Alpha Natural Resources 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended September 30, 2008
For the transition period from to
Commission File No. 1-32423
ALPHA NATURAL RESOURCES, INC.
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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. þ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
þ Large accelerated filer o Accelerated filer ¨ Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
¨ Yes þ No
Number of shares of the registrant’s Common Stock, $0.01 par value, outstanding as of October 31, 2008 – 70,495,814
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2008
(In thousands, except percentages and share data)
(1) Business and Basis of Presentation
Organization and Business
Alpha Natural Resources, Inc. and its consolidated subsidiaries (the “Company”) are primarily engaged in the business of extracting, processing and marketing coal from deep and surface mines, located in the Central and Northern Appalachian regions of the United States, for sale to utility and steel companies in the United States and in international markets.
Basis of Presentation
The accompanying interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting. Accounting measurements at interim dates inherently rely on estimates more than at year-end; however, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Significant items subject to such estimates and assumptions include inventories; mineral reserves; allowance for non-recoupable advanced mining royalties; asset retirement obligations; employee benefit liabilities; future cash flows associated with assets; useful lives for depreciation, depletion, and amortization; workers’ compensation and black lung claims; postretirement benefits other than pensions; income taxes; revenue recognized using the percentage of completion method; and fair value of financial instruments. Due to the subjective nature of these estimates, actual results could differ from those estimates. Results of operations for the nine months ended September 30, 2008 are not necessarily indicative of the results to be expected for the year ending December 31, 2008. These financial statements should be read in conjunction with the audited financial statements and related notes as of and for the year ended December 31, 2007 included in the Company's Annual Report on Form 10-K, and Quarterly Report on Form 10-Q for the quarters ended March 31, 2008 and June 30, 2008, filed with the Securities and Exchange Commission.
Prior period coal revenues and cost of coal sales have been adjusted to exclude changes in the fair value of coal and diesel fuel derivative contracts to conform to the current year presentation. In addition, prior period trade accounts payable and accrued expenses and other current liabilities have been reclassified to reflect the current year presentation. These reclassification adjustments had no effect on previously reported income from operations, net income, current liabilities, or total liabilities.
On September 26, 2008, the Company sold its interests in Gallatin Materials, LLC (“Gallatin”), a lime manufacturing business, to an unrelated third party. The results of operations for the current and prior periods have been reported as discontinued operations (See Footnote 16).
(2) New Accounting Pronouncements
In May 2008, the Financial Accounting Standards Boards ("FASB") affirmed the consensus of FASB Staff Position ("FSP") Accounting Principle Board (“APB”) 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (“FSP APB 14-1”), which applies to all convertible debt instruments that have a ‘‘net settlement feature,” which means that such convertible debt instruments, by their terms, may be settled either wholly or partially in cash upon conversion. FSP APB 14-1 requires issuers of convertible debt instruments that may be settled wholly or partially in cash upon conversion to separately account for the liability and equity components in a manner reflective of the issuers’ nonconvertible debt borrowing rate. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. Early adoption is not permitted and retroactive application to all periods presented is required. The Company is currently assessing the impact of adopting FSP APB 14-1 on its consolidated financial statements.
In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets, (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The guidance contained in this FSP for determining the useful life of a recognized intangible asset is applied prospectively to intangible assets acquired after the effective date. Additional disclosures required in this FSP are applied prospectively to all intangible assets recognized as of, and subsequent to, the effective date. The Company does not expect the adoption of this guidance to have a material effect on its consolidated financial statements.
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In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (“SFAS 161”), which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”). SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. The new standard also improves transparency about the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under SFAS 133; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently assessing the impact of adopting SFAS 161 on its consolidated financial statements.
In December 2007, the FASB issued SFAS 141(R), Business Combinations (“SFAS 141(R)”), and SFAS No. 160, Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS 160”). SFAS 141(R) and SFAS 160 will significantly change the accounting for and reporting of business combination transactions and noncontrolling (minority) interests in consolidated financial statements. SFAS 141(R) retains the fundamental requirements in SFAS 141 while providing additional definitions, such as the definition of the acquirer in a purchase and improvements in the application of how the acquisition method is applied. SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests, and classified as a component of equity. These Statements become simultaneously effective January 1, 2009. Early adoption is not permitted. The Company is currently evaluating the impact this guidance will have on its consolidated financial statements.
