997, a decrease of 32.3%. This decrease is primarily attributed to
$2,300,000 of barge lease revenues for 1997, which were not earned in 1998 due
to the sale of the Company's barge fleet in December 1997. The decrease is also
attributable to a reduction of $1,473,000 in revenue from cotton sales. Cotton
sales are offered as a service to the Company's ginning customers and vary from
year to year depending on the demand for this service from the Company's
customers.
COST OF SALES
Cost of sales-Coal sales. Cost of coal sales totaled $142,642,000 for
the year ended December 31, 1998 compared to $150,076,000 for the year ended
December 31, 1997, a decrease of 5.0%. This decrease resulted primarily from
reduced costs in the Company's production due to efficiency gains in the mining
operations and favorable mining conditions and reduced shipping costs due to a
lower volume of international shipments.
Cost of sales-Leasing. Cost of coal lease revenues totaled $3,980,000
for the year ended December 31, 1998 compared to $3,410,000 for the year ended
December 31, 1997, an increase of 16.7%. The increase primarily resulted from an
increase in the volume of coal mined by lessees and increased legal costs of
$385,000 primarily to litigate the Cheyenne lawsuit. See "Item 3-Legal
Proceedings."
Cost of Sales-Other. Cost of other revenues were $8,479,000 for the
year ended December 31, 1998 compared to $11,184,000 for the year ended December
31, 1997, a decrease of 24.2%. This decrease is primarily related to decreases
in barge costs for the company's barge fleet and cotton sales as discussed
above. See "Revenues-Other".
OTHER
Selling, general and administrative expenses totaled $5,003,000 for the
year ended December 31, 1998 compared to $6,090,000 for the year ended December
31, 1997, a decrease of 17.9%. This decrease primarily resulted from reductions
in salaries and legal fees. Selling, general and administrative expenses were
3.0% and 3.3% of revenues for the year ended December 31, 1998 and 1997,
respectively.
As a result, EBITDA ("EBITDA" as defined to mean operating income plus
depreciation, depletion and amortization; EBITDA is not intended to represent
cash flow from operations as defined by generally accepted accounting principles
and should not be used as an alternative to net income or as an indicator of
operating performance or to cash flows as a measure of liquidity) totaled
$24,487,000 for the year ended December 31, 1998 compared to $26,819,000 for the
year ended December 31, 1997, a decrease of 8.7%. This decrease is primarily
attributable to the reduced revenue in 1998 as a result of the sale of the
Company's barge fleet in December 1997. Excluding the Company's barge fleet,
EBITDA was $24,553,000 for the year ended December 31, 1997.
Interest expense totaled $9,682,000 for the year ended December 31,
1998 compared to $7,906,000 for the year ended December 31, 1997, an increase of
22.5%. This increase is primarily attributable to interest payable to the
Internal Revenue Service relating to settlement of the Company's 1982-1989 tax
court matter. See "Item 3-Legal Proceedings-IRS Proceedings."
Interest income totaled $2,213,000 for the year ended December 31, 1998
compared to $1,224,000 for the year ended December 31, 1997, an increase of
80.8%. This primarily resulted from the additional cash generated from the sale
of the Notes, which was temporarily invested and earning interest. The Company
intends to use this cash to fund a portion of the capital expenditures expected
to be incurred at the Fork Creek operations, a new development expected to begin
production by the year 2000.
Other income was $1,003,000 for the year ended December 31, 1998
compared to $4,901,000 for the year ended December 31, 1997. The decrease
primarily resulted from the sale and resulting gains of $3,574,000 on the
Company's barge fleet which impacted the 1997 results. Exclusive of the barge
sale, Other Income for both periods results primarily from gain on the sale of
certain mining equipment. During 1998 the gain of the sale of mining equipment
totaled $712,000 compared to $1,326,000 in 1997.
Income taxes were a benefit $213,000 for the year ended December 31,
1998 compared to a provision of $2,246,000 for the year ended December 31, 1997,
a decrease of $2,459,000. The decrease is a result of lower income in the year
ended December 31, 1998 than in the year ended December 31, 1997. The reduction
in the effective tax rate from 23.0% in 1997 to (7.1%) in 1998 results primarily
from the favorable impact of the amount of the tax over book depletion expense
in relation to the amount of pretax income.
After the extraordinary item related to the extinguishment of debt of
$1,866,000 (net of taxes), the Company had net income of $1,355,000 for the year
ended December 31, 1998 compared to $7,467,000 for the year ended December 31,
1997. The decrease resulted primarily from the extraordinary item in 1998 and
the gain of the sale of the Company's barge fleet in 1997.
-17-
<PAGE> 20
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Coal sales. Coal sales revenues were $161,462,000 for the year ended
December 31, 1997 compared to $154,205,000 for the year ended December 31, 1996,
an increase of 4.7%. The increase primarily resulted from increased volume of
coal shipped. Coal sales volume was 5.3 million tons for the year ended December
31, 1997 compared to 5.1 million tons for the year ended December 31, 1996, an
increase of 3.9%.
Coal leases. Coal lease revenues were $8,235,000 for the year ended
December 31, 1997 compared to $9,348,000 for the year ended December 31, 1996, a
decrease of 11.9%. The decrease primarily resulted from a reduction of 453,000
tons of coal mined by lessees, resulting in lower revenues. While the Company
does not control its lessees' decisions regarding mining coal, management's
experience is that fluctuations in its coal lease revenues is primarily
attributable to factors such as: (i) lower market prices reducing general
production from the area; (ii) permitting delays; (iii) geological
interruptions; and (iv) the changing of ownership of certain leases.
Other. Other revenues, which includes primarily revenues from cotton
ginning and warehousing and sales of cottonseed, were $12,592,000 for the year
ended December 31, 1997 compared to $18,916,000 for the year ended December 31,
1996, a decrease of 33.4%. The decrease primarily resulted from a reduction in
volume due to an excellent cotton crop in 1996 compared to a poor crop in 1997
due to weather. In addition, revenues from Pen Cotton Tennessee contributed some
revenues in 1996 and no revenues in 1997, since the operation was sold in
September 1996.
COST OF SALES
Cost of Sales-Coal sales. Cost of coal sales totaled $150,076,000 for
the year ended December 31, 1997 compared to $144,213,000 for the year ended
December 31, 1996, an increase of 4.1%. The increase primarily resulted from
increased volume of coal shipped. Costs of coal sold decreased from $28.67 per
ton in 1996 to $28.37 per ton in 1997, a decrease of $0.30 per ton, due
primarily to cost reductions from improved operating efficiencies at the Kiah
Creek operation.
Cost of Sales-Coal leases. Cost of coal lease revenues totaled
$1,940,000 for the year ended December 31, 1997 compared to $2,313,000 for the
year ended December 31, 1996, a decrease of 16.1%. The decrease primarily
resulted from the reduction in depletion expense due to lower volume of coal
mined by lessees.
Cost of Sales-Other. Cost of other revenues totaled $12,654,000 for the
year ended December 31, 1997 compared to $18,437,000 for the year ended December
31, 1996, a decrease of 31.4%. The decrease primarily resulted from the
reduction in volume of cotton ginned due to weather, as well as the sale of Pen
Cotton Tennessee in September 1996.
OTHER
Selling, general and administrative expenses totaled $6,090,000 for the
year ended December 31, 1997 compared to $5,608,000 for the year ended December
31, 1996, an increase of 8.6%. The increase primarily resulted from increased
legal expenses in connection with the case then pending in U.S. Tax Court. See
"Item 3-Business-Legal Proceedings-IRS Proceedings."
As a result of the above, EBITDA totaled $26,819,000 for the year ended
December 31, 1997 compared to $26,640,000 for the year ended December 31, 1996,
an increase of 0.7%.
Interest expense totaled $7,906,000 for the year ended December 31,
1997 compared to $9,186,000 for the year ended December 31, 1996, a decrease of
13.9%. The decrease primarily resulted from reduction of the Company's term
debt.
Other income totaled $6,125,000 for the year ended December 31, 1997
compared to $2,884,000 for the year ended December 31, 1996, an increase of
112.4%. The increase primarily resulted from the sale and resulting gains on the
Company's barge fleet and excess surface mining equipment.
Income taxes were $2,246,000 for the year ended December 31, 1997
compared to $1,463,000 for the year ended December 31, 1996, an increase of
53.5%. The increase is primarily a result of higher earnings in 1997 than 1996.
Loss from discontinued operations totaled $35,000 for the year ended
December 31, 1997 compared to losses of $1,448,000 for the year ended December
31, 1996, a decrease of 97.6%. The decreased loss primarily resulted because
only a small amount of additional loss was accrued in 1997 on operations
discontinued in 1996.
Net income was $7,467,000 for the year ended December 31, 1997 compared
to $2,685,000 for the year ended December 31, 1996, an increase of 178.1%. The
increase primarily resulted from the gain on the sale of the Company's barge
fleet and excess surface mining equipment.
-18-
<PAGE> 21
INFLATION
Inflation has not had a significant effect on the Company's business.
LIQUIDITY AND CAPITAL RESOURCES
On June 8, 1998, Pen Holdings, the Company's parent holding company,
issued the $100,000,000 aggregate principal amount of 9 7/8% senior notes due
2008 ("the Offering"). On December 4, 1998, the Company exchanged all of these
privately placed senior notes for the senior notes which are substantially
identical to the privately placed notes in all material respects. Interest on
the Notes is payable semiannually on June 15 and December 15 of each year,
commencing December 15, 1998. As a result of the Offering, the Company has
significant indebtedness and debt service requirements. At December 31, 1998,
the Company had total indebtedness of $108,003,000, including capital leases and
current maturities. The Indenture for the Notes permits the Company to incur
additional indebtedness, subject to certain limitations. The Indenture also
includes certain covenants that, among other things: (i) limit the incurrence by
the Company of additional indebtedness; (ii) restrict the ability of the Company
to pay dividends or make certain other payments; (iii) limit transactions by the
Company with affiliates; (iv) limit the ability of the Company to incur certain
liens; (v) limit the ability of the Company to consolidate or merge with or
into, or to transfer all or substantially all of its assets to, another person;
and (vi) limit the ability of the Company to engage in other lines of business.
In connection with the Offering, Pen Holdings refinanced its senior
secured indebtedness and entered into an Amended and Restated Credit Agreement,
dated June 8, 1998, among Pen Holdings, certain of its subsidiaries and the
lenders named therein (the "Credit Facility"), which provides for aggregate
borrowings of up to $40,000,000 in principal. Interest rates on the revolving
loans under the Credit Facility are based, at the Company's option, on a grid
spread to LIBOR (as defined therein) or the Prime Rate (as defined therein). The
current grid spread is 1.50% above LIBOR and 0.50% above Prime Rate. The Credit
Facility matures, subject to extensions requested by the Company at the
discretion of the lenders, five years after the closing date which occurred
simultaneously with the closing of the Offering. The Credit Facility contains
certain restrictions and limitations, including financial covenants, that
require the Company to maintain and achieve certain levels of financial
performance and limit the payment of cash dividends and similar payments.
