QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
or
( )
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number: 1-16463
PEABODY ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
13-4004153
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
701 Market Street, St. Louis, Missouri
63101-1826
(Address of principal executive offices)
(Zip Code)
(314) 342-3400
(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. Yes ( X ) 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 (§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 ( X ) 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. (Check one):
Large accelerated filer ( X )
Accelerated filer ( )
Non-accelerated filer ( )
Smaller reporting company ( )
(Do not check if a 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 ( ) No ( X )
There were 272,392,200 shares of common stock with a par value of $0.01 per share outstanding at April 27, 2012.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended March 31,
2012
2011
(Dollars in millions)
Net income
$
178.3
$
178.7
Other comprehensive income, net of income taxes:
Net unrealized holding gains (losses) on available-for-sale securities (net of $6.7 and $0.0 tax benefit for the three months ended March 31, 2012 and 2011, respectively)
(11.5
)
1.0
Net unrealized gains on cash flow hedges (net of $31.4 and $34.3 tax provision for the three months ended March 31, 2012 and 2011, respectively)
Increase in fair value of cash flow hedges
147.8
88.5
Less: Reclassification for realized gains included in net income
(84.2
)
(56.0
)
Net unrealized gains on cash flow hedges
63.6
32.5
Postretirement plans and workers' compensation obligations (net of $8.1 and $0.2 tax provision for the three months ended March 31, 2012 and 2011, respectively)
Net actuarial loss for the period
—
3.5
Amortization of actuarial loss and prior service cost
13.9
10.0
Postretirement plan and workers' compensation obligations
13.9
13.5
Foreign currency translation adjustment
12.7
—
Other comprehensive income
78.7
47.0
Comprehensive income
257.0
225.7
Less: Comprehensive income attributable to noncontrolling interests
5.6
2.2
Comprehensive income attributable to common stockholders
$
251.4
$
223.5
See accompanying notes to unaudited condensed consolidated financial statements.
Accounts receivable, net of allowance for doubtful accounts of $16.6 at March 31,
2012 and $17.0 at December 31, 2011
748.1
922.5
Inventories
514.9
446.3
Assets from coal trading activities, net
43.3
44.6
Deferred income taxes
24.3
27.3
Other current assets
746.7
766.1
Total current assets
3,029.7
3,005.9
Property, plant, equipment and mine development
Land and coal interests
11,542.1
10,781.0
Buildings and improvements
1,229.8
1,131.4
Machinery and equipment
2,743.0
2,862.4
Less: accumulated depreciation, depletion and amortization
(3,545.8
)
(3,412.1
)
Property, plant, equipment and mine development, net
11,969.1
11,362.7
Investments and other assets
1,938.3
2,364.4
Total assets
$
16,937.1
$
16,733.0
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Current maturities of long-term debt
$
114.6
$
101.1
Liabilities from coal trading activities, net
14.6
10.3
Accounts payable and accrued expenses
1,502.8
1,712.3
Total current liabilities
1,632.0
1,823.7
Long-term debt, less current maturities
6,538.4
6,556.4
Deferred income taxes
590.8
554.2
Asset retirement obligations
637.0
621.3
Accrued postretirement benefit costs
1,051.6
1,053.1
Other noncurrent liabilities
674.5
608.5
Total liabilities
11,124.3
11,217.2
Stockholders’ equity
Preferred Stock — $0.01 per share par value; 10.0 shares authorized, no shares
issued or outstanding as of March 31, 2012 or December 31, 2011
—
—
Series A Junior Participating Preferred Stock — $0.01 per share par value; 1.5 shares authorized, no shares issued or outstanding as of March 31, 2012 or December 31, 2011
—
—
Perpetual Preferred Stock — 0.8 shares authorized, no shares issued or outstanding
as of March 31, 2012 or December 31, 2011
—
—
Series Common Stock — $0.01 per share par value; 40.0 shares authorized, no
shares issued or outstanding as of March 31, 2012 or December 31, 2011
—
—
Common Stock — $0.01 per share par value; 800.0 shares authorized, 281.7 shares issued and 272.3 shares outstanding as of March 31, 2012 and 280.3 shares issued and 271.1 shares outstanding as of December 31, 2011
2.8
2.8
Additional paid-in capital
2,255.2
2,234.0
Retained earnings
3,893.5
3,744.0
Accumulated other comprehensive loss
(63.7
)
(142.4
)
Treasury shares, at cost: 9.4 shares as of March 31, 2012 and 9.2
shares as of December 31, 2011
(361.2
)
(353.3
)
Peabody Energy Corporation’s stockholders’ equity
5,726.6
5,485.1
Noncontrolling interests
86.2
30.7
Total stockholders’ equity
5,812.8
5,515.8
Total liabilities and stockholders’ equity
$
16,937.1
$
16,733.0
See accompanying notes to unaudited condensed consolidated financial statements.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
The condensed consolidated financial statements include the accounts of Peabody Energy Corporation (the Company) and its affiliates. All intercompany transactions, profits and balances have been eliminated in consolidation.
The accompanying condensed consolidated financial statements as of March 31, 2012 and for the three months ended March 31, 2012 and 2011, and the notes thereto, are unaudited. However, in the opinion of management, these financial statements reflect all normal, recurring adjustments necessary for a fair presentation of the results of the periods presented. The balance sheet information as of December 31, 2011 has been derived from the Company’s audited consolidated balance sheet. The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results to be expected for future quarters or for the year ending December 31, 2012.
