SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the Quarterly Period Ended March 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____ to ____
Commission file number 1-13105
ARCH COAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 43-0921172
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
One CityPlace Drive, Suite 300, St. Louis, Missouri 63141
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (314) 994-2700
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
At May 1, 2002, there were 52,376,484 shares of registrant's common stock
outstanding.
INDEX
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2002 and
December 31, 2001...............................................................................1
Condensed Consolidated Statements of Operations for the Three Months
Ended March 31, 2002 and 2001...................................................................2
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2002 and 2001......................................................3
Notes to Condensed Consolidated Financial Statements.................................................4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ................................................8
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..........................................................................25
Item 4. Submission of Matters to a Vote of Securities Holders......................................25
Item 6. Exhibits and Reports on Form 8-K...........................................................25
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ARCH COAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
March 31, December 31,
2002 2001
---------------------- ----------------------
(Unaudited)
Assets
Current assets
Cash and cash equivalents $ 1,602 $ 6,890
Trade receivables 139,104 149,956
Other receivables 32,139 32,303
Inventories 70,127 60,133
Prepaid royalties 3,035 1,997
Deferred income taxes 23,840 23,840
Other 13,190 14,337
---------------------- ----------------------
Total current assets 283,037 289,456
---------------------- ----------------------
Property, plant and equipment, net 1,430,170 1,396,786
---------------------- ----------------------
Other assets
Prepaid royalties 51,116 35,216
Coal supply agreements 76,309 81,424
Deferred income taxes 197,209 195,411
Investment in Canyon Fuel 156,608 170,686
Other 36,750 34,580
---------------------- ----------------------
517,992 517,317
---------------------- ----------------------
Total assets $ 2,231,199 $ 2,203,559
====================== ======================
Liabilities and stockholders' equity
Current liabilities
Accounts payable $ 115,228 $ 99,081
Accrued expenses 147,133 134,062
Current portion of debt 6,500 6,500
---------------------- ----------------------
Total current liabilities 268,861 239,643
Long-term debt 792,354 767,355
Accrued postretirement benefits other than pension 325,618 326,098
Accrued reclamation and mine closure 126,074 123,761
Accrued workers' compensation 79,061 78,768
Accrued pension cost 5,353 22,539
Obligations under capital leases 7,691 8,210
Other noncurrent liabilities 59,548 66,443
---------------------- ----------------------
Total liabilities 1,664,560 1,632,817
---------------------- ----------------------
Stockholders' equity
Common stock 527 527
Paid-in capital 835,585 835,427
Retained deficit (249,700) (239,336)
Treasury stock, at cost (5,047) (5,047)
Accumulated other comprehensive loss (14,726) (20,829)
---------------------- ----------------------
Total stockholders' equity 566,639 570,742
---------------------- ----------------------
Total liabilities and stockholders' equity $ 2,231,199 $ 2,203,559
====================== ======================
See notes to condensed consolidated financial statements.
1
ARCH COAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended
March 31,
---------------- ----------------
2002 2001
---------------- ----------------
Revenues
Coal sales $ 358,595 $ 360,043
Income from equity investment 1,268 6,059
Other revenues 8,604 15,325
---------------- ----------------
368,467 381,427
---------------- ----------------
Costs and expenses
Cost of coal sales 347,211 329,525
Selling, general and administrative expenses 9,870 13,794
Amortization of coal supply agreements 5,114 7,586
Other expenses 7,592 4,329
---------------- ----------------
369,787 355,234
---------------- ----------------
Income (loss) from operations (1,320) 26,193
Interest expense, net:
Interest expense (12,002) (21,354)
Interest income 268 251
---------------- ----------------
(11,734) (21,103)
---------------- ----------------
Income (loss) before income taxes (13,054) 5,090
Income tax benefit (5,700) (1,000)
---------------- ----------------
Net income (loss) $ (7,354) $ 6,090
================ ================
Basic and diluted earnings (loss) per common share $ (0.14) $ 0.15
================ ================
Weighted average shares outstanding 52,356 40,411
================ ================
Dividends declared per share $ 0.0575 $ 0.0575
================ ================
See notes to condensed consolidated financial statements.
2
ARCH COAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Three Months Ended
March 31,
--------------------------------------------
2002 2001
-------------------- --------------------
Net income (loss) $ (7,354) $ 6,090
Adjustments to reconcile to cash provided by operating activities:
Depreciation, depletion and amortization 42,741 44,240
Prepaid royalties expensed 1,874 1,607
Net gain on disposition of assets (187) (3,435)
Income from equity investment (1,268) (6,059)
Net distributions from (contributions to) equity investment 15,346 20,755
Changes in:
Receivables 11,016 2,334
Inventories (9,994) (3,358)
Accounts payable and accrued expenses 11,218 14,249
Income taxes (5,700) (5,767)
Accrued postretirement benefits other than pension (480) (3,826)
Accrued reclamation and mine closure 2,313 (2,795)
Accrued workers' compensation benefits 293 1,044
Other 3,440 413
-------------------- --------------------
Cash provided by operating activities 63,258 65,492
-------------------- --------------------
Investing activities
Additions to property, plant and equipment (73,068) (48,547)
Proceeds from dispositions of property, plant and equipment 1,706 3,631
Additions to prepaid royalties (18,812) (18,804)
-------------------- --------------------
Cash used in investing activities (90,174) (63,720)
-------------------- --------------------
Financing activities
Net proceeds from (payments on) revolver and lines of credit 24,999 (51,725)
Payments on term loans - (47,000)
Reduction of obligations under capital leases (519) (752)
Dividends paid (3,010) (2,495)
Proceeds from sale of common stock 158 96,521
-------------------- --------------------
Cash provided by (used in) financing activities 21,628 (5,451)
-------------------- --------------------
Decrease in cash and cash equivalents (5,288) (3,679)
Cash and cash equivalents, beginning of period 6,890 6,028
-------------------- --------------------
Cash and cash equivalents, end of period $ 1,602 $ 2,349
==================== ====================
See notes to condensed consolidated financial statements.