(3) Earnings Per Share
Basic earnings per share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share are computed using the treasury method by dividing net income by the weighted average number of shares of common stock and dilutive common stock equivalents outstanding during the period. Common stock equivalents include the number of shares issuable upon exercise of outstanding options less the number of shares that could have been purchased with the proceeds from the exercise of the options based on the average price of common stock during the period and the number of shares of common stock from the dilutive effect of the 2.375% convertible senior notes due 2015. The convertible senior notes due 2015 become dilutive for earnings per share calculations when the average price for the quarter exceeds the conversion price of $54.66. The shares that would be issued to settle the conversion spread are included in the diluted earnings per share calculation when the conversion option is in the money and amounted to 1,878,735 and 979,484 shares for the third quarter and year to date dilutive earnings per share calculations, respectively. Restricted shares which have not vested at the end of the reporting period are excluded from the calculation of basic earnings per share.
The computations of basic and diluted net income per share are set forth below:
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Inventories consisted of the following:
(5) Income Taxes
The income tax provision from continuing operations and discontinued operations for the three and nine months ended September 30, 2008 are as follows:
A reconciliation of the statutory federal income tax expense at 35% to actual income tax expense on income from continuing operations is as follows:
At September 30, 2008, the Company has concluded that it is more likely than not that deferred tax assets, net of valuation allowances, currently recorded will be realized. The amount of the valuation allowance takes into consideration the Alternative Minimum Tax ("AMT") system as required by SFAS No. 109, Accounting for Income Taxes (“SFAS 109”). The Company monitors the valuation allowance each quarter and makes adjustments to the allowance as appropriate. In the second quarter, due to revised projections of taxable income, the Company changed its judgment with respect to the realizability of deferred tax assets. The Company concluded that it was no longer a perpetual AMT taxpayer, and that the valuation allowance related to its perpetual AMT position should be released. In accordance with FAS 109, the amount of valuation allowance related to its AMT position that existed at the beginning of the year, and that will be realized in future years, was recognized as a discrete item in the second quarter. The amount of valuation allowance related to deferred tax assets that would be realized through current year operations was recognized through the calculation of the annual effective tax rate. In the third quarter, the Company revised its estimate of the amount of the valuation allowance that would be realized in future years, and therefore recognized an additional tax benefit as a discrete item in the third quarter.
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(6) Long-Term Debt
Long-term debt consisted of the following:
On October 26, 2005, Alpha Natural Resources, LLC (“ANR LLC”), entered into a senior secured credit facility with a group of lending institutions led by Citicorp North America, Inc., as administrative agent (the “Credit Agreement”). The Credit Agreement originally consisted of a $250,000 term loan facility and a $275,000 revolving credit facility. The revolving credit facility includes borrowing capacity available for letters of credit.
In March 2008, the Company and its subsidiary, ANR LLC, entered into two amendments to the Credit Agreement. One of these amendments increased the amount available under the revolving credit portion of the facility from $275,000 to $375,000. The other amendment, among other things, removed Alpha Natural Resources, Inc. from the application of most of the restrictive covenants and added exceptions to certain other covenants relating to payment of dividends and distributions.
On April 7, 2008, the Company completed a public offering of $287,500 aggregate principal amount of 2.375% convertible senior notes due 2015. The notes bear interest at a rate of 2.375% per annum, payable semi-annually in arrears on April 15 and October 15 of each year, beginning on October 15, 2008. The Notes will mature on April 15, 2015, unless previously repurchased by the Company or converted. The Company used the net proceeds from this offering and concurrent offering of common stock, in part, to repurchase $175,000 aggregate principal amount of the 10% senior notes due 2012, co-issued by ANR LLC and Alpha Natural Resources Capital Corp, resulting in a $14,702 loss on early extinguishment of debt. The notes are convertible in certain circumstances and in specified periods (as described in the Supplemental Indenture) at an initial conversion rate of 18.2962 shares of common stock per $1,000 principal amount of notes, subject to adjustment upon the occurrence of certain events set forth in the Indenture. Upon conversion of notes, holders will receive cash up to the principal amount of the notes to be converted, and any excess conversion value will be delivered in cash, shares of common stock or a combination thereof, at the Company's election.