The Company's principal liquidity requirements are for debt service
requirements under the Notes, and other outstanding indebtedness, and for
working capital needs and capital expenditures. Historically, the Company has
funded its capital and operating requirements with a combination of cash on
hand, operating cash flow and borrowings under credit facilities and capital
leases. The Company has utilized these sources of funds to make acquisitions,
fund significant capital investments in its properties, fund operations and
service debt under credit facilities.
In 1998, the Company made capital expenditures of $17,098,000
(including $2,156,000 financed through capital leases and Fork Creek capital
expenditures of $3,596,000, which includes capitalized interest of $1,417,000
and capitalized general and administrative expenses of $729,000). In the budget
for 1999, capital expenditures are approximately $66,000,000 (including Fork
Creek capital expenditures of $52,000,000 which includes $4,500,000 of
capitalized interest and $2,000,000 of capitalized general and administrative
expenses). Of the $93,000,000 of anticipated capital expenditures for 1999 and
2000 combined, approximately $29,000,000 relates to new mining equipment for the
Fork Creek mines and $42,000,000 relates to the costs for a preparation plant,
rail-loading facility, shaft and slope access to an underground coal mine, and
other costs associated with the development of the Fork Creek property. The
Company expects to fund its budgeted capital expenditures through a combination
of proceeds from the issuance of the Notes, borrowings or leases from equipment
finance companies, borrowings under the Credit Facility and cash currently on
hand or generated from operations.
The Company is continually engaged in evaluating potential
acquisitions. The Company expects that funding for future acquisitions may come
from a variety of sources, depending on the size and nature of any such
acquisitions. Potential sources of capital include cash on hand, cash generated
from operations, proceeds from the issuance of the Notes, borrowings under the
Credit Facility, additional external debt financing (including seller-financing)
or capital leases. There can be no assurance that such additional capital
sources will be available to the Company on terms which the Company finds
acceptable, or at all.
Management periodically reviews the profitability of all of the
Company's assets, including those which are not a part of its core coal
operations. The Company's cotton ginning and warehousing operation in South
Carolina has continued to contribute positive cash flow to the Company, and
management has no immediate plans to dispose of the assets that comprise the
operations. If management determines that a sale of this operation would
generate cash in excess of the net present value of estimated future cash flows
from those assets, the Company may consider selling the operation.
Net cash generated by operating activities was $16,883,000 for the year
ended December 31, 1998 compared to $17,502,000 for the year ended December 31,
1997. The $619,000 decrease in cash flow from operating activities is primarily
related to a reduction in net income related to the sale of the Company's barge
fleet in 1997.
Net cash used by investing activities was $12,940,000 for the year
ended December 31, 1998 compared to net cash provided by investing activities of
$14,900,000 for the year ended December 31, 1997. The $27,840,000 decrease is
primarily attributed to the reduced proceeds from the sale of equipment of
$22,485,000 which was primarily related to the sale of the Company's barge fleet
and certain mining equipment in 1997. Another contributing factor is the
increased capital expenditures for the year ended December 31, 1998 of
$6,071,000 primarily due to increased mine development costs for several new
mines that were opened during 1998 and capitalized costs for development of the
Fork Creek operation.
-19-
<PAGE> 22
Net cash provided from financing activities of $10,918,000 for the year
ended December 31, 1998 reflects an increase of $39,054,000 over the $28,136,000
used in financing activities for the year ended December 31, 1997. The increase
in net cash provided resulted primarily from net borrowings (after repayment of
outstanding debt) of approximately $26,800,000 under the Notes which is to be
used primarily to fund a portion of the development of the Fork Creek property.
Additionally, because of the non-amortizing nature of the Notes and higher
overall cash position for the year ended December 31, 1998, the revolving line
of credit and the long-term debt repayments were decreased by approximately
$12,015,000.
Based upon its current level of operations and anticipated growth, the
Company believes that the cash available currently, along with cash flow from
operations and available borrowings under the Credit Facility, will be
sufficient to meet its future liquidity needs. However, the Company may make
additional acquisitions and, in connection therewith, may incur additional
indebtedness. In the event that the Company incurs such additional indebtedness,
its ability to make principal and interest payments on its indebtedness,
including the Senior Notes, may be adversely affected. There can be no assurance
that the Company's business will generate adequate cash flow from operations,
that anticipated growth and operating improvements will be realized or that
future borrowings will be available under the Credit Facility or from any other
source in an amount sufficient to enable the Company to service its
indebtedness, including the Senior Notes, or to fund its other liquidity needs.
On October 2, 1998, a jury verdict was rendered in the Cheyenne
litigation in the amount of $9.5 million against the Company's Elk Horn
subsidiary. Elk Horn Coal has appealed the verdict on liability. At present, Elk
Horn Coal's litigation counsel and management believe that there are numerous
meritorious grounds for reversal and/or modification of the Cheyenne litigation
verdicts on appeal. However, because the Cheyenne litigation is on appeal, its
ultimate resolution is not determinable at this time and as a result, the
Company cannot assess whether an adverse resolution of this matter would have a
material adverse impact on the Company's cash flow and results of operations.
See "Item 3-Legal Proceedings" and "NOTE 17 -Guaranties, Commitments and
Contingencies" to the Notes to Consolidated Financial Statements contained
herein.
In 1995, the Company filed a petition in U.S. Tax Court requesting a
determination on the issues raised by the IRS in its examinations for the years
1982 through 1989. In January 1999, the Company reached a settlement of this
matter with the IRS. In addition to settling the Tax Court case, the settlement
also includes the years 1990 through 1994 on one central issue that had been
before the Tax Court. The amount of settlement, including interest, had been
previously accrued by the Company, therefore there is no additional charge to
earnings for the settlement.
The Company issued 10,000 shares of Convertible Preferred Stock in
connection with the recapitalization of the Company in 1995. The liquidation
value of the Convertible Preferred Stock of $10,286,000 (which is net of a
reduction in December 1998 for the January 1999 settlement of the Company's
1982-1989 tax court matter) plus accrued dividends of $12,925,000 will be due in
January 2006, if not reduced by additional tax related reductions. The
Convertible Preferred Stock will be redeemed at that time by the issuance of a
note payable which amortizes over the 10 years following the redemption, unless
converted to common stock in accordance with its terms.
YEAR 2000
Year 2000 Overview
The year 2000 issue relates to the way computer systems and
technologies utilize fields containing date information and recognize and
process such information beyond December 31, 1999. The year portion of such date
information has traditionally been stored as two digits only. Any of the
Company's computers, computer programs, operational or administration equipment
or products that have date sensitive software or imbedded technologies may
interpret the year portion of the date "00" as the year 1900 rather than the
year 2000. System failures or miscalculations may occur as a result, thus
causing disruptions in operations and the ability to process transactions.
State of Readiness
The Company began addressing Year 2000 issues in 1989 with its purchase
of a Year 2000 capable accounting software system. In 1997, an internal
committee of the Company was formed to review the following areas that may be
impacted adversely by Year 2000 issues: Information Systems Infrastructure;
Financial and Administrative Systems; Process Control Systems; and Vendors and
Customers.
The Company has a program in place designed to achieve Year 2000
capability in time to test the Company's systems and minimize significant
effects on the Company's business operations and financial and administrative
transactions.
Information Systems Infrastructure. With respect to its Information
Systems Infrastructure, the Company believes that, with the exception of the
network operating system which provides file and print services to the Company's
network users, all hardware, software and operating systems are Year 2000
capable. The Company anticipates upgrading or replacing this system by the end
of the second quarter of 1999.
Financial and Administrative Systems. The Company's Financial and
Administrative Systems include various financial, office automation and
engineering software, as well as building and telecommunications systems. The
Company has purchased and is in the process of customizing a new coal inventory
costing system which is expected to be Year 2000 capable. Implementation is
scheduled for
-20-
<PAGE> 23
the third quarter of 1999. A significant module of the overall accounting system
is the Purchase Management System which integrates with the accounts payable
system. The software vendor has delivered a version of the Purchase Management
System which the vendor has represented to the Company as Year 2000 compliant.
It is expected that this version will be installed during the second quarter of
1999. The Company believes that all other financial software and the office
automation and engineering software is Year 2000 capable. In February, the
Company's headquarters office upgraded its HVAC and security systems to systems
that are Year 2000 capable. A new phone system at the Company's headquarters
office was installed in January 1999. The vendor has represented the phone
system to be Year 2000 compliant.
Process Central Systems. In its review of Year 2000 issues, the Company
has identified the following Process Control Systems as being production
critical: Coal Preparation Plant Control System; Truck Scale System; Barge
Loading System; Sampling Systems; and Heavy Equipment Control Systems. The
Company has received assurances from the vendors of the Coal Preparation Plant
Control System, Truck Scale System, the Barge Loading System, and the Sampling
Systems that their products are Year 2000 compliant. The Company is in the
process of evaluating the Heavy Equipment Control Systems.
Vendors and Customers. The Company is in the process of surveying its
suppliers and customers that have been identified as critical to business
operations. Should responses to Year 2000 capability be unsatisfactory, the
Company intends to change suppliers, service providers or contractors as needed.
Company's Costs
It is estimated that the costs of the Company's Year 2000 efforts will
be approximately $200,000, of which $35,000 has been included through December
31, 1998. The company has budgeted for the remaining expenditures in its capital
budget and expects to fund them with cash generated from operations. The Company
believes that these costs would have otherwise been incurred to upgrade systems
for operational reasons in the normal course of business. These costs are
associated with the replacement of computer systems and equipment, substantially
all of which will be capitalized. These estimates do not include the costs of
implementing contingency plans or internal costs associated with the continuing
review of Year 2000 issues.
Risks of the Company's Year 2000 Issues
Although the Company expects its critical systems to be compliant by
the end of the third quarter of 1999, there is no guarantee that these results
will be achieved. Specific factors that give rise to this uncertainty include
failure to identify vulnerable systems; possible loss of technical resources;
non-compliance by third parties whose systems and operations impact the Company;
and other similar uncertainties.
With regard to non-compliance by third parties, domestic electric
utilities are the Company's principal customers as well as critical to the
Company's operations. Utilities supply power for the Company's coal production,
preparation, and loading facilities. Therefore, the Company's most significant
risk with regard to the Year 2000 issues hinges on the success of the utilities
in meeting the challenges they are facing with these issues. A major
interruption of power would not only affect the Company's ability to produce
coal, but most likely curtail its ability to sell the coal to its utility
customers. If a sustained interruption of power does occur as a result of Year
2000 issues, it would have a material adverse affect on the Company's results of
operations, liquidity, and financial condition.
Contingency Plan
The Company, in conjunction with its review of the Year 2000 readiness of its
operations and its vendors/suppliers, is conducting a risk analysis to determine
the need to develop contingency plans. These Year 2000 specific contingency
plans will be developed in conjunction with the Company's existing operating
contingency plans.
RECENT ACCOUNTING PRONOUNCEMENTS
There are no recent accounting pronouncements which have not been adopted by
the Company and which are expected to have a material effect on the Company's
financial statements.
ITEM 7A. QUANTITIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Applicable.
-21-
<PAGE> 24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PEN HOLDINGS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AUDITED CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Accountants 23
Consolidated Balance Sheet as of December 31, 1998 and 1997 24
Consolidated Statement of Income for the Years Ended December 31,
1998, 1997 and 1996 25
Consolidated Statement of Changes in Shareholders' Equity for the
Years Ended December 31, 1998, 1997 and 1996 26
Consolidated Statement of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 27
Notes to Consolidated Financial Statements 29
</TABLE>
-22-
<PAGE> 25
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors
of Pen Holdings, Inc.
In our opinion, the accompanying consolidated balance sheet and the
related consolidated statements of income, of changes in shareholders' equity
and of cash flows present fairly, in all material respects, the financial
position of Pen Holdings, Inc. and its subsidiaries at December 31, 1998 and
1997, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Nashville, Tennessee
February 26, 1999
-23-
<PAGE> 26
PEN HOLDINGS, INC.
CONSOLIDATED BALANCE SHEET
(in thousands)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
-------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 21,012 $ 6,151
Accounts receivable (net of allowance for doubtful accounts of $558 and $435 in 1998 and
1997, respectively) 17,970 17,497
Inventories 3,620 4,760
Deferred income taxes 1,435 1,160
Net assets to be disposed (Note 7) 25 4
Other assets 1,834 2,315
-------- --------
Total current assets 45,896 31,887
Investment in unconsolidated affiliated companies 4,559 5,393
Coal reserves and mine development costs, net 135,487 138,502
Property, plant and equipment, net 38,832 34,013
Long-term investments 14,445 13,323
Net assets to be disposed (Note 7) 348 566
Other assets 4,260 1,163
-------- --------
$243,827 $224,847
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 104 $ 11,177
Current maturities of capital leases 2,354 3,936
Accounts payable 7,251 7,704
Accrued liabilities 6,951 5,090
Income taxes payable 1,393 1,047
-------- --------
Total current liabilities 18,053 28,954
Long-term debt 103,267 68,440
Long-term capital leases 2,278 2,818
Deferred income taxes 56,806 59,891
Other liabilities 3,485 3,817
-------- --------
Total liabilities 183,889 163,920
-------- --------
Guaranties, commitments and contingencies (Notes 16 and 17)
Mandatorily redeemable preferred stock (Note 11) 14,115 17,097
Redeemable common stock warrants (Note 12) 2,344
Shareholders' equity:
Class I common stock, $.01 par value; 7,800,000 authorized, 4,290,000 shares issued and
outstanding 43 43
Class II common stock, $.01 par value; 200,000 shares authorized, 177,550 shares issued and
outstanding 2 2
Additional paid in capital 19 19
Retained earnings 45,759 41,422
-------- --------
Total shareholders' equity 45,823 41,486
-------- --------
$243,827 $224,847
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-24-
<PAGE> 27
PEN HOLDINGS, INC.
CONSOLIDATED STATEMENT OF INCOME
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Revenues $ 169,551 $ 182,289 $ 182,469
Operating expenses
Cost of sales 155,102 164,670 164,963
Selling, general and administrative 5,003 6,090 5,608
--------- --------- ---------
Operating income 9,446 11,529 11,898
Other (income) expense
Interest expense 9,682 7,906 9,186
Interest income (2,213) (1,224) (1,087)
Other income (1,003) (4,901) (1,797)
--------- --------- ---------
Income from continuing operations before
income taxes 2,980 9,748 5,596
Provision (benefit) for income taxes (213) 2,246 1,463
--------- --------- ---------
Income from continuing operations 3,193 7,502 4,133
Discontinued operations:
Loss from discontinued operations (less applicable income
tax credits of $393 in 1996, and minority interest of $187 (loss) in
1996) 0 0 (750)
Income (loss) on disposal of discontinued operations, including provision of
$502 for operating losses during phase-out period (less applicable income
tax credits of $105 in 1997 and $367 in 1996,
and minority interest of $27 in 1997 and $125 loss in 1996.) 28 (35) (698)
--------- --------- ---------
Income before extraordinary items 3,221 7,467 2,685
Extraordinary item - loss related to early retirement of debt (less
applicable income tax credits of $962 in 1998) (1,866) 0 0
--------- --------- ---------
Net income 1,355 7,467 2,685
Accretion of preferred stock 431 1,753 1,694
--------- --------- ---------
Net income available to common shareholders $ 924 $ 5,714 $ 991
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-25-
<PAGE> 28
PEN HOLDINGS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(dollar amounts in thousands)
<TABLE>
<CAPTION>
CLASS I CLASS II
COMMON STOCK COMMON STOCK ADDITIONAL
------------ ------------ PAID-IN RETAINED
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ ------ ------ ------- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 4,290,000 $43 $19 $34,731 $34,793
Issuance of Class II
Common Stock 200,000 $2 2
Accretion of Preferred Stock (1,694) (1,694)
Net Income 2,685 2,685
--------- --- ------- -- --- ------- -------
Balance at December 31, 1996 4,290,000 43 200,000 2 19 35,722 35,786
Purchase of Treasury Stock and
concurrent cancellation (22,450) (14) (14)
Accretion of Preferred Stock (1,753) (1,753)
Net Income 7,467 7,467
--------- --- ------- -- --- ------- -------
Balance at December 31, 1997 4,290,000 43 177,550 2 19 41,422 41,486
Adjustment for tax settlement (Note 11) 3,413 3,413
Accretion of Preferred Stock (431) (431)
Net Income 1,355 1,355
--------- --- ------- -- --- ------- -------
Balance at December 31, 1998 4,290,000 $43 177,550 $2 $19 $45,759 $45,823
========= === ======= == === ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
-26-
<PAGE> 29
PEN HOLDINGS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,355 $ 7,467 $ 2,685
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation, depletion and amortization 15,332 15,406 14,921
Equity in net (earnings) losses of affiliates (249) 167 111
Deferred income taxes (3,360) (1,027) (404)
Gain on sale of equipment (525) (6,339) (731)
Minority interest proportionate share
of earnings -- (27) (312)
Interest income on long-term investments (1,122) (1,070) (980)
Extraordinary loss on debt refinancing, net of tax 1,866 -- --
-------- -------- --------
Cash generated from operations, before
changes in assets and liabilities 13,297 14,577 15,290
Changes in assets and liabilities, net of
effects from dispositions:
Accounts receivable (473) 3,236 (482)
Inventories 1,140 4,079 6,327
Accounts payable and accrued expenses 1,861 (3,579) (3,897)
Other 1,058 (811) 1,736
-------- -------- --------
Net cash provided by operating activities 16,883 17,502 18,974
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposit of escrowed funds -- -- (499)
Capital expenditures (14,942) (3,871) (2,321)
Purchase of coal reserves (Note 14) -- (5,000) --
Proceeds from sale of barges and equipment 1,009 23,494 5,138
Distributions from affiliated companies 993 277 122
-------- -------- --------
Net cash provided (used) by investing
activities (12,940) 14,900 2,440
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock -- -- 2
Payment to minority shareholder for
common stock -- -- (12,500)
Buyout of stock warrants (3,000) -- --
Proceeds from issuance of long-term debt 99,216 221 4,300
Repayment of long-term debt (77,065) (19,360) (14,187)
Repayment of capital leases (4,278) (3,798) (5,486)
Net borrowings (payments) under line of
credit agreements and current notes
payable -- (5,185) 182
Debt issuance cost (3,955) -- --
Purchase of treasury stock -- (14) --
-------- --------- --------
Net cash provided (used) by financing activities 10,918 (28,136) (27,689)
-------- -------- --------
Net increase (decrease) in cash 14,861 4,266 (6,275)
Cash and cash equivalents at beginning
of year 6,151 1,885 8,160
-------- -------- --------
Cash and cash equivalents at end of year $21,012 $ 6,151 $ 1,885
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-27-
<PAGE> 30
PEN HOLDINGS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for:
Interest $9,315 $8,096 $10,793
Income taxes 1,675 3,414 197
</TABLE>
SUPPLEMENTAL INFORMATION ON NON-CASH TRANSACTIONS:
The Company leased certain machinery and equipment under capital leases as more
fully described in Note 10.
The Company purchased property containing coal reserves in November 1997 for
consideration of $16,000,000 comprised of $5,000,000 paid at closing and an
$11,000,000 note payable. This note was subsequently paid off from the proceeds
of the issuance of the Senior Notes in 1998.
The Company sold the assets of its lumber operations in August 1998 for
consideration of $400,000 comprised of $25,000 paid at closing and a note
receivable of $375,000.
The accompanying notes are an integral part of these financial statements.
-28-
<PAGE> 31
PEN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--DESCRIPTION OF BUSINESS:
DESCRIPTION OF THE BUSINESS
Pen Holdings, Inc. and its consolidated subsidiaries (the Company) is
primarily engaged in the mining and sale of coal, selling predominantly to
utility companies. The Company also receives royalty income from coal reserves
leased to other companies. The Company's coal reserves and mining operations are
in Kentucky and West Virginia. The Company also processes, warehouses, and sells
cotton and cottonseed.
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the
Company and its majority and wholly-owned subsidiaries. Financial statements of
the subsidiaries are not material for separate presentation. All significant
intercompany balances and transactions have been eliminated in consolidation.
The investment in an affiliated enterprise in which the Company owns
less than a controlling interest is presented under the equity basis of
accounting representing the Company's investment in affiliate, reduced by
goodwill amortization and increased (decreased) by the Company's proportionate
equity in the net income (losses) of the unconsolidated affiliate.
RECOGNITION OF REVENUE
Revenue from sale of coal and cottonseed is recognized when title
passes to the customer. Royalty income is recognized when coal is mined by
lessees. Revenue from cotton ginning and barge rental is recognized when
services are performed.
CASH AND CASH EQUIVALENTS
The Company considers all highly-liquid interest-bearing instruments
purchased with an original maturity of three months or less to be cash
equivalents.
INVENTORIES
Inventories, consisting of coal and cottonseed, are stated at the lower
of cost or market with cost being determined on the first-in, first-out method.
LONG-TERM INVESTMENTS
Long-term investments are considered as held to maturity and are
carried at amortized cost.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentration of credit risk consist principally of cash, accounts receivable,
long-term investments and other off-balance sheet financial instruments. The
Company maintains cash and cash equivalents mostly in large financial
institutions. Concentration of credit risk with respect to trade receivables is
limited due to the diversity of the Company's business and customer base.
Long-term investments principally consist of U.S. Government obligations.
The Company performs continuing credit evaluations of its customers and
does not generally require collateral. Historically, the Company has not
experienced significant losses related to individual customers in any particular
industry or geographic region.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of cash and cash equivalents, accounts receivable,
short-term notes payable, revolving credit loans and accounts payable
approximate fair value due to the short-term maturities of these assets and
liabilities. The fair value of the Senior Notes at December 31, 1998 was
$96,000,000 based on quoted market prices. The carrying value of $99,262,000 was
based on amortized cost. The carrying amount of all other long-term debt
approximates fair value. The carrying amount of mandatorily redeemable stock
approximates fair value as the dividend rate is the equivalent of a market rate
for securities of that type. The market value of long-term investments in U.S.
Government obligations was $16,649,000 and $15,550,000 at December 31, 1998 and
1997, respectively, based on market quotes with a carrying amount of $14,427,000
and $13,305,000, respectively, based on amortized costs.
-29-
<PAGE> 32
DEBT ISSUANCE COSTS
Debt issuance costs are recorded as assets and amortized over the lives
of related debt.
COAL RESERVES AND MINE DEVELOPMENT COSTS
Depletion of coal reserves and certain mine development costs are
recognized based on tons mined during the year as a percentage of total
estimated recoverable tons. Estimated recoverable reserves include only proven
and probable reserves. The Company capitalizes all development costs for
construction in new areas being developed (including employee costs for
employees directly involved in development; site preparation costs; and interest
related to the assets being employed). Once the assets are placed in service,
the Company amortizes these costs over their expected lives. Exploration costs
are expensed as incurred until discovery of proven and probable reserves. Such
expenditures approximated $160,000, $241,000 and $436,000 in 1998, 1997, and
1996, respectively. Mine development costs include $1,417,000, $97,000 and $0 of
capitalized interest cost for the years ended December 31, 1998, 1997 and 1996,
respectively.
PROPERTY, PLANT AND EQUIPMENT
Equipment and other properties are recorded at cost and depreciated
over the estimated useful lives of the respective assets using the straight-line
method. Amortization of capitalized lease assets is included in depreciation
expense and accumulated depreciation. Depreciation expense was $9,267,000 in
1998, $10,100,000 in 1997 and $10,220,000 in 1996. Estimated useful lives are as
follows:
<TABLE>
<S> <C>
Barges 25 years
Building and improvements 10-20 years
River terminals 10-20 years
Machinery and equipment 5-10 years
</TABLE>
GOODWILL AND LONG-LIVED ASSETS
Goodwill related to the Company's investment in affiliated companies is
amortized using the straight-line method over 25 years. Amortization expense of
$219,000 was recognized in each of the years 1998, 1997, and 1996. Goodwill is
included in investment in unconsolidated affiliated companies in the
consolidated balance sheet. The Company periodically reviews the recoverability
of all long-lived assets using a cash flow analysis. If impairment of value
exists, a loss is recognized. No adjustment for impairment was necessary at
December 31, 1998 or 1997.
RECLAMATION COSTS
The Company is subject to various laws and regulations which require
the restoration and reclamation of mined properties. The Company accrues the
reclamation costs for surface mine restoration as the mining operations occur.
Reclamation costs associated with site restoration for the Company's coal
preparation plant are accrued over the estimated useful life of the plant using
the units of production method. The accrued reclamation costs, amounting to
$3,864,000 and $3,278,000 at December 31, 1998 and 1997, are included primarily
in other noncurrent liabilities, net of a current portion based on management's
estimate of funds to be disbursed within the following year.
COST OF SALES AND GENERAL AND ADMINISTRATIVE EXPENSES
Cost of sales includes direct and indirect cost of production,
processing and transportation. Selling, general and administrative expenses
include selling costs and general corporate expenses of the Company.
INCOME TAXES
Provisions for federal and state income taxes are calculated on
reported financial statement pretax income based on current tax law. Deferred
income taxes are provided for the temporary differences between the financial
reporting basis and income tax basis of the Company's assets and liabilities.
The Company's temporary differences consist primarily of excess financial
accounting basis over tax basis of acquired coal reserves, depreciation,
depletion and timing of certain revenue and expense recognition.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingencies at the date of the financial statements and the
reported amounts of revenues and expenses during the period. Actual results
could differ from those estimates.
-30-
<PAGE> 33
NOTE 3--INVENTORIES:
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1998 1997
---- ----
<S> <C> <C>
Coal $3,003 $3,990
Cottonseed 617 770
------ ------
$3,620 $4,760
====== ======
</TABLE>
NOTE 4--COAL RESERVES AND MINE DEVELOPMENT COSTS:
Coal reserves and mine development costs consist of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1998 1997
---- ----
<S> <C> <C>
Coal reserves $ 147,953 $147,953
Mine development costs 12,187 10,387
--------- --------
160,140 158,340
Accumulated depletion (24,653) (19,838)
--------- --------
$ 135,487 $138,502
========= ========
</TABLE>
Depletion expense was $5,133,000, $4,554,000, and $4,014,000 in 1998,
1997, and 1996, respectively.
NOTE 5--PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1998 1997
---- ----
<S> <C> <C>
Machinery and equipment $ 52,045 $ 46,453
River terminals 11,508 11,488
Buildings 5,533 5,595
Coal preparation plant 6,563 6,351
Cotton gins and warehouses 1,368 1,349
Other 5,440 2,733
----------- ----------
82,457 73,969
Accumulated depreciation (43,625) (39,956)
----------- ----------
$ 38,832 $ 34,013
=========== ==========
</TABLE>
Machinery and equipment includes assets under capital leases with
aggregate cost of $15,305,000 and $14,856,000 at December 31, 1998 and 1997,
respectively. Accumulated amortization related to these capitalized leased
assets was $9,121,000 and $7,463,000 at December 31, 1998 and 1997,
respectively. Amortization expense was $3,215,000 in 1998, $3,379,000 in 1997
and $4,470,000 in 1996.
Buildings include an office building and related improvements that
serves as the Company's headquarters. The carrying value of the building was
$3,030,000 and $3,219,000 at December 31, 1998 and 1997, respectively.
Depreciation expense recognized on the building was $215,000, $236,000 and
$209,000 in 1998, 1997, and 1996, respectively.
NOTE 6--LONG-TERM INVESTMENTS:
Long-term investments include zero coupon U.S. Treasury bonds held in
escrow in connection with the Company's purchase of Marine Terminals, Inc. (Note
21) having maturity dates as follows (in thousands at December 31, 1998):
<TABLE>
<CAPTION>
CARRYING MARKET
VALUE VALUE
----- -----
<S> <C> <C>
2000 $ 6,646 $ 7,165
2006 7,781 9,484
-------- ----------
14,427 16,649
Other 18 18
-------- ----------
$ 14,445 $ 16,667
======== ==========
</TABLE>
-31-
<PAGE> 34
NOTE 7--NET ASSETS TO BE DISPOSED:
The Company is exiting the business segments unrelated to its core coal
operations. In line with this strategy, the following transactions occurred in
1996:
DISPOSAL OF OPERATING UNIT
In September 1996, the Company sold substantially all of the assets of
Pen Cotton Company, a wholly-owned subsidiary engaged in cotton ginning and
warehousing in west Tennessee. The selling price was $5,000,000, paid by
$4,500,000 cash at closing and the issuance of a $500,000 note receivable with a
five-year term. The Company continues to own and operate its cotton ginning
operations in South Carolina, therefore the disposition of assets in west
Tennessee is treated as a sale of assets. The gain of approximately $975,000
resulting from the sale is included in other income in 1996.
DISPOSAL OF BUSINESS SEGMENTS--DISCONTINUED OPERATIONS
In August 1996, the Company elected to dispose of its cotton
merchandising business conducted by a wholly-owned subsidiary, Pen Cotton
Company of Alabama. The Company ceased trading activities at that time and
maintained operations until its existing purchase and sales commitments expired
in September 1997. The Company recorded an initial provision for losses on
disposal of the cotton merchandising operations of $408,000 (net of income tax
credits of $213,000) in August 1996. At December 31, 1996, a liability of
$199,000 was included in net assets to be disposed to provide for future losses
on disposal of Pen Cotton Company of Alabama. In 1997, the Company recorded
income of $45,000 (net of income tax credits of $75,000) from final disposal of
this division. The Company had no continuing cotton merchandising operations and
no amounts were accrued for future losses at December 31, 1998 or 1997.
In October 1996, the Company made a decision to dispose of the hardwood
lumber operations of Pen Hardwood Company (a wholly-owned subsidiary which owns
a 78% interest in the general partnership Camden Hardwood Company). The Company
recorded an initial provision for losses on disposal of its hardwood lumber
operations of $290,000 (net of income tax credits of $150,000 and minority
interest of $125,000). At December 31, 1996, a liability of $255,000 was
included in net assets to be disposed to provide for future losses on disposal
of Pen Hardwood Company. The operations were terminated in 1997 and the Company
recorded an additional provision for losses on disposal of $80,000 (net of
income tax credits of $30,000 and minority interest of $27,000). A liability of
$142,000 was included in net assets to be disposed at December 31, 1997 to
provide for future losses on disposal of the hardwood lumber operations. The
Company had no continuing hardwood lumber operations at December 31, 1997. All
remaining inventory and fixed assets were sold in August 1998 in exchange for
$25,000 cash and a note receivable in the amount of $375,000 resulting in an
additional loss of $13,000.
Net assets to be disposed are comprised of the following included in
the balance sheet (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1998
-----------------
PEN COTTON
PEN COTTON CO. OF
COMPANY ALABAMA TOTAL
------- ------- -----
<S> <C> <C> <C>
Accounts receivable $ 112 $ 112
Other assets 37 37
Accounts payable and accrued
expenses (121) (3) (124)
----- ----- -----
Net assets of discontinued
operations--current portion 28 (3) 25
----- ----- -----
Net assets of discontinued
operations--non-current portion $ 348 $ 0 $ 348
===== ===== =====
</TABLE>
-32-
<PAGE> 35
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
PEN COTTON PEN
PEN COTTON CO. OF HARDWOOD
COMPANY ALABAMA COMPANY TOTAL
------- ------- ------- -----
<S> <C> <C> <C> <C>
Accounts receivable $ 128 $ 128
Inventories 11 $ 2 13
Other assets 35 715 750
Loans (415) (415)
Accounts payable and accrued
expenses (149) $(3) (318) (470)
Minority interest (2) (2)
----- --- ----- -----
Net assets of discontinued
operations--current portion $ 25 $(3) $ (18) $ 4
===== === ==== =====
Net assets of discontinued
operations--non-current portion $ 566 $ 566
===== =====
</TABLE>
NOTE 8--REVOLVING LINES OF CREDIT:
The Company has available revolving line of credit facilities totaling
$40,000,000, expiring May 2003, which are secured by assets of the Company other
than mobile equipment. Borrowings bear interest at a variable rate based on
either LIBOR (an effective rate of 6.56% at December 31, 1998) or the bank's
prime lending rate (an effective rate of 8.25% at December 31, 1998). The
revolving lines of credit had no outstanding balance at December 31, 1998 or
December 31, 1997. These agreements contain minimum operating and financial
ratios and covenants as defined in the agreements. The Company was in compliance
with all covenants during the year ended December 31, 1998.
-33-
<PAGE> 36
NOTE 9--LONG-TERM DEBT:
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1998 1997
---- ----
<S> <C> <C>
Senior 9-7/8% Notes (the "Senior Notes") due 2008 in the aggregate principal
amount of $100,000,000. On June 8, 1998, Pen Holdings issued the Senior Notes
which accrue interest at 9-7/8%, payable semi-annually in June and December
through the maturity date of June 15, 2008. The entire principal amount is
due at the maturity date. The Senior Notes were issued with an aggregate
original issue discount of $784,000, which is being amortized over the ten
year term of the Senior Notes. The Senior Notes are general unsecured
obligations of Pen Holdings ranking generally the same in priority of payment
with all existing and future unsubordinated indebtedness of the Company. The
Senior Notes are unconditionally guaranteed (the "Guarantees") on a senior
unsecured basis, as to the payment of principal, premium, if any, and
interest, fully and unconditionally, joint and severally, by certain of Pen
Holdings' subsidiaries (the "Guarantors"). The Guarantees will rank generally
the same in priority of payment with all existing and future unsubordinated
indebtedness of the Guarantors and senior in right of payment to all existing
and future indebtedness of the Guarantors. The Senior Notes are redeemable at
the option of Pen Holdings, in whole or in part, at any time on or after June
15, 2003 at premiums to face value identified in the Indenture by and among
Pen Holdings, the Guarantors, and The Bank of New York, as Trustee, dated
June 8, 1998 (the "Indenture"), relating to the Senior Notes. $ 99,262 --
Notes payable secured by coal reserves, land, buildings, and equipment. Monthly
payments of $708,000 plus interest was due through August 2001, at which time
any remaining balance was due. Additional annual principal payments were
required if the Company's cash flow exceeds certain amounts defined in the
loan agreement. The interest rate was variable based on LIBOR This
indebtedness was repaid with proceeds
from the issuance of the Senior Notes in June 1998. -- $ 63,271
Notes payable secured by coal reserves. Payments of interest only at the bank's
prime lending rate was due monthly through December 1999. Monthly principal
payments of $42,000 plus interest was due beginning January 2000 and were to
increase to $125,000 per month in January 2001 through December 2007. This
indebtedness was repaid with proceeds from
the issuance of the Senior Notes in June 1998. -- 11,000
Notes payable secured by a lien on an office building which serves as the
Company's headquarters, with a net book value of $3,030,000, payable in
monthly installments of $37,000 through 2016. Interest included in the
monthly installments is a fixed rate of 8.33%. 4,109 4,205
Notes payable secured by liens on land, buildings and equipment of a cotton gin
and warehouses with a net book value of $2,296,000, payable in monthly
installments of $20,000 through 2000, including interest at fixed rates of
8.20%. This indebtedness was repaid with proceeds from
the issuance of the Senior Notes in June 1998. -- 1,141
-------- ---------
Total long-term debt 103,371 79,617
Current maturities of long-term debt (104) (11,177)
-------- ---------
$103,267 $ 68,440
======== =========
</TABLE>
The Indenture for the Senior Notes contains various covenants, the most
significant of which restricts the Company's ability to incur certain forms of
additional indebtedness, pay dividends or transfer or sell assets except in the
ordinary course of business. The proceeds from the issuance of the Senior Notes
were used to repay previously existing indebtedness, redeem warrants on the
Company's common stock and provide working capital for future development of
mining properties. Certain of the Company's other loan agreements contain
minimum operating and financial ratios and covenants as defined in the separate
agreements. The Company was in compliance with all covenants during the year
ended December 31, 1998.
-34-
<PAGE> 37
Scheduled principal payments on these obligations as of December 31,
1998 are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
<S> <C>
1999 $ 104
2000 113
2001 123
2002 133
2003 145
Thereafter 103,491
--------
104,109
Less: Unamortized bond discount (738)
--------
$103,371
========
</TABLE>
NOTE 10--LEASES:
CAPITAL LEASES
Property, plant and equipment (Note 5) includes assets under capital leases
with a total cost of $15,305,000 and accumulated depreciation of $9,121,000.
Future minimum payments in the aggregate under these leases consist of the
following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
<S> <C>
1999 $ 2,587
2000 1,356
2001 767
2002 299
2003 15
-------
Total lease payments 5,024
Amount representing interest (392)
-------
Total long-term capital leases 4,632
Current maturities of long-term
capital leases (2,354)
-------
$ 2,278
=======
</TABLE>
Certain of these lease agreements contain minimum operating and
financial ratios and covenants as defined in the separate agreements. The
Company was in compliance with all covenants in 1998.
OPERATING LEASES
The Company utilizes certain vehicles and equipment under
noncancellable operating lease agreements, with minimum payments as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
<S> <C>
1999 $1,800
2000 1,665
2001 1,521
2002 987
2003 346
------
$6,319
======
</TABLE>
Total rent expense under these leases aggregated $1,326,000 in 1998,
$636,000 in 1997, and $284,000 in 1996.
The Company leases its mining rights in certain coal reserves to other
coal companies. Amounts due to the Company under these leases are based on the
greater of fixed amounts per ton or a percentage of the selling price the lessee
receives for the coal when it is sold. The leases also provide for annual
minimum payments. Revenue recognized from leasing of mining rights was
$6,321,000 in 1998, $8,235,000 in 1997, and $9,348,000 in 1996.
The Company also leases office space to various commercial tenants in
the office building that serves as the Company's headquarters under five year
noncancellable operating leases, including renewal options ranging up to ten
years. Rental income was $737,000 in 1998, $678,000 in 1997 and $598,000 in
1996.
-35-
<PAGE> 38
Future minimum lease payments to be received are as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
<S> <C>
1999 $ 3,291
2000 3,227
2001 3,446
2002 3,222
2003 2,821
Thereafter 12,755
-------
$28,762
=======
</TABLE>
NOTE 11--MANDATORILY REDEEMABLE PREFERRED STOCK:
The Company issued 10,000 shares of convertible preferred stock with a
face value of $13,650,000 in January 1996. The face value of the preferred stock
may be reduced by any amounts incurred related to settlement of tax issues
existing at the issuance date. In 1998, the Company reduced the value of the
preferred stock by $3,413,000 for such settlements (Note 16).
No dividends accrue from the date of issuance through December 2000.
Beginning in January 2001, dividends will accrue at 25.25% for a five-year
period. The original aggregate amount of $17,233,000 in dividends which was to
accrue from 2001 through 2006 was being recorded evenly from the date of
issuance in 1996 through the redemption date in 2006. In 1998, accretion of the
preferred stock was reduced by $861,000 to adjust the accumulated accrued
dividends based on the adjusted face value of the preferred stock. The remaining
aggregate amount of $9,047,000 in dividends will be recorded evenly from 1999
through the redemption date in 2006.
The preferred stock calls for mandatory redemption in 2006. The
preferred stock will be redeemed at that time by the issuance of a note payable
which amortizes over the ten years following the redemption. The preferred stock
is convertible, at the option of the holder, into 2,950,000 shares of Class I
common stock. The conversion feature is exercisable in January 2001 and expires
in January 2002. No dividends may be paid on any class of common stock prior to
the full redemption of the convertible preferred stock. The convertible
preferred stock does not contain any voting rights.
NOTE 12--SHAREHOLDERS' EQUITY:
COMMON STOCK
The Company has reserved 560,000 shares of Class I common stock for
issuance pursuant to option, warrant or other rights granted or which may be
granted to financial institutions with which the Company has a borrowing
relationship. As of December 31, 1997, no Class I common stock has been issued
with regard to these options. No other Class I common shares may be issued until
the convertible preferred stock is redeemed in full.
Each holder of Class I common stock has the option to sell to the
Company 100% of the stock held at a price of $.01 per share. This option is
exercisable beginning January 2005 and lapses upon conversion of the convertible
preferred stock to Class I common stock.
The 200,000 shares of authorized Class II common stock were issued in
1996 under the Pen Holdings, Inc. Stock Purchase Plan dated June 1, 1996 to
various officers of the Company. In 1997, 22,450 shares were repurchased for
$13,650 by the Company from one of the officers who resigned. The shares were
concurrently canceled.
STOCK WARRANTS
The Company issued warrants to purchase 326,722 shares of Class I
common stock in January 1996 to its primary lenders in connection with a
recapitalization in 1995. The exercise price of the warrants equaled the fair
value of the Class I common stock at the date of issuance. The warrants were
exercisable beginning January 2001 at $.01 per share. The warrants were to
expire January 2006. The Company repurchased these warrants for $3,000,000
(minimum redemption value identified in the warrant agreement) in connection
with the issuance of the Senior Notes on June 8, 1998. The Company recorded the
present value of its minimum obligation for repurchase of the warrants as
redeemable common stock warrants and a corresponding discount in the underlying
debt. The discount was being amortized as additional interest expense on a
straight-line basis through January 2001.
-36-
<PAGE> 39
NOTE 13--EXTRAORDINARY ITEM:
The Company recorded an extraordinary charge which represents the
after-tax impact of (i) the write-off of unamortized loan costs and (ii) the
write-off of unamortized original issue discount and repurchase of redeemable
common stock warrants on the debt that was repaid with the proceeds from the
issuance of the Senior Notes.
NOTE 14--OTHER MATTERS:
The Company sold its fleet of 98 barges on December 1, 1997,
recognizing a gain of $3,574,000, which is included in other income. Loans
secured by the barges were retired with proceeds from the sale. Revenue
recognized from rental of the barge fleet totaled $2,300,000 in 1997 and
$2,321,000 in 1996.
The Company purchased property containing coal reserves in November
1997 for consideration of $16,000,000 comprised of $5,000,000 paid at closing
and an $11,000,000 note payable.
The Company sold the assets of its lumber operations in August 1998 for
consideration of $400,000 comprised of $25,000 paid at closing and a note
receivable of $375,000. The Company recognized a loss of $156,000 on the sale.
NOTE 15--EMPLOYEE BENEFIT PLANS:
The Company maintains a contributory, defined contribution 401(k)
salary deferral plan to provide retirement and other benefits for its employees.
All employees become eligible after attaining the age of 21, completing one year
of service and working 1,000 hours during the preceding 12 months. The Company
contributes by matching a percentage of employee voluntary contributions.
Company contributions aggregated $402,000 in 1998, $431,000 in 1997, and
$397,000 in 1996.
NOTE 16--INCOME TAXES:
Income tax expense for continuing operations consists of the following
(in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Current
Federal $ 2,815 $ 3,571 $ 1,727
State 320 161 18
------- ------- -------
$ 3,135 $ 3,732 $ 1,745
------- ------- -------
Deferred
Federal $(3,348) $(1,486) $ (282)
State -- -- --
------- ------- -------
$(3,348) $(1,486) $ (282)
------- ------- -------
$ (213) $ 2,246 $ 1,463
======= ======= =======
</TABLE>
Deferred tax expense (benefits) of $1,000 and $(105,000) have been
recognized in the 1998 and 1997 discontinued operations, respectively.