The Company classifies items within discontinued operations in the unaudited condensed consolidated financial statements when the operations and cash flows of a particular component (defined as operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity) of the Company have been (or will be) eliminated from the ongoing operations of the Company as a result of a disposal transaction, and the Company will no longer have any significant continuing involvement in the operations of that component.
(2) Newly Adopted Accounting Standards and Accounting Standards Not Yet Implemented
In January 2010, the Financial Accounting Standards Board (FASB) issued accounting guidance that required new fair value disclosures, including disclosures about significant transfers into and out of Level 1 and Level 2 fair value measurements and a description of the reasons for the transfers. In addition, the guidance required new disclosures regarding activity in Level 3 fair value measurements, including a gross basis reconciliation. The Company began complying with the new fair value disclosure requirements beginning January 1, 2010, except for the disclosure of activity within Level 3 fair value measurements, which became effective January 1, 2011. In May 2011, the FASB issued additional fair value measurement disclosure requirements that were intended to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between United States (U.S.) generally accepted accounting principles (GAAP) and International Financial Reporting Standards. That update required the categorization by level for financial instruments not measured at fair value but for which disclosure of fair value is required, disclosure of all transfers between Level 1 and Level 2, and additional disclosures for Level 3 measurements regarding the sensitivity of fair value to changes in unobservable inputs and any interrelationships between those inputs. The guidance became effective for interim and annual periods beginning after December 15, 2011 (January 1, 2012 for the Company). While the adoption of this guidance had an impact on the Company's disclosures, it did not affect the Company's results of operations, financial condition or cash flows.
(3) Acquisition of Macarthur Coal Limited
On October 23, 2011, PEAMCoal Pty Ltd (PEAMCoal), an Australian company that was then indirectly owned 60% by the Company and 40% by ArcelorMittal, acquired a majority interest in Macarthur Coal Limited (Macarthur) through an all cash off-market takeover offer. On October 26, 2011 (the acquisition and control date), the Company appointed its nominees to the Macarthur Board of Directors and executive management team. The acquisition was completed on December 20, 2011 as PEAMCoal acquired all of Macarthur's remaining outstanding shares of common stock for $4.8 billion, net of $261.2 million of acquired cash, of which the Company's share was $2.8 billion. PEAMCoal accounted for share acceptances under the takeover process as a single transaction occurring on October 26, 2011. On December 21, 2011, the Company acquired ArcelorMittal Mining Australasia B.V., an indirect subsidiary of ArcelorMittal that indirectly owned 40% of PEAMCoal, for $2.0 billion resulting in the Company's 100% ownership of Macarthur.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The preliminary purchase accounting allocations were recorded in the accompanying unaudited condensed consolidated financial statements as of, and for the periods subsequent to the acquisition and control date. The Company has not yet finalized the fair value determination of the assets acquired and liabilities assumed, which is expected once third-party valuation appraisals are completed. The Company is evaluating mine lives and reviewing coal reserve studies on the acquired properties, the outcome of which will determine the final fair value allocated to coal reserve assets. The following table summarizes the preliminary estimated fair values of assets acquired and liabilities assumed that were recognized at the acquisition and control date as well as provisional fair value adjustments made during the first quarter of 2012:
Preliminary
Updated
Allocations
Adjustments
Allocations
(Dollars in millions)
Accounts receivable, net
$
106.6
$
7.7
$
114.3
Inventories
67.1
(10.1
)
57.0
Other current assets
137.5
(3.9
)
133.6
Property, plant, equipment and mine development
3,457.0
112.5
3,569.5
Investments and other assets
1,275.1
(78.7
)
1,196.4
Current maturities of long-term debt
(11.0
)
—
(11.0
)
Accounts payable and accrued expenses
(133.8
)
(25.0
)
(158.8
)
Long-term debt, less current maturities
(59.2
)
—
(59.2
)
Asset retirement obligations
(39.3
)
—
(39.3
)
Other noncurrent liabilities
(31.4
)
(2.5
)
(33.9
)
Noncontrolling interests
(2,011.9
)
—
(2,011.9
)
Total purchase price, net of cash acquired of $261.2
$
2,756.7
$
—
$
2,756.7
The adjustments to the provisional fair values result from additional information obtained about facts in existence at the acquisition and control date. Adjustments to provisional fair values are assumed to have been made as of the acquisition and control date. As a result, "Operating costs and expenses" and "Depreciation, depletion and amortization" for the fourth quarter of 2011 would have been lower by $10.1 million and $10.6 million, respectively, than was previously reported. The results in the unaudited condensed consolidated statements of income reflect these adjustments in the first quarter of 2012.
In connection with the acquisition, the Company acquired contract based intangibles consisting of port, rail and water take-or-pay obligations and recorded a liability for unutilized capacity of $33.3 million, net of tax, which is being amortized based on that unutilized capacity over the terms of the applicable agreements which extend to 2018. As of March 31, 2012, the carrying value of the liability was $30.2 million and the amortization (reduction to “Operating costs and expenses” in the unaudited condensed consolidated statement of income) recorded through March 31, 2012 was $3.1 million. Estimated amortization as of March 31, 2012 is $11.4 million, $17.1 million and $1.7 million for the years ending December 31, 2012, 2013 and 2014, respectively. Unutilized capacity is not expected in years 2015 through 2018.
