Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 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 September 30, 2011

 

o         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

 

GRAPHIC

(Exact name of registrant as specified in its charter)

 

Delaware

 

43-0921172

(State or other jurisdiction

 

(I.R.S. Employer

of incorporation or organization)

 

Identification Number)

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No x

 

At November 7, 2011 there were 211,618,197 shares of the registrant’s common stock outstanding.

 

 

 



Table of Contents

 

Table of Contents

 

 

Page

Part I FINANCIAL INFORMATION

3

Item 1. Financial Statements

3

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

29

Item 3. Quantitative and Qualitative Disclosures About Market Risk

39

Item 4. Controls and Procedures

41

Part II OTHER INFORMATION

41

Item 1. Legal Proceedings

41

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

45

Item 3. Defaults Upon Senior Securities

45

Item 4. Reserved

45

Item 5. Other Information

45

Item 6. Exhibits

47

 

2



Table of Contents

 

Part I

FINANCIAL INFORMATION

 

Item 1.      Financial Statements.

 

Arch Coal, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(in thousands, except per share data)

 

 

 

Three Months Ended September 30

 

Nine Months Ended September 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(unaudited)

 

REVENUES

 

$

1,198,673

 

$

874,705

 

$

3,057,139

 

$

2,350,874

 

 

 

 

 

 

 

 

 

 

 

COSTS, EXPENSES AND OTHER

 

 

 

 

 

 

 

 

 

Cost of sales

 

952,850

 

651,853

 

2,322,124

 

1,773,464

 

Depreciation, depletion and amortization

 

123,026

 

92,857

 

301,746

 

269,135

 

Amortization of acquired sales contracts, net

 

(12,186

)

10,038

 

(4,753

)

26,005

 

Selling, general and administrative expenses

 

33,276

 

26,999

 

92,750

 

89,509

 

Change in fair value of coal derivatives and coal trading activities, net

 

8,360

 

1,832

 

9,248

 

12,296

 

Acquisition and transition costs related to ICG

 

4,694

 

 

53,360

 

 

Gain on Knight Hawk transaction

 

 

 

 

(41,577

)

Other operating income, net

 

(3,613

)

(7,221

)

(9,019

)

(15,004

)

 

 

1,106,407

 

776,358

 

2,765,456

 

2,113,828

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

92,266

 

98,347

 

291,683

 

237,046

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net:

 

 

 

 

 

 

 

 

 

Interest expense

 

(77,694

)

(37,698

)

(154,523

)

(107,906

)

Interest income

 

840

 

927

 

2,341

 

1,888

 

 

 

(76,854

)

(36,771

)

(152,182

)

(106,018

)

Other non-operating expense:

 

 

 

 

 

 

 

 

 

Bridge financing costs related to ICG

 

 

 

(49,490

)

 

Net loss resulting from early retirement of debt

 

(1,708

)

(6,776

)

(1,958

)

(6,776

)

 

 

(1,708

)

(6,776

)

(51,448

)

(6,776

)

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

13,704

 

54,800

 

88,053

 

124,252

 

Provision for (benefit from) income taxes

 

(5,583

)

7,941

 

5,103

 

12,889

 

 

 

 

 

 

 

 

 

 

 

Net income

 

19,287

 

46,859

 

82,950

 

111,363

 

Less: Net income attributable to noncontrolling interest

 

(231

)

(181

)

(822

)

(325

)

Net income attributable to Arch Coal, Inc.

 

$

19,056

 

$

46,678

 

$

82,128

 

$

111,038

 

 

 

 

 

 

 

 

 

 

 

EARNINGS PER COMMON SHARE

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.09

 

$

0.29

 

$

0.45

 

$

0.68

 

Diluted earnings per common share

 

$

0.09

 

$

0.29

 

$

0.45

 

$

0.68

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

211,337

 

162,391

 

182,898

 

162,384

 

Diluted weighted average shares outstanding

 

211,974

 

163,174

 

183,850

 

163,128

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.11

 

$

0.10

 

$

0.32

 

$

0.29

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

3



Table of Contents

 

Arch Coal, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except per share data)

 

 

 

September 30,

 

December 31,

 

 

 

2011

 

2010

 

 

 

(unaudited)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

158,509

 

$

93,593

 

Restricted cash

 

21,428

 

 

Trade accounts receivable

 

342,721

 

208,060

 

Other receivables

 

83,579

 

44,260

 

Inventories

 

346,331

 

235,616

 

Prepaid royalties

 

29,163

 

33,932

 

Deferred income taxes

 

15,795

 

 

Coal derivative assets

 

2,595

 

15,191

 

Other

 

107,462

 

104,262

 

Total current assets

 

1,107,583

 

734,914

 

 

 

 

 

 

 

Property, plant and equipment, net

 

7,703,280

 

3,308,892

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

Prepaid royalties

 

96,869

 

66,525

 

Goodwill

 

539,963

 

114,963

 

Deferred income taxes

 

9,217

 

361,556

 

Equity investments

 

224,684

 

177,451

 

Other

 

173,665

 

116,468

 

Total other assets

 

1,044,398

 

836,963

 

Total assets

 

$

9,855,261

 

$

4,880,769

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

293,446

 

$

198,216

 

Coal derivative liabilities

 

5,824

 

4,947

 

Deferred income taxes

 

 

7,775

 

Accrued expenses and other current liabilities

 

379,707

 

245,411

 

Current maturities of debt and short-term borrowings

 

47,156

 

70,997

 

Total current liabilities

 

726,133

 

527,346

 

Long-term debt

 

3,841,330

 

1,538,744

 

Asset retirement obligations

 

415,877

 

334,257

 

Accrued pension benefits

 

16,235

 

49,154

 

Accrued postretirement benefits other than pension

 

88,820

 

37,793

 

Accrued workers’ compensation

 

64,421

 

35,290

 

Deferred income taxes

 

880,487

 

 

Other noncurrent liabilities

 

277,490

 

110,234

 

Total liabilities

 

6,310,793

 

2,632,818

 

 

 

 

 

 

 

Redeemable noncontrolling interest

 

11,261

 

10,444

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.01 par value, authorized 260,000 shares, issued 213,099 shares and 164,117 shares, respectively

 

2,135

 

1,645

 

Paid-in capital

 

3,012,628

 

1,734,709

 

Treasury stock, 1,512 shares at September 30, 2011 and December 31, 2010, at cost

 

(53,848

)

(53,848

)

Retained earnings

 

586,067

 

561,418

 

Accumulated other comprehensive loss

 

(13,775

)

(6,417

)

Total stockholders’ equity

 

3,533,207

 

2,237,507

 

Total liabilities and stockholders’ equity

 

$

9,855,261

 

$

4,880,769

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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Table of Contents

 

Arch Coal, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in thousands)

 

 

 

Nine Months Ended September 30

 

 

 

2011

 

2010

 

 

 

(unaudited)

 

OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

82,950

 

$

111,363

 

 

 

 

 

 

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation, depletion and amortization

 

301,746

 

269,135

 

Amortization of acquired sales contracts, net

 

(4,753

)

26,005

 

Bridge financing costs related to ICG

 

49,490

 

 

Net loss resulting from early retirement of debt

 

1,958

 

6,776

 

Write down of assets acquired from ICG

 

7,316

 

 

Prepaid royalties expensed

 

26,880

 

26,190

 

Employee stock-based compensation expense

 

9,019

 

9,640

 

Amortization relating to financing activities

 

9,854

 

6,630

 

Gain on Knight Hawk transaction

 

 

(41,577

)

Changes in:

 

 

 

 

 

Receivables

 

(35,874

)

(48,718

)

Inventories

 

(23,716

)

21,818

 

Coal derivative assets and liabilities

 

15,199

 

14,116

 

Accounts payable, accrued expenses and other current liabilities

 

3,742

 

20,879

 

Income taxes, net

 

(21,971

)

(1,923

)

Deferred income taxes

 