The income tax (benefit) expense effective rates of (7.1%), 23.1% and
26.1% for 1998, 1997 and 1996, respectively, reconcile with the federal
statutory tax rate of 34% as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Tax at statutory rate $ 1,013 34.0% $ 3,314 34.0% $ 1,903 34.0%
State income taxes (net of
federal income tax benefit) 211 7.1 106 1.1 12 0.2
Statutory depletion in excess
of cost depletion (1,019) (34.2) (1,259) (12.9) (492) (8.8)
Adjustment of prior years' tax (441) (14.8) -- -- -- --
Goodwill amortization 75 2.5 75 0.8 75 1.3
Other (52) (1.7) 10 0.1 (35) (0.6)
------- ---- ------- ---- ------- ----
$ (213) (7.1)% $ 2,246 23.1% $ 1,463 26.1%
======= ==== ======= ==== ======= ====
</TABLE>
-37-
<PAGE> 40
The net, noncurrent deferred tax liability in the accompanying balance
sheet includes the following amounts of deferred tax assets and liabilities (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997
-------- --------
<S> <C> <C>
Deferred tax liability:
Depletion of coal reserves $ 44,128 $ 45,165
Accelerated depreciation 9,195 10,178
Mine development costs 4,195 3,877
Other 1,350 3,473
-------- --------
$ 58,868 $ 62,693
Deferred tax assets (2,062) (2,802)
-------- --------
$ 56,806 $ 59,891
======== ========
</TABLE>
Deferred taxes primarily result from differences between the financial
accounting and tax basis of acquired coal reserves and differences between the
methods used for computing depreciation and depletion and in the timing of
certain revenue and expense recognition for financial reporting and income tax
purposes. At December 31, 1998, the Company has alternative minimum tax credit
carryforwards of $2,063,000 available to offset future regular tax liabilities,
which can be carried forward indefinitely.
In 1995, the Company filed a petition in U.S. Tax Court requesting a
determination on the issues raised by the IRS in its examinations for the years
1982 through 1989. In January, 1999, the Company reached a settlement of this
matter with the IRS. In addition to settling the Tax Court case, the settlement
also includes the years 1990 through 1994 on one central issue that had been
before the Tax Court. The Company's federal income tax returns for the years
1990 through 1993 are currently under audit.
NOTE 17--GUARANTIES, COMMITMENTS AND CONTINGENCIES:
The Company is a guarantor of $7,667,000 of International Marine
Terminals' debt (IMT, a partnership in which the Company has a 1/3 interest-Note
21). The debt is current. The Company intends to make a capital infusion to IMT
to repay one-third ($21,000,000) of the partnership's debt, which includes the
$7,667,000 described above) at its scheduled maturity. The Company has escrowed
an amount sufficient to fund this infusion (Note 6).
The Coal Industry Retiree Health Benefits Act of 1992 ("CIRHBA")
requires companies currently operating in the coal mining industry to subsidize
the healthcare premiums of retired coal miners and their beneficiaries. The
Social Security Administration assigns miners and their beneficiaries to the
coal companies with which they were formerly employed or related. Until
recently, the Company believed that it fell within the scope of CIRHBA.
Therefore, the Company had established a reserve to satisfy the healthcare
premiums of those miners and their beneficiaries which have been assigned to the
Company. However, on June 25, 1998, the U.S. Supreme Court held in Eastern
Enterprises v. APFEL, Commissioner of Social Security et al., that the
assignment of miners under CIRHBA to certain coal companies violated certain
provisions of the U.S. Constitution. In November 1998, the Social Security
Administration determined that the Company is in the class of coal companies to
which the Constitutional prohibitions to CIRHBA apply and the Company was
refunded $743,000 previously paid under CIRHBA.
On September 22, 1998, a Floyd Circuit Court jury found in favor of
Cheyenne Resources, Inc. and its wholly owned subsidiary, PC&H Construction,
Inc. (collectively "Cheyenne") in a suit brought against Elk Horn Coal (a wholly
owned subsidiary of the Company), on a breach of contract and fraud case
relating to a coal lease that was entered into prior to the Company purchasing
Elk Horn Coal. Elk Horn Coal has already appealed the verdict on liability. On
September 24, 1998, Cheyenne first elected its remedies and specified that as
relief it sought over $18 million in compensatory damages and punitive damages.
On October 1, 1998, the jury awarded damages in favor of Cheyenne of $4.5
million attributable to the fraud claim and $5.0 million attributable to the
breach of contract claim. No punitive damages were awarded. Elk Horn Coal's
litigation counsel and management believe that there are numerous meritorious
grounds for reversal and/or modification of these verdicts on appeal on the
issue of liability as well as the issue of damages. However the Company cannot
determine whether the resolution of this matter will have a material adverse
impact on the Company's financial position or results of operations.
There are other legal proceedings pending against the Company arising
from the normal course of business. Management of the Company and its legal
counsel handling such matters do not expect any of these matters to have a
material effect on the Company's financial position or results of operations.
NOTE 18--OTHER RELATED PARTY TRANSACTIONS:
Related party transactions not otherwise disclosed in the financial
statements include fees paid to International Marine Terminals (Note 21) for
coal loading of $1,758,000 in 1998, $1,988,000 in 1997, and $1,864,000 in 1996.
At December 31, 1998 and 1997, $19,000 and $134,000, respectively, was included
in accounts payable and accrued expenses relating to coal loading fees described
above.
-38-
<PAGE> 41
NOTE 19--LONG-TERM COAL SUPPLY CONTRACTS:
The Company is committed under several long-term coal supply
contracts. The contracts require the Company to supply specified tonnages and
quality of coal during the term of the agreements which extend three to nine
years. The contracts stipulate the base prices at inception, which are subject
to periodic escalation based on specified indices. One of the contracts is
subject to adjustment to an agreed-upon market price annually.
The Company has the capacity to fulfill all contract requirements with
existing proven coal reserves. Approximately 80% of revenues in 1998, 73% in
1997, and 66% in 1996 were derived from seven customers supplied under
long-term contracts. The Company had sales to significant customers as follows
(in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
PERCENTAGE PERCENTAGE PERCENTAGE
DOLLAR OF TOTAL DOLLAR OF TOTAL DOLLAR OF TOTAL
AMOUNT REVENUES AMOUNT REVENUES AMOUNT REVENUES
-------- ---------- --------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Customer A $ 34,991 21% $ 40,131 22% $ 35,041 19%
Customer B 35,120 21 38,740 21 32,579 18
Customer C 26,082 15 27,209 15 27,366 15
-------- -- --------- -- -------- --
$ 96,193 57% $ 106,080 58% $ 94,986 52
======== == ========= == ======== ==
</TABLE>
In 1998, 4,178,000 tons were shipped on long-term coal supply
contracts. Future minimum tonnage commitments under long-term coal supply
contracts are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR SHORT TONS
---- ----------
<S> <C>
1999 4,386
2000 3,273
2001 2,228
2002 711
</TABLE>
-39-
<PAGE> 42
NOTE 20--BUSINESS SEGMENT INFORMATION:
The Company's operations, exclusive of discontinued operations, have
been classified into two business segments: coal and cotton. The coal segment
involves the mining, sale, transportation and leasing of coal. The cotton
segment involves the ginning and warehousing of cotton. There were no
intersegment sales or transfers during the three years ended December 31, 1998.
Operating income by business segment excludes interest income, interest expense
and other nonoperating income. Summarized financial information by business
segment is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
REVENUES
Coal $ 161,106 $ 171,996 $ 165,873
Cotton 8,445 10,293 16,596
----------- ----------- ----------
$ 169,551 $ 182,289 $ 182,469
=========== =========== ==========
OPERATING INCOME
Coal $ 9,581 $ 11,482 $ 11,112
Cotton (135) 47 786
----------- ----------- ----------
$ 9,446 $ 11,529 $ 11,898
=========== =========== ==========
TOTAL ASSETS (AT PERIOD END):
Coal $ 240,140 $ 219,162
Cotton 3,687 5,685
----------- -----------
$ 243,827 $ 224,847
=========== ===========
DEPRECIATION, DEPLETION,
AND AMORTIZATION
Coal $ 14,936 $ 14,948 $ 14,302
Cotton 396 342 440
----------- ----------- ----------
$ 15,332 $ 15,290 $ 14,742
=========== =========== ==========
CAPITAL EXPENDITURES
Coal $ 14,847 $ 3,632 $ 2,235
Cotton 95 239 86
----------- ----------- ----------
$ 14,942 $ 3,871 $ 2,321
=========== =========== ==========
</TABLE>
The Company sells coal to both domestic and foreign customers. Export
sales by country are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
PERCENTAGE PERCENTAGE PERCENTAGE
DOLLAR OF TOTAL DOLLAR OF TOTAL DOLLAR OF TOTAL
AMOUNT REVENUES AMOUNT REVENUES AMOUNT REVENUES
--------- ---------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Taiwan $ 34,991 21% $ 40,131 22% $ 35,041 19%
Other 0 0 2,667 1% 7,547 4%
--------- --- --------- -- ---------- ---
Total export sales $ 34,991 21% $ 42,798 23% $ 42,588 23%
========= === ========= == ========== ===
</TABLE>
-40-
<PAGE> 43
NOTE 21--INVESTMENT IN AFFILIATED COMPANY:
The Company's investment in an affiliated company is a one-third
general partnership interest in International Marine Terminals (IMT), an ocean
marine loading facility located in Louisiana Note 17). Components of the
investment in affiliated company and equity in net earnings (losses) of
affiliated company are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
INVESTMENT IN AFFILIATED COMPANY:
Equity in partnership interest at
time of purchase $ 5,977 $ 5,977 $ 5,977
Earnings since acquisition 476 98 265
Net distributions since acquisition (4,507) (3,514) (3,238)
--------- ------ ------
1,946 2,561 3,004
Goodwill, less accumulated amortization
of $2,862, $2,648 and $2,429 at December 31,
1998, 1997, and 1996, respectively 2,613 2,832 3,051
--------- --------- --------
$ 4,559 $ 5,393 $ 6,055
========= ========= =======
EQUITY IN NET EARNINGS (LOSSES) OF
AFFILIATED COMPANY:
Company's share of affiliate
earnings (losses) $ 378 $ (167) $ (111)
Amortization of goodwill (219) (219) (219)
--------- --------- --------
$ 159 $ (386) $ (330)
========= ========= ========
</TABLE>
The above net earnings (losses) are reported as a component of other
income in the statement of income. All earnings (losses) of IMT are shared by
each partner on a pro rata basis, with the exception of interest expense, which
is allocated to the partners based on their individual credit ratings.