Since the Company retired its $175,000 10% senior notes and the 2.375% convertible senior notes due 2015 issued by the Company are not guaranteed by the Company’s subsidiaries, separate financial information with respect to the Company and its subsidiaries is no longer required.
On July 1, 2008, the $287,500 aggregate principal amount of 2.375% convertible senior notes due 2015 became convertible at the option of the holders and remained convertible through September 30, 2008, the last trading day of the current fiscal quarter. The notes were convertible because the Company’s common stock exceeded the conversion threshold price of $71.06 per share (130% of the applicable conversion price of $54.66 per share) for at least twenty trading days within the thirty consecutive trading days ending June 30, 2008. As a result of the notes becoming convertible in the second quarter of 2008, the Company was required to fully amortize the deferred debt issuance costs in the amount of $8,904 incurred with the issuance of the notes. In addition at June 30, 2008, the Company reclassified from long-term to short-term the $287,500 aggregate principal amount of 2.375% convertible senior notes due 2015 that became convertible. As of September 30, 2008, no holders had converted their notes. On October 1, 2008, the Notes were no longer convertible since the Company’s common stock did not exceed the conversion threshold price of $71.06 per share (130% of the applicable conversion price of $54.66 per share) for at least twenty trading days within the thirty consecutive trading days ending September 30, 2008. As a result, at September 30, 2008, the Company classified the $287,500 aggregate principal amount of 2.375% convertible senior notes due 2015 as long term.
On October 17, 2008, the Company’s $287,500 aggregate principal amount of 2.375% convertible senior notes due 2015 became convertible at the option of the holders. The notes became convertible because the Company’s previously announced merger between the Company and Cliffs Natural Resources Inc. (“Cliffs”) (formerly Cleveland-Cliffs Inc.) may be consummated as early as 30 business days (i.e., potentially as early as December 2, 2008) if the merger were to be approved at the respective special meetings of the shareholders of the two companies (which are now scheduled to take place on November 21, 2008) and all other conditions to the closing of the merger were to be satisfied or waived.
The Credit Agreement places restrictions on the ability of ANR LLC and its subsidiaries to make distributions or loans to the Company. The net assets of ANR LLC are restricted, except for allowable distributions for the payment of income taxes, administrative expenses, payments on qualified debt, and, in certain circumstances, dividends or repurchases of common stock of the Company.
All of the Company borrowings under the Credit Agreement are at a variable rate, so the Company is exposed to the effect of rising interest rates. As of September 30, 2008, the Company has a $233,125 term loan outstanding with a variable interest rate based upon the 3-month London Interbank Offered Rate (“LIBOR”) (3.81% at September 30, 2008) plus the applicable margin (1.75% at September 30, 2008). To reduce the Company's exposure to rising interest rates, effective May 22, 2006, the Company entered into a pay-fixed, receive variable interest rate swap on the notional amount of $233,125 for a period of approximately six and one-half years. In effect, this swap converted the variable interest rates based on LIBOR to a fixed interest rate of 5.59% plus the applicable margin defined in the debt agreement for the remainder of our term loan. The Company accounts for the interest rate swap as a cash flow hedge and changes in fair value of the swap are recorded to other comprehensive income (loss). The critical terms of the swap and the underlying debt instrument that it hedges coincide, resulting in no hedge ineffectiveness being recognized in the income statement during the quarter ended September 30, 2008. The fair value of the swap at September 30, 2008 was $14,199 which was recorded in other liabilities in the condensed consolidated balance sheet and the offsetting unrealized loss of $10,883, net of tax benefit, was recorded in accumulated other comprehensive loss. As interest expense is accrued on the debt obligation, amounts in accumulated other comprehensive loss related to the derivative hedging instrument are reclassified into earnings to obtain a net cost on the debt obligation of 5.59% plus the applicable margin.