23,572

 

(7,561

)

Other

 

25,955

 

43,907

 

 

 

 

 

 

 

Cash provided by operating activities

 

471,367

 

456,680

 

 

 

 

 

 

 

INVESTING ACTIVITIES

 

 

 

 

 

Acquisition of ICG, net of cash acquired

 

(2,894,339

)

 

Increase in restricted cash

 

(5,939

)

 

Capital expenditures

 

(215,899

)

(221,583

)

Proceeds from dispositions of property, plant and equipment

 

25,133

 

252

 

Purchases of investments and advances to affiliates

 

(56,827

)

(16,740

)

Additions to prepaid royalties

 

(26,135

)

(23,715

)

 

 

 

 

 

 

Cash used in investing activities

 

(3,174,006

)

(261,786

)

 

 

 

 

 

 

FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from the issuance of senior notes

 

2,000,000

 

500,000

 

Proceeds from the issuance of common stock, net

 

1,267,776

 

 

Payments to retire debt

 

(604,096

)

(505,627

)

Net increase (decrease) in borrowings under lines of credit and commercial paper program

 

283,096

 

(118,337

)

Net payments on other debt

 

(8,792

)

(9,794

)

Debt financing costs

 

(114,587

)

(12,630

)

Dividends paid

 

(57,470

)

(47,121

)

Issuance of common stock under incentive plans

 

1,628

 

339

 

Contribution from noncontrolling interest

 

 

891

 

 

 

 

 

 

 

Cash provided by (used in) financing activities

 

2,767,555

 

(192,279

)

 

 

 

 

 

 

Increase in cash and cash equivalents

 

64,916

 

2,615

 

Cash and cash equivalents, beginning of period

 

93,593

 

61,138

 

Cash and cash equivalents, end of period

 

$

158,509

 

$

63,753

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

5



Table of Contents

 

Arch Coal, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of Arch Coal, Inc. and its subsidiaries and controlled entities (the “Company”). The Company’s primary business is the production of steam and metallurgical coal from surface and underground mines located throughout the United States, for sale to utility, industrial and export markets. On June 15, 2011, the Company acquired International Coal Group, Inc. (“ICG”), as described in Note 3, “Business Combinations”.  The Company operates 23 mining complexes in West Virginia, Kentucky, Maryland, Virginia, Illinois, Wyoming, Colorado and Utah. All subsidiaries (except as noted below) are wholly-owned. Intercompany transactions and accounts have been eliminated in consolidation.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and U.S. Securities and Exchange Commission regulations. 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 three and nine month periods ended September 30, 2011 are not necessarily indicative of results to be expected for the year ending December 31, 2011. These financial statements should be read in conjunction with the audited financial statements and related notes as of and for the year ended December 31, 2010 included in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission.

 

The Company owns a 99% membership interest in a joint venture named Arch Western Resources, LLC (“Arch Western”) which operates coal mines in Wyoming, Colorado and Utah. The Company also acts as the managing member of Arch Western.

 

2. Accounting Policies

 

There is no new accounting guidance that is expected to have a significant impact on the Company’s financial statements.

 

3. Business Combination

 

On June 15, 2011, the Company completed its acquisition of ICG, a leading coal producer, operating 12 mining complexes in Appalachia and one complex in the Illinois Basin.  In addition, one mine is currently under development in Appalachia.  The Company acquired all of ICG’s outstanding shares of common stock for $3.1 billion. To finance the acquisition, the Company received net proceeds of $1.25 billion from the sale of 48.0 million shares of its common stock and issued $2.0 billion in aggregate principal amount of senior unsecured notes.  See Note 4, “Equity Offering” and Note 5, “Debt and Financing Arrangements” for further information about these transactions.

 

The Company has not finalized the determination of the fair values of the assets acquired and liabilities assumed in the acquisition.  The following table summarizes the consideration paid for ICG and the estimated amounts of assets acquired and liabilities assumed that were recognized at the acquisition date:

 

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Table of Contents

 

 

 

(In millions)

 

Consideration paid, net of cash acquired

 

$

2,894.4

 

Recognized amounts of net tangible and intangible assets acquired and liabilities assumed:

 

 

 

Restricted cash

 

15.5

 

Receivables

 

114.2

 

Inventories

 

87.0

 

Net property, plant and equipment, including mineral rights

 

4,510.6

 

Goodwill

 

425.0

 

Other assets

 

49.2

 

Accounts payable

 

(82.6

)

Other accrued expenses and current liabilities

 

(61.5

)

Debt

 

(604.8

)

Litigation accrual

 

(106.0

)

Accrued postretirement benefits

 

(47.7

)

Asset retirement obligation

 

(80.4

)

Coal supply agreements, net

 

(98.8

)

Deferred income taxes, net

 

(1,189.9

)

Other

 

(35.4

)

Net tangible and intangible assets acquired

 

$

2,894.4

 

 

During the third quarter of 2011, the following adjustments were made to the purchase price and the provisional fair values:

 

 

 

(In millions)

 

Inventories

 

9.5

 

Net property, plant and equipment, including mineral rights

 

(5.8

)

Coal supply agreements, net

 

(21.2

)

Other

 

1.5

 

Purchase price adjustment — cash received

 

$

(16.0

)

 

The adjustments to the provisional fair values result from additional information obtained about facts in existence at the acquisition date.  Adjustments to provisional fair values are assumed to have been made as of the acquisition date.  As a result, cost of sales for the second quarter of 2011 would have been $5.6 million higher than was previously reported. The results in the condensed consolidated statements of income reflect this adjustment as if it had been recorded originally in the second quarter of 2011.

 

The Company’s efforts to value the assets acquired and liabilities assumed are ongoing.    Notably, the valuation report that will support the fair value of the fixed assets, coal reserves and goodwill acquired has not yet been completed.  The estimated assigned value of goodwill in the table above represents the present value of the estimated synergies from the acquisition. The fair values above could change substantially when the valuation report is received.

 

Any goodwill related to the acquisition is not expected to be deductible for tax purposes.  The allocation of goodwill to reporting units will not be completed until the valuation process is completed.

 

The revenues and income before income taxes related to the acquired operations that have been included in the consolidated statements of income for the three months ended September 30, 2011 were $295.6 million and $34.9 million, respectively.  The revenues and income before income taxes related to the acquired operations that have been included in the consolidated statements of income since the date of acquisition were $343.6 million and $43.6 million, respectively.

 

The following unaudited pro forma information has been prepared for illustrative purposes and assumes that the business combination occurred on January 1, 2010.  The unaudited pro forma results have been prepared based upon ICG’s historical results and estimates of the ongoing effects of the transactions that the Company believes are reasonable and supportable.  The results are not necessarily reflective of the consolidated results of operations had the acquisition actually occurred on January 1, 2010, nor are they indicative of future operating results.

 

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Table of Contents

 

The unaudited supplemental pro forma financial information of the combined entity follows:

 

 

 

Three Months Ended September 30

 

Nine Months Ended September 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(In millions)

 

Total revenues

 

 

 

 

 

 

 

 

 

As reported

 

$

1,198.7

 

$

874.7

 

$

3,057.1

 

$

2,350.9

 

Pro forma

 

$

1,198.7

 

$

1,176.9

 

$

3,596.8

 

$

3,212.6

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

 

 

 

 

 

 

 

 

As reported

 

$

13.7

 

$

54.8

 

$

88.1

 

$

124.3

 

Pro forma

 

$

22.3

 

$

47.5

 

$

72.6

 

$

(66.9

)

 

The pro forma income before income taxes includes adjustments to operating costs to reflect the new basis in assets acquired and interest expense to reflect the debt incurred to finance the acquisition.  In addition, the following pre-tax costs and expenses reflected in the income before income taxes for the three and nine month periods ended September 30, 2011 reported in the condensed consolidated statement of income are reflected in the pro forma results as of January 1, 2010.

 

 

 

Three Months Ended
September 30, 2011

 

Nine Months Ended
September 30, 2011

 

 

 

(In thousands)

 

Costs of completing the acquisition - Arch

 

$

1,717

 

$

29,569

 

Costs of completing the acquisition - ICG

 

 

23,503

 

Severance costs

 

2,977

 

16,475

 

Write off of acquired assets

 

 

7,316

 

Bridge financing fees

 

 

49,490

 

 

 

$

4,694

 

$

126,353

 

 

Severance costs represent both change in control payments to executives and severance for employees terminated after the acquisition.  The acquired asset write-off relates to a preparation plant and loadout of an acquired ICG mining operation.  The acquired operation has been combined with an existing operation of the Company, and will utilize an existing facility.

 

Anticipated synergies are not reflected in the pro forma results.

 

In conjunction with the acquisition, the Company has $21.4 million of restricted cash at September 30, 2011 to provide collateral for ICG letters of credit until they can be eliminated or replaced and to fund change in control payments for executives and the board of directors.

 

4.  Equity Offering

 

On June 8, 2011, the Company sold 48 million shares of its common stock at a public offering price of $27.00 per share.  The $1.25 billion in net proceeds from the issuance were used to finance the acquisition of ICG.  On July 8, 2011, the Company issued an additional 0.7 million shares of its common stock under the same terms and conditions to cover underwriters’ over-allotments for net proceeds of $18.4 million.

 

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Table of Contents

 

5.  Debt

 

 

 

September 30,
2011

 

December 31,
2010

 

 

 

(In thousands)

 

Commercial paper

 

$

 

$

56,904

 

Indebtedness to banks under credit facilities

 

340,000

 

 

6.75% senior notes ($450.0 million face value) due July 1, 2013

 

451,132

 

451,618

 

8.75% senior notes ($600.0 million face value) due August 1, 2016

 

588,496

 

587,126

 

7.00% senior notes due June 15, 2019 at par

 

1,000,000

 

 

7.25% senior notes due October 1, 2020 at par

 

500,000

 

500,000

 

7.25% senior notes due June 15, 2021 at par

 

1,000,000

 

 

Other

 

8,858

 

14,093

 

 

 

3,888,486

 

1,609,741

 

Less current maturities of debt and short-term borrowings

 

47,156

 

70,997

 

Long-term debt

 

$

3,841,330

 

$

1,538,744

 

 

The current maturities of debt include contractual maturities, as well as amounts borrowed that are supported by credit facilities that have a term of less than one year and amounts borrowed under credit facilities with terms longer than one year that the Company does not intend to refinance on a long-term basis, based on cash projections and management’s plans.

 

2019 and 2021 Senior Notes

 

On June 14, 2011, the Company entered into an indenture in conjunction with the issuance of the 7.00% senior notes due 2019 (“2019 Notes”) and the 7.25% senior notes due 2021 (“2021 Notes”) as discussed in Note 3, “Business Combinations.” Interest is payable on the 2019 Notes and 2021 Notes on June 15 and December 15 of each year, commencing December 15, 2011.

 

At any time prior to June 15, 2014, the Company may redeem up to 35% of the aggregate principal amount of each of the 2019 Notes and 2021 Notes, plus accrued and unpaid interest, with the net proceeds from certain equity offerings. The Company may redeem the 2019 Notes prior to June 15, 2015 and the 2021 Notes prior to June 15, 2016 at the respective make-whole prices set forth in the indenture. On or after June 15, 2015, the Company may redeem the 2019 Notes for cash at redemption prices, reflected as a percentage of the principal amount, of: 103.5% from June 15, 2015 through June 14, 2016; 101.75% from June 15, 2016 through June 14, 2017; and 100% beginning on June 15, 2017.  On or after June 15, 2016, the Company may redeem the 2021 Notes for cash at redemption prices, reflected as a percentage of the principal amount, of: 103.625% from June 15, 2016 through June 14, 2017; 102.417% from June 15, 2017 through June 14, 2018; 101.208% from June 15, 2018 through June 14, 2019 and 100% beginning on June 15, 2019. In each case, accrued and unpaid interest at the redemption date is due upon redemption. Upon a change in control, the Company is required to make a tender offer for both series of notes at a price of 101% of the principal amount.

 

The 2019 Notes and 2021 Notes are guaranteed by substantially all of the Company’s subsidiaries, including the newly acquired subsidiaries of ICG and excluding Arch Western, its subsidiaries and Arch Receivable Company, LLC and the Company’s subsidiaries outside the U.S. The Company incurred financing fees of $44.2 million related to the issuance of these notes.

 

The Company and the guarantor subsidiaries entered into a registration rights agreement (the “Registration Rights Agreement”) in connection with the issuance and sale of the 2019 Notes and 2021 Notes. Pursuant to the Registration Rights Agreement, the Company and the guarantor subsidiaries agreed to file a registration statement with the Securities and Exchange Commission to register an exchange offer pursuant to which the Company will offer to exchange a like aggregate principal amount of senior notes identical in all material respects to the 2019 Notes and 2021 Notes, except for terms relating to additional interest and transfer restrictions, for any or all of the outstanding 2019 Notes and 2021 Notes. Pursuant to the Registration Rights Agreement, the Company must use commercially reasonable efforts to cause the registration statement to become effective as soon as practicable and to complete the exchange offer no later than June 13, 2012. Should those events not occur within the specified time frame, the applicable interest rates on the 2019 Notes and the 2021 Notes shall be increased by one-quarter of one percent per annum for the first 90 days following the occurrence of such failure.  Such interest rate will increase by an additional one-quarter of one percent per annum thereafter at the end of each subsequent 90-day period up to a maximum aggregate increase of one percent per annum. Once any of the required events occur, the interest rates will revert to the rate specified in the indenture governing the 2019 Notes and 2021 Notes.

 

ICG Debt

 

Upon the closing of the ICG acquisition, the Company gave a 30-day redemption notice to the Trustee of ICG’s 9.125% senior notes and legally discharged its obligation under the 9.125% senior notes by depositing $260.7 million with the Trustee to redeem the debt. On July 14, 2011, all of the outstanding 9.125% senior notes were redeemed at an aggregate price of $251.4 million, including the required make-whole premium, plus accrued interest of $5.2 million, and the remainder of the deposit was returned to the Company.

 

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Table of Contents

 

At the acquisition date, ICG’s 4.00% convertible senior notes with a fair value of $298.5 million and 9.00% convertible senior notes with a fair value of $1.7 million (“convertible notes”) became convertible into cash, pursuant to the amended indentures governing the convertible notes, at a calculated conversion rate of $2,614.6848 for each $1,000 in principal amount surrendered for conversion for the 4.00% convertible notes and $2,392.73414 for the 9.00% convertible notes for conversions occurring prior to August 17, 2011.

 

Other ICG debt, with a fair value of approximately $54.0 million at the acquisition date, consisted mainly of equipment notes and insurance notes payable.

 

The Company recognized net losses of $1.7 million and $2.0 million during the three and nine months ended September 30, 2011, respectively on the early extinguishment of ICG’s debt, including the conversions of the 4.00% and 9.00% convertible notes described above. The remaining amounts outstanding under the convertible notes and other ICG debt is included in “other” in the debt table above.

 

Credit Facilities and Commercial Paper

 

On June 14, 2011, the Company amended and restated its secured credit facility to allow for up to $2.0 billion in borrowings.   Borrowings under this credit facility bear interest at a floating rate based on LIBOR determined by reference to the Company’s leverage ratio, as calculated in accordance with the credit agreement.  The credit facility has a five-year term that expires on June 14, 2016 and is secured by substantially all of the Company’s assets as well as its ownership interests in substantially all of its subsidiaries, excluding its ownership interests in Arch Western and its subsidiaries. Commitment fees of 0.50% per annum are payable on the average unused daily balance of the revolving credit facility. The Company paid and deferred $20.7 million in financing fees related to the amendment of this agreement.  Financial covenant requirements may restrict the amount of unused capacity available to the Company for borrowings and letters of credit.

 

On June 14, 2011, the Company terminated its commercial paper placement program and the supporting credit facility.

 

Availability

 

As of September 30, 2011 the Company had $300.0 million of borrowings outstanding under the amended and restated secured credit facility and $40.0 million of borrowings outstanding under its accounts receivable securitization program.  As of September 30, 2011, the Company had availability of approximately $1.0 billion under all lines of credit, as limited by customary financial covenants that may limit the Company’s total debt based on defined earnings measurements.   The Company also had outstanding letters of credit of $141.0 million as of September 30, 2011.

 

6. Acquired Sales Contracts

 

Coal supply agreements (sales contracts) acquired in a business combination are capitalized at their fair value and amortized over the tons of coal shipped during the term of the contract. The fair value of a sales contract is determined by discounting the cash flows attributable to the difference between the contract price and the prevailing forward prices for the tons under contract at the date of acquisition. Below are the acquired sales contracts reflected in the condensed consolidated balance sheets:

 

 

 

September 30, 2011

 

December 31, 2010

 

 

 

Assets

 

Liabilities

 

Assets

 

Liabilities

 

 

 

(In thousands)

 

(In thousands)

 

Acquired fair value

 

$

145,213

 

$

170,341

 

$

114,453

 

$

40,654

 

Accumulated amortization

 

(105,845

)

(42,877

)

(82,376

)

(14,613

)

Total

 

$

39,368

 

$

127,464

 

$

32,077

 

$

26,041

 

Net total

 

 

 

$

88,096

 

$

6,036

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet classification:

 

 

 

 

 

 

 

 

 

Other current

 

$

23,474

 

$

58,049

 

$

25,063

 

$

5,615

 

Other noncurrent

 

$

15,894

 

$

69,415

 

$

7,014

 

$

20,426

 

 

Above-market contracts with a fair value of $30.8 million and below-market contracts with a fair value of $129.7 million were acquired from ICG. Of these amounts, $13.7 million and $52.3 million were classified as current assets and current liabilities, respectively, at September 30, 2011.  See Note 3, “Business Combinations” for discussion of purchase price adjustments.

 

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Table of Contents

 

The Company anticipates amortization income of all acquired sales contracts, based upon the fair value assigned to acquired ICG sales contracts and expected shipments in the next five years, to be approximately $29 million for the remainder of 2011, $20 million in 2012, $7 million in 2013, $8 million in 2014, $13 million in 2015 and $8 million in 2016.

 

7. Equity Investments and Membership Interests in Joint Ventures

 

The Company accounts for its investments and membership interests in joint ventures under the equity method of accounting if the Company has the ability to exercise significant influence, but not control, over the entity. Below are the equity method investments reflected in the condensed consolidated balance sheets:

 

 

 

Knight Hawk

 

DKRW

 

DTA

 

Tenaska

 

Millennium

 

Tongue River

 

Total

 

 

 

(In thousands)

 

Balance at December 31, 2010

 

$

131,250

 

$

21,961

 

$

14,472

 

$

9,768

 

$

 

$

 

$

177,451

 

Investments in affiliates

 

 

 

 

5,500

 

25,000

 

12,989

 

43,489

 

Advances to (distributions from) affiliates, net

 

(11,450

)

 

4,394

 

 

1,900

 

 

(5,156

)

Equity in comprehensive income (loss)

 

15,807

 

(1,631

)

(3,713

)

(2

)

(1,561

)

 

8,900

 

Balance at September 30, 2011

 

$

135,607

 

$

20,330

 

$

15,153

 

$

15,266

 

$

25,339

 

$

12,989

 

$

224,684

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Notes receivable from investees:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2010

 

$

1,700

 

$

18,100

 

$

 

$

4,100

 

$

 

$

 

$

23,900

 

Balance at September 30, 2011

 

 

28,417

 

 

4,777

 

 

 

33,194

 

 

In July 2011, the Company purchased a 33% membership interest in the Tongue River Holding Company, LLC (“Tongue River”) joint venture.  Tongue River will construct and develop a railway line near Miles City, Montana and the Company’s Otter Creek reserves.  The Company has the right, upon completion of the railway line or under other prescribed circumstances, to require the other investors to purchase all of the Company’s units in the venture at an amount equal to the capital contributions made by the Company at that time, less any distributions received.

 

In January 2011, the Company purchased a 38% ownership interest in Millennium Bulk Terminals-Longview, LLC (“Millennium”), the owner of a brownfield bulk commodity terminal on the Columbia River near Longview, Washington, for $25.0 million, plus additional future consideration upon the completion of certain project milestones. Millennium continues to work on obtaining the required approvals and necessary permits to complete dredging and other upgrades to enable coal, alumina and cementitious material shipments through the terminal. The Company will control 38% of the terminal’s throughput and storage capacity, in order to facilitate export shipments of coal off the west coast of the United States.

 

The Company may be required to make future contingent payments of up to $70.9 million related to development financing for certain of its equity investees. The Company’s obligation to make these payments, as well as the timing of any payments required, is contingent upon a number of factors, including project development progress, receipt of permits and construction financing.

 

8. Derivatives

 

The Company generally utilizes derivative financial instruments to manage exposures to commodity prices. Additionally, the Company may hold certain coal derivative financial instruments for trading purposes.

 

All derivative financial instruments are recognized in the balance sheet at fair value. In a fair value hedge, the Company hedges the risk of changes in the fair value of a firm commitment, typically a fixed-price coal sales contract. Changes in both the hedged firm commitment and the fair value of a derivative used as a hedge instrument in a fair value hedge are recorded in earnings. In a cash flow hedge, the Company hedges the risk of changes in future cash flows related to a forecasted purchase or sale. Changes in the fair value of the derivative instrument used as a hedge instrument in a cash flow hedge are recorded in other comprehensive income. Amounts in other comprehensive income are reclassified to earnings when the hedged transaction affects earnings and are classified in a manner consistent with the transaction being hedged. The Company formally documents the relationships between hedging instruments and the respective hedged items, as well as its risk management objectives for hedge transactions.

 

The Company evaluates the effectiveness of its hedging relationships both at the hedge’s inception and on an ongoing basis. Any ineffective portion of the change in fair value of a derivative instrument used as a hedge instrument in a fair value or cash flow hedge is recognized immediately in earnings. The ineffective portion is based on the extent to which exact offset is not achieved between the change in fair value of the hedge instrument and the cumulative change in expected future cash flows on the hedged transaction from inception of the hedge in a cash flow hedge or the change in the fair value of the firm commitment in a fair value hedge.

 

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Table of Contents

 

Diesel fuel price risk management

 

The Company is exposed to price risk with respect to diesel fuel purchased for use in its operations. The Company anticipates purchasing approximately 90 to 100 million gallons of diesel fuel for use in its operations during 2012. To reduce the volatility in the price of diesel fuel for its operations, the Company uses forward physical diesel purchase contracts, as well as heating oil swaps and purchased call options. At September 30, 2011, the Company had protected the price of approximately 70% of its expected purchases for the remainder of fiscal year 2011 and 55% for fiscal year 2012.

 

At September 30, 2011, the Company held heating oil swaps and purchased call options for approximately 68 million gallons for the purpose of managing the price risk associated with future diesel purchases. Since the changes in the price of heating oil highly correlate to changes in the price of the hedged diesel fuel purchases, the heating oil swaps and purchased call options qualify for cash flow hedge accounting.

 

The Company also purchased call options to hedge the fuel surcharges on its barge and rail shipments that cover increases in diesel fuel prices.  These positions reduce the Company’s risk of cash flow fluctuations related to these surcharges but the positions are not accounted for as hedges.  At September 30, 2011, Company held purchased call options for approximately 19.1 million gallons for the purpose of managing the fluctuations in cash flows associated with fuel surcharges on future shipments.

 

Coal risk management positions

 

The Company may sell or purchase forward contracts, swaps and options in the over-the-counter coal market in order to manage its exposure to coal prices. The Company has exposure to the risk of fluctuating coal prices related to forecasted sales or purchases of coal or to the risk of changes in the fair value of a fixed price physical sales contract. Certain derivative contracts may be designated as hedges of these risks.

 

At September 30, 2011, the Company held derivatives for risk management purposes totaling 0.5 million tons of coal sales and 0.5 million tons of coal purchases that are expected to settle during the remainder of 2011, 1.7 million tons of coal sales and 0.2 million tons of coal purchases that are expected to settle in 2012, 0.7 million tons of coal sales that are expected to settle in 2013, 1.4 million tons of coal sales that are expected to settle in 2014 and 0.7 million tons of coal sales that are expected to settle in 2015.

 

Coal trading positions

 

The Company may sell or purchase forward contracts, swaps and options in the over-the-counter coal market for trading purposes. The Company is exposed to the risk of changes in coal prices on the value of its coal trading portfolio. The estimated future realization of the value of the trading portfolio is $2.4 million of gains for the remainder of 2011, $0.9 million of losses in 2012 and $1.0 million of losses in 2013.

 

Tabular derivatives disclosures

 

The Company’s contracts with certain of its counterparties to allow for the settlement of contracts in an asset position with contracts in a liability position in the event of default or termination. Such netting arrangements reduce the Company’s credit exposure related to these counterparties. For classification purposes, the Company records the net fair value of all the positions with a given counterparty as a net asset or liability in the condensed consolidated balance sheets. The amounts shown in the table below represent the fair value position of individual contracts, regardless of the net position presented in the accompanying condensed consolidated balance sheets. The fair value and location of derivatives reflected in the accompanying condensed consolidated balance sheets are as follows:

 

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Table of Contents

 

Fair Value of Derivatives

(in thousands)

 

 

 

September 30, 2011

 

 

 

December 31, 2010

 

 

 

 

 

Asset
Derivative

 

Liability
Derivative

 

 

 

Asset
Derivative

 

Liability
Derivative

 

 

 

Derivatives Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Heating oil — diesel purchases

 

$

9,352

 

$

 

 

 

$

13,475

 

$

 

 

 

Coal

 

2,708

 

(1,270

)

 

 

2,009

 

(2,350

)

 

 

Total

 

12,060

 

(1,270

)

 

 

15,484

 

(2,350

)

 

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Heating oil — fuel surcharges

 

2,202

 

 

 

 

 

 

 

 

Coal — held for trading purposes

 

10,862

 

(10,365

)

 

 

34,445

 

(24,087

)

 

 

Coal

 

1,812

 

(6,976

)

 

 

1,139

 

(912

)

 

 

Total

 

14,876

 

(17,341

)

 

 

35,584

 

(24,999

)

 

 

Total derivatives

 

26,936

 

(18,611

)

 

 

51,068

 

(27,349

)

 

 

Effect of counterparty netting

 

(12,787

)

12,787

 

 

 

(22,402

)

22,402

 

 

 

Net derivatives as classified in the balance sheets

 

$

14,149

 

$

(5,824

)

$

8,325

 

$

28,666

 

$

(4,947

)

$

23,719

 

 

Net derivatives as reflected on the balance sheets

 

 

 

 

 

September 30,
 2011

 

December 31,
 2010

 

Heating oil

 

Other current assets

 

$

11,554

 

$

13,475

 

Coal

 

Coal derivative assets

 

2,595

 

15,191

 

 

 

Coal derivative liabilities

 

(5,824

)

(4,947

)

 

 

 

 

$

8,325

 

$

23,719

 

 

The Company had a current asset for the right to reclaim cash collateral of $10.7 million and $10.3 million at September 30, 2011 and December 31, 2010, respectively. These amounts are not included with the derivatives presented in the table above and are included in “other current assets” in the accompanying condensed consolidated balance sheets.

 

The effects of derivatives on measures of financial performance are as follows:

 

Three Months Ended September 30

(in thousands)

 

Derivatives used in
Cash Flow Hedging

 

Gain (Loss)
Recognized in OCI
(Effective Portion)

 

Gains (Losses)
Reclassified from
OCI into Income
(Effective Portion)

 

Gain (Loss)
Recognized in
Income (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)

 

Relationships

 

2011

 

2010

 

2011

 

2010

 

2011

 

2010

 

Heating oil — diesel purchases

 

$

(6,386

)

$

3,052

 

$

5,122

(2)

$

93

(2)

$

 

$

 

Coal sales

 

1,820

 

1,500

 

466

(1)

(226

)(1)

 

 

Coal purchases

 

(1,274

)

(2,535

)

(2)

(866

)(2)

 

 

Totals

 

$

(5,840

)

$

2,017

 

$

5,588

 

$

(999

)

$

 

$

 

 

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Table of Contents

 

Derivatives Not Designated as

 

Gain (Loss)

 

Hedging Instruments

 

2011

 

2010

 

Coal — unrealized

 

$

(6,131

)(3)

$

(993

)(3)

Coal — realized

 

$

166

(4)

$

1,079

(4)

Heating oil — fuel surcharges — unrealized

 

$

(2,501

)(4)

$

(4)

 


Location in Statement of Income:

(1)   Revenues

(2)   Cost of sales

(3)   Change in fair value of coal derivatives and coal trading activities, net

(4)   Other operating income, net

 

During the three months ended September 30, 2011 and 2010, the Company recognized net unrealized and realized losses of $2.2 million and $0.8 million, respectively, related to its trading portfolio (including derivative and non-derivative contracts). These balances are included in the caption “Change in fair value of coal derivatives and coal trading activities, net” in the accompanying condensed consolidated statements of income and are not included in the previous table.

 

Nine Months Ended September 30

(in thousands)

 

Derivatives used in
Cash Flow Hedging

 

Gain (Loss)
Recognized in OCI
(Effective Portion)

 

Gains (Losses)
Reclassified from
OCI into Income
(Effective Portion)

 

Gain (Loss)
Recognized in
Income (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)

 

Relationships

 

2011

 

2010

 

2011

 

2010

 

2011

 

2010

 

Heating oil — diesel purchases

 

$

1,535

 

$

(5,508

)

$

14,946

(2)

$

(211

)(2)

$

 

$

 

Coal sales

 

4,570

 

(6,138

)

790

(1)

(1,556

)(1)

 

 

Coal purchases

 

(2,053

)

5,534

 

(2)

(1,202

)(2)

 

 

Totals

 

$

4,052

 

$

(6,112

)

$

15,736

 

$

(2,969

)

$

 

$

 

 

Derivatives Not Designated as

 

Gain (Loss)

 

Hedging Instruments

 

2011

 

2010

 

Coal — unrealized

 

$

(7,550

)(3)

$

(9,381

)(3)

Coal — realized

 

$

313

(4)

$

3,931

(4)

Heating oil — fuel surcharges — unrealized

 

$

(2,501

)(4)

$

(4)

 


Location in Statement of Income:

(1)   Revenues

(2)   Cost of sales

(3)   Change in fair value of coal derivatives and coal trading activities, net

(4)   Other operating income, net

 

During the nine months ended September 30, 2011 and 2010, the Company recognized net unrealized and realized losses of $1.7 million and $2.9 million, respectively, related to its trading portfolio (including derivative and non-derivative contracts). These balances are included in the caption “Change in fair value of coal derivatives and coal trading activities, net” in the accompanying condensed consolidated statements of income and are not included in the previous table.

 

During the next twelve months, based on fair values at September 30, 2011, gains on derivative contracts designated as hedge instruments in cash flow hedges of approximately $9.3 million are expected to be reclassified from other comprehensive income into earnings.

 

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Table of Contents

 

9. Inventories

 

Inventories consist of the following:

 

 

 

September 30,
 2011

 

December 31,
 2010

 

 

 

(In thousands)

 

Coal

 

$

180,988

 

$

115,647

 

Repair parts and supplies, net of allowance

 

165,343

 

119,969

 

 

 

$

346,331

 

$

235,616

 

 

The repair parts and supplies are stated net of an allowance for slow-moving and obsolete inventories of $13.4 million at September 30, 2011, and $12.7 million at December 31, 2010.

 

10. Fair Value Measurements

 

The hierarchy of fair value measurements prioritizes the inputs to valuation techniques used to measure fair value. The levels of the hierarchy, as defined below, give the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

 

·     Level 1 is defined as observable inputs such as quoted prices in active markets for identical assets. Level 1 assets include available-for-sale equity securities and coal futures that are submitted for clearing on the New York Mercantile Exchange.

 

·     Level 2 is defined as observable inputs other than Level 1 prices. These include quoted prices for similar assets or liabilities in an active market, quoted prices for identical assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company’s level 2 assets and liabilities include commodity contracts (coal and heating oil) with fair values derived from quoted prices in over-the-counter markets or from prices received from direct broker quotes.

 

·     Level 3 is defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. These include the Company’s commodity option contracts (primarily coal and heating oil) valued using modeling techniques, such as Black-Scholes, that require the use of inputs, particularly volatility, that are rarely observable.

 

The table below sets forth, by level, the Company’s financial assets and liabilities that are recorded at fair value in the accompanying condensed consolidated balance sheet:

 

 

 

Fair Value at September 30, 2011

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

 

(In thousands)

 

Assets:

 

 

 

 

 

 

 

 

 

Investments in equity securities

 

$

5,351

 

$

5,351

 

$

 

$

 

Derivatives

 

14,149

 

1,018

 

2,695

 

10,436

 

Total assets

 

$

19,500

 

$

6,369

 

$

2,695

 

$

10,436

 

Liabilities:

 

 

 

 

 

 

 

 

 

Derivatives

 

$

5,824

 

$

 

$

(415

)

$

6,239

 

 

The Company’s contracts with certain of its counterparties allow for the settlement of contracts in an asset position with contracts in a liability position in the event of default or termination. For classification purposes, the Company records the net fair value of all the positions with these counterparties as a net asset or liability. Each level in the table above displays the underlying contracts according to their classification in the accompanying condensed consolidated balance sheet, based on this counterparty netting.

 

The following table summarizes the change in the fair values of financial instruments categorized as level 3.

 

 

 

Three Months Ended
September 30, 2011

 

Nine Months Ended
September 30, 2011

 

 

 

(In thousands)

 

Balance, beginning of period

 

$

10,474

 

$

9,183

 

Realized and unrealized losses recognized in earnings, net

 

(8,016

)

(15,140

)

Realized and unrealized losses recognized in other comprehensive income, net

 

(6,702

)

(3,227

)

Purchases

 

9,935

 

20,407

 

Issuances

 

 

(2,160

)

Settlements

 

(1,494

)

(4,866

)

Balance, end of period

 

$

4,197

 

$

4,197

 

 

Net unrealized losses during the three and nine month periods ended September 30, 2011 related to level 3 financial instruments held on September 30, 2011 were $11.7 million and $14.7 million, respectively.

 

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Table of Contents

 

Fair Value of Long-Term Debt

 

At September 30, 2011 and December 31, 2010, the fair value of the Company’s senior notes and other long-term debt, including amounts classified as current, was $3.9 billion and $1.7 billion, respectively. Fair values are based upon observed prices in an active market when available or from valuation models using market information.

 

11. Stock-Based Compensation and Other Incentive Plans

 

During the nine months ended September 30, 2011, the Company granted options to purchase approximately 0.7 million shares of common stock with a weighted average exercise price of $32.18 per share and a weighted average grant-date fair value of $14.18 per share. The options’ fair value was determined using the Black-Scholes option pricing model, using a weighted average risk-free rate of 1.92%, a weighted average dividend yield of 1.25% and a weighted average volatility of 57.43%. The options’ expected life is 4.5 years and the options vest ratably over three years. The options provide for the continuation of vesting after retirement for recipients that meet certain criteria. The expense for these options will be recognized through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn all or part of the award. The Company also granted 130,950 shares of restricted stock during the nine months ended September 30, 2011 at a weighted average grant-date fair value of $31.30 per share. The restricted stock vests after three years.

 

The Company has a long-term incentive program (“LTI plan”) that allows for the award of performance units. The total number of units earned by a participant is based on financial and operational performance measures, and may be paid out in cash or in shares of the Company’s common stock. The Company recognizes compensation expense over the three-year term of the grant. Amounts unpaid for all grants under the LTI plan totaled $10.0 million and $6.4 million as of September 30, 2011 and December 31, 2010, respectively.

 

The Company recognized compensation expense from all stock-based and LTI plans of $3.4 million for the three months ended September 30, 2011 and 2010, respectively. The Company recognized compensation expense from all stock-based and LTI plans of $12.6 million and $12.3 million for the nine months ended September 30, 2011 and 2010, respectively. These expenses are primarily included in selling, general and administrative expenses in the accompanying condensed consolidated statements of income.

 

12. Workers’ Compensation Expense

 

The following table details the components of workers’ compensation expense:

 

 

 

Three Months Ended September 30

 

Nine Months Ended September 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(In thousands)

 

(In thousands)

 

Self-insured occupational disease benefits:

 

 

 

 

 

 

 

 

 

Service cost

 

$

807

 

$

182

 

$

1,246

 

$

545

 

Interest cost

 

619

 

169

 

1,177

 

507

 

Net amortization

 

(109

)

(465

)

(370

)

(1,395

)

Total occupational disease

 

1,317

 

(114

)

2,053

 

(343

)

Traumatic injury claims and assessments

 

5,207

 

2,642

 

10,856

 

6,562

 

Total workers’ compensation expense

 

$

6,524

 

$

2,528

 

$

12,909

 

$

6,219

 

 

13. Employee Benefit Plans

 

The following table details the components of pension benefit costs:

 

 

 

Three Months Ended September 30

 

Nine Months Ended September 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(In thousands)

 

(In thousands)

 

Service cost

 

$

4,122

 

$

3,967

 

$

12,367

 

$

11,902

 

Interest cost

 

4,063

 

3,955

 

12,190

 

11,866

 

Expected return on plan assets

 

(5,453

)

(4,848

)

(16,359

)

(14,544

)

Amortization of prior service cost (credit)

 

(47

)

44

 

(142

)

130

 

Amortization of other actuarial losses

 

2,187

 

1,782

 

6,561

 

5,348

 

Net benefit cost

 

$

4,872

 

$

4,900

 

$

14,617

 

$

14,702

 

 

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The following table details the components of other postretirement benefit costs (credits):

 

 

 

Three Months Ended September 30

 

Nine Months Ended September 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(In thousands)

 

(In thousands)

 

Service cost

 

$

1,493

 

$

378

 

$

2,416

 

$

1,132

 

Interest cost

 

1,125

 

520

 

2,152

 

1,562

 

Amortization of prior service credits

 

(636

)

(591

)

(1,773

)

(1,773

)

Amortization of other actuarial gains

 

(775

)

(729

)

(2,325

)

(2,188

)

Net benefit cost (credit)

 

$

1,207

 

$

(422

)

$

470

 

$

(1,267

)

 

14. Comprehensive Income

 

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income items are transactions recorded in stockholders’ equity during the year, excluding net income and transactions with stockholders.

 

The following table presents the components of comprehensive income:

 

 

 

Three Months Ended September 30

 

Nine Months Ended September 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(In thousands)

 

(In thousands)

 

Net income attributable to Arch Coal, Inc.

 

$

19,056

 

$

46,678

 

$

82,128

 

$

111,038

 

Other comprehensive income, net of income taxes:

 

 

 

 

 

 

 

 

 

Pension, postretirement and other post-employment benefits, reclassifications into net income

 

388

 

28

 

1,254

 

84

 

Unrealized gains (losses) on available-for-sale securities

 

(569

)

738

 

(1,256

)

(178

)

Unrealized gains and losses on derivatives, net of reclassifications into net income:

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) on derivatives

 

(3,671

)

1,200

 

2,703

 

(3,889

)

Reclassifications of (gains) losses into net income

 

(3,575

)

639

 

(10,059

)

1,856

 

Total comprehensive income

 

$

11,629

 

$

49,283

 

$

74,770

 

$

108,911

 

 

15. Earnings per Common Share

 

The following table provides the basis for earnings per share calculations by reconciling basic and diluted weighted average shares outstanding:

 

 

 

Three Months Ended September 30

 

Nine Months Ended September 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(In thousands)

 

(In thousands)

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

211,337

 

162,391

 

182,898

 

162,384

 

Effect of common stock equivalents under incentive plans

 

637

 

783

 

952

 

744

 

Diluted weighted average shares outstanding

 

211,974

 

163,174

 

183,850

 

163,128

 

 

The effect of options to purchase 3.0 million and 3.4 million shares of common stock were excluded from the calculation of diluted weighted average shares outstanding for the three month periods ended September 30, 2011 and 2010, respectively, because the exercise price of these options exceeded the average market price of the Company’s common stock for these periods.  The effect of options to purchase 2.1 million and 2.7 million shares of common stock were excluded from the calculation of diluted weighted average shares outstanding for the nine month periods ended September 30, 2011 and 2010, respectively, because the exercise price of these options exceeded the average market price of the Company’s common stock for these periods.

 

16. Guarantees

 

The Company has agreed to continue to provide surety bonds and letters of credit for the reclamation and retiree healthcare obligations of Magnum Coal Company (“Magnum”) related to the properties the Company sold to Magnum on December 31, 2005. Patriot Coal Corporation (“Patriot”) acquired Magnum in July 2008. The purchase agreement requires Magnum to reimburse the Company for costs related to the surety bonds and letters of credit and to use commercially reasonable efforts to replace the obligations.  If the surety bonds and letters of credit related to the reclamation obligations are not replaced by Magnum within a specified period of time, Magnum must post a letter of credit in favor of the Company in the amounts of the reclamation obligations. As of September 30, 2011, Patriot has replaced $48.9 million of the surety bonds and has posted letters of credit of $32.7 million in the Company’s favor.  At September 30, 2011, the Company had $38.5 million of surety bonds remaining related to properties sold to

 

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Magnum. The surety bonding amounts are mandated by the state and are not directly related to the estimated cost to reclaim the properties.

 

Magnum also acquired certain coal supply contracts with customers who have not consented to the contracts’ assignment from the Company to Magnum. The Company has committed to purchase coal from Magnum to sell to those customers at the same price it is charging the customers for the sale. In addition, certain contracts were assigned to Magnum, but the Company has guaranteed Magnum’s performance under the contracts. The longest of the coal supply contracts extends to the year 2017. If Magnum is unable to supply the coal for these coal sales contracts then the Company would be required to purchase coal on the open market or supply contracts from its existing operations. At market prices effective at September 30, 2011, the cost of purchasing 10.3 million tons of coal to supply the contracts that have not been assigned over their duration would exceed the sales price under the contracts by approximately $264.3 million, and the cost of purchasing 0.9 million tons of coal to supply the assigned and guaranteed contracts over their duration would exceed the sales price under the contracts by approximately $19.5 million. As the Company does not believe that it is probable that it would have to purchase replacement coal, no losses have been recorded in the consolidated financial statements as of September 30, 2011. However, if the Company would have to perform under these guarantees, it could potentially have a material adverse effect on the business, results of operations and financial condition of the Company.

 

In connection with the Company’s acquisition of the coal operations of Atlantic Richfield Company (ARCO) and the simultaneous combination of the acquired ARCO operations and the Company’s Wyoming operations into the Arch Western joint venture, the Company agreed to indemnify the other member of Arch Western against certain tax liabilities in the event that such liabilities arise prior to June 1, 2013 as a result of certain actions taken, 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. If the Company were to become liable, the maximum amount of potential future tax payments is $22.3 million at September 30, 2011, which is not recorded as a liability in the Company’s condensed consolidated financial statements. Since the indemnification is dependent upon the initiation of activities within the Company’s control and the Company does not intend to initiate such activities, it is remote that the Company will become liable for any obligation related to this indemnification. However, if such indemnification obligation were to arise, it could potentially have a material adverse effect on the business, results of operations and financial condition of the Company.

 

17. Contingencies

 

On June 15, 2011, the Company acquired ICG and its subsidiaries.  The following matters relate to certain claims and legal actions involving ICG and/or its subsidiaries.

 

Allegheny Energy Supply (“Allegheny”), the sole customer of coal produced at the Company’s subsidiary Wolf Run Mining Company’s (“Wolf Run”) Sycamore No. 2 mine, filed a lawsuit against Wolf Run, Hunter Ridge Holdings, Inc. (“Hunter Ridge”), and ICG in state court in Allegheny County, Pennsylvania on December 28, 2006, and amended its complaint on April 23, 2007. Allegheny claimed that Wolf Run breached a coal supply contract when it declared force majeure under the contract upon idling the Sycamore No. 2 mine in the third quarter of 2006, and that Wolf Run continued to breach the contract by failing to ship in volumes referenced in the contract. The Sycamore No. 2 mine was idled after encountering adverse geologic conditions and abandoned gas wells that were previously unidentified and unmapped. After extensive searching for gas wells and rehabilitation of the mine, it was re-opened in 2007, but with notice to Allegheny that it would necessarily operate at reduced volumes in order to safely and effectively avoid the many gas wells within the reserve. The amended complaint also alleged that the production stoppages constitute a breach of the guarantee agreement by Hunter Ridge and breach of certain representations made upon entering into the contract in early 2005. Allegheny voluntarily dropped the breach of representation claims later. Allegheny claimed that it would incur costs in excess of $100 million to purchase replacement coal over the life of the contract. ICG, Wolf Run and Hunter Ridge answered the amended complaint on August 13, 2007, disputing all of the remaining claims.

 

On November 3, 2008, ICG, Wolf Run and Hunter Ridge filed an amended answer and counterclaim against the plaintiffs seeking to void the coal supply agreement due to, among other things, fraudulent inducement and conspiracy. On September 23, 2009, Allegheny filed a second amended complaint alleging several alternative theories of liability in its effort to extend contractual liability to ICG, which was not a party to the original contract and did not exist at the time Wolf Run and Allegheny entered into the contract.  No new substantive claims were asserted.  ICG answered the second amended complaint on October 13, 2009, denying all of the new claims. ICG’s counterclaim was dismissed on motion for summary judgment entered on May 11, 2010.  Allegheny’s claims

against ICG were also dismissed by summary judgment, but the claims against Wolf Run and Hunter Ridge were not. The court conducted a non-jury trial of this matter beginning on January 10, 2011 and concluding on February 1, 2011. At the trial, Allegheny presented its evidence for breach of contract and claimed that it is entitled to past and future damages in the aggregate of between $228.0 million and $377.0 million. Wolf Run and Hunter Ridge presented their defense of the claims, including evidence with respect to the existence of force majeure conditions and excuse under the contract and applicable law. Wolf Run and Hunter Ridge presented evidence that Allegheny’s damages calculations were significantly inflated because it did not seek to determine damages as of the time of the breach and in some instances artificially assumed future non-delivery or did not take into account the apparent requirement to

 

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supply coal in the future. On May 2, 2011, the trial court entered a Memorandum and Verdict determining that Wolf Run had breached the coal supply contract and that the performance shortfall was not excused by force majeure. ICG and Allegheny filed post-verdict motions in the trial court and on August 23, 2011, the court denied the parties’ motions.  The court entered a final judgment on August 25, 2011, in the amount of $104.1 million, which included pre-judgment interest.  The parties appealed the lower court’s decision to the Superior Court of Pennsylvania.  Wolf Run and Hunter Ridge have filed an appeal bond in the amount of $124.9 million.  Briefing is scheduled to begin on October 24, 2011, to be completed in early 2012.

 

As of September 30, 2011, the Company has accrued $106.7 million for this lawsuit, including $1.8 million of interest recognized post-acquisition.  The ultimate resolution of this matter could result in an outcome which may be materially different than what the Company has accrued.

 

In addition, 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 pending claims, other than as noted above, will not have a material adverse effect on the consolidated financial condition, results of operations or liquidity of the Company.

 

18. Segment Information

 

The Company has three reportable business segments, which are based on the major coal producing basins in which the Company operates. Each of these reportable business segments includes a number of mine complexes. The Company manages its coal sales by coal basin, not by individual mine complex. Geology, coal transportation routes to customers, regulatory environments and coal quality are characteristic to a basin. Accordingly, market and contract pricing have developed by coal basin. Mine operations are evaluated based on their per-ton operating costs (defined as including all mining costs but excluding pass-through transportation expenses), as well as on other non-financial measures, such as safety and environmental performance. The Company’s reportable segments are the Powder River Basin (PRB) segment, with operations in Wyoming; the Western Bituminous (WBIT) segment, with operations in Utah, Colorado and southern Wyoming; the Appalachia (APP) segment, with operations in West Virginia, Kentucky, Maryland and Virginia.  The Appalachia segment includes the acquired ICG operations in Appalachia, as well as the Company’s previous Central Appalachia segment. The “Other” operating segment represents primarily the Company’s Illinois operations and ADDCAR subsidiary, which manufactures and sells its patented highwall mining system.

 

Operating segment results for the three and nine months ended September 30, 2011 and 2010 are presented below. Results for the reportable segments include all direct costs of mining, including all depreciation, depletion and amortization related to the mining operations, even if the assets are not recorded at the operating segment level. See discussion of segment assets below. Corporate, Other and Eliminations includes the change in fair value of coal derivatives and coal trading activities, net; corporate overhead; land management; other support functions; and the elimination of intercompany transactions.

 

The asset amounts below represent an allocation of assets used in the segments’ cash-generating activities. The amounts in Corporate, Other and Eliminations represent primarily corporate assets (cash, receivables, investments, plant, property and equipment) as well as unassigned coal reserves, above-market acquired sales contracts and other unassigned assets.

 

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Table of Contents

 

 

 

PRB

 

APP

 

WBIT

 

Other
Operating
Segments

 

Corporate,
Other and
Eliminations

 

Consolidated

 

 

 

(In thousands)

 

Three months ended September 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

394,012

 

$

611,403

 

$

168,795

 

$

24,463

 

$

 

$

1,198,673

 

Income (loss) from operations

 

38,630

 

77,511

 

24,653

 

(1,713

)

(46,815

)

92,266

 

Depreciation, depletion and amortization

 

42,676

 

59,576

 

19,125

 

3,781

 

(2,132

)

123,026

 

Amortization of acquired sales contracts, net

 

3,802

 

(16,022

)

 

34

 

 

(12,186

)

Capital expenditures

 

20,937

 

62,121

 

16,111

 

4,705

 

4,300

 

108,174

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

440,439

 

$

296,227

 

$

138,039

 

$

 

$

 

$

874,705

 

Income from operations

 

51,787

 

55,664

 

14,816

 

 

(23,920

)

98,347

 

Depreciation, depletion and amortization

 

49,005

 

24,435

 

18,940

 

 

477

 

92,857

 

Amortization of acquired sales contracts, net

 

10,038

 

 

 

 

 

10,038

 

Capital expenditures

 

8,164

 

16,910

 

20,703

 

 

3,848

 

49,625

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months ended September 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

1,178,537

 

$

1,336,581

 

$

513,388

 

$

28,633

 

$

 

$

3,057,139

 

Income (loss) from operations

 

121,119

 

224,561

 

95,218

 

(1,814

)

(147,401

)

291,683

 

Total assets

 

2,240,458

 

5,159,710

 

667,658

 

222,014

 

1,565,421

 

9,855,261

 

Depreciation, depletion and amortization

 

125,532

 

108,904

 

61,753

 

4,386

 

1,171

 

301,746

 

Amortization of acquired sales contracts, net

 

15,349

 

(20,145

)

 

43

 

 

(4,753

)

Capital expenditures

 

39,422

 

108,711

 

38,003

 

9,078

 

20,685

 

215,899

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

1,170,353

 

$

777,619

 

$

402,902

 

$

 

$

 

$

2,350,874

 

Income from operations

 

101,525

 

147,336

 

41,122

 

 

(52,937

)

237,046

 

Total assets

 

2,304,277

 

701,670

 

677,968

 

 

1,150,871

 

4,834,786

 

Depreciation, depletion and amortization

 

138,059

 

72,190

 

57,700

 

 

1,186

 

269,135

 

Amortization of acquired sales contracts, net

 

26,005

 

 

 

 

 

26,005

 

Capital expenditures

 

12,614

 

41,519

 

54,507

 

 

112,943

 

221,583

 

 

A reconciliation of segment income from operations to consolidated income before income taxes follows:

 

 

 

Three Months Ended September 30

 

Nine Months Ended September 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

(In thousands)

 

(In thousands)

 

Income from operations

 

$

92,266

 

$

98,347

 

$

291,683

 

$

237,046

 

Interest expense

 

(77,694

)

(37,698

)

(154,523

)

(107,906

)

Interest income

 

840

 

927

 

2,341

 

1,888

 

Bridge financing costs related to ICG

 

 

 

(49,490

)

 

Net loss resulting from early retirement of debt

 

(1,708

)

(6,776

)

(1,958

)

(6,776

)

Income before income taxes

 

$

13,704

 

$

54,800

 

$

88,053

 

$

124,252

 

 

19. Supplemental Condensed Consolidating Financial Information

 

Pursuant to the indentures governing Arch Coal, Inc.’s senior notes, certain wholly-owned subsidiaries of the Company have fully and unconditionally guaranteed the senior notes on a joint and several basis. The following tables present unaudited condensed consolidating financial information for (i) the Company, (ii) the issuer of the senior notes, (iii) the guarantors under the senior notes, and (iv) the entities which are not guarantors under the senior notes (Arch Western Resources, LLC and its subsidiaries, Arch Receivable Company, LLC and the Company’s subsidiaries outside the U.S.):

 

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Table of Contents

 

Condensed Consolidating Statements of Income

Three Months Ended September 30, 2011

(unaudited)

 

 

 

 

 

Guarantor

 

Non-Guarantor

 

 

 

 

 

 

 

Parent/Issuer

 

Subsidiaries

 

Subsidiaries

 

Eliminations

 

Consolidated

 

 

 

(In thousands)

 

Revenues

 

$

 

$

651,326

 

$

547,347

 

$

 

$

1,198,673

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs, expenses and other

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

7,442

 

522,636

 

448,680

 

(25,908

)

952,850

 

Depreciation, depletion and amortization

 

718

 

83,775

 

38,533

 

 

123,026

 

Amortization of acquired sales contracts, net

 

 

(15,989

)

3,803

 

 

(12,186

)

Selling, general and administrative expenses

 

20,263

 

5,058

 

9,751

 

(1,796

)

33,276

 

Change in fair value of coal derivatives and coal trading activities, net

 

 

8,360

 

 

 

8,360

 

Acquisition and transition costs related to ICG

 

4,694

 

 

 

 

4,694

 

Other operating (income) expense, net

 

(6,063

)

(30,509

)

5,255

 

27,704

 

(3,613

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

27,054

 

573,331

 

506,022

 

 

1,106,407

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from investment in subsidiaries

 

121,210