Condensed financial information for the affiliated company, IMT, is as follows
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
BALANCE SHEET
Current assets $ 3,165 $ 2,908 $ 2,981
Noncurrent assets 68,622 70,472 72,300
--------- --------- ----------
Total assets $ 71,787 $ 73,380 $ 75,281
========= ========= ==========
Current liabilities 2,927 2,646 3,223
Noncurrent liabilities 63,000 63,045 63,046
--------- --------- ----------
Total liabilities 65,927 65,691 66,269
Equity 5,860 7,689 9,012
--------- --------- ----------
Total liabilities and equity $ 71,787 $ 73,380 $ 75,281
========= ========= ==========
STATEMENT OF INCOME
Revenues $ 19,133 $ 21,968 $ 21,307
========= ========= ==========
Operating income $ 2,707 $ 2,406 $ 3,409
========= ========= ==========
Earnings (loss) $ 1,235 $ (444) $ (258)
========= ========= ==========
</TABLE>
-41-
<PAGE> 44
NOTE 22--QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial data for 1998 and 1997 is summarized below:
<TABLE>
<CAPTION>
MARCH 31 JUNE 30 SEPT 30 DEC 31
-------- ------- ------- ------
<S> <C> <C> <C> <C>
1998:
Net Sales 40,548 38,293 42,482 48,228
Operating Income 2,015 2,480 3,098 1,853
Net Income before extraordinary items 948 531 1,489 253
Net Income (loss) 948 (1,335) 1,489 253
1997:
Net Sales 44,646 43,976 44,404 49,263
Operating Income 1,304 4,187 2,933 3,105
Net Income before extraordinary items 462 2,358 1,042 3,605
Net Income 462 2,358 1,042 3,605
</TABLE>
-42-
<PAGE> 45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
The following information is furnished with respect to the directors
and executive officers of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH PEN HOLDINGS
---- --- --------------------------
<S> <C> <C>
William E. Beckner 47 Chairman of the Board of Directors, President and Chief Executive Officer
Stephen G. Capelli 48 Senior Vice President of Operations; Director
Joseph A. Davis, Jr. 51 Senior Vice President of Sales and Marketing; Director
Mark A. Oldham 41 Senior Vice President, Secretary and Treasurer/Chief Financial Officer
</TABLE>
William E. Beckner has been the President and Chief Executive Officer
of the Company since 1993, and Chairman of the Board of Directors since 1996.
Mr. Beckner also served as Executive Vice President and Chief Operating Officer
of Pen Holdings from 1986 to 1993 and as Vice President of Finance from 1982 to
1986. Mr. Beckner, who has 18 years of experience in the coal industry and has
been with the Company for 15 years, holds a controlling interest in Pen
Holdings. Mr. Beckner received an M.B.A. degree from the University of Tennessee
(Nashville) in 1979 and received a B.S. degree in Business from the University
of Evansville in 1973.
Stephen G. Capelli has been the Senior Vice President of the Company's
coal operations and a director of Pen Holdings since 1996, having previously
served as Vice President of Operations since 1994. Mr. Capelli has 26 years of
experience in the coal industry. Prior to joining the Company, Mr. Capelli was
Vice President of Mining and Development of Amvest Minerals, Inc., a coal
company, from 1991 to 1994. Mr. Capelli serves on the Board of Directors of the
West Virginia Mining and Reclamation Association. Mr. Capelli received a B.S.
degree in Mining Engineering from Virginia Tech University in 1973.
Joseph A. Davis, Jr., has been Senior Vice President of Sales and
Marketing of the Company's coal operations and a director of Pen Holdings since
1996. Prior to that time, Mr. Davis was Vice President of Sales and Marketing
from 1987. Mr. Davis has 22 years of experience in the coal industry. Before
joining the Company, he was Vice President of Sales for Benford-Nightengale
Coal Company from 1977 to 1984, and was Sales Manager of Kentucky Pioneer Coal
Company from 1975 to 1977. Mr. Davis received a B.A. degree from Western
Kentucky University in 1976.
Mark A. Oldham has been Senior Vice President, Secretary and
Treasurer/Chief Financial Officer of the Company since 1996. Prior to that time,
Mr. Oldham served as Vice President from 1993 to 1996 and Controller from 1985
to 1993. Mr. Oldham has 14 years experience in the coal industry. Mr. Oldham is
a Certified Public Accountant (CPA) and has been a member of the American
Institute of Certified Public Accountants and the Tennessee Society of CPA's
since 1982. From 1979 to 1984, Mr. Oldham was employed in public accounting. Mr.
Oldham received a B.S. degree in Business Administration from Tennessee
Technological University in 1979.
BOARD COMPENSATION
All current directors are employees of the Company. No additional
remuneration beyond their compensation as employees is currently given to
directors for their services.
-43-
<PAGE> 46
ITEM 11. EXECUTIVE COMPENSATION
The following table presents certain summary information concerning
compensation paid or accrued by the Company for services rendered in all
capacities for the year ended December 31, 1998, for (i) chief executive
officer of the Company, and (ii) each of the three other most highly
compensated executive officers of the Company who received in excess of
$100,000, determined as of December 31, 1998 (collectively, the "Named
Executive Officers").
Summary Compensation Table
<TABLE>
<CAPTION>
Compensation Annual Annual Other All Other
Name and Principal Position Year Salary Bonus Compensation Compensation (1)
<S> <C> <C> <C> <C> <C>
William E. Beckner 1998 $ 403,325 $ 293,000 -- $ 4,800
President and Chief Executive Officer
Stephen G. Capelli 1998 157,000 67,150 $ 13,618 (2) 4,800
Senior vice President of Operations
Joseph A. Davis, Jr. 1998 147,000 56,785 13,618 4,800
Senior Vice President of
Sales/Marketing
Mark A. Oldham 1998 131,000 46,200 13,618 4,800
</TABLE>
(1) Represents annual contribution made by the Company under its 401(k)
plan.
(2) Represents incremental increases in the value of the officer's account
under the Pen Holdings, Inc. Stock Purchase Plan (the "Stock Purchase
Plan"). The Stock Purchase Plan provides generally that stock issued
to the officer will be repurchased by the Company upon the termination
of the officer's employment with the Company. The repurchase price
for this stock is equal to $0.01 plus the aggregate net income per
common share, determined over the period beginning with the close of
the 1995 fiscal year and ending with the close of the Company's last
fiscal year ending prior to the officer's date of termination. The
amount included does not include amounts credited to the account of
the officer prior to 1998.
-44-
<PAGE> 47
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of December 31, 1998, certain
information concerning ownership of the Class I and Class II Common Stock of
the Company by each director, each named executive officer, each person who is
known to the Company to be the beneficial owner of more than 5% of the Class I
and Class II Common Stock and all directors and executive officers of the
Company as a group. Each stockholder listed below has sole voting and
dispositive power with respect to the shares listed next to such stockholder's
name except as noted below. Except as noted, the address of each stockholder
listed below is: c/o Pen Holdings, Inc., Center Court Building, 3rd Floor,
Brentwood, Tennessee 37027.
<TABLE>
<CAPTION>
Class I Common Stock (1) Class II Common Stock (1)
------------------------------ ------------------------------ Percentage
Number of Percentage Number of Percentage Class I and
Shares of Class Shares of Class Class II
Name and Address Beneficially Beneficially Beneficially Beneficially Beneficially
of Beneficial Owner Owned Owned Owned(2) Owned Owned
------------------- ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
William E. Beckner 4,040,000 94.2% 90.4%
Stephen G. Capelli 44,900 25.3% 1.0%
Joseph A. Davis, Jr 44,900 25.3% 1.0%
Mark A. Oldham 44,900 25.3% 1.0%
Grace Pen 250,000 (3) 5.8% 5.6%
c/o Bass, Berry & Sims
2700 First American Center
Nashville, Tennessee 37238
Directors and Executive Officers
as a group (4 persons) 4,040,000 94.2% 134,700 75.9% 93.4%
</TABLE>
- -----------------
(1) The Company's Class I and Class II Common Stock currently have the
same rights. Prior to the Company's recapitalization in 1995, the
class of stock had different rights, however, the difference in rights
no longer exists.
(2) All shares are subject to repurchase upon termination of employment
with the Company under the Stock Purchase Plan.
(3) Includes 187,500 shares held by a trust of which Ms. Pen is one of the
trustees.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
LOANS AND GUARANTEES
The Company is a guarantor of $7,667,000 of International Marine
Terminals' debt (IMT, a partnership in which the Company has a 1/3 interest).
The debt is current. The Company intends to make a capital infusion to IMT to
repay one-third ($21,000,000) of the partnership's debt, which includes the
$7,667,000 described above) at its scheduled maturity. The Company has escrowed
an amount sufficient to fund this infusion.
The Company is also a guarantor of a bank loan in the amount of
$167,000 to Forests, Inc., the Company's partner in Camden Hardwood Company,
for the partner's capital contribution.
ARRANGEMENTS INVOLVING AFFILIATES
The Company uses the IMT facility to load coal for export. Fees paid
to IMT for coal loading in 1998 were approximately $1,758,000. These fees are
comparable to the fees paid by third parties resulting from arms length
transactions.
-45-
<PAGE> 48
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report:
PEN HOLDINGS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
(1) AUDITED CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Accountants 23
Consolidated Balance Sheet as of December 31, 1998 and 1997 24
Consolidated Statement of Income for the Years Ended December 31,
1998, 1997 and 1996 25
Consolidated Statement of Changes in Shareholders' Equity for the
Years Ended December 31, 1998, 1997 and 1996 26
Consolidated Statement of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 27
Notes to Consolidated Financial Statements 29
</TABLE>
(2) The schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and, therefore, have been omitted.
E-1
<PAGE> 49
(3) Exhibits filed as part of this Report are as follows:
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
3.1* Form of Restated Charter of Pen Holdings, as amended (Exhibit 3.1)
3.2* Form of Amended and Restated Bylaws of Pen Holdings, as amended (Exhibit 3.2)
4.1* Indenture, dated as of June 8, 1998, by and among Pen Holdings,
the Guarantors and The Bank of New York
4.2* Form of 9 7/8% Senior Note due 2008
4.3* Registration Rights Agreement, dated as of June 8, 1998, by and
among Pen Holdings, the Guarantors and CIBC Oppenheimer Corp.
10.1* Amended and Restated Credit Agreement, dated as of June 3, 1998,
by and among Pen Holdings, Mellon Bank, N.A., CIBC, Inc. and
other banks later made a party to such Agreement
10.2* Coal Supply Agreement, dated as of June 15, 1989 by and between
Taiwan Power Company and Pen Coal Corporation, as amended
10.3* Coal Supply Agreement between Pen Coal Corporation and Dayton Power and
Light Company, dated effective July 1, 1992, as amended
10.4* Pen Holdings, Inc. Stock Purchase Plan
10.5* Pen Holdings, Inc. Executive Bonus Plan
10.6** Amendment 7 dated December 21, 1998 of the Coal Supply Agreement,
dated as of June 15, 1989 by and between Taiwan Company and Pen
Coal Corporation
21* Subsidiaries of the Registrant
27.1** Financial Data Schedule (for SEC use only)
</TABLE>
- ------------------
* Incorporated by reference from the Company's Registration Statement on
Form S-4 as amended (Registration No. 333-60599) originally filed with
the Security and Exchange Commission on August 4, 1998.
** Included with this Report.
(b) Reports on Form 8-K.
Not Applicable.
E-2
<PAGE> 50
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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.
Pen Holdings, Inc.
By: /s/ William E. Beckner
-------------------------------------------
Name: William E. Beckner
Title: President & Chief Executive Officer
Dated: March 23, 1999
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities indicated on March 23, 1999.
PEN HOLDINGS, INC.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
- ---------- ----- -----
<S> <C> <C>
/s/ William E. Beckner Chairman of the Board, President, Chief March 23, 1999
- ---------------------------------------- Executive Officer (Principal Executive
WILLIAM E. BECKNER Officer) and Director
/s/ Mark A. Oldham Senior Vice President, Secretary/Treasurer March 23, 1999
- ---------------------------------------- and Chief Financial Officer (Principal
MARK A. OLDHAM Financial Officer)
/s/ Stephen G. Capelli Director March 23, 1999
- ----------------------------------------
STEPHEN G. CAPELLI
/s/ Joseph A. Davis, Jr. Assistant Secretary and Director March 23, 1999
- ----------------------------------------
JOSEPH A. DAVIS, JR.
</TABLE>
S-1
<PAGE> 51
GLOSSARY OF
CERTAIN TERMS
ASH. Non-combustible solid matter consisting of silicia, iron, alumina
and other material similar to ordinary sand, silt, rock or clay.
BTU (BRITISH THERMAL UNIT). A measure of heat required to raise the
temperature of one pound of water one degree Fahrenheit under
controlled conditions. The gross heating value of coal is commonly
reported as "Btu per pound."
CAPTIVE PRODUCTION. Coal produced or contracted to be produced from
Company controlled reserves.
CENTRAL APPALACHIA. A region consisting of southern West Virginia,
eastern Kentucky and Virginia which contains substantial bituminous
coal deposits. The reserves in this region generally contain coal that
is low in sulfur (typically 0.7%=1.5%) and high in Btu content
(typically 12,000-13,500 Btu). A large portion of the coal reserves in
this region exceed the requirements of Phase I of the Clean Air Act
Amendments and meet the requirements of Phase II of the Clean Air Act
Amendments.
COAL DEPOSIT. A coal bearing body which has been appropriately sampled
and assayed in trenches, outcrops, drilling, and underground workings
to support sufficient tonnage and grade to warrant further
exploration-development work. A coal deposit does not qualify as a
commercially viable coal reserve as prescribed by Commission standards
until a final comprehensive evaluation based upon unit cost per ton,
recoverability and other material factors conclude legal and economic
feasibility.
COAL SEAM. A layer of coal deposit below the earth's surface. Each
seam is identified by a name or number based on its geographical
location.
COMPLIANCE COAL. Coal which, when burned, emits less than 1.2 pounds
of sulfur dioxide per million Btu (0.72% for 12,000 Btu). This coal
exceeds the sulfur dioxide emission requirements for air quality of
Phase I of the Clean Air Act Amendments and meets the proposed sulfur
dioxide emission requirements for air quality of Phase II of such
legislation without the need for flue gas desulfurization.
CONTINUOUS MINING. An underground mining method that utilizes a
continuous mining machine which cuts or rips coal from the face and
loads it into shuttle cars or conveyors in one operation. A continuous
mining machine typically has a turning "drum" with sharp bits that cut
and dig out the coal for 20 to 40 feet before mining stops so that the
mined area can be supported with roof bolts.
CONTRACT MINING. The contractual engagement of a third-party mining
company by the mineral rights holder to mine coal. Contract mining
companies are typically paid on a set price per ton of coal mined.
Under most contract mining arrangements the mineral rights holder is
responsible for the permitting of the mine site. The contract miner is
generally responsible for providing all equipment, financing for its
operation, internal mine capital needs, employee benefits and all
other requirements associated with an independent business.
CONVENTIONAL MINING. An underground mining method that utilizes a
cutting machine to cut beneath a coal seam. Such undercuts allow
explosive charges to be set in the coal seam to separate the coal from
surrounding materials. Once separated, the coal is loaded into shuttle
cars and removed from the mine.
EXTRACTION. The process of removing coal from a seam for commercial
use.
HEAVY MEDIA. High density material such as magnetite used in the
gravity separation process to clean coal.
LOW-SULFUR COAL. Coal which, when burned, emits less than 1.6 pounds
of sulfur dioxide per million Btu (0.96% for 12,000 Btu). This coal
exceeds the sulfur dioxide emission requirements for air quality of
Phase I of the Clean Air Act Amendments without the need for flue gas
desulfurization.
MEDIUM-SULFUR COAL. Coal which contains more than 1 percent but less
than 3 percent sulfur by weight; 0.61 to 1.67 pounds of sulfur per
million Btu.
METALLURGICAL COAL. The various grades of coal suitable for
carbonization to make coke for the manufacture of steel. Also know as
"met" coal, it possesses four important qualities: volatility, which
affects coke yield; the level of impurities, which affects coke
quality; composition, which affects coke strength; and basic
characteristics, which affect coke oven safety.
OVERBURDEN. Layers of earth and rock covering a coal seam. In surface
mining operations, overburden is removed prior to coal extraction.
POINT REMOVAL MINING. A mining method used in contour mining when the
overburden ratio makes it economically feasible to mine using the
mountaintop removal method.
G-1
<PAGE> 52
PREPARATION PLANT. A facility that crushes, sizes and washes coal to
prepare it for commercial use. The washing process separates ash from
the coal and may have the added benefit of removing a portion of the
coal's sulfur content. Most of the coal washed in a preparation plant
is extracted from underground mines.
RESERVE. That part of a mineral deposit which could be economically
and legally extracted or produced at the time of the reserve
determination.
PROBABLE (INDICATED) RESERVES. Reserves for which quantity and grade
and/or quality are computed from information similar to that used for
proven (measured) reserves, but the sites for inspection, sampling,
and measurement are farther apart or are otherwise less adequately
spaced. The degree of assurance, although lower than that for proven
(measured) reserves, is high enough to assume continuity between
points of observation.
PROVEN (MEASURED) RESERVES. Reserves for which (a) quantity is
computed from dimensions revealed in outcrops, trenches, workings or
drill holes; grade and/or quality are computed from the results of
detailed sampling and (b) the sites for inspection, sampling and
measurement are spaced so closely and the geologic character is so
well defined that size, shape, depth and mineral content of reserves
are well-established.
RECLAMATION. The restoration of land and environment at a mining site
after the coal is extracted. Reclamation operations are usually
underway in locations where the coal has already been extracted from a
mine, even as mining operations are continuing elsewhere at the site.
The process commonly includes "recontouring" or reshaping the land to
its approximate original appearance, restoring topsoil and planting
native grass and ground covers. Reclamation is closely regulated by
both state and federal law.
RECOVERY RATES. The amount of clean coal produced by weight from the
amount of raw coal processed expressed as a percentage of the coal
available for extraction.
ROOM AND PILLAR MINING. A mining method used in underground mining
which uses either continuous or conventional mining that cuts out a
block of coal in 18- to 20-foot wide passages as high as the coal
seam. Roof bolters, by installing conventional or resin grouted rods,
stabilize the mine roof prior to mine advancement. Pillars (typically
50 feet by 50 feet) are left to provide additional primary roof
support.
SPOT MARKET. Sales of coal pursuant to an agreement or purchase order
for shipments for a period of less than one year. Spot market sales
are generally obtained via a competitive bidding process.
SPREAD. The amount and type of equipment necessary to extract the coal
from a localized reserve area in a surface mine.
SURFACE MINE. A mine in which the coal lies near the surface and can
be extracted by removing the covering layer of soil. See "Overburden."
TON. A "short" or net ton is equal to 2,000 pounds. A "long" or
British ton is 2,240 pounds. A "metric" ton is approximately 2,205
pounds. The short ton is the unit of measure referred to in this
document.
UNDERGROUND MINE. A mine which is typically located several hundred
feet below the earth's surface.
G-2
<PAGE> 53
A small scale map of the Company's coal operations appears in this
space. The map depicts portions of Kentucky and West Virginia. It shows the
Company's operation as shaded portion and also includes major rivers, cities,
roadways, and the demarcation of the county and state borders. The map is dated
March 12, 1999 and reflects a scale whereby one inch equals 10 miles.
M-1
<PAGE> 1
EXHIBIT 10.6
ADDENDUM NO. 7 OF CONTRACT NO. 78-AM-L1102
DATE: DECEMBER 21, 1998
WHEREAS, the Seller and the Buyer (the "Parties") have been unable to
agree on the current market price for purposes of determining the Base Price for
the Year 1998, as contemplated by Sections 5.1 and 5.4 of the Contract, and
WHEREAS, in lieu of referring the price issue to arbitration in
accordance with Section 5.1 of the Contract, the Parties have agreed to adopt
the 1997 Base Price as the 1998 Base Price without regard to the current market
price and to reduce by 180,000 Metric Tons the minimum quantity that the Buyer
is required to purchase at that price,
NOW, THEREFORE, the Parties agree as follows:
1. The Base Price for the year 1998 shall be USD38.05 per Metric
Ton FOBT, and the minimum quantity for the Year 1998 shall be
810,000 Metric Tons, instead of the 990,000 Metric Tons
otherwise provided in Sections 3.1 and 3.2.
2. Any delivery tonnage over 810,000 Metric Tons scheduled to be
lifted before the end of 1998 is deemed as pre-lifted quantity
of 1999 and will be lifted at the 1999 provisional Base Price
subject to retroactive adjustment.
3. All other terms and conditions of the Contract and Addenda
Nos. 1 through 6 remain unaltered.
IN WITNESS WHEREOF, the Parties have executed this ADDENDUM on the date
indicated by their duly authorized representatives.
SELLER: BUYER:
PEN COAL CORPORATION TAIWAN POWER COMPANY
By: /s/ William E. Beckner By: /s/ Gan-Charng Lee
------------------------------- -----------------------------
Name: William E. Beckner Name: Gan-Charng Lee
Title: President Title: Vice President
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 21,012,000
<SECURITIES> 0
<RECEIVABLES> 18,528,000
<ALLOWANCES> 558,000
<INVENTORY> 3,620,000
<CURRENT-ASSETS> 45,896,000
<PP&E> 242,597,000
<DEPRECIATION> 68,278,000
<TOTAL-ASSETS> 243,827,000
<CURRENT-LIABILITIES> 18,053,000
<BONDS> 99,262,000
0
14,115,000
<COMMON> 45,000
<OTHER-SE> 45,778,000
<TOTAL-LIABILITY-AND-EQUITY> 243,827,000
<SALES> 169,551,000
<TOTAL-REVENUES> 169,551,000
<CGS> 155,102,000
<TOTAL-COSTS> 155,102,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9,682,000
<INCOME-PRETAX> 2,980,000
<INCOME-TAX> (213,000)
<INCOME-CONTINUING> 3,193,000
<DISCONTINUED> (28,000)
<EXTRAORDINARY> (1,866,000)
<CHANGES> 0
<NET-INCOME> 1,355,000
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