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(7) Asset Retirement Obligation
At September 30, 2008 and December 31, 2007, the Company has recorded asset retirement obligation accruals for mine reclamation and closure costs totaling $93,667 and $91,199, respectively. The portion of the costs expected to be incurred within a year in the amounts of $8,314 and $8,179 at September 30, 2008 and December 31, 2007, respectively, are included in accrued expenses and other current liabilities. These regulatory obligations are secured by surety bonds in the amount of $149,174 at September 30, 2008 and $142,471 at December 31, 2007. Changes in the reclamation obligation were as follows:
(8) Share-Based Compensation Awards
Share-based compensation expense measured in accordance with SFAS 123(R), Accounting for Stock-Based Compensation, ("SFAS 123(R)"), totaled $1,298 and $2,683 for the three months ended September 30, 2008 and 2007, respectively. Share-based compensation expense measured in accordance with SFAS 123(R) totaled $15,873 and $6,747 for the nine months ended September 30, 2008 and 2007, respectively. Share-based compensation expense for the nine months ended September 30, 2008 includes a $4,463 charge relating to stock grants to employees on May 1, 2008.
As of September 30, 2008 and 2007, approximately 48% and 60%, respectively, of share-based compensation expense is reported as selling, general and administrative expenses, included in the Corporate and Eliminations category for segment reporting purposes (Note 14), and approximately 52% and 40%, respectively, is reported as a component of cost of sales, included in the Coal Operations and All Other segment for segment reporting purposes (Note 14). As of September 30, 2008 and 2007, approximately ($46) and $127, respectively, of share-based compensation costs was capitalized as a component of inventories. Under SFAS 123(R), the Company is required to report the benefits of income tax deductions that exceed recognized compensation as cash flow from financing activities. The excess tax benefits during the three months ended September 30, 2008 and 2007 were $1,353 and $0, respectively, and $3,143 and $0 for the nine months ended September 30, 2008 and 2007, respectively.
Stock option activity for the nine months ended September 30, 2008 is summarized in the following table:
The aggregate intrinsic value of options outstanding at September 30, 2008 was $18,159 and the aggregate intrinsic value of exercisable options was $4,323. The total intrinsic value of options exercised during the three months ended September 30, 2008 and 2007 was $852 and $130, respectively, and for the nine months ended September 30, 2008 and 2007 was $6,425 and $200, respectively. Cash received from the exercise of stock options during the three months ended September 30, 2008 and 2007 was $228 and $473, respectively, and $3,356 and $594 during the nine months ended September 30, 2008 and 2007, respectively. As of September 30, 2008, $1,901 of unrecognized compensation cost related to stock options is expected to be recognized as expense over a weighted-average period of 1.28 years. The weighted-average grant date fair value of options outstanding at September 30, 2008 and 2007 was $7.37 and $7.53, respectively.
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Restricted Stock Awards
Non-vested share award activity for the nine months ended September 30, 2008 is summarized in the following table:
On May 1, 2008, the Company granted 25 shares of stock to all employees, except executive officers, at a grant date value of $48.59 per share subject to a ninety-day holding period before the shares could be sold. The fair value of non-vested restricted share awards is based on the closing stock price on the date of grant, and, for purposes of expense recognition, the total number of awards expected to vest is adjusted for estimated forfeitures. As of September 30, 2008, there was $9,370 of unamortized compensation cost related to non-vested shares, which is expected to be recognized as expense over a weighted-average period of 1.83 years.