Macarthur contributed revenues of $145.2 million and a net loss of $6.5 million during the three months ended March 31, 2012, which includes results from our equity affiliate investment in the Middlemount Mine which is ramping up operations. The results of Macarthur for the three months ended March 31, 2012 are included in the unaudited condensed consolidated statements of income and are reported in the Australian Mining segment, except for the activity associated with certain equity affiliate investments, which is reflected in the Corporate and Other segment.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following unaudited pro forma financial information presents the combined results of operations of the Company and Macarthur, on a pro forma basis, as though the companies had been combined as of January 1, 2011. The unaudited pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and Macarthur constituted a single entity during those periods or that may be attained in the future.
Three Months Ended
March 31, 2011
(Dollars in millions, except earnings per share)
Revenue
$
1,807.8
Income from continuing operations, net of income taxes
113.1
Basic earnings per share
0.35
Diluted earnings per share
0.35
The pro forma income from continuing operations, net of income taxes, includes adjustments to operating costs to reflect the additional expense for the estimated impact of the fair value adjustment for coal inventory, the estimated impact on depreciation, depletion and amortization for the fair value adjustment for property, plant and equipment (including mineral rights) and additional expense for the estimated impact of reflecting the equity affiliate interest at its estimated fair value.
As disclosed in Note 23 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, an outstanding loan balance of $384.6 million was converted to a 90% equity interest in MCG Coal Holdings Pty Ltd. (MCGH), resulting in consolidation of MCGH and recognition of noncontrolling interests of $53.4 million at conversion.
(4) Discontinued Operations
Discontinued operations include certain non-strategic Midwestern and Australian mining assets held for sale where the Company has committed to the divestiture of such assets and other operations recently divested.
Revenues resulting from discontinued operations (including assets held for sale) were $48.4 million and $1.8 million for the three months ended March 31, 2012 and March 31, 2011, respectively. Losses before income taxes from discontinued operations were $8.2 million and $21.5 million for the three months ended March 31, 2012 and March 31, 2011, respectively. The income tax adjustment resulting from discontinued operations reflects a benefit of $4.2 million and $5.6 million for the three months ended March 31, 2012 and March 31, 2011, respectively.
Total assets related to discontinued operations were $156.3 million as of March 31, 2012 and $143.7 million as of December 31, 2011. Total liabilities associated with discontinued operations were $65.9 million as of March 31, 2012 and $86.3 million as of December 31, 2011.
(5) Investments
The Company’s short-term investments are defined as those investments with original maturities of greater than three months and up to one year, and long-term investments are defined as those investments with original maturities greater than one year.
The Company classifies its investments as either held-to-maturity or available-for-sale at the time of purchase and reevaluates such designation periodically. Investments are classified as held-to-maturity when the Company has the intent and ability to hold the securities to maturity.
Investments in securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of income taxes, reported in “Accumulated other comprehensive loss” in the condensed consolidated balance sheets. Realized gains and losses, determined on a specific identification method, are included in “Interest income” in the unaudited condensed consolidated statements of income.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company did not have any held-to-maturity securities as of March 31, 2012 or December 31, 2011.
Investments in available-for-sale securities at March 31, 2012 were as follows:
Available-for-sale securities
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
(Dollars in millions)
Current:
Federal government securities
$
2.9
$
—
$
—
$
2.9
U.S. corporate bonds
5.2
—
—
5.2
Noncurrent:
Marketable equity securities
66.5
—
(27.6
)
38.9
Federal government securities
11.3
0.2
—
11.5
U.S. corporate bonds
4.9
0.2
—
5.1
Total
$
90.8
$
0.4
$
(27.6
)
$
63.6
Investments in available-for-sale securities at December 31, 2011 were as follows:
Available-for-sale securities
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
(Dollars in millions)
Current:
Federal government securities
$
3.3
$
—
$
—
$
3.3
U.S. corporate bonds
3.9
—
—
3.9
Noncurrent:
Marketable equity securities
66.5
—
(9.5
)
57.0
Federal government securities
11.3
0.2
—
11.5
U.S. corporate bonds
7.7
0.1
—
7.8
Total
$
92.7
$
0.3
$
(9.5
)
$
83.5
Contractual maturities for available-for-sale investments in debt securities at March 31, 2012 were as shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Contractual maturities for available-for-sale securities
Cost
Fair Value
(Dollars in millions)
Due in one year or less
$
8.1
$
8.1
Due in one to five years
16.2
16.6
Total
$
24.3
$
24.7
The Company’s investments in marketable equity securities consist of an investment in Winsway Coking Coal Holdings Limited.
Proceeds from sales and maturities of securities amounted to $1.7 million with no realized gain or loss on the sales for the three months ended March 31, 2012.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In addition to the securities described above, the Company held investments in debt securities related to the Company's pro-rata share of funding in the Newcastle Coal Infrastructure Group (NCIG). These debt securities are recorded at cost, which approximates fair value, and are denominated in U.S. dollars. During the three months ended March 31, 2012, the Company sold $1.4 million of the debt securities related to NCIG, with no realized gain or loss on the sale. The fair value of these securities still held at March 31, 2012 was $28.0 million.