3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
Note A - General
The accompanying unaudited Condensed Consolidated Financial Statements have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting and Securities and Exchange Commission regulations, but are
subject to any year-end adjustments that may be necessary. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Results of operations for
the period ended March 31, 2002 are not necessarily indicative of results to be
expected for the year ending December 31, 2002. Arch Coal, Inc. (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 the Utah coal operations, Canyon Fuel Company, LLC
("Canyon Fuel"), are owned 65% by Arch Western and 35% by a subsidiary of ITOCHU
Corporation. The Company's 65% ownership of Canyon Fuel is accounted for on the
equity method in the Condensed Consolidated Financial Statements as a result of
certain super-majority voting rights in the joint venture agreement. Income from
Canyon Fuel is reflected in the Condensed Consolidated Statements of Operations
as income from equity investment (see additional discussion in "Investment in
Canyon Fuel" in Note C).
Note B - 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. The Company adopted FAS 133,
Accounting for Derivative Instruments and Hedging Activities, on January 1,
2001. In accordance with FAS 133, the Company recorded a cumulative effect of
accounting change which is shown below. Following are the items included in
accumulated other comprehensive income (loss) and the related tax effects
including the adoption of FAS 133:
4
Minimum Accumulated Other
Pension Other
Financial Liability Comprehensive
Derivatives Adjustments Loss
--------------- -------------- ------------------
(in thousands)
Adoption (January 1, 2001)
Pre-tax amount $ (7,910) $ - $ (7,910)
Tax benefit 3,085 - 3,085
--------------- -------------- ------------------
Net amount $ (4,825) $ - $ (4,825)
=============== ============== ==================
Three months ended
March 31, 2001
Pre-tax amount $ (15,056) $ - $ (15,056)
Tax benefit 5,872 - 5,872
--------------- -------------- ------------------
Net amount $ (9,184) $ - $ (9,184)
=============== ============== ==================
March 31, 2001
Pre-tax amount $ (22,966) $ - $ (22,966)
Tax benefit 8,957 - 8,957
--------------- -------------- ------------------
Net amount $ (14,009) $ - $ (14,009)
=============== ============== ==================
Minimum Accumulated
Pension Other
Financial Liability Comprehensive
Derivatives Adjustments Loss
--------------- -------------- ------------------
December 31, 2001
Pre-tax amount $ (29,472) $ (4,673) $ (34,145)
Tax benefit 11,494 1,822 13,316
--------------- -------------- ------------------
Net amount $ (17,978) $ (2,851) $ (20,829)
=============== ============== ==================
Three months ended
March 31, 2002
Pre-tax amount $ 10,005 $ - $ 10,005
Tax benefit (3,902) - (3,902)
--------------- ------------- -------------------
Net amount $ 6,103 $ - $ 6,103
=============== ============== ===================
March 31, 2002
Pre-tax amount $ (19,467) $ (4,673) $ (24,140)
Tax benefit 7,592 1,822 9,414
--------------- -------------- -------------------
Net amount $ (11,875) $ (2,851) $ (14,726)
=============== ============== ===================
5
The following table presents comprehensive income:
Three Months Ended
March 31,
-------------------------------
2002 2001
-------------- -------------
(in thousands)
Net income (loss) $ (7,354) $ 6,090
Other comprehensive income (loss) net of income tax benefit 6,103 (14,009)
-------------- -------------
Total comprehensive loss $ (1,251) $ (7,919)
============== =============
Note C - Investment in Canyon Fuel
The following table presents unaudited summarized financial information for
Canyon Fuel, which is accounted for on the equity method:
Three Months Ended
March 31,
-------------------------------
Condensed Income Statement Information 2002 2001
-------------------------------------------------------------- -------------- -------------
(in thousands)
Revenues $ 77,648 $ 70,164
Total costs and expenses 77,155 62,154
-------------- -------------
Net income $ 493 $ 8,010
============== =============
65% of Canyon Fuel net income $ 320 $ 5,207
Effect of purchase adjustments 948 852
-------------- -------------
Arch Coal's income from its equity
investment in Canyon Fuel $ 1,268 $ 6,059
============== =============
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
primarily 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.
Note D - Inventories
Inventories consists of the following:
March 31, December 31,
2002 2001
----------------- ----------------
(in thousands)
Coal $ 37,700 $ 28,165
Repair parts and supplies 32,427 31,968
----------------- ----------------
$ 70,127 $ 60,133
================= ================
6
Note E - Debt
Debt consists of the following:
March 31, December 31,
2002 2001
----------------- ----------------
(in thousands)
Indebtedness to banks under lines of credit $ 9,000 $ 13,500
Indebtedness to banks under revolving credit
agreement, expiring May 31, 2003 111,400 80,000
Indebtedness to banks under variable rate,
non-amortizing term loan due May 31, 2003 675,000 675,000
Other 3,454 5,355
----------------- ----------------
798,854 773,855
Less current portion 6,500 6,500
----------------- ----------------
Long-term debt $ 792,354 $ 767,355
================= ================
At March 31, 2002, the Company had two credit facilities: a $675.0 million
non-amortizing term loan in the name of Arch Western and a revolving credit
facility in the name of the Company that expired on May 31, 2003. The rate of
interest on the borrowings under the agreements was a rate based on LIBOR. 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 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 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.