Performance Share Awards
2008 Granted Awards
The Company granted 165,045 performance share awards for the nine months ended September 30, 2008. Recipients of these awards can receive shares of the Company's common stock at the end of a performance period which ends on December 31, 2010, based on the Company's actual performance against pre-established operating income goals, strategic goals, and total shareholder return goals. In order to receive the shares, the recipient must also be employed by the Company on the vesting date. The performance share awards represent the number of shares of common stock to be awarded based on the achievement of targeted performance and may range from 0 percent to 150 percent of the targeted amount. The grant date fair value of the awards related to operating income targets is based on the closing price of the Company's common stock on the New York Stock Exchange on the grant date of the award and is being amortized over the performance period. The awards related to strategic goals do not meet the criteria for grant date pursuant to SFAS No. 123(R), Share-based Payments (as amended) (“SFAS 123”). The fair value of the awards related to total shareholder return targets is based upon a Monte Carlo simulation and is being amortized over the performance period. For executive officers of the Company to receive these performance share awards, the Company must achieve a pre-determined EBITDA level during the performance period in addition to the criteria set for all other employees participating in the plan. The Company reassesses at each reporting date whether achievement of each of the performance conditions is probable, as well as estimated forfeitures, and adjusts the accruals of compensation expense as appropriate. At September 30, 2008, the Company assessed the operating income and total shareholder return targets as probable of achievement. As of September 30, 2008, there was $2,317 of unamortized compensation cost related to the performance share awards for 2008. This unamortized compensation cost is expected to be recognized over the remaining periods up to December 31, 2010.
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(9) Derivative Financial Instruments
Derivative financial instruments are accounted for in accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), which requires all derivative financial instruments to be reported on the balance sheet at fair value. Changes in fair value are recognized either in earnings or equity, depending on whether the transaction qualifies for hedge accounting and if so, the nature of the underlying exposure being hedged and how effective the derivatives are at offsetting price movements in the underlying exposure.
The Company accounts for certain forward purchase and forward sale coal contracts that do not qualify under the “normal purchase and normal sale” exception of SFAS 133 as derivatives and records these contracts as assets or liabilities at fair value. Changes in fair value of these coal derivative contracts have been recorded as an (increase) decrease in fair value of certain derivative instruments, net, and included as a component of costs and expenses in the consolidated statements of income. At September 30, 2008, the Company had unrealized gains (losses) on open purchase and open sales contracts of $34,015 and ($29,071), respectively. The unrealized gains of $34,015 in open purchases are recorded in prepaid expenses and other current assets. The unrealized losses on open sales contracts are recorded in accrued expenses and other current liabilities and other liabilities in the amount of $25,800 and $3,271, respectively.
The Company has utilized interest rate swap agreements to modify the interest characteristics of a portion of the Company's outstanding debt. The swap agreements essentially convert variable-rate debt to fixed-rate debt and have been designated as cash flow hedges. Changes in the fair value of interest rate swaps designated as hedging instruments of the variability of cash flows associated with floating rate and long-term debt obligations are reported in accumulated other comprehensive loss. These amounts are subsequently reclassified into interest expense in the same period in which the related floating rate debt obligation affects earnings.
The Company is also exposed to the risk of fluctuations in cash flows related to its purchase of diesel fuel. The Company has entered into diesel fuel swap agreements and diesel put options to reduce the volatility in the price of diesel fuel for its operations. The diesel fuel swap agreements and put options are not designated as hedges for accounting purposes and therefore the changes in fair value of these diesel fuel derivative instrument contracts have been recorded as an (increase) decrease in fair value of certain derivative instruments, net, and included as a component of costs and expenses in the consolidated statements of income. These diesel fuel swaps and put options use the NYMEX New York Harbor No. 2 Heating Oil (“No. 2 heating oil”) futures contracts as the underlying commodity reference price. Any unrealized loss is recorded in other current liabilities and other liabilities and any unrealized gain is recorded in other current assets and other assets.
As of September 30, 2008, approximately 4,908 gallons or 75% of the Company's budgeted 2008 remaining diesel fuel usage has been capped with the swap agreements in which the Company has agreed to pay a fixed price and receive a floating price per gallon of No. 2 heating oil. The fixed prices for the notional quantity of 4,908 gallons range from $2.39 to $3.93 per gallon for the last three months of 2008. In addition, as of September 30, 2008, the Company has in place swap agreements with respect to 22,700 gallons, at fixed prices ranging from $2.74 to $4.10 per gallon, which mature in 2009 to 2011. At September 30, 2008, the fair value of these diesel fuel swap agreements is a net liability of $7,108, which is recorded in prepaid expenses and other current assets in the amount of $1,226, other assets in the amount of $574, accrued expenses and other current liabilities in the amount of $4947, and in other liabilities in the amount of $3,961.