At each reporting date, the Company performs separate evaluations of debt and equity securities to determine if any unrealized losses are other-than-temporary. None of the securities that were in an unrealized loss position at March 31, 2012 has been so for greater than 12 months. The Company did not recognize any other-than-temporary losses on any of its investments during the three months ended March 31, 2012.
(6) Inventories
Inventories consisted of the following:
March 31, 2012
December 31, 2011
(Dollars in millions)
Materials and supplies
$
134.6
$
124.9
Raw coal
125.1
95.0
Saleable coal
255.2
226.4
Total
$
514.9
$
446.3
(7) Derivatives and Fair Value Measurements
Risk Management — Non-Coal Trading Activities
The Company is exposed to various types of risk in the normal course of business, including price risk on commodities utilized in the Company's operations, interest rate risk on long-term debt, and foreign currency exchange rate risk for non-U.S. dollar expenditures. In most cases, commodity price risk (excluding coal trading activities) related to the sale of coal is mitigated through the use of long-term, fixed-price contracts, with a small percentage mitigated through the use of financial instruments. For the price risk exposure on other commodities, as well as for the interest rate risk and foreign currency exchange rate risk, the Company utilizes financial derivative instruments to manage the risks related to these fluctuations. All of these risks are actively monitored in an effort to ensure compliance with the risk management policies of the Company.
Interest Rate Swaps. The Company is exposed to interest rate risk on its fixed rate and variable rate long-term debt. From time to time, the Company manages the interest rate risk associated with the fair value of its fixed rate borrowings using fixed-to-floating interest rate swaps to effectively convert a portion of the underlying cash flows on the debt into variable rate cash flows. The Company designates these swaps as fair value hedges, with the objective of hedging against changes in the fair value of the fixed rate debt that results from market interest rate changes. From time to time, the interest rate risk associated with the Company’s variable rate borrowings is managed using floating-to-fixed interest rate swaps. The Company designates these swaps as cash flow hedges, with the objective of reducing the variability of cash flows associated with market interest rate changes. As of March 31, 2012, the Company had no interest rate swaps in place.
Foreign Currency Hedges. The Company is exposed to foreign currency exchange rate risk, primarily on Australian dollar expenditures made in its Australian Mining segment. This risk is managed by entering into forward contracts and options that the Company designates as cash flow hedges, with the objective of reducing the variability of cash flows associated with forecasted foreign currency expenditures.
Diesel Fuel and Explosives Hedges. The Company is exposed to commodity price risk associated with diesel fuel and explosives in the U.S. and Australia. This risk is managed through the use of cost pass-through contracts and derivatives, primarily swaps. The Company generally designates the swap contracts as cash flow hedges, with the objective of reducing the variability of cash flows associated with forecasted diesel fuel and explosives purchases.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Notional Amounts and Fair Value. The following summarizes the Company’s foreign currency and commodity positions at March 31, 2012:
Notional Amount by Year of Maturity
Total
2012
2013
2014
2015
2016
2017 and
thereafter
Foreign Currency
A$:US$ hedge contracts (A$ millions)
$
4,565.5
$
1,694.9
$
1,651.6
$
1,117.5
$
101.5
$
—
$
—
GBP:US$ hedge contracts (GBP millions)
6.5
6.5
—
—
—
—
—
Commodity Contracts
Diesel fuel hedge contracts (million gallons)
190.0
72.3
73.7
41.0
3.0
—
—
U.S. explosives hedge contracts (million MMBtu)
6.6
2.8
2.6
1.2
—
—
—
Account Classification by
Cash Flow
Hedge
Fair Value
Hedge
Economic
Hedge
Fair Value Asset
(Liability)
(Dollars in millions)
Foreign Currency
A$:US$ hedge contracts (A$ millions)
$
4,565.5
$
—
$
—
$
517.9
GBP:US$ hedge contracts (GBP millions)
6.5
—
—
—
Commodity Contracts
Diesel fuel hedge contracts (million gallons)
190.0
—
—
81.9
U.S. explosives hedge contracts (million MMBtu)
6.6
—
—
(12.7
)
Hedge Ineffectiveness. The Company assesses, both at inception and at least quarterly thereafter, whether the derivatives used in hedging activities are highly effective at offsetting the changes in the anticipated cash flows of the hedged item. The effective portion of the change in the fair value is recorded in “Accumulated other comprehensive loss” until the hedged transaction impacts reported earnings, at which time any gain or loss is also reclassified to earnings. To the extent that the periodic changes in the fair value of the derivatives exceed the changes in the hedged item, the ineffective portion of the periodic non-cash changes are recorded in earnings in the period of the change. If the hedge ceases to qualify for hedge accounting, the Company prospectively recognizes the mark-to-market movements in earnings in the period of the change.
A measure of ineffectiveness is inherent in hedging future diesel fuel purchases with derivative positions based on crude oil and refined petroleum products as a result of location and product differences.
The Company’s derivative positions for the hedging of future explosives purchases are based on natural gas, which is the primary price component of explosives. However, a small measure of ineffectiveness exists as the contractual purchase price includes manufacturing fees that are subject to periodic adjustments. In addition, other fees, such as transportation surcharges, can result in ineffectiveness, but have historically changed infrequently and comprise a small portion of the total explosives cost.
