PART II -- ANNUAL REPORT

MANAGEMENT'S DISCUSSION AND ANALYSIS

FORWARD-LOOKING STATEMENTS

Statements in this annual report which are not statements of historical
fact are forward-looking statements within the "safe harbor" provision of the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements are based on the information available to, and the expectations and
assumptions deemed reasonable by, the Company at the time the statements are
made. Because these forward-looking statements are subject to various risks and
uncertainties, actual results may differ materially from those projected in the
statements. These expectations, assumptions and uncertainties include: the
Company's expectation of growth in the demand for electricity; belief that
legislation and regulations relating to the Clean Air Act and the relatively
higher costs of competing fuels will increase demand for its compliance and
low-sulfur coal; expectation of improved market conditions for the price of
coal; expectation that the Company will continue to have adequate liquidity from
its cash flow from operations, together with available borrowings under its
credit facilities, to finance the Company's working capital needs; a variety of
operational, geologic, permitting, labor and weather related factors; and the
other risks and uncertainties which are described below under "Contingencies"
and "Certain Trends and Uncertainties."

RESULTS OF OPERATIONS

2002 COMPARED TO 2001

Net Income (Loss). The Company incurred a net loss of $2.6 million for the
year ended December 31, 2002 compared to net income of $7.2 million for the year
ended December 31, 2001. Results for 2002 were adversely impacted by the state
of oversupply in the coal market that resulted from an extremely mild winter in
late 2001 and early 2002 and a period of industrial economic weakness that
dampened electricity demand. As a result, the Company reduced its rates of
production from planned levels at its mining operations during 2002. The Company
produced 99.6 million tons in 2002, a decrease of 4.9 million tons as compared
to 2001 production. Additionally, the current year results were negatively
impacted by production difficulties and increased costs at the Company's Samples
surface operation in West Virginia during the first half of 2002 resulting from
the transition into a new permit area and away from a sandstone intrusion first
encountered during the second quarter of 2001. Results for the year ended
December 31, 2002 were positively impacted by the following other items: (1) A
$5.6 million pre-tax gain resulting from the settlement of certain coal
contracts with a customer that was partially unwinding its coal supply position
and desired to buy out of the remaining terms of those contracts. (2) A $4.6
million pre-tax gain as a result of a workers' compensation premium adjustment
refund from the State of West Virginia. (3) A $4.4 million pre-tax gain
resulting from retroactive reductions in royalty rates at certain of the
Company's mines. These items were partially offset by a pre-tax charge of $1.1
million for an increase in the Company's litigation reserve resulting from
several litigation settlements.

Results for 2001 were positively impacted by strong margins on the limited
tonnage open to market-based pricing during the early part of 2001 and by
reduced interest expense associated with lower debt levels. The results for 2001
were negatively impacted by production difficulties and increased costs at the
Company's West Elk mine in Gunnison County, Colorado caused by high methane
levels and at the Samples surface operation in West Virginia caused by a
sandstone intrusion into the principal coal seam. Results for the year ended
December 31, 2001 were positively impacted by the following other items: (1) A
$9.4 million pre-tax insurance settlement as part of the Company's coverage
under its property and business interruption policy. The insurance settlement
represented the final settlement for losses incurred for the 2000 West Elk mine
idling described below. (2) A $7.4 million pre-tax gain from a state tax credit
covering prior periods. (3) A $4.6 million pre-tax gain as a result of progress
in processing claims associated

II-1

with the recovery of certain previously paid excise taxes on export sales. The
gain stemmed from an IRS notice during the second quarter of 2000 outlining the
procedures for obtaining tax refunds on black lung excise taxes paid by the
industry on export sales. The notice was the result of a 1998 federal district
court decision that found such taxes to be unconstitutional. Of the $4.6 million
recognized, $3.1 million represented the interest component of the claim and was
recorded as interest income. (4) An increase of pre-tax income of $7.5 million
primarily from a reduction in the amount of expected reclamation work at the
Company's idle Illinois properties resulting from permit revisions. (5) A $13.5
million pre-tax gain primarily on the sale of land. These items were partially
offset by a pre-tax charge of $4.1 million for stock-based compensation benefits
that may be realized in future periods and by a pre-tax charge of $5.6 million
for an increase in the Company's litigation reserve resulting from several
litigation settlements.

Revenues. Total revenues for the year ended December 31, 2002 were
$1,534.1 million, an increase of 3.1% from 2001 revenues. The increase was
primarily attributable to increased coal sales revenue resulting from higher
pricing on coal shipped during 2002 as compared to 2001. Average coal sales
realizations on a per ton basis were $13.81 for the year ended December 31, 2002
compared to $12.82 per ton for the year ended December 31, 2001. Partially
offsetting the impact of higher prices was a decrease in the number of tons
sold, from 109.5 million tons in the year ended December 31, 2001 to 106.7
million for the year ended December 31, 2002.

Income from Equity Investments. For the year ended December 31, 2002,
income from equity investments totaled $10.1 million, a decrease of $16.2
million, or 61.6% from levels in 2001. In 2002, income from equity investments
was comprised of $7.8 million from the Company's investment in Canyon Fuel
Company, LLC and $2.3 million from the Company's investment in Natural Resource
Partners, LP (NRP). Income from equity investment in 2001 was comprised solely
of income from the Company's investment in Canyon Fuel. The decrease in
investment income from Canyon Fuel resulted from decreased operating earnings at
Canyon Fuel due to the expiration of a favorable sales contract at the end of
2001 and a weak market environment for Utah coal throughout 2002. Additionally,
in 2001, Canyon Fuel recognized recoveries of previously paid property taxes.
The Company's share of these recoveries was $2.6 million, which is reflected as
income from equity investments in the Consolidated Statements of Operations.
Income from the Company's equity investment in NRP represents the Company's
share of NRP's earnings for the period from October 17, 2002 (the date of the
formation of NRP) through November 30, 2002. Financial information for NRP
through December 31, 2002 was not available at the time that the Company
released its financial results. As such, the Company will account for income
from its investment in NRP on a one-month lag.

Other Revenues. Other revenues for the year ended December 31, 2002
decreased $8.6 million as compared to the year ended December 31, 2001. The
decrease was primarily attributable to significant asset sales in 2001 which did
not recur in 2002. These asset sales resulted in a pre-tax gain of $13.5 million
in 2001, compared to $0.8 million in 2002. Additionally, royalty income in 2002
from coal reserves leased to third parties declined by approximately $2.9
million, due primarily to the fact that certain of the leased reserves were
contributed to NRP as described above. These items were partially offset by
income from the settlement of coal contracts described above.

II-2

Income from Operations. The following table presents income from
operations excluding the unusual items discussed above.

<Table>
<Caption>
YEAR ENDED
DECEMBER 31,
--------------
2002 2001
----- ------
(IN MILLIONS)

Income from operations (as reported)........................ $29.3 $ 62.5
Adjustments to (exclude)/add-back:
Gain on contract buyout................................ (5.6) --
Workers' compensation premium adjustment............... (4.6) --
Retroactive royalty rate reductions.................... (4.4) --
Samples surface operation losses....................... 3.1 19.2
Losses at the West Elk mine............................ -- 11.3
West Elk mine insurance recoveries..................... -- (9.4)
Land sales............................................. (0.8) (13.5)
Reclamation adjustment -- Illinois properties.......... -- (7.5)
Stock-based compensation accrual....................... -- 4.1
State tax credit....................................... -- (7.4)
Litigation settlement.................................. 1.1 5.6
Black lung excise tax recoveries....................... -- (1.5)
Canyon Fuel property tax recoveries.................... -- (2.6)
----- ------
Adjusted income from operations........................... $18.1 $ 60.8
===== ======
</Table>

The decrease in adjusted income from operations is primarily attributable
to the Company's planned cut-back of production throughout 2002 in response to
the weak market environment described above. The decision to scale back
production during the period came after the Company prepared most of its
operations to maximize production in order to capitalize on the higher market
prices for coal the Company had previously projected for 2002. Therefore,
certain costs incurred to maximize production did not result in higher revenues
but did increase the cost of coal sales. Cost of coal sales on a per ton basis
was $13.24 for the year ended December 31, 2002, compared to $12.21 per ton for
the year ended December 31, 2001.

Adjusted income from operations is not a measure of financial performance
in accordance with generally accepted accounting principles. The Company
presents adjusted income from operations to more clearly disclose the Company's
operating performance excluding events or transactions that the Company does not
believe are necessarily indicative of ongoing mining operations.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $3.8 million to $40.0 million for the year
ended December 31, 2002. The decrease is primarily attributable to the
stock-based compensation accruals recorded during 2001 as discussed above. The
Company did not record any stock-based compensation accruals during the year
ended December 31, 2002.

Amortization of Coal Supply Agreements. Amortization of coal supply
agreements declined $5.3 million primarily as a result of the expiration and
buy-out of above-market contracts that were valued as assets on the Company's
balance sheet and amortized in 2001.

Other Expenses. Other expenses increased from $18.2 million in 2001 to
$30.1 million in 2002, resulting primarily from costs incurred to terminate
certain contractual obligations for the purchase or sale of coal.

Interest Expense. Interest expense decreased by $12.3 million during the
year ended December 31, 2002 primarily as a result of lower average debt levels
during 2002 when compared to the prior year.

II-3

Interest Income. The decrease in interest income of $3.2 million in 2002
is the result of the recognition of the interest component of the black lung
excise tax recovery during the year ended December 31, 2001 described
previously.

Income Taxes. The Company's effective tax rate is sensitive to changes in
annual profitability and percentage depletion. The income tax benefit recorded
in 2002 is primarily the result of favorable tax settlements and the impact of
percentage depletion. During 2002, the Company received notice from the IRS of
proposed adjustments for previous tax years. These adjustments resulted in an
increase in the tax benefit of $10.5 million. The benefit resulting from the
percentage depletion increased in 2002 as compared to 2001 as a result of the
impact of higher coal prices and increased profitability at certain of the
Company's mines.

Adjusted EBITDA. Adjusted EBITDA was $228.9 million for the year ended
December 31, 2002 compared to $282.3 million for the prior year. The decrease in
Adjusted EBITDA was primarily attributable to the decrease in income from
operations resulting from the reduced production levels discussed above.
Adjusted EBITDA is defined as income from operations before the effect of net
interest expense; income taxes; the Company's depreciation, depletion and
amortization; and the Company's equity interest in the depreciation, depletion
and amortization of Canyon Fuel. Adjusted EBITDA is not a measure of financial
performance in accordance with generally accepted accounting principles, and
items excluded to calculate Adjusted EBITDA are significant in understanding and
assessing the Company's financial condition. Therefore, Adjusted EBITDA should
not be considered in isolation nor as an alternative to net income, income from
operations, or cash flows from operations or as a measure of the Company's
profitability, liquidity or performance under generally accepted accounting
principles. The Company believes that Adjusted EBITDA presents a useful measure
of the ability to service and incur debt based on ongoing operations.
Furthermore, analogous measures are used by industry analysts to evaluate
operating performance. Investors should be aware that the Company's presentation
of Adjusted EBITDA may not be comparable to similarly titled measures used by
other companies. The table below shows how the Company calculates Adjusted
EBITDA.

<Table>
<Caption>
TWELVE MONTHS ENDED
DECEMBER 31,
-------------------
2002 2001
-------- --------

Income from operations...................................... $ 29,277 $ 62,456
Depreciation, depletion and amortization of Arch Coal,
Inc. ..................................................... 174,752 177,504
Arch Coal's equity interest in depreciation, depletion and
amortization of Canyon Fuel Company, LLC.................. 24,881 42,325
-------- --------
Adjusted EBITDA............................................. $228,910 $282,285
======== ========
</Table>

2001 COMPARED TO 2000

Net Income (Loss). The Company had net income of $7.2 million for the year
ended December 31, 2001 compared to a net loss of $12.7 million for the year
ended December 31, 2000. Results for 2001 were positively impacted by strong
margins on the limited tonnage open to market-based pricing during the early
part of 2001 and by reduced interest expense associated with lower debt levels.
Results for 2001 were negatively impacted by production difficulties and
increased costs at the Company's West Elk mine in Gunnison County, Colorado
caused by high methane levels and at the Samples surface operation in West
Virginia caused by a sandstone intrusion into the principal coal seam. Results
for the year ended December 31, 2001 were positively impacted by the following
other items: (1) A $9.4 million pre-tax insurance settlement as part of the
Company's coverage under its property and business interruption policy. The
insurance settlement represents the final settlement for losses incurred for the
2000 West Elk mine idling described below. (2) A $7.4 million pre-tax gain from
a state tax credit covering prior periods. (3) A $4.6 million pre-tax gain as a
result of progress in processing claims associated with the recovery of certain
previously paid excise taxes on export sales. The gain stems from an IRS notice
during the second quarter of 2000 outlining the procedures for obtaining tax
refunds on black lung excise taxes paid by the industry on

II-4

export sales. The notice was the result of a 1998 federal district court
decision that found such taxes to be unconstitutional. Of the $4.6 million
recognized, $3.1 million represents the interest component of the claim and was
recorded as interest income. (4) An increase of pre-tax income of $7.5 million
primarily from a reduction in the amount of expected reclamation work at the
Company's idle Illinois properties resulting from permit revisions. (5) A $13.5
million pre-tax gain primarily on the sale of land. These items were partially
offset by a pre-tax charge of $4.1 million for stock-based compensation benefits
that may be realized in future periods and by a pre-tax charge of $5.6 million
for an increase in the litigation reserve resulting from several litigation
settlements.

Results for the year ended December 31, 2000 were adversely impacted by
operating losses incurred at the West Elk mine offset to some extent by partial
pre-tax insurance settlements of $31.0 million received throughout 2000 under
the Company's business interruption policy. The mine was idled from January 28,
2000 to July 12, 2000 following the detection of combustion gases in a portion
of the mine. These combustion gases were unrelated to the high methane levels
experienced at the mine in 2001. Results for the year ended December 31, 2000
were positively impacted by the following other items: (1) Pre-tax gains of
$21.8 million resulting from the settlement of certain workers' compensation
liabilities with the State of West Virginia. This was partially offset by
adjustments to other workers' compensation liabilities resulting from changes in
estimates that caused increases to the liability of $13.5 million. The net
workers' compensation adjustment was a pre-tax gain of $8.3 million. (2) A
pre-tax gain of $7.8 million resulting from a reduction in the Company's
reclamation liability due to permit revisions at its idle mine properties in
Illinois. (3) A $12.1 million pre-tax gain primarily on the sale of land. (4) A
pre-tax gain of $12.7 million related to excise tax recoveries on export
shipments in connection with the IRS notice described above. (5) A $9.8 million
pre-tax curtailment gain resulting from previously unrecognized postretirement
benefit changes that occurred from plan amendments in previous years.

The West Elk mine's coal sales for the year ended December 31, 2001 of
$77.0 million were $35.5 million greater than its sales of $41.5 million in
2000, although the mine experienced significant production difficulties during
both periods as described above. This compares to $110.3 million of coal sales
during the year ended December 31, 1999, a period of uninterrupted production.
Excluding the impact of the related insurance recoveries, operating losses for
the mine for 2001 and 2000 were $11.3 million and $43.4 million, respectively,
compared to operating income of $13.1 million during 1999. At the Samples
surface operation, a sandstone intrusion caused the coal seam to thin which
resulted in lower production and higher associated costs. During the year ended
December 31, 2001, the Samples surface operation experienced an operating loss
of $19.2 million compared to operating income of $4.3 million during the same
period of 2000.

Revenues. Total revenues for the year ended December 31, 2001 were
$1,488.7 million, an increase of $84.1 million from the same period in 2000.
This increase was the result of several factors including the increase in sales
at West Elk when compared to the same period in 2000, improved pricing on the
limited tonnage that was open to market-based pricing during 2001, and increased
pass-through transportation revenues.

Income from Equity Investment. During the year ended December 31, 2001,
Canyon Fuel, recognized recoveries of previously paid property taxes. The
Company's share of these recoveries is $2.6 million, which is reflected as
income from equity investment in the Consolidated Statements of Operations. In
addition, Canyon Fuel experienced improved performance at its three underground
mines in Utah.

II-5

Income from Operations. The following table presents income from
operations, excluding the unusual items discussed above.

<Table>
<Caption>
YEAR ENDED
DECEMBER 31,
---------------
2001 2000
------ ------
(IN MILLIONS)

Income from operations (as reported)........................ $ 62.5 $ 74.0
Adjustments to (exclude)/add-back:
Losses at the West Elk mine............................ 11.3 43.4
West Elk mine insurance recoveries..................... (9.4) (31.0)
Samples surface operation losses....................... 19.2 --
Land sales............................................. (13.5) (12.1)
Reclamation adjustment -- Illinois properties.......... (7.5) (7.8)
Stock-based compensation accrual....................... 4.1 --
State tax credit....................................... (7.4) --
Litigation settlements................................. 5.6 --
Workers' compensation adjustment....................... -- (8.3)
Postretirement medical benefit curtailment............. -- (9.8)
Black lung excise tax recoveries....................... (1.5) (12.7)
Canyon Fuel Company property tax recoveries............ (2.6) --
------ ------
Adjusted income from operations........................... $ 60.8 $ 35.7
====== ======
</Table>

The increase in adjusted income from operations is primarily attributable
to improved pricing on the limited coal tonnage that was open to market-based
pricing during 2001; improved performance at the Company's Black Thunder mine in
Wyoming and the Canyon Fuel operations in Utah; and continued strong performance
at the Company's Mingo Logan operation in West Virginia.

As discussed previously, adjusted income from operations is not a measure
of financial performance in accordance with generally accepted accounting
principles. The Company presents adjusted income from operations to more clearly
disclose the Company's operating performance excluding events or transactions
that the Company does not believe are necessarily indicative of ongoing mining
operations.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $4.9 million. The increase was primarily
attributable to the $4.1 million stock-based compensation charge discussed
above.

Amortization of Coal Supply Agreements. Amortization of coal supply
agreements decreased by $12.3 million primarily as a result of the expiration
and buy-out of above-market contracts that were valued as assets and amortized
on the Company's balance sheet in 2000.

Interest Expense. Interest expense decreased by $27.9 million primarily as
a result of lower debt levels in the year ended December 31, 2001 compared to
the same period of 2000. The net proceeds from two public stock offerings in the
first half of 2001 were used to significantly reduce debt levels from 2000
levels (see additional discussion in "Liquidity and Capital Resources").

Interest Income. The increase in interest income of $2.9 million over 2000
was primarily due to recognition of the interest component of the black lung
excise tax recovery recognized in 2001.

Income Taxes. The Company's effective tax rate is sensitive to changes in
estimates of annual profitability and percentage depletion. The income tax
benefit recorded for the year ended December 31, 2001 is primarily the result of
the impact of percentage depletion.

Adjusted EBITDA. Adjusted EBITDA (as defined previously) was $282.3
million for the year ended December 31, 2001 compared to $315.2 million in 2000.
This decrease is primarily attributable to the

II-6

losses incurred at the Samples surface operation resulting from the sandstone
intrusion during 2001. The table below shows how the Company calculates Adjusted
EBITDA.

<Table>
<Caption>
TWELVE MONTHS ENDED
DECEMBER 31,
-------------------
2001 2000
-------- --------

Income from operations...................................... $ 62,456 $ 73,984
Depreciation, depletion and amortization of Arch Coal,
Inc. ..................................................... 177,504 201,512
Arch Coal's equity interest in depreciation, depletion and
amortization of Canyon Fuel Company, LLC.................. 42,325 39,679
-------- --------
Adjusted EBITDA............................................. $282,285 $315,175
======== ========
</Table>

RECENT DEVELOPMENT

Convertible Preferred Stock Offering. On January 31, 2003, the Company
completed the sale of 2,875,000 shares of its 5% Perpetual Cumulative
Convertible Preferred Stock, which includes the underwriters' full
over-allotment option of 375,000 shares, at a price of $50.00 per share. The net
proceeds from the offering of approximately $139.1 million were used to reduce
indebtedness under the Company's revolving credit facility, to repay lines of
credit, and for working capital and general corporate purposes. Dividends on the
preferred stock will be cumulative and will be payable quarterly at the annual
rate of 5% of the liquidation preference. Each share of the preferred stock will
be initially convertible, under certain conditions, into 2.3985 shares of the
Company's common stock.

OUTLOOK

Production Levels. The Company reduced its overall rate of coal production
by approximately 5% during 2002. This action was taken in response to
unfavorable spot coal markets following an extremely mild winter and a period of
industrial economic weakness that dampened electricity demand. Although the
timing of any recovery in coal markets remains uncertain, there have been
indications that prices may return to more favorable levels in the future. These
indications include more normal weather patterns, some indication of economic
recovery and an overall decrease in coal production and utility stockpiles.

Previously, the Company had disclosed that longwall mineable reserves at
Mingo Logan were likely to be exhausted during 2002. As a result of improvements
to the mine plan, the mine is expected to exhaust its longwall mineable reserves
in 2006, subject to permit modifications. However, due to more difficult mining
conditions, production levels in the future are expected to be lower than those
experienced historically.

Postretirement Obligations. The Company expects to incur significantly
higher expenses related to its postretirement health care obligations in 2003.
These obligations, coupled with a much smaller increase in pension-related
expenses, are expected to increase non-cash costs by approximately $8.0 million
per quarter in 2003.

Permitting Issues. On May 8, 2002, in Kentuckians for the Commonwealth v.
Rivenburgh, the U.S. District Court for the Southern District of West Virginia
enjoined the Huntington, West Virginia office of the U.S. Army Corps of
Engineers from issuing any new Section 404 Clean Water Act permits that
authorize the placement of rock and soil into channels that comprise waters of
the United States. This process is used both in surface mining operations, where
layers of dirt and rock are removed to expose the underlying coal seam, as well
as underground mining operations. The excess material is then placed into
"valley fills." The court reached its conclusion on the basis that the material
constituted "waste" which may not be disposed of in valley fills under
Corps-issued permits. On January 29, 2003, the Fourth Circuit Court of Appeals
reversed the decision in the Kentuckians case.

The plaintiffs in the Kentuckians case may appeal the January 29, 2003
decision to the full panel of the Fourth Circuit, and ultimately to the Supreme
Court. If the plaintiffs are ultimately successful in this

II-7

litigation, the ruling may adversely impact both the Company's ability to
sustain its current mining operations and its ability to open new mines. For
further discussion of this case, see Certain Trends and
Uncertainties -- Environmental and Regulatory Factors -- Clean Water Act
beginning on page II-16.

The Company idled its Dal-Tex operation on July 23, 1999 as a result of an
adverse ruling in prior litigation on the issue of valley fills. This ruling was
later reversed on appeal; however, as of the date of the 2002 injunction
described above, the Company had not yet completed the process necessary to
obtain the Section 404 permits for the mine. Once the Company obtains the
necessary permits, it intends to reopen the mine subject to then-existing market
conditions.

Low-Sulfur Coal Producer. The Company continues to believe that it is
well-positioned to capitalize on the continuing growth in demand for low-sulfur
coal to produce electricity. Substantially all of the Company's current coal
production and approximately 90% of its reserves are low in sulfur. In fact,
approximately 68% of the Company's coal reserves are compliance quality, which
means that the reserves meet Phase II standards of the Clean Air Act without
application of expensive scrubbing technology. With Phase II now in effect,
compliance coal has captured a growing share of United States coal demand and
commands a higher price in the marketplace than high-sulfur coal.

Chief Objectives. The Company continues to focus on taking steps to
increase shareholder returns by improving earnings, strengthening cash
generation, improving productivity and reducing costs at its large-scale mines,
while building on its leading position in its target coal-producing basins, the
Powder River Basin and the Central Appalachian Basin.

DISCLOSURE CONTROLS AND PROCEDURES

An evaluation was performed under the supervision and with the
participation of the Company's management, including the CEO and CFO, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures as of December 31, 2002. Based on that evaluation, the Company's
management, including the CEO and CFO, concluded that the Company's disclosure
controls and procedures were effective as of such date. There have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to December 31, 2002.

LIQUIDITY AND CAPITAL RESOURCES

The following is a summary of cash provided by or used in each of the
indicated types of activities during the past three years:

<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
(IN THOUSANDS)

Cash provided by (used in):
Operating activities........................... $ 176,417 $ 145,661 $ 135,772
Investing activities........................... (128,303) (129,209) (107,496)
Financing activities........................... (45,447) (15,590) (25,531)
</Table>

Cash provided by operating activities increased in 2002 as compared to 2001
due primarily to reduced requirements for working capital components other than
inventories. Cash provided by operating activities increased in 2001 compared to
2000 due primarily to improved operating performance in 2001. Increased
distributions from the Company's investment in Canyon Fuel also positively
affected cash provided by operating activities during 2001. These increases were
partially offset by increased working capital requirements in 2001 compared to
2000.

Cash used in investing activities decreased during 2002 as compared to 2001
due primarily to the impact of the sale of limited partnership units of Natural
Resource Partners, L.P., which generated proceeds of $33.6 million. Excluding
the proceeds from the sale, cash used in investing activities increased due to

II-8

higher capital expenditures and reduced proceeds from property dispositions.
Cash used in investing activities during 2001 increased compared to 2000 due
primarily to higher capital expenditures in 2001 and proceeds from the
termination of coal supply agreements in 2000.

Cash used in financing activities during 2002 primarily represents net
payments under the Company's revolver and lines of credit, payments of
dividends, and reductions of capital lease obligations. In addition, during
2002, the Company entered into a sale and leaseback of equipment that resulted
in proceeds of $9.2 million. Cash used in financing activities during 2001
reflects the cash generated by the February 2001 and May 2001 issuances of
common stock (described below) resulting in proceeds of $372.2 million, the
pay-down of $376.9 million of debt and the repurchase of the Company's common
stock at a cost of $5.0 million.

On February 22, 2001, the Company completed a public offering of 9,927,765
shares of common stock, including the remaining 4,756,968 shares held by its
then largest stockholder, Ashland Inc., and 5,170,797 primary and treasury
shares issued directly by the Company. Proceeds realized from the transaction,
which totaled $92.9 million net of the underwriters' discount and expenses, were
used to pay down debt.

On April 12, 2001, the Company filed a Universal Shelf Registration
Statement on Form S-3 with the Securities and Exchange Commission. The Universal
Shelf allows the Company to offer, from time to time, an aggregate of up to $750
million in debt securities, preferred stock, depositary shares, common stock and
related rights and warrants. On May 8, 2001, the Company utilized the shelf
registration and completed a public offering of 8,500,000 primary shares of
common stock. On May 16, 2001, the underwriters involved in the offering
purchased an additional 424,200 shares pursuant to an over-allotment option
granted by the Company in connection with the May 8, 2001 offering. The proceeds
realized from these transactions after the underwriting discount and expenses
were $279.3 million. The proceeds were used to retire the Company's term loan
with the remainder used to reduce the borrowings under the Company's revolving
credit facility.

On January 31, 2003, the Company again utilized its Universal Shelf and
completed a public offering of 2,875,000 shares of 5% Perpetual Cumulative
Convertible Preferred Stock. The net proceeds realized by the Company from the
offering of $139.1 million are being used to reduce indebtedness under the
Company's revolving credit facility, and for working capital and general
corporate purposes. Subsequent to the January 2003 offering, the Company can
still issue an additional $311.8 million in debt and equity securities under the
Universal Shelf.

The Company generally satisfies its working capital requirements and funds
its capital expenditures and debt-service obligations with cash generated from
operations. The Company believes that cash generated from operations and its
borrowing capacity will be sufficient to meet its working capital requirements
and anticipated capital expenditures for at least the next several years. The
Company's ability to fund planned capital expenditures, to make acquisitions and
to pay dividends will depend upon its future operating performance, which will
be affected by prevailing economic conditions in the coal industry, and by
financial, business and other factors, some of which are beyond the Company's
control.

Expenditures for property, plant and equipment were $137.1 million, $123.4
million and $115.1 million for 2002, 2001 and 2000, respectively. Capital
expenditures are made to improve and replace existing mining equipment, expand
existing mines, develop new mines and improve the overall efficiency of mining
operations.

II-9

On April 18, 2002, the Company and its subsidiary, Arch Western Resources,
LLC ("Arch Western") completed a refinancing of their existing credit
facilities. The new credit facilities include five-and six-year non-amortizing
term loans totaling $675.0 million at Arch Western and a five-year revolving
credit facility totaling $350.0 million for the Company. The five-year
non-amortizing term loan at Arch Western is for $150.0 million while the
six-year non-amortizing term loan is for $525.0 million. The rate of interest on
borrowings under both of the credit facilities is a floating rate based on
LIBOR. The Company's credit facility is secured by its ownership interests in
substantially all of its subsidiaries, except its ownership interests in Arch
Western and its subsidiaries. The Arch Western credit facility is secured by
substantially all of its subsidiaries, but is not guaranteed by the Company.

Financial covenants contained in the Company's new credit facilities
consist of a maximum leverage ratio, a minimum fixed charge ratio and a minimum
net worth test. The leverage ratio requires that the Company not permit the
ratio of total indebtedness at the end of any calendar quarter to adjusted
EBITDA for the four quarters then ended to exceed a specified amount. The fixed
charge coverage ratio requires that the Company not permit the ratio of the
Company's adjusted EBITDA plus lease expense to interest expense for the four
quarters then ended to be less than a specified amount. The net worth test
requires that the Company not permit its net worth to be less than a specified
amount plus 50% of cumulative net income. The Company was in compliance with all
financial covenants at December 31, 2002.

At December 31, 2002, the Company had $42.6 million in letters of credit
outstanding which, when combined with outstanding borrowings under the revolver,
resulted in $242.4 million of unused capacity under the revolving credit
facility. Sufficient unused capacity is currently available to fund all
operating needs. Financial covenant requirements may restrict the amount of
unused capacity available to the Company for borrowings and letters of credit.

At December 31, 2002, debt amounted to $747.3 million, or 58% of capital
employed, compared to $773.9 million, or 58% of capital employed, at December
31, 2001. Based on the level of consolidated indebtedness and prevailing
interest rates at December 31, 2002, debt service obligations, which include the
current maturities of debt and interest expense for 2003, are estimated to be
$67.3 million.

The Company periodically establishes uncommitted lines of credit with
banks. These agreements generally provide for short-term borrowings at market
rates. At December 31, 2002, there were $20.0 million of such agreements in
effect, of which none were outstanding.

The Company is exposed to market risk associated with interest rates. At
December 31, 2002, after taking into consideration interest rate swap
agreements, debt included $740.0 million of floating-rate debt for which the
rate of interest is, at the Company's option, the PNC Bank base rate or a rate
based on LIBOR. To manage this exposure, the Company enters into interest-rate
swap agreements to modify the interest-rate characteristics of outstanding
Company debt. At December 31, 2002, the Company had interest-rate swap
agreements having a total notional value of $525.0 million, including $250.0
million for which the fixed rate becomes effective as of October 2003. These
swap agreements are used to convert variable-rate debt to fixed-rate debt. Under
these swap agreements, the Company pays a weighted average fixed rate of 5.74%
(before the credit spread over LIBOR) and receives a weighted average variable
rate based upon 30-day and 90-day LIBOR. The Company accrues amounts to be paid
or received under interest-rate swap agreements over the lives of the
agreements. These amounts are recognized as adjustments to interest expense over
the lives of agreements, thereby adjusting the effective interest rate on the
Company's debt. Gains and losses on terminations of interest-rate swap
agreements are deferred on the balance sheet (in other long-term liabilities)
and amortized as an adjustment to interest expense over the remaining term of
the terminated swap agreement. The remaining terms of the swap agreements at
December 31, 2002, ranged from 32 to 57 months. All instruments are entered into
for other than trading purposes.

The Company is also exposed to commodity price risk related to its purchase
of diesel fuel. The Company enters into forward purchase contracts and heating
oil swaps to substantially eliminate volatility in the price of diesel fuel for
its operations. The swap agreements essentially fix the price paid for diesel
fuel by requiring the Company to pay a fixed heating oil price and receive a
floating heating oil price. The

II-10

changes in the floating heating oil price highly correlate to changes in diesel
fuel prices. Gains and losses on terminations of heating oil swap agreements are
deferred on the balance sheet (in other long-term liabilities) and amortized as
an adjustment to diesel fuel cost over the original term of the terminated
heating oil swap agreement as if it were still in place.

The discussion below presents the sensitivity of the market value of the
Company's financial instruments to selected changes in market rates and prices.
The range of changes reflects the Company's view of changes that are reasonably
possible over a one-year period. Market values are the present value of
projected future cash flows based on the market rates and prices chosen. The
major accounting policies for these instruments are described in Note 1 to the
consolidated financial statements.

Changes in interest rates have different impacts on the fixed-rate and
variable-rate portions of the Company's debt portfolio. A change in interest
rates on the fixed portion of the debt portfolio impacts the net financial
instrument position but has no impact on interest incurred or cash flows. A
change in interest rates on the variable portion of the debt portfolio impacts
the interest incurred and cash flows but does not impact the net financial
instrument position.

The sensitivity analysis related to the fixed portion of the Company's debt
portfolio assumes an instantaneous 100-basis-point move in interest rates from
their levels at December 31, 2002, with all other variables held constant. A
100-basis-point decrease in market interest rates would result in an $18.3
million increase in the fair value of the fixed portion of the debt at December
31, 2002. Based on the variable-rate debt included in the Company's debt
portfolio as of December 31, 2002, after considering the effect of the swap
agreements, a 100-basis-point increase in interest rates would result in an
annualized additional $4.0 million of interest expense incurred based on
December 31, 2002 debt levels. At December 31, 2002, a $.05 per gallon decrease
in the price of heating oil would result in a $0.2 million decrease in the fair
value of the financial position of the heating oil swap agreements.

CONTRACTUAL OBLIGATIONS

The following is a summary of the Company's significant contractual
obligations as of December 31, 2002 (in thousands):

<Table>
<Caption>
PAYMENTS DUE BY PERIOD
-------------------------------------------------
LESS THAN
1 YEAR 1-3 YEARS 4-5 YEARS AFTER 5 YEARS
--------- --------- --------- -------------

Long-term debt................................. $ 7,100 $ 198 $215,020 $525,024
Operating leases............................... 13,234 18,343 12,067 7,139
Royalty leases................................. 65,523 70,776 58,470 135,795
Unconditional purchase obligations............. 53,807
Other long-term obligations.................... 23,200
-------- ------- -------- --------
Total contractual cash obligations............. $139,664 $89,317 $285,557 $691,158
======== ======= ======== ========
</Table>

Unconditional purchase obligations represent amounts committed for capital
expenditures. Other long-term obligations represent the Company's contractual
amounts owed in conjunction with its ownership interest in Dominion Terminal
Associates as described in Note 20 to the Consolidated Financial Statements.

In addition to the contractual obligations noted above, the Company expects
to make contributions of $18.0 million to its pension plan in 2003. The Company
believes that cash generated from operations, proceeds from the January 2003
preferred stock offering, and availability under its revolving credit facility
will be sufficient to meet these obligations and the Company's requirements for
working capital and capital expenditures.

II-11

CONTINGENCIES

RECLAMATION

The federal Surface Mining Control and Reclamation Act of 1977 ("SMCRA")
and similar state statutes require that mine property be restored in accordance
with specified standards and an approved reclamation plan. The Company accrues
for the costs of final mine closure reclamation over the estimated useful mining
life of the property. These costs relate to reclaiming the pit and support
acreage at surface mines and sealing portals at deep mines. Other costs of final
mine closure common to surface and underground mining are related to reclaiming
refuse and slurry ponds, eliminating sedimentation and drainage control
structures, and dismantling or demolishing equipment or buildings used in mining
operations. The Company also accrues for significant reclamation that is
completed during the mining process prior to final mine closure. The
establishment of the final mine closure reclamation liability and the other
ongoing reclamation liabilities are based upon permit requirements and require
various estimates and assumptions, principally associated with costs and
productivities.

The Company reviews its entire environmental liability periodically and
makes necessary adjustments, including permit changes and revisions to costs and
productivities to reflect current experience. The Company's management believes
it is making adequate provisions for all expected reclamation and other
associated costs.

LEGAL CONTINGENCIES

The Company is a party to numerous claims and lawsuits with respect to
various matters, including those discussed below. The Company provides for costs
related to contingencies, including environmental matters, when a loss is
probable and the amount is reasonably determinable. After conferring with
counsel, it is the opinion of management that the ultimate resolution of these
claims, to the extent not previously provided for, will not have a material
adverse effect on the consolidated financial condition, results of operations or
liquidity of the Company.

CERTAIN TRENDS AND UNCERTAINTIES

SUBSTANTIAL LEVERAGE -- VARIABLE INTEREST RATE -- COVENANTS

As of December 31, 2002, the Company had outstanding consolidated
indebtedness of $747.3 million, representing approximately 58% of the Company's
capital employed. Despite making substantial progress in reducing debt, the
Company continues to have significant debt service obligations, and the terms of
its credit agreements limit its flexibility and result in a number of
limitations on the Company. The Company also has significant lease and royalty
obligations. The Company's ability to satisfy debt service, lease and royalty
obligations and to effect any refinancing of its indebtedness will depend upon
future operating performance, which will be affected by prevailing economic
conditions in the markets that the Company serves as well as financial, business
and other factors, many of which are beyond the Company's control. The Company
may be unable to generate sufficient cash flow from operations and future
borrowings, or other financings may be unavailable in an amount sufficient to
enable it to fund its debt service, lease and royalty payment obligations or its
other liquidity needs.

The Company's relative amount of debt and the terms of its credit
agreements could have material consequences to its business, including, but not
limited to: (i) making it more difficult to satisfy debt covenants and debt
service, lease payment and other obligations; (ii) making it more difficult to
pay quarterly dividends as the Company has in the past; (iii) increasing the
Company's vulnerability to general adverse economic and industry conditions;
(iv) limiting the Company's ability to obtain additional financing to fund
future acquisitions, working capital, capital expenditures or other general
corporate requirements; (v) reducing the availability of cash flows from
operations to fund acquisitions, working capital, capital expenditures or other
general corporate purposes; (vi) limiting the Company's flexibility in planning
for, or reacting to, changes in the Company's business and the industry in which
the Company competes; or

II-12

(vii) placing the Company at a competitive disadvantage when compared to
competitors with less relative amounts of debt.

After taking into consideration the Company's interest rate swaps which
convert the Company's variable rate debt to fixed, approximately 63% of the
Company's indebtedness at December 31, 2002 bears interest at variable rates
that are linked to short-term interest rates. If interest rates rise, the
Company's costs relative to those obligations would also rise.

Terms of the Company's credit facilities and leases contain financial and
other covenants that create limitations on the Company's ability to, among other
things, effect acquisitions or dispositions and borrow additional funds, and
require the Company to, among other things, maintain various financial ratios
and comply with various other financial covenants. Failure by the Company to
comply with such covenants could result in an event of default under these
agreements which, if not cured or waived, would enable the Company's lenders to
declare amounts borrowed due and payable, or otherwise result in unanticipated
costs.

LOSSES

The Company reported a net loss of $2.6 million for the year ended December
31, 2002. The losses in 2002 were primarily attributable to the Company's
decision to scale back production during the year in response to a weak market
environment and increased costs at certain Company operations. The decision to
scale back production came after the Company had prepared most of the operations
to maximize production in order to capitalize on higher market prices for coal
the Company had previously projected for 2002. Therefore, certain costs incurred
to maximize production did not result in higher revenues but did increase the
cost of coal sales.

Because the coal mining industry is subject to significant regulatory
oversight and affected by the possibility of adverse pricing trends or other
industry trends beyond the Company's control, the Company may suffer losses in
the future if legal and regulatory rulings, mine idlings and closures, adverse
pricing trends or other factors affect the Company's ability to mine and sell
coal profitably.

ENVIRONMENTAL AND REGULATORY FACTORS

The coal mining industry is subject to regulation by federal, state and
local authorities on matters such as:

- the discharge of materials into the environment;

- employee health and safety;

- mine permits and other licensing requirements;

- reclamation and restoration of mining properties after mining is
completed;

- management of materials generated by mining operations;

- surface subsidence from underground mining;

- water pollution;

- legislatively mandated benefits for current and retired coal miners;

- air quality standards;

- protection of wetlands;

- endangered plant and wildlife protection;

- limitations on land use;

II-13

- storage of petroleum products and substances that are regarded as
hazardous under applicable laws; and

- management of electrical equipment containing polychlorinated biphenyls,
or PCBs.

In addition, the electric generating industry, which is the most
significant end-user of coal, is subject to extensive regulation regarding the
environmental impact of its power generation activities, which could affect
demand for the Company's coal. The possibility exists that new legislation or
regulations may be adopted or that the enforcement of existing laws could become
more stringent, either of which may have a significant impact on the Company's
mining operations or its customers' ability to use coal and may require the
Company or its customers to change operations significantly or incur substantial
costs.

While it is not possible to quantify the expenditures incurred by the
Company to maintain compliance with all applicable federal and state laws, those
costs have been and are expected to continue to be significant. The Company
posts performance bonds pursuant to federal and state mining laws and
regulations for the estimated costs of reclamation and mine closing, including
the cost of treating mine water discharge when necessary. Compliance with these
laws has substantially increased the cost of coal mining for all domestic coal
producers.

Clean Air Act. The federal Clean Air Act and similar state and local laws,
which regulate emissions into the air, affect coal mining and processing
operations primarily through permitting and emissions control requirements. The
Clean Air Act also indirectly affects coal mining operations by extensively
regulating the emissions from coal-fired industrial boilers and power plants,
which are the largest end-users of the Company's coal. These regulations can
take a variety of forms, as explained below.

The Clean Air Act imposes obligations on the Environmental Protection
Agency, or EPA, and the states to implement regulatory programs that will lead
to the attainment and maintenance of EPA-promulgated ambient air quality
standards, including standards for sulfur dioxide, particulate matter, nitrogen
oxides and ozone. Owners of coal-fired power plants and industrial boilers have
been required to expend considerable resources in an effort to comply with these
ambient air standards. Significant additional emissions control expenditures
will be needed in order to meet the current national ambient air standard for
ozone. In particular, coal-fired power plants will be affected by state
regulations designed to achieve attainment of the ambient air quality standard
for ozone. Ozone is produced by the combination of two precursor pollutants:
volatile organic compounds and nitrogen oxides. Nitrogen oxides are a by-product
of coal combustion. Accordingly, emissions control requirements for new and
expanded coal-fired power plants and industrial boilers will continue to become
more demanding in the years ahead.

In July 1997, the EPA adopted more stringent ambient air quality standards
for particulate matter and ozone. In a February 2001 decision, the U.S. Supreme
Court largely upheld the EPA's position, although it remanded the EPA's ozone
implementation policy for further consideration. On remand, the Court of Appeals
for the D.C. Circuit affirmed the EPA's adoption of these more stringent ambient
air quality standards. As a result of the finalization of these standards,
states that are not in attainment for these standards will have to revise their
State Implementation Plans to include provisions for the control of ozone
precursors and/or particulate matter. Revised State Implementation Plans could
require electric power generators to further reduce nitrogen oxide and
particulate matter emissions. The potential need to achieve such emissions
reductions could result in reduced coal consumption by electric power
generators. Thus, future regulations regarding ozone, particulate matter and
other pollutants could restrict the market for coal and the development of new
mines by the Company. This in turn may result in decreased production by the
Company and a corresponding decrease in the Company's revenues. Although the
future scope of these ozone and particulate matter regulations cannot be
predicted, future regulations regarding these and other ambient air standards
could restrict the market for coal and the development of new mines.

Furthermore, in October 1998, the EPA finalized a rule that will require 19
states in the Eastern United States that have ambient air quality problems to
make substantial reductions in nitrogen oxide emissions by the year 2004. To
achieve these reductions, many power plants would be required to install
additional control measures. The installation of these measures would make it
more costly to operate coal-fired power

II-14

plants and, depending on the requirements of individual state implementation
plans, could make coal a less attractive fuel.

Along with these regulations addressing ambient air quality, the EPA has
initiated a regional haze program designed to protect and to improve visibility
at and around National Parks, National Wilderness Areas and International Parks.
This program restricts the construction of new coal-fired power plants whose
operation may impair visibility at and around federally protected areas.
Moreover, this program may require certain existing coal-fired power plants to
install additional control measures designed to limit haze-causing emissions,
such as sulfur dioxide, nitrogen oxides and particulate matter. By imposing
limitations upon the placement and construction of new coal-fired power plants,
the EPA's regional haze program could affect the future market for coal.

Additionally, the U.S. Department of Justice, on behalf of the EPA, has
filed lawsuits against several investor-owned electric utilities and brought an
administrative action against one government-owned electric utility for alleged
violations of the Clean Air Act. The EPA claims that these utilities have failed
to obtain permits required under the Clean Air Act for alleged major
modifications to their power plants. The Company supplies coal to some of the
currently affected utilities, and it is possible that other of the Company's
customers will be sued. These lawsuits could require the utilities to pay
penalties and install pollution control equipment or undertake other emission
reduction measures, which could adversely impact their demand for coal.

Other Clean Air Act programs are also applicable to power plants that use
the Company's coal. For example, the acid rain control provisions of Title IV of
the Clean Air Act require a reduction of sulfur dioxide emissions from power
plants. Because sulfur is a natural component of coal, required sulfur dioxide
reductions can affect coal mining operations. Title IV imposes a two phase
approach to the implementation of required sulfur dioxide emissions reductions.
Phase I, which became effective in 1995, regulated the sulfur dioxide emissions
levels from 261 generating units at 110 power plants and targeted the highest
sulfur dioxide emitters. Phase II, implemented January 1, 2000, made the
regulations more stringent and extended them to additional power plants,
including all power plants of greater than 25 megawatt capacity. Affected
electric utilities can comply with these requirements by:

- burning lower sulfur coal, either exclusively or mixed with higher sulfur
coal;

- installing pollution control devices such as scrubbers, which reduce the
emissions from high sulfur coal;

- reducing electricity generating levels; or

- purchasing or trading emissions credits.

Specific emissions sources receive these credits, which electric utilities
and industrial concerns can trade or sell to allow other units to emit higher
levels of sulfur dioxide. Each credit allows its holder to emit one ton of
sulfur dioxide.

In addition to emissions control requirements designed to control acid rain
and to attain the national ambient air quality standards, the Clean Air Act also
imposes standards on sources of hazardous air pollutants. Although these
standards have not yet been extended to coal mining operations, the EPA recently
announced that it will regulate hazardous air pollutants from coal-fired power
plants. Under the Clean Air Act, coal-fired power plants will be required to
control hazardous air pollution emissions by no later than 2009. These controls
are likely to require significant new improvements in controls by power plant
owners. The most prominently targeted pollutant is mercury, although other
by-products of coal combustion may be covered by future hazardous air pollutant
standards for coal combustion sources.

Other proposed initiatives may have an effect upon coal operations. One
such proposal is the Bush Administration's recently announced Clear Skies
Initiative. As proposed, this initiative is designed to reduce emissions of
sulfur dioxide, nitrogen oxides, and mercury from power plants. Other so-called
multi-pollutant bills, which could regulate additional air pollutants, have been
proposed by various members of Congress. While the details of all of these
proposed initiatives vary, there appears to be a movement
II-15

towards increased regulation of a number of air pollutants. Were such
initiatives enacted into law, power plants could choose to shift away from coal
as a fuel source to meet these requirements.

Mine Health and Safety Laws. Stringent safety and health standards have
been imposed by federal legislation since the adoption of the Mine Safety and
Health Act of 1969. The Mine Safety and Health Act of 1977, which significantly
expanded the enforcement of health and safety standards of the Mine Safety and
Health Act of 1969, imposes comprehensive safety and health standards on all
mining operations. In addition, as part of the Mine Safety and Health Acts of
1969 and 1977, the Black Lung Act requires payments of benefits by all
businesses conducting current mining operations to coal miners with black lung
and to some survivors of a miner who dies from this disease.

Surface Mining Control and Reclamation Act. SMCRA establishes operational,
reclamation and closure standards for all aspects of surface mining as well as
many aspects of deep mining. SMCRA requires that comprehensive environmental
protection and reclamation standards be met during the course of and upon
completion of mining activities. In conjunction with mining the property, the
Company is contractually obligated under the terms of its leases to comply with
all laws, including SMCRA and equivalent state and local laws. These obligations
include reclaiming and restoring the mined areas by grading, shaping, preparing
the soil for seeding and by seeding with grasses or planting trees for use as
pasture or timberland, as specified in the approved reclamation plan.

SMCRA also requires the Company to submit a bond or otherwise financially
secure the performance of its reclamation obligations. The earliest a
reclamation bond can be completely released is five years after reclamation has
been achieved. Federal law and some states impose on mine operators the
responsibility for repairing the property or compensating the property owners
for damage occurring on the surface of the property as a result of mine
subsidence, a consequence of longwall mining and possibly other mining
operations. In addition, the Abandoned Mine Lands Act, which is part of SMCRA,
imposes a tax on all current mining operations, the proceeds of which are used
to restore mines closed before 1977. The maximum tax is $0.35 per ton of coal
produced from surface mines and $0.15 per ton of coal produced from underground
mines.

The Company also leases some of its coal reserves to third party operators.
Under SMCRA, responsibility for unabated violations, unpaid civil penalties and
unpaid reclamation fees of independent mine lessees and other third parties
could potentially be imputed to other companies that are deemed, according to
the regulations, to have "owned" or "controlled" the mine operator. Sanctions
against the "owner" or "controller" are quite severe and can include civil
penalties, reclamation fees and reclamation costs. The Company is not aware of
any currently pending or asserted claims against it asserting that it "owns" or
"controls" any of its lessees' operations.

On March 29, 2002, the U.S. District Court for the District of Columbia
issued a ruling that could restrict underground mining activities conducted in
the vicinity of public roads, within a variety of federally protected lands,
within national forests and within a certain proximity of occupied dwellings.
The lawsuit, Citizens Coal Council v. Norton, was filed in February 2000 to
challenge regulations issued by the Department of Interior providing, among
other things, that subsidence and underground activities that may lead to
subsidence are not surface mining activities within the meaning of SMCRA. SMCRA
generally contains restrictions and certain prohibitions on the locations where
surface mining activities can be conducted. The District Court entered summary
judgment upon the plaintiff's claims that the Secretary of the Interior's
determination violated SMCRA. By order dated April 9, 2002, the court remanded
the regulations to the Secretary of the Interior for reconsideration.

The significance of this decision for the coal mining industry remains
unclear because this ruling is subject to appellate review. The Department of
Interior and the National Mining Association, a trade group that intervened in
this action, sought a stay of the order pending appeal to the U.S. Court of
Appeals for the District of Columbia Circuit and the stay was granted. If the
District Court's decision is not overturned, or if some legislative solution is
not enacted, this ruling could have a material adverse effect on all coal mine
operations that utilize underground mining techniques, including those of the
Company. While it still may

II-16

be possible to obtain permits for underground mining operations in these areas,
the time and expense of that permitting process are likely to increase
significantly.

Framework Convention on Global Climate Change. The United States and more
than 160 other nations are signatories to the 1992 Framework Convention on
Global Climate Change, commonly known as the Kyoto Protocol, that is intended to
limit or capture emissions of greenhouse gases such as carbon dioxide and
methane. The U.S. Senate has neither ratified the treaty commitments, which
would mandate a reduction in U.S. greenhouse gas emissions, nor enacted any law
specifically controlling greenhouse gas emissions and the Bush Administration
has withdrawn support for this treaty. Nonetheless, future regulation of
greenhouse gases could occur either pursuant to future U.S. treaty obligations
or pursuant to statutory or regulatory changes under the Clean Air Act. Efforts
to control greenhouse gas emissions could result in reduced demand for coal if
electric power generators switch to lower carbon sources of fuel.

Clean Water Act. Section 301 of the Clean Water Act prohibits the
discharge of a pollutant from a point source into navigable waters except in
accordance with a permit issued under either Section 402 or Section 404 of the
Clean Water Act. Navigable waters are broadly defined to include streams, even
those that are not navigable in fact, and may include wetlands.

All mining operations in Appalachia generate excess material, which must be
placed in fills in adjacent valleys and hollows. Likewise, coal refuse disposal
areas and coal processing slurry impoundments are located in valleys and
hollows. Almost all of these areas contain intermittent or perennial streams,
which are considered navigable waters. An operator must secure a Clean Water Act
permit before filling such streams. For approximately the past 25 years,
operators have secured Section 404 fill permits to authorize the filling of
navigable waters with material from various forms of coal mining. Operators have
also obtained permits under Section 404 for the construction of slurry
impoundments although the use of these impoundments, including discharges from
them, requires permits under Section 402. Section 402 discharge permits are
generally not suitable for authorizing the construction of fills in navigable
waters.

On May 8, 2002, the United States District Court for the Southern District
of West Virginia issued an order in Kentuckians for the Commonwealth v.
Rivenburgh enjoining the Huntington, West Virginia office of the U.S. Army Corps
of Engineers from issuing permits under Section 404 of the Clean Water Act for
the construction of valley fills for the disposal of overburden from mountaintop
mining operations solely for the purpose of waste disposal. These valleys
typically contain streams that, under the Clean Water Act, are considered
navigable waters of the United States. The court held that the filling of these
waters solely for waste disposal is a violation of the Clean Water Act. The
effect of this injunction would have been to make mountaintop mining
uneconomical in those areas subject to the injunction.

The court's injunction also prohibited the issuance of permits authorizing
fill activities associated with types of mining activities other than
mountaintop mining where the primary purpose or use of those fill activities is
the disposal of waste. Such activities might include those associated with
slurry impoundments and coal refuse disposal areas.

On January 29, 2003, the Court of Appeals for the Fourth Circuit overturned
the Kentuckians decision as being overly broad and also ruled that the valley
fills in question are not illegal; that the EPA and the U.S. Army Corps of
Engineers have exercised their oversight responsibilities in a reasonable and
consistent manner; and that the agencies' interpretation of the regulation under
which valley fills historically have been permitted is a reasonable construction
of the Clean Water Act.

West Virginia Antidegradation Policy. In January 2002, a number of
environmental groups and individuals filed suit in the U.S. District Court for
the Southern District of West Virginia to challenge the EPA's approval of West
Virginia's antidegradation implementation policy. Under the federal Clean Water
Act, state regulatory authorities must conduct an antidegradation review before
approving permits for the discharge of pollutants to waters that have been
designated as high quality by the state. Antidegradation review involves public
and intergovernmental scrutiny of permits and requires permittees to demonstrate
that the proposed activities are justified in order to accommodate significant
economic or social development in the area where the waters are located. The
plaintiffs in this lawsuit, Ohio Valley Environmental

II-17

Coalition v. Whitman, challenge provisions in West Virginia's antidegradation
implementation policy that exempt current holders of National Pollutant
Discharge Elimination System (NPDES) permits and Section 404 permits, among
other parties, from the antidegradation review process. The Company is exempt
from antidegradation review under these provisions. Revoking this exemption and
subjecting the Company to the antidegradation review process could delay the
issuance or reissuance of Clean Water Act permits to the Company or cause these
permits to be denied. If the plaintiffs are successful and if the Company
discharges into waters that have been designated as high-quality by the state,
the costs, time and difficulty associated with obtaining and complying with
Clean Water Act permits for surface mining of its operations could increase.

Comprehensive Environmental Response, Compensation and Liability
Act. CERCLA and similar state laws affect coal mining operations by, among
other things, imposing cleanup requirements for threatened or actual releases of
hazardous substances that may endanger public health or welfare or the
environment. Under CERCLA and similar state laws, joint and several liability
may be imposed on waste generators, site owners and lessees and others
regardless of fault or the legality of the original disposal activity. Although
the EPA excludes most wastes generated by coal mining and processing operations
from the hazardous waste laws, such wastes can, in certain circumstances,
constitute hazardous substances for the purposes of CERCLA. In addition, the
disposal, release or spilling of some products used by coal companies in
operations, such as chemicals, could implicate the liability provisions of the
statute. Thus, coal mines that the Company currently owns or has previously
owned or operated, and sites to which the Company sent waste materials, may be
subject to liability under CERCLA and similar state laws. In particular, the
Company may be liable under CERCLA or similar state laws for the cleanup of
hazardous substance contamination at sites where it owns surface rights.

Mining Permits and Approvals. Numerous governmental permits or approvals
are required for mining operations. In connection with obtaining these permits
and approvals, the Company may be required to prepare and present to federal,
state or local authorities data pertaining to the effect or impact that any
proposed production of coal may have upon the environment. The requirements
imposed by any of these authorities may be costly and time consuming and may
delay commencement or continuation of mining operations. Regulations also
provide that a mining permit can be refused or revoked if an officer, director
or a shareholder with a 10% or greater interest in the entity is affiliated with
another entity that has outstanding permit violations. Thus, past or ongoing
violations of federal and state mining laws could provide a basis to revoke
existing permits and to deny the issuance of additional permits.

In order to obtain mining permits and approvals from state regulatory
authorities, mine operators, including the Company, must submit a reclamation
plan for restoring, upon the completion of mining operations, the mined property
to its prior condition, productive use or other permitted condition. Typically
the Company submits the necessary permit applications several months before it
plans to begin mining a new area. In the Company's experience, permits generally
are approved several months after a completed application is submitted. In the
past, the Company has generally obtained its mining permits without significant
delay. However, the Company cannot be sure that it will not experience
difficulty in obtaining mining permits in the future.

Future legislation and administrative regulations may emphasize the
protection of the environment and, as a consequence, the activities of mine
operators, including the Company, may be more closely regulated. Legislation and
regulations, as well as future interpretations of existing laws, may also
require substantial increases in equipment expenditures and operating costs, as
well as delays, interruptions or the termination of operations. The Company
cannot predict the possible effect of such regulatory changes.

Under some circumstances, substantial fines and penalties, including
revocation or suspension of mining permits, may be imposed under the laws
described above. Monetary sanctions and, in severe circumstances, criminal
sanctions may be imposed for failure to comply with these laws.

Surety Bonds. Federal and state laws require the Company to obtain surety
bonds to secure payment of certain long-term obligations including mine closure
or reclamation costs, federal and state workers' compensation costs, coal leases
and other miscellaneous obligations. Many of these bonds are renewable
II-18

on a yearly basis. It has become increasingly difficult for the Company to
secure new surety bonds or renew such bonds without the posting of collateral.
In addition, surety bond costs have increased while the market terms of such
bonds have generally become more unfavorable.

West Virginia Cumulative Hydrologic Impact Analysis Litigation. Two
environmental groups sued the West Virginia Department of Environmental
Protection in January 2000 in federal court, alleging various violations of the
Clean Water Act and SMCRA. The lawsuit was amended in September 2001 to name
Gale Norton, Secretary of the Interior, as a defendant. The U.S. Office of
Surface Mining is a division within the Department of Interior. The lawsuit,
Ohio River Valley Environmental Coalition, Inc. v. Castle, specifically alleges
that the West Virginia Department of Environmental Protection has violated its
non-discretionary duty to require all surface and underground mining permit
applications to include certain stream flow and water quality data and an
analysis of the probable hydrologic consequences of the proposed mine, and that
the West Virginia Department of Environmental Protection failed to conduct
SMCRA-required cumulative hydrologic impacts analysis prior to issuing mining
permits. The lawsuit also alleges that the Office of Surface Mining has a
non-discretionary duty to apply the federal SMCRA law in West Virginia due to
the deficiencies in the state program. In March 2001, the district court denied
the plaintiff's motion for a preliminary injunction on its claims against the
West Virginia Department of Environmental Protection. In September 2001, the
district court denied a motion to dismiss for lack of jurisdiction filed by
defendant Michael Callaghan, Secretary of the West Virginia Department of
Environmental Protection. Callaghan filed an interlocutory appeal of this
decision in October 2001. The Fourth Circuit Court of Appeals is awaiting
briefing under an extended schedule in this case. If the plaintiffs are
eventually successful in this lawsuit, the West Virginia Department of
Environmental Protection will have to modify its procedures and requirements for
the content and review of mining permit applications, or the federal government
will be ordered to assume control over mining permits in West Virginia. Any of
these changes are likely to increase the cost of preparing applications and the
time required for their review, and may entail additional operating expenditures
and, possibly, restrictions on operating.

West Virginia SMCRA Bond Lawsuit. In November 2000, the West Virginia
Highlands Conservancy filed a lawsuit in federal district court against the U.S.
Department of Interior, the U.S. Office of Surface Mining and the West Virginia
Department of Environmental Protection. The lawsuit, West Virginia Highlands
Conservancy v. Norton, which seeks declaratory and injunctive relief, generally
challenges the adequacy of the two-tier West Virginia alternative bond
reclamation program. The first tier requires mine operators to post a bond of up
to $5,000 per acre mined. The second tier creates a special reclamation fund
which is funded by an assessment on mine operators of three cents per ton of
coal mined. The West Virginia Highlands Conservancy claims that, individually
and collectively, the alternative bond reclamation program has inadequate funds
to cover the state's cost of conducting mining site reclamation for those sites
where the mine operator has defaulted, or might default, on its reclamation
obligations. Based upon the alleged inadequacy of the alternative bonding
program, the lawsuit claims that the Department of the Interior and the Office
of Surface Mining violated their obligations under SMCRA by either (1) not
asserting federal control over the West Virginia SMCRA bonding program or (2)
not revoking federal approval of the West Virginia SMCRA program and assuming
control under SMCRA. The lawsuit also alleges that the West Virginia Department
of Environmental Protection (1) failed to ensure that the state bonding program
met certain minimum requirements and (2) improperly issued SMCRA permits without
requiring mine operators to post sufficient reclamation bonds.

In May 2001, the district court dismissed all claims against the West
Virginia Department of Environmental Protection based upon the principle of
sovereign immunity. The Office of Surface Mining, in June 2001, initiated formal
administrative action against the West Virginia Department of Environmental
Protection regarding the alleged deficiencies in the state bonding program.

The current deficit will be eliminated through special reclamation taxes on
clean coal production totaling fourteen cents per ton, of which seven cents is
an additional temporary tax that will terminate in 39 months. The Office of
Surface Mining has projected that these taxes will eliminate the deficit. These
taxes and whatever other requirements may be adopted in the future by the
advisory council will likely result in increases in the funds that mine
operators are required to post in order to obtain permits and could
II-19

result in further additional costs or fees related to the operation of a coal
mine or the sale of coal. Any changes to the state reclamation bonding program
could also complicate and protract the process of applying for and obtaining
necessary permits. On June 25, 2002, the West Virginia Highlands Conservancy
filed an amended complaint challenging the Office of Surface Mining's approval
of the amendments to the West Virginia alternative bonding program.

The district court entered a final order on January 9, 2003 denying the
plaintiffs' motion for summary judgment on the issues raised in its complaint.
The court also granted with four minor exceptions the motion for summary
judgment filed by the Office of Surface Mining in support of its May 29 rule.
Unless appealed and stayed, the Department for Environmental Protection will
continue to administer its bonding program to address the deficiencies noted by
OSM in its May 29, 2002 rule.