The Company has also employed an options strategy – both purchasing and selling put options – to protect cash flows in the event diesel prices decline. As of September 30, 2008, the Company had purchased put options for 2,813 gallons at strike prices ranging from $2.25 to $3.25 per gallon for the last three months of 2008, and 2,646 gallons for the first six months of 2009 at a strike price of $3.50 per gallon. In the event that No. 2 heating oil prices decline below the strike price, the Company can exercise the put options and sell the 5,459 gallons at the strike price, therefore reducing the negative impact of any of the swap agreements that have settlement prices above market. As of September 30, 2008, the Company had sold put options for 2,646 gallons for the first six months of 2009 at a strike price of $3.00 per gallon. This was part of a put spread strategy that effectively provided protection for market prices between $3.00 and $3.50. In the event that No.2 heating oil prices decline below the $3.00 strike price, then the sold put options will offset the purchased put options with no net benefit or cost. At September 30, 2008, the fair value of all diesel fuel put options is a net asset of $1,440 of which $2,515 is recorded in prepaid expenses and other current assets and $1,075 is recorded in accrued expenses and other current liabilities.
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(10) Fair Value Measurements
The Company adopted SFAS No. 157, Fair Value Measurements (“SFAS 157”) on January 1, 2008. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Additionally, on January 1, 2008, the Company elected the partial adoption of SFAS 157 under the provisions of FSP FAS 157-2, which amends SFAS 157 to allow an entity to delay the application of this statement until January 1, 2009 for certain non-financial assets and liabilities. The adoption of SFAS 157 did not have a material impact on our consolidated financial statements.
The Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115 (“SFAS 159”), on January 1, 2008. This standard permits entities to choose to measure many financial instruments and certain other items at fair value. The adoption of SFAS 159 did not impact our consolidated financial statements, as the Company elected not to measure any additional financial assets or liabilities at fair value other than those which were recorded at fair value prior to adoption.
SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset and liability. As a basis for considering such assumptions, SFAS 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy defined by SFAS 157 are as follows:
The following table sets forth by level within the fair value hierarchy the company's financial assets that were accounted for at fair value on a recurring basis as of September 30, 2008. As required by SFAS 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.
The following methods and assumptions were used to estimate the fair values of the assets and liabilities in the tables above.
Level 2 Fair Value Measurements
Forward Coal Purchases and Sales — The fair value of the forward coal purchases and sales contracts were estimated using discounted cash flow calculations based upon forward commodity price curves. The curves were obtained from independent pricing services reflecting broker market quotes.
Diesel Fuel Derivatives — Since the Company’s diesel fuel derivative instruments are not traded on a market exchange, the fair values are determined using valuation models which include assumptions about commodity prices based on those observed in the underlying markets.
Interest Rate Swaps — The fair value of the interest rate swaps were estimated using discounted cash flow calculations based upon forward interest-rate yield curves. The curves were obtained from independent pricing services reflecting broker market quotes.
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(11) Postretirement Benefits Other Than Pensions
The following table details the components of the net periodic benefit cost for the Company’s retiree medical plan (the “Plan”):
The Company provides current and certain retired employees and their dependents postretirement medical benefits by accruing the costs of such benefits over the service lives of employees. Premiums are paid by the Company based on years of service, with the difference contributed by the employee, if any. Employer contributions for postretirement medical benefits paid for the three months ended September 30, 2008 and 2007 were $95 and $30, respectively, and for the nine months ended September 30, 2008 and 2007 were $177 and $95, respectively. Employee contributions are insignificant and the Plan is unfunded.
Two of the Company’s subsidiaries are required to make contributions to the 1974 UMWA Pension Plan and Trust and/or the 1993 UMWA Benefit Plan. The contributions made to these plans for the three months ended September 30, 2008 and 2007 were $551 and $345, respectively, and for the nine months ended September 30, 2008 and 2007 were $1,714 and $1,080, respectively.