The Company’s derivative positions for the hedging of forecasted foreign currency expenditures contain a small measure of ineffectiveness due to timing differences between the hedge settlement and the purchase transaction, which could differ by less than a day and up to a maximum of 30 days.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The tables below show the classification and amounts of pre-tax gains and losses related to the Company’s non-trading hedges during the three months ended March 31, 2012 and 2011:
Three Months Ended March 31, 2012
Financial Instrument
Income Statement
Classification Gains (Losses) -
Realized
Gain recognized in income
on non-designated
derivatives
Gain recognized in other
comprehensive
income on derivative
(effective portion)
Gain reclassified from
other comprehensive
income into income
(effective portion)
Gain reclassified from
other comprehensive
income into income
(ineffective portion)
(Dollars in millions)
Commodity swaps and options
Operating costs and expenses
$
—
$
58.1
$
17.3
$
4.6
Foreign currency cash flow hedge contracts:
Operating costs and expenses
—
140.3
113.0
—
Total
$
—
$
198.4
$
130.3
$
4.6
Three Months Ended March 31, 2011
Financial Instrument
Income Statement
Classification Gains (Losses) -
Realized
Gain recognized in income
on non-designated
derivatives
Gain recognized in other
comprehensive
income on derivative
(effective portion)
Gain reclassified from
other comprehensive
income into income
(effective portion)
Gain reclassified from
other comprehensive
income into income
(ineffective portion)
(Dollars in millions)
Commodity swaps and options
Operating costs and expenses
$
—
$
99.0
$
8.1
$
2.3
Foreign currency cash flow hedge contracts
Operating costs and expenses
—
119.8
72.7
—
Total
$
—
$
218.8
$
80.8
$
2.3
Based on the net fair value of the Company’s non-coal trading positions held in “Accumulated other comprehensive loss” at March 31, 2012, unrealized gains to be reclassified from comprehensive income to earnings over the next 12 months associated with the Company’s foreign currency and diesel fuel hedge programs are expected to be approximately $284 million and $61 million, respectively, while the unrealized losses to be realized under the explosives hedge program are expected to be approximately $8 million. As these unrealized gains are associated with derivative instruments that represent hedges of forecasted transactions, the amounts reclassified to earnings will partially offset the realized transactions, while the unrealized losses will add incremental expense to the unaudited condensed consolidated statements of income.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The classification and amount of derivatives presented on a gross basis as of March 31, 2012 and December 31, 2011 are as follows:
Fair Value as of March 31, 2012
Financial Instrument
Current
Assets
Noncurrent
Assets
Current
Liabilities
Noncurrent
Liabilities
(Dollars in millions)
Commodity swaps and options
$
61.2
$
22.2
$
8.2
$
6.0
Foreign currency cash flow hedge contracts
284.8
235.6
1.7
0.8
Total
$
346.0
$
257.8
$
9.9
$
6.8
Fair Value as of December 31, 2011
Financial Instrument
Current
Assets
Noncurrent
Assets
Current
Liabilities
Noncurrent
Liabilities
(Dollars in millions)
Commodity swaps and options
$
43.4
$
11.7
$
7.1
$
15.0
Foreign currency cash flow hedge contracts
270.4
229.0
4.3
4.5
Total
$
313.8
$
240.7
$
11.4
$
19.5
After netting by counterparty where permitted, the fair values of the respective derivatives are reflected in “Other current assets,” “Investments and other assets,” “Accounts payable and accrued expenses” and “Other noncurrent liabilities” in the condensed consolidated balance sheets.
See Note 8 for information related to the Company’s coal trading activities.
Fair Value Measurements
The Company uses a three-level fair value hierarchy that categorizes assets and liabilities measured at fair value based on the observability of the inputs utilized in the valuation. These levels include: Level 1, inputs are quoted prices in active markets for the identical assets or liabilities; Level 2, inputs other than quoted prices included in Level 1 that are directly or indirectly observable through market-corroborated inputs; and Level 3, inputs are unobservable, or observable but cannot be market-corroborated, requiring the Company to make assumptions about pricing by market participants.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Financial Instruments Measured on a Recurring Basis. The following tables set forth the hierarchy of the Company’s net financial asset positions for which fair value is measured on a recurring basis:
March 31, 2012
Level 1
Level 2
Level 3
Total
(Dollars in millions)
Investment in debt and equity securities
$
63.6
$
—
$
—
$
63.6
Commodity swaps and options
—
69.2
—
69.2
Foreign currency cash flow hedge contracts
—
517.9
—
517.9
Total net financial assets
$
63.6
$
587.1
$
—
$
650.7
December 31, 2011
Level 1
Level 2
Level 3
Total
(Dollars in millions)
Investment in debt and equity securities
$
83.5
$
—
$
—
$
83.5
Commodity swaps and options
—
33.0
—
33.0
Foreign currency cash flow hedge contracts
—
490.6
—
490.6
Total net financial assets
$
83.5
$
523.6
$
—
$
607.1
For Level 1 and 2 financial assets and liabilities, the Company utilizes both direct and indirect observable price quotes, including interest rate yield curves, exchange indices, broker quotes, published indices and other market quotes. Below is a summary of the Company’s valuation techniques for Level 1 and 2 financial assets and liabilities:
•
Investment in debt and equity securities: valued based on quoted prices in active markets (Level 1).
•
Commodity swaps and options — diesel fuel and explosives: generally valued based on a valuation that is corroborated by the use of market-based pricing (Level 2).
•
Foreign currency cash flow hedge contracts: valued utilizing inputs obtained in quoted public markets (Level 2).
The Company did not have any transfers between levels during the three months ended March 31, 2012 or 2011 for its non-coal trading positions. The Company’s policy is to value all transfers between levels using the beginning of period valuation.
Other Financial Instruments. The following methods and assumptions were used by the Company in estimating fair values for other financial instruments as of March 31, 2012 and December 31, 2011:
•
Cash and cash equivalents, accounts receivable, including those within the Company’s accounts receivable securitization program, and accounts payable and accrued expenses have carrying values which approximate fair value due to the short maturity or the liquid nature of these instruments.
•
The Company’s investments in debt and equity securities related to the Company’s pro-rata share of funding in NCIG are included in “Investments and other assets” in the condensed consolidated balance sheets. The debt securities are recorded at cost, which approximates fair value.
•
Long-term debt fair value estimates are based on observed prices for securities with an active trading market when available (Level 2), and otherwise on estimated borrowing rates to discount the cash flows to their present value (Level 3). The carrying amounts of the 7.875% Senior Notes due 2026 and the Convertible Junior Subordinated Debentures due 2066 (the Debentures) are net of the respective unamortized note discounts.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The carrying amounts and estimated fair values of the Company’s debt are summarized as follows:
March 31, 2012
December 31, 2011
Carrying
Amount
Estimated
Fair Value
Carrying
Amount
Estimated
Fair Value
(Dollars in millions)
Long-term debt
$
6,653.0
$
6,622.3
$
6,657.5
$
6,922.7
Nonperformance and Credit Risk
The fair value of the Company’s non-coal trading derivative assets and liabilities reflects adjustments for nonperformance and credit risk. The Company manages its counterparty risk through established credit standards, diversification of counterparties, utilizing investment grade commercial banks and continuous monitoring of counterparty creditworthiness. To reduce its credit exposure for these hedging activities, the Company seeks to enter into netting agreements with counterparties that permit the Company to offset asset and liability positions with such counterparties.
(8) Coal Trading
Risk Management
The Company engages in direct and brokered trading of coal, ocean freight and fuel-related commodities in over-the-counter markets (coal trading), some of which is subsequently exchange-cleared and some of which is bilaterally-settled. Except those for which the Company has elected to apply a normal purchases and normal sales exception, all derivative coal trading contracts are accounted for on a fair value basis.
The Company’s policy is to include instruments associated with coal trading transactions as a part of its trading book. Trading revenues are recorded in “Other revenues” in the unaudited condensed consolidated statements of income and include realized and unrealized gains and losses on derivative instruments, including coal deliveries related to contracts accounted for under the normal purchases and normal sales exception. Therefore, the Company has elected the trading exemption to reflect the disclosures for its coal trading activities.
Three Months Ended March 31,
Trading Revenues by Type of Instrument
2012
2011
(Dollars in millions)
Commodity swaps and options
$
10.8
$
(31.8
)
Physical commodity purchase/sale contracts
9.1
21.9
Total trading revenues
$
19.9
$
(9.9
)
Hedge Ineffectiveness. The Company assesses, both at inception and at least quarterly thereafter, whether the derivatives used in hedging activities are highly effective at offsetting the changes in the anticipated cash flows of the hedged item. The effective portion of the change in the fair value is recorded in “Accumulated other comprehensive loss” until the hedged transaction impacts reported earnings, at which time gains and losses are also reclassified to earnings. To the extent that the periodic changes in the fair value of the derivatives exceed the changes in the hedged item, the ineffective portion of the periodic non-cash changes are recorded in earnings in the period of the change. If the hedge ceases to qualify for hedge accounting, the Company prospectively recognizes the mark-to-market movements in earnings in the period of the change.
In some instances, the Company has designated an existing coal trading derivative as a hedge and, thus, the derivative has a non-zero fair value at hedge inception. The “off-market” nature of these derivatives, which is best described as an embedded financing element within the derivative, is a source of ineffectiveness. In other instances, the Company uses a coal trading derivative that settles at a different time, has different quality specifications, or has a different location basis than the occurrence of the cash flow being hedged. These collectively yield ineffectiveness to the extent that the derivative hedge contract does not exactly offset changes in the fair value or expected cash flows of the hedged item.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Forecasted Transactions No Longer Probable. During the three months ended March 31, 2012, the Company reclassified losses of $1.2 million out of “Accumulated other comprehensive loss” to earnings as the underlying forecasted transactions were deemed no longer probable of occurring.
Fair Value Measurements
The fair value of assets and liabilities from coal trading activities is set forth below:
March 31, 2012
December 31, 2011
Gross Basis
Net Basis
Gross Basis
Net Basis
(Dollars in millions)
Assets from coal trading activities
$
196.0
$
43.3
$
170.4
$
44.6
Liabilities from coal trading activities
(95.7
)
(14.6
)
(84.0
)
(10.3
)
Subtotal
100.3
28.7
86.4
34.3
Net margin held (1)
(71.6
)
—
(52.1
)
—
Net value of coal trading positions
$
28.7
$
28.7
$
34.3
$
34.3
(1)
Represents margin held from exchanges of $71.6 million and $52.1 million at March 31, 2012 and December 31, 2011, respectively. Of the margin held at March 31, 2012 and December 31, 2011, approximately $50 million and $23 million, respectively, related to cash flow hedges.
The Company’s trading assets and liabilities are generally made up of forward contracts, financial swaps and margin. The fair value of coal trading positions designated as cash flow hedges of forecasted sales was an asset (before application of margin) of $48.8 million and $22.4 million as of March 31, 2012 and December 31, 2011, respectively.
The following tables set forth the hierarchy of the Company’s net financial asset (liability) coal trading positions for which fair value is measured on a recurring basis:
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For Level 1 and 2 financial assets and liabilities, the Company utilizes both direct and indirect observable price quotes, including U.S. interest rate curves, LIBOR yield curves, Chicago Mercantile Exchange (CME), New York Mercantile Exchange (NYMEX), Intercontinental Exchange indices (ICE), NOS Clearing ASA, LCH.Clearnet (formerly known as the London Clearing House), Singapore Exchange (SGX), broker quotes, published indices and other market quotes. Below is a summary of the Company’s valuation techniques for Level 1 and 2 financial assets and liabilities:
•
Commodity swaps and options: generally valued based on unadjusted quoted prices in active markets (Level 1) or a valuation that is corroborated by the use of market-based pricing (Level 2).
•
Physical commodity purchase/sale contracts: purchases and sales at locations with significant market activity corroborated by market-based information (Level 2).
Physical commodity purchase/sale contracts transacted in less liquid markets or contracts, such as long-term arrangements with limited price availability, are classified in Level 3. Indicators of less liquid markets are those with periods of low trade activity or when broker quotes reflect wide pricing spreads. The Company's risk management function is responsible for valuation policies and procedures, with oversight from executive management. Generally, the Company's Level 3 instruments or contracts are valued using internally generated models that include bid/ask price quotations, other market assessments obtained from multiple, independent third-party brokers or other transactional data. While the Company does not anticipate any decrease in the number of third-party brokers or market liquidity, such events could erode the quality of market information and therefore the valuing of its market positions should the number of third-party brokers decrease or if market liquidity is reduced. The Company's valuation techniques also include basis adjustments for quality, such as heat rate, sulfur content and ash content, location differentials, expressed as port and freight costs, and credit and nonperformance risk. The Company validates its valuation inputs, including unobservable inputs, with third-party information and settlement prices from other sources where available. A daily process is performed to analyze market price changes and changes to the portfolio. Further periodic validation occurs at the time contracts are settled with the counterparty. The Company has consistently applied these valuation techniques in all periods presented, and believes it has obtained the most accurate information available for the types of derivative contracts held.
The Company's Level 3 fair value measures include physical commodity purchase and sale contracts in the amount of $8.9 million at March 31, 2012. These contracts are valued using internally developed models with unobservable inputs related to quality adjustments, location differentials and nonperformance risk. Quality adjustments range from 5% to 20% of the overall valuation with a weighted average of 11%. Location differentials range from 20% to 45% of the overall valuation with a weighted average of 24%. Nonperformance adjustments are 4% of the overall valuation. Significant increases or decreases in the inputs in isolation could result in a significantly higher or lower fair value measurement. The unobservable inputs generally do not have a direct interrelationship, therefore, a change in one unobservable input would not necessarily lead to a change in the other unobservable input.
The following table summarizes the changes in the Company’s recurring Level 3 net financial assets:
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table summarizes the changes in net unrealized gains relating to Level 3 net financial assets held both as of the beginning and the end of the period:
Three Months Ended March 31,
2012
2011
(Dollars in millions)
Changes in net unrealized gains (1)
$
1.9
$
10.0
(1)
Within the unaudited condensed consolidated statements of income and unaudited condensed consolidated statements of comprehensive income for the periods presented, unrealized gains and losses from Level 3 items are combined with unrealized gains and losses on positions classified in Level 1 or 2, as well as other positions that have been realized during the applicable periods.
The Company did not have any significant transfers in its coal trading positions between Level 1 and Level 2 during the three months ended March 31, 2012 or 2011. There were no transfers in or out of Level 3 during the three months ended March 31, 2012. During the three months ended March 31, 2011, certain of the Company's physical commodity purchase/sale contracts were transferred from Level 3 to Level 2 as the settlement dates entered a more liquid market. The Company’s policy is to value all transfers between levels using the beginning of period valuation.
Based on the net fair value of the Company’s coal trading positions held in “Accumulated other comprehensive loss” at March 31, 2012, unrealized gains to be reclassified from comprehensive income to earnings over the next 12 months are expected to be approximately $32 million. As these unrealized gains are associated with derivative instruments that represent hedges of forecasted transactions, the amounts reclassified to earnings may partially offset the realized transactions in the unaudited condensed consolidated statements of income.
As of March 31, 2012, the timing of the estimated future realization of the value of the Company’s trading portfolio was as follows:
Year of
Percentage of
Expiration
Portfolio Total
2012
59
%
2013
32
%
2014
6
%
2015
3
%
100
%
Nonperformance and Credit Risk. The fair value of the Company’s coal derivative assets and liabilities reflects adjustments for nonperformance and credit risk. The Company’s exposure is substantially with electric utilities, steel producers, energy marketers and energy producers. The Company’s policy is to independently evaluate each customer’s creditworthiness prior to entering into transactions and to regularly monitor the credit extended. If the Company engages in a transaction with a counterparty that does not meet its credit standards, the Company seeks to protect its position by requiring the counterparty to provide an appropriate credit enhancement. Also, when appropriate (as determined by its credit management function), the Company has taken steps to reduce its exposure to customers or counterparties whose credit has deteriorated and who may pose a higher risk of failure to perform under their contractual obligations. These steps include obtaining letters of credit or cash collateral (margin), requiring prepayments for shipments or the creation of customer trust accounts held for the Company’s benefit to serve as collateral in the event of a failure to pay or perform. To reduce its credit exposure related to trading and brokerage activities, the Company seeks to enter into netting agreements with counterparties that permit the Company to offset asset and liability positions with such counterparties and, to the extent required, will post or receive margin amounts associated with exchange-cleared positions.
At March 31, 2012, 87% of the Company’s credit exposure related to coal trading activities was with investment grade counterparties while 12% was with non-investment grade counterparties and 1% was with counterparties that are not rated.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Performance Assurances and Collateral. Certain of the Company’s derivative trading instruments require the parties to provide additional performance assurances whenever a material adverse event jeopardizes one party’s ability to perform under the instrument. If the Company was to sustain a material adverse event (using commercially reasonable standards), the counterparties could request collateralization on derivative trading instruments in net liability positions which, based on an aggregate fair value at March 31, 2012 and December 31, 2011, would have amounted to collateral postings of approximately $15 million and $11 million, respectively, to its counterparties. As of March 31, 2012 and December 31, 2011, no collateral was posted to counterparties for such positions (reflected in “Liabilities from coal trading activities, net”).
Certain of the Company’s other derivative trading instruments require the parties to provide additional performance assurances whenever a credit downgrade occurs below a certain level as specified in each underlying contract. The terms of such derivative trading instruments typically require additional collateralization, which is commensurate with the severity of the credit downgrade. If a credit downgrade were to have occurred below contractually specified levels, the Company’s additional collateral requirement owed to its counterparties would have been zero at March 31, 2012 and December 31, 2011 based on the aggregate fair value of all derivative trading instruments with such features that were in a net liability position. No affiliated margin was posted for these transactions as of March 31, 2012 and December 31, 2011.
The Company is required to post collateral on positions that are in a net liability position with an exchange and is entitled to receive collateral on positions that are in a net asset position. This collateral is known as variation margin. At March 31, 2012 and December 31, 2011, the Company was in a net asset position of $71.6 million and $52.1 million, respectively (reflected in “Assets from coal trading activities, net”).
In addition, the Company is required by an exchange to post certain collateral, known as initial margin, which represents an estimate of potential future adverse price movements across the Company’s portfolio under normal market conditions. As of March 31, 2012 and December 31, 2011, the Company had posted initial margin of $28.0 million and $34.0 million, respectively (reflected in “Other current assets”). In addition, the Company had received $18.3 million of margin in excess of the exchange-required variation (discussed above) and initial margin as of March 31, 2012 (reflected in “Accounts payable and accrued expenses”).
MF Global UK Limited
In October 2011, MF Global UK Limited (MF Global UK), a United Kingdom (U.K.) based broker-dealer, was placed into the U.K.'s administration process (a process similar to bankruptcy proceedings in the U.S.) by the Financial Services Authority following the Chapter 11 bankruptcy filing of its U.S. parent, MF Global Holdings Ltd. The Company had used MF Global UK to broker certain of its coal trading transactions. The interruption of the Company's trading operations was limited as the Company opened new accounts with different brokerage firms and transferred its open trading positions formerly held with MF Global UK to those new accounts. While the open trading positions were transferred from MF Global UK successfully, the related margin posted by the Company has been retained by MF Global UK pending resolution of the Company's claims with the special administrators. As of March 31, 2012, the Company had received $20.0 million of the initial $52.6 million that was held with MF Global UK when it was placed into the U.K.'s administration process. The remaining balance is included in "Accounts receivable, net" in the condensed consolidated balance sheets. The Company is pursuing collection and, due to the numerous uncertainties related to the claim, cannot reasonably estimate a potential reserve based upon information available as of the date of filing.
(9) Financing Receivables
The Company had total financing receivables of $392.9 million and $376.1 million at March 31, 2012 and December 31, 2011, respectively, which consisted of the following:
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company periodically assesses the collectability of accounts and loans receivable by considering factors such as specific evaluation of collectability, historical collection experience, the age of the receivable and other available evidence. Below is a description of the Company's financing receivables at March 31, 2012:
Codrilla Mine Project. In 2011, a wholly-owned subsidiary of Macarthur completed the sale of its 85% interest in the Codrilla Mine Project to participants of the Coppabella Moorvale Joint Venture (CMJV) where Macarthur sold down its interest in the Codrilla project to the CMJV (Codrilla sell down) so that, following completion of the sale, ownership of the Codrilla Mine Project reflected the existing ownership of the Coppabella and Moorvale mines with Macarthur retaining a 73.3% ownership. Prior to the Company's acquisition of Macarthur, consideration of $15.0 million Australian dollars was received by Macarthur upon completion of the Codrilla sell down, representing 20% of the agreed price. Two remaining installments are due on the completion of certain milestones, with 40% due on granting of the related mining lease and the final 40% due upon the mine's first coal shipment. There are currently no indications of impairment and the Company expects to receive full payment of amounts currently due. "Accounts receivable, net" included $35.6 million and $34.2 million at March 31, 2012 and December 31, 2011, respectively, and "Investments and other assets" included $37.0 million and $35.6 million at March 31, 2012 and