Note F - Contingencies
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 of these
claims, to the extent not previously provided for, will not have a material
adverse effect on the consolidated financial position, results of operations or
liquidity of the Company.
Note G - Changes in Estimates and Other Non-Recurring Revenues and Expenses
During the first quarter of 2001, as a result of permit revisions at the Arch of
Illinois operation, the Company reduced its reclamation liability resulting in a
pre-tax gain of $3.5 million recognized as a reduction in cost of coal sales.
The gain was more than offset by expense related to stock-based compensation
benefit programs that may be realized in future periods as a result of improved
stock performance. The compensation related accrual resulted in a pre-tax charge
of $6.3 million, $3.6 million of which was recorded in selling, general and
administrative expenses while $2.7 million was recorded in cost of coal sales.
Note H - Earnings (Loss) per Share
The following table sets forth the computation of basic and diluted earnings
(loss) per common share from continuing operations.
7
Three Months Ended
March 31,
-------------------------------------
2002 2001
---------------- ----------------
(in thousands, except per share data)
Numerator:
Net income (loss) $ (7,354) $ 6,090
================ ================
Denominator:
Weighted average shares - denominator for basic 52,356 40,411
Dilutive effect of employee stock options - 169
---------------- ----------------
Adjusted weighted average shares - denominator
for diluted 52,356 40,580
================ ================
Basic and diluted earnings (loss) per common share $ (0.14) $ 0.15
================ ================
Note I - Subsequent Event
On April 19, 2002, the Company created a limited partnership, Natural Resource
Partners L.P., with three affiliated private companies, Western Pocahontas
Properties Limited Partnership, Great Northern Properties Limited Partnership
and New Gauley Coal Corporation. Natural Resource Partners was formed to engage
principally in the business of owning and managing coal royalty properties in
the three major coal producing regions in the United States: Appalachia, the
Illinois Basin and the Western United States. The partnership has filed a
registration statement on Form S-1 with the Securities and Exchange Commission
relating to a proposed underwritten initial public offering of common units
representing limited partner interests in Natural Resource Partners. The Company
is contributing approximately 454 million tons of its 3.4 billion tons of total
coal reserves to Natural Resource Partners in exchange for its ownership
interest in the partnership.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Statements in this quarterly 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 were 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 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 and meet its debt
reduction goals; a variety of market, 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
Quarter Ended March 31, 2002, Compared
to Quarter Ended March 31, 2001
Net Income (Loss). The net loss for the quarter ended March 31, 2002 was $7.4
million compared to net income of $6.1 million for the quarter ended March 31,
2001. Results for the current quarter were negatively impacted by the current
state of oversupply in the coal market that resulted from an extremely mild
winter and a period of economic weakness that dampened electricity demand. As a
result, during the first quarter of 2002 the Company reduced the rate of
production from planned levels at its mining operations by 7%. In addition, as
described below, the Company continued to be negatively impacted by production
difficulties at its Samples surface operation in West Virginia. Partially
offsetting these negative items in the current quarter were higher contract
prices for coal shipped during the quarter compared to the same period in the
8
prior year and reduced interest expense associated with lower debt levels and
lower interest rates. During 2001, the Company was able to enter into higher
priced contracts for coal to be shipped during 2002. Results for the first
quarter of 2001 were positively impacted by strong margins on limited tonnage
that was open to market-based pricing and by strong performances at nearly all
of the Company's mines except for the West Elk mine in Colorado. Also, during
the first quarter of 2001, the Company reversed previously recorded reclamation
liabilities at its Arch of Illinois subsidiary where, as a result of permit
revisions associated with its reclamation activities that reduced the amount of
reclamation work expected, the Company was able to recognize a $3.5 million
pre-tax gain. These positive factors during the first quarter of 2001 were
partially offset by accruals recorded during the same quarter related to
stock-based compensation programs that may be realized in future periods as a
result of improved stock price performance. The compensation related accruals
resulted in a pre-tax reduction of earnings of $6.3 million.
Results at the Samples surface operations for the first quarter of 2002 were
negatively impacted by a sandstone intrusion that caused the principal coal seam
to thin, which resulted in lower production and higher associated costs compared
to the same period in the prior year. The sandstone intrusion was first
encountered during the second quarter of 2001. During the quarter ended March
31, 2002, the Samples surface operation incurred an operating loss of $4.5
million compared to operating income of $1.4 million during the same period of
2001.
Revenues. Total revenues for the quarter ended March 31, 2002 were $368.5
million, a decrease of $12.9 million from the quarter ended March 31, 2001. The
decrease was caused primarily by reduced sales caused by the oversupply
conditions that existed in the market as described above. The Company shipped
24.7 million tons during the quarter ended March 31, 2002 compared to 27.2
million tons during the quarter ended March 31, 2001. Average coal sales
realizations on a per ton basis were $14.53 per ton for the quarter ended March
31, 2002 compared to $13.24 per ton for the quarter ended March 31, 2001. The
increase in the per ton realization was the result of the Company shipping under
more favorably priced contracts during the first quarter of 2002 as compared to
the first quarter of 2001.
Income From Equity Investment. Income from equity investment decreased during
the quarter ended March 31, 2002 to $1.3 million from $6.1 million during the
quarter ended March 31, 2001. The decrease was the result of lower realizations
due to an above market price contract expiring in the prior year and reduced
coal shipments related to a weak market environment in the first quarter of
2002.