(12) Comprehensive Income
Total comprehensive income is as follows for the three months and nine months ended September 30, 2008:
The following table summarizes the components of accumulated other comprehensive loss at September 30, 2008:
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(13) Commitments and Contingencies
(a) Guarantees and Financial Instruments with Off-balance Sheet Risk
In the normal course of business, the Company is a party to certain guarantees and financial instruments with off-balance sheet risk, such as bank letters of credit and performance or surety bonds. No liabilities related to these arrangements are reflected in the Company's condensed consolidated balance sheets. Management does not expect any material losses to result from these guarantees or off-balance sheet financial instruments. The amount of bank letters of credit, excluding letters of credit issued under our Credit Agreement, outstanding as of September 30, 2008 was $85,175. The amount of surety bonds outstanding at September 30, 2008 related to the Company's reclamation obligations is presented in Note 7 to the condensed consolidated financial statements. The Company has provided guarantees for equipment financing obtained by certain of its contract mining operators totaling approximately $424 as of September 30, 2008. The estimated fair value of these guarantees is not significant.
(b) Discontinued Operations
On September 26, 2008, as part of the sale of the Company's interest in Gallatin to an unrelated third party, an escrow balance of $4,500 was established to indemnify and guarantee the buyer against breaches of representations and warranties in the sale agreement and contingencies that may have existed at closing and materialize within one year from the sale date. The Company recorded a liability of $650 as the fair value of this guarantee.
The Company is a party to a number of legal proceedings incident to our normal business activities. While we cannot predict the outcome of these proceedings, we do not believe that any liability arising from these matters individually or in the aggregate should have a material impact upon our consolidated cash flows, results of operations or financial condition.
In December 2004, prior to our Nicewonder Acquisition in October 2005, the Affiliated Construction Trades Foundation brought an action against the West Virginia Department of Transportation, Division of Highways (“WVDOH”) and Nicewonder Contracting, Inc. ("NCI"), which became our wholly-owned indirect subsidiary after the Nicewonder Acquisition, in the United States District Court in the Southern District of West Virginia. The plaintiff sought a declaration that the contract between NCI and the State of West Virginia related to NCI's road construction project was illegal as a violation of applicable West Virginia and federal competitive bidding and prevailing wage laws. The plaintiff also sought an injunction prohibiting performance of the contract but has not sought monetary damages.
On September 5, 2007, the Court ruled that WVDOH and the Federal Highway Administration (which is now a party to the suit) could not, under the circumstances of this case, enter into a contract not requiring the contractor to pay the prevailing wages as required by the Davis-Bacon Act. Although the Court has not yet decided what remedy it will impose, the Company expects a ruling before the end of the first quarter of 2009. The Company anticipates that the most likely remedy is a directive that the contract be renegotiated for such payment. If that renegotiation occurs, WVDOH has committed to agree, and NCI has a contractual right to insist, that additional costs resulting from the order will be reimbursed by WVDOH and as such neither NCI nor the Company believe, at this time, that they have any monetary expense from this ruling. As of September 30, 2008, the Company had a $7,550 long-term receivable for the recovery of these costs from WVDOH and a $7,550 long-term liability for the obligations under the ruling.
(14) Segment Information
The Company extracts, processes and markets steam and metallurgical coal from surface and deep mines for sale to electric utilities, steel and coke producers, and industrial customers. The Company operates only in the United States with mines in the Central Appalachian and Northern Appalachian regions. The Company has one reportable segment: Coal Operations, which as of September 30, 2008, consisted of 35 underground mines and 27 surface mines located in Central Appalachia and Northern Appalachia. Coal Operations also includes the Company's coal sales function, which markets the Company's Appalachian coal to domestic and international customers. The All Other category includes the Company's equipment sales and repair operations, as well as other ancillary business activities, including terminal services, coal and environmental analysis services, and leasing of mineral rights. In addition, the All Other category includes the operations of the Company's road construction businesses. The Corporate and Eliminations category includes general corporate overhead and the elimination of intercompany transactions. The revenue elimination amount represents inter-segment revenues. The Company evaluates the performance of its segment based on EBITDA from continuing operations which the Company defines as income from continuing operations plus interest expense, income tax expense, and depreciation, depletion and amortization, less interest income.
Operating segment results and capital expenditures for the three months ended September 30, 2008 and segment assets as of September 30, 2008 were as follows:
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Operating segment results and capital expenditures for the nine months ended September 30, 2008 and segment assets as of September 30, 2008 were as follows: