Alpha Natural Resources 10-Q 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended March 31, 2009
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec.232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
þ Large accelerated filer o Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company
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 May 1, 2009 – 71,351,023
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Item 1. Financial Statements
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
March 31, 2009
(In thousands, except percentages, share, per share, and per gallon 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 three months ended March 31, 2009 are not necessarily indicative of the results to be expected for the year ending December 31, 2009. 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, 2008 included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission.
Prior period cost of coal sales have been adjusted to exclude changes in the fair value of diesel fuel derivative contracts in the amount of $2,365, which is now included as increase in fair value of derivative instruments, net, to conform to the current year presentation. This reclassification adjustment had no effect on previously reported income from continuing operations or net income.
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 prior periods have been reported as discontinued operations (See Note 15).
On December 3, 2008, the Company announced the permanent closure of the Whitetail Kittanning Mine, an adjacent coal preparation plant and other ancillary facilities (“Kingwood”). The decision resulted from adverse geologic conditions and regulatory requirements that rendered the coal seam unmineable at this location. The mine stopped producing coal in early January 2009 and Kingwood ceased equipment recovery operations at the end of April 2009. Beginning in the first quarter of 2009, the results of operations for the current and prior periods have been reported as discontinued operations (See Note 15).
On January 1, 2009, the Company adopted 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”). 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 was not permitted and retroactive application to all periods presented is required. Due to the adoption of FSP APB 14-1, certain adjustments have been made to the prior period presented for the Company’s condensed consolidated balance sheets (See Note 6).
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(2) New Accounting Pronouncements
There were no issued accounting standards not adopted by the Company as of March 31, 2009 that are expected to have a material impact on the Company’s financial statements.
(3) Earnings Per Share
The number of shares used to calculate basic earnings (loss) per share is based on the weighted average number of the Company’s outstanding common shares during the respective periods. The number of shares used to calculate diluted earnings (loss) per share is based on the number of common shares used to calculate basic earnings (loss) per share plus the dilutive effect of stock options and other stock-based instruments held by the Company’s employees and directors during each period and the 2.375% convertible senior notes due 2015 that are convertible into the Company’s common stock. The convertible senior notes due 2015, which were issued in April 2008, become dilutive for earnings per share calculations when the average share 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. For the three months ended March 31, 2009, the conversion option for the convertible senior notes due 2015 was not in the money, therefore there was no dilutive earnings per share impact.
The computations of basic and diluted net income per share are set forth below:
Inventories consisted of the following:
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(5) Income Taxes
The income tax provision from continuing operations and discontinued operations for the three months ended March 31, 2009 is 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:
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 Statement of Financial Accounting Standards (“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.
(6) Long-Term Debt
Long-term debt consisted of the following:
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Term Loan and Revolving Credit Facility
The Company has a senior secured credit facility (“Credit Agreement”) with a group of lending institutions led by Citicorp North America, Inc. as the administrative agent, which consists of a $250,000 term loan facility and a $375,000 revolving credit facility. As of March 31, 2009, the Company had $361,926 available under the revolving credit facility. The revolving credit facility will terminate in October 2010 and the term loan will mature in October 2012.
The Credit Agreement places restrictions on the ability of Alpha Natural Resources LLC (“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 March 31, 2009, the Company has a $233,125 term loan outstanding with a variable interest rate based upon the 3-month London Interbank Offered Rate (“LIBOR”) (1.25% at March 31, 2009) plus the applicable margin (1.50% at March 31, 2009). 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 the 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 in 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 quarters ended March 31, 2009 and 2008. The fair value of the swap at March 31, 2009 was $27,897 which was recorded in other liabilities in the condensed consolidated balance sheet and the offsetting unrealized loss of $20,937, 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.
2.375% Convertible Senior Notes Due June 2015
In April 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 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.
On January 1, 2009, the Company adopted 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. Upon adoption of FSP APB 14-1, the Company retrospectively applied the change in accounting principle to prior accounting periods. Adoption of the standard resulted in the following balance sheet impacts at December 31, 2008: (1) a reduction of debt by $87,830 and an increase in paid in capital of $69,851, (2) an increase to deferred loan costs of $5,309, (3) a net reduction to deferred tax assets of $23,124 ($36,262 reduction in deferred tax assets, offset by a $13,138 change in the valuation allowance), and (4) a net increase in retained earnings of $164. The adoption of FSP APB 14-1 resulted in an increase to non-cash interest expense of $2,838 for the three month period ending March 31, 2009, of which $2,626 is related to the accretion of the convertible debt discount and $212 is related to the amortization of the deferred loan fees that were reestablished as described above. The deferred loan fees and debt discount will be amortized and accreted, respectively, over the term of the convertible notes, which are due in 2015. Adoption of the standard had no impact on the results of operations for the three months ended March 31, 2008.