Endangered Species. The federal Endangered Species Act and counterpart
state legislation protects species threatened with possible extinction.
Protection of endangered species may have the effect of prohibiting or delaying
the Company from obtaining mining permits and may include restrictions on timber
harvesting, road building and other mining or agricultural activities in areas
containing the affected species. A number of species indigenous to the Company's
properties are protected under the Endangered Species Act. Based on the species
that have been identified to date and the current application of applicable laws
and regulations, however, the Company does not believe there are any species
protected under the Endangered Species Act that would materially and adversely
affect its ability to mine coal from its properties in accordance with current
mining plans.

Other Environmental Laws Affecting the Company. The Company is required to
comply with numerous other federal, state and local environmental laws in
addition to those previously discussed. These additional laws include, for
example, the Resource Conservation and Recovery Act, the Safe Drinking Water
Act, the Toxic Substance Control Act and the Emergency Planning and Community
Right-to-Know Act. The Company believes that it is in substantial compliance
with all applicable environmental laws.

COMPETITION -- EXCESS INDUSTRY CAPACITY

The coal industry is intensely competitive, primarily as a result of the
existence of numerous producers in the coal-producing regions in which the
Company operates, and some of the Company's competitors may have greater
financial resources. The Company competes with several major coal producers in
the Central Appalachian and Powder River Basin areas. The Company also competes
with a number of smaller producers in those and other market regions. The
Company is also subject to the risk of reduced profitability as a result of
excess industry capacity, which results in reduced coal prices.

ELECTRIC INDUSTRY FACTORS; CUSTOMER CREDITWORTHINESS

Demand for coal and the prices that the Company will be able to obtain for
its coal are closely linked to coal consumption patterns of the domestic
electric generation industry, which has accounted for approximately 90% of
domestic coal consumption in recent years. These coal consumption patterns are
influenced by factors beyond the Company's control, including the demand for
electricity (which is dependent to a significant extent on summer and winter
temperatures); government regulation; technological developments and the
location, availability, quality and price of competing sources of coal; other
fuels such as natural gas, oil and nuclear; and alternative energy sources such
as hydroelectric power. Demand for the Company's low-sulfur coal and the prices
that the Company will be able to obtain for it will also be affected by the
price and availability of high-sulfur coal, which can be marketed in tandem with
emissions allowances in order to meet federal Clean Air Act requirements. Any
reduction in the demand for the Company's coal by the domestic electric
generation industry may cause a decline in profitability.

Electric utility deregulation is expected to provide incentives to
generators of electricity to minimize their fuel costs and is believed to have
caused electric generators to be more aggressive in negotiating prices with coal
suppliers. Deregulation may have a negative effect on the Company's
profitability to the extent it causes the Company's customers to be more
cost-sensitive.

II-20

In addition, the Company's ability to receive payment for coal sold and
delivered depends on the creditworthiness of its customers. In general, the
creditworthiness of the Company's customers has deteriorated. If such trends
continue, the Company's acceptable customer base may be limited.

RELIANCE ON AND TERMS OF LONG-TERM COAL SUPPLY CONTRACTS

During 2002, sales of coal under long-term contracts, which are contracts
with a term greater than 12 months, accounted for 84% of the Company's total
revenues. The prices for coal shipped under these contracts may be below the
current market price for similar type coal at any given time. As a consequence
of the substantial volume of its sales which are subject to these long-term
agreements, the Company has less coal available with which to capitalize on
stronger coal prices if and when they arise. In addition, because long-term
contracts typically allow the customer to elect volume flexibility, the
Company's ability to realize the higher prices that may be available in the spot
market may be restricted when customers elect to purchase higher volumes under
such contracts, or the Company's exposure to market-based pricing may be
increased should customers elect to purchase fewer tons. The increasingly short
terms of sales contracts and the consequent absence of price adjustment
provisions in such contracts also make it more likely that inflation related
increases in mining costs during the contract term will not be recovered by the
Company.

RESERVE DEGRADATION AND DEPLETION

The Company's profitability depends substantially on its ability to mine
coal reserves that have the geological characteristics that enable them to be
mined at competitive costs. Replacement reserves may not be available when
required or, if available, may not be capable of being mined at costs comparable
to those characteristic of the depleting mines. The Company has in the past
acquired and will in the future acquire, coal reserves for its mine portfolio
from third parties. The Company may not be able to accurately assess the
geological characteristics of any reserves that it acquires, which may adversely
affect the profitability and financial condition of the Company. Exhaustion of
reserves at particular mines can also have an adverse effect on operating
results that is disproportionate to the percentage of overall production
represented by such mines. Mingo Logan's Mountaineer Mine is estimated to
exhaust its longwall mineable reserves in 2006. The Mountaineer Mine generated
$33.7 million and $36.7 million of the Company's total operating income in the
year ended 2002 and 2001, respectively.

POTENTIAL FLUCTUATIONS IN OPERATING RESULTS -- FACTORS ROUTINELY AFFECTING
RESULTS OF OPERATIONS

The Company's mining operations are inherently subject to changing
conditions that can affect levels of production and production costs at
particular mines for varying lengths of time and can result in decreases in
profitability. Weather conditions, equipment replacement or repair, fuel prices,
fires, variations in coal seam thickness, amounts of overburden rock and other
natural materials, and other geological conditions have had, and can be expected
in the future to have, a significant impact on operating results. A prolonged
disruption of production at any of the Company's principal mines, particularly
its Mingo Logan operation in West Virginia or Black Thunder mine in Wyoming,
would result in a decrease, which could be material, in the Company's revenues
and profitability. Other factors affecting the production and sale of the
Company's coal that could result in decreases in its profitability include: (i)
expiration or termination of, or sales price redeterminations or suspension of
deliveries under, coal supply agreements; (ii) disruption or increases in the
cost of transportation services; (iii) changes in laws or regulations, including
permitting requirements; (iv) litigation; (v) work stoppages or other labor
difficulties; (vi) mine worker vacation schedules and related maintenance
activities; and (vii) changes in coal market and general economic conditions.

TRANSPORTATION

The coal industry depends on rail, trucking and barge transportation to
deliver shipments of coal to customers, and transportation costs are a
significant component of the total cost of supplying coal. Disruption of these
transportation services could temporarily impair the Company's ability to supply
coal to its customers. Increases in transportation costs, or changes in such
costs relative to transportation costs for
II-21

coal produced by its competitors or for other fuels, could have an adverse
effect on the Company's business and results of operations.

RESERVES -- TITLE

The Company bases its reserve information on geological data assembled and
analyzed by its staff which includes various engineers and geologists, and
outside firms. The reserve estimates are annually updated to reflect production
of coal from the reserves and new drilling or other data received. There are
numerous uncertainties inherent in estimating quantities of recoverable
reserves, including many factors beyond the control of the Company. Estimates of
economically recoverable coal reserves and net cash flows necessarily depend
upon a number of variable factors and assumptions, such as geological and mining
conditions which may not be fully identified by available exploration data or
may differ from experience in current operations, historical production from the
area compared with production from other producing areas, the assumed effects of
regulation by governmental agencies, and assumptions concerning coal prices,
operating costs, severance and excise taxes, development costs, and reclamation
costs, all of which may cause estimates to vary considerably from actual
results.

For these reasons, estimates of the economically recoverable quantities
attributable to any particular group of properties, classifications of such
reserves based on risk of recovery and estimates of net cash flows expected
therefrom, prepared by different engineers or by the same engineers at different
times, may vary substantially. Actual coal tonnage recovered from identified
reserve areas or properties, and revenues and expenditures with respect to the
Company's reserves, may vary from estimates, and such variances may be material.
These estimates thus may not accurately reflect the Company's actual reserves.

The Company continually seeks to expand its operations and coal reserves in
the regions in which it operates through acquisitions of businesses and assets.
Acquisition transactions involve various inherent risks, such as assessing the
value, strengths, weaknesses, contingent and other liabilities, and potential
profitability of acquisition or other transaction candidates; the potential loss
of key personnel of an acquired business; the ability to achieve identified
operating and financial synergies anticipated to result from an acquisition or
other transaction; and unanticipated changes in business, industry or general
economic conditions that affect the assumptions underlying the acquisition or
other transaction. Any one or more of these factors could impair the Company's
ability to realize the benefits anticipated to result from the acquisition of
businesses or assets.

A significant part of the Company's mining operations are conducted on
properties leased by the Company. The loss of any lease could adversely affect
the Company's ability to develop the associated reserves. Because title to most
of the Company's leased properties and mineral rights is not usually verified
until a commitment is made by the Company to develop a property, which may not
occur until after the Company has obtained necessary permits and completed
exploration of the property, the Company's right to mine certain of its reserves
may be adversely affected if defects in title or boundaries exist. In order to
obtain leases or mining contracts to conduct mining operations on property where
these defects exist, the Company has had to, and may in the future have to,
incur unanticipated costs. In addition, the Company may not be able to
successfully negotiate new leases or mining contracts for properties containing
additional reserves or maintain its leasehold interests in properties on which
mining operations are not commenced during the term of the lease.

CERTAIN CONTRACTUAL ARRANGEMENTS

The Company's affiliate, Arch Western Resources, LLC, is the owner of
Company reserves and mining facilities in the western United States. The
agreement under which Arch Western was formed provides that a subsidiary of the
Company, as the managing member of Arch Western, generally has exclusive power
and authority to conduct, manage and control the business of Arch Western.
However, consent of BP Amoco, the other member of Arch Western, would generally
be required in the event that Arch Western proposes to make a distribution,
incur indebtedness, sell properties or merge or consolidate with any other
entity if,

II-22

at such time, Arch Western has a debt rating less favorable than specified
ratings with Moody's Investors Service or Standard & Poor's or fails to meet
specified indebtedness and interest ratios.

In connection with the Company's June 1, 1998 acquisition of Atlantic
Richfield Company's ("ARCO") coal operations, the Company entered into an
agreement under which it agreed to indemnify ARCO against specified tax
liabilities in the event that these liabilities arise as a result of certain
actions taken prior to June 1, 2013, including the sale or other disposition of
certain properties of Arch Western, the repurchase of certain equity interests
in Arch Western by Arch Western, or the reduction under certain circumstances of
indebtedness incurred by Arch Western in connection with the acquisition. ARCO
was acquired by BP Amoco in 2000. Depending on the time at which any such
indemnification obligation were to arise, it could impact the Company's
profitability for the period in which it arises.

The membership interests in Canyon Fuel, which operates three coal mines in
Utah, are owned 65% by Arch Western and 35% by a subsidiary of ITOCHU
Corporation of Japan. The agreement that governs the management and operations
of Canyon Fuel provides for a management board to manage its business and
affairs. Some major business decisions concerning Canyon Fuel require the vote
of 70% of the membership interests and therefore limit the Company's ability to
make these decisions. These decisions include admission of additional members;
approval of annual business plans; the making of significant capital
expenditures; sales of coal below specified prices; agreements between Canyon
Fuel and any member; the institution or settlement of litigation; a material
change in the nature of Canyon Fuel's business or a material acquisition; the
sale or other disposition, including by merger, of assets other than in the
ordinary course of business; incurrence of indebtedness; the entering into of
leases; and the selection and removal of officers. The Canyon Fuel agreement
also contains various restrictions on the transfer of membership interests in
Canyon Fuel.

The Company's Amended and Restated Certificate of Incorporation requires
the affirmative vote of the holders of at least two-thirds of outstanding common
stock voting thereon to approve a merger or consolidation and certain other
fundamental actions involving or affecting control of the Company. The Company's
Bylaws require the affirmative vote of at least two-thirds of the members of the
Board of Directors of the Company in order to declare dividends and to authorize
certain other actions.

CRITICAL ACCOUNTING POLICIES

The Company's financial statements are prepared in accordance with
accounting principles that are generally accepted in the United States. The
preparation of these financial statements requires management to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses as well as the disclosure of contingent assets and liabilities.
Management bases its estimates and judgments on historical experience and other
factors that are believed to be reasonable under the circumstances.
Additionally, these estimates and judgments are discussed with the Company's
audit committee on a periodic basis. Actual results may differ from the
estimates used under different assumptions or conditions. Note 1 to the
Consolidated Financial Statements provides a description of all significant
accounting policies. We believe that of these significant accounting policies,
the following may involve a higher degree of judgment or complexity:

ACCRUED RECLAMATION AND MINE CLOSURE COSTS

The federal Surface Mining Control and Reclamation Act of 1977 and similar
state statutes require that mine property be restored in accordance with
specified standards and an approved reclamation plan. Significant reclamation
activities include reclaiming refuse and slurry ponds, reclaiming the pit and
support acreage at surface mines, and sealing portals at deep mines. The Company
accrues for the cost of final mine closure reclamation over the estimated useful
mining life of the property. The Company determines the total amount to be
accrued on a mine-by-mine basis based upon current permit requirements and
various estimates and assumptions, including estimates of disturbed acreage,
cost estimates, and assumptions regarding productivity. Estimates of disturbed
acreage are determined based on engineering data. Cost estimates are based upon
historical internal or third-party costs, depending on how the work is

II-23

expected to be performed. Productivity assumptions are based on historical
experience with the equipment that is expected to be utilized in the reclamation
activities. On at least an annual basis, the Company reviews its entire
reclamation liability and makes necessary adjustments for permit changes as
granted by state authorities, additional costs resulting from accelerated mine
closures, and revisions to cost estimates and productivity assumptions, to
reflect current experience. At December 31, 2002 and 2001, the Company had
recorded reclamation and mine closure liabilities of $137.7 million and $129.4
million, respectively. While the precise amount of these future costs cannot be
determined with certainty, as of December 31, 2002, we estimate that the
aggregate cost of final mine closure is approximately $292.2 million.

Effective January 1, 2003, the Company adopted FAS 143, Accounting for
Asset Retirement Obligations, which significantly changes the way in which the
Company accounts for its reclamation and mine closure liabilities. The statement
requires legal obligations associated with the retirement of long-lived assets
to be recognized at their fair value at the time that the obligations are
incurred. Upon initial recognition of a liability, that cost is capitalized as
part of the related long-lived asset and allocated to expense over the useful
life of the asset. See further discussion regarding the impact of adoption of
FAS 143 in Note 1 to the Consolidated Financial Statements.

EMPLOYEE BENEFIT PLANS

The Company has non-contributory defined benefit pension plans covering
certain of its salaried and non-union hourly employees. Benefits are generally
based on the employee's years of service and compensation. The Company funds the
plans in an amount not less than the minimum statutory funding requirements nor
more than the maximum amount that can be deducted for federal income tax
purposes. The Company accounts for its defined benefit plans in accordance with
FAS 87, Employer's Accounting for Pensions, which requires amounts recognized in
the financial statements to be determined on an actuarial basis.

The Company also currently provides certain postretirement medical/life
insurance coverage for eligible employees. Generally, covered employees who
terminate employment after meeting eligibility requirements are eligible for
postretirement coverage for themselves and their dependents. The salaried
employee postretirement medical/life plans are contributory, with retiree
contributions adjusted periodically, and contain other cost-sharing features
such as deductibles and coinsurance. The postretirement medical plan for
retirees who were members of the United Mine Workers of America ("UMWA") is not
contributory. The Company's current funding policy is to fund the cost of all
postretirement medical/life insurance benefits as they are paid. The Company
accounts for its other postretirement benefits in accordance with FAS 106,
Employer's Accounting for Postretirement Benefits Other Than Pensions, which
requires amounts recognized in the financial statements to be determined on an
actuarial basis.

Various actuarial assumptions are required to determine the amounts
reported as obligations and costs related to the pension and postretirement
benefit plans. These assumptions include the discount rate, future cost trend
rates and future rates of return for pension plan assets. Each of these
assumptions is discussed further below:

- The discount rate assumption reflects the rates available on high-quality
fixed-income debt instruments at year end.

- Future cost trend rates include the rate of compensation increase for the
pension obligation and the health care cost trend rate for other
postretirement benefit obligations. The rate of compensation increase is
determined based upon the Company's long-term plans for such increases.
The health care cost trend rate is determined based upon the Company's
own historical trends for health care costs as well as external data
regarding such costs.

- Assumptions regarding future rates of return for pension plan assets are
based on long-term historical actual return information for the mix of
investments that comprise plan assets, and future estimates of long-term
investment returns.

II-24

Due to changes in these and other assumptions, the Company expects that
expenses in 2003 related to its pension and postretirement plans will increase
by approximately $32 million as compared to expenses incurred in 2002.

INCOME TAXES

The Company records deferred tax assets and liabilities using enacted tax
rates for the effect of temporary differences between the book and tax bases of
assets and liabilities. A valuation allowance is recorded to reflect the
expected future tax benefits to be realized. In determining the appropriate
valuation allowance, the Company takes into account the level of expected future
taxable income and available tax planning strategies. If future taxable income
was lower than expected or if expected tax planning strategies were not
available as anticipated, the Company may record additional valuation allowance
through income tax expense in the period such determination was made.

II-25

REPORT OF INDEPENDENT AUDITORS

To the Stockholders and Board of Directors
Arch Coal, Inc.

We have audited the accompanying consolidated balance sheets of Arch Coal,
Inc. and subsidiaries as of December 31, 2002 and 2001 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2002. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above (appearing on
pages II-28 to II-59 of this annual report) present fairly, in all material
respects, the consolidated financial position of Arch Coal, Inc. and
subsidiaries at December 31, 2002 and 2001, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States.

As discussed in Note 1 to the consolidated financial statements, the
Company changed its method of accounting for derivatives and hedging activities
effective January 1, 2001.

/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP

St. Louis, Missouri
January 22, 2003

II-26

REPORT OF MANAGEMENT

The management of Arch Coal, Inc. is responsible for the preparation of the
consolidated financial statements and related financial information in this
annual report. The financial statements are prepared in accordance with
accounting principles generally accepted in the United States and necessarily
include some amounts that are based on management's informed estimates and
judgments, with appropriate consideration given to materiality.

The Company maintains a system of internal accounting controls designed to
provide reasonable assurance that financial records are reliable for purposes of
preparing financial statements and that assets are properly accounted for and
safeguarded. The concept of reasonable assurance is based on the recognition
that the cost of a system of internal accounting controls should not exceed the
value of the benefits derived. The Company has a professional staff of internal
auditors who monitor compliance with and assess the effectiveness of the system
of internal accounting controls.

The Audit Committee of the Board of Directors, composed of directors who
are free from relationships that may impair their independence from Arch Coal,
Inc., meets regularly with management, the internal auditors, and the
independent auditors to discuss matters relating to financial reporting,
internal accounting control, and the nature, extent and results of the audit
effort. The independent auditors and internal auditors have full and free access
to the Audit Committee, with and without management present.

<Table>

/s/ STEVEN F. LEER /s/ ROBERT J. MESSEY
STEVEN F. LEER ROBERT J. MESSEY
President and Chief Executive Officer Senior Vice President and Chief Financial Officer
</Table>

II-27

CONSOLIDATED STATEMENTS OF OPERATIONS

<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
(IN THOUSANDS OF DOLLARS EXCEPT PER SHARE DATA)

REVENUES
Coal sales.......................................... $1,473,558 $1,403,370 $1,342,171
Income from equity investments...................... 10,092 26,250 12,837
Other revenues...................................... 50,489 59,108 49,613
---------- ---------- ----------
1,534,139 1,488,728 1,404,621
---------- ---------- ----------
COSTS AND EXPENSES
Cost of coal sales.................................. 1,412,541 1,336,788 1,237,378
Selling, general and administrative expenses........ 40,019 43,834 38,887
Amortization of coal supply agreements.............. 22,184 27,460 39,803
Other expenses...................................... 30,118 18,190 14,569
---------- ---------- ----------
1,504,862 1,426,272 1,330,637
---------- ---------- ----------
Income from operations................................ 29,277 62,456 73,984
---------- ---------- ----------
Interest expense, net:
Interest expense.................................... (51,922) (64,211) (92,132)
Interest income..................................... 1,083 4,264 1,412
---------- ---------- ----------
(50,839) (59,947) (90,720)
---------- ---------- ----------
Income (loss) before income taxes..................... (21,562) 2,509 (16,736)
Benefit from income taxes............................. (19,000) (4,700) (4,000)
---------- ---------- ----------
NET INCOME (LOSS)..................................... $ (2,562) $ 7,209 $ (12,736)
========== ========== ==========
Basic and diluted earnings (loss) per common share.... $ (.05) $ .15 $ (.33)
========== ========== ==========
</Table>

The accompanying notes are an integral part of the consolidated financial
statements.
II-28

CONSOLIDATED BALANCE SHEETS

<Table>
<Caption>
DECEMBER 31,
-------------------------
2002 2001
----------- -----------
(IN THOUSANDS OF DOLLARS
EXCEPT SHARE DATA)

ASSETS
Current assets
Cash and cash equivalents................................. $ 9,557 $ 6,890
Trade accounts receivable................................. 135,903 149,956
Other receivables......................................... 30,927 32,303
Inventories............................................... 66,799 60,133
Prepaid royalties......................................... 4,971 1,997
Deferred income taxes..................................... 27,775 23,840
Other..................................................... 15,781 14,337
---------- ----------
Total current assets................................. 291,713 289,456
---------- ----------
Property, plant and equipment
Coal lands and mineral rights............................. 1,075,343 1,141,768
Plant and equipment....................................... 1,048,605 1,013,220
Deferred mine development................................. 159,901 125,888
---------- ----------
2,283,849 2,280,876
Less accumulated depreciation, depletion and amortization... (998,881) (884,090)
---------- ----------
Property, plant and equipment, net................... 1,284,968 1,396,786
---------- ----------
Other assets
Prepaid royalties......................................... 51,078 35,216
Coal supply agreements.................................... 59,240 81,424
Deferred income taxes..................................... 221,116 195,411
Equity investments........................................ 231,551 170,686
Other..................................................... 43,142 34,580
---------- ----------
Total other assets................................... 606,127 517,317
---------- ----------
Total assets......................................... $2,182,808 $2,203,559
========== ==========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities
Accounts payable.......................................... $ 113,527 $ 99,081
Accrued expenses.......................................... 133,287 134,062
Current portion of debt................................... 7,100 6,500
---------- ----------
Total current liabilities............................ 253,914 239,643
Long-term debt.............................................. 740,242 767,355
Accrued postretirement benefits other than pension.......... 324,539 326,098
Accrued reclamation and mine closure........................ 130,097 123,761
Accrued workers' compensation............................... 80,985 78,768
Accrued pension cost........................................ -- 22,539
Obligations under capital leases............................ -- 8,210
Other noncurrent liabilities................................ 118,168 66,443
---------- ----------
Total liabilities.................................... 1,647,945 1,632,817
---------- ----------
Stockholders' equity
Common stock, $.01 par value, authorized 100,000,000
shares, issued 52,791,370 and 52,709,916 shares........ 527 527
Paid-in capital........................................... 835,763 835,427
Retained deficit.......................................... (253,943) (239,336)
Less treasury stock, at cost, 357,200 shares.............. (5,047) (5,047)
Accumulated other comprehensive loss...................... (42,437) (20,829)
---------- ----------
Total stockholders' equity........................... 534,863 570,742
---------- ----------
Total liabilities and stockholders' equity........... $2,182,808 $2,203,559
========== ==========
</Table>

The accompanying notes are an integral part of the consolidated financial
statements.
II-29

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 2002

<Table>
<Caption>
ACCUMULATED
RETAINED OTHER
COMMON PAID-IN EARNINGS TREASURY COMPREHENSIVE
STOCK CAPITAL (DEFICIT) STOCK AT COST LOSS TOTAL
------ -------- --------- ------------- ------------- --------
(IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE DATA)

BALANCE AT JANUARY 1, 2000............ $397 $473,335 $(213,466) $(18,971) $ -- $241,295
Net loss............................ (12,736) (12,736)
Dividends paid ($.23 per share)..... (8,778) (8,778)
Issuance of 8,705 shares of common
stock under the stock incentive
plan.............................. 93 93
---- -------- --------- -------- -------- --------
BALANCE AT DECEMBER 31, 2000.......... 397 473,428 (234,980) (18,971) -- 219,874
Comprehensive income
Net income........................ 7,209 7,209
Minimum pension liability
adjustment...................... (2,851) (2,851)
Unrealized losses on
derivatives..................... (17,978) (17,978)
--------
Total comprehensive loss............ (13,620)
Dividends paid ($.23 per share)..... (11,565) (11,565)
Issuance of 14,094,997 shares of
common stock (including 1,541,146
shares held in treasury) pursuant
to public offerings............... 126 353,088 18,971 372,185
Issuance of 441,732 shares of common
stock under the stock incentive
plan.............................. 4 8,911 8,915
Treasury stock purchases of 357,200
shares of common stock............ (5,047) (5,047)
---- -------- --------- -------- -------- --------
BALANCE AT DECEMBER 31, 2001.......... 527 835,427 (239,336) (5,047) (20,829) 570,742
COMPREHENSIVE INCOME
NET LOSS.......................... (2,562) (2,562)
MINIMUM PENSION LIABILITY
ADJUSTMENT...................... (16,416) (16,416)
UNREALIZED LOSSES ON
DERIVATIVES..................... (5,192) (5,192)
--------
TOTAL COMPREHENSIVE LOSS............ (24,170)
DIVIDENDS PAID ($.23 PER SHARE)..... (12,045) (12,045)
ISSUANCE OF 81,454 SHARES OF COMMON
STOCK UNDER THE STOCK INCENTIVE
PLAN.............................. 336 336
---- -------- --------- -------- -------- --------
BALANCE AT DECEMBER 31, 2002.......... $527 $835,763 $(253,943) $ (5,047) $(42,437) $534,863
==== ======== ========= ======== ======== ========
</Table>

The accompanying notes are an integral part of the consolidated financial
statements.
II-30

CONSOLIDATED STATEMENTS OF CASH FLOWS

<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
(IN THOUSANDS OF DOLLARS)

OPERATING ACTIVITIES
Net income (loss)........................................ $ (2,562) $ 7,209 $ (12,736)
Adjustments to reconcile to cash provided by operating
activities:
Depreciation, depletion and amortization............... 174,752 177,504 201,512
Prepaid royalties expensed............................. 8,503 7,274 7,322
Net gain on disposition of assets...................... (751) (14,627) (20,444)
Income from equity investments......................... (10,092) (26,250) (12,837)
Net distributions from equity investments.............. 17,121 42,219 23,897
Changes in operating assets and liabilities............ (6,181) (38,535) (29,420)
Other.................................................. (4,373) (9,133) (21,522)
--------- --------- ---------
Cash provided by operating activities............... 176,417 145,661 135,772
--------- --------- ---------
INVESTING ACTIVITIES
Additions to property, plant and equipment............. (137,089) (123,414) (115,080)
Proceeds from sale of units of Natural Resource
Partners, LP........................................ 33,603 -- --
Proceeds from coal supply agreements................... -- -- 8,512
Additions to prepaid royalties......................... (27,339) (24,725) (25,774)
Proceeds from disposition of property, plant and
equipment........................................... 2,522 18,930 24,846
--------- --------- ---------
Cash used in investing activities................... (128,303) (129,209) (107,496)
--------- --------- ---------
FINANCING ACTIVITIES
Payments on revolver and lines of credit............... (26,513) (241,940) (30,198)
Net payments on term loans............................. -- (135,000) --
Debt financing costs................................... (8,228) -- --
Proceeds from sale and leaseback of equipment.......... 9,213 -- 13,352
Reductions of obligations under capital lease.......... (8,210) (3,138) --
Dividends paid......................................... (12,045) (11,565) (8,778)
Proceeds from sale of common stock..................... 336 381,100 93
Purchases of treasury stock............................ -- (5,047) --
--------- --------- ---------
Cash used in financing activities................... (45,447) (15,590) (25,531)
--------- --------- ---------
Increase in cash and cash equivalents............... 2,667 862 2,745
Cash and cash equivalents, beginning of year........... 6,890 6,028 3,283
--------- --------- ---------
Cash and cash equivalents, end of year................. $ 9,557 $ 6,890 $ 6,028
========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for interest................. $ 51,695 $ 71,612 $ 85,339
Cash received during the year for income tax refunds... $ (3,115) $ (5,548) $ (1,316)
</Table>

The accompanying notes are an integral part of the consolidated financial
statements.
II-31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS OF DOLLARS EXCEPT PER SHARE DATA)

1. ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Arch Coal,
Inc. and its subsidiaries ("the Company"), which operate in the coal mining
industry. The Company operates one reportable segment: the production of steam
and metallurgical coal from surface and deep mines throughout the United States,
for sale to utility, industrial and export markets. The Company's mines are
primarily located in the Central Appalachian and western regions of the United
States. All subsidiaries (except as noted below) are wholly owned. Significant
intercompany transactions and accounts have been eliminated in consolidation.

The Company's Wyoming, Colorado and Utah coal operations are included in a
joint venture named Arch Western Resources, LLC ("Arch Western"). Arch Western
is 99% owned by the Company and 1% owned by BP Amoco. The Company also acts as
the managing member of Arch Western.

The membership interests in Canyon Fuel Company, LLC ("Canyon Fuel") are
owned 65% by the Company and 35% by a subsidiary of ITOCHU Corporation, a
Japanese corporation. The agreement which governs the management and operations
of Canyon Fuel provides for a Management Board to manage its business and
affairs. Generally, the Management Board acts by affirmative vote of the
representatives of the members holding more than 50% of the membership
interests. However, significant participation rights require either the
unanimous approval of the members or the approval of representatives of members
holding more than 70% of the membership interests. Those matters which are
considered significant participation rights include the following:

- approval of the annual business plan;

- approval of significant capital expenditures;

- approval of significant coal sales contracts;

- approval of the institution of, or the settlement of litigation;

- approval of incurrence of indebtedness;

- approval of significant mineral reserve leases;

- selection and removal of the CEO, CFO, or General Counsel;

- approval of any material change in the business of Canyon Fuel;

- approval of any disposition whether by sale, exchange, merger,
consolidation, license or otherwise, and whether directly or indirectly,
of all or any portion of the assets of Canyon Fuel other than in the
ordinary course of business; and

- approval of request that a member provide additional services to Canyon
Fuel.

The Canyon Fuel agreement also contains various restrictions on the
transfer of membership interests in Canyon Fuel. As a result of these
super-majority voting rights, the Company's 65% ownership of Canyon Fuel is
accounted for on the equity method in the consolidated financial statements.
Income from Canyon Fuel is reflected in the Consolidated Statements of
Operations as income from equity investments. (See additional discussion in
"Investment in Canyon Fuel" in Note 4.)

The Company owns 34% of the limited partnership units of Natural Resource
Partners, LP (NRP) and 42.25% of the general partner interest. The Company's
investment in NRP is accounted for on the equity method in the consolidated
financial statements. (See additional discussion in "Investment in Natural
Resource Partners" in Note 5.)

II-32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's 17.5% partnership interest in Dominion Terminal Associates is
accounted for on the equity method in the consolidated balance sheets. Allocable
costs of the partnership for coal loading and storage are included in other
expenses in the consolidated statements of operations.

ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents are stated at cost. Cash equivalents consist of
highly liquid investments with an original maturity of three months or less when
purchased.

ALLOWANCE FOR UNCOLLECTIBLE RECEIVABLES

The Company maintains allowances to reflect the expected uncollectability
of its trade accounts receivable and other receivables based on past collection
history, the economic environment and specified risks identified in the
receivables portfolio. Allowances recorded at December 31, 2002 and 2001 were
$3.9 million and $0.5 million, respectively.

INVENTORIES

Inventories consist of the following:

<Table>
<Caption>
DECEMBER 31,
-----------------
2002 2001
------- -------

Coal........................................................ $35,039 $28,165
Supplies, net of allowance.................................. 31,760 31,968
------- -------
$66,799 $60,133
======= =======
</Table>

Coal and supplies inventories are valued at the lower of average cost or
market. Coal inventory costs include labor, supplies, equipment costs and
operating overhead. The Company has recorded a valuation allowance for
slow-moving and obsolete supplies inventories of $17.5 million and $16.6 million
at December 31, 2002 and 2001, respectively.

COAL ACQUISITION COSTS AND PREPAID ROYALTIES

Coal lease rights obtained through acquisitions are capitalized and
amortized primarily by the units-of-production method over the estimated
recoverable reserves. Amortization occurs either as the Company mines on the
property or as others mine on the property through subleasing transactions.

Rights to leased coal lands are often acquired through royalty payments.
Where royalty payments represent prepayments recoupable against production, they
are capitalized, and amounts expected to be recouped within one year are
classified as a current asset. As mining occurs on these leases, the prepayment
is charged to cost of coal sales.

COAL SUPPLY AGREEMENTS

Acquisition costs allocated to coal supply agreements (sales contracts) are
capitalized and amortized on the basis of coal to be shipped over the term of
the contract. Value is allocated to coal supply agreements

II-33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

based on discounted cash flows attributable to the difference between the
above-market contract price and the then-prevailing market price. Accumulated
amortization for sales contracts was $191.0 million and $198.6 million at
December 31, 2002 and 2001, respectively.

EXPLORATION COSTS

Costs related to locating coal deposits and determining the economic
mineability of such deposits are expensed as incurred.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are recorded at cost. Interest costs
applicable to major asset additions are capitalized during the construction
period. Expenditures which extend the useful lives of existing plant and
equipment or increase the productivity of the asset are capitalized. Costs of
purchasing rights to coal reserves and developing new mines, or significantly
expanding the capacity of existing mines, are capitalized. These costs are
amortized using the units-of-production method over the estimated recoverable
reserves that are associated with the property being benefited. During 2002, all
mineral reserves of the Company that are capitalized are being amortized on the
units-of-production method through Company operations or through sublease
transactions (for which the Company receives royalty revenue) except for a block
of 197 million tons located adjacent to its Hobet 21 operations. The current
value associated with this property is $178.7 million, which the Company plans
to recover via mining operations in the future. Plant and equipment are
depreciated principally on the straight-line method over the estimated useful
lives of the assets, which range from three to 30 years except for preparation
plants and loadouts. Preparation plants and loadouts are depreciated using the
units-of-production method over the estimated recoverable reserves, subject to a
minimum level of depreciation.

Leased property meeting certain criteria is capitalized and the present
value of the related lease payments is recorded as a liability. Amortization of
capitalized leased assets is computed on the straight-line method over the term
of the lease.

ASSET IMPAIRMENT

If facts and circumstances suggest that a long-lived asset may be impaired,
the carrying value is reviewed. If this review indicates that the value of the
asset will not be recoverable, as determined based on projected undiscounted
cash flows related to the asset over its remaining life, then the carrying value
of the asset is reduced to its estimated fair value.

REVENUE RECOGNITION

Coal sales revenues include sales to customers of coal produced at Company
operations and coal purchased from other companies. The Company recognizes
revenue from coal sales at the time title passes to the customer. Transportation
costs that are billed by the Company and reimbursed to the transportation
provider are included in coal sales and cost of coal sales. Revenues from
sources other than coal sales, including gains and losses from dispositions of
long-term assets, are included in other revenues and are recognized as services
are performed or otherwise earned.

DERIVATIVE FINANCIAL INSTRUMENTS

The Company utilizes derivative financial instruments in the management of
its interest rate and diesel fuel exposures. The Company does not use derivative
financial instruments for trading or speculative purposes. The Company adopted
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities ("FAS 133"), on January 1, 2001. FAS 133
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 the nature of the underlying exposure being hedged
II-34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

and how effective the derivatives are at offsetting price movements in the
underlying exposure. All of the Company's existing derivative positions, which
consist of interest rate swaps and heating oil swaps, qualified for cash flow
hedge accounting under FAS 133 and are deemed to be effective for the variable-
rate debt and diesel fuel purchases being hedged. Prior to the adoption of FAS
133, the fair values of the swap agreements were not recognized in the financial
statements. Gains and losses on terminations of swap agreements that qualify as
cash flow hedges are deferred on the balance sheets (in other long-term
liabilities) and amortized as an adjustment to expense over the remaining
original term of the terminated swap agreement.

The Company evaluates all derivative instruments each quarter to determine
that they are highly effective. Any ineffectiveness is recorded in the
Consolidated Statements of Operations. Ineffectiveness for the year ended
December 31, 2002 was $0.8 million and was recorded as a reduction of other
expenses in the Consolidated Statements of Operations.

The Company enters into interest-rate swap agreements to modify the
interest characteristics of outstanding Company debt. The swap agreements
essentially convert variable-rate debt to fixed-rate debt. These agreements
require the exchange of amounts based on variable interest rates for amounts
based on fixed interest rates over the life of the agreement. The Company
accrues amounts to be paid or received under interest-rate swap agreements over
the lives of the agreements. Such amounts are recognized as adjustments to
interest expense over the lives of agreements, thereby adjusting the effective
interest rate on the Company's debt.

The Company enters into heating oil swaps to eliminate volatility in the
price to purchase diesel fuel for its operations. The swap agreements
essentially fix the price paid for diesel fuel by requiring the Company to pay a
fixed heating oil price and receive a floating heating oil price. The changes in
the floating heating oil price highly correlate to changes in diesel fuel costs.

The Company recorded the fair value of the derivative financial instruments
on the balance sheet as an "other non-current liability" and recorded the
unrealized loss, net of tax, in "accumulated other comprehensive loss." The
adoption of FAS 133 had no impact on the Company's results of operations or cash
flows.

INCOME TAXES

Deferred income taxes are based on temporary differences between the
financial statement and tax basis of assets and liabilities existing at each
balance sheet date using enacted tax rates for years during which taxes are
expected to be paid or recovered.

STOCK-BASED COMPENSATION

These financial statements include the disclosure requirements of Financial
Accounting Standards Board Statement No. 123, Accounting for Stock-Based
Compensation ("FAS 123"), as amended by Statement of Financial Accounting
Standards No. 148, Accounting for Stock-Based Compensation -- Transition and
Disclosure ("FAS 148"). With respect to accounting for its stock options, as
permitted under FAS 123, the Company has retained the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"), Accounting
for Stock Issued to Employees, and related Interpretations. Had compensation
expense for stock option grants been determined based on the fair value at the
grant dates

II-35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

consistent with the method of FAS 123, the Company's net income (loss) and
earnings (loss) per common share would have been changed to the pro forma
amounts as indicated in the following table:

<Table>
<Caption>
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
------ ---- ------

As reported
Net income (loss) (in millions)........................... $ (2.6) $7.2 $(12.7)
Basic and diluted earnings (loss) per share............... (.05) .15 (.33)
Pro forma (unaudited)
Net income (loss) (in millions)........................... $(11.1) $3.4 $(14.1)
Basic and diluted earnings (loss) per share............... (0.21) .07 (.37)
</Table>

ACCOUNTING DEVELOPMENT

Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 143, Accounting for Asset Retirement Obligations ("FAS
143"). The Statement requires legal obligations associated with the retirement
of long-lived assets to be recognized at fair value at the time the obligations
are incurred. Upon initial recognition of a liability, that cost should be
capitalized as part of the related long-lived asset and allocated to expense
over the useful life of the asset. The Company anticipates that application of
the new rules will result in a cumulative effect of adoption ranging from zero
to a gain of $2 million, net of income taxes, in 2003.

In November 2002, the Financial Accounting Standards Board issued FASB
Interpretation No. 45, Guarantors' Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. The
disclosure requirements of the interpretation are included in Note 20,
"Commitments and Contingencies."

In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities. The
interpretation clarifies the application of Accounting Research Bulletin No. 51,
Consolidated Financial Statements, to certain types of entities. The Company
does not expect the adoption of this interpretation to have a material impact on
its financial statements.

2. CHANGES IN ESTIMATES AND OTHER NON-RECURRING REVENUES AND EXPENSES

During the year ended December 31, 2002, the Company settled certain coal
contracts with a customer that was partially unwinding its coal supply position
and desired to buy out of the remaining terms of those contracts. The
settlements resulted in a pre-tax gain of $5.6 million, which was recognized in
other revenues in the Consolidated Statements of Operations.

The Company recognized a pre-tax gain of $4.6 million during the year ended
December 31, 2002 as a result of a workers' compensation premium adjustment
refund from the State of West Virginia. During 1998, the Company entered into
the West Virginia workers' compensation plan at one of its subsidiary
operations. The subsidiary paid standard base rates until the West Virginia
Division of Workers' Compensation could determine the actual rates based on
claims experience. Upon review, the Division of Workers' Compensation refunded
$4.6 million in premiums, which was recognized as an adjustment to cost of coal
sales in the Consolidated Statements of Operations.

During the year ended December 31, 2002, the Company was notified by the
Bureau of Land Management ("BLM") that it would receive a royalty rate reduction
for certain tons mined at its West Elk location. The rate reduction applies to a
specified number of tons beginning October 1, 2001 and ending no later than
October 1, 2005. The retroactive portion of the refund totaled $3.3 million and
has been recognized in 2002 as a reduction of cost of coal sales in the
Consolidated Statements of Operations. Additionally, Canyon Fuel was notified by
the BLM that it would receive a royalty rate reduction for certain

II-36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

tons mined at its Skyline mine. The rate reduction applies to certain tons mined
from September 1, 2001 through September 1, 2006. The Company's portion of the
retroactive refund was $1.1 million, and is reflected in 2002 as income from
equity investments in the Consolidated Statements of Operations.

The Company's operating results for the year ended December 31, 2001,
reflect a $9.4 million insurance settlement as part of the Company's coverage
under its property and business interruption policy. The insurance settlement
represents the final settlement for losses incurred at the West Elk mine in
Gunnison County, Colorado, which was idled from January 28, 2000 to July 12,
2000 following the detection of combustion-related gases. The results for the
year ended December 31, 2000, reflect $31.0 million in partial insurance
settlements associated with this event.

During the year ended December 31, 2001, the Company reduced its
reclamation liability resulting in a pre-tax gain of $7.5 million, of which $5.6
million was the result of permit revisions and the ultimate sale of the surface
rights at its idle mine properties in Illinois, and $1.9 million was a result of
estimate changes. Also, as a result of permit revisions at the idle mine
properties in Illinois during the year ended December 31, 2000, the Company
reduced its reclamation liability, resulting in a pre-tax gain of $7.8 million.

During the year ended December 31, 2001, as a result of progress in
processing claims associated with the recovery of certain previously paid excise
taxes on export sales, the Company recognized a pre-tax gain of $4.6 million. Of
the $4.6 million recognized, $3.1 million represents the interest component of
the claim and was recorded as interest income. The gain stems from an IRS notice
during the second quarter of 2000 outlining the procedures for obtaining tax
refunds on black lung excise taxes paid by the industry on export sales. The
notice was the result of a 1998 federal district court decision that found such
taxes to be unconstitutional. The Company recorded $12.7 million of pre-tax
income related to these excise tax recoveries during the year ended December 31,
2000.

During the year ended December 31, 2001, the Company received a state tax
credit covering prior periods that resulted in a pre-tax gain of $7.4 million.
As a result of several litigation settlements, the Company increased its
litigation reserve during 2001, resulting in a pre-tax decrease in income of
$5.6 million. The Company also increased its stock-based benefit program
accruals for awards that met minimum performance levels to qualify for a payout.
This resulted in a decrease in pre-tax income of $4.1 million during the year
ended December 31, 2001. During 2001, Canyon Fuel, the Company's equity method
investment, recognized recoveries of previously paid property taxes. The
Company's share of these recoveries was $2.6 million and is reflected in income
from equity investment on the Consolidated Statements of Operations for the year
ending December 31, 2001. The Company recognized a $13.5 million pre-tax gain in
2001 and a $12.1 million pre-tax gain in 2000 primarily as a result of selling
land.

In 2000, as a result of adjustments to employee postretirement medical
benefits, the Company recognized $9.8 million of pre-tax curtailment gains
resulting from previously unrecognized postretirement benefit changes which
occurred from plan amendments in previous years. The Company also settled
certain workers' compensation liabilities during 2000 with the state of West
Virginia, resulting in pre-tax gains of $21.8 million. This was partially offset
in 2000 by adjustments to other workers' compensation liabilities resulting from
changes in estimates which caused increases to the liability of $13.5 million.

II-37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. OTHER COMPREHENSIVE INCOME

Other comprehensive income items under FAS 130, Reporting Comprehensive
Income, are transactions recorded in stockholders' equity during the year,
excluding net income and transactions with stockholders. Following are the items
included in other comprehensive income (loss) and the related tax effects:

<Table>
<Caption>
FINANCIAL MINIMUM PENSION ACCUMULATED OTHER
DERIVATIVES LIABILITY ADJUSTMENTS COMPREHENSIVE LOSS
----------- --------------------- ------------------

Adoption (January 1, 2001)
Pre-tax amount....................... $ (7,910) $ -- $ (7,910)
Tax benefit.......................... 3,085 -- 3,085
-------- -------- --------
Net amount........................... (4,825) -- (4,825)
2001
Pre-tax amount....................... (21,562) (4,673) (26,235)
Tax benefit.......................... 8,409 1,822 10,231
-------- -------- --------
Net amount........................... (13,153) (2,851) (16,004)
Total 2001
Pre-tax amount....................... (29,472) (4,673) (34,145)
Tax benefit.......................... 11,494 1,822 13,316
-------- -------- --------
Balance December 31, 2001.............. (17,978) (2,851) (20,829)
-------- -------- --------
2002 ACTIVITY
PRE-TAX AMOUNT....................... (8,512) (26,912) (35,424)
TAX BENEFIT.......................... 3,320 10,496 13,816
-------- -------- --------
NET AMOUNT........................... (5,192) (16,416) (21,608)
-------- -------- --------
BALANCE DECEMBER 31, 2002.............. $(23,170) $(19,267) $(42,437)
======== ======== ========
</Table>

4. INVESTMENT IN CANYON FUEL

The following tables present unaudited, summarized financial information
for Canyon Fuel, which is accounted for on the equity method.

CONDENSED INCOME STATEMENT INFORMATION

<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------
2002 2001 2000
-------- -------- --------

Revenues........................................... $250,325 $301,909 $259,101
Total costs and expenses........................... 249,325 275,883 243,226
-------- -------- --------
Net income......................................... $ 1,000 $ 26,026 $ 15,875
======== ======== ========
65% of Canyon Fuel net income...................... $ 650 $ 16,917 $ 10,319
Effect of purchase adjustments..................... 7,124 9,333 2,518
-------- -------- --------
Arch Coal's income from its equity investment in
Canyon Fuel...................................... $ 7,774 $ 26,250 $ 12,837
======== ======== ========
</Table>

II-38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED BALANCE SHEET INFORMATION

<Table>
<Caption>
DECEMBER 31, 2002
------------------------------------------------------
ARCH
OWNERSHIP OF
CANYON CANYON FUEL ARCH PURCHASE
FUEL BASIS BASIS ADJUSTMENTS ARCH BASIS
---------- ------------ ------------- ----------

CURRENT ASSETS..................... $ 64,365 $ 41,837 $ (2,493) $ 39,344
NONCURRENT ASSETS.................. 346,530 225,245 (68,357) 156,888
CURRENT LIABILITIES................ 30,221 19,644 -- 19,644
NONCURRENT LIABILITIES............. 25,135 16,338 (537) 15,801
-------- -------- -------- --------
MEMBERS' EQUITY.................... $355,539 $231,100 $(70,313) $160,787
======== ======== ======== ========
</Table>

<Table>
<Caption>
DECEMBER 31, 2001
------------------------------------------------------
ARCH
OWNERSHIP OF
CANYON CANYON FUEL ARCH PURCHASE
FUEL BASIS BASIS ADJUSTMENTS ARCH BASIS
---------- ------------ ------------- ----------

Current assets..................... $ 73,184 $ 47,570 $ (2,493) $ 45,077
Noncurrent assets.................. 362,124 235,381 (76,018) 159,363
Current liabilities................ 29,530 19,195 -- 19,195
Noncurrent liabilities............. 24,051 15,632 (1,073) 14,559
-------- -------- -------- --------
Members' equity.................... $381,727 $248,124 $(77,438) $170,686
======== ======== ======== ========
</Table>

The Company's income from its equity investment in Canyon Fuel represents
65% of Canyon Fuel's net income after adjusting for the effect of purchase
adjustments related to its investment in Canyon Fuel. The Company's investment
in Canyon Fuel reflects purchase adjustments primarily related to the reduction
in amounts assigned to sales contracts, mineral reserves and other property,
plant and equipment. The purchase adjustments are amortized consistent with the
underlying assets of the joint venture. During 2001, in accordance with FAS 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of, Canyon Fuel wrote off its investment in LAXT, a coal terminal
located in Los Angeles, resulting in a charge of $10.1 million. The Company did
not value LAXT in its Canyon Fuel purchase allocation and, therefore, there was
no impact of the charge on the Company's financial position.

5. INVESTMENT IN NATURAL RESOURCE PARTNERS, L.P.

During 2002, the Company contributed 454 million tons of coal reserves with
a net book value of $84.9 million to Natural Resource Partners L.P. in exchange
for 4.8 million of NRP's common limited partnership units, 4.8 million of NRP's
subordinated limited partnership units, and 42.25% of NRP's general partner
interest. Concurrent with the contribution, the Company entered into various
leases with NRP for the right to mine approximately 57 million tons of the
contributed reserves. No gain was recorded at the time of the contribution of
the reserves and formation of NRP. The excess of the Company's percentage
ownership of NRP's partners' equity over the Company's historical basis in the
assets contributed to NRP (approximately $37.2 million at December 31, 2002) is
being recognized as income from equity investment over the expected life of the
reserves contributed to NRP.

On October 17, 2002, the Company sold 1.9 million of its common limited
partner units in a public offering for proceeds of $33.6 million. The gain on
the sale of approximately $15.6 million was deferred and will be recognized over
the term of the Company's lease with NRP. After the sale, the Company's
remaining ownership interest in NRP is approximately 34% of NRP's total
partners' equity.

II-39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

As of December 31, 2002, the unit price for NRP's common limited
partnership units was $20.70. Based on this market price, the market value of
the Company's investment is approximately $159.2 million.

Income from the Company's equity investment in NRP represents the Company's
share of NRP's earnings for the period from October 17, 2002 (the formation of
NRP) through November 30, 2002. Financial information for NRP through December
31, 2002 was not available at the time that the Company released its financial
results. As such, the Company will account for income from its investment in NRP
on a one-month lag.

Summarized financial information for NRP as of December 31, 2002 and for
the period from October 17, 2002 through December 31, 2002 is as follows (in
thousands):

<Table>

Results of Operations
Revenues.................................................. $ 13,893
Income from operations.................................... 6,615
Net Income................................................ 6,415
--------
Financial Position
Total assets.............................................. $392,719
Total liabilities......................................... 74,085
Partners' equity.......................................... 318,634
--------
Amounts recorded by the Company
Equity investment in NRP.................................. $ 70,764
Income from equity investment in NRP...................... 2,318
</Table>

6. ACCRUED EXPENSES

Accrued expenses included in current liabilities consist of the following:

<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------

Payroll and related benefits................................ $ 25,823 $ 21,620
Taxes other than income taxes............................... 48,716 49,187
Postretirement benefits other than pension.................. 24,090 22,526
Workers' compensation....................................... 9,497 9,907
Interest.................................................... 5,904 5,676
Reclamation and mine closure................................ 7,636 5,667
Other accrued expenses...................................... 11,621 19,479
-------- --------
$133,287 $134,062
======== ========
</Table>

II-40

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. INCOME TAXES

Significant components of the provision (benefit) for income taxes are as
follows:

<Table>
<Caption>
DECEMBER 31,
----------------------------
2002 2001 2000
-------- ------- -------

Current:
Federal............................................. $(21,646) $(4,360) $(4,882)
State............................................... -- -- --
-------- ------- -------
Total current.................................... (21,646) (4,360) (4,882)
-------- ------- -------
Deferred:
Federal............................................. 5,788 1,301 3,067
State............................................... (3,142) (1,641) (2,185)
-------- ------- -------
Total deferred................................... 2,646 (340) 882
-------- ------- -------
$(19,000) $(4,700) $(4,000)
======== ======= =======
</Table>

A reconciliation of the statutory federal income tax expense (benefit) on
the Company's pretax income (loss) to the actual provision (benefit) for income
taxes follows:

<Table>
<Caption>
DECEMBER 31,
----------------------------
2002 2001 2000
-------- ------- -------

Income tax expense (benefit) at statutory rate........ $ (7,547) $ 943 $(5,858)
Percentage depletion allowance........................ (21,366) (7,561) (9,063)
State taxes, net of effect of federal taxes........... (4,585) (1,067) (1,797)
Change in valuation allowance......................... 25,880 1,863 5,515
AMT credits adjustment due to IRS exam................ -- -- 6,704
Favorable tax settlement.............................. (10,506) -- --
Other, net............................................ (876) 1,122 499
-------- ------- -------
$(19,000) $(4,700) $(4,000)
======== ======= =======
</Table>

During 2002, the Company received notice from the IRS that it will receive
tax refunds of $3.6 million as a result of proposed adjustments to tax years
1997 and 1998. In addition, carryover adjustments have been allowed which will
reduce the Company's 1999 and 2000 taxes paid by an additional $5.3 million.
These favorable adjustments are primarily the result of revisions in the tax
treatment of acquisitions made during the audit years. Tax refunds for 1999 and
2000 will not be realized until audits of those years have been completed.

During 2000, the Company received notice from the IRS of their proposed
adjustments for tax years 1995 and 1996. The Company paid $4.7 million during
the first quarter of 2001, which was charged against previously recorded
reserves to partially settle the audit. During 2002, the Company settled the
remaining portion of the audit by paying $0.6 million and receiving $0.6 million
of additional AMT credits.

Management believes that the Company has adequately provided for any income
taxes and interest which may ultimately be paid with respect to all open tax
years.

II-41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Significant components of the Company's deferred tax assets and liabilities
that result from carryforwards and temporary differences between the financial
statement basis and tax basis of assets and liabilities are summarized as
follows:

<Table>
<Caption>
DECEMBER 31,
---------------------
2002 2001
--------- ---------

Deferred tax assets:
Postretirement benefits other than pension................ $ 134,957 $ 134,708
Alternative minimum tax credit carryforward............... 102,336 88,508
Workers' compensation..................................... 34,119 30,643
Reclamation and mine closure.............................. 22,455 20,747
Net operating loss carryforwards.......................... 61,388 28,121
Plant and equipment....................................... 3,895 1,541
Advance royalties......................................... 14,924 20,020
Other comprehensive income................................ 27,131 13,316
Other..................................................... 32,549 41,595
--------- ---------
Gross deferred tax assets.............................. 433,754 379,199
Valuation allowance....................................... (145,603) (119,723)
--------- ---------
Total deferred tax assets.............................. 288,151 259,476
--------- ---------
Deferred tax liabilities:
Leases.................................................... 4,275 5,172
Coal supply agreements.................................... 5,226 3,804
Other..................................................... 29,759 31,249
--------- ---------
Total deferred tax liabilities......................... 39,260 40,225
--------- ---------
Net deferred tax asset............................... 248,891 219,251
Less current asset..................................... 27,775 23,840
--------- ---------
Long-term deferred tax asset......................... $ 221,116 $ 195,411
========= =========
</Table>

The Company has a net operating loss carryforward for regular income tax
purposes of $61.4 million which will expire in the years 2007 to 2022. The
Company has an alternative minimum tax credit carryforward of $102.3 million,
which may carry forward indefinitely to offset future regular tax in excess of
alternative minimum tax.

The Company has recorded a valuation allowance for a portion of its
deferred tax assets that management believes, more likely than not, will not be
realized. These deferred tax assets include a portion of the alternative minimum
tax credits and some of the deductible temporary differences that will likely
not be realized at the maximum effective tax rate. Such valuation allowance
consisted of the following components at December 31 on the years indicated:

<Table>
<Caption>
2002 2001
-------- --------

Unrealized future deductible temporary differences.......... $102,367 $ 78,744
Unutilized alternative minimum tax credits.................. 43,236 40,979
-------- --------
Valuation Allowance at December 31........................ $145,603 $119,723
======== ========
</Table>

II-42

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. DEBT AND FINANCING ARRANGEMENTS

Debt consists of the following:

<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------

Indebtedness to banks under lines of credit (weighted
average rate at December 31, 2001 -- 2.88%)............... $ -- $ 13,500
Indebtedness to banks under revolving credit agreement,
expiring April 18, 2007 (weighted average rate at December
31, 2002 -- 3.18%; December 31, 2001 -- 2.87%)............ 65,000 80,000
Variable rate non-amortizing term loan due April 18, 2007
(weighted average rate at December 31, 2002 -- 4.37%)..... 150,000 --
Variable rate non-amortizing term loan due April 18, 2008
(weighted average rate at December 31, 2002 -- 4.60%)..... 525,000 --
Variable rate non-amortizing term loan due May 31, 2003
(weighted average rate at December 31, 2001 -- 3.25%)..... -- 675,000
Other....................................................... 7,342 5,355
-------- --------
747,342 773,855
Less current portion........................................ 7,100 6,500
-------- --------
Long-term debt.............................................. $740,242 $767,355
======== ========
</Table>

On April 18, 2002, the Company and Arch Western completed a refinancing of
their existing credit facilities. The new credit facilities include five- and
six-year non-amortizing term loans totaling $675.0 million at Arch Western and a
five-year revolving credit facility totaling $350.0 million for the Company. The
five-year non-amortizing term loan at Arch Western is for $150.0 million and the
six-year non-amortizing term loan is for $525.0 million. The rate of interest on
borrowings under both of the credit facilities is a floating rate based on
LIBOR. The Company's credit facility is secured by ownership interests in
substantially all of its subsidiaries, except its ownership interests in Arch
Western and its subsidiaries. The Arch Western credit facility is secured by its
ownership interests in substantially all of its subsidiaries, but is not
guaranteed by the Company. At December 31, 2002, the Company had $42.6 million
in letters of credit outstanding which, when combined with outstanding
borrowings under the revolver, resulted in $242.4 million of unused borrowings
under the revolver. Financial covenant requirements may restrict the amount of
unused capacity available to the Company for borrowings and letters of credit.
The Company also periodically establishes uncommitted lines of credit with
banks. These agreements generally provide for short-term borrowings at market
rates. At December 31, 2002, there were $20.0 million of such agreements in
effect, of which none were outstanding. Aggregate required maturities of debt
are $7.1 million in 2003, $0.2 million in 2004, none in 2005 and 2006, $215.0
million in 2007 and $525.0 million thereafter.

Terms of the Company's credit facilities and leases contain financial and
other covenants that limit the ability of the Company to, among other things,
effect acquisitions or dispositions and borrow additional funds and require the
Company to, among other things, maintain various financial ratios and comply
with various other financial covenants. In addition, the covenants require the
pledging of assets to collateralize the term loans and the Company's revolving
credit facility. The assets pledged include equity interests in wholly-owned
subsidiaries, certain real property interests, accounts receivable and inventory
of the Company. Failure by the Company to comply with such covenants could
result in an event of default, which, if not cured or waived, could have a
material adverse effect on the Company. The Company was in compliance with these
financial covenants at December 31, 2002.

The Company enters into interest-rate swap agreements to modify the
interest characteristics of the Company's outstanding debt. At December 31,
2002, the Company had interest-rate swap agreements

II-43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

having a total notional value of $525.0 million, including $250.0 million for
which the fixed rate becomes effective as of October 2003. These swap agreements
are used to convert variable-rate debt to fixed-rate debt. Under these swap
agreements, the Company pays a weighted-average fixed rate of 5.74% (before the
credit spread over LIBOR) and is receiving a weighted-average variable rate
based upon 30-day and 90-day LIBOR. At December 31, 2002, the remaining terms of
the swap agreements ranged from 32 to 57 months.

9. FAIR VALUES OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:

Cash and cash equivalents: The carrying amounts approximate fair
value.

Debt: The carrying amounts of the Company's borrowings under its
revolving credit agreement, lines of credit, variable-rate term loans and
other long-term debt approximate their fair value.

Interest rate swaps: The fair values of interest rate swaps are based
on quoted prices, which reflect the present value of the difference between
estimated future amounts to be paid and received. At December 31, 2002 and
2001 the fair value of these swaps are liabilities of $37.4 million and
$24.6 million, respectively.

Heating oil swaps: The fair values of heating oil swaps are based on
quoted prices. The fair value of these swaps are an asset of $0.3 million
at December 31, 2002 and a liability of $2.7 million at December 31, 2001.

10. ACCRUED WORKERS' COMPENSATION

The Company is liable under the federal Mine Safety and Health Act of 1977,
as amended, to provide for pneumoconiosis (black lung) benefits to eligible
employees, former employees, and dependents with respect to claims filed by such
persons on or after July 1, 1973. The Company is also liable under various
states' statutes for black lung benefits. The Company currently provides for
federal and state claims principally through a self-insurance program. Charges
are being made to operations as determined by independent actuaries, at the
present value of the actuarially computed present and future liabilities for
such benefits over the employees' applicable years of service. In addition, the
Company is liable for workers' compensation benefits for traumatic injuries
which are accrued as injuries are incurred. Workers' compensation costs
(credits) include the following components:

<Table>
<Caption>
2002 2001 2000
------- ------- -------

Self-insured black lung benefits:
Service cost........................................ $ 916 $ 1,090 $ 1,273
Interest cost....................................... 3,060 2,777 3,620
Net amortization and deferral....................... (639) (1,537) (1,486)
------- ------- -------
3,337 2,330 3,407
Other workers' compensation benefits.................. 9,038 12,221 6,942
------- ------- -------
$12,375 $14,551 $10,349
======= ======= =======
</Table>

Payments for workers' compensation were $9.9 million, $14.5 million and
$23.2 million in the years ended December 31, 2002, 2001, and 2000,
respectively. The actuarial assumptions used in the determination of black lung
benefits included a discount rate of 7.00% as of December 31, 2002 (7.50% and
7.75% as of December 31, 2001 and 2000, respectively) and a black lung benefit
cost escalation rate of 4% in each year. As discussed in Note 2, the Company
recognized a pre-tax gain of $4.6 million in 2002 as a result of a workers'
compensation premium adjustment refund from the State of West Virginia.

II-44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In 2000, the Company settled several of its mining operations' self-insured
workers' compensation and black lung liabilities with the State of West Virginia
resulting in pre-tax gains of $21.8 million. This was partially offset in 2000
by adjustments to other workers' compensation liabilities resulting from changes
in estimates which caused increases to the liability of $13.5 million. The net
workers' compensation adjustment was a pre-tax gain of $8.3 million.

Summarized below is information about the amounts recognized in the
consolidated balance sheets for workers' compensation benefits:

<Table>
<Caption>
DECEMBER 31,
-----------------
2002 2001
------- -------

Actuarial present value for self-insured black lung:
Benefits contractually recoverable from others............ $ 1,230 $ 1,942
Benefits for Company employees............................ 45,626 37,862
------- -------
Accumulated black lung benefit obligation................. 46,856 39,804
Unrecognized net gain (loss).............................. (680) 5,145
------- -------
46,176 44,949
Traumatic and other workers' compensation................... 44,306 43,726
------- -------
Accrued workers' compensation............................... 90,482 88,675
Less amount included in accrued expenses.................... 9,497 9,907
------- -------
$80,985 $78,768
======= =======
</Table>

Receivables related to benefits contractually recoverable from others of
$1.2 million in 2002 and $1.9 million in 2001 are recorded in other long-term
assets.

11. ACCRUED RECLAMATION AND MINE CLOSING COSTS

The federal Surface Mining Control and Reclamation Act of 1977 and similar
state statutes require that mine property be restored in accordance with
specified standards and an approved reclamation plan. The Company accrues for
the costs of final mine closure reclamation over the estimated useful mining
life of the property. These costs relate to reclaiming the pit and support
acreage at surface mines and sealing portals at deep mines. Other costs of final
mine closure common to both types of mining are related to reclaiming refuse and
slurry ponds. The Company also accrues for significant reclamation that is
completed during the mining process prior to final mine closure. The
establishment of the final mine closure reclamation liability and the other
ongoing reclamation liability is based upon permit requirements and requires
various estimates and assumptions, principally associated with costs and
productivities. The Company accrued $11.9 million, $10.8 million and $10.4
million in 2002, 2001 and 2000, respectively, for current and final mine closure
reclamation, excluding reclamation recosting adjustments identified below. Cash
payments for final mine closure reclamation and current disturbances
approximated $3.9 million, $8.7 million and $18.2 million for 2002, 2001 and
2000, respectively. Periodically, the Company reviews its entire environmental
liability and makes necessary adjustments for permit changes as granted by state
authorities, additional costs resulting from accelerated mine closures, and
revisions to costs and productivities, to reflect current experience. These
recosting adjustments are recorded in cost of coal sales. Adjustments included a
net increase in the liability of $0.1 million in 2002 and a net decrease in the
liability of $7.5 million and $9.2 million in 2001 and 2000, respectively. The
Company's management believes it is making adequate provisions for all expected
reclamation and other costs associated with mine closures.

As discussed in Note 1, in 2003, the Company will begin accounting for its
final mine closure reclamation liabilities in accordance with FAS 143.

II-45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. EMPLOYEE BENEFIT PLANS

DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

The Company also currently provides certain postretirement medical/life
insurance coverage for eligible employees. Generally, covered employees who
terminate employment after meeting eligibility requirements are eligible for
postretirement coverage for themselves and their dependents. The salaried
employee postretirement medical/life plans are contributory, with retiree
contributions adjusted periodically, and contain other cost-sharing features
such as deductibles and coinsurance. The postretirement medical plan for
retirees who were members of the United Mine Workers of America ("UMWA") is not
contributory. The Company's current funding policy is to fund the cost of all
postretirement medical/life insurance benefits as they are paid. Summaries of
the changes in the benefit obligations, plan assets (primarily listed stocks and
debt securities) and funded status of the plans are as follows:

<Table>
<Caption>
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
------------------- ------------------------
2002 2001 2002 2001
-------- -------- ----------- ----------
(IN THOUSANDS)

CHANGE IN BENEFIT OBLIGATIONS
Benefit obligations at January 1..... $155,633 $139,064 $ 337,805 $299,432
Service cost......................... 8,031 7,542 2,903 2,028
Interest cost........................ 11,268 10,472 24,265 23,623
Benefits paid........................ (10,703) (10,390) (23,992) (22,846)
Plan amendments...................... -- (11) -- --
Other-primarily actuarial (gain)
loss.............................. 2,578 8,956 111,495 35,568
-------- -------- --------- --------
Benefit obligations at December 31... $166,807 $155,633 $ 452,476 $337,805
-------- -------- --------- --------
CHANGE IN PLAN ASSETS
Value of plan assets at January 1.... $119,889 $138,864 $ -- $ --
Actual return on plan assets......... (12,806) (9,254) -- --
Employer contributions............... 19,215 669 23,992 22,846
Benefits paid........................ (10,703) (10,390) (23,992) (22,846)
-------- -------- --------- --------
Value of plan assets at December
31................................ $115,595 $119,889 $ -- $ --
-------- -------- --------- --------
FUNDED STATUS OF THE PLANS
Accumulated obligations less plan
assets............................ $ 51,212 $ 35,744 $ 452,476 $337,805
Unrecognized actuarial gain (loss)... (42,305) (14,743) (112,115) 413
Unrecognized net transition asset.... 94 293 -- --
Unrecognized prior service gain...... 1,413 1,656 8,268 10,406
-------- -------- --------- --------
Net liability recognized............. $ 10,414 $ 22,950 $ 348,629 $348,624
-------- -------- --------- --------
</Table>

II-46

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<Table>
<Caption>
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
------------------- ------------------------
2002 2001 2002 2001
-------- -------- ----------- ----------
(IN THOUSANDS)

BALANCE SHEET AMOUNTS
Intangible asset (Other assets)...... $ (627) $ (741) $ -- $ --
Minimum pension liability adjustment
(Other noncurrent liabilities).... (29,929) (2,758) -- --
Accrued benefit liabilities.......... 40,970 26,449 348,629 348,624
-------- -------- --------- --------
Net liability recognized............. 10,414 22,950 348,629 348,624
Less current portion................. 10,414 411 24,090 22,526
-------- -------- --------- --------
Long term liability.................. $ -- $ 22,539 $ 324,539 $326,098
======== ======== ========= ========
</Table>

OTHER POSTRETIREMENT BENEFITS

The actuarial loss generated in 2002 resulted from: changes in expected
claims experience, an increase in the expected health care cost trend rate, and
a reduction in the discount rate.

The actuarial loss generated in 2001 resulted from: changes in demographic
information, a reduction in the discount rate and changes in mine life
assumptions.

PENSION BENEFITS

The actuarial losses in the 2002 and 2001 pension benefit obligation
resulted from changes in plan assumptions. The decrease in funded status in year
2002 resulted from decreased earnings on plan assets during the year, which also
contributed to the increase in the unrecognized actuarial loss as compared to
the prior year.

The following table provides the assumptions used to develop net periodic
benefit cost and the actuarial present value of projected benefit obligations.

<Table>
<Caption>
OTHER
POSTRETIREMENT
PENSION BENEFITS BENEFITS
----------------- ---------------
DECEMBER 31, 2002 2001 2002 2001
- ------------ ------- ------- ------ ------

Weighted Average Assumptions Discount rate........... 7.00% 7.50% 7.00% 7.50%
Rate of compensation increase........................ 4.25% 4.50% N/A N/A
Expected return on plan assets....................... 9.00% 9.00% N/A N/A
</Table>

In determining the other postretirement benefit obligation at December 31,
2002, a 7.50% annual rate of increase in the cost of health care benefits is
assumed for 2003. This rate gradually decreases to 5.00% in 2008 and remains at
that level thereafter. The health care cost trend rate assumption has a
significant effect on the amounts reported. For example, increasing the assumed
health care cost trend rate by one percentage point each year would increase the
accumulated postretirement obligation as of December 31, 2002 by $54.5 million,
or 12.0%, and the net periodic postretirement benefit cost for 2002 by $3.9
million, or 16.3%.

II-47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table details the components of pension and other
postretirement benefit costs.

<Table>
<Caption>
PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS
------------------------------ ------------------------------
YEAR ENDED DECEMBER 31, 2002 2001 2000 2002 2001 2000
- ----------------------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)

Service cost.......... $ 8,031 $ 7,542 $ 6,817 $ 2,903 $ 2,028 $ 1,901
Interest cost......... 11,268 10,472 9,546 24,265 23,623 24,416
Expected return on plan
assets*............. (12,336) (11,517) (10,915) -- -- --
Other amortization and
deferral............ (284) (2,363) (3,047) (3,171) (7,473) (5,382)
Curtailments.......... -- -- -- -- -- (9,756)
-------- -------- -------- ------- ------- -------
$ 6,679 $ 4,134 $ 2,401 $23,997 $18,178 $11,179
======== ======== ======== ======= ======= =======
</Table>

- ---------------

* The Company does not fund its other postretirement liabilities.

In 2000, the Company amended its postretirement medical/life insurance plan
to change eligibility requirements to 10 years of service after reaching age 45
for salaried and non-union hourly participants. This change triggered a
curtailment that resulted in the recognition of $9.8 million in previously
unrecognized prior service gains.

MULTI-EMPLOYER PENSION AND BENEFIT PLANS

Under the labor contract with the United Mine Workers of America ("UMWA"),
the Company made no payments in 2002 and 2001 and payments of $0.1 million in
2000 into a multi-employer defined benefit pension plan trust established for
the benefit of union employees. Payments are based on hours worked and are
expensed as hours are incurred. Under the Multi-employer Pension Plan Amendments
Act of 1980, a contributor to a multi-employer pension plan may be liable, under
certain circumstances, for its proportionate share of the plan's unfunded vested
benefits (withdrawal liability). At December 31, 2002, the Company has estimated
its share of such amounts to be $35.6 million. The Company is not aware of any
circumstances that would require it to reflect its share of unfunded vested
pension benefits in its financial statements. At December 31, 2002,
approximately 16% of the Company's workforce was represented by the UMWA. In
December 2001, a new UMWA collective bargaining agreement was approved,
replacing the previous agreement which was set to expire on December 31, 2002.
The new agreement is effective through December 31, 2006.

The Coal Industry Retiree Health Benefit Act of 1992 ("Benefit Act")
provides for the funding of medical and death benefits for certain retired
members of the UMWA through premiums to be paid by assigned operators (former
employers), transfers of monies in 1993 and 1994 from an overfunded pension
trust established for the benefit of retired UMWA members, and transfers from
the Abandoned Mine Lands Fund (funded by a federal tax on coal production)
commencing in 1995. The Company treats its obligation under the Benefit Act as a
participation in a multi-employer plan and records expense as premiums are paid.
The Company recorded expense of $3.2 million in 2002, $3.0 million in 2001, and
$3.3 million in 2000 for premiums pursuant to the Benefit Act.

OTHER PLANS

The Company sponsors savings plans which were established to assist
eligible employees in providing for their future retirement needs. The Company's
contributions to the plans were $8.4 million in 2002, $8.1 million in 2001, and
$8.0 million in 2000.

II-48

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. CAPITAL STOCK

On February 22, 2001, the Company completed a public offering of 9,927,765
shares of common stock, including the remaining 4,756,968 shares held by its
then largest stockholder, and 5,170,797 primary and treasury shares issued
directly by the Company. The proceeds realized by the Company from the
transaction of $92.9 million after the underwriters' discount and expenses, were
used to pay down debt.

On May 8, 2001, the Company utilized its Universal Shelf and completed a
public offering of 8,500,000 primary shares of common stock. On May 16, 2001,
the underwriters involved in the offering purchased an additional 424,200 shares
pursuant to an over-allotment option granted by the Company in connection with
the May 8, 2001 offering. The proceeds realized from these transactions after
the underwriting discount and expenses were $279.3 million. These proceeds were
used to pay down debt.

On January 31, 2003, the Company utilized its Universal Shelf and completed
a public offering of 2,875,000 shares of 5% Perpetual Cumulative Convertible
Preferred Stock. The net proceeds realized by the Company from the offering of
$139.1 million are being used to reduce indebtedness under the Company's
revolving credit facility, and for working capital and general corporate
purposes. Dividends on the preferred stock will be cumulative and will be
payable quarterly at the annual rate of 5% of the liquidation preference. Each
share of the preferred stock will be initially convertible, under certain
conditions, into 2.3985 shares of the Company's common stock. The preferred
stock is redeemable, at the Company's option, on or after January 31, 2008 if
certain conditions are met. The holders of the preferred stock are not entitled
to voting rights on matters submitted to the Company's common shareholders.
However, if the Company fails to pay the equivalent of six quarterly dividends,
the holders of the preferred stock will be entitled to elect two directors to
the Company's board of directors.

Subsequent to the January 2003 offering, the Company can still issue an
additional $311.8 million in debt and equity securities under the Universal
Shelf.

On September 14, 2001, the Company's Board of Directors approved a stock
repurchase plan, under which the Company may repurchase up to 6.0 million of its
shares of common stock from time to time. Through December 31, 2002, the Company
repurchased 357,200 shares of its common stock for $5.0 million pursuant to the
plan at an average price of $14.13 per share. The repurchased shares are being
held in the Company's treasury, which the Company accounts for using the average
cost method. Future repurchases under the plan will be made at management's
discretion and will depend on market conditions and other factors. As of
December 31, 2000, the Company had acquired 1,726,900 shares under a prior
repurchase program at an average price of $12.29 per share. All of the December
31, 2000 treasury shares were reissued in connection with the February 22, 2001
public offering discussed above.

14. STOCKHOLDER RIGHTS PLAN

On March 3, 2000, the Board of Directors adopted a stockholder rights plan
under which preferred share purchase rights were distributed as a dividend to
the Company's stockholders of record on March 20, 2000. The rights are
exercisable only if a person or group acquires 20% or more of the Company's
Common Stock (an "Acquiring Person") or announces a tender or exchange offer the
consummation of which would result in ownership by a person or group of 20% or
more of the Company's Common Stock. Each right entitles the holder to buy one
one-hundredth of a share of a series of junior participating preferred stock at
an exercise price of $42, or in certain circumstances allows the holder (except
for the Acquiring Person) to purchase the Company's Common Stock or voting stock
of the Acquiring Person at a

II-49

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

discount. At its option, the Board of Directors may allow some or all holders
(except for the Acquiring Person) to exchange their rights for Company Common
Stock. The rights will expire on March 20, 2010, subject to earlier redemption
or exchange by the Company as described in the plan.

15. STOCK INCENTIVE PLAN AND OTHER INCENTIVE PLANS

Under the Company's 1997 Stock Incentive Plan (the "Company Incentive
Plan"), 9,000,000 shares of the Company's common stock were reserved for awards
to officers and other selected key management employees of the Company. The
Company Incentive Plan provides the Board of Directors with the flexibility to
grant stock options, stock appreciation rights (SARs), restricted stock awards,
restricted stock units, performance stock or units, merit awards, phantom stock
awards and rights to acquire stock through purchase under a stock purchase
program ("Awards"). Awards the Board of Directors elects to pay out in cash do
not count against the 9,000,000 shares authorized in the Company Incentive Plan.

As of December 31, 2002, stock options, performance units and restricted
stock awards were the only types of awards granted. Each is discussed more fully
below.

STOCK OPTIONS

Stock options are generally subject to vesting provisions of at least one
year from the date of grant and are granted at a price equal to 100% of the fair
market value of the stock on the date of grant. Information regarding stock
options under the Company Incentive Plan is as follows for the years ended
December 31, 2002, 2001 and 2000:

<Table>
<Caption>
2002 2001 2000
----------------- ----------------- -----------------
WEIGHTED WEIGHTED WEIGHTED
COMMON AVERAGE COMMON AVERAGE COMMON AVERAGE
SHARES PRICE SHARES PRICE SHARES PRICE
------ -------- ------ -------- ------ --------

Options outstanding at
January 1................ 3,153 $21.32 1,589 $19.11 1,809 $19.33
Granted.................... 2,443 20.38 2,069 22.74 62 9.44
Exercised.................. (31) 10.69 (442) 20.08 (9) 10.69
Canceled................... (80) 22.51 (63) 21.02 (273) 18.61
----- ------ ----- ------ ----- ------
Options outstanding at
December 31.............. 5,485 20.85 3,153 21.32 1,589 19.11
===== ====== ===== ====== ===== ======
Options exercisable at
December 31.............. 1,115 $19.76 859 $22.01 965 $23.57
Options available for grant
at December 31........... 2,886 2,299 4,305
</Table>

The Company applies APB 25 and related Interpretations in accounting for
the Company Incentive Plan. Accordingly, no compensation expense has been
recognized for the fixed stock option portion of the Company Incentive Plan. The
after-tax fair value of options granted in 2002, 2001 and 2000 was determined to
be $14.9 million, $13.5 million and $0.2 million, respectively, which for
purposes of the pro forma disclosure in note 1 is recognized as compensation
expense over the options' vesting period. The fair value of the options was
determined using the Black-Scholes option pricing model and the weighted average
assumptions noted below. All stock options granted in 2002 will vest ratably
over four years. Of the 2.1 million stock options granted in 2001, 1.7 million
will vest in their entirety at December 31, 2003 while

II-50

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the remaining 0.4 million options vest ratably over three years. The stock
options granted in 2000 vest ratably over three years.

<Table>
<Caption>
2002 2001 2000
------ ----- ------

Weighted average fair value per share of options granted... $ 8.41 $9.18 $ 4.06
Assumptions (weighted average)
Risk-free interest rate.................................. 2.96% 4.5% 5.1%
Expected dividend yield.................................. 2.0% 2.0% 2.0%
Expected volatility...................................... 52.7% 54.3% 51.2%
Expected life (in years)................................. 5.0 5.0 5.0
</Table>

The table below shows pertinent information on options outstanding at
December 31, 2002 (Options in thousands):

<Table>
<Caption>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------- ----------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL LIFE EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING (YEARS) PRICE EXERCISABLE PRICE
- --------------- ----------- ---------------- -------- ----------- --------

$ 8.50 - $10.69............ 488 6.33 $10.54 377 $10.56
$16.09 - $21.95............ 1,572 8.96 19.00 124 21.78
$22.01 - $22.90............ 3,122 5.88 22.76 323 22.72
$25.00 - $35.00............ 303 3.69 27.36 291 27.53
----- ---- ------ ----- ------
$ 8.00 - $35.00............ 5,485 6.68 $20.85 1,115 $19.76
</Table>

PERFORMANCE UNITS

Performance stock or unit awards can be earned by the recipient if the
Company meets certain pre-established performance measures. Until earned, the
performance awards are nontransferable, and when earned, performance awards are
payable in cash, stock, or restricted stock as determined by the Company's Board
of Directors. As of December 31, 2002, 1.7 million performance units were
outstanding under the plan. These awards will be earned by participants based on
Company performance for the years 2000 through 2003. The Company accrues for
anticipated awards to be paid out in cash over the life of the award.

RESTRICTED STOCK AWARDS

On December 18, 2002, the Company granted a restricted stock award of
50,000 shares. The fair value of the shares on the date of grant was $21.11 per
share. The shares will vest in their entirety on January 31, 2008. The Company
will recognize compensation expense in the amount of the total fair value of the
grant ratably over the vesting period of the award.

16. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS

The Company places its cash equivalents in investment-grade short-term
investments and limits the amount of credit exposure to any one commercial
issuer.

The Company markets its coal principally to electric utilities in the
United States. Sales to foreign countries are immaterial. As of December 31,
2002 and 2001, accounts receivable from electric utilities located in the United
States totaled $116.2 million and $129.7 million, respectively, or 86% of total
trade receivables for each year. Generally, credit is extended based on an
evaluation of the customer's financial condition, and collateral is not
generally required. Credit losses are provided for in the financial statements
and historically have been minimal.

II-51

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company is committed under long-term contracts to supply coal that
meets certain quality requirements at specified prices. These prices are
generally adjusted based on indices. Quantities sold under some of these
contracts may vary from year to year within certain limits at the option of the
customer. The Company and its operating subsidiaries sold approximately 106.7
million tons of coal in 2002. Approximately 84% of this tonnage and revenue was
sold under long-term contracts (contracts having a term of greater than one
year). Prices for coal sold under long-term contracts ranged from $3.56 to
$61.43 per ton. Long-term contracts ranged in remaining life from one to 15
years. Some of these contracts include pricing which is above, and, in some
cases, materially above, current market prices. Sales (including spot sales) to
major customers were as follows:

<Table>
<Caption>
2002 2001 2000
-------- -------- --------

AEP................................................ $233,530 $191,443 $188,129
Southern Company................................... 169,488 217,909 161,553
</Table>

17. EARNINGS (LOSS) PER SHARE

The following table sets forth the computation of basic and diluted
earnings (loss) per common share:

<Table>
<Caption>
2002 2001 2000
------- ------- --------

Numerator:
Net income (loss)................................... $(2,562) $ 7,209 $(12,736)
======= ======= ========
Denominator:
Weighted average shares -- denominator for basic.... 52,374 48,650 38,164
Dilutive effect of employee stock options........... -- 268 --
------- ------- --------
Adjusted weighted average shares -- denominator for
diluted.......................................... 52,374 48,918 38,164
======= ======= ========
Basic and diluted earnings (loss) per common share.... $ (0.05) $ .15 $ (.33)
======= ======= ========
</Table>

At December 31, 2002, 2001 and 2000, 3.8 million, 2.6 million, and 1.6
million shares, respectively, were not included in the diluted earnings per
share calculation since the exercise price is greater than the average market
price.

For the years 2002 and 2000, employee stock options did not have a dilutive
impact because the Company incurred losses in those periods.

18. SALE AND LEASEBACK

On June 27, 2002, the Company sold certain mining equipment for $9.2
million and leased back the equipment under operating leases with terms ranging
from three to seven years. The leases contain renewal options at lease
termination and purchase options at amounts approximating fair value at lease
termination. The gain on the sale and leaseback was deferred and is being
amortized over the base term of the leases as a reduction of lease expense.

On June 30, 2000, the Company sold several shovels and continuous miners
for $14.9 million and leased back the equipment under operating and capital
leases. The shovels have been leased over a period of five years, while the
continuous miners have been leased with terms ranging from two to five years.
The leases contain renewal options at lease termination and purchase options at
amounts approximating fair value at lease termination. The gain on the sale and
leaseback was deferred and is being amortized over the base term of the lease as
a reduction of lease expense.

II-52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

19. RELATED PARTY TRANSACTIONS

As described in Note 1, the Company has a 65% ownership interest in Canyon
Fuel which is accounted for on the equity method. The Company receives
administration and production fees from Canyon Fuel for managing the Canyon Fuel
operations. The fee arrangement is calculated annually and is approved by the
Canyon Fuel Management Board. The production fee is calculated on a per-ton
basis while the administration fee represents the costs incurred by the
Company's employees related to Canyon Fuel administrative matters. The fees
recognized as other income by the Company and as expense by Canyon Fuel were
$9.5 million, $8.1 million and $7.4 million for the years ended December 31,
2002, 2001 and 2000, respectively. Amounts receivable from Canyon Fuel were $6.3
million and $2.7 million as of December 31, 2002 and 2001, respectively. Such
amounts are classified as other receivables in the Consolidated Balance Sheets.

As described in Note 1, the Company has a 34% ownership interest in NRP.
The Company leases certain coal reserves from NRP and pays royalties to NRP for
the right to mine those reserves. Terms of the leases require the Company to
prepay royalties with those payments recoupable against production. Amounts
recognized as cost of coal sales for royalties paid to NRP during the year ended
December 31, 2002 were $2.1 million. Amounts paid to NRP and included in the
accompanying balance sheet as prepaid royalties as of December 31, 2002 were
$1.8 million.

20. COMMITMENTS AND CONTINGENCIES

The Company leases equipment, land and various other properties under
noncancelable long-term leases, expiring at various dates. Rental expense
related to these operating leases amounted to $19.0 million in 2002, $22.5
million in 2001 and $22.7 million in 2000. The Company has also entered into
various non-cancelable royalty lease agreements and federal lease bonus payments
under which future minimum payments are due. On October 1, 1998, the Company was
the successful bidder in a federal auction of certain mining rights in the 3,546
acre Thundercloud tract in the Powder River Basin of Wyoming. The Company's
lease bonus bid amounted to $158 million for the tract, of which $31.6 million
was paid on October 1, 1998 and $31.6 million was paid in the month of January
in each of the years 2000, 2001, and 2002, respectively. The remaining lease
bonus payment is reflected below as a component of "Royalties". The tract
contains approximately 412 million tons of demonstrated coal reserves and is
contiguous with the Company's Black Thunder mine. Geological surveys performed
by outside consultants indicate that there are sufficient reserves relative to
these properties to permit recovery of the Company's investment.

Minimum payments due in future years under these agreements in effect at
December 31, 2002 are as follows (in thousands):

<Table>
<Caption>
OPERATING
LEASES ROYALTIES
--------- ---------

2003........................................................ $13,234 $ 65,523
2004........................................................ 9,309 37,374
2005........................................................ 9,034 33,402
2006........................................................ 7,150 30,284
2007........................................................ 4,917 28,186
Thereafter.................................................. 7,139 135,795
------- --------
$50,783 $330,564
======= ========
</Table>

The Company is a party to numerous claims and lawsuits with respect to
various matters. The Company provides for costs related to contingencies when a
loss is probable and the amount is reasonably determinable. After conferring
with counsel, it is the opinion of management that the ultimate resolution

II-53

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

of pending claims given existing legal accruals, will not have a material
adverse effect on the consolidated financial condition, results of operations or
liquidity of the Company.

The Company holds a 17.5% general partnership interest in Dominion Terminal
Associates ("DTA"), which operates a ground storage-to-vessel coal transloading
facility in Newport News, Virginia. DTA leases the facility from Peninsula Ports
Authority of Virginia ("PPAV") for amounts sufficient to meet debt-service
requirements. Financing is provided through $132.8 million of tax-exempt bonds
issued by PPAV (of which the Company is responsible for 17.5%, or $23.2 million)
which mature July 1, 2016. Under the terms of a throughput and handling
agreement with DTA, each partner is charged its share of cash operating and
debt-service costs in exchange for the right to use its share of the facility's
loading capacity and is required to make periodic cash advances to DTA to fund
such costs. On a cumulative basis, costs exceeded cash advances by $12.2 million
at December 31, 2002 (such amount is included in other noncurrent liabilities).
Future payments for fixed operating costs and debt service are estimated to
approximate $2.3 million annually through 2015 and $26.0 million in 2016.

In connection with the Company's acquisition of the coal operations of
Atlantic Richfield Company ("ARCO") and the simultaneous combination of the
acquired ARCO operations and the Company's Wyoming operations into the Arch
Western joint venture, the Company agreed to indemnify another member of Arch
Western against certain tax liabilities in the event that such liabilities arise
as a result of certain actions taken prior to June 1, 2013, including the sale
or other disposition of certain properties of Arch Western, the repurchase of
certain equity interests in Arch Western by Arch Western or the reduction under
certain circumstances of indebtedness incurred by Arch Western in connection
with the acquisition. Depending on the time at which any such indemnification
obligation was to arise, it could have a material adverse effect on the
business, results of operations and financial condition of the Company.

21. CASH FLOW

The changes in operating assets and liabilities as shown in the
consolidated statements of cash flows are comprised of the following:

<Table>
<Caption>
2002 2001 2000
-------- -------- --------

Decrease (increase) in operating assets:
Receivables....................................... $ 14,028 $ (1,992) $ 8,194
Inventories....................................... (6,666) (12,203) 14,452
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses............. (4,711) (19,836) (4,515)
Income taxes...................................... (15,826) 1,053 (2,683)
Accrued postretirement benefits other than
pension........................................ (1,559) (10,565) (7,330)
Accrued reclamation and mine closure.............. 6,336 4,833 (10,941)
Accrued workers' compensation..................... 2,217 175 (26,597)
-------- -------- --------
Changes in operating assets and liabilities......... $ (6,181) $(38,535) $(29,420)
======== ======== ========
</Table>

II-54

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

22. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Quarterly financial data for 2002 and 2001 is summarized below:

<Table>
<Caption>
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- -------- ------------ -----------

2002:
COAL SALES, EQUITY INCOME AND
OTHER REVENUES............. $368,466 $374,476(1) $400,755 $390,442(3)
INCOME (LOSS) FROM
OPERATIONS................. (1,321) 12,322(2) 10,098 8,178(3)
NET INCOME (LOSS)............. (7,354) 2,080 1,640 1,072
BASIC AND DILUTED EARNINGS
(LOSS) PER COMMON
SHARE(8)................... (0.14) 0.04 0.03 0.02
2001:
Coal sales, equity income and
Other revenues............. $381,427 $368,580 $353,305 $385,416
Income from operations........ 26,194(5) 12,189(4,6) 4,044 20,029(5,7,8)
Net income (loss)............. 6,090 849(6) (8,140) 8,410
Basic and diluted earnings
(loss) per common
share(9)................... 0.15 0.02 (0.15) 0.16
</Table>

- ----------

(1) During the second quarter of 2002, the Company settled certain coal
contracts with a customer that was partially unwinding its coal supply
position and desired to buy out of the remaining terms of those contracts.
The settlements resulted in a pre-tax gain of $5.6 million.

(2) During the second quarter of 2002, the Company recognized a pre-tax gain of
$4.6 million as a result of a workers' compensation premium adjustment
refund from the State of West Virginia. During 1998, the Company entered the
West Virginia workers' compensation plan at one of its subsidiary
operations. The subsidiary paid standard base rates until the West Virginia
Division of Workers' Compensation could determine the actual rates based on
claims experience. Upon review, the Division of Workers' Compensation
refunded $4.6 million in premiums.

(3) During the fourth quarter of 2002, the Company was notified by the BLM that
it would receive a royalty rate reduction for certain tons mined at its West
Elk location. The rate reduction applies to a specified number of tons
beginning October 1, 2001 and ending no later than October 1, 2005. The
retroactive portion of the refund totaled $3.3 million and has been
recognized in 2002 as a reduction of cost of coal sales in the Consolidated
Statements of Operations. Additionally, Canyon Fuel was notified by the BLM
that it would receive a royalty rate reduction for certain tons mined at its
Skyline mine, the rate reduction applies to certain tons mined from
September 1, 2001 through September 1, 2006. The Company's portion of the
retroactive refund was $1.1 million, and is reflected in 2002 as income from
equity investments in the Consolidated Statements of Operations.

(4) The Company idled the West Elk underground mine in Gunnison County,
Colorado, on January 28, 2000 following the detection of combustion-related
gases in a portion of the mine. On July 12, 2000, after controlling the
combustion-related gases, the Company resumed production at the West Elk
mine and started to ramp up to normal levels of production. The Company
recognized a final pre-tax insurance settlement related to the event of $9.4
million during the second quarter of 2001.

(5) During the first and fourth quarters of 2001, the Company recognized an
increase of pre-tax income of $3.5 million and $2.1 million from a reduction
in the amount of expected reclamation work at the Company's idle Illinois
property because of permit revisions.

(6) During 2000, the IRS issued a notice outlining the procedures for obtaining
tax refunds on certain excise taxes paid by the industry on export sales
tonnage. The notice was the result of a 1998 federal court decision that
found such taxes to be unconstitutional. During the second quarter of 2001,
the Company
II-55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

recorded $4.6 million of pre-tax income resulting from additional favorable
developments associated with these tax refunds. Of this amount, $3.1 million
represented the interest portion of the claim and was recorded as interest
income (and therefore did not impact income from operations)

(7) During the fourth quarter of 2001, the Company recognized a $7.4 million
pre-tax gain from a state tax credit covering prior periods.

(8) During the fourth quarter of 2001, the Company increased its litigation
reserves reducing pre-tax income by $5.6 million resulting from several
litigation settlements.

(9) The sum of the quarterly earnings (loss) per common share amounts may not
equal earnings (loss) per common share for the full year because per share
amounts are computed independently for each quarter and for the year based
on the weighted average number of common shares outstanding during each
period.

II-56

SELECTED FINANCIAL INFORMATION

<Table>
<Caption>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
2002(1,2,3) 2001(4,5,6) 2000(4,5,7,8) 1999(9,10) 1998(11,12)
----------- ----------- ------------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

Statement of Operations Data:
Coal sales, equity income and other
revenues............................ $1,534,139 $1,488,728 $1,404,621 $1,567,382 $1,505,635
Costs and expenses:
Cost of coal sales.................. 1,412,541 1,336,788 1,237,378 1,426,105 1,313,400
Selling, general and administrative
expenses.......................... 40,019 43,834 38,887 46,357 44,767
Amortization of coal supply
agreements........................ 22,184 27,460 39,803 36,532 34,551
Write-down of impaired assets....... -- -- -- 364,579 --
Other expenses...................... 30,118 18,190 14,569 20,835 25,070
---------- ---------- ---------- ---------- ----------
Income (loss) from operations......... 29,277 62,456 73,984 (327,026) 87,847
Interest expense, net................. 50,839 59,947 90,720 88,767 61,446
Benefit for income taxes.............. (19,000) (4,700) (4,000) (65,700) (5,100)
---------- ---------- ---------- ---------- ----------
Income (loss) before extraordinary
loss and cumulative effect of
accounting change................... (2,562) 7,209 (12,736) (350,093) 31,501
Extraordinary loss.................... -- -- -- -- (1,488)
Cumulative effect of accounting
change.............................. -- -- -- 3,813 --
---------- ---------- ---------- ---------- ----------
Net income (loss)..................... $ (2,562) $ 7,209 $ (12,736) $ (346,280) $ 30,013
========== ========== ========== ========== ==========
Balance Sheet Data:
Total assets........................ $2,182,808 $2,203,559 $2,232,614 $2,332,374 $2,918,220
Working capital..................... 37,799 49,813 (37,556) (54,968) 20,176
Long-term debt, less current
maturities........................ 740,242 767,355 1,090,666 1,094,993 1,309,087
Other long-term obligations......... 653,789 625,819 606,628 655,166 657,759
Stockholders' equity................ $ 534,863 $ 570,742 $ 219,874 $ 241,295 $ 618,216
Common Stock Data:
Basic and diluted earnings (loss)
per common share before
extraordinary loss and cumulative
effect of accounting change....... $ (0.05) $ .15 $ (0.33) $ (9.12) $ 0.79
Basic and diluted earnings (loss)
per common share.................. $ (0.05) $ .15 $ (0.33) $ (9.02) $ 0.76
Dividends per share................. $ .23 $ .23 $ .23 $ .46 $ .46
Shares outstanding at year-end...... 52,434 52,353 38,173 38,164 39,372
Cash Flow Data:
Cash provided by operating
activities........................ $ 176,417 $ 145,661 $ 135,772 $ 279,963 $ 188,023
Depreciation, depletion and
amortization...................... 174,752 177,504 201,512 235,658 204,307
Purchases of property, plant and
equipment......................... 137,089 123,414 115,080 98,715 141,737
Dividend payments................... 12,045 11,565 8,778 17,609 18,266
Adjusted EBITDA(13)................. $ 228,910 $ 282,285 $ 315,175 $ 325,949 $ 313,500
Operating Data:
Tons sold........................... 106,691 109,455 105,519 111,177 81,098
Tons produced....................... 99,641 104,471 100,060 109,524 75,817
Tons purchased from third parties... 8,060 5,569 5,084 3,781 4,997
</Table>

II-57

- ---------------

(1) During the year ended December 31, 2002, the Company settled certain coal
contracts with a customer that was partially unwinding its coal supply
position and desired to buy out of the remaining terms of those contracts.
The settlements resulted in a pre-tax gain of $5.6 million which was
recognized in other revenues in the Consolidated Statement of Operations.

(2) The Company recognized a pre-tax gain of $4.6 million during the year ended
December 31, 2002 as a result of a workers' compensation premium adjustment
refund from the State of West Virginia. During 1998, the Company entered
into the West Virginia workers' compensation plan at one of its subsidiary
operations. The subsidiary paid standard base rates until the West Virginia
Division of Workers' Compensation could determine the actual rates based on
claims experience. Upon review, the Division of Workers' Compensation
refunded $4.6 million in premiums which was recognized as an adjustment to
cost of coal sales in the Consolidated Statement of Operations.

(3) During the year ended December 31, 2002, the Company was notified by the
BLM that it would receive a royalty rate reduction for certain tons mined
at its West Elk location. The rate reduction applies to a specified number
of tons beginning October 1, 2001 and ending no later than October 1, 2005.
The retroactive portion of the refund totaled $3.3 million and has been
recognized in 2002 as a reduction of cost of coal sales in the Consolidated
Statements of Operations. Additionally, Canyon Fuel was notified by the BLM
that it would receive a royalty rate reduction for certain tons mined at
its Skyline mine. The rate reduction applies to certain tons mined from
September 1, 2001 through September 1, 2006. The Company's portion of the
retroactive refund was $1.1 million, and is reflected in 2002 as income
from equity investments in the Consolidated Statements of Operations.

(4) At the West Elk underground mine in Gunnison County, Colorado, following
the detection of combustion-related gases in a portion of the mine, the
Company idled its operation on January 28, 2000. On July 12, 2000, after
controlling the combustion-related gases, the Company resumed production at
the West Elk mine and started to ramp up to normal levels of production.
The Company recognized partial pre-tax insurance settlements of $31.0
million during 2000 and a final pre-tax insurance settlement related to the
event of $9.4 million during 2001.

(5) The IRS issued a notice outlining the procedures for obtaining tax refunds
on certain excise taxes paid by the industry on export sales tonnage. The
notice was the result of a 1998 federal court decision that found such
taxes to be unconstitutional. The Company recorded $12.7 million of pre-tax
income related to these excise tax recoveries during 2000. During 2001 the
Company recorded an additional $4.6 million of pre-tax income resulting
from additional favorable developments associated with these tax refunds.

(6) The Company recognized a $7.4 million pre-tax gain during 2001 from a state
tax credit covering prior periods.

(7) As a result of adjustments to employee postretirement medical benefits, the
Company recognized $9.8 million of pre-tax curtailment gains resulting from
previously unrecognized postretirement benefit changes which occurred in
prior years.

(8) The Company settled certain workers' compensation liabilities with the
state of West Virginia partially offset by adjusting other workers'
compensation liabilities resulting in a net pre-tax gain of $8.3 million.

(9) The Company changed its depreciation method on preparation plants and
loadouts during the first quarter of 1999 and recorded a cumulative effect
of applying the new method for years prior to 1999 which resulted in a
decrease to net loss in 1999 of $3.8 million net-of-tax.

(10) The loss from operations for 1999 reflects one-time pre-tax charges of
$387.7 million related principally to the write-down of assets at its
Dal-Tex, Hobet 21 and Coal-Mac operations and the write-down of certain
other coal reserves in central Appalachia. Included in this charge was a
$23.1 million pre-tax charge related to the restructuring of the Company's
administrative work force and the closure of mines in Illinois, Kentucky
and West Virginia.

(11) Information for 1998 reflects the acquisition of Atlantic Richfield
Company's domestic coal operations on June 1, 1998. As a result of the
refinancing of Company debt resulting from the acquisition, the

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Company incurred an extraordinary charge of $1.5 million (net-of-tax
benefit) related to the early extinguishment of debt which existed prior to
the acquisition.

(12) Income from operations for 1998 reflects pre-tax gains of $41.8 million
from the disposition of assets including $18.5 million and $7.5 million on
the sale or certain assets and property in eastern Kentucky and the sale of
the Company's idle Big Sandy Terminal, respectively.

(13) Adjusted EBITDA is defined as income (loss) from operations before the
effect of net interest expense; income taxes; our depreciation, depletion
and amortization; our equity interest in the depreciation, depletion and
amortization of Canyon Fuel Company; write-down of impaired assets and
restructuring charges (Note 10 above); and changes in accounting principles
and extraordinary items (Notes 9 and 11 above). Adjusted EBITDA is not a
measure of financial performance in accordance with generally accepted
accounting principles, and items excluded to calculate Adjusted EBITDA are
significant in understanding and assessing our financial condition.
Therefore, Adjusted EBITDA should not be considered in isolation from nor
as an alternative to net income, income from operations, cash flows from
operations or as a measure of our profitability, liquidity or performance
under generally accepted accounting principles. We believe that Adjusted
EBITDA presents a useful measure of our ability to service and incur debt
based on ongoing operations. Furthermore, analogous measures are used by
industry analysts to evaluate operating performance. Investors should be
aware that our presentation of Adjusted EBITDA may not be comparable to
similarly titled measures used by other companies. The table below shows
how we calculate Adjusted EBITDA.

<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- --------- --------
(IN THOUSANDS)

Income (loss) from
operations.................. $ 29,277 $ 62,456 $ 73,984 $(327,026) $ 87,847
Depreciation, depletion and
amortization of Arch Coal,
Inc......................... 174,752 177,504 201,512 235,658 204,307
Arch Coal's equity interest in
depreciation, depletion and
amortization of Canyon Fuel
Company, LLC................ 24,881 42,325 39,679 36,423 21,346
Write-down of impaired
assets...................... -- -- -- 364,579 --
Restructuring charges......... -- -- -- 16,315 --
-------- -------- -------- --------- --------
Adjusted EBITDA............... $228,910 $282,285 $315,175 $ 325,949 $313,500
======== ======== ======== ========= ========
</Table>

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STOCKHOLDER INFORMATION

COMMON STOCK

Arch Coal's common stock is listed and traded on the New York Stock
Exchange and also has unlisted trading privileges on the Chicago Stock Exchange.
The ticker symbol is ACI.

<Table>
<Caption>
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
QUARTER ENDED 2002 2002 2002 2002
- ------------- --------- -------- ------------- ------------

DIVIDENDS PER COMMON SHARE............ $.0575 $.0575 $.0575 $.0575
HIGH.................................. $23.84 $25.04 $22.57 $23.00
LOW................................... $17.55 $19.88 $14.21 $19.50
CLOSE................................. $21.20 $22.57 $16.50 $21.59
</Table>

<Table>
<Caption>
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
QUARTER ENDED 2001 2001 2001 2001
- ------------- --------- -------- ------------- ------------

Dividends per common share............ $.0575 $.0575 $.0575 $.0575
High.................................. $31.50 $38.40 $27.50 $23.82
Low................................... $12.88 $21.20 $14.05 $15.33
Close................................. $29.98 $25.87 $15.60 $22.70
</Table>

On March 3, 2003, Arch Coal's common stock closed at $19.50 on the New York
Stock Exchange. At that date, there were 10,766 holders of record of Arch Coal's
common stock.

DIVIDENDS

In 2002, Arch Coal paid dividends totaling $12.0 million, or $.23 per
share, on its outstanding shares of common stock. In 2001, Arch Coal paid
dividends totaling $11.6 million, or $.23 per share, on its outstanding shares
of common stock. There is no assurance as to the amount or payment of dividends
in the future because they are dependent on Arch Coal's future earnings, capital
requirements and financial condition.

STOCK INFORMATION

Questions by stockholders regarding stockholder records, stock transfers, stock
certificates, dividends, the Dividend Reinvestment Plan or other stock inquiries
should be directed to:

American Stock Transfer & Trust Company
59 Maiden Lane
Plaza Level
New York, NY 10038
Telephone: (800) 360-4519
Web Site: www.amstock.com

INDEPENDENT AUDITORS

Ernst & Young LLP
190 Carondelet Plaza, Suite 1300
St. Louis, MO 63105

FINANCIAL INFORMATION

Copies of the Securities and Exchange Commission Form 10-K are available without
charge. Requests for this document -- as well as inquiries from stockholders and
security analysts -- should be directed to:

Investor Relations
Arch Coal, Inc.
One CityPlace Drive, Suite 300
St. Louis, MO 63141
Telephone: (314) 994-2717
Fax: (314) 994-2878
www.archcoal.com

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