Other Revenues. The decrease in other revenues of $6.7 million in the first
quarter of 2002 compared to the first quarter of 2001 was primarily attributable
to additional land sales during the first quarter of 2001. These land sales
resulted in a gain of $3.3 million in the first quarter of 2001 compared to $0.2
million during the first quarter of 2002. In addition, during the first quarter
of 2001, the Company amortized a gain on a coal sales contract buy-down that
resulted in $2.4 million of income. The gain was fully amortized prior to
December 31, 2001.
Income (Loss) From Operations. The following table presents income (loss) from
operations excluding the unusual items discussed above.
Three Months Ended
March 31,
------------------------------------
2002 2001
---------------- ---------------
(in millions)
Income (loss) from operations (as reported) $ (1.3) $ 26.2
Gain amortization on contract buydown - (2.4)
Samples surface operation losses 4.5 -
Land sales (0.2) (3.3)
Reclamation adjustment - (3.5)
Stock based compensation accrual adjustment - 6.3
---------------- ---------------
Adjusted income from operations $ 3.0 $ 23.3
================ ===============
The decrease in adjusted income from operations is primarily attributable to the
Company's curtailment of production during the first quarter of 2002 in response
to the weak market environment described above. The decision to scale back
production during the quarter came after the Company prepared most of the
operations to maximize production in order to capitalize on the higher market
prices for coal the Company had previously projected for 2002. In addition, the
9
Company experienced higher insurance costs and higher contract mining costs when
compared to the same period in the prior year. 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 $14.07 per ton for
the quarter ended March 31, 2002 compared to $12.12 per ton for the quarter
ended March 31, 2001.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses declined $3.9 million, to $9.9 million, during the first
quarter of 2002 when compared to expenses of $13.8 million in the first quarter
of 2001. The decrease is primarily attributable to the stock-based compensation
accruals recorded during the first quarter of 2001 as discussed above.
Amortization of Coal Supply Agreements. Amortization of coal supply agreements
was reduced to $5.1 million for the quarter ended March 31, 2002, compared to
$7.6 million in the same quarter of 2001. The decrease is 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 to $7.6 million for the first quarter
of 2002 from $4.3 million for the first quarter of 2001 primarily due to the
cost of terminating certain contractual obligations for the purchase or sale of
coal.
Interest Expense. Interest expense decreased by $9.4 million to $12.0 million
for the first quarter of 2002 as a result of lower debt levels and lower
interest rates during the recent quarter when compared to the first quarter of
2001. The net proceeds from two public stock offerings in the first half of 2001
were used to significantly reduce debt levels.
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 in the first quarter of 2002 is primarily the result of the
impact of percentage depletion.
Adjusted EBITDA. Adjusted EBITDA (income from operations before the effect of
net interest expense; income taxes; and depreciation, depletion and amortization
of Arch Coal, its subsidiaries and its ownership percentage in its equity
investments) was $49.1 million for the current quarter compared to $80.3 million
for the first quarter of 2001. The decrease in adjusted EBITDA was primarily
attributable to a $27.5 million decrease in income from operations resulting
from the reduction in production levels and the Samples production issues, both
of which are discussed above.
RECENT DEVELOPMENTS
Natural Resource Partners L.P. The Company announced on April 19, 2002 that it
had created a limited partnership, Natural Resource Partners L.P., with three
private companies - Western Pocahontas Properties Limited Partnership, Great
Northern Properties Limited Partnership and New Gauley Coal Corporation
(collectively, the "WPP Group"). Natural Resource Partners was formed to engage
principally in the business of owning and managing coal royalty properties in
the three major coal-producing regions of the United States: Appalachia, the
Illinois Basin and the Western United States. The partnership has filed a
Registration Statement on Form S-1 with the Securities and Exchange Commission
relating to a proposed underwritten initial public offering of common units
representing limited partner interests in the partnership including 1,901,250
common units anticipated to be sold by the Company. The Company is contributing
approximately 454 million tons of its 3.4 billion tons of total coal reserves to
Natural Resource Partners in exchange for its ownership interest in the
partnership.
Debt Refinancing. The Company and its Arch Western Resources subsidiary
completed the refinancing of their existing credit facilities on April 18, 2002.
The new credit facilities include five- and six-year term loans totaling $675.0
million at Arch Western Resources, 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 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.
10
OUTLOOK
Production Levels. The Company reduced its rate of coal production at its
eastern and western operations by approximately 7% during the first quarter of
2002 and cut its 2002 capital expenditure budget from its previous estimate of
between $180 million and $200 million, to an expected $150 million. These
actions were taken in response to the current unfavorable spot coal prices
following an extremely mild winter and a period of economic weakness that
dampened electricity demand. The Company plans to increase its rate of
production when market prices rebound. Although the timing of any recovery in
coal market prices remains uncertain, there have been indications that prices
may return to more favorable levels during the last half of 2002. These
indications include a pickup in economic activity and an increase in the price
of natural gas, a competing fuel source for electric generation.
West Elk. The Company's West Elk mine encountered higher-than-expected methane
levels following the relocation of its longwall mining system to the eastern
section of the mine in early 2001, which led to a reduction of planned shipments
from the mine during 2001. West Elk's performance has steadily improved as the
mine has implemented a series of methane control procedures. The Company is
hopeful that the mine will operate at breakeven or profitable levels during the
remainder of 2002. However, if the Company is unable to continue to adequately
control methane levels at the mine, it may be forced to continue to operate the
mine at lower levels of production than planned.
West Virginia Operations. 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 U.S. Army Corps of Engineers from issuing any new ss.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 primarily in
surface mining operations where layers of dirt and rock are removed to expose
the underlying coal seam, although underground mining operations also generate
some of this material. 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.
The Company anticipates that a stay of the decision will be sought, and that the
Corps of Engineers and industry defendants will appeal the decision.
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 ss.404 permits for the mine. Therefore, the Company will not be able
to re-open its Dal-Tex surface mining operation unless the current injunction is
stayed pending appeal, or the decision is reversed on appeal and it is able to
obtain all necessary permits. If the current litigation is favorably resolved
and the Company is able to obtain the necessary permits, it may determine to
reopen the mine subject to then-existing market conditions. Unless reversed, the
ruling may also affect the Company's ability to expand its current mining
operations or open new mines in the future.
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 not expected to exhaust its longwall mineable
reserves until 2006, subject to permit modifications.
During the second quarter of 2001, the Company's Samples surface mine in
southern West Virginia encountered a larger-than-expected sandstone intrusion.
The intrusion resulted in the thinning of the principal coal seam which reduced
recoverable coal and drove up mining costs on a per-ton basis. In the first
quarter of 2002, the Samples mine began development work on a new reserve area
with more favorable geology. The Company expects the Samples mine to return to
profitability during the second quarter of 2002, depending on 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. One hundred percent of the Company's current coal
production and approximately 90% of its reserves are low in sulfur.
Approximately 66% of the Company's coal reserves are compliance quality, which
means that they 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 designed to
improve earnings, strengthen cash generation, improve productivity and reduce
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.
11
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 three months ended March 31, 2002 and 2001:
2002 2001
---------------- ----------------
(in thousands)
Cash provided by (used in):
Operating activities $ 63,258 $ 65,492
Investing activities (90,174) (63,720)
Financing activities 21,628 (5,451)
Cash provided by operating activities in the three months ended March 31, 2002
was comparable to the same period in 2001 in spite of production cutbacks and
lower income primarily as a result of reduced working capital requirements in
the first quarter of 2002.
Cash used in investing activities during the three months ended March 31, 2002
increased over the same period in 2001 due to higher capital expenditures during
the first quarter of 2002 as the Company increased capital expenditures to
maintain existing infrastructure and prepared to increase production for
anticipated higher market prices. During the first quarters of 2001 and 2002,
the Company made the third and fourth, respectively, of five annual payments
under the Thundercloud federal lease, which is part of the Black Thunder mine in
Wyoming. The remaining payment is due in January 2003.
Cash provided by financing activities was $21.6 million in the first quarter of
2002 compared to cash used in financing activities of $5.5 million during the
first quarter of 2001. The cash provided by financing activities during the
first quarter of 2002 reflects borrowings on the Company's revolver and line of
credit caused in part by higher capital expenditure during the first quarter of
2002, while cash used in financing activities during the first quarter of 2001
reflects the pay-down of $98.7 million of debt primarily from a February 2001
issuance of common stock which resulted in proceeds of $92.9 million.
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,
anticipated capital expenditures and scheduled debt payments for at least the
next several years. The Company's ability to satisfy debt service obligations,
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 financial, business and
other factors, some of which are beyond the Company's control.
Expenditures for property, plant and equipment were $73.1 million for the three
months ended March 31, 2002, compared to $48.5 million for the three months
ended March 31, 2001. 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. The Company estimates that its
capital expenditures will be approximately $150.0 million in total for 2002. It
is anticipated that these capital expenditures will be funded by available cash
and existing credit facilities.
At March 31, 2002, the Company had $39.6 million in letters of credit
outstanding which when combined with borrowings under the revolver, allowed for
$396.0 million of available borrowings under the Company's revolving credit
facility.
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 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 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 substantially all
of its subsidiaries, but is not guaranteed by the Company.
12
Financial covenants contained in the Company's new credit facilities consist of
a maximum leverage ratio, a minimum fixed charge coverage 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 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 plus lease
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 periodically establishes uncommitted lines of credit with banks.
These agreements generally provide for short-term borrowings at market rates. At
March 31, 2002, there were $20.0 million of such agreements in effect, of which
$9.0 million were outstanding. The Company can also issue an additional $469.5
million in public debt and equity securities under a shelf registration
statement.
The Company is exposed to market risk associated with interest rates. At March
31, 2002, debt included $795.4 million of floating-rate debt, for which the rate
of interest is a rate based on LIBOR and current market rates for bank lines of
credit. To manage this exposure, the Company enters into interest-rate swap
agreements to modify the interest-rate characteristics of outstanding Company
debt. At March 31, 2002, the Company had interest-rate swap agreements having a
total notional value of $425.0 million. 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 6.89% (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 as adjustments to
interest expense, thereby adjusting the effective interest rate on the Company's
debt. After taking into consideration interest-rate swap agreements, debt
exposed to variable rates was $370.4 million. Gains and losses on terminations
of interest-rate swap agreements are deferred on the Company's balance sheet (in
other long-term liabilities) and amortized as an adjustment to interest expense
over the original term of the terminated swap agreement as if it were still in
place. The remaining terms of the swap agreements at March 31, 2002 ranged from
5 to 39 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 heating oil swaps to substantially
eliminate volatility in the price of diesel fuel purchased 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 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 of the Company as of and for the year ended
December 31, 2001 as filed on its Annual Report on Form 10-K with the Securities
and Exchange Commission.
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 March 31, 2002, with all other variables
held constant. A 100-basis-point decrease in market interest rates would result
in an $5.0 million increase in the fair value of the fixed portion of the debt
at March 31, 2002. Based on the variable-rate debt included in the Company's
debt portfolio as of March 31, 2002, after considering the effect of the swap
agreements, a 100-basis-point increase in interest rates would result in an
annualized additional $3.7 million of interest expense incurred based on March
31, 2002 debt levels. Similarly, relative to the Company's diesel hedge
position, at March 31, 2002, a $.05 per gallon decrease in the price of heating
oil would result in a $1.2 million increase in the fair value of the financial
position of the heating oil swap.
13
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.
Kentuckians for the Commonwealth v. Rivenburgh. On May 8, 2002, the U.S.
District Court for the Southern District of West Virginia enjoined the U.S. Army
Corps of Engineers from issuing any new ss.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 in surface mining operations where
layers of dirt and rock are removed to expose the underlying coal seam, although
underground mining operations also generate some of this material. 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. The Company anticipates that a stay of
the decision will be sought, and that the Corps of Engineers and industry
defendants will appeal the decision. The Company is not a party to this
litigation, however the restrictions imposed by it, unless overturned, will
affect all coal mining in the state, including the Company's operations, that
require the issuance of ss.404 permits. Because it is not financially viable for
coal producers to operate some mining properties without valley fills, if the
court's decision is not reversed on appeal, future mining operations in the
region may be severely restricted.
Cumulative Hydrologic Impact Assessment ("CHIA") Litigation. On January 20,
2000, two environmental organizations, the Ohio Valley Environmental Coalition
and the Hominy Creek Watershed Association, filed suit against the West Virginia
DEP in U.S. District Court in Huntington, West Virginia. In addition to
allegations that the West Virginia DEP violated state law and provisions of the
Clean Water Act, the plaintiffs allege that the West Virginia DEP's issuance of
permits for surface and underground coal mining has violated certain
non-discretionary duties mandated by SMCRA. Specifically, the plaintiffs allege
that the West Virginia DEP has failed to require coal operators seeking permits
to conduct water monitoring to verify stream flows and ascertain water quality,
to always include certain water quality information in their permit applications
and to analyze the probable hydrologic consequences of their operations. The
plaintiffs also allege that the West Virginia DEP has failed to analyze the
cumulative hydrologic impact of mining operations on specific watersheds.
The plaintiffs sought an injunction to prohibit the West Virginia DEP from
issuing any new permits which fail to comply with all of the elements identified
in their complaint. The complaint identified, and sought to enjoin, three
pending permits sought by the Company in connection with its Mingo Logan
operations in order to continue existing surface mining operations at the
Phoenix reserve. On January 15, 2001, the West Virginia DEP notified the
plaintiffs that the Company had completed all steps necessary to obtain the
permits. On March 8, 2001, the Court denied the plaintiffs' motion for a
14
preliminary injunction seeking to enjoin the DEP's decision to issue the
permits. The Company subsequently received some of the permits necessary to
continue operating the surface mine. If the plaintiffs ultimately prevail in
this litigation, the Company's ability to mine surface coal at Mingo Logan could
be adversely affected, and depending upon the length of the suspension, the
effect could be material. This matter does not affect Mingo Logan's existing
permits related to its underground operations.
Citizens Coal Council v. Norton. 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 plaintiffs' 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 Company is not a party to this litigation. Its significance for the coal
mining industry remains unclear because this ruling is subject to appellate
review, and the Department of Interior and the National Mining Association, a
trade group that intervened in this action, have announced their intention to
seek a stay of the order pending appeal to the U.S. Court of Appeals for the
District of Columbia Circuit. If the stay is not 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 affect on all coal mine
operations that utilize underground mining techniques, including those of the
Company. While it may still be possible to obtain permits for underground mining
operations in these areas, the time and expense of that permitting process is
likely to increase significantly.
CERTAIN TRENDS AND UNCERTAINTIES
Substantial Leverage - Variable Interest Rate - Covenants.
As of March 31, 2002, the Company had outstanding consolidated indebtedness of
$798.9 million, representing approximately 58.5% 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 (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 46% of the Company's
indebtedness 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
15
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 $7.4 million for the quarter ended March 31,
2002. The losses in the first quarter of 2002 were primarily due to continued
increased costs and decreased production at the Company's Samples surface
operations as described above and decreased production at the Company's other
mines due to adverse market conditions during the quarter.
Because the coal mining industry is subject to significant regulatory oversight
and due to the possibility of continued 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:
o the discharge of materials into the environment;
o employee health and safety;
o mine permits and other licensing requirements;
o reclamation and restoration of mining properties after mining is
completed;
o management of materials generated by mining operations;
o surface subsidence from underground mining;
o water pollution;
o legislatively mandated benefits for current and retired coal miners;
o air quality standards;
o protection of wetlands;
o endangered plant and wildlife protection;
o limitations on land use;
o storage of petroleum products andsubstances that are regarded as
hazardous under applicable laws; and
o 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
16
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 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 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, 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,
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:
o burning lower sulfur coal, either exclusively or mixed with
higher sulfur coal;
o installing pollution control devices such as scrubbers, which reduce the
emissions from high sulfur coal;
o reducing electricity generating levels; or
o purchasing or trading emission credits.
17
Specific emissions sources receive these credits that 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 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 Health and Safety
Act of 1969. The Mine Safety and Health Act of 1977, which significantly
expanded the enforcement of health and safety standards of the Mine Health and
Safety Act of 1969, imposes comprehensive safety and health standards on all
mining operations. In addition, as part of the Mine Health and Safety 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. Because the
regulatory requirements imposed by mine worker health and safety laws are
comprehensive and ongoing in nature, non-compliance cannot be eliminated
completely.
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 their 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
18
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, and the Department of
Interior and the National Mining Association, a trade group that intervened in
this action, have announced their intention to seek a stay of the order pending
appeal to the U.S. Court of Appeals for the District of Columbia Circuit. If the
stay is not granted, 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 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. These restrictions or
uncertainties could have a material adverse effect on the Company's business.
Clean Water Act. The Clean Water Act affects coal mining operations by imposing
restrictions on effluent discharge into navigable waters, a term which courts
have defined to include wetlands. Regular monitoring, as well as compliance with
reporting requirements and performance standards, are preconditions for the
issuance and renewal of permits governing the discharge of pollutants into
water. The Company is also subject to ss. 404 of the Clean Water Act, which
imposes permitting and mitigation requirements associated with the dredging and
filling of wetlands. The Company is contractually obligated to obtain all
necessary wetlands permits required under ss. 404, which permits are issued by
the U.S. Army Corps of Engineers. However, mitigation requirements under those
existing, and possible future, wetlands permits may vary considerably.
The U.S. Army Corps of Engineers' authority to issue Clean Water Act Section 404
permits for the discharge of mining wastes into valley fills was, however,
challenged in an August 2001 lawsuit filed by a citizens group, Kentuckians For
The Commonwealth, Inc., in the United States District Court for the Southern
District of West Virginia. On May 8, 2002, the court enjoined the Army Corps of
Engineers from issuing any new ss.404 permits that authorize the placement of
rock and soil into channels that comprise waters of the United States. The court
reached this conclusion on the basis that the material constituted "waste" which
may not be disposed of under Corps issued permits. A stay of the decision is
currently being sought, and an appeal by the Corps of Engineers and industry
defendants is expected. If the plaintiff in this litigation is eventually
successful, the costs, time and difficulty associated with obtaining Clean Water
Act permits for surface mining operations could increase and could in fact
become infeasible. Additionally, conditions made part of individual Section 404
and 402 permits could require more extensive and costly reclamation.
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 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
19
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 between 12 and 18 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.
As indicated by the legal action involving valley fills that is discussed in
"Contingencies - Legal Contingencies - Kentuckians for the Commonwealth v.
Rivenburgh" above, the regulatory environment in West Virginia is uncertain with
respect to coal mining. No assurance can be made that the plaintiffs will not
ultimately prevail in this litigation. In such event, there could be a material
adverse effect on the Company's financial condition or results of operations.
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
20
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 under Bragg
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. 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 Environment 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 remaining claims in this lawsuit against the federal defendants were the
subject of an August 2001 order by the district court. The court denied the
federal defendants' motion to dismiss the suit and granted partial summary
judgment for the plaintiffs. The court allowed the Office of Surface Mining to
continue its administrative action. That action required the West Virginia
Department of Environmental Protection to submit proposed new regulatory
initiatives to the state legislature's rulemaking committee and, within 45 days
of the close of the 2002 legislative session, the state was required to provide
final, enacted legislation, signed by the Governor of West Virginia, that
addressed all problems with the current state bonding system. The West Virginia
Legislature passed, and the Governor of West Virginia signed, an amended
alternative bond program, called the 7-Up Plan, and the U.S. Office of Surface
Mining approved those amendments.
The plaintiffs filed a motion in January 2002 asking the court to compel the
Office of Surface Mining to perform its non-discretionary duties and find that
the new alternative bonding program promulgated by West Virginia still fails to
meet the requirements of the federal SMCRA. In March 2002, the court denied the
plaintiffs' motion, based in part upon representations by the Office of Surface
Mining that it would make a final determination regarding the adequacy of the
7-Up Plan by no later than May 28, 2002. In any event, the ultimate modification
to the bonding program will likely result in an increase in the amount of
reclamation bonds that coal mine operators in West Virginia, including the
Company, must post and could result in other taxes or fees related to the
operation of coal mines in the state. This would increase the cost of operating
the mines. Any changes to the state reclamation bonding program could also
complicate, protract the process of and increase the cost of applying for and
obtaining necessary permits.
21
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 silvicultural 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 a number of the Company's competitors 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.
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; alternative 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.
Reliance On And Terms Of Long-Term Coal Supply Contracts.
During 2001, sales of coal under long-term contracts, which are contracts with a
term greater than 12 months, accounted for 77% 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.
22
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 $12.0 million and
$11.8 million of the Company's total operating income in the first quarters of
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, 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) the timing and amount of insurance recoveries; (vi) work
stoppages or other labor difficulties; (vii) mine worker vacation schedules and
related maintenance activities; and (viii) changes in coal market and general
economic conditions.
Decreases in the Company's profitability as a result of the factors described
above could adversely impact quarterly or annual results materially. Any such
adverse impact on the Company's operating results could cause its stock price to
decline substantially, particularly if the results are below research analyst or
investor expectations.
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 and thus adversely affect the Company's business and
operating results. Increases in transportation costs, or changes in such costs
relative to transportation costs for coal produced by its competitors or of
other fuels, could have an adverse effect on the Company's business and results
of operations.
Reserves - Title.
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 the 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.
23
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, 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. 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 which 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; entering into 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is contained under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in this report and is incorporated herein by reference.
24
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information required by this Item is contained in the "Contingencies - Legal
Contingencies" section of "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in this report and is incorporated herein
by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
(a) The Company's Annual Meeting of Stockholders was held on April 25, 2002, at
the Company's headquarters at One CityPlace Drive, Suite 300, St. Louis,
Missouri, at 10:00 a.m., central time
(b) At such Annual Meeting, the holders of the Company's common stock elected
the following nominees for director:
Nominee Total Votes For Total Votes Withheld
James R. Boyd 41,998,937 1,595,502
Douglas H. Hunt 42,027,937 1,566,502
A. Michael Perry 42,007,048 1,587,391
At such Annual Meeting, the Company's stockholders, by a vote of 21,886,589 for,
15,157,678 against and 99,253 abstained, also approved an amendment to increase
the number of shares under the Arch Coal, Inc. 1997 Stock Incentive Plan.
At such Annual Meeting, the Company's stockholders, by a vote of 38,587,248 for,
4,903,997 against and 103,191 abstained, also approved the Arch Coal, Inc. 1997
Stock Incentive Plan for purposes of Section 162(m) of the Internal Revenue Code
of 1986, as amended.
At such Annual Meeting, the Company's stockholders, by a vote of 42,527,493 for,
1,029,013 against and 37,931 abstained, also ratified the appointment of Ernst &
Young LLP as the Company's independent auditors for 2002.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)
3.1 Amended and Restated Certificate of Incorporation of Arch Coal, Inc.
(incorporated herein by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-Q for the Quarter Ended March 31, 2000)
3.2 Amended and Restated Bylaws of Arch Coal, Inc. (incorporated herein by
reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for
the Year Ended December 31, 2000)
4.1 Stockholders Agreement, dated as of April 4, 1997, among Carboex
International, Ltd., Ashland Inc. and Arch Coal, Inc. (formerly Arch
Mineral Corporation) (incorporated herein by reference to Exhibit 4.1 of
the Company's Registration Statement on Form S-4 (Registration No.
333-28149) filed on May 30, 1997)
4.2 Assignment of Rights, Obligations and Liabilities under the Stockholders
Agreement between Carboex International, Limited and Carboex, S.A.
effective as of October 15, 1998 (incorporated herein by reference to
Exhibit 4.2 of the Company's Annual Report on Form 10-K for the Year Ended
December 31, 1998)
4.3 Registration Rights Agreement, dated as of April 4, 1997, among Arch Coal,
Inc. (formerly Arch Mineral Corporation), Ashland Inc., Carboex
International, Ltd. and the entities listed on Schedules I and II thereto
(incorporated herein by reference to Exhibit 4.2 of the Company's
Registration Statement on Form S-4 (Registration No. 333-28149) filed on
May 30, 1997, except for amended Schedule I thereto, incorporated herein by
reference to Exhibit 4.2 of the Company's Quarterly Report on Form 10-Q for
the Quarter Ended March 31, 1998)
25
4.4 Assignment of Registration Rights between Carboex International, Limited
and Carboex, S.A. effective as of October 15, 1998 (incorporated herein by
reference to Exhibit 4.4 of the Company's Annual Report on Form 10-K for
the Year Ended December 31, 1998)
4.5 Agreement Relating to Nonvoting Observer, executed as of April 4, 1997,
among Carboex International, Ltd., Ashland Inc., Ashland Coal, Inc. and
Arch Coal, Inc. (formerly Arch Mineral Corporation) (incorporated herein by
reference to Exhibit 4.3 of the Company's Registration Statement on Form
S-4 (Registration No. 333-28149) filed on May 30, 1997)
4.6 Assignment of Right to Maintain a Non-Voting Observer at Meetings of the
Board of Directors of Arch Coal, Inc. between Carboex International,
Limited and Carboex, S.A. effective as of October 15, 1998 (incorporated
herein by referenced to Exhibit 4.6 of the Company's Annual Report on Form
10-K for the Year Ended December 31, 1998)
4.7 Amended and Restated Credit Agreement, dated as of April 18, 2002, by and
among the Company, the Lenders party thereto, PNC Bank, National
Association, as administrative agent, JPMorgan Chase Bank, as syndication
agent, and Citibank, N.A., Credit Lyonnais New York Branch, and U.S. Bank
National Association, as documentation agents (attached to this Quarterly
Report on Form 10-Q as Exhibit 4.7)
4.8 Amended and Restated Credit Agreement, dated as of April 18, 2002, by and
among the Arch Western Resources, LLC, the Lenders party thereto, PNC Bank,
National Association, as administrative agent, JPMorgan Chase Bank, as
syndication agent, and Citibank, N.A., Credit Lyonnais New York Branch, and
U.S. Bank National Association, as documentation agents (attached to this
Quarterly Report on Form 10-Q as Exhibit 4.8)
4.9 Form of Rights Agreement, dated March 3, 2000, between Arch Coal, Inc. and
First Chicago Trust Company of New York, as Rights Agent (incorporated
herein by reference to Exhibit 1 to a Current Report on Form 8-A filed on
March 9, 2000)
10.1 Arch Coal, Inc. 1997 Stock Incentive Plan (as Amended and Restated on
February 28, 2002) (attached to this Quarterly Report on Form 10-Q as
Exhibit 10.1)
(b) Reports on Form 8-K: A report on Form 8-K dated March 18, 2002 announcing
that the Company had reduced production and that its earnings would
subsequently fall short of expectations was filed by the Company in the
quarter ended March 31, 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ARCH COAL, INC.
(Registrant)
Date: May 13, 2002 /s/ John W. Lorson
John W. Lorson
Controller
(Chief Accounting Officer)
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Arch Coal, Inc.
Form 10-Q for Quarter Ended March 31, 2002
INDEX TO EXHIBITS
1. Arch Coal, Inc. Amended and Restated Credit Agreement dated as of April 18,
2002
2. Arch Western Resources, LLC Amended and Restated Credit Agreement dated as
of April 18, 2002
3. Arch Coal, Inc. Amended and Restated 1997 Stock Incentive Plan
28