As of March 31, 2009, the notes were not convertible, and the carrying amounts of the debt and the equity components were $202,296 and $95,511, respectively. The unamortized discount of the liability was $85,204 at March 31, 2009 and will continue to be amortized over 6 years. For the period ending March 31, 2009, the effective interest rate on the liability component was 8.64% and the Company recognized interest expense of $1,707 and $2,626 on the contractual interest coupon and amortization on the discount of the liability, respectively.
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Accounts Receivable Securitization
On March 25, 2009, the Company and certain subsidiaries became a party to an $85,000 accounts receivable securitization facility with a third party financial institution (the “A/R Facility”) by forming ANR Receivables Funding, LLC (the “SPE”), a special-purpose, bankruptcy-remote subsidiary, wholly-owned indirectly by Alpha Natural Resources, Inc. The sole purpose of the SPE is to purchase trade receivables generated by certain of the Company’s operating subsidiaries, without recourse (other than customary indemnification obligations for breaches of specific representations and warranties), and then transfer senior undivided interests in up to $85,000 of those accounts receivable to a financial institution for the issuance of letters of credit or for cash borrowings for the ultimate benefit of the Company.
The SPE is consolidated into the Company’s financial statements, and therefore the A/R Facility has no impact on the Company’s consolidated financial statements as of or for the period ended March 31, 2009. The assets of the SPE, however, are not available to the creditors of the Company or any other subsidiary. The SPE pays facility fees, program fees and letter of credit fees (based on amounts of outstanding letters of credit), as defined in the definitive agreements for the A/R Facility. Available borrowing capacity is based on the amount of eligible accounts receivable as defined under the terms of the definitive agreements for the A/R Facility. The receivables purchase agreement supporting the borrowings under the A/R Facility is subject to renewal annually and, unless terminated earlier, expires March 24, 2010.
As of March 31, 2009, letters of credit in the amount $67,000 were outstanding under the A/R Facility and no cash borrowing transactions had taken place. At March 31, 2009, the SPE had available borrowing capacity under the A/R Facility of $10,800. Under the A/R Facility, the SPE is subject to certain affirmative, negative and financial covenants customary for financings of this type, including restrictions related to, among other things, liens, payments, merger or consolidation and amendments to the agreements underlying the receivables pool. Alpha Natural Resources, Inc. has agreed to guarantee the performance by its subsidiaries, other than the SPE, of their obligations under the A/R Facility. The Company does not guarantee repayment of the SPE’s debt under the A/R Facility. The financial institution, which is the administrator, may terminate the A/R Facility upon the occurrence of certain events that are customary for facilities of this type (with customary grace periods, if applicable), including, among other things, breaches of covenants, inaccuracies of representations and warranties, bankruptcy and insolvency events, changes in the rate of default or delinquency of the receivables above specified levels, a change of control and material judgments. A termination event would permit the administrator to terminate the program and enforce any and all rights and remedies, subject to cure provisions, where applicable.
(7) Asset Retirement Obligation
At March 31, 2009 and December 31, 2008, the Company has recorded asset retirement obligation accruals for mine reclamation and closure costs totaling $101,060 and $98,940, respectively. The portion of the costs expected to be incurred within a year in the amounts of $9,037 and $8,375 at March 31, 2009 and December 31, 2008, respectively, are included in accrued expenses and other current liabilities. These regulatory obligations are secured by surety bonds in the amount of $159,497 at March 31, 2009 and $148,952 at December 31, 2008. Changes in the reclamation obligation were as follows:
(8) Share-Based Compensation Awards
As of March 31, 2009, the total number of shares of Alpha Natural Resources, Inc. common stock available for issuance or delivery under the Company’s current Long-Term Incentive Plan (“LTIP”) was 4,607,820 shares. During the three months ended March 31, 2009 and 2008, all shared-based compensation awards granted by the Company consisted of non-vested restricted shares, non-vested performance shares, and restricted stock units.
Share-based compensation expense totaled $3,225 and $2,989 for the three months ended March 31, 2009 and 2008, respectively.
For the three months ended March 31, 2009 and 2008, approximately 72% and 66%, 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 13), and approximately 28% and 34%, respectively, is reported as a component of cost of sales, included in the Coal Operations and All Other segment for segment reporting purposes (Note 13). As of March 31, 2009 and December 31, 2008, approximately $242 and $170, respectively, of share-based compensation costs was capitalized as a component of inventories. The Company reports 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 March 31, 2009 and 2008 were $0 and $734, respectively.
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In November 2008, the Board of Directors authorized the Company to repurchase common shares from employees to satisfy the employees’ minimum statutory tax withholdings upon the vesting of restricted stock and performance shares. During the three months ended March 31, 2009, 418,433 shares of the Company’s common stock granted to employees vested. During the three months ended March 31, 2009, the Company repurchased 106,739 common shares from employees to satisfy the employees’ minimum statutory tax withholdings upon vesting at an average price paid per share of $18.96.
