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Alpha Natural Resources 10-Q 2008 Documents found in this filing:SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form 10-Q
(Mark
One)
For
the quarterly period ended June 30, 2008
OR
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:
(276) 619-4410
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
July 29, 2008— 70,494,861
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 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 six months ended June 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
filed with the Securities and Exchange Commission.
Reclassifications
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 current year presentation. These
reclassification adjustments had no effect on previously reported income from
operations, net income, current liabilities, or total liabilities.
(2) New Accounting Pronouncements
In May 2008, the
Financial Accounting Standards Board (“FASB”) affirmed the consensus of FASB
Staff Position (“FSP”) 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
finalizing its analysis of FSP APB 14-1 on its consolidated financial
statements. The Company expects to have higher interest expense
retroactive to the date of the issuance of the convertible notes in April 2008
due to the non-cash interest expense accretion.
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.
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.
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 average price of our
shares during the second quarter of 2008 was $68.45 and accordingly we added
1,059,716 and 529,858 shares to second 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:
(4) Inventories
Inventories consisted of
the following:
(5) Income
Taxes
A reconciliation of the
statutory federal income tax expense at 35% to income before income taxes and
minority interest and the actual income tax expense is as follows:
For the three month
period ended June 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 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, the Company recognized a benefit for a portion of the valuation
allowance that existed at the beginning of the year, based on recent positive
evidence regarding the ability to realize its deferred tax assets in the
future.
(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 $14,669 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 are no
longer required.
On July 1, 2008, our
$287,500 aggregate principal amount of 2.375% convertible senior notes due 2015
became convertible at the option of the holders and will remain convertible
through September 30, 2008, the last trading day of the current fiscal
quarter. The notes became 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 is required to fully amortize the deferred debt
issuance costs in the amount of $8,904 incurred with the issuance of the
notes. In addition, 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 on July 1, 2008 and will remain convertible through
September 30, 2008. As of July 31, 2008, no holders have converted
their notes.
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 June 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”) (2.80% at June 30, 2008)
plus the applicable margin (1.75% at June 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 June 30,
2008. The fair value of the swap at June 30, 2008 was $13,452 which
was recorded in other liabilities in the condensed consolidated balance sheet
and the offsetting unrealized loss of $10,425, 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.
(7) Asset Retirement
Obligation
At June 30, 2008 and
December 31, 2007, the Company has recorded asset retirement obligation
accruals for mine reclamation and closure costs totaling $92,743 and $91,199,
respectively. The portion of the costs expected to be incurred within a year in
the amounts of $8,395 and $8,179 at June 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 $146,554 at June 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) totaled $11,586 ($8,918 net of
tax or $0.13 per diluted share), which includes a $4,463 charge relating to
stock grants to employees on May 1, 2008, and $1,393 ($1,048 net of tax or $0.02
per diluted share) for the three months ended June 30, 2008 and 2007,
respectively. Share-based compensation expense measured in accordance
with SFAS 123(R) totaled $14,575 ($11,215 net of tax or $0.16 per diluted share)
and $4,064 ($3,085 net of tax or $0.05 per diluted share) for the six months
ended June 30, 2008 and 2007, respectively.
As of June 30, 2008 and
2007, approximately 51% and 61%, 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 49% and 39%, respectively, is reported as a component of
cost of sales, included in the Coal Operations and All Other segment for
reporting purposes (Note 14). As of June 30, 2008 and 2007,
approximately $202 and $192, 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 June 30, 2008 and 2007 were $1,056 and $0,
respectively, and $1,790 and $0 for the six months ended June 30, 2008 and 2007,
respectively.
Stock
Options
Stock option activity for
the six months ended June 30, 2008 is summarized in the following
table:
The aggregate intrinsic
value of options outstanding at June 30, 2008 was $47,623 and the aggregate
intrinsic value of exercisable options was $12,654. The total intrinsic value of
options exercised during the three months ended June 30, 2008 and 2007 was
$3,525 and $70, respectively, and for the six months ended June 30, 2008 and
2007 was $5,573 and $70, respectively. Cash received from the
exercise of stock options during the three months ended June 30, 2008 and
2007 was $1,412 and $120, respectively, and $3,128 and $120 during the six
months ended June 30, 2008 and 2007, respectively. As of June 30, 2008,
$2,278 of unrecognized compensation cost related to stock options is expected to
be recognized as expense over a weighted-average period of 1.53 years. The
weighted average grant date fair value of options outstanding at June 30, 2008
and 2007 was $7.35 and $7.53, respectively.
Non-vested share award activity for the six months ended June 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 hold 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 June 30, 2008, there was $11,124 of
unamortized compensation cost related to non-vested shares, which is expected to
be recognized as expense over a weighted-average period of
1.99 years.
Performance Share
Awards
2008 Granted
Awards
The Company granted
165,045 performance share awards in the first six months of
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(R)”).
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 June 30, 2008, the Company assessed the operating income and
total shareholder return targets as probable of achievement. As of June 30,
2008, there was $2,575 of unamortized compensation cost related to the
performance share awards for 2008. This unamortized compensation cost
is expected to be recognized over the periods ending December 31,
2010.
(9)
Derivative Financial Instruments
Derivative financial
instruments are accounted for in accordance with 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 June 30, 2008, the Company had unrealized gains (losses)
on open purchase and open sales contracts of $69,338 and ($58,471),
respectively. The unrealized gains of $69,338 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 $44,946 and $13,525,
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 income (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 #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 June 30, 2008,
approximately 9,816 gallons or 74% 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
diesel fuel. The fixed prices for the notional quantity of 9,816
gallons range from $2.39 to $3.93 per gallon for the last six months of
2008. In addition, as of June 30, 2008, the Company has in place swap
agreements with respect to 19,100 gallons, at fixed prices ranging from $2.74 to
$3.89 per gallon, which mature in 2009 to 2011. At June 30, 2008, the
fair value of these diesel fuel swap agreements is an asset of $22,086 which is
recorded in prepaid expenses and other current assets and other assets in the
amount of $13,863 and $8,223, respectively.
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 June 30, 2008, the
Company had purchased put options for 5,185 gallons at strike prices ranging
from $2.20 to $3.25 per gallon for the last six 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 diesel prices decline below the strike price, the Company can
exercise the put options and sell the 7,831 gallons at the strike price,
therefore reducing the negative impact of any of the swap agreements that have
settlement prices above market. As of June 30, 2008, the Company had sold put
options for 2,646 gallons 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 $3.50 and $3.00. The Company did not perceive a meaningful amount of
price risk below the $3.00 strike. Additionally, the put spread strategy
provides the ancillary benefit of partially offsetting the upfront cash premiums
required on the purchased put options. At June 30, 2008, the fair
value of all these diesel fuel put options is a net asset of $616 of which $963
is recorded in prepaid expenses and other current assets and $347 is recorded in
accrued expenses and other current liabilities.
(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 June 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.
- 11
-
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.
(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 June 30, 2008 and 2007 were $50 and $33, respectively, and for the six
months ended June 30, 2008 and 2007 were $82 and $65, 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 June 30, 2008 and 2007 were $53 and
$24, respectively, and for the six months ended June 30, 2008 and 2007 were $98
and $49, respectively.
Total comprehensive
income is as follows for the three months and six months ended June 30,
2008:
The following table
summarizes the components of accumulated other comprehensive loss at June 30,
2008:
(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, not including letters of
credit issued under our Credit Agreement, outstanding as of June 30, 2008 was
$82,195. The amount of surety bonds outstanding at June 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 $651 as of June 30, 2008. The estimated fair value of
these guarantees is not significant.
(b)
Litigation
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.
Nicewonder
Litigation
In December 2004, prior
to the Company's 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 the Company's 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 in 2008. 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 June 30, 2008, the Company had a $7,025 long-term receivable for the recovery
of these costs from WVDOH and a 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 June 30, 2008, consisted of 32
underground mines and 26 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 and the lime processing
business being developed by the Company. 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 which the
Company defines as net income 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 June 30, 2008 and
segment assets as of June 30, 2008 were as follows:
Operating segment results
and capital expenditures for the six months ended June 30, 2008 and segment
assets as of June 30, 2008 were as follows:
Operating segment results and
capital expenditures for the three months ended June 30, 2007 and segment
assets as of June 30, 2007 were as follows:
Operating segment results
and capital expenditures for the six months ended June 30, 2007 and segment
assets as of June 30, 2007 were as follows:
The Company markets
produced, processed, and purchased coal to customers in the United States and in
international markets. Export revenues totaled $418,548 and $636,991 or
approximately 58% and 52% of total coal and freight revenues for each of the
three months and six months ended June 30, 2008, respectively. Export
revenues totaled $153,404 and $299,869 or approximately 36% and 35% of total
coal and freight revenues, respectively, for each of the three months and six
months ended June 30, 2007.
(15) Equity
Offering
On April 7, 2008,
concurrent with the issuance of the $287,500 aggregate principal amount of
2.375% convertible notes due 2015 (See Note 6), the Company completed its public
offering of 4,181,817 shares of common stock at a public offering price of
$41.25 per share, including 545,454 shares granted to the underwriters to cover
over allotments. The net proceeds from the common stock offering were
$164,666 after commissions and expenses.
(16) Subsequent
Events
On July 15, 2008, the Company
entered into a definitive merger agreement pursuant to which, and subject to the
terms and conditions thereof, Cleveland-Cliffs Inc. would acquire all
outstanding shares of the Company in a stock and cash transaction. Under
the terms of the agreement, for each share of the Company’s common stock,
Company stockholders would receive 0.95 Cleveland-Cliffs Inc.’s common shares
and $22.23 in cash.
The transaction is
subject to shareholder approval as well as the satisfaction of customary closing
conditions and regulatory approvals, including expiration or termination of the
applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act
of 1976. The transaction is expected to close by the end of
2008. The agreement contains customary break up fees if the
transaction does not close.
You should read the
following discussion and analysis in conjunction with our financial statements
and related notes included elsewhere in this report and our Annual Report on
Form 10-K for the year ended December 31, 2007. Unless we have
indicated otherwise, or the context otherwise requires, references in this
report to “Alpha,” “the Company,” “we,” “us” and “our” or similar terms are to
Alpha Natural Resources, Inc. and its consolidated subsidiaries.
Cautionary
Note Regarding Forward Looking Statements
This report includes
statements of our expectations, intentions, plans and beliefs that constitute
“forward-looking statements” within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934 and are intended to come within the safe harbor protection provided by
those sections. These statements, which involve risks and uncertainties, relate
to analyses and other information that are based on forecasts of future results
and estimates of amounts not yet determinable and may also relate to our future
prospects, developments and business strategies. We have used the words
“anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,”
“predict,” “project,” “should” and similar terms and phrases, including
references to assumptions, in this report to identify forward-looking
statements. These forward-looking statements are made based on expectations and
beliefs concerning future events affecting us and are subject to uncertainties
and factors relating to our operations and business environment, all of which
are difficult to predict and many of which are beyond our control, that could
cause our actual results to differ materially from those matters expressed in or
implied by these forward-looking statements.
The following factors are
among those that may cause actual results to differ materially from our
forward-looking statements:
- 16
-
When considering these
forward-looking statements, you should keep in mind the cautionary statements in
this report and the documents incorporated by reference. We do not undertake any
responsibility to release publicly any revisions to these forward-looking
statements to take into account events or circumstances that occur after the
date of this report. Additionally, we do not undertake any responsibility to
update you on the occurrence of any unanticipated events which may cause actual
results to differ from those expressed or implied by the forward-looking
statements contained in this report.
Overview
We produce, process and
sell steam and metallurgical (met) coal from eight regional business units,
which, as of June 30, 2008, were supported by 32 active underground mines, 26
active surface mines and 11 preparation plants located throughout Virginia, West
Virginia, Kentucky, and Pennsylvania, as well as a road construction business in
West Virginia and Virginia that recovers coal. We also sell coal produced by
others, the majority of which we process and/or blend with coal produced from
our mines prior to resale, providing us with a higher overall margin for the
blended product than if we had sold the coals separately. For the three months
and six month ended June 30, 2008, sales of steam coal were 4.4 and 8.3
million tons, respectively, and accounted for approximately 56% and 57%,
respectively, of our coal sales volume. For the three and six months ended June
30, 2008, sales of metallurgical coal, which generally sells at a premium over
steam coal, were 3.4 and 6.3 million tons, respectively, and accounted for
approximately 44% and 43%, respectively, of our sales volume. Our
sales of steam coal were made to large utilities and industrial customers in the
Eastern region of the United States, and our sales of metallurgical coal were
made to steel companies in the Northeastern and Midwestern regions of the United
States and in several countries in Europe, South America, Africa and Asia.
Approximately 52% of our coal sales and freight revenue in the first six months
of 2008 was derived from sales made outside the United States, primarily in
Turkey, Brazil, Egypt, Hungary, Canada, and Russia.
We also own 94% of
Gallatin Materials, LLC (“Gallatin”), a lime manufacturing business in Verona,
Kentucky. Gallatin completed the construction of the first of possibly two
rotary pre-heater lime kilns in the first quarter, which produces lime for sale
to steel producers for use as flux in electric arc and basic oxygen furnaces and
municipalities for use in their water treatment facilities. We also
expect future sales to coal burning utilities as a scrubbing agent for removing
sulfur dioxide from flue gas. The minority owners were granted restricted
membership interests in Gallatin, which vest based on performance criteria
over a period of approximately three years from the closing date and which, if
earned in their entirety, would reduce our ownership to 77.5%.
In addition, we generate other
revenues from equipment and parts sales, equipment repair, road construction,
rentals, royalties, commissions, coal handling, terminal and processing fees,
and coal and environmental analysis fees. We also record revenue for freight and
handling charges incurred in delivering coal to our customers, which we treat as
being reimbursed by our customers. However, these freight and handling revenues
are offset by equivalent freight and handling costs and do not contribute to our
profitability.
Our primary expenses are
for wages and benefits, supply costs, repair and maintenance expenditures, cost
of purchased coal, royalties, freight and handling costs, and taxes incurred in
selling our coal. Historically, our cost of coal sales per ton is lower for
sales of our produced and processed coal than for sales of purchased coal that
we do not process prior to resale.
We have one reportable segment, Coal Operations, which includes all of our revenues and costs from coal production and sales, freight and handling, rentals, commissions, coal handling and processing operations and coal recovery incidental to our road construction operations. These revenues and costs included in our Coal Operations segment are reported by us in our coal revenues and cost of coal sales, except for the revenues and costs from rentals, commissions, and coal handling and processing operations, which we report in our other revenues and cost of other revenues, respectively. In March 2008, we sold
our equity interest in Fox River Dock Company, Inc., a coal terminal, which we
acquired with the acquisition of Coastal Coal Company, LLC on March 11, 2003, to
the majority holder of Fox River for $1.5 million in cash. We
recognized a gain of $0.4 million from this transaction.
In March 2008, we and our
subsidiary, ANR LLC, entered into two amendments to our senior secured credit
facility. One of these amendments increased the amount available
under the revolving credit portion of the facility from $275.0 million to
$375.0 million. 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, we completed
concurrent public offerings of 4,181,817 shares of common stock at $41.25 per
share and $287.5 million aggregate principal amount of 2.375% convertible
senior notes due 2015. The aggregate net proceeds from the common
stock offering and the notes offering were $443.3 million after commissions and
expenses. We used the net proceeds from the offerings in part to
repurchase $175.0 million aggregate principal amount of the 10% senior
notes due 2012, co-issued by ANR LLC and Alpha Natural Resources Capital
Corp. As a result, in the second quarter of 2008, we recorded a loss
relating to the early extinguishment of debt of $14.7 million, consisting of
$10.7 million in tender offer consideration and $4.0 million in write-off of
unamortized deferred debt issuance costs.
On April 30, 2008, our
subsidiary, Alpha Terminal Company, LLC, increased its equity ownership position
in Dominion Terminal Associates (“DTA”) from 32.5% to 40.6% by making an
additional investment of $2.8 million. DTA is a 20 million-ton
annual capacity coal export terminal located in Newport News, Virginia. The
terminal, constructed in 1982, provides the advantages of unloading/transloading
equipment with ground storage capability, providing producers with the ability
to custom blend export products without disrupting mining
operations. This transaction maintains our largest ownership stake in
the facility, effectively increasing our coal export and terminaling capacity
from approximately 6.5 million tons to approximately 8.0 millions tons
annually.
On May 1, 2008, we
granted each of our employees except our executive officers 25 shares of our
stock with a 90-day holding period to reward them for their past service and
role in the Company’s financial success. As a result, in the second
quarter of 2008, the Company recorded a charge of $7.2 million, which consists
of $4.5 million in share-based compensation expense and $2.7 million as a cash
bonus on behalf of the employees to cover the required tax withholding
associated with the stock grant.
On July 1, 2008, our
$287.5 million aggregate principal amount of 2.375% convertible senior notes due
2015 became convertible at the option of the holders and will remain convertible
through September 30, 2008, the last trading day of the current fiscal
quarter. The notes became 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 is required to fully amortize the deferred debt issuance costs in the
amount of $8.9 million incurred with the issuance of the notes. As of July
31, 2008, no holders have converted their notes.
On July 15, 2008, the
Company entered into a definitive merger agreement pursuant to which, and
subject to the terms and conditions thereof, Cleveland-Cliffs Inc. would acquire
all outstanding shares of the Company in a cash and stock transaction.
Under the terms of the agreement, for each share of the Company’s common stock,
Company stockholders would receive 0.95 Cleveland-Cliffs Inc.’s common shares
and $22.23 in cash.
Coal
Pricing Trends, Uncertainties and Outlook
Coal supply continues to
tighten around the world as demand continues to increase. While traditional coal
exporting nations such as Australia, Poland, Indonesia and South Africa have
been subject to supply disruptions or voluntary cutbacks, U.S. exports of both
thermal and metallurgical coal have shown sustained strength. With
world steel output climbing, prices for metallurgical coal have risen quickly as
has international demand.
Rising natural gas prices
and the U.S. dollar’s weakness are adding fuel to thermal coal demand both
domestically and overseas, while high steel prices have mills searching the
world for reliable supplies of metallurgical coal. U.S. steel mills, in
particular, are striving to maintain inventories at service centers at a time of
increased production to avoid record high steel prices. In this
environment, Alpha continues its strategy of gradually layering in sales
commitments at favorable prices.
As of July 23, 2008, we
had committed 98% of planned thermal coal production for 2008 while leaving
approximately 13% of planned production uncommitted for 2009 and 62% for 2010.
We are in active discussions with a number of U.S. utilities for supply in 2009
and beyond.
With steel prices rising
at the end of 2007, and the domestic steel industry expecting a strong rebound
this year after a dramatic draw down of service center inventories, demand for
metallurgical coal has remained very strong. Global supplies of hard coking
coals for making steel have tightened considerably due to production and
logistical issues in Eastern Europe and Australia.
As the largest exporter
of metallurgical coal out of the U.S., we have experienced a surge of 778,000
tons in second-quarter exports, year-over-year, which boosted total met coal
sales to 44% of the company’s total sales volumes for the quarter. Due to
the fact that pricing resets at the end of the first quarter of every year for
the majority of our contracted metallurgical business, we achieved a
proportionally higher level of revenues in the second quarter than in the first,
and we expect to continue to achieve proportionally higher revenues in the third
and fourth quarters than in the first quarter as the higher-priced export
contracts continue to phase in. As of July 23, 2008, we had approximately
0.4 million tons of planned metallurgical production remaining to be
contracted for 2008. Uncommitted and unpriced production stands at
approximately 10.1 million tons, approximately78% of our planned production, for
2009 and approximately 11.4 million tons, approximately 89% of our planned
production, for 2010. While our outlook on coal
pricing remains positive, future coal prices are subject to factors beyond our
control and we cannot predict whether or for how long this current coal pricing
environment will continue. As of July 23, 2008, 97% of our planned 2008
production was committed and priced and 3% was uncommitted and unpriced, with
approximately 0.4 million tons uncommitted. Committed steam coal prices for 2008
average $50.12 per ton and met coal prices average $110.85 per ton.
Approximately 57% of our planned production in 2009 is committed.
At June 30, 2008, we had
unrealized gains (losses) on open purchase and sale contracts that meet the
definition of a derivative under SFAS 133 in the amount of $69.3 million and
($58.5 million), respectively. These assets are recorded in prepaid expenses and
other current assets and $45.0 million of the liabilities are recorded in
accrued expenses and other current liabilities and the remaining $13.5 million
of liabilities are recorded in other liabilities on our balance sheet, with
periodic changes in fair value recorded to the income
statement. Since we intend to take delivery or provide delivery
of coal under these contracts, the unrealized gains and losses recorded as
of June 30, 2008 will reverse into the income statement in future
periods. The reversal of the net unrealized gains related to these
contracts will result in higher costs of sales in future periods when we
ultimately take delivery of the coal under these contracts and sell it to our
customers. In addition, as of June 30, 2008, we had an unrealized
gain on diesel swap agreements and put options that met the definition of a
derivative under SFAS 133 that are marked to market in the amount of $22.1
million and $0.6 million, respectively. Due to market price
fluctuations, we could experience significant earnings volatility related
to coal contracts, diesel swap agreements, and diesel put options that are
classified as derivatives.
We own a 24.5% interest
in Excelven Pty Ltd., a coal mine development project located in Venezuela
accounted for under the equity method. The project, currently in the
developmental stage, is challenged by political risk. In particular, the
Venezuelan government has expressed an interest in increasing government
ownership in Venezuelan natural resources. Any future deterioration in the
political environment in Venezuela or the government’s denial of the Affectation
of Resources permit could lead to a potential impairment
adjustment. In addition, such political and economic uncertainties
could also lead to events such as civil unrest, work
stoppages or the nationalization or other expropriation of private enterprises
by the Venezuelan government, which could result in a loss of all or a
portion of our investment in Excelven, which is approximately $4.6 million
as of June 30, 2008.
For additional
information regarding some of the risks and uncertainties that affect our
business, see Item 2 of this report, and Item 1A “Risk Factors,” in our Annual
Report on Form 10-K.
Reconciliation
of Non-GAAP Measures
EBITDA is defined as net
income plus interest expense, income tax expense, and depreciation, depletion
and amortization, less interest income. EBITDA is a non-GAAP measure used by
management to measure operating performance, and management also believes it is
a useful indicator of our ability to meet debt service and capital expenditure
requirements. Because EBITDA is not calculated identically by all companies, our
calculation may not be comparable to similarly titled measures of other
companies.
The following unaudited
table reconciles EBITDA to net income, the most directly comparable GAAP
measure.
Results
of Operations
Three
Months Ended June 30, 2008 Compared to the Three Months Ended June 30,
2007
Summary
For the three months
ended June 30, 2008, we recorded revenues of $732.2 million compared
to $435.3 million for the three months ended June 30, 2007, an
increase of $296.9 million. Net income increased from $4.7 million
($0.07 per diluted share) in the second quarter of 2007 to $74.3 million ($1.04
per diluted share) for the second quarter of 2008. EBITDA, as reconciled to our
net income in the table under “Reconciliation of Non-GAAP Measures” above, was
$141.8 million and $53.7 million in the second quarter of 2008 and 2007,
respectively.
Our results for the
second quarter of 2008 include a benefit of $17.9 million ($0.25 per diluted
share) from reversing a portion of our existing valuation allowance
for deferred tax assets, of which $11.2 million ($0.16 per diluted share) was
recognized as a discrete item with the effect of reducing income tax expense,
charges in the amount of $14.7 million ($11.3 million net of tax or $0.16 per
diluted share) for a loss on early extinguishment of debt, $8.9 million ($6.9
million net of tax or $0.10 per diluted share) of interest expense from the full
amortization of debt issuance costs related to the 2.375% convertible senior
notes due 2015 which became convertible on July 1, 2008, $15.6 million ($12.0
million net of tax or $0.17 per diluted share) related to our employee
appreciation and retention program and other incentive plans, and $6.5 million
in unrealized gains related to changes in the fair value of derivative contracts
($5.0 million net of tax or $0.07 per diluted share).
We sold 7.8 million
tons of coal during the second quarter of 2008, 0.9 million more than the
comparable period in 2007. Coal margin, which we define as coal revenues
less cost of coal sales, divided by coal revenues, increased from 16.8% in the
second quarter of 2007 to 26.8% in the second quarter of 2008. Coal margin per
ton was $21.85 in the second quarter of 2008, a 130% increase from the second
quarter of 2007. Coal margin per ton is calculated as coal sales realization
(sales price) per ton less cost of coal sales per ton.
Revenues
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