Stock option activity for the three months ended March 31, 2009 is summarized in the following table:
The aggregate intrinsic value of options outstanding at March 31, 2009 was $722 and the aggregate intrinsic value of exercisable options was $339. The total intrinsic value of options exercised during the three months ended March 31, 2009 and 2008 was $0 and $2,048, respectively. Cash received from the exercise of stock options during the three months ended March 31, 2009 and 2008 was $0 and $1,688, respectively. As of March 31, 2009, $1,219 of unrecognized compensation cost related to stock options is expected to be recognized as expense over a weighted-average period of 0.79 years. The weighted-average grant date fair value of options outstanding at March 31, 2009 and 2008 was $7.33 and $7.38, respectively.
Restricted Share Awards
Restricted share award activity for the three months ended March 31, 2009 is summarized in the following table:
The Company granted 917,684 restricted share awards during the three month period ending March 31, 2009. The restricted shares vest ratably over three-years or cliff vest after three years (with accelerated vesting upon a change of control), depending on the recipients’ position with the Company.
The fair value of 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 March 31, 2009, there was $20,484 of unamortized compensation cost related to non-vested shares, which is expected to be recognized as expense over a weighted-average period of 2.32 years.
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Performance Share Awards
Performance share award activity for the three months ended March 31, 2009 is summarized in the following table:
The Company issued 35,219 performance shares to employees on February 10, 2009, related to the 2006 performance grant, which ended on December 31, 2008. Based upon the Company’s performance against the pre-established operating income and return on invested capital targets, a 30% award was issued to employees.
The Company granted 403,592 performance share awards during the three month period ending March 31, 2009. 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, 2011, 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% to 200% 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.
As of March 31, 2009, there was $6,828 of unamortized compensation cost related to the outstanding performance share awards. This unamortized compensation cost is expected to be recognized over the remaining periods up to December 31, 2011.
(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.
On January 1, 2009, the Company adopted SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (“SFAS 161”), which amends SFAS 133. SFAS 161 requires enhanced disclosures about derivative instruments and hedging activities to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. The new standard also increases required disclosures regarding 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. Since SFAS 161 requires only additional disclosures concerning derivatives and hedging activities, the adoption of SFAS 161 did not affect the Company’s financial position and results of operations. The required disclosures for SFAS 161 are included in this footnote.
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 March 31, 2009, the Company had unrealized gains (losses) on open sales and open purchase contracts of $4,568 and ($5,617), respectively. The unrealized gains of $4,568 on open sales contracts are recorded in prepaid expenses and other current assets. The unrealized losses on open purchase contracts are recorded in accrued expenses and other current liabilities and other liabilities in the amount of ($5,392) and ($225), respectively.
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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. At March 31, 2009, the fair value of the interest rate swap agreements is a liability of $27,897, which is recorded in other liabilities.
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. Changes in fair value are recognized in earnings if they are not eligible for hedge accounting or other comprehensive income if they qualify for hedge accounting. Most of 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 accrued expenses and other current liabilities and other liabilities and any unrealized gain is recorded in prepaid expenses and other current assets and other assets. For any hedges that qualify for hedge accounting, the effective portion of any unrealized gain or loss is recorded in accumulated other comprehensive income (loss) and any ineffective portion of any unrealized gain (loss) is recorded as an (increase) decrease in fair value of certain derivative instruments, net.
As of March 31, 2009, approximately 11,670 gallons or 52% of the Company's budgeted 2009 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 11,670 gallons range from $1.61 to $4.10 per gallon for the last nine months of 2009. In addition, as of March 31, 2009, the Company has in place swap agreements with respect to 19,310 gallons, at fixed prices ranging from $1.79 to $3.86 per gallon, which mature in 2010 to 2012. At March 31, 2009, the fair value of these diesel fuel swap agreements is a net liability of $36,255, which is recorded in other assets in the amount of $49, accrued expenses and other current liabilities in the amount of $21,023, and in other liabilities in the amount of $15,281.
The Company has also employed an options strategy – both purchasing and selling put options – to protect cash flows in the event diesel fuel prices decline. As of March 31, 2009, the Company had purchased put options for 1,323 gallons at a strike price of $3.50 per gallon for the second quarter of 2009. In the event that No. 2 heating oil prices decline below the strike price, the Company can exercise the put options and sell the 1,323 gallons at the strike price, therefore reducing the negative impact of any of the swap agreements that have settlement prices above market. As of March 31, 2009, the Company had sold put options for 1,323 gallons for the second quarter 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 March 31, 2009, the fair value of all diesel fuel put options is a net asset of $655 of which $2,761 is recorded in prepaid expenses and other current assets and $2,106 is recorded in accrued expenses and other current liabilities.
The following are the derivatives in cash flow hedging relationships and derivatives not designated as hedging instruments, and their related effect in assets as of March 31, 2009 and December 31, 2008:
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The following are the derivatives in cash flow hedging relationships and derivatives not designated as hedging instruments, and their related effect in liabilities as of March 31, 2009 and December 31, 2008:
The following are the derivatives in cash flow hedging relationships and their related effect in the Income Statement and Other Comprehensive Income for the periods ending March 31, 2009 and 2008:
The following are the derivatives not designated as hedging instruments and their related effect in the Income Statement for the periods ending March 31, 2009 and 2008: